AGM 2021

May 13, 2021

Slides

Well, good morning and thank you for joining us today. I'm Ian Davis, Chairman of the Board of Rolls Royce. Our preference would of course have been to welcome you, our shareholders in person to our twenty twenty one AGM, particularly given the constraints we face in 2020. However, with the current restrictions in place on public gatherings and travel, this is simply not possible yet again. We appreciate that the AGM is your opportunity to receive an update on the company and to ask questions of the board. I hope you will see we have endeavored to do what we can to give you an opportunity to engage with us today. I'm joined here in London by our Executive Directors, Warren Ease, Chief Executive and Panos Kokulis, our new Chief Financial Officer. Welcome, Panos. As well as Kevin Smith, our Senior Independent Director and Pam McColles, our Company Secretary. Nick Lough, Chair of our Audit Committee and Paul Adams, our most recent appointment to the Board, have joined remotely to ensure we can maintain the required social distancing here in Kings Place. Since our last AGM, Stephen Daintith, our CFO, informed the Board that he had decided to take up another opportunity. Stephen left in March, I'd like to thank him for all his incredibly hard work and amazing enthusiasm. His successor, Panos Koukoules joined us on May 3 and we are delighted to welcome him to his first AGM. Panos has spent his career at Deloitte, where he advised and assisted a wide range of multinational corporations combining audit, advisory and transaction services. We look forward to benefiting from his experience and expertise. In February, we announced extensions to the terms for both Lewis Booth and Sir Frank Chapman as non executive directors. In light of the COVID-nineteen pandemic, Louis remained as the Chair of the Audit Committee during the year with his intended replacement Nick Lough continuing as a non executive director and member of the Audit Committee. Nick took up his role as Audit Committee Chair in March following the publication of our annual report. Both Lewis and Sir Frank are now standing down having served more than nine years. I'd like to thank both of them for their support over the years and especially their guidance, advice and expertise during this challenging time. Lewis has provided invaluable counsel through his work on the Audit Committee, while Sir Frank has been a tremendous source of advice for our product safety team and a guiding voice as we have developed our sustainability agenda. I am delighted that Dame Angela Strank will succeed Frank as Chair of the Safety, Ethics and Sustainability Committee. Jasmine Stablin is retiring from the Board today, having also completed nine years with us. I would like to thank her too for the insight and tremendous support she has brought to your Board. Finally, I'd like to welcome Paul Adams, who joined the Board in March and sits on the nominations and governance committee, the safety, ethics and sustainability committee and the science and technology committee. Paul has deep experience across aerospace and in engine manufacturing in particular, gained during his more than thirty years of leadership in the aviation industry. His industrial focus will undoubtedly be a great asset to us. Finally, I would like to welcome Paul Adams, who joined the Board in March and sits on the nominations and governance committee, safety, ethics and sustainability committee and the science and technology committee. Paul has deep experience across aerospace and in engine manufacturing in particular, gained during his more than thirty years of leadership in the aviation sector. His industrial focus will undoubtedly be a great asset to us. With the departure of the three today, we acknowledge that we have temporarily fallen behind our board policy on diversity. It is our intention to seek to appoint further directors to replace some of those who are departing and we anticipate that we will appoint another female to the board in the coming months. The impact of COVID-nineteen on Rolls Royce has been stark. I would characterize 2020 as an extraordinary and unprecedented year. The sudden and material effect of measures taken by the governments worldwide to stem the outbreak had a significant impact on the commercial aviation industry, particularly the market for long haul travel and on wider economic and industrial activity. This resulted in a sharp deterioration in the financial performance of our civil aerospace business albeit to a much lesser extent our power systems business. Defense has remained resilient throughout and actually grew during the year. In response, we took decisive and transformative action to fundamentally restructure our operations, materially reduce our cost base and improve our financial position. During the year, we launched the largest restructuring in our recent history, secured further liquidity through a rights issue and the raising of additional debt and launched a significant disposal program. We believe these steps will provide the group with the financial resilience to weather the macroeconomic risks before we return to strong cash generation. They will assist us in creating a more appropriate balance sheet structure as we position the group for the long term to benefit from new technologies focused on sustainable power. The pandemic has affected lives throughout the world and impacted everyone at Rolls Royce. Your board has actively scrutinized the actions being taken to secure the safety and well-being, physical and mental, of our people. Ensuring safety is one of our key values. And in our initial response to the outbreak, we rapidly implemented a number of proactive safety measures in line with local and national guidelines. This enabled us to avoid any significant outbreaks of the virus at our sites. Alongside measures introduced to ensure physical health in the workplace, we have paid particular attention to mental health support. This has been a time of understandable anxiety for many employees, with the impact of the pandemic compounded by our restructuring, the pressures of remote working and for some of our people, a period of time on furlough or similar schemes. The mental well-being of our people remains a significant focus for your Board. Early in the pandemic, a number of cost mitigation measures were implemented to conserve cash and action was taken to bolster our liquidity position, allowing us time to conduct a more detailed review of the Group's capital structure and funding options. During this swift action, your Board decided in April that in light of the uncertain macro outlook, we would not recommend a final shareholder payment for 2019. This was a necessary and prudent decision as the scale of the crisis became apparent. We then confirmed in August that no interim shareholder payment would be made in 2020. I am acutely aware of the importance of these payments to many of you. However, under the terms of some of the loan facilities we now have in place, we are restricted from making payments until after thirty one December twenty twenty two. In May, we launched a fundamental restructuring program to resize the cost base and capital requirements of our civil aerospace business and increase cost efficiency. This vital self help will adjust our business and cost base to the new level of anticipated demand from customers. There remains significant uncertainty about the precise pace of the recovery. So, as a Board, we considered it prudent to prioritize resilience and flexibility. We determined last year that it was in the best interest of shareholders to seek to raise additional capital of approximately £2,000,000,000 through a rights issue, secure additional facilities to take our total debt raise in the year to £5,300,000,000 and deliver a number of potential disposals to raise gross proceeds of at least £2,000,000,000 by early twenty twenty two. I would like to thank shareholders for the overwhelming support we received for the rights issue. It will allow us to continue on our journey to securing a more appropriate balance sheet and deliver disposals in a manner that ensures value for our shareholders. We remain committed to positioning the group for the long term to benefit from new technologies focused on sustainable power. We have sustained R and D investment against these long term growth Due to the limited visibility of the duration and impact of the pandemic, we withdrew our previous guidance for 2020 in April. We subsequently made commitments to investors alongside our fundraising. It is vital that the interests of the executive team are aligned to meeting these commitments. As a result, the Remuneration Committee has decided to replace our previous long term incentive plan and introduce a new policy to be voted on at this meeting. We consulted with our major shareholders on this new policy. It is unique in comparison with schemes that other companies have introduced as a result of the pandemic, but it is designed to meet the specific challenges that Rolls Royce faces. Your Board is very conscious of the difficult environment impacting our people and wider stakeholders, so the policy does not include any cash bonuses. It also removes any risk of the sort of excessive payments which a more traditional long term incentive plan could generate from a share price recovery driven by factors which would be outside of our control. Our markets remain fundamentally attractive and the actions we took in 2020 should enable us to deliver on the clear commitments we have made to investors. Continuing news about vaccine programs being developed and undertaken around the world should give all of us cause for optimism about the future. As countries emerge from the restrictions designed to combat the pandemic and seek to revive our economies, the desire for economic development to be more robustly coupled with reduction in global carbon emissions will only grow stronger. This represents a challenge for Rolls Royce, but also a very significant business opportunity. We are determined to grasp this firmly. We believe that over the longer term, the end markets in which we operate will see growing demand for cleaner and more sustainable power. We are already positioning ourselves to play a crucial role in the world's transition towards a net zero carbon economy. Alongside our own commitment to achieve net zero greenhouse gas emissions in our operations and facilities by 02/1930, Our technology will play a fundamental role in enabling the sectors in which we operate achieve net zero carbon by 02/1950. Finally, all of us on the Board would like to thank everyone in Rolls Royce for their resilience, determination and extraordinary hard work in what have been exceptionally challenging circumstances. With that, I will hand over to Warren, your CEO. Thank you, Ian. As Ian has said, 2020 was an extraordinary and unprecedented year and the impact of COVID-nineteen on the largest part of our business, the civil aerospace was particularly severe. Against this backdrop of adversity, our colleagues made many personal sacrifices. They dug deep to find solutions that help keep our company strong. With airports standing empty, as you can see on the picture, and many flights grounded, we took control of things we could control, and we responded with necessary actions to restructure and protect our business and our people. We swiftly introduced remote working where possible as well as social distancing, enhanced hygiene measures and split shift systems to keep our manufacturing operations going to support those customers remaining active. I'm proud of the response by each and every site, which enabled all our facilities to safely continue production with no significant virus outbreaks. Now it's not just the physical health we focused on, but the mental health and well-being too. We recognized additional health risks from the uncertainty, anxiety and loss experienced by so many in the last year. We've expanded our network of mental health champions and increased the tools available to our people to help them to find support when they need it. The communities in which we all live and work, they're important to us, and we provided practical assistance wherever we could. In The UK, we supported the emergency program to manufacture ventilators. And around the world, our employees volunteered their time and expertise to help their local communities and hospitals. The team pictured on the slide here, for example, have been three d printing face shields. Throughout all this, we've not lost our focus on the future. We've prioritized investment in digital and decarbonization programs, which are central to our long term strategy and provide the power that matters. In 2020, our R squared Data Labs team launched the Emergent Alliance. That's a global community with more than 140 members that uses data analytics to assist economic recovery. We've invested in building a more sustainable future with some great success stories, which I'll share with you later on. Now moving on next slide, Slide seven. 2020 was a challenging year for us financially. Our actions to control cash costs saved over £1,000,000,000 in the year, but the sudden and severe reduction of flying activity still drove a free cash outflow of £4,200,000,000 and an underlying operating loss of £2,000,000,000 To ensure we were well financed, with the help of our shareholders, we raised £7,300,000,000 of additional liquidity. So thank you. In May 2020, we announced the largest restructuring in our recent history with plans to remove over 9,000 roles and consolidate a number of civil aerospace facilities. Of course, we're sorry to lose employees, their colleagues and friends, but these actions were essential to protect the future of our business and expected they are expected to deliver GBP 1,300,000,000.0 in annual cost savings. So we ended 2020 with GBP 1,500,000,000.0 of net debt, and that is expected to increase to around GBP 4,000,000,000 by the 2021. We continue to target a net cash positive position, an investment grade credit rating in the medium term, however. Our plan to achieve this is through organic cash generation as well as the program of disposals we announced to generate at least GBP 2,000,000,000 in proceeds. Our disposal plans are making good progress. We've transferred our Hucknal facility in The UK, where we manufacture aero engine structures to ITP Aero, and we're in discussions regarding the sale of the enlarged ITP Aero business. The news from Norway regarding the sale of Bergen engines was disappointing, but we continue to work with the Norwegian government to proceed with the disposal in due course. We will provide a further update on our disposals as and when that's appropriate. Slide eight shows our performance across the business units. Our largest business unit, Civil Aerospace, made up 41 of the group underlying revenue. Large engine flying hours and large engine deliveries were down 5748% respectively. Business aviation though was more resilient, but it still declined year on year. And as a result, we reported an underlying operating loss of 2,600,000,000 in our Civil Aerospace business compared with a small profit in 2019. The other three business units all achieved positive cash flow generation and profitability. Defense was the only business unit to grow in 2020 with demand unaffected by the pandemic and successful mitigation of the operational supply chain risk that was caused by local and global restrictions. As we look ahead to the future, we remain positive about the underlying demand for our products and services. Now with some travel likely to be displaced by virtual connectivity when the recovery happens, civil aviation will initially be a smaller proportion of the global economy. Historically though, we've seen above GDP growth in civil aviation with increasing level of flying as economies grow, and we expect this trend will be maintained. In power systems, we're closely aligned to growth in industrial, commercial and construction activity, and this is expected to recover more quickly than civil aviation as it's much less dependent on borders being opened. In 2020, we saw good growth in China and resilience in governmental demand. And in the last few months, demand for aftermarket services has increased, and we expect the pace of recovery to accelerate through the remaining months of this year. By 2022, we're targeting revenue back up to 2019 levels. In our defense business, our customers are less sensitive to short term economic trends and demand has remained resilient throughout the pandemic. Global geopolitical tensions and governmental priorities continue to show strong demand for current and future defense programs. The efficacy and pace of vaccine programs is encouraging. However, there does remain a level of uncertainty regarding virus mutations and the pathway therefore to borders reopening. These factors are outside of our control, but we can control our response and we have a range of planning scenarios to help us take the right actions to protect the business during the crisis and position ourselves for recovery. We're targeting group free cash flow to turn positive during the 2021 as our restructuring program delivers the planned savings and engine flying hours recover. We have three clear priorities as we look ahead to the recovery: restore our financial performance, maximize the value from our existing capabilities and deliver the science led innovation in sustainable power that will take us forward in the longer term. Now I'm going to take each one of these in turn. So starting with restoring our performance. Our fundamental restructuring program aims to reduce our fixed cost base, improve productivity and set up the framework that will enable us to recover strongly when the activity levels return. We're targeting annualized pretax savings versus 2019 of more than GBP 1,300,000,000.0 by the 2022, and that's driven by the removal of more than 9,000 roles, mostly from civil aerospace, also from consolidation of our operational footprint and cost discipline across the business. We have made a strong start. In 2020, around 7,000 roles were removed, mostly through our voluntary severance programs, but also as a result of hiring freezes, fewer contractors and some compulsory redundancies. We also began consultations to consolidate 11 sites down to five, with activities being moved to the more productive and cost effective hubs and a reduction in the duplication of work in multiple locations. Over the last decade, we've launched four large engine programs in civil aerospace, which required a period of higher investment. Now as these programs have matured, the spend on them is diminishing. We've tightened our R and D and CapEx plans appropriately across the group, and we're looking to keep our capital expenditure lower in the coming years while maintaining our focus on R and D investment in low carbon technologies. Moving on to the second priority, which is maximizing value from our existing capabilities. We have a long history and a well established base of products and services in civil aviation, power systems and defense. This foundation generates the revenues and profits that drive our returns today, and that enables us to invest in the solutions for the future. If we put the pandemic to one side for a moment, in civil aerospace, we have a significant installed base of large engines and a market leading 55% share of the wide body engines on order, and that supports our long term growth. Our fleet of large engines is less than ten years old on average, and 80% is on the four most utilized wide body aircraft types. In business aviation, we're the market leader with over 7,000 engines in service. Just last week, Dassault revealed it has chosen us to power its new flagship Falcon 10 x aircraft with our latest Pearl business aviation engine, the Pearl 10 x. This will be the first time we've had engines on all three major business jet platforms. In power systems, we have a strong foundation with over a 150,000 engines in service around the world across a wide range of end markets. In particular, we have a fast growing share of the fast growing market in China. And across the world, our shift towards whole system solutions is enhancing our value proposition. In defense, our installed base consists of over 16,000 engines. Our largest customers are the U. S. Department of Defense and the U. K. Ministry of Defense, driving around 5025% of our defense revenues respectively. In The UK, we are a key member of Team Tempest, and the recent government spending review was supportive with increased funding for technology led defense solutions, including a GBP 2,000,000,000 for the Future Combat Air System. In The U. S, we're awaiting an outcome on two large new program opportunities, the B-fifty two engine replacement program that's expected to be determined later this year and the future vertical lift program, which is expected in 2022. Combined, these two prospects have potential lifetime revenues of more than £7,000,000,000 So that leads us on to the third priority, which is investing for our future. Now as shown on Slide 13, we're pivoting our spend towards the opportunities in power systems and defense. This is in part a natural consequence of that growing maturity of the recent civil aerospace engine programs. But alongside that, the shape of our investment is also a reflection of the opportunities across the group, particularly in respect of decarbonization. And if we look at the chart on the right, you can see we're accelerating our spend on net zero power with increased focus on electrical flight, SMRs and alternative power from batteries and hydrogen fuel cells. We have an ambition to become a net zero carbon business by 02/1950. To do this, we're not just looking to eliminate emissions from our own operations by 02/1930, but to invest in the technologies and products that support our customers to do so too. We have a huge opportunity here to make a difference that far exceeds the size of our own footprint. Slide 14 shows some of the programs and investments that we're making today that will enable our markets to achieve sustainable power in the future. We have significant number of low carbon and net zero projects across all our business units, and this is just a little sample of the work we're doing. We intend to publish our pathway to net zero next month, which will set out our strategy and key initiatives in more detail, and we'll do that with a launch event on the June 17 to share our plans. For now, you can see our approach falls into three broad categories. Firstly, it's lowering the carbon footprint of our existing technologies. Now this isn't new. Fuel is a substantial portion of the running cost of our products, and our customers have always been sensitive to the fuel consumption. Next, the next generation of jet engine, the UltraFan, has a 25% emissions reduction compared to the early Trent engines, and that's expected to deliver a double digit saving compared with the newest engines in use today. We're currently putting together a demonstrator engine that will be completed in 2022, and that will be ready for the next new airframe opportunity. How it will take many years to develop zero carbon long haul flight, and that's due to the well known significant challenges, challenges of weight and volume of alternative power sources. Sustainable aviation fuel or SAF's are a possible transition solution for a net zero alternative. Industry certification today only allows a partial SAF mix, but we have successfully test tested our engines to work on a 100% SAF with little change needed to our existing engine architecture. UltraFan has been designed to be 100% SAF compatible from the start. Our hybrid electric solutions further reduce our CO2 impact, and we're embracing hybrid solutions in many different areas across the group. Secondly, our net zero emission programs. In addition to sustainable fuels, we're also looking at hydrogen as a fuel source. In aviation, existing technology can be adapted for hydrogen relatively easily, but there are large challenges for the whole industry more broadly associated with this transition. In Power Systems, the barriers are less problematic, and we're working in partnership on hydrogen powered fuel cells and other carbon neutral energy storage solutions for our microgrid systems. As you probably know, we're very excited by the incremental business opportunity for our Small Modular Reactors or SMRs. These are small nuclear power solutions that could produce a significant amount of carbon neutral power for the grid or they can be used standalone. We believe this could be a big enabler to help advance the transition to SAF's or hydrogen by powering the synthetic production of these fuel sources. We have UK government support for SMRs, and we're targeting first power by 02/1930. Thirdly, we have a collection of programs and technologies to power electric aviation. This is particularly important to transform small and medium distance journeys, and it's an incremental commercial opportunity for us. Earlier this year, we announced our first commercial agreement with Vertical Aerospace to use a Rolls Royce electrical power system in its eVTOL vehicle for short distance journeys. In the commuter and regional space, we have a partnership with the Italian airframe Technan and regional airline Videro to develop the P Volt electric aircraft that could be used in the Norwegian market from 2026. And in the small propeller space, the Spirit of Innovation aircraft, part of the XL program, is on track to set the world record as the fastest electric plane in the next month or so. So to summarize, we faced unprecedented challenges in 2020 with events that were way beyond our control. We acted quickly and decisively putting in place the measures necessary to protect our people and our business. And I'd like to thank our colleagues for the dedication and hard work this year and all our stakeholders for their engagement and support. Looking ahead, we're confident that the significant restructuring actions that we've taken during 2020 will deliver permanent cost reductions, positioning us well for the rebound in international air travel. In business aviation, we're very proud to recently announce that Dassault has chosen us to power their flagship Falcon 10x aircraft. We're committed to our net zero targets and seizing the opportunity of supporting the transition to low carbon, net zero carbon solutions. In the last few months, we've taken significant steps, including successfully testing 100% sustainable aviation fuels in the current generation of engines in Derby, while our spirit of innovation, all electric aircraft, will take to the air within weeks. I will now hand back to Ian. Okay, well with that being no more questions to address, I'd like to draw this meeting towards a close. Your questions will be available with our answers on our website early next week. As we advised in our notice of meeting, due to the restrictions with our articles, we were unable to offer shareholders online voting facilities during the AGM, but encourage you to complete and return a proxy form in advance of the meeting. This ensured that your vote was counted irrespective of the attendance restrictions. I am pleased to say that together with your votes, all resolutions have been passed and the results will be available on our website later today. Thank you all for joining us today. All of us on the board are sorry that we have not been able to meet in person and we look forward to a time when this will be possible. In the meantime, for your continued support.