ESG Update

Apr 3, 2019

Slides

Well, good morning, everyone, and welcome to the Rolls Royce Annual General Meeting. I hope we didn't have too much difficulty getting here. I know the traffic has been very, very difficult around Central Bristol, but very, very pleased to see you all here. My name is Ian Davis. I'm your Chairman, and I'm joined on stage by Warren East, our Chief Executive Stephen Daintith, our Chief Financial Officer and members of our Board committees: Lewis Booth, Chair of the Audit Committee Ruth Canney, Chair of the Remuneration Committee Mr. Kevin Smith, Chair of our Science and Technology Committee, who is also our Senior Independent Director and Irene Dawna, Member of the Safety and Ethics Committee and our Employee Champion on the Board. You will shortly hear from Orin, who will provide a review of 2018 and then we will move on to the formal business of the meeting. But first, I would like to highlight a few key developments. We entered the year with a refined vision strategy and a determination to improve our efficiency and operating performance. During the year, we embarked upon an ambitious restructuring program and increased the focus of the group by rationalizing our portfolio and simplifying our corporate structure. Your Board and management absolutely recognize the need to improve our operational competitiveness and performance. This is an ongoing task, but signs of progress are increasingly clear. After a period of heavy investment, are focused on generating strong returns and the cash flow that will allow us to compete even more effectively in what continue to be attractive growth markets. During 2018, we took a significant step on this journey. Our performance has improved significantly from the position in which we found ourselves four years ago and we further strengthened our balance sheet in 2018. However, it is sustainable free cash flow upon which we must base our shareholder payment strategy and we still have work to do in order to deliver that. It remains our stated objective in the long term to progressively rebuild payments to shareholders to an appropriate level subject to the cash needs of the business. We did experience setbacks in the year, the most significant of which was the operational issues with our Trent 1,000 engine. This has caused pain for us and even more importantly for some of our customers. This has been an area of continued and continuing focus and oversight by your Board. And I would like to praise the sterling efforts of our engineering and customer support teams in addressing these issues while maintaining our absolute dedication to ensuring product safety, which is and always must be our most important priority. You will perhaps be relieved to hear that I do not intend to spend much time on UK's withdrawal from the European Union. Suffice to say that we took steps to prepare for different potential outcomes with a particular focus on supply chain continuity and retaining essential capabilities. We have continued to brief the UK Government, other governments and regulatory agencies on our Brexit related issues and your Board is regularly updated on our risk mitigation activities. These measures remain in place today as we await clarity on the political situation. Strategically, we continue to invest in the innovation that will help us realize our goal to be the world's leading industrial technology company. During 2018, we increased our momentum on technologies to protect the competitiveness of our core products, on digital technologies to drive productivity across manufacturing, design and services and on developing hybrid electric technologies. Hybrid electric and all electric technologies are becoming increasingly important across all our markets. We have always pursued clean, safe and competitive solutions to deliver society's vital power needs. With rising prosperity and increased demand for power on one hand and the impact of emissions on the other on the climate on the other, this task is becoming more and ever more urgent. We have a crucial role to play in creating cleaner, more sustainable and scalable power for the future. Our ability to help customers and society with their transition to lower carbon solutions is and will be a critical priority for your Board. We also understand that technology in and of itself is no guarantee of success. We must have a high performing culture with a diverse and ambitious workforce capable of sustaining our innovation. During the year, work was carried out to reinforce the behaviours that we need to foster a work environment where every employee can be at their best. In addition to generating exciting growth and technology options, we must strengthen our culture in order to retain and attract the talent we need for the future. Delivering a long term impact requires us to have a sustainable business and that means our commercial organisation needs to be as world leading as our technologies. Across Rolls Royce, our immediate focus is on improving our financial and operational performance to generate improved returns. This will give us the sound and credible financial platform we need in order to remain at the cutting edge of innovation in our markets. Our medium term prospects remain bright and our long term growth opportunities are truly significant. I'll now hand over to Warren to provide a review of 2018. Thanks, Ian. Morning, everybody. Thanks very much for coming along, as Iain said. Now we you could be excused for thinking that we're making a bit of a habit of holding the AGM at football grounds. The conference facilities are very convenient, but there isn't really a theme here. The reason that we're here this morning is, of course, to underline the importance of Bristol, to the Rolls Royce Group, a connection that goes back to, 1966, with the acquisition of Bristol Sydney company. But of course, you can't come to Bristol without sort of feeling aviation and aerospace, back to the early part of the twentieth century. I'm told that, Sir George White announced his intention to build a factory and build some flying machines. And five months later, a Bristol designed aircraft, took to the skies. And, when I was told about that, I thought, gosh, we can learn a thing or two about time scales from some of our forebears. But today, in Bristol, we have about 3,000 employees, and more than half of them, just more than half of them are associated with our defense business. And there's really a lot of our defense business happens out of Bristol, the EJ200 for the Typhoon, the TP400 for the Airbus A400M, the lift system for the lift the vertical takeoff versions of the F-35s. And looking forward, then the Team Tempest activity around the new combat aircraft for The UK announced at the Farnborough show last year. Well, the the team working on that is here in Bristol. And it's it's also responsible in Bristol for our naval activity, in particular, the MT-thirty gas turbine, which serves for a number of navies around the world. Naturally, if we look at all the support that we do to navies, are about 70 navies around the world being supported effectively from Bristol. Outside of the defense realm here in Bristol for our supply chain, components and technologies for civil aerospace activity and looking forward new lightweight components built around carbon fiber composites for really lightweight fan cases and fan blades and the like. So actually, there's a very long heritage and a very long history, but also there's emphasis on looking forward as well. And that's a good proxy for the group. I put up this slide last year at the AGM. We had redefined our vision and strategy for the future. And this really talks about a balance between current products and services, making our operations more efficient and innovating around new products, services and technologies for our operations to make us fit for the future and create that leading industrial technology company that Iain spoke about a few moments ago. We began 2018 by talking about restructuring the group and moving from five business units to three, doing things like aligning all of our defense activities into one business would be an example. But moving from five to three has enabled us to get closer to customers, increase the pace of operation and really build a foundation to remove the unnecessary duplication, which had grown over many, many years in our business. And the three interlocking circles there on the slide represent our three businesses, and we're already seeing benefits of this new structure where the businesses operate within what we call a principle of freedom within a framework. And I'm delighted to see that, that is that starting to bear fruit now. If I move on, as well as that restructuring, Iain also mentioned the portfolio, the range of our activities. Well, during 2018, we completed the sale of L'Orange fuel injector business, and that enables our Power Systems business to focus on growth opportunities now and enables us to allocate capital to core future cleaner, technologies. And we also announced in 2018 a strategic review of our commercial marine activity. We moved as a result of that strategic review some of our marine activities to different parts of the group. So the naval marine activity moved to defense. Some of our large naval engine or marine engines moved to our Power Systems business. And then that resulted in the sale of the rest of the business, the commercial marine activity, and that was completed just last month. So there was quite a bit of activity on tidying up of the portfolio. And that created a great foundation so that in the middle of last summer, we could announce the restructuring that Iain mentioned. This is a twenty four month program of fundamental restructuring, creating a much smaller corporate center, much smaller corporate support functions, reducing layers, removing complex complexity. Now some of that obviously results in reduction of headcount, and that's always a difficult topic and a difficult, thing to do. However, have to think about the future and we have to think about the future of all of our workforce and all of our customers. And we have to fundamentally change the way we work, creating a simpler business, healthier, more dynamic with greater productivity where you can make faster decisions, all those sorts of things. Targeting really an environment where we can realize the benefits of the investments that have been made in the past and seize the opportunities now that we need to seize for the future. One of the big changes that we're trying to make is, I think, Iain alluded to, was changes in behavior. So when I talk about the way we work, I don't just mean the structures in the way the business is organized, but actually how people go about their day to day jobs. And it's been great to see some of those changes starting to happen during 2018. And a great example of that was how the organization responded to the challenges that we faced around the issues that emerged on the Trent 1,000 engine, that's the engine that powers the Dreamliner. Now as Ian mentioned, many of our customers experience severe disruption according as a result of that. There were all sorts of interesting facts and figures. And I went to Japan in September and gave an interview in a magazine article, and I was referring to almost half a million passengers in Japan alone that had been affected or had their journeys affected, by the Trent one thousand. So this was a big deal, and, it's a big deal for our customers and our customers' customers, and we understand that. But the good news was the organization responded in a thoroughly constructive, collaborative way. We saw new parts, new service techniques developed. We quickly increased our capacity to create small to create components. We quickly increased our capacity to do repair and overhaul and deal with and support our customers through that operational disruption. And we closed the year with a new design for the compressor blade done and certified, and it's now being fitted into engines. And the health of the Rolls Royce powered Dreamliner fleet is now improving on a day to day basis. And we haven't got it on this slide, but facts and figures around there. We had between forty and fifty airplanes on the ground for most of the second half of last year. In the first quarter of this year to around about now, that number is between 3040%. Actually, it's in the lower 30s at the moment. And we expect to be in single digits, which is back into a sort of normal zone for the size of our Trent one thousand fleet by the end of this year. So that is how we've dealt with the Trent one thousand issue. Now I want to just a quick summary of some of the financial results. We described the year a couple of months ago with our annual results as a year of solid progress. And that's because we don't want to get too excited about it. But this revenue growth, top line growth was really very strong, driven by good performance in our Civil Aerospace business with 12% overall revenue growth and our Power Systems business with 15% overall revenue growth. And that good growth in revenue was also reflected in a healthy growth in profitability measures, albeit, I know, off a very small base. And that led to a doubling of our free cash flow, which is a good step on the journey to at least GBP 1,000,000,000 of free cash flow by 2020 and GBP 1 per share of free cash flow in the medium term, a good step towards those goals, particularly when you take into account the GBP $430,000,000 that we had to spend on the Trent 1,000 issue last year. Delving into some of the numbers in a little bit more detail behind those headline numbers. Our Civil Aerospace business, notwithstanding the Trent 1,000 issue, aside from that, actually had a pretty good year. Very strong growth in flying hours. We now have 4,700 or as of the end twenty eighteen, 4,700 large engines installed. That's 25% greater than the number five years ago. They're more efficient engines, so airlines tend to use them more because they're more efficient than some of the older engines. And therefore, these airplanes are flying more hours a day. So that helped to drive the 14% growth that you see in flying hours there. Back inside Rolls Royce, we worked hard on things like reducing the deficit when we supply one of these engines out to our customers. We also saw entry into service of three new engines in February. The more powerful version of the XWB, the XWB 97 ks was launched in February. And at the end of the year, the Trent 7,000 is powering the new version of the A330. And we saw some important milestones during the year as well. The 84 ks version of XWB passed 2,000,000 hours. It's now over 3,000,000. And the Trent 700, which powers the earlier version of the A330, passed 50,000,000 and has been very successful. And just to show that we haven't forgotten the corporate jet business, we launched the Pearl family in the middle of last year as well, the first of the Pearl engines going on a new aircraft from Bombardier. And obviously, we couldn't talk about that before because corporate jet people like to keep these things quiet until they're absolutely ready to announce them. But moving away from civil aerospace, some of you might have traveled either to or from London down the line that comes through Bristol Parkway, and we'll be traveling these days on these new Hitachi trains. They're powered by Rolls Royce E 1,600 engines. Very pleased to see those entering into service. And actually pioneering some new long term service agreements, taking that service business model from our civil aerospace business and starting to apply it into other sectors. Our Power Systems business, not only did it see strong revenue growth, but also saw strong order growth last year, driven by actually strong markets indeed, but also increasing market share, particularly in some regions like China, where in order to service the expected demand that we see there, we created a new joint venture. It was launched about twelve months ago. The first engine was produced. And by the time two months ago, I stood up and talked about our results, we had produced over 100 engines out of that facility. If I, flick on to defense, we described that as a solid year. It was a particularly strong year in terms of, order backlog and order intake rather to grow backlog. So we saw orders for more F-thirty five lift systems, more EJ200 engines. We also saw design wins so that, that will lead to more orders in future with, for instance, the U. S. Navy, and we saw some new customers for the multirole tanker transport, which is powered actually by the Trent 700 engine, which is civil aerospace engine, but still in the defense application there. And we saw continued success for the MT30 in naval, MT30 again coming out of Bristol. So that's a quick run around the businesses. I just wanted to talk a little bit about technology investment. And I've said before, this is about both current and future. It's very important with a very long term contract that we continue to invest in technology for current products. That investment goes into things like optimizing the designs for cost reduction so that over time, we can make more profit out of selling the same things. And importantly, out of improving the in service performance, longer time on wing. Again, this is key to driving our profitability. And you don't get something for nothing in this world, so that's a result of investment in technologies, for our current businesses. And that's things like material science, design tools, production techniques, and so on. But it isn't all about current technologies. We also need to keep an eye on the future. And here's a picture of, what our new ultra fan demonstrator might look like in a few years' time. This is a very significant architectural change, to our gas turbines, first significant architectural change for many decades. It's going to lead to a step function improvement in efficiency that will result in a big improvement in carbon emissions. We'll also achieve a significant improvement in terms of noise and nitrogen oxides, perhaps 50 improvement in nitrogen oxides. The core of the engine, the Advanced three core, tested during 2018. We tested at full power. It's performing brilliantly. People who are working on that are delighted with how that's going. We also tested the gearbox, which drives the large lightweight fan at the front of the engine. The gearbox has been run up to about 70,000 horsepower, and testing for that is going well also. Now at the end of last year, we made an important commercial decision about UltraFan, which we announced in February when we decided not to take part in Boeing's new mid market aircraft. And that was because we absolutely do not want to do anything that will jeopardize the success of this ultra fan program. And we concluded that the time scales for the Boeing project, would simply be too aggressive and we would not have a product mature enough, in the time line of the Boeing project. And so that's why we withdrew from that opportunity. But it doesn't in any way indicate any dent in our appetite for making this an excellent product when it comes to market. However, we have to think also beyond ultra fan, and I've spoken before about electrification sweeping across the industrial landscape. Electric propulsion is coming to the air as well. We set up a separate capability group in Rolls Royce because we do need to adjust our skills and position our skill base for the future as well. So we created that electrical group. And by the end of the year, we have three programs targeted at electric flight. We have a partnership activity with Airbus, a hybrid demonstrator aimed at regional transport, so regional type size of aircraft. At Farnborough last year, we announced a concept in eVTOL. That's just to sort of size that, that's hybrid concept, but it and it would take four to five people, about 500 miles at about two fifty miles an hour. So that's the sort of size we're working on there. And thirdly, a local project here, a partnership with a local company, where we are targeting an all electric flight, very small aircraft, but all electric flights, and we are hoping to break the world's speed record for electric flight with that aircraft. So innovation there for the future in electric flight. But it's not just about flying, although that's quite interesting and sexy and you can have good pictures about it. It looks quite boring on the bottom of the on the bottom right of the slide there. But we're also spending a lot of time and effort investing in new materials and production techniques to make things lighter and tolerate higher temperatures and the like to make our engines more efficient. You saw on the video the little robot so that you can send into engines to inspect things. And in our Power Systems division, then we're very keen on microgrids where we see great potential for encouraging the take up or faster take up of renewable power. So that's a quick runaround the business, quick run around the technologies. Where are we going looking forward? Well, having stabilized the business, having built some foundations in 2017 and 2018, you see from what I just presented, we're busy targeting, the future, playing our part as the world looks towards a power which doesn't damage the environment so much. We have a key part to play in that. But very much also remembering that there isn't going to be a future, unless we have a healthy competitive business, with the right skills, with where operational excellence is celebrated alongside technical excellence built on diverse talent. And so it's essential that in the immediate short term, we complete our restructuring program at pace. We start to realize the economic benefits of past investment so that we can seize those opportunities for the future across all markets. Thank you. That's a quick review of 2018. Okay. Thanks, Warren. I hope that gave you all a sense of what we're up to in 2018 and the momentum in the company. I'd now like to start the formal proceedings of this Annual General Meeting. All shareholders will have received the annual report by post or a notification by post or email that it is available to view on our website. All shareholders will also have received a notice of the meeting together with explanatory notes of resolutions being put to the meeting today. This was published on twenty five March. In line with best practice, a poll will be taken on each of the resolutions set out in the notice. The poll will be administered by our registrar, Computershare Investor Services. Please do not complete your poll voting cards yet. I'll explain the procedure later in the meeting and I will indicate when you should mark your votes on the cards. I now declare the meeting closed. Sandwiches and light refreshments will be available outside the meeting room in the Heineken suite. As I said, my fellow directors and I will be joining you and we will be happy to take any further questions or comments and to chat with you in a more informal setting.