Rolls Royce Holdings’ (RYCEY) CEO John Rishton on H1 2014 Results – Earnings Call Transcript

And we maintained our full year guidance and continue to expect growth in 2015. We increased the shareholder payment by 5% to 9p, so I think the key financials where we said we would be.

In terms of the first half, we delivered our first XWB engines to Airbus for Qatar Airlines, launch customer — to launch later this year. We’ve run, for the first time, the large XWB engine, the XWB 97K that will power the A350-1000 aircraft and we’ll also run the Trent 1000-TEN engine in the 787.

And you also all will be well aware that at Farnborough, Airbus announced the launch of the A330neo. And we’re the exclusive engine provider with our Trent 7000 engine, with draws on technology from the Trent 1000 and the Trent XWB engines. And I’m delighted we already have 127 aircraft commitments, and that provides even more confidence about strong growth in the future.

Now I hand over to Mark, who’s going to take you through the details of the first half and our views about the second half. Thanks, Mark.

Mark Morris – Chief Financial Officer, Executive Director and Member of Risk Committee

Thank you, John, and good morning to you. So we’ll start with some of the key group highlights in the first half. Let’s just remind ourselves of what we said at the prelims: Revenue and profit for the group will be flat with a similar free cash flow for the year, and that our performance will be weighted to the second half.

As John has said, our H1 results are largely as we expected. As usual, my comments will be restricted to the underlying performance. Now we will go through these results in a little more detail. But before we do, it’s worth mentioning foreign exchange as the pounds has depreciated against a number of currencies, which has impacted our results. You can find a lot more detail in our press release, but across all our currencies, the strengthening pound has reduced revenue by GBP 226 million and profit by GBP 21 million.

Turning to our order book. It remains strong and provides good visibility, over GBP 70 billion, albeit a slight reduction from the year end. Revenue and profit, I will come unto shortly.

On cash, we started the year with GBP 1.9 billion and ended the period with GBP 1.2 billion, a reduction of GBP 762 million, which reflects growth in working capital, continued investment and shareholder payments. And finally, we’ve increased the half year payment to shareholders by 5% to 9p, reflecting our continued confidence in the business.

Let’s take a look now at group revenue. I’ve broken down here the 3 main components of the change in revenue. Original Equipment is down around GBP 200 million, driven predominantly by our Defense and Marine businesses. Defense is down 40%, and Marine is down 15%, mainly on Offshore and Merchant. This is partially offset by OE growth in civil.

Services were also down GBP 57 million, and reductions in every business except Defense, which saw good growth of 9%. And finally, FX, which I’ve mentioned already.

And as we look at it to the second half, we’re looking at around 20% increase in revenue from both higher OE deliveries and a higher run rate of services. And we’ll come back to this later on.

Turning to group profit. Volume is down 4% in constant FX, and that’s reduced operating profit by GBP 89 million. You’re aware of the Marine one-off charge relating to a product quality issue. R&D is GBP 36 million higher, reflecting increased spend in civil programs and lower capitalization as the XWB and 4K [ph] approaches entry into service.

Within other trading, we see the benefit of C&A as a result of indirect headcount reductions made last year, some trading mix impact and aftermarket life cycle cost improvements in Aerospace.

Restructuring spend was GBP 67 million in the first half, which is a GBP 32 million increase over last year as we continue to improve operational efficiency and reduce both direct and indirect costs. These costs are mainly severance costs and site restructuring.

Turning to cash flow. As usual, I’ll just pick out the major [indiscernible] themes in this chart that you’re all familiar with. Networking capital increased by GBP 634 million, which is about a GBP 200 million lower increase than we saw in the first half to 2013. This reflects higher inventory of GBP 195 million, as we prepare for the increase in H2 volumes. The TotalCare net debtor has increased GBP 165 million, reflecting the sale of engines we linked to aftermarket contracts, mainly Trent 700. Deposits were also lower in Defense and Marine, reflecting deliveries in the period.

Cash outflow and CapEx was GBP 303 million, up GBP 20 million on last year as we continue to invest in capacity and capability. Intangibles of GBP 239 million primarily includes GBP 40 million of software; GBP 28 million of contractual aftermarket rights, formerly known as recoverable engine costs, and again, mainly Trent 1000; GBP 91 million of participation payments on civil programs; and GBP 57 million of capitalized development costs.

Pensions and tax comprises GBP 109 million of tax and GBP 80 million of pensions contributions, which brings us to a free cash outflow of GBP 432 million, which is better than guided. Cash continues to remain an area of significant focus. We continue to expect free cash flow to be similar to 2013.

So now we’re going to take a look at each of the businesses. The following figures and commentary in this section reflect the underlying performance at constant foreign exchange, unless otherwise indicated. In Civil Aerospace, whilst the number of engine deliveries was down 1% in the period, OE revenue grew 5%, reflecting 16% higher Trent deliveries, partially offset by 10% lower business jet engine deliveries. Services were down GBP 38 million, and there are a number of moving parts here. On RB211s, we are seeing a combination of lower utilizations as aircraft are converted to freighters and more retirals. Revenue is down about GBP 70 million, and we expect an over-reduction RB211 revenue of about 25% for the full year.

Life Limited Parts are also down, also known as LLPs. LLPs are high-value parts and many them are not covered by TotalCare. So we get this as incremental T&M revenue at the shop visits. As mentioned at the recent investor briefing, we continue to improve the reliability of our engines, which increases the time on wing and delays the overhaul. This improves overall margins, but delays the LLP sale creating a short-term timing issue. This was particularly relevant to the Trent 700 in the period with the number of shop visits deferred. Importantly, our wide-body LTSA revenue continues to grow and is up 9%.

On profits, we are seeing a small benefit from volume with the majority of the trading improvement coming from better life cycle costs and a lower C&A. As guided, the R&D charge was higher as a result of higher spend and lower capitalization.

Looking to the second half, we expect higher OE deliveries, particularly Trent’s engines, supported by 95% order cover. We have 100% order cover for installed engines and a few open orders for spare engines, better aftermarket driven by higher LLP sales and higher T&M, further cost reduction benefits, particularly in the aftermarket and lower restructuring costs.

Turning to our Defense Aerospace business. On revenue, we’ve seen a 40% decline in OE, mainly on engines to power the Typhoon, Hawk, C-130J and V-22. Services increased 9% with growth from the LiftSystem as it enters service and continued to mark demand for parts and services from our large installed base of 16,000 engines.

Turning to profit. We trade in — within trading, we see the impacts of defense having done a good job taking cost out of the business, and this will continue. Defense reduced headcount by 900 since the year end. We’ve also made good progress on life cycle cost reduction.

Margins also benefited from higher aftermarket sales, which was 62% of Defense’s revenue in H1, up from 47% this time a year ago. This proportion will be lower in H2, as OE deliveries increase, particularly on the TP400 and the LiftFan system. So we’ll see some downward pressure in the second half but in line with guidance.

So moving on to our Marine business. We’ve had a challenging first half in Marine. OE revenue was down off the back of lower order intake in 2013, mainly in Offshore. And we had a disappointing performance in services, which is down 9%. Some of this reduced deferrals invested with utilization was also down. On profit, in addition to the negative impact of volume, we also booked a GBP 30 million product quality charge in H1.

Looking to the second half. We’ve reduced our services outlook based on the lower run rates we’ve been experiencing, but this has been offset by a higher order intake of OE. We have 98% OE order cover, so our confidence there is good. And our guidance reflects a mix shift towards OE. That’s why our revenue guidance is stable, but we have reduced our profit guidance. We are making progress on cost reduction in Marine, but it’s been slower than we would have liked. So that’s also reduced our expectations for full year profitability.

Consequently, our full year guidance has been revised downwards for a 15% to 25% reduction in profit, prior to the GBP 30 million one-off. This now makes it consistent with the way we have framed group guidance.

Next, let’s take a look at our Nuclear & Energy business. OE revenue was higher as we completed several major programs. We had high deliveries in Oil & Gas and nuclear subs. Aftermarket revenue was down 5%, largely driven by reductions in our Oil & Gas business. Profits were lower, driven by adverse mix between OE and services. The small trading benefit includes some product cost reduction and C&A improvements, offset by GBP 10 million charge in the first half to resolve contractual disclosure issues.

In the second half, we expect higher OE and aftermarket sales, in line with traditional phasing. On OE, we have 73% order cover. Aftermarket is an area where we have less visibility. We have about half of this covered on the energy side and an 85% order coverage on the nuclear side.

As you know, we’ve announced the sale of the gas turbine and compressor business to Siemens. They are making good progress, but there’s a lot of work to do to prepare the business to separation. We expect this to close around the year end, so our guidance still assumes full year contribution of this business. Following the sale, the retained business will represent around 40% of underlying revenue and profit.

And finally, our Power Systems business. Power Systems had a similar first half to last year, with OE sales up 5% and aftermarket sales down 6%. Naval and defense sales were higher, while oil & gas, mining and power plant sales were lower. Profits were lower in the first half due to a small mix effect and higher restructuring costs. Looking to the second half, we expect higher OE deliveries, particularly coming from higher sales in Oil & Gas mining and power generation, supported by 80% order cover. Better aftermarket, reflecting the traditional second half weighting to spares and firm orders from naval and defense customers and cost reduction benefits and lower restructuring costs.

Turning to financial strength. As you know, we continue to place considerable importance on maintaining an investment-grade rating and strong liquidity. There’s been no change to our credit rating during the period.

Now turning to the guidance. Group guidance is maintained. Excluding foreign exchange translation effects on the one-off charge in Marine, we expect revenue and profit to be flat for the full year with free cash flow similar to 2013. The impact of foreign exchange at current rates will be around GBP 500 million on revenue and GBP 70 million on profit.

It’s worth mentioning the EPS impact from our purchase of the remaining 50% of Power Systems, which we expect to complete towards the end of the year. Daimler relinquished its economic interest in the 25th of March when it exercised its put option. The underlying earnings per share increased 100% of Power Systems profits from that date. In the first half, this improved the underlying EPS by just under 1p.

Turning to segment guidance. As I said at our recent Investor Day, we will provide a new format for guidance that give ranges for revenue and profit. Segmental guidance is maintained except for Marine profit, which we have lowered as mentioned earlier.

The change in Marine profit will be compensated at the group level by improvements in the other businesses.

So some final thoughts to leave you with. Our interim results are as expected, we continue to make progress on the 4Cs with more to do. The reasons we’re confident about a much better second half are high OE order cover, higher OE services, higher OE and services volumes that we see across every business, traditional second half weighting and further benefits from cost reduction.

Finally, shareholder payments are up 5% to 9p, reflecting the continued confidence we have in the business.

With that, I’ll turn over to Q&A.

Question-and-Answer Session

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