Rolls-Royce Holdings Plc 2017 Full Year Results

Commenting on the results, Warren East, Chief Executive, said: “Rolls-Royce made good progress in 2017. Financial results were ahead of our expectations and we achieved a number of important operational and technological milestones, but were impacted by the increasing cost and challenge of managing significant in-service engine issues. The business unit simplification and restructuring programme that we announced this January will drive further rationalisation and is a fundamental step in the journey started two years ago to bring Rolls-Royce closer to its full potential both operationally and financially.

We are encouraged by the improving financial performance in 2017 with growing revenues contributing to improved profitability and cash generation. Looking forward, sustaining this improvement and delivering increasing cash flow generation will strengthen our position as one of the world’s leading industrial technology companies.”

* Organic change at constant translational currency (‘constant currency’) and excluding M&A
**Adj net debt excludes ITP Aero’s £215m net cash. Reported net debt was £305m. FCF excludes £14m post-acquisition ITP Aero cash outflow percentage or absolute change figures in this document are on an organic basis unless otherwise stated

Group financial highlights

• Reported revenue of £16,307m; up 6% on underlying basis, Civil Aerospace service revenues up 12%
• Underlying profit before tax up 25% to £1,071m; strong contribution from Power Systems
• Reported profit before tax of £4,897m; includes a £2.6bn non-cash profit (2016: £4.4bn loss) from the revaluation of our $38.5bn hedge book as sterling strengthened
• Free cash flow improvement driven by improved profits and good working capital management
• 2016-17 transformation programme achieved £200m run-rate savings; at top end of guidance
• €718m ITP Aero acquisition completed in December 2017, first instalment in shares (9.61m issued)

Group operational highlights

• Civil Aerospace widebody invoiced flying hours up 12%; significant in-service engine issues: in-year £170m cash cost (2016: £90m) and £227m charge to profit (2016: £98m)
• Large engine deliveries up by 35% to a record 483 (2016: 357 engines)
• Good further progress with Trent XWB-84 OE economics (cash deficit down 37%)
• Successful UltraFan Power Gearbox testing and Advance3 engine first run completed
• Strong recovery in Power Systems under new leadership; revenue growth, significant cost savings and strong cash generation
• Marine results stable year on year; restructuring benefits delivered; strategic review of Commercial Marine business underway

2018 Reporting & outlook
Rolls-Royce has adopted the IFRS 15 revenue recognition accounting standard from 1 January 2018. As a consequence, our financial results for 2018, commencing with the first half results, will be reported under IFRS 15.

2018 results will also be reported using the new business unit structure and therefore the outlook comments set out below are made on this basis. The impact of adopting IFRS 15 is preliminary and as processes and procedures are further embedded during 2018, it is possible that some changes to the impact may result.

2017 Results: Previous business segment structure

2018 Outlook: New business segment structure (IFRS 15 basis)

* Free cash flow outlook includes in-service engine costs as outlined on page 3
**Other includes Commercial Marine and HQ
***ITP Aero will be reported as a separate unit. Note, the ITP Aero figures in the table are unaudited

Commenting on the Group’s outlook, Warren East added: “As I look to the year ahead, we are embarking on a more fundamental restructuring programme with a refreshed leadership team and an improved market environment. The new business structure provides us with a clearer focus on our customers and markets and, combined with our growing installed base, particularly of widebody engines, delivers the potential to drive sustainable long term free cash flow towards our mid-term ambition of around £1bn by around 2020 with further growth over the subsequent years.

2018 will be one of significant operational progress. In Civil Aerospace we will continue to grow our installed widebody fleet and further reduce cash deficits on engine sales. At the same time over the next few years we will be continuing to implement solutions for our airline customers to address the in-service engine issues we are currently experiencing, the estimated costs of which are significant but are included in our cash flow, revenue and earnings guidance for 2018 and beyond. While Defence faces some challenges due to timing changes on export activity and in contract mix, we continue to have attractive longer term export opportunities. After a year of strong recovery, Power Systems is well positioned for another year of good progress, all of which bodes well for the year ahead.”

Rolls-Royce business structure simplification and further restructuring
In January 2018 we announced a programme to further simplify the business, including the evaluation of strategic options for Commercial Marine and a reduction from five business units to three tightly focussed operating businesses based around Civil Aerospace, Defence and Power Systems. This rationalisation will facilitate a more fundamental restructuring, with empowered businesses supported by a much leaner corporate centre.

The restructure will focus on operational restructuring of management, support and engineering and technology functions across the corporate centre and also in our three divisions, driving simplicity, agility and pace into our business. We are proposing to move to a considerably simplified staff structure, with fewer layers and greater spans of control across the group. We have retained restructuring experts Alvarez & Marsal to support us with this programme. We expect this programme to deliver a significant reduction in costs and assist us in improving performance across the Group as a whole, and we will provide clarity of these benefits later in the year.

Civil in-service engine performance
Our large engine fleet has continued to grow, with over 4,400 engines in active service at the end of 2017, up 7%, on 2016. Invoiced flying hours increased by 12% compared with growth of 4% in 2016.

The Trent XWB-84 was a strong contributor to this growth. This engine now represents 6% of our in-service widebody fleet and has achieved over 1.2 million flying hours with unparalleled levels of reliability. It is expected that the Trent XWB-84 fleet will grow to around 1,000 engines over the next five years. The Trent 700 (36% of our total widebody fleet) continued to perform well in service, and achieved a dispatch reliability of 99.9%. The RB211, Trent 500 and Trent 800 comprise 39% of the widebody fleet and are also performing well in service.

We have, however, experienced an increased level of activity managing significant in-service engine issues on two engine programmes in 2017. This has principally been due to lower than expected durability of a small number of parts for the Trent 1000 (11% of our total widebody fleet) and the Trent 900 (8% of our total widebody fleet).

These issues have required urgent short-term support including both on-wing and shop visit intervention which has resulted in increased disruption for some of our customers. This has been a dynamic situation. We have continued to progress our understanding of both the technical and operational issues and we are making solid progress with longer-term solutions, largely through re-designing affected parts. These are expected to be fully embodied in the Trent 1000 fleet by 2022. On the Trent 900, an extended life turbine blade is already being rolled-out into the current fleet with further re-designs underway which will be available in 2020. Total charges of £227m (2016: £98m) were recognised in the income statement in relation to the Trent 1000 and Trent 900 accelerated maintenance activity and £170m (2016: £90m) in our cash flow.

Based on our current estimates, in 2018 the anticipated annual cash impact in respect of both the Trent 1000 and the Trent 900 is expected to broadly double from the total cash cost in 2017 of £170m and reach a peak in 2018, as maintenance activity intensifies. It is then expected to fall by around £100m in 2019. The majority of the work will be undertaken in 2018 and 2019 although it is expected to be fully complete by 2022. All of these costs are included in our cash flow guidance for 2018 and beyond.

Balance sheet, capital allocation and payments to shareholders
A disciplined approach to capital allocation and to sustaining a healthy balance sheet will play a major part in driving our long-term growth. Through improved free cash flow generation we aim to maintain a strong investment grade rating and ultimately return to A-grade status. For 2017 the final payment to shareholders is held at 7.1 pence giving a full year payment of 11.7 pence (2016 full year: 11.7 pence). Restoring our shareholder payments to an appropriate level over time as free cash flow grows will be a key capital allocation priority. Growing free cash flow will also help sustain our investment in R&D programmes. Through targeted investment we will capture carefully selected growth opportunities. We will provide more details for our capital allocation strategy at our Capital Markets event in June 2018.

ITP Aero acquisition
The €718m acquisition of the 53.1% of ITP Aero we did not already own was completed on 19 December 2017 and the first of eight instalments of the consideration was made through the issuance of 9.61m shares in mid-January 2018. In line with the agreement with the Spanish regulator, ITP Aero will be managed and reported as a separate unit. Given the proximity of closing to our year end, ITP Aero’s trading in the post-acquisition period was immaterial to our results of operations.

Capital Markets event
Rolls-Royce plans to hold a Capital Markets event based in London on 15 June 2018 at which we will be in a position to provide information on the expected nature, financial benefits and exceptional restructuring costs of the simplification and restructuring programme together with more detailed insights into our capital allocation strategy and longer-term KPIs for the business.

Group Financial Highlights – Data table

Notes to financial tables on pages 1-4: Underlying: for definition see note 2 on page 43
* organic change is shown on a constant translational currency basis and excludes M&A impacts; ** translated at actual exchange rates; ***free cash flow defined as operating cash after capital expenditure, pensions and taxes, before payments to shareholders and acquisitions & disposals. The derivation of free cash flow from the cash flow statement is shown on page 52. ****Adj net debt excludes ITP Aero’s £215m net cash. Reported net debt was £305m.
LTSA is long term service agreement (TotalCare)

2017 Business Unit Highlights
Percentage or absolute change figures in this document are on an organic basis unless otherwise stated.

Civil Aerospace - underlying revenue of £8,023m, underlying operating profit of £520m

• Underlying revenue and underlying operating profit growth of 12% and 34% respectively, driven by 35% increase in large engine delivery volumes and a 12% increase in invoiced flying hours
• Underlying services revenue grew by 12%
• Unit cost reductions and pricing improvements; 37% reduction in Trent XWB-84 cash deficit; overall OE cash deficit stable at £1.6m, as expected given the change in production mix
• Good progress on new engine programmes during 2017: Trent 1000 TEN entering into service, Trent XWB-97 achieving certification, and Trent 7000 powering Airbus A330neo first flight
• Significant in-service engine issues on Trent 1000 and Trent 900; principally due to lower than expected durability of certain turbine and compressor rotor blade parts (see page 14); focus to mitigate disruption to customers, current year £227m income statement charge and £170m impact to cash flow
• Change in R&D policy application: £83m of the £243m increase in R&D capitalisation in year

Defence Aerospace - underlying revenue of £2,275m, underlying operating profit of £374m

• Underlying revenue broadly flat with modest decline in both spare parts and LTSA revenues, the latter due to the retirement of the UK MoD’s Gnome-powered Sea King fleet in 2016
• Underlying operating profit down 7% through product mix and higher R&D spend reflecting ongoing future programme development
• Order intake of over $1.4bn secured in the US, including further funding for long term service contracts with US Department of Defense
• Expansion of services offering through the opening of new Service Delivery Centres in Lossiemouth and Bangalore and extended supply agreement signed with Aviall, a Boeing company
• Joint venture signed with Turkish industrial conglomerate Kale Group to develop an indigenous engine solution for the TF-X combat programme
  

Power Systems - underlying revenue of £2,923m, underlying operating profit of £330m

• New leadership team driving transformation programme to streamline product portfolio, reduce fixed costs and improve cash conversion
• Improved financial performance with 3% growth in underlying revenue; signs of market recovery
• Power generation products enjoyed good demand from China and for US data centres
• 240bp rise in underlying gross margin to 28.8% and material improvement in cash flow
• Services revenue growth of 6%: recovery in US spares demand and growing interest in a repair/ reconditioning solution; MTU’s first long-term availability contract signed with Hitachi Rail in UK
• Launch of Customer Care Centres and digital solutions reflect focus on customer service initiatives to provide service capability for the installed base of over 100,000 engines

Marine - underlying revenue of £1,077m, underlying operating (loss) of £(25)m

• Underlying revenue 9% lower, reflecting ongoing offshore market weakness
• Underlying operating loss reduced through strong focus on cost control; modest cash outflow
• Continued investment in Rauma facility, Finland, to create state-of-the-art production and test facilities, together with progress on autonomous shipping programme
• Strategic review of Commercial Marine business underway

Nuclear - underlying revenue of £818m, underlying operating profit of £38m

• Underlying revenue up 4% on greater submarine activity, but lower underlying operating profit as R&D spend on Small Modular Reactors increased
• Submarines achieves strong improvements in operational delivery; further investment in facilities
• Civil Nuclear delivered key milestones as part of the long-term, retrofit contracts in France and Finland

Further guidance for 2018 underlying results under IFRS 15 basis

Civil Aerospace

• Revenue growth from higher OE delivery volumes and services activity
• Higher services activity driving profit growth. Around £50m increased R&D capitalisation
• Increased cash flow from continued flying hour growth and further working capital improvements
• But higher deliveries of cash deficit OE engines albeit at lower unit losses
• Higher Trent 1000 and Trent 900 in-service costs

Defence

• Headwinds from timing changes on export activity and in contract mix, higher investment to support new product development
• Expected non-repeat of £30m favourable timing benefit from the Aviall spares distribution contract

Power Systems

• Continued recovery of naval, oil & gas, and construction & agriculture end markets
• Product mix towards lower margin mining and construction & agricultural products
• Higher R&D spend on alternative fuel solutions

ITP Aero

• Double digit revenue growth driven by strong increase in delivery volumes on civil programmes
• Margin contraction driven by mix change. Lower volumes of higher margin defence engines with strong growth in less profitable civil engines
• Higher cash outflow as a result of investments and contributions to third party programmes. Cash flow expected to move closer to breakeven in 2019

Commercial Marine business: Ongoing cost savings helping to mitigate tough market conditions

Foreign exchange – guidance assumes that foreign exchange rates for the full year remain unchanged from those at the end of 2017. We expect the average USD:GBP achieved hedge rate for 2018 to be unchanged (2017: $1.54).

Net R&D – excluding ITP Aero, net R&D spend is expected to increase by around £50m in 2018 (2017: £1,035m)

Tax charge - we expect our underlying tax charge to show a modest reduction to the prior year (2017: £166m), however it will remain sensitive to the geographical mix of profit. Cash tax is expected to increase substantially in 2018 through timing effects, despite a modest benefit from US tax reform.

Capital expenditure – capital expenditure for 2018 is expected to be around £775m (2017: £764m)

Finance charges - underlying finance charges in 2018 (2017: £112m) are expected to be around £130m partly reflecting the increased level of net debt, and inclusion of ITP Aero.

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Enquiries

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This Full Year Results announcement contains forward-looking statements. Any statements that express forecasts, expectations and projections are not guarantees of future performance and will not be updated. By their nature, these statements involve risk and uncertainty, and a number of factors could cause material differences to the actual results or developments. This report is intended to provide information to shareholders, is not designed to be relied upon by any other party, or for any other purpose and the Company and its directors accept no liability to any other person other than under English law.

Results presentation
A presentation will be held at 09:00 (GMT) today. Details of how to join the event online are provided below. Downloadable materials will be available on the Investor Relations section of the Rolls-Royce website from the start of the event.

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Operational overview

Financial review