Rolls-Royce Holdings plc – Half- year report – 30 June 2020
Notes to the half-year financial statements (extract)
1 Basis of preparation and accounting policies (extract)
In assessing the adoption of the going concern basis in the condensed consolidated financial statements, the Directors have considered the forecast cash flows of the Group and the liquidity available over an eighteen-month period to 28 February 2022. They have paid particular attention to the impact of the COVID-19 outbreak on the Group’s Civil Aerospace and ITP Aero businesses and have assessed both a base case scenario (which reflects the Directors current expectations of future trading) and a severe but plausible downside scenario (which envisages a “stress” or “downside” situation and is further explained below) when evaluating the potential impact of these scenarios on the Group’s future financial performance and cash flows.
We expect the Civil Aerospace business to be most significantly impacted. The key judgement is the severity, extent and duration of the disruption caused by the COVID-19 pandemic and therefore the timing of recovery of commercial aviation to pre-crisis levels, including whether a widespread “second wave” of restrictions will occur. The Directors expect the impact on the Power Systems business (23% of 2019 Group underlying revenue) to be significantly less and shorter in duration than for commercial aviation, and there to be no significant impact on the Defence business (20% of 2019 Group underlying revenue). Given the inherent uncertainty, the Directors believe it is appropriate to provide additional disclosure of the key COVID-19 related assumptions underpinning the base case and severe but plausible downside scenario, as set out below.
Base case scenario
The Group’s base case scenario assumes a deep impact with slow recovery and no second wave of global lockdown restrictions: widebody capacity returns to 75% of the pre-crisis baseline in H2 2021 and over 90% in H2 2022, with a slower growth to a full recovery to 2019 levels of widebody activity by 2024.
The Directors have implemented a number of mitigating actions to reduce cash expenditure and maintain liquidity, as follows:
- Measures have been implemented to minimise discretionary costs such as non-critical capital expenditure projects, reducing consulting spend, professional fees and sub-contractor costs, ceasing all non-essential travel, postponing external recruitment, and reducing salary costs across our global workforce by at least 10%. These are expected to have a full-year cash flow benefit of £1bn in 2020, of which £350m was delivered in the first half.
- The final shareholder payment in respect of 2019 was not approved.
- In April 2020 the Group issued £0.3bn of Commercial Paper to the COVID-19 Corporate Financing Facility (CCFF), a fund operated by the Bank of England on behalf of HM Treasury. The borrowings are repayable on 17 March 2021
- In April 2020, the Group entered into a new £1.9bn revolving credit facility (RCF) which expires in October 2021. This facility remained undrawn up to the date of signing the condensed consolidated financial statements.
- The Group secured a further £2bn term-loan facility, 80% of which is guaranteed by UK Export Finance (UKEF). This was executed on 20 August 2020 and is repayable in August 2025.
The Group launched a major restructuring programme, announced on 20 May 2020, to reshape and resize the Group and in particular the Civil Aerospace business. This will remove at least 9,000 roles across the Group, with forecast annualised savings of over £1.3bn by the end of 2022. On 27 August, approximately 4,000 departures have been agreed, with at least 5,000 expected by the year-end.
Liquidity and borrowings
At 30 June 2020, the Group had liquidity of £6.1bn, including cash and cash equivalents of £4.2bn and an undrawn RCF of £1.9bn.
The Group’s committed borrowing facilities at 30 June 2020, 27 August and 28 February 2022 are set out below. None of the facilities are subject to any financial covenants or rating triggers which could accelerate repayment.
1 A $500m (£329m) Bond matures in October 2020 and a €750m (£639m) Bond matures in June 2021. GBP values presented at hedged FX rates.
2 The £300m CCFF facility matures in March 2021.
3 The £1,900m undrawn RCF expires in October 2021.
Taking into account the maturity of borrowing facilities the Group had committed facilities of £7.8bn at 30 June 2020, £9.8bn at 27 August 2020 and £6.6bn will be available throughout the period to 28 February 2022.
In the base case scenario, where there is assumed to be no second wave and the Group starts a gradual recovery with Civil Aerospace returning to 75% of the pre-crisis baseline in H2 2021, the Directors consider that the Group will continue to operate within its current available committed borrowing facilities for the next eighteen months. In this scenario, in order to provide sufficient liquidity headroom, the Group would replace the £1.9bn RCF following its expiry in October 2021, with replacement funding of a similar amount.
Severe but plausible downside scenario
Due to the inherent uncertainty over the severity, extent and duration of the disruption caused by the COVID-19 pandemic and therefore the timing of recovery of commercial aviation to pre-crisis levels, the Directors have also considered a severe but plausible downside scenario.
This severe but plausible downside is based in principle on a general assumption that there will be a “second wave” of COVID-19 infections that results in further stringent lockdown restrictions, including restrictions on travel between countries, being re-introduced across many parts of the world in 2020 or during the first part of 2021, with a gradual recovery of the global economy and the Group taking place once those restrictions are lifted. The resulting key underlying COVID-19 specific assumptions included in the severe but plausible downside scenario in relation to each of the Civil Aerospace and ITP Aero businesses are as follows:
- Flying hours of widebody aircraft using the Civil Aerospace business’s engines will decrease by 64% in 2020 (compared to 2019), before increasing by 28% in 2021 (compared to 2020).
- Flying hours of business and regional aviation aircraft using the Civil Aerospace business’s engines will decrease by 37% in 2020 (compared to 2019), before increasing by 1% in 2021 (compared to 2020).
- Sales of widebody original equipment engines, which are supplied for use in new aircraft, will decrease by 48% in 2020 (compared to 2019), and decrease further by 47% in 2021 (compared to 2020).
- Sales of widebody original equipment engines, which are supplied to replace engines of aircraft already in operation (spare engines) will decrease by 65% in 2020 (compared to 2019) and decrease further by 41% in 2021 (compared to 2020).
- Sales of business and regional aviation engines will decrease by 18% in 2020 (compared to 2019) and decrease further by 33% in 2021 (compared to 2020).
- The number of shop visits carried out will decrease by 16% in 2020 (compared to 2019) and decrease further by 7% in 2021 (compared to 2020).
The principal risks are set out on page 50. In assessing the going concern basis, the directors have considered these and in particular the additional mitigating actions that have been identified for the principal risks most significantly impacted by COVID-19, as summarised below:
- Safety – Changes to our ways of working at manufacturing sites and through remote working increase our safety risks. We have implemented measures to limit the spread of COVID-19 including additional personal protective equipment requirements, social distancing, improved cleaning regimes and increased remote working. We have increased our focus on supporting the mental health of our employees.
- Financial shock – The drop in demand has reduced our cash inflows. As described above, we have taken rapid actions in H1 2020 to preserve liquidity and reduce costs and the further actions to improve our financial resilience.
- Strategic transformation – COVID-19 has amplified the need for immediate change and will result in the largest reorganisation of our Civil Aerospace operations in our history.
- Business continuity – The large reductions in demand, in particular for Civil Aerospace, mean that supplier distress is now more likely. We are closely monitoring our supply chain and putting in place mitigations where appropriate.
- Talent and Capability – The Group has put in place plans to retain key capabilities as it reduces the size of its workforce.
In the event of a severe but plausible downside scenario modelled by the Directors, the projections indicate that the Group will continue to operate within its available committed borrowing facilities for the next twelve months. When considering a period of eighteen months from the date of this report, to 28 February 2022 the Group would need to draw down the £1.9bn RCF, which is repayable in October 2021. In order to fund operations and maintain a sufficient level of liquidity, replacement of the £1.9bn would be required, along with additional funding, which could be achieved through some combination of debt, equity and the proceeds from business disposals.
Consequently, the Directors are currently assessing options in relation to further funding, to be secured in the period up to October 2021, to ensure that the Group remains a going concern with sufficient liquidity to fund its operations and repay maturing debt facilities in the event of the severe but plausible downside scenario materialising.
After due consideration of the matters set out above, the Directors are satisfied that it remains appropriate to prepare the financial statements on a going concern basis. However, the inherent uncertainty over the severity, extent and duration of the disruption caused by the COVID-19 pandemic and therefore the timing of recovery of commercial aviation to pre-crisis levels and the availability of sufficient funding, represent material uncertainties that may cast significant doubt on the Group’s ability to continue as a going concern and, therefore, to continue realising their assets and discharging their liabilities in the normal course of business. These financial statements do not contain any adjustment that would arise if the financial statements were not drawn up on a going concern basis.
Independent review report to Rolls-Royce Holdings plc (extract)
Report on the Condensed consolidated half-year financial statements (extract)
Emphasis of matter – Going concern
Without modifying our conclusion on the interim financial statements, we have considered the adequacy of the disclosure made in note 1 to the interim financial statements concerning the Group’s ability to continue as a going concern. The Group’s Civil Aerospace business is the most impacted by the COVID-19 pandemic and the Group’s forecasts assume a phased return to commercial aviation flying and thus cash collections based on engine flying hours.
The disclosure in note 1 also highlights that the Group’s £1.9 billion revolving credit facility (RCF) expires in October 2021 and that in the base case scenario additional funding of a similar amount is needed to maintain sufficient liquidity from this point forward. In the event that there is a “second wave” of the pandemic, leading to further travel restrictions being imposed in the markets in which the Group operates, reflected in the Group’s severe but plausible downside scenario, then in order to maintain sufficient liquidity, additional funding would be required, over and above the replacement of the £1.9 billion RCF through a combination of debt, equity and the proceeds from business disposals.
As described in note 1, the timing of recovery of commercial aviation to pre-crisis levels and the availability of sufficient funding indicate the existence of material uncertainties that may cast significant doubt about the Group’s ability to continue as a going concern. The interim financial statements do not include the adjustments that would result if the Group was unable to continue as a going concern.