Cobham Regulatory News (COB)

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26 April 2016

UPDATE ON CURRENT TRADING, FINANCIAL POSITION AND EQUITY ISSUE

Key points

· First quarter trading was behind the Board's expectations. The Group's trading profit was £15m (2015: £50m). There are three principal reasons for this slow start to the year: operational issues in the Wireless business resulting in delayed shipments and a one-off charge of £9m; increasing headwinds in the commercial fly-in fly-out business; and cost increases on a small number of development programmes in the Advanced Electronics Solutions Sector. The remainder of the Group continues to trade in line with the Board's expectations, with the order book slightly ahead of the year end position on a like-for-like basis.

· The impact on earnings of the slow first quarter coupled with the ongoing investment requirements in long term development programmes mean that Cobham now expects the Group's leverage could be close to the net debt to EBITDA covenant ratio of 3.5x at 30 June 2016, the next covenant testing date. Having considered its options, the Board has concluded that it is in the Group's best interests to reduce indebtedness on a more long term basis. Accordingly, the Board has decided to raise sufficient new equity to reduce the net debt to EBITDA ratio to around 2x.

· The equity raise will enable the Group to continue to run its business with a view to value creation over the medium and long term, investing appropriately to bring major development programmes into their initial production phases and in the businesses' differentiated technology solutions and know-how, which are closely aligned to growth opportunities.

· In addition, as part of Cobham's ongoing continuous improvement initiatives, the Group is targeting further net savings in 2016 as well as continuing to focus on working capital management and control of capital expenditure. This will aid mitigation of margin pressure, support the delivery of the Board's earnings expectations, and the generation of free cash flow.

· It is proposed that the new equity finance be raised by way of a rights issue of approximately £500m during the second quarter of 2016 (the "Rights Issue"). The entire amount of the Rights Issue has been fully underwritten on a standby basis by Bank of America Merrill Lynch and Jefferies International Limited.

· Having strengthened the balance sheet, the Board today confirms its intention to pay a rebased total dividend in respect of 2016 which is the same total amount as the £126m dividend paid for 2015. Thereafter the Group will retain its stated dividend policy, which is broadly to align future dividend increases with underlying earnings growth, while rebuilding cover over time.

Bob Murphy, Chief Executive Officer, said:

"In order to put the Company on a sound footing and to secure funding for our major development programmes in the longer term, we have decided to refinance the business through a rights issue to raise approximately £500m.

Profit in the first quarter of 2016 was behind our expectations due to delayed shipments and operational headwinds and contributed to an increase in the net debt to EBITDA ratio. For the full year, the scale of the order book and the impact of the cost reduction programme which we are currently implementing, will mean that the profit shortfall is expected to be limited to about £15m.

We remain confident that continued investment in technology and know-how will enable us to maintain our leading positions in markets with good prospects leaving Cobham well placed to deliver growth over the medium term."

First quarter 2016 trading

First quarter trading was behind the Board's expectations. The Group's trading profit was £15m (2015: £50m). There are three principal reasons for this slow start: operational issues in the Wireless business resulting in delayed shipments and a one-off charge of £9m; increasing headwinds in the commercial fly-in fly-out business; and cost increases on a small number of development programmes in the Advanced Electronics Solutions Sector. The remainder of the Group continues to trade in line with the Board's expectations, with the order book slightly ahead of the year end position on a like-for-like basis.

The biggest adverse impact on underlying trading has been in the Wireless business, where there have been operational issues and delayed shipments to customers. Following a detailed operational review, Cobham has decided to take a one-off £9m charge within the Group's first half trading profit. The charge includes some additional liabilities relating to 2015 shipments and adjustments which reflect the reassessment of some accounting policies. The Group has acted to strengthen internal controls in the business and has made changes to its operational and financial management. The Wireless order book at the end of March was ahead of the prior year comparative and this, together with increased momentum in the in-building wireless order pipeline, is anticipated to result in improved trading in the business as the year progresses.

Cobham has also seen increasing headwinds in its commercial fly-in fly-out business in its Aviation Services Sector towards the end of the first quarter, with certain natural resources customers in Australia slowing-down their operational activities. This development has resulted in reduced flying activity in this market. In response to the increasing headwinds the business has proactively removed costs, including reducing the number of aircraft and making reductions in other direct and indirect costs.

Within Cobham's Advanced Electronic Solutions Sector, there have been cost increases on a small number of development programmes in the first quarter due to a combination of technical and supplier quality issues. Cobham is working through these issues and expects improved performance and recovery through the year.

Notwithstanding these near term issues, the Board is committed to its strategy and sees the Rights Issue as being key to the Group being able to continue to invest in technology and know-how. This investment ensures the Group can maintain its leading positions in markets with good prospects. The Board continues to believe that Cobham is well placed to deliver growth over the medium term.

Further cost actions

Cobham also intends to review its Group-wide cost structures, targeting run-rate net savings of approximately £30m per annum by 31 December 2016, with anticipated net savings of £10m to be delivered in 2016. This will aid mitigation of margin pressure, support delivery of the Board's earnings expectations, the generation of future free cash flow and thus underpin further deleveraging over the medium term, consistent with the stated intention at the time of the Aeroflex acquisition. The savings will be achieved from a combination of restructuring, manufacturing outsourcing and overhead reduction activities across the Group. The costs of achieving the savings will be recognised largely in Cobham's underlying trading profit, with no additional non-underlying charges anticipated.

Outlook

Following the slow start in the first quarter, the Board now anticipates that Group underlying trading profit will be approximately £15m below its previous expectations for the full year. This is primarily due to a combination of the impact of increased headwinds in the commercial fly-in fly-out business in Australia together with the one-off charge of £9m in Wireless and short-term resolution of operational issues. The Board also expects there will be a more pronounced earnings bias to the second half of the year.

Background to and reasons for the equity issue

At the time of the acquisition of Aeroflex the Board decided to raise equity via a cash placing to maintain leverage at approximately 2.5x net debt to EBITDA at completion of the acquisition, with deleveraging thereafter leading to a balance sheet target of 2.1x by the 2015 year end.

However, since the Aeroflex acquisition the Group's leverage has not reduced as expected and by year end 2015 it had reached 2.9x net debt to EBITDA. This was caused in part due to the strengthening of the US dollar against sterling. With approximately 90% of the Group's gross debt denominated in US dollars this has increased net debt since the Aeroflex acquisition by approximately £162m, and which in isolation increased net debt to EBITDA by 0.4x.  

In addition, since the acquisition of Aeroflex, there have been a number of other factors which have constrained cash generation and adversely impacted Group EBITDA as follows:

Defence/security markets

· Ongoing investment in the Group's engineering and development programmes. This includes investment in multi-year aerial refuelling development programmes in the Mission Systems Sector and major electronics upgrade programmes in the Advanced Electronics Solutions Sector. There is ongoing investment of approximately £160m in the Group's balance sheet related to these activities, which is invoiced to customers on achievement of contractual milestones. Cobham continues to make good progress on key programmes, with low rate initial production now commencing on the A400M aircraft and the KC-46 aircraft being in flight test phase. In aggregate the Group's development programmes are expected to deliver long term cash and revenue streams, once engineering/development is completed and production commences.

· Investment in increased levels of capital expenditure to support new contract wins, in particular the Australian Maritime Safety Authority contract for airborne search and rescue. This contract has a value of AUS$640m over twelve years, excluding three optional years. Cobham will invest an expected AUS$110m, including the purchase and modification of four aircraft. The bulk of this being incurred over 2015 and 2016. Flying operations will commence later this year.

Commercial markets

· The Group experienced unexpected and significant market headwinds in some of its shorter cycle commercial markets, adversely impacting earnings and cash. These include the Group's marine SATCOM and Wireless businesses with subdued market conditions being driven primarily by reduced underlying demand in Asia-Pacific and weakness in global oil and gas markets. In addition, these market challenges resulted in a £42m build-up in working capital at the 2015 year end, as conditions deteriorated rapidly. This excess inventory is now being shipped in 2016. The Group remains positive on the medium term macro growth prospects for these communications markets.

The combination of the above issues means that, while the Group has significant headroom within its interest cover covenants in its financing documents, by 30 June 2016, the Group's next lending covenant testing date, net debt to EBITDA could be close to the covenant ratio of 3.5x.

In light of current circumstances the Board is today announcing decisive action to reduce the Group's indebtedness through a rights issue, which it believes to be in shareholders' best interests. This will allow management to focus on bringing the development programmes to production and insulate the Group against short term market headwinds, whilst continuing its focus on operational efficiency and working capital improvement. 

Cash flow and balance sheet

Primarily as a result of the slow trading in the first quarter, operating cash flow has been below Cobham's previous expectations. Cobham has made good progress in reducing inventory in its shorter cycle businesses, following the year-end build up. However, this has been more than offset by other factors, including increases in working capital on large engineering and development programmes and by customer shipment delays in the Advanced Electronic Solutions Sector. Management of working capital remains a key priority.

The combination of Cobham's weaker cash flow and adverse exchange rate movements has impacted net debt, which was £1,207m at the end of 2015. Since then it has increased to £1,314m at the end of March 2016, including a further £64m adverse impact from translation of the Group's foreign currency denominated debt. The Board believes, therefore, it is important to reduce leverage to a more sustainable level which will restore the Group's operational and financial flexibility.

Dividend policy 

The Board today confirms its intention to pay a rebased total dividend in respect of 2016 which is equal in absolute quantum to the £126m dividend announced for 2015. This quantum will be paid over the total share capital, as enlarged by the rights issue, with the additional shares first qualifying for the 2016 interim dividend to be paid on 4 November 2016.

The Board believes that the Group's ability to convert a high proportion of its earnings into cash is unchanged and therefore it remains committed to its stated dividend policy, which is broadly to align future dividend increases with underlying earnings growth, while rebuilding cover over time.

The shares will go ex-dividend in respect of the 8.13p final dividend for 2015 on Thursday 28 April and this will be paid on 27 May 2016 to all eligible shareholders, as previously announced.

Strategy

The Group's vision remains to be a leading global technology and services innovator, respected for providing solutions to the most challenging problems.

Cobham's strategy remains building and maintaining leading positions in its chosen markets by leveraging innovative technology and know-how with a deep insight into customer needs. Supporting this strategy, the Group has five strategic actions which are: to focus on its customers and develop close relationships with them; improve operational performance to ensure customers' needs are being met; invest in innovative and differentiated technology to win new customers and grow market share; allocate capital to optimise revenue and profits; and to enhance skills and capabilities within the business, to create long term competitive advantage.

Cobham's current focus is on organic execution, including the delivery of revenue growth, increased cash generation and the completion of the integration of the former-Aeroflex businesses.

The Board is committed to its strategy and sees the Rights Issue as key to the Group being able to continue to invest in technology and know-how. The Group has made good progress against its strategic actions to date and this includes tangible progress on a number of fronts.

Interim Results

The Group's interims results will be announced on 4 August 2016.

Analyst conference call

There will be a conference call for investors and analysts at 08.00 on Tuesday, 26 April. The call can be accessed by ringing +44 (0) 2071 928000, followed by entering the conference code of 99897821. A replay facility will be available by dialling +44 (0) 1452 550000, followed by the conference code of 99897821.

About Cobham

Cobham protects lives and livelihoods with its differentiated technology and know-how. The Group offers an innovative range of technologies and services to solve challenging problems across commercial, defence and security markets, from deep space to the depths of the ocean. It has market leading positions in air-to-air refuelling; aviation services; wireless; audio, video and data communications, including satellite communications; defence electronics; life support and mission equipment.

Cautionary Statements

This announcement is an advertisement and not a prospectus and not an offer of securities for sale to U.S. persons or in any jurisdiction, including in or into the United States, Australia, Canada, Japan or South Africa.

Neither this announcement nor anything contained herein shall form the basis of, or be relied upon in connection with, any offer or commitment whatsoever in any jurisdiction. Any offer to acquire shares pursuant to the proposed rights issue will be made, and any investor should make his investment decision solely on the basis of the information that is contained in the prospectus (the "Prospectus") to be published by Cobham plc ("Cobham" or the "Company") in due course in connection with the admission of its ordinary shares ("Ordinary Shares") to the Official List of the UK Listing Authority and to trading on the main market for listed securities of London Stock Exchange plc (together, "Admission"). Copies of the Prospectus will, following publication, be available from Cobham plc, Brook Road, Wimborne, Dorset BH21 2BJ.

This announcement contains 'forward-looking statements' with respect to the financial condition, results of operations and business of Cobham and to certain of Cobham's plans and objectives with respect to these items.

Forward-looking statements are sometimes but not always identified by the use of a date in the future or such words as 'anticipates', 'aims', 'due', 'could', 'may', 'should', 'expects', 'believes', 'intends', 'plans', 'targets', 'goal', or 'estimates'. By their very nature forward-looking statements are inherently unpredictable, speculative and involve risk and uncertainty because they relate to events and depend on circumstances that may or will occur in the future.

There are various factors that could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements. These factors include, but are not limited to, changes in the economies, political situations and markets in which the Group operates; changes in government priorities due to programme reviews or revisions to strategic objectives; changes in the regulatory or competition frameworks in which the Group operates; the impact of legal or other proceedings against or which affect the Group; changes to or delays in programmes in which the Group is involved; the completion of acquisitions and divestitures and changes in commodity prices, inflation or exchange rates.

All written or verbal forward-looking statements, made in this document or made subsequently, which are attributable to Cobham or any other member of the Group or persons acting on their behalf, are expressly qualified in their entirety by the factors referred to above. Neither Cobham nor any other person (including BofA Merrill Lynch and Jefferies) intends to update these forward-looking statements.

This announcement does not constitute or form part of, and should not be construed as, any offer, invitation, solicitation or recommendation to purchase, sell or subscribe for any securities in any jurisdiction and neither the issue of the information nor anything contained herein shall form the basis of or be relied upon in connection with, or act as an inducement to enter into, any investment activity. Any purchase of Shares in the proposed rights issue should be made solely on the basis of the information contained in the final Prospectus to be issued by Cobham plc in connection with the proposed rights issue. The information in this announcement is subject to change. This announcement is for information and background purposes only and does not purport to be full or complete.

This announcement is not and does not contain an offer of securities for sale or a solicitation of an offer to purchase or subscribe for securities in the United States, Australia, Canada, Japan or South Africa or any other state or jurisdiction in which such release, publication or distribution would be unlawful. The securities to which this announcement relates (the "Securities") have not been, and will not be, registered under the U.S. Securities Act of 1933, as amended (the "Securities Act"), and may not be offered or sold in the United States unless registered under the Securities Act or pursuant to an exemption from, or a transaction not subject to, registration under the Securities Act. There will be no public offer of the Securities in the United States or any other jurisdiction. Subject to certain exceptions, the Securities may not be offered or sold in Australia, Canada, Japan or South Africa or to, of for the account or benefit of any national, resident or citizen of such countries. The distribution of this announcement and the offering of Shares in certain jurisdictions may be restricted by law. No action has been taken by the Company, BofA Merrill Lynch or Jefferies that would permit an offering of such Shares or possession or distribution of this announcement or any other offering or publicity material relating to such Shares in any jurisdiction where action for that purpose is required. Persons into whose possession this announcement comes are required by the Company, Merrill Lynch International and Jefferies to inform themselves about, and to observe, such restrictions.

No statement in this announcement is intended as a profit forecast for FY16 and no statement in this announcement should be interpreted to mean that underlying operating profit for the current or future financials years would necessarily be above a minimum level, or match or exceed the historical published operating profit or set a minimum level of operating profit.

Jefferies International Limited (Jefferies), which is authorised and regulated in the United Kingdom by the UK Financial Conduct Authority (FCA), and Merrill Lynch International (BofA Merrill Lynch), which is authorised by the Prudential Regulation Authority (PRA) and regulated in the United Kingdom by the PRA and FCA, are acting exclusively for Cobham plc and no one else in connection with the Rights Issue, and will not regard any other person (whether or not a recipient of this announcement) as their respective clients in relation to the Rights Issue and will not be responsible to anyone other than Cobham plc for providing the protections afforded to their respective clients or for providing advice in relation to the Rights Issue referred to in this announcement or any other transaction, arrangement or matter referred to in this announcement.

This announcement has been issued by Cobham plc and is the sole responsibility of Cobham plc. No representation or warranty, express or implied, is or will be made as to, or in relation to, and no responsibility or liability is or will be accepted by Jefferies or BofA Merrill Lynch or their respective affiliates or agents as to, or in relation to, the accuracy or completeness of this announcement or any other information made available to or publicly available to any interested party or its advisers, whether written, oral or in a visual or electronic form, and howsoever transmitted or made available, and any liability therefore is expressly disclaimed.

The information in this announcement may not be forwarded or distributed to any other person and may not be reproduced in any manner whatsoever. Any forwarding, distribution, reproduction, or disclosure of this information in whole or in part is unauthorised. Failure to comply with this directive may result in a violation of the Securities Act or the applicable laws of other jurisdictions.

Neither the content of the Company's website nor any website accessible by hyperlinks on the Company's website is incorporated in, or forms part of, this announcement.

In connection with the proposed rights issue, Merrill Lynch International, Jefferies and any of their affiliates, may take up a portion of the Shares in the proposed rights issue as a principal position and in that capacity may retain, purchase, sell, offer to sell for their own accounts such Shares and other securities of Cobham plc or related investments in connection with the proposed rights issue or otherwise. Accordingly, references in the Prospectus, once published, to Shares in the capital of Cobham plc being issued, offered, subscribed, acquired, placed or otherwise dealt in should be read as including any issue or offer to, or subscription, acquisition, placing or dealing by, Merrill Lynch International, Jefferies and any of their affiliates acting in such capacity. In addition Merrill Lynch International, Jefferies and any of their affiliates may enter into financing arrangements (including swaps or contracts for differences) with investors in connection with which Merrill Lynch International, Jefferies and any of their affiliates may from time to time acquire, hold or dispose of Shares. Merrill Lynch International, Jefferies do not intend to disclose the extent of any such investment or transactions otherwise than in accordance with any legal or regulatory obligations to do so.