Melrose Industries : Risk and Revenue Sharing Partnerships booklet PDF

Risk and Revenue Sharing Partnerships

Purpose of this document

Risk and Revenue Sharing Partnerships (RRSPs) are an important part of the Melrose investment case. In this booklet we aim to provide more information on RRSPs, how Melrose is positioned today, how the cash generation flows and the accounting involved. The Group will provide longer term financial targets for the period beyond 2025 at its full year results in March 2025. This booklet is not intended for this purpose.

This booklet (including any oral or video material and any question-and-answer sessions in connection with it) is provided for information only. It is not intended to and does not constitute or form part of any offer, invitation, inducement or solicitation of any offer to purchase securities, and is provided subject to conditions, qualifications and restrictions as further described on page 35. By reading this booklet, you agree to those conditions. Please also note on page 35 we include the basis of preparing certain financial data, which is important context for numbers presented.

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Melrose's RRSPs at a Glance

• Melrose's Engines division is a world leader in the design and manufacture of structural engine technology, with Risk and Revenue Sharing Partnerships (RRSPs) forming part of the business.
• RRSPs are an important and necessary part of the aerospace engines industry with life-of-programme contracts lasting c.50 years.
• Melrose has an enviable portfolio of 19 RRSPs which cover c.70% of current global flight hours across both narrowbody and widebody aircraft.
• Following decades of investment, 17 of our 19 RRSPs are already in the cash generation phase and the remaining two are on track to turn cash positive by 2028.
• Melrose's RRSP contribution focuses primarily on the design, manufacture and support of engine mount structures and cases, which typically last the life of the engine.
• Melrose is entitled to its share of RRSP programme aftermarket income, but its work is largely done when an engine is shipped, so very high profit margins and strong cashflows are generated as programmes mature.
• Absolute cash generated by the RRSPs is expected to grow through to 2050, as engines age, fleet size increases and flight hours grow; in total the portfolio is forecast to produce £22 billion of cashflow over the coming decades.
• For five RRSPs, due to specific contractual rights, Melrose
  is required under accounting rules (IFRS 15) to record a proportion of future aftermarket income at the point of original equipment (OE) delivery.
• Melrose is prudent with its accounting and typically only records 10% to 30% of aftermarket income as "unbilled work done" for these five RRSPs when new engines are shipped.

19

RRSPs built up over many decades

17

RRSPs are in the cash generation phase

70%

of current global flight hours covered by Melrose's RRSPs

Contents
Executive Summary	04
Melrose's RRSPs in Context	06
What is an RRSP?	08
Melrose's RRSP Portfolio	10
Melrose's RRSP Cashflows	18
Melrose's Accounting for RRSPs	20
Summary	26
Appendices	27
Glossary of Terms	34

RISK AND REVENUE SHARING PARTNERSHIPS

MELROSE INDUSTRIES PLC

3

Executive Summary

With a heritage of over 90 years, the Engines division of Melrose is a recognised world leader in critical engine components on leading civil and defence programmes.

As part of the division, a uniquely broad portfolio of 19 civil-led long- term RRSPs, covering all major engine OEMs, and of varying maturities, provides contractual entitlement to significant cash generation estimated at £22 billion for the next 40 years and beyond.

Typically, within an RRSP, each partner owns a pre-agreed percentage of the engine programme, contributing this percentage towards the programme cost, and receiving the same percentage of that programme's returns, most of which are generated during the aftermarket phase

of an engine's life.

Today, our solutions focus primarily on the design, manufacture and support of the engine mount structures and cases, all of which typically last the life of the engine with minimal incremental aftermarket work once the engine is on the aircraft wing. For Melrose, the dynamic of significant upfront investment but only minimal aftermarket work leads to a very high profit margin and strong cashflow as the programme matures.

With 17 of our 19 RRSPs already generating cash, and the remaining two expected to turn cash positive by 2028 as a result of their maturation cycle and the conclusion of the Pratt & Whitney Geared Turbofan (GTF) powder metal issue (PMI), our RRSP portfolio is entering what we and our partners expect to be a multi-decade

cash generation period. RRSP programme cashflows are projected to increase through to 2050. This is principally as a consequence of the GTF PW1100G and PW1500G1 programmes maturing, supported by the GEnx, Trent XWB and other existing fleets ageing and the overall fleet size increasing. Furthermore, flight hours are projected to grow well into the next decade, leading to higher engine utilisation and more shop visits being completed (when typically we receive the majority of our cash). Given the maturity profile of our RRSPs today, this trajectory is substantially de-risked and all partners have visibility of this data.

90

years of heritage

19

civil-ledlong-term RRSP agreements

40+

years of aftermarket cash generation

1 References to PW1500G also include the PW1900G variant.

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Our 19 RRSPs reflect

the considerable resource, effort and financial investment over the last

40 years. The portfolio is well positioned to generate significant returns for our investors in the coming decades.

2 In 2023 variable consideration represented £173 million of total RRSP revenue

of £680 million.

From an accounting perspective, for 14 of our 19 RRSPs, our revenue reflects the cash received for components that are delivered in the production phase and, once in the aftermarket phase, matches our contractual share of the aftermarket income as and when generated. Both turn into cash within a normal credit term.

For the remaining five RRSPs,

at the point we deliver our engine component we are required by IFRS 15 to record a proportion of future aftermarket income called variable consideration. This is due to a combination of specific contractual rights and the nature of our components in these partnerships, which typically last the lifetime of the engine. The variable consideration, which is currently around a quarter of our overall RRSP revenue2, effectively recognises

or pulls forward a percentage of our future contractually entitled aftermarket income and treats it as revenue at the point of delivery of our components. In order to pull forward the aftermarket income, a rigorous assessment of future revenues and costs is made. This assessment draws upon OEM inputs and other market data for items such as expected fleet size, flight hours and cycles, frequency of shop visits and the expected profitability over the life of an engine.

Importantly, IFRS 15 requires us to ensure that any revenue pulled forward must be highly probable to not reverse at a later stage. As a consequence, any revenue pulled forward is risk adjusted and currently we record only 10% to 30% of available aftermarket income over the life of the engine, despite having substantially completed our work at the manufacturing stage. Our risk assessment considers a wide range of programme risks including the length of an engine's life, potential programme cost pressures, and the cost of any additional development work. These assumptions are reassessed annually and, where appropriate, the prudence is unwound, resulting in a "catch up" addition to variable consideration being recognised.

Variable consideration creates a mismatch between profit and cash, since the cash is typically received at the point of the shop visit that takes place routinely, but often several years after a percentage

of the revenue and profit is recorded. This mismatch is most acute whilst two of our 19 RRSP contracts remain cash negative and the gap is expected to be at its largest

in absolute terms in 2024.

Variable consideration leads to an increase in the unbilled work done asset in the Melrose Group balance sheet and this asset is expected to continue to increase as OEM deliveries grow, and the programmes mature, ahead of the rate

of amortisation.

Current estimates indicate a peak in the unbilled work done asset during the period 2035 to 2040. The unbilled work done asset is amortised over a prudent estimate of the engine life, currently 14 to

18 years in proportion to the cash receipts, and this amortisation is recorded as a reduction to revenue. Over the engine life the unbilled work done asset is fully amortised and replaced by the actual aftermarket revenue to which we are entitled.

In summary, our 19 RRSPs reflect the considerable resource, effort and financial investment over the past 40 years. The portfolio is well positioned to generate significant returns for our investors in the coming decades, currently estimated at £22 billion. Our incumbent, contractually guaranteed positions and technologies also provide the platform for involvement in the next generation of aero engines where our partners know the value we bring. Melrose is extremely pleased to be a partner in these RRSPs and looks forward to benefitting from them for many years to come.

RISK AND REVENUE SHARING PARTNERSHIPS

MELROSE INDUSTRIES PLC

5

Melrose's RRSPs in Context

The Engines division of Melrose is a leading tier one manufacturer of high performance structural and rotating engine components and represented c.36% of Group revenue and c.79% of Group operating profit in 20233.

The division has significant diversification covering civil and defence, OE and aftermarket (AM), RRSP and non-RRSP activity, with the end market split approximately 76% Civil and 24% Defence4.

OE revenue consists of the sale of sophisticated components to leading engine manufacturers in advance of initial engine assembly, typically six to nine months prior to aircraft delivery, whilst aftermarket revenue relates to income generated during the lifetime of an engine after delivery. The aftermarket

is expected to represent c.55% of Engines revenue in 20255 and generate more than 85% of divisional operating profit6. It includes civil-led RRSPs, commercial engine component contracts, repairs

of engine components, and governmental partnerships.

Our Engines division has its origins in a relationship with the Swedish Air Force dating back more than 90 years. It continues to operate on a partnership model based on trust and enduring collaboration. The business entered into its first civil partnership agreement with GE on the CF6 engine in 1981, quickly followed by the JT8D with Pratt & Whitney (P&W) in 1982. Over the course of the next four decades, it further established itself as a reliable and trustworthy partner to all engine OEMs as an indispensable provider of critical technologies and expertise to enhance engine performance on their commercial engine programmes. This partnership model is the basis of the various RRSPs. As of today, we have 19 RRSPs of varying construct7, holding programme shares of up to c.7% depending on the engine. The most recent RRSP was signed in 2011 with the associated engine entering service in 2018.

c.79%

of Group operating profit from Engines division in 2023

>85%

Engines division operating profit generated from aftermarket in 2025

FIGURE 1 - THE ENGINES DIVISION

24% Defence

THE ENGINES

DIVISION4

76% Civil

3 FY23 Full Year Results: Engines revenue £1.19 billion, Engines adjusted operating profit £310 million. Group revenue £3.35 billion, Group adjusted operating profit £390 million.

4 FY23 Full Year Results Presentation: Page 21.

5 Aerospace Capital Markets Day 17 May 2023: Page 11.

6 Aerospace Capital Markets Day 17 May 2023: Page 4.

7 See Appendix 5 for a full breakdown of all our RRSPs.

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We are bringing expertise in the design of complex load-carrying structures, as well as in the use of our proprietary additive fabrication with Laser Wire Deposition (LWD) technology.

Our collaboration with the

OEMs begins at the design stage, including testing and integrating our capabilities in joint technology demonstrators, years before

the actual launch of an engine programme and the associated RRSP. The OEMs rely on us to provide support for their past, current and future programmes, and the barriers to entry for new partners are exceptionally high. Such a high level of partnership and collaboration requires a significant amount of trust and long-term relationships, which only a small group of industry players have gained. We have built this over generations of engine programmes and continue to do so as we look

to the future. It is the fact that we are an integral partner to lead OEMs from conception to delivery that entitles us to decades

of aftermarket income.

We fully expect to participate in future engine programmes, and we are already uniquely placed on the Next Generation GTF and CFM RISE as the only partner on both technology demonstrator programmes. Here, we are bringing expertise in the design and manufacture of complex load-carrying structures, as well as in the use of our proprietary additive fabrication with Laser Wire Deposition (LWD) technology.

The exact timing, contractual nature and percentage programme share of these engines will be determined in the future. As of today, we would not expect any RRSP to be agreed before the end of the decade, with any subsequent significant investment not anticipated until the early 2030s.

RISK AND REVENUE SHARING PARTNERSHIPS

MELROSE INDUSTRIES PLC

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What is an RRSP?

RRSPs are life-of-programme partnerships between engine manufacturers and a handful of strategic partners, such as Melrose.

The introduction of a new engine is a significant financial investment, with total average costs for all partners reaching many billions of dollars8. Before the launch of a programme, and a potential RRSP, there is a relatively light investment phase, typically lasting seven years, focused on the technological development of the engine. At the back end of this phase, and in advance of the significant ramp up in investment during the product development phase, the OEM forms an RRSP, formalising the sharing of the as-yet-unknown costs, risks and returns of an engine programme. Following the product development phase, again typically seven years in duration, the OE production phase begins and the engine enters into service, generating OE revenue.

This phase lasts for a period of around 15 to 20 years, potentially longer. It is worth noting that even when an engine has entered service, the programme partners continue to work on upgrades and further developments, as we are currently seeing with the GTF Advantage. After approximately five to seven years of an engine's life, and therefore still within the OE production phase for that engine programme, the aftermarket phase begins. This can last for a further 30-plus years beyond the end of an engine programme's production phase. This aftermarket phase involves the provision of fleet management, engine upgrades and maintenance, repair and overhaul (MRO).

After approximately five to seven years of an engine's life, and therefore still within the OE production phase for that engine programme, the aftermarket phase begins. This can last for

1. further 30-plus years beyond the end of an engine programme's production phase.

8 For example, the Pratt & Whitney PW1000G GTF is estimated to have cost c.$10 billion to develop.

FIGURE 2 - RRSP ENGINE LIFECYCLE

OEM decision to invest		Programme launch		Entry into service		Production ends
TECHNOLOGY			PRODUCT		7	OE		15
7
DEVELOPMENT	YEARS		DEVELOPMENT		YEARS	PRODUCTION		YEARS
						AFTERMARKET
						SERVICES
LIGHT INVESTMENT		HEAVY INVESTMENT	TURNS CASH POSITIVE
						HIGH PROFIT AND CASH
- Market requirements		- Define engine		- Produce engine		- Fleet management
- New methods			- Meet requirements		- Improve engine		- Engine upgrades
- New materials			- Validation programmes			- Overhaul
- Airframe integration		- Certification programmes			- Repair
- Engine specification
			ENGINE PROGRAMME LIFESPAN CAN BE ~50 YEARS

30

YEARS

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