Rolls-Royce Holdings plc

Okay, I'm just looking for a way from the back to let us know ready. We are.

All right. So thank you.

It's lovely to be back here at the Stock Exchange again. Thank you all for coming out on person on such a busy morning, and welcome to our 2022 full year results presentation.

I think most of you know me, but I'm Isabel Green, Head of Investor Relations. I'm joined here today by our CEO, Tufan Erginbilgic; and our CFO, Panos Kakoullis.

Before we begin, I'm required to show you our safe harbor statement on Slide 2. As always, the full set of results materials can be downloaded from the Investor Relations section of our website.

We're going to start today with a short introduction from Tufan, and then Panos will present the 2022 results. Tufan will come back then to talk about his observations and priorities in the future.

The presentation today is going to last around 45 minutes, so there will be plenty of time for your questions at the end. So with that, thank you very much.

Over to you, Tufan.

Thanks, Isabel. Hello, everyone.

To those in the room, it is good to see you in person. For everyone watching online, welcome too.

As this is my first results announcement at Rolls-Royce, I will introduce myself before handing to Panos. When I was approached last year about the opportunity at Rolls-Royce, I was drawn by the strong brand and reputation, and it is important as a global company.

There are only a handful of companies whose products have helped shape modern society, from the development of jet engine itself, to the wide range of engines and systems we make today. Our ingenuity has helped bring the world closer.

However, I also found a company that wasn't achieving its full potential operationally or financially. I saw an opportunity to make a real difference and take Rolls-Royce to a much stronger position.

Before joining Rolls-Royce, I spent 20 years at BP. I led the onstream business, and before that, the lubricants business through their turnarounds.

I also spent several years on the Board at GKN and most recently worked in private equity. In all my previous roles, I have driven step changes in performance, set clear strategies and delivered sustained improvements in profit, cash flows and returns.

Everything I've seen since arriving has made even more confident in the potential to do the same at Rolls-Royce. I'm now going to ask Panos to run through the 2022 results.

You are going to hear that business has delivered improved performance last year. However, you are then going to hear from me that these results are not good enough for a company like Rolls-Royce.

We have higher expectations for this business, and we are clear on how we are going to deliver on them. Over to you, Panos.

Good morning, everyone, and thank you Tufan. In 2022, group revenue increased 14% to GBP 12.7 billion.

We had strong growth in revenue in Civil Aerospace and Power Systems, which were up 26% and 23%, respectively, as volumes started to recover. There was a more modest 2% growth in defense.

Operating profit increased by GBP 197 million to GBP 652 million, and that was driven by three factors: firstly, improvements in long-term contract margins in Civil Aerospace. Secondly, increased profit from spare engine sales again in Civil Aerospace.

And thirdly, significant revenue growth in Power Systems. Now that was partly offset by the non-repeat of the GBP 140 million foreign exchange credit in 2021, which was in Civil, lower spare parts sales in defense, increased R&D in new markets.

And also, common with many others, the impact of inflation, notably in Power Systems. Free cash flow improved by GBP 2 billion year-on-year from an outflow of GBP 1.5 billion in 2021 to an inflow of GBP 505 million in 2022.

And again, that was driven by 3 things: firstly, the improved cash flow in Civil Aerospace, which reflected strong growth in engine flying hour receipts ahead of shop visit growth; secondly, higher defense cash flows; and thirdly, a reduced working capital outflow. Our net debt position have improved from GBP 5.2 billion at the end of 2021 to GBP 3.3 billion at the end of '22.

And that was due to the completion of our GBP 2 billion disposal program and the free cash flow that we generated during the year. Moving on now to the performance by business unit, and I'll start with Civil Aerospace.

We saw a continued recovery in international travel in '22, driving up our large engine flying hours to 65% of 2019 levels. The reopening of China towards the end of the year drove a further improvement in January, up to 79% of 2019 levels.

This supports our expectations for large engine flying hours to be between 80% and 90% of 2019 levels as we move in 2023. The recovery in large energy flying hours was also complemented by robust performance in business aviation.

We carried out 1,044 total shop visits in '22, which is a 10% increase against the 953 million in 2021. For 2023, we expect between 1,200 and 1,300 total shop visits with a step-up in large engine shop visits as higher flying hours activity converts into increased demand for aftermarket services.

Engine deliveries rose by 15%, driven primarily by business aviation. We delivered a total of 190 large engines, which is 5 fewer than the prior year.

We delivered 44 large spare engines, which is 8 more than the prior year. Large spare engines represented 23% of total OE deliveries, which is higher than the usual 10% to 15% as we build the spare engine pool to underpin fleet health and improve resilience ahead of the anticipated increase in shop visits.

We expect spare engine volumes to remain at a similar level that's in total terms in 2023 and '24. As in all our businesses, supply chain management and wage inflation were more challenging in 2022.

We manage this through commodity hedging, long-term supply contracts and pricing. Now they have also recently been 2 fires at important suppliers, one in late '22 and one in early '23.

These have put additional pressures on our operations. Whilst they did not impact 22's results, they will impact cash flows in '23.

Civil Aerospace revenue was up 25% on the prior year to GBP 5.7 billion, with OEM services up 23% and 26%, respectively. Revenue is higher across all of our portfolio, large engines, business aviation, regional and V2500.

Civil Aerospace profit of GBP 143 million, compared with a loss of GBP 132 million in '21. The year-on-year increase was driven by 3 things: firstly, improved profitability on LTSA contracts, reflecting commercial discipline on pricing, costs and contractual terms.

This resulted in GBP 319 million of contract catch-ups in '22, which compared to GBP 256 million in the prior year. There was also a GBP 51 million decrease in the onerous contract provision, which compares to a charge of GBP 122 million in '21.

That's which reduced the expected losses on those contracts. Secondly, higher volumes and a different mix of large spare engine sales with more third-party sales to capacity providers than in the prior year; thirdly, higher aftermarket profit driven by V2500, business and regional as well as increased large engine shop visits.

These were offset by GBP 140 million headwind from the one-off foreign exchange revaluation benefit in '21, which did not repeat in '22. Our trading cash flow was GBP 226 million, which is a GBP 1.9 billion improvement prior year.

This reflected the recovery in engine flying hours ahead of shop visit growth, which resulted in growth in the Civil net LTSA balance of GBP 792 million. Higher cash flows from spare engine sales and also a smaller working capital outflow compared with the prior year, driven by a reduction in overdue debts and a lower cash outflow on the Trent 1000 engines.

In 2023, we expect the change in the LTSA balance to be between GBP 500 million and GBP 700 million, which reflects a slightly lower level of growth than in '22 due to an increased number of shop visits, including more wide-body refurbs. We expect to continue to collect on overdue balances and target continued contract improvements, which could result -- should result in contract catch-ups of between GBP 100 million and GBP 200 million.

If we now look at defense, revenue was up 2% organically, and we expect a similar level of growth in 2023. Submarine revenues grew by 18%, which were at a relatively lower margin.

Transport and combat revenues grew modestly at 4% and 2%, respectively. Naval revenue fell by 19%, which reflected supply chain challenges.

Defense is a long-cycle business and does not immediately benefit from rising defense spending and geopolitical tensions. However, there is a supportive budgetary backdrop, and we've been successful with some large order campaigns.

In 2021, we were selected to provide the power plant for the B-52 engine replacement program. In 2022, the Bell V-280 powered by AE1107F engines were selected by the U.S.

Army for the Future Long Range Assault Aircraft program. Operating profit of GBP 432 million was down by 10% year-on-year.

The 11.8% operating margin was 1.6 percentage points lower than '21, but at the upper end of our expected range. The year-on-year decrease was mainly due to the non-repeat of GBP 45 million of high-margin spare part sales in '21 that we called out at the interim results.

R&D spend increased by 9% as we invested in long-term programs that will create value in future years. Trading cash flow was up 13% from GBP 377 million to GBP 426 million.

This gave a cash conversion of 99%, which is up from the 82% in 2021, mostly due to the favorable timing of our customer advance payment of around GBP 60 million, which is not expected to repeat in 2023. Moving on to Power Systems.

Order intake in '22 totaled GBP 4.3 billion, which was 29% higher than in '21 with a book-to-bill of 1.3x. Power generation continued to perform well with growth in orders for power solutions to provide backup power for critical locations such as hospital and data centers.

Revenue was up 23% in '22 to GBP 3.3 billion, a significant rise despite the constraints to deliveries from the supply chain. Although absolute operating profit increased by 17% to GBP 281 million, Power Systems operating margin fell by 0.4 percentage points.

That was due to higher costs, some of which were due to inflation and supply chain disruption, increased self-funded R&D and some one-off charges, including impairments and write-down of assets due to the Russia-Ukraine conflict. Trading cash flow was 28% lower in '22.

Cash conversion was only 56% due to increased inventory to manage supply chain disruption as well as meet the volume growth. That was partially offset by structurally higher advanced receipts from customers.

Finally, New Markets. These are our early-stage businesses, Rolls-Royce Electrical and Small Modular Reactors.

In '22, New Markets reported an operating loss of GBP 132 million, which compares to a loss of GBP 70 million in '21 and a headcount increase of around 80% to approximately 1,000 people. This is in line with the guidance we gave in '21, and for SMR was largely covered by third-party funding.

Now the next slide sets out our summary funds flow for '22. We saw a GBP 505 million free cash inflow from continuing operations compared with an outflow of GBP 1.5 billion in '21.

The GBP 2 billion difference year-on-year can be broken down into 3 categories: Firstly, our operating performance has improved by GBP 1.2 billion. This was driven by trading growth in our established businesses and the increase in engine flying hours receipts ahead of shop visits costs, which caused the steep increase in our LTSA balance.

Secondly, working capital was an outflow of around GBP 500 million in '22 versus GBP 800 million in '21, which has a GBP 300 million improvement year-on-year. Inventories increased by around GBP 900 million due to supply chain challenges across the group as well as volume growth.

This was partially offset by just around GBP 400 million of the inflow from receivables, payables and contract balances. This was led by advanced payments in Defense and Power Systems and a reduction of overdue debts in Civil of around GBP 180 million.

Finally, other movements, that was an outflow of GBP 1.5 billion in '22 versus an outflow of GBP 1.9 billion in '21, a GBP 400 million improvement year-on-year. This reflected lower lease payments and derivative settlement costs as well as similar tax and interest costs.

Pension costs were lower than in the prior year as the U.K. defined benefit scheme is now fully funded and in a surplus position.

Turning now to the balance sheet. We ended '22 with GBP 3.3 billion of net debt, which is down from GBP 5.2 billion at the end of '21.

We completed our disposal program in the year and used the proceeds to pay down GBP 2 billion of debt. We retained strong liquidity.

We agreed a new 5-year GBP 1 billion sustainability-linked facility which is 80% guaranteed by the UKEF and that remains undrawn. We've seen positive momentum this year with rating outlook upgrades from Moody's, Fitch and S&P, but there is more to be done.

We're committed to returning to an investment-grade credit rating through systematically improving our underlying cash generation as well as our profitability. I'm going to hand back now to Tufan to show his observations on and priorities for the business.

Thanks, Panos. In the future, I look forward to being more emote in presenting our operational and financial performance.

Now I would like to start by sharing my early observations and some key issues that I see. I spent the last few months learning about our company with the teams, including time in our largest sites in U.K., U.S.

and Germany. We have great people, who are dedicated and committed to the work we do.

We have some of the best products and solutions in the world, supporting the needs of our customers in complex and heavily regulated industries with high barriers to entry. We have good market positions in our key segments.

The businesses we have today are improving as our end markets recover. As Panos showed, our results improved in 2022, helped by recovering markets and some benefits that will not repeat at the same level.

We cannot rely on market recovery alone to deliver better performance in the future. I have much higher expectations from the business and improvements need to be delivered on a sustainable and underlying basis.

Rolls-Royce has been underperforming for an extended period. Our 5-year TSR of negative 67% is evidence of this and shows this is not just a COVID issue.

Cash generation is unsatisfactory, and our debt is still too high. Too much of our gross profit is simply covering our overheads and interest payments.

A weak balance sheet and sub-investment credit rating limit our ability to invest in growth for the future. We have recently completed an extensive benchmarking study that confirmed our margins are below the competition on a like-for-like adjusted basis.

Our low operating margins and relatively high fixed cost base leaves us financially exposed when uncertainty impacts our markets. As a result, in the last 5 years, even excluding 2020 due to COVID, we have averaged a return on capital employed of just 3.5%.

We have also not had sufficient strategic clarity to make investment choices. Instead, we have been trying to keep too many options open.

More importantly, let's turn now to the overall proposition we are looking to create for investors. I believe we have the potential to be a much higher quality and more competitive company, a company focusing on sustainable earnings growth and cash generation with a winning mindset and culture that drives and rewards outperformance.

Underlying performance improvements will drive higher operating cash flows. This coupled with disciplined capital allocation, will grow our sustainable free cash flow.

A strong and flexible balance sheet will allow us to grow shareholder distributions and fund future growth. We will build a strong Rolls-Royce to deliver this proposition.

We are already in action, and we are proceeding with a sense of urgency. This slide sets out our priorities and in a way, our philosophy, how we are thinking about running this business, which is different from what has been done in the past.

These are the priorities we need to focus on to deliver the Rolls-Royce proposition. They deliberately overlap.

They will drive better performance independently and collectively. First, we will improve earnings and cash potential of the business.

The focus will be on quality growth in profits and cash rather than just revenue and market share expansion. Second, we will create an efficient business with a competitive cost base and improved operating leverage.

This will make us more robust to the external environment. Third, we will target sustainable cash generation and will deleverage our balance sheet at pace.

We remain committed to recovering our investment-grade credit rating and resuming shareholder returns. Fourth, we are delivering -- we are developing a clear and granular strategy to prioritize investment opportunities.

We will allocate capital centrally to the attractive market opportunities and programs. And fifth, we have an important role to play in the energy transition and remain committed to achieving net zero.

We will develop a robust framework to make the right choices. We will focus our investment on the most attractive market spaces and programs, evaluating all energy transition opportunities to ensure we are delivering the best value for Rolls-Royce and the shareholders.

We must only invest in new technologies where we are differentiated, where the market opportunity is sufficiently large and where there is a viable business model and synergies with our existing activities. By adding complementary capabilities, we can build winning propositions and derisk the group.

Partnerships will be a purposeful part of our strategy. All this will be underpinned by our most important priority, to ensure that our people and products are safe.

This is the right thing to do. We care about our people and the people that rely on our products.

We have launched a transformation program to deliver a step change in performance systematically and at pace. I'm chairing the weekly transformation planning group and the whole executive team will spend time together each month to focus on this.

Work has already started on critical workstreams. To support this, we have appointed a Chief Transformation Officer reporting to me directly.

We have several workstreams. We have appointed senior leaders to the first for efficiency and simplification, commercial optimization, working capital and strategic review.

I will talk about these in more detail on subsequent slides. The business improvement workstream is being led at the business unit level.

We have set challenging targets based on rigorous peer benchmarking analysis. This identified the performance gaps, our relative position in key businesses and scale the potential for improvement.

We are now working on the detailed plans to deliver that potential. The remaining 2 workstreams, changing the culture and performance management are critical to lasting change.

We will drive them by bringing the right mindset with our teams to be proactive and timely in our actions so that we can manage performance effectively. In January, I got together with our top 80 leaders for a working session on delivering change.

We focus on how we will lead the business through this transformation together as an aligned organization where everyone is mobilized and knows their role. We have also engaged the whole organization in an extensive communication effort on the opportunity ahead.

This will be an ongoing activity. I'm going to share more details about some of the workstreams, starting with efficiency and simplification.

This is about identifying and delivering sustainable improvements across the whole group focused on 3 things: organizational review, footprint consolidation and optimization, direct and indirect third-party cost efficiencies. This will improve our operating leverage so that we are competitive and robust to the external environment.

As you can see on the slide, our costs are high compared to our gross profit. And we are a long way from best-in-class.

Across the group, we have work underway to identify synergies across all our divisions and functions and to simplify our whole organization. A significant part of the cost reductions during COVID were activity-related, and largely in our civil business.

These costs have been going up again as activity levels come back. Our efficiency and simplification plans look to achieve sustainable cost efficiencies across the group that take the activity increase into account.

We will also be looking to capture efficiencies -- efficiency opportunities within each division and function. We are already in action on this.

For example, in Power Systems, we are already removing duplication and optimizing the organizational setup to accelerate decision-making. Commercial optimization is about getting the right reward for the risks we take and the value we create for our customers.

It will focus on Civil Aerospace and Power Systems. A stronger Rolls-Royce will be a better partner for our customers, more able to deliver operationally and invest in product development.

To support this, as part of our executive process, we established a group operating committee. I have already met with a number of our largest customers and they understand this.

We have also changed our commercial discussions on new contracts and renewals. In Civil Aerospace, for example, we set up a task force to review all the large engine LTSA contracts.

We are also working to lower our product cost and drive up the margins in contracts to ensure we achieve the returns that are aligned with the risks that we take. It is early days, but the results are already starting to come in.

We improved several onerous contracts on the balance sheet at the end of last year, and we achieved double-digit price increases on spare parts. We will drive further improvements this year to the margins of both profitable and onerous contracts.

And in Power Systems, we have already been able to renegotiate the prices with a benefit to profit and cash flows. These efforts continue as we speak.

We are becoming a commercially-minded and capable organization. At the end of 2022 -- let me talk about working capital, by the way, right now.

But -- and which is actually very linked to commercial optimization in a way. And at the end of 2022, we have GBP 25 billion gross working capital tied up in the business.

Our net working capital, GBP 2 billion higher than our position before the pandemic despite being -- revenues being lower. We are confident that we can deliver a significant and sustainable reduction in working capital across the group by deep diving into the operational value chain and optimizing each of the components of working capital.

Our immediate focus is on improving inventory management and recovering overdue receivables. The final workstream is our strategic review.

This is already underway. Let me start by making it clear that this is not just about what businesses should stay in the portfolio and what we should sell.

My early take on the portfolio is that all of our established businesses have the potential to create significant future value. One of the outcomes of the strategic review will be to determine which areas we will invest in and which we will not.

To support this new strategic rigor, we will centrally allocate capital to the most attractive market spaces or programs. This is a change from the past when there was more autonomy within the individual businesses.

This more disciplined approach will mean more effective resource allocation of limited available capital. We will continue to support critical safety programs as well as investment to enable the business to execute on the opportunities presented by the market recovery, but we cannot continue to allocate capital to projects that have low returns.

Beyond strategic clarity, a granular strategy will be an effective alignment and performance management tool as well as changing the culture. A clear strategy supported by the right performance management can be cascaded down and used as a powerful engagement tool to align the whole organization.

We will have a strategy implementation plan that makes it clear and meaningful to individuals how their business performance and individual objectives contribute to the strategy and midterm goals. With the right engagement and processes, this not only aligns the organization but also becomes a good performance management tool.

We will have the new strategy and midterm targets for you in the second half of this year, along with the metrics, we will be reporting against to track and measure our progress. Before I wrap up, I want to share our view of 2023 and our guidance for financial performance this year.

In 2022, our performance improved, driven by good underlying progress, but there are also some benefits that will not repeat at the same level. These are detailed in the supplementary slides for you, along with some additional guidance detail we hope you find useful.

We expect to achieve a higher operating profit and cash flows this year, reflecting the actions we are taking and the market growth as wide-body flying recovers and as we convert our order book into profits. For 2023, we expect to deliver operating profit of GBP 800 million to GBP 1 billion, which includes a benefit of GBP 100 million to GBP 200 million from targeted contract improvements versus around GBP 300 million last year.

We expect free cash flow of GBP 600 million to GBP 800 million, which factors in GBP 500 million to GBP 700 million of LTSA creditor growth versus the growth of around GBP 800 million in 2022 as shop visits increase. It also factors around GBP 200 million year-on-year headwind associated with the unwind of legacy or [indiscernible] concessions and around GBP 100 million impact of 2 fires at suppliers late last year and early this year.

We expect this GBP 100 million cash impact to reverse next year. There are environmental uncertainties and challenges in this guidance.

We will need to be agile and commercially minded as we manage the external risks of inflation, supply chain disruption, interest rate rises and recession. So to summarize the key takeaways.

We aim to create a high-performing competitive, resilient and growing business. We have a significant opportunity to expand our cash generation and profitability.

We are already in action to improve underlying performance. We will set a granular strategy with midterm targets.

We have a lot of hard work ahead of us, but we are moving fast and there are big potential rewards for all of our stakeholders when we get this right. Thank you for listening.

I will now open the meeting for questions.

[Operator Instructions]

It's Nick Cunningham from Agency Partners. You've spoken about the restructuring and actually answered quite a lot of questions that were in my mind.

But there's another few that come out. I mean one is Civil has been through a really tough, really 4 or 5 years because you have the Trent issue and then you had the pandemic and you've cut the size of the business by 1/3 already.

So how do you bring the people with you with yet at a round of change? And in particular, how do you avoid losing the good people that you want to keep when you're in the sort of labor market that we're in at the moment?

And then a separate question. And I guess it's something you'll probably be talking about in the second half.

But how do we work out where the Rolls-Royce is outperforming, what recovery would have brought anyway? Now how do we assess, if you like, your performance above what the market would have brought?

Okay. Very good, two good questions.

Let me pick them up in that order. You are absolutely right.

What Civil did, I guess, in COVID, you are referring to job cuts and so on. That's exactly what Civil needed to do because activity disappeared in the market.

And therefore, the company was bleeding cash, and as a result company did what it needed to do in the Civil business. But that kind of when activity comes back, as I made it clear in my remarks, that kind of thing is necessary because you are bleeding cash.

But when activity comes back, those costs come back in, and that has been actually happening. And now we are intervening with that because when the costs come back, I showed you the cost chart, your competitiveness doesn't change, i.e., if you're uncompetitive, and I believe facts are there that we are uncompetitive.

Our benchmarking study demonstrates clearly that we are underperforming on a like-for-like basis our competition. So therefore, that process was necessary but doesn't make you a better company in a sustainable basis.

So what we are trying to do is with our transformation program is really create a business sustainably more competitive and stronger company. And that's what we are trying to do.

But second part of your question is how do you bring people with you. Interesting, I know in the press sort of some comments have been made, but reality is when we engage our people, they are actually very excited about this future because who doesn't want to work for a successful company.

Who wants to work for an underperforming company. So I believe we will be able to unlock the potential actually with our people.

Yes, in this process, in the transformation process, everybody has a role, and we need to actually mobilize to whole force. And I would say, frankly, apart from many things, I think one thing will make a big difference is to make sure, and therefore, I talk about strategy and everybody knowing their role, everybody has a role in this.

And that way, we will make this very different with -- starting with clarity why we need to change. Very clear strategy, everybody knows their role in their strategy and then performance managed in a way that actually we performance manage strategic progress.

So if I come to your second question, recovery, I'm sure you all have your models, how much recovery would take this business to, and obviously, last year, Civil business gave you some numbers as well for midterm. I would say when we come back with our targets, we can actually talk about how we are going to measure our success.

But I'm going to say this -- I'm not going to talk about targets right now, but I'm going to say this, I have higher expectations from this business. And once we set midterm targets, then you can measure our progress against that.

It won't be only my success though. I don't hold it that way.

This will take the whole organization. And that's the power of this.

Thanks for your question. There is one question on the back, then I'll come here.

Chloe Lemarie from Jefferies. I had a first one for you, Tufan, actually.

So your predecessor focused really on fixed costs. You seem to focus a little bit more on positioning and focused investments.

So first question is, is there more to do on the fixed cost side. And in terms of positioning, et cetera, is there something to do in the portfolio, i.e., some areas that you've identified do not belong or is this just a matter of steering investment where it needs to be spent?

Second question would be for Panos, if we could go to the free cash walk between '22 and '23. You already gave the LTSA elements, but I wanted to see if you could give some more color on the Trent 1000 concession payments, please?

Okay. Let me pick up the first question, fixed costs and investment.

Let me start with fixed cost. Do I believe we need to reduce the cost base of Rolls-Royce?

Absolutely. Therefore, we -- if you look at the structure of our transformation program, one of the workstreams is about efficiency and simplification.

And I gave you -- I realized for this industry a new measure, I used that in the past, this total cash cost to gross margin. That measure is, in a way, operating leverage of the company, right?

And how much of our gross margin is actually consumed by our cost. And that is very high right now in Rolls-Royce.

And we will need to reduce that. And our hope is to get it to the best-in-class levels in the graph that I demonstrated.

That way we are going to be much more competitive company, and frankly, much more robust company if there are external shocks because any company needs to be ready for external shocks, but it will also create space to make investments. Second part of your first question is investments here and there.

I think our strategic review is pretty extensive review. I said it in my speech, I don't believe Rolls-Royce today has a granular strategy to make the choices.

And that will allow us to make the choices and there will be investment choices, there will be partnership choices. I don't want to right now double guess, but it is a pretty robust process.

And again, we don't run, that is not -- because strategy is an alignment tool as well as obviously a management tool. But we run this strategy in a way that lots of people actually already involved.

So that is -- but at the end, we will make choices and we will focus to our organization, though I believe Rolls-Royce needs to be a more focused organization and make more choices, investment choices and so on, absolutely. So Panos, over to you.

So I think your question was around the walk from '22 to '23. So -- on free cash flow.

So a material increase in free cash flow between '22 and '23. You've seen in the supplementary slides, we've called out the lumpy items.

We've done that both for profit and for cash year-on-year. The way I think about it, so we've got increased profitability in both Defense and Power Systems, obviously driving increased cash flow there.

On the Civil side, higher EFH receipts driven by the 80% to 90%. That's partially offset by that ramp-up in shop visit costs, and you can see that coming through in the lower number on the movement in LTSA creditor of GBP 500 million to GBP 700 million.

Tufan has talked about the workstream from working capital. So we are anticipating within that a structural improvement in underlying working capital that comes.

We can talk a little bit in a minute around phasing, especially on cash flow. We have got some headwinds that we've called out, again, in the supplementary, and Tufan called out in the guidance.

So the concessions, the legacy Boeing concessions of GBP 200 million outflow on that. And then the GBP 100 million as a result of the fire at the suppliers or the 2 fires at suppliers, which we expect to reverse in '24.

So that's effectively a move from '23 to '24. The other lumpy items we've called out, the hedge closeout costs, that goes up slightly year-on-year.

Tax is broadly flat. There's a little bit of an improvement in interest of 25 to 75.

As a result of the fact, we paid down the U.K. [ EF ] debt.

Other items sort of are broadly similar. So material increase.

Just the other point I'd highlight for you on free cash flow. We've always been a second half weighted business on free cash flow.

That will be the case in '23 as well, particularly driven by some of the supply chain challenges that we've highlighted the impact of those 5. So there is a heavy weighting and the benefits of transformation would likely to be second half weighted as well, will then increase that weighting.

George Zhao from Bernstein here. First one for Tufan, you talked about turning around the subpar performance of the company from recent years.

But I think we can agree that Rolls-Royce certainly did try to improve itself during that stretch. Even excluding the cuts during COVID, there were numerous rounds of restructuring in the last 5-plus years.

So you believe was the shortfall of the company to improve the performance in the past? And what will we do that is different from what has been attempted before to drive a sustained improvement?

And second one, just how do you assess the supply chain as you look to ramp up on the widebody new engine production as the targets laid out by Airbus recently, do you think that's feasible?

Okay. Thanks for the questions.

Frankly, I don't want to comment on what was done, what wasn't done in the past in terms of structuring. I already talked about how I hold the COVID restructuring.

When it comes to, therefore, I would rather talk about what I am -- what we are going to be doing. And frankly, as I shared with you before, I have some experience in turnarounds.

And I'm afraid I'm going to repeat, in any turnaround at least 3 things are very important, really get the organization to understand the reality and why they need to change. Second thing is get very clear strategy that you can make it relevant to everybody.

And I talk about that being an alignment tool as well as performance management tool, I actually seen it in action. It can be very, very powerful.

And then very good performance management, which we need to improve in Rolls-Royce. We need to improve performance reporting as well as performance management.

All those three areas, frankly, sort of needs to take place in Rolls-Royce. And you need to go at pace.

And therefore, we create a transformation program. In these things, you need to be very systematic and go at pace.

And we could have chosen to say we are going to improve the performance and deploy it to the business units with no central governance, et cetera. That was one way of doing that.

I didn't think that was going to create the right outcome. This is one difference I'm going to overemphasize.

This is group-wide program, not Civil Aerospace. Obviously, Civil Aerospace is included in it.

With a very clear transformation program, which is very holistic, it goes from performance management and culture to all the way clear actions on efficiency, optimization and so on. So you need to have those components in place and then align the whole organization then interesting things happen in a positive sense.

So that's what we are looking to do, and that's the journey we are on. On supply chain point, yes, I think we have -- I would say we have slightly 2 different supply chains because Power System supply chain is slightly different than Civil Aerospace and Defense.

Because of activity disappearing in Aerospace with COVID, as you know. So the whole supply chain really reduced the capacity, reduced labor, they took -- now they are all trying to bring that up while activity is recovering.

That is becoming a challenging thing for the whole industry. I'm talking about industry.

And therefore, my view is actually that supply chain will only stabilize between 12 to 18 months for [indiscernible]. Power Systems didn't have the same level of dip with COVID.

That supply chain is actually stabilizing more and it will stabilize and improve much earlier than the other one. So that's how I hold it.

Our Airbus targets, they are in line with our production targets as well. So we are totally aligned.

There's one question there, then I'll come here.

Charlotte Keyworth from Barclays. I just got one question.

I was just picking up on your comments around opportunities for better terms on LTSA contracts. Obviously, you can start that endeavor straight away with the new ones.

But for the renewals, I think the average length is about 12 years. And I just wondered if you could give us some idea in terms of phasing of when the roll off of those contracts would peak?

And when you start, you get the opportunity to renegotiate.

Okay. Let me -- and Panas, you may want to sort of talk about the average life of the contracts.

But let me pick up the question on sort of -- here is how I hold it. Obviously, any new contracts and renewals, we want to make sure that actually everything commercial terms reflect the value we create.

And when I say the value we create, I take it seriously. I -- we have some things to do to improve our operating efficiency and effectiveness, right?

So therefore, we can actually serve better to customers. Therefore, I'm actually thinking about this win-win.

For existing contracts, though, it is clear that some of our contracts are not good. As you know, in balance sheet, we have onerous contract provision.

So therefore, we are actually engaged even for those contracts to find win-win solutions with our key customers. I already met, as I said in my speech, some of our key customers.

And the key here is we need to improve our operational effectiveness and create more value for them and then get better terms, and that's the win-win because any sustainable partnership will have to be win-win. That's my experience.

So that's how we are actually going about it. Panos, in terms of how much left in our sort of...

The average earnings life term is a little bit lower than the number you said. It's closer to 8, 9 years rather than the 12.

The other I would add as well, it doesn't just have to be a pricing discussion on an existing contract. There's also effectively contract management.

So how an engine is flowing? Is it flowing in the way that's contractually agreed because there are different rates depending on how it's flown.

And maybe in the past, people were more forgiving on how it's flown. We're being much tougher on making sure the contractual terms are enforced within that.

This is Alessandro [indiscernible] from JPMorgan. I'd like to ask Tufan two questions on behalf of David Perry and one question to Panos please.

For the first question, Rolls-Royce, as a net LTSA liability of GBP 7.4 billion on its balance sheet. Have you done a specific audit of the contracts behind this liability.

In other words, are you happy with the pricing charge for future shop visits and expect that future profitability as this liability converts into actual work revenue and profit? Second question is Rolls-Royce has net debt of GBP 3.3 billion plus a number of other liabilities on its balance sheet.

Why are you confident that organic deleverage is the right solution? And the question for Panos, apologies if I've missed it, but I can't see any 2023 guidance for divisional EBITDA.

Please can you help us here?

Very good. Best regards to David, by the way.

So let me pick your -- in the order you asked actually. So LTSA GBP 7.4 billion.

My answer would be, first of all, we have obviously margin in that LTSA creditor balance that you are referring to 7.4%. And secondly, our commercial optimization workstream specifically targeting actually multiple workstreams plays into this.

Let me talk to that, specifically targeting improving -- we already have a margin in LTSA creditor balance, just to be clear. Second thing is commercial optimization and some of the things we shared on the earlier question, will obviously look to improve commercial terms and our take from those contracts but also, we are focusing on efficiency and cost because by doing to -- I always believe you need to play on both ends, if you are going to have a turnaround, gross margin improvement as well as cost.

So we are going to be focusing on the efficiency as I articulated in my presentation, and that cost efficiency actually includes shop visit cost as well. So there is the product cost out on OE and there is also a shop visit cost as well as sort of cost of the whole organization.

So both of them will actually improve our margin on LTSA credit. On your second question, we have -- why I believe organic cash generation.

I think I see the potential of the business. This business, if it is managed in the right way, and that is what we are looking to do, I believe has good potential to generate cash.

And that will require, as I said, we are now already into performance improvement effectively our agenda. What -- the way you should think about what we presented is -- because we presented lots of things.

The way we structured this with transformation program and business initiative plans at business unit level, we are looking to drive performance improvement as we speak. So we are actually in action as we speak.

Because we didn't want to wait even for 1 day. So there is a huge sense of urgency there, right?

That's how we -- then strategic clarity will follow that. And then we are going to combine the two.

Then you have a very clear strategy, which will allow you to make choices and performance improvement, transformation program is already progressing. Both of them will actually come together what we will call strategy implementation plan with midterm targets, and we will push that plan down to the level that actually a whole organization can relate to that.

They know their role in it. That's the game plan here.

But we are already on performance improvement side of it and strategic clarity will follow that. Panos.

I think that the last question was around divisional guidance. We haven't given divisional guidance, so you didn't miss it.

So the guidance we've given around operating profit is the GBP 800 million to GBP 1 billion for '23. And we've called out within that GBP 100 million to GBP 200 million of targeted contractual improvements.

We will come back later this year, as Tufan has said, around medium-term targets.

It's Harry Breach here from Stifel. Maybe one for each of you.

Panos, will have the easy one, and forgive my ignorance and lack of time earlier on. Can you help us with the dollar revenue increase in 2022 for the T&M side, and then the LTSA side separately?

And whether when we look to '23, we should be thinking about similar numbers. I won't embarrass you by asking for the number, but if you could give us a sense of that.

Maybe for Tufan. Tufan, one of the -- as I'm sure you know, one of the tremendous challenges is in trying to normalize for differences versus peers at Royce and currency exposure and hedge book in installed base maturity and aftermarket intensity with fewer takeoff and landing cycles, the more narrow body focused competitors and in the broader portfolio outside Civil, and the comparative R&D burden on the business as it is today.

How confident are you normalize for them? And then secondly, can you share at all where you think the normalized margin was in '22 and where the peers were like-for-like in their businesses in '22, so we can see what the gap is normalized?

Okay. we actually done that work, normalization work in the benchmarking that I talked about in my speech.

And what that study did is really -- because there are -- you are right, there are structural differences between the peers. And we actually look at Power Systems as well.

It wasn't that benchmarking was not only about Civil Aerospace, it included all 3 divisions, all big 3 divisions, I should say. And what we did in that study, we said, okay, what are the structural differences.

And we then -- we know what they are because I want to know, frankly, because some of the structural differences, you can do something about it as well. Then we look at the performance gap outside that.

It is very clear. I won't give you numbers right now.

But when we come back with midterm targets, sort of you will see the signs of it there. It is very clear we have performance gap.

I mean performance gap rather than total gap in all divisions especially in Civil Aerospace and Power Systems, to a lesser extent in Defense, partly because of the nature of that business. But -- so we actually done that work.

And obviously, it is informing already, as I mentioned in my speech, our performance actions. Because what we did with that, not only we are putting that into sort of transformation program, i.e., what we need to go with that.

But actually, we created a business unit level targets based on that so that business units are already working on it. So that is how actually we have done that.

But you are right, there are differences.

So I think the other question was on time materials, [indiscernible] pounds rather than dollars, so the time materials increased from -- in terms of revenues from GBP 629 million to GBP 865 million, so still around about 20% of service revenues within that. The primary driver of that increase was the V2500, and the other elements of the increase will relate to LTSA customers, so those elements that aren't covered by LTSA, I think, as we've talked about in the past.

As you look at '23, you can expect a sort of a continued recovery in V2500. That will be the sort of the main driver of 23% revenue growth in that area.

Okay, David.

So two further questions, please. The first one is, do you think the Power Systems is a core business for Rolls-Royce?

Does it have synergies with the rest of the group? And the second question is, how committed are you to the new market strategy?

Okay. Two good questions, as I should expect.

So let me start with Power Systems. When that business properly managed, it is actually a very good business.

It's got a structural advantage from the previous question, actually, that when we did the structural part of it in benchmarking, it got a structural advantage versus competition. And it got really good potential to be a growth -- really good growth business with very good returns.

And therefore, create value. I think that is where my focus is because that will create value for Rolls-Royce and shareholders.

But also, I'm not sure that business fully understood in terms of 2 other things. Actually, I spent 7 years of my life -- last 7 years of my life on energy transition, looking at everything, frankly.

Pace of energy transition in Power Systems, in the key segments of it will be slow. Second thing is even more important, some of the really most profitable key segments in Power Systems because Power Systems is not one thing, really.

Some of that actually not a new engine development, but actually modification. Let me give you an example.

Like take Marine, which is a very profitable, good business. Commercial Marine as well as yards for Power Systems.

Take that, everybody is talking about energy transition. I spend lots of time on it even long before I joined Rolls-Royce.

Methanol or ammonia will be the net zero solution for Marine. Either of them can run in diesel engines.

So all you have to do is a modification and some test rather than a new development, new this, new that. It is the same business model with some modification.

So that's actually important for this business. So in summary, it is really a good business.

That doesn't mean we are not going to -- some aspects of it partnering with somebody may be a good idea, and that's all part of strategic review. So I will never rule out anything like that.

That's not what I am talking about because at the end, this is about actually creating the winning positions for every business we have out there. So that would be my power.

Your second question was new markets. I think we need -- we are going to have a strategic review definitely, and that will tell us for those businesses what the right answer is, what's the best way forward.

But I would say the following for SMR, definitely. I mean if you look at SMR, it is actually a very proven technology and interesting technology.

And it definitely creates 4 things for the U.K., I would say. Because U.K.

is a big factor in the success of that program, frankly. But definitely, it can play a big role in net zero for the world, but also for U.K.

Given the world we live in, I think supply security is increasingly important. And for U.K., it will be important from a supply security perspective.

And then two other things, I believe it will actually contribute to U.K. economy significantly because it has the potential to create significant employment and create significant exports.

But for that to happen, obviously, we are working with other countries as well. But naturally, all the countries are expecting first U.K.

government to support it, i.e., for the first project, then that will give confidence to all other countries to go there. So therefore, we have been engaging with U.K.

government and will continue to engage. But there is an urgency there because we've built a very capable team on SMR.

It's a big team and capable team, and it is important to sustain that team. And without project, it is going to be difficult to sustain.

Second thing is there's competition. We are not in an isolated world.

And in a new technology, first mover advantage is important. Therefore, there are other competitors.

Therefore, actually, we need to land this as quickly as possible with U.K. government so that we can go ahead with the project.

That's what I would say there.

I have got two questions from the web side.

Yes, sure.

So I've got a few questions that have been submitted online. Firstly, a 3-parter from Ben Heelan from Bank of America.

So Ben has asked, Tufan, you talked about a high fixed cost base versus peers, but Rolls has been through 3 large restructuring programs since 2015. How easy is it going to be to improve this?

He also asks how we feel about the makeup of Rolls-Royce' portfolio. Does it make sense in its current form?

And the third part of this question, Airbus announced production increases, how confident are you on the ability to manage the production increase? How should we think about the medium-term headwind to earnings and cash from the production ramp-up?

I do have more questions, but that's all from Ben.

Okay. Let's deal with this.

I think -- so cost reductions was the first question, I believe. I mean, in a way, I covered that Ben in some of the questions.

But effectively, I'll say that GBP 1.3 billion cost reduction was mainly in Civil Aerospace. It didn't actually include other divisions or the group to a great extent.

And second thing is that was activity driven, i.e. activity demand disappeared, therefore, Rolls-Royce did what it needed to do.

Actually, they've done the right things. I'm not in any way -- I'm not saying they didn't do the right things.

They absolutely did the right things. But it was activity-driven.

When activity recovers, those costs have been actually coming in even last year. So what we are now trying to do is really intervene with that, starting from this year and then create a more sustainable and more competitive cost base but improved cost base going forward because the idea here is to make Rolls-Royce more competitive.

There is a purpose. It's not about managing liquidity, managing this, actually taking Rolls-Royce to a much better level.

So -- that's what we are trying to do. Is there room?

Yes, because there is another angle on that. I already talked about how I hold Civil cost, but also -- let's face it, Rolls-Royce has been run as 3 decentralized divisions.

We are not going to run it that way. We are one team, one company and we will take all the synergies not only between divisions, but divisions and group -- and the functions the same because even the functions within functions, actually, we have synergies.

So there is a big synergy opportunity because it has never been actually looked at because of the operating model and the mindset being very different. And then there is a simplification opportunity beyond that, I believe.

So yes, I believe there is room for efficiencies for the reasons I mentioned. On the portfolio question, in a way, I tackle that, Ben, in my speech as well, how I hold established businesses at this point.

But we will do the strategy review. And as a result, we will come back where we need to do what and how we are going to prioritize investment opportunities.

So I don't want to repeat the same thing there. And Airbus production increase, yes, our plans are aligned with their plans.

Yes, supply chain is challenging, as I covered that earlier, but our plans are aligned to Airbus plans.

And apologies, some of these questions get submitted earlier in, but I didn't want to edit them out. So I've also got a multipart question from Ian Douglas-Pennant of UBS.

So he asks, when can we expect the revised medium-term targets from the strategic review? What does engine flying hours at 80% to 90% to 2019 levels in '23 imply in terms of the China recovery?

Are you expecting a slow ramp-up? And when you did the benchmarking exercises on efficiency versus peers, what do you think the potential for the business is at Rolls-Royce for cash flow and margins?

And then finally, from Ian, do you have the right senior team around you, more hires needed similar to the Transformation Officer already hired?

Well, Ian, you got some questions. I think this flying hours, I'm going to also ask Panos for his views.

But on the targets, midterm targets. I mean, as we said, we are going to complete this strategic review and come back to you in the second half of this year with midterm targets as well as the findings of a strategic review.

So that is that. 80%, 90% flying hours, let me say this.

January number is 79%. So in that context, Ian, we are actually confident if China doesn't go backwards in terms of COVID, it will continue to improve.

Therefore, 80% to 90% looks good in terms of assumption. But obviously, within that number, we still expect sort of Europe and U.S., almost 100% levels and China slightly lower.

And therefore, more room for China to improve because in some other regions like Europe, actually, we may be higher than 100%. So -- but do you want to add anything?

That's the right numbers. I would say the other -- I would add, in '22, China was around about 10% of total engine flying hours compared to 2019, it was about 18%.

So you can sort of see the scope for increase. But that 80 million to 90 million is a combination of China getting up towards that level, but coming from a low base and the stronger than that performance in Europe and Americas.

On your last 2 questions, i.e., on the benchmarking efficiency versus peers, I can categorically tell you there was efficiency potential in all of our divisions. Some are more than others, but definitely in all of them in the benchmarking study that also supports the comments I made earlier.

So -- but I'm not going to give you any numbers at this point. Again, when we come back with our midterm targets, hopefully, all this will come together.

But I don't want to go into the numbers at this stage. I think on senior team, I will say as an executive team, we actually -- they all embrace the change, and they all embrace the transformation program.

They are actually driving it. And therefore, we are able to go fast.

So I wouldn't say anything more than that, Ian.

Okay. So in the interest of time, because I think we are sort of running up against the clock now, I'm going to apologize to those who have submitted questions by pulling a few together into my own multipart version of a question.

Otherwise, I think we'll never get to the next stage of the day. So the questions that have come in include any timeline we have in mind for getting back to an investment-grade credit rating?

And also any timeline for the assumption of shareholder payments? Do we expect to take any restructuring charges related to the strategy review?

And also any guidance we can give on the phasing of free cash flow in 2023, particularly in regard to that earlier part about any restructuring charges we might need to take.

Okay. Lots of questions there.

So I think starting sort of -- let's do the work, and once we do the work, we will obviously -- if restructuring charges necessary? Absolutely, we are going to come back to you.

But at this point, we need to do the work. That is definitely potentially be there.

And at the right time, we are going to be informing you. Other questions?

Yes. I think our priority is articulated in a way in the press release as well as in the script.

Our priority at this point is to get to, obviously, the cash generation, and with that, get to investment grade at pace. I'm not going to give you a time on that at this point.

But we would like to go there at pace because strong balance sheet will allow us, which is your second part of your question to resume shareholder returns as well as invest in the future. The way you may want to hold, and I have it in one slide, actually.

But in terms of -- obviously, cash generation is our focus. The way you may want to hold the priorities, with that, first, we are going to deleverage the balance sheet and get to investment grade.

And then we are going to look to reestablish shareholder distributions, and then it will be between shareholder distributions and investment in the future, and we will make those choices. So that's how you may want to think about how we are proceeding.

I think the final part of that question was around phasing of free cash flow. And I think we picked that up in one of the earlier.

Yes, I think Panos covered that, I believe. Okay.

First of all, it was 1.5 hours. You have been very generous with us.

Thanks for listening. Thanks for your questions.

Thanks for your engagement. I think my key message are there.

Well, we are really looking to create a very competitive, growing and resilient company here. Secondly, we believe in the potential for cash generation as well as for profitability and to take Rolls-Royce to a much higher level.

And third point there is very important because we are really in action. We designed this in a way that performance improvement actions are happening as we speak right now.

And obviously, strategy and midterm targets, we will come back to you. One thing personally, I should say, I'm really excited about the opportunity, and we have a great team.

And I'm looking forward to engaging with you at the right time, and I'm sure we will have lots of conversations. With that, have a great day.