Rolls-Royce Holdings PLC

LSE:RR

Earnings Call Transcript 2022-Q2

[Isabel Green, Head, IR]

Hello, and welcome, everyone, to our 2022 half year results presentation. I'm Isabel Green, Head of Investor Relations, and I'm joined today by our CEO, Warren East; and our CFO, Panos Kakoullis.

As usual, today's presentation will begin with a summary of our operational and financial highlights from Warren, followed by a more detailed review of our financial results and Panos, and then Warren will talk you through how we are securing a sustainable future for the business. Our presentation will take just over 30 minutes, leaving time at the end for Warren and Panos to answer your questions. Before we begin, please take note of the 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. I'll now hand over to Warren.

[Warren East, CEO]

Thank you, Isabel. Good morning, everyone, and thank you for joining us today for our results presentation. I'll start with a summary of our performance. We've made good progress in the first half with growth in order intake, revenue and cash flow, and that's based on demand for our products and services, which are improving meaningfully with another period of record order intake in Power Systems accompanied by continued recovery in civil aerospace engine flying hours, and we have good visibility of revenues in defense with a strong order book.

Second point, middle of this slide, we're taking the necessary actions to protect our business from the risks of inflation, supply chain disruption and a tightening labor environment. We can see the benefits of productivity and efficiency improvements, and we expect to see more progress come alongside us being ever more disciplined on our commercial terms. And these actions taken together enable us to deliver on the commitments we've made, working right across the group to deliver better performance for all of our stakeholders.

Now let's turn to operational highlights. In Civil Aerospace, shown in the top left-hand box, picture of Dassault 10X Falcon. We've seen some great milestones in the first half of 2022. Our new Pearl 10X engine powering that plane, successfully underwent its first test run, and it didn't miss a beat. And Gulfstream's G800 business jet, which is powered by our Pearl 700 engine achieved its maiden flight. In fact, some of you may have seen it across at Farnborough a couple of weeks ago. We've also assembled the first UltraFan large engine demonstrator, which will go on test later this year with 100% sustainable aviation fuel. The cover picture is a picture of that engine.

And more generally, for our newest engine programs, we're continuing to invest in ways to improve time on wing between services to maximize the value for us and for our customers. In Defense, that's top right-hand box, we have a strong order book and we have achieved our first milestone on the B-52 program. That was a critical review in support of activities for the integration of the F130 engine onto that airframe.

In Power Systems, moving to the bottom left of the slide, we're delighted to announce another period of record order intake in the second quarter. Demand has been especially strong for power generation with orders including mission-critical backup power for data centers, and orders for some large customers like semiconductor companies worldwide. Finally, in our New Markets segment on the bottom right, we've seen great progress, too. This is a picture of us signing an MOU in Farnborough in July with Hyundai Motor Group to collaborate on bringing all electric propulsion and hydrogen fuel cell technology to the advanced air mobility market.

And with Rolls-Royce SMR, as demand for power and energy independence increases, we've announced a short list of sites for our first SMR factory in the U.K. As a reminder, this is important because we anticipate that 90% of our SMR products will be built in factories before being transported to sites for assembly. And that factory-built modular approach will drive a significant reduction in the cost of continuous zero-carbon electricity, and that's an important part of the solution for energy independence. So turning to our financial summary. Free cash flows have improved by £1.1 billion, and that reflects the higher engine flying hour receipts, which were up 43% versus the first half of 2021 as well as cost control and working capital discipline.

At the same time, we are facing the impact of global supply chain challenges and cost inflation, but we're actively managing these through a sharper focus on pricing, productivity and costs. You'll hear quite a bit more on that from panels as we go through. Some examples. We're partnering with key suppliers, ensuring that we have contractual pricing protection in place through long-term contracts.

We're looking at innovative changes in our manufacturing processes to manage rising costs and supply chain bottlenecks, for example, by repairing and reusing spare parts where we can. And where necessary, we're derisking our customer deliveries by temporarily increasing inventories. We're also delivering on our commitments to rebuild our balance sheet in the medium term. And we've now received the required regulatory approvals for the sale of ITP Aero, and we expect that transition to complete in the coming weeks. The proceeds will be used to pay down the £2 billion U.K. export finance supported loan.

Our liquidity position remains strong with £7.3 billion of liquidity, including £2.8 billion in cash at the end of the period. We had net debt of just over £5 billion, including leases, and no significant debt maturities before 2024.

In terms of the guidance, the group targets for 2022, which we set out in February are unchanged. This is despite the increasing challenges and risks around the pace of market recovery, global supply chain disruption and rising inflation that we think may continue into 2023. And with that, I'll now hand over to Panos for a deeper dive into our financials. Thank you.

[Panos Kakoullis, CFO]

Good morning, everyone, and thank you, Warren. Despite a challenging external environment, we've delivered materially improved cash flows versus the first half of 2021. But we still have more work to do. And let's just take a look at the numbers. The results on the following slides were they're presented on an underlying basis for the continuing businesses in the group. Group revenues, £5.3 billion. That's 4% higher than last year on an organic basis. Revenue growth was strong in Civil Aerospace and Power Systems with lower revenues in Defense, which had a tough comparator last year.

Operating profit of £125 million was below last year's £307 million, lower principally due to the absence of a foreign exchange revaluation credit in the first half of 2021 in Civil Aerospace. That doesn't repeat this year. It was a one-off accounting adjustment of around about £270 million, about half of which unwound in the second half of 2021. And that was already factored into our full year 2022 guidance, and as I said, it's not something we expect to repeat going forward. Defense profits last year, where they benefited by around about £45 million from legacy spare parts sales, which again did not repeat in the first half of 2022.

We reported a free cash outflow of £68 million compared with an outflow of £1.2 billion in the first half of last year. That continues our trajectory from the £4 billion outflow in 2020 and the £1.5 billion outflow in 2021 and moving up towards a modest positive for the full year this year. In Civil Aerospace, total engine flying hours, including business aviation and regional flights where they were up 33% year-on-year, showing a continued recovery in large engine business and a sustained high level of demand in business aviation.

Large engine long-term service agreement flying hours, they rose by 43% in the first half to 4.5 million. You have to remember, we're still in the early stages of that recovery. So that's still only around about 60% of 2019 levels. Large engine major refurbs, where they rose by 22%, although total shop visits were only up 6%. Again, we expect further growth in the second half of 2022. Civil Aerospace revenues grew 8% year-on-year, and that's higher shop visit activity and long-term service agreement catch-ups, offset by fewer OE large engine deliveries. The catch-ups where they reflect strong execution and commercial discipline. That means we've got higher anticipated profitability across the life of these contracts going forward.

Civil Aerospace, reported an operating loss of £79 million against a small profit last year. As I noted earlier, last year's profit included that one-off foreign exchange credit of around £270 million. Adjusting for this, catch-ups and some small favorable provision movements in the period means that Civil's underlying profitability was broadly flat year-on-year. Civil delivered positive £63 million of trading cash flow again, a significant £1.1 billion higher than last year. With costs rebased, as volumes recover, we see Civil Aerospace becoming the cash engine for the group.

In May, we held a Civil Aerospace Investor Day in Derby. If you didn't attend, I'd really encourage you to watch it on our Investor Relations website. We set out 5 key value drivers for the business: one, maximize service receipts; two, reduce service costs; three, improve OE margins; four, grow business aviation; and five, make sure we benefit from a favorable point in the investment cycle as we exit what has been a period of intense product development. And we're going to be reporting on these drivers on a consistent basis going forward.

As part of that day, we also set out medium-term financial targets based on engine flying hours recovering to 2019 levels by around 2024. Within those targets, we expect a low double-digit compound annual growth rate in total revenues based on 2021 as the start year, a high single-digit operating margin and trading cash flow to comfortably exceed operating profit. We remain confident in our ability to deliver these targets and in the operating leverage of the business as our revenues grow. Our defense business, that's a long-cycle business. And it doesn't immediately benefit from the big geopolitical changes we're seeing at the moment in the wider world. However, rising budgets in most Western countries do underpin our confidence in the long-term outlook for this business and its annuity-like cash flows.

We've recently won some very important contracts, that Warren referred to, the B-52, and there are other contracts we're bidding for, such as the Future Long-Range Assault Aircraft for the U.S. Army to reflect -- replace its fleet of Black Hawk helicopters. And we are expecting a decision on that in the coming months. Underlying Defense revenues, £1.6 billion, they were 9% lower than in the first half of last year, and operating profit was £189 million. That gives you an 11.7% margin.

As I noted earlier, the first half of 2021 included an unusually high level of legacy spare engine sales, which added roughly £45 million to profit. Trading cash flow, £89 million, was equal to last year. In Power Systems, we've seen very strong demand, 53% growth in order intake in the period and a book-to-bill ratio of 1.5 with a record quarter for orders in Q2. Order cover is already at 100% for the rest of 2022.

And in fact, in some of our end markets for 2023, we are close to full capacity already. Revenues in the period grew by 20% year-on-year. And that's despite some challenges around Ukraine and the supply chain that Warren referenced. Underlying operating profit, that was £119 million, giving an 8.7% margin against 3.5% in the prior period.

Trading cash was an outflow of £76 million compared with an inflow of £71 million in the prior period. And that partly reflects some working capital investment to support the currently very high levels of revenue growth. We've also got some issues in the supply chain there, and that's resulted in inventory build, which we are working very hard on to make sure we reduce in the second half.

Finally, let's look at New Markets. That includes the SMR and Electrical businesses. New Markets reported an operating loss of £48 million in the first half of 2022. And that, as you'd expect, reflects the ramp-up in R&D costs as we grow our teams. We've got just under £0.5 billion of committed funds in place to cover the R&D costs for our SMRs over the next 5 years. And only 10% of that is the amount we will fund ourselves. The investments that we're making in this segment have a broader synergistic benefit across the whole group, and Warren is going to touch on that later.

This next slide that sets out our group cash flows starts at underlying operating profit. Our free cash outflow was £68 million in the first half. That compares with an outflow in the prior period of £1.2 billion. Our stronger cash flow performance year-to-date gives us confidence in our ability to deliver modestly positive free cash flow for the full year. That £1.1 billion cash flow swing can be broken down into 3 broad buckets. Firstly, we saw an operating profit performance improvement of around about £490 million. And that largely reflects the growth in large engine flying hours in Civil Aerospace.

Secondly, working capital, that was £350 million better as inventory build was partly offset by strong customer collections in period, particularly in Civil Aerospace and improved performance on payables. And thirdly, other impacts were £230 million, better than the prior period with a lower pension contribution and derivative settlement costs. and higher profits coming through from discontinued operations, offsetting higher interest costs. We saw limited impact in the period from concession payments. We started the year with around about £300 million of net concessions slipped from 2021.

Now at that time, we thought those would largely unwind in 2022. Since then, we've seen those further delays in 787 deliveries and the associated concession payments. Important to note though, that's largely offset by a reduction in concession receipts on new Trent 1000 deliveries as Boeing itself manages its own inventory. So as a result, concession outflows were expected to be slightly lower than we originally anticipated. But there is a larger headwind coming in 2023 as those growth slips are compounded in '23 by continued low receipts from Trent 1000 new engine deliveries.

Now when I started this role, I set out 3 clear priorities for the business: deliver on our commitments, simplify how we report and invest wisely for the future. And I just want to give you some examples of our progress in each of those areas. So firstly, delivering on our commitments. We all know how challenging and uncertain the external environment is, given the war in Ukraine, the impact on supply chain, rising inflation, phase of recession and continued intermittent lockdowns in China.

Nevertheless, we stay committed to delivering on what we have promised. I want to share with you some of the ways in which we're actively managing the current situation. Firstly, through commercial discipline and on pricing and also on contract management. In Civil Aerospace, we've been able to contractually pass on higher input prices on both OE and aftermarket through indexation clauses.

In Power Systems, that's a shorter cycle business, we've also been able to raise prices in an environment where demand is very strong and margins are very closely leveraged to volumes. And in Defense, we're working hard to manage supply chain costs through long-term purchasing agreements and focusing on pricing with customers.

Secondly, we are focused on controlling our cost base to ensure that there is operating leverage as revenues grow. We focused on our supplier list, seeking to work with the very best performing suppliers. And in most cases, we have long-term agreements in place, which offer us good protection from near-term price pressures. A case in point, titanium. We've already secured a long-term agreement with a U.S.-based titanium supplier, which means that we continue to be increasingly less reliant on titanium from Russia.

Another example, on the Pearl 10X, where our innovative digital sourcing approach has allowed us to achieve a 10% cost reduction on parts by consolidating our spend with 4 high-performing suppliers. And more broadly in civil aerospace, we've taken proactive steps to further strengthen our focus on supplier management in the first half.

That included very careful selective hiring to support and manage the supply chain. We've established tiger teams in those severely stressed parts of the supply chain, including the use of external specialists. On the commodity side, we've also have hedging in place to protect us for near-term volatility, and an example would be nickel. We currently hedged 75% for 2022 with significant levels of hedging in place for the next 4 years. Jet fuel, we're 80% hedged in 2022 with a ramp down out to 2025.

Now finally, working capital remains a key focus and in particular, customer collections and driving down inventories. Next up, simplify how we report. An example of how we are driving simplicity across the business is our new approach to foreign exchange hedging, which is more cost effective, brings us into line with our peers to allow comparability and allows us to more proactively manage risks. Historically, we've hedged a declining percentage of our foreign exchange exposure across a rolling 10-year horizon, and that was based on our projected U.S. dollar revenues.

Now the issue that gave us going into COVID was we were carrying a very large hedge book, much larger than our peers. And because the material impact COVID had on our medium-term forecast of U.S. dollar revenues, we found ourselves over hedged. And you're all aware, there was a £1.7 billion cost to unwinding these hedges that we charged in 2020, that we feel the cash flow impact of until 2026. And it's worth remembering every $1 movement in the hedge rate impacts our operating profit and cash flows by around about £25 million to £30 million. Under our new approach, we're going to be carrying a smaller hedge book with a declining percentage of cover over a 5-year period, which will mean that market movements in foreign exchange will impact us sooner.

The chart on the slide that shows our current hedging position. We've got some flexibility to move these hedges around, but we are largely hedged at $1.50 to the pound until 2026. From then, you'll start seeing the benefits coming through from the new hedging approach. And my third priority, making sure we invest wisely. We've got strict criteria that we follow when considering new investments. Firstly, they need to be aligned with the group's strategy and focus on sustainability. Warren is going to pick up on that theme shortly. 75% of our R&D investment in the medium-term will be on lower carbon technologies and making our existing products compatible with net-zero.

We also continue to invest in improving the profitability of our products by increasing time on wing, efficiency and productivity. Now whilst we're seeing increasing investment in New Markets, our established businesses are critical to. Around 80% of our CapEx and R&D this year will be focused on Civil, Power Systems and Defense. Next, we very carefully consider the risk reward profile of each investment based on an estimate of its IRR in a range of scenarios. Our investments, where we aim that they generate a combination of near-, medium-term and longer-term returns. That gives us a balance of protecting and growing our established businesses and pursuing longer-term growth opportunities at the same time.

An example of an investment that will generate return in the near-term is the work we've done on extending the time on wing in the Trent 700 engine. At the other end of the spectrum are our investments in electrolyzers and in SMRs. Now for these more longer-dated investments, we make sure that we have a sufficiently high IRR on a risk-adjusted basis.

Just to give you an idea from a process perspective, all investments over £5 million are reviewed by our group investment review committee. That meets monthly, I've shared all of those meetings since I started with the business. We set a very high bar when considering new investments, and there are many examples of projects that didn't make the grade. And we continue to focus on in-flight reviews of investments to make sure we improve the accountability and delivery on existing projects. And I'm going to keep coming back to these 3 themes in the future. So delivering on our commitments, simplify how we report and making sure we invest wisely.

Now my final slide. Despite the challenges around inflation and the supply chain, we are confident in our ability to deliver on our commitments. At the group level, we still expect to deliver low- to mid-single-digit revenue growth. a broadly unchanged operating margin year-on-year and modestly positive free cash flow. And that guidance is based on expected improvements in civil aerospace, driven by higher large engine sales and also increases in shop visits.

Our divisional guidance has changed slightly. In Civil Aerospace, we now expect to deliver good revenue growth in 2022. In Defense, we're now guiding for a low double-digit operating margin in the full year for 2022. That's lower year-on-year due to higher investment spend and also the nonrepeat of those legacy spare parts sales I mentioned earlier.

And lastly, just to help the modeling, a word on tax. We're still expecting group cash tax payments to be broadly similar to the £185 million paid in 2021. Now we expect the P&L charge to be lower than this, but due to the geographical mix of our profits and losses, we will see a higher-than-normal P&L tax rate this year and in 2023. And with that, I'll hand back to Warren.

[Warren East, CEO]

Good. Thank you, Panos. Now securing a sustainable future. When we talk about sustainability, of course, we mean in terms of the energy transition and addressing climate change, but we also mean ensuring business sustainability with disciplined investment for sustainable returns. But before I talk about the future, I'd also like to touch upon last week's announcement regarding the new CEO appointment and a few personal reflections. It's been a great privilege to have been entrusted with the stewardship of this company over the last several years. And I've enjoyed support from loads to people. I especially want to thank the amazing people at Rolls-Royce who make it all happen. In spite of some really challenging events and indeed, all the changes that I have thrust upon them.

We've dealt with some major challenges in that period. And I'm pleased to reflect on how much the company has changed in that time. Indeed, the appetite for further change that we've developed. Rolls-Royce is now much leaner, more agile and more focused than it's ever been. We've taken significant costs out and developed a more cost-conscious culture across the whole organization. But we've not lost the focus on excellence, nor our ingenuity, which enables us to punch well above our weight.

We've developed more efficient, durable and sustainable products and services that will serve our customers for decades to come. And in addition, we've embarked on a net-zero pivot. As you know, in my book, disruption like this spells opportunity. So I'm more optimistic than ever about the future.

I'm also proud of our broader leadership team, which like our people at large is, on average, younger, much more diverse and much more agile. That gives me the confidence to pass the batton to Tufan, who joins us in January. Together, they will create that sustainable future for Rolls-Royce. Now on a sustainable future, the #1 thing is to make the group sustainable as a business. Key to this is leveraging the asset which is our installed base. The largest earnings potential lies in our large engines powering the world's youngest wide-body airline fleet, where we power the majority of aircraft types available for airlines to buy today.

Alongside this, we have over 9,000 business jet engines and more than 16,000 defense engines as well as over 40,000 customers for our Power Systems product. And as we outlined at our Civil Investor Day in Derby recently, we work intensely to increase the profitability of our installed base, and that's the asset with significant barriers to entry that drives our sustainability from a business point of view.

Now I want to shine a light on the technology behind the business opportunity in the other sense of the word sustainability. We're a business that's focused on power, more accurately, perhaps turning stored energy into useful power in particularly difficult applications. This offers challenges, but it also creates excellent barriers to entry once you've developed that domain expertise. Now you hear today about alternative forms of stored energy, and it can all sound very complex. But actually, this is a continuation of our long journey. For much of the time since, say, 1940, we've worked with 2 forms of stored energy, fossil hydrocarbons and nuclear power.

Looking forward, sticking essentially with the same difficult applications where we draw on our decades of expertise and those barriers to entry, I mentioned, we moved from 2 forms of stored energy to 4. If we look at the hydrocarbon stream, we anticipate that over the next 20 years, we will see a switch to synthetic fuels. It will remain prevalent for decades in our reciprocating engines, but in particular, it's going to be relevant for our gas turbines for long-haul aviation. We're ensuring that our gas turbines are ready now for that transition.

Looking to nuclear, moving up the slide, we have multi-decades of experience in providing safe nuclear power in a really challenging application, and that gives us the confidence in our capability to deliver our SMR solution. The huge reduction in the cost of continuous zero-carbon electricity that our SMRs provide makes us firm believers that it is the right solution to decarbonize the grid and to enable stand-alone industrial applications such as producing the synthetic fuels and at the top of the slide, the hydrogen.

There are even future opportunities in space applications with micro reactors. Now electrification is an established trend with progress in battery technology. And for us, initially, this means using battery storage for hybrid propulsion and microgrid solutions on land. However, this is rapidly becoming relevant in aviation. We have several contracts in urban air mobility and commuter aircraft for full electric power and propulsion. And these subsectors will produce revenue and profit relatively soon. We can see full electric and hybrid and more electric solutions moving from smaller aircraft to larger ones as the technology matures.

Now in order to achieve true net-zero, we will, I'm sure, be deploying hydrogen-based power and propulsion solutions in time, even to our widebody customers in long-haul aviation. And I'll show how we prioritize and invest into those alternative forms of energy storage using hydrogen as an example, if we move to the next slide.

Let's just look at the hydrogen pathway. We can deploy hydrogen in a reciprocating engine in a gas turbine with hydrogen fuel cells in between. The gray areas on the slide represent the investment periods and the green areas show where we can make revenue and earn profit. Hydrogen is gaining relevance in many markets, and our customers look to us to help them decarbonize. And some of these are way off, but we need to be ready with the technology as that technology and infrastructure matures.

And you can see that whilst we must be active and present, hydrogen and the gas turbine together for wide-body aviation is a minimal investment today. And based on what we can see, revenue is not likely before the late 2030s. But we're investing now where we see short-term potential for deployment and business return at the top of the slide, for example, around reciprocating engines and coming down the slide in fuel cells moving from land-based stationary to mobile and later into the air.

There are opportunities, too, for inorganic growth -- for instance, the recent acquisition of the electrolyzer specialist Hoeller, will help us to move to market quicker in Power Systems. Alongside disciplined prudent investment in some cases. The best approach, though, is to form partnerships. At Farnborough, the partnership that we announced with Hyundai that I mentioned earlier, includes hydrogen fuel cells. And we also announced the partnership with easyJet, and that's all about hydrogen in gas turbines.

Now these investments and partnerships are creating knowledge, skills and capabilities that flow across our group, creating benefits and applications between our different businesses. It isn't just about the technology, it's about the people. You've heard me say many times before that our key differentiator is our people. So I'm pleased we continue to be a company where talented individuals are keen to work. Since 2021, we've seen an increase of 48% in applications for our early careers and 58% of the graduate hires in 2022 are female and 36% from ethnic minority backgrounds.

In addition to hiring though, it's even more important that we create an environment where all our people can deliver to their full potential. And that means being really inclusive. We support over 20 employee resource groups across all diversity strands, including faith, ethnicity and gender networks. The largest one of those is Prism, which supports our lesbian, gay, bisexual and transgender community here in the U.K. And we're proud that this network has received multiple externally recognized awards.

We can see how inclusion, coupled with the right incentivization, encourages the right business outcomes. For instance, looking at our patent award scheme, in 2022, nearly half of the new inventions filed related to our net-zero ambitions. We've introduced a new approach to learning and this includes a refreshed digitally enabled approach for all of our people to get learning out really quickly. One key aspect of this is a digital internal marketplace for so-called gigs. These are bite-sized pieces of work that are matched on the basis of capability to people anywhere across the organization, leading to much more agile working and ensuring that we develop a capability irrespective of any internal organizational boundaries. And that's especially crucial for highly sought after fields like electrical engineering.

So let's conclude. A reminder of what we have covered. We've progressed well in the first half of the year with substantially better cash flow as we manage our costs and the markets recover. It's a tough environment, though, and we're addressing this with a focus on the operational and commercial actions that can protect our performance. And we're sticking to our commitments. The disposal of ITP has been approved and it will complete in the coming weeks, and we're well positioned to achieve our guidance.

I'm convinced that with the best people and breakthrough technologies for the energy transition and a more modern and much leaner business with a bright and exciting future ahead. And with that, I'd now like to hand over to the moderator to open the meeting to Q&A.

[Isabel Green, Head, IR]

[Operator Instructions] Thank you. And so a question here from the webcast and to Warren, actually. So Warren, your results today have got quite a lot of noise, and you say you're progressing well, but I can't see it coming through in the numbers. Can you tell me a bit more about what's going on in the business?

[Warren East, CEO]

Yes. I'd say we're progressing well because we can see growth. We can see growth coming through in revenues. We can see growth in orders. Our Power Systems businesses just had a record quarter for orders. And actually, the first quarter was very strong for orders as well. So we now have a record order book there. And I can see a massive swing in the cash flow. A reminder of the trajectory, COVID, minus [£4.2 million], last year, minus [£1.5 million]. This year, we said we'd be modestly cash positive and the first half has set us up very well for that being just a £68 million outflow.

And what's really driving that is a recovery in engine flying hours in our Aerospace business as well, large engine flying hours up 43%. And so I think that's the indications of progress. Now when you look at our profit and just compare first half this year to first half last year, then I think that's what's caused a little bit of noise this morning. I think it's important that we understand the moving parts behind that. So I'm going to ask Panos to explain that one.

[Panos Kakoullis, CFO]

And I think you're right, at first blush, when you look period-on-period, or what's happened to operating profit, and I called it out in the presentation, £125 million versus £307 million, it does look. And what we tried to do is just to be helpful to pick out what's really going on behind that? And particularly when we're in the environment we are now of going through breakeven, relatively small numbers either way, it can have a distorting effect. So what we've tried to do is pick out things that are effectively one-off, and we tried to do that in a balanced way. So you'll see that there is a nonrepeat of a revaluation credit. There's a foreign exchange revaluation credit of around about £270 million in last year's numbers due to the change in foreign exchange rates.

There was also a £45 million benefit from the legacy spare parts sales within the Defense business last year, didn't repeat this year. Again, that's consistent with what we expected. Year-on-year, we're benefiting from more positive catch-ups this year than last year, and you can see a benefit of around about £50 million coming through from that. And also this year, we've got a one-off write-off on a legacy contract from a business that we sold just under £30 million.

So when you strip all of those elements out and say, right, what is going on with the underlying business, you end up with an operating profit a little bit up year-on-year. again, it's sort of indicative of the underlying progress.

[Isabel Green, Head, IR]

Now we're going to start to take questions from audio lines. And the first question from the line of Robert Stallard, Vertical Research Partners.

[Robert Stallard, Vertical Research Partners]

Yes. A couple of questions from me. First of all, Warren, you mentioned the -- that you're enforcing indexation in your contracts and the Power division is seeing good pricing. Is this enough to cover the cost inflation that you're seeing coming through the system? And is there a bit of a timing mismatch here that you're getting the price benefit and for the cost impact? And then secondly, Panos, my phone was giving me grief when you were talking about the 787 payments and how that's going to flow out. I was wondering if you could clarify what you said?

[Warren East, CEO]

Yes. I understand your point, Robert, about price before cost, and we're very, very tuned in to that. And the first thing to do is, of course, pass on as much of the inflationary pressure as you can from a contractual perspective. And then you have to look to your costs and think about how we can control those costs. which we're absolutely doing. And part of that is softening the blow of the inflationary pressures by things like hedging, things like long-term supply agreements with our suppliers, focusing on the smaller number of suppliers so that we can actually strike better agreements. Some of these supply agreements, fortunately, do stretch out for a very long period of time. And so we consider that we're well protected. There is a balance to be struck between the pressure that you're getting from costs going up and how much you're able to pass on. And when I talk about commercial discipline, I mean tilting the balance of that so that it is largely within our favor.

[Panos Kakoullis, CFO]

Yes, just a bit to add to it. And you can look at the 3 businesses in different ways. So the Civil Aerospace business, we are -- and I think you talked about enforcing indexation. We are being robust around how we do that. You can see a little bit of the benefit coming through -- the future benefit effectively coming through from the catch-ups. And a lot of those catch-ups are driven by the expectations through that enforcement. From a cash perspective, it actually comes a little bit -- it has a little bit of a lag because it sort of catches up year-on-year. On the Defense side, it tends to be through contract renewals, which happen regularly. So again, a little bit of a lag there.

Within Power Systems, when you have got record demand and a very strong order book, you can be much more regular around price increases. And as Warren has said, the other element is you control costs. So we would have been clear around focusing down on the critical suppliers, the ones that are the best performing supplier. And to be a best-performing supplier, it's not just about cost. It's about being able to deliver to the highest quality as well.

And you'll have heard in the -- maybe in the presentation, we talk about digital sourcing on the Pearl 10X. That's a fancy way of saying we had a supplier conference and a 10% reduction in pricing going forward, and that gets locked in with very low levels of indexation. And that together, as Warren has said, with hedging around commodities, put us in good shape around that.

On the 787 payments, coming into the year, we talked last year about that £300 million slip from '21 into '22 on concession payments we expect to go out. Those haven't happened yet. They look like they might slip in into the following year. It doesn't actually have as big a benefit in terms of lower outflow happening this year as you would have anticipated because Boeing themselves are managing their own inventory.

So new concession receipts are lower than we expected. So the net-net impact is not big this year. It does, though, create a little bit of a headwind for next year as some of those slip into next year. Those payments without necessarily having new orders coming in for and that would generate new concession receipts.

[Operator]

Now we're going to take our next question. [Operator Instructions] The next question comes from the line of David Perry from JPMorgan.

[David Perry, JPMorgan]

Yes. Do you hear me. okay?

[Warren East, CEO]

Yes, we can. I've got great 4 questions. I don't know if that's too greedy. They're quite short. The first one, the Defense guidance of low double-digit margin, I just wanted to clarify, I mean, are we thinking 10% to 12%? And then is that a baseline going forward? Because Defense margins historically have been hard to forecast.

The second one is the finance charge was a lot higher than I expected in H1. I just wondered if you can help us think about the full year. And maybe even going forward because obviously, you've got ITP proceeds and you're going to pay off some debt. Tax charge, clearly very high. Will the second half be the same as the first half? And then the last one, please, the fourth one. The LTSA inflow, £433 million in H1. I think that at the CMD, you talked about the 500-ish a year. So is it still £500 million for this year? Or is it going to be meaningfully higher than that.

[Panos Kakoullis, CFO]

I'll try and keep them, as you said, quite short ones. I'll try and keep them short and sweet. I think on Defense, it's consistent with where we were expecting this year to be. We wanted to be more explicit about that guidance as we went through the -- into the second half, just to make -- to be as helpful as possible around that.

Last year, we did have a little bit of the number being flattered by those legacy spare engine sales. So that's why you see that coming down. It is now representative, I would say, of the mix going forward. So some of the older work was a little bit of a higher margin, and we got the impact coming through of the single-source regulations as well. So you can think of it as that sort of level going forward and the range you talked about is a sort of sensible range to be thinking about, maybe a little bit towards the higher end of that 10% to 12%.

On finance charges, in terms of the actual P&L charge this year, there's a little bit of extra this year because last year, the U.K. EF loan, the £2 billion we took out sort of midway through the first half. So you've got the anniversary-ing effect of that for a full 6-month period. But think of that as being sort of the charge going forward adjusted for ITP proceeds. So as we said in the release, ITP proceeds, we're going to use to pay down the £2 billion U.K. export finance loan. And that's our only floating interest rate loan. All the other loans are at a fixed rate. So that will give you an idea.

On tax. The tax charge does look unusual because we've got 2 territories, the U.S. and Germany, where we are taxpaying. In the U.K., we made taxable losses and we've got a lot of loss to use going forward. So there's no actual charge that comes through from that. So you do get a slightly odd-looking number because you've got 2 taxpaying jurisdictions and the largest one isn't. From a cash perspective, I think of last year and this year being broadly the same.

And in terms of the LTSA, you're right, back at the -- back in Derby on the 13th of May, we sort of talked about in the medium-term being around about a £500 million number on the LTSAs. It is going to be meaningfully more than that this year. You quoted the £433 million for the first half of this year. It's going to be, again, meaningfully more than that as those engine flying hour receipts come through.

The relationship of that with actual shop visits happening and some of that LTSA creditor effectively ending up being -- taking through revenue, that's one of the sort of judgments that we have to take, but it will be meaningfully more than the £500 million this year.

[David Perry, JPMorgan]

And just a follow-up on that. The £500 million a year then, do we -- is that an average? If it's much better this year, is it lower in the future years? Or is it just this year is a one-off and it's still the £500 million a year going forward?

[Panos Kakoullis, CFO]

I think we said £500 million by the medium-term, so over the next few years, it is going to be higher levels than that, depending on trajectory of engine flying hour receipts and the level of shop visits going forward.

[Warren East, CEO]

Yes. I mean I think an elevated rate in the short term is a logical consequence of the sector is recovering from COVID, flying is starting to happen and the shop visits are going to follow. I mean don't forget, we've got a load of shop visits that pre-COVID would have happened over the last year or so, that have effectively been delayed, and that's what's causing the LTSA increment to be at a higher rate right now.

[Operator]

Now we're going to take our next question. And the question comes the line of George Zhao from Bernstein.

[George Zhao, Bernstein]

My first question is now, how do you assess the health of your supply chain as you and the OEMs consider potential wide-body production ramp-up? We're seeing a lot of supply constraints on the narrow-body side of engines right now. And while clearly, the wide-body, they're not taking the same level of ramp-up as the narrow-bodies. Are there risks that some of your suppliers that are involved in the different programs could take some challenges in ramping up?

And secondly, I wanted to understand a bit more about the price indexation on the LTSAs. We've heard some of the other peers comment that they are more preserved against inflation on the time and material versus the long-term agreement. So how do you contract your work here? Is there more of a cap within the LTSAs where which we can pass on the cost inflation, that may be less favorable than the time of material agreement.

[Warren East, CEO]

So I think the key difference between narrow-body and wide-body is obviously the absolute volumes. And that's why the situation is very intense in the single aisle space at the moment because everybody didn't quite come to a grinding halt, but everybody suddenly went very, very slow and now they're being pressured to ramp up very steeply, but the numbers are all large. Obviously, as you pointed out, wide-body is a slower recovery, which gives us also breathing space. But also the absolute numbers are much, much smaller. Now we talked about and Panos cited a supply chain conference a moment ago in an answer to an earlier question. And that's the sort of engagement that we are having with suppliers. Basically, we are spending more with fewer suppliers.

The relationship with those suppliers is richer, the contract terms can be longer and more rigorous. And so those are the steps that we are taking. Obviously, there's real world risks that all of these suppliers face -- but by close working relationship with those suppliers and we've hired people, we're hiring people specifically to manage suppliers at the moment. And we also have task forces from within our business working with suppliers. And I think those measures taken together put us in reasonable shape. And we do anticipate the widebody volumes recovering not sort of immediately, so we do have some time for this, but we can see them recovering. I've been quite vocal in the media about commercial discussions taking -- ramping up and that is going to result in new OE demand over the coming years, but we think we're pretty well positioned for it. LTSA price escalations and the like --

[Panos Kakoullis, CFO]

Just a couple of sort of points of detail around the management and the supply chain. It's procurement specialists, and we've hired around about 70 extra people, specialists in that area. And as those of you who were at the Civil Day back in Derby, will remember Sebastian Resch, our Operations Director. He always talked about -- it's about boots on the ground. It's about spending time with the suppliers to make sure that we're in the right place in the queue. And we understand day-to-day, and we manage day-to-day what's going on around that supply chain.

On the indexation point, I think you asked, is there a limit? Is there a ceiling effectively? Is there a cap? Actually, there's a color. So first few percentage points, we can pass on directly. Then there's a color, a couple of percentage points. And then beyond that, what's called hyperinflation from a contract terminology perspective, we can pass that on again. But each contract will be negotiated on its own terms, but that's the broad shape.

[Isabel Green, Head, IR]

Isabel, again, I've got a question from the webcast. Chloe Lemarie from Jefferies has written her question in. So I'd like to be 2 questions out from her, please, if I may. Firstly, stripping out or the one-offs in Civil, it appears there was a £100 million year-on-year increase in operating profit for the division. Can you provide some color on what drove this between OE and aftermarket or between large engines and others? And the second question from, Chloe, please. Can you detail what drove the catch-up recorded in Civil this half? Additionally, how are you seeing the Trent XWB aftermarket trending in terms of operating performance?

[Panos Kakoullis, CFO]

So just in terms of stripping out the one-offs, when I gave the response earlier on, I was looking at the one-offs across the whole group. The one-offs that specifically apply to the Civil business are the £270 million foreign exchange credit from last year. It doesn't repeat. So you strip that out. The net year-on-year benefit of the catch-up, which is just around just over £50 million. And then we had a little bit of provision released this year versus last year, which gave us a benefit. Actually, when you strip those out, you end up with Civil in the first half being broadly flat.

So it's -- I don't think it's the £100 million you talked about. It is broadly flat. If you unpick that, to say, right, what is behind that from both an OE and Services perspective. OE, we are broadly flat. You can see the sort of installed deliveries at first half this year versus first half last year. It's broadly flat. The mix is actually more in favor of business aviation than wide-body. So that gives us a little bit of a margin uptick. Services, on the other hand, you can see quite, I think, about 22% for memory increase around Services. But that's more -- that's on the wide-body and 6% overall on all shop visits. The mix goes the other way a little bit on that one.

So that's -- if you look at those underlying -- underlying operating drivers. -- and that will get you to the broadly flat once you strip out those one-offs. In terms of what happens going forward and what underpins our view around the outlook for the full year, there is a significant ramp-up in shop visits in the second half, which generates a significant amount of profit and a number of spare engine sales.

We'd originally thought there'd be a few more spare engine sales in the first half, but those have now moved into the second half. And that's a combination of, as I mentioned, of engine sales to customers and also to third parties that operate a pool. In terms of what drove the catch-ups, a lot of that catch-up is around pricing, and it's around that pricing, that commercial discipline that we've been talking about, particularly around business aviation, as those indexation clauses effectively come into effect and mean that we've got greater profitability on those contracts going forward.

And I know I've stressed it a few times around the importance of looking at catch-ups and what they are telling you because they are saying that over the life of those contracts, if it's a positive catch-up over the life of those contracts, we expect those to be more profitable going forward, and there is a catch up now when we look at -- how much we've traded in the past. Works both ways. So we need to be balanced around that. So within Defense, you'll see there's a £22 million charge in defense around some risks on inflation. XWB performance.

[Warren East, CEO]

Yes. XWB performance, I'm actually not quite sure whether you mean how the shop visits are going or how the engine is performing and therefore needing shop visits. But let me have a go. We continue to be pleased with XWB. The actual sort of in-service performance of the engine is excellent, and we get great feedback from our customers. We are -- have been gradually pushing out the service interval on the 84,000s through a process of inspections because obviously, we don't want to do a shop visit until we absolutely have to. And that's been encouraging, and we've spoken about that before. And then those who came to Derby, I think, saw lots of activity aimed at systematically extending the service interval, and we expect that to continue on both the 84,000 and the 97,000 over the coming years. If that's what you meant by the performance in shop visits, then that's the story.

[Isabel Green, Head, IR]

Thank you. I've got 2 more questions. They're quite short. So I'm going to ask them both one after the other. The first one from [indiscernible]. Very short question. Where do you expect working capital to come out for the year? And then secondly, from [Spinecap], could you give us a bit more detail on what changed on the FX hedging and how much net U.S. dollar exposure you expect to have by '24 or stroke '25?

[Warren East, CEO]

I think you can do both of these.

[Panos Kakoullis, CFO]

I can pick that up. In terms of working capital for the full year, you'd expect to see a sort of slightly negative working capital. That unwind of inventories is going to be a little bit more than from where we are now, it's going to be a little bit more than offset by the increase in the performance on payables. So expect it to be a sort of slight negative for the full year. In terms of the FX hedging, current book, I think it's around about £21 billion in terms of exposures going forward.

As I said in the presentation, the aim of the new policy is to make life a little bit simpler for everyone in comparing us with others, also allows us to be more proactive in how we manage that risk as well. So you'll see a policy going forward of a declining cover over a 5-year period. For that to fully be in effect, it's going to take a few years because we've got a hedge book at the moment. That's, I guess, the past policy means we're 100% hedged for the next 5 years. And as that unwinds and we put the new policy in place, you'll see that start coming down over time.

[Operator]

The next question comes from the line of Olivia Charley from Goldman Sachs.

[Olivia Charley, Goldman Sachs]

My first question is just a follow-up on the shop visits. I know you just mentioned with clearly that you're expecting to see a big step-up in the number of shop visits happening in the second half. And I was wondering if you could just give us some more color on that. I mean, I can see the release on the first half. There's only been a pretty modest step-up in shop visit numbers in the first half guidance, I think that you've given for the full year implies a sort of 20% increase in the midpoint. So I'm just wondering what's driving that really material step-up in the second half? And what kind of is giving you confidence in the ability to sort of step those volumes up?

And then just a second question around engine flying hours. Could you give us a sense of what the exit rate is for the first half or where you're tracking roughly now and therefore, what you're expecting to see in the second half? And then also just sort of what gives you confidence in this path to full recovery by 2024? And what are you seeing in sort of Asia Pacific and China as well.

[Panos Kakoullis, CFO]

Okay. I'll take the first 1 yes. Just in terms of shop visits, Olivia. So -- you saw just over, I think, just over 400 in the first half, and we're guiding to around between 1,100 and 1,200 over the full year. And the big driver of that, frankly, is the engine flying hours growth. As that growth comes back, the shop visits follow. So that's what we're seeing, that's what we're seeing effectively being scheduled as we go into the second half. So that's the big driver around that.

[Warren East, CEO]

Yes. And on engine flying hour trajectory, then -- as I said a few moments ago, for the first half as a total, then we're at about 60% of 2019 levels. We guided for between 60% and 70% for the year as a whole. We're reasonably comfortable with that now because, obviously, having got to 60% for the first half, the exit rate is above 60%. We track it on a weekly basis. And we're around about -- or we have had over the recent weeks around about 65% or so. Now exactly how much of that is going to continue into Q4, it's hard for us to say. But we -- having reached 65% -- we're pretty confident we can see through our Power Systems business actually, early signs of the actual lockdown situation in China starting to get a bit better.

The lockdown situation in China has been the key retardant for the Rolls-Royce fleet of engines in terms of keeping our engine flying hours back. So I think that's going to be a contributory factor in the second half to move up from these rates towards the 70% as we get to the year-end. And elsewhere in Asia, we are seeing demand and flights full. We spoke to a lot of airlines at Farnborough a few weeks ago, and people are reporting full flights and challenges with actually being able to sort of deliver on those. So it's not a demand issue at the moment.

So we're still confident of that recovery in '24. I think it will depend -- the actual rate will depend on the broader economic climate. And it's a little bit too early to speculate on that actual rate, but you can see us getting very close to 2019 levels by 2024.

[Panos Kakoullis, CFO]

And just maybe just give you a little bit more color around China. So I think when we look back to 2019, China was around -- China Airlines were about 17% of engine flying hours. They're around 11% at the moment, and they're at 40% of 2019 level. So there's quite a lot of scope for growth within that as those lockdowns ease.

[Operator]

The next question comes from the line of Andrew Humphrey from Morgan Stanley.

[Andrew Humphrey, Morgan Stanley]

I've got a couple on Power Systems, if I may. Firstly, it seems like a lot of the strength you highlighted in orders there was around backup power supply and the like. Can you go into a bit more detail on what is driving that particular strength in the short term? Clearly, a lot of the discussions that we're having at the moment are around potential gas shortages in Europe over the winter? Is there any kind of overlap there with your business?

And secondly, on that, I wanted to ask a bit more about inventory. You've highlighted that you're expecting some unwind in the inventory you've built up over the second half of the year. I wanted to kind of ask about the character of that. I mean is that inventory build in the first half? Has that been sort of prophylactic to protect against some of the supply chain issues that we're seeing? Or are there kind of project delays that we need to keep an eye on? And to what extent are those within your control?

[Warren East, CEO]

Okay. Let me kick off. I think some of the demand that we're seeing around power gen at the moment is a little bit of recovery from projects that were held up during 2020 and 2021. And so we're seeing the orders come through from those now. And yes, Power gen has been strong. With regard to the sort of overall energy situation, gas -- potential gas rationing in Europe and so on. Actually, this is being a positive driver for us not so much in terms of power gen, but in terms of demand for engines for fracking as people seek to mitigate the gas supply challenges. So we've actually seen a positive impact as a result of that.

I think the inventory build is -- no, it's not to do with project delays. It's to do with a combination of proactive building for the second half, which under normal circumstances, we do anyway in Power Systems, to manage our load throughout the year. But also the supply chain challenges and the blockages. I think, Panos said a few moments ago, mentioned about the semiconductors that we've seen holding us back in Power Systems. And some of it is undoubtedly due to that one of these task forces that Panos referred to and is specifically around semiconductors in Power Systems.

And we have been successful there and we've secured supplies for ourselves and for our suppliers. So that we can get that inventory shifted in the second half of the year. And we're continuing with that task force, by the way, because we do anticipate that to be a very tight situation at least into the middle of 2023. And so we want to clear the way ideally through to the end of 2023 as far as that particular part of the supply chain is concerned.

[Panos Kakoullis, CFO]

Maybe just to give you a little bit of a broader feel around supply chain within our systems because it was, I think at this time last year, we were highlighting it as we could see some of that coming and it's maybe an advantage of having a shorter cycle business within the group that we can see that a little bit earlier than maybe in the longer cycle businesses. But -- every week, there's broadly 30 to 50 suppliers that the team there are constantly monitoring what is going on there because anyone -- and not just my presume it could be across a number of areas, that anyone of those could cause a bit of a line stop. So they manage it at a very tight level. And you can see that -- what that trend looks like on a week-to-week basis. So it's that sort of level of granularity to make sure we keep production going.

[Warren East, CEO]

And tracking that we saw through the second half of last year, and we reported in fact, at our full year results. So that trended down during the second half of the year and into Q4, but it has trended up again in the first part of this year. And what we're seeing is the impact of that right now. I think that's it.

[Operator]

The next question comes from the line of Nick Cunningham from Agency Partners.

[Nick Cunningham, Agency Partners]

Yes, coming back to EFH, it looks very much like you'll hit the 80% number sometime in '23, perhaps on average '23 as a whole. And you used to say not so long ago that, that 80% was key to a free cash flow of, I think, as much as £750 million. And does that you still recognize that number, does it still stand? And if not, what's different? In very broad terms, what are the big deltas if you like?

And then second question -- general and sort of geopolitical around China risk. I mean Russia is obviously same as the risk, the trapped assets for Western corporate. China is an order of -- several orders of magnitude bigger than that, plus also a much greater supply chain risk, and it's a really big end market [indiscernible] or wasn't. Is there anything at all Rolls Royce can do to manage that risk? Or is it just there? Or at least is there something you can do to manage that risk on a medium-term basis is just something you think about it?

[Warren East, CEO]

Yes. I didn't actually fully hear that second part of that question. Did you?

[Panos Kakoullis, CFO]

No.

[Warren East, CEO]

Let's do the EFH one. I mean, broadly, Nick, yes, we, at the same time, gave a rule of thumb that said approximately £30 million for 1%. And if we are around about 60% to 65% for somewhere between 60% and 70% for the year as a whole. Then the extra sort of 15% gives us an extra £450 million, which broadly puts us into the zone. So I don't think we're sort of too far out. Obviously, there's been -- since we made that comment, there's been a huge number of puts and takes and changes in the boundary conditions around there. But yes, I think if you peer at those numbers, you can still see it.

[Panos Kakoullis, CFO]

I guess, the bit I'd add on that -- but lots of things have changed since then. We talked about some of the other risks and challenges. We'll give guidance on '23 when we get that.

[Warren East, CEO]

Absolutely. Nick, is there any chance you could sort of repeat the China bit?

[Nick Cunningham, Agency Partners]

Yes, sorry. What I was saying was that there's clearly increasing geopolitical risk around China, around supply chain end market demand, trapped -- potential trapped assets [indiscernible] in Russia. Is there anything that Rolls-Royce can do to manage that risk, perhaps not in the near-term, but in the medium-term? Or is it just too big to be able to manage that.

[Warren East, CEO]

Yes. Well, look, China remains an important market for us for both Civil Aerospace and for Power Systems. And for the time being, we are continuing to do that business in China. And I see huge demand for air travel in China on wide-body jets. And I don't actually see the Chinese getting those jets from anywhere else right now other than the Western suppliers. And so the Chinese airlines remain important customers for us, I think, for the foreseeable future. Yes, there's geopolitics, which is going to happen around that. But we can only control what we can control, and that means supporting our Chinese customers.

In terms of the supply chain, then -- we totally understand that there may be some tightening of the export control sort of in regulations and what we're allowed to source from where and so on. But we aren't hugely dependent on Chinese suppliers and in most cases, we have multiple suppliers for every vital commodity that we really need or every vital part. We do have a small handful of single-source suppliers, but we're not really seeing China as a major risk there at the moment. It's going to be monitored. It's clearly in the discussion for us as an executive team. It's clearly in discussion for us as a Board. And I think you can rely on us behaving quite sensibly around that.

[Panos Kakoullis, CFO]

And I think just pick on that, specifically coming into this year. A lot of things changed geopolitically as we came into this year. And what we've been very active in doing and Warren talked about as an executive as a Board, making sure we properly scenario plan, and we looked at to particular new emerging risks coming into the inflation and how we were going to manage and risk manage around inflation and the other one was around China. What if there was something very dramatic on China? We're not just going to wait to react to it, what can we do now to make sure we're in the right position.

[Operator]

The next question comes from the line of Harry Breach from Stifel.

[Harry Breach, Stifel]

Yes. And I'm sorry if I've missed something as the line quality here has been a bit troublesome. Two ones, if I can. Firstly, guys, time and material, we almost don't talk about it anymore on the calls, but it more than doubled in the first half and it was more than all of your P&L aftermarket revenue growth. Yet we're still less than half below our previous 50% low below our previous sort of first half sort of peak levels in T&M. I'm just wondering if you can give us any flavor in terms of shop visit demand on that side of the business, how that's trending?

And then secondly, guys, just so returning to a popular theme of escalation. On the OE side, my understanding is that it applies to your schedules of PDPs and PUDs, right? So therefore, is going to accelerate the cash you get coming in. So you should, in fact, get on the OE side at any rate, you should be getting a benefit from timing from higher escalation rates, right? We firm cash in. Is that a correct understanding on the OE side? Or is there something I'm missing?

[Warren East, CEO]

Yes. We were able to look at the detail on T&M just then.

[Panos Kakoullis, CFO]

Yes. And the interaction that's going on T&M. So -- and I think you're probably looking at one of the notes in the accounts around things that are a point in time as opposed to over time. Within T&M, there will be pure T&M that you're referring to, but there will also be elements that are covered under our long-term service agreements that aren't within the scope of that. So there'll be some parts, for example, that end up being within that. Going forward, we see sort of T&M being as we get to a more normalized level, it's still around about from the Civil Aerospace perspective, think of it as around 20% of the business. When we're at the levels now and as we're going through that recovery, you can get some of the distortions that you're talking about.

[Warren East, CEO]

Yes. And the escalation clauses on OE and the timing. I think this is a variation on the very first question, actually, about the timing of us getting cash payments and escalation and the costs coming out later. And it's the same answer. We've managed the contracts. Obviously, it's good to be able to enforce escalation and then we have to manage the cost side of the equation. And we -- that's what we're doing, and that's what we've described. And if we can tilt that balance so that the customer and the supplier piece is in our favor, and we can do that in a win-win way with our suppliers, then that's good news, and that's what we're setting out to do..

[Operator]

Now we're going to take our last question. And the last question comes from the line of Zafar Khan from Societe Generale.

[Zafar Khan, Societe Generale]

Good morning, everyone. I've got couple of clarification questions, please, and then 1 on costs. Starting with the cost one. I noticed the commercial admin costs in the first half, it's up by about 15% half-on-half. Just wondered if there was some one-off in there? Or it's just as business resumes and starts to take off, the cost inflation then comes in.

And then the 2 clarifications, please. Just on the indexation, I imagine there must be a cap in terms of how much inflation can be charged in any year and then there's kind of acts of god. And with inflation running at 9%, 10%, will you have to bear quite a bit of that increase yourselves because I imagine you'll have to share the pain with the customers. And then just a clarification on the cash and shop visits.

I think in answer to David's question, Panos, you were saying that you expect a lot more shop visits and therefore, that should help the LTSA cash inflow. I'm getting confused here. I was under the impression that shop visits means you can recognize revenue, which is basically a P&L item. But if you're doing the work, then you're incurring cash costs, so more shop visits that you have, okay, benefits the P&L but it's negative for cash flow. So just need a clarification on that, please.

[Panos Kakoullis, CFO]

Sure. Let me pick -- I can pick up all 3 of those. So I think you talked about the C&A growth around about 16%. There is an element that's effectively underlying growth of the businesses as in fulfilling on the Power Systems side, that sort of growth? And then a Civil Aerospace picks up, you have also -- you're anniversary-ing a one-off 2. So in last year's comparative, we have got a benefit of furlough for part of the period. So that as we get into the full year, you should see a more normalized level of growth.

In terms of indexation, I think there was a question earlier on similar sort of theme. It's not a cap, it's a color. So up to a certain level, we can pass it on. Then there's a color of a couple -- 2 or 3 percentage points that we can't pass on. And then beyond that, what's called effectively a hyperinflationary clause kicks in, which means we can pass on again. So there's not a ceiling on this. You're bound to have customer discussions around how that is going to be enforced and how it works.

What's going to be important for us is, we apply rigorous commercial discipline in having those in having those discussions. The point I was making on your final question was, I think, because David was asking how much is that LTSA creditor going to grow? And what causes it to grow is engine flying hours, cash comes in. What causes it to shrink is shop visits happening. Because as the shop visit happens, it comes out of that and goes into revenue in the P&L. So that's -- that's -- I was -- when David was asking me how much is it going to grow by? Engine flying hours cause it to go up, shop visits cause it to go down a bit. That's how I would read.

In terms of what that means from a cash perspective, if you think about it from a P&L perspective, the costs that go with the shop visit would similarly go into the P&L at the same time. So you'd see the revenue and the cost to do with the shop visit going through the P&L. That turns into operating profit from -- in terms of the start of your bridge from operating profit to free cash flow.

[Warren East, CEO]

And I'm being told there are no further questions. So just to quickly summarize, the message that we've been talking about this morning is one of good progress. And we measure good progress by growth in revenue, growth in orders, big swing around in cash driven by a strong recovery coming through now in Commercial Aerospace, driven by continued strength and record orders in our Power Systems business, and good visibility on Defense.

We've also talked a lot about the operational challenges that we are seeing, just the same as everybody else and just the same as we've been talking about. But we're doing a lot of blocking and tackling. We're doing a lot of anticipation and put a lot of long-term protection in to ensure both supply and protection against inflation. And taken together, that progress, combined with the discipline, the operational discipline, commercial discipline, protecting us against those external pressures is what's enabling us to maintain our guidance.

And yesterday, we announced completion of the conditions or the final approval, regulatory approval for the ITP transaction. And so we're delivering on that commitment of strengthening up the balance sheet, and we'll be paying down that debt just as soon as we get the proceeds.

[Warren East, CEO]

So that's it. That's the summary of the message. And thank you all very much for joining us.