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Executives

Ian Graham King - Chief Executive Officer, Executive Director and Member of Non-Executive Directors Fees Committee

Peter J. Lynas - Group Finance Director and Executive Director

Linda P. Hudson - Head of EI&S, Executive Director, Member of Advisory Board on Tanzania, Member of Non-Executive Directors Fees Committee, Chief Executive Officer of BAE Systems Inc, President of BAE Systems Inc and Executive Director of BAE Systems Inc

Kevin Taylor - Group Strategy Director

Guy Griffiths - Group Managing Director of International

Tom Arseneault - Chief Technology Officer and Executive Vice President of Product Sectors

Analysts

Christian Laughlin - Barclays Capital, Research Division

Robert Stallard - RBC Capital Markets, LLC, Research Division

Celine Fornaro - BofA Merrill Lynch, Research Division

Benjamin Fidler - Deutsche Bank AG, Research Division

Chris Dyett - Investec Securities (UK), Research Division

BAE Systems (OTCPK:BAESY) 2012 Earnings Call February 21, 2013 4:15 AM ET

Ian Graham King

Good morning, everyone. We're, hopefully, on time, just about. Can I -- am I allowed to start, Andy? Okay, Andy says we can start, so we can start.

Well, we're going to break with a bit of tradition here because normally we stand up at the podium and present, so we're going to present sitting down to get a bit more informality, and that will hopefully allow you to ask us lots of questions as well.

The other thing is, normally, our share price plummets as soon as we presented [indiscernible]. So this year, again, we're breaking the tradition. I think it's probably about the first time since I've had the pleasure of doing these results. Hopefully, that all goes well for the very tame questions that you're going to ask us after the presentation. So how are we going to handle is I will provide you a brief overview of the business environment and then some of the key events over the past year. I'll then hand over to Pete to take you through the results in detail and the outlook for the group, and then this will leave plenty of time for questions.

The group has again demonstrated a robust performance with strong trading in a number of areas. We are seeing high-quality performance execution across the business, and in particular, continued improvement in returns as some of our larger programs mature.

We continue to demonstrate a highly disciplined approach to cost control. This includes taking bold decisions to address capacity where we see pressures. We are not sitting and waiting. I believe this cost-focused approach is making us more competitive and is one of the reasons we are demonstrating good success in winning new business.

The group's broad spread of geographic business is providing resilience at a time when some of our markets are constrained by economic pressures. U.S. Defense budgets have flattened, and we expect them to decline as measures to address federal deficits are introduced.

In the U.K., the Defense market remains stable, following the program changes outlined in 2010. In wider international markets, the group is seeing good growth in order intake. Our strategic response in this environment has been to target International markets outside the U.S. and U.K. We have made excellent progress with order intake of GBP 11.2 billion in those markets, up from GBP 4.8 billion in 2011. We also generated a further GBP 11 billion of orders from the U.S. and U.K. The order backlog has risen by GBP 3.3 billion, an increase of 8% over the GBP 42 billion order backlog.

The group's focus on cash generation is expected to further enhance shareholder returns. You'll have seen that we have, today, announced the further share repurchase program. Our

U.S. businesses have felt the dual pressure of reduced activity in support of deployed operations and the start of measures to reduce U.S. federal budget deficits. As previously forecast, the U.S. land vehicles business has seen significant year-on-year reductions.

The U.S. elections have introduced some additional Defense procurement uncertainty with the administration entering a period of a continuing resolution from the end of September 2012. This is expected to continue at least until the end of March. As anticipated, some modest impact on the volume of activity has been apparent from the continuing resolution to date. In truth, we do not yet know what scale of Defense cuts we're dealing with, but we base our plans conservatively and are continuing to address the cost base quickly. We will seek to mitigate any impacts as the situation becomes clearer.

In land, setting aside the budget uncertainty, we have seen some supportive movements. Contracts to extend the reset of Bradley inventory of fighting vehicles into 2014 were helpful. In addition, we're in the proposal stage for low-rate production of the Paladin PIM. We continue to participate in the competitive demonstration phase of the next-generation ground combat vehicle, and we are the vehicle supplier to the Lockheed Martin-led bid in the Joint Light Tactical Vehicle competition.

In support services, we have seen a number of positive developments. In July, we commenced management of the Radford ammunition plant under a 10-year contract award. We were also recently awarded the multiyear maintenance contract for a number of U.S. Navy turboprop aircraft types. The U.S.-based Electronic Systems business recovered from the Johnson City flood. We have relocated the affected plant and were recognized for minimizing disruption to customers. We now have initial operating capability release on the APKWS-guided rocket, and the F-35 program continues to be a key platform for our avionics products. We continue to see good growth in the commercial aircraft electronics business, and good program performance has been achieved in support of the new CFM LEAP engine.

In our government intelligence business, there are circa $2.9 billion of bids awaiting customer decisions. In the U.K., the Defense budget is expected to remain flat, but the recent balancing of equipment requirements and the forward budget has established a more stable planning environment. BAE Systems has a large multiyear order backlog in the U.K., and the combination of good execution and the maturity of these programs is contributing to good performance.

In Military Air, European Typhoon deliveries have continued. Deliveries to the Royal Saudi Air Force are expected to resume as planned in May 2013. We continue to deliver assemblies for the F-35 program, consistent with our planning assumptions. The group's U.K. Maritime business is experiencing a high level of activity. The last of the 6 Type 45 Destroyers completed C trials. Good progress continues to be made on the carrier program with the delivery of major blocks underway, and work also continues on the design of the Type 26 ships to replace the U.K.'s Type 23 frigates from the end of this decade.

Type 26 production, as we recognized under the 15-year naval ship's Terms of Business Agreement, will utilize a lower level of build capacity than the carrier program. And discussions continue with the U.K. government to determine how best to sustain the capability to deliver complex warships in the U.K.

Good growth is anticipated in the submarines business on the back of the multiyear Astute programme and the buildup of engineering work load on the Successor program. We have now over 1,000 people working on the Successor program.

Outside of the U.S. and U.K., we continue to build on our positions in International markets. I'm pleased to report successes in 2012 have resulted in a substantial increase in order book, contributing to the first increase in the group's order backlog since 2009.

In June, our Land Systems business received a boost with a GBP 500 million CV90 vehicle contract for Norway. We continue to develop our business in India. Local assembly of Hawk aircraft by Hindustan Aeronautics is maintained with negotiations for 1/3 batch of aircraft expected to commence this year. The Indian government recently confirmed its intention to buy the first batch of the M777 artillery system under a U.S. foreign military sales program.

In December, the GBP 2.5 billion contract for 12 Typhoon, 8 Hawk aircraft and associated training and support was signed in Oman, significant new business for the U.K., boosting our order backlog and generating a large prepayment.

Defense remains a high priority in the Kingdom of Saudi Arabia. And we have seen -- and we have been progressing a significant number of opportunities. Following on from the budget approvals at the end of 2011, we were awarded a GBP 1.6 billion contract in May for Hawk and Pilatus training aircraft. Also, under the Saudi British Defense Co-operation Programme, we received orders at the year end for 5-year support arrangements.

Through the course of the year, the Tornado Sustainment Programme completed the aircraft modifications and substantial-related equipment orders. We are now negotiating upgrades and additional weapons packages. The Salam Typhoon programme progresses well for the first 24 Typhoon aircraft now in service. Deliveries are expected to resume this year, following a contract amendment last year to enable U.K. final assembly on the balance of the 48 aircraft.

There has also been a modification in the Salam contract to enable Tranche 3 capabilities to be embodied in 24 of the contracted 72 aircraft. We have yet to reach agreement on the price escalation. Negotiations are underway, and as I have said before, quantum, not timing, is what is driving us. We will do the right deal for our shareholders.

Discussions have commenced on the next phase of Salam support following on from the original 3-year agreement that formed part of the arrangements for entry to service of the Typhoon aircraft. Deliveries under the current contract continues to 2017.

We have seen and continue to see major activity in other markets. For example, we are building significant business with U.S. Military aircraft upgrades, such as the electronic warfare contract with Boeing for the Saudi F-15s. We have also won contracts to support overseas F-16 fleets and made a real breakthrough being down-selected for the South Korean F-16 upgrade programme.

We continue to pursue the Bradley opportunity in Saudi Arabia. In the U.A.E., we have won a number of equipment contracts and are pursuing other opportunities, including possibly significant Typhoon interests. The Malaysian prospect for Typhoon remains alive and well. We have one vehicle contract in Sweden and an M777 artillery follow-on contract in Australia. Building on our success in Norway with the CV90 program contract, we are also offering the CV90 vehicle to Denmark and Canada.

Before I hand over to Peter, I would like to touch briefly on strategy and last year's merger discussions. BAE Systems has a well-defined strategy, which is focused on our position as a premier global defense aerospace and security company. In this context, it is worth noting that the merger discussions were at no time seen as a replacement for the group's established strategy, which would have continued to be progressed across an enlarged defense aerospace and security entity. The merger was also expected to be a complex transaction, not least due to multiple government national security considerations, but a prospect of compelling value enhancement and good strategic fit made the opportunity worthy of exploration.

Despite much good progress, the discussions were terminated when it became apparent that not all government preferences could be reconciled and before any proposal could be taken to shareholders.

The group's ongoing strategy is to drive shareholder value through a combination of further improvements in financial performance and enhanced competitive positions across the business. The focus of the group includes growth in our Cyber, Intelligence & Security businesses, but the recent Vodafone announcement demonstrates a key milestone in developing this sector, addressing growth opportunities in Electronic Systems, driving further value from the group's broad base of Platforms & Services positions and increased business in international markets outside of the U.K. and U.S. Services activity now represent 50% of BAE Systems sales, testament to the evolution of the group.

Cash flow has been particularly strong in 2012. In addition to good cash flow from operations, the group has benefited from the funding on the higher international order intake. Some of this cash flows required to fund future working capital, but BAE Systems is a cash-generative business with a strong balance sheet. We recognize the importance to shareholders of the clear capital allocation policy, consistent with sustaining a strong investment-grade credit rating. We continue to believe that, currently, repurchase of the company's own shares still represents a good investment and have today announced a 3-year repurchase program of up to a further GBP 1 billion worth of shares, which Pete will detail shortly.

The group's business portfolio is currently appraised, and we have disposed of 3 small businesses during the year for a combined consideration of just over GBP 100 million. We continue to see bolt-on acquisitions that enhance routes to market or which provide rapid access to technologies and capabilities. In November, we agreed to GBP 60 million -- $60 million acquisition of Marine Hydraulics International, a marine repair and conversion company. Large-scale acquisitions have not been a feature of the group's recent strategy.

In the period 2010 through 2012, we have returned over GBP 2.8 billion to shareholders in dividends and share repurchases invested -- and share repurchases, invested GBP 0.8 billion in acquisitions and generated GBP 0.5 billion from business disposals. This is in addition to our pension funding commitments and the significant organic investments we make in research and technology, training and our operational capability. This is not a business taking short-term measures. We continue to invest for the future.

In summary, BAE Systems continues to deliver a robust performance against an environment of budget constraints in many of its markets. The U.S. continues to be draped in uncertainty around sequestration and near-term continuing resolution constraints. Clarity must emerge at some point, but we do expect the market to decline. The U.K. can be characterized as challenging, but stable. We are making significant progress in growing our International order book and have further opportunities to mitigate the challenges in the U.S. and U.K.

Affordability is a key consideration for all our customers, and the group has been successful in reducing costs over a sustained period. In this environment, we will continue to pursue cost reduction and efficiency measures with vigor. Pete?

Peter J. Lynas

Thanks, Ian. Good morning. As Ian's mentioned, the delay in securing a satisfactory settlement on price escalation to the Salam Typhoon contract has impacted the year's sales and earnings performance. And I'll highlight this as I step through the performance of the sectors later in the presentation. I'm going to cover the 2012 results first and then move on to guidance for 2013.

So firstly, the headline numbers and compared to 2011, sales declined by 7% or GBP 1.3 billion to GBP 17.8 billion. Of this, GBP 0.8 billion came from expected land volume reductions and GBP 0.4 billion for there being no contracted Typhoon aircraft deliveries on the Salam programme in 2012.

Underlying EBITDA reduced by 6% to GBP 1,895,000,000, giving a return on sales of 10.6%. Underlying finance costs in the year of GBP 204 million were marginally higher than in 2011, last year, included a charge arising from early debt redemption relating to the disposal of the Regional Aircraft Asset Management business. And cost in 2012 have included interest on the GBP 400 million debt refinancing that we completed in June and a higher level of net present value charges on long-term liabilities.

Underlying earnings per share, excluding last year's R&D tax credit, reduced by 2% to 38.9p. There was exceptionally strong operating cash flow of GBP 2.7 billion, and as a result, we closed the year with net cash of GBP 387 million. Order backlog increased by 8%, GBP 42.4 billion, the highest for the group since 2009. And the dividend for the year has been increased to 19.5p per share, up 4% on the 2011 dividend. At this level, the dividend is covered 2x by underlying earnings per share, remaining in line with the group's policy and despite the impact of the Salam Typhoon pricing delay.

In addition to the effects of exchange translation, where the U.S. dollar closed at $1.62 compared to the opening $1.55, there were a number of other items materially impacting the balance sheet in the year. Intangible fixed assets reduced mainly for amortization and the goodwill attaching to the Land & Armaments business disposals that we completed in the year; the reported value of investments held has reduced primarily on receipt of a GBP 424 million one-off dividend from our MBDA joint venture. This was done under an arrangement between all 3 shareholders to permanently extract cash that we already held within our respective balance sheets.

Within working capital, there was several significant movements. Down payments increased from receipts on the Omani Typhoon and Hawk order that we received in December and from the Saudi Training Hawk aircraft contract that we received in May. Payments accelerated from 2013 by the Saudi customer on the -- in the first half year on the Tornado upgrade program. And these receipts were more than outweighed by the advances we consumed in the year on the European Typhoon Tranche 2 program. In addition, there were costs incurred on the amount of Offshore Patrol Vessel contract and on rationalization as provisions created in previous years were utilized. In aggregate, working capital was improved by some GBP 900 million.

The IAS 19 accounting pension deficit has increased to GBP 4.6 billion, and I'll cover that on the next slide. And as I said before, we closed with net cash of some GBP 400 million. This slide shows the pension scheme assets, liabilities in deficit as accounted for under IAS 19. The value of the scheme assets has increased over the year to GBP 19.6 billion. And in December, the group contributed a further GBP 75 million of property assets into its largest U.K. scheme. In aggregate, across all the group's pension plans, x the investments, now comprise 52% of scheme assets.

Over the year, liabilities increased by GBP 2 billion to GBP 25.3 billion. Real discount rates reduced by 30 basis points in the U.K. and by 90 basis points in the U.S. on lower bond yields, and this has increased reported liabilities by some GBP 1.7 billion. These discounts unwind in service costs, less pensions paid, accounts for the rest of that increase in liabilities. So the aggregate impact of those movements is an increase to the group's pretax accounting pension deficit of GBP 400 million.

As you know, these mark-to-market movements have no bearing on our scheme funding. Revised funding agreements were reached in February 2012 with the trustees of the 2 largest U.K. schemes. And notwithstanding volatility in accounting deficit, those funding agreements are sustained through 2014. Total deficit funding across all group schemes is around GBP 400 million per annum. As the group seeks to mitigate pension deficit volatility where it can, we have entered into an agreement earlier this week with Legal & General to transfer the longevity risk on some GBP 2.7 billion of our pension liabilities to the insurance market. And we continue to review other mitigation options available to us.

Moving onto cash. This slide sets out the movement from our net debt of GBP 1.4 billion at the beginning of the year. The operating business cash flow was GBP 2,692,000,000. Interest and tax payments were GBP 262 million. Payment of 2011's final and 2012's interim dividend totaled GBP 620 million. And net proceeds arising from disposals made was GBP 96 million, including the 3 Land & Armaments businesses. Exchange translation and all other movements total GBP 80 million, closing net cash down at GBP 387 million.

The cash flow performance of the 5 sectors is shown here, and I'll return to this when I cover the results of each of the sectors. But just to note, the total cash outflow for pension deficit funding made in 2012 was GBP 432 million. And the cash outflow at head office contains GBP 195 million of that.

This next chart shows the gross debt, cash and net debt of the group. At the start of the year, borrowings amounted to GBP 3.2 billion with cash held at GBP 1.8 billion giving the reported net debt of GBP 1.4 billion. The total cash inflow for the year was GBP 1.8 billion. Holdings of short-term commercial paper amounting to some GBP 500 million were repaid during the year. New 10-year term debt of GBP 400 million was put in place in June, and that debt was secured at 4 1/8% to prudently pre-finance debt maturing in 2014, which has a blended rate of 6.3%. Consequently, at the end of the year, total borrowings have reduced to GBP 3 billion. Cash holdings have increased to GBP 3.4 billion, and net cash stood at GBP 400 million.

In addition to the GBP 400 million of debt repayment in 2014, there are some nearer-term demands on that GBP 3.4 billion of cash, which I'll return to later when I get to our 2013 guidance. We continue to manage the group's balance sheet conservatively to retain our investment-grade credit rating and to ensure operating flexibility in dealing with our working capital volatility. Our approach to capital allocation is unchanged. We will meet our pension obligations and continue to pursue organic investment opportunities that meet our financial criteria. We plan to pay dividends in line with the group's policy of long term, sustainable cover of around 2x and return capital to shareholders when the balance sheet balance sheet allows.

Value-enhancing acquisitions will be considered when market conditions are right and when they deliver on the group's strategy. And consistent with this approach, we have, today, announced the longer term, 3-year share repurchase program of up to GBP 1 billion. Full implementation of this program is subject to satisfactory resolution of the Salam Typhoon price escalation negotiations, and we have commenced discussions with our U.K. pension scheme trustees with regards to any associated acceleration of deficit funding.

So I'll turn now to the sectors, and I'll cover the India performance here and then return to the 2013 outlook a little later. And so the first of those sectors, Electronic Systems, and the numbers' here shown in U.S. dollars. Slightly below previous guidance and with October 6-month continuing resolution operating through the final quarter of 2012, sales compared to 2011 decreased by 6% to GBP 4 billion -- $4 billion. The primary driver of this reduction was the completion of Thermal Weapons Sight deliveries made in support of operational tempo-driven requirements. More than 15% of this sector is in the commercial markets, and their sales grew by 10% to $670 million. The return on sales achieved at 14.2% was at the very top end of our forecast range, and programme execution remains strong with good risk retirement seen on that completing production contract. The business also delivered in-year benefit from continued cost-reduction action.

Cash conversion of EBITDA for the year was 72%, and excluding pension deficit funding, that convention rate was 95%. Order backlog increased to $5.8 billion despite a delay in disruption to contract awards caused by the continuing resolution. And this follows the award of a long-term contract to provide electronic warfare upgrades on the Saudi F-15 aircraft.

The Cyber & Intelligence sector comprises the U.S. Intelligence & Security business, together with BAE Systems Detica. The numbers' here again in U.S. dollars. In aggregate, sales for the year of $2.2 billion were almost unchanged over 2011. The U.S. business saw a 1% decrease being impacted by the high level of competitive bids submitted awaiting award decisions during the continuing resolution period. Growth in the BAE Systems Detica business was just 1%, as sales were constrained on a program in the Middle East where we needed to restructure contractual arrangements. The margin achieved of 8.8% was within our guidance range, and the margin level reflects the continued organic investment in the Detica business to support targeted future growth in commercial markets. Cash conversion of EBITDA was at 91%. Order backlog reduced to $1.6 billion, and we had some $2.9 billion of competitive bids from our U.S. Intelligence & Security business awaiting award decisions.

The U.S. Platforms & Services sector aggregates the Land & Armaments and the Support Solutions businesses. The numbers' here again in U.S. dollars. And we continue to provide transparency of the 2 businesses within this sector, so I'll move straight on to the performance of the first of those 2 businesses, Land & Armaments.

As described at the Interim Results Presentation, the comparative numbers for 2011 have been amended to reflect the transfer made at the beginning of the year of the protection systems line of business from Land & Armaments into Support Solutions. Sales of $4.2 billion declined by 20% on a like-for-like basis. As expected, sales reductions were on the FMTV program, which completed in 2011, and for lower volumes at Bradley, Caiman and MRAP activity. The reported margin of 8.6% was in line with previous guidance and includes the charges taken in the first half year for the accelerated closure of the Newcastle site and for certain legal claims.

With regards to cash flow, conversion of EBITDA pre-pension deficit funding was at 83%, as facilities investment under the 10-year U.K. munitions program continued through the year. Order backlog was almost unchanged at $8.3 billion and includes the important Norwegian CV90 contract win and Bradley funding awards through into 2014.

In the Support Solutions business, sales were just 2% down against last year's. New business, in particular, from the Radford Ammunition Plant was offset by lower op tempo-driven volume. Margin of 8.8% was ahead of guidance, benefiting from certain legal settlements that contributed 90 basis points. There was 110 cash flow conversion of EBITDA, excluding pension deficit funding.

Order backlog increased to $5.4 billion, following awards for the Radford Ammunition Plant and U.S. Navy Training Aircraft Maintenance contracts.

In the Platforms & Services U.K. sector, the year's sales of GBP 5.6 billion were lower than 2011 by 10%, there being no contractual aircraft deliveries on the Salam Typhoon program in the year and from 2011's completion of South African aircraft deliveries. Sales were below guidance for the delay in securing the Salam Typhoon price escalation settlement. As expected, the return on sales of 12.2% was at the top end of our forecast range, benefiting from the strong programme execution and risk reduction seen in the first half year on the European Typhoon aircraft production and Type 45 Destroyer contracts.

Cash performance in the year reflects the down payments received on the new Saudi training aircraft and Oman contracts, less advances utilized on the European Typhoon Tranche 2 program and for the costs incurred on the Omani OPV contract and for rationalization. Those Saudi and Omani contract awards have driven up the order backlog to GBP 21.2 billion.

Sales in International sector of GBP 4.1 billion are 9% higher on a like-for-like basis than in 2011. The increase is primarily on weapons deliveries under the Saudi Tornado upgrade contract and on support for Typhoon aircraft now in service. However, this sector was also impacted by the delay in securing the Salam Typhoon price escalation settlement.

EBITDA of GBP 417 million generated a return on sales of 10.2% in the middle of our guidance range. Operating cash flow exceeded EBITDA, benefiting from those receipts accelerated from 2013 by the customer on the Saudi Tornado upgrade program. Order backlog has increased to GBP 9.3 billion following awards secured in December under the 5-year Saudi core support program. For reference, there is a chart providing a summary of the trading performance of the 5 sectors along with the numbers for HQ appended to your presentation packs.

This penultimate chart seeks to give guidance as to how we see the performance of each sector developing from 2012 through into 2013, set against our previously-stated U.S. Defense budget assumptions. Importantly, whilst this guidance does assume a continuing resolution through the first quarter, it does not seek to address the potential impact of sequestration or an equivalent scenario on our U.S.-based sectors. Once we have clarity, and as necessary, we will further update our guidance.

So firstly, electronic systems, and overall, we expect sales in 2013 to be similar to those in 2012. The impact of the 6-month continuing resolution through to the end of March is to delay and defer our new start programs. And given the larger number of short-term contracts in Electronic Systems, this sector has had and continues to have exposure to the effects of the CR. That said, some 15% of the business is in the commercial aerospace market where we expect continued good levels of growth. In aggregate of 2013's projected sales, some 75% are in the 2012 closing order backlog. Our margins would expect the high levels seen in 2012 to move slightly lower, but within our guidance range of 12% to 14%.

Next, Cyber & Intelligence. And here, we expect sales in 2013 to be marginally lower than in 2012. The U.S. business, which is 80% of the sector, is expected to be some 5% lower. The business has a material contract for analysis support relating to Counter IED activity in Afghanistan, and the level of analysis support funding on that contract is expected to significantly ramp down in 2013.

Sales in the Detica business are planned at a double-digit level from the expected expansion in commercial markets. And margins in '13 are expected to be within an 8% to 9% range with ongoing organic investments planned for Detica.

Moving to Platforms & Services U.S., and whilst overall guidance is as shown on the chart, this is best considered in 2 parts. On Land & Armaments, we expect reported sales in 2013 to be around 10% below the '12 level. 6% is due to the full year effect of the business disposals made in 2012 and because the U.K. vehicles and support line of business is being transferred to the platforms and services U.K. as a further cost-reduction action. The remaining 4% largely relates to the 2012 completion of the U.S. contract for Caiman vehicle upgrades.

Some 85% of the sales guidance is currently within order backlog, a stronger position that the business had going into 2012. As for the margin level, we expect delivery around the 8% mark as further rationalization activity and charges are assumed in 2013. We continue to review the Land & Armaments portfolio, and further disposals in addition to the 6 made over the last 2 years are possible. Such further disposals are not reflected within the guidance given today.

In the Support Solutions business, we anticipate 2013 sales to be marginally higher than in '12, benefiting from the new business awards secured on the Radford Ammunition Plant and Naval Training Aircraft Maintenance. Margins in this business will reduce to their underlying level after 2012's legal settlements benefit.

Turning to Platforms & Services U.K. And in this, the largest of our 5 sectors, we expect sales in '13 to increase by around 25%, benefiting from both the anticipated resolution of price escalation and the resumption of aircraft deliveries on the Salam Typhoon contract where 10 aircraft are scheduled for delivery in '12 -- in 2013. Other than the Salam price escalation, some 90% of the sales guidance is within the 2012 closing order backlog. Margins in this sector are expected to be similar to the levels seen in 2012.

And so last of the sectors, Platforms & Services International. And here, we expect sales in 2013 to be marginally higher than last year's. The deferred trading arising from the Salam price escalation and increased levels of support to the Typhoon aircraft now in service are likely to be partly offset by a reduction in the Australian business, primarily related to the Landing Helicopter Dock build program. Other than for Salam price escalation and receipt of the contract extension for ongoing Typhoon support, some 85% of this guidance is covered by order backlog. Margins should benefit from the catch-up arising from the resolution of the Salam Typhoon price escalation. And we, therefore, expect it to be towards the top end of the 10% to 12% range.

And to complete your 2013 models, headquarter's cost are expected to be more than 10% lower than in 2012. Underlying finance costs should be marginally lower, and the effective tax rate is expected to be within a 23% to 25% range, an improvement on previous guidance. And the final numbers, of course, is dependent upon the geographic mix of profits.

In aggregate, and this is subject to the near-term uncertainties relating to U.S. Defense budgets, modest growth in underlying earnings per share is anticipated for 2013. This excludes any benefit from the share repurchase program announced today. And in addition and assuming the satisfactory conclusion to Salam pricing negotiations this year, there will be a further increase of around 3p rolled over from 2012.

With exceptional level of operating cash flows seen in 2012, I thought it would be helpful for this year to give you a final slide to highlight the cash utilization we expect in 2013. As you know, cash forecasting for this group can be a challenge given the digital nature of some of the items we deal with. And we do transact around GBP 35 billion of gross cash flows throughout the year. That said, this slide gives our current view. And I should make it clear, these numbers are before any share buybacks.

So in respect of operating cash flow, firstly, we're not planning any material capital expenditure above depreciation levels. And within working capital, we will utilize 2012's accelerated receipts on the Saudi Tornado upgrade program. We also expect to incur costs of around GBP 400 million against provisions created in previous years that are held in the balance sheet. The most volatile area is around the advances. Against the major advances we received in 2012 on the Saudi trainer aircraft contract and Omani contract, we will see a high level of utilization.

Under the terms of the Omani contract, no further cash will be received until deliveries commence in 2017. There will also be advances consumed on the European Typhoon production contract. The guidance here does anticipate cash inflows from the Salam price escalation settlement. And clearly, those have yet to be negotiated.

The final operating cash flow item in the year is the pension deficit funding, which remains as per previous guidance at around GBP 400 million. The nonoperating cash flow items are far more predictable. And the outflows for interest tax and dividends are expected to total around GBP 1 billion. So overall, 2013 will be a year of significant cash utilization. However, and notwithstanding this, the balance sheet does support the share buyback program that we've announced today. Ian?

Ian Graham King

Thanks, Pete. So if I summarize, we continue to demonstrate strong performance despite the challenging set of market dynamics. The business is delivering the strategy. We continue to develop the business with an equal balance of platforms and services, activities. And we are successfully establishing a path to growth in the international markets.

Clearly, the U.S. budget environment is unhelpful, but I would remind you that a full sequestration would reduce budgets by around 10%, or perhaps, 15% as an impact to investment accounts. BAE Systems is one of the most geographically diverse Defense companies. And with the U.S. comprising 40% of our business, this exposures reduces to circa 6% of the group. We do not take such concerns lightly, but I believe this team has a good track record when addressing challenges. And importantly, as we navigate this current more constrained environment, we continue to deliver sustainable multiyear value back to our shareholders.

Questions?

Question-and-Answer Session

Christian Laughlin - Barclays Capital, Research Division

Christian Laughlin from Barclays. Just a two-part question about EADS, if I may. One, just wanted to hear your views or thoughts around recent commentary Tom Enders has made in the press around a persisting interest in a tie-up at the group level, if you share those views. And if you can -- if it is possible for you to even comment on any -- maybe at what level ongoing discussions may persist? And then secondly, again with EADS, but specifically with Eurofighter, regardless of group level tie-up or not, seems to me that you'll be proceeding ahead with trying to optimize business capture or business development opportunities with the Eurofighter program. Could you go into a little bit more detail on what that really means in the near term and in terms of restructuring their sales campaigns, perhaps? And then on the profitability side, anything you're doing with Eurofighter in concert with EADS just to make the program overall more profitable?

Ian Graham King

Well, you've sort of been asking the questions and then providing your own answers really. I mean, you're absolutely right. We have 2 very strong joint ventures with EADS, which exists already. One is MBDA in missiles, which is the second largest missile company in the world, sometimes the first, sometimes the second, but it's up there. And then we have the Eurofighter joint venture. And what we're doing with Eurofighter, we've talked about this before, is clearly, it was a structure which was optimized around European nations' offtake of aircraft. And as this market gets, for us, gets more driven around full [ph] life support and export markets, then we've restructuring that with our European partners to make sure that that's what it's structured to do. And the cost and the efficiencies of that are required and also the support of the governments and the commitment of the governments to continue to develop the capability of the platform is what our International customers will require as well. So there's a lot of activity going on in that respect, and that's what our focus is with the EADS. It's not for me to comment on what Tom said or not said. I mean companies move on. This is old. We were right, as I said before, to investigate it. We investigated it. The company's stronger today than it was before. There's been no harm done to our business, and we're getting on, and as you can see, successfully delivering our strategy. There's one just behind you and then there's one in the middle.

Robert Stallard - RBC Capital Markets, LLC, Research Division

Rob Stallard from RBC. First of all, on the operations, military operations side, I was wondering if you could give us an idea of how much revenues are tied directly, indirectly, to military operations in 2012, and how much you're forecasting those to reduce in 2013. And then secondly, on the sequester, if it was to kick in, how much of that would actually affect your business this year or would it largely spill into next year?

Peter J. Lynas

So the question on military operations, that relates to...

Robert Stallard - RBC Capital Markets, LLC, Research Division

Across the group, if you got any idea of how much revenue is generated from those operations last year.

Peter J. Lynas

If you're looking through into 2013, the guidance seemed -- incorporates all troop withdrawals that are currently anticipated. So anything -- any impact is already within that guidance.

Ian Graham King

Okay. I'll ask Linda to talk about the sequester. I mean, as I thought, we have no more distinct knowledge than anyone else, but who's got -- Andy? Andy's got it there, Linda.

Linda P. Hudson

I wish there were good concise answers on sequestration, but -- excuse me, I have a cold. We've said all along that given the shape of our portfolio and making some assumptions about how sequestration would impact the business in the U.S., that it would be somewhere in the 10% to 15% of sales we would expect across the portfolio with the way it's currently envisioned. Without more clarity from our customers, it's almost impossible to predict exactly where it will be or how it will play out. But given the situation right now and what we've done, we think it'll be contained in that range and would flow through the performance of the organization. So right now, we're just looking at different scenarios, what could happen, staying focused on taking out costs so we can keep our bottom line performance going strong and being ready to adapt to whatever the priorities are that emerge from the U.S. Government as this unfolds. And of course, it's very difficult to know when it will unfold. It's a difficult environment. But overall, we think we have it bounded and that we understand how we will adapt given the scenario planning that we've done so far.

Ian Graham King

So all we can do is to keep -- out there, Linda spends a huge amount of her time at the White House, the Pentagon. All that team are all switched in as any others of our competitors. I spent time in the U.S., what was it, 2 weeks ago. I was in the Pentagon with Erin. That's all we can do. There was -- they're planning, they're replanning, they're carrying on, doing what they're doing. We will address whatever we have to address.

Nick [ph]?

Unknown Analyst

Sorry, disparate questions. First of all, on the timing of the buyback, I think you've put a conditionality on the Salam repricing being done. But after that, is it sort of immediate onset and then spread evenly over the 3 years? Or will it tend to be episodic? That was one question. Another financial one, your colleagues at Lockheed Martin are looking forward to recovering about $6.5 billion of extra pension contributions they've made as a result of FAS/CAS realignment. Does that have any impact on you? And finally, a bit of a follow-up on the sequestration and CR issue. Judging from the PowerPoint set that Army and Navy have put out, they're going to -- they're intending to virtually cancel all heavy duties, sort of depot level maintenance in the second half of the fiscal. Does that mean that you could suffer particularly nasty impact in ship repair, in particular, and maybe in land as well?

Ian Graham King

Please cover the first 2, and then I'll cover -- between us, cover the third one.

Peter J. Lynas

In terms of buyback, Nick, I mean what we're saying is that full implementation of the buyback is subject to satisfactory resolution of the price escalation issue, so we will be starting the program today, okay? So we're not waiting. We're off. In terms of the pension issue, I think, as you know, in the U.S., if you put pension deficit funding in, you recover it over time through pricing; in the U.K., you don't. You only get your service costs back. About 20% of the group's pension deficit is in the U.S., so to the extent we're funding deficit there, we will get that back through pricing.

Ian Graham King

In terms of your comment on, particularly around naval and what we're getting out of the armed services, you will have seen yesterday that we did have to send some warn notices to our people saying that there is the risk that based on the current allocation or their intent because they don't have their budgets approved, so that could impact 3,500 people, because we have to give 60-day notification to the people. And that's what we would do.

Celine Fornaro - BofA Merrill Lynch, Research Division

Celine Fornaro, Bank of America Merill Lynch. 2 questions, if I may, please. The first one is just if you could tell us on the balance sheet, how much you have of long-term contracts, meaning including program prepayments. If you could just disclose this number. It was GBP 4.1 billion in '11?

Peter J. Lynas

GBP 5.1 billion.

Celine Fornaro - BofA Merrill Lynch, Research Division

Sorry?

Peter J. Lynas

GBP 5.1 billion.

Celine Fornaro - BofA Merrill Lynch, Research Division

Okay. And then the second question is regarding the cyber business, thinking 2011, the split was like 50-50 Defense and Commercial?

Ian Graham King

In Detica, that was 50-50, yes.

Celine Fornaro - BofA Merrill Lynch, Research Division

Okay. And if you could just comment on the Vodafone agreement, so you said it was a step change. So what should we think in terms of the split and where do we think margin are going? I think that the target is the 12% to 14% range, so does Vodafone accelerate this?

Ian Graham King

No, I mean that is our target. We always said that we're investing organically in the business, and that does continue through '13. And we have Kevin Taylor here, who's responsible, supervisor of that business. You want to comment on the Vodafone activity, Kevin, just sort of capsulate what it's about, and why we do view it as a major milestone going forward?

Kevin Taylor

The Vodafone agreement allows for us to supply cyber security services to all Vodafone's mobile business subscribers across the globe. The best way to characterize that is, currently, Vodafone, 160 million business subscribers. So the service that we're offering is new cyber security services through, what they call, the mobile threat manager. And really, how successful that will be will depend on how many of those subscribers pick up that service going forward. And it's now being launched in spring, so we'll see exactly what that take-up is in the coming year.

Ian Graham King

But it's a great step forward. It's something that we and Vodafone had been working on for a while. And now the service has been launched. And you can see the sort of things that we've been investing on in that timeframe.

Celine Fornaro - BofA Merrill Lynch, Research Division

Is there a minimum level of business condition from Vodafone to guarantee to you or not?

Peter J. Lynas

No. So it depends on how many of those subscribers that'll take up the service worldwide.

Ian Graham King

But we have an agreed price for a subscriber.

Peter J. Lynas

Just coming back to your point on advances, just in case you didn't hear the response. GBP 4.1 billion is where we started the year. We closed at GBP 5.1 billion, and that's obviously been driven by the down payment we've got on the Omani contract, as well as the Saudi aircraft training program and in Norway CV90 contract.

Ian Graham King

Okay, Ben, and I think -- was there another one. Or did I just imagine a phantom hand going up somewhere?

Benjamin Fidler - Deutsche Bank AG, Research Division

Yes, Ben Fidler from Deutsche. Probably 3 questions. Firstly, just another one on Detica, what was the impact of that? You talked about the sales constrained by this Middle East contract rejigging. If we were to strip that out, what was the underlying growth then of Detica?

Ian Graham King

Good question. Peter will calculate it as we speak.

Peter J. Lynas

It was about 10%.

Benjamin Fidler - Deutsche Bank AG, Research Division

Okay. The second one was the group -- what the restructuring charges were at the group level in these 2012 numbers, and how we should think about that number for 2013? Maybe it's a slightly difficult one to answer for '13 because you don't quite know what restructuring you're absolutely going to have to do, but any sort of steer you could give us on that? And the third question on Saudi repricing, the delivery milestone for the next Eurofighter, I believe, is in May. Would I be reading too much into thinking that, that might be a reasonably useful watershed or...

Ian Graham King

We have a contractual milestone to meet in the delivery, but it's not unhelpful.

Peter J. Lynas

On the restructuring Ben, the issue with restructuring is, are you asking a question about our gross cost or the net cost? Because some of these, we get -- recover back through pricing. The only material movement from '12 to '13 really is, I mentioned in land we are anticipating we'll do another -- there's some more restructuring to be done, and that probably takes about 1% of the ROCE [ph].

Ian Graham King

I mean it's important. I mean going back to your Saudi question, I mean it's an important factor. Recognize that we have a customer out there, who absolutely likes the aircraft and has a squadron of these aircraft in service and has real plans to introduce the other 2 squadrons into service. So this isn't a position where somebody believes they've got a substandard platform. I mean this is a pricing escalation. And it's absolutely clear and limited very much in the administer of finance minds. There is a settlement to be done. It is about the quantum, not the fact that there's an obligation.

Unknown Analyst

I'm staying with Typhoon for a moment. What are the operational implications of this delay on the pricing agreement? Are you continuing to produce aircraft into inventory? How much is that going to build up to? Or are you sort of stopped for slowing down? And then the second one in Typhoon, there was -- it's now some time back, but there was some discussion at one point of the European governments having an interest in using export sales of Typhoon to offset their commitments. Is that still something that's in the background, or is that gone now?

Ian Graham King

If we answer this, the second part, I mean no, it's not. We -- the European nations do recognize that they meet their obligations to the totality of the scale of the program if we sell overseas. And so they're all very supportive and full on in terms of negotiating those issues with us. So we're getting full support, in particular, from the U.K. government is absolutely leaning forward on this, this commitment to selling this overseas. One of the important facts as we talked -- as I mentioned earlier, it is about keeping on advancing the capability of the aircraft. And so we do have a constant debate with the European nations about how they maintain their capability upgrade so they match what we're offering into export markets, into international markets. And there's really progressive debate on that going on, so they are all leaning forward in recognizing that they have to help us sell overseas in order to also protect their own interest of having a very sustainable aircraft going forward. Sorry, what was the first question? I forgot the first question.

Peter J. Lynas

Actually, it was on the build. Yes, we are continuing build. If you remember one of the issues we had about where was final assembly going to take place, was it going to be in country or was it going to be back in the U.K.? And there was a contract amendment reached, which would sort of move it. So there was a lull, but yes, we are now in -- we are building assemblies.

Ian Graham King

Why don't we ask Guy? Why don't you -- I mean because you're dealing with this customer, day in, day out. What was your view of the status of the relationship and how they feel about the program?

Guy Griffiths

Well, they, first of all, I love the aircraft. It's characteristic that for the first the first squadron, which is a training squadron in Saudi Arabia, we have no difficulty, frankly, achieving the flying hours because the pilots are desperately keen to get airborne and to practice and understand the capability of the aircraft. In terms of -- is it worth me just explaining where we are on the...

Ian Graham King

Yes. We've got him, now we'll never get him off.

Guy Griffiths

So we got -- we did get into quite detailed negotiations in the latter half of 2012 in terms of the price escalation calculation. I think it's noteworthy that we're dealing here with a relatively small, but very capable customer negotiation team. And in parallel with the escalation discussions we were having, you'll have seen from the order intake that we were also negotiating a suite of other new contracts. And from the customer's point of view, actually, it's reasonably understandable that they were more interested in terms of prioritization in moving forward with those other contracts because they are delivering operational capability, which is essential to the Air Force, whereas the escalation negotiation, they see really is just financial adjustment to an existing contracted program. As we move into 2013, it is true that we are now negotiating, and as Ian said earlier, another suite of quite significant new operational commitments around Tornado upgrades, weapon upgrades and the 5-year support arrangement for Typhoon. But I think we really have got the customer's focus both at the operational level and at the political level on finalizing these negotiations. And to that end, they've bolstered their own resources by bringing in external consultancy help to help them with the technical aspects of a price readjustment. In the background of all that, the customer's busy talking to us about further enhancements to the Typhoon platform and what he wants to do with it in terms of weapons fit, in terms of sense of fit. And I think that's a very clear indication of his support for the product going forward.

Ian Graham King

Okay, one final. Pillow [ph]?

Unknown Analyst

Yes, it's only me. Just trying to set a -- sequester is a thing we'll have to deal with. We're not being short term about the way we run the business. Is it possible for someone to sort of just help us out a little bit about how we flex if sequester were to come in? Ship repair capability, they were never going to cut, now they're going to cut it. So somehow, we have to flex, but potentially come back maybe after 3 months or 6 months. Maybe in ship repair, we have some flexibility. Land & Armaments, I'm not so sure. I mean, how would Tom, not that Tom knows me from Adam, how would Tom cope with that in his business if we had to kind of go down and then come back up as things normalize through the course of '13 or '14?

Ian Graham King

Well, the issue with ship repair is one of these orders weren't with us because the way that they provide us the ships to go into the services, so that, if you like, an immediacy of that. If look at the order book that we have today in Land & Armaments, what is it, 85% of this year's sales. So those are existing commitments which are committed. What do you say for the Electronic Systems, Tom, which again, remember 15% of that is in civil avionics where we have long-term commitments?

Linda P. Hudson

Can I speak possibly first....

Ian Graham King

Yes, sure Linda...

Linda P. Hudson

And then let Tom answer that because I think it's important to understand that if sequestration goes into effect as currently in law, the reductions are against unobligated funds. So that does not give the services the authority to cancel programs that are currently obligated. So the bulk of the initial impact will be in the operations and maintenance accounts. That's why you're seeing the direction coming out of the service, talking about ship repair, talking about depot maintenance and those kinds of things. The current way it's envisioned, it is unbalanced, if you will, much more heavily in the operations and maintenance side of things as opposed to the procurement dollars. So unless the law changes, it will be very difficult, at least out of the gate until some revisions, perhaps, get introduced for a service to just slash a program. That's not the way the law reads. The law requires the customers to take an equal reduction out of every unobligated line item in their budget. So we don't expect, at least in this first wave, major procurement cancellations and things going away. What we do expect is things to slow down as they try and sort this out on the procurement side. And the easy cuts, which are in the O&M budgets, are the ones that will happen first, which is why you're seeing the data from the Army and the Navy and the Air Force right now that immediately hits the maintenance funds, but now...

Unknown Analyst

So where do we sit, Tom? Because this is the issue, as Linda says, between do we have a huge number of new start programs in 2013 in the [indiscernible]? Or are we pretty strong on mature programs that are obligated already?

Tom Arseneault

Was the question around Land & Armaments or around Electronic Systems?

Unknown Analyst

Electronics...

Unknown Executive

Well, you can try Saudi if you want, but...

Ian Graham King

Land & Armaments, we've got a very strong order book going into '13, so they've quite helpfully obligated Bradley [ph] through to 2014 during last year. So we've got a good work load going through.

Tom Arseneault

Yes, I think it's also fair to point out that as you have followed over recent years, the size of the workforce in Land & Armaments has come down significantly already. Much of the attention there has been turned to doing 1 of 3 things. One, helping our customers get as much mileage as they can out of the equipment they already have, and that's through upgrades, overhauls and so forth. Secondly, we've positioned ourselves to go after to the extent these program survive sequester or any other budget cuts that come after or in lieu of around Ground Combat Vehicle, Joint Light Tactical Vehicle, those programs. We're well positioned there to the extent these new programs continue. And then thirdly, big emphasis, internationally, you heard about CV90 in Norway. We're well poised also in Canada and in Denmark, and so the portfolio has been brought to a more resilient point here in recent years. The team has worked very hard to get ahead of these reductions in demand and through cost-reduction efforts over the years. To the point around temporary nature of some of this, there are -- furlough is an option that we explore and we would employ if necessary. On the Electronic Systems side, to Ian's point, we are -- there again, we have a very broad and resilient portfolio. The extent to which new programs would be affected, programs like Next-Gen Jammer, for example, large new programs, those are the ones that we're watching the most closely. But we have very many existing programs in the portfolio that we think will stand the test of time.

Ian Graham King

So we do stress test this all the time, Sandy [ph], specifically against that. We're just in this sort of aberration at the moment until whatever it turns out to be gets enacted in terms of an agreed set of budgets.

Unknown Analyst

I mean -- but being absolutely brutal about this then, I've been working for an American bank, now I understand how we flex. I keep my eye on it everyday, let me tell you. I mean bluntly, the impact on our cash in the context of a 3-year share repurchase program from sequester even, it just doesn't really blow us off course because we're contracted and then there'll be ebbs and flows. I mean, is that the right way to look at it? Or am I...

Ian Graham King

It is the right way to look at it. If you look at the exposure of the build -- the billion and say it all happened, so the 6% of the GBP 1 billion, and you look at the cash flows from profit that we'd get from that, because we get very even cash flows from our business, you'd be talking in the range to GBP 100 million to GBP 150 million. This does not blow away our ability to either support the dividend or support our balance sheet and the share repurchase.

Peter J. Lynas

As you know, Ian's talking pretax. So of course, the GBP 100 million would actually be less now on a posttax basis from a cash flow perspective. And the other thing is probably just worth saying, and really build on what Tom said around the land business. We guided 10% sales down for 2013, so that's around $3.8 billion. Less than half of that business now is actually in U.S. vehicles. The rest is in U.K., Sweden, South Africa naval armaments. So I think the -- as Tom said, this business is downsized significantly since the highs of '08 and '09 when we're in operation tempo-driven mode. But the sales for the vehicles businesses is less than $1.7 billion.

Ian Graham King

One in the back, back middle.

Chris Dyett - Investec Securities (UK), Research Division

Chris Dyett of Investec. 2 questions, please. Firstly, obviously, none of us have any idea how sequestration is going to play out. But maybe here's a view of how you're going to communicate how you think it's going to impact your business once we start to get some detail, because obviously, it's going to be kind of drip through, probably, or we won't know what they want to do on budgets. But how are you going to get that information out into the market? Or are we going to have to wait until the interims for your kind of first view of how you see it playing?

Ian Graham King

Well, once we have the information, a bit like we did with the Strategic Defense Review in the U.K., we will go out and then say what the impact of our business is once we have clarity, but it's going to take some time for when you get a regional budget data to determine what the impact on our programs are. But we will get out there as soon as we can.

Peter J. Lynas

Chris, we'll do -- we'd do an RNS. We're not going to wait for interims or an interim management. We'll do an RNS once we've got the clarity that we can guide you with.

Chris Dyett - Investec Securities (UK), Research Division

And second question around the dividend. Obviously, you provided 2x guide. The reality is obviously, your earnings have got quite a lot of volatility potentially over the next, is that [indiscernible] -- a hard and fast rule [ph]? Or should -- have you flexibility, would you go below 2 for 1 or 2 years along with trend?

Peter J. Lynas

The policy is we say around 2x. So if the question was, have you got wiggle room? We say around 2x. But as I said today, even without getting to that escalation settlement, we're still are 2x cover. And the earnings guidance we've just given you for next year is for an increase. Clearly, the buyback also helps earnings per share, which gives more headroom for dividend cover. So I hope that answers the question.

Ian Graham King

With a GBP 42 billion order book, we do have pretty good visibility going forward in majority of our business.

Unknown Executive

Okay, do we have any other questions? Anyone phoning in? Okay, thank you very much, everyone. Thank you.

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