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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 Parker Hudson - Executive Director, Chief Executive Officer of Bae Systems Inc, President of Bae Systems Inc, Member of Advisory Board On Tanzania, Executive Director of Bae Systems and Member of Non-Executive Directors Fees Committee

Alan Garwood - Group Business Development Director

Guy Griffiths - Group Managing Director of International

Analysts

Steven Cahall - RBC Capital Markets, LLC, Research Division

Benjamin Fidler - Deutsche Bank AG, Research Division

Charles Armitage - UBS Investment Bank, Research Division

David H. Perry - JP Morgan Chase & Co, Research Division

Nick Cunningham - Agency Partners LLP

Edward Stacey - Espirito Santo Investment Bank, Research Division

Sandy Morris - Jefferies LLC, Research Division

BAE Systems (OTCPK:BAESY) H1 2013 Earnings Call August 1, 2013 4:30 AM ET

Ian Graham King

Okay. Good morning, everyone, and thank you for joining us on this webcast. I will provide a brief overview of our performance across our markets. Pete will then describe the group's first half financial performance, we will then take questions. The Executive Committee is also available to support us.

With Salam Typhoon price escalation discussion still ongoing, these results reflect our expectations of a significant bias in the group trading through the second half of the year. We continue to work to agree a satisfactory conclusion. I believe we have made good progress in recent months, clearing many of the obstacles to completion and our confidence in the process supports our prior expectations for performance across the year as a whole.

As I have said before, the right settlement is the key driver, not timing. Relationships in the kingdom are progressive with good order intake achieved in the first 6 months. With these orders and other successes across the group, we have sustained our group order backlog following the significant uplift achieved last year. We have received a GBP 4.8 billion of orders outside the U.K./U.S. in the 6 months, a continued sign of the momentum in international activity.

Although uncertainty continues to overhang the Defense and security sector in the U.S., the group's U.S.-based businesses have delivered a first half performance much in line with plan. The underlying budget position is complex, with a continuing resolution, a gain in operation from earlier in the year, to which the sequester has been applied since March. Flexibility has been introduced in certain funding lines to enable some key operational maintenance activity to be sustained. This flexibility has enabled one area of concern from early in the year to be mitigated. The U.S. Navy had in February announced possible changes to a number of ship availability contracts.

As a consequence, we issued preliminary WARN Act notices related to the possible layoff of nearly 3,600 employees in the U.S. ship repair business. With the reconfirmation of funding, those notices were subsequently withdrawn. Some continuing funding issues have resulted in a small number of WARN Act notices again be issued. Limited impact on our U.S. business has been apparent so far. However, unless an overriding agreement is reached, we expect the full impact of the sequester to be progressively felt as the obligated funding lines are consumed over the coming months. It is important to scale the impact of sequestration in the context of the overall

[Audio Gap]

As said before, sequestration is, in essence, a cut of circa 10% to the Defense budget, which may equate to circa 15% in the funding lines that would take the hit after allowing for protected areas of spend.

The U.S. accounted for 41% of the group sales in 2002, so we look at the downside scenario of circa 6% to the group's top line. We expect and have guided for the U.S. to be a lower proportion of group sales this year. Also, in excess of $1 billion of the U.S. -- of that U.S. share is in commercial markets such as electronics, ship build and ship repair. We do not yet know where U.S. Defense cuts will ultimately fall, but we do plan for a reduction in spend. We base our plans on conservative assumptions and have demonstrated our ability to adapt rapidly to change. We will continue to be agile and proactive to reduce our cost base as required. Sequestration does not represent a below-the-waterline impact for BAE Systems.

The outlook for U.K. Defense procurement remains stable following the government spending review announcement in June. We do not anticipate material changes to contracted programs, but we'll continue to work with our U.K. customer to help address affordability issues and deliver value. Much of the group's U.K. business is concentrated on a small number of large programs where multiyear contracts provide good visibility as evidenced by the group's large U.K. order backlog.

In the maritime sector, the Queen Elizabeth Class carriers are progressing well, all major blocks are now joined for the first ship. Surface Ship workload is set to reduce from the peak of the carrier program, and discussions with the MoD continue to determine future capacity requirements.

In submarines, early engineering activity on the Successor program is increasing, alongside multiyear build of the Astute Class boats. In the air sector, we are seeing the sales benefit of Typhoon and Hawk exports and are well-prepared for the anticipated start of the ramp-up in the F-35 program. Typhoon production against existing orders is running at 30 aircraft per year until the first quarter of 2018.

This is an exciting time in International markets. First half activity in Saudi Arabia has been focused on booking a large Tornado-guided weapons contract and the follow-on multiyear Typhoon support arrangements. There are also good reasons for optimism that we can conclude price escalation soon. Firstly, our counterparty has confirmed that all outstanding queries have been addressed that they require no further information. Secondly, in recent months, the Typhoon support agreement has been viewed as a priority by our customer. With this now addressed, we expect to see more rapid progress. Thirdly, there is no significant engagement regarding a second batch of aircraft. Completing the pricing for the first 72 aircraft is distinctly helpful for both parties in this regard. In addition, we are now working with the customer to define a further development of the Tornado with a cockpit upgrade and a bidding on the next phase of capability expansion on the aircraft.

In addition to this high level of activity in Saudi, there are several combat aircraft requirements emerging. BAE Systems has the fortunate position to benefit from those both Typhoon and the F-35 program as it gathers pace. In the U.A.E., Typhoon is emerging as a serious prospect. Not in our plan, but a game-changing prospect for which the aircraft is ideally suited on where we are working with the U.K. government to generate a truly joined-up U.K. proposal.

Other prospects include Malaysia for Typhoon and South Korea in a competition including both F-35 and Typhoon. In the land sector, we are working on bids, including CV90 base proposals for competitions in Denmark, Canada and Poland. In India, we continue to progress contracts on M777 and further Hawk trainer requirements. We see a resurgence of Hawk opportunities as air forces integrate the latest generation of combat aircraft such as Typhoon and F-35. We will not win everything, but we have not seen such an opportunity-rich landscape for some years.

In Cyber & Intelligence services, we are seeing further good growth in commercial markets. We continue to invest to support commercial cyber opportunities, building on our already strong offering in the financial services sector and the provision of cyber protection for critical national infrastructure and corporate networks. We are also pursuing exciting opportunities with telecom companies, including the partnership with Vodafone on their Mobile Threat Manager solution. In the government cyber services sector, our position, we believe, is resilient, with a high concentration of mission-specific support for the intelligence community. We remain well placed to win emerging new business in this high priority area. Pete?

Peter J. Lynas

Thanks, Ian, and good morning. I'll give a trading review as usual, and then I'll move on to the 2013 full year guidance.

So the headline numbers in compare to the first half of 2012. Sales increased marginally to GBP 4.8 billion -- GBP 8.4 billion, with expected volume reductions in Land & Armaments being more than offset by the resumption of Typhoon aircraft deliveries on the Salam programme.

Underlying EBITA decreased by 6% to GBP 865 million, and there was no profit recognition on those Salam Typhoon aircraft. Underlying finance costs in the first half are slightly higher than in 2012, reflecting the interest from the GBP 400 million debt refinancing that we completed in June of last year.

Underlying earnings per share decreased by 4% to 17.8p, and I would note here that the underlying EPS last year has been restated for the IAS 19 accounting change that we referenced in May's IMS, and that change gives a reduction of 0.2p at the half-year and 0.4p for the whole of 2012.

As expected, following the exceptionally strong operating cash flow in the second half of last year, there was an GBP 815 million outflow in the first half of 2013. Net debt at June 30 was just under GBP 1.2 billion.

Order backlog increased to GBP 43.1 billion, benefiting from exchange translation and was sustained on a like-for-like basis.

Finally, the interim dividend has been increased to 8p per share, up 3% on the 2012 interim.

In addition to the effect of the foreign exchange translation, where the U.S. dollar closed at $1.52 compared with opening $1.62, there were a number of specific items within working capital impacting the balance sheet in the period. As anticipated, advances are being consumed on the Omani Typhoon and Hawk program, the European Typhoon contract and the Saudi training aircraft program.

2012's accelerated receipts on the Saudi Tornado upgrade contract are also being utilized, and costs incurred on the Oman offshore patrol vessel program and on rationalization are being charged against the provisions that we created in previous years. The GBP 131 million Trinidad and Tobago termination settlement was paid in the period.

The IAS 19 accounting pension deficit is decreased to GBP 4.3 billion and I'll cover that on the next slide, and the deferred tax asset reduces on that lower pension deficit. Net debt stood at GBP 1.2 billion and I'll get to that when I turn to the cash flow slides.

So this slide shows the pension scheme assets, liabilities and deficit as accounted for under IAS 19. The value of the scheme assets has increased over the period to GBP 20.5 billion. The liabilities increased by GBP 0.7 billion to GBP 26 billion. Real discount rates have reduced by a further 30 basis points in the U.K., as long-term inflation expectations have increased by more than bond rates. In the U.S., where pension liabilities are not subject to inflation increases, it is only the bond yields that impact the discount rate, and these have increased by 80 basis points. So in aggregate, these rate movements have increased reported liabilities by around GBP 300 million. The 6 months of discount unwind and the period service cost, net of pensions paid, account for the rest of that increase in liabilities. So in total, the impacts of these movements is a reduction to the group's pretax accounting pension deficit of around GBP 0.3 billion.

As you know, these mark-to-market movements have no bearing on our scheme funding. The funding agreements reached in February last year with the trustees of the 2 largest U.K. schemes are sustained through 2014. In addition to circa GBP 400 million per year of deficit funding across all our group schemes, we have now reached agreement with the trustees as to the accelerated deficit funding arising from the group's share repurchase program. GBP 340 million will be paid over the life of the program.

Moving onto cash. This slide sets out the movement from the net cash position of GBP 387 million at the beginning of the year. The operating business cash outflow was GBP 815 million. Interest and tax payments were GBP 175 million. 2012's final dividend that we paid in June was GBP 380 million. And since February's announcement of the 3-year share repurchase program of up to GBP 1 billion, we have bought back 23.9 million shares at an average price, including costs, of 381p. Exchange translation and all other movements total GBP 119 million, so a closing net debt of GBP 1,192,000,000.

The cash flow performance of the 5 sectors are shown here, and I'll return to this when I cover the results of each of the sectors, but just one point to note, the total cash outflow for pension deficit funding in the period was GBP 192 million, of which GBP 161 million is reported here within the head office.

This next chart shows the gross debt to cash and net debt of the group. At the start of the year, borrowings amounted to GBP 3 billion with cash held at GBP 3.4 billion, giving a reported net cash of GBP 0.4 billion. The total cash outflow in the first 6 months was GBP 1.5 billion. Translation of our U.S. dollar debt gives a GBP 0.1 billion increase in reported sterling figures. There were no term debt movements in the period, and as I mentioned at the February presentation, the group's next term debt maturities fall in June and November of next year. That GBP 400 million was pre-financed last year. So at the 30th of June, total borrowings are at GBP 3.1 billion, cash holdings have reduced to GBP 1.9 billion, giving a reported net debt of GBP 1.2 billion. I'll come back to our 2013 cash guidance a little later.

So I'll turn now to the sectors, and I'll cover year-to-date performance here and return to the full year outlook a little later. Now in the first of these sectors, Electronic Systems, the numbers here in U.S. dollars. Despite the ongoing U.S. budget uncertainties and some related program delays and disruptions, the sector delivered sales of $1.84 billion, only 1% down compared to the first half of 2012. Sales in the commercial areas of the business grew by 10%, helping to offset some of the pressures on the Defense side. The return on sales achieved at 13.1% was in the middle of our guidance range. Cash conversion of EBITA in the first half year was at only 47% and we would, therefore, expect an improved conversion level over the full year. The order backlog of $5.7 billion was only marginally down from the start of the year.

The Cyber & Intelligence sector comprises the U.S. Intelligence & Security business together with BAE Systems Detica. The numbers here, again, are in dollars. In aggregate, sales reduced by some 10% to just over $1 billion. The U.S. business saw a 14% decrease, driven largely by reduced volumes in the IT Services business. There was also a lower level of analysis support on counter-IED activity in Afghanistan. Growth in BAE Systems Detica was 9%.

The margin achieved at the half-year of 8.1% includes continued organic investment in the Detica business in support of targeted future growth in commercial and international markets. Cash flow performance was good with conversion in excess of profit in the first half. Order backlog reduced to $1.4 billion. U.S. budget uncertainties continue to cause delay in award decisions of competitive bids. And at the end of the period, we had some $2.1 billion of table bids, of which almost half were overdue against decision timescales.

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

Whilst reported sales declined by 19%, that reduction on a like-for-like basis was 9%. This takes into account exchange translation, the impact of last year's business disposals and the transfer of the U.K. vehicles and support business into the Platforms & Services U.K. sector. As expected, the sales reduction was largely from completion of contracts for MRAP vehicle upgrades. The reported margin of 9.5% benefits from ongoing cost-reduction actions and good program execution. Charges for further planned rationalization activity will fall into the second half of the year.

With regards to cash flow, performance will be second half bias due to the usual timing of funding on the U.K. munitions contract. In addition, funding on the GCV program is back-end loaded. Order backlog reduced to $6.9 billion, $0.3 billion of that reduction is due to exchange translation, and we do plan for the M777 engine award in the second half.

In the Support Solutions business and despite the budget uncertainties seen earlier in the year in the naval ship repair activity, sales were 3% higher. The business benefited from new business awards secured last year on the Radford munition plant and the naval training aircraft maintenance. Return on sales in the period of 8% was very similar to last year's level. The cash flow performance in the first half was impacted by timing of receipts in both the ship repair business and on the Radford munitions facility, and we therefore, expect a stronger conversion over the full year. Order backlog reduced in the $4.9 billion on the trading out under the long-term ship repair contracts.

In the Platforms & Services U.K. sector, sales of GBP 3.2 billion increased by 18% on a like-for-like business -- on a like-for-like basis compared to 2012. Salam Typhoon aircraft deliveries were resumed with 4 acceptances in the period. In addition, there was a high level of deliveries under the Indian Hawk contract. The return on sales of 15.8% seen in the first half of 2012 benefited from the strong program execution and risk reduction on the European Typhoon production in Type 45 destroyer contracts. There was also good margin performance in the first half of this year at 12% despite there being no profit recognition on the 4 Salam Typhoon aircraft deliveries.

As expected, the GBP 0.4 billion of cash outflow in the period reflects the consumption of customer advances on the Omani Typhoon and Hawk program, the European Typhoon contract and the Saudi training aircraft program. In addition, provisions are being utilized against costs incurred in rationalization and on the Oman OPV program. The Trinidad and Tobago termination settlement is included within this sector's cash flow. Order backlog reduced to GBP 20.4 billion on the trading of European and Saudi Typhoon aircraft and India Hawks.

Sales in International business for the first 6 months of GBP 1.65 billion are 5% higher than in 2012. And the increase is primarily on the high levels of support to Typhoon aircraft that are now in service. EBITDA was GBP 165 million and the return on sales in the first half of 10% is broadly consistent with last year and in line with guidance. There was an operating cash outflow of GBP 221 million as 2012's accelerated receipts on the Saudi Tornado upgrade program were utilized, and in Australia, where advances were consumed on the Landing Helicopter Dock program.

Order backlog has increased to GBP 11.9 billion following awards for the 5-year Typhoon follow-on support contract and further weapons package in Saudi, together with the renewal of the Australian Hawk support program. For reference, there's a chart providing a summary of the trading performance of the 5 sectors appended to the presentation posted on the web, and that summary also contains the numbers for each Q, and those numbers include a GBP 32 million charge taken in the first half in respect to the contract pricing dispute.

This chart seeks to provide updated guidance for each of the sectors through to the end of the year. Importantly, this guidance has been revised to reflect both the U.S. budgetary pressures we have seen to date and our best view of the impacts of sequestration through 2013. We also assume a continuing resolution operating from the 1st of October through the final quarter.

So firstly, Electronic Systems, and sales volumes in dollar terms are now likely to be marginally below those for '12, albeit with a different mix. Some 20% of the sector sales are in commercial markets where we are seeing good levels of growth. On the Defense side of the business, we anticipate a sales reduction of around 5%. On margins, we continue to expect the high levels seen in '12 to be lower but to be within our guidance range of 12% to 14%.

On Cyber & Intelligence, we expect sales to be some 5% lower than in 2012. The U.S. business, which is around 75% of the sector, is expected to be around 10% below last year's level on the lower level of IT service volumes and as the contract for counter-IED analysis support ramps down. Growth in the Detica business remains forecasted at double-digit level, supported by expansion into commercial markets. We continue to expect margins in 2013 within our 8% to 9% guidance range with ongoing investment in Detica to support organic growth.

Moving to Platforms & Services U.S., amongst the overall guidance is as shown on the chart, this is best taken in 2 parts. Firstly, on Land & Armaments, we are seeing a stretching out of programs by the U.S. customer and some limited project cancellations. And we have, therefore, revised the full year sales guidance from a $3.75 billion level towards $3.6 billion. As the margins, we continue to expect delivery around the 8% mark with further rationalization activity and charges assumed in the second half.

In Support Solutions business, we anticipate 2013 sales to be around the same level as 2012. Downward pressure from the U.S. budget is being compensated for by new business at Radford from the naval training aircraft maintenance contract and from commercial ship build activity. On margin, guidance is unchanged in the Support Solutions business. Levels for the full year are expected to be similar to those delivered at the half.

Turning to Platforms & Services U.K., and this is the group's largest sector, and we expect sales in 2013 to increase by around 25%. We expect second half bias both from the deferred trading of Salam price escalation and there being 6 more Typhoon aircraft deliveries on the Salam program. Including the expected benefit from the catch-up on resolution of the Salam price escalation, we expect margins for the sector to be slightly higher than the levels seen in 2012 and above our normal guidance range.

And on the last of the sectors, Platforms & Services International, we continue to expect sales in 2013 to be marginally higher than last year. Deferred trading arising from Salam price escalation and increased levels of support to the Typhoon aircraft now in service are expected to be partly offset by a reduction in the Australian business as the Landing Helicopter Dock build program ramps down. Margin should benefit from the catch-up arising from resolution of Salam price escalation in respect of the element that relates to the initial support contract, and is, therefore, expected to be towards the higher end of our 10% to 12% guidance range.

To complete the 2013 models, despite the challenge taken in the first half-year, we now expect headquarters cost to be broadly similar to those in '12. Underlying finance costs should be marginally lower. Effective tax rate remains expected within a 23% to 25% range, with the final number dependent upon the geographic mix of profits.

In aggregate, and including both the benefit from the share repurchase program and the downside arising from a reduction to U.S. Defense budgets, double-digit growth in underlying earnings per share is anticipated for 2013. This outlook assumes the satisfactory conclusion to the Salam pricing negotiations this year.

With the exceptional level of operating cash flows seen in 2012, I thought it would again be helpful to give you a final slide to highlight the cash utilization we expect in 2013. The first column shows the position at the half-year, the second column provides the full year guidance, which is unchanged other than for the share repurchase program.

So firstly, the operating cash flow, we are not planning for any material capital expenditure above depreciation levels. Within working capital, we are utilizing 2012's accelerated receipts on the Saudi Tornado upgrade contract. We also expect to incur costs of around GBP 400 million against provisions created in previous years held in the balance sheet. The most volatile area remains the level of customer advances. As expected, the major advances we received in '12 on the Saudi trainer aircraft contract and Omani contract are being consumed. Under the terms of that Omani contract, no further cash will be received until deliveries commence in 2017. Advances are also being 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 is the year's pension deficit funding, which will be around GBP 500 million, and that now includes the accelerated funding arising from the share repurchase program. The non-operating cash flow items are far more predictable, and outflows for interest, tax and dividends are expected to total around GBP 1 billion. And we would expect the share buyback program to cost close to GBP 300 million in the year.

So overall, and as per previous guidance, 2013 will be a year of significant cash utilization. Thank you. Ian?

Ian Graham King

Thanks, Pete. So to summarize, this is a challenging environment, but we continue to take the necessary actions to reduce costs for the benefit of both our customers and our shareholders, and we have a clear top level investor proposition. We plan for the U.S. to be down, but manageable. We expect the U.K. to remain stable. We see growth from international markets supported by a good backlog and virgining opportunities. In addition, we see increasing cyber opportunities, particularly in the civil area.

The group has a well-established portfolio with a 50-50 split between services and products. We will reinvest the cash we generated to sustain and grow the business, and we look to provide good returns to shareholders with attractive dividends supplemented by share repurchases. For the longer-term, we expect our well-established broad geographic reach and strong product and services positions will provide a good platform for future growth.

We will now take questions.

Question-and-Answer Session

Ian Graham King

Oh, no questions?

Operator

[indiscernible] comes from Steven Cahall, Royal Bank of Canada.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Maybe just initially a quick one on the repurchase program. It's possible that what we spent in H1 was maybe below some expectations. I was wondering if you could talk about what sort of challenges you might be facing in the repurchase and where volumes are in the market and how we can expect the pace of that to change throughout the rest of the year?

Ian Graham King

Pete, it's sounds like one for you.

Peter J. Lynas

Yes, that's fine. We announced the buyback program in February. We said GBP 1 billion program subject to resolution of Salam price escalation and that will be over 3 years. I think we're pretty close to GBP 100 million since we launched it in mid-February. So we are pacing it in line with the original 3 years that we outlined. We've done 24 million shares pretty much at 30th of June. We're in the market at the beginning of July, we're back in the market today, so we're still active on the program.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Okay. And then maybe just a quick follow up on the sequester. You mentioned that you see it being progressively -- the impact being progressive throughout the year. Is that pretty much consistent across all of the U.S. Defense business? Or are there areas where you think are going to be most affected and other areas that you think might be less affected?

Ian Graham King

Linda, why don't -- have you got a microphone?

Linda Parker Hudson

It's pretty consistent across the industry. Each customer is behaving a little bit different than the others. Some are being more cautious, some are moving forward with a certain expectation. But by and large, it's consistent across the market as a whole. And I think you'll see that with all the other U.S. companies in the way they're reflecting their expectations for the balance of the year.

Ian Graham King

It was very pleasing to see with the sort of quarterly results coming out from the U.S. peers, that it was very in line with our expectations and you can see, the performance in the 6 months, our performance has been robust. Come on, we won't know what to do the rest of the day if there's no more questions.

Operator

Your question comes from Mr. Ben Fidler from Deutsche Bank.

Benjamin Fidler - Deutsche Bank AG, Research Division

Probably 2 or 3, if I could. Firstly, your guidance for the full year for Platforms & Services U.K., in terms of the margin, I mean, aren't you going to be very significantly ahead of the 12% level? You delivered 12% in the first half with no catch-up payment on Saudi and recognizing no margin on 4 Typhoon deliveries. In the second half, you've clearly got a catch-up payment coming, you've got a lot more -- and you've got the profit recognition on all 10 Typhoons. So then it should be significantly ahead of the 12% level or is something else moving on the other side to help offset that? Do you want me to give you the other questions, or do you want to answer that one first?

Ian Graham King

Let's take your questions one at a time because they're quite detailed questions, Ben. Pete, [indiscernible] that one?

Peter J. Lynas

Yes, on the margin, Ben, you'll have seen the guidance where we -- we announced [indiscernible] we've talked about 10% to 12%, you'll see the word plus appear on the slides. So clearly, we are saying firstly we're going to be above 12%. There is some back ending in the second half sales also on Astute and Successor programs. Clearly, the margin levels in -- on those programs are less than they are on the Typhoon production. So, yes, you're right, we will be through the 12% if we get the -- when we get the VOP resolution completed. But I think 10% to 12%, 12% plus, I think you can take that as a positive.

Benjamin Fidler - Deutsche Bank AG, Research Division

Okay. The next question I had was just around an update on some of the export contract pipeline, if you can share with us your level of optimism and enthusiasm regarding U.A.E., where we're at on potential timing for that. Remind me where we're now at in terms of scale of that. I believe the scale of the contract has expanded somewhat. And also on any Saudi follow-on orders, the Typhoon, where we may be out with the customer on timing for that, and also timing for this Tornado upgrade, what we could think of there?

Ian Graham King

Well, let's ask -- we've got Alan Garwood with us, so I'm always interested what Alan says on these things as well.

Alan Garwood

I'm interested to find out myself, actually. I think the 2 principal bits of activity we've got at the moment are firstly, Malaysia, where there is an emerging MRCA requirement. There may or may not be a full competition probably sometime next year, and we're working hard with the British government to offer Typhoon there together with training package. U.A.E. has still a long way to go. We're enthusiastic with a lot of people working on quite a complex bid. The bid is due to be tendered in about 4 weeks' time, and we'll then have to see where the British government and U.A.E. authorities want to take things.

Ian Graham King

How many aircraft is it, Alan?

Alan Garwood

It's going to be around 60 Typhoon, but it's going to be a government-to-government deal, and therefore, the pace of negotiations will be set by the 2 governments. But we are very firmly supporting them, and it's going to take an awful a lot of activity over the last quarter of the year if we're to get it were we want it to be. And that's probably all I should say at this moment.

Ian Graham King

But we are making good positive progress, and we have the full support of the U.K. government. I mean, they are going above and beyond in terms of the resource and the energy they're putting behind it. So we're very pleased with the progress on it.

Alan Garwood

We're very pleased with the progress, and we could not ask for more from the Prime Minister and HMG in general.

Ian Graham King

Guy, why don't you cover the Saudi requirement?

Guy Griffiths

Okay. So the 72 aircraft that are under order at the moment for Saudi are intended to populate 3 squadrons; 1 training squadron and 2 operational squadrons. The Saudi's operational requirement for Typhoon always was for a minimum of 5 squadrons. And they are now, as Ian indicated in his comments, speaking with us around further procurement activity to meet that full operational requirement. Two more squadrons would imply 48 aircraft, you won't be surprised that we're seeking to influence the customer actually to buy another suite of 72.

Ian Graham King

And sort of when does the current 72 -- when do the current 72 finish in terms of deliveries?

Guy Griffiths

The deliveries finish at the end of 2017, and the intention would be for any follow-on order to continue in terms of production continuity. And in order to safeguard supply chain continuity, we'd be looking, really, at an order within 2014 in order to secure that.

Ian Graham King

So that's what's driving the timescales, Ben, because what we want to do is to sustain the production rate at 30 per year. That's the optimum rate that we've got going through the facilities at the moment.

Benjamin Fidler - Deutsche Bank AG, Research Division

And similarly on the U.A.E. contract, that would dovetail with that sort of 2018 timeframe, would it as well?

Ian Graham King

Absolutely.

Operator

Your next question comes from Mr. Charles Armitage from UBS.

Charles Armitage - UBS Investment Bank, Research Division

A simple one from a confused. I just want to make sure that I've got my sums right. But if I take all the changes you've made and compare it to the previous guidance, I pretty much end up where I started off. Have I done that right?

Peter J. Lynas

That's a pretty good summary, Charles. I mean, if you take our guidance and clearly, we don't -- you do -- I've done these steps through sector by sector, but if you're taking it around, the U.S. business we're basically saying is around 5% down overall but we're holding up on the margins. So you've got a sort of 5% volume impact. Our U.S. business is about $12 billion, so you can work that for yourself. In the U.K., we're holding the guidance of the sales level unchanged, but we are flagging the margin will be stronger. Guidance for the international business, unchanged. We have got that contract pricing dispute charge in HQ. If you take all of that and around, you end up with what we're saying on double-digit growth against last year. Last year was 38.5p, so you can get to the number fairly straightforward. But you're right, it does get you pretty much back to where you started from. So sorry, for that long journey.

Operator

Your next question comes from Mr. David Perry with JPMorgan.

David H. Perry - JP Morgan Chase & Co, Research Division

I've got just 3 very niggly ones, if I may, for Pete and then just one on the U.A.E. tender, please. Peter, my 3 quick ones are, can you just give me the self-funded R&D in H1? Secondly, the pension finance charge, I know you exclude it from EPS. I think the notes that you've provided today say GBP 98 million in H1. Would it be right just to double that for the full year? And secondly -- sorry, thirdly, the HQ EBITA number, which I think you restated to minus GBP 124 million, I think it was originally GBP 80 million, is there anything exceptional in that? Or is that a sort of run rate going forward, please?

Peter J. Lynas

Okay. I'll take those in order. The self-funded R&D is about the same level of last year. The key point, I think, which is what you're getting to, is the step down that we saw from 2011 to '12, we've had about GBP 150 million self-funded in 2012. We would expect that rate to be significantly higher in 2013. On the pension finance charges, yes, your assumption is right. You can double the first half number, that will get you there or thereabouts. And in terms of HQ cost, the issue there is around the GBP 32 million charge that we've taken in the first half-year on the contract pricing dispute. So if you strip that out, you'll see that the headquarter costs would actually be significantly down.

David H. Perry - JP Morgan Chase & Co, Research Division

Sorry, sorry, I lost you there. Because on your Slide 21, I think you show HQ EBITA is minus GBP 124 million for 2012, but I've seen there, restated for IAS 19, because the original number you reported I thought was GBP 85 million.

Peter J. Lynas

Yes, so that's the IAS 19 change, David, for the -- on the accounting. So this is where we are previously taken some pension, admin and the PPF levy costs with an interest not in underlying. There's still economic impact, but they're now -- they've now moved into HQ costs. That's where we're reporting them.

David H. Perry - JP Morgan Chase & Co, Research Division

Sorry, is GBP 120 million the new run rate for the HQ line?

Peter J. Lynas

GBP 120 million will be the comparable number. If you look at what we've then reported this year in the first half of 2013, that includes GBP 32 million for the contract pricing dispute.

David H. Perry - JP Morgan Chase & Co, Research Division

Okay. So it's GBP 150 million this year, but GBP 120 million going forward?

Peter J. Lynas

Yes.

Ian Graham King

Yes.

David H. Perry - JP Morgan Chase & Co, Research Division

Okay. And then, sorry, my one on the U.A.E., can I just check, is this a sole-source tender that you're involved in? Or is it competitive?

Ian Graham King

Sole source.

Operator

Your next question comes from Nick Cunningham from Agency Partners.

Nick Cunningham - Agency Partners LLP

A follow up on the U.S. The U.S. Defense contractors have been reporting, I guess, sort of a surprisingly strong Q1, Q2. And they're attributing that to orders being brought forward by buyers and DoD who are worried about potential sequestration at that point in time. So I think there is some concern there that the second half would be weaker as a result. Is that built into your expectations? Or is there some risk there? And then when you look into 2014, you've pointed out that the outlays in '13 have been protected to some degree by previous budget authorities. Does that mean, though, that even if the FY '14 budget gets passed quite quickly, that '14 would still end up being down for you? And again, is that sort of built into your general expectations?

Linda Parker Hudson

Well, let's start with the first one on some customers have accelerated orders into the first half of the year. We've seen that in certain customer bases. The Navy has been able to move things around and accelerate some programs, make awards. Other customers like our intelligence customers have been far more cautious and moving more slowly, and you see that in the way our results have come out. We do believe the second half of the year will undergo more pressure than the first half of the year as the funds from prior years that had been obligated and non-obligated play out. As the year goes on, it becomes more and more difficult for customers to find bits of money in other accounts that can be allocated to make up for the shortfall. Going into 2014 is difficult right now to forecast. If a budget is passed, we have far more certainty and we'll have far more clarity around what to expect. At the moment, it's pretty much anyone's guess whether the budget will get passed. Largely the expectation is we will have a continuing resolution for the balance of the year, and with the current progress or lack thereof in Congress, it's really a difficult environment to predict. So hard to tell, and we're trying to make our best guesses as we can.

Peter J. Lynas

Nick, if I could just add to that.

Nick Cunningham - Agency Partners LLP

[indiscernible] and clearly the decision appears to be hit O&M budgets rather than procurement, does that mean that it's essentially ship repair that's the part of BAE that we should worry about most?

Linda Parker Hudson

Actually, ship repair has -- well, at the beginning of the year, we expected it to be hit far more than it has been. We've actually taken the Navy's plans into account as we forecast going forward. And right now, while there is certainly some pressure, it does not appear to be nearly as bad as we had anticipated. And we need to remember that Support Solutions is far more than just ship repair. In fact, just yesterday, we won a contract for the support and maintenance for future ICBM [ph] missiles. So the business mix may change, but as we buy fewer and fewer new products, the requirement to support and sustain the ones we have will be an enduring requirement.

Ian Graham King

Yes, we're very happy with our Support Solutions business. And probably, in ship repair, we've got more visibility from that -- from those customers than we've got for any others, actually.

Peter J. Lynas

And Nick, just to sort of directly answer your first question about the 2013 guidance, yes, we are putting our best estimate of how we -- based on what we've seen to date from the impacts in the U.S., plus what we believe is yet to come. And we are assuming a sort of a higher level than we saw in the first half, so it's in the guidance.

Ian Graham King

We've just to remind ourselves, we have about $1 billion of our activity in the U.S. in commercial sectors.

Operator

The next question comes from Edward Stacey from Espirito Santo.

Edward Stacey - Espirito Santo Investment Bank, Research Division

Just one left for me, which is on the amount of sort of one-off catch-up from the Saudi stuff that's included in this year's guidance assumption. I think what's the sort of baseline number for me to kind of base my 2014 earnings forecast? I know you're not talking about guiding for 2014 yet, but I think previously, you'd said there was sort of 3p of carried over Saudi stuff that would get recognized as a one-off -- a kind of a one-off, when you sign the pricing agreement. So would I be right in thinking I'll take this year's underlying EPS guidance and subtract the 3p from that, then that gives me the right sort of baseline to think about the for 2014? Is 3p still the right amount?

Peter J. Lynas

Ed, let me -- I'll try and answer, but in a slightly different way. I mean, clearly, things have moved on since the end of 2012. We've now delivered a further 10 aircraft, so -- oh, sorry, another 4, we'll deliver another 6 in the second half. So at the end of the year, will be around 34 aircraft. That's equivalent, in terms of turnover, of about GBP 2.5 billion. So if you think of the margin that we trade on that of around 10% to 12%, that gives you the reliance we've got in terms of the forecast we've given about the resolution done in this period. I mean, to answer your question in 2014, on the basis that we get the resolution in '13, then there will be, I think, a further 12 aircraft next year. And then we'd be trading those through at around the 10% to 12% mark.

Operator

The next question comes from Sandy Morris from Jefferies.

Sandy Morris - Jefferies LLC, Research Division

Just out of idle curiosity, given the increase in activity in Saudi Arabia as we put more and more aircraft in, how are we going about the wider context of that contract in terms of recruiting people and training people and facilities and countries? Just a little bit of background on that might be helpful.

Ian Graham King

It seems like one for Guy.

Guy Griffiths

Right. Okay. Well, from a -- over the last 3 years, from a base of 0 in terms of Typhoon support infrastructure at the principal base where they're currently operating from, which is [indiscernible] on the West Coast, we now have about 500 of our own people and we've trained about an equivalent number of Saudi Air Force personnel to support the operation of the aircraft. Progressively, as the fleet builds up, part of our task is to ensure that the mix of the workforce that supports the aircraft is increasingly Saudi-zed. So at the same time, we're bringing through our training programs and training infrastructure, Saudi recruits into the workforce and producing trained technicians, and by the way, trained pilots, as part of that process. As future squadrons come online, the Saudi Air Force has determined its basing priorities for those, and we would envisage in the case of some of those that there will be infrastructure requirements over the course of the coming 3 to 5 years, which again, should be reflected in contracting activity for us.

Ian Graham King

I mean, interestingly, the base commander at [indiscernible], who introduced Typhoon into service is now the commander of the Royal Saudi Air Force.

Sandy Morris - Jefferies LLC, Research Division

Is it reasonable then, just look at the number of employees in Saudi Arabia, which you've disclosed in the annual report, and to use the trend in the employee numbers as a rough proxy for what's happening to the support activity?

Guy Griffiths

It's probably as good an indicator as any, actually.

Ian Graham King

It's an indicator when they go into service, but you've got to remember, Sandy, there's an awful lot of facilities and supply chain activity and logistics activity that goes on before that. And as we provide as near -- close to an availability service in Saudi as we do into the U.K., a lot of our activity is that engineering and supply chain management as well, which is not necessarily driven by manpower.

Sandy Morris - Jefferies LLC, Research Division

Okay. I mean, a fairly idiot-like question to Pete, what would have to happen now for higher discount rates or whatever to finally have a more positive impact on the U.K.? I mean, I think we get a little bit excited about short-term discount rates going up. I mean, perhaps, Pete could just give us a flavor of what would actually have to happen?

Peter J. Lynas

Yes, on [indiscernible] pension, Sandy, yes?

Sandy Morris - Jefferies LLC, Research Division

Yes, please.

Peter J. Lynas

Yes, okay. I mean, the pension discount rates we use are those which are aligned with the duration of our pension liability. So these are sort of 15-, 16-, 17-, 18-year rates. The inflation is driven by the difference between index-linked gilts and non-index-linked over that period. The bond rates we use in the accounting are AA corporates over that same sort of period. So what you've got to look at is both of those 2 movements over the sort of 16- to 18-year timeframe, not what you're seeing on the sort of the market rates today. Does that help?

Sandy Morris - Jefferies LLC, Research Division

Well, it does.

Peter J. Lynas

And 10 basis points is around about GBP 400 million of our accounting deficit.

Sandy Morris - Jefferies LLC, Research Division

Yes, and just -- I mean, we can still assume that QE [ph] is just depressing this rate?

Peter J. Lynas

Yes, I'm with you, Sandy. You have to believe over time that the discount rates will get back up to a more normal level, whether that's over 5, 10 years, whatever it might be. But the cash flows from these pension schemes are decades of cash flows. We are -- the schemes that we have in the U.K. are not net payers for another decade yet. So this is a long, long game.

Operator

There are no further questions at this time, sir.

Ian Graham King

Okay. Well, I don't think there's any more questions, so thank you very much. Thanks for joining the webcast.

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