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Executives

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

Roger M. Carr - Chairman

Peter J. Lynas - Group Finance Director and Executive Director

Gerard J. DeMuro - Executive Director

Nigel Whitehead - Group Managing Director of Programmes & Support

Alan Garwood - Group Business Development Director

Tom Arseneault - Chief Operating Officer of BAE Systems Inc.

Analysts

Edward Stacey - Espirito Santo Investment Bank, Research Division

Benjamin Fidler - Deutsche Bank AG, Research Division

Alexandra West - Redburn Partners LLP, Research Division

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

Celine Fornaro - BofA Merrill Lynch, Research Division

BAE Systems (OTCPK:BAESY) 2013 Earnings Call February 20, 2014 4:00 AM ET

Ian Graham King

Right. Good morning, everyone. Thanks for joining us at this venue. I suspect it's more convenient for us than you. But as Andy says, "We're the ones" -- he says, "You should be busy, so this is -- thank you very much for coming to us just across the road." So thanks for joining this session. I will provide an overview of the business environment and report on how we're delivering on our strategy. Pete will then describe the year's financial performance.

But before I start, I am delighted to introduce our new Chairman, Sir Roger Carr, who will commence proceedings this morning. Chairman?

Roger M. Carr

Right. I decided to take the steps. Well, look, good morning, everybody. I just wanted to sort of say a few words before we get into the meat of the presentation with Ian and Peter.

I took up the appointment, as you know, about 3 weeks ago. And I've spent much of the time since then, meeting the shareholders. I visited some of the major sites that we have, and I've become generally engaged with the management, the board members in looking at and reviewing some of the sort of challenges and the opportunities that are there for this business.

Now although it is early days, my initial findings are indeed positive. There is no doubt that my predecessor, Sir Richard Olver, achieved much in establishing, I think, very high governance standards in the business, in the way we do business; and a sound management team focused on strong operational execution; and a good board. And having had the first board meeting yesterday when we were all together, I would say, they do offer really engaged and thoughtful oversight.

Now clearly, the business climate is challenging, particularly in the West, but the combination of a strong order book, some temporary relief from sequestration in the U.S. and continued opportunities that exist in the Middle East and Asia Pacific have brightened, from my perspective, the immediate business picture.

Looking back, since joining the board, there have been some really positive moves forward. The agreement on both price and build issues associated with the carrier program, in addition to the commitment for 3 offshore patrol vessels, have undoubtedly provided a clearer and more stable future for the U.K. naval program.

Equally, continued interest in our cyber defense capabilities has underpinned the view that we have a business model with the sound growth prospects that is capable of both scale and greater diversification into the corporate sector. And management, clearly, will capitalize on that opportunity. Renaming Detica as BAE Systems Applied Intelligence reflected management's belief that this should be seen as an integral part of the group's defense and security capabilities. And over time, this will become a more material contributor to the group's performance. The support, the encouragement and development of this business are firmly fixed on the board's agenda and, indeed, on management's objectives.

Now it's not all been plain sailing. First, we have the decision not to proceed with the purchase of Typhoons by the UAE. Never part of the plan, as you know, but nonetheless, a disappointment when it didn't materialize. And second, the identification of an onerous contract for the operation of a munitions base in the U.S. Ian will comment further on this a little later.

But in summary, the management restructuring has now been made, and renegotiation of acceptable commercial terms is being pursued by Jerry DeMuro as an immediate priority in his new role as CEO of BAE Systems, Inc. Jerry is here today, of course.

On a more positive note, as we all saw from the newspapers this morning, at the 11th hour, I have to say, probably the 59th minute plus the 11th hour, our price variation discussions with the Kingdom of Saudi Arabia were brought to a welcome and mutually acceptable conclusion this week. And we believe the achievement was fair and reasonable, equitable, underpinning the strength of our relationship and acknowledging the potential for future business in the years ahead.

In the coming months, I will continue with my program of engagement with management, customers and shareholders in order that we may develop the right strategic course for the business. I approached the job believing the business is sound, technically strong, well managed with good ethics, disciplined controls and a good future as an independent defense contractor. And I have yet to learn anything that changes these views.

Our success will be built on 3 fundamentals. First, BAE Systems has a unique position as an embedded supplier in the U.K., the U.S., the Middle East and Australia. We will work hard to protect, preserve and deepen these vital and very special relationships.

Second, BAE Systems produces remarkable products, with cutting-edge technology, a number of which I've seen in the last 3 weeks. And they owe much to the skills and abilities of its people. And we will focus on ensuring we continue to attract and develop the very best people to build greater bench strength in the organization and facilitate thoughtful succession planning at all levels.

Third, BAE Systems will continue, clearly, to face budgetary pressures in the West and greater competitive challenge in all parts of the world. It's inevitable. We will drive down costs and improve practices to ensure that margins are protected in areas of weak demand, and competitive edge is honed in those markets of fresh opportunity.

And finally, in recent times, the board has demonstrated its commitment to building shareholder value by maintaining a progressive dividend policy and supplementing returns with a material share buyback program.

My record as Chairman has consistently demonstrated my own belief in shareholder reward, and I remain utterly committed to this principle at BAE Systems. The rewards, of course, are generated by outstanding operational performance and cash production. To that end, the board will encourage management to ensure that flawless plan execution continues to underpin our shareholder value ambitions.

And with that, I'll now hand over to Ian.

Ian Graham King

Great. Thank you, Roger. The company delivered a solid performance in 2013 against a background of reduced government spending and tough market conditions. A continued focus on cost and enhanced competitiveness allowed us to protect our margins across the majority of the business, and we secured further contract wins in the U.S., Saudi Arabia and internationally.

Settling the Salam Typhoon price escalation has been a focus for us all. The important thing was to reach the right agreement. Business relationship is strong and progressive, and I believe the outcome is an equitable conclusion. So whilst it's been an important objective, it is by no means the only significant development for the group. We can claim good progress across many domains of activity.

In the U.S., we have ridden out the second year of the budget storm. A bit weather-beaten in some areas, but still making headway and now with expectations for improving budget visibility. Not everything went to plan, and we have had to address unforeseen operational issues in Support Solutions. Strong execution across the best -- rest of the business has enabled us to deliver good cash performance.

In the U.K., we continue to make good progress on our major programs, and we have satisfactorily agreed a way forward to restructure the naval ships business. Our Applied Intelligence business is well positioned in the fast-growing commercial cyber-security sector, achieving a 60% increase in order backlog.

Cost reduction and efficiency has continued to be a focus. We have been successful in striking a balance of protecting our margins and enhancing competitiveness and affordability for our customers. Despite these pressures, we have continued to invest in research and technology and to develop business in international markets. The strength of our increased order backlog and balance sheet is testament to our business health.

In the U.S., budget uncertainty prevailed through the year, with sequestration measures impacting government spending, procurement decisions and even a government shutdown. Overall, the impact to the group's financial performance has been limited, although we have seen significant impact in some areas, including land and in the Intelligence & Security activity.

You will recall that the sequester targeted savings of approximately $450 billion from U.S. Defense budgets over a 10-year period, equivalent to a 10% overall reduction. Protected areas of spend were expected to result in investment accounts, and operations and maintenance accounts being disproportionately impacted. We, therefore, had assumed that our business where we're exposed to the U.S. discretionary budget would be down from 2012's levels by approximately 15% through 2013 and '14. The budgets passed in January now point to this impact being reduced.

We are rebasing our plans for 2014. However, guidance still has some uncertainty until program clarity is received. That said, there does appear support for some key programs, including the F-35. The F-35, in which we hold a 15% airframe work share, has a well-defined operational requirement and is also supported by the progress now being made in driving down future costs. We are also now seeing a firming of international commitments, some of which form a significant part of the anticipated near- to medium-term production ramp. Not all of the group's U.S. activities were exposed to U.S. government budgets. U.S. sales comprised 37% of the group in 2013. 4% of those sales were commercial and not exposed to sequestration.

We have continued to see good growth in our commercial electronics business and anticipate a rising contribution from foreign military sales, such as the digital electronic warfare upgrade for the F-15 program in Saudi Arabia and the recently agreed Korean F-16 upgrade program, a significant win confirming BAE Systems as a highly credible competitor in a potentially large upgrade market. Additionally, the group continues to be successful in winning new U.S. business, including the 8-year contract to maintain the readiness of the Minuteman missile system awarded in August, and more recently, a similar arrangement to support the U.S. Navy's Trident missiles.

Whilst we've had some notable successes, we have also had some challenges. Two performance issues have recently emerged in the Support Solutions business on commercial shipbuild activities and the multi-year Radford ammunition support contract. Customer volume reductions require the Radford contract to be restructured, and we aim to renegotiate an agreement on this key military capability. We have accounted for this 5-year contract on an existing outcome basis. Actions, as the Chairman said, have been taken to strengthen management in this sector.

The land sector has been through massive change, having grown rapidly to reach nearly $12 billion of sales in 2008 on the back of the Iraq and Afghanistan conflicts. Subsequently, we have seen significantly reduced demand, and by 2012, there was a prospect of a 3-year workload gap in the U.S. combat vehicle sector. We initiated a campaign to protect our combat vehicle industrial base. That campaign is starting to bear fruit with recognition in the DOD of the need to preserve their capability in ground combat systems. Our core markets are tracked combat vehicles, including amphibious vehicles, artillery systems and naval surface fires. A key discriminator for us in these markets is our capability in integrated vehicles and survivability solutions.

We have exited wheeled vehicle assembly. This included closing the Sealy facility and relocating the survivability elements of that business to York. We have also engaged on a wider rationalization of land facilities, reducing 51 separate sites to only 15 centers. We have also worked with our customers to restructure existing contracts and win new work in York. This has extended Bradley and M88 production to mid-2015. In addition, we have been successful in winning new contracts. In October 2013, we secured the low-rate initial production contract for the M109 PIM tracked artillery system. This is expected to progress to a very large program over time.

Although funding for the ground combat vehicle development has been reduced, we expect to continue working on related technology contracts. Engineering enhancements to Bradley remain a realistic prospect, and we believe we also offer an attractive Bradley-based solution to the Armored Multi-Purpose Vehicle requirement. Additionally, we are engaged with the U.S. Navy and Marine Corps to assess and develop solutions for the next-generation amphibious combat vehicle. We are working to preserve key industrial capabilities, and as you will see from the financial results, successfully protected margins, as we manage through this difficult period.

In the U.K., our business is in good shape, and the market outlook remains stable. Much of the group's U.K. business is concentrated on a small number of large programs, where multi-year contracts provide good visibility as evidenced by the large U.K. order backlog.

In the air sector, the first Tranche 3 Typhoon has been flown, and we have only recently been able to reveal the previously classified footage of the Taranis flight trials, more of which later. Details of -- deliveries of Typhoons to European partner nations continued, and we recommenced deliveries to Saudi Arabia.

The agreement with the U.K. government in November on the U.K. naval ships business was a significant development. This agreement includes a restructuring of the aircraft carrier for contract and the build of 3 offshore patrol vessels for the Royal Navy, before we transition to Type 26 later this decade. In consultation with trade unions and employee representatives, the rationalization of the naval ships business is underway. The constructive approach by all parties is enabling substantial mitigation through redeployment and voluntary redundancy.

Submarines activity continues to progress well on the 7-boat Astute Class program, with both Astute and Ambush now in service and Artful substantially complete. Workload is also increasing on the Successor program in preparation for a planned replacement of the Vanguard-class boats towards the end of the next decade.

Building on this strong international order intake performance in 2012, we achieved further good order intake last year. 9.3 billion of non-U.K./U.S. order intake was achieved in the year, a total of GBP 25.3 billion over the last 3 years. The very significant flow of new contract awards from the Kingdom of Saudi Arabia continued through 2013. Contracts valued at approximately GBP 6.4 billion have been signed, including a further GBP 1.5 billion contract for Tornado aircraft upgrades and weapons. Salam Typhoon aircraft deliveries recommenced in April, with 10 aircraft delivered in the year. A further 12 Salam Typhoon aircraft deliveries are planned for 2014.

As the Chairman said, although the UAE decided not to proceed with the Typhoon proposal, we received highly complimentary feedback from the customer on the capability of the Typhoon aircraft against its very exacting requirement. We continue to develop Typhoon prospects with other air forces in the Gulf region. In addition to new combat aircraft, we are also pursuing upgrade opportunities, building on the recent F-15 and F-16 successes in Saudi and South Korea, respectively. And in Australia, a 5-year contract with options through to 2026 to continue support on the Hawk training aircraft was won. We continue commercial discussions on the next tranche of Hawk aircraft in India.

There are a number of international opportunities in the land sector. The group continues to pursue CV90 opportunities for combat vehicles in Denmark and in Poland, where we have teamed with Polish defense industries to address substantial replacement vehicle requirements expected to emerge later this decade.

We also continue to develop opportunities for Bradley fighting vehicles in Saudi Arabia, and more recently, other emerging requirements in the region. We work closely with both the U.K. and U.S. governments in pursuit of international market opportunities and are grateful for the support at all levels on numerous export campaigns.

In Cyber & Intelligence, the weakness in the U.S.-based Intelligence & Security business seen in the first half increased through the year. This was, in part, due to the anticipated rundown of the Counter-IED contract in Afghanistan, but we have also been subject to early budget-driven cuts to services. We still see good opportunities, but contracting activity remains slow with many substantial bids awaiting award decisions.

Our renamed Applied Intelligence business is performing well, with good growth being delivered against our strategy to build a presence in commercial cyber-security markets. The formation in February of a 5-year partnership with Vodafone to provide a mobile device security solution for business users is progressing well.

In September, we signed a framework contract with the U.K.'s Foreign & Commonwealth Office to deliver communication services. Major contracts were also secured with 3 Middle East countries. We continue to organically invest in this business. The closing order book up 60% is the best reflection of success to date.

The group's strategy is consistent going into 2014. We have a well-balanced portfolio. We continue to invest for growth in the cyber and security and commercial aerospace electronics sectors, and have kept up the pace of technology investment in our U.S. defense electronics and U.K. military air and unmanned activities. Investing in our own shares remains an attractive option. We have made a solid start on the buyback program announced last February.

I will now ask Pete to take you through the detailed financials. Pete?

Peter J. Lynas

Okay. Good morning, everybody. As I set through the results for 2013 and our guidance for '14, there are a number of items to highlight, so bear with me as I take the time to go through them.

As Ian has mentioned, securing a settlement on price escalation to the Salam Typhoon contract has delivered benefit to the year's sales and earnings performance. So the headline numbers and compared to 2012. Sales increased by 2% to GBP 18.2 billion. Volume reductions in our U.S. businesses and, in particular, at Land & Armaments, were more than offset by the resumption of Typhoon aircraft deliveries and trading of the price escalation on the Salam program.

Underlying EBITDA of GBP 1.9 billion was 3% higher, giving a return on sales of 10.6%. Underlying finance cost in the year reduced to GBP 179 million. The full year's interest on the GBP 400 million debt refinancing that we completed in June of 2012 was more than offset by a lower level of net present value charges.

Underlying earnings per share increased by 3.3p or 9% to 42p, benefiting from the margin recognition on the Salam program. The group's tax rate for the year was at 22%, a percentage point lower than guidance, as lower profits in the U.S. moved the average rate down.

As you know, we exclude amortization and impairment of intangible assets from our underlying numbers. You would have seen in this morning's announcement that we have taken a noncash goodwill write-down of GBP 865 million against our Land & Armaments and U.S. Intelligence & Security businesses. The write-down arises from both an increase in the group's weighted average cost of capital used in discounting future cash flows to value acquired businesses and our previously signaled long-term view of U.S. defense spending.

Following last year's exceptionally strong operating cash flow performance, the inflow in 2013 was GBP 147 million. This was materially ahead of guidance. Net debt at the end of the year was GBP 699 million. Order backlog increased to GBP 42.7 billion as long-term support contracts and further weapons packages in Saudi Arabia were secured during the year. The dividend for the year has been increased to 20.1p, up 3% on the 2012 level. And the dividend is now covered 2.1x by underlying earnings per share, in line with the group's policy. In addition to the effect of exchange translation, where the U.S. dollar closed at $1.66 compared to the opening $1.62, there were a number of other items materially impacting the balance sheet in the year.

Intangible fixed assets reduced for the goodwill impairment that I mentioned earlier, along with the U.S. amortization charge. Tangible fixed assets reduced as one of our Saudi residential and office compounds was classified as held-for-sale at year end; a sale and leaseback transaction for that compound was completed on January 9, generating GBP 160 million of cash proceeds.

Within working capital, there were several significant movements: 2012's accelerated receipts we utilized on the Saudi Tornado upgrade program; provisions created in previous years we utilized on the Oman Offshore Patrol Vessel contract, the Trinidad and Tobago termination settlement and on rationalization; the major advances received in '12 on the Omani Typhoon and Hawk order, and the Saudi training aircraft contract are being consumed. Advances were also utilized in the year on the European Typhoon Tranche 2 program. In aggregate, working capital increased by some GBP 1.6 billion. The IAS 19 accounting pension deficit decreased to GBP 3.5 billion, and I'll cover that on the next slide. And finally, we closed the year with net debt of GBP 0.7 billion.

So this next slide shows the pension scheme assets, liabilities and the deficit, as I said before, accounted for under IAS 19. The value of the scheme assets has increased over the year by GBP 1.9 billion to GBP 21.5 billion. And in aggregate, across all the group's pension plans, equity investments remain at around half of scheme assets.

As the group seeks to mitigate pension deficit volatility where it can, we entered into 2 more arrangements in December, with Legal & General to transfer the longevity risk on a further GBP 1.7 billion of our pension liabilities into the insurance market.

Over the year, liabilities increased by GBP 0.7 billion to GBP 26 billion. Real discount rates reduced by 50 basis points in the U.K., as long-term inflation expectations have increased, whilst the matching-duration bond rates are unchanged. 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.

These rate movements have increased reported liabilities by around GBP 1.2 billion, whilst our assumptions on the level of future salary inflation increases in the U.K. has been moved to align with long-term RPI, which has reduced liabilities by some GBP 650 million. This discount unwind and the service cost, net of pensions paid, account for the rest of the increase in liabilities. So in total, the impact of all of those movements in the year is a reduction to the group's share of the pretax accounting pension deficit of GBP 1.1 billion.

As you know, these mark-to-market movements have no bearing on our scheme funding. However, 2014 is a significant year for tri-annual funding valuations, with all of the group's U.K. schemes falling due. Since April 2011, the asset returns achieved to-date have been well ahead of expectations. However, gilt yields today still remain around 100 basis points lower, driving up liabilities.

The company and the trustees of the schemes have yet to commence discussions on any of the underpinning assumptions behind the calculation of liabilities, and those will commence in the second quarter. So as we get to the 2014 interim results presentation in July, I should then be able to update you on the revised deficit position on a funding basis.

Moving on to cash. This slide sets out the movement from our net cash position of GBP 387 million at the beginning of the year. Operating business cash flow was GBP 147 million. Interest and tax payments were GBP 304 million. Payment of 2012's final and 2013's interim dividend totaled GBP 638 million.

Under the 3-year share repurchase program of up to GBP 1 billion that we announced in February of last year, by 31st of December, we bought back 51.6 million shares at an average price, including cost, of 412p. The combination of dividend and share repurchases gave a total cash return to shareholders of GBP 850 million in the year. Exchange translation and all other movements totaled GBP 79 million, and so we closed the year with gross debt of GBP 2.9 billion, cash of GBP 2.2 billion and net debt of GBP 0.7 billion.

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 2013 was GBP 389 million, and the cash outflow at head office contains GBP 232 million of that.

So moving now to the sectors, and I'll cover the in-year performance here and then return to the outlook for 2014 a little later, as I usually do. So to the first of those sectors, Electronic Systems, and the figures here are in U.S. dollars. In line with previous guidance, sales compared to 2012 decreased by 3% to just under $3.9 billion.

The commercial areas of the business now amount to 21%, having seen sales growth in the year of 8%. This helped to offset some of the pressures on the defense side, which reduced by 5% in the year. The return on sales achieved at 14% was, again, at the very top end of our forecast range. Program execution remains strong, with good risk retirement and in-year benefit from continued cost reduction.

Cash conversion of EBITDA for the year was at 68%, but excluding pension deficit funding, that conversion rate was 89%. Despite U.S. budget pressures, order backlog of $6.1 billion was up from the start of the year, benefiting from production awards in excess of $300 million on the terminal high-altitude area defense program.

The Cyber & Intelligence sector comprises the U.S. Intelligence & Security business, together with BAE Systems Applied Intelligence. The numbers again here in U.S. dollars. In aggregate, sales in the year reduced by 12%. The U.S. business saw an 18% decrease. In addition to the expected reduction from our Counter-IED program, sales were some $140 million below our last guidance, as impacts from budget reductions were experienced far more quickly than expected and with competitive award decisions continuing to be delayed. Several programs are currently operating under month-to-month extensions.

Growth in the BAE Systems Applied Intelligence business was at 9%. The margin achieved of 9.3% was slightly ahead of guidance range, and this includes the continued organic investment in Applied Intelligence business to support future targeted growth in commercial and international markets. Cash conversion of EBITDA for the year was in excess of 100%.

In aggregate, order backlog reduced to $1.2 billion. The U.S. business continued to suffer from budget-induced delays to bid award decisions. We have some $2.4 billion of competitive bids, pending award decisions, of which more than half are now overdue against decision time scales. In addition, some $320 million of backlog has been removed, following customer descoping across a large number of programs. By contrast, backlog in the Applied Intelligence business grew by 60%.

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

Whilst reported sales declined by 17%, that reduction on a like-for-like basis was 10%. 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. The sales reduction was largely from completion of contracts for MRAP vehicle upgrades and lower Bradley reset work. At $3.5 billion, the sales were marginally below previous guidance. The reported margin was ahead of expectation at 9.3%, benefiting from ongoing cost reduction and good program execution, and this includes the charge taken for the closure of the wheeled vehicle facility at Sealy.

Cash conversion of EBITDA for the year was at 86%, excluding pension deficit funding. Order backlog reduced to $7.2 billion, largely for the trading out of deliveries on M777 and under the long-term U.K. munition contract. Disappointingly, the CV90 prospect in Canada was canceled by the customer, and no procurement decision has yet been taken by the Indian authorities with regard to the M777 lightweight Howitzer acquisition.

In the Support Solutions business, sales were 2% higher than in 2012 for ship repair and ordnance volumes. This margin has been impacted by 2 charges. Firstly, as we seek to restructure the Radford munitions contract, a charge of $46 million has been taken against overhead under-absorption in current and future years. Secondly, a charge of $30 million has been taken against cost overruns on commercial shipbuild activity.

Cash flow conversion of EBITDA was low at 68% before pension deficit funding, due mainly to a short-term government delay in processing of payments, which has now been revolved. Order backlog decreased to $5.1 billion as the 5-year ship repair MSMO contracts are traded through.

In the Platforms & Services U.K. sector, the year's sales of 6.9 billion were 21% higher than in 2012 or 19% on a like-for-like basis, benefiting from the 10 aircraft deliveries made on the Salam Typhoon program and trading of the price escalation. There were no Salam aircraft deliveries made in 2012. The return on sales of 12.8% benefited from not only to catch-up on resolution of the Salam Typhoon price escalation, but also another year of good program execution and risk reduction across the business.

Cash performance was better than expected with a cash inflow, albeit of only GBP 59 million. Consumption of customer advances on the Omani Typhoon and Hawk program, the European Typhoon contract and the Saudi training aircraft contract were lower in the year than anticipated. Provisions were utilized against the cost incurred on rationalization, on the Oman OPV program and for the Trinidad and Tobago termination settlement payment. Order backlog reduced to GBP 20.3 billion on trading of aircraft deliveries under the contracts for European and Saudi Typhoons and Indian Hawks.

Sales in the international sector of GBP 4.1 billion were almost unchanged from 2012. The deferred trading arising from Salam price escalation and increased levels of support for Typhoon aircraft now in service were offset by reductions in the Australian business, as the Landing Helicopter Dock build program ramps down. EBITDA of GBP 429 million generated a return on sales of 10.6%, slightly below previous guidance, but remaining well within our guidance range.

With regards to the operating cash flow, you will recall that in 2012, we received some GBP 200 million of receipts, accelerated from '13 by the customer on the Saudi Tornado upgrade program. We've yet to receive receipts against the Salam price escalation settlement. Order backlog has increased to GBP 12.3 billion, following awards in Saudi for Typhoon 5-year support and further weapons packages, together with renewal of the Australian Hawk support program.

For reference, there's a chart providing a summary of the trading performance of all 5 sectors, along with the numbers for HQ appended to your presentation packs.

Now before I move into our guidance for 2014, I wanted to provide a new chart. And as Ian has described, following the signing of the U.S. Bipartisan Budget Act and the subsequent appropriations bill, we do now have better clarity on the impacts of the spending reductions on our U.S. businesses. And this slide shows the impact by sector from 2012 into 2013 and on to 2014. And just to be clear, this chart relates to defense activity only.

As we said previously, our worst-case view of full sequestration was a 15% reduction across our U.S. sectors when compared to 2012, and with the greatest exposure expected in U.S. land. As you can see, the impact across each of our 4 sectors varies significantly. But as a summary, our 2 largest sectors, Electronic Systems and Support Solutions, have experienced the least impact, whilst land, as expected, has been hardest hit due to the operational tempo rundown and ongoing programmatic funding pressures.

This penultimate chart seeks to give guidance as to how we see the performance of each sector developing from 2013 through into 2014. Overall, we expect -- so firstly, Electronic Systems, and here, we expect 2014 sales in dollar terms to be similar to those in 2013. Some 20% of the business is now in commercial markets, where we expect continued good levels of growth, and this should offset further reductions on the defense side of the business of around 3% to 5%.

In aggregate, of 2014's projected sales, some 75% are in the 2013 closing order backlog, and that's broadly consistent with last year's starting point. On margins, we would again expect to see performance at the high end of our guidance range of 12% to 14%.

Next, Cyber & Intelligence. And here we expect sales in '14 to be broadly in line with those in '13. The U.S. business, which is 75% of this sector in '13, is expected to be only marginally lower, having seen no sharp reductions in 2013. Sales in the Applied Intelligence business are planned at a double-digit level from continued expansion in commercial markets, and such growth is now clearly supported by that 60% increase in the backlog. Margins in '14 are expected to be within an improved 8% to 10% range, with investment in implied intelligence business continuing to support further organic growth.

Moving to Platforms & Services U.S. And whilst overall guidance is shown on the chart, it is best considered in 2 parts. In Land & Armaments, from 2014, we have transferred management responsibility for the U.K. Munitions business into the Platforms & Services U.K. sector as a further cost reduction action. That business generated sales of around $450 million in 2013. So from an adjusted starting point of $3 billion, we anticipate sales to be some 20% to 25% lower.

Activity on Bradley halves to the $250 million mark, whilst the M777 and Medium Mine Protected Vehicle production contracts largely completed in 2013. More than 80% of the sales guidance is within order backlog. As for the margin level, we expect delivery now around the 9% mark in this business.

In the Support Solutions business, we anticipate 2014 sales to be only a little lower than in '13. Again, more than 80% of sales are within the backlog. Due to the charges taken in 2013 in commercial shipbuilding and on the Radford contracts, there will be a dilution to the sales trading through on those contracts in 2014. And we, therefore, anticipate a mid-single-digit margin in the Support Solutions sector for 2014.

Turning next to Platforms & Services U.K. and excluding that transferred munitions business, sales are expected to reduce by around 5%, following the trading in 2013 of the price escalation on the Salam Typhoon contract. Here, almost 90% of this guidance is within the 2013 closing backlog. Following the benefit in 2013 of the Salam price escalation catch-up, margins in this sector are expected to return to within our usual 10% to 12% range.

And the last of these sectors, Platforms & Services International, here we expect sales in '14 to be about the same as in '13. Last year's trading arising from the Salam price escalation and significant weapons volume is expected to be broadly offset by increased levels of support to the Typhoon aircraft now in service. Again, more than 80% of the sales guidance is covered by backlog. Margins are expected to be similar to 2013 within our 10% to 12% range.

To complete your 2014 models, headquarters costs are now expected to be significantly lower, following last year's first half charge taken against the contract pricing dispute. Underlying finance costs are expected to be just marginally higher. The effective tax rate is expected within a 21% to 23% range, an improvement on previous guidance. And the final number there is, of course, dependent on the geographic mix of profits.

In aggregate, following last year's nonrecurring benefit from the Salam price escalation settlement, together with the impact on the business of U.S. budget pressures, we expect the group's underlying earnings per share to be some 5% to 10% lower than in 2013.

With the volatility in operating cash flows seen over the last 2 years, I thought it would again be helpful to give you a final slide on our expectations for 2014. As I said before, cash forecasting for this group can be a challenge given the digital nature and timing of some of the items that we deal with, but that said, this slide gives our current view.

In respect to operating cash flow, firstly, we are not planning for any material capital expenditure above depreciation levels. We have completed the sale and leaseback transaction in January on one of those residential compounds we have in Saudi Arabia, and that generated some GBP 160 million of proceeds.

Within working capital, we expect to incur costs of around GBP 200 million against provisions created in previous years that we hold in the balance sheet. And as always, the most volatile area remains the level of customer advances. Against the major advances we received in 2012 on the Saudi trainer aircraft contract and the Omani contract, we will see a high level of utilization. You'll recall that under the terms of that Omani contract, no further cash will be received until deliveries commence in 2017. There will also be advances consumed on the European Typhoon production program. The guidance here does anticipate cash inflows from the Salam price escalation settlement.

The final operating cash flow item is the U.S. pension deficit funding, which will again be around the GBP 400 million mark, including the accelerated funding arising from the share repurchase program.

The nonoperating cash flow items are far more predictable. Outflows for interest and tax expected to total around GBP 400 million. Dividend payments in the full year of the share buyback program should deliver a further GBP 1 billion of cash returns to shareholders. So overall, 2014 is expected to be a year of significantly higher operating business cash flow but with an increase to net debt post the shareholder returns.

As I said at the beginning, there are a number of items to highlight. On the downside, we have encountered operational issues in Support Solutions. We have seen larger than expected top line reductions from U.S. budget pressures on our land and Intelligence & Security businesses, and we have taken a noncash goodwill impairment charge.

As positives, we have exceeded cash expectations, we've increased the dividend and the order backlog has been sustained. The tax rate is lower and the accounting pension deficit is down. But most importantly, the uncertainties regarding Salam price escalation and near-term U.S. budgets have been lifted. Our balance sheet remains robust, and the credit ratings are solid.

So with that, I'll pass it back to Ian.

Ian Graham King

So to sum up, U.S. and U.K. budget pressures are expected to remain, but we continue to generate good order intake. The record order book at the end of 2012 was sustained during a challenging 2013 trading period. The group's continued focus on cost and targeted investment will enhance competitiveness and affordability for the benefit of customers and sustain attractive returns for shareholders. We have started 2014 with a settlement on Salam pricing, U.S. budgets and a well -- in place, and a well-defined U.K. maritime sector plan.

Good momentum to commence the year with. We are delivering against our strategy to maximize shareholder value from a well-balanced portfolio and solid order backlog. We may continue to face challenges, but we remain confident that we can develop the order book to provide a solid base for growth in the medium term.

Before we get to questions, I'd just like to run a short video. It showcases our technology and demonstrates both the innovation and inspired work this company delivers.

[Presentation]

Question-and-Answer Session

Ian Graham King

Questions? Nick [ph]? And then we've got 1 -- 3 there.

Unknown Analyst

A couple of questions. Some of your U.S. colleagues, your competitors, have said that 2014 probably marks the bottom for short cycle revenues in the U.S. defense market. And first of all, if I look it's actually gone so far to say that it sees some growth in short cycle in '15. Does that apply to you? Do you actually agree with that concept? That's the first question. Shall I ask the others whilst I'm going?

Ian Graham King

Yes.

Unknown Analyst

And sort of going on from that, you're looking at very substantial declines in U.S. land in '14. Could you be sort of specific and perhaps parse a bit as to what the particular programs are that you expect to decline within that? And finally, a different issue, UAE, have you had any debrief from the customer as to what happened, why did it fall through? And is there any likelihood that it will come back again?

Ian Graham King

Let's just answer the last one. Yes, I have had a debrief from the customer, and no, I'm not going to share it with you. What our statement is that it wasn't about the capability of the aircraft. It was about their overall budgeting. So that's as the statement went out in December, that's it, it is absolutely consistent, and yes, we've had the debrief. So I'll ask Peter on the specifics and let me ask Jerry DeMuro since he's on, to talk about what you think about the environment, Jerry, in terms of overall budgets? Shall we start with the specifics, then we can get into...

Peter J. Lynas

Yes, okay. So U.S. Land & Armaments, the step down, you clearly heard me say the guidance having GBP 3 billion sort of baseline for '13 once you've taken out the movement of the munitions business in the U.K. and 20% to 25%. So that's sort of clearly $600 million to $700 million reduction. Half -- $250 million of that is around lower volumes of Bradley reset work. And then the other 2 areas are the M777 lightweight Howitzer into the U.S. and the second program is the Medium Mine Protected Vehicle. So it's those 3 in aggregate which give you the step down. The other question you asked was around 2014 being the bottoming year and ahead of whatever Jerry's going to say -- we haven't rehearsed this bit particularly well here. But 2015, I think we're not going to give guidance on '15, but 2014, if the question is are we bottoming out in the U.S., yes, we're getting pretty close. I think what you've seen on the services business in particular is significant step down that we've seen in '13, 18% in our Intel & Security business, that's where the biggest impact has fallen. So we think we've taken most of the pain in '13. The guidance clearly for '14 is not much more in the service businesses.

Ian Graham King

Jerry, so what do you think is going to happen to the world in budgets?

Gerard J. DeMuro

If I knew that, I might not be here. At any rate, I think as Pete said, we are getting some clarity as most of you know. There was a bipartisan budget act approved by the United States Congress back in December, which resulted in some relief from sequestration in the budget was passed and implemented in January. If you look at that budget for '14 and '15, we have some stability and clarity but it's not uniformly addressed or spread where that relief came. So it really is portfolio dependent as to whether or not the bottom is in '14 or '15. As you look forward with where the sequestration marks are, we see stability pretty much from '14. There's a modest change year-to-year. But from '14 through '16, we've pretty much seen the bottom, so I think that's the basis that we can look at. If it's not the bottom, we can see it. And then if you look at the Budget Control Act, which implemented sequestration, it shows some upturn again in '17 and '18. So again, depending upon your portfolio, there's a delay between when the budget and the appropriations are put in place and when orders are implemented, and then when we have revenues following those orders, and sometimes that's up to 2 years. So on the shorter cycle businesses, it's a little bit less. So we're hopeful that the customer behaviors we've seen over the last couple of years, that the stability that we're projecting here flows right in through '15. So if we're not at bottom, as Pete said, I think we're getting pretty close to a stable position as reflected even in the Intelligence & Surveillance business -- Security business that we have, we're projecting just about flat for the year. So subject to your questions, that's kind of the short-term view. Reasonably optimistic that maybe post our elections in November, this spirit of bipartisan work on the budget may result in further relief from sequestration, possibly even an uplift and, hopefully, again, giving the Department of Defense flexibility on where they apply the cuts instead of just unilateral percentage applied over everything.

Ian Graham King

And the key to us, Nick [ph], as you know, was to make sure we protected our core capabilities in this sector, consolidate that into York, Pennsylvania which we've done, we now have work going through that to, what, mid-2015?

Gerard J. DeMuro

Yes.

Ian Graham King

Focus on that and go from 51 separate sites to 15 sites, and good margins on that business, which we've seen going forward as you can see from Pete's projections.

Gerard J. DeMuro

So that's the key. It's an excellent franchise and our task right now is, as our major customers are in an acquisition hiatus, is to scale that business appropriate to the market and position it for the opportunities that we see. And frankly, I'm reasonably encouraged as we look in '14, the forecast that we have is for a stable to a slight uptick in return on sales as a lot of these economy measures are starting to pay a dividend. And we have a set of opportunities in the United States, as well as internationally that, I think, start to position us. And lastly, we have the United States customer that's absolutely committed to preserving the basic capability in the industrial base and is negotiating with us right now to ensure that they have a competitive environment as they go forward and they pursue their future requirements. So some encouraging signs in that business as well that we've got stability. The key is to scale it, so that it is profitable and cash positive in the interim and well positioned to pursue these opportunities as they're emerging around. So we have a growing pipeline of opportunities as well.

Ian Graham King

So you can see that although Jerry only started with us on the 1st of February, he's got a pretty good understanding of what he has to do with the business portfolio. Thanks, Jerry. Right. There's 2, 1 -- yes, there you go, that's it.

Unknown Analyst

Actually, just a follow-up, Jerry. He can't escape that easily. I was wondering if you could also talk about what the OCO is expected to do going forward from here, and what sort of impact that could have on your business? It's obviously been unclear but there's some pretty significant cuts that can flow through. And then secondly, I was wondering, Ian, if you can comment on Euro 5, there was some comments from Germany yesterday about what they might do.

Ian Graham King

I'll cover both actually. We are not exposed to OCO funding in our portfolio. Most of it is traded through. It's the same position that we were in last year, which is why we've seen the volumes going down.

Unknown Analyst

And if you can comment on Euro 5?

Ian Graham King

We believe what the Germans were referring to is Tranche 3B, that has been out of our planning assumption now for 2 years, Nigel?

Nigel Whitehead

Five.

Ian Graham King

Five years. So it's not something that worried us other than why is it taking them so long to get around to recognize [ph]. So it's not in our planning assumption.

Unknown Analyst

And then maybe one for Pete as well. On the buyback for this year, how do you expect the cadence to progress? Are you going to wait for this pension situation to be formalized or sorted out before you maybe step things up?

Peter J. Lynas

No. When we announced the buyback program last year, we said up to GBP 1 billion over 3 years, and subject to satisfactory conclusion of the Salam pricing escalation. We've now got that and we're in the markets and accelerated rate as from today.

Ian Graham King

Okay. There's one just behind, and there's 1 just to the side.

Edward Stacey - Espirito Santo Investment Bank, Research Division

It's Ed Stacey from Espirito Santo, the question is about the U.K. division and whether that will be at a bottom in 2014. And I guess within that, I wanted to know the step down that you're guiding for, for that division in 2014, is that entirely because there were some extra export Typhoons in 2013 that kind of raised the comp? Or is 2014 actually coming down in terms of the underlying run rate of the U.K. program?

Ian Graham King

The '13 -- the reduction was simply because of the element of the pricing on the Salam, which was trading off previous deliveries, so it was a one-off adjustment from that. In terms of the volume of manufacturing going through on Typhoon, it's consistent from year-to-year at 30 year. That's the manufacturing rate that we have on this going out on existing contracts to first quarter 2018 and our plan will be going out to 2021, '22.

Edward Stacey - Espirito Santo Investment Bank, Research Division

That covers the Typhoon side and then I was going to ask about naval as well, whether you start to get an idea when some more submarine work might be coming through in the U.K.

Ian Graham King

It's increasing as it is. I mean, we have consistent work on the Astute Class submarines which go, I'm not allowed to tell you the dates, but don't you worry about it, it's well and truly into the next decade, and we're building up activity on this, what's called the Successor program. Are we allowed to talk about the number of people we've got on it, Nigel? So we've got in excess of 1,000 people on that program and it's building up on a daily basis. So there's one there and then just -- everybody's in the middle of the room.

Unknown Analyst

Just one question. In thinking about international opportunities and demand, particularly in the GCC states, can you comment on the opportunities and the timing that you're focused on beyond Typhoon?

Ian Graham King

Beyond Typhoon?

Unknown Analyst

Yes, aside from Typhoon. So x Typhoon, what are you thinking about in terms of major platform acquisitions in the GCC and other emerging defense markets?

Ian Graham King

Well, I mean we're in this privileged position as a company that we ride the 2 preeminent combat aircraft programs in the world. So every time F-35 gets sold, we get 15% of every sale of that in perpetuity as well, and then we have [indiscernible] aircraft. So selling F-35 -- it's not in the GCC but into the Far East, which has been the emphasis, is fantastic business for us, as well as winning the F-16 upgrades as well, so, and then eventually they will come into the GCC states over a period of time as they replace existing U.S. assets, because they don't tend to sort of dominate themselves around 1 country's aircraft. Alan, what are the areas we do in the GCC states at the moment?

Alan Garwood

There's some more opportunities possibly in Bahrain. Outside of GCC, we're probably looking at Hawk in maybe Malaysia and then we're chasing a whole raft of F-16 upgrades around the world. So I was in Singapore last week, we're trying to convince the Singapore government they want to open that up to competition in the way that the Koreans bravely did last year, and we beat Lockheed Martin hands down.

Ian Graham King

We also have some vehicle programs which we deal with from 2 sources. We have the Bradley, as we talked about where there's an opportunity in Saudi Arabia and in other countries in that area. And we have a joint venture in Turkey called FNSS, which goes way back to transfer technology from the U.S. some time ago, and it sells an 8x8 vehicle and we're not allowed to talk about the countries, but it's got 2 very successful campaigns going at this moment in time. We have a, what, 50% stake in that? So we're very active. So you've got Typhoon, F-35, Hawk trainers, because whenever they want to buy a next-generation asset, combat aircraft they need to upgrade their training regime, that's what the Australian order was because it was both support and there was an upgrade to reflect that it's taking F-35 going forward. The U.K. is already doing that. That's what Saudi was about when we largely we booked the Hawk order because it was upgrading for the further Typhoons. And so there's a lot of campaigns going on at the moment. And we have another Tranche of Hawks into India as they're building up their aircraft, as they're introducing their new generation of combat aircraft, front-line aircraft into service. It is why we talk about it as a very vibrant opportunity, set of opportunities. Just behind?

Unknown Analyst

[indiscernible] Just a question regarding the Salam program on price escalation, what was the contribution to your headline numbers in terms of revenues and EBITDA?

Ian Graham King

That's what we like, a very blunt question. Pete?

Peter J. Lynas

As we guided back in the last year, we said that we had an earnings dependence of 6p to 7p for 2013. That's been delivered. So the negotiation was, as Ian said, equitable settlement, it delivered on our expectations. So 6p to 7p.

Unknown Analyst

Okay. And then taking into account the outcome of the UAE bid, are you still trying to push in terms of beating India? Or have you given up on there?

Ian Graham King

We have not given -- I mean, one should never give up on India. As you know, they've gone into an election process, and that will determine which hue of party gets in or whatever coalition gets in, I suppose is probably the better way of saying that. And we've always said we're ready and waiting if they're willing to accept another offer. I mean, clearly Typhoon has moved massively on from where we first bid in terms of its capability that are being developed on the back of existing customers. And we believe that we can offer a competitive capability to them. We're waiting. At the back, there's 2 behind.

Unknown Analyst

Just a couple of questions. First on R&D and where you're committing that, it still seems quite a low level at a group perspective. Just comment on where that -- the exact priorities are on that? And then one around the guidance. If we took the sort of low end of that guidance from an earnings perspective, what's the implication of the dividend and growth in that as it would, sort of, fall below your 2x stated cover?

Ian Graham King

Okay. Do you want to cover the dividend, Pete?

Peter J. Lynas

Yes. The dividend, we always say around 2x. Clearly we're not going to give a dividend forecast for '14 here today. But we have plenty of cover around the 2x. So there is no issue of the dividend being at risk in this guidance for '14.

Ian Graham King

In terms of our research and technology, there's 2 factors you have to remember. It's not just what we put into it, it's what our customers put into it and how we link the technology that we spend with orders that they put. So you need to look at the 2 in context and we obviously are not at liberty to disclose all of that activity. So it is different than other sectors where you're purely developing yourself and then hoisting a product on to the marketplace. That's not the nature of the business that we're doing; we are reacting to what our customer requirements are and try to look down a path to how our research and technology match those growing requirements. So if you think about the video, that has been a combination of a lot of money coming in from the company, and then supplanted by money which comes in from our customer, which then leads to this demonstrator program and that's the nature of the sector we're in. Now let me just ask Nigel Whitehead, who runs the U.K. business. Do you want to talk about what we do in technology planning and how we think about the future technologies, Nigel?

Nigel Whitehead

Good morning, everyone. I'm Nigel Whitehead. In terms of technology planning, we do take a long-term view, so 10, 20, even 30 years out, and our priorities are essentially around low-cost manufacture, where we really have something to offer. We have priorities around systems engineering because, again, our proposition to the market is that we underpin the performance, safety cost and schedule of our offerings. And to do that, we really have to understand and have mastery of the entire system. And for specifics, we have put emphasis in research and development and particular development items around enhancing the capability of Typhoon. But also, as illustrated in the video, we put emphasis on the UCAV area, and in particular, fundamental research on autonomy and fundamental research on stealth, both of which have been demonstrated very successfully in the Taranis demonstration program. And we take a very broad view of that, but we make sure that the businesses are actually demanding the technologies and that we're working on those technologies in an advanced technology center and also distributed around our businesses. We have relationships with 63 universities in the U.K. and 130 worldwide to acquire that technology, to bring it into our business and exploit it against well-defined product route maps, which actually deliver for us the capability we deliver to our customers.

Ian Graham King

And our technology largely sits in 2 places. So U.K., you've heard from Nigel in U.K. Let me just ask Tom Arseneault, who's the COO in the Inc. business, to talk about how we handle it in the U.S. context.

Tom Arseneault

Thank you, Ian. It largely parallels what Nigel just outlined. I would point out that in the U.S., the institution of DARPA as an organization is how the U.S. thinks about technology, invests in technology going forward for defense purposes. We have contracts with DARPA that amount to several hundred million dollars a year. We're one of the largest suppliers into DARPA. And we use that, as Ian pointed out, to supplement the company's own indigenous investment in the technologies that we believe will shape the future of our markets. We're very active in that. This is -- we have an entire group we call technology solutions that executes that business in conjunction with all of our lines of business, and feed that technology as we mature it into our products. So very, very fundamental to our operating model in the U.S.

Ian Graham King

And do we believe that we are ahead of our peers or one of the pack in terms of gaining money from DARPA?

Tom Arseneault

Was that a leading question?

Ian Graham King

Yes.

Tom Arseneault

We, again, we're one of -- we're in the top 3 suppliers into that organization in the United States. We're very active. We believe that in the areas as the U.S. looks in the world, turns its attention to the Pacific, some of the technologies there around electronic warfare, anti-access/area denial, those sorts of technologies we're putting on the very front of our list. And so we believe we are in the very forefront of that in the United States.

Ian Graham King

So Pete, can you scale what we spent?

Peter J. Lynas

Just to put some numbers around that, I mean, clearly, we have a significant amount of company funded and an even higher element which is customer funded. The company funded in '12 was GBP 150 million, in 2013 it was GBP 171 million. So we've increased by almost 15%. And if you take the total R&D spend as a percentage of sales for the group, we're around 6%, which is consistent with '11 and consistent with '12.

Ian Graham King

So that's both us and our customer funding at that level. Before we get into the development programs -- okay. We've got a few questions from the webcast, who, I think -- shall we just take one of those, and then we'll come back. So Ben? Ben Fidler? Go on.

Benjamin Fidler - Deutsche Bank AG, Research Division

A couple of questions, please. The first one is just exploring the U.S. Platforms & Services business. The charges that you've taken in both these problematic contracts at Radford and in the ship repair stuff. Do you have confidence that this now underpins your understanding of the risk and the financial liability to you? And how high would you put the likelihood of being able to renegotiate the Radford terms up that may help your margins presumably of that division going forward? The second question was just around cash flow. I'm never very good at forecasting your cash flows; you beat my numbers yet again significantly. Just the provision flows and the movement in provisions in 2013, you'd originally been guiding to about GBP 400 million in provision utilization. I'm struggling to see what that actual number was in 2013. And around the advances guidance for 2014, the advances outflows that you talk about, GBP 750 million to GBP 1.25 billion, just to confirm that is after receipt of the Salam inflows, is that correct? Which would seem to imply a very, very sizable underlying advance outflow in 2014, or am I missing something there?

Ian Graham King

Well, I'm glad to see, Ben, that we've got the level of questions from you that you would've given if you were physically present with us. So Pete, why don't you have a go, you do the cash...

Peter J. Lynas

I'll do the cash flow first. The provision spend in the year was around -- was just over GBP 300 million. The biggest single piece of that was on the Trinidad and Tobago termination settlement. If you recall that was a contract that was terminated. We reached a settlement with the customer. We pay back more than -- well over GBP 100 million on that contract that we previously received from them. So that was the biggest single part of that. But also we've got the Oman Offshore Patrol Vessel contract, again that was a contract we've taken losses in previous years. And as we've now delivered on those, we've actually delivered 2 of the 3 ships. We've been spending the money on that contract to get those ships delivered. And then the third element was on rationalization cost. Again we've announced several programs in the past. We take the provisions and we've been spending the money as that rationalization has happened. In terms of 2014, and I guess where you're coming from is how much is the Salam settlement cash, given that we're saying that is in guidance. I think many of you have published numbers, which are all pretty close, you're not far off, and we expect to receive that cash over '14 and '15.

Benjamin Fidler - Deutsche Bank AG, Research Division

My question was actually more around just the -- it implies the underlying advances outflow will be GBP 1.5 billion to GBP 2 billion presumably after the Salam cash, which is a pretty big number, yes?

Peter J. Lynas

It's a bit less than that number, Ben. But I mean, the big drivers, you've got the Hawk contract for the trainer aircraft into Saudi Arabia. We don't deliver those aircraft until 2016. So we've got significant down payments in those when we got contracts, so we are spending money on that. And the one that's even larger is the Omani contract for Typhoons and Hawks. We got that contract right at the end of 2012. Again, we've got a very significant down payment and there is no cash to come on that contract now until deliveries in 2017. So we are seeing cash quite high on both of those 2 contracts. And then the final one, the final element to that is on the Typhoon European program as we start into the end of Tranche 2 and into Tranche 3, we do have advances on the Tranche 3 program and we will be using those as well.

Benjamin Fidler - Deutsche Bank AG, Research Division

Okay. Just picking on one final thing, if I may, your comment about Hawk. And particularly read across from another U.K. aerospace company, they talked about significant decline in their Hawk revenues. Are you going to see a significant drop-off in Hawk deliveries over the next few years?

Ian Graham King

No, we're ramping up Hawk deliveries over the next 3 years because we ramp -- we've got the Oman contract of Hawks to deliver, the Saudi contract of Hawks to deliver, and we're still delivering batches of Hawks into India.

Benjamin Fidler - Deutsche Bank AG, Research Division

It sounds like [indiscernible] gliders based on the [indiscernible] engines then.

Ian Graham King

In terms of your -- the first part of your question on Radford, this is a fundamental capability for the army and the other forces in the U.S., and we're going to have to negotiate a restructure program with them. Given where we are at the moment in time, because they haven't got finalization of their budgets, we have to pick the right time to have a proper debate with them. But we haven't missed a beat in performance on this program, so it's not like we are not performing, we've just got to restructure it and the right thing to do is to do it at the right time for them and us.

Right. We'll take a question there, and then we'll take a question from David after, so one more question, then David, and then we're on to you, David Perry.

Alexandra West - Redburn Partners LLP, Research Division

Allie West from Redburn. I wondered if you'd be able to quantify how much of the 6p to 7p of earnings is a one-off catch-up from the historic deliveries and how much of it is due to the 10 deliveries that were made in 2013? Just trying to understand how much of that endures going forward?

Peter J. Lynas

I'll say 2/3 will be the catch-up.

Alexandra West - Redburn Partners LLP, Research Division

And if I think about it in a different way, if Platforms & Services U.K. didn't have the catch-up in it, would effectively the guidance be flat?

Peter J. Lynas

It would.

Ian Graham King

Okay, David, David Perry?

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

I've got 3. They're all a bit in the detail for Peter, I'm afraid. Peter, first one is just on FX. Your guidance, there's a little footnote in your guidance for '14 on U.S. sectors in U.S. dollars, so can you just clarify when you talk about EPS down 5% to 10% in 2013, what FX rate you're assuming? That's the first one. Second one, sorry to ask you to plug to the model, but when you say HQ EBITA significantly lower, would you be able to quantify that a bit? And thirdly, I guess following on from what your answer just now to Ben's question on customer advances, it sounds like 2015 could also be a year of quite big outflows, because all of those issues should carry on, Tranche 3 Europe, [indiscernible] Oman, et cetera, Saudi Hawks, I mean are we looking at negative free cash flow '14 and '15? Is that a reasonable assumption?

Peter J. Lynas

Okay. First one, FX rate. I mean the planning rate that we've used is $1.60. Clearly, if you look at where the dollar rate is today, it's above that, we're at about $1.65, $1.66. The rate that's used in the trading is the average rate for the year. But I guess what you're looking for is the sensitivity, $0.10 is about $0.01, okay. HQ costs significantly lower. If you recall in the first half of 2013, we took a charge of $50 million on a -- in respect to a legal or pricing dispute we had in the U.S. That doesn't reoccur. So that gives you the number I think you're looking for. And then the third one in 2015, on those 3 programs that I talked about, then yes, there will be some cash utilization again on Oman. On the Saudi trainer aircraft, there won't be because we get some more receipts. And on the European production program, we're pretty much -- we'll have burned through the advances by the end of '14. So yes, there will be positive free cash flow in '15 without giving guidance.

Ian Graham King

Okay. Seth [ph], on the wire?

Unknown Analyst

Welcome, Sir Roger, to the aerospace and defense sector. We look forward to engaging in discussions. I just wanted to ask about the dividend, I'm not asking for forecasts but just how should we be thinking about potential growth in the dividend going forward, given the cash requirements? And you talked about the 2x cover. How rigid is that? Because the cash earnings and reported earnings, there's a big difference between those. Should we be thinking about the sort of cash flows influencing dividend, or are you going to be reasonably rigid on the reported earnings cover on the dividend? Just need some sort of background on that so we can think about how to project these dividends going forward.

Peter J. Lynas

I mean, our dividend policy is to have the dividend covered around 2x by underlying earnings. So first of all, it's not directly reported, it is underlying. So this is the underlying earnings really are linked to cash over the long term. So dividend around 2x cover. So it's earnings-driven. As you've seen the cash performance of the group, we have plenty of cash, payment of dividend is not an issue. So it's all around the earnings. The buyback clearly is underpinning some of the earnings per share. So as we've said before, we're 5% or thereabouts yield on dividend, every time we buy back, it's saving us cash, and it's earnings enhancing. So it's underpinning the underlying EPS at the same time.

Ian Graham King

So our cash flow projections are not going to impinge the ability to pay the dividend relative to the capital that we have agreed with the board. Okay, Seth [ph]? Celine?

Celine Fornaro - BofA Merrill Lynch, Research Division

I just wanted to ask a question regarding your cyber assets. So looking at, unfortunately, the quite underwhelming performance of that business. I mean, do you feel that you're missing some assets that would...

Ian Graham King

Well, at least, our systems are working, Celine. No, we have...

Celine Fornaro - BofA Merrill Lynch, Research Division

The market trend and you're not going down more than your competitors.

Ian Graham King

We've done quite an analysis, that's a good question about the various aspects of our U.S. business. And those ones that we want to concentrate on that we believe are our core franchises going forward. And no, we do not believe that we're disadvantaged against specific areas. Remember, we were always going to have a decline in that business on this Counter-IED analyst program with the withdrawal from Afghanistan; although we got a follow-on contract, it was for a smaller number of analysts. So no, we have been through that in some detail. And Jerry has quite a distinguished background in this area, and he's also spending quite a lot of his time with Tom and the team making sure that, that's the case. But from where we sit today, we're very happy with the business. And you can see the financial performance of the U.S. business in terms of its cash flow, its profitably has been very good. So we've got good quality business in there.

Celine Fornaro - BofA Merrill Lynch, Research Division

But sorry, Ian, I mean in terms of very good profitability, I mean it is 9%. So generally, you would assume that cyber or IT would be slightly better than that?

Ian Graham King

Not when you're talking about government agency work, absolutely not. That is very high end compared to that business. When you're talking about Applied Intelligence, which is a mix of both government and civil, which today is about 50-50, you would expect on the civil business to get higher margins. But as you know, we're investing organically on that. When we look at the underlying margins of that business, we've always said that we would expect to get them back to the 12% to 14% over a period of time, and the underlying business that we're winning and executing is generating that. But we have high sort of money putting into business development at this stage.

Peter J. Lynas

And Celine, on the guidance you are seeing on that particular sector, whereas previously, we talked about a margin range of 8% to 9%. We have inched that top end up by a percentage point, and that really builds on Ian's comment around the Applied Intelligence business as to what our longer-term expectations for margin in that business are.

Celine Fornaro - BofA Merrill Lynch, Research Division

Okay. And can I ask a second question on the orders and your intention for the order book this year, if you have mentioned an order target for 2014? And also, if you could give us an update on the Typhoon in Malaysia, if this is becoming any more concrete or not really at this stage.

Ian Graham King

Well, we have our man from Malaysia here, Alan Garwood can tell us how concrete it is post the elections. But as we said to you, this was never an order that was projected to come in, in the 2014 time frame. So what do you think the time frames are, Alan?

Alan Garwood

I think it's around, probably, 2015, 2016 now. The Malaysian government is openly saying they have some issues on finance. And while they're bringing in -- ending subsidies and bringing new value-added tax, unlikely there's the appetite to buy Typhoon at this point. What they have done is solicit leasing proposals from every major aerospace company. We will be submitting a leasing proposal next month for Typhoon, together with a purchase option, and expect to have further discussions later in the year, maybe even early next year around that. So order play for Malaysia, but it is going to take a little longer.

Ian Graham King

In terms of the order book, we're not winning -- we're not going to give projections. But if we look at all of the campaigns and the quality of the business that we've got, if we look at through delivery [ph] period because I mean, these big orders can be quite lumpy, we are happy with where we are in our order book. It is a very high quality order book, sat at record levels, which allows us to plan, I think, what was it, the lowest business division had 80% of its 2014 sales in there, I would defy many companies who could show that sort of robustness. Do we have any other questions?

Operator

There are no further questions on the audio at this time.

Ian Graham King

So there's actually no further questions. Anyway, thank you very much. Thanks for joining us, and have a good day. Thank you.

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