Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

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

Peter Lynas - Group Finance Director and Executive Director

Nigel Whitehead - Group Managing Director of Programmes & Support

Robert T. Murphy - Executive Vice President of Product Sectors and Member of Executive Committee

Alan Garwood - Group Business Development Director

Guy Griffiths - Group Managing Director of International

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

Lawrence B. Prior - Member of Advisory Board on Tanzania, Member of Executive Committee and Executive Vice President of Service Sectors for BAE Systems Inc

Analysts

Nick Cunningham

Edward Stacey - Espirito Santo Investment Bank, Research Division

Celine Fornaro - BofA Merrill Lynch, Research Division

Benjamin Fidler - Deutsche Bank AG, Research Division

Rupinder S. Vig - Morgan Stanley, Research Division

Joseph F. Campbell - Barclays Capital, Research Division

David H. Perry - Goldman Sachs Group Inc., Research Division

Sandy Morris - RBS Research

Oliver Sleath - Crédit Suisse AG, Research Division

Steven Cahall - RBC Capital Markets, LLC, Research Division

BAE Systems plc (OTCPK:BAESY) 2011 Earnings Call February 16, 2012 4:00 AM ET

Ian G. King

Good morning, everyone, morning, morning. All right, should we all get started? We've hit the appointed hour. I've got this big clock up there keeping me in order. All right. Well, thank you for coming. I'm sure you will have all have seen the results announcement this morning. I'm going to kick off, and then hand over to Pete to take you through the detail and the outlook.

The results we announced today contain a number of elements that were not planned at the beginning of the year. We handled the slowing demand in Land, disruption from flooding, the Oman OPV contract, the Ground Combat Vehicle and Radford award protest and the deferred trading on Salam. We've been agile and adjusted to mitigate these events. And what should become apparent, as Pete takes you through the detail, is that the underlying business remains strong. Underpinning that solid core has been a combination of good program execution and aggressive cost reduction to maintain returns for shareholders in the face of those headwinds. We are operating in a difficult and rapidly changing business environment. These market pressures have been apparent for some time and the group strategy has developed accordingly. We have moved quickly to take the actions necessary to sustain the bottom line in the near-term and establish a platform for which growth can be pursued.

Affordability has become the priority for our customers. We have cut costs aggressively to both address reducing demand in some activities and to secure competitive advantage. Cost reduction and efficiency actions have been underway since 2009. We are staying ahead of the volume reductions. If this activity will continue, we can still do more. We don't take these decisions lightly. They are difficult but essential if we are going to sustain the business. At the same time, we continue to develop our already substantial position in the services sectors of our markets; invest in the faster-growth streams of business, including cyber, commercial avionics and high-priority defense electronics; sustain our core industrial capabilities through the strong positions on key programs; and address growth in selected international markets.

Cost reduction funds our ability to continue developing the strategy and maintains our competitive edge. We have been successful in growing a position as one of the major providers of capability and services in the cyber and security markets. Having established a strong position in the government in intelligence-related sectors of these markets, we are now seeing the benefits of our more recent drive to expand in the fast-growing commercial and financial services markets. We are well positioned on a number of key platform programs such as the Typhoon and F-35 combat aircraft, submarines, naval ships and armored vehicles. These programs form a large core of business with good multiyear order visibility. These programs generate substantial services and support business.

Our services offering is one of the differentiating strengths of this group. Through the privilege in the military and technical services, we continue to deliver enhanced capabilities while reducing costs for our customers across the air, land and maritime domains. The partnership relationship between the company and the armed forces continues to strengthen. We have been active in supporting U.S. and U.K. operations in Iraq and Afghanistan, and more recently, our products and people made a significant contribution in the success of U.K. operations over Libya.

In the U.S., delays in approving defense budgets result in the business operating under continuing resolution restrictions for 7 months of 2011. Our business remained resilient through this with only a modest amount of trading disruption as a consequence. The 2012 budget has now been passed with a base budget at the same level as 2011 and a similar level of spend on the investment accounts. The January announcement by the President and Secretary Panetta describing the future strategic direction for U.S. defense and security and the recent DOD defense budget were in line with our planning assumptions. The near-term budgetary issues have had some impact on the business and there remains significant uncertainty as to U.S. federal budgets over coming years. But we plan on conservative assumptions. We have already made decisions on likely spending trends and will respond with agility as the facts become clearer. We will not be a victim of the process, and we'll stay ahead of the game.

In the U.K., budget constraints remain. But following the Strategic Defence and Security Review in October 2010, there is now greater program stability and better alignment of government funding with defense program commitments. The SDSR impact on the group following the program changes has been to reduce annual sales by some GBP 500 million. Actions taken to mitigate the impact of these changes are well underway, including workforce reductions and facility rationalization. Contract settlement agreements have been concluded.

There is also more that can be done to drive efficiency. These opportunities reside not just here within industry, but also in enhanced contribution the industry can make through the delivery of cost-effective supporting capability to the armed forces and the security agencies. We continue to work with our U.K. customer to help identify further efficiency improvements.

We are seeing major opportunities mature in our international markets. With order intake in 2011 of GBP 4.8 billion from our markets outside the U.S. and U.K., we are seeing the benefits of our strategy to develop the business across a broad international base. This international footprint provides resilience for the business at a time when defense spending is under pressure in the U.K. and U.S. In India, we are seeing a steady flow of business from the large Hawk program with Hindustan Aeronautics. In 2011, we booked a further GBP 124 million in Hawk-related business. And with other new business, order intake from India totaled GBP 170 million. We are also bidding on the large Future Infantry Combat Vehicle program through our joint venture with Mahindra & Mahindra and continue to progress the potential sale of M777 artillery. We also benefit from the Mirage 2000 update in India. Our share of the weapons order is valued at GBP 300 million. On the recent announcement in India, which made [ph] Rafale as the lowest-priced compliant bid against Typhoon, we should all recognize that this is just a step in the process and not as yet a contract. We will continue to support the Indian customer and the evaluation process.

In Brazil, the contract for the 3 OPVs was great news and paves the way for further opportunities to be explored for the Brazilian Navy. In Australia, we continue to build on our position as the leading provider of equipment and support to the Australian armed forces, working with the Commonwealth government to deliver against a clearly laid-out, multiyear defense and security plan. The potential sale of Typhoons to Oman continues to make good progress. A formal request for proposals has now been received. This is expected to lead to business valued in excess of GBP 2 billion, with opportunity for further Hawk business on top. Interest in Typhoon is high. In addition to Oman, we have discussions underway in Malaysia, Qatar and the UAE. We also anticipate requirements in Saudi will extend beyond the existing order.

Defense spending remains a high priority in the Kingdom of Saudi Arabia, and we continue to deliver a broad range of capabilities to their armed forces. Our announcement at the start of the year identified the streams of work underway, including the changes to the Salam program. The proposed changes relate to final assembly of the last 48 of the 72 Typhoon aircraft, the creation of a maintenance and upgrade facility in the Kingdom of Saudi Arabia, initial provisioning for subsequent insertion of Tranche 3 capability in respect of the last 24 aircraft and finalization of price escalation. On the core program, budgets have been established for the next 5 years of support. This budget provides for an upgrade of the training environment, including new Hawk aircraft, significant new business. As we reported, good progress on these discussions has been made in the weeks before year end, with budgets now improved in Kingdom on all items other than price escalation. To scale this, we have already booked GBP 1.2 billion of orders following approval of the budgets in Saudi. Negotiations will continue in 2012 on the price escalation. And as we said last year, the correct settlement is key, not the timing of the settlement.

In summary, this is a difficult operating environment, but the focus on cost efficiency and program execution to weather with our international footprint and strong positions in priority segments of the defense aerospace and security markets are contributing to our sustained performance. We have a resilient platform for future growth, but in a rapidly changing environment, agility at all levels of the group is becoming ever more important, whether it be responding quickly to meet urgent operational requirements or to address changes in markets. We will continue to keep our strategy under review, and we'll move to adjust our portfolio of businesses where it is in the interest of shareholders.

Growth in shareholder value remains the unambiguous objective. Our position on capital allocation is clear. Despite the challenging trading environment, we have returned GBP 2.2 billion to shareholders over the last 2 years, as well as maintained the development of the business. I am particularly pleased with the integration and performance of the acquisitions completed in the year.

I'll now turn it over to Pete to take you through the 2011 results and outlook for 2012. We will then take your questions. Pete?

Peter Lynas

Thanks, Ian, and good morning. Today is the first time we've reported under our new segmental structure. And you'll recall, we made these changes for 3 primary reasons: to better align to the group's strategic direction of electronic systems, platforms and services; to give disclosure on how our cyber and intelligence assets are performing; and to improve external alignment of reported performance to the management of the operations. And I'm sure you'll find today's increased disclosure helpful.

There are several material items that affect the numbers, and I'll highlight those as I go through the relevant sectors. And I'm going to cover the 2011 results first, and then move on to guidance for 2012. So firstly, the headline numbers and compared to 2010.

Sales declined by 14% to GBP 19.2 billion, primarily from the volume reductions in Land & Armaments, the impacts of the SDSR on the U.K. business and delay in securing some of the contract changes to the Saudi Typhoon program. Underlying EBITA, reduced by 7%, to GBP 2.025 billion. Underlying earnings per share of 45.6p included 5.9p arising from the previously announced U.K. R&D tax settlement. Excluding that benefit, underlying EPS was almost unchanged. Operating cash flow totaled GBP 634 million and net debt closed at GBP 1.439 billion. Finally, the dividend for the year has been increased to 18.8p per share, up 7.4% on 2010. And at this level, the dividend is covered 2.1x by underlying EPS, excluding the R&D tax benefit.

The 2011 results and their comparison to 2010 have been affected by both M&A and exchange rates. The acquisitions announced towards the end of 2010 were all completed in the first half of 2011. In addition, following the disposal of the Regional Aircraft Asset Management business, the results of Regional Aircraft are now reported as a discontinued operation and prior year numbers restated accordingly. The average U.S. dollar exchange rate for the year was $1.60 compared to $1.55 in 2010. We have appended to the presentation packs adjustments made to produce like-for-like comparisons.

Like-for-like sales reduced by 15% or GBP 3.2 billion, of which GBP 2.2 billion came from the volume reductions in the Land business. The underlying EBITA of GBP 2.025 billion gave return on sales of 10.6%. Underlying finance cost of GBP 199 million were GBP 8 million higher than in 2010, and this included a charge of GBP 28 million for the costs arising from the early debt redemption related to the Regional Aircraft disposal, and most of that cost would've been borne in 2012 and 2013. There was a goodwill impairment charge taken of GBP 94 million, and that relates to the Surface Ships and Land businesses. The underlying tax rate of 26% was 2% lower than previous guidance, and this excludes the benefit arising from the U.K. R&D settlement.

A number of items have impacted the balance sheet in the year. Firstly, the acquisitions made have increased intangible assets. Secondly, the Regional Aircraft asset disposal has reduced the tangible fixed assets. Thirdly, working capital has increased for the consumption of advances on the Salam and European Typhoon Tranche 2 programs, utilization of provisions and for the delay in the expected cash receipts pending completion of the changes to the Salam contract. The reported pension deficit has increased by GBP 1.1 billion. And I'll get to the pension provision on the next 2 slides. Deferred tax assets have increased on the higher pension deficits. Financial assets and liabilities at the beginning of the year contained a carrying value of our holding in Saab, which we sold in the first half. And finally, net debt increased to just over GBP 1.4 billion.

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 year to GBP 18.1 billion. In aggregate, across all the group's pension plans, equity investments now comprise 51% of scheme assets. Over the year, liabilities have increased by GBP 2 billion. The year's discount unwind accounts for GBP 1.1 billion of this increase and a further GBP 0.3 billion arises from changes in assumptions, primarily relating to mortality increases. Real discount rates reduced by the net of lower bond yields and lower inflation assumptions, and this accounts for the rest of that increase. The net impact of all these movements then is an increase to the group's accounting pension deficit of GBP 1.1 billion. So that's the accounting at 31st of December. I'll now turn to the funding valuations, which determine our cash contribution levels and the positions we've now reached on the 2 largest U.K. schemes, the 2000 plan and main scheme, plus 2 of the smaller U.K. schemes.

The chart shows the new funding deficit on those 4 schemes and a comparison to the position we expected in 2008, when the last deficit recovery plans were agreed. Whilst the funding deficit has increased only slightly to some GBP 3 billion, it is GBP 1.1 billion higher than would've been expected 3 years ago, due primarily to the lower discount rates and the resulting increase in liabilities. The company and the schemes' trustees have now reached agreement as to these funding deficits, the sustainment to the remaining 15-year deficit recovery period and the revised funding profiles. And the U.K. pensions regulator has been briefed and we await final acceptance of those agreements. Of the incremental GBP 1.1 billion of funding required, some GBP 130 billion was paid in 2011, around GBP 200 million will be paid over the next 5 years and the remainder, some GBP 800 million, is scheduled over the subsequent 10 years. Total annual deficit funding across all group schemes will be some GBP 400 million in 2012. The agreement reached on the sustainment of our multiyear deficit recovery period and the new schedules for deficit clearance are an equitable outcome. The group's U.K.-defined benefit schemes are all being closed to new entrants.

Turning to cash flow. Cash flow from operating activities totaled GBP 951 million, and this number is stated after pension deficit funding of GBP 375 million. After net capital expenditure of GBP 268 million, dividends received of GBP 88 million and further pension contributions of GBP 137 million made into the trust mechanism, the operating business cash flow totaled GBP 634 million. The cash flow performance of the 5 sectors is shown here, but I'll return to this when I cover the results of each of the sectors. So just one point to note here. The all-out total for pension deficit funding made in 2011 was GBP 512 million. The cash flow at head office you see here contains GBP 266 million of that number.

This next slide sets out the movement in net debt through the year. We started the year with debt of GBP 242 million. Interest, tax and dividends amounted to GBP 1.039 billion. The GBP 500 million share buyback program announced with the interim results was completed in December. We acquired 184 million shares or 5.4% of the issued capital at an average price of GBP 2.73 per share. The acquisitions completed in the first half year, net of the proceeds received on disposals, including our Saab holding and the Regional Aircraft transaction, amounted to GBP 256 million. Exchange translation and all other movements totaled GBP 27 million, closing net debt then at GBP 1.439 billion.

This next chart shows the gross debt, cash and net debt of the group. At the start of the year, borrowings amounted to GBP 3 billion, with cash held at GBP 2.8 billion, giving the reported net debt of GBP 0.2 billion. The total cash outflow for the year was GBP 1.2 billion. Within the year, we repaid debt financing of GBP 1 billion. The blended rate of that debt was 5.5%. New term debt of GBP 0.8 billion was put in place in October and that debt was in 3 tranches over 5, 10 and 30 years at a blended rate of 4.75%. Holdings of low-cost, short-term commercial paper were increased by GBP 0.4 billion. And therefore, at the end of the year, total borrowings had increased to GBP 3.2 billion, cash holdings have been reduced to GBP 1.8 billion and net debt therefore was GBP 1.4 billion.

We expect much of the commercial paper to be redeemed in the short-term. Pension deficit funding will be some GBP 200 million in the first quarter of 2012 and the final dividend for 2011 of GBP 0.4 billion is payable on the 1st of May. We continue to manage the group's balance sheet conservatively to retain our investment-grade credit rating and to ensure operating flexibility in dealing with our working capital volatility. The cash dependency from the Salam contract amendments is a prime example of such volatility.

Our approach to capital allocation is that we will meet our pension obligations, continue to pursue organic investment opportunities that meet financial criteria. We plan to pay dividends in line with the group's policy of long-term sustainable cover of around 2x and return capital to shareholders when the balance sheet allows. Investment in value-enhancing acquisitions will be considered when market conditions are right and where they deliver on the group's strategy. The combination of share buybacks and dividend payments in 2010 and 2011 has been GBP 2.2 billion or around 20% of current market capitalization.

So turning now to the sectors. And I'm going to cover the in-year performance here, and then return to the 2012 outlooks a little later. So to the first of those sectors, Electronic Systems. And the figures shown here are in U.S. dollars. Sales compared to 2010 decreased by 7% or 10% on a like-for-like basis to $4.2 billion, primarily due to the completed F-22 and ATIRCM production contracts, the rescheduled F-35 program and the Johnson City flooding, which resulted in sales of some $100 million being deferred into 2012.

The return on sales achieved at 14.6% was marginally above the very top end of our forecast range. Program execution was strong, with good risk retirements seen on those completing production contracts. The business also delivered in-year benefit from continued cost-reduction actions. Order backlog increased marginally to $5.6 billion despite some delays and disruption in contract awards caused by the continuing resolution, which operated throughout the final quarter of 2011. Cash conversion of EBITA for the year was 69%. Excluding pension deficit funding, that conversion rate was 80%, and that was impacted slightly by the timing of insurance receipts following the Johnson City flood.

The Cyber & Intelligence sector comprises the U.S. Intelligence & Security solutions business together with Detica. The numbers here are again shown in U.S. dollars. In aggregate, sales of $2.2 billion increased by 21% over 2010. Of this growth, 17% came from the acquisitions of L-1, ETI and Norkom. Each of those acquisitions has been accretive to earnings in the year and are on track to meet the performance underpinning their acquisition cases. The margin achieved of 9.7% was after both integration costs of the business acquisitions made and organic investment as we position Detica to have less reliance on government consulting business and towards growth in commercial markets. Cash conversion of EBITA for the year was at 90%. Order backlog increased to $1.7 billion, primarily on the backlog acquired with the acquisition of L-1.

The U.S. Platforms & Services sector aggregates the Land & Armaments and the Support Solutions businesses. The numbers here are again shown in U.S. dollars. And as promised, we want to give appropriate transparency as for the respective performance of the 2 businesses within this sector. So this then slide shows the performance of those 2 businesses. Firstly, addressing Land & Armaments. Sales declined by 38% to $5.7 billion, some 5% short of the guidance that we gave at the interim results presentation. There was an expected reduction arising from the completing FMTV contract and lower level of Bradley reset activity. Most of the shortfall to guidance arose from the delayed start of the Ground Combat Vehicle program following the award protest and the deferred customer funding for Caiman upgrade activity. Both of those programs are now underway. In addition, there was some small impact from business disposals made in the year. Margin at 9.3% was also below guidance. We self-funded the cost of the GCV team during the 3 months of award protest. And as a result of the delayed contract placements for GCV and Caiman upgrades, there was a short-term underrecovery of overheads. Cash conversion of operating profit was at 84% as investment in the U.K. munitions facilities continued through the year.

In the Support Solutions business, sales increased as expected by 5%, including a benefit from last year's Atlantic Marine acquisition. Margin of 8.4% was at the high end of our forecast range and cash conversion was at 91%. Order backlog increased to $5.2 billion, primarily for the 3 multiship, multioption 5-year awards received in the first half year. The $850 million award for the Radford Army Ammunition Plant was finally confirmed in January and is therefore yet to be included within this reported order backlog.

In the Platforms & Services U.K. sector, sales at GBP 6.3 billion reduced compared to 2010 by 4% and was similarly below our last guidance due to the delay in securing certain of the contract amendments on the Salam Typhoon program. The 2011 return on sales of 10.5% included 3 material items: the GBP 125 million benefit from the higher level of rationalization cost recovery agreed in June with the U.K. MOD; the first half charge of GBP 160 million taken on the Oman Offshore Patrol Vessel contract; and a GBP 60 million benefit from the increasing carrying value of the ex-Trinidad and Tobago ships to recognize their value under the resale contract to the Brazilian Navy. As forecasted, there was only a small cash inflow in the year as customer advances were consumed on Typhoon and cash expended on the Oman OPV program.

The 2011 performance of the international business has been materially impacted by the delay in securing the contract amendments to the Salam program and particularly the formalization of price escalation, where applicable trading has been deferred until ongoing negotiations have been concluded. As a result, the year sales of GBP 3.8 billion are 12% lower than in 2010. The absolute year-over-year reduction is primarily on the maturing Tornado upgrade and core support programs and the completed tactical vehicle program. However, EBITA of GBP 449 million is unchanged from the prior year as strong performance in risk reduction was delivered on both the Tornado upgrade and core support programs.

In the absence of the cash payments we had expected from the Salam contract amendments, there has been significant cash utilization on that program. Order book has reduced pending receipt of contracts against the budgets approved in December on the Saudi core program and the Typhoon programs. Now for reference, there is a chart providing a summary of the trading performance of the 5 sectors, along with the numbers for HQ, which are little changed from last year, and that's appended in the presentation packs.

Given the number of moving parts within the year's results compared to 2010's, we've provided this chart to bridge between the 2 years at the earnings per share level. Starting at the left of the chart is last year's earnings per share of 39.8p. From that, the 2 red boxes represent the impacts of the low Land volume and the year-over-year charges taken on the Oman and Trinidad and Tobago ship contracts. The next 3 green boxes show the U.K. rationalization cost recovery benefits, the writeup of the ex-Trinidad and Tobago ships and then all other operational improvements. Then there is the impact of exchange translation and increases from the year's lower tax rate and reduced share base following the 2010 and '11 buyback programs.

So earnings per share then of 39.7p plus the R&D tax settlement, giving a total for the year of 45.6p.

I want to move onto now is the outlook for 2012, which I'll do by sector before giving an overall guidance for the group. And with this new sector reporting structure in place, this final chart seeks to give better granularity as to how we see each sector's performance developing from 2011 through into 2012 within the context of the U.S. and U.K. market conditions that Ian referred to earlier. And given the uncertainties in the market, we feel it appropriate this year to give this additional disclosure.

So firstly, Electronic Systems. Overall, we expect sales volumes in 2012 to be broadly similar to 2011, albeit with a different mix. Some 15% of this business is in the commercial aerospace and hybrid drive markets, where we expect good levels of growth. And the majority of the sales lost in 2011 from the Johnson City flooding should also be recovered. On the defense side, we anticipate a small reduction as operational tempo-driven activity completes. On margins, we would expect the high levels seen in 2011 to return to within our guidance range of 12% to 14%.

Next, Cyber & Intelligence. And here, we continue to plan for growth at around the mid-single-digit mark. And whilst the U.S. business, which was some 80% of this sector in 2011, is expected to have a lower growth rate, the Detica business is planned at a double-digit level, supported by its continued expansion into the commercial markets. Margins in '12 are expected to be within our 8.5% to 9.5% range with further organic investment plan for Detica and the acquired ETI and Norkom businesses.

Moving to Platforms & Services for the U.S. The overall guidance is as shown on the chart, that is with a further reduction in sales but an improvement in margin levels. And the guidance for this sector is best addressed in 2 parts. On Land & Armaments, we now see sales of the $5 billion level rather than the previous $6 billion guidance. Whilst we've seen recent positive customer commitments to Land programs, we do see Land as being the largest bill payer under the U.S. defense cuts, with uncertain levels of forced reductions clearly impacting the business. On specific programs such as GCV, the Joint Light Tactical Vehicle and Caiman upgrades, we have already seen delayed and reduced levels of funding being committed by the customer and we expect that to continue. In giving this further downward revision, we are seeking to provide a top line floor.

And to that end and excluding the more short-term individual protection systems business, some 88% of this sales guidance is currently within our order backlog, therefore giving a limited worst-case downside. Of the remaining 12%, half is from sourceless [ph] procurements, the remainder to be won competitively. As to the margin level, we target delivery close to the 10% mark. Both the award and timing of key programs such as JLTV, underpin the viability of the tactical wheeled vehicle facilities. In the Support Solutions business, we anticipate 2012 sales to be around the 2011 level. Customer scheduled activity in the naval shipyards is lower in '12, but we expect this to be compensated for by new business elsewhere, including from the Radford Ammunition Plant award. And margins in the Support Solutions business are expected to be very slightly lower than in 2011.

Turning to Platforms & Services, U.K. We expect sales in 2012 to be broadly similar to last year's. Under the Salam Typhoon contract, there are now no aircraft deliveries scheduled until 2013, following completion in 2011 of the last 6 of the 24 aircraft that were diverted from the U.K. build program. In the absence of any large events as we saw in 2011 and despite a slightly higher pension service cost arising from those lower discount rates, margins in this sector should be maintained within our 10% to 12% guidance range.

And the last of the sectors, Platforms & Services international. Here we expect sales to show significant growth, well in excess of 25%. Firstly, for the deferred trading arising from the Salam price escalation on which, as Ian said, we would expect to conclude negotiations this year. Secondly, for the higher levels of support to the Typhoon aircraft now in service in Saudi. And finally, for weapon deliveries under the Tornado upgrade program. Timing of those Salam price escalation negotiations will determine the shape of the first half, second half split. And margins are expected to be around the 10% level in this sector.

To complete the 2012 models, headquarters cost are expected to be broadly similar. Finance cost will be lower following the early debt redemption charge that we took in 2011. And the effective tax rate is now expected to be within a 26% to 28% range. Now this is a little higher than the rate in 2011 but below our previous guidance of 30%. So in aggregate, whilst little sales growth can be expected in the current market conditions, modest growth in underlying earnings per share is anticipated, assuming a satisfactory conclusion to the Salam negotiations in 2012 and excluding a benefit to the 2011 research and development tax settlement.

As to cash, a higher level of operating business cash inflow is planned in '12 with the anticipated benefit of the cash payment related to the Salam program. And with that, we will turn it over to questions.

Question-and-Answer Session

Ian G. King

Okay, thanks, Pete. Questions? One on the front there, then there's one in the middle there.

Nick Cunningham

It's Nick Cunningham from Agency Partners. A couple questions following the FY '13 budget that we saw published earlier this week. First one on land systems. I think probably of your $5 billion or so for '12, maybe about $2 billion or so would be actually land platforms or such programs of record. Looking in the details of the FY '13 budget, there's worryingly little money for lots of those programs. So do you think that if your $5 billion is a floor, does that still contain some further downside for those big platforms, if you like, your Bradleys and so on? And then second question, F-35 has been pushed off to the right. What's your picture now of the shape of F-35 ramp-up? Was that already contained in your previous guidance? And sort of where do you see it really inflecting and becoming a really meaningful program in volume terms for you?

Ian G. King

Okay. Well, we'll answer this in 3 parts. One, we'll ask Bob to cover land, what he really thinks of -- well, he's going to respond to your question. On F-35, yes, we had anticipated that, that level of reduction and the level of manufacturing would be consistent for the next few years. Let's just ask Nigel to talk about when do we see it sort of ramping up in their latest plans.

Nigel Whitehead

The plan we have essentially shows a production rate of 35 aircraft per year for the next 4 to 5 years. And that's what [indiscernible]

Ian G. King

Okay, Bob, FY '13. And then we'll just ask Peter after that just to talk about it because our $5 billion isn't just vehicles in the U.S. So perhaps we'll get Peter after that just to talk about the shape of the overall sales.

Robert T. Murphy

Yes. I think when we look at the 2013 question, [indiscernible] we didn't really see anything that was a surprise for a hard right turn. So we feel very comfortable right now that what's in that budget is, as Ian said, consistent with our planning assumptions going forward. So there is -- although you won't see all of it shredded out specifically, there is still Bradley reset activity that will continue going forward. And the other things that are important is if you look at the PIM program will continue. And you'll also see a number of smaller programs at tactical vehicles. So we feel good about where we are in the U.S. pieces of it, and as well -- and you'll also see there's a number of other opportunities in that $5 billion, to Ian's point, that aren't necessarily in the U.S. of that $5 billion. There is an awful lot of good, solid international opportunities as well that continue to mature in the marketplace. So at this juncture, we feel very good about where we are in 2013 and comfortable with what the budget assumptions we saw coming out in 2013.

Ian G. King

So Pete, why don't we just go through what's in the $5 billion?

Peter Lynas

Yes. Nick, I mean, this sort of $5 billion, this isn't just about U.S. vehicle program. If you break the Land business down into its consistent parts, the U.K. is just over $1 billion of that $5 billion, and that's supported by the long-term munition contract and the 777 gun contracts that we have. In Sweden, it's about $0.5 billion, in South Africa, it's $0.5 billion. We have a naval guns business in the U.S. as well, which is another $0.5 billion. So what you then have is sort of about that's half of the business. So the other half, we have what's called an individual protection systems business. This is everything from sort of individual sold as body armor, that's another $0.5 billion. So the core land vehicles program business is $2 billion out of that $5 billion. So just to put it in perspective.

Ian G. King

Okay. There was one -- yes, and then another one in the middle.

Edward Stacey - Espirito Santo Investment Bank, Research Division

It's Ed Stacey from Espiritu Santo. Two questions. Firstly, on Typhoon exports. I think there's 2 customers now for Rafale who are still in a position of having selected Rafale but not wrapped it up. So the UAE, could you comment on whether that one is still sort of a live negotiation and then whether there's a risk with that one and with India that you end up with the pricing becoming an issue, where it's really eroding margins for you if you have to keep sort of chasing contracts, where they've already gone to someone else and you're sort of the playing catch-up in that sense? And then second one on the ship repair business, the outlook being flat for this year. Just whether that was surprising compared to what you've previously expected for the business, whether there's anything that's developed not as you'd expected in ship repair.

Ian G. King

Alan, do you want to talk about UAE?

Alan Garwood

Yes, UAE, we're very much in play. The UAE government have announced that they were not satisfied with the offer they had from Rafale, invited Typhoon in. We are experiencing incredibly high-level activity between HMG, the Royal Air Force and the UAE authorities. I was there last week, and we are planning a campaign now that will go forward over the next few months with big encouragement from Sheikh Mohammed bin Zayed and the people in charge in the UAE, so all to play for there. And we're also very much in play in Oman, as you saw on the slide with His Majesty, the Sultan confirming that we are to proceed with the negotiations. I was there last week as well. We are replying in the next 3 weeks to their RFP and I'd expect negotiations to start almost immediately afterwards on the contract that, as Ian said, we expect to generate over GBP 2 billion order this year. And then we're also in play in Qatar -- Malaysia, which is slightly longer-term. Malaysia is actually evaluating the aircraft this week in the U.K. So there's a lot to go for, an awful lot of aircraft orders there at the moment. And I think we're in a pretty good position.

Ian G. King

In terms of your comment on margins. We are not going to chase the margins down on this business. And we don't see that, that's going to be the game that is played. I mean, we have said for a long time, if you look at our international business, you should assume the margins are going to be the same as we get on our government business. And then ship repair? No, there's nothing that we've seen in ship repair that concerns us. We won all of our recompetes in the year. I think we've gone 100%, didn't we, Linda? So no, it's just the programming of when the customer releases the ships to us.

Celine Fornaro - BofA Merrill Lynch, Research Division

Celine Fornaro, Merrill Lynch. Just wanted to ask, you flagged the H1 results, that we now should look at the order book as a key KPI for the group. So I just wanted to have a quick view on the underlying decline of the order book as the reported seems to be down 7% and how we should think about that in 2012. The second one is more for Pete, maybe on the land systems. So margins are 9.5% this year. Is it something that we should expect for next year as well? Or we go back to the normal trend, around the 10%? And my third question is about Saudi. When you look at all these articles regarding the Indian Typhoon price that could come down, how do they really think about that?

Ian G. King

Pete, take the first 2, and then we'll ask Guy who runs our Saudi business to comment about the action.

Peter Lynas

The first question, Celine, was around order book. I think what I actually said at the interim was that we were focusing on order backlog in the U.S. businesses to get a better sort of enduring view of those businesses. But specifically, yes, you're right, the backlog -- the order book in aggregate for the group has declined. The order book is lumpy. It does depend upon timing of some of the major contracts. To give you an example, if you look at Typhoon Tranche 2, for example, you get a big contract and then you trade that over a number of years. So we're always going to see spiky order book. But the real focus that we're trying to bring out in the interim was around the backlog in the U.S. businesses, which is positive in all 3 at the U.S.-related sectors.

Ian G. King

And it doesn't include the Radford win at this date.

Peter Lynas

Not yet. In terms of land systems and the margin, there was 2 issues that impacted the margin. We were at 9.3% for the year. In the second half, because of the GCV protest, we actually self-funded the GCV team. That cost us sort of 20 basis points on the margin. And then because of the delay in both the Caiman upgrade work not being placed until the start of 2012 and not getting the GCV funding, then that was another 40 basis points, where we basically took a short-term underrecovery of overheads. So we still, for 2012, we're still looking at a 10% target.

Ian G. King

And both of those contracts are now up and running. Guy?

Guy Griffiths

In terms of any impact of the Indian announcement on Saudi pricing for Typhoon, the Typhoon supply into Saudi is conducted under a government-to-government arrangement, which provides an obligation on the U.K. government to provide assurance to the Saudi government that the prices we're charging are fair and reasonable by reference to established benchmarks for the supply of equivalent aircraft to the U.K. RAF. And those mechanisms are robust, they're robustly applied and will continue to apply. And Saudis have indicated that they are content to see the pricing down on the basis of that mechanism. More broadly in terms of any impact of the Indian announcement on the Saudi government's commitment to the platform, then I think it's important to note that in the royal decree that Ian referred to that established further budgets for the Salam program, which His Royal Highness King Abdullah signed just before the end of last year, that provided for some significant budget releases, about GBP 1.5 billion on top of the existing program commitment for a series of enhancements to the program, some of which Ian mentioned in terms of final assembly of the last 48 aircraft, conversion of last 24 to a Tranche 3 standard and for the establishment of the scheduled maintenance and upgrade facility in the Kingdom. Those are all being negotiated at the moment. Their budgets also provided for a series of further enhancements, including weapons fit on the program. The strategic significance, I think, of that royal decree and the budget releases is that it signals very firmly the commitment of Saudi Arabia to establishing Typhoon at the very heart of the Royal Saudi Air Forces' force mix. And it's for that reason and the very real commitment we're seeing on the part of the Saudis to continue to develop and enhance the platform that gives us confidence, as Ian said, that there will be a further order downstream for additional aircraft, Typhoon aircraft, to meet the Saudis' operational requirements. So in summary, I don't see anything in the Indian decision that diminishes Saudi commitment to the Typhoon platform.

Ian G. King

Ben?

Benjamin Fidler - Deutsche Bank AG, Research Division

Ben Fidler from Deutsche. A couple of questions. Firstly, just on capital allocation. It seems that your commentary is consistent with sort of your previous commitment to continuing buybacks. So I wonder if you could help us understand what, and it might be the catalyst for you as a management team to reach a point where you feel you might want to press the go button on thinking about further buybacks. The next question is just around Cyber. A couple of sub questions within that, if I could. Firstly, what was the actual organic growth in the commercial side of the business that we saw in 2011? And secondly, how much longer will this investment phase continue in some of the Detica, Norkom businesses? Because it sounds like that's sort of continuing a bit more than I thought in 2012 as far as the margin is concerned. Is that over in '12?

Ian G. King

No, because we will come up with the next phase of driving for the organic growth in the segment. I mean, what is it the organic growth from the commercial sector?

Peter Lynas

In terms of the, let's call it, the legacy Detica business, we have 37% growth in the commercial part of Detica this year.

Ian G. King

So the growth has been more aggressive than we expected it to be. Our ability to get into that sector has been faster, probably to put it better that way. And we have a number of initiatives going on. So we're not going to stop in terms of investment that we need to put in to grow into that sector. So it won't be over in '12.

Peter Lynas

I'd also add to that, Ben. The shape of the Detica business now is it was 70-30 sort of government-commercial. We're now approaching 50-50. So the focus on commercial is much higher than it's ever been. So I come back to the capital allocation question. In terms of capital allocation, clearly we set out the priorities, the first one is to meet the legal obligations we have on pension, then it's organic growth, long-term sustainable cover at 2x the dividend, buybacks when the dividend allow, and then M&A subject to meeting the criteria and being in line with strategy. In terms of the buyback, you've seen how much cash we have, it's GBP 1.8 billion, we've got 0.8 -- sorry, GBP 1 billion of that earmarked in the next 3 months. And clearly, there is a cash dependency around -- to get in this price escalation sorted on the Salam contract. So in terms of when would we revisit a view on what the balance sheet looks like in terms of cash availability, that's the trigger.

Benjamin Fidler - Deutsche Bank AG, Research Division

Just one follow-up. The earnings guidance obviously excludes anything further on buybacks.

Peter Lynas

Correct.

Ian G. King

Yes, absolutely, absolutely. Okay, one in the middle.

Rupinder S. Vig - Morgan Stanley, Research Division

Rupinder Vig, Morgan Stanley. Two questions, please. Ian, one perhaps for you, on India. Can you just clarify what exactly is the status? Because we've heard from the Rafale team saying they've effectively won. So they're in sole negotiations now. So under what mechanism do you get let back in just so we can be sure in this? And then a question perhaps for Linda on the U.S. side. Are you fully expecting the FY '13 budget to go into a continuing resolution? And is that -- is your guidance based upon that planning assumption? And then kind of a follow-up on that, in terms of the sequester, what's your view on that because it seems that's one area of the budget cuts that are being effectively put to one side, given the election coming up.

Ian G. King

Go on, Linda.

Linda P. Hudson

And Erin, you can help me if I get myself in trouble here. This is a presidential election year, so not a whole lot is going to happen in Congress between now and November. I think it's quite likely that we will have a continuing resolution for a short period of time at the end of this year until the result of the election are known. And then we'll see if a lame-duck Congress can actually get something done. It's happened in the past, but it's not a real high probability. So we will have some uncertainty that will play out through the election and into the 1st of next year, and that's what we have expected. That's the way we planned the business. We've tried to be conservative in our assumptions, recognizing that this is just one of those years that happen every 4 years in the U.S. and things get a bit confused. With regard to sequestration, the general view in Washington is that it is not going to happen as currently envisioned. The Pentagon is not planning for it and Congress is trying desperately to find a way to make it go away. And so we do not have a plan that takes into account another $500 billion to $600 billion worth of cuts beyond the cuts that have already been announced. And our customers are not doing any such planning either. So the general view is it's not going to happen. If by some reason it does happen, Secretary Panetta has said he thinks it will be so short-lived that it will never actually get implemented. So that's the basis upon which we're moving forward now, and it's consistent pretty much with the rest of the industry.

Ian G. King

Okay. Well, I'm going to let Guy answer the question on India because the last time I gave a public response to this, I got myself into a bit of hot water. So he can get himself into hot water this time.

Guy Griffiths

The way the process works is that having been nominated as L1, we would expect now the Indian customer to engage in negotiations with that party. The procedures allow at any time during those negotiations for the Indian customer then to seek to engage with the L2, which is us. And it won't surprise you that in order that we are ready for any such engagement, we are working very closely now with our German Cassidian partners, who are leading this bid, and with the 4 governments, the 4 European partner nation governments in the Typhoon program, to look at options by which we can improve our offer without in any way slashing margins. So that if and when the day comes when the Indian customer decides he's got to a point where he does want to engage the L2, we have something interesting to say to him.

Ian G. King

That is as the process runs. And there are enough examples in the Indian procurement, where the L2 has actually ended up with the contract. Joe?

Joseph F. Campbell - Barclays Capital, Research Division

Joe Campbell from -- I wanted to continue on with India. I mean, I'm certainly nowhere near as knowledgeable as your team about how this goes. But my impression is that the BAE team knows how to sell this stuff around the world and that having Cassidian lead the team and having Germans under French-German EADS is somewhat less than optimal and the results weren't what you wanted. Is there any plan to sort of change the way you behave during the process where you wait for the L2 opportunity? And is there anything that you have learned from the debrief about how they selected the other guy that might cause you to do something a little different in the interim?

Ian G. King

I mean, the answer to all those questions are yes. I mean, we've not had a formal debrief yet, formal, formal, formal debrief. But there are certainly information that we have, which would lead us to believe that we can do something in terms of how we structured our bid. And the U.K. government, you will have seen Prime Minister's public responses to this. He's going to get more front to central. But the one thing that we have to recognize is that there as an L1 and there is an L2. And the L2 is a Cassidian bid, German-led bid. And that has to remain, otherwise then the competition can't work because there aren't 2 bids on the table. So any support has to be done in terms of the structure of the original bid. But I think it will be quite certain that we and the U.K. government will be pushing hard to get our German partners to move forward.

Joseph F. Campbell - Barclays Capital, Research Division

I don't really expect -- it's hard to have a really frank answer. But is it -- I mean, how much of this should we think of as a low-probability brave face? And how much of this should be game-on?

Ian G. King

We've always said that this was a 50-50. And so when everybody was out there running away is this is a shoe-in for Typhoon, we never ever said that. That was always a 50-50. It's a capable aircraft. Typhoon has some aspects of it, which are better. So we have to work hard on this. But we're not giving up. There's a long, long way to go in this process yet before it turns into a contract. And we're going to give it our best shot. But it is a capable aircraft. I don't want anybody to believe that it's not. David, I think?

David H. Perry - Goldman Sachs Group Inc., Research Division

David Perry, Goldman Sachs. Three questions, please. Peter, the first one, just for clarification, the use of cash in 2012, and you've got the GBP 200 million into pension. Maybe I misheard you, I thought you talked about GBP 200 million going in over 5 years. So can you just clarify what exactly is happening now on the pension and if you're referring to this sort of additional top-up over and above your normal funding.

Peter Lynas

The GBP 200 million that I referred to is a top-up on top of where we were before. And that's over a 5-year period. We've been running -- before, resets evaluation have only just been reached to -- we've been running with about GBP 350 million per annum of deficit funding, so this takes -- the agreements we've now reached takes it to about GBP 400 million.

David H. Perry - Goldman Sachs Group Inc., Research Division

Sorry, maybe I misread it. Did you say you had GBP 200 million to put in pension -- on your use of cash?

Peter Lynas

What I said total -- yes, in terms of cash, I said we've got GBP 1.8 billion of cash today as of 31st of December. And what I said was of the funding that we will put in GBP 400 million in 2012, GBP 200 million of that goes into the first quarter.

David H. Perry - Goldman Sachs Group Inc., Research Division

Okay. So your near-term cash utilization is -- why is that relevant to us? I just wondered why you're showing us the GBP 200 million.

Peter Lynas

What I'm showing you is that we have GBP 1.8 billion of cash and GBP 1 billion of that is earmarked already, so we have GBP 800 million of cash if you like that we have to use within the balance sheet.

David H. Perry - Goldman Sachs Group Inc., Research Division

Okay, okay. The second one is, I mean, obviously, the guidance for '12 is predicated on Saudi coming through. Can you just say what possible risks there might be around that? And then my final question is just can you comment on the recent press reports of possibly closing one of the U.K. shipyards, please?

Ian G. King

We've always said in terms of the VOP discussion escalation conductions. It's one of the quantum that we want to get rather than the timing. And so the issue will be timing and how we conclude the negotiation. But we are active in those negotiations. And we will do the right deal. We're not going to do an early deal. In terms of all of the press speculation in the closing of the yard, I'll just remind everybody that when we signed up to the terms of business agreement, which was a 10-year agreement, it talked about making sure that we had the right capabilities in the U.K. to maintain a complex warship capability. What that meant is that coming off a massive high of around carrier, we need to make sure that as we then went into the Type 26 program, we had the right capabilities to deliver. Now we're just getting to that time in carrier, where we have to make decisions relative to the terms of business agreement. And we appointed a company called LEK to help us do some work on looking at what capability is needed to be sustained against the future program as defined by the U.K. government. And that's what we're doing. Sandy, and then Ben again.

Sandy Morris - RBS Research

It's Sandy. This is all getting a little bit granular. I mean, your balance sheet in working capital is always a little bit of a mystery to me. But if I'd looked at the cash flows in the U.K. business, they've probably been GBP 400 million or GBP 500 million better over the last 5 years than I would've thought. And essentially it looks to me like in '11 and '12, they're going to take all that extra cash away, and hence be back on a level playing field. Am I'm barking up the wrong tree?

Peter Lynas

Not quite. I mean, if you look at 2012 in particular in the U.K. businesses, we're dealing with 3 issues on the cash front in Nigel's businesses. The first one is we've got the Oman OPV contract. It's a loss-making contract and we're going to have to fund that contract and get those ships delivered. We've got the rationalization program, we've announced job losses in 2010. In 2011, those rationalization costs will be funded. And we've got advances out there on the European Typhoon Tranche 2 program, which we will utilize through 2012. So we've got those 3 items running through the 2012 cash flow.

Sandy Morris - RBS Research

Right. But it sort of still feels to me like in terms of EBIT cash conversion, we're going to be back to more than a normal balance.

Peter Lynas

Yes.

Sandy Morris - RBS Research

And then $2 billion of core land vehicle program. I know you don't want to go probably into even more detail. But when you go through the U.S. budget and you try and add up the line-by-line items, you don't get to much more than $0.5 billion on hidden [ph], Bradley, FIST or whatever. Is it safe for me to assume that this sort of the other $1.5 billion is kind of spares and service and support or not?

Peter Lynas

I mean, there is a lot of support, that means 50% of the business and then...

Ian G. King

Bob, you've studied this in some detail.

Robert T. Murphy

The assumptions are consistent. Yes, so it's consistent. When you look at the budget, the major programs, there really wasn't anything big expected. And the business is about half of it is spares repair, so you won't see a line for itself. So you won't find that in and of itself on an individual line when you add it up. So we feel pretty comfortable at where we're at for 2013. And I think the risk Linda highlighted around sequestration stuff and as that plays out, that's probably the biggest risk you see in the environment that you'd have that would have an impact if it went forward. But we aren't assuming an impact of sequestration in any of our assumptions right now. But other than that, we feel good where we are in U.S. Land content for 2012 and '13.

Sandy Morris - RBS Research

Actually, I wasn't going to ask this question. But in one of the Senate hearings, the guy was pointing out that if the President's FY '13 budget goes through along with the tax increases he is planning and all the rest of it, the sequester would actually disappear. So Obama is trying to make the thing go away, isn't he?

Robert T. Murphy

Yes, if they can find, what, about $1.2 trillion worth of cuts, that's what they would have to do over the budget is they've got to find -- in order sequestration not to happen, they've got to find that $1.2 trillion in cuts over time for that not to occur. And that's not an insignificant challenge.

Ian G. King

But do we think he's trying to make it go away?

Robert T. Murphy

Yes, absolutely.

Ian G. King

They're trying to finesse it, so it goes away.

Robert T. Murphy

Absolutely.

Sandy Morris - RBS Research

And then just on Saudi. Now that we've got all this extra visibility, like a 5-year rolling plan, I mean, how is that going to change the way we operate? And do we have any other visibility therefore into the way the Saudis now run their defense budget with a view to Bradley coming down the tracks at some point?

Ian G. King

Guy? It would be interesting to see what he says here because we might have to increase his targets for this year.

Guy Griffiths

Well, I'll come to Bradley in just a minute with a bit of help from Bob. But in terms of the 5-year budgets that were approved, that Ian referred to, that were approved in the same royal decree just before Christmas, they provide really for 2 fundamental things. One is for a continuation and extension of the basic support services that we provide at all the air force bases across Saudi Arabia. And across a 5-year period, the decree provided for $12 billion funding in relation to that activity. And on top of that, the decree provided for enhancement of the training environment that Ian referred to in terms of the acquisition of 3 new types of training aircraft, including Hawk, at an allocation budget of USD $3 billion. So we're now in the process of translating all that into formal contractual commitments. And the sales phasing and the cash phasing will be determined as part of those negotiations. In terms of the broader sort of budget visibility, the Kingdom of Saudi Arabia does not put it in the public domain, it's government expenditure, budgets, whether for defense or for other items. In terms of Bradley, specifically, the prospective procurement is being conducted through a formal military sales case between the Saudi and U.S. governments. And at the moment, the operational requirement has been confirmed. What we don't have -- I don't have, anyway, a specific visibility that the budget is being created, although we see a lot of activity on the Saudi side aimed at doing that. But certainly, the discussions that are going on give us confidence, I think, that a letter of requirement is likely to be issued at some point later this year.

Sandy Morris - RBS Research

But you operate the tanks, which is what you're doing now. They should do the Bradleys later then?

Guy Griffiths

Well, the Bradley requirement as they've articulated operationally is both for a new buy, which they would start with, and when they're taking delivery at the new buy, then they'd took to the reset programs for their existing inventory. I think that's right. Bob?

Robert T. Murphy

Yes, that's correct.

Ian G. King

So the answer to your question is yes.

Peter Lynas

Sandy, can I just come back on the cash? It might be more of a help. Simple cash flow model for the group. If the aim is you turn your operating profit of cash, the way we look at it, we sort of say, okay, you got EBITA of about GBP 2 billion. If we can get sort of interest tax in dividends, which comes at GBP 1 billion, GBP 1.1 billion, so that's GBP 0.9 billion. We've got our pension deficit funding now at about GBP 400 million. So the free cash flow for the group is about GBP 0.5 billion in any one year. Do we have to deliver that number in any one year? No, we don't because we've got working capital volatility up and down. But that's the sort of baseline position, which we would look at the business before we then talk about, well, are we using it for advances this year? Are we going to get advances on new programs? But that's the sort of simple model that we would use.

Ian G. King

Ben, we'll come back to you in a minute because we've just got one on the line. Oliver?

Oliver Sleath - Crédit Suisse AG, Research Division

It's Oliver Sleath. Just a quick one -- I'm from Credit Suisse. Just for Linda, on the issue of the sequestration. You said that you don't think that the full sequestration, on the sort of $500 billion to $600 billion additional of cuts is likely to happen. Just in terms of where we are right now, we've seen the first round, if you like, of cuts have come through the $450 billion to $500 billion initial for the Budget Control Act. Do you think it is likely that we'll end up with some level of additional cuts, somewhere between what we've already seen and the full sequestration?

Linda P. Hudson

Yes is the short answer to that. We do expect there will continue to be cut, but -- and in fact, our planning number that we've mentioned in the past was, as we came through this year, we were planning for cuts in the neighborhood of $600 billion to $650 billion. And so we were anticipating a slightly larger cut than what actually materialized. And i think it's likely somewhere in the horsetrading of how all of this gets resolved with sequestration that there will be further cuts. To specific programs, but this idea of a broad-based massive cut across the entire Department of Defense is something that -- I mean, I live in Washington, D.C. and no one to the best of my knowledge really believes that an action like that is going to take place. Of course, we're caught up, as you well know, and the Democrats have a plan that does it, but it involves raising taxes. The Republicans have a plan that does it and it involves taking more cuts to social programs. And somewhere in between there's going to be a solution someday, and hopefully it's sooner rather than later. And the likelihood that, that could have some further impact, I think, is a realistic set of expectations. But we don't expect and I don't know anyone that expects anything like a $500 billion to $600 billion further impact on day one on January of next year. So as has been said several times, we planned conservatively. This is not an environment where you get overly bullish about what's going to happen, and it's more difficult to get programs affected because of the sensitivities around earmarks. So I think we're making the right kinds of assumptions and being very prudent about how we look at our programs and staying focused on delivering and performing on our programs so that they don't get caught up in trouble category. And I think that's where you're going to start to see more programs terminated.

Ian G. King

Okay. Ben? And then there's somebody in again.

Benjamin Fidler - Deutsche Bank AG, Research Division

It's a follow-up on Saudi, which Guy has kind of partially answered but I wonder if we could maybe try and dig down a bit deeper. It's just this training environment contract, noncontract. But to try and understand what's really in that for you. So you talked about $3 billion earmarked for that over 3 aircraft types. What did you see as potentially on the table for you guys? And when do you see that progressing to the contract?

Ian G. King

They're looking to place it in a prime contract structure so that where we would be looked to, it would be to procure all 3 aircraft types, including the simulators, including the facilities and training the people to operate the system.

Benjamin Fidler - Deutsche Bank AG, Research Division

So all that value goes to you. And when might we be looking at progress on that?

Ian G. King

Well, I think they'll start placing contracts in '12 against an agreed forward plan.

Celine Fornaro - BofA Merrill Lynch, Research Division

Okay. Just a follow-on question on the Platform Solution business. If you could just give us a bit more color on the performance in 2011. I mean, it's supposed to grow next year -- in '12, sorry. But I expected the business did have significant growth in '11 as well, given the...

Ian G. King

Well, the floods, remember?

Celine Fornaro - BofA Merrill Lynch, Research Division

But excluding -- okay, right.

Peter Lynas

If you put aside the impacts of the flood, the business grew pretty well. It was almost double-digits in terms of the commercial aerospace side of it.

Celine Fornaro - BofA Merrill Lynch, Research Division

Double digits [indiscernible] just on a business level, again excluding the flood?

Ian G. King

Yes, the business is very robust, performed very well and the customers have stuck through us through all of the flood. And what are Boeing going to do, Linda?

Linda P. Hudson

Boeing has informed us that our Johnson City operations, which is where Platform Solutions was located as a standalone entity has been selected as their supplier of the year, and largely because of the way they recovered from the flood and got back up online delivering products, so we're very pleased with that.

Ian G. King

If you've ever sort ask us about what our disaster recovery plans were, then we can give you a chapter and verse that they worked with respect to that. It tested every element of our plans, I can assure you.

Celine Fornaro - BofA Merrill Lynch, Research Division

[indiscernible] setting the business?

Ian G. King

Yes. It's integrated into the business. It's part of our Electronics Systems business under Tom Arseneault. It's fully integrated into our business. We are going to go organically drive that business really hard. There's a question over there.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Steven Cahall from Royal Bank of Canada. You talked a little bit about the services in U.S. and I think the O&M account is one of the few bright spots in the FY '13 request increasing by 5%. But there is equally a lot in the FY '13 request about how services, margins are under pressure, and that looks to be the most aggressive part of the DOD's cost take-out strategy. So firstly, can you give us a little color on how you're looking at services margins in 2012 in the U.S.? And then also how much of your 2012 services are going to be recompetes versus contracts you're already on with a fairly stable flow-through?

Ian G. King

Well, next, Larry, you're on.

Lawrence B. Prior

Thank you, Ian. We expect the margins, as Peter said, would be to the lower end of the range because it's a big investment year for us. So as we won Radford on top of what we do with Holston, there is a ramp-up that we're going to be undertaking. We have a very rich pipeline. Our book-to-bill last year was 1.3. So as we go forward, it's equally rich this next year and grew our qualified pipeline 30% year-to-year. So for us, using a bit of that margin to invest in that growth, both in capturing business as well as ramping up as we win some of it is going to stress that margin a little bit, but helps fuel the organic growth that we contribute to the group.

Linda P. Hudson

[indiscernible] and the pressure on margins, if you will.

Lawrence B. Prior

So what we've seen is when you look at the budget in FY '13, everyone expects that you're going to see O&M always be the front-end cuts in a lot of the budget pressure. We think we're in some very solid segments where we've got a very competitive position and are very able to defend ourselves and guard that profitability.

Ian G. King

Have we got many recompetes ourselves coming up in...

Lawrence B. Prior

I mean, if you think of last year in terms of just percentages, the fact that we won all of our multiship contracts, took care of the lion's share of the recompetes that we were facing. So as we're going forward, we're aggressively going after other people's recompetes. And it's a year for us to try and get out there and take our market share.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Do you have a split of what your recompete is? What percentage of the services business is recompeted in '12?

Lawrence B. Prior

It's less than 30%. I think for us a lot of our contracts are 5 years. So your normal cycle is about 20% of your business each year is recompeted. We had a big year last year so it will be less than that this year.

Ian G. King

And we won them all last year.

Lawrence B. Prior

Yes, we did. And we also obviously had big takeaways with Radford. And I'd like to point out with our joint venture with Winchester with U.S. Munitions, we're going after Lake City as well. We love Winchester.

Ian G. King

Okay, are we done? Okay, thank you very much. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: BAE Systems plc's CEO Discusses 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts