Well, good morning, everybody, and welcome to our twenty seventeen preliminary results meeting. There's absolutely no doubt that 2017 was a successful year. And I think most importantly, a year in which the leadership baton was smoothly and efficiently passed over to Charles as Chief Executive of the group. Now following Charles' appointment, management changes were also made to ensure our structure was simplified and aligned with the demands of business today. These changes acknowledge the increasing requirement for in country production by our customers, the need to continuously hone our competitive edge in all markets and the emphasis that must be placed on efficient execution of a very strong order book.
And I'm confident that these changes will bear fruit in the areas of improved cost control, swifter decision making and greater innovation. As we enter 2018, a substantial order book will, however, not shield the company from a year when the rhythm of customer delivery schedules make our ambitions for sales and profit performance a little more challenging than usual. But I am very pleased to say nonetheless that management has committed to address these short term headwinds and deliver an earnings performance in 2018 that is in keeping with 2017 whilst also maintaining a strong focus on cash performance. This will be an important building block in the return to improved growth in profits and cash as the natural flow of orders and production and delivery is restored in 2019 and beyond. For my part as Chairman, I've been really pleased to witness the company's ability to manage a structural and leadership change in a period of general world turbulence.
It has been made clear to me by customers, shareholders and employees that all have valued the preservation of seasoned executive experience with the introduction of fresh thinking and renewed energy in the management team at this time of geopolitical turbulence. Now this has also been true in the nonexecutive area with the appointment of Revathi Hadvathi to our boardroom, a woman with strong international a very strong international pedigree, relevant engineering and digital skills, first class credentials and really good senior operational experience at both Honeywell and the Eaton Corporation. She's been a great addition to the boardroom, and we just spent two days together, and already great added value. So, so far so good, but the defense market is becoming more competitive and customers continue to be demanding, both at home and abroad. Relationships are, as always, very key, as is reputation.
And in this context, it is pleasing that a very close liaison in The UK and The USA, plus regular visits to both The Gulf and Australia by Charles and I, continue to ensure we are well received at the highest levels of government right across the globe. And that this will be particularly important in 2018 in the pursuit of major business opportunities in land, sea and air that are currently under negotiation. The year ahead, therefore, remains demanding, both in delivering the order book we have and building an even stronger order backlog for the long term future of the business. The management is clear on their mission and under Charles' leadership remain enthusiastic and focused on achieving their objectives. I'll now hand over to Charles and to Peter to look more closely at our performance in 2017 and examine in a little more detail the prospects for the year ahead.
Charles?
Thank you, Sir Roger, and good morning to everyone here in the room and those joining us via webcast. Today, we've announced a good set of results consistent with our earnings expectations for the year and a particularly strong cash performance, in part flattered by some $400,000,000 of timing benefits. Looking back over the past eight months, I'm pleased to say that we've made strong progress in delivering for our customers, securing new business and advancing our strategy. Overall, operational performance was strong. We achieved significant milestones in delivering all eight Hawk aircraft and eight of 12 Typhoons to the Sultanate Of Oman, ramped F-thirty five production up to 80 sets in line with targets to reach full rate production and commenced production on the Type 26 program.
However, in Applied Intelligence, performance was disappointing. We have changed management, restructured the business and taken a goodwill write down reflecting lower growth assumptions. On the balance sheet, reaching clarity and a largely unchanged pension funding position in November was a significant milestone and derisked future cash flows. Order intake of just over £20,000,000,000 meant our large order backlog was sustained, and that's before booking the Qatar order, ensuring good visibility of future sales. Before Pete takes you through the detailed financial results and guidance for 2018, I wanted to start with a brief recap of our strategy and priorities for the year ahead and the actions taken since we last met in August.
After a brief overview of the markets, I'll give a medium term outlook for our key programs and franchises. As usual, we'll take your questions at the end of the presentation. As outlined at the half year results, our strategy remains largely unchanged and is underpinned by a disciplined capital allocation policy. Within the strategy, I set out in August three priority areas to grow and win new business in a fast moving and increasingly competitive market environment. They are as follows: operational excellence, improving our competitive edge and advancing our technology base.
Over the past eight months, we have taken decisive action to improve performance in each of these three key focus areas: Firstly, operational excellence. Our highly skilled workforce is delivering some of the world's most challenging and complex engineering programs. In 2017, we saw a higher tempo of activity across many of our businesses. Manufacturing got underway on the Type 26 and Dreadnought submarine program, and The U. S.
Business continued its ramp to rate in combat vehicles and a number of electronic systems products. In Saudi Arabia, we achieved the key milestone of commencing HAWK aircraft final assembly in Kingdom as part of our ongoing industrialization strategy. As we move into 2018, we need to maintain the drumbeat on U. K. Maritime programs, continue the production ramp in electronic systems and U.
S. Combat vehicles and drive improved performance from our Applied Intelligence business. Where required, management changes have been made to strengthen and underpin our performance. Maintaining focus on delivering to our customers is the best way to highlight our skills and capabilities and therefore, win new business. Secondly, competitiveness.
This is crucial if we're to secure new opportunities and address customer affordability challenges. In 2017, we commenced restructuring actions in military air, maritime services and applied intelligence. These difficult but necessary actions will maintain critical capabilities and enhance our competitive position in securing anticipated new orders. Additionally, the streamlined organizational structure in place since January 1 has been designed to drive focus and performance in each of the three key priority areas. Importantly, we are also starting to see the benefits of increasing collaboration across the group, pursuing new business such as the Land 400 and C5000 programs in Australia, in sharing best practice and in developing and exploiting innovative new technologies.
The procurement transformation being led by Chief Procurement Officer, Paul Smith, is a great example of collaboration in action whilst also improving our competitiveness. For 2018, we need to drive efficiencies across a number of supply chain categories and implement a more strategic approach to managing our suppliers and our design, engineering structure and work now underway in the CTO organization to enhance collaboration are all important steps in 2018 to making us more competitive. Thirdly, technological innovation. Technology is a key driver of competitive advantage and increasingly a critical determinant for our customers in awarding new business. In 2017, we increased self funded R and D by 15%, expanded our partnerships with academia and appointed Nigel Whitehead into the position of Chief Technology Officer.
Nigel and his team will create will target value creation through greater focus, collaboration and innovation in technology across the entire enterprise. There will be more external collaboration opportunities, and we will refine technology plans to underpin our business and product strategies whilst also continuing to appropriately self fund R and D in support of our core franchises. So the strategy and strategic actions are in place and being rolled out across the business. We have a firm foundation, and whilst there is much to do, we are well placed. Moving on to our new organization structure and outlook in key markets.
The new structure is an important step in achieving the strategic objectives as we look to become a stronger company, match fit for the opportunities and challenges ahead. The new air sector, led by Chris Boardman, brings together our combined expertise in military aviation across The U. K, Saudi Arabia, Australia and other international programs to harness our capabilities more effectively for both existing and potential customers around the world. The Maritime sector contains our long term U. K.
Contracted programs in submarine and shipbuilding. These are critical programs for The U. K, and this sector now reports directly to me with an absolute focus on program execution. The U. S.
Sectors continue unchanged after Gerry and the Inc. Team streamlined and reorganized a few years back. So a brief take on market outlook. The U. S.
Business has become skilled at managing through periods of continuing resolution with minimal impact. The Bipartisan Budget Agreement passed in early February would increase the 2018 U. S. Defense budget by approximately 10% over current levels. The agreement increases the budget caps for two years whilst extending the continuing resolution into March to allow time for an omnibus appropriations bill to be passed.
Our U. S.-based businesses continue to plan conservatively and remain well aligned with customer priorities and growth areas, and we see continued support for increases in defense spending as demonstrated by the President's recently released 2019 budget request. In The U. K, defense and security remains a priority for the government. We expect this to be reaffirmed in the ongoing capability reviews.
Our U. K. Business, of course, is centered around our long term contracted positions in Air and Maritime. We continue to execute on these while working with our customers to address their affordability challenges. In our international markets, defense and security remains high on national agendas with a number of countries responding to an increasingly uncertain security environment.
Whilst Pete will outline 2018 guidance in a few minutes, given the market conditions I've just outlined, I wanted to give you more color on the strength and medium term outlook for our key franchises and contracted programs. Electronic Systems has a very broad, well placed technology driven portfolio. Growth will be generated across the portfolio from F-thirty five ramp up and F-fifteen upgrade programs as well as from increased activity in the classified domain. Our APKWS product is also seeing significant demand. Our Investor Day in May will focus on the strength and breadth of our electronic systems franchises.
U. S. Platforms and Services is set to deliver growth from all three of its businesses. Combat Vehicles production is set to double in the next three years, underpinned by our secured positions on the M109, the armored multipurpose vehicle and the Bradley vehicle franchise. The business is also pursuing a number of export opportunities, and an award decision on The U.
S. Amphibious combat vehicle is expected later in the year. Ship repair had a good year of order intake and is expected to benefit from demand requirements and The U. S. Naval budget outlook.
Through the additional capacity added by the new drydock facility in San Diego and our positions across our U. S. Shipyards, we are well placed to compete for future work. Our Weapon Systems business is executing on a number of key orders in our naval guns franchise. Indian M777 production is ramping up, and there is a good drumbeat of work through our Holston and Radford munition facilities.
The air sector comprises a number of different program dynamics as is shown on this slide. The main points to note. As previously flagged, Typhoon and Hawk production were reduced in 2018. Typhoon is then expected to stabilize based on the current order book and anticipated finalization of the Qatar order. We continue to pursue further export opportunities, which, if secured, would drive growth back into this highly capable platform as we move into the next decade.
Typhoon support, already generating more revenue than production, is expected to grow as further aircraft are delivered into service. On the F-thirty five, we are seeing a continued ramp in production over the next three years, and securing a global support position remains a key priority. Having won initial work packages in The U. K. And Australia, we continue to work on long term support positions with our industrial partners and customers.
The final point I would draw out is that our MBDA joint venture has again grown its order book to stand at nearly €17,000,000,000 This supports good sales growth in the medium term. The Maritime sector is underpinned by our long term positions on Astute and Dreadnought and on the Type 26 frigate program. Whilst The U. K. Maritime budgets are under pressure, these contracted programs give us stability and visibility.
In The U. K, we have teamed with Camel Laird for their bid on The U. K. MOD's proposed Type 31E general purpose frigate program. Beyond these U.
K. Programs, we've submitted our tender response to the nine ship Australian C5000 future frigate program, and we have teamed with Lockheed Martin Canada to provide the Type 26 design into their bid for the Canadian surface combatant. Now turning to Cyber. The U. S.
Intelligence and Security business is well run with a high tempo of bid activity. The business is a mix of shorter cycle contracts in what is a highly competitive market. Reflecting the poor operational performance and goodwill impairment, our U. K.-based Applied Intelligence business has been reorganized to focus on a targeted portfolio of products, services and markets that will accelerate improvements in our competitiveness and profitability while still targeting top line growth. So to conclude, we have reaffirmed our strategy and highlighted three priorities in order to maximize performance in the near and medium term and secure further opportunities.
The balance sheet remains strong following the pension funding agreement, which de risked future cash flows, and our capital allocation remains clear, consistent and disciplined. 2018 is a transition year for earnings underpinned by continuing cash generation. The business is well placed from its contracted programs and long standing franchise positions to deliver growth in the medium term. I will now hand over to Pete to run through the year's financials and guidance for 2018. Over to you, Pete.
Good morning, everybody. Thanks, Charles. I'd say today's results are technically more challenging than to present than usual given the impacts we've got from exchange movements, U. S. Tax reform, our new sector reporting structure and changes from the new IFRS accounting standard.
So before I step through the detail, I'd like to draw out some key points. And firstly, in terms of 2017, underlying earnings per share was up 8%, and that's towards the higher end of our guidance range. And the in year loss that Charles referred to at Applied Intelligence was matched by good performance across the rest of the group. Cash performance has been strong, and that's even stripping out the £400,000,000 of timing benefit that we had in the year. Our strong order backlog was maintained on a like for like basis, and that's without yet having booked the Qatar Typhoon contract.
The dividend was growing for the fourteenth consecutive year with earnings cover sustained. And as previously announced, we've materially de risked future free cash flow through a sensible outcome on The U. K. Tri annual pension valuations. And looking into 2018, despite the significant headwind from the lower Typhoon and Hawk production activity and after the IFRS 15 restatement, earnings are expected to be in line with the 2017 performance.
And at the earnings level, the headwind from U. Dollar translation is broadly matched by a lower effective tax rate benefiting from The U. S. Tax reform measures. And other than our U.
S. Services businesses, growth is projected to be strong. We do see the Applied Intelligence business moving back to breakeven as the rationalization programs that we announced in 2017 deliver to the bottom line. And finally, in terms of free cash flow generation, we see around £2,000,000,000 being delivered across 2017 in aggregate, and that's ahead of consensus. So those are the key messages, and I'm now going to move on to the detailed results for 2017 and then the guidance for 2018.
That guidance is in our new sector structure and is prepared under the new IFRS 15 accounting standard. There's been some volatility in exchange rates in the year. And for reference, the dollar rate averaged at $1.29 in 2017 and was $1.35 in 2016. So the headline numbers and compared to 2016. Sales increased by $600,000,000 to 19,600,000,000.0 and the majority of that is being due to currency translation.
Underlying earnings before interest, tax and amortization increased by £129,000,000 to 2,034,000,000.000 Growth on a constant currency basis was at 4%. Underlying finance costs in the year decreased marginally to £245,000,000 Underlying earnings per share were at 43.5p, and that's up 8% over 2016. There was an operating cash inflow of £1,800,000,000 and net debt at the end of the year closed ahead of our guidance at £800,000,000 Order backlog at the end of the year was at £41,200,000,000 and that is unchanged against the previous year on a constant currency basis. As I mentioned, the dividend for the year has been increased to 21.8p per share. That's up 2% on 2016.
And at that level, the dividend is covered twice by underlying earnings per share. In addition to the impacts from exchange translation on the balance sheet, where the U. S. Dollar closed at $1.35 compared to the opening $1.24 there were a number of items that impacted the closing balance sheet. We have taken an impairment charge of £384,000,000 against the goodwill carrying value on the Applied Intelligence business, prudently reflecting the future level and timing of expected returns from that business.
As planned, capital investment was made in support of the production ramp up in our U. S. Electronic Systems and Combat Vehicles businesses. Within working capital, there are some items of note. Firstly, as anticipated, the remainder of the advances received in 2012 on the Omani Typhoon and Hawk order as well as European Typhoon production are almost all now consumed.
On the Saudi support contract renewals, some £300,000,000 of cash was received in 2017, representing advanced funding to be utilized in 2018 and 2019. Costs have been incurred against provisions created in previous years as The U. S. Commercial shipbuilding programs are closed out. And the final working capital point is that around £100,000,000 of VAT payments rolled from December into 2018.
In aggregate, working capital has decreased by some £200,000,000 The group share of the IAS nineteen accounting pension deficit has fallen over the year to £3,900,000,000 and that lower pension deficit also drives the reduced deferred tax asset. And whilst the reduction in U. S. Corporation tax has had no impact on the 2017 underlying earnings, it has also reduced the deferred tax asset by £67,000,000 So I'm now going to move on to the pension deficit position and the clarity achieved through last November's funding agreements. So firstly, a look at the accounting deficit.
I think we're running ahead on the slides, so we want to move back one. Thank you. There are a number of moving parts here, which I'll touch on, but the combined impact of them all is a £2,200,000,000 increase sorry, decrease in the group share of the pretax deficit. The value of the scheme assets has increased over the year to £27,000,000,000 and that's after pension payments paid out of some £1,300,000,000 and an adverse exchange translation impact of £400,000,000 The return on assets in the year was at 9%. At the end of the year, reported liabilities had fallen by 1,300,000,000 to £31,200,000,000 Real discount rates in The U.
K. Were unchanged over the year, and a 50 basis points adverse movement in The U. S. Gave a £300,000,000 increase in reported liabilities. A significant liability reduction of almost £1,000,000,000 has come from the increased mortality assumptions as we adopt both the latest actuarial tables and scheme specific changes based on membership experience.
Reported liabilities have also fallen by £05,000,000,000 due to exchange translation. So overall, a net £2,200,000,000 reduction in the accounting deficit. As we've always stated, it is the funding deficit which really counts and is of economic importance to the company. So we thought it would be useful to illustrate the key differences between the reported accounting number and the agreed U. K.
Funding position. This chart highlights how the reported U. K. Accounting deficit represents a very material overstatement when compared to our agreed funding obligations. It is a complicated chart, so let me step you through it.
To the left of the chart, in the first column, is the accounting deficit. And of that, pounds 3,700,000,000.0 relates to The U. K. Schemes. To the right of the chart, in the last column, is the £2,100,000,000 U.
K. Funding deficit. So in terms of the two columns in the middle, Column two adds back the benefits of the latest actuarial mortality tables. Those tables that benefit was included in the accounting number but was not recognized in the more prudently assessed funding deficit. Column three simply aligns the asset values between the year end accounting date and the April 2017 funding valuation date.
As you can then see, there is a £3,000,000,000 difference and that arises from the use of different discount rates applied to the scheme liabilities. Whilst the accounting uses a AA corporate bond rate, the funding now uses a blended rate of the prudent asset returns that we assume. That blended asset return rate is 3.3%, which is just 70 basis points higher than the accounting discount rate. Moving on to cash. This slide sets out the movement from our net debt position of £1,542,000,000 at the beginning of the year.
The operating business cash flow of £1,752,000,000 was clearly ahead of guidance. Receipts of some £300,000,000 were received in the year, representing advanced funding on the Saudi support contract, and there was also £106,000,000 of VAT payments that rolled from 2017 into 2018. Interest and tax payments were $4.00 £8,000,000 Payment of twenty sixteen's final and twenty seventeen's interim dividend totaled £684,000,000 Exchange translation and all other movements were £130,000,000 So we closed the year with gross debt of £4,000,000,000 cash of £3,200,000,000 and net debt of £800,000,000 And we do have a $1,000,000,000 bond maturing in mid-twenty nineteen, and that will be repaid from cash held. The cash flow performance of the five secondtors 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 2017 was £271,000,000 and the head office number shown on the chart contains £133,000,000 of that.
Okay. I'll move now on to the sectors. I'll cover the in year performance here and the outlook for 2018 a little later. And the first of those sectors is Electronic Systems, and the numbers here are in U. S.
Dollars. Sales compared to 2016 were up 5% at $4,685,000,000 The growth came in the electronic warfare business from the F-thirty five induced programs as well as an increasing volume of classified activity. Sales of the APKWS product almost doubled over the year and now represent one of the top five sales lines in this sector. Return on sales achieved at 15.5% exceeded our guidance range, largely from continued strong program execution and risk retirement. As expected, cash conversion of EBITDA for the full year was at 85%, excluding pension deficit funding.
Order backlog was at a record high of $7,300,000,000 following further awards for F-thirty five systems, classified EW activity and APKWS product. The Cyber Intelligence sector comprises the U. S. Intelligence and Security business together with BA Systems Applied Intelligence, and the numbers here again in dollars. In aggregate and slightly below guidance, sales were marginally lower at $2,346,000,000 The U.
S. Business saw a 4% decrease, largely in the highly competitive area of IT support services to the Intel community. Growth in the Applied Intelligence business was at 6%, benefiting from increases in the U. K. Government and international government service divisions.
The aggregate margin for the sector was just 2.9%. Margins in The U. S. Business were similar to last year at 8.8%. However, in Applied Intelligence, the total loss for the year was £61,000,000 and that includes a £24,000,000 restructuring charge.
The first half loss of £27,000,000 was reduced to a second half operating loss of £10,000,000 as the cost reduction actions under that restructuring program start to deliver bottom line benefit. Cash conversion of EBITDA for the year was in excess of 100% and order backlog reduced marginally in The U. S. To $2,900,000,000 Moving to The U. S.
Platforms and Services sector and the numbers again in dollars. Sales in the year were slightly behind guidance, down by 3% to $3,800,000,000 as deliveries of land vehicles to Brazil and Japan slipped into the 2018. However, in line with guidance, the business has delivered an improved margin of 8.3%. Charges taken in the year on the commercial shipbuilding programs amounted to $16,000,000 or 40 basis points, with just one contract now remaining for completion. As expected, cash conversion of EBITDA was significantly improved despite the impact from the use of provisions on those commercial ship programs.
Order backlog was increased to $6,300,000,000 supportive of future growth expectations. Key awards in the year included the $05,000,000,000 engine order for M777 Ultra lightweight howitzers, around 400,000,000 pounds for Paladin production and a total of $1,300,000,000 in the ship repair business. In The U. K. Platforms and Services sector, the year sales of £7,700,000,000 were only marginally lower than 2016, slightly ahead of our guidance.
Activity levels on the submarine programs were ahead of plan. In line with that guidance, return on sales was at 10.3%. Cash performance was better than expected with an inflow of £427,000,000 However, that does include the temporary £106,000,000 benefit relating to VAT. As I mentioned earlier, consumption of customer advances on the Omani, Saudi and European Typhoon contracts has now largely completed. As expected, order backlog reduced to £16,800,000,000 The £5,000,000,000 order received from Qatar in December for 24 Typhoon aircraft and support has not yet been taken into the backlog pending completion of the financing package, which we expect in the coming months.
Sales in the international sector of £4,100,000,000 were 5% up over 2016. With all 72 Salaam Typhoon aircraft now in service, we have seen high levels of support. And in addition, we've seen expected ramp up coming from MBDA's strong order backlog. EBITDA of £472,000,000 and return on sales of 11.4% was slightly ahead of expectations, reflecting improving performance from our KSA partner companies and stronger performance from MBVA. Operating cash flow was at £671,000,000 although £300,000,000 of that was for the advanced payment on the Saudi support program.
Order backlog was marginally higher at £13,300,000,000 as further order intake was booked under the renewal of the five year support contracts in Saudi Arabia and Qatari naval orders became effective within MBDA. And for reference, there is a chart providing a summary of the trading performance of all five sectors along with the headquarters numbers appended to your presentation, Pax. Okay. Let's move to guidance. And this next chart seeks to give guidance as to how we see the performance of each sector developing from 2017 through to 2018.
But just before I go through that, I'd just like to say that the 2017 performance on this chart has been recut to our new sector structure. And in addition, the numbers have been restated under the new IFRS 15 accounting standard. As we said in November's WebEx, IFRS will impact the way that we account for revenue. On the majority of our longer term contracts, revenue is recognized earlier as we incur costs rather than on performance milestones or deliveries. And as you can see from the chart, that has had a material impact on the reported sales numbers for 2017.
But on those long term contracts, profit will continue to be recognized progressively based on risk mitigation and retirement. On the shorter term contracts, mainly in our U. S. Businesses, there will be some acceleration of both revenue and profit recognition. So as expected, whilst reported 2017 sales under IFRS have reduced by around £1,000,000,000 the impact on earnings per share is just 1.4p.
And I'd stress now that the IFRS 15 will not change the way in which we manage our contracts nor does it change the lifetime contract profitability nor our cash flows. And we have included full reconciliations on both the new sectors and the IFRS 15 restatement in your PACS. And for reference before we get into the guidance, our exchange rate planning assumption for the U. S. Dollar now is at $1.4 and a sensitivity to a $0.10 movement in the U.
S. Dollar is now approximately 1.5p of earnings per share. So looking at the individual sectors and firstly, Electronic Systems. Overall, we expect 2018 sales in dollar terms to show high single digit growth, driven by a number of electronic warfare contracts. And in aggregate, to twenty eighteen's projected sales, some 70% are in the 2017 closing order backlog, and that's similar to last year's starting point.
And on margins, we've changed our guidance to an improved 14% to 16% range. Next, Cyber Intelligence. In an aggregate, we expect the sales to be marginally higher in 2018. The U. S.
Business, which was 70% of this sector last year, is expected to be largely unchanged. In the Applied Intelligence business, we expect to see some top line growth, again coming from The U. K. And International Government Services divisions. The margin in 2018 is expected to improve to around 5%.
The U. S. Business is again expected to contribute around the 8% mark. And whilst Applied Intelligence should move to a breakeven position for the full year, benefiting from the changes made to rationalize the business, this will be second half biased. Moving to Platforms and Services in The U.
S. And here, expect sales growth to be double digit with increasing volumes from The U. S. Combat Vehicles and Weapon Systems businesses as well as higher ship repair activity. Of this sales guidance, almost 75% is already within backlog.
And at the margin level, we expect another year of improvement moving up into a 9% to 10% range. Moving on to Air. And as we've previously flagged, sales are expected to be some 5% lower as production activity on Typhoon for the European, Saudi and Oman contracts is largely complete. Around 80% of that guidance is within closing backlog. And margins in the sector are expected to be within an 11% to 13% range.
And the last of the sectors, Maritime. Here, we expect sales to be stable as activity levels on Carrier reduce but are largely offset by increases on the submarine programs. Around 90% of this guidance is already covered by backlog. And of note, only some 5% of the sector sales come from short term service and support contracts. Margin levels are expected to be similar to those in 2017, within an 8% to 9% range.
And to complete your models, headquarter costs will be similar to those in 2017. Underlying finance costs are expected to be around 15% lower, benefiting from the weaker dollar in which most of the group's interest cost is borne, reduced charges within our equity accounted investments and lower net present value charges. The effective tax rate is expected to reduce from 21% to around 18%, benefiting from The U. S. Tax reform changes.
And the final number there is, of course, dependent upon the geographic mix of profits. And so with the assumption of $1 point at 1.4 we expect the group's 2018 underlying earnings per share to be in line with our 2017 performance as we stated under IFRS 15. This final chart highlights our cash utilization. In the left hand column are the numbers for 2017 and to the right are those for 2018 that we expect. In respect of operating cash flow, firstly, we expect capital expenditure to be marginally above depreciation levels, reflecting continued investment for expanded production facilities in Electronic Systems and The U.
S. Combat Vehicles business. There will also be some spend against provisions created in previous years. As previously indicated, we expect that our historic working capital volatility will be greatly reduced as export customer advances have now been largely utilized. However, in 2018, the £300,000,000 of accelerated receipts will be utilized and the temporary VAT benefit will reverse.
And these flow through both advances and other working capital movements lines on this chart. The final operating cash flow item is the year's pension deficit funding, which we know will be around £300,000,000 The non operating cash flow items are predictable. Outflows for interest and tax are again expected to total around £400,000,000 and dividends to shareholders around 700,000,000 So in aggregate, 2018 is expected to see net debt broadly unchanged. Looking across 2017 and 2018, the group therefore expects to have generated circa £2,000,000,000 of free cash flow, of which around £1,400,000,000 would flow to shareholders in dividends. And with that, I'll pass it back to Charles.
Thanks, Pete. In summary, a good year for the company, delivering sales and earnings growth and strong cash generation while implementing steps to build a firm foundation to deliver medium term growth and a stronger, smarter and sharper business. Looking ahead, we remain focused on delivering our order book, driving our three and driving our three key strategic priorities. This will enable us to generate long term growth and shareholder value. Pete and I will now take your questions.
Thank you.
You very much. Good morning. Christian Laughlin from Bernstein.
Good morning, Christian.
A couple of questions from me, basically centered on aircraft sales campaigns and ground vehicle opportunities, particularly in the export markets. So starting with aircraft, as we start to see potentially some order inflow for additional Typhoons, What are sort of the markers we need to see or the sort of or the milestones with respect to timing that would impact production rates? That is to say, I mean, obviously, with roughly like a two year lead time, we could see some orders come in over the next twelve or eighteen months, but they don't really change the pace of production. Conversely, I guess you can see a flood of orders come in and then you decide to take rates up in about two years or so. So if you could just kind of sort of outline how that works, that would be great.
And then secondly, with respect to ground vehicles, particularly in Middle Eastern export markets, you've discussed before ongoing sales campaigns, particularly with Saudi Arabia for M109s and some Bradley work. Essentially, those activities were somewhat reduced while the U. S. Congress had a ban on equipment sales into that market, but that ban was recently lifted. So could you talk a little bit about how that has changed or not changed the pace of discussions around those campaigns?
Just before I mean, I'll let Charles talk about opportunity on export programs. But just to be clear on Typhoon, we are now at a level in terms of our 2018 guidance where Typhoon production is less than 5,000,000,000 pounds So I know we've had and we clearly stated back in six months ago when we sat here that we were expecting to see sort of £8.900000000 pounds headwind from Typhoon. That's where we are. But it is now less than 3% of the group sales. Support revenues on Typhoon are three times that volume.
So we are moving through. In terms of the question is when would we start trading? One of the issues with IFRS 15 is you don't have to make deliveries before you start trading sales now. It is about when you incur cost on those programs. So as you get those programs in, you'll see some top line coming through, albeit it will be at a very, very low margin because we're still holding on to the fact that we only trade profit or margin on contracts as and when we retire risk.
So you'll see some sales go up. You might see a dilution in terms of margin percentage, but that's just the way IFRS 15 takes you.
Okay. That part, I understand. But my question is mainly more on the physical industrial process of thinking about Typhoon production capacity under various order scenarios. But that was helpful.
Okay. I mean in terms of capacity, if you remember, the original Typhoon production line was set to take 60 a year. We're clearly nowhere near that. I don't think we ever got to 60. I think the most we ever got to is in the 40s, but the capacity is there.
I think it's fair to say that I think you've already concluded that in terms of the opportunity pipeline, in terms of campaigns in Europe and in The Middle East, I think the opportunity pipeline is as good as we've seen it. And I think it certainly encourages us that we'll see growth coming into the next decade in Typhoon production. And you've got to reflect the fact that the platform now with the Centurion upgrades that are going into the RAF, it is at it's the most capable that it's ever been. And I think we'll continue to see further export success. On the combat vehicles, I think, Gerry, would you mind would you want to just say a couple of words on that since you're here?
So Jerry runs our Inc. Business, just to introduce him.
Good morning. With respect to Middle Eastern campaigns, you mentioned the M109, the self propelled howitzer We do have two pending opportunities in The Kingdom Of Saudi Arabia. The congressional hold that was put on sales to Saudi Arabia by Senator Corker, you'll recall, was just lifted recently. So we're just now beginning to reengage with the Congress and State Department on clearance of that.
I would expect that we will probably have to renew discussions with the Saudis about in country content mix and how we're going to deliver that. So that will that is just initiated, but the dialogue has begun. So it take a little while to sort through that, but still very valid requirements.
Rob Staller from Vertical. Maybe a follow-up for Jerry as well, the FY 'nineteen budget request that came out the other day. Was wondering if you could highlight how BA is fed. I know it's just a request, but how it looks at this preliminary stage in terms of your various programs there and what the revenue growth implications could be for the company down the line? And then secondly, maybe one for Pete.
On Qatar, you said that you'd close it at some point in the next six months or so. Have you included any potential impact for cash flow from this closing in your guidance?
Well, I'll answer the second one quickly. The answer is no, we haven't. Gerry, I hope that you've got more extended answers than I have on the first question.
In both the FY 2018 and FY 2019 budgets that have been approved by the authorizers in Congress, we see strong growth potential in really three or four areas. The first one is combat vehicles plus up across the Army brigade combat team and an opportunity to increase production on those vehicles, think about the M88, the Paladin, the self propelled howitzer, the AMPV and the Bradley. All of those will increase by about 50%. So right now in our plan, we're looking at roughly over the next two to three years, roughly depending on when this money finally gets obligated and put on contract, doubling the production volume through our U. S.
Combat vehicle business. You could see roughly another 50% increase from those budgets. So that's one area. Ship repair, you could see maybe about a 10% increase. We're anticipating that with greater stability in the budget, the Navy will be able to extend its repair and modernization times on each of the ship.
We're also seeing strength in electronic warfare as both Charles and Pete had alluded to and an acceleration of some programs. F-thirty five even gets plus up a little bit or at least the production has extended a little bit further out in The U. S. But one area that we mentioned, Charles talked about the APKWS. It's really across a number of our precision weapon systems and initiatives that we have there.
APKWS, we have a couple of other classified programs where we're providing guidance, things like the Seeker on the THAAD. So a host of artillery programs where we're now putting guidance into artillery and the hypervelocity projectile is being accelerated. So in the precision weapons area, ship repair, combat vehicles, we see an opportunity for plus side. As to when that would flow into revenues and earnings, you're probably eighteen months after contract order, you'll really see something noticeable, if that makes sense.
Okay. Maybe on this side here. Halfway down.
Jeremy Bragg from Redburn. I've got two questions, please. Firstly, on cash conversion. You've been very clear as to why cash conversion was strong in 2018 and why it will soften a bit in sorry, strong in 2017 and soften a bit in 2018 But what's the right number in terms of free cash flow to net income conversion?
I mean simplistically, CapEx a bit higher than depreciation, your tax is a bit lower than the P and L charge and you pay 300,000,000 into the pension, give or take. So if you're doing £1,000,000,000 of net income,
you should be
doing 1,200,000,000.0 roughly of free cash flow.
Before dividend, yes, absolutely.
Before dividend, absolutely. So that kind of implies this is my math, so that's like 85% conversion ratio. But if I sum the two years, 2017 and 2018, looks like you're guiding for about 75%, I. E, pounds 2,000,000,000 of cash on £2,800,000,000 of net income. So my question is sorry, it's very long winded.
When do we get to this 85%? And is that the right number? Or is it higher, please?
I mean the piece you're missing is what we said in the guidance this time When we said that 2017, we would see the end of the utilization of advanced payments on those European and Saudi and Omani Typhoon production programs. We're through that. So what you're actually seeing is probably outperformance compared to what we expected. When we looked at if you look at 2018 and what we're guiding today of net debt unchanged, that's giving a total over the two years of debt reduction of about £600,000,000 So yes, we're not at the 85% and your math is pretty good, as you would expect.
But we're getting through that, and 2017 was the last year of using up those advances. So as we move into 2018, 2019 and beyond, your model absolutely holds.
Okay. And then on organic growth, it looks like it's slightly negative this year. I haven't done the detailed math, obviously, because of Typhoon and Hawk. But can you give a comment on 2019 and 2020, please? Clearly, you don't want give guidance on 2019, but just some sort of commitment that you're happy with organic revenue growth in 2019 and 2020, please?
Yes. I think in what we're saying in 2017 is fairly flat. Again, Typhoon production was a big step down. And as we go into 2018, we've got another step down from that 1,300,000,000 pounds typhoon production down to that 500,000,000 that I talked about earlier on. So that's where you're getting the headwind from.
If you look at the guidance we put up on that chart, clearly, we're guiding for growth elsewhere in the business. And then if you look at the charts that Charles put out there, where we're looking at those long term programs and franchises, there are not many arrows going downwards. They're nearly all pointing upwards. So we're pretty confident.
Yes, medium term growth.
You.
Maybe
the guy with the injury.
Just on The U. S. Businesses, you've taken margin guidance up on each of Electronic Systems and The U. S. Platforms businesses.
I appreciate that there's a mix of stuff going on there. But to the extent you're able to characterize it, is that broadly driven by mix? Is it the current budget situation giving you maybe better visibility and better ability to plan? Or is it the feeling that you can go after a bit more of the shorter cycle stuff that's coming through, which maybe gives you a bit more short term margin upside?
A bit of all of those, but I mean if I take the two divisions separately. I mean Electronic Systems, if you look back over the last three years, we've delivered a 15% return on sales in each of the last three years. They have performed well. They continue to perform well. Program execution is strong.
They are getting the benefits of volume coming through, 5% growth last year, another 5% that we're sort of sorry, high single digit we're projecting for 2018. So it's volume and it is program execution in Electronic Systems.
Yes, some operational leverage of growing
the top line
quicker than the cost base.
And in Platforms and Services in The U. S, we're almost through those commercial shipbuild programs. So I talked about there's a 40 basis point hit in 2017 for the $16,000,000 charge. We're not anticipating any more charges in on those programs. And again, with the scale coming through, that gives us confidence to move that margin rate up from a 9% to 10%.
And sometimes we get questions about why is it down at 9% to 10%. You do need to remember that there's about $1200000000.01300000000.0 dollars of ship repair business going through there, and that is not double digit business and nor will it ever be.
That's a very competitive market. Maybe halfway down on the right.
And then Nicky's asking for your question there.
Rami Myerson from Investec. First question would be on a strategic review, Chelsea. You've now completed your first year CEO. And usually, early in the tenure, it provides a good opportunity to do a review of the portfolio, to decide which businesses belong in the portfolio, which businesses can be managed better outside of the portfolio potentially and where you think you need to strengthen. So it doesn't feel like you may be doing that, but if you could just talk a little bit about where you are there, things like vertical integration of your supply chain and digitization.
And the second question is around The U. K. Medium term, which you've alluded to. But how do you reconcile a supportive ten year equipment plan, which is supposed to grow over the next ten years, combined with that pretty supportive political backing on the one hand. On the other hand, U.
K. Revenues for your business don't appear to be growing over the next few years. And when do you expect the growth to recover? And maybe just a small technical question for Pete. Are the margins that you've provided for Air and Maritime representative of the margins that you think that business can do over the medium term?
Well,
terms of the strategic review, I mean, I've outlined the three areas. I think there's a lot of legs left to run on the three areas that I've focused on in as much as we've made some structural changes, but just embedding them in the way that we run the business. So for example, on the Chief Technology Officer organization, I mean, that's an organization that's really designed to look at technology at the enterprise level, and there is a lot to be
done
there. Technology bolt ons, the way we run it, increases in self funded R and D. I think these are all things that I think we have the opportunity to do more and do better at this. And I think there is a lot that we can do down that front. So I'd say that whilst these are early days, I mean, those three themes, I think you will see a lot more to be done on each of those three themes as we go forward.
On the second one, can
you just repeat the second one?
Well, supply chain, I think, was another one. Just
around the portfolio. Yes.
I mean we take a good hard look at the portfolio through the Board reviews and the strategic reviews that we do. And that's really one of those things you would not be surprised to see that we have a good hard look. I do in the short term, I do believe that we've mentioned already in terms of technology bolt ons that there are a number of opportunities that we could and should be looking at there to strengthen our technology portfolio. Supply chain? Yes.
I mean in terms of supply chain, we spend around GBP 8,500,000,000.0 a year across the group. And I think, as you know, and Charles mentioned, we hired Paul Smith as Chief Procurement Officer. We've also hired a new Head of Procurement in The U. K, three global category managers. And really, they will be the chief organs of supply chain management going forward.
In terms of global categories, we're looking at IT, raw materials, machining fabs, electronics. We're targeting now deflationary pricing. We're upgrading IT tools around spend analytics, and we're looking to consolidate the vendor base. All of that is good. It makes us more affordable, more competitive.
More likely to win export opportunities, all of these things. I think it's fair to say that what we see is more opportunities at the enterprise level that we've had a number of we're a portfolio of relatively discrete, well run businesses, and there's more we can get out of the enterprise level, be it through either supply chain, the technology piece of it, the way that we run and manage the business and get more out of this enterprise level. And so far, we've identified through supply chain and others a rich seam of opportunities there that we'll continue to exploit for a number of years.
And there was one other question on the margins in terms of the guidance for Air and Maritime. I mean, yes, we would see those as stable margins going forward. I mean our planning assumption is U. K. Business is stable.
We're not expecting it's not like The U. S, which it will be the growth engine and international opportunities. U. K. Is stable.
I mean U. K. Is committed to 2% GDP. You take a view on the economy and where it is, but I think it's probably a relatively prudent set of assumptions to assume a stable outlook for The U. K.
In the near term here.
Nick. Yes.
Nick Cunningham, Agency Partners. Coming back to the portfolio question and looking at cyber and intel, where it seems to have been a bit of a struggle to try and commercialize that business in The U. K. Is there something wrong there? It's not going to work?
Or is it just it's a technology startup that burns cash for a long time? And is there a cultural problem with having that inside a big corporate like BAE? Could you spin it out? Is the technology separable from BAE that it could go into a spinout and so
on? I think so just to contain, in a sense, the challenge somewhat. I mean the business is about 3% of our total revenue. So not insignificant, but it's not massive. But within that 3%, I think most people in the room recognize that there are three parts of that business.
And the bit that has been causing us some challenges is the commercial piece, which is about onethree of that total business. Meantime, the work that we do for the national security, both here and abroad, has been performing actually pretty well within that business. We certainly see an opportunity in the commercial space to grow that business and to take some of our capabilities and make sure that as that business sort of there is an opportunity for a flight to quality where customers are looking for not just sort of a minimally compliant solution, but who is really the best at doing that. And I think that, that transition and I spoke about that a little bit at the half year, but I think that transition will happen as some of these cyber breaches and the challenges associated with them become more and more costly for customers and the challenges become more obvious. We want to be there when that space opens up.
You are right. This is kind of a growth mentality that you're competing with a lot of start ups who are going for growth and so on and so forth. And that does provide some challenges in the space. I think it's fair to say that in our, in a sense, push for top line growth, we, in some cases, got ahead of ourselves in terms of pushing for opportunities, sales opportunities in various countries. So we've pulled back from that a little bit to basically put this on a sustainable footing to get it on to a better than breakeven position for 2018, and I'm confident that we can do that and demonstrate that we will be there with a quality product when our customers need it.
So just to follow-up on that. Part of the thrust of the question was value realization from that. Is that best if it's retained in BAE and it becomes profitable and cash generative? Or is the scope to spin it, perhaps float it or sell it to somebody else or whatever, who would pay for what that future represents,
if you like? I mean our priority now is to get the business on a sound footing, being able to, in a sense, wash its face with its own financials and make sure that it generates a reasonable return for the business. And we will exchange some top line ambition for in order to do that and put it on a sustainable footing, and that is our priority at this point.
Jamie?
Thanks. Jamie Robotham from Deutsche. Three from me. The first kind of follows on from Jeremy's question about the outlook for free cash. So when we're thinking about the outlook beyond the run rate of whatever it is, 1,000,000,000, 1,100,000,000.0 per annum in 2017, 2018, clearly, don't know what FX is going to be putting that to one side.
And without a typhoon headwind, the outlook for growth potential in profit seems good, driven by The U. S. Businesses. If we thought about other things that could boost the profit growth, it looked like the debt refinancing in 2019 might provide a boost to net income. I don't know if you can give us some numbers around that.
And then as we then think about cash conversion, I hear what you're saying on the pure play advances. I just wondered if there was anything else on the bridge that might boost the cash conversion CapEx, for example, where I hear you're spending still a fair bit in Electronic Systems and P and S U. S. Is the scope for that to come down to the benefit of cash conversion a bit further out? Second one is a slightly dull one for which I apologize on IFRS 15, but the £1,100,000,000 lower revs in 2017, I think it is mainly in the new Air division.
I think that's due more to more performance obligations than milestones met in previous years, but perhaps you could just clarify that and explain which the main contracts are that are sort of causing that? And then finally,
Charles,
you mentioned good visibility on future sales. And Pete, I just wondered, when you look at 2018 having delivered the sort of £41,000,000,000 order book in 2017. Is it possible to give a steer on how much of this year's revs are already contracted or in the bag, if you like? Thanks.
Mean the last one is in excess of 70%. So I think I mentioned that already in my presentation. Yes. Fact, it's
just shy of 70 It's five just shy of 80% in terms of order cover for 2018 sales. Okay. First question was the bond. Yes, we have a $1,000,000,000 U. Bond which matures in mid-twenty nineteen.
I think the coupon on that is north of 6%. So we will be repaying that out of existing cash holdings, including we're getting nothing like that in terms of return on cash. So that you can work that one out. That's worth $0 of earnings in sort of in the full year for 2020 and zero five of that in 2019. You asked about CapEx.
I mean the CapEx we're spending at the moment in excess of depreciation is largely in The U. In support of ramp up for combat vehicles and electronic systems. Yes, we will burn through that. We'll get through that largely in 2018. There'll be some in 2018, but largely in 2018.
And then the IFRS 15 question. If I take you back to the WebEx we had in November, we did say that the cumulative impact of IFRS 15 was going to be to drag back $3,700,000,000 of sales, which is effectively the amount of work in progress that we had in the balance sheet. And that drag back occurs in a number of years. And probably the best way to illustrate that is on the Typhoon Oman contract. So we got that contract at the 2012.
We've been building up WIC through 2013, 2014, 2015, 2016, and we delivered aircraft in 2017. So what's been happening through this IFRS 15 restatement, all the sales that we took on deliveries on those aircraft in 2017 all get pushed back to prior years when we were spending that incurring the cost and spending the cash. So we're pulling sales into prior years. The margin, however, which is why you see a 13.3% margin, I think it was for the sector as restated, it doesn't change the margin performance on that program. So you get a lot of profit coming through when we make the deliveries because the risk of being retired, but almost no sales because all the sales have been taken earlier.
This is IFRS 15. I'm not a fan, as you can tell. Think that was was that all your question?
Morning. Selin Fornaro from UBS. I've got two questions, if I may. The first one would be for Charles. So you mentioned a lot the word competitiveness, and you said that competitiveness comes from R and D, I guess, and efficient costs.
But you haven't really said what you're looking in terms of order and the potential order intake, particularly in The U. S. Divisions or when you see those efforts paying out? My second question would be for Pete. If I look at the Air division, now I appreciate the IFRS 15 dynamics, but fundamentally, it's becoming more and more a support or international business.
So why are we not getting more towards the high end of that range of that division? And when could you have a higher margin range?
I think competitiveness is more of a general comment that there are opportunities that we can exploit at the enterprise level, be it through procurement, technology, so on and so forth, to do more and offer a more competitive product to our customers, which has to help us in export markets and here in The U. K. And in The U. S. I mean there's no question that defense budgets, whilst they might be growing, customers want to do more with less, and we need to be shown to be able to respond to that.
And I think that there are, as we've already seen in the last twelve months, some substantial opportunities for us to do that. And I think we're all taxpayers here in the room and want to make sure that our budgets are being used in the most efficient way possible. And we are finding some a number of opportunities. So these businesses, I've said already, they're well run businesses, but there is a layer at the enterprise that we've not exploited before that we'll continue to push hard. And I think that will then offer better value to our customers and position us better in competitive situations where cost is always a factor in a lot of our bid situations.
On the air question, I think when you look at the margins between production and support, they're not that different in any of our businesses. And if you look within the air sector, for example, now is Saudi support business. The Saudi customer, as you know, with the Saudi contracts are government to government contracts. We execute those contracts on behalf of the U. K.
Government. The pricing that the Saudis get is very similar to The U. K. Pricing. The U.
K. Pricing is driven by social procurement regulations. So there is no big differential between production and support margins. It's very consistent. You will not see big swings in mix between whether we're in production or whether we're in support phases.
It doesn't work like that.
Halfway down
on the right for me or left for you.
Thank you. It's David Perry at JPMorgan. I've got three. I think one is probably for Pete and two for Charles. Pete, just on the Eurofighter production comment, the comment that it's stable post 2018.
As I understand it, Oman drops to zero in 2019. U. K. And Europe deliveries fall a lot. I know they're low value.
There's a little bit of Q8 comes in. But net net, it's a big drop. And even notwithstanding percentage of completion accounting, I don't see how it's stable unless you have in your business plan a new order. So if you could comment on that or if I've just got it wrong, which I may have. And the two for the CEO, please.
The U. K, I mean, you said it looks like a stable outlook. But from what I read in the newspapers, frankly, it could be anything. It strikes me there may be downside risk potentially. So I just wonder if you could talk about this flexibility in your system in the workforce, your planning for certain eventualities that may come out of this defense review.
And then the second one, please, Charles. Interesting times in the global defense sector because it strikes me we're seeing more M and A and quite substantial M and A than we've seen for about twenty years. GD is doing a big deal. Northrop is doing a big deal. Talis is doing a big deal.
BAE doesn't look to have a lot of flexibility. We've talked about the cash flow in previous questions. There isn't a lot left after the dividend. I just wonder how you feel about the risk of BAE perhaps being a little bit left behind in this latest round of consolidation.
You want to do the first one first?
Yes. In terms of Typhoon production, as I said, we're down at sub-five £100,000,000 in terms of volume. But under IFRS 15, it is no longer linked to milestone performance or deliveries. So in our plan, obviously, we've still got Kuwait going through. We've got some European final acceptance activity still going through.
We do assume Qatar in the plan. We have a contract. As I said earlier on, we're waiting for the finance package to be agreed, and then we have that contract. And because from the day you start the contract and start incurring costs, we will be recognizing revenue. We don't wait under IFRS 15 now on revenue for milestones or production deliveries.
So it is a change to the model, Vegas.
Just But I mean, Qatar is 2022.
No, it's not. It's not. When deliveries, David. That's what I'm trying to say. You need to get off deliveries and think about when are we actually doing activity under a contract.
We can take you through it, but you've got to get off that trading on deliveries. That model doesn't work anymore.
Okay. We'll do that one offline.
In terms of U. K, I mean, as you know, there's a defense and security review split into two, security and the defense modernization program. We'll await the outcome of that, but I think The U. K. Is still very much committed to the 2% number.
You're aware that in The U. K, most of the in fact, I mean, 95% of our revenues are on these long term programs, which does give us good visibility, mindful of the affordability challenges, and we've got to make every effort to make sure that we are offering best value to our customer here because that's exactly what they expect of us. So I think our planning assumptions based around that still stand. I think for M and A, I think we've made clear before that we do see opportunities for bolt on small technology additions to the portfolio, And those are the kind of things for the CTO organization that we're going to be pursuing.
Sandy or Barry?
Sandy. Go
ahead, Sandy.
Morning. 23 questions, if I may. Just swiftly, what did you say about provisions in the second half? I thought I heard the word mentioned that they went up quite a bit in the second half just on the balance sheet peak.
Provisions in the second half?
Yes.
Yes. Mean there's two things. One is we took the restructuring charge in AI. I mentioned we took another $16,000,000 on The U. S.
Ship repair programs. And obviously, we took some provisioning in respect of the announcements we made on reorganization back in November. So no one big item. It's a collection.
Okay. And they what sorry, where do they go through? Under
They go through the P and L. Yes. And then the underlying, absolutely. We don't keep those out separate. And then you'll see and what I said on the cash guidance, you'll see the cash then go out through 2018.
Something did well in the second half, didn't it?
Yes.
And then a slightly tedious question because I can't see anything in the cash flow. When Riyadh Wings buys into our operation in Saudi, should I expect to see any payment in the cash flow?
If and when we do that, Sandy, then the answer is yes.
I thought they bought a wee bit.
They bought 4%.
And it's so small that, that doesn't even show up?
It's lost in the roundings when you get to the 0.1s of billions,
Okay. That's not what I expected. Never mind. And then last thing, and this is just back to ship repair. Real bump up in orders in the second half.
And actually, 2018 has not been a slow either. And there is this I heard what Gerry said about 10% more, but there's this argument that the public shipyards this is Rand, not me the public shipyards and I would get full up with work. So much more work comes available to third party yards like yourself. That is the theory that actually ship repair could step up quite a bit. And the pace of contracts already this year has been pretty quick, Yes.
And that's been
You're right, Sandy. And when you looked at the guidance for 'eighteen, you were talking about a 10% to 15% growth rate for that P and S U. S. Business. That's where the ship repair business sits.
We had £1,300,000,000 of orders in that division last year, and that compared to £1,000,000,000 of sales in the division. So absolutely, the order backlog is building nicely.
I mean the services part of the portfolio, as you're aware, mean, is one of the things that sees the benefit of any increased spending quicker anywhere else because you can deploy the additional spending quickly.
Olivier Brochet with Credit Suisse. I will have two questions, please. The first one on F-thirty five and the shift from LRIP to full rate production. Should we expect a change in the margin profile for the group on this program due to that shift? And the second question is, you mentioned MBDA quite a number of times in your prepared remarks.
Can you give us a bit more granularity about what it represents today in terms of contribution to cash and earnings and what it could be in 2020, for instance?
On JSO, I first, we're not expecting a significant change in margin as a result of the step up.
Margins remain double digit. We're not expecting any significant movement from moving to full rate production.
MBDA?
I mean MBDA, it is seeing significant growth. It's not that long ago. Was about a €2,800,000,000 business. It's looking to move to a €4,000,000,000 business over a four- to five year window, and it's seeing good margin growth. It's a double digit margin business and performing very well.
And sales growth will grow in line with increasing backlog. And you saw the orders that we booked during the year. We're very proud owners of that business.
And the cash?
Yes. The cash comes with the orders and then delivery. So it's a nice business to own.
Harry? Harry Breach, Raymond James. I promise, no questions about IFRS 15, Pete. Sorry to But one I want to pick up from one of Dave's questions and another one slightly differently. The pickup from Dave's question is thinking about The UK and the MOD sort of behaviorally at the moment, are we seeing contract awards happen on the pace you'd expect or at least no further behind schedule than normal?
So our contract issuance, is it happening on the pace you'd expect? Are we starting to see lags and delays as due to the uncertainty connected with the review? And then completely differently, much more on program level, it's absolutely not lost on me, Charlie, that you have dreadnought reporting into you directly. Clearly, build design complexity on SSBNs is high. They haven't been manufactured for some decades.
Astute was challenging. Can you help us to think about sort of milestone achievement on that? And particularly, when are we over the highest risk phases with Dreadnought sort of in
I think we I mean it's fair to say that we got, in a sense, on contract with a number of big programs over the last few months. And so we are not seeing any real change in contracting rhythm from The U. K. MOD, it would be fair to say. I don't think
No, mean, you're right. I mean we booked Type 26, so we have the first three ships manufacturing. We've got a stew. We do have to just do the final pricing on Boat seven, but the work has been running for some time. And Dreadnought, we're funded, will require further funding later in the year, but there's no delays.
I mean these are big programs with big, in a sense, marching armies behind them. And we've seen a steady drumbeat of contracting activities as you'd expect with them.
That's a very meaningful delay. No. And then on Dreadnought, the sort of key when do we get key risks retired on that and when?
I mean, as you're aware, it's a very big program, a very complicated program. And we're still at quite early days of transition to build. We did cut steel last year on this. And I think we're I mean, it's first in class, as you're well aware, is always the toughest build of any ship build or boat build. And we're at early days on that.
But I think it's also fair to say it's getting, as you would expect, a very high level of attention both from me and the rest of the exec team to make sure that we deliver well and effectively on this program. And Harry, from
a risk perspective, a financial risk perspective, this is an ascertained cost contract, So this is not a firm fixed price. We're not running those sorts of risk, if that was behind the question.
Sorry, Gacy. What was CCIS?
So I didn't hear the
So it's ascertained cost, so it's cost reimbursement plus fee.
Cost reimbursement. Okay. Thank you.
Charles Armitage, Citi. Political question. You've got a new Minister of Defense who may want to become PM. You've got a Chancellor of the Exchequer who may want to become PM. Can you you mentioned the 2% of GDP.
When Hammond was in defense, he put on, what was it, 0.5% real increase in the modernization budget. Can you just sort of talk through the different dynamics of whether the MOD wants to increase spending outside of modernization and hence modernization gets pushed? How do you see that? Is that 0.5% inviolate or not?
Frankly, I think it would be premature to try and speculate, and it would be speculation given the ongoing reviews that we await with interest the outcomes of. And until we hear something different, we continue to work on the prior planning assumptions, noting that I think the Defense Secretary has said on a number of occasions that he would like to see something that is not spending neutral, is better than that. Frankly, And over and above that would be pure speculation.
Okay. No further questions?
Question on the line we have.
Tristan
Sanson of Exane. Please go ahead. Yes. Good morning, everyone. So it's Tristan Sanson from Exane.
Had two questions. The first one, I wanted to follow-up on the answer you made to David about the fact that you need to think in about the declaration of revenue recognition versus deliveries on some large contracts. So if we're a bit optimistic and we assume that this year you may win 400, E5000 DSCSC in Canada and the ACV in The U. S, if you get these four key contracts, could we see revenue recognition fast enough to get, let's say, single digit organic growth as soon as 2020 level? Am I looking at it the wrong way?
And the second question is I wanted to know if you could give us an outlook for the evolution of self funded R and D going forward.
I think it's fair to say that we never plan on winning everything. That would be a great problem to deal with, but we don't plan on winning everything. I don't know if you want to comment any more on that. So more than that would be real speculation, I think.
It would be. I'll just stress again, and I'm starting to sound like a broken record. Even if we got more revenue, that's not going to change earnings because we will only take risk we will only take profit when we retire risk on programs. So even if we get some top line, and so it looks like organic growth, You need to be focused on the earnings now more than you used to. You can discount sales more than you used to.
Sales is vanity, profit is sanity and cash is king. So focus on the earnings and the cash.
What was the second point?
The second point was around the outlook for R and D.
I think, as you're aware, a large piece of our R and D is, in a sense, customer funded, and that just depends on where we are with programs, what part of the program is developmental items within programs. So that, frankly, will have its ups and downs. But in terms of the self funded part of the R and D, the ambition that we have for the technology organization that we're creating is that we then create a framework to allow us to efficiently or more efficiently deploy self funded R and D programs within the group and to, over time, increase R and D funding. I'm not prepared to sort of give numbers around that. Think a fair bit of it depends on the opportunities that Nigel and the team are able to put together in the context of bolt ons as well and bring to the Board.
But I'm certainly, in a sense, committed to present these opportunities to the Board. And I think done convincingly and with the right organization behind it, we can make a good case, a good investment case to increase self funded R and D.
Any more questions on the line? No more questions? Thank you very much.
Thank you very much.