Thank you very much and good morning everyone. Thank you for joining this BA Systems WebEx. Today on the call, have Peter Linus, Group Finance Director Peter Earl, Director of Financial Control and Reporting and the Investor Relations team of myself, Martin Cooper and Sage Lions. By way of housekeeping, there's a slide presentation on the website, which we shall run through and the slides will be interactive on the WebEx. I will now hand over to Pete.
Thanks, Martin, and good morning, everybody. We're going to cover three things on this call. Firstly, The U. K. Pensions, triennial valuation and funding, which we agreed yesterday.
And then as we trailed in our October trading update, we're going to talk about the reporting sector changes and the move to adopt accounting standard IFRS 15, both of which will be implemented from 2018. Just to be clear, won't be talking about trading today as we have nothing to add to our October trading update. I am going to cover pensions and the sector changes and I am going to hand over to Peter Earl to run through IFRS 15 and we will then have plenty of time for your questions. So, let's get straight to the pensions. As you will have seen, we are pleased to have reached agreements with each of the pension trustee boards and that's been done in consultation with the U.
K. Pensions regulator on all of our U. K. Defined benefit schemes. And whilst targeting to get this done by year end, I think reaching agreement in half the time allowed statutory to do so is a good result for all stakeholders.
So just to pick out the key points from the agreements, UK deficit funding will increase in 2018 by £15,000,000 a year up to £220,000,000 per annum and with a deficit of £2,100,000,000 broadly similar to that at the last funding valuation. In addition, funding will also increase in line with percentage growth in future dividends. In arriving at that deficit number, an asset led discount approach has been used and there are contingency plans in place should the funding fall below modeled funding levels. We believe our return assumptions to be prudent and they are below those we target for the future and what we have achieved in the past. Repayment periods for the schemes, which were all previously due to run through to 2026 are now varied.
The main scheme, the largest, remains unchanged. The second largest scheme now runs through to 2021, leading to a £50,000,000 step down in expected contributions from 2022. Of the other schemes, five are fully funded and two have accelerated funding profiles. I think it's worth reiterating a key point we have made in recent investor updates and that is that the cash profile of the main scheme remains positive until 2028 and that has allowed us to take a long term view. Just to complete your models, we expect U.
S. Deficit funding to continue to run at around $80,000,000 per annum through to 2022. The accounting deficit calculation methodology does remain unchanged and we will report on that as usual at our prelims in February, But given where corporate bond yields remain, there is likely to be a material difference now between the reported accounting deficit and the £2,100,000,000 deficit we have reached under these agreements. Moving on to reporting sectors, as we outlined in the October trading statement, we are implementing some organizational changes to the group and that's going to lead to a change in reporting sectors from the first of Jan. Firstly, you will be glad to know that The U.
S. Sectors of electronic systems, U. S. Platforms and services and the cyber and intelligence sector are unchanged. Gerry and the U.
S. Team streamlined and reorganized a few years back and the current structure is well placed to deliver in an improving U. S. Environment. Replacing the current UK and international platforms and services sectors, they will firstly be a UK maritime sector comprising of submarine, ship build and support businesses.
This sector will report directly to Charles and being in the early program stages on the likes of Dreadnought and Type 26, the focus will be on program execution and operational excellence. For external reporting purposes, the Maritime sector will also include the £300,000,000 per annum revenue U. K. Land business, which is also going to be reporting directly into Charles. The other new sector formed will be air and this will comprise our U.
K.-based military aircraft build and support activities, our KSA business, our Australian business, which is predominantly air, along with our 37.5% shareholding in MBDA. We are creating a strengthened and streamlined air sector to bring together our U. K. And international capabilities to best deliver on existing build and support programs and compete more effectively for international opportunities, a key area for us as deliveries on the European Typhoon program move towards completion. At the Feb results presentation, we will report the twenty seventeen year in the old structure and will also restate to the new.
2018 guidance will then be given against the new reporting structure. The chart you see on the screen now shows in a tabular form the changes from what was in the old structure to the new. I've stepped through most of those, but just for completeness, you'll note that The U. K. Shared services activities will now sit under HQ along with the newly created Chief Technology Officer role.
Just for reference, there are two charts appended to the pack and they provide the twenty sixteen full year and twenty seventeen half year results restated to the new sectors. And as I have already mentioned, we will provide pro form a restated twenty seventeen actuals at the Fed prelims. Okay, now I going to move on to IFRS 15, but just before I turn it over to Peter Earl to take you through the detail, there are a few things that I would like to emphasize. Firstly, IFRS 15 will impact the way in which we account for revenue from contracts with our customers. Adoption of the new standard will mean that for the majority of our contracts, revenue will cumulatively be recognized earlier as we incur costs rather than as we achieve performance milestones.
Profit will continue to be recognized progressively based on risk mitigation and retirement on our longer term contracts. On the shorter term contracts in the group's U. S. Businesses, there will be some acceleration on both revenue and profit recognition. I think it's important to note that IFRS will not change the way in which we manage our contracts under life cycle management, which is our mandated project management process, nor will it impact the lifetime contract profitability or cash flow.
So with that said, Peter, over to
you for the detail. Thank you, Pete. The aim of this presentation is to explain the impact of IFRS 15 revenue from contracts with customers. IFRS 15 is effective for BAE Systems from the 01/01/2018. And as Pete just mentioned, IFRS 15 is an accounting standard that has no impact on lifetime revenue and profitability of our contracts, no impact on the group's cash flow and no impact on our approach to managing contracts.
We expect that the impact of restating our full year 2017 is a reduction of approximately 1p of earnings per share. And the earnings impact on 2018 and beyond is not expected to be material. IFRS 15 replaces two existing accounting standards, IAS 11 and IAS 18. It will impact how we account for contracts and how we account for sales of certain software licenses. We will continue to report on 2017 full year under existing standards.
At our preliminary announcement of our 2017 results on the 02/22/2018, we will represent our 2017 income statement under IFRS 15 and our 2018 earnings guidance will also be under IFRS 15. This slide summarizes the impacts of IFRS 15. On long term contracts, sales will be recognized earlier based on costs incurred plus margin. We will continue to recognize margin progressively as risks have been mitigated or retired. In our U.
S. Businesses, sales and margin will be recognized earlier and margin recognition will be deferred on a few development and production contracts within the MBDA joint venture. As sales will be recognized based on cost incurred, the majority of balance sheet work in progress will be replaced by contract receivables. Finally, some license sales in Applied Intelligence previously taken at the outset of the contract will be deferred over the license term. IFRS 15 introduces the concept of overtime or point in time for sales recognition.
The chart sets out the three technical requirements for overtime recognition of sales. Sales that are not recognized over time are recognized at a point in time, for example, on delivery to the customer. The majority of our long term contracts meet the definition of overtime as our products are typically bespoke to customer requirements and there is limited ability to redirect to other customers. As a result, on those contracts, sales trading depends on costs incurred. There will therefore be no work in progress in the balance sheet on those contracts as the work in progress will be placed with unbilled receivables.
This chart sets out the cumulative impact on transition to IFRS 15 as at thirty one December twenty sixteen on overtime contracts by sector. Balance sheet work in progress of around £3,500,000,000 together with margin of £266,000,000 will be traded as sales of £3,779,000,000 To be absolutely clear, this is the cumulative transition adjustment at thirty one December twenty sixteen and not the in year income statement impact. In our U. S. Businesses, margin will be trading a work in progress at transition at close to out term margin.
In our P and S U. K. And P and S International businesses, where our contracts are typically higher risk and longer term in nature, margin traded at transition is lower relative to sales traded as the risk mitigation retirement points are not affected by the adoption of IFRS 15. Within MBDA, there are a few combined development and production contracts, which are currently correctly traded as one contract. IFRS 15 requires the price and margins to be allocated to the separate design and production elements of those contracts.
This means recognizing the lower margin in the development phase and the higher margin in the production phase on those few contracts. So on transition to IFRS 15 at December 2016, cumulative profits of £79,000,000 being our share previously traded on a combined basis will be de traded and will be traded over the production phases of those contracts. License revenue is either recognized upfront on delivery or spread over the license term. Under IFRS 15, if there is a customer expectation that the group will provide significant updates to the intellectual property, then license revenue would be spread over the license term. Therefore, given this change in accounting on transition at thirty one December twenty sixteen, pounds 39,000,000 of license sales previously traded upfront on delivery will now be deferred over the license term.
So pulling all that together, this slide sets out the cumulative transition adjustment. Cumulative sales of £3,740,000,000 and margin of £148,000,000 will be recognized at thirty one December twenty sixteen. This results in a post tax impact of 92,000,000 which increases reported net assets to £3,656,000,000 at thirty one December twenty sixteen. So in summary, the implementation of IFRS 15 has no impact on lifetime revenue and profitability of our contracts. It has no impact on the group's cash flow or any impact on how we manage our contracts.
The impact of restating our 2017 full year results is expected to be a reduction of approximately 1p on earnings per share, and the earnings impact on 2018 and beyond is not expected to be material. As previously mentioned, the restated 2017 results will be the baseline for 2018 guidance. So, you very much for your attention. And now we can open up the call for questions.
Thank you, We'll now take a question from Robert Stallard of Vertical Research.
Pete, a couple of quick questions on the pension update.
First of
all, I was wondering if you could reconcile the net deficit number you've given here, 2,100,000,000.0, I think it is, versus what you gave in the half year results, which I think was around €6,000,000,000 What's going on there? And then secondly, you mentioned that the agreement with the trustees sees the pension contribution linked to the dividend. Are there any other restrictions, say, with regard to share buybacks or acquisitions?
Okay. The first question is basically how do you reconcile the accounting deficit to the funding deficit and that's really all about the discounting rate that you use. Under accounting, you use a discount rate based on corporate bond yields. What we have reached on the funding agreements here is a move to an asset led discount rate, I. E, you look at the assets you hold in each of those schemes, the different categories of assets, the periods over which you hold them and you come up with a blended rate based on what you expect prudently to get from those assets.
So, there is now going to be a significant difference between the accounting deficit and the funding deficit. The funding deficit clearly will be the lower of the two. I think it will be fair to say if we'd have the second point I'd like to make on that is if we had not moved to the asset discount rates and kept with the same funding basis that we did back in 2014, which was based on a GILTS plus model, then the deficit we'd have reported today would have been twice as much as the £2,100,000,000 So, this is a really good result for all stakeholders. Second question was around the any other issues around restrictions on the amounts we paid. In terms of the dividend linkage, that's really the only one.
If we get into anything else like a share buyback, we'd have the same discussions with the trustees as to arrangements we've had to reach. Know that we've done that in the past and there are absolutely no restrictions in terms of M and A.
Okay. Then a quick follow-up, is there any mechanism to reconcile the or standardize the treatment of the discount rate between what you've got here on the pension with the trustees and the accounting? Because it seems daft to have completely different bases.
I think I wouldn't disagree with you, Rob. I think I've made my point very clear on previous presentation, results presentations. The accounting is the accounting. It's mark to market. It doesn't represent the underlying economics of what's going on with the funding.
In our accounting in our accounts, whilst we clearly are obliged to show the accounting number, we will also be reporting upon the funding position. We have an accounting standard which doesn't reflect underlying economics. I can't do anything about that, Rob.
Okay. Thanks so much Pete.
We'll now take our next question today, which comes from Rami Marston of Investec. Please go ahead. Your line is open.
Good morning, Good morning, Rami. Just some technical questions. So the pension from The U. K, is that now going to be coming out of your HQ or will it be coming out of charge to PNS U. It will come
out of HQ.
Okay. On the outflow for next year, and you've guided to around £200,000,000 for this year in the cash flow statement, is that going to be similar next year as well in 2018?
Yes. What we're saying is that The U. K. Payments will be about $220,000,000 and The U. S.
Will be $80,000,000 so that's what, dollars 60,000,000. So, it's around $280,000,000 in total.
Okay. But the guidance, is that going to be relative to the $200,000,000 that you've guided the outflow for pension deficit funding? So, it will
be close
to $300,000,000 this year?
It will in 2018, it will be around the $280,000,000 mark. Beyond that, it will then decline by £50,000,000 in 2022 as we complete the funding on the what's called the 2,000 plan. That's the second largest scheme.
Okay. And just on The U. K. Exposures, you had about £4,400,000,000 of revenues last year. Can you just clarify how much of that is short cycle work, book and ship type work?
There's a number of questions arisen recently.
Sorry, Rami, I'm not recognizing the 4,400,000,000.0
Your U. K. MOD revenues were about £4,000,000,000 £4,400,000,000 last year.
Okay. Much is short cycle? Very little. I haven't got the exact percentage to hand, but it's very little.
Okay. And maybe just a quick one, Prime Minister was in Saudi this week. Has there been any progress on the Tarfum order?
We're not going to talk about that today, Rami. Nice try.
Thank you.
We'll now move on to our next question today, which comes from Nick Cunningham of Agency Partners.
A couple of questions about the pension. First of all, am I right very simplistically to think about this as five years of €280,000,000 four years of 170,000,000 If I add that up, that's 2,080 million pounds that eliminates the deficit? Sorry, question one. Is that sort of roughly how the plan works? Second one, roughly, yes.
And on the pension itself, it's cash flow, if you like, it's internal cash flow. As I understand that, I think it's still cash positive because of the balance between contributors and those drawing down on it. At what point does that flip over? And then final question, the on the IFRS 15, that €79,000,000 and €39,000,000 I. E, euros 118,000,000, which is to be traded over time, is that effectively the offset for the adverse impact of deferring profit recognition on other contracts?
And is the effect of those things together sort of kind of even or are there any lumpy years that we need to think about in the next few years?
Right. Thanks, Mig. I'll do the easy one, first two. In terms of your the sort of how you look at the cash profile, does that build the does that get rid of the deficit? The answer is yes.
Clearly, you've got some asset returns coming from the assets invested in terms of the assumption that we're making, the modeling is yes. You asked about the second question was in terms of the cash profiling of the scheme itself, when does it how long does it stay positive? Current modeling says that stays positive through to 2028. Thank you. So, this is not a set of distressed schemes where we're having to sell assets off to meet liabilities, which is my point about taking a long term view.
And then I'll turn it back to Pete for the
difficult question. On the IFRS 15, Nick, on MBDA and the sort of de trade effectively on a few development manufacturing contracts, which on transition, there's a de trade in our books of £79,000,000 our share. Going forward, that profit will get traded over the production period of those contracts. And that's going to run out in the sort of five, some of them go out to ten years. So in year impact on that 79,000,000 going forward will not be lumpy.
It will be quite modest in any one particular year. On the 39,000,000 license income, again, on the D*TRADE or as a result of the accounting on transition, that £39,000,000 is going to be spread over five years. So, it's going to be 6 or £7,000,000 per year. So, again, it won't be lumpy and it won't be material.
Thank you, sir.
Thanks, Vic.
And
now your next question, which comes from Celine Fornaro of UBS. Please go ahead.
Yes. Good morning, gentlemen.
Good morning, Celine.
So, one question again regarding the new pension number and the €2,100,000,000 So, the main assumption that you've changed is really on this asset led discount rates. Is there anything else on the mortality rates or other assumptions that we should be aware of?
Yes. But the you picked up a good point there, Celine. On the two major changes, there are a number of smaller ones, but the two big ones is clearly the move to an asset led discount rate. And as I said, as a result of doing that, the 2,100,000,000.0 we've reported today would have been twice that much otherwise. The other benefit has been an improvement in mortality, both in terms of what we've seen over the last three years since the last valuation, but also taking up the new CMI twenty fifteen tables.
So, the mortality has given us a benefit of about £800,000,000 And of course, that will also be reflected into the accounting deficit when we come to report that in Feb 'eighteen.
And so, is the assumption now on the mortality rate?
We are using the actuarial tables, which I referred to as CMI twenty fifteen.
Thank you very much.
Okay.
Our next question today comes from Sandy Morris of Jefferies. Please go ahead.
Good morning, I mean, imagine not knowing the CMI table is off by heart.
I'm surprised, Sandy.
Actually, dull question, but just to satisfy my idle curiosity, in Platforms and Services UK, how many years did we have to go back to arrive at the cumulative adjustment? And I'm just trying to sort of gauge the length at which this IFRS 15 thing ebbs and flows.
Yes. About two or three years, Andy.
Right. So, three years, okay. That makes sense. And I'm guessing it's similar in international?
Yes. Yes.
And then sort of four thirty five in The U. S. Platforms and services, can I sort of regard that as land and armaments or actually is that not the case?
Predominantly land and L and A because the airship repair business in The U. S. Is predominantly support, but there's not much work in progress, I. E, we traded most of sales anyway.
Right. Okay, Jike. I mean because this is almost related to that lumpy thing. I mean, crudely, if we're going back three years and that's the total difference, then it doesn't look like going forward year to year, it could possibly generate much more than, I don't know, I just said $500,000,000 or something. It
will be in that sort of number, will be much more or less, circa that And
that sales, because given that your profit recognition is so patently back end loaded, Even if there was a bit of lumpiness in sales, it doesn't look like there'd be much in EBIT.
No. As you rightly point out and I wouldn't describe it as back end loaded, but certainly it's in line with a successful retirement of risk, then yes, there is as Pete has already said, there is a minimal impact. We will see some volatility on the top line on sales because of this whole move to effectively trading sales on the basis of cost plus a margin on some of these contracts, there is going be some volatility on sales, but it will make almost no difference to profit recognition.
Okay. That's great. Sorry, I was always a bit of an agricultural accountant back end loaded and stuff
like that. Andy.
Thanks very much, gentlemen.
Thanks, Andy.
Our next question comes from Harry Breach of Raymond James. Please go ahead.
Yes. Good morning, Peter, Peter
and Martin. Can you hear me?
Yes, we
can hear you loud and clear.
Great. Guys, just a very simple one. Can you give us sort of across all the schemes, the current balance between the actives, deferreds and pensioners?
Do you know Martin, do you go on that?
I think actives are about 25,000 as we sit. Deferreds are about 60,000 and pensioners are about 100,000.
It. Great.
Thank you very much guys.
Okay. I'm glad we had an answer for you, Harry.
Our next question today comes from David Perry of JP
Three questions, please. The first one is Peter. This restatement for 'sixteen is helpful for us to start building models. I know you're not changing guidance or adding anything to your trading statement. But could you tell us what the margin range will be for 2017 for Air and Maritime, so within the context of your current guidance, because that's what would help us convert to the new sectors?
Okay. I think if you look at the charts at the back, you'll see where we've reported the half year and the 2016 restatement. I talked about those two slides that were attached at the back. Maybe I'll see the full year there.
So Air in 2016, obviously, half year will be will have some lumpiness in it. But Air, you've told us, is 11.8% in 'sixteen. So do you have a range for Air in 'seventeen? And then likewise, Maritime is 8.2 in 'sixteen, but what's the range for 'seventeen?
We're not going to give you those, David. We'll report on those when we get there given that we're this close to the year end.
Yes, okay. But presumably, it's just moving bits around, isn't it, within the context
unchanged guidance. We're just moving things around. Yes, But absolutely
you can't tell us what Air or Maritime range will be for 'seventeen?
No.
Okay. The second one, just to clarify on the dividend linked increases in pension funding. So just so I understand that, for argument's sake, you increased your dividend 5%. Does the entire amount in The U. K, which is what, $220,000,000, does that go up 5%?
Or is it just the incremental £15,000,000 that would go up 5%?
It's the entire amount.
The entire amount. Okay. And it only relates to The U. K. Piece?
Yes, it does.
Okay. And then lastly, this is something I can probably do myself, but just maybe save me some time. I mean this asset linked discount rate is really interesting and hugely positive for you guys. Are you aware of other companies that have done it? Is this now broadly accepted thing for FTSE 100 companies or is BAE out on a limb here?
No, we are aware of three other companies that have done it. They're not all quoted. But this is not something that the regulator has said you cannot do. Indeed, historically, there's not been a need to look at this. It's always been done on a gilts plus approach.
But given that the gilts rate has fallen so far and now bears little reality to the expected return you get on the assets you hold in the schemes, then we've been through this with each of the nine trustee boards. They're independent lawyers. They're independent actuaries. And we've taken it through The U. K.
Pensions regulator. So there is a consistency of acceptance across all parties.
All right. Thank you very much.
Our next question now comes from Tristan Sanson of Exane.
It's Tristan from Exane. I have a few follow ups. First, I would
like to
understand the acceleration of the funding of the smaller fund in The U. K. Is driving a drop in the annual contribution by £50,000,000 in 2022. Can you say by how much it increases actually the contribution in the years before you are accelerating the payments? That's the first one.
Second, I understand yes, kind of understand what you're seeing on the restatement of the accounting of the contracts in backlog or that you started executing according to IFRS 16. If I look at, I don't know, a large export contract that could be placed in 2018 for whatever ships or fighter aircraft. How would it change the recognition compared to of revenues and profit compared to what we knew in the past? Should we assume it's going to be exactly the same? Or should we assume slightly slower profit recognition in the early stage of development that would be useful?
And final question is more of a request. I'm sure you have that in mind, but if you could give us updated pie charts of breakdown of activity of the new Air and Maritime revenues with full year results,
that would be fantastic. Thank you. Tristan, three questions. I'll take the first one, Peter will take the second and Martin will take the third. So, the first one, you talked about the accelerating payments.
The acceleration is all within that £220,000,000 that we are now talking about for The UK contribution commencing in 2018. One of the the second largest scheme, which is called the 2,000 plan, becomes then fully funded in 2021. And at the moment, as part of that £220,000,000 £50,000,000 of that is going into that scheme. So, will be a step down, therefore, in 2022 of £50,000,000 a year on the back of that scheme. The other schemes are much, much smaller.
So, they're not material. So, if your modeling assumption is £220,000,000 a year on U. K. Schemes through to 2021 and then £170,000,000 a year through to 2026 and then we're done.
Actually, what I wanted to know is whether the contribution to the 2000 plan until now was $30.40 compared to the 50 that you're going to have going forward?
No, it's the same. It hasn't changed. What has happened is because of the change to the difference on the discount rate, the actual deficit is lower, so which is why it becomes fully funded earlier. Peter,
do you want to talk On the second on your second question around what about our new large export type contract, say, in 2018 under new accounting, You will see a difference in sales recognition because on sales recognition, the new standard requires us to book sales on cost incurred. So as we incur those costs, there will be a sort of leftward shift earlier recognition than today of sales. But there'll be no change in when we on the timing of profit recognition on those types of contracts. We will continue to trade profit as we hit milestones and mitigate risk.
So you will see a bit of a difference between sales and profit in terms of timing going forward versus today, but profit recognition will be and timing will be the same. And as we said, 2018, we're not expecting the impact of IFRS 15 to be material.
Okay. And Tristan, on your last
Sorry. I mean, if I just to be clear, I mean that the margin percentage share will be slightly more back loaded, but the contribution in million of pounds will be similar.
Yes. As a percent of sales, absolutely right.
Tristan, just on your third point then in the year end presentation in February, then we will do a restatement and split out sectors that give the traditional pie charts by OE production and service revenue. Ladies
and gentlemen, that concludes today's question and answer answer session. At this time, I would like to hand back to Mr. Peter Linus, Chief Financial Officer, for any additional or concluding remarks.
I have no concluding remarks. Thanks for your patience. As I think you'll tell, we're very pleased with the pension outcome both for the company, the schemes and clearly the shareholders. IFRS 15 has no material impact to us and certainly has no economic impact. And the accounting restatements, sorry to screw up your models.
We'll do our best to help you through that, and we'll certainly have a clear presentation in February when we see you. So thanks for your time.