Good. Everybody in position. Excellent. Good. Well, good morning, everybody.
Welcome. Thank you so much for joining us here this morning. I just want to say a few words that set the background to the real results that Iain and Pete are going to cover in some detail. I think undoubtedly, 2015, defense certainly became an increasingly important priority for many countries with the risk of terrorism and the military aggression that we saw continuing to grow. In this context, the nature of our relationships as a strategic supplier to the governments of The UK, The United States, clearly, Kingdom Of Saudi Arabia and Australia were all raised in importance and tempo.
These relationships form the bedrock of our business, and we will continue to invest in strengthening and developing them in the near term. Now equally, our customers are unrelenting in their demand for product excellence and for the continued improvement in competitive pricing with unfailingly high service levels. The executive team have, therefore, focused on managing our costs without compromising our quality and service throughout the year. By working with our customers in the spirit of partnership with common objectives, greater transparency and constructive teamwork, our relationships, I think, have been strengthened and deepened. This style will be the hallmark of our business in the years ahead.
Now as we continue to develop our business and our presence internationally, we have embraced the needs of customers to establish and provide high quality local employment and industrial capability, and this is through partnership and joint ventures for local manufacturing services, procurement and product assembly. And this strategy has been particularly evident in The Kingdom Of Saudi Arabia, and we believe that the expansion of our relationship in The Kingdom will go hand in hand with our commitment to developing greater local content. It is a partnership built over fifty years that we will seek to expand in both of our interests. Reflecting on the highlights of the year, we've enjoyed strong performance in our Electronic Systems business, attractive growth in cybersecurity and very solid achievements across the company, including our marine, our Maritime, Land Vehicles, International and indeed our Service businesses. Our Military Air program has benefited from recent orders for Hawk and Typhoon, and we continue to anticipate the successful conclusion of further orders in 2016.
Our challenges have been primarily limited to delays in some military aircraft orders, the absence of our near term Australian government orders to sustain our local shipbuilding capabilities and the identification of additional costs necessary to complete commercial ship construction in The United States. Overall, we have been satisfied with our achievements in delivering sales of GBP 17,900,000,000.0 and underlying earnings per share of 40.2p. Reassured by the strength of our order backlog of GBP 36,800,000,000.0 and pleased that future cash generation and robust prospects have facilitated a healthy dividend of 20.9p per share. You will, of course, recognize that last year's earnings performance included some one off tax benefits, so a fair base of sustainable earnings would be around 37p. Looking forward, recent financial commitments to the defense sector by the governments of our major customers provide welcome clarity and stability for our core programs.
We take none of our business for granted. The Board and the management team respect the trust that is placed in us and strive to meet our obligations as a constructive partner across the world. As always, the future of the company rests on our ability to retain and attract people of considerable talent and capability. To that end, we have continued to invest in new training facilities to support successful development of the 1,000 apprentices and graduates we recruited in 2015. At the senior level, we have focused on the identification of high performing executives, the strengthening of our talent management programs, providing greater visibility to the Board and targeted training to broaden the experience of our next generation of leaders.
At Board level, we recently announced that Charles Woodburn will join the company in the coming months as Chief Operating Officer and an Executive Director. Reporting to Ian King, he will bring strong engineering credentials, considerable international experience and fresh perspectives to the business while simultaneously developing a detailed knowledge of the defense industry. Together, all of this emphasis on building and growing our human capital is designed to ensure we have a smooth pathway for orderly succession at all levels in the business in the years ahead. I'll now hand over to Iain to provide a more detailed review of our performance and indeed our future prospects. Iain?
Thank you, Roger, and good morning to everyone. Good morning. Well, that's good. So I'll spend a few minutes on the group's business environment and then ask Pete to address our 2015 performance guidance for 'sixteen. So we have delivered another year of solid performance.
The group has demonstrated resilience in markets constrained by wider economic pressures and continues to deliver attractive shareholder returns. We have been successfully navigating through a difficult period. BA Systems has a broader geographic reach than many of our peers. We have major operations in four of the world's largest accessible markets, The U. S, U.
K, Saudi Arabia and Australia. And further growth of our international business remains a key strategic objective. We are very relevant to national security in our core markets. In addition to the design and production of platforms and equipment, we have well established and enduring support business delivering long term capability for our customers. Good program execution is underpinned by the quality of our technology and engineering capability.
We have driven innovation through investment in R and D, and we have active programs to attract, train and retain the skills required to deliver our strategy. Business efficiency and a drive to scale operations to match demand is key and remains a core objective of the group. We must remain competitive. So turning to our key markets. In The U.
S, the business environment is now improving. The bipartisan agreement last year to lift discretionary budget caps enabled the President to sign a revised defense budget providing growth for 2016. These new budget agreements are expected to enhance the funding environment for our U. S. Business through 2017.
Our electronics businesses performed well and grew in 2015. We remain well positioned on priority programs. As a major supplier of electronic equipment on the F-thirty five aircraft, we benefit from the commitment to increases in production output over coming years for both U. S. And international customers.
In addition, we continue to win new business on platforms such as the electronic warfare upgrade for U. S. Air Force F-fifteen aircraft and for electronics upgrades to U. S. Special Ops C-130J aircraft.
We have a strong position in the intelligence, surveillance and reconnaissance domain, providing customers with high technology sensing solutions, including advanced geospatial intelligence capabilities. We continue to grow in commercial electronics through our broadly based flight and engine controls activities. And in addition, the investment in aircraft cabin systems took an important step forward with the signing of the first Intellicabin customer. As a leading supplier of ship repair services to the U. S.
Navy, we are responding to changes as they relocate some ships to new home ports. We expect the enhanced Pacific deployment will benefit our San Diego operations over the midterm, but with a near term reduction in capacity at our Norfolk, Virginia facility. We have addressed the reduced workforce requirement in Norfolk, and we are investing in additional capacity at our San Diego facility. In addition, in 2016, we expect to complete the commercial shipbuild contracts at our Jacksonville and Mobile facilities. Whilst much of our U.
S. Based activity has proven resilient through the downturn in defense spend, land programs and manpower services have been disproportionately impacted over previous years. However, both performed solidly in 2015, supporting expectations for an improved outlook of this now stabilized base. Following external interest last year in our U. S.-based Manpower and Services activities, we undertook a strategic review of that business.
Recognizing the recent improved performance of the business and its good order intake, the review concluded in November that greater value would be derived from retaining the business. In Land, we have seen good progress with success in winning at the 2014 the armored multipurpose vehicle contract. Further order intake was also achieved for the M109A7 tracked artillery system. These two programs draw on commonality with the Bradley family of vehicles and underpin our strong franchise in tracked combat vehicles. We were also awarded one of two contracts for the U.
S. Marine Corps amphibious combat vehicle program, and we are experiencing strong international demand on amphibious programs. FNSS, the Turkish Land Systems business, in which we have a 49% interest, secured further international armored vehicle orders in the year. They are also currently bidding on major Turkish national programs. In The UK, the Strategic Defense and Security Review identified an increased £178,000,000 defense equipment and support plan over ten years and outlined defense and security priorities.
These commitments included the continued investment in expanding Typhoon capabilities and an extension of the aircraft's expected service life to 2,040. There was also a development of complex there was also a renewed commitment to joint investment with France for the development of complex weapons and a future unmanned combat air systems capability. Also in the air domain, the review detailed the introduction of The UK's initial F-thirty five operational strength. The SDSR addressed the continued commitment to seven Astute class submarines and the replacement of the four Vanguard class boats. The UK government reaffirmed its commitment to shipbuilding continuity, a fleet of at least 19 frigates and destroyers are expected to be maintained, including eight Type 26 frigates and a new class of lighter general purpose frigates.
A further two new offshore patrol vessels are also to be built on the Clyde. So a good SDSR for the armed forces and for our industry. Our UK businesses continue to perform well, benefiting from good program execution and stability in customers' requirements. In the air domain, an agreement between Italy and Kuwait was announced this September relating to the supply of 28 Typhoon aircraft for the Kuwait Air Force. We continue to support the campaign led by Finn Mechanica to achieve a formal contract.
In November, we announced a reduction in the production rate for Typhoon assemblies to maintain continuity and efficiency of production over the medium term. Export activity continues to be strongly supported by government. And although there could be no certainty as to the timing of orders, discussions with current and prospective operators of the Typhoon aircraft continue to support the group's expectations for additional Typhoon contract awards. Production of major assemblies for the F-thirty five program is increasing at our Salmsbury Advanced manufacturing facility with much of the production investment in place to achieve the planned high volume anticipated over future years. We are also very busy with Hawk, the first of the new generation aircraft for Saudi Arabia due to be delivered shortly, and we have agreed a contract for a second batch.
We continue to support the Indian Hawk program with the supply of assemblies. In the maritime domain, we are seeing good progress on the carrier program with outfitting of the first of class now well advanced and the assembly of the second vessel underway. Focus on entry into service is expanding. The existing Type 26 and offshore patrol vessel contracts are progressing well. The astute submarine program saw successful sea trials of Boat three and pricing of Boat five to a value of £1,300,000,000 We continue to ramp up activity on the successor submarine program.
Major redevelopment of the Barrow site is underway. Moving on to our other markets and starting with Saudi. Deliveries of Typhoon aircraft to the kingdom continued, and we are supporting a high tempo of training and operations. The Royal Saudi Air Force is achieving high availability and utilization of aircraft across their Typhoon and Tornado fleets, operating under demanding conditions. We received a contract for a further 22 Hawk advanced jet trainer aircraft, which forms part of an enhancement for the kingdom's pilot training capacity.
In this fiftieth year of the relationship, we continue to address current and potential new requirements as part of the long standing agreements between the UK government and the kingdom. In Australia, the second of the two landing helicopter docks was successfully delivered into service with the Royal Australian Navy. Notwithstanding the Australian government's announcement of its intention to launch a naval shipbuilding strategy, the viability of the Williamstown Melbourne shipyard remains uncertain. With no near term prospect of additional work, we announced headcount reductions and an impairment of the carrying value of the facility. Efficiency enhancement measures have been implemented across the Australian businesses, including a reduction from three to two operating sectors.
In India, we have a long standing relationship with Hindustan Aeronautics. Delivery of a second batch of Hawk aircraft continues and negotiations are underway to agree a third batch. Discussions on the M777 howitzer are also maturing well. The MBDA joint venture continues to win significant order intake, including naval weapon systems and weapons in support of multiple combat aircraft types. MBDA is expected to win future orders from recently announced and anticipated international sales of European combat aircraft.
With its already large order book, good growth is expected over the medium term. So turning to cyber. Our Cyber Intelligence sector comprises two businesses: firstly, the work we do in The U. S, supporting U. S.
Government agencies and secondly, our Applied Intelligence business. We have continued to develop Applied Intelligence along three strands of activity: U. K. Services, addressing U. K.
Secure government business International Services and Solutions, addressing international government infrastructure customers and commercial solutions addressing the commercial cyber market. We continue to see good growth opportunities in all three Applied Intelligence business streams, but it is from the commercial space that we see the greatest potential. We are pursuing a substantial expansion of the Applied Intelligence business into commercial markets with significant recruitment and investment in 2015 alongside the successful integration of the formal Civil Sky business acquired at the 2014. Sales and order growth in 2015 was strong at around 30%, and we expect to see good growth continue as cybersecurity becomes increasingly important for governments and commercial enterprises. Recent events highlight how relevant this protection is for all organizations.
Pete?
Thanks, Ian, and good morning. As usual, I'll step through the results for '15 and then move on to our guidance for 2016. There has been considerable volatility in exchange rates during the year. And so for reference, the U. S.
Dollar rate has averaged at $1.53 compared to $1.65 in 2014. So the headline numbers and compared to 2014. Sales increased by £1,300,000,000 to £17,900,000,000 Some £200,000,000 of that increase was due to exchange translation. As expected, sales in The U. K.
Business were up by £800,000,000 for the higher number of aircraft deliveries into Saudi Arabia, trading of radar and DAS equipments on the European Typhoon program and the increased activity across the naval businesses. Underlying EBITDA reduced by £19,000,000 to $1,683,000,000 pounds including the impacts from the Typhoon production slowdown and the Australian shipyard impairment and rationalization charges that we announced in our November trading statement. Year over year, EBITDA benefited by £15,000,000 for exchange translation. Underlying finance costs in the year were slightly lower at £194,000,000 Underlying earnings per share were at 40.2p. This included two tax provision releases, one as we announced in November's trading statement at 2.6p and the second at 1.7p.
Recognizing the number of moving parts that we have year over year within underlying EPS, there is a bridge chart showing those major movements appended to your packs. There was an operating cash inflow of £700,000,000 and net debt at the end of the year closed within our guidance range at £1,400,000,000 Water backlog has reduced to £36,800,000,000 primarily for the trading through of long term support and production contracts in The U. K. And Saudi Arabia. The dividend for the year has been increased to 20.9p per share, up 2% on the 2014 dividend.
In addition to the effect of exchange translation, where the U. S. Dollar closed at $1.47 compared to the opening $1.56 there are a number of items within working capital, along with the mark to market pension accounting, that materially impacted the closing balance sheet. The major advances received in 2012 on the Omani Typhoon and Hawk order and the Saudi training aircraft contract continued to be consumed. Advances were also utilized in the year on European Typhoon production.
Costs are being incurred against provisions created in previous years, including The U. S. Commercial shipbuilding programs and on U. K. Rationalization.
The second of the two payments under the Salaam price escalation settlement were received in the year. In aggregate, working capital increased by some 600,000,000 The IAS 19 accounting pension deficit has decreased over the year to £4,500,000,000 and that pension deficit reduction also reduces the deferred tax asset. And I'll move straight on to the pension deficit position on this next slide. The value of the scheme assets is unchanged over the year at £23,800,000,000 and that's after pension benefits paid out of some £1,100,000,000 In aggregate, across all the group's pension schemes, equity investments now stand at 48% of scheme assets. Over the year, liabilities reduced by £1,200,000,000 to £29,400,000,000 Real discount rates increased by 30 basis points in The U.
K. And by 40 basis points in The U. S, driven by increase in bond yields. These discount rate movements reduced reported liabilities by around £1,500,000,000 The year's discount unwind and service costs, less pensions paid, account for the rest of the movement in liabilities. One point to note, the company, Scheme Trustees and Airbus have reached agreement in principle on the transfer of the Airbus share of assets and liabilities into a separate section of the pension scheme.
This separation is expected to complete in the 2016, and the revised allocation has been reflected in the numbers shown here. In total then, the impact of all of these movements over the year is a 900,000,000 decrease in the group share of the pretax accounting pension deficit. Moving on to cash. This slide sets out the movement from our net debt position of £1,032,000,000 at the beginning of the year. The operating business cash flow was £681,000,000 Interest and tax payments were $289,000,000 Payment of twenty fourteen's final and twenty fifteen's interim dividend totaled £655,000,000 Exchange translation and all other movements totaled £127,000,000 As As you will have seen, we issued a $1,500,000,000 bond in December with a mix of five, ten and thirty year terms at a blended rate of 3.7%.
Whilst this represents an opportunistic and early than planned pre financing of debt maturing in 2019, we have also taken this step recognizing the financing pressures on certain export customers given the ongoing low oil price and the resulting potential for lower advanced payments on future contracts. As a result of that new bond issue and $750,000,000 of maturing bonds repaid in August, we closed the year with gross debt of £4,000,000,000 cash of £2,600,000,000 and net debt of 1,400,000,000.0 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 2005 was £274,000,000 and the cash outflow at head office contains £177,000,000 of that. This next chart sets out the group's capital allocation policy, which remains unchanged. As you'll know, we have a legal obligation to fund our pension deficit recovery plans, which are agreed with the trustees following triennial valuations.
We have been paying around £300 to £400,000,000 a year into The U. K. And U. S. Schemes.
Our next round of U. K. Funding valuations will commence in April 2017. Where we believe we can deliver value for our shareholders, we invest in pursuit of organic growth opportunities. In 2015, net capital expenditure amounted to £284,000,000 We spent £168,000,000 on company funded research and development and £367,000,000 on business development and proposals.
We absolutely recognize the importance of our dividend to shareholders. We continue to plan to pay dividend on the basis of having long term sustainable cover of around 2x underlying earnings. Our approach to share buyback is that we only make accelerated returns when the balance sheet allows and when the return from doing so is in excess of the group's weighted average cost of capital. We use the relatively risk free economic return available from a buyback program as the benchmark for other inorganic investment. And as such, we will seek to invest in value enhancing bolt on acquisitions where market conditions are right and where the opportunities deliver on the group strategy.
Moving now on to the sectors. I'll cover the in year performance here and then return to the outlook for 'sixteen a little later. And the first of those sectors is Electronic Systems and the numbers here in U. S. Dollars.
Sales compared to 2014 increased marginally to £4,030,000,000 The commercial areas of the business now amount to 23%, having seen sales growth in the year of 7%. On the defense side, sales were stable with growth on the F-thirty five program offsetting contracts completing in 2014. The return on sales achieved of 15% was again ahead of guidance, largely from continued strong program execution and risk retirement. By way of reminder, last year included a 50 basis points nonrecurring gain from a contract pricing settlement. Cash conversion of EBITDA for the year was at 89%, excluding pension deficit funding.
Order backlog was sustained at $6,100,000,000 benefiting from awards for enhanced night vision goggles, F-fifteen electronic warfare upgrades, production of P-eight mission computers and F-thirty five low rate initial production batches. The Cyber and 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, sales in the year increased by 3%.
As per guidance, The U. S. Business saw just a 1% decrease largely in government IT services. Growth in the BA Systems Applied Intelligence business was at 31%. Of that growth, 13% came from the acquisition of SilverSky and 18% organically, largely from non U.
K. Government customers. The margin achieved of 7.8% was a little below guidance, and that's due to a high level of cost expensed in the Applied Intelligence business as we focus on further growth. Cash conversion of EBITDA for the year was at 82%, excluding pension deficit funding. In aggregate, order backlog increased to $3,500,000,000 Backlog in The U.
S. Business grew by 13%, largely on imagery analysis and cyber support awards. And in the Applied Intelligence business, backlog increased by 21%, driven mainly by international and commercial awards. Moving to The U. S.
Platforms and Services sector, numbers again in dollars. Sales in the year were ahead of our guidance, declining by 4% to $4,200,000,000 or by just 1% on a like for like basis after adjusting for exchange translation and the South African business disposal. Higher than expected sales were seen on both ship repair activity and munitions volumes. In line with guidance, the business has delivered an improved margin of 6.4%. And whilst further charges had to be taken in the year on the commercial shipbuilding programs, these were partly offset by improvements to the Radford munitions contract.
Cash conversion of EBITDA was impacted by the use of provisions on those commercial ship programs and of customer advances on the CV90 Norway contract. And we have investment being made on the new floating drydock facilities in San Diego. Order backlog reduced to $5,800,000,000 largely for the trading out of the five year MISMO contracts in the ship repair business and the CV90 Norway program. In The U. K.
Platforms and services sector, the year sales of £7,400,000,000 were 12% higher than in 2014, in line with previous guidance. The increase came from a higher number of Saudi aircraft deliveries, trading of radar and DAS equipment on the European Typhoon Tranche three program and for increasing activity in the submarines business. The return on sales was at 9.7%. And as mentioned at this time last year, one of the impacts from lower pension discount rates is that the service cost charged to the P and L increases. And in 02/2005, that amounted to some 50 basis points of margin compared to 2014.
In addition, the 2015 result includes the in year impact from the announced Typhoon production slowdown decision. Cash performance was as expected with an inflow of £220,000,000 Consumption of customer advances occurred on the Omani, Saudi and European Typhoon contracts. There's also been some rationalization cost charge against provision created in prior periods. Order backlog reduced to £17,800,000,000 primarily from the trading of Typhoon Aircraft and Carrier. Sales in the international sector of £3,700,000,000 were 5 percent up over twenty fourteen or 9% on a constant currency basis.
The trading increase comes from the higher levels of support to the Salaam Typhoon aircraft now in service and higher volume of weapon systems. The EBITDA of £335,000,000 is after charges totaling 53,000,000 in respect to the impairment and rationalization costs taken in the Australian business. There was an operating cash inflow of £164,000,000 which includes the second payment under the Salaam VOP agreement. However, you will recall that some £200,000,000 of receivables were collected in December 14 ahead of the contracted 2015 dates. In addition, customer advances were utilized against the Saudi aircraft training program.
Order backlog continues to reduce as expected against the five year support contracts in Saudi Arabia. For reference, there is a chart providing a summary of the trading performance of all five sectors along with the HQ numbers appended to your presentation packs. This next chart seeks to give guidance as to how we see the performance of each sector developing from 2015 through into 2016. With effect from the January 1, we have transferred The U. S.
Geospatial Intelligence and ISR line of business to the Electronic Systems sector. That line of business was reported within the Cyber and Intelligence sector in 2015, and the numbers shown here for 2015 reflect that transfer. For reference, our exchange rate planning assumption for the U. S. Dollar here is at 1.45.
So firstly, Electronic Systems. Overall, we expect 2016 sales in dollar terms to show low single digit growth. In aggregate, with 2016 projected sales, some 76% are in the closing order book, broadly consistent with last year's starting point. On our margins, we've increased our guidance range from 12% to 14% up to 13% to 15%. And we'd expect sixteen's performance to be around the middle of that new range.
Next, Cyber and Intelligence. In aggregate, we expect low single digit sales growth in 2016. The U. S. Business, which is 70% of that sector in 2015, is expected to remain stable following the strong closing order backlog position.
In the Applied Intelligence business, good double digit growth is expected, benefiting from expected organic growth largely in commercial markets. Margins in 2016 are expected to improve to be within a 7% to 9% range. Following twenty fifteen's high level of product development investment, future growth is expected to benefit margins in the Applied Intelligence business. Moving to Platforms and Services in The U. S.
And here, we expect sales to be around 10% lower. And this is due to a reduction in naval ship repair activity, particularly at the Norfolk yard. Of this sales guidance, around 90% is within order backlog. Despite the expected sales reduction, at the margin level, we expect another year of improvement, absent further charges on the commercial ship contracts, moving up into a 7% to 8% range. Turning next to Platforms and Services UK.
Sales are expected to be slightly lower as European Typhoon deliveries reduce. In the naval domain, the higher sales activities from the higher sales levels from activity on Astute and Successor submarine programs are expected to more than offset the reducing carrier trading. Again here, more than 90% of the sales guidance is within the closing backlog. We continue to expect margins in the sector to be within the lower end of our 10% to 12% range. And the last of the sectors, Platforms and Services International.
Here, we expect growth in 2016 of around 5% with increased levels of support to the Salaam Typhoon aircraft now in service. Again, some 90% of this guidance is covered by backlog. Margin levels are expected to be back up to the lower end of our 10% to 12% guidance range. To complete your 2016 models, headquarters costs are expected to be much the same as those in 'fifteen. Underlying finance costs are expected to be some £35,000,000 higher for the cost of carry on the $1,500,000,000 bond pre financing.
The effective tax rate is expected to increase slightly to be around 22%, and the final number will, of course, be dependent upon the geographic mix of profits. This chart summarizes the group's overall earnings guidance for 'sixteen. Twenty fifteen's earnings per share was 40.2p. That included two tax benefits, the one we previously announced at 2.6p and the second at 1.7p. Adjusting to a constant currency basis, that is applying a U.
S. Dollar translation rate of 1.45 to twenty fifteen's dollar earnings, gives 36.6p. In aggregate, against that adjusted position and drawing from the sector guidance given on the previous chart, we expect the group's 2016 reported earnings per share to be some 5% to 10% higher. This final chart highlights our cash utilization. In the left hand column are the numbers for 2015.
To the right are those we expect in 2016. In addition, with 2016 expected to be the last year of significant customer advances utilization, we are also providing some directional guidance as to how we see the position for 2017. In respect of operating cash flow, firstly, we are expecting capital expenditure to be above depreciation levels, and that reflects investment in a number of areas, including the new floating drydock facility in our U. S. Ship repair business and capability insertion in our Saudi partner companies.
Within working capital, the most volatile area remains the level of customer advances. Against the major advances we received in 2012 on the Saudi trainer aircraft contract, we will see a final year of utilization. The majority of the advances on the European Typhoon production contract will also be consumed. Under the terms of the 2012 Omani contract, there will be increased cash flow in 2017 as deliveries commence. The final operating cash flow item in the year is the year's pension deficit funding, which will again be close to £300,000,000 The nonoperating cash flow items are far more predictable.
Outflows for interest and tax are expected to total around £400,000,000 and dividend payments to shareholders will be around £700,000,000 Under the transactions announced last year, we expect receipts of circa £100,000,000 under the restructuring of our Saudi partner companies. So in aggregate, 2016 is expected to see an increase in net debt. However, as you can see from the narrative guidance for 'seventeen, we would then expect to see a year of strong operating cash flow as the previous five year cycle of customer advance receipts and subsequent utilization draws to a close. And with that, I'll pass it back to Ian.
So thanks, Pete. So before I finish, I just want to comment on technology. Technology is a key and sustainable attribute of this company. We have continued to drive innovation through investment in R and D. We work closely with our customers to ensure that there is an appropriate focus to such use of shareholder capital.
In many cases, our approach is to invest in the early phases of a project before requirements have matured and where there is a realistic prospect that a program may emerge and transition to customer funded development. Maintaining a balance between company and customer funded R and D is fundamental. R and D spend last year was 7% of group sales, with the company funded component representing 1%. However, R and D is more relevant in some areas of the group's activities than others, such as defense and commercial electronics, military aircraft, unmanned systems and cybersecurity. Total R and D in these product focused activities was 11% of sales.
By way of example, recognizing the potential of an emergent new technology last year, we agreed the acquisition of a 20% interest in Reaction Engines. Reaction Engines is working on a radical new aerospace engine concept, which combines rocket and jet engine functions made possible by exciting new heat exchanger technology. So in summary, BA Systems has a large order backlog generated by a well balanced portfolio serving the needs of customers in many of the world's larger accessible markets. We have demonstrated resilience through an extended period of economic challenge. The group is well placed to continue to generate attractive returns for shareholders as defense budgets recover and our commercial adjacencies of cyber and commercial electronics continue to grow.
So now we'll take questions. One at the front, two at the front.
Thank you. Good morning, gentlemen. Is Christian Lachlan from Bernstein. Just one high level question from me really. In the context of your platforms business over the medium term, given the improvement of the budget environment of a couple of your major customers and then of course continued growth in some international defense budgets, where
do you
see the biggest opportunities for new contract awards? And which domain, Air, Land or Sea, kind of leads that opportunity set?
Well, all of the domains that we have, have opportunities for future major orders. I mean in the naval sector, in The U. K, we're just in the early phases of Type 26 and the replacement success of submarine program. Astute still has well into the next decade to go. So that area of the business is expanding.
In our Air business, F-thirty five is just at the early stages of ramping up production. We're continuing Typhoon. We have over 40% of our business is in Support Services. And in Land, we're just at the start of a new cycle in terms of major programs. So Gerry, would you like to comment on where we are in the land cycle around AMPV and amphibious?
Sure. On the thanks, Ian. On the domestic side, as Ian alluded to, in The United States, we were successful on two key programs and we're moving through development on both the Army's AMPV and the Marine Corps ACV. That development will move into low rate initial production and then finally into production late in this decade and then really ramp up post-twenty '20. So we see a great opportunity for growth there.
And in fact, on a like for like basis, even with these development programs, we're going to have modest growth next year in land. So we think we have bottomed out, as we said, last year. And then there are a number of international customers, as Ian alluded to, who are very interested. We secured two very important orders this year internationally for the AAB. And we have a number of customers through our FNSS joint venture that are interested.
We have some very active programs going there as well as in The Middle East. So a lot of potential in the pipeline as we've spoken about the last couple of years that's starting to mature. So if
you look across the portfolio and the franchises that we have in there, we do not think that we are ill positioned in any of those franchises. Thanks.
Nick Cunningham from Agency Partners. Could I ask about capital allocation? As I understood it, I think what you're saying is that buyback has to be WACC and M and A has to be buyback, to crudely summarize it. So first question is, as an indicative sort of roughly how what level do you see WACC as being? And secondly, what are the constraints in terms of liquidity, solvency and so on?
And does the outflow that you see in 'sixteen sort of stretch that in any way? Does that push your comfort zone? Then a completely different question. On Intel, having not sold it, is it now a keeper? Or are you just waiting for the big U.
S. Primes to sort out their services strategy before you then come back and do something?
So I'll answer the last one and then you want to go on the others. Look, we had some inbound inquiries onto our I and S business. And we said that we would look at those inbound inquiries. What they were offering was not comparable with what our view of the business is. It's performing well.
It's done extremely well under DS leadership through all that activity. We're very comfortable
Weighted average cost of capital then. So the group's WACC is around 7.5%. Obviously, it moves around all the time, but sort of 7.5%. So that's sort of the benchmark. Obviously, when you look at M and A, you've got to risk adjust that.
So that 7.5% is not the benchmark. We're looking at M and A. It's a lot higher than that. Your point on liquidity, what drives us is the credit rating. We have to sustain an investment grade rating for a number of reasons, not least of which is our ability to get bonding cover for export opportunities.
Clearly, it drives our interest cost. But one of the big things is how it impacts the views of our trustees on our pension schemes. We have twelve year deficit recovery plans on our pension schemes in place, and the credit rating is a key metric for the trustees of the schemes in terms of evaluating the creditworthiness and therefore, term under which they prepare to accept a deficit recovery plan. So we are not going to do anything in terms of balance sheet that's going to put our credit rating at risk.
The rating agencies move in mysterious ways in terms of how they determine their ratings. Is there a key metric that you look at, like net debt to EBITDA or something like that, that we should bear in mind?
There's a number they use and they also look at your customer base, credit risk, everything else that goes with it. One of the issues, of course, is the way the rating agencies look at the accounting pension deficit, so they add that to debt. So clearly, today's position, we're saying that the pension deficit has come down by £900,000,000 that was would be seen as a reduction in debt. Has that changed the cash flow profile of the group at all? No, it hasn't.
So I agree, they do move in mysterious ways, but we have to recognize that and deal with it accordingly.
We understand the mysterious ways. Celine?
Celine Fonaro, Bank of America Merrill Lynch. So my first question would be on the orders and how we should think about that for 2016 in terms of the order intake, mostly probably for The U. S. Exposed businesses and for the international division? And also, remember you were mentioning last year, you had £1,300,000,000 of international order spending.
I was just wondering how much got closed or achieved in 2015?
All of it got closed. Because you saw that the Hawk order, the '22 Hawks, where we were in the negotiation, but we just didn't have the effective contract at the time. That is now in the order book.
You. So yes, if could comment on The U. S. Short cycle businesses. And my second question would be related to the cyber business.
What was the reason to move back the geospatial business into electronics? And looking at the cash generation of that business, at least in 2015, it seems relatively weak. So I was just wondering how we should think about that even in the new perimeter and why is the cash conversion so low there?
You should be pleased that we've moved that business into electronics because it has a different profile of profitability and growth in it. So I mean, that's good news in terms of why we're doing it because we think it's synergistic in terms of the capabilities that it has and it can generate additional business prospects. So I mean, it's a simple comparison of is it can it work more collaboratively as part of the Electronic Systems businesses with prospects that we've got all on its own. And the view was it was better placed in terms of the technology and capabilities and programs it had. So that is a good news because it's about attracting a different sector of the market at higher profit rates and higher growth rates.
In terms of order intake, Gerry, I mean, if you want to just talk about 2016 and probably 2017 in terms of The U. S. Budgets?
Sure. The U. S. Budget, as most of you know and Ian alluded to, there was a bipartisan agreement last year on the defense budget, which raised the 2016 and 2017 numbers by about 6% over the prior budget caps. The investment accounts went up.
If you look at the President's budget, which was just submitted, I think, last week, it shows about $103,000,000,000 increase over the prior caps in the five year plan. So that's another positive. In addition, DoD has stated that between, I think, 16,000,000,000 and $22,000,000,000 roughly in this time period, they're going to increase their investment accounts by 22% in those budgets. So from a macro perspective, we're very pleased. We think that the market has indeed, bottomed out.
And, there's much discussion, as you know, even amongst the candidates, for presidency that the OCO budget, what they used to fund outside The United States operations, things in The Middle East, that, that is going to be a buffer account to allow for increased activity, funding of those things. And so from a macro perspective, we see a very positive trend there. There's also a lot of dialogue with what's going on in The Ukraine and Russia, as you can imagine, about prepositioning some equipments, etcetera, which play very much to our strengths with the Armored Brigade. So that's kind of at a macro level. And as you look across our portfolio, it's very broad, very diverse and we think very relevant not only to the near term, but the midterm as evidenced by some of the wins that we've had in our electronic warfare, spectrum warfare business, both on the unclassified side, which we can talk about and the classified side, which we don't talk much about, but that's behind a lot of this, very market leading capabilities where communications and electronic warfare are coming together, cyber and electronic warfare.
So we think that's very relevant. Part of the reason for the GEOINT relocation into that business, they complement each other very well in their offerings in that space. And we think we can make one on one equal three. And then we talked about the combat vehicles, winning those programs. So those kinds of programs, the F-thirty five, the electronic warfare upgrade for the F-fifteen, the combat vehicle programs that we have, we think we're building very durable backlog in very long cycle businesses that will be relevant.
So the budget trends, the breadth and depth of our portfolio, we're seeing great advance also in the commercial electronics. We're on the two new GE engines. It will be on all the single aisles, both the Airbus and the Boeing airframes. We have very strong positions on the next generation Boeing aircraft, seven thirty seven MAX, 777X, which will all be coming into production post 2020. And we've also taken our military controls business and we've moved that into the private sector, and we're working with both Gulfstream and Embraer on their next versions.
We're putting controls on business aviation. So all of those trends, we think, portel well for this portfolio, particularly as these programs move into production late in the decade.
So I'm looking forward to the first quarter review, Gerry. It sounds very encouraging. Towards
the end
of the decade. Sorry,
on international, the orders?
Sorry, sure, sure.
On international, you didn't comment on the orders?
Well, you know that we have a different cycle on international because we get major order commitments. And if you think of the five year support orders that we got in Saudi, I think the eyewear is $20.17, which is the renewal date. So we're very heavily busy on looking at that support structure because everybody gets fascinated and fixated on sort of major procurement of equipment. But just remember the portion of this business, which is enduring support and the 6,000 people that we have in Saudi doing that. So we're getting into the cycle where we'll be bidding some major support and upgrade programs.
So we're not without a lot of bidding activity. So there was one in the corner and then one there. Have we got people on the phone, Andy? Nobody wants to speak to us on the phone. There's a line down or something.
Rami Myerson from Investec. Three questions. Just where are you on your planning for the Eurofighter for the batch two Eurofighter from Saudi? Is that partially in your numbers? Do you not expect that in 2016 and 2017?
Second question is on the light frigate.
Be persistent with your questions.
The second question is on the light frigate. Are you working with the Royal Navy so that could maybe finally an exportable program after the experience in the Top 45 and Top 26, which doesn't appear to be an exportable program? And lastly, can you talk a little bit about the BAEUK MOD's UAV strategy because they've ordered a couple more UAVs not from BA in. How do think that develops over the next few years?
Well, let's say, in reverse order. I mean, as you know, we've talked about this before, and we actually showed a Taranis video appeared at one of the things. Our emphasis is on unmanned combat air vehicles. That is not what they produce. So if you think about turning Typhoon into an unmanned type facility, they've mainly surveillance activities that they've been procuring.
So we have a number of active programs. I cannot take you through the detail because, obviously, of the classification of them. But I don't want you to worry about that we're not active and engaged in programs that we feel very comfortable about. And if you saw the if you read the SDSR, Strategic Defence Review, it talked about the continuation of the relationship with France in complex weapons and unmanned, well, that's us. What was the second?
Second one was on Light Frigate. Yes, we are working with the Navy. The STSR, again, committed to 19 capital warships, as they call them. So exclude carriers from that because it's not in there. So you're talking about the six Type 45s, the anti submarine warfare Type 26 and then what they a class of multipurpose frigates, which they talked about, which is the balance of number.
And the thing about STSR is it defines capabilities, not contracts. You then have to turn the capability requirements into a set of contracts, and that's what we're working with the Navy and the MoD on at this stage. If the Navy capability is such that they can be exported, that will be taken into account. But the primary aspect is protection of this country's borders. In terms of Batch two, we told you that when we restructured the production line in terms of loading, we were taking a medium term view based on current programs and forward programs, which is why in 2016, you're not seeing the caveat, if you like, relative to orders because we've taken a medium term view of the continuation of this line.
If I can just add to that. I mean, if you remember the trading statement, we said that Typhoon production would go from 1.3 to 1.1. So that's what's still in this guidance. And from the cash perspective, the numbers are the guidance that you saw on that chart for both 2016 and 2017, we are not assuming any major material down payment.
Okay. There was one in yes.
Mainly a question for Peter, although I think Iain has an accounting background.
Long time ago, but I'll give it a go.
Appertaining to IFRS 15, have you got to change any of your long term contracts accounting? And secondly, also appertaining to that, when is it that KPMG will have to undergo an auditing audit, as it were, and possibly, you get new accountants who will be more aggressive?
Okay. IFRS 15, I mean, we've looked at it. This is around sort of long term contracting. We don't believe there'll be any material change to our numbers. So will there be some restatement?
There may be some small element, but we're not expecting any big material change. In terms of the second question on auditor or mandatory auditor rotation, check with where's my is it the 2017, Pete, which is the last year for KPMG's audit? Yes? And
the assertion that the new auditors will be harder is a bit of a you need to talk to KPMG about your views of them, it might be.
We get a very good order from KPMG, as I'm sure you'd expect me to say.
A bit pricey, but good order. There's one in front there.
Yes. Hi, it's Tristan Sanson from Exane BNP Paribas. Sorry, a couple of questions. First, as regards to the SCSR, one of the elements of funding of the extra spending that will come in the strategic and defense and security review will be renegotiation of commercial terms with the supply chain. And can you help us understand what it means specifically for BA Systems?
Is there a risk of pricing pressure or renegotiation of some contracts coming from that? Second question, just a refinement. Can you help me understand actually in your 2016 outlook, what do you think is the range for organic growth you're going to get at group level? Having a number would be helpful. Third, if you could precise what you mean by strong operating cash flow in 2017, that would be also very helpful.
And finally, I would be interested in understanding the stakes of the successor program if you receive the main gate milestone in 2016. What does it mean really for cash flow and top line for the next two, three years for you? Thanks.
This is the last question. Look, whether successor goes through Main Gate or not, we are fully funded on the successor program at this stage, we're building up capability and rejuvenating capability, basically restructuring the yard. So it only goes through main gate. You don't know if you're going through a massive, massive loading of activity. It's just a continuation of the program through the activity.
And our business is growing in submarines across because Astute continues and the success of business grows. But don't worry about the main gate then has this digital impact that it suddenly trebles activity space. It's a steady increase of activity. In terms of the SCSR and about I mean, I think what they were saying was, look, we're increasing the defense budget of defense and support to £178,000,000,000 over ten years. What would you do if you were there?
Wouldn't you say, but that doesn't mean to say that the sort of the rules and regs and the terms and conditions are going to get easier. We want value for money. Have an obligation to get value for money, and they have a various number of mechanisms of how they deal with that with industry, and we consult with them on a regular basis. We, however, BA Systems, have a number of bespoke contracts because of the nature of what we deal with. And I do not believe the nature of those contracts are going to fundamentally change going forward.
What was the you got that one?
Yes. Have two questions. Growth in earnings for 2016, a number.
Organic growth, sorry. Revenue organic growth.
Revenue growth. I think if you model in all those guidances we give you by sector, you'll see that, that should come out as a slight increase in revenue year over year.
1%, 2% is fair.
Yes. And then your question about strong operating cash flow, I mean, what we do with that guidance is clearly, there is not a profit forecast at the top of that chart. But if you sort of look at the model of where we're using our cash, you'll see that if you take your the model the number you're using in your models for profit, there is no drain on operating cash flow through working capital or advances utilization. So it will be what we spend on pensions and then interest tax and dividends. You can work that number through, but you should see around 300 to £400,000,000 of free cash flow as a result of that.
In 'seventeen? Yes.
There's one in the front.
Shaila Key with Berenberg. Just a quick question on the cash contributions for the pension deficit. I've spotted that they're obviously just over GBP 100,000,000 lower than prior year and your four, five year run rate. Given your triennial review is in March year, I just wondered if you could explain what's happened there, the sort of mechanics behind it because I wasn't aware it was a flexible obligation.
Yes. The issue there is one about the buyback program. We have agreed schedules with the trustees, as to your point, every three years. But on top of that, we've been operating with each of the schemes basically in agreement if we do share buybacks, then sort of onethree of what we put into a buyback program, we would accelerate and put into the pension schemes. So clearly, where we have not completed the rest of the buyback program that we announced in February 2013, then this year, the £400,000,000 that we originally thought we were going to buy back program, a third of that has not gone into the pension scheme.
That's your £100,000,000 difference.
That's your expectation for next year?
Yes. Ben in the shadows.
Yes, Ben from Deutsche. A couple of questions, please. Firstly, can I just circle back on cash flow just to make sure I've sort of understood piecing together some of the bits you've said correctly? So you're saying the kind of customer advances cycle finishes in 2017, 2016 and then, yes, 2017 is clean. Prior to that customer advance cycle, if I look back in 2011, you had about GBP 1,400,000,000.0 of net debt.
So when do you think you get back to that GBP 1,400,000,000.0 level?
Okay. Well, let's just test that cycle. If you think we had £1,400,000,000 to your point in 2011, we're at £1,400,000,000 at the 2015. So no net change in that net debt over four years. We've been paying dividend at around £650,000,000 every year.
We've done a £500,000,000 buyback in that program as well. We've done about £200,000,000 worth of acquisitions. So that sort of maybe concept that we've been leveraging balance sheet to pay dividend is fundamentally flawed. That's not what we've been doing. 2016, from the guidance, you'll see there'll be a little bit of cash outflow and then add returns in 2017.
And our assumption is if we're out of that cycle of advances, then you expect the sort of normal profit to cash conversion that we're flagging for 'seventeen as a recurring thing going forward.
And the second question was just on cyber, where maybe my ineptitude at forecasting, but the margins came a little bit lower than I thought. Just to pick on one of your comments on increased investment cost. Just help us understand what is what in 'fifteen was that kind of P and L investment cost in cyber that you had in 'fifteen?
I mean, if we turn it I mean, first thing, we don't carry any of the sort of increased R and D on the balance sheet. We expense everything. The increase I believe it's for an increase year over year. We expensed £40,000,000 more in 'fifteen than we did in 'fourteen.
So what it is, is development in new product sets, development in new markets. So it's business development and product new product sets.
And at what point do you say we invested enough? Is that become a year over year sort of zero as a or does it keep going up?
No, keeps on going up, but the sales will keep on going up. The sales grew by 30% last year, and we're anticipating that we're to get a steady increase in sales going forward consistently forward. So it's the disproportionality of it relative to the sales volume. So they are not going to go up at the same 20% to 30% as the sales volumes.
If we look at it another way, Ben, when we bought all the businesses that form Applied Intelligence, all of those businesses were delivering double digit margins. Today, in 2015, with the amount of investment that we're expensing, it's low single digit. So we've got a lot of margin sort of growth and margin development that we expect to come from Applied Intelligence based on the investment we're putting in.
Okay. Any further questions? Okay. Thanks very much. Thanks for your time.