Good. Everybody in position. Excellent. Good. Well, good morning, everybody. Welcome. Thank you so much for joining us here this morning. I just wanted to say a few words that set the background to the real results that Ian and Peter 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 U.K., the United States, to the 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.
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. 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.
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 50 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 17.9 billion and underlining earnings per share of GBP 0.402, reassured by the strength of our order backlog of GBP 36.8 billion, and pleased that future cash generation and robust prospects have facilitated a healthy dividend of GBP 0.209 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 GBP 0.37.
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 Ian to provide a more detailed review of our performance and indeed our future prospects. Ian?
Thank you, Roger, good morning to everyone. Morning.
Morning.
Well, that's good. I'll spend a few minutes on the group's business environment and then ask Pete to address our 2015 performance and guidance for 2016. We've 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. BAE 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. 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 an 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&D, and we have active programs to attract, train, 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. 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-35 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-15 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 ship build 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, that 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 end of 2014, the Armored Multi-Purpose 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 U.K., the strategic defense and security review identified an increased GBP 178 billion defense equipment and support plan over 10 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 2040. 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 U.K.'s initial F-35 operational strength. The SDSR addressed the continued commitment to 7 Astute-class submarines and the replacement of the 4 Vanguard-class boats. The U.K. government reaffirmed its commitment to shipbuilding continuity. A fleet of at least 19 frigates and destroyers are expected to be maintained, including 8 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. A good SDSR for the armed forces and for our industry. Our U.K. 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 Finmeccanica 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 can 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-35 program is increasing at our Samlesbury advanced manufacturing facility, with much of the production investment in place to achieve the planned high volumes anticipated over future years. We are also very busy with Hawk. The first of the new generation aircraft for Saudi Arabia are 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 3 and pricing of Boat 5 to a value of GBP 1.3 billion. 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 50th year of the relationship, we continue to address current and potential new requirements as part of the long-standing agreements between the U.K. 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 are being 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, 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. 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 and critical national infrastructure customers. 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 former SilverSky business acquired at the end of 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?
That's it? Yeah. Thanks a lot.
There you go.
Cheers. Thanks, Ian, and good morning. As usual, I'll step through the results for 2015 and move on to our guidance for 2016. There has been considerable volatility in exchange rates during the year. For reference, the US dollar rate has averaged at 153 compared to 165 in 2014. The headline numbers compared to 2014, sales increased by GBP 1.3 billion to GBP 17.9 billion. Some GBP 0.2 billion of that increase was due to exchange translation. As expected, sales in the U.K. business were up by GBP 0.8 billion, 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 GBP 19 million to GBP 1.683 billion, 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 GBP 15 million for exchange translation. Underlying finance costs in the year were slightly lower at GBP 194 million. Underlying earnings per share were at GBP 0.402. This included two tax provision releases. One, as we announced in November's trading statement at GBP 0.026, and a second at GBP 0.017. 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 GBP 0.7 billion, and net debt at the end of the year closed within our guidance range at GBP 1.4 billion.
Order backlog has reduced to GBP 36.8 billion, 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 GBP 0.209 per share, up 2% on the 2014 dividend. In addition to the effect of exchange translation, where the US dollar closed at 147 compared to the opening 156, 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 Salam price escalation settlement were received in the year. In aggregate, working capital increased by some GBP 0.6 billion. The IAS 19 accounting pension deficit has decreased over the year to GBP 4.5 billion, and that pension deficit reduction also reduces the deferred tax asset. 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 GBP 23.8 billion, and that's after pension benefits paid out of some GBP 1.1 billion. In aggregate, across all the group's pension schemes, equity investments now stand at 48% of scheme assets. Over the year, liabilities reduced by GBP 1.2 billion to GBP 29.4 billion. Real discount rates increased by 30 basis points in the U.K. and by 40 basis points in the U.S., driven by increasing bond yields.
These discount rate movements reduced reported liabilities by around GBP 1.5 billion. 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 first half of 2016, and the revised allocation has been reflected in the numbers shown here. In total, the impact of all of these movements over the year is a GBP 0.9 billion decrease in the group share of the pre-tax accounting pension deficit. Moving on to cash. This slide sets out the movement from our net debt position of GBP 1,032 million at the beginning of the year.
The operating business cash flow was GBP 681 million. Interest and tax payments were GBP 289 million. Payment of 2014's final and 2015's interim dividend totaled GBP 655 million. Exchange translation and all other movements totaled GBP 127 million. As you will have seen, we issued a $1.5 billion bond in December with a mix of five, 10, and 30-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 million of maturing bonds repaid in August, we closed the year with gross debt of GBP 4 billion, cash of GBP 2.6 billion, and net debt of GBP 1.4 billion.
The cash flow performance of the five sectors is shown here. I'll return to this when I cover the results of each of the sectors. Just to note, the total cash outflow for pension deficit funding made in 2015 was GBP 274 million, and the cash outflow at head office contains GBP 177 million 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 three to GBP 400 million 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 GBP 284 million. We spent £168 million on company-funded research and development, and GBP 367 million 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 two times 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. 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 2016 a little later. The first of those sectors, electronic systems, and the numbers here in US dollars. Sales compared to 2014 increased marginally to $4.03 billion. 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-35 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 non-recurring 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 $6.1 billion, benefiting from awards for Enhanced Night Vision Goggles, F-15 electronic warfare upgrades, production of P-8 mission computers, and F-35 low-rate initial production batches. The Cyber and Intelligence Sector comprises the U.S. intelligence and security business, together with BAE Systems Applied Intelligence. 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 BAE 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 $3.5 billion. 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 $4.2 billion, 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%.
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. We have investment being made on the new floating dry dock facilities in San Diego. Order backlog reduced to $5.8 billion, largely for the trading out of the five-year MSMO contracts in the ship repair business and the CV90 Norway program. In the U.K. platforms and services sector, the year's sales of GBP 7.4 billion 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 3 program, and for increasing activity in the submarines business.
The return on sales was at 9.7%. 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&L increases. In 2015, 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 GBP 220 million. Consumption of customer advances occurred on the Omani, Saudi, and European Typhoon contracts. There's also been some rationalization cost charged against provision created in prior periods. Order backlog reduced to GBP 17.8 billion, primarily from the trading of Typhoon aircraft and carrier. Sales in the international sector of GBP 3.7 billion were 5% up over 2014, or 9% on a constant currency basis.
The trading increase comes from the high levels of support to the Salam Typhoon aircraft now in service and higher volume of weapon systems. The EBITDA of GBP 335 million is after charges totaling GBP 53 million in respect of the impairment and rationalization costs taken in the Australian business. There was an operating cash inflow of GBP 164 million, which includes the second payment under the Salam VOP agreement. However, you will recall that some GBP 200 million of receivables were collected in December 2014, 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 1st of January 2016, 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. The numbers shown here for 2015 reflect that transfer. For reference, our exchange rate planning assumption for the U.S. dollar here is at 145. Firstly, Electronic Systems. Overall, we expect 2016 sales in dollar terms to show low single-digit growth. In aggregate of 2016's projected sales, some 76% are in the closing order book, broadly consistent with last year's starting point.
On margins, we've increased our guidance range from 12%-14% up to 13%-15%, and we'd expect 2016'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%-9% range. Following 2015'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., here we expect sales to be around 10% lower. 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%-8% range. Turning next to platforms and services U.K., sales are expected to be slightly lower as European Typhoon deliveries reduce. In the naval domain, the higher sales levels from activity on the 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%-12% range. 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 Salam 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%-12% guidance range. To complete your 2016 models, headquarters costs are expected to be much the same as those in 2015. Underlying finance costs are expected to be some GBP 35 million higher for the cost of carry on the $1.5 billion 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 2016. 2015's earnings per share was 40.2 pence. That included two tax benefits, the one we previously announced at 2.6 pence and the second at 1.7 pence. Adjusting to a constant currency basis, that is applying a U.S. dollar translation rate of 145 to 2015's dollar earnings gives 36.6 pence. 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%-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, first, we are expecting capital expenditure to be above depreciation levels, and that reflects investment in a number of areas, including the new floating dry dock 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 GBP 300 million. The non-operating cash flow items are far more predictable.
Outflows for interest and tax are expected to total around GBP 400 million, Dividend payments to shareholders will be around GBP 0.7 billion. Under the transactions announced last year, we expect receipts of circa GBP 100 million under the restructuring of our Saudi partner companies. In aggregate, 2016 is expected to see an increase in net debt. However, as you can see from the narrative guidance for 2017, 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. With that, I'll pass it back to Ian.
Thanks, Pete. 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&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&D is fundamental. R&D spend last year was 7% of group sales, with a company-funded component representing 1%. However, R&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&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. In summary, BAE 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. Now we'll take questions. One at the front. Two at the front.
Thank you. Good morning, gentlemen.
Good morning.
This is Christian Laughlin 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, then, of course, continued growth in some international defense budgets, where do you see the biggest opportunities for new contract awards? Which domain, air, land, or sea, leads that opportunity set?
Well, all of the domains that we have have opportunities for future major orders. In the naval sector, in the U.K., we're just in the early phases of Type 26 and the replacement Successor submarine program. Astute still has well into the next decade to go. That area of the business is expanding. In our air business, F-35 is just at the early stages of ramping up production. We're continuing Typhoon. We have over 40% of our businesses in support services. In land, we're just at the start of a new cycle in terms of major programs. Jerry, would you like to comment on where we are in the land cycle around AMPV and amphibious?
Sure. Thanks, Ian. On the domestic side, as Ian alluded to, in the U.S., 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-2020. We see a great opportunity for growth there. In fact, on a like-for-like basis, even with these development programs, we're going to have modest growth next year in land. We think we have bottomed out, as we said last year. There are a number of international customers, as Ian alluded to, who are very interested. We've secured two very important orders this year internationally for the AAV. 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. A lot of potential in the pipeline, as we've spoken about the last couple of years. It's starting to mature.
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.
Okay, thanks.
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 beat WACC, and M&A has to beat buyback, to crudely summarize it. First question is, as an indicative, roughly what level do you see WACC as being? Secondly, what are the constraints in terms of liquidity, solvency, and so on? Does the outflow that you see in 2016 stretch that in any way? Do that push your comfort zone? 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.
Primed to sort out their services strategy before you then come back and do something?
Should I answer the last one, and then you want to go into the others? Look, we had some inbound inquiries onto our I&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 [inaudible] leadership through all that activity. We're very comfortable with the business.
Weighted average cost of capital. The group's WACC is around 7.5%. Obviously, it moves around all the time, but sort of 7.5%. That's sort of the benchmark. Obviously, when you look at M&A, you've got to risk adjust that, so that 7.5% is not the benchmark. We're looking at M&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 drives our interest cost. One of the big things is how it impacts the view of our trustees on our pension schemes.
We have 12-year deficit recovery plans on our pension schemes in place. The credit rating is a key metric for the trustees of the schemes in terms of evaluating the creditworthiness and therefore the term under which they prepare to accept a deficit recovery plan. 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 we should bear in mind?
There is a number they use. 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. They add that to debt. Clearly, today's position, we're saying that the pension deficit has come down by GBP 900 million. That would be seen as a reduction in debt. Has that changed the cash flow profile of the group at all? No, it hasn't. I agree. They do move in mysterious ways. We have to recognize that and deal with it accordingly.
Luckily, we understand their mysterious ways.
I certainly don't. Céline?
Good morning. Céline Fornaro, Bank of America, Merrill Lynch. 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. I remember you were mentioning, last year you had GBP 1.3 billion of pounds 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, we just didn't have the effective contract at the time. That is now in the order book.
Thank you. If you could comment on the U.S. short cycle businesses. My second question would be related to the cyber business. What was the reason to move back the geospatial business into electronics? Looking at the cash generation of that business, at least in 2015, it seems relatively weak. I was just wondering how we should think about that even in the new perimeter, why is the cash conversion so low there?
You should be pleased that we moved that business into electronic because it has a different profile of profitability and growth in it. 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. It's a simple comparison of can it work more collaboratively as part of the electronic systems businesses with prospects that we got all on its own, and the view was it was better placed in terms of the technology and capabilities of programs it had. 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, Jerry, 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 billion increase over the prior caps in the five-year plan. In addition, DoD has stated that between, I think 2016 and 2022, roughly in this time period, they're going to increase their investment accounts by 22% in those budgets. 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 use to fund outside U.S. operations, things in the Middle East, that is going to be a buffer account to allow for increased activity funding of those things. From a macro perspective, we see a very positive trend there. There's also a lot of dialogue with what's gone on in the Ukraine and Russia, as you can imagine, about pre-positioning some equipment, et cetera, which play very much to our strengths with the armor brigade. That's at a macro level.
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. 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 and one equal three. We talked about the combat vehicles, winning those programs.
Those kinds of programs, the F-35, the electronic warfare upgrade for the F-15, the combat vehicle programs that we have, we think we're building very durable backlog and very long cycle businesses that will be relevant. 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 that'll be on all the single aisles, both the Airbus and the Boeing airframes. We have very strong positions on the next generation Boeing aircraft, 737 MAX, 777X, which will all be coming into production post-2020. 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.
All of those trends we think portend well for this portfolio, particularly as these programs move into production late in the decade.
I'm looking forward to the first quarter review, Jerry. It sounds very encouraging.
As I said, towards the end of the decade.
Oh, that's right.
I'm sorry, on international, the orders?
Sorry, 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. If you think of the five-year support orders that we got in Saudi, I think, Guy, it's 2017, which is the renewal date. We're very heavily busy on looking at that support structure, because everybody gets fascinated and fixated on sort of major procurements of equipment. Just remember the portion of this business, which is enduring support and the 6,000 people that we have in Saudi doing that. We're getting into the cycle where we'll be bidding some very major support and upgrade programs. We're not without a lot of bidding activity. 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. Is the line down or something?
Good morning, gentlemen. Rami Myerson from Investec. Three questions. Where are you on your planning for the batch 2 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.
Keep it consistent 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 Type 45 and Type 26, which doesn't appear to be an exportable program? Lastly, can you talk a little bit about the BAE/U.K. MOD's UAV strategy? They've ordered a couple more UAVs, not from BAE, how do you think that develops over the next few years?
Let's do them in reverse order. As you know, we've talked about this before, and we actually showed a Taranis video up here at one of the things. Our emphasis is on unmanned combat air vehicles. That is not what they produce. If you think about turning Typhoon into an unmanned-type facility, they've mainly surveillance activities that they've been procuring. We have a number of active programs. I cannot take you through the detail because obviously of the classification of them. I don't want you to worry about that we're not active and engaged in programs that we feel very comfortable about. If you read the SDSR, Strategic Defence Review, and 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 SDSR again committed to 19 capital warships, as they call them. Exclude carriers from that because it's not in there. You're talking about the 6 Type 45s, the 8 anti-submarine warfare Type 26, and then a class of multipurpose frigates, which they talked about, which is the balancing number. The thing about SDSR is it defines capabilities, not contracts. You 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.
Will they be exportable?
If the Navy capability is such that they can be exported, that will be taken into account. The primary aspect is the protection of this country's borders. In terms of batch 2, 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, if you remember the trading statement, we said that Typhoon production would go from 1.3 to 1.1. That's what's still in this guidance. From the cash perspective, the numbers and 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. Yeah.
Mainly a question for Peter, although I think Ian has an accounting background.
A long time ago. I'll give it a go.
Appertaining to IFRS 15.
It's for you.
Have you got to change any of your long-term contracts accounting? 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, we've looked at it. This is around long-term contracting. We don't believe there'll be any material change to our numbers. 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 contract? Is it the end of 2017, Pete, which is the last year, for KPMG's audit? Yeah.
2017 is KPMG's last year.
The assertion that the new auditors will be harder is you need to talk to KPMG about your views of them, is my basis.
I know that.
We get a very good audit from KPMG, as I'm sure you'd expect me to say.
Bit pricey. A good audit.
There's one in the front there.
Yes. Hi, it's Tristan Sanson from Exane BNP Paribas. Sorry. A couple of questions. First, as regards to the SDSR, one of the elements of funding of the extra spending that will come in the Strategic Defence and Security Review will be renegotiation of commercial terms with the supply chain. Can you help us understand what it means, specifically for BAE 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 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.
Finally, I would be interested in understanding the stakes of the Successor programme. 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.
Let's do the last question. Whether Successor goes through main gate or not, we are fully funded on the Successor programme at this stage. We're building up capability, rejuvenating capability, and restructuring the yard. Even if it goes through main gate, you don't then go through a massive loading of activity. It's just a continuation of the programme through the activity. Our business is growing in submarines across, because Astute continues and the Successor business grows. Don't worry about that 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 SDSR and about, I think what they were saying was, we're increasing the defense budget of defense and support to GBP 178 billion over 10 years. What would you do if you were them?
Wouldn't you say, "That doesn't mean to say that the rules and regs and the terms and conditions are going to get easier. We want value for money." They 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, BAE Systems, have a number of bespoke contracts because of the nature of what we deal with. I do not believe the nature of those contracts are going to fundamentally change going forward. What was. You got that one? Yeah.
Yeah, two questions. Growth in earnings for 2016, a number.
Organic growth, sorry. Top revenue, organic growth.
Oh, 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?
Yeah.
Fair.
Your question about strong operating cash flow. What we do with that guidance is, clearly, there is not a profit forecast at the top of that chart. If you look at the model of where are we using our cash, you'll see that if you take the number you'll use in your models for profit, there is no drain on operating cash flow through working capital or advances utilization. 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 GBP 300 million-GBP 400 million of free cash flow as a result of that.
In 2017?
Yeah.
Okay. Thank you.
There's the one in the front.
Morning. I'm Charlotte Keyworth, Berenberg. Just a quick question on the cash contributions for the pension deficit. I've spotted that they're obviously just over GBP 100 million lower than prior year and your four, five-year run rate. Given your triennial review is in March next 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.
Yeah. The issue there is one about the buyback program. We have agreed schedules with the trustees, as to your point, every three years. On top of that, we've been operating with each of the schemes, basically in agreement, if we do share buybacks, one-third of what we put into a buyback program, we would accelerate and put into the pension schemes. Clearly, where we have not completed the rest of the buyback program that we announced in February 2013, this year, the GBP 400 million that we'd originally thought we were going to buyback program, a third of that has not gone into the pension scheme. That's your GBP 100 million difference.
Your expectation for next year?
Yeah.
Thank you.
Is that Ben in the shadows?
Yes, sir. 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 the piecing together some of the bits you've said correctly. You're saying the kind of customer advances cycle finishes in 2017, end of 2016, and then, yeah, 2017 is clean. Prior to that customer advance cycle, if I look back in 2011, you had about GBP 1.4 billion of net debt. When do you think you get back to that GBP 1.4 billion level?
Okay. Well, let's just test that cycle. If you think we had GBP 1.4 billion, to your point, in 2011, we're at GBP 1.4 billion at the end of 2015. No net change in that net debt over four years. We've been paying dividend at around GBP 650 million every year. We've done a GBP 500 million buyback in that program as well. We've done about GBP 200 million worth of acquisitions. 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 that returns in 2017.
Our assumption is, if we're out of that cycle of advances, then you expect the sort of normal profit and cash conversion that we're flagging for 2017 as a recurring thing going forward.
Thank you. 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 in 2015 was that kind of P&L investment cost in cyber that you had in 2015?
Okay. First thing, we don't carry any of the sort of increased R&D on the balance sheet. We expense everything. The increase, if I put it for an increase year-over-year, we expensed GBP 40 million more in 2015 than we did in 2014.
What it is is development in new product sets, development in new markets. It's business development and new product sets.
At what point do you say we've invested enough? Is that become a year-over-year sort of zero as opposed or does it keep going up?
It keeps on going up, the sales will keep on going up. The sales grew by 30% last year, we're anticipating that we're going to get a steady increase in sales going forward consistently forward. It's the disproportionality of it relative to the sales volume. They are not going to go up at the same 20%-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. 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