BAE Systems plc (BA) Earnings Call Transcript & Summary

Thank you very much and good afternoon, good morning to everyone joining. Welcome to our major programs presentation, with associated Q&A session afterwards. I'll just quickly run through the agenda before handing over to Charles. We're going to start with an introduction and welcome from Charles. And then Brad, our CFO, will then cover the key points from the trading update and highlight our tight alignment to customer priorities in our major markets. Then Charles and Tom will spend some time drilling down a bit further into our key programs and franchises to highlight the scale and duration and sales direction and why we feel well set to deliver good growth in the coming years. [ We'll finish up ] this section with some feature technology case studies to show how we are investing in the [ factory of tomorrow ]. We'll then have a roughly 10-minute break; and then as you are well versed, a traditional Q&A session. So you can ask questions on the online facility or e-mail myself directly, and I will pose the questions to Charles, Brad and Tom for roughly an hour before we wrap up. With that, I'm delighted to hand over to Charles, our Chief Executive. Charles?

Many thanks, Martin. And welcome, everybody. Thank you for joining us today. This is not the site visit event we would have planned but still important and good to connect through some video footage. And hopefully, we can use these to bring to life some of the fantastic privilege program positions we have, the duration and scale of those programs and a feel for some of the technologies we're developing to sustain the business well into the future. To position the session, I wanted to reaffirm the points we made in February and in July around the outlook for the business. The fundamentals of the defense business remain robust. Our strategy remains highly relevant and is working. The group has a well-positioned global defense portfolio. Governments in our key markets continue to prioritize defense and security given the threat environment, and we can play a role in the economic recovery phase for the countries in which we operate. We have a large order backlog and exceptional program positions providing visibility of growth. In addition, there remains a strong pipeline of opportunities. And the acquisitions that we did earlier in the year provide excellent opportunities to accelerate our technology strategy. This is our focus for today. Operational performance continues to improve and remains a priority. This all underpins our confidence in improving long-term cash generation. With the business focused on driving operational performance and cash generation, we have a strong and sustainable business model which is well set to deliver growth. COVID has clearly dominated the year, but the group has shown its strength and resilience, and I'm hugely proud of how we've responded. We have a short video to highlight the response the company has made to the pandemic and give a visual feel for the resilience we've built into our business. [Presentation]

Well, hopefully, that's given you a feel for how we've responded and maintained a strong performance in these challenging times. And we will not forget the lessons we've learned. With that, I'll hand over to Brad to cover the business and market update. Over to you, Brad.

Thanks, Charles. With 6 weeks left to go in this very eventful year, I am pleased to bring you an update on how things are shaping up. On the top line, our midyear guidance holds, where we said we would be increasing by low single digits in percentage terms compared with 2019. As expected, we have seen sales grow significantly in the second half of 2020 compared with the first half. On earnings, we have improved our outlook from where we were estimating at midyear. We are now looking at a reduction in percentage terms, versus last year, in the low single digits. We did have some headwinds in the form of foreign exchange where the pound has strengthened since June, but this has been more than overcome with stronger operational performance and a lower assumed tax rate. Regarding free cash flow, we should be around the GBP 800 million figure for the full year, in line with our midyear guidance. Demand remains strong, and we expect our orders for the year to exceed even our pre-COVID assumptions. In the U.S., we have seen demand continue to build with record backlog in our Electronic Systems business and continued growth across the broader U.S. portfolio. The integrations of the new additions to the group are going well and the businesses are delivering in line with expectations. Elsewhere, the recently announced order for 38 Typhoons in Germany will secure Typhoon production for years to come. Operationally, we remain resolutely focused on execution and delivery and converting the top line ultimately to cash. The team has done a remarkable job in adjusting to the many challenges this year, and the business is in very good shape. As a reminder: The 9.4p interim dividend will be paid as scheduled on November 30. So a quick tour around the shop, starting in the U.S., which is the largest defense market in the world. We continue to grow our business here both organically and through acquisitions. At the half year, the U.S. accounted for 46% of group sales, and we are set up well for further growth given our tight alignment with the National Defense Strategy. Our backlog in Electronic Systems is at record levels, growing by 14% in the first half of the year versus first half '19. We have posted increases across the ES portfolio, including strong growth in classified activity. The acquisition should deliver double-digit revenue CAGRs at high margins for years to come, helping to offset the impact of commercial aviation declines. Growing threat environment and the focus on near-peer adversaries drives the state of strategic priorities at the Department of Defense. And as you can see in the table, we participate in programs that map well with these directions, and these programs will remain highly relevant under a new administration. We see growth opportunities in the pursuit of autonomous vehicles, leveraging our leading positions in combat mission systems on land and our growing undersea capabilities. Our competitive advantage in precision, bolstered by the acquisitions, is increasingly important in air and missile defense, particularly in the growing hypervelocity technologies. Our capabilities in space and [positional] electronics, radiation hardened resilience and ground systems should lead to significant growth in this critical domain. And as a leading partner with DARPA, we collaborate at the cutting edge of defense technology, ensuring that we are well sited on future growth opportunities and requirements. Outside of the U.S., the U.K. business remained stable and strong, featuring long-term contracts like the Type 26 and Dreadnought programs. We employ over 30,000 people in the U.K., with an extended value chain far beyond that. We remain an important source of prosperity and capability for the U.K. government with a valuable role to play in technology and innovation. While our business in KSA remains stable, we see continued growth opportunities in Australia, where we are the leading defense contractor. The Australian government is clearly committed to increasing its capabilities, as evidenced by the recent expansion of defense budgets. We are very well positioned to help deliver solutions and drive growth. Across our other international markets, we are pursuing further Typhoon sales opportunities in Qatar and other European markets. And we expect MBDA to continue on its growth track, providing further support for our outlook. So to recap the headlines here from the trading update you saw yesterday. The business continues to deliver and is largely back to normal operating pace after the Q2 impacts from COVID. Our guidance remains in-line for sales and cash, and we have an improvement in earnings. As these next few weeks of 2020 wind down, we have very good visibility into what should be very strong top line growth in 2021 featuring both margin expansion and increasing cash conversion. Back to you, Charles.

Many thanks, Brad. Now this slide is one many of you have seen us present before and is the basis of our presentation today. Programs and franchises shown here represent over 60% of group revenues. None of these are sunsetting. They are either stable or in many cases growing, as Tom and I will look to demonstrate. A couple of our other most significant business areas not listed here, Brad covered in the positive market alignment slides in MBDA and Australia, both themselves well set with good visibility and opportunity. Tom and I will now spend some time drilling down further into this slide to highlight the scale and duration, a view on the 5-year sales direction and why we feel we are well set to deliver good growth in the coming years. A good place to start is with the F-35. As you all know, this is the largest defense program in the world. And as a Tier 1 partner, we're delivering up to 15% of each aircraft and running about 1 year ahead of Lockheed's schedule. We play a major role in our home markets. And full-rate production for us is expected in 2021 and will then be maintained for over a decade, with in excess of 3,000 aircraft in the program of record and just 600 so far delivered. Within our Electronic Systems division, electronic warfare volumes are expected to be above full-rate production, driven by the Block 4 upgrade program. So in respect to revenues and outlook, what does that mean for us? Well, in 2019, revenue across the Air and Electronic Systems divisions was around GBP 1.3 billion. As we move to the full-rate production, that is set to increase and will continue to grow as sustained revenues, currently at a low level, start to increase as the number of aircraft deployed increases. And there will be cycles of electronic upgrades, as illustrated by the recent Block 4 award. One thing we often get asked is to give an estimate around what our potential future revenue is from these program incumbencies, and really in some cases the backlog we can disclose reflects just a small part of the longevity of those programs. So we've given a feel for the illustrative future revenues on a number of programs. And here, for example, there was over 15 years of production ahead for the aircraft in the program of record, so by simply taking last year's revenue number and multiplying that by 15, you get circa GBP 20 billion, and that excludes sustainment. The other thing we wanted to highlight was where we have some opportunities on these programs. And for example, here on the F-35, the opportunity space is in 2 areas: firstly, further international orders extending the program of record; and secondly, extending our sustainment remit off the back of our availability services support model, especially as more and more international jets go into service. You'll notice in the upcoming video footage the ongoing trials onboard the Queen Elizabeth carrier, great to see. Let's go to the video. [Presentation]

Moving now to another of our key franchises, Typhoon support, and pulling out some key points. We provide maintenance, support and training for aircraft in service, working with our air force partners through an innovative and efficient availability service. We ensure operational requirements are met while driving value for money for our customers. We provide Typhoon support services in the U.K., the Kingdom of Saudi Arabia, Oman; and will do in Qatar. We are developing capabilities in an agile way and faster than ever before, providing a competitive advantage for our customers. An example of this is demonstrated by the radar upgrade contracts secured in 2020. And our technology development tied to -- on Typhoon is critical for underpinning the U.K. combat air strategy as we move forward on Tempest. And we'll talk more about that later. In respect of revenues, Typhoon is expected to be a key platform for our customers until at least 2040. Last year, support and upgrade was around GBP 1.8 billion. With upgrades ongoing; more jets still coming into service, only helped by the German order just announced; and with Qatar support ramping up in the coming years as the jets get delivered, we expect our revenues to continue to grow. Given the in-service longevity, you can see potential future revenues are probably at least GBP 36 billion. In respect of opportunities, this comes primarily in the form of further Typhoon orders and upgrades on the platform as we move forwards to the -- as we move towards the next-generation developments. This evolution is highlighted on the graphic in the slide and one we talked about at the Air Investor Day last year. Before playing some footage or video on the Typhoon support, it's worth just mentioning the Typhoon build, which is around GBP 800 million per year over the 5-year period as the consortium delivers the Kuwaiti and then the Qatari jets. When contracted, the recent German order will extend our production horizon out further, and there remains good opportunities for further orders from the partner nations and in the export market. Now let's go to that video. [Presentation]

So briefly covering where we are in KSA. Typhoon support in the kingdom, we've just covered. The rest of the support and training services business on the Tornado, Hawk and PC-21 platforms has good visibility and durability, as shown by the predicted out-of-service dates. At about GBP 1.5 billion per annum, we see the outlook here is stable, with the very-long-standing contracts renewed every 5 years. Moving on to Submarines. At our submarines build facility in Barrow, we have 2 programs at different ends of their maturity. Astute, the nuclear-powered and conventionally weaponed attack submarine, is a 7-boat program. 4 boats have been delivered; and there are 3 left to deliver, and these are at advanced stages of production. Dreadnought is the nuclear deterrent replacement submarine and is a 4-boat program, as you know. Production of the first 2 is underway, with the first boat due to enter service in the early 2030s. These build programs represent a key U.K. sovereign capability. And the U.K. government has and continues to invest heavily in recent years in the site development, the skills academy and in future technologies. This investment is crucial to maintain the key skills and capabilities required for these very long-term and critical programs to the U.K. As you can see from the time line, the build programs across these 2 is set for at least 20 years. In revenue terms, the overall outlook of GBP 1.4 billion per year is stable, with a visibility of future revenues of in excess of GBP 20 billion. As you watch the video, there is footage of the fourth Astute boat being delivered during lockdown this year, which was a great achievement by all concerned. Let's play the video. [Presentation]

Let's move on to ship build now. The Type 26 global combat ship is set to become a very significant program for the group in the coming years as 2 build programs first ramp up in the U.K. and Australia and we provide engineering support and book a design license fee on the Canadian program. Here in the U.K., the Type 26 is an 8-ship build program. The first 2 ships, HMS Glasgow and HMS Cardiff, are under construction. And first of class is on track to be delivered to the Royal Navy in the mid-2020s. In Australia, we won the Hunter class frigate contract. And the initial design and productionization phase is underway, with the build on the 9-ship program due to start at the end of 2022. In Canada, an expected 15-ship program is a different construct. Here the Type 26 design was chosen, but the program is led by Lockheed Martin and Irving Shipbuilding, with the BAE element being a warship design license fee and engineering support. On revenues, the program in 2019 was around GBP 600 million being nearly all Type 26 in the U.K. As the programs ramp up in the coming years, that revenue will more than double as the U.K. and Australian programs reach steady-state production and there is a contribution in engineering support revenues from Canada. Given the duration of the programs here, the illustrative future revenue stream could be estimated to be at least GBP 20 billion. In terms of opportunity, there then remains the chance of further export build awards or partnerships. Additionally, there is a significant opportunity to develop a truly global support offering, with the 3 classes of ship having a common acoustically quiet hull and open systems architecture to support technological upgrades, overall about 70% commonality across these 3 designs. And with bases in Australia, Canada and the U.K., there is potential for support at reach through a collaborative international approach. This could yield through-life savings and improvements in availability against historic norms. Initial discussions are already underway as we work with our customers to explore these opportunities. Let's play the video. [Presentation]

With that inspiring footage, I'll now hand over to Tom to cover some of the U.S. programs and franchises. Over to you, Tom.

Thank you, Charles. BAE Systems has more than 60 years of experience as a pioneer and world leader in full-spectrum electronic warfare systems. We've produced more than 10,000 tactical systems fielded on over 120 platform types around the world. As our adversaries grow in sophistication, we see a strong demand for our capabilities and solutions to detect and defeat the threats of today and tomorrow. We are investing in partnership with our customers to meet requirements for smaller, lighter and more advanced solutions that provide enhanced situational awareness. And we're working to develop and deliver next-generation cutting-edge solutions faster at commercial time scales. As the slide notes, we see strong growth over the coming 5-year period. In particular, we see opportunities for new orders and upgrades from international customers. Taking a closer look at the programs in this business, we can see here some of the key capabilities we provide: full-spectrum multi-domain electronic warfare, precision geolocation and direction finding and passive threat detection and situational awareness. We're also doing significant work to enhance electronic warfare capabilities with autonomous and network systems. One key advantage we offer across our solutions is our platform-agnostic architectures, which enable more rapid upgrades since they are modular and easier to scale. These rapid upgrades, in combination with our expertise in mission system integration, provide growth potential to our full-life-cycle support of these electronic warfare systems. You can see some of the key programs here. We covered our support of the F-35 earlier, but I want to add that we continue to provide electronic warfare and countermeasure systems, having recently completed Lot 12 deliveries earlier this year and now delivering under Lots 13 and 14. EPAWSS, which provides advanced aircraft protection and situational awareness on the F-15. The Digital Electronic Warfare System or DEWS, which is on a range of new and legacy aircraft. LRASM is a precision-guided anti-ship missile sensor we provide, and I'll talk a bit more about this program later as it's one of the many success stories out of our FAST Labs innovation hub. We also continue to support the electronic warfare system for the F-22 Raptor fighter jet. As you can tell, we are a leading provider of EW systems for fifth-generation aircraft and beyond. And of course, given the sensitive nature of electronic combat and the technologies that support it, a significant book of business is classified work. And now a short video highlighting our leadership in electronic warfare. [Presentation]

And now on to our military GPS business. Of course, one of the most significant strategic actions we've taken as a company this year began in January, as you will recall, when we announced 2 major acquisitions to join our Electronic Systems sector. You'll recall these acquisitions were a unique opportunity coming out of the Raytheon-United Technologies merger, and we successfully completed the second of these transactions to acquire the military GPS business at the end of July. The business case for the GPS business was a strong one, and we believe it remains strong with a positive outlook for sales growth over the coming years. Given the requirement for ubiquitous secure geopositioning in contested battlefields, we expect customer demand to continue for the U.S. military and partners worldwide. Our team has done an amazing job welcoming and integrating over 750 new employees during a pandemic. The integration is going very smoothly. And we just announced a $100 million investment in a new facility in Cedar Rapids, Iowa to house this business, which is part of our precision strike and sensing solutions business area. The business designs and produces advanced, hardened and secure GPS products that include anti-jamming and anti-spoofing technologies as well as the team's development of next-generation M code or military code GPS technologies for the U.S. military. It has an installed base of over 1.5 million devices on approximately 280 platform types around the world, providing a range of ground, airborne and weapon systems with reliable, high-performance operational capabilities in harsh environments. The acquisition supports our priority growth area precision guidance, which is aligned with the U.S. National Defense Strategy. Let's play the video. [Presentation]

And next, we'll turn to ship repair. We continue to shape our market-leading U.S. naval ship repair business, maintaining a strong, good pipeline for repair and modernization services. We are a leading provider with incumbent positions for nonnuclear ship repair, modernization, overhaul and conversion work with major shipyards located on both the Atlantic and Pacific coasts in San Diego, Norfolk and Jacksonville. Featured in the image on this slide, in June, we completed the first tandem dry docking for 2 Arleigh Burke class destroyers, the USS Stethem and USS Decatur, in our San Diego shipyard where they are now undergoing post-dry-docking work. As we continue to work through some of the near-term pandemic challenges, the sales outlook for this business is stable to positive over the coming 5 years. And the navy's demand for repair and modernization remains robust, in line with the National Defense Strategy. And we see opportunities to further leverage our infrastructure investments in current facilities and our dry docking capability to support the navy's goal of increasing utilization levels and ship availabilities. We'll roll another video. [Presentation]

Next, we'll turn to combat mission systems. Earlier this year, we completed a reorganization of our Platforms & Services sector that included the creation of our Combat Mission Systems business shown here. With a backlog of almost 1,350 vehicles, we are focused on execution while ramping up production volumes across the portfolio. We remain bullish on the long-term outlook for our combat vehicle franchise programs. And this positive outlook is underpinned by our long-term contracts for the M109, the AMPV, ACV, Bradley and M88 vehicles. We're on a path to transition AMPV and ACV from limited-rate to full-rate production, and the Bradley upgrade volumes have increased. Notably, we're making this progress against significant headwinds from COVID-19 impacts on our workforce and the supply chain. We've been investing in new technologies and modernizing our facilities to implement cutting-edge manufacturing techniques to meet increasing production volumes. We also see opportunities ahead with Mobile Protected Firepower, next-generation combat vehicles and exports. Now I know these programs are of significant interest, so let me share a bit more detail on where they stand. On M109, we're producing vehicles under a full-rate production contract we were awarded earlier this year. We're achieving our delivery targets and are working toward the army's plan of 689 vehicles. On the Armored Multi-Purpose Vehicle or AMPV, we are working under the low-rate initial production phase now, with the first vehicles delivered this year, in August. When the U.S. Army announced the program in 2015, it was slated for approximately 2,900 vehicles and valued at $10 billion over its life cycle. The amphibious combat vehicle or ACV is an increasingly important platform to the U.S. Marine Corps. The overall program calls for approximately 700 vehicles. And at present, we're in the LRIP phase under our current contract to produce 116 vehicles and are preparing for full-rate production. Following the June award on Bradley A4 upgrade program, we are under contract for 491 vehicle upgrades. And we see this program continuing with additional need for upgrades and with international opportunities. And we'll roll another video. [Presentation]

And with that, I'll turn it back to Charles.

Many thanks, Tom. So we've just covered some of the great examples of the incredible engineering capabilities and high-end discriminating technologies we have within BAE Systems. This gives us a strong base and growth outlook as outlined from the existing positions and technologies. We want to and can do more through advancing our technology positions. As you've heard from me over the last few years, we're working hard to drive forward at pace our technology strategy through investing more in self-funded R&D; making acquisitions to accelerate our positions, as shown by some small bolt-ons and the 2 U.S. acquisitions this year; and working with our customers, industry partners, SMEs and academia. Today, we want to highlight where we've talked about ramping up our self-funded R&D spend in the coming years to position us not just for the here and now but for the future as we look to drive further growth, providing a differentiating advantage for our customers and sustaining the business model over the long run. We're going to give you a feel for this by looking at 3 areas leading the way for us, namely Tempest, factory of the future in the Air sector. And Tom is going to cover FAST Labs in the Electronic Systems division, as he mentioned earlier. So on to Tempest. Launched in 2018 and in response to the U.K.'s combat air strategy, there is strong momentum on the Tempest program, despite the pandemic, as the team gears up to submit the outline business case at the end of the year. The main business case will be submitted by 2025, with production expected to begin the following year and initial operating capability planned for 2035. More than 1,800 people are working across -- are already working within Team Tempest across the MOD and industry, including hundreds of apprentices. And this will increase to more than 2,500 by 2021, providing job opportunities at all levels at this critical time in the country's economic recovery. As a whole, the Team Tempest partners are currently working on more than 60 technology demonstrations. At BAE Systems, we're leading this work in a number of areas, including augmented human performance, artificial intelligence and autonomy, cyber technologies and intelligence, surveillance, target acquisition and reconnaissance and also space and hypersonic technologies. And last month, we revealed some of the latest concepts under development. Leonardo in U.K. is developing new radar technology capable of providing more than 10,000x more data than existing systems. BAE Systems has begun flight testing wearable cockpit technologies, including augmented and virtual reality displays projected directly inside the visor of the helmet. And Rolls-Royce has been developing combustion system technology using advanced composite materials and additive manufacturing to produce lightweight, more power-dense components, which will enable the system to go further, faster or produce less carbon dioxide. International partnering is fundamental in defining and meeting the goals set out in the U.K. combat air strategy both addressing affordability but also providing strategic and capability benefits. We've made significant progress with Sweden and Italy. And we've started trilateral discussions with Saab and Leonardo aimed at strengthening the nation's combat air industrial collaboration and furthering a shared vision to develop world-leading future combat air capability. And on to factory of the future. As part of Team Tempest, we're also transforming the way we work to ensure that we can deliver this future combat air capability faster and more cost effectively than ever before. BAE Systems' factory of the future facility, located in the Northwest of the U.K., is the result of a multimillion-pound investment and collaboration with more than 40 blue chip and SME companies, along with several academic institutions. Drawing on Industry 4.0 technologies, the factory is a digitally connected hub of technologies designed to increase pace and cost effectiveness of future military aircraft production. Bringing together advanced manufacturing technologies, the factory will transform engineering processes. Automated robots, virtual and augmented reality will increase speed, precision and efficiencies; as well as reduce the costs associated with the manufacture of complex military aircraft structures. The factory also demonstrates a new approach to the way humans and machines can operate together. Cobotic and flexible robotic technologies remove the need for heavy, fixed, long-lead tooling; and can quickly switch from the manufacture of one item or platform to another. Intelligent machines and off-the-shelf robotic technology from the automotive industry have already been modified to operate at the precise tolerances required for military aircraft. We've made significant progress and recently started the manufacture of a demonstration front fuselage section using this robotic-assisted assembly for the very first time. For those of you who couldn't join us last year in Warton for our site visit, here is some video footage on Tempest and factory of the future to illustrate the incredible technology advancements already underway as we work towards the next generation of air battle space. Let's play the video. [Presentation]

So I'll now hand over to Tom to cover FAST Labs in the U.S. Over to you, Tom.

Thank you, Charles. So FAST Labs is at the core of our technology advancement strategy. And it promotes collaboration across all of our businesses to identify, incubate, develop and implement discriminating technology capability. Our scientists and engineers deliver breakthroughs for some of the toughest technology challenges in defense, aerospace, power and propulsion and security, focused on the 5 key areas of advanced electronics, autonomy, cyber, electronic warfare and sensors and processing. As our innovation engine for BAE Systems, the business has adopted commercial technology approaches to fuel its innovation velocity, including external technology scouting. We are accelerating the pace of our innovation and technology transition with a dedicated technology scouting team. This speed is critical since our technology pipeline is a key factor in sustaining our growth trajectory. We are continuously seeking to partner and collaborate with the external innovation ecosystem to drive rapid transition of disruptive capabilities, moving from concept to integration on a customer's program of record. This includes a range of potential partners from accelerators to universities, to venture capital. Today, we have nearly a dozen venture capital firms we collaborate with regularly as we look to leverage external technology into dual-use military applications. One such example is GenXComm, an [ In-Q-Tel ] portfolio company with commercial technology for simultaneous transmit-and-receive technology, which is an attractive technology for electronic warfare applications. Our research areas continue to execute customer-funded R&D from government labs such as DARPA, the air force research lab, the Office of Naval Research and others. Technology transition via this model has and continues to deliver products with disruptive capability like LRASM or the Long Range Anti-Ship Missile sensor. LRASM was a DARPA development and demonstration program culminating with flight tests back in 2013; and has now become a navy program of record, starting in 2014. The program focused on an air-launched offensive anti-surface warfare weapon to counter the growing maritime threats in the anti-access/area denial environment. BAE Systems produces the seeker and guidance system for LRASM for Lockheed Martin, and the sensor enables the missile to seek and attack specific high-threat maritime targets. As a result of the original transition, we are today positioned for several new opportunities aligned with the navy's Offensive Missile Strategy looking to develop next-generation weapons to address future threats. Back to you, Charles.

That's great. Thanks, Tom. And with that, we're going to head to a short break before we take Q&A. So I think, Martin, we're going to say about 10 minutes…

Yes. So just top of the hour…

Just top of the hour, we'll regroup.

Yes.

So thanks for joining. And we'll see you in 10 minutes. [Break]

Great. Well, good afternoon again, everyone, and good morning to those in the U.S. Welcome back to the second part of today's session, which is going to be a question-and-answer session primarily led by myself, Martin Cooper. We've got Charles, Brad and Tom, who will field the questions. We're going to allocate just about an hour to this session. We've had quite a lot of questions in advance, and I can see a good few coming in online. So thank you for those.

So to start, we will start with those that people submitted in advance. And it's probably no surprise to most of you listening that one of the key questions we've had in is around the outlook for defense spending and the impact of a Biden presidency with a GOP likely Senate hold on defense spending looking forward. So perhaps I will hand that one straight over to you, Tom, to start with on that.

Great. Happy to take that, Martin. Thank you very much. I -- yes, certainly a lot has been written and speculated about how the transition will impact the defense budget. I think it really sort of comes down to the fundamental point that the threats around the world are -- have not changed. And that, while a President Biden and his administration may put their own stamp around the edges of the defense strategy, we think the National Defense Strategy will stay largely intact. The threats from China and Russia remain. And that is really what's driven the -- sort of the momentum in the areas and the priorities that the services have been paying attention to. And so I think -- we think the work we've done in our -- with our own portfolio here over the last handful of years and aligning around those priorities, suits us well. So we think -- I mean, as we've said, as has been written, I mean, we are expecting a flattening budget environment. We don't -- especially given what will likely be a balanced government, we'll find out in January, but the likelihood is we'll have a Republican senate. We think that that balance brings some stability to the overall posture on the budget. We saw Wall Street react favorably to that as well. So that gets at the highlights. I mean, I think, as we look at our -- again, at our portfolios and some of the investment and the acquisitions around precision guidance, I mean, these are the themes that come up again and again as we talk to our U.S. military customers. We participate in and get outbriefs around some of the war games that have been going on. I mean these are the technologies and the priority areas that are bubbling to the top, and we like our position.

Great. Thanks, Tom. Perhaps we had a sort of a follow-on as well, which was -- and I guess perhaps it's linked to the F-35 or the UAE announcement the other day, but what would you view at this time is the likelihood of a Biden administration continuing to actively support foreign military sales?

Yes. So the UAE announcement, I mean there are still quite a few hoops to jump through there in order for that to be a done deal. But I mean, just on the broader question of Biden's support for FMS, I mean, I think that will continue. There may be some change in posture around the geographies supported there, but I think there has been, back into the Obama administration even, when Joe Biden was the Vice President, I mean you saw support for foreign military sales. About half of our international business in the U.S. goes through FMS, the other half through direct commercial sales. And so we would expect that to continue. The areas that we target, the countries and the technologies we would look to sell are all, I think, in the right spot.

Great. Thanks, Tom. Another area, Charles, that we get asked a lot around, and we've had some questions in, is about the position here in the U.K. with the integrated review ongoing and defense spending outlook in the U.K. Do you want to cover that question?

Yes, I'm very happy to, Martin. I mean as many of you on the call will have read that the U.K. is -- has undertaken the integrated defense, foreign policy and security review. That is, I mean, currently held up. We're not entirely sure when the actual review will get published. And then there's much debate around the associated spending settlement. Obviously, the MOD were looking for a multiyear review, but in the light of the -- a multiyear settlement, but in the light of the COVID pandemic, I think there is at the moment a live debate as to whether it's a single-year settlement, a roll-on, or it ends up being some kind of a hybrid where some of the big programs get multiyear settlements and other parts of the defense portfolio get a 1-year settlement. The point I always make with our U.K. position is that we are on these big, long-term programs. And the bulk of our U.K. business, I mean 90% of our U.K. business, is associated with these big, long-term program positions. And on some of these big programs like Dreadnought and Type 26 have this marching army effect, but also budgets. If you -- I mean, if you make short-term adjustments to budget, all that does is delay schedule and end up, over time, massively increasing the overall program budget. And we have a sophisticated customer who understands that. And it is for that reason that I've maintained for quite some time that our overall outlook for our U.K. business is basically steady as she goes. It's a stable outlook for both revenue and margins, in a sense, despite all that gets written about the ongoing integrated review.

Great. Thanks, Charles. That's probably a good lead-in to a couple of questions we've had online about margins and margins looking forward, so probably one for you, Brad. One we've had in is about is there potential for BAE to improve its group -- overall group EBITA margin. And we've had another one in around sort of some of the moving parts on some of the programs. So just things like the ramp-up in the Type 26 program, could that be an impact downwards on margins, while repricing on AMPV might be not? [Do you want to perhaps] comment on the overall margin outlook?

Yes. So I think we're well set for margin expansion here. I mean if we just look at the mix of where our growth is coming from, we're going to have much higher growth rates coming from our Electronic Systems business, which obviously has the highest margins in the group. So as that revenue expands relative to the other revenue streams, the margin lifts from that. We'll also get a full year of acquisition results and -- next year coming from the GPS and the radios business. So that full year effect also has a nice margin expansion effect. And then across the portfolio, certainly when you compare '21 to '20, of course, '20 has the COVID impacts [and a] recovery scenario in particular. Those won't happen next year, so we will have a lift coming from that. And I think, Type 26, the point there, that's actually been an -- overall in Maritime, I think, in general we've had nice improving margins there. But we feel that that will be a stable outlook there. And then broadly speaking, if you look at combat vehicles, consecutively over time for the next several years out, we've got a few effects happening. We've got, first of all, vehicle volumes improving and advancing, and that gives you some scale benefits. You've got learning curve benefits as well with that. And then you've got pricing events where you convert from low rate to full rate. So I think those factors there combined for, I think, nice margin expansion in combat vehicles. So really when you look across how the portfolio looks and the shape for growth, and we do have good visibility on top line growth, there will be a natural fall-through effect on that too. And we're also focused on making sure that our management and administrative costs are kept in-line so that, when we do get top line growth, we get more fall-through in profit. So just the growth from the portfolio looks good. I think the mix of the growth is helpful for margin expansion, and we're focused on general efficiencies.

Great. Thanks, Brad. I think another one. Clearly margin is always meant to turn into cash, so cash is often talked about across the group. Perhaps 2, just 1 very tactical question come in around DOD accelerated payments. And has that been a net gain this year for us? But then perhaps more widely about sort of perhaps the 3-year or long-term trajectory on cash generation and how you see it. Thank you.

Yes. I guess, the first part of that, yes, we did have in the first half of the year -- you saw in our results at the half year a little bit of a positive operating cash flow. And a lot of that came from some of these constructive measures that the government customers were taking. A lot of that unwinds in the second half, so I think it's sort of net neutral for the full year. We have talked about cash guidance for this year being around GBP 800 million for free cash flow. And so all that is embedded in that guidance number. In general, as we kind of look back in the last few years, when you look at our earnings after tax, interest and minority interest, our cash conversion has been sort of in the mid-50% range. And as we look forward, I see that -- and as we really continue to increase our focus on conversion, I think we have a ramp to get up to the low 70s next year. And then beyond that, as the pension obligations fall away, which as you'll recall we have one more pension payment to make as part of our deficit funding program, that's another ramp-up in our conversion. So I see us getting into the 80s after that. So I think we're in a real nice path of, a, top line growth; followed by margin expansion; and increasing cash flow conversion.

Great. Thanks, Brad. Tom, back over to you for a couple. Firstly, we've had one in saying, can you give us an update? Probably a further update, and we covered it a bit, on the 2 recent acquisitions, the ATR business and the GPS business, now we've had time to sort of get on with the integration. Are you still excited about the growth prospects of these businesses and how they fit in with your Electronic Systems activities? Perhaps just expand a little bit more on our thought process there, Tom.

Thank you, Martin. Yes. I mean I love to talk about the 2 acquisitions. I mean we are as delighted today, if not more than, about these -- than we were when we were successful in our pursuit of them. So for -- we'll start with the radio business. I mean really a smooth integration. I mean this closed back in May right at the height of the pandemic; again a real tribute to the team's ability to welcome a group of employees, around 100 employees, to BAE Systems' family with all that drama going on around them. That said, the business is ticking along like clockwork. In fact, in June, you may have seen that we were awarded full-rate production on the ARC-231A radio. I mean we spoke about this a bit during the acquisition process. This is a tried and true rotary-wing aircraft radio. And the 231A is the software-defined version, so this is the -- this brings all new capabilities to this sort of communication mission and allows for more and better networking amongst aircraft, right? And all of the future of manned, unmanned kind of scenarios will depend heavily on good, reliable covert communications. And so that's where that business is doing well. And then the -- I mean, how can you not get excited about that video and the sorts of things going on in the GPS business? Again a really smooth transition; and the integration going very, very well. The team out there is excited about who -- we're breaking ground on their new home not far from their current site. Business is proceeding well. I think I've mentioned, like within a day or 2 of the close on the business, we were shipping military GPS hardware with BAE Systems' logos on the shipping cartons. And so a real tribute again to good, solid integration there. I mean, just from an outlook standpoint, you may have seen an announcement this past Friday where the team is a recipient of an award for a couple of hundred million dollars-plus for already the next generation, the development of the next generation of these military electronics; the core of the electronics that will become the next generation of this M code, more resilient for what we see as the threats to the future. So just really good progress and a couple of really sort of encouraging wins there. We see that the future being very bright for those 2 acquisitions. Thank you, Martin.

Excellent. Thanks, Tom. I'm not going to let you off without covering I&S. We've had a question in about I&S and its outlook and the future. Clearly, we ran a process, I mean, 5 years ago now on that business, but perhaps you could give us an update on how that business and franchise is performing. Clearly, about a $1.6 billion franchise we didn't cover today, but could you give us an update on how that's looking?

Yes, absolutely. Thank you, Martin. So here's a business, a services-oriented business, supporting DOD and many of the agencies here in the U.S. And I've got to say, and I think this is true, I could say this of the industry, that when COVID hit, I mean, there was quite a bit of fear for the services businesses as they -- many of these programs actually take place in government facilities. And as the government saw the need to start depopulating their facilities to make them more safer for the folks who were coming in to the workplace, that would be -- have a negative impact on these services programs. And then our discussions with our customers there helped to drive what came out of the Section 3610 of the CARES Act, which largely replaced the revenues for -- from those kind of programs. And so despite that and in fact in many instances on our I&S programs, the sort of skills that we provided, if they were not able to do that sort of work remotely, and much of the classified work fits that category as you can imagine, our teams were being called back relatively early in the process. And so we were able to migrate back into standard operations, although obviously following all of the CDC guidelines and so forth. But sort of the net of that is that business came through COVID-19 in a much better shape than what was expected when that whole thing initiated, and our positions continue to be strong there. I mean good customer demand; a good, continued pull for the kinds of skills and resources that we have in those services business. And I think that team has done a remarkable job delivering on results and as the guidance would suggest in the midst of all of what's going on around us. Thank you, Martin.