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Edited Transcript of BA.L earnings conference call or presentation 31-Jul-19 8:30am GMT

Half Year 2019 BAE Systems PLC Earnings Presentation

Farnborough Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of BAE Systems PLC earnings conference call or presentation Wednesday, July 31, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Charles Woodburn

BAE Systems plc - Group CEO & Executive Director

* Gerard J. DeMuro

BAE Systems plc - Executive Director & CEO of BAE Systems, Inc.

* Peter J. Lynas

BAE Systems plc - Group Finance Director & Executive Director

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Conference Call Participants

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* Andrew Edward Humphrey

Morgan Stanley, Research Division - VP

* Andrew Paul Gollan

Joh. Berenberg, Gossler & Co. KG, Research Division - Senior Analyst

* Benjamin Michael Heelan

BofA Merrill Lynch, Research Division - Analyst

* Charlotte Anne Keyworth

Barclays Bank PLC, Research Division - Analyst

* Jaime Bann Rowbotham

Deutsche Bank AG, Research Division - Research Analyst

* Nick Cunningham

Agency Partners LLP - Managing Partner

* Olivier Brochet

Crédit Suisse AG, Research Division - Research Analyst

* Robert Alan Stallard

Vertical Research Partners, LLC - Partner

* Sandy Morris

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [1]

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Good morning to everyone and welcome to the 2019 Interim Results. I'll start with the operational and strategic updates for the half year. Pete, as usual, will cover the detailed financials, and we'll take your questions at the end of the presentation.

The first half has seen an improving operational performance on a number of fronts, a set of results that underpins our guidance for the full year and continued progress on a number of strategic areas. In our key markets, the position is broadly unchanged. The U.S. business further enhanced the outlook with the order backlog increasing by $1 billion. The recent 2-year agreement to lift the U.S. budget caps is encouraging, adding near-term fiscal clarity and is in line with our planning assumptions. We remain well aligned with customer priorities and growth areas. In the U.K., we are focused on delivering our long-term contracted positions in Air and Maritime.

In Saudi Arabia, we continue to provide equipment, support and training under government-to-government agreements. Following the updates in March from the German government regarding export licenses, we continue to work closely with industry partners and the U.K. government to fulfill our contractual support arrangements in the Kingdom. We noted the judgment in June from the Court of Appeal, directing the Secretary of State for International Trade, to revisit the process for granting licenses for the sale of military equipment to Saudi Arabia. We will assess the results of this reconsideration once it has been made.

Whilst the geopolitical environment does remain challenging, the group has a strong order backlog and balance sheet, a well-positioned portfolio and long-term positions on key programs. These are foundations for us to deliver growth and sustainable cash flow. Reflecting this outlook for the business and performance to date, the interim dividend has been increased by 4.4%. Our priority is the delivery of consistent and strong operational performance for our customers and shareholders. Appropriate actions have been taken to tackle operational challenges, and we are ramping activity across a number of our businesses.

Future growth is underpinned by performance on our big programs. So I'll run through an update of how they're progressing just as we did at the Capital Markets Day.

On F-35, the 2019 production ramp-up progresses well towards 140 sets with full rate production levels targeted in 2020. We achieved 67 in the first half. The Qatar Typhoon and Hawk contract is meeting its contractual milestones, and we have recently signed a contract amendment that accelerates the delivery of Typhoon aircraft. Typhoon support continues to perform strongly. And with the Centurion standard having been declared, the U.K. Tornado fleet successfully retired from service on schedule.

In our U.K. Maritime business, work continues on the manufacture of the remaining Astute class submarines with Boat 4 due to exit Barrow later this year. Activity on the Dreadnought program is ramping up, along with the associated major program of building works at the Barrow site. Progress is being made on the Offshore Patrol Vessels with the second ship of 5 HMS Medway accepted by the customer in February and the third ship, HMS Trent being very close to acceptance. This 5-ship program will be completed in 2020.

On the aircraft carriers, HMS Prince of Wales remains on track for sea trials later this year. The Type 26 program is progressing towards its first of class contractual acceptance in the mid-2020s. And in Australia, the Hunter-class frigate program is in the early stages of mobilization under the initial 4-year design and development phase.

In addition to the management changes made, investment in automation and processes has continued in the first half in our U.S. combat vehicle business to support the ramp. We are making slow but steady progress on Paladin, remaining on track to achieve production of 8 vehicles per month by year-end. AMPV and ACV are progressing, with the first ACV undergoing acceptance testing and benefits being seen from the robotic welding lines now installed. With the final commercial ship constructed and delivered, the ship repair business is focused on its core mission of ship repair and maintenance for the U.S. Navy. There is no change to the provision on the Radford subcontractor performance issue taken last year.

As you've seen from the results, the performance in Electronic Systems remains strong as production ramps on F-35, APKWS and a number of classified programs.

To summarize our operational status, steady progress is being made to address our challenging programs with Paladin remaining a clear focus and a continued strong performance across many of our big programs underpins our full year guidance and covers the restructuring charge taken in Applied Intelligence, which I'll come to shortly.

We are very focused on driving our 3 strategic priorities of operational excellence, improving competitiveness and advancing technology as we look to shape the business for the future. The Air Investor Day laid out our strong credentials and performance in current programs, diverse geographical footprint and exciting future opportunities.

The next phase of the U.K.'s future combat air program has commenced between industry partners and the U.K. government, and we are delighted to welcome Sweden to the program as recently announced. In our Applied Intelligence business, government services is performing well and financial services remain a core offering. Following a strategic review of commercial cyber, we've commenced a process for the disposal of the ex-SilverSky business. We've also decided to exit the U.K.-based Managed Security Services business. This has led to a rationalization charge at the half year.

Cybersecurity is, however, an increasingly important part of government security and a core element of stewardship for companies in a sophisticated and persistent threat environment. The services and products we offer in our remaining core business of around GBP 450 million per annum are expected to drive growth and improve returns.

In the U.S., and aligned with our strategy of bolt-on technology acquisitions, we acquired Riptide Autonomous Solutions, a provider of innovative, unmanned underwater vehicles. We shall continue to look for further opportunities to enhance our Electronic Systems portfolio.

In July, following regulatory clearances, the new U.K.-based land vehicle joint venture with Rheinmetall was formed. In Saudi Arabia, in support of the Kingdom's priorities and as part of our ongoing dialogue with Saudi Arabian military industries, we continue to restructure the group's portfolio of interests with the completed sale of our stake in AACC and expected sale of our stake in AEC.

Finally, and as Pete will outline, we further strengthened the balance sheet by repaying the $1 billion maturing bond from cash and reached agreement in respect of certain overseas tax matters.

So in conclusion, we are maintaining group level underlying earnings guidance and driving program performance, whilst continuing to take actions around the portfolio, in line with our strategy to enhance performance. The group has a strong balance sheet, combined with a large order backlog, long-term program visibility and an evolving pipeline of opportunities, which all provide the basis to deliver growth and sustainable cash flow.

I'll now hand over to Pete to run through the financials. Over to you, Pete.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [2]

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Well, thanks, Charles, and good morning to everybody. Just before I get into the numbers, I'd like to remind everyone that these are our first results we prepared under IFRS 16 lease accounting. The adoption of that standard increases EBITDA by circa GBP 50 million on a full year basis, and that's been matched by higher finance costs. There is no restatement to the 2018 numbers.

In terms of exchange translation, there has been a benefit from the stronger U.S. dollar. For reference, the dollar rate averaged 129 in the first half of this year compared to 138 last half year.

So the headline numbers and compared to the first half of 2018. Sales increased to GBP 9.4 billion. That's up 4% on a constant currency basis. Underlying EBITDA of GBP 999 million was 14% higher than last year, and that equates to a 9% increase on a constant currency basis and after removing the IFRS 16 change. And this increase largely reflects the absence in this half year of any material program-related charges.

Underlying finance costs in the first half were GBP 29 million higher, and that includes GBP 25 million for the IFRS 16 impact and GBP 6 million on the stronger dollar.

Underlying earnings per share were up 11% at 21.9p, and that's 8.4% on a like-for-like basis, and that's with an effective first half tax rate of 17%, consistent with last year's. In addition, and as announced on July 18, there was a one-off benefit to earnings of 5p, arising from agreements reached in respect to an overseas tax matter, net of a provision taken against an exposure arising from the EU decision on the U.K.'s Controlled Foreign Company regime. And there is a bridge chart highlighting all the major movements from the first half of '18 attached to the presentation materials.

There was an operating cash outflow in the first half of GBP 309 million and net debt at June 30 stood at GBP 1.9 billion, and I'll cover the cash position on subsequent charts. Order backlog has reduced marginally over the 6 months to GBP 47.4 billion, with trading on multiyear long-term contracts in the Air sector, partly offset by further growth in the U.S. businesses.

And finally, the interim dividend has been increased to 9.4p per share, and that's up 4.4% on the 2018 interim.

There were a limited number of items impacting the balance sheet in the first half. Firstly, with the adoption of IFRS 16, GBP 1.3 billion now appears both within fixed assets and lease liabilities. On working capital, there's a number of working part -- a number of moving parts, which I'll come back to when I cover the cash by sector.

On pensions, the accounting deficit at the half year has increased to GBP 4.3 billion. Discount rates have reduced by 60 basis points in the U.K. and by 70 basis points in the U.S. However, increased mortality assumptions following the latest actuarial tables have reduced liabilities and investment returns were at 9% in the first 6 months. As you all know, the accounting changes have limited impact on the funding position of our schemes, and that funding position is currently estimated at some GBP 2 billion lower than the reported accounting number. Of our 9 U.K. schemes, 3 of the smaller ones are now fully funded, and on the other 6, funding levels range between 88% and 98%.

One other point on the balance sheet, the assets held for sale contain our U.K. vehicle support business going into the joint venture with Rheinmetall and our interest in the AEC company in Saudi Arabia where disposal is expected by the end of the year.

Moving on to cash. This slide sets out the movement from our net debt position of GBP 904 million at the beginning of the year. There was the operating business cash outflow of GBP 309 million. Interest and tax payments were GBP 265 million. 2018's final dividend paid in June, plus dividends paid to minority interests totaled GBP 449 million. All the other cash flow movements totaled GBP 38 million. In June, and as planned, we repaid a maturing $1 billion bond from cash held. And so we closed at June 30 with gross debt of GBP 3.4 billion and cash of GBP 1.5 billion. That net debt number of GBP 1.9 billion is better than expectations, but that is due to timing of cash flows on the Qatar program, both in terms of an accelerated receipt and later payments to subcontractors.

The cash flow performance of the 5 sectors is shown here, and I'll return to this when I recover the -- when I cover the results of each of the sectors. But just to note, the total cash outflow for pension deficit funding in the period reported to the head office numbers was GBP 160 million.

So moving now to the sectors, and I'll cover the year-to-date performance here and back to the full year outlook a little later. And the first of the sectors is Electronic Systems, and the numbers in U.S. dollars. The sector sales of $2.8 billion are 11% up over last year, albeit with some first half bias. Growth in the defense businesses was at 10% as the F-35 and APKWS programs continue to ramp up and classified activity expands. Commercial sales of engine and flight controls and HybriDrive units also grew by some 14% and commercial sales were more than $600 million in the first half.

The return on sales achieved was at 14.8%, and first half conversion of EBITDA reflects the usual second half bias, and we would, therefore, expect an improved conversion level over the full year. Order backlog grew again to a new record of $7.6 billion, and that follows further awards on F-35 and APKWS.

The Cyber & Intelligence sector comprises the U.S. Intelligence & Security business, together with BAE Systems' Applied intelligence. And the numbers again here in dollars. In aggregate, the sales of $1.1 billion were broadly unchanged. Sales in the U.S. business were down marginally and in Applied Intelligence, the sales were up by 6%, all coming from the government business line. Following our decision to dispose of the ex-SilverSky business within Applied Intelligence and to exit from U.K.-based Managed Security Services, a restructuring charge of GBP 25 million has been booked in the first half. Whilst the U.S. business delivered a 9% margin, the aggregate for the sector was at 2.9%, reflecting that charge with AI. Clearly, the planned exit by the end of the year from those areas of Applied Intelligence should be margin-enhancing into 2020 and beyond.

Cash flow is expected to improve in the second half, although the GBP 25 million restructuring is largely a cash cost. And as expected, the order backlog was stable at $2.4 billion.

In the Platforms & Services sector, sales were up 4% to just under $2 billion. As expected, there is a second half bias in the ramp-up of U.S. combat vehicle production activity. Margin performance for the first half improved to 8.9%, absent the charges taken last year on Radford facilities construction and commercial shipbuilding. However, the return on sales for the full year is expected to be slightly lower as combat vehicle volumes of lower-margin sales increase in the second half.

First half cash flow was slightly better than last year, reflects the significant working capital held in the combat vehicles business. We continue to expect to see this converted into cash flow as we move through the last quarter of this year and into 2020 on the increased production deliveries. Order backlog has further increased to $7.2 billion, mainly on award of low-rate initial production for AMPV.

In the Air sector, sales were at GBP 3.4 billion, slightly ahead of last year. Activity on the Typhoon and Hawk program for Qatar and sales from MBDA are expected to ramp in the second half. Given the very early stages of the Qatar program and therefore, the lower margin recognized, those second half sales on Qatar will be dilutive to the full year return. In addition, there is a second half weighting of the self-funded R&D spend on the Tempest future combat Air program. The cash outflow in the period reflects timing of receipts on international Typhoon programs and utilization of advances on the Saudi support contract. In addition, there has been utilization of the advance held on the Qatar program, albeit that is now more weighted to the second half year.

I'd also note that there was a pull forward in customer funding to the first half of some GBP 80 million following the contract amendment to accelerate aircraft deliveries. And I'll talk a little bit more about that when I get to the cash guidance. As expected, order backlog reduced to GBP 25.9 billion, primarily for the trading on multiyear orders received in prior years for Saudi support.

Sales in the Maritime businesses for the first 6 months of GBP 1.5 billion are 5% up on 2018 with a slight first half bias for higher activity levels on the Carrier program and in Portsmouth Naval Base support. EBITDA in the first half was at 8.7%, back within our guidance range. There was an operating cash outflow of GBP 92 million, which includes utilization of the naval ships provision created last year and timing across a number of programs. And the annual funding on the U.K. munition supply contract continues to be scheduled for December.

Order backlog is a little changed at GBP 8.7 billion, with further awards for funding on the Dreadnought program being received, less the sales trading on Astute, Carrier and Type 26. And for reference, there is a chart providing a summary of the trading performance of all 5 sectors and the numbers for HQ appended to the presentation posted on the web. And whilst I wouldn't normally reference the HQ numbers, there is one point to note. Within HQ, we have taken a charge relating to a claim following the fire at our Holston munitions facility, of which GBP 10 million was self-insured.

So moving to guidance. And this chart is the same as presented at the Capital Markets Day back in May. It provides the year's guidance as we set out back at the February results announcement for each of the sectors, but then adjusted for the impact of IFRS 16. And whilst we expect no changes to the overall group earnings guidance, the first half restructuring charge taken at Applied Intelligence, together with the charge of HQ that I referred to a moment ago, are expected to be covered by improved operational performance and a slightly lower effective tax rate.

We continue to assume an exchange rate for the U.S. dollar at an average of 130 and as a sensitivity, a $0.10 movement in that average rate equates to 1.5p of earnings. So in aggregate, we continue to target mid-single-digit growth in the group's 2019 underlying earnings per share. And clearly, that excludes the 5p one-off tax benefit.

This penultimate chart highlights the cash utilization we expect in 2019. The first column shows the position at the half year. The second column provides the full year guidance. In respect of operating cash flow, we continue to expect capital expenditure to be above depreciation levels, with the peak in near-term spend required to support the growing U.S. business.

And on working capital, there are 2 items of note. Firstly, under the contract amendment for the accelerated Qatar aircraft deliveries, we will pull forward some further receipts into the current year. However, we remain in negotiations with our major subcontractors as to their funding profiles. Secondly, on the Paladin program, we are in negotiations on a new delivery schedule, which will push some further cash collection into 2020. The final operating cash flow item is the year's pension deficit funding, which will be, as expected, around GBP 200 million.

And then moving on to the nonoperating cash flow items. Outflows for interest and tax are expected to total around GBP 0.5 billion, and dividend payments to shareholders and minority interests will be around GBP 800 million. So overall, we now expect net debt to be broadly unchanged from 2018 closing position, and that's a slight improvement to the year's guidance. And this does not include the potential disposal proceeds from the sales of our interest in the Saudi Advanced Electronics company and the ex-SilverSky business in Applied Intelligence.

I'd also reiterate our 3-year target of generating free cash flow across 2019 to '21 in excess of GBP 3 billion.

So just before we go to Q&A, I'd like to summarize the key points. Firstly, in terms of cash, the net debt at June was better than expectations, but that's mainly down to timing of both receipts and payments on the Qatar program. We have slightly improved full year cash guidance with timing mix expected on both Qatar and Paladin. That guidance excludes potential proceeds from the disposal of AEC and SilverSky. And after the first 6 months of 2019, our 3-year free cash flow target is reconfirmed.

Secondly, on earnings, the first half performance clearly underpins our guidance for the full year. And finally, we've increased the interim dividend by 4.4%, reflecting our confidence in the outlook for the business.

And on that point, we'll turn it over to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question for today is from Robert Stallard from Vertical Research.

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Robert Alan Stallard, Vertical Research Partners, LLC - Partner [2]

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A couple of questions from me. First of all, on the M109. I was wondering if you could give us an idea of where you are currently in the production per month. And what some of the practical challenges are for ramping it up to 8 per month by the end of the year? And then secondly, on the Eurofighter, you mentioned that the path of deliveries have been accelerated. Does this, unfortunately, as a consequence, also increase the pressure to get a follow-on order from Saudi Arabia to backfill production?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [3]

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I'll -- Robert, I'll just do the last one, and then maybe we'll -- we've got Jerry here from the Inc business, who will say a few words on M109. So for Eurofighter, it's more a phasing issue. The actual delivery and total time of deliveries is consistent. So I would say it doesn't change our position. Obviously, we've got a number of opportunities that we're pursuing at the moment with respect to, for example, the German Tranche 1 replacement, Finland and others for Typhoon. So I think we've got a number of good opportunities that we are working through at the moment. And the change in the acceleration doesn't actually affect the overall, and indeed, the last deliveries of the Typhoon. So it remains unchanged from that perspective. What it does do is just bring forward the sort of peak production. And then, Jerry, do you want to just say a few words on M109?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [4]

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Sure. Rob, thanks for the question. Regarding the 109 and production quantities, we are still targeting to get to 8 per month by December. We're working closely with the Army. Senior executives in the Army just had a program review last week. We're making excellent progress. We've completed deliveries of the option year 2 configuration, and we're beginning deliveries of option 3 configuration, which is a new tech data package. We have, in total, about 80 holds in process in combat vehicles of different types. Of those, about 50 are the M109. And of those 50, well over 40 are already through weld and fabrication, which is the most complex issue. So we have growing confidence in our ability to meet 8 by the end of the year. In fact, as of last Friday, we had about 5 available for testing and acceptance by the government. So now the key will be refining our inspection, acceptance and delivery process with the government to meet the accelerated production schedule. So we're pretty confident we have enough inventory and process, high quality, the volume is there. Now we've got to refine the acceptance and inspection process.

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Operator [5]

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Our next question for today is from Andrew Gollan from Berenberg.

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Andrew Paul Gollan, Joh. Berenberg, Gossler & Co. KG, Research Division - Senior Analyst [6]

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Two for me, please. You mentioned in the script about the Secretary of State review on export licenses for Saudi. Can you just maybe outline what you -- how you assess the risk around that and what it could mean for the business depending on the decisions there? And secondly, back to armed vehicles, actually. The JV with Rheinmetall, can you just maybe expand what the opportunities are there in the U.K.? I know we have booked various other contracts that Rheinmetall is involved in, but how does this enhance the kind of longer-term outlook in your opinion?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [7]

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I'll probably do the second one first. I mean, for the JV with Rheinmetall, I mean, the 2 obvious opportunities are the MIV, the 8x8 program initially and then potentially longer term around the Challenger Life Extension program. So there's 2 obvious U.K. significant procurements for that JV to be working through. With respect to the -- what I said from the Secretary of State, I mean, we'll just have to see how that plays out. I mean, we were not party to the judicial review process. Once we noted the outcome, as you saw in the outcome, I mean, cap -- we're not asking for the cessation of current licenses. And it's more looking at the process. And I think the U.K. government will do the review. And once they've done the review, we'll have to understand the impacts of that. But at the moment, we are meeting our contractual commitments. And obviously, we intend to work with U.K. government to do our best to do that for the future.

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Operator [8]

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Our next question for today is from Jaime Rowbotham from Deutsche Bank.

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Jaime Bann Rowbotham, Deutsche Bank AG, Research Division - Research Analyst [9]

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Two questions, please. One for Pete on the Air division and one for Charles, I think, on Platforms & Services U.S. Pete, in Air, keeping in mind your comments about the utilization of last year's Qatar advances being more second half weighted as well as the GBP 80 million of accelerated receipts from Qatar in H1, I feel as though the cash conversion in Air ought to have been a bit better this year than it was last year when you had the GBP 300 million outflow on Saudi support or SBDCP. Are there basically non-Qatar-related outflows in Air in the first half of '19, similar to the ones in first half '18? And should we expect these to continue going forward, please? And then the second one in Platforms & Services, you had more specifically, ship repair. Have you been able to make any progress, Charles, on the dual docking that you wanted to do to better maximize the utilization of your shipyards?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [10]

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Jaime, I'll take the first one. In terms of Air in the first half, and I did sort of touch on it in the script, there are 2 other items that we got this year. One is we have grown on top of that GBP 130 million of Saudi support advances. That was in our previous guidance, but probably within the overall guidance, but not visible as a line item. But that's no change. And the other one I referred to timing on international Typhoon payments. That's really around in Oman where we have long-term support of delivery ongoing for about the 5-, 6-year period. So there's always going to be timing of when we get the receipts versus when we're putting support, particularly inventory and the like into a country. So those 2 items between them come to a couple of hundred million. I think that probably fills the gap that you got in your model.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [11]

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And then with respect to dual docking, I'm just looking for -- to Jerry here for confirmation, but the last time I spoke to him a couple of weeks ago on the topic was, that was the plan. There were 2 ready to go in. So Jerry, have we actually done that yet?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [12]

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Correct. We were -- we have been selected in San Diego to do the first dual docking in the Pride of California, which is a significant investment that we made to improve the assets that are out there and the capacity in San Diego. So we're in negotiation with the Department of the Navy to begin that docking here in just a couple of months.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [13]

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All right. Thank you, Jerry. Next question?

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Operator [14]

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Our next question for today is from Sandy Morris from Jefferies.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [15]

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Picking up on ship repair, there's kind of a sort of A, B, C. I'll be devastated if you shut down Pearl Harbor because that's always been the obvious place for an analyst visit. But I wouldn't mind understanding what the Navy was doing to the contractual terms that has made you think about that? And then just following on, the order intake in ship repair in the first half was actually relatively subdued compared to last year. That may be because you're out of capacity. And yet, despite the dual-docking thing, you still kind of say, you are looking to increase capacity in ship repairs. So I'm a bit sort of confused as to quite what's going on.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [16]

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Generally speaking, the trend for the business is good. I mean, I will hand over to Jerry just to say a couple of words on Hawaii and why we can't invite too many analysts there in the future. So Jerry, do you want to just say a little bit about the situation there?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [17]

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Sure. With respect to ship repair bookings, for instance, the dual docking is not in the order book because the order hasn't been placed yet, we're negotiating with the Department of the Navy. With respect to capacity, we are working with the Navy on a revised business model to improve not only at our shipyard, but the other repair shipyards and overhaul yards, the throughput. So the Navy can get more capacity from the infrastructure that exists today and the Navy is coming out with a revised acquisition strategy. It was due out this month, probably not going to be out until about September. So as we look forward, we're going to get better utilization of the existing capacity through things like the dual docking. And then secondly, the revised model will allow more ships to move through a little bit more quickly.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [18]

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On Hawaii?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [19]

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Hawaii?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [20]

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Oh, Hawaii. The Hawaii situation is a little bit different. We're going to continue. We have obligations for the next couple of years. We're going to fulfill those obligations as the Navy is exploring an opportunity to perhaps get more small business participation in there where they would look for us to either mobilize or demobilize on a ship-by-ship basis. They're also changing the nature of the work that will be done there to less complicated work, more straightforward. So we do not see an opportunity to get sufficient return on our assets, if that model continues. There's no guarantee the Navy's going to go that route. But if they do, we have told them that we would not bid on that structure of the work. A lot of that, more complex work, will be moving to the San Diego yard, where we think we can add greater value and have greater discriminator. So the volume will shift a little bit from -- under the current plan from Hawaii to San Diego. So we would invite you, the weather in San Diego is not terrible. Come on out and visit there and see the ships going through.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [21]

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It will be [water], again. We knew that, whether it was sunny. A quick follow-up, I mean, I know we paid $235 million for SilverSky. But does it -- I hate to say it like this, does it have any significant residual value?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [22]

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Sandy, we're just launching a sales process next week. So we're not going to say anything on that one at all.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [23]

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Okay. All right. Well, I may not be bidding then. And then last, but not least, in the U.S. intelligence business, which we've all slightly taken our eye off. I get that there was a large consolidation around you a couple of years ago. But it's gone a bit quiet. And you speak about the thing continuing -- market being competitive and evolving. I mean, are we actually okay to be able to hang on in here at around the current level of sales and returns without somebody sort of stealing our lunch?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [24]

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Sandy, the evidence shows that, yes, I think that business has been performing well. There is always a trade-off of either going for growth at the expense of margin or holding your position and maintaining margin. And I think that the strategy of the business have been on and under the leadership of Al Whitmore. And I think the business is performing very well. And certainly, in terms of margin performance compares well with its peers. So I think we're pretty satisfied with the performance of that business.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [25]

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Sandy, I'll just add. I mean, the way we look at that business is, one, the backlog. That's ultimately from a book-to-bill perspective. The backlog is stable. And we look at the recompete wins and competitive wins, and the business has been hitting its targets now for the last 12 to 18 months. So yes, we're holding our own.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [26]

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I mean, I don't mean to be mean. But obviously, we -- the consolidation that took place around us looked quite intimidating in terms of the scale of competitors. I suppose, it's just like are we unique enough in what we do? Or is that they're just much more broadly based is a sort of sense or understanding, I'm trying to get.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [27]

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We have some good positions on certain contracts and good positions with certain of the agencies.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [28]

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Yes. And I would also, just to add to that, say that, what's -- where do you get the scale benefits, how much scale do you need? And our view is that, at that size, we are able to win the recompetes and win new business. And I think we've been quite effectively demonstrating that. So I think we're pretty pleased with the performance of that business. And indeed, what we see in the backlog and the opportunities, I think we remain content.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [29]

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Okay. By the way, I have to go and Google what an active inceptor was. But it does look like you're doing really well in that market.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [30]

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Yes, it's a control stick.

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Sandy Morris, Jefferies LLC, Research Division - Equity Analyst [31]

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Yes. Very impressive thing.

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Operator [32]

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(Operator Instructions) Our next question is from Nick Cunningham from Agency Partners.

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Nick Cunningham, Agency Partners LLP - Managing Partner [33]

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Another couple for Jerry and then perhaps some more general ones. On -- it's good to see the FY 2021 budget assessment, but it's effectively flat on FY '19, which implies perhaps outlays flat from '22 onwards. So I wanted to ask, Jerry, what you thought BAE's positioning was in terms of continuing to grow BAE's portfolio, if you like, within that flat environment. Second one, we're seeing more no bids and I see on T-X, Boeing on GBSD and now BAE on OMFV. I wonder what to make of that. Is there a systemic issue with the terms of business? Or is there something specific? In which case, what's specific about OMFV? And then finally, much more general question. Your cash flow guidance through '21 implies maybe GBP 500 million a year left over after the dividend next year and the year after. Do you have any more thoughts about what's best thing to do with that cash flow?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [34]

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Yes. I'll hand over to Jerry to do the first couple. But when it comes to OMFV and no bidding, I mean, I think it's fair to say that in a business that's growing, you really have to pick your battles and make sure the resources are placed where we feel we can get the best and most-effective return. And there are a number of opportunities in the combat because we're both executing in programs of record that we're working on and the number that are coming down, and we are going to obviously have to be selective of where we place our bets. I mean, Jerry, do you want to just add to that, and then whilst you're up to say a little bit about the U.S. budget outlook?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [35]

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Sure. Let's take the budget first. Actually, the budget has gone up from $717 million to $719 million, the agreement that was struck was at $738 million, 3% or 4%. That's consistent with our planning assumptions. And then in the out years, just adjusted for inflation, again, consistent with our planning assumptions. So the stability and the growth, we're very happy with. But in particular, when you examine the individual programs that are in the budget, the platforms and other key programs are very well supported in the 2-year budget in both the House and the Senate markup. So we're very encouraged about that. We are in some of the fast currents in electronic combat world and certainly in the platform world. And those portions of the budget will continue to grow in the out years. So we're very encouraged by the budget.

With respect to OMFV, it is 1 of 4 or 5 programs that make up the Army's next-generation combat vehicle program. We are participating currently in 3 of the 5. The mobile protected fire, we are heavily engaged and investing in the robotic programs, both the medium and heavy weight. And so OMFV, when we looked at the requirements, the investment and the acquisition model, we have, obviously, limitations on human capital and financial capital, and we thought the best opportunities were -- for us were MPF and in the robotic areas as well as focusing on the backlog that we have in AMPV will also play a role in the future combat vehicle family for the Army. So we're in there with currently 3 of 5, and we'll see how the OMFV program goes. There may be an opportunity to come back and engage in that a little bit later as well, given the acquisition model.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [36]

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And in terms -- thank you, Jerry. And in terms of cash, capital allocation policy remains unchanged. What I would say is that we have a number of these technology bolt-ons like Riptide in hopper, and I'd like to be doing a few more of those as cash allows. I'll hand over to Pete, maybe just to fill in any further details on that.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [37]

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Sure. I mean, we're reconfirming that GBP 3 billion of free cash flow, you've seen the amount of dividend we pay, we -- some persons say that we will, as earnings grow, our coverage of dividend by earnings remain the same. So there'll be some -- you should expect dividend to grow in line with earnings. And clearly, if we've got free cash flow then as Charles says, we'll be looking at small transactions. There's no major deals in the hopper, it'll be small bolt-on acquisitions. And as always, we never roll out buyback, that's part of the capital allocation policy, but we always look at what can we do to grow the business first. So no change.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [38]

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So dividends, bolt-ons and buyback.

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Nick Cunningham, Agency Partners LLP - Managing Partner [39]

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Can I just briefly follow-up with Jerry on the no bid. Why choose OMFVs to not bid on? And back to that question, is there anything general going on in terms of DoD's terms of business, which is leading you and others to no bid?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [40]

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Broadly across the market, I think what you're seeing is DoD is in a period of reinvesting in a couple of areas, applying a lot of capital in combat vehicles, in particular, and some other places. And it's putting pressure on the resources that we have within the industry. And I think you're seeing industry be selective where they think they can best apply those resources and get a return. So instead of betting all the numbers on the roulette table, all of the numbers in a single color, we're being selective in identifying where we think we can really add value for the Army and value for the shareholder. And I think, individually, each company is making those decisions, which set of requirements and investment decisions best match their portfolio.

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [41]

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And just to add to that. I mean, it really plays to the operational performance that we're trying to drive in the business, which means the programs that we do take, we've got to deliver, keep our customers happy and offer flawless execution on them, and that's a real driver for us. And I think we set the bar pretty high on that front.

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Operator [42]

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Our next question for today is from Ben Heelan from Bank of America.

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Benjamin Michael Heelan, BofA Merrill Lynch, Research Division - Analyst [43]

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I had 2. First one on UTX-Raytheon, obviously, that came out prior, just around the Paris Air Show. Has that created a discussion, particularly around the U.S. business about scale and your ability to invest and compete in the U.S. going forward?

And then back to Andrew's question on Rheinmetall and the Land JV, what was it that you felt that you couldn't do alone? And what drove you to get into that joint venture with Rheinmetall? And alongside that, are there any other areas of potential consolidation across the business?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [44]

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I think for the U.S. business, it's really around, as Jerry said, I think the swim lanes that we're in, we feel that we're in some good place of the business, the electronic warfare segment, combat vehicles and ground vehicles that we won there. We feel that we're in a strong position. And that's really not changed by the UTC-Raytheon merger. I mean, we compete with Raytheon. We partner with them on various programs. But the -- I mean, clearly, long term, the question is, what do they do on R&D and making the best use of that space, but that really is a long term evolving one. I mean, right now, when I look at our U.S. business and the places that we are strong and how that aligns to the U.S. budgets for the next few years, I think we're in a -- we're very well placed within our U.S. business.

When it comes to the Rheinmetall joint venture. So I think there the initial program really was around the MIV, which we knew, in a sense, was coming and the box that was effectively the preferred choice. I mean, Rheinmetall is a company that we respect, we work with and they were looking for a U.K. footprint for that. And I think we just started talking about the range of opportunities that, that would then give us. And it looked like a very good fit, both for us, for the workforce and for the capitalizing on the opportunities that were coming. So those are what made us -- I mean, there's a driving factor that made us to do that. I don't think that it presages sort of a next phase of consolidation. I mean, from our perspective, will be selective when there's good opportunities like that, we'll take them, but I don't see a big further wave of consolidations coming on the back of that.

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Operator [45]

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(Operator Instructions) The next question is from Charlotte Keyworth from Barclays.

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Charlotte Anne Keyworth, Barclays Bank PLC, Research Division - Analyst [46]

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I just got one question for Jerry, back to the 109, I'm afraid. I just -- at the beginning of the year, I think we had agreed the rescheduled run rate of 8 vehicles per month by autumn. And it obviously just slipped 2 or 3 months now by the end of the year. I just wondered if you could give us a bit more color on as to why whether this is supply chain related or execution on our part? And then also, could you quantify the inventory wet build that we're expecting in this year, please?

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [47]

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And so Pete, do you want to do the WIP and then...

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [48]

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What's your approach and then I'll cut away. So work in progress has increased. I mean, we'll -- you heard me in the guidance talk about further cash movement into 2020. That's around $150 million of cash will move into 2020 out of '19.

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [49]

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So the reason for the shift, I mentioned that we are delivering to a new technical data package. The -- that's one of the reasons the Army and BAE working together, have tried to derisk that plan with the supply chain. The supply chain, as I mentioned, has now, I think, come to life and is producing at the rate that we need, as evidenced by the number of holds that I mentioned. Over 50 of which are now in WIP on just the M109 program. So we're feeling very comfortable about that. So there was an element of derisking our ability to deliver. But as well, sitting with the Army, we looked at their out-year fielding plans and their funding plans. And when we selected, when we would move to the rate of 8 per month in lieu of going to 12 or 14 or moving to 8 sooner, we wanted to preclude a break in production and supply chain, 2 years down the road, given their funding profile as it's currently in the POM and the suggested budgets. So it's a combination of reasons, including derisk. As I mentioned, a lot of inventory now moving through. It's about getting our inspection, acceptance and fielding process and delivery process able to meet the same rate as production. And I think that's going to be another 30 to 60 days until we get there. So that's why the late fall.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [50]

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So just to summarize, are we getting the quality now?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [51]

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We're getting the quality, and we're getting the production rate that we need at that quality. Now we have to get the inspection, acceptance and delivery process to meet that production rate. So we'll be working through those issues over the next 60 days, but we've got plenty of inventory to meet that demand schedule.

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Operator [52]

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Our next question for today is from Andrew Humphrey from Morgan Stanley.

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Andrew Edward Humphrey, Morgan Stanley, Research Division - VP [53]

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Just a couple. Firstly, on Qatar, obviously, the unwind on the prepayment has been a bit less aggressive than we thought it might be so far this year. But the 3-year guidance is obviously unchanged. I wanted to try and get a question for how much visibility you have on the profile of how that works out over the next couple of years, i.e. should we expect a bit of lumpiness over the next couple of years? How much visibility do you have on that at the moment?

And the second one is just on Electronic Systems. Obviously, we're kind of getting up towards rates on the F-35. That business has been performing extremely well from a growth and margin point of view. Should we sort of expect to get it toward -- more towards your guided range for revenue growth next year, how is the F-35, kind of tops off in terms of the rates, is it that simple or is there kind of other stuff we need to be factoring in looking into 2020 and beyond?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [54]

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Let me have a go. So, Qatar, I'd talk about Qatar first. So we have signed, as we said, a contract amendment for the acceleration of some aircraft into 2022. With that comes a change in the cash profile. I spoke earlier, GBP 80 million has been dragged forward into the first half of this year, and there will be some more in the second half. As you all know, a huge amount of what we do in the Typhoon goes through the subcontract supply chain. We are still in negotiations with the supply chain as to what their funding profiles will be from us. So we have, at the moment, we absolutely know what the new receipts profile looks like. And the money being dragged forward into '19 has no impact on 2020. It's not coming out of 2020. But we still got to go through in terms of the outflows as to what our exact position will be with the subcontractors. And as you know, under IFRS 15 now, we trade sales based on when cost comes through. So that profile will also determine where we end up with -- on these sales and revenue recognition on Qatar as well.

On the Electronic Systems, and Jerry, if you want to add on. But I mean, F-35, you need to remember, yes, it is a big program. There's only 8% of the total business within Electronic Systems. So whilst that maybe being coming towards a max rate, it's not the big program. It's not -- it hasn't got that much of a weight that a slowdown in that program will remove growth from the business. We still got things like APKWS, you're seeing the commercial businesses, 14% growth in the first half. We've got classified activity continuing to ramp up. So I wouldn't be too concerned about growth -- the business going ex-growth as we go into future years. There's a big portfolio of programs in that business. And there's a lot of growth still to come.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [55]

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Very good. Jerry, do you want to?

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Gerard J. DeMuro, BAE Systems plc - Executive Director & CEO of BAE Systems, Inc. [56]

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Yes, I'm happy to add. I think Pete is absolutely right. F-35 is not the only EW program that is ramping up, we're also going to be ramping starting next year with production deliveries for the F-15 upgrades. That's the EPAWSS program. There are a number of classified programs. If you look at that classified line, that continues to grow. We're also growing in precision-guided munitions, not just in APKWS, but we do the seekers on the THAADs and a number of other precision-guided munitions things. So the precision-guided munitions business will continue to grow as well as the classified business. And thirdly, we're getting heavily involved in space resilience. Some of that's in classified, some of that will be reported separately. So we've got a couple of other significant vectors for growth beyond F-35, which will meet roughly the 150 production rate next year. So lots of opportunity there.

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Operator [57]

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Our next question for today is from Olivier Brochet from Crédit Suisse.

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Olivier Brochet, Crédit Suisse AG, Research Division - Research Analyst [58]

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I will have three very quick ones. So the first one on Qatar, if I may. Can you remind us when the first delivery is scheduled and when the peak will be now that you've changed the contract? Second question on AMPV, the modifications to the contract that you've done, when will we see that coming through in revenues? And third, on the U.K. munition comment that you make in Maritime, what if the contract is not finalized by year-end, please?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [59]

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Okay. Qatar, first delivery is in 2022, it's unchanged, and final delivery is in 2024 and peak deliveries in 2023. So the most -- the contract has accelerated some into 2022. It's not a huge shift. And from a revenue recognition perspective, you just need to remember, it's not about aircraft deliveries, it's about the spend profile on the program. I'll answer the third one as well. The U.K. munitions, we have that contract. It's a 15-year-long contract. And we get the funding -- the advance funding from the customer comes on December each year. So this isn't a question about needing to win the program to bring that cash in, we have the program in the backlog today.

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [60]

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This AMPV, can you just repeat the question for us, please?

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Olivier Brochet, Crédit Suisse AG, Research Division - Research Analyst [61]

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Very simple. There was a modification to the contract with the extension of LRIP volumes. When will that flow through in terms of the revenue?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [62]

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AMPV, for AMPV, we'll -- we've got -- started deliveries in the second half of this year. And then clearly that will run through into 2020 and beyond. It doesn't have a '19 impact.

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Olivier Brochet, Crédit Suisse AG, Research Division - Research Analyst [63]

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And does it have a 2020 impact already?

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Peter J. Lynas, BAE Systems plc - Group Finance Director & Executive Director [64]

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Yes, it does.

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Operator [65]

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(Operator Instructions)

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Charles Woodburn, BAE Systems plc - Group CEO & Executive Director [66]

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Okay. Well, it seems that we have no more questions. So thank you all for joining, and I look forward to the full year results early next year. Thank you.