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Edited Transcript of BAB.L earnings conference call or presentation 22-May-19 8:00am GMT

Full Year 2019 Babcock International Group PLC Earnings Presentation

London Jun 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Babcock International Group PLC earnings conference call or presentation Wednesday, May 22, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Archibald Bethel

Babcock International Group PLC - CEO & Executive Director

* Franco Martinelli

Babcock International Group PLC - Group Finance Director & Executive Director

* John Davies

Babcock International Group PLC - Chief Executive of Land & Executive Director

* Michael John Turner

Babcock International Group PLC - Non-Executive Chairman

* Simon Bowen

Cavendish Nuclear Limited - Chief Executive

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Conference Call Participants

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* Allen David Wells

Exane BNP Paribas, Research Division - Research Analyst

* Ed Steele

Citigroup Inc, Research Division - Director

* Joe Brent

Liberum Capital Limited, Research Division - Head of Research and Equity Analyst

* Kean Marden

Jefferies LLC, Research Division - Equity Analyst

* Robert John Plant

Panmure Gordon (UK) Limited, Research Division - Analyst

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Presentation

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [1]

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Ready to go? Okay. Just wanted to signal if there's anyone at the back. Okay. Okay, good morning. Thank you for joining us this morning.

I'm going to be supported this morning by FD, Franco Martinelli, who I'm sure you all know. And also, we have our 4 sector chief executives, who will help me field any questions which I'm not sure about. I'd also like to welcome Ruth Cairnie, who's joined us this morning. Ruth, if you want to give a wave. There we are. As you know, as we've announced, that Ruth will take over from Mike Turner as the Chair at our Annual General Meeting in July. It's a big changeover for Babcock. I'm sure that, that will be a strange Board for a little while without having Mike leading it. He's done a tremendous job, I think, for the company over the last 10 or 11 years as Chairman and led the Board well. And during that period, we've done some amazing things. And I'm now looking forward to working with Ruth, who brings with her an impressive background of experience and expertise which I'm sure will help guide the company over the coming years. So a major change to the business but something which I think we're all looking forward to.

Earlier this morning, we issued the results for 2019. And through this short presentation, Franco and I will add some color to the numbers. And we will also have a closer look at the key actions we have taken during the year that underpin the numbers and give us a solid business base to build on over the next few years. I'll then give you the opportunity to ask questions.

Overall, the results show that we have delivered another robust performance. And I'm satisfied with the progress that we have made in the year, particularly against the backdrop of a challenging external environment. Once again, our profit and strong cash flow generation have allowed us to increase our dividend and our pension scheme contributions, and at the same time, we're reducing our net debt by GBP 157 million. And that's a reduction in net debt of 14% and continues our 4-year unbroken run of year-on-year deleveraging.

During 2019, we really buckled down and pushed forward with our plans for developing and improving our business, focusing on defense, aerial emergency services and civil nuclear as our 3 key markets. We exited or disposed of several small businesses that were not core to our longer-term strategy. And as we informed you during the year, we also tackled a number of issues that had the potential to impact negatively on the business going forward. And we carried out company restructuring across Europe relating to our aircraft operations certificates in the event of a no-deal Brexit.

So all in -- so as well as delivering a decent set of results for 2019, we have firmly focused on the future. And it's been a busy and successful year for all 4 of our sector teams.

After 15 years of design, manufacture, assembly, integration and commissioning, we have reached the final stages of the Queen Elizabeth Class aircraft carrier alliance project at Rosyth.

Welcome, Mike.

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Michael John Turner, Babcock International Group PLC - Non-Executive Chairman [2]

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Thank you.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [3]

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You missed all the nice things I said about you.

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Michael John Turner, Babcock International Group PLC - Non-Executive Chairman [4]

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No, I heard you previously.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [5]

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We continue to deliver in-service and life extension support to both the surface and submarine naval fleets in the U.K. And internationally, we made good progress in developing our global naval marine business. For the Army, we made good progress in the transformation of our DSG armored vehicle engineering support business. And in our Rail business, we secured a strong position in the 10-year CP6 and CP7 contract to support rail and signaling maintenance in the Scottish region. In South Africa, we had a very good year in the equipment business, but unfortunately, that progress was partially offset by delays in the power generation engineering work we are doing for Eskom.

In the aviation sector, there are a number of highlights. We commenced pilot training on our Fomedec contract in France, retained our large search-and-rescue contract in Spain, entered Canadian aerial firefighting in Manitoba. And remobilized on medical emergency services contracts in Norway, Sweden and Finland. In the nuclear sector, we made good progress on our Magnox and Dounreay decommissioning programs and continued our buildup of work on the Hinkley Point C new build project. And after adding GBP 4.5 billion of new business, we ended the year with our order book and near-term pipeline of new opportunities stable at GBP 31 billion, around the same level as last year.

The order book was down a little at GBP 17 billion, and our bidding pipeline up a little at just over GBP 14 billion. And as I've said before in previous presentations, movements of this level are mainly down to the timing of bids converting to new orders. And of course, beyond the GBP 14 billion pipeline, we have a much larger longer-term tracking pipeline of opportunities, so we remain in the strong positioning of having long-term visibility of our order book and our future opportunities both in the U.K. and internationally.

Our competitive position also remained stable. We've had no significant changes in the makeup of our customers, competitors and key suppliers across any of our key markets. And our new bid and renewal win rates remained right in line with our performance in recent years.

Our focus on operational excellence remained a primary focus throughout the year, and that applies particularly in the area of health and safety. Across our heavily regulated activities, whether it be in marine, nuclear, aviation or rail, our performance is underpinned by industry-leading health and safety performance. That means all of our people, no matter where they are in the world, go home safe every day.

Supporting our customers to achieve their performance goals is at the core of our business model, whether it be achieving better performance and availability from critical assets, providing critical services such as emergency response services or training and upskilling their people. We work closely with our customers, often in highly complex environments, and as we always work hard to meet -- and we always work hard to meet and beat their expectations of us. Most of the time, we succeed, and when we don't, we simply work even harder together until we find and deliver the best solution. And this principle is at the heart of the strategic partnering program. And we invest more in innovative technologies that are now driving performance and productivity improvements across the group. We are the largest engineering support provider in the U.K. defense sector and the second largest supplier to the Ministry of Defence. During the year, we were awarded a number of new contracts. And saw our scope expanded on a number of existing contracts such as DSG, Astute and MSSP, where we provide QEC and Type-45 equipment support. We were also awarded our first in-service support contract for HMS Queen Elizabeth now returning to service from Rosyth after undergoing a package of inspection and maintenance work. In Cavendish Nuclear we won additional work at Dounreay and Sellafield. And in aviation we expanded our UK military air business and our U.K. onshore emergency services contracts. And through the MARTASS contract win, we consolidated our position as a key provider of training infrastructure and services to the U.K. Armed Forces. We also built on our strong early-stage positions on a number of long-term contracts. These contracts include the U.K.-U. S. Trident replacement submarine programs, the U.K. submarine disposal program and the nuclear new build project at Hinkley Point.

As we focus on our 3 key markets defense, aerial emergency services and civil nuclear, we continue to strengthen our position in the U.K., but growth and development of our international business remains a key priority. In 2019, international business represented 30% of our revenue. And as you can see here, international opportunities now account for over 40% of the short-term bidding pipeline. In Australia we already operate in the defense and the aerial emergency services markets. And in 2019, we strengthened our sustainment position with the Royal Australian Navy. And we were awarded a long-term contract to support their 2 largest warships, the Canberra class amphibious LHDs. Our success in winning the Manitoba firefighting contract also broadens our presence in Canada, with us now operating in both the defense and aerial emergency services markets. And there is also the opportunity to enter the Canadian civil nuclear market at some point in the future. And in France, Spain and Italy, there is also good potential to develop multi-market and multi-sector operations in the coming years.

And as we told you at the half year, we have opened office and workshop facilities in Korea. In Busan we are focusing on both naval equipment support for the South Korean Navy and also the provision of liquid gas marine transportation systems to the South Korean shipyards. And in Japan, our engineering office is focused on supporting their decommissioning program.

But as I said right upfront, this has been a year where we have taken actions to further strengthen and improve the business. We tackled the challenges of our North Sea Helicopter Services business by rightsizing the fleet, and we dealt with the financial impact of the permanent grounding of our 13 Airbus EC225s. We also took important steps to maintain balance and momentum in our marine and civil nuclear markets. We adjusted for 2 of our largest long-term contracts coming to an end, and of course, I'm referring to the aircraft carrier build alliance contract and the early termination of the Magnox nuclear decommissioning contract. We plan to say more about rightsizing the business at our Capital Markets Day in a couple of weeks’ time. As I said earlier, we completed a restructuring of our European aerial emergency services business to accommodate the potential impacts on our aviation operations in the event of a no-deal Brexit. And with our programs of exits and disposals, we exited activities mainly in the marine and land sectors where we no longer consider them to be strategic to our plans, but whilst taking positive actions to address these issues, which will strengthen the group in the longer term, they result in a step-down in revenue of GBP 410 million, with a corresponding step-down in operating profit. We highlighted this issue earlier in our February trading statement, and Franco will cover this point in detail.

I will also come back to it in my summary, but in the meantime, I'll now hand over to Franco.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [6]

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Thank you, Archie. And good morning.

I'd like to start with a summary of our results.

While our revenue was down slightly, our operating profit was up, and in a minute, I'll take you through that. As Archie said, we had significant change to business to strengthen it for the future, and those changes led to the exceptional charge we first reported in H1. We recognized GBP 120 million in the first half; and there was a further GBP 41 million in the second half, GBP 31 million of which was pensions. The net cash element of the exceptional charge will be relatively small at around GBP 26 million over next years.

As you know, this is a cash-generative business, and this year's cash performance provides further evidence of what I mean. Our operating cash flow conversion post CapEx increased to 104%. That's a record for us. And our free cash flow after pensions was GBP 324 million, again a record. The strong cash performance led to the fourth consecutive year of debt reduction; and we ended the year with net debt-to-EBITDA of 1.4x, as we had expected. Underlying earnings per share is up 1.2%, and the full year dividend is up 1.7%.

Turning now to the revenue bridge slide. FX and the disposals we made during the year had a significant impact on our reported revenue. They accounted for around 2% of revenue. Archie has already talked about our program of exits and disposals of those businesses that are no longer strategic to our plans. In addition to the impact of the disposals I just mentioned, exits in financial year '19 had an impact of GBP 51 million, and I expect there'll be some small exits and disposals going forward. While we had some weakness in procurement and short-cycle business, in our focus markets, excluding QEC, we grew by around 3%.

Looking now at our operating profit bridge, you can see that FX and disposals had an impact but relatively less than on revenue. That made a small contribution to our margin improvement. Organic profit was up as a result of good contract performance in our businesses and including increased contributions from our joint ventures. And we continued to benefit from our operational efficiency programs.

Our total margin improved to 11.4%, with an increase in the year in the JV performance. Excluding JVs, we sustained margin at 10.1%, broadly in line with what we've done in the last couple of years.

Moving now to the reconciliation of underlying to statutory profit. Our exceptional charge is a reconciling item this year and is our first exceptional charge for 5 years. The remaining reconciling items are the same as in previous years. The JV profit contribution is higher this year given the strong performance in Land and Aviation. Next year, as Magnox and Holdfast steps down, JVs will become a smaller part of the group, and so the contribution will obviously be lower. Similarly, both IFRIC 12 income and the charge for amortization of acquired intangibles reduced this year and will reduce again next year, particularly acquired intangibles.

Our actions to strengthen and rightsize the business result in exceptional charges. Our first half charge of GBP 120 million came primarily from the reshaping of the oil and gas business. In addition, it also reflected the capacity reductions as we scaled down QEC, Magnox and Rail. And of course, the exits and disposals, we've already talked about. The H2 charge of GBP 41 million mainly relates to pensions and further exits we made. Our pension liabilities have increased by GBP 31 million. That's mainly due to GBP 26 million for the equalization of guaranteed minimum pension benefits for men and women, but we also had a GBP 5 million charge for the bulk transfer of GBP 110 million of liabilities back to the customer. Over time, the cash costs to this will be part of the pension funding cash flows. In addition, we had a one-off tax charge of GBP 10 million for the restructure of our aviation business in preparation for Brexit. Excluding the pension charges, the net cash impact of these exceptional items will be relatively small at around GBP 26 million, of which GBP 11 million relates to financial year '19 just finished. There will be a cash outflow of GBP 28 million in financial year '20, including the Brexit tax charge, followed by cash inflows in future years dependent on the sale of surplus helicopters.

I'll now take you through each sector, starting with Marine.

The step-down in QEC revenue this year is around GBP 60 million and, together with our exits from renewables, reduced revenue, but if you exclude these factors, the revenue was up slightly. That's the result of increased activity on U.K. naval ships. And whilst infrastructure spend was initially delayed, it's now starting. Equipment spend was also slow to start, as you'll remember, and is also now picking up, both of which will be at -- initially at low margin. We broadly maintained our margin, and that reflects the positive margin impact of exiting renewals (sic) [renewables] and the step-down in QEC revenue offset by contract mix and contract performance elsewhere. This year, we expect good revenue growth excluding QEC, with margin slightly lower due to contract mix.

Our performance in Land was significantly impacted by FX, exits and disposals. Together, they accounted for half of the fall in revenue. In addition, we were affected by lower defense procurement spend, reduced activity in Rail and U.K. Power and by weak trading in our South Africa Power business. Operating performance benefited from better contract performance, Holdfast JV and increasing profits from our South Africa equipment business. This year, we expect slight revenue growth excluding exits and margins maintained excluding the normalization of the Holdfast JV.

In Aviation, Fomedec drove revenue growth. This was partially offset by lower firefighting activity, especially in the second half, as a hot May and June was followed by cooler weather. Oil and gas remains challenging. Oversupply and intense competition affects the market. The steps we've taken to -- in the year to rightsize the business will improve the performance going forward. Contract performance in both our joint ventures and in our group business were better and, together with our ongoing cost-reduction programs, meant we held margins. This year, we expect slight revenue growth, as Fomedec doesn't repeat, with stable margins, excluding the GBP 10 million related Brexit costs.

As expected, we had lower levels of decommissioning work but good growth across the nuclear services business, so we kept revenue broadly flat. Margin was lower this year, reflecting both gainshare at the end of contracts last year and lower margins at the early phases of contracts this year. This year, we expect low revenue growth, excluding Magnox step-down of GBP 256 million, but higher margins reflecting the mix.

We had anticipated another strong year on cash and achieved cash conversion of 104% post CapEx, which was ahead of our post-CapEx new target of 90% and a record performance. It was led by a strong working capital performance with an inflow of GBP 87 million, which will -- I will come on to in a minute. The timing of aircraft deposits and deliveries impacted the net CapEx spend in the year, and it will reverse next year when these purchases convert to operating leases.

I thought it would be helpful if I set out the key receivables and payables balances. We are just showing the key figures here. The full details are in our annual report. And we include these notes in the back of our statement this morning to save you waiting to see them. As you can see on the slide, trade receivables and payables are both down about GBP 30 million. Unbilled receivables are down GBP 119 million year-on-year. We had the positive Fomedec reversal and an improvement in Devonport unbilled receivables. They were partially offset by an increase in accrued income in DSG, which will reverse this year. Unbilled receivables vary throughout the year with the phasing of contracts. Our customers throughout the world tend to agree in working towards the end of the year. That does lead to fluctuations in our working capital throughout the year, which has always been part of our business, and we have managed this dynamic for many years.

On the payables side, contract liabilities were stable, with advance payments up slightly and deferred income down slightly.

The improvement we generated in operating cash flow was broadly carried forward into free cash flow performance, which increased to GBP 324 million, with cash conversion compared to net income up significantly to 76%. I have included a full free cash flow-to-net income reconciliation in the appendix. JV dividends were slightly lower than expected, caused by Magnox delays which will catch up in financial year '20 when the contract ends.

With this cash performance, we de-geared again this year. And net debt is GBP 958 million. That's GBP 157 million lower than last year. You can see in the chart that net debt has been coming down every year for the last 4 years. And we continue to expect to reduce net debt in March 2020 before we include the impact of IFRS 16. During this time, we've paid over GBP 500 million of dividends and made nearly GBP 200 million contributions to the pension scheme and still managed to reduce debt.

As I'm sure you're all aware, IFRS 16 comes into effect for our financial year '20, and that means operating leases will be capitalized onto the balance sheet. On the 1st of April, around GBP 600 million of operating leases were brought onto the balance sheet, with around 80% of these being aircraft leases in our aviation sector which are overwhelmingly matched to customer contracts. We've set out the expected impacts to financial year '20 from our IFRS on this slide -- IFRS 16 on this slide. The main ones are operating profit up around GBP 25 million and net debt-to-EBITDA up around 0.5x. To be clear: The financial year '20 guidance we have given this morning is based on old accounting and does not include the impact of IFRS 16 as set out on this slide.

Moving now on to pensions. As this slide shows, our IAS 19 deficit at the end of the year was GBP 28 million. That's up on the prior year as a result of lower discount rates and higher inflation. The GMP equalization and the transfer of bulk liabilities, I talked about earlier. Our technical provisions deficit is estimated at around GBP 400 million, reflecting more conservative assumptions and discount rates than used under IAS 19. I would expect that we will make cash contribution to make good the steps here over the next 6 years or so. Pensions actions we are taking include the bulk transfer of liabilities back to the customer and closing Babcock Group pension scheme to future accruals. We continue to negotiate the level of increase to Rosyth scheme funding.

This slide sets out the key financials of our JVs. Our future JV dividend stream is supported by the future profit stream and current distributable reserves within our JVs. Our share of those distributable reserves currently stands at around GBP 150 million. I currently expect that dividends for the next 3 years will be stabled -- stable, followed by a step-down beyond that.

Our share of JV net debt was GBP 311 million compared to last year's GBP 354 million. The sale of Helidax in March 2019 reduced our share of net -- JV net debt by GBP 29 million. All JV net debt is nonrecourse to the group. And it is mainly in AirTanker, which our partners are Airbus, Rolls-Royce, Cobham and Thales; and the customer is the U.K. government. You can see that the JVs hold significant cash balances for scheduled debt repayment.

This should be a familiar slide to you all because it sets out our capital allocation priorities, which have not changed. Our first priority is to invest in the business to drive growth. We are highly disciplined, and we require all investments to meet our return-on-capital hurdles. Secondly, we will continue to de-gear the balance sheet. Our balance sheet strength gives us the flexibility to make sure we're well positioned whatever the environment. And we think de-gearing the balance sheet is particularly important during this period of political and economic uncertainty. It also safeguards our credit rating and provides additional funding for our pension schemes. Thirdly, we want to return capital to shareholders. We'll do that primarily through a sustainable dividend. Our ordinary dividend is firmly supported by our strong free cash flow. As we continue to reduce debt, we will have scope for additional returns in the future.

In this slide, I have set out the step-downs to our financial year '19 results we outlined in our statement this morning, step-downs of around GBP 410 million to revenue and around GBP 63 million to profit. These relate to the end of the QEC and Magnox contracts; the impact of the exits and disposal decisions we have made; normalization of the JV profit contribution from Holdfast; and of course, the Brexit-related restructuring costs for aviation. The step-downs have increased due to the further exits and the actual trading results achieved in March. Building on that, let me take you through guidance for financial year '20.

As we look at this year, we are guiding to revenue of around GBP 4.9 billion. Margins are expected in a 10.7% to 11% range. And operating profit guidance is in the range of GBP 515 million to GBP 535 million. We expect free cash flow to be over GBP 250 million, with again performance weighted half 2, particularly for cash flow.

Here's some detailed cash flow guidance. As I said earlier, net CapEx-to-depreciation is likely to decline towards 1x. Working capital would normalize to an outflow after the very strong financial year '19. And as said, we expect an increase in our pension contribution guidance, in part to reflect the Rosyth negotiations. Taking these movements; and the lack of Fomedec inflows from this year, GBP 50 million, we currently expect the free cash flow in financial year '20 to be over GBP 250 million.

Before I hand back to Archie, I'd like to revisit the financial priorities we set out at the half year: one, to sustain our margins; two, to manage our operating cash flow; three, to continuously de-gear and improve ROIC, and this should drive shareholder value. This year, despite the challenging environment, we progressed on all of these measures.

And I'll hand you back to Archie.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [7]

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Okay. Thank you. Thank you, Franco.

And before opening up for questions, I'd just like to emphasize a few points about next year, if I may. We've talked about QEC, Magnox and the business exits and disposals. These will not be part of our business going forward, and the gains Franco walked you through from next year reflects this. At our Capital Markets Day on the 5th of June, we'll look to the future. And we will look at the long-term, sustainable growth opportunities that we have in front of us. Our 3 core businesses in defense, aerial emergency services and civil nuclear are robust and resilient. We have strong market leadership positions in all 3. And when we combine the strong market position with our focus on innovative technology, we are confident of continuing to win new business across these markets both in the U.K. and around the world just as we are currently doing.

So let me finish the presentation by reemphasizing a few points. Our financial performance in 2019 was robust. And crucially, we achieved our main financial goals of improving cash flows, maintaining margins, reducing net debt as well as exiting poorer-performing businesses. Our GBP 31 billion order book and pipeline, combined with strong positions in our 3 primary markets, give us real confidence that we can grow the business steadily over the next few years. And once again, we grew the business faster internationally than we did in the U.K., and we expect this trend to continue. We have dealt decisively with the loss of the Magnox contract. We dealt decisively with the Airbus EC225 issues. And we dealt decisively with the end of the QEC contract and our exit from low-value business lines.

So we are creating a strong base to grow from. And we have delivered consistently for our customers around the world, and that was against the backdrop of a challenging political and economic environment. This is a truly fantastic business supported by great people. And we are now ready to push forward and demonstrate our underlying strengths and value to our customers and to our investors.

So I'll now be happy to take questions.

(inaudible) here. I think these two, first. [Robert]...

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Questions and Answers

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Robert John Plant, Panmure Gordon (UK) Limited, Research Division - Analyst [1]

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It's Rob Plant from Panmure. You mentioned that conditions are quite challenging politically. The U.K. faces a lot of uncertainty. Do you think your guidance bakes in what's happening in terms of Brexit and general election risk and what's happening on the ground in terms of governments and outsourcing decisions?

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [2]

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I think we have. We've hit the direct problems of Brexit right upfront. So things like stocking. And we've talked about the air operating certificates. I think it's difficult to predict beyond that. I think, like everyone, we are watching the U.K. politics that's going on, and we have to play through these. I think the main thing we've been trying to do is growing the business strongly for whatever kind of comes forward so we can react or strengthening the balance sheet. We've gone out of areas which are not contributing. I think we are doing things that have very much got an eye on what may happen in the future. In terms of the short-term and the order placement -- to be honest, we have seen a general sort of a softening through this year and next year on some of the short-cycle-type work. And we also saw -- a major contract, ASDOT, in the air side for the Air Force, we saw that being canceled, but there are still a number of big opportunities on the pipeline and the future, none of which we've baked in our forecasts, by the way, but which we will be participating and then -- projects like Project Selborne in the training side, Type 31s, FSS in the marine side. These are big opportunities. And we expect to see more on the nuclear side.

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Allen David Wells, Exane BNP Paribas, Research Division - Research Analyst [3]

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Allen Wells from Exane. Just a couple for me, please. Just looking at the rebased numbers on Slide 30 for '19 and thinking about your guidance obviously implies about GBP 150 million of incremental revenues; and sort of plus 10 million, minus 10 million on incremental profits. I guess, 2 questions on that. Firstly, on the incremental revenue side, maybe you can just touch on what are the bigger moving parts on the growth side. So thinking about things like a Norwegian helicopter contract, et cetera on that side. And then on the profit bridge, if you look at that plus or 10 minus -- plus or minus 10 million, I guess it suggests a plus 6, minus 6 incremental EBIT margin on the new work, of GBP 150 million. And it feels quite low for the type of work you guys typically win. I wonder if you could sort of comment on if I'm doing something wrong or on how you think about that...

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [4]

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Well, Franco does that kind of sums. What I'd say about the next year's forecast: I mean what we've done is look at the underlying performance this year; and as Franco's slide shows, that if you take out the things that are not in next year, underlying we grew by about 3%. If you look at the GBP 4.9 billion as the guidance for next year, that's based on -- I said, on our underlying business will grow again about 3%. I think across the sectors that's likely to be different. So to look at defense, our assumption there is that we'll be pretty flat in the U.K., so we've taken a fairly flat view of what may happen in defense. And on national defense, we've been a bit more optimistic about; and Canada, Australia in particular; but also in South Korea, as we mentioned, and opening up there to support the program we've got there. We see a bit more growth in the international. In the aerial emergency services, again, we've had a very strong growth there for the last 4 or 5 years. We expect to see that to continue again over the next 2 or 3 years. And in nuclear, again we are predicting a fairly flat position there for the next couple of years. So the mixture of these together has given us the kind of guidance numbers.

In terms of margins. I mean we've shown a 10.7% to 11%. That's basically been our margin -- we've never been outside that in the last 10 years. So what we're basically saying there is we are not spotting anything that's [predicting only definite] in the market. We've achieved 11% before. That's totally possible. 10.7%, I think, would be we are signaling as the low point depending on that sort of mix of business. And as we've talked about before, we do have a portion of business that's in short-cycle, lower-margin business. And that kind of is the main factor, dependent on how much of that is in the mix, whether the -- we'll be at the 10.7% or the 11% range. But I don't know. Franco, do you want to add?

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [5]

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No, I think -- I don't think I look at it quite in the way that you've looked at it as a marginal movement. I think you look at close to GBP 525 million of profit as the middle of the range. And within that, there's a small range of outcomes. And to be honest, 0.3% range on that is quite small on the level of contracts that we have. So I think it's an overall view rather than reconciling it for the movement.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [6]

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Joe?

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Joe Brent, Liberum Capital Limited, Research Division - Head of Research and Equity Analyst [7]

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Joe Brent from Liberum. Three questions, if I may. Firstly, can you help us reconcile the movement in the pipeline? Clearly, a lot has moved into orders, I'm interested in what new has come into that. Secondly, historically, you've talked about target leverage of 1x debt-to-EBITDA, but clearly IFRS 16 makes that a bit more complicated. Do you include the IFRS 16 adjustment in that 1x debt-to-EBITDA number? And thirdly, you talk about a technical deficit, which I assume is an actuarial deficit. And you talk about recovering that over 6 years. Are we right to just take the GBP 400 million and divide by 6 as the cash outflow going forward?

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [8]

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Franco, why don't you do the...

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [9]

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I'll do the pensions, okay, because that's the one everyone is most interested in. The answer is yes. That's -- really is the funding deficit. Will it be even over the 6 years? I think, for modeling, that's what you should do. I think the negotiation we have with Rosyth is ongoing, which may create some more lumpiness. I don't expect that this year. I expect a slight increase for Rosyth this year, so as indicated in the guidance, but I think it could be lumpier than straight line is the answer to that question. Your first question again...

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [10]

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It was on the pipeline.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [11]

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Reconciling the pipeline.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [12]

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Yes, yes. I mean, the pipeline, that's a moving thing all the same, but at end of the year, it's just over GBP 14 billion, which was up a little bit, I guess, gone up a little bit again since we did that. I mean I think generally across the 4 sectors the pipeline kind of stays steadily with these growth opportunities coming into that. There are some big opportunities in that. And what we tend to do on really big projects like the kind of one-offs is we factor them in, factor their number so that we don't have the big dislocations. So big contracts like, say, one FSS or a Type 31 will be in there somewhere but at much lower values than maybe what the -- than where they end up at. So we try and balance the pipeline value to match really the, like, long-term pattern we've had of conversion.

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Joe Brent, Liberum Capital Limited, Research Division - Head of Research and Equity Analyst [13]

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(inaudible) ASDOT comes out of that?

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [14]

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ASDOT is out of that, yes, which was a quite a big number we had. And that still wasn't the full amount that was canceled, but it was a significant number.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [15]

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(inaudible) there are opportunities in Australia, opportunities in Canada in defense, some big ones there. We're now working on the AOC [relap] which is a bigger, much bigger, program, which is called Project MITER. So there's a bunch of stuff that's coming over the year.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [16]

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Yes. I mean one of the things I'm very pleased at is the fact that, looking at that pipeline, we are 42% of that. And remember, in that pipeline we are showing, that's stuff we expect to be sentenced in the next 12 months, so it's not long term beyond that. May be a little bit longer than that, but it's no more than those things that we are actually working on, working on bids, proposal. So it's not the tracking pipeline, so to be in 42% of that actually, I think, is pretty good sign.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [17]

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And your second question, Joe, again. Sorry.

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Joe Brent, Liberum Capital Limited, Research Division - Head of Research and Equity Analyst [18]

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The third question was on historically you've talked about target leverage of 1x debt-to-EBITDA. Now you've got IFRS 16 muddying the water.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [19]

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I think, as -- (inaudible). Okay. Where we are with this is that, yes, okay, the metric is moving. We need to see how the market will expect that move. We've seen various people look at it, and some people exclude it completely and some people include it. We need to just understand how the market effects it. I still think, in the next 1 to 2 years, we'll be in a position to pay additional money back to shareholders because we will continue to pay down debt.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [20]

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Yes. Ed?

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Ed Steele, Citigroup Inc, Research Division - Director [21]

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Ed Steele from Citi. 2 or 3 things for me, please, as well. First of all, on the Magnox step-down, which you've given us some data on, I thought that contract was going to end, end of August. Is that right? So you've got GBP 24 million operating profit step-down, but I mean the whole of Cavendish Nuclear JV last year was GBP 37 million. Obviously, there's a bit of Dounreay in there, so why is there such a big step-down in Magnox for only half year impacts, please?

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [22]

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Because the GBP 24 million is obviously the right number. The contract which is Magnox is a complex contract, as you would imagine. And there are various KPIs that earn fee and then there's a base contract, but there's multiple layers of where you're earning fee. And we achieved a lot of the KPIs early. And then there's groupings of KPIs. And if you achieve all of those groupings, then you get to pay the dividends. So that's why there's a little bit of delay in dividends. And we've actually achieved more of the KPIs in this year than we would have been expecting to or than we hoped to. It's quite, let's say, complex. So basically you earn a fee per KPI...

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Ed Steele, Citigroup Inc, Research Division - Director [23]

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Is there any Magnox profit inside the 100% owned Cavendish Nuclear profit stream, please? Or...

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [24]

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Nothing of significance.

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Ed Steele, Citigroup Inc, Research Division - Director [25]

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No, okay. Second area: So your guidance for aviation is for, I think, slight growth in 2020 for top line. How much kind of pass-through-type revenue was the -- in Fomedec in 2019 that will give you a tough comp effect in 2020, please? So -- or the equipment [posting]...

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [26]

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The equipment was not pass-through, to use the phrase that you're saying. We earned a margin on it. The step-down, I would say, allowing for the contract that we get which is the ongoing maintenance contract, is around GBP 100 million.

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Ed Steele, Citigroup Inc, Research Division - Director [27]

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And that's fully factored in the guidance for growth.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [28]

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Correct.

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Ed Steele, Citigroup Inc, Research Division - Director [29]

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Yes. Okay. And then my third question. Was there any material change in your factoring of receivables in 2019 second half -- sorry, full year numbers? And will you be disclosing your factoring receivables in this year's annual report, please? Because you haven't done that before.

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [30]

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The answer is it's around GBP 90 million compared to last year, around GBP 80 million. I don't think it is in the stats, no. It's not in the stats, but it was around GBP 90 million compared to GBP 80 million.

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Ed Steele, Citigroup Inc, Research Division - Director [31]

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I think there's been a lot of pressure from the FRC to disclose this stuff, so why are you not doing it still, please?

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Franco Martinelli, Babcock International Group PLC - Group Finance Director & Executive Director [32]

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Because it's only GBP 90 million on a total balance. It's not significant. We give it when we're asked, as I've just done for you, Ed.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [33]

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Any other questions? Can you just -- Kean?

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Kean Marden, Jefferies LLC, Research Division - Equity Analyst [34]

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It's Kean Marden from Jefferies. Can we just touch on some of the operational parts of the business? So just on DSG, which for various reasons have been in the press a little bit over the last few weeks. If you can give us an update on contract performance and also the potential for scope extension within that contract, that will be helpful. And then secondly, I'm sort of intrigued on your comments about opportunities in Canadian civil nuclear. So when you went for the Chalk River bid process, I suppose you sort of came runner-up in that process, so what's changed to make you believe that you have an opportunity to bid? And I'll presume that's not Chalk River coming back to market, so presumably there are other opportunities that are coming through in Canadian civil. So if you can give some background on that would be helpful.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [35]

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Right. Maybe we'll start off with what John thinks about DSG. The answer on Chalk River is easy. We moved it from Roger to Simon. And I mean I think -- and for me, that -- Chalk River, we had a good go at, but probably part of the weakness was that we weren't well-enough established in Canada and that side of it. So since we lost, since we didn't -- lost Chalk River -- we learned a lot about the market through that process, and we're now taking a different approach to that. And under Cavendish Nuclear and Simon, we are looking at other entries. There's a big market in Canada. It's almost as big as the U.K. market. Canada has got a really big nuclear -- it's well served. It's not -- it's a mature market, but I think, from the experiences that we've known, learned from Dounreay, from Magnox, we definitely have skills and capabilities and offerings that I think will be attractive in that Canadian business. And I will get -- I'll maybe get you come back to that after John tells about DSG.

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John Davies, Babcock International Group PLC - Chief Executive of Land & Executive Director [36]

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Yes. So DSG, I'll mentioned the word Boatman. Perhaps I shouldn't. Boatman, I think we'll just stick to the facts. So there were certain allegations made. I'd answer it in very simple terms. Firstly, Boatman said there's a cost-plus contract, fixed price. Boatman said we bought it in 2014 -- bought it in 2015. Boatman said that protected mobility had been withdrawn. We hadn't secured it. We actually won it last year, and we announced it to the City. Boatman said Ajax was an opportunity that had been missed. It was actually awarded to GD before we even bought the business. So I could carry on for quite a long time, but I won't do. Those are the kind of inaccuracies, so I'll move on from that to say that DSG is performing well. We have done some really good work under the auspices of the Cabinet Office transformation program. We've been working on that for some time and we have worked in a very collaborative way, and I'll say more about that at the Capital Markets Day, but there's been some good work done. We've secured business over the last year. We secured Leconfield garrison, where we've taken on the civil servants. 70 civil servants have [GP-ed] across to us. And we've won protected mobility. We've won 1 division replacing the Royal Electrical and Mechanical Engineers in the field doing maintenance on vehicles. And that probably totals about GBP 120 million, 140 million. So we continue to work well in DSG. And in terms of future, again I'll say a bit more at the Capital Markets Day, but projects like Warrior and Challenger. And contract churn, we do get quite a bit every year to some contract churn; and also, just to leave you with this, taking a potential gainshare on the procurement pass-through, which will be a very significant development. So I'll leave it there, if I may, unless there are any other questions on DSG.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [37]

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Thank you, John. Simon, give us a quick one on Canada?

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Simon Bowen, Cavendish Nuclear Limited - Chief Executive [38]

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Simon Bowen. Canada is an interesting market for us. Chalk River, I think, was an opportunist bid that we went into partnership with. And you're absolutely correct. We weren't successful. I think we've reevaluated Canada with the help of our marine team. So our in-country team have given us a lot more intelligence in terms of the way to get into the market, and what we're doing is going into the market with a different offering. So it's much more of the capabilities that we've got in our nuclear services business. So it's technologies that we have in terms of things like in-cell decommissioning with robotics and with AI, artificial intelligence. It's obsolescence management to help Bruce Power and Ontario Power with some of their major obsolescence issues and all of the work that we're doing with EDF on lifetime extension. So those are kind of discrete technology offerings which will give us organic growth in partnership with a number of Canadian companies that we're talking about. So there's a much more organic approach to it. We would still consider doing something of the scale of Chalk River because Chalk River is -- would be a big opportunity. And it may well come back to market. We're not quite sure, but this focus is all about nuclear services, differentiated offering of the stuff that we do here which is not available in the Canadian market.

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Archibald Bethel, Babcock International Group PLC - CEO & Executive Director [39]

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Thank you, Simon. Any follow-up questions? And with -- there's not. Can I end by just, one, thanking you for coming along this morning.

And I would like to kind of remind you that, on the 5th of June, we are holding a Capital Markets Day, where we do intend to provide a great deal of detail and information about how we see the business moving forward in the next 3 years. And we kind of hope that most of you who are here will manage to make it in that day.

So thank you. Thank you again.