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Edited Transcript of BBY.L earnings conference call or presentation 14-Aug-19 8:00am GMT

Half Year 2019 Balfour Beatty PLC Earnings Presentation

London Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Balfour Beatty PLC earnings conference call or presentation Wednesday, August 14, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Leo M. Quinn

Balfour Beatty plc - Group Chief Executive & Executive Director

* Philip J. Harrison

Balfour Beatty plc - CFO & Executive Director

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Conference Call Participants

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* Andrew Nussey

Peel Hunt LLP, Research Division - Analyst

* Gregor Kuglitsch

UBS Investment Bank, Research Division - Executive Director, Head of European Building & Construction Research and Equity Research Analyst

* Howard David Seymour

Numis Securities Limited, Research Division - Director of Equity Analysis

* Marcin Karol Wojtal

BofA Merrill Lynch, Research Division - Analyst

* Saravana Bala

Jefferies LLC, Research Division - Equity Associate

* Stephen Joseph Rawlinson

Edison Investment Research Limited - Analyst

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Presentation

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [1]

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I'm Leo Quinn, Balfour Beatty's Chief Executive. There is a live webcast, so we'll -- that's for everybody on the webcast.

First slide I'd like to put up is actually our Balfour Beatty 110 years. In January of this year, the company has been around for 110 years which I think is a phenomenal achievement and you'll love that graphic, I'm sure, the way we build it with cranes and trucks. First and foremost, it plays very nicely into the fact that our Build to Last program has always been designed to actually put in place a platform for the next 100 years of success, and that's building on the 110.

Today, we've announced what I think is a strong set of results, and there's a continuation of the progress we've made over the last 5 years. Encouraging to see that our profits are up some 29% and beneath that our construction services in the U.K. has actually improved by some 41%, so it's nice to see that.

If you remember back in 2015, I think, we had 79 distressed projects. So it's good to see those work through the system. The real highlight is actually the cash. And I think last time we presented our cash for various reasons wasn't as strong as we would like it to be, but our average net cash during the period is GBP 290 million, which is a huge step up from where it was last year and our closing was GBP 425 million. That's cash in the bank as opposed to overdraft.

And our financial strength is underpinned by a GBP 1.2 billion investment portfolio, which has the benefits of a strong yield, but it also has the benefits as the assets mature we choose to sell them off. We've got a strong performance in the second half of the year. The first half was a little lighter than the prior year.

In terms of our growth in orders, we've used the word manage because we don't want to get ourselves back into this position we were in and where the industry was in terms of forced growth, where you have to grow your top line in order to keep feeding the cash flow to keep funding the losses. So it's really important for us that we are highly selective in terms of the risks that we're taking, and this is the first time we've really allowed the order book to grow on the back of what we think are very good solid projects.

And then finally, our confidence in the future is underpinned by a 31% increase in the dividend, and this is the third year in a row where we've had a 30% increase, behind that is some of the leading indicators. And what's important about this next slide is not so much the Lean, Expert, Trusted and Safe, but this is a 5-year trend of continuous improvement. And it really doesn't matter what you measure, but provided you're measuring something and holding yourself to account. If it keeps improving, something good is going to be happening underneath that.

In terms of Lean, we're looking at cash in, cost out. But more importantly, how we're investing in the infrastructure to support the next 100 years as a company, which will allow us to drive the productivity. And as you see in the next slide, our overheads continue to reduce in absolute terms, not only as a percent. I'm encouraged, if you look at -- we have GBP 400 million improved cash flow ahead of where we were back in 2014, and each year that line keeps rising and it flattens out around the 0 point. So that's a very encouraging trend.

We're an industry that's based on the capability of its people, and it's up to us to create a great place to work in order to keep our employees with Balfour Beatty. And you can see for the fourth year in a row, our employee engagement index has actually risen and the number of participants in that survey is the highest level it's been in the company in the last 5 years. So I think everything is going well here. This is important to attract people in and also to retain people within the company.

Our trusted is about doing what we say we will do, and this is more a case of our customer satisfaction and we measure that and that's remained at 97% for the period.

This is an incredible progression, and I think safety is a sort of a leading indicator of how the business is going to perform. And 5 years ago to think we could actually halve it, which is an improvement, by the way, less accidents, is quite unimaginable, but we are there. We were recently recognized with the construction use safety award and the quote was, "We're not only leading the industry, we're setting the standard for the industry." And I think that's a great accolade to all of the work that the senior managers do top to bottom in this company to make sure that we send people home safely every night. So great track record in terms of 5 years of improvement and hopefully another 5 years.

If we actually move on to some of the hard numbers behind those particular trends, if I look at the average net cash for the half year period forward, back in 2015, we were overdrawn to the tune of GBP 16 million. Today, we have net cash of GBP 290 million. For our earnings-based businesses at the end of the first half of '15, we lost GBP 180 million. Today, we're generating GBP 63 million.

By the way, the amount that we generate, in my view, is absolutely derisory. But the point is, if you look at the trend and if you project that forward, you can almost become optimistic and encouraged. If I look at operating expense, 2015, our overhead was GBP 212 million. On the same volume, we're GBP 137 million. That's a GBP 75 million improvement in the first half. And I think we're talking about GBP 185 million improvement in the year, which is an improvement of about GBP 10 million over last year.

And then in terms of attrition, which is -- this is a real cost to the business, it's particularly our business where you've got records, history and the likes of that. You to have gone from 15% down to 11%, we still have a target of 10%. Again, that's really encouraging place to be. And from a brand and an industry point of view, I do feel we have sort of the place that people actually want to come to work today. So it's great to have a brand that's been restored to its former strength and the place that people do actually want to come to.

So on the back of that, what I'll do is I'll hand over to Phil, who will now treat you to some facts.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [2]

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Thanks, Leo. Good morning, everyone. Let's look at the headline numbers. I'm particularly pleased with the profit from operations up 9% on relatively flat revenues as we continue to focus on operational delivery. At a pretax level, profits increased by 14%. Another highlight is the order book, which increased again under the group's managed growth strategy, which we'll cover later. We also saw year-on-year improvements on average net cash with our first half performance of GBP 290 million, up more than GBP 100 million on prior year. Given this performance, the Board has declared an interim dividend of 2.1p, a 31% increase on prior year.

Now let's look at the results in detail. Turning to underlying profit from operations. In the earnings-based businesses, profits increased by 29% to GBP 63 million, which contributed to the overall 9% increase in the group's underlying profit at GBP 72 million.

Looking at the constituent parts, construction services improved by 41% to GBP 45 million and support services by 6% to GBP 18 million. Following significant disposals in 2018, infrastructure investment profits from operations decreased GBP 8 million to GBP 25 million.

Order book. We saw an increase of 5% from year-end 2018, an increase in both absolute terms and the constant exchange rates. The construction order book increased by 4% due to increased orders in the U.S. In the first half, we booked significant buildings projects across our U.S. regions at the Wharf project in Washington, D.C.; Block 216 in Portland, Oregon; Jacksonville International Airport in Florida; and a significant commercial office in Plano, Texas.

The U.K. order book remained stable at GBP 3 billion. As a reminder, it does not include our share of HS2, the GBP 2.5 billion civil work or the GBP 1 billion Old Oak Common station in London. Work is progressing to deliver detailed plans and costs for the civil works for lots N1 and N2 under an early works contract, work we now expect to complete by the end of the year. Importantly, our financial forecast for this year and next do not rely on HS2 going ahead.

In Support Services, the order book increased 7% to GBP 3 billion, following growth in the transportation sector, namely the award of the Central Track Alliance by Network Rail, where we have booked GBP 250 million of the expected GBP 1.2 billion of work under the 10-year framework agreement. And we also saw the re-award of the London Underground infrastructure contract for a further 4 years.

Now let's look in more detail at each segment, starting with construction. In the U.K., revenue increased 7%. The first time revenue has increased under Build to Last. Profit from operation showed an improvement to GBP 17 million, with an associated margin of 1.7%. We expect that for the full year, U.K. construction will be within the 2% to 3% industry standard margin target range.

In the U.S., revenue increased 10%, 3% at constant exchange rates. The PFO margin was consistent with last year at 1.1%. We anticipate margin improvement in the second half of the year as new work booked in 2018 progresses.

At Gammon, revenue was lower in the period as the timing of revenue from project starts compared to last year is more heavily weighted to the second half. Importantly, margin performance improved to 2.4%.

Now turning to Support Services. As you can see on the slide, Support Services' revenue decreased by 7%, as expected by the -- following the conclusion of the Area 10 highways maintenance contract and lower volumes in the power transmission business. Importantly, profit from operations and PFO margin for the period increased to GBP 18 million and 3.6%, respectively. We continue to expect the full year PFO will be broadly in line with prior year.

Breaking down the constituent parts into a bit more detail. In power, new business wins in substations and power lines for National Grid will feed through into higher volumes next year. The gas and water business is moving towards the end of its current regulatory cycles. In water, the group has started to engage on M7 planning cycle, including negotiating the renewal of current contracts. In transportation, the underlying highways market is good with multiple local authority contracts coming to market. Whilst the rail, our partnership contract with London Underground, as I said, was renewed at the start of 2019. And in March, we got the 10-year Central Track Alliance Contract to design and deliver track renewals and associated infrastructure works across the London Northwest, London Northeast and East Midland routes.

Moving to infrastructure investments. The business continued its strategy of optimizing value through the disposal of operational assets while also continuing to invest in new opportunities. Following significant disposals in 2018, underlying profit from operations decreased to GBP 25 million, with both predisposal operating profit and profit from disposals lower than the prior year.

It is worth remembering that the investment portfolio is integral to the group, a constantly regenerating asset base that interlinks with our Construction and Support Services businesses. As examples in the U.K., investments in construction are working on a major student accommodation project at the University of Sussex. And in the U.S., our Civils and Building businesses are working with investments on the LA Airport Automated People Mover. The group continues to see opportunities to invest in high-quality projects with good returns.

In the U.S., the focus is on student accommodation, multifamily housing and public/private partnerships. In the U.K., the focus is on student accommodation and public authority-led regeneration schemes. We continue to look to time asset sales to realize optimum value to shareholders with more disposals expected in the second half.

Turning to the Directors' Valuation. Looking at the moving parts, we invested GBP 11 million in new and existing projects, whilst cash yield from distributions amounted to GBP 32 million as the portfolio continues to generate cash flow to the group net of investment. The sale proceeds were GBP 26 million from the sale of Borden Data Centre in Canada and 3 multifamily housing assets in the U.S. The unwind of discount was circa GBP 45 million with the period end valuation again rounding to GBP 1.2 billion, this equates to 169p per share.

If I go to the next slide, this slide shows all the investment disposals that the group has made since 2015. Each bubble represents one disposal. The size of the bubble represent the sale proceeds received. The color of the bubble represents whether the asset was sold either at or above Directors' Valuation. Blue is above DV or dark blues above DV. On the left-hand side of the graphic, we have the end-to-end multiple for each project at the point of disposal. This is calculated as the sale proceeds plus distributions received over time divided by the original equity investment. The graph demonstrates that the group continues to make strong returns from its investments. Over the period, we've realized GBP 650 million from the portfolio with the majority of the disposals above DV. Returns have averaged over 3x the initial equity outlay, and we continue to target a minimum 2x return on new equity.

Now if we move to cash flow. I'll start by highlighting the good average net cash performance for the group at GBP 290 million for the first 6 months. This is substantially higher than last year. And for the full year 2019, we have now increased to a range between GBP 280 million to GBP 300 million.

Now moving to the waterfall. The total cash movements in the period resulted in GBP 88 million increase to the group's net cash, positioned to GBP 425 million. The increase came primarily from the GBP 94 million operating cash flow with working capital broadly neutral. It is worth pointing out with the adoption of IFRS 16, the operating lease cash flows are no longer categorized in operating cash flow. But in financing activities, these amounted to GBP 24 million in the period, other flows were as expected.

Negative working capital as a percentage of revenue remained stable at 10.7% versus full year at 10.3%. You can find additional information on working capital splits as well as IFRS 16 in the appendix.

My final comments before I hand you back to Leo, a good first half performance in terms of profit and cash. We continue to be selective in the work we bid for, and we continue to focus on operational delivery. Therefore, the Board expects the group to deliver a full year performance in line with expectations.

So that concludes my remarks. I'll now hand you back to Leo.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [3]

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Right. Thanks, Phil. Back to Build to Last. We're creating a platform in which to build the future of the business here. But at the same time and underneath that, we've also created what I regard as a geographically and operationally a diversified company.

Today, over 50% of our returns come from outside of the United Kingdom. And although we're a British-listed company, it sometimes overlook just how much comes from Hong Kong and primarily the United States. In the case of investments, you've seen over the last 4 to 5 years, where those ratios have actually switched, we used to be about 44% in the U.S. and 56% in the U.K. We've now switched that round.

The operationally diversed portfolio we have is the different business models we operate within the various territories. But if I spend a few minutes in terms of the U.S., although we're looking at bookings here, in revenue terms, the U.S. building business is about 80% of our turnover and that operates on the basis of construction management. So we receive a low fee in that area in the order of 4% to 5%, but we actually take a much lower risk because the risk is passed down to our supply chain. The remainder, which is about GBP 700 million to GBP 800 million, is in our Civils business, which in some ways is slightly neanderthal in terms of how it contracts. And it hasn't matured to the point that where the U.K. business and market is, and I'll explain that in a few minutes to you. But there's an awful lot of hard bidding goes on in this area, where it's a fixed guaranteed maximum price, which can carry superior returns but also can come with superior challenges. And you'll have noticed from the industry that some of the competition have had some big challenges recently.

In terms of Gammon, I'll touch on this in a bit more detail, but this for us is a full-service model, again, primarily guaranteed maximum price. But our focus on Gammon is really around the dividend, I'll explain that.

If I look at the U.K. in terms of U.K. construction and U.K. services, again, very different models in terms of our U.K. services is primarily focused on long-term engagement with customers 10-year contracts, which actually demand of you to be more productive at the end of the cycle rather than the beginning. And there is lower cost invested in securing this work because it runs over 10 years, but they can be equally challenging over time. And U.K. construction is a myriad of construction or contracting models, which I'll touch on in a later slide as well.

In the case of our investment portfolio, which is really the jewel in our crown and will continue to be, not only in terms of its size, but the security of the income that comes from it and the flexibility affords us if we want to sell down assets at the peak, as Phil has described. This works best when we have a model that the -- we design, build, finance and operate, where we're a full service provider. And there are a number of models, which I'll touch on in next few slides, which portray that. It's not foolproof, it can actually go wrong. But today, as we use this asset to our advantage, we seem to be building better with long-term returns in this business than we had in the past across the whole portfolio i.e. delivering profit to construction and delivering finance profits to the infrastructure business.

If I move to the U.S., I talked about geographically diverse. You're aware of our Southern Smile in terms all the way from Seattle round through California, Texas and up into the north the Mid-Atlantic and the Carolinas, and that's referred to as a Southern Smile. And as the population gets older, it migrates to the warmer parts of the country. So we've seen population growth, which brings with accommodation, housing, infrastructure and the likes of that, which actually caters to what we do. We're also diverse in terms of our customer base and who we cater to. And they are very different markets and there's value in that diversity because not everything rises and falls at the same time.

If I look up in the northern area, we're primarily focused on the tech sector companies like Amazon and data centers, Microsoft and their campus and things like that. As I move down into California, our primary building focus is largely around schools. If I go down to Florida here, we're actually engaged in the likes of Disney, Universal, hotels, leisure and the likes of that. And if I look at the final areas of our building business in terms of Texas, the Mid-Atlantic and the Carolinas, it's primarily offices and residential accommodation, mostly construction or concrete build frame -- or concrete frame buildings and the likes.

And as I then look towards the other side of our portfolio, which is actually the more hard-bid area. In the area of Texas, we're one of the primary deliverers of roads. We've had a very successful Horseshoe delivery. We've got a very successful project with The Southern Gateway, and we recently were the winner of a GBP 1.7 billion I-635 highway project. That's an area where we work closely with a client. We've had a 20-year relationship, and it is a very successful business for us.

Our other big Civils infrastructure activities are in California, where we're in to rail and water treatment plants. And in the Carolinas, where it's the same all the way down from Washington down into the north of Florida here. So those are our 2 particularly strong business models. It turns over about GBP 3.5 billion annually. In terms of our investment portfolio in the U.S., it's about GBP 650 million, and that's primarily our military housing asset and other unique locations.

If I look at the prospects for this market, I refer you here to the right. There's no shortage of opportunity in the U.S. at the moment, and there's an awful lot of growth. Our challenge is being particularly careful and selective in what we go for. And because a lot of the models -- business models are around hard bidding in that area, we need to sort of start to change some of these because the risk tied up in some of these major infrastructures are so large, they can't really be absorbed by a single company. That doesn't mean you put together a joint venture and absorb that risk over multiple companies, it means you either play on the basis of a cost reimbursable or you decide not to play.

If you look at this chart as well, you'll see there's 55 stars, which actually represent all of our military housing assets across the United States. We look after 43,000 residential homes for the military on a 50-year concession. It's serviced by 1,200 employees, who are committed to providing the highest possible service, and many of them actually have a service background. So they are intimately connected with that industry.

You'll be aware from the press recently that we've had reports around allegations in 2 of our bases, Tinker and Mountain Homes of issues around the processing of work scheduling orders in terms of repairs. We've looked into this. We take the matter very, very seriously, and what we want to ensure is that we have an independent review. So we've -- in order to ensure the independence, we've appointed external counsel, and there is an investigation underway. Given what we know today, we see no reason to change either our financial forecasts or our Director's Valuation in respect to that asset. And if there are any further questions on that, we'll take them during the Q&A.

If I move to the U.K., it's hard to think that a country of the size of the U.K. is geographically diverse, but I can assure you it is, and we do operate all the way Scotland down to the London area in the south. The point I'd like to talk about here in terms of the U.K. business models is that if I look here up to the top right, where we're looking at things like Scape, Regional Investment Programme, which is highways England and the new Central Track Alliance, these are invariably long-term partnership arrangements. Scapes 4 years, but the Regional Programme and the CTA is actually a 10-year program. What they hold in common is the fact is that most of the work is actually constructed under what is an ECI, which is an early contractor engagement. And what that means in simple terms is that the customer pays for us to put together the scope, the cost and the schedule of the job. And once we understand the risk and the client understands the risk, we then decide whether or not we proceed with that work. This is transformational, when especially I'm going to touch on large projects. This is transformational in terms of where the U.K. sits today compared to Civils work in the United States. And I think that you'll see in the future the Civils in the United States will start to evolve to a much more collaborative model. This long-term engagement does give security of work and although it underpins a good reliable workforce.

If I look at the areas over here, some of our major infrastructures work with the M4, for example, Hinkley, and I'll even include HS2 in that discussion is that these are major infrastructure projects. They carry with them very, very high risk if you get them wrong. But the good thing that's happened in the U.K. as a result of whether it's Interserve or Carillion or this is that. The way we engage with our clients today is completely different to the way we used to engage. So what we're doing is we are actually working, collaborating with the likes of Hinkley, HS2 and M4 to engage with them early, whereby we put together the cost, the schedule and the scope, and then we work through what is practical and what's feasible.

And what we're now starting to see is models emerge, which effectively is like a cost-incentivized fee, where our fee and overhead is guaranteed on the contract and then there's a pain gain formula, which is in the tight band. It says if you overperform, you'll get a small marginal improvement. If you underperform, you will actually get a small marginal loss, and that band is important because what it means is you never drive a contractor into loss when they can't manage. If, however, you don't perform, you'll simply recover your overhead and you won't make any profit from it, but you don't end up with the disaster scenarios occurred.

So this market is changing and evolving. And again, this is, I think, a real important indicator as to where we'll see other markets around the world change in the future as well. If I also look at the future prospects here, the fact of the matter is, is that there is a very ripe infrastructure market sitting out there at the moment. As you know, we were selected on N1, N2, which is a Birmingham area for High Speed 2. We were also selected for Old Oak Common, which is currently in dispute. There's been a protest against the bidding process and HS2 is taking that to court in early September to have that presided over and decision made. At the moment, everything is on hold in respect to that.

Our position in that contract is purely as a construction manager, where we get a fee for our service. If I look at this pipeline ahead here, all of the work that we're looking at this moment in time is invariably some form of collaborative bidding as opposed to just simple hard bid and things have actually changed. Some contracts have come out in the last year, and there have actually been no tenders for it. And so the government and the associations had to go back and change how it's going to procure in the marketplace, which just shows how the market is evolving.

Phil talked about our investment business and the Sussex University. Where we make our best returns is when we actually act in concert with our investments, financing and our construction building, and we make a wall-to-wall return on the basis of that. And we've got a couple of big projects, the concession on the M25, which runs for 30 years, which is running well; and the Sussex University, we've recently completed the first 1,000 rooms in their upgrade program. So an important market to us and one that actually, I think, has been derisked all the time that we work within it.

If I look at Hong Kong, we're a joint venture with Jardine Matheson 50-50. It's about GBP 1 billion worth of turnover from us. And the most important takeaway actually from this business is that Hong Kong for us is an annual dividend. This company has its own balance sheet. It bonds on the back of its own balance sheet. It takes risk on its own balance sheet. It is a strong balance sheet, but its primary purpose for us is the dividend that it yields at each year.

It's a full-service construction company. In terms of that, we do ground engineering. We mix cement. We deliver it all the way through to the mechanical and electrical it goes on. We have a variety of infrastructure projects ranging from the M&A on the tunnel to the Viaduct that we just recently completed. We're engaged in some of the major building infrastructures in the center of Hong Kong in terms of the Lyric Theatre. Interesting enough, it sits over a railway line. How you have a concert with a railway underneath it. It's another mystery to me. And then the M Building museum. And then we're even in the area of water parks and the likes of that. So this is a full-service business. The business model over here is still hard bid, it's -- which means that you really have to know that market and you have to be ingrained in it. However, what we're now seeing is signs that that's moving towards a more collaborative model in terms of the first NEC contracts and the first early engagement types of contracts.

So I think the challenging market, but I think the future looks bright here. The amount of work that's coming down the pipeline is phenomenal over in Hong Kong, particularly around the fact they've got a 10-year hospital plan, they've got a 10-year residential housing plan, they've also got supporting infrastructure plan. So this is a very buoyant market. And although there's a short-term chaos that's going on in Hong Kong, it's not something that long term I would spend a lot of time worrying about.

So really, in summary, I think Balfour Beatty this time in all of our chosen geographies have a strong position in the infrastructure market, and we're going to see that grow over the next 10 years. My number one challenge and priority is how do we recruit and retain the people in Balfour Beatty in order to deliver that work. And as you know, we're strongly engaged in bringing on apprentices and graduates into the industry, but we're equally engaged in ensuring that those people who got 40 years of experience don't retire at 60. So to help them along the way, we've canceled all retirement at 60 for our employees. And the fact of the matter is, is that I'm sure they'll be engaged and wanting to stay a lot longer in light of the future challenges and work that's coming.

We've spent a lot of time in bidding -- in embedding what I would describe as a risk management culture, whether that would be in our GTIC process, whether it be on our projects on the page. But for us, it's really, really important that we understand the risk. We won't always get it right, but the fact of the matter is, we're involved, we're engaged and we're making the decisions as to what we will and what we won't do at a very high level, and that involvement is critical to our future success and our future improving margins.

And the Build to Last, we've put in a platform, which is capable of growing the business and scaling it. It helps us in terms of how we manage our financials, how we drive productivity through the company and also how we scale it. I believe we've got a truly scalable model if we ever wanted to use it. And I'll give you an example. Under the Central Track Alliance, we've just recently TUPE'd over 500 employees and contractors from various companies around the United Kingdom into our system. And to date, it's gone flawlessly. That's a major task because it's not only about moving someone's employment file, it's about giving them a new car, a new van, a computer, a telephone and everything needs to be up and running and working. And when we took over sort of 165 employees from Carillion a couple of years ago, that went seamlessly for us, and I'm sure this will go seamlessly as well, all that leads to driving more productivity and costs down.

And then finally, the strength of our balance sheet, and in particular the strength of our investment portfolio, I think, leads us ideally to the point that in the future we can see strong cash distributions from the company. And as I've said before, our first priority is always going to be next year, we've got 110 million preference shares with a 10% coupon on them. We've got a GBP 25 million private placement. So that's our first priority to get those paid down, and those are the singly most value-accretive things that we can do within the company.

So on the basis of that, I think we'll hand over for Q&A, and we can take any questions that you care to offer.

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Questions and Answers

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Andrew Nussey, Peel Hunt LLP, Research Division - Analyst [1]

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Andrew Nussey from Peel Hunt. Couple questions, if I may. First of all, on the infrastructure business, you said there's lots of opportunities out there for investment. I'm just wondering what the market is like for asset sales at the moment in order you get to maximize the value for the group? And then secondly, in the U.S., if we work an assumption of more collaborative working, should we expect a greater shift to Civils over the Building business over the next probably 2 to 3, maybe 5 years?

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [2]

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I'll do the second one first, if I can. I think it all depends on the risk. There's absolutely no shortage of opportunity in the last, what, 48 hours, we've looked at high-speed rail in California. We looked to Expressway, which is the high-speed rail to Las Vegas, et cetera, and it all comes down to on the basis to which they want to actually contract. And of course, from a client's point of view, what they want is a fixed price guaranteed lump sum. Well, you know not on this planet, it just cannot happen. You can't take those risks on board. So I think it's very much a question of -- I could see the Civils business growing to a certain extent, you have to remember, we've only got a limited capacity and limited number of people. But at the end of the day, it's going to have to be on terms that means that we're not carrying the risk of delivering their high-speed railway to a certain schedule and that it's worked collaboratively overcoming the challenges that you come. If you compare that with the way HS2 has been handled, it's working on a very tight budget. And what they've realized is that they're better to work on a cost-adjusted incentivized fee with the contractor and not try and pass down bonding costs and liquidated damages, et cetera, because ultimately the risk stays with them whatever happens. So we've got to get the U.S. and the U.S. client base to the same point of view. If I let Phil touch on the asset sales.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [3]

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I think our -- as you've seen and demonstrated over the last 5 years, we've been very good at extracting value as we go into the market. The investment team has done a great job there. Values are still strong. The secondary market is strong. There is a -- if you like, a lack of assets into the secondary market. So there is a, I think, a pent-up demand there. So we'll continue to time and extract the best value from those assets. We don't see that at this point changing.

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Howard David Seymour, Numis Securities Limited, Research Division - Director of Equity Analysis [4]

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Howard Seymour from Numis. Two, if I may on unrelated areas. Firstly, could I just ask on the military housing. Thank you for the slide, very useful. You alluded to the fact that you don't see any sort of impact on DV, 2 questions there. One, is there an actual schedule timetable going on in terms of what's going on in terms of the allegations that we can understand? And secondly, in what circumstances could you see a change in the DV on the basis of the allegations? And I don't know if you can put any quantification on that as well? And then, I'll come to second question.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [5]

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Right. First and foremost, putting it in context, we are talking about 2 military bases out of 55 and allegations made by 2 ex employees and second big case one work order. So the challenge is, is that -- I'm going to be very careful with my words, the challenge is that you want to make sure that we review it independently, which then means you'll then -- despite working with the Air Force, you'll then forced to go down through a process, and it's never easy to communicate and get all i's dotted and t's crossed. So yes, it will take time. I can't tell you how long that will be, but I know it is as equally challenging, embarrassing for the customer as it is for us. And so it's in all our interest to try and move this forward as expeditiously as possible. In terms of circumstances, I can't think of any, but Phil might have a thought on that?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [6]

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I mean, what we reiterate we have no knowledge today that would make us change the DV. I don't really want to speculate on future occurrences. We'll deal with that when they arise.

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Howard David Seymour, Numis Securities Limited, Research Division - Director of Equity Analysis [7]

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Okay. Okay. And secondly just on payment terms in terms of the U.K., which again has been quite a sort of contentious area for us, I suppose. You can see that the payments have come down, just real thoughts in terms of where the government is on this at the moment? They seem to be a little bit less draconian perhaps than they were, but do you perceive that you'll continue to see that the payment days drop over a period of time from Balfour's and the industry point of view?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [8]

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We've been on a process over the last 18 months pre anything that's happened this year to improve our processes in terms of actually collecting cash and paying our suppliers on time. The industry is very complex when it comes to invoicing, making payments just because of the difficulties that go on day-to-day on sites and changes that occur. But over the last 18 months, we've improved all our metrics significantly. We have an action plan that has been approved by the Prompt Payment Code, which we're working through that we will consistently, I think, deliver improvements as we go forward, which is our commitment. I say our first commitment is actually always to our supply chain because we live and breathe what we do and how we deliver by our supply chain partners. So it's essential to us to make sure that they are paid and also perform. The government itself has brought out new guidance. It made the guidance earlier in the year that said that you would not receive or you would be reviewed if you're below 95% payment to suppliers within 60 days. In the last 3 weeks, they've reduced that to 75%. I think that's in recognition that the processes and the improvements that need to be made across the industry is going to take more time, but we're committed to improving. And as you can see, our results this time around again is an improvement.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [9]

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Yes. I think our branch is built that one way is -- first of all, we're totally committed to paying to terms. But beyond that, we're totally supportive of our supply chain. It's not a question of whether we follow the K, The fact is, it's in our interest and getting the job done on time that we're philosophically supportive of paying our suppliers on time. So I see it's ingrained as part of our culture.

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Gregor Kuglitsch, UBS Investment Bank, Research Division - Executive Director, Head of European Building & Construction Research and Equity Research Analyst [10]

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Greg Kuglitsch from UBS. I've got, I think, 4, some should be easy, some maybe not, but just on the military housing, can we have 2 questions there. So the first one is the 2 bases, how much are they of the DV so we can get a sense of kind of what the risk is? And just to be 100% clear, are these contracts all structured separately on SPV basis with nonrecourse to the group, just we can understand what they maybe thinking about contagion risk of some sort?

And then the second question is on the incentive fees. So can you just give us a sense how much either the whole portfolio as a percentage the incentive fees represent as part of the value because obviously that's a bid, I think, that's been kind of under discussion?

And finally, obviously, we're not privy to the contracts, but are there any clauses in the contract where you can get fined for, I guess, this kind of misconduct? Sorry, this was kind of 3 questions, actually only supposed to be 1.

So second question is just you're mentioning on the U.K. construction business that the sort of contract terms are changing of lower risk and more collaboration, how much of your book or your business is actually on those new terms? Because I guess there's still -- not everything is like that, but I would want to know how much is actually in that sort of lower risk phase where your loss potential is lower?

And then the third and final question perhaps is, could you just give us an update what the resolution is with the Scottish Department of Transport on Aberdeen bypass on any potential settlement of the final contract?

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [11]

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If we could have done a separate presentation for you, couldn't we. Phil, let's take the military housing one because that's easy one to get that out of the way for you. And then what we'll do is I'll tear off the construction one and the Transport Scotland and the Aberdeen Peripheral bypass.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [12]

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So on military housing, I think you asked, are they -- are these bases in separate SPVs? We -- the 2 -- the Air Force bases are in separate SPVs. The Tinker is in a project that -- wrapper that we call AMC West. So we have 21 project companies in our portfolio that add up to the 55 bases. There is -- they are nonrecourse debt. They are not cross defaults. So I think that's important to recognize. On incentive fees, we make a statement in the -- and I'm just trying to -- I think it's 13% is the figure that we have told you in the statement and that's all Air Force bases, the 21. And you can roughly extrapolate that to the DV.

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Gregor Kuglitsch, UBS Investment Bank, Research Division - Executive Director, Head of European Building & Construction Research and Equity Research Analyst [13]

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And then just -- sorry, before we move on to sort of 2 entities, the SPVs, AMC West and, I guess, I don't know Mountain Home, how much is that of the entire -- is it 2% out of 20%, so 10% roughly of the DV.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [14]

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No. It's...

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [15]

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I think rather than to answer it now...

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [16]

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We'll just take it off line and give you the answer to it.

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Unidentified Company Representative, [17]

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(inaudible) percentages of the military housing portion of the DV, not the whole DV, so all these percentages may relate to the element...

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Gregor Kuglitsch, UBS Investment Bank, Research Division - Executive Director, Head of European Building & Construction Research and Equity Research Analyst [18]

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Absolutely, yes, yes.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [19]

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Yes, they don't relate to our GBP 1.2 billion. If you don't put it into GBP 1.2 billion contract, it's immaterial.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [20]

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Yes. Your questions were around U.K. Constructions, how much of the portfolio falls into that more collaborative side? So it's obviously very difficult to measure it because you've obviously got historical contracts, which you're trading through and you do have a complete myriad. But I'd have to say the portfolio is dominated by what I think is the collaborative type of engagement. If I think of Highways England and I think of their revenue, if I take a Scape partnership in that, if I take our service contracts, I'd say the portion is large. And with the likes of HS2 as and when it comes into the portfolio, it will be even larger. And I think that's actually also in self-preservation because I think the client base is realizing it has to work collaboratively on these projects, otherwise it will have no one to do them in the future. And there's been a lot of failures on the back of the old model.

In terms of the resolution of Transport Scotland, we continue in a good faith dialogue with Transport Scotland. There is an impending deadline, which in December proceedings have to be filed with the court so that we don't sort of exhaust the statute or the limitation of the statute on the claim. So it will be coming to the head by the end of the year either in court or some sort of resolution.

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Marcin Karol Wojtal, BofA Merrill Lynch, Research Division - Analyst [21]

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It's Marcin Wojtal from Bank of America. So first question is on your dividend, which was increased 31%. So can you explain how did you get to this number? Does it track your profits from operations? And can you maybe help us a little bit to try to forecast your final dividends for the year on that basis?

Number two, just going back to contract structures in the U.S., you've got a couple of large Civils projects in Los Angeles and also in Texas. So are those fixed priced contracts? Or there are some elements of profit sharing or cost plus perhaps?

And maybe lastly on working capital, which was quite solid, I think, in H1, but what do you expect for the second half? Because I think, as you show in your results release, there was some progress on the receivables, but at the same time a buildup of payables. So I'm just wondering if this is sustainable what we saw in H1?

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [22]

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So obviously, I have no idea how Phil determines the dividend. So it would be good to hear an answer to that question myself. So if you could do the dividend and working capital, I'll do the Texas contracts?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [23]

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Well, you want me to decide. Well, the Board determines the dividend. The dividend, we look at a number of -- or the Board considers a number of things. Clearly, dividend cover, the progress of the business. The 31% is actually a little bit around the math because we prior year did 33% increase. If you actually look at the split, our split is typically 1/3, 2/3. If you extrapolate the -- what we've done now, you'll work out that if the Board does declare in the same ratio as last year, it would be a 33% increase full year, if the Board determines that full year, but that's up to the Board at full year to do.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [24]

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So we'll leave the Board to determine that, will we?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [25]

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Yes.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [26]

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And the working capital?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [27]

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Working capital, I think, we're looking at being relatively neutral through the full year. I can say is being plus or minus full year GBP 20 million or GBP 30 million, but clearly we're not anticipating anything of the size of last year. And as you know that was predicated on some very specific things, around outflows in Aberdeen. The U.S. revenue declines that we experienced last year and some of the payment progress that we made. So we're not anticipating those things to repeat in the second half this year.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [28]

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Okay. And the answer to the question -- I'm sorry, I just deviated from the last question, it was about the nature of the contracts in the U.S. So in the case of LAWA, which is the LAX People Mover, that's a design, build, finance and operate. So that's taking the full portfolio risk. There's also a maintenance contract on the back of that. We're not part of that long-term maintenance contract on that job. I was visiting the job -- or I visited the job, should I say, 2 weeks ago. And at the moment, it's on program or a little bit behind on the schedule for breaking ground but things look to be well within the range of where we've struck the forecast.

In the case of the University of North Carolina where we're doing a 1,000 room student accommodation, that is a design, build, finance and operate. That was actually -- I was there 4 months ago and that actually is proceeding very well. Interesting enough, that is our top-performing construction team in the United States. And I'm very, very confident that, that will come in on time and schedule. So everything I saw gave me confidence, and we're already on that campus doing other work. This is a run on from that work.

In the case of the I-635, which is the interstate in Dallas, that is a hard-bid job. It is in joint venture. The Texas is our most successful highways construction operation. We delivered the Horseshoe Bend project, which was GBP 500 million at a double-digit margin, very capable team. The same team is actually delivering the Southern Gateway, which is on program at the moment, and this is actually what 25 miles up the road from those 2 projects. So it's -- it will be a bid around a high degree of confidence because of our previous experience in the area, but also working with the client. But make no mistake, it's GBP 1.7 billion is a big road project, lot of dependencies. There is risk in it. It has questioned our ability to manage the risk, but I would have a high degree of confidence in this team in that geography.

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Unidentified Analyst, [29]

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It's Stephen Rawlinson. Can I ask 4 questions, sorry for that, 4 unrelated questions. The record 7, by the way, set by Mark Stockdale. So I'm still short on that one. Just first one, on the GBP 150 million you've got to find next year on the perhaps -- and some other chunk of change you got to find, how would that manifest itself in the P&L coming through next year and 2021 because obviously the interest cost was about GBP 15 million, I think, on that particular item last year. So how could we expect that to drop through? And would you repay it in cash or might it be repaid in shares in which we think of that as well?

Secondly, with regard to risk, you mentioned risk in the U.K. context in relation to construction. Could you just talk about a little bit in relation to services because, obviously, we've got things like the outsources playbook and so on. And in the text of the statement this morning, you talked about managed 5% growth by maintaining disciplined bidding practices. This is sort of the implication being that actually perhaps you could have grown a little bit faster on the order book if you haven't maintained them or perhaps also it might be that the government is coming back with tender documents that improve the original terms, given the fact that nobody bid in the first place?

Thirdly, you talked a bit about growth. Well, how should we be thinking about that because you talk about the platform for growth? And finally, forgive me on this one also, the pension. The discount rate has gone down to 2.2% from 2.8%, which has increased the net liability and you were seeing GBP 16 million outflow in the first half in cash. How should we be thinking in future about the cash flow item related to pension fund deficit funding?

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [30]

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Well, given the first one is financial, I better take that.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [31]

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Yes. You'll do that one.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [32]

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Yes, I'll do that one, but the press will be paid down out of cash. I think, from memory, they carry GBP 11 million coupon a year.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [33]

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Or GBP 12 million, yes.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [34]

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GBP 12 million. And that effectively will go back to earnings and cash flow. We will just go into the parts, and then we'll decide how that gets distributed or used either in the future to buy down shares or pay a bigger dividend and whatever. But it's -- after 20 years of the prefs, it would be nice to see them going at a 10% coupon.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [35]

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I don't think so.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [36]

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Nor does one of our Board members who is a holder of them. On the pension, I should probably take that, but that's an easy one so I'll give that to Phil.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [37]

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I don't remember the pension one...

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [38]

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Pension was the 2 -- the reduction in interest rates -- for the fact is our pensions hedged for a reduction interest rates. So it doesn't penalizes...

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [39]

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Yes. I mean, that's the -- it's not the actuarial valuation. It's just the IFRS calculation. So we just adopt the normal discount rates that are prevalent in the market. I think the more important point is that we're in the triennial revaluation year, so we're working to through that this year, and we hope to conclude that at the end of the year. That's our current goal...

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Stephen Joseph Rawlinson, Edison Investment Research Limited - Analyst [40]

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And so your cash flow, going forward, what we should be thinking in regards to that given, what, GBP 15 million, I think, of unusual -- of abnormal payments in the first half?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [41]

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Yes. And you should -- it will be roughly the same in the second half. So we're not changing any of our assumptions around cash that we've given to you previously.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [42]

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Okay. And the service one is really interesting question because like everything it's -- it looks perfect on the outside, like a sausage, but you're never quite sure what's the contents are. So we're trying to unravel some of the contents and make sense for you. The portfolio is made up of rail service and maintenance, local road maintenance, gas and water with gas and water being very different and also power. Within that, the road maintenance business with many local authorities has been well established for over 10 years plus and is actually well understood, well managed and we're fairly comfortable about the forward projections in that area. We haven't seen a lot of growth in that business because some of the suicidal bidding that's gone on in the last few years, but what we've done is we've maintained our portfolio. And as we get more productive over time, we get better returns.

In terms of our rail service business, obviously that's a strong business for us, where we consider to be a very good supplier. And we've just added the Central Track Alliance to that, which is GBP 1 billion over the next 10 years. And we've recently won the Welsh rail contract there as well. So I think we see strong growth happening there. The nature of the contract -- I can't actually remember what terms it's signed up on, but I'm fairly confident that the terms would be very acceptable because they would align with where we are contracting today.

In the area of gas, gas is a challenging contract because it's coming to the end of its period, and there's always goals for increased productivity. So that remains a challenging area. On the other hand where water is the end of its end period and we're rebidding that, but water remains a good business on fair terms. There's always odd nuances around the recognition of profit and the likes of that, but we -- you could write sort of a bible on that.

And then the final area is power. Power is a business, which has the highest barriers to entry. That is invariably struck on a contract-by-contract basis. It's an oligopoly. It's primarily SEC and national grid, and we fully understand those terms and know how to work with them. We see revenue growing very rapidly in that area over the next 2 to 3 years because of the Hinkley electrification and power transmission lines. This year, power is actually probably as low as revenue level. Its cost base has been adjusted to match that revenue level. So as we see the sales growing in the future, we're rather optimistic about improving returns in that area. Sorry about the vagueness of the reply, but it is actually really complex number businesses tied up in there.

And then in terms of growth, I think there's no doubt we could take on more business and grow, but I think that would be reckless. So what we've done is that where we can't live with the terms is we've worked with the clients. We've never rejected. We've worked with the clients to get them onto a platform basis, where we can go ahead. And sometimes within our frameworks, some of the terms that were asked for neanderthal which we will never sign up to. But we find that as we work with the customer, we can get to a point where it is workable and there isn't the risk transfer that was previously sought. So we're a great believer in managing to a successful outcome on terms which are acceptable. But generally, I see terms in the U.K. moving to much more sensible than they were in the past.

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [43]

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Okay. So we'll do this and one more, because I know people have got schedules, and it's just after 10. So please carry on.

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Saravana Bala, Jefferies LLC, Research Division - Equity Associate [44]

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Saravana from Jefferies here. Just 3 questions for me, please. First one is on the supply chain. So given the importance and close relationship you have with the supply chain and the upcoming VAT changes possibly adding some pressure on the cash flow, I was wondering if you see any consequential impact on Balfour Beatty besides the invoicing, which you flagged in the press release?

Second is on Gammon. I appreciate that selective bidding is very much the priority but with bidding trends seemingly improving, could we see some further growth coming in -- higher growth coming through in the coming years?

And finally, sorry to go back on the military housing, but have you identified any scenarios whereby the maintenance concessions could be revoked without compensation?

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [45]

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Okay. I'll have to get you to talk about the VAT implications, but the -- on the new arrangements, logistically and process-wise, it's a nightmare for the industry. For those of you who don't know, the responsibility of collecting VAT is moving from the government, collecting it from the subcontractor and the supply chain to the main contractor. I think that's right way of describing it, isn't it? And the change in processing systems is huge. It's an extremely challenging task, and I'm not sure everybody will be ready on the prescribed date associated with that. In terms of the VAT and cash flow implications?

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Philip J. Harrison, Balfour Beatty plc - CFO & Executive Director [46]

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It's too early to say what will be the impact. We've got a team. We've got the systems in place. We're well ahead of doing what we need to do. We'll just have to work with our supply chain and deal with the issues that arise.

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Leo M. Quinn, Balfour Beatty plc - Group Chief Executive & Executive Director [47]

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In terms of your question on Gammon, I could answer that generally in terms of the U.K., U.S.A. and Gammon. Our issue isn't around opportunities to do work. It's -- the issue is around the risk involved with work and the margin associated with that. So I don't see in the current market, globally, we're entering into what I think is an era of we're supplier constrained. Even if we won all the work, we don't have the ability to man up and deliver it. So we're not short of opportunity. What we're short of is, the right terms; and then for the limited workforce we have, how we engage it for the best of the best advantage and that applies to Gammon as well as in the U.S. and the U.K.

In terms of military housing, I probably have to go back to my statement. There's nothing that we know of, whereby service could be taken away or would be taken away. You got to remember, these are allegations. Nothing has actually been proven at this moment in time, and we're investigating it. And our statement says that we know no reason to change either our financial forecast or our Directors' Valuation for the business. I probably don't see any sense of why I have asking -- or answering the question.

Any last questions? Otherwise, you're all free to go. Thank you for your time and patience and look forward to a successful day.