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Edited Transcript of ULE.L earnings conference call or presentation 7-Aug-19 8:15am GMT

Half Year 2019 Ultra Electronics Holdings PLC Earnings Call

London Aug 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Ultra Electronics Holdings PLC earnings conference call or presentation Wednesday, August 7, 2019 at 8:15:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Amitabh Sharma

Ultra Electronics Holdings plc - Group Finance Director & Executive Director

* Simon Pryce

Ultra Electronics Holdings plc - CEO & Director

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Conference Call Participants

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* Andrew Chambers

Edison Investment Research Limited - Analyst

* Andrew Paul Gollan

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

* Christopher Leonard

Crédit Suisse AG, Research Division - Research Analyst

* Hamish Albert Dalgarno

Jefferies LLC, Research Division - Equity Associate

* Nick Cunningham

Agency Partners LLP - Managing Partner

* Richard Paul Paige

Numis Securities Limited, Research Division - Analyst

* Ross Law

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

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Presentation

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [1]

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So good morning, everybody, thanks for coming. And thanks for your continuing interest in Ultra. And welcome to our 2019 interim results presentation.

Before we begin, I'd just like to deal with a couple of administrative issues. On health and safety, as far as I'm aware, there's no planned fire or indeed any other alarm today. So if you do hear alarm -- an alarm, please head out through those doors and follow the fire exit signs, listening to anybody who looks like they know what they're talking about, to get out of the building.

Also this presentation and any subsequent questions and answers is being recorded and will be the subject of a webcast, which will be available on the group website around midday.

Finally, the presentation itself. We know you're all busy. We're going to try and keep the formal presentation to about 30 minutes. Hopefully, we'll touch on most of the things you want to know about, but there will be plenty of time for questions and answers at the end. But we'll try and get you away between 10 and 10:15.

So on to the real stuff. We had a solid start to 2019. We continue to benefit from strong markets, particularly relatively buoyant U.S. Department of Defense spend and actually combined USD procurement and RTD&E (sic) [RDT&E] spend. Outlays over the last couple of years have been between

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some years. And this is actually before receipt of the annual sonobuoy order that we would normally expect to get in half 1, which, as a result of the 5-year IDIQ, which I'll talk about in a bit, we only received after the half end.

Revenue growth was up 8%, which is slightly better than we anticipated at the beginning of the year. And as you'll hear from Ami in a minute, this has then flowed through to operating profit and cash flow and EPS. And very much, Ultra is delivering as anticipated.

And secondly, we've also made a solid start to our strategic journey. As you know, we've commenced the process of strategic evolution to become a more collaborative and value-focused, application-engineered defense, critical detection and control solutions provider. We've made focus -- we made progress on our Focus, Fix, Grow change program. We're already bringing more focus to the group, and in the first half, completed the sale of 2 noncore businesses, Airport Systems, which we announced in March; and CORVID PayGate, a small secure payments processing business with total consideration -- combined consideration of $23 million.

We're making good progress on fixing some of the basics, and we've won positions in potentially significant new programs, which represent exciting opportunities for Ultra to grow -- to continue to grow in the future.

So as we begin our change journey at Ultra, I'm increasingly confident that there is significant opportunity to go after over time. And the key messages that I hope you'll take out of today's presentation is, at the moment, we're delivering as anticipated. There's more potential in this group. But to get at it, we have to change. We've defined what that change looks like. We've started the change journey, and we're making good progress so far.

So a bit more on changing strategy. We've now completed our high-level review of all of the Ultra businesses to understand their competitive positions and the attractiveness of the offerings they supply, and where there's commonality or actual or potential parenting advantage from the businesses within the portfolio. As a result of this work, we are changing Ultra's strategy. We're changing it from what I found when I arrived at Ultra, which I think I have already reported to you before, but which I'll remind you of, and that is an aggregation of autonomous and relatively tactical technology-rich businesses that were site-based with good engineers and committed people.

We believe that we had about 130 capabilities, which were actually a mix of locations, technologies, products, skills, people and business models. These businesses had poor connectivity, and they had processes and practices and indeed functional capability that reflected their autonomous nature, and importantly, they're small scale. There also seems to be a little attempt to generate parenting advantage from this aggregation of businesses other than through financing and scale.

As a result of the work that we've done, we're going to evolve this group of really quite high-quality businesses into something slightly different. So over time, you'll see us become a focused applications-engineered solutions provider.

We're going to specialize in Maritime, Intelligence and Communication defense. We also have positions in

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where we see opportunities through more collaboration in technology and know-how, through more efficient utilization of our core competencies and indeed, our physical capabilities, from sharing and standardizing best practice and by the more effective development of strategic relationships and marketing and cross-selling.

We also see opportunities across all of our businesses for greater standardization and the centralization of certain administrative processes and also to take better advantage of shared support functions, such as IT and HR. All of which should lead to us over time having the opportunity to realize significant economies of both scale and scope.

Now we're in the process of developing more detailed plans that support execution of this strategy, which is focused very much on value creation. And we'll also be identifying and detailing the growth and performance improvement potential that we think it'll deliver. And we hope to share more of this with you early next year.

So Fix. I'm pleased to report that in addition to a pretty good set of numbers and in parallel with our strategic planning work, we're also making good progress on fixing some of the basics. As you know, we have a number of initiatives ongoing that are focused on improving some of the basics at Ultra to better support execution and delivery. This is a pretty busy slide, which groups all these initiatives under 4 key themes, and I'll just like to highlight progress in a couple of areas.

Firstly, in culture and talent. We continue to strengthen our governance and compliance environment and improve our people capability. We've made a number of changes to the executive team. And we've made key external hires in HR, legal, Investor Relations and in risk. We've also refreshed and updated our ethics policy and our code of conduct, and are launching an enhanced training program group-wide to support it.

Next, under operating model. We've commenced a review of our organizational design to ensure that we're focused on harnessing our strengths, accelerating our strategy execution and improving efficiency and delivery. Whilst it's unlikely that this will lead to a whole-scale restructuring. It is certain that the roles and responsibilities within the group will evolve, that there'll be a reallocation of corporate, divisional and local resources, but all the time empowering capable of individuals -- capable individuals at the right level through a responsible core delivery.

In process and practice, we're making some progress on improving a number of our core processes, which have been problematic for us in the past, particularly in the areas of program management, commercial management and technology investment, although there is more work to do here.

And then finally, under infrastructure, we're making good progress in improving our underlying IT systems, which is key to a more collaborative organization. We've launched an intranet that works across the group, and we're continuing to standardize our major applications. And we expect our investment structure to accelerate in the second half of this year, as you'll hear from Ami.

So as I hope this slide highlights, there's quite a lot going on at Ultra at the moment. And actually, to improve the coordination and as well as -- and to manage some of the interdependencies that exist, the resource allocations and the approved program management discipline that we need as part of our Fix, Focus and Grow program. We have appointed recently a transformation director, who will lead a transformation office to oversee effective execution over the next few years. But generally and most importantly, we're making good progress on the key initiatives that we set out at the beginning of the year.

I'm also pleased that our technology strength and the work of the team over the last couple of years, and clearly, I mean I would like to take full credit for all of this, but there's actually nothing to do with us. The technology strength and the work that the teams have done over the last couple of years have delivered to us in the first half positions on a number of key and sizable programs that we've been working on for some time, that have the ability to deliver good growth in the future, but that is not yet reflected in our order book. And I particularly like to highlight 4 that we've signed in the first half.

Firstly, the Canadian Surface Combatant, where we've won the underwater war -- the underwater warfare and the Sonar Systems leadership role in the definition phase on this key Canadian program to build up to 15 frigates, which is based on the U.K.'s Type 26 Global Combat Ship. This positions us well for the product delivery phase, which, if the Canadian government were to build the 15 frigates, could be worth in excess of $500 million to Ultra over time.

Next, NGSSR. We've been awarded the U.S. Navy's Next Generation Surface Search Radar production program. Whilst this is currently a sole-sourced development and qualification contract worth around $35 million. That actually positions us to provide navigation and general surface search radar functionality to all of the U.S. Navy ships, which, depending on the number that they choose to install it on and when they choose to install it, could be a program that has potential value to Ultra over time of $250 million.

Thirdly, the ORION radio IDIQ. As you know, we've been working on this for some time. And we completed the development work on the product, a $500 million IDIQ supporting the Army's -- the U.S. Army's Network Modernization program has now been placed, and the initial order of $17 million is already in our order book. But not only is this IDQ -- IDIQ a $500 million IDIQ, the nature of the product means that it will also lead to significant potential additional opportunities to support the communications upgrade needs of a number of other U.S. and foreign armed forces. All of this gives me great confidence in the future of Ultra. And last but not least, I should mention the sonobuoy IDIQ. This is a 5-year, sole-sourced IDIQ for up to $1 billion, which was awarded to ERAPSCO, our joint venture with Spartan, and therefore, is worth $500 million to Ultra. It cements our position in supporting the growing demand of the U.S. Navy for 4 key types of sonobuoys out over the next 5 years. And the first order under this IDIQ was placed in July, and you'll hear about -- a bit more about that in the coming weeks.

So whilst the growth potential of a number of these programs isn't yet in our order book, it does highlight why I have the confidence that I do in Ultra's exciting future.

So with that and those highlights, I'm going to hand over to Ami who'll tell you how it all delivered into numbers.

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [2]

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Thank you, Simon, and good morning, everyone. I'm pleased to present our interim results for the 6 months ended June 30, 2019, which build upon the momentum that started in the second half of last year. Our order book grew organically by 6.6%, reflecting some of the key program wins that Simon has already mentioned, including the Orion radio IDIQ and a number of long-term wins in our Maritime division. The order book exceeded GBP 1 billion for the first time at a period end in a number of years.

The book-to-bill ratio was 1.16 in the first half compared to 1.12 over the same period last year. Underlying operating profit improved by 7.7%, as it grew from GBP 49.1 million to GBP 52.9 million on a like-for-like basis. Operating margins of 13.7% were flat when compared to the same period last year.

I will cover the 2018 Herley cost overruns in the following slides.

Underlying earnings per share improved by 16.4% to 52.5p. This was due to the increased profits, a slightly lower tax rate and a lower number of shares in issue following the buyback program, which we completed in January 2019. We are recommending an increase in the interim dividend by 2.7% to 15p. As a reminder, we have a progressive dividend policy with a through-cycle target of circa 2x normalized cash and earnings cover. We will take a closer look at the final dividend at the end of the year.

Overall, I'm pleased with our performance, and we've delivered a solid first half.

As you can see, revenues are up nearly GBP 30 million or 8.3% organically compared to the first half of 2018. This includes revenues from the recently won Next Generation Surface Search Radar, or NGSSR, development contract, military aircraft platforms and the tactical, command and control systems.

As you can see from the bridge, at a headline level, there was a positive translation impact from weaker sterling during the period, with the average rate moving from 1.38 to 1.29. And of course, the disposal of Airport Systems in the half.

Turning to operating profit. Disposal of Airport Systems reduced operating profit slightly, although this was offset by a positive currency translation and an IFRS 16 impact. Pleasingly, we did not see a repeat of the GBP 6.5 million Herley cost overruns that we highlighted to you in 2018. After increased investment in R&D, additional incentive accruals in the half 1 2019 and the nonrecurrence of a GBP 1.2 million foreign exchange gain in Aerospace & Infrastructure, which, as previously disclosed, is now hedged and did not repeat this year. Underlying profits grew by 7.7% to GBP 52.9 million, representing good organic growth.

Looking at divisional performance in detail. We start with Aerospace & Infrastructure. The division's order book grew organically by 4.5%. The largest order win being a GBP 17 million multiyear order from Pratt & Whitney to provide ice protection equipment for the Joint Strike Fighter engine.

Revenue grew organically by 13.4% over the period primarily due to increased activity in military aircraft platforms, including the bill rate of our high-pressure pure air generating units for the Joint Strike Fighter program.

Margins released 11.2%. Also reduction was anticipated as the FX gain I referred to earlier did not repeat. It was slightly worse than expected. This was in part due to mix and some restructuring costs, but also by some challenges in our energy business, which has been hit by the U.S.-China trade war and by slower-than-anticipated orders from our major U.K. customer. Margins are expected to recover to more normal levels over the second half with a better energy performance.

Turning to Communications & Security. In addition to the usual presentation, we've also presented the margin percentage, excluding the Herley cost overruns in 2018. The order book reduced organically by 9.7% due to strong comparatives, but has increased by GBP 29 million since December 2018. Significant order wins include a $17 million order for Orion military radios as the first tranche of the $500 million IDIQ. Revenues grew organically by 2.9% as the division benefited from strong sales of ADSI tactical command and control systems and higher levels of activity from electronic warfare and microwave products.

Operating profit increased to GBP 12 million and margins to 10.2%. However, after adjusting for the Herley cost overruns, as anticipated, margins actually declined from 12.9%. This was due to reduced military radio sales and lower forensics revenues. Margins will improve over the second half as we ship more military radios.

Maritime & Land had a very strong half. The order book increased organically by over 20%. This growth included a 10-year contract with the U.K. MOD for support of its fleet of 16 surface ship torpedo defense systems. Shortly after the period end, the ERAPSCO joint venture was awarded a 5-year $1 billion IDIQ for sonobuoys to the U.S. Navy.

Revenue grew organically by 9.3%, driven by the recently won NGSSR development contract and maritime propulsion system activity. Demand also remains positive for Ultra's U.S. sonobuoys. Whilst operating margins remain similar to last year, this division was impacted by an increased volume of cost-plus development contracts as anticipated. This will have a small negative impact on margins in half 2.

I'm pleased to say that our new focus on average 12-month working capital turn is improving behaviors across the business, and we're already seeing benefits both financially, where we are starting to see a smoother working capital cycle throughout the year and also operationally, with a more level loading of engineering hours.

Net debt, excluding the impact of IFRS 16, is broadly unchanged from June 2018. We guided to a cash impact of around GBP 45 million for the normalization of working capital this year, and circa GBP 31 million of that has fallen into the first half. This normalization has reduced our accounting cash conversion, but we still generated operating cash flow of GBP 13.4 million in the first half. Structurally, we remain an 80% to 85% cash conversion business.

We've put this slide in as a reminder that we are a business with long-term contracts. And so unsurprisingly, we apply long-term contract accounting. There are 2 elements to this, the carryout work throughout the year on which we recognized revenue as we complete it, but we only invoice it in accordance with contract milestones. Receivables under these contracts move around. But as this chart shows, the balance churns through constantly.

In the first half, we recognized revenue of GBP 80.5 million and invoiced GBP 72.3 million. On a couple of contracts, we carry out work which we recover as we ship product, and this creates long-term receivables of greater than 1 year. We continue to deliver product on the A400M and Sonar 2150 contracts. And as the chart at the bottom of this slide shows, the balance declined as anticipated.

This slide gives you an update on our Focus, Fix, Grow investments, so you can keep track of our progress. Within company-funded R&D, we have increased spend but not by quite as much as we indicated in March. This is largely due to greater visibility and a more rigorous assessment of investment and return discipline. We now anticipate internal R&D spend to be between 3.5% and 4% of revenue in 2019. In the medium to long term, we still expect it to be between 4% and 5% of revenue.

Looking at IT and our other Fix-related projects. We are still on track to spend circa GBP 5 million per year over the next 3 years. 2019 will be second half weighted as we ramp up these projects. Both R&D and IT spend are both operational costs, but these investments are factored into our mid-teens margin guidance.

Capital expenditure is now expected to be in the GBP 20 million to GBP 25 million range in 2019, again due to greater investment discipline.

There are no significant changes to the technical guidance provided back in March. We expect organic revenue growth this year to be first half weighted, but we expect underlying operating margins to improve over the second half with a better energy performance and increased military radio sales. We see no material changes to our income statement as a result of IFRS 16. At the year-end, we will present free cash flow both pre and post the impact of IFRS 16.

Cash conversion will be impacted by the circa GBP 45 million working capital normalization but is expected to return to normal levels in 2020. The expected tax rate guidance remains unchanged at circa 20% for 2019.

The group is monitoring developments relating to the European Commission decision that the U.K. CFC rules are partial State Aid. The U.K. government has appealed the decision and requested certain information from recipients, including Ultra, but not yet provided details of how it'll quantify and seek to recover State Aid.

The European commission CFC potential exposure is between GBP 0 and GBP 20 million. We do not currently expect this to be resolved in the near term.

I have confidence in the future with a number of long-term positions being won and some very exciting positions happening internally. With that, I will now hand back to Simon to wrap up.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [3]

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Thanks, Ami. So just in summary, as you can see, there's a lot going on, and there's still plenty to do. But probably, the thing that pleases me most about our first half performance is that there is a growing recognition within Ultra of the desire and the need to change and the opportunity that change will allow us to realize. We're benefiting from strong markets. And with the most recent budget agreements in the States, those positive DoD spend is likely to continue for a couple of years, and that's all feeding through for us into a good order book development, and we entered H2 with a very strong order cover.

We've delivered a period of good, continued organic revenue growth, which, as you've heard from Ami, is feeding through to the bottom line as it should. And pleasingly, in the first half, Ultra is back to delivering as anticipated. And all in all, it was a half of really good progress for us.

And as we enter the second half of the year, we've commenced our journey of strategic development and focus as we evolve into an application engineered defense specialist critical detection and control solutions provider. We're in the process of developing detailed plans to support execution of this strategy that builds on our technology strength, and I think there's plenty of upside to go for. We're making progress on a number of those fix initiatives that I've referred to that is improving the underlying basics of Ultra and facilitates more effective execution and delivery of our business going forward. And as we begin to see and facilitate closer collaboration and coordination within the group, we're finding plenty of opportunities to take advantage of both scope and scale, and that represents good ongoing improvement potential for us.

We're winning new positions on important programs that have significant long-term upside for us. And a lot of this is coming from the collaborative culture that we're seeking to promote, building on and using expertise and capability from across the group to bid on, differentiate ourselves and increase the chances of winning new programs and derisking delivery of them for our customers.

Just to illustrate a little bit what I mean by this, taking the example of the Canadian Surface Combatant that I referred to earlier. In order to deliver that program, we'll actually be drawing on Ultra people and capability from 4 separate businesses in 4 countries: the U.K., Australia, the U.S. and Canada, that will ultimately result in a delivery of the best solution for the customer in the most cost-effective way.

Taking all this together, we've got really positive momentum into the second half. And I know that 2019 is going to be a year of good progress for Ultra. Perhaps more importantly, the extraordinary efforts of our exceptional people and the performance I've seen them deliver over the last 12 months gives me great confidence in the longer-term opportunities for Ultra and all of its stakeholders.

With that, it's the end of our formal presentation. So now, we'll open the meeting up for questions. (Operator Instructions)

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Questions and Answers

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Ross Law, Joh. Berenberg, Gossler & Co. KG, Research Division - Research Analyst [1]

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It's Ross from Berenberg. A few for me. Firstly, on H1, H2 weighting, you've just been kind of 46% to 48% H1 weighted on revenues. Is that a similar profile you're expecting for this year? And is there anything that came into the first half that you were expecting to come maybe in the second half or indeed anything that slipped into H2 that you'd expected in the first half?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [2]

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Did the people hear that? So I think, Ami...

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [3]

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Yes, that's one for me.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [4]

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One for you on H1, H2 weighting.

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [5]

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So yes, it's a slightly better half 1, half 2 weighting, i.e., more first half weighted than before. Based on consensus, it was around 48%/52%. And in the past, we've been at 47%/53% or 46%/54%, depending on how the FX has fallen. In terms of anything that's moved into half 1 that we were not anticipating, no, broadly, everything's fallen as it should do in the half that it should do. So nothing really accelerated in that regard.

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Ross Law, Joh. Berenberg, Gossler & Co. KG, Research Division - Research Analyst [6]

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Okay. What's your U.S. dollar rate expectation for the full year?

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [7]

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So for the full year, it will be around -- if spot continues at where it is currently, it will be our $1.27 or so for the full year.

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Ross Law, Joh. Berenberg, Gossler & Co. KG, Research Division - Research Analyst [8]

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Okay. And on the GBP 45 million charge to normalized working capital obviously you highlighted that GBP 31 million came through in the first half. I think you were previously quite confident that this would be just an H1 hit. So what was the reason for some of this being delayed?

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [9]

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It was in place. Old habits die hard, Ross. And so we're still working on the behaviors. Another -- it will be GBP 45 million we will normalize in fall. So there was a degree of squeeze even at June, and we will work on that on the next second half.

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Ross Law, Joh. Berenberg, Gossler & Co. KG, Research Division - Research Analyst [10]

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Okay. Is there any expectation that, that GBP 45 million may be less?

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [11]

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At this point, we still believe it to be GBP 45 million.

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Christopher Leonard, Crédit Suisse AG, Research Division - Research Analyst [12]

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Chris Leonard from Credit Suisse. A few, if I can, please. Just thinking about ERAPSCO award and the sonobuoys IDIQ in the U.S., just wondering if the DoD gave any further color on what they saw the competitive environment looking like in the 2020s and sort of the long-term growth potential for that market for you.

And secondly, the ORION Radio contracts, how much of that ceiling value of around $500 million do you guys anticipate you could receive? And what's the sort of delivery schedule there looking out into the 2020s as well?

And sort of following on from that, with the Communications & Security division, good to hear that the cost overruns didn't reoccur after the charge of GBP 6.5 million last H1. Do you think that we -- with the ORION Radio contract coming through, we can anticipate the division getting back to sort of margins of 15% to 16% underlying in the future when those contracts come through?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [13]

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Okay. So I'll take the first 2, ERAPSCO and ORION. And then Ami will just talk about margins. Just -- on ERAPSCO, just to be clear, the DOJ's involvement was around the aborted acquisition of Sparton back in 2017. The DOJ as part of its decision associated with blocking that acquisition, continues to monitor the space, but it is not the DOJ that is demanding or driving how the Navy procures sonobuoys. I think as we said, and have said at the time, there will be more competition in the sonobuoy market. The sonobuoy market continues to grow materially, and we expect to be an active player in that market for some years to come. And clearly, what happens to the ERAPSCO joint venture will be driven by the desires of the customer and by broader market conditions.

On ORION, we are the sole source provider under that contract. So theoretically, if the IDIQ is placed in full with us as its sole source provider, it would all come to us. But clearly, it's an IDIQ, indefinite delivery, indefinite quantity. So who knows? It's a good contract to win. It will be executed over a number of years, but it's a very positive long-term growth opportunity for us and reestablishes our Communications business in that space. C&S margins...

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [14]

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Yes. In terms of C&S margins, in the short term, we still see margins around 12% to 13% in that range. Beyond that, it depends very much on the profile of the radios, and we're still working through that with a customer. Again, as Simon has said, it could be anywhere 0 and $500 million. But the profile won't be as -- it won't be like it was back in 2011, 2012, if that's what you're thinking. There's no active conflict going on, and they still have a big inventory of the old radios on hand. I think the profile, we're still working through with the customer, and we'll see where that goes.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [15]

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I don't think we generally give guidance on margins by division, but this is a mid-teens margin business over the long term, and we don't see anything that's changed there.

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Richard Paul Paige, Numis Securities Limited, Research Division - Analyst [16]

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Richard Paige from Numis. Two questions, if I may. 7% organic growth in the order book plus those long-term contract positions win, some of that not in the order book. How should we think how that translates into growth over the next sort of 3 years or so please?

And the second one on the forensics business, you talked about lower international sales. Is that a short-term problem? Or is there something more behind that?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [17]

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So on organic growth, I think we've sort of guided that our major markets should grow at between 3% and 7% over the next 5 years. I'm not sure that we've seen anything that should materially change that. So I think if you've got that in your head, that's not a bad place to be. And if that changes, we'll let you know.

In terms of forensics, I mean that business can be quite lumpy. It doesn't make regular sales into country, it makes a sale and then doesn't sell again for 4 or 5 years. So I think that business is always lumpy. I don't think it's necessarily a signal of any sort of slowdown. It's just where it is in the cycle of the products that it sells.

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Richard Paul Paige, Numis Securities Limited, Research Division - Analyst [18]

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Sorry, just one follow-up. The R&D charge and guidance for the full year is obviously slightly below where you were before. Is that because you've culled a few programs? Or is it -- what's happening there?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [19]

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Yes. I think as I alluded to back in March, I wasn't that comfortable with our whole internal research and development investment process. So I think we have introduced much more investment discipline and oversight into the stuff we're spending our own money on. And as a result, that has led to the reduction in a few of the programs that would otherwise have been undertaken. But that's sort of a timing issue. I absolutely think we'll get back to that 4% to 5% level Ami talked about in 2020 and beyond. And we just don't got enough time to spend that money between now and the end of the year on the new programs, the new opportunities that we are identifying where we do need to make group internal research and development investment in.

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Hamish Albert Dalgarno, Jefferies LLC, Research Division - Equity Associate [20]

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Hamish Dalgarno from Jefferies. Just following on from the R&D question. You said that the reduction in R&D will be offset by development contracts. Could you maybe elaborate what those development contracts are? And could you also provide an update on the sea whip contract, is that now complete?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [21]

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Sure. So I don't think we've said -- we actually increased our R&D spend, not reduced it, it's just we haven't increased as much as we thought we were going to. And we haven't really replaced it with development contract. It is more us choosing not to invest in some things that would have been invested in because we can't see the long-term financial benefit or indeed business benefit of doing so. I think we are all getting much better at targeting the areas that we think we need to invest in to develop product and capability for the customer out over the next 10 to 15 years. So it's -- I think it's not being replaced. It's just we're starting to put it into the right places.

I think it is fair to say we have quite a lot of development contracts going on at the moment. That is also using up some of our engineering development hours, but it isn't a barrier to us investing more in the right sort of R&D.

And just on Herley, the sort of problematic contract that we referred to where we saw significant cost overruns last year. That program isn't finished. We didn't anticipate finishing it until the end of this year. It remains challenging but under control. And we remain confident that we're able to deliver that product as we committed to the Navy when we committed to deliver it. Andy?

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Andrew Chambers, Edison Investment Research Limited - Analyst [22]

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Yes, this is Andy. A slightly odd question, that marine corps expeditionary headquarters communications thing that you won, that looked quite interesting. That seemed to sort of broaden out your role in it.

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [23]

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Radios, is it the radios you're talking about?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [24]

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Do you mean the ORION?

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Andrew Chambers, Edison Investment Research Limited - Analyst [25]

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No. This was one of the ones that came up the other day. And it was marine corps expeditionary command and control headquarters. Is that a much bigger area for you to play in than played in before?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [26]

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No, I don't think particularly. That is relatively small. We did it a long time ago. We are looking at it again. It's not a big opportunity for us. It's just that it's taking some of our existing capability and deploying it in a slightly different way.

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Andrew Chambers, Edison Investment Research Limited - Analyst [27]

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So I was just thinking about the sort of spread, if you know what I mean. And I know this is going to sound a bit tedious, but I'm going to zero in just on Herley. But does the group as a whole place much demand on Herley. And could it, if it doesn't -- if you see what I'm getting at.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [28]

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Just expand that question a bit. Help me a bit.

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Andrew Chambers, Edison Investment Research Limited - Analyst [29]

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Well, Herley came in and everyone -- lots of people here will remember it being a sort of "Why?"-type reaction in the audience that day.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [30]

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Some sympathy with that.

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Andrew Chambers, Edison Investment Research Limited - Analyst [31]

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And just when you talk about sort of [Harrington] and scope and scale, my guess is Herley could supply stuff into the group, or the group could go to Herley and say "Is that feasible?" Is that the sort of thing we're talking about? Or have I just picked a really stupid example?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [32]

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No, no, you haven't. I mean it's a good point. It's really with us trying to allude to when I was trying to put some color around what collaboration actually looks like in our organization. I'm not sure that a vertical supply chain is where we're going. I mean clearly, if we have a unique capability that sets us apart from somebody else that means we should vertically integrate, then we will absolutely do that. But rather than alighting on Herley, which is actually quite a complicated business and has numerous capabilities in there, let me just sort of -- we manufacture -- or we assemble PCBs in 5 places. Is it right that we assemble PCBs at all? It's multibillion-dollar industry, last time I looked. Well, yes, there are some specialist things that we need to do, but do we need to do it everywhere and should we outsource or insource. Those are the sorts of discussions we're beginning to have today in a way that we would not have had them 6 months ago. In fact, it took somebody some time to find out the fact we actually did assemble PCBs in 5 places in the organization.

He might be standing in front of you, but it is not the way we thought going forward. So I don't think I've answered your question directly. But the collaboration piece is using the capabilities that distinguish us from our competitors in the most effective way and when we're not effective to outsource.

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Andrew Chambers, Edison Investment Research Limited - Analyst [33]

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Because you see your comments about the Canada Type 26 makes a huge pile of sense because clearly, the U.K. is going to build up a lot of experience and then Australia and then Canada. And if you can genuinely keep the Canadian requirement for domestic sourcing and everything, I mean that would be really cunning and will be the group pulling together. But I can't decide whether it needs a program to pull it together or whether you can actually push it there first. If you...

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [34]

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I think you'll have to talk to some of the other Ultra people in the room as to whether it's a pull or a push. I think it is fair to say that if it was a pull, it probably would have happened already, but it doesn't necessarily seem to have happened as effectively as perhaps it could do. So I think I suspect it's a bit of both because also the 5 eyes are taking a slightly different approach to technology and technology sharing than they would have taken 5 years ago.

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Nick Cunningham, Agency Partners LLP - Managing Partner [35]

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Nick Cunningham, Agency Partners. You've had some big wins in all the really big programs that I can remember, like ORION, ADSI, sonobuoys and the Canadian sonar is a bit like the Australian sonar contract, I think, in that sense. So what -- I suppose the question is what else is there left outstanding where you could be making big wins. Or are we talking about, more traditionally, if you like, Ultra, smaller ticket, shorter cycle, forming the new order intake?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [36]

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So I think it's a bit of both. I think there are only so many big programs you can get on because there's only so many big programs out there. I just wanted to flag that the benefits of technology in the group and the hard work of the group over the last couple of years has delivered some good positions on new programs, and there's lots of other stuff out there that we're looking at that will not just secure the next 5 years but beyond that. So I'd rather not get drawn on those big-picture programs. But certainly today and as we look forward, the sorts of orders that we'll be getting should be against a lot of the existing programs that we're on, many of which are still in development phase.

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Nick Cunningham, Agency Partners LLP - Managing Partner [37]

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One of the virtues of Ultra, going back some years, was that you used to be able to...

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [38]

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I mean you found one then.

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

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No, Ultra is one of my favorite company. But some...

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [40]

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Mine too.

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Nick Cunningham, Agency Partners LLP - Managing Partner [41]

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But the virtue, as it was seen at the time at least was that no single contract represented more than about 1% of sales. But some of the things that went wrong maybe went against that historic rule. If we look at the company now, apart from maybe sonobuoys, is there anything in that mix now, which is a very substantial part of revenues looking forward, that we know -- therefore, we might be a focused risk?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [42]

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No. I mean I don't -- I'm not sure that, that probably was even true, that only 1% of the revenue. There was no contract worth 1% of the revenue because we've been making sonobuoys for a gazillion years. But I don't think there's any material change in our dependency on individual orders. Now we've always been dependent on programs. But as you know, most of these programs are awarded and then we only book the orders as and when the product gets called off. So we are and will continue to be a group that has a very diverse exposure to a range of different defense and other programs. So I don't think that's going to change.

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Nick Cunningham, Agency Partners LLP - Managing Partner [43]

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So the best proxy is probably going to continue to be U.S. outlay growth.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [44]

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Yes, I would say that U.S. outlay growth probably in the maritime and the communications and intelligence spaces. Those will give you the best long-term indicators. But again, don't forget, we're very small in these spaces. USDA, the outlays this year were $718 billion. And they're going to be $738 billion or something next year. We only turn over $800 million, so -- $500 million of that is North America. There's plenty of room for us to do better than the market, and that's certainly the intent of our strategy, which we'll share with you more in January. Andrew?

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Andrew Paul Gollan, Joh. Berenberg, Gossler & Co. KG, Research Division - Senior Analyst [45]

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Andrew from Berenberg. So 3 questions, please. You called out in the presentation delayed orders. There was the energy issue and also the negative impact to trade disputes. Can you maybe just elaborate on those kind of the exposures and risks and really your confidence as to why that you're reasonably comfortable with the second half on those issues?

Second one, on cash conversion, you said structurally, 80% to 85% as a business. If you strip out the working capital flow, you actually exceeded that in the first half. Is that just a matter of timing in the half? Or are you just being conservative given you've got a lot to go for as you just said as a group?

And then lastly, I guess for -- being devil's advocate and trying to look for negatives, dividend growth was fairly anemic, if you could say, given the performance of the group at, what is it, 2.7%. Dividend cover increased in the half, and it's kind of at odds with your confidence going forward. So maybe if you could just chat around capital allocation priorities and your thoughts there.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [46]

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So I'll deal with the first and the third point, and Ami will deal with the cash conversion point. So on the delayed orders in energy, both from our major U.S. -- U.K. customer who I think you'll work out who that is relatively quickly, and in China, the second half can't be much worse than the first half because the first half wasn't very good at all. There is built-up demand for our product, and it will get called off. It's just timing and availability and I think the relative priorities of our customer. China is going to be difficult, and it will be difficult as this trade war continues because a chunk of the product that we ship into China, we ship in from America. So I think it's not a major risk to the second half, but it's something that we're monitoring, and we believe we have some plans in place to deal with it, and we actually have done a small reorganization in that business to ensure that we're rightsizing the cost base to the medium-term future that we see.

I'll deal with dividend and then Ami will pick up the rest. I think, Andrew, I think we've come out and said our dividend policy on a 3-cycle basis is 2x cash and earnings covered. Please don't read too much into the interim. There's been quite a lot on. We didn't think that hard about it other than we've got a policy. The policy hasn't changed, and the time that we look hard at the dividend will be at the final, and that will always be the case here. So our interim will just be a placeholder. The final dividend, which will be the dividend for the full year will reflect the pluses, don't worry too much about it.

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [47]

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So on the cash conversion. I mean if you look back over a period of time, 1 year is never enough really to assess cash because it's usually over a 3 to 5 years. And over the last 3 years, we've been around 90% cash conversion, really. And so I still say, 80% to 85%. Remember that we take GBP 11 million out every year as defined benefit contributions. So that takes 10% off to begin with and then we allow a bit for working capital growth. But yes, we did have a good first half if you use the math that you just said, we did have a good first half, cash-wise. But that doesn't change the 80% to 85% sort of guidance.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [48]

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Any other questions?

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Andrew Chambers, Edison Investment Research Limited - Analyst [49]

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Just one really quick one, are we happy that -- now that 787 is at 14 a month, how has wing ice protection, the electric wing ice protection on that played as an investment? Is it something that would encourage you to do more in civil aerospace? Or is that not a market you'd go hunting in?

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [50]

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So I think -- and Ami probably should comment a bit on this well.

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Amitabh Sharma, Ultra Electronics Holdings plc - Group Finance Director & Executive Director [51]

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The shipset is around 100, 120 per plane. So it's not a big proportion of our revenues, but we do spend a lot to get on that program to be fair.

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [52]

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But I think to be fair on that particular product, actually, it probably looks like it was not a bad investment. I think we just need to make sure that we apply the same level of investment discipline to our commercial aerospace business that we do to the rest of our businesses and perhaps more discipline than has been applied in the past. We just need to get comfortable on the commercial risk/reward analysis of the investments we're making. We haven't got them all right, as you know. I think that is in part due to process.

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Andrew Chambers, Edison Investment Research Limited - Analyst [53]

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I've got a few investments wrong as well, mate. Mainly in wives. All I'm sort of getting at is I'm not saying we were going off the rails or anything like that, we were doing what companies do. And as soon as you went into commercial aerospace, we broke with this tradition where, yes, we funded some stuff in terms of development but the customer took more sort of the really big risk. And I was just sort of curious, as we go through this, and you may not decide for years whether commercial aerospace is still an adjacent market or whether it's actually a completely different market, if you see where I'm getting at. It's a bit laborious and tedious, but...

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Simon Pryce, Ultra Electronics Holdings plc - CEO & Director [54]

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No. I think, sadly, you're right, commercial aerospace market is completely different to the defense aerospace market and you need to adapt the capabilities and technology in your investment thesis and approach to reflect the market that you're in. That -- I don't think that means we're not in commercial aerospace going forward. It just means we have to apply appropriate investment disciplines that reflect the risk and reward you're being asked to take on when you're taking on some of these contracts. So no, I think that we're going to invest in all of our businesses whilst we hold them if we see good value creation potential there. If we don't, we won't invest.

All right, everybody. Thanks very much. Hopefully, that's sort of midway between 10:00 and 10:15. So thanks very much for your time. Hopefully, we'll see some or all of you sometime next year. Thanks.