BAE Systems’ (BAESY) CEO Ian Graham King on Q2 2014 Results – Earnings Call Transcript

August 5, 2014 6:14 am | By More

Source: Seeking Alpha

 

Executives

Ian Graham King – Chief Executive Officer, Executive Director and Member of Non-Executive Directors Fees Committee

Peter J. Lynas – Group Finance Director and Executive Director

Gerard J. DeMuro – Executive Director

Nigel Whitehead – Group Managing Director of Programmes & Support

Kevin Taylor – Group Strategy Director

Guy Griffiths – Group Managing Director

Analysts

Christian Laughlin – Bernstein

Benjamin Fidler – Deutsche Bank AG

BAE Systems PLC ADR (OTCPK:BAESY) Q2 2014 Results Earnings Conference Call July 31, 2014 5:00 AM ET

Ian Graham King – Chief Executive Officer, Executive Director and Member of Non-Executive Directors Fees Committee

Good morning, and thanks for joining our webcast on this busy morning for reporting. Operationally, the Group continues to perform well, benefiting from good program performance on our large backlog of almost £40 billion. Clearly, we faced some exchange rate headwind, but this is about translation, not transaction.

We expect sales to be weighted towards the second half as a result of a stronger second half performance from contracted deliveries. Margin performance was, in general, very good during the first half with a couple of legacy issues in our U.S. support solutions business, which our new management team are on top of.

Our order backlog of close to £40 billion remains very strong, even though it’s reduced by some £400 million as a result of exchange rate translation. There are some £1.3 billion of international orders where contractual paperwork is being finalized and £1 billion of sole source U.K. naval contracts, which are at an advanced stage of negotiations yet to be booked into this order backlog.

Overall, we expect robust underlying performance across the group for the full year. However, as we set out at the results announcement in February, the one of benefits to earnings we enjoyed in the second half last year from the settlement of pricing on Salam Typhoon aircraft to Saudi Arabia will not be repeated this year.

As a result of the non-recurring nature of this settlement, we expect earnings per share to decline by approximately 5% to 10% compared to 2013, excluding any impact from foreign exchange translation.

In the U.S., the Bipartisan Budget approval in December 2013 is providing improved near-term clarity, and should enable some program priorities to be better addressed. Against this background, we have seen an improved level of procurement activity within our U.S.-based electronic system business and on some support programs.

I’m also pleased to report that our U.S. land business is on plan. We continue to bid for the armored multipurpose vehicle to replace the large fleet of U.S. M113 vehicles. A major competitor recently withdrew from this competition, and success and winning this large and valuable program would do much to secure our tracked vehicle industrial position in the U.S. for a number of years. We expect a decision within the next 12 months on the first phase.

Budget constrains and reduced activity are most apparent in our Intelligence & Security business, where we continue to have only short lead time contract visibility. The impact of the 2013 underperformance in the Radford contract and commercial shipbuilding continue to depress margins in the U.S. support solutions business into the first half.

Gerry DeMuro has hit the ground running and he is on top of these support solutions issues. He has been quick to make his mark and have streamlined the organization, reducing four sectors to three to bring new management oversight to the activities of the former support solutions businesses and reduce administrative overhead.

We continue to make ground in our strategy for organic growth in commercial aircraft electronics. Boeing’s recent selection of BAE Systems to supply the integrated digital flight control system on its next generation 777X program was a key win, securing an important role on this promising platform.

Turning now to the U.K. Much of the Group’s U.K. business is concentrated on a small number of large programs where multi-year contracts provide good visibility and a large order backlog. We continue to perform well on our major U.K. programs. We welcome the discipline that has enabled MOD to balance the defense plan. It has not been easy for either government or industry.

Our military air business continues to benefit from both stable Typhoon production and our extensive support and upgrade business. In the first half of this year, we have delivered four Salam Typhoon aircraft of an anticipated 12 deliveries this year. The phasing of Salam Typhoon aircraft deliveries and European Tranche 3 aircraft results in higher second half sales.

A progressive release of additional capabilities is planned for the already very advanced Typhoon aircraft. A high level of activity is underway to clear additional weapons and sensors onto the aircraft for the four partner nations and international customers.

In addition, at the Farnborough Air Show earlier this month, the Prime Minister announced the £72 million contract to further de-risk E-Scan radar development for the RAF’s Typhoon fleet. This activity is part of the U.K. MOD’s procurement process, ahead of the award of a full scale development contract.

BAE Systems has an enviable position on the world’s two preeminent combat aircraft programs. Our participation in the F-35 combat aircraft program continues to develop. 21 airframe subassemblies were delivered in the period, and we are now starting a significant production ramp as the planned aircraft delivery rate accelerates.

A second phase of highly successful trials of the Taranis unmanned air system has been completed, demonstrating the aircraft’s ability to fly in full stealth mode. As a reminder, this is the most advanced aircraft developed in the U.K. by British companies lead by BAE Systems, and we are considering next steps with the U.K. government.

In addition, the U.K. government is also commitment to join U.K.-French funding in this sector with the announcement during the Farnborough Air Show of £120 million funding for feasibility work ahead of a potential demonstration.

We are investing in the Group’s maritime businesses in the U.K. following a dream in last year with the U.K. government on the surface ship strategy. As part of the investment phase for the Type 26 frigates we have made a proposal for the design and manufacture of the ships. This activity, along with the commitment to build three offshore petrol vessels and the restructuring agreement, will provide long-term clarity for complex warship manufacturer in the U.K.

The Queen Elizabeth Class aircraft carrier program is progressing well, and the first vessel is structurally complete. The carrier was named in the formal ceremony by Her Majesty, the Queen earlier this month, and has subsequently been floated out of the dry dock in which the ship was assembled, allowing assembly of the second ship to get underway.

In the submarines business, Artful, the third of the seven Astute Class submarines was launched in May. Alongside build of Astute Class boats, engineering work continues to accelerate on the successor program.

In Saudi Arabia, the Group continues to make good progress with the provision of capabilities that now support 38 Typhoon aircraft in service. In addition to delivering a high-end defense capability, we are committed to the continued development of Saudi Arabia’s industrial base, in line with the Kingdom’s stated national agenda.

In June, we have managed the reorganization of our portfolio of interest in a number of industrial companies in Saudi Arabia and an enhancement of an existing relationship with Riyadh Wings. This reorganization is expected to enhance the growth prospects of these businesses in Saudi Arabia and support skills and technology development in Kingdom with increasing local employment.

In Australia where BAE Systems is the largest defense contractor, there was a government commitment to increase defense spending. We continue to perform well on the Canberra class landing helicopter dock program with the first of the two ships completed and expected to be delivered to the customer in the second half of the year. We are discussing with the Australian government options needed to sustain industrial capabilities across the shipbuilding sector. It is important we resolve this key issue.

Other international markets offer a range of opportunities. We now have initial funding for the large Korean F-16 upgrade program and see other military aircraft upgrade prospects. Our MBDA joint venture recently won a key contract for ASRAAM, a precision air-to-air guided weapon with the new government in India. Other prospects in India for M777 Howitzers and the next batch of Hawks continued to be pursued in this new political environment.

We are seeing significant renewed interest in MBDA for ground-based air defense systems from international markets, and we have vibrant campaigns to address international opportunities for Typhoon aircraft and combat vehicles.

In the area of Cyber Security & Intelligence, our U.S.-based business continues to be impacted by delays in procurement awards and increases in the number of award protests. Much of the reduction has come from the Afghanistan withdrawal and the impact on our lower margin IT support activity. The strategy to develop our U.S. government mission support activities remains robust and we continue to address substantial bid prospects.

As you may have seen, we have just completed a small bolt-on technology acquisition with Signal Innovations Group, a provider of imaging technologies and analytics to the U.S. intelligence community. Although small in scale, this acquisition provides us with additional technology that has the potential to be exploited for commercial applications.

Through the Applied Intelligence business we continue to successfully develop our strategy for commercial cyber with good growth in the first half and contract wins across international markets. We achieved further strong order intake, growing the order backlog 25% in the first half. This success builds on our 60% growth in the order backlog last year. We continue to invest in the business as we build our cyber skills base. For the second year running, over 40% of BAE Systems graduate intake in the U.K. will join the Applied Intelligence business.

In addition to the drive into cyber, we invest heavily in the skills and technologies we need to sustain and grow our wider business for the future. We focus company-funded investment in the areas of both defense and commercial aircraft electronics, unmanned technologies, and as I mentioned, to build our commercial cyber business.

We should remember that in defense work we work with our customers to develop the skills and technologies to meet their requirements. Customer-funded R&D is an important component of our overall investment. Today, the overall percentage of both our own and customer-funded R&D is approximately 6% of Group sales.

Group’s capital allocation policy remains unchanged. We continue to supplement dividends with returns to shareholders through the share repurchase program announced last year.

I will now hand over to Pete to take you through the detailed financials. Pete?

Peter J. Lynas – Group Finance Director and Executive Director

Thanks Ian, and good morning. As Ian mentioned, our results have been impacted by the stronger pound, both in absolute terms against 2013 and against the assumptions made in our guidance. And I’ll make that impact clear as I give the usual trading review and then move into the 2014 full-year guidance. For reference, the U.S. dollar is average 167 so far this year compared to 154 last.

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