Earnings Transcript for BA.L - Q4 Fiscal Year 2019

Roger Carr: Well, good morning, everybody. I'm very pleased to report that 2019 was another good year for the company. Now as always, Charles and Pete will review our performance for the year in some detail, but I really wanted just to preface their comments with some remarks as to the overall position of the business as I see it today at the start of what is clearly a new decade. Essentially, I believe the company is at a pivotal moment in its development, transitioning from a sound base, built over the last 10 years under 1 management, to a higher-growth, higher-cash generative, technology-led model under a new executive team. The financial foundations put in place by Pete Lynas of rigor, project discipline and prudent accounting have been the bedrock on which the current business has been and will continue to be developed under Charles and his team. Gerard DeMuro has mirrored the great work done outside the U.S.A. by stabilizing and then strengthening the North American business, and most importantly, growing land and electronics. And the benefit of his leadership has been successfully dovetailed into the overall growth of the business mix. Both Pete and Jerry will leave the business in a much better place than they found it, and we are all hugely appreciative of their legacy. Now whilst Jerry will undertake some special assignments for the company in the balance of the year, Pete will leave the company in March. And I have to say, we wish them both well for the future. It is on these very secure foundations that the baton will be, I think, now seamlessly passed by Pete and Jerry in the coming weeks to Brad Greve and Tom Arseneault; Brad, now having had 6 months to get to know the business and Tom, moving up in April from President and Chief Operating Officer to President and Chief Executive of BAE Systems, Inc. Together, Brad and Tom will become the new key lieutenants for Charles in taking the business forward and delivering the potential it has from a strong order book and an expanded electronics business. I think in this regard, the acquisition of Collins Aerospace Military Global Positioning System and Raytheon's Airborne Tactical Radios business, which we hope, let me say, to conclude following regulatory clearance from UTC-Raytheon, the merger, in the near future. We hope this will mark a very material step forward in accelerating our growth, reinforcing our strength in the electronics sector and continues the rebalancing of the geographic spread of our global activities. These acquisitions were at the sweet spot of our strategic ambition, delivering immediate benefits in profit and cash returns and demonstrated the wisdom of patience and prudence in our M&A strategic thinking. Finally, we wish to address the challenge of our pension deficit by taking advantage of current benign interest rates and the strength of our business and balance sheet providing certainty to our scheme members and greater clarity as to the future cash flows of the business. Whilst there are still some political uncertainties to navigate and, of course, export license to secure, future prospects are encouraging. To be clear, our focus remains on execution, integrating the acquisitions, delivering the growth and generating the cash. And I am confident that Charles and his team have both the mindset and the skill set to deliver these important goals. And with that, I'll hand over to Charles. Charles?

Charles Woodburn: Thank you, Sir Roger, and good morning to everyone here in the room and those joining us via webcast. I'll start with a summary of the results and then a business overview with a focus on our order backlog, major programs, key markets and how we're driving our strategy, all of which provide me with confidence in our growth outlook. Pete, as usual, will cover the detailed financial results and provide forward guidance as well as covering the pensions agreement announced today. As usual, we'll take your questions at the end of the presentation. Turning now to 2019 performance. We've announced a good set of results consistent with our earnings and cash guidance, which reflect a much improved operational performance against the backdrop of significant geopolitical turbulence. Operationally, the Electronic Systems and Air sectors once again performed strongly, and we made progress in Maritime and U.S. Combat Vehicles. Positively, our U.S. business again delivered growth and is well set to maintain that momentum in the coming years, with the order backlog growing by $1.8 billion. We are delighted with the 2 proposed acquisitions, both of which are strategically attractive, falling within and complementary to the sweet spot of our Electronic Systems portfolio. They represent a golden opportunity to purchase high-quality, technology-based businesses with market-leading capabilities and long histories of leading innovation in their respective fields. The pension agreement announced today is a good outcome for all stakeholders, providing greater near-term clarity for all concerned. From a business perspective, it will give us additional cash flow from 2022, and therefore, opportunities for further generation of shareholder value. 2019 has been a year of significant progress on a number of fronts. Reflecting both the in-year performance and the Board's confidence in the outlook for the business, the dividend has been increased by 4.5%, the highest increase in 8 years. As I said last month, when we announced the proposed acquisitions, I'm delighted they have emerged at a time when my confidence in our business has improved significantly. Operational performance continues to improve. We have a large order backlog and exceptional program positions providing visibility of growth, and there remains a strong pipeline of opportunities. We're driving program performance to ensure successful delivery of that backlog. This underpins confidence in long-term cash generation, as outlined by our new 3-year cash guidance. Recognizing the importance of free cash flow, the remco intends to include cash targets in our updated long-term incentive plans. Our strategy is consistent and working. The group has a well-positioned global portfolio, governments in our key markets continue to prioritize defense and security, and there is a strong demand for our capabilities, products and services. The pension agreement is a very positive outcome, bringing forward the triennial review and providing certainty and clarity through 2022. Meanwhile, the proposed acquisitions provide excellent opportunities to accelerate our technology strategy. With the business focused on driving operational performance and cash generation, we have a strong and sustainable business model, which is well set to deliver continued growth. This growth is underpinned by performance on our large programs. So at this point, let me run through how we're progressing. On F-35, production ramped up to the planned 142 sets. And in 2020, we're targeting full rate production levels of around 160. The Qatar Typhoon and Hawk contract is meeting its contractual milestones, with Typhoon aligned to the accelerated delivery schedule. Typhoon support continues to perform strongly in the U.K. and Oman, and in Saudi Arabia, we're meeting our contractual requirements. In U.K. Maritime, there is increasing activity on Dreadnought with revenues on the program now exceeding those on Astute. The Offshore Patrol Vessel program stabilized in the year with ships 2 and 3 delivered. The fourth was accepted this past month, and the final ship is expected to complete this year. The Queen Elizabeth Aircraft Carrier build program was completed with HMS Prince of Wales being accepted by the customer. Manufacturing work on U.K. Type 26 continues to increase, following cut steel on the second ship. In Australia, the Hunter Class frigate program has commenced the initial 4-year design and development phase, and in Canada, mobilization activities are progressing. The U.S. Combat Vehicle business continues to implement a number of process and automation improvements to meet the increased production volumes across multiple programs. M109 met its delivery targets in the second half of the year and has now reached its steady state monthly production rate. Initial Amphibious Combat Vehicle deliveries were made and work on the Armored Multi-Purpose Vehicle program is progressing towards deliveries in 2020 with all 5 variants in build. The Combat Vehicle ramp remains an area of focus with 3 upgrade and 3 newbuild programs now going through our facilities. We continue to shape our market-leading ship repair business, maintaining a strong bid pipeline for repair and modernization services and working with the U.S. Navy to improve utilization levels. To that end, the first tandem docking of destroyers in our San Diego facility was a very welcome milestone. Electronic Systems had another excellent year with increased activity on F-35, classified work and APKWS, a great backdrop against which to integrate our acquisitions. To summarize our operational status, steady progress is being made with a number of legacy program challenges either completed or stabilized with investments in people, processes and tools ongoing to provide strong and sustainable performance. As you know, order backlog can, in some cases, represent just a small proportion of the expected through-life value of a program. This chart shows the duration of our major programs, split by what is in the order backlog, what is expected in future awards and where we have new business winning opportunities. Pulling out some key examples. On F-35, where we currently contract annually, we moved to full-rate production this year and expect that to continue through the decade with the opportunity to secure long-term support positions as the U.K. and global fleets grow. Typhoon manufacturing activity at current levels has been secured for the coming years. The potential pipeline for Typhoon is positive with opportunities both with partner nations and through exports. Furthermore, on Typhoon support, incumbent positions are expected to extend beyond the current contractual horizons. On Dreadnought, we're contracted until early 2021, but this program will run for the next two decades. On Type 26, we have an order for the first 3 ships of an 8-ship program that will extend through the 2030s. And on the Australian Hunter Class program, we have booked the initial order, which runs to 2022, with the build program then extending into future decades. In the U.S., where contracting tends to be based on annual funding, the M109 is now proceeding towards the full rate production phase and the Combat Vehicle programs, such as AMPV and ACV, could yield close to $10 billion over 10 years in combination with additional export potential. In U.S. ship repair, we're a leading player with high barriers to entry. Our Electronic Systems portfolio again closed with record order backlog and received a multiyear $2.7 billion IDIQ contract for future U.S. and international APKWS orders. We've provided further color in the backup charts, but these examples highlight the longevity of our programs well beyond the order backlog. This is why we're placing such a strong focus on program execution. We must meet our customers' requirements to best position us to secure future opportunities and to deliver top and bottom line growth and improving cash flow in the coming years. Moving now to our key markets. In the U.S., which represents over 40% of group sales, our portfolio remains well aligned with customer priorities and the key focus areas of the National Defense Strategy. Recent budget increases include the passing of the 2020 Defense Appropriations bill, which will underpin near-term growth and see positive momentum in support of military readiness and modernization. As mentioned earlier, our Combat Vehicle programs run for years to come, and our U.S. ship repair and naval gun franchises are supported by the growth outlook in Navy budgets and the projected fleet size. In Electronic Systems, our strong technology positions and increased levels of classified work will be supplemented by the two proposed acquisitions. Here in the U.K., currently around 22% of group sales, we have political clarity following the general election. The U.K. remains Europe's largest defense market. The U.K. government recently restated its commitment to uphold defense spending to at least 2% of GDP and to increase the defense budget by at least 0.5% above inflation in every year of the current parliament. The government is also expected to launch an integrated foreign policy, defense and security review during the course of 2020. Our business here in the U.K. has a stable outlook based on long-term contracted programs in both Air and Maritime. We employ over 30,000 people across the U.K. and many more in our supply chains. Additionally, work under Team Tempest to develop the next-generation combat air technologies, skills and expertise, in collaboration with the U.K. government and industry partners, is progressing at pace. The commitment of Sweden and Italy to work with the U.K. on creating next-generation capability is a very welcome development. In Saudi Arabia, which now represents around 13% of group sales, we're working closely with industry partners and the U.K. government to ensure that the export licenses required to enable us to fulfill our contractual obligations remain in place. We continue to address current and potential new requirements as part of the long-standing agreements between the U.K. and the Kingdom, with work ongoing on the localization of defense capabilities in Saudi Arabia in support of their national transformation plan and Vision 2030. In Australia, currently 3% of group sales, the pace of military modernization in the Asia Pacific region continues to drive their commitment to increase defense spending. Through the Hunter Class frigate program, our Australian business will double in size over time. In Qatar, our relationship has started a new chapter through the Typhoon, Hawk and MBDA programs and is now a key market for us. A number of European countries are looking to increase their defense spending and move closer to meeting their NATO commitments. The group is well positioned to benefit through potential Typhoon opportunities, our holding in MBDA and our Swedish land vehicle business. Finally, in our other accessible markets, especially Asia Pacific, defense and security remains high on national agendas with a number of countries responding to an increasingly uncertain security environment and the need to recapitalize or upgrade existing equipment. Moving to strategy. When I took this job in 2017, I outlined 3 strategic priorities, namely operational excellence, competitiveness and technology. I am certain they remain as relevant today as they were then. We are now seeing the benefit in our results. Additionally, we've made good strides in shaping the portfolio to strengthen the business for the future. In addition to the 2 proposed acquisitions, we made 2 technology bolt-ons in the year, continued to shape our shareholdings in Saudi partner companies, completed the land vehicle joint venture with Rheinmetall and are progressing the disposal of the ex-Silversky business within Applied Intelligence. The balance sheet remains robust and positive actions were taken in the year by repaying the $1 billion maturing bond from cash and reaching a positive outcome in respect of overseas tax matters. The pension agreement and the proposed acquisitions enable us to accelerate the strategy. People management is particularly vital in a time of growth, and we are embedding strategic workforce planning into the business to ensure we're building the right people, skills, technologies and facilities to deliver our future growth plans. So in summary, top line growth is underpinned by our strong order backlog, program visibility and an evolving pipeline of opportunities, whilst earnings and cash growth is driven by improving program performance. From a balance sheet perspective, we remain committed to maintaining an investment-grade credit rating and the capital allocation policy for the group remains unchanged. Our strategy is clear and consistent. We are focused on building a sustainable business with enhanced financial performance, supported by free cash flow generation to deliver growth in shareholder value over the coming years. I'll now hand over to Pete to run through the financials. Over to you, Pete.

Peter Lynas: Well, thanks, Charles, and good morning, everybody. And just before I step through the detail, I'd like to draw out the key points we've got here. Firstly, in terms of 2019, underlying earnings per share, 45.8p, and that was delivered in line with guidance. Free cash flow performance was slightly ahead, delivering £850 million in the year. The dividend was grown by 4.5% and earnings cover sustained, and that's the 16th consecutive year of dividend growth. And although the accounting pension deficit is up over the year, the funding deficit has reduced. And as I'll cover later, we today announced an accelerated deficit funding plan. Looking ahead, we're targeting mid-single-digit growth in underlying earnings per share for 2020. And in terms of free cash flow generation, we now target in excess of £3.5 billion over the next 3 years, and I'll talk more about that when I get to the guidance. And just to be clear, guidance today does not include the recently announced acquisitions. Given the uncertainty as to the timing of the completion date, we will provide an update to the year's guidance at that time. So just before I get to the numbers, a reminder that these results include the changes under IFRS 16 lease accounting. Adoption of that standard increases our EBITDA by around £50 million, but that's matched by higher finance costs. And 2018 numbers have not been restated. And for reference, the U.S. dollar rate averaged at 128 in 2019 compared to 133 in the prior year. So the headline numbers and compared to '18. Sales increased to £20.1 billion. That's up 7% on a constant currency basis. Underlying earnings before interest, tax and amortization of £2.117 billion were 10% higher than last year, and that's a 5% increase on a like-for-like basis. Underlying finance costs in the year of £257 million were £42 million higher, and that includes the IFRS 16 impact. The stronger dollar and the higher cost in joint ventures largely offset the 6 months benefit from the $1 billion bond that we repaid back in June. Underlying earnings per share were 45.8 p, up 7% compared to 2018. And that's with an effective tax rate of 19%. And there's a bridge chart highlighting the major year-over-year EPS movements attached to the presentation materials. As we announced back in July, there was also a one-off benefit to earnings of 5p arising from agreements reached in respect of an overseas tax matter, net of a provision taken on an exposure arising from the EU's decision on the U.K.'s Controlled Foreign Company regime. There was an operating cash inflow of £1.3 billion, and net debt at the end of the year closed slightly better than our guidance at £743 million. Order backlog has reduced over the year to £45.4 billion, with trading on multiyear long-term contracts in the Air sector partly offset by further growth in our U.S. businesses. The dividend for the year has been increased by 4.5% to 23.2p per share. And as I mentioned earlier, at this level, the dividend is covered 2x by EPS. So turning to the balance sheet and the other impacts from exchange translation, where the U.S. dollar closed at $1.32 compared to the opening $1.27, there were a limited number of items impacting the closing balance sheet. Firstly, with the adoption of IFRS 16, around £1.3 billion now appears within both fixed assets and lease liabilities. Working capital has increased by around £300 million, mainly for some inventory build in our U.S. businesses, some receivables timing and utilization of provisions. In addition, there was some usage of last year's customer funding on the Qatar program. On pensions, the group share of the accounting deficit stands at £4.5 billion, and I'll get back to that in a minute. The net tax asset has increased following the one-off provision release made back at the half year, together with a higher deferred tax asset on that pensions deficit. And assets held for sale contain our AEC subsidiary in Saudi Arabia, and those of the ex-Silversky business of Applied Intelligence. So moving to pensions, and firstly covering off the accounting. The value of the scheme assets has increased over the year to £27.7 billion. Asset returns in the year was strong at 12%, generating £3 billion. Pension benefits paid out amounted to £1.4 billion. Reported liabilities at the end of the year increased to £32.5 billion. Real discount rates in the U.K. reduced by 50 basis points and by 110 basis points in the U.S. Those changes in rates increased reported liabilities by £3.2 billion. And against that, current mortality assumptions have reduced liabilities by almost £500 million. So some significant moving parts, but the combined impact of them all is a reported accounting deficit increase of about £500 million, with a group share of the deficit now at £4.5 billion. And as you know, it's not the IAS 19 accounting which is important here. It's the funding position of our U.K. schemes. As we approach 2020, a key issue for us was the next triennial funding valuation. So I'm very pleased to brief you on the agreement that we announced this morning. On the first of October, we completed the consolidation of 6 of our 9 U.K. schemes. Following that scheme consolidation, the company agreed with the new Trustee Board to accelerate the funding valuation that were scheduled for 2020, bringing it forward to October 31, 2019. Following agreement with the trustees, and in consultation with the pensions regulator, the deficit has been agreed at £1.9 billion and the scheme is 92% funded. The deficit funding plan has been replaced by a new plan, under which £1 billion will be paid in the near future as a one-off, together with payments of £240 million in 2020 and circa £250 million in 2021. The deficit recovery also assumes an allowance of 50 basis points for asset outperformance. This is clearly a positive move for the pension scheme Trustee Board and the company and provides improved certainty to both; and as shown on the chart, give sight of enhanced free cash flow for the group in the near term. And for reference, the 3 smaller U.K. schemes are each fully funded, and in the U.S., deficit funding will be $80 million in 2020 and expected at $40 million per annum through to 2025. So one last point before I leave pensions and one I've made many times before

A - Charles Woodburn: Yes. So Andrew?

Andrew Humphrey: If I may, maybe one for Brad and one for Charles. Brad, you've been in the business 6 months now, seen a couple of fairly substantial balance sheet changes over that time. Clearly, there are parts of the business that are also in an investment phase. What do you see as your priorities for the balance sheet over the next 2 to 3 years? And then one for Charles. Maybe, Charles, any -- or what should we be expecting on a potential German Typhoon order this year?

Charles Woodburn: Brad, you want me just to go first on the German Typhoon? I mean Airbus, as you're aware, we've been talking -- I mean the expectation is that something will happen this year. Timing is still to be determined and depending on the political cycle, but really, Airbus are the ones that are managing that bid. And they've been very consistent with their messaging they're expecting it this year. And so do we. Brad, over to you.

Bradley Greve: Yes. Thanks. So really, the first few months that I've been in the company, it's been really about -- just learning about the business. So traveling around to locations, seeing where we work and what we do, and more importantly, the employees that do that. So that's really been kind of Phase 1 of what I've been up to. And then Phase 2 is really the sort of planning of what we do. And I got involved in the planning process. So the numbers that Pete presented today in the guidance, I was part of that. I signed off on that, and I own those numbers. Third phase is really about, and getting to your question about what we've done a little bit with the balance sheet, so it was two projects that I think were very important to the value story. And I think you all know that the pension deficit has been a cloud that's hung over the company for a long time. So I think what we've done here with the deficit funding is really important to kind of get those clouds clearing. And I think the end is in sight for that. So I was very excited to be part of that. And then the second one was the acquisitions that we did. So I think you saw 2 very high-quality assets that were brought into the portfolio. And I think those are going to be adding value for the long-term for the company. So those were 2 very important things that we've done with the balance sheet. So going forward, I think it's all about sort of managing our performance, driving the cash flow growth that will come from that and the natural deleveraging that will happen. So we'll focus on that. I think the last thing I want to say, since I have the opportunity, is just to really acknowledge the job that Pete's done, and he's been fantastic in just helping me understand the business. And everywhere I've gone to and all the people I've talked to, there's just this consistent high level of respect that come across for the job that Pete's done. And I certainly understand why that is. And I've seen that first-hand for myself. So I'd like to just really thank Pete for that. And also, just to say, I'm really looking forward to taking over for him.

Charles Woodburn: Thank you, Brad. Charlotte? And then Jaime.

Charlotte Keyworth: I'm Charlotte from Barclays. I've got 3 questions. The first one is probably for Jerry, actually. It's around the U.S. budget. Obviously, we had the 2021 presidential request, and there were some, in dollar terms, some reasonable step-downs on the AMPV and Paladin production -- sorry, levels for 2021. Just, I guess, how would you look to think about smoothing volumes longer term? And how should we think now about the potential margin inflection on land vehicles looking forward? And then secondly, just more broadly, how do you see this latest DoD spending round panning out across the portfolio for you? And then the final one is really just to get on your technology road map and cash. Obviously, with the pension payments stepping down to 0, and then we've got M&A overlay on that from the U.S., we've got really quite a nice place to be in 2 or 3 years' time in terms of cash. So you touched on Tempest R&D increases. What else in the portfolio do you see in terms of cash cost from an R&D perspective, looking at your organic growth profile?

Charles Woodburn: I'll get Jerry to jump up on the combat vehicles. But on the R&D, if I just take that last one. Yes, I think we've been fairly consistent with our priorities. I mean the increase in self-funded R&D is going in two areas. One is Tempest funding, and that steps up, but it steps up and then sort of stabilizes at a level for some time. But Electronic Systems has proven to be a very fertile ground for self-funded R&D, and that will continue to be an area where we invest. So areas like space, underwater and precision ammunitions are the three areas that we've been ramping up. And the success of things like APKWS is built on that. So obviously, we want more of that kind of highly successful, high-growth programs in the portfolio. And Electronic Systems, as I said, has been a very fertile ground for that. So Jerry, can I just ask you just to jump up on the Combat Vehicles and then the broader U.S. budgets generally?

Gerard DeMuro: Well, let's start with the large scale, the U.S. budget. We're very comfortable. The President's request for '21 is consistent with the 2-year agreement. As Charles alluded to, we had the 2020 budget funded at roughly, what, $738 billion. The 2021 request is at $740 billion, so it's consistent with that agreement. It's consistent with our planning. As we talked about and as has been reported in the press, our expectation was that, that was going to level off. We're very comfortable with that. We're also comfortable with the alignment of our portfolio, our key programs, electronic warfare programs, our countermeasure programs and the investments that we made. Thank you, Board, for the investments in the 2 high-quality acquisitions. Very relevant to the -- not only our portfolio, but to the national defense strategies. So we're very comfortable at the top line. We're also very comfortable with where our portfolio is. You had a question, which I'm happy to answer; some confusion over what the Army is doing with their funding on combat vehicles. We are funded on those Army combat vehicles for production. We have, in funded backlog already, enough to carry us into 2023 on PIM, on AMPV. Bradley is funded through, I think, 2024. So what you see the Army doing in close coordination with us is aligning their funding for what it needs to be in each given year to continue those consistent production rates. As has been reported in the press over the last year, starting with PIM and then with AMPV, we are working with the Army to ensure that we hit production rates that meet their fielding and delivery schedules, as you know, the Army fields and brigade combat sets. So there's been very close coordination with that and making sure that there's no disruption to the production rates that are in our plan. I'll give you some totals in a moment. And also with the supply chain. If you recall, the AMPV, the PIM, each of them have over, I think, 4,000 parts, 200-plus suppliers. So it's been a careful examination of that supplier base and what do we need to maintain continuity now that we're building that supplier base up through the LRIP phases of those programs. As you know, under the DoD standard, LRIP, low-rate initial production, is intended to do 3 or 4 things

Charles Woodburn: Thank you. Jerry. And I think, Pete... yes.

Peter Lynas: Charles, can I just add one thing. I mean -- I hate to raise accounting and IFRS 15, you know that's one of my least favorite topics. But we are selling as cost as incurred. So as Jerry talks about those volume of deliveries, that's not representative of the sales that we're going through. So when I talked about taking sales at initial low-margin, very low-margin on those programs, if you're just incurring costs without delivering, that's where you take really low margins. So you've got deliveries later, sales early. But as you deliver and retire risk that's when you take a profit.

Charles Woodburn: Yes. Jaime, you had a question?

Jaime Rowbotham: Yes. Just one from me, Jaime Rowbotham from Deutsche Bank. For Pete on the cash guidance. Obviously, the boost to the rolling 3-year from the proactivity on the pensions is very welcome. There's a line item in that guidance that looks like it might be going slightly the other way a bit, CapEx to depreciation. Could you tell us what you're going to be investing in there and perhaps a bit about the phasing of that over the three years?

Peter Lynas: Yes. Okay. You're right, Jaime. I mean the guidance, we have moved CapEx up a little bit. What we're seeing, and it's a quality problem to have in support of the growth in the U.S. particularly in Electronic Systems, we're having to put some investment into new facilities. So it's increasing classified activity. You can't house classified activity on unclassified sites. So we're having to create new facilities to take that work and house the people. We've got a new facility that we're building -- will be built down in Austin. We've got one in Huntsville, and we're also doing some redevelopment of the existing Canal Street site in Nashua. So it's really around the facilities. And a lot of that is going to be front -- of those 3 years, it's going to be front-end loaded, which is why when we talked about around £1 billion of that free cash flow, you're going to see a lot of that CapEx appearing in 2020.

Charles Woodburn: So largely Electronic Systems, and as you said, a high-quality problem to have. Nick?

Nick Cunningham: Nick Cunningham, Agency Partners. First of all, could I say thanks to Pete and Jerry for being so patient over the years. Probably going to test that again. But your biggest division, Air, is actually the hardest one to forecast because it's got so many big moving pieces to it. And I know you don't give medium-term guidance, but I wonder if perhaps you could draw some kind of a picture, if you like, as to those big pieces in terms of both the revenue, top line and the margin mix impact, as things like Qatar, U.K. upgrades -- I had a list of other things. And particularly, the one that certainly I don't feel I understand at all, which is the movement of Saudi support into the JVs, how that actually works mechanically in terms of what it does to the top line, the minority cash flows. Do you get paid for passing that equity value over? Or was it just...

Peter Lynas: How long have you got?

Nick Cunningham: Well, yes...

Charles Woodburn: No, I was just going to say, at the Air Capital Markets day, if you recall last year, we did give some -- and I think we're largely consistent with that. I'll hand over to you to talk, but it ends up being a rather boringly stable story. But if you want to...

Peter Lynas: Yes. I mean in terms of top line, what's building up, clearly, we've got Qatar sort of rolling on and rolling up. And whilst that drives the top line, it's the bottom line that's more important. And as we move into the risk retirement, as we start deliveries, and first deliveries are not until 2022, then you start seeing that delivering more margin. F-35, we delivered 142 sets in 2019. We're going to 160 this year in 2020. Lockheed talked about going beyond that. We could if we needed to. So that's -- you've got growth there and sustainability. On the support side, we've got what we do in the U.K. We've got what we do in Saudi Arabia. That's sort of fairly steady state and rolls on for several years. So we've got some growth coming off the 2 big programs. I think what's probably causing a little bit of -- more difficult to predict is the margin levels because once you get above the top line, you've also then got to think about the R&D investment we're putting in. G&A is pretty stable. And it's really the R&D if you look at Tempest. And I think you know because of the nature of the program and security, we can't even talk about the numbers on it. But Tempest R&D is stepping up. It steps up quite a lot in 2020 compared to 2019, which is why you've got that slight margin pressure. I think as Charles said earlier, that'll then hold for sort of 2 to 3 years before it then comes back down again. Who knows what we'll be spending on R&D investment back into sort of '24, '25? But we are going to see a high level of R&D going through. And then the other impact we've got, of course, is the pension service costs, which are driven by the accounting pension deficit. As that comes down over time, then the service costs should come down over time. So we should see margins moving back up. We've held that 11% to 13% guidance range for many years now and we've always been within it. We guided today that we're going to be towards the bottom end of that for 2020. But as you move back out, with hopefully lower pension cost burden, improving Qatar margins, then you'd expect to see us move back up through that range.

Nick Cunningham: Right. And the self-funded Tempest R&D for several years, do you have visibility of that transitioning into a funded R&D program?

Peter Lynas: I mean, the way we are handling it, we are getting funding today from the U.K. government, But we are also putting in some money ourselves. So when I talk about self-funded R&D, that's purely the bit of ours that flows to the P&L. I'm not talking about the government funding. But if you took the gross number, it's a big number.

Charles Woodburn: Yes. And I mean government committed at the outset to £2 billion, and they've been funding their share of the program as we go through it. So we've been seeing that.

Nick Cunningham: Okay. I'll go back and reread my notes on the Saudi JVs from the CMD.

Peter Lynas: Yes. I mean the basic direction on Saudi JVs is we have been selling down some of our -- we're not selling outward clearly. But in line with the 2030 Vision, we've been investing in the country. We're bringing partners into some of those joint ventures. So as they come into those joint ventures, you get a higher minority interest building up. What we've not built into our cash guidance is anything further -- in terms of the further sell-downs to those partners as we go through 2020 and 2021. And once we've got those numbers in clarity, we -- obviously, we -- we can share that with you. But that's the sort of direction of travel.

Charles Woodburn: David?

David Perry: David Perry from JPMorgan. I've got some fairly dry technical questions. I think they're important, though. First one is very simple. The £1.5 billion you're putting into the pension, would that just come off the IFRS deficit as well? So if everything stayed the same on interest rates and assets, £4.5 billion would go to £3 billion?

Peter Lynas: Yes.

David Perry: Okay. Second question, follows from that, is slightly theoretical. Imagine you were buying a company tomorrow, and it had the same pension situation as you. So a £3 billion IFRS pension deficit with 0 actuarial that required no funding whatsoever. As a CFO, how would you think about that in terms of valuing the company? Is it -- fiction, it doesn't exist. Or does it exist? Just help me think about how I would value BAE.

Peter Lynas: Yes. I'd always look at what's the underlying economics, what's the cash flow requirements. If you look at where we could be -- to your point, if asset returns stay the same, deliver everything they said, we could have no funding deficit at the end of 2021 and still have an accounting deficit. So the accounting deficit is meaningless if it doesn't require cash injection. So if I was looking at value of business, I'd be looking on a cash flow basis.

David Perry: Okay. To all intents and purposes, that £3 billion doesn't exist. It's there in accounting.

Peter Lynas: That's why I'll always, always stressed the point that our funding obligation is around £2.5 billion less than the accounting deficit. That's the way we look at it.

David Perry: Okay. I'll ponder it. The third one is customer advances, the amount of money you had, you used to report that very precisely. And I think with the IFRS 15, it gets bundled into this contract liability number. Do you know what the actual amount of customer cash you actually have on balance sheet today?

Peter Lynas: It's around the £3 billion mark is the accounting number. And as you know, David, when we talk about being mutually funded by our customers, clearly, mutually funded to customers is at selling price, which includes profit and G&A which we have expensed. So there's always going to be a degree of that number which relates to money we've already expended and written off. So that's not a sort of £3 billion that we owe the customers. It's just the way the accounting works.

David Perry: Okay. Great. And then the last one, on the new 3-year cash flow guidance, are you willing to share an annual cadence on that?

Peter Lynas: I think you can work out...

Charles Woodburn: It's not that hard.

Peter Lynas: Yes. I'll -- this is how I do it, okay? If you think of what we guided when we talked -- when we sat here this time last year, we talked about sort of in excess of £3 billion. Well, you can see we delivered £850 million this year. I've just said in this year's guidance it will be around the £1 billion mark in 2020. So clearly, you could have got to a number of around £1.2-ish billion for 2021. So if you then roll into this year, and the in excess of -- we've given you a range clearly, but you've got £1 billion for 2020, you've got that £1.2-ish billion for 2021. And therefore, by inference, 2022, there's got to be -- even if you just added the benefit...

Charles Woodburn: Even better.

Peter Lynas: You'd be at £1.4 billion, £1.5 billion. So that's the run rate. Working capital is always going to be volatile. If we get big advanced payments or anything like that, that could -- all those numbers could shift, which is why we think looking at a 3-year model is better than just looking at in-year. But if you want to break it down in each of those years, then that's the way I'd look at it.

Charles Woodburn: Can I maybe just ask Sandy? I think you wanted to say a word.

David Perry: Already? Good God.

Peter Lynas: Question first.

Charles Woodburn: Yes. You may have a question first, by the way so...

David Perry: Well, we do come this. Sorry. Sorry, folks. Jerry escapes. I would like to attribute it to the special relationship because it's just I haven't got any dirt on Jerry. Pete does not escape. I think we all forget that when Pete became FTE, he had to step into some fairly big shoes when George Rose retired. He did that and then some. And Pete's ability with numbers and depth of knowledge of the numbers has never been in question. However, competent finance directors tend to bring out the worst in me. And I still have fond memories of just a moment's hesitation when I suggested to him, he may just have revealed the 2013 results when we were supposed to be reporting 2012. Only once, however, did I ever see Pete taken completely aback by something. My wonderful sales lady, Sonal, and myself were in the States years ago, and we were hooking up with Pete, Ian King and Andy Russell to have dinner. It was Pete's birthday. So Sonal dutifully bought him a tie. I didn't like it, but it doesn't matter. It's the thought that counts. And then off we went to this dinner. And the conversation bubbled away, as you can imagine, with Ian. And ultimately, Sonal politely inquired what Ian and Pete were doing that weekend. The answer was they were going to watch Portsmouth play. Play what? Said Sonal. Well, football, of course. Sonal was incredulous. Does Portsmouth have a football team? So Pete and Ian embarked on a praise over the sporting prowess of Portsmouth Football Club. So after 2 or 3 hours, we escaped. Now this is where I sort of out myself, I suppose. Careful, don't leap to conclusions. I am standing here well aware that Portsmouth beat Exeter 3-2 on Tuesday evening. And so were on their way to Wembley, where they hope to retain the leasing.com trophy against the mighty city -- that's Salford City, by the way. And so here we are, and I was mulling over this and thinking, it shows what respect we've all had for Pete that we remember his birthday -- or Sonal does. We buy him a tie, and that I've come out of the closet as a Portsmouth FC follower. And I'm thinking, well, then the penny kind of drops and thought, well, it's respect. Yes, of course, it's respect. But actually, that's the sort of thing that you would only do for a friend. So I hope you will all join me in missing my friend, Pete. In fact, I honestly believe all our friends, Pete, the very best in the future. And thank you for everything you've done for us while you've been doing in the job. Really much appreciated. Good luck.

Charles Woodburn: I've offered him the mic, but I'm not sure he wants to.

Peter Lynas: I'm not sure I can. So thanks for the kind words. It's been a privilege to be up here. And I've enjoyed working with you. It's been a pleasure most of the time, but always, always a privilege. So thank you all. Thanks for the support. And thanks for the words, Sandy.

Charles Woodburn: Oh, yes. On the line. I'm sorry about that.

Operator: [Operator Instructions]. And your first question comes from the line of Ben Heelan from Bank of America.

Benjamin Heelan: I'm sorry to have a relatively boring question after what Sandy just said. And yes, Pete, thank you for all the help over the years as well. My question was around Tempest. And we saw from Airbus last week, more and more charges on the A400M, which I think goes to highlight some of the issues companies can have when they get locked into long-term contracts on some of these very, very significant technology, new technology programs. How are you guys thinking about the contracting, the negotiations with the customers and managing the risk of getting locked into contracts long term?

Charles Woodburn: That's a very good question, Ben. And we are very mindful of contractual issues elsewhere and are obviously trying to protect our commercial position going forward. It's still very early days on a program such as Tempest, and plenty of time for the commercial model with international partners to evolve. We've seen across the patch some that have worked more successfully than others. And you can just absolutely be assured that we're looking to make sure that we find the right model that works with international partnerships and also gives us surety of outcome. I think that was it for questions.

Charles Woodburn: So thank you all for joining. And thanks again to Pete. So thank you.