Franco Martinelli - Group Finance Director

Tom Wildgoose - Nomura Asset Management Joel Spungin - Bank of America Merrill Lynch Allen Wells - Exane BNP Paribas Robert Plant - JPMorgan Sylvia Foteva - Deutsche Bank Peter Testa - One Investments Karl Green - Credit Suisse Andrew Farnell - Morgan Stanley

Welcome to the Babcock International Group plc trading statement. My name's Vicky and I will be the operator on today's call. I will now hand over to your host, Franco Martinelli, to begin today's presentation. Franco, if you'd like to go ahead.

Good morning. Thank you, all, for joining the call. You should have all seen the update. But, to summarize, trading in the quarter has been in line with our expectations and so our outlook for the full year remains the same, as it was at the half year, in November. As you know, most of our order book is made up of multi-year contracts and we continue to make good progress with those. In addition, we've had strong order intake, winning a number of new contracts. Of course, you know the big ones, like the French Air Force training contract, FOMEDEC which was formally awarded to us in January and the first batch of missile launch tube assembly for the joint UK-U.S. program, but each of our divisions has continued to win contracts. As we head towards the end of the financial year, we've topped up our order book and pipeline, so they remain at £20 billion for the order book and £10.8 billion for the pipeline. And the tracking pipeline of medium term opportunity is at a very healthy level. One thing I do want to mention is the realignment of the Group. You'll have seen that in our half-year presentation Archie referred to focusing the business on our core engineering work in marine, land, aviation and civil nuclear. The point of the realignment is to reflect how we're actually managing the business today and how we will manage the business going forward. We've built up significant positions in those sectors over the last decade or so and, as we continue to grow both in the UK and internationally, it makes sense to start organizing ourselves internally, along those lines. So, from April, we will be running the business in these four sectors which will replace the existing divisions. It feels like a very natural move to us. The day-to-day work of the vast majority of people will not be affected. For example, the civil aviation business will now sit under the same management team as the defense and aviation business. And the team that manages London Fire Brigade fleet of vehicles will sit under the same management team at DSG which manages the Army's fleet of vehicles. We think formally bringing these teams together with help us focus on driving technology across the Group and will help us make the most of our strengths. We have scheduled a presentation on March 14, where Archie will present more on the detail of the new reporting structure and how it helps us to address our growing UK and international markets. That's all from me, so let me open it up now for any questions you may have.

[Operator Instructions]. Our first question today comes from Robert Plant from JPMorgan. Please go ahead.

Franco, the MoD is your biggest customer, any change in how they're behaving? I'm thinking about the single-margin contracts and also working capital payments. Thank you.

Rob, talking about the single-source contracts, we're becoming less and less concerned about that particular methodology. They will deliver their single-source rate as some point in March. We will then, as per usual, look to use those starting points to generate the similar margins than we ever thought we would do in the first place. And we've actually had a couple of sole-source contracts this year and the margins, if anything, have improved compared to the previous position. So we're not concerned with that. It's just part of the -- the scope that we dealt with previously of the yellow book now, the single source. There are no significant contracts coming up shortly. So that's where we're on the sole source.On the working capital, yes, nothing really particularly to say. You may have seen some stuff in the press about the MoD having a little bit of difficulty with some of its payments on -- paying some invoices in the payment system. We've had discussions with the customer; they will make every effort to make sure that our year-end remains intact and we're assuming that, that will happen. And, therefore, we've got no update on that. And the general environment of working capital hasn't changed. So that's where we're. So I think pretty much no change is what I would say.

Our next question today comes from Karl Green from Credit Suisse. Please go ahead.

A couple of questions, please, Franco. Firstly, just on the FOMEDEC contract, I appreciate you're still in discussions with the customer about the exact procurement requirements there. But could you give us some sort of sense as to the range of potential CapEx that might impact the fiscal year-end 2018, please? And the second question, just in terms of organic growth as we've moved through the second half, how's that shaping up? And then, obviously, in terms of the -- some of the deferrals and delays that you referenced at the half-year stage, what's the organic run rate you're penciling in for H1 2018, please?

Okay, Karl, firstly, FOMEDEC, there'll be no CapEx as such, but it's just an accounting issue. What it will be is there will be a -- the FOMEDEC contract was originally at EUR400 million, it will -- has grown to EUR500 million, of which approximately EUR200 million, this is euro I'm talking, will be for the provision of the asset. Those assets will be debited as we make payments on account to the -- mainly to the aircraft provider and then they will become a finance release to the French Government at some point over the next two years. The exact timing of both the payments to the suppliers and the acceptance of the assets by the customer is currently up for discussion and once that's resolved we will issue more guidance. But at this point, I'm -- I wouldn't give any more information. In terms of organic growth for this year, yes, I think we're stating this clear, we're just repeating our guidance. And in terms of top-line growth, in the second number there's some positives and some negatives, but generally, overall, in line with what we said it would be. And what that means is because, as we said previously, we didn't think -- and we're not changing our guidance for 2018. So anything that we've said previously it's -- There is the issue on 2018, as you're all aware, of the Magnox. This year we've got the Magnox Dounreay step down which is roughly 2%. That will not repeat into next year, so that gives us a, for want of a better phrase, pro forma bit of a running start compared to this year is what I would say. So I think that's probably the answer to your questions, Karl.

Our next question today comes from Andrew Farnell from Morgan Stanley. Please go ahead.

I just wondered if you could give us a bit of an update on the outlook for new-build nuclear, given all the headlines we've seen with the difficulties in the sector; and then, also, just on decommissioning as well.

Okay, on nuclear new build, as you're aware, the Moorside thing looks questionable, but the Hinkley and Wylfa things are still going ahead, as far as we can see. And certainly Hinkley and we expect Wylfa to do the same which will create opportunities. In terms of revenue, we're seeing some revenue already, small numbers, however. And I think really not until 2019, 2020 do we think that's going to really kick in. And there'll be a bunch of opportunities at that point in time, given that we're the biggest nuclear engineer in the UK. We expect significant opportunities. EDF did invite us, the other day, as one of its core suppliers, to back it up in a presentation it was giving and we were specifically invited. So they obviously feel it as an important relationship for them as well which is good. So that's all positive from new build. And we do expect it to go head, but it will be 2019, 2020 before any significant revenues come in. In terms of decommissioning, as I said, we have -- the programs for Dounreay and Magnox are going well. We still haven't agreed the variation on both of those. The NDA's in a little bit of a difficult position with the change of management and a court case that it's fighting, so that's delayed it a little bit. We're hoping those things are going to come to a solution sooner, rather than later. There are a bunch of opportunities. We're starting to see stuff coming out of Sellafield which is a positive. It's not quite into the pipeline yet, but we can see it coming over the horizon now. Some opportunity, so we're very positive about that space as well. So, yes, good news in the decommissioning area, really.

Okay. And then, just one final one on when would you expect some pickup in flow from the MoD? There's been, again, press articles highlighting the pressure on the budget, given the decline in sterling. I know that's on the CapEx side, but they have talked about need to increase savings. So just when would you expect to see a more aggressive pickup on that side?

Well, what we're seeing is following the SSO we saw a bunch of programs that they needed to get into, all of which will be saving them money. So they need to get on with those. We see that as a positive. We see it as a positive because, as I say, they need to run the programs they've identified which are already baked into their budget. So if they don't go ahead with the programs then that -- they're going to be behind further than they are. They did identify the need to make, as I say, significant savings within the SSO and that hasn't gone slightly -- it's gone up a bit, because of what you've referred to in terms of foreign currency spend. So they need to do more. So we see that as a positive. I think they can be aggressive, but we're used to it. And, at the end of the day, they need to focus on what the costs are going to be, as opposed to what margins are, referring to a previous question. And we will save them some money the more they outsource. So that's -- we see it as a positive. And we have been successful in that sort of austerity-type environment previously.

Our next question today comes from Sylvia Foteva from Deutsche Bank. Please go ahead.

Two questions, please. First of all, going back to next year's organic growth, you said that there is no change to guidance. Can you just confirm that there is actually no formal guidance or is that not the case?

Sylvia, I'm not actually going to give you guidance for next year. All I would say is I feel, given what I can see in the pipeline and the order book, comfortable with what's out there. And that's where I am. I am not changing anything at this point in time.

And on that point, can I just check, so if we think about Met Police, Qantas and FOMEDEC then, in terms of the -- in terms of how much revenue you're actually going to get next year, I got to about 1.5%, but is that a reasonable assumption? Or how much revenue growth do you think these three larger contracts will contribute to next year?

You've got that as 1.5%. It's certainly more than 1% and it's not as much as 2%.

Right, okay. And on the shape of the FOMEDEC then, in terms of margins, obviously, if you're just procuring for it, presumably, the margin is very low on that?

No.

No? Okay. Shall we assume a single-digit margin in 2018?

The overall contract will make around the 10% margin, as well as on that.

Okay. And just secondly, on the balance sheet, obviously, you'll probably be below 2 times by the end of this year. What are you thinking in terms of options? Are other defense markets looking more interesting? Obviously, there's a lot of spend in the U.S. Are you thinking about any M&A in any new areas, potentially?

Look, we're always looking. But we're not -- we haven't got anything on the -- hot to trot for. I don't think that -- and particularly not in the U.S. I can't see that happening. I can see that, that market's obviously going to boom, but it's not really for us. Basically, we will be focusing on our core sectors, the four sectors that we've talked about, marine, land, civil nuclear and air. And if we see an opportunity to have some bolt-ons, we will consider it; but at the moment, we can't see any. So that's where we're, we're focusing on running our core business.

Our next question today comes from Joel Spungin from Bank of America Merrill Lynch. Please go ahead.

Franco, just a couple. First of all, just following on from the earlier question, I'm just wondering if you can make a general remark with regards to cash generation through the second half and whether there's been any substantive change versus what you were indicating at the first half. And then, just following on, if there's an update on the Met Police contract that would be helpful, as well? And then finally, just in terms of defense opportunities, there seems to be quite a lot of new defense work coming through with stuff like Hades, Hestia, Brize Norton, are you looking at any of that stuff?

Okay, cash generation will be pretty much in line with last year. We show a cash conversion above 100%, the pre-CapEx and around 80% for post CapEx and that's where I still expect it to be. I think this will give us a gearing around 1.8 times net debt-to-EBITDA at the year end. So that's what we expect. The Met Police contract hasn't yet been approved and signed. We expect that to happen in the first half of next year. The -- it's just going through some more approval processes. In terms of the defense opportunities you listed three there, Hades and you said Brize Norton which we call Gateway and Hestia. We won't be in Hestia, it's not one for us. The other two are things that we have in our pipeline. So we will be looking at that. I think that's what you asked?

Our next question today comes from Peter Testa from One Investments. Please go ahead.

Just three questions, please. One, with the new Group organization coming and putting different teams together, do you see any particular savings or efficiencies, direct or indirect, from that process?

No, I don't think there'll be any savings, in particular. I think there might be some slight costs that relate to the technology and international push that we need -- because we need to drive the technology across the Group. So we'll be establishing a team to make sure that, that happens. I don't actually see it as a saving; a slight cost, if anything, I would say.

Okay.

I do see that there'll be efficiencies through when we get our capability together and how we drive that in terms of the growth potential. I think that is something that will come through and that's why -- a main part of why we're doing it. This is not a cost-cutting exercise.

Yes, okay. And then on a couple of the design projects, Coast Guard and LNG, do you have any sense as to whether these can move beyond design-type contracts into something else?

We would not be wanting to do anything else is the answer to that question. We're very much in the design end of that. We do the LNG and we'll do the equipment for that which we subcontract substantially, but we won't get into the build phase; that's not really what we do.

Fine. And on the MoD question, as your point being that they need to shift or focusing on margins and focus on costs and now they're getting late into the implementation single source so they've got a better hand on that, do you see any move out of this focus on margins on the cost; i.e., projects moving along, now that they've got a methodology sorted out?

I don't think they've got any chance of doing that in terms of the costs. They need to try and focus on it, but that's really down between the MoD and us. It won't be sole-source regulatory office; they won't have the skill set to be able to do that. I think they will try and focus on target costs and savings which is what we want to do. And every time we talk to the MoD, they're very focused that they need to reduce the cost so they understand they really would be disappointed to feel that we'd be just all focusing on the margin. I think they need to reduce their costs; and, in order to do that, that would provide opportunities for us to keep generating the margins that we're generating. So I think that's--

No, I was thinking more, just from their internal processes, whether they've been internally focused on this and now they're becoming more externally focused on actually doing business.

I think, the MoD -- the SSO has created a little bit of noise, but I don't think it's -- it's not as all-encompassing as perhaps people imagine.

Our next question today comes from Allen Wells from Exane BNP. Please go ahead.

Franco, a couple from me. Could I get a bit more of an update on MCS, what you're seeing in the oil and gas side? Any update on the EC225 grounding, when that may come to an end and things move? And then, maybe on South Africa as well, obviously, the power and the vehicle business there a little bit weaker in the -- still weak in the first half. Wondering if there's any update on how that's progressing in the second half and how you're thinking about that as you look into the FY18? And then finally, just on the pipeline, your tracking pipeline, you talk about increasing in size during the period. I wonder if you can give any more color on that, any particular areas that you're seeing stuff. Or is it just MoD opportunities flowing through or whether anything slightly unusual progressing through there? Thank you.

Allen, oil and gas MCS, yes, it remains a tough market, actually. It remains a tough market. There are opportunities there, but it's at tough margins. So I think I'd characterize it as one of the more difficult areas. The EC225s are -- the EASA, the European regulator, has lifted its restrictions so we're no longer getting a lease rental holiday, but the civil regulator in UK and Norway have still got their no-fly restrictions. We've had discussions or we're having ongoing discussion, with Airbus as to how we cover this cost, but overall it will not affect our expectations for the current year. So that's where we're with EC225. Costs on an EC225 lease rental is about £12 million per year, is what we've got in our numbers; and, as I say, we're looking to talk to Airbus as to how we cover that. In terms of South Africa, yes, second half has been, if anything, better than we thought it was going to be in the second half. So, that's good news. In terms of the pipeline, yes, it's at a buoyant record level, I would say, the tracking pipeline. And it's across the business, it's from both the defense and civil. And, yes, it gives us good confidence.

[Operator Instructions]. Our next question today comes from Tom Wildgoose from Nomura Asset Management. Please go ahead.

Just very broad question, could you give me -- one of the -- let's say, the top three things you really worry about, looking at not so much the next -- the rest of this year, but looking into 2018 and beyond? What gives you a bit of a sleepless night?

I sleep very well. But aside from that particular issue, I think the -- oil and gas is, I think, continues to be [indiscernible]. It's only £130 million, £140 million revenue for us in MCS, but it's always a difficult thing. But other than that, I think everything else seems to be going all in the right direction. So I don't have three, really; I only have really the one. Yes, I think as we're driving -- no, actually, I think that's all I would say actually. We're very conscious of a bunch of things. Like, as we grow internationally we need to make sure that the governance and the controls replicate the ones that we've spent a lot of time putting in place in the UK. And, at the moment, we're very much overdoing that which is good, because we need to that and be careful. So, both of those things. I think there's a lot of opportunities internationally, but we need to make sure that we're taking the right ones and we're very cognizant of that fact. So those are probably the two, for me, that I would focus on at--.

We have no further questions.

Excellent. Thank you very much, everybody, for dialing in. Thank you very much. And we'll see you on March 14 which I'm very much looking forward to. Thank you very much.

Ladies and gentlemen, this does conclude today's call. Thank you for joining. You may now disconnect your lines.