BAE Systems PLC

LSE:BA

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the BAE Systems Interim Results 2022 Webcast. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chief Executive, Charles Woodburn. Please go ahead.

[Charles Woodburn, executive]

Thank you very much, and good morning, everyone. Welcome to our half year results presentation.

We have delivered a strong set of half year results, building on our track record of consistent operational and financial performance. As a result, our full year underlying guidance is maintained. The business continues to adapt to the evolving environment, and I've been proud of how effectively we've stepped up to meet the mission-critical requirements from our customers. We are well-positioned for sustained future growth from our current program and franchise positions underpinned by a now record high defense order backlog, and we see an expanding opportunity pipeline given the increase in many defense budgets around the world.

The positive conclusion of the U.K. pension triennial review is good for all stakeholders giving us enhanced clarity on cash flows and increased strategic and financial flexibility. This outcome supports a balanced and efficient capital allocation policy that enables us to both invest in the business and increase overall shareholder returns.

Reflecting this, our strong performance in the half and our confidence in the outlook for the group, we are today announcing a 5% increase in the interim dividend plus a new 3-year share buyback program of up to GBP 1.5 billion.

Against our 3-year scorecard, we are making strong progress against our value-creation priorities. We are focused on revenue growth, margin expansion and cash conversion over the medium term, and we are making good progress across these areas.

Moving to some of the operational and strategic highlights of the half. Program execution has been good across all divisions, and you will see from the margin performance -- as you will see from the margin performance, and this is in the face of the ongoing pressures to our supply chains, delivery lead times and tight labor markets across our operations. The air sector is delivering at full rate levels on F-35 rear-fuse large assemblies. The first deliveries of Typhoon to Qatar are on track for later this year, and we have stepped up our Typhoon support to the U.K. in response to the escalated threat environment.

Electronic Systems program execution remains strong but throughput in the half has been impacted by the industry-wide shortages of both microelectronics and labor. In P&S, U.S. combat vehicle deliveries have been maintained. Ship repair performance has improved and in our Swedish-based Hägglunds business, work is ramping up over a number of programs.

In Maritime, manufacturing levels continue at pace on Type 26 with the first 3 ships now in production and activity across our submarine programs is at a high tempo. Cyber & Intelligence had a remarkable first half, particularly impressive as we bought several businesses together to create digital intelligence.

On M&A, we completed the acquisition of Bohemia in March, and the integration into Cyber & Intel is underway. Those of you who came to see us at Farnborough hopefully saw some of their impressive suite of products. Now more than ever, they are well-positioned to help a number of NATO countries address their future training requirements.

Earlier this month, we signed an agreement for the sale of our financial crime detection business as our digital intelligence business focuses on its growing government and defense markets. Investing in the business is fundamental to our aspirations. We have increased self-funded R&D in recent years and a further increase is planned this year. You can see that investment in areas such as air are coming to fruition as we move towards building a flying demonstrator on Tempest within the next 5 years.

We are also increasing our technical agility and strengthening our partnerships with SMEs to provide rapid defense solutions. We are furthering our ambitions in sustainable technology through our own investments, but also looking for innovative partnerships as demonstrated by our recent announcement to collaborate with Embraer.

Building on CapEx investment over recent years, we continue to improve our facilities and working environment to drive efficiency, support the growth outlook and provide a good employment proposition. For example, in the second half of this year, we are set to open our new Cedar Rapids facility to support our military GPS business. Investment in our people continues to pace, especially in our early careers and outreach activities as we look to hire and retain the best talent.

As we assist governments in delivering their mission-critical requirements in the face of escalating threats, the importance of our role as a defense and security company in contributing to security and prosperity is clearer than it has been for many years. We continue to build and strengthen the core foundations of our ESG agenda, and we are setting ambitious targets for those areas in which we have an opportunity to support our customers, create a difference and contribute to our global future.

In progressing our ESG agenda, we have identified 4 key focus areas, namely: ideas, innovation and technology; opportunities for people and communities; addressing climate risks; and success through collaboration and partnering. These align with the company's strategic priorities and our core strengths and capabilities, and we shall give a full ESG update in October.

I'll now hand over to Brad for the financials.

[Bradley Greve, executive]

Thanks, Charles. I'll start with the financial headlines before discussing pension and the results at group level. I'll finish with guidance and capital allocation. For presentation purposes, my comments will be on a constant currency basis, which gives a better picture of underlying business performance. Also, the results presented today reflect the changes to operational reporting lines effective from the beginning of the year. As a reminder, the Australia business moved from air into maritime and the newly formed digital intelligence business rolls up under the Cyber & Intelligence segment.

Operationally and financially, the business continues to deliver, and I give special thanks to our teams for the job they've done and continue to do. The GBP 18 billion in orders booked in the half year demonstrates the increasing demand for our products and services, and we are now at a record defense order backlog. This sets a clear foundation for continued topline growth over the medium term.

We delivered sales growth nearing 3.5% as the business continued to manage through the ongoing supply chain disruptions and tight labor markets. Despite these challenges, we maintained strong program execution, leading to a 20 basis point margin expansion with return on sales hitting 10.5%. The underlying earnings before interest and tax of GBP 1.1 billion was up 4%, led by strong gains in platforms and services in particular.

We delivered free cash flow of GBP 123 million, in line with our usual second half weighted business cycle. In terms of capital allocation, we are increasing dividends by 5% and have announced a GBP 1.5 billion 3-year share buyback program, underlining strong long-term capital discipline. Detailed financials are shown here. For reference, the dollar rate averaged around $1.30 compared to $1.39 last year, naturally benefiting the reported numbers.

The strong operational performance resulted in underlying EPS of 24.5p, up 8%. The underlying tax rate for the half was 19%. You'll note that the IAS 19-based pension balance has improved by GBP 3 billion from year-end and now sits at a GBP 900 million surplus, driven predominantly by the move in corporate bond rates.

So sticking with pensions, one of the 3 Ps, together with performance and portfolio, we have taken proactive action over the last 2 years to finally get out from under the pension deficit shadow. With the higher bond rates, the IAS pension is now in surplus for the first time. Further, I am pleased to say we have now completed the triennial review, which is the most important part of the overall pension funding process. The key points arising from the view were that on a technical provisions basis, the scheme is fully funded. No deficit funding cash contributions are needed at this time, and the covenant for the group and the overall outlook has strengthened. This is a good result for all stakeholders and underpins our assumptions for our 3-year cash targets.

Moving to the key group financials, starting with our record first half orders of GBP 18 billion. In the U.S., we posted a book-to-bill of 1. Electronic Systems secured key orders on electronic combat, precision strike, C4ISR programs and a welcome pickup and controls & avionics. In P&S, combat vehicle orders were around $1 billion, driven by M109 and ACV awards, and ship repair signed over $400 million in new work.

In the Air sector, we recorded the renewal of the Saudi support contract and there were other notable wins for F-35, the Hawk support contract, the Spain Typhoon order and nearly GBP 2 billion in orders for MBDA. And Maritime, GBP 4 billion of orders were led by GBP 2.5 billion of Dreadnought funding. Cyber & Intelligence posted a book-to-bill of over 1 with several long-term renewals.

Sales for the half at GBP 10.6 billion were up nearly 3%. In Electronic Systems sales were stable with the challenges on supply chain and resourcing having the impact we expected in the first half. We see a stronger second half and good growth across the medium term and beyond as evidenced by the strong backlog and U.S. defense spending outlook.

Our Platforms & Services business was down 2.5% on lower ship repair activity, but again tracking in line for full year guidance. And looking forward, this is a sector with a much enhanced opportunity pipeline, which Charles will cover. Air sales came in around 4% higher with F-35 at full rate volumes.

Our Maritime business was up around 6%, driven by the continued growth in Dreadnought and Type 26 activity. Cyber & Intelligence had the strongest half benefiting from good utilization and program performance in both intelligence and security and digital intelligence.

Our profit levels continue to grow ahead of sales, up 4%, reaching GBP 1.1 billion with a return on sales at 10.5%, up 20 basis points over last half year, reflecting our focus and progress on margin expansion. Electronic Systems performed well and in line with last year, and we expect the usual second half profit weighting to continue again this year.

Platforms & Services margins at 8.9% expanded by over 200 basis points with recovery in ship repair and improved operational performance and combat vehicles. Their sector delivered good operational performance across the board coming in at 10.4% for the first half.

The Maritime sector margin of 8.4% reflects continued strong operational performance across highly complex programs. Cyber & Intelligence margins expanded by 140 basis points to 11.7% as both I&S and digital intelligence delivered an impressive program performance, high levels of utilization, the performance from the new Bohemia acquisition and more efficient cost structures. And there are further sector details in the backup materials.

Operating cash flow at GBP 410 million was broadly in line with last year when adjusting for the GBP 250 million receipts from the sale of Filton and Broughton facility and last year's results. As expected, there were working capital outflows in the first half following usual business patterns and the early receipts at last year-end. Air cash flow was higher than expected due to advances received on a number of MBDA orders. The cash performance for this year -- half year underlines our confidence in both our end year and 3-year cash guidance.

To complete the cash analysis, the movement in net debt is shown here. As usual, the net debt moved up at midyear, and we expect the normal second half weighted cash flow pattern to continue again this year. The recent upgrade by S&P to BBB+ further validates the improving trend in our overall leverage ratios.

Moving now to guidance. As detailed here, the group's full year 2022 guidance is unchanged across all metrics on a constant currency basis. The guidance assumed a rate of $1.38, and our results up to the half year have been reported at an average rate of just under $1.30. Should the current dollar rate persist for the year, there will be a significant tailwind to reported results. As a reminder, the sensitivity to reported EPS is around 1p for every 5p movement. The sales and EBIT sensitivities are GBP 320 million and GBP 45 million, respectively.

I spoke in February of the continued need to work on our 3Ps, performance, portfolio and pension. I emphasized the importance of improving our performance as ultimately measured by margin expansion and cash conversion, enhancing the portfolio as we have done with the acquisitions and divestments and the need to continue to derisk the pension exposure. And as you have heard from us today, we have made solid progress to date on all 3.

Margin expansion remains a key priority, and we remain confident that this will continue in 2022 and beyond. The half year results demonstrated this with the main drivers being improved program performance, particularly in P&S on both ship repair and combat vehicles and more broadly across the portfolio where the focus on operational excellence has allowed us to retire risk without consuming it. In C&I as we continue to focus on higher-margin business and make accretive bolt-ons and across the group where we are making efficiency improvements to our delivery models.

Finally then, let me turn to capital allocation. With the pension now in surplus, our balance sheet continues to strengthen. We continue to see the business delivering higher cash and improving long-term cash generation from operations, meaning we have increasing amounts of capital to allocate to maximize value for our shareholders. Through investment in R&D and CapEx, we continue to prioritize growing and investing in our business. Thereafter, there are 3 potential uses for the resulting free cash flow.

First, we recognize the importance of the dividend and have announced another increase for this half year period.

Secondly, we will continue to look to grow the business through value-enhancing bolt-on M&A, where we continue to be disciplined and active.

Thirdly, we want to return surplus cash to shareholders as demonstrated by the accelerated completion of last year's buyback program and the announcement of a new 3-year share buyback of GBP 1.5 billion. The timing of this program ties in with our 3-year cash guide and underlines the confidence we have in our business over the medium term.

So in summary, the record defense backlog is an indicator of our growth prospects. Our margin expansion demonstrates improvements in our operational excellence and our capital allocation is demonstrating the importance we place on value creation.

With that, back to you, Charles.

[Charles Woodburn, executive]

Thank you, Brad. I will now cover the business positioning and outlook.

First, a quick reminder of our competitive advantages, which are helping us tackle some of the macro challenges and underpin our confidence in growing the group in the coming years.

We have the following: Multiyear programs with visibility on long-term value generators, a diverse geographic footprint and deep customer relationships, leading defense franchises with incumbent positions often with high barriers to entry, differentiated technology and an operating model that drives strong value creation.

In terms of inflation and supply chain, these factors have contributed to how we are managing both supply chain constraints and growing inflation. Whilst not immune, with microelectronics supply being especially constrained, we continue to take mitigating actions, some of which are detailed here.

We benefit from many long-term program positions with more stable forward visibility for long lead items, allowing us to continue to actively manage supplier lead times. Additionally, we are focused on hiring and retaining critical skills in a tight labor market with a focus on our overall employment proposition. In the U.S., where the labor market is particularly tight, it has been really pleasing to see over 250 former employees come back to work for the business, very much driven by our culture and the noble mission of supporting those who protect us.

Moving now to the defense spending outlook and the opportunity pipeline. Global events have more than ever demonstrated the need for strong defense and security in the face of aggression by nation states. We are seeing many countries in which we operate, look to increase their defense spending over the long term, and therefore, our geographic spread of markets and diverse capabilities is becoming increasingly differentiated. Additionally, our ability to export from the U.K., U.S., Australia and Sweden coupled with our positions on Typhoon, F-35 and our shareholding in MBDA, means we are uniquely well placed to compete in multiple allied defense and security markets.

The U.S. defense spending outlook is positive with the current budget proposal supporting our growth aspirations. That is likely to be enhanced during the congressional markups alongside the Ukraine-related supplementary spending build and increased levels of foreign military sales. Here in the U.K., defense spending is already planned to increase, and there are calls for that to step up further. As the leading defense prime, we have long-term visibility for our major U.K. operations in build -- build and support and the Defense command paper identified a number of new capability requirements, which will create opportunities in the future.

In Australia, where defense spending is increasing, BAE Systems is the largest local defense prime, and we are well-positioned to collaborate with the Australian government to assist in delivering on AUKUS and other opportunities. We are well set to benefit in the wider Asia Pacific region from increased defense spending through export opportunities and collaborations from our U.K., U.S. and Australian businesses.

In our Middle East markets, our long-standing relationships at government and company levels, continued regional instability, the nature of our long-term contracts and a high oil price mean we expect defense and security to remain a priority, and we are progressing a number of opportunities with existing customers.

Moving now to Europe, where the significant step-up in German expenditure is important for long-term defense funding. As reinforced at the NATO Summit and alongside the actions of Sweden and Finland, we see other nations increasing their defense budgets towards and, in some cases, even beyond the 2% GDP commitments. We are pursuing a number of significant opportunities in Europe and are very well-placed to benefit from defense spending increases through our position on the Eurofighter Typhoon, our shareholding in MBDA our BAE Systems, Hägglunds and Bofors businesses based in Sweden and through U.S. foreign military sales of either our products or on platforms where we have mission-enabling electronic systems content.

Whilst end markets are important to the overall outlook, I also want to highlight the programs and opportunities that will underpin our growth. This is the slide we presented back in February, and I wanted to reiterate some key points. We have a large order backlog now at record levels for the defense business and exceptional program visibility. We see growth in all our sectors from known programs and that backlog. What we look in funded backlog is, in many cases, just a subset of the long-term program outlook we enjoy. For example, Typhoon support, F-35, submarine and shipbuilding incumbency positions give us visibility well over a decade.

We expect the second half to see continued strong order flow. Our major franchises are either growing or stable and recent defense spending announcements are likely to reinforce and prolong this view. And looking forward, there are some areas in which we would expect to see an upward trend from what is detailed here, especially across our combat vehicle portfolio and MBDA.

We have an excellent pipeline of opportunities that are incremental to the current outlook. Since February, this has increased given the numerous defense announcements and the expected restocking and replacements required for the support provided to Ukraine.

Highlighting some of the key movements and changes in recent months. Within Air, there are further Eurofighter orders being pursued along with sustainment and training opportunities, especially given the high levels of current flying requirements and MBDA is set to benefit across numerous platforms.

In Maritime, AUKUS is the highest profile and discussions continue at pace between the 3 nations on the way forward across a broad range -- across a broad number of defense programs. There may also be restocking requirements in U.K. munitions.

In Electronic Systems, many of the U.S. foreign military sales have our capabilities embedded. Within Cyber & Intelligence there is an expanding bid pipeline of defense and international prospects. The acquisition of Bohemia, which offers synthetic training is looking highly relevant as NATO looks to increase its troop readiness numbers.

Within P&S, we have a strong combat vehicle in artillery portfolio with 4 of the 5 vehicles in the U.S. heavy brigades, the Amphibious Combat Vehicle, the M777, the CV90 and the BvS10 products from our Hägglunds business and the Archer self-propelled howitzer from Bofors. As detailed here, numerous opportunities are being tracked with some moving at pace, those furthest progressed in recent months of the CV90 for Slovakia and Czech Republic and the BvS10 for Germany. Whilst it is still too early to give a view on the impact on growth rates ahead, this is a pan sector opportunity pipeline, and we are well-placed given the competitive advantages of our portfolio and diverse geographic presence.

So in summary, another half of delivering on our commitments and aspirations. We've continued our strong operational performance across programs, all underpinned by a now record high defense order backlog. We delivered clear financial progress with topline growth, margin expansion and consistent cash generation, all in a challenging environment.

We've seen the heightened global threat environment driving expansion in defense budgets, creating a strong opportunity backlog. We've embedded our ESG agenda in everything we do with Karin appointed as ESG Director on our Executive Committee to drive forward our ESG ambitions. And a further dividend increase alongside a new multiyear share buyback program demonstrates our confidence in the business and our commitment to return excess capital to shareholders.

Finally, I'm delighted that Cressida Hogg has agreed to join the Board of BAE Systems in November and take over his chair in May of next year. I very much look forward to working with her to continue to take this company forward. Of course, the handover is still some way off. And in the meantime, Sir Roger continues to motivate us all in terms of being performance-driven and values led. Closer to the time, I will be saying more about the undoubted strength of his legacy and the appreciation we all feel.

Thank you for listening. And with that, I shall now turn it over to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Robert Stallard at Vertical Research.

[Robert Stallard, analyst]

Charles, we'll kick off on the supply chain issue. It seems to be particularly acute in the U.S. defense sector in the second quarter. So I was wondering, from your perspective, do you think we've now seen the worst of this and perhaps some sort of idea of how long it's going to last? And then secondly, regarding the buyback, clearly, welcome here. But what does this mean for your M&A pipeline? Is this reflective of the lack of potential targets out there?

[Charles Woodburn, executive]

Maybe -- I mean on the first point, I'll maybe pull Tom in because he's on the line here. But I mean, the point is we are managing through this, but it is requiring behind the scenes an awful lot of work and particularly around microelectronics which, of course, the Electronic Systems business is the most exposed to. So Tom, I know you're on the line, can you maybe just come in and comment on that?

[Tom Arseneault, executive]

Yes, happy to, Charles.

Yes, the supply chain continues to be the pacing challenge for us, and it's certainly led by microelectronics. The team has been working in a number of dimensions here. One, qualifying alternate sources where possible to compensate for that. We've also demonstrated some remarkable agility, I think, on some of our production lines where they are temporarily and efficiently resequencing their production flows in order to accommodate these delays. And so I think quite a bit of work to -- to work around these.

Now you'll note though that while that has pressured sales a bit, you can see that the margins are still in line or better than first half of last year and across some of the sectors. So we're going to continue to work this until the supply chains recover. Our best guess is we shouldn't expect to see that happen this year. And so we're planning to continue this pace until we see it recover.

[Charles Woodburn, executive]

And on the -- just coming back on the M&A side. So the buyback still allows us plenty of strategic flexibility to do the kind of M&A deals that we've done in recent years. And I mean the kind of sort of bolt-on type M&A opportunities. And we are continuing to look in areas adjacent to electronic systems, space, space electronics, some areas around sustainability-driven product innovation like the hybrid buses that we've been doing successfully, but taking some of those capabilities into other sectors or the transport streams like electric EV toll and the agreement that we just signed with GE and NASA on the hybrid gas turbine capability.

I mean there's a number of areas that we're pursuing that we said are strategically important from a technology perspective. And obviously, that's driving our interest in M&A. And I'm absolutely confident that with the announced buyback that we have sufficient capacity to be able to do that and pursue these M&A targets.

Is there any you want to add to that, Brad?

[Bradley Greve, executive]

Yes. I think, first of all, the strong balance sheet is worth pointing out, the pension swinging to a surplus over GBP 900 million and the deleveraging that we've done over the last several years has left our balance sheet in a very, very strong position. And we're generating EBITDA, it's now well north of our net debt. So the buyback is something that we can do alongside continued activity in the inorganic space. So we've done some really good value accretive deals in the last couple of years, power and propulsion, in space, tech model, the GPS and radios business, Bohemia Interactive. So we want to continue to be very active but very disciplined in the bolt-on M&A space. And our balance sheet gives us the capacity to do that alongside this GBP 1.5 billion share buyback program.

[Operator]

[Operator Instructions] Our next question comes from the line of Chloe Lemarie at Jefferies.

[Chloe Lemarie, analyst]

Maybe the first one to [indiscernible] question on the M&A pipeline. I mean, are you seeing sellers reconsidering planned defense asset sales. I would think in the current environment, this could be happening but again, maybe partnering for growth could be beneficial. So if you could provide any color on this, that would be helpful.

Then if you could share with us any net debt-to-EBITDA target that you would have in terms of capital allocation and balance between buyback and M&A, that would be great.

And last point on the F-35. There's been quite a lot of news flow around deliveries to the U.S. So I wanted to have some clarification from your side. What kind of level of production you've agreed with your industrial partner over the next few years? And by when could the export pipeline start to expand on the current production levels?

[Charles Woodburn, executive]

The first point on M&A I think we're not seeing too much change yet. I think there's still quite an active opportunity pipeline for us that we're pursuing in the areas that I handled in the question with -- that Rob posed. So I won't go through that again. But there are opportunities, I think, for partnership. I think we announced a couple of interesting partnerships at Farnborough and [indiscernible] other with Embraer. So I think there are some opportunities on both fronts. So we're actively exploring those.

I think on the target financial targets, Brad, do you want to comment on that?

[Bradley Greve, executive]

Yes. I think the way that we think about our credit position is really sort of the parameters around investment-grade credit, and we always want to stay within that parameter. And we've got a very as I said earlier, a strong balance sheet and very comfortable with the leverage vision we're at because we also want to preserve capacity to be able to continue to grow the business organically. And we're in a really good position with where we're at with leverage to be able to do that right now. So I won't give a very prescriptive guide on net debt to EBITDA targets. But we do want to maintain that sort of perimeter within investment-grade credit.

[Charles Woodburn, executive]

And then on F-35 production levels, where basically -- our expectation is the circa 150 level for -- plus/minus from 1 year to the next, but over the next 10 years, and there's nothing that we hear from our teammates that suggest otherwise.

[Operator]

[Operator Instructions] Our next question comes from the line of Charlotte Keyworth at Barclays.

[Charlotte Keyworth, analyst]

So if you just turn to the backlog. I mean, I expected to get to a record position by the end of the year and you're already there. So I guess how do you see orders tracking in H2 versus H1? And then obviously, within that GBP 53 billion, I mean, how much of it might we consider shorter cycle, given obviously the proximity of the war, et cetera. And I'm just sort of thinking about where consensus organic growth is at the moment for next year and it's below 4%. And I wonder that's actually a little bit low. Could you start incurring costs and recognizing revenues? So that's the first question.

The second is related to -- I'd like to just explore this Cyber margin a bit more. I mean, you're substantially higher than versus my expectations. And I just wanted to understand, I know there's a bit of M&A in there, but how much of that is higher utilization and given the demand environment, presumably that's sustainable, if not possibly we started to go?

And then my final question is just related to interest rates. I mean 92% of that U.S. dollar denominated. Just wondered how you're thinking about that given interest rate rises?

[Charles Woodburn, executive]

I mean in terms of backlog, I think it's worth noting that in the first half, most of that backlog came from our position on -- well, you've seen from the slide on incumbent positions. I think in terms of, obviously, growth for next year, we'll be updating -- we're doing our IBP process in the second half year, and we'll be updating that as we do normally at the full year results point.

On Cyber margins, Brad, do you want to pick up on that? I mean it was really a very strong performance from the other side of the Atlantic.

[Bradley Greve, executive]

Yes, really good. And we always expect this business to reach to sort of double -- low double-digit type margins, and we're seeing that happen in the first half. And it was helped with very strong utilization, which is something that is seasonal. So the first half is high utilization. The second half, you have some of the vacation periods in Christmas and the holiday seasons and whatnot. So you do have seasonality effects that does impact utilization in the second half. But overall, we do expect this business to be producing low double-digit type margins. And the inclusion of now Bohemia Interactive is a really useful addition and is helpful and value accretive addition to the portfolio, and we're really happy about having them on the team and excited about where we can go with this business because that is highly accretive in what it does. And so I think that's part of the story too.

[Charles Woodburn, executive]

On interest rates?

[Bradley Greve, executive]

Yes. Charlotte, our interest rates, our U.S. debt exposure is fixed. So we don't -- we're not exposed to an increasing interest rate environment in terms of our existing debt structure. So not too worried about that. Obviously, it affects cost of borrowing going forward. But we're -- as I said, we're happy with our leverage right now, and we'll be dynamic as we move forward with whatever happens. But our existing debt structure is largely fixed, so we're not exposed to the increased interest rates.

[Charles Woodburn, executive]

And just circling back on that first question. I mean, there are some -- a number of key opportunities we're pursuing in the second half. But I would caution that it won't be the same again having had such a standout first half. But overall, I think it will be -- continue to be a very strong year for order intake.

[Operator]

[Operator Instructions] And our next question comes from Nick at Agency Partners.

[Nick Cunningham, analyst]

A couple of questions. Going back to the M&A issue. We've seen recently the FTC is being increasingly difficult, so we say, certainly about some of the larger deals. Does that affect you at the sort of bolt-on level, which you prefer to operate at? And is that in any way impacting on the sort of opportunity universe that you see? And also, looking again at capital allocation, do you think you've exhausted other ways of deploying capital internally? And is it mostly done in terms of self-funded R&D or even self-funding some -- just in case some inventory given the supply chain issues.

And then a completely separate question. On the pension, is there any opportunity to lock in some of that gain that you've made in terms of the position by transferring some of the pension assets and liabilities to a third-party insurance company or whatever?

[Charles Woodburn, executive]

Yes. On the first point, I think the answer is we don't actually know yet. I'll bring Tom in on this, but we're not expecting the kind of bolt-on deals that we've done in the past. And actually, we're looking at some as we speak, to be problematic under that regime. But I mean, the truth is it's very, very new. And I don't know, Tom, if you want to just comment on that?

[Tom Arseneault, executive]

Sure, Charles. We've been tracking that. There certainly has been a change in the posture on the FTC, but I think your point is right, and that is it's really focused on larger deals and deals that represent more of a vertical play, meaning a consolidation of a segment of the market that would result in what they view as an antitrust situation. And so we're very careful as we look through our pipeline to take into account those kind of implications. As you saw, we had no issue whatsoever with the Bohemia acquisition. We'd expect additional bolt-ons, we would take the same approach. Hope that's helpful.

[Charles Woodburn, executive]

Yes. And then on sort of capital allocation, I think it's fair to say that we have significantly increased our funded R&D, and we will continue to do that around Electronic Systems and in the Air sector. So I think we feel that the buyback that we announced, we've still got ample flexibility to do the increases that we see and indeed build out capacity in facilities. Again, we -- as we said in the comments, we're investing in our facilities both from a production capacity side and also for our people, things like the Cedar Rapids facility, the new military GPS facility in the U.S. And again, I mean, we obviously were very cognizant of all of that as we considered the overall capital allocation.

Brad, is there anything you want to add to that whilst also then moving on to the pension point?

[Bradley Greve, executive]

I think you're right to highlight, we've increased R&D spending double digits and again, double digits is the plan this year. So we are actively increasing that allocation method. And then we're also investing in CapEx, as Charles mentioned. So we haven't exhausted those millions of allocations at all. And in fact, we also -- to your point on inventory, where we can, we are building inventory across the business particularly where we're most strategically exposed. And so that has been something we've been actively doing.

And then after that, of course, is the free cash flow that comes out, and we've allocated that with I think a lot of capital discipline with increasing our dividend and the buyback program that we announced.

And then on your question on pension, Nick, first of all, we're really pleased that we're finally in a surplus position. So that's a very good place to be. The buyout market, to your point, process things at sort of a gilt level -- so it's quite prohibitive at this stage. But it's absolutely something that we will continue to look at when it does become more sensible from a price perspective. Derisking the pension is -- has always been one of my top priorities, and we'll always look at ways to do that.

[Nick Cunningham, analyst]

I mean, it's above my in terms of understanding what moves those prices, if you like. But -- is there any likelihood that those opportunities will arise. Do you see that happening in the market?

[Bradley Greve, executive]

Yes. I mean you need 200, 300 circa basis point increase in gilt to sort of get to a level where it starts to become doable. But we're running our scheme right now. It's a maturity. That's the way we're looking at it. But if those price environments change, we want to be positioned to be able to look at that. So it's on the options that I would just say at this stage. But right now, it's just not sensible from a cost perspective.

[Operator]

[Operator Instructions] Our next question comes from the line of Christophe Menard at Deutsche Bank.

[Christophe Menard, analyst]

Yes. I had a few questions. The first one is, can you help us model the share buyback on a yearly basis? I suspect it's not totally linear, so any indication will be helpful for our modeling.

The second question is more philosophical. It's about competition in defense markets. We've seen some countries like South Korea selling equipment to Poland, for instance. And I was wondering what mix you stand out versus competition? Is it relationship, is it U.S. exposure? So any kind of competitive advantage that you have here would be of interest, especially given the opportunities you listed and the potential at the moment in terms of order intake?

And the last question is more HR-related in terms of investing in people. Outside the U.S., how are you, I mean, preparing for the future in terms of recruiting people, I mean, given the order backlog, the growth in upcoming activity, what is your strategy in hiring, recruiting people? Where do you hire? So that's kind of a broad question, but I mean probably support for future growth.

[Charles Woodburn, executive]

I think first point, I'll hand over to Brad on the share buyback, and then I'll take a stab at the next 2.

[Bradley Greve, executive]

Yes, we certainly aim to execute the full GBP 1.5 billion over a 3-year period. And I think the GBP 500 million buyback that we announced last year is useful to look at. I mean we were -- I think we did about 35% of that when we announced it at the half year last year. And by the time we got to the end of the year, we did about 75% of that. So that's kind of the level you may be able to expect. Of course, as you said, it won't be a linear, it won't be sort of a same type of volume every month. And then the years after that, it should be for your sort of estimations being roughly the remainder over the next couple of years beyond what we do this year. So I mean we do want -- we will execute the GBP 1.5 billion is our full expectation. It won't be linear. We'll try to get as much of it done in this year, in the remainder of the year. And then after that, we'll take 2 years to work off the rest of it.

[Charles Woodburn, executive]

And then to your point on competition in defense, I think some of the things that make us unique as a company, one of which is the diversity of our portfolio of products, I mean, both air, sea, land, cyber and space. We have a very diverse and exceptionally, I think, well-suited to current defense needs portfolio. But importantly, we also have a very diverse geographic portfolio. I think that's one of the key differentiators for us. I mean we've been seeing an increase in European defense spending driven by the threat drive into our business and our positions, as we said in the presentation, the Swedish businesses of Hägglunds and Bofors, our position on Eurofighter and then our shareholding in MBDA was -- we've seen in the last couple of years, and of course, that now accelerates with Germany's decision. You've got things like the down select of the CV90 for Czech Republic and Slovakia. Obviously, we've got to get those on to contract in -- certainly for Slovakia second half and probably into next year for Czech Republic, but very good progress there.

So I'd say that that's one of our unique differentiators. And then finally, I think something that we do that is, I think, often not widely appreciated is we, as a company, we're very strong on collaboration. And we have a long history of doing it. So whether it's things like Tempest or some of the Maritime programs, and whatever opportunities might come with AUKUS, we have a long-term track record of being a good partner, and I think that those are the kind of things. I mean the strength of those relationships, and we understand the need. It's not just around capabilities. It's around jobs, sovereign capability, local skills development. I mean these are things that we have this, I think, an enviable track record, and we take it incredibly seriously. And those are some of the competitive advantages, which I think will really come to the fore in the coming years as defense spending increases.

And -- but at the same time, people are expecting to see value from their defense companies in the defense industrial base. And that maybe leads me on to the last point about preparing for the future. I mean, as you know, we do have -- we have some world-class programs in terms of taking people into apprentice programs and graduate training programs. And obviously, as we see the growth trajectory ahead of us accelerating, we are now ramping up those programs. And I'm very glad that we have things like the Academy of Skills and Knowledge in -- at Sainsbury for the air sector that we have an equivalent facility for our submarines. And we're looking at further investments to make sure that we really are ready for the challenge ahead of us, but we're building on very strong foundations there, and it's something that we, as a company, I think, do exceptionally well. I'll probably just leave it there.

[Operator]

[Operator Instructions] This question comes from the line of Harry Breach at Stifel.

[Harry Breach, analyst]

Yes. Charles, Brad, just 3 things of interest. One is maybe a little technical, one maybe for Brad.

Brad, MBDA strong new order intake, we see and hear the level of campaign activity there. The shareholders have as I understand, are sort of right to withdraw money from the treasury. I just want to sort of understand whether that cash, whether it sort of constitutes part of your free cash flow? Can you just remind us about how much you've got sort of outstanding from MBDA? How you're thinking about that as the advances will start to come in significantly?

Secondly, just to Charles' point about international collaboration. Clearly, there's the news flow in recent months about Japan in the context of Tempest. Is there potential for broader cooperation in Japan and I don't know if you're in a position to maybe give some examples about that.

And then just finally in terms of space, Charles, I think you mentioned that was an area where you were under contemplation for potential acquisitions. And I'm just wondering, would that take you sort of beyond the component level into sort of payload level or potentially buses or services. Can you give us any -- any sort of -- any more of an idea about how you're thinking about space strategically in your capability there?

[Charles Woodburn, executive]

Yes, I'll maybe do the first on reverse order. I think on space, I think we continue to have active acquisition pipeline. I'm not sort of ruling out any particular area on space. I think what's clear to us has been what's building in the U.S., we've had a significant space business for some time as a component supplier. In countries like the U.K. or Australia or Canada or Japan, for example, with defense spending at our sort of levels, the LEO satellite opportunity, I mean, that enables countries to create a dedicated space capability at a price point that simply would be unimaginable 10 years ago.

So there is now a sort of a jumping on point. I'm glad that we spotted this opportunity a few years back. I mean, obviously, launch costs have come down as the small sat market. And the acquisition of In-Space Missions that we did last year, I'm very pleased with that acquisition but there are a number of others in the pipeline that we are considering. So I don't want to sort of rule out any in particular, but I'm glad that we've we identified that early and started driving that forward. And in the whole sort of multi-domain battle space. I mean, clearly, space is an important part of that, and we're developing, I think, quite an exciting offering around that.

On international collaboration, I think you're absolutely right. I mean, obviously, working now on joint concepting between FX and FCAS and we'll just have to see where that leads. I mean we outlined at Farnborough, the Japanese will be making decisions around that later this year. And I think we're off to a very good start, very encouraging start. And certainly, as Japan have outlined their desire to increase overall defense spending quite significantly due to the increased threat environment that they see. I think there are more opportunities for us, be it longer term in the Maritime side too, electronics, defense electronics. We've always had a good business with respect to combat vehicles into Japan out of our U.S. business.

But I mean, their sort of plan over the next 5 years of potentially getting to sort of NATO levels of defense spending. I mean that's a significant increase in defense spending and obviously represents an opportunity for us and plays again to our strength of partnership with local companies and building that combination of building a capability but also a strong sovereign capability and sovereign base. And again, I think our track record of partnerships positions us well potentially there.

On MBDA, Brad, do you want to comment on that?

[Bradley Greve, executive]

Thanks for the technical question, Harry. Yes, we have 37.5% share of MBDA, and that's what we reflect on our free cash flow, our share of that. So that's precisely what we do.

[Charles Woodburn, executive]

I think that brings us to an end if I'm not mistaken on questions. I'm sorry, was that Harry coming back?

[Harry Breach, analyst]

Charles, I just -- sorry to keep my complete level of ignorance again. Just -- so Brad, you just proportionately consolidate MBDA's free cash flow at 37.5%. And is there a net off from that if they make a loan into you, if you take money out of the treasury for MBDA?

[Bradley Greve, executive]

No.

[Harry Breach, analyst]

No. Okay. It's just straight proportional consolidation. It's pretty easy to see.

[Bradley Greve, executive]

Yes.

[Operator]

This concludes today's conference call. So speakers, please continue.

[Charles Woodburn, executive]

Very good. Well, thank you all for joining us. We'll not be seeing many of you as we get out on the road show and look forward to seeing you there or at the next set of results.

[Operator]

This concludes today's conference call. Thank you for participating. Speakers, please stand by.