DefenceContracts Accounting and RiskManagement

Transcription

1 Defence Contracts Accounting and Risk Management Erik Buschmann, Airbus Military CFO Dr. Gerlinde Honold, Military Aircraft CFO Franck Le Rebeller, MBDA Group Financial Controller Christian Pechmann, EADS Head of Controlling Third Annual Global Investor Forum Toledo, Spain June 21st & 22nd, Content 1. EADS Defence Business 2. Revenues Recognition 3. Margin Recognition and Risk Management 4. Adapting to a Changing Environment 2

2 EADS Defence Business Today 2003 EADS Revenues Breakdown EADS 30.1 bn Defence = 24% of total revenues 7 bn revenues in EADS Defence Revenues Breakdown by Business Eurocopter 3% 9% 12% 22% 7% 18% 9% 20% Military Aircraft Space Defence Electronics Missiles Defence & Communication Systems Military Transport Aircraft others 3 EADS Defence Strategy Top ranking Defence order-book Defence order-book +109% 22 bn 46 bn generates strong organic growth Defence revenues +18% 6 bn 7 bn ~10 bn EADS Group Revenue Split 2002 Target ~20% ~30% ~80% ~70% Commercial Defence to create value Target to trigger synergies to mitigate commercial cycles 4

3 EADS Defence Customers UK Ministry of Defence: Defence Procurement Agency (DPA) French Ministry of Defence: Direction Générale de L Armement (DGA) German Ministry of Defence: Bundesamt für Wehrtechnik und Beschaffung (BWB) Spanish Ministry of Defence: Dirección General de Armamento y Material (DGAM) Multinational agencies: OCCAR (A400M, Aster), NETMA (Eurofighter),. Export customers 2003 EADS Defence revenues breakdown by customer Export 27% Uk, France, Germany, Spain 73% Trend towards harmonisation of Defence Procurement 5 EADS Defence Contracts Current Status Development Serie Production Bid Offer Export campaigns Eurofighter, missiles, helicopters. Preselection FSTA, GBAD AGS, MEADS, Herkules. Customer contract Meteor, A400M, Skynet5 Tiger, NH90, Aster PAAMS. Delivery phase Eurofighter Storm Shadow, Scalp Support Aftersales Tornado, MICA, Super Puma Long-term negotiation for long-term contracts - Time between Bid Offer and Contract: A400M: ~5 yrs; Meteor: ~3 yrs - Contract period: A400M: ~20 yrs; Meteor: ~15 yrs EADS defence business generation: contracts in all stages from negotiation to after-sales. 6

4 Strict Rules for Booking Defence Orders Letter Of Intent (LOI) Memorandum of Understanding (MoU) Non-contracted Tranches of an Umbrella contract Preferred Bidder non-eligible to EADS order-book Firm order prerequisites contract signed: terms and conditions: - Requirements list - Schedule - Term of Payments - Milestones - Default. Conditions for entry into force met (down-payments in export contracts,.) Included in Order-book EADS Defence Order-book evolution in bn 22 bn Eurofighter Tranche1 NH90, Tiger Aster, Meteor, Taurus. 46 bn A400M 19.7 bn Paradigm/ Skynet 5 Aster Phase3 Eurofighter Austria, Expected 2004 ~50 bn Eurofighter Tranche2 Tiger Spain, YE 2002 YE 2003 YE 2004 E 7 Contract Structure : Multi-Procurement Processes or The Eurofighter example: Umbrella Contract with different Tranches Development Phase Development Phase Frame Contract Contract Supplement 1 Contract Supplement 2 Production Investment Phase Tranche 1 Basic Effort Series Production Phase Tranche 2 Tranche 3 Supplement a/c (44GE/20SP Tranche 1 Supplement a/c (68GE/33SP) Tranche 2 Suppl a/c (68 GE/34SP) Tranche 3 Integrated Logistic Support (ILS) In-Service Phase Plain colour = booked Dotted colour = not yet booked 8

5 . One Single Contract A400M example : The single Phase programme Programme Launch First Flight First Delivery * Including Civil JAA Certification & Military Qualification THE SINGLE PHASE PROGRAMME * 1st Engine Test Run Final Assembly Start DELIVERIES to European Air Forces and Export Customers The Nations agree to follow a Commercial Approach. This eliminates the multiple stages and decisions of usual military procurement processes. Industry responds : fixed-price proposal, guaranteed performances, and guaranteed delivery dates 9 Pricing Rules Advantages for the Industry Credit-worthy Customer Less-cyclical sector Long-term contracts, visibility Customer-financed R&D No or Limited working capital Early Termination costs recovered Environment Specificities Limited market access Limited competition Technology rights Confidentiality Political Market prices rarely applicable Prices derived from statutory margin Strict rules Determination of allowable costs Imputed Profit: profit formula calculated on estimated costs Reimbursement to industry of interest on capital employed Price auditing by the Customer agencies when no market prices available (most of the cases, except A400M, ) 10

6 Quoting the Price Most of the EADS contracts are Fixed/Firm price: - assessed BEFORE the contract signing - FIRM: for limited duration contracts, quoted in constant currency with no escalation - FIXED: for long-term contracts, escalated prices using an agreed formula; generally back to back with major suppliers Accurate and Robust controlling/accounting process - Cost Long-term planning - Remuneration for risk - Tools for risk management - Transparent and prudent accounting policies Secure and Improve the margin/cash at completion 11 Content 1. EADS Defence Business 2. Revenue Recognition 3. Margin Recognition and Risk Management 4. Adapting to a Changing Environment 12

7 Principles of Value Recognition Transparency: - External: customers; financial markets. - Internal: planning, risk assessment. Prudence: Contingencies; risk remuneration. IAS compliant - Long-Term contracts ( construction contracts ): revenues recognised by reference to the stage of completion - Stage of completion determined by milestones - Margin To Completion reflected in current earnings as identified - Reviews; provisions for estimated losses recorded when identified 13 Completion Milestones Development, Support phases - Customer acceptance/signature of milestone, or - Internal milestone acceptance : clear and unambiguous; eg. Independent Review from Designers to Project managers Production phase - Trade sales on delivery/transfer of ownership to customer (major components or final assembly) - Value = quantity x unit price A400M example: 206 Milestones in total Not yet any physical delivery, but already major milestones met Examples : Q3 2003: Acceptance of Quality Plan Q4 2003: Internal Design milestone Q1 2004: Launch of Engine development 14

8 Total A400M Expected Revenue Profile Single contract with Revenue recognition according to Milestones: One margin for the contract Requires a detailed and thorough controlling/risk evaluation process Allows value recognition from start, with conservative ramp up of margin M cec REVENUE 19.7 bn Cumulative Revenue FIRST DELIVERY Q END OF DEVELOPMENT PHASE 01/ / / / / / / / / / / / / / / / / / / / Profit Recognition in Case of Cross-BU Contract Consolidation rules of Airbus Military (A400M project) Accounting consolidation rules of AM (Airbus Military) subsidiary: - consolidated at Equity in Airbus S.A.S - 100% consolidated in EADS NV Segment reporting in EADS consolidated accounts: Airbus MTAD (AM+ EADS CASA) HQ/Conso EADS Order (may 2003) 14 bn 20 bn (14 bn) 20 bn Revenues (milestones) Profit (milestones) Cash (closing date) Work-share (~70%) Own Profit from Program Own cash from Program 100% AM AM Profit + EADS CASA AM cash + EADS CASA (Airbus share of revenues) 100% AM AM Profit + EADS CASA + Airbus Profit AM cash + EADS CASA + Airbus Cash 16

9 Content 1. EADS Defence Business 2. Revenue Recognition 3. Margin Recognition and Risk Management 4. Adapting to a Changing Environment 17 Robust Monitoring of Costs at Completion Costs at completion: - assessed and monitored in bid phase in contract performance phase financial project control from cradle to grave - complemented by integrated projects risk management Cost at completion: established bottom-up by project head who is accountable for it: - at bid phase when first commitment is made to customer ; - at contract award: confirm at minimum the margin and cash stated at bid phase. 18

10 Bid Phase: Bid Document Includes Commercial Section Executive Summary - Price, terms & conditions - Payment terms and delivery schedule - Sub-contracting proposal Contract Management Section: - Project plans, schedule, reporting structure, risk management - Detailed contract deliverables Technical Section Financial Section: - Margin at completion - Forecasted P & L impacts - Cash profile Formal financial review and approval: - from BU Finance Committee, - For large contract: from shareholder/eads (Committee headed by EADS CFO) Multi-skilled reviews of of each each Section «Red Red Teams» 19 Cost at Completion At contract award, a baseline Costs at completion and Profitability Statement are established, using - Contract WBS (Work Breakdown Structure) for internal costs: labour costs other costs (including Travel, ) - Major Equipment Procured items (MEP) - Risk contingency Assessment of the cash profile Thereafter, Formal review Bottom-Up Cost At Completion twice a year 20

11 Cost at Completion Summary (MBDA Example) SELLING PRICE % Sales Traded Reference C@C Previous C@C Current C@C Movements at bid June De. 31, 2003 Current vs. Costs charged to contract C@C Previous COSTS Development - Internal cost - - External cost - Production - Internal cost - - External cost - Project Management - Other - TOTAL WORKS COSTS OTHER CHARGES/PROVISIONS e.g. Finance charges - Liquidated Damages - - etc. - RISK/CONTINGENCY GRAND TOTAL MARGIN MARGIN % 18,0% 18,0% 20,0% 2,0% - 21 Risk Management Related to Projects Risk assessment/management = key element of the Cost at Completion assessment/ review Risks (opportunities) against what baseline? - steer business considering financial statements/planning baseline. - accountability: the same for baseline and for risks and opportunities (i.e. project head). - some actions could have trade off effects Risk assessment riskcontingencies = element to the Cost at Completion Goal: develop actions in order to - mitigate risks Improve margins - make up opportunities 22

12 Profit Recognition Related to Projects Single predicted margin per contract (even in multi-phase) Traded margin% based on Cost At Completion/Risk assessment, taking also into account prudence to acknowledge critical milestones. Profit at milestone = Traded Margin % applied to total Sales up to date Margin Percentage Traded 20 Example: MBDA Completion of Interim CofD First Firing Trial Successful Completion of Subsystem Interface Trial Acceptance of CofD by Customer Installation of System Final Firing Trial Successful C@C Predicted Margin (%) Margin Traded (%) T0+ Milestone Dates 23 Risk Assessment/ Cost at Completion Reporting Reported on quarterly basis to BU top management and Shareholder/EADS levels in order to focus attention, show actions progress and fi nancial impact Example: MBDA risk mapping 24

13 Content 1. EADS Defence Business 2. Revenue Recognition 3. Margin Recognition and Risk Management 4. Adapting to a Changing Environment 25 New Challenges from Changing Environment Budget constraints: - No customer financed R&D but Self-finance future technologies (around 160 m per year) - Emergence of new financing schemes: PFI, PPI - Harmonisation of procurement needs: managing multicustomer contracts Customer needs evolution: - A new business model (services, ): PFI, PPI, pricing over lifetime exceeding 20 years, - Integrated system: prime contractor ship organisation, crossorganisations,... Globalisation of the industry, of the market: increased competition => towards a more commercial approach? (A400M, Tanker, ) 26

14 Generating Value from EADS Defence Business Strong organic growth, supported by order-book Systematic and robust risk management Prudent policy to report revenue and margin Expertise in planning/monitoring costs On-going productivity improvements Growing added value contribution from EADS Defence contracts 27 28

15 Appendix Third Annual Global Investor Forum Toledo, Spain June 21st & 22nd, Program Consolidation Rules (1/2) Consolidated entity: e.g. A400M program AM 100% consolidated by EADS; Airbus A400M share eliminated at EADS group level 69% 21% 4.5% 5.5% Order OCCAR Customer Industrial contracts Airbus EADS Flabel TAI Propulsion Prime Contractor Responsible for Development and Production 100% consolidated by EADS in MTA division 30

16 Program Consolidation Rules (2/2) Non-consolidated entity: e.g. Eurofighter: Eurofighter GmbH consortium = non-consolidated entity Revenue recognition at the level of each partner according to its own milestones; Order NETMA Customer Eurofighter GmbH Sub-contracts Not-consolidated by partners Staff & Administration costs covered by NETMA Each partner recognises its own revenues based on its own milestones 31 Variation of Price (VoP) Example of formula contained in a missiles contract P = 0.9 x UP x (C - Co) Co P = Adjustment to Unit Price UP = Unit Price of each item C = output price index for period in question Co = output price index at contract effectivity Co = MM19 - Manufacture of Weapons and Ammunitions index 32

17 Eurofighter Organisational Structure Germany Italy Spain United Kingdom Contractor Customer Alenia BAES EADS CASA Board of Directors EADS Deutschland Eurofighter Jagdflugzeug GmbH Steering Committee Board of Directors NETMA (NATO EF2000 and Tornado Development, Production and Logistic Management Agency) contract Firm order ICD ACA Avio ITP MTU Board of Directors Eurojet Turbo GmbH Legend: ICD: Interface Control Document ACA: Associate Contractors Agreement RR Alenia BAES EADS CASA EADS Deutschland Avio ITP MTU RR Supplier 33 A400M Programme Organisation DEFENCE MINISTRIES GERMANY FRANCE UK SPAIN TURKEY BELGIUM / LUX GOVERNMENT OCCAR* INDUSTRY EXPORT CUSTOMERS Airbus S.A.S.** EADS CASA TAI FLABEL PARTNER COMPANIES * Organisation Conjointede Coopération en Matièred Armement ** Airbus S.A.S. represents Airbus Deutschland, Airbus U.K., Airbus Españaand Airbus France 34