Qinetiq Regulatory News (QQ.)

Interim Results

16 November 2023

Delivering long-term sustainable growth

Results for six months to 30 September 2023 ('H1 FY24')

Strong and consistent operational performance globally

A differentiated company responding to national and global security needs

Full year performance in-line with market expectations, longer-term guidance unchanged

Steve Wadey, Group Chief Executive Officer of QinetiQ said:

"I'm delighted with our strong first half results that have been achieved as a result of consistent operational performance from across the Group and the continued dedication of our people to deliver high value services and products critical to national defence and security. We have delivered excellent organic growth and improved our margin performance. We have also won significant new business and major contract renewals, with a major highlight being the outstanding orders performance of Avantus with $657m of contract awards since the start of the financial year.

"We enter the second half of the year with confidence and positive momentum. Our relevance in the market is evidenced by the increasing demand for our distinctive offerings and growing order pipeline. We remain focused on supporting our customers' mission and increasing returns for shareholders."

Interim results presentation:

We will be hosting an in-person results presentation at 09:30 GMT at the London Stock Exchange, 10 Paternoster Square, London, EC4M 7LS. Registration to join in-person or via the live webcast is available here:

https://www.qinetiq.com/en/investors/results-reports-and-presentations/fy24-interim-results

About QinetiQ:

QinetiQ is an integrated global defence and security company focused on mission-led innovation. QinetiQ employs circa 8,500 highly-skilled people, committed to creating new ways of protecting what matters most; testing technologies, systems, and processes to make sure they meet operational needs; and enabling customers to deploy new and enhanced capabilities with the assurance they will deliver the performance required.

For further information please contact:

Basis of preparation:

Throughout this Interim Report, certain measures are used to describe the Group's financial performance which are not recognised under UK-adopted International Accounting Standards. The Group's Directors and management assess financial performance based on underlying measures of performance, which are adjusted to exclude certain 'specific adjusting items'. In the judgement of the Directors, the use of adjusted performance measures (APMs) such as underlying operating profit and underlying earnings per share are more representative of ongoing trading, facilitate meaningful year-to-year comparison and, therefore, allow the reader to obtain a fuller understanding of the financial information. The adjusted measures used by QinetiQ may differ from adjusted measures used by other companies. Details of QinetiQ's APMs are set out in the glossary to this document.

Year references (FY24, FY23, 2024, 2023) refer to the year ended 31 March. H1 FY24 and H1 FY23 refer to the six months ended 30 September.

Disclaimer

This document contains certain forward-looking statements relating to the business, strategy, financial performance and results of the Company and/or the industry in which it operates. Actual results, levels of activity, performance, achievements and events are most likely to vary materially from those implied by the forward-looking statements. The forward-looking statements concern future circumstances and results and other statements that are not historical facts, sometimes identified by the words 'believes',' expects', 'predicts', 'intends', 'projects', 'plans', 'estimates', 'aims', 'foresees', 'anticipates', 'targets', 'goals', 'due', 'could', 'may', 'should', 'potential', 'likely' and similar expressions, although these words are not the exclusive means of doing so. These forward-looking statements include, without limitation, statements regarding the Company's future financial position, income growth, impairment charges, business strategy, projected levels of growth in the relevant markets, projected costs, estimates of capital expenditures, and plans and objectives for future operations. Forward-looking statements contained in this announcement regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. Nothing in this document should be regarded as a profit forecast.

The forward-looking statements, including assumptions, opinions and views of the Company or cited from third party sources, contained in this announcement are solely opinions and forecasts which are uncertain and subject to risks. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to be correct. Actual results may differ materially from those expressed or implied by these forward-looking statements. A number of factors could cause actual events to differ significantly and these are set out in the principal risks and uncertainties section of this document. Most of these factors are difficult to predict accurately and are generally beyond the control of the Company. Any forward-looking statements made by, or on behalf of, the Company speak only as of the date they are made. Save as required by law, the Company will not publicly release the results of any revisions to any forward-looking statements in this document that may occur due to any change in the Directors' expectations or to reflect events or circumstances after the date of this document.

Chief Executive Officer's Review

We delivered strong and consistent operational performance globally through the first half of the year. We secured a record first half order intake of £953m, with a book-to-bill ratio of 1.3x, demonstrating the continued high demand for our distinctive offerings. We achieved 31% revenue growth, 19% on an organic constant currency basis, with underlying operating profit margin at 11.3%, an improvement on first half performance last year. Whilst cash conversion in the first half was 50%, lower than the prior year due to short-term timing effects, full year cash conversion will be in-line with our previous guidance.

EMEA Services continues to perform particularly well, maintaining the momentum and strong performance from FY23. EMEA Services delivered 23% organic revenue growth compared to the prior year first half, consistent revenue compared to the prior year second half, and margin improved to 11.8%. Global Solutions has benefitted from the first half performance of Avantus, that we acquired in late-November 2022, and on an organic basis is broadly flat compared to the first half of last year.

Avantus has won $657m of new contract awards since the start of the financial year - this positions us well to drive future revenue growth. First half revenue was slower than expected, due to the US continuing resolution and competitor protests, but with the significant step-up in contract awards we have confidence in delivering good growth in the second half of the year. We remain confident in delivering double digit revenue growth at stable margin in the future.

We are deeply saddened to report that one of the PC-9 aircraft that we operate crashed in September 2023 in the Neuenstein area of Germany whilst on a customer training exercise and the two aircrew on-board did not survive the crash. We are continuing to support the families of our two colleagues that were on-board and the team in Germany. The safety of our employees remains our highest priority and we are working closely with all relevant authorities to support the external investigations into this tragic incident.

Strategic achievements

We have continued to make good progress implementing our strategy. Our major strategic achievements delivered in the first half include:

The growing market opportunity

The geopolitical climate is increasingly uncertain as the global security situation continues to deteriorate. The Hamas attack on Israel has elevated tensions and increased the threat of a broader regional conflict in the Middle East. In Europe, Russia's invasion of Ukraine is reshaping their relationship with the West, and the threat from China remains uncertain. These dynamics are driving defence and security policies, increasing prioritisation of budgets and modernisation of capabilities. Our major focus is on supporting our three home countries which have a shared defence and security mission under the trilateral partnership known as AUKUS.

The US has requested the largest ever Research & Development and Test & Evaluation budget at $145bn, a 40% increase since 2020. The UK refreshed its Integrated Review earlier in the year and is investing £6.6bn in R&D and experimentation over four years. The Australian government has completed its Defence Strategic Review and is increasing defence spending by 7% to $53bn. 

All three countries are committed to working together on a range of advanced capabilities and technologies, critical to future warfare, such as advanced cyber and directed energy, as well as the new nuclear submarine programme. These areas align well with our strengths and provide attractive opportunities over the long-term.

A differentiated company responding to national and global security needs

Within this geopolitical context, we are a differentiated company that helps our customers respond to their national and global security needs. Our unique value proposition is to rapidly develop and experiment with new capabilities, test those capabilities are safe and perform as intended against the threat, and ensure our warfighters are trained and operationally ready. With us, our customers can accelerate through this critical cycle and be prepared and ready to counter the increasing threat.

We are a purpose-driven company and our purpose has never been more relevant: protecting lives and serving the national security interests of our customers. Our purpose drives our strategy, which has three inter-related components:

In order to counter the increasing threat, our customers are prioritising their budgets on rapid defence modernisation. Our value proposition is structurally aligned to their high-priority and high-growth segments, such as RDT&E (Research, Development, Test and Evaluation) and C5ISR (Command, Control, Communications, Computers, Cyber, Intelligence, Surveillance and Reconnaissance), Cyber and Electronic Warfare and Autonomy and AI. Our alignment to higher growth segments is why our growth is outpacing headline defence spending: QinetiQ has delivered organic revenue at double the growth rate of national defence budgets over the last five years.

Building our global platform to deliver sustainable growth

At our full year results in May 2023 and re-confirmed at our Investor Seminar in New York a few weeks ago, we have a robust plan to deliver organic growth to c.£2.4bn revenue by FY27. With our highly cash generative business model this plan provides optionality to deploy our capital to further accelerate our growth and shareholder returns. Through strategy-led bolt-on acquisitions, we see an opportunity to build a business of circa £3bn revenue by FY27.

Our organic growth plan is underpinned by a disciplined approach to bid and programme delivery performance, to ensure consistent operational performance through both winning and contract delivery. We continue to invest in our people, technologies and capabilities to ensure we retain and recruit the best talent to deliver for our customers and enhance our offerings and capabilities through organic investments. We are seeing success in leveraging our distinctive offerings across our global business to drive synergies; recent examples include establishing a US final assembly and test capability for Banshee Jet 80 aerial targets to support future US customer demand, SPUR robot sales into Australia from the US, bringing advanced sensing and robotics to our Avantus Intelligence customers, and selling our threat representation and targets capabilities globally.

Our priority is to deliver on our organic growth ambitions. Alongside this we continue to actively manage our portfolio, as evidenced by the nine acquisitions and four disposals that we have completed over the last eight years. We have an active pipeline of acquisition opportunities and remain disciplined in the evaluation of opportunities, considering their strategic fit, financial returns and the right approach to integration. We are prioritising bolt-on acquisitions in the US and Australia, with our plan for leverage to remain under 1.5x (net debt to EBITDA). We have a clear and active capital allocation policy which alongside our strategy, governs our long-term investment choices. We consider capital allocation proactively, evaluating organic and inorganic investments and shareholder returns on their short and long-term benefits, seeking to maximise long-term shareholder return.

Outlook: FY24 in-line with market expectations

We enter the second half of FY24 with confidence, a healthy order-book and positive momentum with 92% revenue under contract. We confirm that our full year performance will be in-line with market expectations1. We expect to deliver high single-digit organic revenue growth and high teens total revenue growth at a stable operating profit margin. Capital expenditure is expected to remain within the £90m to £120m range.

(1) - Analyst expectations (average) for FY24 as at 14/11/23: Revenue £1,868m, Op profit £209m

Outlook: Longer-term guidance unchanged

We are targeting high single-digit organic revenue growth, to deliver c.£2.4bn organic revenue at c.12% margin by FY27. With our highly cash generative business model, this provides optionality to deploy our capital to compound our growth and shareholder returns - through bolt-on acquisitions we see an opportunity to build a company of circa £3bn revenue at 11-12% margin by FY27. This delivers attractive return on capital employed at the upper end of the 15-20% range.

Trading environment

Global context

We are operating in an environment where there is an increasing threat of wider global conflict. This follows Russia's full-scale invasion of Ukraine; the threat posed by China's growing military power coupled with its push to change global norms and potentially threaten its neighbours; the rise of extremism in Africa; and ongoing tensions and conflict in the Middle East.

In parallel, rapidly emerging and evolving technologies, such as Generative AI, continue to disrupt traditional business and society with both positive and negative outcomes as well as creating unprecedented vulnerabilities.

Strategic response

To meet these increasing challenges, the UK, US and Australia have reviewed their strategic defence and security capabilities and investment priorities as well as their allied activities.

UK

The 2023 Integrated Review Refresh (IRR). As announced in 2021, the UK MOD is also investing over £6.6bn in research and development to develop next-generation and emerging technologies in areas such as cyber, space, directed-energy weapons, and advanced high-speed missiles.

As the UK seeks to develop and deploy next-generation capabilities faster than adversaries, we are well positioned to support them in applying mission-led innovation to achieve this. Our unrivalled expertise in Research & Development and Test & Evaluation combined with our investment to modernise UK test ranges help our customers generate and assure new and emerging technologies at pace. Delivering value for money remains critical to our customers and we will continue to utilise innovative delivery models to support our customers in achieving this.

US

The 2022 National Defense Strategy and National Security Strategy recognised an intensifying competitive landscape and the urgent need to sustain and strengthen deterrence. The 2024 Department of Defense Budget Request builds on the principles of National Security Strategy and has grown by nearly $100bn (13%) to $842bn since 2022. As part of this, the FY24 Research Development Test and Evaluation budget request is the largest ever at $145bn. This represents an increase of $26bn (22%) since FY22.

Investment in critical technology areas aimed at strengthening technological advantage include: directed energy, hypersonics and integrated sensing and cyber.

In the US, we are a market leader in robotics, autonomy and advanced sensing solutions, an area of budget growth, delivering value to our customers through the rapid development and deployment of disruptive solutions. With the acquisition of Avantus we are also a leading cyber, data analytics and software development provider. There is a growing need to provide actionable intelligence into war-fighters' hands quicker, and a push to develop and integrate multiple autonomous and semi-autonomous systems as the US seeks to invest in next-generation technologies to maintain technological advantage.

Australia

The 2023 Defence Strategic Review addresses the prospect of major conflict in the Indo-Pacific that directly threatens Australia's national interest. It frames the priority of investment in Defence capability and posture to meet Australia's security challenges through to 2032-33. In the 2023 Budget, Defence spending will increase by 7% to AUD$52.6bn in 2023-24.

The Australian government reinforced its commitment to delivering on the recommendations of the Defence Strategic Review, with plans to commence the work to deliver Australia's nuclear-powered submarine program. Defence spending as a proportion of GDP will lift above its current trajectory to be 0.2% higher by 2032-33.

We continue to support the Australian forces in modernising sovereign defence capabilities, leveraging expertise across the global business.

The significance of the AUKUS Alliance

In September 2021, leaders of Australia, the United Kingdom, and the United States announced the creation of AUKUS, the enhanced trilateral security partnership. AUKUS is intended to strengthen the ability of each government to support security and defence interests, building on longstanding and ongoing bilateral ties. It will promote deeper information sharing and technology sharing; and foster deeper integration of security and defence-related science, technology, industrial bases and supply chains.

The first initiative under AUKUS is a commitment to support Australia in acquiring nuclear-powered submarines for the Royal Australian Navy. The second initiative centres on enhancing joint capabilities and interoperability, focusing on cyber and electronic warfare capabilities, artificial intelligence, quantum technologies, additional undersea capabilities, as well as hypersonic and counter-hypersonic capabilities.

With these collaboration activities involving technology development, trials and experimentation, we anticipate increasing demand for support across each of our three 'home' nations.

Broader international markets

The strategic landscape has undergone a seismic shift following Russia's invasion of Ukraine in February 2022. This has provoked NATO to increase its defence capabilities and readiness to respond, adding to the pressure for the NATO member countries to increase their defence spending of at least 2% of GDP. Following the announcement of Germany to increase defence spending by ?100bn over the next five years, many other NATO and European countries are also increasing their defence and security investment.

While our priority and investment focus is aligned to our three home country strategies (UK, US and Australia), we will continue to conduct business in the support of allies in 5-Eyes, NATO and Continental Europe.

Chief Financial Officer's Review

Operating performance

We delivered excellent order performance in the period with orders of £952.7m (H1 FY23: £798.8m), up 19% on a reported basis. Organically and on a consistent currency basis, orders grew 2% year on year against a strong prior year comparator. Orders won include £190m Engineering Delivery Partner (EDP) orders, a $84m full production contract for NGABS ($34m recognised in H1 FY24), a continuation of the threat representation training contract that underpins our German business and a £39m renewal of the battlefield communication programme (BATCIS) in the UK. Avantus has had impressive contract awards of $657m since the start of the financial year. Due to the multi-year phasing and funding approach to contract awards in the US, we have only recognised $195m in first half orders, in-line with our prudent order recognition policy.

Revenue visibility remains good and the Group's total funded order backlog at 30 September 2023 stood at £3.1bn, a modest increase on the same period last year. As we deliver revenue on our large long-term contracts (with orders booked in prior years, most significantly with the Long Term Partnering Agreement) backlog will naturally reduce, it is therefore pleasing to see backlog continuing to grow year-on-year due to the strong orders growth across the Group. At the start of H2 FY24, the Group had approximately £840m of H2 FY24 revenue under contract. This compares with approximately £700m of H2 FY23 revenue at the same time last year.

Revenue was £883.1m (H1 FY23: 673.4m), up 31% on a reported basis. Organically and on a consistent currency basis, revenue grew 19% compared to the same period last year. Organic growth was driven by strong performance in EMEA Services delivering revenue from the excellent order in-take in the prior year, particularly in the UK, which saw continued growth in EDP, short-term operational priorities and inflation. Global Solutions revenue was flat organically with total growth driven by the addition of Avantus. 

Operating profit from segments was £100.1m (H1 FY23: £74.1m), up 35% on a reported basis. Organically and on a consistent currency basis, underlying operating profit grew by 25% compared to the same period last year. The significant improvement in profit is largely driven from EMEA Services revenue growth and improving margin in both segments. Our acquisitions achieved margins in-line with expectations with Avantus maintaining double digit operating profit margin.

Operating profit margin from segments was 11.3%, an improvement from H1 FY23 (11.0%) and consistent with our FY23 performance. The modest increase from H1 FY23 is due to margin improvement across both segments; most significantly Global Solutions profit margin increased up to 10% due to good margin stability in the US and higher margin product deliveries (global threat representation and niche intelligence products).

Operating profit from segments excludes income from Research and Development Expenditure Credits (RDEC). RDEC income increased from £7.5m in H1 FY23 to £11.9m in H1 FY24 due to the UK RDEC rate increase from 13% to 20%. Seasonality / cyclicality has not had a material impact on the interim income statement performance of the Group.

Specific adjusting items

The total impact of specific adjusting items on operating profit (which are excluded from underlying performance) before tax was an expense of £20.7m (H1 FY23 restated: income of £45.6m). H1 FY23 included a £42.9m gain from the foreign exchange derivative contract which was taken out to hedge the foreign exchange exposure on the $590m Avantus acquisition and was executed in accordance with the Group's Treasury Policy - this was a one-off timing gain at H1 FY23 which unwound in H2 FY23 by the time of the transaction completion. H1 FY23 restated also includes a £19.6m gain from the release of the liability for MOD appropriation of RDEC.

Acquisition and disposal costs of £0.6m (H1 FY23: £6.4m) comprise costs associated with various ongoing projects and acquisitions that we have decided not to pursue, demonstrating our disciplined capital allocation policy. The H1 FY23 amount related to Avantus and Air Affairs. Acquisition related remuneration of £1.1m relates to specific post-acquisition retention arrangements for Avantus employees which were anticipated at the time of the transaction. Acquisition integration costs of £2.6m relate to the one-off costs of integrating both Avantus and Air Affairs with the existing Group operations.

Our digital investment programme continues to deliver improvements to the infrastructure, digital tools and operating systems of the company - roughly two thirds of the costs in the first half are reported as specific adjusting items in the P&L given their one-off nature, with ongoing recurring operating costs (such as licence costs and overheads) remaining within underlying operating costs. In H1 FY24 the exceptional cost element of the digital investment programme within specific adjusting items totals £5.1m (H1 FY23: £2.5m).

Also included within specific adjusting items were a gain on the sale of property in the UK of £2.1m (H1 FY23 £0.9m) and impairment of right of use lease assets in the US following space relocation of £0.7m. Amortisation of acquisition intangibles of £12.7m (H1 FY23: £5.6m) has increased due to the inclusion of amortisation of the intangible assets relating to the Avantus acquisition.

Net finance costs

Underlying finance income on the group's cash reserves increased from £1.4m to £8.9m due to the increase in interest rates. Underlying finance expense increased from £1.9m to £16.6m due to the interest payable on the debt financing which was taken out at the time of the Avantus acquisition. The underlying net finance expense, which excludes the pension net finance income, was £7.7m (H1 FY23: £0.5m).

The pension net finance income, which is a specific adjusting item of £2.2m (H1 FY23: £4.9m) reduced due to a lower opening net pension surplus. Net finance expense was £5.5m (H1 FY23: net finance income of £4.4m).

Tax

The total tax charge is £22.1m (H1 FY23 restated charge: £21.4m). The underlying tax charge of £27.0m (H1 FY23 restated: £15.7m) is calculated by applying the expected underlying effective tax rate at a geographic level for the year ending 31 March 2024 to the underlying profit before tax for the six months to 30 September 2023.

The Group's full year expected underlying effective tax rate is 26.1% which is higher than the half year underlying effective tax rate of 25.9% (H1 FY23 restated: 19.4%) due to the geographic mix of profits in H1 FY24.

The underlying effective tax rate has risen due to the increase in the UK statutory rate effective from 19% to 25% from 1st April 2023. In future we expect the effective rate to be above the UK statutory rate subject to the geographic mix of profits and the recognition of deferred tax in respect of overseas tax losses and excess interest deductions.

On 20 June 2023, Finance (No.2) Act 2023 was substantively enacted in the UK, introducing a global minimum effective tax rate of 15%. The legislation implements a domestic top-up tax and a multinational top-up tax, effective for accounting periods starting on or after 31 December 2023. The Group has applied the exception under the amendment to IAS 12 to recognising and disclosing information about deferred tax assets and liabilities related to top-up income taxes.

Research and Development Expenditure Credits (RDEC) are now recognised within other operating income following the change in accounting policy in FY23. Amounts receivable in respect of RDEC are recognised as 'other receivables' within 'trade and other receivables'. Amounts receivable are offset against outstanding UK corporation tax liabilities at the year-end only to the extent that the balances can be and are intended to be settled on a net basis.

At the FY23 balance sheet date the FY23 RDEC of £15.4m was outstanding and was expected to be received as a step 1 offset against the UK corporation tax liability. Part of the FY23 corporation tax liability was already paid as Quarterly Instalment Payments during FY23 with a residual corporation tax liability of £3.8m outstanding at the year end. This residual liability was paid to HMRC in April 2023.

Tax on specific adjusting items includes a £3.4m credit for tax on the amortisation of acquisition intangibles and a £1.5m credit in respect of other pre-tax specific adjusting items, the total specific adjusting items tax credit was £4.9m (H1 FY23 restated: charge of £5.7m).

Return on Capital Employed (ROCE)

Due to our focus on returns, we have included Return on Capital Employed in our interim results for the first time, using the calculation of: Underlying operating profit less amortisation for the previous 12 months / (average capital employed less net pension asset), where average capital employed is defined as shareholders' equity plus net debt (or minus net cash).

For H1 FY24 Group ROCE was 25.5% (H1 FY23: 28.8%), modestly lower due to the increased capital employed with the acquisitions completed in H2 FY23. As we continue to invest in our business to support sustainable long-term growth, our ROCE is forecast to remain attractive at the upper end of the 15-20% range.

Earnings per share

Underlying basic earnings per share for the Group was 13.4p up 18% on the prior year first half (H1 FY23: 11.4p), with the increase primarily due to the increase in profits. Statutory basic earnings per share (including specific adjusting items) were 11.0p (H1 FY23 restated: 19.2p) with the prior half year comparative period enhanced by the £42.9m foreign exchange gain on the derivatives taken out to hedge the exposure on the Avantus acquisition and the £19.6m release of the liability in respect of UK MOD appropriation of RDEC.

Dividend

An interim dividend of 2.6p (H1 FY23: 2.4p) will be paid on 2 February 2024 to shareholders on the register on 4 January 2024. The interim dividend represents one third of the prior year total dividend reflecting our previously communicated methodology. The full year dividend will be announced with our full year preliminary results in May 2024.

Cash performance

Underlying net cash flows from operations was £71.7m (H1 FY23: £106.8m), resulting in cash conversion before capital expenditure of 50% (H1 FY23 restated: 98%). H1 FY24 operating cash flow was impacted by the timing of customer billing milestones (which impacts deferred income) and receipts. There are also some normal cash flow differences between the first and the second half which impacted our H1 FY24 cash conversion, such as the timing of receiving RDEC income (the prior year income is received in cash in H2).

Changes in net working capital of £74.2m in H1 FY24 included a £71.5m reduction in trade and other payables. This comprises timing related movements within deferred income, trade payables and accrued expenses. These timing impacts are already reversing and we are on-track to deliver full year underlying operating cash conversion of at least 90%, in-line with our previous guidance.

Capex for the period was £46.9m (H1 FY23: £48.5m). We continue to invest in core contracts including the LTPA following the contract amendment announced in April 2019. Full year total capex is expected to be in-line with previous guidance of £90-120m.

At 30 September 2023 the Group had £273.8m net debt, compared to £206.9m at 31 March 2023. The increase is due to neutral free cash flow, the dividend payment and £26.4m of new lease obligations. The reported H2 FY23 and H1 FY24 EBITDA and 30 September 2023 net debt position result in a leverage ratio of 0.9x (31 March 2023: 0.8x), below our maximum leverage guidance of 1.5x introduced at our recent Investor Seminar.

The net debt balance as at 30 September 2023 includes £12.3m of net financial derivative assets, predominantly the interest rate swaps which have been taken out to hedge future interest rate exposure on the term loan, £2.7m of capitalised bank fees and £54.3m of lease liabilities. Lease liabilities increased from £31.3m as at 31 March 2023 due to new property arrangements entered into on a long term basis in both the UK and US.

We maintain a rigorous approach to the deployment of our capital, scrutinising organic and inorganic opportunities to ensure returns to our shareholders are appropriate. At our recent Investor Seminar we provided modest refinements to our capital allocation policy as follows:

Committed facilities

The acquisition of Avantus last year was financed using a combination of cash and debt from a multicurrency floating rate Term Loan placed with our relationship banks, acquisition financing totalled £340m. The Loan is split into two Tranches: GBP Term Loan £273m (Tranche A); and, USD Term Loan £67m (Tranche B), and has a 3-year term with two 1-year extension options. Participating banks have lent on a 2-tier basis, 3-banks at £67m and 4-banks at £35m. In-line with Group policy, £270m (c.80%) of the floating rate debt has been fixed using SONIA interest rate swaps split over a 3-year and 5-year tenure at a weighted average rate of 3.29%. Including all fees and charges, the weighted average cost of debt is 5.21%.

The Group has a £275m bank revolving credit facility with an additional 'accordion' facility to increase the limit up to £400m. The facility which will mature on 27 September 2025 was undrawn at 30 September 2023 and provides the Group with significant scope to execute its strategic growth plans.

We adopt a strict policy on managing counterparty risk through a combination of diversification of investments and regular reviews of counterparty limits using credit rating assessments. We are proud that our debt sits with our key relationship banks who have strong credit ratings and diverse portfolios demonstrating their resilience to the bank turmoil. The banks have been selected for their capabilities in our home countries to support our business. 

Foreign exchange

The Group's income and expenditure is largely settled in the functional currency of the relevant Group entity, mainly Sterling, US Dollar or Australian Dollar. The Group has a policy to hedge all material transaction exposure at the point of commitment to the underlying transaction. Uncommitted future transactions are not routinely hedged. The Group does not hedge its exposure to translation of the income statement. The principal exchange rates affecting the Group were the Sterling to US Dollar and Sterling to Australian Dollar exchange rates.

Foreign exchange translation has provided a modest headwind to revenue and operating profit in the first half. Most significantly, the US Dollar has weakened against the Sterling with the average exchange rate increasing from 1.21 to 1.25. Our guidance assumes FX rates as at the closing rate above (£/US$ 1.22, £/A$ 1.89).

In H1 FY24, 22% of our total Group revenue was generated in the US. As a result of the weakening of the US Dollar and other FX movements in the half, revenue decreased by £6.5m and operating profit decreased by £1.2m. Looking ahead we expect US revenues to represent 25-30% of Group revenues, so for every 1% move in the FX rate this would impact Group revenue by c.£5m and Group profit by c.£0.5m.

Pensions

The net pension asset under IAS 19, before adjusting for deferred tax, was £95.0m (31 March 2023: £119.8m). The key driver for the decrease in the net pension asset since the March 2023 year end was a reduction in asset values, driven by the Liability Driven investments (LDI), in excess of the reduction in Scheme liabilities (which have also fallen substantially, due to an increase in the discount rates). The triennial valuation as at 30 June 2023 is ongoing and is not expected to result in a requirement for the Group to make a contribution into the scheme.

The key assumptions used in the IAS 19 valuation of the scheme are set out in note 13.

Operating review

EMEA Services

Overview

EMEA (Europe, Middle East and Australasia) Services combines world-leading expertise with unique facilities to provide capability generation and assurance, underpinned by long-term contracts that provide good visibility of revenue and cash flows.

Financial performance

Orders were up 5% to £631.1 (H1 FY23: £600.8m), driven by £190m orders in EDP, a £39m renewal to the battlefield communication contract (BATCIS) in the UK Intelligence sector, a continuation of the threat representation training contract that underpins our German business and a £54m uplift to the LTPA contract to reflect inflationary effects in the UK.

Revenue increased 23% on an organic basis driven by revenue delivery on the excellent orders won in the prior year, particularly with good continued growth in EDP and strong execution across our contracts, as well as growth in the LTPA due to contractually covered cost inflation, and short-term operational priorities.

Underlying operating profit increased by 26% to £77.4m (H1 FY23: £61.5m). This has been achieved through the strong revenue growth mentioned above and modest margin improvement to 11.8% (H1 FY23: 11.7%), demonstrating consistent operational performance.

Including the LTPA, approximately 67% of EMEA Services revenue is derived from single source contracts (H1 FY23: approximately 65%) demonstrating our critical and unique capabilities for our customers.

Sector commentary

UK Defence (61% of EMEA Services revenue)

The UK Defence sector delivers mission critical solutions, innovating for our Air, Maritime and Land customers' advantage. The sector provides a focus on our strategy of maximising growth through our framework contracts, building new core offerings through our global campaigns and exploring new growth opportunities; it improves coherence of our distinctive offerings across our customer base, with the embedding of enabling functions bringing greater cohesion to operational strategy execution for business performance excellence.

UK Intelligence (29% of EMEA Services revenue)

The UK Intelligence sector helps government and commercial customers respond to fast-evolving threats based on its expertise in training, secure communication networks and devices, intelligence gathering and surveillance sensors, and cyber security. Contained within UK Intelligence are three acquired businesses: QinetiQ Training and Simulation Limited (QTSL, formerly NSC), Inzpire and Naimuri.

Australia (10% of EMEA Services revenue)

Our Australia sector is a specialist advisory, engineering and threat representation products and services business in the Australian, German and Canadian markets. It has both an Australian country-focus in advisory and engineering services, as well as a focus on exploitation of our threat representation capabilities globally.

Global Solutions

* Definitions of the Group's 'Alternative Performance Measures' can be found in the glossary

Global Solutions combines our world-leading technology-based products and services. Our strategy is to expand the portfolio of solutions to win larger, longer-term programmes providing good visibility of revenue and cash flows.

Financial performance

Orders increased by 62% to £321.6m (H1 FY23: £198.0m). Organically and on a consistent currency basis, orders were broadly flat, following a strong prior year performance in the US. Avantus has had impressive contract awards of $657m since the start of the financial year. Due to the multi-year phasing and funding approach to contract awards in the US, we have only recognised $195m in first half orders, in-line with our prudent order recognition policy.

Revenue was up 53% to £228.3m (H1 FY23: £149.1m). Organically and on a consistent currency basis, revenue was broadly flat with the same period last year, with the Avantus contribution driving the total reported growth.

Underlying operating profit increased to £22.7m (H1 FY23: £12.6m), with an underlying operating profit margin of 9.9% (H1 FY23: 8.5%). The significant improvement in profit is as a result of good margin stability in the US and higher margin products with QTS and niche intelligence products.

Sector commentary

United States (84% of Global Solutions revenue)

Our US sector provides technical advice, design and manufacture of innovative defence products specialising in robotics, autonomy and sensing solutions, and with the acquisition of Avantus is an expert in cyber, data analytics and software development. We have invested to support the long-term growth of our US sector, in leadership, integration, systems and tools; the business is now a fully integrated single US sector.

Other Products and Solutions (16% of Global Solutions revenue)

The portfolio of our other products and solutions provide research services and bespoke technological solutions developed from intellectual property spun out from EMEA Services, and includes our threat representation product sales in QinetiQ Target Systems (QTS).

Principal risks and uncertainties

There are a number of risks and uncertainties which management continue to identify, assess and mitigate to minimise their potential impact on performance. An explanation of risks and their mitigations, together with details of our risk management framework can be found in the 2023 Annual Report and Accounts (on pages 75 to 83) which is available for download at: https://www.qinetiq.com/investors.

Having considered recent geopolitical and macroeconomic events, the Group believes the principal risks and uncertainties for the remainder of FY24 are included in, and are therefore unchanged from, those reported in the 2023 Annual Report and Accounts. The Group's principal risks and uncertainties at 31 March 2023 related to the following areas: UK large contract renewals, acquisition integration, the digital and data programme, significant breaches of laws and regulations, security, P3M (project, programme and portfolio management), climate change resilience and net-zero, cyber, health and safety, strategic workforce planning, culture and macroeconomic volatility.

Condensed consolidated income statement

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

* Alternative performance measures are used to supplement the statutory figures. These are additional financial indicators used by management internally to assess the underlying performance of the Group. Definitions can be found in the glossary.

Condensed consolidated statement of comprehensive income

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Condensed consolidated statement of changes in equity

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Condensed consolidated balance sheet

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Condensed consolidated cash flow statement

Reconciliation of movement in net (debt)/cash

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Notes to the condensed interim financial statements

Revenue by category and reconciliation to revenue on an organic, constant currency basis

Other income

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Revenue by customer geographical location 

Revenue by major customer type 

For the six months ended 30 September

Operating segments

* Definitions of the Group's 'Alternative Performance Measures' can be found in the glossary

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Reconciliation of segmental results to total profit

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

In the income statement, the Group presents specific adjusting items separately. In the judgement of the Directors, for the reader to obtain a proper understanding of the financial information, specific adjusting items need to be disclosed separately because of their size and nature. Underlying measures of performance exclude specific adjusting items. The following specific adjusting items have been (charged)/credited in the consolidated income statement:

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Reconciliation of underlying profit for the period to total profit for the period

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

The total impact of specific adjusting items on operating profit (which are excluded from underlying performance) before tax was an expense of £20.7m (H1 FY23 restated: income of £45.6m). H1 FY23 included a £42.9m gain from the foreign exchange derivative contract which was taken out to hedge the foreign exchange exposure on the $590m Avantus acquisition and was executed in accordance with the Group's Treasury Policy - this was a one-off timing gain at H1 FY23 which unwound in H2 FY23 by the time of the transaction completion. H1 FY23 restated also includes a £19.6m gain from the release of the liability for MOD appropriation of RDEC.

Acquisition and disposal costs of £0.6m (H1 FY23: £6.4m) comprise costs associated with various ongoing projects and acquisitions that we have decided not to pursue, demonstrating our disciplined capital allocation policy. The H1 FY23 amount related to Avantus and Air Affairs. Acquisition related remuneration of £1.1m relates to specific post-acquisition retention arrangements for Avantus employees which were anticipated at the time of the transaction. Acquisition integration costs of £2.6m relate to the one-off costs of integrating both Avantus and Air Affairs with the existing Group operations.

Our digital investment programme continues to deliver improvements to the infrastructure, digital tools and operating systems of the company - roughly two thirds of the costs in the first half are reported as specific adjusting items in the P&L given their one-off nature, with ongoing recurring operating costs (such as licence costs and overheads) remaining within underlying operating costs. In H1 FY24 the exceptional cost element of the digital investment programme within specific adjusting items totals £5.1m (H1 FY23: £2.5m).

Also included within specific adjusting items were a gain on the sale of property in the UK of £2.1m (H1 FY23 £0.9m) and impairment of right of use lease assets in the US following space relocation of £0.7m. Amortisation of acquisition intangibles of £12.7m (H1 FY23: £5.6m) has increased due to the inclusion of amortisation of the intangible assets relating to the Avantus acquisition.

There were no acquisitions in H1 FY24 or H1 FY23. The cash flow statement includes £3.8m of deferred consideration which was settled in respect of the Air Affairs acquisition. A further £1.1m of deferred consideration was settled in respect of legacy acquisitions made by the Avantus business before its acquisition by QinetiQ.

In H1 FY23, the Group incurred £6.4m costs in respect of the acquisitions of Avantus Federal and Air Affairs, and the disposal of Space NV. A £1.6m deposit payment had been made on the Air Affairs acquisition which was included within trade and other receivables as at 30 September 2022 and the cash flows from investing activities for H1 FY23.

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

The total tax charge is £22.1m (H1 FY23 restated charge: £21.4m). The underlying tax charge of £27.0m (H1 FY23 restated: £15.7m) is calculated by applying the expected underlying effective tax rate at a jurisdictional level for the year ending 31 March 2024 to the underlying profit before tax for the six months to 30 September 2023.

The Group's full year expected underlying effective tax rate is 26.1% which is higher than the half year underlying effective tax rate of 25.9% (H1 FY23 restated: 19.4%) due to the jurisdictional mix of profits in H1 FY24.

The underlying effective tax rate has risen due to the increase in the UK statutory rate effective from 19% to 25% from 1st April 2023. In future we expect the effective rate to be above the UK statutory rate subject to the jurisdictional mix of profits and the recognition of deferred tax in respect of overseas tax losses and excess interest deductions.

On 20 June 2023, Finance (No.2) Act 2023 was substantively enacted in the UK, introducing a global minimum effective tax rate of 15%. The legislation implements a domestic top-up tax and a multinational top-up tax, effective for accounting periods starting on or after 31 December 2023. The Group has applied the exception under the amendment to IAS 12 to recognising and disclosing information about deferred tax assets and liabilities related to top-up income taxes.

Tax losses and specific adjusting items

At 30 September 2023 the Group had unused tax losses and surplus interest costs of £182.3m (31 March 2023: £175.6m) which are available for offset against future profits.

Within deferred tax assets recognised on the balance sheet is £18.4m in respect of £87.8m of US net operating losses, £4.9m in respect of £21.3m of Canadian net operating losses and £2.5m in respect of £7.7m of German trade losses.

No deferred tax asset is recognised in respect of the £65.5m of US interest deductions due to uncertainty over the timing and extent of their utilisation. Full recognition of the US interest deductions would increase the deferred tax asset by £17.7m. The Group has recognised £32.8m of time-limited US net operating losses of which £23.2m will expire in 2035 and £9.6m in 2036. Deferred tax has been calculated using the enacted future statutory tax rates.

Tax on specific adjusting items includes a £3.4m credit for tax on the amortisation of acquisition intangibles and a £1.5m credit in respect of other pre-tax specific adjusting items, the total specific adjusting items tax credit was £4.9m (H1 FY23 restated: charge of £5.7m).

Basic earnings per share is calculated by dividing the profit attributable to owners of the Company by the weighted average number of ordinary shares in issue during the period. The weighted average number of shares used excludes those shares bought by the Group and held as own shares. For diluted earnings per share the weighted average number of shares in issue is adjusted to assume conversion of potentially dilutive ordinary shares arising from unvested share-based awards including share options.

Underlying basic earnings per share figures are presented below, in addition to the basic and diluted earnings per share, because the Directors consider this gives a more relevant indication of underlying business performance and reflects the adjustments to basic earnings per share for the impact of specific adjusting items (see note 3) and tax thereon.

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Reconciliation of net cash flow from operations to underlying net cash flow from operations to free cash flow

^ Prior period comparatives have been restated due to a change in accounting policy in respect of Research and Development Expenditure Credits (RDEC). See note 18.

Underlying cash conversion ratio