Saab AB (publ) (OTCPK:SAABF) Q2 2022 Earnings Conference Call July 21, 2022 4:00 AM ET
Company Participants
Merton Kaplan – Head of IR
Micael Johansson – President, CEO and Director
Christian Luiga – CFO and Deputy CEO
Conference Call Participants
Charley Olivia – Goldman Sachs
Heelan Ben – Bank of America
Golrang Erik – SEB
Tusa Sash – Agency Partners
Merton Kaplan
Hello, everyone, and welcome to Saab’s Q2 2022 Earnings Presentation. I’m Merton Kaplan, Head of Investor Relations at Saab. And with me today in the studio, I have Saab CEO, Micael Johansson; and Saab’s CFO, Christian Luiga. We will start with a presentation and we will, as usual, go to our Q&A session at the end of that.
Without losing any time, I would like to hand over to you, Micael.
Micael Johansson
Thank you, Merton, and thank you all for joining us for this Q2 presentation in a very warm Stockholm today. And before I jump into the numbers a bit, I’d like to give you some context on the environment that we’re working in right now. What are sort of the discriminators for us in this business environment.
As you know, I mean, we have completely changed the security landscape with a tragic war in Ukraine, and it’s just ongoing and ongoing. And many of the European defense — many countries in Europe have now increased their defense spending forecast significantly, including Sweden, 2% of GDP. And many European countries also, even 3% we see in some countries. And this is, of course, affecting our environment that we haven’t seen sort of much of the result of that yet since many countries are still looking into the medium- and long-term planning in terms of what capabilities are needed and they will be clarified, I would say, towards the later part of this year in Sweden.
Our Supreme Commander will come out and talk about this, how he will reach 2% in November. Then, of course, the importance of security of supply and protecting your country has become much more sort of in focus, which affects us also in the way we look at the supply chain, in the way we look at local endogenous capabilities in some countries in Europe. And that is, of course, extremely good for Sweden to have a company like Saab with a great portfolio supporting them in their defense growth, us being an integrated part of our Swedish defense forces.
Now eventually, Sweden and Finland then have been invitees and applied to NATO membership. And I’ve said many times before that I think that will affect us as a company in a positive way. First of all, when it comes to credibility as an industry and also as a country being part of this alliance will, of course, give another view of us long-term. Our systems and products are, of course, NATO-compatible. That has not changed. But we will have access to acquisitions and procurements within NATO, from the NSPA. And we have great capabilities to offer GlobalEye, surveillance capability, sensor capabilities. So I see a positive thing looking at this. And since I also think that Sweden and the other Nordic countries will have a great responsibility in terms of capability in the Nordic region, in the Arctic region, we can support that in growth when it comes to air defense, in the air domain and also when it comes to the Baltic Sea.
Overall, we see a big interest in Saab product portfolio. But I wouldn’t say that the increase in defense spending that we see has right now affected really our order intake growth, even though, as you see, that is a great increase, that is still to come medium- to long-term. And I think we are exceptionally well positioned to meet the customer demands when it comes to shorter lead times, increased demands with the portfolio that we have in our core areas.
And that is specifically seen right now when it comes to support weapons and sensors and training and simulation, but other things will come in the future as well. And of course, we’ll work a lot with the different lead times we have in our portfolio for different parts, everything from six months to up to two years, of course. And that is a big pressure from all the customers today to see increased deliveries and shorter lead times. So this is the environment.
Looking at the numbers then. Q2 was a good quarter. We had a very strong order intake, SEK17.3 billion and for the half year, SEK25.5 billion. That is a great sign of how attractive our portfolio is in the marketplace. Our sales was in-line with last year. And according to our plan for this year, where we’ve said that we have a much stronger second half of this year. So we have reiterated our guidance on around 5% growth. Same thing for profitability. We have an increase of profitability of 3% quarter-to-quarter and 6% on the half year to half year. And also on that side, we have reiterated that we will have a stronger second half year and be in the upper part of our span of 8% to 12% EBIT growth.
We have a positive cash flow, and that is also according to plan. It will be positive for the year, not as positive as last year because we had big payments from the GlobalEye contract we had then, but it will be positive. Big — a couple of big sort of milestones that we have met now during this quarter is the keel-laying ceremony for the first A26. This is when you actually mount two of the bigger parts of the submarine and attach them together. So it really starts looking at the full submarine. And also we’ve completed the T-7A, the training aircraft deliveries to St. Louis and Boeing. So now we are transferring the production completely to West Lafayette, Indiana. Sustainability is still a very important subject to us, and we have initiated a number of task forces now for different areas, where I’ll come back to that later in the presentation.
So key things that happened during the second quarter when it comes to order intake is, of course, extremely pleased to see that Sweden now have decided to acquire the GlobalEye, two of them, with options to buy two more, and that is SEK7.3 billion order intake. We’ve also had additional contracts on the Gripen C/D to upgrade that one for Sweden. And we are looking into the future, we have now started new initiatives to look at what is coming sort of beyond the Gripen E and what is a system of — systems capability that we will need in our country in the 2060 and onwards when it comes to the fighter capability. Good orders also on the RBS15 Missiles Systems and in the U.S. for sensor system, the ground air task-oriented radar sensor system for the U.S., which is an ongoing production that we have in the U.S., that is a very good contract to us. And as you’ve seen, many countries have a great interest in our support weapons. So we have had several orders when it comes to the Carl-Gustaf and also ammunition to that, Sweden, U.S., Denmark and a few others. So the — second quarter when it comes to order intake has been excellent, I would say.
Looking at the business area, a couple of highlights on them. The Gripen program have good progress. We have had extremely high intensity when it comes to flight testing activity in the quarter. And we’re continuing our deliveries. We have now done a lot of preparations, and we are ready to start production in West Lafayette, Indiana. Preparations include, of course, setting up the full factory when it comes to [indiscernible] and processes and so forth, and that’s done. And Aeronautics is flat when it comes to sales, which is according to our plan, and it’s a bit affected from profitability levels when it comes to the preparations from T-7.
Dynamics has a very good growth when it comes to order intake. Sales is very much connected to deliveries when it comes to Dynamics. And we had a very good quarter last year in quarter two when it comes to deliveries. And this is a timing thing, and when the deliveries will come in Dynamics, so they will have a very good second quarter — second half year, I would say. And of course, the EBIT margins are excellent, and that will continue to be so. And that is a growth area of the substance to us, of course. Surveillance. Strong order intake, of course, because of the GlobalEye to Sweden and also several other medium-sized orders when it comes to sensor systems. We see growth in all business units, and we have good project execution. So the margins are now increasing in Surveillance according to plan. And we are growing also when it comes to resources in Saab as a whole, but specifically also when it comes to Surveillance.
Kockums is on the trajectory of trend of improving margins as we have seen both in the surface side, but also on the submarine side. We have a new contract of modifying the third Gotland-class submarine, which is adding to our profitability in Kockums, but also a good export contract when it comes to the surface ships, that gives us also increased profitability. And they are also growing when it comes to growth for the first half year in a very good way.
A couple of comments. Innovation is so incredibly important to us, and we are known to be an agile innovative company. I just want to give you couple of many highlights when it comes to things that we’ve launched this quarter. Support weapons are important to us, and one might think that the Carl-Gustaf is always a Carl-Gustaf, but we work all the time with new innovations when it comes to how easy it must be to use, what ranges it can be used on and what accuracy it has as a weapon system. And now we created a new programmable round of munition that communicates with the fire control device and the weapon. So that means that it’s much easier to use and much faster to use for an operator. And this is a weapon that you learn to use within an hour, even for a non-experienced solider, I would say. So that is a very big step to make this weapon even more capable when it comes to range and accuracy.
On the sensor systems side, we are looking at much more lightweight type of sensor technology that can be used, as you see on this slide, using drones to carry it. This is an excellent example of engineering capability where we have used both our capabilities in Finland, in Tampere, but also here outside Stockholm in Jarfalla to create a fantastic low-weight, low footprint type of passive sensor that gives you an excellent awareness of what’s going on around you without you being exposed to anything around you. It’s platform-agnostic. You can actually use it on drones, vehicles, vessels, masts or man-portable as well. It’s just a few kilos in weight, this sensor system. So those are two examples of excellent innovations and product launches that we’ve done during this quarter.
When it comes to sustainability, we have, as you know, connected ourselves to raise to 0, and we have applied for science-based targets and expecting response on that in the later part of the year. Meantime, of course, we have initiated all our task forces, looking both on how we do energy supplies, how we do transport and also how we work with our aviation fuel systems and a couple of other task forces. So that is what’s going on, on the environmental side. And of course, we are continuing to implement our responsible sales policy, which is very much about looking into much detail in how we affect human rights aspects of what we do in each and every country where we have operations and where we sell products. So we have implemented that in detail in our business model.
Looking forward from my side. I mean, there are priorities that are really important to us. We stick with our multi-domestic strategy, establishing ourselves in the U.S., U.K., Germany, Australia and, of course, Sweden and Finland and Brazil. So that is an important strategy. We stick with our core areas. I think it’s very good that we have a wide portfolio now, looking at the capabilities that will be needed from increased defense spending. So everything from fighter aircraft to submarine systems to globalize and sensor systems to advanced weapon systems will be so important and will be mapping towards the capability developments that we see now coming up in different countries.
To capture these market opportunities is, of course, an intensive thing now. We’re building our workforce to do that, and we put a lot of effort into accessing now the NATO capabilities being inside the alliance, working with different parts of the forums that you have be connected to catch that market. But we cannot do here and now only. I mean we have an order backlog of SEK112 billion now. So we have a lot to deliver going forward, as Christian will talk about soon. But we are also investing in new technologies and embracing new technologies, working with autonomous systems in all domains, especially air domain and the subsurface domain, but also taking the next steps on sensor systems using complete digital systems that will be connected to together in a new way and also looking up on our system being connected in a cloud, secure cloud, which we call combat cloud technology. So there are many things coming up sort of going forward from an innovation perspective.
It’s of great essence to us also to increase capacity, as I talked about. We have done that as an example, in Karlskoga. We have doubled our capacity when it comes to units coming out of that facility from one year to the other, but we will build more production lines, both in in-shipping when it comes to the weapons part and the munition part in Karlskoga, but also looking at redundancy, having manufacturing both in the U.K. and potentially also in the U.S. will be important to us. Also to us, the inflation part and supply chain challenges are of essence to work with, of course. We are protected in contracts we have today by clauses looking at protecting us from inflation, but also currency exposure. And this will be important going forward. And we, of course, affect our prices to our customers when needed if our supply chain need to increase their prices. So this is a diligent work we’re doing going forward.
We have coverage when it comes to supply chain for some time going forward. We are fine this year and a bit into next year when it comes to what we have in stock. We don’t have any problems delivering our stuff as we see right now. And we’re working with the supply chain continuously to regionalize it, but also to make sure that we have things in stock going forward. And then, of course, beyond ’23, ’24, we have also, if this continues, our work to do to make sure that we get our things in-house, but we’re fine for now. And then, of course, fighter competence and talent is a huge thing today. Saab is employing around 1,800 people this year, and we are right out there fighting for the same competitions and talents as many other companies. So these are our priorities going forward now.
I just want to underline that, of course, what we see in the marketplace now has not really affected our order intake growth as of now. Just a little, I would say. We have great opportunities to grow going forward, looking at the defense spending that we see in Europe and also the big market in the U.S. So with the portfolio we have, of course, we have opportunities to grow even further. And I’m looking forward now to see the more strategic plans, the capability plans and acquisitions plans from each and every country coming up in the next few months, including Sweden then in November.
So with that, with a positive note on the future, I will hand over to my CFO, Christian Luiga to talk a little bit more about our numbers.
Christian Luiga
Thank you, Micael, and good morning, everyone. I just want to start with to emphasize, as Micael said already, in the beginning of February when we met discussing the quarter four results, we were very clear that this year will be illustrated by a weaker first half and a stronger second half. And we deliver on our plans. We deliver in accordance with that, and we have a good positive upswing also on top of that on our order intake.
And starting with our order backlog, I think there’s a couple of things that is notable in our report and the 76%, of course, in the quarter, driven by one larger order, but also some other medium-sized order between SEK100 million and SEK1 billion and they are very important, of course, both for the pace of production, but also for profitability. And the backlog now is at the peak of SEK112 billion. We have never been there before. 62% outside Sweden, even though this quarter was very heavy on Sweden because of the GlobalEye to Sweden.
Something that is interesting to see is that, our order to backlog to sales for this year, that means the second half, is now SEK20.2 billion. That means that without selling anything more this year we will have SEK20.2 billion to deliver in sales. And of course, last year we had 17.3%, so it’s up 17%. And that number also means that we do typically sell something on the top, which is also needed and natural as we expect a higher growth in the second half. But interesting enough, also, we see that year two and year three and year four also is now improving steadily and gives us then a good potential for growth and next year alone is increasing by 13%.
Let me step into the half year first, and I’ll come back actually to the quarter when I talk about the business areas. The half year is weaker, as we said, it’s 1% in sales growth. We still have our outlook for around 5% for the year. That means that we will be around 10-ish for the second half. And this comes from different aspects that I’ll come back to when we talk about the sales. Overall, the gross income and the gross margin is improving, and we see a 0.3% gross margin increase and improvements in all business areas, except for Aeronautics at this point, which is very good. The EBIT level is up. And in here, we can have — we can talk about a couple of things. One is that the — last year we were impacted by a onetime restructuring that we announced in the second half, in the quarter two report of SEK85 million. But even without that, we see an improvement and the depreciation and amortization, for example, did increase between the years with 0.3% from — to 5.2% of sales compared to 4.8% of sales last year.
Another thing that is visible in our report is that, we have higher corporate cost in this period, in this first half. And several of those cost items are of onetime nature and will then, therefore, mean that the second half will not have as heavy increase that we had in the first half. It will be substantially less. And these examples are share-based programs that has costed more. We have also had corporate initiatives to increase our branding on HR perspective, as we are a great employer of many engineers right now and we want to boost that in this market.
Security IT has also been part of that increase with the security situation we have had during the first half. And on top of that, we have some minority portfolio investments that have done some write-downs in the first half. So that’s why the corporate cost is higher. And I will not go into the details, but what I want to say is that, the second half increase will be substantially less than the first half.
Finally, on the net income. The net income is decreasing, meanwhile, the EBIT is increasing. As you have may have seen, we have a quite strong liquidity position. We have SEK9.7 billion in bonds primarily where we do short-term investments. And according to IFRS, we need to market value these investments at each time, even though we remain with them. So technically, what we have to do is that, we have to — as the interest rate is increasing, we have to value them down. But then you take that and reverse that provision until the maturity of that bond unless you sell it beforehand, and there’s no cash effect. So it’s moving a future sort of income that we will now reverse to today’s loss or the opposite. So without that, the net income would have increased, the EPS would have increased 7% — 5%, sorry, and EPS would have been SEK7.05.
Then into the business area a bit. There is a low sales growth in Aeronautics. I say low sales growth because we believe it’s going to be somewhat stronger, and that is because the Gripen program, which are two large huge programs. It’s a little bit slower in the first half and will be then coming a bit stronger later on. This means that there’s nothing strange. These are huge programs that goes a little bit up and down and in pace. And it means also that from a profitability point of view, it impacts much of the OpEx you cover at each time in this business area.
On Dynamics, we have our home run last year in quarter two. Quarter two, all business units had their best sales ever in Dynamics. That’s why we have a negative 21% in growth in this quarter. But there’s no worry here. We see the pipeline in Dynamics extremely strong, and the comparison numbers will disappear from next quarter. Surveillance pushed by a lot of good project execution, not only pre-start by GlobalEye, but in many of the projects that we have actually taken into the business area over the last two years are now starting to deliver and pace up, which is promising and good. And Kockums, flat for the quarter, not much to comment on.
This one, I’d like to show all the time, it’s sort of a pulse meter or a trend meter for me to see that we are on the right track. We say that both these two should continue to go up. The sales, rolling 12 months, is an indicator if we’re growing. Between last quarter and this quarter and the beginning of the year, of course, it’s a slower pace, and that’s because of this first half year is weaker, and we see then that with a 5% growth for the year that the second half or — and the new yellow bars that we will show you in the next two quarters will pick up. And the EBITDA is growing and it’s steady growing, and it’s up now to 12.6%, 1% up over two years’ time. And this is where we need to see an improvement coming from gross margin improvement, making sure that we become a more profitable company over time.
A bit on the EBIT and EBIT margins. As I said, Aeronautics is hit by the somewhat slower pace in the Gripen programs. There is also some negative currency effects in the quarter on Aeronautics that hits, not to be seen as something that will continue even if actually the currency continues to go up. We have some clauses around this, but there could be also timing effects and currency effects. But it is a currency effect that hits the quarter.
The project mix and execution within Dynamics make still the margin go up. And even if you adjust for that onetime effect last year when we closed down our site — Barracuda site in U.S., the margin will go up in Dynamics. So Dynamics is performing better and better as we see also that they both bring up the efficiency and get a good pipeline to deliver on. And this is the same pattern we see in Surveillance, even though from a much lower level.
Kockums has a good mix, both in the surface and the submarine projects and also brings the margin up. And this is actually the level, as I said before, that we should see Kockums on and not the previous level that we had last year. Combitech had a tough quarter, but I’ll come back to that in a second. And this is the second. So here we are. Digital transformation and actually contracts, including 5G private network but also a lot of interesting projects toward the defense sector has been signed in quarter two. And it is very encouraging to see that we — Combitech is actually a company working both towards Saab and towards external customers. And where we see the high growth is in our external customer market and that drives a lot of activities, but this is also an industry right now, the consulting industry where there’s a lot of competition for competence and resources remains a challenge. And we have had a quite high turnover during this first half coming out of COVID and a lot of people that want to seek new opportunities, but we are hiring extensively, and this means that we get a higher cost in driving the business at this point, that’s one reason why the margin goes down.
Then to cash flow. We have guided for a positive cash flow for the year. We are on our plan towards that. We have a — specific thing I want to talk about — a couple of things. One is actually the inventory. We have a change in working capital that is negative. If you look into our balance sheet, you will see that the inventory is up compared both to last year and also to the end of the year. And this is part of our journey to secure that we are safe in our deliveries. There’s many aspects that we work with our suppliers on renegotiating with them. We make sure we in-source, we do other kind of partnerships, and we build some inventory to make sure that we will have less impact than necessary from the supply chain issues that we see out there. And this is something we started already during COVID. We talked about it before, and this is what we continue to do. And we believe it’s actually worth every penny to make sure that we can deliver to our customers and be well prepared.
Then we have lower investments, mainly due to lower capitalization in R&D, doesn’t mean that we are stepping down on R&D. The R&D — the capitalized R&D goes up and down a bit. We have the same amount actually in our income statement that we have taken charge to our income statement for R&D development. And we continue, as Micael said, to have good examples and spending around R&D. And this is something that we should not compromise on going forward. And then, we have initiated a lot of activities around bringing up the capacity and production. And some of them, smaller steps have been coming into our cash flow. But actually, there is no bigger impact from future investments into the cash flow right now. That said, we don’t see a substantial increase in investments as it looks right now. And we will have to come back to that during the fall also when we see how the order book and the — our capabilities meet the customers’ demand in the programs they are going to come out with.
So that is about cash flow. And that leads us then into what I talked about before, our very strong financial position. If you have an increase in EBITDA, which we do have, 5% this quarter and you have a positive cash flow, then the net debt-to-EBITDA will automatically, of course, become more positive every quarter, and this is something we have seen over the last three years. And we now have a very strong and healthy balance sheet, but we also have a very strong and healthy liquidity position, that makes us also prepared for whatever can come up going forward that can help us to catch the opportunity we see now, which is bigger than ever.
Finally, our outlook. As Micael said, we see more opportunities than ever. But still, there is certain lead times in some of these things. And order book is improving day by day, and we had a 76% order intake. But right now, we stick to our organic sales growth of around 5%, means that it will pick up in the second half. We want to be a little bit more direct on the operating income to make sure that we don’t underestimate the improvement we see. And therefore, we have said on top of our guidance of being in between 8% to 12%, which remain that we estimate it to be in the upper end of this range. And the operational cash flow to be positive as we have said, but at a lower level than in 2021, where it was SEK3.3 billion.
That’s it from my side. Thank you.
Merton Kaplan
Great. Thank you, Christian, and thank you, Micael. So now we have — before I leave the — hand back to our moderator to open up the Q&A session I want to highlight for everybody and all our viewers that you can dial-in to the conference to ask your question and you can also send them over on the website to ask and we will pick up those questions. And I would also like to underline that please ask your questions one or two at a time as everybody gets a chance to ask the question, because we have some time for it, so you’ll have opportunity to ask more questions. So with that, I’ll hand over to the moderator.
Question-and-Answer Session
Operator
Ladies and gentlemen, we will now begin the the question-and-answer session. [Operator Instructions] The first question is from the line of Charley Olivia with Goldman Sachs. Please go ahead.
Charley Olivia
Hi there, good morning. Thanks very much for taking my question. I have two questions to start with. The first is just yesterday we saw some announcements about the Czech Republic taking — deciding to take F-35 aircraft instead of the Gripen, and I know that you’ve been in a tender process there and have pre-existing Gripen’s operating in the Czech Republic. Could you maybe just comment on sort of the outcome of this tender process and what’s happened? And then also just sort of looking ahead, what do you see as the kind of future for the Gripen program here? Where are future orders? What are the countries potential areas for growth for Gripen?
And then my second question sort of also staying in the area of Aeronautics. Could you just talk around margin progression in Aeronautics, and particularly with the focus on T-7. We’ve seen margin decline in Aeronautics in the first half, and I know that you flagged that there’s sort of higher development — higher T-7 development costs. It would just be good to get a sense of those costs peak? And therefore, when can we expect margins to sort of recover? And also sort of what is the absolute level of development that you’re completing? Thanks.
Micael Johansson
Thank you for the questions, and let me start with Gripen in — or the Czech Republic then. Well, we noted that yesterday that they came out with a statement, of course. It is a fact that we have a very successful Gripen program in Czech Republic today, and they are very pleased with the system. They have a capability today. It is completely upgradable many steps from now in the Gripen C/D version that they have. And they could seamlessly go into the E version if they like, which would be extremely efficient from an infrastructure point of view and transition with people and pilots and so forth. So of course, we are going to give them an attractive proposal also. And if they want to sort of have a reference and go and have a discussion with the U.S., that’s up to them, of course.
We have a contract with them, and this is where then Sweden FMV, Defence Material Organization, have a direct lease contract with them until ’27 with an option to go forward here. That will create revenue for us for many years to come, and we will upgrade the system for them. So — and in parallel, we will, of course, compete with the U.S. to say that we also have a great offer to give them on the capability growth with the next-generation fighter with the Gripen E. So this is not done yet. They have decided to do this on a direct dialogue, they say, without sort of open acquisition process, which is normal. But in any way, we will have — we will be in contact with them to clarify exactly what we can offer them in parallel, and then we will see what they decide in the end.
When it comes to the Gripen as a whole, we, of course, still see many opportunities going forward. As you know, I mean, I’m quite sure that Sweden will continue to sort of have more platforms going forward in Sweden beyond ‘60. Also looking at the capability targets and what they have to do together with other Nordic countries in this region. Also, Brazil have announced that they will add four aircrafts immediately to the existing contract. And then we in parallel are starting — we have started a discussion on the second batch of another 26 aircrafts with them. There are a couple of other countries in Latin America and that looks very promising. And then we have the existing customers of Gripen, including Czech Republic, I must say, where we will not give up, but we have Hungary, we have Thailand and a few others. So I still — I am still very positive when it comes to our position on the fighter systems side in the world.
However, I mean, also, I would say that NATO is sort of a piece in this puzzle going forward, because we will be part of an alliance where we will be long-term credible as an industry in country being part of that alliance. And that, I hope, will also give us more substance and, from a security politics perspective, a better position when it comes to creating more contracts on the Gripen side, because these decisions are political. There — this is about security policy and what relations you want to have with certain countries. So it’s not only about that you have to have a great system, which we have, you also have to have a position where you can create an alliance with the country. But I am positive about the future, absolutely.
On the Aeronautics side, when it comes to — when will we see the margins increase? We don’t really guide now on business areas. But of course, I mean, the production ramp-up of the Gripens will start within a couple of years of time when it be higher volumes. We are imminent about starting the production in West Lafayette on the T-7, as we speak. And immediately, when the first low-rate initial production batch comes into play, of course, the sort of — the spending sort of that we’ve seen right now will stop, and we will start seeing better margins in Aeronautics. Those are two important parts of increasing the margins for Aeronautics. I don’t know whether you want to add something, Christian?
Christian Luiga
Yes, let me just add then that the T-7 is correctly, and I think we have tried to illustrate that in the report also. It has a material impact on the margin right now and has had that, and that will disappear as Micael say, pace out, as we start to then bring up the production slowly than in West Lafayette. And that’s something we stick to and is still true.
Charley Olivia
Okay. That’s helpful. And just to clarify on T-7. So would it be fair to assume if you’re starting production in West Lafayette very imminently that this is kind of the trough year for margins or might we expect a couple more years where the margins are still impacted?
Micael Johansson
Well, we definitely will start the production of T-7 from a low rate, initial production point of view, sort of imminently, hopefully, within the month, so to say. But then again, it will phase out the costs that we’ve seen so far, as Christian said, without guiding exactly on this, but it will, of course, phase out.
Christian Luiga
It depends a little bit on the pace we then get into what sort of decision we take together with Boeing on how fast we then bring it up. So that’s why we’re a little bit vague on that statement.
Charley Olivia
Okay. That’s helpful. Thank you.
Merton Kaplan
Thank you, Olivia. Can we take the next question please.
Operator
The next question is from the line of Heelan Ben with Bank of America. Please go ahead.
Heelan Ben
Yeah, morning guys. It’s Ben from BofA. Firstly, orders, obviously, were very, very strong. How is that impacting how you think about the medium-term outlook? I know you’ve said single digit in the past, but how should we think about that? Second question is, you talked there post that last question around kind of being part of NATO would be potentially a positive for the Gripen program. Are there other areas of the business that could benefit from Sweden becoming a member of NATO? And if you could just talk around that. And then finally, on inflation and your ability to pass through those costs, are there any areas of the business that you are nervous that you won’t be able to pass those on or stuck with kind of fixed price contracting? Thank you.
Micael Johansson
Thank you very much. When it comes to order intake, yes, as I said, I mean, I don’t think we have seen the effect really just from sort of the defense spending increase in many countries in Europe. It is still to be clarified, medium- to long-term, exactly what capabilities there will be a need for and in what pace. I do — however, I am very positive that we have a good portfolio to support that in our country, in other European countries. So I think we will have many growth opportunities going forward, especially when we have established ourselves, both in Europe and in the U.S., in the U.K. So I’m very positive on that. So order intake and growth based on that, yes, great opportunities. That’s all I can say.
When it comes to NATO, specific areas where I feel that we have really things to contribute with. First of all, I think on the surveillance side, I think we have the GlobalEye, we have other great EW capability and sensor capabilities and command and control, where we have not been sort of inside defense to contributing work with other countries and with the alliance on these things. So those are example of areas where I think we can be very strong, apart from many nations, of course, within NATO on the whole host of our portfolio, including support weapons and missile technology. But then again, depending on the responsibility and the capability targets that Sweden and other Nordic countries will have as part of NATO, we’re strengthening the capabilities here in this region will also add to what we saw before in terms of planning in Sweden and in the Nordic area.
So I see hopefully a stronger sort of air domain capability based on more Gripens, but also the Baltic Sea protecting that. And since we have conventional submarines that will also be an area which I’m looking positive into going into with them. So there are many opportunities, but we are pursuing all these things now getting into all the forums to understand what we can access, of course, opportunities.
Inflation. Well, I don’t see any area specifically where we are sort of worried about inflation. I mean, we have in our portfolio backlog that we have now, the SEK112 billion, we’ve gone through that, and we are covered with clauses when it comes to exposure on price increases, indexes and currency. Different type of clauses, depending on when and exactly the contract was settled. But all in all, we’re fine, and this is going to be very important to protect ourselves going forward, of course, including being on our toes to increase our prices if needed based on the supply chain pricing increases. So no, I can’t see — short answer, no, I can’t see that the risk area being connected to inflation on our side.
Heelan Ben
Okay, great. Thank you.
Micael Johansson
Thanks, Ben.
Operator
The next question is from the line of Golrang Erik with SEB. Please go ahead.
Golrang Erik
Thank you. I have a couple of questions here. The first one is, I guess, it relates to the inflation question as well. But we’re getting — given that there’s more focus on delivery in the market and demand is certainly heating up even if a lot of the longer-term procurement programs hasn’t been really outlined yet. But — are you seeing any signs that pricing is strengthening at the margin in the backlog as a result of that is improving? That’s the first question.
And then I want to follow up on the discussion on Aeronautics and the margin there. It seems — there’s always something — we always are supposed to look a couple of years ahead but something happened and the margin will improve and something else shows up and it weighs on it. What — I mean, is there a pattern there? I mean we could very well have another big order that results in initial development costs and so on, once the T-X program is up and running. Is it really reasonable to expect a margin in line with the group target for Aeronautics over time? I’ll stop there.
Micael Johansson
Well, again, when it comes to increased demand in the market short-term and if you look at the product level, of course, the support weapons, for example, or sensors. I mean, volumes — lead times are extremely important to our customers today. And adding volumes, we can do more, of course, on increasing productivity and efficiency in what we do, definitely. So I mean my short answer is, we can manage the prices in the marketplace being very competitive and also increase our margins at the same time when volumes comes up — comes into that part of the portfolio. That is clear. Aeronautics, other things shows up, well —
Golrang Erik
Sorry, just to follow-up. So it’s more of a volume factor that would have you expand margins as opposed to actually net pricing strengthening a bit because of high demand?
Christian Luiga
Well, the pricing may go up if the input material is higher cost as we — we have sort of a cost-plus model, you could say with our customers, even if it’s not a clear cost-plus model, if the material and we have index clauses saying if material becomes more expensive, then we will charge more for that material and then we will have a higher sales, and we will have the agreed margin maybe or we will have a possibility to work with that. But that’s sort of — and that means also that maybe a bit of this increase in budget will be spent on higher pricing on the same material from our customers. That’s sort of not — that’s nothing we can avoid with the situation we have in the world.
But then that said, sort of how do we improve our margins in this environment where inflation is increasing? Will inflation then eat up our margin? No is the answer. We don’t believe so. So we will continue to drive our margin upwards. So then the key question is that, in this volume increase can we utilize that even better then to get the scale effects, as Micael said, on our production? So there’s two different answers to that question.
Micael Johansson
When it comes to Aeronautics and the margins, I mean, you can always speculate that something else pops in that would give you sort of a pressure on margin. But we have been in an unusually development-heavy type of time period within Aeronautics. And if it’s something that sort of the experience of Aeronautics shows is that when you get into production and have a balance between production and development, the margins will increase, because we are very efficient building airplanes. So that is what I see going forward.
Merton Kaplan
Great. Thanks. Was that answer to your question?
Golrang Erik
Yes. I guess. Thank you
Merton Kaplan
Thank you. I know we have one more on the line, but I was going to take a pause and take some questions that we’ve been receiving here from the other viewers as well. There’s a couple of questions that we have already covered, but I will have one question for you, Micael and one question for you, Christian. One of our investors here are wondering about the potential about Australia, which we haven’t talked about, especially in the submarines segment. Is there anything you can say there with Saab’s relations with Australia?
Micael Johansson
That’s a good question. I mean we are looking at some uncertainty still about what will the gap be between the existing Collins Class submarines end-of-life. And when will the nuclear-powered submarines come into play and be selected and when can they be in operations, so to say, that in my view today there will be a gap in time. And the life of type extension of Collins Class is absolutely something we are working on together with the Australian Submarine Corporation. But then again, the potential is also, will there have — will there be a need for a gap filler, so to say. We call it son of Collins or something else, and we are absolutely player that want to be in that competition to — but it’s not clear yet from the defense forces in Australia, but we are pursuing that as sort of a campaign today. So there are potential in Australia.
And of course, then we to build that capability locally. We have 700 people in Australia involved in command and control systems and in other things. And we have great engineering capability, and we can transfer technology to Australia to support this.
Merton Kaplan
Great. Thank you. And we have one question for you, which is a bit more detailed, Christian, from one investor in London, who wants to understand a bit more on the currency impact that we had in the quarter, I believe, in Aeronautics. What was the nature of that? And is that something that will continue that type of currency?
Christian Luiga
Well, to make it a little bit complicated, but still simplify it, we have a lot of purchase in foreign currency, Gripen and Aeronautics is depending on different kind of currency in this production. Meanwhile, we have index clauses that is more taken on a sort of regular basis, but with a longer time period in between. So we could have currency effects right now, and then we could have actually an index clause update by the end of the year. And then we see if we are plus/minus or if we are actually even with what we may be affected on. And some of these, we do not hedge as we do think that the currency clause will hit them later on. And some of this we hedge because we have taken responsibility and already covered them when we did actually the purchase.
So — and it’s not a one single math solution, unfortunately. This is something that is typically with the large projects where we do work over several years with our customer could be the Swedish or foreign customer and decide what part should go through directly and what should we take the risk on. And if we take the risk on, we add the price for that and add maybe the currency hedge and take that hedge immediately. And that is actually several hundred pages of details of the material. So I don’t want to complicate, but I also want to make it simple. So that’s how it looks like.
Merton Kaplan
Those are very clear. Thank you. So we return back to moderator, please, questions on the call.
Operator
The next question is from the line of Tusa Sash with Agency Partners. Please go ahead.
Tusa Sash
It’s Sash Tusa here from Agency Partners. I’ve got a couple of U.K. — slightly U.K.-focused questions. The first is on future combat air. You mentioned in your comments earlier about the run-out of the Swedish Gripen program sometime in the 2060s. I wondered if you could just tie that into your involvement in the British Future Combat Air program? And also was the announcement this week of the entrance of Japan potentially into the U.K. Tempest program? Was that a surprise to you? Does that in any way change your approach to being involved for the U.K. and BAE?
Micael Johansson
Good questions. Thank you. Well, I mean, there is still an MOU between Sweden and U.K. on the Future Combat Air System, and we are participating and continuing our work in relationship to that. As I said earlier, Sweden is also in parallel now taking a strategic look at sort of what is going to — what do we need in the more long-term perspective? And as we know, this is a systems of systems approach. So there is not only sort of a core platform type of thing where you have to replace the Eurofighter, of course, and you have to have a man fighter. That’s my view as well. But we talk about the systems of systems. So that’s still very interesting to us, and we still work in a very good way with BAE on how we can support the FCAS program in different parts of it or as a whole. So that will continue. Sweden has to come out with their strategy on what they want to do with the — in their domain going forward.
And we await that before we know where the Sweden as a country will be heavily involved now in the future commentary systems, but as of now a sort of business as usual for a while until the study is done and then we will see how deeply involved Sweden will be. But we will continue our industrial relationship with the U.K. industry as far as we can. And we focus on different parts now of the systems of systems. So I’m still very eager to be part of that. Meanwhile, we’re looking at the study that has been done in Sweden. Japan didn’t come as a surprise to me. No. I know there has been discussions, and I don’t know whether something has been settled completely and still to be seen how deeply involved they will be and what that means to the Japanese F-X two project and FCAS in the U.K. But no, that was not a surprise. They have capabilities, good capabilities, but FCAS is still important to us as an industry, absolutely, and we have good relationships with the U.K. industry. That is what I can say right now.
Tusa Sash
Great. And then just turning to NLAW. There was a very interesting statement from SMV a couple of months ago effectively extending the relationship with the U.K. on NLAW to and low mark to, at least that’s why I’m reading on this. And talking about continuing production of current missiles and future micelles in the U.K. So does that mean that there is — there are still U.K. as well as Swedish production of NLAW? And is there any material difference in your work share depending on when the missiles — where the missiles are produced?
Micael Johansson
Well, I also see that as a very promising sort of frame agreement that they will work together, including, I think, Finland and the Baltic states as well. We will continue to support the manufacturing in the U.K. and Northern Ireland, of course, to set that up and speed that up again, and that’s very important. I’m just sort of waiting the contracts right now. And there could be portions of this that will also be done in Sweden. But in essence, we supply the kits, so to say, to Northern Ireland today.
So I don’t have the details, but I wouldn’t say it’s a big difference. Of course, the difference would be if we manufacture it in Sweden as well completely, the final assembly and test will, of course, be done in Sweden, and then that is a difference, but then we supply the kits to the Northern Ireland and they do the final assembly and tests. It’s not that much of a difference. It’s good to have redundancy. But what’s important now, based on this frame agreement, is to sort of get us to be contracted on actually get going with this. And that I hope will come soon.
Tusa Sash
Thank you.
Merton Kaplan
Thank you. I believe we have one more question. So let’s try to finish up with that last question from, I think, Erik.
Operator
Yes. The next question is a follow-up question from the line of Golrang Erik. Please go ahead.
Golrang Erik
Yeah. Thank you. I think you said something, but I mean you’re obviously very optimistic about the business potential for you now given everything that has happened. You’re not committing to anything just yet? So is it reasonable to expect that you’ll have some kind of event after we get some visibility on where different countries are heading where their spending plans late this year or early next year?
Micael Johansson
Of course, we will look at all the sort of medium- to long-term spending plans and strategic directions on capabilities and all that. And of course, when we have made our adjustments or our assessments, I would say, of the growth potentials, we would, of course, inform the market of our view. I can’t exactly say when. But of course, that is in our mind to go that direction.
Golrang Erik
Thank you.
Merton Kaplan
Thank you. I believe that was the last question. So with that, I think this conference call is over. Thank you very much.
Micael Johansson
Thank you so much for all listening in. And this time, everything worked with questions and all, and I’m pleased to see that and hear that, and thank you for joining us today. I look forward to the next time.
A – Christian Luiga
Thank you. Bye.
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