BAE Systems (BAES.L), the world's third-largest defense contractor by revenue, said it believed the worst was over for spending cuts in its key U.S. market as it forecast that earnings would return to growth in 2015.

Its profits have been hit in recent years by government spending cuts, particularly in the United States and Britain, which together account for almost two thirds of its sales.

However, it said U.S. spending was now stabilizing and set to improve "modestly" from next year, with Chief Executive Ian King saying he was encouraged by a recent higher order for F-35 combat jets, for which BAE is a key development partner.

He also suggested the company could benefit from heightened military activity, when asked about the battle against Islamic State in Iraq and rising tensions in Ukraine.

"Defense and security is high on governments' priorities at the moment," King told reporters on a conference call on Thursday.

"We have a lot of bidding activity going on at the moment, we also have a lot of support activity going on."

The company said that in 2015 earnings per share were expected to be "marginally higher", a forecast which included some reliance on anticipated new orders for naval equipment and aircraft, such as the Eurofighter Typhoon jet.

King noted that for the first time, Middle Eastern countries were deploying their assets against Islamic State.

Saudi Arabia, which has participated in strikes against IS and is still BAE's biggest customer in the region, accounting for 20 percent of its total sales. Analysts said the reference to new aircraft orders were likely to relate to a new batch of Typhoons for the country.

BAE's positive stance on the Middle East and U.S. contrasts with its home market in Britain, where there is still potential for more cuts after the election in May when a new five-yearly Strategic Defence and Security Review (SDSR) will take place.

But King reassured on BAE'S position in Britain, where it is the largest supplier to the country's Ministry of Defence.

"I'm not overly concerned about the SDSR because of our long-term position on our programs," he said.

The government has cut its defense spending by around 8 percent over the last four years but a new defense spending review due to take place after the national election on May 7 makes for an uncertain outlook.

Shares in BAE Systems were up 0.2 percent at 523 pence by 1108 GMT (06:08 a.m. EST) having risen 16 percent in the last six months, compared with a 1.5 percent gain in Britain's blue-chip FTSE 100 index .FTSE, on hopes that the company is through the worst on defense cuts.

For 2014 BAE posted earnings per share (EPS) of 38 pence, down 9.5 percent on a year ago but just ahead of the consensus forecasts of 37.7 pence according to a company survey of analysts and in line with its own forecast of a 5-10 percent fall from the comparable result for 2013.

The dividend was raised by 2 percent to 20.5 pence a share.

For 2015 analysts have on average been predicting earnings of 39.4 pence a share, according to Thomson Reuters data.