Europe's biggest defense contractor BAE Systems (BAES.L) warned on Thursday it expected earnings this year to drop by up to 10 percent as a result of U.S. spending cuts, with conditions still difficult despite a recent budget deal in Congress.

The British group, which had announced on Wednesday that it had at last agreed a price increase on its sale of Eurofighter Typhoon jets to Saudi Arabia, saw its shares suffer their biggest one-day percentage fall since October 2008.

They fell 11.1 percent in early trading to 388.1 pence, wiping 1.5 billion pounds ($2.5 billion) off the firm's market value.

"The storms of U.S. defense cuts ... have passed, but their shadows linger in full-year 2014," said Jefferies analyst Sandy Morris, adding that BAE's earnings per share expectations were 4 to 5 percent lower than Jefferies' forecast of 40.8 pence.

Agency Partners analyst Nick Cunningham called the guidance "very weak" saying that it measured against previous expectations of flat earnings per share.

At 1311 GMT, shares in BAE cut some of their early losses to trade 8.2 percent lower at 401 pence. It was the biggest faller on the FTSE 100 (.FTSE) which was down 0.26 percent.

For 2013 BAE reported a 9 percent rise in underlying earnings per share to 42 pence and said it expected earnings to fall by 5 to 10 percent in 2014, driven down by the combination of U.S. budgetary pressures and the non-recurring benefit from the settlement of the Salam deal with Saudi Arabia, which had already been anticipated in the 2013 result.

Finance Director Peter Lynas said the majority of the forecasted fall in earnings was due to the price settlement, as the company had already delivered 34 of the 72 aircraft sold, meaning that it had recouped the benefits of the pricing deal against those aircraft in last year's results.

Nervousness amongst investors over defense spending cuts was already evident last week when Rolls-Royce's (RR.L) share price tumbled after it said U.S. and European spending cuts would halt a decade-long run of profit growth for the engine maker.

BAE said while a two-year bi-partisan federal budget deal passed by U.S. Congress late last year eased "the significant and indiscriminate cuts that were expected in 2014 and 2015", it expected pressures to reduce spending and address the U.S. deficit to continue.

PAIN

Its U.S. businesses - Intelligence & Security and Land & Armaments - took a non-cash goodwill impairment charge of 865 million pounds in 2013 due to increased weighted average cost of capital and an estimate of reduced U.S. defense spending. It expects Land & Armaments sales to fall 20-25 percent in 2014.

"Budget pressures in some of the group's larger markets are expected to prevail but BAE Systems has a broad-based portfolio," Chief Executive Ian King said.

Lynas, however, said that they believed the U.S. businesses had endured most of the pain in 2013 and that it was close to "bottoming out" in 2014. BAE had previously forecast a decline of 15 percent in its U.S. defense and security units.

Other contractors such as Lockheed Martin (LMT.N) and Raytheon (RTN.N) have also said they expect the brunt of U.S. cuts would be felt this year.

BAE's results for last year were in line with analyst expectations, with underlying earnings before interest, tax and amortization (EBITA) up 3.4 percent at 1.925 billion pounds on sales up 2 percent at 18.2 billion pounds. It maintained its order book backlog at 2012 levels at 42.7 billion pounds.

Analysts on average had expected the company to make a profit at the EBITA level of 1.897 billion pounds, on revenue of 18.8 billion pounds, according to Thomson Reuters data. Earnings per share were on average expected to be 42.5 pence.

The firm's net debt was 699 million pounds, compared with a net cash position of 387 million pounds at the end of 2012, which analysts said was much better than their expectations. BAE's cash flow is traditionally volatile as it is affected by when customers make payments on contracts.

The company also said it would be "upping the pace" on its 1 billion-pound share buyback program following the Salam deal's resolution. So far it has bought back 65 million shares for about 271 million pounds.

On Germany's cancellation of its final shipment of 37 Eurofighter jets, King said BAE would not be affected as it had took the order out of its financial assumptions three years ago.

Following the conclusion of Salam, BAE is still in talks with Saudi Arabia over future contracts, he said.

The company raised its final dividend to 12.1 pence a share from 11.7 a year ago to increase the total payout for the year by 3 percent to 20.1 pence.