Annual Report and Accounts

RNS Number : 7243P

BAE SYSTEMS PLC

30 March 2009

 



Cautionary statement: All statements other than statements of historical fact included in this document, including, without limitation, those regarding the financial condition, results, operations and businesses of BAE Systems and its strategy, plans and objectives and the markets and economies in which it operates, are forward-looking statements. Such forward-looking statements which reflect management's assumptions made on the basis of information available to it at this time, involve known and unknown risks, uncertainties and other important factors which could cause the actual results, performance or achievements of BAE Systems or the markets and economies in which BAE Systems operates to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Nothing in this document shall be regarded as a profit forecast. BAE Systems plc and its directors accept no liability to third parties in respect of this report save as would arise under English law. Accordingly, any liability to a person who has demonstrated reliance on any untrue or misleading statement or omission shall be determined in accordance with section 90A of the Financial Services and Markets Act 2000. It should be noted that section 90A and section 463 Companies Act 2006 contain limits on the liability of the directors of BAE Systems plc so that their liability is solely to BAE Systems plc.

BAE Systems plc - Annual Report 2008

BAE Systems plc has today published its annual report and accounts for the year ended 31 December 2008 ('Annual Report 2008'). The full document can be viewed on the Company's website at:

www.baesystems.com/reporting/

Copies of the annual report and accounts have been posted to those shareholders who have requested to receive communications from the Company in printed form. Copies of the document have also been lodged at the UK Listing Authority's document viewing facility at 25 The North Colonnade, Canary Wharf, London E14 5HS.

This announcement contains regulated information issued in accordance with section 6.3 of the Financial Services Authority's Disclosure and Transparency Rules and accordingly contains certain sections of the Annual Report 2008 in unedited full text. Page references within the text of this announcement are references to pages in the Annual Report that can be viewed as detailed above.

The Annual Report 2008 contains the following responsibility statement:

Responsibility statement of the directors in respect of the annual financial report 

Each of the directors listed below confirms that to the best of his knowledge: 

- the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and 

- the Directors' report includes a fair review of the development and performance of the business, and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. 

Dick Olver	Chairman
Ian King	Chief Executive
Walt Havenstein	Chief Operating Officer - BAE Systems, Inc.
George Rose	Group Finance Director
Phil Carroll	Non-executive director
Michael Hartnall	Non-executive director
Andy Inglis	Non-executive director
Sir Peter Mason	Non-executive director
Roberto Quarta	Non-executive director
Sir Nigel Rudd	Non-executive director
Carl Symon	Non-executive director
Ravi Uppal	Non-executive director

  Chief Executive's review

'The Group performed well with organic growth from well-positioned businesses' 

Ian King Chief Executive

BAE Systems continued to make good progress during 2008 in addressing its strategy to deliver sustainable growth in shareholder value by being the premier global defence and aerospace company. 

The Group performed well with organic growth in our US businesses benefiting from strong demand in their respective market sectors. The Group has also delivered growth from recent acquisitions. Increased profitability is being achieved across this higher volume of business from good programme execution. 

The Group continues to benefit from delivery against its strategic framework. The Group's progression has been achieved through the focus on existing defence capabilities, the broadening to other domains such as the land systems sector, and the substantial expansion of the business footprint across its markets. Activity is starting to increase in India as resources are committed to developing that market. 

In 2008, the Group has further developed the business with targeted value-adding acquisitions.

In June, the acquisition of US-based MTC Technologies was completed. The acquisition focuses on the substantial readiness and sustainment opportunities seen in the US defence market and builds on the Group's established through-life support capabilities. 

Also in June, the acquisition of the Australia-based defence business Tenix Defence was completed, positioning the Group as the industry leader in the Australian defence market with air, land and naval capabilities. The acquisition is another step in progressing the Group's strategy to grow through the provision of through-life capability in partnership with the armed forces in its home markets.

The acquisition of Detica in September addressed the Group's strategy of targeting national security markets. Opportunities are being identified to leverage the Group's system integration capabilities to meet adjacent, non-military, security requirements for government customers. 

The Group will continue to increase emphasis on maximising defence and security capabilities across the home markets in the US, UK, Saudi Arabia, Australia, Sweden and South Africa. In addition, the Group will look to expand where it sees opportunities to establish an industrial presence in new markets, such as India.

Export performance has remained solid with awards including RG-series vehicles to a number of countries, including Spain and Sweden, M777 guns to Canada, CV90 infantry fighting vehicles, and a number of orders for Electronics, Intelligence & Support products, including those in support of US platforms.

In July, BAE Systems completed an agreement with VT Group plc (VT) to consolidate the UK naval shipbuilding industry supported by the signing of the manufacturing contract for the Future Aircraft Carrier programme and by an agreement for the future domestic warship workload with the UK government. The merger of the warship build and support businesses of VT and BAE Systems into the BVT joint venture was achieved in 2008. The joint venture is subject to put and call options and, in January 2009, VT announced that it had decided to exercise its put option to sell its interest in BVT to BAE Systems and that VT expects to be in a position to exercise that option by 1 July 2009. 

Even after the active programme of acquisitions over recent years, good cash generation has enabled 
BAE Systems to maintain a strong balance sheet. Diligent treasury management enabled the Group, during 2008, to avoid the effects of the extreme dislocation in capital markets. Bank counterparty risk has been and continues to be monitored closely on a systematic and ongoing basis, taking account of the size of the institution, its credit rating and its credit default swap price.

The difficult economic environment, and in particular the falls in equity markets in 2008, has affected the Group's pension schemes. Pension scheme funding is regularly reviewed with the Trustees of the schemes. The agreed funding plans have been considered over the longer term and are deemed to continue to be reasonable. An agreement with the Trustees of the Main UK Pension Scheme has recently been concluded following the actuarial valuation carried out as at April 2008. The recovery plan to clear the deficit has been accepted by the Pensions Regulator. 

In May 2008, the Woolf Committee, an independent body appointed by the Board under the chairmanship of Lord Woolf to review the Group's ethical standards, published its report. A steering group and associated working groups have been established to address all 23 recommendations and a plan has been developed for implementation of recommendations within three years. The aim is to establish the Group as a leader in business conduct, not just within our sector but within the global business community.

Consistent with the importance attached to Corporate Responsibility and the drive towards leadership in business ethics, the Group has taken steps to embed such issues more directly in its day-to-day operations. An important part of this drive is the establishment of a Global Code of Conduct in which all employees have a clear understanding of what is expected of them. The Code of Conduct was launched in January 2009 to codify the required standards of personal and business conduct.

The Group has been reorganised and the Executive Committee restructured1. The operating group heads and functional leaders are all now represented on the Executive Committee. 

The Executive Committee's top ten objectives for 2009 are summarised opposite. Many of these objectives are consistent with those from 2008. In particular, the team will remain focused on delivering financial performance, consistent programme execution and developing business in its defined home markets. In addition, further emphasis is being placed on safety performance and the Corporate Responsibility agenda is made a key objective for the executive team in 2009.

A well implemented strategy and good programme execution are only two of the elements of high performance. BAE Systems comprises well over 100,000 talented people working in numerous locations around the globe. The challenge and the opportunity is to further develop the Group as a cohesive, inclusive organisation. The move to embrace a single, Group-wide, high performance culture is creating an environment in which all employees can make a real contribution and be recognised for their part in BAE Systems' drive for continuing success. 

BAE Systems has consistently delivered progressive performance over recent years. BAE Systems is not insulated from the difficult wider economic environment. The Group recognises that defence budgets are likely at some stage in the future to come under further pressure and it will continue to apply conservatism to its planning assumptions. The Group is well positioned, having a large forward order book, a good balance of market positions around the globe, a well spread portfolio of programmes and a strategy to address anticipated priority areas of spend for its customers.

The following pages describe the Group's strategy, its markets and the way the business is managed.

Ian King Chief Executive

1 For more information on the Executive Committee see page 19.

  Financial review

'Another good year, with strong earnings growth and good cash flow generation' 

George Rose Finance Director

- The £46.5bn (2007 £38.6bn) order book1 continues to provide excellent forward  visibility.

- Underlying earnings3 per share has increased by 23% to 37.1p per share (2007 30.1p).

- The total dividend is 14.5p per share (2007 12.8p), an increase of 13.3%.

Order book1 Order book1 increased by 20% to £46.5bn (2007 £38.6bn). Exchange translation, primarily due to the weakening of sterling against the US dollar, accounted for £5.9bn of the increase. Awards for the new 15-year UK munitions capability contract, the UK Future Aircraft Carrier and US land vehicles, together with a net increase from acquisitions and disposals, delivered underlying order book growth. 

Income statement

Summary income statement - continuing operations
	2008 £m	2007 £m
Sales1	18,543	15,710
Underlying EBITA2 (restated)	1,897	1,449
Return on sales	10.2%	9.2%
Profit on disposal of businesses	238	40
Uplift on acquired inventories	-	(12)
Amortisation of intangible assets	(247)	(149)
Impairment of intangible assets	(177)	(148)
Net financial income1	697	93
Taxation expense1	(640)	(373)
Profit for the year	1,768	900

Exchange rates

£/$ - average	1.853	2.002
£/€ - average	1.258	1.461

Sales1 increased by 18% to £18.5bn (2007 £15.7bn). This includes contributions from the MTC, Tenix Defence and Detica businesses acquired during the year (£0.3bn) and a full year of sales from the Armor Holdings business, acquired in July 2007, of £2.3bn (2007 £0.7bn). Like-for-like growth, after adjusting for the impact of exchange translation, and acquisitions and disposals, was 3% primarily driven by high demand for armoured wheeled vehicles in the US, partially offset by a reduction in the UK businesses as the Typhoon programme transitions from Tranche 1 to Tranche 2 deliveries. US-led businesses accounted for 59% (2007 47%) of sales1. Sales1 generated from the Group's six home markets represented 88% (2007 85%) of sales. The Group's sales1 performance is illustrated in the bridge chart opposite.

Underlying EBITA2 (restated) Management uses an underlying profit measure to monitor the year-on-year profitability of the Group, which is defined as earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding profit/(loss) on disposal of businesses and uplift on acquired inventories. This definition, which is referred to as underlying EBITA, has been amended to exclude profit/(loss) on disposal of businesses, which unlike in previous years, is material this year. It is also consistent with the profit measure disclosed in note 3 to the Group accounts on a segmental basis.

Underlying EBITA2 increased by 31% to £1,897m (2007 £1,449m) giving a return on sales of 10.2%, up from last year's 9.2%. The contributions from the businesses acquired in the year totalled a £4m loss and a full year of trading from the ex-Armor Holdings business contributed a profit of £236m (2007 £89m). In the prior year, the Group's Regional Aircraft business recognised net charges of £76m against asset carrying values, although this was largely offset by a one-off gain of £52m on completion of the Brunei Offshore Patrol Vessel arbitration process. Exchange translation, primarily relating to US dollar-denominated businesses, generated £61m of the increase. US-led businesses delivered 57% (2007 53%) of the Group's underlying EBITA2. The increase in underlying EBITA2 is illustrated in the bridge chart opposite.

Profit on disposal of businesses was £238m (2007 £40m). This includes the accounting gain on the disposal of the Group's interests in the businesses contributed to the BVT Surface Fleet joint venture (£121m), and profit on the disposal of the Surveillance & Attack business (£61m) and the Group's interest in Flagship Training (£56m).

Amortisation of intangible assets is £98m higher at £247m reflecting a full year charge in respect of the ex-Armor Holdings business and £35m relating to the businesses acquired during the year.

Impairment of intangible assets totalled £177m (2007 £148m) largely reflecting a reduction in the market value of the Group's interest in Saab of Sweden (£120m) and lower sales volumes in the US-based Products Group business (£40m), which was acquired with Armor Holdings in 2007. The prior year charge included £145m in respect of the Insyte business.

Net financial income1 was £697m (2007 £93m). The underlying net interest charge was £102m (2007 £38m). A net credit of £799m (2007 £131m) arose from pension accounting, marked-to-market revaluation of financial instruments and foreign currency movements. The underlying net interest charge has increased primarily as a result of the cash cost of business acquisitions. The net credit of £799m has increased mainly on the weakening of sterling against the US dollar during the second half of the year. Underlying interest cover was 19 times (2007 38 times).

Taxation expense reflects an effective tax rate of 26% (2007 26%), which is expected to increase to 28% in 2009.

Earnings per shareBasic earnings per share, in accordance with IAS 33 Earnings per Share, from continuing operations, increased by 91% to 49.6p (2007 26.0p). 

Reconciliation from underlying EBITA2 to underlying earnings3 - continuing  operations
	2008 £m	2007 £m
Underlying EBITA2	1,897	1,449
Net financial expense excluding non-cash finance movements on pensions and financial derivatives, and interest on the debt instrument of the convertible preference shares	(102)	(25)
	1,795	1,424
Taxation	(467)	(371)
Interest on the debt instrument of the convertible preference shares	-	(13)
Minority interests	(23)	(21)
Underlying earnings3	1,305	1,019
Weighted average number of shares	3,519m	3,386m
Underlying earnings3 per share	37.1p	30.1p

Underlying earnings3 per share from continuing operations was 37.1p (2007 30.1p), an increase of 23%. The increase in underlying earnings3 per share is illustrated in the bridge chart opposite.

DividendsThe Board is recommending a final dividend of 8.7p per share (2007 7.8p), bringing the total dividend for the year to 14.5p per share (2007 12.8p), an increase of 13.3%.

The proposed dividend is covered 2.6 times by underlying earnings3 from continuing operations (2007 2.4 times), which is consistent with the Group's policy of growing the dividend whilst maintaining a long-term sustainable earnings cover of approximately two times.

  Balance sheet

Summary balance sheet
	2008 £m	2007 £m
Intangible assets	12,306	9,559
Property, plant and equipment, and investment property	2,558	1,887
Equity accounted investments and other investments	1,040	787
Other financial assets and liabilities (net)	240	52
Tax assets and liabilities (net)	256	63
Assets held for resale	-	64
Retirement benefit obligations	(3,325)	(1,570)
Working capital	(5,825)	(5,540)
Net cash as defined by the Group4	39	700
Net assets	7,289	6,002

Exchange rates

£/$ - year end	1.451	1.988
£/€ - year end	1.042	1.361

Favourable exchange translation, principally in respect of the Group's US-dollar denominated businesses, increased net assets by £1,004m (2007 £42m).

The £2.7bn increase in intangible assets to £12.3bn (2007 £9.6bn) mainly reflects goodwill on the acquisition of MTC (£0.1bn), Tenix Defence (£0.3bn) and Detica (£0.4bn), plus US dollar exchange translation of £2.1bn.

The movement in retirement benefit obligations during the year was as follows:

	£m
Deficit in defined benefit pension plans at 1 January 2008	(1,999)
Decrease in liabilities due to changes in assumptions	1,433
Actual return on assets below expected returns	(3,724)
Contributions over service cost	321
Transfers arising on acquisitions	(8)
Exchange translation	(240)
Other movements	62
Deficit in defined benefit pension plans at 31 December 2008	(4,155)
US healthcare plans	(61)
Total IAS 19 deficit	(4,216)
Allocated to equity accounted investments and other participating employers	891
Group's share of IAS 19 deficit at 31 December 2008	(3,325)

The net effect of worse than expected investment returns, an increase in real discount rates and the inclusion of an allowance for a minimum rate of future annual improvements in the mortality assumption has resulted in the Group's share of the pre-tax pension deficit increasing to £3,325m from £1,570m at 31 December 2007.

Further disclosure on the above is provided in note 22 to the Group accounts.

A net deferred tax asset of £1,115m (2007 £522m) relating to the deficit above is included within net tax assets and liabilities and disclosed in note 8 to the Group accounts.

  Cash flow

Reconciliation of cash inflow from operating activities to net cash
	2008 £m	2007 £m
Cash inflow from operating activities	2,009	2,162
Capital expenditure (net) and financial investment	(503)	(262)
Dividends received from equity accounted investments	89	78
Operating business cash flow	1,595	1,978
Interest and preference dividends	(98)	(65)
Taxation	(261)	(112)
Free cash flow	1,236	1,801
Acquisitions and disposals	(1,001)	(1,574)
Debt acquired on acquisition of subsidiary	(37)	(538)
(Purchase)/issue of equity shares	(27)	603
Equity dividends paid	(478)	(396)
Dividends paid to minority interests	(11)	(1)
Preference share conversion	-	245
Cash outflow from matured derivative financial instruments	(440)	(14)
Movement in cash collateral	106	9
Other non-cash movements	339	62
Foreign exchange	(374)	36
Movement in cash on customers' account5	26	32
	(661)	265
Opening net cash as defined by the Group4	700	435
Closing net cash as defined by the Group4	39	700
The components of net cash as defined by the Group4 are as follows:
	2008 £m	2007 £m
Debt-related derivative financial assets - non-current	203	-
Term deposits - current	-	164
Cash and cash equivalents	2,624	3,062
Loans - non-current	(2,608)	(2,197)
Loans - current	(154)	(283)
Overdrafts - current	(19)	(16)
Loans and overdrafts - current	(173)	(299)
Cash on customers' account5 (included within trade and other payables)	(7)	(30)
Closing net cash as defined by the Group4	39	700

There was an outflow from net capital expenditure and financial investment of £503m (2007 £262m), which included £183m (2007 £52m) in respect of new residential and office facilities in Saudi Arabia.

Dividends received from equity accounted investments, primarily BVT, MBDA, Saab and Eurofighter, totalled £89m (2007 £78m).

Interest and preference dividends increased to £98m (2007 £65m) largely reflecting the cash cost of business acquisitions.

Taxation payments increased by £149m to £261m (2007 £112m) mainly as a result of the higher profits generated by the Group.

During the year, the Group acquired MTC, Tenix Defence and Detica for cash consideration totalling £1.1bn. The cash outflow for acquisitions and disposals of £1.0bn is shown net of the proceeds from the disposal of the Group's Surveillance & Attack business and its 50% interest in Flagship Training, which amounted to £134m. Net cash outflow relating to other acquisitions and disposals was £74m. In 2007, the Group acquired Armor Holdings for $4.5bn (£2.2bn).

The Group has financed part of its investment in the US through an intercompany loan. As at 31 December 2008, $2.1bn of a total of $6.6bn was hedged using a rolling programme of short-term foreign exchange hedges. As a consequence of the strengthening of the US dollar, there has been a cash outflow from matured derivative financial instruments of £440m in the second half of 2008 from rolling these hedges into 2009.

Foreign exchange translation during the year, primarily in respect of the Group's US dollar-denominated borrowing, decreased reported cash by £374m (2007 increased reported cash by £36m).

1    Including share of equity accounted investments. 

2    Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding profit/(loss) on disposal of businesses and uplift on acquired inventories. Restated to exclude profit/(loss) on disposal of businesses. 

3    Earnings excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, profit/(loss) on disposal of businesses and uplift on acquired inventories. Restated to exclude profit/(loss) on disposal of businesses. 

4    See note 29 to the Group accounts.

5    Cash on customers' account is the unexpended cash received from customers in advance of delivery which is subject to advance payment guarantees unrelated to Group performance.

  Operating group reviews

Electronics, Intelligence & Support

The Electronics, Intelligence & Support operating group, with 33,900 employees1 and headquartered in the US, designs, develops, produces and services systems and subsystems for a wide range of military and commercial applications. The operating group comprises four lines of business: Electronic Solutions, Information Solutions, Platform Solutions and Support Solutions.

Financial highlights

– Like-for-like organic sales1 growth of 6% over 2007

– Underlying EBITA2 includes a credit of £23m from share scheme mark-to-market accounting

– Order book1 increased

Performance

	2008	2007	2006
Sales1	£4,459m	£3,916m	£4,007m
Underlying EBITA2 (restated)	£506m	£437m	£429m
Return on sales	11.3%	11.2%	10.7%
Cash inflow3	£380m	£302m	£273m
Order intake1	£4,904m	£4,178m	£4,311m
Order book1	£5.2bn	£3.5bn	£3.4bn

Key points

- Maintained leadership in electronic warfare systems

- Won key IT, situational awareness and aviation sustainment contracts

- Addressing market for vehicle power management systems

- Sustained leadership in US non-nuclear ship repair

- Increased research and development investment

Looking forward 

BAE Systems projects further growth as it delivers on its record order book and builds on existing enterprise capabilities, and continued research and development expenditure, to meet expected customer demand in cyber-space activity, and through-life product support of defence and aerospace electronics programmes. Growth in services, mission support and sustainment markets is expected to continue.

In 2008, Electronics, Intelligence & Support (EI&S) achieved underlying EBITA2 of £506m (2007 £437m) on sales1 of £4,459m (2007 £3,916m) and generated operating cash inflow3 of £380m (2007 £302m). 

On a like-for-like basis, sales1 growth was 6% over 2007. 

In June, BAE Systems completed the acquisition of MTC Technologies which contributed post-acquisition sales1 of $181m (£98m) and underlying EBITA2 of $2m (£1m). 

Electronic Solutions 

The low-rate initial production contract for the US Navy's decoy system on the F/A-18 E/F Super Hornet was received. The system provides aircraft defence against radar-guided missiles. 

The F-35 Lightning II low-rate initial production (LRIP) of two electronic warfare suites continues, with existing funding providing deliveries through to 2012.

BAE Systems was selected as a partner in developing and producing the Airborne Maritime Fixed Station Joint Tactical Radio Systems (JTRS), which will consist of software-defined radios that enable commanders to share information across ships, enhance decision-making, and increase mission capability. With this award, BAE Systems is now a partner on all five programmes that comprise JTRS, the family of software-programmable tactical radios that will permit combat personnel to communicate at every level of command.

Deliveries commenced under a five-year contract to provide thermal imaging modules for the US Army's Common Remotely Operated Weapon System that allows soldiers to detect and identify targets while remaining protected in their vehicles. To date, orders received under this contract total $110m (£76m). A $169m (£116m) extension from the US Army for continued production of thermal weapon sights was received. This programme has a production rate of 1,500 units per month, with more than 37,000 delivered by the end of 2008. 

In support of homeland security and safety, JETEYE®, the infrared aircraft missile defence system, began its nine-month evaluation aboard civilian passenger aircraft in July and First InterComm™, an interoperable communications and data solution system for first responders, has been deployed in seven US states. 

US defence research and development programmes launched in 2008 included bio-inspired, miniature, intelligence-gathering robots, tactical ultra-low visibility communications, advanced night vision technology, and all-weather advanced persistent surveillance systems. These programmes represent the strengthening of core business areas as well as advances into new market areas.

Information Solutions

Our Information Technology business continues to be ranked in the top 25 by Computer World Magazine as a Best Place to Work in IT. 

Five multiple and one single-award indefinite delivery/indefinite quantity contracts were received in the year, including a position on the Defense Information Systems Agency's Encore II contract. 

Platform Solutions

Following the launch of its improved HybriDrive® propulsion system, BAE Systems' partner, Alexander Dennis, delivered its first double-deck hybrid electric bus to Transport for London with the buses scheduled to enter revenue-service testing in 2009. BAE Systems also expanded the global reach of the HybriDrive® programme by entering into agreements with Japan's ISUZU and North America's New Flyer Industries. 

Collaborating with Land & Armaments, the business will provide power management components on board the Warrior demonstration vehicle supporting the UK Ministry of Defence programme to create an architecture that allows vehicles to power systems such as communications and electronic warfare suites. The same architecture will allow future upgrades to add more accessories and convert hydraulic systems to electrically powered systems.

Support Solutions 

The US Air Force named BAE Systems one of 12 prime contractors on the Future Flexible Acquisition and Sustainment Tool contract. This indefinite delivery/indefinite quantity contract, under which prime contractors compete for task orders, has a total potential value of $6.9bn (£4.8bn). The contract will address future US Air Force requirements for modifications, development, and maintenance of weapon systems managed by the US Air Force and Air Force Special Operations Command.

BAE Systems received a US Air Force contract to support the Tactical Air Control Party (TACP) Modernisation Vehicular Communications System programme. With an initial value of $120m (£83m) and a maximum potential value of $233m (£161m), BAE Systems will design, produce and install state-of-the-art communications for up to 400 TACP ground vehicles. 

In the ship repair business, work continues at the San Diego shipyard to maintain, repair, and modernise the guided missile cruiser USS Bunker Hill, and efforts are progressing on a five-year multi-ship, multi-option contract to maintain and repair all Arleigh Burke-class destroyers. The US Navy awarded BAE Systems a post-shakedown availability contract for destroyers and a multi-ship multi-option award for repairs to mine countermeasures ships. 

In June, the acquisition of MTC Technologies provided the business with increased technical and professional service capabilities, and equipment integration and modernisation capabilities for the US military and intelligence customers. 

In 2008, the Technology Solutions and Services business won all of its major recompetes.

  Land & Armaments

The Land & Armaments operating group, with 21,300 employees1 and headquartered in the US, is a global leader in the design, development, production, through-life support and upgrade of armoured combat vehicles, tactical wheeled vehicles, naval guns, missile launchers, artillery systems and munitions.

Financial highlights

- Like-for-like organic sales1 growth of 38% over 2007

- UK business secured a 15-year munitions partnering agreement with growth potential to £3bn

- Ex-Armor Holdings business performing ahead of expectations

Performance

	2008	2007	2006
Sales1	£6,407m	£3,538m	£2,115m
Underlying EBITA2 (restated)	£566m	£324m	£168m
Return on sales	8.8%	9.2%	7.9%
Cash inflow3	£467m	£10m	£137m
Order intake1	£8,568m	£4,535m	£2,964m
Order book1	£11.5bn	£7.3bn	£4.9bn

Key points

- High volume of vehicle reset and upgrade activity

- Successfully addressed US mine protected vehicle requirements

- 15-year UK munitions partnering agreement secured

- Wheeled armoured vehicle successes

- Joint Light Tactical Vehicle down select

Looking forward

After a period of significant growth primarily driven by deliveries on the short-term Mine Resistant Ambush Protected programme, demand in the medium term is expected to be influenced by the tempo of operations in Iraq and Afghanistan. 

Land & Armaments will continue to pursue opportunities globally leveraging leadership positions in Tracked Combat Systems, Medium Tactical Vehicles, Mine Resistant Vehicles, Armour and Survivability Technologies and Artillery Systems. 

In 2008, Land & Armaments achieved underlying EBITA2 of £566m (2007 £324m) on sales1 of £6,407m (2007 £3,538m) and generated operating cash inflow3 of £467m (2007 £10m). The 2008 results included sales1 of $3.1bn (£1.7bn) from the largely completed Mine Resistant Ambush Protected (MRAP) programme. The results include a full year of operations from the former Armor Holdings, Inc. business acquired in July 2007.

United States 

The MRAP vehicle programme was largely completed in 2008, with global production of 4,714 mine protected vehicles. 

In addition to the MRAP programmes, continued growth was secured in the area of vehicle armour protection, most notably for the High Mobility Multi-purpose Wheeled Vehicles (HMMWV) and individual soldier protection. The business was also awarded a $3.7bn (£2.6bn) contract for the production of 20,000 Family of Medium Tactical Vehicles (FMTVs).

The sole-sourced Medium Mine Protected Vehicle (MMPV) programme was awarded with orders in 2008 totalling $110m (£76m). The MMPV contract envisions production of up to 2,500 vehicles at a potential value of $2.2bn (£1.5bn) through to 2015.

BAE Systems continued to serve as the premier support agency for the US Army Heavy Brigade Combat Team, providing remanufacturing and reset for key brigade components, including the Bradley Fighting Vehicle, as well as unveiling mortar and ambulance variants of the Bradley.

BAE Systems secured two technology development contracts for the US multi-service Joint Light Tactical Vehicle (JLTV). These 27-month contracts are the next step in selecting a new generation of tactical vehicles. 

In the year, BAE Systems unveiled the first Non-Line-of-Sight Cannon (NLOS-C) for the US Army's Future Combat Systems Manned Ground Vehicles programme. Two vehicles are undergoing firing and mobility tests at Army testing facilities, with four additional vehicles undergoing integration. Along with the NLOS-C deliveries, successful test firing continued for the NLOS-C mortar platform.

BAE Systems' 57mm Mk 110 Naval Gun System was selected for the National Security Cutter and Littoral Combat Ship programmes, the gun systems entering into service in August and November, respectively. 

United Kingdom

The munitions business secured a 15-year partnering agreement with growth potential to £3bn from the UK Ministry of Defence (MoD) in August covering the supply of approximately 80% of general munitions consumed by UK Armed Forces, including small arms and medium-calibre ammunition, mortar bombs, tank ammunition and artillery shells. Under the contract, BAE Systems will invest over £120m in new, highly-automated facilities.

The Weapons & Vehicles business secured significant work supporting operations in Iraq and Afghanistan, particularly in carrying out urgent upgrades to vehicles such as Bulldog, CVR(T), Warrior and Panther to protect against rapidly-evolving threats. The commitment and support given by the business to finding innovative solutions for Urgent Operational Requirements (UORs) in very tight timescales has been recognised by the customer on several occasions and 15 employees were awarded campaign medals by the MoD for their support in theatre. 

Production of the M777 155mm lightweight howitzer programme continues, with 168 guns delivered in 2008 and a total of 737 guns ordered to date, to the US and Canadian armed forces. The M777 system has been deployed in operations in both Iraq and Afghanistan. 

Requirements and schedule changes on the challenging Terrier armoured tractor programme have now been agreed with the customer. The programme has been rebaselined, and includes further improvements to protection levels and the robustness of the vehicle. Pre-production and proving of the Terrier will commence in 2009. 

Sweden 

The Swedish business underwent two restructuring measures in the year in order to better position the business to match future strategic demands.

A contract for 20 BvS10 VIKING amphibious armoured all-terrain vehicles was received from the UK MoD, bringing the total number of vehicles ordered by the MoD to 149. 

BAE Systems is partnered with Raytheon on the Excalibur artillery programme, the next generation family of guided projectiles for the US Army and Marine Corps artillery. 

The 155mm Archer self-propelled Artillery System has been selected by Sweden and Norway with contracts to be awarded for up to 48 systems.

South Africa 

The South African business benefited significantly in the year from support to the US MRAP programme as well as the growing international requirement for mine-protected wheeled vehicles. A total of 475 RG31s were delivered to customers worldwide in 2008 bringing the total of RG31s sold to over 2,200. The business acquired IST Dynamics in August 2008, building on its systems integration capability, particularly in the areas of Turret Systems and Fire-Control Systems.

  Programmes & Support

The Programmes & Support operating group, with 30,200 employees1, comprises the Group's UK-based air and naval activities, the activities of the acquired Detica security business and the Integrated System Technologies business.

Financial highlights

– Sales1 reduced over 2007 on Brunei OPV completion and transition to Typhoon Tranche 2 deliveries

– Return on sales1 improved to 10.6%

– Typhoon Tranche 2 pricing agreed

Performance

	2008	2007	2006
Sales1	£4,638m	£5,327m	£4,615m
Underlying EBITA2 (restated)	£491m	£456m	£331m
Return on sales	10.6%	8.6%	7.2%
Cash inflow3	£651m	£807m	£449m
Order intake1	£4,195m	£9,091m	£5,178m
Order book1	£19.8bn	£20.9bn	£17.0bn

Key points

- Successful transition to start of Typhoon Tranche 2 deliveries

- BVT naval joint venture formed

- Manufacturing contract for Future Carriers secured

- Detica acquisition completed

- First Type 45 successfully delivered off contract

Looking forward

Programmes & Support is driven by its existing order book and the level of future UK MoD funding to meet current UK armed forces operational requirements and delivery of the Defence Industrial Strategy.

The BVT joint venture is underpinned by the six ship Type 45 programme, the manufacturing phase of the Future Aircraft Carrier (CVF) programme and export contracts. 

Detica's position in the UK market means that it is well-positioned to benefit from increasing government focus on intelligence, security and resilience. 

During 2008, Programmes & Support achieved underlying EBITA2 of £491m (2007 £456m) on sales1 of £4,638m (2007 £5,327m) and generated an operating cash inflow3 of £651m (2007 £807m). The lower sales1 in 2008 reflect the transition from Typhoon Tranche 1 deliveries to Tranche 2 and completion in 2007 of the Brunei Offshore Patrol Vessel (OPV) contract. The acquisition of Detica in September contributed sales1 and underlying EBITA2 of £55m and £9m, respectively.

Military Air Solutions

Military Air Solutions is responsible for delivering a range of military programmes including Typhoon, Hawk, Nimrod MRA4, F-35 Lightning II and autonomous air vehicles. In addition, it is responsible for through-life support to Harrier, Hawk, Tornado, Nimrod MR2, E-3D Sentry and VC-10 aircraft.

The business made good progress during 2008 in delivering on its programme commitments. Work continues with the UK MoD to explore whether a long-term partnering agreement (LTPA) in the air sector may provide mutual value to both parties. 

Delivery of Typhoon aircraft to the four partner nations continues with a cumulative total of 57 aircraft delivered to the UK and 97 to the other European partner nations. All Tranche 1 aircraft have now been delivered and Tranche 2 deliveries commenced. In October, the first flight of a Typhoon aircraft for the Saudi customer took place marking the start of the flight test programme.

In the UK, Royal Air Force (RAF) Typhoons are operational in Air Defence and Quick Reaction Alert roles, and have a full multi-role capability. Discussions to establish a long-term, availability-based support contract are progressing. Work has also commenced on further air-to-ground capability enhancements. Discussions regarding the Tranche 3 requirements of each of the four partner nations are ongoing. 

On the Hawk contract for India, 23 of the UK-built aircraft have been accepted by the customer and have been inducted to the Indian Air Force. Customer acceptance of the last of the 24 Hawk aircraft for South Africa took place in November. 

The first five South African Gripen aircraft have been accepted by the customer to plan.

Aircraft acceptances of the Hawk Mk128 Advanced Jet Trainer for the RAF are expected to commence in early 2009, with RAF pilots then starting their Mk128 conversion flying programme. Support under the Hawk Integrated Operational Support programme, and provision of synthetic training to RAF fast jet pilots, continues at RAF Valley.

The current Nimrod MRA4 aircraft development programme is progressing with completion of the flight test programme and qualification of the aircraft systems expected during 2009. All nine production standard aircraft are in manufacture. 

The contracts for VC-10, Sentry and Nimrod MR2 aircraft support continue, and a contract expansion for much of the on-base engineering, logistics and technical support for the VC-10 has been secured.

The Tornado availability programme, ATTAC, is in full service and continues to perform in line with contractual milestones. 

The Harrier GR9 upgrade programme is on schedule. The Harrier aircraft is currently providing close air support to UK military operations overseas. Discussions are progressing on contracting for a Harrier availability service.

All three F-35 Lightning II aircraft variants, Carrier, Conventional Take-Off and Landing, and Short Take-Off and Vertical Landing (STOVL), are now in various stages of manufacture and assembly. The STOVL variant had its maiden flight in June. Low-rate initial production continues under contract from Lockheed Martin.

BAE Systems continues to leverage its expertise in Unmanned Aircraft Systems (UAS) and position itself in this growth market. In addition to the existing Taranis programme, which is a key enabler to the UK MoD's evaluation of future requirements, BAE Systems has entered into a jointly funded UK MoD Mantis advanced technology demonstrator programme. The aim of this programme is to demonstrate the potential of a large unmanned system to support future operational needs. The UAS portfolio also includes the HERTI surveillance system. The pre-production HERTI unmanned air system has been operating at fully active overseas customer airbases integrated with manned platform operations. 

The redundancy programme announced in April affecting over 600 jobs at the Brough and Woodford sites is progressing towards its 2010 completion.

BVT Surface Fleet Limited (BVT) (55% interest)

The joint venture between BAE Systems and VT Group (VT) was formed on 1 July 2008, creating the UK's leading provider of surface warship building and through-life support operations. Following formation, BVT signed the manufacturing contract for the Future Aircraft Carrier (CVF) and has assumed overall responsibility for delivery of the programme, including project management, engineering, shipbuild and integration. BVT is also responsible for the engineering and build of blocks 2 and 4. The cutting of steel for the first ship is planned for spring 2009.

The programme to build six Type 45 Destroyers has progressed well during the year with all key milestones being achieved, including the successful completion of sea trials and acceptance off contract by the customer of the first of class ship, HMS Daring.

Both contracts to build three Ocean Patrol Vessels for the Royal Navy of Oman and three Offshore Patrol Vessels for the Trinidad and Tobago Coastguard are projected to incur significant losses. Consistent with estimates provided by BVT management, loss provisions of £96m (£53m at our 55% share) have been recorded through fair value accounting. As a result of a review of these export contracts, which were contributed by VT into BVT, BAE Systems is in negotiation with VT regarding a possible injection of capital by VT into the BVT business.

In September 2008, a contract was received to support the construction of two further Fast Attack Craft for the Hellenic Navy, building on the successful contract for the previous five vessels.

The last of the three ex-Royal Navy Type 23 frigates for the Chilean Navy completed its reactivation and was handed over to the customer. 

In January 2009, VT announced that it has decided to exercise its put option to sell its interest in BVT to BAE Systems and that it expects to be in a position to exercise that option by 1 July 2009.

Submarine Solutions 

In a challenging year for the Astute programme, HMS Astute, the first of class, is now scheduled for delivery to the customer at the end of 2009. Orders have been received to continue the build of boat 4 and for long lead items on boat 5. 

Detica 

BAE Systems acquired Detica, a leading UK consultancy servicing the counter-threat agenda, in September 2008. Detica employs 1,400 staff. Detica helps its clients tackle terrorism and serious crime by helping them collect, manage and exploit information to reveal actionable intelligence. Services range from business and technology consulting, system integration and support to the sale of proprietary hardware and software.

Detica assists clients with initiatives in areas such as counter-terrorism, serious and organised crime, and immigration and border control, as well as fraud detection and identity management through its sales of Detica NetReveal® software. Its financial services business remains challenged by current market conditions.

Detica's sales for the full year increased by 20% on 2007 reflecting higher sales to the UK government and, in particular, growth in sales of Detica NetReveal® software.

Integrated System Technologies (Insyte) 

Following the successful sea trials of the first of class Type 45 destroyer, HMS Daring, during 2008, the Sampson Radar, Combat Management System and Long Range Radar are all now fitted to the next three ships.

The Seawolf Mid-Life Update system has now passed successful system harbour trials and is undertaking sea trials on the Type 23 HMS Sutherland.

The establishment of the Maritime Composite Training Systems, state-of-the-art training facilities at HMS Collingwood and Royal Naval Base Devonport, will be achieved in 2009.

The Sting Ray lightweight torpedo programme remains ahead of schedule with the fourth batch of production weapons accepted by the customer in November 2008. Progress on securing an export order for this torpedo is well advanced.

  International

The International operating group, with 19,200 employees1, comprises the Group's businesses in Saudi Arabia and Australia, together with a 37.5% interest in the pan-European MBDA joint venture, a 20.5% shareholding in Saab of Sweden and a 49% shareholding in Air Astana.

Financial highlights

– Aggregate return on sales1 maintained at 13% for the sector

– Cash inflow3 reflects utilisation of advances received in 2007 on the Salam Typhoon programme

– Post-acquisition sales1 of £130m from Tenix Defence

Performance

	2008	2007	2006
Sales1	£3,333m	£3,359m	£3,428m
Underlying EBITA2 (restated)	£435m	£435m	£412m
Return on sales	13.1%	13.0%	12.0%
Cash inflow3	£163m	£678m	£171m
Order intake1	£4,065m	£3,876m	£3,854m
Order book1	£11.0bn	£7.9bn	£7.1bn

Key points

- Saudi Typhoon programme (Salam) progressing to schedule

- Tenix Defence acquisition completed; price adjustments in negotiation

- Impairment taken of £120m on Saab carrying value

Looking forward

The Group seeks to sustain its long-term presence in the Kingdom of Saudi Arabia through delivering on current programme and industrialisation commitments, and developing new business. In Australia, the acquisition of Tenix Defence and reinforcement of the business as through-life capability partner to the Australian Defence Force across all domains, are expected to provide growth in the near term.

During 2008, the International operating group achieved underlying EBITA2 of £435m (2007 £435m) on sales1 of £3,333m (2007 £3,359m) and generated an operating cash inflow3 of £163m (2007 £678m) as advances received in 2007 on the Salam Typhoon programme were utilised. In June 2008, BAE Systems completed the acquisition of Tenix Defence, which contributed sales1 of £130m and a £12m post-acquisition loss2 after including integration costs.

CS&S International  

BAE Systems has a major presence in the Kingdom of Saudi Arabia where it acts as prime contractor for the UK government-to-government defence agreement. Progress continues to be made to modernise the Saudi armed forces in line with the Understanding Document signed in December 2005 between the UK and Saudi Arabian governments. 

Under the 2007 contract for the supply of 72 Typhoon aircraft, the first aircraft remains on schedule for delivery in June 2009. Discussions continue with the Royal Saudi Air Force (RSAF) to agree the support and training solutions for the aircraft to enable their entry into service during 2009. 

The support provided under the Saudi British Defence Co-operation Programme continues to provide operational capability to both the RSAF and Royal Saudi Naval Forces operations. In particular, work is ongoing in partnership with the RSAF to maintain and enhance the capability of the Tornado aircraft while extending its operational life. 

In addition to some 1,500 employees in the UK, around 4,400 people are employed by the Group in the Kingdom of Saudi Arabia of whom approximately half are Saudi nationals. The business continues to develop its presence in Saudi Arabia and remains committed to developing a greater indigenous capability in the Kingdom. 

The security of employees is the highest priority and new residential and office facilities were completed in 2008, incorporating increased security measures and a greater range of pastoral and recreational facilities for the workforce. Further facilities will be completed in 2010.

Work is ongoing at a senior level to refine the strategy for securing a greater proportion of business in the land sector. The Royal Saudi Land Forces are anticipated to require upgrades and capability enhancements in future years. 

Australia  

Following the acquisition of Tenix Defence during 2008, including 100% of the former joint venture company Tenix Toll Defence Logistics, BAE Systems is now the largest defence contractor in Australia. This acquisition has ensured that BAE Systems Australia can offer capability across the aerospace, land, maritime and joint domains. 

BAE Systems Australia is a subcontractor to Boeing to deliver the ground and air subsystems of the Wedgetail Airborne Early Warning and Control programme. Wedgetail has experienced significant schedule delays and cost overruns. An agreement was reached with Boeing that defines and concludes the Group's role in delivering the ground subsystem by June 2009. 

The Australian government has re-evaluated its requirements under the Land 121 contract for the supply of medium and heavy tactical trucks and is issuing a revised Request for Tender. BAE Systems Australia remains in the competition with responsibility for tendering (and carrying out the project) transferred from BAE Systems Inc. to BAE Systems Australia.

Major programmes now in BAE Systems Australia's portfolio following the Tenix Defence acquisition include the prime contract for the supply of two Landing Helicopter Dock (LHD) ships to the Royal Australian Navy, and the supply of one multi-role, two offshore and four inshore patrol vessels to the New Zealand Ministry of Defence. The LHD programme is in the early stages of a fixed price development programme that will need continued focus to deliver the contracted outcomes. The multi-role vessel under the New Zealand contract has been accepted by the customer, but a number of warranty claims have subsequently been made. The remaining vessels will be progressively presented for acceptance in 2009. The completion accounting process for the Tenix Defence acquisition is ongoing. 

Saab (20.5% shareholding) 

Saab's sales were SEK23.8bn (£2.0bn), with export sales accounting for 68%. Operating income was SEK166m (£14m), producing an operating margin of 0.7%. 

The Group has taken an impairment of £120m against the carrying value of its shareholding in Saab, reflecting a significant reduction in Saab's share price during the year.

MBDA (37.5% interest)  

MBDA's performance in 2008 delivered an increasing return on sales on broadly unchanged sales volume. 

Key domestic production deliveries included Mica air-to-air missiles, Aster surface-to-air missiles, Seawolf naval air defence missiles and Taurus cruise missiles. 2008 saw the completion of deliveries on the UK MoD's Brimstone air-to-ground missile programme and export deliveries of an air weapons package to Greece. MBDA delivered over 2,500 missiles in 2008.

Development programmes continue to progress well. 2008 saw a number of successful development firings on key programmes, including the Meteor and Aster weapon systems. 

As the UK MoD's designated lead contractor in managing its complex weapons sector under the Defence Industrial Strategy, MBDA secured a series of important Assessment Phase contracts for new programmes, including the Fire Shadow loitering munition which was successfully fired early in 2008, completing a rapid development demonstrator programme lasting just 15 months. An important contract amendment has also been received on the Meteor (air-to-air missiles) development contract to re-align the programme to a revised customer timetable. A 15-year availability contract to support the Seawolf missile system was secured. 

A key export contract win was for the £398m Spada air-to-surface weapon system to Pakistan.  

  HQ & Other Businesses

HQ & Other Businesses, with 1,800 employees1, comprises the regional aircraft asset management and support activities, head office and UK shared services activity, including research centres and property management.

Financial highlights

- FRIP dispute settled with all major reinsurers

Performance

	2008	2007	2006
Sales1	£235m	£243m	£295m
Underlying EBITA2 (restated)	£(101)m	£(203)m	£(146)m
Cash (outflow)/inflow3	£(66)m	£181m	£(225)m
Order intake1	£212m	£345m	£267m
Order book1	£0.4bn	£0.4bn	£0.3bn

Looking forward

Market conditions in the aircraft asset management business are increasingly challenging given the economic downturn and restrictions on available credit to higher risk customers which is an increasing feature of new markets. Losses are expected to continue at levels comparable to 2008.

During 2008, HQ & Other Businesses reported a loss2 of £101m (2007 loss2 £203m) on sales1 of £235m (2007 £243m) and had an operating cash outflow3 of £66m (2007 inflow3 £181m). Of this, the reported loss2 for Regional Aircraft was £17m (2007 £105m) with operating cash outflow3 of £3m (2007 inflow3 £175m).

The commercial aircraft market has become increasingly challenging with the tightened availability of funding to aircraft operators due to the global credit issues and economic slowdown. Oil prices have been high over the year impacting operator profitability and their operational cash flows. Discussions are ongoing with operators as to their future fleet requirements and marketing activity is focused on both uncontracted idle and returning aircraft. During 2008, the Regional Aircraft business placed 75 aircraft through new leases, extensions with existing customers and sales. Support revenues have fallen on lower demand for aircraft components and services. Power-by-the-hour contracts worth £43m in 2008 were secured.

Historically, much of the leasing business has been underpinned by the Group's Financial Risk Insurance Programme (FRIP) which made good shortfalls in actual lease income against originally estimated future income for a 15-year period from 1998 to 2013. Since 2006, the Group and certain reinsurers have been in dispute over several areas of the policy. During 2007 and 2008, agreements were reached with all major reinsurers and settlements paid by them. 

The balance sheet carrying value of aircraft (£240m) is based on the net present value of forecast future net leasing or disposal income and reflects the current adverse economic climate.

1    Including share of equity accounted investments.

2    Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding profit/(loss) on disposal of businesses and uplift on acquired inventories. Restated to exclude profit/(loss) on disposal of businesses. See page 29.

3    Net cash (outflow)/inflow from operating activities after capital expenditure (net) and financial investment, and dividends from equity accounted investments.

  Principal risks

Defence spending

The Group is dependent on defence spending and reductions in such spending could adversely affect the Group.

Description: The Group's core businesses are primarily defence-related, selling products and services directly and indirectly primarily to the US, the UK, the Saudi Arabian and other national governments. In any single market, defence spending depends on a complex mix of political considerations, budgetary constraints and the ability of the armed forces to meet specific threats and perform certain missions. Because of these factors, defence spending may be subject to significant fluctuations from year to year. 

Although the Group expects growth in US defence spending to slow, it believes it is well placed to support the US Department of Defense's likely emphasis on force sustainment, readiness and affordable transformation. The UK defence equipment budget is expected to continue to be constrained, having potential implications for the sustainability of long-term funding for future defence technologies and engineering capabilities in the UK. Saudi Arabia is expected to remain one of the heaviest defence spenders in the world.

Impact: A decrease in defence purchases by the Group's major customers could have a material adverse effect on the Group's future results of operations and financial condition.

Mitigation: The Group's business is geographically spread across six home markets and its products are marketed across a range of sectors within the defence arena. In addition, the Group uses realistic assumptions to underpin its financial and operational planning.

Large contracts

Certain parts of the Group's business are dependent on a small number of large contracts.

Description: A significant proportion of the Group's revenue comes from a small number of large contracts. These contracts individually are typically worth or potentially worth £1bn or more including, but not limited to, those contracts in the Programmes & Support operating group. 

Impact: The loss, expiration, suspension, cancellation or termination of any one of these contracts, for any reason, could have a material adverse effect on the Group's future results of operations and financial condition.

Mitigation: The Board regularly reviews the Group's performance in these markets, and the Executive Committee continues to work closely with its customers to ensure the Group strategy is aligned with theirs (refer to Strategy section on page 10).

Government contracts

The Group's largest customer contracts are government contracts.

Description: The governments of the United Kingdom, the United States and the Kingdom of Saudi Arabia are the Group's three largest end customers. Any significant disruption or deterioration in the relationship with these governments and a corresponding reduction in government contracts would significantly reduce the Group's revenues. Moreover, companies engaged in the supply of defence-related equipment and services to government agencies are subject to certain business risks particular to the defence industry. These governments could unilaterally cancel, suspend or amend their contractors' funding under existing contracts or eligibility for new contracts potentially at short notice. Terms and risk sharing agreements can also be amended. In addition, the Group, as a government contractor, is subject to financial audits and other reviews by some of its governmental customers with respect to the performance of, and the accounting and general practices relating to, government contracts. As a result of these audits and reviews, costs and prices under these contracts may be subject to adjustment. 

Impact: The termination of one or more of the contracts for the Group's programmes by governments, or the failure of the relevant agencies to obtain expected funding appropriations for the Group's programmes, could have a material adverse effect on the Group's future results of operations and financial condition. 

Mitigation: The Board regularly reviews the Group's performance in these markets, and the Executive Committee continues to work closely with its customers to ensure the Group strategy is aligned with theirs (refer to Strategy section on page 10).

Contract timing

The timing of contracts could materially affect the Group's future results of operations and financial condition.

Description: The Group's operating performance and cash flows are dependent, to a significant extent, on the award of defence contracts.

Impact: Because the amounts payable under these contracts can be substantial, the timing of award or failure to receive anticipated orders could materially affect the Group's operating results and cash flow for the periods affected.

Mitigation: The Board regularly reviews the Group's performance with regard to contract awards, and the Executive Committee actively manages the assets and resources of the Group in line with the timing of awards.

Fixed-price contracts

The Group has fixed-price contracts.

Description: A significant portion of the Group's revenue is derived from fixed-price contracts, although the Group has reduced its exposure to fixed-priced design and development activity which is in general more risk intensive than fixed-price production activity. An inherent risk in these fixed-price contracts is that actual performance costs may exceed the projected costs on which the fixed prices for such contracts are agreed.

Impact: The Group's failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-priced contract may reduce the profitability of such a contract or result in a loss.

Mitigation: To manage contract-related risks and uncertainties, contracts are managed through the application of the Lifecycle Management (LCM) business process mandated by the Group's Operational Framework at the operational level (refer to page 21 for further information on LCM). The consistent application of metrics is used to support the review of individual contract performance (refer to page 26 for KPIs relating to programme execution).

Global market

The Group is exposed to risks inherent in operating in a global market.

Description: BAE Systems is a global company which conducts business in a number of regions, including the Middle East, and, as a result, assumes certain risks associated with businesses with a broad geographical reach. In some countries these risks include, and are not limited to, the following: government regulations and administrative policies could change quickly and restraints on the movement of capital could be imposed; governments could expropriate the Group's assets; burdensome taxes or tariffs could be introduced; political changes could lead to changes in the business environment in which the Group operates; and economic downturns, political instability and civil disturbances could disrupt the Group's business activities. 

Impact: The occurrence of any such events could have a material adverse effect on the Group's future operational performance and financial condition.

Mitigation: The Group has a balanced portfolio with six home markets.

Export controls and other restrictions

The Group is subject to export controls and other restrictions.

Description: A portion of the Group's sales is derived from the export of its products. Many of the products the Group designs and manufactures for military or dual use are considered to be of national strategic interest. The export of such products outside the jurisdictions in which they are produced is normally subject to licensing and export controls and other restrictions. No assurance can be given that the export controls to which the Group is subject will not become more restrictive, that new generations of the Group's products will not also be subject to similar or more stringent controls, or that political factors or changing international circumstances will not result in the Group being unable to obtain necessary export licences. 

Impact: Reduced access to export markets could have a material adverse effect on the Group's future results of operations and financial condition. Failure to comply with export controls and wider regulations could expose the Group to fines and other penalties, including potential restrictions on trading.

Mitigation: The Group has formal systems and policies in place which are mandated under the Group's Operational Framework to ensure adherence to regulatory requirements and to identify any restrictions that could adversely impact the Group's future activities.

Consortia and joint ventures

The Group is involved in consortia, joint ventures and equity holdings where it does not have control.

Description: The Group participates in various consortia, joint ventures and equity holdings, exercising varying and evolving degrees of control. While the Group seeks to participate only in ventures in which its interests are aligned with those of its partners, the risk of disagreement is inherent in any jointly controlled entity, and particularly in those entities that require the unanimous consent of all members with regard to major decisions, and that specify restricted rights.

Impact: In the event of disagreement within a consortium, joint venture or equity holding and the business arrangement failing to meet its strategic objectives or expected benefits, the Group's business and results of operations may be adversely affected.

Mitigation: The Group has formal systems and procedures in place to monitor the performance of such business arrangements and identify and manage any adverse scenario arising.

Competition

The Group's business is subject to significant competition.

Description: Most of the Group's businesses are focused on the defence industry and subject to competition from national and multi-national firms with substantial resources and capital, and many contracts are obtained through a competitive bidding process. The Group's ability to compete for contracts depends to a large extent on the effectiveness and innovation of its research and development programmes, its ability to offer better programme performance than its competitors at a lower cost to its customers, and the readiness of its facilities, equipment and personnel to undertake the programmes for which it competes. 

Additionally, in some instances, governments direct to a single supplier all work for a particular programme, commonly known as a sole-source programme. Although governments have historically awarded certain programmes to the Group on a sole-source basis, they may in the future determine to open such programmes to a competitive bidding process. Government contracts for defence-related products can, in certain countries, be awarded on the basis of home country preference. Therefore, other defence companies may have an advantage over the Group for some defence-related contracts on the basis of the jurisdiction in which they are organised, where the majority of their assets are located or where their officers or directors are located. 

Impact: In the event that the Group is unable adequately to compete in the markets in which it operates, the Group's business and results of operations may be adversely affected.

Mitigation: The Group's strong global market positioning, balanced portfolio, leading capabilities and performance continue to address this risk (refer to pages 15 to 17 for further information on the Group's positioning and portfolio).

Pension funding

The Group is exposed to funding risks in relation to the defined benefits under its pension schemes.

Description: The Group operates certain defined benefit pension schemes. At present, in aggregate, there is an actuarial deficit between the value of projected liabilities of these schemes and the value of the assets they hold. The Group has put in place and is implementing deficit recovery plans in line with agreements reached with the respective scheme trustees based on actuarial advice and valuation results.

Impact: The amount of the deficits may be adversely affected by a number of factors, including lower than assumed investment returns, changes in long-term interest rate and price inflation expectations, and greater than anticipated improvements in members' longevity. An increase in pension scheme deficit may require the Group to increase the amount of cash contributions payable to these schemes, thereby reducing cash available to meet the Group's other obligations or business needs.

Mitigation: The performance of the Group's pension schemes and deficit recovery plans are regularly reviewed by both the Group and the Trustees of the schemes taking actuarial and investment advice as applicable. The results of these reviews are discussed with the Board and appropriate action taken (refer to page 136 for further details of the Group's retirement benefit plans).

Acquisitions

The Group has experienced growth through acquisitions. Anticipated benefits of acquisitions may not be realised. 

Description: The Group has experienced growth through acquisitions and continues to pursue acquisitions in order to meet its strategic objectives. Integrating the operations and personnel of acquired businesses is a complex process. The Group may not be able to integrate the operations of acquired businesses with existing operations rapidly or without encountering difficulties. 

Impact: The diversion of management attention to integration efforts and any difficulties encountered in combining operations could adversely affect the Group's business. The failure to manage growth by acquisition while at the same time maintaining adequate focus on the existing assets of the Group could have a material adverse effect on the Group's business, future results of operations or financial condition. In addition, failure to integrate acquisitions appropriately creates the risk of impairments arising on goodwill and other intangible assets. 

Mitigation: The Group has an established methodology in place to deliver the effective integration of acquisitions. The Group has an established policy for monitoring impairment risks. See note 1 to the Group accounts on page 110 for further information on Group's approach to impairment testing.

Laws and regulations

The Group is subject to risk from a failure to comply with laws and regulations.

Description: The Group's operations are subject to numerous domestic and international laws, regulations and restrictions. Non-compliance with these laws, regulations and restrictions could expose the Group to fines, penalties, suspension or debarment, which could have a material adverse effect on the Group. The Group has contracts and operations in many parts of the world and operates in a highly regulated environment. The Group is subject to the laws and regulations of many jurisdictions, including those of the UK and US. These include, without limitation, regulations relating to import-export controls, money-laundering, false accounting, anti-bribery and anti-boycott provisions. From time to time, the Group is subject to government investigations relating to its operations. 

Impact: Failure by the Group or its sales representatives, marketing advisers or others acting on its behalf to comply with these laws and regulations could result in administrative, civil or criminal liabilities resulting in significant fines and penalties and/or result in the suspension or debarment of the Group from government contracts for some period of time or suspension of the Group's export privileges.

Mitigation: During the year, the Group has continued to add to its resources dedicated to legal and regulatory compliance in order to further enhance its capability to identify and manage the risk of compliance failure. Internal and external market risk assessments form an important element of the ongoing corporate development process. Policies and procedures for the appointment of advisers engaged in business development have been further refined, and a uniform global policy and process has been established. The investigation announced in 2004 by the Serious Fraud Office into suspected false accounting and corruption is continuing. In June 2007, the Company was notified by the US Department of Justice that it had commenced an investigation relating to the Group's compliance with anti-corruption laws, including its business concerning the Kingdom of Saudi Arabia.

Exchange rates

The Group is exposed to volatility in currency exchange rates.

Description: The global nature of the Group's business means it is exposed to volatility in currency exchange rates in respect of foreign currency denominated transactions, and the translation of net assets and income statements of foreign subsidiaries and equity accounted investments. The Group is exposed to a number of foreign currencies, the most significant being the US dollar. 

Impact: Significant fluctuations in exchange rates to which the Group is exposed could have a material adverse effect on the Group's future results of operations and financial condition.

Mitigation: In order to protect itself against currency fluctuations, the Group's policy is to hedge all material firm transactional exposures, unless otherwise approved as an exception by the Treasury Review Management Committee, as well as to manage anticipated economic cash flow exposures over the medium term. The Group aims, where possible, to apply hedge accounting treatment for all derivatives that hedge material foreign currency exposures. The Group does not hedge the translation effect of exchange rate movements on the income statement or balance sheet of overseas subsidiaries and equity accounted investments it regards as long-term investments. Hedges are, however, undertaken in respect of investments that are not considered long-term or core to the Group.

Additional risks and uncertainties currently unknown to the Group, or which the Group currently deems immaterial, may also have an adverse effect on the financial condition or business of the Group.

  Consolidated income statement

for the year ended 31 December

	Notes	2008 £m	Total 2008 £m		2007 £m	Total 2007 £m
Continuing operations
Combined sales of Group and equity accounted investments	3		18,543			15,710
Less: share of sales of equity accounted investments	3		(1,872)			(1,401)
Revenue	3		16,671			14,309
Operating costs	4		(15,386)			(13,480)
Other income	5		415			209
Group operating profit excluding amortisation and impairment  of intangible assets		2,003			1,335
Amortisation	11	(247)			(149)
Impairment	11	(56)			(148)
Group operating profit			1,700			1,038
Share of results of equity accounted investments excluding finance costs and taxation expense		132			142
Financial income of equity accounted investments		44			35
Taxation expense of equity accounted investments		(37)			(38)
Share of results of equity accounted investments	14	139			139
Impairment in respect of equity accounted investments	14	(121)			-
Contribution from equity accounted investments			18			139
EBITA1 excluding profit on disposal of businesses and uplift on acquired inventories		1,897			1,449
Profit on disposal of businesses2	9	238			40
Uplift on acquired inventories (included in operating costs)		-			(12)
EBITA1		2,135			1,477
Amortisation		(247)			(149)
Impairments		(177)			(148)
Financial income of equity accounted investments		44			35
Taxation expense of equity accounted investments		(37)			(38)
Operating profit	3		1,718			1,177
Finance costs	6
Financial income		3,380			1,257
Financial expense		(2,727)			(1,199)
			653			58
Profit before taxation			2,371			1,235
Taxation expense	8
UK taxation		(351)			(201)
Overseas taxation		(252)			(134)
			(603)			(335)
Profit for the year from continuing operations			1,768			900
Profit for the year from discontinued operations	9		-			22
Profit for the year			1,768			922
Attributable to:
BAE Systems shareholders			1,745			901
Minority interests			23			21
			1,768			922
Earnings per share	10
Continuing operations:
Basic earnings per share			49.6p			26.0p
Diluted earnings per share			49.5p			25.8p
Discontinued operations:
Basic earnings per share			-			0.6p
Diluted earnings per share			-			0.6p
Total:
Basic earnings per share			49.6p			26.6p
Diluted earnings per share			49.5p			26.4p

1    Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense. 

2    Comprises a loss of £nil in operating costs (2007 £8m) and a profit of £238m in other income (2007 £48m).

Note references used above are references to notes to the Group accounts in the Annual Report 2008 that can be viewed on the Company's website.  Consolidated balance sheet

as at 31 December 

	Notes		2008 £m		2007 £m
Non-current assets
Intangible assets	11		12,306		9,559
Property, plant and equipment	12		2,446		1,774
Investment property	13		112		113
Equity accounted investments	14		1,034		781
Other investments	15		6		6
Other receivables	16		162		322
Other financial assets	17		514		48
Deferred tax assets	8		1,026		567
			17,606		13,170
Current assets
Inventories	18		926		701
Trade and other receivables including amounts due from customers for contract work	16		3,831		2,933
Current tax			14		35
Other investments	15		-		164
Other financial assets	17		674		101
Cash and cash equivalents			2,624		3,062
			8,069		6,996
Non-current assets and disposal groups held for sale	19		-		94
			8,069		7,090
Total assets	3		25,675		20,260
Non-current liabilities
Loans	20		(2,608)		(2,197)
Trade and other payables	21		(701)		(413)
Retirement benefit obligations	22		(3,365)		(1,629)
Other financial liabilities	17		(383)		(26)
Deferred tax liabilities	8		(80)		(40)
Provisions	23		(459)		(399)
			(7,596)		(4,704)
Current liabilities
Loans and overdrafts	20		(173)		(299)
Trade and other payables	21		(9,165)		(8,245)
Other financial liabilities	17		(362)		(71)
Current tax			(704)		(499)
Provisions	23		(386)		(410)
			(10,790)		(9,524)
Liabilities directly associated with disposal groups held for sale	19		-		(30)
			(10,790)		(9,554)
Total liabilities	3		(18,386)		(14,258)
Net assets			7,289		6,002
Capital and reserves
Issued share capital	25, 27		90		90
Share premium	27		1,238		1,222
Other reserves	27		5,974		4,631
Retained earnings	27		(68)		23
Total equity attributable to equity holders of the parent			7,234		5,966
Minority interests	27		55		36
Total equity			7,289		6,002

Approved by the Board on 18 February 2009 and signed on its behalf by:
I G King    G W Rose
Chief Executive    Group Finance Director

Note references used above are references to notes to the Group accounts in the Annual Report 2008 that can be viewed on the Company's website.

  Consolidated cash flow statement 

for the year ended 31 December

	Notes		2008 £m		2007 £m
Profit for the year from continuing operations			1,768		900
Profit for the year from discontinued operations			-		22
Profit for the year			1,768		922
Taxation expense			603		335
Share of results of equity accounted investments	14		(139)		(139)
Net finance costs			(653)		(58)
Depreciation, amortisation and impairment			755		610
(Gain)/loss on disposal of property, plant and equipment	4, 5		(33)		3
Gain on disposal of investment property	5		(5)		(47)
Gain on disposal of non-current other investments			-		(8)
Gain on disposal of businesses - continuing operations	4, 5		(238)		(40)
Gain on disposal of businesses - discontinued operations	9		-		(22)
Cost of equity-settled employee share schemes			51		34
Movements in provisions			(115)		52
Decrease in liabilities for retirement benefit obligations			(272)		(233)
Decrease/(increase) in working capital:
Inventories			46		(188)
Trade and other receivables			(5)		(271)
Trade and other payables			246		1,212
Cash inflow from operating activities			2,009		2,162
Interest paid			(249)		(224)
Interest element of finance lease rental payments			(5)		(6)
Taxation paid			(261)		(112)
Net cash inflow from operating activities			1,494		1,820
Dividends received from equity accounted investments	14		89		78
Interest received			156		175
Purchases of property, plant and equipment			(520)		(307)
Purchases of intangible assets			(32)		(31)
Equity accounted investment funding			-		(4)
Proceeds from sale of property, plant and equipment			44		13
Proceeds from sale of investment property			5		53
Proceeds from sale of non-current other investments			-		15
Purchase of non-current other investments	15		-		(1)
Purchase of subsidiary undertakings	29, 31		(1,078)		(1,731)
Cash and cash equivalents acquired with subsidiary undertakings	29		2		6
Purchase of equity accounted investments	29		(12)		(1)
Proceeds from sale of subsidiary undertakings	9		131		96
Cash and cash equivalents disposed of with subsidiary undertakings	29		(60)		(1)
Proceeds from sale of equity accounted investments	9		16		57
Proceeds from sale of other deposits			164		343
Net cash outflow from investing activities			(1,095)		(1,240)
Capital element of finance lease rental payments			(18)		(25)
Proceeds from issue of share capital	27		16		805
Purchase of treasury shares	27		-		(152)
Purchase of own shares	27		(43)		(50)
Equity dividends paid	30		(478)		(396)
Dividends paid to minority interests			(11)		(1)
Dividends paid on preference shares			-		(10)
Cash outflow from matured derivative financial instruments			(440)		(14)
Cash inflow from reduction in cash collateral			106		9
Cash outflow from repayment of loans			(306)		(777)
Net cash outflow from financing activities			(1,174)		(611)
Net decrease in cash and cash equivalents			(775)		(31)
Cash and cash equivalents at 1 January			3,046		3,074
Effect of foreign exchange rate changes on cash and cash equivalents			334		3
Cash and cash equivalents at 31 December			2,605		3,046
Comprising:
Cash and cash equivalents			2,624		3,062
Overdrafts			(19)		(16)
Cash and cash equivalents at 31 December			2,605		3,046

Note references used above are references to notes to the Group accounts in the Annual Report 2008 that can be viewed on the Company's website.

  Consolidated statement of recognised income and expense

for the year ended 31 December

	Notes		2008 £m		2007 £m
Currency translation on foreign currency net investments:
Subsidiaries			807		(1)
Equity accounted investments	14		197		43
Amounts credited to hedging reserve			469		41
Net actuarial (losses)/gains on defined benefit pension schemes:
Subsidiaries			(1,937)		544
Equity accounted investments			(60)		24
Fair value movements on available-for-sale investments			-		5
Current tax on items taken directly to equity	8		58		96
Deferred tax on items taken directly to equity:
Subsidiaries	8		425		(259)
Tax rate adjustment1	8		-		(19)
Equity accounted investments			17		(6)
Recycling of fair value movements on disposal of available-for-sale investments			-		(6)
Recycling of cumulative currency translation on disposal:
Continuing operations			1		-
Net (expense)/income recognised directly in equity			(23)		462
Profit for the year			1,768		922
Total recognised income and expense			1,745		1,384
Attributable to:
Equity shareholders			1,722		1,363
Minority interests			23		21
			1,745		1,384

1 The UK current tax rate was reduced from 30% to 28% with effect from 1 April 2008. In 2007, in line with this change, the rate applying to UK deferred tax assets and liabilities was also reduced from 30% to 28%, creating a rate adjustment, which was partly reflected in the Consolidated income statement and partly in the Consolidated statement of recognised income and expense.

Note references used above are references to notes to the Group accounts in the Annual Report 2008 that can be viewed on the Company's website.

  Note 33 to the Group accounts

33.    Related party transactions

The Group has a related party relationship with its directors and key management (as disclosed in the Remuneration report on pages 75 to 93 and in note 7), its equity accounted investments (note 14) and the pension plans (note 22).

Transactions occur with the equity accounted investments in the normal course of business and are priced on an arm's-length basis and settled on normal trade terms. The more significant transactions are disclosed below:

	Sales to  related party			Purchases from related party			Amounts owed by related party			Amounts owed to related party			Lease income/ (expense) with related party			Other
Related party	2008 £m	2007  £m		2008 £m	2007  £m		2008  £m	2007  £m		2008  £m	2007  £m		2008  £m	2007  £m		2008  £m	2007  £m
BVT Surface Fleet Limited	74	-		1	-		4	-		54	-		-	-		-	-
Eurofighter Jagdflugzeug GmbH	889	1,063		-	-		61	107		221	-		-	-		-	-
Flagship Training Limited	-	-		-	1		-	-		-	7		-	-		-	-
Fleet Support Limited	-	1		-	2		-	1		-	-		-	-		-	-
Gripen International KB	1	-		-	-		114	109		161	136		-	-		-	-
MBDA SAS	56	143		10	11		9	20		1,034	709		-	2		-	-
Panavia Aircraft GmbH	57	71		127	132		11	1		4	-		-	-		-	-
Saab AB	4	3		9	-		1	-		2	-		-	-		-	1
CTA International SAS	-	-		-	2		-	-		-	-		-	-		-	-
Flight Control System Management GmbH	-	-		-	-		-	1		-	1		-	-		-	-
	1,081	1,281		147	148		200	239		1,476	853		-	2		-	1

Note and page references used above refer to the Annual Report 2008 that can be viewed on the Company's website.

Issued on 30 March 2009

 

END

 

 

FR URVORKKROOAR