REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
BAE Systems plc Annual Report 2007
Annual Report 2007
BAE Systems plc
6 Carlton Gardens
London SW1Y 5AD
United Kingdom
Telephone +44 (0)1252 373232
Registered in England and Wales No. 1470151
Website details
www.baesystems.com
Contents
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 n respect of this report save as would arise under English law. In particular,
section 463 Companies Act 2006 limits the liability of the directors of BAE Systems plc so that their liability is solely
to BAE Systems plc.
Cover image:
RG33 Mine Resistant
Ambush Protected vehicle
Results in brief, highlights
and outlook 1
Chairman’s letter 2
Executive leadership 4
Business review
Directors’ report
Board of directors 54
Corporate governance 56
Remuneration report 64
Other statutory and reguatory
information, including statement
of directors’ responsibilities 84
Corporate governance
Index to the accounts 88
Independent auditors’ report 89
Consolidated financial statements 90
Notes to the Group accounts 94
Company balance sheet 135
Notes to the Company accounts 136
Five year summary 144
Shareholder information 146
Financial calendar 147
Glossary 148
Annual Report online 149
Shareholder feedback 149
The following symbols are used
within this Report
They point you towards further
information either within the report
or online.
Annual and Interim Reports in
digital format online
To receive shareholder communications
electronically in future, including
your Annual Report, visit:
www.baesystems.com/annualreport
Financial statements
Shareholder information
Cross reference within report
p67
For more information visit
www.baesystems.com
Chief Executive’s review 6
Strategic overview 12
Implementing our strategy 14
Financial review 18
Key Performance Indicators (KPIs) 25
Business group reviews 27
Electronics, Intelligence
& Support 28
Land & Armaments 30
Programmes & Support 32
International Businesses 34
HQ & Other Businesses 36
Corporate responsibility review 37
Risk management and
principal risks 44
Resources 51
Further information
See overleaf for an overview
of our business today
REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
Annual Report 2007
REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
BAE Systems plc Annual Report 2007
Annual Report 2007
BAE Systems plc
6 Carlton Gardens
London SW1Y 5AD
United Kingdom
Telephone +44 (0)1252 373232
Registered in England and Wales No. 1470151
Website details
www.baesystems.com
Contents
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 n respect of this report save as would arise under English law. In particular,
section 463 Companies Act 2006 limits the liability of the directors of BAE Systems plc so that their liability is solely
to BAE Systems plc.
Cover image:
RG33 Mine Resistant
Ambush Protected vehicle
Results in brief, highlights
and outlook 1
Chairman’s letter 2
Executive leadership 4
Business review
Directors’ report
Board of directors 54
Corporate governance 56
Remuneration report 64
Other statutory and reguatory
information, including statement
of directors’ responsibilities 84
Corporate governance
Index to the accounts 88
Independent auditors’ report 89
Consolidated financial statements 90
Notes to the Group accounts 94
Company balance sheet 135
Notes to the Company accounts 136
Five year summary 144
Shareholder information 146
Financial calendar 147
Glossary 148
Annual Report online 149
Shareholder feedback 149
The following symbols are used
within this Report
They point you towards further
information either within the report
or online.
Annual and Interim Reports in
digital format online
To receive shareholder communications
electronically in future, including
your Annual Report, visit:
www.baesystems.com/annualreport
Financial statements
Shareholder information
Cross reference within report
p67
For more information visit
www.baesystems.com
Chief Executive’s review 6
Strategic overview 12
Implementing our strategy 14
Financial review 18
Key Performance Indicators (KPIs) 25
Business group reviews 27
Electronics, Intelligence
& Support 28
Land & Armaments 30
Programmes & Support 32
International Businesses 34
HQ & Other Businesses 36
Corporate responsibility review 37
Risk management and
principal risks 44
Resources 51
Further information
See overleaf for an overview
of our business today
REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
Annual Report 2007
BAE Systems at a glance
Land & Armaments
Land & Armaments provides design,
development, production, through-life support
and upgrade of armoured combat vehicles,
tactical wheeled vehicles, naval guns, missile
launchers, artillery systems and intelligent
munitions.
US, UK, Sweden, South Africa, Global
– High volume of vehicle reset and
upgrade activity
– UK business returned to profitability
– Wheeled armoured vehicle successes
– Good progress in next-generation combat
vehicle programmes
Programmes & Support
Programmes & Support comprises the Group’s
UK-based air, naval and underwater systems
activities, the Integrated System Technologies
business and a 50% interest in the Gripen
International joint venture.
UK, Global
– RAF Typhoons now operational
– Full six ship Type 45 contract awarded
– Launch of first of class Astute submarine
– Orders received for second and third Astute
Class submarines
– Offshore Patrol Vessel arbitration settled
International Businesses
International Businesses comprises the Group’s
businesses in Saudi Arabia and Australia,
together with a 37.5% interest in the pan-
European MBDA joint venture and a 20.5%
interest in Saab of Sweden.
UK/Europe, Middle East, Australia
– Saudi Typhoon contract secured
– Investment in the Kingdom of Saudi Arabia
continues
– Down-selection for the provision of vehicles
for the Australian Defence Force
– Proposed acquisition of Tenix Defence
announced in January 2008
Electronics, Intelligence
& Support
Electronics, Intelligence & Support provides
a variety of communications, electronic
identification, navigation and guidance systems,
network-centric warfare solutions and a broad
range of support solutions, including major ship
repair activities for the US Navy.
Key points
– Good financial performance
– Continued growth from US businesses
– Leadership position established in global land systems sector
US, UK, Global
– Continued leadership in the provision
of electronic warfare systems
– New markets developing for the HybriDrive®
propulsion systems
– Stable demand for ship repair services
Delivering global growth
Group
£15,710m
Sales
4
for 2007
Sales
1
by business group
3
(%)
24
21
22
33
Electronics, Intelligence & Support
Land & Armaments
Programmes & Support
International Businesses
£1,477m
EBITA
2
for 2007
EBITA
2
by business group
3
(%)
26
27
19
28
Electronics, Intelligence & Support
Land & Armaments
Programmes & Support
International Businesses
HQ & Other Businesses
HQ & Other Businesses comprises the regional
aircraft asset management and support
activities, head office and UK shared services
activity, including research centres and property
management.
Principal operations
Main operating
locations
Major markets
Key points
from 2007
BAE Systems’ Group strategy is ‘to deliver sustainable growth in shareholder value by being the premier
global defence and aerospace company’.
BAE Systems, with 97,500 employees
4
worldwide, delivers a full range of products and services for air, land and
naval forces, as well as advanced electronics, information technology solutions and customer support services.
Annual Report online
1 before elimination of intra-group sales
2 earnings before amortisation and impairment
of intangible assets, finance costs and
taxation expense
3 excluding HQ & Other Businesses
4 including share of equity accounted investments
p36 p28 p30 p32 p34
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REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
Annual Report 2007
If you would like to give us any feedback on this year’s Annual Report,
please send your written comments to our investor relations team at:
BAE Systems plc
6 Carlton Gardens
London SW1 5AD
United Kingdom
or by e-mail to andy[email protected]
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BAE Systems Annual Report 2007 1
Directors’ report
Results in brief, highlights and outlook
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense
3 earnings excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, and uplift on acquired inventories
(see note 10 to the Group accounts)
4 basic earnings per share in accordance with International Accounting Standard 33
5 including share of equity accounted investments’ order books and after the elimination of intra-group orders of £1.4bn (2006 £1.0bn)
Highlights
Results in brief
Outlook
We have excellent forward visibility and a further year of good growth is anticipated in 2008, including
a full year contribution from the former Armor Holdings business. In addition, part-year contributions are
expected following the anticipated completion in 2008 of the proposed acquisitions of MTC Technologies
and Tenix Defence.
– Good financial performance
– Continued growth from US businesses
– Leadership position established in global land systems sector
– Underlying earnings
3
per share up 30% to 31.0p
– Dividend increased 13.3% to 12.8p per share for the year
£15,710m
Sales
1
2006: £13,765m
31.0p
Underlying earnings
3
per share
2006: 23.8p
12.8p
Dividend per share
2006: 11.3p
Results from continuing operations
Other results including discontinued operations
£1,477m
EBITA
2
2006: £1,207m
26.0p
Basic earnings per share
4
2006: 19.9p
£2,162m
Cash inflow from operating
activities
2006: £778m
£1,177m
Operating profit
2006: £1,054m
£38.6bn
Order book
5
2006: £31.7bn
£700m
Net cash as defined
by the Group
2006: £435m
2 www.baesyste ms.com
to achieve the highest standards of governance in the conduct of our
day-to-day business.
As part of that drive, the Board agreed to undertake an expert and
independent audit of our ethical business conduct, to measure where
we stand today and to provide a point of reference with which to
measure our progress over time. In June 2007, the Board appointed
an independent committee, chaired by Lord Woolf, the former Lord
Chief Justice of England and Wales. The Woolf Committee will report
on the status of ethics and governance in the Group and make
recommendations on improving
areas of weakness that may
be found. The report will be
published and the Board has
undertaken to act on all
such recommendations of the
Committee. We have taken
this bold step because we are
committed to being the industry
leader in business ethics. The
Woolf Committee report will be
a valuable tool in our pursuit of
this objective.
During the year, further changes
were made in the composition of
the Board. With a ratio of eight
Directors’ report
Chairman’s letter
“2007 has been another successful year for
BAE Systems. The Group has again delivered
a strong nancial performance and has
achieved much success in pursuit of its
strategic objectives.”
Dick Olver Chairman
2007: A year of delivery
1 earnings excluding amortisation
and impairment of intangible
assets, non-cash finance
movements on pensions and
financial derivatives, and uplift
on acquired inventories (see
note 10 to the Group accounts)
2007 was another successful year for BAE Systems. The Group has
again delivered a strong financial performance and has achieved much
success in pursuit of its strategic objectives.
Our multi-home market strategy continues to generate opportunities
for growth.
In the UK, an increased emphasis on through-life business support
is being addressed successfully. Similarly, the Group’s strategy to
develop an enhanced industrial presence in the Kingdom of Saudi
Arabia has underpinned the winning of substantial new business
that will provide future growth in that market.
In the US, we continue to see the benefits of a well-executed
acquisition strategy.
Our global strategy will continue to develop. The Group’s focus on
business in its six home markets is delivering good returns and
consideration is now being given to establish a presence in new
home markets.
A more global footprint brings with it responsibility to a wider, more
diverse stakeholder base. As we grow internationally, it becomes
increasingly important to keep pace with evolving customer and
stakeholder expectations – both in programme delivery and the
methods by which we deliver our business. We seek to nurture a
culture within the Group of continuous improvement – in all aspects
of business performance. This includes ethical awareness as we work
13.6
18.4
23.8
31.0
5
10
15
20
25
30
35
07060504
Underlying earnings
1
per share
from continuing operations (pence)
The Woolf Committee
BAE Systems Annual Report 2007 3
independent non-executive directors to four executive directors,
excluding myself as Chairman, we have a strong Board with a wealth
of experience in both our own industry and international business
generally. During the year we welcomed Andy Inglis, who has a strong
background in global programme execution, to the Board. Also, I am
pleased to report that Ravi Uppal will be joining the Board in April as
a non-executive director. He is currently President, Global Markets for
ABB Limited and has first hand experience of managing engineering
and technology businesses in Europe, the Middle East and India. One
of our current non-executive directors, Peter Weinberg, will be standing
down and not seeking re-election at this year’s Annual General
Meeting in May. He leaves us to dedicate more time to his business
interests as a partner in the rapidly growing financial services firm,
Perella Weinberg Partners. I wish him well for the future.
Ulrich Cartellieri, Steve Mogford and Chris Geoghegan retired from
the Board during the year and my sincere thanks go to them for their
dedicated service to the Group.
Succession planning is vital to the wellbeing of a company, and
BAE Systems has a well-defined and rigorous process for ensuring
the continuity of high quality management appointments throughout
the Group. The announcement setting out the timetable for the
appointment of a successor to Mike Turner as Chief Executive, when
he steps down in August 2008, is a key part of that planning process.
Mike has made an outstanding contribution across his 42 years
with the Group, starting as an apprentice and culminating as Chief
Executive of the highly successful company that BAE Systems is today.
Mike leads a highly skilled workforce of some 97,500 people who
have delivered excellent performance during the year by providing
outstanding capability and support for the armed forces and all the
customers in the countries we serve. I extend my thanks to each of
them for their contribution to the Group’s success.
The Board is recommending an increased final dividend of 7.8p
making a total of 12.8p for the year, an increase of 13.3% over 2006
endorsing our outlook for the Group. At this level the annual dividend
is covered 2.4 times by underlying earnings (2006 2.1 times). Subject
to shareholder approval at the 2008 Annual General Meeting, the
dividend will be paid on 2 June 2008 to holders of ordinary shares
registered on 18 April 2008.
Dick Olver Chairman
In June 2007 the Board appointed Lord Woolf to lead
an independent expert committee to study and publish
a report on the Group’s ethical policies and processes.
It is chaired by Lord Woolf.
The full terms of reference can be found on the Woolf
Committee website at http://www.woolfcommittee.com/
The Committee was appointed to:
– review the Group’s ethical policies
and processes, and to review the
Group’s adherence to applicable
anti-corruption legislation,
including relevant international
treaty obligations;
– reach a judgement as to how the
Group’s policies and procedures
benchmark against industry
standards, whether they are
sufficiently robust to ensure
compliance with its ethical business
policies generally and in particular
to detect and prevent violations of
anti-corruption laws; and
– to make recommendations for any
remedial actions it believes the
Group should take.
Summary terms of reference
– The Rt. Hon. The Lord Woolf of
Barnes (Chairman), former Lord
Chief Justice of England and Wales.
– Sir David Walker, Senior Adviser
and former Chairman of Morgan
Stanley International Ltd.
– Philippa Foster Back OBE, Director
of the Institute of Business Ethics.
– Douglas N. Daft, AC, former
Chairman and Chief Executive
of the Coca-Cola Company.
– Dr Richard Jarvis (Secretary to
the Committee), former Secretary
to the Committee on Standards
in Public Life.
Members of the Committee
BAE Systems is managed through a combination of operational line leaders responsible
for the operation and performance of their respective businesses and functional leaders
providing Group-wide expertise and guidance. The line leaders report to two Chief
Operating Ofcers principally reecting the geographic spread of the Group, split between
US-led operations, and operations in the UK and other regions. The Chief Executive, Chief
Operating Ofcers and Group Finance Director are members of the Board (page 54). An
Executive Committee, comprising members from the senior leadership team, is the focus
for developing and delivering the Group’s strategy.
4 www.baesyste ms.com
Directors’ report
Executive leadership
Our executive leadership
Marshall Banker
President
Customer Solutions
Mike Hefron
President
Electronics & Integrated Solutions
Board member
Executive Committee member
Mike Turner
Chief Executive
Linda Hudson
President
Land & Armaments
Scott O’Brien
President
Products Group
Murray Easton
Managing Director
Submarine Solutions
Vic Emery
Managing Director
Surface Fleet Solutions
Guy Griffiths
Managing Director
Businesses
Peter Wilson
Managing Director
CS&S International
Nigel Whitehead
Group Managing Director
Military Air Solutions
Charlotte Lambkin
Group Communications Director
Alastair Imrie
Group HR Director
Alison Wood
Group Strategic Development Director
Alan Garwood
Group Business Development Director
Philip Bramwell
Group General Counsel
George Rose
Group Finance Director
Walt Havenstein
Chief Operating Officer
President and CEO, BAE Systems, Inc.
Ian King
Chief Operating Officer
UK/Rest of World
Functional leadershipOperational leadership
p12
For more information on the
Group’s strategy see page 12
Business review
Chief Executive’s review 6
Strategic overview 12
Implementing our strategy 14
Financial review 18
Key Performance Indicators (KPIs) 25
Business group reviews 27
Electronics, Intelligence & Support 28
Land & Armaments 30
Programmes & Support 32
International Businesses 34
HQ & Other Businesses 36
Corporate responsibility review 37
Risk management and principal risks 44
Resources 51
The Royal Navy's largest and most
powerful attack submarine, the first
of class Astute, was rolled out of the
Devonshire Dock Hall on 8 June 2007.
Directors’ report
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
Directors’ report – Business review
Chief Executive’s review
6 www.baesyste ms.com
Delivering global growth
“BAE Systems once again performed well
in 2007. Each of the four business sectors
delivered good profitability underpinned
by good programme schedule and cost
performance across the Group.”
Mike Turner Chief Executive
Objective What we have achieved
The Group performed well and delivered its
financial plan for the year and a strong five-year
business plan was presented to and agreed by
the Board.
The Group continued to embed the principles
of good governance, values, policies and
processes that guide our work and behaviour,
with a clear system of delegated authority
across the Group.
Programme execution is central to the Group
and a key determinant of customer satisfaction.
Both schedule and cost performance improved
in 2007 and will continue to be a focus of
management attention, building on the excellent
progress in recent years.
1. Meet financial
targets
2. Ensure
application
of mandated
business
processes
3. Further increase
management
focus on
programme
execution
Performance against top ten objectives for 2007
The Board reviews and updates the Group strategy
annually. Our strategy is ‘to deliver sustainable
growth in shareholder value by being the premier
global defence and aerospace company’. Within
this context the Chief Executive and the Executive
Committee agree the Group strategic objectives, the
business portfolio actions and the top ten objectives
for the executive team each year. The following
summarises achievements against the 2007 top
ten objectives. The top ten objectives for 2008
are set out on page 11.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 7
is the very strong growth in the land systems business in recent
years. Following the earlier acquisitions of Alvis in 2004 and United
Defense in 2005, the acquisition of Armor Holdings, Inc. in 2007 has
established BAE Systems as having a clear leadership position in the
land sector.
Our multi-home market business focus continues to generate
opportunities for growth, especially in the Kingdom of Saudi Arabia
where the Group has a growing home market position.
United States
BAE Systems is a valued, trusted and high-performing part of the US
defence industrial base and is one of the top ten largest defence
companies in the US.
In the US, the Group is a market leader in advanced information
technology, intelligence analysis, geospatial exploitation software
and the development of knowledge-based systems. In addition,
BAE Systems continues to see strong demand for sophisticated
electronic warfare and protection systems, and in its support solutions
business the ship repair facilities have remained fully utilised.
In the land systems sector, further contracts to reset Bradley combat
vehicles and other US tracked vehicles to ‘as new’ condition were
awarded, providing extended visibility of throughput at the current
high level of activity. In addition to the high volume of reset activity,
strong demand for vehicle upgrades with new digital systems
Objective What we have achieved
The Group is achieving success growing in the US,
with 19% organic growth and the acquisition of
Armor Holdings, Inc. in 2007.
Progress in implementing the Defence Industrial
Strategy in the UK was made, which will deliver
combined benefits of more capability and lower
cost for the UK customer and acceptable returns for
industry through long-term partnering agreements.
The business in the Kingdom of Saudi Arabia
is moving forward with the established core
programme progressing well, in-Kingdom
investment is ongoing and significant new
business has been achieved.
The contract award for 72 Typhoons for Saudi
Arabia was a notable success. Whilst export
markets are very competitive, the Group continues
to address a number of opportunities for exports
from each of its six home markets.
4. Grow US
businesses
5. Continue to
implement the
UK Defence
Industrial
Strategy
6. Progress the
business in the
Kingdom of
Saudi Arabia
7. Focus on key
export
opportunities
Objective What we have achieved
8. Demonstrate
a commitment
to partnering
9. Develop
existing and
new home
markets
10. Demonstrate
leadership at
all levels
BAE Systems once again performed well in 2007, demonstrating the
significant fundamental strengths and quality of the business. EBITA
1
increased by 22% to £1,477m on sales
2
of £15,710m, up 14%
compared with 2006. Underlying earnings
3
per share increased 30%
to 31.0p for the year. The Group had net cash of £700m at year end,
having invested $4.5bn (£2.2bn) excluding fees in the acquisition
of Armor Holdings, Inc. during the year.
Each of the four business sectors delivered good profitability with
return on sales exceeding 8.5% in all sectors. This profitability
stems from good programme cost and schedule performance
across the Group.
Underlying this performance are principles of ethical conduct, good
governance, our values and policies and processes that guide the
Group’s business and the behaviour of its people, with a clear system
of delegated authority within a ‘One Company’ approach. BAE Systems
is determined that the business policies and processes mandated
across the organisation align with global best practice.
BAE Systems is a global company with a strategy currently focused
around six home markets. Together these home markets were
responsible for generating 85% of Group sales
2
in 2007 (2006 84%).
The Group is benefiting from a well-executed strategy with good
profitable growth generated from substantial business operations in
its home markets and especially the United States. A notable success
The Group continues to identify and benefit from
opportunities to work together and share best
practice across the Group’s global businesses.
Constraints to technology sharing between the
UK and US remain but in June 2007 the US
President and UK Prime Minister signed a defence
technology treaty. Once ratified by the US Senate,
this would mark a significant step forward towards
greater technology co-operation.
The Group is successfully implementing its
strategy to develop the six home markets in which
it currently operates and is pursuing opportunities
to establish additional new home markets for the
longer term.
Underpinning all of the above objectives is an
emphasis on leadership throughout the Group to
achieve continuous performance improvements
and embed a high-performance culture.
1 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense
2 including share of equity accounted investments
3 earnings excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, and uplift on acquired inventories
(see note 10 to the Group accounts)
The market
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
8 www.baesyste ms.com
Directors’ report – Business review
Chief Executive’s review (continued)
continues, in part driven by the move in the US to modular forces
requiring the fielding of a common standard of more capable vehicles.
To complement BAE Systems’ tracked vehicle position in the US,
the Group has been executing a wheeled vehicle strategy to meet
a valuable, near-term, urgent operational requirement for Mine
Resistant Ambush Protected (MRAP) vehicles. This has resulted in the
establishment of a new assembly facility for the RG33 mine protected
vehicle in York, Pennsylvania, alongside the Bradley reset facility.
Following the substantial contract award for RG33 MRAP vehicles in
2007, manufacturing volume has increased rapidly in the last months
of 2007 with the completion of 23 vehicles in October rising to 102
in December.
The acquisition of Armor Holdings, Inc. delivered further progress as
regards the wheeled vehicle strategy. The business is a key player in
the tactical wheeled vehicle market and in the increasingly vital areas
of armour protection and survivability. With strong demand for its
products, notably for the Family of Medium Tactical Vehicles (FMTV)
and the Caiman mine protected vehicle derivative, the Armor Holdings
acquisition is well on track to deliver our required return on investment.
BAE Systems has worked across its global businesses rapidly to
design, produce and deliver vehicles to protect the armed forces.
The Group’s role on the MRAP programme involves collaboration
across sites and businesses globally, including the integration of the
former Armor Holdings’ capabilities. The programme brings together
more than 35 years of experience in mine protected wheeled vehicle
expertise and highly survivable combat platforms.
In December 2007, the Group announced the proposed acquisition
of MTC Technologies, Inc.. MTC complements BAE Systems’ existing
readiness and sustainment capabilities in the US.
United Kingdom
The Group’s UK-based businesses are performing well with good
programme schedule and cost performance. This performance
improvement included a recovery to profitable trading for the land
systems business in the UK.
BAE Systems continues to make progress in developing integrated
through-life support business in partnering arrangements with the UK
MoD and the UK’s armed forces. Benefits are now apparent as some
of the earlier programme relationships mature. For example, the
National Audit Office has concluded that the partnered support
arrangements for the Tornado combat aircraft have contributed to a
51% reduction in cost per flying hour and cost savings over the past
five years of £1.3bn. BAE Systems is similarly involved in support
for a number of other UK air platforms and is addressing through-life
support for the UK’s armoured fighting vehicle fleet. The Group
Supplemental budgets in the US to fund overseas
operations, combined with good growth in the
underlying US defence budget have contributed
to overall growth in the global accessible defence
market. US supplemental budgets are not
expected to be maintained but underlying global
defence expenditure is forecast to continue to grow
with increasing contributions from the fast-growing
Asian economies. This expenditure naturally
determines where Group attention is focused.
The top 15 countries account for 80% of the global
total and the US accounts for around 50% alone.
Most of the Group’s businesses are focused
on the defence industry and are subject both
to competition from multi-national firms and
to government regulation.
BAE Systems’ market position (US$bn)
Top 10 defence companies in 2007 (based on 2006 defence revenues)
Source: Defense News
10
15
20
25
30
35
40
5
0
36.0
30.8
25.0
23.6
19.5
18.7
13.2
9.9
9.0
7.6
Lockheed Martin
Boeing
BAE Systems
Northrop Grumman
Raytheon
General Dynamics
EADS
L3 Communications
Finmeccanica
United Technologies
BAE Systems Annual Report 2007 9
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identifies further opportunities to develop such arrangements in air,
land and naval support.
The UK government’s commitment to the new Carrier programme
in July enabled BAE Systems to enter into a Framework Agreement
with VT Group for the establishment of a joint venture which would,
subject to completion, bring together BAE Systems’ and VT Group’s
respective surface warship building and surface warship through-life
support operations.
Other home markets
Saudi Arabia continues to be an important home market for
BAE Systems, building on a performance track record established
over many decades.
The large programme of support for Tornado is being maintained and
the modernisation of existing assets continues. In September 2007,
under the new defence co-operation programme known as ‘Project
Salam’, contracts were signed between the UK government and the
Kingdom of Saudi Arabia for the supply of 72 Typhoon aircraft.
We continue to invest within Saudi Arabia in both the expansion
of the Kingdom’s industrial capability and new secure residential
accommodation. The first of two new compounds for our employees
is now being occupied in Riyadh.
In Sweden, production of the CV90 infantry fighting vehicle is underway for
the Dutch Army, continuing the good export performance of this business.
In Australia, the Group continues to build on its position as a through-
life capability partner to the Australian Defence Force, including a
follow-on multi-year support contract for the Hawk aircraft.
The selection by Australia of the FMTV as the basis for the Land 121
vehicle programme will generate substantial industrial involvement in
Australia. BAE Systems is also a major subcontractor on the Australian
Wedgetail Airborne Early Warning and Control programme, where we
are jointly engaged with Boeing and the customer to re-baseline
this programme.
In January 2008, the Group announced the proposed acquisition of
Tenix Defence, a leading Australian defence contractor. The acquisition
will more than double BAE Systems’ presence in Australia, making
it the largest in-country supplier to the Australian Defence Force. The
organisations are an excellent fit and have largely complementary
programmes and capabilities. This acquisition is a significant step in
the implementation of the Group’s strategy to develop as the premier
global defence and aerospace company by growing the business in
Australia, one of the Group’s six home markets.
In South Africa, the land systems OMC business is achieving growth
through exports with its RG31 and RG32 mine protected vehicles.
Global equipment market (US$bn)
2007 estimated defence procurement
Forecast defence budget by major region
(US$bn in constant 2008 prices)
The US represents around 50% of the total forecast global defence spend
(including equipment, personnel and operating costs) to 2010.
Source: BAE Systems internal analysis
15141312111009080706050403
400
600
800
1000
1200
1400
200
0
Year
0 15 30 45 60 75 90 105 120 135 150
Rest of World (excluding markets inaccessible for business by the Group)
Europe (West, Central and Eastern European countries, excluding former
Soviet Union nations)
US supplemental budget
US base budget
US (including supplemental budgets, excluding Research, Testing,
Development & Evaluation)
Europe (West, Central and Eastern European countries, excluding former Soviet
Union nations)
Rest of World (excluding markets inaccessible for business by the Group)
The US accounts for around 50% of estimated total global procurement in 2008.
Source: BAE Systems internal analysis
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Chief Executive’s review (continued)
10 www.baesyste ms.com
We have excellent forward visibility and a further year of good growth
is anticipated in 2008, including a full year contribution from the
former Armor Holdings business. In addition, part-year contributions
are expected following the anticipated completion in 2008 of the
proposed acquisitions of MTC Technologies and Tenix Defence.
Mike Turner Chief Executive
Summary and outlook
BAE Systems has a successful track record of identifying and
addressing market opportunities through organic investments and
acquisitions. Following the acquisition of Armor Holdings, Inc., the
Group has maintained a strong balance sheet and is performing well.
The Group continues to look for further value enhancing opportunities
across its home markets and remains focused on delivering good
business performance and generating value, to the benefit of
customers and shareholders.
The Group is continuing to deliver its strategy with strong financial
and programme performance. It is delivering value for money and
capability to its customers and is well positioned for the future with
an established footprint in six home markets. BAE Systems is a
quality business based on a strong, well-balanced portfolio and is
well positioned to continue to deliver shareholder value in line with
our long-term plans.
The defence market in the UK is expected to
become more challenging in the coming years.
Overall defence spending is being held to low
levels of real growth, at just over 2% of GDP,
despite significant ongoing operational
commitments. Spending on defence
equipment in the UK is under particular
pressure, balancing the demands of
procurement with personnel-related costs
and the impact of ongoing operations in
Afghanistan and Iraq. A high level of activity
due to Urgent Operational Requirements
(UORs) has resulted from these operations.
Implementation of the UK’s Defence
Industrial Strategy (DIS) is underway
against a challenging set of milestones.
BAE Systems continues to work with the UK
MoD to ensure transformation of the
business to meet challenging requirements,
particularly focused on developing Long Term
Partnering Agreements (LTPAs) across air,
land and naval domains.
United Kingdom marketUnited States market
The US continues to be the most attractive of
all the major defence markets, accounting for
around 50% of global defence expenditure in
markets accessible for business by the Group
(see chart on page 9) and approximately 4% of
GDP. The US will remain one of BAE Systems’
key markets, offering programme scale and
high levels of investment in research and
development. BAE Systems has continued
to grow in the US by leveraging its market
leadership positions and introducing new
capabilities that meet customers’ needs.
The Group is well placed to support the US
Department of Defense in its likely emphasis
on force sustainment and readiness and
affordable transformation.
The short-term outlook for defence continues
to be favourable, although growth in US defence
spending is expected to slow beyond 2010.
Politically, the US is now starting the run-up to
the next presidential election in November
2008. Both parties remain supportive of
national security and consequently, whatever
the outcome, support for defence spending
is expected to remain robust.
In recent years, US defence spending has
been buoyed by supplemental budgets aimed
at covering additional defence costs related
to the ongoing operations in Afghanistan and
Iraq. When the US disengages from these
operations, the scale of these supplemental
budgets will probably decline.
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BAE Systems Annual Report 2007 11
Meet 2008 financial targets and set
challenging and realistic longer-term plans
Develop our partnering approach to meet
our customers’ capability requirements
Ensure continued quality application of our
mandated business policies and processes
Further enhance programme execution
through schedule and cost performance
Progress development of our security
businesses in our home markets
2008 Executive Committee top ten objectives
Objective
1. Financial targets
2. Develop our
partnering approach
3. Business policies
and processes
4. Programme
execution
5. Security
Grow our US business including the
execution of planned investments
Progress delivery of the Saudi
industrialisation plan and further develop
business in the Kingdom of Saudi Arabia
Continue to implement the UK Defence
Industrial Strategy including execution of
our transformation and investment plans
Progress export opportunities from each
of our home markets
Continue to drive performance in safety,
ethics and diversity
Objective
6. US business
7. Kingdom of
Saudi Arabia
8. UK Defence
Industrial Strategy
9. Export
opportunities
10. Safety, ethics and
diversity
The Executive Committee has set the following objectives for 2008. A review of the performance against these
objectives will be contained in the Annual Report 2008. The aim of these objectives is to provide focus for the
leadership and engagement of people at all levels of our Company.
Other home markets
Saudi Arabia is, and is expected to remain,
one of the major defence markets in the
world, dedicating up to 10% of GDP to this
sector, with a significant part of this spent
on external procurement. An Understanding
Document was signed on 21 December
2005 between the UK and Saudi Arabian
governments, outlining plans to modernise the
capabilities of the Saudi armed forces. These
modernisation activities are underway, helping
to develop a greater indigenous capability in
the Kingdom.
The Australian Government has committed
to an increase in defence spending of 3% p.a.
(real) until 2015–16, on an annual budget
of A$22 billion. Its stated preference is to
maintain a strong local defence capability
which will underpin strong market growth.
It has also released the Defence Capability
Plan 2006–2016, which outlines the major
capital equipment outlays over this time frame.
A total of A$74.6bn is forecast to
be spent on capital investment over the
next decade, reflecting the government’s
commitment to growth in defence spending.
The UK government’s publication of the DIS
version 2 has been delayed into 2008 to take
account of the difficult decisions required
in the UK MoD’s current Planning Round 08
following the 2007 Comprehensive Spending
Review. To deliver value for money and meet
current and future equipment needs of the
armed forces, the securing of through-life
capability management and appropriate
LTPAs will be even more necessary under
difficult budgetary conditions.
South Africa, with one of the best trained
and equipped militaries in sub-Saharan
Africa, is spending between 1.2% and 1.6%
p.a. of its GDP on defence. It is currently
undergoing a major re-equipment programme
as a result of defence procurements
approved by the government in 1999.
The Swedish military is also undergoing
reform as it changes from a force for
defence against invasion to one that
is more flexible and mobile. Since the
beginning of this process, defence spending
fell from 2% of GDP to 1.4% in 2006. Over
the same period there has been government
encouragement for the industry to move
towards greater participation in international
collaborative programmes.
To enhance its positions in these markets
and optimise its ability to execute its home
market strategy, the Company intends to
establish home market advisory boards in
those markets where it would benefit from
advice focused on in-country business
development and industrial partnering.
A strategy that delivers growth
Our Group strategy is ‘to deliver sustainable growth in shareholder value by being the
premier global defence and aerospace company’. We deliver this through our Group
strategic objectives, business portfolio actions and integrated business plans. The six
Group strategic objectives are championed by the Executive Committee and apply
across all of our businesses, while the business portfolio actions are championed
by the relevant Executive Committee member and are delivered by the businesses
either separately or jointly. Both are underpinned by our integrated business plans.
To deliver sustainable growth in shareholder value by being the
premier global defence and aerospace company
Continue to embed a high-performance culture across the Company
Further enhance our programme execution capabilities
Increase sharing of expertise
, technology and best practice between our global businesses
Develop a partnering approach to meet our customer requirements
Develop our capabilities in existing and new home markets
Establish security businesses in our home markets
Establish in the
UK sustainably
profitable through-life
businesses in
Air, Land and Sea
Grow our business
in the United States
both organically
and via acquisitions
Implement the home
market strategy and
grow in the Kingdom
of Saudi Arabia
Grow our global land
systems business
Grow our export
business from our
home markets
Grow our global
support, solutions
and services
businesses
Integrated Business Plans
Business Portfolio Actions
Group Strategic Objectives
Group Strategy
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Strategic overview
12 www.baesyste ms.com
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BAE Systems Annual Report 2007 13
The Group delivers its strategy through the Group strategic objectives
detailed opposite, business portfolio actions and integrated business
plans. The strategy is also supported by ten short-term objectives
agreed annually by the Executive Committee (see page 11) which
address the key challenges in delivering the strategy in the year
ahead. The objectives are directly underpinned by a set of nancial
and non-nancial performance indicators that are regularly reported
to the Board and linked to executive remuneration. These KPIs are
detailed on pages 25 and 26 and provide a succinct and meaningful
measurement system to assess enterprise performance and
continuous improvement in line with our strategy.
Effective management of risk and opportunity is essential to the
delivery of the Group’s objectives and achievement of sustainable
shareholder value. The Group’s approach to risk management is to
remove or reduce the likelihood and effect of risks before they occur,
and deal effectively with problems if they do.
Further information on the risk management processes and
procedures, and the committees involved in the management of risk,
is given on pages 44 and 45.
The key resources and arrangements the Group uses to achieve its
strategic objectives include:
– the people it employs;
– relationships with its customers, subcontractors and other suppliers;
– research and development;
– intellectual property; and
– its capital structure.
Each of these is discussed further on pages 51 and 52, with the
exception of the Group’s capital structure which is explained on
page 22 in the Financial review.
Group strategic objectives
Each year the Group strategic objectives are reviewed and rened to
ensure that they remain relevant. For 2008 we have claried the intent
of the objective ‘Develop our capabilities in emerging growth markets’
and separated it into two:
– ‘Develop our capabilities in existing and new home markets’, focuses
on developing the Group’s multi-home market strategy; and
– ‘Establish security businesses in our home markets’, highlights the
importance of this adjacent market opportunity.
Continue to embed a high-performance culture across the Company
Having a high-performance culture underpins our ability to achieve
our strategy. This means setting challenging targets and reviewing
our performance so that we deliver against our commitments. This
is underlined by demonstrating high standards of business conduct
in line with our ethical principles.
Further enhance our programme execution capabilities
Excellence in programme execution remains at the core of the
successful delivery of our strategy, both in terms of executing on
our existing contracts and winning new business. Being recognised
by our customers as their reliable partner of choice to deliver to their
expectations on time and budget will ensure we deliver continuing
performance and growth of our business.
Increase sharing of expertise, technology and best practice between
our global businesses
As our customers’ requirements increasingly demand the ability to offer
through-life and capability solutions, we are committed to nding ways
to increasingly collaborate across our business and project boundaries
to deliver these solutions. We need to continue to build on our ability
to work across the lines of business that span our six home markets.
Develop a partnering approach to meet our customer requirements
Mutually benecial trust-based partnering relationships with our
customers are increasingly important to the long-term future and
stability of our business. Many of our customers are recognising the
long-term nature and strategic importance of defence procurements.
We are responding to this by building our partnering capabilities in
ways such as working in integrated project teams and embedding
our activities alongside customers.
Develop our capabilities in existing and new home markets
We continue to evaluate ways in which we can develop our in-country
presence, both in our six existing home markets and in potential new
home markets.
Establish security businesses in our home markets
In 2007, we evaluated opportunities to grow into related new
market segments, providing we could lever our core technologies
and capabilities appropriately. We decided to focus on establishing
security businesses in our home markets.
Strategy
p12
Key Performance Indicators (KPIs)
p25
Risks
p44
Resources
p51
The following three case
studies demonstrate
examples of how we are
implementing our strategy.
13
52
35
Strategic acquisitions in both the wheeled and tracked vehicle sectors have
resulted in BAE Systems’ leadership positions in these key growth areas.
Further convergence of these two sectors will continue to create growth
opportunities for the Group as it begins to focus on the development of
light wheeled vehicles.
US military vehicles
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Implementing our strategy
14 www.baesyste ms.com
– 2005 acquisition of United Defense established
BAE Systems’ strong position in the tracked combat
vehicle sector
– 2007 acquisition of Armor Holdings positioned
BAE Systems as a leader in the growing military wheeled
vehicle sector
– Further convergence of such tracked combat and wheeled
vehicle technology will present future growth opportunities
for the Group
BAE Systems is today a leader in military land systems with sales of
$7.1bn in 2007 and principal operations in the US, UK, Sweden and
South Africa. This large global presence has been established over
a short period. The Group embarked on a distinct and cohesive
strategy to enter both the tracked and wheeled vehicle sectors, and
the convergence of these capabilities is now providing signicant
growth opportunities.
Prior to 2004 BAE Systems’ involvement in the land systems
sector was limited to its RO Defence activities in the UK. In 2004
BAE Systems acquired Alvis plc, recognising the opportunity to
address the market for through-life support of the UK armoured
Fighting Vehicle fleet and to better address the opportunity to
participate in the UK’s largest projected land systems programme,
the Future Rapid Effect System (FRES). Alvis included not only the
principal constituents of the UK armoured vehicle capability but also
the Swedish Hägglunds business and OMC in South Africa.
With its newly expanded land sector presence and its strategy
to grow in the US market, BAE Systems targeted the good growth
prospects for support and reset work in the large armoured vehicle
eets in the US. Reset is the process of taking worn vehicles out
of service and refurbishing them to an as-new condition for return
to service. BAE Systems identied United Defense, a major tracked
combat vehicle business in the US, as a focus for increased reset
activity and has seen substantial growth since its acquisition of that
company in June 2005.
Having established a strong position in the tracked combat
vehicle sector, BAE Systems looked to address the newly emerging
opportunities for wheeled military vehicles. Wheeled vehicle fleets
have in the past been assigned primarily to utility and support
applications while the heavier combat vehicles, with their enhanced
survivability, were deployed for combat operations.
The growth of insurgency and the terrorist threat, including the use
of mines and improvised explosive devices has led to a demand for a
new class of utility vehicle. These more sophisticated utility vehicles
retain wheeled mobility but have the survivability characteristics of
tracked combat vehicles. This evolving convergence of utility and
combat vehicle capabilities led BAE Systems to acquire Armor
Holdings, Inc., a leading US supplier of wheeled utility vehicles
and armour protection technology. The Armor Holdings capabilities
complement the tracked combat vehicle capabilities of the former
United Defense business in the US (see gure 1).
When BAE Systems acquired Armor Holdings the requirement in the
US for Mine Resistant Ambush Protected (MRAP) vehicles was just
emerging. BAE Systems has been able to respond to this urgent
Figure 1
Total US military vehicle eet (%)
255,000 military vehicles (2006 inventory)
US wheeled vehicles (%)
Primarily support
20
25
43
12
US tracked vehicles (%)
Primarily combat
BAE Systems
Others
Bradley
M2/M3
Light
M113
armoured
personnel carrier
M1 Abrams
tank
Acquisition of
Armor Holdings
Combat and
Heavy
Fire
support
platforms
Medium
BAE Systems – major participation
BAE Systems – some participation
Others
Acquisition of
United Defense
13
87
A global leader in land systems
Grow UK
through-life
businesses
Grow US
business
Grow land
systems
Grow export
business
Grow in the
Kingdom of
Saudi Arabia
Grow global
support
Business portfolio actions (addressed in this case study)
Case study one
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BAE Systems Annual Report 2007 15
Mine Resistant Ambush Protected (MRAP) vehicle – RG33
The MRAP programme awards reflect both the Group’s
industrial capacity and its ability to collaborate across sites
and businesses globally.
requirement, winning large orders for MRAP vehicles sourced
from three of its operations: the OMC business in South Africa;
the former United Defense facilities in York, Pennsylvania; and the
recently acquired former Armor Holdings facilities in Sealy, Texas
and Faireld, Ohio (see gure 2).
New generation vehicle programmes are likely to emerge in response
to the continuing convergence of utility and combat vehicle
requirements. Near-term MRAP requirements are expected to evolve
in two directions. Medium Mine Protected Vehicle (MMPV) is the US
Army programme of record for future MRAP-like requirements, while
the proposed Joint Light Tactical Vehicle (JLTV) programme is likely
to involve the application of advanced new technologies to achieve
a range of three types of light to medium vehicles of comparable
size and mass to the lightweight High Mobility Multipurpose Wheeled
Vehicles (HMMWV) in use by the American military (see gure 3).
The requirements for the JLTV will apply lessons learned by the US
military for survivable, combat-ready utility vehicles, as have been
demonstrated with up-armoured HMMWVs and MRAPs. BAE Systems
is approaching the JLTV requirement through the formation of two
entirely separate teaming arrangements.
Demand for a new class of utility vehicle which incorporates the mobility
of wheeled utility vehicles with the survivability of tracked combat vehicles
has led to the development of mine protected wheeled vehicles.
BAE Systems’ land systems strategy and key acquisitions have ensured
it is a leading player in this key growth area.
Mine protected vehicles
Figure 3
Figure 2
BAE Systems has been
awarded contracts for
approximately one-third of
the c. 12,000 MRAP vehicles
ordered in the US.
In addition, the business has
received contracts for over
1,000 mine protected vehicles
in other markets.
US MRAP orders (%)
14
14
7
65
RG33
Caiman
RG31
Other
BAE Systems
Others
BAE Systems has developed its land systems strategy at a time of significant
growth in activity. Production of FMTV (Family of Medium Tactical Vehicles) has
increased and MRAP vehicles have been in demand throughout 2007. This is
likely to continue in the short term with MMPVs and JLTVs likely to become
the focus. BAE Systems currently has two distinct JLTV bids underway.
Wheeled utility vehicle route map
Previous Now Future
MRAP
RG33
Caiman
RG31
JLTV
MMPV
FMTV
BAE Systems
Others
Subject to competition
Up-armour programme
HMMWV
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Implementing our strategy (continued)
16 www.baesyste ms.com
Delivering benefits
from partnered support
BAE Systems’ UK Tornado support programme is a key example of how the
Group is meeting customer demands for ‘through-life’ capability and support.
Initially the Group piloted projects with the UK military aircraft fleet, which
have now culminated in the Tornado ATTAC programme. This model can now
be followed for other projects both within the UK and other export markets.
Tornado support roadmap
Initial pilot contracts
Spares and
component support
Through-life
support contract
Whole aircraft
support
Availability contract
ATTAC
Tornado weapon
system availability
Future availability
contract opportunities
e.g Typhoon,
Nimrod MRA4
Tornado support roadmap
BAE Systems contracts
Possible future BAE Systems contracts
– BAE Systems and its predecessor companies have
developed extensive support capability in the Kingdom
of Saudi Arabia over several decades
– Pilot projects launched within the UK based on this
experience realised significant cost and efficiency benefits
– BAE Systems’ partnering approach took a significant step
forward in 2006 with the UK Tornado support programme
– The partnered support model is being developed for other
projects and in other markets, such as Australia
In response to customer demands BAE Systems has developed
a partnered support approach which is providing cost savings and
efciencies for customers while developing a substantial and
protable stream of business for the Group.
For several decades BAE Systems and its predecessor companies
have been developing a deep relationship in support of the armed
forces in Saudi Arabia, principally the Royal Saudi Air Force. This highly
successful relationship has provided a basis on which to develop
support solutions programmes into other markets, most notably
with the armed forces in the UK.
Initial pilot projects were established, identifying components of
the UK’s military aircraft fleet where industry could bring enhanced
efficiency to the management of parts, repair and overhaul. In an
environment of severe cost restraint the benefits quickly became
apparent, delivering reduced costs together with the operational
benefit of enhanced availability.
Progressively, BAE Systems’ deeper involvement in support of the Royal
Air Force (RAF) has been expanded across larger airframe assemblies
and sub-systems leading to contracts to manage the maintenance and
support of whole aircraft eets. A combined maintenance and upgrade
facility was established at RAF Cottesmore for the UK’s Harrier eet,
co-locating the RAF and Royal Navy engineering activities with those
of BAE Systems.
The similar concept now in place for the larger eet of Tornado aircraft
in the UK enabled aircraft down-time for maintenance to be optimised
to facilitate modications and systems upgrade to take place
concurrently. Combined maintenance and upgrade has reduced
traditional maintenance manhours by 50%. Highlighting the success of
this programme, the UK government’s National Audit Ofce reported in
2007 that these arrangements had contributed to savings of £1.3bn
over the past ve years on Tornado support, with a 51% reduction in
Tornado ying hour costs.
Grow UK
through-life
businesses
Grow US
business
Grow land
systems
Grow export
business
Grow in the
Kingdom of
Saudi Arabia
Grow global
support
Business portfolio actions (addressed in this case study)
At the end of 2006 the Group’s partnership approach to supporting
the UK’s armed forces took a further major step forward with the
signing of the ATTAC (Availability Transformation: Tornado Aircraft
Contract) agreement. ATTAC is potentially worth £1.5bn and includes
on-aircraft maintenance of the Tornado GR4 aircraft eet, spares
support, technical support and training. Under the ATTAC agreement,
BAE Systems has taken responsibility for deep support at
RAF Marham and combines this with a capability development and
sustainment service as a structured and cost-effective approach
to inserting new capability into the aircraft, so as to maintain its
war-ghting effectiveness throughout its service life. ATTAC is an
availability contract where BAE Systems is responsible for ensuring
the required aircraft, at an agreed capability, are provided to the
front-line when they are required.
Similar opportunities exist across a number of areas, including new
platforms such as Typhoon and those due to enter service, such as
the MRA4 Nimrod. In addition, similar partnered support arrangements
are being developed across the UK’s armoured ghting vehicle eets
and in UK naval support.
Case study two
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BAE Systems Annual Report 2007 17
Saudi Arabia
BAE Systems’ home market strategy in
Saudi Arabia is focused on the in-country
development of industrial capability.
Kingdom of Saudi Arabia programme evolution
British Aircraft Corporation
Lightning, Strikemaster
British Aerospace
Tornado, Hawk
BAE Systems
Typhoon
1970 1980 1990 2000 2010 2020 2030
Grow UK
through-life
businesses
Grow US
business
Grow land
systems
Grow export
business
Grow in the
Kingdom of
Saudi Arabia
Grow global
support
Business portfolio actions (addressed in this case study)
A home market strategy in
the Kingdom of Saudi Arabia
– Moving from an export programme to a home market
– Focus on investment and training within Saudi Arabia
Saudi Arabia has been an important market for BAE Systems for a
number of decades. The Group continues to strengthen this market
relationship, creating new opportunities for the future and the
development of Saudi Arabia as a home market.
BA E Systems can trace the roots of its relationship with the Kingdom
of Saudi Arabia back through its predecessor companies to the supply
of Lightning and Strikemaster aircraft in the late 1960s. The initial
aircraft deliveries were followed by the provision of extensive support
arrangements. In 1985 agreement was reached between the UK
government and the Kingdom of Saudi Arabia for a substantial
enhancement to the capability of the Royal Saudi Air Force (RSAF)
and Royal Saudi Naval Forces (RSNF) through the purchase of Tornado
aircraft and associated training systems and support, and supply of
ships. As with the Lightning programme, Tornado was initially a UK
export programme supported by a large expatriate workforce.
Over time, BAE Systems and the RSAF have worked to substantially
increase the number of Saudi nationals employed on the programme.
Well-trained and highly skilled Saudi nationals have progressively
replaced a high proportion of the expatriate workforce and the
capability to undertake major maintenance and upgrade activity has
been established in Saudi Arabia. The Group employs approximately
2,300 Saudi nationals. BAE Systems has made signicant
investments into Saudi Arabia, both in new facilities for its people and
in companies through which aerospace work is undertaken in support
of the programme. The Group’s commitment to Saudi Arabia as one
of its key home markets includes the recent relocation of the
divisional management team to the Kingdom.
In December 2005 the UK government and the Kingdom of Saudi
Arabia signed an agreement to modernise the Saudi Arabian armed
forces. This programme, Salam, includes the supply of Typhoon
aircraft, a contract for which was signed in 2007. Importantly, the
agreement sets out a plan that will further enhance both Saudi
Arabia’s indigenous capability and BAE Systems’ position as a major
constituent of the Saudi Arabian defence industrial base and a major
local employer. Further investment in industrial facilities is already
underway to facilitate the modernisation of the RSAF and support the
introduction of Typhoon aircraft under the Salam programme.
Case study three
Aircraft export sale
Integrated defence capability
Industrialisation
BAE Systems’ relationship with Saudi Arabia can be traced back to the
late 1960s through its predecessor companies. Today this has developed into
a successful home market with the Salam programme to supply
Typhoon aircraft signed in 2007.
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Financial review
18 www.baesyste ms.com
A year of continued growth
Sales
1
increased 14% from £13,765m to £15,710m. Sales in the
full year from the Armor Holdings business, acquired in July 2007,
were £725m. Like-for-like growth, after adjusting for the impact of
exchange translations and acquisitions and disposals, was also
14%. US-led businesses were responsible for 47% of sales
1
and
sales
1
generated from home markets represented 85% of the
Group total.
EBITA
2
increased 22% to £1,477m (2006 £1,207m). The growth
includes the benet of ve months trading from the Armor Holdings
business, acquired in July 2007, which contributed EBITA
2
of £77m
in the year. Translation of US$ generated results decreased EBITA
2
by £47m when compared with 2006. US-led businesses delivered
50% of the Group’s EBITA
2
.
Return on sales (EBITA
2
adjusted for uplift on acquired inventories
expressed as a percentage of sales) for the Group increased from
8.8% to 9.5%.
Amortisation and impairment
The impairment charge of £148m includes £145m in respect of the
goodwill associated with the Group’s Insyte business.
Order book
1
increased to £38.6bn, primarily on the award of the Saudi
Typhoon contract, MRAP orders and the acquisition of Armor Holdings.
Net nance costs
1
Financial income, including the Group’s share of the nance costs
of equity accounted investments, was £93m (2006 £174m nancial
expense). The underlying net interest charge of £38m (2006 £157m)
was offset by a net credit of £131m (2006 increased by a net charge
of £17m) arising from pension accounting, marked-to-market
revaluation of nancial instruments and foreign currency movements.
Results for the year – continuing operations
Finance costs were reduced in 2007, primarily as a result of the
benet of the October 2006 Airbus net disposal proceeds (£1.2bn).
Underlying interest cover based on EBITA
2
increased from 7.7 times
to 39 times.
Taxation
The Group’s effective tax rate for continuing operations for the year
was unchanged from 2006 at 26%.
Earnings per share
Underlying earnings
3
per share from continuing operations for 2007
increased by 30% to 31.0p.
Basic earnings per share, in accordance with IAS 33 Earnings per
Share, from continuing operations, increased by 31% to 26.0p
(2006 19.9p).
Dividend
The Board is recommending a
nal dividend of 7.8p per share
(2006 6.9p), bringing the total
dividend for the year to 12.8p
per share (2006 11.3p), an
increase of 13.3%.
The proposed dividend is covered
2.4 times by earnings
3
from
continuing operations (2006 2.1
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.
“These are another set of strong results.
They demonstrate the signicant
fundamental strengths and quality
of the business.”
George Rose Finance Director
9.5
10.3
11.3
9.2
12.8
3
6
9
12
15
0706050403
Dividend (pence per share)
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 19
Summary income statement – continuing operations
Business group summary
2007 2006
5
Cash Cash inflow/
Sales
1
EBITA
2
inflow
4
Order book
1
Sales
1
EBITA
2
(outflow)
4
Order book
1
£m £m £m £bn £m £m £m £bn
Electronics, Intelligence & Support 3,916 429 302 3.5 4,007 429 273 3.4
Land & Armaments 3,538 312 10 7.3 2,115 168 137 4.9
Programmes & Support 5,327 456 807 20.9 4,615 342 449 17.0
International Businesses 3,359 435 678 7.9 3,428 415 171 7.1
HQ & Other Businesses 243 (155) 181 0.4 295 (147) (225) 0.3
16,383 1,477 1,978 40.0 14,460 1,207 805 32.7
Intra-group (673) – – (1.4) (695) – – (1.0)
Discontinued businesses ––––– – (23) –
15,710 1,477 1,978 38.6 13,765 1,207 782 31.7
2007 2006
£m £m
Sales
1
15,710 13,765
EBITA
2
1,477 1,207
Amortisation (149) (105)
Impairment (148) (34)
Net finance costs
1
93 (174)
Taxation expense
1
(373) (248)
Profit for the year 900 646
Basic earnings per share 26.0p 19.9p
Underlying earnings
3
per share 31.0p 23.8p
Dividend per share 12.8p 11.3p
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 earnings excluding amortisation and impairment of intangible assets, non-cash finance
movements on pensions and financial derivatives, and uplift on acquired inventories
(see note 10 to the Group accounts)
4 net cash inflow/(outflow) from operating activities after capital expenditure (net) and
financial investment, and dividends from equity accounted investments
5 restated following changes to the Group’s organisational structure
The resulting operating business cash inow of £1,978m (2006 £782m)
gave rise to free cash inow, after interest, preference dividends and
taxation, of £1,801m (2006 £490m).
On 31 July 2007, the Group acquired Armor Holdings, Inc. for $4.5bn
(£2.2bn) excluding fees. Net cash outow from all acquisitions and
disposals was £2,112m.
In the period, 33 million shares were purchased under the buyback
programme announced in October 2006. The cash outow in respect
of this programme was £152m in the period. In May, £750m, before
costs, was raised following the placing of new ordinary shares to part
nance the proposed acquisition of Armor Holdings, Inc.
Conversion of the outstanding 260 million 7.75p (net) cumulative
redeemable preference shares into ordinary shares removed the debt
element of these preference shares, giving rise to an increase in
reported cash of £245m.
The Group’s net cash at 31 December 2007 was £700m, a net inow
of £265m from the net cash position of £435m at the start of the year.
Retirement benet obligations
The movement in retirement benet obligations during the year was
as follows:
£m
Deficit in defined benefit pension plans at 1 January 2007 (3,167)
Decrease in liabilities due to changes in assumptions 952
Actual return on assets below expected returns (156)
One-off contributions 76
Recurring contributions over service cost 214
Transfers arising on acquisitions (22)
Other movements 104
Deficit in defined benefit pension plans
at 31 December 2007 (1,999)
US healthcare plans (21)
Total IAS 19 deficit (2,020)
Allocated to equity accounted investments and other
participating employers 450
Group’s share of IAS 19 deficit at 31 December 2007 (1,570)
Following higher regular contributions and an increase in real discount
rates partly offset by lower than expected investment returns and the
adoption of new mortality tables, the Group’s share of the pension decit
decreased to £1,570m from £2,428m at 31 December 2006 after
allocations to equity accounted investments and other participating
employer companies.
A net deferred tax asset of £522m is disclosed in note 8 to the Group
accounts relating to the above decit.
Further disclosure on the above is provided in note 22 to the
Group accounts.
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Financial review (continued)
20 www.baesyste ms.com
Reconciliation of cash inow from operating activities to net cash
2007 2006
£m £m
Cash inflow from operating activities 2,162 778
Capital expenditure (net) and financial
investment (262) (141)
Dividends received from equity accounted
investments 78 145
Operating business cash flow 1,978 782
Interest and preference dividends (65) (207)
Taxation (112) (85)
Free cash flow 1,801 490
Acquisitions and disposals (1,574) 1,330
Debt acquired on acquisition of subsidiary (538) –
Issue/(purchase) of equity shares 603 (71)
Equity dividends paid (396) (346)
Dividends paid to minority interests (1) –
Preference share conversion 245 6
Other non-cash movements 57 (11)
Foreign exchange 36 323
Movement in cash on customers’ account
6
32 (9)
265 1,712
Opening net cash/(debt) as defined by the Group 435 (1,277)
Closing net cash as defined by the Group 700 435
Analysed as:
Term deposits – non-current – 4
Term deposits – current 164 503
Cash and cash equivalents 3,062 3,100
Loans – non-current (2,197) (2,776)
Loans – current (283) (308)
Overdrafts – current (16) (26)
Loans and overdrafts – current (299) (334)
Cash on customers’ account
6
(included within trade and other payables) (30) (62)
Closing net cash as defined by the Group 700 435
6 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
Cash ows
Cash inow from operating activities was £2,162m (2006 £778m),
which is after £76m (2006 £441m) special contributions to the UK
pension schemes.
There was an outow from net capital expenditure and nancial
investment of £262m (2006 £141m).
Dividends from equity accounted investments, primarily MBDA, Gripen
International, Euroghter and Saab, amounted to £78m.
Exchange rates
The principal exchange rates impacting the Group are as follows:
2007 2006
£/€ – average 1.461 1.467
£/$ – average 2.002 1.844
£/€ – year end 1.361 1.484
£/$ – year end 1.988 1.957
EBITA
2
– continuing operations (£m)
£m
0
400
800
1200
1600
2007ArmorPerformance2006
Currency
translation
The following charts illustrate the underlying performance of the Group, identifying separately the impact of currency and the acquisition of
Armor Holdings.
Underlying earnings
3
per share – continuing operations
(pence per share)
2007Armor
(net)
Finance costs
reduction
(ex-Armor)
EBITA
(ex-Armor)
Currency
translation
2006
Pence per share
0
9
18
27
36
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 21
Treasury policy
The Group’s treasury activities are overseen by the Treasury Review
Management Committee (TRMC). Two executive directors are
members of the TRMC, including the Group Finance Director who
chairs the Committee. The TRMC also has representatives with legal
and taxation expertise.
The Group operates a centralised treasury department that is
accountable to the TRMC for managing treasury activities in accordance
with the framework of treasury policies and guidelines approved by
the Board. It is an overriding policy that trading in nancial instruments
for the purpose of prot generation is prohibited, with all nancial
instruments being used solely for risk management purposes.
Other key policies are:
– to maintain a balance between continuity of funding and exibility
through the use of borrowings with a range of maturities, currencies
and xed/oating rates of interest reecting the Group risk prole;
– to maintain adequate undrawn committed borrowing facilities;
– to mitigate the exposure to interest rate uctuations on borrowings
and deposits by utilising interest rate swaps, interest rate options
and forward rate agreements; and
– to hedge all material rm transactional exposures, unless otherwise
approved as an exception by the TRMC, as well as to manage
anticipated economic cash ows over the medium term.
Within this policy framework the treasury department’s principal
responsibilities are:
– to manage the Group’s core funding and liquidity;
– to manage exposure to interest rate movements;
– to manage exposure to foreign currency movements;
– to control and monitor bank credit risk and credit capacity utilisation;
and
– to manage the Group’s relationship with debt capital market investors,
banks and rating agencies.
The treasury department transacts with an extensive range of
counterparty banks and nancial institutions, and adopts a systematic
approach to the control and monitoring of counterparty credit risk.
A credit limit is allocated to each counterparty with reference to its
relevant credit rating. For internal credit risk purposes, all transactions
are marked-to-market and the resultant exposure is allocated against
the credit limit.
The Group, through its internal audit department, monitors compliance
against the principal policies and guidelines (including the utilisation
of credit) and any exceptions found are reported to the TRMC.
Further disclosure on nancial instruments is set out in note 32 to the
Group accounts.
2 earnings before amortisation and impairment of intangible assets, finance costs
and taxation expense
3 earnings excluding amortisation and impairment of intangible assets, non-cash
finance movements on pensions and financial derivatives, and uplift on acquired
inventories (see note 10 to the Group accounts)
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Financial review (continued)
22 www.baesyste ms.com
Credit rating
Three credit rating agencies, Moody’s Investors Service, Standard
and Poor’s Ratings Services and Fitch’s Investors Service, publish
credit ratings for the Group. During the year Standard & Poor’s
improved their rating to BBB+ and all three maintained the outlook
for their rating as stable.
As at 31 December 2007, the Group’s long-term credit ratings
provided by these agencies were as follows:
Rating agency Rating Outlook Category
Moody’s Baa2 Stable Investment grade
Standard & Poor’s BBB+ Stable Investment grade
Fitch BBB Stable Investment grade
The Board continues to view the maintenance of an investment
grade credit rating as important to the efcient operation of the
Group’s activities.
Capital structure
The Group funds its operations through a mixture of shareholders’
funds and borrowing facilities, including bank and capital market
borrowings. All the Group’s material borrowings are arranged by the
central treasury function and funds raised are lent onward to operating
subsidiaries as required. The Group’s objective is to ensure the
continuity of competitively priced funding by borrowing from a range
of markets and spreading the maturity dates of the various facilities.
Details of the Group’s debt are included in note 20 to the Group
accounts. During 2007, the US$200m Bond and the Euroghter
GmbH loans were repaid. No new long or medium-term debt was
raised during the year. It remains the Group’s intention to ensure
the business is funded conservatively and to be proactive in
accessing the bank and capital markets in achieving this aim.
Liquidity
Strong cash generation in recent years and a prudent nancing
strategy has resulted in the Group currently being well positioned
to withstand the credit crisis in the bank and capital markets. The
Group had cash and short-term investments at 31 December 2007 of
£3,226m (2006 £3,603m). This, together with an undrawn committed
Revolving Credit Facility (RCF) of £1.5bn (which is syndicated amongst
the Group’s core relationship banks), is available to meet any general
corporate funding requirement. The RCF provides standby funding for
the Group’s US Commercial Paper programme which is not currently
utilised. The RCF was contracted originally for ve years until 2010.
However, it has been extended by two one-year extension agreements
until 2012, although the available amount for the nal year has been
reduced from £1.5bn to £1.3bn. The RCF remained undrawn
throughout the year.
Since the start of the credit crisis in the summer of 2007, the Group
has adopted a more conservative approach to the investment of its
surplus cash, with money market deposits being placed with relatively
stronger nancial institutions for shorter periods. Bank counterparty
credit risk is 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.
Generally, excluding the impact of acquisition or disposal nancing, the
net cash/debt of the Group is driven by operational performance, the
level of receipts on the major contracts and the performance of the
equity accounted investments. Historically, the net cash/debt position
of the Group is usually at its best at the year end.
Insurance
The Group operates a policy of partial self-insurance, with the majority of
cover placed in the external market. The Group continues to monitor its
insurance arrangements to ensure the quality and adequacy of cover.
Directors’ report – Business review
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Shareholder information
BAE Systems Annual Report 2007 23
Where goods are supplied under arrangements not considered to
represent Construction Contracts, as dened by IAS 11, sales are
recognised when the signicant risks and rewards of ownership
have been transferred and the related revenue and costs can be
measured reliably.
Where services are rendered, sales are recognised when the stage of
completion of the services and the related revenue and costs can be
measured reliably.
Additional details concerning the Group’s revenue recognition policy are
in note 1 to the Group accounts.
Retirement benet plans
The Group accounts for post-retirement pension and healthcare plans
in accordance with IAS 19 Employee Benets (IAS 19).
For dened benet retirement plans, the cost of providing benets is
determined periodically by independent actuaries and charged to the
income statement in the period in which those benets are earned
by the employees. Actuarial gains and losses are recognised in full
in the period in which they occur and are recognised in the statement
of recognised income and expense. Past service cost is recognised
immediately to the extent the benets are already vested, or otherwise
is amortised on a straight-line basis over the average period until the
benets become vested.
The retirement benet obligations recognised in the balance sheet
represent the present value of the dened benet obligation as adjusted
for unrecognised past service cost and as reduced by the fair value of
plan assets.
The main assumptions made in accounting for the Group’s post-
retirement plans relate to the expected return on investments within
the Group’s plans, the rate of increase in pensionable salaries, the rate
of increase in the retail price index, the mortality rate of plan members
and the discount rate applied in discounting liabilities. For each of these
assumptions there is a range of possible values and, in consultation with
our actuaries, management decides the point within that range that most
appropriately reects the Group’s circumstances. Small changes in these
assumptions can have a signicant impact on the size of the decit
calculated under IAS 19.
The Group has allocated an appropriate share of the pension decit
to its equity accounted investments and to other participating
employers using a consistent and reasonable method of allocation
which represents, based on current circumstances, the directors’ best
estimate of the proportion of the decit anticipated to be funded by
these entities. The Group’s share of the pension decit allocated to the
equity accounted investments is included on the balance sheet within
equity accounted investments.
The Group’s signicant accounting policies are outlined in note 1 to
the Group accounts (page 94). Not all of these signicant accounting
policies require management to make difcult, subjective or complex
judgements or estimates.
The following is intended to provide an understanding of those policies
that management considers critical because of the level of complexity,
judgement or estimation involved in their application and their impact
on the consolidated nancial statements. These judgements involve
assumptions or estimates in respect of future events, which can
vary from what is anticipated. However, the directors believe that the
consolidated nancial statements reect appropriate judgements and
estimations and provide a true and fair view of our nancial performance
and position over the relevant period.
Contract revenue and prot recognition
The majority of the Group's defence activities are conducted under long-
term contract arrangements and are accounted for in accordance with
International Accounting Standard 11 Construction Contracts (IAS 11).
Revenue is recognised on such contracts based on the achievement of
performance milestones. No prot is recognised on contracts until the
outcome of the contract can be reliably estimated.
Prot is calculated by reference to reliable estimates of contract revenue
and forecast costs after making suitable allowance for technical and
other risks related to performance milestones yet to be achieved.
Owing to the complexity of many of the contracts undertaken by the Group
the cost estimation process requires signicant judgement and is based
upon the knowledge and experience of the Group’s project managers,
engineers, nance and commercial professionals and using the Group’s
contract management processes. Factors that are considered in
estimating the cost of work to be completed and ultimate protability
of the contract include the nature and complexity of the work to be
performed, availability and productivity of labour, the effect of change
orders, the availability of materials, performance of subcontractors and
availability and access to government-furnished equipment.
Cost and revenue estimates and judgements are reviewed and updated
at least quarterly and more frequently as determined by events or
circumstances. When it is probable that total contract costs will exceed
total contract revenue, the expected loss is recognised immediately as
an expense. Contract costs comprise directly attributable costs including
an allocation of direct overheads. Indirect overheads are only regarded
as contract costs when their recovery is explicitly allowed for under the
terms of the contract. Indirect costs are otherwise treated as a period
cost and are expensed as incurred. Material changes in one or more of
these estimates, whilst not anticipated, would affect the protability of
individual contracts.
Critical accounting policies
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Financial review (continued)
24 www.baesyste ms.com
The Group has granted RVGs in respect of certain aircraft sold of which
£134m remains outstanding (2006 £191m). It is considered that the
Group’s net exposure to these guarantees is covered by the provisions
held, on a net present value basis, and the estimated residual values of
those aircraft. Additional details concerning this are given in note 24 to
the Group accounts.
The valuing of assets and liabilities at a point in time rather than
matching expectations of assets and liabilities over time has no
impact on short-term cash contributions to the pension plans.
These funding requirements are derived from separate independent
actuarial valuations.
Additional details concerning the Group’s retirement benet plans
are given in note 1 and note 22 to the Group accounts.
Intangible assets
In accordance with International Financial Reporting Standard 3
Business Combinations (IFRS 3), goodwill arising on acquisition of
subsidiaries is capitalised and included in intangible assets. Goodwill
on acquisitions of joint ventures and associates is included in equity
accounted investments. IFRS 3 also requires the identication of other
acquired intangible assets. The techniques used to value these
intangible assets are in line with internationally used models but do
require the use of estimates which may differ from actual outcomes.
Future results are impacted by the amortisation period adopted for
these items and, potentially, any differences between estimated and
actual circumstances related to individual intangible assets.
Goodwill is not amortised but is tested annually for impairment and
carried at cost less accumulated impairment losses. The impairment
review calculations require the use of estimates related to the future
protability and cash-generating ability of the acquired business.
Additional details concerning the Group’s treatment of intangible assets
and impairment reviews are given in note 1 to the Group accounts.
Regional Aircraft valuations
The Group holds a number of regional aircraft on its balance sheet.
These aircraft are leased to airline operators. In addition, the Group has
provided residual value guarantees (RVGs) in respect of certain regional
aircraft sold. The aircraft held on balance sheet are subject to regular
impairment testing. During the year the anticipated aircraft values were
reassessed to a value based on their contracted rental inows plus a
residual value determined by the aircraft type and age. Provisions related
to the RVGs are measured as the difference between amounts payable
to customers and the estimated fair value of the aircraft. The estimated
fair value of those aircraft is made on the same basis as for the aircraft
held on balance sheet.
Much of the leasing business was underpinned by the Group’s Financial
Risk Insurance Programme, which makes good shortfalls in actual lease
income against originally estimated future income for a 15-year period
from 1998 to 2013. Since 2006, BAE Systems and certain of the
reinsurers have been in dispute over several areas of the policy. During
2007, agreement was reached with almost all the reinsurers and
settlements have been paid by them based on the net present value
of estimated future claims. Arbitration proceedings now continue with
only one reinsurer. Additional details concerning these arrangements
are contained in the Risk management and principal risks section on
page 49 of this report.
To measure financial performance:To measure growth:
Further explanation of many of these Group nancial KPIs for the years ending 31 December 2007 and 2006 are included within the Financial
review, together with information on underlying earnings per share – a metric used alongside underlying EBITA
1
to communicate underlying
performance. Individual business group nancial KPIs are included within the Business group reviews on pages 28 to 36.
1 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense adjusted for the uplift on acquired inventories. The directors consider this
measure more appropriate to assess the ongoing performance of the acquired businesses. For 2007, this adjustment was £12m (2006 £nil).
Order intake (£bn) 2007: £21.2bn +33%
2006: £15.9bn
Order intake represents the value of funded orders received from customers
in the period.
0
6
12
18
24
07060504
Order book (£bn) 2007: £38.6bn +22%
2006: £31.7bn
Order book represents the balance of unexecuted, funded orders received
from customers.
0
10
20
30
40
07060504
Sales (£bn) 2007: £15.7bn +14%
2006: £13.8bn
Sales represents the amounts derived from the provision of goods
and services, and includes the Group’s share of the sales of equity
accounted investments.
0
4
8
12
16
07060504
Underlying EBITA
1
(£m) 2007: £1,489m +23%
2006: £1,207m
Underlying EBITA
1
is used by the Group for internal performance analysis
as a measure of operating protability that is comparable over time.
300
600
900
1200
1500
07060504
Return on sales (%) 2007: 9.5%
2006: 8.8%
Return on sales represents underlying EBITA
1
divided by sales, expressed
as a percentage.
2
4
6
8
10
07060504
Operating business cash ow (£m) 2007: £1,978m +153%
2006: £782m
Operating business cash ow represents net cash ow from operating
activities after capital expenditure (net) and nancial investment and
dividends from equity accounted investments.
500
1000
1500
2000
2500
07060504
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
Directors’ report – Business review
Key Performance Indicators (KPIs)
BAE Systems Annual Report 2007 25
The Board uses a range of nancial and non-
nancial performance indicators, reported on a
periodic basis, to monitor the Group’s performance
over time. These include:
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Key Performance Indicators (KPIs) (continued)
26 www.baesyste ms.com
In addition to the above, long-term contracts are managed through the
application of mandated business processes. These processes include
the reporting of the following metrics:
– Programme Margin Variation (outturn projections of and movements
in margin of key customer-funded projects): to provide an indicator
of our ability to effectively manage major programmes;
– Schedule Adherence (on time achievement of key milestones):
to measure how well we are performing against our stated key
contract commitments;
– Customer Satisfaction (customer opinions on key customer-funded
projects): to provide an opportunity for the customer to share
information on perceived performance levels and identify areas
of strength and weakness; and
– Lifecycle Management (LCM) Application (the application of the
core process BAE Systems uses to manage its projects): to provide
assurance that we are applying a structured approach to managing
the Group’s projects.
These metrics are consistently used by the Board to provide oversight
of contract performance. These metrics can only be fully interpreted
and understood on a contract by contract basis.
The Board recognises its responsibilities to the Group’s shareholders,
employees, customers and suppliers, the wider community and to the
environment. The following indicators are used by the Board, either
directly or through the Corporate Responsibility Committee, to monitor
the application of mandated policies with the objective of meeting the
Group’s responsibilities in these areas:
– Health and safety management (injuries and lost days): to minimise
risk to our employees and our operations and drive continual
performance improvement (see opposite and page 39);
– Environment (energy use, waste generation and greenhouse gas
emissions): to ensure operational efciency, regulatory compliance
and minimising environmental impact (see page 40);
– Ethics (number of issues raised and investigated): to demonstrate
that employees are aware of our ethical standards and that issues
or concerns are being raised and addressed. Also, to measure how
successful our ethics training is in ensuring that all employees are
aware of the Group’s ethical standards and policies (see page 39); and
– Workplace (employee opinion surveys and demographic information):
to monitor the opinions of our employees as part of the development
of a high-performance culture across the Group and to increase
diversity and broaden the culture to drive innovation and performance
(see page 39).
Directors’ remuneration is linked to a range of measures, including
certain of these nancial and non-nancial measures. Further
information is given within the Remuneration report on pages 64
to 83 of this report.
The Board continues to adopt a progressive approach in the
development of appropriate Group-wide metrics such that
performance is monitored in a comparable and transparent way.
To measure corporate responsibility performance:
Further information on the Group’s safety and environmental
performance is given within the Corporate responsibility review
on pages 37 to 43.
1 This data is derived from internal recording systems and is not subject to external
verification or audit.
Days recorded lost to work-related injuries (per 100,000 employees)
1
Days recorded lost to work-related injuries down by 14% to 8,734
(2006 10,204).
2011 target – 2,000 days lost to work-related injuries. We are developing a
four-year plan for improving our safety performance. Initial focus areas include
visible senior leadership, establishing specic targets for improvement and
linking safety performance to senior management bonuses. These have
been incorporated into our 2008 leadership objectives (see page 38).
0
3000
6000
9000
12000
070605
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 27
Our global business
Electronics, Intelligence & Support
Comprises two operating groups, Electronics & Integrated
Solutions and Customer Solutions.
Land & Armaments
Comprises businesses in the US, the UK, Sweden and
South Africa.
Programmes & Support
Comprises the Group's UK-based air, naval and
underwater systems activities, and the Integrated System
Technologies business.
International Businesses
Comprises the Group's businesses in Saudi Arabia and
Australia, and its interests in the pan-European MBDA joint
venture and Saab of Sweden.
Our existing home markets and operating structure
Inc.
UK/Rest of World
International
Businesses
Land & Armaments
Electronics,
Intelligence
& Support
UK employees:
34,000
Sweden employees:
1,700
US employees:
44,000
South Africa
employees: 500
Saudi Arabia
employees: 4,300
Australia
employees: 2,600
Land & Armaments
Land & ArmamentsElectronics, Intelligence & Support
Programmes
& Support
International
Businesses
Other
Businesses*
Land &
Armaments
Electronics,
Intelligence
& Support
BAE Systems
Inc.
Land & Armaments
International
Businesses
* Other Businesses comprises the regional aircraft asset management and support activities, and UK shared services activity.
Directors’ report – Business review
Business group reviews
Our global business is based around our home markets in the US, the UK, Australia, Saudi Arabia,
South Africa and Sweden. These markets have been identied as having a signicant and sustained
commitment to defence, and we are already well positioned in their defence industrial base and have
strong customer relationships. We intend to invest and grow in these markets.
Programmes & Support International Businesses
UK/Rest of World
p28
p30
p32
p34
Note: employee numbers
exclude the Group’s share
of equity accounted
investments
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Business group reviews (continued)
28 www.baesyste ms.com
During 2007, Electronics, Intelligence & Support achieved EBITA
2
of £429m (2006 £429m) on sales
1
of £3,916m (2006 £4,007m)
and generated operating cash inflow
3
of £302m (2006 £273m).
In 2006, the return on sales benefited from a £61m pension-related
accounting gain.
In 2007, US$ translations decreased sales
1
and EBITA
2
when
compared with 2006 by £296m and £35m respectively.
In August, BAE Systems completed the sale of its Inertial Products
business for $140m (£70m). In December, the Group agreed to sell
its Surveillance and Attack business in Lansdale, Pensylvannia for
a cash consideration of $240m (£121m). Also in December, the
Group announced the proposed $448m (£225m) acquisition of MTC
Technologies, Inc., a company providing technical and professional
services, and equipment integration and modernisation for the US
military and intelligence agencies.
Electronics & Integrated Solutions (E&IS)
E&IS designs, develops and produces electronic systems and
sub-systems for a wide range of military and commercial applications.
The operating group is focused on four primary capabilities: electronic
warfare, commercial and military avionics, flight and engine controls,
and tactical and national network systems.
During 2007, E&IS delivered its 100th F-22A electronic warfare (EW)
system, the first F-35 Lightning II (Joint Strike Fighter) EW system
and its 1,000th Common Missile Warning System to protect US Army
helicopters and aircraft from heat-seeking missiles. E&IS continued
its role with the US Department of Homeland Security to develop
a commercial version of BAE Systems Directed Infrared
Countermeasures (DIRCM) system, JETEYE™, which seeks
to defeat the threat of shoulder-fired anti-aircraft missiles.
The Thermal Weapon Sight (TWS) programme achieved a production
rate of more than 1,500 units per month, surpassing 18,000 total
deliveries by the year end. The microbolometer technology that
underpins TWS was also used to secure important night vision
goggle and remote weapon stations contracts.
E&IS received a contract for the production of 50 fire fielding units of
the Terminal High Altitude Area Defense (THAAD) missile, supporting
the transition to production of this ballistic missile defence system.
Building on its strong legacy in C4ISR
4
systems, E&IS has begun initial
deployment of its First InterComm
TM
system, which enables emergency
services first responders to communicate more effectively using their
existing radios and frequencies.
The business received an order to build more than 1,000 helmet
assemblies for Typhoon and introduced new helmet-mounted,
heads-up display technology.
BAE Systems’ commercial hybrid propulsion business continues to
grow and reveal new opportunities. HybriDrive®propulsion technology
– Like-for-like organic sales
1
growth of 7% over 2006
– Return on sales improved to 11%
The Electronics, Intelligence & Support business
group, with 30,600 employees
1
and its
headquarters in the US, is a provider of defence
and aerospace systems, sub-systems and services.
It comprises two operating groups: Electronics &
Integrated Solutions and Customer Solutions.
Electronics, Intelligence & Support
2007 2006 2005
Sales
1
£3,916m £4,007m £3,697m
EBITA
2
£429m £429m £324m
Return on sales 11.0% 10.7% 8.8%
Cash inflow
3
£302m £273m £323m
Order intake
1
£4,178m £4,311m £3,659m
Order book
1
£3.5bn £3.4bn £3.5bn
– Continued leadership in the provision of electronic warfare systems
– New markets developing for the HybriDrive® propulsion systems
– Stable demand for ship repair services
Key points
2008 should see continued organic growth with an anticipated part-year
contribution from the proposed acquisition of MTC Technologies.
Profitable growth is anticipated in the electronic warfare and other defence
and aerospace electronics activities, based on the business’ strong legacy
technology and services positions, combined with its continued investments in
key capabilities. Ship repair activity is expected to remain stable. Growth in the
IT and services businesses is dependent on the near-term priorities of the US
Department of Defense.
Looking forward
Share of Group sales
5
24%
Share of Group EBITA
2,6
26%
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 net cash inflow from operating activities after capital expenditure (net) and financial
investment, and dividends from equity accounted investments
4 Command, Control, Communications, Computing, Intelligence, Surveillance and
Reconnaissance
5 before elimination of intra-group sales
6 excluding HQ & Other Businesses
E&IS awarded new multi-year thermal
weapon sight contract by US Army
E&IS’s thermal imaging technology enables
soldiers to see deep into the battlefield in
all weather conditions, both day and night.
Helmet development
BAE Systems has developed new helmet-
mounted display technology, the Q-Sight
family of helmet displays and tracking
products, that addresses a critical warfighter
need for enhanced situational awareness.
BAE Systems Ship Repair
With continued success in winning and
delivering on its US Navy contracts and mix
of other government and commercial work,
BAE Systems Ship Repair is building on its
market leading position in US non-nuclear
ship repair, conversion and modernisation.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 29
and US Navy communications station operations and maintenance
in Hawaii. TSS expanded into adjacent markets by supporting the US
Army with critical personnel for the global war on terror and by obtaining
the integrator role for the new US Air Force Battle Control System.
BAE Systems Ship Repair secured a five-year, multi-ship multi-option
contract from the US Navy to maintain and repair all Arleigh Burke-class
destroyers homeported or visiting San Diego, with a total potential value
in excess of $150m (£75m). Ship Repair also secured a three-year
contract from the US Navy for work on three newly commissioned San
Antonio-class amphibious transport dock ships and a contract from the
US Navy for modernisation of the Ticonderoga-class guided missile
cruiser USS Bunker Hill.
is in daily service on more than 1,100 transit buses in the United
States and Canada, and ten prototypes are scheduled to enter the
London bus fleet in 2008. Orders were received for an additional 1,500
systems in 2007 from New York City, Toronto, Ottawa and Houston.
As part of its initiative to integrate commercial and defence
capabilities, E&IS demonstrated the first hybrid electric drive system
for ground combat vehicles as part of the US Army’s Future Combat
Systems (FCS) programme and has developed and demonstrated a
common modular power system to meet the increasing electric power
demand onboard military vehicles.
E&IS continues to focus on through-life product and logistics support
for the US military through its Readiness & Sustainment efforts.
An on-site presence at Warner Robins Air Force Base and Tobyhanna
Army Depot provides a first-hand perspective to forecast and
develop upgrades.
Customer Solutions
Customer Solutions comprises three lines of business: BAE Systems
Information Technology (IT); Technology Solutions and Services (TSS);
and BAE Systems Ship Repair.
Customer Solutions integrates communications systems, builds and
maintains precision tracking radars, and is one of the largest service
providers to the US Navy. The business is also a leader in US air and
missile defence systems.
BAE Systems IT capabilities include enterprise-wide managed IT
operations, mission-critical application development and lifecycle
information assurance solutions and analytical services. TSS provides
services and solutions, system and sub-system integration, equipment
sustainment, and operations and maintenance. BAE Systems Ship
Repair is the leading non-nuclear ship repair company in the US
providing conversion and modernisation services principally in the
home ports of the US Navy.
BAE Systems IT operates within the large US government information
technology market and continues to deliver mission-enabling support
to its customers. BAE Systems ranked sixth in Computerworld’s ‘Best
Places to Work in IT’ for 2007. Contract successes include an award as
a prime contractor for the General Services Administration (GSA) Alliant
government-wide acquisition contract, a ten-year, $50bn (£25bn)
multiple award/indefinite-delivery indefinite-quantity (IDIQ) programme
designed to provide full IT lifecycle support services in support of the
US defence, intelligence and civilian government markets. The business
was also awarded a competitive $120m (£60m), five-year contract
to develop applications for the US Department of Labor. A variety of
contracts were secured by winning re-competes and new business to
provide key services such as network implementation and operation,
and lifecycle software development engineering to the US government.
In 2007, TSS won more than 98% of its re-competes, including
technical support to the US Missile Defense Agency and Federal
agencies, US Air Force range radar depot and engineering support work,
Directors’ report – Business review
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Directors’ report – Business review
Business group reviews (continued)
30 www.baesyste ms.com
During 2007, Land & Armaments achieved EBITA
2
of £312m (2006
£168m) on sales
1
of £3,538m (2006 £2,115m) and generated
operating cash inflow
3
of £10m (2006 £137m). The 2007 results
showed strong organic growth on core products in addition to success
in winning new business in the mine-protected vehicle market. The
results include five months of operations from the former Armor
Holdings, Inc. business.
At the end of July, BAE Systems completed the $4.5bn acquisition
of Armor Holdings, Inc. This acquisition has enhanced the Land &
Armaments global land systems business, most notably in the
increasingly important tactical wheeled vehicle sector, together with
technology in the vital areas of armour and survivability. Sales and
EBITA
2
from the acquired business amounted to $1,452m (£725m)
and $155m (£77m) respectively.
United States
During the year, US Army contracts were secured for the refurbishment
and upgrade of Bradley, M88 Hercules improved recovery vehicles and
M113 fighting vehicles totalling $2.3bn (£1.2bn).
As expected, during the first half of 2007, the US Army announced its
intention to terminate the M113 fighting vehicle programme. Sales of
M113 vehicles in 2007 totalled $105m (£52m).
BAE Systems is one of several companies providing the US Army
and Marine Corps with new Mine Resistant Ambush Protected (MRAP)
wheeled vehicles. In February 2007, the US business received an
initial order for 94 MRAP vehicles. Following evaluation and testing,
follow-on awards have been received for 3,485 MRAP vehicles with
a total value of $2.2bn (£1.1bn). MRAP vehicles are produced as
4x4 and 6x6 wheeled vehicles including the Heavy Armed Ground
Ambulance and Special Operation variants. BAE Systems has been
awarded approximately 35% of all MRAP vehicle orders placed to date.
BAE Systems continued to make substantial progress on the Manned
Ground Vehicles of the Future Combat Systems programme. Land &
Armaments delivered the Non-Line-of-Sight Mortar (NLOS-M) prototype
firing platform in early 2007. Test firing of the Non-Line-of-Sight
Cannon (NLOS-C) continues at the Yuma Proving Ground with the first
pre-production prototype delivery scheduled for May 2008. October
saw the opening of a temporary facility as well as the commencement
of construction for a 150,000 square foot NLOS-C integration facility in
Elgin, Oklahoma. The new facility will be adjacent to the US Army Field
Artillery School at Fort Sill and is targeted for completion in early 2009.
Development of the 155mm Advanced Gun System (AGS) and the
Long Range Land Attack Projectile for the US Navy’s DDG-1000
programme continues, with design, integration and production awards
secured totalling $386m (£194m). Land & Armaments conducted
a successful interim baseline review in August of AGS and production
is ramping-up at a new production site in Alabama. Land & Armaments
is designing and testing a Vertical Launching System that will enable
the US Navy’s DDG-1000 to launch a wide range of missiles.
– Like-for-like organic sales growth of 41% over 2006
– Post-acquisition sales of $1.5bn from Armor Holdings
– Success in wheeled vehicle market
– Order book growth on core products and urgent
operational requirements
The Land & Armaments business group, with
20,700 employees
1
and its headquarters in
the US, is a 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 intelligent munitions.
Land & Armaments
2007 2006 2005
Sales
1
£3,538m £2,115m £1,270m
EBITA
2
£312m £168m £42m
Return on sales 8.8% 7.9% 3.3%
Cash inflow
3
£10m £137m £168m
Order intake
1
£4,535m £2,964m £1,541m
Order book
1
£7.3bn £4.9bn £4.4bn
Further organic growth is anticipated in 2008 together with a full year’s
contribution from the former Armor Holdings business.
In the near term, US Land & Armaments operations are expected to continue
to benefit from operational requirements in Iraq and Afghanistan and the
Group’s investment made in the wheeled vehicle market. In the longer term,
the outlook will be dependent on the land sector continuing to be a priority
area of spend for the US and the UK.
UK operations will continue their emphasis on performance improvements,
seeking to secure an integrator role on the Future Rapid Effect System (FRES)
programme and on reaching resolution on a mutually beneficial, sustainable
munitions contract with the UK MoD.
The businesses in Sweden and South Africa aim to deliver growth through
both new domestic government business and building on their track record
of securing export orders.
Share of Group sales
4
22%
Share of Group EBITA
2,5
19%
Looking forward
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 net cash inflow from operating activities after capital expenditure (net) and financial
investment, and dividends from equity accounted investments
4 before elimination of intra-group sales
5 excluding HQ & Other Businesses
– High volume of vehicle reset and upgrade activity
– UK business returned to profitability
– Wheeled armoured vehicle successes
– Good progress in next-generation combat vehicle programmes
Key points
Upgrade contract
The British Army’s FV430 Bulldog and
Warrior armoured infantry vehicles will be
upgraded by BAE Systems over the next
two years.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 31
Deliveries of CV9035 armed vehicles to the Netherlands and Denmark
commenced during the fourth quarter of the year, under a multi-year
contract to provide 229 vehicles through to 2010.
In the area of intelligent munitions for artillery and mortar systems, the
155mm Excalibur supplied to the US Army performed well in theatre.
In November, Land & Armaments acquired Pitch Technologies,
an innovative computer-based training and research simulation
technologies company for £5m. The combination of BAE Systems
and Pitch creates a world-class capability in enterprise-level
simulation interoperability and solutions for training and simulation.
South Africa
The growing international requirement for mine-protected wheeled
vehicles continues to generate new orders for the RG31 and RG32
vehicles built by OMC, Land & Armaments’ South African subsidiary.
Land & Armaments received an initial award in February 2007 from
the prime contractor, General Dynamics, for the production of 24
RG31 MRAP vehicles for the US Marine Corps. This was followed
by a further order in August for 600 vehicles, of which 305 are being
produced by OMC in South Africa.
Land & Armaments is also providing a 57mm medium-calibre gun for
the DDG-1000, the US Navy’s Littoral Combat Ship and the Coast
Guard’s Deepwater programme.
United Kingdom
The British Army’s operations in Afghanistan and Iraq have resulted
in numerous urgent operational requirement orders to enhance FV430
and Warrior vehicles and many small and medium-calibre ammunition
orders in excess of £400m.
Full rate production of the M777 lightweight howitzer is on track with
delivery of an initial 151 guns to the US Army completed. An additional
award for 173 guns was received in December. The M777 system has
also been deployed in Afghanistan by the Canadian Army.
Engineering Tank Systems production continues with a total of 33
bridge-laying Titan vehicles and 33 Trojan obstacle-clearing vehicles
being delivered to the British Army. The Panther programme completed
Reliability Qualification Testing in August and is scheduled to deliver
408 vehicles by May 2009. The Terrier armoured tractor programme
is experiencing delays and a revised programme baseline is under
discussion with the customer.
In order to provide long-term savings to the customer and deliver a
sustainable munitions business, discussions continue with the UK
MoD aimed at agreeing a revised long-term contractual arrangement
for the Munitions Acquisition Supply Solution.
Land & Armaments continues to compete for the vehicle integrator role
on the Future Rapid Effect System (FRES) programme. BAE Systems
is the UK partner and Design Authority for much of the UK Armoured
Fighting Vehicle fleet.
Sweden
BAE Systems received a funding contract for £24m on the Archer self-
propelled artillery programme demonstrating Sweden and Norway’s joint
commitment to continue the final phase of the development programme.
Archer
Archer is the next generation, highly mobile,
self-propelled artillery system for Sweden
and Norway. Archer is scheduled to be
delivered to the Swedish Armed Forces
starting in 2008.
Bradley armoured fighting vehicle
Further contracts for the refurbishment and
upgrade of the Bradley armoured fighting
vehicle have been secured in the year.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Business group reviews (continued)
32 www.baesyste ms.com
During 2007, Programmes & Support achieved EBITA
2
of £456m
(2006 £342m) on sales
1
of £5,327m (2006 £4,615m) and generated
an operating cash inflow
3
of £807m (2006 £449m).
Return on sales benefited by 0.8% arising from one-off gains recorded
in the first half of 2007, including completion of the Offshore Patrol
Vessel arbitration process.
Order intake includes the appropriate work share of the award of the
Saudi Typhoon contract.
Military Air Solutions
Military Air Solutions is responsible for delivering five major
programmes: Typhoon, Hawk, Nimrod MRA4, F-35 Lightning II
(Joint Strike Fighter), and Autonomous Systems & Future Capability.
In addition, it is responsible for through-life support for these
programmes as well as for the UK’s Royal Air Force (RAF) fleets
of Harrier, Tornado, Nimrod MR2 and VC-10 aircraft.
The business made strong progress during 2007; both on delivering
its programme commitments and working in partnership with its
customers to enhance their military capability. Work continues
towards the creation of an air sector Long-Term Partnering Agreement
(LTPA) as envisaged in the Defence Industrial Strategy, published in
December 2005. A foundation contract, setting out the partnering
principles and providing a framework for detailed negotiations, was
agreed in March. This has enabled the Group to generate a shared
view of the business and is helping to direct investment.
Delivery of Typhoon aircraft to the four partner nations continues
with a total of 53 aircraft delivered to the UK and 84 across the other
European partner nations as at 31 December 2007. Five of the 15
contracted aircraft for Austria were also delivered during the year.
In the UK, RAF Typhoons are operational in air defence and Quick
Reaction Alert roles. Discussions to establish long-term integrated
logistics support contracts are progressing well. Tranche 2 aircraft are
now in final assembly with the first delivery planned for 2008. Work
has also commenced on further air-to-ground capability enhancements.
Good progress is being made on development and production of the
UK RAF Hawk Advanced Jet Trainer, where the first production aircraft
is now structurally complete.
On the Hawk contract for India, ten aircraft have been accepted by the
customer during the year. Twenty Hawk aircraft for South Africa have
been delivered, with the remaining aircraft due for delivery in the first
half of 2008. In March, the 200th T-45 Goshawk aircraft was delivered
to the US Navy and the ongoing T-45 production programmes continue
to schedule.
The Nimrod MRA4 aircraft development programme is progressing and
the production programme continues to perform to the contractual
milestones. A Stability Augmentation System has now been embodied
into the aircraft.
– Sales
1
growth of 15%
– Return on sales improved to 8.6%
– Order book
1
at a new high of £20.9bn
The Programmes & Support business group, with
29,100 employees
1
, comprises the Group’s UK-
based air, naval and underwater systems activities
and the Integrated System Technologies business.
Programmes & Support
Restated
4
Restated
4
2007 2006 2005
Sales
1
£5,327m £4,615m £4,660m
EBITA
2
£456m £342m £261m
Return on sales 8.6% 7.4% 5.6%
Cash inflow
3
£807m £449m £441m
Order intake
1
£9,091m £5,178m £4,186m
Order book
1
£20.9bn £17.0bn £16.8bn
– RAF Typhoons now operational
– Full six ship Type 45 destroyer contract awarded
– Launch of first of class Astute submarine
– Orders received for second and third Astute Class submarines
– Offshore Patrol Vessel arbitration settled
Key points
The future of Programmes & Support is linked to MoD funding in order to meet
current UK armed forces operational requirements and delivery of the Defence
Industrial Strategy.
In the air sector, short-term growth is dependent both upon production execution
and in-service support performance in the UK and on export deliveries.
The naval sector expects the creation of the joint venture, BVT Surface Fleet
Limited. Growth prospects for the joint venture include the UK’s Future Carrier
(CVF) programme and the Military Afloat Reach and Sustainability programme.
The six ship Type 45 programme underpins the business for the next few years.
The Submarines business is focused on the Astute programme and securing
concept design work on the Future Submarine programme. Securing orders
for Astute Boats 4 to 7 is key in retaining the necessary skill base in order
to design and build the next generation nuclear deterrent submarine.
Looking forward
Share of Group sales
5
33%
Share of Group EBITA
2,6
28%
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 net cash inflow from operating activities after capital expenditure (net) and financial
investment, and dividends from equity accounted investments
4 restated following changes to the Group’s organisational structure
5 before elimination of intra-group sales
6 excluding HQ & Other Businesses
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 33
The naval joint ventures continue to perform to plan. Upon creation
of the new maritime sector joint venture, BVT Surface Fleet Limited,
BAE Systems will sell its share of Flagship Training Limited to VT
Group, and Fleet Support Limited will become wholly owned by BVT
Surface Fleet Limited.
Submarine Solutions
The first of class boat, HMS Astute, was launched in June 2007
and has completed Trim & Basin Trials successfully. The boat is
on schedule for delivery to the November 2008 contracted date.
Construction activities on Boats 2 and 3 are also progressing well.
Agreement of pricing of Boats 2 and 3 was reached and an order
received to allow the start of production on Boat 4.
Integrated System Technologies (Insyte) and Underwater Systems
The Sampson Radar, the Combat Management System and Long
Range Radar programmes for the Type 45 destroyers continue to
meet all key milestones. The first of class radar has been successfully
installed onto HMS Daring.
The Seawolf Mid-Life Update Tracker completed all of its trials at the
shore-based facility, HMS Collingwood.
The Falcon programme continues to progress to schedule and will
provide the UK Armed Forces with a new tactical communications
network, providing a secure information infrastructure capability.
The Sting Ray lightweight torpedo main production order remains
on schedule with the third batch accepted in October 2007.
The Archerfish mine disposal system has successfully passed initial
qualification trials as the Common Neutraliser for sea mines with the
US Navy.
Talisman, the company-funded Unmanned Underwater Vehicle, has
been developed further, reducing the size, unit cost and the underwater
drag while retaining the payload capacity. It has undertaken exercises
with the US Navy.
The support contracts for the VC-10 and Nimrod MR2 aircraft continue
and VC-10 fleet maintenance has now been extended to 2013.
The Tornado availability programme, ATTAC, is fully effective and
a contract expansion has been agreed. This increases the scope
of ATTAC to include the remaining areas of the Tornado aircraft.
The Harrier GR9 aircraft has transitioned successfully into service.
Harrier has supported UK military operations with high recognition
for the capability it is providing.
Military Air Solutions is partnered with Lockheed Martin and Northrop
Grumman on the F-35 Lightning II programme, with responsibility for
the design and manufacture of the rear fuselage, empennage and
delivery of a number of key aircraft systems. Three aircraft variants
are in development; Carrier, Conventional Take-Off and Landing (CTOL)
and Short Take-Off and Vertical Landing (STOVL). The Carrier variant
completed its final Critical Design Review successfully in June and
manufacture and assembly has now commenced. All three aircraft
variants are now in various stages of manufacture and assembly.
Successful trials of a highly autonomous medium-altitude long-
endurance unmanned air system, HERTI, took place in 2007.
The Taranis unmanned combat air vehicle technology demonstration
programme continues on plan and to cost with the first metal cut of
the demonstration vehicle in September. Taranis is a key enabler to
the UK MoD’s evaluation of future capability requirements.
In-country flight testing of the first South African Gripen is proceeding
to plan.
Surface Fleet Solutions
In August, the Type 45 six ship contract was signed, capturing
the remaining scope of work to complete all six destroyers and
establishing a jointly managed risk profile against a robust schedule,
that met the MoD’s cost aspirations.
The second and third ships, Dauntless and Diamond, were launched
in January and November 2007 respectively, whilst the first of class,
HMS Daring, commenced sea trials in July.
The final vessel of the Bay Class Landing Ship Dock (Auxiliary),
RFA Lyme Bay, was handed over to the customer in June – two
months ahead of the contract date.
Two of the three ex-Royal Navy Type 23 frigates for the Chilean Navy
completed their reactivation and were delivered to the customer. The
third ship is planned to be handed over to the Chilean Navy in May 2008.
The CVF programme passed the UK MoD Main Gate Review in 2007.
Contracts for the manufacturing phase are now in the final stages
of negotiation.
The arbitration process in respect of the Offshore Patrol Vessels
was settled and title to all three vessels transferred to the customer
in April 2007.
Type 45
The first of class Type 45, HMS Daring,
successfully completed her stage one sea
trials on schedule in August 2007.
Partnering
Progress has been made towards
establishing a partnered through-life
availability support solution for the
RAF Typhoon.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Business group reviews (continued)
34 www.baesyste ms.com
During 2007, International Businesses achieved EBITA
2
of £435m
(2006 £415m) on sales
1
of £3,359m (2006 £3,428m) and generated
an operating cash inflow
3
of £678m (2006 £171m).
Sales
1
and EBITA
2
in 2006 included £99m and £2m respectively for
the Atlas Elektronik business that was disposed of in August 2006.
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. Over the last two decades the programme has
included the provision of aircraft, associated hardware, support,
infrastructure and manpower training for the Royal Saudi Air Force
(RSAF) and Royal Saudi Naval Forces (RSNF). Progress is being made
on modernising the Saudi armed forces in line with the Understanding
Document signed on 21 December 2005 between the UK and Saudi
Arabian governments. Under the terms of the signed document,
Typhoon aircraft will replace Tornado Air Defence Variant aircraft and
others currently in service with the RSAF. A contract for the delivery
of 72 Typhoon aircraft was agreed in the year with delivery of the first
aircraft scheduled for June 2009. Discussions are ongoing with the
RSAF to define and agree the support and training solutions to enable
their entry into service during 2009.
Around 4,300 people are employed by the Group in the Kingdom
of Saudi Arabia, of whom approximately half are Saudi nationals.
The business is continuing to develop its presence in Saudi Arabia,
including the relocation of staff from the UK, and is helping to develop
a greater indigenous capability in the Kingdom.
The security of employees is the highest priority and progress is well
advanced on new residential and office facilities as well as increased
security measures. Employees are in occupation at the first new
residential compound and office facility.
Through the core Saudi support programme, the business continues
to provide significant support to both the RSAF and RSNF operations
and their operational capability. In particular, steps are being taken
with the RSAF to maintain the capability of the Tornado aircraft while
extending its operational life.
BAE Systems’ investment and support for infrastructure development
in the Kingdom of Saudi Arabia includes the creation of training and
youth welfare programmes.
In December 2007, the first 22 RSAF Tornado Technicians to undertake
a new ‘multi-skilled training programme’, graduated. The programme,
designed in partnership with the RSAF, is aimed at producing multi-
skilled, rather than single-skilled, aircraft technicians.
BAE Systems also makes valuable contributions to the communities in
Saudi Arabia. Youth sports partnership activities between Saudi Arabia
and the United Kingdom began in 1987 with a formal Memorandum
of Understanding on sports exchange. Since that time, 1,000 Saudi
coaches have successfully undertaken Sports Coach UK qualification
– Sales
1
increased by 1%, net of 2006 Atlas disposal
– Return on sales increased to 13.0%
– Cash flow
3
generation of £678m, including Saudi
Typhoon milestones
The International Businesses business group,
with 15,300 employees
1
, comprises the Group’s
businesses in Saudi Arabia and Australia,
together with a 37.5% interest in the pan-European
MBDA joint venture and a 20.5% interest in Saab
of Sweden.
International Businesses
Restated
4
Restated
4
2007 2006 2005
Sales
1
£3,359m £3,428m £3,138m
EBITA
2
£435m £415m £400m
Return on sales 13.0% 12.1% 12.7%
Cash inflow
3
£678m £171m £711m
Order intake
1
£3,876m £3,854m £3,235m
Order book
1
£7.9bn £7.1bn £6.7bn
– Saudi Typhoon contract secured
– Investment in the Kingdom of Saudi Arabia continues
– Down-selection for the provision of vehicles for the Australian Defence Force
– Proposed acquisition of Tenix Defence announced in January 2008
Key points
The Group seeks to sustain its long-term presence in the Kingdom of Saudi
Arabia through delivering on current support and investment commitments,
and developing new business, and to reinforce its business in Australia as
through-life capability partner to the Australian Defence Force, including land
sector support.
In January 2008 the Group announced its proposed acquisition of Tenix Defence
which will, on completion, be integrated with BAE Systems’ Australian operations.
Looking forward
Share of Group sales
5
21%
Share of Group EBITA
2,6
27%
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 net cash inflow from operating activities after capital expenditure (net) and financial
investment, and dividends from equity accounted investments
4 restated following changes to the Group’s organisational structure
5 before elimination of intra-group sales
6 excluding HQ & Other Businesses
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 35
mounted displays, from the Royal Australian Navy for combat and
fire control management systems, from Tenix Marine for combat
management systems on Australian Navy’s landing helicopter dock
class ships and from the Royal Netherlands Army for a Mobile
Battalion Combat Training Centre.
Saab’s order book at the end of the year was SEK47.3bn (£3.7bn)
which included a reduction for the Pakistan airborne surveillance
system being re-negotiated to supply fewer systems than was
originally recorded in 2006.
MBDA (37.5% interest)
MBDA continued to maintain strong deliveries across a number of
key programmes. Key domestic deliveries included the Brimstone air-
launched anti-armour weapon, Mica air-to-air missile, Storm Shadow,
SCALP and Taurus cruise missiles. In the export market, key deliveries
included air weapons packages to Greece and UAE and Aster and
Rapier short-range air defence missiles.
Development programmes also progressed well. The six-nation
Meteor beyond visual range air-to-air missile continues to meet its
development milestones with the successful completion of the four
key development milestones and a continuing active firing campaign.
The Principal Anti-Air Missile System (PAAMS) programme for the
Royal Navy is now entering firing trials in preparation for qualification
while the tri-national MEADS area defence system is preparing for the
critical design review phase.
MBDA is leading negotiations towards the Team Complex
Weapons strategic partnering agreement under the UK's Defence
Industrial Strategy.
During 2007 MBDA acquired the German rocket motor company
Bayern Chemie GmbH, supplier of the ramjet for the Meteor missile.
Multi-skilled training for Royal Saudi Air
Force (RSAF)
A new training programme has commenced
that will produce the first multi-skilled
Tornado aircraft technicians for the RSAF.
Land 121 Project
BAE Systems has been selected by the
Australian government as the preferred
bidder for the next generation of medium and
heavy tactical trucks and modular payloads.
courses. In addition, national team training camps in a range of sports
have taken place annually in both Saudi Arabia and the UK.
Australia
BAE Systems Australia continues to reinforce its position as a through-
life capability partner to the Australian Defence Force (ADF). Work has
commenced on the Electronic Support Measures mid-life upgrade on
the AP-3C aircraft, and continues under the second five-year support
contract for the Australian Hawk Lead-In Fighter aircraft.
A five-year support contract, with two five-year options, has been
agreed with the ADF for the ongoing upgrade, operation and support of
the Jindalee over-the-horizon radar. The Nulka active missile decoy has
received export approval in principle from both the US and Australian
authorities. To date the Nulka active missile decoy has been fitted
to over 100 ships across the Australian, Canadian and US navies.
BAE Systems has recently been down-selected by the Australian
Government to provide medium/heavy capability vehicles to replace
the Army’s wheeled tactical logistic vehicle fleet.
The business is a subcontractor to Boeing on the Wedgetail airborne,
early warning and control system for the Royal Australian Air Force.
The programme is behind schedule and BAE Systems is engaged
jointly with Boeing and the customer to re-baseline the programme.
Saab (20.5% shareholding)
Sales rose by 9.5% to SEK23bn (£1.7bn), with export sales
accounting for 65%. Operating income rose to SEK2,607m (£193m),
including non-recurring items of SEK453m (£34m), producing an
operating margin of 11.3%. Although reduced in comparison with
2006, order intake remained strong at SEK20.8bn (£1.5bn). This
included orders from FMV to upgrade 31 Gripen fighters and helmet
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Business group reviews (continued)
36 www.baesyste ms.com
During 2007, HQ & Other Businesses reported a loss of £155m
(2006 loss £147m) on sales
1
of £243m (2006 £295m) and had an
operating cash inflow
3
of £181m (2006 outflow £225m). Of this, the
reported loss for Regional Aircraft was £101m (2006 loss £114m)
with operating cash inflow of £175m (2006 outflow £66m).
The reduction in sales when compared with 2006 was due to the
disposal in March 2006 of the Aerostructures business.
During the period the Regional Aircraft leasing team made significant
progress securing leases for 64 aircraft, including Avro RJ Jets to
CityJet of Ireland, Blue1 of Denmark and British Airways. The market
continues to be challenging. Compared with last year, revenues
remained stable. A freighter conversion programme for the 146 Jet
was launched after the success of a similar programme for the
ATP fleet.
Much of the leasing business was underpinned by the Group’s
Financial Risk Insurance Programme which makes good shortfalls
in actual lease income against originally estimated future income for
a 15-year period from 1998 to 2013. Since 2006, BAE Systems and
certain of the reinsurers have been in dispute over several areas
of the policy. During 2007, agreement was reached with almost all
reinsurers and settlements have been paid by them based on the net
present value of estimated future claims. Arbitration proceedings now
continue with one remaining reinsurer. Additional details concerning
these arrangements are contained in the Risk management and
principal risks section on page 49.
The Regional Aircraft loss for the year includes net charges of £76m
(2006 £77m) against the carrying value of the assets of the business
of which £61m was taken in the first half year. These charges include
the effect of a change to the Group’s aircraft valuation methodology
and will reduce the future depreciation charged on these aircraft.
A gain of £44m was recorded in respect of the disposal of the Group’s
50% interest in the Xchanging Procurement Services and Xchanging
HR Services joint ventures.
A charge of £35m was taken for an onerous lease provision
following the sublease of two vacated buildings at the Group’s
Farnborough site.
– Agreements reached with the majority of reinsurers under
the Group’s Financial Risk Insurance Programme
– Regional Aircraft fleet valuation methodology changed
HQ & Other Businesses, with 1,800 employees
1
,
comprises the regional aircraft asset management
and support activities, head office and UK shared
services activity, including research centres and
property management.
HQ & Other Businesses
2007 2006 2005
Sales
1
£243m £295m £471m
EBITA
2
£(155)m £(147)m £(118)m
Cash inflow/(outflow)
3
£181m £(225)m £(79)m
Order intake
1
£345m £267m £398m
Order book
1
£0.4bn £0.3bn £0.6bn
The leasing market for BAE Systems aircraft continues to remain challenging,
with new markets likely to be dominated by higher risk customers. Support
revenues are expected to remain stable but are dependent on maintaining
aircraft in service. Following the charges taken in 2007 against the carrying
value of the assets, future losses are expected to be reduced.
Looking forward
1 including share of equity accounted investments
2 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
3 net cash inflow/(outflow) from operating activities after capital expenditure (net) and
financial investment, and dividends from equity accounted investments
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Corporate responsibility review
BAE Systems Annual Report 2007 37
Strategy and direction
Our Group strategy is to deliver sustainable growth in shareholder
value by being the premier global defence and aerospace company.
To achieve sustainable growth we must identify and manage long-term
risks to our business – including non-financial, operational and
reputational risks. As a leading defence company we want to set
standards for our industry in the area of corporate responsibility (CR)
and aspire to reach the standards set by companies in other sectors.
As a global business we must ensure our approach is applied
consistently across all of our operations, worldwide.
The Executive Committee met in May 2007 to review our CR priorities.
The workshop was supported by PricewaterhouseCoopers (PwC), who
provided information on best practice in CR among leading companies.
The Executive Committee considered issues that could have a
significant impact on the sustainability of our business, either by
directly impacting our ability to operate or by affecting our reputation
and the level of trust stakeholders have in our Group. Their analysis
took into account the views of key stakeholders, including customers,
employees and investors.
Ethics and safety were reconfirmed as our CR priorities and those
where the Group should aspire to a leadership position.
We recognise that to achieve a leadership position requires continual
progress. A programme to address this began in 2007 and will
continue through 2008. Key aspects of this are:
– establishing an independent view of best practice for ethical
business conduct in both the defence sector and across industry;
– benchmarking safety performance across all industries – not just the
defence sector;
– establishing specific objectives on leadership behaviours especially
in the areas of ethics, safety and diversity; and
– setting management objectives in 2008 that drive us towards our
desired leadership position in the areas of ethics, safety and diversity.
The Woolf Committee (see page 3) was established during 2007
to study and publicly report upon the Group’s ethical policies and
processes. We will receive recommendations from the Woolf
Committee during 2008, which we believe will assist us in meeting
our ethics objectives.
Progress towards a leadership position on safety commenced with
a review of BAE Systems’ safety performance. This considered both
individual business level performance and benchmarking against
aerospace and defence sector companies and across other sectors
considered to be best in class. In conclusion, while we can
demonstrate overall year on year improvement in safety performance,
our underlying business performance is not consistent. While we
perform at a similar level to a number of other defence sector
companies we are behind the best in class group of companies. We
have developed a route to more closely align our performance in this
area with those best in class companies. The delivery of the first part
of a four year plan to achieve this has been incorporated into the
leadership objectives for 2008.
We will focus on improving performance year on year and set
challenging objectives that move the Group further towards best
practice in these priority areas. To demonstrate our commitment
we have increased the proportion of senior executive performance
bonuses that are linked to improvements in performance in ethics
and safety. In 2008, 12% of the potential bonus will be determined
by performance in ethics and safety. The Corporate Responsibility
Committee will review progress against our objectives quarterly.
Governance of corporate responsibility
Our corporate responsibility objectives are delivered through our
business operations and managed through the Executive Committee.
The Corporate Responsibility Committee is responsible for providing
oversight, governance and assurance. This includes reviewing and
monitoring the processes that the Group uses to manage non-financial
risks. The Corporate Responsibility Committee’s report on 2007
activity can be found on page 63.
During 2007 the Corporate Responsibility Committee met five times.
The Committee undertook a number of activities which included
reviewing and approving the decision of the Executive Committee
to prioritise ethics and safety as the key issues for the corporate
responsibility agenda in 2008. The Corporate Responsibility
Committee reviewed performance data on ethical business conduct,
safety and environment. This included details from internal audits,
employee surveys and operational assurance statements.
The Corporate Responsibility Committee met with the Woolf Committee
to discuss ethics in general and the role of the Corporate Responsibility
Committee in relation to the prospective implementation and assurance
of activity that may be recommended.
External opinion
External views help shape our approach to corporate responsibility
and also influence how we report progress. This year, we asked
three experienced corporate responsibility practitioners to review our
Corporate Responsibility Report and give their views on our corporate
responsibility strategy and intended direction. Participants were:
– Julia King, Vice President Corporate Responsibility, GlaxoSmithKline
– Dawn Rittenhouse, Director of Sustainable Development, DuPont
– Mark Wade, formerly Head of Sustainable Development Policy,
Strategy and Reporting, Shell
The panel met in February 2008 and reviewed a draft copy of this
year’s Corporate Responsibility report. They made comments and
recommendations in three areas: corporate responsibility strategy
and governance, reporting, and our approach to assurance.
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
Directors’ report – Business review
Corporate responsibility review (continued)
38 www.baesyste ms.com
Corporate responsibility objectives
Safety, health and environment
2007 safety metrics to improve relative to 2006:
– Establish appropriate industry benchmarks
for each line of business to monitor
performance and establish targets to move
towards best in class.
– Group performance (lost days metric) to be
better than relevant industry average.
– Continue to achieve an improvement
year-on-year in injuries/lost working time.
– A benchmarking study of BAE Systems
businesses and external companies was
performed. The targets thus derived are
those set within 2008 objectives.
– In 2007, we reduced the number of lost days
by more than 10% over 2006. We continue to
perform at a level better than the industry
average, with 8,734 days lost due to work-
related injury per 100,000 employees,
(compared with the UK manufacturing
average of 25,000).
Continue to drive performance in safety:
– Reduce days lost to work-related injuries by
10% of the gap between 2007 performance
and external benchmark (2,000 days).
– Senior Leadership to demonstrate
commitment to safety by leading safety
audits across our operations.
– Progress to benchmark safety performance
against a five level Safety Maturity Matrix –
all businesses to achieve Level 3 by the end
of 2008 and have a plan in place to attain
Level 5 by the end of 2011 (Level 5 has been
benchmarked against leading companies).
2007 objectives
Ethics
– Initial ethics awareness training to be
completed by new starters within one
month of joining.
– Initial ethics awareness training to be
implemented within three months of
completion date of any acquisition.
– Survey to be undertaken to evaluate
effectiveness of 2006 UK ethics awareness
training package. Implement agreed
corrective actions in 2007.
What we achieved
– Ethics awareness training has been
introduced to new starter induction
processes.
– New businesses are issued with the
Group’s ethics guide promptly after
acquisition and this is followed up with
online or DVD training.
– A survey was undertaken which indicated
that 99% of UK employees have some
awareness of our ethical standards. Action
plans to address areas identified for
improvement have been put in place.
2008 objectives
– Senior Leadership to communicate and
demonstrate commitment to high ethical
standards through employee engagement.
– Develop and integrate a Group-wide ‘code
of conduct’.
– Communicate and implement the response
to Woolf Committee recommendations.
Workplace
– 85% of employee grievances under the UK
‘Respect at Work’ policy to be resolved
through local discussion without proceeding
to the corporate process for formal
investigation.
– In each of the home markets, move towards
establishing a workforce reflective of the
national average in terms of gender mix and
ethnic diversity, taking into account variations
by region and industrial sector.
– 91% of employee grievances were resolved
at a local level during 2007.
– Diversity action plans were implemented
within each of our businesses to
reflect their local communities and
recruitment populations.
Create an environment that values and
respects the contribution, based on merit,
of all members of the communities in which
we operate:
– Demonstrate Senior Leadership commitment
to diversity in the workplace.
– Establish a Group-wide Women’s Forum.
– Evolve action plans to enhance diversity
and inclusion.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 39
Our operations and CR impacts
The panel was supportive of the way corporate responsibility strategy
is developed at BAE Systems. They considered that our selected
priority areas of ethics and safety rightly reflect the key issues.
The panel recommended that BAE Systems should:
– ensure there is a solid foundation of values on which all employees
frame decisions, large and small;
– develop a roadmap including future aspirations and opportunities
as well as challenging targets;
– address key issues such as human rights and climate change;
– provide greater understanding of the Group’s processes for
preventing bribery and corruption;
– engage with a wider range of stakeholders; and
– align its corporate responsibility reporting with the Global Reporting
Initiative guidelines.
The panel’s full statement is included in our Corporate Responsibility
Report. We will develop the necessary plans to action these
recommendations and report on progress through our website and
in future Corporate Responsibility Reports.
Monitoring our performance
We monitor our Corporate Responsibility performance through sector
benchmarking to track our performance and help us better manage
key environmental and social impacts. In 2007, BAE Systems’
performance level in the Dow Jones Sustainability World Index was
similar to our 2006 scoring.
Dow Jones Sustainability Index 2007 2006
Economic factors 69% 69%
Environmental factors 90% 85%
Social factors 71% 80%
We are reviewing the reasons for the lower social factors rating in 2007,
which include the areas of labour practices, career development and
training, and charitable giving. We will address areas for improvement
during 2008.
Workplace
We believe that all employees have the right to work in an environment
where they are treated with dignity and respect. We have processes in
place that support employees if they feel that they are being subjected
to inappropriate or unacceptable behaviour.
We are committed to equality of opportunity for all employees and
to creating a workplace where individual contribution is recognised.
A diverse and inclusive workforce is an essential part in creating the
necessary innovative and progressive culture to achieve competitive
advantage. It also promotes the behaviours necessary to secure
successful partnerships with our customers and suppliers.
Investing in the training and development of employees at all levels
of the Group is key to us maintaining high performance. Training helps
our people develop their skills and capabilities. It also enables us to
keep pace with changing technologies and continue to improve our
customer service.
In 2007 one of our corporate responsibility objectives was to ‘move
towards establishing a workforce reflective of the national average in
terms of gender mix and ethnic diversity, taking into account variations
by region and industrial sector’. Each business developed an action
plan which considered the demographics of the existing workforce,
the surrounding communities and that of the populations from which
we recruit. The cultural influences and heritage within our six home
markets requires different emphasis to achieve our overall aim. For
example, our diversity plans in South Africa are aligned with the Black
Economic Empowerment Agenda; our focus in the Kingdom of Saudi
Arabia is on Saudisation of our workforce which is a programme for
transferring skills from expatriates to local employees. By the end of
2007 our Saudi workforce comprised more than 53% Saudi nationals.
Our diversity objectives for 2008 include awareness training for
senior leaders and the launch of a women’s network. This will provide
support for women across BAE Systems enabling them to share ideas
and experiences and develop their careers.
Health and safety
Our approach to safety is one of zero tolerance of an unsafe
workplace and unsafe working practices. Safety is one of our key
corporate responsibility priorities for 2008. Our goal is to be amongst
the leaders for high safety standards both within our industry and
measured against leading companies in other industrial sectors.
We recognise the risks associated with the variety of operations we
conduct and aim to minimise these as far as possible. All sites are
required to comply with our Safety, Health and Environment policy and to
demonstrate continuous improvement in performance through the setting
and monitoring of targets. Performance is reviewed through our business
assurance processes and overseen by the Executive Committee and the
Corporate Responsibility Committee on behalf of the board of directors.
In November 2007, a tragic incident during a flight testing exercise
resulted in the death of one our employees. We are working with the
investigative authorities in connection with this incident.
Case study: In our Hattiesburg site in Mississippi, US, all employees
have been appointed safety officers as part of a programme to raise
awareness and encourage employees to report potential hazards.
Everyone in that business is now responsible for their own safety and
the safety of those around them. In 2007, there were more than 180
potential hazards reported and corrected each month. This contributed
to the site recording no injuries in 2007.
Ethical business conduct
Ethical business conduct is fundamental to the reputation and
success of BAE Systems. We will not compromise on our ethical
principles and policies.
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
Directors’ report – Business review
Corporate responsibility review (continued)
40 www.baesyste ms.com
Our manufacturing and engineering operations, offices and products
have an impact on the environment. This includes the use of natural
resources and raw materials as well as waste generation and
emissions. We are committed to managing and minimising these
impacts wherever practicable.
We have taken positive steps in relation to the management of
environmental issues most notably to Product Environmental
Protection, which has been incorporated in the Company’s Lifecycle
Management process. This helps to ensure that the design of a new
product considers the environmental impact that it might have and
that steps are built into the design phase to mitigate the potential
impact through the product’s lifecycle.
A specific area of focus for the Group is the REACH (Registration,
Evaluation, Authorisation and Restriction of Chemical Substances)
legislation which although EU-based will also affect our US products
which come to the UK. We are working with our customer, the UK
Ministry of Defence, to share an understanding in this area and
develop a common approach.
We are placing a specific emphasis on reducing our greenhouse
gas emissions and have developed a number of energy reduction
initiatives that include employee engagement, engineering initiatives
and improved manufacturing efficiencies. Our primary contribution
to greenhouse gasses is through the use of energy.
We participate in national initiatives to reduce defence sector impacts
on climate change. We have nine sites in the UK which participate in
the EU Emissions Trading Scheme and in 2007 we externally traded
4,500 tonnes of carbon. A key focus of our partnering approach with
the UK Ministry of Defence will be the sustainable development of
defence products and services.
Case study: To help reduce emissions in our UK Land Systems
business, every employee has been asked to ‘Pledge A Tonne’ and
a range of communication material has been provided to engage and
educate employees and their families. People are asked to ‘sign up’
to make simple but effective changes to the way they conduct their
day-to-day life, both at home and at work. Daily actions such as leaving
lights and heaters on, the way employees travel to work or travel whilst
at work and how employees control the environment they live in, all
contribute to the carbon footprint of each individual and the business.
Climate change is an important issue for all businesses, particularly
those operating globally and one which the Group needs to address.
In 2008, we will measure our carbon footprint and establish a formal
position as to actions we would seek to take in reducing this footprint.
Working with others
We recognise that our responsibilities extend beyond our own
employees. This includes contractors working on our sites, our
suppliers and partners. We aim to work with all groups to mutually
improve standards. A key area of focus in 2008 continues to be safety
performance of contractors on our sites. We intend to include this in
our future external reporting on safety performance.
Case study: In the UK we are part of the 21st Century Supply Chain
(SC21) initiative. The objective of the initiative is to get all customers and
suppliers throughout the defence and aerospace industry to collaborate
by using the same tools to improve performance and modernise working
practices. This approach, where we are working closely with our industry
peers, avoids duplication in key areas and will help us to achieve an
improved working culture based on openness, honesty and trust.
In 2007, we invited Lord Woolf, the former Lord Chief Justice of England
and Wales, to head an expert independent review committee to study
and report on our policies and processes and make recommendations
aimed at achieving a leadership position in ethical business practice
amongst corporate industry peers. More information on the Woolf
Committee can be found on page 3.
We have training and awareness programmes in place to ensure
that employees understand how we do business and what is
expected of them.
We continue to roll out ethical awareness training to employees
worldwide through brochures, online training, DVDs and class room
sessions. At the end of 2007 training had been completed in Australia,
South Africa, the UK and the US. Our ethics DVD and online training have
been translated into Arabic and are being rolled out in Saudi Arabia. A
Swedish translation has been developed and will be introduced in 2008.
We changed our policy in 2007 to ensure new recruits receive
ethics awareness training within one month of joining the Group and
employees of newly acquired businesses receive an ethics guide
promptly after acquisition and our ethics awareness training within
three months of joining the Group.
All staff involved with business development are required to undertake
a training course on the prevention of corruption and refresher training
every two years. Over 5,500 employees have undertaken this training
since 2001. Training is tracked to help ensure compliance.
In 2007 we initiated a review of our ethical code of conduct to ensure
it remains appropriate for our changing business. We will act on any
recommendations from the Woolf Committee and plan to introduce
a revised code of conduct at the end of 2008.
Case study: We are members of the UK Defence Industry Anti-
corruption Forum and, in the US, the Defense Industry Initiative (DII)
on Ethics and Business Conduct. In the UK, the Anti-corruption Forum
has been developing common anti-corruption industry standards for
the Aerospace and Defence Industries Association of Europe. This
year in the US, we participated in the DII working group, which includes
the co-ordination of the Defense Industry Benchmark ethics survey.
Community and education
We play an important role in the communities in which we operate.
In 2007, we invested approximately £6.1m in local communities
around our sites, supporting charities and educational establishments.
During 2007 our employees volunteered 4,310 days supporting local
community projects.
An area that is critical to the future sustainability of our business
is education, specifically in the fields of science and engineering.
Every year the Group supports a wide range of education projects.
In Australia, the UK, the US, and Saudi Arabia we run educational
programmes that encourage young people at all stages of education
to take an interest in science and technology.
Case study: India partnership – We have pledged £100,000 and
committed to support the UK India Education & Research Initiative.
The initiative has been designed to give students in both India and
the UK a better understanding of science and engineering. Helping
improve education links between the two countries will hopefully
encourage greater economic collaboration.
Environment
We operate globally, with operations and customers in many countries.
Stakeholders, particularly our employees, expect us to understand
and respond to global challenges such as climate change and
sustainable development.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 41
We collect data on ethics, diversity, environment and health and safety to help us monitor our corporate responsibility
performance and identify areas for improvement. The data is recorded by the businesses and collated centrally for review.
Explanations of trends are provided on pages 42 and 43. Specific notes are recorded below.
2005 2006 2007
Health & safety (per 100,000 employees)
Major injuries recorded 55 47 48
Days recorded lost to work-related injuries
3
8,774 10,204 8,734
Total recorded injuries to all employees 6,009 4,788 4,454
Environment
Energy use
4
(Gwh) 1,767 1,742 1,706
CO
2
emissions (million tonnes) 0.58 0.57 0.55
Waste (‘000 tonnes) 57 105 129
Waste recycled (‘000 tonnes) 37 67 42
Volatile organic compound emissions (tonnes) 610 742 642
Ethics
Ethics enquiries from employees 367 410 327
Diversity
Gender diversity:
Male employees 81% 80% 79%
Female employees 19% 20% 21%
Ethnic diversity:
White 88% 87% 82%
Non-white 12% 13% 18%
Age diversity:
Under 25 7% 7% 8%
26 to 35 18% 18% 17%
36 to 49 44% 42% 39%
50 to 59 25% 26% 27%
60 + 6% 7% 9%
Corporate responsibility recorded data summary
1,2
1 This data is derived from internal recording systems and is not subject to external verification or audit.
2 In 2007 we acquired Armor Holdings. The integration of corporate responsibility data from that business is underway and will be reported in 2008.
3 The decrease in 2007 over 2006 in days lost recorded due to work-related injuries reflects a much improved performance in our Surface Fleet Solutions business, which reduced the
number of days lost by 75% over 2006 levels.
4 Our energy use is directly related to volumes of product manufacture and throughput of specific projects. The decrease shown in energy use, despite increases in volume and
throughput, reflects a specific focus at a number of businesses on energy management and efficient operations.
Energy use
4
Directors’ report – Business review
Corporate responsibility review (continued)
Health and safety* Environment*
The overall performance on safety has improved over 2006. This
reflects a strong performance is some businesses, notably Surface
Fleet Solutions. A key focus for 2008 is to ensure a consistent
improvement in safety performance across all businesses.
Environmental impacts are directly related to the stage and volume
of production or manufacture and throughput of specific projects.
Given the potential diversity of influences we report data as absolute
values and have provided specific explanation of the variance below.
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
Major injuries
1,2
1 The above data includes one fatality. This occurred during a ight training exercise
at a UK facility. The investigation into the incident is ongoing.
2 Major injuries as dened under the UK Reporting of Injuries, Diseases and
Dangerous Occurrences Regulations (RIDDOR).
Waste
5
(‘000 tonnes)
Volatile organic compound
emissions
5
(tonnes)
Total injuries
0
2000
4000
6000
8000
200720062005
Year
Days lost to work-related injuries is shown on page 26.
070605
Year
0
30
60
90
120
150
0
15
30
45
60
75
070605
Year
0
150
300
450
600
750
Year
070605
Recycled waste
6
(‘000 tonnes)
Cause of injury
3
(%)
Slips, trips or falls on same level
Falls from height – up to and including two metres
Struck by moving, including flying/falling, object
Struck by moving vehicle
Strike against something fixed or stationary
Injured while handling, lifting or carrying
Falls from height – over two metres
Exposure to an explosion
Contact with moving machinery
Exposure to, or contact with, a harmful substance
Contact with electricity or electrical discharge
42 www.baesyste ms.com
0
20
40
60
80
200720062005
Year
3 Primary causes of injuries remain slips, trips and falls from height. We continue to
work on preventative measures and raising employee awareness of potential risks.
5 In 2007 we responded to Urgent
Operation Requirements from the US
Department of Defense for armoured
vehicles. The resultant increase in
throughput primarily impacted our Steel
Products and Mobility and Protection
Systems divisions in the US. This
resulted in an increase in waste being
generated in Steel Products and in usage
of paints and solvents at Mobility and
Protection Systems. The resulting
emissions of Volatile Organic
Compounds associated with paint and
solvent use increased accordingly.
6 The increase in the level recycled waste
in 2006 related to a specific soil
remediation project at Chorley in the UK.
* The above data is derived from internal recording systems and is not subject to external verification or audit.
Energy use (Gwh)
CO
2 emissions (million tonnes)
4 Energy use is down 2% to 1,706 Gwh (2006 1,742 Gwh). CO
2
emissions down 3.5% to
0.55 million tonnes (2006 0.57 million tonnes).
0.00
0.25
0.50
0.75
1.00
070605
Year
Energy use (Gwh)
CO2 emissions
(million tonnes)
0
500
1000
1500
2000
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 43
Diversity* Community*
We are working to change the demographics within our business
but recognise that this will occur slowly over time. The sustainability
of our workforce and our ability to win and fulfil global contracts
depends on us being able to recruit and retain talented people
from all backgrounds. Our diversity objectives for 2008 include
awareness training for senior leaders and the launch of a Group-wide
women’s network.
In 2007, our total community investment was approximately £6.1m.
This figure includes cash and in-kind donations to charity as well as
our direct support for communities and education across the world.
Gender diversity
7
(%)
UK, US, Australia, Saudi Arabia and
South Africa
Male
Female
070605
0
20
40
60
80
100
Year
Age diversity (%)
UK, US, Australia, Saudi Arabia, South Africa
and Sweden
Under 25
26 to 35
36 to 49
50 to 59
60+
0
20
40
60
80
100
070605
Year
Ethnic diversity
8
(%)
UK, US and South Africa
0
20
40
60
80
100
070605
Year
Ethnic diversity (%)
Saudi Arabia
Not declared
Asian
Saudi nationals
White/European
0
20
40
60
80
100
0706
Year
Non-white
White
Focus of contribution (%)What we contribute to (%)
Community investments
Charitable gifts
Sponsorship
Education
Social welfare
Emergency relief
Health
Arts
Economic
Environment
Other
7 Due to legislation in Sweden we cannot
report gender diversity information for
this country.
8 Due to legislation in Australia and
Sweden we cannot report ethnic diversity
information for these countries.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Risk management and principal risks
44 www.baesyste ms.com
Risk management within BAE Systems
Executive
Committee review
Board review
Assurance / Self-assessment
– Organisation
– Culture
– Governance
– Core Business Processes
– Delegated Authorities
– Mandated Policies
Operational Framework
Reporting / Monitoring
Reporting / Monitoring
Business risk management
Identification
– At least annually, each business
and function undertakes a full
review of potential risks
– Risks are recorded in a register
explaining the event(s) with
cause and effect statements
prompting effective mitigation
strategies
– Risk owners are allocated who
have authority and responsibility
for assessing and managing
the risk
Analysis
– Risks are analysed for impact
and probability to determine
exposure to the business
Monitoring and control
– Risks and plans are monitored and regularly and rigorously reviewed with significant risks immediately notified through the business reporting functions
– Key risks are reported through the Integrated Business Plan, twice yearly through the Operational Assurance Statement self-assessment and at
Quarterly Business Reviews
– The Executive Committee conducts risk workshops to analyse and allocate management responsibility for the management of the most significant
non-financial risks to the Group
– The Board and the Audit and Corporate Responsibility committees review risk on a regular basis
m
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The effective management of risk is essential to
the delivery of the Group’s strategy and objectives.
Evaluation
– Risk exposure is comprehensively
reviewed and the risks prioritised
in relation to the achievement of
business objectives
– Risk evaluation is documented in
controlled risk registers showing:
– the risks that have been
identified
– characteristics of the risk
– the basis for determining
mitigation strategy
– necessary review and
monitoring
Mitigation
– Implementation of action plans to
manage, or respond to, the risks
– Robust mitigation strategy subject
to regular and rigorous review
Board Committee review
– Audit Committee review – Corporate Responsibility Committee review
Internal Audit
Internal Audit independently reviews the
risk identification procedures and control
processes implemented by management.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 45
Group management of risks
Effective management of risk and opportunity is essential to the delivery
of the Group’s objectives, achievement of sustainable shareholder
value and protection of its reputation. The Group’s approach to risk
management is to remove or reduce the likelihood and effect of risks
before they occur, and deal effectively with problems if they arise. The
Group is committed to the protection of its assets, which include human,
property and nancial resources, through an effective risk management
process, underpinned where appropriate by insurance.
The management of risk is linked into the Group’s strategy, the
environment in which it operates, the Group’s appetite for risk and the
delivery of the Group’s business objectives. The underlying principles are
that risks are continuously monitored, associated action plans reviewed,
appropriate contingencies are provisioned and this information is
reported through established management control procedures.
To enable this process, BAE Systems has developed a system of internal
control, the ‘Operational Framework’ (OF), that encompasses, amongst
other things, the mandated policies and core business processes that
provide a common framework for how we do business and what it means
to be part of BAE Systems.
The Board has overall responsibility for ensuring that risk is effectively
managed across the Group and has delegated to the Audit Committee
the responsibility for reviewing in detail the effectiveness of the Group's
system of internal controls. During the year, the Executive Committee
has further enhanced its oversight of material non-nancial risks
including, in particular, those arising in connection with safety and
ethical issues. Close attention has been paid to analysing risks
associated with the conduct of international business and new policies
and processes have been implemented seeking to provide the highest
levels of assurance. The Executive Committee advises the Corporate
Responsibility Committee of all matters within the latter’s remit.
In order to assist the Committees and the Board in their review, the
Group has a self assessment Operational Assurance Statement (OAS)
process. The OAS is in two parts: a self-assessment of compliance with
appropriate parts of the OF; and a report showing the key risks for the
relevant business. Together with independent reviews undertaken by
Internal Audit, and the work of the external auditors, the OAS forms
the Group’s process for reviewing the effectiveness of the system
of internal controls.
Reporting within the Group is structured so that key issues are escalated
through the management team, ultimately to the Board if appropriate.
The responsibility for risk identication, analysis, evaluation, mitigation,
reporting and monitoring rests with line management. Both the Audit
Committee and the Corporate Responsibility Committee report the
ndings of their reviews to the Board so that the Board can form a view.
Further information on the activities of the Board and its Committees is
given in the Corporate governance section on pages 54 to 63 of this
report.
Five core processes and 27 policies are mandated by the OF, enabling
the business to respond appropriately to material risks faced by the
Group. As with any system of internal control, the policies and processes
that are mandated in the OF are designed to manage rather than
eliminate the risk of failure to achieve business objectives, and can
only provide reasonable, and not absolute, assurance against material
misstatement or loss.
Further detail on these business processes and mandated policies
is given in the Internal control section of the Corporate governance
section on page 60.
Action
The Board regularly reviews
the Group’s performance
in these markets, and the
Executive continues to work
closely with its customers
to ensure the Group strategy
is aligned with theirs (refer
to strategy section page 12).
Summary of principal risks
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.
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.
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
business 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.
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.
The Group’s operating performance and cash flows are dependent, to a significant extent,
on the award of defence contracts and its performance in delivering these contracts.
Impact
Because the amounts payable under these contracts can be substantial, the award
or completion of one or more contracts, the timing for manufacturing and delivery
of products under these contracts or the failure to receive anticipated orders could
materially affect the Group’s operating results and cash flow for the periods affected.
The Group is
dependent on
defence spending
and reductions in
such spending
could adversely
affect the Group.
Certain parts of
the Group’s
business are
dependent on a
small number of
large contracts.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Risk management and principal risks (continued)
46 www.baesyste ms.com
The Group’s largest
customer contracts
are government
contracts.
The timing of
contracts could
materially affect
the Group’s
future results of
operations and
financial condition.
Defence spending
Action
To manage contract-related
risks and uncertainties,
contracts are managed
through the application
of the Group’s mandated
Lifecycle Management (LCM)
business process at the
operational level and the
consistent application of
metrics is used to support
the review of individual
contract performance
(refer to page 52 for further
information on LCM).
Action
The Group has a
balanced portfolio
with six home markets.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 47
A significant portion of the Group’s revenues are 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.
The Group
has fixed-price
contracts.
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.
The Group is
exposed to
risks inherent
in operating in
a global market.
Action
The Group has formal
systems and policies in
place to ensure adherence
to regulatory requirements
and to identify any restrictions
that could adversely impact
the Group’s future activities.
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 of 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.
The Group is
subject to export
controls and other
restrictions.
Fixed-price contracts
Export controls and other restrictions
Global market
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Risk management and principal risks (continued)
48 www.baesyste ms.com
Most of the Group’s businesses are focused on the defence industry and subject to
competition from multinational 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.
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 consortia, joint venture or equity holding and
the business arrangement fails to meet its strategic objectives or expected benefits,
the Group’s business and results of operations may be adversely affected.
The Group’s
business is subject
to significant
competition.
Action
The Group’s strong global
market positioning, balanced
portfolio, leading capabilities
and performance continue to
address this risk (refer to page
12 for further information
on the Group’s positioning
and portfolio).
The Group
is involved in
consortia, joint
ventures and
equity holdings
where it does
not have control.
Action
The Group has formal systems
and procedures in place to
monitor the performance of
such business arrangements
and identity and manage any
adverse scenario arising.
Action
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
117 for further details
on the Group’s retirement
benefit plans).
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 the 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.
The Group is
exposed to funding
risks in relation
to the defined
benefits under its
pension schemes.
Pension funding
Competition
Consortia and joint ventures
Action
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.
Action
The Group’s primary action is
to operate an efficient asset
management organisation.
Much of the leasing business
was underpinned by the
Group’s Financial Risk
Insurance Programme, which
makes good shortfalls in
actual lease income against
originally estimated future
income for a 15-year period
from 1998 to 2013. Since
2006 BAE Systems and the
reinsurers have been in
dispute over several areas
of the policy. During 2007,
agreement was reached with
almost all reinsurers and
settlements have been paid
by them based on the net
present value of estimated
future claims.
Arbitration proceedings
are ongoing in relation to
several claims advanced
by one reinsurer who has a
maximum potential liability
under the policy of $145m.
These claims are being
vigorously defended.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 49
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 risks.
The Group has
experienced
growth through
acquisitions.
Anticipated
benefits of
acquisitions may
not be realised.
Acquisitions
These aircraft are leased, or have been sold, to airline operators.
Impact
Values of regional aircraft are impacted by a range of factors including the financial
strength of regional aircraft operators, market demands for regional aircraft and the
impact of economic factors on aircraft operating costs.
Reductions in the valuations of these aircraft could result in impairment charges
against the carrying value of the aircraft or additional provisions against the
guarantees given.
The Group holds
a number of
regional aircraft
on its balance
sheet and has
provided residual
value guarantees
in respect of
certain regional
aircraft sold.
Regional Aircraft
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Risk management and principal risks (continued)
50 www.baesyste ms.com
Additional risks and uncertainties currently unknown to the Group, or which the Group currently deems
immaterial, may also have an adverse effect on the nancial condition or business of the Group.
The Group is
subject to risk
from a failure to
comply with laws
and regulations.
The Group is
exposed to volatility
in currency
exchange rates.
Action
During the year, the Group has devoted
additional resource and further enhanced
its mandated procedures designed to ensure
compliance with its policies relating to the
conduct of international business. The
Executive Committee maintains a list of
approved export markets arrived at on the
basis of a market risk assessment utilising
input from externally developed risk
assessments. A panel of experts scrutinises
all adviser appointments within the Group.
Findings of the panel of experts are reviewed
by members of the Executive Committee and
material market or programme risks are
discussed by the Board.
The investigation by the Serious Fraud
Office into suspected false accounting
and corruption is continuing and the
Group continues to co-operate with this
investigation. In June 2007, the Company
was notified by the US Department of
Justice that it had commenced a formal
investigation relating to the Group’s
compliance with anti-corruption laws,
including its business concerning the
Kingdom of Saudi Arabia.
Action
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.
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.
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.
Laws and regulations
Exchange rates
The Operational Framework (OF) (page 44) encompasses the mandated
policies and core business processes that provide a common framework
for how we do business. These mandated policies and core business
processes together with our key resources help us to achieve the
Group’s strategic objectives.
People
Our employees are key to our success, both now and in the future.
We invest extensively in education schemes to encourage an interest
in science and education amongst school children and support higher
levels of education through our apprentice programmes and graduate
sponsorship schemes. The Group employs 88,000 people in its
subsidiaries, with a further 9,500 employed in joint ventures. The
workforce encompasses a broad range of skills and experience
delivering a full range of products and services for air, land and
naval forces as well as advanced electronics, information technology
solutions and customer support services.
The Group aims to get the best from its employees by treating
them with respect, creating a supportive workplace and giving them
opportunities for development. This helps the Group attract and retain
highly talented people who can deliver the products and services
customers need.
Performance Centred Leadership (PCL), the Group’s integrated
approach to managing leadership performance, development and
reward, is critical to the Group achieving its strategic objective of
continuing to embed a high-performance culture. PCL addresses
the setting of objectives and performance assessment together with
the determination of reward, development needs and potential. The
process was applied to 600 leaders at its launch in 2000 and is now
deployed to over 6,200 executives globally across all of the Group’s
operations. It drives business success by linking individual’s goals with
the wider goals of the organisation, enabling employees to understand
how their own success contributes to the success of the Group. PCL
is a core business process mandated by the OF to be used across
the Group.
All employment policies include a commitment to equal opportunities
regardless of sex, race, colour, nationality, ethnic origin, religion, age or
disability, subject only to considerations of national security. The Group’s
policy is to provide, wherever possible, employment opportunities for
disabled people and to ensure that disabled people joining the Group
and employees who become disabled whilst in our employment benet
from training and career development opportunities.
The Group has put into place a number of ways of consulting with
employees and providing them with information on the performance of
the Group and other matters that affect them. The effectiveness of the
communication process is assessed regularly with the aim of ensuring
continual improvement so as to provide employees with the information
they want by the most effective means.
Employees are actively encouraged to become shareholders in the
Company by way of all-employee share schemes.
Honours In the UK, the following individuals were honoured in
Her Majesty the Queen’s 2008 New Year Honours lists:
CBE: Murray Easton and Alan Garwood
OBE: Vic Emery
MBE: Dave Blacker
Further details on the approach to employee engagement and
development are detailed on pages 37 to 43 in the Corporate
responsibility section of this report.
Relationships with customers
The Group regards the relationship with its customers as a key
discriminator in a competitive industry. Its core businesses are mostly
defence related, selling products and services primarily to the US, the
UK, the Saudi Arabian and other national governments, both directly
and indirectly with other defence and aerospace companies. In many
cases these relationships extend over decades and span the full
product and service lifecycle from the initial concept denition, through
the system development phase, into production and then on to support
for the system in service.
Apprenticeships
The BAE Systems Advanced Apprenticeship programme is
one of the largest such schemes in the UK. At any one time,
the Group has up to 1,000 young people employed on its
numerous training programmes.
BAE Systems wins Sun Microsystems’ Supplier Award
BAE Systems was named Meritorious Performance Supplier
in Sun Microsystems’ 2007 Supplier Awards programme.
The Supplier Awards recognise companies that make
outstanding contributions to Sun Microsystems’ record of
delivering superior technology, quality service and excellent
value to its customers.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
Directors’ report – Business review
Resources
BAE Systems Annual Report 2007 51
The key resources and arrangements the Group
uses to achieve its strategic objectives include:
– the people it employs;
– relationships with its customers, subcontractors
and other suppliers;
– research and development;
– intellectual property; and
– its capital structure.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Business review
Resources (continued)
52 www.baesyste ms.com
UK Association for Project Management (APM) Awards
In 2007, ATTAC (the Availability Transformation: Tornado
Aircraft Contract) (see page 16) was awarded ‘Project of
the Year’ by the UK APM.
This lifecycle approach is used as the basis of one of the Group’s core
business processes.
Lifecycle Management (LCM) The OF mandates the use of LCM across
the Group. LCM provides a structured approach to managing the
Group’s commitments and investments throughout product and project
lifecycles, promoting the application of best practice management and
facilitates continuous improvement.
Throughout this lifecycle the Group engages extensively with its
customers and undertakes customer satisfaction surveys as part of
its drive for continuous performance improvement.
Increasingly contracts are being awarded for the delivery of a
capability, rather than just a product. Reecting this new approach,
traditional customer relationships are evolving into long-term
partnerships with governments and their armed forces.
Managing subcontractors and other suppliers
Managing major subcontracts is a key strategic capability. Expenditure
on subcontractors represents a signicant portion of project cost and,
therefore, effective management of this expenditure is a key value
driver for our Group. The benets of capability-based contracting,
combined with ongoing budget pressures, are leading many customers
to demand a more integrated, partnering, approach to meeting their
requirements. Transforming relationships with suppliers is an
essential part of developing systems integration and through-life
management capabilities. BAE Systems is committed to improving
supply chain relationships and working together with other companies,
large and small, in each of the Group’s home markets to deliver better
value and innovation for its customers.
BAE Systems is a founder of the UK aerospace and defence 21st
Century Supply Chain (SC21) programme, designed to coordinate
multiple customers with suppliers in improving supplier management
and development through using common processes in a coordinated
way, thereby reducing duplication. BAE Systems supports SC21
by providing the project director for the industrial programme,
coordinating the 16 primes and tier one companies, managing the
industrial implementation plan (including over 100 suppliers) and
interfacing with the UK MoD. BAE Systems has also implemented
the SC21 principles and processes across its own Supply Chain
Excellence improvement programme, and is leading improvement work
with 11 of the industrial plan suppliers. Several common improvement
plans are in place, coordinating the improvement requirements of the
supplier and its other aerospace and defence customers.
The Group’s Centre for Performance Excellence has identied best
practices in managing major subcontracts from across BAE Systems
and industry. These best practices are being embedded in the Group’s
processes, guidance and training to help deliver on commitments to
customers. This directly aligns with the Group’s strategic objectives of
enhancing programme execution capabilities, sharing of best practice
between the Group’s global businesses and embedding a high-
performance culture.
Research and development (R&D) and intellectual property
The continued development of the Group’s technological capabilities
and expertise is key to achieving the Group’s strategic objectives.
The Group is engaged in a signicant R&D programme in support of
the platforms, systems and services that it provides to its customers.
This covers a wide range of work and includes performance innovations,
improvements to manufacturing techniques and technology to improve
the through-life support of products.
The development and demonstration of capabilities in networked
systems, and enabling interoperability, is an important area of focus
in both the UK and the US. Long-term research is undertaken through
partnerships with the academic sector and in the Group’s Advanced
Technology Centre and Systems Engineering Innovation Centre.
Application of this research is managed by the Group’s business units
through business focused R&D programmes. Customers fund directly
much of the near-term product development work undertaken by the
Group. Total R&D expenditure for the Group amounted to £1,460m
(2006 £1,248m), of which £176m (2006 £162m) was funded by
the Group.
Intellectual property is created every day, in every part of the Group.
It takes many forms, not only tangible products but also ‘know how’
developed over the years. The Operational Framework mandates a
policy to protect the Group’s intellectual property through appropriate
use and observance of intellectual property law, so that returns
made from the investment in R&D and technological innovation
are protected.
The Group led patent applications covering over 100 new inventions
in 2007 in support of its global businesses, and has a total portfolio
of patents and patent applications covering more than 1,500
inventions worldwide.
Corporate governance
Board of directors 54
Corporate governance 56
Remuneration report 64
Other statutory and
regulatory information 84
Typhoon with Paveway air-to-surface
weapon load.
Directors’ report
Directors’ report – Business review
Directors’ report – Governance
Financial statements Shareholder information
Directors’ report – Corporate governance
Board of directors
54 www.baesyste ms.com
12 3 4 5 6
1. Dick Olver FREng
3, 4
Dick Olver was appointed as
Chairman in 2004. A civil
engineer, Dick Olver joined BP
in 1973 where he held a variety
of senior positions culminating in
his appointment to the board of
BP p.l.c. as CEO of Exploration
and Production in 1998. He was
subsequently appointed deputy
group chief executive of BP in
2003, stepping down from that
position when he assumed the
chairmanship of BAE Systems.
Dick Olver chairs the Board’s
Nominations Committee and the
Non-Executive Directors’ Fees
Committee. He is a non-executive
director of Reuters Group plc,
a Fellow of the Royal Academy
of Engineering and a member of
the Royal Academy Council and
the Trilateral Commission.
Appointed: 2004 Age: 61
2. Mike Turner CBE
4
Chief Executive
Mike Turner was appointed as
Chief Executive in 2002, having
been a Chief Operating Officer
since 1999. He is a non-executive
director of Lazard Limited and a
former non-executive director of
Babcock International Group Plc
and The Peninsular and Oriental
Steam Navigation Company (P&O).
Appointed: 1994 Age: 59
3. Walt Havenstein
4
Chief Operating Officer, President
and CEO, BAE Systems, Inc.
Appointed to the Board on
2 January 2007, Walt Havenstein
is President and CEO of
BAE Systems, Inc. He was
previously President of the
Company’s US-based Electronics
& Integrated Solutions business.
He was President of the Sanders
defence electronics business
prior to it being acquired by the
Company from Lockheed Martin
in 2000. A graduate of the US
Naval Academy, he served 12
years in the US Marine Corps.
Appointed: 2007 Age: 58
4. Ian King
Chief Operating Officer, UK
and Rest of World
Appointed to the Board on
1 January 2007, Ian King was
previously Group Managing
Director of the Company’s
Customer Solutions & Support
business and, prior to that, Group
Strategy and Planning Director.
Immediately prior to the BAe/MES
merger he was Chief Executive of
Alenia Marconi Systems, having
previously served as Finance
Director of Marconi Electronic
Systems. He is a non-executive
director of Rotork plc.
Appointed: 2007 Age: 51
5. George Rose
Group Finance Director
George Rose was appointed Group
Finance Director in 1998. Prior to
joining the Company in 1992, he
held senior positions in the Rover
Group and Leyland DAF. He is a
non-executive director of Saab AB
and National Grid Transco plc,
and a member of the Financial
Reporting Review Panel. He is a
Fellow of the Chartered Institute
of Management Accountants.
Appointed: 1998 Age: 55
6. Phil Carroll
2, 3
Phil Carroll is a former chairman
and chief executive of Fluor
Corporation and a former
president and chief executive of
Shell Oil Company Inc. He was
appointed by the US Department
of Defense in 2003 to serve as
the first Senior Adviser to the
Iraqi Ministry of Oil. He is a former
non-executive director of Scottish
Power plc.
Appointed: 2005 Age: 70
7. Michael Hartnall
1
Michael Hartnall is a former
finance director of Rexam plc, prior
to which he held senior positions
with a number of manufacturing
companies. He is a non-executive
director of Lonmin plc and a
former non-executive director of
Elementis plc. Michael Hartnall
chairs the Board’s Audit
Committee. He is a Fellow of the
Institute of Chartered Accountants
in England and Wales.
Appointed: 2003 Age: 65
1 member of the Audit Committee
2 member of the Corporate Responsibility Committee
3 member of the Nominations Committee
4 member of the Non-Executive Directors’ Fees Committee
5 member of the Remuneration Committee
The Board
Chairman Executive directors Non-executive directors
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BAE Systems Annual Report 2007 55
78 9 10 11 12
8. Andy Inglis
2
Appointed to the BAE Systems
Board on 13 June 2007, Andy
Inglis is a director of BP p.l.c. He
is a member of the BP executive
management team, and is also
chief executive of BP’s Exploration
& Production business. He is a
Fellow of the Royal Academy of
Engineering and a Fellow of the
Institute of Mechanical Engineers.
Appointed: 2007 Age: 48
9. Sir Peter Mason
1, 3
Sir Peter Mason is the non-
executive chairman of Thames
Water and a non-executive director
of Acergy S.A. He was formerly
chief executive of AMEC plc,
executive director of BICC plc,
chairman and chief executive
of Balfour Beatty Limited and
chief executive of Norwest Holst
Group PLC. Sir Peter has been
nominated the Board’s Senior
Independent Director.
Appointed: 2003 Age: 61
10. Roberto Quarta
1, 5
Roberto Quarta is a partner in the
private equity firm Clayton, Dubilier
& Rice, in connection with which
he serves as chairman of Rexel
SA and Italtel. He was previously
chairman and chief executive
of BBA Group plc, an executive
director of BTR plc and a non-
executive director of PowerGen plc
and Equant NV.
Appointed: 2005 Age: 58
11. Sir Nigel Rudd
2, 5
Sir Nigel Rudd is currently
chairman of BAA Limited and
Pendragon plc and deputy
chairman of Barclays PLC. He
was formerly chairman of Alliance
Boots Group PLC and Pilkington
plc. He also holds a number of
other public appointments,
including chairman of the CBI’s
Boardroom Issues Group. Sir Nigel
chairs the Board’s Remuneration
Committee. He is a Fellow of the
Institute of Chartered Accountants
in England and Wales.
Appointed: 2006 Age: 61
12. Peter Weinberg
2, 5
Peter Weinberg is a partner at
Perella Weinberg Partners, a
financial services firm. He was
previously chief executive officer
of Goldman Sachs International
where he was co-head of the
Partnership Committee, and prior
to that was co-head of the Global
Investment Banking Division. He
joined Goldman Sachs in 1988
and became a partner in 1992.
Peter Weinberg chairs the Board’s
Corporate Responsibility
Committee.
Appointed: 2005 Age: 50
Each of the seven non-executive
directors listed above is
considered to be independent for
the purposes of the Combined
Code on Corporate Governance.
Company Secretary
David Parkes
Dick Olver Chairman
Directors’ report – Business review
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Directors’ report – Corporate governance
Corporate governance
56 www.baesyste ms.com
This section of the report deals with how the Board and its committees
discharge their duties and how we apply the principles in the UK’s
Combined Code on Corporate Governance. Over the page you will nd
detailed statements concerning our compliance with the provisions
of the Code. However, rst I would like to highlight certain corporate
governance matters and developments during the year.
At the end of last year the Financial Reporting Council issued the
results of its review of the Combined Code. It reported that investors
perceived that there had been a continued improvement in overall
governance standards of UK companies since the introduction of the
Code. I am pleased that the efforts made by companies such as ours
in seeking to continually improve and stay at the forefront of corporate
governance best practice is recognised.
Standards and values
As the Combined Code states, boards should set the values and
standards for a company. To provide the BAE Systems Board with the
best possible guidance on governance in this area, earlier this year we
appointed an independent committee headed by a former Lord Chief
Justice of England and Wales, Lord Woolf. In forming the committee
to study and publicly report upon its policies and processes, the
Company seeks to:
“garner and implement recommendations which enable the
Company to maintain a leadership position in ethical business
practice amongst comparable industry peers; and
further enhance the publicly available level of assurance
regarding the accuracy of its assertions as to its policy,
processes and conduct.”
The Woolf Committee is to publish its report in due course and
the Board has agreed to act on its recommendations.
Our governance framework
“As Chairman, my principal duty is to ensure
that BAE Systems is headed by an effective
board that is accountable to shareholders
for the Company’s performance.”
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 57
We need not only the right mix of knowledge, skills and experience
around the Board table but also we have to be in a position to resource
effectively the Board’s committees. This is an important consideration
because, as with the Audit and Remuneration committees, we believe
the membership of the Corporate Responsibility Committee should be
formed exclusively of independent non-executive directors.
Board committees
The role that board committees play in the UK’s corporate governance
structure should not be underestimated. As we seek to continually
improve the effectiveness of our governance processes the demands
on the committees have increased. The table on page 59 detailing the
attendance of directors at board committee meetings during the year
shows that a total of 26 meetings were held last year; this compares
with 17 meetings ve years ago – over a half more.
A unitary board containing a good number of both executive and
non-executive directors is an excellent forum within which to develop
and challenge strategy and provide entrepreneurial leadership for a
company. However, certain responsibilities can only be undertaken
effectively by directors who are independent of the activities they are
required to oversee. The Audit and Remuneration committees are
obvious examples of this, but this applies equally to the Corporate
Responsibility Committee. You will nd a report from this committee
on page 63, but I would like to highlight in particular the role it has in
overseeing compliance with the highest standards of ethical behaviour
by all Group employees and also in overseeing our performance in
keeping our employees safe and healthy in the workplace. With Peter
Weinberg retiring from the Board, Andy Inglis has been appointed to
succeed him as chairman of the Corporate Responsibility Committee,
having rst been nominated for appointment to this position by the
Nominations Committee.
Board performance evaluation
I mentioned earlier the recent report on the Combined Code by the
Financial Reporting Council. Reporting on its consultative exercise, it
had the following to say on the subject of board performance evaluation:
“A number of respondents singled out the Code’s recommendation
that boards should carry out regular evaluations of their performance
as having been particularly benecial. This view was endorsed by
the chairmen of the FTSE 350 companies surveyed by Independent
Audit, of whom over 90% had found the exercise to be useful.”
I am a big believer in performance evaluation, as this is a
fundamental part of performance improvement. As a Board we
have just completed our fourth such performance evaluation. This
exercise covered the performance of the Board, its committees and
that of the individual directors.
The Board evaluation includes a review of the Board’s effectiveness,
the effectiveness of each Board Committee, and an assessment of
each Board director. One-on-one feedback discussions between the
Chairman and each director occur in the rst quarter of the year. The
table overleaf details some of the objectives that the Board has
agreed as a result of the evaluation process.
I see the formation of the Woolf Committee as positive afrmation of
the Board seeking to continually improve, and in the area of business
ethics not only achieve best practice but provide leadership.
Succession planning
Ensuring that we have the right people running the Company is one
of the Board’s core governance duties. Last year I reported on the
new processes introduced by the Nominations Committee to identify
and oversee the development of over 50 employees from across the
Group. These individuals form the backbone of the Company’s senior
management resource and in the future candidates for appointment
to the Board are likely to be drawn from amongst them. Overseeing
the management of their development is a key responsibility for the
Board and the Nominations Committee.
A review of management resources was completed in November last
year and I am pleased to report that we have a good number of quality
succession candidates across the current senior management roles
in the Group. These individuals cover the range from ‘ready now’ to
those candidates who we believe have the potential to take up the
most senior positions in several years’ time. In some areas we have
identied a need in the succession plans for greater ‘bench strength’.
Where this is the case we are working at achieving full coverage. In
addition, we have augmented our strategic management development
activities to address certain common development requirements
identied by our development and succession planning processes.
Naturally, the Chief Executive position is covered by these processes
and with Mike Turner due to retire later this year the Nominations
Committee has been actively engaged since last November on
who should succeed him. As mentioned above, the Company has
comprehensive succession planning and management evaluation
processes and these have been of great assistance. In line with best
practice, the Nominations Committee has also initiated an external
search for suitable candidates for the Chief Executive position, with
the aim of ensuring that the individual that the Board ultimately
chooses to appoint is the best person available for the job. Progress
is being made and we hope to be in a position to announce a
successor later this year.
Board appointments
During the year Andy Inglis joined the Board in a non-executive
capacity. As a director of BP p.l.c. he has excellent large global
company experience as well as having considerable international
project execution experience.
We have agreed that as a Board, in addition to the chairman, we
should aim to have eight non-executive and four executive directors.
With Ulrich Cartellieri having retired last September and Peter
Weinberg due to retire from the Board at the Annual General Meeting
(AGM) in May, the Nominations Committee has been active and I am
pleased that Ravi Uppal will be joining the Board as a non-executive
director in April. Search activity continues with a view to appointing
an additional non-executive director later this year.
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Directors’ report – Corporate governance
Corporate governance (continued)
58 www.baesyste ms.com
2007 Objectives
– Continue the work started in 2006 on
succession planning, with a focus on
the support and development of the next
generation of senior executives and also
the identication and enhancement of the
Group’s management bench strength.
– Develop further the work the Board
has initiated on nancial performance
monitoring and looking at project and
programme KPIs in more detail.
– Build on current non-nancial performance
monitoring, including the Corporate
Responsibility Committee’s focus on
corporate reputation issues.
– Provide additional opportunities for
non-executive directors to meet to
discuss issues independently and
with the Chief Executive.
2007 Achievements
– Good progress made on succession
planning with greater coverage across
all senior executive succession plans.
New senior management programme
rolled-out to address the common
development needs identied during
succession planning activities.
– The Board reviewed programme and project
KPIs regularly and uses these alongside
standard nancial measures to monitor
the Company’s performance.
– The Board and Corporate Responsibility
Committee have overseen the
development of new non-nancial risk
processes. More work will be done in
this area in 2008, aligning with Woolf
Committee recommendations.
– Additional opportunities were made available
for the non-executive directors to meet to
discuss issues informally as a group and
with the Chief Executive present.
2008 Objectives
– Engage non-executive and executive
directors in dialogue to ensure smooth
and transparent selection and transition
of the new Chief Executive.
– Board to conduct additional site visits
as part of its meeting programmes.
Use the visits as an opportunity to meet
with senior management to support
succession planning.
– Understand and review the competencies,
processes and culture required to support
the Company’s increasingly global position.
– Ensure that ethical and reputational
implications of strategic growth options
are explored and understood. Plan for
and commence embedding the Woolf
Committee recommendations.
– Keep attention focused on programme KPIs.
When we started the evaluation process in 2004 I was keen to use an
external facilitator to conduct individual interviews with each director.
No evaluation process is perfect but I believe our approach does allow
us to deal effectively with not only the procedural or administrative
aspects of how we operate but also some of the behavioural aspects
of performance. As Chairman, it is important I receive full and frank
feedback on my own performance and I receive this each year from
our Senior Independent Director after he has met with the facilitator.
Shareholder communication
Finally, I would like to highlight the importance I place on
communications with our shareholders and the central role the
AGM plays in this. I want attendance at our AGM to be an interesting
and worthwhile experience, allowing directors to report on their
stewardship of the Company and to answer shareholders’ questions
on this. I hope as many shareholders as possible are able to attend
and participate in the meeting on 7 May.
Dick Olver
Chairman
Board performance evaluation – objectives
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 59
Compliance with the provisions of the Combined Code
Compliance statement
The Company was compliant with the provisions of the Combined Code
on Corporate Governance throughout 2007.
The Board
The Board comprises a non-executive chairman, seven non-executive
directors and four executive directors.
The Board considers all of the non-executive directors, with the exception
of the Chairman, to be independent for the purposes of the Combined
Code. Each of these directors have been identied on pages 54 and 55
of this report.
Peter Weinberg was appointed to the Board in 2005. As Mr Weinberg
was a senior director of Goldman Sachs Inc. (an investment bank that
provides services to BAE Systems) the Board addressed the issue of
his independence prior to his appointment in light of provision A.3.1 of
the Combined Code concerning the possible existence of a ‘material
business relationship’ between the director and the Company or
between the Company and a party with which the director is a major
shareholder, senior employee, partner or director. It determined that
he was independent for the purposes of the Combined Code,
notwithstanding the relationship with Goldman Sachs. The reasons
for reaching this conclusion were:
– Goldman Sachs is a very large organisation with many clients.
BAE Systems is therefore just one of many clients it has worldwide
and the fees earned from its relationship with the Company
represents a very small part of its total revenues. As a
consequence, the Board believes that the relationship between the
Company and Goldman Sachs does not represent ‘a material
business relationship’; and
– prior to his appointment to the Board, Mr Weinberg had no
involvement with BAE Systems and none of the executive directors
or the Chairman had had any business dealings with him.
Mr Weinberg ceased to be associated with Goldman Sachs in 2006.
In 2007 the Board was scheduled to meet eight times and in addition
one day was spent reviewing strategy. Additional Board meetings are
called as required and in total the Board met 12 times during the year.
The Board has appointed Sir Peter Mason as the Senior Independent
Director. Amongst the duties undertaken by Sir Peter during the year
was to meet with the non-executive directors without the Chairman
present to appraise the Chairman’s performance.
The attendance by individual directors at meetings of the Board and
its committees in 2007 was as follows:
Applying the principles of the Combined Code on Corporate Governance
The Board has structured its activities so as to incorporate the main
and supporting principles in the UK’s Combined Code, recognising these
to be a sound statement of accepted good practice for a company such
as BAE Systems. The core activities of the Board and its committees
are documented and planned on an annual basis but this only forms
the basic structure within which the Board operates. The directors are
required to provide entrepreneurial leadership for the Company, relying
on the business skills and judgement that each director possesses.
The governance structure recognises this essential human element
and the role of the Chairman in ensuring that decisions are made by
the directors within a framework of prudent and effective controls.
The Board has adopted a document, the Board Charter, in which there
is a statement of governance principles that guide the activities of the
Board and also details of the roles of the Chairman, Chief Executive
and the Senior Independent Director. The governance principles reect
the main and supporting principles contained in the Combined Code
and cover the following:
– Strategy – reviewing and agreeing strategy;
– Performance – monitoring the performance of the Group and also
evaluating its own performance;
– Standards and Values – setting standards and values to guide the
affairs of the Group;
– Oversight – ensuring an effective system of internal controls is in
place, ensuring that the Board receives timely and accurate
information on the performance of the Group and the proper
delegation of authority; and
– People – ensuring the Group is managed by individuals with the
necessary skills and experience and that appointments to the Board
are managed effectively.
The Board Charter states that the Chief Executive is responsible for
the leadership and operational management of the Company within
the strategy and business plan agreed by the Board. Included within
the Charter is a schedule of matters that have been reserved for the
Board’s decision. These include approving the vision, values, principles
of ethical conduct, overall governance structure of the Company and
its strategy and business plans. Within the Board’s delegated
authorities it has reserved for itself, amongst other things, certain
decisions concerning contract bids and tenders, acquisitions and
disposals of businesses, capital expenditure and Company-funded
product development expenditure.
A copy of the Board Charter can be found on the Company’s website,
or alternatively, can be obtained from the Company Secretary.
Corporate Non-Executive
Audit Responsibility Nominations Remuneration Directors’ Fees
Director Board Committee Committee Committee Committee Committee
Professor S Birley
1
3 (5) – 1 (1) – 3 (3) –
Mr P Carroll 11 (12) – 5 (5) 7 (8) 1 (1) –
Dr U Cartellieri
2
8 (9)3 (3)––––
Mr C V Geoghegan 10 (12) –––––
Mr M J Hartnall 12 (12) 4 (4) ––––
Mr W Havenstein 11 (12) ––––1 (1)
Mr A G Inglis
3
6 (6) – 2 (2) – – –
Mr I G King 11 (12) –––––
Sir Peter Mason 10 (12) 3 (4) – 7 (8) 1 (1) –
Mr S L Mogford
1
3 (5)–––––
Mr R L Olver 12 (12) – – 8 (8) – 1 (1)
Mr R Quarta 9 (12) 1 (1)
4
– – 8 (8) –
Mr G W Rose 12 (12) –––––
Sir Nigel Rudd 11 (12) – 5 (5) – 8 (8) –
Mr M J Turner 12 (12) ––––1 (1)
Mr P A Weinberg 10 (12) – 5 (5) – 7 (8) –
Figures in brackets denote the maximum number of meetings that could have been attended.
1 retired from the Board on 9 May 2007
2 retired from the Board on 26 September 2007
3 appointed to the Board on 13 June 2007
4 in attendance at three additional meetings when not a member of the Committee
Directors’ report – Business review
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Corporate governance (continued)
60 www.baesyste ms.com
The Board has delegated to the Audit Committee responsibility for
reviewing in detail the effectiveness of the Company’s system of
internal controls. Having undertaken such reviews, the Committee
reports to the Board on its ndings so that the Board as a whole can
take a view on this matter. In order to assist the Audit Committee and
the Board in this review, the Company has developed the Operational
Assurance Statement (OAS) process. This has been subject to regular
review over a number of years, which has resulted in a number of
renements being made.
The OAS requires that each part of the business completes a formal
review of its compliance against the Operational Framework, including
operational and nancial controls and risk management processes.
It is signed-off by the managing director of every line of business and
relevant functional directors. The OAS is completed every six months
and includes a formal assessment of business risk.
The overall responsibility for the system of internal control within
BAE Systems rests with the directors of the Company. Responsibility
for establishing and operating detailed control procedures lies with
the line leaders of each operating business.
In line with any system of internal control, the policies and processes
that are mandated in the Operational Framework are designed to
manage rather than eliminate the risk of failure to achieve business
objectives, and can only provide reasonable and not absolute
assurance against material misstatement or loss.
The responsibility for internal control procedures with joint ventures
and other collaborations rests, on the whole, with the senior
management of those operations. The Company monitors its
investments and exerts inuence through Board representation.
Going concern
After making due enquires, the directors have a reasonable
expectation that the Group has adequate resources to continue
operational existence for the foreseeable future. For this reason they
continue to adopt the going concern basis in preparing the accounts.
Relations with shareholders
The Company has a well-developed investor relations programme
managed by the Chief Executive, Group Finance Director and Investor
Relations Director. In addition, the Chairman is in regular contact with
major shareholders and looks to keep them informed of progress on
corporate governance matters. In order to assist in developing an
understanding of the views of major shareholders, each year the
Company commissions a survey of investors undertaken by external
consultants. The results of the survey are presented to the Board.
The Company maintains a comprehensive Investor Relations website
that provides, amongst other things, information on investing in
BAE Systems and copies of the presentation materials used for key
shareholders presentations. This can be accessed via the Company’s
website, www.baesystems.com.
The AGM provides all shareholders with the opportunity to develop
their understanding of the Company and ask questions on the matters
put to the meeting including this Annual Report. All shareholders are
entitled to vote on the resolutions put to the AGM and, to ensure that
all votes are counted, the Company’s Articles of Association requires
that a poll is taken on all the resolutions in the Notice of Meeting.
The results of the votes on the resolutions will be published on the
Company’s website.
The Company’s Articles of Association require that all new directors
seek re-election to the Board at the following AGM. In addition, all
directors are required to stand down and seek re-election to the
Board at least once every three years.
The Board has set out in the Notice of Annual General Meeting
(enclosed with this report) their reasons for supporting the re-election
of those directors seeking re-election at the forthcoming AGM.
Internal control
The Board has conducted a review of the effectiveness of the Group’s
system of internal controls, including nancial, operational and
compliance controls and risk management systems, in accordance
with the Combined Code and the Turnbull guidance (as revised).
BAE Systems has developed a system of internal control that
was in place throughout 2007 and to the date of this report, that
encompasses, amongst other things, the policies, processes, tasks
and behaviours that taken together, seek to:
– facilitate the effective and efcient operation of the Company
by enabling it to respond appropriately to signicant operational,
nancial, compliance and other risks that it faces in carrying out
its business;
– assist in ensuring that internal and external reporting is accurate
and timely and based on the maintenance of proper records
supported by robust information gathering processes; and
– assist in ensuring that the Company complies with applicable laws
and regulations at all times and also internal policies in respect of
the standards of behaviour and conduct mandated by the Board.
Reporting within the Company is structured so that key issues are
escalated through the management team ultimately to the Board
if appropriate. The Operational Framework provides a common
framework across the Company for operational and nancial controls
and is reviewed on a regular basis by the Board. The business policies
and processes detailed within the Operational Framework draw on
global best practice and their application is mandated across the
organisation. Lifecycle Management (LCM) is such a process and
promotes the application of best practice programme execution and
facilitates continuous improvement across the Group. It considers
the whole life of projects from inception to delivery into service and
eventual disposal, and its application is critical to our capability in
delivering projects to schedule and cost.
Further key processes are Integrated Business Planning (IBP), Quarterly
Business Reviews (QBR) and Performance Centred Leadership (PCL).
The IBP, approved annually by the Board, results in an agreed long-term
strategy for each business group, together with detailed near-term
budgets. The QBRs, chaired by the Chief Operating Ofcers, evaluate
progress against the IBP and business performance against objectives,
measures and milestones. PCL drives business success by linking
individual goals to those of the organisation enabling employees to
understand how their own success contributes to the success of the
whole business.
Whilst the quality of the control processes is fundamental to the
overall control environment, the consistent application of these
processes is equally important. The consistent application of
world-class control processes is a key management objective.
The Company is committed to the protection of its assets, which
include human, property and nancial resources, through an
effective risk management process, underpinned where appropriate
by insurance.
The Internal Audit team independently reviews the risk identication
procedures and control processes implemented by management. It
provides objective assurance as to the operation and validity of the
systems of internal control through a programme of cyclical reviews
making recommendations for business and control improvements
as required.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 61
Activities
One of the Committee’s principal duties is to review the effectiveness
of the Group’s internal control processes. Robust internal controls are
essential. They ensure that the information on the performance of the
Company is accurate and timely, thereby assisting management and
directors in the effective management of the Group. They are also
essential in ensuring that the Group complies with law and regulations
including those that concern external reporting. As in previous years,
the Committee received a report and presentation from the Auditors
summarising the ndings of their review of the Group’s control
environment. In addition, the Committee received reports on control
matters from the Internal Audit function and, as explained on page 60,
twice during the year it reviewed the ndings from the Group’s
Operational Assurance Statement process.
One of the Committee’s key responsibilities is monitoring the
effectiveness of the Company’s Auditors and Internal Audit function.
Each year the Committee reviews the results of an internal evaluation
of the performance of the Internal Audit function that looks at its
effectiveness in terms of work planning, the skills and experience
available to the function, quality of reporting, implementation of audit
recommendations and its independence. In addition, last year the
Committee commissioned an independent third-party to provide the
Committee with an external view of the effectiveness of the Internal
Audit function – this being in line with best practice recommended
by the Institute of Internal Auditors.
An evaluation of the effectiveness of the Auditors, KPMG Audit Plc,
was completed during the year.
The Committee accepts that certain work of a non-audit nature is best
undertaken by the Auditors. The Audit Committee reviews the amount
and nature of non-audit work undertaken by the Auditors during the
year and has agreed that, whilst it believes it is not appropriate to
manage such work by limiting it to a certain percentage of audit work,
such work should be controlled to ensure that it does not compromise
the independence of the Auditors. Consequently, the Committee has
agreed the following rules to control the quantity and the nature of the
work undertaken by the Auditors:
– any non-audit work to be undertaken by the Auditors in excess
of £250,000 to be authorised by both the Chairman of the Audit
Committee and the Group Finance Director;
– no partner/director of the Auditor’s worldwide audit team is to be
employed by the Company within two years of the conclusion of a
relevant audit;
– no qualied member of the worldwide audit team at manager level
or below is to be employed by the Company within two years of the
conclusion of a relevant audit; and
– no partner/director of the Auditors not associated with the audit is
to be employed by the Company without the approval of the Group
Finance Director and the Chairman of the Audit Committee.
As part of the Committee’s annual schedule of meetings, a meeting
is held at one of the Company’s operations so that members of the
Committee can meet management and develop a greater understanding
of various aspects of the Company. This year a meeting of the
Committee was held at the Woodford site in the UK where the Regional
Aircraft business and Nimrod MR4A programme were reviewed.
Members
Michael Hartnall (Chairman)
Sir Peter Mason
Roberto Quarta
During the year, Dr Ulrich Cartellieri was a member of the Committee
until his retirement from the Board on 26 September 2007.
Responsibilities
– Reviewing the effectiveness of the Company’s nancial reporting,
internal control policies and procedures for the identication,
assessment and reporting of risk.
– Monitoring the role and effectiveness of the Internal Audit
function including approving the appointment or removal
of the Head of Internal Audit.
– Considering and making recommendations to the Board
on the appointment of the Auditors.
– Keeping the relationship with the Auditors under review, including
the terms of their engagement and fees, their independence and
their expertise, resources and qualications.
– Monitoring the integrity of the Company’s nancial statements.
– Reviewing signicant nancial reporting issues and judgements.
The full terms of reference of the Audit Committee can be
found on the Company’s website or can be obtained from the
Company Secretary.
Governance
The Audit Committee was in place throughout 2007 during which all
its members were non-executive directors deemed to be independent
in accordance with provision A.3.1 of the Combined Code.
The Committee is chaired by Michael Hartnall who is a chartered
accountant and has relevant experience of serving as a nance
director of a large UK listed company.
The Committee normally asks that the Chief Executive, Group Finance
Director and Head of Internal Audit attend its meetings. However,
during the year the Committee held individual meetings without
Company executives present, with only the Head of Internal Audit
present and also with only the external auditors present.
The Committee met four times in 2007.
Audit Committee report
Michael Hartnall
Audit Committee
Chairman
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Corporate governance (continued)
62 www.baesyste ms.com
Members
Dick Olver (Chairman)
Phil Carroll
Sir Peter Mason
Responsibilities
– Reviewing regularly the structure, size and composition of the
Board and making recommendations to the Board on any
desired changes.
– Identifying and nominating for the Board’s approval suitable
candidates to ll vacancies for non-executive and, with the
assistance of the Chief Executive, executive directors.
– Planning for the orderly succession of new directors to the Board.
– Recommending to the Board the membership and chairmanship
of the Audit and Remuneration committees.
The full terms of reference of the Nominations Committee can
be found on the Company’s website or can be obtained from the
Company Secretary.
Governance
The Nominations Committee was in place throughout 2007. It is
chaired by the Chairman of the Company. Whilst he is not deemed
to be independent, the other two members of the Committee are
independent non-executive directors in accordance with provision
A.3.1 of the Combined Code.
The Committee normally asks the Chief Executive and Group Human
Resources Director to attend its meetings. However, during the year
the Committee did meet without Company executives present.
The Committee met eight times in 2007.
Activities
The Committee is responsible for nominating suitable candidates
for appointment to the Board – in both executive and non-executive
capacities. When the Committee identies a need to recruit new non-
executive directors, a prole of the ideal candidate is produced based
on the skills and experience required. The Company is increasingly
global and looks beyond both the UK and the US to identify the
right people. Search consultants have an important role to play
in identifying suitable candidates based on the Committee’s
requirements. In 2007, The Zygos Partnership was engaged to
assist in such search activities.
Each year the Committee undertakes a detailed review of the
Company’s management resources and the succession plans for all
senior executive positions. The Committee is interested in both the
The Audit Committee also undertook the following during 2007:
– reviewed the effectiveness of the Group’s internal controls and the
disclosures made in the Annual Report on this matter;
– reviewed the output from the Group-wide process used to identify,
evaluate and mitigate risk;
– received a report from the Auditors on their review of the
effectiveness of the controls across the Group;
– reviewed the nancial statements in the 2006 and 2007 Annual
Report and the Interim Report issued in August 2007, and received
a report from the Auditors on the statements;
– reviewed and agreed the approach and scope of the audit work
to be undertaken by the Auditors;
– agreed the fees to be paid to the Auditors in respect of the
2007 audit;
– received a report from the Head of Internal Audit on the work
undertaken by the Internal Audit function;
– undertook an assessment of fraud risks;
– reviewed proposals concerning the Group’s periodic nancial
reporting obligations;
– reviewed the Group’s procedures for disclosing information to the
Auditors and the statement concerning such disclosures in the
Annual Report;
– reviewed the Committee’s terms of reference; and
– reviewed the effectiveness of the Company’s helpline procedures
in respect of the reporting of possible accounting, nancial control
and other nancial irregularities.
On behalf of the Audit Committee
Michael Hartnall
Audit Committee Chairman
Nominations Committee report
Dick Olver
Nominations Committee
Chairman
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 63
Activities
Corporate responsibility concerns a company’s economic, social
and environmental impact. All companies are different when it comes
to their impact in these areas and therefore it is important for the
Corporate Responsibility Committee to focus on the areas of corporate
responsibility that are of particular importance for BAE Systems. The
Committee has therefore agreed that its prime focus should be ethics
and health and safety. However, it also deals with a range of other
areas, including matters such as workforce diversity and a range
of environmental matters.
The Committee monitors and reviews compliance with the Company’s
standards of business behaviour and the work undertaken to ensure
that all employees are aware and understand the application of these.
The activities of the Committee during 2007 included reviewing the
Company’s Ethics Helpline and Group ethics awareness programmes,
including the results of surveys assessing such awareness. As
reported elsewhere in this report, the Board has formed the Woolf
Committee to study and report on the Group’s ethical policies and
processes. During the year the Corporate Responsibility Committee
met with members of the Woolf Committee to discuss ethics in
general and its role in relation to the prospective implementation
and assurance of activity that may be recommended. We look
forward to the publication of the report later this year.
The health and safety of our employees is a key priority for the Company
and also for the Corporate Responsibility Committee. We monitor safety
performance and have reviewed various aspects of the management
of health and safety within the Company. In addition, the Committee
considered the output from a workshop held by management on
corporate responsibility and was pleased to endorse the priority
it is giving to health and safety in addition to ethics.
During the year the Company has been developing further its risk
management processes, particularly in respect of the monitoring and
mitigation of non-nancial risks. The Committee reviews, on an annual
basis, the relevant output from such processes as they relate to health
and safety, workplace policies, environmental impact, business ethics
and compliance with anti-corruption laws and regulation.
The Committee undertook the following activities in 2007:
– received reports on corporate responsibility matters including,
amongst other things, engagement with shareholders and safety,
health and environment performance information;
– received reports from the Internal Audit function on audits
undertaken on ethical and environmental matters;
– reviewed and approved the proposed approach to progress the
Company towards a ‘best in class’ position on safety performance;
– reviewed the Company Corporate Responsibility Report;
– reviewed its terms of reference; and
– liaised with the Remuneration Committee on the setting of coporate
responsibility-related non-nancial objectives to be included in the
directors’ annual bonus plan.
See pages 37 to 43 for more detail on the Group’s corporate
responsibility activities.
On behalf of the Corporate Responsibility Committee
Peter Weinberg
Corporate Responsibility Committee Chairman
quality of management resource and also its depth, looking at who
is ready to take on specic management positions now, as well as
who is likely to come through in the next couple of years and beyond.
The Committee also monitors the development of senior management,
ensuring that individual development plans are in place.
Overseeing the process for the appointment of executive directors
is the most important task that the Committee has to perform. As
reported on page 57, the Committee is undertaking the task of nding
the right person to succeed Mike Turner when he retires later this year.
This process was started last year and the Committee is committed to
doing this in line with best practice, reviewing rigorously both external
and internal candidates.
On behalf of the Nominations Committee
Dick Olver
Nominations Committee Chairman
Corporate Responsibility Committee report
Peter Weinberg
Corporate
Responsibility
Committee
Chairman
Members
Peter Weinberg (Chairman)
Phil Carroll
Andy Inglis
Sir Nigel Rudd
Responsibilities
– Assisting the Board on overseeing the development of strategy
and policy on social, environmental and ethical matters.
– Monitoring and reviewing the Company’s performance in
managing social, environmental, ethical and reputational risk.
– Overseeing and supporting key stakeholder engagement
on social, environmental and ethical issues.
The full terms of reference of the Corporate Responsibility
Committee can be found on the Company’s website or can
be obtained from the Company Secretary.
Governance
The Corporate Responsibility Committee was in place throughout 2007
during which all its members were non-executive directors deemed to be
independent in accordance with provision A.3.1 of the Combined Code.
The Committee normally asks the Head of Internal Audit, Group
Human Resources Director, Group General Counsel and Corporate
Responsibility Director to attend its meetings.
The Committee met ve times in 2007.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
64 www.baesyste ms.com
Directors’ report – Corporate governance
Remuneration report
Members:
Sir Nigel Rudd (Chairman)
Roberto Quarta
Peter Weinberg
During the year, Professor Sue Birley served as a member and as
Chairman of the Remuneration Committee until her retirement from
the Board on 9 May 2007.
Responsibilities
– Agreeing a policy for the remuneration of the Chairman, executive
directors, members of the Executive Committee, the Company
Secretary and other senior executives.
– Within the agreed policy, determining individual remuneration
packages for the Chairman and executive directors.
– Agreeing the terms and conditions to be included in service
agreements for executive directors, including termination
payments.
– Approving any employee share-based incentive schemes and
any performance conditions to be used for such schemes.
– Determining any share scheme performance targets.
The full terms of reference of the Remuneration Committee,
which conform with the requirements of the Combined Code,
can be found on the Company’s website or can be obtained from
the Company Secretary.
Governance
The Committee is chaired by Sir Nigel Rudd and all of its members
are independent non-executive directors. The Company’s Chairman
and Chief Executive attend Committee meetings by invitation only.
They do not attend where their individual remuneration is discussed
and no director is involved in deciding his own remuneration.
In 2007 the Committee met eight times and details of attendance
at these meetings are provided in the Corporate Governance Report
on page 59.
In August 2007 the Committee appointed Kepler Associates as its
Independent Adviser. The role of the Committee’s Independent
Adviser is to provide advice to the Committee and its individual
members on all aspects of the Committee’s remit, and Kepler
Associates will not undertake any work for the Company whilst they
are retained as the Committee’s Independent Adviser. Representatives
from Kepler Associates have attended each of the Committee
meetings since their appointment and will be in attendance at all
meetings unless specically requested otherwise by the Committee.
During the year the Committee also received material assistance
and advice on remuneration policy from the Company’s Human
Resources Director, Alastair Imrie, and the Human Resources Director,
Group Remuneration and Benets, Graham Middleton. Dick Olver
Remuneration Committee report
Sir Nigel Rudd
Remuneration Committee
Chairman
The Board has delegated authority for remuneration policy and
determining the specic packages for the Chairman and executive
directors to the Remuneration Committee, and has delegated
authority to agree fees payable to the non-executive directors to
the Non-Executive Directors’ Fees Committee. The reports from
both these Committees are incorporated into this Remuneration
report, together with a report on the remuneration or fees paid to
directors and the policy underpinning this.
The Remuneration report is structured as follows:
– Remuneration Committee report
– Non-Executive Directors’ Fees Committee report
– Remuneration reporting
– Remuneration policy and service contracts for executive directors
– Chairman’s appointment, term and fees
– Non-executive directors’ appointment, term and fees
– Tabular information on directors’ shareholdings, emoluments,
pensions and share-based incentives
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 65
and Mike Turner, in their respective capacities as Chairman and
Chief Executive, also provided advice that was of material assistance
to the Committee.
Legal advice to the Committee has been provided by Linklaters
and Freshelds Bruckhaus Deringer, who are both appointed by the
Company, and who also provided services to the Company during the
year. The Committee is satised that the services provided to it by
these rms were of a technical nature and did not create any conict
of interest. If a conict of interest were to arise in the future, the
Committee would appoint separate legal advisers from those used
by the Company.
PricewaterhouseCoopers (PwC), who are appointed by the Company
and also provided services to the Company during the year, provided
detailed information on market trends and the competitive positioning
of packages. New Bridge Street Consulting, who are appointed by the
Committee, provided advice on long-term incentive plans and the total
shareholder return gures for assessing the performance condition
under the Performance Share Plan.
Activities
In discharging its responsibilities, the Committee has, during the year,
undertaken a thorough review of the Company’s reward strategy. As a
result of that review, the Committee has agreed a number of changes
as set out in this report. In addition, the Committee has agreed the:
– performance targets for the year and progress against those targets;
– operation of the long-term incentive plans and policy for executive
share scheme grants including the level of individual grants and
performance conditions;
– policy for the operation of the all-employee share schemes;
– award of bonuses based on the prior year’s performance;
– Chairman’s fees for his second three-year term;
– base salary for the two new Chief Operating Ofcers in the light
of their progress at the half year;
– discretionary elements of the executive share plans;
– terms on which Steve Mogford and Chris Geoghegan left the
Company during the year; and
– terms on which Mike Turner will retire from the Company at the end
of August 2008.
In addition, the Committee has also:
– reviewed the Remuneration report; and
– consulted with major shareholders over aspects of remuneration policy.
The Company’s remuneration strategy, policy and details of executive
remuneration are set out on pages 66 to 83 of this Remuneration report.
On behalf of the Remuneration Committee
Sir Nigel Rudd
Remuneration Committee Chairman
Non-Executive Directors’ Fees Committee report
Dick Olver
Non-Executive Directors’
Fees Committee
Chairman
Members:
Dick Olver (Chairman)
Philip Bramwell
Walt Havenstein
Mike Turner
Responsibilities
– Reviewing the fees payable to non-executive directors
(excluding the Chairman) and making changes to such fees
as deemed appropriate.
Governance
The Non-Executive Directors’ Fees Committee has delegated authority
from the Board to agree fees payable to non-executive directors on
its behalf.
Activities
The Board has approved the following guidelines to be used by the
Committee when discharging its responsibilities:
– fees shall be sufcient to attract and retain individuals with the
necessary skills, experience and knowledge required to ensure that
the Board is able to discharge its duties effectively;
– in setting fees the Committee shall have regard to the amount of
time individual non-executive directors are required to devote to their
duties and also the scale and complexity and international nature of
the business and the responsibility involved;
– fees payable to non-executive directors shall be paid in cash and
shall not be performance-related; and
– non-executive directors shall not participate in the Company’s share-
based incentive schemes or pension scheme.
The Committee held one meeting in 2007 attended by all members,
and met in January 2008.
On behalf of the Non-Executive Directors’ Fees Committee
Dick Olver
Non-Executive Directors’ Fees Committee Chairman
Directors’ report – Business review
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
66 www.baesyste ms.com
In the second half of 2007, the Committee undertook a full review
of the remuneration arrangements for executive directors to ensure
they remained appropriate and supported the Group strategy given
the growth of the Group internationally and the increased focus on
excellence in Programme Management and through-life support.
As a result of the review, the Committee has made a number of
changes to the arrangements for executive directors for 2008 as
detailed below. These changes will ow down to the 250 most senior
executives within the Group globally to create a consistent global
approach to reward.
Following the announcement in October 2007 that the Chief
Executive, Mike Turner, would retire from the Company at the end of
August 2008 after 42 years with the Company, the Committee has
agreed a separate arrangement for him detailed on page 70.
Policy
– Base salary
– Annual bonus
– Long-term incentive plans
• Executive Share Option Scheme*
• Performance Share Plan
• Share Matching Plan
– Pension provision
– Car/allowance
– Other benets
– Global all-employee incentive plan
* no further awards from 2008
Package
Remuneration strategy and policy for executive directors
This section of the report explains the Company’s remuneration strategy and policy, the individual components of executive directors’
remuneration and details of their service contracts as required by legislation.
Remuneration strategy and 2007 review
The Company’s remuneration strategy, policy and package for executive directors is:
To provide a remuneration package that:
– helps to attract, retain and motivate
– is aligned to shareholders’ interests
– is competitive against the appropriate
market
– encourages and supports a high
performance culture
– is fair and transparent
– can be applied consistently throughout
the Group.
Strategy
Objectives of the review and summary
To drive creation of long-term value for shareholders
– Set base salary at median competitive
level
– Reward upper quartile performance with
upper quartile reward
– Balance between:
• short and long-term reward
• xed and variable reward
• with balance becoming more long-term
and more highly geared with seniority
– Competitive package of benets
Objective
Increase focus on sustainable
long-term performance
Simplify package with more
transparent link between
performance and reward
Competitive package with
increased reward for improved
performance
Incentivise increased share
ownership amongst executives
To provide a remuneration package that:
– helps to attract, retain and motivate
– is aligned to shareholders’ interests
– is competitive against the appropriate
market
– encourages and supports a high-
performance culture
– is fair and transparent
– can be applied consistently throughout
the Group
Summary of changes made
– Increase to one-third the proportion of annual bonus driven off specic objectives
– Part of the annual bonus to be specically linked to performance on safety, ethics and diversity
– Compulsory deferral of at least one-quarter of annual bonus into the Share Matching Plan
– Increase proportion of package delivered through long-term incentives
– Further extend eligibility of long-term incentive plans to cover the top 250 senior executives globally
– Replace share options by improved awards of performance shares
– Increase focus on long-term Earnings per Share (EPS) as key driver of long-term performance
– Half the awards of performance shares to be based on Total Shareholder Return (TSR) and half on EPS
– Use actual growth in EPS rather than real growth in excess of UK ination
– Improve Share Matching Plan to increase its weight in package
– Improved maximum bonus levels coupled with reduced payout for achieving the base nancial targets
– Uniform match of 1:1 for 2008 awards under Share Matching Plan for all eligible executives
– Improved 2:1 match for 2009 awards under Share Matching Plan for improved performance
– Increased awards of performance shares where necessary to maintain competitive package
– All future awards of long-term incentives will be made over shares rather than options
– Compulsory deferral of part of the annual bonus into Share Matching Plan
– Extend eligibility of long-term incentives and improve award levels
– Extend Minimum Shareholding Requirement to all senior executives receiving long-term incentives
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 67
practice, and also takes account of the performance of the individual, the
Company as a whole and the pay and conditions of Group employees.
Base salary
As a result of the above review and, having taken account of the
competitive positioning, performance and general market trends,
the Committee has increased the annual base salaries of executive
directors with effect from January 2008 as follows:
Base salary at Base salary at Percentage
Executive director 31 December 2007 1 January 2008 increase
George Rose
Group Finance Director £560,000 £592,500 5.8%
Ian King
1
Chief Operating Ofcer –
UK/Rest of World £560,000 £592,500 5.8%
Walt Havenstein
1
Chief Operating Ofcer –
US $850,000 $900,000 5.9%
1 The two Chief Operating Officers were new in post at the beginning of 2007. Following
a half year review of performance in their new roles, the base salary of Ian King was
increased from £530,000 to £560,000, and that of Walt Havenstein was increased
from $750,000 to $850,000, with effect from 1 July 2007.
Annual bonus
Structure: The annual bonus for 2008 has been restructured to
increase the focus on long-term performance and risk management
(both business risk and reputation risk). To further reinforce the
importance of key aspects of the Group’s corporate responsibility
agenda, a specic part of the annual bonus will be based on driving
performance and improvement in ethics and safety. The structure of
the annual bonus for 2008 will be:
Measure % of bonus
In-year nancial performance 66% Down from 75%
Ethics and safety 12%
Up from 25%
Other objectives that support the
Executive Committee’s top ten objectives 22%
At present, executive directors can invest some or all of their net
annual bonus into the Share Matching Plan (SMP). To increase the
alignment between short-term and long-term reward, executive
directors will be required to invest at least one-quarter (one-third for
the Chief Operating Ofcer – US) of their net 2008 annual bonus into
the SMP when the bonus is paid in 2009. Further investment can be
made on a voluntary basis up to a maximum investment of half their
net bonus.
Levels: To remain competitive and to increase the gearing to drive for
high performance, the maximum bonus levels have been increased
to market median levels but the payout for achieving on-target
performance against the in-year nancial targets has been reduced
from 50% to 40% of maximum. The table below summarises the
revised bonus structure and levels for the executive directors.
Maximum bonus as UK executive directors US executive director
percentage of salary Current New Current New
In-year nancial
performance 75% 83% 112.5% 150%
Ethics and safety 15% 27%
Other objectives 25% 37.5%
supporting
the Group strategy 27% 48%
Total 100% 125% 150% 225%
Bonus compulsorily
invested into SMP – 31.25% – 75%
Maximum bonus
payable in cash 100% 93.75% 150% 150%
The Committee’s executive remuneration policy continues to be
to set base salaries at median competitive levels, taking into account
performance and experience in role, whilst seeking to reward upper
quartile performance with potential upper quartile remuneration
through the focused use of bonus schemes and share-based
incentives. The Committee believes that the above changes and
improvements to the incentive packages will:
– bring the remuneration packages into line with market
competitive levels;
– simplify the arrangements to improve line-of-sight between
performance and reward;
– shift the focus towards long-term sustainable growth in EPS;
– reinforce the key aspects of the Group’s corporate responsibility
agenda;
– directly align short-term and long-term reward through compulsory
deferral of part of the bonus into the Share Matching Plan for all
executive directors; and
– increase the gearing to drive for high performance as most of
the improvement in package is only delivered for achieving more
stretching targets.
The Committee intends to continue with the executive remuneration
policy as detailed in this report in 2008 and subsequent years,
and will continue to consult on material changes with principal
shareholders. The principles of the remuneration strategy are applied
consistently across the Group, taking account of seniority and local
market practice.
The following sections describe the changes made in more detail
and the specic arrangements for executive directors.
Approach to the review
The review not only considered the Company’s executive remuneration
packages against the market but also the Company’s performance
to date, its strategy for the next ve years and the views of the
Committee members and senior executives.
Information on the market for comparable management positions
was provided by PwC so that the Committee could form a view as
to where to position the various elements of the package relative
to comparable companies.
The methodology used was to construct appropriate comparator
groups for the individual positions, taking account of company size,
scale of operations and breadth of role. The comparator group for
the UK executive directors comprised 25 of the FTSE 50 companies
(excluding nancials and retail) with market capitalisation nearest
to that of BAE Systems (12 larger and 13 smaller). The Committee
believes that the change from a comparator group based on turnover
(as used last year) to one based on market capitalisation creates
better alignment between the value placed on the Company and
the value placed on the executives who manage it.
For the US Chief Operating Ofcer, regression analysis was used on
US aerospace, defence and general industry sector data to produce
appropriate market gures consistent with the size and scale of the
US business, adjusting where necessary to reect the extra responsibility
for his plc board role.
The base salary, total cash reward (base salary plus annual bonus),
total direct reward (total cash reward plus long-term incentives)
and total reward (total direct reward plus pension) were analysed
at the median and upper quartile for the relevant posts in the
comparator group companies. This gives the Committee a view
on the competitiveness of the individual elements of the package
as well as the package as a whole.
The Committee also reviewed the trends in the elements of remuneration
to ensure that the structure of the package stays in line with market
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
68 www.baesyste ms.com
– Share options
Details of the current Executive Share Option Plan are set out on
page 79. No further grants of share options will be made, except in
exceptional circumstances.
– Performance Share Plan (PSP)
A detailed explanation of the PSP is contained on page 71. The
Committee believes that the PSP offers better value for money than
share options as executives generally place a higher value on such
plans than share options, and they require fewer shares to deliver the
same value, thus reducing the dilutive effect of executive share-based
reward. Following the decision not to award further grants of share
options, the Committee has made a number of changes to the PSP.
In line with current corporate governance guidelines, shares awarded
under the PSP will attract dividends prior to vesting. The additional
value of these dividends has been taken into account in assessing
the overall value of awards to be granted.
To further increase the proportion of the package driven off long-term
EPS growth, half the PSP awards will be based on the current TSR
performance condition and vesting scale, with the other half based
on EPS growth.
The EPS performance condition will be based on annual EPS growth,
with no vesting at 5% pa growth, increasing on a straight line basis
to full vesting at 11% pa growth.
To remain competitive and to replace the value of previous share
option grants, the award levels for 2008 will be:
– 200% of base salary for the UK executive directors (split 100%
of salary on PSP
TSR
and 100% of salary on PSP
EPS
); and
– 250% of base salary for the US executive director (split 125%
of salary on PSP
TSR
and 125% of salary on PSP
EPS
).
The PSP was approved by shareholders in May 2006. At that time
it was agreed that the Committee should have the exibility for
executives below Board level to base up to half of any award on
appropriately stretching internal measures, with the rest based on
TSR as at present. In addition, the maximum award under the PSP
was limited to two times base salary. Shareholder approval will be
sought at the May 2008 AGM to base half the PSP award for executive
directors on appropriately stretching internal measures, which will be
EPS for awards in 2008, and to increase the maximum award level
under the PSP to four times base salary. Whilst it is not envisaged that
awards at this level will be necessary, it does allow the Committee the
exibility in future should special circumstances arise. Naturally
shareholders will be consulted on any signicant changes to the
normal award levels.
It is proposed that executive directors will receive the 2008 award
of PSP
TSR
in the normal cycle, ie shortly after the Company’s annual
results. The 2008 award of PSP
EPS
will be made shortly after the May
2008 AGM, but with a slightly reduced vesting period (eg two years
and ten months rather than the normal three years) so that both
awards vest at the same time.
The nancial targets, both base and stretch, are derived from the
Integrated Business Plan (IBP), which is agreed by the Board and
which implements corporate strategy on a group-wide basis by
ensuring that business plans which support the strategy are
integrated across all businesses. In determining the in-year nancial
performance measures, the view was taken that the Company’s major
investors believe EPS and cash targets (and, where appropriate,
EBITA
1
) to be key indicators of long-term nancial performance and
value creation.
The Executive Committee top ten objectives are agreed by the Board
each year as those key to delivering the Group’s strategy. These are
set out on page 11 and used as the basis to set the individual
objectives for the executive directors which are agreed by the
Chairman and the Committee. These then ow down to members of
the Executive Committee and the senior leadership team to ensure
that all businesses within the Group are aligned with the overall Group
strategy. The annual bonus targets set by the Committee for the
executive directors, which the Committee believes are stretching
but achievable, are summarised in the table below.
Long-Term Incentive Plans (LTIPs)
To simplify the LTIPs and increase the line of sight between the
executive’s reward and performance, no further awards of share
options will be made (except in exceptional circumstances, eg to
secure a new hire in a competitive situation). Instead, the awards of
performance shares will be increased and half the award will be based
on an EPS performance condition with the other half based on TSR.
At present, the LTIP arrangements that use EPS growth (ie share
options and the Share Matching Plan for executive directors) use real
growth in EPS in excess of UK ination and have stepped vesting with
one-third vesting at real annual growth of 3%, jumping to two-thirds
vesting at 4% pa and full vesting at 5% pa. From 2008, where EPS
is used as a measure in LTIPs, actual (ie nominal) rather than ‘real’
EPS growth will be used, with a straight line vesting scale to avoid
stepped vesting.
– Share Matching Plan (SMP)
The SMP is seen as a key part of the long-term incentive package,
directly linking short-term reward with long-term reward. A more
detailed explanation of the SMP is contained on page 72. For awards
in 2008 in respect of the 2007 annual bonus, none of the matching
shares will vest unless the annual EPS growth over the three-year
performance period exceeds 5% pa, increasing uniformly from no
match to a 1:1 match for 8% pa growth.
For 2009 awards in respect of the 2008 annual bonus, the matching
scale will be extended on a uniform basis to provide a 2:1 match for
annual EPS growth of 11% pa. However, executive directors will only be
able to invest a maximum of half their net annual bonus into the SMP.
The increase in match from 1:1 to 2:1 for increased performance, to
be applied in 2009, will require formal shareholder approval which will
be sought at the May 2008 AGM.
Annual bonus as a percentage of base salary for 2008 George Rose Ian King Walt Havenstein
Base Stretch Base Stretch Base Stretch
Measure target target target target target target
Group EPS 16.6% 41.5% 8.3% 20.75% 15% 37.5%
Group cash 16.6% 41.5% 8.3% 20.75% 15% 37.5%
Business EBITA
1
– – 8.3% 20.75% 15% 37.5%
Business cash – – 8.3% 20.75% 15% 37.5%
Ethics and safety Up to 15% Up to 15% Up to 27%
Other objectives supporting the Group’s strategy Up to 27% Up to 27% Up to 48%
If performance is between the base and stretch targets, the bonus is pro-rated on a straight line basis
1 earnings before amortisation and impairment of intangible assets, finance costs and
taxation expense
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 69
Pension provision
Following the changes made recently in the UK in response to
pensions simplication legislation (as reported last year), and in the
US to increase the pay averaging period for existing executives to ten
years by 2015, no further changes to the pension arrangements for
executive directors are required.
Fixed and performance-related reward
At on-target performance, more than half the package (two-thirds
for the US executive director) is performance related, rising to over
three-quarters for the UK executive directors and over 85% for the
US director at stretch performance. This is shown in the chart below.
Total value of incentives
In making the above changes to the package, the Company has been
mindful of the impact on the overall value of the package. Using
assumptions consistent with those underlying the value placed on
LTIPs in the Company’s accounts, and assuming executive directors
invest half their net bonus into the SMP, the table below summarises
the proposals and compares ‘expected’ value of the total direct reward
(base salary plus bonus plus long-term incentives) before and after the
changes. As the improvements in the annual bonus levels for 2008
will not feed into the SMP until 2009, and the extension of the SMP
match will not be introduced until 2009, the expected values of the
incentive package delivered in both 2008 and 2009 are shown.
The charts below show the key drivers of performance and their
inuence on the incentive package.
Performance drivers of incentive package
Base salary Pension Cash bonus Deferred bonus SMP PSP
Proportion of package value delivered through xed
and performance-related reward
UK executive
directors
US executive
director
Stretch
Performance
On-Target
Performance
Stretch
Performance
On-Target
Performance
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Proportion of overall package
Total value of incentives as a percentage of salary
UK executive directors US executive director
Current New Current New
Annual bonus
On-target 54% 61% 81% 110%
Maximum 100% 125% 150% 225%
Share Matching Plan
Match
1
/
3
:1 – 1:1 0 – 2:1
1
/
3
:1 – 1:1 0 – 2:1
EPS growth target (% pa) Real growth Actual growth Real growth Actual growth
of 3% – 8% of 5% – 11% of 3% – 8% of 5% – 11%
Share option grant
Award (% of salary) 150% – 150% –
PSP grant on TSR
Award (% of salary) 100% 100% 100% 125%
TSR vesting ¼ at median, ¼ at median, ¼ at median, ¼ at median,
All at top 20% All at top 20% All at top 20% All at top 20%
PSP grant on EPS
Award (% of salary) – 100% – 125%
EPS growth target (% pa) – Nil at 5%, – Nil at 5%,
all at 11% all at 11%
Expected value of total direct
reward as a percentage of salary
2007 258% 293%
2008 282% 366%
2009 298% 400%
In-year measures Long-term EPS Relative TSR Share price
UK executive
directors
US executive
director
Stretch
Performance
On-Target
Performance
Stretch
Performance
On-Target
Performance
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Proportion of incentive package
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
70 www.baesyste ms.com
Arrangements for the Chief Executive
On 16 October 2007, the Company announced that Mike Turner, the
Chief Executive, will retire at the end of August 2008. The Committee
agreed a 5.8% salary increase from 1 January 2008, taking account
of his performance and the competitive positioning. This increases his
annual base salary from £945,000 to £1,000,000. He will be eligible
to participate in an annual bonus plan for 2008, with a maximum bonus
unchanged at 150% of base salary, and with the following targets:
Annual bonus as percentage of base salary Mike Turner
Base Stretch
Measure target target
Group EPS 20% 50%
Group cash 20% 50%
Ethics and safety Up to 18%
Other objectives supporting the Group’s strategy Up to 32%
If performance is between the base and stretch targets, the bonus is pro-rated.
He will be eligible to invest up to one-third of his 2007 net annual
bonus into the Share Matching Plan but will not be eligible to invest
any of his 2008 annual bonus.
He will not be eligible to participate in the Performance Share Plan
for the 2008 nancial year. Instead, the Committee has implemented
a tailored incentive arrangement for the period prior to his retirement
as announced to shareholders on 16 October 2007.
On 16 October 2007, Mike Turner was granted a performance-related
conditional award over 231,618 ordinary shares (‘Share Award’). The
number of ordinary shares under the Share Award was calculated as
£1,181,250 (being 1.25 times his base salary at that time) divided
by 510p, being the market value of an ordinary share averaged over
the three business days ending 15 October 2007.
The Share Award will vest subject to the satisfaction of certain
performance targets, which the Committee will assess as at 31
August 2008. These targets relate to: continuing the successful
implementation of the Company’s business strategy; satisfaction
of leadership objectives set by the Committee; achieving an orderly
handover of key external relationships; and facilitating an orderly
succession to the Chief Executive role. Any ordinary shares which
vest will be released in two equal tranches over the year following
his retirement. The Share Award will be satised by way of a transfer
of existing ordinary shares from the Company’s employee trust.
In tandem with the Share Award, he was granted a conditional cash award
of £1,181,250. This will be subject to the same performance targets, and
will vest and be released on the same basis, as set out above.
The Committee was satised that these awards were the most
appropriate incentive for Mike Turner in relation to his remaining
period of service and these targets are consistent with the Company’s
strategy of giving emphasis to non-nancial objectives in order to
foster a performance culture within the Company.
As this was a special arrangement to facilitate Mike Turner’s retention
and incentivisation, shareholder approval was not required under the
Listing Rules. Any benets under this arrangement will not be
pensionable.
Performance in 2007
The structure of the 2007 Annual Bonus Plan was set out in last
year’s Remuneration report.
2007 was another very successful year, building on the excellent
performances in 2004, 2005 and 2006. Apart from the Australian
business, all the major business groupings achieved their stretch
targets on prot and cash. As a result, all the nancial targets within
the 2007 Annual Bonus Plan for executive directors were met at the
stretch level apart from that part of Chris Geoghegan’s bonus linked
to the prot performance of his group of businesses. In addition,
excellent progress was made against most of the key non-nancial
objectives as set out on page 26 and, accordingly, bonus payments
for 2007, which are set out in Table F on page 82, range from 83.9%
to 97% of the maximum bonus for the executive directors who served
throughout 2007.
In addition, the real growth in EPS over the three years to 2007
exceeded 5% pa so that the awards of share options granted in
2005 vest in full.
The Company’s total shareholder return for awards of shares made
in March 2005 under the Performance Share Plan exceeded the upper
quintile position when compared against the comparator group of 18
other defence and aerospace companies. The Committee has
satised itself that there has been a sustainable improvement in the
underlying performance of the Group over the three-year performance
period and so this award has vested in full.
This graph, which has been produced in accordance with the requirements of
Schedule 7A to the Companies Act 1985, shows the value by 31 December 2007, on
a total shareholder return basis, of £100 invested in BAE Systems on 31 December
2002 compared with the value of £100 invested in the FTSE 100 Index. The other
points plotted are the values at intervening financial year ends.
The FTSE 100 is considered to be an appropriate comparator for this purpose as it is a
broad equity market index. As BAE Systems is a constituent member of the FTSE 100,
it was deemed to be the most appropriate general UK equity index.
The graph above shows the value shareholders have achieved by their investment
in BAE Systems over recent years as compared to (i) the FTSE 100 Index; (ii) the
companies forming the sectoral peer group for the BAE Systems Performance Share
Plan; and (iii) the companies forming the comparator group for the 2007 executive
pay review. The graph depicts the value for BAE Systems and the comparators at the
end of 2007 of a single £100 investment made at the beginning of each of the last
five years.
Value at 31 December 2007 of £100 investment
at 31 December 2002
BAE Systems
FTSE 100
£100
£200
£300
£400
£500
31 Dec 0731 Dec 0631 Dec 0531 Dec 0431 Dec 0331 Dec 02
Value at 31 December 2007 of £100 investment
BAE Systems Aerospace & defence comparator group
FTSE 100 UK executive director pay review comparator group
£0
£125
£250
£375
£500
0706050403
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 71
Performance Share Plan (PSP)
Key features for PSP awards in 2008:
– half the PSP award will be based on a Total Shareholder Return
performance condition (PSP
TSR
) and the other half on an Earnings
per Share (PSP
EPS
)* performance condition; and
– length of period for performance condition: three years* with any
shares vesting paid out in three equal tranches on vesting at the
end of years three, four and ve.
* The PSP
EPS
award for executive directors is subject to shareholder approval at the May
2008 AGM and, subject to that approval, will have a slightly shorter vesting period so
that it vests at the same time as the 2008 PSP
TSR
award.
– Shares under award attract dividends prior to vesting.
Performance Condition – PSP
EPS
– Proportion of the award capable of exercise: determined by the
rate of annual actual EPS growth over the three-year performance
period, with nil vesting at annual actual EPS growth of 5% or less
and 100% vesting at 11% growth as set out below:
– Rationale for performance measure: major investors consider
EPS to be a key indicator of long-term nancial performance and
value creation.
Performance Condition – PSP
TSR
– Proportion of the award capable of exercise determined by:
(i) the Company’s TSR (share price growth plus dividends) ranking
relative to a comparator group of 18 other international
defence and aerospace companies (see table below):
PSP
TSR
– sectoral peer group
Boeing General Dynamics Raytheon
Cobham GKN Rockwell Collins
Dassault Aviation Goodrich Rolls-Royce
EADS Honeywell International Smiths Group
Embraer PN Lockheed Martin Thales
Finmeccanica Northrop Grumman United Technologies
– nil vesting if the Company’s TSR is outside the top 50%
of TSRs achieved by the sectoral comparator group and
100% vesting if it is in the top quintile (ie top 20%) as set
out below:
and
(ii) whether there has been a sustained improvement in the
Company’s underlying nancial performance and whether it is
appropriate to release some or all of the awards. In taking such
a view, the Committee may consider (but not exclusively) the
following nancial metrics: net cash/debt; EBITA; order book;
turnover; risk and underlying project performance.
– Rationale for performance measures: importance to major
investors as an indication of both earnings and capital growth
relative to other major companies in the same sector and to
ensure that awards only vest if there has been a clear improvement
in the Company’s performance over the relevant period.
The graph above summarises the position for all outstanding
awards under the PSP as at 31 December 2007. The coloured box
shows the range of TSR required for 25% vesting to full vesting,
and the square shows BAE Systems' TSR.
Plan provisions
Performance conditions for grants of awards to be made under the Performance Share Plan and the Share Matching Plan in 2008 are
detailed below. Performance conditions for grants of awards made prior to 2008 are detailed on pages 77 and 78.
Summary of long-term incentive plans
How the PSP operates
% of total
award vesting
8060 70 1009040 502010 300
Performance relative to comparator group (percentile)
0
25
50
75
100
% of total
award vesting
86 7 10 119452130
Annual actual EPS growth (%)
0
25
50
75
100
Performance of outstanding PSP awards
PSP
Award
PSP award
paid in
shares
(amount
varying in
accordance
with
performance
achieved)
One-third available
immediately at the
end of year three
The second third
available at the
end of year four
The nal third
available at
the end of
year ve
50% of award based on
TSR growth relative to
a sectoral comparator
group of companies
over the three-year
performance period,
subject to a secondary
nancial measure
50% of award
based on actual
annual EPS growth
over the three-year
performance period
Year 1 Year 2 Year 3
Year 3 Year 4 Year 5 Year 6 Year 7
For the US executives, the awards are automatically delivered at the end of years three,
four and five, subject to the performance condition achieved.
30 Mar 0712 Apr 0622 Dec 0524 Mar 05
(Vested in full Mar 08)
0
35
70
105
140
% of Total Shareholder
Return (TSR)
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
72 www.baesyste ms.com
Share Incentive Plan (SIP)
During 2007 the UK executive directors were eligible to participate in
the all-employee free shares element of the Share Incentive Plan. As
a result of the Company’s performance in 2007, all eligible employees
(including the UK executive directors) will be entitled to receive shares
worth £436. A similar arrangement operates for non-UK employees on
a cash or shares basis depending on local tax and security laws.
The Company operates a share purchase arrangement (Partnership
Shares) under the Share Incentive Plan which replaced the SAYE Share
Option Scheme in 2005. Under this arrangement, UK-based employees
(including executive directors) may purchase ordinary shares in
BAE Systems by either monthly investments of between £10 and
£125 a month, or lump sum investments of between £10 and £1,500
in a tax year, both limited to 10% of salary if less. The Partnership
Shares attract Matching Shares. As the plan is an all-employee plan,
the Matching Shares are not subject to performance conditions in
accordance with legislation. Prior to August 2007, one free Matching
Share was awarded for every two Partnership Shares purchased by the
employee, up to a maximum monthly Partnership Share investment of
£30. From August 2007, one free matching share is awarded for each
Partnership Share up to a maximum of £63 per month.
Dividends paid in respect of the shares in the Share Incentive Plan
for UK-based employees are reinvested as Dividend Shares.
Dilution of share capital
The Committee has agreed that, in respect of new issue or treasury
shares, shares representing no more than 1% of the Company’s
issued share capital will be used in any one nancial year for the
grant of share options under all employee share schemes. The table
below sets out the available dilution capacity for the Company’s
employee share schemes based on the limits set out in the rules
of those schemes.
2007
Total issued share capital as at 31 December 2007 3,574m
All schemes:
10% in any consecutive 10 years 357.4m
Remaining headroom 245.0m
Executive schemes:
5% in any consecutive 10 years 178.7m
Remaining headroom 111.7m
The number of ordinary shares in issue at 31 December 2007 was
3,574,509,017 and the number of shares granted under option during
2007 totalled 6,160,572 (0.17% of the total shares in issue). With the
changes in remuneration policy as set out above, the Company intends
to use new issue shares to satisfy future share awards under the
executive long-term incentive plans within the 0.5% annual dilution limit.
Personal shareholding policy
The Committee has agreed a policy whereby all executive directors are
required to establish and maintain a minimum personal shareholding
equal to 200% of base salary. As a minimum, a holding equal to 100%
of base salary must be achieved as quickly as possible using shares
vesting or options exercised through the executive share option
schemes or long-term incentive schemes, by using 50% of the shares
that vest or 50% of the options which are exercised on each occasion.
Thereafter, executive directors are required to increase their personal
shareholding gradually, on each occasion using 25% of the shares
that vest or 25% of the options exercised each year, until a personal
shareholding equal to 200% of annual base salary is achieved and
maintained. These limits are reviewed periodically. A similar
arrangement applies to senior executives eligible for share-based
long-term incentives with limits aligned to the levels of awards made
under these plans.
Details of the directors’ personal shareholdings are shown in Table A
on page 76.
Post-retirement benets
UK pension benets
As a result of the age discrimination legislation introduced in 2006,
UK executive directors’ default retirement age will be 65 but they will
retain any previous rights they had to retire and draw their pensions
without actuarial reduction for early payment at an earlier age.
Following the consultations with employees in 2005, a number of
changes were made to the pension schemes in respect of benets
accruing from 6 April 2006 as a means of funding the decits
disclosed in the schemes. These changes applied to executive
directors in the same way as to other employees and included the
introduction of the Longevity Adjustment Factor, a reduction in the
maximum level of pension increases and a change in the denition
of Pensionable Pay.
The UK-based executive directors with the exception of Ian King (see
below) are members of the BAE Systems Pension Scheme (the Main
Scheme) and the BAE Systems Executive Pension Scheme (the ExPS).
The ExPS tops up the benets from the Main Scheme and, for
executive directors, is designed to produce a target pension payable
from age 60 of two-thirds of Final Pensionable Pay (FPP) if potential
service is 20 or more years. FPP is dened as base salary averaged
over the last 12 months prior to leaving service in respect of service
Share Matching Plan (SMP)
Key features for grants of awards in 2008 and 2009:
– stand-alone share investment plan with the investment linked
to the bonus awarded under the Annual Bonus Plan;
– participants are granted a conditional award of Matching Shares
against the gross value of the bonus invested; and
– Matching Shares attract dividends during the three-year deferral
period, released on vesting of any Matching Shares.
– 2008 awards:
– the executive directors will be invited to acquire shares
(Investment Shares) by deferring part or all of their 2007
net annual bonus into the SMP; and
– match and performance condition: nil match for actual EPS
growth of 5% pa or less, increasing uniformly to a 1:1 match
for 8% pa growth.
– 2009 awards:
– the UK-based executive directors are required to invest one
quarter of their 2008 net bonus into the SMP and the US-based
executive director one-third;
– maximum level of investment will be 50% of the net annual
bonus; and
– match and performance condition: the match will be extended
from a 1:1 match at 8% pa actual EPS growth, increasing
uniformly to a 2:1 match at 11% pa growth*.
– rationale for performance measure: major investors consider
EPS to be a key indicator of long-term nancial performance and
value creation.
* the increase in the match in 2009 is subject to shareholder approval at the May 2008 AGM
Annual EPS growth %
Match
0
1:1
2:1
11850
Annual EPS growth %
Match
0
1:1
2:1
11850
Performance condition: SMP 2008 Performance condition: SMP 2009
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 73
accrued to 5 April 2006 and 36 months prior to leaving in respect
of service from 6 April 2006. These schemes also provide a lump
sum death-in-service benet equal to four times base salary at date
of death, and a spouse’s death-in-service pension equal to two-thirds
of the prospective pension at normal retirement age. Children’s
allowances are also payable, usually up to the age of 18. Spouses’
pensions and children’s allowances are also payable upon death in
retirement and death after leaving the Company’s employment with a
deferred pension. Pensions are increased annually by the rise in the
Retail Prices Index subject to a maximum increase of 5% per year in
respect of pre 6 April 2006 service and 2.5% per year in respect of
service from 6 April 2006. Directors pay contributions at the same
rate as all other employees participating in schemes.
Ian King is a member of the BAE Systems 2000 Pension Plan (the
2000 Plan), applicable to former employees of Marconi Electronic
Systems (MES), and a member of the ExPS. The 2000 Plan provides
a pension of 1/50th of Final Pensionable Earnings (FPE) for each year
of pensionable service, payable from a normal retirement age of 65.
FPE under the 2000 Plan is the best three-year average of base salary
and bonus in the ten Plan Years prior to leaving, less an offset for
State pensions. The Company decided in 2006 to limit pensionable
bonuses in the 2000 Plan in the 2006/07 Plan Year to 20% of base
salary and to 10% of base salary for the 2007/08 Plan Year and
thereafter. However, there is a guarantee that the FPE gure for
benets service prior to 6 April 2007 will not be less than the FPE
gure at 5 April 2007 to ensure that employees do not lose the
benet of contributions paid on past bonuses. Ian King joined the
ExPS in 1999 following the BAe/MES merger. The ExPS tops up the
2000 Plan benets to provide a target benet payable from age 62
of 1/30th of Final Pensionable Pay for each year of ExPS pensionable
service (subject to a maximum of two-thirds). Final Pensionable Pay for
the purposes of this top up is calculated by reference to base salary
only, averaged over 12 months and 36 months as described above.
Therefore Ian King’s total pension is the sum of his 2000 Plan
benets plus the top up from the ExPS.
Following the changes made to take account of the Pensions
Simplication tax changes which came into effect from April 2006,
UK executives reaching the Lifetime Allowance (LTA) are given a
number of choices as previously reported. These are:
– remain in the pension scheme and pay any additional tax charge; or
– opt out of the pension scheme (and so earn no further pension
benets in respect of future service) and instead receive a taxable
salary supplement. This supplement will be 30% of salary and 20%
of salary for those senior executives with a two-thirds salary target
after at least 20 years and 30 years service respectively; or
– restrict scheme benets to the value of the LTA with the remainder
being provided directly from the Company as an unfunded promise.
At retirement, the unfunded Company benets can be either taken
as pension or can be commuted in full for a taxable lump sum.
The Committee reviewed these arrangements in 2007 in the light
of developing market practice and believes they remain appropriate
as they provide executives with choices which may better suit their
needs whilst being broadly cost neutral to the Company, are in line
with market practice and do not compensate executives for changes
in taxation.
UK executives, including the UK executive directors, affected or likely
to be affected by the LTA before April 2009 were provided with
independent nancial advice paid for by the Company. Mike Turner and
Chris Geoghegan elected to opt out of the pension schemes in April
2006 in return for a cash supplement of 30% of base salary. Ian King
and Steve Mogford elected to have their scheme benets restricted in
return for a Company unfunded promise.
George Rose was affected by the previously applicable Inland Revenue
earnings cap on approved pensions and has an unapproved (ie non-tax
qualied) pension arrangement to top up his benets from the approved
schemes. This was designed so that the total pension from all sources
would be broadly in line with the pension he would have received from
the Group pension schemes had he not been subject to the earnings
cap. The Pension Simplication tax changes allowed the exibility to
remove the earnings cap for George Rose in respect of service from
April 2006, although some of his benets will remain to be provided
by means of an unfunded promise from the Company. No further
contributions will be paid into his funded unapproved top up
arrangement. Further information on the amounts paid by the Company
in respect of these arrangements is included in the notes to Table G
on page 83.
US pension benets
Walt Havenstein is a member of the BAE Systems Employees’
Retirement Plan which provides a pension from age 60 for each year
of pensionable service of 1.25% on his Final Average Pay (FAP) up to
Social Security Covered Compensation (circa $70,000) plus 1.5% on
his FAP in excess of Social Security Covered Compensation. FAP is
currently the highest three-year average of base salary plus bonus
but the averaging period will increase by one year each year beginning
in 2009 and reaching a ten-year average in 2015. Directors pay
contributions at the same rates as other employees in the plan. The
pension does not carry any spouse’s pension or pension increases.
Walt Havenstein also receives a 50% match on his contributions
to his 401(k) plan up to a maximum contribution of 8% of earnings.
Details of post-retirement benets for each of the executive directors
who served during 2007 are shown in Table G on page 83 and are
calculated in accordance with the requirements of Schedule 7A of the
Companies Act 1985.
Other benets
Other benets provided to the executive directors include a car
allowance, the taxable benet of any private use of a chauffeur and
a cash allowance for medical examination.
The two Chief Operating Ofcers (COOs) were new in post in 2007.
In view of the requirement for the COO – US role to be based in the
Washington DC area, Walt Havenstein’s package includes relocation
expenses in line with the Company’s standard US policy. As the
COO – UK/Rest of World is now required to spend increasing amounts
of time in central London, the Committee has also agreed to provide
Ian King with a second home allowance.
Executive directors’ service contracts
It is the Committee’s policy that executive directors should normally
have service contracts that provide for the Company to give the
individual 12 months’ notice of termination. This policy has been
chosen because it provides a reasonable balance between the need
to retain the services of key individuals and the need to limit the
liabilities of the Company in the event of the termination of a contract.
The executive directors have service contracts with Group companies
and details of these are as follows:
Date of contract Unexpired term Notice period
Walt Havenstein 1 December 2006 3 months 3 months
either party
Ian King 31 January 2007 12 months 12 months
either party
George Rose 16 November 1998 12 months 12 months from
(amended: the Company,
3 December 1999 6 months from
15 January 2004 the individual
and 17 October 2005)
In the event of the termination of an executive director’s contract
it is the Committee’s policy to seek to limit any payment made in
lieu of notice to a payment equal to the amount of one year’s base
salary. The service contracts for all of the executive directors contain
specic provisions to the effect that the Company has the right, and
in Walt Havenstein’s case, generally has the obligation, to pay a sum
Directors’ report – Business review
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Directors’ report – Corporate governance
Remuneration report (continued)
74 www.baesyste ms.com
The Committee was satised that these arrangements were
appropriate for the purpose of ensuring that Mike Turner remains
fully committed to the Company and fully incentivised in relation
to share price and EPS performance until the vesting date of these
options and awards. The Committee also considered that these
arrangements, and the special incentive described on page 70,
constituted an optimal incentive structure for Mike Turner’s
remaining period of service.
Other executive directors
Steve Mogford, who retired as a director on 9 May 2007, had a
service contract dated 6 April 2000 (as amended 15 January 2004
and 28 October 2005). Chris Geoghegan, who retired as a director
on 31 December 2007, had a service contract dated 10 July 2002
(as amended 15 January 2004 and 13 October 2005). On leaving the
Company, both were entitled to a payment of 12 months’ base salary
in lieu of notice as set out in their contracts. Both waived their rights
to these payments in return for the same amounts being paid into the
Executive Pension Scheme (ExPS) and matched by equivalent payments
from the Company. Their pension benets were augmented by
purchasing additional benets under the ExPS in accordance with the
scheme’s normal augmentation factors. Further details are provided in
Table G on page 83.
Policy on external board appointments
The long-standing policy of allowing executive directors to hold external
non-BAE Systems related non-executive directorships with the prior
approval of the Committee will continue. The Committee considers
that external directorships provide the Company’s senior executives
with valuable experience that is of benet to BAE Systems. It is also
considered appropriate for BAE Systems to contribute to the pool of
non-executive expertise available for the benet of the wider business
community, thereby reciprocating the benet that it in turn has
received from other organisations which have permitted members
of their senior management teams to serve on the BAE Systems
Board. The Committee believes that it is reasonable for the individual
executive director to retain any fees received from such appointments
given the additional personal responsibility that this entails. Such fees
retained by the executive directors in 2007 for the period in which they
served on the BAE Systems Board were as follows: Chris Geoghegan
£14,542; Ian King £27,000; Steve Mogford £14,027; George Rose
£79,000; and Mike Turner £38,722 plus grants of Deferred Stock
Units to the value of £49,460.
equivalent to 12 months’ salary (plus the continuation of 18 months’
medical benets in Walt Havenstein’s case) in the event of the
Company terminating their contracts for reasons other than gross
misconduct. No executive director has provisions in his service
contract that relate to a change of control of the Company (and neither
does the Chairman nor the non-executive directors in their respective
letters of appointment).
Retirement arrangements for Mike Turner
Mike Turner is employed under a service contract dated 22 February
1994 (amended 30 May 1995, 3 December 1999, 8 May 2002,
15 January 2004 and 14 October 2005). It was announced on
16 October 2007 that Mike Turner would be stepping down at the end
of August 2008. Under a termination agreement, he will at that time
become entitled to a termination payment of £236,884 in respect
of his contractual and statutory rights relating to the unserved portion
of his 12-month notice period to 16 October 2008, together with any
payment due in respect of his 2008 annual bonus.
As a result of the pension tax changes which came into force on
6 April 2006, Mike Turner opted out of further accrual of pension
with effect from that date in return for a cash supplement of 30%
of salary. His pension on retirement will be calculated in accordance
with the rules of the relevant plans by reference to his Pensionable
Service to 6 April 2006 and Final Pensionable Pay at retirement.
Mike Turner will not be entitled to participate in the Company’s
Performance Share Plan for 2008 but, as announced on 16 October
2007, has been granted a performance-related conditional award as
described on page 70.
In accordance with the termination agreement and the rules of the
relevant plans, his existing options and awards will be treated as
follows on retirement:
– unexercised options under the Executive Share Option Plan will be
preserved, and may be exercised in full within 12 months after his
retirement. Any performance condition in relation to those options
that remains to be satised will be waived;
– PSP awards that have already vested (that is, awards granted in
2005 and earlier years) will be preserved, and may be exercised
within six months of retirement;
– for unvested PSP awards (that is, awards granted in 2006 and
2007), the performance conditions will be tested (at Mike Turner’s
election) either at retirement or at the end of the normal three-year
performance periods. Such awards will vest to the extent that the
performance conditions have been satised, and may be exercised
within six months. The number of shares which vest will not be time
prorated to reect his actual service during the applicable three-year
periods; and
– for the unvested matching award under the SMP granted in 2007
(in respect of Mike Turner’s 2006 annual bonus) and any matching
award granted in 2008 should he elect to invest up to one-third of
his 2007 annual bonus into the SMP, the performance conditions
will be tested at his election either at retirement or at the end of the
normal three-year performance periods. The awards will vest to the
extent that the performance conditions have been satised and will
not be time prorated. His linked investment shares will be released
at the same time the matching shares vest.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 75
The non-executive directors do not have service contracts but do
have letters of appointment detailing the basis of their appointment.
The dates of their original appointment were as follows:
Non-executive director Date of appointment Expiry of current term*
Phil Carroll 07.09.2005 06.09.2008
Michael Hartnall 10.06.2003 09.06.2009
Andy Inglis 13.06.2007 12.06.2010
Sir Peter Mason 22.01.2003 21.01.2009
Roberto Quarta 07.09.2005 06.09.2008
Sir Nigel Rudd 10.09.2006 09.09.2009
Peter Weinberg 16.06.2005 15.06.2008
* Subject to re-election at the AGM following their appointment and subsequently at intervals
of no more than three years in accordance with the Company’s Articles of Association.
The non-executive directors are normally appointed for two consecutive
three-year terms subject to review after the end of the rst three-year
period and with any third term of three years being subject to rigorous
review and taking into account the need progressively to refresh the
Board. They do not have periods of notice and the Company has no
obligation to pay compensation when their appointment terminates. They
are subject to re-election at the AGM following their appointment and
subsequently at intervals of no more than three years. Sue Birley retired
from the Board on 9 May 2007 at the conclusion of the 2007 AGM,
having originally been appointed to the Board on 22 November 2000,
and Ulrich Cartellieri retired from the Board on 26 September 2007,
having originally been appointed to the Board on 1 December 1999.
The letters of appointment for non-executive directors detail the
amount of time it is anticipated that the individual will need to devote
to his or her duties as a director. Non-executive directors are proposed
by the Nominations Committee and are appointed by the Board on
the basis of their experience to provide independent judgement on
issues of strategy, performance, resources and standards of conduct.
The level of their fees is set by the Non-Executive Directors’ Fees
Committee to reect the time commitment required of the director
and after reviewing practice in other comparable companies. The fee
level for the chairmen of the Audit, Corporate Responsibility, and
Remuneration Committees, and for the Senior Independent Director,
reects their additional responsibilities and workload.
Non-executive director 2007 fee* 2008 fee*
Chairman Audit Committee £77,500 £83,000
Senior Independent Director £72,500 £78,000
Chairman Remuneration Committee £72,500 £78,000
Chairman Corporate Responsibility Committee £72,500 £78,000
Other non-executive directors £57,500 £63,000
* In addition, a transatlantic meeting allowance of £4,000 per meeting is paid to
European-based non-executive directors attending meetings in the US and US-based
non-executive directors attending meetings in Europe.
By order of the Board
Dick Olver
Chairman
20 February 2008
Dick Olver was appointed Chairman on 1 July 2004. His appointment
was for an initial xed three-year term with effect from 17 May 2004
(the date that he was appointed to the Board as a non-executive director)
and was extended by the Board in 2007, on the recommendation of the
Nominations Committee (as chaired by Sir Peter Mason, the Senior
Independent Director), for a second term of three years to 16 May 2010
unless terminated earlier in accordance with the Company’s Articles of
Association, or by either party giving the other not less than six months’
prior written notice. His appointment is documented in a letter of
appointment which is not a contract of employment and he is required
to devote no fewer than two days a week to his duties as Chairman. His
appointment as Chairman will automatically terminate if he ceases to be a
director of the Company. His fee for the second three-year term, which has
been set by the Committee at £600,000 per annum, will not be subject to
review during the three-year term.
Chairman’s appointment, term and fees
Non-executive directors’ appointment, term
and fees
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
76 www.baesyste ms.com76 www.baesyste ms.com
Table A
The table below gives details of the interests in ordinary shares in BAE Systems plc held by directors and their connected persons for those
individuals who were directors of the Company as at 31 December 2007. There have been no changes in the interests of the current directors
listed in the table below between 31 December 2007 and 20 February 2008 with the exception of the interests in ordinary shares of Ian King and
George Rose who have each acquired an additional 77 ordinary shares since 31 December 2007 under the partnership and matching shares
elements of the Share Incentive Plan so that their benecial shareholdings at the date of this report stood at 317,974 and 538,109 respectively.
Directors’ interests
As at 1 January 2007*
Share Performance
Ordinary Restricted Matching Performance Share
shares Options Share Plan Plan Share Plan Award
P J Carroll
1
––––––
C V Geoghegan
2
143,150 1,411,363 42,764 – 722,231 –
M J Hartnall 20,000 – – – – –
W P Havenstein
3
37,484 466,586 10,249 – 278,788 –
A G Inglis
4
––––––
I G King
5
164,002 1,186,815 75,627 – 638,707 –
Sir Peter Mason 25,283 – – – – –
R L Olver 40,000 – – – – –
R Quarta – – – – – –
G W Rose 354,950 1,660,221 33,971 – 803,817 –
Sir Nigel Rudd – – – – – –
M J Turner 435,880 2,446,712 137,924 – 1,363,562 –
P A Weinberg – – – – – –
As at 31 December 2007
Share Performance
Ordinary Restricted Matching Performance Share
shares Options Share Plan Plan Share Plan Award
P J Carroll
1
12,000 –––––
C V Geoghegan
2
199,304 1,362,269 22,770 – 681,305 –
M J Hartnall 20,000 –––––
W P Havenstein
3
72,328 327,640 10,249 18,947 303,607 –
A G Inglis
4
––––––
I G King
5
317,897 1,270,250 37,950 46,410 552,675 –
Sir Peter Mason 25,283 –––––
R L Olver 40,000 –––––
R Quarta ––––––
G W Rose 538,032 768,769 18,975 – 675,994 –
Sir Nigel Rudd 11,400 –––––
M J Turner 560,867 1,500,021 37,950 109,529 1,291,048 231,618
P A Weinberg ––––––
* or upon appointment
1 the ordinary shares held by Phil Carroll are represented by 3,000 American Depositary Shares
2 retired as a director on 31 December 2007
3 appointed as a director on 2 January 2007. The option figures for Walt Havenstein include Stock Appreciation Rights under the Executive Share Option Plan.
4 appointed as a director on 13 June 2007
5 appointed as a director on 1 January 2007
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 77
Information subject to audit
The Auditors are required to report on the information contained in Tables B, C, D, E, F and G on pages 77 to 83.
The Company’s register of directors’ interests (which is open to inspection) contains full details of directors’ share interests. Details of directors’
interests in the share option schemes and long-term incentive plans are shown in Tables B, C, D and E. The mid-market price for the Company’s
ordinary shares at 31 December 2007 was 498p (2006 425.75p) and the range during 2007 was 401.5p to 515p.
Table B
Long-term incentive plans
Share Matching Plan
1 January Awarded during Vested during 31 December
2007* the year the year 2007
C V Geoghegan
1
––––
W P Havenstein
2
– 18,947 – 18,947
I G King
3
– 46,410 – 46,410
S L Mogford
4
––––
G W Rose – – – –
M J Turner – 109,529 – 109,529
The market price at the date of award for awards made on 22 March 2007 under the Share Matching Plan was £4.565. The awards will vest, subject to the attainment of the performance
condition, on the third anniversary of grant.
The performance condition for the grants of matched shares made in 2007 under the Share Matching Plan on a one-to-one match was based on real EPS growth over the three-year
performance period, with one-third of the matched shares vesting where the Company achieved on average real EPS growth per annum of 3% but less than 4%, two-thirds vesting with a
growth rate of 4% but less than 5%, and full vesting at growth of 5% or over. The revised performance conditions for the Share Matching Plan for grants to be made in 2008 and 2009 are
set out on page 72.
Restricted Share Plan
In respect of shares vested during the year
Market
price at Market
Awarded Vested date of price on
1 January during during 31 December Date of award Date of vesting
2007* the year the year 2007 award £ vesting £
C V Geoghegan
1
42,764 – 19,994 22,770 26.03.04 2.00 26.03.07 4.5575
W P Havenstein
2
10,249 – – 10,249––––
I G King
3
75,627 – 37,677 37,950 26.03.04 2.00 26.03.07 4.5575
S L Mogford
4
––––––––
G W Rose 33,971 – 14,996 18,975 26.03.04 2.00 26.03.07 4.5575
M J Turner 137,924 – 99,974 37,950 26.03.04 2.00 26.03.07 4.5575
The matching award of shares under the Restricted Share Plan, under which awards have not been granted since 2006, was historically not subject to any performance criteria as it was
designed to retain key staff and encourage executives to re-invest in company shares the cash bonuses that they had earned under the annual bonus plan which was itself subject to
performance conditions. The Restricted Share Plan was replaced by the Share Matching Plan, which is subject to performance conditions as described above and on page 72.
Performance Share Plan
In respect of shares vested during the year
Market
price at Market
Awarded Vested date of price on
1 January during during 31 December Date of award Date of vesting
2007* the year the year 2007 award £ vesting £
W P Havenstein
2
32,270 30.09.03 1.72 01.10.07 4.91
26,454 30.03.04 2.01 30.03.07 4.575
Total 278,788 83,543 58,724 303,607
Awards granted to Walt Havenstein (a US national) under the Performance Share Plan are characterised as long-term incentives rather than options as, subject to attainment of the
performance condition, they are delivered automatically on the third, fourth and fifth anniversary of the award without the need to exercise an option. They are subject to the same
performance conditions as options granted under the Performance Share Plan to the UK-based directors as set out on page 78. The market price at the date of the award granted
on 30 March 2007 was £4.57.
The net aggregate value of assets received by directors in 2007 from long-term incentive plans, as calculated at the date of vesting, was £1,066,284 (2006 nil).
* or upon appointment
1 retired as a director on 31 December 2007. With the Remuneration Committee’s agreement, the Matching award of shares under the Restricted Share Plan for Chris Geoghegan
will be released in full at the end of the three-year period.
2 appointed as a director on 2 January 2007
3 appointed as a director on 1 January 2007
4 retired as a director on 9 May 2007
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
78 www.baesyste ms.com
Table C
Directors’ Share Options
Performance Share Plan
1 January Granted during Exercised during Lapsed during 31 December
2007 the year the year the year 2007
C V Geoghegan
1
722,231 107,221 148,147 – 681,305
I G King
2
638,707 115,973 202,005 – 552,675
S L Mogford
3
722,231 – 575,545 146,686 –
G W Rose 803,817 122,538 250,361 – 675,994
M J Turner 1,363,562 310,175 382,689 – 1,291,048
Note: Awards granted to Walt Havenstein
4
, a US national, under the Performance Share Plan are characterised as long-term incentives, rather than as options, and are shown under Table B.
The breakdown of the options held by executive directors under the Performance Share Plan is as follows:
Granted Exercised Lapsed Date Date
1 January during during during 31 December Date of of exercise from which Expiry
2007 the year the year the year 2007 grant or lapse exercisable* date
C V Geoghegan
1
234,145 – 78,048 – 156,097 30.09.03 30.03.07 30.09.06
5
30.09.10
210,298 – 70,099 – 140,199 30.03.04 30.03.07 30.03.07
5
30.03.11
168,560–––168,560 24.03.05 – 24.03.08
5
24.03.12
109,228–––109,228 12.04.06 – 12.04.09
6
12.04.13
– 107,221 – – 107,221 30.03.07 – 30.03.10
6
30.03.14
Total 722,231 107,221 148,147 – 681,305
I G King
2
212,209 – 70,736 – – 30.09.03 23.02.07 30.09.06
5
30.09.10
– – 70,736 – 70,737 30.09.03 23.10.07 30.09.07
5
30.09.10
181,601 – 60,533 – 121,068 30.03.04 30.03.07 30.03.07
5
30.03.11
147,935–––147,935 24.03.05 – 24.03.08
5
24.03.12
96,962–––96,962 12.04.06 – 12.04.09
6
12.04.13
– 115,973 – – 115,973 30.03.07 – 30.03.10
6
30.03.14
Total 638,707 115,973 202,005 – 552,675
S L Mogford
3
234,145 – 78,048 – – 30.09.03 23.02.07 30.09.06
5
30.09.10
– – 156,097 – – 30.09.03 10.05.07 10.05.07
5
10.11.07
210,298 – 70,099 – – 30.03.04 30.03.07 30.03.07
5
30.03.11
– – 140,199 – – 30.03.04 10.05.07 10.05.07
5
10.11.07
168,560 – 131,102 37,458 – 24.03.05 10.05.07 10.05.07
3
10.11.07
109,228 – – 109,228 – 12.04.06 – 12.04.09
3
12.04.13
Total 722,231 – 575,545 146,686 –
G W Rose 260,494 – 86,831 – – 30.09.03 23.02.07 30.09.06
5
30.09.10
– – 86,831 – 86,832 30.09.03 01.10.07 30.09.07
5
30.09.10
230,099 – 76,699 – 153,400 30.03.04 30.03.07 30.03.07
5
30.03.11
189,393–––189,393 24.03.05 – 24.03.08
5
24.03.12
123,831–––123,831 12.04.06 – 12.04.09
6
12.04.13
– 122,538 – – 122,538 30.03.07 – 30.03.10
6
30.03.14
Total 803,817 122,538 250,361 – 675,994
M J Turner 392,442 – 130,814 – – 30.09.03 23.02.07 30.09.06
5
30.09.10
– – 130,814 – 130,814 30.09.03 01.10.07 30.09.07
5
30.09.10
363,184 – 121,061 – 242,123 30.03.04 30.03.07 30.03.07
5
30.03.11
303,030–––303,030 24.03.05 – 24.03.08
5
24.03.12
304,906–––304,906 12.04.06 – 12.04.09
6
12.04.13
– 310,175 – – 310,175 30.03.07 – 30.03.10
6
30.03.14
Total 1,363,562 310,175 382,689 – 1,291,048
1 retired as a director on 31 December 2007. With the agreement of the Remuneration Committee the performance condition on the 2005, 2006 and 2007 PSP awards for Chris
Geoghegan will be tested at the end of the normal three-year performance period, and any part of the award vesting will be pro-rated for service completed and be exercisable for
six months.
2 appointed as a director on 1 January 2007
3 retired as a director on 9 May 2007. With the agreement of the Remuneration Committee the performance condition on the 2005 and 2006 PSP awards for Steve Mogford was tested
at his date of retirement. The 2005 award vested in full (subject to pro-rating for service completed) and the 2006 award lapsed. All vested PSP awards became exercisable within
six months of retirement.
4 appointed as a director on 2 January 2007
5 subject to a performance condition which has been met
6 subject to a performance condition that is yet to be tested
* The date from which exercisable refers to the first date from which any tranche of the option remaining at the year end is exercisable (subject to the attainment of the performance
condition where the award has not yet vested).
Awards granted under the Performance Share Plan between 2003 and 2007 are subject to the same performance conditions as those for awards to be granted under the PSP
TSR
in 2008
as set out on page 71, ie 100% of the conditional awards vest if the Company’s Total Shareholder Return (TSR) is in the top 20% of TSRs achieved by a sectoral comparator group of 18
companies, with 25% vesting if TSR is in the top 50%, and nil vesting if the Company’s performance is outside the top 50%. The awards are also subject to the same secondary measure
for underlying financial performance set out on page 71. Awards that vest at the end of year three are exercisable in three tranches at the end of years three, four and five.
The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 79BAE Systems Annual Report 2007 79
SAYE Share Option Scheme
All outstanding options held by the executive directors in the SAYE Share Option Scheme were exercised in 2007.
No further options will be granted under this Scheme.
Granted Exercised Lapsed Exercise Date of Date
1 January during the during the during the 31 December price Date of exercise from which Expiry
2007 year year year 2007 £ grant or lapse exercisable date
C V Geoghegan
1
435 – 435 – – 1.56 20.04.04 01.06.07 01.06.07 01.12.07
I G King
2
435 – 435 – – 1.56 20.04.04 01.06.07 01.06.07 01.12.07
G W Rose 435 – 435 – – 1.56 20.04.04 22.08.07 01.06.07 01.12.07
M J Turner 1,499 – 1,499 – – 2.56 09.04.02 07.06.07 01.06.07 01.12.07
The exercise of options under the SAYE Share Option Scheme, an all-employee scheme, was not subject to the satisfaction of any performance conditions.
Executive Share Option Plan
1 January Granted during Exercised during Lapsed during 31 December
2007 the year the year the year 2007
C V Geoghegan
1
1,410,928 160,831 – 209,490 1,362,269
W P Havenstein
3
96,453 125,315 – – 221,768
I G King
2
1,186,380 173,960 – 90,090 1,270,250
S L Mogford
4
1,469,136 – 819,020 233,433 416,683
G W Rose 1,659,786 183,807 815,123 259,701 768,769
M J Turner 2,445,213 465,262 1,133,439 277,015 1,500,021
The BAE Systems Executive Share Option Plan was used to grant options to the executive directors between 2001 and 2007. No further grants will be made under this Plan other than in
exceptional circumstances. Options granted under this Plan are normally exercisable between the third and tenth anniversary of their grant and options granted between 2005 and 2007
may only be exercised during this period as follows: (i) 33.33% of each option grant is exercisable if the Company achieves on average real EPS growth per annum of 3% but less than 4%
over the three-year performance period; (ii) 66.67% of each option grant is exercisable if the Company achieves on average real EPS growth of 4% but less than 5% over the three-year
performance period; and (iii) 100% of each option grant is exercisable if the Company achieves on average real EPS growth per annum of 5% or more over the three-year performance
period. The performance conditions for the grants of options made between 2001 and 2004 were the same as for grants made between 2005 and 2007 with the exception of the re-
testing provision: for grants made between 2001 and 2003, where the original three-year performance is not met, performance is re-tested at the end of years four and five against the full
period from grant; for grants made in 2004, where the original performance target is not met, performance is re-tested at the end of year five against the full period from grant. In all these
cases the option will lapse in year five if the targets have not been achieved. In determining the performance measures the Remuneration Committee took the view that the Company’s
major investors believe EPS to be a key indicator of long-term financial performance and value creation.
On completion of the BAe/MES merger in 1999, options were granted to executive directors (and other senior executives) under the predecessor Executive Share Option Scheme. Options
granted to Ian King in 1999 could only be exercised if the pre-exceptional EPS for any three-year period exceeded the sum of inflation for that period and a real growth requirement of 9% was
achieved and these options vested in full in February 2006. Options granted to the other executive directors in 1999 (which partially vested in 2004) were conditional on the satisfaction
of a special performance condition based on the achievement of cost savings of the merger integration process over the three-year performance period commencing on 1 January 2000.
The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.
A breakdown of options held by executive directors under the Executive Share Option Plan is given overleaf.
Awards granted to Walt Havenstein under the Executive Share Option Plan between 2003 and 2005 were granted under the Stock Appreciation Rights (SARS) Schedule to that plan and are
equity-settled. They are subject to the same performance conditions as options granted under this plan as set out above.
Executive Share Option Plan – Stock Appreciation Rights (SAR)
Subject to Vested on
Granted exercise exercise SAR Date
1 January during during during 31 December price Date of Date of from which Expiry
2007 the year the year the year 2007 £ grant exercise exercisable date
W P Havenstein
3
145,217 – 145,217 91,675 – 1.72 30.09.03 23.02.07 30.09.06 30.09.13
119,044 – 119,044 67,167 – 2.01 30.03.04 30.03.07 30.03.07 30.03.14
90,949–––90,949 2.64 24.03.05 – 24.03.08 24.03.15
14,923–––14,923 3.56 22.12.05 – 22.12.08 22.12.15
Total 370,133 – 264,261 158,842 105,872
During 2007 SAR awards over 264,261 shares were subject to exercise and the number of shares vesting and allotted under these stock appreciation rights totalled 158,842 as set
out above.
In addition, Walt Havenstein has a cash-settled SAR over 53,010 ordinary shares granted on 27 November 2000 at a SAR price of £3.73, exercisable from 27 November 2003. The right is
exercisable until 27 November 2010 and was subject to the performance condition relating to options granted in 2000 (ie exercisable only if growth in pre-exceptional EPS for any three-
year period over the ten-year life exceeded the sum of inflation for that period and a growth requirement of 9%) which has been met.
1 retired as a director on 31 December 2007
2 appointed as a director on 1 January 2007
3 appointed as a director on 2 January 2007
4 retired as a director on 9 May 2007
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Remuneration report (continued)
80 www.baesyste ms.com
The breakdown of the options held by executive directors under the Executive Share Option Plan is as follows:
Granted Exercised Lapsed Exercise Date of Date
1 January during the during the during the 31 December price Date of exercise from which Expiry
2007 year year year 2007 £ grant or lapse exercisable date
C V Geoghegan
1
118,090 – – – 118,090 3.98 03.05.00 – 03.05.03
5
03.05.10
89,552 – – 89,552 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12
119,938 – – 119,938 – 3.26 22.10.02 21.02.07 22.10.05 22.10.12
351,218 – – – 351,218 1.72 30.09.03 – 30.09.06
5
30.09.13
315,447 – – – 315,447 2.01 30.03.04 – 30.03.07
5
30.03.14
252,840 – – – 252,840 2.64 24.03.05 – 24.03.08
5
24.03.15
163,843 – – – 163,843 4.28 12.04.06 – 12.04.09
6
12.04.16
– 160,831 – – 160,831 4.57 30.03.07 – 30.03.10
6
30.03.17
Total 1,410,928 160,831 – 209,490 1,362,269
W P Havenstein
2
96,453 – – – 96,453 4.28 12.04.06 – 12.04.09
6
12.04.16
– 125,315 – – 125,315 4.57 30.03.07 – 30.03.10
6
30.03.17
Total 96,453 125,315 – – 221,768
I G King
3
138,242 – – – 138,242 4.21 20.12.99 – 20.12.02
5
20.02.09
90,090 – – 90,090 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12
318,314 – – – 318,314 1.72 30.09.03 – 30.09.06
5
30.09.13
272,388 – – – 272,388 2.01 30.03.04 – 30.03.07
5
30.03.14
221,903 – – – 221,903 2.64 24.03.05 – 24.03.08
5
24.03.15
145,443 – – – 145,443 4.28 12.04.06 – 12.04.09
6
12.04.16
– 173,960 – – 173,960 4.57 30.03.07 – 30.03.10
6
30.03.17
Total 1,186,380 173,960 – 90,090 1,270,250
S L Mogford
4
64,415 – 64,415 – – 4.21 20.12.99 10.05.07 20.12.02
5
10.05.09
87,940 – 87,940 – – 3.98 03.05.00 10.05.07 03.05.03
5
10.05.09
233,433 – – 233,433 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12
351,218 – 351,218 – – 1.72 30.09.03 23.02.07 30.09.06
5
30.09.13
315,447 – 315,447 – – 2.01 30.03.04 30.03.07 30.03.07
5
30.03.14
252,840 – – – 252,840 2.64 24.03.05 – 24.03.08
5
24.03.15
163,843 – – – 163,843 4.28 12.04.06 – 12.04.09
6
12.04.16
Total 1,469,136 – 819,020 233,433 416,683
G W Rose 79,233 – 79,233 – – 3.29 06.10.98 23.02.07 06.10.01
5
06.10.08
115,125 – – – 115,125 4.21 20.12.99 – 20.12.02
5
20.12.09
259,701 – – 259,701 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12
390,741 – 390,741 – – 1.72 30.09.03 23.02.07 30.09.06
5
30.09.13
345,149 – 345,149 – – 2.01 30.03.04 30.03.07 30.03.07
5
30.03.14
284,090 – – – 284,090 2.64 24.03.05 – 24.03.08
5
24.03.15
185,747 – – – 185,747 4.28 12.04.06 – 12.04.09
6
12.04.16
– 183,807 – – 183,807 4.57 30.03.07 – 30.03.10
6
30.03.17
Total 1,659,786 183,807 815,123 259,701 768,769
M J Turner 122,855 – – – 122,855 4.21 20.12.99 – 20.12.02
5
20.12.09
277,015 – – 277,015 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12
588,663 – 588,663 – – 1.72 30.09.03 23.02.07 30.09.06
5
30.09.13
544,776 – 544,776 – – 2.01 30.03.04 30.03.07 30.03.07
5
30.03.14
454,545 – – – 454,545 2.64 24.03.05 – 24.03.08
5
24.03.15
457,359 – – – 457,359 4.28 12.04.06 – 12.04.09
6
12.04.16
– 465,262 – – 465,262 4.57 30.03.07 – 30.03.10
6
30.03.17
Total 2,445,213 465,262 1,133,439 277,015 1,500,021
1 retired as a director on 31 December 2007. With the Remuneration Committee’s agreement, and exercise being subject to attainment of the performance condition, options granted
prior to 2001 for Chris Geoghegan had their period of exercise determined as 24 months from the date of leaving and options granted from 2001 onwards had their period of exercise
determined as the end of the option’s ten-year life.
2 appointed as a director on 2 January 2007
3 appointed as a director on 1 January 2007
4 retired as a director on 9 May 2007. With the Remuneration Committee’s agreement, and exercise being subject to attainment of the performance condition, options granted prior to
2001 for Steve Mogford had their period of exercise determined as 24 months from the date of leaving and options granted from 2001 onwards had their period of exercise determined
as the end of the option’s ten-year life.
5 subject to a performance condition which has been met
6 subject to a performance condition that is yet to be tested
The maximum duration for the grant of an option under the Executive Share Option Plan is ten years.
The mid-market price for the Company’s ordinary shares at 31 December 2007 was 498p (2006 425.75p). The range during the year was 401.5p to 515p.
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 81
Table D
Options exercised during 2007
Realised Unrealised gain
Number of Number of gain on sold on retained Price of Market price Market price Date option Date option
Date of options shares sold shares shares option on exercise at year end first would have
exercise exercised on exercise £ £ £ £ £ exercisable
1
lapsed
C V Geoghegan
2
30.03.07 78,048 38,091 174,838 183,403 nil 4.59 4.98 30.09.06 30.09.10
30.03.07 70,099 34,212 157,033 164,721 nil 4.59 4.98 30.03.07 30.03.11
01.06.07 435 – – 1,294 1.56 4.535 4.98 01.06.07 01.12.07
W P Havenstein
3
23.02.07 91,675 91,675 417,350 – nil* 4.5525 4.98 30.09.06 30.09.13
30.03.07 67,167 67,167 307,289 – nil* 4.575 4.98 30.03.07 30.03.14
I G King
4
23.02.07 70,736 34,522 157,201 164,906 nil 4.55364 4.98 30.09.06 30.09.10
30.03.07 60,533 29,543 134,716 141,314 nil 4.56 4.98 30.03.07 30.03.11
01.06.07 435 – – 1,294 1.56 4.535 4.98 01.06.07 01.12.07
23.10.07 70,736 34,522 170,798 179,169 nil 4.9475 4.98 30.09.07 30.09.10
S L Mogford
5
23.02.07 351,218 323,327 916,192 79,033 1.72 4.55364 4.98 30.09.06 30.09.13
23.02.07 78,049 68,059 309,916 45,491 nil 4.55364 4.98 30.09.06 30.09.10
30.03.07 315,447 315,447 804,390 – 2.01 4.56 4.98 30.03.07 30.03.14
30.03.07 70,099 70,099 319,651 – nil 4.56 4.98 30.03.07 30.03.11
10.05.07 64,415 64,415 13,044 – 4.21 4.4125 4.98 20.12.02 10.05.09
10.05.07 87,940 87,940 38,034 – 3.98 4.4125 4.98 03.05.03 10.05.09
10.05.07 156,096 156,096 688,774 – nil 4.4125 4.98 10.05.07 10.11.07
10.05.07 140,199 140,199 618,628 – nil 4.4125 4.98 10.05.07 10.11.07
10.05.07 131,102 131,102 578,488 – nil 4.4125 4.98 10.05.07 10.11.07
G W Rose 23.02.07 79,233 66,208 83,663 16,459 3.29 4.55364 4.98 06.10.01 06.10.08
23.02.07 390,741 390,741 1,107,219 – 1.72 4.55364 4.98 30.09.06 30.09.13
23.02.07 86,831 86,831 395,397 – nil 4.55364 4.98 30.09.06 30.09.10
30.03.07 345,149 246,586 630,644 252,075 2.01 4.5675 4.98 30.03.07 30.03.14
30.03.07 76,699 37,432 170,971 179,352 nil 4.5675 4.98 30.03.07 30.03.11
22.08.07 435 – – 1,263 1.56 4.4625 4.98 01.06.07 01.12.07
01.10.07 86,831 64,604 316,721 108,968 nil 4.9025 4.98 30.09.07 30.09.10
M J Turner 23.02.07 588,663 588,663 1,668,059 – 1.72 4.55364 4.98 30.09.06 30.09.13
23.02.07 130,814 130,814 595,680 – nil 4.55364 4.98 30.09.06 30.09.10
30.03.07 544,776 544,776 1,389,179 – 2.01 4.56 4.98 30.03.07 30.03.14
30.03.07 121,061 121,061 552,038 – nil 4.56 4.98 30.03.07 30.03.11
07.06.07 1,499 – – 2,582 2.56 4.2825 4.98 01.06.07 01.12.07
01.10.07 130,814 130,814 645,044 – nil 4.931 4.98 30.09.07 30.09.10
Total 13,360,956 1,521,324
1 subject to performance condition
2 retired as a director on 31 December 2007
3 appointed as a director on 2 January 2007
4 appointed as director on 1 January 2007
5 retired as a director on 9 May 2007
* equity-settled Stock Appreciation Right
The aggregate amount of gains made by directors from the exercise of share options in 2007, as calculated at the date of exercise, was £14,882,280 (2006 £1,395,166).
Table E
Performance Share Award
1 January Awarded during Vested during 31 December
2007 the year the year 2007
M J Turner – 231,618 – 231,618
Mike Turner was granted a contingent award over 231,618 shares on 16 October 2007. The shares will vest in two equal tranches, for nil consideration, in the year following his retirement
on 31 August 2008, subject to the satisfaction of certain performance targets by 31 August 2008. These targets relate to continuing the successful implementation of the Company’s
business strategy, satisfaction of leadership objectives set by the Remuneration Committee, achieving an orderly handover of key external relationships and facilitating an orderly
succession to the Chief Executive role. The market price at the date of award was £5.10.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report – Corporate governance
Remuneration report (continued)
82 www.baesyste ms.com
Table F
Directors’ remuneration
2007 2006
Base Base
salary Fees Bonus Benefits Other pay Total salary Fees Bonus Benefits Other pay Total
£’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000
Chairman
R L Olver – 562 – 19 – 581 – 500 – 6 – 506
Executive directors
C V Geoghegan
2
490 – 411 33 147 1,081 468 – 444 31 105 1,048
W Havenstein
3
390 – 584 61 – 1,035 n/a n/a n/a n/a n/a n/a
I G King
3
545 – 532 22 – 1,099 n/a n/a n/a n/a n/a n/a
M Lester
1
n/a n/a n/a n/a n/a n/a 568 – 556 27 – 1,151
S L Mogford
2
176 – 243 13 – 432 468 – 463 25 – 956
M H Ronald
1
n/a n/a n/a n/a n/a n/a 542 – 773 31 643 1,989
G W Rose 560 – 532 32 – 1,124 530 – 519 27 – 1,076
M J Turner 945 – 1,375 35 284 2,639 870 – 1,305 31 196 2,402
Non-executive directors
Prof S Birley
2
–26–––26–73–––73
P J Carroll –78–––78–70–––70
Dr U Cartellieri
2
–47–––47–58–––58
M J Hartnall –86–––86–78–––78
A Inglis
3
–40–––40n/a n/a n/a n/a n/a n/a
Sir Peter Mason –81–––81–73–––73
Rt Hon M Portillo
1
n/a n/a n/a n/a n/a n/a –17–––17
R Quarta –66–––66–58–––58
Sir Nigel Rudd –75–––75–15–––15
P A Weinberg –93–––93–77–––77
3,106 1,154 3,677 215 431 8,583 3,446 1,019 4,060 178 944 9,647
1 retired during or at the end of 2006
2 retired during or at the end of 2007
3 appointed in 2007
All emoluments and compensation paid to the directors during the year are shown above. Where the individual was appointed during the year the amount shown is for the period from
appointment.
The other pay received by Chris Geoghegan and Mike Turner was in respect of a cash supplement payable from opting out of future accrual under the Company pension schemes.
The benefits received by the UK-based executive directors include, where applicable, the provision of a car and the taxable benefit of any private use of a chauffeur, attendance at corporate
events and support in relation to relocation/second residence. The benefits received by Walt Havenstein, the US-based executive director, include a cash allowance for a car, medical
examination, dental benefits and insured life benefits. The benefit received by the Chairman, Dick Olver, was the taxable benefit relating to the private use of a chauffeur.
In 2007, Chris Geoghegan and Steve Mogford were each entitled to a sum of £490,000, being 12 months’ salary in lieu of notice, to which they waived their rights in return for augmented
pension benefits as disclosed on page 74 and in Table G on page 83.
The fees payable to the non-executive directors during 2007 are detailed on page 75. In addition, a transatlantic meeting allowance of £4,000 per meeting was paid to the US-based non-
executive directors, Phil Carroll and Peter Weinberg, who attended five meetings in the UK. With the exception of Ulrich Cartellieri and Sue Birley, the remaining non-executive directors,
being UK-based, received the same allowance to attend two meetings in the US. Ulrich Cartellieri received £4,000 to attend one meeting in the US prior to his retirement from the Board
and Sue Birley did not attend any meetings in the US during 2007.
Sir Charles Masefield retired as a director on 28 February 2003 and was employed by the Company on a part-time basis in an overseas representational role until 31 December 2007.
In 2007 his remuneration was £331,600 (2006 £316,600) and comprised a salary and a cash allowance for a car. Sir Richard Evans retired as a director and Chairman on 30 June 2004.
He remained employed in a part-time customer relationship role and will cease to be an employee on 29 February 2008. The Company will invite him to become a member of its Home
Market Advisory Board for Saudi Arabia. In 2007 his remuneration was £332,400 (2006 £317,350) and comprised a salary and a cash allowance for a car.
There were no other payments to former directors during the year other than the payment to Richard Lapthorne referred to in the notes to Table G on page 83.
Directors’ report – Business review
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Shareholder information
BAE Systems Annual Report 2007 83
Table G
Post-retirement benets
Change in
Accrued Increase/ accrued Transfer Transfer Increase in
pension at (decrease) pension value at value at transfer value
31 December in accrued after allowing 1 January 31 December Director’s less director’s
2007
1
benefits for inflation 2007
2
2007 contributions contributions
Age NRA* £ per annum £ per annum £ per annum £ £ £ £
C V Geoghegan
3
53 60 267,458 20,525 11,573 3,381,361 3,495,623 – 114,262
W Havenstein
4
59 60 75,905 19,073 18,350 590,700 791,208 3,375 197,133
I G King 51 62 373,388 40,934 28,882 2,736,838 3,075,417 46,230 292,349
S L Mogford
5
51 60 184,155 (51,408) (59,948) 2,813,722 3,165,154 16,258 335,174
G W Rose
6
55 60 295,575 32,590 23,056 3,944,663 4,326,358 51,857 329,838
M J Turner
7
59 60 659,544 85,138 64,315 10,546,221 11,637,570 – 1,091,349
* Normal Retirement Age
1 Accrued pensions may be reduced if they are taken before the normal retirement age of the scheme. In addition, a longevity adjustment factor applies to UK pension accrued after
5 April 2006.
2 Transfer values have been calculated in accordance with GN11 issued by the actuarial profession. For UK-based directors the assumptions are the same as those used in the
calculation of cash equivalents from the schemes. For US-based directors the assumptions are the same as those used for accounting disclosures. The amount of the increase in
transfer value arising from the change in assumptions is: Chris Geoghegan (£224,755); Walt Havenstein (£35,712); Ian King (£218,519); Steve Mogford (£132,759); George Rose
(£271,274); Mike Turner (£693,464).
3 As a result of the changes to taxation of pensions introduced in April 2006, Chris Geoghegan elected to opt out of the pension scheme and since April 2006 has been receiving a
taxable salary supplement of 30% of his base salary. The pension shown above is the accrued pension at 31 December 2007. Chris Geoghegan retired from the Board on
31 December 2007 and started to draw his pension with effect from 1 January 2008. His accrued pension was reduced on retirement to £201,814 to allow for early payment. This
early retirement pension was increased by £32,102 pa by way of a Company augmentation of £980,000 relating to his payment in lieu of notice and the matching Company payment as
referred to on page 74, calculated in accordance with the scheme’s normal augmentation factors.
4 Walt Havenstein’s accrued pension comprises of £13,902 from a contributory Qualified Plan and £62,003 from Non-Qualified Plans. In addition, Walt Havenstein participates in a
Section 401(k) defined contribution arrangement set up for US employees in which the Company will match employee contributions up to a limit. In 2007 the Company paid
contributions of $6,308 (£3,173) into this 401(k) arrangement. In addition, the Company paid $13,427 (£6,754) into a Deferred Compensation arrangement. Walt Havenstein is paid
in US dollars. Of the change in the accrued benefit and the transfer value (£1,206) and (£12,574) respectively is due to currency movements.
5 Steve Mogford retired from the Board on 9 May 2007 and started to draw his pension with effect from 1 June 2007. His pension was reduced for early payment. This early retirement
pension was increased by £31,056 pa by way of a Company augmentation of £980,000 relating to his payment in lieu of notice and the matching Company payment as referred to on
page 74, calculated in accordance with the scheme’s normal augmentation factors.
6 George Rose has an unapproved retirement arrangement for pensionable service before 5 April 2006 that is partly funded and partly unfunded. No company contributions have been
made to these arrangements during the year.
7 As a result of the changes to taxation of pensions introduced in April 2006 Mike Turner elected to opt out of the pension scheme and since April 2006 has been receiving a taxable
salary supplement of 30% of his base salary.
Richard Lapthorne, a former director, has an unfunded pension arrangement payable by the Company. In 2007, pension payments made by the Company to him were £93,554
(2006 £90,078).
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Directors’ report
Other statutory and regulatory information
84 www.baesyste ms.com
each, 275,000,000 7.75p (net) cumulative redeemable preference
shares of 25p each and one Special Share of £1.
As at 31 December 2007, BAE Systems’ issued share capital of
£89,362,726 comprised 3,574,509,017 ordinary shares of 2.5p
each and one Special Share of £1.
Rights and obligations of ordinary shares
On a show of hands at a general meeting every holder of ordinary
shares present in person or by proxy and entitled to vote shall have
one vote and on a poll, every member present in person or by proxy
and entitled to vote shall have one vote for every ordinary share held.
Subject to the relevant statutory provisions and the Company’s Articles
of Association, holders of ordinary shares are entitled to a dividend
where declared or paid out of prots available for such purposes.
Subject to the relevant statutory provisions and the Company’s Articles
of Association, on a return of capital on a winding-up, holders of
ordinary shares are entitled, after repayment of the £1 Special Share,
to participate in such a return.
Rights and obligations of cumulative redeemable preference shares
Following conversion of all the cumulative redeemable preference
shares in issue into ordinary shares pursuant to the Company’s
Articles of Association, there were no cumulative redeemable
preference shares in issue as at 31 December 2007. The Company
has no intention of re-issuing such shares and the effect of a special
resolution to be proposed at the 2008 AGM will be, amongst other
things, to delete the provisions of the Articles of Association relating
to such shares.
Rights and obligations of the Special Share
The Special Share is held on behalf of the Secretary of State for Trade
and Industry (the ‘Special Shareholder’) (now the Secretary of State
for Business, Enterprise and Regulatory Reform). Certain provisions
of the Company’s Articles of Association cannot be amended without
the consent of the Special Shareholder. These provisions include the
requirement that no foreign person, or foreign persons acting in
concert, can have more than a 15% voting interest in the Company,
the requirement that the majority of the directors are British, the
requirement that decisions of the directors at their meetings, in their
committees or via resolution must be approved by a majority of British
directors and the requirement that the chief executive and any
executive chairman are British.
The holder of the Special Share is entitled to attend a general meeting,
but the Special Share carries no right to vote or any other rights at any
such meeting, other than to speak in relation to any business in respect
of the Special Share. Subject to the relevant statutory provisions and
the Company’s Articles of Association, on a return of capital on a
winding-up, the Special Share shall be entitled to repayment of the
£1 capital paid up on the Special Share in priority to any repayment
of capital to any other members.
The holder of the Special Share has the right to require the Company
to redeem the Special Share at par or convert the Special Share into
one ordinary share at any time.
Treasury shares
As at the date of this report 61,945,000 ordinary shares were held in
treasury. The rights to such shares are restricted in accordance with
the Companies Acts and, in particular, the voting rights attaching to
these shares are automatically suspended.
Restrictions on transfer of securities
The restrictions on the transfer of shares in the Company are as follows:
– the Special Share may only be issued to, held by and transferred
to the Special Shareholder or his successor or nominee;
– the directors shall not register any allotment or transfer of any
shares to a foreign person, or foreign persons acting in concert,
Principal activities
The BAE Systems Group delivers, through its wholly-owned subsidiaries
and equity accounted investments, a full range of products and
services for air, land and naval forces, as well as advanced electronics,
information technology solutions and customer support services.
Directors
The current directors who served during the 2007 nancial year are
listed on pages 54 to 55. Of those directors, Ian King was appointed
to the Board on 1 January 2007, Walt Havenstein on 2 January 2007
and Andy Inglis on 13 June 2007. On 16 October 2007 the Company
announced that Mike Turner, the Chief Executive, would be retiring at
the end of August 2008.
The following directors also served on the Board in 2007 from
1 January 2007 to the date of their retirement as stated below:
Director Date retired from the Board
Professor Sue Birley 9 May 2007
Dr Ulrich Cartellieri 26 September 2007
Chris Geoghegan 31 December 2007
Steve Mogford 9 May 2007
Dividend
An interim dividend of 5.0 pence per share was paid on 30 November
2007. The directors propose a nal dividend of 7.8p per ordinary
share. Subject to approval of the shareholders, the nal dividend will
be paid on 2 June 2008 to shareholders on the share register on
18 April 2008.
Annual General Meeting (AGM)
The Company’s AGM will be held on 7 May 2008. The Notice of Annual
General Meeting is enclosed with this Annual Report and details the
resolutions to be proposed at the meeting.
Ofce of Fair Trade undertakings
As a consequence of the merger between British Aerospace and
the former Marconi Electronics Systems businesses in 1999, the
Company gave certain undertakings to the Secretary of State for Trade
and Industry (now the Secretary of State for Business, Enterprise and
Regulatory Reform). In February 2007, the Company was released
from the majority of these undertakings and the remainder have been
superseded and varied by a new set of undertakings. Compliance
with the undertakings is monitored by a compliance ofcer. Further
information regarding the undertakings and the contact details of the
compliance ofcer may be obtained through the Company Secretary
at the Company’s registered ofce or through the Company’s website.
Supplier payment policy
It is Group policy that each business unit is in compliance with
local best practice in the country of operation in respect of supplier
payment policies. Agreed payment schedules are maintained provided
that the supplier complies with all relevant terms and conditions. It is
Group policy that changes to the agreed payment schedule are only
made with the prior agreement of the supplier.
The average number of days credit provided in 2007 by suppliers was
39 days (2006 37 days).
Charitable donations
During 2007, the amount donated for charitable purposes in the UK
was £1.4m (2006 £1m). Further details of the Company’s charitable
activities are set out on page 40.
Political donations
No political donations were made in 2007.
Structure of share capital
As at 31 December 2007, the Company’s authorised share capital of
£180,000,001 comprised 4,450,000,000 ordinary shares of 2.5p
Directors’ report – Business review
Directors’ report – Governance Financial statements
Shareholder information
BAE Systems Annual Report 2007 85
The majority of directors holding ofce must be British. Otherwise
the directors who are not British shall vacate ofce in such order
that those who have been in ofce for the shortest period since their
appointment shall vacate their ofce rst, unless all of the directors
otherwise agree among themselves. Any director who holds the ofce
of either chairman (in an executive capacity) or chief executive shall
also be British.
The Company must have six directors holding ofce at all times. If the
number is reduced to below six, then such number of persons shall
be appointed as directors as soon as is reasonably practicable to
reinstate the number of directors to six. The Company may by ordinary
resolution from time to time vary the minimum number of directors.
At each AGM of the Company, any director who was elected or last
re-elected at or before the AGM held in the third calendar year before
the then current calendar year must retire by rotation and such further
directors must retire by rotation so that in total not less than one-third
of the directors retire by rotation each year. A retiring director is eligible
for re-election.
Amendment of the Company’s Articles of Association
The Company’s Articles of Association may only be amended by a
special resolution at a general meeting of shareholders. Where class
rights are varied, such amendments must be approved by the members
of each class of shares separately.
In addition, certain provisions of the Articles of Association cannot
be amended without the consent of the Special Shareholder. These
provisions include the requirement that no foreign person, or foreign
persons acting in concert, can have more than a 15% voting interest
in the Company, the requirement that the majority of the directors
are British, the requirement that decisions of the directors at their
meetings, in their committees or via resolution must be approved
by a majority of British directors and the requirement that the chief
executive and any executive chairman are British.
At the 2008 AGM a special resolution will be put to shareholders
proposing amendments to the existing Articles of Association
primarily in order to accommodate the provisions of the new
Companies Act 2006.
Powers of the directors
The directors are responsible for the management of the business
of the Company and may exercise all powers of the Company subject
to applicable legislation and regulation and the Memorandum and
Articles of Association.
At the 2007 AGM, the directors were given the power to buy back
a maximum number of 320,008,915 ordinary shares at a minimum
price of 2.5p each. The maximum price was an amount equal to 105%
of the average of the middle market quotations of the Company’s
ordinary shares as derived from the London Stock Exchange Daily
Ofcial List for the ve business days immediately preceding the day
on which such ordinary shares are contracted to be purchased. This
power will expire at the earlier of the conclusion of the 2008 AGM or
9 August 2008. A special resolution will be proposed at the 2008
AGM to renew the Company’s authority to acquire its own shares.
As part of a share buyback programme which commenced in October
2006, the Company repurchased 33,270,000 of its ordinary shares
(having a nominal value of £831,750) during 2007 for an aggregate
consideration of approximately £147m. The shares repurchased
represented 0.93% of the called-up share capital of the Company as at
31 December 2007. No further shares have been repurchased since
the year end. The repurchased shares are held in treasury.
At the 2007 AGM, the directors were given the power to issue new
shares up to an amount of £26,664,742. This power will expire on
the earlier of the conclusion of the 2008 AGM or 8 August 2008.
who at the time have more than a 15% voting interest in the
Company, or who would, following such allotment or transfer,
have such an interest;
– the directors shall not register any person as a holder of any
shares unless they have received: (i) a declaration stating that
upon registration, the share(s) will not be held by foreign persons
or that upon registration the share(s) will be held by a foreign person
or persons; (ii) such evidence (if any) as the directors may require
of the authority of the signatory of the declaration; and (iii) such
evidence or information (if any) as to the matters referred to in the
declaration as the directors consider appropriate;
– the directors may, in their absolute discretion, refuse to register any
transfer of shares which are not fully paid up (but not so as to prevent
dealings in listed shares from taking place);
– the directors may also refuse to register any instrument of transfer
of shares unless the instrument of transfer is in respect of only one
class of share and it is lodged at the place where the register of
members is kept, accompanied by a relevant certicate or such
other evidence as the directors may reasonably require to show
the right of the transferor to make the transfer;
– the directors may refuse to register an allotment or transfer of
shares in favour of more than four persons jointly;
– where a shareholder has failed to provide the Company with certain
information relating to their interest in shares, the directors can, in
certain circumstance, refuse to register a transfer of such shares;
– certain restrictions may from time to time be imposed by laws
and regulations (for example, insider trading laws);
– restrictions may be imposed pursuant to the Listing Rules of
the Financial Services Authority whereby certain of the Group’s
employees require the Company’s approval to deal in shares; and
– awards of shares made under the Company’s share incentive plan
are subject to restrictions on the transfer of shares prior to vesting.
The Company is not aware of any arrangements between its
shareholders that may result in restrictions on the transfer of shares
and/or voting rights.
Signicant direct and indirect holders of securities
As at 20 February 2008, the Company had been advised of the following
signicant direct and indirect interests in the issued ordinary share
capital of the Company:
AXA S.A. and its group of companies 10.32%
Barclays PLC 3.98%
Capital Group Companies, Inc. 6.99%
Franklin Resources, Inc. and afliates 4.92%
Legal and General Group Plc 4.07%
Exercise of rights of shares in employee share schemes
The Trustees of the employee trusts do not seek to exercise
voting rights on shares held in the employee trusts other than on
the direction of the underlying beneciaries. No voting rights are
exercised in relation to shares unallocated to individual beneciaries.
Restrictions on voting deadlines
The notice of any general meeting shall specify the deadline for
exercising voting rights and appointing a proxy or proxies to vote in
relation to resolutions to be proposed at the general meeting. The
number of proxy votes for, against or withheld in respect of each
resolution are publicised on the Company’s website after the meeting.
Appointment and replacement of directors
Subject to certain nationality requirements mentioned below, the
Company may by ordinary resolution appoint any person to be a director.
Directors’ report – Business review
Directors’ report – Governance Financial statements Shareholder information
Directors’ report
Other statutory and regulatory information (continued)
86 www.baesyste ms.com
and have elected to prepare the parent company nancial
statements in accordance with UK Accounting Standards and
applicable law (UK Generally Accepted Accounting Practice).
The Group nancial statements are required by law and IFRSs as
adopted by the EU to present fairly the nancial position and the
performance of the Group; the Companies Act 1985 provides in
relation to such nancial statements that references in the relevant
part of that Act to nancial statements giving a true and fair view
are references to their achieving a fair presentation.
The parent company nancial statements are required by law to give
a true and fair view of the state of affairs of the parent company.
In preparing each of the Group and parent company nancial
statements, the directors are required to:
– select suitable accounting policies and then apply
them consistently;
– make judgements and estimates that are reasonable
and prudent;
– for the Group nancial statements, state whether they have
been prepared in accordance with IFRSs as adopted by the EU;
– for the parent company nancial statements, state whether
applicable UK Accounting Standards have been followed, subject
to any material departures disclosed and explained in the parent
company nancial statements; and
– prepare the nancial statements on the going concern basis
unless it is inappropriate to presume that the Group and the
parent company will continue in business.
The directors are responsible for keeping proper accounting records
that disclose with reasonable accuracy at any time the nancial
position of the parent company and enable them to ensure that its
nancial statements comply with the Companies Act 1985. They
have general responsibility for taking such steps as are reasonably
open to them to safeguard the assets of the Group and to prevent
and detect fraud and other irregularities.
Under applicable law and regulations, the directors are also
responsible for preparing a directors’ report, directors’ remuneration
report and corporate governance statement that comply with that
law and those regulations.
Statement of disclosure of information to auditors
The directors who held ofce at the date of approval of this
Directors’ report conrm that, so far as they are each aware, there
is no relevant audit information of which the Company’s auditors
are unaware; and each director has taken all the steps that he
ought to have taken to make himself aware of any relevant audit
information and to establish that the Company’s auditors are aware
of that information.
By order of the Board
David Parkes
Company Secretary
20 February 2008
Accordingly, a resolution will be proposed at the 2008 AGM to renew
the Company’s authority to issue further new shares.
Directors’ indemnities
The Company has entered into deeds of indemnity with all its current
directors and those persons who were directors for any part of 2007
which are qualifying indemnity provisions for the purpose of the
Companies Act 2006. A similar indemnity has been provided to
Sir Richard Evans, a former director who retired from the Board on
30 June 2004 but remained an employee of the Company in a part-
time customer relationship role.
Change of control – signicant agreements
The following signicant agreements contain provisions entitling the
counterparties to exercise termination, alteration or other similar
rights in the event of a change of control of the Company:
– The Group has entered into a £1.5bn Revolving Credit Facility dated
1 February 2005 (as amended) and a £500m Letter of Credit Facility
dated 27 March 2006, which provide that, in the event of a change
of control of the Company, the lenders are entitled to renegotiate
terms, or if no agreement is reached on negotiated terms within
a certain period, to call for the prepayment or cancellation of the
facilities. The Revolving Credit Facility was undrawn as at
31 December 2007;
– The Company has entered into a Restated and Amended
Shareholders Agreement with European Aeronautic Defence
and Space Company EADS N.V. (EADS) and Finmeccanica S.p.A
(Finmeccanica) relating to MBDA S.A.S. dated 18 December 2001
(as amended). In the event that control of the Company passes to
certain specied third party acquirors, the agreement allows EADS
and Finmeccanica to exercise an option to terminate certain
executive management level nomination and voting rights and
certain shareholder information rights of the Company in relation
to the MBDA joint venture. Following the exercise of this option,
the Company would have the right to require the other shareholders
to purchase its interest in MBDA at fair market value. The Company
and EADS have agreed that if Finmeccanica acquires a controlling
interest in the Company, EADS will increase its shareholding in
MBDA to 50% by purchasing the appropriate number of shares in
MBDA at fair market value;
– The Company, BAE Systems North America Inc. (now BAE Systems,
Inc.) and BAE Systems Holdings Inc. entered into a Special Security
Agreement dated 29 November 2000 with the US Department of
Defense regarding the management of BAE Systems, Inc. in order
to comply with the US government’s national security requirements.
In the event of a change of control of the Company, the Agreement
may be terminated or altered by the US Department of Defense.
In addition, the Company’s share plans contain provisions as a result
of which options and awards may vest and become exercisable on
a change of control of the Company in accordance with the rules of
the plans.
Auditors
KPMG Audit Plc, the auditors for the Company, have indicated their
willingness to continue in ofce and a resolution proposing their
re-appointment will be put to the AGM.
Statement of directors’ responsibilities in respect of the Annual Report
and nancial statements
The directors are responsible for preparing the Annual Report and
the Group and parent company nancial statements in accordance
with applicable law and regulations. Company law requires the
directors to prepare Group and parent company nancial statements
for each nancial year. Under that law they are required to prepare the
Group nancial statements in accordance with International Financial
Reporting Standards (IFRSs) as adopted by the EU and applicable law
Financial statements
Independent auditors’ report 89
Consolidated financial statements 90
Notes to the Group accounts 94
Company balance sheet 135
Notes to the Company accounts 136
Five year summary 144
The first of class Type 45 destroyer,
HMS Daring, successfully completed
her stage one sea trials on schedule
in August 2007.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Financial statements
Index to the accounts
88
Index to the Group accounts Note Page Index to the Company accounts Note Page
Independent auditors’ report
89
Accounting policies 1
136
Accounting policies 1
94
Company balance sheet
135
Acquisition of subsidiaries 31
129
Contingent liabilities and commitments 11
141
Changes in accounting policies 2
98
Creditors 9
140
Consolidated balance sheet
91
Current asset investments 6
139
Consolidated cash flow statement
92
Debtors 5
139
Consolidated income statement
90
Employee share schemes 13
142
Fixed asset investments 3
138
Consolidated statement of recognised income and
expense
93
Loans and overdrafts 8
140
Contingent liabilities and commitments 24
122
Other financial assets and liabilities 7
139
Disposals 9
106
Other information 16
143
Disposal groups 19
114
Provisions for liabilities and charges 10
140
Dividends 30
129
Reserves 14
142
Earnings per share 10
107
Share capital 12
141
Employees and directors 7
103
Statutory reserve 15
143
Equity accounted investments 14
111
Stocks 4
139
Events after the balance sheet date 35
134
Tangible fixed assets 2
138
Finance costs 6
102
Financial risk management 32
131
Five year summary
144
Group entities 34
134
Intangible assets 11
108
Inventories 18
114
Investment property 13
110
Loans and overdrafts 20
115
Net cash/(debt) as defin ed by the Group 29
128
Operating costs 4
101
Other financial assets and liabilities 17
114
Other income 5
102
Other investments 15
112
Property, plant and equipment 12
109
Provisions 23
121
Reconciliation of movement in capital and reserves 27
127
Reconciliation of operating business cash flow 28
128
Related party transactions 33
133
Retirement benefit obligations 22
117
Segmental analysis 3
99
Share-based payments 26
124
Share capital 25
123
Tax 8
103
Trade and other payables 21
116
Trade and other receivables 16
113
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
Independent auditors’ report to the members of BAE Systems plc
89
We have audited the Group and parent company financial statements
(the ‘financial statements’) of BAE Systems plc for the year ended
31 December 2007 which comprise the Consolidated Income
Statement, the Consolidated and Company Balance Sheets, the
Consolidated Cash Flow Statement, the Consolidated Statement
of Recognised Income and Expense and the related notes. These
fina
ncial statements have been prepared under the accounting
policies set out therein. We have also audited the information in
the Directors' Remuneration Report that is described as having
been audited.
This report is made solely to the Company’s members, as a body,
in accordance with section 235 of the Companies Act 1985. Our
audit work has been undertaken so that we might state to the
Co
mpany’s members those matters we are required to state to
them in an auditor’s report and for no other purpose. To the fullest
extent permitted by law, we do not accept or assume responsibility
to anyone other than the Company and the Company’s members
as a body, for our audit work, for this report, or for the opin
ions
we have formed.
Respective responsibilities of directors and auditors
The directors’ responsibilities for preparing the Annual Report
and the Group financial statements in accordance with applicable
law and International Financial Reporting Standards (IFRSs) as
adopted by the EU, and for preparing the parent company financial
statements and the Directo
rs’ Remuneration Report in accordance
with applicable law and UK Accounting Standards (UK Generally
Accepted Accounting Practice) are set out in the Statement of
Directors’ Responsibilities on page 86.
Our responsibility is to audit the financial statements and the part
of the Directors’ Remuneration Report to be audited in accordance
with relevan
t legal and regulatory requirements and International
Standards on Auditing (UK and Ireland).
We report to you our opinion as to whether the financial statements
give a true and fair view and whether the financial statements and
the part of the Directors’ Remuneration Report to be audited have
been pr
operly prepared in accordance with the Companies Act 1985
and, as regards the Group financial statements, Article 4 of the
IAS Regulation. We also report to you whether in our opinion the
information given in the Directors’ Report is consistent with the
financial statements.
In addition we report to you if, in our opinion, the Com
pany has
not kept proper accounting records, if we have not received all
the information and explanations we require for our audit, or if
information specified by law regarding directors’ remuneration
and other transactions is not disclosed.
We review whether the Corporate Governance Statement
reflects
the Company’s compliance with the nine provisions of the 2006
Combined Code specified for our review by the Listing Rules of the
Financial Services Authority, and we report if it does not. We are
not required to consider whether the Board’s statements on internal
control cover all risks and controls, or form an opinion on
the
effectiveness of the Group’s corporate governance procedures
or its risk and control procedures.
We read the other information contained in the Annual Report
and consider whether it is consistent with the audited financial
statements. We consider the implications for our report if we
become aware of any appare
nt misstatements or material
inconsistencies with the financial statements. Our responsibilities
do not extend to any other information.
Basis of audit opinion
We conducted our audit in accordance with International Standards
on Auditing (UK and Ireland) issued by the Auditing Practices Board.
An audit includes examination, on
a test basis, of evidence relevant
to the amounts and disclosures in the financial statements and the
part of the Directors’ Remuneration Report to be audited. It also
includes an assessment of the significant estimates and judgements
made by the directors in the preparation of the financial statements,
and of whether the accounting policies are approp
riate to the
Group’s and Company’s circumstances, consistently applied and
adequately disclosed.
We planned and performed our audit so as to obtain all the
information and explanations which we considered necessary in
order to provide us with sufficient evidence to give reasonable
assurance that the financial statements and the part of the
Directors’ Remune
ration Report to be audited are free from material
misstatement, whether caused by fraud or other irregularity or error.
In forming our opinion we also evaluated the overall adequacy of the
presentation of information in the financial statements and the part
of the Directors’ Remuneration Report to be audited.
Opinion
I
n our opinion:
– the Group financial statements give a true and fair view, in
accordance with IFRSs as adopted by the EU, of the state of
the Group’s affairs as at 31 December 2007 and of its profit for
the year then ended;
– the Group financial statements have been properly prepared in
accordance with the Companies Act 1985 and Article 4 of the
IAS Regulation;
– the par
ent company financial statements give a true and fair
view, in accordance with UK Generally Accepted Accounting
Practice, of the state of the parent company’s affairs as at
31 December 2007;
– the parent company financial statements and the part of the
Directors’ Remuneration Report to be audited have been properly
prepa
red in accordance with the Companies Act 1985; and
– the information given in the Directors’ Report is consistent with
the financial statements.
KPMG Audit Plc
Chartered Accountants
Registered Auditor
London
20 February 2008
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Consolidated income statement
for the year ended 31 December
90
Notes
2007
£m
Total
2007
£m
2006
£m
Total
2006
£m
Continuing operations
Combined sales of Group and equity accounted investments 3 15,710 13,765
Less: share of equity accounted investments 3 (1,401) (1,432)
Revenue 3 14,309 12,333
Operating costs 4 (13,480) (11,763)
Other income 5 209 371
Group operating profit excluding amortisation and impairment
of intangible assets 1,335 1,080
Amortisation 11 (149) (105)
Impairment 11 (148) (34)
Group operating profit 1,038 941
Share of results of equity accounted investments excluding finance costs
and taxation expense 142 127
Financial income of equity accounted investments 35 21
Taxation expense of equity accounted investments (38) (35)
Share of results of equity accounted investments 14 139 113
1
Earnings before amortisation and impairment of intangible assets,
finance costs and taxation expense (EBITA) 1,477 1,207
Amortisation (149) (105)
Impairment (148) (34)
Financial income of equity accounted investments 35 21
Taxation expense of equity accounted investments (38) (35)
Operating profit 3 1,177 1,054
Finance costs 6
Financial income 1,257 1,330
Financial expense (1,199) (1,525)
58 (195)
Profit before taxation 1,235 859
Taxation expense 8
UK taxation (201) (97)
Overseas taxation (134) (116)
(335) (213)
Profit for the year from continuing operations 900 646
Profit for the year from discontinued operations 9 22 993
Profit for the year 922 1,639
Attributable to:
BAE Systems shareholders 901 1,636
Minority interests 21 3
922 1,639
Earnings per share 10
Continuing operations:
Basic earnings per share 26.0p 19.9p
Diluted earnings per share 25.8p 19.8p
Discontinued operations:
Basic earnings per share 0.6p 30.8p
Diluted earnings per share 0.6p 29.4p
Total:
Basic earnings per share 26.6p 50.7p
Diluted earnings per share 26.4p 49.2p
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
Consolidated balance sheet
as at 31 December
91
Notes
2007
£m
2006
£m
Non-current assets
Intangible assets 11 9,559 7,595
Property, plant and equipment 12 1,774 1,746
Investment property 13 113 123
Equity accounted investments 14 781 671
Other investments 15 6 11
Other receivables 16 322 569
Other financial assets 17 48 51
Deferred tax assets 8 567 1,077
13,170 11,843
Current assets
Inventories 18 701 395
Trade and other receivables including amounts due from customers for contract work 16 2,933 2,253
Current tax 35 3
Other investments 15 164 503
Other financial assets 17 101 50
Cash and cash equivalents 3,062 3,100
6,996 6,304
Non-current assets and disposal groups held for sale 19 94 –
7,090 6,304
Total assets 3 20,260 18,147
Non-current liabilities
Loans 20 (2,197) (2,776)
Trade and other payables 21 (413) (465)
Retirement benefit obligations 22 (1,629) (2,499)
Other financial liabilities 17 (26) (45)
Deferred tax liabilities 8 (40) (15)
Provisions 23 (399) (271)
(4,704) (6,071)
Current liabilities
Loans and overdrafts 20 (299) (334)
Trade and other payables 21 (8,245) (6,717)
Other financial liabilities 17 (71) (50)
Current tax (499) (417)
Provisions 23 (410) (424)
(9,524) (7,942)
Liabilities directly associated with disposal groups held for sale 19 (30) –
(9,554) (7,942)
Total liabilities 3 (14,258) (14,013)
Net assets 6,002 4,134
Capital and reserves
Issued share capital 25,27 90 81
Share premium 27 1,222 841
Equity option of convertible preference shares 27 – 76
Other reserves 27 4,631 4,330
Retained earnings 27 23 (1,211)
Total equity attributable to equity holders of the parent 5,966 4,117
Minority interests 27 36 17
Total equity 6,002 4,134
Approved by the Board on 20 February 2008 and signed on its behalf by:
M J Turner G W Rose
Chief Executive Group Finance Director
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Consolidated cash flow statement
for the year ended 31 December
92
Notes
2007
£m
2006
£m
Profit for the year from continuing operations 900 646
Profit for the year from discontinued operations 22 993
Profit for the year 922 1,639
Taxation expense – continuing operations 335 213
Taxation expense – discontinued operations – 4
Share of results of equity accounted investments – continuing operations 14 (139) (113)
Share of results of equity accounted investments – discon tinued operations – (70)
Net finance costs – continuing operations (58) 195
Net finan
ce costs – discontinued operations – (2)
Depreciation, amortisation and impairment 610 422
Loss/(gain) on disposal of property, plant and equipment 4,5 3 (60)
Gain on disposal of investment property 5 (47) (84)
Gain on disposal of non-current other investments (8) –
Gain on disposal of businesses – contin
uing operations 4,5 (40) (13)
Gain on disposal of businesses – discontinued operations 9 (22) (925)
Impairment of other investments 15 – 2
Cost of equity-settled employee share schemes 34 21
Movements in provisions 52 47
Decrease in liabilities for retirement benefit obligations (233) (834)
(Increase)/decrease in working capital:
Inventories (188) 28
Trade and other receivables (271) (187)
Trade and other payables 1,212 495
Cash inflow from operating activities 2,162 778
Interest paid (224) (315)
Interest element of finance lease rental payments (6) (11)
Taxation paid (112) (85)
Net cash inflow from operating activities 1,820 367
Dividends received from equity accounted investments – continuing operations 78 57
Dividends received from equity accounted investments – discontinued operations – 88
Interest received 175 139
Purchases of property, plant and equipment (307) (419)
Purchases of intangible assets (31) (27)
Equity accounted investment funding (4) –
Proceeds from sale of property, plant and equipment 13 135
P
roceeds from sale of investment property 53 174
Proceeds from sale of non-current other investments 15 1
Purchase of non-current other investments 15 (1) (5)
Purchase of subsidiary undertakings 29,31 (1,731) (12)
Net cash acquired with subsidiary undertakings 6 –
Purchase of equity accounted investments
(1) (4)
Proceeds from sale of subsidiary undertakings 9 96 174
Cash and cash equivalents disposed of with subsidiary undertakings (1) (40)
Proceeds from sale of equity accounted investments 9 57 1,212
Proceeds from sale of Exchange Property 15 – 557
Net proceeds from sale/(purchase) of other deposits/securities 343 (468)
Net cash (outflow)/inflow from investing activities (1,240) 1,562
Capital element of finance lease rental payments (25) (45)
Proceeds from issue of share capital 27 805 53
Purchase of treasury shares 27 (152) (112)
Purchase of own shares 27 (50) (12)
Equity dividends paid 30 (396) (346)
Dividends paid to minority interests (1) –
Dividends paid on preference shares (10) (20)
Cash inflow from loans – 66
Cash outflow from repayment of loans (782) (921)
Net cash outflow from financing activities (611) (1,337)
Net (decrease)/increase in cash and cash equivalents (31) 592
Cash and cash equivalents at 1 January 3,074 2,491
Effect of foreign exchange rate changes on cash and cash equivalents 3 (9)
Cash and cash equivalents at 31 December 3,046 3,074
Com
p
risin
g
: Cash and cash e
q
uivalents 3,062 3,100
Overdrafts (16) (26)
Cash and cash equivalents at 31 December 3,046 3,074
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
Consolidated statement of recognised income and expense
for the year ended 31 December
93
Notes
2007
£m
2006
£m
Currency translation on foreign curren cy net investments:
Subsidiaries (1) (162)
Equity accounted investments 14 43 (26)
Amounts credited to hedging reserve 41 221
Net actuarial gains on defined benefit pension schemes:
Subsidiaries 544 692
Equity accounted investments 24 72
Fair value movements on available-for-sale investments 5 –
Current tax on items taken directly to equity 8
96 21
Deferred tax on items taken directly to equity:
Subsidiaries 8 (259) (227)
Tax rate adjustment
1
8 (19) –
Equity accounted investments (6) (92)
Recycling of fair value movements on disposal of available-for-sale investments (6) –
Recycling of cumulative currency translation on disposal:
Continuing operations – 3
Discontinued operations – 11
Recycling of cumulative net hedging reserve on disposal – discontinued ope
rations – (448)
Net income recognised directly in equity 462 65
Profit for the year 922 1,639
Total recognised income and expense 1,384 1,704
Attributable to:
Equity shareholders 1,363 1,701
Minority interests 21 3
1,384 1,704
1 The UK current tax rate will be reduced from 30% to 28% with effect from 1 April 2008. In line with this change, the rate applying to UK deferred tax assets and liabilities has also
been reduced from 30% to 28%, creating a rate adjustment, which is partly reflected in the Consolidated income statement and partly in the Consolidated statement of recognised
income and expense.
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84 www.baesyste ms.com
Notes to the Group accounts
94
1. Accounting policies
The principal accounting policies applied in the preparation of these
consolidated financial statements are set out below. These policies
have been consistently applied to all the years presented, unless
otherwise stated.
Basis of preparation
The consolidated financial statements of BAE Systems plc have
been prepared in accordance with EU endorsed In ternational
Financial Reporting Standards (IFRS), Intern
ational Financial
Reporting Interpretations Committee interpretations (IFRICs)
and the Companies Act 1985 applicable to companies reporting
under IFRS.
The consolidated financial statements are presented in pounds
sterling and, unless stated otherwise, rounded to the nearest million.
They have been prepa
red under the historical cost convention, as
modified by the revaluation of available-for-sale financial assets,
and other relevant financial assets and financial liabilities (in cluding
derivative instruments).
The preparation of financial statements in conformity with IFRS
requires the use of certain critical accounting estimates and
judgem
ents. An analysis and explanation of the critical accounting
estimates and judgements used in producing this set of financial
statements is made in the Directors’ report on pages 23 and 24.
Basis of consolidation
The financial statements of the Group consolidate the results of the
Company and its subsidiary entities, and include its share of its joint
ventures’ and associates’
results accounted for under the equity
method, all of which are prepared to 31 December.
A subsidiary is an entity controlled by the Group. Control is the power
to govern the operating and financial policies of the entity so as to
obtain benefits from its activities. Subsidiaries include the special
purpose entities that the Group transacted through for the provision of
guarantees in respect of residual values and head lease a
nd finance
payments on certain regional aircraft sold.
The purchase method of accounting is used to account for the
acquisition of subsidiaries by the Group. The cost of the acquisition
is measured as the fair value of the assets given, equity instruments
issued and liabilities incurred or assumed at the date of exchange,
plus costs directly attributable to the acquisition. Identifiable assets
acquired and liabilities and contingent liabilities assumed i
n a
business combination are measured initially at their fair values at the
acquisition date. The excess of the cost of acquisition over the fair
value of the Group’s share of the identifiable net assets acquired is
recorded as goodwill. The results of such subsidiaries are included in
the consolidated income statement from the date of acquisition, up to
the date of disposal.
An entity is regarded as a joint venture if the Group has joint control
over its ope
rating and financial policies. An entity is regarded as an
associate if the Group has significant influence, but not control, over
its operating and financial policies. Joint ventures and associates are
accounted for under the equity method where the Group’s income
statement includes its share of their profit and losses and the Group’s
balance sheet i
ncludes its share of their net assets.
Where the Group contributes a business, or other non-monetary
assets for an interest in a subsidiary, joint venture or associate,
such transactions are recorded so that the reduction in ownership
of the business being contributed is accounted for as a disposal
while the increased interest in the e
nlarged Group or new interest
in the business contributed by other parties to the transaction is
accounted for as an acquisition. Fair values are applied to those
operations which are subject to the exchange and which have not
previously been held within the Group. Any loss or realised gain
resulting from the transaction is recorded in the income statem
ent
while any unrealised gain is eliminated against the investment.
Goodwill
Goodwill on acquisitions of subsidiaries is included in intangible
assets. Goodwill on acquisitions of joint ventures and associates
is included in the carrying value of equity accounted investments.
Goodwill is tested annually for impairment and carried at cost less
accumulated impairment losses. Gains and losses on the disposal
of an e
ntity include the carrying amount of goodwill relating to the
entity sold.
Goodwill is allocated to cash-generating units for the purpose of
impairment testing.
Goodwill arising on acquisitions before the date of transition to
IFRS (1 January 2004) has been retained at the previous UK GAAP
amounts, as any amounts related to intangible assets that would have
been recorded in the acquired entity if it had applied IAS 38 I
ntangible
Assets at the date it was acquired by the Group were considered
immaterial, after being tested for impairment at that date. Goodwill
written off to reserves under UK GAAP prior to 1998 has not been
reinstated and is not included in determining any subsequent profit
or loss on disposal.
Impairment
The carrying amounts of the Group’s assets are reviewed at each
balance sheet date to dete
rmine whether there is any indication of
impairment as required by IAS 36 Impairment of Assets. If any such
indication exists, the asset’s recoverable amount is estimated. For
intangible assets that are not yet available for use, and goodwill, the
recoverable amount is estimated at each balance sheet date.
An impairment loss is recognised whenever the carrying amount of
a
n asset or its cash-generating unit exceeds its recoverable amount.
Impairment losses are recognised in the income statement.
The recoverable amount of assets carried at amortised cost is
calculated as the present value of estimated future cash flows,
discounted at appropriate pre-tax discount rates. Receivables with
a short-term duration are not discounted.
The recoverable am
ount of other assets is the greater of their fair
value less cost to sell and value in use. In assessing value in use,
the estimated future cash flows are discounted to their present
value using an appropriate pre-tax discount rate.
These calculations use cash flow projections based on the Group’s
Integrated Business Plan and include a terminal value based on
the projections for the final year of that plan. This is considered
appropriate due to the long-term nature of the defence industry.
A pre-tax discount rate of 8.43% has been used in discounting the
projected pre-tax cash flows.
For an asset that does not generate largely independent cash inflows,
the recoverable amount is determined for the cash-generating unit to
which the asset belongs.
An impairment loss in respect of assets, other tha
n goodwill,
carried at amortised cost is reversed if the subsequent increase in
recoverable amount can be related objectively to an event occurring
after the impairment loss was recognised. An impairment loss in
respect of an equity investment classified as available for sale is
not reversed through profit or loss. An impairment loss in respect
of goodwill is
not reversed. An impairment loss in respect of other
assets is reversed if there has been a change in the estimate used
to determine the recoverable amount. An impairment loss is reversed
only to the extent that the asset’s carrying amount does not exceed
the carrying amount that would have been determined, net of
depreciation or amo
rtisation, if no impairment loss had
been recognised.
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BAE Systems Annual Report 2007 85
BAE Systems Annual Report 2007 85
95
1. Accounting policies (continued)
Revenue and profit recognition
Sales include the Group’s net share of sales of joint ven tures and
associates. Revenue represents sales made by the Company and its
subsidiary undertakings, excluding the Group’s share of sales of joint
ventures and associates.
Long-term contracts
The majority of the Group’s lon g-term contract arrangements
are accounted for under
IAS 11 Construction Contracts. Sales
are recognised as soon as the Group has obtained the right to
consideration in exchange for its performance. This is usually when
title passes or a separately identifiable phase (milestone) of a
contract or development has been completed and accepted by
the customer.
No profit is recognised on contracts until the outcome of the contract
can be reliably estimated. Profit is calculated by reference to reliable
estimates of contract revenue and forecast costs after making
suitable allowances for technical and other risks related to
performance milestones yet to be achieved. The amount of profit
attributable to the stage of completion of these con tracts is arrived at
by reference to the estimated overall profitability of the contract. When
it is probable that total contract costs will exceed total contract
revenue, the expected loss is recognised immediately as an expense.
Goods sold and services rendered
Sales of goods and the provision of services not under a long-term
contract are recognised in the income statement when the significant
risks and rewards of ownership have been transfe
rred to the buyer and
revenue and costs can be reliably measured.
Profit is recognised at the time of sale. Sales and profits on
intercompany trading are generally determined on an arm’s length basis.
Lease income
Rental income from aircraft operating leases is recognised in
revenue on
a straight-line basis.
Foreign currencies
Transactions in foreign currencies are translated at the exchange
rates ruling at the dates of the transactions. Monetary assets and
liabilities denominated in foreign currencies are retranslated at the
exchange rates ruling at the balance sheet date. These exchange
differences are recognised in the con
solidated income statement
unless they qualify for net investment hedge accounting treatment,
in which case the effective portion is recognised directly in a separate
component of equity.
For consolidation purposes the assets and liabilities of overseas
subsidiary entities, joint ventures and associates are translated
at the exchange rate ruling at the balance sheet date. Inco
me
statements of such entities are translated at average rates of
exchange during the year. All resultin g exchange differences including
exchange differences arising from the translation of borrowings and
other financial instruments designated as hedges of such investments
are recognised directly i
n a separate component of equity.
Translation differences that arose before the transition date to
IFRS (1 January 2004) are presented in equity but not as a separate
component. When a foreign operation is sold, the cumulative
exchange differences recognised since 1 January 2004 are recognised
in the income statement as pa
rt of the profit or loss on sale.
Research and development
The Group undertakes research and development activities either
on its own behalf or on behalf of customers.
Group funded expenditure on research activities is written off as
incurred and charged to the income statement.
Group-funded expenditure on development activities applied to a plan
or design for the p
roduction of new or substantially improved products
and processes, is capitalised as an internally generated intangible
asset if certain conditions are met. The expenditure capitalised
includes the cost of materials, direct labour and related overheads.
Capitalised development expenditure is stated at cost less
accumulated amortisation and impairment losses. Capitalised
development expen
diture is amortised over the expected life of
the product.
Where the research and development activity is performed for
customers, the revenue arising is recognised in accordance with
the Group’s revenue recognition policy above.
Other intangible assets
Acquired computer software licences for use within the Group are
capitalised as an intangible asset on the basis of the costs incurred
to acqui
re and bring to use the specific software.
Costs that are directly associated with the production of identifiable
and unique software products controlled by the Group, and that will
probably generate economic benefits exceeding costs beyond one
year, are recognised as intangible assets. Capitalised software
development expenditure is stated at cost less accumulated
amortisation and impairment losses. Group fun
ded expenditure
associated with enhancing or maintaining computer software
programmes for sale is recognised as an expense as incurred.
Trademarks and licences have definite useful lives and are carried
at cost less accumulated amortisation and impairment losses.
Intangible assets arising from a business com
bination are recognised
at fair value, amortised over their estimated useful lives and subject
to impairment testing.
Amortisation is charged to the income statement on a straight-line
basis over the estimated useful lives of the intangible assets.
The estimated useful lives are as follows:
Acquired computer software licences 2 to 5 years
Capitalised software development 2 to 5 years
Trademarks and licences up to 20 years
Other intangibles up to 10 years
Property, plant and equipment
Items of property, plant and equipment are stated at cost less
accumulated depreciation and impairment losses. The cost of self-
constructed assets includes the cost of materials, direct labour and
an appropriate proportion of production overheads.
Depreciation is provided, normally on a straight-line basis, to
write off the cost of property, plant and equipment ove
r their
estimated useful lives to any estimated residual value, using the
following rates:
Buildings up to 50 years, or the lease
term if shorter
Research equipment 8 years
Computing equipment,
motor vehicles and short life
works equipment
3 to 5 years
Aircraft up to 15 years, or the lease
term if shorter
Other equipment 10 to 15 years, or the project
life if shorter
In the Group’s North American businesses, depreciation is normally
provided on a basis consistent with cost reimbursement profiles under
US government contracts. Typically this provides for a faster rate
of depreciation than would otherwise arise on a straight-line basis.
No depreciation is provided on freehold land and assets in the course
of construction.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
96
1. Accounting policies (continued)
The assets’ residual values, useful lives and depreciation
methods are reviewed, and adjusted if appropriate, at each balance
sheet date. Where applicable, useful lives reflect the component
accounting principle.
Assets obtained under finance leases are included in property, plant
and equipment and stated at an amount equal to the lower of the
fair value and the present value of the minimum lease paym
ents
at inception of the lease, less accumulated depreciation and
impairment losses.
Investment property
Land and buildings that are leased to non-group entities are
classified as investment property. The Group measures investment
property at its cost less accumulated depreciation and accumulated
impairment losses.
Depreciation is provided, on a straight-line basis, to w
rite off the cost
of investment property over its estimated useful life of up to 50 years.
The assets’ residual values and useful lives are reviewed, and
adjusted if appropriate, at each balance sheet date.
Other investments
The Group determines the classification of its other investments
at initial recognition taking account of, where relevant, the purpose for
which the investments were acquired. The Group classifies its other
investments as follows:
(a)
loans and receivables: term deposits, principally comprising funds
held with banks and other financial institutions, are carried at
amortised cost using the effective interest method;
(b) at fair value through profit or loss: financial instruments held for
trading or designated by management on initial r
ecognition. They
are held at fair value and included in non-current assets unless
management intends to dispose of the investment within
12 months of the balance sheet date;
(c) held to maturity: non-derivative financial assets with fixed or
determinable payments and fixed maturities that the Group’s
management has the positive intentio
n and ability to hold to
maturity. During the year, the Group did not hold any investments
in this category;
(d) available-for-sale: investments other than interests in joint ventures
and associates and term deposits and not classified as (b) or (c)
above. They are held at fair value and included in non-current
assets unless management i
ntends to dispose of the investment
within 12 months of the balance sheet date.
Purchases and sales of investments are recognised at the date on
which the Group commits to purchase or sell the asset. Investments
are initially recognised at fair value plus transaction costs for all
financial assets not carried at fair value through profit or loss.
Investments are derecogn
ised when the rights to receive cash
flows from the investments have expired or have been transferred and
the Group has transferred substantially all risks and rewards
of ownership.
Realised and unrealised gains and losses arising from changes in the
fair value of the investments classified as at fair value through profit
or loss are included in fi
nance costs in the income statement in the
period in which they arise. Unrealised gains or losses arising from
changes in the fair value of investments classified as available-for-sale
are recognised in equity. When investments classified as available-for-
sale are sold or impaired, the accumulated fair value adjustments are
included in the income stateme
nt as gains and losses from
investment securities within finance costs.
The fair values of quoted investments are based on bid prices at the
balance sheet date.
Trade and other receivables
Trade and other receivables are stated at their amortised cost less
impairment losses. A provision for impairment is established when
there is objective evidence that the Group will not be able to collect
all amounts due according to the or
iginal terms of the receivables.
Significant financial difficulties of the debtor, probability that the
debtor will enter bankruptcy or financial reorganisation, and default
or delinquency in payments are considered indicators that the trade
receivable is impaired.
Amounts due from customers for contract work include lo
ng-term
contract balances less attributable progress payments.
Long-term contract balances are stated at cost, plus attributable
profit, less provision for any anticipated losses. Appropriate provisions
for any losses are made in the year in which they are first foreseen.
Progress payments are amounts received from custo
mers in
accordance with the terms of contracts which specify payments in
advance of delivery and are credited, as progress payments, against
any expenditure incurred for the particular contract. Any unexpended
balance in respect of progress payments is held in trade and other
payables as customer stage payme
nts or, if the amounts are subject
to advance payment guarantees unrelated to company performance,
as cash received on customers’ account.
Cash received on customers’ account is excluded from net cash/(debt)
as defined by the Group.
Inventories
Inventories are stated at the lower of cost, including all relevant
overhead expenditure, and net realisable value.
Cash and cash equivalents
Cash a
nd cash equivalents includes cash in hand, call deposits
and other short-term liquid investments with original maturities of
three months or less and which are subject to an insignificant risk
of change in value. For the purpose of the cash flow statement,
cash and cash equivalents also includes bank overdrafts that are
repayable on demand.
Non-current assets and disposal groups held for sale
Non-current assets an
d disposal groups are classified as assets held for
sale and stated at the lower of carrying amount and fair value less costs
to sell if their carrying amount is to be recovered principally through a
sale transaction rather than through continuing use.
This condition is regarded as met only when the sale is highly
probable and expected to be completed within a year from the
classification. In additio
n, the asset (or disposal group) is to be
available for immediate sale in its present condition and is actively
being marketed at a price that is reasonable in relation to its current
fair value.
Loans and overdrafts
Loans and overdrafts are recognised initially at fair value, less
attributable transaction costs. Subsequent to initial recognition, loans
and overdrafts are stated at amo
rtised cost or fair value in respect of
the hedged risk where hedge accounting has been adopted, with any
difference between cost and redemption value being recognised in the
income statement over the period of the borrowings on an effective
interest basis.
Borrowing costs
Borrowing costs in connection with the acquisition or construction
of items of property, pla
nt and equipment, investment property and
inventories are not capitalised.
Trade and other payables
Trade and other payables are stated at their cost.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
BAE Systems Annual Report 2007 85
97
1. Accounting policies (continued)
Leases
Assets obtained under finance leases are included in property, plant
and equipment at cost and are depreciated over their useful lives, or
the lease term, whichever is the shorter. Future instalments under
such leases, net of financing costs, are included within loans. Rental
payments are apportioned between the finance elem
ent, which is
included in finance costs, and the capital element, which reduces the
outstanding obligation for future instalments, so as to give a constant
charge on the outstanding obligation.
Payments, including any incentives, made under operating leases are
recognised in the income statement on a straight-line basis over the
lease term.
Assets held for leasing out under operating leases are included in
property, plant and equipment at cost less accumulated depreciation
and accumulated impairment losses. Rental income is recognised in
revenue on a straight-line basis.
Assets leased out under finance leases cease to be recognised in
the balance sheet after the inception of the lease. Instead, a fin
ance
lease receivable, representing the discounted future lease payments
to be received from the lessee plus any discounted unguaranteed
residual value, is recorded as a long-term financial asset. Interest
income is recognised in the income statement as it accrues, taking
into account the effective yield on the asset.
Derivative financial instruments
The global nature of the Group’s business means it is exposed to
volatility in currency exchange rates. In order to protect itself against
currency fluctuations, the Group’s policy is to hedge all material firm
transactional exposures as well as to manage anticipated economic
cash flow exposures over the medium term. The Group also uses
interest rate derivative instruments to manage the Group’s exposure
to interest rate fluctuation
s on its borrowings and deposits by varying
the proportion of fixed rate debt relative to floating rate debt over the
forward time horizon. The Group aims to achieve hedge accounting
treatment for all derivatives that hedge material foreign currency
exposures and those interest rate exposures where hedge accounting
can be achieved.
In accordance with its t
reasury policy, the Group does not hold
derivative financial instruments for trading purposes. However,
derivatives that do not qualify for hedge accounting are accounted
for as trading instruments.
Derivative financial instruments are recognised initially at fair value.
Subsequent to initial recognition, such inst
ruments are stated at
fair value at the balance sheet date. Where a derivative financial
instrument is designated as a hedge of cash flows relating to a highly
probable forecast transaction (income or expense), the effective
portion of any change in the fair value of the instrument is recognised
directly in reserves. Amounts recognised in rese
rves are recycled from
reserves and recognised in the income statement when the underlying
transaction affects profit or loss. The ineffective portion of any change
in the fair value of the instrument is recognised in the income
statement immediately. Where a derivative financial instru
ment is
designated as a fair value hedge, changes in the fair value of the
underlying asset or liability, and gains and losses on the derivative
instrument, are recognised in the income statement for the period.
Gains and losses on derivative financial instruments that do not
qualify for hedge accounting are recognised in the i
ncome statement
for the period.
Tax
Income tax on the profit or loss for the year comprises current and
deferred tax. Income tax is recognised in the income statement except
to the extent that it relates to items recognised directly in equity, in
which case it is recognised in equity.
Current tax is the expected tax payable on the taxable income for the
year, usin
g rates enacted or substantively enacted at the balance
sheet date, and any adjustment to tax payable in respect of
previous years.
Deferred tax is provided in full, using the balance sheet liability
method, on temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts
used for taxation purposes. The following tempor
ary differences are
not provided for: goodwill not deductible for tax purposes, the initial
recognition of assets or liabilities that affect neither accounting nor
taxable profit, and differences relating to investments in subsidiaries
to the extent that they will probably not reverse in the foreseeable
future. The amount of deferred tax provided is based on the expected
manner of r
ealisation or settlement of the carrying amount of assets
and liabilities, using tax rates enacted or substantively enacted at the
balance sheet date.
A deferred tax asset is recognised only to the extent that it is probable
that future taxable profits will be available against which the asset can
be utilised. Deferred tax assets are reduced to the extent that it is no
longer probable that the related tax benefit will be realised.
Additional income taxes that arise from the distribution of
dividends a
re recognised at the same time as the liability to pay
the related dividend.
Provisions
A provision is recognised in the balance sheet when the Group has
a present legal or constructive obligation as a result of a past event,
it is probable that an outflow of economic benefits will be required to
settle the obligation and the amount has been reliably estimated. If
the effect is material, provisions are determined by discounting the
expected futur
e cash flows at an appropriate pre-tax discount rate.
A provision for warranties is recognised when the underlying
products and services are sold. The provision is based on historical
warranty data and a weighting of all possible outcomes against their
associated probabilities.
A provision for restructuring is recognised when the Group has approved
a detailed and formal
restructuring plan, and the restructuring has either
commenced or has been publicly announced. Future operating costs are
not provided for.
A provision for onerous contracts is recognised when the expected
benefits to be derived by the Group from a contract are lower than
the unavoidable cost of meeting its obligations un
der the contract.
Provisions for losses on contracts are recorded when it becomes
probable that total estimated contract costs will exceed total
contract revenues. Such provisions are recorded as write downs
of work-in-progress for that portion of the work which has already
been completed, and as liability provisions for the remainder
. Losses
are determined on the basis of estimated results on completion of
contracts and are updated regularly.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
98
1. Accounting policies (continued)
Employee benefits – Pension obligations
Group companies operate various pension plans. The Group has both
defined benefit and defined contribution plans.
Obligations for contributions to defined contribution pension plans are
recognised as an expense in the income statement as incurred.
For defined benefit retirement pla
ns, the cost of providing benefits is
determined periodically by independent actuaries and charged to the
income statement in the period in which those benefits are earned by
the employees. Actuarial gains and losses are recognised in full in the
period in which they occur, and are recognised in the statement of
recognised income and expense. Past ser
vice cost is recognised
immediately to the extent the benefits are already vested, or otherwise
is recognised on a straight-line basis over the average period until the
benefits become vested.
The retirement benefit obligations recognised in the balance sheet
represent the present value of the defined benefit obligations as
adjusted for unrecognised past service cost and as reduced by the
fair value of scheme assets.
Long-term service benefits – Equity and equity-related
compensation benefits
The Group issues equity-settled and cash-settled share options to
employees. In accordance with the requirements of IFRS 2 Share-
based Payments (IFRS 2), the Group has applied IFRS 2 to all equity-
settled share options granted after 7 November 2002 that were
unvested as of 1 January 2005 and all cash-settled options
outstanding at the balance sheet date.
As explained in note 26, equity-settled share options are measured at
fair value at the date of grant using an option pr
icing model. The fair
value is expensed on a straight-line basis over the vesting period,
based on the Group’s estimate of the number of shares that will
actually vest.
Cash-settled share options are measured at fair value at the balance
sheet date using an option pricing model. The Group recognises
a liability at the balance sheet date based on these fair values,
and taking into account the estimated number of the options that
will actually vest and the
relative completion of the vesting period.
Changes in the value of this liability are recognised in the income
statement for the year.
Preference share capital
During the year, the Group’s 7.75p (net) cumulative redeemable
preference shares of 25p each were converted into the Group’s
ordinary shares of 2.5p on the basis of 0.47904 ordinary shares
for every prefere
nce share.
In accordance with IAS 32 Financial Instruments: Presentation, the
preference shares were considered a compound financial instrument
and, accordingly, split into an underlying debt instrument, classified
within loans and overdrafts, and an equity con
version option,
classified within equity.
The underlying debt instrument was presented on an amortised
cost basis until extinguished on conversion.
The equity conversion option was presented at its historic fair value,
based on the date of original issue of the preference shares. On
conversion of the preference shares into o
rdinary shares, the equity
component was reclassified to share capital and share premium.
Dividends thereon are recognised in the income statement as
finance costs.
Dividends
Equity dividends on ordinary share capital are recognised as a liability
in the period in which they are declared.
2. Changes in accounting policies
Standards, amendments and interpretations effective in 2007
With effect from 1 January 2007 the Group has adopted IFRS 7,
Financial Instruments: Disclosures. This introduces new disclosures
for financial instruments, but does not have any impact on the
consolidated income statement or balance sheet.
The following amendments and interpretations to published standards
are effective fo
r accounting periods beginning on or after 1 January
2007:
– IFRIC 7, Applying the restatement approach under IAS 29;
– IFRIC 8, Scope of IFRS 2;
– IFRIC 9, Reassessment of embedded derivatives;
– IFRIC 10, Interim financial reporting and impairment; and
– Amendment to IAS 1, Presentation of fin
ancial statements –
capital disclosures.
None of these have any significant impact on the Group’s accounts.
New standards and interpretations to existing standards that are not
yet effective and have not been early adopted by the Group
The following EU endorsed standards and interpretations to existing
standards have been published and are mandatory for the Group’s
accounting period beginning on 1 January 2008 or later periods but
have not been
early adopted by the Group:
– IFRS 8, Operating Segments (effective for 2009). This requires that
entities adopt the ‘management approach’ to reporting the financial
performance of its operating segments. The standard is concerned
with disclosure only and will therefore have no impact on the
consolidated income statement or balance sheet. Followin
g the
changes to the Group’s organisational structure from 1 January
2007, it is not expected to have a significant disclosure impact;
– IFRIC 11, IFRS 2, Group and Treasury Share Transactions is
effective for 2008. It is not expected to have any significant impact
on the Group’s accounts; and
– IFRIC 14, IAS 19, The Limit on a Defined Benefit Asset, Minimum
Funding Requirem
ents and their Interaction is effective for 2008.
The interpretation aims to clarify how to determine in normal
circumstances the limit on the asset that an employer’s balance
sheet may contain in respect of its defined benefit pension plans and
when additional liabilities might be required to be recognised. This is
not expected to have any significa
nt impact on the Group’s accounts.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
99
3. Segmental analysis
Analysis by business group
Combined sales of
Group and equity
accounted
investments
Less:
sales by equity
accounted
investments
Add:
sales to equity
accounted
investments Revenue
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
3,916
4,007 (7) (10)
–
–
3,909
3,997
Land & Armaments 3,538 2,115 (1) (4) – 1 3,537 2,112
Programmes & Support 5,327 4,615 (1,367) (1,522) 1,111 1,255 5,071 4,348
International Businesses 3,359 3,428 (1,307) (1,321) – – 2,052 2,107
HQ & Other Businesses 243 295 – (8) – – 243 287
16,383
14,460 (2,682) (2,865)
1,111
1,256
14,812
12,851
Intra-business group sales/revenue (673) (695) – – 170 177 (503) (518)
15,710
13,765 (2,682) (2,865)
1,281
1,433
14,309
12,333
Intra-business
group revenue
Revenue from
external customers
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
97
92
3,812
3,905
Land & Armaments 11 14 3,526 2,098
Programmes & Support 361 377 4,710 3,971
International Businesses 10 14 2,042 2,093
HQ & Other Businesses 24 21 219 266
503
518
14,309
12,333
EBITA
2
Amortisation of
intangible assets
Impairment of
intangible assets
Business
group result
3
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
429
429 (15) (14)
–
(2)
414
413
Land & Armaments 312 168 (110) (66) – – 202 102
Programmes & Support 456 342 (19) (20) (145) – 292 322
International Businesses 435 415 (4) (4) – – 431 411
HQ & Other Businesses (155) (147) (1) (1) (3) (32) (159) (180)
1,477
1,207 (149) (105) (148) (34)
1,180
1,068
Financial income of equity accounted investments
35
21
Taxation expense of equity accounted investments (38) (35)
Operating profit
1,177
1,054
Finance costs 58 (195)
Profit before taxation
1,235
859
Taxation expense (335) (213)
Profit for the year from continuing operations
900
646
1 restated following changes to the Group’s organisational structure
2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense
3 the analysis by business group of the share of results of equity accounted investments is provided in note 14
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Notes to the Group accounts (continued)
100
3. Segmental analysis (continued)
Assets excluding
intangible assets
and equity
accounted
investments
Intangible assets
Equity accounted
investments
Total assets Total liabilities
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
1,406
1,360
4,491
4,591
3
13
5,900
5,964 (1,164) (1,117)
Land & Armaments 1,510 697 4,435 2,208 – 1 5,945 2,906 (1,191) (787)
Programmes & Support 1,035 1,178 575 731 45 58 1,655 1,967 (3,696) (3,431)
International Businesses 1,106 677 27 31 733 599 1,866 1,307 (1,778) (1,159)
HQ & Other Businesses 882 1,211 31 34 – – 913 1,245 (1,705) (1,416)
5,939
5,123
9,559
7,595
781
671
16,279
13,389 (9,534) (7,910)
Disposal groups held for sale (note 19)
94
– (30) –
Tax 602 1,080 (539) (432)
Retirement benefit obligations 59 71 (1,629) (2,499)
Cash/(debt) as defined by the Group (note 29) 3,226 3,607 (2,526) (3,172)
Consolidated total assets/(liabilities)
20,260
18,147 (14,258) (14,013)
Capital expenditure
2
Depreciation
and amortisation
2
2007
£m
Restated
1
2006
£m
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
92
107
84
89
Land & Armaments 82 47 144 94
Programmes & Support 77 84 110 93
International Businesses 60 176 18 10
HQ & Other Businesses 30 124 51 49
341
538
407
335
Analysis by geographical location
Customer location Asset location
Sales
3
Revenue
Carrying value of
segment assets
Capital expenditure
2
2007
£m
2006
£m
2007
£m
2006
£m
2007
£m
2006
£m
2007
£m
2006
£m
United Kingdom
3,433
2,802
3,179
2,580
3,319
3,544
102
165
Rest of Europe 2,611 2,704 1,750 1,806 1,360 1,197 25 66
Middle East 2,061 1,993 1,927 1,827 485 470 52 169
United States and Canada 6,383 5,402 6,333 5,372 10,936 7,987 150 131
Asia and Pacific 978 595 930 532 106 104 7 4
Africa, Central and South America 244 269 190 216 73 87 5 3
15,710
13,765
14,309
12,333
16,279
13,389
341
538
Analysis of revenue by category
2007
£m
2006
£m
Sale of goods
4,559
3,775
Construction contracts 7,611 6,558
Services 2,070 1,921
Lease income 63 66
Royalty income 6 13
14,309
12,333
1 restated following changes to the Group’s organisational structure
2 includes intangible assets, property, plant and equipment and investment property
3 combined sales of the Group and equity accounted investments
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
101
4. Operating costs
2007
£m
2006
£m
Raw materials and other bought in items
5,557
4,169
Change in inventories of finished goods and work-in-progress 13 153
Cost of inventories expensed
5,570
4,322
Staff costs (note 7) 3,924 3,868
Depreciation, amortisation and impairment 610 422
Loss on disposal of property, plant and equipment 4 1
Loss on disposal of businesses (note 9) 8 1
Other operating charges 3,364 3,149
13,480
11,763
Included within the analysis of operating costs are the following expenses:
Lease and sublease payments:
Minimum lease payments 112 84
Contingent rents – 1
112
85
Research and development expense including amounts funded under contract 1,460 1,248
Fees payable to the Company’s auditor and its associates included in operating costs
2007 2006
UK
£’000
Overseas
£’000
Total
£’000
UK
£’000
Overseas
£’000
Total
£’000
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts*
1,111 – 1,111
1,023 – 1,023
Fees payable to the Company’s auditor and its associates for other services
The audit of the Company’s subsidiaries pursuant to legislation* 2,203 3,407 5,610 2,000 2,430 4,430
Other services pursuant to legislation:
Interim Review 520 – 520 500 – 500
Other including shareholder circular related work 104 – 104 563 22 585
Further assurance services
Advice on accounting matters 28 – 28 52 – 52
Internal controls 16 – 16 125 – 125
Due diligence 880 1,036 1,916 116 354 470
Tax services
Compliance 308 793 1,101 301 773 1,074
Advisory
909 488 1,397 687 349 1,036
Other services 313 – 313 46 62 108
Total fees payable to the Company’s auditor and its associates
6,392 5,724 12,116
5,413 3,990 9,403
* Total fees payable to the Company’s auditor and its associates for audit services 6,721 5,453
Tax services include tax compliance support and services in relation to the Group’s expatriate employees based around the world. The majority
of services provided outside the UK were provided in the US.
Significant one-off costs included in operating costs
2007
£m
2006
£m
Rationalisation programmes
25
51
2007
£m
Restated
1
2006
£m
Electronics, Intelligence & Support
5
14
Land & Armaments 2 17
Programmes & Support 4 3
International Businesses 9 15
HQ & Other Businesses 5 2
25
51
1 restated following changes to the Group’s organisational structure
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
102
5. Other income
2007
£m
2006
£m
Rental income from operating leases
46
43
Profit on disposal of investment property 47 84
Profit on disposal of property, plant and equipment 1 61
Profit on disposal of businesses (note 9) 48 14
Management recharges to equity accounted investments 15 13
Pension curtailment gains – 99
Other 52 57
209
371
6. Finance costs
2007
£m
2006
£m
Interest income
169
143
Net present value adjustments 21 39
Expected return on pension scheme assets (note 22) 845 739
Net gain on remeasurement of financial instruments 135 259
Net gain on remeasurement of embedded derivatives – 3
Gain on sale of available-for-sale investments 6 –
Foreign exchange gain
s 81 147
Financial income
1,257
1,330
Interest expense:
On bank loans and overdrafts (4) (9)
On finance leases (6) (11)
On bonds and other financial instruments (218) (277)
On preference debt (13) (28)
(241) (325)
Facility fees (4) (4)
Net present value adjustments (22) (31)
Interest charge on pension scheme liabilities (note 22) (753) (694)
Net loss on remeasurement of investments at fair value through profit or loss – (42)
Net loss on remeasurement of financial instruments at fair value through profit or loss (77) (172)
Foreign
exchange losses (102) (257)
Financial expense (1,199) (1,525)
Net finance costs
58
(195)
Additional analysis of finance costs
2007
£m
2006
£m
Net finance costs – Group
58
(195)
Net finance costs – share of equity accounted investments 35 21
93
(174)
Analysed as:
Net interest:
Interest income 169 143
Interest expense (241) (325)
Facility fees (4) (4)
Net present value adjustments (1) 8
Gain on sale of available-for-sale investments 6 –
Share of equity accounted investments 33 21
(38) (157)
Other finance costs:
Group:
Net financing credit on pensions 92 45
Other 37 (62)
Share of equity accounted investments 2 –
93
(174)
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
103
7. Employees and directors
The weekly average and year end numbers of employees, excluding those in equity accounted investments, were as follows:
Weekly average At year end
2007
Number
‘000
Restated
1
2006
Number
‘000
2007
Number
‘000
Restated
1
2006
Number
‘000
Electronics, Intelligence & Support
31
32
31
32
Land & Armaments 16 11 21 12
Programmes & Support 27 26 27 26
International Businesses 7 8 7 7
HQ & Other Businesses 2 2 2 2
83
79
88
79
1 restated following changes to the Group’s organisational structure
The aggregate staff costs of Group employees, excluding employees of equity accounted investments, were:
2007
£m
2006
£m
Wages and salaries
3,353
3,274
Social security costs 269 271
Share options granted to directors and employees – equity-settled 18 21
Share options granted to directors and employees – cash-settled 40 47
Pension costs – defined contribution plans 62 57
Pension costs – defined benefit plans 178 196
US healthcare plans 4 2
3,924
3,868
The Group considers key management personnel as defined under IAS 24 Related Party Disclosures to be the members of the Group’s
Executive Committee and the Company’s non-executive directors. Fuller disclosures on directors’ remuneration are set out in the Remuneration
report on pages 64 to 83. Total emoluments for dir
ectors and other key management personnel are £19,463,000 (2006 £23,095,000).
8. Tax
Taxation expense
2007
£m
2006
£m
Current taxation expense
UK corporation tax
Current tax (140) (91)
Double tax relief 29 35
Adjustment in respect of prior years (21) (93)
(132) (149)
Overseas tax charges
Current year (160) (91)
Adjustment in respect of prior years – 15
(160) (76)
(292) (225)
Deferred taxation expense
UK
Origination and reversal of temporary differences (103) 25
Adjustment in respect of prior years 39 27
Tax rate adjustment
1
(5) –
Overseas
Origination and reversal of temporary differences 22 (49)
Adjustment in respect of prior years 4 5
Attributable to recoverable deferred tax assets – 4
(43) 12
Taxation expense (335) (213)
1 The UK current tax rate will be reduced from 30% to 28% with effect from 1 April 2008. In line with this change, the rate applying to UK deferred tax assets and liabilities has also
been reduced from 30% to 28%, creating a rate adjustment, which is partly reflected in the Consolidated income statement and partly in the Consolidated statement of recognised income
and expense.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
104
8. Tax (continued)
The following table shows a reconciliation from the theoretical income tax expense, using the UK corporation tax rate, to the reported tax
expense. The reconciling items represent, besides the impact of tax rate differentials and changes, non-taxable benefits or non-deductible
expenses arising from differences between the local tax base and the reported fina
ncial statements.
2007
£m
2006
£m
Profit before tax
1,235
859
UK corporation tax rate 30.0% 30.0%
Expected income tax expense (371) (258)
Effect of tax rates in foreign jurisdictions (13) (20)
Expenses not tax effected (38) (50)
Income not subject to tax 70 69
Research and development tax credits 39 34
Goodwill (44) (9)
Chargeable gains (28) –
Utilisation of previously unrecognised tax losses 23 –
Recoverable deferred tax asset previously unrecognised – 4
Curr
ent year losses not tax effected (11) (9)
Adjustments in respect of prior years 22 (46)
Adjustments in respect of equity accounted investments 36 34
Other (20) 38
Taxation expense (335) (213)
Current tax taken in equity
2007
£m
2006
£m
Relating to financial instruments (1) (1)
Relating to share-based payments 28 –
Relating to pensions 69 22
96
21
Deferred tax assets/(liabilities)
Deferred tax
assets
Deferred tax
liabilities
Net balance
at 31 December
2007
£m
2006
£m
2007
£m
2006
£m
2007
£m
2006
£m
Property, plant and equipment
1
1 (71) (68) (70) (67)
Intangible assets – – (372) (143) (372) (143)
Provisions 271 261 (2) (1) 269 260
Goodwill – – (25) (17) (25) (17)
Pension/retirement plans:
Deficits 522 793 – (15) 522 778
Additional contributions 106 158 – – 106 158
Share-based payments 75 82 – – 75 82
Financial instruments 6 25 – – 6 25
Othe
r items 16 19 (7) (47) 9 (28)
Rolled over capital gains – – (18) (19) (18) (19)
Capital losses carried forward 18 19 – – 18 19
Unremitted overseas earnings – – – (1) – (1)
Trading losses carried forward 7 15 – – 7 15
Deferred tax assets/(liabilities)
1,022
1,373 (495) (311)
527
1,062
Set off of tax (455) (296) 455 296 – –
Net deferred tax assets/(liabilities)
567
1,077 (40) (15)
527
1,062
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BAE Systems Annual Report 2007 85
105
8. Tax (continued)
Movement in temporary differences during the year
At 1 January
2007
£m
Exchange
movements
£m
Acquisitions
(note 31)
£m
Other
movements
£m
Recognised
in income
£m
Recognised
in equity
£m
At 31
December
2007
£m
Property, plant and equipment (67) – (8) 1 4 – (70)
Intangible assets (143) (5) (272) – 47 1 (372)
Provisions 260 (2) 42 (3) (28) – 269
Goodwill (17) – 18 – (26) – (25)
Pension/retirement plans:
Deficits 778 (3) 7 – (50) (210) 522
Additional contributions 158 – – – (1) (51) 106
Share-based payments 82 – – – 1 (8) 75
Financial instruments 25 – – – (7) (12) 6
Other items (28) 2 7 1 25 2 9
Rolled over capital gains (19) – – – 1 – (18)
Capital losses carried forward 19 – – – (1) – 18
Unremitted overseas dividends (1) – – – 1 – –
Trading losses carried fo
rward 15 1 – – (9) – 7
1,062 (7) (206) (1) (43) (278)
527
At 1 January
2006
£m
Exchange
movements
£m
Acquisitions
£m
Other
movements
£m
Recognised
in income
£m
Recognised
in equity
£m
At 31
December
2006
£m
Property, plant and equipment (66) 3 – 1 (5) – (67)
Intangible assets (180) 15 – (8) 30 – (143)
Provisions 239 (21) – 4 38 – 260
Goodwill 11 – – – (28) – (17)
Pension/retirement plans:
Deficits 1,313 (29) – 6 (130) (382) 778
Additional contributions – – – – 18 140 158
Share-based payments 59 (3) – (3) 21 8 82
Financial instruments –––– 18 725
Other items (57) (1) – 7 23 – (28)
Rolled over capital gains (24) – – – 5 – (19)
Capital losses carried forward 24 – – – (5) – 19
Unremitted overseas dividends (27) – – – 26 – (1)
Trading losses carried forward 16 (1) – (1) 1 – 15
1,308 (37) – 6 12 (227) 1,062
Unrecognised deferred tax assets
Deferred tax assets have not been recognised in respect of the following items:
2007
£m
2006
£m
Deductible temporary differences
22
28
Capital losses carried forward 59 60
Trading and other losses carried forward 140 130
221
218
These assets have not been recognised as the precise incidence of future profits in the relevant countries and legal entities cannot be sufficiently
accurately predicted at this time.
The aggregate temporary differences associated with investments in subsidiaries, branches, associates and joint ventures for which deferred tax
liabilities have not been recognised is £847m (2006 £500m).
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Notes to the Group accounts (continued)
106
9. Disposals
Continuing operations
On 17 January 2007, the Group completed the sale of its 50% shareholding interest in HR Enterprise Limited and its subsidiary, Xchanging HR
Services Limited, (together ‘XHRS’) to HR Holdco Limited (a company within the Xchanging group) for a cash consideration of £10m.
On 6 March 2007, the Group completed the sale of its 50% shareholding interest in Xchanging Procurement Ser
vices (Holdco) Limited (XPS),
to XUK Holdco (No.2) Limited (a company within the Xchanging group) for a cash consideration of £47m.
On 20 August 2007, the Group completed the sale of its Inertial Products business to investment affiliates of J. F. Lehman & Company, the US
private equity firm, for a cash consideration of $140m (£70m), subject to potential adjustment according to the level of working capital and net
debt or net cash in the business at closi
ng.
On 13 December 2007, the Group completed the sale of its Customer Training Centre (CTC) at Woodford, Manchester, UK, to Flight Academy
UK Limited for a cash consideration of £6m.
Profit on disposal of businesses of £48m (note 5) comprises the disposals of XHRS (£nil), XPS (£44m) and CTC (£4m).
Loss on disposal of businesses of £8m (note 4) comprises the disposals of Inertial Products (£6m) and the TEMPEST products business (£2m).
Discontinued operations
On 30 March 2007, the sale of the Group’s remaining 25% interest in SELEX Sensor and Airbourne Systems SpA (SELEX) was completed
following the exercise by Finmeccanica SpA of its call option granted as part of the original disposal transaction in 2005. Net proceeds of £24m
comprise the consideration of £277m, less £253m which was assigned to the BAE Systems 2000 Pension Plan in 2006.
A profit of £22m was r
ecognised during the year upon settlement of warranties and similar obligations.
The results from discontinued operations, which have been included in the consolidated income statement, are shown below. The results for the
year ended 31 December 2006 include the results of Airbus SAS for the period to disposal on 13 October 2006.
2007
£m
2006
£m
Revenue
–
–
Expenses – –
EBITA
1
–
–
Share of results of equity accounted investments excluding finance costs and taxation expense
–
144
Finance costs of equity accounted investments – (25)
Taxation expense of equity accounted investments – (49)
Share of results of equity accounted investments
–
70
Financial income, net – 2
Profit before taxation
–
72
Taxation expense – (4)
Profit for the year
–
68
Profit on disposal of discontinued operations 22 925
Profit for the year from discontinued operations
22
993
1 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense
Proceeds from the sale of subsidiary undertakings in the consolidated cash flow statement of £96m in 2007 comprise the disposals of Inertial
Products (£70m), SELEX (£24m), CTC (£6m) and TEMPEST (£1m), less transaction costs (£5m).
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
107
10. Earnings per share
2007 2006
£m
Basic
pence per
share
£m
Diluted
pence per
share
£m
Basic
pence per
share
£m
Diluted
pence per
share
Profit for the year attributable to equity shareholders
901 901
1,636 1,636
Interest on the debt instrument of the convertible preference
shares –13 – 28
Profit for the year after adjusting for interest on the debt
instrument of the convertible preference shares
901 26.6 914 26.4 1,636 50.7 1,664 49.2
Represented by:
Continuing operations
879 26.0 892 25.8
643 19.9 671 19.8
Discontinued operations 22 0.6 22 0.6 993 30.8 993 29.4
Add back/(deduct):
Net financing credit on pensions, post tax (68) (68) (33) (33)
Uplift on acquired inventories, post tax 99 – –
Market value movements on derivatives, post tax (29) (29) 55 55
Amortisation and impairment of intangible assets, post tax 110 110 79 79
Impairment of goodwill 148 148 32 32
Underlying earnings
1,071 31.6 1,084 31.3
1,769 54.9 1,797 53.1
Represented by:
Continuing operations 1,049 31.0 1,062 30.7 767 23.8 795 23.5
Discontinued operations 22 0.6 22 0.6 1,002 31.1 1,002 29.6
1,071 31.6 1,084 31.3
1,769 54.9 1,797 53.1
Underlying earnings excluding profit on disposal of
Airbus SAS (2006 £925m) 844 26.2 872 25.8
Represented by:
Continuing operations 767 23.8 795 23.5
Discontinued operations 77 2.4 77 2.3
844 26.2 872 25.8
Millions Millions Millions Millions
Weighted average number of shares used in calculating basic
earnings per share
3,386 3,386 3,225 3,225
Add:
Incremental shares in respect of employee share schemes 24 32
Incremental shares in respect of convertible preference shares 56 125
Weighted average number of shares used in calculating diluted
earnings per share
3,466 3,382
Underlying earnings per share is presented in addition to that required by IAS 33 Earnings per share as the directors consider that this gives
a more appropriate indication of underlying performance.
In accordance with IAS 33, the diluted earnings per share are without reference to adjustments in respect of outstandi
ng share options and
convertible preference shares where the impact would be anti-dilutive.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
108
11. Intangible assets
Goodwill
£m
Other
1
£m
Total
£m
Cost or valuation
At 1 January 2006 9,722 678 10,400
Additions:
Acquired separately –2525
Internally generated –22
Acquisition of subsidiaries 4–4
Adjustments to provisional fair values (8) 3 (5)
Disposals (6) (2) (8)
Reclassified as non-current assets and disposal groups held for sale (28) – (28)
Exchange adjustments (480) (49) (529)
At 31 December 2006 9,204 657 9,861
Additions:
Acquired separately –3131
Acquisition of subsidiaries (note 31) 1,563 753 2,316
Disposals (31) (4) (35)
Asset reclassifications (2) 2 –
Reclassified as non-current assets and disposal groups held for sale (note 19) (42) – (42)
Exchange adjustments (31) 12 (19)
At 31 December 2007 10,661 1,451 12,112
Amortisation and impairment
At 1 January 2006 2,090 93 2,183
Disposals (5) (2) (7)
Amortisation charge
2
– 105 105
Impairment charge 32 2 34
Exchange adjustments (46) (3) (49)
At 31 December 2006 2,071 195 2,266
Disposals (1) (4) (5)
Amortisation charge
2
– 149 149
Impairment charge 148 – 148
Exchange adjustments (5) – (5)
At 31 December 2007 2,213 340 2,553
Net book value
At 31 December 2007 8,448 1,111 9,559
At 31 December 2006 7,133 462 7,595
At 1 January 2006 7,632 585 8,217
1 other intangibles includes internally funded development costs and intangible assets recognised on acquisition of subsidiary companies, of which the most significant are in respect of
the acquired order book and of on-going programme relationships
2 amortisation is included in operating costs in the income statement
The Group has no indefinite life intangible assets other than goodwill. The Group has allocated its goodwill across approximately 20 cash-
generating units. Other than the goodwill allocated to the US operations within the Land & Armaments business group acquired as part of the
acquisition of United Defense Industries, Inc. in 2005 (£1,984m) and Armor Holdings, Inc. in 2007 (£1,554m), none of the cash-generating
units has allocated goodwill exceeding 10% of the Group’s total goodwill balance.
The Group’s approach to goodwill impairment testing is set out in the accounting policies on page 94. All significant goodwill balances have
been considered with regard to value in use calculations.
The key assumption underpinning the Integrated Business Plan projections for the US operations within the Land & Armaments business group is
that US government defe
nce spending will remain broadly stable in the foreseeable future. The directors have not identified any reasonable possible
changes in key assumptions for this business that would cause the carrying value of recognised goodwill to exceed its recoverable amount.
Beyond the assumptions that US and UK government defence spending remains stable there are no individually significant assum
ptions made
in relation to the other cash-generating units where changes to key assumptions would cause the carrying value of recognised goodwill to
exceed its recoverable amount.
The result of the review of the carrying value of goodwill across the Group is an impairment charge of £148m (2006 £32m). The majority of
the impairment charge relates to the Insyte business within Programmes & Suppo
rt reflecting lower exports and Homeland Security activity.
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BAE Systems Annual Report 2007 85
109
12. Property, plant and equipment
Land and
buildings
£m
Plant and
machinery
£m
Aircraft
£m
Total
£m
Cost
At 1 January 2006 1,233 2,120 548 3,901
Additions 214 184 113 511
Transfers from inventories – 1 – 1
Transfers to inventories – (3) – (3)
Transfers from investment property 2 – – 2
Reclassification between categories 9 (9) – –
Disposals (80) (147) (1) (228)
Exchange adjustments (65) (68) (54) (187)
At 31 December 2006 1,313 2,078 606 3,997
Additions 96 190 24 310
Acquisition of subsidiaries (note 31) 32 54 6 92
Transfers from inventories – 5 – 5
Transfers to inventories – (6) (1) (7)
Reclassified as non-current assets and disposal groups held for sale (note 19) (11) (16) – (27)
Disposals (24) (172) (25) (221)
Disposal of subsidiaries (10) (29) – (39)
Exchange adjustments (10) (9) (8) (27)
At 31 December 2007 1,386 2,095 602 4,083
Depreciation and impairment
At 1 January 2006 408 1,507 282 2,197
Depreciation charge for the year 49 149 28 226
Impairment loss for the year – – 53 53
Transfers to inventories – (1) – (1)
Transfers from investment property 1 – – 1
Reclassification between categories 2 (2) – –
Disposals (18) (132) (1) (151)
Exchange adjustments (9) (41) (24) (74)
At 31 December 2006 433 1,480 338 2,251
Depreciation charge for the year 67 155 32 254
Impairment loss for the year
1
19 2 34 55
Transfers to inventories – (4) – (4)
Reclassified as non-current assets and disposal groups held for sale (note 19) (5) (13) – (18)
Disposals (15) (170) (10) (195)
Disposal of subsidiaries (4) (21) – (25)
Exchange adjustments (1) (3) (5) (9)
At 31 December 2007 494 1,426 389 2,309
Net book value
At 31 December 2007 892 669 213 1,774
At 31 December 2006 880 598 268 1,746
At 1 January 2006 825 613 266 1,704
1 During the year, the directors revised the valuation methodology used to determine the value of regional aircraft with a £34m impairment charge arising and a £45m increase to
provisions in respect of residual value guarantees
The amounts above include:
Net book value of assets held as capitalised finance leases (including investment property (note 13))
At 31 December 2007 6 11 16 33
At 31 December 2006 1 17 15 33
Assets in the course of construction (including investment property (note 13))
At 31 December 2007 88 68 – 156
At 31 December 2006 148 68 – 216
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
110
12. Property, plant and equipment (continued)
Net book value of:
Land and
buildings
£m
Plant and
machinery
£m
Aircraft
£m
Total
£m
Freehold property 809 – – 809
Long leasehold property 55 – – 55
Short leasehold property 28 – – 28
Plant and machinery – 594 – 594
Fixtures, fittings and equipment – 75 – 75
Aircraft – – 213 213
892 669 213 1,774
The aircraft fleet that is held under capitalised finance lease arrangements is leased to airline companies under operating leases. The leases
have varying terms, escalation clauses and renewal rights.
The future aggregate minimum lease income from the non-cancellable elements of operating leases for assets capitalised (including investment
property (note 13)) are as follows:
Receipts due:
2007
£m
2006
£m
Not later than one year
93
72
Later than one year and not later than five years 234 185
Later than five years 63 63
390
320
Under the terms of the lease agreements, no contingent rents are payable. Within the above lease income is £15m (2006 £25m) relating to
assets held by the Group under capitalised finance leases.
13. Investment property
£m
Cost
At 1 January 2006 272
Transfers to property, plant and equipment (2)
Disposals (103)
At 31 December 2006 167
Disposals (9)
At 31 December 2007 158
Depreciation and impairment
At 1 January 2006 54
Transfers to property, plant and equipment (1)
Depreciation charge for the year 4
Disposals (13)
At 31 December 2006 44
Depreciation charge for the year 4
Disposals (3)
At 31 December 2007 45
Net book value of investment property
At 31 December 2007 113
At 31 December 2006 123
At 1 January 2006 218
Fair value of investment property
At 31 December 2007 160
At 31 December 2006 218
The fair values above are based on and reflect current market values as prepared by in-house professionals. The valuations were prepared
by persons having the appropriate professional qualification and with recent experience in valuing properties in the location and the type of
property being valued.
2007
£m
2006
£m
Rental income from investment property
20
19
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BAE Systems Annual Report 2007 85
111
14. Equity accounted investments
Carrying value of equity accounted investments
Share
of net
assets
£m
Purchased
goodwill
£m
Carrying
value
£m
At 1 January 2006 317 1,404 1,721
Share of results after tax – continuing operations 113 – 113
Share of results after tax – discontinued operations (note 9) 70 – 70
Acquired through acquisition (62) 66 4
Reclassified from intangible assets – 28 28
Disposal (239) (1,063) (1,302)
Dividends (145) – (145)
Market value adjustments in respect of derivative financial instruments, net of tax 144 – 144
Actuarial gains on defined benefit pension schem
es, net of tax 59 – 59
Revaluation of net assets acquired by equity accounted investments
1
5 – 5
Foreign exchange adjustment (24) (2) (26)
At 31 December 2006 238 433 671
Share of results after tax – continuing operations 139 – 139
Acquired through acquisition 1 – 1
Adjustment to provisional fair values 3 (3) –
Disposal (10) – (10)
Dividends (78) – (78)
Market value adjustments in respect of derivative financial instruments, net of tax (2) – (2)
Actuarial gains on defined benefit pension schemes, net of tax 17 – 17
Foreign exchange adjustment 13 30 43
At 31 December 2007
321 460 781
1 The revaluation gain in 2006 arose as a result of MBDA SAS acquiring control of LFK GmbH, which was previously accounted for as a trade investment. The £5m gain reflects a fair value
uplift in respect of the carrying value of the original investment. The gain is reflected as a credit to equity (note 27).
Included within purchased goodwill is £110m (2006 £113m) relating to the goodwill arising on acquisitions made by the Group’s equity
accounted investments subsequent to their acquisition by the Group.
The market value of the Group’s shareholding in Saab AB at 31 December 2007 was £225m (2006 £350m).
Share of results of equity accounted investments by continuing business group
2007
£m
Restated
2
2006
£m
Share of results excluding finance costs and taxation expense:
Electronics, Intelligence & Support 1 1
Programmes & Support 27 25
International Businesses 114 94
HQ & Other Businesses – 7
142
127
Financial income 35 21
Taxation expense (38) (35)
139
113
2 restated following changes to the Group’s organisational structure
Share of the assets and liabilities of equity accounted investments
2007
£m
2006
£m
Assets:
Non-current assets 892 856
Current assets 3,032 2,633
3,924
3,489
Liabilities:
Non-current liabilities (618) (582)
Current liabilities (2,525) (2,236)
(3,143) (2,818)
Carrying value
781
671
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
112
14. Equity accounted investments (continued)
Principal equity accounted investments
Joint ventures Principal activities
Principally
operates in
Country of
incorporation
Air Astana JSC (49%)
(Held by BAE Systems (Kazakhstan) Limited)
Commercial aerospace activities Kazakhstan Kazakhstan
Eurofighter Jagdflugzeug GmbH (33%)
(Held by BAE Systems plc)
Management and control of Eurofighter
Typhoon programme
Germany Germany
Flagship Training Limited (50%)
(Held via BAE Systems Electronics Limited)
Supply of naval training and support
services
UK England and Wales
Fleet Support Limited (50%)
(Held via BAE Systems Surface Fleet Solutions Limited)
Engineering and facilities management
support to the Royal Navy
UK England and Wales
Gripen International KB (50%)
(Held via BAE Systems (Operations) Limited)
Marketing and selling of Gripen fighter
aircraft
Sweden Sweden
MBDA SAS (37.5%)
(Held via BAE Systems Electronics Limited and
BAE Systems (Overseas Holdings) Limited)
Development and manufacture of guided
weapons
Europe France
Panavia Aircraft GmbH (42.5%)
(Held via BAE Systems plc)
Management and control of Tornado
programme
Germany Germany
Saab AB (20.5%)
(Held via BAE Systems (Sweden) AB)
Defence and commercial aerospace
activities
Sweden Sweden
15. Other investments
2007
£m
2006
£m
Non-current
Loans and receivables
Term deposits – 4
Available-for-sale financial assets
Equity securities 6 7
6
11
Current
Loans and receivables
Term deposits 164 503
164
503
Reconciliation of movements
2007
£m
2006
£m
Non-current
At 1 January 11 9
Additions 1 5
Disposals (11) (1)
Creation of impairment provision – (2)
Fair value movements 5 –
At 31 December
6
11
Current
At 1 January 503 634
Additions 19 499
Disposals (358) (588)
Fair value movements recognised in finance costs – (42)
At 31 December
164
503
Exchange Property
The Group’s shareholding in Vodafone Group Plc (Exchange Property) was disposed of during 2006.
The Group had designated the Exchange Property as at fair value through profit or loss. Accordingly, movements in the fair value of the
Exchange Property in 2006 to disposal of £42m were recognised in finance costs in the income statement (note 6).
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BAE Systems Annual Report 2007 85
113
16. Trade and other receivables
2007
£m
2006
1
£m
Non-current
Other receivables 255 496
Pension prepayment (note 22) 57 66
Prepayments and accrued income 10 7
322
569
Current
Long-term contract balances 4,389 4,440
Less: attributable progress payments (4,013) (4,027)
Amounts due from contract customers
1
208 151
Amounts due from customers for contract work
584
564
Trade receivables
1
1,608 1,060
Amounts owed by equity accounted investments 239 218
Other receivables 281 225
Pension prepayment (note 22) 2 5
Prepayments and accrued income 219 181
2,933
2,253
1 Following the adoption of IFRS7, the Group has reviewed the categorisation of its trade and other receivables. As a result of this review, the comparative amount for amounts due from
contract customers has been restated by £429m from £580m to £151m and the comparative amount for trade receivables has been restated by £429m from £631m to £1,060m.
Included within amounts due from customers for contract work:
2007
£m
2006
£m
Retentions outstanding against long-term contracts
1
1
The ageing of trade receivables is detailed below:
2007 2006
Gross
£m
Provision
£m
Net
£m
Gross
£m
Provision
£m
Net
£m
Not past due – 180 days
1,342
(17)
1,325
1,060 (7) 1,053
Past 180 days 319 (36) 283 31 (24) 7
1,661
(53)
1,608
1,091 (31) 1,060
Trade receivables are disclosed net of a provision for impairment losses. Movement on the provision is as follows:
2007
£m
2006
£m
At 1 January
31
46
Created 42 20
Released (22) (24)
Exchange adjustments – (2)
Acquisitions/(disposals) 3 (1)
Utilised (1) (8)
At 31 December
53
31
The other classes within trade and other receivables do not contain impaired assets.
The Group has material receivables due from the UK, US and Saudi Arabian governments where credit risk is not considered an issue. For the
remaining trade receivables, the provision has been calculated taking into account individual assessments based on past credit history and pr
ior
knowledge of debtor insolvency or other credit risk. All credit and recovery risk associated with trade receivables has been provided for in the
balance sheet.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
114
17. Other financial assets and liabilities
2007
Assets
£m
2007
Liabilities
£m
2006
Assets
£m
2006
Liabilities
£m
Non-current
Cash flow hedges – foreign exchange contracts 34 (20) 30 (43)
Other foreign exchange/interest rate contracts 14 (6) 21 (2)
48
(26) 51 (45)
Current
Cash flow hedges – foreign exchange contracts 63 (44) 36 (36)
Other foreign exchange/interest rate contracts 38 (27) 14 (14)
101
(71) 50 (50)
Debt-related derivative financial instruments
Other foreign exchange/interest rate derivatives 17 (190) 6 (243)
The debt-related derivative financial instruments are presented as a component of loans and overdrafts (note 20).
The ineffective portion recognised in the income statement that arises from fair value hedges amounts to a gain of £4m (2006 gain of £5m).
The ineffective portion recognised in the income statement that a
rises from cash flow hedges amounts to £nil (2006 £nil).
The notional principal amounts of the outstanding contracts are detailed in note 32.
18. Inventories
2007
£m
2006
£m
Short-term work-in-progress
304
205
Raw materials and consumables 285 100
Finished goods and goods for resale 112 90
701
395
The Group recognised £53m (2006 £20m) as a write down of inventories to net realisable value in 2007.
19. Disposal groups
On 19 December 2007, the Group agreed the sale of its Surveillance and Attack business to Sensor and Antenna Systems, Lansdale, Inc.,
a subsidiary of Cobham Defence Electronic Systems Corporation, for a cash consideration of $240m (£121m). Completion of the sale is
conditional upon regulatory approvals being given and is expected to take place in the first quarter of 2008. Accordingly, the busi
ness is
presented as held for sale on the balance sheet as at 31 December 2007.
The Group's Mobile International business was acquired with Armor Holdings, Inc. on 31 July 2007 (note 31) with a view to immediate resale.
Accordingly, it is classified as held for sale in the acquisition balance sheet and as at 31 December 2007.
The assets and liabilities of Surveillance and Attack, and Mobile International relate to the Electronics, Intelligence & Support and Land &
Arma
ments business groups, respectively.
Surveillance
and Attack
£m
Mobile
International
£m
2007
£m
2006
£m
Non-current assets
Intangible assets 42 1 43 –
Property, plant and equipment 9 9 18 –
51 10 61
–
Current assets
Inventories 7 17 24 –
Trade and other receivables 2 7 9 –
9 24 33
–
Assets of disposal groups
60 34 94
–
Current liabilities
Trade and other payables (4) (26) (30) –
(4) (26) (30) –
Liabilities of disposal groups (4) (26) (30) –
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BAE Systems Annual Report 2007 85
115
20. Loans and overdrafts
2007
£m
2006
£m
Non-current
Euro-Sterling £150m 11⅞% bond, repayable 2008 – 150
European Investment Bank loan, final instalment 2009 4 11
Alvis loan notes, redeemable 2009 1 1
Debt instrument of the convertible preference shares, redeemable 2010 – 242
US$500m 4.75% bond, repayable 2010 254 249
US$1bn 6.4% bond, repayable 2011 517 515
Class B and Class G ce
rtificates, final instalments 2011/2013 498 599
Euro-Sterling £100m 10¾% bond, repayable 2014 99 99
US$750m 5.2% bond, repayable 2015 376 382
US$500m 7.5% bond, repayable 2027 249 253
Bank loans 6 28
Obligations under finance leases 20 31
Debt-related derivative financial instruments 173 216
2,197
2,776
Current
Bank loans and overdrafts 41 33
US$200m 7% bond, repayable 2007 – 102
Euro-Sterling £150m 11⅞% bond, repayable 2008 150 –
European Investment Bank loan, final instalment 2009 7 7
Class B and Class G certificates, final instalment 2011/2013 87 82
Obligations under finance leases 14 23
Debt-related derivative financial i
nstruments – 21
Eurofighter GmbH loan – 66
299
334
The maturity of the Group’s borrowings is as follows:
Less
than
one year
£m
Between
one and
five years
£m
More than
five years
£m
Total
£m
At 31 December 2007
Carrying amount 299 1,157 1,040 2,496
Contractual cash flows
1
484 1,649 1,370 3,503
At 31 December 2006
Carrying amount 334 1,578 1,198 3,110
Contractual cash flows
1
653 1,947 1,554 4,154
1 including interest payments
Contractual cash flows in respect of all other financial liabilities are equal to the balance sheet carrying amount. Current contractual amounts
are settled within the normal operating cycle of the business. Non-current amounts are expected to be settled between one and five years.
The European Investment Bank borrowing is fixed with an interest rate of 6.86%.
For
more information on the debt instrument of the convertible preference shares refer to note 1.
The US$500m 4.75% bond, repayable 2010 was converted on issue to a floating rate bond by utilising an interest rate swap giving an effective
rate during 2007 of 5.85%.
The US$1bn 6.4% bond, repayable 2011 has been partially converted to a floating rate bond by utilising a se
ries of interest rate swaps with
different tenors; US$500m has been swapped until maturity of the bond in 2011 and US$250m was swapped until December 2007. This has
been overlayed by US$300m of floating to fixed interest rate swaps that fix the interest payments at a lower rate than the original coupon.
The effective interest rate during 2007 was 6.49% with an interest rate split on the bond at 31 Decembe
r 2007 being US$800m fixed and
US$200m floating.
The Class B and Class G certificates are repayable in 2011 and 2013 respectively with fixed US$ coupon rates of 7.156% and 6.664%, giving
a weighted average interest rate of 6.879%. At 31 December 2007, the gross outstanding principal due is US$1,138m. Of this balance, US$348m
has been converted to a sterling floating rate bond by utilising a cross-currency swap which resulted in an effective interest r
ate during 2007 of
6.75% on this element.
The US$500m 7.5% bond, repayable 2027 was converted at issue to a sterling fixed rate bond by utilising a cross-currency swap and has an
effective interest rate of 7.73%.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
116
20. Loans and overdrafts (continued)
The debt-related derivative financial instruments represent the market value of certain interest rate and cross-currency derivatives which are
specifically hedging loans disclosed within the above note. These derivatives have been entered into specifically to manage the Group’s
exposure to foreign exchange or interest rate risk. The US$200m 7% bond, was repaid in July 2007.
The Eurofighter GmbH loan represented surplus cash lent by Eurofighter GmbH to its shareholders. The loan incurred interest at LIBOR minus
10bp and was repaid in January 2007.
Finance lease obligations
The Group has a number of non-cancellable finance lease arrangements predominantly in respect of aircraft. The matur
ity of these lease
liabilities from the balance sheet date is shown below.
2007
£m
2006
£m
Finance lease liabilities – minimum lease payments due:
Not later than one year 15 24
Later than one year and not later than five years 22 37
37
61
Future finance charges on finance leases (3) (7)
Present value of finance lease liabilities
34
54
Present value of finance lease liabilities – payments due:
Not later than one year 14 23
Later than one year and not later than five years 20 31
34
54
Under the terms of the lease agreements, no contingent rents are payable.
The interest rate inherent in these finance leases is fixed at the contract date for all of the lease term. The average interest rate on finance
lease payables at 31 December 2007 was 7% (2006 7%).
21. Trade and other payables
2007
£m
2006
£m
Non-current
Amounts due to long-term contract customers 56 113
Cash received on customers’ account
1
for long-term contracts 2 43
Amounts owed to equity accounted investments 7 10
Other payables 306 287
Accruals and deferred income 42 12
413
465
Current
Amounts due to long-term contract customers 4,710 3,836
Amounts due to other customers 162 153
Cash received on customers’ account
1
:
Long-term contracts 27 16
Others 1 3
Trade payables 913 638
Amounts owed to equity accounted investments 847 616
Other taxes and social security costs 58 34
Other payables 297 343
Accruals and deferred income 1,230 1,078
8,245
6,717
Included above:
2007
£m
2006
£m
Amounts due to long-term contract customers
4,795
4,008
1 Cash received on customers’ account is the unexpended cash received from customers in advance of delivery which is subject to advance payments guarantees unrelated to company
performance.
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BAE Systems Annual Report 2007 85
117
22. Retirement benefit obligations
Pension plans
BAE Systems plc operates pension plans for the Group’s qualifying employees in the UK, US and other countries. The principal plans in the
UK and US are funded defined benefit plans and the assets are held in separate trustee administered funds. The plans in other countries are
unfunded or defined contribution plans. Pension
plan valuations are regularly carried out by independent actuaries to determine pension costs
for pension funding and to calculate the IAS 19 deficit.
The disclosures below relate to post-retirement benefit plans in the UK, US and other countries which are accounted for as defined benefit plans
in accordance with IAS 19. The valuations used for the IAS 19 disclosures are based on the most r
ecent actuarial valuation undertaken by
independent qualified actuaries and updated to take account of the requirements of IAS 19 in order to assess the deficit of the plans at
31 December each year. Plan assets are shown at the bid value at 31 December each year.
Post-retirement benefits other than pensions
The Group also operates a number of non-pension post-retirement benefit plans, under which certain e
mployees are eligible to receive benefits
after retirement, the majority of which relate to the provision of medical benefits to retired employees of the Group’s subsidiaries in the US.
The latest valuations of the principal plans, covering retiree medical and life insurance plans in certain US subsidiaries, were performed by
independent actuaries as at 1 January 2007. The
method of accounting for these is similar to that used for defined benefit pension plans.
The financial assumptions used to calculate liabilities for the principal plans were:
UK US
2007
%
2006
%
2005
%
2007
%
2006
%
2005
%
Inflation rate
3.3
3.0 2.8
3.0
3.0 3.0
Rate of increase in salaries 4.3 4.0 3.8 5.8 5.8 5.8
Rate of increase for pensions in payment 2.3 – 3.3 2.9 – 3.0 2.6 – 2.8 – ––
Rate of increase for deferred pensions 3.3 3.0 2.8 n/a n/a n/a
Discount rate 5.8 5.2 4.8 6.5 5.9 5.8
Long-term healthcare cost increases n/a n/a n/a 5.4 5.5 5.6
The assumptions used are estimates chosen from a range of possible actuarial assumptions which, due to the timescale covered, may not
necessarily occur in practice. The bid value of plan assets, which are not intended to be realised in the short term and may be subject to
significant change before they are realised, and the present value of plan liabilities, which are derived from cash flow projections over lon
g
periods and thus inherently uncertain, as at 31 December are shown in the tables below.
For its UK pension arrangements the Group has, for the purpose of calculating its liabilities as at 31 December 2007, used PA 00 (2006 PA 92)
medium cohort tables based on year of birth (as published by the Institute of Actuaries) for both pensioner and non-pensioner members in
con
junction with the results of an investigation into the actual mortality experience of plan members. For its US pension arrangements the
mortality tables used for pensioners and non-pensioners are RP 2000 projected to 2010. The current life expectancies underlying the value of
the accrued liabilities for the main UK and US plans ran
ge from 18 to 22 years for current male pensioners at age 65 and 21 to 25 years for
current female pensioners at age 65.
The Group has a number of healthcare arrangements in the US. The long-term healthcare cost increases shown in the table above are based
on the assumptions that the increases are 10% in 2007 reducing to 5% by 2015 for pre-r
etirement and 10% in 2007 reducing to 5% for
post-retirement.
A summary of the movements in the retirement benefit obligations is shown below. The full disclosures, as required by IAS 19, are provided in
the subsequent information.
Additional disclosure – summary of movements of the retirement benefit obligations
UK
£m
US and
other
£m
Total
£m
Deficit in defined benefit pension plans at 1 January 2007 (2,866) (301) (3,167)
Transfers arising on acquisitions – (22) (22)
Actual return on assets (below)/above expected return (171) 15 (156)
Decrease in liabilities due to changes in assumptions 817 135 952
One-off contributions 76 – 76
Recurring contributions over service cost 166 48 214
Other movements 70 34 104
Deficit in defined benefit pension plans at 31 December 2007 (1,908) (91) (1,999)
US healthcare plans – (21) (21)
Total IAS 19 deficit (1,908) (112) (2,020)
Allocated to equity accounted investments and other participating employers 450 – 450
Group’s share of IAS 19 deficit excluding Group’s share of amounts allocated to equity accounted investments
and other participating employers
(1,458) (112) (1,570)
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
118
22. Retirement benefit obligations (continued)
Amounts recognised on the balance sheet
2007 2006
UK defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
UK defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
Present value of unfunded obligations (1) (97) (13) (111) – (80) (15) (95)
Present value of funded obligations (15,099) (1,912) (103) (17,114) (15,445) (1,931) (111) (17,487)
Fair value of plan assets 13,192 1,918 95 15,205 12,579 1,710 91 14,380
Total IAS 19 deficit, net (1,908) (91) (21) (2,020) (2,866) (301) (35) (3,202)
Allocated to equity accounted investments and other
participating employers
1
450 – – 450 774 – – 774
Group’s share of IAS 19 deficit, net (1,458) (91) (21) (1,570) (2,092) (301) (35) (2,428)
Group’s share of IAS 19 deficit of equity accounted
investments (49) – – (49) (83) – – (83)
Represented by:
Pension prepayments (within trade and other receivables) 14 32 13 59 35 25 11 71
Retirement benefit obligations (1,472) (123) (34) (1,629) (2,127) (326) (46) (2,499)
Group’s share of IAS 19 deficit, net (1,458) (91) (21) (1,570) (2,092) (301) (35) (2,428)
1 Certain of the Group’s equity accounted investments participate in the Group’s defined benefit plans as well as Airbus SAS, the Group’s share of which was disposed of during the year
ended 31 December 2006. As these plans are multi-employer plans the Group has allocated an appropriate share of the IAS 19 pension deficit to the equity accounted investments and
to Airbus SAS based upon a reasonable and con sistent allocation method i
ntended to reflect a reasonable approximation of their share of the deficit. The Group’s share of the IAS 19
pension deficit allocated to the equity accounted investments is included in the balance sheet within equity accounted investments.
Amounts for the current and previous four years are as follows:
Defined benefit pension plans
2007
£m
2006
£m
2005
£m
2004
£m
2003
£m
Defined benefit obligations (17,109) (17,456) (17,767) (14,482) (12,386)
Plan assets
2
15,110 14,289 12,461 10,143 9,305
Total deficit before tax and allocation to equity accounted investments
and other participating employers (1,999) (3,167) (5,306) (4,339) (3,081)
Actuarial gain/(loss) on plan liabilities
952
473 (2,100) (1,221) (788)
Actuarial (loss)/gain on plan assets (156) 521 1,138 265 827
2 at bid value
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BAE Systems Annual Report 2007 85
119
22. Retirement benefit obligations (continued)
Assets of defined benefit pension plans
2007
UK US Total
£m %
Expected
return %
£m %
Expected
return %
£m %
Equities
8,296 63 8.0 1,384 72 9.25 9,680 64
Bonds 3,331 25 4.9 305 16 6.0 3,636 24
Property 1,142 9 6.0 115 6 7.0 1,257 8
Other 423 3 5.5 114 6 5.0 537 4
Total
13,192 100 7.0 1,918 100 8.25 15,110 100
2006
UK US Total
£m %
Expected
return %£m %
Expected
return % £m %
Equities 8,232 65 8.0 1,324 77 8.75 9,556 67
Bonds 2,735 22 4.8 260 15 5.5 2,995 21
Property 1,255 10 6.25 – – n/a 1,255 9
Other 357 3 5.0 126 8 7.0 483 3
Total 12,579 100 7.0 1,710 100 8.5 14,289 100
When setting the overall expected rate of return on plan assets, historical markets are studied and long-term historical relationships between
equities and bonds are preserved. This is consistent with the widely accepted capital market principle that assets with higher volatility generate
a greater return over time. Current market factors such as inflation and interest
rates are evaluated before expected return assumptions are
determined for each asset class. The overall expected return is established with proper consideration of diversification and rebalancing. Peer
data and historical returns are reviewed to check for reasonableness and appropriateness.
Changes in the fair value of plan assets are as follows:
UK defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
Value of plan assets at 1 January 2006 10,833 1,628 92 12,553
Assets acquired on acquisitions – 4 – 4
Expected return on assets 779 132 6 917
Actuarial gain 421 100 3 524
Actual return on assets 1,200 232 9 1,441
Contributions by employer 960 137 10 1,107
Contributions by employer in respect of employee salary sacrifice arrangements 86 – – 86
Total contributions by employer 1,046 137 10 1,193
Members’ contributions (including DWP
3
rebates) 42 11 – 53
Currency loss – (214) (12) (226)
Benefits paid (542) (88) (8) (638)
Value of plan assets at 31 December 2006 12,579 1,710 91 14,380
Assets acquired on acquisitions
4
– 55 – 55
Expected return on assets 879 144 7 1,030
Actuarial (loss)/gain (171) 15 (3) (159)
Actual return on assets 708 159 4 871
Contributions by employer 384 103 8 495
Contributions by employer in respect of employee salary sacrifice arrangements 107 – – 107
Total contributions by employer 491 103 8 602
Members’ contributions (including DWP
3
rebates) 29 10 – 39
Currency loss – (25) (1) (26)
Benefits paid (615) (94) (7) (716)
Value of plan assets at 31 December 2007
13,192 1,918 95 15,205
3 Department for Work and Pensions
4 on 31 July 2007, the Group acquired Armor Holdings, Inc. and its associated pension plans (note 31)
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
120
22. Retirement benefit obligations (continued)
Changes in the present value of the defined benefit obligations before allocation to equity accounted investments and other participating employers
are as follows:
UK defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
Defined benefit obligations at 1 January 2006 (15,492) (2,275) (144) (17,911)
Net liabilities transferred on acquisitions/disposals
5
– 62 – 62
Current service cost (173) (60) (2) (235)
Contributions by employer in respect of employee salary sacrifice arrangements (86) – – (86)
Total current service cost (259) (60) (2) (321)
Members’ contributions (including DWP
3
rebates) (42) (11) – (53)
Past service cost (7) (2) – (9)
Actuarial gain/(loss) on liabilities 499 (26) 2 475
Curtailment gains 52 61 – 113
Interest expense (738) (118) (8) (864)
Currency gain – 270 18 288
Benefits paid 542 88 8 638
Defined benefit obligations at 31 December 2006 (15,445) (2,011) (126) (17,582)
Net liabilities (assumed)/transferred on acquisitions/disposals
4
– (77) – (77)
Current service cost (142) (55) (2) (199)
Contributions by employer in respect of employee salary sacrifice arrangements (107) – – (107)
Total current service cost (249) (55) (2) (306)
Members’ contributions (including DWP
3
rebates) (29) (10) – (39)
Past service cost (14) – (2) (16)
Actuarial gain on liabilities 817 135 12 964
Interest expense (795) (115) (7) (917)
Currency gain – 30 2 32
Benefits paid 615 94 7 716
Defined benefit obligations at 31 December 2007 (15,100) (2,009) (116) (17,225)
3 Department for Work and Pensions
4 on 31 July 2007, the Group acquired Armor Holdings, Inc. and its associated pension plans (note 31)
5 includes liabilities of £67m transferred on the disposal of Atlas Elektronik GmbH
Contributions
The Group contributions made to the defined benefit plans in the year ended 31 December 2007 were £403m (2006 £1,020m). In 2008, the
Group expects to make regular contributions at a similar level to those made in 2007. The Group also incurred a charge in respect of the cash
contributions of £62m (2006 £57m) paid to defined contribution plans for employees. It expects to make a contr
ibution of £63m to these plans
in 2008.
The amounts recognised in the income statement after allocation to equity accounted investments and other participating employers are
as follows:
2007 2006
UK
defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
UK
defined
benefit
pension
plans
£m
US and
other
pension
plans
£m
US
healthcare
plans
£m
Total
£m
Included in operating costs:
Current service cost (113) (55) (2) (170) (129) (60) (2) (191)
Past service cost (10) – (2) (12) (5) (2) – (7)
(123) (55) (4) (182) (134) (62) (2) (198)
Included in other income:
Curtailments and settlements ––––49 61 – 110
Included in finance costs:
Expected return on plan assets 694 144 7 845 601 132 6 739
Interest on obligations (631) (115) (7) (753) (568) (118) (8) (694)
63 29 – 92
33 14 (2) 45
Included in share of results of equity accounted investments:
Group’s share of equity accounted investments’ operating costs (6) – – (6) (7) – – (7)
Group’s share of equity accounted investments’ finance costs 2––2 – – – –
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
121
22. Retirement benefit obligations (continued)
A one percentage point change in assumed healthcare cost trend rates would have the following effects:
One percentage
point increase
£m
One percentage
point decrease
£m
Effect on the aggregate of service cost and interest cost 0.2 0.2
Effect on defined benefit obligations 2 2
A 0.5 percentage point change in net discount rates used to value liabilities would have the following effect:
0.5 percentage
point increase
£bn
0.5 percentage
point decrease
£bn
Effect on defined benefit obligations 1.2 1.4
23. Provisions
Aircraft
financing
£m
Warranties and
after-sales service
£m
Reorganisations –
ongoing operations
£m
Legal costs,
environmental
and other
£m
Total
£m
Non-current – 82 14 175 271
Current 52 65 38 269 424
At 1 January 2007 52 147 52 444 695
Created 105 48 14 238 405
Released (49) (23) (13) (94) (179)
Utilised (20) (22) (25) (114) (181)
Provisions and fair values arising on acquisitions (note 31) – 9 – 61 70
On disposals – (5) – – (5)
Discounting ––– 77
Exchange adjustments (3) 2 – (2) (3)
Other provision movements – 1 – (1) –
At 31 December 2007
85 157 28 539 809
Represented by:
Non-current 65 93 4 237 399
Current 20 64 24 302 410
85 157 28 539 809
Aircraft financing
The provision includes probable exposures under residual value guarantees issued by the Group on previous sales transactions. Further
information is provided in note 24. Such costs are generally incurred within five years.
Warranties and after-sales service
Warranties and after-sales service are provided in the normal course of business with provisions for associated costs being made based
on an assessment of future claims with reference to past experience. Such costs are generally incurred within three years post-delivery.
Reorganisations – ongoing operations
The costs associated with the reorganisation programmes are supported by detailed plans and based on previous experience as well as other
known factors. Such costs are generally incurred within one to three years.
Legal costs, environmental and other provisions
The Group holds provisions for expected legal, environmental and other costs that it expects to incur over an extended period. These costs are
based on past experience of similar items and other known factors and represent management’s best estimate of the likely outcome.
Included within legal costs, environmental and other is £75m (2006 £82m) in
respect of the cash-settled elements of certain of the Group’s
share option schemes (note 26). The costs in respect of this liability are expected to occur over the next five years.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
122
24. Contingent liabilities and commitments
Aircraft financing contingent liabilities
Included within the aircraft financing provision of £85m (note 23) is an exposure of £70m as discussed below:
2007
£m
2006
£m
Potential future cash flow payments in respect of aircraft financing obligations
134
191
Anticipated aircraft values (55) (159)
Adjustments to net present values (9) (5)
Net exposure provided
70
27
The Group has provided residual value guarantees (RVGs) in respect of certain commercial aircraft sold. At 31 December 2007 the Group’s
exposure to make future payments in respect of these arrangements was £134m (2006 £191m). The Group’s net exposure to these
guarantees is covered by the provisions held and the residual values of the related aircraft.
The net exposure has increased during the year
as a result of the re-assessment of anticipated aircraft values and the settlement of the
commitments of six RVGs.
The Group is also exposed to actual and contingent liabilities arising from commercial aircraft financing and RVGs given by Saab AB. Provision
is made against the expected net exposures on a net present value basis within the accounts of Saab. The Group’s share of such exposure is
limited to its perce
ntage shareholding in Saab.
Guarantees and performance bonds
The Group has entered into a number of guarantee and performance bond arrangements in the normal course of business. Provision is made
for any amounts that the directors consider may become payable under such arrangements.
Operating lease commitments – where the Group is the lessee
The Group leases various offices, facto
ries, shipyards and aircraft under non-cancellable operating lease agreements. The leases have varying
terms, escalation clauses and renewal rights.
The future aggregate minimum lease payments under non-cancellable operating leases and associated future minimum sublease income
are as follows:
Paymen
ts due:
2007
£m
2006
£m
Not later than one year
125
121
Later than one year and not later than five years 460 393
Later than five years 731 731
1,316
1,245
Total of future minimum sublease income under non-cancellable subleases 249 212
Capital commitments
Capital expenditure contracted for but not provided for in the accounts is as follows:
2007
£m
2006
£m
Property, plant and equipment
121
133
Intangible assets 6 5
127
138
Treasury contingent liabilities
Treasury contingent liabilities are set out in note 32.
Other contingent liabilities
The Group is subject to an ongoing investigation by the UK Serious Fraud Office (the SFO) in connection with marketing of the Group’s products.
The Group is co-operating fully with the SFO.
At this stage management cannot determine whether or not it might lead to any proceedings being brought against the Group. Accordingly, the
pote
ntial for fines or other penalties cannot currently be assessed, although the directors continue to consider that the Group has not acted
unlawfully in relation to any of the matters under investigation. As the investigation is ongoing it is not possible to identify the timescale in which
these issues might be resolved.
In addition, in June 2007, the US Department of Justice notified the Group that it had commenced a fo
rmal investigation relating to the Group’s
compliance with anti-corruption laws, including its business concerning the Kingdom of Saudi Arabia. Again, given the status of this matter it is
not possible to provide any details of any possible future financial effects that might result from the investigation and any subsequent actions or
events that might occur as a result of the investigation. Equally it is not possible to pr
ovide any timescale in which these issues might be
resolved. The directors continue to consider that the Group has not acted unlawfully in relation to its dealings with the Kingdom of Saudi Arabia
or in relation to anti-corruption laws.
Should any financial effects arise as a result of these investigations the directors consider it unlikely that there is any likelihood of reimbursement
for such costs fr
om any sources other than certain rights to recover reimbursement of the legal costs under the Group's insurance policies.
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BAE Systems Annual Report 2007 85
123
25. Share capital
Equity Non-equity Total
Ordinary shares
of 2.5p each
Special Share
of £1
Number of
shares
m
Nominal
value
£m
Number of
shares
Nominal
value
£
Nominal
value
£m
Authorised
At 1 January 2007 and 31 December 2007 4,450 111 1 1 111
Issued and fully paid
At 1 January 2006 3,219 80 1 1 80
Exercise of options 24 1 – – 1
Conversion of preference shares 3 – – – –
At 1 January 2007 3,246 81 1 1 81
Exercise of options 29 1 – – 1
Placing of shares 174 5 – – 5
Conversion of preference shares 125 3 – – 3
At 31 December 2007
3,574 90 1 1 90
Special Share
One Special Share of £1 in the Company is held on behalf of the Secretary of State for Business, Enterprise and Regulatory Reform (formerly
the Secretary of State for Trade and Industry) (the Special Shareholder). Certain parts of the Company’s Articles of Association cannot be
amended without the consent of the Special Shareholder. These articles include the requirement that no for
eign person, or foreign persons
acting in concert, can have more than a 15% voting interest in the Company, the requirement that the majority of the directors are British, the
requirement that decisions of the directors at their meetings, in their committees or via resolution must be appr
oved by a majority of British
directors and the requirement that the Chief Executive and any executive chairman are British citizens. The effect of these requirements can
also be amended by regulations made by the directors and approved by the Special Shareholder.
The Special Shareholder may require the Company at any time to redeem the Special Share at par or to conver
t the Special Share into one ordinary
voting share. The Special Shareholder is entitled to receive notice of and to attend general meetings and class meetings of the Company’s
shareholders but has no voting right, nor other rights, other than to speak in relation to any business in respect of the Special Share.
Placing of shares
On 11 May 2007, 174,418,605 new ordinary sha
res of 2.5p each were placed at a price of 430p, raising £750m before expenses.
Conversion of preference shares
As at 1 January 2007, the Company also had in issue 259,962,909 7.75p (net) cumulative redeemable preference shares of 25p each. During
the year, the shares were converted into ordinary shares of 2.5p each on the basis of 0.47904 ordinary shares for each preference share, as a
result of which 124,532,630 ordinary shares of 2.5p were issued. The
re were, therefore, no preference shares in issue as at 31 December 2007.
In accordance with IAS 32 the convertible preference shares were considered to be a compound financial instrument consisting of both a debt
element and an equity component which required separate accounting treatment. Followin
g conversion to ordinary shares the amounts
previously recognised within equity (note 27) and within loans and overdrafts (note 20) have been extinguished.
Treasury shares
In connection with the disposal of its interest in Airbus, the Company stated its intention to return up to £500m to ordinary shareholders by way
of on-market purchases of ordi
nary shares using authorities granted at the 2006 AGM and to hold the repurchased shares initially in treasury.
The Company commenced this buyback programme on 26 October 2006 and, as at 31 December 2007, 61,945,000 (2006 28,675,000) 2.5p
ordinary shares with an aggregate nominal value of £2m (2006 £1m) were held in treasury.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
124
26. Share-based payments
Details of the terms and conditions of each share option scheme are given in the Remuneration report on pages 64 to 83.
Executive Share Option Scheme (ExSOS)
Equity-settled options
2007 2006
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Outstanding at the beginning of the year
56,202 2.80
71,399 2.78
Granted during the year 6,161 4.59
6,082 4.28
Converted during the year – – 8,641 2.15
Exercised during the year (19,294) 2.34 (13,353) 2.40
Expired during the year (11,341) 3.07 (16,567) 3.23
Outstanding at the end of the year
31,728 3.33
56,202 2.80
Exercisable at the end of the year 9,922 2.68
16,269 2.86
Cash-settled share appreciation rights
2007 2006
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Outstanding at the beginning of the year
35,805 2.82
69,129 2.88
Converted during the year – – (8,641) 2.15
Exercised during the year (8,512) 2.48 (4,843) 2.29
Expired during the year (10,300) 3.32 (19,840) 3.45
Outstanding at the end of the year
16,993 2.67
35,805 2.82
Exercisable at the end of the year 11,452 2.67 11,736 3.01
2007 2006
Equity-settled Cash-settled Equity-settled Cash-settled
Range of exercise price of outstanding options (£)
1.72 – 4.87 1.72 – 4.21
1.72 – 4.87 1.72 – 4.21
Weighted average remaining contracted life (years) 76 7 6
Weighted average fair value of options granted (£) 1.46 – 1.30 –
Expense recognised for the year (£m) 815 9 18
Performance Share Plan (PSP)
Equity-settled options
2007
Number of
shares
‘000
2006
Number of
shares
‘000
Outstanding at the beginning of the year
25,608
18,917
Granted during the year 4,107 4,055
Converted during the year – 5,669
Exercised during the year (7,240) (2,495)
Expired during the year (1,523) (538)
Outstanding at the end of the year
20,952
25,608
Exercisable at the end of the year 963 –
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
125
26. Share-based payments (continued)
Cash-settled options
2007
Number of
shares
‘000
2006
Number of
shares
‘000
Outstanding at the beginning of the year
12,701
21,389
Converted during the year – (5,669)
Exercised during the year (4,053) (2,188)
Expired during the year (699) (831)
Outstanding at the end of the year
7,949
12,701
No options were exercisable at the end of the year.
2007 2006
Equity-settled Cash-settled Equity-settled Cash-settled
Weighted average remaining contracted life (years)
44
5 4
Weighted average fair value of options granted (£) 2.29 – 1.88 –
Expense recognised for the year (£m) 718 8 22
The exercise price for the PSP is £nil (2006 £nil).
Restricted Share Plan (RSP)
All awards are equity-settled.
2007
Number of
shares
‘000
2006
Number of
shares
‘000
Outstanding at the beginning of the year
1,338
1,047
Granted during the year – 303
Exercised during the year (619) (9)
Expired during the year (116) (3)
Outstanding at the end of the year
603
1,338
Exercisable at the end of the year – –
2007 2006
Weighted average remaining contracted life (years)
1
1
Weighted average fair value of options granted (£) – 3.89
Expense recognised for the year (£m) 1 1
The exercise price for the RSP is £nil (2006 £nil).
Share Matching Plan (SMP)
All awards are equity-settled.
2007
Number of
shares
‘000
2006
Number of
shares
‘000
Granted during the year
464
–
Expired during the year (1) –
Outstanding at the end of the year
463
–
Exercisable at the end of the year – –
2007 2006
Weighted average remaining contracted life (years)
2
–
Weighted average fair value of options granted (£) 4.59 –
Expense recognised for the year (£m) – –
The exercise price for the SMP is £nil.
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
126
26. Share-based payments (continued)
Save-As-You-Earn (SAYE)
Equity-settled options
2007 2006
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Outstanding at the beginning of the year
21,174 1.71
33,651 1.80
Exercised during the year (10,873) 2.10 (11,215) 1.96
Expired during the year (824) 1.64 (1,262) 1.74
Outstanding at the end of the year
9,477 1.25
21,174 1.71
Exercisable at the end of the year 157 1.62 128 1.74
Cash-settled share appreciation rights
2007
2006
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Outstanding at the beginning of the year
8,923 2.76
14,388 2.70
Exercised during the year (3,214) 2.08 (4,361) 2.48
Expired during the year (555) 3.18 (1,104) 2.91
Outstanding at the end of the year
5,154 3.14
8,923 2.76
Exercisable at the end of the year 1,865 2.40 1,592 1.74
2007
2006
Equity-settled Cash-settled
Equity-settled Cash-settled
Range of exercise price of outstanding options (£)
0.93 – 2.56 1.72 – 3.56
0.93 – 3.21 1.72 – 3.56
Weighted average remaining contracted life (years) 11 2 2
Expense recognised for the year (£m) 27 3 7
Details of options granted in the year
The fair value of equity-settled awards granted in the year has been measured using the weighted average inputs below and the following
valuation models:
PSP – Monte Carlo
RSP – Dividend valuation model
ExSOS & SAYE – Binomial model
2007 2006
Range of share price at date of grant (£)
4.32 – 4.86
4.18
Exercise price (£) 0 – 4.79 0 – 4.28
Expected option life (years) 4 – 5 3 – 5
Volatility 25 – 36% 27 – 38%
Spot dividend yield 2.5 – 2.8% 2.5%
Risk free interest rate 5.0 – 5.3% 4.4%
Volatility was calculated with reference to the Group’s weekly share price volatility, after allowing for dividends and stock splits, for the greater of
30 weeks or for the period until vest date.
The average share price in the year was £4.52 (2006 £3.96).
The liability in respect of the cash-settled elements of the schemes shown above and reported within provisions at 31 December 2007 is £75m
(2006 £82m).
The intrinsic value of cash-settled options that have vested at 31 December 2007 is £26m (2006 £14m).
Share Incentive Plan
The Group also incurred a charge of £16m in respect of the all-employee free shares element of the Share Incentive Plan.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
127
27. Reconciliation of movement in capital and reserves
Attributable to equity holders of the parent
Issued
share
capital
£m
Share
premium
£m
Equity
option of
preference
shares
£m
Other
reserves
£m
Retained
earnings
£m
Total
£m
Minority
interests
£m
Total
equity
£m
Balance at 1 January 2006 80 782 78 4,720 (2,872) 2,788 16 2,804
Total recognised income and expense – – – (476) 2,177 1,701 3 1,704
Share-based payments
1
– – – – 46 46 – 46
Share options:
Proceeds from shares issued 1 52 – – – 53 – 53
Purchase of own shares by ESOP – – – – (12) (12) – (12)
Conversion of preference shares – 7 (2) 6 (6) 5 – 5
Purchase of treasury shares – – – – (112) (112) – (112)
Release of unrealised gain on the sale of Atlas Elektronik – – – (11) – (11) – (11)
Revaluation of net assets acquired by equity accounted
investments (note 14)
––– –5 5 –5
Reclassification – – – 91 (91) – – –
Other ––––– – (2)(2)
Ordinary share dividends – – – – (346) (346) – (346)
At 31 December 2006 81 841 76 4,330 (1,211) 4,117 17 4,134
Total recognised income and expense – – – 72 1,291 1,363 21 1,384
Placing of shares (net of costs) 5 – – – 736 741 – 741
Share-based payments – – – – 34 34 – 34
Share options:
Proceeds from shares issued 1 63 – – – 64 – 64
Purchase of own shares – – – – (50) (50) – (50)
Conversion of preference shares 3 318 (76) 229 (229) 245 – 245
Purchase of treasury shares – – – – (152) (152) – (152)
Other ––––– – (1)(1)
Ordinary share dividends – – – – (396) (396) (1) (397)
At 31 December 2007
90 1,222 – 4,631 23 5,966 36 6,002
Other reserves include a merger reserve of £4,589m (2006 £4,589m), a statutory reserve of £202m (2006 £202m), a translation reserve of
£217m debit (2006 £259m debit) and a hedging reserve of £57m (2006 £27m). Under Section 4 of the British Aerospace Act 1980 the statutory
reserve may only be applied in paying up unissued shares of the Group to be allotted to members of the Group as fully paid bonus shar
es.
1 The credit in respect of share-based payments for the year ended 31 December 2006 comprises £21m in respect of equity-settled share-based paym ent schemes, £21m relating
to a change in the terms of certain share-based payment schemes from cash-settled to equity-settled and £4m relating to discontinued operations.
Placing of shares
On 11 May 2007, 174,418,605 new ordinary shares of 2.5p each were issued by a placing of shares (note 25). The placing structure utilised
attracted merger relief under Section 131 of the Companies Act 1985, resulting in a credit to the merger reserve of £736m. Subsequent
internal transactions required to complete the placing structure have resulted in this part of the m
erger reserve being transferred to the
retained earnings reserve.
Own shares held
Own shares held, including treasury shares and shares held by BAE Systems ESOP Trust, are recognised as a deduction from retained earnings.
Conversion of preference shares
During the year, 259,962,909 (2006 6,116,123) preference shares were converted into ordina
ry shares of 2.5p each on the basis of 0.47904
ordinary shares for each preference share (note 25).
Treasury shares
During the year, 33,270,000 ordinary shares of 2.5p each were repurchased under the buyback programme announced in October 2006. As
at 31 December 2007, 61,945,000 (2006 28,675,000) 2.5p ordinary shares with an aggregate nominal value of £2m (2006 £1m) were held
in treasu
ry.
BAE Systems ESOP Trust
The Group has an ESOP discretionary trust to administer the share plans and to acquire Company shares, using funds loaned by the Group,
to meet commitments to Group employees. A dividend waiver was in operation for shares within the ESOP Trust, other than those owned
beneficially by the participants, for the dividend paid in November 2007.
At 31 Decembe
r 2007, the ESOP held 1,552,015 (2006 2,382,835) 2.5p ordinary shares with a market value of £8m (2006 £10m). The shares
held by the ESOP are recorded at cost and deducted from retained earnings until such time as the shares vest unconditionally to employees.
A dividend waiver is also in operation over shares within the Company’s Share Incentive Plan Trust other than those shares owned beneficially
by the participan
ts.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Notes to the Group accounts (continued)
128
28. Reconciliation of operating business cash flow
2007
£m
Restated
1
2006
£m
Cash inflow from operating activities
2,162
778
Purchases of property, plant and equipment (307) (419)
Additions to intangible assets (31) (27)
Equity accounted investment funding (4) –
Proceeds from the sale of property, plant and equipment
13
135
Proceeds from the sale of investment property
53
174
Proceeds from the sale of non-current other investm
ents
15
1
Purchase of non-current other investments (1) (5)
Dividends received from equity accounted investments
78
145
Operating business cash flow
1,978
782
Electronics, Intelligence & Support
302
273
Land & Armaments
10
137
Programmes & Support
807
449
International Businesses
678
171
HQ & Other Businesses
181
(225)
Discontinued operations
–
(23)
Operating business cash flow
1,978
782
1 business group analysis restated following changes to the Group’s organisational str ucture
29. Net cash/(debt) as defined by the Group
2007
£m
2006
£m
Term deposits – non-current
–
4
Term deposits – current 164 503
Cash and cash equivalents 3,062 3,100
3,226
3,607
Loans – non-current (2,197) (2,776)
Loans – current (283) (308)
Overdrafts – current (16) (26)
Loans and overdrafts – current (299) (334)
Cash received on customers’ account
1
(included within payables) (30) (62)
(2,526) (3,172)
Closing net cash as defined by the Group
700
435
Movement in net cash/(debt) as defined by the Group
2007
£m
2006
£m
Operating business cash flow
1,978
782
Interest and preference dividends (65) (207)
Taxation (112) (85)
Free cash inflow
1,801
490
Acquisitions and disposals (1,574) 1,330
Debt acquired on acquisition of subsidiary undertaking (538) –
Proceeds from issue of share capital
805
53
Equity dividends paid (396) (346)
Dividends paid to minority interests (1) –
Preference share conversion
245
6
Other non-cash movements
57
(11)
Purchase of treasury shares (152) (112)
Purchase of ow
n shares (50) (12)
Foreign exchange
36
323
Movement in cash received on customers’ account
1
32
(9)
Movement in net cash as defined by the Group
265
1,712
Opening net cash/(debt) as defined by the Group
435
(1,277)
Closin
g
net cash as defined by the Group
700
435
1 cash received on customers’ account is the unexpended cash received from customers in advance of delivery which is subject to advance payments guarantees unrelated to
company performance
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
129
29. Net cash/(debt) as defined by the Group (continued)
Cash flows in relation to acquisitions and disposals
Subsidiaries
Equity
accounted
investments
Armor
Holdings
£m
Other
acquisitions
2
£m
Total
acquisitions
£m
Inertial
Products
£m
SELEX
£m
Other
disposals
2
£m
Total
disposals
£m
XPS/
XHRS
£m
Other
£m
Total
£m
Cash (consideration)/proceeds (1,696) (9) (1,705) 65 24 7
96
57 (1) (1,553)
Transaction costs incurred
by acquiree (26) – (26) –––– – – (26)
(1,722) (9) (1,731) 65 24 7
96
57 (1) (1,579)
Cash and cash equivalents net of
overdrafts acquired/(disposed) 6 – 6 (1) – – (1) – – 5
Acquisitions and disposals (1,716) (9) (1,725) 64 24 7
95
57 (1) (1,574)
Debt acquired on acquisition
of subsidiary
(538) – (538) –––– – – (538)
(2,254) (9) (2,263) 64 24 7
95
57 (1) (2,112)
2 other acquisitions and disposals are described in notes 31 and 9, respectively
30. Dividends
2007
£m
2006
£m
Equity dividends
Prior year final 6.9p dividend per ordinary share paid in the year (2006 6.3p) 221 203
Interim 5.0p dividend per ordinary share paid in the year (2006 4.4p) 175 143
396
346
After the balance sheet date, the directors proposed a final dividend of 7.8p (2006 6.9p). The dividend, which is subject to shareholder
approval, will be paid on 2 June 2008 to shareholders registered on 18 April 2008. The ex-dividend date is 16 April 2008.
Shareholders who do not at present participate in the Company’s Dividend Reinvestment Plan and wish to receive the final dividend in shares
rather than cash should complete a mandate form for the Divide
nd Reinvestment Plan and return it to the registrars no later than 9 May 2008.
31. Acquisition of subsidiaries
The Group made a number of acquisitions during the year, the most significant of which was of Armor Holdings, Inc. in the US. The acquisitions
took place throughout the year, but if they had occurred on 1 January 2007, combined sales of Group and equity accounted investments would
have been £17.4bn, revenue £16.0bn and profit for the year from continuing operations £946m.
Armor Holdings, Inc.
On 31 July 2007, the Group acquired 100% of the issued share capital of Armor Holdings, Inc. (Armor), in the US, for a consideration of
£1,696m, excluding transaction costs incurred by the acquiree (£26m). Goodwill arising on consolidation amounted to £1,554m. Armor is a
major manufacturer of tactical wheeled vehicles and a leading provider of vehicle and individual armour systems a
nd survivability technologies
for the military and for the law enforcement and commercial security markets.
In the period from acquisition to 31 December 2007, Armor contributed EBITA
1
of £77m and profit after tax of £18m to the Group’s
consolidated results.
Mobile International, a subsidiary of Armor, was acquired with a view to immediate resale. Accordingly, it has been classified as held for sale in
the acquisition balance sheet and as at 31 December 2007 (note 19).
The acquisition of Armor complements the existing US business in the Land & Armaments business group creating synergy potential. It allows
for continued development of the Mine Resistant Ambush Protected (MRAP) vehicles and Family of Medium Tactical Vehicles (FMTV)
programmes, as well as advanced ceramics for body armour. The opportunities presented by these circumstances do not translate to separately
identifiable intangible assets, but represent much of the assessed value within the Land & Armaments business group supporting the
recog
nised goodwill.
Certain of the fair values assigned to the net assets acquired are provisional. These will be amended as necessary in light of subsequent
knowledge or events to the extent that these reflect conditions as at the date of acquisition.
1 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
130
31. Acquisition of subsidiaries (continued)
The acquisition had the following effect on the Group’s assets and liabilities:
Book value
£m
Accounting
policy
alignments
£m
Fair value
adjustments
£m
Fair value
£m
Intangible assets 172 – 581 753
Property, plant and equipment 85 (1) 8 92
Inventories 163 (5) (4) 154
Receivables 158 (1) (1) 156
Current tax receivable 33 – 2 35
Deferred tax assets 23 3 – 26
Payables (204) (1) (20) (225)
Deferred tax liabilities (87) – (145) (232)
Retirement benefit obligations (24) 4 (2) (22)
Provisions (13) – (57) (70)
Cash and cash equivalents 6 – – 6
Loans (386) (5) (147) (538)
Held for sale 14 – (7) 7
Net (liabilities)/assets acquired (60) (6)
208 142
Goodwill
1,554
Consideration
1,696
Consideration satisfied by:
Cash 1,682
Directly attributable costs:
Paid 14
Accrued –
1,696
The intangible assets acquired as part of the acquisition of Armor can be analysed as follows:
£m
Programmes 551
Customer relationships 129
Trademarks 69
Patents 4
753
Other acquisitions
Other acquisitions include the acquisition of Pitch Technologies AB and iSC for a consideration of £5m and £4m, respectively. In each case,
100% of the shares were acquired. As a result of these acquisitions, an additional £9m of goodwill was generated in the year.
During 2006, the Group acquired 100% of the shares of National Sensor Systems, LLC. for £5m in cash and paid deferred consideration of £7m
in respect of its acquisition, i
n May 2005, of OMC Group.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
131
32. Financial risk management
A discussion of the Group’s treasury objectives and policies and the use of financial instruments can be found in the Directors’ report. Financial
instruments comprise net debt (note 29) together with other financial assets and other financial liabilities (note 17) and other instruments
deemed to be financial instru
ments under IAS 32 including non-current receivables, non-current payables and non-current provisions.
Hedging instruments
The notional, or contracted, amounts of derivative financial instruments are shown below, analysed between foreign exchange contracts and
interest rate co
ntracts, classified by year of maturity.
31 December 2007 31 December 2006
Foreign exchange contracts
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Net forward (sales)/purchase contracts
US dollar (2,366) 141 (12) (2,237) (1,498) 25 (38) (1,511)
Euro 1,277 425 (1) 1,701 643 10 3 656
Other 131 3 – 134 36 2 – 38
(958)
569
(13) (402) (819) 37 (35) (817)
31 December 2007 31 December 2006
Interest rate contracts
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Interest rate swap contracts
US dollar – 654 – 654
128 664 – 792
Sterling 30 120 31 181
26 99 53 178
30 774 31 835
154 763 53 970
31 December 2007 31 December 2006
Cross-currency swap contracts
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Not
exceeding
one year
£m
Between
one year
and
five years
£m
More
than
five years
£m
Total
£m
Net forward (sales)/purchase contracts
US dollar 38 176 339 553 143 252 301 696
Swedish krona (143) – – (143) – (137) – (137)
(105)
176 339 410
143 115 301 559
Fair value of financial instruments
The fair value of a financial instrument is the price at which one party would assume the rights and/or duties of another party.
The fair values of financial instruments have been determined based on available market information at the balance sheet date, and the
valuation methodologies listed below:
– the fair value of forward foreign exchange contracts are calculated by discounting the co
ntracted forward values and translating at the
appropriate balance sheet rates;
– the fair value of both interest rate and cross-currency swaps are calculated by discounting expected future principal and interest cash flows
and translating at the appropriate balance sheet rates;
– the fair value of loans and overdrafts has been estimated by discounting the future cash flows to net pr
esent values using appropriate market-
based interest rates prevailing at 31 December.
Due to the variability of the valuation factors, the fair values presented at the balance sheet date may not be indicative of the amounts the
Group would expect to realise in a current market environment.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
84 www.baesyste ms.com
Notes to the Group accounts (continued)
132
32. Financial risk management (continued)
The following table compares the estimated fair values of certain financial assets and liabilities to their carrying values at the balance
sheet date
1
.
Net carrying
amount
2007
£m
Estimated
fair value
2007
£m
Net carrying
amount
2006
£m
Estimated
fair value
2006
£m
Assets
Non-current
Other investments – – 44
Other receivables
2
265 265 569 569
Other financial assets 48 48 51 51
Current
Other investments 164 164 503 503
Other financial assets 101 101 50 50
Cash and cash equivalents 3,062 3,062 3,100 3,100
Liabilities
Non-current
Loans (2,197) (2,399) (2,776) (2,964)
Other financial liabilities (26) (26) (45) (45)
Current
Loans and overdrafts (299) (308) (334) (339)
Other financial liabilities (71) (71) (50) (50)
1 the estimated fair values of the remaining financial assets and liabilities are consistent with their carrying values at the balance sheet date
2 net carrying amount approximates to estim ated fair value as there is no active market
Interest rate risk
Based on contracted maturities and/or repricing dates, the following amounts are exposed to interest rate risk over the future as shown below:
2008
£m
2009
£m
2010
£m
2011
£m
2012
£m
Beyond
2012
£m
Assets
Non-current
Other receivables 109 – – – – –
Current
Other investments 164–– – ––
Cash and cash equivalents 3,062 – – – – –
Liabilities
Non-current
Loans (577) (577) (545) (263) (127) (94)
Current
Loans and overdrafts (41)–– – ––
Collateral
As shown above, the Group has entered into a number of financial derivative contracts to hedge certain long-term foreign currency and interest
rate exposures. Cash collateral payments can be required to be made periodically to the counterparty dependent on the market value of these
financial derivatives. Cash deposited in this way is treated as a non-cu
rrent receivable and at 31 December 2007 totalled £109m (2006 £115m).
Committed undrawn borrowing facilities
At 31 December 2007 the Group had a committed Revolving Credit Facility (RCF) of £1.5bn, which expires in more than two years but less than
five years (2006 £1.5bn which expires in more than two years but less than five years). The RCF was originally contracted for five years until
2010. However, it has been extended by the agreement of two one-year extension
s until 2012, although the available amount for the final year
has been reduced from £1.5bn to £1.3bn. The RCF remained undrawn throughout the year.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
133
32. Financial risk management (continued)
Interest rate fluctuations
The objective of interest rate risk management is to reduce the exposure to interest rate fluctuations on borrowings and deposits. This is
achieved through varying the proportion of fixed rate debt relative to floating rate debt over the forward time horizon by utilising derivative
instruments, mainly interest rate swaps. The Group’s current in
terest rate managemen t policy is that a minimum of 25% (2006 25%) and a
maximum of 75% (2006 75%) of debt is maintained at fixed interest rates. At 31 December 2007, the Group had 75% (2006 72%) of fixed
rate debt and 25% (2006 28%) of floating rate debt based on a gross debt of £2.5bn (2006 £3.1bn).
The floating rate debt has been predominantly achieved by entering into interest rate swaps which swap the fixed rate US dollar interest payable
o
n debt into either floating rate sterling or US dollars. At the end of 2007, the Group had a total of $1.3bn (2006 $1.6bn) of this type of swap
outstanding with a weighted average duration of 3.2 years (2006 3.6 years). In respect of the fixed rate debt the weighted average period in
respect of which interest is fixed was seven years (2006 six years).
Given the level of short-term interest rates during the year, the average cost of the floating rate debt was 6.7%, with 6.3% on US dollars and
7.3% on sterli
ng (2006 both 5.8%). The cost of the fixed rate debt was 7.1% (2006 7.0%). A change of 100 basis points in short-term rates
applied to the average fixed/floating mix and level of borrowings would vary the interest cost to the Group by £7m (2006 £11m).
In respect of cash deposits, given the fluctuation in the Group’s working capital requirements, cash is generally invested for short-term periods
based at floating interest rates. A change of 100 basis points in the average interest
rates during the year applied to the average cash deposits
would vary the interest receivable by £23m (2006 £15m).
Credit risk on cash and cash equivalents
The Group is exposed to credit risk on its cash and cash equivalents to the extent of non-performance by its counterparties in respect of
financial instruments. However, the Group has policies in place to ensure credit risk is limited by placing concentration limits. BAE System
s has
a credit limit system to manage actively its exposure to treasury counterparties. The cash and cash equivalents balance at 31 December 2007
of £3,062m (2006 £3,100m) was invested with 26 (2006 45) financial institutions. The system assigns a maximum exposure based on the
counterparty’s size, FT composite rating and Credit Default Swap price. These limits are regularly monitored and updated. The Group has
m
aterial receivables due from the UK, US and Saudi Arabian governments where credit risk is not considered to be an issue. For the remaining
trade receivables no one counterparty constitutes more than 3% of the balance (2006 4%).
The cash and cash equivalents of the Group are invested in non-speculative financial instruments which are usually highly liquid such as short-
term deposits. The Group, therefore, believes it has negligible exposure to price risk.
Currency risk
In order to protect itself against currency fluctuations, the Group’s policy is to hedge all material firm transactional exposures. Further explanation
is set out in the Risk management and principal risks section of the Directors’ report on page 50.
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 64 to 83
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 o
n an arm’s-length basis and settled
on normal trade terms. The more significant transactions are disclosed below:
For the year ended 31 December 2007
Related party
Sales to
related
party
£m
Purchases
from
related
party
£m
Amounts
owed by
related
party
£m
Amounts
owed to
related
party
£m
Lease
income/
(expense)
with related
party
£m
Other
£m
Eurofighter Jagdflugzeug GmbH
1,063 – 107 – – –
Flagship Training Limited –1– 7 ––
Fleet Support Limited 121 – ––
Gripen International KB – – 109 136 – –
MBDA SAS 143 11 20 709 2 –
Panavia Aircraft GmbH 71 132 1 – – –
Saab AB 3 – – – – 1
CTA International SAS – 2 – – – –
Flight Control System Management GmbH – – 1 1 – –
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84 www.baesyste ms.com
Notes to the Group accounts (continued)
134
33. Related party transactions (continued)
For the year ended 31 December 2006
Related party
Sales to
related
party
£m
Purchases
from
related
party
£m
Amounts
owed by
related
party
£m
Amounts
owed to
related
party
£m
Lease
income/
(expense)
with related
party
£m
Other
£m
Airbus SAS
1
50 – – – 15 –
Eurofighter Jagdflugzeug GmbH 1,212 – 97 66 – –
Flagship Training Limited – 2 – 16 – –
Fleet Support Limited 1 8 – 2 – –
Gripen International KB – – 103 115 – –
MBDA SAS 124 12 14 482 2 –
Panavia Aircraft GmbH 75 53 2 – – –
Saab AB 4 2 – – – 1
CTA International SAS 1 – – – – –
Silicon Sensing Systems ––– 7 ––
Xchanging Procurement Services
2
16 101 2 2 – –
Xchanging HR Services
2
–26 – 2 – –
1 transactions up to the date of disposal
2 no transactions with Xchanging Procurement Services and Xchanging HR Services are reported during 2007 as the effective date of the disposal of the Group’s interest in these entities
was 1 January 2007
34. Group entities
Principal subsidiary entities Principal activities
Principally
operates in
Country of
incorporation
BAE Systems (Operations) Limited
(Held via BAE Systems Enterprises Limited and
BAE Systems (Overseas Holdings) Limited)
Defence and commercial aerospace
activities
UK England and
Wales
BAE Systems Australia Limited
(Held via BAE Systems Australia Holdings Limited)
Defence support and avionics Australia Australia
BAE Systems Electronics Limited
(Held via Meslink Limited)
Naval prime contracting UK England and
Wales
BAE Systems Marine Limited
(Held via BAE Systems Marine (Holdings) Limited)
Shipbuilding UK England and
Wales
BAE Systems Integrated System Technologies Limited
(Held via BAE Systems Electronics Limited)
Defence systems UK England and
Wales
BAE Systems Inc.
(Held via BAE Systems Holdings Inc.)
Defence systems US US
BAE Systems AH Inc. (formerly Armor Holdings, Inc.)
(Held via BAE Systems Inc.)
Manufacture of military vehicles and
supply of vehicle and armour systems
US US
BAE Systems Land & Armaments Inc.
(Held via BAE Systems Inc.)
Manufacture and support of military
vehicles and ship repair
US & Sweden US
BAE Systems Land Systems (Munitions & Ordnance) Limited
(Held via BAE Systems (Holdings) Limited)
Manufacture of ammunition and weapon
systems
UK England and
Wales
BAE Systems Land Systems (Weapons & Vehicles) Limited
(Held via BAE Systems Land Systems (Finance) Limited and
Alvis Limited)
Design, manufacture, supply and support
of armoured vehicles
UK England and
Wales
BAE Systems Surface Fleet Solutions Limited
(Held via BAE Systems Surface Fleet Solutions (Holdings) Limited)
Shipbuilding UK England and
Wales
Alvis Limited
(Held via BAE Systems (Holdings) Limited)
Manufacture and support of military
vehicles
UK England and
Wales
The above list sets out the principal subsidiaries within the Group accounts. It does not represent a full list of subsidiaries. All holdings
represent 100% of ordinary share capital.
35. Events after the balance sheet date
In January 2008, BAE Systems entered into an agreement to acquire Tenix Defence, a leading Australian defence contractor, for up to A$775m
(£342m) in cash. The acquisition of Tenix Defence will more than double BAE Systems’ presence in Australia making it the largest in-country
defence supplier to the Australian Defence Force.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
Company balance sheet
as at 31 December
135
Notes
2007
£m
2006
£m
Fixed assets
Tangible assets 2 6 9
Investments
Investments in subsidiary undertakings 3 5,596 4,979
5,602
4,988
Current assets
Stocks 4 – 2
Debtors due within one year 5 7,670 4,599
Debtors due after one year 5 116 144
Investments 6 130 491
Other financial assets due within one year 7 139 82
Other financial assets due after one year 7 63 85
Cash at bank and in hand 2,360 2,714
10,478
8,117
Liabilities falling due within one year
Loans and overdrafts 8 (188) (123)
Creditors 9 (11,607) (8,903)
Other financial liabilities 7 (129) (87)
(11,924) (9,113)
Net current liabilities
(1,446) (996)
Total assets less current liabilities
4,156
3,992
Liabilities falling due after one year
Loans 8
(448) (913)
Creditors 9
(9) (1)
Other financial liabilities 7
(57) (76)
(514) (990)
Provisions for liabilities and charges
10
(70) (12)
3,572
2,990
Capital and reserves
Issued share capital 12 90 81
Equity option of convertible preference shares 12 – 76
Share premium account 14 1,222 841
Statutory reserve 15 202 202
Other reserves 14 118 101
Profit and loss account 14 1,940 1,689
Equity shareholders’ funds
3,572
2,990
Approved by the Board on 20 February 2008 and signed on its behalf by:
M J Turner G W Rose
Chief Executive Group Finance Director
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84 www.baesyste ms.com
Notes to the Company accounts
136
1. Accounting policies
Basis of preparation
The financial statements have been prepared under the historical
cost convention, as modified by the revaluation of available-for-sale
financial assets, and financial assets and financial liabilities
(including derivative instruments) at fair value through profit or
loss, and in accordance with applicable accounting standards in
the United Kingdo
m (UK GAAP). The going concern basis has been
applied in these accounts.
In the Company’s accounts, all fixed asset investments (including
subsidiary undertakings and joint ventures) are stated at cost (or
valuation in respect of certain listed investments) less provisions
for impairments. Dividends received and receivable are credited to
the Compan
y’s profit and loss account. In accordance with Section
230(4) of the Companies Act 1985 the Company is exempt from the
requirement to present its own profit and loss account. The amount
of profit for the financial year of the Company is disclosed in note 14
to these accounts.
Relief under Sections 131 and 133 of the Companies Act 1985 is
taken wherever possible. Accordingly, wher
e such relief is available,
the difference between the fair value and aggregate nominal value
of shares is not recognised in either shareholders’ funds or cost
of investment.
Changes in accounting policies
Financial Reporting Standard 29 Financial Instruments: Disclosures
(FRS 29) is applicable to the Company for the year ended 31
December 2007. The Company is exempt fr
om presenting FRS 29
disclosures as full equivalent disclosures are presented on a Group
basis within the consolidated financial statements.
Urgent Issues Task Force (UITF) Abstract 41 Scope of FRS 20 is
applicable to the Company for the year ended 31 December 2007.
This does not have any significant impact on the Company’s accounts.
UITF Abstract 44 FRS 20, Group and treasury share transactions
will be applicable for the year ending 31 December 2008. It is not
expected to have any significant impact on the Company’s accounts.
Cash flow statement
The Company is exempt under the terms of Financial Reporting
Standard 1 from the requirement to publish its own cash flow
statement, as its cash flows are included within the consolidated
cash flow statement of the Group.
Foreign currencies
Transactions i
n foreign currencies are translated at the exchange
rates ruling at the dates of the transactions. Monetary assets and
liabilities denominated in foreign currencies are retranslated at the
exchange rates ruling at the balance sheet date. These exchange
differences are recognised in the profit and loss account unless they
qualify for hedge accountin
g treatment, in which case the effective
portion is recognised directly in a separate component of equity.
Tangible fixed assets
Depreciation is provided, normally on a straight-line basis, to write
off the cost or valuation of tangible fixed assets over their estimated
useful economic lives to any estimated residual value using the
following rates:
Buildings up to 50 years, or the lease
term if shorter
Computing equipment, motor
vehicles and short life works
equipment
3 to 5 years
No depreciation is provided on freehold land and assets in the course
of construction.
Impairment reviews are undertaken if there are indications that the
carrying values may not be recoverable.
Leases
Assets obtained under finance leases are included in tangible fixed
assets at cost and are depreciated over their useful economic lives,
or
the term of their lease, whichever is shorter. Future instalments
under such leases, net of finance charges, are included within loans.
Rental payments are apportioned between the finance element,
which is charged as interest to the profit and loss account, and the
capital element, which reduces the outstanding obligation for future
instalmen
ts, so as to give a constant rate of charge on the
outstanding obligation.
Rental payments under operating leases are charged to the profit
and loss account on a straight-line basis in arriving at operating profit.
Investments
The Company’s investment in shares in group companies are stated
at cost less provision for impairment.
Stocks
Stocks are stated at the lower of cost, including all relevant overhead
expenditure, and net realisable value.
Tax
The charge for taxation is based on the profit for the year and takes
account of taxation deferred because of timing differences between
the treatment of certain items for taxation and accounting purposes.
Deferred tax is recognised on an undiscoun
ted basis in respect of all
timing differences between the treatment of certain items for taxation
and accounting purposes which have arisen but not reversed by the
balance sheet date where there is an obligation to pay more tax, or
a right to pay less tax, in the future.
Pensions and other post-retirement benefits
The Company contributes to Group pension plans operated in the
UK. Details of the prin
cipal plans and the financial assumptions
used are contained in the consolidated accounts of BAE Systems plc.
As permitted by Financial Reporting Standard 17 Retirement Benefits,
the plans are accounted for as defined contribution plans, as the
employer cannot identify its share of the underlying assets and
liabilities of the plans. The employer’s contribution
s are set in
relation to the current service period and also to fund a series
of agreed measures to address the pension scheme deficits.
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BAE Systems Annual Report 2007 85
137
1. Accounting policies (continued)
Share options and own shares held
The Company issues equity-settled share options to Group employees.
In accordance with the requirements of FRS 20 Share-based payment
(FRS 20), the Company has applied FRS 20 to all equity-share options
granted after 7 November 2002 that were unvested as of 1 January
2005. Equity-settled share options are measured at fair value at the
date of grant using an option pricing model. The fair value is expensed
on a str
aight-line basis over the vesting period, based on the
Company’s estimate of the number of shares that will actually vest.
In accordance with UITF Abstract 25 National insurance contributions
on share option gains the Company provides in full for the employer’s
national insurance liability estimated to arise on the future exercise
of share options granted, except whe
re the employee has agreed to
settle the employer’s national insurance liability as a condition of the
grant of the options.
As required under UITF Abstract 38 Accounting for ESOP trusts the
cost to the Company of own shares held is shown as a deduction from
shareholders’ funds within the profit and loss account. Consideration
paid or received for the purchase or sale of the Com
pany’s own
shares in the ESOP trust is shown separately in the reconciliation
of movements in shareholders’ funds.
Preference share capital
During the year, the Company’s 7.75p (net) cumulative preference
shares of 25p each were converted into the Company’s ordinary
shares of 2.5p each on the basis of 0.47904 ordinary shares for
every pr
eference share.
In accordance with FRS 25 Financial Instruments: Disclosure
and Presentation the preference shares were considered
a compound financial instrument and, accordingly, split into an
underlying debt instrument, classified within loans and overd
rafts,
and an equity conversion option, classified within equity.
The underlying debt instrument was presented on an amortised
cost basis until extinguished on conversion.
The equity conversion option was presented at its historic fair value,
based on the date of original issue of the preference shares. On
conversion of the prefer
ence shares into ordinary shares, the equity
component was reclassified to share capital and share premium.
Dividends thereon are recognised in the profit and loss account
as finance costs.
Dividends
Equity dividends on ordinary share capital are recognised
as a liability in the period in which they are declared.
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84 www.baesyste ms.com
Notes to the Company accounts (continued)
138
2. Tangible fixed assets
Land and
buildings
£m
Plant and
equipment
£m
Total
£m
Cost
At 1 January 2007 14 40 54
Disposals (5) (13) (18)
At 31 December 2007 9 27 36
Depreciation and impairment
At 1 January 2007 10 35 45
Depreciation – 2 2
Disposals (4) (13) (17)
At 31 December 2007 6 24 30
Net book value
At 31 December 2007 3 3 6
At 31 December 2006 4 5 9
The amounts above at 31 December 2007 include:
Land and
buildings
£m
Plant and
equipment
£m
Total
£m
Capitalised finance leases
Cost – 24 24
Accumulated depreciation – 24 24
Assets let under operating leases
Cost – – –
Accumulated depreciation – – –
Net book value of:
Long leasehold property 3 – 3
Fixtures, fittings and equipment – 3 3
3 3 6
Land and buildings comprise:
– freehold and long leasehold land and buildings owned by the Company as at 30 June 1996, excluding certain overseas properties,
revalued at that date. The majority of the Group’s operational properties at that time were valued on a depreciated replacement basis,
owing to their specialisation, with the remainder on an existing use value basis. Other non-operational properties were valued on
the
basis of open market value;
– short leaseholds at cost;
– additions subsequent to 30 June 1996 at cost; and
– land and buildings owned by subsidiary undertakings acquired since 30 June 1996 at fair value at the date of acquisition.
3. Fixed asset investments
Subsidiary
undertakings
£m
Other
£m
Total
£m
Cost
At 1 January 2007 5,042 – 5,042
Additions 617 1 618
Disposals – (7) (7)
Fair value movements – 6 6
At 31 December 2007 5,659 – 5,659
Impairment provisions
At 1 January 2007 and 31 December 2007 64 (1) 63
Net carrying value
At 31 December 2007 5,595 1 5,596
At 31 December 2006 4,978 1 4,979
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BAE Systems Annual Report 2007 85
139
4. Stocks
2007
£m
2006
£m
Development properties
–
2
5. Debtors
2007
£m
2006
£m
Due within one year
Corporation tax recoverable 34 32
Amounts owed by subsidiary undertakings 7,580 4,500
Amounts owed by Group joint ventures 3 1
Other debtors 23 33
Prepayments and accrued income 30 33
7,670
4,599
Due after one year
Amounts owed by Group joint ventures – –
Other debtors 116 143
Prepayments and accrued income – 1
116
144
Other debtors includes cash collateral of £109m (2006 £115m).
6. Current asset investments
2007
£m
2006
£m
Other securities
130
491
7. Other financial assets and liabilities
2007
Assets
£m
2007
Liabilities
£m
2006
Assets
£m
2006
Liabilities
£m
Due within one year
Cash flow hedges – foreign exchange contracts 62 (41) 31 (36)
Other foreign exchange/interest rate contracts 77 (88) 51 (51)
139
(129) 82 (87)
Due after one year
Cash flow hedges – foreign exchange contracts 34 (20) 30 (42)
Other foreign exchange/interest rate contracts 29 (37) 55 (34)
63
(57) 85 (76)
Full disclosures relating to the Group’s other financial assets and liabilities and financial risk management strategies are given in the Financial
review section of the Directors’ report and note 32 to the Group accounts.
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84 www.baesyste ms.com
Notes to the Company accounts (continued)
140
8. Loans and overdrafts
2007
£m
2006
£m
Due within one year
Bank loans and overdrafts 15 85
Euro-Sterling £150m 11⅞% bond, repayable 2008 150 –
European Investment Bank loans, final instalment 2009 7 7
Debt-related financial instruments – 19
SYSTEMS 2001 Asset Trust:
Option Aircraft bond 16 12
188
123
Due after one year
Euro-Sterling £150m 11⅞% bond, repayable 2008 – 150
European Investment Bank loan, final instalment 2009 4 11
Euro-Sterling £100m 10¾% bond, repayable 2014 99 99
SYSTEMS 2001 Asset Trust:
Option Aircraft bond, final instalment 2013 153 192
Debt instrument of the convertible preference shar
es, redeemable 2010 – 242
Debt-related financial instruments 191 217
Alvis loan notes, redeemable 2009 1 2
448
913
Bank loans and overdrafts are at a floating rate of interest.
The European Investment Bank borrowing is fixed with an interest rate of 6.86%.
The SYSTEMS 2001 Asset Trust bonds are at a floating rate of interest, having been converted to a sterling floating rate bond by utilising a
cross-currency swap which resulted in an effective interest rate dur
ing 2007 of 6.75% (2006 5.59%).
Loans and overdrafts are repayable as follows:
2007
£m
2006
£m
In one year or less
188
123
Between one and two years 26 180
Between two and five years 87 317
In later years 335 416
636
1,036
The total amount of loans repayable by instalments, where any instalment is due after five years, is £169m (2006 £203m).
9. Creditors
2007
£m
2006
£m
Due within one year
Amounts owed to subsidiary undertakings 10,584 8,125
Amounts owed to Group joint ventures 844 605
Other creditors 141 134
Accruals and deferred income 38 39
11,607
8,903
Due after one year
Other creditors 9 1
9
1
10. Provisions for liabilities and charges
Contracts and other
£m
At 1 January 2007 12
Created 63
Utilised (5)
At 31 December 2007
70
Provisions created mainly relate to onerous property leases.
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BAE Systems Annual Report 2007 85
141
11. Contingent liabilities and commitments
Company guaranteed borrowings
Borrowings by subsidiary undertakings totalling £1,981m (2006 £2,182m) which are included in the Group’s borrowings have been guaranteed
by the Company.
12. Share capital
Equity Non-equity Total
Ordinary shares
of 2.5p each
Special Share
of £1
Number of
shares
m
Nominal
value
£m
Number of
shares
Nominal
value
£
Nominal
value
£m
Authorised
At 1 January 2007 and 31 December 2007 4,450 111 1 1 111
Issued and fully paid
At 1 January 2006 3,219 80 1 1 80
Exercise of options 24 1 – – 1
Conversion of preference shares 3 – – – –
At 1 January 2007 3,246 81 1 1 81
Exercise of options 29 1 – – 1
Placing of shares 174 5 – – 5
Conversion of preference shares 125 3 – – 3
At 31 December 2007
3,574 90 1 1 90
Special Share
One Special Share of £1 in the Company is held on behalf of the Secretary of State for Business, Enterprise and Regulatory Reform (formerly
the Secretary of State for Trade and Industry) (the Special Shareholder). Certain parts of the Company’s Articles of Association cannot be
amended without the consent of the Special Shareholder. These articles include the requirement that no for
eign person, or foreign persons
acting in concert, can have more than a 15% voting interest in the Company, the requirement that the majority of the directors are British, the
requirement that decisions of the directors at their meetings, in their committees or via resolution must be appr
oved by a majority of British
directors and the requirement that the Chief Executive and any executive chairman are British citizens. The effect of these requirements can
also be amended by regulations made by the directors and approved by the Special Shareholder.
The Special Shareholder may require the Company at any time to redeem the Special Share at par or to conver
t the Special Share into
one ordinary voting share. The Special Shareholder is entitled to receive notice of and to attend general meetings and class meetings of
the Company’s shareholders but has no voting right, nor other rights, other than to speak in relation to any business in respect of the
Special Share.
Placing of shares
On 11 May 2007, 174,418,605 new ordinar
y shares of 2.5p each were placed at a price of 430p, raising £750m before expenses.
Conversion of preference shares
As at 1 January 2007, the Company also had in issue 259,962,909 7.75p (net) cumulative redeemable preference shares of 25p each.
During the year, the shares were converted into ordinary shares of 2.5p each on the basis of 0.47904 ordinary shares for each preference
share, as a result of which 124,532,630 ordinary shares of 2.5p we
re issued. There were, therefore, no preference shares in issue as at
31 December 2007.
In accordance with FRS 25 the convertible preference shares were considered to be a compound financial instrument consisting of both
a debt element and an equity component which required separate accounting treatme
nt. Following conversion to ordinary shares the amounts
previously recognised within equity and within loans and overdrafts have been extinguished.
Treasury shares
In connection with the disposal of its interest in Airbus, the Company stated its intention to return up to £500m to ordinary shareholders by way
of on-market purchases of ordin
ary shares using authorities granted at the 2006 AGM and to hold the repurchased shares initially in treasury.
The Company commenced this buyback programme on 26 October 2006 and, as at 31 December 2007, 61,945,000 (2006 28,675,000) 2.5p
ordinary shares with an aggregate nominal value of £2m (2006 £1m) were held in treasury.
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84 www.baesyste ms.com
Notes to the Company accounts (continued)
142
13. Employee share schemes
Options over shares of the ultimate parent undertaking, BAE Systems plc, have been granted to employees of the Company under various
schemes. Details of the terms and conditions of each share option scheme are given in the Remuneration report on pages 64 to 83 of
this report.
Executive Share Option Scheme Save-As-You-Earn
2007 2006 2007 2006
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Number of
shares
‘000
Weighted
average
exercise
price
£
Outstanding at the beginning of the year
27,513 2.84
36,141 2.77
654 1.78
1,027 1.88
Granted during the year 2,994 4.59 2,886 4.28 – – ––
Exercised during the year (9,840) 2.31 (3,864) 2.30 (351) 2.23 (248) 2.58
Expired during the year (5,621) 3.34 (7,650) 3.32 (7) 1.44 (125) 1.09
Outstanding at the end of the year
15,046 3.35
27,513 2.84
296 1.25
654 1.78
Weighted average remaining life (years) 7 6 1 2
Weighted average fair value of options granted (£) 1.47 1.30 – –
Range of exercise price of outstanding options (£) 1.72 – 4.87 1.72 – 4.87 0.93 – 2.57 0.93 – 2.57
Expense recognised for the year (£m) 4 4 – –
Share
Matching
Plan
Performance
Share
Plan
Restricted
Share
Plan
2007
Number of
shares
‘000
2007
Number of
shares
‘000
2006
Number of
shares
‘000
2007
Number of
shares
‘000
2006
Number of
shares
‘000
Outstanding at the beginning of the year
– 12,197
11,471
882
826
Granted during the year 281 1,996 1,924 – 119
Exercised during the year – (3,742) (944) (508) (9)
Expired during the year (1) (577) (254) (23) (54)
Outstanding at the end of the year
280 9,874
12,197
351
882
Weighted average remaining life (years) 24 5 – 1
Weighted average fair value of options granted (£) 4.59 2.31 1.88 – 3.89
Expense recognised for the year (£m) –3 4 – 1
The exercise price for the Share Matching Plan, Performance Share Plan and Restricted Share Plan is £nil (2006 £nil).
Information on options granted in the year can be found on page 126 (note 26 to the Group accounts).
14. Reserves
Share premium
account
£m
Other
reserves
£m
Profit and
loss account
£m
At 31 December 2006 841 101 1,689
Profit for the year –– 92
Dividends paid – – (396)
Share placing (net of costs) – – 736
Share-based payments –– 34
Exercise of options 63 – –
Purchase of own shares – – (50)
Conversion of preference shares 318 – –
Purchase of treasury shares – – (152)
Other movements – – (13)
Fair value movements on available-for-sale investments – – 6
Recycling of fair value
movements on disposal of available-for-sale investments – – (6)
Movements in hedging reserve – 17 –
At 31 December 2007
1,222 118 1,940
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BAE Systems Annual Report 2007 85
143
14. Reserves (continued)
Other reserves
Other reserves for the Company comprise: capital reserve £24m (2006 £24m); hedging reserve £8m credit (2006 £9m debit); and non-
distributable reserve arising from property disposals to other Group undertakings £86m (2006 £86m). The non-distributable reserve arising
from property disposals to other
Group undertakings relates to the revaluation surplus realised by the Company on properties which were sold
to other Group companies as part of operational reorganisations in prior years. Amounts within this reserve will be transferred to the profit and
loss account as distributable when the related properties are disposed of outside the Group, or w
ritten down following impairment.
Placing of shares
On 11 May 2007, 174,418,605 new ordinary shares of 2.5p each were issued by a placing of shares. The placing structure utilised attracted
merger relief under Section 131 of the Companies Act 1985, resulting in a credit to the merger reserve of £736m. Subsequent internal
transactions required to complete the placing st
ructure have resulted in this part of the merger reserve being transferred to the retained
earnings reserve.
Own shares held
Own shares held, including treasury shares and shares held by BAE Systems ESOP Trust, are recognised as a deduction from
retained earnings.
Conversion of preference shares
During the year, 259,962,909 (2006 6,116,123) preference shares we
re converted into ordinary shares of 2.5p each on the basis of
0.47904 ordinary shares for each preference share.
Treasury shares
During the year, 33,270,000 ordinary shares of 2.5p each were repurchased under the buyback programme announced in October 2006.
As at 31 December 2007, 61,945,000 (2006 28,675,000) 2.5p ordinary shares with an aggregate nominal value of £2m
(2006 £1m) were
held in treasury.
BAE Systems ESOP Trust
The Company has an ESOP discretionary trust to administer the share plans and to acquire Company shares, using funds loaned by the Group,
to meet commitments to Group employees. A dividend waiver was in operation for shares within the ESOP Trust, other than those owned
beneficially by the participants, for
the dividend paid in November 2007.
At 31 December 2007, the ESOP held 1,552,015 (2006 2,382,835) 2.5p ordinary shares with a market value of £8m (2006 £10m).
The shares held by the ESOP are recorded at cost and deducted from retained earnings until such time as the shares vest unconditionally
to employees.
A dividend waiver is also in operation over shares within the Company’s Share Incentive Plan Trust other
than those shares owned beneficially
by the participants.
Company profit
The Company’s profit for the financial year was £92m (2006 £1,617m).
15. Statutory reserve
Under Section 4 of the British Aerospace Act 1980 this reserve may only be applied in paying up unissued shares of the Company to be allotted
to members of the Company as fully paid bonus shares.
16. Other information
Employees
The total number of employees of the Company at 31 December 2007 was 520 (2006 596). Total staff costs, excluding charges for share
options, were £68m (2006 £67m).
Total directors’ emoluments, excluding company pension contributions, were £8,580,000 (2006 £9,647,000). These emoluments were paid for
their services on behalf of the BAE Systems Group. No emoluments related specifically to their work for the Com
pany.
Company audit fee
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts totalled £1,111,000 (2006 £1,023,000).
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84 www.baesyste ms.com
Five year summary
144
2007
IFRS
£m
2006
IFRS
£m
2005
IFRS
£m
2004
IFRS
£m
2003
UK GAAP
1
£m
Income statement
2,3,4,5,6
Sales including Group’s share of equity accounted investments
Electronics, Intelligence & Support 3,916 4,007 3,697 3,063 –
Land & Armaments 3,538 2,115 1,270 482 –
Programmes & Support 5,327 4,615 4,660 – –
International Businesses 3,359 3,428 3,138 – –
Programmes – – – 2,219 2,374
Customer Solutions & Support – – – 2,856 2,042
Integrated Systems & Partnerships – – – 2,022 –
Commercial Aerospace
4
– – – – 2,904
HQ & Other Businesses 243 295 471 464 281
Avionics
5
– – – – 650
North America – – – – 2,636
International Partnerships – – – – 1,685
Intra-business group sales (673) (695) (655) (417) –
15,710
13,765 12,581 10,689 12,572
EBITA
7
Electronics, Intelligence & Support 429 429 324 256 –
Land & Armaments 312 168 42 (8) –
Programmes & Support 456 342 261 – –
International Businesses 435 415 400 – –
Programmes – – – 10 56
Customer Solutions & Support – – – 497 411
Integrated Systems & Partnerships – – – 95 –
Commercial Aerospace
4
– – – – 204
HQ & Other Businesses (155) (147) (118) (50) –
Avionics
5
– – – – 12
North America – – – – 232
International Partnerships – – – – 65
1,477
1,207 909 800 980
Amortisation and impairment of intangible assets (297) (139) (122) (110) (518)
Exceptional items (UK GAAP only) (9)
Finance costs including share of equity accounted investments 93 (174) (196) (132) (220)
Profit before taxation
1,273
894 591 558 233
Taxation expense including share of equity accounted investments (373) (248) (147) (219) (225)
Profit for the year from continuing operations
900
646 444 339 8
Profit/(loss) for the year from discontinued operations 22 993 111 (336) –
Profit for the year
922
1,639 555 3 8
Balance sheet
Intangible assets 9,559 7,595 8,217 6,115 6,000
Property, plant and equipment, and investment property 1,887 1,869 1,922 1,901 1,699
Non-current investments 787 678 1,730 1,535 1,710
Inventories 701 395 485 498 775
Payables (excluding cash on customers’ account) less receivables (5,373) (4,298) (4,596) (3,891) (3,126)
Other financial assets and liabilities 52 6 (7) – –
Retirement benefit obligations (1,629) (2,499) (4,101) (3,210) 362
Pr
ovisions (809) (695) (718) (491) (749)
Net tax 63 648 1,012 876 (195)
Net cash/(debt) 700 435 (1,277) (668) (870)
Disposal groups held for sale 64 – 137 – –
Minority interests (36) (17) (16) (10) (15)
Total equity attributable to equity holders of the parent
5,966
4,117 2,788 2,655 5,591
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 85
145
Movement in net cash/(debt) as defined by the Group
2007
IFRS
£m
2006
IFRS
£m
2005
IFRS
£m
2004
IFRS
£m
2003
UK GAAP
1
£m
Cash flow from operating activities
2,162
778 2,099 2,350 836
Net capital expenditure
8
(262) (141) (250) (285) (248)
Dividends from equity accounted investments 78 145 88 69 37
Operating business cash flow
1,978
782 1,937 2,134 625
Acquisitions and disposals (2,112) 1,330 (1,836) (630) (62)
Finance costs (65) (207) (152) (179) (117)
Tax and dividends (509) (431) (342) (312) (227)
Other non-cash movements 57 (11) (52) 9 121
Issue/(purchase) of equity shares 603 (71) 373 – –
Preference share conversion 245 6 – – –
Exchange movements 36 323 (219) 129 72
Net increase/(decrease) in net funds
233
1,721 (291) 1,151 412
Movement in cash on customers’ account 32 (9) (35) (13) 16
Movement in net cash/(debt)
265
1,712 (326) 1,138 428
Opening net debt 435 (1,277) (668) (870) (1,298)
Impact of IFRS adoption – – (283) (936) –
Closing net cash/(debt)
700
435 (1,277) (668) (870)
Other information
2007 2006 2005 2004 2003
Basic earnings/(loss) per share – total
26.6p
50.7p 17.4p (0.6)p (0.5)p
Basic earnings per share – underlying
9
31.0p 23.8p 18.4p 13.6p 16.6p
Dividend per ordinary share 12.8p 11.3p 10.3p 9.5p 9.2p
Number of employees, excluding share of employees of equity accounted investments,
at year end
88,000 79,000 80,000 73,300 68,400
Capital expenditure including leased assets £341m £538m £347m £359m £243m
Order book including the Group’s share of equity accounted investments £38.6m £31.7bn £30.8bn £29.5bn £46.0bn
1 for the year ended 31 December 2003, the information is pr esented on a UK GAAP basis
2 for the year ended 31 December 2003, the business group information presented under UK GAAP has not been restated to reflect the changes made to the business groups in 2005,
2006 and 2007
3 for the year ended 31 December 2004, the business group information presented under
IFRS has not been restated to reflect the changes made to the business groups in 2005, 2006
and 2007
4 for the years ended 31 December 2004 to 2006, Airbus SAS is presented as a discontinued operation under IFRS and the remaining Commercial Aerospace business group
is reported within HQ & Other Businesses
5 for the years ended 31 December 2004 and 2005, the Avionics business group is p
resented as a discontinued operation under IFRS
6 for the years ended 31 December 2005 and 2006, the business group information presented under IFRS has been restated to reflect changes made to the Group’s organisational
structure
7 for the years ended 31 December 2004 to 2007, this is defined as earnings before amortisation and impairme
nt of intangible assets, finance costs and taxation expense.
For the year ended 31 December 2003, this is defined as profit before interest and tax, excluding goodwill amortisation and impairment, and exceptional items.
8 includes expen diture on property, plant and equipment, investment property, intangible assets and other in
vestments
9 for IFRS, underlying earnings is presented for continuing operations after adjusting for amortisation and impairment of intangible assets, non-cash finance movements on
pensions and financial derivatives, and uplift on acquired inventories. For UK GAAP, u
nderlying earnings is presented after adjusting for goodwill amortisation and impairment,
and exceptional items.
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
86 www.baesyste ms.com
Shareholder information
146
Registered office
6 Carlton Gardens
London
SW1Y 5AD
United Kingdom
Telephone: +44 (0)1252 373232
Company website: www.baesystems.com
Registered in England and Wales, No. 1470151
Registrars
Equiniti Limited (0140)
Aspect House, Spencer Road, Lancing
West Sussex BN99 6DA
United Kingdom
Telephone: 0871 384 2044
Calls to the above number are charged at 8p per minute from a BT
landline. Other telephon
y providers’ costs may vary.
Telephone number from outside the UK: +44 121 415 7058
If you have any queries regarding your shareholding, please contact
the registrars.
Shareview service
The Shareview service from our registrar, Equiniti, gives shareholders:
– direct access to data held on their behalf on the share register
including recent share movements and dividend details; and
– the ability to change their address or dividend payment
instructions online.
To sign up for Shareview you need the ‘shareholder reference’ printed
on your proxy form or dividend stationery. There is no charge to register.
When you register with the site, you can register your preferred
format (post or e-m
ail) for shareholder communications. If you select
‘e-mail’ as your mailing preference, you will be sent shareholder
communications, such as proxy forms and annual results
by e-mail instead of post, as long as this option is available.
If you have your dividends paid straight to your bank account, and you
have selected ‘e-mail’ as your mailing preference, you can also collect
your tax voucher electronically. I
nstead of receiving the paper tax
voucher, you will be notified by e-mail with details of how to download
your electronic version.
However, if you choose ‘post’ as your preference, you will be sent
paper documents as usual.
Visit the website for more details: www.shareview.co.uk
Details of software and equipment requirements are given on
the website.
Shareholder dealing service
A low cost, execution-only, postal share-dealing service for the purchase
and sale of BAE System
s plc shares is available from Pershing
Securities Ltd. Commission is 1% with a minimum charge of £15.
The service is restricted to UK residents and transactions are limited to
€15,000 (approximately £10,000). Pershing Securities Ltd is authorised
and regulated by the Financial Services Authority and is a member of
LIFFE and the London Stock Exchange. For details, please contact:
Per
shing Securities Ltd
Broker Services Team
The Royal Liver Building
Pier Head
Liverpool L3 1LL
Telephone number for purchases: 020 7661 6616
Telephone number for sales: 020 7661 6617
ShareGift
The Orr Mackintosh Foundation operates a charity donation
scheme for shareholders with small parcels of shares which may
be uneconomic to sell. Details of the scheme are available from
Shar
eGift at www.sharegift.org or by telephone on 020 7930 3737.
Share price information
The middle market price of the Company’s ordinary shares on
31 December 2007 was 498p and the range during the year was
401.5p to 515p.
Daily share prices are available in the UK on the FT Cityline service on
0906 843 0000.
At the menu following the FTSE 100 index, select option 2 for share
prices and for BAE Systems plc ordinary sha
res enter the four-digit
code 1890.
Calls are charged at 60p per minute at all times.
Alternatively you can view teletext or a similar service.
Dividend reinvestment plan
The Company offers holders of its ordinary shares the option to elect
to have their dividend reinvested in shares purchased in the market
instead of cash. If you would like to make this election, please
request a dividend reinvestment plan mandate f
rom our registrars:
Equiniti Financial Services Limited
Aspect House, Spencer Road, Lancing
West Sussex BN99 6DA
Telephone: 0871 384 2268
Calls to the above number are charged at 8p per minute from a BT
landline. Other telephony providers’ costs may vary.
Telephone number from outside the UK: +44 121 415 7058
American Depositary Receipts
The BAE Systems plc American Depositary Receipts (ADRs) a
re traded
on the Over The Counter market (OTC) under the symbol BAESY. One
ADR represents four BAE Systems plc ordinary shares.
JPMorgan Chase Bank, N.A. is the depositary.
If you should have any queries, please contact:
JPMorgan Service Center
PO Box 3408
South Hackensack
NJ 07606-3408
USA
Toll free telephone number: 800 990 1135
Telephone number from outside the US: +1 201 680 6630
Website: www.adr
.com
Email: jpmorganadr@mellon.com
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
BAE Systems Annual Report 2007 87
147
Financial calendar
Financial year end 31 December
Annual General Meeting 7 May 2008
2007 final ordinary dividend payable 2 June 2008
2008 interim results announcement 31 July 2008
2008 interim ordinary dividend payable 1 December 2008
2008 full year results – preliminary announcement February 2009
– report and accounts April 2009
2008 final ordinary dividend payable June 2009
Analysis of share register at 31 December 2007
Ordinary shares of 2.5p
Accounts Shares
Number
‘000
%
Number
million
%
By category of shareholder
Individuals 108.2 92.5 108.4 3.0
Nominee companies 7.8 6.6 3,327.6 93.1
Banks – – 22.6 0.7
Insurance and pension funds – – 0.1 –
Other 1.0 0.9 115.8 3.2
117.0 100.0 3,574.5 100.0
By size of holding
1 – 99 23.5 20.1 1.2 –
100 – 499 32.9 28.1 8.8 0.3
500 – 999 24.4 20.9 17.4 0.5
1,000 – 9,999 33.6 28.7 79.8 2.2
10,000 – 99,999 1.5 1.3 39.5 1.1
100,000 – 999,999 0.7 0.6 266.3 7.5
1,000,000 and over 0.4 0.3 3,161.5 88.4
117.0 100.0 3,574.5 100.0
Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information
86 www.baesyste ms.com
Glossary
148
ADF
Australian Defence Force.
AGS
Advanced Gun System: a 155mm gun system.
AGM
Annual General Meeting.
ATTAC
Availability Transformation: Tornado Aircraft Contract.
Bradley
Tracked armoured fighting vehicles which fulfil critical infantry, cavalry,
fire support, battle command and engineer roles for the US Army.
C4ISR
Comma
nd, Control, Communications and Computing (C4), Intelligence,
Surveillance and Reconnaissance (ISR): systems that provide a precise
picture of the battlefield in ‘real-time’, optimising the information
available for decision making.
CTOL
Conventional Take-off and Landing.
CV9035
An armoured infantry fighting vehicle developed by BAE Systems Land
Systems Hagglunds to meet international demand.
CVF
The UK’s future aircraft carrier.
DDG-1000
A next-generation destroyer for the US Navy.
Defence Industrial Strategy
Published by the UK government in December 2005 following
consultation with industry, recognises the skills and capabilities that
will be needed to equip and support the UK armed forces and ensure
the UK defence industry rem
ains world-leading.
DIRCM
Directed Infrared Countermeasures.
EW
Electronic Warfare.
FCS
Future Combat System.
FMTV
Family of Medium Tactical Vehicles.
FRES
Future Rapid Effect System: the UK Ministry of Defence (MoD)
programme to provide the British Army with a family of medium-weight,
network-enabled, air-deployable armoured vehicles.
FRS
Financial Reporting Stan
dards.
FV430 Bulldog
An armoured personnel carrier.
GAAP
Generally Accepted Accounting Principles.
GDP
Gross Domestic Product.
HERTI
Highly autonomous medium-altitude long-endurance unmanned
air system.
HMMWV
High Mobility Multipurpose Wheeled Vehicle.
Home market
A market is one in which the Group has a strong domestic presence
and is a key part of the defence i
ndustry capability in that country.
BAE Systems has six home markets: Australia; Saudi Arabia; South
Africa; Sweden; the UK and the US.
IBP
Integrated Business Plan.
IDIQ
Indefinite-Delivery/Indefinite-Quantity: a US government contract
allowing flexibility for orders.
IFRS
International Financial Reporting Standards.
JLTV
Joint Light Tactical Vehicle.
KPI
Key Performa
nce Indicator.
LCM
Lifecycle Management: a process and control environment within
which the Company’s projects are executed.
Line leader
An individual with specific profit and loss accountability for a business.
LTPA
Long-Term Partnering Agreement.
M88 Hercules
A fully-tracked, armoured recovery vehicle.
M113
Armoured personnel carrie
rs, medical, command and control, and
engineering mortar launching vehicles.
M777
A lightweight 155mm field howitzer.
MMPV
Medium Mine Protected Vehicle.
MoD
UK’s Ministry of Defence.
MRAP
Mine Resistant Ambush Protected wheeled vehicle.
Nimrod MRA4
The replacement Maritime and Patrol Attack aircraft for the UK’s Royal
Air Force.
NLOS-C
Non-Line-of-Sight Cann
on.
NLOS-M
Non-Line-of-Sight Mortar.
OAS
Operational Assurance Statement: a six-mon thly review of internal
controls and risk management processes.
OF
Operational Framework: the Company’s common framework for
operational and financial controls.
PAAMS
P
rincipal Anti-Air Missile System. Aster PAAMS: a medium-range anti-
aircraft vertical launching missile system based on the Aster 15 and
Aster 30 anti-missile missiles.
PCL
Performance Centred Leadership: a leadership and performance
management system used throughout the Company.
QBR
Quarterly Business Review.
RAF
The UK’s Royal Air Force.
RSAF
The Royal Saudi Air Force.
RSNF
The Royal Saudi Naval Forces.
RG31, RG32 and RG33
Mine protected armoured personnel carriers.
Sting Ray
A lightweight torpedo.
STOVL
Short Take-Off and Vertical Landing.
THAAD
Thermal High Altitude Area Defense.
TRMC
Treasury Review Management Committee.
TWS
Thermal Weapon Sight.
BAE Systems at a glance
Land & Armaments
Land & Armaments provides design,
development, production, through-life support
and upgrade of armoured combat vehicles,
tactical wheeled vehicles, naval guns, missile
launchers, artillery systems and intelligent
munitions.
US, UK, Sweden, South Africa, Global
– High volume of vehicle reset and
upgrade activity
– UK business returned to profitability
– Wheeled armoured vehicle successes
– Good progress in next-generation combat
vehicle programmes
Programmes & Support
Programmes & Support comprises the Group’s
UK-based air, naval and underwater systems
activities, the Integrated System Technologies
business and a 50% interest in the Gripen
International joint venture.
UK, Global
– RAF Typhoons now operational
– Full six ship Type 45 contract awarded
– Launch of first of class Astute submarine
– Orders received for second and third Astute
Class submarines
– Offshore Patrol Vessel arbitration settled
International Businesses
International Businesses comprises the Group’s
businesses in Saudi Arabia and Australia,
together with a 37.5% interest in the pan-
European MBDA joint venture and a 20.5%
interest in Saab of Sweden.
UK/Europe, Middle East, Australia
– Saudi Typhoon contract secured
– Investment in the Kingdom of Saudi Arabia
continues
– Down-selection for the provision of vehicles
for the Australian Defence Force
– Proposed acquisition of Tenix Defence
announced in January 2008
Electronics, Intelligence
& Support
Electronics, Intelligence & Support provides
a variety of communications, electronic
identification, navigation and guidance systems,
network-centric warfare solutions and a broad
range of support solutions, including major ship
repair activities for the US Navy.
Key points
– Good financial performance
– Continued growth from US businesses
– Leadership position established in global land systems sector
US, UK, Global
– Continued leadership in the provision
of electronic warfare systems
– New markets developing for the HybriDrive®
propulsion systems
– Stable demand for ship repair services
Delivering global growth
Group
£15,710m
Sales
4
for 2007
Sales
1
by business group
3
(%)
24
21
22
33
Electronics, Intelligence & Support
Land & Armaments
Programmes & Support
International Businesses
£1,477m
EBITA
2
for 2007
EBITA
2
by business group
3
(%)
26
27
19
28
Electronics, Intelligence & Support
Land & Armaments
Programmes & Support
International Businesses
HQ & Other Businesses
HQ & Other Businesses comprises the regional
aircraft asset management and support
activities, head office and UK shared services
activity, including research centres and property
management.
Principal operations
Main operating
locations
Major markets
Key points
from 2007
BAE Systems’ Group strategy is ‘to deliver sustainable growth in shareholder value by being the premier
global defence and aerospace company’.
BAE Systems, with 97,500 employees
4
worldwide, delivers a full range of products and services for air, land and
naval forces, as well as advanced electronics, information technology solutions and customer support services.
Annual Report online
1 before elimination of intra-group sales
2 earnings before amortisation and impairment
of intangible assets, finance costs and
taxation expense
3 excluding HQ & Other Businesses
4 including share of equity accounted investments
p36 p28 p30 p32 p34
Visit the 2007 Shareholder Reporting Centre at:
http://ir.baesystems.com/investors/reporting/
You can now view the BAE Systems Annual Report 2007 on our website, along with further information about our
performance, information for the Annual General Meeting and our latest presentations.
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presentations
Keep up to date with our
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from our Results Centre.
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for our 2008 Annual General
Meeting available here. You
can also vote electronically on
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the meeting.
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REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
Annual Report 2007
If you would like to give us any feedback on this year’s Annual Report,
please send your written comments to our investor relations team at:
BAE Systems plc
6 Carlton Gardens
London SW1 5AD
United Kingdom
or by e-mail to andy[email protected]
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REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
BAE Systems plc Annual Report 2007
Annual Report 2007
BAE Systems plc
6 Carlton Gardens
London SW1Y 5AD
United Kingdom
Telephone +44 (0)1252 373232
Registered in England and Wales No. 1470151
Website details
www.baesystems.com
Contents
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 n respect of this report save as would arise under English law. In particular,
section 463 Companies Act 2006 limits the liability of the directors of BAE Systems plc so that their liability is solely
to BAE Systems plc.
Cover image:
RG33 Mine Resistant
Ambush Protected vehicle
Results in brief, highlights
and outlook 1
Chairman’s letter 2
Executive leadership 4
Business review
Directors’ report
Board of directors 54
Corporate governance 56
Remuneration report 64
Other statutory and reguatory
information, including statement
of directors’ responsibilities 84
Corporate governance
Index to the accounts 88
Independent auditors’ report 89
Consolidated financial statements 90
Notes to the Group accounts 94
Company balance sheet 135
Notes to the Company accounts 136
Five year summary 144
Shareholder information 146
Financial calendar 147
Glossary 148
Annual Report online 149
Shareholder feedback 149
The following symbols are used
within this Report
They point you towards further
information either within the report
or online.
Annual and Interim Reports in
digital format online
To receive shareholder communications
electronically in future, including
your Annual Report, visit:
www.baesystems.com/annualreport
Financial statements
Shareholder information
Cross reference within report
p67
For more information visit
www.baesystems.com
Chief Executive’s review 6
Strategic overview 12
Implementing our strategy 14
Financial review 18
Key Performance Indicators (KPIs) 25
Business group reviews 27
Electronics, Intelligence
& Support 28
Land & Armaments 30
Programmes & Support 32
International Businesses 34
HQ & Other Businesses 36
Corporate responsibility review 37
Risk management and
principal risks 44
Resources 51
Further information
See overleaf for an overview
of our business today
REAL PERFORMANCE. REAL ADVANTAGE.
Delivering global growth
Annual Report 2007
