Delivering Global Growth Results in Brief, Highlights Chairman’S Letter 2 and Outlook 1 Executive Leadership 4

BAE Systems plc Report Annual BAE Systems plc 6 Carlton Gardens Annual Report 2007 London SW1Y 5AD Contents United Kingdom Telephone +44 (0)1252 373232 See overleaf for an overview of our business today

Registered in England and Wales No. 1470151

Website details www.baesystems.com

2007 Directors’ report Delivering global growth Results in brief, highlights Chairman’s letter 2 and outlook 1 Executive leadership 4

Business review Chief Executive’s review 6 Land & Armaments 30 Strategic overview 12 Programmes & Support 32 Implementing our strategy 14 International Businesses 34 Financial review 18 HQ & Other Businesses 36 Key Performance Indicators (KPIs) 25 Corporate responsibility review 37 Business group reviews 27 Risk management and Electronics, Intelligence principal risks 44 & Support 28 Resources 51

Corporate governance Board of directors 54 Other statutory and reguatory Corporate governance 56 information, including statement Remuneration report 64 of directors’ responsibilities 84

Financial statements Index to the accounts 88 Company balance sheet 135 Independent auditors’ report 89 Notes to the Company accounts 136 Consolidated financial statements 90 Five year summary 144 Notes to the Group accounts 94

Shareholder information Shareholder information 146 Glossary 148 Financial calendar 147 Annual Report online 149 Shareholder feedback 149

Further information The following symbols are used Annual and Interim Reports in within this Report digital format online They point you towards further To receive shareholder communications information either within the report electronically in future, including or online. your Annual Report, visit: www.baesystems.com/annualreport

p67 Cross reference within report

For more information visit www.baesystems.com

Registered in England and Wales No. 1470151

Website details www.baesystems.com

2007 Directors’ report Delivering global growth Results in brief, highlights Chairman’s letter 2 and outlook 1 Executive leadership 4

Corporate governance Board of directors 54 Other statutory and reguatory Corporate governance 56 information, including statement Remuneration report 64 of directors’ responsibilities 84

Shareholder information Shareholder information 146 Glossary 148 Financial calendar 147 Annual Report online 149 Shareholder feedback 149

p67 Cross reference within report

For more information visit www.baesystems.com

Annual Report 2007 Cover image: Cautionary statement RG33 Mine Resistant All statements other than statements of historical fact included in this document, including, without limitation, Delivering global growth Ambush Protected vehicle 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 REAL PERFORMANCE. REAL ADVANTAGE. to BAE Systems plc. REAL PERFORMANCE. REAL ADVANTAGE. BAE Systems at a glance Annual Report online BAE Systems’ Group strategy is ‘to deliver sustainable growth in shareholder value by being the premier global defence and aerospace company’. You can now view the BAE Systems Annual Report 2007 on our website, along with further information about our BAE Systems, with 97,500 employees4 worldwide, delivers a full range of products and services for air, land and performance, information for the Annual General Meeting and our latest presentations. naval forces, as well as advanced electronics, information technology solutions and customer support services. Get more online Delivering global growth Search the Report for key information You can quickly and easily search Group Electronics, Intelligence Land & Armaments Programmes & Support International Businesses BAE Systems Annual Report 2007 for the information you would like to & Support read. Simply type in the words you would like to search for, and the relevant pages will be listed for you Key points Principal operations Electronics, Intelligence & Support provides Land & Armaments provides design, Programmes & Support comprises the Group’s International Businesses comprises the Group’s to choose. a variety of communications, electronic development, production, through-life support UK-based air, naval and underwater systems businesses in Saudi Arabia and Australia, – Good financial performance identification, navigation and guidance systems, and upgrade of armoured combat vehicles, activities, the Integrated System Technologies together with a 37.5% interest in the pan- network-centric warfare solutions and a broad tactical wheeled vehicles, naval guns, missile business and a 50% interest in the Gripen European MBDA joint venture and a 20.5% – Continued growth from US businesses range of support solutions, including major ship launchers, artillery systems and intelligent International joint venture. interest in Saab of Sweden. – Leadership position established in global land systems sector repair activities for the US Navy. munitions.

Sales1 by business group3 (%) EBITA2 by business group3 (%)

Main operating 21 24 27 26 locations

22 33 19 Links to further 28 Download our corporate information reporting literature From the Shareholder Reporting All BAE Systems corporate reports will section of our website you can link Electronics, Intelligence & Support Electronics, Intelligence & Support be available as downloadable pdfs to other areas of interest, including Land & Armaments Land & Armaments from this section of the website. Programmes & Support Programmes & Support the Annual Report, financial International Businesses International Businesses Major markets US, UK, Global US, UK, Sweden, South Africa, Global UK, Global UK/Europe, Middle East, Australia calendar and much more.

2007 Key points – Continued leadership in the provision – High volume of vehicle reset and – RAF Typhoons now operational – Saudi Typhoon contract secured Annual Report Download the latest from 2007 presentations of electronic warfare systems upgrade activity – Full six ship Type 45 contract awarded – Investment in the Kingdom of Saudi Arabia £15,710m £1,477m Keep up to date with our – New markets developing for the HybriDrive® – UK business returned to profitability continues Delivering global growth 4 2 – Launch of first of class Astute submarine presentations on performance Sales for 2007 EBITA for 2007 propulsion systems – Wheeled armoured vehicle successes – Orders received for second and third Astute – Down-selection for the provision of vehicles from our Results Centre. – Stable demand for ship repair services – Good progress in next-generation combat Class submarines for the Australian Defence Force vehicle programmes – Offshore Patrol Vessel arbitration settled – Proposed acquisition of Tenix Defence announced in January 2008 Access the Notice of Meeting and vote online You will find the Notice of Meeting for our 2008 Annual General HQ & Other Businesses Meeting available here. You can also vote electronically on Visit the 2007 Shareholder Reporting Centre at: REAL PERFORMANCE. REAL ADVANTAGE. the resolutions proposed at HQ & Other Businesses comprises the regional http://ir.baesystems.com/investors/reporting/ the meeting. aircraft asset management and support activities, head office and UK shared services activity, including research centres and property 1 before elimination of intra-group sales Shareholder feedback management. 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense If you would like to give us any feedback on this year’s Annual Report, 3 excluding HQ & Other Businesses please send your written comments to our investor relations team at: 4 including share of equity accounted investments BAE Systems plc 6 Carlton Gardens p36 p28 p30 p32 p34 London SW1 5AD United Kingdom or by e-mail to [email protected] The paper used in this document has FSC certification and is sourced from well managed forests and controlled sources certified in accordance with the rules of the Forest Stewardship Council. Directors’ report Results in brief, highlights and outlook

Results in brief

Results from continuing operations £15,710m £1,477m £1,177m Sales1 EBITA2 Operating profit

2006: £13,765m 2006: £1,207m 2006: £1,054m 31.0p 26.0p £38.6bn Underlying earnings3 Basic earnings per share4 Order book5 per share 2006: 23.8p 2006: 19.9p 2006: £31.7bn

Other results including discontinued operations 12.8p £2,162m £700m Dividend per share Cash inflow from operating Net cash as defined activities by the Group 2006: 11.3p 2006: £778m 2006: £435m

Highlights

– Good financial performance – Continued growth from US businesses – Leadership position established in global land systems sector – Underlying earnings3 per share up 30% to 31.0p – Dividend increased 13.3% to 12.8p per share for the year

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.

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)

BAE Systems Annual Report 2007 1 Directors’ report Chairman’s letter

2007: A year of delivery

“2007 has been 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.”

Dick Olver Chairman

2007 was another successful year for BAE Systems. The Group has to achieve the highest standards of governance in the conduct of our again delivered a strong financial performance and has achieved much day-to-day business. success in pursuit of its strategic objectives. As part of that drive, the Board agreed to undertake an expert and Our multi-home market strategy continues to generate opportunities independent audit of our ethical business conduct, to measure where for growth. we stand today and to provide a point of reference with which to measure our progress over time. In June 2007, the Board appointed In the UK, an increased emphasis on through-life business support an independent committee, chaired by Lord Woolf, the former Lord is being addressed successfully. Similarly, the Group’s strategy to Chief Justice of England and Wales. The Woolf Committee will report develop an enhanced industrial presence in the Kingdom of Saudi on the status of ethics and governance in the Group and make Arabia has underpinned the winning of substantial new business recommendations on improving that will provide future growth in that market. areas of weakness that may Underlying earnings1 per share In the US, we continue to see the benefits of a well-executed be found. The report will be from continuing operations (pence) acquisition strategy. published and the Board has undertaken to act on all 35 Our global strategy will continue to develop. The Group’s focus on 31.0 such recommendations of the 30 business in its six home markets is delivering good returns and Committee. We have taken 25 consideration is now being given to establish a presence in new this bold step because we are 23.8 home markets. committed to being the industry 20 18.4 leader in business ethics. The A more global footprint brings with it responsibility to a wider, more 15 13.6 Woolf Committee report will be diverse stakeholder base. As we grow internationally, it becomes 10 increasingly important to keep pace with evolving customer and a valuable tool in our pursuit of this objective. 5 stakeholder expectations – both in programme delivery and the methods by which we deliver our business. We seek to nurture a During the year, further changes culture within the Group of continuous improvement – in all aspects were made in the composition of 04 05 06 07 of business performance. This includes ethical awareness as we work the Board. With a ratio of eight

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)

2 www.baesyste ms.com independent non-executive directors to four executive directors, The Woolf Committee 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 In June 2007 the Board appointed Lord Woolf to lead background in global programme execution, to the Board. Also, I am an independent expert committee to study and publish pleased to report that Ravi Uppal will be joining the Board in April as a report on the Group’s ethical policies and processes. a non-executive director. He is currently President, Global Markets for It is chaired by Lord Woolf. 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 Members of the Committee 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, – The Rt. Hon. The Lord Woolf of – Douglas N. Daft, AC, former Perella Weinberg Partners. I wish him well for the future. Barnes (Chairman), former Lord Chairman and Chief Executive Chief Justice of England and Wales. of the Coca-Cola Company. Ulrich Cartellieri, Steve Mogford and Chris Geoghegan retired from – Sir David Walker, Senior Adviser – Dr Richard Jarvis (Secretary to the Board during the year and my sincere thanks go to them for their and former Chairman of Morgan the Committee), former Secretary dedicated service to the Group. Stanley International Ltd. to the Committee on Standards in Public Life. Succession planning is vital to the wellbeing of a company, and – Philippa Foster Back OBE, Director BAE Systems has a well-defined and rigorous process for ensuring of the Institute of Business Ethics. the continuity of high quality management appointments throughout the Group. The announcement setting out the timetable for the Summary terms of reference 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 The Committee was appointed to: standards, whether they are with the Group, starting as an apprentice and culminating as Chief – review the Group’s ethical policies sufficiently robust to ensure Executive of the highly successful company that BAE Systems is today. and processes, and to review the compliance with its ethical business policies generally and in particular Mike leads a highly skilled workforce of some 97,500 people who Group’s adherence to applicable anti-corruption legislation, to detect and prevent violations of have delivered excellent performance during the year by providing including relevant international anti-corruption laws; and outstanding capability and support for the armed forces and all the treaty obligations; – to make recommendations for any customers in the countries we serve. I extend my thanks to each of – reach a judgement as to how the remedial actions it believes the them for their contribution to the Group’s success. Group’s policies and procedures Group should take. The Board is recommending an increased final dividend of 7.8p benchmark against industry 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

The full terms of reference can be found on the Woolf Committee website at http://www.woolfcommittee.com/

BAE Systems Annual Report 2007 3 Directors’ report Executive leadership

Our executive leadership For more information on the p12 Group’s strategy see page 12

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 Officers principally reflecting the geographic spread of the Group, split between US-led operations, and operations in the UK and other regions. The Chief Executive, Chief Operating Officers 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.

Mike Turner Chief Executive

Operational leadership Functional leadership

Walt Havenstein Ian King George Rose Chief Operating Officer Chief Operating Officer Group Finance Director President and CEO, BAE Systems, Inc. UK/Rest of World

Marshall Banker Murray Easton Philip Bramwell President Managing Director Group General Counsel Customer Solutions Submarine Solutions

Mike Hefron Vic Emery President Managing Director Alan Garwood Electronics & Integrated Solutions Surface Fleet Solutions Group Business Development Director

Linda Hudson Guy Griffiths President Managing Director Alastair Imrie Land & Armaments Businesses Group HR Director

Scott O’Brien Nigel Whitehead President Group Managing Director Charlotte Lambkin Products Group Military Air Solutions Group Communications Director

Peter Wilson Managing Director Alison Wood CS&S International Group Strategic Development Director

Board member Executive Committee member

4 www.baesyste ms.com Directors’ report

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. The Group performed well and delivered its The Group performed well financial plan for the year and a strong five-year presented to and agreed by business plan was the Board. The Group continued to embed the principles policies and values, of good governance, processes that guide our work and behaviour, with a clear system of delegated authority across the Group. Programme execution is central to the Group determinant satisfaction. of customer and a key Both schedule and cost performance improved in 2007 and will continue to be a focus of building on the excellent management attention, progress in recent years. Chief Executive targets application of mandated business processes management on focus programme execution Objective achieved have What we Mike Turner Turner Mike 1. Meet financial 2. Ensure 3. Further increase in 2007. Each of the four business sectors of the four in 2007. Each profitability underpinneddelivered good and cost good programme schedule by across the Group.” performance “BAE Systems once again performed well well once again performed “BAE Systems growth global global ms.com www.baesyste www.baesyste

Performance against top ten objectives for 2007 top ten objectives for against Performance 6

are set out on page 11. ten objectives. The top ten objectives for 2008 ten objectives. The top ten objectives for summarises achievements against the 2007 top summarises achievements for the executive team each year. The following the executive team each year. for business portfolio actions and the top ten objectives Committee agree the Group strategic objectives, the Committee agree the Group strategic objectives, this context the Chief Executive and the Executive global defence and aerospace company’. Within and aerospace company’. global defence growth in shareholder value by being the premier growth in shareholder value by annually. Our strategy is ‘to deliver sustainable annually. The Board reviews and updates the Group strategy The Board reviews

Delivering Delivering Chief Executive’s review Executive’s Chief Directors’ report – Business review

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 7 on software ploitati mor Holdings, Inc. in 2007 has Inc. mor Holdings, BAE Systems Annual Report 2007 , geospatial ex , vatives, and uplift on acquired inventories and uplift on acquired inventories vatives, as having a clear leadership positionin the as having The Group continues to identify and benefit from opportunities to work together and share best global businesses. practice across the Group’s Constraints to technology the sharing between UK and US remain but in June 2007 the US President and UK Prime Minister signed a defence US Senate, the Once ratified by technology treaty. towards this would mark significant step forward a greater technology co-operation. The Group is successfully implementing its strategy markets in which the six home to develop it currently is pursuing operates and opportunities home markets for the to establish additional new longer term. objectives is an Underpinning all of the above emphasis on leadership throughout the Group to continuous performanceachieve improvements and embed a high-performance culture. leadership at all levels existing and home new markets a commitment to partnering Objective achieved have What we 10. Demonstrate 9. Develop 8. Demonstrate is the veryin the land systems business in recent strong growth the earlieryears. in 2004 and United acquisitions of Alvis Following theDefense in 2005, Ar of acquisition established BAE Systems land sector. business focus continues to generate Our multi-home market especially in the Kingdom of Saudi Arabia opportunities for growth, position. where the Group has a growing home market United States trusted and high-performing partBAE Systems is a valued, of the US top ten largest defence defence industrial base and is one of the companies in the US. the Group is a market leader in advanced information In the US, intelligence analysis technology, and the development of knowledge-based systems. In addition, and the development BAE Systems continues to see strong demand for sophisticated and in its support solutions and protection systems, electronic warfare fully utilised. remained business the ship repair facilities have further combat Bradley contracts to reset In the land systems sector, condition were vehicles to ‘as new’ vehicles and other US tracked extended visibility of throughput at the current providing awarded, to the high volume of reset activity, In addition of activity. high level digital systems strong demand for vehicle upgrades with new 1 with in 2007 (2006 84%). 2 per share increased 30% per share increased 30% 3 of £15,710m, up 14% up of £15,710m, 2 The Group is achieving success growing in the US, The Group is achieving with 19% organic growth and the acquisition of Inc. in 2007. Armor Holdings, Progress in implementing the Defence Industrial which will deliver made, Strategy in the UK was 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 with the established core forward is moving in-Kingdom programme progressing well, is ongoing and significant new investment business has been achieved. for Saudi for 72 Typhoons The contract award a notable success. Whilst exportArabia was the Group continues markets are very competitive, to address a number of opportunities for exports from each of its six home markets. export opportunities business in the Kingdom of Saudi Arabia implement the UK Defence Industrial Strategy businesses (see note 10 to the Group accounts) Objective achieved have What we its home markets and especially the United States. A notable success its home markets and especially the United profitable growth generated from substantial business operations in profitable growth generated from substantial The Group is benefiting from a well-executed strategy The Group is benefiting from a well-executed with good responsible for generating 85% of Group sales around six home markets. Together these home markets were these home markets around six home markets. Together BAE Systems is a global company with a strategy currentlyBAE Systems is a global company focused across the organisation align with global best practice. across the organisation align with global best is determined that the business policies and processes mandated of delegated authority within a ‘One Company’ approach. BAE approach. of delegated authority within a ‘One Company’ Systems Group’s business and the behaviour of its people, with a clear system with a clear of its people, business and the behaviour Group’s governance, our values and policies and processes that guide the our governance, Underlying this performance are principles of ethical conduct, good Underlying this performance of ethical conduct, are principles across the Group. stems from good programme cost and schedule performancestems from good programme cost and schedule return on sales exceeding 8.5% in all sectors. profitability This Each of the four business sectors delivered good profitability of Armor Holdings, Inc. during the year. Inc. of Armor Holdings, having invested $4.5bn (£2.2bn) excluding fees in the acquisition $4.5bn (£2.2bn) excluding fees in the invested having to 31.0p for the year. The Group had net cash of £700m at year end, The Group had to 31.0p for the year. 1 earnings before amortisation finance costs and taxation expense and impairment2 of intangible assets, including share of equity accounted investments 3 earnings on pensions and financial deri excluding amortisation non-cash finance movements and impairment of intangible assets, 7. on key Focus 6. Progress the 5. Continue to 4. Grow US significant fundamental strengths and quality of the business. EBITA strengths and quality of the business. significant fundamental on sales 22% to £1,477m increased by BAE Systems once again performed well in 2007, demonstrating the demonstrating in 2007, performedBAE Systems once again well compared with 2006. Underlyingcompared with 2006. earnings Directors’ report – Business review Chief Executive’s review (continued) Directors’ report – Business review Business – report Directors’

continues, in part driven by the move in the US to modular forces across sites and businesses globally, including the integration of the requiring the fielding of a common standard of more capable vehicles. former Armor Holdings’ capabilities. The programme brings together more than 35 years of experience in mine protected wheeled vehicle To complement BAE Systems’ tracked vehicle position in the US, ietr’rpr Governance – report Directors’ expertise and highly survivable combat platforms. the Group has been executing a wheeled vehicle strategy to meet a valuable, near-term, urgent operational requirement for Mine In December 2007, the Group announced the proposed acquisition Resistant Ambush Protected (MRAP) vehicles. This has resulted in the of MTC Technologies, Inc.. MTC complements BAE Systems’ existing establishment of a new assembly facility for the RG33 mine protected readiness and sustainment capabilities in the US. vehicle in York, Pennsylvania, alongside the Bradley reset facility. United Kingdom Following the substantial contract award for RG33 MRAP vehicles in The Group’s UK-based businesses are performing well with good 2007, manufacturing volume has increased rapidly in the last months programme schedule and cost performance. This performance of 2007 with the completion of 23 vehicles in October rising to 102 improvement included a recovery to profitable trading for the land in December. systems business in the UK. The acquisition of Armor Holdings, Inc. delivered further progress as BAE Systems continues to make progress in developing integrated regards the wheeled vehicle strategy. The business is a key player in through-life support business in partnering arrangements with the UK the tactical wheeled vehicle market and in the increasingly vital areas MoD and the UK’s armed forces. Benefits are now apparent as some of armour protection and survivability. With strong demand for its of the earlier programme relationships mature. For example, the products, notably for the Family of Medium Tactical Vehicles (FMTV) National Audit Office has concluded that the partnered support and the Caiman mine protected vehicle derivative, the Armor Holdings arrangements for the Tornado combat aircraft have contributed to a acquisition is well on track to deliver our required return on investment. 51% reduction in cost per flying hour and cost savings over the past Financial statements Financial BAE Systems has worked across its global businesses rapidly to five years of £1.3bn. BAE Systems is similarly involved in support design, produce and deliver vehicles to protect the armed forces. for a number of other UK air platforms and is addressing through-life The Group’s role on the MRAP programme involves collaboration support for the UK’s armoured fighting vehicle fleet. The Group

The market

Supplemental budgets in the US to fund overseas BAE Systems’ market position (US$bn) Top 10 defence companies in 2007 (based on 2006 defence revenues) operations, combined with good growth in the underlying US defence budget have contributed 40 36.0 to overall growth in the global accessible defence 35 market. US supplemental budgets are not 30 30.8 25 25.0 Shareholder information expected to be maintained but underlying global 23.6

defence expenditure is forecast to continue to grow 20 19.5 18.7 with increasing contributions from the fast-growing 15 13.2 Asian economies. This expenditure naturally 10 9.9 9.0 7.6 determines where Group attention is focused. 5

The top 15 countries account for 80% of the global 0 total and the US accounts for around 50% alone. EADS Boeing

Most of the Group’s businesses are focused Raytheon BAE Systems on the defence industry and are subject both Finmeccanica Lockheed Martin General Dynamics Northrop Grumman L3 Communications to competition from multi-national firms and United Technologies to government regulation.

Source: Defense News

8 www.baesyste ms.com Directors’ report – Business review Business – report Directors’

identifies further opportunities to develop such arrangements in air, In Sweden, production of the CV90 infantry fighting vehicle is underway for land and naval support. the Dutch Army, continuing the good export performance of this business. The UK government’s commitment to the new Carrier programme In Australia, the Group continues to build on its position as a through- ietr’rpr Governance – report Directors’ in July enabled BAE Systems to enter into a Framework Agreement life capability partner to the Australian Defence Force, including a with VT Group for the establishment of a joint venture which would, follow-on multi-year support contract for the Hawk aircraft. subject to completion, bring together BAE Systems’ and VT Group’s The selection by Australia of the FMTV as the basis for the Land 121 respective surface warship building and surface warship through-life vehicle programme will generate substantial industrial involvement in support operations. Australia. BAE Systems is also a major subcontractor on the Australian Other home markets Wedgetail Airborne Early Warning and Control programme, where we are jointly engaged with Boeing and the customer to re-baseline Saudi Arabia continues to be an important home market for this programme. BAE Systems, building on a performance track record established over many decades. In January 2008, the Group announced the proposed acquisition of Tenix Defence, a leading Australian defence contractor. The acquisition The large programme of support for Tornado is being maintained and will more than double BAE Systems’ presence in Australia, making the modernisation of existing assets continues. In September 2007, it the largest in-country supplier to the Australian Defence Force. The under the new defence co-operation programme known as ‘Project organisations are an excellent fit and have largely complementary Salam’, contracts were signed between the UK government and the programmes and capabilities. This acquisition is a significant step in Kingdom of Saudi Arabia for the supply of 72 Typhoon aircraft. the implementation of the Group’s strategy to develop as the premier global defence and aerospace company by growing the business in We continue to invest within Saudi Arabia in both the expansion Australia, one of the Group’s six home markets. statements Financial of the Kingdom’s industrial capability and new secure residential accommodation. The first of two new compounds for our employees In South Africa, the land systems OMC business is achieving growth is now being occupied in Riyadh. through exports with its RG31 and RG32 mine protected vehicles.

Forecast defence budget by major region Global equipment market (US$bn) (US$bn in constant 2008 prices) 2007 estimated defence procurement

1400

1200

1000 Shareholder information 800

600

400

200

0 03 04 05 06 07 08 09 10 11 12 13 14 15 0 15 30 45 60 75 90 105 120 135 150 Year Rest of World (excluding markets inaccessible for business by the Group) US (including supplemental budgets, excluding Research, Testing, Europe (West, Central and Eastern European countries, excluding former Development & Evaluation) Soviet Union nations) Europe (West, Central and Eastern European countries, excluding former Soviet US supplemental budget Union nations) US base budget Rest of World (excluding markets inaccessible for business by the Group)

The US represents around 50% of the total forecast global defence spend The US accounts for around 50% of estimated total global procurement in 2008. (including equipment, personnel and operating costs) to 2010.

Source: BAE Systems internal analysis Source: BAE Systems internal analysis

BAE Systems Annual Report 2007 9 , despite significant ongoing operational commitments. Spending on defence equipment in the UK is under particular the demands of balancing pressure, procurement with personnel-related costs and the impact of ongoing operations in of activity Afghanistan and Iraq. A high level due to Urgent Operational Requirements (UORs) has resulted from these operations. Defence Implementation of the UK’s Industrial Strategy (DIS) is underway against a challenging set of milestones. BAE work Systems continues to with the UK MoD to ensure transformation of the business to meet challenging requirements, particularly Long Term focused on developing across air, Partnering (LTPAs) Agreements domains. land and naval United Kingdom market to The defence market in the UK is expected become more challenging in the coming years. Overall defence spending is being held to low 2% of GDP at just over of real growth, levels Chief Executive We have excellent forward visibility and a further visibility and excellent forward have growth year of good We year contribution from the including a full is anticipated in 2008, part-yearformer Armor contributions In addition, Holdings business. the anticipated completion in 2008 of the are expected following Defence. and Tenix of MTC Technologies proposed acquisitions Turner Mike the outcome, support for defence spending the outcome, is expected to remain robust. US defence spending has In recent years, supplemental budgets aimed by been buoyed defence costs related additional at covering to the ongoing operations in Afghanistan and Iraq. When the US disengages from these of these supplemental the scale operations, budgets will probably decline. (continued) ms.com www.baesyste www.baesyste

The US continues to be the most attractive of The US continues to be the most attractive accounting for all the major defence markets, around 50% of global defence expenditure in the Group markets accessible for business by (see chart approximately 4% of on page 9) and The US will remain one of BAEGDP. Systems’ scale and offering programme markets, key in research and of investment high levels BAEdevelopment. Systems has continued its market leveraging to grow in the US by leadership introducing new positions and capabilities that meet customers’ needs. placed to supportThe Group is well the US Department emphasis its likely of Defense in on force sustainment and readiness and affordable transformation. The short-term outlook for defence continues growth in US defence although to be favourable, 2010. spending is expected to slow beyond the US is now starting the run-up to Politically, the next presidential election in November 2008. Both parties supportive remain of whatever national security and consequently, United States market 10 our long-term plans. well positioned to continue to deliver shareholder value in line with positioned to continue to deliver shareholder well quality business based on a strong, well-balanced portfolio well-balanced quality business based on a strong, and is an established footprint in six home markets. BAEan established footprint in six home markets. Systems is a capability to its customers and is well positioned for the future with capability to its customers and is well and programme performance. It is delivering value for money and and programme performance. It is delivering value for money The Group is continuing to deliver its strategy with strong financial customers and shareholders. business performance and generating value, to the benefit of business performance and generating value, across its home markets and remains focused on delivering good across its home markets and remains focused The Group continues to look for furtherThe Group continues enhancing opportunities value Group has maintained a strong balance sheet and is performingGroup has maintained well. acquisitions. Following the acquisition of Armor Holdings, Inc., the Inc., the acquisition of Armor Holdings, acquisitions. Following addressing market opportunities and investments through organic BAE Systems has a successful track record of identifying and BAE Systems has a successful Summary and outlook Chief Executive’s review review Executive’s Chief Directors’ report – Business review

Directors report’ – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 11 BAE Systems Annual Report 2007 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 plans our transformation and investment Progress export opportunities from each of our home markets Continue to drive performance in safety, ethics and diversity South Africa, with one of the best trained South Africa, and equipped militaries in sub-Saharan 1.2% and 1.6% between is spending Africa, p.a. of its GDP on defence. It is currently undergoing a major re-equipment programme as a result of defence procurements in 1999. the government by approved militaryThe Swedish is also undergoing reform a force for as it changes from to one that defence against invasion is more flexible and mobile. Since the defence spending beginning of this process, fell from 2% of GDP to 1.4% in 2006. Over the same period there has been government encouragement for the industry to move greater participationtowards in international collaborative programmes. enhance its positions in these markets To and optimise its ability to execute its home intends to the Company market strategy, establish home market advisory boards in those markets where it would benefit from advice focused on in-country business and industrial partnering.development diversity Saudi Arabia Industrial Strategy opportunities Objective 6. US business 7. Kingdom of 8. UK Defence 9. Export 10. ethics and Safety, Other home markets and is expected to remain, Saudi Arabia is, one of the major defence markets in the dedicating up to 10% of GDP to this world, with a significant part of this spent sector, on external An Understanding procurement. signed on 21 December Document was the UK and Saudi Arabian 2005 between outlining plans to modernise the governments, capabilities of the Saudi armed forces. These helping modernisation underway, activities are a greater indigenous capability in to develop the Kingdom. has committed The Australian Government to an increase in defence spending of 3% p.a. on an annual budget (real) until 2015–16, of A$22 billion. Its stated preference is to maintain a strong local defence capability which will underpin growth. strong market It has also released the Defence Capability which outlines the major Plan 2006–2016, this time frame. over capital equipment outlays A total of A$74.6bn is forecast to the over be spent on capital investment the government’s reflecting next decade, commitment to growth in defence spending. Meet 2008 financial targets and set challenging and realistic longer-term plans partnering our Develop 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 of our security Progress development businesses in our home markets

execution and processes partnering approach

2008 Executive Committee top ten objectives 2008 Executive Objective 5. Security 4. Programme 3. Business policies 3. Business 2. our Develop 1. Financial targets difficult budgetary conditions. LTPAs will be even more necessary will be even under LTPAs capability management and appropriate armed forces, the securing of through-life armed forces, current needs of the and future equipment Review. To deliver value for money and meet deliver value for money To Review. following the 2007 Comprehensive Spending in the UK MoD’s current Planning Round 08 in the UK MoD’s account of the difficult decisions required version 2 has been delayed into 2008 to take version 2 has been delayed The UK government’s publication of the DIS The UK government’s leadership of our Company. of people at all levels and engagement objectives will be contained in the Annual Reportobjectives will be contained focus for the these objectives is to provide 2008. The aim of The Executive Committee has set the following objectives for 2008. A review of the performance these against for 2008. A review has set the following objectives The Executive Committee Directors’ report – Business review Strategic overview ietr’rpr Business review – report Directors’

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 ietr’rpr Governance – report Directors’ 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.

Group Strategy

To deliver sustainable growth in shareholder value by being the premier global defence and aerospace company Financial statements Financial

Group Strategic Objectives

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

Business Portfolio Actions Shareholder information

Establish in the Grow our business Implement the home Grow our global land Grow our export Grow our global UK sustainably in the United States market strategy and systems business business from our support, solutions profitable through-life both organically grow in the Kingdom home markets and services businesses in and via acquisitions of Saudi Arabia businesses Air, Land and Sea

Integrated Business Plans

12 www.baesyste ms.com Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 13 p25 p44 p51 The following three case The following studies demonstrate are of how we examples our strategy. implementing BAE Systems Annual Report 2007 inancial review. the Group’s capital structure which is explained on the Group’s Resources Key Performance Indicators (KPIs) Performance Key Risks The Group delivers its strategy Group strategic objectives through the business portfolio actions and integrated business detailed opposite, plans. The strategy is also supported ten short-term by objectives the Executive Committee (see page 11) which agreed annually by challenges in delivering the strategy in the year address the key a set of financial ahead. The objectives are directly underpinned by and non-financial performance indicators regularly that are reported to executive remuneration. These KPIs are to the Board and linked a succinct and meaningful detailed on pages 25 and 26 and provide measurement system to assess enterprise performance and strategy. in line with our continuous improvement Effective management of risk and opportunity is essential to the delivery of of sustainable objectives and achievement the Group’s shareholder approach to risk management is to value. The Group’s remove occur, risks before they and effect of or reduce the likelihood and do. if they deal effectively with problems Further information management processes and on the risk in the management of risk, and the committees involved procedures, is given on pages 44 and 45. resources and arrangements its to achieve the Group uses The key strategic objectives include: – the people it employs; – subcontractors and other suppliers; relationships with its customers, – research and development; – intellectual property; and – its capital structure. Each of these is discussed further with the on pages 51 and 52, exception of page 22 in the F p12 home markets capabilities culture across the Company to meet our customer requirements technology practice between and best in our home markets high-performance programme execution partnering approach security businesses sharing of expertise, importance market opportunity. of this adjacent on developing the Group’s multi-home market strategy; and the Group’s on developing Strategy security businesses in our home markets. and capabilities appropriately. We decided to focus on establishing We and capabilities appropriately. market segments, providing we could lever our core technologies lever could we providing market segments, In 2007, we evaluated opportunities evaluated we to grow into related new In 2007, Establish home markets. presence, both in our six existing home markets and in potential new both in presence, We continue to evaluate ways in which we can develop our in-country can develop in which we ways continue to evaluate We Develop our capabilities in existing and new our capabilities in existing and new Develop our activities alongside customers. ways such as workingand embedding in integrated project teams ways We are responding to this by building our partnering are responding to this by capabilities in We long-term nature and strategic importance of defence procurements. stability of our business. Many of our customers are recognising the stability of our business. Many customers are increasingly important to the long-term future and Mutually beneficial trust-based partnering with our relationships Develop a Develop to work across the lines of business that span our six home markets. to deliver these solutions. We need to continue to build on our ability to deliver these solutions. We to increasingly collaborate across our business and project boundaries to increasingly collaborate across our business through-life and capability solutions, we are committed to finding ways are committed to finding we through-life and capability solutions, As our customers’demand the ability to offer requirements increasingly our global businesses Increase performance and growth of our business. expectations on time and budget will ensure we deliver continuing we expectations on time and budget will ensure by our customers as their reliable partner of choice to deliver to their our business. Being recognised winning new existing contracts and successful delivery of our strategy, both in terms on of executing successful delivery strategy, of our Excellence in programme execution remains at the core of the Excellence in programme execution remains Further enhance our in line with our ethical principles. is underlined by demonstrating high standards of business conduct is underlined demonstrating high standards by our performance so that we deliver against our commitments. This deliver against our commitments. our performance so that we our This means setting challenging targets and reviewing strategy. Continue to embed a high-performance a culture underpinsHaving our ability to achieve – ‘Establish security businesses in our home markets’, highlights the highlights security businesses in our home markets’, – ‘Establish – ‘Develop our capabilities in existing and new home markets’, focuses home markets’, and new our capabilities in existing – ‘Develop and separated it into two: of the objective ‘Develop our capabilities in emerging growth markets’ of the objective ‘Develop ensure that they remain relevant. For 2008 we have clarified the intent have 2008 we For remain relevant. ensure that they Each year the Group strategic objectives are reviewed and refined to strategic objectives are reviewed Each year the Group Group strategic objectives Directors’ report – Business review Implementing our strategy ietr’rpr Business review – report Directors’

Case study one A global leader in land systems

US military vehicles

Business portfolio actions (addressed in this case study) Strategic acquisitions in both the wheeled and tracked vehicle sectors have ietr’rpr Governance – report Directors’ resulted in BAE Systems’ leadership positions in these key growth areas. Grow UK Grow US Grow in the Grow land Grow export Grow global through-life business Kingdom of systems business support Further convergence of these two sectors will continue to create growth businesses Saudi Arabia opportunities for the Group as it begins to focus on the development of light wheeled vehicles.

– 2005 acquisition of United Defense established Total US military vehicle fleet (%) BAE Systems’ strong position in the tracked combat 255,000 military vehicles (2006 inventory) vehicle sector – 2007 acquisition of Armor Holdings positioned 13 BAE Systems as a leader in the growing military wheeled vehicle sector Acquisition of Acquisition of – Further convergence of such tracked combat and wheeled United Defense Armor Holdings vehicle technology will present future growth opportunities 87 for the Group

Financial statements Financial 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 US tracked vehicles (%) US wheeled vehicles (%) South Africa. This large global presence has been established over Primarily combat Primarily support a short period. The Group embarked on a distinct and cohesive strategy to enter both the tracked and wheeled vehicle sectors, and M1 Abrams Bradley Combat and Light tank M2/M3 Heavy the convergence of these capabilities is now providing significant 20 13 growth opportunities. 25 Prior to 2004 BAE Systems’ involvement in the land systems 52 sector was limited to its RO Defence activities in the UK. In 2004 12 BAE Systems acquired Alvis plc, recognising the opportunity to 35 address the market for through-life support of the UK armoured Fire 43 M113 Fighting Vehicle fleet and to better address the opportunity to support armoured Medium platforms participate in the UK’s largest projected land systems programme, personnel carrier the Future Rapid Effect System (FRES). Alvis included not only the BAE Systems BAE Systems – major participation principal constituents of the UK armoured vehicle capability but also Others BAE Systems – some participation the Swedish Hägglunds business and OMC in South Africa. Others

Shareholder information With its newly expanded land sector presence and its strategy Figure 1 to grow in the US market, BAE Systems targeted the good growth prospects for support and reset work in the large armoured vehicle The growth of insurgency and the terrorist threat, including the use fleets in the US. Reset is the process of taking worn vehicles out of mines and improvised explosive devices has led to a demand for a of service and refurbishing them to an as-new condition for return new class of utility vehicle. These more sophisticated utility vehicles to service. BAE Systems identified United Defense, a major tracked retain wheeled mobility but have the survivability characteristics of combat vehicle business in the US, as a focus for increased reset tracked combat vehicles. This evolving convergence of utility and activity and has seen substantial growth since its acquisition of that combat vehicle capabilities led BAE Systems to acquire Armor company in June 2005. Holdings, Inc., a leading US supplier of wheeled utility vehicles and armour protection technology. The Armor Holdings capabilities Having established a strong position in the tracked combat complement the tracked combat vehicle capabilities of the former vehicle sector, BAE Systems looked to address the newly emerging United Defense business in the US (see figure 1). opportunities for wheeled military vehicles. Wheeled vehicle fleets have in the past been assigned primarily to utility and support When BAE Systems acquired Armor Holdings the requirement in the applications while the heavier combat vehicles, with their enhanced US for Mine Resistant Ambush Protected (MRAP) vehicles was just survivability, were deployed for combat operations. emerging. BAE Systems has been able to respond to this urgent

14 www.baesyste ms.com Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 15 FMTV JLTV MMPV BAE Systems has been contracts for awarded approximately one-third of the c. 12,000 MRAP vehicles ordered in the US. the business has In addition, over received contracts for 1,000 mine protected vehicles in other markets. BAE Systems Annual Report 2007 MRAP RG33 Caiman RG31 Other RG33 RG31 Caiman HMMWV 7 14 systems strategy and key acquisitions have ensured have acquisitions systems strategy and key 14 Up-armour programme 65 BAE Systems Others Subject to competition BAE Systems Others US MRAP orders (%) Wheeled utility vehicle route map its land systems strategy BAE Systems has developed at a time of significant has Vehicles) of Medium Tactical Production of FMTV (Family growth in activity. been in demand throughout 2007. This is increased and MRAP vehicles have to become likely to continue in the shortlikely term with MMPVs and JLTVs bids underway. BAE Systems currently has two distinct JLTV the focus. Mine protected vehicles Mine protected class of utility vehicle which incorporates a new the mobility Demand for with the survivabilityof wheeled utility vehicles combat vehicles of tracked vehicles. of mine protected wheeled has led to the development BAE Systems’ land growth area. in this key it is a leading player Previous Now Future Figure 3 Figure 2 sourced vehicles s for MRAP Mine Resistant Ambush Protected (MRAP) vehicle –Mine Resistant Ambush Protected RG33 reflect both the Group’s The MRAP programme awards ability to collaborate across sites industrial capacity and its and businesses globally. entirely separate teaming arrangements. is approaching the JLTV requirement through the formation of two is approaching the JLTV demonstrated with up-armoured HMMWVs and MRAPs. BAE Systems military for survivable, combat-ready utility vehicles, as have been as have military utility vehicles, for survivable, combat-ready The requirements for the JLTV will apply lessons learned by the US will apply lessons learned by The requirements for the JLTV Vehicles (HMMWV) in use by the American military (HMMWV) in use by (see figure 3). Vehicles size and mass to the lightweight High Mobility Multipurpose Wheeled size and mass to the lightweight a range of three types of light to medium vehicles of comparable a range of three types of light to medium to involve the application of advanced new technologies to achieve technologies to achieve the application of advanced new to involve the proposed Joint Light Tactical Vehicle (JLTV) programme is likely programme is likely (JLTV) Vehicle the proposed Joint Light Tactical Army programme of record for future MRAP-like requirements, while requirements, of record for future MRAP-like programme Army requirement, winning large order requirement, (MMPV) is the US Vehicle in two directions. Medium Mine Protected requirements. Near-term are expected to evolve MRAP requirements to the continuing convergence of utility and combat vehicle to the continuing convergence New generation vehicle programmes are likely to emerge in response vehicle programmes are likely generation New and Fairfield, Ohio (see figure 2). Ohio (see and Fairfield, recently acquired former Armor Holdings facilities in Sealy, Texas Texas recently acquired former Armor in Sealy, Holdings facilities the former United Defense facilities in York, Pennsylvania; and the Pennsylvania; the former United Defense facilities in York, from three of its operations: the OMC business in South Africa; from three of its operations: the OMC business Future availability contract opportunities e.g Typhoon, Nimrod MRA4 Availability contract Availability ATTAC weapon Tornado system availability Through-life Through-life support contract Whole aircraft support BAE Systems contracts future BAE Systems contracts Possible Tornado supportTornado roadmap support example of how the BAE Systems’ UK Tornado programme is a key capability and support. ‘through-life’ demands for Group is meeting customer projects with the UK military which Initially the Group piloted aircraft fleet, programme. This model can now ATTAC the Tornado now culminated in have other projects both within the UK and other export for markets. be followed Initial pilot contracts Spares and component support Tornado support roadmap Tornado At the end of 2006 the Group’s partnership approach to supporting At the end of 2006 the Group’s armed took a further forces with the major step forward the UK’s Aircraft Tornado Transformation: (Availability signing of the ATTAC is potentially worth £1.5bn and includes Contract) agreement. ATTAC spares GR4 aircraft fleet, on-aircraft maintenance of the Tornado agreement, support, technical support and training. Under the ATTAC BAE responsibility for deep support Systems has taken at RAF and Marham and combines this with a capability development sustainment service as a structured approach and cost-effective so as to maintain its to inserting capability into the aircraft, new is an ATTAC throughout its service effectiveness war-fighting life. contract where BAEavailability Systems is responsible for ensuring to the are provided at an agreed capability, the required aircraft, required. are front-line when they Similar opportunities including new exist across a number of areas, due to enter service, such as and those platforms such as Typhoon similar partnered the MRA4 Nimrod. In addition, support arrangements armoured fighting vehicle fleets across the UK’s are being developed support.and in UK naval support Grow global (continued) business Grow export systems Grow land (addressed in this case study) (addressed in this Kingdom of Grow in the Saudi Arabia ms.com Grow US business www.baesyste www.baesyste

Grow UK

Business portfolioactions projects and in other markets, such as Australia such projects and in other markets, forward in 2006 with the UK Tornado support programme the UK Tornado in 2006 with forward experience realised significant cost and efficiency benefits experience realised significant cost developed extensive supportdeveloped capability in the Kingdom decades several of Saudi Arabia over through-life businesses Tornado flying hour costs. Tornado over the past five years on Tornadosupport, with a 51% reduction in the past five years over on 2007 that these arrangements had contributed to savings of £1.3bn 2007 that these arrangements had contributed to savings this programme, the UK government’s National Audit Office reported in the UK government’s this programme, traditional maintenance manhours by 50%. Highlighting the success of traditional maintenance manhours by concurrently. Combined maintenance and upgrade has reduced concurrently. to facilitate modifications and systems upgrade to take place to facilitate modifications and systems upgrade to take in the UK enabled aircraft down-time for maintenance to be optimised The similar concept now in place for the larger fleet of Tornado aircraft The similar concept now in place for the larger fleet of 16 of BAE Systems. co-locating the RAF and Royal Navy engineering activities with those Navy co-locating the RAF and Royal facility was established at RAF Cottesmore for the UK’s Harrier fleet, Harrier fleet, RAF Cottesmore for the UK’s established at facility was support of whole aircraft fleets. A combined maintenance and upgrade and sub-systems leading to contracts to manage the maintenance and Air Force (RAF) has been expanded across larger airframe assemblies (RAF) has been Air Force Progressively, BAE Systems’ deeper involvement in support BAE Systems’ deeper involvement of the Royal Progressively, benefit of enhanced availability. benefit of enhanced availability. apparent, delivering reduced costs together with the operational delivering apparent, environment of severe cost restraint the benefits quickly became of severe environment efficiency to the management of parts, repair and overhaul. In an efficiency to the management of parts, repair and overhaul. the UK’s military aircraft fleet where industry could bring enhanced the UK’s Initial pilot projects were established, identifying components of established, Initial pilot projects were with the armed forces in the UK. support solutions programmes into other markets, most notably support into other markets, solutions programmes successful relationship has provided a basis on which to develop a successful relationship has provided forces in Saudi Arabia, principally the Royal Saudi Air Force. This highly Saudi Air Force. principally the Royal forces in Saudi Arabia, have been developing a deep relationship in support developing been have of the armed For several decades BAE Systems and its predecessor companies decades BAE Systems and several For profitable stream of business for the Group. efficiencies for customers a substantial and while developing a partnered support and cost savings approach which is providing – The partnered support for other model is being developed In response to customer demands BAE Systems has developed – BAE Systems’ partnering approach took a significant step

– within the UK based on this Pilot projects launched – predecessor companies have BAE Systems and its

from partnered support Delivering benefits benefits Delivering

Case study two Case Implementing our strategyImplementing Directors’ report – review Business

Business portfolioactions (addressed in this case study) E Systems can trace the roots of its relationship with the Kingdom E Systems can trace the roots of its relationship Grow UK

through-life businesses introduction of Typhoon aircraft under the Salam programme. introduction of Typhoon underway to facilitate the modernisation of the RSAF and supportunderway the local employer. Further industrial facilities is already in investment local employer. constituent of the Saudi Arabian defence industrial base and a major Arabia’s indigenous capability and BAEArabia’s Systems’ position as a major agreement sets out a plan that will further enhance both Saudi aircraft, a contract for which was signed in 2007. Importantly, the signed in 2007. Importantly, for which was a contract aircraft, forces. This programme, Salam, includes the supply of Typhoon Salam, forces. This programme, Arabia signed an agreement to modernise the Saudi Arabian armed In December 2005 the UK government and the Kingdom of Saudi divisional management team to the Kingdom. of its key homeof its key includes the recent relocation of the markets of the programme. The Group’s commitment to Saudi Arabia as one commitment to Saudi Arabia of the programme. The Group’s in companies through investments into Saudi Arabia, both in new facilities for its people and both in new Arabia, into Saudi investments 2,300 Saudi nationals. BAE Systems has made significant been established in Saudi Arabia. The Group employs approximately been established in Saudi Arabia. The Group employs capability to undertake activity has major maintenance and upgrade replaced a high proportion of the expatriate workforce and the Well-trained and highly skilled Saudi nationals have progressively and highly skilled Saudi nationals have Well-trained increase the number of Saudi nationals employed on the programme. increase the number of Saudi nationals employed Over time, BAE Systems and the RSAF have worked to substantially BAE Systems and the RSAF have Over time, export programme supported a large expatriate workforce. by ships. As with the Lightning programme, Tornado was initially a UK was Tornado ships. As with the Lightning programme, aircraft and associated training systems and support, and supply of aircraft and associated training systems and and Royal Saudi Naval Forces (RSNF) through the purchase of Tornado (RSNF) through the purchase Forces Saudi Naval and Royal enhancement to the capability of the Royal Saudi Air Force (RSAF) Saudi Air Force enhancement to the capability of the Royal government and the Kingdom of Saudi Arabia for a substantial government and the Kingdom of Saudi Arabia arrangements. In 1985 agreement was reached between the UK reached between arrangements. In 1985 agreement was aircraft deliveries were followed by the provision of extensive support the provision by followed aircraft deliveries were of Lightning and Strikemaster aircraft in the late 1960s. The initial of Lightning and Strikemaster of Saudi Arabia back through its predecessor companies to the supply of Saudi Arabia back through its predecessor BA development of Saudi Arabia as a home market. development relationship, creating new opportunities creating new for the future and the relationship, number of decades. The Group continues to strengthen this market number of decades. The Group continues Saudi Arabia has been an important market for BAE Systems for a – and training within Saudi Arabia on investment Focus – from an export Moving programme to a home market the Kingdom of Saudi Arabia of Saudi the Kingdom

A home market strategymarket A home in Case study three Case 07 12.8 06 11.3 05 10.3 04 9.5 03 9.2 increased from 7.7 times 2 Dividend (pence per share) 15 12 9 6 3 from 3 per share from continuing operations for 2007 3 Finance Director to 39 times. Taxation tax rate for continuing operations for the year effective The Group’s unchanged from 2006 at 26%. was Earnings per share Underlying earnings continuing operations (2006 2.1 with which is consistent times), policy of growing the the Group’s dividend whilst maintaining a long-term sustainable earnings of approximately two times. cover Finance costs were reduced in 2007, primarily as a result of the Finance reduced in 2007, costs were proceeds (£1.2bn). benefit of the October 2006 Airbus net disposal Underlying based on EBITA cover interest 30% to 31.0p. increased by in accordance with IAS 33 Earnings per Basic earnings per share, 31% to 26.0p increased by operations, from continuing Share, (2006 19.9p). Dividend The Board is recommending a final dividend of 7.8p per share the total bringing (2006 6.9p), dividend for the year to 12.8p an per share (2006 11.3p), increase of 13.3%. The proposed dividend is covered earnings 2.4 times by George Rose They demonstrate the significant demonstrate They strengths and quality fundamental of the business.” “These are another set of strong results. set of strong results. “These are another 2 and 1 of £77m 2 continued growth continued . 2 adjusted for uplift on acquired inventories 2 ms.com 1 (EBITA increased to £38.6bn, primarily on the award of the Saudi primarily on the award increased to £38.6bn, 1 increased 22% to £1,477m (2006 £1,207m). The growth increased 22% to £1,477m (2006 £1,207m). generated from home markets represented 85% of the generated from home markets represented increased 14% from £13,765m to £15,710m. Sales in the increased 14% from £13,765m to £15,710m. www.baesyste www.baesyste 2 1 1

Results for the year –Results for operations continuing Net finance costs Typhoon contract, MRAP orders and the acquisition of Armor Holdings. contract, Typhoon Order book goodwill associated with the Group’s Insyte business. the Group’s associated with goodwill business, acquired in July 2007, which contributed EBITA acquired in July 2007, business, The impairment charge of £148m includes £145m in respect of the includes the benefit of five months trading from the includes the benefit of five months trading Armor Holdings Amortisation and impairment 8.8% to 9.5%. in the year. Translation of US$ generated results decreased EBITA Translation in the year. Return on sales expressed as a percentage of sales) for the Group increased from 14%. US-led businesses were responsible for 47% of sales 14%. US-led businesses were EBITA exchange translations and acquisitions and disposals, was also was disposals, exchange translations and acquisitions and Group total. were £725m. Like-for-like growth, after adjusting for the impact of after adjusting growth, £725m. Like-for-like were full year from the Armor Holdings business, acquired in July 2007, full year from the Armor Holdings business, sales 18 revaluation of financial instrumentsrevaluation and foreign currency movements. of £17m) arising from pension accounting, marked-to-market of £17m) arising from pension accounting, was offset by a net credit of £131m (2006 increased by a net charge a net credit of £131m (2006 increased by offset by was expense). The underlying net interest charge of £38m (2006 £157m) of equity accounted investments, was £93m (2006 £174m financial was of equity accounted investments, Financial income, including the Group’s share of the finance costs including the Group’s Financial income, 50% of the Group’s EBITA 50% of the Group’s by £47m when compared with 2006. US-led businesses delivered £47m when compared by Sales

A year of A year Financialreview Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 1 19 £m 2006 (34) 646 (174) (248) (105) Order book 23.8p 19.9p 11.3p 1,207 4 13,765 (outflow) 5 Cash inflow/ 2006 2 £m 2007 EBITA 93 900 (373) (149) (148) 31.0p 26.0p 12.8p 1,477 BAE Systems Annual Report 2007 1 15,710 – – (23) – £m £m £m £bn Sales 295 (147) (225) 0.3 (695) – – (1.0) 4,0072,115 4294,615 1683,428 273 342 137 415 3.4 449 4.9 171 17.0 7.1 14,460 1,207 80513,765 1,207 32.7 782 31.7 1 Order book 4 Cash inflow 2007 2 EBITA 1 –––– £m £m £m £bn Sales 243 (155) 181 0.4 (673) – – (1.4) 3,9163,538 4295,327 3123,359 302 456 435 10 3.5 807 678 7.3 20.9 7.9 16,383 1,477 1,97815,710 40.0 1,477 1,978 38.6 per share 3 1 1 1 2

taxation expense and uplift on acquired inventories on pensions and financial derivatives, movements (see note 10 to the Group accounts) and dividends from equity accounted investments financial investment,

Business group summary Summary – income statement operations continuing 3 earnings excluding amortisation non-cash finance and impairment of intangible assets, 4 net cash inflow/(outflow) from operating activities after capital expenditure (net) and 5 organisational structure restated following changes to the Group’s 1 including share of equity accounted investments 2 earnings before amortisation finance costs and and impairment of intangible assets, Discontinued businesses Intra-group HQ & Other Businesses International Businesses Land & Armaments Programmes & Support Electronics, Intelligence & SupportElectronics, Dividend per share Underlying earnings Basic earnings per share Profit for the year Taxation expense Taxation Net finance costs Impairment Amortisation EBITA Sales Directors’ report – Business review Financial review (continued) ietr’rpr Business review – report Directors’

Reconciliation of cash inflow from operating activities to net cash The resulting operating business cash inflow of £1,978m (2006 £782m) 2007 2006 gave rise to free cash inflow, after interest, preference dividends and £m £m taxation, of £1,801m (2006 £490m).

ietr’rpr Governance – report Directors’ Cash inflow from operating activities 2,162 778 On 31 July 2007, the Group acquired Armor Holdings, Inc. for $4.5bn Capital expenditure (net) and financial (£2.2bn) excluding fees. Net cash outflow from all acquisitions and investment (262) (141) disposals was £2,112m. Dividends received from equity accounted investments 78 145 In the period, 33 million shares were purchased under the buyback Operating business cash flow 1,978 782 programme announced in October 2006. The cash outflow in respect Interest and preference dividends (65) (207) of this programme was £152m in the period. In May, £750m, before costs, was raised following the placing of new ordinary shares to part Taxation (112) (85) finance the proposed acquisition of Armor Holdings, Inc. Free cash flow 1,801 490 Acquisitions and disposals (1,574) 1,330 Conversion of the outstanding 260 million 7.75p (net) cumulative Debt acquired on acquisition of subsidiary (538) – redeemable preference shares into ordinary shares removed the debt element of these preference shares, giving rise to an increase in Issue/(purchase) of equity shares 603 (71) reported cash of £245m. Equity dividends paid (396) (346) Dividends paid to minority interests (1) – The Group’s net cash at 31 December 2007 was £700m, a net inflow Preference share conversion 245 6 of £265m from the net cash position of £435m at the start of the year.

Financial statements Financial Other non-cash movements 57 (11) Retirement benefit obligations Foreign exchange 36 323 The movement in retirement benefit obligations during the year was Movement in cash on customers’ account6 32 (9) as follows: 265 1,712 £m Opening net cash/(debt) as defined by the Group 435 (1,277) Deficit in defined benefit pension plans at 1 January 2007 (3,167) Closing net cash as defined by the Group 700 435 Decrease in liabilities due to changes in assumptions 952 Analysed as: Actual return on assets below expected returns (156) Term deposits – non-current – 4 One-off contributions 76 Term deposits – current 164 503 Recurring contributions over service cost 214 Cash and cash equivalents 3,062 3,100 Transfers arising on acquisitions (22) Loans – non-current (2,197) (2,776) Other movements 104 Loans – current (283) (308) Deficit in defined benefit pension plans Overdrafts – current (16) (26) at 31 December 2007 (1,999) Loans and overdrafts – current (299) (334) US healthcare plans (21) Cash on customers’ account6 Total IAS 19 deficit (2,020) Allocated to equity accounted investments and other Shareholder information (included within trade and other payables) (30) (62) Closing net cash as defined by the Group 700 435 participating employers 450 Group’s share of IAS 19 deficit at 31 December 2007 (1,570) 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 Following higher regular contributions and an increase in real discount rates partly offset by lower than expected investment returns and the Cash flows adoption of new mortality tables, the Group’s share of the pension deficit Cash inflow from operating activities was £2,162m (2006 £778m), decreased to £1,570m from £2,428m at 31 December 2006 after which is after £76m (2006 £441m) special contributions to the UK allocations to equity accounted investments and other participating pension schemes. employer companies. There was an outflow from net capital expenditure and financial A net deferred tax asset of £522m is disclosed in note 8 to the Group investment of £262m (2006 £141m). accounts relating to the above deficit. Dividends from equity accounted investments, primarily MBDA, Gripen Further disclosure on the above is provided in note 22 to the International, Eurofighter and Saab, amounted to £78m. Group accounts.

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

20 www.baesyste ms.com ietr’rpr Business review – report Directors’

Treasury policy Within this policy framework the treasury department’s principal The Group’s treasury activities are overseen by the Treasury Review responsibilities are: Management Committee (TRMC). Two executive directors are – to manage the Group’s core funding and liquidity; members of the TRMC, including the Group Finance Director who Governance – report Directors’ chairs the Committee. The TRMC also has representatives with legal – to manage exposure to interest rate movements; and taxation expertise. – to manage exposure to foreign currency movements; The Group operates a centralised treasury department that is – to control and monitor bank credit risk and credit capacity utilisation; accountable to the TRMC for managing treasury activities in accordance and with the framework of treasury policies and guidelines approved by the Board. It is an overriding policy that trading in financial instruments – to manage the Group’s relationship with debt capital market investors, for the purpose of profit generation is prohibited, with all financial banks and rating agencies. instruments being used solely for risk management purposes. The treasury department transacts with an extensive range of Other key policies are: counterparty banks and financial institutions, and adopts a systematic approach to the control and monitoring of counterparty credit risk. – to maintain a balance between continuity of funding and flexibility A credit limit is allocated to each counterparty with reference to its through the use of borrowings with a range of maturities, currencies relevant credit rating. For internal credit risk purposes, all transactions and fixed/floating rates of interest reflecting the Group risk profile; are marked-to-market and the resultant exposure is allocated against – to maintain adequate undrawn committed borrowing facilities; the credit limit. – to mitigate the exposure to interest rate fluctuations on borrowings The Group, through its internal audit department, monitors compliance Financial statements Financial and deposits by utilising interest rate swaps, interest rate options against the principal policies and guidelines (including the utilisation and forward rate agreements; and of credit) and any exceptions found are reported to the TRMC. – to hedge all material firm transactional exposures, unless otherwise Further disclosure on financial instruments is set out in note 32 to the approved as an exception by the TRMC, as well as to manage Group accounts. anticipated economic cash flows over the medium term.

The following charts illustrate the underlying performance of the Group, identifying separately the impact of currency and the acquisition of Armor Holdings.

EBITA2 – continuing operations (£m) Underlying earnings3 per share – continuing operations Shareholder information (pence per share)

1600 36

1200 27

800 18 £m Pence per share Pence 400 9

0 0 2006 Currency Performance Armor 2007 2006 Currency EBITA Finance costs Armor 2007 translation translation (ex-Armor) reduction (net) (ex-Armor)

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)

BAE Systems Annual Report 2007 21 Credit rating Service, Standard Investors Moody’s Three credit rating agencies, Service, publish Investors Ratings Services and Fitch’s and Poor’s Group. During the year Standard & Poor’s credit ratings for the outlook to BBB+ and all three maintained the their rating improved for their rating as stable. long-term credit ratings the Group’s As at 31 December 2007, as follows: these agencies were by provided Rating agencyMoody’sStandard & Poor’sFitch BBB+ Rating the maintenance of an investment The Board continues to view grade credit rating as important to the efficient operation of the Baa2 activities. Group’s Stable Outlook BBB Stable grade Investment grade Investment Stable Category grade Investment (continued) ms.com www.baesyste www.baesyste

insurance arrangements to ensure the quality and adequacy of cover. cover placed in the external cover market. The Group continues to monitor its The Group operates a policy of partial with the majority of self-insurance, Insurance of the Group is usually at its best at the year end. equity accounted investments. Historically, the net cash/debt position Historically, equity accounted investments. level of receipts on the major contracts and the performancelevel of the net cash/debt of the Group is driven by operational performance, the operational performance, net cash/debt of the Group is driven by Generally, excluding the impact of acquisition or disposal financing, the excluding the impact of acquisition or disposal financing, Generally, credit default swap price. price. credit default swap taking account of the size of the institution, its credit rating and its taking account of the size of the institution, credit risk is monitored closely on a systematic and ongoing basis, stronger financial institutions for shorter periods. Bank counterparty surplus cash, with money market deposits being placed with relatively market deposits being with money surplus cash, has adopted a more conservative of its approach to the investment Since the start of the credit crisis in the summer of 2007, the Group Since the start crisis in the summer of 2007, of the credit throughout the year. reduced from £1.5bn to £1.3bn. The RCF remained undrawn reduced from £1.5bn to £1.3bn. The RCF until 2012, although the available amount for the final year has been although the available until 2012, However, it has been extended by two one-year extension agreements it has been extended by However, utilised. The RCF was contracted originally for five years until 2010. utilised. The RCF was the Group’s US Commercial Paper programme which is not currently Commercial Paper US the Group’s corporate funding requirement. The RCF provides standby funding for funding standby corporate funding requirement. The RCF provides the Group’s core relationship banks), is available to meet any general to meet any is available relationship banks), core the Group’s Revolving Credit Facility (RCF) of £1.5bn (which is syndicated amongst (RCF) of £1.5bn (which is syndicated Facility Credit Revolving £3,226m (2006 £3,603m). This, together with an undrawn committed together with an undrawn £3,226m (2006 £3,603m). This, Group had cash and short-term 2007 of at 31 December investments to withstand the credit crisis in the bank and capital markets. The to withstand the credit crisis in the bank and strategy positioned in the Group currently has resulted being well Strong cash generation in recent yearsprudent and a financing Liquidity accessing the bank and capital markets in achieving this aim. achieving accessing the bank and capital markets in the business is funded conservatively and to be proactive in raised during the year. It remains the Group’s intention to ensure intention It remains the Group’s raised during the year. GmbH loans were repaid. No new long or medium-term long repaid. No new debt was GmbH loans were accounts. During 2007, the US$200m Bond and the Eurofighter the US$200m Bond and the Eurofighter accounts. During 2007, Details of the Group’s debt are included in note 20 to the Group Details of the Group’s of markets and spreading the maturity dates of the various facilities. of markets and spreading the maturity dates continuity of competitively priced funding by borrowing from a range continuity of competitively priced funding by subsidiaries as required. The Group’s objective is to ensure the The Group’s subsidiaries as required. central treasury to operating lent onward function and funds raised are borrowings. All the Group’s material borrowings the are arranged by borrowings. All the Group’s funds and borrowing facilities, including bank and capital market including bank funds and borrowing facilities, The Group funds its operations through a mixture of shareholders’The Group funds its operations Capital structure

22 Financial review Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 23 BAE Systems Annual Report 2007 Where goods are supplied under arrangementsWhere goods are supplied not considered to sales are by IAS 11, as defined represent Construction Contracts, of ownership significant risks and rewards recognised when the been transferred and costs can be revenue and the related have measured reliably. of sales are recognised when the stage Where services are rendered, completion of the services and costs can be and the related revenue measured reliably. recognition policy are revenue Additional details concerning the Group’s in note 1 to the Group accounts. Retirement benefit plans and healthcare plans The Group accounts for post-retirement pension (IAS 19). Benefits in accordance with IAS 19 Employee benefits is the cost of providing defined benefit retirement plans, For independent actuaries and charged to the determined periodically by benefits are earnedincome statement in the period in which those full Actuarial gains and losses are recognised in the employees. by occur and are recognised in the statement in the period in which they serviceof recognised income and expense. Past cost is recognised otherwise or already vested, immediately to the extent the benefits are is amortised period until the the average basis over on a straight-line benefits become vested. in the balance sheet The retirement benefit obligations recognised benefit obligation as adjusted represent the present value of the defined for unrecognised past service the fair value of cost and as reduced by plan assets. post- for the Group’s The main assumptions made in accounting within retirement plans relate to the expected return investments on the rate in pensionable salaries, the rate of increase plans, the Group’s the mortality of increase in the retail price index, rate of plan members each of these and the discount rate applied in discounting liabilities. For in consultation with assumptions there is a range of possible values and, decides the point within that range that most management our actuaries, in these circumstances. Small changes appropriately reflects the Group’s of the deficit a significant impact on the size assumptions can have calculated under IAS 19. The Group has allocated an appropriate share of the pension deficit and to other participatingto its equity accounted investments employers using a consistent and reasonable method of allocation the directors’ best based on current circumstances, which represents, estimate of the proportionby of the deficit anticipated to be funded to the share of the pension deficit allocated these entities. The Group’s is included on the balance sheet within equity accounted investments equity accounted investments. Critical accounting policies Critical accounting individual contracts. these estimates, whilst not anticipated, would affect the profitability of whilst not anticipated, these estimates, cost and are expensed as incurred. Material changes in one or more of terms of the contract. Indirect costs are otherwise treated as a period as contract costs when their recovery for under the is explicitly allowed an allocation of direct overheads. Indirect overheads are only regarded Indirect overheads an allocation of direct overheads. an expense. Contract costs comprise directly attributable costs including total contract revenue, the expected loss is recognised immediately as total contract revenue, circumstances. When it is probable that total contract costs will exceed at least quarterly or events and more frequently as determined by Cost and revenue estimates and judgements are reviewed and updated estimates and judgements are reviewed Cost and revenue availability and access to government-furnished equipment. availability orders, the availability of materials, performance of subcontractors and of materials, the availability orders, performed, availability and productivity of labour, the effect of change and productivity of labour, availability performed, of the contract include the nature and complexity of the work to be estimating the cost of work to be completed and ultimate profitability contract management processes. Factors that are considered in that are considered contract management processes. Factors engineers, finance and commercial professionals and using the Group’s engineers, upon the knowledge and experience of the Group’s project managers, upon the knowledge and experience of the Group’s the cost estimation process requires significant judgement and is based the cost estimation process requires significant Owing to the complexity of many of the contracts undertaken the Group Owing to the complexity of many by other risks related to performance to be achieved. milestones yet and forecast costs after making suitable allowance for technical and and forecast costs after making suitable allowance Profit is calculated by reference to reliable estimates of contract revenue Profit is calculated outcome of the contract can be reliably estimated. outcome of the contract can be reliably estimated. performance on contracts until the milestones. No profit is recognised Revenue is recognised on such contracts based on the achievement of on such contracts based on the achievement is recognised Revenue International Accounting Standard 11 Construction Contracts (IAS 11). term contract arrangements in accordance with and are accounted for The majority of the Group's defence activities are conducted under long- The majority of the Group's defence activities Contract revenue and profit recognition Contract revenue and position over the relevant period. the relevant and position over estimations and provide a true of our financial performanceestimations and provide and fair view consolidated financial statements reflect appropriate judgements and consolidated financial statements reflect vary from what is anticipated. However, the directors that the believe vary However, from what is anticipated. assumptions or estimates in respect of future events, which can events, assumptions or estimates in respect of future on the consolidated financial statements. These judgements involve on the consolidated financial statements. judgement or estimation involved in their application and their impact in their application and their impact judgement or estimation involved that management considers of complexity, the level critical because of The following is intended to provide an understanding of those policies The following is intended to provide judgements or estimates. policies require management to make difficult, subjective or complex difficult, to make policies require management the Group accounts (page 94). Not all of these significant accounting the Group accounts (page The Group’s significant accounting policies are outlined in note 1 to significant accounting The Group’s The Group has granted RVGs in respect of certain in respect which RVGs aircraft sold of The Group has granted the (2006 £191m). It is considered that £134m remains outstanding the provisions by is covered net exposure to these guarantees Group’s residual values of and the estimated on a net present value basis, held, details concerningthose aircraft. Additional to this are given in note 24 the Group accounts. (continued) ms.com www.baesyste www.baesyste

page 49 of this report. are contained in the Risk management and principal risks section on only one reinsurer. Additional details concerning these arrangements only one reinsurer. of estimated future claims. Arbitration proceedings now continue with settlements have been paid by them based on the net present value been paid by settlements have 2007, agreement was reached with almost all the reinsurers and was agreement 2007, reinsurers have been in dispute over several areas of the policy. During areas of the policy. several been in dispute over reinsurers have from 1998 to 2013. Since 2006, BAE Systems and certain from 1998 to 2013. Since 2006, of the income against originally estimated future income for a 15-year period Risk Insurance Programme, which makes good shortfalls which makes in actual lease Risk Insurance Programme, Much of the leasing business was underpinned by the Group’s Financial Group’s the underpinned by Much of the leasing business was held on balance sheet. fair value of those aircraft is made on the same basis as for the aircraft to customers and the estimated fair value of the aircraft. The estimated to the RVGs are measured as the difference between amounts payable as the difference between are measured to the RVGs residual value determined by the aircraft type and age. Provisions related the aircraft type and age. Provisions residual value determined by reassessed to a value based on their contracted rental inflows plus a impairment testing. During the year the anticipated aircraft values were aircraft sold. The aircraft held on balance sheet are subject to regular aircraft sold. The aircraft held on balance sheet provided residual value guarantees (RVGs) in respect of certain regional residual value guarantees (RVGs) provided These aircraft are leased to airline operators. In addition, the Group has These aircraft are leased to airline operators. In addition, The Group holds a number of regional aircraft on its balance sheet. The Group holds a number of regional aircraft Regional Aircraft valuations and impairment reviews are given in note 1 to the Group accounts. and impairment reviews Additional details concerning the Group’s treatment of intangible assets Additional details concerning the Group’s profitability and cash-generating ability of the acquired business. profitability and cash-generating ability of the review calculations require the use of estimates related to the future review carried at cost less accumulated impairment The impairment losses. Goodwill is not amortisedGoodwill impairment but is tested annually for and actual circumstances related to individual intangible assets. actual circumstances related to individual intangible these items and, potentially, any differences between estimated and differences between any potentially, these items and, Future results are impacted by the amortisationFuture results are impacted by adopted for period require the use of estimates which may differ from actual outcomes. require the use of estimates which may intangible assets are in line with internationally used models but do acquired intangible assets. The techniques used to value these acquired intangible assets. The techniques accounted investments. IFRS 3 also requires the identification of other accounted investments. on acquisitions of joint ventures and associates is included in equity on acquisitions of joint ventures and associates subsidiaries is capitalised and included in intangible assets. Goodwill assets. Goodwill subsidiaries is capitalised and included in intangible Business Combinations (IFRS 3), goodwill arising on acquisition of goodwill Business Combinations (IFRS 3), In accordance with International Financial Reporting Standard 3 Intangible assets are given in note 1 and note 22 to the Group accounts. are given in note 1 and note 22 to the Group Additional details concerning the Group’s retirement benefit plans Additional details concerning the Group’s actuarial valuations. These funding requirements are derived from separate independent These funding requirements impact on short-term plans. cash contributions to the pension matching expectations of assets and liabilities over time has no time has of assets and liabilities over matching expectations The valuing of assets and liabilities at a point in time rather than The valuing of assets

24 Financial review Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Key Performance Indicators (KPIs) ietr’rpr Business review – report Directors’ The Board uses a range of financial and non- financial performance indicators, reported on a periodic basis, to monitor the Group’s performance over time. These include:

To measure growth: To measure financial performance: Order intake (£bn) 2007: £21.2bn +33% Underlying EBITA1 (£m) 2007: £1,489m +23% 2006: £15.9bn 2006: £1,207m ietr’rpr Governance – report Directors’

24 1500 18 1200 12 900 6 600 0 300 04 05 06 07 04 05 06 07 Order intake represents the value of funded orders received from customers Underlying EBITA1 is used by the Group for internal performance analysis in the period. as a measure of operating profitability that is comparable over time.

Order book (£bn) 2007: £38.6bn +22% Return on sales (%) 2007: 9.5% 2006: £31.7bn 2006: 8.8%

40 10

30 8 statements Financial 20 6 10 4 0 2 04 05 06 07 04 05 06 07 Order book represents the balance of unexecuted, funded orders received Return on sales represents underlying EBITA1 divided by sales, expressed from customers. as a percentage.

Sales (£bn) 2007: £15.7bn +14% Operating business cash flow (£m) 2007: £1,978m +153% 2006: £13.8bn 2006: £782m

16 2500 12 2000 8 1500

4 1000 Shareholder information 0 500 04 05 06 07 04 05 06 07 Sales represents the amounts derived from the provision of goods Operating business cash flow represents net cash flow from operating and services, and includes the Group’s share of the sales of equity activities after capital expenditure (net) and financial investment and accounted investments. dividends from equity accounted investments.

Further explanation of many of these Group financial 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 EBITA1 to communicate underlying performance. Individual business group financial 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).

BAE Systems Annual Report 2007 25 1 07 06 05 verification or audit. Days recorded lost to work-related recorded injuries (per 100,000 employees) Days recorded lost to work-related 14% to 8,734 injuries down by Days (2006 10,204). 2011 target – a are developing lost to work-related injuries. We 2,000 days areas include Initial focus performance. our safety improving plan for four-year and for improvement establishing specific targets visible senior leadership, to senior management bonuses. These have performance linking safety been incorporated into our 2008 leadership objectives (see page 38). 12000 9000 3000 6000 0 1 This data is derived from internal recording systems and is not subject to external To measure corporate responsibility performance: To environmental safety and Further information on the Group’s performance is given within the Corporate responsibility review on pages 37 to 43. Directors’ remuneration is linked to a range of measures, including to a range of measures, Directors’is linked remuneration certainmeasures. Further of these financial and non-financial information the Remuneration report is given within on pages 64 to 83 of this report. to adopt a progressive approach in the The Board continues metrics such that of appropriate Group-wide development performance transparent way. is monitored in a comparable and (continued) ms.com www.baesyste www.baesyste

to monitor the opinions of our employees as partto monitor the opinions of our employees of the development of a high-performance culture across the Group and to increase diversity and broaden the culture(see page 39). to drive innovation and performance emissions): to ensure operational efficiency, regulatory compliance emissions): to ensure operational efficiency, impact (see page 40); and minimising environmental risk to our employees and our operations and drive continual and our operations risk to our employees performance (see opposite and page 39); improvement in margin of key customer-funded projects): to provide an indicator an indicator projects): to provide customer-funded in margin of key manage major programmes; of our ability to effectively are performing against our stated key we to measure how well contract commitments; an opportunityprojects): to provide for the customer to share information on perceived performance and identify areas levels and of strength and weakness; core process BAE uses to manage its projects): to provide Systems are applying a structured approach to managing assurance that we projects. the Group’s that employees are aware of our ethical standards and that issues are aware that employees to measure how or concerns are being raised and addressed. Also, are successful our ethics training is in ensuring that all employees aware of the Group’s ethical standards and policies (see page 39); and – opinion surveys (employee information): and demographic Workplace – to demonstrate Ethics (number of issues raised and investigated): – generation and greenhouse gas waste (energy Environment use, – to minimise Health and safety management (injuries and lost days): Group’s responsibilities in these areas: responsibilities Group’s the application of mandated policies with the objective of meeting the the application of mandated policies with directly or through the Corporate Responsibility Committee, to monitor to directly or through the Corporate Committee, Responsibility environment. The following indicators are used by the Board, either the Board, The following indicators are used by environment. employees, customers and suppliers, the wider community and to the customers and suppliers, employees, The Board recognises its responsibilities to the Group’s shareholders, the Group’s The Board recognises its responsibilities to and understood on a contract by contract basis. and understood on a contract by of contract performance. be fully interpreted These metrics can only – milestones): of key Schedule Adherence (on time achievement – customer-funded Customer Satisfaction (customer opinions on key – Lifecycle Management (LCM) Application (the application of the oversight the Board to provide These metrics are consistently used by – (outturn projections of and movements Margin Variation Programme the reporting of the following metrics: application of mandated business processes. These processes include In addition to the above, long-term are managed through the contracts In addition to the above,

26 Key Performance Indicators Performance (KPIs) Key Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 27 p32 p34 Australia employees: 2,600 Businesses International International Businesses BAE Systems Annual Report 2007 Other Land & & Support & Support Businesses Electronics, Intelligence Armaments Businesses* International Programmes UK/Rest of World Programmes & Support Saudi Arabia employees: 4,300 UK/Rest of World 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. South Africa employees: 500 Businesses International p28 p30 UK employees: 34,000 BAE Systems Sweden employees: 1,700 Land & Armaments Land & Armaments Land & Armaments Inc. US employees: 44,000 global business global investments & Support Electronics, Intelligence of equity accounted Land & Armaments Note: employee numbers exclude the Group’s share Electronics, Intelligence & Support

Our existing home markets and operating structure home markets and operating Our existing Comprises businesses in the US, the UK, Sweden and South Africa. Electronics, Intelligence & Support Comprises two operating groups, Electronics & Integrated Solutions and Customer Solutions. Land & Armaments Inc. * asset management and support activities, and UK shared services activity. Other Businesses comprises the regional aircraft

Our strong customer relationships. We intend to invest and We intend relationships. strong customer in these markets. grow commitment to defence, and we are already well positioned in their defence industrial base and have industrial in their defence well positioned and we are already to defence, commitment South and sustained a significant as having have been identified markets and Sweden. These Africa Our global business is based around our home markets in the US, the UK, Australia, Saudi Arabia, UK, Australia, Saudi in the US, the home markets around our business is based Our global Directors’ report – report Directors’ review Business reviews group Business 2 when 2 and EBITA 1 systems, E&IS has begun initial of £302m (2006 £273m). of £302m (2006 £273m). 4 system, which enables emergency of £3,916m (2006 £4,007m) of £3,916m (2006 £4,007m) 3 1 TM compared with 2006 by £296m and £35m respectively. compared with 2006 by £296m and £35m In August, BAE the sale of its Inertial Products Systems completed the Group agreed to sell business for $140m (£70m). In December, Pensylvannia for its Surveillance and Attack business in Lansdale, Also in December, the a cash consideration of $240m (£121m). acquisition of MTC Group announced the proposed $448m (£225m) and professional Technologies, Inc., a company providing technical for the US services, and equipment integration and modernisation military and intelligence agencies. Electronics & Integrated Solutions (E&IS) systems and E&IS designs, develops and produces electronic commercial applications. sub-systems for a wide range of military and capabilities: electronic The operating group is focused on four primary flight and engine controls, warfare, commercial and military avionics, and tactical and national network systems. electronic warfare (EW) During 2007, E&IS delivered its 100th F-22A Fighter) EW system system, the first F-35 Lightning II (Joint Strike System to protect US Army and its 1,000th Common Missile Warning missiles. E&IS continued helicopters and aircraft from heat-seeking Security to develop its role with the US Department of Homeland a commercial version of BAE Systems Directed Infrared which seeks Countermeasures (DIRCM) system, JETEYE™, 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 and generated operating cash inflow and generated operating deployment of its First InterComm 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 During 2007, Electronics, Intelligence & Support achieved EBITA During 2007, Electronics, on sales of £429m (2006 £429m) sales benefited from a £61m pension-related In 2006, the return on accounting gain. In 2007, US$ translations decreased sales 26% 2,6 2006 2005 10.7% 8.8% £3.4bn £3.5bn £429m £324m £273m £323m (continued) £4,311m £3,659m £4,007m £3,697m and its 1 2007 Share of Group EBITA 11.0% £3.5bn £429m £302m growth of 7% over 2006 growth of 7% over £4,178m £3,916m 1 24% 5 ms.com 1 3 1 2 1 www.baesyste

taxation expense investment, and dividends from equity accounted investments Reconnaissance

Looking forward 2008 should see continued organic growth with an anticipated part-year Technologies. contribution from the proposed acquisition of MTC 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. Key points warfare systems – Continued leadership in the provision of electronic – New markets developing for the HybriDrive® propulsion systems – Stable demand for ship repair services Share of Group sales Electronics, Intelligence & Support Electronics, 28 3 net cash inflow from operating activities after capital expenditure (net) and financial 4 Command, Control, Communications, Computing, Intelligence, Surveillance and 5 before elimination of intra-group sales 6 excluding HQ & Other Businesses 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and Order book Order intake Return on sales Cash inflow EBITA Sales – Like-for-like organic sales – Like-for-like organic group, with 30,600 employees group, with The Electronics, Intelligence & Support business & Support Intelligence The Electronics, and Customer Solutions. Integrated Solutions Business group reviews reviews group Business & groups: Electronics two operating It comprises Directors’ report – report Directors’ review Business and services. sub-systems systems, and aerospace headquarters in the US, is a provider of defence is a provider of in the US, headquarters – Return on sales improved to 11% – Return on sales

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information E&IS awarded new multi-year thermal Business review Directors’ report – 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. 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. Governance Directors’ report – 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 and US Navy communications station operations and maintenance develop upgrades. in Hawaii. TSS expanded into adjacent markets by supporting the US Army with critical personnel for the global war on terror and by obtaining Customer Solutions the integrator role for the new US Air Force Battle Control System. Customer Solutions comprises three lines of business: BAE Systems Information Technology (IT); Technology Solutions and Services (TSS); BAE Systems Ship Repair secured a five-year, multi-ship multi-option and BAE Systems Ship Repair. contract from the US Navy to maintain and repair all Arleigh Burke-class Financial statements destroyers homeported or visiting San Diego, with a total potential value Customer Solutions integrates communications systems, builds and in excess of $150m (£75m). Ship Repair also secured a three-year maintains precision tracking radars, and is one of the largest service contract from the US Navy for work on three newly commissioned San providers to the US Navy. The business is also a leader in US air and Antonio-class amphibious transport dock ships and a contract from the missile defence systems. US Navy for modernisation of the Ticonderoga-class guided missile BAE Systems IT capabilities include enterprise-wide managed IT cruiser USS Bunker Hill. 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 Shareholder information 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,

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.

BAE Systems Annual Report 2007 29 of £312m (2006 2 Operation variants. BAE Systems has been of £10m (2006 £137m). The 2007 results of £10m (2006 £137m). 3 of £3,538m (2006 £2,115m) and generated of £3,538m (2006 £2,115m) 1 from the acquired business amounted to $1,452m (£725m) from the acquired business amounted to $1,452m Oklahoma. The new facility will be adjacent to the US Army Field 2 £168m) on sales During 2007, Land & Armaments achieved EBITA During 2007, Land & operating cash inflow growth on core products in addition to success showed strong organic The in the mine-protected vehicle market. in winning new business of operations from the former Armor results include five months Holdings, Inc. business. At the end of July, BAE completed the $4.5bn acquisition Systems enhanced the Land & of Armor Holdings, Inc. This acquisition has most notably in the Armaments global land systems business, sector, together with increasingly important tactical wheeled vehicle survivability. Sales and technology in the vital areas of armour and EBITA and $155m (£77m) respectively. United States for the refurbishment During the year, US Army contracts were secured recovery vehicles and and upgrade of Bradley, M88 Hercules improved M113 fighting vehicles totalling $2.3bn (£1.2bn). the US Army announced its As expected, during the first half of 2007, programme. Sales of intention to terminate the M113 fighting vehicle M113 vehicles in 2007 totalled $105m (£52m). BAE companies providing the US Army Systems is one of several Ambush Protected (MRAP) and Marine Corps with new Mine Resistant business received an wheeled vehicles. In February 2007, the US evaluation and testing, initial order for 94 MRAP vehicles. Following MRAP vehicles with follow-on awards have been received for 3,485 are produced as a total value of $2.2bn (£1.1bn). MRAP vehicles Heavy Armed Ground 4x4 and 6x6 wheeled vehicles including the Ambulance and Special 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, 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. 19% 2,5 2006 2005 7.9% 3.3% £4.9bn £4.4bn £168m £42m £137m £168m (continued) £2,115m £1,270m £2,964m £1,541m 2007 Share of Group EBITA 8.8% £10m £7.3bn £312m £3,538m £4,535m and its headquarters in in and its headquarters 1 22% 4 ms.com 1 3 1

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operational requirements 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. Looking forward – 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 Share of Group sales Land & Armaments

systems and intelligent munitions. systems and intelligent vehicles, naval guns, missile launchers, artillery vehicles, naval of armoured combat vehicles, tactical wheeled tactical combat vehicles, of armoured production, through-life support and upgrade support and upgrade through-life production, the US, is a leader in the design, development, is a leader in the the US, 30 3 net cash inflow from operating activities after capital expenditure (net) and financial 4 before elimination of intra-group sales 5 excluding HQ & Other Businesses 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and Order book Order intake Return on sales Cash inflow EBITA Sales – Order book growth on core products and urgent – Order book growth on core products – Success in wheeled vehicle market – Success in wheeled vehicle market – Post-acquisition sales of $1.5bn from Armor Holdings sales of $1.5bn from Armor Holdings – Post-acquisition – Like-for-like organic sales growth of 41% over 2006 – Like-for-like organic 20,700 employees 20,700 The Land & Armaments business group, with business group, & Armaments The Land Business group reviews reviews group Business Directors’ report – report Directors’ review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Bradley armoured fighting vehicle Business review Directors’ report – Further contracts for the refurbishment and upgrade of the Bradley armoured fighting vehicle have been secured in the year.

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. ietr’rpr Governance Directors’ report – 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. Upgrade contract The British Army’s FV430 Bulldog and Engineering Tank Systems production continues with a total of 33 Warrior armoured infantry vehicles will be upgraded by BAE Systems over the next bridge-laying Titan vehicles and 33 Trojan obstacle-clearing vehicles two years. 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 Deliveries of CV9035 armed vehicles to the Netherlands and Denmark is experiencing delays and a revised programme baseline is under

commenced during the fourth quarter of the year, under a multi-year Financial statements discussion with the customer. contract to provide 229 vehicles through to 2010. In order to provide long-term savings to the customer and deliver a In the area of intelligent munitions for artillery and mortar systems, the sustainable munitions business, discussions continue with the UK 155mm Excalibur supplied to the US Army performed well in theatre. MoD aimed at agreeing a revised long-term contractual arrangement for the Munitions Acquisition Supply Solution. In November, Land & Armaments acquired Pitch Technologies, an innovative computer-based training and research simulation Land & Armaments continues to compete for the vehicle integrator role technologies company for £5m. The combination of BAE Systems on the Future Rapid Effect System (FRES) programme. BAE Systems and Pitch creates a world-class capability in enterprise-level is the UK partner and Design Authority for much of the UK Armoured simulation interoperability and solutions for training and simulation. Fighting Vehicle fleet. South Africa Sweden The growing international requirement for mine-protected wheeled BAE Systems received a funding contract for £24m on the Archer self- vehicles continues to generate new orders for the RG31 and RG32 propelled artillery programme demonstrating Sweden and Norway’s joint vehicles built by OMC, Land & Armaments’ South African subsidiary. commitment to continue the final phase of the development programme. 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 Shareholder information by a further order in August for 600 vehicles, of which 305 are being produced by OMC in South Africa.

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.

BAE Systems Annual Report 2007 31 of £456m 2 of £807m (2006 £449m). of £5,327m (2006 £4,615m) and generated of £5,327m (2006 £4,615m) 3 1 (2006 £342m) on sales During 2007, Programmes & Support achieved EBITA During 2007, Programmes an operating cash inflow by 0.8% arising from one-off gains recorded Return on sales benefited including completion of the Offshore Patrol in the first half of 2007, Vessel arbitration process. share of the award of the Order intake includes the appropriate work Saudi Typhoon contract. Military Air Solutions five major Military Air Solutions is responsible for delivering F-35 Lightning II programmes: Typhoon, Hawk, Nimrod MRA4, & Future Capability. (Joint Strike Fighter), and Autonomous Systems support for these In addition, it is responsible for through-life Air Force (RAF) fleets programmes as well as for the UK’s Royal aircraft. of Harrier, Tornado, Nimrod MR2 and VC-10 2007; both on delivering The business made strong progress during in partnership with its its programme commitments and working Work continues customers to enhance their military capability. Partnering Agreement towards the creation of an air sector Long-Term Strategy, published in (LTPA) as envisaged in the Defence Industrial out the partnering December 2005. A foundation contract, setting negotiations, was principles and providing a framework for detailed to generate a shared agreed in March. This has enabled the Group investment. view of the business and is helping to direct nations continues Delivery of Typhoon aircraft to the four partner UK and 84 across the other with a total of 53 aircraft delivered to the 2007. Five of the 15 European partner nations as at 31 December during the year. contracted aircraft for Austria were also delivered 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. 4 Restated 28% 2,6 4 2006 2005 7.4% 5.6% Restated £342m £261m £449m £441m (continued) £17.0bn £16.8bn £5,178m £4,186m £4,615m £4,660m 2007 Share of Group EBITA 8.6% £456m £807m £20.9bn £9,091m £5,327m , comprises the Group’s UK- the Group’s , comprises 1 33% 5 ms.com at a new high of £20.9bn 1 1 3 1 growth of 15% 1

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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 Key points – 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 Share of Group sales Programmes & Support Programmes

– Order book – Return on sales improved to 8.6% – Return on sales

and the Integrated System Technologies business. Technologies Integrated System and the based air, naval and underwater systems activities systems naval and underwater based air, 32 3 net cash inflow from operating activities after capital expenditure (net) and financial 4 restated following changes to the Group’s organisational structure 5 before elimination of intra-group sales 6 excluding HQ & Other Businesses 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and Order book Order intake Return on sales Cash inflow EBITA Sales – Sales 29,100 employees 29,100 The Programmes & Support business group, with business & Support The Programmes Business group reviews reviews group Business Directors’ report – report Directors’ review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 33 BAE Systems Annual Report 2007 Type 45 The first of class Type 45, HMS Daring, successfully completed her stage one sea trials on schedule in August 2007. The naval joint ventures continue to perform to plan. Upon creation continue to perform to plan. Upon creation The naval joint ventures joint venture, BVT Surface Fleet Limited, of the new maritime sector BAE Limited to VT will sell its share of Flagship Training Systems BVT Limited will become wholly owned by Group, and Fleet Support Surface Fleet Limited. Submarine Solutions in June 2007 The first of class boat, HMS Astute, was launched The boat is and has completed Trim & Basin Trials successfully. 2008 contracted date. on schedule for delivery to the November also progressing well. Construction activities on Boats 2 and 3 are reached and an order Agreement of pricing of Boats 2 and 3 was Boat 4. received to allow the start of production on Underwater Systems Integrated System Technologies (Insyte) and System and Long The Sampson Radar, the Combat Management destroyers continue to Range Radar programmes for the Type 45 radar has been successfully meet all key milestones. The first of class installed onto HMS Daring. all of its trials at the The Seawolf Mid-Life Update Tracker completed shore-based facility, HMS Collingwood. to schedule and will The Falcon programme continues to progress communications provide the UK Armed Forces with a new tactical capability. network, providing a secure information infrastructure order remains The Sting Ray lightweight torpedo main production in October 2007. on schedule with the third batch accepted successfully passed initial The Archerfish mine disposal system has for sea mines with the qualification trials as the Common Neutraliser US Navy. Talisman, the company-funded Unmanned Underwaterbeen Vehicle, developed has further, reducing thedrag size, while unit retaining cost the and payload thewith capacity. underwater the It US has Navy. undertaken exercises Partnering been made towards Progress has partnered through-life establishing a solution for the availability support RAF Typhoon. in April 2007. was settled and title to all three vessels transferred to the customer The arbitration process in respect of the Offshore Patrol Vessels of negotiation. Contracts for the manufacturing phase are now in the final stages The CVF programme passed the UK MoD Main Gate Review in 2007. third ship is planned to be handed over to the Chilean Navy in May 2008. completed their reactivation and were delivered to the customer. The Two of the three ex-Royal Navy Type 23 frigates for the Chilean Navy months ahead of the contract date. RFA Lyme Bay, was handed over to the customer in June – two The final vessel of the Bay Class Landing Ship Dock (Auxiliary), HMS Daring, commenced sea trials in July. in January and November 2007 respectively, whilst the first of class, The second and third ships, Dauntless and Diamond, were launched that met the MoD’s cost aspirations. establishing a jointly managed risk profile against a robust schedule, the remaining scope of work to complete all six destroyers and In August, the Type 45 six ship contract was signed, capturing In August, the Type 45 six ship contract was Surface Fleet Solutions to plan. In-country flight testing of the first South African Gripen is proceeding In-country flight testing of the first South African the UK MoD’s evaluation of future capability requirements. the UK MoD’s evaluation of future capability the demonstration vehicle in September. Taranis is a key enabler to the demonstration vehicle in September. Taranis programme continues on plan and to cost with the first metal cut of programme continues on plan and to cost The Taranis unmanned combat air vehicle technology demonstration The Taranis unmanned combat air vehicle endurance unmanned air system, HERTI, took place in 2007. endurance unmanned air system, HERTI, took Successful trials of a highly autonomous medium-altitude long- Successful trials of a highly autonomous medium-altitude variants are now in various stages of manufacture and assembly. variants are now in various stages of manufacture manufacture and assembly has now commenced. All three aircraft manufacture and assembly has now commenced. completed its final Critical Design Review successfully in June and completed its final Critical Design Review and Short Take-Off and Vertical Landing (STOVL). The Carrier variant and Short Take-Off and Vertical Landing (STOVL). are in development; Carrier, Conventional Take-Off and Landing (CTOL) are in development; Carrier, Conventional delivery of a number of key aircraft systems. Three aircraft variants delivery of a number of key aircraft systems. the design and manufacture of the rear fuselage, empennage and the design and manufacture of the rear fuselage, Grumman on the F-35 Lightning II programme, with responsibility for Grumman on the F-35 Lightning II programme, Military Air Solutions is partnered with Lockheed Martin and Northrop Military Air Solutions is partnered with Lockheed for the capability it is providing. Harrier has supported UK military operations with high recognition Harrier has supported UK military operations The Harrier GR9 aircraft has transitioned successfully into service. The Harrier GR9 aircraft has transitioned successfully of ATTAC to include the remaining areas of the Tornado aircraft. of ATTAC to include the a contract expansion has been agreed. This increases the scope has been agreed. This increases the scope a contract expansion The Tornado availability programme, ATTAC, is fully effective and programme, ATTAC, is fully effective and The Tornado availability and VC-10 fleet maintenance has now been extended to 2013. and VC-10 fleet maintenance The support contracts for the VC-10 and Nimrod MR2 aircraft continue The support contracts of £435m 2 of £678m (2006 £171m). of £3,359m (2006 £3,428m) and generated of £3,359m (2006 £3,428m) 3 1 in 2006 included £99m and £2m respectively for in 2006 included £99m 2 and EBITA 1 During 2007, International Businesses achieved EBITA During 2007, International (2006 £415m) on sales an operating cash inflow Sales the Atlas Elektronik business that was disposed of in August 2006. the Atlas Elektronik business CS&S International BAE presence in the Kingdom of Saudi Arabia Systems has a major government-to-government where it acts as prime contractor for the UK the programme has defence agreement. Over the last two decades hardware, support, included the provision of aircraft, associated Royal Saudi Air Force infrastructure and manpower training for the Progress is being made (RSAF) and Royal Saudi Naval Forces (RSNF). line with the Understanding on modernising the Saudi armed forces in between the UK and Saudi Document signed on 21 December 2005 the signed document, Arabian governments. Under the terms of Variant aircraft and Typhoon aircraft will replace Tornado Air Defence contract for the delivery others currently in service with the RSAF. A with delivery of the first of 72 Typhoon aircraft was agreed in the year are ongoing with the aircraft scheduled for June 2009. Discussions training solutions to enable RSAF to define and agree the support and their entry into service during 2009. Group in the Kingdom Around 4,300 people are employed by the are Saudi nationals. of Saudi Arabia, of whom approximately half in Saudi Arabia, The business is continuing to develop its presence and is helping to develop including the relocation of staff from the UK, a greater indigenous capability in the Kingdom. and progress is well The security of employees is the highest priority as well as increased advanced on new residential and office facilities at the first new security measures. Employees are in occupation 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 4 Restated 27% 2,6 4 2006 2005 Restated 12.1% 12.7% £7.1bn £6.7bn £415m £400m £171m £711m (continued) £3,854m £3,235m £3,428m £3,138m 2007 Share of Group EBITA 13.0% £7.9bn , comprises the Group’s £435m £678m 1 £3,876m £3,359m 21% 5 ms.com generation of £678m, including Saudi generation of £678m, including Saudi 1 3 3 1 increased by 1%, net of 2006 Atlas disposal increased by 1%, net 1

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Typhoon milestones 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 – 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 Share of Group sales International Businesses International – Cash flow – Return on sales increased to 13.0% – Return on sales of Sweden. MBDA joint venture and a 20.5% interest in Saab together with a 37.5% interest in the pan-European businesses in Saudi Arabia and Australia, 34 3 net cash inflow from operating activities after capital expenditure (net) and financial 4 restated following changes to the Group’s organisational structure 5 before elimination of intra-group sales 6 excluding HQ & Other Businesses 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and

Order intake Order book Cash inflow EBITA Return on sales Sales – Sales with 15,300 employees The International Businesses business group, Business group reviews reviews group Business Directors’ report – report Directors’ review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 35 BAE Systems Annual Report 2007 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. mounted displays, from the Royal Australian Navy for combat and the Royal Australian Navy for combat and mounted displays, from systems, from Tenix Marine for combat fire control management on Australian Navy’s landing helicopter dock management systems the Royal Netherlands Army for a Mobile class ships and from Centre. Battalion Combat Training the end of the year was SEK47.3bn (£3.7bn) Saab’s order book at airborne surveillance which included a reduction for the Pakistan systems than was system being re-negotiated to supply fewer originally recorded in 2006. MBDA (37.5% interest) across a number of MBDA continued to maintain strong deliveries included the Brimstone air- key programmes. Key domestic deliveries missile, Storm Shadow, launched anti-armour weapon, Mica air-to-air export market, key deliveries SCALP and Taurus cruise missiles. In the and UAE and Aster and included air weapons packages to Greece Rapier short-range air defence missiles. well. The six-nation Development programmes also progressed continues to meet its Meteor beyond visual range air-to-air missile completion of the four development milestones with the successful active firing campaign. key development milestones and a continuing programme for the The Principal Anti-Air Missile System (PAAMS) for qualification Royal Navy is now entering firing trials in preparation system is preparing for the while the tri-national MEADS area defence critical design review phase. Team Complex MBDA is leading negotiations towards the the UK's Defence Weapons strategic partnering agreement under Industrial Strategy. rocket motor company During 2007 MBDA acquired the German for the Meteor missile. Bayern Chemie GmbH, supplier of the ramjet included orders from FMV to upgrade 31 Gripen fighters and helmet 2006, order intake remained strong at SEK20.8bn (£1.5bn). This operating margin of 11.3%. Although reduced in comparison with including non-recurring items of SEK453m (£34m), producing an accounting for 65%. Operating income rose to SEK2,607m (£193m), Sales rose by 9.5% to SEK23bn (£1.7bn), with export sales Saab (20.5% shareholding) jointly with Boeing and the customer to re-baseline the programme. The programme is behind schedule and BAE Systems is engaged early warning and control system for the Royal Australian Air Force. The business is a subcontractor to Boeing on the Wedgetail airborne, the Army’s wheeled tactical logistic vehicle fleet. Government to provide medium/heavy capability vehicles to replace BAE Systems has recently been down-selected by the Australian to over 100 ships across the Australian, Canadian and US navies. authorities. To date the Nulka active missile decoy has been fitted received export approval in principle from both the US and Australian the Jindalee over-the-horizon radar. The Nulka active missile decoy has agreed with the ADF for the ongoing upgrade, operation and support of A five-year support contract, with two five-year options, has been A five-year support contract, with two five-year contract for the Australian Hawk Lead-In Fighter aircraft. contract for the Australian Hawk Lead-In Fighter the AP-3C aircraft, and continues under the second five-year support the AP-3C aircraft, and continues under the commenced on the Electronic Support Measures mid-life upgrade on commenced on the Electronic Support Measures life capability partner to the Australian Defence Force (ADF). Work has life capability partner to the Australian Defence BAE to reinforce its position as a through- Systems Australia continues Australia have taken place annually in both Saudi Arabia and the UK. have taken place annually in both Saudi Arabia courses. In addition, national team training camps in a range of sports courses. In addition, national team training 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. of £243m (2006 £295m) and had an of £243m (2006 £295m) 1 of £181m (2006 outflow £225m). Of this, the of £181m (2006 outflow 3 During 2007, HQ & Other Businesses reported a loss of £155m During 2007, HQ & Other sales (2006 loss £147m) on Aircraft was £101m (2006 loss £114m) reported loss for Regional of £175m (2006 outflow £66m). with operating cash inflow when compared with 2006 was due to the The reduction in sales business. disposal in March 2006 of the Aerostructures team made significant During the period the Regional Aircraft leasing Avro RJ Jets to progress securing leases for 64 aircraft, including Airways. The market CityJet of Ireland, Blue1 of Denmark and British last year, revenues continues to be challenging. Compared with for the 146remained stable. A freighter conversion programme Jet programme for the was launched after the success of a similar ATP fleet. by the Group’s Much of the leasing business was underpinned makes good shortfalls Financial Risk Insurance Programme which future income for in actual lease income against originally estimated 2006, BAEa 15-year period from 1998 to 2013. Since Systems and over several areas certain of the reinsurers have been in dispute reached with almost all of the policy. During 2007, agreement was by them based on the net reinsurers and settlements have been paid Arbitration proceedings now present value of estimated future claims. details concerning continue with one remaining reinsurer. Additional management and these arrangements are contained in the Risk principal risks section on page 49. net charges of £76m The Regional Aircraft loss for the year includes the assets of the business (2006 £77m) against the carrying value of year. These charges include of which £61m was taken in the first half valuation methodology the effect of a change to the Group’s aircraft on these aircraft. and will reduce the future depreciation charged 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. operating cash inflow , 1 2006 2005 £0.3bn £0.6bn £295m £471m £267m £398m (continued) £(147)m £(118)m £(225)m £(79)m 2007 £0.4bn £243m £181m £345m £(155)m 3 ms.com 1 1

2 1 www.baesyste

taxation expense financial investment, and dividends from equity accounted investments

the Group’s Financial Risk Insurance Programme the Group’s Financial Looking forward The leasing market for BAE Systems aircraft continues to remain challenging, risk customers. Support with new markets likely to be dominated by higher dependent on maintaining revenues are expected to remain stable but are 2007 against the carrying aircraft in service. Following the charges taken in be reduced. value of the assets, future losses are expected to HQ & Other Businesses HQ & Other property management. property services activity, including research centres and research centres activity, including services and support activities, head office and UK shared head office and activities, and support comprises the regional aircraft asset management the regional comprises 36 3 net cash inflow/(outflow) from operating activities after capital expenditure (net) and 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and Order book Cash inflow/(outflow) Order intake EBITA Sales

– Regional Aircraft fleet valuation methodology changed – Regional Aircraft fleet valuation methodology – Agreements reached with the majority of reinsurers under – Agreements reached

HQ & Other Businesses, with 1,800 employees Businesses, HQ & Other Business group reviews reviews group Business Directors’ report – report Directors’ review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 37 BAE Systems Annual Report 2007 Strategy and Reporting, Shell area with those best in class companies. The deliveryarea with those best of the first part this has been incorporated achieve of a four year plan to into the leadership 2008. objectives for performance year on year and set will focus on improving We further the Group that move challenging objectives best towards demonstrate our commitment areas. To practice in these priority increased the proportion have we of senior executive performance in performance in ethics to improvements bonuses that are linked potential bonus will be determined 12% of the In 2008, and safety. The Corporate Responsibility performance in ethics and safety. by against our objectives quarterly. progress Committee will review of corporateGovernance responsibility Our corporate responsibility objectives are delivered through our the Executive Committee. business operations and managed through The Corporate Responsibility Committee is responsible for providing and and assurance. This includes reviewing governance oversight, to manage non-financial monitoring the processes that the Group uses report on 2007 risks. The Corporate Responsibility Committee’s 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 the decision of the Executive Committee and approving reviewing for the corporate issues to prioritise ethics and safety as the key responsibility agenda in 2008. The Corporate Responsibility performance data on ethical business conduct, Committee reviewed This included details from internal audits, safety and environment. surveysemployee and operational assurance statements. Committee The Corporate Responsibility Committee met with the Woolf the Corporateto discuss ethics in general and the role of Responsibility and assurance Committee in relation to the prospective implementation be recommended. of activity that may External opinion External help shape our approach to corporate views responsibility asked we reportand also influence how we progress. This year, three experienced corporate our responsibility practitioners to review Corporate Report Responsibility on our corporate and give their views responsibility strategy and intended direction. Participants were: – GlaxoSmithKline Vice President Corporate Julia King, Responsibility, – DuPont Director of Sustainable Development, Rittenhouse, Dawn – formerly Policy, Head of Sustainable Development Mark Wade, of this The panel met in February copy a draft 2008 and reviewed Corporate report. Responsibility comments and made They year’s recommendations in three areas: corporate responsibility strategy reporting, and our approach to assurance. and governance,

business conduct in both the defence sector and across industry;business conduct in both the defence sector defence sector; safety and diversity; and in the areas of ethics, safety and diversity. desired leadership in the areas of ethics, position have developed a route to more closely align our performance developed in this have companies we are behind the best in class group of companies. We companies we perform to a number of other defence sector at a similar level our underlying performance business is not consistent. While we demonstrate overall year on year improvement in safety performance, year on year improvement demonstrate overall considered to be best in class. In conclusion, while we can while we considered to be best in class. In conclusion, aerospace and defence sector companies and across other sectors individual business level performanceindividual business level and benchmarking against a review of BAE Systems’ safety performance. This considered both a review Progress towards a leadership position on safety commenced with Progress towards our ethics objectives. Committee during 2008, which we believe will assist us in meeting believe which we Committee during 2008, processes. We will receive recommendations from the Woolf processes. We to study and publicly report upon the Group’s ethical policies and to study and publicly report upon the Group’s – benchmarking safety performance across all industries – not just the – specific objectives on leadership establishing especially behaviours – our setting management objectives in 2008 that drive us towards during 2007 established Committee (see page 3) was The Woolf – of best practice for ethical view establishing an independent continue through 2008. Key aspects of this are: continue through 2008. Key progress. A programme to address this began in 2007 and will progress. A programme to address this began We recognise that to achieve a leadership that to achieve recognise position requires continual We where the Group should aspire to a leadership position. Ethics and safety were reconfirmed as our CR priorities and those Ethics and safety were employees and investors. employees took into account the views of key stakeholders, including customers, stakeholders, of key took into account the views and the level of trust stakeholders have in our Group. Their analysis in our of trustand the level have stakeholders directly impacting our ability to operate or by affecting our reputation by directly impacting our ability to operate or significant impact on the sustainability of our business, either by either our business, significant impact on the sustainability of The Executive Committee considered issues that could have a that could have The Executive Committee considered issues provided information on best practice in CR among leading companies. provided The workshop was supported by PricewaterhouseCoopers (PwC), who The workshop supported (PwC), was PricewaterhouseCoopers by The Executive Committee met in May 2007 to review our CR priorities. 2007 to review The Executive Committee met in May consistently across all of our operations, worldwide. consistently across all of our operations, As a global business we must ensure our approach is applied must ensure our approach As a global business we and aspire to reach the standards set by companies in other sectors. companies and aspire to reach the standards set by standards for our industry in the area of corporate responsibility (CR) reputational risks. As a leading defence company we want to set want we a leading defence company reputational risks. As risks to our business – including non-financial, operational and operational – including non-financial, risks to our business To achieve sustainable growth we must identify and manage long-term we sustainable growth achieve To value by being the premier global defence and aerospace company. being the premier value by Our Group strategy growth in shareholder is to deliver sustainable Strategy and direction Corporate review responsibility Directors’ report – Business review of conduct’. Committee recommendations. to Woolf demonstrate commitment to high ethical demonstrate commitment engagement. standards through employee commitment to safety by leading safety by commitment to safety audits across our operations. – Maturity Matrix Safety against a five level the end 3 by Level all businesses to achieve a plan in place to attain of 2008 and have 5 has been the end of 2011 (Level 5 by Level against leading companies). benchmarked to diversity in the workplace. and inclusion. 10% of the gap between 2007 performance 10% of the gap between and external benchmark (2,000 days). – a Group-wide ‘code and integrate Develop – Communicate and implement the response 2008 objectives – Senior Leadership and to communicate – Senior Leadership to demonstrate – performance Progress to benchmark safety that values and Create an environment based on merit, respects the contribution, of all members of the communities in which operate: we – Senior Leadership Demonstrate commitment – Forum. Establish a Group-wide Women’s – Evolve action plans to enhance diversity Continue to drive performance in safety: Continue to drive performance – lost to work-related injuries by days Reduce (continued) introduced to new starterintroduced to new induction processes. guide promptly after ethics Group’s up with followed acquisition and this is training. online or DVD some have that 99% of UK employees of our ethical standards. Action awareness plans to address areas identified for been put in place. have improvement at a local level during 2007. at a local level within each of our businesses to reflect their local communities and recruitment populations. businesses and external companies was performed. The targets thus derived are those set within 2008 objectives. continue to 2006. We more than 10% over by perform better than the industry at a level lost due to work- with 8,734 days average, related injury per 100,000 employees, (compared with the UK manufacturing of 25,000). average – training has been Ethics awareness – issued with the businesses are New – A survey undertaken was which indicated What we achieved What we – resolved were grievances 91% of employee – implemented Diversity action plans were – A benchmarking study of BAE Systems – reduced the number of lost days we In 2007, ms.com www.baesyste www.baesyste

‘Respect at Work’ policy to be resolved policy ‘Respect at Work’ through local discussion without proceeding to the corporate for formal process investigation. establishing a workforce reflective of the in terms of gender mix and national average taking into account variations ethnic diversity, region and industrial sector. by better than relevant industrybetter than relevant average. year-on-year in injuries/lost working time. for each line of business to monitor performance and establish targets to move best in class. towards completed by new starters new completed by within one month of joining. months of implemented within three acquisition. completion date of any UK ethics awareness effectiveness of 2006 agreed training package. Implement corrective actions in 2007. Corporate objectives responsibility – towards move In each of the home markets,

– under the UK grievances 85% of employee Workplace – an improvement Continue to achieve – be metric) to Groupperformance (lost days – Establish appropriate industry benchmarks 2007 safety metrics to improve relative to 2006: 2007 safety metrics to improve Safety, health and environment Safety, – training to be awareness Initial ethics – Survey to be undertaken to evaluate – training to be awareness Initial ethics 2007 objectives Ethics

38 Corporate responsibility review Corporate review responsibility Directors’ report – Business review

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 39 BAE Systems Annual Report 2007 Our operations and CR impacts and CR Our operations Workplace to work the right in an environment have that all employees believe We processes in have We are treated with dignity and respect. where they are being subjected place that support feel that they if they employees behaviour. to inappropriate or unacceptable of opportunity are committed to equality and We employees for all to creating a workplace contribution is recognised. where individual A diverse and inclusive workforce is an essential part in creating the necessary competitive and progressive culture to achieve innovative necessary the behaviours advantage. It also promotes to secure successful partnerships our customers with and suppliers. at all levels of employees in the training and development Investing helps to us maintaining high performance. Training of the Group is key their skills and capabilities. It also enables us to our people develop our technologies and continue to improve pace with changing keep customer service. to ‘move In 2007 one of our corporate responsibility objectives was in establishing a workforcetowards reflective of the national average taking into account variations terms of gender mix and ethnic diversity, an action developed region and industrial sector’. Each business by the existing workforce, plan which considered the demographics of the surrounding communities and that of the populations from which recruit. The cultural influences and heritage within our six home we aim. For our overall markets requires different emphasis to achieve our diversity plans in South Africa are aligned with the Black example, Agenda; our focus in the Kingdom of Saudi Economic Empowerment Arabia is on Saudisation of our workforce which is a programme for of By the end transferring skills from expatriates to local employees. 2007 our Saudi workforce comprised more than 53% Saudi nationals. training for Our diversityfor 2008 include awareness objectives network. This will provide senior leaders and the launch of a women’s support for women across BAE Systems enabling them to share ideas their careers.and experiences and develop Health and safety of an unsafe Our approach to safety is one of zero tolerance workplace working and unsafe Safety is one of our key practices. corporatepriorities for 2008. Our goal is to be amongst responsibility the leaders standards both within our industry for high safety and measured against leading companies in other industrial sectors. recognise the risks associated with the variety of operations we We conduct and aim to minimise these as far as possible. All sites are policy and to Health and Environment required to comply with our Safety, in performance through the setting demonstrate continuous improvement through our business is reviewed and monitoring of targets. Performance the Executive Committee and the by assurance processes and overseen CorporateCommittee on behalf of the board of directors. Responsibility a tragic incident during a flight testing exercise 2007, In November are working with the We resulted in the death of one our employees. incident. authorities in connection with this investigative all employees US, Case study: In our Hattiesburg site in Mississippi, been appointed safety officers as parthave of a programme to raise to report and encourage employees potential hazards. awareness Everyone is now responsible for their own safety and in that business more than 180 there were the safety of those around them. In 2007, 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 will not compromise on our ethical success of BAE Systems. We principles and policies. Initiative guidelines. preventing briberypreventing and corruption; as well as challenging targets; as well frame decisions, large and small; frame decisions, during 2008. similar to our 2006 scoring. will address areas for improvement and charitable giving. We training, performance level in the Dow Jones Sustainability World Index was Index performance Sustainability World in the Dow Jones level and career development which include the areas of labour practices, key environmental and social impacts. In 2007, BAE Systems’ and social impacts. In 2007, environmental key social factors rating in 2007, the reasons for the lower reviewing are We benchmarking to track our performance and help us better manage Social factors 71% 80% We monitor our Corporate monitor performance Responsibility through sector We Economic factors factorsEnvironmental 90% 69% 85% 69% Monitoring our performance Dow Jones Sustainability Index 2007 2006 in future Corporate Responsibility Reports. recommendations and report and on progress through our website Report. We will develop the necessaryReport. will develop plans to action these We The panel’s full statement is included in our Corporate full statement is included Responsibility The panel’s – corporate its align responsibility reporting Reporting with the Global – and with a wider range of stakeholders; engage – processes for greater understanding of the Group’s provide – change; such as human rights and climate issues key address – and opportunities a roadmap including future aspirations develop – all employees there is a solid foundation of values on which ensure The panel recommended that BAE Systems should: recommended that BAE The panel priority areas of ethics and safety rightly reflect the key issues. rightly reflect the key of ethics and safety priority areas is developed at BAE Systems. They considered that our selected considered They at BAE Systems. is developed The panel was supportive corporate strategy responsibility was The panel of the way Our manufacturing and engineering operations, offices and products offices operations, and engineering Our manufacturing the use of natural This includes the environment. an impact on have generation and as waste materials as well and raw resources these and minimising are committed to managing We emissions. practicable. impacts wherever of steps in relation to the management positive taken have We Environmental issues most notably to Product environmental Lifecycle which has been incorporated in the Company’s Protection, a new This helps to ensure that the design of Management process. and impact that it might have product considers the environmental the design phase to mitigate the potential that steps are built into lifecycle. impact through the product’s (Registration, for the Group is the REACH A specific area of focus of Chemical Substances) Authorisation and Restriction Evaluation, EU-based will also affect our US products legislation which although the UK are workingour customer, with We which come to the UK. to share an understandingMinistry in this area and of Defence, approach. a common develop our greenhouse are placing a specific emphasis on reducing We a number of energy developed reduction gas emissions and have engineering initiatives engagement, initiatives that include employee manufacturing efficiencies. Our primaryand improved contribution of energy. to greenhouse gasses is through the use participateWe to reduce defence sector impacts in national initiatives nine sites in the UK which participate have in on climate change. We externally traded Scheme and in 2007 we the EU Emissions Trading focus of our partnering4,500 tonnes of carbon. A key approach with the UK Ministry of of Defence will be the sustainable development defence products and services. help reduce emissions in our UK Land Systems Case study: To and every to ‘Pledge A Tonne’ has been asked employee business, and to engage provided a range of communication material has been to ‘sign up’ are asked People and their families. educate employees their conduct they changes to the way simple but effective to make both at home and at work. such as leaving Daily actions life, day-to-day whilst to work or travel travel employees the way lights and heaters on, all in, live they at work control the environment and how employees individual and the business. contribute to the carbon footprint of each particularlyClimate change is an important issue for all businesses, Group needs to address. those operating globally and one which the will measure our carbon footprint and establish a formal we In 2008, in reducing this footprint. would seek to take position as to actions we with others Working our own recognise that our responsibilities extend beyond We our This includes contractors workingemployees. on our sites, suppliers and partners. aim to work with all groups to mutually We area of focus in 2008 continues to be safety A key standards. improve intend to include this in performance of contractors on our sites. We our future external reporting on safety performance. are partCase study: In the UK we of the 21st Century Supply Chain (SC21) initiative. The objective of the initiative is to get all customers and suppliersdefence and aerospace industry throughout the to collaborate performance and modernise the same tools to improve using workingby are working closely with our industry where we practices. This approach, an areas and will help us to achieve duplication in key avoids peers, and trust. honesty workingimproved culture based on openness, (continued)

ms.com www.baesyste www.baesyste Corporate responsibility review Corporate review responsibility Directors’ report – Business review sustainable development. and respond to global challenges such as climate change and Stakeholders, particularly expect us to understand Stakeholders, our employees, We operate globally, with operations and customers in many countries. and customers with operations in many operate globally, We Environment encourage greater economic collaboration. improve education links between the two countries will hopefully education links between improve the UK a better understanding of science and engineering. Helping The initiative has been designed to give students in both India and committed to support UK India Education & Research Initiative. the Case study: India partnership – We have pledged £100,000 and Case study: India partnership have – We to take an interest in science and technology. to take programmes that encourage young people at all stages of education In Australia, the UK, the US, and Saudi Arabia we run educational and Saudi Arabia we the US, the UK, In Australia, Every year the Group supports a wide range of education projects. is education, specifically in the fields of science and engineering. specifically in the fields is education, An area that is critical to the future sustainability of our business community projects. During 2007 our employees volunteered 4,310 days supporting volunteered 4,310 days During 2007 our employees local around our sites, supporting charities and educational establishments. around our sites, In 2007, we invested approximately £6.1m in local communities invested we In 2007, We play an important play operate. role in the communities in which we We Community and education the co-ordination of the Defense Industry Benchmark ethics survey. year in the US, we participated which includes we in the DII working group, year in the US, the Aerospace and Defence Industries Association of Europe. This the Aerospace and Defence Industries Association has been developing common anti-corruptionhas been developing industry standards for on Ethics and Business Conduct. In the UK, the Anti-corruption Forum on Ethics and Business Conduct. In the UK, corruption Forum and, in the US, the Defense Industry (DII) Initiative in the US, corruption Forum and, Case study: We are members of the UK Defence IndustryCase study: We Anti- a revised code of conduct at the end of 2008. code a revised recommendations from the Woolf Committee and plan to introduce recommendations from the Woolf it remains appropriate for our changing business. We will act on any We it remains appropriate for our changing business. In 2007 we initiated a review of our ethical code of conduct to ensure of our ethical code initiated a review In 2007 we since 2001. Training is tracked to help ensure compliance. to help is tracked since 2001. Training every undertaken have two years. this training Over 5,500 employees a training courseof corruption on the prevention and refresher training All staff involved with business development are required to undertake with business development All staff involved three months of joining the Group. promptly after acquisition and our ethics awareness training within training promptly after acquisition and our ethics awareness employees of newly acquired businesses receive an ethics guide of newly employees ethics awareness training within one month of joining the Group and training within one month of joining ethics awareness We changed our policy in 2007 to ensure new recruits2007 to ensure new changed our policy in receive We Swedish translation has been developed and will be introduced in 2008. been developed translation has Swedish been translated into Arabic and are being rolled out in Saudi Arabia. A and are being rolled out in Saudi Arabia. been translated into Arabic South Africa, the UK and the US. Our ethics DVD and online training have DVD the UK and the US. Our ethics South Africa, sessions. At the end of 2007 training had been completed in Australia, sessions. At the end of worldwide through brochures, online training, DVDs and class room DVDs online training, worldwide through brochures, We continue to roll out ethical awareness training to employees awareness continue to roll out ethical We expected of them. that employees understand how we do business and what is do business understand how we that employees We have training and awareness programmes in place to ensure programmes training and awareness have We Committee can be found on page 3. Committee can be found amongst corporate industrypeers. More information on the Woolf aimed at achieving a leadershipaimed at achieving business practice position in ethical and report recommendations and make our policies and processes on and Wales, to head an expert to study committee review independent and Wales, In 2007, we invited Lord Woolf, the former the of England Lord Chief Justice Lord Woolf, invited we In 2007,

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 40 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 41 48 42 8% 9% 129 327 642 82% 79% 21% 18% 17% 39% 27% 0.55 2007 4,454 1,706 8,734 BAE Systems Annual Report 2007 Surface Fleet Solutions business, which reduced the Surface Fleet Solutions business, n energy use, despite increases in volume and n energy use, e reported in 2008. 2005 2006 8,774 10,204 1,2 3 (Gwh) 1,767 1,742 4 60 + 6% 7% Under 2526 to 3536 to 4950 to 59 7% 18% 44% 25% 7% 18% 42% 26% Female employeesFemale WhiteNon-white 19% 20% 12% 88% 13% 87% Male employees 81% 80% emissions (million tonnes) 0.58 0.57 2 Age diversity: Ethnic diversity: Gender diversity: Ethics enquiries from employees 367 410 Volatile organic compound emissions (tonnes)Volatile 610 742 CO (‘000 tonnes)Waste tonnes) recycled (‘000 Waste 37 57 67 105 Energy use Total recorded injuries to all employees recorded injuries Total 6,009 4,788 Major injuries recorded recorded lost to work-related injuries Days 55 47

number of days lost by 75% over 2006 levels. 75% over lost by number of days reflects a specific focus at a number of businesses on energy management and efficient operations. throughput,

Corporate data summary recorded responsibility 4 Our energy directly related to volumes of product manufacture and throughput of specific projects. The decrease shown i use is 3 lost recorded due to work-related performance in our injuries reflects a much improved 2006 in days The decrease in 2007 over 1 This data is derived from internal recording systems and is not subject to external verification or audit. 2 and will b acquired Armor Holdings. The integration of corporate In 2007 we responsibility data from that business is underway

Diversity Ethics

Environment Health & safety (per 100,000 employees) Health & safety Explanations of trends are provided on pages 42 and 43. Specific notes are recorded below. on pages 42 and 43. Specific are provided Explanations of trends performance and identify areas for improvement. The data is recorded by the businesses and collated centrally for review. the businesses by The data is recorded performance identify areas for improvement. and We collect data on ethics, diversity, environment and health and safety to help us monitor our corporate and health and safety to help responsibility environment diversity, collect data on ethics, We Directors’ report – Business review Corporate responsibility review (continued) Directors’ report – Business review Business – report Directors’

Health and safety* Environment*

The overall performance on safety has improved over 2006. This Environmental impacts are directly related to the stage and volume reflects a strong performance is some businesses, notably Surface of production or manufacture and throughput of specific projects. Fleet Solutions. A key focus for 2008 is to ensure a consistent Given the potential diversity of influences we report data as absolute improvement in safety performance across all businesses. values and have provided specific explanation of the variance below.

Major injuries1,2 Energy use4 ietr’rpr Governance – report Directors’

2000 1.00 80

0.75 60 1500

40 1000 0.50 (million tonnes) CO2 emissions 20 Energy use (Gwh) 500 0.25

0 0 0.00 2005 2006 2007 05 06 07 Year Energy use (Gwh) Year 1 The above data includes one fatality. This occurred during a flight training exercise CO2 emissions (million tonnes) at a UK facility. The investigation into the incident is ongoing. 2 Major injuries as defined under the UK Reporting of Injuries, Diseases and 4 Energy use is down 2% to 1,706 Gwh (2006 1,742 Gwh). CO2 emissions down 3.5% to Dangerous Occurrences Regulations (RIDDOR). 0.55 million tonnes (2006 0.57 million tonnes). Financial statements Financial

Total injuries Waste5 (‘000 tonnes) Recycled waste6 (‘000 tonnes)

150 75 8000 120 60 6000 90 45 4000 60 30

2000 30 15

0 0 0 2005 2006 2007 05 06 07 05 06 07 Year Year Year Shareholder information

5 In 2007 we responded to Urgent Cause of injury3 (%) Volatile organic compound Operation Requirements from the US emissions5 (tonnes) Department of Defense for armoured vehicles. The resultant increase in throughput primarily impacted our Steel Slips, trips or falls on same level 750 Products and Mobility and Protection Falls from height – up to and including two metres Systems divisions in the US. This Struck by moving, including flying/falling, object 600 resulted in an increase in waste being Struck by moving vehicle generated in Steel Products and in usage Strike against something fixed or stationary 450 of paints and solvents at Mobility and Injured while handling, lifting or carrying Protection Systems. The resulting Falls from height – over two metres 300 emissions of Volatile Organic Exposure to an explosion Compounds associated with paint and Contact with moving machinery 150 solvent use increased accordingly. Exposure to, or contact with, a harmful substance 6 The increase in the level recycled waste Contact with electricity or electrical discharge 0 in 2006 related to a specific soil remediation project at Chorley in the UK. 05 06 07 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.

Days lost to work-related injuries is shown on page 26. * The above data is derived from internal recording systems and is not subject to external verification or audit.

42 www.baesyste ms.com Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 43 Charitable gifts Sponsorship Community investments Focus of contribution (%) Focus BAE Systems Annual Report 2007 Other Arts Economic Environment Education Social welfare Emergency relief Health What we contribute to (%) What we Community* In 2007, our total community investment was approximately £6.1m. was community investment our total In 2007, as and in-kind donations to charity as well This figure includes cash our direct support across the world. for communities and education 07 07 White/European 50 to 59 60+ Saudi nationals Year 06 06 Year 05 Not declared Asian Under 25 26 to 35 36 to 49 Ethnic diversity (%) Saudi Arabia Age diversity (%) South Africa Saudi Arabia, Australia, US, UK, and Sweden 100 80 60 40 20 0 80 60 40 20 0 100 07 07 (%) (%) 7 06 06 Year 8 Year 05 05 Non-white White Male Female Sweden we cannot report we Sweden ethnic diversity information for these countries. report gender diversity information for this country. Ethnic diversity US and South Africa UK, Gender diversity Saudi Arabia and Australia, US, UK, South Africa Diversity* 0 20 40 60 80 100 20 40 60 80 100 0 8 Due to legislation in Australia and 8 7 Due to legislation in Sweden we cannot we Due to legislation in Sweden 7 women’s network. women’s awareness training for senior leaders a Group-wide and the launch of awareness from all backgrounds. Our diversityfrom all backgrounds. for 2008 include objectives depends on us being able to recruitdepends on us being retain talented people and of our workforce fulfil global contracts and our ability to win and but recognise that this will occur slowly over time. The sustainability time. The sustainability will occur slowly over but recognise that this We are working within our business to change the demographics We st significant essment and at siness reporting functions identified mitigation strategy monitoring – been the risks that have – characteristics of the risk – the basis for determining – necessary and review reviewed and the risks prioritised reviewed of in relation to the achievement business objectives controlled risk registers showing: manage, or respond to, the risks or respond to, manage, to regular and rigorous review Evaluation – Risk exposure is comprehensively – in is documented Risk evaluation Mitigation – of action plans to Implementation – mitigation strategy Robust subject – Authorities Delegated – Policies Mandated

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Identification – business each At least annually, – Risks are recorded in a register – owners Risk are allocated who Analysis – are analysed for impact Risks – risks are reported twice yearly through the Operational Assurance Statement self-ass Key through the Integrated Business Plan, Monitoring and control – with significant risks immediately notified through the bu monitored and regularly Risks and plans are and rigorously reviewed – Executive Committee conducts risk workshops The analyse and allocate management responsibility for the management of the mo to – risk on a regular basis Board and the Audit and Corporate The Responsibility committees review – Organisation – Culture

Risk management within BAE Systems Risk management 44 the strategy and objectives. delivery Group’s of the The effective management of risk is essential to of risk is management The effective Risk management and principal risks principal and management Risk Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information ietr’rpr Business review – report Directors’

Group management of risks

Effective management of risk and opportunity is essential to the delivery In order to assist the Committees and the Board in their review, the Governance – report Directors’ of the Group’s objectives, achievement of sustainable shareholder Group has a self assessment Operational Assurance Statement (OAS) value and protection of its reputation. The Group’s approach to risk process. The OAS is in two parts: a self-assessment of compliance with management is to remove or reduce the likelihood and effect of risks appropriate parts of the OF; and a report showing the key risks for the before they occur, and deal effectively with problems if they arise. The relevant business. Together with independent reviews undertaken by Group is committed to the protection of its assets, which include human, Internal Audit, and the work of the external auditors, the OAS forms property and financial resources, through an effective risk management the Group’s process for reviewing the effectiveness of the system process, underpinned where appropriate by insurance. of internal controls. The management of risk is linked into the Group’s strategy, the Reporting within the Group is structured so that key issues are escalated environment in which it operates, the Group’s appetite for risk and the through the management team, ultimately to the Board if appropriate. delivery of the Group’s business objectives. The underlying principles are The responsibility for risk identification, analysis, evaluation, mitigation, that risks are continuously monitored, associated action plans reviewed, reporting and monitoring rests with line management. Both the Audit appropriate contingencies are provisioned and this information is Committee and the Corporate Responsibility Committee report the reported through established management control procedures. findings of their reviews to the Board so that the Board can form a view. To enable this process, BAE Systems has developed a system of internal Further information on the activities of the Board and its Committees is control, the ‘Operational Framework’ (OF), that encompasses, amongst given in the Corporate governance section on pages 54 to 63 of this other things, the mandated policies and core business processes that report. statements Financial provide a common framework for how we do business and what it means Five core processes and 27 policies are mandated by the OF, enabling to be part of BAE Systems. the business to respond appropriately to material risks faced by the The Board has overall responsibility for ensuring that risk is effectively Group. As with any system of internal control, the policies and processes managed across the Group and has delegated to the Audit Committee that are mandated in the OF are designed to manage rather than the responsibility for reviewing in detail the effectiveness of the Group's eliminate the risk of failure to achieve business objectives, and can system of internal controls. During the year, the Executive Committee only provide reasonable, and not absolute, assurance against material has further enhanced its oversight of material non-financial risks misstatement or loss. including, in particular, those arising in connection with safety and Further detail on these business processes and mandated policies ethical issues. Close attention has been paid to analysing risks is given in the Internal control section of the Corporate governance associated with the conduct of international business and new policies section on page 60. 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. Shareholder information

Internal Audit Internal Audit independently reviews the risk identification procedures and control processes implemented by management.

BAE Systems Annual Report 2007 45 Directors’ report – Business review Risk management and principal risks (continued) ietr’rpr Business review – report Directors’

Summary of principal risks

Defence spending The Group is The Group’s core businesses are primarily defence-related, selling products and dependent on services directly and indirectly primarily to the US, the UK, the Saudi Arabian and defence spending other national governments. In any single market, defence spending depends on and reductions in a complex mix of political considerations, budgetary constraints and the ability of such spending the armed forces to meet specific threats and perform certain missions. Because could adversely of these factors, defence spending may be subject to significant fluctuations from affect the Group. 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 ietr’rpr Governance – report Directors’ 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.

Certain parts of A significant proportion of the Group’s revenue comes from a small number of large the Group’s contracts. These contracts individually are typically worth or potentially worth £1bn business are or more including, but not limited to, those contracts in the Programmes & Support dependent on a business group. Action small number of Impact The Board regularly reviews large contracts. The loss, expiration, suspension, cancellation or termination of any one of these the Group’s performance contracts, for any reason, could have a material adverse effect on the Group’s future in these markets, and the Financial statements Financial results of operations and financial condition. Executive continues to work closely with its customers The Group’s largest The governments of the United Kingdom, the United States and the Kingdom of to ensure the Group strategy customer contracts Saudi Arabia are the Group’s three largest end customers. Any significant disruption is aligned with theirs (refer are government or deterioration in the relationship with these governments and a corresponding to strategy section page 12). contracts. 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 Shareholder information 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 timing of The Group’s operating performance and cash flows are dependent, to a significant extent, contracts could on the award of defence contracts and its performance in delivering these contracts. materially affect Impact the Group’s Because the amounts payable under these contracts can be substantial, the award future results of or completion of one or more contracts, the timing for manufacturing and delivery operations and of products under these contracts or the failure to receive anticipated orders could financial condition. materially affect the Group’s operating results and cash flow for the periods affected.

46 www.baesyste ms.com ietr’rpr Business review – report Directors’

Fixed-price contracts The Group A significant portion of the Group’s revenues are derived from fixed-price contracts, Action has fixed-price although the Group has reduced its exposure to fixed-priced design and development To manage contract-related contracts. activity which is in general more risk intensive than fixed-price production activity. risks and uncertainties, An inherent risk in these fixed-price contracts is that actual performance costs may contracts are managed exceed the projected costs on which the fixed prices for such contracts are agreed. through the application Impact of the Group’s mandated The Group’s failure to anticipate technical problems, estimate costs accurately or Lifecycle Management (LCM) control costs during performance of a fixed-priced contract may reduce the profitability business process at the of such a contract or result in a loss. operational level and the consistent application of Governance – report Directors’ metrics is used to support the review of individual contract performance (refer to page 52 for further information on LCM).

Global market

The Group is BAE Systems is a global company which conducts business in a number of regions, Action exposed to including the Middle East, and, as a result, assumes certain risks associated with The Group has a risks inherent businesses with a broad geographical reach. In some countries these risks include, balanced portfolio in operating in and are not limited to, the following: government regulations and administrative with six home markets. a global market. 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 statements Financial 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.

Export controls and other restrictions

The Group is A portion of the Group’s sales is derived from the export of its products. Many of the Action subject to export products the Group designs and manufactures for military or dual use are considered The Group has formal controls and other to be of national strategic interest. The export of such products outside of the systems and policies in restrictions. jurisdictions in which they are produced is normally subject to licensing and export place to ensure adherence controls and other restrictions. No assurance can be given that the export controls to regulatory requirements to which the Group is subject will not become more restrictive, that new generations and to identify any restrictions of the Group’s products will not also be subject to similar or more stringent controls, that could adversely impact or that political factors or changing international circumstances will not result in the the Group’s future activities. Group being unable to obtain necessary export licences.

Impact Shareholder information 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.

BAE Systems Annual Report 2007 47 Action strong global The Group’s balanced market positioning, portfolio, leading capabilities and performance to continue to page address this risk (refer 12 for further information positioning on the Group’s and portfolio). 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 pension schemes Group’s and deficit recovery plans both by are regularly reviewed of the Group and the Trustees the schemes taking actuarial advice as and investment applicable. The results of are discussed these reviews with the Board and appropriate (refer to page action taken 117 for further details retirement on the Group’s benefit plans). (continued) The Group operates certain defined benefit pension schemes. At present, in aggregate, The Group operates certain defined benefit pension schemes. At present, of these schemes the value of projected liabilities there is an actuarial deficit between hold. The Group has put in place and is implementing and the value of the assets they deficit recovery scheme plans in line with agreements reached with the respective trustees based on actuarial advice and the valuation results. Impact including a number of factors, be adversely affected by The amount of the deficits may changes in long-term and price interest rate returns, than assumed investment lower in members’ and greater than anticipated improvements longevity. inflation expectations, Group to increase the amount of require the An increase in pension scheme deficit may to meet reducing cash available thereby to these schemes, cash contributions payable other obligations or business needs. the Group’s The Group participatesvarious consortia, joint ventures and equity holdings, in exercising varying degrees of control. While the Group seeks to and evolving participate in which its interests are aligned with those of its only in ventures and jointly controlled entity, partners, any the risk of disagreement is inherent in particularly in those entities that require the unanimous consent of all members and that specify restricted rights. with regard to major decisions, Impact of disagreement within a consortia, joint venture or equity holding and In the event the business arrangement objectives or expected benefits, fails to meet its strategic be adversely affected. and results of operations may business the Group’s Most of the Group’s businesses are focused on the defence industry are focused on businesses subject to and Group’s Most of the from multinational firmscompetition many and capital and with substantial resources to ability Group’s through a competitive bidding process. The contracts are obtained and innovation depends to a large extent on the effectiveness compete for contracts ability to offer better programme its programmes, of its research and development readiness and the performance customers, cost to its than its competitors at a lower equipment and personnelto undertake the programmes for which it of its facilities, competes. to a single supplier all work governments direct for in some instances, Additionally, Although commonly known as a sole-source programme. a particular programme, certainawarded historically programmes to the Group on a sole- governments have future determine in the to a to open such programmes may they source basis, competitive bidding process. in certain countries, for defence-related products can, Government contracts other defence on the basis of home countrybe awarded preference. Therefore, defence-related the Group for some an advantage over have companies may where the are organised, which they contracts on the basis of the jurisdiction in their officersmajority of their assets are located or where or directors are located. Impact that the Group is unable adequately to compete in the markets in which In the event be adversely affected. and results of operations may business the Group’s it operates, ms.com www.baesyste www.baesyste

pension schemes. benefits under its not have control. not have to the defined where it does funding Pension risks in relation equity holdings exposed to funding ventures and The Group is consortia, joint is involved in is involved The Group Consortia and joint ventures Competition competition. to significant business is subject business is The Group’s

48 Risk management and principal risks risks principal and management Risk Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information ietr’rpr Business review – report Directors’

Acquisitions The Group has The Group has experienced growth through acquisitions and continues to pursue Action experienced acquisitions in order to meet its strategic objectives. Integrating the operations and The Group has an growth through personnel of acquired businesses is a complex process. The Group may not be able established methodology in acquisitions. to integrate the operations of acquired businesses with existing operations rapidly place to deliver the effective Anticipated or without encountering difficulties. integration of acquisitions. benefits of Impact The Group has an acquisitions may The diversion of management attention to integration efforts and any difficulties established policy for not be realised. encountered in combining operations could adversely affect the Group’s business. monitoring impairment risks. 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. Governance – report Directors’

Regional Aircraft The Group holds These aircraft are leased, or have been sold, to airline operators. Action a number of Impact The Group’s primary action is regional aircraft Values of regional aircraft are impacted by a range of factors including the financial to operate an efficient asset on its balance strength of regional aircraft operators, market demands for regional aircraft and the management organisation. sheet and has impact of economic factors on aircraft operating costs. Much of the leasing business provided residual Reductions in the valuations of these aircraft could result in impairment charges was underpinned by the value guarantees against the carrying value of the aircraft or additional provisions against the Group’s Financial Risk in respect of guarantees given. Insurance Programme, which certain regional makes good shortfalls in aircraft sold. actual lease income against originally estimated future income for a 15-year period from 1998 to 2013. Since statements Financial 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. Shareholder information These claims are being vigorously defended.

BAE Systems Annual Report 2007 49 Action Group has devoted the year, During the furtheradditional resource and enhanced designed to ensure its mandated procedures relating to the compliance with its policies conduct of international The business. maintains a list of Executive Committee exportapproved markets arrived at on the assessment utilising basis of a market risk input from externally risk developed of expertsassessments. A panel scrutinises within the Group. all adviser appointments Findings panel of experts of the are reviewed members of the Executive Committee and by risks are material market or programme the Board. discussed by the Serious Fraud by The investigation Office into suspected false accounting and corruption and the is continuing Group continues to co-operate with this the Company In June 2007, investigation. the US Department notified by was of Justice that it had commenced a formal relating to the Group’s investigation compliance with anti-corruption laws, including its business concerning the Kingdom of Saudi Arabia. Action In order to protect itself against currency to hedge policy is the Group’s fluctuations, all material firm transactional exposures, as an exception unless otherwise approved Management Review the Treasury by as to manage as well Committee, anticipated economic cash flow exposures the medium term.over The Group aims, to apply hedge accounting where possible, treatment for all derivatives that hedge material foreign currency exposures. The Group does not hedge the translation on effect of exchange rate movements the income statement or balance sheet of overseas subsidiaries and equity accounted long-term it regards as investments however, Hedges are, investments. undertaken in respect of investments that are not considered long term or core to the Group. (continued) The global nature of the Group’s business means it is exposed to The global nature of the Group’s volatility in currencyof foreign currency exchange rates in respect and and the translation of net assets denominated transactions, and equity accounted income statements of foreign subsidiaries The Group is exposed to a number of foreign currencies, investments. the most significant being the US dollar. Impact which the Group Significant fluctuations in exchange rates to a material adverse effect on the Group’s is exposed could have future results of operations and financial condition. The Group’s operations are subject to numerous domestic and subject to numerous operations are The Group’s with Non-compliance regulations and restrictions. international laws, expose the Group to regulations and restrictions could these laws, a material which could have suspension or debarment, penalties, fines, adverse effect on the Group. parts and operations in many The Group has contracts the world of and Group is subject to the The environment. operates in a highly regulated of the UK including those jurisdictions, and regulations of many laws to import- regulations relating without limitation, and US. These include, anti-bribery false accounting, and export money-laundering, controls, the Group is subject to time to time, From provisions. anti-boycott relating to its operations. government investigations Impact marketing advisersor the Group or its sales representatives, by Failure and regulations others to comply with these laws acting on its behalf in civil or criminal liabilities resulting could result in administrative, in the suspension or significant fines and penalties and/or result debarment for some period of the Group from government contracts export privileges. of time or suspension of the Group’s ms.com

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Exchange rates Laws and regulations and Laws 50 immaterial, may also have an adverse effect on the financial condition or business of the Group. also have may immaterial, Additional risks and uncertainties or which the Group currently deems currently unknown to the Group, exchange rates. in currency exposed to volatility The Group is and regulations. comply with laws from a failure to subject to risk The Group is The Group Risk management and principal risks risks principal and management Risk Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Resources ietr’rpr Business review – report Directors’ 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.

The Operational Framework (OF) (page 44) encompasses the mandated All employment policies include a commitment to equal opportunities policies and core business processes that provide a common framework regardless of sex, race, colour, nationality, ethnic origin, religion, age or for how we do business. These mandated policies and core business disability, subject only to considerations of national security. The Group’s processes together with our key resources help us to achieve the policy is to provide, wherever possible, employment opportunities for Governance – report Directors’ Group’s strategic objectives. disabled people and to ensure that disabled people joining the Group and employees who become disabled whilst in our employment benefit People from training and career development opportunities. Our employees are key to our success, both now and in the future. We invest extensively in education schemes to encourage an interest The Group has put into place a number of ways of consulting with in science and education amongst school children and support higher employees and providing them with information on the performance of levels of education through our apprentice programmes and graduate the Group and other matters that affect them. The effectiveness of the sponsorship schemes. The Group employs 88,000 people in its communication process is assessed regularly with the aim of ensuring subsidiaries, with a further 9,500 employed in joint ventures. The continual improvement so as to provide employees with the information workforce encompasses a broad range of skills and experience they want by the most effective means. delivering a full range of products and services for air, land and Employees are actively encouraged to become shareholders in the naval forces as well as advanced electronics, information technology Company by way of all-employee share schemes. solutions and customer support services. Honours In the UK, the following individuals were honoured in The Group aims to get the best from its employees by treating Her Majesty the Queen’s 2008 New Year Honours lists: them with respect, creating a supportive workplace and giving them CBE: Murray Easton and Alan Garwood opportunities for development. This helps the Group attract and retain Financial statements Financial highly talented people who can deliver the products and services OBE: Vic Emery customers need. MBE: Dave Blacker Performance Centred Leadership (PCL), the Group’s integrated Further details on the approach to employee engagement and approach to managing leadership performance, development and development are detailed on pages 37 to 43 in the Corporate reward, is critical to the Group achieving its strategic objective of responsibility section of this report. continuing to embed a high-performance culture. PCL addresses Relationships with customers the setting of objectives and performance assessment together with The Group regards the relationship with its customers as a key the determination of reward, development needs and potential. The discriminator in a competitive industry. Its core businesses are mostly process was applied to 600 leaders at its launch in 2000 and is now defence related, selling products and services primarily to the US, the deployed to over 6,200 executives globally across all of the Group’s UK, the Saudi Arabian and other national governments, both directly operations. It drives business success by linking individual’s goals with and indirectly with other defence and aerospace companies. In many the wider goals of the organisation, enabling employees to understand cases these relationships extend over decades and span the full how their own success contributes to the success of the Group. PCL product and service lifecycle from the initial concept definition, through is a core business process mandated by the OF to be used across the system development phase, into production and then on to support the Group. for the system in service. Shareholder information

Apprenticeships BAE Systems wins Sun Microsystems’ Supplier Award The BAE Systems Advanced Apprenticeship programme is BAE Systems was named Meritorious Performance Supplier one of the largest such schemes in the UK. At any one time, in Sun Microsystems’ 2007 Supplier Awards programme. the Group has up to 1,000 young people employed on its The Supplier Awards recognise companies that make numerous training programmes. outstanding contributions to Sun Microsystems’ record of delivering superior technology, quality service and excellent value to its customers.

BAE Systems Annual Report 2007 51 and development through using common processes in a coordinated through using common and development reducing duplication. BAE thereby way, Systems supports SC21 programme, the project director for the industrial providing by managing the and tier one companies, coordinating the 16 primes 100 suppliers) plan (including over and industrial implementation BAE MoD. interfacing with the UK implemented Systems has also its own Supply Chain the SC21 principles and processes across work and is leading improvement programme, Excellence improvement with 11 of the industrial plan suppliers. common improvement Several of the requirements coordinating the improvement plans are in place, customers.supplier and its other aerospace and defence Excellence has identified best for Performance Centre The Group’s from across BAEpractices in managing major subcontracts Systems Group’s These best practices are being embedded in the and industry. to guidance and training to help deliver on commitments processes, strategic objectives of customers. This directly aligns with the Group’s practice sharing of best enhancing programme execution capabilities, and embedding a high- global businesses the Group’s between performance culture. (R&D) and intellectual propertyResearch and development technological capabilities of the Group’s The continued development strategic objectives. and expertise the Group’s to achieving is key programme in supportThe Group is engaged in a significant R&D of systems and services to its customers.the platforms, that it provides This covers a wide range of work and includes performance innovations, and technology to manufacturing techniques improvements to improve the through-life support products. of and demonstration of capabilities in networked The development is an important area of focus and enabling interoperability, systems, in both the UK and the US. Long-term is undertaken research through Advanced partnerships with the academic sector and in the Group’s Centre. Centre and Systems Engineering Innovation Technology business units the Group’s Application of this research is managed by through business focused R&D programmes. Customers fund directly much of the near-term work product development undertaken the by R&D expenditure for the Group amounted to £1,460m Group. Total funded by of which £176m (2006 £162m) was (2006 £1,248m), the Group. in every partIntellectual property of the Group. is created every day, not only tangible products but also ‘know how’ forms, many It takes mandates a the years. over The Operational Framework developed intellectual property through appropriate policy to protect the Group’s so that returns use and observance of intellectual property law, in R&D and technological innovation made from the investment are protected. inventions over 100 new The Group filed patent applications covering in 2007 in support and has a total portfolio of its global businesses, more than 1,500 of patents and patent applications covering worldwide. inventions The OF mandates the use of LCM across (continued) ms.com www.baesyste www.baesyste

multiple customers with suppliers supplier management in improving Century designed to coordinate Supply Chain (SC21) programme, BAE Systems is a founder of the UK aerospace and defence 21st value and innovation for its customers. value and innovation large and small, in each of the Group’s home markets to deliver better in each of the Group’s large and small, supply chain relationships and working together with other companies, management capabilities. BAE Systems is committed to improving essential part integration and through-life systems of developing requirements. Transforming relationships with suppliers relationships is an requirements. Transforming 52 to demand a more integrated, partnering, to meeting their approach to demand a more integrated, combined with ongoing budget pressures, are leading many customers are leading many combined with ongoing budget pressures, driver for our Group. The benefits of capability-based contracting, therefore, effective management of this expenditure is a key value management of this expenditure is a key effective therefore, on subcontractors represents a significant portion of project cost and, Managing major subcontracts is a key strategic capability. Expenditure strategic capability. Managing major subcontracts is a key Managing subcontractors and other suppliers partnerships with governments and their armed forces. traditional customer relationships are evolving into long-termtraditional customer relationships are evolving capability, rather than just a product. Reflecting this new approach, rather than just a product. Reflecting this new capability, Increasingly contracts are being awarded for the deliveryIncreasingly contracts are being awarded of a its drive for continuous performance improvement. its drive for continuous performance improvement. customers and undertakes customer satisfaction surveys part as of Throughout this lifecycle the Group engages extensively with its Throughout this lifecycle the Group engages facilitates continuous improvement. lifecycles, promoting the application of best practice management and promoting the application of best practice management lifecycles, Group’s commitments and investments throughout product and project and investments commitments Group’s the Group. LCM provides a structuredthe Group. LCM provides approach to managing the Lifecycle Management (LCM) Lifecycle business processes. This lifecycle approach is used as the basis of one of the Group’s core of one of the Group’s This lifecycle approach is used as the basis

UK Association for Project Management (APM) Awards UK Association for Tornado Transformation: (the Availability ATTAC In 2007, ‘Project of awarded Aircraft Contract) (see page 16) was the UK APM. by the Year’ Resources Resources Directors’ report – review Business

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report

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. 1 2, 3 2, Phil Carroll is a former chairman and chief executive of Fluor Corporation and a former president and chief executive of Inc. He was Shell Oil Company the US Departmentappointed by 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 plc. Power Appointed: 2005 Age: 70 7. Michael Hartnall Michael Hartnall is a former prior finance director of Rexam plc, 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 Audit chairs the Board’s of the Committee. He is a Fellow Institute of Chartered Accountants in England and Wales. Appointed: 2003 Age: 65 6. Phil Carroll Appointed: 1998 Age: 55 Appointed to the Board on 1 Ian King was January 2007, Managing Group previously Director of the Company’s Customer Solutions & Support Group prior to that, business and, Strategy Planning Director. and Immediately prior to the BAe/MES Chief Executive of merger he was having Alenia Marconi Systems, servedpreviously 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 appointed Group George Rose was Finance Director in 1998. Prior to he in 1992, joining the Company held senior positions in the Rover He is a DAF. Group and Leyland non-executive director of Saab AB plc, and National Grid Transco and a member of the Financial Reporting He is a Panel. Review of the CharteredFellow Institute of Management Accountants. 4. Ian King UK Chief Operating Officer, and of World Rest 4 4 Appointed: 2007 Age: 58 Appointed: 1994 Age: 59 Havenstein 3. Walt President Chief Operating Officer, Inc. Systems, BAE and CEO, Appointed to the Board on Havenstein Walt 2 January 2007, is President and CEO of BAE Inc. He was Systems, President of the previously US-based Electronics Company’s & Integrated Solutions business. President of the Sanders He was defence electronics business the prior to it being acquired by from Lockheed MartinCompany in 2000. A graduate of the US he served 12 Academy, Naval years in the US Marine Corps. Chief Executive appointed as was Turner Mike having Chief Executive in 2002, been a Chief Operating Officer since 1999. He is a non-executive director of Lazard Limited and a formerof non-executive director Babcock International Group Plc and Oriental and The Peninsular (P&O). Company Steam Navigation 2. Mike Turner CBE Turner 2. Mike 3, 4 3, 12 3 4 5 6 ms.com www.baesyste www.baesyste

Appointed: 2004 Age: 61 Dick Olver was appointed as Dick Olver was Chairman in 2004. A civil Dick Olver joined BP engineer, 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 stepping down from that 2003, 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, Academy of the Royal a Fellow of Engineering and a member of Council and Academy the Royal Commission. the Trilateral Chairman1. Dick Olver FREng Executive directors Non-executive directors 54 1 member of the Audit Committee 2 member of the Corporate Committee Responsibility 3 Committee member of the Nominations 4 Committee Directors’ member of the Non-Executive Fees 5 Committee member of the Remuneration

The Board Board of directors of Board Directors’ report – Corporate governance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 55 BAE Systems Annual Report 2007 Each of the seven non-executive Each of the seven is directors listed above considered to be independent for the purposes of the Combined Code on Corporate Governance. SecretaryCompany Parkes David 2, 5 2, Peter Weinberg is a partner Weinberg at Peter a Partners, Weinberg Perella financial services firm. He was chief executive officer previously of Goldman Sachs International co-head of the where he was and prior Partnership Committee, co-head of the Global to that was Division. He Banking Investment joined Goldman Sachs in 1988 and became a partner in 1992. chairs the Board’s Weinberg Peter Corporate Responsibility Committee. Appointed: 2005 Age: 50 12. Peter Weinberg 12. Peter 1, 5 1, 2, 5 2, Appointed: 2006 Age: 61 Appointed: 2005 Age: 58 11. Sir Nigel Rudd Sir Nigel Rudd is currently chairman of BAA Limited and plc and deputy Pendragon PLC. He chairman of Barclays formerlywas 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 Remuneration chairs the Board’s of the Committee. He is a Fellow Institute of Chartered Accountants in England and Wales. Roberto Quarta is a partner in the Dubilier private equity firm Clayton, which in connection with & Rice, he serves as chairman of Rexel previously SA and Italtel. He was chairman and chief executive an executive of BBA Group plc, director of BTR plc and a non- plc executive director of PowerGen and Equant NV. 10. Roberto Quarta 1, 3 1, 2 78 9 101112 Appointed: 2003 Age: 61 Sir Peter Mason is the non- Sir Peter executive chairman of Thames and a non-executive director Water of Acergy formerly S.A. He was chief executive of AMEC plc, executive director of BICC plc, chairman executive and chief of Balfour Beatty Limited and Holst chief executive of Norwest has been Group PLC. Sir Peter Senior nominated the Board’s Independent Director. 9. Sir Peter Mason 9. Sir Peter Appointed: 2007 Age: 48 8. Andy Inglis Appointed to the BAE Systems Andy Board on 13 June 2007, Inglis is a director of BP p.l.c. He is a member of the BP executive and is also management team, Exploration chief executive of BP’s & Production business. He is a of Academy of the Royal Fellow of the Engineering and a Fellow Institute of Mechanical Engineers. Directors’ report – Corporate governance Corporate governance ietr’rpr Business review – report Directors’

Our governance framework

“As Chairman, my principal duty is to ensure that BAE Systems is headed by an effective ietr’rpr Governance – report Directors’ board that is accountable to shareholders for the Company’s performance.”

Dick Olver Chairman

Financial statements Financial 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 find detailed statements concerning our compliance with the provisions of the Code. However, first 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

Shareholder information 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.

56 www.baesyste ms.com Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 57 BAE Systems Annual Report 2007 that boards should carry of their performance out regular evaluations been particularlyas having by was endorsed beneficial. This view the chairmen of the FTSE 350 companies surveyed Independent by 90% had found the exercise to be useful.” of whom over Audit, “A number of respondents singled out the Code’s recommendation number of respondents singled out the Code’s “A We need not only the right mix of knowledge, skills and experience mix of knowledge, need not only the right We to resource to be in a position have but also we around the Board table This is an important committees. consideration effectively the Board’s believe we committees, as with the Audit and Remuneration because, the membership of the Corporate Responsibility Committee should be formed non-executive directors. exclusively of independent Board committees corporate governance in the UK’s The role that board committees play seek to continually structure be underestimated. As we should not processes the demands the effectiveness of our governance improve increased. The table on page 59 detailing the on the committees have attendance of directors during the year at board committee meetings held last year;shows that a total of 26 meetings were this compares half more. with 17 meetings five yearsover a ago – A unitary a good number of both executive and board containing non-executive directors is an excellent forum within which to develop and challenge strategy entrepreneurial leadership and provide for a certain responsibilities can only be undertaken However, company. are directors who are independent of the activities they effectively by committees are required to oversee. The Audit and Remuneration but this applies equally to the Corporate examples of this, obvious will find a reportcommittee from this Responsibility Committee. You to highlight in particular but I would like in the role it has on page 63, of ethical behaviour overseeing compliance with the highest standards and also in overseeing our performance all Group employees in by in the workplace. With Peter safe and healthy our employees keeping Andy Inglis has been appointed to retiring from the Board, Weinberg succeed him as chairman of the Corporate Committee, Responsibility by the firstbeen nominated for appointment to this position having Nominations Committee. evaluation Board performance I mentioned earlier the recent report the Code by on the Combined Financial Reporting Council. Reporting it on its consultative exercise, on the subject of board performance evaluation: had the following to say as this is a in performanceI am a big believer evaluation, fundamental part of performance As a Board we improvement. just completed our fourthhave such performance This evaluation. its committees and the performance exercise covered of the Board, that of the individual directors. effectiveness, of the Board’s includes a review The Board evaluation and an assessment of the effectiveness of each Board Committee, the One-on-one feedback discussions between each Board director. The Chairman and each director occur in the first quarter of the year. table overleaf has details some of the objectives that the Board process. agreed as a result of the evaluation an additional non-executive director later this year. an additional non-executive director later this year. director in April. Search activity continues with a view to appointing director in April. Search activity continues with a view pleased that Ravi Uppal will be joining the Board as a non-executive Uppal will be joining the Board as pleased that Ravi (AGM) in May, the Nominations Committee has been active and I am the in May, (AGM) Weinberg due to retire from the Board at the Annual General Meeting Weinberg With Ulrich Cartellieri retired last September and Peter having should aim to have eight non-executive and four executive directors. eight non-executive and four executive should aim to have We have agreed that as a Board, in addition to the chairman, we in addition to the chairman, agreed that as a Board, have We project execution experience. company experience as well as having considerable international as having experience as well company capacity. As a director of BP p.l.c. he has excellent large global As a director of BP p.l.c. he capacity. During the year Andy Inglis joined the Board in a non-executive Board appointments successor later this year. is being made and we hope to be in a position to announce a hope is being made and we chooses to appoint is the best person available for the job. Progress chooses to appoint is the best person available the aim of ensuring that the individual that the Board ultimately search for suitable candidates for the Chief Executive position, with search for suitable candidates for the Chief Executive position, practice, the Nominations Committee has also initiated an external the Nominations practice, processes and these have been of great assistance. In line with best processes and these have comprehensive succession planning and management evaluation comprehensive succession planning and management who should succeed him. As mentioned above, the Company has the Company who should succeed him. As mentioned above, Committee has been actively engaged since last November on last November Committee has been actively engaged since and with Mike Turner due to retire later this year the Nominations Turner and with Mike Naturally, the Chief Executive position is covered by these processes by Chief Executive position is covered the Naturally, identified by our development and succession planning processes. and by our development identified activities to address certain requirements common development addition, we have augmented our strategic management development augmented our strategic management have we addition, Where this is the case we are working at achieving full coverage. In are working full coverage. Where this is the case we at achieving identified a need in the succession plans for greater ‘bench strength’. identified a need in the succession plans most senior positions in several years’ time. In some areas we have years’most senior positions in several time. In some areas we those candidates who we believe have the potential to take up the the potential to take have believe those candidates who we in the Group. These individuals cover the range from ‘ready now’ to the in the Group. These individuals cover succession candidates across the current management roles senior year and I am pleased to report a good number of quality have that we A review of management resources was completed in November last completed in November of management resources was A review Board and the Nominations Committee. the management of their development is a key responsibility for the responsibility is a key the management of their development to the Board are likely to be drawn from amongst them. Overseeing to be drawn to the Board are likely management resource and in the future candidates for appointment management resource and in the future candidates Group. These individuals form the backbone of the Company’s senior Group. These individuals form the Company’s the backbone of and oversee the development of over 50 employees from across the 50 employees of over and oversee the development new processes introduced by the Nominations Committee to identify the Nominations introduced by processes new of the Board’s core governance duties. Last year I reported core governance duties. the on of the Board’s Ensuring that we have the right people running the Company is one the right people running the Company have Ensuring that we Succession planning ethics not only achieve best practice but provide leadership. but provide best practice ethics not only achieve the Board seeking to continually improve, and in the area of business continually improve, the Board seeking to I see the formation of the Woolf Committee as positive affirmation of I see the formation Woolf of the 2008 Objectives directors smooth in dialogue to ensure and transition and transparent selection Chief Executive. of the new as part of its meeting programmes. Use the visits as an opportunity to meet to supportwith senior management succession planning. processes and culture required to support increasingly global position. the Company’s implications of strategic growth options are explored and understood. Plan for and commence embedding the Woolf Committee recommendations. – non-executive and executive Engage – conduct additional site visits Board to – the competencies, Understand and review – Ensure that ethical and reputational – focused on programme KPIs. attention Keep 2007 Achievements planning with greater coverage across coverage planning with greater plans. all senior executive succession senior management programme New the common rolled-out to address needs identified during development activities. succession planning KPIs regularly and uses these alongside to monitor standard financial measures performance. the Company’s overseen the Committee have non-financial risk of new development processes. More work will be done in aligning with Woolf this area in 2008, Committee recommendations. for the non-executive directors to meet to discuss issues informally as a group and with the Chief Executive present. – made on succession Good progress – programme and project reviewed The Board – The Board and Corporate Responsibility – Additional opportunities made available were (continued) ms.com www.baesyste www.baesyste

2007 Objectives succession planning, with a focus on with a focus succession planning, the support of the next and development and also generation of senior executives enhancement of the the identification and management bench strength. Group’s performancehas initiated on financial at project and monitoring and looking detail. programme KPIs in more including the Corporate monitoring, focus on Responsibility Committee’s corporate reputation issues. non-executive directors to meet to discuss issues independently and with the Chief Executive. Board performance evaluation – objectives – evaluation Board performance Chairman Dick Olver – further Develop the work the Board – Build on current non-financial performance – additional opportunities Provide for – the work Continue started in 2006 on and participate in the meeting on 7 May. on this. I hope as many shareholders as possible are able to attend on this. I hope as many stewardship of the Company and to answer shareholders’ questions and to answer of the Company stewardship and worthwhile allowing directors to report experience, on their AGM plays in this. I want attendance at our AGM to be an interesting attendance at our AGM in this. I want plays AGM communications with our shareholders and the central role the Finally, I would like to highlight the importance I would like on I place Finally, Shareholder communication our Senior Independent Director after he has met with the facilitator. met with the facilitator. our Senior Independent Director after he has feedback on my own performance and I receive this each year from feedback on my of performance. As Chairman, it is importantof performance. As Chairman, full and frank I receive aspects of how we operate but also some of the behavioural aspects operate but also some of the behavioural aspects of how we us to deal effectively with not only the procedural or administrative us to deal effectively with not only the procedural No evaluation process is perfect but I believe our approach does allow our approach does process is perfect but I believe No evaluation external facilitator to conduct individual interviews with each director. When we started the evaluation process in 2004 I was keen to use an started to use keen When we process in 2004 I was the evaluation

58 Corporate governance Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 59 BAE Systems Annual Report 2007 –––– – – 8 (8) – Corporate Non-Executive 4 ––––1 (1) ––––– ––––1 ––––– ––––1 (1) ––––– ––––1 Audit Responsibility Nominations Remuneration Directors’ Fees BAE clients it has worldwide just one of many Systems is therefore and the fees earned the Company from its relationship with represents a very small part As a of its total revenues. the that the relationship between the Board believes consequence, and Goldman Sachs does not represent ‘a material Company business relationship’; and with BAEinvolvement directors Systems and none of the executive business dealings with him. or the Chairman had had any Compliance with the provisions of the Combined Code with the provisions Compliance statement Compliance Code of the Combined with the provisions compliant was The Company on Corporate 2007. throughout Governance The Board non-executive seven a non-executive chairman, The Board comprises directors directors. and four executive with the exception The Board considers the non-executive directors, all of purposes to be independent for the of the Combined of the Chairman, been identified on pages 54 and 55 Code. Each of these directors have of this report. Weinberg appointed to the Board in 2005. As Mr was Weinberg Peter bank that (an investment a senior director of Goldman Sachs Inc. was servicesprovides to BAE the Board addressed the issue of Systems) A.3.1 of to his appointment in light of provision his independence prior the Combined Code concerning of a ‘material the possible existence or the director and the Company business relationship’ between and a party the Company between with which the director is a major It determined that partner or director. senior employee, shareholder, independent for the purposes of the Combined Code, he was Sachs. The reasons notwithstanding the relationship with Goldman for reaching this conclusion were: – Goldman Sachs is a very clients. large organisation with many – had no Mr Weinberg prior to his appointment to the Board, ceased to be associated with Goldman Sachs in 2006. Mr Weinberg scheduled to meet eight times and in addition In 2007 the Board was Additional Board meetings are strategy. spent reviewing was one day 12 times during the year. called as required and in total the Board met Mason as the Senior Independent The Board has appointed Sir Peter during the year Amongst the duties undertaken Sir Peter by Director. to meet with the non-executive directors without the Chairmanwas performance. present to appraise the Chairman’s directors individual at meetings of the Board and The attendance by as follows: its committees in 2007 was 8 (9)3 (3)–––– (9)3 3 (5)8 (5)––––– –6 (6)3 1 (1) – – 2 (2) 3 (3) – – – – Board Committee Committee Committee Committee Committee 1 1 2 3 evaluating its own performance; its evaluating affairs of the Group; ensuring that the Board receives timely and accurate place, information on the performance the proper of the Group and delegation of authority; and necessary and that appointments to the Board skills and experience are managed effectively. Mr P CarrollDr U Cartellieri Mr C V Geoghegan Mr I G KingMr R L OlverMr R Quarta 10 (12) 11 (12) – 11 (12) 12 (12) 5 (5) 9 (12) – 7 (8) 1 (1) 1 (1) – – 8 (8) – 1 (1) Mr M J HartnallMr W HavensteinMr A G Inglis MasonSir Peter Mr S L Mogford 12 (12) 11 (12) 10 (12) 4 (4) (4) 3 – 7 (8) 1 (1) – Mr G W RoseSir Nigel RuddMr M J Turner 12 (12) 11 (12) 12 (12) – 5 (5) – 8 (8) – or alternatively, can be obtained from the Company Secretary. Secretary. can be obtained from the Company or alternatively, A copy of the Board Charter can be found on the Company’s website, of the Board CharterA copy can be found on the Company’s product development expenditure. product development disposals of businesses, capital expenditure and Company-funded disposals of businesses, decisions concerning contract bids and tenders, acquisitions and decisions concerning contract bids and tenders, authorities it has reserved for itself, amongst other things, certain other things, authorities it has reserved amongst for itself, its strategy and business plans. Within the Board’s delegated its strategy plans. Within the Board’s and business of ethical conduct, overall governance structure of the Company and governance structure overall of the Company of ethical conduct, Board’s decision. These include approving the vision, values, principles values, the vision, These include approving decision. Board’s the Charter been reserved of matters is a schedule that have for the the strategy and business plan agreed by the Board. Included within the strategy plan agreed by and business the leadership and operational management of the Company within the leadershipof the Company and operational management – – Performance the performance monitoring of the Group and also – – Standards and Values setting standards and values to guide the – Oversight – ensuring an effective system of internal is in controls – – People with the individuals Group is managed by ensuring the The Board Charter that the Chief Executive is responsible for states – Strategy – and agreeing strategy; reviewing and cover the following: and cover the main and supportingin the Combined Code principles contained and the Senior Independent Director. The governance principles reflect The governance principles Director. and the Senior Independent Board and also details of the roles of the Chairman, Chief Executive of the roles of the Chairman, Board and also details is a statement of governance principles that guide the activities of the principles that guide the activities is a statement of governance The Board has adopted a document, the Board Charter, in which there Board Charter, the a document, The Board has adopted the directors within a framework of prudent and effective controls. and the role of the Chairman in ensuring that decisions are made by and the role of the Chairman in ensuring that decisions are made by The governance structure essential human element recognises this on the business skills and judgement that each director possesses. and judgement that each director possesses. on the business skills required to provide entrepreneurial leadership for the Company, relying entrepreneurial leadership for the Company, required to provide the basic structure operates. The directors within which the Board are are documented and planned on an annual basis but this only formsare documented and as BAE The core activities of the Board and its committees Systems. to be a sound statement of accepted good practice for a company such a company good practice for statement of accepted to be a sound and supporting principles in the UK’s Combined Code, recognising these Combined Code, and supporting principles in the UK’s The Board has structuredThe Board so as to incorporate its activities the main Applying the principles of the Combined Code on Corporate principles of the Combined Applying the Governance Figures in brackets denote the maximum number of meetings that could have been attended. Figures that could have denote the maximum number of meetings in brackets 1 2007 retired from the Board on 9 May 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 Mr P A Weinberg 10 (12) – 5 (5) – 7 (8) – Professor S Birley Director The Board has delegated to the Audit Committee responsibility for Audit Committee responsibility has delegated to the The Board of system of the Company’s the effectiveness in detail reviewing the Committee undertakeninternal Having controls. such reviews, reports a whole can so that the Board as on its findings to the Board Audit Committee and In order to assist the this matter. on a view take the Operational has developed the Company the Board in this review, regular (OAS) process. This has been subject to Assurance Statement of which has resulted in a number a number of years, over review refinements being made. each partThe OAS requires that completes a formal of the business including Framework, of its compliance against the Operational review controls and risk management processes. operational and financial the managing director of everyIt is signed-off by line of business and functional directors.relevant is completed every The OAS six months and includes a formal of business risk. assessment for the system of internal responsibility control within The overall BAE Responsibility directors Systems rests with the of the Company. procedures lies with for establishing and operating detailed control the line leaders of each operating business. the policies and processes system of internal control, In line with any are designed to that are mandated in the Operational Framework business to achieve manage rather than eliminate the risk of failure reasonable and not absolute and can only provide objectives, or loss. assurance against material misstatement The responsibility for internal with joint ventures control procedures with the senior on the whole, and other collaborations rests, monitors its management of those operations. The Company and exertsinvestments representation. influence through Board Going concern a reasonable the directors have After making due enquires, resources to continue expectation that the Group has adequate this reason they future. For operational existence for the foreseeable continue to adopt the going concernpreparing the accounts. basis in Relations with shareholders relations programme investor has a well-developed The Company Group Finance Director and Investor the Chief Executive, managed by the Chairman is in regular contact with In addition, Relations Director. them informedmajor shareholders of progress on and looks to keep corporate governance matters. an in developing In order to assist each year the understanding of major shareholders, of the views commissions a surveyCompany undertaken of investors external by consultants. The results of the survey are presented to the Board. Relations website maintains a comprehensive Investor The Company in information on investing amongst other things, that provides, BAE Systems and copies of the presentation materials used for key shareholders presentations. This can be accessed via the Company’s www.baesystems.com. website, all shareholders provides with the opportunityThe AGM to develop and ask questions on the matterstheir understanding of the Company put to the meeting including this Annual Report. All shareholders are to ensure that and, entitled to vote on the resolutions put to the AGM Articles of Association requires the Company’s all votes are counted, the resolutions in the Notice of Meeting. on all that a poll is taken The results of the votes on the resolutions will be published on the website. Company’s (continued) ms.com www.baesyste www.baesyste

and timely and based on the maintenance of proper records and timely and based on the maintenance supported robust information and gathering processes; by and regulations at all times and also internalpolicies in respect of the Board. and conduct mandated by the standards of behaviour by enabling it to respond appropriately to significant operational, by compliance and other risks that it faces in carryingfinancial, out its business; as required. making recommendations for business and control improvements making recommendations for business and control improvements systems of internal control through a programme of cyclical reviews provides objective assurance as to the operation and validity of the provides procedures and control processes implemented by management. It procedures and control processes implemented by The Internal Audit team independently reviews the risk identification The Internal Audit team independently reviews by insurance. by effective risk management process, underpinned where appropriate effective risk management process, include human, property and financial resources, through an propertyinclude human, and financial resources, The Company is committed to the protection of its assets, which assets, is committed to the protection of its The Company world-class control processes is a key management objective. world-class control processes is a key processes is equally important. The consistent application of overall control environment, the consistent application of these the consistent control environment, overall Whilst the quality of the control processes is fundamental to the whole business. understand how their own success contributes to the success of the individual goals to those of the organisation enabling employees to individual goals to those of the organisation enabling employees measures and milestones. PCL drives business success by linking measures and milestones. PCL drives business success by progress against the IBP and business performance against objectives, budgets. The QBRs, chaired by the Chief Operating Officers, evaluate the Chief Operating Officers, chaired by budgets. The QBRs, strategy for each business group, together with detailed near-term strategy for each business group, The IBP, results in an agreed long-term the Board, annually by approved Business Reviews (QBR) and Performance Centred Leadership and Performance (QBR) (PCL). Business Reviews Further key processes are Integrated Business Planning (IBP), QuarterlyFurther Business Planning (IBP), processes are Integrated key delivering projects to schedule and cost. eventual disposal, and its application is critical to our capability in and its application disposal, eventual the whole life of projects from inception to deliverythe whole life of projects from inception to into service and facilitates continuous improvement across the Group. It considers across facilitates continuous improvement promotes the application of best practice programme execution and promotes the application of best practice organisation. Lifecycle Management (LCM) is such a process and organisation. Lifecycle Management (LCM) global best practice and their application is mandated across the global best practice and their application is and processes detailed within the Operational Framework draw on draw Framework and processes detailed within the Operational and is reviewed on a regular basis by the Board. The business policies on a regular basis by and is reviewed framework across the Company for operational and financial controls for operational framework across the Company if appropriate. The Operational Framework provides a common provides if appropriate. The Operational Framework escalated through the management team ultimately to the Board escalated through the management team – complies with applicable laws assist in ensuring that the Company Reporting issues are is structured so that key within the Company – assist in ensuring that internal and external reporting is accurate – facilitate the effective and efficient operation of the Company and behaviours that taken together, seek to: together, that taken and behaviours encompasses, amongst other things, the policies, processes, tasks processes, the policies, amongst other things, encompasses, was in place throughout 2007 and to the date of this report, that in place throughout 2007 and to the date was BAE a system of internal has developed Systems control that with the Combined Code and the Turnbull guidance (as revised). and the Turnbull with the Combined Code compliance controls and risk management systems, in accordance risk management systems, compliance controls and system of internal controls, including financial, operational and operational including financial, system of internal controls, The Board has conducted a review of the effectiveness of the Group’s of the effectiveness a review The Board has conducted Internal control of those directors re-election at the forthcoming seeking AGM. (enclosed with this report) their reasons for supporting the re-election The Board has set out in the Notice of Annual General Meeting The Board has set out Board at least once everyBoard at least years. three directors to the and seek re-election to stand down are required seek re-election to the Board at the following AGM. In addition, all In addition, the following AGM. to the Board at seek re-election The Company’s Articles directors require that all new of Association The Company’s

60 Corporate governance Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 61 BAE Systems Annual Report 2007 of £250,000 to be authorised by both the Chairman of the Audit of £250,000 to be authorised by Committee and the Group Finance Director; within two years of the conclusion of a the Company by employed audit; relevant within two years of the the Company by or below is to be employed audit; and conclusion of a relevant of the Group without the approval the Company by to be employed Finance Director and the Chairman the Audit Committee. of Activities the effectiveness duties is to review principal Committee’s One of the internal internal processes. Robust control controls are of the Group’s ensure that the information on the performanceThey essential. of the and assisting management thereby is accurate and timely, Company are also directors management of the Group. They in the effective and regulations that the Group complies with law essential in ensuring including those that concern external reporting. years, As in previous a reportthe Committee received from the Auditors and presentation control Group’s of the of their review summarising the findings the Committee received reports on control In addition, environment. as explained on page 60, matters from the Internal function and, Audit the findings from the Group’s it reviewed twice during the year Statement process. Operational Assurance is monitoring the responsibilities key One of the Committee’s Auditors and Internal Audit function. effectiveness of the Company’s the results of an internal evaluation Each year the Committee reviews of the performance of the Internalthat looks at its Audit function effectiveness in terms the skills and experience of work planning, quality of reporting, of audit implementation to the function, available the last year addition, recommendations and its independence. In third-partyCommittee commissioned an independent the to provide Committee with an external of the effectiveness of the Internal view practice recommended Audit function – this being in line with best the Institute of Internal Auditors.by KPMG Audit Plc, of the effectiveness of the Auditors, An evaluation completed during the year. was The Committee accepts that certain work of a non-audit nature is best undertaken the amount the Auditors. The Audit Committee reviews by and nature of non-audit work undertaken the Auditors during the by it is not appropriate to whilst it believes year and has agreed that, manage such work limiting it to a certain by percentage of audit work, such work controlled to ensure that it does not compromise should be the Committee has the independence of the Auditors. Consequently, agreed the following rules to control the quantity and the nature of the work undertaken the Auditors: by – non-audit work to be undertaken any Auditors the in excess by – worldwide audit team is to be no partner/director of the Auditor’s – worldwide audit team at manager level no qualified member of the – no partner/director of the Auditors not associated with the audit is a meeting annual schedule of meetings, As part of the Committee’s operations so that members of the is held at one of the Company’s a greater understandingCommittee can meet management and develop This year a meeting of the of various aspects of the Company. site in the UK where the Regional Woodford held at the Committee was reviewed. Aircraft business and Nimrod MR4A programme were Michael Hartnall Audit Committee Chairman the terms of their engagement and fees, their independence and the terms of their engagement and fees, their expertise, resources and qualifications. on the appointment of the Auditors. function including approving the appointment or removal or removal the appointment function including approving of the Head of Internal Audit. internal control policies and procedures for the identification, internal control policies and procedures for assessment and reporting of risk. – financial statements. the integrity of the Company’s Monitoring – reporting significant financial Reviewing issues and judgements. Committee can be of the Audit The full terms of reference or can be obtained from the website the Company’s on found Secretary. Company – including under review, the Auditors the relationship with Keeping – and making recommendations to the Board Considering – of the Internal Audit the role and effectiveness Monitoring – reporting, financial of the Company’s the effectiveness Reviewing Responsibilities Audit Committee report Committee Audit The Committee met four times in 2007. present and also with only the external auditors present. Company executives present, with only the Head of Internal Audit executives present, Company during the year the Committee held individual meetings without Director and Head of Internal Audit attend its meetings. However, The Committee normally asks that the Chief Executive, Group Finance The Committee normally asks that the Chief Executive, director of a large UK listed company. director of a large UK listed company. accountant and has relevant experience of servingaccountant and has relevant as a finance The Committee is chaired by Michael HartnallThe Committee is chaired by who is a chartered in accordance with provision A.3.1 of the Combined Code. in accordance with provision its members were non-executive directorsits members deemed to be independent were The Audit Committee was in place throughout 2007 during which all The Audit Committee was Governance until his retirement from the Board on 26 September 2007. until his retirement from the Board on 26 During the year, Dr Ulrich Cartellieri a member of the Committee was During the year, Roberto Quarta Sir Peter Mason Sir Peter Michael Hartnall (Chairman) Members Dick Olver Nominations Committee Chairman candidates to fill vacancies for non-executive and, with the for non-executive and, candidates to fill vacancies executive directors. assistance of the Chief Executive, and Remuneration committees. of the Audit Board and making recommendations to the Board on any Board and making recommendations to the desired changes. – suitable approval the Board’s and nominating for Identifying – the orderly directors of new succession for to the Board. Planning – to the Board the membership Recommending and chairmanship of the Nominations Committee can The full terms of reference or can be obtained from the website on the Company’s be found Secretary. Company Responsibilities – size and composition of the regularly the structure, Reviewing Nominations Committee report Committee Nominations Governance in place throughout 2007. It is The Nominations Committee was Whilst he is not deemed the Chairman of the Company. chaired by the other two membersare of the Committee to be independent, independent non-executive directors with provision in accordance A.3.1 of the Combined Code. The Committee normally asks the Chief Executive and Group Human during the year Resources Director to attend its meetings. However, present. executives the Committee did meet without Company 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 identifies a need to recruit non- new a profile of the ideal candidate is produced based executive directors, is increasingly on the skills and experience required. The Company both the UK and the US to identify the global and looks beyond an importantright people. Search consultants have role to play in identifying suitable candidates based on the Committee’s The Zygos Partnership engaged to was requirements. In 2007, assist in such search activities. Each year the Committee undertakes of the a detailed review resources and the succession plans for all management Company’s senior executive positions. The Committee is interested in both the Members Dick Olver (Chairman) Phil Carroll Mason Sir Peter (continued) ms.com www.baesyste www.baesyste

in respect of the reporting financial control of possible accounting, and other financial irregularities. Auditors and the statement concerning in the such disclosures Annual Report; reporting obligations; disclosures made in the Annual Report made in the Annual disclosures on this matter; and mitigate risk; evaluate across the Group; effectiveness of the controls Report and received and the Interim Report issued in August 2007, a report from the Auditors on the statements; to be undertaken the Auditors; by 2007 audit; undertaken the Internal Audit function; by Audit Committee Chairman Michael Hartnall On behalf of the Audit Committee – helpline procedures Company’s the effectiveness of the reviewed – terms of reference; and the Committee’s reviewed – procedures for disclosing information to the the Group’s reviewed – periodic financial proposals concerning the Group’s reviewed – to identify, output from the Group-wide process used the reviewed – a report received of the from the Auditorson their review – Annual financial statements in the 2006 and 2007 the reviewed – work agreed the approach and scope of the audit and reviewed – the fees to be paid to the Auditors agreed of the in respect – received a report from the Head of Internal work Audit on the – undertook an assessment of fraud risks; – internal controls and the Group’s effectiveness of the the reviewed The Audit Committee also undertookThe Audit Committee 2007: the following during

62 Corporate governance Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 63 BAE Systems Annual Report 2007 amongst other things, engagement with shareholders and safety, amongst other things, performance information;health and environment undertaken matters; on ethical and environmental a ‘best in class’ position on safety performance; towards Company responsibility-related non-financial objectives to be included in the directors’ annual bonus plan. Activities social economic, Corporate concerns responsibility a company’s when it comes are different impact. All companies and environmental therefore it is important in these areas and to their impact for the Corporate Committee to focus on the areas of corporate Responsibility of particularresponsibility that are importance for BAE The Systems. ethics agreed that its prime focus should be Committee has therefore of other it also deals with a range However, and health and safety. including matters such as workforce diversity and a range areas, matters. of environmental with the Company’s compliance The Committee monitors and reviews and the work undertaken behaviour standards of business to ensure and understand of these. the application are aware that all employees the during 2007 included reviewing The activities of the Committee programmes, awareness Ethics Helpline and Group ethics Company’s As of surveysincluding the results assessing such awareness. reported in this report, the Board has formed elsewhere the Woolf ethical policies and Committee to study and report on the Group’s processes. During the year the Corporate Committee Responsibility Committee to discuss ethics in met with members of the Woolf implementation general and its role in relation to the prospective look be recommended. We and assurance of activity that may to the publication of the reportforward year. later this priority for the Company is a key The health and safety of our employees monitor safety and also for the Corporate We Responsibility Committee. performance and have reviewedof various health aspects and of safety theconsidered within management the the output Company. from Incorporate a addition, responsibility workshop the and held Committee wasit by pleased management is to on giving endorse to the health priority and further has been developing During the year the Company its risk safety in addition particularlymanagement processes, in respect of the monitoring and to ethics. on an annual reviews, mitigation of non-financial risks. The Committee relate to health such processes as they output from the relevant basis, business ethics impact, environmental workplace policies, and safety, and compliance with anti-corruption and regulation. laws The Committee undertook the following activities in 2007: – received reports on corporate responsibility matters including, – received reports from the Internal Audit function on audits – the proposed approach to progress the and approved reviewed – Corporate Responsibility Report; the Company reviewed – its terms of reference; and reviewed – Committee on the setting of coporate liaised with the Remuneration corporate See pages 37 to 43 for more detail on the Group’s responsibility activities. On behalf of the Corporate Responsibility Committee Weinberg Peter Corporate Responsibility Committee Chairman Peter Weinberg Peter Corporate Responsibility Committee Chairman on social, environmental and ethical issues. environmental on social, managing social, environmental, ethical and reputational risk. ethical and reputational environmental, managing social, and policy on social, environmental and ethical matters. environmental and policy on social, The full terms of reference of the CorporateThe full terms Responsibility of reference or can website on the Company’s Committee can be found Secretary. be obtained from the Company – Overseeing engagement and supporting stakeholder key – in performance the Company’s Monitoring and reviewing – of strategy Assisting the Board on overseeing the development Responsibilities Corporate Committee report Responsibility Nominations Committee Chairman Dick Olver On behalf of the Nominations Committee On behalf of the Nominations and internal candidates. doing this in line with best practice, reviewing rigorously both external rigorously both reviewing best practice, doing this in line with This process was startedThis process was year and the Committee is committed to last the right person to succeed Mike Turner when he retires later this year. when Turner the right person Mike to succeed reported on page 57, the Committee is undertakingreported the task of finding on page 57, is the most important has to perform. task that the Committee As Overseeingfor the appointment of executive directors the process ensuring that individual development plans are in place. development ensuring that individual The Committee also monitorsThe Committee of senior management, the development who is likely to come through in the next couple of years come through in the to beyond. and who is likely is ready to take on specific management positions now, as well as as positions now, on specific management take is ready to quality of management resource and also its depth, looking at who and also its depth, resource quality of management The Committee met five times in 2007. Responsibility Director to attend its meetings. Human Resources Director, Group General Counsel and Corporate Group General Counsel Human Resources Director, The Committee normally asks the Head of Internal Audit, Group The Committee normally asks the Head of Internal Audit, independent in accordance with provision A.3.1 of the Combined Code. independent in accordance with provision during which all its members were non-executive directorsduring which all its members deemed to be were The Corporate Responsibility Committee was in place throughout 2007 The Corporate Responsibility Committee was Governance Sir Nigel Rudd Andy Inglis Phil Carroll Peter Weinberg (Chairman) Weinberg Peter Members Sir Nigel Rudd Remuneration Committee Chairman directors, members of the Executive Committee, the members of the Executive Committee, directors, Company Secretary executives. and other senior the Chairman and executive directors.packages for including termination executive directors, agreements for payments. such schemes. conditions to be used for performance any Remuneration Committee report Committee Remuneration Responsibilities – executive the remuneration of the Chairman, Agreeing a policy for – determining individual remuneration Within the agreed policy, – Agreeing the terms and conditions to be included in service – share-based incentive schemes and employee any Approving – targets. share scheme performance Determining any of the Remuneration Committee, The full terms of reference with the requirements of the Combined Code, which conform or can be obtained from website on the Company’s can be found Secretary. the Company Governance Sir Nigel Rudd and all of its members The Committee is chaired by Chairman are independent non-executive directors. The Company’s only. invitation and Chief Executive attend Committee meetings by their individual remuneration is discussed do not attend where They in deciding his own remuneration. and no director is involved In 2007 the Committee met eight times and details of attendance in the Corporate at these meetings are provided Governance Report on page 59. Associates as its In August 2007 the Committee appointed Kepler Independent The role of the Committee’s Independent Adviser. advice to the Committee and its individual Adviser is to provide and Kepler remit, members on all aspects of the Committee’s Associates will not undertake whilst they work for the Company any Representatives Independent Adviser. are retained as the Committee’s attended each of the Committee have Associates from Kepler meetings since their appointment and will be in attendance at all by the Committee. meetings unless specifically requested otherwise During the year the Committee also received material assistance Human and advice on remuneration policy from the Company’s and the Human Resources Director, Alastair Imrie, Resources Director, Graham Middleton. Dick Olver Group Remuneration and Benefits, Members: Sir Nigel Rudd (Chairman) Roberto Quarta Weinberg Peter Professor Sue Birley served as a member and as During the year, Chairman her retirement from of the Remuneration Committee until 2007. the Board on 9 May ms.com www.baesyste www.baesyste

– policy and service Remuneration contracts for executive directors – term and fees appointment, Chairman’s – term fees and Non-executive directors’ appointment,

pensions and share-based incentives 64 – reporting Remuneration – emoluments, information directors’ on shareholdings, Tabular –Committee report Directors’ Non-Executive Fees – Committee report Remuneration The Remuneration report is structured as follows: directors and the policy underpinning this. report, together with a reportreport, together with or fees paid to on the remuneration both these Committees are incorporatedboth these Committees into this Remuneration the Non-Executive Directors’ Fees Committee. The reports Committee. The the Non-Executive Directors’ Fees from authority to agree fees payable to the non-executive directors to the non-executive to payable authority to agree fees directors to the Remuneration Committee, and has delegated and has directors Remuneration Committee, to the determining for the Chairman specific packages the and executive The Board has delegated authority for remuneration policy and for remuneration has delegated authority The Board Remuneration reportRemuneration Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 65 Dick Olver Non-Executive Directors’ Committee Fees Chairman BAE Systems Annual Report 2007 (excluding the Chairman) to such fees and making changes as deemed appropriate. necessary skills, experience and knowledge required to ensure that necessary experience and knowledge skills, the Board is able to discharge its duties effectively; time individual non-executive directors to their to devote are required internationalduties and also the scale and complexity and nature of the business and the responsibility involved; shall not be performance-related; and based incentive schemes or pension scheme. Non-Executive Directors’ Fees Committee report Committee Directors’Non-Executive Fees Responsibilities – directors to non-executive payable the fees Reviewing Members: Dick Olver (Chairman) Philip Bramwell Havenstein Walt Turner Mike Governance Committee has delegated authority The Non-Executive Directors’ Fees to non-executive directors on from the Board to agree fees payable its behalf. Activities the guidelines to be used by the following The Board has approved Committee when discharging its responsibilities: – fees shall be sufficient to attract and retain individuals with the – regard to the amount of in setting fees the Committee shall have – to non-executive directors shall be paid in cash and fees payable – share- non-executive directors shall not participate in the Company’s all members, The Committee held one meeting in 2007 attended by and met in January 2008. Committee On behalf of the Non-Executive Directors’ Fees Dick Olver Committee ChairmanNon-Executive Directors’ Fees policy. policy. Company during the year;Company and of August 2008. of their progress at the half year; share scheme grants including the level of individual grants and share scheme grants including the level performance conditions; Remuneration Committee Chairman Sir Nigel Rudd On behalf of the Remuneration Committee – consulted with major shareholders aspects of remuneration over remuneration are set out on pages 66 to 83 of this Remuneration report. – the Remuneration report; reviewed and policy and details of executive strategy, remuneration The Company’s – at the end will retire from the Company Turner terms on which Mike has also: the Committee In addition, – terms left the Mogford and Chris Geoghegan on which Steve – discretionary elements of the executive share plans; – base salary Chief Operating Officers for the two new in the light – fees for his second three-year term; Chairman’s – performance; of bonuses based on the prior year’s award – share schemes; policy for the operation of the all-employee – operation of the long-term incentive plans and policy for executive – performance targets for the year and progress against those targets; as set out in this report. In addition, the Committee has agreed the: as set out in this report. the Committee addition, In result of that review, the Committee has agreed a number of changes result of that review, undertaken a thorough review of the Company’s reward strategy. As a strategy. reward undertaken of the Company’s a thorough review In discharging its responsibilities, the Committee has, during the year, the Committee has, In discharging its responsibilities, Activities under the Performance Share Plan. under the Performance shareholder returnperformance figures for assessing the condition Committee, provided advice on long-term incentive plans and the total provided Committee, of packages. New Bridge Street Consulting, who are appointed by the who are appointed by Bridge Street Consulting, of packages. New detailed information trends and the competitive positioning on market and also provided services to the Company during the year, provided servicesand also provided year, during the to the Company PricewaterhouseCoopers (PwC), who are appointed by the Company the are appointed by who (PwC), PricewaterhouseCoopers by the Company. the Company. by Committee would appoint separate legal advisersCommittee would appoint from those used of interest. If a conflict of interest were to arise in the future, the in the future, were to arise of interest of interest. If a conflict these firms were of a technical nature and did not create any conflict not create any were of a technical nature and did these firms year. The Committee is satisfied that the services The Committee by to it provided year. Company, and who also provided services and who also provided during the to the Company Company, and Freshfields Bruckhaus Deringer, who are both appointed by the by are both appointed who Bruckhaus Deringer, and Freshfields Legal advice to the Committee has been provided by Linklaters by been provided to the Committee has Legal advice to the Committee. to the Committee. Chief Executive, also provided advice that was of material assistance of advice that was also provided Chief Executive, and Mike Turner, in their respective capacities as Chairman in their respective capacities and Turner, and Mike ctors’ Package • Executive Share Option Scheme* Plan Share • Performance • Share Matching Plan – Base salary – Annual bonus – Long-term incentive plans – provision Pension – Car/allowance – Other benefits – incentive plan Global all-employee * no further from 2008 awards detailed below. These changes will flow down to the 250 most senior These changes detailed below. a consistent global executives within the Group globally to create approach to reward. the announcement in October 2007 that the Chief Following at the end of would retire from the Company Turner, Mike Executive, the Committee has August 2008 after 42 years with the Company, agreed a separate arrangement on page 70. for him detailed Policy and more highly geared with seniority level upper quartile reward • short and long-term reward • fixed and variable reward • with balance becoming more long-term – Set base salary at median competitive – quartile upper Reward performance with – Balance between: – Competitive package of benefits Objectives of the review and summaryObjectives of the review To drive creation of long-term value for shareholders drive creation of long-term value for To (continued) – of performance shares where necessary Increased awards to maintain competitive package – shares rather than options of long-term incentives will be made over All future awards – Compulsory deferral of part bonus into Share Matching Plan of the annual – levels Extend eligibility of long-term award incentives and improve – Extend Minimum Shareholding Requirement to all senior executives receiving long-term incentives Summary of changes made – proportion Increase to one-third the of annual bonus driven off specific objectives – ethics and diversity Part to performance on safety, bonus to be specifically linked of the annual – Compulsory deferral of at least one-quarter of annual bonus into the Share Matching Plan – Increase proportion long-term of package delivered through incentives – Further the top 250 senior executives globally extend eligibility of long-term incentive plans to cover – of performance shares awards improved Replace share options by – driver of long-term Increase focus on long-term performance Earnings per Share (EPS) as key – Shareholder Returnon EPS (TSR) and half of performance shares to be based on Total Half the awards – Use actual growth in EPS rather than real growth in excess of UK inflation – in package Share Matching Plan to increase its weight Improve – the base financial targets for achieving coupled with reduced payout maximum bonus levels Improved – under Share Matching Plan for all eligible executives Uniform match of 1:1 for 2008 awards – performance under Share Matching Plan for improved 2:1 match for 2009 awards Improved Strategy ms.com www.baesyste www.baesyste the Group performance culture market

the Group. performance culture performance market – is fair and transparent – can be applied consistently throughout – encourages and supports a high- To provide a remuneration package that: provide To – retain and motivate helps to attract, – is aligned to shareholders’ interests – is competitive against the appropriate – is fair and transparent – can be applied consistently throughout – encourages and supports a high To provide a remuneration package that: provide To – retain and motivate helps to attract, – is aligned to shareholders’ interests – is competitive against the appropriate Incentivise increased share ownership amongst executives Competitive package with for improved increased reward performance Simplify package with more transparent link between performance and reward Increase focus on sustainable long-term performance Objective

In the second half of 2007, the Committee undertook a full review In the second half of 2007, of the remuneration arrangements directors for executive to ensure remained appropriate and supportedthey strategy the Group given the growth of the Group internationally increased focus on and the through-life support.excellence in Programme Management and the Committee has made a number of As a result of the review, changes to the arrangements for executive directors for 2008 as Remuneration strategy and policy for executive strategyRemuneration policy for and directors 66

This section of the report explains the Company’s remuneration strategy and policy, the individual components of executive dire the individual components remuneration strategy and policy, This section of the report explains the Company’s Remuneration reportRemuneration policy and package for executive directors is: remuneration strategy, The Company’s Directors’ report – Corporategovernance Remuneration strategy and 2007 review remuneration and details of their serviceremuneration and details legislation. as required by contracts

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 67 Up from 25% BAE Systems Annual Report 2007 Base salary at salary Base at Percentage 1 The annual bonus for 2008 has been restructured to 1 To remain competitive and to increase the gearing to drive for To a half year review of performance in their new roles, the base salary of performance roles, of Ian King was in their new a half year review increased was Havenstein and that of Walt increased from £530,000 to £560,000, effect from 1 July 2007. with from $750,000 to $850,000, Other objectives that support the the Group strategy TotalBonus compulsorily into SMPinvested Maximum bonus in cashpayable 27% – 100% 100% 31.25% 93.75% 125% 150% – 150% 48% 150% 225% 75% Measure In-year financial performanceEthics and safety top ten objectivesExecutive Committee’s some or all of their net executive directors can invest 22% At present, 66% Down from 75% increase the (SMP). To annual bonus into the Share Matching Plan short-term executive alignment between and long-term reward, at least one-quarterdirectors will be required to invest (one-third for the Chief Operating Officer – US) of their net 2008 annual bonus into the SMP when the bonus is paid in 2009. Further can be investment 12% made on a voluntary of half their basis up to a maximum investment net bonus. Levels: % of bonus been increased have the maximum bonus levels high performance, on-target for achieving but the payout to market median levels performance against the in-year financial targets has been reduced from 50% to 40% of maximum. The table below summarises the bonus structurerevised for the executive directors. and levels Maximum bonus as percentage of salaryIn-year financial performanceEthics and safetyOther objectives UK executive directors Currentsupporting US executive director 75% New 25% Current 83% 15% 112.5% New 150% 37.5% 27% practice, and also takes account of of Group employees. and conditions the and the pay as a whole Company performance of the the individual, Base salary of the account taken having and, review of the above As a result performance and general market trends, competitive positioning, the annual base salaries of executive the Committee has increased directors January with effect from 2008 as follows: Executive directorGeorge Rose Group Finance DirectorIan King – Chief Operating Officer UK/Rest of World £560,000December 2007 31 Havenstein Walt 1 January2008 £592,500 – Chief Operating Officer US increase 1 5.8% Following in post at the beginning of 2007. new Officers The two Chief Operating were £560,000 £592,500Annual bonus Structure: 5.8% increase the focus on long-term performance risk management and further the reinforce (both business risk and reputation risk). To corporate responsibility importance aspects of the Group’s of key a specific part will be based on driving agenda, of the annual bonus $850,000 The structure of safety. performance in ethics and and improvement $900,000the annual bonus for 2008 will be: 5.9% deferral of partinto the Share Matching Plan for all of the bonus executive directors; and more for achieving in package is only delivered the improvement stretching targets. agenda; competitive levels; performance and reward; to ensure that the structure of the package stays in line with market The Committee also reviewed the trends in the elements of remuneration as well as the package as a whole. as the package as well on the competitiveness of the individual elements of the package comparator group companies. This gives the Committee a view comparator group companies. This gives the Committee a view at the median and upper quartile posts in the for the relevant and total reward (total direct reward plus pension) were analysed plus pension) were (total direct reward and total reward total direct reward (total cash reward plus long-term incentives) (total cash reward total direct reward The base salary, total cash reward (base salary total cash reward plus annual bonus), The base salary, for his plc board role. US business, adjusting where necessary adjusting US business, to reflect the extra responsibility appropriate market figures consistent with the size and scale of the US aerospace, defence and general industry defence US aerospace, sector data to produce For the US Chief Operating Officer, regression analysis was used on regression analysis Officer, the US Chief Operating For the value placed on the executives who manage it. better alignment between the value placed on the Company and the value placed on the Company better alignment between (as used last year) to one based on market capitalisation creates believes that the change from a comparator group based on turnover believes to that of BAE Systems (12 larger and 13 smaller). The Committee (excluding financials and retail) with market capitalisation nearest the UK executive directors comprised 25 of the FTSE 50 companies scale of operations and breadth of role. The comparator group for groups for the individual positions, taking account of company size, taking account of company groups for the individual positions, The methodology to construct used was appropriate comparator to comparable companies. to where to position the various elements of the package relative to where to position the various elements was provided by PwC so that the Committee could form as a view by provided was Information positions on the market for comparable management Committee members and senior executives. to date, its strategy years for the next five of the and the views to date, packages against the market but also the Company’s performance Company’s packages against the market but also the The review not only considered the Company’s executive remuneration not only considered the Company’s The review Approach to the review and the specific arrangementsdirectors. for executive The following sections describe the changes made in more detail The following sections describe the changes market practice. consistently across the Group, taking account of seniority and local taking account of seniority consistently across the Group, shareholders. strategy The principles of the remuneration are applied and will continue to consult on material changes with principal and will continue to consult on material changes policy as detailed in this report in 2008 and subsequent years, – increase the gearing to drive for high performance as most of executive remuneration The Committee intends to continue with the – directly align short-term compulsory through and long-term reward – corporate responsibility aspects of the Group’s the key reinforce – remuneration packages into line with market bring the – between the arrangements line-of-sight simplify to improve – long-termsustainable growth in EPS; focus towards shift the improvements to the incentive packages will: to the improvements incentives. The Committee believes that the above changes and that the above believes incentives. The Committee through the focused use of bonus schemes and share-based through the focused use quartile performance quartile with potential upper remuneration performance and experience in role, whilst seeking to reward upper to reward whilst seeking performance experience in role, and to set base salaries at median competitive levels, taking into account taking into competitive levels, salaries at median to set base The Committee’s executive remuneration policy continues to be remuneration policy executive The Committee’s . ); and ). EPS EPS will be made shortly after the May EPS and 100% of salary on PSP and 125% of salary on PSP TSR TSR in the normal cycle, ie shortly after the Company’s annual ie shortlyin the normal cycle, after the Company’s TSR of salary on PSP of salary on PSP The PSP was approved by shareholders in May 2006. At that time 2006. At shareholders in May by approved The PSP was the flexibility for agreed that the Committee should have it was on award to base up to half of any executives below Board level on with the rest based appropriately stretching internal measures, under the PSP the maximum award TSR as at present. In addition, will be Shareholder approval limited to two times base salary. was for executive to base half the PSP award 2008 AGM sought at the May be which will directors on appropriately stretching internal measures, level award and to increase the maximum in 2008, EPS for awards that Whilst it is not envisaged under the PSP to four times base salary. it does allow the Committee the will be necessary, at this level awards flexibility in future should special circumstances arise. Naturally significant changes to the shareholders will be consulted on any levels. normal award It is proposed that executive directors will receive the 2008 award of PSP – 250% of base salary 125% for the US executive director (split 2008 AGM, but with a slightly reduced vesting period (eg two years 2008 AGM, and ten months rather than the normal three years) so that both vest at the same time. awards results. The 2008 award of PSP results. The 2008 award – Share options currentDetails of the out on Option Plan are set Executive Share except in furtherpage 79. No options will be made, grants of share circumstances. exceptional – Plan (PSP) Share Performance of the PSP is contained on page 71. The A detailed explanation than offers that the PSP Committee believes better value for money generally place a higher value on such share options as executives to deliver the shares require fewer and they plans than share options, effect of executive share-based thus reducing the dilutive same value, further the decision not to award of share grants Following reward. of changes to the PSP the Committee has made a number options, shares awarded In line with current corporate governance guidelines, dividends prior to vesting.under the PSP will attract The additional account in assessing into has been taken value of these dividends to be granted. awards value of the overall further increase the proportion driven off long-termTo of the package the current will be based on TSR half the PSP awards EPS growth, with the other half based performance condition and vesting scale, on EPS growth. The EPS performance on annual EPS growth, condition will be based basis increasing on a straight line with no vesting at 5% pa growth, to full vesting at 11% pa growth. share remain competitive and to replace the value of previous To for 2008 will be: levels the award option grants, – 200% of base salary for the UK executive directors 100% (split . – – 8.3% 20.75% 15% 37.5% Base Stretch Base Stretch Base Stretch target target target target target target (continued) ms.com 1 ) to be key indicators of long-term financial performance) to be key and www.baesyste www.baesyste 1

taxation expense

EBITA investors believe EPS and cash targets (and, where appropriate, EPS and cash targets (and, believe investors performance measures, the view was taken that the Company’s major that the Company’s taken was the view performance measures, integrated across all businesses. In determiningintegrated across all the in-year financial ensuring that business plans which support business plans which ensuring that the strategy are which implements corporatewhich implements strategy basis by on a group-wide Integrated Business Plan (IBP), which is agreed by the Board and by which is agreed Business Plan (IBP), Integrated The financial targets, both base and stretch, are derived from the base and stretch, both targets, The financial able to invest a maximum of half their net annual bonus into the SMP a maximum able to invest annual EPS growth of 11% pa. However, executive directors executive will only be annual EPS growth of 11% pa. However, 2008 AGM. be sought at the May scale will be extended on a uniform a 2:1 match for basis to provide will require formal which will shareholder approval be applied in 2009, For 2009 awards in respect of the 2008 annual bonus, the matching in respect of the 2008 annual bonus, 2009 awards For to The increase in match from 1:1 to 2:1 for increased performance, match to a 1:1 match for 8% pa growth. performance period exceeds 5% pa, increasing uniformly from no performance period exceeds 5% pa, shares will vest unless the annual EPS growth over the three-year over shares will vest unless the annual EPS growth in 2008 in respect of the 2007 annual bonus, none of the matching none of the in 2008 in respect of the 2007 annual bonus, detailed explanation of the SMP is contained on page 72. For awards on page 72. For detailed explanation of the SMP is contained directly linking short-term A more with long-term reward. reward The SMP is seen as a key partThe SMP is seen as a key of the long-term incentive package, – Share Matching Plan (SMP) stepped vesting. EPS growth will be used, with a straight line vesting scale to avoid with a straight line vesting scale to EPS growth will be used, is used as a measure in LTIPs, actual (ie nominal) rather than ‘real’ is used as a measure in LTIPs, vesting at 4% pa and full vesting at 5% pa. From 2008, where EPS 2008, From vesting at 4% pa and full vesting at 5% pa. one-third vesting at real annual growth of 3%, jumping to two-thirds one-third vesting at real annual growth of 3%, growth in EPS in excess of UK inflation and have stepped vesting with have growth in EPS in excess of UK inflation and options and the Share Matching Plan for executive directors)options and the Share Matching Plan for executive use real At present, the LTIP arrangements that use EPS growth (ie share the LTIP At present, on an EPS performance half based on TSR. condition with the other performance shares will be increased and half the award will be based performance the award shares will be increased and half secure a new hire in a competitive situation). Instead, the awards of the awards hire in a competitive situation). Instead, secure a new options will be made (except in exceptional circumstances, eg to circumstances, options will be made (except in exceptional executive’s reward and performance, no further of share and performance, awards reward executive’s To simplify the LTIPs and increase the line of sight between the the line of sight between and increase simplify the LTIPs To Long-Term Incentive Plans (LTIPs) Incentive Plans (LTIPs) Long-Term but achievable, are summarised in the table below. are summarised but achievable, executive directors, which the Committee believes are stretching which the Committee believes executive directors, strategy. The annual bonus targets set by the Committee for the the Committee set by The annual bonus targets strategy. that all businesses within the Group are aligned with the overall Group the Group are aligned with the overall that all businesses within the Executive Committee and the senior leadershipthe Executive Committee team to ensure Chairman These then flow down to members and the Committee. of objectives for the executive directors which are agreed by the directorsobjectives for the executive which are agreed by set out on page 11 and used as the basis to set the individual set out on page 11 and each year as those key to delivering the Group’s strategy. These are strategy. delivering the Group’s to each year as those key The Executive Committee top ten objectives are agreed by the Board top ten objectives are agreed by The Executive Committee value creation. 68 1 earnings before amortisation finance costs and and impairment of intangible assets, If performance is between the base and stretch targets, the bonus is pro-rated on a straight line basis the base and stretch targets, If performance is between Other objectives supporting the Group’s strategyOther objectives supporting the Group’s Up to 27% 27% Up to Up to 48% Business cashEthics and safety – 15% Up to – Up to 15% 8.3% 20.75% Up to 27% 15% 37.5% Group cashBusiness EBITA 16.6% 41.5% 8.3% 20.75% 15% 37.5% Measure Group EPS 16.6% 41.5% 8.3% 20.75% 15% 37.5% Annual bonus as a percentage of base salary 2008 for George Rose Ian King Havenstein Walt Remuneration reportRemuneration Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 69 :1 – 1:1 0 – 2:1 3 / 1 BAE Systems Annual Report 2007 Proportion package of overall 282%298% 366% 400% all at 11% all at 11% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Stretch Stretch On-Target On-Target

Performance Performance Performance Performance

Base salary Pension Cash bonus Deferred bonus SMP PSP directors director

UK executive directors US executive director UK executive executive UK Proportionfixed of package value delivered through reward and performance-related executive US Pension provision provision Pension to in the UK in response changes made recently the Following and in the (as reported legislation pensions simplification last year), executives to ten period for existing averaging the pay US to increase no further arrangements 2015, changes to the pension years for by executive directors are required. Fixed reward and performance-related the package (two-thirds more than half At on-target performance, rising to over is performancefor the US executive director) related, three-quarters 85% for the for the UK executive directors and over performance.US director at stretch This is shown in the chart below. Current New Current New :1 – 1:1 0 – 2:1 3 / 1 of 3% – 8% of 5% – 11% of 3% – 8% of 5% – 11% All at top 20% All at top 20% All at top 20% All at top 20% , the table below summarises , Proportion of incentive package 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Stretch Stretch On-Target On-Target

Performance Performance Performance Performance

directors director In-year measures Long-term EPS Relative TSR price Share

UK executive executive UK Performance drivers of incentive package Performance executive US 2009 20072008 258% 293% Award (% of salary)Award EPS growth target (% pa) – – Nil at 5%, 100% – – 5%, Nil at 125% Award (% of salary)Award (% of salary)Award TSR vesting 150% 100% ¼ at median, ¼ at median, – 100% ¼ at median, ¼ at median, 150% 100% 125% – Match On-targetMaximum 54% 100% 125% 61% 150% 81% 225% 110% EPS growth target (% pa) Real growth Actual growth Real growth Actual growth reward as a percentage of salaryreward Expected value of total direct influence on the incentive package. influence on the incentive The charts drivers of performance their and below show the key incentive package delivered in both 2008 and 2009 are shown. incentive package delivered match will not be introduced until 2009, the expected values of the until 2009, match will not be introduced will not feed into the SMP until 2009, and the extension of the SMP SMP until 2009, will not feed into the changes. As the improvements in the annual bonus levels for 2008 in the annual bonus levels changes. As the improvements (base salary plus bonus plus long-term before and after the incentives) the proposals and compares ‘expected’ value of the total direct reward ‘expected’ value of the total direct the proposals and compares invest half their net bonus into the SMP invest LTIPs in the Company’s accounts, and assuming executive directors and assuming executive accounts, in the Company’s LTIPs assumptions consistent with those underlying consistent with those assumptions value placed on the mindful of the impact on the overall value of the package. Using value of the package. the impact on the overall mindful of In making the above changes to the package, the Company has been the Company to the package, changes above In making the Total value of incentives Total

Annual bonus Total value of incentives as a percentage of salary Total PSP grant on EPS Share option grant PSP grant on TSR Share Matching Plan 07 06 05 04 03 BAE SystemsFTSE 100 Aerospace & defence comparator group comparator group review UK executive director pay Value at 31 December 2007 of £100 investment at 31 December Value £500 £375 £250 £125 £0 The graph above shows the value shareholders have achieved by their investment their investment by achieved shows the value shareholdersThe graph above have recent yearsin BAE Systems over as compared to (i) the FTSE 100 Index; (ii) the Share the BAE Systems Performance the sectoral peer group for companies forming the 2007 executive the comparator group for Plan; and (iii) the companies forming Systems and the comparators BAE at the The graph depicts the value for review. pay last made at the beginning of each of the end of 2007 of a single £100 investment five years. In tandem with the Share Award, he was granted a conditional cash award granted a conditional he was the Share Award, In tandem with and to the same performance This will be subject of £1,181,250. targets, out above. as set basis, be released on the same will vest and were the most awards these satisfied that was The Committee relation to his remaining in Turner for Mike appropriate incentive period of service with the Company’s and these targets are consistent strategy objectives in order to of giving emphasis to non-financial foster a performance within the Company. culture retention Turner’s a special arrangement to facilitate Mike As this was under the not required was shareholder approval and incentivisation, this arrangement benefits under will not be Listing Rules. Any pensionable. in 2007 Performance set out in last The structure Plan was of the 2007 Annual Bonus Remuneration report. year’s building on the excellent another very2007 was successful year, 2005 and 2006. Apartperformances from the Australian in 2004, their stretch all the major business groupings achieved business, within all the financial targets targets on profit and cash. As a result, met at the directorsthe 2007 Annual Bonus Plan for executive were bonus linked apartstretch level from that part of Chris Geoghegan’s to the profit performance In addition, of his group of businesses. non-financial made against most of the key excellent progress was bonus payments accordingly, objectives as set out on page 26 and, range from 83.9% F on page 82, which are set out in Table for 2007, directorsto 97% of the maximum bonus for the executive who served throughout 2007. the three years the real growth in EPS over to 2007 In addition, of share options granted in exceeded 5% pa so that the awards 2005 vest in full. made of shares total shareholder return for awards The Company’s Share Plan exceeded the upper in March 2005 under the Performance comparator group of 18 quintile position when compared against the The Committee has other defence and aerospace companies. in the improvement satisfied itself that there has been a sustainable underlying the three-year performance performance of the Group over in full. has vested period and so this award Base Stretch 31 Dec 07 31 Dec 06 (continued) 31 Dec 05 31 Dec 04 ms.com 31 Dec 03 31 Dec 02 www.baesyste www.baesyste

BAE Systems FTSE 100

Value at 31 December 2007 of £100 investment 2007 of £100 investment at 31 December Value at 31 December 2002 £200 £100 £300 £400 £500 70 The FTSE this purpose as it is a 100 is considered to be an appropriate comparator for broad equity market index. As BAE Systems is a constituent member of the FTSE 100, deemed to be the most appropriate general UK equity index. it was This graph, which has been produced in accordance with the requirements of This graph, Schedule 31 shows the value by 7A to the Companies Act 1985, on December 2007, in BAE of £100 invested a total shareholder return basis, Systems on 31 December in the FTSE2002 compared with the value of £100 invested 100 Index. The other points plotted are the values at intervening financial year ends. of existing ordinary shares from the Company’s employee trust. employee of existing ordinary from the Company’s shares his retirement. The Share Award will be satisfied by way of a transfer way by will be satisfied his retirement. The Share Award vest will be released in two equal tranches over the year following over vest will be released in two equal tranches succession to the Chief Executive role. Any ordinarysuccession to the Chief Executive role. Any shares which handover of key external relationships; and facilitating an orderly of key handover of leadership objectives set by the Committee; achieving an orderly the Committee; achieving of leadership objectives set by implementation of the Company’s business strategy; satisfaction implementation of the Company’s August 2008. These targets relate to: continuing the successful August 2008. These targets relate to: continuing performance targets, which the Committee will assess as at 31 performance targets, The Share Award will vest subject to the satisfaction of certainThe Share Award the three business days ending 15 October 2007. the three business days by 510p, being the market value of an ordinary over 510p, share averaged by £1,181,250 (being 1.25 times his base salary at that time) divided number of ordinary shares under the Share Award was calculated as number of ordinary was under the Share Award shares conditional award over 231,618 ordinary 231,618 The over shares (‘Share Award’). conditional award On 16 October 2007, Mike Turner was granted a performance-related was Turner Mike On 16 October 2007, as announced to shareholders 2007. on 16 October a tailored incentive arrangement prior to his retirement for the period for the 2008 financial year. Instead, the Committee has implemented Instead, for the 2008 financial year. He will not be eligible to participate Share Plan in the Performance any of his 2008 annual bonus. of his any bonus into the Share Matching Plan but will not be eligible to invest bonus into the Share Matching Plan but will He will be eligible to invest up to one-third of his 2007 net annual He will be eligible to invest Other objectives supporting the Group’s strategyOther objectives supporting the Group’s bonus is pro-rated. the the base and stretch targets, If performance is between to 32% Up unchanged at 150% of base salary, and with the following targets: and with the following base salary, unchanged at 150% of Group cashEthics and safety 18% Up to 20% 50% to participate in an annual bonus plan for 2008, with a maximum bonus with a maximum to participate in an annual bonus plan for 2008, MeasureGroup EPS 20% target 50% target annual base salary He will be eligible from £945,000 to £1,000,000. of base salaryAnnual bonus as percentage Turner Mike of his performance competitive positioning. and the This increases his agreed a 5.8% salaryagreed a 5.8% account 1 January taking increase from 2008, Chief Executive, will retire at the end of August 2008. The Committee the end of August 2008. will retire at Chief Executive, On 16 October 2007, the Company announced that Mike Turner, the Turner, announced that Mike the Company 2007, On 16 October Arrangements for the Chief Executive the Chief Arrangements for Remuneration reportRemuneration Directors’ report – Corporategovernance

100 75 50 25 0

TSR (TSR) Return

award vesting award

(i) price growth plus dividends) ranking TSR (share the Company’s and (ii) Shareholder Total of % of TSRs achieved by the sectoral comparator group and the sectoral comparator by of TSRs achieved 20%) as set 100% vesting if it is in the top quintile (ie top out below: as an indication of both earningsinvestors and capital growth relative to other major companies in the same sector and to only vest if there has been a clear improvement ensure that awards period. the relevant performance over in the Company’s summarises the position for all outstanding The graph above under the PSP as at 31 December 2007. The coloured box awards shows the range of TSR required for 25% vesting to full vesting, and the square shows BAE Systems' TSR. % of total total of % Performance of outstanding PSP awards Performance – Proportion capable of exercise determined by: of the award PSP BoeingCobhamDassault AviationEADSEmbraer PNFinmeccanica Goodrich– TSR is outside the top 50% Dynamics General nil vesting if the Company’s GKN Lockheed Martin Northrop Grumman Raytheon International Honeywell Rolls-Royce Smiths Group United Technologies Thales Collins Rockwell – Rationale for performance measures: importance to major Performance Condition – PSP Performance year five made prior to 2008 the end of available at available The final third available at the at available end of year four The second third 9 end of year three One-third available immediately at the 8 Year 3Year 4 Year 5 Year 6 Year 7 Year award. award. TSR with shares 6 7 10 11 paid in (amount varying in achieved) PSP award accordance performance ) and the other half on an Earnings) and the other half on TSR EPS 45 Annual actual EPS growth (%) comparator )* performance and condition; 2 EPS Year 1Year 2 Year 3 Year 50% of award 50% of award based on actual financial measure over the three-year the over group of companies over the three-year the over annual EPS growth performance period, performance performance period performance a sectoral TSR growth relative to subject to a secondary 50% of award based on 50% of award 13 award for executive directors at the May shareholder approval is subject to award EPS 0

100 75 50 25 0 award vesting award

2008 AGM and, subject to that approval, will have a slightly shorter will have vesting period so subject to that approval, and, 2008 AGM that it vests at the same time as the 2008 PSP per Share (PSP total of % shares vesting paid out in three equal tranches on vesting at the shares vesting paid out in three equal tranches four and five. end of years three, EPS to be a key indicator of long-term financial performance and EPS to be a key value creation. rate of annual actual EPS growth over the three-year performance rate of annual actual EPS growth over at annual actual EPS growth of 5% or less with nil vesting period, and 100% vesting at 11% growth as set out below: performance condition (PSP PSP Award How the PSP operates Plan provisions Plan provisions in 2008 are Share Plan and the Share Matching Plan Performance to be made under the of awards conditions for grants Performance conditions for grants of awards Performance detailed below. –of period for performance length condition: three years* with any – Rationale for performance consider measure: major investors – attract dividends prior to vesting. Shares under award Condition – PSP Performance – the Proportion capable of exercise: determined by of the award * The PSP Performance Share Plan (PSP) Performance in 2008: features for PSP awards Key – Shareholder Return will be based on a Total PSP award half the Summary of long-term incentive plans For the US executives, the awards are automatically delivered at the end of years three, the awards the US executives, For subject to the performance condition achieved. four and five, 11 8 5 Annual EPS growth % 0

0 2:1 1:1 Match Performance condition: SMP 2009 Performance 11 8 5 Annual EPS growth % 0 bonus; and increasing EPS growth, match at 8% pa actual from a 1:1 uniformly at 11% pa growth*. to a 2:1 match 0

2:1 1:1

– of the net annual will be 50% investment of level maximum – match and performance will be extended condition: the match Match EPS to be a key indicator of long-term indicator of financial performance and EPS to be a key value creation. Performance condition: SMP 2008 Performance changes in remuneration policy as set out above, the Company intends the Company above, changes in remuneration policy as set out under the shares to satisfy future share awards issue to use new executive long-term annual dilution limit. incentive plans within the 0.5% policy shareholding Personal all executive directors are The Committee has agreed a policy whereby personalrequired to establish and maintain a minimum shareholding a holding equal to 100% As a minimum, equal to 200% of base salary. of base salary as quickly as possible using shares must be achieved share option vesting or options exercised through the executive using 50% of the shares by schemes or long-term incentive schemes, exercised on each occasion. that vest or 50% of the options which are executive directors are required to increase their personal Thereafter, on each occasion using 25% of the shares shareholding gradually, until a personal each year, that vest or 25% of the options exercised salaryshareholding equal to 200% of annual base and is achieved A similar periodically. maintained. These limits are reviewed arrangement for share-based applies to senior executives eligible made long-term of awards levels incentives with limits aligned to the under these plans. A Details of the directors’ personal shareholdings are shown in Table on page 76. benefits Post-retirement UK pension benefits As a result of the age discrimination legislation introduced in 2006, will UK executive directors’ default retirement age will be 65 but they their pensions and draw had to retire rights they previous retain any at an earlierwithout actuarial reduction for early age. payment a number of in 2005, with employees the consultations Following the pension schemes in respect of benefits made to changes were accruing from 6 April 2006 as a means of funding the deficits disclosed in the schemes. These changes applied to executive and included the as to other employees directors in the same way a reduction in the Adjustment Factor, introduction of the Longevity of pension increases and a change in the definition maximum level Pay. of Pensionable The UK-based executive directors with the exception of Ian King (see Scheme (the Main below) are members of the BAE Systems Pension Scheme (the ExPS). Scheme) and the BAE Systems Executive Pension for The ExPS tops up the benefits from the Main Scheme and, is designed to produce a target pension payable executive directors, (FPP) if potential from age 60 of two-thirds of Final Pay Pensionable service is 20 or more years. FPP is defined as base salaryaveraged service the last 12 months prior to leaving over in respect of service * 2008 AGM at the May to shareholder approval the increase in the match in 2009 is subject – for performance rationale consider measure: major investors 2007 (continued) ms.com www.baesyste www.baesyste quarterbonus into the SMP and the US-based of their 2008 net executive director one-third; (Investment Shares) by deferring part Shares) by (Investment or all of their 2007 the SMP; and net annual bonus into increasing uniformly to a 1:1 match growth of 5% pa or less, for 8% pa growth.

– one the UK-based executive directors are required to invest – to acquire shares directors the executive will be invited –and performance match EPS condition: nil match for actual period, released on vesting of any Matching Shares. Matching Shares. released on vesting of any period, against the gross value of the bonus invested; and of the bonus invested; against the gross value to the bonus awarded under the Annual Bonus Plan; under the Annual Bonus awarded to the bonus

– 2009 awards: – 2008 awards: – deferral Shares attract dividends during the three-year Matching – participants of Matching Shares award are granted a conditional Share Matching Plan (SMP) Share Matching in 2008 and 2009: grants of awards features for Key – linked investment plan with the investment stand-alone share of those schemes. employee share schemes based on the limits set out in the rulesemployee below sets out the available dilution capacity for the Company’s dilution capacity for the below sets out the available grant of share options under all employee share schemes. The table grant of share options under all employee issued share capital will be used in any one financial year for the one financial issued share capital will be used in any 72 shares, shares representing no more than 1% of the Company’s shares representing shares, The Committee has agreed that, in respect of new issue or treasury in respect of new The Committee has agreed that, 2007 totalled 6,160,572 (0.17% of the total shares in issue). With the Dilution of share capital 3,574,509,017 and the number of shares granted under option during for UK-based employees are reinvested as Dividend Shares. are reinvested for UK-based employees The number of ordinary shares in issue at 31 December 2007 was Dividends paid in respect of the shares in the Share Incentive Plan Executive schemes: consecutive 10 years5% in any Remaining headroom 178.7m 111.7m Partnershipof £63 per month. Share up to a maximum Remaining headroom 245.0m £30. From August 2007, one free matching share is awarded for each one free matching share is awarded August 2007, £30. From All schemes: consecutive 10 years10% in any 357.4m employee, up to a maximum monthly Partnership of Share investment employee, issued share capital as at 31 December 2007 Total 3,574m Share was awarded for every two Partnership awarded the Share was Shares purchased by accordance with legislation. Prior to August 2007, one free Matching one free 2007, accordance with legislation. Prior to August the Matching Shares are not subject to performance conditions in Shares attract Matching Shares. As the plan is an all-employee plan, is an all-employee Shares attract Matching Shares. As the plan in a tax year, both limited to 10% of salary if less. The Partnership in a tax year, £125 a month, or lump sum investments of between £10 and £1,500 of between or lump sum investments £125 a month, BAE £10 and of between either monthly investments Systems by (including executive directors) may purchase ordinary(including executive directors) may shares in Option Scheme in 2005. Under this arrangement, UK-based employees Option Scheme in 2005. Under this arrangement, Shares) under the Share Incentive Plan which replaced the SAYE Share replaced the SAYE Shares) under the Share Incentive Plan which The Company operates a share purchase arrangement (PartnershipThe Company a cash or shares basis depending on local tax and security laws. tax and security laws. a cash or shares basis depending on local worth on £436. A similar arrangement operates for non-UK employees (including the UK executive directors) to receive shares will be entitled a result of the Company’s performance in 2007, all eligible employees performance in 2007, a result of the Company’s the all-employee free shares element of the Share Incentive Plan. As free shares element of the all-employee During 2007 the UK executive directors were eligible to participateDuring 2007 the UK executive directors were in Share Incentive Plan (SIP) Remuneration reportRemuneration Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 73 either party either party BAE Systems Annual Report 2007 (amended: the Company, Date of contract Unexpired term period Notice 15 January 2004 the individual 3 December 1999 6 months from and 17 October 2005) In the event of the termination of an executive director’s contract of the terminationIn the event of an executive director’s made in payment policy to seek to limit any it is the Committee’s base one year’s equal to the amount of lieu of notice to a payment The servicesalary. contracts for all of the executive directors contain and has the right, to the effect that the Company specific provisions a sum to pay generally has the obligation, case, Havenstein’s in Walt Walt HavensteinWalt 1 December 2006 3 months 3 months schemes. This was designed so that the total pension from all sources the total pension designed so that was schemes. This from received pension he would have in line with the would be broadly to the earnings he not been subject pension schemes had the Group to the flexibility allowed tax changes Simplification cap. The Pension the earningscap for George Rose in respect of serviceremove from will remain to be provided although some of his benefits April 2006, No further means of an unfunded promise from the Company. by top up paid into his funded unapproved contributions will be arrangement. Further the Company information by on the amounts paid G in respect of these arrangements is included in the notes to Table on page 83. US pension benefits the BAE Systems Employees’ is a member of Havenstein Walt year a pension from age 60 for each provides Retirement Plan which up to of pensionable service (FAP) of 1.25% on his Final Pay Average 1.5% on Compensation (circa $70,000) plus Social Security Covered is Compensation. FAP in excess of Social Security Covered his FAP of base salarycurrently the highest three-year average plus bonus one year each year beginning period will increase by but the averaging in 2015. Directors pay in 2009 and reaching a ten-year average in the plan. The contributions at the same rates as other employees increases. pension or pension pension does not carry spouse’s any also receives a 50% match on his contributions Havenstein Walt of 8% of earnings.to his 401(k) plan up to a maximum contribution of the executive directorsDetails of post-retirement benefits for each and are G on page 83 who served shown in Table during 2007 are of Schedule 7A of the calculated in accordance with the requirements Companies Act 1985. Other benefits directors to the executive include a car Other benefits provided of a chauffeur and private use the taxable benefit of any allowance, for medical examination. a cash allowance in post in 2007. were new The two Chief Operating Officers (COOs) requirement for the COO – US role to be based in the of the In view package includes relocation Havenstein’s Walt DC area, Washington As the standard US policy. expenses in line with the Company’s is now required to spend increasing amounts COO – UK/Rest of World to provide the Committee has also agreed of time in central London, Ian King with a second home allowance. Executive directors’ service contracts policy that executive directors should normally It is the Committee’s service to give the have for the Company contracts that provide individual 12 months’ notice of termination. This policy has been the need a reasonable balance between chosen because it provides to retain the services and the need to limit the individuals of key of the termination in the event of a contract. liabilities of the Company serviceThe executive directors have contracts with Group companies and details of these are as follows: Ian KingGeorge Rose 1998 16 November 31 January 2007 12 months months 12 12 months from 12 months being provided directly from the Company as an unfunded promise. directly from the Company being provided benefits can be either taken unfunded Company the At retirement, as pension or can be commuted in full for a taxable lump sum. benefits 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 qualified) pension arrangement to top up his benefits from the approved earnings cap on approved pensions and has an unapproved (ie non-tax earnings pensions and has an unapproved cap on approved George Rose was affected by the previously applicable Inland Revenue the previously by affected George Rose was return for a Company unfunded promise. return for a Company and Steve Mogford elected to have their scheme benefits restricted in Mogford elected to have and Steve 2006 in return for a cash supplement of 30% of base salary. Ian King 2006 in return for a cash supplement of 30% of base salary. Chris Geoghegan elected to opt out of the pension schemes in April independent financial advice paid for by the Company. Mike Turner and Mike by the Company. independent financial advice paid for to be affected by the LTA before April 2009 were provided with provided before April 2009 were the LTA to be affected by UK executives, including the UK executive directors, affected or likely the UK executive directors, including UK executives, in taxation. with market practice and do not compensate executives for changes needs whilst being broadly cost neutral to the Company, are in line needs whilst being broadly cost neutral to the Company, as they provide executives with choices which may better suit their executives with choices which may provide as they of developing market practice and believes they remain appropriate they market practice and believes of developing The Committee reviewed these arrangements in the light in 2007 The Committee reviewed – with the remainder LTA the value of the restrict scheme benefits to – opt out of the pension scheme (and so earn no further pension – additional tax charge; or any remain in the pension scheme and pay number of choices as previously reported.number of choices as previously These are: UK executives reaching the Lifetime Allowance (LTA) are given a (LTA) UK executives reaching the Lifetime Allowance Simplification tax changes which came into effect from April 2006, effect from April 2006, Simplification tax changes which came into Following the changes made to take account of the Pensions the changes made to take Following benefits plus the top up from the ExPS. Therefore Ian King’s total pension is the sum of his 2000 Plan Therefore Ian King’s only, averaged over 12 months and 36 months as described above. 12 months and 36 months as described over averaged only, the purposes of this top up is calculated by reference to base salarythe purposes of this top up is calculated by service (subject to a maximum of two-thirds). Final Pensionable Pay for service of two-thirds). Final Pay (subject to a maximum Pensionable of 1/30th of Final Pensionable Pay for each year of ExPS pensionable of 1/30th of Final Pay Pensionable 2000 Plan benefits to provide a target benefit payable from age 62 payable benefit a target 2000 Plan benefits to provide ExPS in 1999 following the BAe/MES merger. The ExPS tops up the ExPS in 1999 following the BAe/MES merger. benefit of contributions paid on past bonuses. Ian King joined the benefit of contributions paid on past bonuses. figure at 5 April 2007 to ensure that employees do not lose the figure at 5 April 2007 to ensure that employees benefits service6 April 2007 will not be less than the FPE prior to thereafter. However, there is a guarantee that the FPE figure for there is a guarantee However, thereafter. salary and to 10% of base salary for the 2007/08 Plan Year and salary salary and to 10% of base for the 2007/08 Plan Year bonuses in the 2000 Plan in the 2006/07 Plan Year to 20% of base Plan Year bonuses in the 2000 Plan in the 2006/07 State pensions. The Company decided in 2006 to limit pensionable State pensions. The Company and bonus in the ten Plan Years prior to leaving, less an offset for prior to leaving, and bonus in the ten Plan Years FPE under the 2000 Plan is the best three-year average of base salary average FPE under the 2000 Plan is the best three-year of pensionable service, payable from a normal retirement age of 65. of pensionable service, payable a pension of 1/50th of Final Earningsa pension of 1/50th year (FPE) for each Pensionable Systems (MES), and a member of the ExPS. The 2000 Plan provides ExPS. The 2000 Plan provides and a member of the Systems (MES), 2000 Plan), applicable to former employees of Marconi Electronic applicable to former employees 2000 Plan), Ian King is a member of the BAE Systems 2000 Pension Plan (the of the BAE Systems 2000 Pension Ian King is a member rate as all other employees participatingrate as all other employees schemes. in service same contributions at the from 6 April 2006. Directors pay respect of pre 6 April 2006 servicerespect of pre 6 April year in respect of and 2.5% per Retail Prices Index subject to a maximum increase of 5% per year in to a maximum increase of 5% per year Retail Prices Index subject deferred pension. Pensions are increased annually by the rise in the the annually by are increased deferred pension. Pensions retirement and death after leaving the Company’s employment with a employment the Company’s after leaving retirement and death pensions and children’s allowances are also payable upon death in are also payable allowances pensions and children’s allowances are also payable, usually up to the age of 18. Spouses’ usually up to the age are also payable, allowances of the prospective pension at normalof the prospective pension retirement age. Children’s of death, and a spouse’s death-in-service equal to two-thirds pension and a spouse’s of death, sum death-in-serviceto four times base salary benefit equal at date of service a lump schemes also provide 6 April 2006. These from accrued to 5 April 2006 and 36 months prior to leaving in respect in accrued36 months prior to leaving to 5 April 2006 and The Committee was satisfied that these arrangements were these arrangements satisfied that was The Committee remains Turner for the purposeappropriate that Mike of ensuring incentivised in relation and fully to the Company fully committed and EPS performanceto share price of these until the vesting date that these The Committee also considered options and awards. described on page 70, and the special incentive arrangements, incentive structure Turner’s constituted an optimal for Mike remaining period of service. Other executive directors had a 2007, who retired as a director on 9 May Mogford, Steve service 15 January contract dated 6 April 2000 (as amended 2004 and 28 who retired as a director 2005). Chris Geoghegan, October on 31 had a service 2002 2007, contract dated 10 July December (as amended 15 January the 2005). On leaving 2004 and 13 October of 12 months’ base salary to a payment entitled both were Company, their rights out in their contracts. Both waived in lieu of notice as set in return same amounts being paid into the for the to these payments equivalent payments Scheme (ExPS) and matched by Executive Pension by were augmented Their pension benefits from the Company. in accordance with the purchasing additional benefits under the ExPS normal factors. augmentation Further in details are provided scheme’s G on page 83. Table external on board appointments Policy directorsThe long-standing policy of allowing executive to hold external non-BAE non-executive directorships Systems related with the prior The Committee considers of the Committee will continue. approval senior executives that external directorships the Company’s provide to BAEwith valuable experience that is of benefit Systems. It is also considered appropriate for BAE Systems to contribute to the pool of non-executive expertise for the benefit of the wider business available benefit that it in turn reciprocating the has thereby community, permitted membersreceived from other organisations which have of their senior management teams to serve on the BAE Systems that it is reasonable for the individual Board. The Committee believes fees received from such appointments executive director to retain any given the additional personal this entails. Such fees responsibility that the executive directors in 2007 for the period in which they retained by served on the BAE as follows: Chris Geoghegan Systems Board were Mogford £14,027; George Rose £14,542; Ian King £27,000; Steve £38,722 plus grants of Deferred Stock Turner £79,000; and Mike Units to the value of £49,460. (continued) , the performance conditions , ms.com www.baesyste www.baesyste

preserved, and may be exercised in full within 12 months after his preserved, and may performance condition in relation to those options retirement. Any waived; that remains to be satisfied will be 2005 and earlier be exercised years) will be preserved, and may within six months of retirement; Turner’s the performance conditions will be tested (at Mike 2007), election) either at retirement or at the end of the normal three-year will vest to the extent that the performance periods. Such awards be exercised and may been satisfied, performance conditions have within six months. The number of shares which vest will not be time prorated to reflect his actual service during the applicable three-year periods; and matching 2006 annual bonus) and any Turner’s (in respect of Mike up to one-third of granted in 2008 should he elect to invest award his 2007 annual bonus into the SMP will be tested at his election either at retirement or at the end of the will vest to the normal three-year performance periods. The awards been satisfied and will extent that the performance conditions have shares will be released investment not be time prorated. His linked at the same time the matching shares vest. – granted in awards vested (that is, already that have PSP awards – granted in 2006 and awards (that is, PSP awards for unvested – SMP granted in 2007 under the matching award for the unvested – unexercised options under the Executive Share Option Plan will be follows on retirement: relevant plans, his existing options and awards will be treated as and awards his existing options plans, relevant In accordance with the termination and the rules agreement of the described on page 70. 2007, has been granted a performance-related conditional award as has been granted a performance-related conditional award 2007, Performance Share Plan for 2008 but, as announced on 16 October Share Plan for 2008 but, Performance Mike Turner will not be entitled to participate will not in the Company’s Turner Mike Service to 6 April 2006 and Final Pensionable Pay at retirement. Service Final Pay to 6 April 2006 and Pensionable with the rules of the relevant plans by reference to his Pensionable with the rules plans by relevant of the of salary. His pension on retirement will be calculated in accordance of salary. with effect from that date in return supplement of 30% for a cash 6 opted out of further accrual of pension Turner Mike April 2006, As a result of the pension tax changes which came into force on As a result of the pension tax changes which payment due in respect of his 2008 annual bonus. due in respect of his payment of his 12-month notice period to 16 October 2008, together with any period to 16 October 2008, of his 12-month notice of his contractual and statutoryof his contractual and to the unserved rights relating portion become entitled to a termination payment of £236,884 in respect terminationbecome entitled to a payment of August 2008. Under a termination agreement, he will at that time a terminationof August 2008. Under agreement, 16 end would be stepping down at the Turner 2007 that Mike October 15 January on announced 2005). It was 2004 and 14 October 1994 (amended 30 May 1995, 3 December 1999, 8 May 2002, 8 May 3 December 1999, 1995, 1994 (amended 30 May Mike Turner is employed under a service is employed contract dated 22 February Turner Mike Retirement arrangements for Mike Turner Mike Retirement arrangements for letters of appointment). does the Chairman non-executive directors nor the in their respective contract that relate to a change of control of the Company (and neither a change of control of the Company contract that relate to misconduct. No executive director has provisions in his service has provisions No executive director misconduct. Company terminating other than gross contracts for reasons their Company medical benefits in Walt Havenstein’s case) in the event of the case) in the Walt Havenstein’s in medical benefits equivalent to 12 months’ salaryequivalent 18 months’ the continuation of (plus

74 Remuneration reportRemuneration Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 75 BAE Systems Annual Report 2007 of no more than three years in accordance with the Company’s Articles of Association. of no more than three years in accordance with the Company’s European-based non-executive directors attending meetings in the US and US-based non-executive directors attending meetings in Europe. Non-executive directors’ appointment, term directors’Non-executive appointment, and fees Non-executive directorChairman Audit CommitteeSenior Independent DirectorChairman Remuneration CommitteeChairman Corporate Responsibility CommitteeOther non-executive directors £72,500 £78,000 * £4,000 per meeting is paid to of a transatlantic meeting allowance In addition, £72,500 £78,000 £77,500 £83,000 £72,500 £78,000 2007 fee* £57,500 £63,000 2008 fee* By order of the Board Dick Olver Chairman 20 February 2008 The non-executive directors do not have serviceThe non-executive directors do not have but do contracts letters the basis of their appointment. of appointment detailing have as follows: appointment were The dates of their original Non-executive directorPhil CarrollMichael Hartnall Date of appointmentAndy Inglis MasonSir Peter Roberto QuartaSir Nigel Rudd 10.06.2003 Expiry of current term* WeinbergPeter 07.09.2005* 22.01.2003 following their appointment and subsequently at intervals Subject to re-election at the AGM 13.06.2007 07.09.2005The non-executive directors are normally for two consecutive appointed after the end of the firstthree-year terms three-year subject to review 10.09.2006 09.06.2009 16.06.2005 third term of three yearsperiod and with any being subject to rigorous 06.09.2008 and taking into account the need progressively to refresh the review has no of notice and the Company periods do not have Board. They 21.01.2009 12.06.2010 compensation when their appointment terminates. They obligation to pay 06.09.2008 their appointment and following are subject to re-election at the AGM subsequently at intervals 09.09.2009 of no more than three years. Sue Birley retired 15.06.2008 2007 at the conclusion of the 2007 AGM, from the Board on 9 May 2000, been appointed to the Board on 22 November originally having and Ulrich Cartellieri from the Board on 26 September 2007, retired been appointed to the Board on 1 December 1999. originally having The letters of appointment for non-executive directors detail the will need to devote amount of time it is anticipated that the individual Non-executive directors are proposed to his or her duties as a director. the Board on the Nominations Committee and are appointed by by independent judgement on the basis of their experience to provide resources and standards of conduct. performance, issues of strategy, Non-Executive Directors’ the Fees their fees is set by of The level required of the director Committee to reflect the time commitment fee practice in other comparable companies. The and after reviewing and Corporate Responsibility, chairmen for the level of the Audit, Director, and for the Senior Independent Remuneration Committees, reflects their additional responsibilities and workload. Chairman’s appointment, term and fees appointment, Chairman’s review during the three-year term. review been set by the Committee at £600,000 per annum, will not be subject to the Committee at £600,000 per annum, been set by director of the Company. His fee for the second three-year term, which has fee for the second three-year term, His director of the Company. appointment as Chairman will automatically terminate if he ceases to be a to devote no fewer than two days a week to his duties as Chairman. His a week days than two no fewer to devote appointment which is not a contract of employment and he is required and he is required a contract of employment appointment which is not prior written notice. His appointment is documented in a letter of prior written notice. His Association, or by either party either or by not less than six months’ giving the other Association, unless terminated earlier in accordance with the Company’s Articles of unless terminated earlier Company’s in accordance with the Independent Director), for a second term 2010 three years of to 16 May Independent Director), Nominations Committee (as chaired by Sir Peter Mason, the Senior Mason, Sir Peter (as chaired by Nominations Committee and was extended by the Board in 2007, on the recommendation of the on the in 2007, the Board extended by and was (the date that he was appointed to the Board as a non-executive director) appointed to the Board as (the date that he was was for an initial fixed three-year term with effect from 17 May 2004 for an initial fixed three-year termfrom 17 May with effect was Dick Olver was appointed Chairman His appointment on 1 July 2004. Dick Olver was hares t directors of Ian King and of Ian King 109 respectively. ons for those Share Performance Share Performance Executive Share Option Plan. As at 1 January 2007* As at 31 December 2007 ––––– ––––– ––––– ––––– ––––– –––––– –––––– –––––– –––––– –––––– shares Options Plan Share Plan Share Plan Award shares Options Share Plan Plan Share Plan Award Ordinary Restricted Matching Performance Share Ordinary Restricted Matching Performance Share 20,000 25,283 40,000 11,400 12,000 72,328 327,640 10,249 18,947 303,607 – 37,484 466,586 10,249 – 278,788 – 560,867 1,500,021 37,950 109,529 1,291,048 231,618 538,032 768,769 18,975 – 675,994 – 317,897 1,270,250 37,950 46,410 552,675 – 199,304 1,362,269 22,770 – 681,305 – 143,150 1,411,363 42,764164,002 1,186,815 75,627 – 722,231 – 638,707 – – (continued) ms.com ms.com 3 3 2 2 1 1 4 4 5 5 www.baesyste www.baesyste www.baesyste

7676 4 appointed as a director on 13 June 2007 5 appointed as a director on 1 January 2007 * or upon appointment 1 the ordinary 3,000 American Depositary Phil Carroll are represented by shares held by Shares 2 retired as a director on 31 December 2007 3 include Stock Appreciation Rights under the Havenstein appointed as a director on 2 January 2007. The option figures for Walt M J Turner P A Weinberg Sir Nigel Rudd R Quarta G W Rose Sir Peter Mason Sir Peter R L Olver I G King W P Havenstein A G Inglis C V Geoghegan M J Hartnall P J Carroll P A Weinberg – – – – – – M J Turner 435,880 2,446,712 137,924 – 1,363,562 – G W RoseSir Nigel Rudd 354,950 1,660,221 – 33,971 – – 803,817 – – – – – R L Olver R Quarta 40,000 – – – – – – – – – – – Sir Peter Mason Sir Peter 25,283 – – – – – A G Inglis I G King M J HartnallW P Havenstein 20,000 – – – – – P J Carroll C V Geoghegan Directors’ interests The table below gives details of the interests in ordinary gives details of The table below directors their connected pers and plc held by in BAE Systems shares Table A Table Remuneration reportRemuneration Directors’ report – Corporategovernance individuals who were directors of the Company as at 31 December 2007. There have been no changes in the interests of the curren in the interests been no changes 2007. There have as at 31 December directors of the Company who were individuals 20 February December 2007 and 31 table below between listed in the interests in ordinary the exception of the 2008 with shares an additional 77 ordinary each acquired George Rose who have under the partnership shares since 31 December 2007 matching s and at the date of this report Incentive Plan so that their beneficial shareholdings elements of the Share stood at 317,974 and 538,

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 77 the Company’s s. Details of directors’s. Details of Market Market price at Market price at Market BAE Systems Annual Report 2007 In respect of shares vested during the year In respect of shares vested during the year Restricted Share Plan for Chris Geoghegan l vest, subject to the attainment of the performance subject to the attainment l vest, based on real EPS growth over the three-year based on real EPS growth over m of 3% but less than 4%, two-thirds vesting with a two-thirds m of 3% but less than 4%, market price at the date of the award granted market price at the date of the award ally not subject to any performance criteria as it was ally not subject to any itions as described above and on page 72. itions as described above r the annual bonus plan which was itself subject to itself subject r the annual bonus plan which was ther than options as, subject to attainment of the ther than options as, 9–––– sting, was £1,066,284 (2006 nil). was sting, Matching Plan for grants to be made in 2008 and 2009 are Matching Plan for grants to be made in 2008 and 2009 d to exercise an option. They are subject to the same d to exercise an option. They 32,27026,454 30.09.03 30.03.04 1.72 01.10.07 2.01 30.03.07 4.91 4.575 –––– –––––– 18,947 46,410 – – 18,947 46,410 2007* the year the year 2007 Awarded Vested date ofAwarded Vested price on date of price on 1 January during Awarded during Vested 31 December –––––––– 2007* the year the year 2007 award £ vesting £ 2007* the year the year 2007 award £ vesting £ 1 January during during 31 December Date of award Date of vesting 1 January during during 31 December Date of award Date of vesting 42,76410,24975,627 – – 19,994 – 22,770 26.03.04 37,677 – 37,950 26.03.04 2.00 10,24 26.03.07 4.5575 2.00 26.03.07 4.5575 Total 278,788 83,543 58,724 303,607 2 2 2 1 1 4 4 3 3

will be released in full at the end of the three-year period.

Awards granted to Walt Havenstein (a US national) under the Performance Share Plan are characterised as long-term (a US national) under the Performance incentives ra Havenstein granted to Walt Awards W P Havenstein as calculated at the date of ve directors in 2007 from long-termThe net aggregate value of assets received by incentive plans, 1 of shares under the the Matching award agreement, retired as a director on 31 December 2007. With the Remuneration Committee’s designed to retain key staff and encourage executives to re-invest in company shares the cash bonuses that they had earned unde shares the cash bonuses that they in company executives to re-invest staff and encourage designed to retain key which is subject to performance cond the Share Matching Plan, replaced by performance conditions. The Restricted Share Plan was fourth delivered automatically on the third, and fifth anniversary are without the nee they performance of the award condition, performance Share Plan to the UK-based directors conditions as options granted under the Performance page 78. The as set out on on 30 £4.57. March 2007 was * or upon appointment Performance Share Plan Performance M J Turner historic was not been granted since 2006, have which awards under of shares under the Restricted Share Plan, The matching award 137,924 – 99,974 37,950 26.03.04 2.00 26.03.07 4.5575 S L Mogford G W Rose 33,971 – 14,996 18,975 26.03.04 2.00 26.03.07 4.5575 I G King C V Geoghegan W P Havenstein Restricted Share Plan 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 wil The awards £4.565. made on 22 March 2007 under the Share Matching Plan was for awards The market price at the date of award M J Turner – 109,529 – 109,529 Table B Table S L Mogford G W RoseThe performance match was condition for the grants of matched shares made in 2007 under the Share Matching Plan on a one-to-one – – – – 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 C, B, option schemes and long-terminterests in the share are shown in Tables incentive plans ordinary 401.5p to 515p. the range during 2007 was 498p (2006 425.75p) and shares at 31 December 2007 was W P Havenstein I G King on the third anniversarycondition, of grant. real EPS growth per annu on average achieved with one-third of the matched shares vesting where the Company performance period, performance The revised conditions for the Share and full vesting at growth of 5% or over. growth rate of 4% but less than 5%, set out on page 72. C V Geoghegan Long-term plans incentive Share Matching Plan The Company’s register of directors’ full details of directors’ to inspection) contains (which is open interests share interest The Company’s The Auditors are required to report on the information contained in Tables B, C, D, E, F and G on pages 77 to 83. F and G on pages 77 E, D, C, B, The Auditors required to report are information on the in Tables contained Information subject to audit subject to Information 23 appointed as a director on 2 January 2007 4 appointed as a director on 1 January 2007 2007 retired as a director on 9 May in 2008 24.03.12 12.04.13 30.03.14 30.09.10 30.09.10 30.03.11 24.03.12 12.04.13 30.03.14 30.09.10 30.03.11 24.03.12 12.04.13 30.03.14 30.09.10 30.09.10 30.03.11 24.03.12 12.04.13 30.03.14 30.09.10 10.11.07 30.03.11 10.11.07 10.11.07 12.04.13 30.09.10 30.09.10 30.03.11 TSR 6 6 5 5 5 5 6 6 5 5 5 6 6 5 5 5 5 6 6 5 5 5 5 3 3 5 5 5 5 own under Table B. own under Table 005, 2006 and 2007 PSP awards for Chris 2006 and 2007 PSP awards 005, d 2006 PSP awards for Steve Mogford was tested was Mogford for Steve d 2006 PSP awards or awards to be granted under the PSP or awards as 401.5p to 515p. rated for service and be exercisable for completed d. All vested PSP awards became exercisable within d. All vested PSP awards rcisable (subject to the attainment of the performance of TSRs achieved by a sectoral comparator group of 18 by of TSRs achieved awards are also subject to the same secondaryawards measure nches at the end of years three, four and five. four and nches at the end of years three, 96,962 12.04.06 – 12.04.09 303,030 24.03.05304,906 12.04.06 – 24.03.08 – 12.04.09 109,228 12.04.06 – 12.04.09 147,935 24.03.05 – 24.03.08 189,393 24.03.05123,831 12.04.06 – 24.03.08 – 12.04.09 168,560 24.03.05 – 24.03.08 Granted Exercised Lapsed Date Date – 310,175 – – 310,175 30.03.07 – 30.03.10 – –– 86,831 122,538– – – 86,832 30.09.03 – 01.10.07 30.09.07 130,814 – 122,538 30.03.07 – 130,814 30.09.03 – 01.10.07 30.03.10 30.09.07 – 107,221– – –– – 70,736 115,973 107,221 30.03.07– – –– 70,737 – 30.03.10 30.09.03 – 23.10.07 30.09.07 156,097 – 115,973 – 30.03.07 140,199 – – – 30.03.10 – 30.09.03 10.05.07 10.05.07 – 30.03.04 10.05.07 10.05.07 0––– 6––– 8––– 5––– 2––– 3––– 1––– 0––– 2007 the year the year the year 2007 2007 the year the year the year 2007 grant or lapse exercisable* date 1 January Granted during Exercised during Lapsed during 31 December 1 January during during during 31 December Date of of exercise from which Expiry 96,96 722,231638,707722,231 107,221 115,973 – 148,147 202,005 575,545 – – 146,686 681,305 552,675 – 303,03 304,90 168,560109,228 – 131,102 –230,099 37,458189,39 123,83 – – 109,228 – 24.03.05 76,699 10.05.07 10.05.07 –363,184 12.04.06 – 153,400 30.03.04 30.03.07 30.03.07 – – 12.04.09 121,061 – 242,123 30.03.04 30.03.07 30.03.07 109,22 212,209181,601147,93 – 70,736 – 60,533234,145 –210,298 – – 121,068 – 30.03.04 78,048 30.09.03 30.03.07 30.03.07 – 23.02.07 30.09.06 70,099 – – – 30.09.03 23.02.07 30.09.06 – 30.03.04 30.03.07 30.03.07 234,145210,298168,56 – – 78,048 70,099 – 156,097 – 30.09.03 140,199 30.03.07 30.09.06 30.03.04 30.03.07 30.03.07 (continued) , a US national, under the Performance Share Plan are characterised as long-term incentives, rather than as options, and are sh rather than as options, Share Plan are characterised as long-term under the Performance incentives, national, a US , 4 Total 1,363,562 310,175 382,689 – 1,291,048 Total 722,231 – 575,545Total 146,686 803,817 122,538 – 250,361 – 675,994 Total 722,231 107,221 148,147Total – 681,305 638,707 115,973 202,005 – 552,675 ms.com 1 1 3 3 2 2 www.baesyste www.baesyste

Geoghegan will be tested at the end of the normal three-year performance period, and any part vesting will be pro- and any Geoghegan will be tested at the end of the normal of the award three-year performance period, six months. at his date of retirement. The 2005 award vested in full (subject to pro-rating for service lapse at his date of retirement. The 2005 award completed) and the 2006 award six months of retirement. condition where the award has not yet vested). condition where the award

78 1 retired as a director on 31 December 2007. With the agreement of the Remuneration Committee the performance condition on the 2 M J Turner 392,442 – 130,814 – – 30.09.03 23.02.07 30.09.06 G W Rose 260,494 – 86,831 – – 30.09.03 23.02.07 30.09.06 S L Mogford I G King C V Geoghegan The breakdown of the options held by executive directors under the Performance Share Plan is as follows: directors executive under the Performance options held by The breakdown of the M J Turner Havenstein granted to Walt Note: Awards 1,363,562 310,175 382,689 – 1,291,048 S L Mogford G W Rose 803,817 122,538 250,361 – 675,994 I G King C V Geoghegan Performance Share Plan Share Performance Directors’ Share Options Table C Table Remuneration reportRemuneration Directors’ report – Corporategovernance 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% Total vest if the Company’s ie 100% of the conditional awards as set out on page 71, performance 50%. The is outside the top if the Company’s and nil vesting with 25% vesting if TSR is in the top 50%, companies, in three tra for underlying that vest at the end of year three are exercisable financial performance set out on page 71. Awards ordinary 498p (2006 425.75p). The range during the year w shares at 31 December 2007 was The mid-market price for the Company’s 2 appointed as a director on 1 January 2007 3 2007. With the agreement of the Remuneration Committee the performance condition on the 2005 an retired as a director on 9 May 4 appointed as a director on 2 January 2007 5 subject to a performance met condition which has been 6 subject to a performance be tested condition that is yet to * The date from which exercisable refers year end is exe tranche of the option remaining at the to the first any date from which Awards granted under the Performance Share Plan between 2003 and 2007 are subject to the same performance conditions as those f Share Plan between granted under the Performance Awards

During 2007 SAR awards over 264,261 shares were subject to exercise and the number of shares vesting and allotted under these s subject to exercise and 264,261 shares were over During 2007 SAR awards In addition, Walt Havenstein has a cash-settled SAR over 53,010 ordinary has a cash-settled SAR over 2000 at a SAR price of £ Havenstein shares granted on 27 November Walt In addition, out above. subject to the performance granted in 2000 (ie exercis condition relating to options 2010 and was exercisable until 27 November of inflation for that period and a growth requirement of 9%) which has been the ten-year life exceeded the sum year period over 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 2007 retired as a director on 9 May W P Havenstein Executive Share Option Plan – Stock Appreciation Rights (SAR) The BAE Systems Executive Share Option Plan was used to grant options to the executive directors between 2001 and 2007. No furt used to grant options to the executive directors between The BAE Systems Executive Share Option Plan was G W Rose M J Turner 1,659,786 2,445,213 183,807 465,262 815,123 1,133,439 259,701 277,015 1,500,021 768,769 S L Mogford W P Havenstein I G King granted to executive directors (and other senior executives) under th options were On completion of the BAe/MES merger in 1999, granted under the Stock Appr 2003 and 2005 were Option Plan between under the Executive Share Havenstein granted to Walt Awards C V Geoghegan tenth anniversary the third and Plan are normallyexceptional circumstances. Options granted under this exercisable between of on achieves if the Company only be exercised during this period as follows: (i) 33.33% of each option grant is exercisable may real on average achieves the three-year performance option grant is exercisable if the Company over period; (ii) 66.67% of each real EPS growth per a on average achieves performance period; and (iii) 100% of each option grant is exercisable if the Company the same as for grants made betwee 2001 and 2004 were period. The performance conditions for the grants of options made between performance is three-year performance where the original is not met, 2001 and 2003, for grants made between testing provision: performance is re-tested at the e where the original performance target is not met, period from grant; for grants made in 2004, In determining not been achieved. the performance measures the Rem cases the option will lapse in year five if the targets have indicator of long-term financial performance and value creation. EPS to be a key believe major investors exceeded the sum of in three-year period pre-exceptional EPS for any granted to Ian King in 1999 could only be exercised if the and these options vested in full in Februaryachieved to the other executive directors 2006. Options granted in 1999 (which par the three-ye of the merger integration process over of a special performance of cost savings condition based on the achievement ordinary 498p (2006 425.75p). The range during the year w 2007 was shares at 31 December The mid-market price for the Company’s executive directors under the Executive Share Option Plan is given overleaf. A breakdown of options held by are subject to the same performanceset out above. conditions as options granted under this plan as equity-settled. They The exercise of options under the SAYE Share Option Scheme, an all-employee scheme, was not subject to the satisfaction of any subject to the satisfaction of any not was scheme, an all-employee Option Scheme, Share the SAYE The exercise of options under Plan Executive Share Option M J Turner M J Turner 1,499 – 1,499 – – 2.56 09.04.02 07.06.07 01.06.07 01.12.07 I G King G W Rose 435 – 435 – – 1.56 20.04.04 22.08.07 01.06.07 01.12.07 C V Geoghegan

All outstanding options held by the executive directors in the SAYE Share Option Scheme were exercised in 2007. exercised were Share Option Scheme executive directors the in the SAYE options held by All outstanding No further this Scheme. options will be granted under SAYE Share Option Scheme SAYE 30.03.17 20.12.09 30.09.13 30.03.14 24.03.15 12.04.16 30.03.17 03.05.10 30.09.13 30.03.14 24.03.15 12.04.16 30.03.17 12.04.16 30.03.17 30.09.13 30.03.14 24.03.15 12.04.16 10.05.09 10.05.09 30.09.13 30.03.14 24.03.15 12.04.16 06.10.08 20.12.09 30.09.13 30.03.14 24.03.15 12.04.16 30.03.17 20.02.09 5 5 5 5 6 6 5 5 5 5 6 6 6 6 5 5 5 5 6 6 5 5 5 5 5 6 5 5 5 5 5 6 6 nt of the performance condition, options granted options nt of the performance condition, as 401.5p to 515p. 001 onwards had their period of exercise determined 001 onwards the performance condition, options granted prior to options granted the performance condition, nted from 2001 onwards had their period of exercise nted from 2001 onwards 2.01 30.03.044.28 12.04.06 – 30.03.07 – 12.04.09 272,388 145,443 (continued) Granted ExercisedofDate Lapsed Exercise Date – 465,262 – – 465,262 4.57 30.03.07 – 30.03.10 – 183,807 – – 183,807 4.57 30.03.07 – 30.03.10 – 173,960 – – 173,960 4.57 30.03.07 – 30.03.10 – 160,831– 125,315 – – – 160,831 – 4.57 125,315 30.03.07 4.57 30.03.07 – 30.03.10 – 30.03.10 2007date exercisable lapse 2007year year year or grant £ 1 January during the the during during the December 31 price Date of exercise from which Expiry 64,41587,940 – – 64,415 87,940 – – – – 4.21 3.98 20.12.99 03.05.00 10.05.07 10.05.07 20.12.02 03.05.03 90,090 – – 90,090 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12 96,453 – – – 96,453 4.28 12.04.06 – 12.04.09 89,552 – – 89,552 – 3.35 03.04.02 21.02.07 03.04.05 03.04.12 588,663544,776454,545457,359 – – 588,663 – 544,776 – – – – – – – – – 454,545 1.72 457,359 2.01 30.09.03 2.64 30.03.04 23.02.07 4.28 24.03.05 30.03.07 30.09.06 12.04.06 30.03.07 – – 24.03.08 12.04.09 284,090185,747 –277,015 – – – – – – – 284,090 185,747 277,015 2.64 4.28 24.03.05 12.04.06 – 3.35 – – 03.04.02 24.03.08 21.02.07 12.04.09 03.04.05 03.04.12 163,843115,125259,701 –390,741345,149 – – – – – 390,741 – 345,149 – – 163,843 259,701 – – – 4.28 115,125 12.04.06 – – 4.21 – 3.35 20.12.99 1.72 – 03.04.02 2.01 30.09.03 21.02.07 12.04.09 30.03.04 23.02.07 03.04.05 – 30.03.07 03.04.12 30.09.06 20.12.02 30.03.07 233,433351,218315,447252,840 – – – 351,218 – 315,447 – 233,433 – – – – – – – 3.35 252,840 1.72 03.04.02 2.01 30.09.03 21.02.07 2.64 30.03.04 23.02.07 03.04.05 24.03.05 30.03.07 03.04.12 30.09.06 30.03.07 – 24.03.08 318,314272,388221,903145,443 – – – – – – – – – – 318,314 – – 221,903 1.72 30.09.03 2.64 24.03.05 – 30.09.06 – 24.03.08 252,840163,843 – – – – – – 252,840 163,843 2.64 4.28 24.03.05 12.04.06 – – 24.03.08 12.04.09 118,090119,938351,218315,447 – – – – – – – 119,938 – – 118,090 – – – 3.98 351,218 03.05.00 315,447 3.26 1.72 22.10.02 2.01 30.09.03 21.02.07 – 30.03.04 22.10.05 03.05.03 22.10.12 – – 30.09.06 30.03.07 138,242 – – – 138,242 4.21 20.12.99 – 20.12.02 ms.com 2 1 4 3 www.baesyste www.baesyste

Total 2,445,213 465,262 1,133,439 277,015 1,500,021 Total 1,659,786 183,807 815,123 259,701 768,769 Total 1,469,136 – 819,020 233,433 416,683 Total 1,186,380 173,960 – 90,090 1,270,250 Total 96,453 Total 125,315 – – 221,768 Total 1,410,928 Total 160,831 – 209,490 1,362,269 prior to 2001 for Chris Geoghegan had their period of exercise determined as 24 months from the date of leaving and options gra prior to 2001 for Chris Geoghegan had their period of exercise determined as 24 months from the date of leaving ten-year life. determined as the end of the option’s 2001 for Steve Mogford had their period of exercise determined as 24 months from the date of leaving and options granted from 2 Mogford had their period of exercise determined2001 for Steve as 24 months from the date of leaving ten-year life. as the end of the option’s

80 1 and exercise being subject to attainme agreement, retired as a director on 31 December 2007. With the Remuneration Committee’s M J Turner 122,855 – – – 122,855 4.21 20.12.99 – 20.12.02 G W Rose 79,233 – 79,233 – – 3.29 06.10.98 23.02.07 06.10.01 S L Mogford I G King W P Havenstein W P Havenstein C V Geoghegan

The breakdown of the options held by executive directors follows: Option Plan is as the Executive Share under by of the options held The breakdown Remuneration reportRemuneration Directors’ report – Corporategovernance 2 appointed as a director on 2 January 2007 3 appointed as a director on 1 January 2007 4 and exercise being subject to attainment of agreement, 2007. With the Remuneration Committee’s retired as a director on 9 May The mid-market price for the Company’s ordinary 498p (2006 425.75p). The range during the year w shares at 31 December 2007 was The mid-market price for the Company’s The maximum duration for the grant of an option under the Executive Share Option Plan is ten years. 5 subject to a performance met condition which has been 6 subject to a performance be tested condition that is yet to

82 All emoluments and compensation paid to the directors during the year are shown above. Where the individual was appointed durin Where the individual was All emoluments and compensation paid to the directors during the year are shown above. 1 retired during or at the end of 2006 2 retired during or at the end of 2007 3 appointed in 2007 P A Weinberg R Quarta Sir Nigel Rudd Sir Peter Mason Sir Peter Rt Hon M Portillo M J Hartnall A Inglis future from opting out of payable in respect of a cash supplement was Turner Chris Geoghegan and Mike received by The other pay a transatlantic meeting allow to the non-executive directors during 2007 are detailed on page 75. In addition, The fees payable on a part-timeSir Charles the Company Masefield retired as a director on 28 February by over basis in an employed 2003 and was Dr U Cartellieri appointment. the taxable ben of a car and the provision where applicable, directors the UK-based executive include, The benefits received by executive the US-based Havenstein, and supportevents Walt received by in relation to relocation/second residence. The benefits the taxable benef was Dick Olver, the Chairman, insured life benefits. The benefit received by dental benefits and examination, being 12 months’ salary of £490,000, in lieu of notice, each entitled to a sum Mogford were Chris Geoghegan and Steve In 2007, 83. G on page pension benefits as disclosed on page 74 and in Table who attended five meetings in the UK. With the exception of Ulrich Cartel Weinberg, Phil Carroll and Peter executive directors, to attend two meetings in the US. Ulrich Cartellieri received the same allowance £4,000 to attend one received being UK-based, meetings in the US during 2007. and Sue Birley did not attend any Sir Richard Evans £331,600 (2006 £316,600) and comprised a salaryIn 2007 his remuneration was for a car. and a cash allowance in a part-timeHe remained employed on 29 February customer relationship role and will cease to be an employee 2008. The Compan Market Advisory £332,400 (2006 £317,350) and comprised a salary for Saudi Arabia. In 2007 his remuneration was Board and a cash to former Richard Lapthorne to directors referred no other payments during the year other than the payment to in the There were Prof S Birley P J Carroll M J Turner M J Turner Non-executive directors G W Rose S L Mogford M H Ronald I G King M Lester W Havenstein Executive directors C V Geoghegan Chairman R L Olver Directors’ remuneration Table F Table Remuneration reportRemuneration Directors’ report – Corporategovernance

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 83 2007 contributions contributions 2007 contributions BAE Systems Annual Report 2007 to £201,814 to allow for early payment. This to £201,814 to allow for early payment. Geoghegan retired from the Board on the matching Company payment as referred to on payment the matching Company ing disclosures. The amount of the increase in eu of notice and the matching Company payment as payment eu of notice and the matching Company ,519); Steve Mogford (£132,759); George Rose ,519); Steve up to a limit. In 2007 the Company paid up to a limit. In 2007 the Company . In addition, Walt Havenstein participates Havenstein in a Walt . In addition, ompensation arrangement. Walt Havenstein is paid Havenstein ompensation arrangement. Walt as reduced for early payment. This earlyas reduced for early retirement payment. e by the Company to him were £93,554 to him were the Company e by tly unfunded. No company contributions have been contributions have tly unfunded. No company sumptions are the same as those used in the 2 ustment factor applies to UK pension accruedustment factor applies to UK after cy movements. scheme and since April 2006 has been receiving a me and since April 2006 has been receiving a taxable Change in benefits for inflation benefits for 2007 1 2007 Accrued Increase/ accrued Transfer Transferin Increase 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 Age NRA* £ per annum £ per annum £ per annum £ £ £ £ 5359 6051 60 267,4585559 75,905 60 20,525 60 184,155 19,073 60 11,573 295,575 (51,408) 659,544 18,350 3,381,361 32,590 (59,948) 85,138 3,495,623 23,056 2,813,722 590,700 64,315 3,165,154 3,944,663 791,208 10,546,221 4,326,358 11,637,570 – 16,258 114,262 335,174 3,375 51,857 197,133 329,838 – 1,091,349 3 4 5 7 6 5 April 2006. calculation of cash equivalents from the schemes. For US-based directors those used for account the assumptions are the same as calculation of cash equivalents from the schemes. For (£35,712); Ian King (£218 Havenstein is: Chris Geoghegan (£224,755); Walt transfer value arising from the change in assumptions (£693,464). Turner (£271,274); Mike taxable salary supplement of 30% of his base salary. The pension shown above is the accruedtaxable salary The pension shown above pension at 31 December 2007. Chris supplement of 30% of his base salary. 31 December 2007 and started his pension with effect from 1 January to draw 2008. His accrued reduced on retirement pension was in li his payment augmentation of £980,000 relating to of a Company way pa by £32,102 early increased by retirement pension was normal augmentation factors. calculated in accordance with the scheme’s referred to on page 74, Section 401(k) defined contribution arrangement set up for US employees in which the Company will match employee contributions match employee will in which the Company Section 401(k) defined contribution arrangement set up for US employees paid $13,427 (£6,754) into a Deferred C the Company contributions of $6,308 (£3,173) into this 401(k) arrangement. In addition, in US dollars. Of the change in the accrued benefit and the transfer value (£1,206) and (£12,574) respectively is due to curren in lieu of notice and augmentation of £980,000 relating to his payment of a Company way by £31,056 pa increased by pension was normal augmentation factors. with the scheme’s calculated in accordance page 74, made to these arrangements during the year. salary supplement of 30% of his base salary. 1 adj a longevity before the normal In addition, retirement age of the scheme. are taken be reduced if they Accrued pensions may * Normal Age Retirement M J Turner S L Mogford G W Rose W Havenstein W Havenstein I G King 51 62 373,388 40,934 28,882 2,736,838 3,075,417 46,230 292,349 C V Geoghegan Table G Table benefits Post-retirement 2 UK-based directors the as For the actuarial profession. been calculated in accordance with GN11 issued by values have Transfer 3 elected to opt out of the pension Chris Geoghegan As a result of the changes to taxation of pensions introduced in April 2006, 4 accrued comprises of £13,902 from a contributory pension Qualified Plan and £62,003 from Non-Qualified Plans Havenstein’s Walt 5 2007 and started 1 June 2007. His pension w Mogford retired from the Board on 9 May his pension with effect from Steve to draw 6 retirement arrangement George Rose has an unapproved for pensionable service before 5 April 2006 that is partly funded and par 7 sche elected to opt out of the pension Turner As a result of the changes to taxation of pensions introduced in April 2006 Mike Richard Lapthorne, a former director, has an unfunded pension arrangement payable by the Company. In 2007, pension payments mad pension payments In 2007, the Company. by has an unfunded pension arrangement payable a former director, Richard Lapthorne, (2006 £90,078). on a return of capital on a Subject to the relevant statutory and provisions to the Special Shareholder or his successor or nominee; or foreign persons acting in concert, shares to a foreign person, each, 275,000,000 7.75p (net) cumulative redeemable preference (net) cumulative redeemable 275,000,000 7.75p each, Share of £1. each and one Special shares of 25p BAE 2007, As at 31 December capital of Systems’ issued share ordinary comprised 3,574,509,017 £89,362,726 of 2.5p shares Share of £1. each and one Special of ordinaryRights and obligations shares a general meeting everyOn a show of hands at holder of ordinary to vote shall have proxy and entitled shares present in person or by every proxy present in person member one vote and on a poll, or by one vote for every have and entitled to vote shall ordinary share held. Articles statutorySubject to the relevant and the Company’s provisions holders of ordinaryof Association, shares are entitled to a dividend available for such purposes. out of profits where declared or paid Articles statutorySubject to the relevant and the Company’s provisions holders of on a return winding-up, of capital on a of Association, of the £1 Special Share, after repayment ordinary shares are entitled, to participate in such a return. shares preference Rights and obligations of cumulative redeemable of all the cumulative redeemable preference conversion Following shares in issue into ordinary shares pursuant to the Company’s no cumulative redeemable Articles there were of Association, 2007. The Company preference shares in issue as at 31 December and the effect of a special has no intention of re-issuing such shares other amongst will be, resolution to be proposed at the 2008 AGM of the Articles to delete the provisions of Association relating things, to such shares. Rights and obligations of the Special Share SecretaryThe Special Share is held on behalf of the of State for Trade and Industry Shareholder’) (now the Secretary (the ‘Special of State Enterprise and Regulatoryfor Business, Reform). Certain provisions Articlesbe amended without of Association cannot of the Company’s include the These provisions the consent of the Special Shareholder. or foreign persons acting in requirement that no foreign person, more than a 15% voting interest in the Company, concert, can have the the requirement that the majority of the directors are British, in their requirement that decisions of the directors their meetings, at British a majority of by committees or via resolution must be approved directors and any and the requirement that the chief executive executive chairman are British. to attend a general meeting,The holder of the Special Share is entitled other rights at any but the Special Share carries no right to vote or any business in respect other than to speak in relation to any such meeting, of the Special Share. Articles of Association, the Company’s of the Share shall be entitled to repayment the Special winding-up, repayment £1 capital paid up on the Special Share in priority to any other members. of capital to any 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 time. share at any shares Treasury As at the date of this report 61,945,000 ordinary held in shares were The rights to such shares are restricted in accordance with treasury. attaching to the voting rights in particular, the Companies Acts and, these shares are automatically suspended. of securities Restrictions on transfer are as follows: The restrictions on the transfer of shares in the Company and transferred held by only be issued to, may the Special Share – allotment or transfer of any the directors shall not register any – ms.com www.baesyste www.baesyste

1 January their retirement as stated below: 2007 to the date of The following directors served also 2007 from on the Board in the end of August 2008. announced that Mike Turner, the Chief Executive, would be retiring at would be retiring the Chief Executive, Turner, announced that Mike and Andy Inglis on 13 June 2007. On 16 October 2007 the Company and Andy Inglis on 13 to the Board on 1 January 2007, Walt Havenstein on 2 January Havenstein 2007 Walt to the Board on 1 January 2007, listed on pages 54 to 55. Of those directors, Ian King was appointed Ian King was 55. Of those directors, listed on pages 54 to The current directors who served year are during the 2007 financial Directors information technology support solutions and customer services. services for air, land and naval forces, as well as advanced electronics, as advanced as well forces, naval land and services for air, and equity accounted investments, a full range of products and a full range of products accounted investments, and equity The BAE its wholly-owned subsidiaries through delivers, Systems Group Principal activities £180,000,001 comprised 4,450,000,000 ordinary shares of 2.5p As at 31 December 2007, the Company’s authorised share capital of the Company’s As at 31 December 2007, Structure of share capital No political donations were made in 2007. No political donations were Political donations Political activities are set out on page 40. was £1.4m (2006 £1m). Further details of the Company’s charitable Further £1.4m (2006 £1m). was details of the Company’s During 2007, the amount donated for charitable purposes the in the UK During 2007, Charitable donations 39 days (2006 37 days). (2006 37 days). 39 days The average number of days credit provided in 2007 by suppliers was in 2007 by credit provided number of days The average made with the prior agreement of the supplier. made with the prior agreement of the supplier. Group policy that changes to the agreed payment schedule are only schedule Group policy that changes to the agreed payment that the supplier complies with all relevant termsthat the supplier complies with all relevant It is and conditions. 84 payment policies. Agreed payment schedules are maintained provided policies. Agreed payment payment local best practice in the country of operation in respect of supplier It is Group policy that each business unit is in compliance with Supplier payment policy Supplier payment at the Company’s registered office or through the Company’s website. website. office or through the Company’s registered at the Company’s compliance officer may be obtained through the Company Secretary be obtained through the Company compliance officer may information regarding the undertakings and the contact details of the with the undertakings is monitored by a compliance officer. Further with the undertakings officer. a compliance by is monitored superseded and varied by a new set of undertakings. set of a new superseded and varied by Compliance from the majority of these undertakings been and the remainder have Regulatory released was Reform). the Company In February 2007, and Industry Enterprise (now the Secretary and of State for Business, Company gave certain gave Company undertakings to the Secretary of State for Trade the former Marconi Electronics Systems businesses in 1999, the the former in 1999, Marconi Electronics Systems businesses As a consequence of the merger between British Aerospace and As a consequence of the merger between Office of Fair Trade undertakings Fair Office of resolutions to be proposed at the meeting. General Meeting is enclosed with this Annual ReportGeneral Meeting is enclosed with this Annual and details the The Company’s AGM will be held on 7 May 2008. The Notice of Annual will be held on 7 May AGM The Company’s Annual General Meeting (AGM) 18 April 2008. be paid on 2 June 2008 to shareholders share register on on the share. Subject to approval of the shareholders, the final dividend will the final dividend of the shareholders, share. Subject to approval 2007. The directors of 7.8p per ordinary propose a final dividend An interim dividend of 5.0 pence per share was paid on 30 November was An interim dividend of 5.0 pence per share Dividend Steve MogfordSteve 2007 9 May Chris Geoghegan 31 December 2007 Professor Sue BirleyDr Ulrich Cartellieri 26 September 2007 2007 May 9 Director Board Date retired from the Other statutoryOther and regulatory information Directors’ report

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 85 BAE Systems Annual Report 2007 The majority of directorsThe majority Otherwise must be British. holding office the directors order vacate office in such are not British shall who shortest been in office for the who have that those their period since all of the directors unless first, shall vacate their office appointment director who holds the office themselves. Any otherwise agree among of either chairman executive capacity) or chief executive shall (in an also be British. six directors office at all times. If the holding must have The Company such number of persons then shall below six, number is reduced to be appointed as directors as soon as is reasonably practicable to ordinary by may of directorsreinstate the number to six. The Company to time varyresolution from time number of directors. the minimum elected or last was director who any Company, of the At each AGM before held in the third calendar year the AGM re-elected at or before and such further rotation the then current year must retire by calendar directors so that in total not less than one-third rotation must retire by A retiring director is eligible rotation each year. of the directors retire by for re-election. Articles of Association Amendment of the Company’s Articles a only be amended by of Association may The Company’s shareholders.special resolution at a general meeting of Where class the members by such amendments must be approved rights are varied, of each class of shares separately. certain of the ArticlesIn addition, provisions of Association cannot These Shareholder. be amended without the consent of the Special or foreign no foreign person, include the requirement that provisions more than a 15% voting interest persons acting in concert, can have the requirement that the majority of the directors in the Company, the requirement that decisions of the directorstheir at are British, in their committees or via resolution must be approved meetings, a majority of British directors and the requirement that the chief by executive chairman are British. executive and any will be put to shareholders a special resolution At the 2008 AGM proposing amendments to the existing Articles of Association of the new primarily in order to accommodate the provisions Companies Act 2006. of the directors Powers The directors of the business are responsible for the management subject of the Company exercise all powers and may of the Company to applicable legislation and regulation and the Memorandum and Articles of Association. to buy back given the power the directors were At the 2007 AGM, a maximum number of 320,008,915 ordinary shares at a minimum an amount equal to 105% price of 2.5p each. The maximum price was the Company’s of the middle market quotations of of the average ordinary shares as derived from the London Stock Exchange Daily day preceding the days immediately Official List for the five business on which such ordinary shares are contracted to be purchased. This earlier will expire at the or power of the conclusion of the 2008 AGM 9 August 2008. A special resolution will be proposed at the 2008 authority to acquire its own shares. the Company’s to renew AGM As part of a share buyback programme which commenced in October repurchased 33,270,000 of its ordinary the Company shares 2006, for an aggregate a nominal value of £831,750) during 2007 (having consideration of approximately £147m. The shares repurchased as at represented 0.93% of the called-up share capital of the Company 31 December 2007. No further been repurchased since shares have the year end. The repurchased shares are held in treasury. to issue new given the power the directors were At the 2007 AGM, will expire on shares up to an amount of £26,664,742. This power the earlier 2008. or 8 August of the conclusion of the 2008 AGM ordinary person to be a director. resolution appoint any are subject to restrictions on the transfer of shares prior to vesting.are subject to restrictions on the transfer of the Financial Services certain Authority whereby of the Group’s and to deal in shares; approval require the Company’s employees and regulations (for example, insider trading laws); and regulations (for example, information relating to their interest in shares, the directors can, in the directors can, information relating to their interest in shares, transfer of such shares; certain refuse to register a circumstance, shares in favour of more than four persons jointly; shares in favour of shares unless the instrumentof shares unless the is in respect of only one of transfer where the register of class of share and it is lodged at the place certificate a relevant accompanied by or such members is kept, reasonably require to show as the directorsother evidence may the transfer;the right of the transferor to make transfer up (but not so as to prevent of shares which are not fully paid from taking place); dealings in listed shares shares unless they have received: (i) a declaration stating that received: (i) a declaration stating have shares unless they foreign persons be held by the share(s) will not upon registration, a foreign person the share(s) will be held by or that upon registration require directors as the may or persons; (if any) (ii) such evidence signatoryof the authority of the and (iii) such of the declaration; as to the matters or information referredevidence (if any) to in the declaration as the directors consider appropriate; who at the time have more than a 15% voting interest in the more than a 15% time have who at the or transfer, such allotment following or who would, Company, such an interest; have capital of the Company: capital of the Company: significant direct and indirect interests in the issued ordinarysignificant direct and indirect interests in the share As at 20 February 2008, the Company had been advised of the following As at 20 February the Company 2008, Significant direct and indirect holders of securities and/or voting rights. shareholders that may result in restrictions on the transfer of shares shareholders that may The Company is not aware of any arrangements between its arrangements between of any is not aware The Company – awards of shares made under the Company’s share incentive plan of shares made under the Company’s awards – – restrictions may be imposed pursuant be imposed to the Listing Rules of restrictions may – – certain restrictions may from time to time be imposed by laws certain laws from time to time be imposed by – restrictions may – where a shareholder has failed to provide the Company with certain the Company where a shareholder has failed to provide – – the directors may refuse to register an allotment or transfer of refuse to the directors may – – the directors may also refuse to register any instrument of transfer also refuse to register any the directors may – – the directors may, in their absolute discretion, refuse to register any in their absolute discretion, the directors may, – – the directors shall not register any person as a holder of any personthe directors as a holder of any any shall not register – Company may by may Company Subject to certain nationality requirements mentioned below, the to certainSubject mentioned below, nationality requirements Appointment and replacement of directors resolution are publicised on the Company’s website after the meeting. website resolution are publicised on the Company’s number of proxy votes for, against or withheld in respect of each against or withheld in respect number of proxy votes for, relation to resolutions to be proposed at the general meeting. The exercising voting rights and appointing a proxy or proxies to vote in The notice of any general meeting shall specify the deadline for general meeting shall specify the The notice of any Restrictions on voting deadlines exercised in relation to shares unallocated to individual beneficiaries. the direction of the underlying beneficiaries. No voting rights are voting rights on shares held in the employee trustsvoting rights on shares held in the employee than on other The Trustees of the employee trusts of the employee do not seek to exercise The Trustees Exercise of rights of shares in employee share schemes Exercise of rights of shares in employee Franklin Resources, Inc. and affiliates Resources, Franklin Legal and General Group Plc 4.92% 4.07% Barclays PLCBarclays Inc.Capital Group Companies, 6.99% 3.98% AXA S.A. and its group of companies 10.32% (continued) them consistently; and prudent; the EU; adopted by been prepared in accordance with IFRSs as subject been followed, applicable UK Accounting Standards have departures material to any disclosed and explained in the parent financial statements; and company the Group and the unless it is inappropriate to presume that will continue in business. parent company and have elected to prepare the parent company financial company prepare the parent elected to and have and UK Accounting Standards in accordance with statements Practice). Generally Accepted Accounting (UK law applicable as and IFRSs by law are required financial statements The Group the EU to present fairly the financial position and the adopted by in performance the Companies Act 1985 provides of the Group; statements that references in the relevant relation to such financial parta trueof that Act to financial statements giving and fair view a fair presentation. achieving are references to their to give by law statements are required financial The parent company a true of the state of affairs and fair view company. of the parent financial Group and parent company In preparing each of the the directors are required to: statements, – suitable accounting policies and then apply select – and estimates that are reasonable judgements make – have state whether they for the Group financial statements, –whether state financial statements, for the parent company – prepare the financial statements on the going concern basis proper accounting records The directors are responsible for keeping time the financial any that disclose with reasonable accuracy at and enable them to ensure that its position of the parent company Act 1985. They financial statements comply with the Companies responsibility for taking such steps as are reasonably general have Group and to prevent open to them to safeguard the assets of the and detect fraud and other irregularities. the directors are also and regulations, Under applicable law responsible for preparing a directors’ report, directors’ remuneration report and corporate statement that comply with that governance those regulations. and law to auditorsStatement of disclosure of information The directors of this who held office at the date of approval there aware, Directors’ are each report so far as they confirm that, auditors audit informationis no relevant of which the Company’s all the steps that he and each director has taken are unaware; audit relevant of any himself aware to make taken ought to have auditors are aware information and to establish that the Company’s of that information. By order of the Board Parkes David SecretaryCompany 20 February 2008 ms.com www.baesyste www.baesyste

Inc.) and BAE Systems Holdings Inc. entered into a Special Security Inc.) and BAE Systems Holdings Inc. entered the US Department 2000 with Agreement dated 29 November of Inc. in order Defense regarding the management of BAE Systems, national security requirements. to comply with the US government’s the Agreement of a change of control of the Company, In the event the US Department be terminated or altered by may of Defense. Shareholders Defence Agreement with European Aeronautic (EADS) and Finmeccanica S.p.A EADS N.V. and Space Company (Finmeccanica) relating to MBDA S.A.S. dated 18 December 2001 to passes that control of the Company (as amended). In the event certain specified third party the agreement allows EADS acquirors, and Finmeccanica to exercise an option to terminate certain nomination and voting rights and executive management level certain in relation shareholder information rights of the Company the exercise of this option, joint venture. Following to the MBDA the right to require the other shareholders would have the Company at fair market value. The Company to purchase its interest in MBDA agreed that if Finmeccanica acquires a controlling and EADS have EADS will increase its shareholding in interest in the Company, purchasing the appropriate number of shares in to 50% by MBDA at fair market value; MBDA 1 FebruaryLetter of Credit Facility 2005 (as amended) and a £500m of a change in the event that, which provide dated 27 March 2006, the lenders are entitled to renegotiate of control of the Company, or if no agreement is reached on negotiated terms within terms, or cancellation of the a certain to call for the prepayment period, as at undrawn was Credit Facility facilities. The Revolving 31 December 2007; Reporting the EU and applicable law Standards (IFRSs) as adopted by Group financial statements in accordance with International Financial for each financial year. Under that law they are required to prepare the they Under that law for each financial year. directors to prepare Group and parent company financial statements directors to prepare Group and parent company with applicable law and regulations. Company law requires the law and regulations. Company with applicable law the Group and parent company financial statements in accordance financial statements the Group and parent company The directors are responsible for preparing the Annual Report and and financial statements Statement of directors’ responsibilities in respect of the Annual Report re-appointment will be put to the AGM. willingness to continue in office and a resolution proposing their KPMG Audit Plc, the auditors for the Company, have indicated their have the auditors for the Company, KPMG Audit Plc, Auditors Auditors the plans. a change of control of the Company in accordance with the rules in accordance of a change of control of the Company of which options and awards may vest and become exercisable on may of which options and awards In addition, the Company’s share plans contain provisions as a result share plans contain provisions the Company’s In addition, – The Company, BAEThe Company, – Systems NorthInc. (now BAE Systems, America – The Company has entered into a Restated and Amended has entered The Company – – The Group has entered into a £1.5bn Revolving Credit Facility dated Credit Facility Revolving The Group has entered into a £1.5bn – rights in the event of a change of control of the Company: of a change of rights in the event counterparties alteration or other similar to exercise termination, The following significant agreements contain provisions entitling the entitling agreements contain provisions The following significant Change of control – significant agreements Change of control – significant time customer relationship role. time customer relationship 30 June 2004 but remained an employee of the Company in a part- of the Company an employee 30 June 2004 but remained Sir Richard Evans, a formerretired from the Board on director who Sir Richard Evans, Companies Act 2006. A similar indemnity has been provided to A similar indemnity has been provided Companies Act 2006. which are qualifying indemnity provisions for the purpose provisions of the which are qualifying indemnity directors and those persons who were directors for any partdirectors directors and those persons for any who were of 2007 The Company has entered into deeds of indemnity with all its current indemnity with all its into deeds of has entered The Company Directors’ indemnities the Company’s authority to issue further shares. new the Company’s Accordingly, a resolution will be proposed at the 2008 AGM to renew to the 2008 AGM will be proposed at a resolution Accordingly,

86 Other statutoryOther and regulatory information Directors’ report

Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 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

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n n p n d the pa ti able able n d fai ts a m ity o ce n n n n r n o n d judge epa t of the r e r r al Sta al n s as at at as s siste actices Boa actices r n m n ts a view, i view, r all the the all ecessa cial state cial t of the r ue a easo ee f ee n r ly p ticle 4 of the the of 4 ticle r n n n r egula r iate to the r r d of p d of its e tly applied a applied tly r a g P rr atio all adequacythe of n n n r m n i e f ates a ates ed ed op d fai r r rn d A r ope r t is co t is d the pa n m r n r te y’s affai y’s n p n n siste cial state cial ies Act 1985; a Act ies d the pa the d n side n n othe n t to be audited. It also also It audited. be to t ue a ue n n pa r ts a ts give a t give ts a r e app r t esti 2007 a 2007 ce to give r r of the fi of the n n n n m pa n cial state cial n e e s’ Repo ts a n be m r t to bet to audited. m m n ally Accepted Accou Accepted ally a r BAE Systems Annual Report 2007 t co r aud o m ce with I ifica ces, co e n Repo r atio n e n n r n the fi the n a test basis, of evide of basis, test a m e n t toaudited bet have bee ecto n r t evide n r r da r n ts have bee ts give a t ts ies Act 1985 a sta audit so as to obtai as to so audit t to be audited a Repo epa atio r r n n r , o n r the fi the n es i m g policies g policies a e e n r e n n s whichwe co cial state cial cial state cial pa n i cu m m Repo ti n n n r acco u d) issued by the Auditi the by issued d) n atio the Di m n n a a r atio n n ts. ed ou n cial state cial Repo the p the m n n e n t of the sig n ce with the Co i n i causedby f n n atio n n r e n atio n a rm we also evaluated the ove the evaluated also we ela atio n u m e y fi y fi y’s ci y’s r r ts n s i n m fo n n n r s as at 31 Dece 31 at s as da e n rm m ce with UK Ge UK with ce m atio r r r s’ Re io r ded; ded; d I n d disclosu

n r audit i audit cial state cial state fo r ta n pa pa give pa e n n r u n ; n n n n n n 2007; 2007; da n m m ecto m e m a a r r the accou u d pe r d expla d s’ Re s’ n r n n ecto opi n : acco r ts a n r r t, whethe t, m be of of i atio n n n t co t co n assess ce withce the Co ce with IFRSs as adopted by the EU, of the state of of state the of EU, the by adopted as IFRSs with ce n a cial state cial d Co y 2008 y 2008 m cludes exa io n e n ovide us with sufficie us with ovide the n r n n s’ Re s’ n g (UK a g (UK n rm r acco n ou r n n r e e ecto ed a g ou n m ed i ed r r a r n oup fi oup oup’s affai oup’s oup fi oup ed Audito ed ce that the fi the that ce fo r s’ Re s’ m ua da r r da r n r n ducted ou

ed Accou r i r r r tatio n nn n r atio n n opi n a top ecto r r te r rm r actice, of the state of the pa of the state of the actice, epa r rm do r r t of the Di ecto audit i audit r Auditi d of d of whethe n IAS Regulatio IAS pa the acco p the G the the yea the Di the G the acco 31 Dece pa the P the fi the the G the view, i the i the oup’s a oup’s r ese de ade by the di the by ade isstate fo ou cludes a cludes fo r n n n r r

n n n n A o – a Di Opinion I of the Di the of Basis of audit opinion We co m 20 Feb – assu Lo p Registe o i I pa – KPMG Audit Plc KPMG Audit Plc Cha adequately disclosed. disclosed. adequately We pla i – m – G to the a ts al n ts t e d

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i n g m n e n n n t t n n da sibility sibility n da a n e be if the ally r r i es r ts a r r m r cial cial n e n r io ti n n n r m m t of e n eflects eflects n n y has y has sibilities sibilities atio e r the io e n n a atio atio n n y fi d the pa r co n n e t rn ial ial n m m ies Act 1985 ies n n ts o r e n t ifwe n acco espo acco rm o r m pa t witht the n cial state cial ot. We a We ot. n r te n otes. These These otes. e n n ocedu s,as a body, n n pa n g Rules of the the of g Rules n e n r u fo r n opi cial state cial m e y’s ate eceived all all eceived espo m r pa a n ual Repo ual Repo audit, o audit, t i ts a io n r n r m ticle 4 of theticle 4 m m the yea the r r n epo the opi s of the 2006 2006 s of the n

r d I n m m n r be a m r ed to state to to state to ed r ce Sheets, the the Sheets, ce r e

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r nn nn n e ibed as havi as ibed r n r ou r ot ot ce p n r pa r m siste ce with applicable applicable with ce pose.To the fullest the accou the ou y fi n n t co n fo m dsGe (UK ies Act 1985. Ou ies r e r r n n cial state cial r m opi r s’ s’ n ight state to the the to state ight i t to be audited have have audited be to t da n a n ts, A elated elated r r r n ou ts a n m Repo n r equi ts o e assu solidated I solidated r , the Co solidated State solidated de n the State m da r r a rn n r da pa pu n ts. Ou n r ovisio ce State n pa n n a e n the A the t, o n r e fo the fi the n s plcfo e r n r n e y Bala r r e n g theA d’s state d’s n m t if it does t if it y’s y’s m r io m r ecto r e n a m m n s fo t is co rm r m n i n r atio g Sta e Repo e p r n m r d the rn r ed u ed epo pa . n n n ed i t co acco r equi fo e r d the Co cial state cial n pa i t to bet to audited i epo g Sta n r r d). d). ti the fi the n n g di r n m n r n o othe n opi t witht the auditedfi n r r n n m g the pa g the epa r e n ce withCo the ate gove ate u n a n r t that is desc r ti s we a s we r

n equi atio t, the Co tai eview by Listi the n epa r r n i r r r di y a r ts i n m r isstate atio se a se r n n ise the Co p r

ela e set out i this the Boa ds, if we have have we if ds, ot accept o accept ot e ou n so that we we that so r n r plicatio po r s’ Repo n r y d Co r r e cial state r r s we s we da m p ols, o r r r n n n d we d we n p e r Repo rm es. r n n n d pa n m siste t atte r t m co d fo u n pa ate Gove ate cial state cial t to you whethe you t to n d I page 86. epa a ega r m m n r

n ou n fo n n n r n r as to whethe to as n Repo eco n s’ Re r m n m m e n r k, fo r a n ot disclosed. disclosed. ot n ecto cial Repo cial d whethe d r p atio of directors and auditors and auditors of directors r po take 235 of the Co 235 i r n t a r r r atio n n g n r acco n n epo r d Expe io r the i ity, a atio ce with the ce with r d co a n r r n n n ocedu whethe egulato e ts’)of BAE Syste oup a oup de n actice) a actice) n atio r n r ti r ecto . We have also audited the i the audited also have . We s’ Re r oup’s co n r n r oup fi oup r rm n d fo r r d UK Accou n n r epo it is co it s is s is u e e sibilities fo sibilities d n e a g (UKa r r the Co n ed i ed fo opi y appa u n side n n n ei s those s those r cial state cial plia t to yout to if, i n r the Di the solidated a solidated m y othe n g P ol p m r n r al Fi r n m n side n u r view a the Co the n ts. ts havebee n n ’s ’s d expla n n t r m i r sibilities o sibilities n ecto n audit wo audit r a n n r isks a i n r ti m r n be co n r epa n e e n n ade solely to the Co the to solely ade tha r n epo accou a espo r m r r d the Di d the . We also . We also r s’ Re s’ m sactio m atio n m ou d fai e r 2007 which co which 2007 Auditi ed. n e ofa n ds the G the ds r n whethe vices Autho r all r d co r d to a n rn r n r y’s co y’s r ly p itted by law,we do t legal a t legal s’ s’ m a s' Re ce with sectio cies with the fi n r give specified by law specified n r sibility is to audit the fi to audit the is sibility r r n ope rm n audito we oup fi oup be n n te cial state cial atio r n n ised I t is n r t, theCo ess of the G the of ess ed to co to ed t ts a ts. We co n rm ecto n r k has bee k has t to you ou n n ega r r n r e othe m n n r pa r n n y’s y’s r ue a ue side da s’ Respo s’ ds o ds a rm ope ed Code specified fo specified ed Code a n r e r t of thet Di r r e e n r ecto n e awa ecto m isk a isk n d I r n atio n atio r r r fo epo eleva t pe m cial Se cial siste n m yo m i ol cove cial state cial cial state cial p audited. audited. espo r m r da equi eview whethe eview epo bi ead the othe pa n ot exte ot r n r n n r solidated Cash Flow State Flow Cash solidated n r r r n n n rm rm n t

n m n a ecto r n m m a d othe a d co d, as as d, d the G d the n r its additio acco fo co fo n n n ot ot n n n n r ot kept p kept ot n n n n n the pa the bee Co fi with with audit wo audit of the Di the of as a body, fo as a body, of Recog of give a t i I Co Ou do do state co State We Di We adopted by the EU, a EU, the by adopted bee This state beco a to a Sta the Di the Fi n fi 31 Dece Accepted Accou exte law a policies set out the out set policies Co IAS Regulatio IAS i (the ‘fi (the a the i a the i the i with applicable law a applicable law with a the Co the We have audited the G the audited have We Independent auditors’ report to the members of BAE Systems plc Systems BAE of members the to report auditors’ Independent effective o We n we have fo have we Respective responsibilities Respective responsibilities The di m £ Total 2006 1 m £ 2006 (1,432) 12,333 (1,525) 13,765 1,330

3 (195) 859 (97) (116) 646 993 (11,763) 941 113 1,054 1,636 1,639 19.8p 19.9p (213) 1,639 371 30.8p 29.4p 50.7p 49.2p 1,080 1,207 127 (105) (34) 21 21 (35) (35) (105) (34) £m Total Total 2007 2007 (1,401) 14,309 15,710 21 58 1,235 900 22 (13,480) 1,038 139 1,177 901 922 25.8p 26.0p (335) 922 209 0.6p 0.6p 26.6p 26.4p 35 35 £m (38) (38) 142 2007 2007 (201) (134) (149) (148) (149) (148) 1,257 1,335 1,477 (1,199) 3 3 8 9 4 3 6 5 10 11 11 14 Notes ts 3 ts n e m investments costsexcluding finance vest n ted i equity accounted investments investments accounted equity n s e e e r r r r ty accounted investments investments accounted ty ty accounted investments investments accounted ty e e e r r r s: sha sha sha n r r r sha sha sha s: eholde

r r r r n n atio e se ms.com r n gs pe gs gs pe gs gs pe gs m atio ests ests n n n r gs pe gs pe gs pe r i i i s sha

co n n n i i i e of equity accou equity of e te n m rn rn rn n r n rn rn rn g ope ued ope ued n n ity i cial expe cial cial i cial r ti seas taxatio n ui n r www.baesyste www.baesyste o n a n a

n finance costs and taxation expense (EBITA) expense taxation costs and finance and taxation expense expense taxation and of intangible assets assets of intangible n n ti n

Taxation expense of equity accounted investments investments accounted of equity expense Taxation Amortisation Amortisation Impairment of equi income Financial Financial income of equi income Financial investments accounted of equity expense Taxation assets, intangible of impairment and amortisation before Earnings Impairment Share ofof results equity accounted Group operating profit excluding amortisation and impairment impairment amortisation and profit excluding Group operating Amortisation Revenue 90

Earnings per share Earnings

to: Attributable Profit for the year from continuing operations operations continuing from the year Profit for operations discontinued from the year Profit for Taxation expense Profit before taxation Profit before taxation Operating profit costs Finance Share of results of equity accounted investments Group operating profit Group operating profit Less: sha Less: Fi Operating costs Continuing operations operations Continuing and of Group Combined sales

for the year ended 31 December 31 yearfor the ended Consolidated income statement statement income Consolidated

UK taxatio UK Ove the year Profit for Syste BAE Co Other income Other income Fi Mi Disco Basic ea Basic ea Diluted Basic ea Basic ea Diluted Total: Basic ea Basic ea Diluted 84

– – 3 91 m 85 £ 51 11 50 76 81 17 (50) (15) (45)

569 671 503 123 841 395 2006 (424) (417) (271) (334) (465) 1,077 3,100 6,304 4,117 2,253 4,330 1,746 7,595 6,304 4,134 4,134 (1,211) (7,942) (6,071) (6,717) (2,776) (2,499) (7,942) 11,843 18,147 (14,013) – 6 48 35 23 94 90 36 £m (71) (40) (26) (30) 567 322 101 781 164 113 701 2007 (410) (499) (399) (299) (413) 3,062 6,996 5,966 4,631 2,933 1,774 1,222 9,559 6,002 7,090 6,002 (9,524) (4,704) (8,245) (1,629) (2,197) (9,554) 13,170 20,260 (14,258)

BAE Systems Annual Report 2007

8 8 3 3 17 16 15 17 14 15 23 13 27 27 23 20 21 17 12 18 27 22 17 20 11 11 21 27 Notes 25,27 k 16 k 16 r act wo act r t n co r s fo r e m

r its behalf by: by: behalf its sale sale 19 n r custo ecto r m ed o ed o r n ce Di n sale sale 19 d sig a r n n oups held fo held oups ts due f due ts r n es 27 es 27 r ou oup Fi oup r m y 2008 a y 2008 r g a ce sha oups held fo held oups n n r ua e r r cludi efe t n r s n ts n e equity holders of the parent holders of the equity n 20 Feb e ts m n n m tible p tible d disposal g d disposal r d o n r ve vest n n ty d equip r afts afts eceivables i eceivables r r ts ts n payables payables

payables payables gs efit obligatio d

n n r r r r n n i e e ted i t a ope m r of co of ectly associated with disposal g disposal with associated ectly n n m m rn r e capital n iu ves cial assets assets cial cial assets assets cial cial liabilities liabilities cial cial liabilities liabilities cial r t assets a r G W Rose Rose W G t p t be n n n n m r n d ove n s s n d othe d d othe d d othe d a a a a e e e d cash equivale d cash ies n vest vest e r n n e n n n n n n n r n eceivables eceivables ese rr n n t tax t tax rn ty, pla ed ea ed r r ed tax assets assets tax ed ed tax liabilities ed tax liabilities m m r fi

i fi i

fi fi n n to n

gible assets assets gible s a s r r r r r r r r rr rr e e p oved by the Boa the by oved e e n -cu r r n r n n n rr rr

ovisio ovisio ope ade a ade ade a ade ade a ade vest ve ta r r r r r r n n n

Defe Othe Othe Cash a Cash

Othe Othe Othe

Equity accou Equity Cu Othe Retai to attributable equity Total P

T Cu I P Othe optio Equity T Defe P T Reti Othe App Minority interests interests Minority Issued sha Issued Net assets Net assets Capital and reserves liabilities Total Liabilities di Current liabilities Current liabilities Loa Non-current liabilities liabilities Non-current Loa Total assets No Executive Chief G I Current assets Sha equity Total I Non-current assets assets Non-current

as at 31 December 31 December at as Consolidated balance sheet sheet balance Consolidated M J Tu – – – – 2 4 1 m (5) (9) (2) £ 88 21 57 47 28 53 66 (4) (70) (27) (85) (11) (12) (84) (45) (60) (40) (13) (26) (20) (12) 195 135 367 139 557 422 646 993 213 174 495 778 174 592 2006 (113) (468) (419) (834) (925) (187) (315) (921) (112) (346) 1,562 1,212 3,074 1,639 2,491 3,100 3,074 (1,337) £m 2007 (58) – 13 (4) (139) 6 (8)

(1,240) 343 (31) (112) 1,820 175 – 57 – (307) (6) (1,731) (47) – 34 (233) (25) – 78 (1) 15 3 52 610 (22) (1) 3,046 922 (188) 3 900 22 335 – 96 2,162 1,212 (271) 3,074 (224) 53 (40)

(1) 3,062 (611) (31) (16) 3,046 805 (10) – (782) (1) (50) (396) (152)

27 30 27 Notes s n s n atio s s r n atio s 14 r n atio r ts atio n r gs g ope ued ope n n n ti ui n n taki g ope ued ope ti r ities n n n r ti de ui n s 9 s n n t 4,5 t n ti n s 4,5 s n y u e s s r n ts – co ts – disco n m t t atio n n d cash equivale cash d r n ts ts ts 9 e e n e atio n n r m m e ts ts e ts ts m ts ts – disco ts – co n n m m n s s n n e e es es gs gs e n e e d equip vest vest gs9 m n deposits/secu m s s n m g ope ued ope t t r m s s m m n n s s n cash a n vest t t vest n n n n n n atio n n n t a ty e ti ts 15 ts ts ts s r s efit obligatio d equip ui taki r i vest e n n n r n ty 15 n taki n n y n r n vest vest m atio r ted i ted i n r r ty5 e e atio atio r ti ts n n r r n n i r tal pay rm s de e sche r n n ted i t a tal pay ope m m ges o de n r ua n n r g g atio atio n t be n n ope n r n e r n n es r pai gs 29,31 gs n r e ope r ty, pla r t othe ted i ted i r t p y u r n e di g ope ued ope m vest vest r n n n y u n d equip n n r ests n n m n ts 15 ts e uivale t othe t e t p r n g capital: g capital: ge P ti d i i e n q n ui g ope rr n ued ope g ope ty, pla taki ued ope ope r r n t of loa m chase) of of othe chase) n n n te r r r e e capital capital e 27 e n t fu n e n r n n r t a ate cha ate n n ki ce sha ti n rr ti r ti a m -cu ted i eti r n ui e m ui de es g activities n r esses – co esses – disco esses e n n n n ts disposed of with subsidia of with disposed ts ts at 1 Ja at 1 ts n n ployee sha ployee r n

n ce lease lease ce ope n vest n e n n m r equity accou equity accou equity ce lease r o n n -cu s r ti m ity i ge ti n n m t othe t r wo n n financing activities activities financing n n co disco n n n vest a m m vest ati n s y u o es es n a o r n n r o o r d cash e d cash m m n e efe n n n r r ty, pla n i r i y sha epay eceivables eceivables n vest r o o afts afts rr tisatio r r r r gible assets r r sale/(pu r r n

payables payables

m p ms.com n r r d f f o ovisio ope loa m n r r r sha m -cu r excha t offi ope ed with subsidia with ed ta o ease i ease n m o se – disco n se – co t of of fi t r r m m r r disposal of of p disposal n n sale of p sale of Excha sale of equity accou equity of sale sale of sale of subsidia issue of sha of issue sale of i r n p easu ted i n o n n ds paid paid ds o o n e r r r n m n m m , a m m m m n e n liabilities fo liabilities eig m o o o n o o o o eceived f eceived f eceived : Cash a : Cash d othe d d othe d r ) o n m r r r r r r r t of othet of r r ies g esults of equity accou equity of esults esults of equity accou equity of esults n n ts i n r n r r ce costs – co ce costs – disco – costs ce eceived eceived n the yea the yea n r paid paid expe expe d cash equivale d cash d cash equivale d cash e n n r r disposal ofbusi disposal of disposal of i disposal ofbusi to flow f flow flow f flow ds ds ds paid to to paid ds o paid ds e n n n n n a a isi n n n n n n n oceeds f n n n n www.baesyste www.baesyste r rm n n r m

eciatio e of e of ease i o est est o o est ele est est paid paid est o p ease)/dec ade a ade ade a ade ve r r r r r r r r r r n n n n chases of p of chases chase of equity accou equity of chase chases of i of chases chase of of subsidia chase chase of of chase chase of of t chase chase of of ow chase n m

r r c r r r r r pai oceeds f oceeds f oceeds f oceeds f oceeds f oceeds f ofit fo ofit fo ofit oceeds f te te te r n r r r r r r r r n m n n Net fi Net Net fi Net P Sha P Net cash (outflow)/inflow from investing activities Pu accou Equity Net cash inflow from operating activities activities from operating Net cash inflow Pu Gai Net p Net Pu Taxatio Net cash acqui cash Net Gai (I P I Pu Gai Cost of equity-settled e of equity-settled Cost Move Sha Pu Loss/(gai I Dec P Cash and cash equivalents at December 31 Profit for the year the year Profit for Taxatio Dep Cash a Cash Cash i Cash T T I P Gai P 92 Effect of of fo Effect Cash and cash equivalents at December 31 Ove Co Cash a Cash Net (decrease)/increaseand in cash cash equivalents P Capital ele Capital Divide Divide I I Taxatio P P

for the year ended 31 December 31 yearfor the ended Consolidated cash flow statement flow statement cash Consolidated Net cash outflow from Net cash outflow Cash i Cash Pu Pu divide Equity Divide Divide f outflow Cash 84

93 – – – 85 3 3 m £ 11 72 65 21 (92) (26)

221 692 2006 (448) (227) (162) 1,639 1,701 1,704 1,704 ised n ecog r t of t of n e – – – 5 m (6) (6) (1) 24 41 43 21 96 £m d liabilities has also (19) n 544 462 922 2007 (259) 1,363 1,384 1,384

solidated state n BAE Systems Annual Report 2007 ed tax assets a rr

8 8 the Co the n Notes tly i r g to UK defe n d pa n t a n e m ate applyi r e state m ge, the the ge, n co n s s n ts ts atio n r e solidated i n m e with this cha this e with n li n vest the Co the ued ope ued n n n ti n il 2008. I -sale i -sale r r eflected i r 1 Ap tly r m o ts: ts: r es: es: ts ts n n e m e m m disposal – disco – disposal disposal: disposal: sche t, which is pa vest n n n n vest n e o n m n sio et i et ve o n r n -sale i -sale cy disposal of available-fo of disposal ese slatio r r n n n ate adjust ate e 30% to 28% with effect f r g a ve ve efit pe efit r r rr m n n o r ts o g a ectlyequity: to n n cu r cy t ts ts ts 14 14 ts ese ectly to equity equity to ectly 8 e n r r n n n n eati di e e e e m ed be g r n di eig rr n n m m m r educed f s n et hedgi et available-fo r ove n n n directly in directly in equity fo

s m 1 defi n vest vest vest n t s n n n n s take atio n r o ts o r s take e n n m atio s o e m r m ulative ulative ulative cu ulative ate will be be will ate n ted i ted i ted i r 30% to 28%, c value m ite se. ests ests r m m n n n r n m n ite o eholde slatio n r te r t tax t tax ove n g ope ies ies ies ued ope ued n edited to hedgi to edited n r r r a r n ial gai n e m r r d expe rr ti ui n g of cu g of cu g of fai ity i n n r ate adjust n n n ts c t tax o t tax cy t r educed f ti ed tax o tax ed e a o r n n n

n n rr m n e e value ou r co rr rr

n bee i m Co Cu Disco Recycli Recycli Fai Subsidia Net actua accou Equity Recycli A Net income recognised Net income recognised Subsidia

to: Attributable Profit for the year the year Profit for Equity sha Equity Subsidia Cu Defe Tax Equity accou Equity Equity accou Equity and expense income recognised Total Mi 1 The UK cu 1

for the year ended 31 December 31 yearfor the ended Consolidated statement of recognised income and expense and expense income of recognised statement Consolidated t.

g r

n sed sed

n gible gible r n r r it to

i n n flows, flows, ofit ofit of

n ou n r t of rr n n ts. t n ed ta y. n fai m oup’s eve r use, use, n n y such r g the g the ed r n r r t p g u r to n e n n ou ease i n n gible gible n r ti ate used used ate espect t. m ot exceed exceed ot ot bee ated. Fo ated. n r ese g to the sale is is sale m c n side

n r t occu r dust n n ati m t lossi n et of of et pose of of pose n m side n dicatio r ta n e n n r t cash i able a n n p n n sitio e n the G r g a r t i n vest d goodwill, the e m of of thei the disposal disposal the i n n n r n n n n y i n d associates n a elati t loss is is t loss ce i g value i e co yi de eve goodwill, goodwill, r rm r n ed, ed, n r ied at cost less less cost at ied n n espect ofothe n n n evious UK GAAP UK GAAP evious n rr discou n r e cash flows, flows, e cash tised cost is is cost tised t does does t r e i rr

r r t loss i t loss eviewed at each each at eviewed n ecove eate n t is estit is the pu the ted i ted the esti pai r r r n o y subseque y n r n n n ce sheetdate. e state rm rm es a e n m tha e ou m al value based o based value al r use, a n e is a r r depe i r d ca m t loss had r n ou t of Assets. If a cluded i ate. ate. i n m t at that date. Goodwill that date. t at n rm tu tedto thei . This is co pai oup we n n r ates. Receivables with with Receivables ates. g a ge i s based o n the ca the n r m to 1998 has to 1998 n r co n n its fo its n r e n n n t r e assessi d losseso m usedi gible assets that would have have would that assets gible dete i rm e n n t the cash-ge t a t lossi g a the n pai n n i n n n r n io r ated futu ated n n i rm n n r n rm gely i gely m t ve eve rm ta e e t of goodwill of goodwill t ed at the p the at ed ied at at a ied g u yi r m e of the defe i n n s a n n n rm r e theof date t n ised. A ised. ted. rr rr pai able a able n ies is i pai r n the i t. A rm a cha rm r pai n n r ojectio ed fo ed n m ou n r n m ati use. I use. e discou n m atu it exceeds it exceeds its r i etai r n m pai pai sed if the subseque the if sed tity if it had applied IAS 38 I IAS applied had it if tity r i n n ate la ate e o i ou assets is the g r dete

r n clude a clude te pla of that ed by the G the by ed r n n e whethe m ecog m s of joi rm r r n n e oup’s assets a t classified as available fo as available classified t m n r s befo ecove n g a i r i n ised i ised g u r rm n i n r loss. A loss. e-tax discou e-tax n ised whe ised eve n n elated objectively to a to objectively elated n n r ated atated each bala r e-tax discou e-tax e UK GAAP p r d i , if n r r ot yet available fo available yet ot r ed e ed elated to i to elated yi rm n n ot discou ot r r m m n ati g-te rr n r al yea al de d value i d value e has bee a n t value of esti of value t ot ge ot able a e g value of equity accou equity of value g r ts e n be be t losses. Gai t losses. ecog n r n n r e n ofit o ofit n t of assets ca assets of t t of of othe t cluded i espect of assets, othe assets, of espect n ecog r s of subsidia r n t is dete n iate p n n r sed. A sed. r r vest ually fo ually n n r n gs. iate p r n

n yi e g tested fo g tested r e n a ed by IAS 36 I 36 IAS by ed n tisatio n r ou n rr r r ese n nn t loss was acquisitio ou ou op ts of thets G ate of 8.43% hasbee ou e cash flows a flows e cash r t that would have bee have would that t t is esti t ca rm r ot i ot acquisitio o op m r n ves u r n eve n the fi the r ecove n n n m m r n n g. r s use cash flow p flow cash s use r m r e t m the acqui the t that the asset’s ca bei ess Pla ess n n atio pai ough p ough n r ou equi y a n n ou ou ou r tised cost is is cost tised n r r a ot sed if the rm g o y 2004) has bee r n app r r ese m m r t loss i t loss is n s fo clude the ca the clude m m m r n the ca d is d is o equity i n n n n n o ised. ised. du n n n e-tax cash flows. flows. cash e-tax pai able a able able a able acquisitio e the its cash-ge its m ua e e able a r n n isi r g a r ded i r eve t lossesa t testi t as g a r r n n g a n disposal. disposal. r r m i exists, the asset’s asset’s the exists, n rm ated futu ated n n n n n sed th sed n rm rm n tity i ial, afte r yi e e e ted atapp yi iate due to the to lo the due iate m r able a able a rm n r ts,a as off to off to rr ulated i ulated n r r eco ecog t-te rr asset that does does that asset ojectio ated Busi ated r pai pai r r n ce sheetdate to dete rm n rm rm r e ecove ecove gible assets that a n r

m eve ecove the i eciatio op r r ate n cluded i cluded e-tax discou e-tax r r r n ied at a ied at m m stated a stated n n r n r r ou a n i i n ly to the exte tity sold. pai asset o asset pai pai r rr itte loss o loss ojected p ojected teg ta dicatio r n n m r ot ot n n r n especta of ecove ei ecove n m m n n mm m bee of a of accu Goodwill is tested a tested Goodwill is A a IFRS (1 Ja is i of goodwill is of goodwill is dep which the asset belo asset the which a The a sho bala Impairment Impairment The ca o n the p the A discou Goodwill a assets. Goodwill o Goodwill assets. r the ca the the the These calculatio I calculated as the p the as calculated i r Goodwill is allocated to cash-ge allocated Goodwill is r afte o value usi i The e Goodwill Goodwill o Fo i I w i to dete p the esti the bee Assets at the date it was acqui was it date the at Assets assets is is assets r A p value less cost to sell a sell to value less cost i ca app

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m epa n e o r ese clude the special r n , equity i , equity n r r al Fi al n r d which have have d which r n . Ide rm n pa u n n oup has joi be n es a r n et assets acqui assets et r tu pages 23 a pages 23 r oup o e applied to those those to applied e tity is fo ough fo ough m r r n d losses a d losses m r n n s p n n ce, but but ce, st the i st the cial liabilities (i liabilities cial ese r tu n e the G e the eductio g esti r oup. Co g this set of of fi set this g the i ted fo othe ies i ies atio sed I etatio n n n r r d head leasea r clude its sha its clude n e ge a r ded to the r the p the r r n n n t o n et assets. assets. et -sale fi -sale a solidate the n n r co n ical cost co ical n n n t ve rn p r ti y loss o y loss ted fo n r n n of the c of the r e p n the date of of acquisitio date the n

do n n r n ties to t the flue ged G te r n t ve d i ed at the date of excha ou r n ofit a ofit r itially at thei itially te m n r n r n n epo tifiable d fi ded i ded n n m o ts i r e if the G e if the oduci t liabilities assu t liabilities la r r ess, o n r n r t i e set out below. These policies policies These below. out set e p values a ts a n ts ofts BAE Syste n pa sacted th sacted n oup. The cost of the acquisitio the of cost The oup. atio y, joi r r r n n r r r n e n s’ n t f p tu n g is used to accou ated agai ated r oup co oup ed i ed aft sold. sold. aft oup. A oup. e e ge a n n r n eco n r r cial policies of the e the of policies cial m ethod whe ethod r n r r wise, wise, n i e c ti assu ts a r n ittee i ittee m m the histo the . Fai r e of e of thei r ifica m ti ed to 31 Dece ed to 31 n r n tities, a a r m r m n the e n n ecto t ve is olled by theG e n n r itical accou itical n r n easu n de r mm t oup t m ds (IFRS), ds (IFRS), I d expla ded so that the the so that ded e of thei e of cial policies. A policies. cial ibuted is accou ibuted is esults accou esults al ai n of available-fo of the G the r esults of such subsidia such of esults ed o ed n ce with EU e r r r epa r r y e m c d fi n r n r n t esidual values a esidual values r n n d co n rr e of the ide the of e n is eli is r n a ts used i n r e est i est n da a subsidia cial state cial n r r cial assets a assets cial n s Co n e state value of the assets give assets the of value ies by the G by the ies eco cu da g policies applied i applied policies g n ts ofG the n e p tai cial state cial cial state cial ed u ed n n r r the Di the ibutes a busi ibutes cial policies. Joi policies. cial r n r sactio e ibutable to the acquisitio the ibutable to r g a r a r te n r n egio n r m n a n a n n ibuted by othe by ibuted n t r tity co n tly appliedall toyea the n n d fi ti g co e m r e

ts). a its activities. Subsidia activities. its n a n the equity a acquisitio a n r t e subject to the excha the to e subject n n r n n n r co n n n n r n n alysis a alysis m est i est oup has has sig oup n cial state cial m epa ati n g Sta e r r e ms.com r r t fi n n o acco atio de ded as a joi as ded evaluatio etatio s a cludes its sha its cludes n tai ies Act 1985 applicable to co Act 1985 ies n r ade i ade n g a r ethod of of accou ethod r r a m r te n n of of fi d fi p less stated othe stated less n held withi held a n n ti n espect of n p oup’s sha n u r siste m n n n r n n n n m r r bi r the t u

as a ectly att ectly n eased i eased i d judge d oup co ealised gai r r ce r pa cludes its sha its cludes r ega ati d associates’ d associates’ n r d its subsidia d its m ed i n te st ess bei ess m n ess co ess r r d liabilities a d liabilities n n c g a r tities that G the n n y is a y is nr eleva m of of subsidia date. The excess of the cost of acquisitio of cost the of excess The date. n n n atio o efits f n d, u d, n r co r n n a n r r ed as the fai the as ed d liabilities i liabilities d ts. A n n

t i ts is s which a s which r sactio n n cial state cial the ope the r n r n n g I n y a n y u n n cipal accou cipal n solidated fi solidated solidated fi solidated ts o ati epa chase g f solidated i solidated rn e ted fo ted fo n e n e n a r r tees i n a r n n n epa i g a be n n es’ a es’ r ed a ed www.baesyste www.baesyste n n ti es theuse of ce IFRS. IFRS. tity is n ates a ates r r n ce sheet i r ess co m r cial Repo cial e wise stated. stated. wise m m r

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n n eviously bee odified by the the by odified ethod, all of which a which of all ethod, the busi the n n n n r n equi esulti eco n They have bee bala ste state while the i the while judge accou ve of the busi gua r ove acqui plus costs di costs plus The p Co pu The co u de its ope Fi A the date of disposal. disposal. of date the issued a issued such t such obtai bee The fi Basis of consolidation a the co the The pu is acquisitio state accou ope p assets fo assets r esti to gove Repo m a associate if the G the if associate othe The co Basis of preparation r value ofG the acquisitio i Whe m A subsidia have bee busi pay

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1. The p

co Notes to the Group accounts accounts the Group to Notes 84 94 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 95

85 n r se r d

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r n r r e capitalised e capitalised s, o a faste r r e basis, to s, o s, o oup, a oup, r m n e r r t ove aight-li elated ove elated

atio r r r gible assets. assets. gible rm n r r r n n t o te te n n se as i se as s acco r r d assets i se ded expe ded e. e eciatio n r d r te g costs beyo r n tially i pute r bi n n ials, di ials, n ditu pai r ta e n r m n n oductio n n m m a st a bu r heads. m m a r n the expected life of of life expected the d a r s r m aight-li ate r ally ge ally n e stated at cost less less cost at stated e t activities applied to a pla a to applied activities t t losses. Capitalised Capitalised losses. t r d i t losses. The cost of self- of cost The losses. t if sho if if sho if expe esidual value, usi esidual r ised i ovides fo ei n n n m g co r n use use withi rn r r oup fu n n ated useful lives a lives useful ated r ove e e n r e rm rm i a ise o t a te n ess co d equip r m substa n m n a st n the basis of the costs i costs the of basis the r n e state t activity is pe te 3 to 5 yea 3 to 5 life if sho te n n rm BAE Systems Annual Report 2007 rm ite useful lives a lives useful ite n e e is stated at cost less less cost at stated e is n i n olled by the G by the olled esses, dep ated ated r m ecog n tai r n e n r t m t a ect labou ect n pai tised ove ces yea 2 to 5 ces fo pai esti m t yea 2 to 5 r n n co r eehold la eehold efits exceedi r et. The expe The et. m ew o ew n n policy above. above. policy n r ai m wise a n m o ditu n tisatio n r n e oductio ally o m ised as a as ised f r n r g is g is m a busi a m busi n n t with cost

d i 85 gible assets. Capitalised softwa Capitalised assets. gible o e as follows: d i develop m e n r r n t losses. G losses. t thei rm n r n m n y esti itio n of of n r m n o e lice e lice o n ty, pla d equip ic be n n isi ials, di ials, a r r r ta r a e r n r ica of of p g o n s a r n n m ecog n e o n n t life t expe e is stated at cost less accu less cost at stated is e e is a r r n e g f o r siste r r rm oducts co oducts gible asset o d develop n t a ci ate r n ope n n ecog m cludes the cost of tio n ces have defi ces ces yea 20 to up n e r n n ue a ue t, r r ovided o ovided m ated useful lives of the i the of lives useful ated n acts. Typically this p g. n n r pai ged to the i the to ged n ditu n t 8 yea isi r ta m would othe ditu ditu r ditio e develop r e p oductio t n ulated a ulated g to use the specific softwa specific the use g to ha n e softwa softwa n m tisatio r r r n n tised ove n n m n r r eciatio th A ue ue n r d sho ovided, ovided, n n r ectly associatedwith p the e ch a opo r r m i i r m r n o eve r n r t o r ised as i t yea 10 to 15 n sale is r is p d i m ty, pla r n co d lice d lice . n n ate eco ate m r n tha n m t co r e n n n n pute pute e n t testi eve d b e di n e the p isp ischa a r r t expe t t expe t m n n r e m m m esea n n n a basis co a basis n tai gibles gibles yea 10 to up r ope n n iate p e r the esti the r ecog ates: ates: n es fo r ated useful lives a lives useful ated n e ded expe ded e r g equip r ks a ks a r s, the fo uctio e a r r r oup’s No n n rm r r n m rnm ta eciatio m m r op g e a a BAE Systems Annual Report Annual BAE Systems 2007 e r ch equip ch r ique softwa ique eciatio gs gs yea 50 to up r n ulated a ulated ulated dep ulated ocesses, is capitalised as a as is capitalised ocesses, mm r n ucted assets i assets ucted st r ed co ed ed co ed oup’s oup’s oduct. oduct. value,a vehicles a vehicles r n m m ateduseful livesa to n m r equip i r r r tisatio r r tisatio a e the r pai gible assets a assets gible n r r eciatio m m puti s of s of p r aft aft yea 15 to up r r r , a r n m r st ks equip ks r m o o r m m c app d p d u n ite off the cost of p of cost the off ite oup-fu desig og obably ge obably ovided o ovided ade oto ade ta r cludes the cost of of cost the cludes the G the r r m r m r n n r n r r r n n n I at cost less accu less at cost develop to acqui to capitalised as a capitalised o accu T w Acqui Capitalised develop Capitalised i asset if ce if asset Other intangible assets Other intangible Acqui a Dep G The esti the G the basis ove basis p No dep No develop US gove of dep a custo yea p co A a esti followi Buildi the p the Whe p wo m to i at fai at associated with e with associated accu Othe I co of Capitalised softwa Capitalised T Othe Property, plant and equipment Ite Resea Co Ai a Costs that a that Costs

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r n seas r n n r t r es a es n n n t n m n a sepa ts r n eat e off as slated n n r n r aki pa n tu co n ces i owi ight to ight e e) of a of e) ce to ’s le t of p r m sale. sale. n n a n ates of of ates date to date rr m a lo g t the sig the

n n r n ulative ulative ised i ised r slated at the the at slated m n r e r n n n y assets a y assets itte e r rm n acts is a is acts e state n e of the co the of e r r m r ofits o r ti ou ot as a sepa ot as e of sales of joi of sales of e e t ge r t a t ve de ectly i ectly edbuye to the a m r r r n m n r acts. Sales Sales acts. n n n n m n rr r elated to to elated age age eta sitio efe t a r ilesto r of of bo et co t activitieseithe r d p d accepted by by d accepted ecog ed the r a n y 2004 a y 2004 n t whe n rr n r n t of equity. equity. of t n r n n m loss o n n a sfe n r ot u e n e r ediately as a ge diffe t. n r e n e ua Co n n isks isks a m ised di ised n n m r r ce. This is usually whe This is usually ce. n e

act a act n ed o s. Mo s. slated at the excha the at slated slatio mm n r t r ed. ed. r d liabilities of ove of d liabilities n ofit o ofit po m t n oup’s sha n n r n a i ade bythe Co r e r n n a a e the t cies a cies m equity but ce sheet date. I ofitability of the co ofitability vices pleted a pleted r r m til the outco til the r r r m uctio of these co rm rm n n n ecog r ecast costs afte costs ecast n issold, the cu r m n solidated i solidated e co r g excha ised i ised t hedge accou hedge t e state ce 1 Ja fo e t n d associates a easu g leases is slated at ave at slated ch activities is w n st d othe r r rr n n n r n sactio n n n e of sales of joi m n d develop n rm all p e e state m co is ated as hedges of such i such of hedges as ated ce sheetdate. These excha r n ted i the t r a n oup has obtai has oup ate co ate g the G g the d fo n n n of of se r n a r atio cu n r m co m ati tifiable phase ( phase tifiable r n r m n pletio ed n r acts u acts t ofp the n n n r ecog g-te r r es a o tio esea ts sales ally dete e t esulti r ose befo ose co t r r m r cies a cies r n e of sale. Sales a Sales sale. of e r r r r its pe ical a ical ch a n the co

ese n n r ised si act costs will exceed total co ofit is calculated by by is calculated ofit n de eig r e vest r tu n r n r n et sha et r m ope ue a ue g f n eliably eliably n e t n n ship have bee have ship n r n r n n n the i e ovisio n rr co g at the bala the at g ese r r ated ove ated fo a sepa e e p . All ts desig ts n r e o aft ope n n r r e basis. e basis. IAS 11 Co 11 IAS isi r n et i et r n n t as pa t as ge fo n esea t has bee has t asG the eig m r r t ve tech behalf of of custo behalf e ge r n cu eve c be be ecog n ately ide ately r tities a n e n ised i ised r ep n n r r r uli

r r n es yet to be achieved. The a The achieved. be to yet es n oup’s lo r n n gs, excludi gs, n r e r n e poses the assets a r de ated. P ated. m n oup’s oup’s g at the bala g at the r n ditu o ai r vices n m ised i u ces that a g a m r n n m r r eig ised o ised ue ue act act ated i ated n n d the p d the a fo n ectly i ectly r ces ces a m u r ged to the i ate ate r n n pu n n e r n t st r r uli takes n taki n ecog o i aight-li ces fo r excha r r n r r r r n acts acts n ds of ds of ow fo e e g the yea ilesto adi ised at the ti the at ised n r n r m y 2004) a r r d se a sepa r t n n r e n r ge i ecog de o i tities, joi de m . n e f r n e r r r ecog n e state n n y t n n n d associates. r s i ua e m d cha diffe d costs ca d costs a st ted fo n ates ates m cial i cial e develop ewa ised di ised as soo n m t. Whe t of equity. of equity. t n behalf o behalf ce r n g at the dates of thet r r ce to the esti n ity of the G r co n n n n ded expe n ts of suchts e m n n r n y e y u n ecog n n co n n n co atio pa r r r a n co eliably esti eliably cludeG the d e e r a n ces a e r solidatio n rm n ge ge diffe ge ge diffe ge ge du e n n r n n n m uli oup u n obable that total co total that obable ajo es a es n r r n n n n r ed a ed ates of co of ates ue o r ue a ue, the expected loss is is loss expected the ue, ofit is ofit is fi e rm m

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less they qualify fo qualify they less r its ow its n m r m n n n n n oup fu oup ofit is ofit e accou e e a a the i which case the effective po effective the case which cu te r r r r n n r r r eve isks a ates ates eve eve n n n n a a The at the excha the at r Lo diffe r i othe ve excha excha Re No p No IFRS (1 Ja co Lease i Fo subsidia the custo the subsidia associates. Reve associates. by by i co title passes o passes title excha att G i liabilities de co i co o r Sales of goods a of goods Sales P co excha pe T r u state ca Sales i Revenue and profit recognition 1. Accounting policies (continued) policies (continued) Accounting 1. suitable allowa The G Research and development T Foreign currencies Foreign currencies it is p it is r Goods sold a sold Goods a esti

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te cial assets with fixed o fixed with assets cial d i e o n tha n e n n atu m the i n n r tio n r n n n ts classified as available-fo as classified ts n ed o ed e ce sheetdate. n m r n ulated dep ulated m a n ulated fai ulated ated useful life of up to 50 yea 50 to up of life useful ated ds to dispose of the i the of dispose ds to n the ou ts a m n e n m te oup did did oup m m n cial i tially all tially ed. The G The ed. n ts a r t of, whe m n r m value th ce costs. n d lossesa n e te vest n aight-li ce sheet date. date. sheet ce r n t as gai r n a age a n n n e chase o chase n loss: fi loss: n m ty. The G The ty. ts othe ts r a n n ulated dep ulated n r i deposits, p r d useful lives a lives useful d cluded i e valuea ealised gai n t i m n a d fixed vest n r n n m s a fi e value plus t plus value n m n n nr r rm r ce leases a leases ce a st deposits a deposits fi ce costs i m n e , the G , the ivative fi vest its esti its m ope n r d i n r n ce sheet date; ts classified as at fai at as classified ts n r e acqui r e leased to to e leased n vest ised whe ised d adjustedd if app r m ofit o a n n r rm n a g accou ts have expi have ts r t valueof the n n n ts a n ied at fai ied at e n n n -de n t p n ed substa its to pu vest g the effective i effective g the e rr fi n ed, the accu ise. U n m fi age e rr d othe r r r ds to dispose of the i the of dispose ds to n n d te e state o e n n m ty ove n n ts we m n ese n ecog r ated by by ated es the classificatio taki a m r de r m n mm iate, at each bala each at iate, sfe pai value of i of value n te n n ough p ised at fai at ised r vest d stated at a at d stated n e i r m ot ca ot valuea g the yea g the ovided, o ovided, ms.com e held at at fai e held n r ths of bala the n y; y; equity. Whe equity. co ities withi e applicable, useful lives lives useful e applicable, r r n ealised gai ealised r n n m vest r n gs that a n ity: r r ks a ks a ope m n n n i r i op r r n itio rm t has the positive i positive has the t t i n ciple. r n vest -sale: i -sale: nr r r e de o r eceivables: te eceivables: t a r n n n eviewed, a eviewed, n n ed u ed d sales of of i sales d r i r cluded i esidual valuesa esidual values, useful lives a lives useful values, esidual less n m t p e e r isp desig atu n r r oup co n d the p d the ecog vest n able pay able r d u e of the lease, lessaccu n r n d r e n n m m the i ths of the bala of the ths the fai the n r n m ised i n t losses. t losses. n n e the i ts a ts as follows: as follows: ts t secu i m g p n n n e i ecog n n n n n n value th 12 ity. Du g o r r which they a they which ship. ship. m m n o r tised cost usi cost tised r e e d buildi e e r e n n rm values of quoted i quoted of values n age age r s a o ti e sold o e sold n r e oup dete r m ty at its cost less accu less at its cost ty n n o r oup has has t oup n www.baesyste www.baesyste m m m n r itially r d associates a d associates ce sheetdate. rm rm r n

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sheet date. Whe Notes to the Group accounts accounts the Group to Notes of i of 84 96 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information

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m yi eithe the G the efits will be n r ed by by discou ed po s u n is based o based is n r the u n k which hasal n acted at the bala at the acted n rr n ded as w ded se i se n n r n n i r r m n ded whe ded co taxpu vest ised di esults o the ca the r ised whe ised r r r d the d the the taxable i n n n n g pu e as the liability to pay pay to the liability as e s fo rm iate p n n substa the i as a as eve a co eco n r n r g te ic be ced. Futu efit will be r r m n n the dist the eco ti n n m r n ovisio , a r m op e r ce sheetwhe m ly toexte the o ecog n ated ated r ot ot r ovided is basedo g to i ecog educed to the exte the to educed o tively e e r r e ti BAE Systems Annual Report 2007 ou r ised whe n o r n r r n t has bee n n g the bala g the n r m ised whe ised n e dete act costs will exceed total exceed total will act costs the yea the t of thet ca s m epo n ovisio n ofwo the r e r ised i ised r ly. s a nn n r r r t n r n n m n acted o acted app g pla n e ou oup f oup n n elati n s a t to tax payable i ise f ise g its obligatio its g r i r tio ecog r ces betwee ces m m r ised o ised n n r cial cial r n acts a acts equity. equity. ecog 85 n r n acts is is acts obably obably g of all possible outco all possible g of e n r n t ed tax p tax ed ecog r substa r e egula n r the bala the t r a r r n ot deductible fo deductible ot ovisio rr m loss fo loss ces full, usi full, r n n n eeti uctu r n g is elated tax be tax elated n r ates e ates n ated co ated r e sold.The p uctive obligatio uctive n r publicly a publicly ovisio fi m ecog e co settle r i r liabilities that affect that liabilities r r r r r r d the a d the n r m ised i n est that po that n st ties is n r r o y diffe ofits will be available agai outflow eco of outflow poses. The followi ised i ised at the sa elates to ite to elates ofit o n n r r n r r a r d as liability p d as liability acted o acted n n n e tax is is e tax ous co a a al uctu y adjust g tax n r n n d. ial, p r t of defe the basis ofesti r ed tax assets a assets ed tax ived by the G by the ived r n rr n co m e ovided i ovided n n n r d diffe vices a pu ecog r d a weighti r e taxesa that rr rm e updated e updated r n r po n : goodwill n r n . co est ess fo ess r ecog ecog m ou d a ate r r has bee r e cash flows at at a e cash flows o wa ues. Such p the p m r r n

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Notes to the Group accounts accounts the Group to Notes i be is pe 84 98 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 99 1 1 1 s r 85 m m m

21 £ £ £ 3 (35) m 411 322 646 102 859 413 266 m 287 2006 2006 o (180) (213) (195) (518) 2006 r 1,068 1,054 2,098 3,971 2,093 3,905 2,107 4,348 3,997 2,112 ue ess ess esult n 12,333 12,851 12,333 r n Restated Restated Restated ue f n al custo oup Busi 35 58 £m £m r rn £m (38) g 431 292 900 202 414 219 243 Reve 2007 2007 2007 (159) (335) (503) 1,180 1,177 1,235 3,526 4,710 2,042 3,812 2,052 5,071 3,909 3,537 exte 14,309 14,812 14,309 1 1 1 – – – – – – 1 m m m (2) 14 14 92 21 £ £ £ (32) (34) ue 377 518 177 ts Reve 2006 2006 t of ess n 2006 n n n 1,256 1,255 1,433 ted e e n eve m Restated Restated Restated r rm

Add: – – – – – – – gible assets a-busi vest (3) pai r n 11 10 97 24 accou £m £m £m oup t n r i m n 170 361 503 ta I I g 2007 2007 2007 2007 2007 2007 sales to equity (148) (145) n i 1,111 1,111 1,281 BAE Systems Annual Report 2007

1 1 – m m (1) (4) (8) (4) £ £ (20) (66) (14) (10) of ts 2006 2006 n (105) n ted e (2,865) (2,865) (1,321) (1,321) (1,522) (1,522) (2,865) (2,865) n m Restated Restated tisatio Less: Less: r – – gible assets vest o (1) (4) (1) (7) n accou £m £m n i (19) (15) m ta sales by equity 2007 2007 A (149) (110) n i (2,682) (1,307) (1,367) (2,682) 1 1 m m £ £ 415 295 342 168 429 ts 2006 (147) (695)

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3 co 84 100 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information 1 101 1 1 1 2 3 m m m 85 £ £ £ 85 84 51 15 17 51 14 ity Total r 153 422 2006 2006 2006 £’000 4,322 3,149 1,248 4,169 3,868 5,453 ajo 11,763 Restated m – 5 9 4 8 2 4 5 25 13 25 £m £m £m seas 112 112 610 2007 2007 2007 r £’000 5,570 3,364 1,460 5,557 3,924 ld. The 13,480 Ove r UK 52 – 52 46 62 108 116 354301 470 773 1,074 125 – 125 500563 – 22 500 585 687 349 1,036 £’000 5,413 3,990 9,403 1,0232,000 – 2,430 1,023 4,430 d the wo d the 2006 n ou r Total Total £’000 £’000 BAE Systems Annual Report 2007

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Loss o Loss Dep – – – 3 8 m m m (4) (9) (4) £ £ £ 99 57 13 21 14 45 61 21 43 84 39 (28) (42) (11) (62) (31) 371 259 143 143 739 147 2006 2006 2006 (157) (172) (325) (174) (277) (325) (694) (174) (195) (195) (257) 1,330 (1,525) – – – 6 6 1 2 (6) (4) (4) (1) (4) 52 15 48 46 47 21 58 81 £m £m 33 93 92 37 93 35 58 £m (77) (13) (22) (38) 209 135 169 845 169 2007 2007 2007 (241) (218) (753) (102) (241) 1,257 (1,199) loss loss r

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oss outsta r n ce sha espectively with fixed US$ coupo US$ fixed with espectively d i r e n n e rr r ate split o ate split r ate of 6.86%. of 6.86%. ate ted to a floati ted to oss-cu r e equal to the bala the to equal e -cu r r r efe n r ve est est r issuefloatia to d 2013 n est able 2010 2010 able r n n g a c te m te n n 2007, the g r n i tible p ity of the bo r ate swaps that fix the i the fix that swaps ate r i n ess. No ess. r be ted o ted n n r ve edee ted at issue to a ste tially co m r r r atu n ve 2011 a 2011 est est m n n r ve pa n es, es, cial liabilities a liabilities cial te r n til d by utilisi n n t 2011/2013 n ts 2011/2013 n t 2009 t t 2009 t a n n n n n e e e e fi m r m t of co the m m ce sha n ts ts n epayable i epayable ate bo ate e r r n n e stal stal g is fixed with a r stal stal e e m g e n n n n n r g fixed i to u n m m g cycle of the busi cycle g r n swapped u swapped efe u u gs is as follows: follows: as is gs n al i al i r owi r r n al i al al i al st epayable 2014 2014 epayable epayable 2008 2008 epayable epayable 2008 2008 epayable n n n r r r n n rr n st st ati r n n d, d, d, d, d, d, owi , fi , fi g 2007 was 6.49% with a was 6.49% g 2007 g floati n n n n n rr n k bo n tible p i epayable 2010 was co epayable 2010 r r of floati of li n r tificates a ate of 6.879%. At 31 Dece r cial i cial epayable 2027 was co epayable 2027 cial i cial r r r m has bee has al ope ve n n espect of all othe all of espect % bo % bo d, d, r epayable 2011 has bee has epayable 2011

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s n – (80) (15) (95) m m n ed efit £ £ 35 25 1135 25 71 n sio e ofwas whichdisposed of du (83) – – (83) n 521 1,138 265 827 473 (2,100) (1,221) (788) 774 – –774 – 774 r n pla 2006 be pe (3,167) (5,306)(3,167) (4,339) (3,081) deficit to the equity accou (2,092) (301)(2,092) (35) (2,428) (2,127) (326)(2,127) (46) (2,499) (2,866) (301) (2,866) (35) (3,202) (2,092) (301) (2,092) (35) (2,428) 14,289 12,461 10,143 9,305 12,579 1,710 91 14,380 n (17,456) (17,767)(17,456) (14,482) (12,386) (15,445) (1,931)(15,445) (111) (17,487) e of the deficit. The G UK defi r sio n oup’s sha oup’s r £m ts. ts. sha r n 952 £m 2007 e (156) Total m (1,999) 15,110 (17,109) of thei of vest n n atio ted i ted US bus SAS, the G m £m n r e of the IAS 19 pe r plans oxi r healthcare iate sha iate r 2007 2007 able app £m n op equityaccou r other n s assAi as well plans

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r e r es 3 318 (76) 229 (229) 245 –245 245 3es 318 (76) 229 (229) es – 7 (2) 6 (6) 5 –5 5 – es 7 (2) 6 (6) r the sale of Atlas Elekt Atlas of sale the payi etio r r sha easu r Sectio n ts, fo ts, n r n ge r oup e oup d expe d expe r debit) a debit) n ed to co ed to ope r efe o n n tai e r r ded at cost a cost ded at g t n r es – – – – (152) (152)––es (152) – – – (152) es – – – – (112) (112)––es (112) – – – (112) m de n r r r n m n e-based pay e-based es – – – – (50) (50)––es (50) – – – (50) es by ESOP ESOP es by – – – – (12) (12) – (12) – – – – 46 46 –46 46 – – – – 46 r ve. r r e a e a 1 ce sha ce sha r ds – – – – (396) (396)(1) (397) –ds – – – (396) ds – – – – (346) (346)– (346) –ds – – – (346) equi eco es issued issued es 1 63 – – – 64 – 64 es issued issued es 1 52 – – – 53 – 53 ticipa n n r m m r r r r n n ts – – – – 34 34 –34 34 –ts – – – 34 ts s of ce e e ts to G ts to y 2006 80 782 78 4,720 (2,872) 2,788 16 2,804 cludi et of costs) of costs) et 5 – – – 736 741 – 741 n n y sha y sha r r s e r co co r r n ese sha sha each p each r n n rm e e n r r elief u ESOP disc ESOP n n e n n r is also i is ote 14) ua sha sha clude a m m ts.

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Notes to the Group accounts accounts the Group to Notes Equity accou Equity Fo Move Additio 84 128 Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information Directors’ report – Business review Directors’ report – Governance Financial statements Shareholder information

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BAE Systems Annual Report 2007

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Sales1 by business group3 (%) EBITA2 by business group3 (%)

Main operating 21 24 27 26 locations

2007 Key points – Continued leadership in the provision – High volume of vehicle reset and – RAF Typhoons now operational – Saudi Typhoon contract secured Annual Report Download the latest from 2007 presentations of electronic warfare systems upgrade activity – Full six ship Type 45 contract awarded – Investment in the Kingdom of Saudi Arabia £15,710m £1,477m Keep up to date with our – New markets developing for the HybriDrive® – UK business returned to profitability continues Delivering global growth 4 2 – Launch of first of class Astute submarine presentations on performance Sales for 2007 EBITA for 2007 propulsion systems – Wheeled armoured vehicle successes – Orders received for second and third Astute – Down-selection for the provision of vehicles from our Results Centre. – Stable demand for ship repair services – Good progress in next-generation combat Class submarines for the Australian Defence Force vehicle programmes – Offshore Patrol Vessel arbitration settled – Proposed acquisition of Tenix Defence announced in January 2008 Access the Notice of Meeting and vote online You will find the Notice of Meeting for our 2008 Annual General HQ & Other Businesses Meeting available here. You can also vote electronically on Visit the 2007 Shareholder Reporting Centre at: REAL PERFORMANCE. REAL ADVANTAGE. the resolutions proposed at HQ & Other Businesses comprises the regional http://ir.baesystems.com/investors/reporting/ the meeting. aircraft asset management and support activities, head office and UK shared services activity, including research centres and property 1 before elimination of intra-group sales Shareholder feedback management. 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense If you would like to give us any feedback on this year’s Annual Report, 3 excluding HQ & Other Businesses please send your written comments to our investor relations team at: 4 including share of equity accounted investments BAE Systems plc 6 Carlton Gardens p36 p28 p30 p32 p34 London SW1 5AD United Kingdom or by e-mail to [email protected] The paper used in this document has FSC certification and is sourced from well managed forests and controlled sources certified in accordance with the rules of the Forest Stewardship Council. BAE Systems plc Report Annual BAE Systems plc 6 Carlton Gardens Annual Report 2007 London SW1Y 5AD Contents United Kingdom Telephone +44 (0)1252 373232 See overleaf for an overview of our business today

Registered in England and Wales No. 1470151

Website details www.baesystems.com

2007 Directors’ report Delivering global growth Results in brief, highlights Chairman’s letter 2 and outlook 1 Executive leadership 4

Corporate governance Board of directors 54 Other statutory and reguatory Corporate governance 56 information, including statement Remuneration report 64 of directors’ responsibilities 84

Shareholder information Shareholder information 146 Glossary 148 Financial calendar 147 Annual Report online 149 Shareholder feedback 149

p67 Cross reference within report

For more information visit www.baesystems.com