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BAE Systems plc A

6 Carlton Gardens E Annual Repo rt 2006 London SW1Y 5AD S y

United Kingdom s t e

Telephone +44 (0)1252 373232 m s p l

Registered in England and Wales No. 1470151 c A n n

www.baesystems.com u a l R e p o r t 2

0 Cover image: BAE Systems, 0

6 with its partners, is delivering the Type 45 anti-air warfare destroyer. The Group has responsibility for the design, development and delivery for the class. The through-life support arrangements are now under discussion, with initial packages on contract.

See overleaf for an overview Shaping our business of our business today

Information key Cautionary statement All statements other than statements of historical fact included in this document, including, without limitation, Cross reference those regarding the financial condition, results, operations and businesses of BAE Systems and its strategy, 67 within report 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 For more information visit available to it at this time, involve known and unknown risks, uncertainties and other important factors which www.baesystems.com could cause the actual results, performance or achievements of BAE Systems or the markets and economies in which BAE Systems operates to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Nothing in this document shall be regarded as a profit forecast. BAE Systems plc and its directors accept no liability to third parties in respect of this report save as would arise under English law. In particular, section 463 Companies Act 2006 limits the liability of the directors of BAE Systems plc so that their liability is solely to BAE Systems plc.

REAL PERFORMANCE. REAL ADVANTAGE. B

BAE Systems plc A

6 Carlton Gardens E Annual Repo rt 2006 London SW1Y 5AD S y

United Kingdom s t e

Telephone +44 (0)1252 373232 m s p l

Registered in England and Wales No. 1470151 c A n n

www.baesystems.com u a l R e p o r t 2

0 Cover image: BAE Systems, 0

See overleaf for an overview Shaping our business of our business today

REAL PERFORMANCE. REAL ADVANTAGE. BAE Systems at a glance

BAE Systems is the premier global defence and aerospace company delivering a full range of products and services for air, land and naval forces as well as advanced electronics, information technology solutions and customer support services.

Electronics, Land & Armaments Programmes Intelligence & Support Principal Provides a variety of military Provides design, development, Comprises the Group’s air systems, communications, electronic production and through-life support naval ships and submarines activities, operations identification, navigation and guidance and upgrade of armoured combat with the UK MoD its principal customer. systems, network-centric warfare vehicles, naval guns, missile solutions and a broad range of launchers, artillery systems and support solutions, including major intelligent munitions. ship repair activities for the US Navy.

Main operating locations

Major markets US, Global US, UK, Sweden, South Africa UK, Global Share of 2006 Group sales (before elimination £4,007m £2,115m £2,927m of intra-group sales) 28% 15% 21%

Key points – Strong demand for electronic – Benefiting from high volume of reset – Good schedule and cost adherence warfare systems and upgrade activity – Programmes transitioning from from 2006 – Key support solutions business wins – Good progress in next-generation development to production – Group-wide capabilities combine technology programmes – Hawk and Nimrod production to win FastTrack contract – Accelerated rationalisation in the orders secured – Key Federal information technology UK business – UAV technology agreements secured solutions awards – Wheeled armoured vehicle successes

14 16 18 Group

– Good financial performance – Continued growth from US businesses £13,765m 88,600 – Implementation of UK Defence Industrial Sales for 2006 Number of employees, Strategy underway including share of employees of equity accounted investments

Customer Solutions Integrated Systems HQ and other businesses & Support & Partnerships Provides partnered, through-life A portfolio of high-technology defence Comprises the regional aircraft asset Principal support and capability solutions to the systems businesses comprising the management and support activities, UK MoD and manages the businesses wholly-owned Integrated System head office and UK shared services operations in Saudi Arabia and Australia. Technologies and Underwater Systems activity, including research centres businesses, together with a 37.5% and property management. interest in the pan-European MBDA joint venture, a 20.5% interest in Saab of Sweden and a 50% interest in the Gripen International joint venture.

Main operating locations

UK/Europe, Middle East, Australia UK/Europe UK Major markets Share of 2006 Group sales £3,180m £1,748m £295m (before elimination 22% 12% 2% of intra-group sales)

– Tornado ATTAC agreement signed – European portfolio restructuring – Aerostructures sale completed Key points in the UK complete – UK pension funding deficit addressed – Kingdom of Saudi Arabia – Major Insyte communication system from 2006 modernisation programme underway wins in UK – Investment in Kingdom of Saudi – MBDA programme milestones Arabia continues achieved – Australian Hawk support – Saab’s acquisition of Ericsson contract secured Microwave Systems complete

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Contents

Operating and financial review 2 Highlights, outlook and results in brief 4 Chairman’s letter

6 Chief Executive’s review 10 Strategy 12 Markets 14 Electronics, Intelligence & Support 16 Land & Armaments 18 Programmes 20 Customer Solutions & Support 22 Integrated Systems & Partnerships 24 HQ and other businesses

25 Key Performance Indicators 26 Financial review including critical accounting policies 31 Risks and uncertainties 34 Resources 35 Corporate responsibility

Corporate governance 42 Board of directors 44 Corporate governance 51 Remuneration report 66 Directors’ report 68 Statement of directors’ responsibilities

Financial statements 71 Independent auditors’ report 72 Consolidated financial statements 76 Notes to the Group accounts 115 Company balance sheet 116 Notes to the Company accounts 124 Five year summary

Shareholder information 126 Shareholder information 127 Financial calendar 128 Glossary 129 Shareholder feedback

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Operating and financial review Highlights, outlook and results in brief

Highlights – Good financial performance – Continued growth from US businesses – Implementation of UK Defence Industrial Strategy underway – European business portfolio restructuring completed – UK pension funding deficit addressed – Airbus sale completed – Underlying earnings3 per share up 29.3% at 23.8p – Dividend increased 9.7% to 11.3p per share for the year

Outlook Looking forward to 2007 we anticipate a further year of good growth led by our US businesses, in particular from the Land & Armaments sector, and from further progress in the Programmes business. We anticipate good operating cash flow again in 2007.

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Results in brief Restated6 Results from continuing operations 2006 2005 Sales1 £13,765m £12,581m EBITA2 £1,207m £909m Operating profit £1,054m £761m Underlying earnings3 per share 23.8p 18.4p Basic earnings per share4 19.9p 13.9p Order book5 £31.7bn £30.8bn

Other results including discontinued operations Dividend per share 11.3p 10.3p Cash inflow from operating activities £778m £2,099m Net cash/(debt) as defined by the Group £435m £(1,277)m

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 £0.8bn (2005 £0.9bn) 6 restated following the sale of Airbus SAS

www.baesystems.com 3 Operating and financial review Chairman’s letter Chairman’s letter 2006: a successful year for BAE Systems

Good operational performance and effective implementation of a well-defined, soundly based strategy are combining to deliver real performance.

Dick Olver Chairman

4 BAE Systems Annual Report 2006 Good operational performance and effective we have looked hard at the composition of the Group in Saudi Arabia. Our policies implementation of a well-defined, soundly of the Board to ensure it continues to for conducting ethical business are clear based strategy are combining to deliver provide the most effective leadership and unambiguous, with established real performance. of the Group’s development. processes to ensure compliance. The focus of the Group’s strategy in recent

BAE Systems has a Board with a wealth The underlying UK company law provisions letter Chairman’s years has seen a drive to improve returns of collective experience. That experience concerning narrative reporting have changed and eliminate excessive risk in the UK- includes not just defence and aerospace since our last annual report. The matters based operations, alongside the expansion domain knowledge but brings learning from required to be reported as part of the new of the Group’s presence in the US. This other international contracting businesses business review requirements are dealt with twin approach is transforming the Group’s and finance backgrounds. In addition to the on pages 2 to 40 of this report and cover performance in the UK market and has three new non-executive directors appointed the Group’s activities during the year and established BAE Systems as one of the in 2005, we welcomed Sir Nigel Rudd to likely future developments. Best practice major US defence companies. the Board on 10 September 2006. Michael in narrative reporting will continue to evolve Notable achievements in 2006 included Lester and Mark Ronald retired from the and we will strive to remain at the forefront the resolution of the approach to funding the Board on 31 December 2006. Both have of developments in this area. made major contributions to the Group deficit on the Group’s pension schemes, the The Group’s corporate responsibility and this industry, throughout long careers. completion of the sale of our 20% interest in performance is summarised on pages 35 Airbus and good progress towards securing At the start of 2007 I was pleased to to 40 and also detailed in an important further significant business in Saudi Arabia. welcome to the Board Walt Havenstein, as separately published report. Like all high Underlying these individual achievements Chief Operating Officer, with responsibility for performance companies, our policies has been a broad-based improvement in our US-led operations, and Ian King, as are kept constantly under review, and performance across the Group. Chief Operating Officer, with responsibility for we are committed to take action wherever In addition to continuing to pursue the the Rest of World, including UK, businesses. necessary to maintain the highest standard of corporate governance. development of the Group in its two largest In February we agreed retirement dates for defence and aerospace markets, the UK Sue Birley and Ulrich Cartellieri. They have The Board is recommending an increased and the US, the Group’s strategy recognises afforded the Group great service through final dividend of 6.9p per share, making opportunities in the other home markets their contribution to both the Board and its a total of 11.3p for the year. At this level, in which BAE Systems has a local presence committees. The Group has benefited from having taken account of the sale of Airbus, and capability; Australia, Saudi Arabia, their wise counsel and we thank them for this. the annual dividend is covered 2.1 times South Africa and Sweden. The Board now comprises approximately by underlying earnings from continuing Alongside the development of the Group 60% non-executive directors. operations (2005 1.8 times). Subject to in these six home markets, BAE Systems shareholder approval at the 2007 Annual will continue to nurture a high performance The changes in the composition of the General Meeting, the dividend will be paid culture. The delivery of continuous Board have enabled us to strengthen the on 1 June 2007 to holders of ordinary performance improvement remains key to Board committee s that provide oversight to shares registered on 20 April 2007. the twin objectives of delivering cost-effective executive remuneration, succession planning, capability to our customers and maximising audit and corporate responsibility. returns for our shareholders. BAE Systems has a highly skilled and The Group’s strategy is reviewed regularly as dedicated workforce. Our people have part of the Group’s annual business planning demonstrated that they can rise to the process. This review tests the continued challenge of delivering performance in relevance of the current strategy. The a challenging technological industry and adaptations made to the strategy are set I am grateful to them for their contribution out on page 11 and reflect the progress to the Group’s progress. made over the past 12 months. In December 2006, a decision was reached Dick Olver Chairman With the transition of the Group from by the Serious Fraud Office to conclude recovery to sustained performance growth, its investigation related to the activities 21 February 2007

Dividend (pence per share)

02 9.2 03 9.2 04 9.5 05 10.3 06 11.3

www.baesystems.com 5 Operating and financial review Chief Executive’s review

A strong platform for future performance Chief Executive’s review BAE Systems delivered another year of good financial performance, underpinned by programme schedule and cost adherence across the Group.

Mike Turner Chief Executive

6 BAE Systems Annual Report 2006 Year in review contribution rates, reductions in future as the return of Bradley vehicles to ‘as BAE Systems delivered another year of benefits for employees and one-off cash and new’ condition. Substantial funding for such good financial performance, underpinned asset contributions by the Group. This shared reset activities has been available through by programme schedule and cost adherence approach has achieved a good outcome for supplemental budgets in support of current across the Group and reflecting the benefits all parties. The Board is in consultation with military operations. Supplemental spending now flowing from our world-class Lifecycle the trustees of the Group’s pension schemes is expected to continue in the near term Management and Performance Centred to consider the implication of the Airbus sale but the Group’s business plans are based Leadership processes. on pension scheme funding. on more prudent longer-term assumptions. The performance of the US businesses US businesses BAE Systems is a leader in electronic has again been excellent with the Group’s In the US, the integration of the former warfare technology including electronic expansion in the US market over recent United Defense activities into BAE Systems protection systems. Such advanced years generating good returns. Good has been completed successfully. The land, protection systems are expected to progress has continued in the UK armaments and ship repair activities that continue to be a funding priority. businesses with programmes on track comprised the acquired United Defense and meeting their key milestones. business are performing well. Equipment modernisation is also expected to continue and the Group is actively A number of export opportunities have also The Electronics, Intelligence & Support involved in current and new generation progressed, most notably in the Kingdom business continued to achieve growth land systems, including Future Combat of Saudi Arabia where, under an agreement ahead of the addressable US Department System variants. In addition, the digitised, Chief Executive’s review Chief Executive’s between the Kingdom of Saudi Arabia and of Defense (DoD) budget, with like-for-like A3, version of the Bradley is a core element the UK government, the Group is working to sales up 6%. Contributing to this growth of the modernisation and modularisation modernise the Saudi armed forces including was strong demand for electronic protection of US forces. progressing towards a contract for 72 systems. The business continues to lay the Typhoon aircraft. foundations for sustained performance with BAE Systems is a high technology new business wins, including substantial business and a major participant in force We have continued to divest those businesses contracts for Common Missile Warning transformation activities including new that were non-core to our strategy. In May Systems to protect aircraft. generation Intelligence, Surveillance and the Group initiated the sale of its 20% Reconnaissance programmes. shareholding in Airbus. The decision to A number of significant new support sell the Airbus stake was consistent with business wins include the award of a prime As a result of strong positions in these priority our strategy of maximising value from contract to provide software development areas, and notwithstanding expectations for a that business, recognising it was facing and management support services to flattening of growth in overall defence spend, an increasing number of challenges. The the Department of Homeland Security. organic growth in the US businesses is sale was completed in October following BAE Systems continues to look for expected to continue at a level above the shareholder approval. The proceeds will opportunities to grow its US business underlying DoD addressable budget growth. be directed to developing the core business by acquisition following the successful and a repurchase of up to £500m of the UK businesses additions to the Group over recent years. Group’s shares is underway. The performance on large complex weapon Progress has been slowed by sustained system programmes in the UK has been The sale of the Aerostructures business high valuations of businesses that would good and is expected to continue to progress was completed in March and the sale of align with the Group’s strategy. Further as more programmes move to production. Atlas Elektronik was completed in August. acquisitions will have to continue to meet our strict value creation criteria. In the Deliveries of Typhoon continue to schedule. A big concern for the Group in recent years meantime, organic growth in the US 113 aircraft have been delivered to the four has been the funding of its pension schemes. businesses continues. partner nations including 38 now in service Agreements were concluded during 2006 with the UK’s Royal Air Force (RAF). to address funding deficits. The revised The focus on current operations in funding plan in the UK schemes includes a Afghanistan and Iraq is generating a high Flight development of the Nimrod MRA4 combination of higher company and employee level of armoured vehicle reset activity such programme continues and the formal

Performance Centred Leadership (PCL) Support Council The Group’s PCL framework was A support council has been created designed and developed using best to share best practice and co-ordinate practice from around the globe. It drives support activities and processes business success by linking individual across the Group with the objective goals with the wider goals of the of optimising through-life support, not organisation, enabling employees only for in-service equipment, but also to understand how their own success for platforms under development. contributes to the success of the whole business.

www.baesystems.com 7 Operating and financial review Chief Executive’s review (continued)

production contract was received in July Pioneering work that BAE Systems previously At the heart of this strategic framework for nine aircraft together with an option for undertook through a series of small pilot is the recognition that industry has to the conversion of the three aircraft currently support programmes, in partnership with the demonstrate and deliver value for money in flight development to production standard. UK Defence Logistics Organisation, is now and through-life capability for the UK armed being applied across the MoD’s fixed wing forces, whilst also generating appropriate In October, a production order for 28 Hawk aircraft fleet. In December the Group signed returns for shareholders. BAE Systems is well Mk128 aircraft for the RAF was secured. a ten-year availability-based partnership positioned to address these requirements. Following the launch of the first of class agreement providing all support up to the In response to encouragement from DIS, Type 45 destroyer, outfitting is progressing front-line for the UK’s Tornado aircraft. BAE Systems has been considering to programme. The second ship was Within the land sector, the successful opportunities for a more integrated UK naval launched on 23 January 2007 and major introduction of the armoured fighting vehicle capability. Such considerations included

Chief Executive’s review steel sections are also well underway for partnering arrangement is underway with discussions with VT Group regarding the the third and fourth ships. The planned build the in-service date achieved, on schedule, possibility of a bid for Babcock. These efficiencies from one ship to the next are for the upgraded FV430 Bulldog armoured initial discussions were not taken forward being met or exceeded. Following successful fighting vehicle. In addition, progress but opportunities for consolidation of the risk reduction, a small amount of profit has continues towards the transformation of UK naval industry continue to be explored, been recognised on the programme. arrangements for the supply of munitions. and, in December, the Group announced Both of the Landing Ship Dock (Auxiliary) At the end of 2005 the UK government discussions with VT Group with a view to ships originally contracted to BAE Systems published its Defence Industrial Strategy integrating the naval surface ship activities. for the UK’s Royal Fleet Auxiliary were (DIS). DIS is a very significant change completed. The Group was asked to Other markets programme for both industry and the UK In addition to its strong positions in the assist with completion of the fourth MoD. It will help determine the future level of UK and US markets, BAE Systems has a ship in addition to taking over lead BAE Systems’ involvement in the UK defence significant presence in the other important yard responsibility for the ship class. industrial base as it is implemented. markets of Australia, Saudi Arabia, South Development and assembly of the first of It is intended that long-term partnering Africa and Sweden. class Astute submarine progressed well. agreements, currently being discussed In all six countries, BAE Systems is A key 2006 milestone, electrical power with the UK MoD in all three air, land and recognised as an important on-shore to switchboards, was achieved enabling sea sectors, will form the basis for much of defence and aerospace supplier. The commissioning activity on the boat to the implementation of DIS. These long-term Group continues to look for opportunities commence. Work on the second boat, partnering agreements will specify the future to strengthen its position as part of the Ambush, is also proceeding well with capabilities and requirements for each defence industrial base of those countries. major milestones, such as the closure sector, enabling both the UK MoD and of the reactor compartment, demonstrating industry to make long-term investment A major growth opportunity is the Group’s significant schedule advance compared with decisions with a greater degree of certainty role in supporting the partnership between the first boat. Pricing discussions on boats than has been possible previously. the UK government and the Kingdom two and three, together with the initial The UK MoD has committed to a complex of Saudi Arabia to update the capability of phase of boat four, are well advanced. weapon long-term partnering agreement that the Kingdom’s armed forces. A key feature of this agreement is also to assist the In addition to UK weapon system will preserve capabilities and business within Kingdom in developing its defence industrial procurement programmes, the development the MBDA guided weapons joint venture. base and the training of its workforce. of the support business continues. An integral part of DIS is the identification of BAE Systems is delivering a reduction in the those technologies that are likely to remain BAE Systems has been pursuing a strategy UK Ministry of Defence’s (MoD) in-service key to the future capability of the UK armed to transition its Saudi business from cost, improving equipment availability and forces and that need to be retained on-shore. a UK-centric operation to a major consequently front-line capability for the A good early example was the launch of an in-Kingdom presence. Consistent with armed forces. Further opportunities for Unmanned Combat Air Vehicle technology this strategy BAE Systems continues valuable support business growth remain. demonstrator programme in December. to invest in the Kingdom.

Nimrod under ice Lifecycle Management (LCM) Nimrod MRA4 undertook its first transatlantic The delivery of the Group’s strategy is flight in September to Eglin Air Force Base, dependent upon the successful winning Florida, where the development aircraft, and execution of projects. The application PA2, underwent a series of successful of our world-class LCM process is critical environmental trials to demonstrate the to our capability to deliver these projects maturity and reliability of the aircraft at to schedule and cost. LCM is a powerful and flexible process which promotes the extreme temperatures, from -40oC to +44oC. application of best practice programme execution and facilitates continuous improvement across the Group.

8 BAE Systems Annual Report 2006 Recognising that the security and welfare of the 4,600 employees and their Executive Committee 2007 Top Ten objectives: dependants in Saudi Arabia is paramount, a major construction programme is well In support of the Group’s strategy, the Executive Committee has agreed the top ten objectives underway to create two new residential for 2007. and workplace facilities. 1. Financial targets 6. Kingdom of Saudi Arabia These investments establish a significant Meet our 2007 financial targets and Progress the business strategy with industrial footprint in Saudi Arabia with through the rolling five year Integrated the Kingdom of Saudi Arabia a growing in-Kingdom technical capability. Business Planning process set 7. Exports This will enable the Group to satisfy business plans that are both realistic Focus on key export opportunities many of its Saudi customer’s needs and challenging from on-shore companies. 8. Partnering 2. Application of mandated business Demonstrate a commitment to Industrialisation is a key feature of processes partnering across the business to the modernisation programme and the Ensure application of the mandated maximise business-winning opportunities commitment to Typhoon will allow us to business processes build on the established Tornado support 9. Develop existing and new home markets 3. Programme execution activity. Opportunities for new business in Maximise development and growth in Further increase management focus other areas of the Kingdom’s armed forces existing and new home markets

on meeting our contracted schedule review Chief Executive’s are also being considered. and cost commitments 10. Leadership As in the UK, Typhoon and Tornado are Demonstrate leadership at all levels 4. US businesses expected to operate side by side for many towards achieving a world-class high- Continue to grow our US businesses years and these in-country investments performance culture that helps deliver the strategy and objectives are expected to generate returns for 5. UK businesses shareholders over many decades. Continue to implement DIS with focus on through-life capability management in the In summary, BAE Systems is progressing air, land and sea domains to deliver cost well. The Group’s strategy is delivering and capability benefits to our customers and a focused, high performing, defence and acceptable profit levels to our shareholders aerospace business with good positions in key markets around the globe. As a result, the Group has a robust plan to deliver profitable growth for our shareholders.

Mike Turner Chief Executive 21 February 2007

Managing Major Subcontractors Successful relationships with our partners and subcontractors across the supply chain are key to our performance. We have distilled best practice from within the Group and other world class organisations into a ‘Gold Standard for Managing Major Subcontracts’. Roll-out of this best practice across the Group will accelerate our learning and improve performance in this strategically important capability.

www.baesystems.com 9 Operating and financial review Strategy

Delivering on our strategy Strategy Our Group strategy is ‘to deliver sustainable growth in shareholder value by being the premier global defence and aerospace company’. We deliver this through our group strategic objectives, business portfolio actions and integrated business plans. The five group strategic objectives are owned by the Executive Committee and apply across the Group. The business portfolio actions are championed by the relevant Executive Committee members and are delivered by the businesses either separately or jointly.

Group strategy

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

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 partnership approach to meet our customer requirements Develop our capabilities in emerging growth markets

Business portfolio actions

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

Financial metrics detailed on page 25 of sales, order intake and order book are used by the Board in measuring business growth. Return on sales, underlying EBITA and operating business cash flow are used to measure performance of the business. These metrics directly underpin the Group strategic objectives and business portfolio actions above.

10 BAE Systems Annual Report 2006 Group strategy Business portfolio actions Two new actions have been introduced. The significant progress made in 2006 The drive to build sustainable, profitable, Building on a relationship that spans several has been reflected by the evolution of our through-life businesses in the air, land and Strategy decades we will pursue opportunities to Group strategy. We have refocused our sea sectors of the UK market continues, grow our business in the Kingdom of Saudi strategy to be ‘to deliver sustainable growth building on the good progress last year. Arabia. Our focus will be the transition in shareholder value by being the premier We continue to seek growth in the US of the relationship from one of an export defence and aerospace company’ global through continuing to target above-market market to the implementation of a home where previously the emphasis was just organic growth from the Group’s established market strategy. . This recognises the renewed transatlantic business activities, and by looking for value- emphasis on growing our six home markets Export sales are an important source of enhancing acquisitions. (UK, US, Australia, Saudi Arabia, South growth for the Group and we look to generate Africa and Sweden) and on generating Following our success in recent years in export business from our home markets. exports from these established home establishing a global land systems business markets. We will also now consider we continue to pursue growth opportunities opportunities in new high-growth markets. in this market sector. We have reviewed and updated the Group The Group will continue to target growth strategic objectives. We have also made a in support, solutions and services activity in number of changes to the business portfolio our global markets, reflecting the increasing actions to reflect recent progress. focus of customers to procure capability on a through-life basis. Customers’ requirements increasingly demand the ability to offer ‘through-life’ The sale of the Group’s 20% interest in and ‘capability’ solutions. We now identify Airbus successfully delivered the action of portfolio actions that, consistent with maximising the value from our Airbus stake our customers’ requirements, will support and that action has now been removed. the delivery of our strategy. Increasingly Good progress made in 2006 to address businesses must find ways to work together non-core activities within the Group through across traditional business boundaries business disposals has enabled this action to deliver these actions. As a result to be removed. our businesses may now support more than one portfolio action. The updated actions also reflect the Group’s revised organisational structure.

Working with the customer Type 45 BAE Systems worked closely with the UK The new-generation Type 45 destroyer will MoD to develop Hawk, a highly capable deliver leading-edge capability whilst cutting advanced jet trainer, to train pilots for operating costs by 37%. Daring was launched next generation combat aircraft such as on 1 February 2006 and Dauntless’ launch Typhoon and the F-35 Lightning II. The followed in January 2007. Hawk has the very latest navigation and avionics systems enabling future combat pilots to experience features previously only available on front-line aircraft.

www.baesystems.com 11 Operating and financial review Markets

Our global markets Markets The defence industry in the UK and US has 1 consolidated over recent years resulting in Global defence procurement expenditure continued fewer, larger, defence companies. The nature to rise with a 7% real increase among the 15 largest of the defence industry today is such that many of these industry constituents are military nations. With customers in over 100 countries suppliers, customers and partners as well and strong positions in the UK, US, Australia, as competitors. BAE Systems is one of the world’s leading Saudi Arabia, South Africa and Sweden, BAE Systems defence companies and is one of only is well placed for further growth in both new and four companies with global defence sales in excess of $20bn. It is Europe’s largest established defence markets. defence company and ranks number seven within the US defence industry. BAE Systems is reliant upon the levels of funding committed by the domestic governments of the countries in which the Group’s operations are based and those to which the Group exports. United States The Group’s US business now delivers over US$9bn (£5bn) of annual sales and employs approximately 40,000 people in 36 states. BAE Systems is both a prime contractor to the US government and a supplier of major sub-systems to the other large prime contractors. The Group is a market leader in the provision of electronic warfare systems, many of which have application on airborne programmes. BAE Systems has a substantial BAE Systems home markets business supporting network systems and IT for US government agencies and provides 1 last available data 2005 technical support services to the US Navy, US Army, NASA and the FAA. In land systems, the Group is one of the two largest suppliers

Global defence spend Global equipment market BAE Systems’ market position Forecast defence expenditure by major region 2007 forecast defence procurement Top 10 defence companies in 2006 (US$ billions at constant 2007 prices) (US$ billions at constant 2007 prices) (Defence revenue US$ billion) 1,200 US2 106 40 1,000 Rest of World 59 800 Europe Europe 600 Rest of World (accessible) 65 20 400 US 200 2 including supplemental budget, excluding 01 02 03 04 05 06 07 08 09 10 Reseach Technology Development & Engineering 1 2 3 4 5 6 7 8 9 10

The US represents around 45% The US accounts for over 45% of 1. Lockheed Martin 6. General Dynamics of the total forecast global defence forecast total global procurement 2. Boeing 7. EADS spend (including equipment, in 2007. 3. Northrop Grumman 8. L-3 personnel and operating costs) 4. BAE Systems 9. Thales to 2010. 5. Raytheon 10. Halliburton

Source: BAE Systems internal analysis Source: BAE Systems internal analysis Source: Defense News

12 BAE Systems Annual Report 2006 of armoured vehicles in the US and the of the industrial strategy is the formation strategy, we continue to make substantial wider accessible global market. of long-term partnering agreements between investments in the Kingdom, establishing industry and the UK Ministry of Defence a major industrial footprint with a growing The US defence market accounts for over (MoD). A good start has been made in in-Kingdom technical capability enabling 45% of global defence spending and implementing such agreements and other the Group to satisfy many of our Saudi remains one of BAE Systems’ key markets, elements of DIS. customer’s needs from on-shore companies. offering programme scale and high levels of investment in research and development. BAE Systems now has a well-established, Industrialisation is a key feature in this US defence spending has increased growing and successful through-life capability market and the commitment to Typhoon will substantially over recent years, including the business in the air sector working closely with allow us to build on the established Tornado Procurement and Research and Development the UK MoD and the Royal Air Force. Progress support activity. We also see opportunities budgets from which the defence industry has also been made in the land systems for new business in other areas. derives much of its business. This high sector with the development of a similar level of funding is expected to sustain armoured vehicle through-life partnership. Rest of World In addition to its strong positions in the UK, further growth in the near term, but with Despite a substantial forward programme Markets a levelling out anticipated towards the end US and Kingdom of Saudi Arabia markets, of new equipment requirements, the UK of the decade. BAE Systems has a significant presence defence procurement budget has been in the other important markets of Australia, In addition to the underlying defence spend, pacing inflation with only limited real growth. South Africa and Sweden. the US market has seen large supplemental BAE Systems has successfully grown its budget allocations to fund overseas participation in UK defence support activity BAE Systems’ Australian business continues operations. This supplemental spend which has, in turn, generated savings for the to secure contracts and strengthen its includes the cost of resetting equipment to customer that are being passed through position as a through-life capability partner combat readiness following heavy operational to enhance equipment procurement. to the Australian Defence Force. South Africa use. BAE Systems has benefited from this is another market that continues to offer For some years the UK government has funding, which is expected to continue in opportunity, while our businesses in Sweden encouraged competition in the defence the near term but then reduce as current continue to perform well both in home market from off-shore suppliers and, despite overseas deployments of armed forces markets and in securing export opportunities. the Group’s strong presence in the UK, decrease. Although growth in US defence the market remains highly competitive. We continue to evaluate ways to develop spending is expected to slow, the Group is in-country presence in markets which are well placed to support the US Department The Kingdom of Saudi Arabia forecast to have significant and growing of Defense’s likely continued emphasis on Saudi Arabia has been an important market defence expenditure and which want to force sustainment and readiness. for BAE Systems for many decades and develop a significant local defence industry. there are significant new opportunities We have focused on a small group of United Kingdom to both continue, and strengthen, this BAE Systems is the largest defence prime countries, including India, which meet relationship into the future. contractor in the UK with strong positions these criteria. in the design, development, manufacture A key growth opportunity is the Group’s role and support of air, land and sea systems. in supporting the partnership between the The Group also provides command and governments of the Kingdom of Saudi Arabia communications infrastructure. Business is and the UK in updating the capability of the generated in other defence markets around Kingdom’s armed forces. We are committed the globe through the export of UK-derived to assisting the Kingdom in developing its weapon system programmes, subject to defence industrial base and the training UK government regulation. and up-skilling of its workforce. The publication in December 2005 by the BAE Systems is pursuing a strategy to UK government of its Defence Industrial transition our Saudi business from a UK- Strategy (DIS) was significant in shaping centric export sales operation to a significant the future UK defence market. A key element in-Kingdom presence. In line with this

Sharing between our global businesses Investing in Australia Delivering next-generation products The 57mm Mk 110 Mod 0 Naval Gun BAE Systems is developing strategic The RG33 series was developed to System has currently been selected capabilities to enhance its support of meet the growing requirement for highly for both versions of the US Navy’s the Australian Defence Force by investing survivable, flexible mine-protected wheeled Littoral Combat Ship and as the main in fast jet support and autonomous vehicles. BAE Systems’ design teams in armament to go aboard the US Coast systems capabilities. CS&S Australia South Africa and the US applied the latest Guard’s National Security Cutter. The is responsible for delivering effective in collaborative design systems and tools system is currently manufactured in through-life support to the Royal to rapidly prototype and produce the first Sweden, but plans are underway to Australian Air Force’s Hawk Lead-In RG33 family vehicle in a 6x6 configuration. transfer assembly to a US facility. Fighter and the F/A-18 Hornet.

www.baesystems.com 13 Operating and financial review Electronics, Intelligence & Support

The Electronics, Intelligence & Support business group, with 31,700 employees1 and headquartered in the US, is a provider of defence and aerospace systems, sub-systems and services. It comprises two operating groups: Electronics & Integrated Solutions and Customer Solutions. Business group reviews Financial highlights During 2006, Electronics, Intelligence & Support achieved EBITA2 of £429m (2005 – Organic sales growth of 6% over 2005 £324m) on sales1 of £4,007m (2005 – Return on sales improved to 9.2% (excluding one-off accounting gain) £3,697m) and generated an operating cash inflow3 of £273m (2005 £323m). – Good conversion of EBITA2 to operating cash flow 2006 EBITA2 includes a £61m accounting gain relating to a revision to pension benefits arising from changes to the 2006 2005 2004 calculation of final pensionable salaries. Sales1 £4,007m £3,697m £3,063m A one-off cash contribution of $100m EBITA2 £429m £324m £256m (£54m) was made to the principal US pension fund at the end of the year. Return on sales 10.7% 8.8% 8.4% 3 The Ship Repair business of United Cash inflow £273m £323m £190m Defense, acquired in June 2005, contributed Order intake1 £4,311m £3,659m £3,310m full year sales1 of £316m (2005 £164m) 2 Order book1 £3.4bn £3.5bn £3.1bn and EBITA of £23m (2005 £15m). Electronics & Integrated Solutions (E&IS) Key points E&IS designs, develops and produces electronic systems and sub-systems for – Strong demand for electronic warfare systems a wide range of military and commercial applications. The business focuses on – Key support solutions business wins five primary capabilities: electronic warfare – Group-wide capabilities combined to win FastTrack contract (EW), including information operations; – Key Federal information technology solutions awards communications, with emphasis on integrated C4ISR6 and tactical networking; avionics, flight and engine controls; sensor Looking forward systems, providing remote sensing technology, mission sub-systems and Defence spending in the US continues to be robust for the near term, however fiscal pressures missile seekers; and intelligence systems. may make the budget environment more challenging in subsequent years. Customers will need to balance priorities to equip effectively the current fighting force, whilst developing capabilities E&IS delivered the first EW system for the to transform the future force. Joint Strike Fighter F-35 Lightning II aircraft and received funding for the system’s Low BAE Systems will continue to focus on offering tailored, mission-enabling support solutions Rate Initial Production. E&IS also delivered and lifecycle services to the US defence, intelligence, Federal and civilian markets. the first production digital EW system for The business is positioned to capitalise on recent organisational and integration actions the US Air Force F-22A Raptor. Current to reduce costs. Reducing costs will make the business more competitive and enable further production quantities are for 183 aircraft, investment in new business opportunities to drive top-line growth. taking F-22A production through to 2011. The National Geospatial-Intelligence Agency selected E&IS to lead the team to develop a web-based surveillance and targeting system, Global Net-Centric Surveillance and Targeting, which will rapidly identify battlefield targets to speed decision-making by intelligence analysts and military personnel.

Share of Group sales4 Share of Group EBITA2,5 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash inflow from operating activities after capital 28% 32% expenditure (net) and financial investment, and dividends from equity accounted investments 4 before elimination of intra-group sales 5 excluding HQ and other businesses 6 Command, Control, Communications and Computing, Intelligence, Surveillance and Reconnaissance

14 BAE Systems Annual Report 2006 BAE Systems continues to hold a leadership Army’s Tobyhanna Depot in Pennsylvania requirements and goals. BAE Systems IT position in the development of Advanced to enhance communications and electronics was also successful in 100% of its Threat Infrared Countermeasure (ATIRCM) lifecycle management and with the US Air recompetes in 2006. systems. In 2006, E&IS began phase three Force’s Open Air Logistics Center, Utah, TSS won the US Air Force Space Command’s of a Department of Homeland Security to support aircraft sustainment. potential 12-year, $509m (£260m) contract programme to develop a commercial version Customer Solutions for operation and maintenance of the Solid of the ATIRCM system, JETEYETM, which Customer Solutions comprises three State Phased Array Radar Systems at five seeks to defeat the threat of shoulder-fired businesses: radar sites worldwide. The US Army Space anti-aircraft missiles. and Missile Defense Command’s Future – BAE Systems Information Technology (IT) BAE Systems was selected to develop the Warfare Center signed an agreement with active inceptor system for the US Army’s – Technology Solutions and Services (TSS) BAE Systems worth up to $482m (£246m) under the Concepts and Operations for UH-60M Black Hawk helicopter programme. – BAE Systems Ship Repair The Black Hawk will be the first production Space and Missile Defense Integration helicopter to combine active inceptor BAE Systems IT capabilities include Capabilities contract. enterprise-wide managed IT operations, technology with a fly-by-wire system that BAE Systems Ship Repair provides a full mission-critical application development saves weight and provides pilots with array of ship repair services in support of and lifecycle support information analysis intuitive tactile cues for easier aircraft US Navy vessels. In 2006, the Ship Repair and assured delivery. TSS provides services handling and reduced workload. business was awarded a service contract

including system engineering and technical Business group reviews for guided missile cruiser class ships home BAE Systems is the world’s leading supplier assistance, system and sub-system ported in Norfolk, Virginia, potentially valued of hybrid propulsion systems for urban transit integration, operations and maintenance. at $169m (£86m). A second multi-ship, buses. New orders received in 2006 totalled Ship Repair is the US’s leading non-nuclear multi-option contract was awarded for repair 415 HybriDrive® propulsion systems. ship repair company and also provides and maintenance of all US Navy surface E&IS is a supplier of state-of-the-art infrared, conversion and modernisation services, principally in the home ports of the US Navy. ships home ported in Hawaii, potentially millimetre-wave, and laser technologies valued at $270m (£138m). for missile seekers, guided munitions and Customer Solutions integrates target designators. Using a BAE Systems’ communications systems, builds and seeker, the THAAD (Terminal High Altitude maintains precision tracking radars, and Area Defense) missile system successfully is one of the largest service providers to detected and intercepted an incoming the US Navy. The business is also a leader ballistic missile target. This demonstration in air and missile defence systems and is of ‘a bullet hitting a bullet’ was a key one of the world’s largest manufacturers milestone in the development of this of explosives. defence against missile-borne weapons of mass destruction. During 2006, significant contract wins were secured, underpinning the future growth in The US Army fully funded the Thermal the Customer Solutions business. Weapon Sight (TWS) at $285m (£146m) with full production to produce and deliver BAE Systems was awarded a prime contract, 29,600 units by mid-2008. In 2006, more worth approximately $250m (£128m), from the Department of Homeland Security than 4,500 TWS units were delivered on time to improve efficiency and reduce IT costs. or ahead of schedule to meet critical fielding. The business also received an estimated To increase focus on through-life product $250m (£128m) award from the US Army and logistics support, E&IS opened its first under the Information Technology Enterprise Readiness & Sustainment centre adjacent to Solution – 2 Services contract. This contract Robins Air Force Base, Georgia. E&IS also provides IT services to support the Army’s signed partnership agreements with the US enterprise information infrastructure

Terminal High Altitude Area Defence (THAAD) Common Missile Warning System (CMWS) Transatlantic partnership delivers on a FastTrack BAE Systems is responsible for the Under a CMWS contract, potentially By leveraging its experience and expertise development of the infrared seeker head worth $1.4bn (£0.7bn), the US Army has found around the world, the BAE Systems on the THAAD missile system. The THAAD the flexibility to order at various times FastTrack team demonstrated speed, agility missile system is designed to defend any number of systems. E&IS increased and Group-wide collaboration to win a new against attacks from short and medium- production from 30 to 50 systems contract with the US Navy valued at up range ballistic missiles. Here assemblers a month to outfit all US Army helicopters to $450m (£230m) over seven years. at BAE Systems in Nashua, New Hampshire, in Afghanistan and Iraq. Under this contact, BAE Systems will install a THAAD seeker forward ring reengineer and remanufacture aircraft parts assembly into a vibration test fixture. to optimise the US military’s ageing aircraft.

www.baesystems.com 15 Operating and financial review Land & Armaments

Land & Armaments business group, with 11,600 employees1 and headquartered in the US, is a leader in the design, development, production and through-life support and upgrade of armoured combat vehicles, naval guns, missile launchers, artillery systems and intelligent munitions. Business group reviews Financial highlights During 2006, Land & Armaments achieved EBITA2 of £168m (2005 £42m) on sales1 – Sales of £1.4bn from acquired United Defense business of £2,115m (2005 £1,270m) and generated an operating cash inflow3 of £137m – Improvements in UK business performance (2005 £168m). – Order book growth The United Defense Land & Armaments business, acquired in June 2005, contributed full year sales1 of £1,354m 2006 2005 2004 (2005 £625m) and EBITA2 of £146m Sales1 £2,115m £1,270m £482m (2005 £45m). EBITA2 £168m £42m £(8)m Following rationalisation activity in 2005 and further announcements in 2006, Return on sales 7.9% 3.3% (1.7)% the UK-managed business returned to Cash inflow3 £137m £168m £60m profit a year ahead of plan. Order intake1 £2,964m £1,541m £869m United States Order book 1 £4.4bn £2.2bn The US business has substantial US £4.9bn Army contracts for the refurbishment and upgrade of Bradley, M88 Hercules improved Key points recovery vehicles and M113 fighting vehicles. These contracts involve restoring – Benefiting from high volume of reset and upgrade activity current systems to combat-ready condition – Good progress in next-generation technology programmes following extensive operational use and – Accelerated rationalisation in the UK business upgrading them to more advanced configurations. – Wheeled armoured vehicle successes Following the final US FY07 Defense Appropriations Bill, Land & Armaments Looking forward reached agreement with the US Army in November 2006 for contracts for In the near term, US Land & Armaments operations are expected to continue to benefit from 610 reset/upgraded Bradley vehicles, operational requirements in Iraq and Afghanistan. In the longer term, the business may be 113 M88 Hercules vehicles and upgrade impacted by increased pressure on defence budgets. of 447 M113 fighting vehicles at a total UK operations will continue their emphasis on performance improvements, securing a leadership value of $1.6bn (£0.8bn). role on the Future Rapid Effect System (FRES) programme and on reaching resolution on In May 2006, BAE Systems was awarded a mutually beneficial, sustainable munitions contract with the UK MoD. its first wheeled vehicle contract in the US The businesses in Sweden and South Africa aim to deliver growth through both new domestic to manufacture the Iraqi Light Armoured government business and building on their track record of securing export opportunities. Vehicle, designed to protect Iraqi armed forces against roadside bombs and mine blasts. Under this $187m (£96m) contract, Land & Armaments will supply an initial 378 vehicles for Iraqi forces. If all contract options are exercised, delivery orders could total 1,050 vehicles. Progress on the Future Combat Systems programme continues with the successful

Share of Group sales4 Share of Group EBITA2,5 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash inflow from operating activities after capital 15% 12% expenditure (net) and financial investment, and dividends from equity accounted investments 4 before elimination of intra-group sales 5 excluding HQ and other businesses

16 BAE Systems Annual Report 2006 completion of preliminary design and Engineering Tank Systems deliveries continue early in 2007. A major milestone was commencement of system functional reviews on schedule with 17 bridge-laying Titan achieved when a guided firing of the 155mm and critical design reviews on manned vehicles and 17 Trojan obstacle-clearing Excalibur from an Archer self-propelled ground and armed robotic vehicles. vehicles delivered to the British Army. artillery platform was successfully completed. Integration of the first Non-Line of During 2006, the British Army identified Through December 2006, deliveries of Sight-Cannon (NLOS-C) prototype system urgent operational requirements for FV430 155mm BONUS Mk 2 munitions to the commenced with the mission module Bulldog armoured personnel carriers to Swedish government continued to schedule. testing using tactical software in support requirements in Iraq. In total, Land BONUS is also being evaluated by the Minneapolis, Minnesota, and chassis & Armaments received orders for FV430 US and UK governments. fabrication in York, Pennsylvania. The vehicles valued at £36m. NLOS-C firing platform was unveiled during South Africa A Framework Partnering Agreement is the The growing international need for mine- ceremonies in September. The platform was current basis for the supply of munitions delivered to the US Army’s Yuma Proving protected vehicles has continued to to the UK MoD. BAE Systems and the UK Ground ahead of schedule and successfully generate new orders for the four-wheeled MoD are evaluating a follow-on Munitions fired its first live test round in October, RG-31 and RG-32 from the business in Acquisition Supply Solution in order to build beginning two years of live fire testing. South Africa. In October, Land & Armaments a sustainable munitions business and The US Army has ordered two additional successfully unveiled the RG-33L Mine provide long-term savings to the customer. prototypes for a total of eight to be Protected Vehicle at the Association of delivered by early 2009. United States Army trade show. A seven- The Land & Armaments businesses in the Business group reviews month collaborative effort between UK and Sweden are co-operating to establish Development of the 155mm Advanced a strong position to develop the FRES operations in the US and South Africa Gun System (AGS) and the Long Range programme. The Swedish Modular Armoured produced the RG-33L mine-protected vehicle Land Attack Projectile (LRLAP) for the Tactical Vehicle Programme (SEP) is the basis that has the potential to meet urgent mine US Navy’s new destroyer, DDG-1000, of one of the proposals from BAE Systems. protection needs of US, UK and coalition continues. In live fire testing, the AGS forces in Afghanistan and Iraq. achieved a sustained firing rate of ten Sweden rounds per minute at ranges of up to During 2006, the Land & Armaments 63 nautical miles with accuracy well within Swedish businesses (Hägglunds and Bofors) US Navy requirements. In September 2006, were combined under one newly created Land & Armaments received a $251m company called BAE Systems AB. This will (£128m) contract for LRLAP. In addition, leverage strengths of the individual Land & Armaments is designing and testing businesses in engineering and production, a new Vertical Launching System that will while also allowing BAE Systems to become enable the DDG-1000 ship to launch a wide a more effective solutions provider. range of missiles. BAE Systems AB was awarded a £19m In the medium-calibre naval gun system contract for an additional 52 Bv206S arena, the BAE Systems 57mm gun has armoured all terrain vehicles from the Swedish been selected for the DDG-1000, the US government. The company has manufactured Navy’s Littoral Combat Ship and the Coast more than 11,000 Bv206 vehicles, which have Guard’s Deepwater programme. been sold to nearly 40 countries, including customers in France, Germany, Sweden, United Kingdom Netherlands, UK, Italy and Spain. Initial production deliveries of the M777 Lightweight Artillery System to the US Army In the area of intelligent munitions for and Marine Corps have been completed, and artillery and mortar systems, the US Army full rate production has begun. The M777 has declared Excalibur ready for formal system has also been ordered by Canada testing prior to accelerated fielding to US and fielded in Afghanistan. and Canadian forces in Iraq and Afghanistan

ILAV win Meeting the customer’s needs Swedish future ground systems In May, BAE Systems received an initial Bradley combat vehicles have been playing The Swedish Modular Armoured Tactical order for 378 Iraqi Light Armoured Vehicles a crucial role in Iraq, providing outstanding Vehicle Programme (SEP) is the latest (ILAV). The 4x4 ILAV leverages proven designs survivability, mobility and lethality in all types in the line of innovative products from and includes a V-shaped hull designed to of combat. BAE Systems has joined forces BAE Systems AB in Sweden which deflect the force of explosions away from with the US Army to create a first-of-its-kind, includes the CV90, Bv206 and BvS10. passengers. The first ILAVs were delivered national level reset programme to help to Iraq 90 days after contract award. remanufacture and upgrade the vehicles.

www.baesystems.com 17 Operating and financial review Programmes

The Programmes business group, with 17,900 employees1 and based in the UK, comprises the Group’s air systems, naval ships and submarines activities, with the UK Ministry of Defence its principal customer. Business group reviews Financial highlights During 2006, Programmes achieved EBITA2 of £167m (2005 £133m) on sales1 of – Sales growth of 4% over 2005 £2,927m (2005 £2,819m) and generated an operating cash inflow3 of £173m – Margin further improved (2005 £285m). – EBITA2 up 26% Air Systems – Good cash performance The Air Systems group is responsible for delivering five major programmes: Typhoon, 2006 2005 2004 Nimrod MRA4, Hawk, F-35 Lightning II (JSF) Sales1 £2,819m £2,219m and Autonomous Systems & Future £2,927m Capability (Air). EBITA2 £167m £133m £10m Deliveries of Typhoon aircraft to the air Return on sales 5.7% 4.7% 0.5% forces of the four partner nations continued Cash inflow3 £173m £285m £442m with a further 40 aircraft delivered in the 1 year. BAE Systems continues to provide Order intake £2,772m £2,101m £5,264m support to the UK’s Royal Air Force (RAF) Order book1 £12.1bn £12.3bn £13.0bn training and operational build up, with aircraft operating in three squadrons in the UK. Key points Negotiations to establish ongoing integrated logistics support contracts continue. In – Good schedule and cost adherence addition, the UK MoD has awarded an initial contract combining scheduled maintenance – Programmes transitioning from development to production work with upgrade activity. – Hawk and Nimrod production orders secured Final assembly of the first of 236 Tranche 2 – UAV technology agreements secured aircraft is underway, in addition to the first of 18 aircraft for Austria. Looking forward Further export possibilities are being pursued, including the supply of Typhoon The future of Programmes is closely linked to UK MoD funding both to meet future aircraft to Saudi Arabia. requirements of the UK’s armed forces and to subsequently generate export business. During the year the UK MoD awarded the For Air Systems, growth in the short term is dependent upon anticipated higher activity, Nimrod MRA4 production contract, signalling as UK development programmes move to production, and on potential Hawk and Typhoon renewed confidence in the programme and export sales. in the capability the aircraft will deliver. Naval Ships expects to be involved in the implementation of the Defence Industrial Strategy The design and development programme in the maritime sector. Growth prospects include the UK’s Future Carrier (CVF) programme is on target to achieve the product maturity and the MARS (Military Afloat Reach and Sustainability) programme. contained within the production bid assumptions. Activities are now concentrated The Submarines business is expected to grow with increased activity on the Astute programme in developing, jointly with the customer, an and the anticipated build of a major block of the Future Carrier. Completion of pricing of boats innovative support solution for the first five 2 and 3 and securing orders for Astute boats 4 to 7 is key in retaining the necessary skill base years of service. in order to design and build the next-generation nuclear deterrent submarine. Development of the UK’s Hawk Advanced Jet Trainer proceeded to plan and helped secure the production order for 28 Hawk Mk128 aircraft from the UK MoD. Hawk is well

Share of Group sales4 Share of Group EBITA2,5 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash inflow from operating activities after capital 21% 13% expenditure (net) and financial investment, and dividends from equity accounted investments 4 before elimination of intra-group sales 5 excluding HQ and other businesses

18 BAE Systems Annual Report 2006 positioned to meet continued market The business is focused on working with the to this work has been to prepare full cost, demand for training aircraft, including UK MoD to deliver the SUAV(E) and Taranis schedule and programme inputs in existing Hawk customers who wish to demonstration contracts to establish the support of the UK MoD Main Gate Review upgrade their fleet. role of UAVs/UCAVs in the future force mix for the approval of the whole programme. and transitioning the HERTI demonstration BAE Systems, holding significant All six Hawk aircraft for Bahrain were system into a production programme. responsibilities across the total CVF delivered on time, the India contract is scope of work, is committed to working proceeding to plan, with the first flight of Naval Ships with the other alliance partners to secure an Indian Hawk achieved in December, The second of the originally contracted a successful outcome. and 15 aircraft have been delivered Landing Ship Dock (Auxiliary) ships, RFA to South Africa. Cardigan Bay, was handed over in August. The arbitration process over the acceptance The contract was expanded as the UK MoD of the three offshore patrol vessels for BAE Systems is partnered with Lockheed contracted to Naval Ships the responsibility Brunei continues. Martin and Northrop Grumman on the JSF for completion of the final vessel, Lyme Bay, programme, having responsibility for the A letter of intent was signed with the together with class design and warranty design and manufacture of the rear fuselage government of Malaysia for two frigates. authority. and empennage and for the supply of Negotiations continue to convert this certain air vehicle systems. With four Type 45 ships in various stages agreement into a contract. of production, a high level of activity The first flight of the System Development and resource load has been reached. Submarines and Demonstration aircraft was achieved The construction of the first of class boat, Business group reviews To meet this demand, over 500 new staff in December. Astute, is largely completed with the test joined the business in 2006, largely in and commissioning activities now the 2007 will see the substantial completion production areas. of the detailed design for each of the major focus. Whilst the major focus remains on the F-35 variants and the acceleration of the setting-to-work and commissioning of the The Astute programme continued its manufacture and delivery of major units Type 45 first of class, Daring, in readiness improved performance with nine of its ten for the remaining development aircraft in for sea trials in the second half of 2007, key milestones achieved in the year, eight the System Development and Demonstration excellent progress was made on the second being achieved ahead of plan and one phase of the programme. Low rate initial and third ships, with build efficiency targets behind plan. The remaining milestone was production is expected to commence in met or exceeded. achieved early in 2007. The launch of 2007. Discussions between the UK and Astute has been brought forward by three US governments on appropriate levels of Milestone achievements continue to plan months to June 2007. technology sharing on the JSF programme and these, combined with successful risk- progressed during the year. reducing system integration work in the Productivity improvements are being Maritime Integration Support Centre, have addressed through innovative build The medium-altitude long-endurance enabled initial profit recognition on the strategies. These include increased use Unmanned Air Vehicle (UAV) system (HERTI) programme in 2006. of modular assembly and vertical outfitting was unveiled in 2006 and the ASTRAEA of full sections, in addition to investment programme was launched – a multi-faceted The Group is currently working with the in facilities, simplification of processes, UK programme working towards creating customer to restructure the existing contract systems and design to reduce cost. These the right conditions for operating unmanned around a new six ship proposal to provide a measures are aimed at reducing the cost of aircraft in UK airspace. cost-effective solution that ensures timely production following the first of class boat. delivery of agreed capability across the Risk reduction activities were completed class under a jointly managed risk profile. for the Strategic Unmanned Air Vehicle This is expected to conclude in mid-2007. (Experiment) (SUAV(E)) project with the UK MoD and, in December, a follow-on technology The Carrier Alliance has established a set demonstration programme, Taranis, to support of contracts with the various alliance MoD evaluation of unmanned air combat partners for the demonstration phase of the vehicle technologies, was secured. CVF programme. One of the key components

Typhoon development programme Astute class submarine – reducing costs Unmanned Air Vehicle (UAV) capability The Typhoon development programme BAE Systems is actively looking at ways The UK Defence Industrial Strategy continued through the year with a series to work in partnership with its supply highlighted the importance of developing of releases of UK Paveway II Laser Guided chain. The Submarines business has set UAV capability within the UK industrial base. Bombs, demonstrating its ability to perform up a ‘suppliers club’ which, together with BAE Systems has developed, built and flight the air-to-ground role – a step towards innovative build strategies, is helping to tested UAV demonstration systems in as ensuring that Typhoon provides the drive down costs on the Astute programme. little as six months, only a quarter of the cornerstone of NATO’s defence capability time usually needed. for the next 30 years.

www.baesystems.com 19 Operating and financial review Customer Solutions & Support

The Customer Solutions & Support (CS&S) business group, with 14,600 employees1, provides partnered, through-life support solutions and capability to the UK MoD and manages the Group’s business in Saudi Arabia and Australia. Business group reviews Financial highlights During 2006, CS&S achieved EBITA2 of £477m (2005 £419m) on sales1 – Sales growth of 9% over 2005 of £3,180m (2005 £2,923m) and – Return on sales maintained at c.15% generated an operating cash inflow3 of £289m (2005 £850m). – Cash flow includes £130m incurred on Saudi infrastructure Saudi Arabia BAE Systems has a major presence in the Kingdom of Saudi Arabia where it acts as 2006 2005 2004 prime contractor for the UK government-to- Sales1 £3,180m £2,923m £2,856m government defence agreement. Over the last two decades the programme has 2 EBITA £477m £419m £497m included the provision of aircraft, associated Return on sales 15.0% 14.3% 17.4% hardware, support, infrastructure and Cash inflow3 £850m £1,102m manpower training for the Royal Saudi £289m Air Force (RSAF). On 21 December 2005 Order intake1 £4,367m £3,280m £3,543m the UK and Saudi Arabian governments Order book1 £6.0bn £5.0bn £4.6bn signed an Understanding Document outlining plans to modernise the Saudi armed forces. Modernisation activities are Key points now underway. Under the terms of the – Tornado ATTAC agreement signed in the UK signed document, Typhoon aircraft will replace Tornado Air Defence Variant aircraft – Kingdom of Saudi Arabia modernisation programme underway and others currently in service with the – Investment in the Kingdom of Saudi Arabia continues RSAF. Detailed negotiations are continuing to progress the Understanding Document – Australian Hawk support contract secured towards a contract for the delivery of Typhoon aircraft. Looking forward Around 4,600 people are employed by CS&S will continue to seek to sustain its long-term presence in Saudi Arabia through developing the Group in the Kingdom of Saudi Arabia, new business and delivering on current support commitments. of whom more than half are Saudi nationals. The business is continuing to develop its CS&S will continue to work with the UK customer to provide smarter, more integrated support presence in Saudi Arabia and is helping to and capability solutions on customer bases. Development of these solutions will be underpinned develop a greater indigenous capability in by the migration of the Availability Transformation: Tornado Aircraft Contract (ATTAC) model to the Kingdom. The security of employees other future UK platforms. is the highest priority and progress on new residential and office facilities as well as increased security measures continues. Occupation of the first new residential compound and new office facilities began on schedule in late 2006. Performance on the Saudi support programme in 2006 has progressed well. Margins have stabilised following increased indigenous Saudi content in repair and overhaul work.

Share of Group sales4 Share of Group EBITA2,5 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash inflow from operating activities after capital 22% 35% expenditure (net) and financial investment, and dividends from equity accounted investments 4 before elimination of intra-group sales 5 excluding HQ and other businesses

20 BAE Systems Annual Report 2006 United Kingdom In support of the Hawk programme a bid However, in January 2007, it was announced In the UK, CS&S continued to develop its was submitted to provide availability support that this programme was to be awarded to successful partnering arrangement with the to the RAF’s TMk1 aircraft. the competing consortium led by QinetiQ. UK MoD’s Defence Logistics Organisation focusing on through-life capability management An extension to the existing Nimrod Integrated The business was unsuccessful in its bid and value for money in line with the UK’s Support contract was received in June. for an integrated through-life support Defence Industrial Strategy (DIS). contract to support the Victoria Class Naval submarines in Canada. A key message from DIS is the need for In the naval domain, the reactivation of investment in supply chain skills, capabilities three ex-Royal Navy frigates for the Chilean Australia and technologies. BAE Systems has Navy is progressing. The handover and CS&S Australia performed well in 2006 established a supply chain capability project commissioning of Almirante Cochrane on securing a number of contracts and to further develop its suite of high-quality 22 November was a significant milestone in strengthening its position as a through-life support processes across the business. the programme. The first of a series of capability partner to the Australian Memoranda of Understanding with the Defence Force. In air support, performance under the customer with respect to delivering a Tornado Combined Maintenance and Negotiations for a five-year A$343m support solution for the vessels was signed Upgrade contract remains strong with (£138m) support contract for the in October. 11 aircraft returned to front-line service Australian Hawk Lead-In Fighter aircraft since contract award in December 2005. The naval joint ventures performed well. were successfully completed, and the

business is also a key supplier in providing Business group reviews In December, the Tornado ATTAC contract BAE Systems has 50% interests in Fleet a new airborne early warning system to was signed. The contract offers a full Support Limited (FSL) and Flagship Training South Korea. Tornado availability service for the next Limited (FTL). In parallel with the naval base ten years with an initial value of £947m. review announced by the UK Secretary of ATTAC will deliver reduced costs and State for Defence in September 2006, FSL increased operational efficiencies with has been involved in a number of cost- improved aircraft availability to the front-line. saving initiatives. Experience of the ATTAC bid is being used In October, FSL signed a Memorandum of to progress a similar availability contract Understanding (MoU) between FSL, DML and for the Harrier aircraft, with negotiations Babcock and the Minister of Defence on an initial risk reduction package well Procurement in support of the Surface Ship advanced. The Harrier Joint Upgrade and Support Alliance. This activity will develop Maintenance Programme at RAF Cottesmore throughout 2007 to jointly identify a more is already helping to meet urgent operational effective model for the support of surface requirements for the front-line in Afghanistan ships with projected savings of £90m while at the same time maintaining the GR9 per year. upgrade programme. The results of the UK MoD naval base In September, the in-service date for the review are expected in 2007. Harrier GR9 upgrade was achieved on schedule. The GR9 upgrade is carried out in The delivery of high-quality training solutions a partnered arrangement with the UK MoD continues, primarily through FTL which, based at RAF Cottesmore. The programme building on the strong partnering has delivered cost savings and reduced relationship with the Royal Navy, was aircraft ‘downtime’ from 52 to 35 weeks awarded a £45m contract for the planning during the upgrade. and delivery of a number of courses for existing and future naval personnel. The ATTAC model should also provide the blueprint for future support arrangements FTL formed part of the MC3 Training bid for on Typhoon. the Defence Training Review programme.

Ship reactivation Tornado ATTAC Saudi Arabia BAE Systems is prime contractor for BAE Systems is to provide availability BAE Systems’ home market strategy in the reactivation of former Royal Navy support to the Tornado platform for the Saudi Arabia is focused on the warships for overseas customers Royal Air Force (RAF), known as ATTAC development of indigenous industrial including preparation of the vessels (Availability Transformation: Tornado capabilities in-country to strengthen the and training of crews. Aircraft Contract). ATTAC will see Group’s long-term presence in an BAE Systems partnering with the UK important and successful market. MoD and the RAF, reflecting the aims and objectives of the UK’s Defence Industrial Strategy.

www.baesystems.com 21 Operating and financial review Integrated Systems & Partnerships

The Integrated Systems & Partnerships business group, with 10,500 employees1, is a portfolio of high-technology defence systems businesses comprising the wholly-owned Integrated System Technologies and Underwater Systems, together with a 37.5% interest in the pan-European MBDA joint venture, a 20.5% interest in Saab of Sweden and a 50% interest in the Gripen International joint venture. Business group reviews Financial highlights During 2006, Integrated Systems & Partnerships achieved EBITA2 of £113m – Results reflect further portfolio restructuring in the year (2005 £109m) on sales1 of £1,748m (2005 – Margin further improved to 6.5% £1,834m) and generated an operating cash inflow3 of £158m (2005 £17m). This result follows the significant restructuring of the Group’s portfolio of European defence businesses in 2005.

2006 2005 2004 In August the Group disposed of its wholly- Sales1 £1,748m £1,834m £2,022m owned Atlas Elektronik business for €149m (£103m), generating a profit on disposal 2 EBITA £113m £109m £95m of £3m. Return on sales 6.5% 5.9% 4.7% In addition to its main businesses, the Cash inflow3 £158m £17m £59m results of which are explained in more Order intake1 £1,516m £1,756m detail below, the Group has a 25% interest £1,655m in Selex Sensors and Airborne Systems SpA. Order book1 £5.8bn £5.9bn £7.0bn This is subject to a put option at an agreed value of £268m exercisable by BAE Systems Key points in the three-month period from the beginning of June 2007 and a call option by – European portfolio restructuring complete Finmeccanica at any time to August 2007. – Major Insyte communication systems wins in UK Integrated System Technologies (Insyte) – MBDA programme milestones achieved The Insyte business completed its first full year of trading as a wholly owned subsidiary. – Saab’s acquisition of Ericsson Microwave Systems complete Order book grew primarily on receipt of the FALCON Increment A contract (£267m). Looking forward FALCON will provide the British armed forces with a new mobile, high-capacity, secure Implementation of the UK’s Defence Industrial Strategy (DIS) is material to the UK activities information system infrastructure at the of the Integrated Systems & Partnerships business group. operational and tactical levels of command. Growth is anticipated from the Insyte business, building on the UK naval systems market The business secured its first significant position and recent success in land systems. national security contract in 2006 and was contracted as the mission system For Underwater Systems, the follow-on activities from DIS will play an important role in shaping prime contractor on the CVF programme the future position of the business. and was also awarded the T93 Radar The announcement in 2006 by the UK MoD of the creation of ‘Team CW’ (Complex Weapons) Replacement contract to support the UK led by MBDA represented a significant step forward in the implementation of DIS in this sector. Air Defence Systems. The business has a number of key programmes. Sampson radar, the Command Management System and Long Range Radar Development and Production contracts for the Type 45 destroyers, and the Seawolf Midlife Upgrade for Type 22 and 23 destroyers all achieved their key milestones in the year.

Share of Group sales4 Share of Group EBITA2,5 1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash inflow from operating activities after capital 12% 8% expenditure (net) and financial investment, and dividends from equity accounted investments 4 before elimination of intra-group sales 5 excluding HQ and other businesses

22 BAE Systems Annual Report 2006 Underwater Systems MBDA has been selected by the UK MoD order from the Swedish government for the The Sting Ray lightweight torpedo main to lead the UK’s Complex Weapons sector continued development of the Gripen system. production order for the UK MoD is under the Defence Industrial Strategy, The acquisition of Ericsson Microwave progressing on schedule with the second working with the UK MoD to develop Systems for SEK3.75bn (£280m) was batch of torpedoes being accepted in a Strategic Partnering Agreement which completed on 1 September. This acquisition December 2006. will underpin the sovereign UK capability added radar and sensor operations to in complex weapons technologies, design, The Archerfish product was selected as Saab’s existing portfolio in the areas of development and manufacturing for the the Common Mine Clearance Neutraliser defence, aviation, space and civil security. future. It is anticipated that 2007 will see for the US Navy and is to be used on three this work brought to fruition. Saab’s order book at the end of the year different programmes. was SEK51bn (£3.8bn). Important progress has been made Talisman, which is a Group-funded during the year on MBDA’s development Unmanned Underwater Vehicle, achieved Gripen International (50%) programmes. Significant milestones included The first Gripen test aircraft arrived in South what is believed to be a world first by the successful air-launched demonstration Africa and has commenced the integration launching and controlling another weapon firings of the new Meteor beyond visual and development test programme. Deliveries while itself operating at a distance from range air-to-air missile, the first system of aircraft to Hungary commenced in the the mother ship. This successful test was qualification of the Franco-Italian year and the contractual offset obligations observed by potential customers. Aster/PAAMS (E) naval air defence system to both Hungary and the Czech Republic

The business continues discussions with and qualification firings of the SAMP/T are being met. Business group reviews the UK MoD on a long-term partnering land-based system. In addition, the PAAMS agreement to sustain capability for the programme for the Royal Navy’s Type 45 longer term. destroyer is now progressing through integration and testing following deliveries MBDA (37.5%) of the Sampson radar. MBDA also achieved MBDA performed well with increases in development successes with the first firing both sales and EBITA2 as 4,000 missiles of the new Exocet Block 3 coastal attack were produced and delivered, including missile, completion of development of the the Storm Shadow and Scalp airborne Marte Mk2/S helicopter-launched anti-ship cruise missiles, Mica air-to-air weapon, weapon and Milan ER anti-armour missile. Exocet anti-ship missile, and the Taurus cruise missile. The new Customer Service The acquisition of the German missile & Support division also reported successful company LFK was completed in March sales and orders in the year. 2006, with integration well advanced. Financial performance of the acquired A number of export orders were secured business has exceeded expectations in the year, including a €450m (£303m) to date. order from the UAE (Exocet Blocks 2 and 3), a contract from Saudi Arabia for the Mistral Saab (20.5%) air defence system, an order from India for Sales rose by 9% to SEK21bn (£1.55bn), the ATAM missile system for the new ALH of which 65% is attributable to sales helicopter, as well as orders from Chile for outside Sweden. Operating income rose the new Seawolf Block 2 naval missile and to SEK1,745m (£129m), producing an Exocet. Domestic orders remained strong operating margin after restructuring costs underpinned by the Aster/PAAMS of 8.3%. Order intake is substantially programme, a contract from France for the improved compared with 2005, mainly new Scalp Naval cruise missile and an order attributable to the SEK5.5bn (£411m) order from Germany for the Pars 3 next-generation from Pakistan for an airborne surveillance anti-armour weapon for the Tiger helicopter. system together with a SEK1bn (£75m)

Technology delivered to the battlefield Talisman launches a world first FALCON is a mobile, high-capacity Talisman, the BAE Systems’ developed information infrastructure that brings unmanned underwater vehicle (UUV), has the latest all-internet protocol technology achieved its latest capability breakthrough, to the battlefield. It is a rapidly deployable, by becoming the first UUV to successfully truck-mounted system that allows troops fire and control weapons at sea during trials. and battlefield commanders to communicate Talisman is an example of BAE Systems’ quickly, securely and reliably with each approach to rapid prototyping, with other and with other levels of command. concurrent design, development and testing.

www.baesystems.com 23 Operating and financial review HQ and other businesses

HQ and other businesses, with 2,300 employees1, comprises the regional aircraft asset management and support activities, head office and UK shared services activity, including research centres and property management. Business group reviews Financial highlights and key points During 2006, HQ and other businesses reported a loss of £147m (2005 £118m) – Total Regional Aircraft loss of £114m and had an operating cash outflow3 of – Cash outflow from Regional Aircraft of £66m £225m (2005 £79m). Of this, the reported loss for Regional Aircraft was £114m – Aerostructures sale completed (2005 £95m), and operating cash outflow – UK pension funding deficit addressed was £66m (2005 £73m). Regional Aircraft Restated4 Restated4 The regional aircraft leasing market continued 2006 2005 2004 to be impacted by high oil prices and over Sales1 £295m £471m £464m supply of aircraft. The leasing team was successful in securing extensions in 2006 EBITA2 £(118)m £(50)m £(147)m to existing leases with both large established Cash (outflow)/inflow3 £(225)m £(79)m £57m operators in Europe as well as new business Order intake1 £267m £398m £264m in India, Nepal and the Middle East. Leases were also secured for a number of aircraft 1 Order book £0.3bn £0.6bn £0.5bn converted to freighter configuration with further demand expected. Other leasing opportunities continue to emerge although markets remain highly competitive. Support revenues grew with a number of orders secured during the year for power-by- the-hour contracts and aircraft modifications. The majority of the leasing business is underpinned by the Group’s Financial Risk Insurance Programme (FRIP) which makes Looking forward good shortfalls in actual lease income against originally estimated future income. The regional aircraft leasing market remains challenging with new markets likely to be These insurance arrangements are discussed dominated by higher risk customers. Support revenues are dependent on maintaining aircraft in more detail in critical accounting policies in service and conversion of new customers to managed services such as power-by-the-hour on page 30 and in the risks and uncertainties contracts. Losses are expected to continue in this difficult market, albeit at levels lower than section on page 32. in the preceding two years. The Regional Aircraft results for the year include £37m for costs incurred in managing the leased aircraft portfolio and supporting the fleet, and £77m for provisions taken. Aerostructures In March 2006, the sale of the UK Aerostructures business to Spirit AeroSystems Inc. was completed, for a cash consideration of £80m. This disposal generated a profit of £11m arising from the resultant reduction of pension liabilities.

1 including share of equity accounted investments 2 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense 3 net cash (outflow)/inflow from operating activities after capital expenditure (net) and financial investment, and dividends from equity accounted investments 4 restated following the sale of Airbus SAS

24 BAE Systems Annual Report 2006 Operating and financial review Key Performance Indicators (KPIs)

The Board uses a range of financial and non-financial performance indicators, reported on a periodic basis, to measure the Group’s performance over time. These include:

Financial metrics: In addition to the above, long-term contracts employees are aware of our ethical are managed through the application standards and issues or concerns are To measure growth of the business: of mandated business processes at being raised and addressed. Also, to – Order intake represents the value of the operational level. These processes measure how successful our ethics funded orders received from customers include the reporting of consistent metrics training is in ensuring that all employees in the period; related to matters such as schedule and are aware of the Group’s ethical standards cost performance, risk mitigation and and policies (see page 36); and – Order book represents the balance of customer satisfaction. These metrics unexecuted, funded orders received from – employee opinion surveys and are consistently used by the Board and Workplace ( customers; and demographic information): to monitor the operational management in the review opinions of our employees as part of the – Sales represents the amounts derived of contract performance. from the provision of goods and services, development of a high performance culture and includes the Group’s share of equity Non-financial metrics: across the Group and to increase diversity accounted investments’ sales. and broaden the culture to drive innovation The Board recognises its responsibilities and performance (see page 36). To measure performance of the business: to the Group’s shareholders, employees, The Board continues to adopt a progressive – Underlying EBITA1 is used by the Group customers and suppliers, the wider community approach in the development of appropriate for internal performance analysis as and to the environment. The following Group-wide metrics such that performance a measure of operating profitability indicators are used by the Board and the is monitored in a comparable and comparable over time; Corporate Responsibility Committee to monitor transparent way. – represents underlying the application of mandated policies and Return on sales Indicators Performance Key procedures with the objective of meeting the EBITA1 divided by sales, expressed as a percentage; and Group’s responsibilities in these areas: – (injuries – Operating business cash flow represents Health and safety management net cash flow from operating activities and lost days): to minimise risk across after capital expenditure (net) and financial our operations and drive continual investment and dividends from equity performance improvement (see page 36); accounted investments. – Environment (energy and water consumption, waste generation and Further explanation of these Group financial greenhouse gas emissions): to ensure KPIs for the years ending 31 December operational efficiency, regulatory 2006 and 2005 are included on pages 26 compliance and minimising environmental to 30 within the financial review. In addition, impact (see page 36); individual business group financial KPIs are included within the business group reviews – Ethics (number of issues raised and on pages 14 to 24. investigated): to demonstrate that

Order intake and order book (£bn)2 Sales and return on sales (£bn and %)2 1 Since the adoption of IFRS the directors have calculated underlying earnings before amortisation 40 14 10.0 and impairment of intangible assets, finance costs 13 9.5 and taxation expense (underlying EBITA) to eliminate 30 12 9.0 the impact of an acquisition accounting entry required to remove the profit in acquired inventory. This allows 11 8.5 20 the contribution from acquired businesses to be 10 8.0 assessed on a consistent basis from the date of 10 9 7.5 acquisition. This adjustment did not impact the 04 05 06 04 05 06 results for 2006 (2005 £44m). order intake order book sales return on sales 2 On a continuing basis.

Underlying EBITA (£m)2 Operating business cash flow (£m)2 1,250 2,500

1,140 2,000 1,030 1,500 920 1,000 810 Further historical financial information is presented on pages 124 and 125. 04 05 06 04 05 06

www.baesystems.com 25 Operating and financial review Financial review

A year of continued growth

Summary income statement – continuing operations

Restated5 Year to 31 December 2006 Year to 31 December 2005 £m £m Sales1 13,765 12,581 EBITA2 1,207 909 Amortisation (105) (77) Impairment (45)

Financial review Financial (34) Net finance costs1 (174) (196) Taxation expense1 (248) (147) Profit for the year 646 444

Basic earnings per share 19.9p 13.9p Underlying earnings3 per share 23.8p 18.4p

Dividend per share 11.3p 10.3p

Business group summary 2006 20055 Cash Cash inflow/ Order inflow/ Order Sales1 EBITA2 (outflow)4 book1 Sales1 EBITA2 (outflow)4 book1 £m £m £m £bn £m £m £m £bn Electronics, Intelligence & Support 4,007 429 273 3.4 3,697 324 323 3.5 Land & Armaments 2,115 168 137 4.9 1,270 42 168 4.4 Programmes 2,927 167 173 12.1 2,819 133 285 12.3 Customer Solutions & Support 3,180 477 289 6.0 2,923 419 850 5.0 Integrated Systems & Partnerships 1,748 113 158 5.8 1,834 109 17 5.9 HQ and other businesses 295 (147) (225) 0.3 471 (118) (79) 0.6 Less intra-group (507) – – (0.8) (433) – – (0.9) Discontinued businesses – – (23) – – – 373 – 13,765 1,207 782 31.7 12,581 909 1,937 30.8

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 4 net cash inflow/(outflow) from operating activities after capital expenditure (net) and financial investment, and dividends from equity accounted investments 5 restated following the sale of Airbus SAS

26 BAE Systems Annual Report 2006 Results for the year – Taxation as required. The Group’s objective is to The Group’s effective tax rate for continuing ensure the continuity of competitively priced continuing operations operations for the year was 26% (2005 22%). funding through borrowing from a range Sales1 increased 9% from £12,581m to The increase in the rate arises principally of markets and at varied maturities. £13,765m. Organic growth was 5%. Sales due to recognition in 2005 of an Australian Details of the Group’s debt are included in the full year from the former United deferred tax asset previously unrecognised. Defense activities, acquired in June 2005, in note 20 to the Group accounts. During were £1,670m (2005 £789m). Earnings per share 2006, the Exchangeable £676m 3.75% Bond Underlying earnings3 per share from matured and was repaid, and the Exchange EBITA2 increased 33% to £1,207m (2005 continuing operations for 2006 increased Property, represented by the Group’s holding £909m). The growth includes the benefit by 29% to 23.8p compared with 2005. in the ordinary share capital in Vodafone of a full year’s trading from the former United Group Plc, was sold (see note 15 to the Basic earnings per share, in accordance with Defense activities, acquired in June 2005, Group accounts). The US$500m floating rate 2 IAS 33 Earnings per Share, from continuing which contributed EBITA of £169m (2005 note was repaid in the year with no new long operations, increased by 43% to 19.9p £60m) in the year. As reported at the half or medium-term debt raised. It remains the 2 (2005 13.9p). year, included within EBITA is a £61m Group’s intention to ensure the business one-off accounting gain in the Electronics, Basic earnings per share in respect of is funded conservatively and to be proactive

Intelligence & Support business group discontinued operations amounted to 30.8p, in accessing the bank and capital markets Financial review arising from a reduction in the net pension primarily arising from the gain made on the in achieving this aim. liability following the changes to the disposal of the Group’s 20% interest in Airbus calculation of final US pensionable salaries. to EADS (see note 10 to the Group accounts). Losses at Regional Aircraft amounted to Liquidity At 31 December 2006, the Group had gross £114m, these are reported within HQ and Dividend borrowings of £3.1bn (2005 £4.4bn). The other businesses. The Board is recommending a final dividend decrease in level of gross borrowings in the of 6.9p per share (2005 6.3p), bringing the Return on sales (EBITA2 adjusted for uplift year was predominantly as a result of the total dividend for the year to 11.3p per share on acquired inventories expressed as a repayment of the Exchangeable £676m 3.75% (2005 10.3p), an increase of 9.7%. percentage of sales) for the Group increased Bond and the US$500m floating rate note. from 7.6% to 8.8%. Return on sales excluding The proposed dividend is covered 2.1 times In addition to its gross borrowings, the the one-off pension gain referred to above by earnings3 from continuing operations Group has a committed revolving credit was 8.3%. (2005 1.8 times) which is consistent with facility (RCF) of £1.5bn, which is syndicated the policy of growing the dividend whilst Order book1 increased to £31.7bn, primarily amongst the Group’s core relationship maintaining a long-term sustainable earnings on US awards in the Land & Armaments banks, that is available to meet any general cover of approximately two times. business and on securing the Tornado corporate funding requirement and supports ATTAC contract in CS&S. Discontinued operations the Group’s commercial paper programme. Finance costs The results for discontinued operations are The RCF was originally contracted for five Finance costs, including the Group’s share disclosed in note 9 to the Group accounts years until 2010. However, it has been of the finance costs of equity accounted and relate to the disposal of the Group’s extended by the agreement of two one-year investments, were £174m (2005 £196m). shareholding in Airbus. extensions until 2012, although the The underlying interest charge of £157m available amount for the final year has been Capital structure reduced from £1.5bn to £1.3bn. The RCF (2005 £191m) was increased by a net The Group funds its operations through remained undrawn throughout the year. charge of £17m (2005 £5m) arising from a mixture of shareholders’ funds and pension accounting, marked-to-market borrowing facilities, including bank and The Group had cash, short-term investments revaluation of financial instruments and capital market borrowings. All the Group’s and non-current term deposits of £3,607m foreign currency movements. material borrowings are arranged by the (2005 £3,215m) and cash on customers’ Underlying interest cover based on EBITA2 central treasury function and funds raised account of £62m (2005 £53m) giving increased from 4.8 times to 7.7 times. are lent onward to operating subsidiaries net cash of £435m (2005 net debt of

Sales – continuing operations (£bn)1 EBITA – continuing operations (£m)2 Exchange rates The principal exchange rates impacting the 04 10.7 04 800 Group are as follows: 2006 2005 05 12.6 05 909 £/€ – average 1.467 1.462 06 13.8 06 1,207 £/$ – average 1.844 1.819 £/€ – year end 1.484 1.455 £/$ – year end 1.957 1.718

www.baesystems.com 27 Operating and financial review Financial review (continued)

£1,277m). Generally, excluding the impact Reconciliation of cash flow from operating activities to net cash/(debt) of acquisition or disposal financing, the net Excluding debt of the Group is driven by operational one-off One-off performance, the level of receipts on the pension pension funding funding 2006 2005 major contracts and the performance of the £m £m £m £m equity accounted investments. Historically, Cash flow from operating activities 1,273 (495) 778 2,099 the net debt/cash position of the Group is usually at its best at the half and full year. Capital expenditure (net) and financial investment (383) 242 (141) (250) Cash flows Dividends received from equity Cash inflow from operating activities was accounted investments 145 – 145 88 £778m (2005 £2,099m), which includes £441m one-off contributions into the UK Operating business cash flow 1,035 (253) 782 1,937 pension schemes, representing cash of Interest and preference dividends (207) (152) £199m and proceeds from the sale of Taxation (85) (27) property of £242m. A one-off contribution Free cash flow 490 1,758 of $100m (£54m) was also made into the Equity dividends paid (315) US pension schemes in December 2006. (346) Acquisitions and disposals 1,330 (1,836) Good conversion of EBITA2 to operating Other non-cash movements (5) (52) business cash flow was delivered across the Group. (Purchase)/issue of equity shares (71) 373 Foreign exchange 323 (219) There was an outflow from net capital 6 Movement in cash on customers’ account (35) expenditure and financial investment of (9) Financial review Financial £141m (2005 £250m). This includes the 1,712 (326) receipt of £242m from the disposal of Group Opening net debt as defined by the Group (1,277) (668) property to fund the additional contributions Adoption of IAS 32 and IAS 39 – (283) made to the UK pension funds (see note 22 Closing net cash/(debt) as defined by the Group 435 (1,277) to the Group accounts). Excluding this item, the underlying net capital expenditure and Analysed as: financial investment cash outflow was £383m (2005 £250m). Term deposits – non-current 4 – Other investments – current 503 634 The resulting operating business cash Cash and cash equivalents 2,581 inflow of £782m (2005 £1,937m) gave 3,100 rise to free cash inflow, after interest, Loans – non-current (2,776) (3,534) preference dividends and taxation, of Loans – current (308) (815) £490m (2005 £1,758m). Overdrafts – current (26) (90) The net cash inflow from acquisitions and Loans and overdrafts – current (334) (905) disposals was £1,330m including the receipt Cash on customers’ account6 of net proceeds of £1,212m from the October (included within trade and other payables) (62) (53) disposal of the Airbus shareholding. Closing net cash/(debt) as defined by the Group 435 (1,277) Net cash of the Group at 31 December 2006 was £435m, a net inflow of £1,712m from the net debt position of £1,277m at the credit ratings provided by these agencies 2005 which was predominantly attributable start of the year. were as follows: to the increased gearing following the United Defense acquisition. Insurance Rating agency Rating Outlook Category The Group operates a policy of partial self- Moody Baa2 Stable Investment The Board continues to view the maintenance insurance, with a majority of cover placed grade of an investment grade credit rating as important to the efficient operation of the in the external market. The Group continues Standard BBB Stable Investment to monitor its insurance arrangements to & Poor’s grade Group’s activities. ensure the quality and adequacy of cover. Fitch BBB Stable Investment grade Credit rating The Group subscribes to Moody, Standard & During the year the Group’s outlook Poor’s, and Fitch investors’ service for assigned by these agencies improved to its official publicised credit ratings. As at stable, a positive development from the 31 December 2006, the Group’s long-term ‘negative’ outlook held at 31 December

6 cash on customers’ account is the unexpended cash 3 Underlying earnings per share from received from customers in advance of delivery which continuing operations (pence per share)7 is subject to advance payment guarantees unrelated to Group performance 04 13.6 7 underlying earnings per share has been restated to exclude the results of Airbus SAS 05 18.4

06 23.8

28 BAE Systems Annual Report 2006 Retirement benefit obligations to the expected return on investments within the Group’s plans, the rate of increase in The movement in retirement benefit obligations during the year is as follows: pensionable salaries, the rate of increase £m in the retail price index, the mortality rate of Deficit in defined pension plans at 1 January 2006 (5,306) plan members and the discount rate applied Decrease in liabilities due to changes in assumptions 473 in discounting liabilities. For each of these assumptions there is a range of possible Actual return on assets above expected returns 521 values and, in consultation with our One-off contributions 733 actuaries, management decides the point Recurring contributions over service cost 131 within that range that most appropriately Curtailment gains 113 reflects the Group’s circumstances. Small changes in these assumptions can have a Acquisitions/disposals 66 significant impact on the size of the deficit Other movements 102 calculated under IAS 19. Deficit in defined benefit pension plans at 31 December 2006 (3,167) The reported IAS 19 net pension deficit, US healthcare plans (35) including healthcare plans, at 31 December Total IAS 19 deficit (3,202) 2006 is £2.4bn (2005 £4.1bn). Liabilities Allocated to equity accounted investments and other participating employers 774 decreased due to one-off company Group’s share of IAS 19 deficit (2,428) contributions of cash and assets of £733m, together with a reduction in pension liabilities from revised retirement benefits. In June 2006, the Group announced it had statements. These judgements involve The remainder of the decrease was primarily agreed a programme of measures to address assumptions or estimates in respect of attributable to an increase in discount rates the funding deficit in its principal UK pension future events, which can vary from what is and higher than expected return on assets. schemes. The measures included one-off anticipated. However, the directors believe contributions and agreed changes to the that the consolidated financial statements The Group has allocated an appropriate share members’ benefits to reduce future liabilities. reflect appropriate judgements and of the pension deficit to the equity accounted estimations and provide a true and fair investments and other participating Following one-off contributions of £733m, view of our financial performance and employers using a consistent and reasonable comprising cash of £253m, property and Financial review position over the relevant period. method of allocation which represents, based deferred cash assets of £480m, higher on current circumstances, the directors’ best than expected investment returns and an Retirement benefit plans estimate of the proportion of the deficit increase in real discount rates, the Group’s The Group accounts for post-retirement anticipated to be funded by these entities. share of the pension deficit decreased pension and healthcare plans in accordance The Group’s share of the pension deficit to £2,428m after allocation to equity with International Accounting Standard 19 allocated to the equity accounted investments accounted investments and other Employee Benefits (IAS 19). is included on the balance sheet within equity participating employers. For defined benefit retirement plans, the accounted investments. A net deferred tax asset of £778m is cost of providing benefits is determined The valuing of assets and liabilities periodically by independent actuaries and disclosed in note 8 to the Group accounts at a point in time rather than matching charged to the income statement in the relating to the above deficit. expectations of assets and liabilities over period in which those benefits are earned time has no impact on short-term cash Further disclosure on the above is given by the employees. Actuarial gains and contributions to the pension plans. These in note 22 to the Group accounts. losses are recognised in full in the period in which they occur and are recognised in funding requirements are derived from the statement of recognised income and separate independent actuarial valuations. Critical accounting policies expense. Past service cost is recognised Additional details concerning the Group’s The Group’s significant accounting policies immediately to the extent the benefits are retirement benefit plans are given in note 1 are outlined in note 1 to the Group accounts already vested, or otherwise is amortised and note 22 to the Group accounts. (page 76). Not all of these significant on a straight-line basis over the average period until the benefits become vested. Contract revenue and profit recognition accounting policies require management The majority of the Group’s defence to make difficult, subjective or complex The retirement benefit obligations activities are conducted under long-term judgements or estimates. recognised in the balance sheet represent contract arrangements and are accounted The following is intended to provide an the present value of the defined benefit for in accordance with IAS 11 Construction understanding of those policies that obligation as adjusted for unrecognised Contracts. Revenue is recognised on management considers critical because past service cost and as reduced by the such contracts based on the achievement fair value of plan assets. of the level of complexity, judgement or of performance milestones. No profit is estimation involved in their application and The main assumptions made in accounting recognised on contracts until the outcome their impact on the consolidated financial for the Group’s post-retirement plans relate of the contract can be reliably estimated.

www.baesystems.com 29 Operating and financial review Financial review (continued)

Profit is calculated by reference to reliable and included in intangible assets. Goodwill granted. The value of this cover to the estimates of contract revenue and forecast on acquisitions of joint ventures and Group takes account of the actual net costs after making suitable allowance associates is included in equity accounted income generated by these aircraft, over for technical and other risks related to investments. IFRS 3 also requires the a significant period of time. Accordingly, performance milestones yet to be achieved. identification of other acquired intangible the Group is required to make estimates assets. The techniques used to value Owing to the complexity of many of the of the future net income for these aircraft these intangible assets are in line with contracts undertaken by the Group the to assess the value of this cover. internationally used models but do require cost estimation process requires significant the use of estimates which may differ The assumptions and judgements used to judgement and is based upon the knowledge from actual outcomes. Future results determine the values of these aircraft and and experience of the Group’s engineers, are impacted by the amortisation period any related impairment charges, adjustments project managers, finance and commercial adopted for these items and, potentially, to provision levels and the assessed value professionals and using the Group’s contract any differences between estimated and of the FRIP cover reflect the best estimate management processes. Factors that are actual circumstances related to individual of the current circumstances. considered in estimating the cost of work intangible assets. to be completed and ultimate profitability The Group has granted residual value of the contract include the availability Goodwill is not amortised but is tested guarantees in respect of aircraft sold of and productivity of labour, the nature and annually for impairment and carried at which £191m remains outstanding (2005 complexity of the work to be performed, the cost less accumulated impairment losses. £460m). After taking account of the FRIP effect of change orders, the availability of The impairment review calculations require and independent appraisal valuations it is materials, performance of subcontractors the use of estimates related to the future considered that the Group’s net exposure to and availability and access to government- profitability and cash-generating ability of these guarantees is covered by the provisions furnished equipment. the acquired business. Additional details held, on a net present value basis, and the Cost and revenue estimates and judgements concerning the Group’s treatment of residual values of the related aircraft.

Financial review Financial intangible assets and impairment reviews are reviewed and updated at least quarterly Additional details concerning the Group’s are given in note 1 to the Group accounts. and more frequently as determined by aircraft financing contingent liabilities are events or circumstances. When it is Regional Aircraft valuations given in note 24 to the Group accounts. probable that total contract costs will The Group holds a number of regional exceed total contract revenue, the expected aircraft on its balance sheet. These aircraft loss is recognised immediately as an are leased to airline operators. In addition, expense. Contract costs comprise directly the Group has provided residual value attributable costs including an allocation guarantees (RVGs) in respect of certain of direct overheads. Indirect overheads are regional aircraft sold. The aircraft held only regarded as contract costs when their on balance sheet are subject to regular recovery is explicitly allowed for under the impairment testing comparing their carrying terms of the contract. Indirect costs are value with estimates of the future net rental otherwise treated as a period cost and are inflows. To the extent that rental income is expensed as incurred. Material changes in not contracted, estimates of future income one or more of these estimates, whilst not anticipated, would affect the profitability levels are made. of individual contracts. Provisions related to the RVGs are measured Where goods are supplied under arrangements as the difference between amounts payable not considered to represent construction to customers and the estimated fair value contracts, sales are recognised when the of the aircraft. The fair value of these aircraft significant risks and rewards of ownership is determined through independent appraisal have been transferred and the related revenue valuations using specific data such as aircraft and costs can be measured reliably. model, age and condition, and the market conditions for specific aircraft and similar Where services are rendered, sales are models. These valuations inherently require recognised when the stage of completion a number of judgements and assumptions of the services and the related revenue to be made. and costs can be measured reliably. The Group holds insurance cover through Additional details concerning the Group’s the Financial Risk Insurance Programme revenue recognition policy are in note 1 (FRIP) contracted for in 1998 that makes to the Group accounts. good shortfalls in actual income against Intangible assets estimated future income used for the In accordance with IFRS 3 Business valuation of the majority of the on-balance Combinations (IFRS 3), goodwill arising sheet aircraft and a number of the aircraft on acquisition of subsidiaries is capitalised where residual value guarantees have been

30 BAE Systems Annual Report 2006 Operating and financial review Risks and uncertainties

This section addresses the principal risks to which the Group is exposed, which could adversely affect the business, results of operations, cash flow, financial condition, turnover, profits, assets, liquidity and capital resources of the Group.

The Group is dependent on defence spending during performance of a fixed-priced contract to the contract by the procuring agency and any reductions in such spending could may reduce the profitability of a fixed-price as appropriations are made by the US adversely affect the Group. contract or cause a loss. government for future fiscal years. The The Group’s core businesses are primarily termination of one or more of the contracts To mitigate contract-related risks and defence-related, selling products and services for the Group’s programmes by the US uncertainties, contracts are managed through directly and indirectly primarily to the US, the government, or the failure of the relevant the application of the Group’s mandated UK and Saudi Arabian governments. In any agencies to obtain expected appropriations Lifecycle Management business process single market, defence spending depends for the Group’s programmes, could have a at the operational level and the consistent on a complex mix of political considerations, material adverse effect on the Group’s future application of metrics is used to support the budgetary constraints and the ability of the results of operations and financial condition. armed forces to meet specific threats and review of individual contract performance. The timing of contracts could materially perform certain missions. Because of these The Group’s largest customer contracts affect the Group’s future results of factors, defence spending may be subject are government contracts. to significant fluctuations from year to year. In The governments of the United Kingdom, operations and financial condition. The Group’s operating performance and addition, downturns in broad economic trends the United States and the Kingdom of cash flows are dependent, to a significant in the markets in which the Group operates Saudi Arabia are the Group’s three largest extent, upon the timing and amounts of may result in decreases in defence purchases end customers. Any significant disruption or defence contracts and the work performed by the Group’s major customers. deterioration in the relationship with these thereunder. Because the amounts payable governments and a corresponding reduction Certain parts of the Group’s business under these contracts can be substantial, Risks and uncertainties are dependent on a small number of in government contracts would significantly the award or completion of one or more large contracts. reduce the Group’s revenues. Moreover, contracts, the timing for manufacturing and A significant proportion of the Group’s companies engaged in the supply of delivery of products under these contracts revenue comes from a small number of defence-related equipment and services or the failure to receive anticipated orders large contracts. These contracts individually to government agencies are subject to could materially affect the Group’s operating are typically worth or potentially worth £1bn certain business risks particular to the results and cash flow for the periods affected. or more including, but not limited to, those defence industry. These governments could contracts in the Programmes business unilaterally cancel, suspend or amend their The Group is exposed to risks inherent group. The loss, expiration, suspension, contractors’ funding under existing contracts in operating in a global market. cancellation or termination of any one of or eligibility for new contracts potentially at BAE Systems is a global company which these contracts, for any reason, could have a short notice. In addition, the Group, as a conducts business in a number of regions, material adverse effect on the Group’s future government contractor, is subject to financial including the Middle East, and, as a result, results of operations and financial condition. audits and other reviews by some of its assumes certain risks associated with governmental customers with respect to businesses with a broad geographical reach. The Group has fixed-price contracts. the performance of, and the accounting and In some countries these risks include, and A significant portion of the Group’s revenues general practices relating to, government are not limited to, the following: government are derived from fixed-price contracts, contracts. As a result of these audits and regulations and administrative policies although the Group has reduced its exposure reviews, costs and prices under these could change quickly and restraints on the to fixed-priced design and development contracts may be subject to adjustment. movement of capital could be imposed; activity which is in general more risk governments could expropriate the Group’s intensive than fixed-price production activity. The US government usually appropriates assets; burdensome taxes or tariffs could An inherent risk in these fixed-price contracts funds for a given programme on an annual be introduced; political changes could lead is that actual performance costs may exceed basis, even though contract performance to changes in the business environment in the projected costs on which the fixed may take more than one year. Consequently, which the Group operates; and economic contract prices were based. The Group’s at the outset of a major programme, the downturns, political instability and civil failure to anticipate technical problems, contract is usually only partially funded and disturbances could disrupt the Group’s estimate costs accurately or control costs additional monies are normally committed business activities. The occurrence of

www.baesystems.com 31 Operating and financial review Risks and uncertainties (continued)

any such events could have a material to the Group on a sole-source basis, they of the deficits may be further affected by adverse effect on the Group’s future results may in the future determine to open such a number of factors including declines in of operations and financial condition. programmes to a competitive bidding process. investment returns and changes in interest rates, which may require the Group to Government contracts for defence-related Addressing this exposure the Group has increase the amount of cash contributions products can, in certain countries, be a balanced portfolio with six home markets to these schemes, thereby reducing cash awarded on the basis of home country and we are considering opportunities in new available to meet the Group’s other preference. Therefore, other defence high-growth markets. obligations or business needs. companies may have an advantage over the The Group is subject to export controls Group for some defence-related contracts on The Group has experienced growth and other restrictions. the basis of the jurisdiction in which they are through acquisitions. Anticipated benefits A portion of the Group’s sales is derived organised, where the majority of their assets from the export of its products. Many of acquisitions may not be realised. are located or where their officers or The Group has experienced growth through of the products the Group designs and directors are located. acquisitions and continues to pursue manufactures for military or dual use are Although the Group expects growth in acquisitions in order to meet its strategic considered to be of national strategic objectives. Integrating the operations and interest. The export of such products US defence spending to slow, the Group believes it is well placed to support the US personnel of acquired businesses is a outside of the jurisdictions in which they are complex process. The Group may not be produced may be subject to licensing and Department of Defense’s likely emphasis on force sustainment and affordable able to integrate the operations of acquired export controls and other restrictions where businesses with its operations rapidly transformation. The UK defence equipment many of the Group’s activities are located. or without encountering difficulties. The budget is expected to continue to be No assurance can be given that the export diversion of the attention of management constrained, having potential implications controls to which the Group is subject will to the integration effort and any difficulties for the sustainability of long-term funding for not become more restrictive, that new encountered in combining operations could generations of the Group’s products will not future defence technologies and engineering

Risks and uncertainties adversely affect the Group’s business. The capabilities in the UK. also be subject to similar or more stringent failure to manage such growth, while at the controls, or that political factors or changing In the event that the Group is unable same time maintaining adequate focus on international circumstances will not result in adequately to compete in the markets in which the existing assets of the Group, could have the Group being unable to obtain necessary it operates, the Group’s business and results a material adverse effect on the Group’s export licences. Reduced access to export of operations may be adversely affected. business, future results of operations or markets could have a material adverse effect financial condition. on the Group’s future results of operations The Group’s strong global market positioning, and financial condition. balanced portfolio, leading capabilities and Addressing this exposure the Group has an performance continue to address this risk. established methodology in place to deliver Addressing this exposure the Group has the effective integration of acquisitions. formal systems and policies in place to The Group is involved in consortia, joint ensure adherence to regulatory requirements ventures and equity holdings where it The Group holds a number of regional and to identify any restrictions that could does not have control. aircraft on its balance sheet and has adversely impact the Group’s future activities. The Group participates in various consortia, provided residual value guarantees in joint ventures and equity holdings, exercising respect of certain aircraft sold. The Group’s business is subject to varying and evolving degrees of control. The Group holds a number of regional significant competition. While the Group seeks to participate only in aircraft on its balance sheet. These aircraft Most of the Group’s businesses are focused ventures in which its interests are aligned with are leased to airline operators. In addition, on the defence industry and subject to those of its partners, the risk of disagreement the Group has provided residual value competition from multinational firms with is inherent in any jointly controlled entity, and guarantees (RVGs) in respect of certain substantial resources and capital and many particularly in those entities that require the regional aircraft sold. contracts are obtained through a competitive unanimous consent of all members with Values of regional aircraft are impacted by bidding process. The Group’s ability to regard to major decisions, and that specify a wide range of factors including the financial compete for contracts depends to a large restricted rights. strength of regional aircraft operators, market extent on the effectiveness and innovation of demands for regional aircraft and the impact of its research and development programmes, its The Group is exposed to funding risks in economic factors on aircraft operating costs. ability to offer better programme performance relation to the defined benefits under its than its competitors at a lower cost to its pension schemes. Reductions in the valuations of these aircraft The Group operates certain defined benefit customers, and the readiness of its facilities, could result in impairment charges against pension schemes. At present, in aggregate, equipment and personnel to undertake the the on-balance sheet aircraft or additional there is an actuarial deficit between the value programmes for which it competes. provisions against the guarantees given. of projected liabilities of these schemes and Additionally, in some instances, governments the value of the assets they hold. The Group The Group holds insurance cover through the direct to a single supplier all work for a is making contributions towards deficits Financial Risk Insurance Programme (FRIP) particular programme, commonly known as a in line with agreements reached with the contracted for in 1998 that makes good sole-source programme. Although governments respective scheme trustees based on the shortfalls in actual income against estimated have historically awarded certain programmes recommendations of actuaries. The amount future income used for the valuation of the

32 BAE Systems Annual Report 2006 majority of the on-balance sheet aircraft and with sales representatives and marketing Additional risks and uncertainties currently a number of the aircraft where RVGs have advisers are governed by detailed compliance unknown to the Group, or which the Group been granted. procedures, the application of which is currently deems immaterial, may also have monitored by a dedicated compliance function. an adverse effect on the financial condition At the end of 2006, the anticipated income or business of the Group. from the FRIP was £250m on a net present In 2004 the UK Serious Fraud Office and value basis. This may increase further if Ministry of Defence Police commenced an Further information on how the Group outstanding residual value guarantees are investigation into suspected false accounting manages risk through the activities of the exercised by the airlines or if there are and corruption. The investigation is wide Audit Committee is included on page 48. further reductions in market lease rates. ranging and concerns a number of jurisdictions and contractual arrangements. In 2006, some FRIP reinsurers asserted claims that they were entitled either to In December 2006, the Serious Fraud Office terminate, or to be discharged from, liability discontinued the investigation in so far as it under their reinsurance contracts. Having related to Saudi Arabia. The Group continues raised formal arbitration proceedings, to co-operate fully with the investigation. reinsurers subsequently decided, in January 2007, that they would not pursue these The Group is exposed to volatility in currency claims. Arbitration proceedings are however exchange rates. The global nature of the Group’s business ongoing in relation to various other claims means it is exposed to volatility in currency advanced by reinsurers. These claims will exchange rates in respect of foreign currency be vigorously defended. denominated transactions, the translation The Group is subject to risk from a failure of net assets and the translation of income to comply with laws and regulations. statements of foreign subsidiaries and equity The Group’s operations are subject to accounted investments. The Group is numerous domestic and international exposed to a number of foreign currencies, laws, regulations and restrictions, and the most significant being the US dollar. non-compliance with these laws, regulations In order to protect itself against currency and restrictions could expose the Group fluctuations, the Group’s policy is to hedge all to fines, penalties, suspension or debarment, material firm transactional exposures as well which could have a material adverse effect. as to manage anticipated economic cash The Group has contracts and operations in flow exposures over the medium term. The Risks and uncertainties many parts of the world and operates in a Group aims, where possible, to apply hedge highly regulated environment. The Group is accounting treatment for all derivatives that subject to numerous UK, US and other laws hedge material foreign currency exposures. and regulations, including, without limitation, The Group does not hedge the translation regulations relating to import-export controls, effect of exchange rate movements on money-laundering, false accounting, anti- the income statement or balance sheet bribery and anti-boycott provisions. From time of overseas subsidiaries and equity to time, the Group is subject to government accounted investments it regards as long- investigations relating to its operations. term investments. Hedges are, however, Failure by the Group or its sales undertaken in respect of investments that representatives, marketing advisers or are not considered long-term or core to others acting on its behalf to comply with the Group. these laws and regulations could result The Group’s gross debt, after the impact in administrative, civil or criminal liabilities of foreign currency swaps, was 52% (2005 and could result in significant fines 58%) denominated in sterling and 48% and penalties and could result in the (2005 42%) denominated in US dollars. suspension or debarment of the Group from government contracts for some period of time or suspension of the Group’s export privileges. Addressing this exposure the Group has mandated policies and procedures to help ensure that employees act with the highest ethical standards and comply with relevant laws and regulations. In particular, all dealing

www.baesystems.com 33 Operating and financial review Resources

The principal resources the Group uses to Throughout this lifecycle the Group engages achieve its strategic objectives are its people, extensively with its customers and relationships with customers, intellectual undertakes customer satisfaction surveys property and capital. The Group’s capital as part of its drive for continuous structure is explained on page 27 of the performance improvement. financial review and people, relationships Increasingly contracts are being awarded for with customers and intellectual property the delivery of a capability, rather than just are discussed below. a product. Reflecting this new approach, People traditional customer relationships are The Group employs 79,000 people in evolving into long-term partnerships with its subsidiaries with a further 10,000 governments and their armed forces. employed in joint ventures. Intellectual property The workforce encompasses a broad range Intellectual property is created every day, in of skills and experience delivering a full every part of the Group, and can take many range of products and services for air, land forms, not only tangible products but also and naval forces as well as advanced ‘know how’ developed over the years. The electronics, information technology solutions Group protects this intellectual property, and customer support services. so that full benefit is retained and returns The Group aims to get the best from its made from the investment in research and employees by treating them with respect, development, and techological innovation creating a supportive and diverse workplace are protected. and giving them opportunities for The Group files patent applications covering Resources development. This helps the Group attract and some 100 new inventions each year in retain highly talented people who can deliver support of its global businesses, and has the products and services customers need. a total portfolio of patents and patent Performance Centred Leadership (PCL) is applications covering more than 1,500 the Group’s performance management and inventions worldwide. leadership development framework, founded on world-class methodologies that focus on delivering performance through effective leadership behaviours and competencies. The process was applied to 600 leaders at its launch in 2000 and is now deployed to over 6,000 executives globally across all of the Group’s home markets. It ensures that the Group’s strategic objectives are realised through a clear flow down of objectives and a strong link between achievement of an individual’s personal objectives and reward. Further details on the approach to employee engagement and development are detailed on pages 35 to 40 in the Corporate Responsibility section of this report. Relationship with customers The Group regards the relationship with its customers as a key discriminator in a competitive industry. The Group’s customers primarily comprise government agencies and armed forces of countries around the world together with other defence and aerospace prime contractors. In many cases these relationships extend over decades and span the full product and service lifecycle from the initial concept definition, through the system development phase, into production and then on to support for the system in service.

34 BAE Systems Annual Report 2006 Operating and financial review Corporate responsibility

BAE Systems recognises its responsibilities to its shareholders, the people it employs, its customers and suppliers, the wider community and the environment.

Highlights of our progress and performance capability model and this, in conjunction Monitoring our performance across all areas of our social, ethical and with our global aspirations, will require We monitor our CR performance through environmental responsibilities during 2006 us to align both culture and capabilities sector benchmarking. In 2006 BAE Systems are detailed below. Further information to take the Group forward. maintained its position in both the Dow and supporting data can be found in Jones Sustainability World Index and the Governance of CR our Corporate Responsibility Report or pan-European Dow Jones STOXX The board of directors has overall Sustainability Index. on our website www.baesystems.com. responsibility for the governance of Strategy and direction CR matters within the Group. Specific Our total score for 2006 was 77%, this Corporate Responsibility (CR) in BAE Systems responsibility has been assigned to the being the highest score reached in our is based on good business practice and CR Committee of the Board. All members specific industry sector and considerably continual improvement. Our CR framework of this Committee are non-executive higher than the sector average of 47%. has been developed through analysis of directors and comprise Peter Weinberg, The total score is an average of three potential risk to our business, key stakeholder Professor Sue Birley, Sir Nigel Rudd and dimension scores (see below). interest and feedback, and the extension Phil Carroll. and evaluation of existing practices. Reputation is vital to the long-term Economic Dimension 69% sustainability of all companies. The CR Over the last four years we have progressed Environmental Dimension 85% from communicating existing policies and Committee is central to the Board’s oversight practices to the use of the external reporting of the critical non-financial issues that are Social Dimension 80% Corporate responsibility process and stakeholder feedback so as to fundamental to the Group’s reputation. evaluate the effectiveness and subsequent The Committee is responsible for reviewing development of those processes. and monitoring the processes the Group uses to manage social, environmental and A sustainable CR agenda must be based ethical risk, as well as supporting the Board With the continued growth of our US business upon both the communication and effective in the approval of strategy and policy in deployment of our policies and practices as we also monitor our performance within this area. the Pacific Sustainability Index, which a means of challenging the Group to ensure analyses and ranks the environmental and we are delivering on our commitment to high The Committee is supported by the Group sustainability reporting of all the companies performance and continual improvement, Legal Director, Audit Director, Group HR in the aerospace and defence sector listed consistent with Group strategy, which is Director and Director of Corporate on the Fortune Global 500 and Fortune 1000 to be the premier global defence and Responsibility. list. BAE Systems was ranked third of the aerospace company. Non-financial metrics 18 companies in that sector. The implication of this global agenda on The Board recognises its responsibilities our CR strategy is to broaden the number to the Group’s shareholders, employees, Roberts Environmental Center – Pacific customers and suppliers, the wider community Sustainability Index of companies against which we benchmark BAE Systems Industry our performance and to look wider than and the environment. The indicators on page score average local impacts to develop our position on 36 are used by the Board to monitor the % score % global issues. application of mandated policies and Environmental Intent 80 46 procedures with the objective of meeting Environmental Reporting 69 31 Key development areas for 2007 concern the Group’s responsibilities in these areas. Environmental Performance 19 8 ethics, safety and environment and their Commentary on progress against these Social Intent 89 43 impact on our reputation. This will include Social Reporting 65 31 our response to climate change and a more indicators is summarised on pages 37 to 39 Social Performance 41 11 formal approach to product stewardship. and a full analysis of the data is included The UK defence sector is evolving from in our Corporate Responsibility Report. Overall Score 67 32 being product orientated to a through-life

www.baesystems.com 35 Operating and financial review Corporate responsibility (continued)

Key performance indicators (KPIs) We use a range of non-financial performance indicators to measure the Group’s performance over time.

2006 2005 2004 2003 Health and safety1 (per 100,000 employees) Major accidents 47 55 61 56 Days lost to work-related injuries 10,204 8,774 9,126 12,658 Total injuries to BAE Systems’ employees 4,788 6,009 7,969 11,181 Environment1,2 Energy use (Gwh) 1,742 1,767 1,321 1,279

CO2 emissions (million tonnes) 0.57 0.58 0.49 0.4 Waste (‘000 tonnes) 105 57 345 540 Corporate responsibility Corporate Waste recycled (‘000 tonnes) 66 37 67 437 Volatile organic compound emissions (tonnes) 742 610 241 341 Water use (million m3) 40 36 46 72 Ethics Ethics enquiries 410 367 616 206 Diversity Gender diversity: Male employees 80% 81% 80% 81% Female employees 20% 19% 20% 19% Ethnic diversity: White 87% 88% 92% xx%92% Non-white 13% 12% 8% 8% Age diversity3: under 25 6.6% 6.6% 5.9% 7.5% 26 to 35 18.2% 18.4% 14.7% 16.2% 36 to 49 42.6% 43.3% 40.8% 37.6% 50 to 59 25.9% 25.3% 20.8% 19.0% 60+ 6.7% 6.4% 5.2% 4.6% 1 the increases shown for 2006 reflect the expansion of our business in the US in 2005 to include the former United Defense and Ship Repair businesses (2006 is the first full reporting year). This particularly affects the safety risk profile and use of resources. We will be aiming to reduce the impact of each individual business year on year. 2 recalculated to include 2005 acquisitions 3 2003 and 2004 figures do not include data for Saudi Arabia

Employee opinion survey

Positive changes (top 4) % Change favourable from Question 2006 2004 I have access to the training I need to be productive in my current position 68 10 I have confidence in the job being done by the senior management of BAE Systems 52 9 I would recommend BAE Systems to others as a good place to work 68 6 I understand how my job contributes to my Business Unit/Line of business in achieving its business plan 84 6

Negative changes (worst 4) % Change favourable from Question 2006 2004 Poor individual performance issues are addressed effectively where I work 33 -3 I am supported and encouraged to make my own decisions 74 -3 In my team we get regular feedback on how satisfied customers are with the work we perform 54 -2 My immediate manager/team leader lets me know how I am doing on an ongoing basis 56 -2

36 BAE Systems Annual Report 2006 Workplace senior female managers represented the Training and development Group at events such as the International In the UK employees completed 38,000 The Group employs 79,000 people in Women of Excellence and the International e-learning courses (equating to 24,000 its wholly owned businesses across five Women’s Forum. Junior female employees hours of online training time). Many courses continents, the majority being based in the also attended these events as participants. are run in partnership with colleges and UK and the US, with a significant presence An outcome of this representation was the universities. In the US we have invested in Australia, Saudi Arabia, South Africa initiative to establish a women’s network at in employee development and recent and Sweden. our Submarines site at Barrow in the UK as executive appointments from within our To deliver the products and services our a pilot to assess the potential to develop leadership ranks demonstrate career growth customers require we need to attract and further network groups elsewhere across opportunities. Two new CEO-sponsored retain a highly talented workforce. We do the business. leadership programmes were introduced this with a focus on a high performance in 2006 and were delivered to more than A workshop was held with senior female 600 executives in the US and UK. culture which, in addition to setting out managers from the UK Ministry of Defence to goals and objectives, also defines the discuss barriers to gender progression within Employee engagement behaviours we expect of our employees. the respective organisations and to explore In 2006, more than 45,000 employees took part in our bi-annual global Employee 2006 Objectives mutual areas to address. In 2006 two workplace-related objectives Opinion Survey (EOS). Overall the results The Group sponsors science education events were encouraging with clear improvement were set as part of the leadership objectives targeted at young women including the UK reported against 2004 performance. for the Group’s senior executives (other CR- 2006 Women Into Science and Engineering related leadership objectives are discussed (WISE) event for 13-14-year-old girls. The greatest areas of improvement were in context in subsequent sections). in career development and rewards, trust Respect at work in leadership and engagement. The most – Reflect gender diversity on leading university 97% of employee grievances in the UK negative score related to employee courses in our choice of graduate trainees were resolved at a local level during 2006. perceptions as to how ‘poor performers’ through a focused recruitment plan. Only one complaint required a corporate are managed. While this reflects the high – Resolve 75% of employee grievances in level investigation under the Group’s Respect standards our employees expect, it is an the UK at local level (i.e. drive solutions at Work policy. This indicated improved issue of concern which the Group’s Executive to employee issues through effective management and resolution of issues at Committee has committed to improve in local management). a local level. In the UK, we have continued 2007 (see table on page 36). to work closely with the DTI and AMICUS on Progress the Dignity At Work partnership. This year 2007 Objectives Corporate responsibility The specific CR objectives agreed by the Diversity the partnership launched research into Board for the Chief Executive and Group’s We met our target to recruit at least an the impact of bullying in the workplace and Executive Committee for 2007 are: equal proportion of female graduates to that hosted several high-profile events to raise seeking a career in engineering. Over the awareness of this important issue. – In each of the home markets, move year, 12% of our UK and 20% of our US towards establishing a workforce reflective engineering graduate recruits were women. Employee recognition of the national average in terms of gender The Group rewards employee excellence Our Group HR Director, Alastair Imrie, is mix and ethnic diversity, taking into account and innovation through the Chairman’s our senior Gender Champion with a remit variations by region and industrial sector. Awards Scheme. Over 3,000 nominations to raise awareness of potential barriers to were received for 2006, recognising over – 85% of employee grievances under the the career progress of women in the Group 17,000 employees from around the world. UK ‘Respect at Work’ policy to be resolved and to identify ways to address those From those, 6 Gold, 54 Silver and over through local discussion without escalation potential barriers. 100 Bronze awards were awarded across to the corporate investigation process. Recognising that the Group’s senior the three categories of Innovation, leadership plays a significant role in Transferring Best Practice, and Enhancing influencing behaviours, a number of our Customer Performance.

Insyte participated in the Women Into Science Naval Ships held Learning at Work Days at our Filton and Engineering (WISE) scheme. The scheme aims and Govan sites where employees were given health to promote science, engineering, technology (SET) advice, learned new skills and were encouraged to and construction as suitable career choices for girls take up new hobbies. and women. They also launched an Everyday Skills programme which offers courses on basic IT, communication, literacy and numeracy.

www.baesystems.com 37 Operating and financial review Corporate responsibility (continued)

Ethics all UK employees covering: What is Business These covered a variety of topics, but Ethics and Why is it Important to Me?, primarily concerned workplace issues and We are committed to meeting the highest Why Following the Law is not Enough, and acceptable IT Use policy. In the US, there ethical standards in our relationships Examples of Ethics in the Workplace. were 348 formal enquiries (including 186 with others. We will not tolerate unethical requiring formal investigation) to ethics Employees must complete a test at the behaviour or attempts to improperly influence officers via our helpline, post, e-mail or end of the course to measure understanding the decisions of customers or suppliers. visits to the ethics office. Unethical behaviour is wrong, could lead of the issues raised during the training. to loss of business, seriously damage our A DVD and classroom training package 50 employees were dismissed for reasons reputation and leave the Group and its was used for employees who did not have relating to unethical behaviour during 2006. employees open to criminal sanction. ready access to a computer. Both training Reasons for dismissal included misuse of packages were introduced and endorsed company IT, fraud and threatening behaviour. 2006 Objectives by our Chief Executive. In 2006 two objectives specifically Working with others relating to ethics were set within the By the end of 2006 80% of UK employees In July 2006 BAE Systems and other UK leadership objectives. had successfully completed the training. defence companies established the UK Plans are in place to ensure the remaining Defence Industry Anti-corruption Forum, – Meet the standards defined in our internal 20% complete the training early in 2007. We to share good practice on ethics and assurance statement (for ethical issues, missed our target to also train all employees anti-corruption programmes. Members of the minimum acceptable score within in Australia during 2006 but intend to roll out the Forum met twice in 2006 and heard from our assurance process is confirmation the training to all employees in Australia, a range of speakers including the Institute of compliance with all applicable laws Saudi Arabia, South Africa and Sweden of Business Ethics, ICC (UK), Transparency and standards). during 2007. International (UK) and law firms, Linklaters – Develop, pilot and roll out ethics training In the US, all employees completed refresher and Bryan Cave LLP. Corporate responsibility Corporate to all employees in the UK and Australia. training on our workplace harassment, ethics In the US we are a signatory to the Defense policies, and ethical decision making. All Progress Industry Initiative on Ethics and Business Meeting our standards employees receive annual training on ethics- Conduct, and a sponsoring partner of the The Group has training and awareness related topics. This year all employees Ethics and Compliance Officers Association. programmes to ensure employees understand viewed a new ethics video called Playing With Fire: Abuse and Intimidation in the Workplace. 2007 Objectives our policies and the standards expected The specific CR objectives agreed by the of them. We held our annual conference for Board for the Chief Executive and Group’s We provide training on our anti-bribery BAE Systems Ethics Officers in Baltimore, Executive Committee for 2007 are: US. More than 50 participants from the US, programme to managers from marketing, the UK and Sweden were joined by speakers – Initial ethics training to be completed by commercial, procurement, finance, customer from the US Department of Defense and the new employees within one month of joining support and other functions. On completing Ethics Resource Center. Experts led training the Group. the training, employees are required to sign sessions on ethics investigations and a statement confirming they will comply with – Initial ethics training to be implemented for regulations on harassment and violence our policies and will report any issues of all employees within three months of in the workplace. concern. This training is mandatory for all the completion date of any acquisition. senior employees and for those employees During 2006 we also held ethics training – A survey to be undertaken to evaluate involved in dealings with marketing advisers. for the Board and Executive Committee, effectiveness of the 2006 UK Ethics debating and agreeing the role of leadership Awareness and training training package with implementation in ensuring high ethical standards throughout A survey of UK employees undertaken in of agreed corrective actions. the Group. 2005 showed that although our employees regard the Group as ethical, awareness of Monitoring and compliance our ethical standards and helpline was low. In 2006, 62 enquiries were made to our UK In 2006 we introduced new online training for ethics helpline and worldwide e-mail address.

Our ethical principles are: Accountability: We are personally answerable for our conduct and actions Honesty: There is no substitute for the truth Integrity: We say what we do, we do what we say Openness: When questions are asked, we will be frank and straightforward in our answers Respect: We value and treat each individual with dignity and thoughtfulness

38 BAE Systems Annual Report 2006 Safety, health and environment Compared with 2005 both the overall Environment number of accidents and the number of The environment data shown on page 36 The health and safety of our employees, serious accidents decreased in 2006. reflects the numerous changes to our contractors and engagement with the The majority of our businesses continue to business and activity over the last four communities around our facilities is of demonstrate improvements (i.e. reductions) years. We monitor trends at an individual primary importance to BAE Systems. in the days lost to work-related injuries site level and continue to see reductions indicating both a reduction in the number We recognise the risks associated with the in both water and energy consumption. of accidents and length of time for variety of operations we conduct and aim to rehabilitation back into the workplace. The The overall data now includes the former minimise these as far as possible. All sites increase indicated in the table on page 36 United Defense businesses and these are required to comply with our safety, health reflects the inclusion of a full year of data for account for the increases in consumption. and environment policy and to demonstrate our US Ship Repair business and does not Whilst the use of natural resources is driven continual improvement in performance therefore indicate a significant deterioration. by the growth of our business we remain though the setting of targets. Performance committed to delivering ongoing operational is reviewed through our business assurance The commitments made as part of the UK efficiencies and improvements in this area. processes and overseen by the Executive government’s ‘Revitalising Health & Safety’ Further breakdown and explanation of our Committee and the CR Committee on behalf initiative have been exceeded; we have environmental data for our main operating of the board of directors. already met targets for performance. regions are provided in our full CR Report. Our environment policy and framework Partnership with the UK HSE Waste Electrical and Electronic Equipment We continued our partnership project with the is focused on preventing or controlling (WEEE) Directive UK HSE and other large UK manufacturers. environmental impacts and minimising waste The WEEE Directive became effective in The project, named Large Organisation (or consumption when related to energy and January 2007 requiring producers of certain Partnership Pilot (LOPPs), aims to raise electronic equipment to account for end of water). All our major manufacturing sites are safety standards in UK manufacturing sites. certified to the international environmental life disposal. During 2006 we conducted management standard ISO 14001. In 2006 a joint team of BAE Systems’ reviews to assess the impact of this managers, trade union safety representatives Directive and put in place measures to 2006 Objectives and the HSE developed key performance monitor and manage the issue going forward. We recognise the role of leadership in indicators (KPIs) in six areas: work at height; driving high standards of safety, health and control of contractors; hand-arm vibration; 2007 Objectives The specific CR objectives agreed by the environment performance and, accordingly, work in confined spaces; slips and trips; Board for the Chief Executive and Group’s a number of leadership objectives in 2006 and manual handling. related to this area. Executive Committee for 2007 are: Corporate responsibility The KPIs are used by our businesses to – To achieve an improved position relative – Meet our safety, health and environment monitor and improve performance through to 2006. targets (performance improvement criteria an audit programme. Eight of our UK sites appropriate to risk established for each were audited against the relevant topic – Establish, where practical, appropriate individual business). standard during 2006. Only one audit failed. industry benchmarks for each line of Improvement actions were put in place and business to monitor performance and – Exceed the safety performance a follow-up audit confirmed that corrective establish targets to move towards best commitments made to the UK Health actions had been implemented. in class. and Safety Executive (HSE). We are communicating the output of these – Group performance (lost days metric) to Progress audits to all UK businesses through news be better than relevant industry average. Targets were set against individual business bulletins, office and workshop talks and a issues and all businesses included safety, training DVD. Employees can also access the – Continue to achieve an improvement health and environment in their quarterly information on our LOPPs website. We will year on year in injuries/lost working time. business reviews. The overall performance continue to use the audit programme as part on safety reflects the good performance of our drive for high performance across all against those targets. areas of safety, health and environment.

Our Customer Solutions & Support Electronics & Integrated Systems is business group this year achieved the working with the US Federal Transit international health and safety standard Administration (FTA) to develop OHSAS 18001 for all its UK businesses. hydrogen fuel cell technology for city New safety, health and environment (SHE) buses. Fuel cells generate electricity ‘passport’ training was introduced for cleanly and quietly, like a battery. all employees, as well as SHE training Fuelled by hydrogen, their only by- specifically for senior executives. A products are water and heat, so they distance learning health and safety don’t contribute to climate change. course was also put in place for our Saudi employees.

www.baesystems.com 39 Operating and financial review Corporate responsibility (continued)

Education and community BAE Systems has made a commitment to The Saudi-British sports co-operation be one of the ‘corporate champions’ behind programme, which began in 1987, had Education, specifically in the fields of science the British Council’s UK India Education & its most active year to date in 2006. This and engineering, is extremely important to Research Initiative. The Initiative, which was BAE Systems managed project is geared to the future sustainability of our business. launched last year by the Prime Minister, the raising of standards and the introduction The number of students enrolling in is designed to strengthen education and of new sports, and takes as a main aim engineering and technology courses has business links between the UK and India. the education of administrators, medical fallen considerably in recent years. We are As part of our commitment we will be practitioners, coaches and others who will concerned that in the future there will be too supporting links between schools in Brough stimulate the development of the sector. in the UK with Bangalore in India, an few candidates with the skills our business, Australia exchange of best practice in vocational and the engineering sector in general, needs. In Australia, BAE Systems supports a wide training and an innovative research project We therefore invest worldwide in a range of range of school and university programmes, on Unmanned Aircraft Vehicles linking programmes which support and encourage offering sponsorship and mentoring Leicester University with the Indian Institute young people into science and engineering. programmes, with the aim of inspiring young of Science at Bangalore. We also have a structured programme people to become involved in engineering. for support to charities and encourage our United States These projects included sponsorship of employees to support their local communities We sponsor a number of programmes to South Australia’s Engineering Week and through fundraising and volunteering. support science and technology across Super Science Sunday, involvement with the US. Our scholarships to colleges and the Doxa Youth Foundation mentoring Education universities have enabled hundreds of programme; and the support for the In Australia, Saudi Arabia, the UK and students to take technical courses. Young Achievement Australia Business the US we run an education programme Skills Programme. to encourage young people at all stages In 2006 this support included: providing Corporate responsibility Corporate of their education to take an interest in project challenges and mentors to Penn Community science and technology. State’s Learning Factory – an innovative and Employee involvement nationally recognised programme that has In the 18 months to September 2006, our United Kingdom multi-disciplinary student teams working on global employee fundraising scheme, Charity Over 350 employees (known as ambassadors) industry-sponsored projects; sponsorship Challenge, raised £8m. This was donated visit schools to help with engineering projects of Science and Technology Way at Maryland primarily to the Stroke Association in the UK, and to give careers advice. Day – an open house showcase held at the the National Heart Foundation in Australia Our schools road show is designed to University of Maryland; and the sponsorship and The American Cancer Society in the encourage children to think about a career of the annual Rube Goldberg Machine US. Over the same period, employees in engineering before making subject choices Contest held at Purdue University. volunteered 10,500 days of their own time. Our partner charities for the next 18-month at 14. The 2006 road show visited 100 Saudi Arabia schools, involving 10,000 children aged 9 campaign will be Macmillan Cancer Support BAE Systems’ long association with to 13 in performances and workshops. In in the UK, the Australian Cancer Council academia from the Kingdom of Saudi Arabia 2006 our education programme was awarded and the Alzheimer’s Association in the US. has continued with the funding of research a Business in the Community ‘Big Tick’ carried out by Saudi lecturers in the UK. Award and was a finalist in the Opportunity Company giving In 2006 our total global community Now Awards. Following completion of the four-year investment was £8,223,160. This figure Saudi government campaign to establish We participated in Enterprise Week 2006 includes cash and in-kind donations as national vocational skill standards, backed delivering a schools road show performance well as our direct support for education. by BAE Systems, the Group sponsored a at an Enterprise in Education conference. conference on the next round of challenges We are a member of the London We have strategic partnerships with facing those in the vocational training Benchmarking Group (LBG) and use their 20 colleges and universities to support establishment in meeting the needs of agreed methodology to evaluate our annual research and improve graduate recruitment. the Saudi labour market. community contributions.

Many remote communities in the Platform Solutions is helping to prepare Peruvian Amazon have no access to young people for life after school by medical services. Five years ago, Naval partnering with the Medway Education Ships employees converted a former Business Partnership (MEBP), a charity Royal Navy boat into the Amazon Hope, working to improve the links between a floating hospital, which extended a schools and businesses. Our employees lifeline to these communities. In 2006, donate money and time and this year Submarines employees helped create 11 employees mentored students a sister medical vessel for the region. from schools.

40 BAE Systems Annual Report 2006 22781 BAE001_p35_41.qxd:Layout114/3/0715:26Page41 Corporate governance 42 68 51 44 66 responsibilities Statement Corporate Board Contents Remuneration Directors’ of directors report governance of directors’ www.baesystems.com report 41

Corporate governance Corporate governance Board of directors

Chairman Executive directors

1. Dick Olver FREng 3, 4 2. Mike Turner CBE 4 5. Ian King Appointed Chairman on 1 July 2004. Chief Executive Chief Operating Officer, UK and Rest of World A civil engineer, Dick Olver joined BP Appointed Chief Executive in 2002, having Appointed to the Board on 1 January 2007, in 1973 where he held a variety of senior been a Chief Operating Officer since 1999. he was previously Group Managing Director positions culminating in his appointment to He is a non-executive director of Lazard of the Company’s CS&S business and, prior the board of BP p.l.c. as CEO of Exploration Limited and a former non-executive director to that, Group Strategy and Planning Director. and Production in 1998. He was subsequently of Babcock International Group Plc and The Immediately prior to the BAe/MES merger appointed deputy group chief executive Peninsular and Oriental Steam Navigation he was Chief Executive of Alenia Marconi of BP in 2003, stepping down from that Company (P&O). Systems, having previously served as position when he assumed the chairmanship Appointed: 1994 Age: 58 Finance Director of Marconi Electronic of BAE Systems. Dick Olver chairs the Systems and of Marconi Defence Systems. Board’s Nominations Committee and the 3. Chris Geoghegan He is a non-executive director of Rotork plc. Group Executive Director Non-Executive Directors’ Fees Committee. Appointed: 2007 Age: 50 He is a non-executive director of Reuters Appointed to the Board in 2002 as a Chief Group plc, a Fellow of the Royal Academy Operating Officer he is now Group Executive 6. Steve Mogford of Engineering and a member of the Royal Director responsible for Businesses. He was Group Executive Director Academy and the Trilateral Commission. formerly responsible for the Group’s Airbus Appointed to the Board in 2000 as a Chief operations and, in 2000, was appointed Operating Officer he is now Group Executive Appointed: 2004 Age: 60 Group Managing Director of the Avionics Director responsible for leading the business. He is President of the Society Company’s drive for the restructuring of the of British Aerospace Companies. Naval Ships and Submarines industry in line Appointed: 2002 Age: 52 with the Defence Industrial Strategy. He has held a number of senior positions within the 4 4. Walt Havenstein Group. He is a non-executive director of Chief Operating Officer, US Carillion plc. Appointed to the Board on 2 January 2007, he is President and CEO of BAE Systems, Appointed: 2000 Age: 50 Inc. He was previously President of the 7. George Rose Company’s US-based Electronics & Integrated Group Finance Director Solutions business. He was President of the Appointed Group Finance Director in 1998. Sanders defence electronics business prior Prior to joining the Company in 1992, he held 1 member of the Audit Committee to it being acquired by the Company from senior positions in the Rover Group and Leyland 2 member of the Corporate Responsibility Committee Lockheed Martin in 2001. A graduate of DAF. He is a non-executive director of Saab AB 3 member of the Nominations Committee the US Naval Academy, he served 12 years and National Grid Transco plc, and a member 4 member of the Non-Executive Directors’ Board of directors Fees Committee in the US Marine Corps. of the Financial Reporting Review Panel. 5 member of the Remuneration Committee Appointed: 2007 Age: 57 Appointed: 1998 Age: 54

12 3456 7

42 BAE Systems Annual Report 2006 22781 BAE001_p42_43.qxp:Layout 1 24/4/07 14:30 Page 43

Non-executive directors

8. Professor Sue Birley 2, 5 11. Michael Hartnall 1 14. Sir Nigel Rudd 2, 5 Formerly Professor of Entrepreneurship Formerly finance director of Rexam plc, Appointed to the Board on 10 September at Imperial College, University of London, prior to which he held senior positions 2006. Currently chairman of Alliance Boots and has held a number of academic posts with a number of manufacturing companies. Group PLC and Pendragon plc and deputy at INSEAD, London Business School and He is also a non-executive director of chairman of Barclays PLC. Until recently, Cranfield Institute of Technology. She was Lonmin plc and a former non-executive he was chairman of Pilkington plc. formerly a non-executive director of National director of Elementis plc. Michael Hartnall He also holds a number of other public Westminster Bank plc. Professor Birley chairs chairs the Board’s Audit Committee. appointments including chairman of the the Board’s Remuneration Committee. He is a Fellow of the Institute of Chartered CBI’s Boardroom Issues Group. He is Appointed: 2000 Age: 63 Accountants in England and Wales. a Fellow of the Institute of Chartered Appointed: 2003 Age: 64 Accountants in England and Wales. 9. Phil Carroll 2, 3 Appointed: 2006 Age: 60 Appointed to the Board in 2005, Phil Carroll 12. Sir Peter Mason KBE 1, 3 is a former chairman and chief executive Non-executive chairman of Thames Water 15. Peter Weinberg 2, 5 of Fluor Corporation and a former president and a non-executive director of Acergy S.A. Appointed to the Board in 2005, Peter and chief executive of Shell Oil Company Inc. Formerly chief executive of AMEC plc, Weinberg is a partner at Perella Weinberg He was appointed by the US Department executive director of BICC plc, chairman Partners, a financial services firm. He was of Defense in 2003 to serve as the first and chief executive of Balfour Beatty Limited previously chief executive officer of Goldman Senior Adviser to the Iraqi Ministry of Oil. and chief executive of Norwest Holst Group Sachs International and co-head of the He is a former non-executive director of PLC. Sir Peter Mason has been nominated Partnership Committee, and prior to that Scottish Power plc. the Board’s Senior Independent Director. was co-head of the Global Investment Appointed: 2005 Age: 69 Appointed: 2003 Age: 60 Banking Division. He joined Goldman Sachs in 1988 and became a partner in 1992. 10. Dr Ulrich Cartellieri 1 5 13. Roberto Quarta Peter Weinberg chairs the Board’s Corporate Ulrich Cartellieri served as a member Appointed to the Board in 2005, Roberto Responsibility Committee. of the Managing and subsequently the Quarta is a partner in the private equity Supervisory Board of Deutsche Bank AG firm Clayton, Dubilier & Rice, in connection Appointed: 2005 Age: 49 for over 20 years until 2004. He was also with which he serves as chairman of a member of the International Advisory Rexel SA and Italtel. He was previously Each of the eight non-executive directors Committee of the Federal Reserve Bank chairman and chief executive of BBA Group, listed above is considered to be independent of New York. He is currently a director of an executive director of BTR plc and a for the purposes of the Combined Code on Robert Bosch GmbH and is a past chairman non-executive director of PowerGen plc Corporate Governance. of Karstadt AG and a past deputy chairman and Equant NV. of Siemens AG. Appointed: 2005 Age: 57 Appointed: 1999 Age: 69 Company Secretary David Parkes Board of directors

8 9 10 1112 13 14 15

www.baesystems.com 43 Corporate governance Corporate governance

Our governance framework

As Chairman my principal duty In this section of the Annual Report, I and my fellow directors report on how we discharge is to ensure that BAE Systems our duties, both individually and collectively, for the good governance of the Company. is headed by an effective board I will begin by drawing together some of the that is accountable to shareholders highlights and important themes of the work undertaken by the Board in the last year. for the Company’s performance. In 2006 we continued to push forward in developing the work that the Board undertakes and one of our priorities for the year was senior management succession planning. This is a fundamental task for all large company boards and one that is widely seen as being critical to the long-term success of a company. Last year I reported to shareholders that we had reviewed our succession planning tools and work had been undertaken to understand the ‘critical competencies’ that we require in our senior executives. From this work we developed an externally facilitated programme for 50 of our most senior executives. The results from this were presented to the Nominations

Corporate governance Corporate Committee, together with information from other executive performance review processes. This gave the committee the information it required to make informed decisions about the overall strength of our management resource, the depth of talent available against the key management positions and to make recommendations on individual appointments. This was of great assistance in agreeing the appointment of two new executive directors. During 2006 the Nominations Committee agreed that the Board would benefit from the knowledge and experience of an additional non-executive director with large UK company Dick Olver experience. I am therefore very pleased that Chairman we were able to appoint Sir Nigel Rudd to the Board in September. He brings a wealth of industrial management and boardroom experience which complement the skill and knowledge that our other non-executives bring to the Board. Following his appointment, there are eight non-executive directors

44 BAE Systems Annual Report 2006 (excluding myself) and six executive directors on the Board. Board performance evaluation – changes for 2006 The Board is responsible for setting goals and 2006 Achievements Looking ahead in 2007 objectives for the Company and monitoring – Conducted in-depth succession planning – Continue the work started in 2006 on performance against these. I reported last and reviewed bench strength among senior succession planning, with a focus on year on the formation of the Centre for management leading to the appointment the support and development of the next Performance Excellence (CfPE), a small of two new executive directors. generation of senior executives and also strategic team reporting to the Chief Executive the identification and enhancement of – Broadened the scope of director and helping to drive performance improvement the Group’s management bench strength. across the Company. The suite of performance development to include ethics and metrics developed by the CfPE was used to long-term contract accounting training. – Develop further the work the Board has inform the Board about performance during – Continued the Board’s involvement in initiated on financial performance the year and we are encouraged by the strategy development and increased monitoring, and looking at project and progress made in this area. focus on longer-term strategic challenges programme KPIs in more detail. and opportunities. It is important that we have clear alignment – Build on current non-financial performance between executive pay and the Company’s monitoring, including the Corporate performance during the year. To help Responsibility Committee’s focus on ensure that we achieve this alignment the corporate reputation issues. Remuneration Committee and I have been – Provide additional opportunities for non- working with the Chief Executive on refining executive directors to meet to discuss issues the process we use for setting and measuring independently and with the Chief Executive. performance against the non-financial measures used to determine the level the Company’s strategy. We have further company chairmen, myself included. He was of annual bonus payable to the executive evolved the process during the year and interested to hear our views on corporate directors. These non-financial measures I believe we have a sound basis for the governance matters and the Combined Code account for 25% of the maximum bonus. development of Group strategy that is in particular. I welcomed this opportunity and We have just completed our third formal facilitated by a central team, draws on the agreed with the overall findings as reported by performance evaluation as required by the knowledge of senior management across the Sir Christopher, which included the following: Company and is subject to robust analysis Combined Code – all of which have been “...Chairs were adamant that the Code had facilitated externally. As Chairman, I find and challenge by the Board. A sound not been too detrimental to their Boards’ the evaluation process a very powerful tool understanding of our capabilities, our markets focus on strategy. It had increased the in helping me do my job of overseeing the and the dynamics of these markets is the amount of time required from non-executive development of the Board and looking at how essential bedrock on which the Board can directors, but it had simply raised the bar we can do things better. I meet with directors make decisions – time taken in this work of their job specification...” on a one-to-one basis and use feedback from pays dividends when important strategic the evaluation to inform them of their own decisions need to be taken. I agree wholeheartedly with this and performance and to discuss any areas for Involvement in the development of strategy and recognise the challenge in ensuring the improvement. Similarly, each year I receive the prosecution of strategy through merger and BAE Systems Board meets the demanding feedback from our Senior Independent acquisition activity is the high tempo, and for performance requirements set by Director, Sir Peter Mason, on my performance many the most interesting, part of a board’s shareholders and ourselves. I believe as Chairman. work. However, it is important that a balance that the bar has been raised for all listed company boards and that we must be One of the objectives we set ourselves is maintained between this work and the Corporate governance following last year’s evaluation was to equally important role a board has in diligent in ensuring that we measure up to conduct in-depth succession planning as overseeing the effectiveness of controls the governance obligations and expectations well as developing senior leadership bench and ensuring that risks to the business are of our shareholders and other stakeholders. strength. As reported, I think we have made understood and managed. This work has great strides in this area. We also wanted a lower tempo but a more regular beat. The to broaden the scope of director training and Board and its committees have an annual development and in 2006 we focused on programme of work dealing with supervisory long-term contract accounting and also the matters. I recognise that it is my job to ensure cultural and political background to certain we get the balance right between the various overseas markets. Finally, in line with our elements that a board needs to cover. commitment to provide ethics training to Last year Sir Christopher Hogg, in his capacity all employees, the whole board participated as Chairman of the Financial Reporting in an ethics awareness session. Council (the body charged with overseeing Dick Olver Chairman Last year we agreed that we should refine the UK’s Combined Code on Corporate how the Board helps to develop and agree Governance), met with a large number of UK 21 February 2007

www.baesystems.com 45 Corporate governance Corporate governance (continued)

Applying the Principles of the Combined Compliance with the Provisions of the The Board addressed the issue of his Code on Corporate Governance Combined Code independence prior to his appointment in The Board has structured its activities so light of provision A.3.1 of the Combined Compliance statement as to incorporate the main and supporting Code concerning the possible existence of The Board was compliant with the principles in the UK’s Combined Code, a ‘material business relationship’ between provisions of the Combined Code on recognising these to be a sound statement the director and the company or between the Corporate Governance throughout 2006 on accepted good practice for a company company and a party with which the director is and up to the date of this report. such as BAE Systems. The core activities a major shareholder, senior employee, partner of the Board and its committees are The Board or director. The Nominations Committee and documented and planned on an annual basis The Board comprises a non-executive the Board have reviewed Mr Weinberg’s forming the basic structure within which the chairman, eight non-executive directors independence and continue to believe that Board operates. The directors are required and six executive directors. In addition to he is independent for the purposes of the to provide entrepreneurial leadership for the his appointment as Chairman, Dick Olver Combined Code, notwithstanding the past company relying on the business skills and is also a non-executive director of Reuters relationship with Goldman Sachs. The judgement that each director possesses. Group plc. Up until 30 September 2006 reasons for reaching this conclusion remain The governance structure recognises this he was also a non-executive director and as previously stated, that is: deputy chairman of TNK-BP. essential human element and the role of – Goldman Sachs is a large organisation the Chairman in ensuring that decisions are Two non-executive directors will be retiring with many clients. BAE Systems is made by the directors within a framework in 2007. Ulrich Cartellieri will be retiring therefore just one of many clients it has of prudent and effective controls. from the Board on 26 September and worldwide and the fees earned from its The Board has adopted a document, Sue Birley will be retiring immediately after relationship with the Company represented the Board Charter, which states certain the Company’s Annual General Meeting on a very small part of its total revenues. principles to guide the activities of the 9 May 2007. The Nominations Committee As a consequence, the Board believes Board and details of the roles of the has initiated a search for suitable candidates that the relationship between the Company Chairman, Chief Executive and the Senior with a view to ensuring that the composition and Goldman Sachs does not represent Independent Director. The Charter also of the Board continues to comprise eight ‘a material business relationship’. contains a statement of the matters non-executive directors. – Prior to his appointment to the Board reserved for the Board and the terms The Board considers all of the non-executive of reference of the Board’s committees. Mr Weinberg had had no involvement with directors, with the exception of the Chairman, BAE Systems and none of the executive The governance principles reflect the main to be independent for the purposes of the and supporting principles contained in the directors or the Chairman had had any Combined Code. Each of these directors business dealings with him. Combined Code and cover the following: have been identified on pages 42 to 43 – Strategy – reviewing and agreeing strategy. of this report. Mr Weinberg ceased to be associated with Goldman Sachs in 2006. – Performance – monitoring the performance Peter Weinberg was appointed to the Board Corporate governance Corporate of the Group and evaluating the Board’s in 2005 and at the time was a senior director In 2006 the Board was scheduled to meet performance. of Goldman Sachs Inc., an investment bank seven times and in addition spent one day that provides services to BAE Systems. reviewing strategy. Additional Board meetings – Standards and Values – setting values and standards to guide the affairs of the Group. The attendance by individual directors at meetings of the Board and its committees in 2006 – Oversight – ensuring that an effective was as follows: system of internal controls is in place, that the Board receives timely and accurate Corporate Non-Executive information on the performance of the Audit Responsibility Nominations Remuneration Directors’ Fees Director Board Committee Committee Committee Committee Committee Group and that the Board’s authority is properly delegated where necessary. Prof S Birley 8 (8) – 3 (3) – 7 (7) – Mr P Carroll 8 (8) – 3 (3) 6 (6) – – – People – ensuring that appointments to the Dr U Cartellieri8 (8)5 (5)–––– Board are managed effectively and that the Group has the necessary depth and quality Mr M J Hartnall 8 (8) 5 (5) –––– of management resource. Mr C V Geoghegan8 (8)––––– A copy of the Board Charter can be found on Mr M Lester 8 (8) ––––1 (1) the Company’s website, or alternatively, can Sir Peter Mason 8 (8) 5 (5) – 6 (6) – – be obtained from the Company Secretary. Mr S L Mogford 8 (8) ––––– Mr R L Olver 8 (8) – – 6 (6) – 1 (1) Rt Hon M Portillo1 3 (3)1 (1)–––– Mr R Quarta 8 (8) 0 (1)3 ––7 (7)– Mr M H Ronald 8 (8) ––––1 (1) Mr G W Rose8 (8)––––– Sir Nigel Rudd2 1 (2) – 0 (1) – 0 (1) – Mr M J Turner8 (8)––––1 (1) Mr P Weinberg 8 (8) – 3 (3) – 6 (7) –

Figures in brackets denote the maximum number of meetings that could have been attended. 1 retired from the Board on 4 May 2006 2 appointed to the Board on 10 September 2006 3 in attendance at four additional meetings when not a member of the Committee

46 BAE Systems Annual Report 2006 are called as required and in total the Further key processes are Integrated The overall responsibility for the system Board met eight times in 2006. For 2007 Business Planning (IBP), Quarterly Business of internal control within BAE Systems eight meetings have been scheduled. Reviews (QBR) and Performance Centred rests with the directors of the Company. Leadership (PCL). The IBP, approved annually Responsibility for establishing and operating The Board has appointed Sir Peter Mason by the Board, results in an agreed long-term detailed control procedures lies with the as the Senior Independent Director. strategy for each business group, together managing director of each operating business. The Company’s Articles of Association with detailed near-term budgets. The QBRs, In line with any system of internal require that all new directors seek re-election chaired by the Chief Operating Officers, control, the policies and processes that to the Board at the following Annual General evaluate progress against the IBP and are mandated in the Operational Framework Meeting (AGM). In addition, all directors are business performance against objectives, are designed to manage rather than required to stand down and seek re-election measures and milestones. PCL drives to the Board at least once every three years. eliminate the risk of failure to achieve business success by linking individual goals business objectives, and can only provide The Board has set out in the Notice of with the wider goals of the organisation, reasonable, and not absolute, assurance Annual General Meeting (enclosed with enabling employees to understand how their against material misstatement or loss. this report) their reasons for supporting own success contributes to the success the re-election of those directors seeking of the whole business. The responsibility for internal control re-election at the forthcoming AGM. procedures with joint ventures and other Whilst the quality of the control processes collaborations rests, on the whole, with the Internal Control is fundamental to the overall control senior management of those operations. The The Board has conducted a review of environment, the consistent application Company monitors its investments and exerts the effectiveness of the Group’s system of these processes is equally important. influence through Board representation. of internal controls, including financial, The consistent application of world-class operational and compliance controls and control processes will remain one of Going Concern risk management systems, in accordance management’s prime objectives and, After making due enquiries, the directors with the Turnbull guidance. likewise, the monitoring of performance have a reasonable expectation that the in this area will continue to be a key Group has adequate resources to continue BAE Systems has developed a system operational existence for the foreseeable of internal control, which has been in responsibility for the Audit Committee and the Board. future. For this reason they continue to place throughout 2006 and to the date of adopt the going concern basis in preparing this report, that encompasses, amongst The Company is committed to the protection the accounts. other things, the policies, processes and of its assets, which include human, property behaviours that, taken together, seek to: and financial resources, through an effective Relations with shareholders The Company has a well developed investor – facilitate the effective and efficient risk management process, underpinned, relations programme managed by the Chief operation of the Company by enabling where appropriate, by insurance. Executive and Finance Director. In addition, it to respond appropriately to significant The Internal Audit team independently reviews the Chairman is in regular contact with operational, financial, compliance and the risk identification procedures and control major shareholders and looks to keep other risks that it faces in carrying out processes implemented by management. them informed of progress on corporate its business; It provides objective assurance as to the governance. In order to assist in developing – assist in ensuring that internal and operation and validity of the systems of an understanding of the views of major external reporting is accurate and timely internal control through a programme of shareholders, the Company commissions and based on the maintenance of proper cyclical reviews, making recommendations each year a survey of investors undertaken records supported by robust information for business and control improvements by external consultants. The results of gathering processes; and as required. the survey are presented to the Board. Corporate governance – assist in ensuring that the Company The Board has delegated to the Audit The Company maintains a comprehensive complies with applicable laws and Committee responsibility for reviewing in Investor Relations website that provides, regulations at all times and also internal detail the effectiveness of the Company’s amongst other things, information on policies in respect of the standards system of internal controls. Having investing in BAE Systems and copies of of behaviour and conduct mandated undertaken such reviews, the Committee the presentation materials used for key by the Board. reports to the Board on its findings so shareholder presentations. This can be Reporting within the Company is structured that the Board as a whole can take a view accessed via the Company’s website, so that key issues are escalated through the on this matter. In order to assist the Audit www.baesystems.com. management team ultimately to the Board Committee and the Board in this review, the The AGM provides all shareholders with the if appropriate. The Operational Framework Company has developed the Operational opportunity to develop their understanding provides a common framework across Assurance Statement (OAS) process. This of the Company and ask questions on the the Company for operational and financial has been subject to regular review over matters put to the meeting including this controls. The business processes detailed a number of years, which has resulted in report and accounts. All shareholders are within the Operational Framework draw on a number of refinements being made. entitled to vote on the resolutions put global best practice and their application is The OAS requires that each part of the to the AGM and, to ensure that all votes mandated across the organisation. Lifecycle are counted, the Company’s Articles of Management (LCM) is such a process and business completes a formal review of Association requires that a poll is taken on promotes the application of best practice its compliance against the Operational all the resolutions in the Notice of Meeting. programme execution and facilitates Framework, including operational and The results of the votes on the resolutions continuous improvement across the Group. financial controls and risk management will be published on the Company’s website. It considers the whole life of projects processes. The review is signed off by the from inception to delivery into service managing director of every line of business and eventual disposal, and its application and relevant functional directors. The OAS is critical to our capability to deliver these is completed every half year and includes projects to schedule and cost. a formal assessment of business risk.

www.baesystems.com 47 Corporate governance Corporate governance (continued)

Audit Committee Report The full terms of reference of the Audit on management action taken in response Committee can be found on the Company’s to work undertaken by the Auditors in 2006; website or can be obtained from the – agreed the fees to be paid to the Auditors Company Secretary. for their audit work in 2006; Governance – undertook an evaluation of the performance The Board has established an Audit of the Internal Audit function; Committee the terms of reference of which comply with the requirements of the – undertook an evaluation of the performance Combined Code. The Committee is chaired of the Auditors; Michael Hartnall by Michael Hartnall who is a chartered – agreed a programme of work for the Audit Committee accountant and has recent experience of Company’s Internal Audit function; Chairman serving as a finance director of a major UK Members: listed company. All members of the Audit – received a report from the Internal Audit Michael Hartnall (Chairman) Committee are independent non-executive Director on the work undertaken by Internal Dr Ulrich Cartellieri directors. The Committee normally asks the Audit and management responses to Sir Peter Mason Company’s Chief Executive, Finance Director, proposals made in the audit reports issued Internal Audit Director and Auditors to attend by the function during the year; its meetings. However, during the year Roberto Quarta, a non-executive director, – received presentations on the Company’s the Committee did meet with no executive attends all meetings of the Committee. tax affairs; However, he is not a member of the directors present and has also met with Committee as the provisions of the just the Audit Director present and just the – reviewed proposals concerning the contents Company’s Articles of Association require Auditors present. of the 2006 report and accounts; that a majority of the members of all Board The Committee met five times in 2006. The – reviewed the circular sent to shareholders committees are British nationals. This Committee has agreed an annual programme concerning the proposed disposal of the requirement would not be met if Mr Quarta of matters to be covered and has asked that Company’s interest in Airbus; and Dr Cartellieri, both non-UK nationals, at least one of the scheduled meetings be – received a presentation on changes to the were members. Michael Portillo was a hosted by one of the Company’s businesses law concerning the disclosure of information member of the Committee from the start to allow the Committee to meet local to auditors and agreed processes aimed at of the year until his retirement from the management and discuss audit risk and ensuring compliance with these regulations; Board on 4 May 2006. control processes. and Activities – reviewed the Committee’s terms of reference. Responsibilities Since the beginning of 2006 the Audit – Reviewing the effectiveness of the Committee has undertaken the following The Committee recognises that one of its key Company’s financial reporting, internal in order to discharge its responsibilities: responsibilities is reviewing the risks to the Corporate governance Corporate control policies and procedures for the Company’s performance and the security of – reviewed the financial statements in the identification, assessment and reporting its assets. Twice a year the Committee 2005 and 2006 report and accounts and of risk. reviews the output from the group process the interim report issued in September that is used to identify and evaluate risk, this – Monitoring the role and effectiveness 2006. As part of this work the Committee process also reports on the elimination or of the Internal Audit function including received a report from the Auditors on their mitigation of risk and the relative level of risk approving the appointment or removal audit of the annual reports and accounts within the Group. This information is verified of the Head of Internal Audit. and review of the interim report; by the Internal Audit function and made – Considering and making – reviewed the output from the Group-wide available to the Auditors. process used to identify, evaluate and recommendations to the Board on The Committee has formally reviewed whether mitigate risks; the appointment of the Auditors. there are any factors that may prejudice the – Keeping the relationship with the – reviewed the effectiveness of the Company’s independence of the Auditors. Part of this Auditors under review, including the internal controls and disclosures made review involved the receipt of a letter from terms of their engagement and fees, in the annual report and accounts on KPMG Audit Plc confirming that they believed their independence and their expertise, this matter; they remained independent within the meaning of the regulations on this matter and resources and qualifications. – reviewed and agreed the approach and their professional standards. The Committee scope of the audit work to be undertaken – Monitoring the integrity of the recognises that in addition to the statutory by the Auditors; Company’s financial statements. audit work undertaken by the Company’s – Reviewing significant financial – considered a report from the Auditors on Auditors there will be certain work of a non- reporting issues and judgements. their review of the effectiveness of controls audit nature that is best undertaken by the across the Company and received a report Auditors. It believes that, provided suitable

48 BAE Systems Annual Report 2006 controls are in place, doing this work does Nominations Committee Report Work was initiated in 2005 aimed at not compromise the independence of the ensuring that the Committee had quality Auditors. The Committee has agreed the information on which to draw conclusions following rules to control the nature and about the strength of the Company’s quantity of non-audit work undertaken by management resource and to assist the Auditors: in agreeing succession plans for senior managers. As reported on page 45, this – any non-audit work to be undertaken by the work provided the Committee with good- Auditors for fees in excess of £250,000 quality information on management requires the authority of both the Group Dick Olver Finance Director and the Chairman of the Nominations resources and enabled it to complete an Audit Committee; Committee in-depth review of succession plans for Chairman the most senior positions in the Company. – no partner/director of the Auditor’s This comprehensive review of the Group’s Members: worldwide audit team is to be employed management resource was externally Dick Olver (Chairman) by the Company within two years of the Phil Carroll facilitated and provided in-depth analysis conclusion of a relevant audit; Sir Peter Mason of over fifty senior executives and individual – no qualified member of the worldwide competencies for key roles. audit team at manager level or below is to Responsibilities Combined with other performance be employed by the Company without the – Reviewing regularly the structure, management processes, this work was approval of the Group Finance Director; and size and composition of the Board used to develop and validate the detailed – no partner/director of the Auditors not and making recommendations to succession plans that have been developed associated with the audit is to be employed the Board on any changes desirable. for the Group’s senior executive positions. by the Company without the approval of the In addition, the succession planning work – Identifying and nominating for the Group Finance Director and the Chairman overseen by the Committee provided useful Board’s approval suitable candidates of the Audit Committee. information on the quality and depth of to fill vacancies for non-executive the Group’s management resources. The The Committee believes that it is not and, with the assistance of the Committee will continue to review succession appropriate to manage the level of non-audit Chief Executive, executive directors. plans on a regular basis, informed by the fees by reference to a specific ratio of audit – Plan for the orderly succession output from the rigorous processes that to non-audit fees but rather it looks to ensure of new directors to the Board by are in place. that any non-audit work is subject to robust regularly reviewing the Company’s Following the conclusion of the executive procurement processes and awarded subject management resources and key to the guidelines detailed above. management processes in September 2006, executive succession plans. the Board made two Chief Operating Officer The Committee has adopted a programme of – Recommending to the Board the appointments, with Walt Havenstein being undertaking a major review of the Company’s membership and chairmanship of the appointed to lead the US businesses and Auditors every three years and in the years in Audit and Remuneration committees. Ian King to lead the rest of the business, between undertaking a review to monitor their including the UK. performance. A major review was completed at the beginning of 2006 and a review has The full terms of reference of the Having agreed that the Board would benefit been undertaken recently to monitor ongoing Nominations Committee can be found from additional large UK company experience performance. On the basis of this work, the on the Company’s website or can be the Committee engaged external search

Committee recommended to the Board that it obtained from the Company Secretary. consultants to assist in identifying suitable Corporate governance support the re-appointment of KPMG Audit Plc candidates. As a result, Sir Nigel Rudd as the Company’s Auditors. The Board agreed Governance was identified as an excellent fit for the with this recommendation and consequently The Board has established a Nominations agreed candidate profile and in due course a resolution to this effect will be put to Committee that is chaired by the Chairman was nominated by the Committee to join shareholders at the Company’s AGM. of the Company, Dick Olver. Whilst he is not the Board. deemed to be independent, the other two The Chairman of the Committee reports to the members of the Committee are independent Following Sir Nigel’s appointment, the Board on the proceedings of all Committee non-executive directors. The Committee met Committee nominated him to join the meetings and the minutes of all meetings six times in 2006. Remuneration Committee. This was agreed are made available to Board members. by the Board. Activities On behalf of the Audit Committee The Committee’s key objective is to ensure On behalf of the Nominations Committee that the Board comprises individuals with the Michael Hartnall requisite skills, knowledge and experience Dick Olver Audit Committee Chairman Nominations Committee Chairman to ensure that it is effective in discharging 21 February 2007 its responsibilities. 21 February 2007

www.baesystems.com 49 Corporate governance Corporate governance (continued)

Corporate Responsibility Committee Report is chaired by Peter Weinberg, an independent non-executive director. All of the members of the Committee are independent non- executive directors. The Company’s Group Legal Director, Group HR Director, Director of Corporate Responsibility and Audit Director attend meetings at the request of the Committee. The Committee met Peter Weinberg three times in 2006. Corporate Responsibility Activities Committee The Committee undertook the following Chairman activities in 2006: Members: – reviewed significant social, environmental Peter Weinberg (Chairman) and ethical risks as identified by the Professor Sue Birley Company’s risk management processes and Phil Carroll actions being taken to mitigate those risks; Sir Nigel Rudd – received reports on corporate responsibility matters including, amongst other things, Responsibilities engagement with shareholders and safety, – Assist the Board in overseeing the health and environment performance; development of strategy and policy on – reviewed the effectiveness of the social, environmental and ethical matters. Company’s Ethics Hotline and received a – Monitor and review the Company’s summary of the nature of the issues raised performance in managing social, and details of action taken. The Company environmental, ethical and reputational established this hotline to provide risk. Specifically, the Committee shall employees with a means by which they can review whether appropriate policies, raise concerns about any matters that they systems and metrics are in place believe may be unlawful, dishonest, harmful relating to workplace, community, to others, against Company policy, improper environment and marketplace issues. business conduct or unacceptable These shall include, but shall not behaviour. To help ensure that employees necessarily be restricted to, health and have faith in this arrangement it is provided safety, workplace policies, responsible by a third party who passes details of calls Corporate governance Corporate supply chain management, or e-mails received to the Audit Director. environmental impact, business ethics Details of matters reported to the Ethics and compliance with law and regulation. Hotline are monitored by a committee chaired by the head of the Company’s – Review the Company’s Corporate Internal Audit function; Responsibility Report, prior to – received reports from the Internal approval of the report by the Board. Audit function on audits undertaken – Oversee and support key stakeholder on ethical and environmental matters; engagement on social, environmental – provided input on appropriate non-financial and ethical issues. objectives for the Chief Executive and – The Committee Chairman is required to other executive directors; and report to the Board on the proceedings – commissioned a report on various of the Committee on a regular basis. corporate responsibility matters and looking at best practice in these areas. The full terms of reference of the Corporate On behalf of the Corporate Responsibility Committee can be found on Responsibility Committee the Company’s website or can be obtained from the Company Secretary. Peter Weinberg Corporate Responsibility Governance Committee Chairman The Board established the Corporate Responsibility Committee in 2005 and it 21 February 2007

50 BAE Systems Annual Report 2006 Corporate governance Remuneration report

The Board has delegated authority for Remuneration Committee Report provided in the Corporate Governance Report remuneration policy and determining the on page 46. specific packages for the Chairman and During the year Dick Olver and Mike Turner, in executive directors to the Remuneration their respective capacities as Chairman and Committee, and has delegated authority Chief Executive, provided advice that was of to agree fees payable to the non-executive material assistance to the Committee. The directors to the Non-Executive Directors’ Committee also received material assistance Fees Committee. The reports from both and advice on remuneration policy from the these Committees are incorporated into Sue Birley Company’s Group Human Resources Director, this Remuneration report, together with a Remuneration Alastair Imrie, and from the Human report on the remuneration or fees paid to Committee Resources Director, Remuneration and directors and the policy underpinning this. Chairman Benefits, Graham Middleton. In addition, the The Remuneration report is structured Members: Committee received advice and services as follows: Professor Sue Birley (Chairman) from PricewaterhouseCoopers (PwC) in Sir Nigel Rudd respect of the design and competitive – Remuneration Committee report Roberto Quarta positioning of senior executive remuneration – Non-Executive Directors’ Fees Peter Weinberg (including a review of the share plan Committee report performance conditions) and senior executive pension arrangements; from New Bridge Responsibilities – Remuneration reporting Street Consultants (NBSC) in respect of the The Board has delegated the following – Remuneration policy and service operation of share plans and the new share responsibilities to the Remuneration contracts for executive directors plans approved by shareholders in 2006; Committee: – Chairman’s appointment, term and fees and from Linklaters in respect of legal – Non-executive directors’ appointment, – Agreeing a policy for the remuneration advice. NBSC was appointed by the term and fees of the Chairman and executive directors. Committee, whilst PwC and Linklaters were appointed by the Company and, during the – Tabular information on directors’ – Within the agreed policy, determining year, provided consulting services (PwC) and shareholdings, emoluments, pensions individual remuneration packages for legal services (Linklaters) to the Company. and share-based incentives the Chairman and executive directors. The Committee is satisfied that the services – Agreeing the terms and conditions to provided to it by PwC and Linklaters were of be included in service agreements for a technical nature and did not create any executive directors. conflict of interest. If a conflict of interest were to arise in the future, the Committee – Approving any employee share-based would appoint separate consultants or legal incentive schemes and any performance advisers from those used by the Company. conditions to be used for such schemes. Activities – Determining any share scheme During the year the Committee has performance targets. discharged its responsibilities by reviewing and agreeing: The full terms of reference of the – performance targets for the year and Remuneration Committee, which conform progress against those targets; with the requirements of the Combined Remuneration report Code, can be found on the Company’s – the operation of the long-term incentive website or can be obtained from the plans and policy for executive share scheme Company Secretary. grants including the level of individual grants and performance conditions; Governance The Committee is chaired by Professor – policy for the operation of the all-employee Sue Birley and all of its members are share schemes; independent non-executive directors. The – the award of bonuses based on the prior Company’s Chairman and Chief Executive year’s performance; attend committee meetings by invitation only. They do not attend where their individual – the basis for the annual review of executive remuneration is discussed and no director directors’ remuneration, including the composition of the comparator groups is involved in deciding his own remuneration. and the positioning of the remuneration In 2006 the Committee met seven times and packages for the two new incoming details of attendance at these meetings are Chief Operating Officers;

www.baesystems.com 51 Corporate governance Remuneration report (continued)

– the levels and structure of remuneration Non-Executive Directors’ Fees Remuneration policy and service contracts payable to senior executives; Committee Report for executive directors – the discretionary elements of the executive This section of the report explains the share plans; and ongoing remuneration policy for executive directors, the individual components of their – pension arrangements for senior executives. remuneration and details of their service In addition, the Committee has: contracts, as required by legislation. – reviewed the Remuneration Report; and The Remuneration Committee’s (the Dick Olver Committee) executive remuneration policy – consulted with major shareholders over Non-Executive continues to be to set basic salaries at median aspects of remuneration policy. Directors’ Fees competitive levels whilst seeking to reward Committee The Committee’s remuneration strategy Chairman upper quartile performance with potential is to provide a remuneration package that: upper quartile remuneration through the use Members: of bonus schemes and share-based incentives. – helps attract, retain and motivate the Dick Olver (Chairman) The Committee intends to continue with the highest calibre executives; Philip Bramwell executive remuneration policy as detailed in Walt Havenstein – is aligned to shareholders’ interests this report in 2007 and subsequent years, Mike Turner to create sustainable long-term and will continue to consult on material shareholder value; changes with principal shareholders. Responsibilities – is competitive against the appropriate – Reviewing the fees payable to non- Remuneration of executive directors consists market, providing median reward for executive directors (excluding the typically of basic salary, a bonus based median performance and upper quartile Chairman) and making changes to on annual performance, participation in reward for upper quartile performance; such fees as deemed appropriate. employee share schemes and retirement benefits. The Committee reviews the split – encourages and supports a high Governance between basic salary and the performance- performance culture whilst providing The Non-Executive Directors’ Fees Committee related elements of remuneration each year a balance between fixed and variable has delegated authority from the Board to in order to incentivise properly executive reward; and agree fees payable to non-executive directors directors, and believes that a significant – is fair and transparent and can be applied on its behalf. During the year Michael Lester proportion of remuneration should be consistently throughout the Group. and Mark Ronald also served as members based on schemes that encourage them of this Committee until their retirement from to perform at the highest level. Through Details of executive remuneration are the Board on 31 December 2006. Walt this arrangement, it is possible for those set out on pages 52 to 65 of this Havenstein and the Group Legal Director, individuals who contribute to sustained high Remuneration Report. Philip Bramwell, joined the Committee in levels of company performance to receive at

Remuneration report January 2007. Professor Sue Birley least a similar level of reward from variable Chairman of the Remuneration Committee Activities compensation to that received from fixed compensation. At median performance, 21 February 2007 The Board has approved the following guidelines to be used by the Committee variable remuneration represents when discharging its responsibilities: approximately 50% of the remuneration package as shown in the chart below: – fees shall be sufficient to attract and retain individuals with the necessary skills, Target Performance (median) experience and knowledge required to ensure that the Board is able to discharge Salary 34% its duties effectively; Pension 17% Bonus 17% – in setting fees the Committee shall have Long-term regard to the amount of time individual non- incentive rewards 32% executive directors are required to devote to their duties and also the scale and complexity and international nature of the business and the responsibility involved; The package of the Chief Executive is more highly geared with almost 60% of the remuneration being – fees payable to non-executive directors performance related. shall be paid in cash and shall not be At upper quartile performance variable performance related; and remuneration represents significantly more – non-executive directors shall not participate than 50% of the total package. in the Company’s share-based incentive The principles of the remuneration strategy schemes or pension scheme. are applied consistently across the Group In 2006 the Committee held one meeting, taking account of seniority and local attended by all members, at which it agreed market practice. the structure of non-executive directors’ fees detailed on page 64 of this report. Dick Olver Chairman of the Non-Executive Directors’ Fees Committee 21 February 2007

52 BAE Systems Annual Report 2006 Base salary aerospace, defence and general industry which implements corporate strategy on a Executive directors’ base salaries are sector data to produce appropriate market groupwide basis by ensuring that business reviewed each year by the Committee and figures consistent with the size and scale of plans which support the strategy are adjusted to reflect performance and the the US business, adjusting where necessary integrated across all businesses. The IBP competitiveness of salaries relative to to reflect the extra responsibility for the plc is used to set the objectives for senior the market. Information on the market board role. The remuneration package of the management including the base and stretch for comparable management positions is new appointee was positioned competitively, targets for the financial measures used obtained from independent sources and but materially below that of the retiring US for the executive directors in the Annual is provided to the Committee so that it Chief Operating Officer in recognition of the Bonus Plan. can form a view as to where to position fact that the incoming US Chief Operating basic salaries and benefits relative to Officer is new to the role. In view of the The setting of non-financial targets is comparable companies. requirement for the role to be based in the initiated by the Chairman of the Board who, Washington DC area, the package includes after consultation with the Chief Executive, The methodology used is to construct discusses the matter with the Committee. appropriate comparator groups for the relocation expenses in line with the Company’s standard US policy. The Committee approves the Chief individual positions taking account of Executive’s objectives and those for the company size, scale of operations and As a result of this review, the Committee Executive Committee as a whole. The Chief breadth of role. The median and upper determined the base salaries of the executive Executive then makes proposals to the quartile positions are then analysed for directors with effect from January 2007 to Committee regarding individual non-financial base salary, total cash reward (base salary be as follows: objectives for each of the executive directors plus annual bonus), total direct reward (total and the other members of the Executive £945,000 cash reward plus long-term incentives) and Mike Turner Committee for approval by the Committee. total reward including pension. This gives Chief Executive the Committee a view on the competitiveness George Rose £560,000 2006 was another very successful year, of the individual elements of the package Group Finance Director building on the excellent performances in 2004 and 2005. All the major business as well as the package as a whole. The £490,000 Chris Geoghegan groupings achieved their stretch targets Committee also reviews the trends in the Group Executive Director on profit and cash and, as a result, all the elements of remuneration to ensure that the Walt Havenstein1 $750,000 financial targets within the 2006 Annual structure of the package stays in line with Chief Operating Officer – US Bonus Plan for executive directors were met market practice, and also takes account 2 £530,000 at the stretch level. In addition, excellent of the performance of the individual, the Ian King Chief Operating Officer – UK and RoW progress was made against all the key non- Company as a whole and the pay and financial objectives and, accordingly, bonus conditions of Group employees. Steve Mogford £490,000 Group Executive Director payments for 2006 which are set out in A number of changes were made to the Table E on page 64 range from 95% to Company’s executive management structure 1 Appointed to the Board with effect from 2 January 2007 100% of the maximum bonus. towards the end of 2006 to reflect the 2 Appointed to the Board with effect from 1 January 2007 The Remuneration Committee has reviewed evolving nature of the organisation and this and agreed bonus targets for 2007 for the impacted on the way in which the base salary Annual Bonus Plan The executive directors and other senior executive directors and believes that both structure for the executive directors has been the financial and non-financial targets are determined for 2007. executives participate in a cash bonus plan that rewards those individuals if pre- stretching but achievable and are aligned to the Group’s overall objectives. For the Chief Executive and Group Finance determined targets are met. The targets Director a comparator group was constructed are derived from the Integrated Business As a result of its annual review of the Remuneration report consisting of the 19 FTSE 50 companies Plan (IBP), which is agreed by the Board and performance related part of the remuneration (excluding financial institutions) with turnover closest to BAE Systems (nine larger and ten smaller), the turnover figure for BAE Systems The structure of the Annual Bonus Plan for executive directors in 2007 (expressed as being £12bn which excludes turnover from percentages of base salary) is as follows: joint ventures. The Committee also reviewed Steve Mogford remuneration data for aerospace and Corporate roles Mike Turner George Rose defence companies within the FTSE 100. Base Stretch Base Stretch For the incoming Chief Operating Officer, Bonus element target target target target UK and RoW, as there were no similar EPS targets 28.125% 56.25% 18.75% 37.5% sized roles in the comparator group, the Group cash targets 28.125% 56.25% 18.75% 37.5% Committee benchmarked this new role using Non-financial objectives up to 37.5% up to 25% regression analysis for main board directors of UK companies with responsibility for an Operating roles Chris Geoghegan international portfolio of businesses that Ian King Walt Havenstein have a turnover of £6bn. Base Stretch Base Stretch Bonus element target target target target Following the change in roles for the two EPS targets 9.375% 18.75% 14.0625% 28.125% Group Executive Directors, the Committee Group cash targets 9.375% 18.75% 14.0625% 28.125% reviewed data relating to the expected salary 1 trends for FTSE 50 directors in 2007 and, Business group EBITA target 9.375% 18.75% 14.0625% 28.125% taking account of their performance and Business group cash target 9.375% 18.75% 14.0625% 28.125% contribution, awarded a salary increase Non-financial objectives up to 25% up to 37.5% in line with the expected trend. 1 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense For the incoming US Chief Operating Officer, Intermediate payments are payable for performance against these targets. regression analysis was used on US The Chairman and non-executive directors do not participate in the Annual Bonus Plan.

www.baesystems.com 53 Corporate governance Remuneration report (continued)

package, the Committee has determined that plans, taking account of continuing changes – Share Matching Plan The new Share the maximum bonus potential for 2007 will in market practice and investors’ comments Matching Plan, which shareholders remain unchanged from 2006 at 100% of following the shareholder consultation approved last year, replaces the Restricted base salary (150% for the US-based executive exercise in early 2006 on changes to Share Plan for awards in 2007 and director and the Chief Executive, with at least executive remuneration policy. In considering introduces an EPS performance condition one-third of the Chief Executive’s bonus being the variety of ways in which companies on the award of matching shares aligned to compulsorily deferred into the Share Matching reward performance in terms of plan design, that used for share options. The Committee Plan in 2007). performance measures and different believes that this remains appropriate. weightings of short-term and long-term Plan provisions In determining the performance measures for rewards, the review concluded that there Performance conditions for grants of options the Annual Bonus Plan, the Committee took was no standard approach with companies or awards to be made under the Executive the view that the Company’s major investors tailoring their corporate approach to suit Share Option Plan, the Performance Share believed earnings per share (EPS) and cash their own sectoral or specific needs. The Plan and the Share Matching Plan in 2007 targets (and, where appropriate, EBITA), Committee believes that the Company’s are detailed below. Performance conditions to be key indicators of long-term financial approach provides a good balance of for earlier grants under the Executive Share performance and value creation. These, short-term and long-term reward, potentially Option Plan are shown as notes to Table C. coupled with the non-financial measures, more weighted towards long-term rewards Performance conditions for grants of awards align the executive directors’ objectives than a number of other companies, but under the Performance Share Plan made with corporate strategy and targeted consequently aligned to and consistent between 2003 and 2006 are the same business performance. with the long-term nature of the Company’s as for awards to be made in 2007 as business. The Committee has therefore The EPS figure used for the bonus plan (and detailed below. the Executive Share Option Plan) is based on retained the current long-term underlying EPS (as reported in the report and incentive arrangements. Executive Share Option Plan Options granted under the Executive Share accounts) but may be adjusted (up or down) As part of the review, the Committee Option Plan are normally exercisable between if necessary to ensure that the figures for considered the performance conditions for the third and tenth anniversary of their grant. individual years are broadly comparable. the various share-based incentive plans, Options may only be exercised during this benchmarking the performance conditions Share option plans and long-term period as follows: incentive plans against market practice. The Committee’s Policy conclusions are as follows: – 33.33% of each option grant is exercisable The Committee seeks to align the if the Company achieves on average real – Performance Share Plan The Committee interests of executive directors (and EPS growth per annum of 3% but less than has concluded that the current comparator other senior executives) with those of other 4% over the three-year performance period; group and vesting schedule remain shareholders through the use of share-based appropriate and suitably stretching. – 66.67% of each option grant is exercisable incentive schemes. The Company operates if the Company achieves on average real a combination of options and share awards – Share Option Plan Until last year, share EPS growth per annum of 4% but less than Remuneration report for senior executives within the framework options awards had failed to meet the 5% over the three-year performance period; detailed below. This is broadly in line associated performance condition for a with similar plans operated by other number of years. In addition, the awards – 100% of each option grant is exercisable if FTSE 50 companies. made in 2001 and 2002 have lapsed as the Company achieves on average real EPS a result of failing to meet the required growth per annum of 5% or more over the In 2005, effective from 2006, the Committee three-year performance period. revised its policy in relation to the provision performance target. Furthermore, almost of share-based incentive plans by awarding half of the executives receiving share awards In determining the performance measure share-based long-term incentives which are are US executives for whom a performance for the Executive Share Option Plan (and for settled in shares rather than cash to those US condition on share options is still rare. the Matching Shares in the Share Matching senior executives who qualify as “Accredited The Committee is also aware that the Plan described below), the Committee took Investors”, thus enhancing the alignment with anticipated dilutive effect of the sale of the view that the Company’s major investors shareholders’ interests. In order to operate the Company’s stake in Airbus, which believed EPS to be a key indicator of long- within existing dilution limits, the remuneration shareholders approved last year, has term financial performance and value creation. strategy for senior managers globally below made the existing performance conditions Option grants under the Executive Share the senior executive population has been potentially more stretching. The Committee Option Plan will continue to be set at a reviewed with share-based rewards being has decided that the existing EPS maximum of 1.5 times base salary (2.25 replaced by a cash-based long-term incentive performance conditions on share options times base salary for the Chief Executive) plan linked to earnings performance. The will not be rebased but instead management in 2007 and there will be no retesting after Committee believes that this will promote will be expected to generate sufficient growth the three-year performance period. a consistent global approach and will derive not only to meet the required targets but also enhanced value for money from the executive to recoup the anticipated dilutive effect of Performance Share Plan (PSP) reward programmes. the Airbus transaction. Conditional awards of shares are made under the Performance Share Plan which The Committee also decided to settle in The Committee accordingly concluded that are contingent on meeting pre-determined shares rather than cash unvested awards to change the performance condition at this performance criteria. Under the PSP, awards of share options and performance shares time was unnecessary and would act as a may be made up to 2 times base salary. for those US executives who qualify as disincentive until executives had experience Awards in 2007 to executive directors will accredited investors. This further enhances of share options meeting required be granted at a value equal to 1 times base their alignment with shareholders’ interests performance conditions, and has therefore salary (1.5 times base salary for the Chief and reduces the volatility of the income decided to retain the existing EPS growth Executive). The proportion of the award which statement charges arising on these awards. condition for awards in 2007 of real EPS is capable of exercise is determined by the In 2006 the Committee reviewed the growth of 5% per annum for full vesting. Company’s Total Shareholder Return (share Company’s share-based long-term incentive This will be kept under review. price growth plus dividends) ranking relative

54 BAE Systems Annual Report 2006 to a comparator group of 18 other defence and measures (with the rest based on TSR) to As a result of the Company’s performance in aerospace companies operating internationally, create improved incentive and alignment with 2006, all eligible employees (including the UK and by a secondary financial measure. the individual’s own business performance. executive directors) will be entitled to receive shares worth £420. A similar arrangement Performance for the 2007 awards will be Share Matching Plan (SMP) operates for non-UK employees on a cash measured as follows: Following shareholder approval at the 2006 or shares basis depending on local tax and AGM, the new Share Matching Plan replaces (i) Total shareholder return (TSR) security laws. the previous Restricted Share Plan in 2007. 100% of the conditional shares are awarded The Company operates a share purchase to directors if the Company’s TSR over a The SMP is a stand-alone share investment arrangement (Partnership Shares) under three-year period is in the top 20% of TSRs plan with the maximum investment linked to the Share Incentive Plan which replaced the achieved by the sectoral comparator group, the bonus awarded under the Annual Bonus SAYE Share Option Scheme in 2005. Under with 25% vesting if the TSR is in the top 50%. Plan. Participants will be invited to acquire this arrangement, UK-based employees Intermediate positions will be calculated on shares up to an amount not exceeding the (including executive directors) may purchase a straight-line pro-rata basis. No awards will net amount of any discretionary annual ordinary shares in BAE Systems by either be made if the Company’s performance is bonus the individual received for the previous monthly investments of between £10 and outside the top 50%. Awards will be made financial year (Investment Shares). As stated £125 a month, or lump sum investments in three equal instalments at the end of above, the Chief Executive is required to of between £10 and £1,500 in a tax year, years three, four and five. defer at least one-third of his bonus into the both limited to 10% of salary if less. SMP. The participant will be granted a (ii) Underlying financial performance Dividends paid in respect of the shares in the conditional award of Matching Shares under As a secondary measure the Committee Share Incentive Plan for UK-based employees the SMP against the gross bonus invested; will consider whether there has been a are reinvested as Dividend Shares. for executive directors the match will be in sustained improvement in the Company’s the ratio of 1:1. With effect from December 2006 the underlying financial performance and Committee agreed the introduction of whether it is appropriate to release some The performance condition that will apply to Matching Shares into the Share Incentive or all of the awards. In taking a view of the Matching Shares under the SMP in Plan Partnership Shares arrangement on the a sustained improvement in underlying 2007, and the rationale for its use, is the basis of one free Matching Share for every financial performance, the Committee may same as that which has been applied to two Partnership Shares purchased by the consider (but not exclusively) the following options granted under the Company’s employee up to a maximum monthly financial metrics: net debt/cash; EBITA; executive share option plans as set out on Partnership Share investment of £30. order book; turnover; risk and underlying page 54. The plan is an all-employee plan and project performance. The Matching Shares will attract dividends in accordance with legislation the A sectoral peer group will continue to be used during the three-year deferral period which Matching Shares are not subject in 2007 as the principal performance measure will be released at the same time as the to performance conditions. due to its importance to the Company’s vesting of any Matching Shares. Dilution of share capital shareholders as an indication of both earnings Restricted Share Plan The Committee has agreed that, in respect and capital growth relative to major global The Restricted Share Plan (RSP), which of new issue or treasury shares, shares defence and aerospace companies. A relative operated for the final time in 2006, representing no more than 1% of the measure is considered important as it rewards historically acted as a share-based Company’s issued share capital will be used management if they outperform against major extension of the Annual Bonus Plan in that in any one financial year for the grant of companies in the sector rather than success share options under all-employee share executive directors who participated in the possibly being determined solely by growth

schemes. The table below sets out the Remuneration report Annual Bonus Plan could be given the option in stock markets. The second measure was available dilution capacity for the Company’s of taking any net cash bonus paid partly or included to ensure that awards will only vest employee share schemes based on the wholly in shares through the RSP. If an if there has been a clear improvement in the limits set out in the rules of those schemes. election was made to take shares through Company’s underlying performance over the the Plan, they were held in trust for a period relevant period. 2006 of three years after which the Company Total issued share capital as The composition of the TSR sectoral peer awarded the individual an equal number of at 31 December 2006 3,246m group for awards to be made in 2007 is shares (Matching Shares) provided the the same as that in 2006 and comprises: individual normally remained in the All schemes: 10% in any consecutive 10 years 324.6m Boeing Cobham Company’s employment at the vesting date. Where executive directors have elected to Remaining headroom 193.5m Dassault Aviation EADS use such bonuses through the RSP, details Executive schemes: Embraer PN Finmeccanica of the shares held are set out in Table B on 5% in any consecutive 10 years 162.3m General Dynamics GKN page 60. None of the executive directors Remaining headroom 92.9m Goodrich Honeywell International who served during 2006 participated in the Lockheed Martin Northrop Grumman 2006 operation of the RSP. The number of ordinary shares in issue at Raytheon Rockwell Collins The matching award of shares was 31 December 2006 was 3,246,232,539 and the number of shares granted under option Rolls-Royce Smiths Group historically not subject to any performance criteria and has now been superseded by during 2006 totalled 6,082,429 (0.19% Thales United Technologies the Share Matching Plan which is subject of the total shares in issue). In addition, a to performance criteria. decision was taken in 2006 to settle awards As agreed by shareholders at the 2006 AGM, over 8,641,212 executive share options for PSP participants other than executive Share Incentive Plan (granted as Stock Appreciation Rights) in directors, the Committee has the flexibility During 2006 the UK executive directors were equity, rather than in cash, for US executives to agree that up to half of any award can be eligible to participate in the all-employee free satisfying the accredited investor rules. based on appropriately stretching internal shares element of the Share Incentive Plan. These are included in the dilution figures.

www.baesystems.com 55 Corporate governance Remuneration report (continued)

Personal shareholding policy of funding the deficits disclosed in the and 2.5% per year in respect of service from The Committee has agreed a policy schemes. These changes apply to executive 6 April 2006. Directors pay contributions whereby all executive directors are required directors in the same way as to other at the same rate as all other employees to establish and maintain a minimum employees and include the introduction of the participating in schemes. personal shareholding equal to 200% of Longevity Adjustment Factor, a reduction in Michael Lester, who retired from the Board base salary. As a minimum, a holding equal the maximum level of pension increases and at the end of 2006, had a normal retirement to 100% of base salary must be achieved a change in the definition of Pensionable Pay. age of 62 and was already in receipt of as quickly as possible using shares vesting The UK-based executive directors with his pension. or options exercised through the executive the exception of Ian King (see below) are share option schemes or long-term incentive Ian King is a member of the BAE Systems members of the BAE Systems Pension schemes, by using 50% of the shares 2000 Pension Plan (the 2000 Plan) Scheme (the Main Scheme) and the that vest or 50% of the options which are applicable to former employees of Marconi BAE Systems Executive Pension Scheme exercised on each occasion. Thereafter, Electronic Systems (MES) and a member of (the ExPS). The ExPS tops up the benefits executive directors are required to increase the ExPS. The 2000 Plan provides a pension from the Main Scheme and, for executive their personal shareholding gradually, on of 1/50th of Final Pensionable Earnings directors, is designed to produce a target each occasion using 25% of the shares (FPE) for each year of pensionable service, pension payable from age 60 of two-thirds that vest or 25% of the options exercised payable from a normal retirement age of 65. of Final Pensionable Pay (FPP) if potential each year, until a personal shareholding FPE under the 2000 Plan is the best three- service is 20 or more years. FPP is defined equal to 200% of annual base salary is year average of base salary and bonus in the as basic salary averaged over the last achieved and maintained. These limits ten Plan Years prior to leaving, less an offset 12 months prior to leaving service in respect are reviewed periodically. for State pensions. The Company decided of service accrued to 5 April 2006 and last year to limit pensionable bonuses in the Details of the directors’ personal 36 months prior to leaving in respect of 2000 Plan in the 2006/07 Plan Year to 20% shareholdings are shown in Table A. service from 6 April 2006. These schemes of base salary and this will reduce to 10% of also provide a lump sum death-in-service base salary for the Plan Year commencing on Post-retirement benefits benefit equal to four times basic salary UK pension benefits 6 April 2007. However, there is a guarantee at date of death, and a spouse’s death-in- As a result of the recently introduced age that the FPE figure for benefits service prior service pension equal to two-thirds of the discrimination legislation, UK executive to 6 April 2007 will not be less than the prospective pension at normal retirement directors’ default retirement age will be 65 FPE figure at 5 April 2007 to ensure that age. Children’s allowances are also payable, but they will retain any previous rights they employees do not lose the benefit of usually up to the age of 18. Spouses’ had to retire and draw their pensions without contributions paid on past bonuses. Ian pensions and children’s allowances are also King joined the ExPS in 1999 following the actuarial reduction for early payment at payable upon death in retirement and death BAe/MES merger. The ExPS tops up the an earlier age. after leaving the Company’s employment with 2000 Plan benefits to provide a target Following the consultations with employees a deferred pension. Pensions are increased benefit payable from age 62 of 1/30th of

Remuneration report last year, a number of changes were made to annually by the rise in the Retail Prices Index Final Pensionable Pay for each year of ExPS the pension schemes in respect of benefits subject to a maximum increase of 5% per pensionable service (subject to a maximum accruing from 6 April 2006 as a means year in respect of pre 6 April 2006 service of two-thirds). Final Pensionable Pay for the

Value at 31 December 2006 of £100 investment at 31 December 2001 Value at 31 December 2006 of £100 investment

£200 £450

£160 £360

£120 £270

£80 £180

£40 £90

31 Dec 01 31 Dec 02 31 Dec 03 31 Dec 04 31 Dec 05 31 Dec 06 2002 2003 2004 2005 2006 BAE Systems FTSE 100 BAE Systems Aerospace & Defence Comparator Group This graph shows the value, by 31 December 2006, of £100 invested in FTSE 100 UK Executive Pay Review Comparator Group BAE Systems on 31 December 2001 compared with the value of £100 invested in The graph above shows the value shareholders have achieved by their investment the FTSE 100 Index. The other points plotted are the values at intervening financial in BAE Systems over recent years as compared to (i) the FTSE 100 Index; (ii) the year ends. companies forming the sectoral peer group for the BAE Systems Performance Share Plan; and (iii) the companies forming the comparator group for the 2006 executive The graph, which has been produced in accordance with the requirements of pay review. The graph depicts the value for BAE Systems and the comparators at the Schedule 7A to the Companies Act 1985, shows the total shareholder return for end of 2006 of a single £100 investment made at the beginning of each of the last a holding in the Company’s ordinary shares for the period 2001-2006 relative to five years. a holding of shares representing the FTSE 100. The FTSE 100 is considered to be an appropriate comparator for this purpose as it is a broad equity market index. As BAE Systems is a constituent member of the FTSE 100, it was deemed to be the most appropriate general UK equity index.

56 BAE Systems Annual Report 2006 purposes of this top up is calculated by of an unfunded promise from the Company. period will increase by one year each year reference to base salary only, averaged over No further contributions will be paid into his beginning in 2009 and reaching a ten-year 12 months and 36 months as described funded unapproved top up arrangement. average in 2015. Directors pay contributions above. Therefore Ian King’s total pension is Further information on the amounts paid by at the same rates as other employees in the sum of his 2000 Plan benefits plus the the Company in respect of these arrangements the plan. The pension does not carry any top up from the ExPS. is included in the notes to Table F. spouse’s pension or pension increases. Walt Havenstein also receives a 50% match on Following the changes made last year to take US Executives his contributions to his 401(k) plan up to account of the Pensions Simplification tax Mark Ronald retired from the Board at the a maximum contribution of 8% of earnings. changes which came into effect from April end of 2006 and was already in receipt of 2006, UK executives reaching the Lifetime his pension. Details of post-retirement benefits for Allowance (LTA) are given a number of each of the executive directors who served Walt Havenstein is a member of the choices as set out in last year’s during 2006 are shown in Table F on BAE Systems Employees’ Retirement Plan remuneration report. These are: page 65 and are calculated in accordance which provides a pension from age 60 for with the requirements of Schedule 7A – remain in the pension scheme and pay any each year of pensionable service of 1.25% of the Companies Act 1985. additional tax charge; or on his Final Average Pay (FAP) up to Social Security Covered Compensation (circa – opt out of the pension scheme (and Other benefits $70,000) plus 1.5% on his FAP in excess of Other benefits provided to the executive so earn no further pension benefits in Social Security Covered Compensation. FAP directors include a car allowance, the taxable respect of future service) and instead is currently the highest three-year average benefit of any private use of a chauffeur, and receive a taxable salary supplement. This of base salary plus bonus but the averaging a cash allowance for medical examination. supplement will be 30% of salary and 20% of salary for those senior executives with a two-thirds salary target after at least 20 Executive directors’ service contracts years and 30 years service respectively; or It is the Committee’s policy that executive directors should normally have service contracts – restrict scheme benefits to the value of that provide for the company to give the individual 12 months’ notice of termination. This the LTA with the remainder being provided policy has been chosen because it provides a reasonable balance between the need to retain directly from the Company as an unfunded the services of key individuals and the need to limit the liabilities of the Company in the event promise. At retirement, the unfunded of the termination of a contract. The executive directors have service contracts with Group Company benefits can be either taken companies; details of these contracts are as follows:

as pension or can be commuted in full Date of contract Unexpired term Notice period for a taxable lump sum. Chris Geoghegan 10 July 2002 12 months 12 months either party The Committee reviewed these arrangements (amended 15 January 2004 at the beginning of 2007 in the light of and 13 October 2005) developing market practice and believes Walt Havenstein 1 December 2006 3 months 3 months either party they remain appropriate as they provide Ian King 31 January 2007 12 months 12 months either party executives with choices which may better suit their needs whilst being broadly cost Steve Mogford 6 April 2000 12 months 12 months either party neutral to the Company, are in line with (amended 15 January 2004 market practice, and do not compensate and 28 October 2005) executives for changes in taxation. George Rose 16 November 1998 12 months 12 months from the (amended 3 December 1999 Company, 6 months UK executives, including the UK executive 15 January 2004 from the individual Remuneration report directors, affected or likely to be affected and 17 October 2005) by the Lifetime Allowance before April 2009 Mike Turner 22 February 1994 12 months 12 months from the were provided with independent financial (amended 30 May 1995 Company, 6 months advice paid for by the Company. Mike Turner 3 December 1999 from the individual and Chris Geoghegan elected to opt out of 8 May 2002 the pension schemes in April 2006 in return 15 January 2004 for a cash supplement of 30% of base and 14 October 2005) salary. Steve Mogford and Ian King elected to have their scheme benefits restricted in return for a Company unfunded promise. In the event of the termination of an provisions in his service contract that George Rose was affected by the previously executive director’s contract it is the relate to a change of control of the applicable Inland Revenue earnings cap on Committee’s policy to seek to limit any Company (and neither does the Chairman approved pensions and has an unapproved payment made in lieu of notice to a nor the non-executive directors in their (i.e. non-tax qualified) pension arrangement payment equal to the amount of one year’s respective letters of appointment). to top up his benefits from the approved basic salary. The service contracts for all schemes. This was designed so that the of the executive directors contain specific Michael Lester and Mark Ronald, who total pension from all sources would be provisions to the effect that the Company retired as directors on 31 December 2006, broadly in line with the pension he would has the right, and in Walt Havenstein’s also had service contracts. The service have received from the group pension case, generally has the obligation, to pay a contract for Michael Lester was dated schemes had he not been subject to the sum equivalent to 12 months’ salary (plus 26 November 1999 and had been renewed earnings cap. The Pension Simplification tax the continuation of 18 months’ medical on a rolling one year basis since 2002 changes have allowed the flexibility to remove benefits in Walt Havenstein’s case) in the when he reached his normal retirement the earnings cap for George Rose in respect of event of the Company terminating their age of 62. The service contract came to service from April 2006, although some of his contracts for reasons other than gross an end when he retired from the Board benefits will remain to be provided by means misconduct. No executive director has on 31 December 2006.

www.baesystems.com 57 Corporate governance Remuneration report (continued)

The service contract for Mark Ronald was Chairman’s appointment, term and fees subject to re-election at the AGM following dated 17 April 2002 and had been renewed Dick Olver was appointed Chairman on their appointment and subsequently at on a rolling one year basis since 2003 when 1 July 2004. His appointment is for an intervals of no more than three years. he reached his normal retirement age of 62. initial fixed three year term with effect Michael Portillo retired from the Board at The service contract came to an end when from 17 May 2004 (the date that he was Mark Ronald retired from the BAE Systems the conclusion of the 2006 AGM on 4 May appointed to the Board as a non-executive 2006, having originally been appointed plc Board and as President and Chief director) unless terminated earlier in to the Board on 11 September 2002. Executive of BAE Systems, Inc. on accordance with the Company’s Articles 31 December 2006. As disclosed previously, of Association, or by either party giving the The letters of appointment for non-executive the terms of Mark Ronald’s contract other not less than six months’ prior written directors detail the amount of time it is contained an entitlement to a lump sum notice. His appointment is documented in a anticipated that the individual will need to equal to 12 months’ salary and the letter of appointment which is not a contract devote to his or her duties as a director. continuance of medical benefits for 18 of employment and he is required to devote Non-executive directors are proposed by the months if his contract was terminated by no fewer than two days a week to his duties Nominations Committee and are appointed BAE Systems, Inc., his directorship of the as Chairman. The Nominations Committee by the Board on the basis of their experience parent company ceased, or if his contract will review his appointment prior to the end to provide independent judgement on issues was not renewed at the end of its one year of the three-year term and will, if appropriate of strategy, performance, resources and rolling term. Details of this contractual (and subject to the agreement of Mr Olver), standards of conduct. The level of their payment are included in Table E on page 64. recommend to the Board that he be invited fees is set after reviewing practice in to serve for an additional period. His In order for the Company to benefit from appointment as Chairman will automatically other comparable companies. his considerable experience of the US terminate if he ceases to be a director of defence market, Mark Ronald has been Details of the non-executive directors’ fees the Company. His fee, which has been set appointed as non-executive Chairman in 2006 are shown in Table E on page 64. by the Committee at £500,000 per annum, of BAE Systems, Inc. with effect from will not be subject to review during the initial Fees payable to the non-executive directors 15 January 2007 and will also provide three-year term. are agreed by the Non-Executive Directors’ advisory services. Fees payable to him in Fees Committee. Non-executive directors are his non-executive capacity are consistent Non-executive directors’ appointment, term paid a fee reflecting the time commitment with those paid to other non-executive and fees required of the director. The fee level for directors of BAE Systems, Inc. These The non-executive directors do not have the chairmen of the Audit, Corporate arrangements will automatically cease service contracts but do have letters of Responsibility, and Remuneration Committees, on 31 December 2007 unless he and appointment detailing the basis of their and for the Senior Independent Director, BAE Systems, Inc. mutually agree to appointment. The dates of their original extend them for a further year. reflects their additional responsibilities and appointment were as follows: workload. In addition, a transatlantic meeting Policy on external board appointments allowance of £4,000 per board meeting is Non-executive Date of Expiry of The long-standing policy of allowing executive payable to non-executive directors; this takes

Remuneration report director appointment current term* directors to hold external non-BAE Systems Sue Birley 22.11.2000 09.05.2007 into account the additional time commitment related non-executive directorships with the required by the European-based non-executive Phil Carroll 07.09.2005 06.09.2008 prior approval of the Committee will continue. directors to attend board meetings in the US The Committee considers that external Ulrich Cartellieri 01.12.1999 26.09.2007 and similarly the commitment of US-based directorships provide the Company’s senior Michael Hartnall 10.06.2003 09.06.2009 non-executive directors to attend board executives with valuable experience that is of Sir Peter Mason 22.01.2003 21.01.2009 meetings in Europe. benefit to BAE Systems. It is also considered Roberto Quarta 07.09.2005 06.09.2008 appropriate for BAE Systems to contribute to The fees payable to the non-executive the pool of non-executive expertise available Sir Nigel Rudd 10.09.2006 09.09.2009 directors were reviewed in February 2007 for the benefit of the wider business Peter Weinberg 16.06.2005 15.06.2008 and the following fee structure was community, thereby reciprocating the benefit agreed for 2007 to reflect the various which it in turn has received from other * subject to re-election at the AGM following their responsibilities of the individual directors: a organisations which have permitted members appointment and subsequently at intervals of no more than three years in accordance with the Company’s fee of £77,500 for the chairman of the Audit of their senior management teams to serve Articles of Association Committee; a fee of £72,500 for each of the on the BAE Systems Board. The Committee chairman of the Remuneration Committee, believes that it is reasonable for the The non-executive directors are normally the chairman of the Corporate Responsibility individual executive director to retain any fees appointed for two consecutive three-year Committee, and the Senior Independent received from such appointments given the terms subject to review after the end of the Director; and a fee of £57,500 for each additional personal responsibility that this first three-year period and with any third term of the other non-executive directors. entails. Such fees retained by the executive of three years being subject to rigorous directors who served in 2006 were as review and taking into account the need By order of the Board follows: Michael Lester: £16,135; Steve progressively to refresh the Board. They do Mogford: £13,016; George Rose: £65,000; not have periods of notice and the Company Dick Olver Chairman and Mike Turner: £43,756 plus grants of has no obligation to pay compensation when Deferred Stock Units to the value of £42,118. their appointment terminates. They are 21 February 2007

58 BAE Systems Annual Report 2006 Table A As at 31 December 2006, the directors of the Company and their families had the following beneficial and non-beneficial interests in the Company’s securities. There have been no changes in the interests of the current directors listed in the table below between 31 December 2006 and 21 February 2007 with the exception of: (i) the share interests of Steve Mogford who has acquired an additional 63 ordinary shares since 31 December 2006 under the partnership and matching shares elements of the Share Incentive Plan so that his beneficial shareholding at the date of this report stood at 149,003; and (ii) the option figures for Chris Geoghegan, Steve Mogford, George Rose and Mike Turner which have reduced on account of the lapse of share options in February 2007 so that their option figures as at the date of this report were as follows: Chris Geoghegan: 1,201,873; Steve Mogford: 1,235,703; George Rose: 1,400,520; and Mike Turner: 2,169,697. The interests of the two directors appointed since 31 December 2006, as at the date of approval of this report, are stated in a footnote to the table below.

Directors’ interests As at 1 January 2006* As at 31 December 2006** Ordinary Restricted Performance Ordinary Restricted Performance shares Options Share Plan Share Plan shares Options Share Plan Share Plan Prof S Birley 2,925 – – – 2,925 – – – P J Carroll –––––––– Dr U Cartellieri –––––––– C V Geoghegan 141,016 1,363,186 42,764 613,003 143,150 1,411,363 42,764 722,231 M J Hartnall 20,000 – – – 20,000 – – – M Lester1 616,553 1,931,908 87,937 753,691 618,702 1,843,973 87,937 886,284 Sir Peter Mason 25,000 – – – 25,283 – – – S L Mogford 127,869 1,572,757 – 613,003 148,940 1,469,136 – 722,231 R L Olver 40,000 – – – 40,000 – – – Rt Hon M Portillo2 –––––––– R Quarta –––––––– M H Ronald1 255,587 1,618,677 81,928 659,808 255,587 1,262,461 81,928 708,308 G W Rose 354,831 1,728,860 33,971 679,986 354,950 1,660,221 33,971 803,817 Sir Nigel Rudd3 –––––––– M J Turner 419,646 2,262,728 137,924 1,058,656 435,880 2,446,712 137,924 1,363,562 P A Weinberg ––––––––

* or upon appointment ** or upon ceasing to be a director of the Company 1 retired as a director on 31 December 2006 2 retired as a director on 4 May 2006 3 appointed on 10 September 2006 Remuneration report As at 31 December 2006 Michael Lester held a non-beneficial interest in 200,000 (2005 200,000) ordinary shares. The executive directors, in common with all employees of the Company, have an interest in the unallocated shares held in employee share ownership trusts. As at 31 December 2006, no (2005 702,481) such shares were held in the ESOP trust, 90,394 (2005 80,111) (91,250 as at the date of this report) shares in the Profit Sharing Scheme trust, and 152,742 (2005 103,158) (150,771) as at the date of this report) shares in the Share Incentive Plan trust. It is the Company’s policy not to seek to exercise voting rights on shares held in the employee trusts other than on the direction of the underlying beneficiaries. The interests of the two directors appointed since the year end, as at the date of approval of this report, were as follows: W P Havenstein: Ordinary shares 57,984; Options 466,586; Restricted Share Plan 25,624; and Performance Share Plan 278,788. I G King: Ordinary shares 164,066; Options 1,096,725; Restricted Share Plan 75,627; and Performance Share Plan 638,707.

www.baesystems.com 59 Corporate governance Remuneration report (continued)

Information subject to audit The Auditors are required to report on the information contained in Tables B, C, D, E and F on pages 60 to 65. The Company’s register of directors’ interests (which is open to inspection) contains full details of directors’ share interests. Details of directors’ interests in the share option schemes and long-term incentive plans are shown in Tables B, C and D. The figures in the tables that form part of this report have been calculated by reference to a mid-market price for the Company’s ordinary shares at 31 December 2006 of 425.75p (2005 381.75p). The range during 2006 was 329p to 449.75p. Table B Long-term incentive plans Restricted Share Plan 1 January Awarded during Vested during 31 December 2006 the year the year 2006 C V Geoghegan 42,764 – – 42,764 M Lester1 87,937 – – 87,937 S L Mogford –––– M H Ronald1 81,928 – – 81,928 G W Rose 33,971 – – 33,971 M J Turner 137,924 – – 137,924

1 retired as a director on 31 December 2006

No awards were granted to or vested in respect of directors who served during 2006.

Table C Directors’ Share Options Executive Share Option Plan 1 January Granted during Exercised during Lapsed during 31 December 2006 the year the year the year 2006 C V Geoghegan 1,360,721 163,843 – 113,636 1,410,928 M Lester1 1,929,878 198,890 – 284,795 1,843,973 S L Mogford 1,571,545 163,843 54,556 211,696 1,469,136

Remuneration report M H Ronald1 1,618,677 200,944 384,583 172,577 1,262,461 G W Rose 1,728,425 185,747 – 254,386 1,659,786 M J Turner 2,259,199 457,359 – 271,345 2,445,213

1 retired as a director on 31 December 2006

The BAE Systems Executive Share Option Plan has been used to grant options to the executive directors since 2001. The performance conditions applying to the grants of options made in 2001-2004 are the same as for grants to be made in 2007, as set out on page 54 of this report, with the exception of the re-testing provision: for grants made between 2001-2003, where the original three-year performance is not met, performance is re-tested at the end of years four and five against the full period from grant; for grants made in 2004, where the original performance target is not met, performance is re-tested at the end of year five against the full period from grant. In all these cases the option will lapse in year five if the targets have not been achieved. The performance conditions applying to the grants of options made in 2005 and 2006 are the same as for grants to be made in 2007, as set out on page 54 of this report; there is no re-testing of performance for grants made in 2005 and beyond.

On completion of the BAE/MES merger in 1999, options were granted to executive directors under the predecessor Executive Share Option Scheme. Options granted to Michael Lester and Mark Ronald in 1999 could only be exercised if the pre-exceptional EPS for any three-year period exceeded the sum of inflation for that period and a real growth requirement of 9% was achieved and these options vested in full in February 2006. Options granted to the other executive directors in 1999 (which partially vested in 2004) were conditional on the satisfaction of a special performance condition based on the achievement of cost savings of the merger integration process over the three year performance period commencing on 1 January 2000.

In addition, Mark Ronald has a cash-settled Stock Appreciation Right (SAR) over 115,675 ordinary shares granted on 3 May 2000 at a SAR price of £3.98, exercisable from 3 May 2003. The potential payment on exercise is the difference between the SAR price and the share price on the date of exercise. The right is exercisable until 31 December 2007 and was subject to the performance condition relating to options granted in 2000 (i.e. exercisable only if growth in pre-exceptional EPS for any three-year period over the ten-year life exceeded the sum of inflation for that period and a real growth requirement of 9%) which has been met.

A breakdown of options held by executive directors under the Executive Share Option Plan is given overleaf.

60 BAE Systems Annual Report 2006 The breakdown of the options held by executive directors under the Executive Share Option Plan is as follows: Granted Exercised Lapsed Exercise Date ofDate 1 January during the during the during the 31 December price Date of exercise from which Expiry 2006 year year year 2006 £ grant or lapse exercisable date C V Geoghegan 118,090 – – – 118,090 3.98 03.05.00 – 03.05.031 03.05.10 113,636 – – 113,636 – 3.30 23.05.01 23.02.06 23.05.04 23.05.11 89,552 – – – 89,552 3.35 03.04.02 – 03.04.052 03.04.12 119,938 – – – 119,938 3.26 22.10.02 – 22.10.052 22.10.12 351,218 – – – 351,218 1.72 30.09.03 – 30.09.061 30.09.13 315,447 – – – 315,447 2.01 30.03.04 – 30.03.071 30.03.14 252,840 – – – 252,840 2.64 24.03.05 – 24.03.083 24.03.15 – 163,843 – – 163,843 4.28 12.04.06 – 12.04.093 12.04.16 Total 1,360,721 163,843 – 113,636 1,410,928 M Lester4 223,800 – – – 223,800 4.21 20.12.99 – 20.12.021 20.12.09 284,795 – – 284,795 – 3.42 04.05.01 23.02.06 04.05.04 04.05.11 290,746 – – – 290,746 3.35 03.04.02 – 03.04.052 03.04.12 437,451 – – – 437,451 1.72 30.09.03 – 30.09.061 30.09.13 386,268 – – – 386,268 2.01 30.03.04 – 30.03.071 30.03.14 306,818 – – – 306,818 2.64 24.03.05 – 24.03.083 24.03.15 – 198,890 – – 198,890 4.28 12.04.06 – 12.04.093 12.04.16 Total 1,929,878 198,890 – 284,795 1,843,973 S L Mogford 54,556 – 54,556 – – 2.75 02.10.96 28.02.06 02.10.991 02.10.06 64,415 – – – 64,415 4.21 20.12.99 – 20.12.021 20.12.09 87,940 – – – 87,940 3.98 03.05.00 – 03.05.031 03.05.10 211,696 – – 211,696 – 3.42 04.05.01 23.02.06 04.05.04 04.05.11 233,433 – – – 233,433 3.35 03.04.02 – 03.04.052 03.04.12 351,218 – – – 351,218 1.72 30.09.03 – 30.09.061 30.09.13 315,447 – – – 315,447 2.01 30.03.04 – 30.03.071 30.03.14 252,840 – – – 252,840 2.64 24.03.05 – 24.03.083 24.03.15 – 163,843 – – 163,843 4.28 12.04.06 – 12.04.093 12.04.16 Total 1,571,545 163,843 54,556 211,696 1,469,136 M H Ronald4 159,952 – – – 159,952 4.21 20.12.99 – 20.12.021 20.12.09 172,577 – – 172,577 – 3.30 23.05.01 23.02.06 23.05.04 23.05.11 296,435 – – – 296,435 3.35 03.04.02 – 03.04.052 03.04.12 384,583 – 384,583 – – 1.72 30.09.03 21.12.06 30.09.061 30.09.13 325,632 – – – 325,632 2.01 30.03.04 – 30.03.071 30.03.14 255,531 – – – 255,531 2.64 24.03.05 – 24.03.083 24.03.15 Remuneration report 23,967 – – – 23,967 3.56 22.12.05 – 22.12.083 22.12.15 – 200,944 – – 200,944 4.28 12.04.06 – 12.04.093 12.04.16 Total 1,618,677 200,944 384,583 172,577 1,262,461 G W Rose 79,233 – – – 79,233 3.29 06.10.98 – 06.10.011 06.10.08 115,125 – – – 115,125 4.21 20.12.99 – 20.12.021 20.12.09 254,386 – – 254,386 – 3.42 04.05.01 23.02.06 04.05.04 04.05.11 259,701 – – – 259,701 3.35 03.04.02 – 03.04.052 03.04.12 390,741 – – – 390,741 1.72 30.09.03 – 30.09.061 30.09.13 345,149 – – – 345,149 2.01 30.03.04 – 30.03.071 30.03.14 284,090 – – – 284,090 2.64 24.03.05 – 24.03.083 24.03.15 – 185,747 – – 185,747 4.28 12.04.06 – 12.04.093 12.04.16 Total 1,728,425 185,747 – 254,386 1,659,786 M J Turner 122,855 – – – 122,855 4.21 20.12.99 – 20.12.021 20.12.09 271,345 – – 271,345 – 3.42 04.05.01 23.02.06 04.05.04 04.05.11 277,015 – – – 277,015 3.35 03.04.02 – 03.04.052 03.04.12 588,663 – – – 588,663 1.72 30.09.03 – 30.09.061 30.09.13 544,776 – – – 544,776 2.01 30.03.04 – 30.03.071 30.03.14 454,545 – – – 454,545 2.64 24.03.05 – 24.03.083 24.03.15 – 457,359 – – 457,359 4.28 12.04.06 – 12.04.093 12.04.16 Total 2,259,199 457,359 – 271,345 2,445,213

1 subject to a performance condition which has been met 2 lapsed February 2007 (the information above is stated as at 31 December 2006) 3 subject to a performance condition that is yet to be tested 4 retired as a director on 31 December 2006 The maximum duration for the grant of an option under the Executive Share Option Plan is ten years.

www.baesystems.com 61 Corporate governance Remuneration report (continued)

SAYE Share Option Scheme 1 January Granted during Exercised during Lapsed during 31 December 2006 the year the year the year 2006 C V Geoghegan 2,465 – 2,030 – 435 M Lester1 2,030 – 2,030 – – S L Mogford 1,212 – 1,212 – – G W Rose 435 – – – 435 M J Turner 3,529 – 2,030 – 1,499

1 retired as a director on 31 December 2006

The exercise of options under the SAYE Share Option Scheme is not subject to the satisfaction of any performance conditions.

The breakdown of the options held by executive directors under the SAYE Share Option Scheme is as follows: Granted Exercised Lapsed Exercise Date of Date 1 January during the during the during the 31 December price Date of exercise from which Expiry 2006 year year year 2006 £ grant or lapse exercisable date C V Geoghegan 2,030 – 2,030 – – 2.56 18.04.01 01.06.06 01.06.06 01.12.06 435 – – – 435 1.56 20.04.04 – 01.06.07 01.12.07 Total 2,465 – 2,030 – 435 M Lester1 2,030 – 2,030 – – 2.56 18.04.01 01.06.06 01.06.06 01.12.06 S L Mogford 1,212 – 1,212 – – 2.56 18.04.01 01.06.06 01.06.06 01.12.06 G W Rose 435 – – – 435 1.56 20.04.04 – 01.06.07 01.12.07 M J Turner 2,030 – 2,030 – – 2.56 18.04.01 01.06.06 01.06.06 01.12.06 1,499 – – – 1,499 2.56 09.04.02 – 01.06.07 01.12.07 Total 3,529 – 2,030 – 1,499

1 retired as a director on 31 December 2006 Performance Share Plan 1 January Granted during Exercised during 31 December 2006 the year the year 2006 C V Geoghegan 613,003 109,228 – 722,231

1 Remuneration report M Lester 753,691 132,593 – 886,284 S L Mogford 613,003 109,228 – 722,231 M H Ronald1 659,808 133,962 85,462 708,308 G W Rose 679,986 123,831 – 803,817 M J Turner 1,058,656 304,906 – 1,363,562

1 retired as a director on 31 December 2006

Performance conditions for the awards made in 2003-2006 are the same as for awards to be made in 2007 as set out on pages 54 and 55 of this report. A breakdown of options held by executive directors under the Performance Share Plan is given overleaf.

62 BAE Systems Annual Report 2006 The breakdown of the options held by executive directors under the Performance Share Plan is as follows: Granted Exercised Lapsed Date Date 1 January during during during 31 December Date of of exercise from which Expiry 2006 the year the year the year 2006 grant or lapse exercisable date C V Geoghegan 234,145 – – – 234,145 30.09.03 – 30.09.061 30.09.10 210,298 – – – 210,298 30.03.04 – 30.03.071 30.03.11 168,560 – – – 168,560 24.03.05 – 24.03.082 24.03.12 – 109,228 – – 109,228 12.04.06 – 12.04.092 12.04.13 Total 613,003 109,228 – – 722,231 M Lester3 291,634 – – – 291,634 30.09.03 – 30.09.061 30.09.10 257,512 – – – 257,512 30.03.04 – 30.03.071 30.03.11 204,545 – – – 204,545 24.03.05 – 24.03.082 24.03.12 – 132,593 – – 132,593 12.04.06 – 12.04.092 12.04.13 Total 753,691 132,593 – – 886,284 S L Mogford 234,145 – – – 234,145 30.09.03 – 30.09.061 30.09.10 210,298 – – – 210,298 30.03.04 – 30.03.071 30.03.11 168,560 – – – 168,560 24.03.05 – 24.03.082 24.03.12 – 109,228 – – 109,228 12.04.06 – 12.04.092 12.04.13 Total 613,003 109,228 – – 722,231 M H Ronald3 256,388 – 85,462 – 170,926 30.09.03 02.10.06 30.09.061 30.09.10 217,088 – – – 217,088 30.03.04 – 30.03.071 30.03.11 170,354 – – – 170,354 24.03.05 – 24.03.082 24.03.12 15,978 – – – 15,978 22.12.05 – 22.12.082 22.12.12 – 133,962 – – 133,962 12.04.06 – 12.04.092 12.04.13 Total 659,808 133,962 85,462 – 708,308 G W Rose 260,494 – – – 260,494 30.09.03 – 30.09.061 30.09.10 230,099 – – – 230,099 30.03.04 – 30.03.071 30.03.11 189,393 – – – 189,393 24.03.05 – 24.03.082 24.03.12 – 123,831 – – 123,831 12.04.06 – 12.04.092 12.04.13 Total 679,986 123,831 – – 803,817 M J Turner 392,442 – – – 392,442 30.09.03 – 30.09.061 30.09.10 363,184 – – – 363,184 30.03.04 – 30.03.071 30.03.11 303,030 – – – 303,030 24.03.05 – 24.03.082 24.03.12 – 304,906 – – 304,906 12.04.06 – 12.04.092 12.04.13 Total 1,058,656 304,906 – – 1,363,562

1 subject to a performance condition which has been met Remuneration report 2 subject to a performance condition which is yet to be tested 3 retired as a director on 31 December 2006

The terms and conditions of the options detailed on pages 60 to 63 were not varied during the period 1 January 2006 to 31 December 2006. The mid-market price for the Company’s ordinary shares at 31 December 2006 was 425.75p (2005 381.75p). The range during the year was 329p to 449.75p.

Table D Options exercised during 2006 Realised Unrealised gain Number of Number of gain on sold on retained Price of Market price Market price Date option Date option Date of options shares sold shares shares option on exercise at year end first would have exercise exercised on exercise £ £ £ £ £ exercisable1 lapsed C V Geoghegan 01.06.06 2,030 – – 2,588 2.56 3.835 4.2575 01.06.06 01.12.06 M Lester2 01.06.06 2,030 – – 2,588 2.56 3.835 4.2575 01.06.06 01.12.06 S L Mogford 28.02.06 54,556 35,190 53,137 29,243 2.75 4.26 4.2575 02.10.99 02.10.06 01.06.06 1,212 – – 1,545 2.56 3.835 4.2575 01.06.06 01.12.06 M H Ronald2 02.10.06 85,462 36,283 144,878 196,372 nil 3.993 4.2575 30.09.06 30.09.10 21.12.06 384,583 384,583 962,227 – 1.72 4.222 4.2575 30.09.06 30.09.13 M J Turner 01.06.06 2,030 – – 2,588 2.56 3.835 4.2575 01.06.06 01.12.06 Total 1,160,242 234,924

1 subject to performance condition 2 retired as a director on 31 December 2006

The aggregate amount of gains made by directors from the exercise of share options in 2006, as calculated at the date of exercise, was £1,395,166 (2005 £85,110).

www.baesystems.com 63 Corporate governance Remuneration report (continued)

Table E Directors’ remuneration 2006 2005 Basic Basic salary Fees Bonus Benefits Other pay Total salary Fees Bonus Benefits Total £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 Chairman R L Olver – 500 – 6 – 506 – 500 – 5 505 Executive directors C V Geoghegan 468 – 444 31 105 1,048 445 – 423 25 893 M Lester1 568 – 556 27 – 1,151 540 – 529 31 1,100 S L Mogford 468 – 463 25 – 956 445 – 441 24 910 M H Ronald1 542 – 773 31 643 1,989 495 – 744 32 1,271 G W Rose 530 – 519 27 – 1,076 500 – 495 27 1,022 M J Turner 870 – 1,305 31 196 2,402 800 – 792 46 1,638 Non-executive directors Prof S Birley –73–––73–63 – – 63 P J Carroll –70–––70–18 – – 18 Dr U Cartellieri –58–––58–53 – – 53 M J Hartnall –78–––78–73 – – 73 Lord Hesketh3 n/a n/a n/a n/a n/a n/a – 16 – – 16 Sir Peter Mason –73–––73–63 – – 63 Rt Hon M Portillo1 –17–––17–53 – – 53 R Quarta –58–––58–18 – – 18 Sir Nigel Rudd2 –15–––15n/a n/a n/a n/a n/a P A Weinberg –77–––77–34 – – 34 3,446 1,019 4,060 178 944 9,647 3,225 891 3,424 190 7,730

1 retired during or at the end of 2006 2 appointed during 2006 3 retired in 2005 Remuneration report All emoluments and compensation paid to the directors during the year are shown above. Where the individual was appointed during the year the amount shown is for the period from appointment. The other pay received by Mark Ronald, the US-based executive director, is in relation to salary in lieu of unused holiday ($185,000) and his contractual termination payment of $1m (as previously disclosed and detailed on page 57), which relates to the 2006 financial year but will be later paid in 2007 in accordance with US law. The other pay received by Chris Geoghegan and Mike Turner is in respect of a cash supplement payable from opting out of future accrual under the Company pension schemes. The benefits received by the UK-based executive directors include, where applicable, the provision of a car and the taxable benefit of any private use of a chauffeur, attendance at corporate events, support in relation to relocation/second residence and independent financial planning for pension advice. The benefit received by Dick Olver was the taxable benefit relating to the private use of a chauffeur. The benefits Mark Ronald received include a cash allowance for a car, medical examination, dental benefits, and insured life and disability benefits. The fees payable to the non-executive directors during 2006 comprised £70,000 for the chairman of the Audit Committee; a fee of £65,000 for the chairman of the Remuneration Committee, the chairman of the Corporate Responsibility Committee, and the Senior Independent Director; and a fee of £50,000 for each of the other non-executive directors. In addition, a transatlantic meeting allowance of £4,000 per meeting was paid to European-based non-executive directors attending board meetings in the US and to US-based non- executive directors attending board meetings in Europe. Sir Charles Masefield retired as a director on 28 February 2003 and remains employed by the Company on a part-time basis in an overseas representational role. In 2006 his remuneration was £316,600 (2005 £302,500) and comprised a salary and a cash allowance for a car. Sir Richard Evans retired as a director and chairman on 30 June 2004 and remains employed by the Company in a part-time customer relationship role. In 2006 his remuneration was £317,350 (2005 £303,000) and comprised salary and a cash allowance for a car. There were no other payments to former directors during the year other than the payment to Richard Lapthorne referred to in the notes to Table F on page 65.

64 BAE Systems Annual Report 2006 Table F Post-retirement benefits Change in Accrued accrued Transfer Transfer Increase in pension at Increase pension value at value at transfer value 31 December in accrued after allowing 1 January 31 December Director’s less director’s 2006 benefits for inflation 20061 2006 contributions contributions Age NRA* £ per annum £ per annum £ per annum £ £ £ £ C V Geoghegan2 52 60 246,934 5,891 (517) 2,947,733 3,381,361 10,816 422,812 S L Mogford 50 60 235,563 19,282 13,533 2,374,257 2,813,722 43,263 396,202 G W Rose3 54 60 262,985 29,651 23,448 3,243,501 3,944,663 40,762 660,400 M J Turner2 58 60 574,406 51,070 37,159 8,723,438 10,546,221 20,164 1,802,619

* Normal Retirement Age 1 Transfer values have been calculated in accordance with GN11 issued by the actuarial profession. For UK-based directors the assumptions are the same as those used in the calculation of cash equivalents from the Group’s UK pension schemes. The amount of the increase in transfer value arising from the change in assumptions is: Chris Geoghegan £61,658; Steve Mogford £39,874; George Rose £43,042; Mike Turner £53,331. 2 As a result of the changes to taxation of pensions introduced in April 2006, Mike Turner and Chris Geoghegan elected to opt out of their pension schemes and since April 2006 have been receiving a taxable salary supplement of 30% of their basic salaries. 3 George Rose’s unapproved retirement arrangement is partly funded and partly unfunded. The Company’s pension contribution to the funded unapproved retirement arrangement for George Rose in 2006 was £336,657 (2005 £569,378). Of this amount, approximately £100,507 (2005 £377,328) relates to the cost of benefits accruing during the year and approximately £236,150 relates to fully funding the unapproved arrangement for pensionable service up to 6 April 2006.

Actual pension in payment at 31 December Increase/ Transfer Transfer Change in 2006 (decrease) value at value at Change in transfer value (excluding in pension in 1 January 31 December transfer value less director’s AVC pension) payment 2006 2006 over the year contributions Age £ per annum £ per annum £ £ £ £ M Lester4 66 252,940 5,928 5,016,071 5,100,989 84,918 84,918 M H Ronald5 65 361,511 (48,502) 3,623,981 3,016,352 (607,629) (607,629)

4 Under the rules of the UK schemes, Michael Lester commenced his pension in 2002 having reached normal retirement age. There has been no further benefit accrual since retiring other than pension increases awarded to all pensioner members of the relevant pension schemes. Michael Lester retired from the Board on 31 December 2006. 5 Under the rules of his pension arrangements, the majority of Mark Ronald’s pension commenced in January 2004 when he reached normal retirement age. The pension in payment includes an accrued pension of $47,914 ($44,839 at 31 December 2005) from the BAE Systems North America Qualified Plan that commenced when he retired from the Board on 31 December 2006. The Qualified Plan is a contributory arrangement. Of the pension in payment, $406,322 is payable up to when he reaches age 72 and $253,242 has a contingent 50% spouse’s pension. Mark Ronald participated in a Section 401(k) defined contribution arrangement set up for US employees in which the Company matched employee contributions up to a limit. In 2006 the Company paid contributions of $5,293 (2005 $5,465) into Mark Ronald’s 401(k) arrangement. Mark Ronald’s pension is paid in US dollars. Of the change in pension £(50,292) is due to currency movements and £1,790 is due to increases in his accrued pension. In accordance with the plan’s standard terms the Company will match any contributions made by Mark Ronald in 2007 into his 401(k) arrangement relating to eligible earnings earned in respect of service up to 31 December 2006 up to the federal limit in each year (currently $15,000).

Richard Lapthorne, a former director, has an unfunded pension arrangement. In 2006 the Company paid Richard Lapthorne £90,078 (2005 £87,605) in respect of this arrangement. Remuneration report

www.baesystems.com 65 Corporate Governance Directors’ report

The directors of BAE Systems plc present their Office of Fair Trading undertakings Within this policy framework the treasury report, together with the financial statements, As a consequence of the merger between department’s principal responsibilities are: for the year ended 31 December 2006. British Aerospace and the former GEC- – to manage the Group’s core funding Marconi Electronics Systems businesses and liquidity; Principal activities in 1999, the Company is required to comply BAE Systems is a group delivering, through with undertakings given to the Secretary of – to manage exposure to interest rate its wholly owned subsidiaries and equity State for Trade and Industry. Compliance movements; accounted investments, a full range of with the undertakings is monitored by an products and services for air, land and naval – to manage exposure to foreign currency independent compliance officer. Further forces, as well as advanced electronics, movements; information regarding the undertakings information technology solutions and and the contact details of the compliance – to control and monitor bank credit risk customer support services. Further details officer may be obtained through the Company and credit capacity utilisation; and of the principal activities of the Group and Secretary at the Company’s registered office. likely future developments in the business – to manage the Group’s relationship with are set out in the operating and financial Corporate governance debt capital market investors, banks and review on pages 2 to 40. Disclosures on the application of the principles rating agencies. and compliance with the provisions of the Prior to the sale of its equity accounted The treasury department transacts with an UK’s Combined Code can be found on investment in Airbus on 13 October 2006 extensive range of counterparty banks and pages 44 to 47. the Group was involved in the design and financial institutions, and adopts a systematic manufacture of commercial aircraft. Treasury policy approach to the control and monitoring of The Group’s treasury activities are overseen counterparty credit risk. A credit limit is Business Review by the Treasury Review Management allocated to each counterparty with reference The information provided in the operating and Committee (TRMC). Two executive directors are to its relevant credit rating. For internal credit financial review on pages 2 to 40 reports on members of the TRMC, including the Group risk purposes, all transactions are marked-to- the activities during the year, post balance Finance Director who chairs the committee. market and the resultant exposure is sheet events and likely future developments. The TRMC also has representatives with allocated against the credit limit. The information in this review constitutes legal and taxation expertise. the business review required under the The Company, through its internal audit Companies Act and forms part of this The Group operates a centralised treasury department, monitors compliance against Directors' Report. department that is accountable to the TRMC the principal policies and guidelines for managing treasury activities in accordance (including the utilisation of credit) and any Research and development with the framework of treasury policies and exceptions found are reported to the TRMC. The Group is engaged in a significant guidelines approved by the Board. An Further disclosure on financial instruments programme of research and development overriding policy is that trading in financial is set out in note 32 to the Group accounts. in support of the platforms, systems and instruments for the purpose of profit services that it provides to its customers. generation is prohibited, with all financial Supplier payment policy Directors’ report Directors’ The programme covers a wide range of It is Group policy that each business unit is instruments being used solely for risk work and includes performance innovations, in compliance with local best practice in the management purposes. improvements to manufacturing techniques, country of operation in respect of supplier and technology to improve the through-life Other key policies are: payment policies. Agreed payment schedules support of products. A particular priority is are maintained provided that the supplier – to maintain a balance between continuity research and development into systems complies with all relevant terms and conditions. of funding and flexibility through the use integrating both platforms and other systems It is Group policy that changes to the agreed of borrowings with a range of maturities, and also the horizontal integration of payment schedule are only made with the currencies and fixed/floating rates of systems. The development and demonstration prior agreement of the supplier. interest reflecting the Group risk profile; of capabilities in networked systems, and The average number of days credit provided enabling interoperability, is an important area – to maintain adequate undrawn committed in 2006 by suppliers was 37 days (2005 of focus in both the UK and US. Long-term borrowing facilities; 38 days). research is undertaken through partnerships – to mitigate the exposure to interest rate with the academic sector and in the Company’s fluctuations on borrowings and deposits by Advanced Technology Centre and Systems utilising interest rate swaps, interest rate Engineering Innovation Centre. Application options and forward rate agreements; and of this research is managed by the Group’s business units through business focused – to hedge all material firm transactional research and development programmes. exposures as well as to manage anticipated Customers fund directly much of the near- economic cash flows over the medium term. term product development work undertaken by the Company. Note 4 to the Group accounts details the amounts spent on research and development in 2006.

66 BAE Systems Annual Report 2006 Employment At the Annual General Meeting (AGM) held Beneficial and non-beneficial interests, The Group has a programme in place to assist on 4 May 2006 the Company was given including family interests, in the share capital employees to achieve their full potential and authority to purchase up to 321,987,720 of of the Company for those persons who were to develop the skills necessary to meet the its ordinary shares. The authority will expire directors at the end of the financial year are current and future expectations of our at the AGM held in 2007. In connection with detailed on page 59. There have been no customers. The programme focuses on both the disposal of its interest in Airbus, the changes in such interests in the period from personal and technological development. All Company had stated its intention to return the year end to 21 February 2007 except employment policies include a commitment to up to £500m to ordinary shareholders by way as declared on page 59. equal opportunities regardless of sex, race, of on-market purchases of ordinary shares The Board is not aware of any contract of colour, nationality, ethnic origin, religion, age using authorities granted at the 2006 AGM significance (other than service contracts or or disability, subject only to considerations and to hold the repurchased shares initially as disclosed in the remuneration report) in of national security. The Group’s policy is in Treasury. The Company commenced this relation to the Company or its subsidiaries to provide, wherever possible, employment buyback programme on 26 October 2006 in which any director has, or has had, any opportunities for disabled people and to and, as at the date of this report, had material interest. ensure that disabled people joining the Group repurchased 41,695,000 of its ordinary and employees who become disabled whilst shares. A special resolution will be put to Directors’ indemnities in our employment benefit from training and shareholders at this year’s AGM to renew The Company has entered into deeds of career development opportunities. The Group the authority to make market purchases of indemnity with all its current directors, which has put into place a number of ways of the Company's shares up to a maximum of are qualifying third-party indemnity provisions consulting with employees and providing 10% of the share capital of the Company. for the purpose of the Companies Act 1985. them with information on the performance A similar indemnity has been provided to of the Group and other matters that affect Results and dividends Sir Richard Evans, a former director who Profit for the year was £1,639m (2005 them. The effectiveness of the communication retired from the Board on 30 June 2004 £555m). The directors propose a final dividend process is assessed regularly with the aim but remains an employee of the Company of 6.9p per ordinary share, amounting to of ensuring continual improvement so as to in a part-time customer relationship role. £224m (2005 £203m), which together with provide employees with the information they the interim dividend, amounts to a total want by the most effective means. Annual General Meeting annual dividend of 11.3p per ordinary The Company’s Annual General Meeting Employees are actively encouraged to share (2005 10.3p). will be held on 9 May 2007. The Notice of become shareholders in the Company by Annual General Meeting is enclosed with this way of employee share schemes. Charitable donations annual report and details the resolutions to During 2006, the amount donated for be proposed at the meeting. These include charitable purposes in the UK was £1m Honours special resolutions for the disapplication of In the UK, the following individuals were (2005 £1.2m). Further details of the pre-emption rights pursuant to section 89 of honoured in Her Majesty the Queen’s 2006 Company’s charitable activities are set the Companies Act 1985 and for amendments Birthday Honours and 2007 New Year out on page 40. to the Articles of Association to incorporate Honours lists: Political donations provisions concerning electronic MBE: David Armstrong No political donations were made in 2006. communications with shareholders. Philip Jones Directors Auditors Alan Smith The names of the current directors appear KPMG Audit Plc, the auditors for the on pages 42 to 43. Company, have indicated their willingness to Dr Trevor Taylor Directors’ report continue in office and a resolution proposing Bernard Waldron All of the current directors served as their re-appointment will be put to the Annual directors of the Company throughout the year General Meeting. Share capital ended 31 December 2006 with the exception As at 21 February 2007, the Company had of Sir Nigel Rudd who was appointed as a The directors who held office at the date been advised of the following significant non-executive director of the Company on of approval of this Directors’ Report confirm interests in the issued ordinary share capital 10 September 2006, Ian King who was that, so far as they are each aware, there is of the Company: appointed as a director on 1 January 2007 no relevant audit information of which the Barclays PLC: 3.98% and Walt Havenstein who was appointed as a Company’s auditors are unaware; and each Capital Group Companies, Inc.: 5.9462% director on 2 January 2007. Michael Portillo director has taken all the steps that he/she FMR Corp and served as a director during the period up to ought to have taken to make himself/herself Fidelity International Limited: 3.96% his retirement at the conclusion of the AGM aware of any relevant audit information and held on 4 May 2006. In addition, Michael to establish that the Company’s auditors Franklin Resources, Inc. Lester and Mark Ronald served as directors are aware of that information. and affiliates: 4.9246% throughout the year, and both retired as By order of the Board Legal and General Group Plc: 3.45% directors on 31 December 2006. The remuneration report is set out on David Parkes The Company’s Articles of Association contain Company Secretary provisions to the effect that no foreign pages 51 to 65. person, or foreign persons acting in concert, 21 February 2007 can have an interest in more than 15% of the Company’s issued ordinary share capital.

www.baesystems.com 67 Corporate Governance Statement of directors’ responsibilities in respect of the annual report and the financial statements

The directors are responsible for preparing The directors are responsible for keeping the Annual Report and the group and parent proper accounting records that disclose with company financial statements, in accordance reasonable accuracy at any time the financial with applicable law and regulations. position of the parent company and enable them to ensure that its financial statements Company law requires the directors to comply with the Companies Act 1985. prepare group and parent company financial They have general responsibility for taking statements for each financial year. Under such steps as are reasonably open to that law the directors are required to prepare them to safeguard the assets of the the group financial statements in accordance group and to prevent and detect fraud with International Financial Reporting and other irregularities. Standards (IFRS) as adopted by the EU and have elected to prepare the parent company Under applicable law and regulations, financial statements in accordance with UK the directors are also responsible for Accounting Standards. preparing a Directors’ Report, Directors’ Remuneration Report and Corporate The group financial statements are required Governance Statement that comply by law and IFRSs as adopted by the EU with that law and those regulations. to present fairly the financial position and performance of the group; the Companies Act 1985 provides in relation to such financial statements that references in the relevant part of that Act to financial statements giving a true and fair view are references to their achieving a fair presentation. The parent company financial statements are required by law to give a true and fair view of the state of affairs of the parent company. In preparing each of the group and parent company financial statements, the directors are required to: – select suitable accounting policies and then apply them consistently; – make judgements and estimates that responsibilities Statement of directors’ are reasonable and prudent; – for the group financial statements, state whether they have been prepared in accordance with IFRSs as adopted by the EU; – for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and – prepare the financial statements on the going concern basis unless it is inappropriate to presume that the group and the parent company will continue in business.

68 BAE Systems Annual Report 2006 Financial statements

Contents 71 Independent auditors’ report 72 Consolidated financial statements 76 Notes to the Group accounts 115 Company balance sheet 116 Notes to the Company accounts 124 Five year summary Financial statements

www.baesystems.com 69 115 121 121 119 119 119 123 122 121 123 119 118 116 121 120 120 Page Note ilities and charges 10 Loans and overdrafts overdrafts and Loans 8 Other financial assets and liabilities liabilities and assets financial Other 7

Index to accounts Index the Company sheet balance Company commitments and liabilities Contingent Creditors9 investments asset Current 5 Debtors investments asset Fixed 11 Other information for liab Provisions 13 Reserves capital Share reserve Statutory 4 Stocks 6 assets fixed Tangible 3 15 14 12 2 Accounting policies policies Accounting 1 97 83 96 84 94 91 99 81 85 98 95 76 80 73 74 72 88 96 89 85 93 84 90 96 92 71 75 110 103 109 110 113 106 105 111 104 111 114 111 124 114 Page Note in capital and reserves and reserves in capital 27 BAE Systems Annual Report 2006 Consolidatedstatement of recognised incomeand expense 70 70

Tax 8 payables other and Trade receivables other and Trade 21 16 Retirement benefit obligations obligations benefit Retirement analysis Segmental payments Share-based capital Share 22 26 3 25 Reconciliation of movement Reconciliation of movement flow cash Reconciliation of operating business transactions party Related 28 33 Other investments investments Other equipment and plant Property, 23 Provisions 12 15 Net cash/(debt) as defined by the Group Group the by defined as cash/(debt) Net costs Operating liabilities and assets financial Other income Other 29 17 4 5 Inventories 18 Inventories property Investment overdrafts and Loans 13 20 Five year summary summary year Five entities Group Intangible assets 34 11 Equity accounted investments investments accounted Equity date sheet balance the after Events costs Finance management risk Financial 35 14 32 6 Dividends 30 Dividends Earnings per share directors and Employees 7 10 Contingent liabilities and commitments commitments and liabilities Contingent 9 Disposals groups Disposal 24 19 Consolidated cash flow statement statement flow cash Consolidated statement income Consolidated Acquisition of subsidiaries of subsidiaries Acquisition policies accounting Changes in sheet balance Consolidated 2 31 Index to Index the Group accounts policies Accounting 1 Index to the accounts accounts the to Index Financial statements statements Financial Independent auditors’ report

Financial statements do not extend to any other information. inconsistencies with thefinancia become awareof any apparent misstatementsmaterial or statements. We consider the implications for our report if we and consider whether it isconsistent with the audited financial We read the other information contained in the Annual Report or its risk and control procedures. effectiveness of the group’s corporate governance procedures the on opinion an form or controls, risksand all cover control required to consider whether the board’s statements on internal Financial Services Authority, and we report ifit does not. We are not Combined Code specified for our review by the Listing Rules of the the company’s compliance with th reviewWe whetherthe Corporate Governance Statementreflects and other transactions is not disclosed. information specified by law regarding directors’ remuneration informationthe and explanationsrequirewe for our audit,if or not kept proper accounting records, if we have not received all In addition we report to you if, in our opinion, the company has section of the Directors’ Report. Financial Review that is cross referred from the Business Review includes that specific information presented in the Operating and financial statements. The information given in the Directors’ Report the with isconsistent Report the Directors’ in given information the opinion inour whether to you report also We Regulation. IAS and, as regards the group financial statements, Article 4 of the been properly have audited to be Report Remuneration Directors’ the of part the and statements thefinancial whether and view fair and atrue give We report to you our opinion as to whether the financial statements Standardson Auditing (UK and Ireland). with relevant legal and regulatory requirements and International inaccordance audited to be Report Remuneration Directors’ the of Our responsibility is to Directors’ Responsibilit Accepted Accounting Practice) are set out in the Statement of (UK Generally Standards Accounting UK and law applicable with statements and the Directors’ Remuneration Report in accordance by the EU, and for preparing the parent company financial and International Financial Reporting Standards (IFRSs) as adopted the group financial statements in accordance with applicable law The directors’ responsibilities fo Respective responsibilities we have formed. opinions the or for report, this for work, audit our for a body, as members company’s the and company the than other anyone to extent permittedlaw,by do we not accept or assumeresponsibility them in an auditors’ report and for no other purpose. To the fullest to tostate required are we matters those members company’s audit work has been undertaken so that we might state to the 235 in accordancesection with as a body, members, company’s to the solely ismade report This been audited. having as is described that Report Remuneration the Directors’ in policies set out therein.We haveaudited also theinformation financialstatements have been preparedunder the accounting of Recognised Income and Expense and the related notes. These the Consolidated Cash Flow Statement, the Consolidated Statement Statement, the Consolidated and Parent Company Balance Sheets, 31 December2006 whichcomprise (the ‘financial statements’) of BAE Systems plc for the year ended We have audited the group and parent company financial statements Independent auditors’reporttothemembersofBAESystemsplc

prepared in ac auditthe financial statements and thepart ies on page 68. of directors andauditors cordance with the Companies Act1985 with cordance of theCompanies Act 1985.Our r preparing the Annual Report and l statements.Our responsibilities e nine provisions of the2003 theConsolidated Income – – In our opinion: Opinion audited. to be Report Remuneration Directors’ the of presentation of information in the financial statements and the part of the adequacy theoverall evaluated we also our opinion forming In misstatement, whether caused by fraud or other irregularity or error. Directors’ Remuneration Report to be audited are free from material assurance that the financial statements and the part of the order to provide us with sufficient evidence to give reasonable information and explanations which we considered necessary in We planned and performed our audit so as to obtain all the and adequately disclosed. to the group’s and company’s circumstances, consistently applied statements, and of whether the accounting policies are appropriate judgements made by the directors in the preparation of the financial also includes an assessment of the significant estimates and It audited. to be Report Remuneration Directors’ the of part the theamountsto and disclosuresthe in financial statements and An audit includes examination, on a test basis, of evidence relevant on Auditing (UK and Ireland) issued by the Auditing Practices Board. We conducted our audit in accordance with International Standards opinion ofaudit Basis – – 21 February2007 London Registered Auditor Chartered Accountants KPMG AuditPlc –

the groupthe financialstatements have beenproperly preparedin ended; then the year for the group’s affairs asat 31 De accordance with IFRSs as adopted by the EU, of the state of the group financial statements give a true and fair view, in prepared inaccord Directors’ Remuneration Report to be audited have been properly the parent company financial statements and the part of the 31 December2006; Practice, of the state of the parent company’s affairs as at view, in accordance with UK Generally Accepted Accounting the parentcompany financialstatements truegive a and fair IAS Regulation; accordance with theCompanies the financial statements. the information given in the Directors’ Report is consistent with ance withtheComp cember2006 andof Act 1985 and Article 4 of the anies Act1985; and www.baesystems.com its profit 71

Financial statements 1 £m Total Total 2005 Restated 1 £m 2005 Restated 12,581

761 1,224 (1,428) 557 (37) (76) 444 111 553 (1,562) (10,579) 687 74 (204) (113) 555 2 11,019 247 555 13.9p 14.1p

3.5p 3.3p

17.4p 17.4p 809 100 909 8 (34) (77) (45) 8 (34) (77) (45)

3 £m Total Total 859 646 993 941 113 371 2006 2006 (195) (213) 19.9p 19.8p 30.8p 29.4p 50.7p 49.2p 1,054 1,636 1,639 1,639 (1,432) 13,765 12,333 (11,763) 21 21 £m (97) (35) (34) (35) (34) 127 2006 (116) (105) (105) 1,330 1,080 1,207 (1,525) 3 3 6 8 9 4 3 5 10 11 11 14 Notes investments costsexcluding finance equity accounted investments investments accounted equity ty accounted investments investments accounted ty ty accounted investments investments accounted ty BAE Systems Annual Report 2006 finance costs and taxation expense (EBITA) expense taxation costs and finance and taxation expense expense taxation and of intangible assets assets of intangible Taxation expense of equity accounted investments investments accounted of equity expense Taxation Amortisation Amortisation Impairment of equi income Financial Taxation expense of equity accounted investments investments accounted of equity expense Taxation assets, intangible of impairment and amortisation before Earnings Share ofof results equity accounted of equi income Financial Group operating profit excluding amortisation and impairment impairment amortisation and profit excluding Group operating Amortisation Impairment 72 72

1 1 restated following the sale of Airbus SAS (note 9) per share Earnings Attributable to: Attributable shareholders Systems BAE 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 Operating costs Continuing operations operations Continuing and of Group Combined sales investments accounted of equity share Less: 3 for the year ended 31 December 31 yearfor the ended Consolidated income statement statement income Consolidated Continuing operations: operations: Continuing Minority interests Minority the year Profit for UK taxation taxation Overseas Financial income income Financial expense Financial Revenue Other income share per earnings Basic

share per earnings Diluted Discontinued operations: share per earnings Basic share per earnings Diluted Total: share per earnings Basic share per earnings Diluted

Financial statements qiyoto fcnetbepeeec hrs 7 27 W G Rose Group Finance Director Chief Executive M JTurner Approved by theBoard Total equity Minority interests Total equity attributable to earnings Retained Other reserves Equity optionof convertible preference shares Share premium Issued share capital Capital andreserves Net assets Total liabilities Liabilities directly associated Loans and overdrafts Current liabilities 14 12 Trade and other payables Loans Non-current liabilities assets Total Non-current assets and disposal groups held for sale 16 Cashcash and equivalents Other financial assets Other investments tax Current Trade and other receivables including amounts due from customers for contract work Inventories Current assets tax assets Deferred Other financial assets Other receivables Other investments Equity accountedinvestments Investment property Property, plant and equipment assets Intangible Non-current assets as at31December Consolidated balancesheet eieetbnftolgtos 2 22 liabilitiesOther financial Trade and other payables liabilitiesOther financial Retirement benefit obligations Current tax tax Current Deferred taxliabilities Provisions Provisions

on 21February 2007 and sign equity holdersofthe parent with non-currentassets anddisposalgroups heldsale for ed onits behalf by: 5 7 25, 27 Notes 21 20 19 17 15 18 17 16 15 13 11 27 27 27 27 19 20 17 21 17 23 23 3 8 3 8

(14,013) 18,147 11,843 (2,776) (1,211) (7,942) (6,717) (2,499) (7,942) (6,071) 3,100 2,253 1,077 1,746 7,595 4,330 6,304 6,304 4,134 4,117 4,134 www.baesystems.com (465) (334) (417) (424) (271) 2006 503 395 569 671 123 841 (50) (45) (15) £m 50 51 11 17 76 81 3 – –

(17,431) 20,235 14,177 (2,872) (8,921) (3,534) (7,006) (4,101) (8,651) (8,510) 4,720 2,581 1,877 1,331 1,721 1,704 8,217 2,804 2,788 2,804 6,058 5,651 (270) (905) (432) (316) (343) (375) 2005 782 634 485 912 218 407 (81) (45) (23) 16 78 80 54 20 65 £m 9 73

Financial statements 1 – – – – 1 2 4 8 2 (4) 99 88 30 54 30 45 54 16 99 £m (31) (90) (27) (89) (17) (17) (12) (17) (43) (21) (98) 373 872 444 111 555 114 460 207 524 128 125 872 596 (213) (213) (318) (315) (357) 2005 2,491 2,491 1,842 1,650 2,581 2,099 1,005 (2,262) (1,566) Restated

– – 1 2 (9) (5) (4) 53 66 28 21 47 £m (26) (85) (12) (45) (11) (27) (40) (12) (60) (84) (13) (20) 367 592 139 646 993 217 145 135 174 174 193 422 557 495 778 2006 2006 (315) (419) (112) (183) (468) (346) (187) (921) (925) (834) 3,074 3,074 2,491 3,100 1,639 1,212 1,562 (1,337)

30 Notes Notes discontinued operations) discontinued £88m (2005 £64m) from from £64m) £88m (2005 d operations) ludes £70m (2005 £139m) from from (2005 £139m) ludes £70m vestments (including vestments (including £1m) from discontinue me £2m (2005 expense £3m) from from expense £3m) (2005 me £2m rement benefit benefit obligations rement accounted investments (inc accounted investments equity accounted in BAE Systems Annual Report 2006 discontinued operations) operations) discontinued discontinued operations) operations) discontinued Cash and cash equivalents at December 31 Cash and cash equivalents at December 31 Net cash inflow from operating activities activities from operating Net cash inflow 74 74 Comprising: Comprising: equivalents and cash Cash Overdrafts 1 restated following the sale of Airbus SAS (note 9) Cash and cash equivalents at 1 January January at 1 equivalents and cash Cash equivalents cash and cash on changes rate exchange foreign of Effect Netcash increase and in cash equivalents Capital element of finance lease rental payments payments rental lease finance of element Capital capital share of issue from Proceeds shares treasury of Purchase 27 27 Purchase of subsidiary undertakings undertakings of subsidiary Purchase 31 Dividends received from Dividends received Interest received equipment and plant property, of Purchases Interest paid payments rental lease finance of element Interest paid Taxation Taxation expense (includes £4m (2005 (2005 Taxation expense (includes £4m equity of Share of results Profit for the year the year Profit for operations Continuing operations Discontinued for the year ended 31 December 31 yearfor the ended Consolidated cash flow statement statement flow cash Consolidated Purchaseof own sharesESOP by 27 Cash and cash equivalents disposed of with subsidiary undertakings undertakings subsidiary of with disposed equivalents and cash Cash Net cashacquired with subsidiary undertakings Purchaseof equity accounted investments Proceedsfrom sale of subsidiary undertakings Proceeds from sale of investment property property investment of sale from Proceeds investments other non-current of sale from Proceeds investments other non-current of Purchase 15 Capital expenditure on investment property property investment on expenditure Capital Purchases of intangible assets equipment and plant property, of sale from Proceeds Depreciation, amortisation and impairment impairment and amortisation Depreciation, (Gain)/lossdisposal on property, of plant and equipment 4,5 Net finance costs (includes inco (includes costs finance Net Equity dividends paid Net cash inflow/(outflow) from investing activities activities investing from Net cash inflow/(outflow) Proceeds from sale of equity accounted investments investments accounted equity of sale from Proceeds Proceeds from sale of Exchange Property deposits/securities other of (purchase)/sale from proceeds Net 9 15 payables other and Trade activities operating from inflow Cash (Gain)/loss on disposal of business – continuing operations operations – continuing business of disposal on (Gain)/loss 4,5 Gain on disposal of investment property property investment of disposal on Gain 5 Cash inflow from loans loans from inflow Cash Cash outflow from repayment of loans Dividends paid on preference shares shares on preference paid Dividends receivables other and Trade Decrease/(increase) in working capital: Inventories (Gain)/lossdisposal on business of discontinued – operations 9 Net cash (outflow)/inflow from financing activities Movements in provisions Movements for reti liabilities in Decrease Impairment of other investments investments other of Impairment schemes share employee equity-settled of Cost 15

Financial statements ended for theyear 31December Consolidated statementofrecognisedincomeandexpense eyln fcmltv urnytasaino ipsl 9 recogn Net income/(expense) Recyclingcumulative of net hedgingreserve disposal on – discontinued operations Discontinued operations Continuing operations Recycling of cumulative currency translation on disposal: Eut cone netet 8 14 Minority interests Equity shareholders Attributable to: ofAdoption IAS 39 32 andIAS Total recognised income and expense Profit for theyear Equity accounted Subsidiaries investments to equity: directly taken tax on items Deferred Current tax on items taken directly to equity Equity accounted Subsidiaries investments Actuarial gains/(losses) on defined benefit pension schemes: Amounts credited/(charged) to hedging reserve Equity accounted Subsidiaries investments Currency translation on foreign currency net investments:

ised directlyinequity Notes 9 8

1,704 1,701 1,704 1,639 1,704 www.baesystems.com (448) (227) (162) 2006 692 221 (92) (26) £m 65 11 21 72 3 3 –

(916) (361) (363) (361) (652) (688) 2005 276 555 193 422 (72) (23) 53 61 £m (3) 2 – – – 75

Financial statements r the purpose of r the purpose of transition to of transition to ed at ed UK GAAP the previous at An impairment loss in respect of respect An impairment loss in ount of goodwill relating to the to the relating of goodwill ount pairment and carried at cost less less at cost carried and pairment rves under UK GAAP prior to 1998 1998 GAAP prior to rves under UK nerating units nerating units fo of subsidiaries is included in intangible intangible in included is of subsidiaries sitions before the date sitions loss in respect of an equity investment classified as available for for available as classified investment equity an of respect in loss in loss impairment An loss. or profit through reversed not is sale not reversed. is respect of goodwill estimate the in a change been has there if is reversed assets other is loss impairment An amount. recoverable the determine to used does amount carrying asset’s the that extent the to only reversed determined, been have would that amount carrying the exceed not had loss impairment no if amortisation, or depreciation of net recognised. been appropriate due to the long-term nature of the defence industry. industry. defence the of nature long-term the to due appropriate the discounting in used been has 8.11% of rate discount pre-tax A flows. cash pre-tax projected cash independent largely generate not does that asset an For cash- the for is determined amount recoverable the inflows, belongs. asset the which to unit generating goodwill, than other assets, of respect in loss impairment An increase subsequent the if reversed is cost amortised at carried event an to objectively related be can amount in recoverable occurring after impairment the loss was recognised.An impairment If any such indication exists, the asset’s recoverable amount is is amount recoverable asset’s the exists, indication such any If estimated. For intangible assets that areyet not available use, for balance each at estimated is amount recoverable the goodwill, and sheet date. of amount carrying the whenever recognised is loss impairment An amount. recoverable its exceeds unit cash-generating its or asset an statement. income the in recognised are losses Impairment is cost amortised at carried assets of amount recoverable The flows, cash future estimated of value present the as calculated with Receivables rates. discount pre-tax appropriate at discounted discounted. not are duration a short-term fair their of greater the is assets other of amount recoverable The use, in value assessing In use. in value and sell to cost less value present their to discounted are flows cash future estimated the rate. discount pre-tax appropriate an using value Group’s the on based projections flow cash use calculations These on based value a terminal include and Plan Business Integrated considered is This plan. that of year final the for projections the IFRS (1 January 2004) has IFRS (1 been January retain would that assets intangible to related amounts any as amounts, 38 IAS applied had it if entity acquired the in recorded been have IntangibleAssets at thewas date acquired it by the Group were that at impairment for tested being after immaterial, considered written off to rese Goodwill date. any determining in included not is and reinstated been not has disposal. on loss or profit subsequent Impairment each at reviewed are assets Group’s of the amounts The carrying of indication is any there whether determine to date sheet balance 36). (IAS Assets of Impairment 36 IAS by required as impairment resulting from the transactionrecorded is in income the statement investment. the against is eliminated gain unrealised any while Goodwill Goodwill on acquisitions assets. Goodwillacquisitions on of joint ventures and associates investments. accounted equity of value carrying the in is included for im annually tested Goodwill is disposal the on losses and Gains losses. impairment accumulated am the carrying entity include of an sold. entity to cash-ge allocated Goodwill is testing. impairment on acqui Goodwill arising (including derivative (including rounded to the nearest million. nearest million. to the rounded of such subsidiaries are included included are subsidiaries of such the acquisition. Identifiable assets ingent liabilities assumed in a in assumed ingent liabilities ed otherwise, d financial liabilities d financial liabilities BAE Systems Annual Report 2006 Accounting policies policies Accounting

76 76 sterling and, unless stat and, unless sterling Reporting Interpretations Committee interpretations (IFRICs) reporting companies to 1985 applicable Act Companies and the IFRS. under The consolidatedfinancial statementsare presented in pounds Basis of preparation have plc Systems BAE of statements financial consolidated The International endorsed EU with accordance been in prepared Financial International (IFRS), Standards Financial Reporting consolidated financial statements are set out below. These policies policies These below. out set are statements financial consolidated unless presented, years all the to applied consistently been have stated. otherwise 1. these of preparation the in applied policies accounting principal The Notes to the Group accounts accounts Group the to Notes in the business contributed by other parties to the transaction are are transaction the to parties other by contributed business in the those to applied are values Fair acquisition. an as for accounted not have which and exchange the to subject are which operations gain realised or loss Any Group. the within held been previously such transactions are recorded so that the reduction in ownership ownership in reduction the so that recorded are transactions such disposal a as for accounted is contributed being business the of while the increased interest in the enlargedGroup ornew interest income statement includes its share of theirprofit and lossesand assets. net their of share its includes sheet balance Group’s the non-monetary other or business, a contributes Group the Where associate, or venture joint subsidiary, a in interest an for assets over its operating and financial policies. An entity is regarded as an an as is regarded entity An policies. financial and operating its over over control, not but influence, significant has Group the if associate associates and ventures Joint policies. financial and its operating Group’s the where method equity the under for accounted are in the consolidated income statement from the date of acquisition, acquisition, of date the from statement income consolidated in the disposal. of date up to the An entity is regardeda joint as ventureGroup if the has joint control business combination are measured initially at their fair values at at values fair their at initially measured are combination business the over acquisition of cost the of excess The date. acquisition the fair value ofGroup’s the shareof the identifiable net assets acquired results The goodwill. as is recorded is measured as the fair value of the assets given, equity instruments instruments equity given, assets the of fair value the as is measured exchange, of date the at assumed or incurred liabilities and issued directlyplus costs attributable to and cont acquired and liabilities finance payments on certain regional aircraft sold. sold. aircraft regional certain on payments finance The purchase methodof accounting is used to account for the acquisition the of cost The Group. the by subsidiaries of acquisition to govern the financial and operating policies of the entity so as to to so as entity the of policies operating and financial the to govern special the include Subsidiaries activities. its from benefits obtain provision the for through transacted Group the that entities purpose and lease head and values residual of respect in guarantees of ventures’ and associates’ results accounted for under the equity equity the under for accounted results associates’ and ventures’ method, all ofwhich are preparedDecember. to 31 power is the Control Group. the by controlled entity an is subsidiary A Basis of consolidation the of results the consolidate Group the of statements financial The joint its of share its include and entities, subsidiary its and Company judgements. An analysis and explanation of the critical accounting accounting critical of the explanation and analysis An judgements. financial of set this producing in used judgements and estimates on Review Financial and Operating the in made is statements 30. and 29 pages and financial assets an assets and financial loss. or profit through value fair at instruments) IFRS with conformity in statements financial of preparation The and estimates accounting critical certain of use the requires They have been prepared under the historical cost convention, as as convention, cost historical the under prepared been have They assets financial available-for-sale of revaluation the by modified

Financial statements on its own behalf or on behalf of customers. customers. of behalf or on behalf itsown on The Group undertakes research and development activities either development and Research on sale. recognised in the income statement as part of the profit or loss exchange differences recogn cumulative the is sold, operation aforeign When component. Januaryin IFRS (1 2004)arepresented Translation differences that arose before the transition date to of equity. of such investments are recognised directly in a separate component borrowingsand other financialinstruments designated ashedges including exchange differences arising from the translation of of exchange during the year. All resulting exchange differences statementssuch of entities are translated at averagerates at the exchange rate ruling at the balance sheet date. Income translated are associates and ventures joint entities, subsidiary consolidationFor purposesthe assetsliabilities and overseas of of equity. the effective portion is recognised directly in a separate component unless they qualify for hedge accounting treatment, in which case differences are recognised in the consolidated income statement exchange rates ruling at the balance sheet date. These exchange liabilities denominatedin foreign and assets Monetary the transactions. of the dates at ruling rates Transactions in foreign currencies are translated at the exchange Foreign currencies in revenue on a straight-line basis. Rental income from aircraft operating leases is recognised income Lease length basis. intercompanytrading are generallydetermined onan arm’s Profit isrecognised at the time of sale. Sales and profits on and revenue and costs can be reliably measured. tothe buyer transferred been have ownership of rewards risks and contract are recognised in the income statement when the significant Salesgoods of the and provisionservices of notunderlong-term a Goods sold and services rendered as anexpense. total contract revenue, the expected loss is recognised immediately contract. Whenit is probable that arrived at byreferenc is contract along-term of completion tothe stage of attributable performance milestones yet to be achieved. The amount of profit making suitable allowances for technical and other risks related to after costs forecast and revenue contract of estimates reliable to contract can be reliably estimated. Profit is calculated by reference No profit is recognised on contracts until the outcome of the the customer. contractdevelopment or hasbeen completed andaccepted by titlepasses or aseparately identifiable phase (milestone)of a consideration in exchange for its performance. This is usually when the outcome of a long-term contract and has obtained the right to Sales are recognised as soon as the Group can reliably estimate Long-term contracts ventures and associates. subsidiary undertakings, excludingthe Group’s sharesales ofjoint of associates. Revenue represents sales made by the Company and its includeSales the Group’s net shareof sales ofventures joint and profitrecognition and Revenue 1. Accounting policies (continued)

e tothe estimated over ised since 1 January2004 are currencies areretranslated at the totalcontract costs will exceed equitybutnotas a separate all profitability ofthe programmes for sale is recognised as an expense as incurred. associated with enhancing or maintaining computer software amortisation and impairment losses. Group funded expenditure development expenditure is stated at cost less accumulated year, are recognised as intangible assets. Capitalised software probably generate economic benefits exceeding costs beyond one and unique software pro Costs that are directly associated with the production of identifiable to acquire and bring to use the specific software. capitalised as an intangible asset on the basis of the costs incurred are Group the within for use licences software computer Acquired Other intangible assets the Group’srevenue recognition policy above. customers, the revenue arising is recognised in accordance with for is performed activity development and research the Where the product. development expenditure is amortised over the expected life of less accumulated amortisation and impairment losses. Capitalised overheads. Capitalised development expenditure is stated at cost capitalised includes the cost of materials, direct labour and related intangible asset if certain conditions are met. The expenditure products and processes,capitalisedis asaninternally generated plan or design for the production of new or substantially improved Group fundedexpenditure on development activities appliedtoa statement. income tothe charged and incurred Group funded expenditure on research activities is written off as curdcmue otaelcne 2to 5 years Acquired computer software licences follows: lives as are useful estimated The basis overthe estimateduseful livesthe ofintangible assets. Amortisation is charged to the income statement on a straight-line lives. useful estimated their over Intangible assets arising from a business combination are amortised accumulated amortisationand impairmentlosses. andlicences havedefinite usefullives and are carriedcost at less Trademarks and licences are stated at historical cost. Trademarks icat up to 15 years, or the lease 10to 15 years, or the project of depreciation thanwouldotherwise arise ona straight-line basis. rate faster a for provides this Typically contracts. US government provided onabasis consistent withreimbursement cost profiles under In the Group’s North American businesses,depreciation isnormally up to 50 years, or the lease Other equipment 8years Aircraft works equipment life short and vehicles motor Computing equipment, Research equipment Buildings following rates: up to 10 years estimated useful lives to any estimated residual value, using the write off the cost of property, plant and equipment over their Depreciation is provided, normally on a straight-line basis, to up to 20 years an appropriate proportion of production overheads. constructed assets includes the cost of materials, direct labour and accumulated depreciation and impairment losses. The cost of self- Items of property, plant and equipment are stated at cost less Property, plantandequipment 2to 5 years Other intangibles Trademarks and licences Capitalised software development ducts controlled by the life ifshorter if shorter term 3 to 5 years if shorter term www.baesystems.com Group, andthat will 77

Financial statements

inventories are not capitalised. not capitalised. are inventories Cash and cash equivalents deposits call hand, in cash includes equivalents cash and Cash of maturities original with investments liquid short-term other and risk insignificant an to subject are which and less or months three of change in value. For the purpose of the cashflow statement, are that overdrafts bank includes also equivalents cash and cash demand. on repayable sale for held groups disposal and assets Non-current classified held are as assets and disposal groups assets Non-current less value and fair amount of carrying lower the at sale and stated for principally be recovered is to sell amount to carrying if their costs continuing use. through rather than a sale transaction through highly is sale the when only as met regarded is condition This the from year a within completed be to expected and probable be to is group) disposal (or asset the addition, In classification. actively is and condition present its in sale immediate for available current its to relation in reasonable is that price a at marketed being value. fair and overdrafts Loans less value, fair at initially recognised are overdrafts and Loans attributable transaction Subsequent costs. to initial recognition, where fair value or cost at amortised stated are overdrafts and loans between difference any with adopted, been has accounting hedge statement income the in recognised being value redemption and cost basis. interest effective an on borrowings the of period the over costs Borrowing construction or acquisition the with connection in costs Borrowing and property investment equipment, and plant property, of items of The fair values of quoted investments are based on bid prices at the the at prices bid on based are investments quoted of values fair The date. sheet balance receivables Trade and other less cost amortised their at stated are receivables other and Trade losses. impairment Amounts due from customersfor contract work include long-term contractbalances attributable less progress payments. any for provision less cost at stated are balances contract Long-term made are losses any for provisions Appropriate losses. anticipated foreseen. first are they which in year in the in customers from received amounts are payments Progress in payments specify which contracts of terms the with accordance against payments, progress as are credited, and delivery of advance unexpended Any contract. particular the for incurred expenditure any other and trade in held is payments progress of respect in balance subject are amounts the if or, payments stage customer as payables performance, company to unrelated guarantees payment advance to account. customers’ on received as cash as debt net from excluded is account customers’ on received Cash Group. the by defined Inventories all relevant including cost, of lower the at stated are Inventories value. realisable net and expenditure, overhead (continued) BAE SYSTEMS Annual Report 2006 ventures and associates and term deposits. They are held at fair fair at held are They deposits. term and associates and ventures management unless assets non-current in included and value the of months 12 within investment the of dispose to intends date. sheet balance management has the positive intention and ability to hold to to hold to ability and intention positive the has management investments any hold not did Group the year, the During maturity. in this category; joint in interests than other investments available-for-sale: management intends to dispose of the investment within within investment the of dispose to intends management date; sheet balance the of 12 months held to maturity: non-derivativefinancial assetswith fixed or Group’s the that maturities fixed and payments determinable amortised cost using the effective interest method; method; interest effective the using cost amortised for held instruments financial loss: or profit through value fair at They recognition. initial on management by designated or trading unless assets non-current in and included value at fair held are loans and receivables: term deposits, principally comprising funds funds comprising principally deposits, term receivables: and loans at carried are institutions financial other and banks with held 78 78 available-for-sale are sold or impaired, the accumulated fair value fair value accumulated the or impaired, sold are available-for-sale and gains as statement income the in included are adjustments costs. finance within securities investment from losses profit or loss are included in finance costs in the income statement statement income the in costs finance in included are loss or profit arising losses or gains Unrealised arise. they which in period in the available- as classified investments of value fair the in changes from as classified investments When equity. in recognised are for-sale of ownership. ownership. of in changes from arising losses and gains unrealised and Realised through value fair at as classified investments the of value fair the financial assets not carried at fair value through profit or loss. or loss. profit through value fair at not carried assets financial Investmentsare derecognised when the rights to receive cash transferred been have or expired have investments the from flows rewards and risks all substantially transferred has Group the and Purchases and sales of investments are recognised at the date on on date the at recognised are investments of sales and Purchases Investments asset. the sell or purchase to commits Group the which all for costs transaction plus value fair at recognised initially are (d) (c) (b) investments as follows: as follows: investments (a) Other investments TheGroup determines the classificationofother its investments the which for purpose the on depending recognition initial at other its classifies Group The acquired. were investments of up to 50 years. years. 50 to up of and reviewed, are lives useful and values residual assets’ The date. sheet balance each at if appropriate, adjusted impairment losses. losses. impairment write to basis, straight-line a on normally provided, is Depreciation life useful estimated its over property investment of cost the off Investment property Investment are entities non-group to leased are that buildings and Land investment measures Group The property. investment as classified accumulated and depreciation accumulated less cost its at property fair value and the present value of the minimum lease payments payments lease minimum the of value present the and value fair and depreciation accumulated less lease, the of inception at losses. impairment accounting principle. principle. accounting plant property, in included are leases finance under obtained Assets of the lower to the equal amount an at and stated equipment and course of construction. of construction. course The assets’ residual values, useful lives and depreciation methods sheet balance each at appropriate, if adjusted and reviewed, are component the reflect lives useful applicable, Where date. 1. Accounting policies (continued) policies (continued) Accounting 1. the in assets and land freehold on is provided depreciation No

Notes to the Group accounts accounts Group the to Notes

Financial statements statement for the period. do not qualify for hedge accounting are recognised in the income the period. Gains and losses on derivative financial instruments that derivative instrument, are recognised in the income statement for value ofthe underlying asset or li the fair in changes hedge, value as a fair isdesignated instrument income statement immediately. Where a derivative financial the of fairvalue inthe change transaction affects profit or loss. The ineffective portion of any underlying the when statement income the in recognised and reserves from recycled are reserves in recognised Amounts reserves. the ins of fairvalue inthe change forecasttransaction (incomeor expense), the effective portion of any recognisedassociated witha asset instrument is designatedas a hedg financial aderivative Where date. sheet balance the at value Subsequent toinitial recognition, su ar instruments financial Derivative as trading instruments. derivatives that do not qualify for hedge accounting are accounted for derivative financialinstruments fortrading purposes. However, In accordance withtreasuryits policy,the Group does nothold accounting can be achieved. exposures and those interest rate exposures where hedge treatment for all derivatives that hedge material foreign currency forward time horizon. The Group aims to achieve hedge accounting the proportion of fixed rate debt relative to floating rate debt over the to interest rate fluctuations on its borrowings and deposits by varying interest rate derivative instruments to manage the Group’s exposure cash flow exposures over the medium term. The Group also uses transactional exposures as well as to manage anticipated economic currency fluctuations, the Group’s policy is to hedge all material firm volatility in currency exch to itisexposed means business Group’s the of nature global The Financial instruments into account the effective yield on the asset. income is recognised in the income residual value, is recorded as long-term financial assets. Interest to be received from the lessee plus any discounted unguaranteed lease receivable, representing the discounted future lease payments the balance sheet after the inception of the lease. Instead, a finance in recognised to be cease leases finance under out leased Assets revenue on a straight-line basis. and accumulated impairment losses. Rental income is recognised in property, plant and equipment at cost less accumulated depreciation Assets held for leasing out under operating leases are included in lease term. recognised in the income statement on a straight-line basis over the Payments, including any incentives, made under operating leases are constant charge on the outstanding obligation. the outstanding obligation for future instalments, so as to give a included in finance costs, and the capital element, which reduces paymentsare apportioned betweenthe finance element,whichis such leases, net of financing costs, are included within loans. Rental under Future instalments istheshorter. whichever term, lease the and equipment at cost and are depreciated over their useful lives, or Assets obtained under finance leases are included in property, plant Leases Trade and other payables are stated at their cost. andother payables Trade 1. Accounting policies(continued)

ange rates. Inorderto instrument is recognised in the inthe isrecognised instrument ability, and gains and losses onthe trument is recognised directly in in directly isrecognised trument e recognised initially atcost. e of thevariability incashflows statement as it accrues, taking or liability,a ch instruments are stated at fair protect itself against highly probable extent thatitis the asset can be utilised. Deferred probable that future taxable profits will be available against which it is that the extent to only isrecognised tax asset A deferred enacted at the balance sheet date. of assets andliabilities, using ta expected manner of realisation or settlement of the carrying amount future. The amount of deferred tax provided is based on the to theextentthatthey will prob taxable profit, and differences relating to investments in subsidiaries recognition of assets orliabilities goodwillprovided for: notdeducti for taxation purposes. The following temporary differences are not reportingliabilities forfinancial temporary differences between the carrying amounts of assets and Deferred taxis provided in full respect ofprevious in years. taxto payable date, andanyadjustment sheet the at enactedbalance rates substantively or enacted year, using the for income taxable onthe expectedthe tax tax payable is Current in equity, in which case it is recognised in equity. except to the extent that it relates to items recognised directly statement income inthe tax isrecognised Income tax. deferred and current comprises the year or loss for the tax profit on Income Tax been completed, and as liabilitycompleted, andas been pr of work in progress for that portion of the work which has already contract revenues. Such provisions are recorded as write downs total will exceed costs contract estimated total that probable Provisions for losses on contracts are recorded when it becomes the unavoidable cost of meeting its obligations under the contract. benefits to be derived by the Group from a contract are lower than A provision for onerous contracts is recognised when the expected announced.Future operatingcostsare not provided for. restructuringthe has either commenced or has beenpublicly has approved a detailed and formal restructuring plan, and A provision forrestructuring is associated probabilities. data and a weighting of all possible outcomes against their and services are sold. The provision is based on historical warranty A provision for warranties is recognised when the underlying products expected future cash flows at an appropriate pre-tax discount rate. Additional income taxes that arise from the distribution of be realised. the effect is material, provisions are determined by discounting the settle the obligation and the amount has been reliably estimated. If it is probable that an outflow of economic benefits will be required to a presentlegal constructive or obligationresultas a of apast event, A provision is recognised in the balance sheet when the Group has Provisions pay the related dividend. the recognised at dividends are are recognised as an expense in the income statement as incurred. Obligations for contributions to defined contribution pension plans both defined benefit and defined contribution plans. Group companies operate various pension plans. The Group has Pension obligations benefits: Employee contracts and are updatedregularly. of completion results on of estimated basis the on determined are no longer probab no recognised when the Group Group the when recognised , using the liability method, on ably not reverse intheforeseeable purposes and thepurposes and same time as theliability to x rates enacted or substantively le thatthe relatedtax benefit will ble for tax purposes,theinitial that affectneitheraccountingnor ovisions forthe tax assets arereducedto the www.baesystems.com amounts used amounts used remainder. Losses 79

Financial statements

balance sheet. introduces new January 2006) in the ive for 2009). This requires This ive for 2009). have any significant impact impact significant any have existing standards that are not are that standards existing r periods but r have not been periods but rticipating in a specific market – market a specific in rticipating e statement or income balance statement or the Group has adopted IFRIC 4, 4, IFRIC adopted the Group has l Rehabilitation Funds; and Funds; Rehabilitation l for 2007). This concerned with disclosure only and only with disclosure concerned which they are declared. are declared. they which nning on or after 1 or after 1 on nning

Changes in accounting policies policies accounting in Changes

IFRICApplying 7, the restatement approach under IAS 29, IFRIC 8, derivatives embedded of Reassessment 9, IFRIC 2, IFRS of Scope all are impairment, and reporting financial Interim 10, IFRIC and significant any have to expected not are They 2007. for effective accounts. Group’s the on impact and transactions share treasury and Group 2, IFRS IFRIC 11, effective both are arrangements, concession Service IFRIC 12, for expected are not They 2008. to on the Group’saccounts. IFRIC 6, Liabilities arising from pa IFRIC 6, Liabilities equipment. electronic and electrical Waste – statements financial of Presentation 1, IAS to Amendment (effective disclosures capital no have will such as and disclosures capital for requirements sheet. balance or statement income consolidated the on impact 2007). This for (effective IFRS Disclosures 7, Financial Instruments: and as such financial instruments for new disclosures introduces will have no impact on the income Operating Segments (effect IFRS 8, the reporting to approach’ ‘management the adopt entities that impact The segments. operating its of performance financial recent the of light in review under is accounts Group’s the on January 1 from structure group revised the about announcements 2007, but the standard is no on impact th will have as such sheet. IFRS 6, Exploration for and Evaluation of Mineral Resources; Resources; Mineral of Evaluation and for Exploration IFRS 6, RightsIFRIC 5, to Interests arisingfromDecommissioning, and Environmenta Restoration Amendment to IAS 19,Employee BenefitsActuarial – gains and disclosure; and plans group losses, Amendment to IASEffects 21,The of Changes in ForeignExchange Rates; Amendment to IAS 39,Cashflow hedge accountingforecast for intra-group transactions; and and Recognition instruments: Financial 39, IAS to Amendment option. fair value the – Measurement

None of thesehaveany significant impact on the Group’saccounts. to and interpretations New standards by the Group early adopted have not been yet effective and to interpretations and amendments standards, following The Group’s the to relevant are published, been have standards existing period accounting Group’s the for mandatory are and operations on 1 January beginning 2007 or late early adopted by the Group: on or after 1 January 2006: 1 January 2006: after on or 2. 2006 1 January With effect from However a Lease. contains Arrangement an whether Determining Group. the on impact significant a have not does interpretation the 2006 effective in published standards Amendments to for (effective amendments following the adopted early The Group begi periods accounting 2005: December ended 31 year for the statements financial effective in 2006 and interpretations amendments Standards, to interpretations and amendments standards, following The beginning periods accounting for effective are standards published Dividends thereon are recognised in the income statement as as statement income the in recognised are thereon Dividends costs. finance Dividends as recognised are capital share ordinary on dividends Equity period in in the a liability – – – – – – – – – – – – (continued) ng shares at ng the preference e vesting period. e vesting hare at 31 December hare at 31 ettled options ettled of Association em any outstandi based on these fair values, on these fair values, based arrears and accruals of dividends. arrears and accruals of 1 July 2007, the option to convert convert option to the 1 July 2007, option will be transferred to the completion of completion th ility are recognised in the income in the income ility are recognised and all cash-s on the basis of ordinary 0.47904 r every preference s granted after 7 November 2002 that were were 2002 that November after 7 granted BAE SYSTEMS Annual Report 2006 80 80 into ordinary shares is extinguished, and accordingly the remaining remaining the accordingly and extinguished, is shares ordinary into on the equity conversion balance reserve. earnings retained value, based on the date of original issue of the preference shares. shares. preference the of issue original of date the on based value, the shares, ordinary into share preference a of conversion On attributableamountof the equity component is reclassifiedshare to premium. From and share capital cost basis until extinguished on conversion or maturity of the of the or maturity conversion on extinguished until basis cost shares. preference fair historic its at presented is option conversion equity The a compound financial instrument and accordingly, have been split split been have accordingly, and instrument financial a compound and loans within classified instrument, debt underlying an into equity. within classified option, conversion equity an and overdrafts, amortised an on presented is instrument debt underlying The 1 January 2010, the Group may rede 1 January 2010, the Group may with any 100p per share, together considered are shares preference the 32 IAS with accordance In 0.47554 ordinary shares fo with 2006. the Articles accordance In share of result a as further adjusted be will rate conversion share to 2007 July 2006. From 1 December 31 after made repurchases ordinary shares of 2.5p each at the option of the holder on on 31 May holder of the option the at each of 2.5p shares ordinary of the years up to 2007, any in share the of a result As share. preference every for shares to decreased has rate conversion the 2006, during repurchases Preference share capital redeemable cumulative (net) 7.75p issue in has Group The Group’s the into convertible are that each 25p of shares preference and taking into account the estimated number of the options that that options the of number estimated the account into taking and vest and the relative actually will liab value of this the Changes in year. the for statement Cash-settled share options are measured at fair value at the balance balance the at value fair at measured are options share Cash-settled recognises Group The model. pricing option an using date sheet date sheet balance at the a liability at fair value at the date of grant using an option pricing model. model. pricing option an using grant of date the at value fair at Thefair value is expensedstraight-lineon a basis over the vesting that shares of number the of estimate Group’s the on based period, will actually vest. unvested as of 1 January 2005 of unvested as date. sheet balance the at outstanding measured are options share equity-settled 26, note in explained As The Group issues equity-settled and cash-settled share options to to options share cash-settled and equity-settled issues Group The employees.accordance In with the requirements of IFRS 2 Share- equity- all 2 to IFRS applied has Group the 2), (IFRS Payments based settled share options Long-term service benefits: benefits: service Long-term benefits compensation equity-related and Equity The retirement benefit obligations recognised in the balance sheet sheet balance the in recognised obligations benefit retirement The as obligations benefit defined the of value present the represents the by reduced as and cost service past unrecognised for adjusted fair valuescheme of assets. of recognised income and expense. Past service cost is recognised is recognised cost service Past expense. and income recognised of or vested, already are benefits the extent the to immediately average the over basis a straight-line on amortised is otherwise vested. become benefits until the period determined periodically by independent actuaries and charged to the income statement in the periodwhich in thosebenefits are earned in full in recognised are losses and gains Actuarial employees. the by statement the in recognised are and occur, they which in period the 1. Accounting policies (continued) policies (continued) Accounting 1. is benefits providing of cost the plans, retirement benefit defined For

Notes to the Group accounts accounts Group the to Notes

Financial statements

2 the analysis by business group of the share of results of equity accounted investments is provided in note 14 note in provided is investments accounted equity of results of share the of group business by analysis the 2 expense taxation and costs finance assets, intangible of impairment and amortisation before earnings 1 Profit for theyear from continuing operations Taxation expense Profit beforetaxation Finance costs profit Operating Taxation expense of equity accounted investments Financial income of equity accounted investments businesses other and HQ Integrated Systems& Partnerships Customer Solutions & Support Programmes Armaments & Land IntelligenceElectronics, &Support businesses other and HQ Integrated Systems& Partnerships Customer Solutions & Support Programmes Armaments & Land IntelligenceElectronics, &Support Intra-business group sales/revenue Customer Solutions & Support Programmes Armaments & Land IntelligenceElectronics, &Support group bybusiness Analysis 3. businesses other and HQ Integrated Systems& Partnerships

Segmental analysis

13,765 14,272 Combined salesCombined of 1,207 3,180 2,927 2,115 4,007 1,748 Group andequity (507) (147) 2006 2006 113 477 167 168 429 295 investments accounted £m £m EBITA 12,581 13,014 Restated Restated Restated Restated 2,923 2,819 1,270 3,697 1,834 1

(433) (118) 2005 2005 909 109 419 133 324 471 £m £m 42 (2,865) (1,202) (2,865) (1,225) nagbeast intangible assets Amortisation of Amortisation (105) (416) sales byequity 2006 2006 investments (10) (12) (66) (14) accounted £m £m (4) (1) (6) (6) (8) – Less: Restated Restated Restated Restated (2,960) (1,241) (2,960) (1,271) (420) 2005 2005 (16) (77) (43) (10) £m £m (5) (7) (1) (9) (9) (5) –

1,433 1,202 1,353 intangible assets sales toequity group revenue group 2006 2006 2006 Intra-business Impairment of 151 427 108 investments Revenue investments Revenue (34) (32) accounted £m £m £m 80 97 53 14 92 21 41 (2) 1 – – – – – – Add: Add:

Restated Restated Restated Restated Restated Restated 1,398 1,242 1,332 www.baesystems.com 2005 2005 2005 103 367 (45) (26) (12) £m £m £m 66 71 18 84 19 24 40 97 (7) 1 – – – – –

12,333 12,760 12,333 external customers 2,927 2,112 3,997 2,817 1,068 2,776 2,098 3,905 1,054 2,709 (427) (180) (213) (195) 2006 2006 2006 Revenue from Revenue 287 620 413 646 859 101 471 161 102 266 579 group result group (35) £m £m £m 21 Business 11,019 11,386 Restated Restated 11,019 Restated Restated Restated Restated 2,820 1,266 3,681 2,521 2,424 2,736 1,247 3,578 (367) (145) (113) (204) 2005 2005 2005 464 634 787 302 444 557 761 100 403 128 440 594 (34) 2 £m £m £m

(1) 8 81

Financial statements

2 – 2 6 7 1 £m £m 75 17 64 26 24 69 80 64 £m £m 15 32 333 347 102 190 2005 2005 2005 2005 (308) (339) (733) (270) 3,466 6,173 1,288 (8,229) (1,141) (2,274) (1,694) (2,079) (4,101) (4,492) Restated Restated 11,019 (17,431) – – – 4 3 49 27 17 59 89 94 66 13 £m £m 66 £m £m Depreciation 335 538 131 169 165 2006 2006 2006 2006 (272) (432) (787) 3,775 6,558 1,921 and amortisation (7,910) (1,117) (2,577) (1,741) (1,416) (2,499) (3,172) 12,333 (14,013) Capital expenditure Capital

2 5 £m 15 36 42 88 33 £m £m 20 68 44 128 347 825 891 407 145 2005 2005 2005 1,173 6,260 1,129 1,813 1,351 3,151 3,215 8,238 4,022 2,725 Restated Restated 15,242 20,235 15,242 – – – 16 63 47 71 87 £m £m £m 124 181 538 107 104 470 2006 2006 2006 2006 2006 2006 5,964 1,092 1,008 1,174 1,245 1,080 2,906 3,607 7,987 3,544 1,197 segment assets Carrying value of 13,389 18,147 13,389 Capital expenditure Capital assets Total Total liabilities

– 3 (3) £m £m 14 53 481 481 193 2005 2005 1,173 1,721 4,301 1,526 2,545 1,973 Restated Restated 11,019 – – 1 3 13 89 £m £m investments investments 671 565 532 216 2006 2006 Equity accounted 5,372 1,827 2,580 1,806 12,333 – £m £m 65

138 177 497 632 211 2005 2005 Revenue Revenue 8,217 4,797 2,543 4,339 1,658 2,849 2,892 3 Customer location Asset location Restated Restated 12,581 – Sales 34 71 £m £m 202 489 595 269 2006 2006 Intangible assets 7,595 4,591 2,208 5,402 1,993 2,802 2,704 13,765 – £m 611 684 661 151 2005 5,304 1,449 1,748 (continued) Restated – £m and equity accounted investments investments 697 887 848 120 2006 Assets excluding intangible assets 5,123 1,360 1,211

onics business sold in 2005

1 4 ations represents the Avi BAE Systems Annual Report 2006 Discontinued operations HQ and other businesses Asia and Pacific Pacific and Asia America South and Central Africa, Integrated Systems & Partnerships & Partnerships Systems Integrated

United States and Canada Canada and States United Customer Solutions & Support & Support Solutions Customer

Middle East East Middle Programmes 82 82 Sale of goods Construction contracts Analysis of revenue by category by category Analysis of revenue 1 discontinued operations represents Airbus, sold during the year (note 9) 2 includes intangible assets, property, plant and equipment and investment property 3 investments accounted equity and of Group oper sales combined 4 discontinued United Kingdom of Europe Rest Analysis by geographical location location by geographical Analysis Land & Armaments Electronics, Intelligence & Support Electronics, Intelligence

Tax obligations benefit Retirement HQ and other businesses sale for held groups Disposal Electronics, Intelligence & Support Electronics, Intelligence Land & Armaments 3. Segmental analysis (continued) analysis (continued) Segmental 3.

Notes to the Group accounts accounts Group the to Notes Services Cash/(debt) as defined by the Group (note 29) (note Group the by defined as Cash/(debt) Discontinued operations Programmes & Support Solutions Customer & Partnerships Systems Integrated Lease income Consolidated total assets/(liabilities) assets/(liabilities) total Consolidated Royalty income Royalty income

Financial statements

Other operating charges Loss on disposal of businesses of businesses on disposal Loss equipment and plant of property, on disposal Loss Contingent rents Depreciation, amortisation and impairment Costinventories of expensed Programmes Programmes Armaments & Land IntelligenceElectronics, &Support Rationalisation programmes Significant one-off costsincluded inoperating costs The majority of services provided outside the UK were provided in the US. Tax services include tax compliance support and services in relation to the Group’s expatriate employees based around the world * Total fees payable to the Company’s auditor and its associates for audit services The audit of the Company’s subsidiaries pursuant to legislation* Feespayable totheCompany’s auditor anditsassociates forotherservices for auditor Company’s the to payable Fees andit auditor to the Company’s Fees payable Impairment losses recognised in the period on receivables Research and development expense including amounts funded under contract Minimum lease payments: sublease and Lease payments Included within the analysis of operating costs are the following expenses: Staff costs (note 7) work-in-progress and goods finished of ininventories Change items in bought other and materials Raw 4. businesses other and HQ Integrated Systems& Partnerships Customer Solutions & Support matters on accounting Advice Other including shareholder circular related work Further assurance services Interim Other services pursuant to legislation: Review Total fees payable to the Company’s auditor and its associates Other services Advisory Compliance Tax services Due Internal diligence controls

Operating costs Operating

the audit of the Company’s annualaccounts theCompany’s of audit the s associates included in operating costs inoperating included s associates *

,2 –1,023 1,023 ,0 2,4304,430 2,000 ,1 3,9909,403 5,413 £’000 6 22585 –500 563 500 8 3491,036 7731,074 687 301 354470 –125 116 125 2–52 52 662108 46 UK Overseas 2006 £’000 5,453

£’000 Total 2005 ,1 1,110 1,110 – ,9 ,4 4,339 1,894 2,445 ,5 6 1,523 1,355 168 ,2 ,9 11,518 7,325 4,193 www.baesystems.com £’000 9 895 355 893 2 355 – 7 9 1,269 1,005 674 595 150 855 871 813 58 1–81 81 – UK 070 – 70 5,449

Overseas 11,763 3,149 4,322 1,248 3,868 4,169 £’000 2006 2006 2006 422 153 £m £m £m 85 17 14 51 84 51 15 . 1 1 1 2 3 – – 10,579 2,335 4,158 1,449 3,554 3,894 £’000 2005 2005 2005 518 264 Total 24 27 89 89 14 21 12 83 82 19 £m £m £m 3 2 1 83 –

Financial statements – – 8 8 8 (2) (5) £m £m £m 99 32 43 43 22 23 59 (13) (17) (27) (10) (25) (75) (10) 247 123 632 159 228 123 2005 2005 2005 (253) (310) (633) (217) (158) (204) (204) (196) (310) (191) (196) 1,224 (1,428) Restated – 3 8 (9) (4) (4) 99 57 43 84 61 14 13 39 £m £m 21 21 £m (11) (28) (31) (42) (17) 371 143 739 259 147 143 2006 2006 2006 (277) (325) (694) (172) (257) (195) (195) (174) (325) (174) (157) 1,330 (1,525)

(continued) ension scheme liabilities scheme ension BAE Systems Annual Report 2006 Finance costs Other income Other income

Pension curtailment gains (note 22) 22) (note gains curtailment Pension Other 84 84 Other finance costs – Group Group – costs finance Other Facility fees Facility adjustments value present Net Analysed as: Analysed interest: Net income Interest expense Interest Finance costs – Group Group – costs Finance investments accounted equity of share – costs Finance Additional analysis of finance costs costs of finance analysis Additional Foreign exchange losses expense Financial costs finance Net Net present value adjustments adjustments value present Net on p charge Interest loss or profit through value fair at investments of remeasurement on loss Net loss or profit through value fair at instruments financial of remeasurement on loss Net debt preference On Facility fees Interest expense: overdrafts and loans bank On leases finance On instruments financial other and bonds On Net gain on remeasurement of financial instruments instruments financial of remeasurement on gain Net derivatives embedded of remeasurement on gain Net Foreign exchange gains income Financial Interest income adjustments value present Net assets scheme pension on return Expected 6. Profit on disposal of businesses of businesses disposal on Profit investments accounted equity to recharges Management impaired were that equipment and plant property, of items for parties third from recoverable Amounts Rental income from operating leases leases operating from income Rental property investment of disposal on Profit equipment and plant of property, disposal on Profit 5.

Notes to the Group accounts accounts Group the to Notes

investments accounted equity of Share

Financial statements Attributable to recoverable deferred tax tax assets deferred to recoverable Attributable Adjustment in respect of prior years Origination and reversal of temporary differences Overseas Adjustment in respect of prior years 1 The recoverable deferred tax as tax deferred Therecoverable 1 expense Taxation Origination and reversal of temporary differences UK Deferred taxation expense Adjustment in respect of prior years Current year Overseas tax charges Adjustment in respect of prior years Double tax relief Current tax UK corporation tax Current taxationexpense expense Taxation 8. (2005 £16,354,000). Remuneration Report onpages 51 to65. To Executive Committee and the Company’s non-executive directors. Fuller disclosures on directors’ remuneration are set out in the Group’s the of members the tobe Disclosures Party 24Related IAS under defined as personnel management key considers Group The US healthcare plans Pension costs – defined benefit plans Pension costs – defined contribution plans – cash-settled employees and todirectors granted options Share Share options granted to directors and employees – equity-settled Social securitycosts salaries and Wages The aggregate staff costs of Group employees, excluding employees of equity accounted investments, were: Armaments & Land IntelligenceElectronics, &Support The weekly average and year end numbers of employees, excluding those in equity accounted investments, were as follows: 7.

Programmes Programmes Customer Solutions & Support Integrated Systems& Partnerships HQ and other businesses businesses other and HQ Discontinued operations operations Discontinued

extent it is probable that future taxable profits will allow the deferred tax asset to be recovered. recovered. be to asset tax deferred the allow will profits taxable future that probable is it extent Employees anddirectors Tax

set of £4m (2005 £21m) arises in Australia primar in arises (2005 ofset £21m) £4m tal emolumentsfor director 1

Weekly average At yearend At average Weekly ily in respect of tax ily in respect s and other key managements andotherkey losses previously unrec previously losses ognised,but whichhave now been recognised tothe personnel are £23,095,000

Number 2006 ‘000 11 32 17 12 79 5 2 – Restated Restated Number www.baesystems.com 2005 ‘000 30 16 12 74 8 4 3 1

Number 3,274 3,868 (213) (225) (149) 2006 2006 2006 196 271 ‘000 (49) (76) (91) (93) (91)

£m £m 27 25 15 35 57 47 21 12 12 32 17 12 79 5 2 4 4 2 – Restated Restated Number 3,554 2,989

(113) (131) (105) 2005 2005 2005 192 253 ‘000 (28) (22) (73) (91) (58) 43 18 33 14 41 61 16 18 21 11 33 16 12 80 £m £m 4 2 6 2 85 –

Financial statements

– – – – (3) (3) £m £m 24 16 59 11 £m 49 39 21 66 22 (7) (57) (24) (27) (66) 239 (73) (13) (40) 2005 2005 101 557 (15) (96) (180) 2005 30.0% (167) (113) 1,308 1,313 1,308 Restated

– – – 4 (1) (1) 25 19 15 82 22 21 £m £m (9) (9) 69 34 34 38 £m (28) (19) (67) (17) Net balance 778 158 260 (50) (20) (46) 2006 2006 -deductible -deductible 859 (143) 2006 at 31 December 30.0% (258) (213) 1,062 1,062 eported tax

– – – – – – – – £m (64) (24) (27) (74) (23) 346 2005 (369) (180)

– – – – – (1) (1) Deferred £m (47) (19) (15) (68) (15) (17) tax liabilities 296 2006 2006 (311) (143)

– – – – – 7 8 £m 24 16 59 11 239 2005 (346) 1,677 1,313 1,331 – – – – 1 Deferred 19 19 15 82 25 £m tax assets 793 158 261 2006 (296) 1,373 1,077

(continued)

ts/(liabilities) ts/(liabilities) ts/(liabilities) ts/(liabilities) eviously unrecognised tax losses losses tax unrecognised eviously BAE Systems Annual Report 2006 – additional contributions contributions – additional – deficits Trading losses carried forward forward carried losses Trading Deferred tax asse Other items items Other gains capital over Rolled forward carried losses Capital earnings overseas Unremitted Share-based payments payments Share-based instruments Financial Pension/retirement plans: plans: Pension/retirement Adjustments in respect of prior years years prior of respect in Adjustments investments accounted equity of respect in Adjustments Other Taxation expense Utilisation of pr unrecognised previously asset tax deferred Recoverable effected tax not losses year Current Research and developmentcredits tax Goodwill Effectof tax foreign rates in jurisdictions gains Chargeable Expected income tax expense expense tax income Expected effected tax not Expenses to subject tax not Income 86 86 Net deferred tax assets/(liabilities) assets/(liabilities) Net deferred tax Set off of tax Provisions Property, plant and equipment equipment and plant Property, Intangible assets Deferred tax asse Relating to financial instruments Relating to pensions Current tax taken in equity in equity taken tax Current UK corporation tax rate Profit before tax expense. The reconciling items represent, besides the impact of tax rate differentials and changes, non-taxable benefits or non or benefits non-taxable changes, and differentials rate tax of impact the besides represent, items reconciling The expense. statements. financial reported the and base tax local the between differences from arising expenses 8. Tax (continued) r the to rate, tax corporation UK the using expense, tax income theoretical the from a reconciliation shows table following The

Notes to the Group accounts accounts Group the to Notes Goodwill

Financial statements rdn osscridfrad 0 –16 (57) (27) (24) 24 (12) – 59 – – 5 – 23 6 (27) (17) 6 (6) 30 10 – 2 (1) – 1 – (66) – (35) – – – – – – (29) 29 6 12 tax liabilities have not been The aggregate temporary differences associated with investments in subsidiaries, branches, associates and joint ventures for wh (28) sufficiently accurately These assets have not been recognised as the precise incidence of future profits in the relevant countries and legal entities c (1) Trading and otherlossescarried forward (49) Capital losses carried forward Deductible temporary differences – Deferred tax assets have not been recognised in respect of the following items: Unrecognised deferredtaxassets 30 – Trading losses carried forward (8) Unremitted overseas dividends Capital losses carried forward (5) 16 Rolled over capital gains 15 Other items Share-based payments 1 18 Pension/retirement plan (180) Goodwill Provisions 172 3 Intangible assets Property, plant and equipment (66) 4 33 (21) Pension/retirement plans: Goodwill Provisions 239 Intangible assets Property, plant and equipment Movement in temporary diffe (continued) 8. Tax 38 239 – – te tm (7 1 2 – – – 7 23 – – 1 5 7 18 8 (5) 26 (1) – – (1) – – 21 (1) (3) (57) – – – – 16 (3) (24) – (27) 24 59 Trading losses carried forward Unremitted overseas dividends Capital losses carried forward Rolled over capital gains Other items Financial instruments Share-based payments diinlcnrbtos 1 140 18 – – 1,313 – – additional contributions – deficits

predicted at this time. time. this at predicted ,1 7118 27 s 1,010 (24) 1,313 182 recognised is£500m (2005£414m). rences during the year 1 January 1 January ,0 3)612 (227) (37) 1,308 ,7 0(9 8131,308 (19)18 193 40 1,076 2006 2005 4)()(4)1 –(180) – 18 (146) (8) (44) 1––(8 – –(28) – 11 622 3) 11 – 28(35) 2 16 £m £m At At movements movements Exchange Exchange Exchange Exchange 2)6(130) (382) (29) £m £m movements movements Other Other £m £m

Recognised Recognised Recognised Recognised in income in income www.baesystems.com £m £m Recognised Recognised Recognised

in equity in equity annot be 2006 £m £m 218 130 £m 60 28 ich deferred ich deferred December December 1,062 (143) 2005 2005 At 31 190 148 2006 At 31 260 158 778 (17) (67) (19) (28) 29 13 £m 15 19 25 82 £m £m (1) 87

Financial statements (9) (4) (1) (8) (3) £m £m (11) (43) 111 (16) (19) 448 925 239 111 139 119 120 273 2005 (127) (115) 1,650 2,896 1,063 1,302 1,846 (2,388) (1,919) (1,302) Restated tinued tinued eration eration S for ust 2006. – – – rom the 2 The results The results rostructures (4) 70 68 72 £m (25) (49) 144 925 993 2006

Airbus SAS to EAD SAS Airbus it of £11m arising f arising it of £11m classified as a discon classified of £1,212m comprise total consid total comprise of £1,212m oup’s shareholding in oup’s shareholding posal generated a prof Airbus SAS Airbus SAS been have

business which was disposed of on 29 April 2005. of on 29 disposed was which business rbus SAS held by rbus the Group (£625m). held SAS ed accordingly. ed accordingly. of disposal were as follows: as follows: were of disposal less transaction costs (£11m). less transaction costs onsolidated cash flow statement onsolidated cash (continued) to EADSto was on (£103m) and ThyssenKruppcompleted for €149m 3 Aug ed the resolution to dispose of the Gr dispose of the to ed the resolution ent has been restat s excluding finance costs and taxation expense expense and taxation costs finance excluding s the results of the Avionics results the ctures business for £80m in cash. The dis The cash. for £80m in ctures business investments in the c in the investments (£9m) and cash deposits from Ai deposits from (£9m) and cash liabilities of Airbus SAS at the date at the Airbus SAS of liabilities d Atlanta Purchasing Group (£2m), d Atlanta Purchasing was completed on 13 October 2006. The results of results The October 2006. 13 on was completed hareholders approv hareholders ated income statem ated income pension liabilities. pension liabilities.

BAE Systems Annual Report 2006 1 Disposals

Share ofof results equity accounted investment Finance costs of equity accounted investments investments accounted of equity expense Taxation Proceeds from the sale of subsidiary undertakings in the consolidated cash flow statement of £174m comprise the disposals of Ae of disposals the comprise of £174m statement flow cash consolidated in the undertakings subsidiary of sale the from Proceeds an (£103m) Atlas Elektronik (£80m), The disposal generated a profit of of £3m. a profit generated The disposal resultant reduction of resultant reduction The sale of previouslythe wholly-owned Elektronik GmbH Atlas (£1,846m), less transaction costs paid (£1,846m), less operations Continuing Aerostru the Group sold its UK 2006 In March 88 88 1 earnings before amortisation and impairment of intangible assets, finance costs and taxation expense Profit on disposal Profit on accounted of equity sale from the Proceeds Net assets disposed of disposed assets Net Liabilities retained Cumulativehedging net gain Cumulative currency translation loss consideration Total paid – costs Transaction accrued – costs Transaction Share of net assets assets net of Share Goodwill Net assets disposed of Non-current assets assets Non-current assets Current liabilities Non-current Current liabilities The Group’s share of the assets and assets of the share The Group’s Profit for theyear operations of discontinued disposal on Profit/(loss) operations discontinued from the year Profit for Share of resultsequity of accounted investments net income/(expense), Financial expense Taxation Revenue Revenue Expenses EBITA The results from discontinued operations, which have been included in the consolidated income statement, are derived as below. below. as derived are statement, income consolidated the in included been have which operations, discontinued from results The 2005 include December ended 31 year for the On 4 October 2006, the Group’s s the October 2006, On 4 sale in cash. The (£1.8bn) €2.75bn consolid operation and the 2005 9. operations Discontinued

Notes to the Group accounts accounts Group the to Notes Profit before taxation

Financial statements a more appropriate indication of underlying performance. Underlying earnings per share is presented in addition to that required by IAS 33 Earnings per share as the directors consider Weighted average numbershares of in usedcalculating diluted Incremental shares in respect of convertible preference shares Incremental shares in respect of employee share schemes Add: Weighted average number of shares used in calculating basic Discontinued operations Continuing operations by: Represented Underlying earnings excludin Continuing operations by: Represented Underlying earnings Impairmentofgoodwill Amortisation and impairment of intangible assets, post tax Market value movements on derivatives, post tax tax post inventories, on acquired Uplift Net financing (credit)/charge on pensions, posttax Add back/(deduct): by: Represented debt the on interest for adjusting after year the for Profit Interest on the debt instrument of the convertible preference shareholders to equity attributable year the for Profit 10. Discontinued operations ibsSS(95) 4 628225.8 872 26.2 844 earnings per share earnings per share SAS (£925m) Airbus Discontinued operations Continuing operations instrument of the convertible preference shares shares

Earnings per share g profit ondisposal of ,6 4917753.1 1,797 54.9 1,769 49.2 1,664 50.7 1,636 1,636 1,636 ,6 4917753.1 29.6 1,797 1,002 54.9 31.1 1,769 1,002 6 387523.5 795 23.8 767 29.4 19.8 993 671 30.8 19.9 993 643 4 628225.8 872 23.5 26.2 795 844 23.8 767 3)(33) (33) £m 232 79 55 32 79 55 7247 2.3 77 2.4 77 –– –28 pence per ilosMlin Millions Millions ,2 3,225 3,225 share Basic 2006 £m pence per 3,382 Diluted share 125 32 9 19 2 21.7 723 696 21.9 17.4 580 553 17.4 553 553 9 19 2 21.7 3.3 723 696 21.9 18.4 111 3.5 111 612 585 18.4 3.3 14.1 111 3.5 111 469 442 13.9 / / / n/a n/a n/a n/a n/a n/a n/a n/a 45 45 60 60 34 34 £m 3 3 1 1 – 27

3,332 128 21 3,183 3,183 pence per Millions share Basic www.baesystems.com Restated Restated 2005 that this gives this that £m pence per Diluted share 89

Financial statements £m Total ons ness 1 part of the ng value value ng £m eeding 10% 10% eeding Other hanges in key key in hanges duction in the the in duction y 20 cash-

– 77 77 – 105 105 – 10– 7 10 7 – 25– 2 25 2 4 – 4 (5) (2) (7) (5) – (5) (8)(6) 3 (2) (5) (8) £m 45 – 45 32 2 34 (46) (3) (49) (79) – (79) 267 26 293 (810) – (810) (480) (49) (529) 7,133 462 7,595 2,090 93 2,183 2,071 195 2,266 7,632 585 8,217 5,927 188 6,115 8,059 206 8,265 2,263 443 2,706 9,722 678 10,400 9,204 657 9,861 2,132 18 2,150 Goodwill

odwill across approximatel across odwill ts has allocated goodwill exc goodwill allocated ts has companies, of which the most significant are in respect hat there will be no re material ent charge of £32m. charge ent

The Group has allocated its go allocated has Group The none of the cash-generating uni of the cash-generating none in future in the foreseeable and t e Group is an impairm (continued) le asset other than goodwill. goodwill. other than le asset ence spending will remain stable stable will remain spending ence dustries, Inc. in 2005 of £1,984m, 2005 of £1,984m, in dustries, Inc. the carrying value of goodwill across th of goodwill carrying value the

2 2 BAE Systems Annual Report 2006 Intangible assets Intangible

of theof acquired order book andon-going of programmerelationships Impairment charge charge Impairment adjustments Exchange 2006 December At 31 Reclassified as non-current assets and disposal groups held for sale sale for held groups disposal and assets non-current as Reclassified 2005 December At 31 (8) (2) (10) Impairment charge charge Impairment 90 90 of recognised goodwill to exceed its recoverable amount. amount. recoverable its exceed to goodwill recognised of review of The result of the Beyond the assumptions that US and UK government defence spending remains stable there are no individually significant assumpti significant individually no are there stable remains spending defence government UK and US that assumptions the Beyond carryi the cause would assumptions key to changes possible reasonably where units cash-generating other the to relation in made The key assumption underpinning the Integrated Business Plan projections for the US operations within the Land & Armaments busi Armaments & Land the within operations US the for projections Plan Business Integrated the underpinning assumption key The def government US that group is c possible reasonable any identified not have directors The participates. currently it which in programmes of share businesses’ assumptions for this business thatwould cause the carrying value of recognised goodwillexceed to its recoverableamount. of the Group’s total goodwill balance. The Group’s approachgoodwill to impairment testing is set out in the accountingpolicies on page 76. The Group has no indefinite life intangib life no indefinite The Group has as acquired group business Armaments & Land the within operations US the to allocated goodwill the than Other units. generating of United Defense In acquisition 1 other intangibles includes internally funded development costs and intangible assets recognised on acquisition of subsidiary 2 amortisation is included in operating costsin the income statement Net book value At 31 December 2006 2005 December At 31 January 2005 At 1 Amortisation charge Disposals Disposals At 1 January 2005 January 2005 At 1 Disposals Amortisation charge Exchange adjustments adjustments Exchange 2006 December At 31 impairment and Amortisation Acquisition of subsidiaries subsidiaries of Acquisition values fair provisional to Adjustments Disposals investments accounted equity to Reclassified (28) – (28) At 31 December 2005 December At 31 Additions: separately Acquired generated Internally Disposals Disposals sale for held groups disposal and assets non-current as Reclassified adjustments Exchange (52) (14) (66) Acquired separately Acquired generated subsidiaries Internally of Acquisition values fair provisional to Adjustments Cost or valuation Cost or valuation January 2005 At 1 Additions: 11.

Notes to the Group accounts accounts Group the to Notes

Financial statements sesi h oreo osrcin(nldn netetpoet nt 3) At 31 December 2005 2006 31December At Assets in the course of construction (including investment property (note 13)) elsiiainbtenctgre 2 2 –– – (2) 2 – – 20 – (5) 5 – – 20 At 31 December 2005 2006 31December At – The net book value of assets held as capitalised finance leases (including investment (30) The amounts above include: (9) – At 1 January 2005 At 31 December 2005 9 (17) 2006 31December At – Net bookvalue (13) At 31 December 2006 32 Exchange adjustments – Disposals Reclassification betweencategories – Transfers from investment (12) property Transfers to inventories – Impairment loss for the year 12 Depreciation charge for the year At 31 December 2005 32 Exchange adjustments Disposals asaresult of dispos Disposals Reclassification betweencategories (87) Reclassified as non-current assets and disposal groups held for sale Transfers to investment property – Transfers from investment property Impairment loss for the year Depreciation charge for they (32) At 1 January 2005 Depreciation and impairment (55) At 31 December 2006 Exchange adjustments Disposals Reclassification betweencategories Transfers from investment property Transfers to inventories Transfers from inventories Additions At 31 December 2005 Exchange adjustments Disposals asaresult of dispos Disposals categories between Reclassification Reclassified as non-current assets and disposal groups held for sale Transfers to investment property Transfers from investment property Transfers from inventories Acquisitionsubsidiaries of Additions At 1 January 2005 Cost 12. property (note13))

Property, plantandequipment ear (includes £6mrela lo uiess 6 (5) (165) – (159) (6) al of businesses al of businesses ted todiscontinued operations) 54 158 251 39 Land and Land buildings ,1 ,7 663,997 606 1,313 2,078 3,901 548 1,233 2,120 3,887 418 1,216 2,253 4 0 198 – 148 50 6 ,8 9 2,141 99 360 1,682 511 214 184113 5 7 1 1,746 1,704 856 571319 825 613266 2,251 338 433 1,480 2,197 282 408 1,507 4 8 216 – 148 68 8 9 6 1,746 880 598268 6)(8 5)(187) (228) (65) (68)(54) (1) (80) (147) (261) (218) – (4) (10) (251) (33) (181) (89) – (89) – 1)(3) 1 (151) (1) (18) (132) (186) (2) (17) (167) 73 4112 47 3134 201 318 – 63 138 50 168100 919 8226 29 28 49 149 5 14 10 £m 9 4)(4 (74) (9) (41)(24) (9) – (9) – 2 2 – 1 1 – 71 33 1 1715 3 –(3) 1 – – (3) – – 1 6 – – 6 82 59 – 3821 (1) 53 – – (1) – 53 146 – 5 141

machinery Plant and Plant www.baesystems.com £m Aircraft £m Total £m 91

Financial statements 9 5 4 2 (1) (1) (2) £m £m 61 54 44 12 89 81 (20) (13) (32) (15) 123 218 218 155 378 216 272 167 204 161 446 £m 2005 (103) Total is also ng 72 63 £m 185 320 £m 2006 ses. The leases The leases ses. Aircraft the Group £m Plant and machinery 3m) where 3m) where – 519 268– 79 – –– – 268 519 79 £m 51 – –51 – –29 – 51 29 800 – –800 – 800 268880 598 1,746 buildings Landand e above is £25m (2005 £1 above is e

e payable. Within th e payable. (continued) eements, no contingent rents ar rents eements, no contingent vestment property vestment property BAE Systems Annual Report 2006 Investment property Investment property

92 92 At 31 December 2006 2005 December At 31 At 31 December 2006 2005 December At 31 January 2005 At 1 property investment of Fair value Disposals Disposals 2006 December At 31 of in Net book value Disposals Disposals 2005 December At 31 equipment and plant property, to Transfers year the for charge Depreciation At 1 January 2005 January 2005 At 1 equipment and plant property, from Transfers equipment and plant property, to Transfers year the for charge Depreciation Disposals Disposals 2006 December At 31 impairmentand Depreciation Transfers from inventories inventories from Transfers Disposals 2005 December At 31 equipment and plant property, to Transfers At 1 January 2005 January 2005 At 1 expenditure subsequent Capitalised equipment and plant property, from Transfers equipment and plant property, to Transfers Cost Under the terms of the lease agr Under the terms of the lease asset. the of lessee the 13. Later than one year and not later than five years years five than later not and year one than Later Later than five years Receipts due: due: Receipts Not later than one year The aircraft fleet that is held under capitalised finance lease arrangements is leased to airline companies under operating lea operating under companies airline to leased is arrangements lease finance capitalised under held is that fleet aircraft The rights. renewal and clauses escalation terms, varying have (includi capitalised assets for leases operating of elements non-cancellable the from income lease minimum aggregate future The follows: as are 13)) (note property investment Aircraft Long leasehold property property leasehold Long property leasehold Short Plant and machinery equipment and fittings Fixtures, Freehold property property Freehold 12. (continued) and equipment Property, plant of: Net book value

Notes to the Group accounts accounts Group the to Notes

Financial statements Share of results of equity accounted in accounted ofequity ofresults Share The market value of the accounted investments subsequent to their acquisition by the Group. At 31 December 2006 31December At Foreign exchange adjustment Taxation expense Financial income businesses other and HQ Integrated Systems& Partnerships 59 Customer Solutions & Support Programmes – Armaments & Land Intelligence Electronics, &Support 59 Share of results excluding finance 70 costs and taxation expense: – 70 (47) 74 Included withinpurchased – accounts. the Group to notes and statement – as arising from discontinuing operations, rather than continuing operations in the consolidated income statement, consolidated (47) of Financial Statements and IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations, the results of Airbus are recl On 13 October 2006 thesaleof 74 as for accounted previously was which GmbH, LFK of control acquiring SAS MBDA of a result as arisen has gain revaluation The 1 Revaluation of net assets acquired by equity accounted investments Actuarial gains on defined benefit pension schemes, net of tax Market value adjustmentsinres Dividends Disposal Reclassified from intangible assets Acquired through acquisition Share of results after tax – discontinued operations (note 9) Share ofresults af At 31 December 2005 Foreign exchange adjustment Actuarial losses on defined benefit pension schemes, net of tax Market value adjustments inrespec Dividends Reduction in shareholding Disposal Acquired through acquisition Share ofresults aftertax– discont Share of results after tax – continuing operations At 1 January 2005 investments accounted equity of value Carrying 14. Rental income from investment property the external independentvaluations from A The fair values above, which are based on market values, were prepared by in-house professionals and are predominantly supporte Investmentproperty(continued) 13. having an appropriate professional qualification with recent experience in the relevant location of the property being valued. are considered to reflect current values. Other valuations were prepared by in-house professionals. All valuations were prepare value uplift in respect of the carrying value of the original investment. The gain has been reflected as a credit to equity (no equity to credit a as reflected been has gain The investment. original of the value carrying the of respect in uplift value

Equity accounted investments e a otnigoeain 13 113 – 113 ter tax– continuing operations Group’s shareholding in goodwillis£113m (2005 £47m) pect of derivative financial inderivative financial pect of inued operat t of derivative financial insderivative financial t of Group’s shareh vestments by continuing business group business bycontinuing group vestments ttis Real Weatherall and CB Ri os(oe9 19 139 – 139 ions (note 9) SaabAB at 31 December 2006 was£350m (2005 £278m). olding in Airbus SAS to EADS wascomple relating tothegoodwill arising on tuet,nto a 14 144 – 144 struments, net oftax rmns e ftx 40 –(470) – (470) truments, net oftax 1 5 5 – chardprepared within Ellis ted. Inaccordance with IAS 1 Presentat acquisitions made by theGroup’seq te 27). 27). te the last two years. These v a trade investment. gain The reflects £5m fair a

assets www.baesystems.com 15 (145) (145) – (1,302) (239) (1,063) Share Share of net 1 ,0 1,721 317 1,404 4 140 (136) 2,239 616 1,623 3 3 671 238 433 2)()(26) (24) (2) 8)–(88) (130) (88) – (62) (68) 6)6 4 (62) 66 3–23 23 – £m 8 1)(23) (8) (15) 828 – 28

Purchased Purchased goodwill d by thosed by aluations 2006 2006 113 127 cash flow (35) assified £m £m £m 21 90 28 19 7 1 1 uity – d by d by ion Restated Restated Carrying Carrying value 2005 2005 100 (34) £m 74 68 18 32 £m £m (1) 8 9 1 5 93

Financial statements – 9 9 £m £m 35 599 634 2005 2005 Wales Wales 3,453 5,764 9,217 1,721 (3,550) (3,946) (7,496) Country of – 7 4 incorporation 11 £m £m 503 503 856 671 2006 2006 (582) 2,633 3,489 (2,236) (2,818)

UK and England Principally operates in rcraft Sweden Sweden

nagement support to the nagement Gripen fighter ai (continued) Commercial aerospace activities Kazakhstan Kazakhstan Management and control of Eurofighter Typhoon programme programme Typhoon Eurofighter of and control Management Germany services support and training naval of Supply Germany ma and facilities Engineering Royal Navy of and selling Marketing weapons guided of manufacture and Development UK programme of Tornado and control Management and England Defence and commercial aerospaceactivities Europe Germany France Germany Sweden Sweden ectronics Limited and and Limited ectronics azakhstan) Limited) Electronics Limited) Limited) Electronics BAE Systems Annual Report 2006 Other investments Other investments

BAE Systems (Overseas Holdings) Limited)

94 94 Designated at fair value through profit or loss on initial recognition recognition initial profit or loss on through value at fair Designated Property Exchange Loans and receivables and receivables Loans deposits Term Assets at fair value through profit or loss Term deposits Term Current Non-current assets financial for sale Available securities Equity 15. (Held via BAE Systems plc) (Held via (20.5%) AB Saab AB) BAE Systems (Sweden) (Held via MBDA SAS (37.5%) MBDA SAS BAE Systems El (Held via (42.5%) GmbH Aircraft Panavia (HeldBAE Systems via Marine (Holdings) Limited) (50%) KB Gripen International (HeldBAE Systems via (Operations) Limited) (Held by BAE Systems plc) (50%) Limited Training Flagship BAE Systems (Held via (50%) Limited Support Fleet Air Astana JSC (49%) (49%) JSC Astana Air (Held by BAE Systems (K Eurofighter Jagdflugzeug GmbH (33%) Principal equity accounted investments investments accounted equity Principal Joint ventures Principal activities Non-current liabilities liabilities Non-current liabilities Current value Carrying Current assets assets Current Liabilities: Assets: Assets: assets Non-current 14. (continued) investments Equity accounted investments accounted of equity and liabilities assets Share of the

Notes to the Group accounts accounts Group the to Notes

Financial statements Retentionsoutstanding against long-termcontracts Included within amounts due fromcustomers forcontract work: Prepayments and accrued income Pension prepayment (note 22) Other receivables Amounts owed by equity accounted investments Trade receivables Amounts due from customers for contract work Amounts due from contract customers payments progress attributable Less: Long-term contract balances Current Amounts owed by equity accounted investments Non-current 16. to disposalof Exchange Property valu inthe fair movements Accordingly, loss. or profit through value at fair as Property the Exchange had designated Group The The Group’sshareholding Exchange Property 31December At Fair value movements recognised in finance costs Disposals Additions At 1 January Current Acquisitions of subsidiaries Additions At 1 January Non-current Reconciliation of movements Otherinvestments (continued) 15. Prepayments and accrued income Pension prepayment (note 22) Other receivables Fair value movements Creationimpairment of provision undertakings to subsidiary Transfer Disposals At 31 December 31December At

Trade andotherreceivables in Vodafone Group Plc (Exchange Property) was disposed of during the year. £42m are recognisedinfi nance costs in the inco me statement (2005 £75m). www.baesystems.com

(4,027) 2,253 4,440 e of thee of (588) 2006 2006 2006 503 499 634 181 225 218 631 993 580 569 496 (42) £m £m £m 66 11 (2) (1) 1 5 5 9 7 – – – – (3,914) 1,877 4,315 2005 2005 2005 134 242 608 841 440 634 763 912 869 (75) (85) (48) (30) 10 52 31 17 66 13 20 10 £m £m £m (2) 2 9 4 95 –

Financial statements 5 (2) (5) (1) £m 57 78 56 £m £m (67) (75) (18) 118 211 289 407 222 146 117 485 2005 2005 2005 (177) (195) (270) Liabilities –(3) – – – – – – – – – – – – – – – – – es £m 3134 (41) 65 (4) (45) 3915 (72) 54 (6) (81) 12 (147) £m 90 £m 205 100 395 2005 2006 2006 Assets

£m (45) (50) 2006 Liabilities

– – 6 (243) 30 (43) 21 (2) 51 36 (36) 14 (14) 50 £m structures business 2006 2006 Assets

nik GmbH and Aero UK realisable value in 2006. realisable

ventories to their net ventories to their (continued) and liabilities related to the Atlas Elektro Atlas and liabilities related to the as a write down of in write down as a ented the assets ncial instruments 2006 (note 9). (note 9). 2006 BAE Systems Annual Report 2006 Disposal groups Disposal groups Inventories Inventories Other financial assets and liabilities and assets Other financial

Other receivables Other receivables Trade and other receivables receivables other and Trade Property, plant and equipment equipment and plant Property, 96 96 of disposal groups Liabilities Current liabilities Current liabilities payables other and Trade Provisions Deferred tax liabilities Deferred tax liabilities Provisions liabilities Non-current payables other and Trade obligations benefit Retirement Assets of disposal groups Assets of disposal groups Current assets Inventories Non-current assets assets Non-current Intangible assets disposed of in 19. 2005 repres The balances in Finished goods and goods for resale resale for goods and goods Finished £26m) (2005 £20m The Group recognised Short-term work-in-progress consumables and materials Raw The debt-related financial instruments are presented as a component of loans and overdrafts (note 20). 20). (note overdrafts and loans of a component as presented are instruments financial debt-related The 18. Debt-related fina derivatives rate exchange/interest foreign Other Cash flow hedges – foreign exchange contracts contracts exchange foreign – hedges flow Cash contracts rate exchange/interest foreign Other derivatives Embedded Other foreign exchange/interest rate contracts contracts rate exchange/interest foreign Other Current Non-current contracts exchange foreign – hedges flow Cash 17.

Notes to the Group accounts accounts Group the to Notes

Financial statements Debt-related financial instruments Obligations under finance leases Bank loans US$500m 7.5% bond,repayable 2027 US$750m 5.2% bond,repayable 2015 Euro-Sterling £100m 10¾ Class B andClass G certifica US$1bn 6.4% bond,repayable 2011 US$500m 4.75% bond,repayable 2010 Alvis loan notes, redeemable 2009 The EuropeanInvestmentBank bo The Groupexercised its option toredeemthe US 7.62%. of rate interest effective The US$200m 7% bond,repayable 2007 was conv At 31 December 2005 2006 31December At follows: is as borrowings theGroup’s of maturity The Debt-related financial instruments Obligations under finance leases Class B andClass G certifica US$200m 7% bond, repayable 2007 Exchangeable £676m 3.75%Bond Bankloans and overdrafts Current Debt instrument ofth European Investm Euro-Sterling £150m 11 US$500m floating rate note, repayable2008 US$200m 7% bond, repayable 2007 Non-current 20. giving aweightedrate interest average The ClassB and Class G certificates arere floating. US$450m and fixed coupon. The effective intere This has been over different tenors;US$500m ha The US$1bn 6.4% bond,repayable 2011 has been effective rate du The US$500m 4.75% bond,repayable2010 was conve 1. tonote refer shares preference the convertible of instrument the debt on information more For 6.86%. of rate interest an with isfixed loan outstanding the on rate coupon The in2009. matures loan GmbH Eurofighter European Investment an effective interest rate of 7.73%. 7.73%. of rate interest effective an The US$500m 7.5% bond,repayable interest rate during 2006 of5.59% onthiselement. balance, US$414m has be

Loans andoverdrafts ring 2006 of 5.71%. ent Bank loan,final instalment 2009 layed by US$300m offl Bank loans, final instalment 2009 e convertible preference ⅞ % bond, repayable 2008 % bond, repayable 2014 en convertedto a sterling floating st rate during 2006 was6.35% with aninterest ra tes, final instalments 2011/2013 tes, final instalment 2011/2013 s been swappe s been rrowing consists ofthree sterling denominated lo 2027 was convertedatissue toasterling fixedra of 6.879%. At 31 December 2006, the gross ou oating to fixed interest rate payable in2011 and 2013respecti d until maturityofthe bond shares, rede $500m floating ratenote erted at issueto a sterling fixedrate partiallyconverted to a floating rate bo rted on issue to a floating rate bond by rateto afloating bond issue rted on emable 2010 rate bond by utilising a cross-curre by utilisingrate a bond swaps thatfixthe interestpa in 2011 andUS$250m has been during September 2006. te split onthe bond at 31 December 2006 being US$ vely withfixed ans, two of which matured during2006 whilst th tstanding principal du te bond by utilisingte a bondby bond by utilising across-currency swapand nd by utilising aseri US$ couponrates utilising aninterest rateswapgiving ncy swapwhich resulted in an ef yments at a lo yments at 1 year swapped untilDecember2007. 0 ,1 ,2 4,439 905 1,610 1,924 3 ,7 ,9 3,110 334 1,578 1,198 Less than e isUS$1,306m. Of th cross-currency swapa £m es ofinterest rat of 7.156% and6.66 of wer ratethan Between Between 5 years 1 and www.baesystems.com £m 5 years 2,776 2006 More 216 253 382 599 515 249 242 102 150 334 than e swapswith the original £m £m 31 28 99 11 33 21 23 82 66 fective 1 7 – – – nd has an an has an an has 550m e third e third is is 4%, 3,534 2005 135 288 434 784 590 284 240 667 150 290 116 905 Total 70 34 99 18 38 82 26 92 £m £m 2 – – –

Financial statements 1 1 2 5 £m £m £m 46 10 15 26 46 77 38 69 (16) 124 108 108 120 241 432 155 606 357 2005 2005 2005 3,452 1,256 1,147 7,006 3,620 – – 3 nd was (7) sure to to sure e lease lease e 61 54 54 43 10 12 16 34 24 37 23 31 £m £m £m 343 113 287 465 153 638 616 2006 2006 2006 1,078 6,717 4,008 3,836 are specifically specifically are t rate on finance finance on rate t

e Property. to the Exchang to the

g some minor conversions in some minor conversions g (continued) ty during July 2006 followin ty during July 2006 (continued) (continued)

nimum payments due: nimum lease sheet date is shown below. below. shown sheet date is mber 2006 was 7% (2005 7%). was 7% mber 2006 nce lease liabilities nce lease liabilities nance lease liabilities – payments due: payments – nance lease liabilities BAE Systems Annual Report 2006 Trade and other payables Trade and other

liabilities from the balance balance from the liabilities repaid in January 2007. 2007. January in repaid obligations lease Finance thes of maturity The aircraft. of respect in predominantly arrangements lease finance non-cancellable of number a has Group The Eurofighter GmbH loan GmbH Eurofighter a 10bp minus LIBOR at interest incurred loan The shareholders. its to GmbH Eurofighter by lent cash surplus represents loan The 98 98 Included above: above: Included customers contract long-term to due Amounts Accruals and deferred income income deferred and Accruals Amounts owed to equity accounted investments investments accounted equity to owed Amounts costs security social and Other taxes payables Other Cash received on customers’ account: account: customers’ on received Cash contracts Long-term Others payables Trade Current customers contract long-term to due Amounts customers other to due Amounts Amounts owed to equity accounted investments investments accounted equity to owed Amounts payables Other income deferred and Accruals Non-current customers contract long-term to due Amounts contracts long-term for account customers’ on received Cash 21. Under the terms of the lease agreements, no contingent rents are payable. payable. are rents contingent no agreements, lease the of terms the Under interes average The term. lease the of all for date contract the at fixed is leases finance these in inherent rate interest The lease payables at 31 Dece Later than five years of fi value Present Not later than one year years five than later not and year one than Later Future finance charges on finance leases leases finance on charges finance Future of fina value Present Finance lease liabilities – mi – Finance lease liabilities Not later than one year years five than later not and year one than Later Later than five years The bond was redeemed at par on maturi at was redeemed The bond hedging loans disclosed within the above note. These derivatives have been entered into specifically to manage the Group’s expo Group’s the manage to specifically into entered been have derivatives These note. above the within disclosed loans hedging risk. rate interest or exchange foreign Bond 3.75% Exchangeable £676m 20. Loans and overdrafts which derivatives cross-currency and rate interest certain of value market the represent instruments financial debt-related The

Notes to the Group accounts accounts Group the to Notes

Financial statements Additional disclosure – summary of movements of the retirement benefit obligations obligations benefit retirement the of movements of – summary disclosure Additional information. the subsequent in A summary of the movements in the retirement benefit obligations is shown below. The full disclosures, as required by IAS 19, a post-retirement. on theassumptions thattheincr The Group has a number of healthcare arrangements in the US. The long-term healthcare cost increases shown in the table above a and 21 to 25 years for current female pensioners at age 65. underlying the value of theaccrue healthcare arrangements the post-retirement mortality assumptions allow for expected increases in longevity. The current life e Group’s shareofIAS19deficitexclud 19deficit IAS Total tables usedforand non-pensione pensioners with the results of an investigation into the actual mortality experience of plan members. For its US pension arrangements the cohort tables based on year of birth (as published by the Institute of Actuaries) for both pensioner and non-pensioner members For its UK pension arrangements the Group periods and thus inherently uncertain, as at 31 December are shown in the tables below. Allocated toequityaccoun US healthcareplans Deficit indefined bene Other movements gains Curtailment Recurring contributions over service cost One-off contributions Decrease/(increase) in liabilities du Actual returnonassets disposals and Acquisitions Deficit indefined bene significant change before necessarily occur in practice. The bid value of plan assets, which are not intended to be realised in the short term and may be m covered, tothe timescale due which, assumptions actuarial of possible arange from chosen estimates are used assumptions The Long-term healthcare cost increases rate Discount pensions deferred for increase of Rate Rate of increase for pensions in payment Rate of increase in salaries rate Inflation The financial assumptions usedtocalculat pension plans. performed byindependent actu in the US. The latest valuations of the principal plans, covering retiree medical and life insurance plans in certain US subsid the to relate which of the majority retirement, after benefits The Group also operates a number of non-pension post-retirement benefit plans, under which certain employees are eligible to re Post-retirement benefits otherthan pensions 31 December each year. Plan assets are shown at the bid value at 31 December each year. by independent qualified actuaries and updated to take account of the requirements of IAS 19in order to assess the deficit of plans in accordance with IAS 19. The valuations used for the IAS 19 disclosures are based on the most recent actuarial valuatio The disclosures below relate to post-retirement benefit plans in the UK, US and other countries which are accounted for as defi calculate the IAS 19 deficit. unfunded. Pension plan valuations are regularly carried out by independent actuaries to determine pension costs for pension fun UK and US are funded defined benefit plans and the assets are held in separate trustee administered funds. The plans in other c BAE Systems plc operates pension plans for the Group’s qualifying employees in the UK, US and other countries. The principal pl Pension plans 22. and other participating employers employers otherparticipating and

Retirement benefit obligations i eso ln t3 eebr20 (,6)(301) (2,866) (647) (4,659) fit pension plans at 31 December2006 fit pension plans at 1 January2006 bv xetdrtr 41 100 421 above expectedreturn they arerealised, and the ted investmentsand other pa aries asat 1January2006. The meth eases are10%in 2006 reducingto5% by2015 for d liabilities for themain UK and ocagsi supin 49 (26) 499 e tochanges inassumptions ing Group’s share ofamounts allocated toequity accounted investments e liabilities forthe principal plans were: UK US has, for the purposehas, for of rs are RP 2000 projected to2010 (2005 RP present value of pl tcptn mlyr 74 – 774 rticipating employers provision of medical benefits to retired employees of the Group’ US plans range from 18 to22 calculating its liabilitiesas od of accounting for theseissi an liabilities,whichare deri pre-retirement and10%in 2006 reducing to5% 2.9-3.0 2000 projected to2006) 2006 n/a 3.0 4.0 3.0 5.2 % at 31 December years forcurrentmale pension 2.6-2.8 2.5-3.0 ved from cash 2005 milar tothat used for defined n/a 2.8 2.7 3.8 3.7 2.8 2.7 4.8 5.3 % 2004 2006, used PA9 2006, % flowprojec

. Forthe pension a 202 (336) (2,092) (336) (2,866) www.baesystems.com 2006 108 23 679 54 n/a 5.8 3.0 5.9 5.7 34 68 52 61 £m UK % – – (35) – 66 tions overlong s subsidiaries s subsidiaries iaries, were were iaries, US and US subject to mortality mortality xpectancies the plans at ned benefit benefit ned 2005 ers at age 65 other in conjunction / n/a n/a . 5.8 3.0 5.8 3.0 . 5.9 5.8 . 5.7 5.7 n undertaken ding andto re provided 2 medium ceive £m ans in the benefit benefit ountries are % –– re based re based for for ay not nd (2,428) (3,202) (3,167) (5,306) 2004 774 102 113 131 733 473 521 Total (35) £m 66 99 %

Financial statements £m £m Total 2002 US £m £m plans 2003 healthcare 2005 £m £m other plans 2004 USand pension return % £m % return % £m % Expected Expected Expected

– (145) – (145) – (67) – (67) – 20 – 20 £m £m plans 2005 (303) – – (303) benefit 1,210 – –1,210 – 1,210 1,138 265 827 (2,048) pension (5,306) (4,339) (3,081) (4,339) (5,306) (3,125) (2,100) (1,221) (1,221) (2,100) (788) (408) (3,449) (647) (3,449) (52) (4,148) (4,659) (647) (4,659) (52) (5,358) (667) (3,449) (52) (647) (3,449) (4,168) (52) (4,148) (3,449) (600) (3,449) (52) (4,101) 12,461 10,143 9,305 8,127 10,833 1,628 92 12,553 (17,767) (14,482) (12,386) (14,482) (17,767) (11,252) (15,492) (2,130) (2,130) (15,492) (144) (17,766) UK defined eficit. The Group’s share of the IAS 19 pension equity accounted investments and to Airbus SAS 2006 2006 2005 £m he Group’s share ofwas which disposed of duringthe 473 521 £m 2006 628 100 8.5 12,461 100 628 100 8.5 Total (3,167) 14,289 (17,456) US £m plans return % £m % return % £m %

Expected Expected healthcare 2006 2006 £m (80) (15) (95) other plans UK US Total Total UK US UK US Total UK US US and pension – –––– £m % 35 25 11 71 £m £m % (83) – – (83) 774 – – 774 357 3 5.0 126483 8 7.0 3 plans benefit 8,2322,7351,255 65 22 10 8.0 4.8 6.25 1,3249,556 2,995 260 77 8.75 67 –1,255 21 15 5.5 – n/a 9 pension (2,092) (301) (35) (2,428) (2,866) (301) (35) (3,202) (2,127)(2,092) (326) (301) (46) (2,499) (35) (2,428) (2,127) (326) (46) (2,499) 12,579 100 7.014,289 1,710 100 100 8.5 12,579 1,710 91 14,380 (15,445) (1,931) (111) (17,487) UK defined (continued) with non-current assets and non-current assets with

1 on plan liabilities liabilities on plan

2 BAE Systems Annual Report 2006 year. As these plans are multi-employer plans the Group has allocated an appropriate share of the IAS19 pension deficit to the based upon a reasonable and consistent allocation method intended to reflect a reasonable approximation of their share of the d deficit allocated to the equity accounted investments is included in the balance sheet within equity accounted investments. participating employers employers participating disposal groups held for sale sale for held groups disposal investments participating employers participating Total deficit before tax and allocation to equity accounted investments and other other and investments accounted equity to allocation and tax before deficit Total Group’s share of IAS 19 deficit, net net deficit, 19 IAS of share Group’s 100 Bonds 2,276 21 4.3 231 14 5.5 2,50720 5.5 Bonds 2,276 property) (mainly Other Total 10,833 21 100 4.3 7.0 231 1, 14 1,068 10 6.0 127 8 7.0 1,195 10 Equities 7,489 69 8.0 1,270 78 8.75 8,75970 8.75 Equities 7,489 69 8.0 1,270 78 Total Equities Equities Bonds Property Other 2 at bid value from 2003 and at mid-value for prior years plans pension benefit of defined Assets Actuarial gain/(loss) gain/(loss) Actuarial assets plan on gain/(loss) Actuarial Defined benefit pension plans Defined benefit Defined benefitobligations assets Plan Amounts for the current and previous four years are as follows: follows: as are years four previous and current the for Amounts 1 Certain of the Group’s equity accounted investments participate in the Group’s defined benefit plans as well as Airbus SAS, t Liabilities directly associated associated Liabilities directly net deficit, 19 IAS of share Group’s Pension prepayments (within trade and other receivables) receivables) other and trade (within prepayments Pension accounted equity of deficit 19 IAS of share Group’s Fair value of plan assets assets plan of value Fair Total IAS 19 deficit, net Allocated to equity accounted investmentsother and Present value of unfunded obligations obligations unfunded of value Present obligations funded of value Present 22. (continued) obligations Retirement benefit sheet balance the on recognised Amounts

Notes to the Group accounts accounts Group the to Notes Represented by: obligations benefit Retirement

Financial statements 4 this includes liabilit thisincludes 4 Pensions and for Work Department 3 Net liabilities (assumed)/transfe 86 – Members’ contributions – (including DWP Current service cost Liabilities assumed Defined benefit obligations at1 2005 January 86 employers are as follows: Changes in the present value of the defined benefit obligations before allocation to equity accounted investments and other par Members’ contributions (including DWP Contributions by employer in respect of salary sacrifice arrangements Contributionsemployer by onassets return Actual acquisitions on acquired Assets Members’ contributions (including DWP Contributionsemployer by onassets return Actual acquisitions on acquired Assets ofplanassetsValue at1January2005 Changes in the fair value of plan assets are as follows: diversification and rebalancing. Peer data and historical returns are reviewed to check for reasonableness and appropriateness. return assumptionsare determined for each assetclass. The overall expected return is established with proper considerationof volatility generate a greate between equities and bonds are preserved. This isconsistent with the widely accepted capital market principle that assets with Whensetting the overall expectedratereturn of on plan assets,historical markets are studiedlong-term and historicalrelati Retirementbenefit obligations (continued) 22. Defined benefit obligations paid Benefits Currency gain expense Interest gains Curtailment Actuarial gain/(loss) on cost service Past Defined benefit obligatio paid Benefits Currency loss expense Interest gains Curtailment Actuarial (loss)/gain onliab cost service Past otiuin yepoe nrseto aaysciiearneet (6 – (86) – – (86) Members’ contributions (including DWP Contributions by employer in respect of salary sacrifice arrangements Current service cost Currency gain Value ofplanassetsValue 2006 at31December paid Benefits Currency loss ofplanassetsValue 2005 at31December paid Benefits Actuarial gain Expected return on assets gain/(loss) Actuarial Expected return on assets

ies of £67m transferred on the disp onthe transferred ies of£67m naqiiin – 52 (0 (562) (40) (522) – on acquisitions laiiis 9 (6 2475 2 (26) 499 liabilities ns at31 2005 December r return over time.Current market factorssuch as a 1Dcme 06 1,4) 201 (2)(17,582) (126) (2,011) (15,445) at31 2006 December ilities (2,054) (46) (2,089) 11 rred on acquisitions/disposalsrred on 3 3 3 3 rbts 4 1 –53 – 11 42 139 – 10 129 rebates) rebates) rbts (2 (1 –(53) – (11) (42) (139) – (10) (129) rebates) rebates) osal of Atlas Elektronik GmbH GmbH Elektronik Atlas of osal 4 – 62 62 – inflation andinterest rates areevaluated befor UK defined UK UK defined UK 1,7)(,0) 18 (14,590) (108) (13,074) (1,408) 1,9)(,7) 14 (17,911) (144) (15,492) (2,275) 083168 212,553 92 10,833 1,628 259170 114,380 91 12,579 1,710 pension pension ,1 1 1,909 1,133 – 1,818 91 (5) 1,151 (13) 10,182 39 9,199 944 ,0 3 91,441 9 1,200 232 benefit benefit 10 5) 2 (218) (2) (160) (56) 78 18 ()(864) (8) (738) (118) (791) (8) (685) (98) 13 6) 2 (235) (2) (173) (60) 55 7) 7 (645) (7) (565) (73) 52 8) 8 (638) (8) (542) (88) plans plans 2 0 3524 917 3 421 100 6 779 132 333 776 252 7110 5 667 104 6 3 1 1,107 10 960 137 4 8 638 8 542 88 645 7 565 73 1)() (9) 9 (17) (1) 26 –113 – 52 61 62 62 – £m £m 7 2 –(9) – (7) (2) 4 – – 4 476 43 – 433 7 1 288 18 – 270 (220) (13) – (207) 5 7159 7 – 152 24 (2 (226) (12) – (214) pension pension US and US US and US plans plans other other £m £m www.baesystems.com healthcare healthcare e expected plans plans onships onships £m £m US US higher ticipating

Total Total £m £m 101

Financial statements £m 99 11 £m £m 108 (103) Total

plans. plans. The cash xpects 1m in 2007. rs are are rs In addition, addition, In ilment gains gains ilment point decrease US £m One percentage e in UK nsideration nsideration contributions contributions osal was plans alaries and £11m and alaries £11m healthcare 2005 3 2 £m £m other re liabilities. plans to these plans plans to these USand pension 2005 £260m). Of this 2005 £260m).

– – – – point increase (4) 6 (3)(4) 6 (1) (4) – – (4) UK £m One percentage (12) (1) 9 (4) (11) – – (11) e of the £113m curta the £113m e of 523 104 5 632 plans (135) (57) 7 (185) (123) (56) (2) (181) (527) (98) (8) (633) benefit defined pension ty accounted investments. investments. ty accounted ge in respect of the cash to reduce futu to reduce at £238m, and £199m in cash. cash. and £199m in at £238m, bution of £56m of £56m bution 45 £m were £1,020m ( were £1,020m Total contributions. In 2007, the Group e Group the 2007, contributions. In ceive a share of ceive the deferred co pating employers. Of this £110m gain, £6 gain, £110m Of this employers. pating . The Group’s shar . The US (2) £m plans of £100m. Within EBITA, this profit on disp profit this EBITA, Within of £100m.

healthcare ddress the funding deficit in its principal UK pension pension UK principal its deficit in funding ddress the 2006 2006 ts with the Group’s equi Group’s the ts with £m other plans US and pension It expects to make a contri expects to make It The Group also incurred a char also incurred Group The nsaction in 2005 and valued and valued in 2005 nsaction anges to the members’ benefits the members’ anges to –––– (5) (2) – (7) (7) – – (7) UK 33 14 49 61 – 110 £m measures to a 601 132 6 739 plans (134) (62) (2) (198) (129) (60) (2) (191) (568) (118) (8) (694) benefit defined pension valued at £242m, the right to re the right valued at £242m, the year ended 31 December 2006 2006 December year ended 31 the (continued) the deficit and £287m were regular regular were deficit and £287m the ctures business disposed in of 2006 sult of certain benefit changes made benefit changes of certain sult the Eurosystems tra the ion schemes of $100m (£54m). (£54m). of $100m ion schemes certain properties properties certain et value, generating a profit on disposal a profit on disposal generating et value, quity accounted investments and other partici and other accounted investments quity level to those made in 2006. in to those made level d agreed a programme of a programme agreed d d contribution plans for employees. for plans d contribution butions towards funding funding butions towards the defined benefit plans in benefit the defined ontributions of £679m and agreed ch agreed £679m and of ontributions

6 g in the period were a g re in the period were contribution to US pens n arrangement arising from arising n arrangement harge of £103m arrangemen to relating various funding of £11m of in respect of the UK Aerostru ating costs of £11,763m costs ating BAE Systems Annual Report 2006 une 2006, the Group announced it ha une 2006, the Group announced it Gain on disposal of property, plant and equipment, and investment property property investment and equipment, and plant property, of disposal on Gain gains curtailment Pension 100 operating costs costs operating properties were sold to the scheme at mark at sold to the scheme were properties an operating c by offset Income statement items current service costs in the period due to the movement in discount rates. rates. discount in movement the to due period the in costs service current consolidated the and statement income consolidated the in reflected been have items these how summarises analysis following The statement: flow shown above is £110m after allocation to e allocation £110m after is shown above s pensionable US final the of calculation the to changes the from arising liability pension net the in reduction the to related increas an by offset partly is remainder The 2006. March in business Aerostructures UK the of disposal the of a result as arose there was a one-off cash under the put/call optio under the put/call The curtailment gains arisin The one-off contributions of £679m included of £679m contributions The one-off

Interest on obligations obligations on Interest Past service cost 102 Curtailment gains within share of results of equity accounted investments excluding finance costs and taxation expense expense taxation and costs finance excluding investments accounted equity of results of share within gains Curtailment EBITA 1 Included within other income of £371m: Included within other income of businesses disposal on Profit Included within oper The measures included one-off c one-off included The measures Effect on the aggregate of service cost and interest cost cost interest and cost service of aggregate the on Effect obligations benefit on defined Effect In J 0.2 0.2 A one percentage point change in assumed healthcare cost trend rates would have the following effects: effects: following the have would rates trend cost healthcare assumed in change point percentage one A Group’s share of equity accounted investments’ finance costs finance investments’ accounted equity of share Group’s 6 includes a curtailment gain Included of results in share of equity accounted investments: investments’ accounted equity of share Group’s Expected return on plan assets assets plan on return Expected Included in other income: income: Included in other Curtailments and settlements Included in operating costs: cost service Current The Group contributions made to The Group contributions 22. (continued) obligations Retirement benefit Contributions

Notes to the Group accounts accounts Group the to Notes Included infinance costs: The amounts recognised in the income statement after allocation to equity accounted investments and other participating employe participating other and investments accounted equity to allocation after statement income the in recognised amounts The as follows: amount, £733m were special contri special amount, £733m were a similar at contributions regular to make of £57m (2005 £41m) paid to define of £57m (2005

Financial statements Cret 26 829 424 271 269 175 – (37) 38 14 2 (22) 718 65 82 (1) 393 (1) share optionschemes (n Included within legal costs,en 52 are based on past experience of similar items and other known factors and represent management’s best estimate of the likely ou The Group holds provisions for expected legal, environmental and other costs that it expects to incur over an extended period. – Legal costs,environmental andother provisions 63 (7) 7 (1) other known factors. Such costs are generally incurred within one to three years. The costs associated with the reorganisation programmes are supported by detailed plans and based on previous experience as wel Reorganisations –ongoingoperations on an assessment of future claims with reference to past experience. Such costs are generally incurred within three years post- (72) 154 Warranties and after-sales service are provided in the normal course of business with provisions for associated costs being mad (7) (61) 199 – Warranties and 1 after-sales service 176 information is provided in note 24. Such costs are generally incurred within five years. 217 The provision includes probable exposures under residual value guarantees issued by the Group on previous sales transactions. F Aircraft financing (26) 8 108 (17) 33 – Current 50 Non-current 13 by: Represented (34) 2006 31December At (37) 72 Other provision movements (207) 339 (124) Exchange adjustments 64 Discounting – 375 Provisions 90 andfairvalues aris 343 Utilised (75) Released (9) Created 35 At 1 January 2006 Current 53 Non-current 55 23. Operating business cash outflow Proceeds from saleof property, plantand equipment Cash outflow from operating activities Decrease in working capital: Decrease in liabilities for re Gain on disposal of business –continuing operations Gain on disposal of investment property Gain on disposal of property investments accounted of equity results of Share year the for Profit Cash flow statement items: Retirementbenefit obligations (continued) 22. Trade and other receivables

Provisions ote 26). Thecosts inre tirementobligations benefit n naqiiin –––() (2) (2) – – – ing on acquisitions vironmental andother is £82m (2005 £80m)in respec spect of this liability areexpected to

financing Aircraft £m 2175 444695 444695 52 52 147 147 52 52 after-sales service Warranties and £m occur over the next fiveyears.occur over t of thecash-settled ongoing operations ongoing Reorganisations – Reorganisations £m elements ofcertain of environmental Legal costs, and other www.baesystems.com £m

These costs delivery. e based e based the Group’s Group’s the urther urther tcome. l as l as (253) (495) (706) Total 242 215 108 (11) (65) (35) £m 103 £m (1)

Financial statements 8 £m £m 93 66 (4) ered ered £m 101 273 552 891 118 65 2005 2005 e 460 (391) is made is made Group’s e of such such e of 5 d aircraft £m £m s have s have 121 393 731 212 133 138 2006 2006 hese hese b AB. 1,245 31 December 2005

(5) £m these arrangements are cov arrangements these 27 RVGs given by Saa given RVGs 191 (159) ft sold. At 31 December 2006 the 2006 December At 31 sold. ft 31 December 2006 raft financing and raft financing £27m as discussed below: as discussed £27m

s £191m (2005 £460m). Certain of £460m). (2005 s £191m (continued) respect of certain commercial aircra commercial of certain respect (note 23) is an exposure of exposure is an 23) (note liabilities arising from commercial airc commercial from arising liabilities spect of these arrangements wa spect of these arrangements g provision of £52m value guarantees (RVGs) in (RVGs) value guarantees tual and contingent tual and contingent s are set out in note 32. 32. s are out note set in BAE Systems Annual Report 2006 Contingent liabilities and commitments commitments and liabilities Contingent

104 Treasury contingent liabilities liabilities contingent Treasury liabilitie contingent Treasury Intangible assets Capital expenditure contracted for but not provided for in the accounts is as follows: follows: as is accounts the in for provided not but for contracted expenditure Capital equipment and plant Property, Total of future minimum sublease income under non-cancellable subleases subleases non-cancellable under income sublease minimum future of Total commitments Capital Later than one year and not later than five years years five than later not and year one than Later Later than five years Payments due: due: Payments Not later than one year The Group leases various offices,factories, shipyardsandaircraft under non-cancellable operating lease agreements. The lease varying terms, escalation clauses and renewal rights. incom sublease minimum future associated and leases operating non-cancellable under payments lease minimum aggregate future The follows: as are The Group has entered into a number of guarantee and performance bond arrangements in the normal course of business. Provision Provision business. of course normal the in arrangements bond performance and guarantee of number a into entered has Group The arrangements. such under payable become may consider directors the that amounts any for Operatingcommitments lease is the lessee – where the Group The reduction in the net exposure reflects the settlement of the commitment in respect of 47 RVGs in the period. period. the in 47 RVGs of respect in commitment the of settlement the reflects exposure net the in reduction The bonds performance and Guarantees The Group is also exposed to ac also The Group is shar The Group’s of Saab. accounts the within basis value present a net on exposures net expected the against made is Provision Saab. in shareholding percentage its to limited is exposure by a Financial Risk Insurance Programme (FRIP) under which the Group would place reliance on insurance cover for the anticipate the for cover insurance on reliance place would Group the which under (FRIP) Programme Insurance Risk Financial a by called. were guarantees the if values t to exposure net Group’s the that consider directors the valuations appraisal independent and FRIP the of account taking After aircraft. related the of values residual the and held provisions the by covered is guarantees The Group has provided residual residual The Group has provided re payments in future exposure to make Potential future cash flow payments in respect of aircraft financing obligations obligations financing aircraft of respect in payments flow cash future Potential Anticipated aircraft values values present net to Adjustments provided exposure Net Aircraft financing contingent liabilities liabilities contingent financing Aircraft financin aircraft within the Included 24.

Notes to the Group accounts accounts Group the to Notes

Financial statements up or credited as paid up on the preference shares together with a premium of 75p per share, and all arrears of preferential di ovrino rfrnesae –– – – 15 – – 3 – 15 600 In connection with thedisposal shares Treasury 2006 31December At Conversionof preference shares Exercise of options At 1 January 2006 Exercise of options Placingshares of At 1 January 2005 fully paid and Issued 2006 2006and31December 1January At Authorised in the year At 1 January 2005 Authorised 25. shares of £76m (2005 £78m)is included as a element and an equity component which require separate accounting treatment. Under IAS 32, the equity option component of prefe In accordance with IAS 32 the convertible preference shares are considered to be a compound financial instrument consisting of maximum redemptionvalue of the remainingredeem any sh 31 December2006. The Company may Articles of Association the preference share conversion rate will be adjusted further as a result of share repurchases made aft the conversion rate shares. 2007 will bethe final year inwhich 0.47904ordinarthe basisof have been convertible into ordinary shares of 2.5p each at the option of the holder on 31May in any of the years since issue u Company’s shareholders but hasnovotingnor right, other rights, ordinary voting share. The Special Shareholder is entitled to re The Special Shareholder may require the Company at any time to r Shareholder. citizens. The effect of these requirements can also be amended by regulations made by the directors and approved by the Special requirement that the majority of the directors are British, and the requirement that the Chief Executive and any executive chai requirement that no foreign person, or foreign persons acting in concert, can have an interest in more than 15% of the Company, parts of the Company’s Articles of Association cannot be amended without the consent of the Special Shareholder. These articles One Special Share of £1in the Company is held on behalf of the Secretary of State for Trade and Industry (the Special Sharehol Special Share shares with an aggregate nominal value of £1m were held in treasury. treasury. The Company commenced th way of on-marketpurch of the capital paid up on the Special Share and in priority to any payment to any other class of shareholder, to the return of motion isto be proposed for the winding up of the Company. On a winding up, holders of the preference shares are entitled, aft in arrears, or where a motion is to be proposed which abrogates, varies or modifies the rights of the preference shareholders, The preference shares carry voting rights at a general meeting of the Company only where the preferential dividend is six month overdrafts (note 20). The Company also has in issue 260 million(2 Preference shares

Share capital has decreased to0.47554 ordina ases of ordinary shares us ares on1 January2010, in y shares foreveryprefer y of itsinterest in Airb preference shares,ignoring an is buyback programme on 26 Octobe redeem all oftheremaining preference shares at shareholders can elect toconvert theirs 005 266million) 7.75p (net)cumulative red separate reserve within equi ing authorities granted at ing us, the Compan each case at 100ppersharetogether wi ence share. Duringthe year6,116,123 ry shares for every prefer ry sharesforevery ceive notice of and to attend general meetings and classmeetin other than inrelation to speak anybusinessin to respect of y arrears or accruals of divide y arrearsoraccruals edeem the Special Share at par or to convert the Special Share y stated its intentio r 2006 and, as at 31 December the 2006 AGM and toholdth ty (note27).The debt element ence shareat31 December hares. As aresultof hares. n toreturnup £500m to ordinary s any time after1 July eemable preferences Number of shares were conv shares were ,1 0 1 80 1 77 1 1 80 1 96 3,219 77 1 3,060 1 96 3,850 ,4 1 1 81 1 1 81 111 3,246 1 1 111 4,450 th anyarrearsand shares Ordinary shares nd, isth of 2.5peach 5 –3 – – 3 150 41 – 1 – – 1 24 Equity Equity Total Non-equity m 9– – – – Nominal erefore £260m (2005£266m thesharerepurchas e repurchased sharesinit value is recognised within loa 2006. In accordance with £m 2006, 28,675,000 2.5p ordinary

2007 and,in any case, erted for2,929,867

Number of hares of 25peach wh accrualsdividen of shares Special Share Share Special www.baesystems.com of £1

the SpecialShare. Nominal amounts paid hareholders by by hareholders gs of the rman are British es during 2006, es during value er vidends. or where a p to2007,on er repayment more s or der). Certain the the into one £ both a debt include the the include

ially in ns and d. The ordinary rence rence the the ). ich will Nominal value

£m 105

Financial statements £ £ – – – ‘000 price price 2005 (806) shares 5,261 average average exercise exercise 18,917 14,462 Weighted Weighted 8.6m 8.6m Number of – –– ‘000 ‘000 ‘000 2006 (538) (992) 1.65 odified options shares shares shares 5,669 4,055 2,350 3.18 (2,495) (1,653) 3.35 25,608 18,917 63,47510,569 2.76 2.89 71,399 2.78 Number of Number of Number of 8,946 2.71 2005 2005

61,957 2.90 –– ––

(5) 2.40 (1,769) 2.68 69,129 2.88 2005 £ £ 7 7 6 27 price price price 1.00 1.62 average average exercise exercise Weighted Weighted termination made that termination made Equity-settled Cash-settled – – 2006 2006 2006 1.72 – 4.87 1.72 – 4.21 1.72 – ‘000 ‘000 ‘000 shares shares 6,082 4.28 8,641 2.15 8,641 2.15 (8,641) 2.15 (4,843) 2.29 69,129 2.88 11,736 3.01 71,399 2.78 16,269 2.86 56,202 2.80 35,805 2.82 Number of (13,353) 2.40 (13,353) 2.40 (19,840) 3.45 (16,567) 3.23 (16,567) 3.23 Number of re modified and a de re modified

76 918 2006 2006 1.30 – Equity-settled Cash-settled 1.72 – 4.87 1.72 – 4.21 (continued) ExSOS Share Appreciation Rights (SARs) we Rights Appreciation ExSOS Share BAE Systems Annual Report 2006 Share-based payments payments Share-based

Expired during the year year the during Expired year the of end the at Outstanding Exercised during the year year the during Exercised Converted during the year year the during Converted SARs should be settled on exercise by way of shares (equity-settled) rather than cash (cash-settled). The fair value of these m these of value fair The (cash-settled). cash than rather (equity-settled) shares of way by exercise on settled be should SARs time. same the at issued options equity equivalent the of value the on based calculated was 106 Exercisable at the end ofyear the year the of beginning the at Outstanding year the during Granted Equity-settled awards awards Equity-settled Performance Share Plan (PSP) (£) options outstanding of price of exercise Range (years) life contracted remaining average Weighted (£) granted options of fair value average Weighted Exercisable atthe end ofyear the unvested settlement for of the terms In 2006 Converted during the year year the during Converted Outstanding at the beginning of the year year the of beginning the at Outstanding year the during Granted Exercisable atthe end ofyear the rights appreciation share Cash-settled Outstanding at the beginning of the year year the of beginning the at Outstanding year the during Granted Details of the terms and conditions of each share option scheme are given in the Remuneration Report on pages 51 to 65. 65. 51 to pages on Report Remuneration the in given are scheme option share each of conditions and terms the of Details (ExSOS) Executive Scheme Option Share options Equity-settled 26.

Notes to the Group accounts accounts Group the to Notes Converted during the year year the during Converted Expense recognised for the year (£m) (£m) year the for recognised Expense Exercised during the year year the during Exercised Exercised during the year year the during Exercised Expired during the year year the during Expired Expired during the year year the during Expired year the of end the at Outstanding Outstanding at the end of the year year the of end the at Outstanding

Financial statements Exercisable at the end of the year the year of end atthe Exercisable Outstanding at the end of the year Expired during the year Exercised during the year Outstanding at the beginning of the year Equity-settled options Save-As-You-Earn (SAYE) The exercise price for the RSP is £nil (2005 £nil). Expense recognised for the year (£m) Weighted averagevalue fair of options granted (£) Weighted average remaining contracted life (years) the year of end atthe Exercisable Granted during the year Outstanding at the beginning of the year All awards are equity-settled. Restricted Share Plan(RSP) The exercise price for the PSP is £nil (2005 £nil). Expense recognised for the year (£m) Weighted averagevalue fair of options granted (£) Weighted average remaining contracted life (years) was calculated based on the value of the equivalent equity options issued at the same time. SARs should be settled on vesting by way of shares (equity-settled) rather than cash (cash-settled). The fair value of these mo In 2006 theterms of settlement for unvested the year of end atthe Exercisable Granted during the year Outstanding at the beginning of the year Cash-settled awards 26. Share-based payments (continued) Exercised during the year Converted during the year Expired during the year Exercised during the year Released during the year Outstanding at the end of the year Expired during the year Outstanding at the end of the year

PSP Share Appreciation Rights (SARs)PSP ShareAppreciation were qiystldCash-settled Equity-settled .8– 1.88 82254 2006 modifiedandadete Number of (11,215) 1.96 21,174 1.71 33,651 1.80 (1,262) 1.74 shares 128 1.74 ‘000 2006 Equity-settled Cash-settled Equity-settled rmination madethat 5 Weighted Weighted exercise exercise average www.baesystems.com price 1.48 2.77 £ 6 25 5 2005 3,5 1.80 –– 2.62 33,651 2.51 (13,191) 2.10 (7,372) 54,214

2005 Number of Number of Number of 21,389 12,701 (5,669) (2,188) shares 3,071 1,047 1,338 shares shares dified options (831) 3.89 2006 2006 ‘000 2006 303 ‘000 ‘000 (9) (3) 1 1 – – – Number of Number of .7m Weighted 16,076 21,389 exercise average 5,822 1,047 shares shares (509) (213) 2.38 2005 2005 2005 price 481 799 ‘000 ‘000 (20) 107 £ 1 2 – – – – –

Financial statements £ price 2005 2.6% 3 – 5 average exercise Weighted 0 – 3.56 27 – 42% 4.1 – 4.2% 4.1 – 2005 2006 is 2006 is ollowing ollowing 2.62 – 3.85 2.62 – ‘000 shares Number of plits, for the

16,924 4,424 2.46 (557) 3.56 (6,403) 2.56 14,388 2.66 3,093 2.70 2.71 2005 £ 2006 2006 4.18 price price 2.5% 4.4% 3 – 5 average exercise Weighted 0 – 4.28 27 – 38% Equity-settled Cash-settled – – 2006 2006 ‘000 ‘000 shares 8,923 2.76 1,592 1.74 (4,361) 2.48 (1,104) 2.91 14,388 2.70 Number of 3.21 0.93 – 3.56 1.72 –

– 1.15 2 2 – 9 3 wing for dividends and stock s and stock for dividends wing reported within provisions at 31 December December 31 at within provisions reported

–– 22 37 2006 2006 Equity-settled Cash-settled 0.93 – 3.21 1.72 – 3.56 share price volatility, after allo after share price volatility, (continued) at 31 December 2006 is £14m (2005 £3m). (2005 is £14m 31 December 2006 at the Group’s weekly Group’s the elements of shown above the and schemes e year was £3.96 (2005 £2.94). (2005 e year was £2.94). £3.96 sh-settled options that have vested options that sh-settled BAE Systems Annual Report 2006 108 The liability in respect of the cash-settled respect The liability in £82m (2005 £80m). of ca value The intrinsic Volatility was calculated with reference to with reference calculated was Volatility date. vest until period the for or weeks 30 of greater share price in th The average Volatility Volatility yield dividend Spot free interestRisk rate Range of share price at date of grant (£) grant of at date price of share Range (£) price Exercise (years) life option Expected RSP – Dividend valuation model model valuation RSP – Dividend ExSOS– Binomial & SAYE model The fair value of equity-settled awards granted in the year has been measured using the weighted average inputs below and the f the and below inputs average weighted the using measured been has year the in granted awards equity-settled of value fair The models: valuation Carlo Monte – PSP Weighted average fair value of options granted (£) (£) granted options of fair value average Weighted (£m) year the for recognised Expense year in the granted of options Details (£) options outstanding of price of exercise Range (years) life contracted remaining average Weighted Exercisable at the end ofyear the Exercised during the year year the during Exercised year the during Expired year the of end the at Outstanding Outstanding at the beginning of the year year the of beginning the at Outstanding year the during Granted 26. Share-based payments (continued) payments 26. Share-based rights appreciation share Cash-settled

Notes to the Group accounts accounts Group the to Notes

Financial statements Not yet allocated to share option schemes

Held under PerformanceShare Plan

3 Under section 4 of the British Aerospace Aerospace British the of 4 section Under 3 paymshare-based of respect Thecreditin 2 hrsise 330––– 7 –373 – 16 (315) – 373 – – 2,804 (315) 16 16 (315) – 16 – 2,788 (2,872) 4,720 – – – 78 – 370 782 – 3 80 – – – At 31 December 2005 Ordinary sharedividends OtherShares issued Share-based payments Total recognised income an ––––– – 44 income statement on an accruals basis. basis. accruals on an statement income Dividends on the shares held in the ESOP Trust have not been waived. Finance costs and other administrative charges are include Held under Restricted Share Plan Allocation Not yet allocated to share option schemes Under option value Market are the trustees. Information on the market value and allocation of these shares to the Group’s various share option schemes is each in BAE Systems plc, listed on the London Stock Exchange, and are held by BAE Systems ESOP Trust of which IFG Trust (Jersey Own shares with aweighted aver TrustLimited ESOP Systems BAE Own shares held, including treasury shares and shares held by the ESOP Trust, are recognised as a deduction from retained earni Own sharesheld 3,087 fair reserv the value 2004, December At 31 1 10 Other reserves includes amerg 3,077 (3,504) 6,014 78 412 77 Share-based payments Total recognised income and Reclassification Balance at1 January2005 27. riaysaedvdns 36 (4) (346) – (346) (346) 5 – 53 – – – 5 53 – (11) (6) – – – 6 – (11) (2) – – 7 (91) (11) 52 91 – – 1 – – – 2006 31December At Ordinary sharedividends – Other – Reclassification Revaluation of net assets acquired by equity accounted Releaseunrealised of gainthe onsale of Atlas Elektronik Purchase of treasuryshar Conversionof preference shares by shares own of Purchase – Proceeds from sharesissued options: Share ––––– – – – (2)(2) of £259mdebit (2005 £85m de Other employees: Executive directors: Other employees: Executive directors: netet nt 4 5 5 – 5 5 – – – – investments (note 14) fully paid bonus shares. to a change in the terms of certain share-based payment schemes from cash-settled to equity-settled and £4m relating to discont to relating £4m and equity-settled to cash-settled from schemes payment share-based certain of terms the in change a to this was reclassifiedinto retainedearnings. prof valuethrough fair at asset hol Group’s the 1, IFRS with accordance in and 32, IAS of adoption On date. that at value market to cost historical from shares

Reconciliation ofmovement 1 –––(3)636 (636) – – – – – – under option under option under option under option 2 ––––46 – – – – 46 46 – s––––(112) – – – es – (112) (112) – it or loss. As a result, from 1 January 2005move January from 1 As aresult, or loss. it xes –––(5)25 33 2(361) 2 (363) 295 (658) – – – d expense EO ––––(2 (2 –(12) – (12) (12) – – – – ESOP xes 46 2,177 (476) – – expense – 1,701 1,704 3 er reserve of £4,589m (2005 bit) and a hedging rese bit) andahedging age costof£8m (2005 £5m)comprise a holding of Act 1980 the statutory reserve may only be appl be only may reserve statutory 1980the Act ents for the year ended 31 December 2006 co 2006 December ended 31 theyear for ents e of £636m represented e of £636mrepresented in capital and reserves the unrealised gain on the Grou on the gain the unrealised rve of£27m (2005£225m). £4,589m), astatutory reserve ments in the market val inthemarket ments Issued capital share £m 1817 4,330 76 841 81 mprises £21minrespec mprises ied in paying up unissued shares of t of shares unissued up paying in ied premium Attributable to equity holders of the parent holdersoftheparent toequity Attributable Share £m p’s holdings in the shares of shares the holdings in p’s ue of these shares are ue oftheseshares preference option of 2,382,835 (2005 1,748,945) shares Equity £m t of equity-settled 3 of£202m(2005 £202m), a reserves Other £m he Group to be allotted to members of the Group as Group the of members to allotted be to Group he ding in these shares was designated as a financial a financial as designated was shares these in ding recorded through the income statement. Accordingly, Accordingly, statement. income the through recorded Vodafone Group Plc that arose on uplifting the the uplifting on arose that Plc Group Vodafone inued operations. operations. inued share-based payment schemes, £21m relating relating £21m schemes, payment share-based Retained Retained earnings earnings (1,211) £m 2,382,835 1,138,671

Number of 573,639 470,952 199,573 ,1 74,134 4,117 17 www.baesystems.com shares ordinary shares of 2 ordinary sharesof 2006 2006 Total £m 10 10 £m – –

translation reserve interests Minority £m as follows: 1,748,945 ngs. d in the d inthe ) Limited Limited ) 702,481 661,940 384,524 Number of shares .5p equity 2005 2005 Total £m £m 109 7 3 4 – –

Financial statements – – – £m £m £m 30 54 30 88 17 (35) (52) (12) (17) (17) (79) (53) (27) (90) 373 323 168 285 850 373 634 2005 2005 2005 (668) (283) (951) (288) (315) (219) (318) (905) (152) (815) 1,758 2,099 1,937 1,937 2,581 3,215 1,937 (1,277) (1,548) (3,534) (1,277) (4,492) Restated – – – 1 4 (9) (5) (5) 53 £m £m £m (12) (26) (85) (27) (23) (62) 435 323 503 435 782 490 778 135 174 145 782 273 137 173 289 158 782 2006 2006 2006 (112) (308) (334) (207) (346) (419) (225) 3,100 3,607 1,330 (2,776) (1,277) (1,277) (3,172)

payments guarantees unrelated to

(continued)

1 (included within payables) payables) within (included 1 BAE Systems Annual Report 2006 Net cash/(debt) as defined by the Group Net cash/(debt) as defined by the Reconciliation of operating business cash flow business of operating Reconciliation

company performance performance company Operating business cash flow Interest and preference dividends Taxation Loans – current Overdrafts – current Closing net cash/(debt) as defined by the Group Group the by defined as cash/(debt) net Closing 110 1 cash on customers’ account is the unexpended cash received from customers in advance of delivery which is subject to advance Foreign exchange account customers’ on received cash in Movement Equity dividends paid movements non-cash Other shares treasury of Purchase Purchaseof own shares byESOP Free cash inflow inflow cash Free Acquisitions and disposals undertaking subsidiary of acquisition on acquired Debt capital share of issue from Proceeds Opening net debt as defined by the Group Group the by defined as debt net Opening 39 IAS 32 and IAS of Adoption Group the by defined as debt net opening Restated Closing net cash/(debt) as defined by the Group Group the by defined as cash/(debt) net Closing net cash/(debt) asMovement defined by the Group in Loans and overdrafts – current – current overdrafts and Loans account customers’ on received Cash non-current – Loans Term deposits – non-current – current investments Other equivalents and cash Cash 29. HQ and other businesses Discontinued operations Operating business cash flow Programmes & Support Solutions Customer & Partnerships Systems Integrated Operating business cash flow & Support Electronics, Intelligence Land & Armaments Proceeds from the sale of non-current other investments investments other non-current of sale the from Proceeds investments other non-current of Purchase investments accounted equity from received Dividends Capital expenditure on investment property property investment on expenditure Capital assets intangible to Additions equipment and plant property, of sale the from Proceeds property investment of sale the from Proceeds Cash inflow from operating activities activities operating from inflow Cash equipment and plant property, of Purchases 28.

Notes to the Group accounts accounts Group the to Notes

Financial statements interest rate contracts, classified by year of maturity. maturity. of year by classified contracts, rate interest The notional, or contracted, amounts of derivative financial instruments are shown below, analysed between foreign exchange con Hedging instruments non-current provisions. Sterling US dollar Net forward (sales)/purchase contracts contracts swap Cross currency US dollar contracts swap rate Interest Interest ratecontracts US dollar Net forward (sales)/purchase contracts Foreign exchange contracts instru liabilities andother review and the directors’ report. Financial instruments comprise net debt (note 29) together with other financial assets and ot A discussion of the Group’s treasury objectives and policies and the use of financial instruments can be found in the operating 32. Group paid deferr The company specialises in the development of electro-optical sensor systems for aerospace and defence applications. In additio On 16 October 2006 theGroupco 31. ratherthan cashshouldcomplete amandate form for the DividendReinvestment Planandreturn itthe to registrars nolater tha Shareholders whodonot at present participate the Company’s in approval, will bepaidon1 June 2007 to After thebalance sheet dat Prior year final 6.3p dividend per or Equity dividends 30.

Other Euro Other Euro Interim 4.4p dividend perordinary

Financial risk management subsidiaries Acquisition of Dividends ed consideration of£7min respect ofit ments deemed tobe e, the directorsproposedafinaldi e,

mpleted the acquisitionof mpleted share paid in the year (2005 4.0p) dinary share paid in shareholders registered on financial instruments underIAS 32 includi the year (2005 5.8p) the year(2005 s acquisition, inMa 100% oftheshares of vidend of6.9p (2005 6.3p). The Dividend Reinvestment Planandwishto receive the finaldivide exceeding exceeding exceeding 20 April 2007. The ex-div 148 5(8 (1,511) (38) 25 (1,498) 1 year 1 year 1 year (819) 4 5 0 696 301 252 143 4 1 0 559 301 115 143 2 6 792 – 664 128 5 6 3970 53 763 154 4 03656 3 10 643 Not Not Not £m £m £m 69 3178 53 99 26 62–38 – 2 36 17 (137) – (137) – –––– y 2005, of OMC Group. OMC y 2005,of Between 31 December 2006 Between Between 31 December 2006 31 December 2006 5 years 5 years 5 years 1 year 1 year 1 year and and and £m £m £m 37 National Sensor System 5 years 5 years 5 years ng non-current receng non-current More More More than than than 3)(817) (35) £m £m £m idend date is18 April 2007. dividend, which is subject to sh Total Total Total £m £m £m

–( 3)–(135) (95) – – – – 758 (135) (95) 21 277 460 2 740528 2147 460

120 5)21,183 2 156 (1,348) (35) – 20 (59) 136 93 1,240 (1,406) (4)10 3)(9) (33) 170 (146) 31December2005 31December2005 31December2005 exceeding exceeding exceeding exceeding exceeding ivables, non-curren s, LLC. for $8.7m (£5m)i 1 year 1 year 1 year Not Not Not £m 250471,019 116 497 12 510 31 12 73 £m £m 3 6 903 466 – 437 www.baesystems.com Between Between Between Between Between 5 years 5 years 5 years 1 year 1 year 1 year and and and £m £m £m

n 10 May2007. n 10 nd inshares nd 5 years her financial 5 years 5 years areholder and financial financial and t payables and 2006 More 203 346 143 More More than than than £m £m £m £m n, the the n, tracts and n cash. n cash. 2005 186 315 129 Total Total Total £m £m £m £m 111

Financial statements £m £m 2005 2011 Beyond fair value Estimated –– £m and the the and £m 54 54 65 65 Net propriate propriate (45) (45) (81) (81) 2011 634 634 912 912 2005 ing at the (905) (905) (319) (610) . erest cash flows cash flows erest 2,581 2,581 amount carrying (3,534) (3,825) as shown below: he amounts the the amounts he the balance balance the £m £m 2010 2006 2006 (573) (281) (141) fair value fair value Estimated Estimated

£m 4 4 2009 50 50 51 51 £m Net (45) (45) (50) (50) 503 503 569 569 2006 2006 be indicative of t be indicative (334) (339) 1,072 879 3,100 3,100 amount carrying carrying (2,776) (2,964)

£m 2008 balance sheet date s to their carrying values at values to their carrying s £m 2007 (764) (636) (608)

nce sheet date may not date may nce sheet financial assets and assets financial liabilitie presented at the bala at the presented (continued) and liabilities are consistent with their carrying values at the estimated fair values of certain ation factors, the fair values fair values ation factors, the prevailing at 31 December. December. at 31 prevailing

2 . 1 BAE Systems Annual Report 2006 market-based interest rates market-based interest appropriate balance sheet rates; rates; sheet balance appropriate rates; sheet balance appropriate the at translating and Current Loans and overdrafts (112) – – – – – Group would expect to realise in a current market environment. environment. market a current in realise to expect would Group the table compares The following Other financial liabilities liabilities financial overdrafts and Loans Other Other financial liabilities liabilities financial Other Current 112 Liabilities Non-current Loans Other investments investments Other Current equivalents and cash Cash 503– – – – 3,100 – – – – – – Assets Non-current receivables other and Trade 115 – – – – – Based on contracted maturities and/or repricing dates, the following amounts are exposed to interest rate risk over the future future over the risk rate interest to exposed are following amounts dates, the and/or repricing maturities Based on contracted 1 the estimated fair values of the remaining financial assets 2 net carrying amount approximates to estimated fair value as there is no active market Interest rate risk Other receivables Other Assets Non-current investments Other sheet date sheet – the fair value of loans and overdrafts has been estimated by discounting the future cash flows to net present values using ap using values present net to flows cash future the – discounting by estimated been has overdrafts and loans of value fair the the valu of Due to the variability – the fair value of forward foreign exchange contracts are calculated by discounting the contracted forward values and translat and values forward contracted the – discounting by calculated are contracts exchange foreign forward of value fair the int and principal future expected discounting by – calculated are swaps cross-currency and rate interest both of value fair the The fair value of a financial instrument is the price at which one party would assume the rights and/or duties of another party another of duties and/or rights the assume would party one which at price is the instrument financial a of value fair The date, sheet balance the at information market available on based determined been have instruments financial of values fair The below: listed methodologies valuation 32. (continued) management risk Financial instruments financial of Fair value

Notes to the Group accounts accounts Group the to Notes Loans Liabilities Non-current Current investments Other assets financial Other equivalents and cash Cash assets financial Other

Financial statements However, it hasbe However, Xchanging HRServices Xchanging ProcurementServices Silicon Sensing Systems CTA International Saab AB Panavia Aircraft GmbH SAS MBDA Gripen International KB Fleet Support Limited Flagship Training Limited GmbH Jagdflugzeug Eurofighter Airbus SAS party Related 2006 For theyearended 31December settled on normal trade terms. The more significant transactions are disclosed below: Transactions occur with the equity accounted investments in the normal course of business and are priced on an arm’s-length bas 22). (note plans pension the 14)and (note investments accounted its equity 7), innote 65 and The Group has a related party relationship with its directors and key management (as disclosed in the Remuneration Report on pa 33. instruments, mainlyintere achieved through varying the proportion of fixed rate debt relative to floating rate debt over the forward time horizon by util deposi and on borrowings fluctuations rate interest to the exposure istoreduce riskmanagement rate of interest objective The fluctuations rate Interest been reduced from £1.5bn to £1.3bn. The RCF remained undrawn throughout the year. (2005 £1.5bn which expiresin more thantw At 31 December 2006 the Grou Committed undrawnbo (2005 £80m). of thesefinancial derivat require can be payments collateral Cash rate exposures. interest As shown above, the Group has entered into a number of financial derivative contracts to hedge certain long-term foreign curren Collateral 32. maximum of75% (200575%) of debt overnight deposits and money market funds. The Group, therefore, believes it has negligible exposure to price risk. risk. toprice exposure negligible it has believes therefore, The Group, market funds. money and deposits overnight The cash and cash equivalents of the Group are invested in non-speculative financial instruments which are usually highly liqui counterparty’s FT composite rating. These limits are regularly monitored and updated. has a credit limit system to manage actively its exposure to treasury counterparties. The system assigns a maximum exposure bas financial instruments. However, the Group has policies in place to ensure credit risk is limited by placing concentration limit The Group is exposed to credit risk on its cash and cash equivalents to the extent of non-performance by its counterparties in Credit risk on cash and cash equivalents rates. interest at floating based periods In respect of cash deposits, given the fluctuation in the Group’s working capital requirements, cash is generally invested for £9m by tothe cost Group interest the vary would ofborrowings level mixand fixed/floating end the year to applied rates term sterling (2005 5.3% – 5%on US dollarsand6. Given the level of short-term interest rates during the year, the average cost of the floating rate debt was 5.8% on both US do period in respect ofwhic type of swap outstand payable on debt intoeith The floating rate debt has been predominantly achieved by entering into interest rate swaps which swap the fixed rate US dollar rate debt and28% (200530%) of fl

Financial risk management (continued) Related partytransactions 1

en extended by theagreement oftwo ing withanaverageduration rrowing facilities h interest is fixed was ives. Cash depositedin er floating rate sterling or US dollars. At theen st rateswaps.Th p had a revolving credit facility ( oating ratedebt is maintained at fixedinterest e Group’s current interest ra o yearsbutlessthan fiveyears).The RCF 1% onsterling); the cost ofthe fixed ra six years (2005 six years). years (2005six six this way istreatedas of 3.6 years(20054.5 year based on a gross debt of a gross based on one-year extens RCF) of £1.5bn, whichexpiresin d to be made periodically to the counterparty dependent on the rates. At 31 December2006, a non-current receivablea non-current an d of2006, the Group had a te management policyisthat a minimum of 25%(2005 25% ions until2012,althoughthe Sales to £3.1bn (2005 £4.4bn). ,1 76 –– – 9766 – 1,212 related s). In respectofthe fixe party 2 21 8 2– 2 14482 12 124 £m 0–––1 – – – 15 – 50 61122–– – 2 – 101 – 2– 16 53 75 – 1 – – – – – 2 1 4 18– 2–– 0 1 –– – – –26 103115 – ––– –16 – – 2 7 2 – – – –– – te debt was 7.0% (2005 6.8%). A 1% change 1% 7.0% (20056.8%).A was te debt Purchases Purchases was originally contracted forfiveyearsu related party from £m more thantwoyearsbutlessth d at 31 December 2006total the Group had 72% (2005 70%)of f 72% (2005 the Grouphad Amounts total of$1.6bn (2005 $1. owed by related available amount party d rate debt theweighted £m related party Amounts owed to £m www.baesystems.com for the fin for with related (expense) ising derivative income/ s. BAE Systems Systems BAE s. short-term short-term Lease party llars and 7bn) of this this of 7bn) (2005 £13m). respect of of respect d suchas £m ntil 2010. average ts.is This interest interest led £115m cy and an five years years five an market value value market al yearhas ges 51 to is and inshort- ed on the the on ed ) and a and ) ixed Other £m 113

Financial statements £m Other Wales Wales Wales Wales Wales Wales Wales Country of incorporation sh sh £m party Lease income/ . All holdings All holdings . (expense) with related UK England and and UK England and UK England and UK England UK England and and UK England £m Principally party operates in related owed to Amounts US & Sweden US £m party hanging HR Services for a Services for ca HR hanging related etary, BAE Systems plc. owed by Amounts £m from party related Purchases

2 –1 – – – £m party related Sales to to Sales HR Enterprise Limited to Xc Limited to Enterprise HR vehicles and ship repair repair ship and vehicles systems weapon vehicles armoured of support vehicles activities Shipbuilding UK England and and England avionics and support Defence contracting prime Naval UK Shipbuilding Australia systems Defence systems Defence Australia of military support and Manufacture UK and ammunition of Manufacture and England and supply manufacture, Design, of military and support Manufacture UK and England US US Principal activities Defence and commercial aerospace (continued) le of its 50% interest in the date of disposal in October 2006 nary share capital. nary share capital. Electronics Limited) Limited) Electronics BAE Systems Annual Report 2006 Events after the balance sheet date sheet balance Events after the Group entities Related party transactions (continued) transactions Related party

Alvis Limited) Alvis Limited) BAE Systems (Holdings) Limited) consideration of £10m. consideration 114 35. the sa completed Group the 2007, On 17 January The above list sets out the principal subsidiaries within the Group accounts. It does not represent a full list of subsidiaries of list full a represent not does It accounts. Group the within subsidiaries principal the out sets list above The ordi of represent 100% * Company subject to specific Office of Fair Trading undertakings. Copies of its accounts may be obtained from the Company Secr Alvis Limited (HeldBAE Systems via (Holdings) Limited) BAE Systems Land Systems (Munitions Limited & Ordnance) (HeldBAE Systems via (Holdings) Limited) Limited & Vehicles) (Weapons Systems Land BAE Systems (HeldBAE Systems via Land Systems (Finance) Limited and (Held via BAE Systems Holdings Inc.) (Held via Inc. Armaments & Land Systems BAE BAE Systems Inc.) (Held via (HeldBAE Systems via Marine (Holdings) Limited) Limited Technologies System Integrated Systems BAE BAE Systems (Held via Inc. BAE Systems (HeldBAE Systems via Australia Holdings Limited) Limited Electronics Systems BAE (HeldMeslink via Limited) Limited* Marine Systems BAE BAE Systems (Operations) Limited Limited (Operations) Systems BAE (HeldBAE Systems via Enterprises Limited and BAE SystemsAustralia Limited 34. entities Principal subsidiary Xchanging HR Services Services HR Xchanging 1 transactions with AirbusSAS up to – 6 2 – – – Saab AB AB MBDA SAS Panavia Aircraft GmbH Saab Services Procurement Xchanging –– – 431 14 24 22 106 79 1 14 2 – 27 3 478 – – 2 – 3 – Flagship Training Limited Limited Training Flagship Limited Support Fleet KB Gripen International – – – 2 9 – – – 4 13 24 – – – – – – – Related party Airbus SAS NV AMS GmbH Jagdflugzeug Eurofighter 1,242 – 177 18 – – – – 745 – 17 – 33. 31 December ended For the year 2005

Notes to the Group accounts accounts Group the to Notes

Financial statements

Other financial liabilitiesOther financial Creditors Creditors M J Turner G W Rose W G Rose Group Finance Director Chief Executive M JTurner Approved by theBoard 7 Issued share capital Capital andreserves 7 Provisions forliabilities and charges 3 Loans Liabilities falling dueafteroneyear Total assetslesscurrent liabilities Net current liabilities liabilitiesOther financial Creditors Loans and overdrafts Liabilities falling duewithin one year Cash at bank and in hand Other financial assetsdueafter one year year one within due assets financial Other Investments Debtors due afteroneyear Debtors due withinoneyear Stocks Current assets Investmentsin subsidiary undertakings Investments Tangible assets Fixed assets as at31December Company balancesheet qiyoto fcnetbepeeecssae 1 12 account loss and Profit Other reserves Statutory reserve Share premium account Equity optionof convertible preferencesshares Equity shareholders’ funds funds shareholders’ Equity

on 21February 2007 and sign ed onits behalf by: oe Notes 212 10 3 13 13 14 13 7 9 8 7 9 8 6 5 5 4 2

www.baesystems.com (9,113) (8,903) 3,992 8,117 2,714 4,599 4,988 4,979 2,990 2,990 1,689 (990) (913) (996) (123) 2006 491 144 101 202 841 (76) (87) (12) £m 85 82 76 81 (1) 2 9 (10,622) (2,244) (9,707) 1,771 2,753 8,378 1,332 6,115 4,997 4,978 1,771 (979) (936) (167) (748) 2005 152 599 121 202 782 580 (42) 57 19 49 78 80 £m 115 (1) (3) 2

Financial statements of shares that will that of shares re unvested as of ition of the grant of the options. of the options. grant ition of the er’s national insurance liability liability insurance er’s national ttled share options are measured at fair fair at are measured ttled share options estimate of the number number estimate of the 7 November 2002 that we 2002 that November 7 ion for impairment. national insurance liability as a cond a as insurance liability national The Company hasadvantage taken ofexemption the offered in UrgentIssues Task Force AbstractEmployee 17 – share schemes 20% the account loss and profit the to charging from 17) (UITF operated Company such in partaking employees to offered discount schemes. SAYE reversed by the balance sheet date where there is an obligation is obligation an there where date sheet balance by the reversed to pay more tax, ora right pay to less tax, infuture. the benefits post-retirement Pensions and other the in operated plans pension Group to contributes Company The UK. Details ofprincipal the plans and the financialassumptions Systems BAE of accounts consolidated the in contained are used 17 Retirement Standard Reporting Financial by permitted As plc. as defined for accounted are plans the 17), (FRS Benefits of share its identify cannot employer the as plans, contribution employer’s The plans. the of liabilities and assets underlying the and period service current the to relation in set are contributions the during agreed were which measures of a series fund to also deficits. scheme pension the address to year and own shares held Share options In employees. to options share equity-settled issues Company The payment Share-based 20 FRS of requirements the with accordance (FRS 20), the Company has applied FRS 20 to all equity-share after options granted 1 January 2005. Equity-se fair The model. pricing option an using grant of date the at value value expensed is a on straight-line basis over the vesting period, Company’s on the based vest. actually National 25 – Abstract Force Task Issues Urgent with accordance In Company the 25) (UITF gains option share on contributions insurance for the employ full provides in granted, options share of exercise future the on arise to estimated employer’s the settle to agreed has employee the where except Leases Leases fixed tangible in included are leases finance under obtained Assets lives, economic useful their over depreciated are and cost at assets or theof term their lease, whichever is shorter.Future instalments loans. within included are charges, finance of net leases, such under element, finance the between apportioned are payments Rental the and account, loss and profit the to as interest charged is which capital element, which reduces the outstandingobligation future for the on charge of rate constant a give as to so instalments, obligation. outstanding profit the to charged are leases operating under payments Rental profit. operating at arriving in basis straight-line a on account and loss Investments stated are companies group in shares in investment Company’s The provis less at cost Stocks all relevant including cost, of lower the at stated are Stocks value. realisable net and expenditure, overhead Tax takes and year the for profit the on based is taxation for charge The between differences timing of because deferred taxation of account purposes. accounting and taxation for items certain of treatment the of respect in basis undiscounted an on recognised is tax Deferred for items certain of treatment the between differences all timing not but arisen have which purposes accounting and taxation e Company is exempt from the exempt is e Company termshorter if years 5 3 to currencies are retranslated at the at are retranslated currencies assets and financial liabilities liabilities financial and assets 131 and 133 of the Companies Act 1985 is Act 1985 of the Companies and 133 131 BAE Systems Annual Report 2006 Accounting policies policies Accounting

116 No depreciation is provided on freehold land and assets in the the in assets and land freehold on is provided depreciation No of construction. course the that indications are there if undertaken are reviews Impairment carrying valuesmaynot be recoverable. Computing equipment, motor motor equipment, Computing works life short and vehicles equipment following rates: rates: following Buildings lease the or years, 50 to up Tangible fixed assets assets fixed Tangible write to basis, straight-line a on normally provided, is Depreciation estimated their over assets fixed tangible of valuation or cost the off the using value residual estimated any to lives economic useful differences are recognised in the profit and loss account unless they they unless account loss and profit the in recognised are differences effective the case which in treatment, accounting hedge for qualify portion is recogniseddirectly a separate in componentequity. of Transactions in foreign currencies are translated at the exchange exchange the at translated are currencies foreign in Transactions rates ruling at dates the oftransactions. the Monetaryassetsand foreign in liabilities denominated exchange These date. sheet balance the at ruling rates exchange the consolidated cash flow statement of the Group. Group. the of statement flow cash consolidated the Foreign currencies Cash flow statement Reporting Financial of terms the under exempt is Company The its publish to requirement the from 5a, paragraph 1, Standard within included are flows cash its as statement, flow cash own thedifference between thevalue fair and aggregatenominal value cost or funds shareholders’ either in recognised not is shares of investment. of of profit for the financial year of the Company is disclosed in note 13 13 note in disclosed is Company the of year financial the for profit of to these accounts. Relief under sections available, is relief such where Accordingly, possible. wherever taken the Company’s profit and loss account. In accordance with section section with accordance In account. loss and profit Company’s the th Act 1985 230(4) of the Companies amount The account. loss and profit own its present to requirement In the Company’s accounts, all fixed asset investments (including (including investments asset fixed all accounts, Company’s In the (or cost at stated are ventures) joint and undertakings subsidiary provisions less investments) listed certain of respect in valuation to credited are receivable and received Dividends impairments. for (including derivative instruments) at fair value through profit or or profit through value fair at instruments) derivative (including in standards accounting applicable with accordance in and loss, been has basis concern going The GAAP). (UK Kingdom United the accounts. these in applied Basis of preparation historical the under prepared been have statements financial The available-for-sale of revaluation the by modified as convention, cost financial and assets, financial 1. Notes to the Company accounts accounts Company the to Notes

Financial statements liability intheperiod which they are declared. Equity dividendson ordinary sharecapital arerecognised asa Dividends finance costs. Dividends thereon are recognised in the income statement as profit and loss reserve. balanceconversionthe equity on into ordinary shares is extinguished, and accordingly the remaining capital andshare premium. From to isreclassified share component equity the of amount attributable conversionof apreference shareinto ordinaryshares, the based on the date of original issue of the preference shares. On The equity conversion option is presented at its historic fair value, shares. basis until extinguishedconversion on maturity or theof preference The underlying debt instrument is presented on an amortised cost and an equity conversion option, classified within equity. an underlying debt instrument, classified within loans and overdrafts, compound financialinstrument and accordingly,have beensplitinto In accordance with FRS 25the preference shares are considered a togetherwithany arrears and accrualsof dividends. Company may redeem any outstanding shares at 100p per share, 31 December2006. From 1July be adjusted further as a result of share repurchases made after of Associationthe pref the Articles every preference the conversion rate preference sh years up to2007, on thebasis of 2.5pof each at the optionthe of holderin31 May on anythe of of 25p each that are convertible into the Company’s ordinary shares The Company has in issue 7.75p (net) cumulative preference shares capital Preference share shareholders’ funds. in movements of reconciliation the in separately shown purchase or sale of the Company’s own shares in the ESOP trust is the profit and loss account. Consideration paid or received for the shares heldis shownasdeductiona from shareholders’ funds within Accounting for ESOP trusts (UITF 38) the cost to the Company of own 38– TaskForce Issues Abstract Urgent under required As 1. Accounting policies(continued)

are. As a result of thes share at31 December has decreased to0.47554 2007 to1 January2010,the option will be transferred to the to option willbetransferred 1 July2007, the option to convert 0.47904 ordinary shares for every erence share conv hare repurchases during 2006, 2006. In accordance2006. with ordinary sharesfor ersion rate will www.baesystems.com 117

Financial statements £m £m Total Total basis, basis, on the basis basis the on £m £m Plant and Plant and equipment equipment

– –– – – – – 24 24 – –– –– 5 – – 5 – 1 1 – 24 24 4 5 9 4 5 9 4 – 4 (3) -– (3) £m £m 26 4050 – 66 14 40 50 54 13 34 47 10 35 45 13 6 19 (62) – (62) erseas properties, buildings buildings Land and Land and

excluding certain ov certain excluding

(continued) ned by the Company as at 30 June 1996, June 1996, as at 30 ned by the Company 30 June 1996 at cost; and at cost; June 1996 30 December 2006 include: include: 2006 December ehold land and buildings ow ehold land and buildings operating leases leases operating BAE SYSTEMS Annual Report 2006 Tangible fixed assets Tangible land and buildings owned by subsidiary undertakings acquired since 30 June 1996 at fair value at the date of acquisition. acquisition. of date the at value fair at 1996 30 June since acquired undertakings subsidiary by owned buildings and land owing to their specialisation, with the remainder on an existing use value basis. Other non-operational properties were valued valued were properties non-operational Other basis. value use existing an on remainder the with specialisation, their to owing of open marketvalue; cost; at leaseholds short additions subsequent to freehold and long leas and long freehold replacement depreciated a on valued were time that at properties operational Group’s the of majority The date. that at revalued

Cost depreciation Accumulated 118 – – – Land and buildings comprise: comprise: buildings and Land – Short leasehold property property leasehold Short equipment and fittings Fixtures, Net book value of: Net book value property Freehold property leasehold Long Assets let under let under Assets Capitalised leases finance Cost depreciation Accumulated The amounts above at above The 31 amounts At 31 December 2006 2005 December At 31 Disposals Disposals 2006 December At 31 Net book value Depreciation and impairment and Depreciation January 2006 At 1 Depreciation Additions Additions Disposals 2006 December At 31 Cost January 2006 At 1 2. Notes to the Company accounts accounts Company the to Notes

Financial statements Exchange Property represented the Company’s shareholding in Vodafone Group Plc which was sold during the year. Other securities Exchange Property 6. includ Other debtors ventures joint Group by owed Amounts 5,042 after oneyearDue – Prepayments and accrued income Other debtors 5,042 ventures joint Group by owed Amounts Amounts owed by subsidiary undertakings Corporation tax recoverable withinoneyear Due 5. Development properties 4. At 31 December 2005 2006 31December At value carrying Net 2006 31December At Released At 1 January 2006 Impairment provisions 2006 2006and31December 1January At Cost 3. Prepayments and accrued income Other debtors

Fixed assetinvestments Current assetinvestments Debtors Stocks es cash collateral of £115m (2005 £80m).

undertakings undertakings Subsidiary ,7 4,978 4,978 – ,7 4,979 4,978 1 www.baesystems.com 4–64 64 – 64 £m 1 (1) – (1)

4,599 4,500 Other 2006 2006 2006 491 491 144 143 £m (1) £m £m £m 33 33 32 1 2 1 – – 6,115 5,988 2005 2005 2005 599 599 121 113 Total £m 16 72 32 63 £m £m £m 119 7 2 1 7 –

Financial statements

– 2 1 £m £m £m 11 99 91 44 26 18 936 748 139 667 240 361 287 484 748 150 2005 2005 2005 1,684 Liabilities hird hird – – –(3) 2 7 12 99 19 11 85 £m 57 (42) 35 (70) 2829 (38) (4) £m £m y utilising y utilising a 913 123 217 242 416 192 317 180 150 123 152 (167) 117 (94) 2006 2006 2005 Assets 1,036 ven in the

£m (87) (76) 2006 2006 Liabilities Liabilities e Property.

– – 31 (36) 51 (51) 82 30 (42) 55 (34) 85 £m floating rate bond b floating rate bond 2006 2006 Assets to the Exchang to the

nverted to a sterling nverted ter five years, is £203m (2005 £299m). (2005 £203m is five years, ter ans, two of which matured during 2006 and the t and during 2006 matured which of ans, two nancial risk management strategies are gi strategies management risk nancial g some minor conversions in some g (continued) during during 2006 of 5.59%. and liabilities and fi and liabilities emable 2010 emable s, where any instalment is due af is due s, where any instalment oating rate of interest, having been co been having of interest, oating rate shares, rede fective interest rate fective interest ty during July 2006 followin ty during July 2006 rrowing consists of three sterling-denominated lo sterling-denominated of three consists rrowing yable by instalment yable e Group’s other financial assets other financial Group’s e % bond, repayable 2014 % bond, repayable 2008 bond, repayable 2010 ¾ ⅞ e convertible preference preference e convertible Bank loans, final instalment 2009 final instalment loans, Bank ent Bank loan, final instalment 2009 instalment loan, final ent Bank BAE Systems Annual Report 2006 Loans and overdrafts Other financial assets and liabilities and assets Other financial

Permitted Investment Option Aircraft bond, final instalment 2013 instalment bond, final Aircraft Option Option Aircraft bond

Alvis loan notes, redeemable 2009 2009 redeemable notes, loan Alvis Debt instrument of th Debt instrument instruments financial Debt-related

Exchangeable £676m 3.75% Bond Bond 3.75% £676m Exchangeable In lateryears Loans and overdrafts are repayable as follows: follows: as repayable are overdrafts and Loans SYSTEMS 2001 Asset Trust: Asset 2001 SYSTEMS SYSTEMS 2001 Asset Trust: Asset 2001 SYSTEMS Between two and five years years five and two Between cross-currency swap which resulted in an ef in resulted which cross-currency swap 3.75% Bond Exchangeable £676m on maturi par was redeemed at The bond matures in 2009. The coupon rateon the outstanding loan is fixedwithan interest rate of 6.86%. fl a are at bonds Trust Asset 2001 The SYSTEMS European Investm 10 £100m Euro-Sterling Debt-related financial instruments instruments financial Debt-related European Investment 120 The total amount of loans repa The total In one year or less or year In one Between one andyears two The European Investment Bank bo The European Investment Bank Bank loans and overdrafts are at a floating rate of interest. of interest. rate a floating at are overdrafts and loans Bank Due after one year Due one year after 11 £150m Euro-Sterling Due within one year overdrafts and loans Bank 8. Full disclosures relating Full disclosures relating to th financial reviewandnote 32 to the Group accounts. Due after one year Due one year after contracts exchange foreign – hedges flow Cash contracts rate exchange/interest foreign Other Other foreign exchange/interest rate contracts contracts rate exchange/interest foreign Other derivatives Embedded Due within one year contracts exchange foreign – hedges flow Cash 7. Notes to the Company accounts accounts Company the to Notes

Financial statements ovrino rfrnesae –– – – 15 – – 3 – 15 600 2006 31December At Conversionof preference shares Exercise of options At 1 January 2006 Exercise of options Placingshares of At 1 January 2005 fully paid and Issued 2006 2006and31December 1January At Authorised in the year At 1 January 2005 Authorised 12. Borrowings bysubsidiary undertakings to Company guaranteed borrowings 11. Provisions created relate to onerous property leases. 2006 31December At Utilised Created At 1 January 2006 10. Other creditors after oneyearDue undertakings subsidiary to owed Amounts withinoneyear Due 9. guaranteed by the Company. the Company. by guaranteed Amounts owed to Group joint ventures Other creditors Accruals and deferredincome

Creditors

Share capital Contingent liabilities and commitments Provisions for liabilities and charges talling £2,182m (2005 £2,868m)which are includ Number of ed in the Group’s ,1 0 1 80 1 77 1 1 80 96 1 3,219 1 77 3,060 1 96 3,850 ,4 1 1 81 1 1 81 111 3,246 1 1 111 4,450 shares Ordinary shares of 2.5peach 5 –3 – – 3 150 41 – 1 – – 1 24 Equity Equity Total Non-equity m 9– – – – Nominal value £m borrowings have been

Number of shares Special Share Share Special www.baesystems.com of £1

Nominal Contracts andother Contracts 8,125 8,903 value 2006 605 134 £m 39 £ 1 1 Nominal 8,268 1,246 9,707 2005 value 162

31 13 £m 12 £m £m 121 (4) 1 1 3

Financial statements

£m - ich ich ll ll ). rence the Profit and ordinary ordinary rdrafts d. The The d. nitially in into one rve arising arising rve loss account both a debt debt a both include Special Special ich were any, the der). Certain Certain der). er repayment repayment er s or more p to 2007, on gs of the or where a where or er 31 ends. ends. the Special the Special ng impairment. impairment. ng erred to the the to erred es during es during 2006, rman arerman hareholders amounts paid up up paid amounts £m Other reserves accruals of dividen accruals hares of 25p each wh of 25p each hares erted for 2,929,867 2,929,867 erted for 2005 £79m debit); and non and £79m debit); 2005 2006, 28,675,000 2.5p ordinary 2.5p 28,675,000 2006, 2006. In accordance with accordance In 2006. 2007 and, in any case, wi any case, and, in 2007 the share repurchas gnised within loans and ove and loans within gnised erefore £260m (2005 £266m erefore ). The non-distributable rese non-distributable ). The –– 25 –––– – 1,617 – – (346) – 80 (80) (18) 17 £m 52 – – 841 101 1,689 d to hold the repurchased shares i the repurchased hold d to account nd, is th th any arrears and shares were conv eemable preference s

Share premium n to return up to £500m to ordinary s ordinary to £500m n to return up to hares. As a result of dging reserve £9m debit ( £9m debit reserve dging es at any time after 1 July any time after 1 at es ence share at 31 December ence share at 31 ty. The debt element is reco element The debt ty. r 2006 and, as at 31 December at 31 as and, r 2006 y stated its intentio stated its y (continued) y arrears or accruals of divide Group undertakings £86m (2005 £104m (2005 undertakings £86m Group g authorities granted at the 2006 AGM an AGM at the 2006 granted authorities g ry shares for every prefer ence share. During the year 6,116,123 year 6,116,123 share. During the ence each case at 100p per share together wi at 100p per share together case each us, the Compan us, the the remaining preference shar the remaining separate reserve within equi separate reserve 005 266 million) 7.75p (net) cumulative red 7.75p (net) cumulative 266 million) 005 shareholders can elect to convert their s to convert elect can shareholders is buyback programme on 26 Octobe on 26 programme is buyback preference shares, ignoring an preference shares, ignoring of its interest in Airb in of its interest of ordinary shares usin shares of ordinary om property disposals to other disposals om property y shares for every prefer mpany comprise: capital reserve £24m (2005 £24m); he £24m); (2005 reserve £24m comprise: capital mpany ares on 1 January 2010, in January 2010, ares on 1 has decreased to 0.47554 ordina decreased to 0.47554 has y shares – – (112) BAE Systems Annual Report 2006 Reserves

The Company also has in issue 260 million (2 260 issue has in also The Company Company’s shareholders but has no voting right, nor other rights, other than to speak in relation to any business in respect of respect in business any to relation in speak to than other rights, other nor right, voting no has but shareholders Company’s Share. Preference shares Shareholder. Shareholder. Share Special the convert to or par at Share Special the redeem to time any at Company the require may Shareholder Special The meetin class and meetings general attend to and of notice receive to entitled is Shareholder Special The share. voting ordinary parts of the Company’s Articles of Association cannot be amended without the consent of the Special Shareholder. These articles These Shareholder. Special the of consent the without amended be cannot Association of Articles Company’s the of parts Comp the of 15% than more in interest an have can concert, in acting persons foreign or person, foreign no that requirement the chai executive any and Executive Chief the that requirement the and British, are directors the of majority the that requirement the by approved and directors the by made regulations by amended be also can requirements these of effect The citizens. British shares with an aggregate nominal value of £1m were held in treasury. treasury. in held were £1m of value nominal aggregate an with shares Special Share Sharehol Special (the Industry and Trade for State of Secretary the of behalf on held is Company the £1 in of Share Special One by way of on-market purchases on-market purchases by way of th commenced The Company treasury. 122 Other reserves the Co for Other reserves fr distributable reserve arising Other movements movements Other reserve hedging in Movements At31 December 2006 – (10) – Conversion of preference shares shares preference of Conversion Purchaseof own sharesESOP by Purchase of treasur Reclassification 7 – – – – (12) Dividends paid paid Dividends payments Share-based options of Exercise At 31 December 2005 December At 31 profit Retained 782 49 580 13. in arrears, or where a motion is to be proposed which abrogates, varies or modifies the rights of the preference shareholders, shareholders, preference the of rights the modifies or varies abrogates, which proposed be to is a motion where or arrears, in aft entitled, are shares preference the of holders up, winding a On Company. the of up winding the for proposed be is to motion of return the to shareholder, of class other any to payment any to priority in and Share Special the on up paid capital the of divid preferential of arrears all and share, per 75p of premium a with together shares preference the on up paid as credited or element and an equity component which require separate accounting treatment. Under FRS 25, the equity option component of prefe of component option equity the FRS 25, Under treatment. accounting separate require which component equity an and element a as included £78m) is (2005 of £76m shares 8). (note month six is dividend preferential the where only Company the of meeting general a at rights voting carry shares preference The redeem any remaining sh redeem any remaining the of maximum redemption value of consisting instrument financial a compound be to considered are shares preference convertible 25 the FRS with accordance In shares. 2007 will be the final year in which final be the will 2007 shares. rate the conversion aft made repurchases share of result a as further adjusted be will rate conversion share preference the Association of Articles of all may redeem Company The 2006. December have been convertible into ordinary shares of 2.5p each at the option of the holder on 31 May in any of the years since issue u issue since years the of any in 31 May on holder the of option the at each 2.5p of shares ordinary into convertible been have the basis of ordinar 0.47904 In connection with the disposal the disposal with In connection 12. Share capital (continued) (continued) capital 12. Share Treasury shares Notes to the Company accounts accounts Company the to Notes from property disposals to other Group undertakings relates to the revaluation surplus realised by the Company on properties wh properties on Company the by realised surplus revaluation the to relates undertakings Group other to disposals property from transf be will reserve this within Amounts years. prior in reorganisations operational of part as companies Group other to sold followi down written or Group, the outside of disposed are properties related the when distributable as account loss and profit

Financial statements Not yet allocated to share option schemes Held under PerformanceShare Plan Total directors’emoluments, excludingco £ options, were Fees payable to the Comp audit fee Company for their services on behalf of the BAE Systems Group. No emoluments related specifically to their work for the Company. The total numberofemployees Employees 15. allotted to members of the Company as fully paid bonus shares. Under section 4 of the British Aerospace Act 1980 this reserve may only be applied in paying up unissued shares of the Company 14. The Company’s profit Company profit profit and loss account on an accruals basis. Dividends on the shares held in the ESOP Trust have not been waived. Finance costs and other administrative charges are include Held under Restricted Share Plan Allocation Not yet allocated to share option schemes Under option value Market follows: is as schemes option share various Company’s the to shares these of allocation value and themarket on Information by the BAE Systems ESOP Trust of which IFG Trust (Jersey) Limited are the trustees. a holding of2,382,835 (2005 1,748,945) ordinary Within the profit andloss acc Own sharesheld 13. Reserves (continued)

Other employees: Executive directors: Other employees: Executive directors:

Other information Statutory reserve 67m (2005£59m). under option under option under option under option for thefinancial year was £1,617m (2005 £728m). any’s auditor forthe a ount ofthe Company thereare dedu of theCompany at 31 December 2006 was 596 (2005 478). mpany pension contributmpany pension udit of the Company’s annualaccoun the udit of shares of2.5p each in th ctions for thevalue of ownshar ions, were £9,647,000 (2005 £7,730 e Company, listedontheLo ts totalled £1,023,000 (2005 £1,110,000). Total staff costs, ex es held of £8m(2005 £5m) which

,000). These emoluments,000). Thesewere ndon StockExchange andar 2,382,835 1,138,671 Number of 573,639 470,952 199,573 cluding chargesfors www.baesystems.com shares 2006 2006 £m 10 10 – –

1,748,945 d in the d inthe to be be to comprise comprise 702,481 661,940 384,524 Number of e held hare shares 2005 2005 paid paid £m 123 7 3 4 – –

Financial statements 1 UK £m GAAP 2002 1 UK £m GAAP 2003 £m IFRS IFRS 2004 (9) (797)

– – 65– – (11) – – 1,6851,648 – – – – 232– – 247 – – 2,6362,561 – – – – 12– – 66 – – 650– – 727 – – 2,9042,716 – – 204– – 195 (7) – – – £m 42 (8) – – 111 (336) – – (16) (10) (15) (20) IFRS IFRS 909 800 980909 800 1,002 591 558 233591 558 (616) 775485 498 768 471 464 281471 464 300 324 256 –56133 10 411419 497 – 109 95 69 – 454 – 444 339 88555 3 (686) (686) 137 – –137 – – 2005 (433) (417) – – (196) (132) (220) (206) (118) (50) – (18) (122) (110) (518) (615) (147) (219) (225) (70) (718) (491) (749) (858) 8,217 6,115 6,0008,217 6,115 1,6991,922 1,901 6,417 1,710 1,709 1,730 1,535 1,515 3,697 3,063 1,270 482 –2,3742,819 2,219 –2,0422,923 2,856 2,060 2,133 1,834 2,022 – – – – 1,012 876 (195)1,012 876 4 5,5912,788 2,655 5,665 (4,596) (3,891)(4,596) (3,126) (2,887) (4,101) (3,210)(4,101) 362 (668)(1,277) 315 (870) (1,298) 12,581 10,689 12,57212,581 10,689 12,145

– – – – – – – – – 6 £m (17) IFRS 894 678 395 295 429 168 167 477 113 646 993 648 435 2006 2006 (507) (174) (147) (139) (248) (695) 1,207 7,595 1,869 1,639 4,007 2,115 2,927 3,180 1,748 4,117 (4,298) (2,499) 13,765 equity holders of the parent holders of the equity

3 3

2,3

4 4

BAE Systems Annual Report 2006 5

Intra-business group sales sales group Intra-business International Partnerships Partnerships International International Partnerships Partnerships International North America America North North America America North Property, plant and equipment, and investment property property investment and equipment, and plant Property, investments Non-current Inventories receivables less account) customers’ on cash (excluding Payables Intangible assets Finance costs including share of equity accounted investments investments accounted equity of share including costs Finance Profit/(loss) before taxation HQ and other businesses Avionics HQ and other businesses Avionics Commercial Aerospace Land & Armaments Programmes & Support Solutions Customer & Partnerships Systems Integrated Electronics, Intelligence & Support Electronics, Intelligence 124 Other financial assets and liabilities liabilities and assets financial Other obligations benefit Retirement Balance sheet Taxation expense including share of equity accounted investments investments accounted equity of share including expense Taxation operations continuing from year the for Profit/(loss) operations discontinued from year the for Profit/(loss) year Profit/(loss) for the Exceptional items (UK GAAP only) only) GAAP (UK items Exceptional Amortisation and impairment and impairment Amortisation EBITA Commercial Aerospace Land & Armaments Programmes & Support Solutions Customer & Partnerships Systems Integrated Income statement Sales includingGroup’s share of equity accounted investments & Support Electronics, Intelligence Five year summary summary year Five Total equity attributable to to attributable equity Total Net tax cash/(debt) Net sale for held groups Disposal Minority interests Provisions Provisions

Financial statements for ended the years 31 5 7 for IFRS, underlying earnings is presented for continuing operations after adjusting for amortisation and impairment of intan of impairment and amortisation for adjusting after operations continuing for presented is earnings underlying IFRS, for 7 investments other and assets intangible property, investment equipment, and plant property, on expenditure includes 6 Decemb ended 31 foryears the 4 pr is SAS Airbus 2006, 2004to December 31 ended years forthe 3 2 for the years ended 31 Decemb ended 31 foryears the 2 Decemb ended 31 foryears the 1 To aid comparison, certain Basic earnings per share – underlying – total share per Basic earnings/(loss) Other information Closingcash/(debt) net Impact of IFRS adoption Opening net debt Movement in net cash/(debt) Movement in cash on customers’ account Net increase/(decrease) in net funds movements Exchange (Purchase)/issue of equity shares Other non-cash movements dividends and Tax Finance costs disposals and Acquisitions Net capital expenditure Cash flow from operatingactivities in Movement definedbytheGroup as net cash/(debt) Operating business cash flow Dividends from equity accountedinvestments Order book including the Group’s share of equity accounted investments Capital expenditure including leased assets Number of employees, excluding share of employees of equity accounted investments, Dividend per ordinary share at year end and exceptional items. items. exceptional and adj after presented is earnings underlying GAAP, UK For inventories. acquired on uplift and derivatives, financial and pensions ende For theyears is reported withinHQ and other businesses 2006 and 2005 groups in

d 31 December 2002 and 2003, this is de is and 2003,this 2002 31 December d December 2004 to 2006 this is defined defined is 2006this 2004to December 6

er 2004 and 2005, the Avionics busin Avionics and 2005,the er 2004 er 2002 and 2003, the business group business and 2003,the er 2002 is and 2003,theinformation er 2002 presentational ch 7

anges have been made tothe fined as profit before profit fined as as as earnings before am esented as a discontinued operation under IFRS and the remainin the and IFRS under operation discontinued a as esented ess group presented is as disc presented on a UK GAAP basis UK GAAP basis on a presented information presented information presented interest andexcludi interest tax, ortisation andimpairm under UK GAAPhas under UK IFRS amounts in 2004 and2005. ontinued o ng goodwill amortisati ng goodwill ent of intangible ass ent of intangible perations under IFRS under perations not been restated t been restated not £31.7bn £538m 79,000 (1,277) 1,712 1,721 1,330 50.7p 11.3p 23.8p (431) (207) (141) 2006 2006 gible assets, non-cash finance movements on on movements finance non-cash assets, gible 435 323 778 782 145 IFRS (71) £m usting for goodwill amortisation and impairment, impairment, and amortisation goodwill for usting (9) (5) – on and impairment, and exceptional items items exceptional and impairment, and on ets, finance costs and taxation expense. expense. taxation and costs finance ets, 3.b 2.b 4.b £42.5bn £30.8bn £29.5bn£46.0bn g Commercial Aerospace business group group business Aerospace Commercial g 0007,0 84068,100 80,000 73,30068,400 37 39 23 £274m £347m £359m£243m

127 68 80 (1,298) (1,277) (668)(870) 41 (62) (1,836) (630) ,9 ,5 86136 836 2,099 2,350 ,3 ,3 6531 625 1,937 2,134 o reflect the changes made to the business business the to made changes the reflect o 74 06p(.) (23.2)p 17.4p (0.6)p (0.5)p 03 .p92 9.2p 17.3p 10.3p 9.5p9.2p 18.4p 13.6p16.6p 23 96 –– – (467) (283) (936) (831) (668) (870) 428 (476) (1,298) 97 (326) 1,138 412 (291) 1,151 72 (219) 129 (391) (150) (342) (312)(227) (152) (179)(117) 20 25 28 (183) (250) (285)(248) 0520 032002 2005 20042003 2005 7 32 373 – IFRS 3)(3 1 9 16 (35) (13) (136) (52) 9 121 86 778 88 6937 £m www.baesystems.com 2004 IFRS £m 2003 GAAP £m UK 1 2002 GAAP £m 125 UK 1

Financial statements JPMorgan Service Center Center Service JPMorgan 3408 PO Box NJ 07606-3408 South Hackensack USA freeToll telephone number: 800 990 1135 US: the outside from number Telephone 6630 +1 201 680 Website: www.adr.com [email protected] Email: Dividend reinvestment plan The Company offers holdersofits ordinary shares option the to elect have to their purchased shares in reinvested dividend would you If cash. of instead market in the a request please election, this make like to from mandate plan reinvestment dividend our registrars: Registrars TSB Lloyds Worthing Causeway, The 6DA BN99 West Sussex 241 3018 Telephone: 0870 UK: the outside from number Telephone 7058 +44 121 415 Receipts Depositary American Depositary American plc Systems BAE The Receipts(ADRs) are traded on the OverThe Counter market (OTC) under the symbol four represents ADR One BAESY. shares. ordinary plc Systems BAE the is N.A. Bank, Chase JPMorgan depositary. please queries, any have should If you contact: N.A. Bank, Chase JPMorgan g the FTSE 100 index, g the FTSE ill be paper sent similar service. 329p to 449.75p. 329p to 449.75p. UK on in the available are prices share Daily 843 0000. service on 0906 Cityline the FT At the menu followin the and prices share for 2 option select below: shown code four-digit relevant – shares ordinary plc Systems BAE code 1890 four-digit enter the – shares preference plc Systems BAE code 5174 four-digit enter the at minute per 60p at charged are Calls all times. Alternativelyyou can view teletext or a Govettwhich Limited authorised is and regulated by the Financial ServicesAuthority. ShareGift a operates Foundation Mackintosh Orr The shareholders for scheme donation charity may which shares of parcels small with the of Details sell. to uneconomic be at ShareGift from available are scheme on telephone by or www.sharegift.org 020 7828 1151. information price Share Company’s the of price market middle The ordinary shares on 31 December 2006 was was the year 425.75p and the range during www.shareview.co.uk www.shareview.co.uk equipment and of software Details website. the on given are requirements Shareholder dealing service cost low a offers Limited Govett Hoare resident UK enabling service dealing postal plc Systems BAE sell or buy to shareholders to subject 1%, is commission Basic shares. you require If £15.00. of charge a minimum contact: please information further on Limited Govett Hoare 7678 8300 (0)20 Telephone: +44 by Hoare approved been has notice This However,chooseyou if ‘post’as your w you preference, usual. as documents details: for more website Visit the eference, eference, their address or e-mail with details of e-mail with details g preference, you can g our mailing pr mailing our shareholder shareholder BAE Systems Annual Report 2006 dividend payment instructions on-line. on-line. instructions payment dividend share movements and dividend details; details; dividend and movements share and ability to change the direct access to data held on their behalf behalf their on held data to access direct recent including register share the on 126 – The Shareviewservice from our registrar, shareholders: gives Registrars, TSB Lloyds – Shareview service service Shareview If you have any queries regarding your your regarding queries any have If you registrars. the contact please shareholding, United Kingdom 600 3982 Telephone: 0870 UK) outside the from 415 7058 (+44 121 Registrars Registrars (0140) Registrars Lloyds TSB Worthing Causeway, The 6DA BN99 West Sussex Registered in England and Wales, Wales, and England in Registered No. 1470151 SW1Y 5AD SW1Y 5AD United Kingdom 373232 (0)1252 Telephone: +44 www.baesystems.com website: Company Registered office office Registered 6 CarltonGardens London Shareholder information information Shareholder you will be notified by version. electronic your download to how your bank account, and you have selected selected have you and account, bank your as your mailin ‘e-mail’ electronically. voucher tax your collect also voucher, tax paper the receiving of Instead annual/interim results by e-mail instead of of instead e-mail by results annual/interim available. is option this as as long post, to straight paid dividends your have If you for shareholder communications. If you you If communications. shareholder for ‘e-mail’ as y select you will be sent and forms proxy as such communications, charge to register. register. to charge can you site, the with register you When register your preferred format (post or e-mail) To sign up for Shareview you need the the need you Shareview for To sign up proxy your on printed reference’ ‘shareholder no is There stationery. dividend or form

Shareholder information 9 572. . – –– – – 3.0 0.1 7.4 – – 7.9 0.1 19.3 2.1 11.0 5.1 – 2.8 0.4 0.1 0.2 0.1 – – 1.2 7.7 0.6 0.3 40.7 249.3 0.3 – 18.9 1.3 84. 9.6 0.6 1.3 21.0 0.3 28.3 20.4 28.1 – 0.7 1.6 26.6 35.8 25.7 35.4 – – 0.1 – 2, 6.1 7.7 – 100. 3,246.2 100.0 126.1 1,000,000 and over 100,000 – 999,999 10,000 – 99,999 1,000 – 9,999 500 –999 100 –499 3.3 0.8 1 –99 100. By size of holding 107.3 3,246.2 25.5 100.0 0.9 126.1 – 3.6 Other 1.1 Insurance and pensionfunds 116.2 Banks – 93.0 Nominee companies Individuals 117.3 By category of shareholder accounts and –report Analysis of share register at 31 December 2006 2007 final ordinary dividend payable – pr 2007 full year results interim ordinarydividendpayable 2007 0.1 – 2007 interimresults announcement 2.1 2007 halfyearlypreferen 2006 final ordinary dividend payable Preference shares conversion date (final opportunity) Annual General Meeting Financial year end Financial calendar 63.3 1.8 – 3.4 8.9 2.0 3.8 5.3 9.7

ce dividend payable eliminary announcement Ordinary shares of 2.5p Preference sharesof25p Preference Ordinarysharesof2.5p Shares Accounts Shares Accounts Number ‘000 % ,4. 87.6– 1.0 86.0 2,841.5 223.7 Number 9. 23113. 3. 90.8 92.31.1 34.9 236.1 997.1 million . . 80903.5 2.6 2.5 78.0 9.0 9 0 3.3 100.0 100.0 260.0 0 3.3 100.0 100.0 260.0 %

Number ‘000 www.baesystems.com 30 November2007 % Number 9 August2007 February 2008 million 31 May2007 31 December 1 June2007 9 May2007 2 July 2007 June 2008 April 2008 127 %

Shareholder information d Capability. MoD Defence. of Ministry UK’s NEC Networked Enable MRA4 Nimrod The replacement MaritimePatrol and Attack aircraftfor UK’s the Royal Air Force. PAAMS PrincipalAnti-Air Missile System.Aster vertical anti-aircraft a medium-range PAAMS: launching missile system based on the AsterAster and 30 anti-missile 15 missiles. PCL a Leadership: Centred Performance USAF Force. Air States United UUV Vehicle. Underwater Unmanned VLS System. Launching Vertical Mine protected armoured personnel carriers. carriers. personnel armoured protected Mine SAMP/T system defence air A land-based incorporatingAster the missile, 30 MBDA. by developed SEP vehicle system. multi-role A modular SETAC System Engineering and Technical Contract. Assistance SHE Environment. and Health Safety, SUAV(E) Strategic Unmanned AirVehicle (Experiment). Mod 1 Stingray torpedo. A lightweight T93 radar Radar. Defence Air 93 Type UAV Vehicle. Air Unmanned UCAV Vehicle. Air Combat Unmanned leadership and performance management management performance and leadership Company. the throughout used system RAF The UK’s RoyalAir Force. RSAF The Royal Saudi Air Force. and RG-33 RG-32 RG-31, allowing flexibility allowing flexibility DD(X) programme. programme. DD(X) M88 Hercules fully-tracked,A armoured recovery vehicle. M113 medical, carriers, personnel Armoured engineering and control, and command mortar launching vehicles. M777 howitzer. field 155mm A lightweight ER Milan missile. anti-armour range extended An published by the International Standards Organisation,specifies which actual the requirements for an environmental management system. IT Information Technology. LCM control and process a Management: Lifecycle Company’s the which within environment executed. are projects LRLAP Projectile: Attack Land Range Long the under developed being a system FV430 Bulldog FV430 Bulldog carrier. personnel armoured An ALH Advanced Light Helicopter: a multi-role, multi-mission helicopter. IDIQ a Indefinite-Delivery/Indefinite-Quantity: contract US government orders. for ISO14001 The standard for environmental management service with USAF.the FALCON An information infrastructuresystem for the British Army. FCS Future Combat System. FRES FutureRapid Effect System: The UK programme (MoD) Defence of Ministry family a with Army British the provide to network-enabled, medium-weight, of vehicles. armoured air-deployable EW Warfare. Electronic F-22A Raptor An advanced tactical fighteraircraft in p and support the UK p and support the UK and capabilities that and capabilities cavalry, fire support, ill allow autonomous ill allow autonomous BAE Systems Annual Report 2006 128 DoD DoD Defense. of Department States United will be needed to equi be needed to will defence UK the ensure and forces armed industry remains world-leading. The Defence Industrial Strategy, published published Strategy, Industrial Defence The 2005 in December government by the UK industry, with consultation following skills the recognises DDG-1000 Navy. US the for destroyer A next-generation DIS CVF The UK’s futureaircraft carrier. An armoured infantry fighting vehicle vehicle fighting infantry armoured An Systems Land Systems BAE by developed demand. international meet to Hagglunds CfPE Centre for PerformanceExcellence. CV90 provide a precise picture of the battlefield in in battlefield the of picture precise a provide ‘real-time’, optimising information the making. decision for available C4ISR C4ISR Command, Control, Communications and Surveillance Intelligence, (C4), Computing that systems (ISR): Reconnaissance and fulfil critical infantry, critical infantry, fulfil the for roles engineer and command battle US Army. A sensor fused 155mm munition. munition. 155mm fused A sensor Bradley which vehicles, fighting armoured Tracked Bv206 vehicle. all-terrain Armoured BONUS ATTAC ATTAC Availability Transformation: Tornado Aircraft Contract. Air-To-Air Mistral (a very short-range air system). missile defence vehicles to operate safely and routinely routinely and safely operate to vehicles UK. in the ATAM Airborne Evaluation & Assessment: a Assessment: & Evaluation Airborne the on focuses that programme and facilities systems, technologies, w procedures that DD(X) programme. programme. DD(X) ASTRAEA Related Technology Systems Autonomous AGS gun a 155mm System: Gun Advanced system being developed under the Glossary Glossary

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BAE Systems plc A

6 Carlton Gardens E Annual Repo rt 2006 London SW1Y 5AD S y

United Kingdom s t e

Telephone +44 (0)1252 373232 m s p l

Registered in England and Wales No. 1470151 c A n n

www.baesystems.com u a l R e p o r t 2

0 Cover image: BAE Systems, 0

See overleaf for an overview Shaping our business of our business today

REAL PERFORMANCE. REAL ADVANTAGE.