Annual Financial Report

RNS Number : 8299D

BAE SYSTEMS PLC

29 March 2011

Cautionary statement: All statements other than statements of historical fact included in this document, including, without limitation, those regarding the financial condition, results, operations and businesses of BAE Systems and its strategy, plans and objectives and the markets and economies in which it operates, are forward-looking statements. Such forward-looking statements which reflect management's assumptions made on the basis of information available to it at this time, involve known and unknown risks, uncertainties and other important factors which could cause the actual results, performance or achievements of BAE Systems or the markets and economies in which BAE Systems operates to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Nothing in this document shall be regarded as a profit forecast. BAE Systems plc and its directors accept no liability to third parties in respect of this report save as would arise under English law. Accordingly, any liability to a person who has demonstrated reliance on any untrue or misleading statement or omission shall be determined in accordance with schedule 10A of the Financial Services and Markets Act 2000. It should be noted that schedule 10A and section 463 Companies Act 2006 contain limits on the liability of the directors of BAE Systems plc so that their liability is solely to BAE Systems plc.

BAE Systems plc - Annual Report 2010

BAE Systems plc has today published its annual report and accounts for the year ended 31 December 2010 ('Annual Report 2010'). The full document can be viewed on the Company's website at:

www.baesystems.com/reporting/

Copies of the annual report and accounts have been posted to those shareholders who have requested to receive communications from the Company in printed form.

This announcement contains regulated information issued in accordance with section 6.3 of the Financial Services Authority's Disclosure and Transparency Rules and accordingly contains certain sections of the Annual Report 2010 in unedited full text. Page and chart references within the text of this announcement are references to pages and charts in the Annual Report that can be viewed as detailed above.

The Annual Report 2010 contains the following responsibility statement:

Responsibility statement of the directors in respect of the Annual Report and financial statements
Each of the directors listed below confirms that to the best of their knowledge:
- the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company, and the undertakings included in the consolidation taken as a whole; and
- the Directors' report includes a fair review of the development and performance of the business, and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
Dick Olver	Chairman
Ian King	Chief Executive
Linda Hudson	President and Chief Executive Officer of BAE Systems, Inc.
George Rose	Group Finance Director
Paul Anderson	Non-executive director
Harriet Green	Non-executive director
Michael Hartnall	Non-executive director
Sir Peter Mason	Non-executive director
Roberto Quarta	Non-executive director
Nick Rose	Non-executive director
Carl Symon	Non-executive director
Ravi Uppal	Non-executive director
On behalf of the Board Dick Olver Chairman 16 February 2011

Chief Executive's review

"BAE Systems is one of the world's leading defence and security companies."

Ian King

Chief Executive

BAE Systems has business operations providing key national capabilities in many of the world's larger defence and security markets. Although the Group faces a more challenging trading environment as governments look for cost savings to address budgetary pressures, our broad base of activity results in a resilient business that is well positioned to withstand near-term market pressures.

Affordability and value for money are increasingly the priorities for customers. Early recognition by the Group of customer budgetary pressures resulted in significant cost reduction and efficiency actions being taken in 2009 which have continued throughout 2010. These actions have resulted in net headcount reduction of approximately 15,100 (including contractors) in the past two years. This cost reduction programme will enhance competitiveness, deliver further improved value for customers, and be of sustained benefit to the Group's performance.

BAE Systems has a substantial presence in Services activities in its defence and security markets. These activities, which represented 48% of sales in 2010, include Readiness & Sustainment business in the air, land and maritime defence domains, and provision of Cyber & Intelligence services. The Group is successfully growing its Services businesses, delivering enhanced capabilities whilst reducing costs for its customers.

BAE Systems' business is based around home markets where the Group has established, or seeks to establish, a strong position in the defence industrial base. The Group's key home markets are in Australia, India, Saudi Arabia, the UK and the US. Sweden and South Africa remain an important part of the Group's Land & Armaments business.

Following a review of markets and customers' needs in the US, changes to the Group's organisation were implemented in the first half of the year to realign BAE Systems, Inc. to better deliver on its strategy. Reductions in costs, benefiting both the Group's customers and shareholders, are flowing from the simplified organisation. These changes enable BAE Systems to be more competitive in a challenging environment and more agile in responding effectively to customers' needs. In July, following changes to the Group's US organisation, Larry Prior was appointed Executive Vice President, Service Sectors and Bob Murphy was appointed Executive Vice President, Product Sectors, both reporting to Linda Hudson, President and Chief Executive Officer of BAE Systems, Inc.. Larry and Bob are also members of the Group's Executive Committee.

In early February 2010, the US Quadrennial Defense Review (QDR) was released. The accompanying US defence budget for Fiscal Year 2011 identified growth in the allocation to the investment account element. The QDR restated the US's commitment to the large, next generation, F-35 combat aircraft programme. BAE Systems, through both its US and UK businesses, is a significant participant on this programme.

The US defence and security markets continue to generate a number of business opportunities, despite budgetary pressures. These pressures are leading to Department of Defense programme reprioritisations and a drive for greater efficiencies in procurement. These efficiencies are expected to help fund continued modest growth on investment in defence capability.

Pressure to reduce government expenditure in the UK was reflected in the Comprehensive Spending Review and the findings of the UK Strategic Defence and Security Review (SDSR) were published in October. The review identified a number of changes to UK defence and security priorities over the coming years.

The Group continues to work with the UK Ministry of Defence to address the detailed implications of the changes identified by the SDSR. The Group believes that it can continue to help in delivering efficiency improvements and value for money in the way capability is generated and delivered. In aggregate, the changes resulted in some modest impact on the performance of the Group's UK business in 2010 and, thereafter, are expected to result in a reduction of approximately one pence in earnings per share, per annum, when compared with the Group's prior financial planning assumptions.

Other home markets

The Group continues to seek growth in Australia and the Kingdom of Saudi Arabia where it has strong, established home market positions.

In Australia, the defence budget is expected to grow following publication in 2009 of a Defence White Paper outlining the key areas for defence spend over the coming years.

In the Kingdom of Saudi Arabia, defence spending is expected to continue to be a high priority, representing some 10.9% of GDP in 2009.

Defence spending in India is expected to grow substantially. In the year, the Group has taken a number of steps to develop India as one of its home markets. A second major contract for the supply of Hawk aircraft to India was received, with local assembly to be undertaken by Hindustan Aeronautics Limited. A land systems joint venture with Mahindra & Mahindra Limited was established, which is currently developing and marketing several vehicles with the support of other BAE Systems' businesses.

M&A activity

In addition to pursuing organic growth, the Group has continued to make progress in developing its business through targeted acquisitions. Notably, acquisitions have been made since January 2010 in Services and Electronic Systems, specifically high technology electronic and electro-optic systems. BAE Systems continues to target these areas, which are identified as priorities for customers and offer prospects for growth.

In July 2010, the Group completed the acquisition of Atlantic Marine Holding Company, a naval services business, for $372m (£245m). The business employs approximately 1,500 people at Mayport and Jacksonville, Florida; Moss Point, Mississippi; and Mobile, Alabama. The acquisition complements BAE Systems' existing ship repair and upgrade capabilities serving the US Navy. The Group anticipates continued strong demand for naval support capabilities in the US, and the acquisition is consistent with our strategy to address anticipated growth in Services activities.

In October, BAE Systems completed the acquisition of OASYS Technology, LLC, a US manufacturer of electro-optical systems and sub-assemblies, for an initial cash consideration of $24m (£15m) and a potential earn out of up to $29m (£18m). The acquisition complements BAE Systems' existing electro-optical capabilities, technologies and product offerings.

In January 2011, the Group completed the acquisition of stratsec.net Pty Limited, an Australian information security company supplying government and commercial customers. The A$24m (£16m) acquisition supports the Group's strategy to add capabilities and footprint in the growing area of Cyber & Intelligence.

In February 2011, BAE Systems completed the acquisition of L-1 Identity Solutions, Inc.'s Intelligence Services Group, a leading provider of security and counter threat capabilities to the US government, for a cash consideration of approximately $297m (£190m).

In December, the Group entered into a definitive agreement to acquire ETI A/S, a leading Danish Cyber & Intelligence company providing advanced technology products and services to government and commercial clients worldwide, for a cash consideration of DKK1.2bn (£138m).

In January 2011, the Group entered into an agreement to acquire the 91.3% outstanding equity of Fairchild Imaging, Inc. for a cash consideration of $86m (£55m). The California-based business provides solid-state electronic imaging components, cameras, and systems for aerospace, industrial, medical and scientific imaging applications. The acquisition complements the Group's electro-optics and night vision capabilities.

The proposed acquisitions of ETI A/S and Fairchild are conditional, among other things, upon receiving regulatory approval.

In January 2011, the Group announced a recommended €217m (£186m) cash offer for Norkom Group plc, a provider of innovative counter-fraud and anti-money laundering solutions to the global financial services industry.

In June, BAE Systems completed the sale of half of its non-strategic 20.5% shareholding in Saab AB for a cash consideration of SEK1,041m (£92m). The sale of the Group's remaining investment in Saab is expected in due course.

In September, BAE Systems announced that it was reviewing strategic options with regard to its Platform Solutions business. In January 2011, the Group announced that the sale of the business was no longer being pursued.

Cash flow

Good cash generation has been achieved in the year, and is expected to continue, notwithstanding any short-term volatility. Use of this cash flow is expected to include a focus on pursuing opportunities for enhanced equity returns through investment in the business by way of organic development or precisely targeted acquisitions. In addition, the Group will continue to meet its pension funding obligations. Accelerated returns of capital to shareholders remain an option to address extended periods of balance sheet inefficiency.

Total Performance

Total Performance is not just about what the Group does but also about how we do it. Building a culture of Total Performance means focusing on delivering shareholder value, on meeting the needs of our customers and acting responsibly at all times.

BAE Systems performed well in 2010, delivering against both its Financial Performance and non-financial objectives, including Customer Focus, Programme Execution and Responsible Behaviour. Embedding the importance of non-financial performance measures in the culture of the Group, through the drive for a more integrated, Total Performance, approach, has contributed to this success.

BAE Systems is committed to achieving the highest standards of business conduct to give its customers, suppliers, regulators, employees and shareholders the confidence that it is a business which they can trust. During the year, a major focus has been on embedding a culture of Responsible Behaviour across the business. Mandated policies and processes within our Operational Framework have been comprehensively updated to ensure they reflect our Responsible Trading Principles. Employees in all markets are receiving refresher training to help them to continue to apply our global Code of Conduct in their work. This training is scheduled to be completed by May 2011. We are pleased at the progress made and have commissioned ethics consultancy, Ethical Leadership Group, to review the work undertaken in response to the Woolf Committee recommendations. Interviews with a number of senior leaders in each home market and more than 60 employee focus groups across our businesses have been undertaken.

We are deeply saddened to report the death of one of our employees at our York facility in the US. We have reviewed the cause of this accident and co-operated fully with the regulatory investigation. The regulatory authority was unable to determine a cause for the accident or identify any non-compliances during the course of its investigation and, as a result, has taken no further action. Any lessons learnt from this incident will be applied across our global business.

Maintaining and developing the skills and capabilities of our people is a key factor in the sustained success of the Group. As well as Total Performance Leadership (see page 34), programmes for high potential employees, leadership and competency frameworks were provided, and appropriately tailored, to each of the Group's home markets. The Group's 'Developing You' programme continued to deliver training across a number of functional specialities and a Diversity & Inclusion strategy was adopted to better support the recruitment, retention and engagement of talented employees from all backgrounds.

BAE Systems remains a broadly-based and resilient business, with a focus on business opportunities in Services, Electronic Systems and Platforms. In addition, cost efficiency will continue to be a priority focus for management to the benefit of customers and to extract greater performance from the Group's large order book.

Ian King

Chief Executive

Financial performance

"A robust performance evidencing the quality and resilience of the Group."

George Rose

Group Finance Director

FINANCIAL HIGHLIGHTS

- Headline sales² increased by 1.8%

- Underlying EBITA³ up 0.8% to £2,214m (2009 £2,197m) after a charge of £100m taken in respect of the terminated Trinidad and Tobago ship contract

- Underlying earnings⁴ per share increased by 1.7% to 40.8p (2009 40.1p)

- The total dividend has increased by 9.4% to 17.5p (2009 16.0p)

- £500m market purchase of shares completed

SUMMARY INCOME STATEMENT - CONTINUING OPERATIONS

		2010 £m	Restated¹ 2009 £m
Sales²	KPI	22,392	21,990
Underlying EBITA³	KPI	2,214	2,197
Return on sales		9.9%	10.0%
Profit on disposal of businesses		1	68
Pension accounting gains		2	261
Regulatory penalties		(18)	(278)
EBITA		2,199	2,248
Amortisation of intangible assets		(392)	(286)
Impairment of intangible assets		(125)	(973)
Finance costs²		(194)	(698)
Taxation expense²		(461)	(352)
Profit/(loss) for the year		1,027	(61)
Exchange rates - average
£/$		1.545	1.566
£/€		1.166	1.123
£/A$		1.682	1.990

Following the sale of half of the Group's 20.5% shareholding in Saab AB, its share of the results of Saab AB to the date of disposal are now shown within discontinued operations for the current and prior periods (see note 9 to the Group accounts).

Income statement - continuing operations

Sales² increased by 1.8% to £22.4bn (2009 £22.0bn). Like-for-like sales², after adjusting for the impact of exchange translation, and acquisitions and disposals, reduced by 1.9% as increased Typhoon deliveries and support activities in the Kingdom of Saudi Arabia were more than offset by the planned lower level of land vehicle sales in the US.

US-led businesses were responsible for 51% (2009 55%) of sales². Sales² generated from home markets represented 92% (2009 92%) of sales². The Group's sales² performance is illustrated in the bridge chart below.

Underlying EBITA³ Management uses an underlying profit measure to monitor the year-on-year profitability of the Group. This is defined as earnings before amortisation of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items.

Underlying EBITA³ increased by 0.8% to £2,214m (2009 £2,197m). This increase includes favourable exchange translation of £25m. A charge of £100m was taken in the year in respect of the terminated Trinidad and Tobago ship contract. Excluding that charge, return on sales increased to 10.3%.

US-led businesses delivered 56% (2009 52%) of the Group's underlying EBITA³. The increase in underlying EBITA³ is illustrated in the bridge chart below.

Non-recurring items are defined as items that are relevant to an understanding of the Group's performance with reference to their materiality and nature. The non-recurring items, which are unchanged from the prior year, are as follows:

In the prior year, profit on disposal of businesses of £68m included £58m for the finalisation of the accounting gain arising from the BVT joint venture transaction.

The pension accounting gain in the prior year of £261m resulted from pension benefit restructuring in the US.

The regulatory penalties of £278m in the prior year reflect the global settlement of the regulatory investigations by the US Department of Justice (DoJ) and the UK's Serious Fraud Office. The £18m charge in the current year reflects the US dollar exchange rate movement on payment of the penalty in respect of the DoJ.

Amortisation of intangible assets is £106m higher at £392m mainly reflecting the profile of vehicle deliveries under the Family of Medium Tactical Vehicles (FMTV) contract.

Impairment of intangible assets of £125m includes £70m relating to the Surface Ships business primarily arising from the underperformance of the ex-VT Group export ship contracts. The £973m charge in the prior year primarily reflected the non-award of the follow-on FMTV production contract (£592m) and the weaker outlook for the US-based Products Group business (£264m).

Finance costs² were £194m (2009 £698m). The underlying interest charge was £191m (2009 £193m). A net expense of £3m (2009 £505m) arose from pension accounting, marked-to-market revaluation of financial instruments and foreign currency movements. The net expense in the prior year arose from movements in exchange rates on the unhedged element of an intercompany loan from the UK to the US business. That loan has subsequently been capitalised.

Taxation expense² reflects an effective tax rate of 29% (2009 28%). The effective tax rate is based on profit before taxation excluding goodwill impairment of £84m (2009 £725m) and regulatory penalties of £18m (2009 £278m). The underlying tax rate for 2011 is expected to be around 30%, with the final number dependent on the mix of profits between the UK and US.

Earnings per share - continuing operations

RECONCILIATION FROM UNDERLYING EBITA³ TO UNDERLYING EARNINGS⁴ - CONTINUING OPERATIONS

		2010 £m	Restated¹ 2009 £m
Underlying EBITA³	KPI	2,214	2,197
Finance costs excluding non-cash finance movements on pensions and financial derivatives (see note 6 to the Group accounts)		(191)	(193)
		2,023	2,004
Taxation		(587)	(567)
Non-controlling interests		(29)	(22)
Underlying earnings⁴		1,407	1,415
Weighted average number of shares		3,451m	3,532m
Underlying earnings⁴ per share	KPI	40.8p	40.1p

Underlying earnings⁴ per share was 40.8p (2009 40.1p), an increase of 1.7%. The effect of the Trinidad and Tobago £100m charge taken in 2010, net of tax, amounts to an earnings per share reduction of 2.1p. Excluding that charge, underlying earnings⁴ per share increased by 7.0% compared with 2009. The increase in underlying earnings³ per share is illustrated in the bridge chart below.

Basic earnings per share, in accordance with IAS 33, Earnings per Share, increased to 28.9p compared with a loss in 2009 of 2.3p.

Dividends

The Board is recommending a final dividend of 10.5p per share (2009 9.6p), bringing the total dividend for the year to 17.5p per share (2009 16.0p), an increase of 9.4%.

The proposed dividend is covered 2.3 times by underlying earnings⁴ from continuing operations (2009 2.5 times), which is consistent with the Group's policy of growing the dividend whilst maintaining a long-term sustainable earnings cover of approximately two times.

Cash flow

RECONCILIATION OF CASH INFLOW FROM OPERATING ACTIVITIES TO NET (DEBT)/CASH (AS DEFINED BY THE GROUP)⁶

		2010 £m	2009 £m
Cash inflow from operating activities		1,535	2,232
Capital expenditure (net) and financial investment		(364)	(489)
Dividends received from equity accounted investments		71	77
Assets contributed to Trust		(25)	(225)
Cash held for charitable contribution to Tanzania		(30)	-
Operating business cash flow⁷	KPI	1,187	1,595
Interest		(173)	(186)
Taxation		(352)	(350)
Free cash flow		662	1,059
Acquisitions and disposals		(88)	(253)
Debt acquired on acquisition of subsidiary		-	(1)
Purchase of equity shares (net)		(520)	(20)
Equity dividends paid		(574)	(534)
Dividends paid to non-controlling interests		(32)	(5)
Cash (outflow)/inflow from matured derivative financial instruments		(123)	36
Movement in cash collateral		11	(11)
Movement in cash received on customers' account⁸		7	(12)
Foreign exchange translation		(20)	262
Other non-cash movements		32	(157)
Total cash (outflow)/inflow		(645)	364
Opening net cash (as defined by the Group)⁶		403	39
Closing net (debt)/cash (as defined by the Group)⁶		(242)	403

COMPONENTS OF NET (DEBT)/CASH (AS DEFINED BY THE GROUP)⁶

	2010 £m	2009 £m
Debt-related derivative financial assets	45	39
Other investments - current	260	211
Cash and cash equivalents	2,813	3,693
Loans - non-current	(2,133)	(2,840)
Loans and overdrafts - current	(920)	(453)
Less: Cash received on customers' account⁸	(16)	(20)
Less: Assets held in Trust	(261)	(227)
Less: Cash held for charitable contribution to Tanzania	(30)	-
Net (debt)/cash (as defined by the Group)⁶	(242)	403

Cash inflow from operating activities was £1,535m (2009 £2,232m), which includes contributions in excess of service costs for the UK and US pension schemes totalling £554m (2009 £475m), and the payment of the regulatory penalty to the US Department of Justice (£266m).

There was an outflow from net capital expenditure and financial investment of £364m (2009 £489m). The prior year included £94m in respect of new residential and office facilities in Saudi Arabia.

Dividends received from equity accounted investments, primarily MBDA, FNSS, Air Astana, Advanced Electronics Company and Eurofighter GmbH, totalled £71m (2009 £77m).

Assets contributed to Trust comprise a £25m payment made during the year for the benefit of the Group's main pension scheme (2009 £225m).

Cash held for charitable contribution to Tanzania Whilst the £29.5m charitable contribution for the benefit of the people of Tanzania (referred to in the Chairman's letter on page 7) had not been made at the date of this Annual Report, the amount has been deducted from the Group's stated net debt at 31 December 2010 and, with effect from 1 January 2011, is being held by the Company in a notional deposit account accruing interest for the benefit of the people of Tanzania at the Sterling London Interbank Bid Rate.

Taxation payments were £352m (2009 £350m).

Net cash outflow in respect of acquisitions and disposals of £88m mainly comprises the acquisition of Atlantic Marine and OASYS Technology (£260m), less the disposal of half of the Group's 20.5% shareholding in Saab AB (£92m) and an initial payment of A$112.5m (£65m, net of legal fees) received from the former owners of the Tenix Defence business relating to the resolution of outstanding issues from the 2008 acquisition. The prior year outflow of £253m mainly reflects £315m paid to acquire VT Group's 45% interest in BVT, less £70m deferred consideration received relating to the 2008 disposal of a 50% interest in Flagship Training.

The net purchase of equity shares of £520m (2009 £20m) includes 144 million shares purchased under the buyback programme at a cost of £500m (excluding transaction costs of £3m).

As a consequence of movements in the US dollar and Euro exchange rates during the year, there has been a cash outflow from matured derivative financial instruments of £123m (2009 inflow £36m) from rolling hedges on balances with the Group's subsidiaries and equity accounted investments.

Foreign exchange translation primarily arises in respect of the Group's US dollar-denominated borrowing.

Pensions

Pension schemes

The Group's principal pension plans are funded defined benefit plans. The two largest schemes are the BAE Systems Pensions Scheme (Main Scheme) and the BAE Systems 2000 Pension Plan (2000 Plan). In aggregate, these two plans represent 73% (2009 77%) of the total IAS 19, Employee benefits, deficit at 31 December 2010.

Investment strategy

In aggregate, some 60% of the Group's pension assets are held in equities due to the higher expected level of return over the long term. The investment portfolios are highly diversified in order to provide reasonable assurance that no single security or type of security could have a materially adverse impact on the total portfolio. In addition, some of the Group's pension schemes use derivative financial instruments as part of their investment strategy to manage the level of risk.

An analysis of pension scheme assets split between equities, bonds, property and other investments, together with the expected returns on those investments, is shown in note 21 to the Group accounts.

Valuation

Pension plan valuations are performed by independent actuaries for both IAS 19 accounting (see critical accounting policies on page 44) and funding purposes.

Accounting valuations

A summary of the Group's pension scheme assets and liabilities is set out on the opposite page.

Pension scheme assets are included in the valuation at bid value.

The key assumptions used to calculate pension scheme liabilities for the principal plans are shown below:

PRINCIPAL PENSION ACCOUNTING VALUATION ASSUMPTIONS

	UK		US
	2010	2009	2010	2009
Real discount rate⁹ (%)	2.1	2.2	2.5	2.9
Rate of increase in salaries (%)	4.4	4.5	4.5	4.5
Rate of increase in pensions in payment (%)	2.3-3.6	2.3-3.7	n/a	n/a
Rate of increase in deferred pensions (%)	2.8-3.4	3.5	n/a	n/a
Life expectancy of a male currently aged 65 (years)	19-23	19-23	19	19
Life expectancy of a female currently aged 65 (years)	22-26	22-26	21	21

The discount rate assumptions are based on third party AA corporate bond indices using yields that reflect the maturity profile of the expected benefit payments.

The valuation of the Group's pension liabilities is highly sensitive to movements in real discount rates. During the year, these rates have continued to be volatile. A ten basis point movement in the rate changes the pre-tax liability by some £0.3bn. The relationship between the UK pension deficit (as defined by the Group) and the real discount rate is illustrated in the chart opposite.

Certain of the Group's equity accounted investments participate in the Group's defined benefit plans as well as Airbus SAS, the Group's share of which was sold in 2006. As these are multi-employer plans, the Group allocates an appropriate share of the IAS 19 pension deficit to those equity accounted investments and to Airbus SAS.

Funding valuations

The triennial funding valuations of the Group's two largest pension schemes, the Main Scheme and 2000 Plan, were performed as at 5 April 2008 and 2010, respectively.

Pension scheme assets are included in the valuation at market value, whilst the liabilities are determined based on prudent assumptions set by the trustees following consultation with scheme actuaries.

The triennial funding valuations form the basis for the Group's cash funding obligations to its pension schemes.

The current deficit recovery plan agreed with the trustees of the Main Scheme runs until April 2026 and includes annual lump sum contributions of £40m until 2016. In addition, as part of the agreed deficit recovery plan, the Group contributed a further £25m into Trust in 2010. The cumulative contributions into Trust of £250m are reported within other investments (£260m after cumulative fair value gains of £11m), and cash and cash equivalents (£1m) at 31 December 2010, and the use of these assets is restricted under the terms of the Trust. A final £25m is due to be paid into Trust in 2011. The Group considers these contributions to be equivalent to other lump sum contributions it makes into the Group's pension schemes and, accordingly, presents a definition of the pension deficit including them.

During the year, the Group made an incremental lump sum contribution of £51m into the 2000 Plan. This payment was made in advance of the finalisation of discussions between the trustees and the Group to determine the funding implications of the 2010 triennial valuation. The deficit recovery plan in respect of the 2010 triennial valuation was subsequently agreed and runs until April 2026. It includes lump sum contributions of £15m in 2011 and £77m in 2012, and annual lump sum contributions of £54m thereafter.

The Group also made contributions to the UK pension schemes totalling £157m following the £500m share buyback programme completed in July 2010.

The results of future triennial valuations and associated funding requirements will be impacted by the future performance of investment markets, and interest and inflation rates.

Balance sheet

SUMMARY BALANCE SHEET

	2010 £m	Restated⁵ 2009 £m
Intangible assets	11,216	11,306
Property, plant and equipment, and investment property	2,848	2,663
Equity accounted investments and other investments	798	852
Other financial assets and liabilities (net)	(10)	(45)
Tax assets and liabilities (net)	580	896
Pension deficit (as defined by the Group)	(3,146)	(4,410)
Working capital	(6,641)	(7,002)
Net (debt)/cash (as defined by the Group)⁶	(242)	403
Net assets	5,403	4,663

Exchange rates - year end
£/$	1.565	1.615
£/€	1.166	1.125
£/A$	1.526	1.795

Exchange translation, principally in respect of the Group's US dollar-denominated businesses, increased net assets by £154m.

The £90m reduction in intangible assets to £11.2bn (2009 £11.3bn) mainly reflects amortisation and impairments (£517m), largely offset by the acquisition of Atlantic Marine Holding Company (Atlantic Marine) (£170m) and exchange translation (£277m). Intangible assets are accounted for in accordance with IFRS 3, Business Combinations (see critical accounting policies on page 44).

The reduction in equity accounted investments and other investments from £852m to £798m includes a £155m impact from the sale of half of the Group's 20.5% shareholding in Saab AB.

The movement in the pension deficit (as defined by the Group) during the year was as follows:

MOVEMENT IN THE PENSION DEFICIT (AS DEFINED BY THE GROUP)

	£m
Total IAS 19 deficit at 1 January 2010	(5,616)
Actual return on assets above expected return	1,043
Decrease in liabilities due to changes in assumptions	55
Contributions in excess of service cost	554
Past service cost	(39)
Curtailment gains	2
Net financing charge	(103)
Exchange translation	(21)
Movement in US healthcare plans	22
Total IAS 19 deficit at 31 December 2010	(4,103)
Allocated to equity accounted investments and other participating employers	696
Group's share of IAS 19 deficit at 31 December 2010	(3,407)
Assets held in Trust	261
Pension deficit (as defined by the Group)	(3,146)

Better than expected investment returns, a £348m impact arising from the change from the Retail Prices Index to the Consumer Prices Index as the measure of price inflation for the purposes of determining minimum statutory pension increases, and deficit funding are the primary reasons for the Group's share of the pre-tax pension deficit reducing. With the exception of the 2000 Plan, the change to the measure for determining the minimum statutory pension increases has affected all of the Group's UK pension schemes for deferred pension increases, but has only affected two of the Group's smaller schemes for increases to pensions in payment.

PENSION ASSETS AND LIABILITIES

	2010 £m	2009 £m
Fair value of plan assets	17,203	15,023
Present value of obligations	(21,306)	(20,639)
Total IAS 19 deficit, net	(4,103)	(5,616)
Allocated to equity accounted investments and other participating employers	696	979
Group's share of IAS 19 deficit, net	(3,407)	(4,637)
Assets held in Trust	261	227
Pension deficit (as defined by the Group)	(3,146)	(4,410)

A net deferred tax asset of £1.0bn (2009 £1.4bn) relating to the Group's pension deficit is included within net tax assets and liabilities, and disclosed in note 8 to the Group accounts.

Further disclosure is provided opposite and in note 21 to the Group accounts.

Capital

The Group funds its operations through a mixture of equity funding and debt financing, including bank and capital market borrowings.

At 31 December 2010, the Group's capital was £5,356m (2009 £4,550m), which comprises total equity of £5,403m (2009 £4,663m), less amounts accumulated in equity relating to cash flow hedges of £47m (2009 £113m). Net debt (as defined by the Group)⁶ was £242m (2009 net cash £403m).

The capital structure of the Group reflects the judgement of the directors of an appropriate balance of funding required. The Group's policy is to maintain an investment grade credit rating. The Group's dividend policy is to grow the dividend whilst maintaining a long-term sustainable earnings cover of approximately two times.

Tax

The Group's tax strategy is fully aligned with its business strategy and, as part of that, the Group seeks to build constructive, open working relationships with tax authorities in all of the countries in which it operates.

1 Restated following the sale of half of the Group's 20.5% shareholding in Saab AB and subsequent classification as a discontinued operation.

2 Including share of equity accounted investments.

3 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items.

4 Earnings excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, and non-recurring items.

5 Restated following finalisation of the fair values recognised on acquisition of the 45% shareholding in BVT Surface Fleet Limited.

6 See note 27 to the Group accounts.

7 See note 26 to the Group accounts.

8 Cash received on customers' account is the unexpended cash received from customers in advance of delivery which is subject to advance payment guarantees unrelated to Group performance. It is included within trade and other payables in the Group's balance sheet.

9 Discount rate net of inflation.

Operating group reviews

Electronics, Intelligence & Support

OVERVIEW

Electronics, Intelligence & Support, with 30,800 employees¹, provides a wide range of electronic systems and subsystems for military and commercial applications, technical and professional services for US national security and federal markets, and ship repair and modernisation services.

KEY POINTS - FINANCIAL

- Order intake¹ growth of 7.5%

- Return on sales increased to 11.8%

- Cash flow³ conversion of underlying EBITA² at 85%

PERFORMANCE

		2010	2009	2008
Financial
Order intake¹	KPI	£5,823m	£5,416m	£4,904m
Order book¹		£4.8bn	£4.5bn	£5.2bn
Sales¹	KPI	£5,653m	£5,637m	£4,459m
Underlying EBITA²	KPI	£668m	£575m	£506m
Return on sales		11.8%	10.2%	11.3%
Cash inflow³	KPI	£568m	£380m	£380m
Safety
Lost Work Day Case Rate (per 100,000 employees)	KPI	262	315	472

KEY POINTS - OPERATIONAL

- Acquisitions of Atlantic Marine and OASYS Technology completed

- Central operating group headquarters closed as part of the restructuring of BAE Systems, Inc.

- Continued to perform on legacy programmes and secured several strategic contract awards in new markets

- US Army qualified IMX-101 as a safer and effective alternative for the potential replacement of TNT in artillery

- Strong ship repair performance continued, with order intake totalling $1bn (£0.6bn) in 2010

In 2010, Electronics, Intelligence & Support sales¹ were £5,653m (2009 £5,637m). On a like-for-like basis, sales¹ decreased by 2.4% over 2009 primarily reflecting the impact of contracting delays caused by the extended Continuing Resolution funding at the end of 2009.

Return on sales increased to 11.8% (2009 10.2%) reflecting good programme execution on certain maturing programmes, and ongoing cost reduction and efficiency programmes.

Operating cash inflow³ was £568m (2009 £380m) reflecting good working capital management.

The business reduced its Lost Work Day Case Rate by 17% in 2010, driven by good performance in high risk areas. Although the overall target of a 20% reduction was not achieved, the safety performance of the businesses has continued to demonstrate a year-on-year improvement. With the exception of Atlantic Marine sites acquired in 2010, all sites with more than 150 personnel progressed to Level 4 on the Group's Safety Maturity Matrix.

Electronic Solutions

Electronic Solutions completed the $53m (£33m) acquisition of OASYS Technology, an electro-optical systems manufacturer, which strengthens BAE Systems' Electronic Systems capabilities, providing a wide range of night vision, soldier-borne imaging systems.

The business maintained its leadership position in electronic warfare, with strong performance on Low-Rate Initial Production (LRIP) of electronic warfare suites for F-35. The initial countermeasures system was delivered, with significant improvements made to its mission systems flight testing software.

The F-22 electronic warfare programme completed its required deliveries, retired all risk items as planned and exceeded its cost reduction expectations.

The US Army continues to order the Common Missile Warning System, a helicopter missile warning system, with contract awards of $34m (£22m) in 2010. The business also unveiled its directable, infrared countermeasures suite, Boldstroke™, an integrated aircraft survivability system for protecting aircraft from infrared-guided missiles and other threats.

A $46m (£29m) LRIP contract was signed with the US Navy for the Advanced Precision Kill Weapon System. BAE Systems designed the laser guidance and controls on this cost-effective guidance kit that transforms standard unguided rockets into highly precise laser-guided missiles.

The business continues to invest in research and development. As part of a three-year, $70m (£45m) investment in the development of state-of-the-art manufacturing and systems engineering facilities for integrated aircraft survivability equipment, the Worrell/Weeks Aircrew Protection Center, a new testing and equipment evaluation laboratory, was dedicated during the year.

Following strong performance by the business on legacy contracts, US Army demand for thermal weapon sights continued in 2010 with the award of an additional $123m (£79m) contract under a five-year, Indefinite-Delivery/Indefinite-Quantity contract. The order increases the total thermal weapon sight contract value to more than $1bn (£0.6bn) since 2004.

In 2010, the Driver's Vision Enhancer Family of Systems completed the hardware qualification phase and began production deliveries, with orders totalling more than $92m (£59m). The combat-proven Check-6® thermal camera system received additional contracts worth more than $120m (£77m) and deliveries exceeded 21,000 units.

In an emerging market related to unmanned aerial vehicle opportunities, BAE Systems was awarded several wide-area persistent surveillance contracts totalling over $100m (£64m).

In export markets, the business secured a $67m (£43m) contract with the Slovak Ministry of Defence for a newly designed mobile military communications system (MOKYS). The system supports secure transfer of information in the form of voice, data and images at both operational and tactical levels of command.

Intelligence & Security

In February 2011, BAE Systems completed the acquisition of L-1 Identity Solutions, Inc.'s Intelligence Services Group, which expands its existing presence in the US intelligence community, for a cash consideration of approximately $297m (£190m).

Within the Services market segment, Intelligence & Security continues to support US and international government and commercial clients in the collection and management of information to gather intelligence, maintain security, manage risks and strengthen resilience in today's complex operating environments. Key focus areas are intelligence and counterintelligence, homeland security, law enforcement, and support of military operations.

With sustained intelligence and security operations around the world, the business captured significant, indefinite-quantity contract vehicles to provide knowledge management, cyber, information technology, and analysis support to defence and intelligence agencies, and the US Federal Bureau of Investigation (FBI).

Other key contract awards included: Next Generation Desktop for up to $300m (£192m) that will deploy over 12,000 analyst workstations across the intelligence community; a $40m (£26m) contract for the FBI supporting enterprise network operations and information assurance; and a command and control system contract for the US Navy with an estimated value of $100m (£64m) that leverages BAE Systems' market-leading capabilities in full-motion video analysis, geospatial imagery analysis and mission planning.

Platform Solutions

In the air domain, the business extended a long-term agreement with Boeing, securing its exclusive position for Boeing original equipment and aftermarket work through to 2019. The contract covers commercial electronics for the Boeing 737, 747, 767 and 777 aircraft, with a potential value of $800m (£511m).

In the UK, the business delivered the first order of new helmet-mounted optical sighting systems to the Royal Navy, addressing a mission-critical need for increased air door gunner situational awareness.

BAE Systems began production deliveries of its HybriDrive® propulsion system to British bus builder Alexander Dennis under the UK Green Bus Fund initiative, with over 100 systems in service to date. The business began the development of a hydrogen fuel cell system for SunLine Transit, delivered its first production bus to the Seattle Transit System, and was selected to power New Flyer hybrid buses in Atlanta, Georgia and Everett, Washington. Transit buses powered by BAE Systems' HybriDrive® green propulsion systems surpassed 200 million miles of clean, reliable revenue service.

Support Solutions

Consistent with the Group's strategy to grow its Readiness & Sustainment activities, Atlantic Marine was acquired in July for $372m (£245m). The acquisition enhances the Group's ability to meet ongoing demand for ship maintenance, repair, overhaul and conversion services; marine fabrication; and construction. Integration of the business is largely complete.

A five-year, $400m (£256m) MSMO contract was secured to repair and modernise eight combatant ships for the US Navy. The contract includes docking and non-docking work on four CG-47 Ticonderoga class cruisers and four DDG-51 Arleigh Burke class destroyers.

In another Services market, the US Army awarded the business a contract worth up to $95m (£61m) to install and maintain automated access control systems at US Army bases and other installations. This award expands BAE Systems' support of physical security at US government sites.

BAE Systems has been approved to provide engineering and technical services to the US Army and other federal customers under the Rapid Response - 3rd Generation $16.4bn (£10.5bn) government-wide contract, making it eligible to bid on a range of task orders during the ten-year life of the contract.

OUTLOOK

Pressures continue on the US defence budget. The US Secretary of Defense recently announced a directive aimed at reducing funding for multiple programmes and services. Whilst these funding reductions and expected slowing or ultimate cancellations of new programmes could impact the business, BAE Systems remains well positioned to support its US customers with a balance of products, technologies and services. In recognition of the growing importance of affordability and efficiencies, BAE Systems streamlined the organisation of its US business in 2010 to reduce costs and improve flexibility. BAE Systems expects to benefit from its presence in markets that are forecast to grow despite general market pressures, such as Cyber & Intelligence and ship repair services. The business will continue to focus its investment in market areas where growth is expected.

p12 For more information on the Group's 2010 Executive Committee objectives

Land & Armaments

OVERVIEW

Land & Armaments, with 16,100 employees¹, designs, develops, produces, supports and upgrades armoured combat vehicles, tactical wheeled vehicles, naval guns, missile launchers, artillery systems, munitions and law enforcement products.

KEY POINTS - FINANCIAL

- Return on sales increased to 10.2% (2009 9.0%)

- Cash flow³ conversion of underlying EBITA² at 142.1%

PERFORMANCE

		2010	2009	2008
Financial
Order intake¹	KPI	£3,707m	£3,934m	£8,568m
Order book¹		£5.9bn	£7.8bn	£11.5bn
Sales¹	KPI	£5,930m	£6,738m	£6,407m
Underlying EBITA²	KPI	£604m	£604m	£566m
Return on sales		10.2%	9.0%	8.8%
Cash inflow³	KPI	£858m	£480m	£467m
Safety
Lost Work Day Case Rate (per 100,000 employees)	KPI	277	500	737

KEY POINTS - OPERATIONAL

- Restructured to create a leaner, more responsive business to meet customers' needs

- Net headcount reduced by 5,500 (including contractors)

- Demand continues for land vehicle Readiness & Sustainment

- Continued progress in pursuit of supply chain efficiencies

- Continued Mine Resistant Ambush Protected vehicle activity

In 2010, Land & Armaments sales¹ were £5,930m (2009 £6,738m). On a like-for-like basis, and as expected, sales¹ were 13.7% below 2009 reflecting the lower level of land vehicle activity, primarily Bradley and Family of Medium Tactical Vehicles (FMTV).

Underlying EBITA² was £604m (2009 £604m). Return on sales increased to 10.2% (2009 9.0%) benefiting from both performance on the FMTV and Bradley programmes, and continuing rationalisation and efficiency activities. Underlying EBITA² in the prior year included £42m of costs associated with the unsuccessful Mine Resistant Ambush Protected (MRAP) All-Terrain Vehicle (ATV) bid.

Operating cash inflow³ was £858m (2009 £480m) reflecting strong working capital management.

The business reduced its Lost Work Day Case Rate by 45%, exceeding the 2010 objective of a 20% improvement on 2009. All sites with more than 150 personnel progressed to Level 4 on the Group's Safety Maturity Matrix.

In 2010, Land & Armaments restructured its operations to reflect the expected lower demand for new vehicles. As a result of the rationalisation programmes, total headcount (including contractors) was reduced by 5,500.

United States

BAE Systems has reset and upgraded more than 3,390 Bradley vehicles to support its customers since 2007. The business is extending the lives of 552 Bradley Fighting Vehicles by replacing old and damaged components under a $91m (£58m) contract modification from the US Army Tank-automotive and Armaments Command Life Cycle Management Command. This is in addition to contracts totalling $440m (£281m) awarded on other Bradley and HERCULES upgrades. The January statements by the US Secretary of Defense included the need to continue to upgrade the Bradley family of vehicles.

Early in 2010, following a rapid design and development process, BAE Systems introduced the Caiman Multi-Terrain Vehicle to provide an effective combination of interior capacity, tactical mobility, operator comfort and survivability. The business was awarded a $629m (£402m) contract from the US MRAP Joint Program Office to upgrade 1,700 Caiman MRAP vehicles.

BAE Systems is on schedule to deliver seven Paladin Integrated Management prototype vehicles to the US Army under the existing research and development contract. The upgraded vehicles use combat-proven technologies from the Bradley vehicle family and feature the Group's enhanced on-board power management capability.

BAE Systems received orders from the US Marine Corps Systems Command worth $170m (£109m) to produce 32 US Special Operations Command (SOCOM) Armored Utility Vehicles (AUV) and provide major upgrades to existing vehicles. The US SOCOM AUV is one of several MRAP variants based on the RG33 family of vehicles. To date, nearly 350 SOCOM MRAP vehicles have been produced and, in total, the business has delivered more than 6,400 MRAP vehicles to support urgent needs in Iraq and Afghanistan, with nearly $5bn (£3.2bn) in contract awards for the production and service of MRAPs.

Two new Services facilities were opened to provide the US Army with work areas to maintain the RG33 SOCOM vehicles in theatre. These facilities provide complete maintenance and service capabilities in support of the Group's products in the field, training classrooms to assist soldiers, and living quarters for workers. Expansion plans include support of all the Group's products in service with the US armed forces in the region.

During the year, the US business was awarded over $30m (£19m) in orders to deliver armour protection kits for Armored Security Vehicles (ASV), demonstrating BAE Systems' position as a leader in innovative armouring technologies. BAE Systems has produced more than 2,500 armour kits for the highly manoeuvrable, four-wheel drive ASV.

BAE Systems opened a new state-of-the-art design and prototyping centre in Sterling Heights, Michigan, housing facilities for vehicle and subsystem modifications, integration and testing, electrical assembly fabrication, software development, and system integration of vehicle control and crew station electronics.

The business continues to deliver ahead of schedule and to cost under its existing FMTV contract, producing over 7,000 vehicles at a record high quality level, with sales of some $2bn (£1.3bn) in 2010. This contract is expected to complete in the first quarter of 2011.

Following the submission of a bid for the development phase of the US Army's new Ground Combat Vehicle programme in May, the business was notified of a change in the customer's requirements and re-submitted its bid. The technology demonstration phase of the programme is expected to be awarded late in 2011.

United Kingdom

The munitions business has seen significant investment and transformation activity during the year, with work on new facilities at Radway Green and Washington. Throughout this period, the business has continued to perform under its 15-year partnership with the UK Ministry of Defence (MoD) to deliver small arms ammunition, achieving cumulative schedule adherence of 99% and sales of £302m in 2010.

The vehicles business received Readiness & Sustainment contracts from the UK MoD, valued at £30m, for the design, production and embodiment of upgrade kits for 78 British Army Warrior infantry fighting vehicles. In March, the business delivered the last of the latest tranche of BVs10 Viking Mk2 vehicles.

In March, the UK government announced that it had not selected BAE Systems' proposal for the Future Rapid Effect System (FRES) Specialist Vehicles requirement.

The weapons business received an order for 93 additional M777 howitzers, taking total cumulative orders since product launch to 955 systems, worth in excess of £1bn.

Sweden

The weapons business was awarded a £135m contract for the production of 48 Archer 155mm self-propelled artillery gun systems for the Swedish and Norwegian armed forces.

The vehicles business was awarded a long-term contract from the Dutch MoD to supply spares for their CV9035 infantry fighting vehicles.

In June, BAE Systems launched the latest member of the CV90 family, the CV90 Armadillo, which has been modified to provide a higher degree of payload and flexibility to address new threats, and adapt to rapidly changing operational environments, thereby introducing a new build standard.

Despite its upheld legal appeal against the decision of the Swedish Defence Materiel Administration, the Group's proposed modular 8x8 vehicle, named Alligator, was not selected for the Armoured Wheeled Vehicle programme.

South Africa

Through a partnership with General Dynamics Land Systems Canada, the business received a $160m (£102m) follow-on contract award to build 250 RG31 Mk5E vehicles in support of the MRAP vehicle programme for use in Afghanistan.

In December, the business received a contract for $130m (£83m) for the upgrade of approximately 700 MRAP RG31 vehicles. The upgrade includes new engines, and new independent suspension and tyre inflation systems.

Joint ventures

FNSS, a 49% owned joint venture with Nurol Group of Turkey, signed a letter of intent for approximately $500m (£320m) with DEFTECH of Malaysia for the design and manufacture of 250 armoured wheeled vehicles for the Malaysian armed forces.

OUTLOOK

Land & Armaments faces a challenging market environment. It is expected that pressures on defence budgets, particularly in the US and UK, will continue. Recent statements by the US Secretary of Defense indicated that the 2011 US defence budget is likely to include anticipated cost efficiencies, programme reductions and potential cancellations. However, the business is well positioned to compete for sustainment and upgrade work on its existing platforms in the event of new vehicle programme terminations.

Sales in 2011 will be impacted by approximately $1.6bn (£1.0bn) on completion of the current FMTV contract and by approximately $1.0bn (£0.6bn) for the lower level of Bradley reset/remanufacture activity.

Going forward, the focus will be on securing key new programmes, pursuing export opportunities, and sustaining the margin improvement from the business's ongoing restructuring and efficiency initiatives.

p12 For more information on the Group's 2010 Executive Committee objectives

Programmes & Support

OVERVIEW

Programmes & Support, with 31,600 employees¹, primarily comprises the Group's UK-based air, maritime and Cyber & Intelligence activities.

KEY POINTS - FINANCIAL

- Underlying EBITA² includes a charge of £100m on the terminated Trinidad and Tobago Offshore Patrol Vessel (OPV) programme

PERFORMANCE

		2010	2009	2008
Financial
Order intake¹	KPI	£4,139m	£8,789m	£4,195m
Order book¹		£21.1bn	£24.3bn	£19.8bn
Sales¹	KPI	£6,680m	£6,298m	£4,638m
Underlying EBITA²	KPI	£529m	£670m	£491m
Return on sales		7.9%	10.6%	10.6%
Cash inflow³	KPI	£227m	£285m	£651m
Safety
Lost Work Day Case Rate (per 100,000 employees)	KPI	426	812	992

KEY POINTS - OPERATIONAL

- £537m Hawk India contract secured

- Third Type 45 destroyer accepted off contract and sixth launched

- HMS Astute acceptance completed and second boat, Ambush, launched

- Nimrod MRA4 programme terminated and Harrier to be taken out of service in 2011 following Strategic Defence and Security Review (SDSR)

- Continued rationalisation and efficiency activity across the operating group and alignment of cost base post SDSR

Order intake¹ in the year was £4.1bn (2009 £8.8bn). The prior year intake included long-term orders for production of Typhoon Tranche 3A aircraft, and support for Typhoon, Harrier, Type 45 and Spearfish and Sting Ray torpedoes.

Sales¹ in 2010 were £6.7bn, which, on a like-for-like basis, were broadly unchanged from 2009.

Underlying EBITA² was £529m (2009 £670m) with a return on sales of 7.9% (2009 10.6%). Underlying EBITA² in 2010 includes a £100m charge on the terminated Trinidad and Tobago OPV programme. As expected, margins were impacted by higher pension service costs arising from a fall in the discount rates applied to pension liabilities.

The business reduced its Lost Work Day Case Rate by 48%, exceeding the 2010 objective of a 20% improvement on 2009. There were particular improvements in safety in the Surface Ships business. All sites with more than 150 personnel progressed to Level 4 on the Group's Safety Maturity Matrix.

In addition to approximately 1,750 redundancies announced in 2009, a further 2,900 were announced across the operating group in 2010 to continue to deliver efficiencies and align the cost base following the SDSR.

Military Air Solutions

Delivery of Typhoon Tranche 2 aircraft to the four partner nations continued with 41 aircraft delivered in the year. Deliveries to the Royal Saudi Air Force (RSAF) were made in accordance with the programme, with 18 of the 72 contracted aircraft delivered to date.

A £111m, four and a half-year Services contract was awarded on the Hawk Advanced Jet Trainer (AJT) fleet at RAF Valley. Twenty-five of the 28 Hawk AJT aircraft for the RAF have now been accepted.

BAE Systems has secured a £537m contract from Hindustan Aeronautics Limited to supply products and services to enable an additional 57 Hawk AJT aircraft to be built under licence in India.

On F-35, major unit deliveries to Lockheed Martin have been completed for the development programme and the first two production contract lots. Production continues to schedule on Lot 3, which includes the first two UK operational test and evaluation aircraft. The SDSR decision to acquire the F-35 Carrier variant instead of the F-35 Short Take Off and Vertical Landing variant will not change BAE Systems' role on the programme. BAE Systems' workshare arrangements are not matched against the UK government's decisions on aircraft type or quantities.

On the Tornado and Harrier programmes, operational requirements continued to be met through the delivery of contractual milestones and Urgent Operational Requirements.

BAE Systems continues to show good progress in its Unmanned Aircraft Systems activities, with the roll out of the joint MoD and industry Taranis Unmanned Combat Aircraft System demonstrator in July.

Surface Ships

Programmes for the Royal Navy have progressed to plan, with construction well advanced on sections of the first Queen Elizabeth Class aircraft carrier in Portsmouth and Glasgow.

The Type 45 build programme continues, with delivery of third of class, Diamond, sea trials for fourth of class, Dragon, and launch of the sixth and final ship, Duncan, during 2010. The Type 45 support solution has been contracted for and established in Portsmouth.

Considerable achievements have been made to transform the business and drive cost savings under the Terms of Business Agreement (ToBA) with the MoD, including efficiency savings generated in the year to March 2010 for the MoD of £66m.

BAE Systems was awarded a four-year, £127m contract by the MoD to develop a highly flexible, multi-role frigate for the Royal Navy, the Type 26.

The export contracts for Oman, and Trinidad and Tobago have encountered significant difficulties during construction that have led to further delays and losses of £163m. The fair values of these contracts have been updated accordingly (see note 29).

In September, BAE Systems received written notice from the Government of the Republic of Trinidad and Tobago (GORTT) of its intention to cancel the contract for three OPVs. The Group has challenged GORTT's entitlement to cancel and has itself issued a termination for default notice on GORTT. The parties are now proceeding in accordance with the contract's dispute resolution provisions and a charge of £100m has been taken.

Submarine Solutions

HMS Astute, the first of class attack submarine for the Royal Navy, was accepted by the MoD in November. Ambush, the second of class, was launched in January 2011 and will now undertake commissioning activities prior to commencing sea trials. Construction continues on the third and fourth boats. A £360m order, which includes commencement of construction of the fifth boat and long lead procurement for the sixth boat, has been received.

The concept phase for the successor to the Vanguard class submarine is scheduled to complete in March 2011, with the assessment, design and development phases then to follow.

Detica

Detica's Cyber & Intelligence activity, which focuses on cyber security and information assurance, countering terrorism and organised crime, and border security, has maintained sales growth despite reduced UK government spending. Growth opportunities in other BAE Systems home markets, and elsewhere in the Middle East and Europe, have secured sales into the law enforcement, telecommunications and financial services sectors.

In the UK, cyber security has been highlighted as a significant threat in the National Security Strategy. Detica continues to be well placed as a strategic partner to UK government. In 2010, Detica launched a new cyber security service, Detica Treidan^TM, and is advising commercial and government customers on preventing and responding to attacks on their networks.

The Detica NetReveal® solution continues to show global sales growth with some key wins, particularly in the financial services sector.

In July 2010, the Home Office terminated the e-Borders contract. Detica was a subcontractor to Raytheon on that programme and has submitted a claim in connection with the termination for convenience of its subcontract.

In December 2010 and January 2011, respectively, the Group announced the proposed acquisitions of ETI A/S and Norkom Group plc in the Cyber & Intelligence domain.

Integrated System Technologies (Insyte)

The FALCON secure deployable broadband communication system for the British Army and RAF completed Technical Field Evaluation in July. The contract provides for the initial operational capability to be accepted in 2011. The business is in discussions with the customer with regard to a revision to the programme schedule.

A re-baselined programme on the Maritime Composite Training System has been agreed with the customer. A revised ready for training date is planned for September 2011.

The ARTISAN 3D radar successfully completed Customer Critical Design Review in June, allowing the programme to progress towards full production.

The Sting Ray lightweight torpedo main production order for the Royal Navy completed production deliveries in May. The delivery contract for the government of Norway is on schedule, with initial deliveries achieved in December.

OUTLOOK

Anticipating the impact of pressure on government spending and the SDSR, the business has worked closely with the MoD to align objectives and transformation plans. Programmes & Support was re-organised with effect from 1 January 2011. A new Maritime business has been created, encompassing all UK maritime activities, and the new Military Air & Information line of business integrates the military air and information systems activities.

Maritime is underpinned by the Type 45, Queen Elizabeth carrier and Astute class submarine manufacturing programmes, the 15-year ToBA, and the concept design of the successor submarine.

In Military Air & Information, growth is linked to increasing combat aircraft production. The business is underpinned by the Typhoon and F-35 programmes.

Detica's position in the UK market, and its development as a solutions integrator and provider of cyber security services, means that it is well positioned to support the UK government's National Security Strategy, the increased focus on intelligence and security in the UK and overseas, and growing commercial markets.

p12 For more information on the Group's 2010 Executive Committee objectives

International

OVERVIEW

International, with 17,200 employees¹, comprises the Group's businesses in Australia, India and Saudi Arabia, together with interests in the pan-European MBDA joint venture and Air Astana.

KEY POINTS - FINANCIAL

- Like-for-like sales¹ growth of 15.3% over 2009

- Settlement achieved with the former owners of Tenix Defence

PERFORMANCE

		2010	Restated⁴ 2009	Restated⁴ 2008
Financial
Order intake¹	KPI	£2,908m	£4,564m	£3,559m
Order book¹		£9.1bn	£11.0bn	£10.2bn
Sales¹	KPI	£4,534m	£3,828m	£2,926m
Underlying EBITA²	KPI	£478m	£419m	£417m
Return on sales		10.5%	10.9%	14.3%
Cash inflow³	KPI	£195m	£813m	£163m
Safety
Lost Work Day Case Rate (per 100,000 employees)	KPI	896	746	1,393

KEY POINTS - OPERATIONAL

- A further ten Typhoon aircraft delivered under the Salam programme

- Typhoon operational capability being provided under the support contract

- 157 Tactica vehicles accepted by the Saudi Arabia National Guard

- BAE Systems Australia selected as Lockheed Martin's partner for maintenance and upgrade support on the Australian F-35 programme

- Defence Land Systems India Private Limited joint venture became operational

During 2010, International sales¹ were £4,534m (2009 £3,828m). The increase in sales was predominantly a result of increased activity on the Saudi British Defence Co-operation Programme (SBDCP) in the Kingdom of Saudi Arabia and progress on the Landing Helicopter Dock programme in Australia.

Underlying EBITA² of £478m (2009 £419m) generated a return on sales of 10.5% (2009 10.9%). The reduction in return on sales is due to the low margin being traded on increased activity on the early stages of the Salam and Landing Helicopter Dock programmes.

Operating cash inflow³ was £195m (2009 £813m) reflecting the expected utilisation of advance funding on the Salam programme.

The Lost Work Day Case Rate increased by 20% compared with 2009. The overall trend in safety performance has been improving since 2007, but this level of improvement was not maintained in 2010. Senior management are reviewing safety processes in order to put in place an improvement plan. All sites with more than 150 personnel progressed to Level 4 on the Group's Safety Maturity Matrix.

Saudi Arabia

The business continues to develop its presence in Saudi Arabia and remains committed to developing a greater indigenous capability in the Kingdom. This strategy is being enhanced by the entry into service of Typhoon aircraft and subsequent development of the Typhoon in-country industrial base. Of the 72 Typhoon aircraft contracted under the Salam programme, 18 have been delivered to the customer. Six of the ten aircraft delivered this year are the twin-seat variant which will allow the Royal Saudi Air Force (RSAF) to conduct their own training missions.

Whilst deliveries on the Salam programme remain on schedule, the programme is likely to be adjusted to accommodate some customer changes. These may include relocating final assembly of the last 48 of the 72 aircraft, the creation of a maintenance and upgrade facility in the Kingdom of Saudi Arabia and, in addition, the last 24 of the 72 aircraft might be delivered with modifications to allow future incorporation of Tranche 3 capability.

The business continues to provide support to the operational capability of both the RSAF and Royal Saudi Naval Force through the SBDCP. Customer discussions are ongoing for the next phases of SBDCP and the Salam programme. The Group expects the customer to place a greater emphasis on performance-based contracting and use of the Saudi industrial base.

All 200 Tactica land vehicles have been delivered to the Saudi Arabia National Guard. In 2010, 157 vehicles were accepted by the customer and entered into service. The remaining 43 vehicles are expected to be accepted in the first quarter of 2011. The business continues to support these vehicles in accordance with a separate contract.

The C4I⁵ programme remains challenging, but good progress continues towards design completion.

Australia

In 2010, BAE Systems consolidated its position as a strategic support provider to the Australian Defence Force (ADF). The Australian government's parallel commitments to maintain defence funding in real terms until 2018 and achieve A$20bn (£13.1bn) of savings through its ten-year Strategic Reform Programme represent both an opportunity and a challenge to the business.

The business has formally presented a proposal to the customer that is expected to deliver savings of at least 20% on the support contract for the Royal Australian Air Force's (RAAF) Hawk Lead-In Fighter fleet without impacting aircraft availability.

A Memorandum of Understanding was signed with Lockheed Martin to establish BAE Systems as the preferred Australian partner for maintenance and upgrade support for the F-35 that will form the mainstay of the RAAF's air combat capability later this decade.

The business is a sub-contractor to Boeing on the Wedgetail Early Warning and Control aircraft programme. During the year, the business completed delivery of the airborne components of the Electronic Support Measures package under the programme.

The maritime business achieved on-schedule performance for the Landing Helicopter Dock project. On the Air Warfare Destroyer programme, work continues to recover the schedule for the construction of hull blocks following initial fabrication difficulties.

The business was not down-selected as a preferred tenderer for the Land 121 Phase 3 project to supply medium and heavy tactical vehicles to the ADF.

Outstanding issues concerning the acquisition of the Tenix Defence business in 2008 have been resolved. Payments totalling A$127.5m (£74m, net of legal fees) are to be made to us by the former owners of the business.

MBDA

MBDA has delivered increased sales and increased return on sales compared to 2009.

Order intake in 2010 was below the level achieved in 2009 as global budgetary constraints meant certain export contracts were delayed. Order intake with domestic customers was good with new production orders received for additional Mistral surface-to-air missiles in France, the development and early manufacture contract for Fire Shadow loitering munitions, and the assessment phase, development and early manufacture for SPEAR (Selectable Precision Effects At Range) weapons under the Complex Weapons contract in the UK.

Key deliveries included Aster surface-to-air missiles, Mica air-to-air missiles, Eryx anti-armour missiles, Taurus stand-off missiles, Milan anti-armour missiles and Exocet anti-ship missiles.

Development programmes continue to progress well, with key milestones being passed on the MEADS air-defence programme, SCALP Naval stand-off missile programme, Meteor beyond visual range air-to-air missile, and all assessment and development phases of the UK Complex Weapons Programmes.

The issues arising during last year's Sea Viper firings have been resolved, culminating in a number of successful trial test firings of the Aster missile. A successful system firing involving an Aster 30 missile was also made in October, to achieve Europe's first ever intercept of a tactical ballistic missile.

India

In 2010, Defence Land Systems India Private Limited, the Group's 26% joint venture with Mahindra & Mahindra Limited, became operational, giving BAE Systems a domestic capability in the land sector. The first new product, Mine Protected Vehicle India, was unveiled in Delhi in February.

BAeHAL Software Limited, the Group's 40% joint venture with Hindustan Aeronautics Limited, has undertaken a series of initiatives to expand its scope of operations and provide IT solutions to a wider range of customers.

Air Astana

Air Astana achieved another year of strong performance. The Group's share of revenue increased by 18% to $321m (£208m), with an improvement in profit driven by rising passenger demand and strong cost base control across its portfolio of international and domestic routes.

Oman

The business has strengthened its presence in Oman during the year and significant activity is ongoing to agree an order for the supply of Typhoon aircraft to the Royal Air Force of Oman. A number of other longer-term prospects are being pursued, and the business is also developing strategies to improve its Services offerings across the significant installed and anticipated future product base.

OUTLOOK

The Group seeks to sustain its long-term presence in the Kingdom of Saudi Arabia through delivering current programmes and industrialisation, and developing new business in support of all Saudi military and paramilitary forces.

The Salam programme changes referred to will necessitate contract and pricing revisions that will need to be concluded in 2011. These will bias both sales and profits to the second half of 2011.

In Australia, BAE Systems aims to capture its share of the growth in defence spending through delivery of innovative, value for money solutions across both new and existing programmes in close co-operation with its major customer, the Australian Defence Materiel Organisation.

In India, BAE Systems plans to develop its home market strategy through existing and, if appropriate, additional joint ventures and partnerships to address the future requirements of the Indian armed forces, in new product and support activities.

p12 For more information on the Group's 2010 Executive Committee objectives

HQ & Other Businesses

OVERVIEW

HQ & Other Businesses, with 2,500 employees¹, comprises the regional aircraft asset management and support activities, head office and UK shared services activity, including research centres and property management.

KEY POINTS - FINANCIAL

- Regional Aircraft underlying EBITA² of £35m in the year

- Payment of the regulatory penalty to the US Department of Justice

PERFORMANCE

		2010	2009	2008
Financial
Order intake¹	KPI	£207m	£175m	£212m
Order book¹		£0.3bn	£0.4bn	£0.4bn
Sales¹	KPI	£278m	£254m	£235m
Underlying EBITA²	KPI	£(65)m	£(71)m	£(101)m
Cash outflow³	KPI	£(665)m	£(366)m	£(66)m

KEY POINTS - OPERATIONAL

- 52 aircraft placements contracted

- Long-term lease of six RJ100 aircraft with Swiss International Airlines

In 2010, HQ & Other Businesses reported a loss² of £65m (2009 £71m) on sales¹ of £278m (2009 £254m).

Operating cash outflow³ in 2010 was £665m (2009 £366m). This includes the payment of the regulatory penalty to the US Department of Justice (£266m) and additional contributions in respect of UK pension schemes totalling £326m (2009 £310m).

Regional Aircraft

Conditions in the commercial aviation sector remain challenging. Despite this, the business has secured 52 aircraft placements to new and existing customers in the year, including a long-term lease of six RJ100 aircraft with Swiss International Airlines.

Lease and sale discussions continue with operators with regard to both current and future fleet requirements and support needs. Marketing activity continues to focus on both uncontracted idle aircraft and those returning off lease.

Whilst market conditions have continued to impact airline profitability, the portfolio customer base remains relatively robust and the business continues to closely monitor operator performance against default risk.

Support revenues have remained under pressure reflecting the current trading conditions. This has been partially offset by good performance within the engineering business.

The balance sheet carrying value of aircraft in the Regional Aircraft business (£166m) is based on the net present value of forecast net leasing or disposal income.

OUTLOOK

Trading conditions for the commercial aircraft market are anticipated to remain challenging given the restricted availability of credit to smaller operators and competition from surplus used aircraft.

1 Including share of equity accounted investments.

2 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 37).

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

4 Restated following the sale of half of the Group's 20.5% shareholding in Saab AB and subsequent classification as a discontinued operation.

5 Command, Control, Communications, Computers and Intelligence.

Principal risks

DEFENCE SPENDING

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

Description

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

Despite budgetary pressures, the US defence market continues to generate a substantial number of business opportunities. In the UK, pressure to reduce government expenditure has been reflected in the Strategic Defence and Security Review (SDSR), which identified a number of changes in priorities, with consequent implications for certain of the Group's programmes. Saudi Arabia is expected to remain one of the largest defence spenders in the world, with defence expenditure of 10.9% of GDP in 2009.

Impact

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

Mitigation

The Group's business is geographically spread across five key home markets, and its products are marketed across a range of sectors within the defence and security arenas. The Group has a highly sustainable Services business, which represented 48% of sales in 2010. This is an area for growth as customers' operations and maintenance budgets come under pressure. The Group has already made significant cost reductions in anticipation of the increased budgetary pressure. The Group continues to use realistic assumptions to underpin its financial and operational planning.

p20 For more information on the Group's five key home markets

p24 For more information on the SDSR

GOVERNMENT CUSTOMERS

The Group's largest customer contracts are government contracts.

Description

The governments of the US, UK and Kingdom of Saudi Arabia are the Group's three largest end customers. Any significant disruption or deterioration in the relationship with these governments and a corresponding reduction in government contracts would significantly reduce the Group's revenues. Companies engaged in the supply of defence and security related equipment and services to government agencies are subject to certain business risks particular to the defence and security industries. These governments could modify contracts or terminate them at short notice and at their convenience. For example, long-term US government contracts are normally funded annually and are subject to cancellation or delay if funding appropriations for subsequent performance periods are not made. Terms and risk sharing agreements can also be amended. In addition, the Group, as a government contractor, is subject to financial audits and other reviews by some of its governmental customers with respect to the performance of, and the accounting and general practices relating to, government contracts. As a result of these audits and reviews, costs and prices under these contracts may be subject to adjustment.

Impact

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

Mitigation

The Board regularly reviews the Group's performance in these home markets, and the Executive Committee continues to work closely with these customers to ensure the Group strategy is aligned with theirs. In the event of a customer termination for convenience, the Group would typically be paid for work done and commitments made at the time of termination. Having sovereign governments as major customers offers the benefits of dealing with mature procurement organisations with which the Group can have long-standing business relationships, and well established and understood terms of trade.

p14 For more information on the Group's strategy

p32 For more information on the Group's customers

GLOBAL MARKET

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

Description

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

Impact

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

Mitigation

The Group has a balanced portfolio of businesses with five key home markets.

p20 For more information on the Group's five key home markets

CONTRACT AWARD TIMING

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

Description

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

Impact

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

Mitigation

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

p32 For more information on Lifecycle Management (LCM) which mandates project management processes from business winning to contract execution

LARGE CONTRACTS

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

Description

A significant proportion of the Group's revenue comes from a small number of large contracts. Each of these contracts, which are primarily in the Programmes & Support and International operating groups, is typically worth or potentially worth over £1bn.

Impact

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

Mitigation

The Group has a large forward order book and a well-balanced spread of programmes, which provides long-term visibility. An analysis of the Group's order book by major programme and operating group is presented on the inside front cover of this report. The Board regularly reviews the Group's performance on these contracts, and the Executive Committee continues to work closely with these customers to ensure the Group's strategy is aligned with theirs.

p14 For more information on the Group's strategy

FIXED-PRICE CONTRACTS

The Group has fixed-price contracts.

Description

A significant portion of the Group's revenue is derived from fixed-price contracts. An inherent risk in these fixed-price contracts is that actual performance costs may exceed the projected costs on which the fixed prices for such contracts are agreed. These contracts can extend over many years and it can be difficult to predict the ultimate outturn costs associated with the terms on which they are based.

Impact

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

Mitigation

The Group has reduced its exposure to fixed-price design and development activity which is in general more risk intensive than fixed-price production activity. To manage contract-related risks and uncertainties, contracts are managed through the application of the Lifecycle Management (LCM) business process mandated by the Operational Framework at the operational level. Robust bid preparation and approvals processes are well established throughout the Group, with decisions required to be taken at the appropriate level in line with clear delegations of authority. The consistent application of metrics is used to support the review of individual contract performance.

p32 For more information on LCM

COMPONENT AVAILABILITY, SUBCONTRACTOR PERFORMANCE AND KEY SUPPLIERS

The Group is dependent upon component availability, subcontractor performance and key suppliers.

Description

The Group is dependent upon the delivery of materials by suppliers and the assembly of components and subsystems by subcontractors used in its products in a timely and satisfactory manner, and in full compliance with applicable terms and conditions.

Impact

Some of the Group's suppliers or subcontractors may be impacted by the economic environment and constraints on available financing, which could impair their ability to meet their obligations to the Group. In some instances, the Group is dependent on one or a limited number of suppliers. If any of these suppliers or subcontractors fails to meet the Group's needs, the Group may not, in the short term, have readily available alternatives, thereby impacting its ability to complete its customer obligations satisfactorily and in a timely manner. These events could have a negative impact on the Group's future results of operations and financial condition.

Mitigation

The Group's procurement function is responsible for establishing and managing end-to-end integrated supplier arrangements. It is led by a member of the Executive Committee. The Executive Committee continues to monitor this risk and the Group has experienced no material negative impact to date. The Group reviews the financial health of strategically important suppliers globally on an ongoing basis.

p33 For more information on the Group's subcontractors and other suppliers

LAWS AND REGULATIONS

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

Description

The Group has contracts and operations in many parts of the world, operates in a highly regulated environment and is subject to applicable laws and regulations of many jurisdictions. These include, without limitation, regulations relating to import-export controls, money-laundering, false accounting, anti-bribery and anti-boycott provisions. Non-compliance could expose the Group to fines, penalties, suspension or debarment, which could have a material adverse effect on the Group. From time to time, the Group is subject to government investigations relating to its operations.

Impact

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

Mitigation

During the year, the Group has continued to add resources dedicated to legal and regulatory compliance in order to further enhance its capability to identify and manage the risk of compliance failure. Internal and external market risk assessments form an important element of the ongoing corporate development process. A uniform global policy and process for the appointment of advisers engaged in business development is in effect. Pursuant to its commitments concerning ongoing regulatory compliance made in the course of the settlement reached with the US Department of Justice (DoJ) in February 2010, the Group has appointed an independent monitor for a period of up to three years to monitor the Group's compliance with such commitments.

p48 For more information on the Group's approach to business conduct

COMPETITION

The Group's business is subject to significant competition.

Description

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

In some instances, governments direct to a single supplier all work for a particular programme, commonly known as a sole-source programme. Although governments have historically awarded certain programmes to the Group on a sole-source basis, they may in the future determine to open such programmes to a competitive bidding process. Government contracts for defence-related products can, in certain countries, be awarded on the basis of home country preference.

Impact

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

Mitigation

The Group's global, multi-home market presence, balanced portfolio of businesses, leading capabilities and performance continue to address this risk.

p20 For more information on the Group's five key home markets

PENSION FUNDING

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

Description

The Group operates certain defined benefit pension schemes. At present, in aggregate, there is an actuarial deficit between the value of the projected liabilities of these schemes and the value of the assets they hold. The Group continues to implement the deficit recovery plans agreed with the respective scheme trustees based on actuarial advice and funding valuation results.

Impact

The amount of the deficits may be adversely affected by changes in a number of factors, including investment returns, long-term interest rate and price inflation expectations, and anticipated members' longevity. Further increases in pension scheme deficits may require the Group to increase the amount of cash contributions payable to these schemes, thereby reducing cash available to meet the Group's other operating, investing and financing requirements.

Mitigation

The performance of the Group's pension schemes and deficit recovery plans are regularly reviewed by both the Group and the trustees of the schemes taking actuarial and investment advice as applicable. The results of these reviews are discussed with the Board and appropriate action taken.

p40 For more information on the Group's pension accounting and funding valuations, and deficit recovery plans

EXPORT CONTROLS AND OTHER RESTRICTIONS

The Group is subject to export controls and other restrictions.

Description

A portion of the Group's sales is derived from the export of its products. The export of defence and security products outside the jurisdictions in which they are produced is subject to licensing and export controls, and other restrictions. No assurance can be given that the export controls to which the Group is subject will not become more restrictive, that new generations of the Group's products will not also be subject to similar or more stringent controls, or that political factors or changing international circumstances will not result in the Group being unable to obtain necessary export licences.

Impact

Reduced access to export markets could have a material adverse effect on the Group's future results of operations and financial condition. Failure to comply with export controls and wider regulations could expose the Group to fines, penalties, suspension or debarment, which could have a material adverse effect on the Group.

Mitigation

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

p21 For more information on exports

ACQUISITIONS

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

Description

The Group has experienced growth through acquisitions and continues to pursue acquisitions in order to meet its strategic objectives. Whether the Group realises the anticipated benefits from these transactions depends upon the integration of the acquired businesses and their performance relative to the Group's acquisition expectations.

Impact

The diversion of management attention to integration efforts, difficulties in combining operations and the performance of the acquired businesses below expectations could adversely affect the Group's business, and create the risk of impairments arising on goodwill and other intangible assets.

Mitigation

The Group has established policies in place to manage the acquisition process, integrate acquired businesses, and monitor performance and potential impairments.

p9 For more information on M&A activity during the year

p132 For more information on impairment testing

CONSORTIA AND JOINT VENTURES

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

Description

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

Impact

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

Mitigation

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

p155 For more information on the Group's principal joint ventures

EXCHANGE RATES

The Group is exposed to volatility in currency exchange rates.

Description

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

Impact

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

Mitigation

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

p42 For more information on the Group's treasury policies

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

Page references used above are references to page numbers in the Annual Report 2010 that can be viewed on the Company's website.

Consolidated income statement

for the year ended 31 December

		2010		Restated¹ 2009
	Notes	£m	Total £m	£m	Total £m
Continuing operations
Combined sales of Group and equity accounted investments	3		22,392		21,990
Less: share of sales of equity accounted investments	3		(1,295)		(1,616)
Revenue	3		21,097		20,374
Operating costs	4		(19,761)		(20,060)
Other income	5		169		465

Group operating profit excluding amortisation and impairment of intangible assets		2,022		2,038
Amortisation	11	(392)		(286)
Impairment	11	(125)		(973)
Group operating profit			1,505		779
Share of results of equity accounted investments excluding finance costs and taxation expense		177		210
Financial (expense)/income of equity accounted investments	6	(2)		2
Taxation expense of equity accounted investments		(44)		(25)
Share of results of equity accounted investments	14		131		187

EBITA² excluding non-recurring items		2,214		2,197
Profit on disposal of businesses³	9	1		68
Pension curtailment gains³		2		261
Regulatory penalties⁴		(18)		(278)
EBITA²		2,199		2,248
Amortisation	11	(392)		(286)
Impairment	11	(125)		(973)
Financial (expense)/income of equity accounted investments	6	(2)		2
Taxation expense of equity accounted investments		(44)		(25)
Operating profit	3		1,636		966
Finance costs	6
Financial income		1,358		1,573
Financial expense		(1,550)		(2,273)
			(192)		(700)
Profit before taxation			1,444		266
Taxation expense	8
UK taxation		(152)		(105)
Overseas taxation		(265)		(222)
			(417)		(327)
Profit/(loss) for the year - continuing operations			1,027		(61)
Profit for the year - discontinued operations	9		54		16
Profit/(loss) for the year			1,081		(45)

Attributable to:
BAE Systems shareholders			1,052		(67)
Non-controlling interests			29		22
			1,081		(45)

Earnings/(loss) per share	10
Basic earnings/(loss) per share			30.5p		(1.9)p
Diluted earnings/(loss) per share			30.3p		(1.9)p

Earnings/(loss) per share - continuing operations
Basic earnings/(loss) per share			28.9p		(2.3)p
Diluted earnings/(loss) per share			28.7p		(2.3)p

1 Restated following the sale of half of the Group's 20.5% shareholding in Saab AB and subsequent classification as a discontinued operation (see note 9).

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

3 Included in other income.

4 Included in operating costs.

Note references used above are references to notes to the Group accounts in the Annual Report 2010 that can be viewed on the Company's website.

Consolidated statement of comprehensive income

for the year ended 31 December

		2010			Restated¹ 2009
	Notes	Other reserves² £m	Retained earnings £m	Total £m	Total £m
Profit/(loss) for the year		-	1,081	1,081	(45)
Other comprehensive income
Currency translation on foreign currency net investments:
Subsidiaries		160	-	160	(246)
Equity accounted investments	14	(6)	-	(6)	(56)
Amounts charged to hedging reserve		(84)	-	(84)	(393)
Gain on revaluation of step acquisition		-	-	-	14
Net actuarial gains/(losses) on defined benefit pension schemes³:
Subsidiaries		-	874	874	(2,008)
Equity accounted investments		-	40	40	(54)
Fair value movements on available-for-sale investments	15	-	14	14	2
Recycling of cumulative currency translation reserve on disposal	9	(17)	-	(17)	-
Recycling of cumulative net hedging reserve on disposal	9	(4)	-	(4)	-
Current tax on items taken directly to equity	8	(2)	70	68	78
Deferred tax on items taken directly to equity:
Subsidiaries	8	24	(309)	(285)	573
Tax rate adjustment⁴	8	-	(23)	(23)	-
Equity accounted investments		-	(12)	(12)	16
Total other comprehensive income for the year (net of tax)		71	654	725	(2,074)
Total comprehensive income for the year		71	1,735	1,806	(2,119)

Attributable to:
Equity shareholders		71	1,706	1,777	(2,141)
Non-controlling interests		-	29	29	22
		71	1,735	1,806	(2,119)

Note references used above are references to notes to the Group accounts in the Annual Report 2010 that can be viewed on the Company's website.

Consolidated statement of changes in equity

for the year ended 31 December

	Attributable to equity holders of the parent
	Issued share capital £m	Share premium £m	Other reserves² £m	Retained earnings £m	Total £m	Non-controlling interests £m	Total equity £m
At 1 January 2010	90	1,243	5,399	(2,141)	4,591	72	4,663
Profit for the year	-	-	-	1,052	1,052	29	1,081
Total other comprehensive income for the year	-	-	71	654	725	-	725
Share-based payments	-	-	-	58	58	-	58
Share options:
Proceeds from shares issued	-	6	-	-	6	-	6
Purchase of own shares	-	-	-	(23)	(23)	-	(23)
Purchase of treasury shares⁵	-	-	-	(503)	(503)	-	(503)
Other	-	-	-	-	-	2	2
Ordinary share dividends	-	-	-	(574)	(574)	(32)	(606)
At 31 December 2010	90	1,249	5,470	(1,477)	5,332	71	5,403

At 1 January 2009	90	1,238	5,974	(68)	7,234	55	7,289
(Loss)/profit for the year	-	-	-	(67)	(67)	22	(45)
Total other comprehensive income for the year	-	-	(575)	(1,499)	(2,074)	-	(2,074)
Share-based payments	-	-	-	52	52	-	52
Share options:
Proceeds from shares issued	-	5	-	-	5	-	5
Purchase of own shares	-	-	-	(25)	(25)	-	(25)
Ordinary share dividends	-	-	-	(534)	(534)	(5)	(539)
At 31 December 2009 (restated¹)	90	1,243	5,399	(2,141)	4,591	72	4,663

1 Other reserves reduced by £64m following finalisation of the fair values recognised on acquisition of the 45% shareholding in BVT Surface Fleet Limited (see note 29).

2 An analysis of other reserves is provided in note 24.

3 Includes a £348m benefit arising from the change from the Retail Prices Index to the Consumer Prices Index as the measure for determining minimum statutory pension increases (see note 21).

4 The UK current tax rate will be reduced from 28% to 27% with effect from 1 April 2011, which creates a tax rate adjustment (see note 8).

5 Includes transaction costs of £3m.

Note references used above are references to notes to the Group accounts in the Annual Report 2010 that can be viewed on the Company's website.

Consolidated balance sheet

as at 31 December

	Notes	2010 £m	Restated¹ 2009 £m
Non-current assets
Intangible assets	11	11,216	11,306
Property, plant and equipment	12	2,714	2,552
Investment property	13	134	111
Equity accounted investments	14	787	846
Other investments	15	11	6
Other receivables	16	282	201
Other financial assets	17	110	133
Deferred tax assets	8	1,160	1,531
		16,414	16,686
Current assets
Inventories	18	644	887
Trade and other receivables including amounts due from customers for contract work	16	3,559	3,764
Current tax		51	32
Other investments	15	260	211
Other financial assets	17	289	216
Cash and cash equivalents		2,813	3,693
		7,616	8,803
Total assets	3	24,030	25,489
Non-current liabilities
Loans	19	(2,133)	(2,840)
Trade and other payables	20	(694)	(522)
Retirement benefit obligations	21	(3,456)	(4,679)
Other financial liabilities	17	(255)	(261)
Deferred tax liabilities	8	(6)	(8)
Provisions	22	(425)	(377)
		(6,969)	(8,687)
Current liabilities
Loans and overdrafts	19	(920)	(453)
Trade and other payables	20	(9,352)	(10,381)
Other financial liabilities	17	(109)	(94)
Current tax		(625)	(659)
Provisions	22	(652)	(552)
		(11,658)	(12,139)
Total liabilities		(18,627)	(20,826)
Net assets		5,403	4,663

Capital and reserves
Issued share capital	24	90	90
Share premium		1,249	1,243
Other reserves	24	5,470	5,399
Accumulated losses		(1,477)	(2,141)
Total equity attributable to equity holders of the parent		5,332	4,591
Non-controlling interests		71	72
Total equity		5,403	4,663

1 Restated following finalisation of the fair values recognised on acquisition of the 45% shareholding in BVT Surface Fleet Limited (see note 29).

Approved by the Board on 16 February 2011 and signed on its behalf by:

I G King G W Rose

Chief Executive Group Finance Director

Note references used above are references to notes to the Group accounts in the Annual Report 2010 that can be viewed on the Company's website.

Consolidated cash flow statement

for the year ended 31 December

	Notes	2010 £m	Restated¹ 2009 £m
Profit/(loss) for the year - continuing operations		1,027	(61)
Profit for the year - discontinued operations		54	16
Profit/(loss) for the year		1,081	(45)
Taxation expense		417	327
Share of results of equity accounted investments - continuing operations	14	(131)	(187)
Share of results of equity accounted investments - discontinued operations	9	(2)	(16)
Net finance costs		192	700
Depreciation, amortisation and impairment		899	1,600
Gain on disposal of property, plant and equipment	4, 5	(13)	(17)
Gain on disposal of businesses - continuing operations	5	(1)	(68)
Gain on disposal of businesses - discontinued operations	9	(52)	-
Cost of equity-settled employee share schemes		58	52
Movements in provisions		101	52
Decrease in liabilities for retirement benefit obligations		(452)	(657)
Decrease/(increase) in working capital:
Inventories		318	6
Trade and other receivables		183	52
Trade and other payables		(1,063)	433
Cash inflow from operating activities		1,535	2,232
Interest paid		(220)	(250)
Interest element of finance lease rental payments		(1)	(2)
Taxation paid		(352)	(350)
Net cash inflow from operating activities		962	1,630
Dividends received from equity accounted investments - continuing operations	14	67	74
Dividends received from equity accounted investments - discontinued operations	14	4	3
Interest received		48	66
Purchases of property, plant and equipment		(394)	(483)
Purchases of investment property		(14)	-
Purchases of intangible assets		(19)	(42)
Proceeds from sale of property, plant and equipment		68	36
Proceeds from sale of investment property		2	-
Purchase of subsidiary undertakings	27	(198)	(357)
Cash and cash equivalents acquired with subsidiary undertakings	27	19	33
Purchase of equity accounted investments	27	(2)	(1)
Equity accounted investment funding	14	(7)	-
Proceeds from sale of subsidiary undertakings - continuing operations	9	-	2
Proceeds from sale of equity accounted investments - continuing operations	9	1	70
Proceeds from sale of equity accounted investments - discontinued operations	9	92	-
Purchase of other deposits/securities	15	(40)	(209)
Net cash outflow from investing activities		(373)	(808)
Capital element of finance lease rental payments		(7)	(13)
Proceeds from issue of share capital		6	5
Purchase of treasury shares		(503)	-
Purchase of own shares		(23)	(25)
Equity dividends paid	28	(574)	(534)
Dividends paid to non-controlling interests		(32)	(5)
Cash (outflow)/inflow from matured derivative financial instruments		(123)	36
Cash inflow/(outflow) from movement in cash collateral		11	(11)
Cash inflow from loans		1,317	920
Cash outflow from repayment of loans		(1,576)	(133)
Net cash (outflow)/inflow from financing activities		(1,504)	240
Net (decrease)/increase in cash and cash equivalents		(915)	1,062
Cash and cash equivalents at 1 January		3,678	2,605
Effect of foreign exchange rate changes on cash and cash equivalents		39	11
Cash and cash equivalents at 31 December		2,802	3,678
Comprising:
Cash and cash equivalents		2,813	3,693
Overdrafts		(11)	(15)
Cash and cash equivalents at 31 December		2,802	3,678

1 Restated following the sale of half of the Group's 20.5% shareholding in Saab AB and subsequent classification as a discontinued operation (see note 9).

Note references used above are references to notes to the Group accounts in the Annual Report 2010 that can be viewed on the Company's website.

Note 31 to the Group accounts

31. Related party transactions

The Group has a related party relationship with its directors and key management (as disclosed in the Remuneration report on pages 96 to 119 and in note 7), its equity accounted investments (note 14) and the pension plans (note 21).

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

	Sales to related party		Purchases from related party		Amounts owed by related party		Amounts owed to related party		Lease income/ (expense) with related party		Management recharges
Related party	2010 £m	2009 £m	2010 £m	2009 £m	2010 £m	2009 £m	2010 £m	2009 £m	2010 £m	2009 £m	2010 £m	2009 £m
Advanced Electronics Company Limited	-	-	149	-	1	-	-	-	-	-	-	-
BVT Surface Fleet Limited¹	-	64	-	4	-	-	-	-	-	-	-	6
Eurofighter Jagdflugzeug GmbH	1,313	1,073	-	-	283	132	143³	159	-	-	-	-
FADEC International LLC	49	-	-	-	-	-	-	-	-	-	-	-
Gripen International KB	1	1	1	-	11	59	67³	98	-	-	-	-
MBDA SAS	36	46	162	302	10	4	1,010³	1,080	-	2	14³	18
Panavia Aircraft GmbH	40	52	92	103	1	9	12	15	-	-	-	-
Saab AB²	3	5	20	17	-	-	-	1	-	-	-	-
CTA International SAS	-	-	-	-	-	3	-	-	-	-	-	-
Other	2	-	-	-	1	-	-	-	-	-	-	-
	1,444	1,241	424	426	307	207	1,232	1,353	-	2	14	24