Doc re. Annual Report

RNS Number : 0791J

BAE SYSTEMS PLC

27 March 2018

 

BAE Systems plc
Annual Report 2017

BAE Systems plc has today published its Annual Report and Accounts for the year ended 31 December 2017 ('Annual Report 2017'). The full document can be viewed on the Company's website at:
www.baesystems.com/investors

Copies of the Annual Report 2017 will be posted to those shareholders who have requested to receive communications from the Company in printed form on 29 March 2018.

In compliance with Section 9.6.1 of the Listing Rules, a copy of the Annual Report 2017 has also been submitted to the National Storage Mechanism and will shortly be available for inspection at: http://www.morningstar.co.uk/uk/NSM

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 2017 in unedited full text. Page and chart references within the text of this announcement are references to pages and charts in the Annual Report 2017 that can be viewed as detailed above.

The financial information for the year ended 31 December 2017 contained in this announcement was approved by the Board on 21 February 2018. This announcement does not constitute statutory accounts of the Company within the meaning of Section 435 of the Companies Act 2006, but is derived from those accounts.

Statutory accounts for the year ended 31 December 2016 have been delivered to the Registrar of Companies. Statutory accounts for the year ended 31 December 2017 will be delivered to the Registrar of Companies following the Company's Annual General Meeting.

The auditors have reported on those accounts. Their reports were not qualified, did not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying their report, and did not contain a statement under Section 498 (2) or (3) of the Companies Act 2006.

The Annual Report 2017 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 Strategic report and Directors' report, taken together, include 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.

In addition, each of the directors considers that the Annual Report, taken as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the Company's position and performance, business model and strategy.

Sir Roger Carr	Chairman
Charles Woodburn	Chief Executive
Jerry DeMuro	President and Chief Executive Officer of BAE Systems, Inc.
Peter Lynas	Group Finance Director
Revathi Advaithi	Non-executive director
Elizabeth Corley	Non-executive director
Harriet Green	Non-executive director
Chris Grigg	Non-executive director
Paula Rosput Reynolds	Non-executive director
Nick Rose	Non-executive director
Ian Tyler	Non-executive director

On behalf of the Board

Sir Roger Carr

Chairman
21 February 2018

Chief Executive's review

"BAE Systems delivered a good performance in 2017, consistent with our expectations for the year."

Charles Woodburn Chief Executive

Introduction

BAE Systems delivered a good performance in 2017, consistent with our expectations for the year. We are taking the actions necessary to address costs and to meet our customers' affordability challenges. Despite economic and political uncertainties, governments in our major markets continue to prioritise defence and security, with strong demand for our capabilities. We are investing in our business, our people, and in the technology and skills we need to drive the business forward. With an improving outlook for defence budgets in a number of our markets and a solid foundation for medium-term growth, we are well placed to generate good returns for shareholders.

Since taking on the role of Chief Executive, I have reiterated that we are a strong company, with a number of key advantages, pursuing the right strategy.

We have a broad geographic footprint and diversified market positions. Importantly, our track record of successful partnerships in international markets to develop local industry, employment and skills is now becoming a key requirement to do business in those markets.

We have world-class technologies in the fields of electronic warfare, autonomous systems, advanced manufacturing, robotics and data analytics, and we continue to invest in research and development, often alongside our customers, to identify and develop emerging technologies. The speed of change in technology means that we must continually build on our technological advantage, and attract and retain the right talent in order to stay competitive.

It is important to recognise that in a tough, competitive market, we need to become a stronger, smarter and sharper organisation to win new business and grow, which means increasing our focus and efforts in three priority areas:

Operational excellence

We have a number of major programmes under way on which we are ramping up production, so it is vital that we maintain our focus on operational excellence by delivering for our customers. There is simply no better way to highlight our skills and capabilities and, therefore, win new business.

Competitiveness

Good progress has been made in making the organisation more efficient over the last few years, and there are further opportunities with procurement and enhanced collaboration at the forefront.

Technological innovation

We have a long heritage of developing and integrating cutting-edge technologies to create complex systems that give our customers a capability advantage. The accelerating pace of technological change is a disruptive force and a key driver of competitive advantage and, increasingly, a determinant for our customers in awarding new business.

Driving performance in these three areas will be key for the development of the business as we execute on our strategy in 2018 and beyond.

2017 performance

US

After seven months under a Continuing Resolution that maintained funding at the prior year's level, the fiscal year 2017 defence budget ultimately rose by approximately 4%. Similarly, fiscal year 2018 has begun under multiple Continuing Resolutions. On 9 February 2018, Congress passed, and the President signed, a budget agreement that supports the medium-term planning assumptions for our US businesses. This budget agreement increases the budget caps for two years, and extends the current Continuing Resolution to 23 March 2018 to allow lawmakers to pass a fiscal year 2018 omnibus appropriations bill.

We see continued support for increased defence spending in the President's recently-released fiscal year 2019 budget request. This request maintains positive momentum in funding for military readiness and modernisation, and provides greater near-term certainty. Our US-based portfolio remains well aligned with customer priorities and growth areas, such as the ramp-up of production on a number of our long-term programmes.

Our US electronics business delivered good operational performance across our core franchise positions in the high-technology areas of electronic warfare, precision-guided munitions, Intelligence, Surveillance and Reconnaissance, and electro-optics.

BAE Systems has sustained its leadership position in the US electronic warfare market and production is ramping up to execute orders across a number of programmes, some of which are classified. As the electronic warfare system supplier on the F-35 Lightning II combat aircraft programme, we are increasing production and are well positioned to meet further increases in output rates over the coming years to meet the requirements of both US and international customers. On F-15, upgrade programmes are contracted and progressing for the US Air Force and international customers.

The Group's US-based combat vehicles business is underpinned by programmes for the manufacture of Armored Multi-Purpose Vehicles and M109A7 self-propelled howitzers, and Bradley upgrades which all progressed in the year. In the amphibious vehicle market, 16 prototypes have been delivered to the US Marine Corps under the Amphibious Combat Vehicle 1.1 programme. We are one of two competitors for this programme, with final down-selection expected in 2018.

BAE Systems is a leading supplier of ship repair services to the US Navy and continues to adjust its workforce and facilities to meet evolving demand. Additional dry dock capacity at our San Diego shipyard became operational in February 2017 and accepted its first ship during the year.

Whilst market conditions remain highly competitive and continue to evolve, our US-based Intelligence & Security business is focused on delivering on its contracts and maintaining a high level of bid activity.

UK

Defence and security remains a priority for the UK government. We expect this to be reaffirmed in the National Security Capability Review, and in the Modernising Defence Programme, which was announced in January 2018 by the Defence Secretary.

Transition arrangements after March 2019 will be important to enable companies to prepare for potential changes in the regulatory environment. As there is relatively limited UK-EU trading and movement of EU nationals into and out of BAE Systems' UK businesses, the resulting Brexit impact on the business is likely to be limited, depending on the terms of any transition and final agreements for the UK's future relationship with the European Union.

We will support the government in achieving its aim to ensure that the UK maintains its key role in European security and defence post-Brexit, and to strengthen bilateral relationships with key partners in Europe. This will be important for ongoing collaboration in the development of defence capabilities.

In December, BAE Systems and the Government of Qatar entered into a contract, valued at approximately £5bn, for the supply of 24 Typhoon aircraft. Alongside supplying the aircraft, the agreement provides for the supply of ground support to the Qatar Armed Forces and delivery of technical and pilot training in Qatar. The contract is subject to financing conditions and receipt by the Group of first payment which are expected to be fulfilled no later than mid-2018.

Discussions with current and prospective operators of the Typhoon aircraft continue to support the Group's expectations for additional Typhoon contract awards. However, there can be no certainty as to the timing of these orders.

As a result of reducing production activity on Typhoon and Hawk, and also taking into account the changes to support requirements as the Royal Air Force transitions from Tornado to F-35 Lightning II, the business announced in October a total proposed headcount reduction of up to 1,400 roles over the next three years.

The Typhoon aircraft's progression towards the Royal Air Force Centurion standard will enable transition of capability from Tornado to Typhoon as the UK Tornado fleet is scheduled to come out of service at the end of the decade.

UK-based production of rear fuselage assemblies for the F-35 Lightning II aircraft increased to 82 in the year, with most of the advanced manufacturing investment in place to achieve the planned increase in production volumes. In readiness for the arrival of the UK's first F-35 Lightning II aircraft in 2018, good progress has been made on the support facilities for the stand-up of the operational service at RAF Marham in Norfolk.

In the maritime domain, there remains pressure on the Navy's near-term budgets.

On the aircraft carrier programme, HMS Queen Elizabeth successfully concluded initial sea trials and entered HM Naval Base, Portsmouth, for the first time in August, with operational handover to the Royal Navy in December.

Following contract award for the first batch of three Type 26 frigates, worth £3.7bn, production for the first ship, Glasgow, commenced in July. The National Shipbuilding Strategy announced in September committed to all eight Type 26 frigates to be built in our Scottish manufacturing facilities. In October, we announced a teaming agreement with Cammell Laird for their bid for the UK Ministry of Defence's proposed Type 31e general purpose frigate programme.

Submarine activity is increasing with the Astute and Dreadnought class submarines now both in production and major redevelopment of the Barrow site to deliver the Dreadnought programme under way.

International

The Saudi Arabian In-Kingdom Industrial Participation programme continues to make good progress and we have commenced discussions with the new Saudi Arabian Military Industries (SAMI) organisation to explore how we can collaborate to deliver further In-Kingdom Industrial Participation. All of these activities are aligned with our long-term industrialisation strategy, as well as the Saudi Arabian government's National Transformation Plan and Vision 2030.

On the Salam Typhoon programme, all contracted 72 aircraft have now been delivered and the Typhoon support contracts are operating well, exceeding the baseline flying programme contracted with the customer.

Discussions with the Saudi Arabian customer through 2017 resulted in contractual agreements under the Saudi British Defence Co-operation Programme being formalised. These provide support services to the Royal Saudi Air Force and Royal Saudi Naval Forces for a further five years to 31 December 2021.

In Australia, the business is underpinned by long-term support contracts, whilst activity progresses on two major bid opportunities.

Firstly, as one of two tenderers for the Land 400 Phase 2 Combat Reconnaissance Vehicle programme, we have completed the Risk Mitigation Activity contract and submitted our final proposal, with final preferred tender selection anticipated in the first half of 2018.

Secondly, our initial tender response for the Commonwealth's nine-ship SEA 5000 Future Frigate programme was submitted in August and we anticipate a preferred tender selection in 2018.

The MBDA joint venture has continued to win orders in both domestic and export markets. The increase in business volumes has resulted in the requirement to expand production capacities in the UK and France.

Cyber security

Applied Intelligence achieved sales growth from the continued delivery of national security solutions for the UK and international governments. In addition, we have deployed anti-fraud, regulatory compliance, and cyber security products and services across a large range of commercial customers.

In 2017, Applied Intelligence reported an underlying loss of £61m, including a £24m restructuring charge. The first half loss of £27m was followed by a reduced second half loss, before the restructuring charge, of £10m as cost reduction actions started to deliver bottom-line benefit. A goodwill impairment of £384m was taken in 2017 reflecting the future level and timing of expected returns from the business.

Effective 1 January 2018, the business changed its operating model to deliver a more targeted portfolio of products and services focused on customers within three core business units: Government; Financial Services; and Technology & Commercial. The restructuring will enable a greater focus on customer needs and higher levels of operational efficiency, in the commercial business, that will accelerate improvements in competitiveness and profitability.

Balance sheet and capital allocation

The Group's balance sheet is managed conservatively, in line with its policy, to retain its investment grade credit rating and to ensure operating flexibility. Consistent with this approach, the Group expects to continue to meet its pension obligations, invest in research and technology and other organic investment opportunities, and plans to pay dividends in line with its policy of long-term sustainable cover of around two times underlying earnings and to make accelerated returns of capital to shareholders when the balance sheet allows. Investment in value-enhancing acquisitions will be considered where market conditions are right and where they deliver on the Group's strategy.

Pension schemes

The 2017 UK triennial pension funding valuations concluded in November, with the aggregate funding deficit as at 31 March 2017 across the UK schemes at £2.1bn. The deficit recovery plan on the Group's largest pension scheme, the BAE Systems Pension Scheme, continues to March 2026, with the other schemes now with reduced repayment periods or fully funded.

The UK funding deficit at 31 March 2017 is some £3bn lower than the accounting deficit, using like-for-like mortality assumptions and asset values at 31 December 2017, largely due to lower liabilities as a result of the discount rate assumption based on the expected returns on the investments held by the schemes.

Research and technology

BAE Systems has developed some of the world's most innovative technologies and invests in research and development to generate future products and capabilities. We embrace disruptive technology, drive innovation and invest appropriately both on a self-funded basis and in conjunction with our customers, universities, and small and medium-sized enterprises. Company-funded research and development contributes, along with customer funding, in driving focused investment in areas such as defence and commercial electronics, military aircraft, precision weapons and cyber security.

Responsible business

We continue to build a culture where our people are empowered to make the right decisions and know where to go to seek help or guidance. During 2017, we rolled out further ethics training across the Group to support employees and, in January 2018, launched our revised Code of Conduct.

The safety of our employees, and anybody who works on, or visits, our sites, remains a key priority. Our safety culture and our employees demand high standards for all aspects of health and safety. In 2017, there was a 3% reduction in the Recordable Accident Rate and a 28% reduction in the total number of major injuries recorded as we continued to focus on reducing risk and embedding safety culture to drive improvement.

Recruiting and retaining talented people is a key priority. We want every employee to reach their full potential within a diverse and inclusive work environment. We have programmes in place across the business to support strategic workforce planning, career development and retention, as well as to improve diversity and inclusion.

Organisational changes

In October, we announced a restructure of our operations outside of the US-managed business in support of our three priorities of delivering operational excellence, honing our competitive edge and accelerating our technology innovation. The new operating model, effective 1 January 2018, will simplify our management structure to create strengthened Air and Maritime reporting segments, whilst changes to our UK-based Applied Intelligence cyber security business are focused on meeting customer needs and accelerating improvements in competitiveness and profitability.

Our 2017 results are re-presented on page 56 to reflect the organisational changes and our segmental guidance for 2018 is presented on page 57 on a consistent basis. On pages 58 and 59, we summarise the short-to medium-term prospects for our five principal reporting segments from 1 January 2018.

Summary

Our business benefits from a large order backlog, strong franchises and established positions on long-term programmes in the US, UK, Saudi Arabia and Australia. Our strategy is clear and well defined, with governments in our major markets continuing to prioritise defence and security, with strong demand for our capabilities. Through execution of a consistent strategy, we are well placed to maximise opportunities, deal with the challenges and continue to generate good shareholder returns.

Charles Woodburn Chief Executive

Extract from

Chairman's letter

Board and Executive Committee

With effect from 1 July, Charles Woodburn succeeded Ian King as Chief Executive. Ian retired after a career spanning more than 40 years at the Company, including leading BAE Systems as Chief Executive since 2008.

Building a pipeline of talent and managing succession at all levels in the business is, of course, an essential part of strategic planning. Our Nominations Committee consistently reviews membership of the Board and Executive Committee. In this respect, in 2017, we were fortunate to recruit Revathi Advaithi as a non-executive director bringing wide international operational experience with strong engineering and digital credentials, and Karin Hoeing as Group Human Resources Director and member of the Executive Committee. As we look forward, beyond the current year, we will continue to refresh the Board and Executive Committee to ensure our experience and skillset is fit for purpose in a changing world.

To avoid complacency and in the pursuit of excellence, we conduct rigorous annual reviews of the Board with the employment of an external advisor every other year. The key findings of the 2018 Independent Board Evaluation are outlined in the Chairman's Governance letter on page 72 of this report. As a Board, we debate and review our culture each year to ensure we continue to treat everyone respectfully, trade responsibly, act with integrity and govern scrupulously.

Summary

In summary, we have been pleased to deliver another year of good performance with sales of £19.6bn and underlying earnings per share of 43.5p, underpinned by an order backlog of £41.2bn.

Against the background of a strong Board, and a refreshed and committed management team, we are both content with the year's performance and positive about our future prospects.

The Board therefore has recommended a final dividend of 13p for a total of 21.8p per share for the full year. Subject to shareholder approval at the May 2018 Annual General Meeting, the dividend will be paid on 1 June 2018 to holders of ordinary shares registered on 20 April 2018.

Sir Roger Carr Chairman

Financial review

We monitor the underlying financial performance of the Group using the alternative performance measures defined on page 6. These measures are not defined in IFRS¹ and, therefore, are considered to be non‑GAAP² measures. Accordingly, the relevant IFRS¹ measures are also presented where appropriate.

P06 Alternative performance measure definitions

Income statement

Financial performance measures as defined by the Group		2017 £m	2016 £m
Sales	KPI	19,626	19,020
Underlying EBITA	KPI	2,034	1,905
Return on sales		10.4%	10.0%

Financial performance measures defined in IFRS1		£m	£m
Revenue		18,322	17,790
Operating profit		1,480	1,742
Return on revenue		8.1%	9.8%

Reconciliation of sales to revenue		£m	£m
Sales	KPI	19,626	19,020
Deduct Share of sales by equity accounted investments		(2,575)	(2,427)
Add Sales to equity accounted investments		1,271	1,197
Revenue		18,322	17,790

Reconciliation of underlying EBITA to operating profit			£m	£m
Underlying EBITA	KPI		2,034	1,905
Non-recurring items			(13)	(12)
Amortisation of intangible assets			(86)	(87)
Impairment of goodwill			(384)	-
Financial expense of equity accounted investments			(34)	(28)
Taxation expense of equity accounted investments			(37)	(36)
Operating profit			1,480	1,742
Net finance costs			(346)	(591)
Taxation expense			(250)	(213)
Profit for the year			884	938
Underlying interest expense			(245)	(257)
Net interest expense on retirement benefit obligations			(173)	(177)
Fair value and foreign exchange adjustments on financial instruments and investments			38	(185)
Net finance costs (including equity accounted investments)			(380)	(619)

Exchange rates

Average		2017	2016
£/$		1.289	1.354
£/€		1.141	1.223
£/A$		1.681	1.823

Sensitivity analysis
Estimated impact on sales of a ten cent movement in the average exchange rate	£m
$	550
€	75
A$	35

Income statement

Sales increased by £0.6bn to £19.6bn (2016 £19.0bn) largely reflecting currency translation.

Underlying EBITA increased by £129m to £2,034m (2016 £1,905m), giving a return on sales of 10.4% (2016 10.0%). There was an exchange translation benefit of £50m. Growth on a constant currency basis⁴ was at 4%.

Revenue increased by £0.5bn to £18.3bn (2016 £17.8bn) largely reflecting currency translation.

Operating profit decreased by £262m to £1,480m (2016 £1,742m). 2017 includes a £384m impairment in respect of the Applied Intelligence business, which is excluded from underlying EBITA. There was an exchange translation benefit of £39m.

Non-recurring items in 2017 of £13m represents a loss on the disposal of the BAE Systems San Francisco Ship Repair business. Non-recurring items in 2016 of £12m represented an impairment taken in respect of that business.

Amortisation of intangible assets is in line with the prior year at £86m (2016 £87m).

Impairment of goodwill in 2017 represents the impairment of goodwill in Applied Intelligence reflecting the future level and timing of expected returns from the business.

Net finance costs, including equity accounted investments, were £380m (2016 £619m). The underlying interest charge, excluding pension accounting, and fair value and foreign exchange adjustments on financial instruments and investments decreased marginally to £245m (2016 £257m). Net interest expense on the Group's pension deficit was £173m (2016 £177m). There was a credit in respect of fair value and foreign exchange adjustments of £38m (2016 £185m charge) on exchange translation of US dollar-denominated bonds.

Taxation expense, including equity accounted investments, of £287m (2016 £249m) reflects the Group's underlying effective tax rate for the year of 21%, partially offset by a £40m credit in respect of US tax reform enacted in December 2017. The US federal tax rate has been reduced from 35% to 21% with effect from 1 January 2018, while the estimated state tax rate has increased from 5% to 6%. In line with this change, the rate applying to US deferred tax assets and liabilities at 31 December 2017 has been reduced from 40% to 27%, creating a rate adjustment in 2017, which is partly reflected in the income statement.

The calculation of the underlying effective tax rate is shown in note 6 to the Group accounts on page 155.

The underlying effective tax rate for 2018 is expected to reduce from 21% to around 18% benefiting from US tax reform, with the final rate dependent on the geographical mix of profits.

Looking beyond 2018, the effective tax rate will depend principally on whether there are any changes in tax legislation in the Group's most significant countries of operation, the geographical mix of profits and the resolution of open issues.

1.  International Financial Reporting Standards.

2.  Generally Accepted Accounting Principles.

3.  Including share of equity accounted investments.

4.  Current year compared with prior year translated at current year exchange rates.

Earnings per share

Underlying earnings per share for the year increased by 8% to 43.5p (2016 40.3p). The in-year loss at Applied Intelligence was offset by good performance across the rest of the Group.

Basic earnings per share was 26.8p (2016 28.8p). Basic earnings per share is lower than underlying earnings per share mainly reflecting the £384m goodwill impairment charge taken in 2017 which is excluded from underlying earnings per share.

Earnings per share

Financial performance measures as defined by the Group		2017	2016
Underlying earnings		£1,383m	£1,277m
Underlying earnings per share	KPI	43.5p	40.3p

Financial performance measures defined in IFRS1
Profit for the year attributable to equity shareholders		£854m	£913m
Basic earnings per share		26.8p	28.8p

Reconciliation of underlying EBITA to underlying earnings		£m	£m
Underlying EBITA		2,034	1,905
Underlying interest expense (including equity accounted investments)		(245)	(257)
		1,789	1,648
Taxation expense (at the underlying effective tax rate)		(376)	(346)
Non-controlling interests		(30)	(25)
Underlying earnings		1,383	1,277

Reconciliation of underlying earnings to profit for the year attributable to equity shareholders		£m	£m
Underlying earnings		1,383	1,277
Impact of US tax reform enacted in December 2017		40	-
Non-recurring items, post tax		(10)	(9)
Amortisation and impairment of intangible assets, post tax		(68)	(69)
Impairment of goodwill		(384)	-
Net interest expense on retirement benefit obligations, post tax		(137)	(140)
Fair value and foreign exchange adjustments on financial instruments and investments, post tax		30	(146)
Profit for the year attributable to equity shareholders		854	913
Non-controlling interests		30	25
Profit for the year		884	938

P157 Note 7 to the Group accounts

Orders

Order intake² decreased by £2.2bn to £20,257m (2016 £22,443m). The most significant award was the production contract for the first batch of three Type 26 frigates, with £2.8bn of order intake in the year.

Order backlog² decreased by £0.8bn to £41.2bn (2016 £42.0bn) reflecting currency translation.

Orders

Financial performance measures as defined by the Group
		2017	2016
Order intake2	KPI	£20,257m	£22,443m
Order backlog2		£41.2bn	£42.0bn

1.  International Financial Reporting Standards.

2.  Including share of equity accounted investments.

Cash flow

Financial performance measures as defined by the Group		2017 £m	20162 £m
Operating business cash flow	KPI	1,752	1,004

Financial performance measures defined in IFRS1		£m	£m
Net cash flow from operating activities		1,897	1,229

Reconciliation from operating business cash flow to net cash flow from operating activities		£m	£m
Operating business cash flow	KPI	1,752	1,004
Add back Net capital expenditure and financial investment		444	450
Deduct Dividends received from equity accounted investments		(72)	(38)
Deduct Taxation		(227)	(187)
Net cash flow from operating activities		1,897	1,229
Net capital expenditure and financial investment		(444)	(450)
Dividends received from equity accounted investments		72	38
Interest received		23	10
Acquisitions and disposals		(11)	6
Net cash flow from investing activities		(360)	(396)
Interest paid		(204)	(210)
Net (purchase)/sale of own shares		(1)	3
Equity dividends paid		(684)	(670)
Dividends paid to non-controlling interests		(8)	(24)
Cash flow from matured derivative financial instruments		(83)	480
Movement in cash collateral		(15)	32
Net cash flow from loans		-	(286)
Net cash flow from financing activities		(995)	(675)
Net increase in cash and cash equivalents		542	158
Add back Net cash flow from loans		-	286
Add back/(deduct) Cash classified as held for sale		2	(2)
Foreign exchange translation		301	(621)
Other non-cash movements		(55)	59
Decrease/(increase) in net debt		790	(120)
Opening net debt		(1,542)	(1,422)
Net debt	KPI	(752)	(1,542)

1.  International Financial Reporting Standards.

2.  Re-presented to reclassify interest paid from investing to financing activities.

P187 and P188 Notes 24 and 26 to the Group accounts

Cash flow

Operating business cash flow was £1,752m (2016 £1,004m), which includes cash contributions in respect of pension deficit funding, over and above service costs, for the UK and US schemes totalling £271m on a funding basis.

The remainder of the advances received in 2012 on the Omani Typhoon and Hawk order, as well as European Typhoon production, are almost all now consumed. On the Saudi support contracts renewal, some £300m of cash was received in 2017 representing advance funding to be utilised in 2018 and 2019. Costs have been incurred against provisions created in previous years as the US commercial shipbuilding programmes are closed out. Approximately £100m of VAT payments rolled from December 2017 into January 2018.

Taxation payments increased to £227m (2016 £187m) in line with the increase in adjusted profit before taxation as calculated in note 6 to the Group accounts on page 155.

Net capital expenditure and financial investment was £444m (2016 £450m). As planned, capital investment was made in support of the production ramp-up in our US Electronic Systems and Combat Vehicles businesses.

Dividends received from equity accounted investments of £72m (2016 £38m) is primarily receipts from MBDA, FNSS and Advanced Electronics Company. There was a higher dividend from MBDA in 2017.

Interest received was £23m (2016 £10m).

The cash outflow in respect of acquisitions and disposals in 2017 of £11m reflects costs incurred in respect of the disposal of BAE Systems San Francisco Ship Repair and the acquisition of IAP Research, Inc. The cash inflow in 2016 of £6m reflected the sale of a 4.1% shareholding in a subsidiary company in Saudi Arabia.

Interest paid was £204m (2016 £210m).

Equity dividends paid in 2017 represents the 2016 final (£404m) and 2017 interim (£280m) dividends.

Dividends paid to non-controlling interests decreased to £8m (2016 £24m) reflecting a lower payment by Saudi Maintenance & Supply Chain Management Company in which the Group has a 51% shareholding.

There was a cash outflow from matured derivative financial instruments of £83m (2016 £480m inflow) from rolling hedges relating to balances with the Group's subsidiaries and equity accounted investments. The cash flow partially offsets the foreign exchange translation on the Group's external US dollar-denominated borrowing (see below).

Net cash flow from loans in 2016 represented repayment of a $350m (£286m) 3.5% bond at maturity.

Foreign exchange translation primarily arises in respect of the Group's US dollar-denominated borrowing. In 2016, this was materially offset by the cash flow from matured derivative financial instruments (see above).

Balance sheet

Summarised balance sheet		2017 £m	2016 £m
Intangible assets		10,378	11,264
Property, plant and equipment, and investment property1		1,977	1,999
Equity accounted investments and other investments		390	305
Working capital1		(3,752)	(3,564)
Group's share of the net IAS 19 pension deficit (see below)		(3,920)	(6,054)
Net tax assets and liabilities		435	935
Net other financial assets and liabilities		18	121
Net debt	KPI	(752)	(1,542)
Net assets held for sale		10	-
Net assets		4,784	3,464

1.  Funding received from the UK government for property, plant and equipment at Barrow-in-Furness, UK, relating to the Dreadnought submarine programme included in working capital in the Consolidated balance sheet is presented here in property, plant and equipment, and investment property.

Components of net debt		£m	£m
Cash and cash equivalents		3,271	2,769
Debt-related derivative financial instrument assets		60	114
Loans - non-current		(4,069)	(4,425)
Loans and overdrafts - current		(14)	-
Net debt	KPI	(752)	(1,542)

Exchange rates

Year end		2017	2016
£/$		1.353	1.236
£/€		1.126	1.172
£/A$		1.730	1.707

 

Balance sheet

The £0.9bn decrease in intangible assets to £10.4bn (2016 £11.3bn) mainly reflects exchange translation (£0.5bn) and the Applied Intelligence goodwill impairment (£0.4bn).

Property, plant and equipment, and investment property is £2.0bn (2016 £2.0bn).

Equity accounted investments and other investments increased to £390m (2016 £305m) reflecting the Group's share of profit for the year (£116m) and reduced pension allocation from the lower deficit (£66m), less dividends received (£72m).

The Group's share of the net IAS 19 pension deficit reduced to £3.9bn (2016 £6.1bn) mainly reflecting asset returns, updated mortality tables and allowances for future mortality improvements. The major movements in the net pension deficit are shown in the bridge chart below.

In November, the 2017 UK triennial funding valuations and, where necessary, deficit recovery plans were agreed with the trustees and certified by the scheme actuaries after consultation with the Pensions Regulator.

The funding deficit across the UK schemes at 31 March 2017 was £2.1bn. The UK accounting deficit, using like-for-like mortality assumptions and asset values at 31 December 2017, is approximately £3bn higher than the funding deficit. The discount rate applied to liabilities for accounting purposes reflects the yield on high-quality corporate bonds. The discount rate for funding purposes reflects a prudent assessment of expected returns on the investments held by the schemes.

Based on the new funding valuations, the Group will increase current annual deficit recovery payments to the UK schemes to £220m a year from 1 April 2018.

Details of the Group's pension schemes are provided in note 21 to the Group accounts on page 174.

A net deferred tax asset of £0.7bn (2016 £1.2bn) relating to the Group's pension deficit is included within net tax assets and liabilities.

In aggregate, there was a £0.2bn decrease in working capital largely reflecting advance funding on support contracts in Saudi Arabia and timing of VAT payments, partly offset by previous advances now largely utilised.

The Group's net debt at 31 December 2017 is £752m, a net decrease of £790m from the net debt position of £1,542m at the start of the year. There are no material debt maturities before 2019. The maturity of the Group's borrowings is shown in the chart on page 32.

Cash and cash equivalents of £3,271m (2016 £2,769m) are held primarily for the repayment of debt securities, pension deficit funding, payment of the 2017 final dividend and management of working capital.

Net assets held for sale represents the Aircraft Accessories and Components Company expected to be sold in 2018.

Accounting policies

Critical accounting policies

Certain of the Group's significant accounting policies are considered by the directors to be critical because of the level of complexity, judgement or estimation involved in their application and their impact on the consolidated financial statements:

Revenue and profit recognition Revenue £18.3bn (year ended 31 December 2017) See note 1 to the Group accounts

Carrying value of goodwill Goodwill £10.0bn (at 31 December 2017) See note 8 to the Group accounts

Deferred tax asset on retirement benefit obligations Deferred tax asset on pension/retirement scheme deficits £0.7bn (at 31 December 2017) See note 14 to the Group accounts

Tax provisions Tax provisions £351m (at 31 December 2017) See note 16 to the Group accounts

Retirement benefit obligations Group's share of the net IAS 19 pension deficit £3.9bn (at 31 December 2017) See note 21 to the Group accounts

P142 For more information

Changes in accounting policies

Effective 1 January 2018, BAE Systems adopted IFRS 15, Revenue from Contracts with Customers. The Group's results announcement for the half year ending 30 June 2018 will be the first to be prepared under IFRS 15.

The new Standard does not change the way in which we manage our contracts under Lifecycle Management, our mandated project management process, or the lifetime profitability and cash flow.

Revenue on the majority of contracts, currently being recognised based on the completion of milestones or deliveries, will cumulatively be recognised earlier.

The provisional impact of restating our results for the adoption of IFRS 15 is a reduction in underlying earnings per share of 1.4p to 42.1p for the year ended 31 December 2017 and an increase in net assets of £57m at 31 December 2017. The restated results will be used as the comparatives for the Group's financial statements for the year ending 31 December 2018. The earnings impact on 2018 and beyond is not expected to be material.

Details of the impact of IFRS 15 are provided in note 34 to the Group accounts on page 199.

Capital

Objectives

Maintain the Group's investment grade credit rating and ensure operating flexibility, whilst:

·     meeting its pension obligations;

·     pursuing organic investment opportunities;

·     paying dividends in line with the Group's policy of long-term sustainable cover of around two times underlying earnings;

·     making accelerated returns of capital to shareholders when the balance sheet allows and when the return from doing so is in excess of the Group's Weighted Average Cost of Capital; and

·     investing in value-enhancing acquisitions, where market conditions are right and where they deliver on the Group's strategy.

Policies

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

The capital structure of the Group reflects the judgement of the directors of an appropriate balance of funding required. Three credit rating agencies publish credit ratings for the Group:

Rating	Outlook	Category
Moody's Investors Service
Baa2	Stable	Investment grade
Standard & Poor's Ratings Services
BBB	Stable	Investment grade
Fitch Ratings
BBB	Stable	Investment grade

P185 Note 23 to the Group accounts

Dividends

As part of the Group's capital allocation policy, the Group plans to pay dividends in line with its policy of long-term sustainable cover of around two times underlying earnings.

The Board has recommended a final dividend of 13p per share making a total of 21.8p per share for the year, an increase of 2% over 2016. At this level, the annual dividend is covered two times. Subject to shareholder approval at the 2018 Annual General Meeting, the dividend will be paid on 1 June 2018 to holders of ordinary shares registered on 20 April 2018. The ex-dividend date is 19 April 2018.

At 31 December 2017, the Company had retained earnings of £2.6bn (2016 £2.1bn), the non-distributable portion of which is £649m (2016 £604m) (see page 202). Total external dividends relating to 2017 are £694m (2016 £677m), including the interim dividend paid during the year of £280m (2016 £273m) and the final dividend proposed of approximately £414m (2016 £404m). On an annual basis, the Company receives dividends from its subsidiaries to increase further its distributable reserves and, accordingly, the Company expects to have sufficient distributable reserves to support its dividend policy.

The Group's dividend policy is underpinned by its viability and going concern statements (see page 81).

Treasury

The Group's treasury activities are overseen by the Treasury Review Management Committee (TRMC). Two executive directors are members of the TRMC, including the Group Finance Director who chairs the Committee. The TRMC also has representatives with legal and tax expertise. The Group operates a centralised treasury department that is accountable to the TRMC for managing treasury activities in accordance with the treasury policies approved by the Board.

Objectives/policies

Net debt

Maintain a balance between the continuity, flexibility and cost of debt funding through the use of borrowings from a range of markets with a range of maturities, currencies and interest rates, reflecting the Group's risk profile.

·     Material borrowings are arranged by the central treasury department and funds raised are lent onward to operating subsidiaries as required.

Interest rates

Manage the exposure to interest rate fluctuations on borrowings through varying the proportion of fixed rate debt relative to floating rate debt with derivative instruments, including interest rate and cross-currency swaps.

·     A minimum of 50% and a maximum of 90% of gross debt is maintained at fixed interest rates.

Liquidity

Maintain adequate undrawn committed borrowing facilities.

·     An undrawn committed Revolving Credit Facility of £2bn contracted to December 2018 and £1.9bn contracted from December 2018 to December 2020 is available to meet expected general corporate funding requirements.

Monitor and control counterparty credit risk and credit limit utilisation.

·     The Group adopts a conservative approach to the investment of its surplus cash. It is deposited with financial institutions with strong credit ratings for short periods.

Currency

Reduce the Group's exposure to transactional volatility in earnings and cash flows from movements in foreign currency exchange rates.

·     All material firm transactional exposures are hedged.

·     The Group does not hedge the translation effect of exchange rate movements on the income statements or balance sheets of foreign subsidiaries and equity accounted investments it regards as long-term investments.

P190 Note 28 to the Group accounts

Tax strategy

The Group's tax strategy is to:

·     ensure compliance with all applicable tax laws and regulations; and

·     manage the Group's tax expense in a way that is consistent with its values and its legal obligations in all relevant jurisdictions.

The Group does not tolerate activities designed to facilitate tax evasion offences.

The Group promotes collaborative professional working with tax authorities in order to build open, transparent and trusted relationships. As part of this, the Group engages in open and early dialogue to discuss tax planning, strategy, risks and significant transactions, and discloses any significant uncertainties in relation to tax matters. Queries and information requests by tax authorities are responded to in a timely fashion and the Group ensures that tax authorities are kept informed about how issues are progressing. The Group seeks to resolve issues in real time and before returns are filed where possible. Fair, accurate and timely disclosures are made in tax returns, reports and documents that the Group files with, or submits to, tax authorities. Where disagreements over tax arise, the Group works proactively to seek to resolve all issues by agreement (where possible) and reach reasonable solutions. In the UK, the Group is subject to an annual risk assessment by HM Revenue & Customs and strives to achieve as low a risk rating as can be achieved by a group of BAE Systems' size and complexity.

Whilst the Group aims to maximise the tax efficiency of its business transactions, it does not use structures in its tax planning that are contrary to the intentions of the relevant legislature. The Group interprets relevant tax laws in a reasonable way and ensures that transactions are structured in a way that is consistent with a relationship of co-operative compliance with tax authorities. It also actively considers the implications of any planning for the Group's wider corporate reputation.

The Group is open and transparent with regard to decision-making, governance and tax planning in its business, keeping tax authorities informed of who has responsibility, how decisions are reached, how the business is structured and where different parts of the business are located.

BAE Systems operates internationally and is subject to tax in many different jurisdictions. The Group employs professional tax managers and takes appropriate advice from reputable professional firms. The Group is routinely subject to tax audits and reviews which can take a considerable period of time to conclude. Provision is made for known issues based on management's interpretation of country-specific legislation and the likely outcome of negotiations or litigation. The assessment and management of tax risks are regularly reviewed by the Audit Committee, as is the Group's tax strategy.

Arm's-length principles are applied in the pricing of all intra-group transactions of goods and services in accordance with Organisation for Economic Co-operation and Development guidelines. Where appropriate, the Group engages with governments in relation to proposed legislation and tax policy. The Group endorses the statement of tax principles issued by the Confederation of British Industry in May 2013 (www.cbi.org.uk/cbi-prod/assets/File/pdf/statement-of-tax-principles.pdf).

P154 Note 6 to the Group accounts

Chart, note and page references used above refer to the Annual Report 2017 that can be viewed on the Company's website.

Principal risks

Risks are identified based on the likelihood of occurrence and the potential impact on the Group. The Group's principal risks are identified below, together with a description of how we mitigate those risks.

Description		Impact		Mitigation
1. Defence spending The Group is dependent on defence spending.
In 2017, 92% of the Group's sales were defence-related. Defence spending by governments can fluctuate depending on change of government policy, other political considerations, budgetary constraints, specific threats and movements in the international oil price. There have been constraints on government expenditure in a number of the Group's principal markets, in particular in the US and UK. A National Security Capability Review is being undertaken by the Cabinet Office, and a Modernising Defence Programme was announced in January 2018 by the Defence Secretary. The outcome of both is aimed to be announced by the summer of 2018. The result of the EU referendum in the UK has led to a period of uncertainty and, in the longer term, there is a risk relating to the Group's ability to participate in further collaborative defence programmes in Europe.		Lower defence spending by the Group's major customers could have a material adverse effect on the Group's future results and financial condition.		The business is geographically spread across US, UK and international defence markets: ·     In the US, after seven months under a Continuing Resolution that maintained funding at the prior year's level, the fiscal year 2017 defence budget ultimately rose by approximately 4%. Whilst the fiscal year 2018 budget remains under a Continuing Resolution, the bipartisan budget agreement passed on 9 February 2018 would increase the US defence budget by approximately 10% over current levels, reflecting continued growth in defence spending to $700bn (£518bn) for the fiscal year ending 30 September 2018. This budget agreement increases the budget caps for two years and extends the Continuing Resolution to 23 March 2018 to allow lawmakers to pass a 2018 spending bill. The US business has become adept at managing through Continuing Resolutions and brief government shutdowns, mitigating any short-term interruptions across our portfolio. ·     The UK is Europe's largest defence market and, after a period of budgetary decline, defence spending has stabilised. The 2017 Spring Budget reinforced previous commitments to increase defence spending, as well as the continued pledge to maintain spending at 2% of GDP. ·     In Saudi Arabia, regional tensions continue to dictate that defence remains a high priority. The diverse product and services portfolio is marketed across a range of defence markets. BAE Systems benefits from a large order backlog, with established positions on long-term programmes in the US, UK, Saudi Arabia and Australia. BAE Systems has a growing portfolio of commercial businesses, including commercial avionics and the commercial areas of the Applied Intelligence business. We will support the government in achieving its aim to ensure that the UK maintains its key role in European security and defence post-Brexit, and to strengthen bilateral relationships with key partners in Europe. This will be important for ongoing collaboration in the development of defence capabilities.
Description		Impact		Mitigation
2. Government customers The Group's largest customers are governments.
The Group has long-standing relationships and security arrangements with a number of its government customers, including its three largest customers, the governments of the US, UK and Saudi Arabia, and their agencies. It is important that these relationships and arrangements are maintained. In the defence and security industries, governments can typically modify contracts for their convenience or terminate them at short notice. Long-term US government contracts, for example, are funded annually and are subject to cancellation if funding appropriations for subsequent periods are not made. Governments also from time to time review their terms of trade and underlying policies and seek to impose such new terms and policies when entering into new contracts. The Group's performance on its contracts with some government customers is subject to financial audits and other reviews which can result in adjustments to prices and costs.		Deterioration in the Group's principal government relationships resulting in the failure to obtain contracts or expected funding appropriations, adverse changes in the terms of its arrangements with those customers or their agencies, or the termination of contracts could have a material adverse effect on the Group's future results and financial condition.		Government customers have sophisticated procurement and security organisations with which the Group can have long-standing relationships with well-established and understood terms of business. In the event of a customer terminating a contract for convenience, the Group would typically be paid for work done and commitments made at the time of termination.

Description		Impact		Mitigation
3. International markets The Group operates in international markets.
BAE Systems is an international company conducting business in a number of regions, including the US and the Middle East. The risks of operating in some countries include: social and political changes impacting the business environment; economic downturns, political instability and civil disturbances; the imposition of restraints on the movement of capital; the introduction of burdensome taxes or tariffs; change of government policy and regulations in the UK, US and all other relevant jurisdictions; and the inability to obtain or maintain the necessary export licences. The Group is exposed to volatility arising from movements in currency exchange rates, particularly in respect of the US dollar, euro, Saudi riyal and Australian dollar. There has been volatility in currency exchange rates in the period since the EU referendum in the UK. In July 2017, the High Court of England and Wales ruled that the UK government has been acting lawfully in granting defence export licences to the Kingdom of Saudi Arabia. The Court of Appeal is currently considering whether to permit an appeal of the High Court's decision.		The occurrence of any such events could have a material adverse effect on the Group's future results and financial condition.		The Group has a balanced portfolio of businesses across a number of markets internationally. The Group benefits from a large order backlog, with established positions on long-term programmes in the US, UK, Saudi Arabia and Australia. The Group's policy is to hedge all material firm transactional currency exchange rate exposures. The Group's contracts are often long-term in nature and, consequently, it may be able to mitigate these risks over the terms of those contracts. Political risk insurance is held in respect of export contracts not structured on a government-to-government basis. BAE Systems has a well-established legal and regulatory compliance structure aimed at ensuring adherence to regulatory requirements and identifying restrictions that could adversely impact the Group's activities, including export control requirements.
4. Competition in international markets The Group's business is subject to significant competition in international markets.
The Group's business plan depends upon its ability to win and contract for high-quality new programmes, an increasing number of which are expected to be in markets outside the US and UK. The Group is dependent upon US and UK government support in relation to a number of its business opportunities in export markets.		The Group's business and future results may be adversely impacted if it is unable to compete adequately and obtain new business in the markets in which it operates.		The Group has an international, multi-market presence, a balanced portfolio of businesses, leading capabilities and a track record of delivery on its commitments to its customers. The Group continues to invest in research and development, and to reduce its cost base and improve efficiencies, to remain competitive. In the UK, export contracts can be structured on a government-to-government basis and government support can also involve military training, ministerial support for promotional activities and financial support through UK Export Finance. In the US, most of the Group's defence export sales are delivered through the Foreign Military Sales process, under which the importing government contracts with the US government.

Description				Impact				Mitigation
5. Laws and regulations The Group is subject to risk from a failure to comply with laws and regulations.
The Group operates in a highly-regulated environment across many jurisdictions and is subject, without limitation, to regulations relating to import-export controls, money laundering, false accounting, anti-bribery and anti-boycott provisions. It is important that the Group maintains a culture in which it focuses on embedding responsible business behaviours and that all employees act in accordance with the requirements of the Group's policies, including the Code of Conduct, at all times. Export restrictions could become more stringent and political factors or changing international circumstances could result in the Group being unable to obtain or maintain necessary export licences.			Failure by the Group, or its sales representatives, marketing advisers or others acting on its behalf, to comply with these regulations could result in fines and penalties and/or the suspension or debarment of the Group from government contracts or the suspension of the Group's export privileges, which could have a material adverse effect on the Group. Reduced access to export markets could have a material adverse effect on the Group's future results and financial condition.				BAE Systems has a well-established legal and regulatory compliance structure aimed at ensuring adherence to regulatory requirements and identifying restrictions that could adversely impact the Group's activities. Internal and external market risk assessments form an important element of ongoing corporate development and training processes. A uniform global policy and process for the appointment of advisers engaged in business development is in effect. BAE Systems continues to reinforce its ethics programme globally, driving the right behaviours by supporting employees in making ethical decisions and embedding responsible business practices. The special compliance officer, appointed pursuant to commitments concerning ongoing regulatory compliance made in the course of the 2011 settlement with the US Department of State, concluded his monitorship in May 2014 and, at the invitation of BAE Systems, agreed to remain in a limited capacity for a limited further period of time.
6. Contract risk and execution The Group has many contracts, including a small number of large contracts and fixed-price contracts.
In 2017, 47% of the Group's sales were generated by its 15 largest programmes. At 31 December 2017, the Group had five programmes with order backlog in excess of £1bn. A significant portion of the Group's revenue is derived from fixed-price contracts. Actual costs may exceed the projected costs on which the fixed prices are agreed and, since these contracts can extend over many years, it can be difficult to predict the ultimate outturn costs. It is important that the Group maintains a culture in which it delivers on its projects within tight tolerances of quality, time and cost performance in a reliable, predictable and repeatable manner.			The inability of the Group to deliver on its contractual commitments, the loss, expiration, suspension, cancellation or termination of any one of its large contracts or its failure to anticipate technical problems or estimate accurately and control costs on fixed-price contracts could have a material adverse effect on the Group's future results and financial condition.				Contract-related risks and uncertainties are managed under the Group's mandated Lifecycle Management process. A leadership development programme for project directors has been deployed across the Group, covering the leadership competencies required to manage complex projects containing significant levels of risk and uncertainty. A significant proportion of the Group's largest contracts are with the UK Ministry of Defence. In the UK, development programmes are normally contracted with appropriate levels of risk being initially held by the customer and contract structures are used to mitigate risk on production programmes, including where the customer and contractor share cost savings and overruns against target prices. The Group has a well-balanced spread of programmes and significant order backlog which provides forward visibility. The Group has limited exposure to fixed-price design and development activity which is in general more risk intensive than fixed-price production activity. 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.
Description				Impact				Mitigation
7. Contract awards and cash profiles The Group is dependent on the award timing and cash profile of its contracts.
The Group's profits and cash flows are dependent, to a significant extent, on the timing of, or failure to receive, award of defence contracts and the profile of cash receipts on its contracts.			Amounts receivable under the Group's defence contracts can be substantial and, therefore, the timing of, or failure to receive, awards and associated cash advances and milestone payments could materially affect the Group's profits and cash flows for the periods affected, thereby reducing cash available to meet the Group's cash allocation priorities, potentially resulting in the need to arrange external funding and impacting its investment grade credit rating.				The Group's balance sheet continues to be managed conservatively in line with its policy to retain an investment grade credit rating and to ensure operating flexibility. The Group monitors a rolling forecast of its liquidity requirements to ensure that there is sufficient cash to meet its operational needs and maintain adequate headroom.
8. Pension funding The Group has an aggregate funding deficit in its defined benefit pension schemes.
In aggregate, there is an actuarial deficit between the value of the projected liabilities of the Group's defined benefit pension schemes and the assets they hold. The funding deficits may be adversely affected by changes in a number of factors, including investment returns and anticipated members' longevity.				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 cash allocation priorities.				In the UK, new employees have been offered membership of defined contribution rather than defined benefit schemes since April 2012 and, in the US, employees have not accrued salary-related benefits in defined benefit schemes since January 2013. In November, the 2017 UK triennial funding valuations and, where necessary, deficit recovery plans were agreed with the trustees and certified by the scheme actuaries after consultation with the Pensions Regulator. The funding deficit across the UK schemes at 31 March 2017 was £2.1bn. Based on the new funding valuations, the Group will increase current annual deficit recovery payments to the UK schemes to £220m a year from 1 April 2018. The deficits in each of the schemes are expected to be cleared between 2021 and 2026. Under the last agreement made in 2014, all scheme deficits were only projected to be cleared in 2026.

Description		Impact				Mitigation
9. Information technology security The Group could be negatively impacted by information technology security threats.
The security threats faced by the Group include threats to its information technology infrastructure, unlawful attempts to gain access to its proprietary or classified information and the potential for business disruptions associated with information technology failures.			Failure to combat these risks effectively could negatively impact the Group's reputation among its customers and the public, cause disruption to its business operations, and could result in a negative impact on the Group's future results and financial condition.			The Group has a broad range of measures in place, including appropriate tools and techniques, to monitor and mitigate this risk.
10. People The Group's strategy is dependent on its ability to recruit and retain people with appropriate talent and skills.
Delivery of the Group's strategy and business plan is dependent on its ability to compete to recruit and retain people with appropriate talent and skills, including those with innovative technological capabilities. The Group's business plan is targeting an increasing level of business in international export markets outside the US and UK. It is important that the Group recruits and retains management with the necessary international skills and experience in the relevant jurisdictions.			The loss of key employees or inability to attract the appropriate people on a timely basis could adversely impact its ability to deliver its strategy, meet the business plan and, accordingly, have a negative impact on the Group's future results and financial condition.			The Group recognises that its employees are key to delivering its strategy and business plan, and focuses on developing the existing workforce and hiring talented people to meet current and future requirements. The Group has well-established graduate recruitment and apprenticeship programmes and, in order to maximise the contribution that its workforce can make to the performance of the business, has an effective through-career capability development programme. In order to seek to maximise its talent pool, the Group is committed to creating a diverse and inclusive environment for its employees.

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

Segmental review

Electronic Systems

Electronic Systems comprises the US and UK-based electronics activities, including electronic warfare systems, electro-optical sensors, military and commercial digital engine and flight controls, precision guidance and seeker solutions, next-generation military communications systems and data links, persistent surveillance capabilities, and hybrid electric drive systems.

Electronic Combat includes the Integrated Electronic Warfare, Low Observable Tactical Aircraft Electronic Warfare and Tactical Aircraft Electronic Warfare product lines. The business provides a depth of capability in integrated electronic warfare systems for airborne applications, including electronic support, electronic attack and electronic protection technologies.

Survivability, Targeting & Sensing exploits the electro-optical and infrared spectrum to provide leading threat warning and infrared countermeasures systems, precision guidance and seeker solutions, advanced targeting solutions, head-up displays and state-of-the-art tactical imaging systems.

C4ISR Systems addresses the market for actionable intelligence through innovative technical solutions for airborne persistent surveillance, identification systems, signals intelligence, underwater and surface warfare solutions, and space products.

Controls & Avionics addresses the commercial and military aircraft electronics markets, including fly-by-wire flight controls, full authority digital engine controls, flight deck systems, cabin management systems and mission computers.

Power & Propulsion Solutions delivers electric propulsion and power management performance, with innovative products and solutions that advance vehicle mobility, efficiency and capability in the transit, military, marine and rail markets.

P06 Alternative performance measure definitions

Operational and strategic highlights

·     Orders worth over $450m (£333m) received for F-35 Lightning II hardware production and support

·     Invested more than $100m (£74m) in our 'Ramp to Rate' initiative to prepare the business for future Electronic Warfare growth

·     Received a $311m (£230m) contract to provide the Digital Electronic Warfare System (DEWS) to support the sale of new aircraft to an international customer

·     Growing demand for APKWS™ laser-guided rockets, with awards totalling approximately $300m (£222m) during the year

·     LiteHUD® Head-Up Display selected by critical launch customers, with first flights in 2017

·     The FADEC Alliance joint venture transitioned to Full-Rate Production of the full authority digital engine control for the LEAP commercial aircraft engine

·     Major milestone achieved with the delivery of our 8,000th hybrid-electric system

Financial performance

Financial performance measures as defined by the Group

		2017	2016
Sales	KPI	£3,635m	£3,282m
Underlying EBITA	KPI	£562m	£494m
Return on sales		15.5%	15.1%
Operating business cash flow	KPI	£450m	£469m
Order intake1	KPI	£4,175m	£3,322m
Order backlog1		£5.4bn	£5.2bn

Financial performance measures defined in IFRS²

		2017	2016
Revenue		£3,635m	£3,282m
Operating profit		£542m	£474m
Return on revenue		14.9%	14.4%
Cash flow from operating activities		£569m	£568m

·     Sales compared with 2016 were up 5% at $4.7bn (£3.6bn). The growth came in the electronic warfare business from the F-35 Lightning II and DEWS programmes, as well as increasing classified activity. Volumes of the APKWS™ product almost doubled over the year and now represent one of the top five sales lines.

·     The return on sales achieved of 15.5% (2016 15.1%) reflects continued strong programme execution and risk retirement.

·     Cash conversion of underlying EBITA for the full year was at 85% (2016 97%), excluding pension deficit funding.

·     Order backlog was at a record high of $7.3bn (£5.4bn) following further awards for F-35 Lightning II systems, classified Electronic Warfare activity and APKWS™ product.

1.  Including share of equity accounted investments.

2.  International Financial Reporting Standards.

Operational performance

Electronic Combat

BAE Systems has sustained its leadership position in the US electronic warfare market and production is ramping up across a number of programmes, some of which are classified.

Low-Rate Initial Production (LRIP) hardware deliveries for the F-35 Lightning II programme continue with Lot 10 and 11 deliveries. We have received initial Lot 12 funding, with an anticipated final award value in excess of $300m (£222m), and a Request for Proposal for a potential block buy encompassing multiple lots.

BAE Systems reached a price agreement with Lockheed Martin on a $155m (£115m) Electronic Warfare Performance Based Logistics contract. The award provides Electronic Warfare material availability and support for the F-35 Lightning II aircraft over a five-year period.

The business is under contracts from Boeing and Warner Robins Air Logistics Complex, totalling more than $1.0bn (£0.7bn), to install the Digital Electronic Warfare System on select new F-15 aircraft, upgrade existing F-15 aircraft, and to provide spare units and modules for an international customer. The programme remains on schedule. BAE Systems has also received a $311m (£230m) contract to provide the Digital Electronic Warfare System to support the sale of new F-15 aircraft to another international customer.

Following our selection by Boeing in 2015 to develop and manufacture the next-generation digital electronic warfare system for the US Air Force's Eagle Passive Active Warning Survivability System programme to upgrade up to 400 F-15 aircraft, we are currently executing the $161m (£119m) engineering and manufacturing development contract. The programme could be worth more than $1.0bn (£0.7bn) over its life.

We have been awarded $87m (£64m) worth of modifications to a competitively awarded contract for an electronic warfare system for the US Air Force Special Operations Command's fleet of C-130J aircraft. The total value of the contract, including all options, could exceed $300m (£222m). This award extends our position to include our electronic warfare capabilities on large, fixed-wing aircraft.

Production of our sensor technology for the Long Range Anti-Ship Missile has commenced following a $40m (£30m) order from prime contractor Lockheed Martin. We provided the sensor technology that supported a successful launch of the missile, demonstrating its ability to address the US Navy's requirement for versatile, multi-platform precision munitions that enable distributed operations.

For over a decade, we have provided full lifecycle support as the prime mission system integrator for the US Air Force's EC-130H Compass Call stand-off electronic attack platform. We are under contract to cross-deck the mission electronics onto a new Gulfstream G550 business jet for the US Air Force. BAE Systems will continue to sustain the existing EC-130H electronics as we develop, manufacture, procure, integrate and sustain the electronics. The programme could be worth more than $2.0bn (£1.5bn) over the next decade.

Due to the sensitive nature of electronic combat systems and technology, many of our programmes are classified. As a world leader in electronic warfare, we continue to experience growth in these increasingly important areas.

Survivability, Targeting & Sensing

Our Advanced Precision Kill Weapon System (APKWS™) laser-guided rocket is experiencing growing demand, with over 13,000 units delivered as at 31 December 2017. In addition to expanding its use in the US military, the system is generating strong international attention, with 19 nations expressing interest. The programme received awards totalling approximately $300m (£222m) during the year.

We continue to execute on the Terminal High-Altitude Area Defence programme. We have received a $30m (£22m) production contract for long-lead material on Lots 9 and 10, and anticipate that additional units will be added in response to increasing demand.

On the $236m (£174m) Common Missile Warning System programme, we continue to deliver to schedule.

Under the five-year, $434m (£321m) Enhanced Night Vision Goggle III and Family of Weapon Sights - Individual Indefinite Delivery, Indefinite Quantity contract, we continued to progress the production qualification testing.

The US Army's Family of Weapon Sights - Crew Served programme completed its System Critical Design Review during the year. This seven-year contract awarded in 2016 has a potential value of up to $384m (£284m).

The LiteHUD® Head-Up Display has been selected by critical launch customers for integration on multiple platforms. In 2017, it had its first flights on a C-130J aircraft, a Textron Scorpion jet and our advanced Hawk demonstrator aircraft.

In December, the US Department of Defense announced that we were awarded a contract by the US Army for the Limited Interim Missile Warning System programme.

C4ISR Systems

In September, the Communications & Navigation Solutions product line joined the Intelligence, Surveillance & Reconnaissance business to form a new C4ISR Systems business that spans the entire mission lifecycle (sensing, processing, exploitation and dissemination).

As a leading provider of space-qualified subsystems and components, we continue to experience growth in the areas of integrated on-board processors, reconfigurable processing payloads and secure communications.

We have been awarded an $81m (£60m) contract for the Network Tactical Common Data Link programme to provide the US Navy with the ability to simultaneously transmit and receive real-time intelligence, surveillance and reconnaissance data over multiple data links with a system to be fielded on various surface ship types.

Since winning the Geospatial Data Services Foundational GEOINT Content Management programme in 2014, we have been awarded orders valued at $214m (£158m). The business is meeting all delivery requirements in assisting US intelligence community customers with the development of advanced geospatial intelligence data collection and processing solutions.

As a provider of signals intelligence capabilities, we are executing the $132m (£98m) Tactical Signals Intelligence Payloads programme for the US Army's Gray Eagle unmanned aircraft.

Work continues on the US Navy's P-8A Poseidon maritime surveillance aircraft programme to provide state-of-the-art processing capabilities. The programme is expected to be worth $1.2bn (£0.9bn) over its life.

Controls & Avionics

BAE Systems is a major supplier of engine controls, flight controls, and cabin and flight deck systems. The development of the integrated flight control electronics and remote electronic units for Boeing's next-generation 777X aircraft remains on schedule, with all hardware in qualification and systems integration testing progressing to plan.

On the Boeing 737 MAX aircraft, a successful first flight was completed on the MAX 9 with our spoiler controls, flight deck systems and utilities electronics.

The development of our civil active inceptors is progressing, with Gulfstream G500 and Embraer KC390 aircraft continuing flight tests with positive pilot feedback. A derivative of the civil inceptors for the Boeing CH-47 Chinook helicopter, LinkEdge™ (Active Parallel Actuation Subsystem), has successfully completed its Preliminary Design Review.

FADEC Alliance, a joint venture between FADEC International (our joint venture with Safran Electronics & Defense) and GE Aviation, has transitioned the full authority digital engine control (FADEC) for the LEAP engine to Full-Rate Production. The LEAP engine powers the Airbus A320neo, the Boeing 737 MAX and the Comac C919. The development of the FADEC for the GE9x engine for the Boeing 777X is on schedule, with certification planned for 2018.

On the F-35 Lightning II programme, LRIP Lot 11 is ongoing for the current vehicle management computer and active inceptor system equipment. Orders for Lot 12 are expected in 2018.

BAE Systems has been awarded a multi-million dollar contract to provide flight control computers, active inceptors, accelerometers and integrated colour display systems for new Taiwanese Air Force training aircraft. The award establishes our footprint on a new platform.

Power & Propulsion Solutions

With the transit bus market continuing its shift towards more electric bus systems to meet emission targets and to satisfy an environmentally-conscious public, BAE Systems achieved a major milestone with the delivery of its 8,000th hybrid-electric system. Transit operators around the world are looking for reliable, low-emission technologies and major cities, such as Seattle, Boston, Quebec, London and Paris, are adopting our advanced hybrid solutions, which are capable of emission-free driving up to half of the time.

P56 Re-presentation of 2017 results

Looking forward

Forward-looking information for the Electronic Systems reporting segment is provided later in this report.

P58 Segmental looking forward

Cyber & Intelligence

Cyber & Intelligence comprises the US‑based Intelligence & Security business and UK‑headquartered Applied Intelligence business, and covers the Group's cyber security, secure government, and commercial and financial security activities.

Intelligence & Security delivers a broad range of services to the US military and government.

Global Analysis & Operations provides innovative, mission-enabling analytic solutions and support to the US government.

Integrated Electronics & Warfare Systems provides systems engineering, integration and through-life support services for US defence and coalition partner customers.

IT Solutions delivers secure solutions and services that enable US national security customers to perform mission-sensitive operations and protect their data and networks.

Applied Intelligence provides data intelligence solutions which enable governments and commercial organisations to defend against national-scale threats, protect their networks and data against sophisticated attacks and operate successfully in cyberspace. Its solutions are delivered as licensed technologies, software-as-a-service subscriptions, through outsourced managed services, and via consulting and systems integration projects.

UK Services delivers cyber security, data analytics, and digital transformation consulting and systems integration services to national security, government and large enterprises in the UK.

International Services & Solutions provides cyber intelligence and defence solutions to international government agencies and communications service providers.

Commercial Solutions provides cyber defence, counter-fraud and financial compliance products to commercial organisations globally.

P06 Alternative performance measure definitions

Operational and strategic highlights

Intelligence & Security

·     Six task orders secured valued at more than $180m (£133m) for Full-Motion Video Intelligence, Surveillance and Reconnaissance analysis support

·     Won a position on a US Department of Treasury programme to support the Office of Terrorism and Financial Intelligence, with a maximum lifecycle value of $135m (£100m)

·     Awarded three US Navy contracts with an estimated lifecycle value of approximately $180m (£133m) to provide engineering and integration support for critical mission systems

·     Selected by the US Navy to pursue orders to provide equipment and support services for Space and Naval Warfare Systems Center Atlantic

Applied Intelligence

Contracts won with UK government and commercial customers for secure IT transformation and cyber defence

Restructuring activities under way, including headcount and facility reductions and a move to a revised operating model, effective 1 January 2018, to drive profitable growth

Financial performance

Financial performance measures as defined by the Group

		2017	2016
Sales	KPI	£1,820m	£1,778m
Underlying EBITA	KPI	£52m	£90m
Return on sales		2.9%	5.1%
Operating business cash flow	KPI	£116m	£83m
Order intake1	KPI	£1,859m	£1,885m
Order backlog1		£2.1bn	£2.4bn

Financial performance measures defined in IFRS²

		2017	2016
Revenue		£1,820m	£1,778m
Operating (loss)/profit		£(367)m	£59m
Return on revenue		(20.2)%	3.3%
Cash flow from operating activities		£127m	£106m

·     In aggregate, sales were marginally lower at $2.3bn (£1.8bn). The Intelligence & Security business saw a 4% decrease largely in the highly competitive area of IT support services to the intelligence community. Growth in Applied Intelligence was at 6%, benefiting from increases in the UK Services and International Services & Solutions divisions.

·     Return on sales was 2.9% (2016 5.1%), after a restructuring charge taken in the Applied Intelligence business. Return on sales in the Intelligence & Security business was similar to last year at 8.8%. In Applied Intelligence, the underlying loss for the year was £61m, including £24m for the restructuring charge. The first half loss of £27m was followed by a reduced second half loss, before the restructuring charge, of £10m as the cost-reduction actions under the ongoing restructuring started to deliver bottom-line benefit.

·     There was an operating loss of £367m (2016 profit £59m), which includes a £384m goodwill impairment in Applied Intelligence reflecting the future level and timing of expected returns from the business.

·     Cash conversion of underlying EBITA for the year was in excess of 100%.

·     Order backlog reduced marginally to $2.9bn (£2.1bn).

1.  Including share of equity accounted investments.

2.  International Financial Reporting Standards.

Operational performance

Intelligence & Security

Global Analysis & Operations

We are pursuing task orders under a new Indefinite Delivery, Indefinite Quantity contract with an estimated value of more than $400m (£296m) to expand our work in motion-imagery analysis, analytic training, multi-media support and research for the US intelligence community. During the year, the business secured six task order contracts valued at more than $180m (£133m).

We won a position on a US Department of Treasury programme to support the Office of Terrorism and Financial Intelligence. The maximum lifecycle value of all task orders to be awarded under the programme is estimated at $135m (£100m).

Integrated Electronics & Warfare Systems

The business is executing on the second year of a five-year, sole-source contract worth up to $368m (£272m) to provide systems engineering services to the US Navy's Strategic Systems Programs office. The programme provides support for weapons systems on board US Ohio and UK Vanguard Class submarines, as well as future Ohio Class replacement and UK Dreadnought Class submarines.

US Navy contract awards in the year include: a new five-year, $42m (£31m) multiple-award contract with the Naval Undersea Warfare Center Division to install submarine multi-mission trainer systems at bases in the US, Guam and Australia; a 22-month, $76m (£56m) contract to support the rapid design, development, fabrication, customisation and lifecycle maintenance of new and existing communication and electronic platforms for the Naval Warfare Center Aircraft Division; and a five-year, $64m (£47m) contract to provide lifecycle systems engineering and technical support for a variety of deployed systems that ensure operational readiness of the fleet.

In addition, the US Navy awarded BAE Systems a position on a five-year Indefinite Delivery, Indefinite Quantity contract to provide research, development, test and evaluation services support for the Naval Warfare Center Aircraft Division's Aircraft Prototype Systems Division. The potential lifecycle value of all task orders under this contract across the eight awardees could reach $487m (£360m).

The US Navy has also selected BAE Systems to provide equipment and support services for Space and Naval Warfare Systems Center Atlantic. As one of several companies involved, we will pursue future orders as part of this five-year, Indefinite Delivery, Indefinite Quantity contract. The total value of all orders to be awarded over the life of the contract is estimated at $180m (£133m).

On the US Air Force Intercontinental Ballistic Missile Integration Support Contractor programme, we were awarded over $29m (£21m) of additional engineering change proposals in 2017, raising the total lifecycle value of the contract to $922m (£682m). Our work includes programme management, systems sustainment, and cyber security assessment and defence.

We continue to pursue task orders on a nine-year Indefinite Delivery, Indefinite Quantity contract to support the US Army in developing next-generation technologies for space, high-altitude and missile defence.

IT Solutions

Our contract to connect a number of US agencies under one shared IT environment passed significant security testing and was authorised for adoption into the government IT infrastructure. Although we executed on our task orders and provided IT services to foster greater systems integration and information sharing for the intelligence community, we have been advised that future contract options will not be exercised as the government reassesses its acquisition strategy in favour of a more federated desktop approach. We therefore do not anticipate any future awards beyond the $164m (£121m) of funding to date.

Our business was awarded a contract increase of $160m (£118m) to extend the period of performance of a major software development and IT support contract for a US intelligence community customer.

We received a five-year, $41m (£30m) contract with the US Department of Homeland Security, National Protection and Programs Directorate to provide data analytics, risk scoring and systems engineering support, as well as cyber security assessment, governance and training to ensure all federal civilian agencies are in compliance with government cyber security regulations.

Organisational changes

Effective 12 February 2018, the business moved to a revised operating model to position for growth through three customer-focused business areas: Integrated Defence Solutions; Intelligence Solutions; and Air Force Solutions.

Applied Intelligence

The business has delivered revenue growth from the continued delivery of national security solutions for the UK and international governments, as well as deployment of anti-fraud, regulatory compliance, and cyber security products and services to commercial customers.

UK Services

The business continues to invest in engineering disciplines and specialist expertise in the cyber, digital and data domains to support our customers in national security intelligence, national-scale cyber defence, commercial cyber security and regulatory compliance.

We have won a number of contracts with both UK government and commercial enterprises, helping our customers to maximise the benefits of secure IT transformation and cyber defence.

International Services & Solutions

The business was underpinned by significant demand for our national-scale cyber defence capabilities. We continue to work with key national security customers in Asia-Pacific and the Middle East. Our technical capability in multi-source intelligence analytics has advanced significantly. In order to improve the cost competitiveness of our engineering, we are continuing to expand our off-shore service operations and delivery centres.

Commercial Solutions

We have a focused set of cyber security, anti-fraud and regulatory compliance solutions.

We continue to see demand for our NetReveal™ anti-fraud and compliance suite, with solutions being deployed to an increasing number of prominent multi-national customers in the financial services sector. Customers are increasingly consuming these solutions as multi-year managed services.

We are continuing to renew existing long-term customer contracts where we deploy a comprehensive portfolio of products. Provision of our anti-fraud and anti-money laundering capabilities continues to see demand with financial services customers.

Organisational changes

In the second half of the year, the business commenced a restructuring that resulted in a headcount reduction and, effective 1 January 2018, the business moved to a revised operating model to deliver a more targeted portfolio of products and services focused on customers within three core business units: Government; Financial Services; and Technology & Commercial. The restructuring will enable a greater focus on customer needs and higher levels of operational efficiency, in the commercial business, that will accelerate improvements in competitiveness and profitability.

P56 Re-presentation of 2017 results

Looking forward

Forward-looking information for the Cyber & Intelligence reporting segment is provided later in this report.

P58 Segmental looking forward

Platforms & Services (US)

Platforms & Services (US), with operations in the US, UK and Sweden, manufactures combat vehicles, weapons and munitions, and delivers services and sustainment activities, including ship repair and the management of government-owned munitions facilities.

US Combat Vehicles focuses on a portfolio of tracked combat vehicles, amphibious vehicles, accessories, protection systems and tactical support services for the US military and international customers.

Weapon Systems focuses on naval weapons, artillery, advanced weapons, precision munitions, high explosives and propellants for US, UK and international customers.

Services include complex munition site management for the US Army's Holston and Radford facilities.

US Ship Repair is a major provider of non-nuclear ship repair, modernisation, overhaul and conversions to the US Navy, government and commercial maritime customers. It has five operational sites in the US on the Atlantic, Gulf of Mexico and Pacific coasts, as well as in Hawaii.

BAE Systems Hägglunds focuses on the tracked vehicle market for Swedish and international customers.

FNSS, the Turkish land systems business in which BAE Systems holds a 49% interest, produces and upgrades tracked and wheeled military vehicles for domestic and international customers.

P06 Alternative performance measure definitions

Operational and strategic highlights

·     Vehicle deliveries nearing completion under the engineering and manufacturing development phase of the Armored Multi-Purpose Vehicle programme

·     Awarded a $414m (£306m) contract for the third and final option for Low-Rate Initial Production under the Paladin Integrated Management programme

·     Completed deliveries of the 16 Amphibious Combat Vehicle prototypes to the US Marine Corps

·     First two M777 lightweight howitzers shipped to India for testing under the $542m (£401m) contract awarded in January 2017

·     $140m (£104m) contract awarded for the modernisation of USS Tortuga

·     Construction of the final commercial ship is nearing completion and the ship is expected to be delivered in the first half of 2018

·     FNSS received a €155m (£138m) contract to provide 27 amphibious assault vehicles to the Turkish Ministry of National Defence

Financial performance

Financial performance measures as defined by the Group

		2017	2016
Sales	KPI	£2,928m	£2,874m
Underlying EBITA	KPI	£242m	£211m
Return on sales		8.3%	7.3%
Operating business cash flow	KPI	£222m	£58m
Order intake1	KPI	£3,542m	£3,308m
Order backlog1		£4.6bn	£4.6bn

Financial performance measures defined in IFRS²

		2017	2016
Revenue		£2,825m	£2,783m
Operating profit		£218m	£182m
Return on revenue		7.7%	6.5%
Cash flow from operating activities		£286m	£129m

·     Sales reduced by 3% to $3.8bn (£2.9bn) as deliveries of land vehicles to Brazil and Japan slipped into the first half of 2018.

·     The business delivered an improved return on sales of 8.3% (2016 7.3%). Charges taken in the year on the commercial shipbuilding programmes amounted to $16m (£12m), with just one contract now remaining for completion.

·     Cash conversion of underlying EBITA was significantly improved despite the impact from the use of provisions on the commercial shipbuilding programmes.

·      Order backlog was increased to $6.3bn (£4.6bn), supportive of future growth expectations. Key awards in the year included the $0.5bn (£0.4bn) Indian order for M777 howitzers, $0.4bn (£0.3bn) for Paladin production and a total of $1.3bn (£1.0bn) in the Ship Repair business.

1.  Including share of equity accounted investments.

2.  International Financial Reporting Standards.

Operational performance

US Combat Vehicles

The business continues to perform on a number of key franchise combat vehicle programmes across both domestic and international markets.

On the US Army's Armored Multi-Purpose Vehicle programme, we have nearly concluded deliveries of the first 29 vehicles under the engineering and manufacturing development phase. The contract, which has a potential value of $1.2bn (£0.9bn), including options for 289 vehicles in Low-Rate Initial Production, brings the US Army closer to achieving its objective to replace its legacy M113 armoured personnel carriers.

In December, we received a $414m (£306m) contract for the third and final option for Low-Rate Initial Production of 48 M109A7 self-propelled howitzers and M992A3 ammunition carriers under the Paladin Integrated Management programme. With options for Full-Rate Production of a further 180 vehicle sets over three years, the award is worth approximately $1.7bn (£1.3bn).

The business is executing a $286m (£211m) engineering and manufacturing development contract to address the space, weight, power and cooling limitations of the Bradley family of vehicles and to prepare the vehicle for communication network upgrades. The US customer's production decision regarding the upgrade of approximately 500 vehicles over a three-year period is expected in 2018.

In September, we received a contract from the US Army worth up to $69m (£51m) for the conversion of the next 20 M88A1 recovery vehicles to the more capable Heavy Equipment Recovery Combat Utility Lift Evacuation Systems (HERCULES) configuration. In March, we received a contract from the US Army worth up to $112m (£83m) for technical support and sustainment of M88 recovery vehicles.

Teamed with Iveco Defence, we completed deliveries of the 16 Amphibious Combat Vehicle (ACV) 1.1 prototypes to the US Marine Corps for testing under the $158m (£117m) engineering and manufacturing development phase of the programme. We are one of two competitors for this programme, with final down-selection expected in 2018.

Whilst we have encountered some production challenges, work continues on multiple contracts totalling $165m (£122m) for Assault Amphibious Vehicles (AAVs) for the Japanese Ministry of Defence, including a contract for 30 new AAVs, and an $82m (£61m) contract with Brazil to provide 23 upgraded AAVs.

Weapon Systems

BAE Systems remains a leading provider of gun systems and precision strike capabilities. In February 2017, we completed the acquisition of IAP Research, Inc., a US engineering company focused on the development and production of electromagnetic launchers, power electronics and advanced materials.

We continue to execute on a £183m contract to provide the gun system known as the Maritime Indirect Fire System for the Royal Navy's Type 26 frigate.

Following the contract modification received in 2016 from the Swedish government formalising its purchase of an additional 24 Archer systems, production work continues with deliveries expected to begin in 2018. In October, we received a contract to deliver additional Bofors 155mm BONUS smart anti-armour munitions to the Swedish Army in 2019.

In January 2017, we received a $542m (£401m) Foreign Military Sale contract from the US government to provide 145 M777 lightweight howitzers to the Indian Army. We will build the first 25 guns in our facilities, with the remaining systems assembled in India by Mahindra Defence Services, our selected supplier to establish an assembly, integration and test facility in India. The first two guns were shipped during the year and are progressing through in-country testing.

In July, we received a $47m (£35m) contract for the continued development of the precision-guided Hypervelocity Projectile, a next-generation, low-drag projectile capable of executing multiple missions from a number of gun systems.

In the complex ordnance manufacturing business, we continue to manage the US Army's Radford and Holston munitions facilities, operating near capacity. In 2017, we received additional funding of $177m (£131m) to continue construction of a new nitrocellulose facility in Radford. At Holston, we are performing on modernisation contracts totalling $135m (£100m) for waste water management and a $146m (£108m) contract for the construction of a nitric acid recovery facility to produce larger quantities of insensitive munitions.

US Ship Repair

As a leading provider of US Navy ship repair and modernisation services, we secured firm orders across our US shipyards totalling approximately $1.3bn (£1.0bn) in 2017, including a $140m (£104m) contract for the modernisation of the USS Tortuga at our Norfolk shipyard.

We continue to adjust our workforce and facilities to meet evolving customer demand, including the new dry dock in our San Diego shipyard, which completed operational certification in February and welcomed the USS New Orleans as its first vessel for servicing.

One of the final two commercial ships is complete and awaiting acceptance sea trials pending identification of a buyer following the original customer's decision not to take delivery of the vessel. Construction of the final ship is nearing completion and the ship is expected to be delivered in the first half of 2018.

BAE Systems Hägglunds

Series production of CV90 Infantry Fighting Vehicles for Norway was completed during the year under the $865m (£640m) contract.

We have received contracts from the Estonian government for a sustainment programme for 44 CV90s. We are performing to schedule on the refurbishment of Swedish CV90 vehicles, and the sustainment and upgrade of Danish CV90s. We are integrating Mjölner mortar systems on 40 Swedish CV90s, and testing and verification of Active Protection Systems on Dutch CV90s is under way, together with significant vehicle upgrades.

We continue to perform on a contract to produce 32 BvS10 military vehicles for Austria.

FNSS

FNSS, our land systems joint venture based in Turkey, continues to perform under its $524m (£387m) programme to produce 259 8x8 wheeled armoured vehicles for the Royal Malaysian Army.

Production has completed on a contract to upgrade M113 tracked armoured personnel carriers for the Royal Saudi Land Forces. The next phase of the contract is expected in 2018.

In support of an export contract to Oman awarded in 2015 for the PARS Wheeled Armoured Vehicle, work continues to deliver 8x8 and 6x6 vehicles in a number of configurations. Deliveries of the first 8x8 and 6x6 vehicles have been accepted, with the first production batch of 8x8 vehicles delivered in December.

Work has begun under two Turkish Land Forces contracts, a €278m (£247m) contract signed in June 2016 to supply 260 Anti-Tank Vehicles and an €84m (£75m) contract signed in December 2016 for air defence vehicles.

In March, FNSS received a €155m (£138m) contract to provide 27 amphibious assault vehicles to the Turkish Ministry of National Defence.

P56 Re-presentation of 2017 results

Looking forward

Forward-looking information for the Platforms & Services (US) reporting segment is provided later in this report.

P58 Segmental looking forward

Platforms & Services (UK)

Platforms & Services (UK) comprises the Group's UK‑based air, maritime, land and shared services activities.

Military Air & Information includes programmes for the production of Typhoon combat and Hawk trainer aircraft, F-35 Lightning II manufacture and support, support and upgrades for Typhoon, Tornado and Hawk aircraft, and development of next-generation Unmanned Air Systems and defence information systems.

Maritime programmes include the construction of two Queen Elizabeth Class aircraft carriers, five River Class Offshore Patrol Vessels and seven Astute Class submarines for the Royal Navy, the design and production of the Dreadnought Class submarine and Type 26 frigate, and in-service support, including the delivery of services at HM Naval Base, Portsmouth.

Land UK provides combat vehicle upgrades and support to the British Army and international customers, and designs, develops and manufactures a comprehensive range of munitions products servicing its main customer, the UK Ministry of Defence, as well as international customers. The business also develops and manufactures cased-telescoped weapons through its CTA International joint venture.

Organisational changes

Effective 1 January 2018, BAE Systems revised its reporting segments to reflect the organisational changes described on page 17. The Platforms & Services (UK) and Platforms & Services (International) management structures have been removed with the organisation streamlined, and strengthened Air and Maritime reporting segments created.

P06 Alternative performance measure definitions

Operational and strategic highlights

·     Contract valued at approximately £5bn signed in December to supply 24 Typhoon aircraft and support to Qatar, subject to financing conditions and receipt by the Group of first payment

·     First eight Typhoon and all eight Hawk aircraft for Oman delivered to the Sultanate of Oman

·     Signed the full £3.7bn production contract for the initial batch of three Type 26 frigates

·     Received the full £1.4bn contract for the sixth Astute Class submarine from the Royal Navy in March, and the fourth Astute boat, Audacious, was launched in April

·     Rationalisation activities announced, including potential headcount reductions in the Military Air & Information and Maritime Services businesses

Financial performance

Financial performance measures as defined by the Group

		2017	2016
Sales	KPI	£7,682m	£7,806m
Underlying EBITA	KPI	£794m	£810m
Return on sales		10.3%	10.4%
Operating business cash flow	KPI	£427m	£199m
Order intake1	KPI	£6,817m	£8,024m
Order backlog1		£16.8bn	£17.8bn

Financial performance measures defined in IFRS²

		2017	2016
Revenue		£7,624m	£7,699m
Operating profit		£774m	£780m
Return on revenue		10.2%	10.1%
Cash flow from operating activities		£607m	£385m

·      Sales of £7.7bn (2016 £7.8bn) were marginally lower than 2016. Activity levels on the submarine programmes were ahead of plan.

·      Return on sales was at 10.3% (2016 10.4%).

·      There was a cash inflow of £427m (2016 £199m), which includes a £106m temporary benefit relating to VAT. Consumption of customer advances on the Omani, Saudi Arabian and European Typhoon contracts has now largely completed.

·      Order backlog reduced to £16.8bn (2016 £17.8bn). The £5bn order received from Qatar in December for 24 Typhoon aircraft and support has not yet been taken into order backlog, pending completion of the financing package which we expect in the coming months.

1.  Including share of equity accounted investments.

2.  International Financial Reporting Standards.

Operational performance

Military Air & Information

In December, BAE Systems and the Government of Qatar entered into a contract, valued at approximately £5bn, for the supply of 24 Typhoon aircraft. Alongside supplying the aircraft, the agreement provides for the supply of ground support to the Qatar Armed Forces and delivery of technical and pilot training in Qatar. The contract is subject to financing conditions and receipt by the Group of first payment which are expected to be fulfilled no later than mid-2018.

In the year, 20 Typhoon aircraft were delivered from the UK final assembly facility, of which four were delivered to Saudi Arabia, completing the contract for 72 aircraft. All 236 Tranche 2 aircraft have been delivered to the UK, Germany, Italy and Spain, together with 51 of the 88 contracted Tranche 3 aircraft.

There were eight Typhoon and eight Hawk aircraft deliveries to the Oman customer in the year, with the remaining four Typhoon aircraft scheduled to be delivered in 2018.

Good progress continues to be made on airframe manufacture for the contract to supply 28 Typhoon aircraft to Kuwait secured by Italian Eurofighter partner, Leonardo, in 2016, with fuselage deliveries due to commence in 2018.

Development towards the Royal Air Force Centurion standard continues, which will enable transition of air capabilities from Tornado to Typhoon. Flight testing for Storm Shadow and Meteor weapons capability enhancements was completed during the year. Integration of the Captor E-Scan radar continues.

We have continued to support our UK and European customers' Typhoon and Tornado aircraft and their operational commitments. The ten-year partnership arrangement with the Ministry of Defence to support the UK Typhoon fleet continues as planned, with availability of aircraft being sustained at contractual levels.

The initial support package has been substantially delivered as part of the contract to commence operations at a new operating air base at Adam in Oman.

On the F-35 Lightning II programme, full contract award was secured on Lot 10 and 82 rear fuselage assemblies were manufactured for the Low-Rate Initial Production Lot 10 and 11 contracts. Negotiations continued on Lot 11, with additional order intake received in the year of £248m. Lot 11 negotiations are expected to conclude during the first quarter of 2018, with the balance of the order intake also expected in this timeframe.

At RAF Marham in Norfolk, good progress has been made on construction of the engineering and training facilities and the stand-up of the operational service in readiness for the arrival of the UK's first F-35 Lightning II aircraft in 2018.

Following the announcement that the UK had been chosen as a major European repair hub for the maintenance, repair, overhaul and upgrade of F-35 Lightning II avionics and components, we have established a joint venture with the UK Ministry of Defence and Northrop Grumman, and progress on establishing the repair facility and capability continues to plan.

Support continues to be provided to users of Hawk trainer aircraft around the world. The long-term support contract for the Royal Air Force's UK fleet of Hawk fast jet trainer aircraft continues to deliver against all contractual milestones.

Discussions continue with the Government of India and Hindustan Aeronautics Limited (HAL) for the supply of additional kit sets which will result in aircraft built under licence by HAL for the Indian Air Force and Indian Navy.

Following an extensive review with our partner, Northrop Grumman, of the requirements and conditions of the US Air Force future trainer programme, both companies decided not to proceed with the competitive bid.

An initial contract for the Anglo-French unmanned combat air system feasibility and definition phase of £16m was received during the year. It is anticipated that an Anglo-French follow-on programme will be agreed in 2018.

A £119m contract was secured for collaboration on the first design and development phase of an indigenous fifth-generation fighter jet for the Turkish Air Force.

As a result of reducing production activity on Typhoon and Hawk, and also taking into account the changes to support requirements as the Royal Air Force transitions from Tornado to F-35 Lightning II, the business announced in October a total proposed headcount reduction of up to 1,400 roles over the next three years.

Maritime

On the aircraft carrier programme, HMS Queen Elizabeth successfully concluded initial sea trials and entered HM Naval Base, Portsmouth, for the first time in August. Operational handover and acceptance by the Royal Navy took place in December. HMS Prince of Wales floated out of the dock at Rosyth in December. Large volume installation activities continue to progress, with commissioning of systems planned to commence in 2018 and sea trials beginning in 2019.

The full £3.7bn production contract was signed in June for the first batch of three Type 26 frigates, with £2.8bn of order intake in the year, following funding in previous years for long-lead items. Production of the first ship, Glasgow, commenced in July. The programme currently employs over 1,000 people and production activities will progressively build up during 2018 as more of the ship transitions from completion of the detailed design through to production readiness.

The first Offshore Patrol Vessel (OPV), HMS Forth, completed sea trials in December and was accepted by the Ministry of Defence in January 2018. Construction of the remaining four OPVs on the Clyde continues.

Under the Maritime Support Delivery Framework contract, which the Ministry of Defence has agreed in principle to extend until 31 March 2020, we provide services at HM Naval Base, Portsmouth, and support to half of the Royal Navy's surface fleet. We remain on track to achieve target cost. The business was unsuccessful on a competitive bid to provide equipment procurement and equipment management services for the Queen Elizabeth Class aircraft carriers and Type 45 destroyers.

BAE Systems provides significant support and maintenance to the Royal Navy's fleet of Type 45 destroyers, and has responded to a Ministry of Defence competitive proposal on its power improvement project, with the award decision expected in 2018.

Progress continues on the £270m Spearfish torpedo upgrade demonstration and manufacture phases, with the demonstration phase forecast to complete in 2020.

Evolving customer requirements and a focus on improved efficiency and removing cost in the Maritime Services business have led to the announcement in October of a proposed headcount reduction of around 375 roles. The proposed rationalisation will more closely align capacity with workload and improve competitiveness to retain and grow our position on key programmes, while retaining critical skills.

The first three Astute Class submarines are in operational service with the Royal Navy. Progress continues on the manufacture of the remaining four boats, with launch of the fourth boat, Audacious, achieved in April. A full contract award for the sixth boat, Agamemnon, was secured in March for £1.4bn, with £0.6bn of order intake in the year after order intake in previous years for long-lead items. Further funding of £80m was received for the seventh boat.

Functional and spatial design, and the production of the first of class continues to advance on the Dreadnought Class submarine, the replacement for the Royal Navy's Vanguard Class submarine. The next phase of the contract is scheduled to commence in April 2018.

The major programme of building works at the Barrow site continues, with contracts in place totalling more than £500m, with two further major buildings being completed during the year.

The detailed arrangements for the Dreadnought Alliance, including the organisational, governance and commercial arrangements between the three parties, the Ministry of Defence, BAE Systems and Rolls-Royce, continue to be developed.

Land UK

The business continues to provide UK and international customers with a full range of light and heavy munitions, with orders totalling £133m received in the year.

During the year, 131 40mm cased-telescopic cannons were delivered to the Ministry of Defence by CTA International, a joint venture between BAE Systems and Nexter, bringing cumulative deliveries to 160 of 515. This is the first entirely new medium calibre cannon and ammunition system qualified by the British Army since the late 1960s.

The business has continued to provide support to previously supplied armoured vehicles and bridging systems, with orders of £48m received in the year. The business is one of two contenders delivering the design stages of the Challenger 2 Life Extension Programme and the British Army's bridging system.

P56 Re-presentation of 2017 results

Looking forward

Forward-looking information reflecting the organisational changes described on page 48 is provided later in this report.

P58 Segmental looking forward

Platforms & Services (International)

Platforms & Services (International) comprises the Group's businesses in Saudi Arabia, Australia and Oman, together with its 37.5% interest in the pan‑European MBDA joint venture.

In Saudi Arabia, the business provides operational capability support to the country's air and naval forces through UK/Saudi government-to-government programmes. The Saudi British Defence Co-operation Programme and Salam Typhoon project provide for multi-year contracts between the governments.

In Australia, the business delivers production, upgrade and support programmes for customers in the defence and commercial sectors across the air, maritime and land domains. Services contracts include the provision of sustainment, training solutions and upgrades.

In Oman, the business is developing its position building on a long history of relationships with the Omani armed forces through the provision, support and upgrade of defence platforms and cyber security services. Business generated in Oman is executed through our relevant reporting segments.

MBDA is a leading global prime contractor of missiles and missile systems across the air, maritime and land domains.

Organisational changes

Effective 1 January 2018, BAE Systems revised its reporting segments to reflect the organisational changes described on page 17. The Platforms & Services (UK) and Platforms & Services (International) management structures have been removed with the organisation streamlined, and strengthened Air and Maritime reporting segments created.

P06 Alternative performance measure definitions

Operational and strategic highlights

·     Final four of 72 Typhoon aircraft delivered to Saudi Arabia on the Salam Typhoon programme

·     The Typhoon support contracts are operating well and a contract for support to additional flying hours was agreed in April

·     Contracts agreed to provide ongoing support services to the Royal Saudi Air Force and Royal Saudi Naval Forces for a further five years

·     The first major units of the second batch of Hawk aircraft delivered on schedule to Saudi Arabia allowing final assembly to commence

·     Assigned the role of F-35 Regional Warehouse provider for the Asia-Pacific region

·     Selected as the preferred tenderer for the Jindalee Operational Radar Network upgrade programme

·     MBDA signed a contract in December to supply Brimstone and Meteor missiles to Qatar, subject to financing conditions and receipt of first payment

·     MBDA contracts for naval fleet air defence and coastal defence in Qatar became effective in July

Financial performance

Financial performance measures as defined by the Group

		2017	2016
Sales	KPI	£4,138m	£3,943m
Underlying EBITA	KPI	£472m	£400m
Return on sales		11.4%	10.1%
Operating business cash flow	KPI	£671m	£435m
Order intake1	KPI	£4,365m	£6,175m
Order backlog1		£13.3bn	£13.1bn

Financial performance measures defined in IFRS²

		2017	2016
Revenue		£3,136m	£3,037m
Operating profit		£427m	£365m
Return on revenue		13.6%	12.0%
Cash flow from operating activities		£669m	£473m

·     Sales of £4.1bn (2016 £3.9bn) were 5% up over 2016. With all 72 Salam Typhoon aircraft now in service, we have seen higher levels of support. In addition, we have seen the expected ramp-up from MBDA's strong order backlog.

·     Underlying EBITA of £472m (2016 £400m) and the return on sales of 11.4% (2016 10.1%) benefited from improving performance from our Saudi partner companies and stronger performance at MBDA.

·     Operating cash inflow was £671m (2016 £435m), although approximately £300m of this was for an advance payment on the Saudi support programme.

·     Order backlog was marginally higher at £13.3bn (2016 £13.1bn) as further order intake was booked under the renewal of the five-year support contract in Saudi Arabia and Qatari naval orders became effective within MBDA.

1.  Including share of equity accounted investments.

2.  International Financial Reporting Standards.

Operational performance

Saudi Arabia

On the Salam Typhoon programme, with four deliveries in the year, all 72 contracted aircraft have been delivered to the customer. Typhoon capability development programmes continue to progress.

The Typhoon support contracts are operating well and a contract for support to additional flying hours was agreed in April.

Discussions have continued with the Saudi Arabian customer though 2017, resulting in contractual agreements under the Saudi British Defence Co-operation Programme to provide ongoing support services to the Royal Saudi Air Force and Royal Saudi Naval Forces for a further five years to 31 December 2021.

Final aircraft deliveries for the first batch of 22 Hawk aircraft were completed in the second half of the year. The first major units of the second batch of 22 aircraft, contracted in 2015, have been delivered on schedule to Saudi Arabia allowing final assembly to commence.

Under the Royal Saudi Naval Forces' Minehunter mid-life update programme, acceptance of the third and final ship is expected in the first half of 2018.

Under the planned reorganisation of our portfolio of interests in a number of industrial companies in Saudi Arabia, Riyadh Wings Aviation Academy LLC acquired a 4.1% shareholding in a Group subsidiary, Overhaul and Maintenance Company, during 2016 and is expected to acquire a further interest up to a maximum of 49%. The reorganisation supports our strategy to expand the customer base of our In-Kingdom Industrial Participation programme, promoting training, development and employment opportunities in line with the Kingdom's National Transformation Plan and Vision 2030.

The Saudi Arabian In-Kingdom Industrial Participation programme continues to make good progress. During 2017, there has been further capability and knowledge transfer on the Typhoon and Hawk platforms. The first Hawk aircraft assembled in Saudi Arabia will come off the production line in 2018 for delivery to the Royal Saudi Air Force.

We have commenced discussions with the new Saudi Arabian Military Industries (SAMI) organisation to explore how we can collaborate to deliver further In-Kingdom Industrial Participation. All of these activities are aligned with our long-term industrialisation strategy, as well as the Saudi Arabian government's National Transformation Plan and Vision 2030.

Australia

We have continued to provide in-service support to the Navy's two Landing Helicopter Docks under a four-year support contract awarded in 2014. Final acceptance of these vessels is expected in 2018.

HMAS Stuart, the final Anzac Class frigate to be modernised under the Anti-Ship Missile Defence programme, has been accepted into service by the Commonwealth.

The scope of activities for the next five years of sustainment and upgrade of the Anzac fleet under the Warship Asset Management Alliance has been agreed and contracts totalling A$561m (£324m) have been awarded to BAE Systems.

The next upgrade cycle for the Anzac frigate fleet, the Mid-Life Capability Assurance Programme, has commenced, with the first ship, HMAS Arunta, being docked at our Henderson shipyard during the second half of the year. The upgrade programme is planned to run through to 2023.

The delayed JP 2008 Phase 3F programme to provide enhanced defence satellite communications services was formally accepted by the Commonwealth in November. We will continue to provide in-service support to the system under a five-year support contract.

Mobilisation activities for sustainment of the Regional F-35 Lightning II fleet continues to progress at our Williamtown facility, with an increased scope following the announcement in August that BAE Systems was assigned the role of F-35 Regional Warehouse provider for the Asia-Pacific region.

Our existing Hawk Mk127 Lead-in Fighter sustainment contracts continue to perform strongly.

The Capability Assurance Programme to upgrade the Hawk fleet to meet the training requirements of the fifth-generation F-35 Lightning II is progressing ahead of schedule, with 20 of the 33 aircraft modified at the end of 2017. During 2017, the Australian Air Force customer declared achievement of initial operating capability and has commenced training with the aircraft.

In June, the Commonwealth announced that we have been selected as the preferred tenderer for the Jindalee Operational Radar Network upgrade programme. If successful, the expected value of the contract over the initial award term of ten years is approximately A$1.0bn (£0.6bn).

Following down-select in 2016 as one of two tenderers for the Land 400 Phase 2 Combat Reconnaissance Vehicle programme, we have completed the Risk Mitigation Activity contract and submitted our final proposal to the Commonwealth in August. Customer evaluation is ongoing, with final preferred tender selection anticipated in the first half of 2018.

Our tender response for the Commonwealth's nine-ship SEA 5000 Future Frigate programme was submitted in August. The Commonwealth continues to fund Schedule Protection Activity to support its evaluation timetable and we anticipate a preferred tender selection in the first half of 2018.

Oman

The Oman Typhoon and Hawk aircraft programme, being undertaken by Platforms & Services (UK), completed delivery of the first eight Typhoon aircraft and all eight Hawk trainer aircraft in 2017. The remaining four Typhoon aircraft are scheduled to be delivered in 2018.

Separately, we continue to fulfil our legacy industrial participation obligations in Oman through delivery of an agreed training and knowledge transfer programme.

MBDA

In March, MBDA secured a contract from the UK and French governments for a three-year concept phase of the Future Cruise/Anti-Ship Weapon, which will prepare for the replacement of the existing missiles deployed by the UK and French armed forces. This contract follows on from the joint UK-France 2016 programme for the mid-life refurbishment of their current inventory of missiles.

In July, MBDA finalised the financing package to secure effectivity of the Qatari contracts signed in 2016, which will supply air defence systems and anti-ship missiles for the naval surface fleet along with coastal defence systems.

The German Ministry of Defence and MBDA have entered into a formal negotiation process for the German ground-based air defence system, TLVS, a key element of the German defence strategy. Lockheed Martin will be the joint venture partner with MBDA on this programme.

Significant progress has been made in securing positions on a number of fast jet platforms. The Meteor Beyond Visual Range Air-to-Air Missile is already in operational service on Gripen with the Swedish Air Force and has now achieved qualification for both Typhoon and Rafale aircraft. A contract has been received to procure further Brimstone missiles to equip Typhoon. Integration of MBDA missiles on F-35 Lightning II has progressed well, with successful Advanced Short Range Air-to-Air Missile qualification firings achieved and contracts received from the UK to integrate Meteor.

In December, MBDA entered into a contract with Qatar for the supply of Brimstone and Meteor missiles. The contract is subject to financing conditions and receipt by MBDA of first payment which are expected to be fulfilled no later than mid-2018.

Success in both domestic and export markets has significantly increased MBDA's production volumes resulting in the requirement to expand production capacities. A new manufacturing facility is fully operational in Bolton, UK, and a capacity enhancement is under way in Bourges, France.

P56 Re-presentation of 2017 results

Looking forward

Forward-looking information reflecting the organisational changes described on page 52 is provided later in this report.

P58 Segmental looking forward

Re-presentation of 2017 results

Effective 1 January 2018, BAE Systems revised its reporting segments to reflect the organisational changes described on page 17 and adopted International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers.

P06 Alternative performance measure definitions

Financial performance measures for the year ended 31 December 2017 as re-presented to reflect the organisational changes are as follows:

		As defined by the Group							Defined in IFRS1
Year ended 31 December 2017		KPI Sales £m	KPI  Underlying EBITA £m	Return on sales %	KPI  Operating business cash flow £m	KPI Order intake2 £m	Order backlog2 £bn		Revenue £m	Operating profit/(loss) £m	Return on revenue %	Net cash flow from operating activities £m
Electronic Systems		3,635	562	15.5	450	4,175	5.4		3,635	542	14.9	569
Cyber & Intelligence		1,820	52	2.9	116	1,859	2.1		1,820	(367)	(20.2)	127
Platforms & Services (US)		2,928	242	8.3	222	3,542	4.6		2,825	218	7.7	286
Air		8,059	1,000	12.4	832	6,128	20.4		7,120	952	13.4	888
Maritime		3,151	258	8.2	278	4,671	9.1		3,119	247	7.9	396
HQ3		336	(80)		(146)	337	-		47	(112)		(142)
Deduct Intra-group		(303)				(455)	(0.4)		(244)
Deduct Taxation4												(227)
Total		19,626	2,034	10.4	1,752	20,257	41.2		18,322	1,480	8.1	1,897

Financial performance measures for the year ended 31 December 2017 as re-presented to reflect both the organisational changes and the impact of the adoption of IFRS 15 are as follows:

		As defined by the Group							Defined in IFRS1
Year ended 31 December 2017		KPI Sales £m	KPI  Underlying EBITA £m	Return on sales %	KPI Operating business cash flow £m	KPI Order intake2 £m	Order backlog2 £bn		Revenue £m	Operating profit/(loss) £m	Return on revenue %	Net cash flow from operating activities £m
Electronic Systems		3,598	541	15.0	450	4,175	4.8		3,598	521	14.5	569
Cyber & Intelligence		1,818	58	3.2	116	1,859	2.1		1,818	(361)	(19.9)	127
Platforms & Services (US)		2,951	237	8.0	222	3,542	4.2		2,848	213	7.5	286
Air		7,210	967	13.4	832	6,128	19.5		6,312	921	14.6	888
Maritime		2,877	251	8.7	278	4,671	8.5		2,845	240	8.4	396
HQ3		336	(80)		(146)	337	-		47	(112)		(142)
Deduct Intra-group		(303)				(455)	(0.4)		(244)
Deduct Taxation4												(227)
Total		18,487	1,974	10.7	1,752	20,257	38.7		17,224	1,422	8.3	1,897

The Group and segmental guidance for 2018 shown opposite is based on the Group's actual financial performance for 2017 as re-presented to reflect both the organisational changes and the impact of the adoption of IFRS 15.

1.  International Financial Reporting Standards.

2.  Including share of equity accounted investments.

3.  HQ comprises the Group's UK-based head office and shared services activities, together with a 49% interest in Air Astana.

4.  Taxation is managed on a Group-wide basis.

Segmental looking forward

Effective 1 January 2018, BAE Systems has five principal reporting segments, Electronic Systems, Cyber & Intelligence, Platforms & Services (US), Air and Maritime, which align with the strategic direction of the Group.

Electronic Systems

Electronic Systems comprises the US and UK-based electronics activities, including electronic warfare systems, electro-optical sensors, military and commercial digital engine and flight controls, precision guidance and seeker solutions, next-generation military communications systems and data links, persistent surveillance capabilities, and hybrid electric drive systems.

Electronic Systems is well positioned to address current and evolving priority programmes from its strong franchise positions in electronic warfare, precision guidance and seeker solutions. Electronic Systems has a long-standing programme of research and development, and its focus remains on maintaining a diverse portfolio of defence and commercial products and capabilities for US and international customers.

The business expects to benefit from its ability to apply innovative technology solutions that meet defence customers' changing requirements. That, along with strong programme positions, particularly on F-35 Lightning II and F-15 upgrades, and specific products such as APKWS™, position the business well for the medium term.

In the commercial aviation market, Electronic Systems' technology innovations are enabling the business to maintain its long-standing customer positions and to compete for, and win, new business.

Cyber & Intelligence

Cyber & Intelligence comprises the US-based Intelligence & Security business and UK-headquartered Applied Intelligence business, and covers the Group's cyber security, secure government, and commercial and financial security activities.

Intelligence & Security

The outlook for the US government services sector is stable, although market conditions remain highly competitive and continue to evolve.

Whilst the government's decision not to exercise future options on our contract to develop a shared IT environment for US agencies could impact revenue in 2018, the shift in the government's IT strategy could present new opportunities for the business.

With effect from 12 February 2018, the business has restructured to better align with its customer base and position the business to more effectively compete and grow in critical, mission-focused areas with three business areas: Integrated Defence Solutions; Intelligence Solutions; and Air Force Solutions.

Applied Intelligence

With effect from 1 January 2018, the Applied Intelligence business has restructured to focus on a more targeted portfolio of products and services, delivering for customers within three core business units: Government; Financial Services; and Technology & Commercial. The restructuring will enable a greater focus on customer needs and higher levels of operational efficiency, in the commercial business, that will accelerate improvements in competitiveness and profitability.

Sales growth is expected to continue as cyber security is an increasingly important part of government security and a core element of stewardship for commercial enterprises in a sophisticated and persistent threat environment.

P06 Alternative performance measure definitions

P19 Our markets

Platforms & Services (US)

Platforms & Services (US), with operations in the US, UK and Sweden, manufactures combat vehicles, weapons and munitions, and delivers services and sustainment activities, including ship repair and the management of government-owned munitions facilities.

The land vehicles business is underpinned by strong positions on key franchise programmes. These include the US Army's Armored Multi-Purpose Vehicle, M109A7 self-propelled howitzer and Bradley upgrade programmes, and the CV90 and BvS10 export programmes from our BAE Systems Hägglunds business.

The business continues to pursue a range of domestic and international opportunities in combat and amphibious vehicles as well as weapon systems.

FNSS has grown its order book with both domestic and international orders.

These long-term contracts and our franchise position in tracked vehicles, which offer opportunities in international markets, make the land business well placed for growth in the medium term.

In the maritime domain, the Group has a strong position on naval gun programmes and US Navy ship repair. Additional dry dock ship repair capacity has been established in San Diego to support the US Navy's increased requirements in the Asia-Pacific region.

The Group remains a leading provider of gun systems and precision strike capabilities and, in the complex ordnance manufacturing business, we continue to manage the US Army's Radford and Holston munitions facilities under long-term contracts.

Air

Air comprises the Group's UK-based air activities for European and International markets and US Programmes and its businesses in Saudi Arabia and Australia, together with its 37.5% interest in the pan-European MBDA joint venture.

In the UK, as current export contracts for Typhoon and Hawk complete, and UK Tornado support ends, sales are underpinned by our workshare on Typhoon for Kuwait, Typhoon and Hawk support, and F-35 Lightning II production and support. UK-based production of rear fuselage assemblies for F-35 Lightning II will increase over the next three years to reach its expected peak rate for the next decade. We play a significant role in the F-35 Lightning II sustainment programme in support of Lockheed Martin.

Discussions continue with current and prospective operators on contract awards for Typhoon and Hawk, and we continue to develop long-standing international partnerships in the air domain, maintaining our skills and capabilities.

The UK and Saudi support operations are underpinned by long-term contracts. In Saudi Arabia, the In-Kingdom Industrial Participation programme continues to make good progress consistent with our long-term strategy, as well as the Saudi Arabian government's National Transformation Plan and Vision 2030.

In Australia, the business is structured around long-term sustainment and upgrade activities, and we are progressing significant opportunities with the Australian government in the maritime and land domains.

MBDA has a strong order book which is driving increasing production and sales. Development programmes continue to improve the long-term capabilities of the business.

Maritime

Maritime comprises the Group's UK-based maritime and land activities.

Maritime

In Maritime, there remains pressure on the Navy's near-term budgets and a highly-competitive environment in ship support and upgrade.

Within submarines, the business is executing on the Astute Class programme, with four boats still in build. On the Dreadnought programme, production on the first boat of four commenced in 2016. Investment continues in the Barrow facilities to provide the capability on these long-term programmes through the next decade.

In shipbuilding, sales are underpinned by the contracts to manufacture the Queen Elizabeth Class aircraft carriers, Type 26 frigates and River Class Offshore Patrol Vessels.

The through-life support of surface ship platforms provides a sustainable business in technical services and mid-life upgrades.

Land UK

The Land UK business continues to deliver support to armoured vehicle and bridging systems in UK and international markets, munitions under the 15-year Munitions Acquisition Supply Solution partnering agreement secured in 2008 and 40mm cased-telescopic cannons for the UK and French armies.

US defence budget

Whilst we continue to operate under a Continuing Resolution, the bipartisan budget agreement passed on 9 February 2018 would increase the US defence budget by approximately 10% over current levels, reflecting continued growth in defence spending to $700bn (£518bn) for the fiscal year ending 30 September 2018. This budget agreement increases the budget caps for two years and extends the Continuing Resolution to 23 March 2018 to allow lawmakers to pass a 2018 spending bill.

Page references used above refer to the Annual Report 2017 that can be viewed on the Company's website.

Consolidated income statement

for the year ended 31 December

			2017			2016
	Notes		£m	Total £m		£m	Total £m
Continuing operations
Sales	1		19,626			19,020
Deduct Share of sales by equity accounted investments	1		(2,575)			(2,427)
Add Sales to equity accounted investments	1		1,271			1,197
Revenue	1			18,322			17,790
Operating costs	2			(17,089)			(16,274)
Other income	4			131			136
Group operating profit				1,364			1,652
Share of results of equity accounted investments	1			116			90
Underlying EBITA	1		2,034			1,905
Non-recurring items	1		(13)			(12)
EBITA			2,021			1,893
Amortisation of intangible assets	1		(86)			(87)
Impairment of intangible assets	1		(384)			-
Financial expense of equity accounted investments	5		(34)			(28)
Taxation expense of equity accounted investments	6		(37)			(36)
Operating profit	1			1,480			1,742
Financial income			416			713
Financial expense			(762)			(1,304)
Net finance costs	5			(346)			(591)
Profit before taxation				1,134			1,151
Taxation expense	6			(250)			(213)
Profit for the year				884			938
Attributable to:
Equity shareholders				854			913
Non-controlling interests				30			25
				884			938
Earnings per share	7
Basic earnings per share				26.8p			28.8p
Diluted earnings per share				26.7p			28.7p

Consolidated statement of comprehensive income

for the year ended 31 December

			2017				2016
	Notes		Other reserves1 £m	Retained earnings £m	Total £m		Other reserves1 £m	Retained earnings £m	Total £m
Profit for the year			-	884	884		-	938	938
Other comprehensive income
Items that will not be reclassified to the income statement:
Subsidiaries:
Remeasurements on retirement benefit schemes			-	2,105	2,105		-	(1,468)	(1,468)
Tax on items that will not be reclassified to the income statement	6		-	(490)	(490)		-	260	260
Equity accounted investments (net of tax)			-	53	53		-	(53)	(53)
Items that may be reclassified to the income statement:
Subsidiaries:
Currency translation on foreign currency net investments			(625)	-	(625)		1,287	-	1,287
Amounts credited to hedging reserve			59	-	59		96	-	96
Tax on items that may be reclassified to the income statement	6		(11)	-	(11)		(17)	-	(17)
Equity accounted investments (net of tax)			(15)	-	(15)		45	-	45
Total other comprehensive income for the year (net of tax)			(592)	1,668	1,076		1,411	(1,261)	150
Total comprehensive income for the year			(592)	2,552	1,960		1,411	(323)	1,088
Attributable to:
Equity shareholders			(587)	2,522	1,935		1,408	(348)	1,060
Non-controlling interests			(5)	30	25		3	25	28
			(592)	2,552	1,960		1,411	(323)	1,088

1.  An analysis of other reserves is provided in note 23.

Consolidated statement of changes in equity

for the year ended 31 December

	Attributable to equity holders of BAE Systems plc
	Issued share capital £m	Share premium £m	Other reserves1 £m	Retained earnings £m	Total £m	Non-controlling interests £m	Total equity £m
At 1 January 2017	87	1,249	6,685	(4,583)	3,438	26	3,464
Profit for the year	-	-	-	854	854	30	884
Total other comprehensive income for the year	-	-	(587)	1,668	1,081	(5)	1,076
Share-based payments (inclusive of tax)	-	-	-	53	53	-	53
Net purchase of own shares	-	-	-	(1)	(1)	-	(1)
Ordinary share dividends	-	-	-	(684)	(684)	(8)	(692)
At 31 December 2017	87	1,249	6,098	(2,693)	4,741	43	4,784
At 1 January 2016	87	1,249	5,277	(3,624)	2,989	13	3,002
Profit for the year	-	-	-	913	913	25	938
Total other comprehensive income for the year	-	-	1,408	(1,261)	147	3	150
Share-based payments (inclusive of tax)	-	-	-	59	59	-	59
Net sale of own shares	-	-	-	3	3	-	3
Ordinary share dividends	-	-	-	(670)	(670)	(24)	(694)
Partial disposal of shareholding in subsidiary undertaking	-	-	-	(3)	(3)	9	6
At 31 December 2016	87	1,249	6,685	(4,583)	3,438	26	3,464

1.  An analysis of other reserves is provided in note 23.

Consolidated balance sheet

as at 31 December

	Notes		2017 £m	2016 £m
Non-current assets
Intangible assets	8		10,378	11,264
Property, plant and equipment	9		2,230	2,098
Investment property	10		101	110
Equity accounted investments	11		384	299
Other investments			6	6
Other receivables	12		387	351
Retirement benefit surpluses	21		302	223
Other financial assets	13		226	345
Deferred tax assets	14		724	1,251
			14,738	15,947
Current assets
Inventories	15		723	744
Trade and other receivables including amounts due from customers for contract work	12		3,586	3,305
Current tax	16		20	5
Other financial assets	13		89	204
Cash and cash equivalents	17		3,271	2,769
Assets held for sale			26	2
			7,715	7,029
Total assets	18		22,453	22,976
Non-current liabilities
Loans	19		(4,069)	(4,425)
Other payables	20		(1,722)	(1,027)
Retirement benefit obligations	21		(4,222)	(6,277)
Other financial liabilities	13		(133)	(102)
Deferred tax liabilities	14		(4)	(10)
Provisions	22		(413)	(372)
			(10,563)	(12,213)
Current liabilities
Loans and overdrafts	19		(14)	-
Trade and other payables	20		(6,322)	(6,540)
Other financial liabilities	13		(104)	(212)
Current tax	16		(305)	(311)
Provisions	22		(345)	(234)
Liabilities held for sale			(16)	(2)
			(7,106)	(7,299)
Total liabilities			(17,669)	(19,512)
Net assets			4,784	3,464
Capital and reserves
Issued share capital	23		87	87
Share premium			1,249	1,249
Other reserves	23		6,098	6,685
Retained earnings - deficit			(2,693)	(4,583)
Total equity attributable to equity holders of BAE Systems plc			4,741	3,438
Non-controlling interests			43	26
Total equity			4,784	3,464

Approved by the Board on 21 February 2018 and signed on its behalf by:

C N Woodburn      P J Lynas
Chief Executive       Group Finance Director

Consolidated cash flow statement

for the year ended 31 December

	Notes		2017 £m	20161 £m
Profit for the year			884	938
Taxation expense	6		250	213
Research and development expenditure credits	4		(20)	(22)
Share of results of equity accounted investments	1		(116)	(90)
Net finance costs	5		346	591
Depreciation, amortisation and impairment	2		728	345
Profit on disposal of property, plant and equipment	2,4		(1)	(5)
Profit on disposal of investment property	2,4		(9)	(12)
Loss on disposal of businesses	2		13	-
Cost of equity-settled employee share schemes			61	55
Movements in provisions			150	(122)
Decrease in liabilities for retirement benefit obligations			(138)	(214)
(Increase)/decrease in working capital:
Inventories			(29)	95
Trade and other receivables			(449)	(93)
Trade and other payables			454	(263)
Taxation paid			(227)	(187)
Net cash flow from operating activities			1,897	1,229
Dividends received from equity accounted investments	11		72	38
Interest received1			23	10
Purchase of property, plant and equipment, and investment property			(389)	(408)
Purchase of intangible assets			(87)	(82)
Proceeds from sale of property, plant and equipment, and investment property			34	45
Proceeds from sale of intangible assets			1	-
Purchase of subsidiary undertakings			(3)	-
Equity accounted investment funding	11		(3)	(5)
Cash flow from sale of subsidiary undertakings			(6)	6
Cash and cash equivalents disposed of with subsidiary undertakings			(2)	-
Net cash flow from investing activities			(360)	(396)
Interest paid1			(204)	(210)
Net (purchase)/sale of own shares			(1)	3
Equity dividends paid	23		(684)	(670)
Dividends paid to non-controlling interests			(8)	(24)
Cash flow from matured derivative financial instruments			(83)	480
Cash flow from movement in cash collateral			(15)	32
Cash flow from repayment of loans			-	(286)
Net cash flow from financing activities	25		(995)	(675)
Net increase in cash and cash equivalents			542	158
Cash and cash equivalents at 1 January			2,771	2,537
Effect of foreign exchange rate changes on cash and cash equivalents			(49)	76
Cash and cash equivalents at 31 December			3,264	2,771
Comprising:
Cash and cash equivalents	17		3,271	2,769
Overdrafts	19		(7)	-
Cash classified as held for sale			-	2
Cash and cash equivalents at 31 December			3,264	2,771

1.  Re-presented to reclassify interest paid from investing to financing activities.

Notes to the Group accounts

30. Related party transactions

The Group has a related party relationship with its directors and key management personnel (see below), equity accounted investments (note 11) and pension schemes (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 party1			Management recharges1
Related party	2017 £m	2016 £m		2017 £m	2016 £m		2017 £m	2016 £m		2017 £m	2016 £m		2017 £m	2016 £m
Advanced Electronics Company Limited	86	27		158	95		24	-		5	-		-	-
CTA International SAS	8	6		-	-		3	4		-	-		-	-
Eurofighter Jagdflugzeug GmbH	1,004	997		-	3		47	41		49	126		-	-
FADEC International LLC	95	79		-	-		-	-		-	-		-	-
FAST Training Services Limited	2	-		-	-		-	-		-	-		-	-
Gripen International KB	-	-		-	-		-	18		-	16		-	-
MBDA SAS2	28	24		199	199		9	2		873	608		16	16
Panavia Aircraft GmbH	48	64		51	79		3	4		-	-		-	-
	1,271	1,197		408	376		86	69		927	750		16	16

1.  Also relates to disclosures under IAS 24, Related Party Disclosures, for the parent company, BAE Systems plc. At 31 December 2017, £884m (2016 £631m) was owed by BAE Systems plc and £43m (2016 £119m) by other Group subsidiaries.

2.  Amounts owed to related party in 2016 excludes £285m included within amounts due to long-term contract customers.

The Group considers key management personnel as defined under IAS 24, Related Party Disclosures, to be the members of the Group's Executive Committee and the Company's non-executive directors. Fuller disclosures on directors' remuneration are set out in the Annual remuneration report on pages 96 to 115. Total emoluments for directors and key management personnel charged to the Consolidated income statement were:

	2017 £'000	2016 £'000
Short-term employee benefits	16,878	19,389
Post-employment benefits	1,661	1,931
Share-based payments	5,123	5,744
	23,662	27,064

Note and page references used above refer to the Annual Report 2017 that can be viewed on the Company's website.

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. 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 of the 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.

 

END

 

 

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