BAE Systems Annual Report 2018

FY2018 Annual Report · BAE Systems

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Annual Report
2018

Who we are

At BAE Systems, our advanced
defence technology protects people
and national security, and keeps critical
information and infrastructure secure.

We search for new ways to provide
our customers with a competitive
edge across the air, maritime,
land and cyber domains. Segmental

review

We employ a skilled workforce
of 85,800 people1 in more than
40 countries, and work closely with
local partners to support economic
development by transferring knowledge,
skills and technology. How our

business works

Further information can be
found online by visiting
baesystems.com

220
Shareholder information

1. Including share of equity accounted investments.

Contents

Strategic report
Who we are

Our business at a glance

Our key products and services

Group financial highlights

Operational and strategic highlights

Chairman’s letter

Chief Executive’s review

Group strategic framework

Our markets

How our business works

Our people

Our technology

Our values and responsible behaviour

Our partners and key relationships

Responsible sourcing and impact

Group financial review

Guidance for 2019

Segmental review

Electronic Systems

Cyber & Intelligence

Platforms & Services (US)

Air

Maritime

Segmental looking forward

How we manage risk

Our principal risks

Governance
Directors’ report

Chairman’s governance letter

Directors’ duties

Board governance

Board of directors

Board information

Governance disclosures

Audit Committee report

Corporate Responsibility Committee report 87

Nominations Committee report

Remuneration Committee report

Annual remuneration report at a glance

Annual remuneration report

Preface to the Directors’
remuneration policy

Directors’ remuneration policy

Statutory and other information

Independent Auditor’s report

116

117

130

135

Financial statements
Group accounts

Preparation

Consolidated income statement

Consolidated statement
of comprehensive income

Consolidated statement
of changes in equity

Consolidated balance sheet

Consolidated cash flow statement

Notes to the Group accounts

142

144

145

146

147

148

Company accounts

Company statement of comprehensive
income

212

Company statement of changes in equity 212

Company balance sheet

Notes to the Company accounts

213

214

Operational and
strategic highlights

Segmental
review

Board
governance

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.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our business
at a glance

BAE Systems has strong, established
positions in the air, maritime, land
and cyber security domains.

Air

– Manufacture, development,

upgrade and in-service support
of Typhoon combat aircraft
– Workshare partner for the

design and manufacture of major
sub-assemblies and systems, and
provision of support for F-35
Lightning II combat aircraft

– Design, manufacture and

support of electronics equipment
for military aircraft

– In-service support of Tornado

combat aircraft

– Manufacture, upgrade and
in-service support of Hawk
trainer aircraft

– Development of next-generation

unmanned air systems and
defence information systems

– Design, manufacture and

support of avionics equipment
for commercial aircraft
– Design and manufacture
of missiles and missile
systems through a 37.5%
interest in MBDA

52%
Sales1 by
domain

A Typhoon
B F-35 Lightning II
C Defence electronics
D Tornado
E Commercial avionics
F Weapon systems
G Hawk
H Other

26%
Sales1 by
domain

A Submarines

B Complex warships

C US naval ship repair

D UK naval support

E Other

Maritime

– Design and manufacture

of submarines

– Design and manufacture
of complex warships

– Provision of naval ship repair
and modernisation services
in the US

– Provision of in-service support
to surface ships and facilities
management in the UK
– Design and manufacture of

naval gun systems, torpedoes,
radars, and naval command
and combat systems

21%
12%
25%
13%
9%
8%
5%
7%

Employees by location

85,800
Employees2

30,500
US

10,800
Other

29%

17%

18%

10%

26%

Our
people

34,100
UK

6,300
Saudi Arabia

4,100
Australia

1. Revenue plus the Group’s share of revenue of equity accounted investments.
2. Including share of equity accounted investments.
3. Includes £0.7bn (4%) of sales generated under the Typhoon workshare agreement with Eurofighter Jagdflugzeug GmbH.

BAE SystemsAnnual Report 20182018 sales1

2018 revenue

£18,407m

£16,821m

Our key products
and services

Group financial
review

17%
Sales1 by
domain

A Combat vehicles

B Munitions

C Commercial

D Weapon systems/other

38%

20%

33%

Cyber

– Supply of cyber, intelligence
and security capabilities to
US government agencies
– Supply of cyber, intelligence

and security capabilities to UK
and other government agencies

– Supply of defence-grade
cyber solutions for the
commercial market

5%
Sales1 by
domain

A US government

B UK and other
governments

C Commercial

42%

35%

23%

Land

– Design, manufacture, upgrade
and support of tracked and
amphibious combat vehicles
– Manufacture of ammunition
and precision munitions for
US, UK and other armed forces

– Design and manufacture

of electric and hybrid electric
drive systems

– Design and manufacture of
artillery systems and missile
launchers for US, UK and
other armed forces

Sales1 by destination
BAE Systems has leading positions in
its principal markets – the US, UK, the
Kingdom of Saudi Arabia and Australia
– as well as established positions in a
number of other international markets.

Sales1 by activity
BAE Systems has a diverse portfolio,
broadly balanced between an
enduring services and support business,
long-term platform and product
programmes, electronic systems, and
activities in cyber and intelligence.

Sales1 by reporting segment
BAE Systems reports its performance
through five principal reporting
segments.

Our
markets

Segmental
review

A US

B UK

C Saudi Arabia

D Australia
E Other international markets3

42%

21%

14%

A Platforms

B Military and technical services and support

C Electronic systems

30%

43%

22%

A Electronic Systems

B Cyber & Intelligence

C Platforms & Services (US)

D Cyber

20%

D Air

E Maritime

22%

16%

37%

16%

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our key products
and services

BAE Systems has strong, established positions
supplying defence equipment, electronics
and services, as well as cyber, intelligence and
security solutions for governments.

Typhoon and Hawk
manufacture and
capability development

Manufacture of major Typhoon assemblies
for European partner nations and other
export customers. Aircraft assembly for the
Royal Air Force and Royal Saudi Air Force.
Supply of Typhoon and Hawk aircraft with
support and training package to Qatar.
Expansion of the capabilities of the aircraft.

F-35 Lightning II design
and manufacture

Unmanned and future
air system capabilities

Design and manufacture of sub-assemblies
in the UK, including the aft fuselage and
empennage. Provision of equipment in the
US, including the electronic warfare suite.
BAE Systems has a significant workshare on the
world’s largest defence programme.

Development of future air system capabilities,
including joint investment with the UK
government and industry in next-generation
combat air systems. The Tempest programme
has been launched in support of the UK
Combat Air Strategy, announced in July.

Complex warships

Defence electronics

Design and manufacture of two 65,000-tonne
aircraft carriers, five Offshore Patrol Vessels, and
Type 26 frigates for the Royal Navy. The first
Type 26 is expected to enter service in the
mid-2020s. Contract signed with the Australian
government that provides the framework for
the design and manufacture of Hunter Class
frigates.

Design, manufacture and support of avionics
equipment across a range of US and other allied
nations’ military aircraft programmes, including
a leadership position in the electronic warfare
market.

Commercial avionics
equipment

Design, manufacture and support of avionics
equipment across multiple commercial aircraft
platforms, including engine and flight controls,
and cabin and cockpit systems, together with
aftermarket support services. BAE Systems is a
leading supplier of engine controls for GE, and
is a major supplier of flight control electronics
for Boeing and other aircraft platforms.

BAE SystemsAnnual Report 2018We also have a growing position in
adjacent commercial markets, including
avionics and cyber security.

Submarines

Combat vehicles

Air support and training

Design and manufacture of seven Astute
Class nuclear-powered attack submarines
for the Royal Navy. The first three Astute
Class submarines are in operational service with
the Royal Navy, with the remaining four boats
in build. The final boat is expected to enter
service in the middle of the next decade.
Design and manufacture of four Dreadnought
Class nuclear-powered submarines to carry the
UK’s Trident ballistic missiles. Manufacture of
the first Dreadnought Class boat, Dreadnought,
commenced in 2016.

Upgrade of tracked vehicles, including Bradley
Fighting Vehicles; design and manufacture of
the M109 self-propelled howitzer and
Armored Multi-Purpose Vehicle; and
development of light combat vehicles under
the Mobile Protected Firepower programme
for the US Army. Manufacture of amphibious
vehicles for the US Marine Corps and
international customers. Design, manufacture
and support of the CV90 and BvS10 combat
vehicles for international customers. Vehicle
upgrade and support to the British Army.

Provision of support to operational capability,
including maintenance, support and training
for Typhoon aircraft in service with the UK,
Saudi Arabian and Omani air forces. Under the
Saudi British Defence Co-operation Programme,
delivery of contracts for manpower, logistics
and training, training aircraft (including Hawk)
and upgrades to Tornado aircraft in Saudi
Arabia. Provision of support for Hawk aircraft
in service in 14 countries and a range of
sustainment services for the F-35 Lightning II
aircraft in the Europe and Pacific regions.

Weapon systems
and munitions

Naval ship repair
and support

Design and manufacture of naval gun
systems, munitions, torpedoes, radars,
naval command and combat systems,
artillery systems, missile launchers and,
through a 37.5% interest in MBDA, missiles
and missile systems. BAE Systems also
manages and operates complex ammunition
plant operations for the US Army to produce
insensitive munitions and propellant grains.

Provision of naval ship repair and modernisation
services in the US and UK, together with
support to the navies of the US, UK and
Australia. In the US, BAE Systems has facilities
located on the Atlantic and Pacific coasts,
as well as in Hawaii, to include expanded
dry dock facilities in the San Diego shipyard
to support the US Navy’s increased focus
on Asia-Pacific operations.

Cyber security

Delivery of a broad range of services to
enable the US military and government
to recognise, manage and defeat threats.
Support to UK and other government agencies
in their intelligence missions. Provision of
defence-grade solutions for commercial cyber
applications.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Group financial
highlights

We monitor the underlying financial
performance of the Group using alternative
performance measures. 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.

– Sales3 decreased by £0.1bn but grew 1%

excluding the impact of currency translation.
– Underlying EBITA decreased by £46m, a 1%

decline on a constant currency basis3,4.
– Underlying earnings per share3 increased

by 2% to 42.9p.

– Operating business cash flow decreased

by £759m to £993m.

Financial performance measures as defined by the Group

– Net debt increased by £152m compared

with 31 December 2017.
– Order intake5 of £28.3bn.
– Order backlog3,5 of £48.4bn was up 25%.

Sales3

£18,407m

(2017 £18,487m)

KPI

Net debt

BONUS KPI

Definition Revenue plus the
Group’s share of revenue of
equity accounted investments.

Purpose Allows management to
monitor the sales performance
of subsidiaries and equity
accounted investments.

£(904)m

(2017 £(752)m)

Definition Cash and cash
equivalents, less loans and
overdrafts (including debt-related
derivative financial instruments).

Purpose Allows management
to monitor the indebtedness of
the Group.

Underlying EBITA3

£1,928m

(2017 £1,974m)

KPI

Order intake5

BONUS KPI

Definition Operating profit
excluding amortisation and
impairment of intangible assets,
finance costs and taxation expense
of equity accounted investments
(EBITA), and non-recurring items6.
Purpose Provides a measure of
operating profitability that is
comparable over time.

£28,280m

(2017 £20,257m)

Definition Funded orders
received from customers including
the Group’s share of order intake
of equity accounted investments.

Purpose Allows management
to monitor the order intake of
subsidiaries and equity accounted
investments.

Underlying earnings per share3

BONUS KPI

Order backlog3,5

42.9p

(2017 42.1p)

Definition Basic earnings per
share excluding amortisation and
impairment of intangible assets,
non-cash finance movements on
pensions and financial derivatives,
and non-recurring items6.
Purpose Provides a measure
of underlying performance that
is comparable over time.

£48.4bn

(2017 £38.7bn)

Operating business cash flow

KPI

£993m

(2017 £1,752m)

Definition Net cash flow from
operating activities excluding taxation
and including net capital expenditure,
financial investment and dividends
from equity accounted investments.

Purpose Allows management to
monitor the operational cash
generation of the Group.

Definition Funded and unfunded
unexecuted customer orders
including the Group’s share of
order backlog of equity accounted
investments. Unfunded orders
include the elements of US
multi-year contracts for which
funding has not been authorised
by the customer.

Purpose Supports future years’
sales performance of subsidiaries
and equity accounted investments.

KPI

References to Key Performance Indicators
(KPIs) throughout the Annual Report.

BONUS

80% of the UK executive directors’
bonuses are based on the achievement
of financial KPIs (see page 107).

BAE SystemsAnnual Report 2018
Reconciliations from the financial performance
measures as defined by the Group to the
financial performance measures defined
in IFRS1 are provided in the Group financial
review on pages 35 to 41.

– Revenue3 decreased by £0.4bn, a 1% decline

on a constant currency basis.

– Operating profit3 increased to £1,605m.

The prior year included a £384m non-cash
goodwill impairment in Applied Intelligence.

– Basic earnings per share3 increased by 20% to 31.3p.
– Net cash flow from operating activities reduced

by £697m to £1,200m.

– Group’s share of the pre-tax accounting net

pension deficit3 reduced by £0.1bn to £3.9bn
compared to 31 December 2017.

– Final dividend of 13.2p making a total of
22.2p per share for the year, an increase
of 2% over 2017.

Financial performance measures defined in IFRS1

Other financial highlights

Revenue3

Group’s share of the net pension deficit3

£16,821m

(2017 £17,224m)

Definition Income derived from
the provision of goods and services
by the Company and its subsidiary
undertakings.

£(3.9)bn

(2017 £(4.0)bn)

Definition Net International
Accounting Standard 19 Employee
Benefits, deficit excluding amounts
allocated to equity accounted
investments.

Operating profit3

£1,605m

(2017 £1,419m)

Definition Profit for the year before
finance costs and taxation expense.
This measure includes finance costs
and taxation expense of equity
accounted investments.

Dividend per share

22.2p

(2017 21.8p)

Definition Interim dividend
paid and final dividend
proposed per share.

Basic earnings per share3

31.3p

(2017 26.0p)

Definition Basic earnings per share
in accordance with International
Accounting Standard 33 Earnings
per Share.

Net cash flow from operating activities

£1,200m

(2017 £1,897m)

Definition Net cash flow from
operating activities in accordance
with International Accounting
Standard 7 Statement of
Cash Flows.

1. International Financial Reporting Standards.
2. Generally Accepted Accounting Principles.
3. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15

Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined
benefit pension schemes. See note 37 to the Group accounts for details regarding
the restatement.

4. Current year compared with prior year translated at current year exchange rates.
5. Including share of equity accounted investments.
6. Items that are not relevant to an understanding of the Group’s underlying performance

(see page 35).

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Operational and
strategic highlights

In 2018, we made good progress
across the Group in achieving our
strategic objectives.

During the year, BAE Systems’ Type 26 frigate was selected for the
Commonwealth of Australia’s Hunter Class nine-ship Future Frigate
programme with the contract which provides the framework for the
design and build of the ships being signed in December. The Type 26
was also selected as the design for Canada’s Surface Combatant
programme, reinforcing its position as one of the world’s most
advanced anti-submarine warships.

The contract with the Government of the State of Qatar for
the supply of 24 Typhoon aircraft and nine Hawk Advanced
Jet Trainer aircraft, along with a bespoke support and training
package, became effective in September upon receipt of the
first contractual payment. Deliveries of the first Hawk aircraft
are expected to commence in 2022 and the first Typhoon
aircraft in 2023.

We were awarded a $376m (£295m) contract
by the US Army for the development phase
of the Mobile Protected Firepower programme,
to deliver a rapidly deployable and highly agile
armour-protected light combat vehicle.

The US-based Intelligence and Security business secured
seven new task orders valued at approximately $320m
(£251m) to provide motion-imagery analysis, training and
research support services to the US intelligence community.

The first four UK F-35 Lightning II aircraft arrived at
RAF Marham in June and initial operational services
were stood up. Additionally, the integration of the
F-35 onto the new HMS Queen Elizabeth aircraft
carrier commenced, and the first F-35 deck landing
was successfully completed in September.

BAE SystemsAnnual Report 201813

Chief Executive’s
review

Group strategic
framework

Segmental
review

In June, BAE Systems and industry teammate Iveco
Defence Vehicles were competitively selected for
the US Marine Corps’ Amphibious Combat Vehicle 1.1
programme phase. We have commenced work
on the production contract for an initial 30 vehicles
worth $198m (£155m), with options for a total
of 204 vehicles worth up to $1.2bn (£0.9bn).

During the year agreement was reached
with the Saudi Arabian government to continue
to provide support services for Typhoon aircraft
in service with the Royal Saudi Air Force.

The UK Combat Air Strategy announced in July is a significant milestone
for our Air sector and sends a strong signal of intent about the UK’s
commitment to retaining a leading position in Combat Air. The strategy
will enable long-term planning in a key strategic part of the business as
UK government and industry jointly invest in cutting-edge, next-generation
combat air systems. The Tempest programme has been launched in
support of the strategy.

During the year we secured the full £1.6bn contract
for delivery of the seventh Astute Class submarine,
and a further £1.3bn of funding on the Dreadnought
programme from the UK Ministry of Defence.

Our Advanced Precision Kill Weapon System (APKWS®)
is experiencing growing demand in both the US and
internationally, with awards totalling nearly $400m (£314m)
in the year, and we continue to ramp-up production capacity
towards an annual production level of 25,000 units.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Chairman’s letter

Sir Roger Carr
Chairman

“2018 was another successful
year for the Company
under the leadership of
Charles Woodburn in his first
full year as Chief Executive,
strengthening the outlook
with significant contract wins.”

Our record order book
We added to the strong order book we
had built in the previous 12 months to create
a record defence order book. Our successes
included the completion of financing for
the Typhoon and Hawk aircraft for Qatar,
continued strong demand for our electronic
systems products and the award of a
contract for the Hunter Class nine-frigate
programme by the Australian government
to be built in Adelaide based on the design
of the Type 26. This contract, won in the
face of fierce competition, demonstrated
the cutting-edge anti-submarine warfare
capabilities of the Type 26 frigate already
ordered by the Royal Navy and the value
of the deep partnership we have built in
Australia over the last half century.

I visited Australia in November to thank the
Australian government for placing this order
with the Company and toured the shipyard
in which the Hunter Class frigates will be built.
The existing site was impressive and the new
shipyard under construction will prove to be
a world-class facility when it is completed in
the early 2020s.

The competitive strength of the Type 26
was further underpinned when the
Canadian government selected the design
in February 2019.

From the challenge of building a strong
order book, I was pleased that management
focus in the second half of the year moved
to the task of manufacturing and delivering
additional volumes of products and services.

Our US Combat Vehicles business further
increased both the deep order book and
production volumes on a number of
programmes. Whilst the sudden increase
in pace and incline of the production ramp
caused teething problems in the early
months, management continues to make
steady progress toward establishing
production stability in support of
expanding requirements.

Increased production volume associated
with the F-35 Lightning II aircraft was
successfully managed by the Samlesbury
team who also celebrated the arrival of the
first nine aircraft to the UK squadron and
the successful completion of initial F-35
flight trials on the deck of the Queen Elizabeth
carrier off the East Coast of the US.

The drumbeat of our submarine production
in Barrow continued to increase with the build
of the first Dreadnought Class submarine
alongside the existing Astute boats.

Recognising the increasing demands on
the business, our focus was to ensure the
executive team has the skillset, experience
and career time horizon to drive change and
manage performance as the deep order
backlog is converted into finished product
and customer service. Our processes and
procedures remain vital to the discipline and
control of the business, but people make
the difference.

BAE SystemsAnnual Report 2018Our people and culture
During the course of the year, succession
planning and talent management became top
priorities for the Executive Committee and the
Board. In that context, Charles made a series
of changes in his leadership team by
promotions from within, supplemented by a
number of external recruitments, to ensure
fresh thinking is balanced with seasoned
industry experience.

These changes are now evident in the
leadership of Human Resources, Australia,
Maritime sector management, submarine
production and the consolidation of our
UK Air business with our operations in
the Kingdom of Saudi Arabia.

I am pleased to say the benefits of these
changes are being seen in improved
performance, greater co-ordination,
increased sharing of knowledge and
stronger focus on technology in line with
Charles’s business priorities.

I continue to believe that in keeping with our
culture and tradition of building home-grown
capability, we develop the skills we need in
the business by an unwavering commitment
to apprenticeships, graduate training and
life-long learning.

During 2019, we plan to recruit nearly 700
apprentices and 300 graduates across our
UK business, a 30% increase on the previous
year and a demonstration of the work we do
to nurture talent and develop high-end skills
for the future. It is vital we train the next
generation of engineers and business leaders
to develop the necessary skills needed to drive
innovation and solve complex challenges.

Looking forward, our emphasis will remain on
ensuring we have a talent pipeline that reflects
ambition, enthusiasm, ability and diversity and
is committed to the values of the organisation
as to how we make money rather than simply
how much money we make.

We continue to believe that being performance
driven, but values led, should be at the core of
our culture.

Our strategy
Our strategy is regularly reviewed, but has
remained constant. We are a business that
is focused on the provision of technology
products and services through government-
approved contracts as a world leader in the
defence industry.

As with many UK companies, we have been
carefully considering and planning for any
potential impact that Brexit could have on

the Company, and the Board has been kept
informed of this analysis. Whilst we have
recognised some potential Brexit impact in
our Principal Risks analysis (see page 69), we
are fortunate that, given the geographic spread
of our operations, the near-term impacts
across the business are likely to be limited.

The Middle East remains unstable. In the
Gulf region we work primarily with Oman,
Qatar, Kuwait and the Kingdom of Saudi
Arabia, respecting the importance of the
defence and security relationships, and the
strength and depth of our economic ties.

To that end, agreement was reached
at the end of the year with the Kingdom
for us to extend the provision of Typhoon
support services.

It should be recognised, however, that the
Company is reliant on the approval of export
licences by a number of governments in order
to continue supplies to Saudi Arabia. In this
context, the current position on export
licensing adopted by the German government
may affect our ability to provide the required
capability to the Kingdom. We are therefore
working closely with the UK government
to minimise the risk of any such occurrence
and the impact it would have on financial
performance, the supply chain and relationships.

Dividend (pence)

22.2p
+2%

2018

2017

2016

2015

2014

22.2
21.8
21.3
20.9
20.5

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Chairman’s letter
continued

Recognising the fluctuation in demand
patterns, we seek to diversify our markets
over a wide geographic area with particular
emphasis on the US, the UK, the Kingdom
of Saudi Arabia and Australia.

In 2018, the major programme award we
received from the Australian government
for the advanced anti-submarine warships
will serve, over time, to add further attractive
balance to our geographic mix.

We continue to operate in all domains of
air, maritime, land and cyber. The weighting
of maritime activities within our long-term
business mix has increased with the
considerable orders for Dreadnought Class
submarines and Type 26 frigates we have
received over the last two years.

Our continued commitment to the air domain
is underpinned by recent orders for Typhoon
and Hawk and our decision to work in close
partnership with the UK government on the
Tempest programme to develop the next
generation of military fighter jet.

Our US Combat Vehicles business
continues to grow following the award
of the Amphibious Combat Vehicle and
Mobile Protected Firepower programmes.
In the UK the proposed joint venture with
Rheinmetall is expected to secure the
production and upgrade of vehicles for
the British Army for years to come.

In Cyber we have focused investment at the
top end of the market, where sophisticated
systems for military grade intelligence provide
barriers to entry for competitors.

In order to smooth the inevitable fluctuations
in demand for our products, our business
model has a strong service content, which
offers a reliable revenue stream and
strengthens the partnership with our
major customers.

Summary
In summary, we are pleased to have
delivered another year of strong performance
with sales of £18.4bn and underlying earnings
per share of 42.9p, underpinned by an order
backlog of £48.4bn.

Whilst the fundamentals of the business are
sound, the order backlog substantial and the
management team strong, the geopolitics in
which we operate have become increasingly
challenging and unstable.

As we look forward to 2019 and beyond
our focus will be on reinforcing our customer
relationships, providing exceptional products
and services, preserving our culture, investing
in technology and developing our people.
By remaining steadfast in our approach,
we will seek to continue to deliver for all
our stakeholders.

The Board therefore has recommended
a final dividend of 13.2p for a total of
22.2p for the full year. Subject to shareholder
approval at the May 2019 Annual General
Meeting, the dividend will be paid on 3 June
2019 to holders of ordinary shares registered
on 23 April 2019.

Sir Roger Carr Chairman

There are few businesses with such strong
order books and with programme visibility
extending for several decades, few defence
companies that enjoy such a wide geographic
spread and even fewer technology and
engineering businesses that have the depth
of expertise that is embedded in BAE Systems.

It is against this background that I believe
our strategy is sound and our emphasis on
operational excellence appropriate to ensure
the delivery of long-term shareholder value.

Our Board
The Board continues to benefit from a
high-quality team that is diverse in gender,
skill, experience, country of origin and time
served. With Revathi Advaithi joining us at
the beginning of 2018, currently 28% have
been Board members for up to three years,
36% for between three and six years, and
36% for over six years, with an average
tenure of five and a half years.

Board chemistry is excellent with candour,
mutual respect and collective commitment
providing a healthy dynamic for debate,
challenge and decision making.

Board succession planning is key to preserving
this position, and to that end we have been
fortunate to appoint two new non-executive
directors recently, Nicole Piasecki and Stephen
Pearce, both of whom will join the Board on
1 June 2019. Nicole is a former senior executive
with Boeing who has a strong track record in
strategic planning and international operations
and relations. Stephen is Finance Director of
Anglo American plc at present, and as such
has the skills and experience necessary to
succeed Nick Rose as Chairman of our Audit
Committee from the beginning of next year.
I am pleased that Nick has agreed to stay
on until then, which will allow us to continue
to draw on his experience and his oversight
of the new auditor, during what is a period
of change and geopolitical turbulence.
This will also allow Stephen to develop his
knowledge of BAE Systems before taking
on the chairmanship of an important
Board committee.

BAE SystemsAnnual Report 2018Chief Executive’s review

“The Group made good
progress in strengthening
the outlook and geographic
base of the business, with
a number of significant
contract wins, leading
to a record high defence
order backlog.”

Charles Woodburn
Chief Executive

Introduction
2018 was both a year of geopolitical
turbulence and a transition year in terms
of earnings for the Group. Production
on a number of programmes began
ramping-up especially in our Electronic
Systems, US Combat Vehicles and
Submarines businesses whilst Typhoon
and Hawk production stepped down, and
the Aircraft Carrier build programme moved
towards completion. The order backlog
grew by 25% to a record high. Key business
wins were secured globally: for example
on the Amphibious Combat Vehicle for
the US Marine Corps; in Australia for the
design and build of nine ships for the Future
Frigate programme; in Qatar for the provision
of 24 Typhoon and nine Hawk aircraft;
and in Canada where the Type 26 design
was selected for the Canadian Surface
Combatant programme. These wins further
strengthened the outlook and the geographic
base of the Group.

Governments in our key markets continue
to prioritise defence and security, and there
is a growing demand for our capabilities,
products and services. BAE Systems is a
diverse and resilient company, pursuing the
right strategy for long-term performance.
We have a strong order backlog giving
multi-year visibility, a broad portfolio with
long-term positions on key programmes
with strong customer relationships, and
a track record of successful partnerships
in international markets to develop local
industry, employment and skills.

Within the core strategy, execution on the key
strategic objectives of operational excellence,
competitiveness and technological innovation
is vital for the successful delivery of the order
backlog to deliver future growth and in
evolving our business to become a stronger,
smarter and sharper organisation.

Operational excellence
Raising the bar operationally to improve
delivery of the record defence order book
remains the priority for the Group, in order
to drive growth, strengthen customer
relationships and win new and repeat work
in the future. Whilst areas of the business
are performing strongly and the restructuring
actions taken to return the Applied Intelligence
business to profitability are gaining traction,
there were some disappointments on certain
long-standing programmes in our Maritime
and Platforms & Services (US) businesses.
Steps have been taken to address these
operational issues. In Maritime, Andrew
Wolstenholme was appointed to lead that
business with a clear focus on programme
schedule and cost performance. In Platforms
& Services (US), the new leadership team
is maintaining a keen focus on programme
execution as investments are made in
operational processes and automation
to meet the ramp-to-rate challenges in
US Combat Vehicles and position the business
for successful programme delivery during
its upcoming growth phase.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Chief Executive’s review
continued

US Marine Corps image by LCpl Morris.

Growth in the US-based Combat Vehicles
business is underpinned by the ramp-up of
production on the Armored Multi-Purpose
Vehicle, M109A7 self-propelled howitzer
and Bradley upgrade programmes, and the
growth outlook was advanced in 2018 with
our competitive win on the Amphibious
Combat Vehicle 1.1 programme and our
selection as one of two companies to proceed
to the engineering and manufacturing
development phase for the Mobile
Protected Firepower programme.

Across our US shipyards, Platforms and
Services (US) continues to be a leading
supplier of ship repair and modernisation
services to the US Navy. The ship repair
and our naval gun franchises are well
supported by the growth outlook in
US Navy budget funding.

In our US-based Intelligence & Security
business, whilst market conditions remain
highly competitive, the business is maintaining
a high level of bid activity, and secured a
number of successful wins on recompeted
contracts and new business awards in
mission-critical areas. The business is delivering
on contracts with good programme and
financial performance in the period.

Competitiveness
The Group continues to take the necessary
steps to be competitive. Our customers
demand value for money and it is important
that we can demonstrate exactly that. The
new organisational structure announced
in 2017 became effective in 2018. Within
procurement, global and national category
managers are now in place and efficiencies
are being delivered through supply chain
rationalisation and enhanced data analytics.
Increasing collaboration across the Group,
industry partners and academia is becoming
more important in delivering competitive
offerings. The Group structure and functional
councils are in place to ensure this remains
a key focus area and we will be relentless in
our pursuit of competitiveness and efficiency.

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.
Coordinated through the Chief Technology
Officer, the Group is aiming to increase
self-funded research and development
spend over time, as well as working with
our customers in developing technologies
for use today and into the future. In 2018,
technology plans were established that
supported the sector strategies. The
increase in spend will be achieved through
a blend of self- and jointly-funded customer
programmes, and through a pipeline of
investment opportunities and targeted
bolt-on acquisitions.

2018 performance
US
On 28 September, the fiscal year 2019
Defense Appropriations bill was enacted.
This is the first time since 2008 that the
Department of Defense had funding in place
by the 1 October start of the fiscal year, and
provided near-term clarity for the industry
and demonstrated strong bi-partisan support
for defence funding under the two-year
agreement passed in early 2018.

The enacted Defense Appropriations bill
maintains support for our medium-term
planning assumptions and positive
momentum for military readiness and
modernisation programmes. Our US-based
portfolio remains well aligned with customer
priorities and growth areas with support
for many key BAE Systems programmes,
including combat vehicles, F-35 Lightning II,
electronic warfare programmes, and current
and future precision-weapons systems.

Our US electronics business delivered
a stand-out operational performance in
2018 especially in our core franchise positions
in the high-technology areas of electronic
warfare, precision-guided munitions,
intelligence, surveillance and reconnaissance,
and electro-optics. The business closed with
a record order backlog with the portfolio
well aligned with the US National Defense
Strategy. We continue to leverage these
defence electronics capabilities for
international programmes.

Platforms and Services (US) worked to
address a number of operational challenges
in the year, preparing for significant
production rate increases in the US Combat
Vehicles business. To help position the
business to deliver during its upcoming
growth phase, management changes have
been made and process and automation
improvements are being implemented.

BAE SystemsAnnual Report 2018Our strategy in action

BAE Systems
team wins
Amphibious
Combat Vehicle
competition

In June, the US Marine Corps
selected our vehicle for its
Amphibious Combat Vehicle
(ACV) 1.1 programme. The $198m
(£155m) contract for 30 ACVs has
options which, if exercised, could
result in a total of 204 vehicles
worth $1.2bn (£0.9bn).

Along with teammate Iveco Defence
Vehicles we will provide the Marine Corps
with its next generation of vehicles
designed to go from ship-to-shore
to engage in land combat operations.

The new ACV 1.1 is an advanced 8x8
open ocean-capable vehicle. It provides
exceptional mobility in all terrains,
and blast mitigation protection for all
three crew and 13 embarked Marines,
along with other improvements over
currently-fielded systems.

The selection of our vehicle further
solidifies our 70-year legacy of supplying
amphibious capabilities. As a leading
provider of combat vehicles, we have
produced more than 100,000 systems
for customers worldwide.

Group strategic
framework

More online
baesystems.com

UK
Defence and security remain a priority for
the UK government. This was reaffirmed in
the Modernising Defence Programme and
budget updates in the year. In July, the UK
government launched its Combat Air Strategy,
a significant milestone for our Air sector
which sends a strong signal of intent about
the UK’s commitment to retaining a leading
position in Combat Air. The strategy will
enable long-term planning in a key strategic
part of the business as UK government and
industry jointly invest in cutting-edge,
next-generation combat air systems.

During 2018 we remained focused on the
execution of our long-term contracted
positions in Air and Maritime.

In Air, the production ramp-up of rear
fuselage assemblies for the F-35 Lightning II
aircraft is progressing, and we are on track
to achieve full rate production in 2020.
The first nine UK F-35 Lightning II aircraft
arrived at RAF Marham during the year
and initial operational services were stood
up. As the UK and global fleets grow,
securing a long-term support position
on F-35 Lightning II remains a key focus
for the Air business.

Following delivery of the final four Typhoon
aircraft to the Royal Air Force of Oman,
Typhoon production is now focused on
the remaining partner nations’ deliveries,
sub-assembly build on the Kuwait programme
and the commencement of the Qatar
programme, which sustains production
into the next decade. Whilst a degree of
geopolitical turbulence exists, the potential
pipeline for Typhoon remains positive,
with opportunities both with partner
nations and through exports. Securing
any additional orders would further extend
production. Typhoon support continues
to be a high-performing line of business
for the Group and the Royal Air Force has

declared Typhoon meets the Centurion
standard, enabling the transition of capabilities
from Tornado to Typhoon as the UK Tornado
fleet comes out of service in 2019.

In Maritime, there remains pressure on the
Royal Navy’s near-term budgets. The Offshore
Patrol Vessels programme was impacted in the
year by quality issues which led to a provision
being taken. Lessons learned are being applied
to the other ships in build. The programme
is due to complete in 2020. The Type 26
programme is on track for the first of class
contractual date in the mid-2020s. Initial flight
trials on HMS Queen Elizabeth off the coast
of the US were completed successfully and
HMS Prince of Wales is due to commence
sea trials in the next year.

The strengthened management team in
Barrow is delivering improved performance on
both the Astute and Dreadnought submarine
programmes. The major site development
work at Barrow continues, and in November
the new Submarines Academy for Skills and
Knowledge was opened.

In January 2019, we entered into an agreement
with Rheinmetall to create a joint UK-based
military land vehicle design, manufacturing
and support business subject to regulatory
approvals. Joining forces with Rheinmetall
will bring the strength of both businesses
together to be more competitive in the UK
and international markets whilst maintaining
many jobs in the UK. Rheinmetall will purchase
a 55% stake in the existing BAE Systems
UK-based combat vehicles business for
£28.6m, with BAE Systems retaining 45%.

The final agreement of the terms of the
UK’s exit from the EU after March 2019
will be important to enable companies
to prepare for potential changes in the
regulatory environment. There is relatively
limited UK-EU trading and movement of
EU nationals into and out of BAE Systems’

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Chief Executive’s review
continued

Our strategy in action

The UK’s Combat
Air Strategy and
Team Tempest

The UK government launched
its Combat Air Strategy at the
2018 Farnborough International
Airshow. It outlined an ambitious
vision for the future and initiated
the programme which will deliver
the next generation of combat air
capability by 2035.

The strategy describes a new and
evolutionary approach to developing
future combat air systems. The world-
leading capabilities and technologies of
Typhoon will continue to be developed
and deployed and will ultimately
transition to a future system, with the
aim of providing a seamless integration
of the very latest technologies.

As part of Team Tempest, we are
working with the UK government
and our industry partners Rolls-Royce,
Leonardo and MBDA, to develop and
invest in technologies which will deliver
world-leading capabilities for the future,
ensuring that the UK can continue to
maintain its operational advantage and
freedom of action, while supporting
prosperity and international influence.

Group strategic
framework

More online
baesystems.com

UK businesses, and the resulting Brexit
near-term impacts across the business are
likely to be limited. BAE Systems will support
the UK government in achieving its aim of
ensuring that the UK maintains its key role
in European security and defence post-Brexit,
and to strengthen bilateral relationships with
key partners in Europe.

International
In an uncertain global environment with
complex threats, our defence and security
capabilities remain highly relevant. 2018 was
a strong year in widening our international
reach and there are good prospects in
existing and new international markets for
our products and services in air, maritime,
land and cyber.

The contract between BAE Systems and the
Government of the State of Qatar for the
supply of 24 Typhoon and nine Hawk aircraft
to the Qatar Emiri Air Force, along with a
bespoke support and training package,
became effective in September, and
production has commenced.

In Oman, following delivery of the final
Typhoons we are delivering on a five-year
availability service for their Typhoon and
a support package for Hawk aircraft.

In Australia, the Group submitted bids on
two significant production contracts. Whilst
unsuccessful in the bid for the Land 400
Phase 2 combat vehicle programme, in June,
the Commonwealth of Australia selected us
as the preferred tenderer for the Hunter
Class Frigate programme to deliver nine
Future Frigates for the Royal Australian Navy.

The contract providing the framework for the
design and build of the ships was signed in
December. The build scope is to be negotiated
in due course and production of the first ship
is expected to commence in South Australia
in the early 2020s. This Hunter Class
programme is expected, over time, to double
the size of the Australian business which is
currently underpinned by long-term support
and upgrade programmes.

Building on this success, in February 2019,
the Canadian government together with
Irving Shipbuilding selected Lockheed Martin
Canada, using BAE Systems’ Type 26 design,
as subcontractor for the Canadian Surface
Combatant programme.

In Saudi Arabia, BAE Systems continues
to address current and potential new
requirements as part of long-standing
agreements between the UK government
and the Kingdom. The Memorandum of
Intent signed between the Kingdom of Saudi
Arabia and the UK government in March
2018 continues to progress towards reaching
an Agreement for a further 48 Typhoon
aircraft, support and transfer of technology
and capability. This will enable BAE Systems
to continue with the Industrialisation of
Defence capabilities in the Kingdom of
Saudi Arabia, in support of the Saudi Arabian
government’s National Transformation Plan
and Vision 2030.

The final assembly of the Typhoon would
follow on from the Hawk programme where
the first In-Kingdom final-assembled Hawk
aircraft is expected to be delivered to the
Royal Saudi Air Force in 2019. Agreement
has been reached with the Saudi Arabian
government for BAE Systems to continue
to provide Typhoon support services to the
Royal Saudi Air Force.

BAE SystemsAnnual Report 2018It should be recognised that the Group is
reliant on the continued approval of export
licences by a number of governments in
order to continue supplies to the Kingdom
of Saudi Arabia. Significant changes in the
policies of such governments may affect our
own provision of capability to the country and
we are liaising closely with the UK government
in working to reduce the impact of any
such occurrence.

The MBDA joint venture has continued to win
orders in both domestic and export markets
with the order backlog once again increasing,
giving clear visibility of growth in the coming
years. The business also continues to invest
in new products and is well placed to
benefit from defence spend increases in
a number of European countries and from
export opportunities.

Cyber security
The UK-managed Applied Intelligence
business delivered a much-improved
performance following restructuring actions
taken in 2017 and achieved a break-even
position for the year. Focused recruitment
in the second half of the year positions
the business for a return to growth and
profitability as the market develops.
The commercial market remains highly
competitive; however, 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.

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.

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.

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 would deliver on
the Group’s strategy.

Pension schemes
The Group’s share of the pre-tax accounting
net pension deficit reduced to £3.9bn
(2017 £4.0bn).

Executive Committee changes
Reflecting the new organisational structure
from the start of 2018 there were a number of
changes to the Executive Committee. Members
appointed as a result of the new structure
were Chris Boardman as head of Air, Andrew
Wolstenholme as head of Maritime and Julian
Cracknell as head of Applied Intelligence.
Other new appointments were Karin Hoeing
as Group Human Resources Director and at
the start of 2019 David Armstrong as Group
Business Development Director following
Alan Garwood’s retirement.

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.

Summary
Our business benefits from a large order
backlog, with established positions on
long-term programmes in the US, UK,
Saudi Arabia and Australia along with a
growing presence in other international
markets. Our strategy is working, it is clear
and well defined. With governments in our
major markets continuing to prioritise defence
and security there is a strong demand for our
capabilities. Through improved programme
execution and maintaining the strategy and
capital allocation policy, BAE Systems is well
placed to maximise opportunities, manage
the challenges and continue to generate
good shareholder returns.

Charles Woodburn
Chief Executive

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Group strategic
framework

We have shared values:
Trusted, Innovative, Bold
– these give us the right
emphasis for our culture,
behaviours, relationships
and reputation.

Our strategy is comprised of five
key long-term areas of focus that
will help us achieve our vision and
mission. It is centred on maintaining
and growing core franchises and
securing growth opportunities.
Our three strategic priorities which
are embedded throughout the Group
provide the link between our longer-
term strategy and near-term business
objectives for all our employees.

Our vision
To be the premier international defence,
aerospace and security company

Our mission
To provide a vital advantage to help our customers
protect what really matters

Our strategy

1 Maintain and grow our defence businesses

2 Continue to grow our business in adjacent markets

3 Develop and expand our international business

4 Inspire and develop a diverse workforce to drive success

5 Enhance financial performance and deliver sustainable growth in shareholder value

Our strategic priorities

Drive operational
excellence

Continuously improve
competitiveness and efficiency

Advance and further
leverage our technology

Our values
Trusted, Innovative, Bold

BAE SystemsAnnual Report 2018Our markets

Group strategic
framework

BAE Systems has leading positions in its
principal markets – in the US, UK, the
Kingdom of Saudi Arabia and Australia –
as well as established positions in a number
of other international markets. We are one
of the largest global defence companies.

Supporting our customers
Our strategy is focused on providing a
vital advantage to our customers across
the US, UK and international markets.
In particular, we have built strong positions
aligned with our core defence platforms to
support our customers in our four principal
markets. These principal markets – the
US, UK, the Kingdom of Saudi Arabia and
Australia – have been identified as having
a significant and sustained commitment
to defence and security. BAE Systems has
established strong and enduring relationships
in these markets and is recognised as playing
a key role in the industrial capability of each
of these countries.

Our unique position and capabilities
Our strong position in the US through the
Special Security Agreement, together with
our standing as the leading defence contractor
in the UK, provides us with unique capabilities
that can be leveraged across the Group to
support our customers. In addition, our diverse
portfolio of capabilities in the air, maritime,
land and cyber domains, provides us with
a comprehensive offering for our customers
around the world making us one of the
broadest and most geographically diverse
major defence companies.

Responding to changes in defence
and security requirements
Our business continues to respond to
geopolitical and technology trends that will
influence and shape our customers’ defence
and security requirements now and into the
future. Our excellence in complex engineering,
developing cutting-edge technology and
seeking innovative solutions enables us to
respond to our customers’ requirements for
greater agility, global reach, and advanced
technology products and services.

Growth aspirations
A number of key markets for the Group
have either grown or stabilised spending
in response to an increasingly uncertain
security environment.

We have a significant international
presence supported by long-standing
customer relationships and the ability to
leverage our range of capabilities around
the Group. Following a number of significant
wins in the last two years we continue
to see further opportunities in a number
of international markets.

Accessible global defence markets1

Top ten global defence markets accessible
for business by the Group ($bn)

1. US

2. India

3. UK

4. France

5. Saudi Arabia

6. Japan

7. Germany

8. South Korea

9. Australia

10. Brazil

61
57
53
52
48
44
38
32
29

606

Principal markets

Source: 2017 US budget as shown in the Department of Defense Fiscal Year 2019 Budget
Request and, outside the US, IHS Jane’s Defence Budgets (based on 2017 total defence
budgets and constant 2018 US dollars).

BAE Systems’ global defence market position

Top ten global defence
contractors’ revenue ($bn)

1. Lockheed Martin

2. Raytheon

3. BAE Systems

4. Northrop Grumman

5. Boeing

6. General Dynamics

7. Airbus

8. Almaz-Antey

9. Thales

10. Leonardo

22
22
21
20

9
9
9

Source: Defense News Top 100 for 2018 (based on 2017 numbers). Exchange rate applied
to BAE Systems is $1.289/£1.

1. Markets inaccessible for business by BAE Systems are excluded.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our markets
continued

Sales1 by destination

A US

B UK

C Saudi Arabia

D Australia
E Other international markets2

42%

21%

14%

20%

1. Revenue plus the Group’s share of revenue

of equity accounted investments.

2. Includes £0.7bn (4%) of sales generated

under the Typhoon workshare agreement
with Eurofighter Jagdflugzeug GmbH.

The US continues to represent
the single largest defence
market in the world and
BAE Systems remains a top ten
defence supplier in the US.
On 28 September, the fiscal year 2019
Defense Appropriations bill was enacted.
This is the first time since 2008 that the
Department of Defense had funding in
place by the 1 October start of the fiscal
year, which provided near-term clarity for the
industry and demonstrated strong bi-partisan
support for defence funding as part of the
two-year agreement passed in early 2018.

The enacted Defense Appropriations bill
maintains support for our medium-term
planning assumptions and positive momentum
for military readiness and modernisation
programmes. The portfolio of the US-based
business is well aligned with customer
priorities and growth areas, which include
combat vehicles, precision-guided munitions,
naval ship repair and modernisation services,
electronic warfare, and space security.
BAE Systems has strong positions on a number
of premier defence programmes, including
F-35 Lightning II, Paladin self-propelled
howitzer, Armored Multi-Purpose Vehicle
and Amphibious Combat Vehicle, and we
are a leader in advanced electronic systems,
real-time intelligence and analysis, naval gun
systems and artillery systems.

In addition to our position on US defence
programmes, the US-based portfolio is also
focused on Foreign Military Sales and direct
international sales to allied nations.

We continue to deliver on existing commercial
programmes, including engine and flight
controls, and electric drive propulsion systems.

BAE Systems remains the
largest defence company
in the UK, with strong and
long-standing relationships
with the Ministry of Defence.
The UK is Europe’s largest defence market
and, after a period of budgetary decline,
defence spending has stabilised. The Autumn
Budget reinforced the UK government’s
commitment to defence and security spending,
as well as the continued pledge to maintain
spending at 2% of GDP. Additionally, the
UK Combat Air Strategy announced in July is
a significant milestone, sending a strong signal
of intent for the UK’s commitment to retaining
a leading position in Combat Air. The strategy
will enable long-term planning and joint
government and industry investment in
next-generation combat air systems.

In light of the UK’s referendum decision to
leave the EU, the government has signalled
its intent to continue to play a major role in
defence and security co-operation in Europe.
The final agreement of the terms of the
UK’s exit from the EU after March 2019
will be important to enable companies
to prepare for potential changes in the
regulatory environment. There is relatively
limited UK-EU trading and movement of
EU nationals into and out of BAE Systems’
UK businesses, and the resulting Brexit
near-term impacts across the business are
likely to be limited. BAE Systems will support
the UK government in achieving its aim of
ensuring that the UK maintains its key role
in European security and defence post-Brexit,
and to strengthen bilateral relationships with
key partners in Europe.

The UK government provides vital support
in the pursuit of international export
opportunities, recognising the value that
BAE Systems and the defence industry
contributes to the UK economy.

BAE Systems plays an important role in
providing capabilities to support the UK
government and armed forces across the
air, maritime, land and cyber domains.
Our involvement across the major UK
defence programmes, including Typhoon
aircraft, Queen Elizabeth Class aircraft
carriers, Type 26 frigates, and Astute and
Dreadnought Class submarines, maintains
our diverse skillsets, allowing us to provide
a vital advantage to our customers.

Our UK-managed cyber business has a
focused investment strategy to ensure that
we support our commercial and government
customers as cyber security becomes an
increasingly important part of a sophisticated
and persistent threat environment.

BAE SystemsAnnual Report 2018The Kingdom of Saudi
Arabia continues to be
a significant military power
and one of the largest
defence markets globally.
Saudi Arabia has a strong commitment
to defence and security spending driven
by regional security instability.

Saudi Arabia’s Vision 2030 strategy
to promote In-Kingdom industrialisation
and diversification away from reliance
on oil continues to shape our activities in
support of Saudi Arabia’s national objectives
of technology development, local skills,
and the development of an indigenous
defence industry and capability. Through
the restructuring of the Group’s portfolio
of interests in a number of Kingdom of
Saudi Arabia industrial companies along with
sustaining current industrialised capability and
building on our strong history in Saudi Arabia,
we are working in partnership to continue to
deliver these priorities with the Saudi Arabian
Military Industries (SAMI) organisation to
explore how we can collaborate to deliver
further In-Kingdom Industrial Participation.

We remain well placed as a leading
in-country contractor in support of air
defence platforms and training systems
for the Royal Saudi Air Force, as well as
support for mine countermeasure vessels
for the Royal Saudi Naval Forces.

BAE Systems is one of the
largest defence companies
in Australia, with strong
activities across all domains.
Regional instability and the pace of military
modernisation in the Asia-Pacific region
continue to drive the government’s
commitment to defence spending, with
major recapitalisation programmes under
way in the air, maritime and land domains.

The government has indicated its intent
to grow defence spending by committing
to spend 2% of GDP by 2020/21. As part
of this commitment, the government has
made clear its objective to build a stronger
and more sustainable domestic defence
industry, ensuring that over time the nation
has in place a sovereign industrial base that
has the skills, knowledge and capability to
manage and support the platforms and
systems it has invested in.

We are well positioned to support this
through an established business and a
workforce based at more than 25 sites
across the country, in addition to our ability
to leverage our international positions within
the Group to support domestic Australian
products in export markets.

We currently provide support to the
Australian Defence Force through engineering,
programme management and sustainment
solutions, including the Jindalee Operational
Radar Network upgrade, Hawk Lead-In
Fighter support, F-35 Lightning II sustainment,
and Anzac frigate support and upgrade.
The award to BAE Systems Australia in 2018
of the nine-ship Hunter Class Frigate
programme, to be built at the ASC shipyard
facility in Adelaide, will in time give the
business a balanced portfolio of build and
support work.

BAE Systems has many strong
and enduring relationships in
other international markets.
Regional security tensions, the growing
emphasis on indigenous capabilities and
varying economic conditions continue to
influence defence spending internationally.
In Asia-Pacific and the Middle East,
BAE Systems has developed and seeks
to further relationships with partners
and customers in a number of countries.

In Qatar, the contract to provide Typhoon
and Hawk aircraft along with a bespoke
support and training package became
effective in September.

In Oman, where we completed the delivery
of the final Typhoons in 2018, we provide
support to Typhoon and Hawk aircraft and
naval vessels.

We have a strong presence in Sweden
through our BAE Systems Hägglunds business
supplying and supporting tracked vehicles
for international customers.

In Turkey we are collaborating on the first
development phase of an indigenous
fifth-generation fighter jet, TF-X, for the
Turkish Air Force and we maintain our position
in armoured combat vehicles through the
FNSS joint venture.

In India, we have long-established
relationships with local industry partners
Hindustan Aeronautics Limited on Hawk
aircraft and with Mahindra Defence Systems
on M777 ultra-lightweight howitzers.

In Malaysia, we are a supplier to the armed
forces, both directly and through joint
ventures. We have set up a Global Engineering
Centre in Kuala Lumpur focusing on local
delivery and global support of our cyber
and financial crime detection services.

Our US businesses export combat vehicles
and precision weapon systems to a number
of international customers and leverage further
international markets through our partnerships
in defence and commercial electronics.

Through our shareholding in MBDA, our
position in the missiles and missile systems
market continues to grow in European and
other international markets.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018How our
business works

We provide advanced technology
defence, aerospace and security
solutions that aim to give our
customers a competitive edge.

We aim to deliver…

We create value through…

…products and services
that provide a vital
advantage to help our
customers protect what
really matters:
Our largest customers are
governments, but we also sell to large
prime contractors and commercial
businesses. We take on and solve
some of our customers’ most
complex and challenging engineering
and technology projects to give them
a competitive edge, helping them
protect what matters most.

Our key products
and services

– Established positions on long-term programmes

– Strong and collaborative relationships with
governments and commercial customers

– Our position as a trusted supplier allows us

to identify emerging trends and opportunities
for growth

… identifying

customer needs

… services, sustainment

and upgrade

– Understanding our customers to provide

competitive services that add value

– Technical expertise acquired through product

design and development

– Flexibility and responsiveness to maximise
availability of our customers’ products

Our business model is underpinned by…

…our values
Our values of Trusted, Innovative
and Bold are at the heart of
everything we do and provide the
right focus and framework for our
employees to aspire to and live by,
now and into the future.

…our people
We have a diverse range of
talented people. We invest in
education and training for our
existing workforce, including
apprenticeship and graduate
programmes, and work with
education sectors to help shape
the workforce of the future.

Group strategic
framework

Our
people

BAE SystemsAnnual Report 2018Non-financial information statement
This section of the Strategic report, entitled
‘How our business works’, constitutes
the Non-Financial Statement as required
by the Companies Act 2006 as amended.

– Strategic focus on technological capabilities

which drive innovation

– Partnerships with small and medium-sized

enterprises and academia to develop new solutions

– Early-stage research which is self-funded and

then developed further with customer funding

– Critical skills in identifying risk, whilst

focusing on value for customers

– Record of delivery on complex projects

– Partnerships with local companies
supporting economic development

… research and
development

… bidding and
contracting

… advanced manufacturing,

commissioning and integration

… designing and
developing

– Investment in advanced manufacturing

facilities and techniques

– Focus on operational excellence with

safety as a key priority

– Management of complex projects and

collaboration across global supply chains

– Engineering expertise in developing
cutting-edge products and services

– Product safety embedded in our designs
to maximise safety in the construction
and use of our products

– Products designed to be easily maintained

and upgraded as technology evolves

…our technology
We focus on technology
innovation and engineering
excellence, prioritising and
investing in next-generation
research and development
programmes to deliver
competitive solutions to
meet our current and future
customers’ needs.

…our partners and
key relationships
We have close relationships
with suppliers, universities
and governments which help
us to create best-in-class,
cost-effective equipment,
goods, services and solutions.

…responsible sourcing
and impact
We take pride in managing
our operations responsibly
and we require our employees
to conduct business in an
ethical way under our Code
of Conduct to enable us to
earn and maintain the trust
of our stakeholders.

…our governance
framework
Our robust governance
framework sets out the way we
do business. It details our policies
and processes which, together
with our culture, enable us to
deliver operational excellence
in a clear, accountable and
consistent way.

Our
technology

Our partners and
key relationships

Responsible sourcing
and impact

Board
governance

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our people
How our business works
continued

Creating an inclusive culture
where everyone can fulfil their
potential is a key priority for
BAE Systems.

We value our employees and the contribution
they make, and we are committed to creating
an inclusive culture where everyone can give
their best. This is essential if we are to attract
and retain talent and drive innovation to solve
our customers’ complex challenges.

Gender diversity

Board

Senior managers1,2

Total employees3,4

Male
7
64%

276
83%

62,000
79%

Female
4
36%

58
17%

16,000
21%

Age diversity3,4

60 years
and older
10,000

24 years and
younger
6,000

25–34
years
16,000

50–59
years
22,000

35–49
years
24,000

1. Senior managers are defined as employees (excluding

executive directors) who have responsibility for planning,
directing or controlling the activities of the Group or a
strategically significant part of the Group and/or who
are directors of subsidiary companies.

2. Excludes executive directors.
3. Excluding share of equity accounted investments and

rounded to the nearest thousand employees.

4. See summary of Deloitte LLP assurance on page 34.

Our approach
BAE Systems’ business strategy is dependent
on its ability to recruit and retain people with
appropriate talent and skills, and we have
identified this as a principal risk (see page 71).
Our Human Resources Strategy prioritises
identifying, attracting and developing talent
through robust succession planning, as well
as engaging and rewarding employees.

Our Group Human Resources Director
reports directly to the Chief Executive and
chairs the Global HR Council ensuring our
Human Resources Strategy supports the
Integrated Business Plan and People Policy.

Diversity and inclusion
BAE Systems is committed to being an
inclusive organisation with a diverse workforce
that reflects the communities in which we
work. Diversity and inclusion is not just the
right thing to do, it will differentiate and
strengthen us for the future.

We recognise that employees from varied
backgrounds, beliefs and life experiences
bring innovation in all that we do. We know
people perform at their best when they truly
can be themselves.

We are determined to increase the number
of women in senior executive positions in
our industry by working on the attraction
and retention of more women within the
Company. Our businesses own and drive
strategies to support these priorities and
we have measures in place to track progress.
We have signed up to the Women in Aviation
Charter and are launching a leader-led gender
equity network in the US to provide mentoring
and coaching for junior to mid-level women.

Identifying and recruiting talent
We must recruit a diverse range of
professionals to deliver excellence to our
customers, including engineers, designers,
software developers and project managers.

We have focused our recruitment on the next
generation to mitigate Science, Technology,
Engineering and Mathematics (STEM) skills
shortages, and to accelerate diversity within
our leadership.

We regularly provide high-quality training
for thousands of apprentices and graduates
across our business. We have partnered with
Cranfield University in the UK and multiple
colleges, universities and trade schools
throughout the US to create innovative
apprenticeship and technical-development
programmes to attract and retain great talent
and boost high-end skills.

In the Kingdom of Saudi Arabia our
technical training programmes are revered
for their contribution to the economy through
the development of indigenous capability.
We are responsible for qualifying more
than 1,200 people annually in teaching
and engineering professions.

Training and development
We want all of our employees to reach their
full potential, evolving their skills to meet our
customers’ current and future requirements.
We support this through comprehensive
career frameworks, development programmes
and gaining experience from the breadth of
our global operations. From deploying more
than 1,500 expatriates and investing in our
local Saudi workforce through a range of
overseas assignments, to equipping our
production-floor supervisors in the US
with the skills to lead growing teams in
an advanced technological environment,
continual improvement of competence
and skills transfer helps us to develop
world-leading technologies, giving our
customers a critical advantage.

BAE SystemsAnnual Report 2018In 2018, we conducted a Group-wide
survey to measure employees’ views on key
engagement factors and our current ways
of working. The results of this survey will help
us to build on our strengths and focus on
areas where we can further evolve our ways
of working to support future success.

Our global Chairman’s Awards programme
recognises individuals and teams for their
outstanding contribution to the success of
the Group.

We encourage employees to become
shareholders in BAE Systems and, in some
markets, offer share schemes to support this.

We seek to maintain constructive relationships
with trade unions in Australia and the UK,
and labour unions in the US. 55% of our
UK employees are members of a trade union
with 69% covered by a collective bargaining
agreement. In the UK, we retain excellent
relationships with the main organisations
involved and organise regular meetings
through our Corporate Consultation
Committee. We have structures in place
to work with trade union representatives
in our local markets, where it is appropriate
and legally acceptable.

Employee Engagement groups exist
across the businesses, in order to provide
engagement forums for those not covered
by collective bargaining.

Responsibility for development is led by
each employee, in partnership with their
manager and with support from the
Company. We encourage each employee
to have conversations with their manager
to create a meaningful plan to ensure their
professional development.

Reward
We provide our employees with competitive
reward packages which reflect their individual
responsibilities and contribution to business
performance, and we recognise individual
and team successes.

We have published our second annual gender
pay gap report in line with UK regulations.
For 2018, the average gender pay gap for our
UK workforce was 9.0% (2017 11.2%), which
is lower than the current UK national average
of 17.9%. We have a gender pay gap because
we employ around four times more men than
women and a greater proportion of our senior
leadership population is male. We rely on
employing large numbers of employees
with STEM qualifications and we, like other
companies, face challenges recruiting females
with these qualifications because there are
significantly fewer women who study and
work in these fields.

Employee engagement
Employee engagement is a primary focus
for our leaders and managers – connecting
employees to our strategy and purpose,
empowering them to contribute to improving
business performance and creating an
environment in which everyone can fulfil
their potential.

We keep employees informed about what
is happening across the business through
our intranet and email, podcasts, newsletters,
and leadership blogs and briefings.

Our strategy in action

Employee
Resource Groups

BAE Systems’ Employee Resource
Groups (ERGs) are voluntary,
employee-led groups that serve
as a resource for members and
organisations by fostering a diverse,
inclusive workplace aligned with our
organisation mission, values, goals,
business practices and objectives.

They play an important role in BAE Systems’
commitment to diversity and inclusion. Our
ERGs provide programmes to enhance personal
growth and professional development,
help support business priorities, and allow
employees to expand their internal and
external networks. In alignment with our
diversity and inclusion strategy, the ERGs
are grassroots efforts that work to positively
impact our workforce, workplace and the
community. Each network has a formal
structure, periodic meetings, objectives,
and in most cases an executive sponsor.
Our ERGs include: Outlink in the UK and US
for our Lesbian, Gay, Bisexual, Transgender
and Questioning community which strives
to promote equality through education;
ENabled Disability Network in the UK
(called ABLE in Saudi Arabia and the US)
which draws upon the experience of its
members to provide relevant guidance and
support regarding disability issues; Women’s
Network in Australia, Saudi Arabia, the UK
and the US which aims to foster an inclusive
community focused on the needs and
interests of women in the workplace and
the community; and our Veteran’s Support
Network in the US whose mission it is to
help connect former service members, active
duty members, reservists and those who are
supportive of our armed forces.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our technology
How our business works
continued

Our technology provides
customers with a competitive
edge across air, maritime, land
and cyber to help them to
protect what matters most.

In the complex and fast-changing environment
in which we work, harnessing technology
and innovation is key to developing the
most effective and efficient solutions for
our customers. We are addressing this pace
of change by ensuring that our products are
designed, built and supported in a way that
provides for future flexibility with the ability
to upgrade in an agile manner.

Technology and innovation are central
to our business. They underpin our strategy
and the development of our products and
services, helping to make our products more
cost-effective, including the operational
and through-life costs of current and
future systems.

Our planning process starts with the business
strategy informing a product strategy which in
turn defines the capabilities and technologies
that are required.

This structured approach ensures we have a
clear focus for our research and development
(R&D) spend and that of our customers,
to maximise future product and service
capabilities and the way we work.

A collaborative approach
The Technology team, part of the Chief
Technology Officer organisation, works with
the BAE Systems businesses to develop the
technology plans. Our people are encouraged
to innovate and embrace disruptive
technologies focused on those that will ensure
our customers are equipped to face present
and future threats. We employ highly skilled
engineers, technologists and scientists who
enable us to deliver the most cutting-edge
technology.

We are focused on improving collaboration
across the business, increasing connections
and identifying opportunities and projects
where we can leverage the power of the
Group including across areas such as autonomy,
maritime battlespace, future combat air, cyber
and advanced manufacturing. In advanced
manufacturing, we continue to invest in our
additive manufacturing capabilities across the
business and developing partnerships with
universities and supply chain companies with
a particular focus on a reduction of the
design-to-manufacture time.

As well as taking a collaborative approach
within our own business we work with a
range of partners including our customers,
defence and security industry partners, other
industry partners, small and medium-sized
enterprises and academia. Often we work
with others to develop embryonic technology
before selecting and maturing it for use in our
own products and services.

Business
strategy

Product
strategy

Capability
gaps

Technology
plan

1. The views, opinions and findings expressed are those of BAE Systems and should not be interpreted
as representing the official views or policies of the Department of Defense or the US government.

Our strategy in action

Insights into
causes of conflict for
military planning

We are developing technology for
the US Defense Advanced Research
Projects Agency (DARPA) and
US Air Force Research Laboratory
that will aid military planners in
understanding and addressing
the complex dynamics that drive
conflicts around the world.

Through the Causal Exploration of Complex
Operational Environments programme, we
are developing software that models different
political, territorial and economic tensions
that often lead to conflicts, helping planners
to avoid unexpected outcomes.

This original software, called Causal Modeling
for Knowledge Transfer, Exploration and
Temporal Simulation, is intended to create
an interactive model of an operational
environment, allowing planners to explore
the causes of a conflict and assess
potential approaches.

This solution aims to replace today’s time-
consuming and labour-intensive approaches,
to give planners a quicker and deeper
understanding of conflicts to help avoid
unexpected and counter-intuitive outcomes.1
This and other programmes are managed by
our Electronic Systems FAST Labs™ business
area. The team collaborates across the
Company’s global enterprise to create and
develop advanced technology capabilities
in advanced electronics, autonomy, cyber,
electronic warfare, and sensors and processing.
Our scientists and engineers solve some
of the toughest challenges in the defence,
aerospace, power and propulsion, and
security domains. The team is also partnering
with universities and commercial technology
companies to leverage innovation for
powerful new capabilities for our customers.

BAE SystemsAnnual Report 2018In the US, UK and Australia we forge strong
relationships and partnerships with universities
to enable us to identify and learn about new
technologies that can help our customers.

We also assess the utility of our existing
technology to determine if we can create
value through licences and sales of rights
to the technology to other organisations.

Horizon scanning
Part of the role of our Technology team
is to scan the developments in science and
engineering happening across the world
and to bring to our attention the latest
advances that may have utility in the
defence, aerospace and security markets.

We work hard to identify key trends that
will shape our future business, taking into
account the increasing pace of technological
change and the huge growth in R&D spend
in the commercial and consumer-focused
sectors that has applicability for our business.
Work in this area includes the virtual training
environment where we are developing virtual
platforms and their support environments by
leveraging commercial gaming technologies.

The use of technology, innovations and
advanced manufacturing techniques across
our business is essential in driving greater
efficiency and increased productivity. A good
example of this is the work we are doing to
develop an intelligent, self-optimising and
adaptable digital factory for future platforms
that will integrate intelligent robotic
technologies to support manufacturing and
assembly. Aligned to this is our investment
in intelligent robotic technologies, such as
collaborative robots (or Cobots), which are
powerful enablers for reduced manufacturing
costs, improved productivity and the safety
of manufacturing environments.

We are also investing in digital twin
technology to evaluate the potential of
a product digital twin that can facilitate
virtual testing to be undertaken in a digital
environment, significantly reducing the
requirement and cost of physical testing.

Our investment
We continue to invest in a wide range of
R&D activities that are targeted in customer
priority areas and in programmes that will
give us a competitive advantage. In 2018,
we spent £1.5bn (2017 £1.6bn) on R&D, of
which £222m (2017 £238m) was funded by
BAE Systems. In addition, the Group’s share
of the R&D expenditure of its equity accounted
investments in 2018 was £0.2bn (2017 £0.1bn).

We protect our investments in technologies
and have a portfolio of patents and patent
applications covering approximately 2,500
inventions worldwide.

In order to accelerate our R&D programmes we
make value-adding investments or acquisitions
in key and emergent new technologies. In 2018
we announced a collaboration with Prismatic
to invest in the development and flight testing
of the PHASA-35™ system, a new solar electric
unmanned aerial vehicle which has the potential
to fly for up to a year, and a further investment
in Reaction Engines.

Research and development expenditure1

£1.7bn (2017 £1.7bn)

1. Including share of equity accounted investments.

Our strategy in action

Mixed reality
cockpit

BAE Systems’ specialist team of
Human Factors engineers collaborate
with pilots to better understand and
anticipate their needs. These insights
shape the intuitive technologies
that the team is developing for
the cockpit of the future.

One area of focus is on technologies that
enable pilots to control the cockpit in new
ways. An example is the ‘wearable cockpit’
which removes many of the physical elements
of current cockpit design, and replaces it with
a virtual display, projected through the pilot’s
helmet. This provides the pilot with a
software-only cockpit that is upgradeable,
adaptable and reconfigurable.

We have integrated our virtual reality cockpit
with the Striker® II helmet and are now
working to evaluate its effectiveness in a
range of simulated scenarios.

As military domains become more contested
and technologies become more complex, we
are focusing on the controls that are critical
to the pilot and how these can become easier
to manage. Eye-tracking technology will allow
the pilot to physically look and highlight an
object, and then make a gesture to ‘press’ a
button, rather than having a series of physical
buttons on the aircraft.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our values and responsible behaviour
How our business works
continued

Our strategy in action

Training our
Ethics Officers

Each year, BAE Systems holds
two two-day forums (one in the
US, and a global one in the UK)
to provide training and updates
for our Ethics Officers.

In 2018, these included introductions from
Jerry DeMuro, President and Chief Executive
Officer of BAE Systems Inc. and Charles
Woodburn, Chief Executive of BAE Systems
stressing the importance of the role our
Ethics Officers play.

The global ethics conference focused on
providing our Ethics Officers with additional
training on supporting people who raise
concerns, aiming to further normalise the
Speak Up process. The US conference
provided our Ethics Officers with training
on the importance of culture and the skills
related to investigations.

We are a business that
operates responsibly and
with integrity, supporting
sustainable long-term
performance by managing
non-financial risks that
can impact reputation
and shareholder value.

The Board delegates the detailed oversight
of responsible behaviour matters to the
Corporate Responsibility Committee, which is
chaired by a non-executive director (see page
87). The Corporate Responsibility Committee
meets as part of the Board’s annual schedule
of meetings (see page 80), and agrees the
Group’s responsible business priorities relating
to our employees, trust and integrity, health
and safety, and resource efficiency.

The Chief Executive is responsible for
ensuring that we meet our own standards.
He is supported by the Managing Director
Operational Governance with guidance
and oversight from the Board via the
Corporate Responsibility Committee.
The performance review process is used
to flow down corporate responsibility
objectives through the Group.

For information about how our business
model is underpinned by our commitment
to corporate responsibility, see page 23.

Our Operational Framework (see page 76)
sets out the way we do business. We set
Group-wide policies, which are enacted at a
local level by our businesses, and help business
leadership to make informed decisions.

Our Operational Framework is underpinned
by our Operational Assurance Statement (OAS)
which is a six-monthly process used to monitor
compliance with the Operational Framework
and policies. The OAS also requires a report
showing the key financial and non-financial
risks for each business and Group function
completed by the line and functional leaders.

The Internal Audit Director owns the
OAS Policy, and is responsible for the
consolidation and reporting of the OAS
submissions from the businesses to the
Group Audit Review Board, the Audit
Committee and the Corporate Responsibility
Committee. The Internal Audit Director
reports functionally to the Audit Committee
and, for day-to-day operations, to the Chief
Executive. The Corporate Responsibility and
Audit Committees hold a joint meeting
each year to review the OAS and assurance
matters as both committees are concerned
with both financial and non-financial risk.

The Board has overall responsibility for
determining the nature and extent of the
risk that the Group is willing to take and
for ensuring that risks are managed effectively
across the Group. The Board reviews risk as
a regular agenda item and as part of its annual
strategy review process.

Our corporate responsibility programmes
focus on:
– continuously improving employee wellbeing

and standards of safety for employees
and those we work with, to ensure that
everyone goes home safely (see page 30);

– developing an inclusive, diverse

workplace to drive innovation and enhance
the performance of our employees
(see page 24);

– engaging with our communities by
supporting projects and employee
volunteering (see page 31);

BAE SystemsAnnual Report 201866

How we
manage risk

Our principal
risks

– supporting our employees in making the
right decisions and doing the right thing
(see page 29);

We encourage employees to contact us as
early as possible when a potential incident
can still be prevented by timely advice.

– managing the environmental impacts of our
facilities and products to improve efficiencies
and cost savings (see page 33); and

– working with suppliers to deliver excellence
and innovation to support our businesses in
delivering on their objectives (see page 31).

Trust and integrity
We aim to be a recognised leader in business
conduct which helps us to earn and maintain
stakeholder trust and sustain business success.

We consider it fundamental to maintain a
culture focused on embedding responsible
business behaviours. All employees are
expected to act in accordance with the
requirements of the Group’s policies,
including the Code of Conduct, at all times.
As well as being the right thing to do, this
reduces the risk of compliance failure and
supports us in attracting and retaining
high-calibre employees.

We work to build a culture where our people
are empowered to make the right decisions
and know where to go to seek help or
guidance. Our Code of Conduct sets out
clear expectations on ethical conduct and
we offer training and support to help people
understand the right thing to do.

During 2018, we rolled out face-to-face
ethics training that covered realistic, issue-
based scenarios. This training, delivered by
line managers to their teams across the Group,
was designed to stimulate conversations
around difficult issues faced by employees in
their workplace. Certain employees received
additional training according to their role,
such as anti-bribery and anti-corruption,
and export control training.

Employees can speak up via our network
of over 160 Ethics Officers or by contacting
our 24-hour Ethics Helpline by phone, email
or an external website to ask for support or
report a concern, anonymously if preferred.

We collect data on ethics enquiries and
dismissals for reasons relating to unethical
behaviour (see opposite). In 2018, there
were 1,2861 ethics enquiries, an increase
of 0.5% on 2017. This positive trend reflects
our efforts to encourage our people to speak
up and we will continue to communicate to
our employees the methods for making
contact. Our 2018 anonymity rate of 28%
compares favourably with international
benchmarks.

In 2018, 48% of the ethics enquiries
received were requests for guidance and
advice, which we believe reflects our
employees coming to us before a situation
has worsened and requires investigation.

All enquiries reported to Ethics Officers
and via the Ethics Helpline were reviewed
and reported either to the Ethics Review
Committee or, in BAE Systems, Inc., to
the Ethics Review Oversight Committee.

Anti-bribery and anti-corruption
We have well-established anti-bribery and
anti-corruption policies aimed at ensuring
adherence to the associated legal and
regulatory requirements in light of the bribery
and corruption risk faced by the Company.
Our commitment to comply with all applicable
laws and regulations, including those
addressing anti-bribery and anti-corruption,
and our commitment never to offer, give or
receive bribes or inducements is also clearly
set out in our Code of Conduct.

The policies referred to above include
the following:
– Advisers Policy – which governs the

appointment, management and payment
of third parties who are engaged to assist
with our sales and marketing activities or
the strategic development of the Group;

– Gifts and Hospitality Policy – which
governs the offering, giving or receipt
of gifts or hospitality;

– Conflict of Interest Policy – designed

to ensure that personal conflicts of
interest do not impair employees’
judgement and damage the Group’s
integrity and interests; and

– Facilitation Payments Policy – designed
to ensure that Facilitation Payments are
not paid and that the Group and its
employees seek to eliminate the practice
of facilitation payments.

Other policies, including our Finance Policy,
Fraud Prevention Policy, Export Control
Policy, Lobbying, Political Donations and
Other Political Activity Policy, Offset Policy
and Procurement Policy include measures
to address bribery and corruption risks.

Risk-based due diligence procedures
have been implemented to address
bribery, corruption and other financial and
non-financial risk, and our Policies include
processes for risk-based internal and external
approvals, ongoing monitoring and repeat
due diligence.

For the principal risks relating to compliance
with anti-bribery and anti-corruption
regulations and how the risk is mitigated,
see the laws and regulations risk description
on page 70.

Total ethics enquiries1

2018

2017

2016

2015

2014
Anonymity rate

1,286
1,280

1,121
1,148

1,037

28% (2017 24%)

2018 ethics enquiries by type1

615

227

179

128
137

1 Guidance and advice

2 Employee relations and conduct

3 Management practices

4 Accounting charges practices

5 Other

Dismissals for reasons relating
to unethical behaviour2

2018

2017

2013

2012

219
219

265

292
298

1. See summary of Deloitte LLP assurance on page 34.
2011
2. Verified by BAE Systems Internal Audit.

For further information,
see our Corporate
responsibility summary
baesystems.com/crsummary

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our values and responsible behaviour
How our business works
continued

Human rights
We are committed to respecting human
rights. This applies equally to our employees,
our suppliers and business partners, all of
whom are expected to adopt the same or
similarly high standards of ethical behaviour.
We are committed to conducting business
responsibly and to maintaining and improving
systems and processes to reduce the risk of
slavery and human trafficking in our business
or supply chain.

Our Code of Conduct and other global
policies and processes mandated under the
Operational Framework, together with our
supporting principles and guidance on
responsible trading and suppliers, support
our commitment to human rights. This results,
for example, in due diligence being carried out
during the supplier evaluation stage against
non-financial risks, including human rights,
working hours, harassment and unlawful
discrimination, anti-whistleblowing, slavery,
human trafficking and child labour.

Suppliers are regularly reviewed throughout
their contractual relationships against such
non-financial risks. In 2018, we published
our response to the UK Modern Slavery
Act and a statement in response to the
California Transparency in Supply Chain
Act on our website.

Health and safety
Our collective focus on employee wellbeing
and the health and safety of employees and
those who work on, or visit, our sites is a
contributory factor to the success of our
organisation. Our safety culture and our
employees demand high standards for all
aspects of health and safety. This is supported
both by our mandated Health and Safety
Policy and the principles contained within
our Code of Conduct for employees.

Employee wellbeing
We promote wellbeing through a wide variety
of programmes, ranging from exercise and
fitness promotion to occupational health
checks. We know that good mental and
physical health contributes to better decision-
making, greater productivity and higher levels
of employee satisfaction. We run campaigns
to encourage employees to take responsibility
for their health. Our Employee Assistance
Programme is a confidential service available
to employees and includes support and advice
on personal matters.

Safety
Our business is highly complex and our
employees are exposed to many risks. These
range from slips, trips and falls in an office
environment, confined space working and
machinery hazards within manufacturing to
fire and explosion risks associated with the
manufacture and storage of munitions. Many
of our employees operate heavy equipment,
work at height or do physically demanding
work in high-risk environments.

In order to ensure consistency, all businesses
are required to comply with our Health and
Safety Policy, which outlines and prescribes
the responsibilities and arrangements in place
for ensuring safety. It is the responsibility of
individual business leaders to ensure that their
organisations comply with the policy. We aim
to mitigate or manage safety risks by finding
new ways to enhance safety standards,
increase awareness and continually drive
a strong safety culture.

Due to the varied risk profiles and work
environments within the Group, we operate
safety management systems within each
business, many of which are externally
accredited to the OHSAS1 18001 or
ISO2 45001 standard. These systems identify
and control risk, and are used to assure that
the processes and procedures are protecting
our people and others who may be affected
by our operations. Teams of safety specialists
assist management in ensuring safety
management systems are effective and the
operational control of risk is maintained.
Health and safety specialists provide expert
advice and tools to put our safety policies
into practice.

Some employees may be exposed to
long-term health risks from hazardous
substances and other physical hazards.
We aim to reduce exposure levels to
hazardous substances and to seek alternatives,
where possible. We provide our employees
with health surveillance to understand and
reduce the impact of workplace health risks.

We use the Recordable Accident Rate as
a key performance indicator to measure
workplace injuries. This metric, along with
the number of major injuries, is used to
determine an element of executive bonus
(see page 107). In 2018, there was a 16%
decrease in the Recordable Accident Rate.
The overall number of major injuries recorded
increased to 37 compared with 28 in 2017,
and sadly, an accident on 11 June in a facility
in Radford resulted in one fatality and injuries
to two employees. The health and safety of
our employees has always been and continues
to be our highest priority.

We continue to focus on reducing risk
and embedding a strong safety culture
to drive improvements.

Our principal
risks

Operational
framework

2019 priorities
We will continue to drive towards a
world-class level of safety performance;
focus on the management and reduction
of safety risk; and drive a strong safety
culture through communication, awareness
and visible leadership. We will target a 10%
reduction in the Recordable Accident Rate.
We will roll out our annual Business
Conduct scenario-based training to
all employees. This forms part of our
continuing efforts to build a culture
of responsible behaviour and ethical
decision-making.

Recordable Accident Rate
(per 100,000 employees)3

2018

2017

471

564

Major injuries recorded3,4

2018

2017

BONUS

KPI

BONUS

5% of the UK executive directors’ bonuses are based on the
achievement of safety KPIs (see page 107).

1. Occupational Health and Safety Assessment Series.
2. International Organisation for Standardization.
3. See summary of Deloitte LLP assurance on page 34.
4. The definition of a major injury was updated in 2017
to more closely align with the Reporting of Injuries,
Diseases and Dangerous Occurrences Regulations 2014.

BAE SystemsAnnual Report 2018

Our partners and key relationships

We engage regularly with
our partners and listen and
inform in equal measure
through formal mechanisms
and ongoing dialogue.

Suppliers
We create best-in-class products and services
through extensive collaboration with more
than 20,000 suppliers worldwide.

We work with suppliers and their supply
chains to provide fully compliant, cost-effective
equipment, goods, services and solutions.
Our supplier relationships are often long term
due to the length of our product lifecycles, so
we aim to work with suppliers who share our
values and who embrace standards of ethical
behaviour consistent with our own.

Our policy is to identify and select suppliers
who meet our standards, and to support them
by managing risks throughout the lifecycle
of any commercial arrangement. We manage
risk with our suppliers in accordance with our
Procurement Policy, our Lifecycle Management
Framework and our Supplier Principles –
Guidance for Responsible Business. Our
business leaders and the Global Procurement
Council oversee compliance with the policies
and principles, and our Procurement teams
assess suppliers against the Principles,
including anti-corruption criteria.

After selection, we continue to engage with
our suppliers for ongoing assurance at all stages
of a project. Our key supplier and procurement
policies are compliant with national and
international laws. In 2018, we reconfirmed our
commitment to the enhanced UK Government
Prompt Payment Code and were one of the
inaugural signatories to the Australian Small
Business Supplier Payment Code.

Partners
We continue to work with peers across
the defence industry to improve ethical
standards. During 2018 we continued to
participate in the International Forum on
Business Ethical Conduct’s Council and
worked with the Institute of Business Ethics
to set up a UK Defence Practitioners Group.
This group met several times in 2018 to share
experiences and best practice on ethical
issues of particular concern to the industry
and to receive expert briefings.

The BAE Systems, Inc. business continued
strong support of the Defense Industry
Initiative by participating in the Working
Group, webinars and the annual Best Practices
Forum. In addition, BAE Systems, Inc. is on
the governing board for the Capital Area
Business Ethics Network (CABEN). CABEN
provides members who are professionals
in ethics, compliance and corporate
social responsibility fields, in the greater
Washington, D.C. area, with a forum for
sharing best practices and networking
opportunities to exchange information.

BAE Systems, Inc. also contributed to
a Best Practices Paper with Ethics and
Compliance Initiative on Using Your
Organization’s Performance Evaluation
System to Drive Ethical Conduct.

Community investment
Giving back to the communities in which
we operate, and to charities that have
meaning to our business is vitally important
to our Company and our employees,
allowing us to make a positive difference
and have an impact where it counts.

During 2018 the Group contributed
more than £11m3 to local, national and
international charities and not-for-profit
organisations through our community
investment programme. This includes
charitable sponsorships, donations,
employee fundraising and volunteering.

Our strategy in action

UK:
Movement
to Work

BAE Systems is a founder
supporter of the Movement
to Work (MtW) initiative in the
UK, an employer-led initiative
to tackle youth unemployment.

MtW is designed to help provide a pathway
into work for young people by providing them
with quality work experience and employability
skills training, and our funding and support
provides 98 new placements per year.

So far, we have provided 431 placements
and 259 young people have gone on to full
employment or further education as a direct
result of this programme. Of these, 113 have
succeeded in gaining an apprenticeship with
BAE Systems.

Our approach
Pursuant to our Community Investment Policy,
our Global Community Investment Strategy
aims to build and nurture mutually beneficial
relationships between our business, our
people and local stakeholders. We partner
with organisations that align to our strategy
which allows us to support initiatives that
have meaning and impact to our business
and employees.

Our strategy outlines primary focus
areas, where measurable impact can be
demonstrated and these are defined as:
– Armed forces – supporting active service
personnel, veterans and their families;
– Education and skills – inspiring young
people to consider Science, Technology,
Engineering and Maths (STEM) subjects
and careers; and

– Local community – working to support
the communities in which we operate.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our partners and key relationships
How our business works
continued

Our strategy in action

Australia:
Soldier On

In 2018, we announced an enhanced
partnership to support the health,
employment and rehabilitation of
Australia’s veterans and their families.

Our commitment will support the expansion
of Soldier On’s health and wellbeing, education,
employment and social programmes, and
will complement BAE Systems’ employee
fundraising and volunteering activities. These
programmes are vitally important to the
veteran community, with one in four veterans
experiencing a mental health issue each year.
Soldier On’s programmes focus on the
prevention and treatment of these issues
by providing physical and mental health
rehabilitation, education, employment and
career transition support, as well as creating
meaningful connections and a sense of
belonging. Together, BAE Systems Australia
and Soldier On are creating and supporting
a legacy for Australia’s service community
and their families.

Each market develops its own programme
which is in support of the Global Community
Investment Strategy, and is relevant to their
lines of business, charitable needs, culture
and local communities.

skills and time. Our communications team also
supports awareness-raising efforts, promoting
projects and community causes through our
website, social media channels, intranet and
media outlets.

Community investment is not paid to third-
party fundraisers or directly to individuals.
As part of our due diligence procedures,
prior to a charitable sponsorship or donation
being committed, the charity is vetted
through a recognised external organisation
to ensure that the funding will be used for
charitable purposes.

To avoid the risk of conflicts of interest,
any community investment activity is tested
against the principle that it does not place, or
does not appear to place, actual or potential
customers, suppliers or government officials
under any obligations.

The Global Community Investment
Committee reports to the Executive
Committee on all community investment
activities, including employee fundraising
activities. All such expenditure and any
associated employee fundraising is reported
through an online system and validated
by an external assurance provider.

Our impact
We collaborate with organisations that can
demonstrate a positive impact locally and
encourage our employees to volunteer in
support of their work. These include not-for-
profit organisations and education providers.

We use the London Benchmarking Group
methodology to define the value of our
support and its impact on our community
partners, in comparison with our peers and
other organisations.

As well as donations, sponsorship and
employee fundraising, we develop and
support structured education programmes
and enable our employees to volunteer their

We have strong ties with armed forces
charities across a number of our markets,
and an important strand of our strategy is
support for organisations that assist active
service personnel, veterans and their families.
In the UK we have Gold Award status in
the Employer Recognition Scheme, managed
by the UK Ministry of Defence. The scheme,
first run in 2014, is the highest accolade
for organisations that have signed the
Armed Forces Covenant and demonstrated
outstanding commitment to active and
former service personnel. As a winner, we
demonstrated a proactive commitment to
advocate and support our armed forces, a
positive attitude towards service personnel
during recruitment and full support of
employee reservists. In the US, we partner
with The Mission Continues, which empowers
veterans to continue their service in
transformative ways within their communities
and supports their transition to new careers
that draw upon their military service.

Volunteering remains an important part of
our employees’ career journey and can be
pursued as a personal development goal.
In the Kingdom of Saudi Arabia and the UK,
our education ambassadors have offered
their time to encourage school age children
to pursue STEM subjects and careers.

Based on local practices, we apply
matched funding and offer volunteering
opportunities during company time for
a number of our employee groups,
encouraging them to support our charitable
partners and communities in alignment with
our Community Investment strategy and
focus areas.

BAE SystemsAnnual Report 2018Responsible sourcing and impact

We are committed
to minimising the
environmental impact of
our operations and products.

As a major manufacturer, we recognise
that our operations have an impact on the
environment – from the energy and resources
we use, to the products we manufacture
and the waste that we generate. As an
organisation, we are committed to reducing
the environmental impact of our operations
and products, minimising our environmental
footprint and, in turn, decreasing our
operational costs.

Governance
As owner of the Environmental Policy, the
Chief Executive has been assigned overall
responsibility for environment, inclusive
of issues relating to climate change. He is
supported by the Corporate Responsibility
Committee in ensuring that appropriate
policies, systems, reporting structures and
metrics are in place to achieve the Group’s
environmental performance objectives as
well as ethical and social objectives.

Our Environmental Policy outlines our
commitment to improving standards of
environmental management, and compliance
with the Policy is directed by environmental
teams across the Group. Through our
bi-annual Operational Assurance Statement
process, business unit compliance with the
Policy is also monitored.

Strategy
We recognise that environmental and climate
risks could directly impact our ability to meet
our strategic priorities. Matters which are
considered likely to influence our organisation
and future strategic decisions include:

– constrained supply and volatile prices

of fuel and the associated taxes;

– availability of critical materials;

– increasing stringency of

environmental legislation;

– impact of climate change on the
operability of our products; and

– contribution towards UN Sustainable

Development Goals.

Risk management
The business acknowledges that there are
significant environmental and climate risks
that are likely to influence our operations,
products and facilities. The underlying
principles of the Group’s risk management
processes are that risks are monitored
continuously, associated action plans
reviewed, appropriate contingencies
provisioned and that information is reported
through established management control
procedures. The overall responsibility for
climate risk identification, analysis, evaluation
and mitigation rests with the business units
and detailed risk registers and self-assessments
are completed to ensure the effective
management of environmental risks.

Our strategy in action

Energy savings

More than 10,000 solar panels
at BAE Systems’ sites in the UK
and Sweden aid the reduction of
our carbon emissions and deliver
savings for our customers.

The solar array installed at BAE Systems
Hägglunds, in Örnsköldsvik, Sweden is
the largest of its kind in any Nordic country.
The array has produced a monthly average
rate of 18 MWh and more than 200 MWh
annually. The 2,500m2 array has produced
more than 600 MWh since becoming
operational in 2015 and has saved BAE Systems
Hägglunds more than SEK600,000 in energy
costs so far while reducing carbon emissions
by around 500 tonnes.

The solar array installed at BAE Systems
in Samlesbury, UK is exceeding its targets.
The array has produced a monthly
average rate of 197 MWh and more
than 2,300 MWh annually.
The array, consisting of more than 17,000m2
of solar panel area, has produced about
9,046 MWh since becoming operational in
2015. It has saved the Company more than
£870,000 in energy costs so far, and attracted
more than £590,000 of Feed-in-Tariff
payments back into the Company, giving a
total saving to date of more than £1.4m which
is more than 50% of the cost of installation.
The solar array has reduced the site’s carbon
emissions by more than 3,357 tonnes, which
is equivalent to the annual electricity use of
more than 2,150 UK homes.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Responsible sourcing and impact
How our business works
continued

Greenhouse gas emissions data from 1 November 2017
to 31 October 2018 (tonnes CO2e)

Combustion of fuel within BAE Systems
facilities and vehicles (Scope 1)1

2018

2017

506,248
525,032

Electricity and steam purchased
for BAE Systems use (Scope 2 –
location-based)1

2018

2017

514,187
528,411

Business travel in non-BAE Systems
vehicles (Scope 3)1

2018

2017

151,280
147,125

Total greenhouse gas emissions1

2018

2017

1,171,715
1,200,568

Total greenhouse gas emissions
per employee2

2018

2017

1. See summary of Deloitte LLP assurance below.
2. Excluding share of equity accounted investments.

Methodology

The greenhouse gas emissions data is reported in line with the
Greenhouse Gas Protocol Corporate Accounting and Reporting
Standard ‘Operational Control’ approach, and emission factors
for fuels and electricity are published at www.gov.uk/government/
collections/conversion-factors-for-company-reporting.

For the 2018 reporting cycle, the 2018 emissions factors have
been utilised as opposed to the 2017 factors. In previous years
the emissions factors used for the Group’s greenhouse gas
emissions reporting have been a year behind, mainly due to the
factors not being released in time for half year assurance (for
example, 2016 emissions factors used for 2017 reporting cycle).
Going forward, the emissions factors used will coincide with
the year of the reporting cycle as these are the latest factors
available for the majority of the Group’s reporting period.

The CO2e associated with carbon dioxide, methane and nitrous
oxide is reported. Greenhouse gas emissions associated with
hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride
are estimated to be immaterial to total emissions and are,
therefore, not reported.

The principal record of the Group’s worldwide facilities is its
legal department’s Global Property Database.

Greenhouse gas emissions are primarily calculated from
energy consumption records reported via the Group’s global
environmental database. Where actual usage data is not
available for facilities and residences within the Global Property
Database, an estimated consumption is used based on the type
of building.

Greenhouse gas emissions related to business travel include air
travel data for the majority of the global business and rail data
for business units operating in the UK and US. These data are
taken from travel suppliers’ procurement records.

Emissions from joint ventures and pension scheme properties
not occupied by the Group are not included. Where a business
or facility is acquired during a reporting year, it will be included
in our reporting in the next full reporting year after the change.

The Scope 2 greenhouse gas emissions associated with the
Greenhouse Gas Protocol ‘market-based’ method have been
calculated as 533,031 tonnes CO2e. Supplier-specific emission
factors have been sought for our most significant operating
regions, but were either deemed of insufficient quality to use
at present or were unavailable. Therefore, in line with the
Greenhouse Gas Protocol guidance, this figure has been
calculated using residual-mix emission factors where available
for our UK, US and Swedish operations. In our other significant
operating regions, residual-mix emission factors are either
unavailable or the resulting absolute emissions at Group level
are within the margin of error and, therefore, country-specific
emissions factors have been used in line with the GHG
Protocol Guidance.

Metrics and targets
Due to the differences in geography and
function, each business unit implements its
own environmental goals and initiatives which
broadly focus on materials resilience, energy
and climate change, and waste, emissions
and discharges. In all cases, we aim for the
efficient use of resources and a reduction in
waste across the full lifecycle of our products,
from design through to manufacturing, use
and end-of-life.

As a business, we are continually improving
energy efficiency and de-carbonising
our energy supply to reduce greenhouse
gas (GHG) emissions. In the 12 months
to 31 October 2018, Group-wide
GHG emissions have decreased by 2%.

In 2018 our ten largest sites accounted
for approximately 68% of total energy
consumption. All of these sites operate an
environmental management system, with
100% certified to ISO* 14001, with an aim
to reduce their energy consumption and in
turn direct and indirect GHG emissions. A full
Basis of Reporting on our GHG emissions is
available on our website.

2019 priorities
We will continue to drive improvements
in the management of materials and
resources across all businesses and will
develop our environmental policy further
alongside progressing our alignment to
the UN Sustainable Development Goals.

*International Organisation for Standardization.

Deloitte LLP assurance
Deloitte LLP has provided limited assurance on the following performance indicators
at Group level:

Diversity – total employees split by gender and age;

Ethics – employee and third-party enquiries to Ethics Officers and the Ethics Helpline;

Safety – Recordable Accident Rate, the number of major injuries recorded and the
number of fatalities;

Environment – greenhouse gas emissions (total, and Scope 1, 2 and 3); and

Community – total value of Community Investment programme donations.

More online
To see Deloitte LLP’s
unqualified assurance
statement visit
baesystems.com/deloitteassurancestatement

To see our Basis of
Reporting 2018 visit
baesystems.com/2018crdata

BAE SystemsAnnual Report 2018Group financial
review

Peter Lynas
Group Finance
Director

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.

Financial performance

Measures as defined by the Group

Measures defined in IFRS1

Sales3

KPI

Revenue3

£18,407m (2017 £18,487m)

£16,821m (2017 £17,224m)

Underlying EBITA3

KPI

Operating profit3

£1,928m (2017 £1,974m)

£1,605m (2017 £1,419m)

Underlying earnings per share3

42.9p (2017 42.1p)

KPI
BONUS

Basic earnings per share3

31.3p (2017 26.0p)

Operating business cash flow

KPI

Net cash flow from operating activities

£993m (2017 £1,752m)

£1,200m (2017 £1,897m)

Net debt

KPI

£(904)m (2017 £(752)m)

BONUS

Order intake4

£28,280m (2017 £20,257m)

KPI
BONUS

Alternative performance
measure definitions

Order backlog3,4

£48.4bn (2017 £38.7bn)

Accounting change
With effect from 1 January 2018, the
Group adopted IFRS 15 Revenue from
Contracts with Customers, which
outlines principles for the measurement
and recognition of revenue from contracts
with customers. Comparative financial
information has been restated
accordingly. IFRS 9 Financial Instruments
was also adopted from 1 January 2018;
however no adjustments were required
to prior years.

1. International Financial Reporting Standards.
2. Generally Accepted Accounting Principles.
3. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from

Contracts with Customers. See note 37 to the Group accounts for details regarding the restatement.

4. Including share of equity accounted investments.

BONUS

80% of the UK executive directors’ bonuses are based
on the achievement of financial KPIs (see page 107).

Strategic reportGovernanceFinancial statements

Group financial review
continued

Income statement
Sales1 decreased by £0.1bn to £18.4bn
(2017 £18.5bn) as the expected reduction
in Typhoon production activity was largely
offset by growth in our US businesses.

Underlying EBITA1 decreased by £46m
to £1,928m (2017 £1,974m), giving a return
on sales of 10.5% (2017 10.7%). There was an
adverse exchange translation impact of £34m.

Revenue1 decreased by £0.4bn to £16.8bn
(2017 £17.2bn), a 1% decline on a constant
currency basis.2

Operating profit1 increased by £186m to
£1,605m (2017 £1,419m). 2017 included a
£384m impairment in respect of the Applied
Intelligence business, which is excluded from
underlying EBITA. There was an adverse
exchange translation impact of £31m.

Non-recurring items in 2018 of £154m
comprises a Guaranteed Minimum Pension
equalisation charge of £114m, and a loss
on disposal of the Mobile, Alabama,
shipyard of £40m. Non-recurring items
in 2017 of £13m represented a loss on the
disposal of the BAE Systems San Francisco
Ship Repair business.

Amortisation of intangible assets is in
line with the prior year at £85m (2017 £86m).

Impairment of intangible assets in 2018
related to Silversky customer-related intangibles
in the Applied Intelligence business. In 2017,
the charge represented 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 £394m
(2017 £380m). The underlying interest
charge, excluding pension accounting, and
fair value and foreign exchange adjustments
on financial instruments and investments
decreased to £215m (2017 £245m). Net
interest expense on the Group’s pension
deficit was £106m (2017 £173m). There
was a charge in respect of fair value and
foreign exchange adjustments of £73m
(2017 £38m credit) on exchange translation
of US dollar-denominated bonds.

Income statement

Financial performance measures as defined by the Group
Sales

Underlying EBITA

Return on sales

Financial performance measures defined in IFRS3
Revenue

Operating profit

Return on revenue

Reconciliation of sales to revenue
Sales

Deduct Share of sales by equity accounted investments

Add Sales to equity accounted investments

Revenue

KPI

2018
£m

18,407

1,928

10.5%

2017
(restated)1
£m

18,487

1,974

10.7%

£m

16,821

17,224

1,605

9.5%

1,419

8.2%

£m

KPI

18,407

18,487

(2,812)

(2,534)

1,226

16,821

1,271

17,224

Reconciliation of underlying EBITA to operating profit
Underlying EBITA

KPI

Non-recurring items

Amortisation of intangible assets

Impairment of intangible assets

Financial expense of equity accounted investments

Taxation expense of equity accounted investments

Operating profit

Net finance costs

Taxation expense

Profit for the year

Underlying interest expense5

Net interest expense on retirement benefit obligations

Fair value and foreign exchange adjustments on financial instruments and investments

Net finance costs (including equity accounted investments)

Exchange rates
Average

£/$

£/€

£/A$

Sensitivity analysis

Estimated impact on sales of a ten cent movement in the average exchange rate

€

£m

1,974

(13)

(86)

(384)

(34)

(38)

1,419

(346)

(216)

857

(245)

(173)

(380)

2017

1.289

1.141

1.681

£m

1,928

(154)

(85)

(33)

(13)

(38)

1,605

(381)

(191)

1,033

(215)

(106)

(73)

(394)

2018

1.335

1.130

1.786

£m

600

BAE SystemsAnnual Report 2018Taxation expense1, including equity
accounted investments, of £229m (2017
£254m) reflects the Group’s underlying
effective tax rate for the year of 18% which
reduced from 21% in 2017, benefiting from
the reductions to federal taxes in the US.

Looking beyond 2019, 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 tax positions.

The calculation of the underlying effective
tax rate is shown in note 6 to the Group
accounts on page 158.

The underlying effective tax rate for 2019
is expected to increase from 18% to around
20%, with the final rate dependent on the
geographical mix of profits.

Earnings per share
Underlying earnings per share1 for the
year increased by 2% to 42.9p (2017 42.1p).

Basic earnings per share1 was 31.3p
(2017 26.0p).

Orders
Order intake4 increased by £8.0bn to
£28,280m (2017 £20,257m). The most
significant order intakes were for the Qatar
Typhoon and Hawk aircraft and support
package (£5.1bn), Saudi Arabian Typhoon
support continuation (£3.2bn) and a
£1.1bn initial contract for the Australian
Hunter Class frigate programme.

Order backlog1,4 increased by £9.7bn
to £48.4bn (2017 £38.7bn) following
the year’s record order intake.

Earnings per share

Financial performance measures as defined by the Group
Underlying earnings

Underlying earnings per share

2018

2017
(restated)1

£1,370m £1,338m

KPI

42.9p

42.1p

Financial performance measures defined in IFRS3
Profit for the year attributable to equity shareholders

Basic earnings per share

£1,000m

31.3p

£827m

26.0p

Orders
Financial performance measures
as defined by the Group

2018

2017
(restated)1

Order intake4

KPI

£28,280m £20,257m

Order backlog4

£48.4bn

£38.7bn

Reconciliation of underlying EBITA to underlying earnings
Underlying EBITA

Underlying net interest expense (including equity accounted investments)5

Taxation expense (at the underlying effective tax rate)

Non-controlling interests

Underlying earnings

Reconciliation of underlying earnings to profit for the year
attributable to equity shareholders
Underlying earnings

Impact of US tax reform enacted in December 2017

Non-recurring items, post tax

Amortisation and impairment of intangible assets, post tax

Impairment of goodwill

Net interest expense on retirement benefit obligations, post tax

Fair value and foreign exchange adjustments on financial instruments

and investments, post tax

Profit for the year attributable to equity shareholders

Non-controlling interests

Profit for the year

£m

1,928

(215)

1,713

(310)

(33)

1,370

£m

1,370

–

(126)

(97)

–

(87)

(60)

1,000

1,033

£m

1,974

(245)

1,729

(361)

(30)

1,338

£m

1,338

(10)

(68)

(384)

(137)

827

857

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers.

See note 37 to the Group accounts for details regarding the restatement.

2. Current year compared with prior year translated at current year exchange rates.
3. International Financial Reporting Standards.
4. Including share of equity accounted investments.
5. Underlying net interest expense is defined as finance costs for the Group and its share of equity accounted investments,
excluding net interest expense on retirement benefit obligations and fair value and foreign exchange adjustments on
financial instruments and investments.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Group financial review
continued

Cash flow
Operating business cash flow was
£993m (2017 £1,752m), which includes
cash contributions in respect of pension
deficit funding, over and above service
costs, for the UK and US schemes totalling
£330m on a funding basis.

On the Qatar contract there was a net inflow
of approximately £400m to be utilised in 2019.
Timing benefits of £400m seen in 2017 on the
Saudi support contract and UK VAT payment
reversed in 2018. In the Platforms & Services
(US) business there has been working capital
growth on utilisation of advance payments on
international programmes, some late customer
receipts, delivery delays to be recovered in
the near term and new business ramp-up.

Taxation payments decreased to £200m
(2017 £227m) primarily reflecting lower
payments in the US due to the reduction
in the US federal tax rate.

Net capital expenditure and financial
investment was £464m (2017 £444m).
Planned capital investment was made
to support production ramp-up in
Electronic Systems.

Dividends received from equity
accounted investments of £57m (2017
£72m) was primarily receipts from MBDA,
FNSS and Advanced Electronics Company.

Interest received was £25m (2017 £23m).

The cash inflow in respect of acquisitions
and disposals in 2018 of £41m reflects
the reduction in the Group’s shareholding
in Overhaul Maintenance Company (£17m),
cash acquired as part of the ASC Shipbuilding
acquisition (£14m) and cash received on the
sale of the Mobile, Alabama, shipyard (£12m),
offset by purchases of equity accounted
investments. The cash outflow in 2017 of
£11m reflected costs incurred in respect of
the disposal of BAE Systems San Francisco Ship
Repair and the acquisition of IAP Research, Inc.

Interest paid was £203m (2017 £204m).

Equity dividends paid in 2018 represents
the 2017 final (£415m) and 2018 interim
(£288m) dividends.

Dividends paid to non-controlling
interests increased to £28m (2017 £8m),
reflecting a higher payment by Saudi
Maintenance & Supply Chain Management
Company, in which the Group has a
51% shareholding.

There was a cash inflow from matured
derivative financial instruments of £6m
(2017 £83m outflow). The prior year outflow
arose from rolling hedges relating to balances
within the Group’s subsidiaries and equity
accounted investments.

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

Cash flow

Financial performance measures as defined by the Group
Operating business cash flow

Financial performance measures defined in IFRS1
Net cash flow from operating activities

Reconciliation from operating business cash flow
to net cash flow from operating activities
Operating business cash flow

Add back Net capital expenditure and financial investment

Deduct Dividends received from equity accounted investments

Deduct Taxation

Net cash flow from operating activities

Net capital expenditure and financial investment

Dividends received from equity accounted investments

Interest received

Acquisitions and disposals

Net cash flow from investing activities

Interest paid

Net sale/(purchase) of own shares

Equity dividends paid

Dividends paid to non-controlling interests

Cash flow from matured derivative financial instruments

(excluding cash flow hedges)

Movement in cash collateral

Net cash flow from loans

Net cash flow from financing activities

Net (decrease)/increase in cash and cash equivalents

Add back Net cash flow from loans

Add back Cash classified as held for sale

Foreign exchange translation

Other non-cash movements

(Increase)/decrease in net debt

Opening net debt

Net debt

Operating business cash flow

Interest paid, net of interest received

Taxation

Free cash flow (as defined by the Group)2

192 and 193 Notes 25 and 27 to the Group accounts

KPI

2018
£m

993

£m

1,200

£m

993

464

(57)

(200)

1,200

(464)

(341)

(203)

(703)

(28)

(7)

(932)

(73)

–

(188)

102

(152)

(752)

(904)

993

(178)

(200)

615

2017
£m

1,752

£m

1,897

£m

1,752

444

(72)

(227)

1,897

(444)

(11)

(360)

(204)

(1)

(684)

(8)

(83)

(15)

–

(995)

542

–

301

(55)

790

(1,542)

(752)

1,752

(181)

(227)

1,344

1. International Financial Reporting Standards.
2. Free cash flow is defined as operating business cash flow less interest paid (net) and taxation.

BAE SystemsAnnual Report 2018Balance sheet
The £0.3bn increase in intangible assets
to £10.7bn (2017 £10.4bn) mainly reflects
exchange translation.

Property, plant and equipment, and
investment property is £2.0bn (2017 £2.0bn).

Equity accounted investments and
other investments1 increased to £442m
(2017 £328m) mainly reflecting the Group’s
share of profit for the year (£140m) and
reduced pension allocation from the lower
deficit (£8m), less dividends received (£57m).

The Group’s share of the net IAS 19
pension deficit reduced to £3.9bn
(2017 £4.0bn3) mainly reflecting a decrease
in liabilities due to an increase in the discount
rate in the UK and US, partly offset by
lower returns on scheme assets. The major
movements in the net pension deficit are
shown in the bridge chart below.

Details of the Group’s pension schemes are
provided in note 22 to the Group accounts
on page 178.

Balance sheet

Summarised balance sheet
Intangible assets

Property, plant and equipment, and investment property2

Equity accounted investments and other investments

Working capital2

Group’s share of the net IAS 19 pension deficit (see below)

Net tax assets and liabilities

Net other financial assets and liabilities

Net debt

Net assets held for sale

Net assets

2018
£m

2017
(restated)1
£m

10,658

10,378

2,017

442

(3,288)

(3,932)

449

(904)

106

5,618

1,977

328

(3,595)

(4,022)

413

(752)

4,755

KPI

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers
and to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s
defined benefit pension schemes. See note 37 to the Group accounts for details regarding the restatement.

2. 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
Cash and cash equivalents

Debt-related derivative financial instrument assets

Loans – non-current

Loans and overdrafts – current

Net debt

Exchange rates
Year end

£/$

£/€

£/A$

KPI

£m

3,232

163

£m

3,271

(3,514)

(4,069)

(785)

(904)

(14)

(752)

2018

1.274

1.114

1.809

2017

1.353

1.126

1.730

Accounting net pension deficit – bridge (£bn)3

Maturity of the Group’s borrowings (£bn)

20173

Add back 2017 allocation4

Change in mortality assumptions

Actual return on assets

Interest on liabilities

Real discount rate

Other

Deduct 2018 allocation4

2018

178 Note 22 to the Group accounts

(4.0)

(0.3)
0.2

(0.7)

(0.2)
0.3

(3.9)

(0.8)
1.6

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

(2.3)
(2.3)

(1.7)

(1.1)
(1.1)

(0.7)
(0.75)

176 Note 20 to the Group accounts

(4.3)

(3.5)

(3.1)

(2.7)

3. The prior year deficit has been restated to correct a prior year error in respect of the
accounting valuation of a longevity swap held by one of the Group’s defined benefit
pension schemes.

4. Amounts allocated to equity accounted investments.
5. Repayable in 2041 (£0.3bn) and 2044 (£0.4bn).

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Changes in accounting policies
Effective 1 January 2019, BAE Systems
adopted IFRS 16 Leases. The Group’s results
announcement for the half year ending
30 June 2019 will be the first to be prepared
under IFRS 16. The Group will transition in
accordance with the modified retrospective
approach, and prior year information will
not be restated.

IFRS 16 requires a lessee to recognise assets
and liabilities for almost all leases. In the
income statement, operating lease charges
will be replaced by depreciation and interest
expenses. The estimated impact on the Group
in 2019 is expected to be an increase in EBITA
of £50m, offset by an increase in finance costs
of £50m, with an immaterial impact on profit
after tax and underlying earnings. On transition,
right-of-use assets will be recognised on the
balance sheet of £1,300m with a lease liability
of £1,486m and a transition adjustment of
£92m will be recognised as a debit to retained
earnings. The Group will also recognise
a finance lease receivable balance of £70m,
a reduction in our investment in equity
accounted investments of £11m and a
deferred tax asset of £2m. Details of the
impact of IFRS 16 are provided in note 38
to the Group accounts on page 210.

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.

Group financial review
continued

A net deferred tax asset of £0.7bn (2017
£0.7bn) relating to the Group’s pension
deficit is included within net tax assets
and liabilities.

In aggregate, there was a £0.3bn increase
in working capital largely reflecting the
reversal of 2017 timing benefits, costs incurred
against provisions, advance payment utilisation,
delivery timings and new business ramp-up,
partly offset by the Qatar net inflow.

The Group’s net debt at 31 December 2018
is £904m, a net increase of £152m from the
position at the start of the year, of which
£86m relates to exchange translation. In June
2019, a $1.0bn (£0.8bn) bond will become
due for repayment. The maturity of the
Group’s borrowings is shown in the chart
on the previous page.

Cash and cash equivalents of £3,232m
(2017 £3,271m) are held primarily for the
repayment of debt securities, pension deficit
funding, payment of the 2018 final dividend
and management of working capital.

Net assets held for sale represent the
UK-based combat vehicles business, where
the Group has entered into an agreement
with Rheinmetall to form a joint military land
vehicle design, manufacturing and support
business, in which BAE Systems will retain
a 45% stake, and also the Group’s 75.6%
shareholding in Aircraft Accessories and
Components Company, the disposal of
which completed in January 2019.

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 £16.8bn (year ended 31 December 2018)
See note 1 to the Group accounts
Carrying value of goodwill
Goodwill £10.2bn (at 31 December 2018)
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 2018)
See note 14 to the Group accounts
Tax provisions
Tax provisions £361m (at 31 December 2018)
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 2018)
See note 22 to the Group accounts

142 For more information

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:

Category

Stable

Outlook

Rating
Moody’s Investors Service
Baa2
Standard & Poor’s Ratings Services
BBB
Fitch Ratings
BBB

Stable

Investment grade

190 Note 24 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 13.2p per share making a total of 22.2p
per share for the year, an increase of 2%
over 2017. At this level, the annual dividend
is covered 1.9 times. Subject to shareholder
approval at the 2019 Annual General Meeting,
the dividend will be paid on 3 June 2019
to holders of ordinary shares registered
on 23 April 2019. The ex-dividend date
is 18 April 2019.

At 31 December 2018, the Company had
retained earnings of £2.8bn (2017 £2.6bn), the
non-distributable portion of which is £701m
(2017 £649m) (see page 212). Total external
dividends relating to 2018 are £710m (2017
£695m), including the interim dividend paid
during the year of £288m (2017 £280m) and
the final dividend proposed of approximately
£422m (2017 £415m). 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 pages 81 and 82).

BAE SystemsAnnual Report 2018Treasury
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
April 2023 is available to meet 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:
(a) the income statements or balance
sheets of foreign subsidiaries; and

(b) equity accounted investments it

regards as long-term investments.

195 Note 29 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).

157 Note 6 to the Group accounts

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Guidance for 2019

Whilst the Group is subject to geopolitical
uncertainties, the following guidance is provided
on current expected operational performance.

For the year ending 31 December 2019, we expect the Group’s underlying earnings
per share to grow by mid-single digit compared to the full-year underlying earnings
per share in 2018 of 42.9p, assuming a US$1.30 to sterling exchange rate.
The guidance is based on the measures used to monitor the underlying financial
performance of the Group. Reconciliations from these measures to the financial
performance measures defined in International Financial Reporting Standards
for 2018 are provided in the Group financial review on pages 35 to 41.

Electronic Systems

Cyber & Intelligence

Platforms & Services (US)

– Sales, in US dollar terms, are expected to
show mid-single digit growth driven by a
number of electronic warfare contracts and
APKWS® volumes. Some 70% of projected
sales are in the 2018 closing order backlog,
similar to the prior year.

– Margin1 is expected to remain in a range

of 14% to 16%.

– In aggregate, sales, in US dollar terms,
are expected to be relatively stable.
The US business, which represented some
70% of this segment in 2018, is expected
to be largely unchanged.

– In the Applied Intelligence business we

expect to see some top line growth, coming
from both the Government and Financial
Services areas.

– Margin1 in 2019 is expected to improve to

be around 7%. The US business is expected
to contribute around the 8% to 9% mark.
In Applied Intelligence, we expect the
business to move back into profitability,
albeit at an initial low margin.

– Sales growth, in US dollar terms, is
expected to be mid- to high-single
digit with increasing volumes from the
US Combat Vehicles and Weapon Systems
businesses, as well as higher ship repair
activity. More than 80% of guidance is
within the closing order backlog, a stronger
starting point than at this time last year.

– Margin1 is expected to improve to the
8% to 9% range, after the charges
taken in 2018.

– HQ costs are expected to be slightly

higher than 2018.

– Underlying finance costs are expected
to be slightly lower with six months of
benefit from the maturing $1bn (£0.8bn)
bond which carries a 6.3% coupon.
– The underlying effective tax rate is

expected to increase from 18% to around
20%, with the final rate dependent on
the geographical mix of profits.

– The expected increase in In-Kingdom
ownership and workshare into our
Saudi companies will lead to an increase
in the non-controlling interest expense
to the Group.

– The adoption of IFRS 16 Leases is expected
to increase both EBITA and finance costs
by an estimated £50m, but is expected
to have no material impact on earnings
per share2.

– The Group has delivered £2bn of free
cash flow in the period 1 January 2017
to 31 December 2018, and is targeting in
excess of a further £3bn of free cash flow
over the three-year period 2019 to 2021,
assuming a US$1.30 to sterling exchange
rate. Free cash flow generation will,
however, not be linear over the three-year
period and, in 2019, the cash profile of the
Typhoon Qatar contract and capital
expenditure required to support our
growing US businesses will mean that
we would expect the Group’s net debt
at 31 December 2019 to increase slightly
from the net debt at 31 December 2018.

Air

– Sales are expected to be some 10%
higher, for activity on the new Qatar
Typhoon and Hawk programme and the
continued ramp-up on F-35. More than
85% of guidance is within the closing
order backlog.

– Margin1 is expected to be lower than
2018, towards the bottom end of our
11% to 13% range. There will be minimal
profit recognition on the Qatar sales, given
the early stage of the programme, and
company-funded research and development
expenditure increases for the Tempest
future combat air programme.

Maritime

– Sales are expected to be stable. Activity

levels on the Carrier programme will decline
as it moves towards completion. This is
expected to be largely offset by increases
on the Dreadnought submarine and Type 26
programmes. Around 95% of guidance
is already covered by the order backlog.

– Following the charges taken on the Offshore
Patrol Vessels programme in 2018, margin1
levels are expected to improve back into the
8% to 9% range.

1. Underlying EBITA as a percentage of sales.
2. The EBITA impact by segment is provided in note 38 to the Group accounts on page 210.

BAE SystemsAnnual Report 2018Segmental
review

The Group reports its
performance through five
principal reporting segments.

Financial performance measures

As defined by the Group

Defined in IFRS2

Year ended 31 December 2018

Electronic Systems

Cyber & Intelligence

Platforms &
Services (US)

Air

Maritime

HQ3

Deduct Intra-group

Deduct Taxation4

KPI

Underlying
EBITA
£m

Return
on sales
%

606

15.3

431

KPI
Operating
business
cash flow
£m

KPI

Order
intake1
£m

4,624

111

210

6.6

7.0

1,802

(30)

3,693

Sales
£m

3,965

1,678

3,005

Order
backlog1
£bn

5.4

1.9

5.4

Revenue
£m

3,965

1,678

2,864

6,712

859

12.8

666

14,845

27.4

5,579

2,975

209

7.0

3,513

9.0

2,940

590

161

810

191

350

(278)

(67)

(226)

358

0.1

(206)

(555)

(0.8)

(246)

Operating
profit/(loss)
£m

Return
on revenue
%

Net cash
flow from
operating
activities
£m

14.9

575

3.5

5.6

14.5

6.5

719

190

(211)

(200)

Total

18,407

1,928

10.5

993

28,280

48.4

16,821

1,605

9.5

1,200

With effect from 1 January 2018, the Group revised its reporting segments to reflect the organisational changes announced in 2017. The five
principal reporting segments are Electronic Systems, Cyber & Intelligence, Platforms & Services (US), Air and Maritime. These align with the
strategic direction of the Group. Financial information for 2017 has been re-presented to reflect these new segments.

We use financial performance measures as defined by the Group to monitor the underlying financial performance of the Group’s reporting
segments. Reconciliations from these measures to the financial performance measures defined in IFRS2 are provided in the Group financial
review on pages 35 to 41. Reconciliations by reporting segment for revenue and operating profit are included in note 1 to the Group accounts
(see page 148) and for net cash flow from operating activities in note 25 to the Group accounts (see page 192).

1. Including share of equity accounted investments.
2. International Financial Reporting Standards.
3. HQ comprises the Group’s head office activities, together with a 49% interest in Air Astana.
4. Taxation is managed on a Group-wide basis.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Electronic Systems
Segmental review
continued

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 provides a depth of
capability in advanced electronic warfare
solutions 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 resiliency products.

Controls & Avionics develops and produces
electronics for military and commercial aircraft,
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.

Sales by domain (%)

Sales by line of business (%)

Sales analysis: Defence and commercial (%)

Land
17%

Maritime
4%

Air
79%

Controls &
Avionics/Power
& Propulsion
Solutions
24%

Electronic
Combat
30%

Commercial
22%

Defence
78%

C4ISR
Systems
26%

Survivability,
Targeting & Sensing
20%

BAE SystemsAnnual Report 2018Employees1

15,900

Operational and strategic key points
– Continued production ramp-ups on

– New facilities being established in

F-35 Lightning II hardware, with initial
funding on Low-Rate Initial Production
Lot 13

Huntsville, Alabama, and Manchester,
New Hampshire to increase capacity
and expand operations

– Further awards for APKWS® laser-guided
rockets secured worth nearly $400m
(£314m) and production capacity ramping
towards 25,000 units per annum

– Delivered the 10,000th electric hybrid
bus system and continue to pursue
expanding capabilities in the air and
maritime domains

– Continued growth in classified work,

increasing to 11% of the business

Our strategy in action

APKWS® –
ramping-up to
meet increased
demand

We are delivering APKWS® laser-
guided rockets to meet customer
demands while maintaining an
unwavering commitment to quality.

Our state-of-the-art precision guidance
system manufacturing facilities in
New Hampshire and Texas, along with
a strong supplier network, have enabled
us to accelerate full-rate production,
exceed manufacturing expectations,
and deliver units to meet the increased
customer demand.

APKWS® is experiencing growing
demand, and our Survivability,
Targeting & Sensing team continues
to ramp-up production capacity as it
builds toward an annual production
level of 25,000 units.

Financial performance
Financial performance measures
as defined by the Group

Financial performance
measures defined in IFRS3

Sales

Underlying EBITA

Return on sales

Operating business

cash flow

Order intake1

Order backlog1

KPI

2018

2017
(restated)2

£3,965m £3,598m

Revenue

£606m

15.3%

£541m

Operating profit

15.0%

Return on revenue

Cash flow from

2018

2017
(restated)2

£3,965m £3,598m

£590m

14.9%

£521m

14.5%

£431m

£450m

operating activities

£575m

£569m

£4,624m £4,175m

£5.4bn

£4.8bn

– Sales compared to 2017, in US dollar

terms, were up 14% at $5.3bn (£4.0bn).
The growth came in the electronic warfare
business from the F-35 programme as well
as increasing classified activity. As expected,
sales of the APKWS® product doubled over
the year and now represent one of the top
three sales lines in the segment. Commercial
sales of engine and flight controls, and
hybrid electric drive units also grew, and
amount to some 22% of the segment.

– Underlying EBITA was up to $809m
(£606m), delivering a return on sales
of 15.3%, within our guidance range.

– As expected, cash conversion of EBITA
improved in the second half of the year
and was at 81% for the full year excluding
pension deficit funding. Capital expenditure
in the business amounted to some $200m
(£150m).

– Order backlog was secured at a record high
of $6.9bn (£5.4bn), following awards for
further F-35 systems, classified electronic
warfare activity and APKWS® units.

Alternative performance
measure definitions

1. Including share of equity accounted investments.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts

with Customers. See note 37 to the Group accounts for details regarding the restatement.

3. International Financial Reporting Standards.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental review
continued

Operational performance
Electronic Combat
BAE Systems continues to sustain its leadership
position in the US electronic warfare market
with production continuing to ramp-up across
a number of programmes, some of which
are classified.

Low-Rate Initial Production Lot 11 hardware
deliveries continue on the F-35 Lightning II
programme. We have received initial Lot 12
and 13 funding, and are currently negotiating
Lots 12, 13 and 14 with an anticipated final
award value exceeding $1bn (£0.8bn).
BAE Systems is also executing an Electronic
Warfare Performance Based Logistics contract
from Lockheed Martin to provide material
availability and support for the F-35
programme over a five-year period.

Following our 2015 selection by Boeing to
develop and manufacture the next-generation
digital electronic warfare system for the
US Air Force’s Eagle Passive Active Warning
Survivability System (EPAWSS) programme
to upgrade up to 200 F-15E aircraft, we are
currently executing the $194m (£152m)
engineering and manufacturing development
contract, with a critical system delivery
completed in 2018.

Under a contract by Boeing and Warner
Robins Air Logistics Complex totalling more
than $1bn (£0.8bn), BAE Systems completed
the installation of the Digital Electronic
Warfare System (DEWS) on new F-15 aircraft,
and continues to upgrade existing F-15 aircraft
and provide spare units and modules for an
international customer. We are also executing
a $311m (£244m) contract to provide DEWS
to support the sale of new F-15 aircraft to
another international customer.

Production of BAE Systems’ sensor technology
for the Long Range Anti-Ship Missile (LRASM)
continues with orders from prime contractor
Lockheed Martin. We provided the sensor
technology that supported several successful
tests of LRASM leading to a successful Early
Operational Capability on the B1-B platform.
We have also been awarded the LRASM
Radio Frequency Sensor 110 Production
Build valued at over $75m (£59m).

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, and we will continue to
sustain the existing EC-130H electronics.
We also execute multiple contracts to
cross-deck the mission electronics onto
a new Gulfstream G550 business jet for
the US Air Force.

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 25,000 units
produced as at year end. In addition to
expanding US military use, the system is
generating strong international attention,
with 20 nations expressing formal interest.
The programme has received awards totalling
nearly $400m (£314m) this year, as part of
a 2016 Indefinite Delivery, Indefinite Quantity
contract. Production capacity is set to increase
from 10,000 units per annum to 25,000 units
per annum to meet the increased demand for
cost-effective guided munitions for US armed
forces and allied international customers.

We are developing a next-generation missile
warning system for the US Army under the
Limited Interim Missile Warning System
programme awarded in 2017. Critical design
reviews and initial prototypes have been
completed on schedule.

The US Army’s Family of Weapon Sights –
Crew Served programme is in development
testing. This seven-year contract awarded
in 2016 has a potential value of up to
$384m (£301m).

Both fixed and rotary-wing demonstrations
of our Striker® II helmet-mounted display
(HMD) are ongoing and we continue to
validate it as a readily accessible HMD for
existing aircraft with analogue-based or
digital electronic systems.

The LiteHUD® Head-Up Display has completed
development testing and has been selected
by critical launch customers for integration
on multiple platforms, including the Textron
Scorpion jet.

C4ISR Systems
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 continue to execute 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 for a system to be fielded
on various surface ship types. The programme
completed Critical Design Review in 2018.

Since winning the Geospatial Data Services
Foundational GEOINT Content Management
programme in 2014, we have been awarded
orders valued at $240m (£188m) and are
meeting 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, user acceptance under the
$132m (£104m) Tactical Signals Intelligence
Payloads programme for the US Army’s
Gray Eagle unmanned aircraft is complete.
Follow-on awards are expected in 2019.

Work continues on state-of-the-art
processing capabilities for the US Navy’s
P-8A Poseidon maritime surveillance
aircraft programme which is expected
to be worth $1.2bn (£0.9bn) over its life.
We have delivered our hundredth system.

Controls & Avionics
BAE Systems is a major supplier of full
authority digital engine controls (FADECs),
fly-by-wire flight controls, vehicle
management systems, mission systems,
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 is
progressing, with all hardware in qualification
and systems integration testing to support
a 2019 first flight.

Flight testing of the Boeing 737 MAX 7
aircraft is continuing with our spoiler controls,
flight deck systems and utilities electronics,
with entry into service planned for 2019.
Initial development has begun on the
changes required for the MAX 10 variant.

BAE SystemsAnnual Report 2018Development of our civil active inceptors for
the Gulfstream G500 and Embraer KC390
aircraft is complete and aircraft certification
has been received. A derivative of the active
inceptors, the LinkEdge™ (Active Parallel
Actuation Subsystem), is being developed
for the Chinook CH-47 and is currently in
integration testing.

FADEC Alliance, a joint venture between
GE Aviation and FADEC International
(our joint venture with Safran Electronics
& Defense), has broadened its agreement
with GE Aviation to include collaboration
on system architectures and technologies for
future engines. FADEC Alliance will develop,
produce and support FADECs for all future
GE Aviation commercial engines. The GE9X
FADEC for the Boeing 777X has completed
certification testing and Low-Rate Initial
Production will begin in 2019.

Development has begun on the next-
generation advanced digital flight control
computer for the F-16 aircraft for the
United Arab Emirates.

On the F-35 Lightning II programme,
Low-Rate Initial Production Lot 11 is ongoing
for the vehicle management computer
and active inceptor system equipment, and
a successful systems requirements review
was held on the competitively-awarded
F-35 vehicle management computer
technology refresh.

Power & Propulsion Solutions
This year we achieved a major milestone,
delivering our 10,000th electric hybrid bus
system and we continue to pursue expanding
our capabilities for application in the maritime
domain, and for the airborne market by
marrying our safety-critical know-how from
the Controls & Avionics business with our
hybrid electric expertise. As transit operators
in cities such as San Francisco, Boston,
Montreal, London and Brussels lean toward
more electric power, our solutions meet
operational goals towards totally emission-free
operations. We are prepared for the future of
transit with zero emission solutions as early
providers of battery-electric propulsion
solutions and hydrogen fuel cell-based
systems. Paris has recently become the latest
city to commit to battery-electric vehicles
powered by our technology and in the US
more than 20 hydrogen fuel cell transit buses
are operating with our propulsion systems,
which are expected to pave the way for the
world’s first passenger vessel powered by
hydrogen in 2019.

We are also using our clean technology to
power passenger vessels, research vessels,
and inland towboats to address the increased
demand for environmentally friendly
marine vessels.

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

Segmental
looking forward

Our strategy in action

Improving
reliability

In the commercial aircraft industry,
extending the life of ageing assets
is essential to airlines operating
at peak efficiency. We offer cost-
effective overhaul and asset
management programmes
designed to keep fleets flying.

These programmes include overhaul
options for flight controls and full
authority digital engine controls, and
lease and exchange arrangements that
ensure spare parts are available when
needed. Programmes can be tailored
to meet the needs of each customer
and are a proven discriminator in the
success of the aftermarket segment
of the business.

One such programme is for Slat/Flap
Control Computers (SFCC), launched
in autumn 2018. SFCCs are essential
avionics used during take-off and
landing to control speed on more than
4,000 Airbus A320s. This system was
our second product-specific aftermarket
programme launched during the period,
following the 777 Actuator Control
Electronics Exchange programme.

Group strategic
framework

More online
baesystems.com

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Cyber & Intelligence
Segmental review
continued

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 comprises the three
US-based Intelligence & Security businesses.

Air Force Solutions focuses on providing the
US Air Force and its combatant commands
with innovative solutions to help modernise,
maintain, test, and cyber-harden aircraft,
radars, missile systems, and mission
applications that detect and deter threats
to national security.

Integrated Defense Solutions provides the
US Army, Navy, and federal civilian markets
with systems engineering, integration, and
sustainment services for C4ISR systems and
enterprise IT networks that enhance mission
effectiveness. Our solutions are deployed
across platforms and networks in the
air, maritime, land and cyber domains.

Intelligence Solutions provides innovative
mission-enabling solutions and services
to enhance the collection, analysis, and
processing of data across the US civilian
and military intelligence communities.
Our business also develops and deploys
high-assurance networks that facilitate the
secure sharing of data amongst intelligence
agencies in support of national security.

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. Our solutions
are delivered as licensed technologies,
software-as-a-service subscriptions, through
outsourced managed services, and via
consulting and systems integration projects.

Government is focused on delivering
national security and intelligence solutions
to the UK government and allied international
governments. The business also delivers
enterprise-level data and digital services
to UK government departments.

Financial Services delivers anti-fraud and
regulatory compliance solutions to banking
and insurance customers across Europe,
North America, the Middle East, Africa
and Asia-Pacific.

Technology & Commercial provides security
advisory and managed security services to
a range of commercial customers in the
UK and North America.

Sales by business (%)

Sales analysis: Intelligence & Security (%)

Sales analysis: Applied Intelligence (%)

Applied
Intelligence
30%

Intelligence
& Security
70%

Intelligence
Solutions
40%

Air Force
Solutions
27%

Technology
& Commercial
17%

Government
62%

Integrated Defense
Solutions
33%

Financial
Services
21%

BAE SystemsAnnual Report 2018Employees1

10,300

Operational and strategic key points
Intelligence & Security

– New awards valued at approximately

$320m (£251m) to provide motion-imagery
analysis, training and research support
services to the US intelligence community

– Secured a five-year, $90m (£71m)

US Navy contract to provide engineering
and technical support for fixed, airborne and
mobile intelligence collection platforms

– Awarded additional change proposals
worth $55m (£43m) to support the
US Air Force ICBM Integration Support
Contractor programme

Applied Intelligence

– 2017 restructuring programme completed,

returning the business to break-even

Our strategy in action

Collaborating
on cloud

In April, we announced the first in
a series of strategic collaboration
agreements to market the first
scalable, hybrid cloud solution
of its kind to the US government.

The federated secure cloud, developed
by BAE Systems and Dell EMC, is
designed from the ground up to meet
both the mission needs and security
requirements for any US intelligence
community, Department of Defense, or
federal/civilian government organisation.

The federated secure cloud has the
flexibility to deploy to public, on-premise
or hybrid cloud environments, to include
smaller tactical deployments. The
solution enables rapid deployment of
secure cloud services without the costly
delay of long security engineering and
authorisation cycles.

Additional market collaborations with
Splunk Inc. and Flexera reflect our
strategy to drive the best commercial
cloud technologies on the market to
the US government.

Financial performance
Financial performance measures
as defined by the Group

Financial performance
measures defined in IFRS3

Sales

Underlying EBITA

Return on sales

Operating business

cash flow

Order intake1

Order backlog1

KPI

2018

2017
(restated)2

2018

2017
(restated)2

£1,678m £1,818m

Revenue

£1,678m £1,818m

£111m

6.6%

£58m

3.2%

Operating profit/(loss)

Return on revenue

Cash flow from

£59m

3.5%

£(361)m

(19.9)%

£85m

£116m

operating activities

£96m

£127m

£1,802m £1,859m

£1.9bn

£2.1bn

– Cash conversion of EBITA for the year was
at 95%, excluding pension deficit funding.

– In aggregate, order backlog reduced

to $2.4bn (£1.9bn). In the US Intelligence
& Security business, order backlog was
adjusted for the closed out service contract.

– In aggregate sales were 5% lower on a

constant currency basis at $2.2bn (£1.7bn).
The US Intelligence & Security business
saw a 4% decrease, largely as a result
of the customer’s decision to end a shared
IT services environment contract. In the
Applied Intelligence business, sales declined
by 9% as pursuit of sales growth was
tempered to enhance profit performance.

– Despite the sales reduction, the aggregate
return on sales for the sector was improved
to 6.6%. In the US business return on sales
was similar to last year at 9.0%. The Applied
Intelligence business returned to break-even
as the cost reduction actions under the 2017
restructuring programme delivered to plan.

Alternative performance
measure definitions

1. Including share of equity accounted investments.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts

with Customers. See note 37 to the Group accounts for details regarding the restatement.

3. International Financial Reporting Standards.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental review
continued

Operational performance
Intelligence & Security
Air Force Solutions
We were awarded engineering change
proposals valued at more than $55m (£43m)
under the US Air Force Intercontinental
Ballistic Missile Integration Support Contractor
programme. The awards increased the total
lifecycle value of the programme to $972m
(£763m). Our work includes programme
management, systems engineering,
integration and testing, sustainment,
and cyber defence.

To support US Air Force testing and
training operations, we were awarded
contracts totalling just over $58m (£46m)
in 2018 to provide a proprietary electronic
warfare/electronic attack solution.

Our business earned a position on a new
nine-year Indefinite Delivery, Indefinite
Quantity contract with the US Department
of Defense, which positions us to bid on
upcoming research, development, testing,
and evaluation task orders to support the
future needs of the US military across physical
and digital domains. The contract affords us
opportunities to leverage our investments in
artificial intelligence and machine learning.

We secured a three-year, $37m (£29m)
contract to continue providing the US Air
Force with obsolescence management
support for which we have been the
provider of choice since 1991.

Integrated Defense Solutions
Our US Navy Strategic Systems Program
experts are executing the third year of a
five-year, $368m (£289m) sole-source contract
to support weapons systems on board
US Ohio and UK Vanguard Class submarines,
as well as future Ohio Class replacement
and UK Dreadnought Class submarines.

In October, we secured a five-year, $106m
(£83m) contract to continue providing logistics
and information technology support services
to the US Navy’s Strategic Systems Program.
Our team provides logistics support for the
US and UK Navies’ Trident II submarines,
US submarine support facilities and US Ohio
Class guided-missile submarines.

In November, we earned a five-year, $79m
(£62m) contract to continue maintaining and
operating multiple electronic, communication,
and computing platforms for the US Navy.
The programme, which supports the Naval
Computer and Telecommunications Area
Master Station, Pacific, provides 24/7 mission
support for ship-to-shore, shore-to-aircraft,
and shore-to-shore long-range
communications systems.

Also in the maritime domain, we received a
five-year, $90m (£71m) US Navy contract to
continue providing engineering and technical
support for a variety of fixed, airborne, and
mobile intelligence collection platforms.
The business also secured a four-year, $44m
(£35m) contract to provide munitions handling
and management support for the US Navy’s
Pacific fleet.

We were selected for Indefinite Delivery,
Indefinite Quantity contracts to pursue
new work in support of the US government.
Two of the contracts are single-award, with
a total potential value of more than $150m
(£118m) to support the rapid integration
and sustainment of command, control,
communications, reconnaissance, and combat
systems for the Naval Air Warfare Center
Aircraft Division. Under the third contract,
which has a maximum value of $72m (£57m),
we will compete for future task orders to
provide equipment modification, system
safety work, test bed operations, and
technical services to support air traffic
control and landing systems on ships and
at US Navy facilities.

Intelligence Solutions
New task order contracts valued at
approximately $320m (£251m) were won
to provide motion-imagery analysis, training,
and research support services to the
US intelligence community.

The US Army awarded the business a
four-year, $100m (£79m) contract to provide
technical, functional, and general support to
enhance the overall situational awareness and
training of troops deployed around the world.

A US Department of Defense contract to
continue providing mission-critical intelligence
analysis support for forward-deployed soldiers
was revised by the customer to a total lifecycle
value of more than $110m (£86m) over an
18-month period.

We secured a five-year, $73m (£57m) contract
to expand our analysis portfolio in support of
the US intelligence community.

BAE SystemsAnnual Report 2018Technology & Commercial
The business has won a number of
significant multi-year Managed Security
Services deals with UK and US commercial
customers in the year, facilitated by investment
in the product offering to enhance customer
experience. We continue to see high levels
of demand for the outsourcing of security
monitoring through specialist operations
centres, driven in the main by the increasing
importance companies are placing on
mitigating ever-increasing cyber risks. The
level of customer churn with US small and
medium-sized businesses has increased in
the year, contributing to reduced revenue
levels in this area.

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

Segmental
looking forward

Applied Intelligence
Applied Intelligence delivered a full year
break-even position as a result of significant
benefits from the restructuring activity
undertaken at the end of 2017. This
improvement in profitability has been
delivered through removing surplus delivery
capacity, relocating roles to lower cost
international delivery centres, exiting certain
unprofitable markets and improving the
organisational structure. Following the
embedding of the organisational changes,
the second half of the year has seen an
increase in headcount and focused investment
initiatives to drive higher levels of growth in
the future.

Government
The Government business has delivered
growth in orders from key accounts across
UK government customers as demand for
our national security and intelligence offerings
remains strong. There has been an increased
focus on investment in our people throughout
the year to enhance capability required to
support specialist customer requirements
while also improving employee retention
in a competitive labour market.

Financial Services
The business has continued to see steady
demand for anti-fraud and regulatory
compliance products across multi-national
financial institutions. Strong customer loyalty
has been maintained through a number of
product upgrades with established key
accounts. Investment in product engineering,
primarily NetReveal® and Managed Security
Services, has increased in the year to drive
higher levels of demand in 2019 and beyond.
Emerging product offerings, such as broader
data and digital services, are also proving
to be in demand.

Our strategy in action

Data analytics
trial assisting child
protection work

In partnership with UK child protection
and law enforcement agencies, we
undertook a trial to implement our
data analytics technology into the
child protection system.

High profile cases of child abuse and
neglect in the UK have highlighted poor
data sharing as a key reason why abuse
and neglect is not identified sooner.
Through predictive analytics and
visualisation with our NetReveal™
software, we created an innovative,
joined-up view of risk around vulnerable
children, driving a safer, fairer and faster
response to concerns raised about
children’s welfare.

The project took three years’ worth
of disparate, historical data sets and
analysed them in just four hours,
allowing practitioners to research
cases significantly faster and presented
a rich and complete analysis of the
information in a visually engaging way.

The next stage will see the technology
move beyond the successful proof of
concept to an operational trial, where
the true extent of the benefits can be
evaluated in a live setting.

Group strategic
framework

More online
baesystems.com

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Platforms & Services (US)
Segmental review
continued

Platforms & Services (US),
with operations in the US, UK
and Sweden, manufactures
combat vehicles, weapons
and munitions, and delivers
services and sustainment
activities, including naval ship
repair, and the management
and operation 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
and operation of 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 four operational sites
in the US located on the Atlantic and
Pacific coasts and 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 Turkish
and international customers.

Sales by domain (%)

Sales by line of business (%)

Sales analysis: Platforms and services (%)

Land
59%

Air
1%

Maritime
40%

FNSS
4%

BAE Systems
Hägglunds
5%

US Combat
Vehicles
30%

Services
72%

Platforms
28%

US Ship
Repair
28%

Weapon
Systems
33%

BAE SystemsAnnual Report 2018Employees1

11,900

Operational and strategic key points
– Selected by the US Marine Corps for the

Amphibious Combat Vehicle 1.1 programme

– One of two competitors selected

for the US Army’s Mobile Protected
Firepower programme

– Deliveries of the first batch of M777 ultra-
lightweight howitzers to the Indian Army

– Continued to deliver Mk45 Gun Systems

to US and international customers

– Secured $1.3bn (£1.0bn) in new orders

across the four US shipyards

– In commercial shipbuilding, activities
continue to complete the final ship

– Divested the Mobile, Alabama

shipbuilding yard

– Management changes made and

investment in process and automation
improvements to position the business
for its upcoming growth phase

– An accident in a nitrocellulose drying

facility at Radford sadly resulted in one
fatality and injuries to two employees

Our strategy in action

Supporting
US Navy cruiser
modernisation

BAE Systems continues to play
a key role in supporting the
modernisation of the US Navy’s
fleet of 22 guided-missile cruisers.

Major modernisation work aboard
the USS Gettysburg under a contract
awarded to our Norfolk, Virginia,
shipyard in 2018 begins in early 2019.
In addition to the Gettysburg, across our
four US shipyards, we are working aboard
four other cruisers in various phases
of the modernisation programme.

For the Gettysburg, our scope of work
includes upgrading the ship’s weapons
and engineering equipment; supporting
the installation of a new Aegis combat
system, communications suite and
tactical network; and renovation
of the crew’s living spaces.

The Gettysburg is scheduled to be
completed in mid-2020 and rejoin
the operational fleet soon thereafter.
The work is expected to extend the life
of the 28-year-old warship to 2035.

Financial performance
Financial performance measures
as defined by the Group

Financial performance
measures defined in IFRS3

Sales

Underlying EBITA

Return on sales

Operating business

cash flow

Order intake1

Order backlog1

KPI

2018

2017
(restated)2

£3,005m £2,951m

Revenue

£210m

£237m

Operating profit

7.0%

8.0%

Return on revenue

Cash flow from

2018

2017
(restated)2

£2,864m £2,848m

£161m

5.6%

£213m

7.5%

£(30)m

£222m

operating activities

£31m

£286m

£3,693m £3,542m

£5.4bn

£4.2bn

– Sales in the year, in US dollar terms, were

– Cash flow performance in the year reflects

up 5% to $4.0bn (£3.0bn) but growth was
behind guidance, due to the delayed Paladin
production order award, and the Ship Repair
customer requirement to award each ship
individually, rather than multi-ship awards,
meant we have not been able to maximise
shipyard utilisation.

– Return on sales for the year was at

7.0% following the charges taken in
the first half of the year on the remaining
commercial shipbuilding contract and
for the subcontractor performance issues
on the Radford facilities construction
programme. There were no further charges
taken on those programmes in the second
half of the year. The charges impacted
return on sales by 150bps.

advance payment utilisation on international
programmes, some late customer receipts,
delivery delays to be recovered in the near
term, and new business ramp-up.

– Order backlog increased to $6.8bn (£5.4bn),
supportive of future growth expectations.
Key awards in the year included Low-Rate
Initial Production for the Amphibious
Combat Vehicle for the US Marine Corps,
the Armored Multi-Purpose Vehicle,
Low-Rate Initial Production on Paladin,
and the Mobile Protected Firepower
engineering and manufacturing
development phase for the US Army,
as well as growth in Ship Repair.

Alternative performance
measure definitions

1. Including share of equity accounted investments.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts

with Customers. See note 37 to the Group accounts for details regarding the restatement.

3. International Financial Reporting Standards.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental review
continued

Our strategy in action

India receives
its first M777s

The first M777 ultra-lightweight
howitzers have been delivered
to India under the landmark Foreign
Military Sale agreement between
the US and Indian governments.

We will deliver 145 M777A2 gun
systems under a $542m (£426m) contract
issued in January 2017. Deliveries began
in the second half of 2018, with the first
batch transferred during an official
ceremony in November.

BAE Systems is building the first
25 guns fully assembled, the remaining
120 guns will be assembled in India
by Mahindra Defence Systems Limited
under an arrangement designed to
support defence industrial co-operation
and promote local economic growth.

The delivery of the M777s marks
a key step toward modernising and
strengthening the Indian Army’s
artillery capabilities.

Group strategic
framework

More online
baesystems.com

Operational performance
US Combat Vehicles
The business continues to address
manufacturing and execution challenges
on some programmes as it ramps-up
production levels. Measures undertaken
in the period include management changes
and investments in modernising facilities
and manufacturing technologies, to include
automation and robotic welding.

In June, BAE Systems and industry teammate
Iveco Defence Vehicles were selected to
supply Amphibious Combat Vehicles (ACV)
for the US Marine Corps under the
competitively-awarded ACV 1.1 programme
phase. Low-Rate Initial Production has begun
under a contract initially valued at $198m
(£155m) for 30 vehicles, with options for
a total of 204 vehicles worth up to $1.2bn
(£0.9bn). A second, $140m (£110m)
contract for Low-Rate Initial Production 2
for an additional 30 vehicles was awarded
in December.

In December, the US Army awarded us a
$376m (£295m) contract under the Mobile
Protected Firepower programme for the
engineering and manufacturing development
phase for rapid prototyping efforts and with
Low-Rate Initial Production options included.
We were one of two competitors selected
for this phase. The Army is expected to
down select to a single contractor for the
Low-Rate Initial Production phase in the
first half of 2022.

On the US Army’s Armored Multi-Purpose
Vehicle programme, we received a $298m
(£234m) contract to procure long-lead material
to support Low-Rate Initial Production.
Including the engineering and manufacturing
development phase with options for 280
to 300 vehicles under Low-Rate Initial
Production, the programme has a potential

cumulative value of $1.2bn (£0.9bn). In 2019
we have been awarded contract modifications
worth up to $575m (£451m) for Low-Rate
Initial Production options.

Work continues on a $365m (£287m) contract
for the fourth Low-Rate Initial Production
phase for 48 Paladin self-propelled howitzer
and ammunition carrier vehicles sets, with
an option for an additional 12. A full-rate
production decision is expected in 2019.

The business is nearing completion
on a $322m (£253m) 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. In June we received
a $348m (£273m) contract, initially funded
at $132m (£104m), to upgrade 164 vehicles
to the Bradley A4 configuration.

We continue to work on US Army
contracts awarded in 2017 for upgrades
and sustainment of M88 recovery vehicles,
to include upgrades to the Heavy Equipment
Recovery Combat Utility Lift Evacuation
Systems (HERCULES) configuration. In July,
we received a $114m (£90m) contract for
the follow-on production.

Internationally, we completed deliveries
in 2018 of 41 Assault Amphibious Vehicles
(AAVs) to Japan under contracts totalling
$165m (£130m). We continue to work on
an additional 11 vehicles for Japan. All of the
23 AAVs ordered by Brazil under an $82m
(£64m) contract were also delivered, and work
has begun on an $84m (£66m) contract with
Taiwan for 36 AAVs.

We continue to execute a $54m (£42m)
contract to provide 32 upgraded self-propelled
howitzers to the Brazilian Army, with first
deliveries to take place in 2019.

BAE SystemsAnnual Report 2018Weapon Systems
We have delivered the first M777
ultra-lightweight howitzers to the Indian
Army under a $542m (£426m) Foreign Military
Sale contract to provide 145 M777s. We are
building the first 25 guns in our facilities,
with the remaining systems assembled in
India by Mahindra Defence Systems, our
selected supplier, who has established an
assembly and integration facility in India.

We are executing on a $47m (£37m) contract
modification from the US Navy in December
2017 to deliver four additional Mk45 Gun
Systems upgraded to increase firepower
and extend range. We also received contracts
to provide additional 57mm Mk110 gun
systems for the Navy’s Littoral Combat Ship
programme, and the US Coast Guard’s
National Security Cutter Legend Class and
Offshore Patrol Cutter programmes.

In March, we received a contract to provide
eight payload tubes for two block V version
Virginia Class submarines, each featuring a
new payload module for increased firepower.

Work continues under a 2017 contract
to deliver 155mm BONUS ammunition to
the Swedish Army, and we were awarded
a further contract in 2018 for delivery of
the round to the US Army. The business
is delivering 24 additional Archer artillery
systems under a 2016 contract modification
with the Swedish government. In December,
we received a contract from the Swedish
Armed Forces for two of the newest
40 Mk4 gun systems.

We continue to execute on a $183m (£144m)
contract to provide the Maritime Indirect Fire
System for the Royal Navy’s Type 26 frigate.

We achieved a fifth consecutive award term
providing world-wide lifecycle support for the
M777 ultra-lightweight howitzers that are in
service with the US Marine Corps and Army.
This support contract includes engineering
maintenance, parts repair/replacement and
other field- and depot-level service support.
The M777 team, from both the US and UK,
has now scored five consecutive ‘excellent’
ratings, a 100% record, resulting in the
contract’s extension until May 2023.

In the complex ordnance manufacturing
business, we continue to manage and operate
the US Army’s Radford and Holston munitions
facilities under previously-awarded contracts.
In September, the Army awarded a $97m
(£76m) contract modification for the
construction of a natural gas-fired steam
facility at Holston. Also at Holston, we are
progressing on modernisation contracts
totalling $135m (£106m) for waste water
management and a $146m (£115m)
contract for the construction of a nitric acid
recovery facility to produce larger quantities
of insensitive munitions. At Radford,
subcontractor performance issues and
cost overruns on the nitrocellulose facility
modernisation programme have been
encountered, impacting the financial
performance of the sector.

We are saddened to report that an accident
on 11 June in a nitrocellulose drying facility
in Radford resulted in one fatality and injuries
to two employees. The health and safety of
our employees has always been and continues
to be our highest priority. Investigations
concluded the accident likely resulted from
a unique set of conditions, and processes
were modified to prevent future occurrences.

US Ship Repair
As a leading provider of US Navy ship
repair and modernisation services, we are
strategically located in four of the US Navy’s
primary ports, with the homeported fleet
projected to grow in San Diego and
Jacksonville. Our shipyards are equipped
to service a broad range of maritime vessels,
to include cruisers, destroyers, amphibious
warships and littoral combat ships for the
US Navy, as well as select private and
commercial vessels.

In 2018, we secured firm orders across
our US shipyards totalling approximately
$1.3bn (£1.0bn), including awards to
modernise the USS Philippine Sea in
Jacksonville; the USS Gettysburg in
Norfolk; and the USS Sterett in San Diego.

In commercial shipbuilding, completion,
outfitting and delivery activities for the
final ship, Hull 113, continued. Hull 112
remains a completed asset held on our
balance sheet awaiting the identification
of a new buyer and final sea trials.

Earlier in 2018, we ceased operations at
our Mobile shipyard and in October, we
completed the divestiture of the shipyard.

BAE Systems Hägglunds
With an installed base of nearly 1,300
CV90 vehicles in Sweden and across six
other international markets, the business
continues to execute and pursue a number
of significant CV90 contracts.

We continue to evaluate the opportunity
for the CV90 into Australia’s LAND 400
Phase 3 competition for a Mounted Close
Combat Capability family of vehicles.
Our bid with teammate Patria for the
LAND 400 Phase 2 Combat Reconnaissance
Vehicle was unsuccessful.

We continue to advance local industrial
co-operation arrangements with Czech
companies in support of an anticipated
bid of the CV90 for the country’s next
fleet of infantry fighting vehicles.

Work continues to refurbish Swedish
CV90 vehicles under a contract awarded
in 2016, and we are integrating Mjölner
mortar systems on 40 Swedish CV90s
under a separate contract.

Initial deliveries have begun under a contract
for 32 BvS10 all-terrain vehicles for Austria.
We are also pursuing opportunities for the
BvS10 and its unarmoured sister Beowulf
vehicle in the US.

FNSS
FNSS, our land systems joint venture based
in Turkey, continues to perform under its
$524m (£411m) programme to produce
259 8x8 wheeled armoured vehicles for
the Royal Malaysian Army.

Programme deliveries are on schedule
under the contract with Oman for PARS
Wheeled Armoured Vehicles in 8x8 and
6x6 configurations.

Work progresses under multiple contracts
to Turkish Armed Forces, including a €278m
(£250m) contract to supply 260 Anti-Tank
Vehicles, an €84m (£75m) contract for air
defence vehicles, and a €155m (£139m)
contract to provide 27 amphibious
assault vehicles.

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

Segmental
looking forward

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Air
Segmental review
continued

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
European MBDA joint venture.

Our UK-based business includes programmes
in European and International Markets for
the production of Typhoon combat and
Hawk trainer aircraft, support and upgrades
for Typhoon, Tornado and Hawk aircraft,
and development of next-generation
Unmanned Air Systems and defence
information systems, as well as US
Programmes, primarily the UK-based
F-35 Lightning II manufacture, engineering
development and support activity.

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 primarily delivers
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.

The Type 26 frigate was selected for the
Commonwealth of Australia’s Hunter Class
nine-ship Future Frigate programme, with
a framework agreement including the scope
for the initial design and productionisation
phase signed in December.

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

Sales by line of business (%)

Sales analysis: Platforms and services (%)

Services
62%

Platforms
38%

MBDA
16%

Australia
9%

European and
International Markets
28%

US Programmes
11%

Saudi Arabia
36%

BAE SystemsAnnual Report 2018Employees1

27,800

Operational and strategic key points
– Contract with the Qatar government for

the supply of 24 Typhoon and nine Hawk
aircraft, air and ground training, and ground
support became effective in September.
MBDA contract for the supply of missiles
also became effective

– Signature in March 2018 of a Memorandum
of Intent between the Kingdom of Saudi
Arabia and the UK government to aim to
finalise discussions for the purchase of a
further 48 Typhoon aircraft

– RAF declaration of Typhoon Centurion

standard, enabling transition of capabilities
from Tornado to Typhoon

– Announcement of UK Combat Air Strategy
and launch of the Tempest programme

– Completion of the final four of 12 Typhoon

deliveries to Oman

– In November the first flight of a Hawk
assembled in Saudi Arabia took place

– Integration of F-35 Lightning II onto aircraft
carrier HMS Queen Elizabeth commenced,
and the first F-35 deck landing completed
– Order intake of £3.2bn for support services
up to 2022 in respect of the continuation
of Typhoon support in Saudi Arabia
– Current German government position

on export licensing may affect the Group’s
ability to provide capability to Saudi Arabia
which may have a consequential impact
on the Group’s financial performance
and relationships

– Type 26 frigate selected for the

Commonwealth of Australia’s Hunter
Class nine-ship Future Frigate programme
with the framework agreement including
the A$1.9bn (£1.1bn) scope for the initial
design and productionisation phase signed
in December

Financial performance
Financial performance measures
as defined by the Group

Financial performance
measures defined in IFRS3

Sales

Underlying EBITA

Return on sales

Operating business

cash flow

KPI

2018

2017
(restated)2

£6,712m £7,210m

Revenue

£859m

12.8%

£967m

Operating profit

13.4%

Return on revenue

Cash flow from

2018

2017
(restated)2

£5,579m £6,312m

£810m

14.5%

£918m

14.5%

£666m

£832m

operating activities

£719m

£888m

Order intake1

KPI £14,845m £6,128m

Order backlog1

£27.4bn

£19.5bn

– Sales were down 7% at £6.7bn. As

– The £666m of cash inflow in the year

expected production activity on Typhoon
for the European, Saudi and Oman contracts
has largely completed. The F-35 programme
continues to ramp-up to plan and Middle
East support volumes continue to grow.

– The return on sales of 12.8% was at the top
end of our guidance. There has been some
profit trading on completing the Typhoon
Oman contract with minimal sales, and that
has generated a 70bps benefit within the
reported return on sales.

reflects full consumption of the £300m
early receipts seen in 2017 against the
Saudi Arabia support programme, utilisation
of advances on the residual Typhoon export
contracts, and a net advance now held on
the Qatar programme.

– Order backlog stands at £27.4bn,

significantly higher following the awards
for the £5.1bn Qatar Typhoon and Hawk
programme, the £1.1bn initial contract
under the Australian Hunter Class frigate
programme, and in respect of the £3.2bn
continuation of Typhoon support through
2022 in Saudi Arabia.

Alternative performance
measure definitions

1. Including share of equity accounted investments.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts

with Customers. See note 37 to the Group accounts for details regarding the restatement.

3. International Financial Reporting Standards.

Our strategy in action

State of Qatar
becomes ninth
country to choose
Typhoon

The contract between BAE Systems
and the Government of the State of
Qatar for the supply of 24 Typhoon
and nine Hawk aircraft to the Qatar
Emiri Air Force, along with a bespoke
support and training package,
became effective in September.
It represented a significant step
in our long-term relationship with
the State of Qatar, as it became the
ninth country to choose Typhoon.

The proven combination of Typhoon
and Hawk will provide the Qatari Armed
Forces with the most advanced and
flexible multi-role combat aircraft on the
market today, along with best-in-class
support and training.

With a contract value of around £5bn,
deliveries of the first Hawk aircraft are
expected to commence in 2022 and
the first Typhoon aircraft in 2023.
BAE Systems is the prime contractor
for both the provision of the aircraft
and the agreed arrangements for the
in-service support and initial training.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental review
continued

Operational performance
European and International Markets
The contract entered into between
BAE Systems and the Government of the
State of Qatar, valued at approximately £5bn,
for the supply of 24 Typhoon and nine Hawk
aircraft became effective during September.
The agreement also provides for the supply
of ground support and training to the Qatar
Armed Forces. The business has begun
mobilising resources and supply chain.

The final four out of a total of 12 Typhoon
aircraft were delivered to the Royal Air Force of
Oman during the year. The five-year availability
service contract for the aircraft continues.

Production is ongoing under the Kuwait
Typhoon contract, secured by Italian
Eurofighter partner Leonardo, with all
28 major units now in work. BAE Systems
deliveries will commence in 2019.

In the year, the Royal Air Force accepted
seven Typhoon aircraft from the UK final
assembly facility. The German, Italian and
Spanish Air Forces accepted a total of 15
aircraft, which brings deliveries of Tranche 3
aircraft to 73 of the 88 contracted.

The Royal Air Force declared Typhoon to
have met Centurion standard, enabling the
transition of capabilities from Tornado to
Typhoon. Integration of the Captor E-Scan
radar continues to progress as we conduct
first flight trials to develop and improve
the radar’s capability.

In the UK we continue to support the
Ministry of Defence Typhoon fleet under
a ten-year partnership arrangement which
provides flying hours and we also support
the European Partner Nations support
arrangements at above contractual levels.

Following the £119m contract secured
in 2017 for collaboration on the first
design and development phase of an
indigenous fifth-generation fighter jet
for the Turkish Air Force, activity has
focused on mobilising resources.

Discussions with the Government of India
and Hindustan Aeronautics Limited for the
supply of Hawk aircraft kit sets to be used
to build additional aircraft under licence in
India for the Indian Air Force and Navy, have
ceased pending a clearer understanding
of their requirements.

Support to the Royal Air Force’s UK fleet
of Hawk fast jet trainer aircraft continues
through the long-term availability contract,
along with support to users of Hawk trainer
aircraft around the world.

The UK Combat Air Strategy, announced
in the year, is a significant milestone for the
Air sector and sends a strong signal of intent
about the UK’s commitment to retaining a
leading position in Combat Air. The Tempest
programme is a key enabler to deliver this
strategy and the business is currently
mobilising resources against a contract
awarded in July, whilst also engaging with
industry partners and the Ministry of Defence
to define and mature the technologies and
capabilities that are required.

Our strategy in action

Support for the
UK Typhoon
fleet

In August, we completed the first
two years of an innovative ten-year
partnership agreement with the
UK Ministry of Defence to transform
support of the UK Typhoon fleet.

The Typhoon Total Availability eNterprise
(TyTAN) arrangement introduced new
ways of working to further reduce
the costs of operating the fleet at
RAF Coningsby and RAF Lossiemouth.
The arrangements will aim to enable
an estimated £500m of savings to be
reinvested to develop new capability
enhancements for the aircraft.

TyTAN involves working with partners
across our supply chain to drive
improvements and to deliver the lowest
possible costs to the Ministry of Defence.
The arrangement, which includes a
joint avionics solution with Eurofighter
partner company Leonardo, aims to
reduce the cost of the support service
by around one-third while maintaining
and improving levels of support to
the UK Typhoon fleet.

Group strategic
framework

More online
baesystems.com

BAE SystemsAnnual Report 2018US Programmes
Final price agreement was secured on F-35
Lot 11. Negotiations on Lots 12 to 14 are
expected to conclude in the first half of 2019,
which will enable an expected ramp-up to
full-rate production by 2020. In the year,
110 rear fuselage assemblies were delivered
for the Low-Rate Initial Production contracts
across Lots 10, 11 and 12.

At RAF Marham in Norfolk, following
acceptance of the Lightning Operating
Centre, the UK’s first four F-35 aircraft
arrived in June, and a further five aircraft
arrived during September, enabling the
UK government to declare Initial Operational
Capability in December. The integration
of F-35 onto the Queen Elizabeth Aircraft
Carrier has commenced, with the initial phase
of First of Class Flight trials now complete.

During the second half of the year, contract
award for the Performance Based Logistics
arrangements for BAE Systems equipment
responsibilities was achieved, underpinning
a growing contribution by BAE Systems to
the F-35 global fleet support.

Saudi Arabia
The Memorandum of Intent signed between
the Kingdom of Saudi Arabia and the UK
government in March 2018 continues to
progress towards reaching an Agreement
for a further 48 Typhoon aircraft, support
and transfer of technology and capability.
This will enable BAE Systems to continue with
the Industrialisation of Defence capabilities in
the Kingdom of Saudi Arabia. Final assembly
of all 48 Typhoon aircraft will be In-Kingdom.

The Typhoon support contracts continue to
operate well. Agreement has been reached
with the Saudi Arabian government for
BAE Systems to continue to provide Typhoon
support services to the Royal Saudi Air Force
against which we have booked order intake
of £3.2bn in December 2018 for support
services up to and including 2022.

The Royal Saudi Air Force will receive their
first In-Kingdom final-assembled Hawk aircraft
in early 2019. The company has delivered 14
of 22 major units on schedule, to meet this
final assembly programme and first flight of
a Hawk assembled in Saudi Arabia occurred
in November.

The Royal Saudi Naval Forces accepted the
third and final ship in the Minehunter mid-life
update programme in April, with a training
services contract signed in the year.

Work continues to reorganise our portfolio of
interests in a number of industrial companies
in Saudi Arabia. During the year Riyadh Wings
Aviation Academy LLC increased its ownership
to 11.85% in the Group’s Overhaul and
Maintenance Company (OMC) subsidiary,
and is contracted to acquire a further interest
up to 49%. OMC has disposed of its 85.7%

shareholding in Aircraft Accessories and
Components Company to Saudi Arabian
Military Industries (SAMI) in 2019. These
reorganisations are in support of our strategy
to develop indigenous supply in Saudi Arabia
through our In-Kingdom Industrial
Participation programme, promoting training,
development and employment opportunities
in line with the Kingdom’s National
Transformation Plan and Vision 2030.

Through the restructuring of the Group’s
portfolio of interests in a number of Kingdom
of Saudi Arabia industrial companies along
with sustaining current industrialised capability
and building on our strong history in Saudi
Arabia, we are working in partnership to
continue to deliver these priorities with the
SAMI organisation to explore how we can
collaborate to deliver further In-Kingdom
Industrial Participation.

It should be recognised that the Group is
reliant on the continued approval of export
licences by a number of governments in order
to continue supplies to the Kingdom of Saudi
Arabia. Significant changes in policies of such
governments may affect our own provision
of capability to the country and we are liaising
closely with the UK government in working
to reduce the impact of any such occurrence.

Australia
In March, the Commonwealth of Australia
agreed upgrade and sustainment contracts
worth A$1.0bn (£0.6bn) for the Jindalee
Operational Radar Network, to be delivered
over an initial ten-year term. Mobilisation of
the acquisition and support teams has been
completed and support of all radar sites
transferred to the business.

In June, the Commonwealth of Australia
selected the Group as the preferred tenderer
for the design and build of up to nine ships
for the Hunter Class programme for the
Royal Australian Navy. We subsequently
agreed the contract and scope for the initial
four-year design and productionisation
phase with a value of A$1.9bn (£1.1bn).
The production scope is to be negotiated
in due course for the first batch of ships.

We have continued to provide in-service
support to the Royal Australian Navy’s two
Landing Helicopter Docks under the support
contract which was extended to run until June
2019. Trials have identified a number of areas
where rectifications are in process, with final
acceptance of the vessels under the acquisition
contract expected in 2019. However, in
December, the Commonwealth announced
that we had not been selected for the next
stage of Landing Helicopter Dock support.

Progress continues on the sustainment and
upgrade of the Anzac fleet under the Warship
Asset Management Alliance.

The Hawk Mk127 Lead-In Fighter project
team continues to maintain the high level
of aircraft availability required. The Capability
Assurance Programme to upgrade the Hawk
fleet to meet the F-35 training requirements
remains on schedule.

Mobilisation activity for sustainment of
the regional F-35 fleet continues to progress
at our Williamtown facility, with the first two
aircraft to be supported arriving in Australia
in December.

We were notified in March 2018 that we
had been unsuccessful in our bid for the
Land 400 Phase 2 Combat Reconnaissance
Vehicle programme.

MBDA
During the year MBDA secured new contracts
for additional Taurus stand-off missiles in
South Korea and for Marte Extended Range
anti-ship missiles to Qatar. The contract for the
supply of missiles to Qatar for the 24 Typhoon
aircraft became effective in September.

MBDA also secured the development
and manufacture of next-generation MICA
air-to-air missiles in France, and further
five-year support to the Aster system in
France, Italy and the UK.

An amended Request for Proposal was
received for the proposed future German
ground-based air defence system, TLVS.
MBDA is partnered with Lockheed Martin
on this opportunity.

MBDA made good progress on development
programmes with key test firings successfully
achieved in the year for both Sea Venom
anti-ship and Land Ceptor air defence missiles.

The Sea Ceptor naval air defence missile
system entered into service with the Royal
Navy Type 23 frigates in May. Meteor entered
into service with the Royal Air Force on
Typhoon. The French Army introduced in
operations the new fifth-generation land
combat missile MMP.

Looking forward
Forward-looking information for the
Air reporting segment is provided later
in this report.

Segmental
looking forward

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Maritime
Segmental review
continued

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

Maritime programmes include the
construction of the second of the Queen
Elizabeth Class aircraft carriers, five River
Class Offshore Patrol Vessels and seven
Astute Class submarines for the Royal Navy;
as well as the design and production of
the Royal Navy’s future Dreadnought Class
submarine and Type 26 frigate. Additionally
the Maritime portfolio includes in-service
support, including the delivery of training
services and management of HM Naval Base,
Portsmouth, and the design and manufacture
of combat systems, torpedoes and radars.

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.

Sales by domain (%)

Sales by line of business (%)

Sales analysis: Platforms and services (%)

Land
10%

Maritime
90%

Land UK
10%

Naval Ships
45%

Services
31%

Platforms
69%

Submarines
45%

BAE SystemsAnnual Report 2018Employees1

16,000

Operational and strategic key points
– HMS Queen Elizabeth has undergone

successful initial F-35 Lightning II flight trials

– Cost growth on the Aircraft Carrier

programme has resulted in a more
conservative trading of contract profitability.
Sea trials for HMS Prince of Wales are
expected within the next year

– Type 26 selected as the design for the

Canadian Surface Combatant programme

– Offshore Patrol Vessel programme quality
issues have required the creation of a £47m
loss provision

– Management strengthened across
segment to focus on programme
schedule, execution and cost performance

– CTA International, BAE Systems’ joint

venture with Nexter, delivered 115 40mm
cased-telescopic cannons

– Receipt of the full £1.6bn contract for the

– In January 2019, entered into an

seventh Astute Class submarine, Agincourt,
with order intake in the year of £0.7bn

– Further £1.3bn funding extension for the
Dreadnought programme received

agreement with Rheinmetall to create
a joint UK-based military land vehicle
design, manufacturing and support
business, subject to regulatory clearances

Financial performance
Financial performance measures
as defined by the Group

Financial performance
measures defined in IFRS3

Sales

Underlying EBITA

Return on sales

Operating business

cash flow

Order intake1

Order backlog1

KPI

2018

2017
(restated)2

£2,975m £2,877m

Revenue

£209m

£251m

Operating profit

7.0%

8.7%

Return on revenue

Cash flow from

2018

2017
(restated)2

£2,940m £2,845m

£191m

£240m

6.5%

8.4%

£67m

£278m

operating activities

£190m

£396m

£3,513m £4,671m

£9.0bn

£8.5bn

– Sales of £3.0bn are marginally higher than
2017. As expected, whilst the Dreadnought
submarine and Type 26 programmes
continue to ramp-up, activity levels on
the Carrier programme are reducing.

– Return on sales for the year was at 7.0%.
Further charges on the five-ship Offshore
Patrol Vessels contract were taken and
trading on the Carrier programme was
at a more conservative level than planned.
Performance in the submarines business
was ahead of plan on improved milestone
achievement and risk retirement.

– There was an operating cash inflow of
£67m. Reported performance reflects
the reversal of the £106m VAT timing
benefit from last year.

– Order backlog increased to £9.0bn following
the awards in the first half of the year for
Astute Boat 7 pricing and further funding
under the Dreadnought programme.

Our strategy in action

Progression
on our submarine
programmes

In March, BAE Systems was
awarded a £1.6bn contract
(with order intake in the year
of £0.7bn) for delivery of the
seventh Astute Class submarine.
On the Dreadnought submarine
programme, £0.9bn order intake
was received in March, with a
further £0.4bn received in October.

During a visit to Barrow, the Secretary
of State for Defence named the seventh
and final submarine in the Astute Class,
Agincourt. He also formally opened
a new state-of-the-art manufacturing
facility, marking the latest development
in a major infrastructure investment
programme at our Barrow site. Certain
phases of construction for the
Dreadnought Class will take place
at the new Central Yard Facility, which
includes production, workshop and
office facilities.

Construction on the first of four new
Dreadnought submarines started in
2016 and this latest funding will support
ongoing design and build activities,
procurement of materials and investment
in new and existing facilities for a further
12 months.

Alternative performance
measure definitions

1. Including share of equity accounted investments.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts

with Customers. See note 37 to the Group accounts for details regarding the restatement.

3. International Financial Reporting Standards.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental review
continued

Our strategy in action

F-35 Lightning II
carrier integration

BAE Systems has a unique role
in the design, build and support
of both the F-35 Lightning II
aircraft and Queen Elizabeth
Class aircraft carriers.

As the First of Class Flight Trials
commenced to bring together the
F-35 Lightning II and HMS Queen
Elizabeth, BAE Systems’ employees
were at the heart of the integration.

Two month-long trials took place off the
east coast of the United States, involving
a unique and complex set of exercises
that tested the aircraft’s ability to operate
safely and effectively from the aircraft
carrier in a range of sea states and wind
speeds during both day and night.
Our F-35 test pilot, the only industry
pilot who flew in the trials, made
history by performing the world’s first
F-35 Shipborne Rolling Vertical Landing.

Group strategic
framework

More online
baesystems.com

Our Type 26 platform design has opened
up opportunities abroad and in February
2019, the Canadian government together
with Irving Shipbuilding selected Lockheed
Martin Canada, using our Type 26 platform
design, as subcontractor for the Canadian
Surface Combatant programme. This is a
further endorsement of the Global Combat
Ship as one of the world’s most advanced
anti-submarine warships.

Submarines
The first three Astute Class submarines are
in operational service with the Royal Navy.
Progress continues on the manufacture of
the remaining four boats. A full contract
award for the seventh boat, Agincourt,
was secured in March.

Functional and spatial design and production
on the first of class continues to advance on
the Dreadnought Class submarine programme,
the replacement for the Vanguard Class
submarines. Contract funding of £1.3bn
was received through 2018.

The major programme of building works
at the Barrow site continues, with contracts
in place totalling more than £0.5bn.

The Dreadnought Alliance Agreement
detailing the organisational, governance
and commercial arrangements between
the three parties, the Submarine Delivery
Agency, BAE Systems and Rolls-Royce
was agreed, allowing for the formal stand-up
of the Alliance from April 2018.

Operational performance
Maritime
Naval Ships
On the aircraft carrier programme, large
volume installation activities continue to
progress on HMS Prince of Wales, with
commissioning of systems continuing
through 2019 and sea trials also scheduled
to take place in 2019.

Work continues to support HMS Queen
Elizabeth. Following the completion of a
Capability Insertion Period, successful fixed
wing flight trials took place in the second
half of 2018, with the first F-35 Lightning II
deck landing completed. However, cost
growth on the programme has resulted
in a more conservative trading of contract
profitability in the period.

The first of the five Offshore Patrol Vessels,
HMS Forth, completed sea trials in December
2017. However, quality issues have had to be
resolved resulting in unanticipated programme
cost growth and a £47m loss provision has
been recorded in the year. Lessons learned
are being applied to the other ships in build.
Sea trials on the second ship, HMS Medway,
took place in November 2018 and the ship
is due to be delivered to the customer in
the first quarter of 2019. Construction of
the remaining three Offshore Patrol Vessels
on the Clyde continues through 2019.

The three Type 26 ships continue in production.
The programme currently employs over
1,500 people and activities have continued
to build progressively during 2018 on
transition from detailed design through to
production readiness and the commencement
of unit build.

BAE SystemsAnnual Report 2018Looking forward
Forward-looking information for the
Maritime reporting segment is provided
later in this report.

Segmental
looking forward

Maritime Services
BAE Systems continues to manage and
maintain HM Naval Base, Portsmouth, and
supports more than half of the Royal Navy’s
surface fleet through the Maritime Support
Delivery Framework contract. The Ministry
of Defence extended this contract to March
2020 in the early part of the year.

During the second half of the year, we have
mobilised the Type 45 Power Improvement
Programme in collaboration with Cammell
Laird and BMT, having been selected as
prime contractor in the first half of 2018.

Progress continues on the £270m Spearfish
torpedo programme, with the demonstration
phase forecast to complete in 2020.

Maritime Services has delivered a
transformation programme through 2018
to streamline its processes and ensure it is
able to deliver value for money as we continue
to provide the Royal Navy with the capability
it needs to protect the nation’s interests.

Land UK
The business continues to provide UK and
international customers with a wide range
of light and heavy munitions, and support
to previously supplied armoured vehicles
and bridging systems.

During the year, 115 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 275 of 515. This is
the first entirely new medium-calibre cannon
and ammunition system qualified by the
British Army since the late 1960s. Also during
the period an order for £72m was received
to deliver 110 Case Telescoped Armament
Systems to the French Army under their
6x6 combat armoured reconnaissance
vehicle programme.

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.

In January 2019 the business entered into
an agreement with Rheinmetall to create
a joint UK-based military land vehicle
design, manufacturing and support business.
Rheinmetall will purchase a 55% stake in
the existing BAE Systems UK-based combat
vehicles business for £28.6m with BAE Systems
retaining 45%. The transaction is subject
to regulatory approvals which are anticipated
to be completed in the first half of 2019.
The transaction does not include Land UK’s
munitions business or its holding in the
CTAI joint venture with Nexter.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Segmental
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.

2018 sales1

A Electronic Systems

B Cyber & Intelligence

C Platforms & Services (US)

D Air

E Maritime

22%

16%

37%

16%

2018 underlying EBITA2

A Electronic Systems

B Cyber & Intelligence

C Platforms & Services (US)

D Air

E Maritime

30%

11%

43%

10%

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. The US business remains well
positioned and will continue to leverage its
established market positions and reputation
for reliable and adaptable performance to
meet customer demands for innovative,
cost-effective and cyber-hardened solutions
to pursue recompeted contracts and new
business across its portfolio of sustainment,
integration and modernisation solutions
for military, intelligence and nuclear
triad customers.

Applied Intelligence
Strong market demand and continued
investment in people and products position
the business for revenue growth in the
medium term. Profitability is expected
to continue to benefit from focus on
operational efficiency and cost control.

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. As a result, the
business is well positioned for the medium
term with strong significant roles on
F-35 Lightning II and classified programmes,
as well as with specific products such as
APKWS®. Over the longer term, the business
is poised to leverage its technology strength
in emerging areas of demand such as space
resilience and autonomous vehicles.

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.

1. Revenue plus the Group’s share of revenue of equity

accounted investments.

2. Operating profit excluding amortisation and

impairment of intangible assets, finance costs and
taxation expense of equity accounted investments
(EBITA), and non-recurring items.

BAE SystemsAnnual Report 2018Platforms & 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 and
operation of government-
owned munitions facilities.

The combat vehicles business is underpinned
by a growing order backlog and incumbencies
on key franchise programmes. These include
the US Army’s Armored Multi-Purpose
Vehicle, M109A7 self-propelled howitzer,
Bradley upgrade programmes, the Amphibious
Combat Vehicle; and the CV90 and BvS10
export programmes from our BAE Systems
Hägglunds business.

FNSS continues to execute on its order book
of both Turkish and international orders.

These long-term contracts and franchise
positions make the combat vehicles business
well placed for growth in the medium term
and the team is closely following the
US Army’s acquisition plans for its next
generation of combat vehicles.

In the maritime domain, the sector has a
strong position on naval gun programmes
and US Navy ship repair activities where
the business has invested in facilities in key
homeports. This capitalised infrastructure
represents a high barrier to entry, and the
business remains well aligned to the
US Navy’s operational strategy.

The Group remains a leading provider of
gun systems and precision strike capabilities
and, in the complex ordnance manufacturing
business, continues to manage and operate
the US Army’s Radford and Holston munitions
facilities under previously awarded contracts.

Alternative performance
measure definitions

Our
markets

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
European MBDA joint venture.

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

Maritime
In Maritime, there remains pressure
on the Royal Navy’s near-term budgets
and a highly-competitive environment
in ship support and upgrade. Overall the
outlook is stable based on the long-term
contracted positions.

Within Submarines, the business is executing
the Astute Class programme, with four boats
still in build. On the Dreadnought programme
manufacturing activities continue on the
first of class boat. Investment continues
in the Barrow facilities in order to provide
the capabilities to deliver these long-term
programmes through the next decade
and beyond.

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.

In January 2019 BAE Systems entered into
an agreement with Rheinmetall to create
a joint UK-based military land vehicle
design, manufacturing and support business.
Rheinmetall will purchase a 55% stake
in the existing BAE Systems UK-based
combat vehicles business for £28.6m,
with BAE Systems retaining 45%. The new
business is well positioned to address the
upcoming Challenger II upgrade programme.

Future UK sales are underpinned by existing
contracts for both Typhoon production
and support. Production of rear fuselage
assemblies for F-35 Lightning II will increase
over the next two years to reach its expected
peak rate for the next decade. The business
plays a significant role in the F-35 sustainment
programme in support of Lockheed Martin.

Defence and security remain priorities for the
UK government, reaffirmed in the Modernising
Defence Programme and the recently
announced UK Combat Air Strategy, which
provides the base to enable long-term
planning and investment in a key strategic
part of the business.

Discussions continue with current and
prospective customers in relation to potential
further contract awards for Typhoon and Hawk.

The UK Typhoon support operation is
underpinned by a long-term partnering
arrangement with the Ministry of Defence.

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 order to provide ongoing
capability to international customers, the
company is reliant on the continued approval
of export licences by a number of
governments. Any significant change in UK
or foreign government policy in this regard
may have an adverse effect on the Group’s
provision of capability to the Kingdom of
Saudi Arabia and the Group is liaising closely
with the UK government in working to
reduce the impact of any such occurrence.

The Australian business has long-term
sustainment and upgrade activities in
maritime, air, wide-area surveillance, missile
defence and electronic systems. It will expand
into ship design and productionisation on the
Hunter Class frigate programme from 2019.

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.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018How we
manage risk

Effective management of risks and opportunities is
essential to the delivery of the Group’s strategic objectives
and the creation of sustainable shareholder value.

Board
The Board has overall responsibility for
determining the nature and extent of the risk
the Group is willing to take, and ensuring that
risks are managed effectively across the Group.

Risk is a regular agenda item at Board meetings
and the Board reviews risk as part of its annual
strategy review process. This provides the
Board with an appreciation of the key risks
within the business and oversight of how
they are being managed.

The Board delegates oversight of certain
risk management activities to the Audit
and Corporate Responsibility committees
as follows:

Audit Committee
The Audit Committee monitors the Group’s
key risks identified by the risk assessment
processes and reports its findings to the Board
twice a year. It is also responsible for reviewing
in detail the effectiveness of the Group’s
system of internal control policies, and
procedures for the identification, assessment
and reporting of risk.

Corporate Responsibility Committee
The Corporate Responsibility Committee
monitors the Group’s performance in managing
the Group’s significant non-financial risks,
including those arising in respect of business
conduct, health and safety, and the
environment. The Committee reports its
findings to the Board on a regular basis.

Approach
The Group’s Risk Management Policy is
set out in the Operational Framework, the
Group’s detailed governance framework.

The Group’s approach to risk management
is aimed at the early identification of key risks,
mitigating the effect of those risks before
they occur and dealing with them effectively
if they crystallise.

The Group is committed to the protection
of its assets, which include human resources,
intellectual and physical property, and
financial resources, through an effective risk
management process, underpinned where
appropriate by insurance.

Reporting within the Group is structured
so that key issues are escalated through
the management team and ultimately to
the Board where appropriate. The underlying
principles of the Group’s risk management
processes are that risks are monitored
continuously, associated action plans reviewed,
appropriate contingencies provisioned and
this information reported through established
management control procedures.

The Board has conducted a review of the
effectiveness of the Group’s systems of risk
management and internal control processes,
including financial, operational and compliance
controls and risk management systems, in
accordance with the UK Corporate Governance
Code. The Company has developed a system
of internal controls that was in place throughout
2018 and to the date of this report.

As with any system of internal control, the
policies and processes that are mandated in
the Operational Framework are designed to
manage rather than eliminate the risk of failure
to achieve business objectives and can only
provide reasonable, and not absolute, assurance
against material misstatement or loss.

Financial and non-financial risks
Financial risks expose the Group to potential
costs which are quantifiable on the basis
that their probability and impact can be
understood adequately and related to the
financial statements.

Non-financial risks cannot be assessed readily
in financial terms and, therefore, cannot be
reflected reliably in the financial statements.

Process
Businesses
The responsibility for risk identification, analysis,
evaluation and mitigation rests with the line
management of the businesses. They are also
responsible for reporting and monitoring key
risks in accordance with established processes
under the Group’s Operational Framework.

The Group’s risk management process is set
out in the Risk Management Policy, a mandated
policy under the Operational Framework,
and, in respect of projects, in the Lifecycle
Management Framework, a core business
process under the Operational Framework.
Further guidance is provided by a Risk
Management Maturity self-assessment tool.

Identified risks are documented in risk
registers showing: the risks that have been
identified; characteristics of the risk; the basis
for determining mitigation strategy; and
what reviews and monitoring are necessary.
Each risk is allocated an owner who has
authority and responsibility for assessing
and managing it.

Project risks are reported and monitored in
Group-mandated format Contract Review
Packs, which are reviewed by management
at monthly Contract Reviews. The financial
performance of projects is reported and
monitored using Contract Status Reports,
which form part of the Contract Review Pack.
These include programme margin metrics,
which are reviewed regularly by the Executive
Committee and Board. Project margin is
recognised after making suitable allowances
for technical and other risks related to
performance milestones yet to be achieved.

In addition, every six months, the
businesses and Group functions complete
an Operational Assurance Statement (OAS),
which is a mandated policy under the
Operational Framework. The OAS is in two
parts: a self-assessment of compliance with
the Operational Framework; and a report
showing the key financial and non-financial
risks for the relevant business and Group
functions. Together with reviews undertaken
by Internal Audit and the work of the external
auditors, the OAS forms the Group’s process
for reviewing the effectiveness of the system
of internal controls.

Executive Committee
The key financial and non-financial risks
identified by the businesses from the risk
assessment processes are collated and reviewed
by the Executive Committee to identify those
issues where the cumulative risk, or possible
reputational impacts, could be significant.

Management responsibility for the management
of the Group’s most significant non-financial
risks is determined by the Executive Committee.

The OAS and non-financial risk registers are
reviewed regularly by the Executive Committee
to monitor the status and progression of
mitigation plans, and these key risks are
reported to the Board on a regular basis.

Principal and emerging risks
The Board has carried out a robust assessment
of the emerging and principal risks facing the
Group. Emerging and principal risks have been
identified, and are managed or mitigated,
through the application of the policies and
processes outlined above.

Principal risks include those that would
threaten the Group’s business model, future
performance, solvency, liquidity or reputation.
Risks have been identified as principal based
on the likelihood of occurrence, the potential
impact on the Group and the timescale over
which they might occur. The principal risks,
together with details of how they are being
mitigated and managed, are detailed on
pages 68 to 71.

Our principal
risks

BAE SystemsAnnual Report 2018Risk management framework

Board
Overall responsibility for risk management

Risk challenge,
monitoring and reporting

Audit Committee
Operational Assurance Statement Risk Register
and Non-financial Risk Register

Corporate Responsibility Committee
Non-financial Risk Register

Risk challenge,
monitoring and reporting

Executive Committee
Operational Assurance Statement Risk Register and Non-financial Risk Register

Risk challenge, monitoring and reporting

Chief Executive’s Business Review – Core Business Process*
Quarterly top-level review of the key operational, financial and non-financial performance issues within the business, and significant forthcoming bids and events

Quarterly Business Review – Core Business Process*
Quarterly management review of the performance of each of the Group’s businesses against their objectives, measures and milestones

Integrated Business Plan – Core Business Process*
Annual long-term strategy and five-year plan for each business

Strategic objectives and shareholder value

Project objectives and financial return

Business Risk
Risk Management Policy – Mandated Policy*

Project Risk
Lifecycle Management Framework – Mandated Policy*

1. Identification
Financial and non-financial risks
recorded in risk registers

2. Analysis
Risks analysed for impact and probability
to determine gross exposure

1. Identification
Financial and non-financial risks
recorded in risk registers

2. Analysis
Risks analysed for impact and probability
to determine gross exposure

4. Mitigation
Risk owners identified and action plans
implemented. Robust mitigation strategy
subject to regular and rigorous review

3. Evaluation
Risk exposure reviewed
and risks prioritised

4. Mitigation
Risk owners identified and action plans
implemented. Robust mitigation strategy
subject to regular and rigorous review

3. Evaluation
Risk exposure reviewed
and risks prioritised

Operational Assurance Statement – Mandated Policy*
Six-monthly management self-assessment of compliance
with the Operational Framework and summary of key risks

Lifecycle Management Project Performance Review*
Regular management review of project performance and issues
to ensure that appropriate decisions and actions are taken

Audit Review Board
Assurance of the Business and Project Risk management processes as mandated in the Audit Charter.
Including Operational and Non-financial Risk Management assurance.

Operational
Framework

*As defined in the Group’s Operational Framework.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our 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 2018, 91% 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 UK.

Lower defence spending
by the Group’s major
customers could have a
material adverse effect on
the Group’s future results
and financial condition.

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.

The business is geographically spread across US, UK
and international defence markets:
– in the US, the fiscal year 2019 Defense Appropriations

bill was enacted in September 2018 providing near-term
clarity and support for the industry. The enacted bill
maintains support for our medium-term planning
assumptions and positive momentum for military
readiness and modernisation programmes;

– in the UK, the Modernising Defence Programme has
outlined a clear direction of travel for the Ministry of
Defence. This statement re-emphasises the UK’s
commitment to strong defence and security;

– in Saudi Arabia, regional tensions continue to dictate

that defence remains a high priority; and

– in Australia, regional instability and the pace of military
modernisation in the Asia-Pacific region continue to
drive the government’s commitment to defence
spending, with major recapitalisation programmes
under way. The government has indicated its intent
to grow defence spending by committing to spend
2% of GDP by 2020/21.

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.

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.

BAE SystemsAnnual Report 2018Description

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 export
control and other government policy and regulations in the UK,
US and all other relevant jurisdictions; and the inability to obtain
or maintain the necessary export licences.

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 has given permission for the decision of the High Court
to be appealed and the hearing and determination of the appeal
is awaited.

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.

The terms of the UK’s exit from the EU on 29 March 2019
are currently uncertain, rendering it difficult for the Group to
prepare for potential changes in the regulatory environment.
In particular, a no-deal Brexit could have an impact on
programmes which depend on the movement of goods
between the UK and the EU.

There is also a risk that, as a result of the UK leaving the EU,
the Group’s ability to take part in collaborative industrial
programmes in Europe could encounter new EU barriers.

The occurrence of any
such events could have a
material adverse effect on
the Group’s future results
and financial condition.
The risk of the Group’s
inability to obtain and
maintain the necessary
export licences for our
business in the Kingdom
of Saudi Arabia could affect
the Group’s provision of
capability to the country.

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 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.

The Group’s policy is to hedge all material firm
transactional currency exchange rate exposures.

BAE Systems benefits from
a large order backlog with
established positions on
long-term programmes in
the US, UK, Saudi Arabia
and Australia and there is
relatively limited UK-EU
trading. In respect of people,
the majority of persons
employed in the UK are UK
nationals, with only small
movements of EU nationals
into and out of the Group’s
UK businesses. Accordingly,
the resulting Brexit near-term
impacts across the business
are likely to be limited.

If there is no deal before the UK leaves the EU, it will
require the Group to put in place a set of actions
and mitigations to prepare for the change that might take
place in relation to a range of business activities. These
include customs procedures, export control, and the use
of speciality chemicals whose use is currently authorised
by an EU agency.

BAE Systems will support the UK 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.

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.

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Our principal risks
continued

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.

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.

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.

6. Contract risk and execution
The Group has many contracts, including a small number of large contracts and fixed-price contracts.

Contract-related risks and uncertainties are managed under
the Group’s mandated Lifecycle Management process.

A leadership development programme for project directors
continues to be 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.

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.

In 2018, 44% of the Group’s sales were generated by its
15 largest programmes. At 31 December 2018, the Group
had eight 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.

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.

BAE SystemsAnnual Report 2018Description

Impact

Mitigation

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 members’
anticipated 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.

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.

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 2017, the 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 these funding valuations, deficit recovery
payments to the UK schemes were £211m in 2018.
The deficits in each of the schemes are expected
to be cleared between 2021 and 2026.

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 the Group’s 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.

Strategic report
The Strategic report was approved by the board of directors on 20 February 2019.

David Parkes
Company Secretary

Strategic reportGovernanceFinancial statementsBAE SystemsAnnual Report 2018Chairman’s
governance letter

Contents

Chairman’s governance letter

Directors’ duties

Board governance

Board of directors

Board information

Governance disclosures

Audit Committee report

Corporate Responsibility
Committee report

Nominations Committee report

Remuneration Committee report

Dear Shareholders,
It is clear from conversations with all
our stakeholders that board governance,
corporate behaviour, stakeholder engagement
and environmental sustainability are all
becoming increasingly important when
considering the activities of any company.

I would like to address each of these
important areas in this review.

Board governance
Details of our governance processes and
procedures are given on pages 76 and 77.
In summary, however, we have a balanced
Board with a good mix of gender, skills and
experience with effective committees to
oversee our financial, corporate responsibility,
executive remuneration and board member
nomination practices.

A comprehensive Board evaluation is conducted
each year with an external advisor employed
every other year to facilitate the process.
Following the evaluation, I hold one-to-one
meetings with individual directors to provide
feedback and our Senior Independent Director
leads a Board appraisal of my performance.
We have found the evaluation process to be
helpful in ensuring that an open dialogue
delivers good practice and establishes a
culture of continuous improvement.

Each year we use the evaluation to agree a
number of objectives for the Board to progress
over the year ahead. Amongst other things,
in 2018 we agreed that we should continue
to develop what we do to engage directly
with stakeholders, and thereby look to learn
more about the Company’s performance
and the quality of key relationships from their
perspective. We also agreed to ensure that
we made time to have a more open-ended
dialogue on matters such as corporate
strategy, culture and performance. Progress
was made against these and the other
objectives the Board agreed last year.

Stakeholder engagement
We seek to maintain an open dialogue with
all stakeholders including shareholders, key
suppliers, customers and our employees.

Shareholders
Our day-to-day shareholder contact is largely
conducted by our investor relations team,
and is supplemented by regular meetings with
our Chief Executive, Group Finance Director,
and President and Chief Executive Officer of
our US business.

I visit a number of major shareholders each
year and the Chair of the Remuneration
Committee also engages with shareholders
to discuss remuneration policies and practice.

Last year, we arranged a separate governance
event with major shareholders and investors.
Attended by myself, the Chief Executive
and non-executive directors, the meeting
allowed us to discuss openly our governance
arrangements, corporate culture and
committee work. The feedback we received
was positive and we have decided to continue
this practice at regular intervals or when there
is a major change in Board membership.

Employees
The Company has well-established links
with the principal trades unions representing
members of our workforce in the UK which,
at six-monthly intervals, bring together union
officials with the Chief Executive for an open
discussion on the business and matters
concerning employees.

In 2018, the Board decided that it would
be helpful if the Chief Executive was
accompanied by the Chair of the Corporate
Responsibility Committee, Ian Tyler, in order
to provide wider Board engagement with
the unions and our workforce.

BAE SystemsAnnual Report 2018Conclusion
I am confident that both Board and
management believe in the values and
benefits of frequent and open dialogue with
stakeholders. We are consistently reviewing
how we communicate and engage, including
how we use technology to broaden our reach
and assess the feedback we obtain, to ensure
that our messages are well received,
appropriately directed and our responses
helpful and valued. As a Board we are clear
that it is not simply how much money the
Company makes but how it makes money
that is important to all our stakeholders.

Sir Roger Carr Chairman

This has been welcomed by all parties and,
in addition, Ian Tyler will, from time to time,
accompany the Chief Executive on his site
visits in the normal course of business.

In addition, as Chairman, I continue to visit
sites across the world and encourage open
‘town hall’ sessions with the employees as a
matter of course. Similar events are conducted
when all Board members attend operational
sites as part of the Board’s annual programme,
and in 2018 we held such meetings in
Rochester, UK and San Diego, US.

Employee engagement is also developed
through surveys, podcasts and informal
breakfast and dinner meetings with members
of the management team and directors.

A new provision in the recently revised
UK Corporate Governance Code requires
companies to have an effective means of
engaging with their workforce. The Board
has agreed that our Corporate Responsibility
Committee – which has a membership
comprising only independent non-executive
directors – will be responsible for discharging
this role, and in doing so will build on the
range of employee engagement opportunities
we have been undertaking to date. The
Committee took on this responsibility from
the start of 2019, and therefore we will
be well placed to comply with this new
requirement and report further on it in
next year’s Annual Report.

Customers
The nature of our business and the culture
of the Company encourages the development
of deep, transparent and constructive
relationships with our customers. It recognises
that, whilst on occasion we may have
competing commercial objectives, we are
united in our mutual commitment to serve
and protect those that serve and protect us.

Customer contact involving relevant
management personnel, the Chief Executive
and also myself, is with governments, officials
and military personnel across the world on
a regular basis. During the course of the year,
we invited the Chief of the Royal Air Force
and the Permanent Under Secretary of the
Foreign and Commonwealth Office to meet
the Board for an open discussion on the
value of our relationship and ways to
improve our interaction.

We will continue this practice in the years
to come.

Suppliers
The appointment of a senior supply chain
management team is starting to deliver a
much closer working relationship with our
major suppliers. This has been achieved
through supplier conferences, strategic
partnerships and clearer communication
on the ambition and expectation we have
in building long-term supplier partnerships.

We have found that this increase in
professionalism has delivered a mutual benefit
reflected in improved commercial terms and
higher commitment to quality. The Board will
continue to focus on supplier management
and we will report further on this in next
year’s Annual Report.

Community investment
and the environment
The Board recognises the importance of
leading a company that not only generates
value for shareholders but also contributes
to wider society. As a major employer that
develops and trains a highly-skilled workforce,
principally in manufacture and engineering
roles, we make an important economic
contribution to the communities in which
we operate. In addition, through our Global
Community Investment Strategy we build
and nurture mutually beneficial relationships
between our business, our people and
local stakeholders.

I have been fortunate to see at first-hand how
this is being put into action, with initiatives
focused on our support for the armed forces,
education and skills, and the support we
provide for the communities in which we
operate. Well-managed companies are an
essential part of society but in order to succeed
business needs strong, vibrant and prosperous
communities.

Recognition of our wider impacts is also
an important part of our environmental
commitments. As a major manufacturing
company, we recognise that environmental
and climate risks could impact us directly. We
are committed to reducing the environmental
impact of our operations and products, and
minimising our environmental footprint. This
is important to our role in wider society and
in 2019 we will develop our environmental
policy further and progress our alignment
to the UN Sustainable Development Goals.
The Board and the Corporate Responsibility
Committee will provide oversight of this
and monitor implementation.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’
duties

This is an overview of how the directors have
performed their duty to promote the success
of the Company.

The directors of BAE Systems –
and those of all UK companies
– must act in accordance with a
set of general duties. These duties
are detailed in the UK’s Companies
Act and include a duty to promote
the success of the Company,
which is summarised below.
As part of their induction, the directors are
briefed on their duties and they can access
professional advice on these – either through
the Company or, if they judge it necessary,
from an independent provider.

Typically, in large and complex companies
such as BAE Systems, the directors fulfil their
duties partly through a governance framework
that delegates day-to-day decision-making
to employees of the Company.

The Board recognises that such delegation
needs to be much more than simple financial
authorities and, in this section of the report,
we have summarised our governance
structure, which covers: the values and
behaviours expected of our employees; the
standards they must adhere to; how we
engage with stakeholders; and how the Board
looks to ensure that we have a robust system
of control and assurance processes.

For more detail on our governance structure,
see pages 76 and 77.

Section 172 of the UK’s Companies Act
In summary, as required by Section 172
of the UK’s Companies Act, a director
of a company must act in the way he
considers, in good faith, would most likely
promote the success of the company for
the benefit of its shareholders. In doing
this, the director must have regard,
amongst other matters, to the:

– likely consequences of any decisions

in the long term;

– interests of the company’s employees;

– need to foster the company’s business
relationships with suppliers, customers
and others;

– impact of the company’s operations
on the community and environment;

– company’s reputation for high

standards of business conduct; and

– need to act fairly as between members

of the company.

Shareholders | Employees | Customers
Suppliers | Community and Environment

A board should communicate effectively with its shareholders and understand
their views, and also act fairly as between different members. Employees are
central to the long-term success of a company, as such, a board should
consider their interests, and, to assist in doing so, have means of engaging with
and understanding their views. Fostering business relationships with key
stakeholders, such as customers and suppliers, is also important to a company’s
success. A board should have visibility of these relationships so that it is able
to take stakeholder considerations into account when making decisions. In their
decision-making, directors need to have regard to the impact of a company’s
operations on the community and environment.

Overview of how the Board performed its duties
Shareholders
Members of the Board, including the chairs of the principal board committees, held a
governance event with major shareholders in 2018. This allowed directors to liaise directly
with shareholders on the Company’s governance arrangements, including the important
work undertaken by the committees. The feedback received was positive and the Board
intends to continue such events at regular intervals.

Employees
The Company has a well-developed structure through which it engages regularly with trade
union officials to discuss and understand matters concerning UK employees. During the year,
one of the non-executive directors, Ian Tyler, joined the Chief Executive when engaging with
employee representatives through this forum.

Also, in terms of employee engagement, a number of Board meetings were held on
operational sites throughout the year which provided an opportunity for all directors to
engage directly with employees on a variety of topics. This included ‘town hall’ meetings
with groups of employees at our Rochester, UK and San Diego, US sites. It is proposed
that directors will attend further such meetings at Company sites during 2019.

Customers
The Chief Executive and the President and Chief Executive Officer of our US business are
in regular contact with our principal customers, and at all scheduled Board meetings they
brief the Board on our performance in delivering on our commitments to customers and
the quality of these critical relationships. The Chairman also maintains close links with many
of our customers and regularly briefs the Board on the feedback he receives. In addition,
in order to help directors to develop their understanding of the Company’s performance
and relationship with key customers at first-hand, a number of informal meetings were
held in 2018 with senior customer representatives. Such meetings are an integral part
of the Board’s annual programme and similar events will take place during 2019.

Suppliers
The Board met with the leadership of the Company’s Procurement function to understand
more about how they are developing deeper relationships with companies in our supply
chains and developing strategic relationships with key suppliers. The Board will continue
to focus on supplier management in 2019.

Community and environment
The Board recognises the importance of leading a company that not only generates value
for shareholders but also contributes to wider society. Through the Operational Framework
the Board has mandated that our businesses implement the requirements of our Community
Investment Policy, which looks to ensure that we build and nurture mutually beneficial
relationships between our business, our people and local stakeholders.

As a major manufacturing company, we recognise that environmental and climate risks
could impact us directly, and we are committed to reducing the environmental impact
of our operations and products, and minimise our environmental footprint. Through
the Operational Framework the Board has mandated that our businesses implement the
requirements of our Environmental Policy, which details our commitment to high standards
of environmental management.

Compliance with the above policies is monitored through our Operational Assurance
Statement process, the output from which is reviewed regularly by the Audit and Corporate
Responsibility committees. Also, community and environmental matters form part of the
Board’s annual review of corporate responsibility matters.

Group strategic
framework

Our
people

Chairman’s
governance letter

Board
governance

Corporate Responsibility
Committee report

BAE SystemsAnnual Report 2018Culture, values and standards
Culture, values and standards underpin how a company creates
and sustains value over the longer term and are key elements
of how it maintains a reputation for high standards of business
conduct. They also guide and assist in decision making and
thereby help promote a company’s success, recognising, amongst
other things, the likely consequences of any decision in the long
term and wider stakeholder considerations. The standards set
by a board mandate certain requirements and behaviours with
regards to the activities of its directors, employees and others
associated with it.

Overview of how the Board discharged its duties
The Board is supporting the Chief Executive in embedding a culture that
will help deliver long-term success. To assist with this work, during the year
the Company undertook an employee engagement survey. The results of
this have been reviewed by the directors, together with the subsequent
actions the Chief Executive will be taking to reinforce the Company’s values
and ensure that we have the right culture to meet the strategic needs of the
business. Further work on this will be undertaken during 2019.

The Board sets the values and standards required of all employees through
its Operational Framework, which contains our Code of Conduct. In 2018,
this document was reviewed and amendments agreed by the Board.

In overseeing the effectiveness of the Company’s processes for dealing with
employees whose behaviour falls short of required standards, the Corporate
Responsibility Committee has continued to monitor the nature of issues
reported through the Company’s Ethics Helpline. Also during the year, the
Board reviewed the processes in place for the investigation of complaints
concerning inappropriate behaviour by employees. The integrity of these
processes is an important part of our governance arrangements and the
Board will review these processes again in 2019 to ensure they remain effective.

Operational
framework

Operational Assurance
Statement

Corporate Responsibility
Committee report

Decision-making | Governance and
performance oversight | Risk

Boards of large companies invariably delegate day-to-day
management and decision-making to executive management.
Directors should maintain oversight of a company’s performance
and ensure that management is acting in accordance with the
strategy and plans agreed by a board, and its delegated authorities.
The culture, values and standards that underpin this delegation
should help ensure that when decisions are made their wider impact
has been considered. A board should also reserve certain matters
for its own consideration so that it can exercise judgement directly
when making major decisions, and in doing so promote the success
of the company whilst having regard to all necessary matters.

A board needs assurance that a company’s financial reporting, risk
management, governance and internal control processes, including
policies mandating procedural requirements and standards, are
operating effectively.

Overview of how the Board discharged its duties
Each year, the Board undertakes an in-depth review of the Company’s strategy,
including the business plan for the following five years. Once approved by the
Board, the plan and strategy form the basis for financial budgets, resource
plans and investment decisions, and also the future strategic direction of the
Company. In making decisions concerning the business plan and future strategy,
the Board has regard to a variety of matters including the interests of various
stakeholders, the consequences of its decisions in the long term and its
long-term reputation.

In 2018, the Board’s review of strategy included presentations from the
Group Human Resources Director and the leaders of our Procurement function.
The Chief Executive is responsible for delivering the plans and strategy agreed
by the Board, with authority delegated to executive directors but subject to
all decisions being made on the basis of the values and standards mandated
in the Company’s Operational Framework and underpinned by the culture
set by the Board, Chief Executive and senior management.

The Board has approved the Group’s Risk Management Policy, which aims to
ensure that risks are managed effectively across the Group. It also has overall
responsibility for determining the nature and extent of the risk the Company
is willing to take. During the year, the Audit Committee reviewed output
from the Company’s risk management processes. Also in 2018, the Corporate
Responsibility Committee reviewed the output from the Company’s processes
for managing significant non-financial risks, including those arising in respect
of business conduct, health and safety, and the environment. Both committees
reported their findings to the Board following such reviews. Risk is also an
important consideration for Board members when reviewing major bids and
contracts. Last year the Board undertook such reviews in respect of the Mobile
Protected Firepower programme, Qatar Typhoon sales financing, APKWS®
production, Astute Boat 7 and the Hunter Class Frigate programme (see below).

The Board has reserved certain matters for its own decision, including the
approval of major bids and contracts. For example, in 2018 the Company
signed a contract with the Commonwealth of Australia for its Hunter Class
Frigate programme. Following extensive reviews by the Chief Executive and
the business team, the initial bid and the subsequent contract were referred
to the Board for its review and approval. In reaching its decisions on this,
the Board had regard to a number of matters, including the business case
and financial returns, technical and programme management matters, risk
management, workforce matters and the long-term reputation of the Company
in dealing with various aspects of a complex international programme.

The Board has adopted a revised Board Charter, which incorporates governance
principles that are aligned with the requirements of the revised UK Corporate
Governance Code. Also, revised terms of reference have been adopted by the
Board’s principal committees to recognise the Code changes.

How we
manage risk

Operational
framework

Board
information

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsBoard
governance

This is the structure through which we manage
the Company. It has evolved over time, and continues
to evolve to meet the needs of the business and our
stakeholder responsibilities.

Operational governance
The Operational Framework sets
out how we do business across
BAE Systems, and encapsulates
our values, policies and processes,
together with clear levels of
delegated responsibility aimed
at ensuring that all of our
employees and businesses act
in a clear, accountable and
consistent manner. It is reviewed
and approved annually by
the Board.

Oversight of
performance
and compliance
with Operational
Governance

Shareholders
The Company has
approximately 100,000
individual, corporate and
employee shareholders.

Annual General Meeting
Shareholders vote on key
governance matters,
including the re-election of
directors, their remuneration,
the payment of dividends
and the appointment of
the auditor.

Shareholder relations
The Chief Executive and
Group Finance Director meet
the Company’s principal
shareholders on a regular
basis. Separately, the
Chairman maintains regular
contact with the Company’s
principal shareholders on
governance matters and
ensures that all directors are
aware of their views.

Board
The Board consists of executive and
independent non-executive directors,
plus a non-executive chairman who
was independent in accordance with
the UK Corporate Governance Code
on his appointment.

The non-executive directors constructively
challenge and help develop proposals
on strategy. They also scrutinise the
performance of management in meeting
agreed goals and objectives, and satisfy
themselves as to the integrity of financial
information, and that systems of risk
management are robust and defensible.
In addition, they set the remuneration of
the executive directors and oversee Board
succession planning.

Chairman
Responsible for leading the Board and
ensuring that it discharges its duties
efficiently.

Chief Executive
Responsible for the implementation and
delivery of the strategy agreed by the Board.

Senior Independent Director
Acts as a sounding board for the Chairman
and acts as an intermediary for the other
directors as necessary.

Company Secretary
Responsible to the Board for ensuring
that Board procedures are complied with.
Through the Chairman, he is responsible
for ensuring that directors are supplied
with information in a timely manner.

Board committees
The membership of the principal board committees
(see below) solely comprises non-executive directors.
They provide leadership, scrutiny and oversight over
key governance areas.

Audit
83 Committee

Corporate Responsibility

87 Committee

Nominations

90 Committee

Remuneration

92 Committee

BAE SystemsAnnual Report 2018

Group strategic
framework

How we work
The Operational Framework sets out the principles of
good governance which, together with our culture, guide
our work and behaviour in support of the strategy set in
our Group strategic framework (see page 18). Here we
set out the values that we ask all our employees to
demonstrate in their day-to-day work, wherever they
are in the world.

Organisation
From the Board downwards, we set out how we are
organised and the responsibilities of the Board, the
Chairman, the Chief Executive, the Executive Committee,
our Functional Councils (such as Engineering, Human
Resources and Procurement) and the senior executives
charged with running our businesses.

Governance
The UK Corporate Governance Code’s (the Code) principles are embedded in the Operational Framework, and
its policies and processes underpin all the disclosures made by the Board pursuant to the Code’s provisions.

How we conduct our business is fundamental to the success of BAE Systems. The Operational Framework sets
out our approach and the standards to which we adhere. It includes the following:

Responsible
Trading Principles
We do not
compromise on the
way we do business
and here we mandate
a principles-based
approach to our
business activity.

Code of Conduct
Lays out the
standards that are
expected of each
of us, to support
us in doing the right
thing. All employees
receive annual
training designed
to stimulate
conversations
about ethical
decision-making.

Risk framework
This is how we
identify, analyse,
evaluate and
mitigate risk
(see page 66).

Internal controls
Provide assurance
regarding:
– the reliability

and integrity of
information;
– compliance with

policies, processes,
laws, regulations
and contracts;
– the safeguarding
of assets and
protection against
fraud; and

– the economical

and efficient use
of resources.

Workplace and
operational
environment
This covers how we
expect our people
to be managed and
the obligations
placed on us all
concerning avoiding
conflicts of interest,
anti-bribery, and
managing the
security of our
people, information
and other assets.

Delegated
authorities
As part of a robust
system of internal
controls, the Board
has delegated
certain authorities
to executive
management.
Delegation is subject
to financial limits
and other
restrictions, above
which matters
must be referred
to the Board.

Operational Assurance Statement (OAS)
This key governance process requires that a return is completed every six months by each operational and functional business
head, reporting their formal view against such matters as compliance with law and regulation, ethical business conduct,
financial controls, risk management, compliance with business planning processes, health and safety, conflicts of interest,
delegated authorities, appointment of advisers and product safety. There is a separate OAS process for our joint ventures.
Our Internal Audit function owns the OAS process. It is managed independently from management functions. The Internal
Audit Director reports functionally to the Audit Committee and, for day-to-day operations, to the Chief Executive.

Core business processes
These core business processes are mandated by the Operational Framework and designed to ensure consistent planning,
reporting and review of business performance across all businesses:

IBP
(Integrated Business Planning)

Approved by the Board annually,
creates a consistent approach
to strategic planning, aligning
resources with the delivery of
forecast financial performance
and strategic objectives.

LCM
(Lifecycle Management Policy)

How we plan and manage the
execution of all projects above a
certain minimum level, providing
decision gate reviews at key
stages from initial opportunity
to final closure.

M&A
(Mergers & Acquisitions Policy)

A structured approach to mergers,
acquisitions and disposals.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsBoard of directors

Sir Roger Carr
Chairman
Appointed to the Board: 2013 Nationality: UK

Charles Woodburn
Chief Executive
Appointed to the Board: 2016 Nationality: UK

Peter Lynas
Group Finance Director
Appointed to the Board: 2011 Nationality: UK

Skills, competence and experience
Having joined the Board in 2013, Sir Roger was
appointed Chairman in 2014. He is an experienced
company chairman with a wealth of knowledge
gained across a number of business sectors. With
over two decades of boardroom experience, Sir Roger
has a deep understanding of corporate governance
and what is required to lead an effective board.
Sir Roger is a Senior Advisor to KKR and Chairman of
the English National Ballet. In 2018, he was appointed
as co-chair of the Industrial Infrastructure and
Manufacturing Council, an advisory council to the
Prime Minister.
He has previously held a number of senior
appointments including Chairman of Centrica plc,
Vice Chairman of the BBC Trust, Deputy Chairman and
Senior Independent Director of the Court of the Bank
of England, President of the Confederation of British
Industry, Chairman of Cadbury plc, Chairman of Chubb
plc, Chairman of Mitchells & Butlers plc, Chairman of
Thames Water plc and Chief Executive of Williams plc.
Throughout his career he has served on a number
of external committees including the Prime Minister’s
Business Advisory Group, the Manufacturing Council
of the CBI, The Higgs Committee on Corporate
Governance and Business for New Europe. He is a
Fellow of the Royal Society for the encouragement
of Arts, Manufactures and Commerce, a Companion
of the Institute of Management, and an Honorary
Fellow of the Institute of Chartered Secretaries and
Administrators. He is also a Visiting Fellow of Saïd
Business School, University of Oxford and holds an
Honorary Doctorate in Business from Nottingham
Trent University.
He was knighted for Services to Business in the
Queen’s New Year’s Honours list 2011.

Other non-executive appointments
None.

Committee membership
Chairman of the Nominations Committee.

Chairman

Executive directors

Non-executive directors

Skills, competence and experience
Charles joined BAE Systems in May 2016 as Chief
Operating Officer and became Chief Executive on
1 July 2017. Prior to joining the Company, he spent
over 20 years in the oil and gas industry, holding
a number of senior management positions in the
Far East, Australia, Europe and the US. He joined
the Company from the oilfield services business,
Expro Group, where he served as Chief Executive
Officer. Prior to that, he spent 15 years
with Schlumberger Limited.

Non-executive appointments
None.

Skills, competence and experience
Peter, a qualified accountant, was appointed to the
Board as Group Finance Director in 2011. His role
has since been expanded to include responsibility
for UK Shared Services, Procurement and Group
Mergers & Acquisitions.
Peter previously served for a number of years as
Director, Financial Control, Reporting & Treasury.
He joined GEC-Marconi in 1985 having previously
worked for other companies in the UK and Europe.
After progressing through a number of positions,
he was appointed Finance Director of GEC’s Marconi
Electronic Systems business, which was subsequently
acquired by British Aerospace in 1999 to become
BAE Systems.

Non-executive appointments
Non-executive director of SSE plc and chairman of
its audit committee.

Jerry DeMuro
President and Chief Executive Officer
of BAE Systems, Inc.
Appointed to the Board: 2014 Nationality: US

Skills, competence and experience
Appointed to the Board on 1 February 2014 as President
and Chief Executive Officer of BAE Systems, Inc.,
Jerry is an experienced US executive who has worked
in the national security, technology and aerospace
industry for over 30 years. Prior to joining the Company,
he served as executive vice president and corporate
vice president of General Dynamics’ Information
Systems and Technology Group. Earlier in his career,
he spent almost a decade as an acquisition official at
the US Department of Defense.
Jerry has been actively involved with several
associations and non-profit organisations, including
the Aerospace Industries Association, where he is
currently a member of its Executive Committee,
the Association of the United States Army, the
MILCOM Conference Board, and AFCEA International,
where he served on the Board of Directors as an
Executive Committee member and as chair of the
Audit Committee.

Non-executive appointments
None.

Revathi Advaithi
Non-executive director
Appointed to the Board: 2018 Nationality: US

Skills, competence and experience
Revathi brings extensive operational experience
and a deep understanding of digital technology
and international markets to the Board, gained from
her leadership of multinational engineering and
manufacturing businesses. In February 2019,
Revathi assumed the role of Chief Executive Officer
and became a member of the board of directors at
Flex Ltd, a global manufacturing company. Prior to
this appointment, Revathi was president and chief
operating officer for the Electrical Sector business
at Eaton, a power management company. She joined
Eaton in 1995 and led the Electrical Sector in the
Americas and Asia-Pacific, with a three-year
assignment in Shanghai. Between 2002 and 2008,
Revathi worked at Honeywell, where she held
leadership roles spanning manufacturing, procurement,
supply chain and sourcing, including a role as general
manager, Automation and Control Solutions. Revathi
returned to Eaton in 2008 as vice president and general
manager of the Electrical Components division.

Other non-executive appointments
None.

Committee membership
Corporate Responsibility Committee and Nominations
Committee.

BAE SystemsAnnual Report 2018Elizabeth Corley CBE
Non-executive director
Appointed to the Board: 2016 Nationality: UK

Harriet Green OBE
Non-executive director
Appointed to the Board: 2010 Nationality: UK

Skills, competence and experience
Elizabeth brings investor, governance and boardroom
experience to the Board. She is currently a Senior
Advisor at Allianz Global Investors. She has served
as Chief Executive Officer of Allianz Global Investors,
initially for Europe then globally, from 2005 to 2016.
Prior to that, she worked for Merrill Lynch Investment
Managers. Elizabeth is active in representing the
investment industry and developing standards within
it. She is a member of the CFA Future of Finance
Advisory Council and the AQR Institute of Asset
Management at the London Business School.
Elizabeth is currently chair of the industry Taskforce
for the UK government on social impact investing.
In 2017, she stepped down from the board of the
UK Financial Reporting Council after completing
her second three-year term of appointment.
Elizabeth is also an acclaimed writer, a Fellow
of the Royal Society for the encouragement of Arts,
Manufactures and Commerce and a trustee of the
British Museum.

Other non-executive appointments
Non-executive director of Pearson plc and
Morgan Stanley.

Committee membership
Nominations Committee and Remuneration Committee.

Skills, competence and experience
Harriet is a transformative business leader with
international operational and boardroom experience.
She is currently Chief Executive Officer and Chairman
of Asia-Pacific at IBM. Harriet has extensive global
business leadership experience. She previously served
as Chief Executive Officer and executive director of
Thomas Cook plc. Prior to that, she was Chief Executive
Officer and executive director of Premier Farnell plc.
Previously, she was also a non-executive director of
Emerson Electric Co. In 2017, Harriet was named as
one of the Fast Company’s 100 Most Creative People
in Business and in 2018 she was again placed by
The Financial Times in the top ten of their ‘HERoes
ranking: Champions of Women in Business’ list.
In 2016, she won the Women in Technology Institute
(WITI) Award and, in 2014, she received the Veuve
Clicquot Business Woman Award. Harriet is a member
of the Singapore Economic Development Board.

Other non-executive appointments
None.

Committee membership
Corporate Responsibility Committee and Nominations
Committee.

Chris Grigg
Non-executive director
Appointed to the Board: 2013 Nationality: UK

Skills, competence and experience
As chief executive of a FTSE 100 company, Chris
brings management and boardroom experience
to the Board. He is currently Chief Executive of
The British Land Company PLC, a position he has
held since 2009.
Chris has more than 30 years’ experience in the
banking and real estate industries. Prior to joining
British Land, he was Chief Executive of Barclays
Commercial Bank. Before that, he was a partner
at Goldman Sachs. Chris is currently a member
of the executive board of the European Public
Real Estate Association and the board of the
British Property Federation.

Other non-executive appointments
None.

Committee membership
Corporate Responsibility Committee and Nominations
Committee.

Paula Rosput Reynolds
Non-executive director
Appointed to the Board: 2011 Nationality: US

Skills, competence and experience
An experienced company director in both the UK
and North America, Paula is currently Chief Executive
Officer and President of the business advisory group
PreferWest LLC.
Starting her career as an economist, she spent over
20 years in the energy sector, culminating in her
appointment as President and Chief Executive Officer
of AGL Resources in 2002. She served as President and
Chief Executive Officer of Safeco Corporation before
becoming Vice Chairman and Chief Restructuring
Officer of American International Group, overseeing
its divestiture of assets and serving as chief liaison with
the Federal Reserve Bank of New York. She received the
National Association of Corporate Directors National
Lifetime Achievement Award in 2014.
Past roles include non-executive directorships at
Coca-Cola Enterprises Inc., Anadarko Petroleum
Corporation, Delta Air Lines Inc., Air Products and
Chemicals Inc., and Siluria Technologies, Inc.

Other non-executive appointments
Non-executive director of BP p.l.c., CBRE Group, Inc.,
General Electric Company and TransCanada Corporation.

Committee membership
Chairman of the Remuneration Committee, and member
of the Audit Committee and Nominations Committee.

Nick Rose
Non-executive director and
Senior Independent Director
Appointed to the Board: 2010 Nationality: UK

Skills, competence and experience
Nick brings to the Board considerable financial
expertise and boardroom experience. Nick was
Chief Financial Officer of Diageo plc for over ten years
until 2010. In this role, he was responsible for supply,
procurement, strategy and IT on a global basis. His
financial experience was developed during his time as
group treasurer and group controller at Diageo, and
also in his earlier career at Ford Finance. He is a former
Chairman of the engineering technology company
Edwards Group Limited and former non-executive
director of Moët Hennessy SNC and Scottish Power plc.
Nick is currently an adviser to CCMP Capital Advisors, LLC.

Other non-executive appointments
Chairman of Williams Grand Prix Holdings PLC;
non-executive director and senior independent
director of BT Group plc; and non-executive chairman
of Loch Lomond Group.

Committee membership
Chairman of the Audit Committee, and member of the
Nominations Committee and Remuneration Committee.

Ian Tyler
Non-executive director
Appointed to the Board: 2013 Nationality: UK

Skills, competence and experience
Ian brings considerable financial and long-term
international contracting experience to the Board.
Having qualified as a chartered accountant, Ian
subsequently held a number of senior finance and
operational positions within industrial companies
before being appointed Finance Director of Balfour
Beatty plc in 1996. He was subsequently appointed
as Chief Executive in 2005. He is currently Chairman
of Bovis Homes Group PLC and Cairn Energy plc.
Ian is a former non-executive director of Mediclinic
International plc, Cable & Wireless Communications
Plc and VT Group plc.

Other non-executive appointments
Chairman of Amey plc, a subsidiary of Ferrovial, S.A.,
and AWE Management Limited.

Committee membership
Chairman of the Corporate Responsibility Committee,
and member of the Audit Committee and Nominations
Committee.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsBoard information

Membership

Committee
membership

Nationality

Tenure

0
1
0
2

1
1
0
2

2
1
0
2

3
1
0
2

4
1
0
2

5
1
0
2

6
1
0
2

7
1
0
2

8
1
0
2

9
1
0
2

0
2
0
2

1
2
0
2

2
2
0
2

3
2
0
2

4
2
0
2

5
2
0
2

6
2
0
2

Sir Roger Carr
Chairman1

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 and
Senior Independent Director

Ian Tyler
Non-executive director

C N

N R

C N

A N R

A C N

The average length of appointment of non-executive members of the Board (as at 31 December 2018) was 5.6 years.

Date of appointment to the Board of executive members

Charles Woodburn
Chief Executive

Peter Lynas
Group Finance Director

Jerry DeMuro
President and Chief Executive Officer of BAE Systems, Inc.

The average length of appointment of executive members of the Board (as at 31 December 2018) was 5.1 years.

Chairman

Non-executive director

Executive director

Committee chair
A Audit Committee
N Nominations Committee

C Corporate Responsibility Committee
R Remuneration Committee

First term

Second term

Third term

Attendance
Individual directors’ attendance at meetings of the Board and its committees in 2018

Board

Audit
Committee

Corporate
Responsibility
Committee

Nominations
Committee

Remuneration
Committee

Tenure – independent
non-executive directors

Over
six years
3

Up to
three years
2

Revathi Advaithi

Sir Roger Carr

Elizabeth Corley

Jerry DeMuro

Harriet Green

Chris Grigg

Peter Lynas

Paula Rosput Reynolds

Nick Rose

Ian Tyler

Charles Woodburn

8/8

6/8

8/8

–

5/5

–

4/4

–

2/4

4/4

–

4/4

–

5/6

6/6

–

5/6

6/6

–

6/6

–

6/6

–

6/6

–

1. Sir Roger Carr joined the Board in October 2013 and was appointed as Chairman in February 2014.

Over three and
up to six years
2

Diversity – Board

4 female
7 male

BAE SystemsAnnual Report 2018
Governance disclosures

UK Corporate Governance
Code (the Code) compliance

The Company was compliant
with the provisions of the
Code throughout 2018 and the
Board has applied its principles
in its governance structure
and operations. The following
statements are made in
compliance with the Code.

Risk management and internal
control statement
The Board is responsible for the Company’s
risk management and internal control systems.
It has delegated responsibility for reviewing in
detail the effectiveness of these systems to the
Audit Committee, which reports to the Board
on its findings so that all directors can take a
view on the matter.

An overview of the processes used to identify,
evaluate and manage the principal risks can be
found on pages 66 and 67. These processes
are an integral part of our governance
framework, the Operational Framework,
details of which can be found on page 76.
The Operational Framework mandates the
Operational Assurance Statement process,
which is owned by the Company’s Internal
Audit function and is one of the principal
processes used by the Board in monitoring
the effectiveness of the Company’s internal
control systems.

The risk management and internal control
systems detailed in the Operational Framework
were in place throughout the year and the
Board, having reviewed their effectiveness,
believes they accord with the Financial
Reporting Council’s Guidance on Risk
Management, Internal Control and Related
Financial and Business Reporting.

Viability statement
As required by the provisions of the Code,
the Board has undertaken an assessment of
the future prospects of the Company, taking
into account the Company’s current position
and principal risks. This assessment considered
both the Company’s long-term prospects
and also its ability to continue in operation
and meet its liabilities as they fall due over
its five-year business planning period.

Analysis of business prospects
Whilst recognising the geopolitical
environment in which the Company operates
and with due regard to the principal risks
set out on pages 68 to 71, the Board has
also considered the long-term prospects of
the Company based on our strategy, markets
and business plan as outlined on pages 18
to 34 of this report. In its strategic review
of the Company, the Board recognised the
importance of certain factors that underpin
its long-term prospects and viability. In
summary, these are:
– a diverse portfolio of businesses based on

well-established market positions, providing
both complex, high technology products
and programmes, and differentiated technical
services and support. In 2018, 30% of group
sales were product/programme related and
70% services and support;

– a geographically diverse business with

a high proportion of sales to governments
and other major prime defence contractors.
In 2018, 28% of sales were to the US
Department of Defense, 21% to the UK
Ministry of Defence and 13% to the Kingdom
of Saudi Arabia Ministry of Defence and
Aviation. Major new business wins in the
Middle East, Australia and Canada provide
a strong foundation for further market
diversity and growth;

– long-term visibility of sales and future
sale prospects through a substantial
order backlog (2018 £48.4bn) and
incumbent positions on major defence
programmes; and

– market positions underpinned by a highly
skilled workforce, intellectual property
assets and proprietary know-how, which
are safeguarded and developed for the
future by customer- and Company-funded
investment. Such investment is focused on
a well-developed understanding of future
technologies and the threat environment
shaping the long-term defence and
aerospace market.

Assessment
The Board’s assessment of the Company’s
prospects was informed by the following
business processes:

Risk management process – the Company
has developed a structured approach to the
management of risk (see above) and emerging
and principal risks identified are considered
as part of the Board’s annual review of the
Integrated Business Plan.

Integrated Business Plan (IBP) – the IBP
represents a common process with standard
outputs and requirements that produces an
integrated strategic and business plan for the
Company and also for each of its businesses
over the following five years. The use of a
five-year period provides a robust planning
tool against which long-term decisions can
be made concerning, amongst other things,
strategic priorities, funding requirements
(including commitments to the Company’s
pension schemes), returns made to
shareholders, capital expenditure and resource
planning. Longer-term strategic inputs also
form part of the IBP process and, where
activity is required to meet such long-term
priorities, this is provided for in the plan.

The detailed plan is reviewed each year
by the Board as part of its strategy review
process. Once approved by the Board, the
IBP provides the basis for setting all detailed
financial budgets and strategic actions across
the businesses, and is subsequently used
by the Board to monitor performance.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsIn addition to being a non-executive director
of the Company, Ian Tyler is chairman of
two listed FTSE 250 companies, Bovis Homes
Group and Cairn Energy, and also two
non-listed companies, AWE Management,
a private company owned by three joint
venture partners, and Amey, a subsidiary
of Ferrovial, S.A., a Spanish listed company.
The Chairman has reviewed Ian Tyler’s other
commitments and is satisfied that they do
not impinge on his ability to discharge his
responsibilities to BAE Systems effectively.
He will keep this matter under review.

In addition to being a non-executive
director of the Company, Paula Rosput
Reynolds is currently a director of four other
listed companies. However, it has been
announced that she will shortly be standing
down from the board of CBRE Group, Inc.

As detailed in the Nominations Committee
report (see pages 90 and 91), the Board
believes that, despite having served as a
non-executive director for more than nine
years with effect from 8 February 2019,
Nick Rose remains independent for the
purposes of the Code.

The Company considers that all of the
non-executive directors identified on pages
78 and 79 of this report are independent
in accordance with Code provisions.

Governance disclosures
continued

Liquidity analysis – the Board regularly
reviews an analysis based on the financial
output from the IBP, looking at the forecast
working capital requirements, cash flow,
and committed borrowing and other funding
facilities available to the Company over the
five-year period covered by the IBP. This
analysis includes ‘stress testing’ of the
Company’s liquidity under severe, but
plausible, scenarios as developed from the
IBP, including the following:
– the Company being unable to access debt

markets to renew term debt facilities;
– an unfavourable change to the terms of
trade the Company enjoys with certain
principal customers;

– the Company failing to win certain major

export contracts;

– potential change of UK government policy;

and

– the loss of a major export market.

The scenarios tested included the impact
of multiple adverse factors.

Conclusion
In undertaking its review of the IBP in 2018,
the Board considered the prospects of the
Company over the five-year period covered
by the process. On the basis of this and other
matters considered and reviewed by the
Board, the Board has reasonable expectations
that the Company will be able to continue in
operation and meet its liabilities as they fall
due over the following five years. It is
recognised that such future assessments are
subject to a level of uncertainty that increases
with time and, therefore, future outcomes
cannot be guaranteed or predicted with
certainty. Also, this assessment was made
recognising the principal risks that could have
an impact on the future performance of the
Company (see pages 68 to 71).

Going concern statement
Accounting standards require that directors
satisfy themselves that it is reasonable for
them to conclude whether it is appropriate
to prepare financial statements on a going
concern basis and the Code requires that, if
appropriate, this report includes a statement
to that effect. Following review, the directors
have concluded that it is appropriate to
adopt the going concern basis for these
financial statements and have not identified
any material uncertainties concerning the
Company’s ability to do so in the 12-month
period from the date of approving them.

For this reason, they continue to adopt the
going concern basis in preparing the accounts.

Directors
All directors undertake a structured induction
programme when they first join the Board,
thereafter they regularly update and refresh
their knowledge of the Company.

In compliance with the Code, all directors are
subject to annual election by shareholders.
The Chairman has confirmed that, based on
the formal performance evaluations undertaken
in 2018, all remain committed to the role and
the individual performance of all directors
continues to be effective. Also, in compliance
with the Code, the Company ensures that
non-executive directors have sufficient time
to fulfil their obligations. This is assessed when
a director is appointed and also in the event
of there being a material change to an
individual’s circumstances.

Elizabeth Corley, a non-executive director
of the Company, is a non-executive director
of Morgan Stanley, a US listed company.
One of its UK subsidiary companies provides
corporate broking services to the Company
and, consequently, an assessment has been
undertaken to determine whether this
relationship has a bearing on her independence
for the purposes of provision B.1.1 of the
Code. After review, it was determined that this
was not a material business relationship given
the relatively low value of the contractual
arrangements and the nature of the
relationship, i.e. broking services are provided
by a UK subsidiary of Morgan Stanley and her
appointment is to the board of the US parent
company and non-executive in nature.

Should there be any change to either
Elizabeth Corley’s role with Morgan Stanley
or a material change in the services its UK
subsidiary provides to the Company, this
decision will be reconsidered.

BAE SystemsAnnual Report 2018Audit Committee
report

Nick Rose
Chairman of the
Audit Committee

Members

Nick Rose (Chairman)
Paula Rosput Reynolds
Ian Tyler

Dear Shareholders,
I reported last year on progress on our audit
re-tender and on our audit transition plans.
I am pleased to report that our audit re-tender
process, for which preparatory work had
commenced in 2016, concluded at the
Annual General Meeting on 10 May 2018
when shareholders approved the appointment
of Deloitte LLP as the Company’s auditor,
succeeding KPMG LLP in that role.

Whilst the audit re-tender process and
subsequent transition spanned quite a lengthy
period, we were keen to ensure that the
incoming auditor had a good understanding
of our business that would enable it to identify
areas of audit risk efficiently, formulate a
risk-focused approach to audit scope, and to
embark on the 2018 audit as well-prepared as
possible. That there has been a smooth
transition has been testament to the ground
work laid in execution of the transition plan
which included Deloitte shadowing the 2017
year-end audit conducted by the outgoing
auditor, KPMG. We are also pleased that
Deloitte have commented favourably on the
constructive engagement with management,
both centrally and across the Group, during
the transition period.

The section on the Audit Committee’s year
on page 86 provides an overview of the work
that we have undertaken in the last 12 months
and I will comment here on several aspects
of that activity.

As part of the auditor transition arrangements,
and subsequent to their appointment, we
have reviewed on a regular basis similar
confirmations and information from Deloitte
to ensure their independence.

Non-audit services policy
The Committee has a formal policy
governing the engagement of the auditor
to provide non-audit services which we
review on an annual basis. The policy
prohibits certain activities from being
undertaken by the auditor and also places
restrictions on the employment of former
employees of the auditor.

We recognise that the auditor is best placed
to undertake certain work of a non-audit
nature, and thus the policy permits the
provision of Audit-Related Services and
Permitted Non-Audit Services up to limits
that are pre-approved by the Committee,
with specific approvals required beyond
such limits by the Committee. A copy of the
policy is available on the Company’s website.

Following the selection of Deloitte as the
Company’s proposed auditor in 2017, the
Committee reviewed the non-audit services
being provided by Deloitte at that time and
the steps being taken by Deloitte to ensure
audit independence by 1 October 2017
when shadowing began. Certain services,
even though they fell within the Permitted
Non-Audit Services category, were wound
up or discontinued. A number of non-audit
services being provided by Deloitte which
were expected to continue beyond 1 January
2018 were carefully considered and
individually approved by the Committee.
Particular consideration was given to
consultancy work undertaken in relation to
the Group’s Submarines business which had
been disclosed in the pre-audit qualification
exercise. Actions were taken to ensure that
independence was successfully managed
throughout the regulatory ‘cooling in’ period
which commenced on 1 January 2017, as
well as from 1 October 2017 onwards when
shadowing began. The Committee is satisfied
that independence was maintained throughout
this period.

Details of fees payable to the auditor are
set out on page 154. In 2018, non-audit fees
for Deloitte represented 30% of the audit
fee. The principal non-audit services provided
by Deloitte related to its review of the
half-yearly financial report and completion
in 2018 of consultancy work that was already
under way prior to Deloitte’s appointment
as our auditor.

In June we agreed the scope and level of
materiality of the 2018 audit plan of work
and discussed with Deloitte the areas that
they had identified as key risks and other
particular areas of focus, and the specific
audit procedures that they would perform
to undertake the related audit work. Whilst
audit continuity is important, as a Committee
we equally recognise the benefits that fresh
perspective, challenge and insight can bring.

At the beginning of the year the Group
adopted accounting standard IFRS 15
Revenue from Contracts with Customers,
in the financial statements. A significant
amount of work had been undertaken
throughout the Group to enable the new
standard to be implemented and further
information on IFRS 15 is provided in note 37
to the Group accounts on pages 205 to 209.

We also reviewed the implementation
and disclosures relating to the adoption
of IFRS 9 Financial Instruments by the
Group on 1 January 2018 which did not
result in any adjustments in previous periods.
Further information is set out in note 37 to
the Group accounts on pages 205 to 209.

A further accounting change coming into
force in 2019 is the adoption of IFRS 16
Leases. We reviewed the implementation
plan and disclosures relating to IFRS 16
which will be adopted by the Group with
effect from 1 January 2019. The expected
impact of IFRS 16 is set out in note 38 to the
Group accounts on pages 210 and 211.

Using our Internal Audit function to
optimal effect within the overall context of
the risk environment remains a key priority
for us. I reported last year that an external
assessment of the function originally
scheduled to be undertaken in 2017 had
been deferred until 2018 following
organisational changes taking effect from
1 January 2018. That assessment has since
been completed and is reported on below.

Audit Quality Review (AQR)
The Financial Reporting Council’s AQR team
monitors the quality of audit work of certain
UK audit firms through inspections of a
sample of audits and related procedures
at individual audit firms. Deloitte have taken
us through their latest AQR report (of which
the period under review preceded their
appointment as the Company’s auditor)
and outlined actions being taken to address
the issues raised.

Audit independence
We reviewed in detail the confirmation
and information received from KPMG on
the arrangements that they had in place
to safeguard auditor independence and
objectivity, including specific safeguards in
place where they were providing permissible
non-audit services to the Group.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAudit Committee report
continued

Financial statements
The Committee reviews all significant issues concerning the financial statements. The principal
matters we considered concerning the 2018 financial statements, in addition to the going
concern and viability statement reviews referred to opposite, were:

Recognition of revenue, profit
and provisioning
From 1 January 2018 the Group adopted
IFRS 15 Revenue from Contracts with
Customers.

The Committee reviewed the Group’s
implementation and processes for the
adoption of IFRS 15. In addition, the
Committee reviewed key estimates and
judgements applied in determining the
financial status of the more significant
programmes including UK aircraft carrier
programme, Astute, OPVs, Radford,
Saudi British Defence Co-operation
Programme and Saudi Typhoon.

Goodwill
Impairment testing of goodwill on the
balance sheet is underpinned by the value
of the future prospects of the related
business which have to be estimated.

We considered the level of goodwill held
on the Group’s balance sheet and whether,
given the future prospects of the acquired
businesses, the value of goodwill held on
the balance sheet remains appropriate.
The methodology for impairment testing
used by the Group is set out in note 8 to the
Group accounts on page 161. No goodwill
impairments were identified as a result of
this review.

Pensions
Accounting for pensions and other post-
retirement benefits involves making estimates
when measuring the Group’s retirement
benefit obligations. These estimates require
assumptions to be made about uncertain
events such as discount rates and longevity.

Taxation
Computation of the Group’s tax expense
and liability, the provisioning for potential
tax liabilities and the level of deferred tax asset
recognition are underpinned by management
judgement and estimation of the amounts
that could be payable.

Whilst tax policy is ultimately a matter for
the Board’s determination, we reviewed the
Group’s tax strategy as set out on page 41.
Twice during the year, we reviewed the
Group’s tax charge, tax provisions and the
basis of recoverability of the deferred tax
asset relating to the Group’s pension deficit.

Recognising the scale of the Group’s pension
obligation, we reviewed the key assumptions
supporting the valuation of the retirement
benefit obligation. This included a comparison
of the discount and inflation rates used against
externally-derived data. We reviewed the
methodology used to allocate a proportion
of the retirement benefit obligation to equity
accounted investments and concluded that
this was appropriate with reference to
agreements between the Company and those
companies. We also considered the adequacy
of disclosures in respect of the sensitivity of
the deficit to changes in these key assumptions
(see note 22 to the Group accounts on pages
178 to 188).

The Committee also reviewed the disclosures
set out in note 37 to the Group accounts on
pages 205 and 206 in relation to the correction
of a prior year error in the value of pension
scheme assets regarding the treatment of
experience collateral in the accounting
valuation of a longevity swap.

How we ensure that the Group’s financial statements, taken as a whole, are fair,
balanced and understandable and provide information necessary for shareholders
to assess the Company’s position and performance, business model and strategy

The process is:
– comprehensive guidance issued to all the contributors at operational level;
– a verification process dealing with the factual content of the reports;
– comprehensive reviews undertaken at different levels in the Group that aim to ensure

consistency and overall balance; and

– comprehensive review by the directors and the Executive Committee.

Going concern and viability statements
The Committee also agreed the parameters
of, and reviewed the supporting report for,
the going concern statement (see page 82)
and the statement on the Board’s assessment
of the prospects of the Company (the viability
statement on page 81) over the five-year
period used in the Integrated Business Plan.
The Committee considered the period covered
by the viability statement and continues to be
of the view that a five-year period remains the
most appropriate timespan in this regard.

Internal control and risk
The Board has delegated to the Committee
responsibility for reviewing in detail the
effectiveness of the Company’s risk
management and internal control system.
The Committee’s review of the effectiveness
of internal controls has encompassed a review
of the reports relating to the six-monthly
Operational Assurance Statements (OAS), which
are submitted by each business or function
as a mandated policy under the Group-wide
Operational Framework, controls reports, and
reports from both internal and external auditors.

A key focus for the Committee is the controls
environment surrounding the Company’s
Lifecycle Management (LCM) process, the
bedrock of our programme execution and
management. LCM is integral to the successful
execution of the Group’s projects and
programmes, and of particular importance
in the early identification of programme risk
and the determination of profit recognition or
provisioning which, you will see from above,
tend to be areas where we are required to
exercise judgement. We have discussed the
outputs of financial, IT and LCM controls
testing, and any required improvement
actions, with management, and internal and
external audit, with a view to ensuring the
ongoing robustness of programme execution
and risk mitigation.

We have reviewed the ongoing effectiveness
of the Company’s risk management processes
as part of our wider review of internal controls.
The Group’s principal risks are set out on
pages 68 to 71.

For a number of years it has been part of the
Committee’s remit to oversee the effectiveness
of the whistle-blowing facility with particular
reference to matters of financial concern.
Under the new UK Corporate Governance
Code effective from 1 January 2019,
responsibility for oversight of an anonymous
whistle-blowing facility rests with the Board,
and we have therefore taken the opportunity,
with the agreement of the Board, to re-align
the Committee’s Terms of Reference to reflect
the new Code provision.

BAE SystemsAnnual Report 2018Internal audit
Internal Audit plays an integral role in the
Company’s governance structure and provides
regular reports to the Committee. These
include an overview of the work undertaken
in the period under review, individual reports
on audits conducted and progress against
the agreed internal audit plan, as well as
the outputs of the twice-yearly OAS process
and the tracking of remedial action in
the case of any control failures. Specific
attention has been paid during the year
to the organisational changes effective
from 1 January 2018.

The annual Internal Audit programme is
agreed jointly by the Audit and Corporate
Responsibility committees to ensure that
the overarching programme covers not only
financial risk, but also the assessment of
the effectiveness of key areas of ethical and
reputational risk. The assurance programme
comprises a broad range of audits covering
areas such as mandated governance, OAS
outputs, risk register findings, change
programmes, structural and business changes,
and areas relating to responsible behaviour
and non-financial risk. Internal Audit may also
from time-to-time undertake other work
within the context of the risk environment.

During the year under review, and separate
from the normal regular sessions we hold
with the Internal Audit Director without
management present, we held a separate
session with him, his heads of internal
audit and the external auditor, after we
had had the benefit of Deloitte’s output
on their controls testing. At this session
we continued our discussions around
(i) the mandated control environment,
e.g. finance and export compliance controls;
and (ii) other risk-based assurance priorities,
e.g. general IT, quality, project management
and engineering controls.

An External Quality Assessment (EQA) of
the Internal Audit function was undertaken in
2018 by Ernst & Young LLP (EY). The objective
of the EQA was to independently assess the
quality and effectiveness of Internal Audit,
in line with the International Standards for
the Professional Practice of Internal Auditing.

During the assessment, EY interviewed a
sample of Internal Audit’s stakeholders across
the business and reviewed working papers
and outputs related to a sample of internal
audits that had been conducted in 2017.
Based on their work, EY concluded that
within BAE Systems the Internal Audit
function is respected and trusted, is clear
on its role and remit in the organisation, has
access to the majority of skills and capabilities
that it needs to deliver its current programme
of audits, and has many strong operational
processes in place which enable it to deliver
on its mandate.

Recommendations were made by EY to
supplement the continuous improvement
activities already under way, which will be
addressed by the function through a number
of workstreams over the next two years.
The areas of improvement include the use of
technology and tools specifically in connection
with data analytics, embedding cultural
assessments into audit activities, and working
with the business to improve integrated
assurance across the three lines of defence
(see below).

We have had the opportunity to hear direct
from the VP, Internal Audit, on internal audit
work undertaken within the US businesses
as well as from the Head of Audit – Risk,
in respect of optimising impactful internal
audit reporting and risk-based approaches
to developing and executing the annual
internal audit plan.

Nick Rose
Chairman of the Audit Committee

How the effectiveness of the external
audit process and audit transition
was assessed

Who we surveyed:
– Executive directors
– Operating group/sector and line

of business management

– Internal Audit Director
– Other senior executives, including

key finance roles

Areas we covered:
– Transition process
– Understanding of the Group’s risks
– Audit plan
– Robustness of audit processes
– Objectivity
– Quality of communications
– Ability to provide a seamless

service across differing jurisdictions

as well as interaction with the Committee
members.

The output of the review was positive
with a strong transition and the
incoming auditor demonstrating a good
understanding of key business risks,
and providing robust and constructive
challenge. It was recognised that a key
requirement going forward would be
to retain continuity of the audit team
in order to develop the knowledge base
and level of experience.

On the basis of the review following
the 2018 year-end audit, the Committee
has proposed to the Board that it
recommend that shareholders support
the re-appointment of Deloitte LLP at the
2019 AGM.

Three lines of defence model

Endorsed by the Chartered Institute of Internal Auditors, the three lines of defence
model comprises:

First line of defence
Operational management has ownership, responsibility and accountability for assessing,
controlling and mitigating risks.

Second line of defence
Activities covered by certain components of internal governance (e.g. compliance, quality,
project management, engineering etc).

Third line of defence
Internal audit function and other independent assurance.

Competition and Markets
Authority Audit Order
The Committee has complied with
the provisions of the Competition and
Markets Authority Audit Order in respect
of committee responsibilities and audit
re-tendering disclosures.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAudit Committee report
continued

The Audit Committee’s year

February

Committee

June

Committee

London, UK
– Considered the accounting, financial

control and audit issues reported by the
auditor that flowed from the audit work.

– Reviewed the financial statements and
specific disclosures, including viability
and going concern, for recommendation
to the Board.

– Reviewed the effectiveness of the

external audit process.

– Received a report from the Group

Taxation Director.

– Considered output from the six-monthly

OAS review.

– Reviewed the procedures and outputs
for the identification, assessment and
reporting of risk.

– Reviewed the effectiveness of the
Company’s helpline procedures in
respect of the reporting of accounting
or financial improprieties.
– Regular quarterly items1.

Joint session with the Corporate
Responsibility Committee:
– Agreed final iteration of the annual

Internal Audit programme.

May

Committee

Farnborough, UK
– Agreed the AGM Trading Statement.
– Received a report on the Group’s

insurance arrangements.

– Agreed the audit engagement letter2.

Baltimore, US
– Agreed audit strategy and scope.
– Reviewed external auditor independence

issues.

– Agreed audit fee.
– Considered output of the Internal

Audit Director’s report.

– Received a presentation from VP, Audit

for the US businesses.
– Regular quarterly items1.

July

Committee

London, UK
– Considered the accounting, financial

control and audit issues reported by the
auditor that flowed from the half-year
review work.

– Reviewed the financial statements and

specific disclosures, including going concern,
for recommendation to the Board.

– Received a report from the Group Taxation

Director.

– Considered output from the six-monthly

OAS review.

– Reviewed the procedures and outputs
for the identification, assessment and
reporting of risk.

– Considered output from the external quality
assessment of the Internal Audit function.

– Regular quarterly items1.

1. The Committee reviews the nature and level of non-audit services (including independence safeguards from the
incumbent auditor where it provides such services), and holds a separate session with the Internal Audit Director
and external auditor without management present. The Audit Committee Chairman also meets separately with
internal and external audit on an ad hoc basis.

2. Subject to Deloitte LLP being appointed as auditor at the 2018 AGM.

December

Committee

London, UK
– Considered the external auditor’s

controls report.

– Considered output of the Internal

Audit Director’s report.

– Received a presentation from

Head of Audit – Risk.

– Reviewed Internal Audit Charter.
– Received a report on export control

compliance.

– Reviewed the Non-Audit Services Policy.
– Discussed the first iteration of the annual

Internal Audit programme.

– Set the parameters for work supporting

the viability and going concern statements.

– Received briefing on IFRS 16 Leases.
– Review of the Committee’s Terms

of Reference.

– Regular quarterly items1.

Meeting

London, UK
– Informal meeting with the Internal
Audit Director and external auditor
to discuss the balance between
mandated audits and other risk-based
assurance processes.

Committee composition and evaluation
The breadth of experience of the
Audit Committee members is set out
on page 79. The performance evaluation
of the Committee is undertaken as part
of the wider Board evaluation and the
Board believes the Committee to have
the appropriate composition, skills and
experience to discharge its responsibilities.

Audit Committee timeline

February
Committee

May
Committee

June
Committee

July
Committee

December
Committee

Meeting

BAE SystemsAnnual Report 2018Corporate Responsibility
Committee report

Ian Tyler
Chairman of the Corporate
Responsibility Committee

Members

Ian Tyler (Chairman)
Revathi Advaithi
Harriet Green
Chris Grigg

Dear Shareholders,
I am pleased to provide you with an update
on the activities undertaken by the Corporate
Responsibility Committee during the year.
The Committee continues to develop its
agenda to address the key developments
in corporate responsibility and responsible
business conduct. The scope of the work
has necessarily broadened over recent
years and our agenda focuses on both our
core areas of safety, ethics and responsible
business conduct and now more fully
covers the broader definition of corporate
responsibility, and as such includes diversity
and inclusion, stakeholder and employee
engagement and supplier conduct as regular
agenda items.

Safety
As I have done in previous reports, I begin
with a discussion of our health and safety
agenda, which remains a priority. The
year saw an improvement in the overall
number of recordable injuries, which was
welcomed by the Committee. However, this
was offset by some significant major events.
In June last year, Committee members
were alerted to a serious incident at the
US Army munitions plant in Radford, Virginia,
a facility operated by our US business. An
accident in the plant’s nitrocellulose drying
facility resulted in the tragic death of a
Company employee, Andrew Goad, and
injuries to two other employees. Shortly
afterwards, the Committee met with local
management and the leaders of our US
business to understand more about the
incident and the actions being taken by
the Company. We have continued to receive
reports on the incident, and with all the
investigations having been completed
recently, the Committee will now be looking
more broadly at whether there are lessons
to be learnt and shared, both at Radford
and more widely across the Group.

In light of our ongoing focus on safety,
the Committee has continued to undertake
a deep dive into the safety metrics and
practices at each of our businesses on a
rotation throughout the year. This allows for
a comprehensive review of each area and for
the Committee to develop an understanding
of how the local management teams are taking
measures to improve safety performance and
for us to assess the strength of the safety
culture across the business. While good
progress has been made on all aspects, the
serious nature of the Radford incident has
been reflected in the assessment of safety
performance both for the business concerned
but also for senior management in the US
and at Group level.

Diversity and inclusion
The way in which the Committee has overseen
the Company’s diversity and inclusion agenda
was further developed during 2018. In 2017,
I reported to you that we had carried out a
deep dive into different areas of the business,
meeting with line leaders to understand the
particular challenges and successes they had
experienced. At our meeting in February we
carried out the last of these detailed reviews,
focusing on Applied Intelligence.

In 2018, the focus of the Committee was on
gaining an understanding of the aspirations
and direction of the Company as a whole and
the way in which progress could be measured
and targeted. The Committee asked the
Chief Executive and his management team
to provide a clear view and detailed analysis
of the direction and activity to be undertaken
to ensure an inclusive, engaged and diverse
workforce to drive success.

In September, the Committee received a
report on diversity and inclusion from Karin
Hoeing, Group Human Resources Director,
setting out the outcome of an internal
review of data, key trends, benchmarking,
successes and challenges. This was a
thorough assessment of the Company’s
current position and we will use this to inform
how we measure progress as we continue on
our diversity and inclusion journey. Accordingly
a specific objective on diversity and inclusion
has been set as part of the executive annual
incentive plan in 2019.

Responsible business conduct
The Company’s responsible business policies,
set out in the Operational Framework, are
the fundamental controls that govern how
we do business. Adherence to these policies
is mandated across the Group and the
Committee regularly reviews the robustness
of the control environment in this area.
We recognise that implementation of these
policies in some markets can be more
challenging than in others due to differences
in regulatory regimes and different commercial
arrangements. The Committee is therefore
interested in understanding how we practically
do business in different markets, how
responsible trading risks are managed and
the decision-making process behind our
presence in certain markets. The Committee
looks for robust adherence to the policies
and also how any additional controls and
compliance measures may be used to reduce
both operational and reputational risk.

For example, the Company has put in
place an enhanced compliance governance
framework to support the delivery of the
Typhoon contract in Qatar.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsCorporate Responsibility Committee report
continued

Our annual schedule includes a detailed
review of the Adviser Policy and the adviser
appointments. This policy and the
accompanying procedures are designed
to ensure that any risks posed by working
with advisers are managed so that the
Company abides by its ethical principles
and complies with anti-bribery and
corruption laws and regulations that govern
the Company’s activities around the world.
The Committee receives reports on the
advisers appointed by the Company, the
work that they do and the commercial
arrangements governing their appointments.

Consideration of responsible business
conduct formed part of the agenda during
our site visit to India in August 2018. The
Committee also reviewed other markets
at its meetings during the year.

Responsible procurement
We have seen a significant change in the
Procurement function over the last two years
with new leadership taking the helm. A key
milestone was reached in early 2017 when
the global Supplier Principles were launched.
These principles have now been in place for
two years and at our review in December with
the Chief Procurement Officer, the Committee
considered the actions that have been taken
to embed these principles in the culture of our
own Company and, importantly, in our supply
chain. It was pleasing to see that the focus in
2018 has been on strengthening internal
education and that we have actively assessed
how well our suppliers understand and are
embracing our principles. We will review the
position again in 2019 as part of our ongoing
focus on reducing the threat of unethical
behaviour in our supply chain and the
associated reputational risk.

Workforce engagement
The 2018 UK Corporate Governance Code has
given additional focus to the way in which
boards consider the impact of the decisions
they make with regard to the various
stakeholders. During the second half of the
year, the Board considered how it would
discharge the requirement to seek to
understand the views of the workforce, noting
the suggested mechanisms in the revised
Code. After consideration of the options, the
Board agreed that the Corporate Responsibility
Committee would be appointed to fulfil this
requirement. The Committee already provides
a conduit for employee engagement through
trade union interaction, site visits and the
review of employee survey and ethics helpline
calls. Initial discussions were held on how to
extend this engagement, noting that this is an
emerging area of governance and we expect
to review this approach at the end of 2019.
We will report to you in the 2019 Annual
Report in more detail.

In December, the Committee reviewed the
initial results of a short and confidential survey
that was open to all employees. The survey
asked for employees’ views on characteristics
and behaviours that will be key to the future
success of the Company. We discussed with
the Group Human Resources Director how
the results of the survey would be analysed
and used by the senior management team
to understand the current strengths, and also
the areas we need to focus on as we evolve
the organisational culture of the Company.

Next year
Our agenda for next year, as in previous years,
will be structured around our key areas of
focus: safety, ethics, diversity and inclusion,
and responsible business conduct. In addition,
we will look more closely at workforce
engagement in the first year of implementation
of the new UK Corporate Governance Code.
We will also continue to develop our
understanding of the sustainability agenda for
the Company as wider market practice around
targets and reporting continues to develop.

Ian Tyler
Chairman of the Corporate
Responsibility Committee

Focus on governance
Delhi, India
In August, the Committee visited
our office in Delhi to gain a deeper
understanding of the following areas:
– responsible trading and particularly
corruption risks, either directly or
through our partners;

– workplace safety and employee welfare;

and

– diversity and inclusion.

The Committee spent time with the
BAE Systems employees based in Delhi
and discussed how the team is delivering
on our corporate responsibility agenda.
We looked at how the Company engages
with local procurement processes,
considering the governance in place
to ensure that we meet the customer’s
and our own compliance requirements.
The Committee visited the new M777
ultra-lightweight howitzer manufacturing
facility that has been built and will be
operated by Mahindra Defence Systems.
This was a good opportunity for the
members of the Committee to understand
the safety culture of the team and how
best practice will be brought into the
new manufacturing line.

The visit emphasised the risk in
operating in export markets and the
need for the Company to continue to
be vigilant in ensuring that we robustly
apply our responsible trading policies.
The Committee will continue to monitor
how we operate in overseas markets,
such as India, to ensure that we have
the governance oversight and controls
in place to allow us to meet high
standards of ethical conduct.

Barrow, UK
During the year the Chair of the
Corporate Responsibility Committee
visited the shipyard at Barrow,
accompanied by the Managing Director,
Operational Governance. The aim of the
visit was to meet with members of the
team to understand the processes in
place for adherence to the Company’s
nuclear licensing requirements. As part
of the visit the Chair met with the senior
management team responsible and
reviewed the robustness of these
processes. During the visit he met with
employees from the different functions
and talked with them about their roles
and experience of working at the
Company, with an aim to understand
more about the culture of the Company
at different sites.

BAE SystemsAnnual Report 2018Schedule for 2019

Committee

February
– Review of performance metrics

for 2018.

– Trading policy review.
– Review and approval of

Modern Slavery statement.

– Workplace engagement update.

June
– Workplace safety deep dive.
– Workplace engagement update.
– Diversity and inclusion update.

September
– Workplace safety deep dive.
– Sustainability and environment review.

December
– Consideration of forward-looking

objectives.

– Responsible procurement update.
– Workplace safety deep dive.
– Anti-bribery and anti-corruption

policy review.

The Corporate Responsibility Committee’s year

February

Committee

September

Committee

San Diego, US
– A further detailed update was received on

the incident at the US Army munitions plant
in Radford, US.

– Received a report on diversity and inclusion
from the Group Human Resources Director.

– Review of the current environmental

position of the Company and outline plans
for a programme of work to consider
whether changes are made to the way
in which the Company monitors its impact
on the environment.

December

Committee

London, UK
– Consideration of the Company’s approach
to responsible procurement. An update
was received from the Chief Procurement
Officer on the way in which the Global
Procurement Policy and the Supplier
Principles are being embedded.

– Undertook the annual review of the

Gifts and Hospitality, Facilitation Payments
and Advisers policies. Received a report
on the number and type of advisers
currently appointed.

– Agreed the approach to be taken

with regard to workforce engagement
in 2019 as part of the new UK Corporate
Governance Code.

– Received a top level summary of the

results of the enterprise-wide employee
opinion survey.

– Consideration of the structure and focus
of the corporate responsibility objectives
for 2019.

– Review of the corporate responsibility
audit review programme for 2019.

London, UK
– A review of the Product Trading

principles of the Company. This included
a consideration of how the Company does
business in markets which may experience
political and/or economic instability and
the ways in which any risks are either
mitigated or managed.

– As part of a review across the business

of the strategy for diversity and inclusion,
a presentation was made by the Applied
Intelligence business on the progress
made to date to attract and retain
a diverse workforce and advance
an inclusive workplace.

– Review of performance against the
2017 safety performance objectives.
A recommendation on the performance
rating was made to the Remuneration
Committee.

June

Committee

Baltimore, US
– A review of the anti-bribery and anti-

corruption policies, including a consideration
of the application of the adviser policy to
joint venture partners. This covered the
proposed arrangements for the sale of
Typhoon to Qatar.

– A report was made to the Committee

on an incident that had occurred at the
US Army munitions plant in Radford, US,
which had resulted in the death of one
employee and injuries to two others.
The Committee reviewed the immediate
actions that had been taken at that
point, including how the Company was
supporting both the families of those
affected and our employees.
– The annual review of the safety

performance of BAE Systems, Inc.,
considering the recordable injury rate
statistics, the work undertaken to improve
safety, behavioural change and the ways
in which risk could be reduced through
engineering initiatives.

Corporate Responsibility Committee timeline

February
Committee

June
Committee

August
Site visit

India

September
Committee

December
Committee

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsNominations
Committee report

Sir Roger Carr
Chairman of the
Nominations Committee

Members

Sir Roger Carr (Chairman)
Revathi Advaithi
Elizabeth Corley
Harriet Green
Chris Grigg
Paula Rosput Reynolds
Nick Rose
Ian Tyler

Dear Shareholders,
The Nominations Committee was active
throughout 2018 dealing with both executive
and non-executive succession planning.

With Charles Woodburn now well established
as Chief Executive, the Committee has been
working with him in researching the strength
and depth of the executive pipeline below the
Board and what we are doing to develop this
further. With regard to non-executive director
membership, last year we welcomed Revathi
Advaithi who, with her global industrial sector
business experience, has been a valuable
addition to the Board. The need to refresh
the Board but at the same time maintain
a knowledgeable and experienced team
of non-executive directors is essential, and
this is something that the Committee has
continued to address in our succession
management discussions. Further details
of this and the other principal responsibilities
of the Committee are detailed below.

Executive succession
With effect from the beginning of 2018, our
Chief Executive implemented his plans for a
new organisational structure for the Company.
This was an important matter for the Board,
and in the months prior to it the Committee
engaged with Charles in understanding his
plans, ambitions and resource requirements.
We were particularly interested in how he
intended to use this opportunity to refresh
the management team and create
opportunities for high-potential individuals
within the executive pipeline. One of the
Board’s principal objectives agreed with the
Chief Executive is to ensure that the Company
is making best use of the many highly talented
individuals we employ and that we use such
individuals to create a culture that supports
a diverse and inclusive working environment.
This is vital to the long-term health of the
Company and is fundamental to the effective
management of executive succession at all
levels, and blends seasoned experience with
fresh thinking.

During the year, the Committee spent time
with the Chief Executive and our Group
Human Resources Director hearing about
the work they have under way to ensure
that we have effective executive succession
planning processes in place. This included the
presentation of data analysing all executive
grade positions across the Group and the
succession candidates for these roles. This
analysis has been one of the key inputs to
the work currently under way to actively
manage our succession planning performance
across all executive grades. The oversight of
this work will remain a priority for the
Committee in 2019.

Board composition
One of the Company’s strategic objectives is
to develop a diverse workforce to drive success
at all levels. Against this background, I am
pleased to report that we have continued to
make progress in refreshing and strengthening
the Board, and in doing so we have become
increasingly more diverse in terms of gender,
ethnicity and nationality. Our policy on Board
gender diversity is aligned to the target set by
the Hampton-Alexander Review, i.e. 33%
representation of women on FTSE 350 boards
by the end of 2020. We are performing well
against this target, with women representing
36% of Board membership at present.

In terms of other aspects of board diversity,
our policy is to continue, over time, to create
a Board that not only brings together
individuals with the right skills, knowledge
and experience, but one that also has a
diversity that reflects the multi-national nature
of the business world in general. We will
continue to engage with search consultants
to identify candidates in a manner that is
consistent with achieving these objectives.

Non-executive succession
The need to refresh the Board is central to
the remit of the Nominations Committee.
On page 80, you will see the analysis of the
length of time that individual non-executive
directors have served. This shows that we have
a reasonable spread of terms, ranging from
Revathi Advaithi, who joined the Board just
over a year ago, to Nick Rose who has just
completed his ninth year on the Board.

In 2018, the Committee recognised the
need to recruit up to two new non-executive
directors, including a suitable candidate to
join the Board and succeed Nick Rose as Chair
of the Audit Committee. However, recognising
that we have a new auditor this year and the
level of geopolitical uncertainty facing the
Company at present, the Board considered it
was in the Company’s and shareholders’ best
interests that we extend Nick Rose’s tenure as
Senior Independent Director and Chair of the
Audit Committee beyond the nine-year period
to 31 December 2019.

I recognise that the provisions of the UK
Corporate Governance Code state that a
term of office in excess of nine years is one
of the factors that is likely to impair, or could
appear to impair, a non-executive director’s
independence. However, if a board believes
that such an individual remains independent,
the Code requires it to clearly explain why
it takes that view. Having worked with him
for some years, his fellow Board members
and I certainly take the view that Nick Rose
remains independent. He has been an
excellent non-executive member of the
Board, and our annual board evaluations
evidence the quality of his contribution
and the effective manner in which he

BAE SystemsAnnual Report 2018Board evaluation
Period of evaluation
December/January with feedback and review taking place at a Board meeting
held on 20 February 2019.

Evaluation process
Internally evaluated using a questionnaire developed by the Company using best
practice guidance, including the FRC’s Guidance on Board Effectiveness.
Questions covered the performance of the Board, its committees and individual
directors. In addition, feedback was requested on the Board’s performance
against the objectives agreed following the previous year’s evaluation, and
directors were also asked to identify their priorities for the Board in 2019.

Facilitator
The Company Secretary, with guidance from the Chairman.

Feedback
The Company Secretary produced a report for the Board analysing the
responses to the questionnaire, including any additional comments made
by directors. Also, where the same questions had been used for previous surveys,
the trend in performance relative to past years was provided. The report formed
the basis of a discussion at a Board meeting, following which it agreed a number
of objectives for 2019. Reports were also produced analysing the responses
to questions concerning the performance of the Board’s committees, which
have been provided to committee chairs and will be considered by the
individual committees.

Feedback from the survey concerning individual directors has been provided
to the Chairman and he will use this as part of an annual review process with
each board member. Feedback on the Chairman’s performance has been
provided directly to the Senior Independent Director who, following discussion
with his fellow non-executive directors, will discuss this with him.

Resulting actions
The Board has agreed the following actions in response to the evaluation:
– facilitate the use by executives of the competences, knowledge

and skills offered by individual non-executive directors;

– further develop the Board’s strategy review process;
– provide further opportunities for Board members to engage directly

with stakeholders;

– complete non-executive director succession planning actions;
– drive best practice executive succession planning across the Company; and
– provide further opportunities for directors to undertake deep-dive reviews

into major programmes.

discharges his responsibilities in chairing
the Audit Committee and acting as our
Senior Independent Director. I have also
engaged with a number of our principal
shareholders on this matter and they were
very helpful in giving me the opportunity
to explain the above, and were supportive
of the decision.

The recruitment consultants, Spencer Stuart,
and other sources were used to identify
possible candidates for the non-executive
director succession requirements identified
by the Committee in 2018. As reported in my
opening letter, this has resulted in the recent
appointments of Nicole Piasecki and Stephen
Pearce as non-executive directors, effective
from 1 June 2019. Stephen will succeed Nick
Rose as Chairman of the Audit Committee
with effect from the beginning of next year.

I am pleased to report that Elizabeth Corley,
who joined us three years ago, has agreed
to serve for a further three years. I am also
appreciative that Ian Tyler and Chris Grigg
have each agreed to serve for an additional
three-year period when their current six-year
terms come to an end later this year.
As evidenced by our annual performance
evaluation, all three continue to be highly
engaged and valuable non-executive
members of the Board and its committees.

Harriet Green will step down from the
Board in November this year having been
a valuable contributor for nine years. Her
engagement, knowledge and experience
will be much missed.

Finally, the Board’s most recent annual
performance evaluation is detailed opposite.
With regard to the Nominations Committee
and its remit and duties, the evaluation
specifically asked directors about the
effectiveness of succession planning, in terms
of both executive and non-executive directors,
and also senior management. Overall, it was
believed that good progress had been made
on this issue in 2018 but it was agreed that
the Board would continue to work with the
Chief Executive in ensuring that our executive
succession planning processes fully support
our strategic objectives and make best use
of the talented people we employ.

Sir Roger Carr
Chairman of the Nominations Committee

Nominations Committee timeline

March
Committee

May
Committee

July
Committee

September
Committee

November
Committee

December
Committee

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsRemuneration
Committee report

Paula Rosput Reynolds
Chairman of the
Remuneration Committee

Members

Paula Rosput Reynolds
(Chairman)
Elizabeth Corley
Nick Rose

Dear Shareholders,
2018 was a year of intense activity on
the part of the Remuneration Committee.
Although we do not plan to renew our
Policy until the spring of 2020, the volume
of initiatives and regulations being introduced
has stimulated much discussion as to how
best to engender a healthy environment of
incentives while addressing broader societal
concerns. More immediately though, the
Committee has been deeply engaged with
the Chief Executive on implementing a robust
performance management approach and
using our reward structure to create stronger
alignment with the execution of our strategy.

As you will be aware, the Group operates
within a challenging and rapidly changing
political, economic, defence and security
environment around the world. You will read,
within the contents of this report, how the
Committee has supported ambitious operating
goals and sustained financial performance. In
other words, whilst the environment is difficult,
it is our expectation that management will
not relent in its efforts to deliver underlying
business performance. Our Chief Executive
is making changes in the organisation and
redefining expectations. Whilst change does
not happen overnight, the Committee is using
its tools to reinforce these efforts.

In addition to our focus on the internal
workings of BAE Systems, the Committee has
followed closely the emergence of the new
UK Corporate Governance Code (the Code)
requirements. Prior to the issuance of the
requirements, we had already begun an
analysis of wider workforce remuneration,
pension provision, and constructive ways to
engage with our employees around the world.
Broadly, the Board believes that employee
engagement is part of a modern business
culture and hence it is not merely a
remuneration exercise.

Where feasible, we are adopting in our
2018 Annual Report many aspects of the
Code requirements ahead of the mandated
schedule, including:
– a new section setting out more information

in relation to our wider workforce;

– building on our previous Chief Executive
pay ratio disclosure which has been well
received by stakeholders, and reflecting
publication of the regulations, we are
additionally disclosing the Chief Executive
pay ratio on the new required basis;
– describing how the Committee has

addressed the factors of clarity, simplicity,
risk, predictability, proportionality and
alignment to culture; and

– recognition of the Committee’s expanded
remit with its Term of Reference having
been updated accordingly.

Acknowledging the relevant provisions of
the new Code as well as broader expectations
of investors, the Committee intends to make
necessary changes to our existing Policy on
minimum shareholding requirements to ensure
an appropriate post-cessation holding policy
is in place. This policy will be finalised and
implemented as part of our broader executive
remuneration policy proposals to be submitted
for approval at the Company’s Annual General
Meeting (AGM) in May 2020. The Committee
additionally recognises the requirements and
expectations in relation to executive director
pension provision and will review this as part
of our remuneration policy to be approved
at the 2020 AGM.

With respect to our customary remuneration
activities, all changes we are making for 2019
are within the current approved Policy; you
will see them summarised immediately below
and detailed more fully within the contents
of this report.

Summary of key decisions for 2018
– Salary of the Chief Executive is increased by 2.5% from 1 January 2019.

– Salary of the Group Finance Director is increased by 2.5% from 1 January 2019.

– Salary of the President and Chief Executive Officer of BAE Systems, Inc. is increased

by 2.5% from 1 January 2019.

– Approval of remuneration packages for newly appointed Executive Committee members.

– Long-term incentive awards of Performance Shares granted in spring 2018, subject
to the same performance conditions as applied in 2017, and Restricted Shares to
US executive director only.

– For 2019, in respect of the annual short-term bonus programme metrics, revised

weighting of the financial measures agreed (which account for 75% of the annual
incentive opportunity), and the remainder continuing to be subject to personal
objectives and safety measures.

BAE SystemsAnnual Report 2018Context to the Committee’s decisions
The Committee remains responsible for the
full spectrum of senior executive employment
matters: recruiting, promoting and retaining
the best top-level leaders, setting the
incentives under which these leaders
operate, and monitoring the results they
produce and the manner in which they
produce them. Our overall remuneration
framework has a number of specific goals.
It is designed to motivate our key talent to
achieve the Company’s strategic objectives,
to deliver on customer commitments, to lead
and inspire employees, and to drive value for
our shareholders. It is also designed to be
competitive in the various markets in which
we operate and compete for talent.

Our short-term programme metrics are tied
to Group performance, business segment
performance and individual goals, including
the leadership behaviours that underpin
BAE Systems’ Total Performance culture.
Working with our Chief Executive, we have
considerably expanded the individual goals
of our leaders to tie objectives more explicitly
to strategy and to enhance accountability.
Our long-term incentive programme measures
absolute performance of the Group and
performance relative to peers.

In addition to developing the overall
remuneration framework, the Committee
assesses the level of challenge within our
annual and long-term incentive plan targets.
Annually, in November, the full Board reviews
and adopts the Integrated Business Plan.
Thereafter, the Committee reviews the
specific business targets/metrics for the
one and three-year periods and examines
the underlying assumptions, including the
degree of ‘stretch’ contained within them.
After setting one and three-year targets,
the Committee periodically reviews progress
towards the attainment of the objectives.
After the close of each year, the Committee
undertakes a thorough review of annual
and three-year performance. Separately, the
Committee regularly considers the overall
construct of the remuneration package to
ensure that potential pay outcomes are
appropriate and reasonable against different
performance scenarios. As we have enhanced
the individual goals, it provides the challenge
and opportunity to exercise greater judgement
in evaluating the performance, contributions
and potential of our executives.

2019 remuneration
To confirm, for 2019 no revisions are
proposed to our executive remuneration
framework that would constitute a change
to the Policy. In line with our commitment to
continued transparency, we have contacted
our major shareholders on the following
modest changes for 2019:
– taking account of the need of our leadership

team to continue to steer the Company
through a period of significant change and
the skills, experience and performance of
each executive, the Committee believes it
is appropriate to adjust the salaries of the
executive directors by 2.5% from 1 January
2019. This increase is in line with the
broader workforce; and

– for 2019, the split of financial and non-
financial performance measures within
the annual incentive remains at 75%/25%
respectively. The 25% non-financial element
will continue to be based 20% on personal
performance objectives that provide clear
line of sight to our strategic objectives, with
5% relating to safety, diversity and inclusion
targets. Recognising the significant focus
on delivering earnings growth in 2019, the
following weighting of financial measures,
which account for 75% of the total annual
incentive, will apply:

Group
underlying
EPS/EBITA
%

Group
debt
%

Order
intake
%

45
60

22.5
30

7.5
10

Total
%

75
100

2019

Allocation

Weighting

In setting 2019 financial targets, the Committee
has reduced the relative importance of order
intake and cash targets relative to earnings
as compared to past years. This change
principally recognises the importance that
shareholders attach to greater earnings
growth. However, it also reflects the fact
that 2018 was a record year of order intake
and that 2019 is a year for greater emphasis
on the execution of the order book rather
than building a larger backlog. The Committee
remains mindful of the importance of cash to
the health of the Group and to our dividend-
paying capability, and we believe that our
discretion in evaluating the outcome can
serve as the appropriate balance to ensuring
that overall bonus outturn is reasonable.

Incentive outturn
After the close of 2018, the Committee
met and reviewed performance under the
short-term annual incentive for all of the
executive directors and Executive Committee
members. Financial results were achieved at
or above target; non-financial achievements
varied for the executive directors and
Executive Committee members.

As disclosed in our report, the Group achieved
a record order intake in 2018 of £28.3bn,
reflecting, among other achievements, the
aircraft award in Qatar and the maritime
award in Australia. However, an anticipated
aircraft purchase by the Kingdom of Saudi
Arabia, which was included in the 2018 order
intake component of the financial goals, was
not finalised within the year. In March 2018,
a Memorandum of Intent was signed by the
UK government with the Kingdom to aim
to finalise discussions for the purchase by the
Kingdom of 48 Typhoon aircraft, but given
the prevailing geopolitical environment, the
Committee agreed that it was not reasonable
to hold the executives responsible for the
delay in achieving that order, or, in the
alternative, for booking replacement orders
of comparable magnitude. Therefore, the
Committee used its discretion with respect
to the order intake measure and agreed that
the record intake of £28.3bn was on-target.

The Committee used its judgement in
evaluating non-financial performance,
including the executives’ commitment to
safety, diversity and inclusion, as well as
overall leadership contributions. A discussion
of that evaluation and the bonuses earned
by the executive directors are reported on
pages 107 and 108.

The Performance Shares and Share Options
granted in 2016 under our long-term
incentives will partially vest in early 2019
as will the Restricted Shares granted to our
US executive director. The details of the
vesting outcomes and amounts awarded
are also described in the following report.

As described above, after the close of
2018, the Committee thoroughly reviewed
annual and three-year performance, and
relative to the remuneration outcomes,
is satisfied that the Policy operated as
intended during 2018.

Concluding comments
The backdrop of the Group’s business and the
changes in leadership approach made for a
challenging year at BAE Systems. Nevertheless,
the leadership team kept its focus on delivering
solid financial results and made material
improvements in key areas such as our UK
Maritime business, the widening scope of our
US Inc. business, and the significant increase
in our order book internationally. We believe
the rewards conferred in the performance
cycle just concluded are commensurate with
the progress the Group has made. Further,
the goals and incentives we have approved for
the upcoming period are, we believe, consistent
with achieving an ambitious future plan.

On behalf of the Board

Paula Rosput Reynolds
Chairman of the Remuneration Committee

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsRemuneration Committee report
continued

The Remuneration Committee’s year

January

Committee

May

Committee

Farnborough, UK
– Reviewed feedback from shareholder

consultation on 2018 remuneration review.
– Considered detailed analysis of the factors
influencing the structure of long-term
incentive design, including an analysis
of the application of such arrangements
at Executive Committee level and below.
– Approved changes to Company’s employee
share plans to assist in complying with the
requirements of the EU’s General Data
Protection Regulations.

September

Committee

San Diego, US
– Received an update on the 2018 UK AGM
season and recent corporate governance
changes.

– Agreed the approach to 2019 and 2020

incentive design and key considerations for
the route map towards the renewal of the
Company’s remuneration policy in 2020.
– Approved remuneration package for new

or existing Executive Committee members.
– Received update on performance conditions

for Long-Term Incentive awards.
– Received remuneration analysis for
individuals on succession plans.

London, UK
– Agreed 2018 objectives for executive
directors and Executive Committee
members.

– Approved remuneration package for new

or existing Executive Committee members.

– Reward framework deep dive session on

pay and benefits received by the workforce
across the Group.

February

Committee

London, UK
– Determined 2017 bonuses against

performance for executive directors
and Executive Committee members
for payment in March 2018.

– Approved 2017 Group All-Employee

Free Share Plans payments.

– Determined vesting outcome for

2015 Long-Term Incentive awards.
– Approved 2018 Long-Term Incentive
awards and associated performance
targets for executive directors and
Executive Committee members.

– Approved 25% weighting on non-financial

objectives in annual incentive.

– Reviewed feedback from shareholder

consultation on 2018 remuneration review.

– Approved 2017 Annual remuneration

report.

– Reviewed Remuneration Committee terms

of reference.

– Appointed PricewaterhouseCoopers (PwC)
as independent adviser to the Committee.

November

Committee

New Milton, UK
– Approved the approach to the

development of the 2018 Annual
remuneration report including early
adoption of the new requirements.
– Reviewed level of executive directors’
and Executive Committee members’
shareholdings relative to their Minimum
Shareholding Requirement.

– Reviewed dilution levels and share usage

under Employee Share Plans.

– Approved operation of Group All-Employee

Free Share Plans.

– Considered high-level remuneration market

practice findings.

– Received presentation on the UK Gender

Pay Report for 2018.

– Reviewed Remuneration Committee terms

of reference.

December

Committee

London, UK
– Considered the recent updates to
institutional investor guidance.

– Reviewed and set salaries and bonus

opportunity levels for executive directors
and Executive Committee members.

– Agreed the approach, structure and targets

for the 2019 annual incentive plan.

– Considered the approach to setting the
2019 strategic objectives applicable to
Executive Committee members.

– Approved remuneration package for new

or existing Executive Committee members.

– Reviewed and evaluated the proposed
2019 annual and three-year targets.

Remuneration Committee timeline

January
Committee

February
Committee

May
Committee

September
Committee

November
Committee

December
Committee

BAE SystemsAnnual Report 2018Annual remuneration report at a glance
for the year ended 31 December 2018

Business performance and incentive outcomes in 2018

2018
performance

2018
incentive outcome

Group underlying EPS1

Group net debt1

Group order intake1

Average three-year diluted underlying EPS growth

Three-year TSR

Recordable Accident Rate (per 100,000 employees)2

Major injuries recorded

AIP

LTI

AIP

41.8p

£(951)m

£29.2bn

<3%

21.9%

471

1. Adjusted to be on a like-for-like basis with the targets (see page 107).
2. Although the Company met its stretch target for reduction in recordable injuries, the amount awarded was reduced

by the Corporate Responsibility Committee to reflect the employee fatality and increase in major accidents.

Below threshold
Between threshold and target
Between target and stretch

AIP Annual Incentive Plan

LTI Long-Term Incentive

This resulted in the following incentive outcomes:
– 2018 annual bonus payouts for the executive directors ranged from 52.7% to 65.6% of maximum; and
– Performance Shares (EPS) granted to Group Finance Director and President and Chief Executive Officer of BAE Systems Inc. in March 2016
and to the Chief Executive in September 2016 did not meet their performance condition and will lapse. Performance Shares (TSR) and
Share Option awards granted at March 2016 to Group Finance Director and President and Chief Executive Officer of BAE Systems Inc.
will vest at 18.8%. The performance period in respect of the Performance Shares (TSR) and Share Option awards granted in September
2016 to the Chief Executive has not yet been completed and will be reported on in 2019.

Summary of executive directors’ remuneration in 2018
The charts below show the 2018 actual remuneration achieved, as disclosed in the single total figure of remuneration
on page 105, compared with the 2018 on-target opportunity. On-target remuneration assumes target vesting of
incentives payable in respect of the performance period with year-end 2018, although actual remuneration for each
of the executive directors was less than target, reflecting business performance.

£m
4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

£2.42m

£m
4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

£1.92m

£m1
4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

£2.78m

Share Options
Performance Shares
Restricted Shares
Annual Incentive
Pension and beneﬁts
Base Salary

On-target

Actual

On-target

Actual

On-target

Actual

Charles Woodburn2
Chief Executive

Peter Lynas
Group Finance Director

Jerry DeMuro3
President and Chief Executive Ofﬁcer
of BAE Systems, Inc.

1. The figures for Jerry DeMuro have been converted from US dollars to sterling.
2. Charles Woodburn’s first LTI is not due to vest until September 2019 (subject to performance conditions being met). However, the EPS performance condition was tested as at

31 December 2018 and failed to meet the necessary threshold requirement and therefore this portion of the award will lapse. The TSR performance period has not yet completed.
3. Long-term incentive figures in the charts above are based on the 2016 Performance Shares, Share Options and Restricted Shares awards. For Jerry DeMuro, the single total figure

of remuneration on page 105 includes his 2018 Restricted Shares award as required by regulation.

Remuneration in the wider context
Context to our executive director remuneration in light of wider workforce considerations:
– Consistent remuneration philosophy and strategy applicable to all employees across the Group.
– Wider workforce predominantly have access to competitive retirement plans and participate in all-employee share plans and/or

recognition schemes.

– Level of salary adjustment for the executive directors remains consistent with the average increase for employees across the Group.
– Ratio of CEO pay to pay of global workforce of 33:1.
– UK gender pay gap of 9.0%.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report at a glance
for the year ending 31 December 2019

Executive director remuneration in 2019
For 2019, no revisions are proposed to the executive remuneration framework which would constitute a change to the Policy.

Summary of remuneration framework
The overall remuneration framework applicable in 2019 to each of the three executive directors under the policy approved by shareholders at the
2017 Annual General Meeting1 is summarised in the following table.

Purpose and link to strategy

Base Salary
(with effect from
1 January 2019)

Recognise market value of role and individual’s
skills, experience and performance to ensure
the business can attract and retain talent.

Pension and benefits Provide competitive benefits.

Annual Incentive

Drive and reward annual performance of
individuals and teams on both financial and
non-financial metrics, including leadership
behaviours, in order to deliver sustainable
growth in shareholder value. Compulsory
deferral into shares increases alignment
with shareholder interests.

Performance Shares

Drive and reward delivery of sustained
long-term Earnings per Share (EPS) and
Total Shareholder Return (TSR) performance
aligned to the interests of shareholders.

Restricted Shares

Provide long-term reward through time-
vesting awards principally in the Company’s
US market.

Minimum
Shareholding
Requirement

Provide long-term alignment with
shareholder interests.

Charles
Woodburn
CEO

Peter
Lynas
GFD

Jerry
DeMuro
CEO Inc.

£919,500

£657,700

$1,080,000

Defined
contribution

Defined
benefit

Section 401(k)
defined
contribution

On-target/maximum
opportunity (% salary)

112.5%/225%

80%/160%

112.5%/225%

Performance condition

75% financial/25% non-financial

Deferral into Deferred
Bonus Plan

One-third compulsory deferral

Grant (% salary)

370%

335%

298%

Performance condition

50% on relative TSR/
50% on three-year diluted underlying EPS growth

Grant (% salary)

n/a

150%

(% salary)

300%

200%

425%

1. The full Directors’ remuneration policy approved by shareholders at the 2017 Annual General Meeting is set out on pages 117 to 129.

Application of 2019 package for UK executive directors

Application of 2019 package for US executive director

Performance
Shares

Compulsory
bonus deferral

Annual
Incentive

Base
Salary

Vests in year 5
subject to
three-year TSR
and EPS conditions,
and two-year
holding period

One-third
compulsorily
deferred in shares
for three years

Two-thirds paid in
cash immediately

Performance
Shares

Restricted
Shares

Compulsory
bonus deferral

Annual
Incentive

Base
Salary

Vests in years 3,
4 and 5 subject to
three-year TSR and
EPS conditions;
vested shares
released in
one-thirds

Vests subject to
three-year service
condition with an
additional two-year
clawback period

One-third
compulsorily
deferred in shares
for three years

Two-thirds paid in
cash immediately

Year

Charts are illustrative and are not to scale.

Year

BAE SystemsAnnual Report 2018Annual remuneration report
for the year ended 31 December 2018

This section details the remuneration of the executive and non-executive
directors (including the Chairman) during the financial year ended
31 December 2018 and will be proposed for an advisory vote by shareholders
at the 2019 Annual General Meeting (AGM). It has been prepared on
the basis prescribed in the Large and Medium-sized Companies and
Groups (Accounts and Reports) (Amendment) Regulations 2013.

Response to new remuneration reporting provisions
in the 2018 UK Corporate Governance Code
As set out in the Remuneration Committee report on page 92 we are
adopting a number of the new 2018 UK Corporate Governance Code
requirements in our remuneration reporting in advance of the mandated
time schedule for their inclusion.

These include:

Describing how the Committee has addressed the factors of clarity, simplicity,
risk, predictability, proportionality and alignment to culture.

100

A new section setting out more information in relation to the wider workforce.

101

Building on our previous Chief Executive pay ratio and additionally disclosing
the Chief Executive ratio on the new regulatory basis.

105

Disclosure of how much of individual directors’ long-term incentive awards
is attributable to share price appreciation.

116

Disclosure of maximum remuneration receivable assuming a 50% share price
appreciation in the application of the remuneration policy charts.

Statement of voting
Shareholder voting on the resolutions to approve the Annual remuneration report
put to the 2018 AGM and the Directors’ remuneration policy put to the 2017 AGM
was as follows:

Annual remuneration report

Votes for

Votes against

2,425,636,219

98.40

39,353,964

Directors’ remuneration policy

Votes for

Votes against

2,286,232,998

95.09

118,030,799

1.60

4.91

Total votes cast

Votes withheld
(abstentions)

2,464,990,183

33,369,345

Total votes cast

Votes withheld
(abstentions)

2,404,263,797

6,035,623

The Company’s remuneration policy approved at the 2017 AGM, which took effect
on 10 May 2017, is detailed on pages 117 to 129.

Contents

Response to new provisions in the
2018 UK Corporate Governance Code

Statement of voting

Remuneration overview and link
to Group pay policy

Appropriateness of remuneration
and link to strategy

Wider employee remuneration

Single total figure of remuneration:
– for the Chairman and

non-executive directors
– for the executive directors

Executive directors’ remuneration in
the year ending 31 December 2019

Annual bonus

Long-Term Incentive Plan (LTIP)
performance

Pension entitlements

Share interests:
– Scheme interests awarded during

the financial year

100

104
105

106

107

109

110

111

– Description of share plans and

summary of performance conditions 112

– Statement of directors’ shareholdings

and share interests

Remuneration Committee
composition and advisers

113

115

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Remuneration overview and link to Group pay policy

Our reward philosophy and approach

Our aim across the Group is to provide a reward package that is aligned to shareholders’ interests, supports the achievement
of the Company’s in-year and strategic objectives, is competitive against the appropriate market and is consistent with our focus
on performance and our values of Trusted, Innovative and Bold. This means:
– base salaries are set with reference to median of the relevant market competitive level;
– high performance and exceptional contribution are recognised through in-year incentives;
– packages for leadership roles have an increased emphasis on longer-term share-based reward;
– providing employees with competitive and affordable retirement benefits which reward long-term contribution and loyalty; and
– ensuring access to a competitive and cost-effective package of other benefits as part of our total reward offering.

Element

Base salary

Structure/operation

Normally reviewed annually.

Senior executive reward framework

Market pay approach taking into account individual’s skill, knowledge,
experience levels and contribution to role.

Pension and benefits

Differentiated by competitive practice in relevant home market.

Annual incentive

Incentive based on annual financial performance and non-financial metrics
paid in cash and shares (see bonus deferral below).
75% weight on financial metrics on following KPIs:
– Group underlying earnings per share (45%)
– Net debt (22.5%)
– Order intake (7.5%)
25% weight non-financial metrics:
– Safety (5%)
– Key strategic objectives (20%) around six key areas:

– Drive operational excellence
– Continuously improve competitiveness and efficiency
– Advance and further leverage our technology
– Pursue and deliver growth
– Lead and inspire high-performing teams and individuals
– Build trust by operating to the highest standards of business conduct

Bonus deferral

Compulsory deferral into shares for three years.

Performance shares

Restricted shares
(US only)

Shares vest subject to three-year performance period as follows:
– 50% on diluted underlying earnings per share (EPS)
– 50% on total shareholder return (TSR) against sectoral comparator

group and the companies in the FTSE 100 index

– UK executive directors have a further two-year holding period
– Others have phased release in years 3, 4 and 5
– For executives below Executive Committee within the US Inc. business,

TSR is replaced with Inc. operating cash flow

Award of shares that are released after three-year service condition.

Purpose and link to strategy

Recognise market value of role and
individual’s skills, experience and
performance to ensure the business
can attract and retain talent.

Provide employment benefits
and competitive post-retirement
benefits to ensure overall package
is market competitive.

Drive and reward annual
performance of individuals
and teams on both financial and
non-financial metrics, including
leadership behaviours, in order to
deliver sustainable growth in
shareholder value.
Further detail on KPIs is provided
in the Group financial review
(pages 35 to 41) and on safety
within Our values and responsible
behaviour (pages 28 to 30).

Increases alignment with
shareholder interests.

Drive and reward delivery of
sustained company financial
performance including long-term
EPS and TSR performance aligned
to the interests of shareholders.

Provide long-term reward through
time-vesting awards principally in
the Company’s US market.

Share options (below
executive director level)

Award of share options that are exercisable after three-year vesting period. Drive and reward delivery of
sustained improvement in the
Company’s share price.

Minimum shareholding
requirement

Requirement to establish and hold minimum personal shareholding.

Provide long-term alignment with
shareholder interests.

BAE SystemsAnnual Report 2018Appropriateness of remuneration and link to strategy

The Committee has established the following six core principles which underpin our approach to executive remuneration aligned
to BAE Systems’ strategic objectives, taking account of shareholder expectations and the new remuneration factors in the 2018
UK Corporate Governance Code, as well as reflecting a stronger performance accountability across the enterprise:

Simplicity – Clarity and simplicity of design; ease of understanding by executives and external stakeholders.

Motivational – Plans are relevant and meaningful with clear line of sight between actions and reward outcomes; metrics and targets
which drive superior performance and value for shareholders.

Aligned with shareholder interests – Close alignment of reward outcomes and shareholder experience; long-term share ownership
and ‘skin in the game’ for executives.

Globally competitive – Compensation opportunity aligned to relevant competitive employment market; enabling mobility across
different businesses and geographies.

Acceptable to shareholders – Compliance with proxy bodies and corporate governance guidelines; continuing government, investor,
media and public scrutiny of executive pay and fairness relative to wider workforce.

Flexibility/adaptability – Transparent and responsible application of discretion to override formulaic outcomes; ability to respond
to special/unforeseen circumstances during life of binding policy.

How the Committee has addressed the following factors in the 2018 UK Corporate Governance Code

Factor

How this has been addressed

Clarity
Remuneration arrangements should be
transparent and promote effective engagement
with shareholders and the workforce.

In line with our commitment to full transparency and engagement with our shareholders
on the topic of executive remuneration, the Remuneration Committee chairman engages
with our major shareholders to set out the changes planned for the following year. In a year
of significant change, the chairman will consult with our major shareholders to discuss and
seek views on potential changes.

The Company consults directly with the broader employee population on their
remuneration through a variety of methods including WebEx, explanatory guides hosted
on intranet, human resources or business-led briefings.

Simplicity
Remuneration structures should avoid
complexity and their rationale and operation
should be easy to understand.

Clear direction of travel for changes to our reward framework in recent years has been
to reduce the complexity of our long-term incentive arrangements as demonstrated by:
– 2014: Introduction of new single ‘umbrella’ LTI plan – simplicity and flexibility of design.
– 2018: Simplification of construct by elimination of share options for executive directors.

Risk
Remuneration arrangements should ensure
reputational and other risks from excessive
rewards, and behavioural risks that can
arise from target-based incentive plans,
are identified and mitigated.

Full range of design features exist within remuneration arrangements to take risks into
account as follows:
– Malus and clawback mechanisms within AIP and LTIs.
– Remuneration Committee application of reasonable discretion to override formulaic

outcomes.

– Safety objective within AIP – focus on recordable accident rate and major injuries

recorded.

Predictability
The range of possible values of rewards
to individual directors and any other limits
or discretions should be identified and
explained at the time of approving the policy.

Remuneration Policy approved at 2017 AGM contains the following:
– Maximum award levels and vesting outcomes applicable to annual and long-term

incentive arrangements.

– As set out above in Risk, Committee has the ability to apply malus, clawback and

reasonableness discretion where appropriate.

Proportionality
The link between individual awards,
the delivery of strategy and the long-term
performance of the company should be
clear. Outcomes should not reward
poor performance.

Performance conditions attached to annual and long-term incentive arrangements require
a minimum level of performance to be achieved before any payout is made. As set out in
senior executive reward framework on page 98, there is a direct link between individual’s
reward and their contribution to driving strategy and increasing company performance.
No payment is made for poor performance. Any individual’s performance that is below
expectations is dealt as part of our performance management process – any individual
leaving due to performance issues would not be entitled to any incentive payments.

Alignment to culture
Incentive schemes should drive behaviours
consistent with company purpose, values
and strategy.

As set out in senior executive reward framework on page 98, there is a direct link between
driving BAE Systems’ strategy and an individual’s reward.

As set out above, the Committee has established six core principles which underpin the
philosophy and approach to executive remuneration to ensure alignment to BAE Systems’
strategic objectives.

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Wider employee remuneration
The Committee has responsibility for reviewing remuneration and related policies applicable to the wider workforce,
ensuring that this is taken into account when setting the policy for executive remuneration. As part of our commitment
to openness and transparency we have introduced this section which sets out more information in relation to our wider
workforce and recognises the requirements of the revised UK Corporate Governance Code in this area. Further detail
regarding our employees is provided in the Our People section on page 24 including our approach, diversity and
inclusion, reward and employee engagement.

For our wider employee population, reward is managed by reference to external competitor benchmarks, differentiated
by competitive practice in each home market.

Share plans
All-employee share plans are a long-established and highly valued part of our total reward package, providing
opportunity for eligible employees in a number of our markets to acquire shares in the Company and share in its success.
The Company rewards eligible employees under these plans with an annual award of free shares, or cash equivalent,
based on and subject to our Group financial performance. We also invite eligible employees to participate in and receive
free matching shares in our Company Share Incentive Plan (SIP) or international equivalent.

Retirement benefit provision
Our reward framework includes the provision of competitive and affordable retirement benefits which reward long-term
contribution and loyalty. This is achieved through providing access to competitive retirement plans aligned to local market
practice in our various locations across the globe. In the UK, all defined benefit schemes are closed to new entrants, with
benefits for all new employees being provided through a defined contribution scheme.

Informing the Committee on wider workforce
To build the Remuneration Committee’s understanding of reward arrangements applicable to the wider workforce, the
Committee undertook a deep dive session in 2018 covering the broader executive reward framework as well as a range
of other topics including reward principles, job sizing, pay philosophy and pay ranges, annual and long-term incentive
design, employee share plans and other employee benefits including pension and retirement schemes.

It is intended that a similar deep dive session will be undertaken on an annual basis in order to provide the Committee with
visibility of remuneration practices in the different sectors/markets in which we operate and for the different populations
within the wider workforce across the Company globally.

During meetings, the Remuneration Committee is periodically updated on wider employee matters such as the outcome
of our UK gender pay analysis.

Whilst the Company does not currently directly consult with employees as part of the process of reviewing executive pay
and formulating the Remuneration Policy, the Company does receive insights from the broader employee population on
an annual basis using an engagement survey.

Communication with employees
BAE Systems’ employees are kept informed of its activities and performance through a series of employee briefings at
regular points during the year. These briefings also serve as an informal forum for employees to ask questions about the
Company. Corporate announcements and other relevant information are circulated to employees and supplemented
with updates on the Company’s intranet.

The Chief Executive, Group Finance Director and other sector and business managing directors post blogs to keep
employees informed of relevant Company or sector and business matters. Monthly radio podcasts called ‘Our Conversation’
are delivered for BAE Systems employees around the world. The topics vary and typically include discussions on recent
programme or contract activity, company performance updates, and specific deep dive features into a programme,
business or market opportunity.

As shareholders through our all-employee share schemes, eligible employees are encouraged to vote and attend
our Annual General Meeting (AGM). In addition to providing an update on our business performance, it also provides
the opportunity for them in their capacity as shareholders to ask questions to our Chairman and other members of
the Board.

Communication with shareholders
In line with our commitment to full transparency and engagement with our shareholders on the topic of executive
remuneration, the Remuneration Committee chairman annually writes to our major shareholders to set out the changes
planned for the following year. In a year of significant change, such as during our Remuneration Policy renewal, the
Remuneration Committee chairman will additionally engage directly with our major shareholders to discuss and seek
views on potential changes. The Remuneration Committee chairman values direct engagement with our shareholders
and makes herself available for such meetings throughout the year to hear their perspective on remuneration matters.

In early 2018, BAE Systems conducted a Governance Investor event, aimed at encouraging greater transparency
and awareness of our governance programmes, with an opportunity to provide closer contact with non-executives,
particularly the committee chairs. As part of this, the Remuneration Committee chairman shared an overview of
the Remuneration Committee including the key themes and areas for focus for the Committee looking forward.

100

BAE SystemsAnnual Report 2018Pay comparisons
Pay ratio of Chief Executive to global average employee
The Committee is mindful of the relationship between Chief Executive remuneration and remuneration of the wider
BAE Systems employee population. Therefore, in line with our commitment to transparency, the table below provides
the ratio of remuneration of the Chief Executive to the average employee of the Group for the past five years.

As can be seen, the ratio has typically been around 50:1, with the ratio being higher in 2014 as a result of the partial
vesting of Long-Term Incentive awards in that year. The ratio could range from around 20:1 to 100:1 depending on
the level of performance against the measures which drive the Annual and Long-Term Incentive Plans.

The ratio of remuneration of the Chief Executive to the average employee of the entire Group over the last five years
was as follows:

Chief Executive’s remuneration (£’000)2

Average employee remuneration (£’000)3

Ratio

2014

3,519

60:1

2015

2,929

47:1

2016

3,463

52:1

20171

3,365

47:1

2018

2,416

33:1

1. Chief Executive’s remuneration in 2017 includes a combination of the remuneration of Ian King and Charles Woodburn. As Charles Woodburn’s

overall remuneration is lower than Ian King’s, the calculation for 2017 results in a downward movement in the pay ratio.

2. The Chief Executive’s remuneration is calculated on the same basis as the single total figure of remuneration table.
3. Average employee remuneration is based on staff costs calculated on the same basis as note 3 to the Group accounts, excluding social security

costs and US healthcare costs. The 2018 figure excludes the Guaranteed Minimum Pension equalisation charge (see note 22 to the Group accounts).

Recognising the global nature of our workforce, we believe the above pay ratio measured against the average
employee of the entire Group is the most appropriate for BAE Systems. We will therefore continue to provide
the pay ratio on this basis.

Pay ratio of Chief Executive to UK average employee
The UK government has now introduced legislation requiring companies to publish the ratio of their Chief Executive to
that of the median, 25th and 75th percentile total remuneration of full-time equivalent employees. We are voluntarily
disclosing the pay ratio on the required basis in this year’s report as shown in the table below:

Year

2018

Method

Option B

25th
percentile
pay ratio

61:1

Median
pay ratio

48:1

75th
percentile
pay ratio

38:1

The reporting regulations offer three calculation approaches for determining the pay ratio – Options A, B and C.
The table above has been calculated using the approach determined by Option B which is deemed the most appropriate
methodology for BAE Systems. Recognising that BAE Systems has more than 30,000 UK employees, operating on
different human resources and payroll systems, it is not feasible to adopt Option A. The calculations for the relevant
representative employees were performed as at 31 December 2018.

To ensure Option B provides a sufficiently accurate representation of the UK workforce, we have performed sensitivity
analysis around the three quartiles. Our approach has been to consider the total pay and benefits for a number of
employees centred around each quartile. This allows any anomalies that may arise when calculating the total pay
and benefits for the full financial year (such as if an employee left part way through the year) to be adjusted or excluded.
By taking an average of the remaining figures, this provides a robust representation of each quartile.

The total full-time equivalent pay and benefits for the relevant employees has been calculated based on the amount paid
or receivable in respect of the financial year. The calculations are on the same basis as required for the Chief Executive’s
remuneration for single total figure purposes. For pension-related benefits, employer pension costs have been estimated
using the employer contribution rates applicable to the member’s pension scheme. No other estimates or adjustments
have been used in the calculation and no remuneration items have been omitted. A minority of employees in this
calculation are employed on a part-time basis and therefore their remuneration has been annualised to reflect the
full-time equivalent.

Our reward framework across the Group is based on a consistent set of principles, including managing reward by
reference to external competitor benchmarks (see page 98). In the case of our Chief Executive, his total remuneration
comprises a significant proportion in variable pay and therefore the single figure will vary considerably depending on
the level of performance against the measures which drive the Annual and Long-Term Incentive Plans. In 2018, there
was no vesting of long-term incentives for the Chief Executive in respect of performance ending in 2018 which has
resulted in a decrease to the pay ratio. The employees in the calculation would not typically participate in any long-term
incentive plans and receive a significantly higher proportion of their remuneration in the form of fixed pay. The difference
in ratio at the three quartiles is consistent with our market-based approach to reward, with the ratio increasing as the
Chief Executive’s remuneration is compared with that of more junior employees.

Total pay and benefits

Salary component

25th
percentile

41,918

29,498

50th
percentile

53,248

39,286

75th
percentile

63,135

47,404

101

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Total Shareholder Return (TSR) performance and Chief Executive pay
The graph below shows the value by 31 December 2018, on a TSR basis, of £100 invested in BAE Systems on 31 December
2008 compared with the value of £100 invested in the FTSE 100 index, including the effect of dividends. The graph
includes the ratio of remuneration of the Chief Executive to the average employee of the Group for the past five years.

The FTSE 100 is considered to be an appropriate comparator for this purpose as it is a broad equity index of which
BAE Systems is a constituent member and reflects the investment interests of our UK shareholder base. In addition,
it forms 50% of the TSR performance measure for awards made from 2016 onwards. The equivalent data is shown
for the sectoral comparator group which is of relevance to our international shareholder base.

Value at 31 December 2018 of £100 investment at 31 December 2008

BAE Systems
FTSE 100
Sectoral comparator group
CEO:Average employee
pay ratio

£450

£400

£350

£300

£250

£200

£150

£100

£50

£0
Change in Chief Executive’s
remuneration over 10 years
Chief Executive’s single total
figure (£’000)2

Ian King

Charles Woodburn

Bonus paid as a percentage

of maximum

Ian King

Charles Woodburn

LTI as a percentage of maximum

vesting2

Ian King

Charles Woodburn

60:1

45:1

30:1

15:1

1:1

2008

2009

2010

2011

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2015

2016

20171

2018

4,030

4,810

4,613

2,574

2,499

3,519

2,929

3,463

2,086

n/a

–

1,279

2,416

4,030

4,810

4,613

2,574

2,499

3,519

2,929

3,463

3,365

2,416

83.0% 71.0% 68.6% 55.6% 53.4% 74.3% 72.4% 82.3% 75.9%

n/a

–

– 75.8% 65.6%

65.5% 57.6% 44.3%

–

nil

–

nil 16.8%

–

nil

–

nil 11.3%

–

n/a

nil

1. Ian King retired and stepped down as Chief Executive on 30 June 2017 and Charles Woodburn took over the position on 1 July 2017.
Ian King’s remuneration is shown from the start of the financial year until 30 June 2017. Charles Woodburn’s remuneration is shown
from 1 July 2017 to the end of that financial year.

2. Total remuneration includes the value of share plans vesting that were granted prior to appointment as Chief Executive.

102

BAE SystemsAnnual Report 2018Percentage change in Chief Executive’s remuneration
The percentage change from 2017 to 2018 in remuneration of the Chief Executive and average UK employee is shown
in the table below. As required by statute, the table shows the details for the Chief Executive role and, therefore, includes
a combination of the remuneration of Ian King and Charles Woodburn for the 2017 financial year. As Charles Woodburn’s
overall remuneration is lower than Ian King’s, the calculation for 2018 results in a downward movement in the year-on-year
percentage change. If the table below reflected Charles Woodburn’s remuneration for the full financial year, the percentage
movement on a like-for-like basis would be a 2.5% increase in salary, a 0.1% decrease in taxable benefits and a decrease
of 11.3% in bonus.

Base salary

Taxable benefits

Bonus

Change in
Chief Executive’s
remuneration
%

Change in
average UK employee1
remuneration
%

−3.4

−49

−16.4

+2.5

−17.8

1. The BAE Systems UK employee population has been chosen as this employee comparator group reflects the local employment conditions of the

Chief Executive for the purpose of this comparison.

Gender pay
BAE Systems has published its second annual gender pay gap report in line with the UK regulations. For 2018, the
average (mean) gender pay gap for our UK workforce was 9.0% (2017 11.2%), which is lower than the current UK
national average of 17.9%. We have a gender pay gap because we employ around four times more men than women
and a greater proportion of our senior leadership population is male. We rely on employing large numbers of employees
with STEM qualifications and we, like other companies, face challenges recruiting females with these qualifications
because there are significantly fewer women who study and work in these fields.

Relative importance of spend on pay
The following charts set out underlying EBITA1, amounts paid in returns to shareholders, total employee costs and
average headcount for the years ended 31 December 2017 and 2018.

Underlying EBITA1,2 (£m)

Returns to shareholders (£m)

Total employee costs3 (£m)

Average headcount4 (’000)

-2%
2018

2017

1,928
1,974

+3%
2018

2017

703
684

+3%
2018

2017

5,986
5,830

0%
2018

2017

76
76

1. Operating profit excluding amortisation and impairment of intangible assets, finance costs and taxation expense of equity accounted investments

(EBITA), and non-recurring items (see page 36).

2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 to the

Group accounts for details regarding the restatement.

3. 2018 includes £110m relating to the Guaranteed Minimum Pension equalisation charge (see note 22 to the Group accounts).
4. Excluding share of equity accounted investments.

103

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Single total figure of remuneration
Single total figure of remuneration for the Chairman and non-executive directors

Chairman
Sir Roger Carr

Non-executive directors
R Advaithi1
E P L Corley

H Green

C M Grigg

P Rosput Reynolds

N C Rose

I P Tyler

Fees

2018
£’000

700

105

130

105

2017
£’000

696

n/a

103

127

103

Benefits

2018
£’000

–

2017
£’000

–

n/a

Other

2018
£’000

2017
£’000

Total

2018
£’000

–

n/a

700

112

118

141

140

117

2017
£’000

696

n/a

137

133

109

1. Appointed to the Board on 1 January 2018.

Chairman
Sir Roger Carr’s fee was increased to £700,000 per annum with effect from 1 February 2017 on the commencement
of his second three-year term.

The Chairman’s fee is set by the Remuneration Committee and will not be reviewed again for the remainder
of his current three-year term.

Non-executive directors
The non-executive directors’ fees are set by the Non-Executive Directors’ Fees Committee which comprises Sir Roger Carr
(Chairman), Philip Bramwell (Group General Counsel), Jerry DeMuro and Charles Woodburn.

With effect from 1 April 2017, the fee structure on a per annum basis was set as follows: (i) Chairman, Audit Committee:
£105,000 (2016 £100,000); (ii) Chairman, Corporate Responsibility Committee: £105,000 (2016 £95,000); (iii) Chairman,
Remuneration Committee: £105,000 (2016 £95,000); (iv) other non-executive directors: £80,000 (2016 £75,000);
and (v) additional fee for Senior Independent Director: £25,000 (2016 £20,000). These amounts are shown in the
‘Fees’ column above.

A travel allowance of £4,500 (2016 £4,500) per meeting is also paid on each occasion that a non-executive director’s
travel necessitates air travel of more than five hours (one way) to the meeting location, subject to a maximum of six travel
allowances per year. These amounts are shown in the ‘Other’ column.

The amounts in the ‘Benefits’ column relate to travel expenses and subsistence.

The non-executive fee structure will not be reviewed again until 1 April 2020.

The above table has been subject to audit.

104

BAE SystemsAnnual Report 2018Single total figure of remuneration for the executive directors

Base salary

Taxable benefits1

Bonus2

LTIP3

Pension4

Other5

Total

2018
£’000

2017
£’000

2018
£’000

2017
£’000

2018
£’000

2017
£’000

2018
£’000

2017
£’000

2018
£’000

2017
£’000

2018
£’000

2017
£’000

2018
£’000

2017
£’000

C N Woodburn*

P J Lynas

J DeMuro6

I G King**

897

642

789

n/a

813

592

794

491

n/a

1,324

1,311

653

936

n/a

724

1,578

838

–

145

200

n/a

327

434

497

171

460

n/a

154

570

219

–

2,416

2,302

1,925

2,243

1,217

950

3,197

3,802

n/a

2,079

* Appointed as Chief Executive on 1 July 2017 having been appointed to the Board in 2016 as Chief Operating Officer.
** Retired as Chief Executive and from the Board on 30 June 2017.

The above table has been subject to audit.

1. The benefits received by Charles Woodburn include the provision of a car allowance and the private use of a

chauffeur-driven car (2018 £23k; 2017 £23k). The benefits received by Peter Lynas include the provision of a car
allowance and the private use of a chauffeur-driven car (2018 £23k; 2017 £21k). In addition, Peter Lynas received the
final payments in respect of his second residence allowance of £2k (2017 £8k) on the basis disclosed in previous years.
Jerry DeMuro’s benefits include private use of a chauffeur-driven car and parking (2018 £2k; 2017 £3k); medical and
dental benefits (2018 £13k; 2017 £14k); insured life and disability benefits (2018 £9k; 2017 £9k); and the private use
of a company aircraft (2018 £18k; 2017 £9k). The prior year benefits figure for Ian King for the six months ended
30 June 2017 includes the provision of a car allowance and the private use of a chauffeur-driven car. In addition,
upon his retirement, Ian King received a leaving gift totalling £5k as disclosed last year with the tax due on this
being settled by the Company.

2. Further detail on bonus payments is provided on page 107. One-third of the net bonus paid to Charles Woodburn,

Peter Lynas and Jerry DeMuro will be deferred compulsorily into BAE Systems shares for a three-year period, without
additional performance conditions.

3. This column relates to the estimated or actual value of Long-Term Incentive Plans for which the performance period

ended in the relevant financial year.

The values in the 2018 column are calculated on the basis of the three-month average share price of £5.17 as at
31 December 2018 and relate to the vesting portion (18.8%), including shares deriving from notional reinvested
dividends, of the 2016 LTIP PSTSR and LTIP SO awards granted to Peter Lynas and Jerry DeMuro for which the
performance periods ended on 31 December 2018 (see page 109 for further detail).

An estimate of the amount of 2016 LTIP PS award attributable to share price appreciation is £4,114 in respect of
Peter Lynas’ awards and £5,623 in respect of Jerry DeMuro’s awards. An estimate of the amount of 2016 LTIP SO
award attributable to share price appreciation is £11,479 in respect of Peter Lynas’ awards and £18,122 in respect
of Jerry DeMuro’s awards. An estimate of the amount of 2016 LTIP RS award for Jerry DeMuro that is attributable
to share price appreciation is £27,483.

As required by regulation, the estimated vesting values for the awards shown in the 2017 column (which were
calculated in the 2017 Annual Report on the basis of the three-month average share price of £5.75 as at 31 December
2017), have been adjusted to reflect the actual value on the vesting of the performance award in March 2018 based
on the then share price of £5.66. The figures reported in the 2017 column in the 2017 Annual Report on the estimated
basis were Peter Lynas: £332k; Jerry DeMuro: £441k; and Ian King: £504k. The respective figures in the 2017 Total
column have been recast accordingly. The Chief Executive figures in the pay ratio and TSR performance/Chief Executive
pay disclosures on pages 101 and 102 reflect the original 2017 total for Ian King (£2,086k).

4. The figures for Peter Lynas in this column reflect defined benefit arrangements and have been calculated in line with

the method set out in Section 229 of the Finance Act 2004 using a capitalisation factor of 20 to assess the increase in
the value of the pension promise over the year under review, net of inflation. These figures are also sensitive to salary
increases and Consumer Prices Index (CPI) inflation as follows:
– Salary increase: Pensionable salary is averaged over three years. The figures for Peter Lynas reflect his salary increase

since 31 December 2017.

– CPI inflation: In a year with high CPI inflation, the increase in the value of the pension promise would be lower than

in a year with lower CPI inflation. For the 2018 figures, the reference CPI inflation was 3.0%.

The figures for Charles Woodburn relate to a salary supplement in lieu of Company pension contributions.

The figures for Jerry DeMuro include company contributions paid into his Section 401(k) defined contribution
arrangement.

The prior year figures for Ian King in this column show the added pension value received in the defined benefit schemes
from 1 January 2017 to the date of his retirement on 30 June 2017.

Further detail on pensions is given on page 110.

105

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

5. This column includes (i) the value of Free Share awards under the UK all-employee Share Incentive Plan (SIP) of £394
for Charles Woodburn, and his Matching Shares under voluntary investment in the SIP (and in the prior year figure
for Ian King for the six months to 30 June 2017); and (ii) for Jerry DeMuro, the value of the 2018 grant of Restricted
Shares (£1,138k). This award formed part of Jerry DeMuro’s 2018 LTIP allocation but is required to be reported under
‘Other’ as it has no performance conditions attached. The balance of the 2018 figure (£79k) relates to the value of
notional reinvested dividends in respect of his 2015 Restricted Share Plan award which vested in March 2018, the
third anniversary of grant. The value of the related award was reported in the 2015 Remuneration report. His prior
year figure relates to a similar Restricted Shares award in 2017 and the value of the notional reinvested dividends in
respect of his 2014 Restricted Share Plan award. For Peter Lynas, the value of his 2018 Free Share award under the
SIP was £394.

6. Jerry DeMuro is paid in US dollars with the disclosed figures above being converted into sterling at the required
exchange rate. The 2018 salary reflects his 3.0% salary increase and the exchange rate fluctuations experienced
in 2018.

There were no other payments to former directors in 2018.

Executive directors’ remuneration in the year ending 31 December 2019
For the purposes of the Companies Act 2006, the Directors’ remuneration policy (the Policy) has been operating
in practice since the date of its approval on 10 May 2017 at the 2017 AGM. The remuneration for 2019 will be
implemented as follows:
– The salary of the Chief Executive is increased by 2.5% to £919,500 with effect from 1 January 2019.
– The salary of the Group Finance Director is increased by 2.5% to £657,700 with effect from 1 January 2019.
– The salary of the President and Chief Executive Officer of BAE Systems, Inc. is increased by 2.5% to $1,080,000

with effect from 1 January 2019.

– Annual and Long-Term Incentive opportunity levels remain in line with 2017 approved Policy.
– Long-Term Incentive awards of Performance Shares only for UK executive directors, and Performance Shares and

Restricted Shares for US executive director.

– The performance measures and weightings for 2019 for the Annual Incentive and Long-Term Incentives are set

out on page 116.

– The Committee is of the view that bonus targets for the Annual Incentive are commercially sensitive and that it
would be detrimental to the Company to disclose them in advance. The targets will be disclosed retrospectively
after the end of the relevant financial year.

External directorships
Fees retained in 2018 by executive directors, during the period in which they served in that capacity, in respect
of non-executive directorships were: Peter Lynas £86,912 in respect of his directorship of SSE plc and Jerry DeMuro
$12,500 in respect of his (then) directorship of Aero Communications, Inc.

These amounts are not included in the remuneration table on page 105.

106

BAE SystemsAnnual Report 2018Annual bonus
Annual bonuses for the 2018 year are paid in March 2019. Annual bonus is made up of financial metrics, safety and
personal objectives, designed to support the achievement of certain strategic outcomes necessary for sustaining the
Group’s long-term vitality. The breakdown of bonus measures, achievement and pay-out for each executive director
is shown below. One-third of the net bonus payment is subject to compulsory deferral into BAE Systems shares for
a three-year period, for which there is no additional performance condition.

Chief Executive
Charles Woodburn

Measures

Financial Group underlying EPS

Group net debt

Group order intake2

Personal

Safety

Key strategic objectives

Group Finance Director
Peter Lynas

Measures

Financial Group underlying EPS

Group net debt

Group order intake2

Personal

Safety

Key strategic objectives

Weight (as a
percentage
of target)

Actual performance against targets set

Below

Threshold

Target

Stretch

38.0

23.0

14.0

5.0

20.0

Weight (as a
percentage
of target)

Actual performance against targets set

Below

Threshold

Target

Stretch

38.0

23.0

14.0

5.0

20.0

President and Chief Executive Officer of BAE Systems, Inc.
Jerry DeMuro

Measures

Financial Group underlying EPS

Group net debt

Group order intake2

BAE Systems, Inc. underlying EBITA

BAE Systems, Inc. debt

BAE Systems, Inc. order intake

Personal

Safety

Key strategic objectives

Weight (as a
percentage
of target)

Actual performance against targets set

Below

Threshold

Target

Stretch

12.7

7.7

4.7

25.3

15.3

9.3

5.0

20.0

Threshold
for 2018

Target
for 2018

Stretch
for 2018

Actual
performance1

40.0p

42.1p

43.2p

41.8p

£(1,816)m £(1,592)m £(1,248)m

£(951)m

n/a

£29.2bn

£30.1bn

£29.2bn

See note 3 below

See Key strategic objectives section on page 108

Percentage
of maximum
opportunity

45.7%

100%

50%

45%

80%

Total bonus (as a percentage of maximum)

65.6%

Threshold
for 2018

Target
for 2018

Stretch
for 2018

Actual
performance1

40.0p

42.1p

43.2p

41.8p

£(1,816)m £(1,592)m £(1,248)m

£(951)m

n/a

£29.2bn

£30.1bn

£29.2bn

See note 3 below

See Key strategic objectives section on page 108

Percentage
of maximum
opportunity

45.7%

100%

50%

45%

70%

Total bonus (as a percentage of maximum)

63.6%

Threshold
for 2018

Target
for 2018

Stretch
for 2018

Actual
performance1

40.0p

42.1p

43.2p

41.8p

£(1,816)m £(1,592)m £(1,248)m

£(951)m

n/a

£29.2bn

£30.1bn

£29.2bn

$1,259.9m $1,304.8m $1,327.2m $1,227.9m

$2,480m $2,553m $2,656m

$2,547m

n/a

$11.09bn

$11.65bn

$12.5bn

See note 3 below

See Key strategic objectives section on page 108

Percentage
of maximum
opportunity

45.7%

100%

50%

73.8%

100%

45%

70%

Total bonus (as a percentage of maximum)

52.7%

The above table has been subject to audit.

1. Adjusted to be on a like-for-like basis with the targets.

2. The Committee exercised its discretion in respect of the Group order intake measure and assessed the actual outcome
of £28.3bn as on-target achievement, even though the on-target level had been set at £29.2bn. In doing so, the
Committee recognised the order intake for 2018 was a record achievement, and that the prevailing geopolitical
climate has created an unavoidable delay in translating the March 2018 Memorandum of Intent between the UK
government and the Kingdom of Saudi Arabia for a further 48 Typhoon aircraft, support and transfer of technology
and capability into a confirmed order.

3. Performance against the safety element of the bonus was determined by the Corporate Responsibility Committee
(whose composition is stated on page 87). The objective requires a reduction in the level of significant risk and
improvement in safety culture, as well as targeted improvements against key safety indicators including a reduction
in recordable injuries. Although the Company met its stretch target for reduction in recordable injuries, the amount
awarded was reduced by the Committee to reflect the incident at Radford, Virginia, which resulted in an employee
fatality and two other employees being seriously injured.

107

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Key strategic objectives
Achievement against key strategic objectives represents 20% of the annual bonus opportunity applicable to each
of the executive directors. These objectives relate to the delivery of the Group’s strategic objectives and demonstration
of leadership behaviours. In 2018, a new framework was introduced whereby the executive directors and Executive
Committee members were assigned primary responsibility for, or required to support, a set of shared common strategic
objectives. The objectives were both technical and organisational, grouped under the three key areas of Operational
Excellence, Competitive Edge and Technology Innovation. On the technical side, the objectives ranged from leveraging
technology, engineering and manufacturing capabilities and driving flawless programme execution to delivering
savings through global collaboration across the broader enterprise. From an organisation perspective, objectives
ranged from embedding the new organisation structure and maintaining the highest standards of business conduct,
to implementing a strategy for talent management that included strategic workforce planning and the ability to attract
and retain a diverse workforce.

Key achievements in the year included:

Charles Woodburn
Chief Executive

Peter Lynas
Group Finance Director

Jerry DeMuro
President and Chief Executive
Officer of BAE Systems, Inc.

Operational Excellence
– Achieved significant orders across the
sectors including Amphibious Combat
Vehicle, F-35 production and SEA5000.

– Improved execution and performance

on a number of programmes, particularly
in the Maritime sector.

– Achieved key project salients

and milestones.

Competitive Edge
– Delivered significant global

procurement savings.

– Drove global collaboration opportunities
and streamlined procurement process,
thereby improving the Company’s ability
to compete for future business.

– Strengthened the role of functional
councils and increased commitment
to research and development.

– Embedded the new organisation structure.

– Implemented strategy to strengthen

performance management and to support
succession planning, talent management
and diversity and inclusion targets.

– Increased employee engagement to
support culture change and strategy.

Technology Innovation
– Made progress in strengthening
Company’s technology capability
and positioning.

– Ensured plan performance for profit,

cash and orders achieved or exceeded.

– Reinforced growth strategy.

– Developed and implemented

contractual constructs to support
financial performance.

– Achieved significant orders including
Amphibious Combat Vehicle and
F-35 production.

– Delivered key project salients

and milestones against ambitious
performance goals.

– Maintained Group’s licence to trade in US.

– Delivered significant global procurement

savings.

– Implemented organisational changes to
enhance execution in key platform areas.

– Addressed challenging capital allocation

– Collaborated successfully with rest of

issues, including pension funding.

– Maintained transparent and credible

communications with investors, rating
agencies and other stakeholders.

– Embedded stronger performance

accountability and culture throughout
the organisation.

Group on various programmes including
M777 India and F-35 flight trials on
HMS Queen Elizabeth.

– Provided strong leadership to

achievement of procurement savings,
succession and performance culture
change in the US business.

– Met IT improvement objectives.

– Strengthened technology capabilities

and continued to expand the product suite
to enhance competitive positioning in the
US defence market.

Achievements were offset by shortcomings
in programme performance and the need
to continue to drive safety culture.

Performance achievements were offset
by lack of progress in rationalising certain
non-core businesses.

Achievements were offset by shortcomings
in programme performance under certain
legacy contracts and safety outcomes.

Payout (% of maximum): 80%

Payout (% of maximum): 70%

108

BAE SystemsAnnual Report 2018Long-Term Incentive Plan (LTIP) performance
Annual average diluted underlying EPS growth

Outperformance of performance conditions ending on 31 December 2018

Threshold

Maximum

2018 EPS requirement

Annual average EPS growth

Relative TSR against comparator groups

43.7p

48.5p

Outperformance of performance conditions ending on 31 December 2018

Threshold

Maximum

TSR against sectoral comparator group

TSR against FTSE 100 comparator group

Overall vesting against TSR

56.8%

14.9%

70.3%

56.0%

Actual

42.8p

<3%

Actual

21.9%

Percentage of
maximum achieved

37.6%

18.8%

2016 Performance Shares (LTIP PS)
– Performance conditions: half on relative TSR against two comparator groups (with equal weighting), half on EPS growth
of 3% to 7% per annum. The TSR three-year performance period ended on 31 December 2018 and resulted in 18.8%
vesting of the TSR portion. The Committee is satisfied that there has been a sustained improvement in the Company’s
underlying financial performance and that it is appropriate for vesting of 18.8% of the TSR portion. With respect to the
2016 LTIP PSEPS award, for which the performance period also ended on 31 December 2018, the related performance
condition was not met and thus this portion of the award will lapse.

2016 Share Options (LTIP SO)
– Performance condition: relative TSR against two comparator groups (with equal weighting). The TSR three-year

performance period ended on 31 December 2018 and resulted in 18.8% vesting.

In respect of the 2016 LTIP PSTSR and LTIP SO awards made to Charles Woodburn in September 2016, the performance
period ends on 30 June 2019 with the TSR performance condition tested at that time and the outcome due to be
reported in the 2019 Remuneration Report. The EPS portion of his 2016 LTIP PS, for which the performance period
ended on 31 December 2018, will lapse as the related performance condition was not met.

A summary of TSR performance to 31 December 2018 on outstanding TSR-related LTIP awards is illustrated in the
chart below. The vesting percentage for the 23 March 2016 award is the actual vesting outturn referred to above.

The grey boxes show the range of TSR required for 25% vesting to full vesting in respect of the sectoral
international defence and FTSE 100 comparator groups, as appropriate, and the orange diamonds show
BAE Systems’ TSR. The proportion that would vest is shown in the boxes at the top of the chart.

TSR performance under the TSR-related awards as at 31 December 2018

18.8% vesting

14.0% vesting

0% vesting

70%

60%

50%

40%

30%

20%

10%

–10%

23 March 2016
award

6 September 2016
award

23 March 2017
award

21 March 2018
award

Sectoral comparator group
FTSE 100 comparator group
BAE Systems’ TSR

109

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Pension entitlements
Total pension entitlements

Figures included in the remuneration table on page 105

Normal
retirement
age

Accrued
benefit at

1 January 20181,2
£ per annum

31 December 20181,2

£ per annum

Added pension
value received in
the year from
defined
benefit
scheme2
£

Added pension
value received in
the year from
defined
contribution
scheme
£

17,486

285,564

136,043

27,037

319,969

169,031

n/a

460,311

n/a

–

n/a

12,954

Total
£

–

460,311

12,954

Director

Charles Woodburn

Peter Lynas

Jerry DeMuro

Age

1. Accrued benefit for Charles Woodburn is the total value of his defined contribution account, including employee
contributions and investment returns. Accrued benefit for Jerry DeMuro is the total value of his Section 401(k)
account, including both employee and company contributions as well as investment returns.

2. The figure includes both funded and unfunded defined benefit arrangements for Peter Lynas. Accrued benefit for

Peter Lynas is annual pension payable on retirement prior to any reduction for early payment or exchanging pension
for cash. In addition, a longevity adjustment factor is applied to pension accrued after 5 April 2006 to mitigate against
life expectancy changes. The figures allow for the current factors in force, whereas in practice the factors are updated
annually and those in force at retirement will be applied.

The above table has been subject to audit.

Charles Woodburn participates in the BAE Systems Executive Pension Scheme Defined Contribution Retirement Plan
(EPS DCRP), which is a defined contribution arrangement for senior executives. Charles Woodburn contributes the
maximum £10,000 per annum into the EPS DCRP arrangement as permitted by the Annual Allowance and a
19% salary supplement is paid in lieu of the Company contributions.

Jerry DeMuro participates in a Section 401(k) defined contribution arrangement set up for US employees in which
the Company will match his contributions up to a maximum contribution of 6% of salary, up to US regulatory limits
(2019 $19,000; 2018 $18,500). In 2018, the company paid contributions of $16,500 into this arrangement.

Peter Lynas is a member of the BAE Systems Executive Pension Scheme (ExPS) and the BAE Systems 2000 Pension Plan
(2000 Plan) which together provide a pension for executive directors payable at 62 of 1/30th of three-year average final
salary for each year of service subject to the payment of members’ contributions (currently 8%). Benefits paid prior to
age 62 for ExPS and age 65 for 2000 Plan will be subject to actuarial reduction.

The ExPS tops up the underlying employee plan to provide a target benefit for executive directors payable from normal
retirement age of 1/30th of Final Pensionable Pay (FPP) for each year of ExPS pensionable service (subject to a maximum
of two-thirds of FPP). FPP is defined as annual base salary averaged over the last 12 months prior to leaving service in
respect of service accrued to 5 April 2006 and 36 months prior to leaving in respect of service from 6 April 2006. The
ExPS also provides a lump sum death-in-service benefit equal to four times base salary at date of death, and a spouse’s
death-in-service pension equal to two-thirds of the prospective pension at normal retirement age. Spouses’ pensions
are also payable upon death in retirement and death after leaving the Company’s employment with a deferred pension.
Once in payment, pensions are increased annually by the rise in the Retail Prices Index subject to a maximum increase of
5% per year in respect of pre-6 April 2006 service and 2.5% per year in respect of service from 6 April 2006. Peter Lynas
joined the ExPS in 1999.

The 2000 Plan provides a pension of 1/50th of Final Pensionable Earnings (FPE) for each year of pensionable service,
payable from a normal retirement age of 65 and members pay contributions of 8% of Pensionable Earnings. FPE under
the 2000 Plan is the best consecutive three-year average of base salary and bonus in the ten Plan Years prior to leaving,
less an offset for State pensions. The Company decided in 2006 to limit pensionable bonuses in the 2000 Plan in the
2006/07 Plan Year to 20% of base salary and to 10% of base salary for the 2007/08 Plan Year and thereafter. However,
there is a guarantee that the FPE figure for benefits in respect of service prior to 6 April 2007 will not be less than the
FPE figure at 5 April 2007 to ensure that employees do not lose the benefit of contributions paid on past bonuses.
Peter Lynas has 33 years and two months’ service in the 2000 Plan.

The review of pension policies carried out in 2010 by the Committee concluded that the pension benefits should
continue to be based on the Company’s registered pension schemes and that, in appropriate circumstances, the
Company will continue to have the option to offer an unfunded pension promise so as to mitigate the impact of further
reductions to the Lifetime Allowance and the impact of the reduced Annual Allowance. Peter Lynas was given the choice
to remain in the current arrangement and pay the increased tax or to take an unfunded promise; he elected for the latter.
The Committee has decided that in cases where the Company is to pay an unfunded promise, executives will be given
the choice to commute some or all of the benefit for a taxable lump sum, or take it as pension. Where an unfunded
pension is taken, ten years after retirement, the executive will be given a further opportunity to commute the residual
value of the unfunded pension for a lump sum.

Therefore, Peter Lynas’ total pension is the sum of his 2000 Plan benefits plus the top-up from the ExPS, most of which
is provided through the unfunded promise referred to above.

110

BAE SystemsAnnual Report 2018Share interests

Scheme interests awarded during the financial year

Scheme

Type of interest

Date of grant

Number
of shares

Basis of award

Face value
of award1
£

Exercise
price
£

Date to which
performance
is measured

Performance
condition

Charles Woodburn

LTIP PSTSR

LTIP PSEPS

Peter Lynas

LTIP PSTSR

LTIP PSEPS

Jerry DeMuro

LTIP PSTSR

LTIP PSEPS

Performance
Shares/nil
cost option

Performance
Shares

20.03.18

285,227

185% of salary

1,659,451

20.03.18

285,227

185% of salary

1,659,451

20.03.18

184,731

167.5% of salary

1,074,765

20.03.18

184,731

167.5% of salary

1,074,765

20.03.18

194,279

149% of salary

1,130,315

20.03.18

194,280

149% of salary

1,130,321

LTIP RS

Retention

20.03.18

195,584

150% of salary

1,137,908

nil

n/a

Three years
to 31.12.20

TSR/secondary
financial measure

Three years
to 31.12.20

EPS/secondary
financial measure

Three years
to 31.12.20

TSR/secondary
financial measure

Three years
to 31.12.20

EPS/secondary
financial measure

Three years
to 31.12.20

n/a

TSR/secondary
financial measure

EPS/secondary
financial measure

n/a

1. The value of the award is calculated on the date of grant by reference to the middle market quotation at the close of the preceding day.

Key: LTIP – Long-Term Incentive Plan. PS – Performance Shares. RS – Restricted Shares.

Note: Performance Shares and Restricted Shares – Shares under award attract notional reinvested dividends prior to vesting. Performance Shares are
intended to be free share awards and are structured as a nil cost option to give the participant more flexibility as to the timing of the benefit. For the
US executive director, awards of Performance Shares are classified as conditional share awards (rather than share options) and are deliverable on the
third, fourth and fifth anniversary of grant, subject to attainment of the performance condition. For the UK executive directors, shares vest on the fifth
anniversary of grant.

The table above has been subject to audit.

Percentage
of interests
receivable
if minimum
performance
achieved

25%

n/a

111

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Description of share plans and summary of performance conditions
Long-term incentives operate under the BAE Systems Long-Term Incentive Plan (LTIP) approved by shareholders at the
2014 AGM. The three main vehicles in use are Performance Shares, Share Options and Restricted Shares.

LTIP Performance Shares
Up to 2017, shares under award vest after satisfaction of the three-year performance condition. Awards that vest
are capable of exercise in three equal tranches on a phased basis from the third, fourth and fifth anniversary of grant.
Any unexercised awards will lapse on the seventh anniversary of grant. From 2018, awards to non-US executive directors
remain subject to the three-year performance period but will not vest until the fifth anniversary of grant. They will be
exercisable until the seventh anniversary of grant. For US participants, the awards are automatically delivered at the end
of years three, four and five, subject to the performance condition being achieved. Shares under award attract notional
reinvested dividends prior to tranche vesting.

Awards are weighted 50% on the EPS performance condition and 50% on the TSR performance condition as set out
below. The TSR sectoral comparator group is shown below.

Plan

Performance condition

LTIP PSEPS

Rate of average annual diluted underlying EPS growth over the three-year performance period, with 25% vesting
at 3% average growth per annum, 50% vesting at 5% average growth per annum and 100% vesting at 7% average
growth per annum, with vesting on a straight-line basis between these parameters. Awards will not vest unless the
Board is satisfied that there has been a sustained improvement in the Company’s underlying financial performance.
In taking such a view, the Committee may consider (but not exclusively) the following financial metrics: net cash/debt;
order book; risk; and project performance.

LTIP PSTSR

For awards made from 2016, the proportion of the award capable of exercise is determined by:

(i) 50% of the TSR measure is on the current sectoral comparator group of 13 other international defence companies
and 50% is on a TSR percentile ranking against the companies in the FTSE 100 index. Under both the sectoral
and FTSE 100 comparator groups, no shares vest if the Company’s TSR is less than median TSRs achieved by
the comparator group, with 25% vesting at median, 100% vesting if the Company’s TSR is in the top quintile
and vesting on a straight-line basis between these two parameters; and

(ii) whether there has been a sustained improvement in the Company’s underlying financial performance. In taking such
a view, the Committee may consider (but not exclusively) the following financial metrics: net cash/debt; EBITA1; order
book; turnover; risk; and project performance.

1. Operating profit excluding amortisation and impairment of intangible assets, finance costs and taxation expense of equity accounted investments.

The TSR sectoral comparator group for awards from 2016 comprises:

Cobham

General Dynamics

Harris Corporation
L3 Technologies2
Leidos

2. Formerly named L-3 Communications.
3. Formerly named Finmeccanica.

Leonardo3
Lockheed Martin

Meggitt

Northrop Grumman

Raytheon

SAIC

Thales

United Technologies

LTIP Share Options
Options are normally exercisable between the third and tenth anniversary of their grant, subject to the performance
condition set out below being achieved. Awards are subject to a further two-year clawback period after the initial
three-year vesting period. From 2018 executive directors no longer receive share option awards.

Plan

LTIP SO

Performance condition

For awards made from 2016, 50% of the TSR measure is on the current sectoral comparator group of 13 other
international defence companies and 50% is on a TSR percentile ranking against the companies in the FTSE 100 index.
Under both the sectoral and FTSE 100 comparator groups, no shares vest if the Company’s TSR is less than median
TSRs achieved by the comparator group, with 25% vesting at median, 100% vesting if the Company’s TSR is in the
top quintile and vesting on a straight-line basis between these two parameters.

LTIP Restricted Shares
Restricted Shares are not subject to a performance condition as they are designed to address retention issues principally
in the US. The shares are subject only to the condition that the participant remains employed by the Group at the end
of the vesting date (three years after the award date). Shares under award attract notional reinvested dividends prior
to vesting. Awards made to the US executive director are subject to a further two-year clawback period after the initial
three-year vesting period.

112

BAE SystemsAnnual Report 2018Statement of directors’ shareholdings and share interests
Minimum Shareholding Requirement (MSR)
Executive directors are compulsorily required to establish and maintain a minimum personal shareholding equal to a
set percentage of base salary. An Initial Value must be achieved as quickly as possible using shares vesting or options
exercised through the executive share option schemes and Long-Term Incentive schemes by retaining 50% of the net
value (i.e. the value after deduction of exercise costs and tax) of shares acquired under these schemes. Once the Initial
Value is achieved, a Subsequent Value must be achieved in the same way, except that a minimum of 25% of the net value
must be retained on each exercise or acquisition. Shares owned beneficially by the director (including the portion of net
annual bonus deferred compulsorily into BAE Systems shares) and his/her spouse count towards the MSR. Any case of
non-compliance would be dealt with by the Committee.

The MSR does not currently apply after the individual has ceased to be a director. The Committee intends to make
necessary changes to the existing policy to ensure an appropriate post-cessation holding policy is in place, as part of
the broader executive remuneration policy proposals to be submitted for approval at the Company’s Annual General
Meeting (AGM) in May 2020.

The following table sets out MSR Initial Value and Subsequent Value and actuals as at 31 December 2018:

Charles Woodburn

Peter Lynas

Jerry DeMuro

Initial Value

Subsequent Value

150%

100%

212.5%

300%

200%

425%

Actual

71%

188%

186%

The actual MSR figures in the table are provided as at 31 December 2018, based on the year-end share price of £4.59.
The share price fluctuated throughout the year such that for the majority of the year, the actual MSR figures held by the
executive directors were accordingly higher.

Charles Woodburn and Jerry DeMuro joined the Board in 2016 and 2014 respectively, and have been gradually building
up their shareholdings. The higher MSR values applicable to Jerry DeMuro (which were increased at the beginning of
2018) recognise the higher LTI opportunity and broader US market practice.

There are MSR requirements in place for all of the employee population who receive LTIPs.

There are no shareholding requirements for the Chairman or the non-executive directors.

Share interests as at 31 December 2018
The interests of the directors who served during the year ended 31 December 2018 in the shares of BAE Systems plc,
or scheme interests in relation to those shares, were as follows:

Scheme interests: Options and awards over shares

Share awards
with performance
conditions

Share awards
without performance
conditions

Share options
with performance
conditions

Share options
with performance
conditions, vested
but unexercised

Total
scheme
interests

Sir Roger Carr

R Advaithi1

E P L Corley

J DeMuro

H Green

C M Grigg

P J Lynas

P Rosput Reynolds

N C Rose

I P Tyler

C N Woodburn

126,093

–

19,000

335,766

–

24,555

264,289

25,200

55,000

–

138,226

–

1,082,993

463,597

1,045,249

–

1,457,948

–

2,257,641

1. Appointed to the Board on 1 January 2018.

The above table has been subject to audit.

–

2,591,839

–

1,457,948

–

2,257,641

The interests of directors include those of their connected persons. The shares held by Paula Rosput Reynolds are represented
by 6,300 American Depositary Shares. Details of the share interests in options and awards held by the executive directors
as at 31 December 2018 are given on page 114 together with details of nil-cost options exercised in 2018.

Performance Shares granted under the LTIP are classified as share awards with performance conditions for the
US executive director and as nil-cost options with performance conditions for the UK executive directors.

Since 31 December 2018, Charles Woodburn has acquired an additional 87 shares under the Partnership and Matching
shares elements of the Share Incentive Plan so that his beneficial shareholding at the date of this report stood at 138,313.

There have been no changes in the interests of the remaining directors in the shares of BAE Systems plc between
31 December 2018 and the date of this report.

113

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsAnnual remuneration report
continued

Breakdown of scheme interests: Options and awards held as at 31 December 2018

Charles Woodburn

Jerry DeMuro

31 December
2018

Date of grant

Exercise
price
£

Date from which
exercisable or part
exercisable

31 December
2018

Date of grant

Exercise
price
£

Date from which
exercisable or part
exercisable

LTIP PSTSR

LTIP PSEPS

LTIP PSTSR

LTIP PSEPS

LTIP PSTSR

LTIP PSEPS

LTIP SO

Peter Lynas

LTIP PSEPS

LTIP PSTSR

LTIP PSEPS

LTIP PSTSR

LTIP PSEPS

LTIP PSTSR

LTIP PSEPS

LTIP SO

334,8331

334,8332

132,8971

285,2271

1,505,914

405,0401

346,6871

751,727

06.09.16

21.03.17

20.03.18

nil

06.09.16

21.03.17

5.56

6.49

06.09.19

LTIP PSEPS

06.09.19

LTIP PSTSR

21.03.20

LTIP PSEPS

21.03.20

LTIP PSTSR

20.03.23

LTIP PSEPS

20.03.23

LTIP PSTSR

LTIP PSEPS

06.09.19

21.03.20

LTIP SO

LTIP RS

45,8443

168,2034

168,2032

156,0921

194,2791

194,2801

1,082,993

542,1434

503,1061

1,045,249

139,011

129,002

195,584

463,597

25.03.15

23.03.16

21.03.17

20.03.18

23.03.16

21.03.17

23.03.16

21.03.17

20.03.18

n/a

4.99

6.49

n/a

25.03.19

23.03.19

21.03.20

20.03.21

23.03.19

21.03.20

23.03.19

21.03.20

20.03.21

31 December
2018

Date of grant

Exercise
price
£

Date from which
exercisable or part
exercisable

34,5103

123,0604

123,0602

96,9441

96,9451

184,7311

843,981

343,4244

270,5431

613,967

25.03.15

23.03.16

21.03.17

20.03.18

nil

23.03.16

21.03.17

4.99

6.49

25.03.19

23.03.19

21.03.20

20.03.23

23.03.19

21.03.20

1. Subject to a performance condition that is yet to be tested.
2. The outstanding option or award will lapse after the end of the financial year having

not met the full performance condition.

3. Subject to a performance condition that has been met.
4. The outstanding option or award will partially lapse after the end of the financial

year having not met the full performance condition.

Performance Shares – nil cost options exercised during 2018

Peter Lynas

Exercised
during the
year

17,254

Exercise
price

£ Date of grant

Date of
exercise

Market price
on exercise
£

nil

25.03.15

12.04.18

5.92

LTIP PSEPS

The Performance Shares nil-cost option exercised by Peter Lynas attracted notional reinvested
dividends which equated to an additional 1,976 shares on exercise of this tranche.

The tables above have been subject to audit.

Performance conditions
Performance conditions for the LTIP are detailed on page 112.

114

BAE SystemsAnnual Report 2018Remuneration Committee composition and advisers
The Committee members comprise Paula Rosput Reynolds (Chairman), Elizabeth Corley and Nick Rose.
Advisers to the Remuneration Committee are shown below.

During the year, the Committee received material assistance and advice on remuneration policy from the Group Human
Resources Director, Karin Hoeing, and the Human Resources Director, Reward, Paul Farley. Charles Woodburn in his role
as Chief Executive, also provided advice that was of material assistance to the Committee.

Adviser

Services provided

Appointment

Governance

Fees (in respect
of services provided
to the Committee)

£81,652

Fee basis: Hourly

Committee
appointment.

By the Company
at the request of
the Committee.

The Committee is aware that PwC provides
a variety of other services to the Company,
including tax and pensions advice. PwC also
provides a range of consultancy services.

PwC is a member of the Remuneration
Consultants Group (RCG) and is a signatory
to the RCG’s code of conduct.

By the Company
with the approval
of the Committee.

Only provides legal compliance, legal
drafting and review services, and does
not advise the Committee.

£8,574

Fee basis: Hourly

Independent adviser to the Committee,
including attendance at Remuneration
Committee meetings.

Also provided information on market
practice in relation to different aspects
of remuneration, market trends and
benchmarking of the remuneration
packages for the executive population.

Provided legal services, principally
regarding all-employee share plans
and plan rule changes relating to
the EU’s General Data Protection
Regulations.

PricewaterhouseCoopers
(PwC)

Linklaters

Aon

Advises on the TSR outcomes as
required for assessing the performance
condition under the BAE Systems
Long-Term Incentive Plan 2014.

By the Company.

The Committee is aware that Linklaters is
one of a number of legal firms that provide
legal advice and services to the Company
on a range of matters.

Linklaters is regulated by the Law Society.

The Committee is aware that Aon provides
a variety of other human resources-related
services to the Company.

The nature of the advice provided to the
Committee is limited to factual information
concerning the performance of the
Company’s shares.

Aon is a member of the Remuneration
Consultants Group (RCG) and is a signatory
to the RCG’s code of conduct.

£19,400

Fee basis: Fixed fee

115

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsPreface to the
Directors’ remuneration policy

The Directors’ remuneration policy (the Policy) set out on pages 117 to 129 was agreed by shareholders
at the Annual General Meeting (AGM) on 10 May 2017 and took legal effect on that date. The approved
policy has been re-printed verbatim from the 2016 Annual Report, updated only so that the page numbers,
where appropriate, refer to the 2018 Annual Report in order to aid readability, and to report subsequent
Board membership changes.

Directors’ remuneration for 2019
For 2019, it remains our intention to operate the Policy that was
agreed by shareholders at the 2017 AGM. This section sets out
how the Policy will apply in 2019.

Metrics and weightings applicable in 2019
– The performance metrics and weightings applicable to the 2019
annual incentive are 75% on financial metrics relating to Group
underlying EPS, Group net debt and Group order intake, 5% on
safety and 20% on personal objectives designed to support the
Group’s strategy. As set out in our Remuneration Committee
Chairman’s letter on page 92, recognising the significant focus on
delivering earnings growth in 2019, the following weighting of
financial measures will apply:

Group
underlying
EPS/EBITA
%

45
60

Group
debt
%

22.5
30

Order
intake
%

7.5
10

Total
%

75
100

2019

Allocation

Weighting

– There are no changes proposed to the quantum applicable to

the executive directors, and one-third of the net annual incentive
will continue to be deferred into shares for three years on a
compulsory basis.

– Performance Shares will continue to have 50% of the award

based on TSR performance as follows: 50% of the TSR measure
on the current sectoral comparator group of 13 other international
defence companies and 50% on a TSR percentile ranking against
the companies in the FTSE 100 index. For 2019, the remaining 50%
of the award is subject to the EPS condition with a performance
range of 3% to 7% average annual EPS growth requirement.
For US participants, other than members of the Executive
Committee, 50% of the awards made in 2019 are subject to
the long-term operating cash performance of the US business
in place of TSR performance.

– There is no change in 2019 to the criteria and weightings applying

to Restricted Shares.

– UK executive directors will receive Performance Shares only.

The US executive director will receive an equal weight in expected
value in Performance Shares and Restricted Shares.

Illustration of application of policy for 2019
The following charts show the value of the package each
of the executive directors would receive based on 2019 base
salaries, remuneration and 2019 LTI awards assuming the
following scenarios:
1. minimum fixed pay (including salary, benefits and
pension as provided in the single total figure table
on page 105), and the Restricted Shares award for
the US executive director;

2. pay receivable assuming on-target performance is met;
3. maximum pay assuming all variable elements pay out

in full; and

4. 50% share price appreciation on maximum pay out.

The minimum, on-target and maximum scenarios exclude
any share price appreciation and dividends. 50% share price
appreciation assumes all variable elements pay out in full
and there is 50% gain in share price in respect of
Performance Shares and Restricted Shares awards received.

UK legislation requires that these charts are given in relation
to the first year in which the remuneration policy takes legal
effect (see page 125). The charts below are reporting the
actual levels for 2019.

Chief Executive (£’000)
50% share price
appreciation

13% 25%

62%

Maximum

17%

31%

On-target

Minimum

33%

100%

37%

30%
1,118
2,000

52%
3,429

8,290

6,589

8,000
6,000
4,000
Value of package (£’000)

10,000

12,000

Group Finance Director (£’000)
50% share price
appreciation

60%

19%

21%

Maximum

On-target

26%

46%

Minimum

100%

24%

50%

2,496

33%

21%
1,143

5,501

4,399

1,000

4,000
3,000
2,000
Value of package (£’000)

5,000

6,000

President and Chief Executive Officer
of BAE Systems, Inc. ($’000)
50% share price
appreciation

45%

33%

22%

Maximum

On-target

33%

54%

Minimum

100%

2,000

29%

38%
5,196

23%

23%
2,774
8,000
6,000
4,000
Value of package ($’000)

10,842

8,422

10,000

12,000

116

Fixed elements of remuneration
Annual bonus
Performance Shares

BAE SystemsAnnual Report 2018Directors’
remuneration policy

This Directors’ remuneration policy (the Policy) will take legal effect from the conclusion of the 2017 Annual General
Meeting (AGM) subject to shareholder approval at the 2017 AGM1.

The Remuneration Committee (the Committee) considers remuneration policy annually to ensure that it remains aligned
with business needs and is appropriately positioned relative to the market. However, in the absence of exceptional or
unexpected circumstances which may necessitate a change to the Policy, there is currently no intention to revise the
Policy more frequently than every three years. We use target performance to estimate the total potential reward and
benchmark it against reward packages paid by BAE Systems’ competitors.

The Policy is to set base salary with reference to the relevant market-competitive level. Actual total direct reward reflects
the performance of the individual and the Company as a whole. The aim is to deliver an overall remuneration package for
executive directors which provides an appropriate balance between short-term and long-term reward and between fixed
and variable reward as described in the table below.

Whilst our Long-Term Incentive Plan provides the Committee with discretion in respect of vesting outcomes that affect the
actual level of reward payable to individuals, as explained on page 120, such discretion would only be used in exceptional
circumstances and, if exercised, disclosed at the latest in the report on implementation of the Policy (i.e. the Annual
remuneration report) for the year in question.

Changes compared to the policy approved at the 2014 AGM
The Policy contains no components which were not in the remuneration policy approved at the 2014 AGM. However,
the material changes from the policy approved in 2014 are summarised below with the supporting rationale provided
in the Remuneration Committee Chairman’s letter on pages 79 to 82 of the 2016 Annual Report.

Salary
– Clarity on cap on salary increases.

Annual incentive
– Introduction of separate maximum for Chief Operating Officer.
– Introduction of limits for new executive director role.
– Incorporation of malus and clawback mechanisms.

Long-Term Incentives (LTI)
– Introduction of reasonableness discretion.
– Introduction of separate maximum for Chief Operating Officer.
– Introduction of limits for new executive director role.
– Clarity on flexibility to vary weightings of different award types and the associated impact on opportunity

levels subject to the parameters set out.

– Incorporation of malus and clawback mechanisms.
– Introduction of two-year holding period for shares acquired on vesting of awards to non-US directors.
– Introduction of Earnings per Share (EPS) alongside Total Shareholder Return (TSR) on share options with

equal weighting.

– Removal of Share Options for US executive director and redistribution into Performance Shares and Restricted

Shares to maintain current Expected Value.

– Increase in Minimum Shareholding Requirement for US executive director.

Pension
– Participation in executive defined contribution retirement plan (or cash equivalent) introduced as default pension

vehicle for new directors.

– Inclusion of salary supplement as vehicle to offset impact of Lifetime Allowance and/or Annual Allowance.

Non-executive directors’ fees
– Introduction of maximum for Chairman’s fees and benefits.

1. Approved at the AGM on 10 May 2017.

117

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Executive directors’ policy table

Base salary

Purpose and link to strategy
Recognise market value of role and individual’s skills, experience and performance to ensure the business can attract
and retain talent.

Operation
Salaries are reviewed annually. Business and individual performance, skills, the scope of the role and the individual’s time in the role are
taken into account when setting and assessing salaries, as is market data for similar roles in the relevant market comparator group.

The comparator group for UK executive directors is comprised of selected companies from the FTSE 100 and is constructed to position
BAE Systems around the median in terms of market capitalisation. For the President and Chief Executive Officer of BAE Systems, Inc.,
the comparator group is drawn from companies in the US aerospace and defence sectors, together with similar organisations in the
general industry sector where BAE Systems, Inc. is positioned at the median of the comparator group by reference to revenue size.

Maximum opportunity
When considering salary increases for the executive directors in their current roles, the Committee considers the general level of
salary increase across the Group and in the relevant external market.

Actual increases for the executive directors in their current roles will generally not exceed the average percentage increase for
employees as a whole, taking account of the level of movement within the relevant UK/US comparator group.

As a maximum, in exceptional circumstances (such as a material increase in job size or complexity while performing the same role,
or a recently appointed executive director where the salary is positioned low against the market), the increase will not exceed 10%
in any single year for executive directors performing the same role. If an individual’s role changes then a salary increase above 10%
may be awarded in any single year to position their salary appropriately in accordance with the base salary principles described under
‘Operation’ above. As a matter of policy, no new executive director role will have a salary greater than the Chief Executive at that time.

Performance metrics used, weighting and time period applicable
None.

Annual incentive

Purpose and link to strategy
Drive and reward annual performance of individuals and teams on both financial and non-financial metrics, including
leadership behaviours in order to deliver sustainable growth in shareholder value.

Compulsory deferral into shares increases alignment with shareholder interests.

Operation
The annual incentive is driven off in-year financial performance, corporate responsibility and other non-financial objectives
measured at the Group and individual level.

One-third of the total annual incentive amount is subject to compulsory deferral for three years in BAE Systems shares without
any matching.

A malus mechanism may be applied to any bonus, and a clawback mechanism may be applied to the deferred bonus shares until
up to the end of the three-year deferral period, in respect of 2015 or subsequent years where:
– the Company is entitled to terminate employment for cause or the participant has engaged in misconduct (including breach

of policy) which gives rise to other disciplinary sanction;

– the results of the Company and/or relevant business or businesses for any period have been restated or subsequently appear

materially inaccurate or misleading; and/or

– any Group company or business unit has made a material financial loss.
Cash dividends are payable to the participants on the shares during this three-year deferral period.

118

BAE SystemsAnnual Report 2018Annual incentive continued

Maximum opportunity
Chief Executive and the President and Chief Executive Officer of BAE Systems, Inc.: 225% of salary

Chief Operating Officer: 200% of salary

Group Finance Director: 160% of salary

Where a new executive director role is established, the maximum opportunity will not exceed that of the Chief Operating Officer
role as set out above.

The pay-out for maximum performance is double the payout for on-target performance. The pay-out for target performance is half
of the respective maximum percentages above. The pay-out for achieving a threshold performance is 40% of the payout for on-target
performance (i.e. 20% of maximum), with no pay-out for achieving less than this. Pay-out for performance between targets is calculated
on a straight-line basis.

Performance metrics used, weighting and time period applicable
Performance is assessed on an annual basis, using a combination of the Group’s main performance indicators for the year and other
objectives designed to support the Group’s strategy. Metrics, which will include financial and non-financial metrics as well as the
achievement of personal objectives, will be determined and weighted each year according to business priorities. 75-80% will relate
to financial metrics.

Metrics and weightings to be determined annually. Proposed metrics and weightings applicable in 2017:
Group EPS – 40%
Group cash – 25%
Order intake – 15%
Safety – 5%
Personal objectives designed to support the Group’s strategy – 15%

See notes 4 and 5 on page 124 regarding the selection and weighting of performance metrics.

Notwithstanding performance against the applicable metrics, all bonus payments are at the discretion of the Committee, which will
be based on an assessment of the individual’s personal contribution to business performance over the relevant year and leadership
behaviours demonstrated in making that contribution, relative to others.

Long-Term Incentives (LTI)

Operation
Long-term incentives will operate under the BAE Systems Long-Term Incentive Plan approved by shareholders at the 2014 AGM.

The size of awards granted is based on a percentage of salary, which is divided by the share price to determine the number of
shares subject to the award.

Dividend equivalents in respect of vested shares may be paid at the time of vesting (or exercise, in the case of options) and are
not taken into account when determining individual limits.

A malus and clawback mechanism may be applied, until two years after vesting, or if sooner, the fifth anniversary of grant, or
the occurrence of certain corporate events, to all awards granted on or after 25 March 2015 where:
– the Company is entitled to terminate employment for cause or the participant has engaged in misconduct (including breach

of policy) which gives rise to other disciplinary sanction;

– the results of the Company and/or relevant business or businesses for any period have been restated or subsequently appear

materially inaccurate or misleading;

– any Group company or business unit has made a material financial loss; and/or
– the measurement of any performance condition does not reflect the actual performance of the Company over the

performance period.

The Committee will establish the targets for each measure at the start of each performance period based on Group projections and
market expectations for the business. The performance conditions for previous awards are described in the Annual remuneration report.

Awards and performance conditions can be adjusted to take account of variations of share capital and other transactions or events.

On a change of control or similar transaction, awards generally will vest to the extent performance conditions are then satisfied
(if applicable) and then be pro-rated to reflect the acceleration of vesting unless the Committee decides otherwise. Alternatively,
awards may be exchanged for equivalent awards over shares in the acquiring company.

The share plan rules may be amended from time-to-time by the Committee in certain circumstances including minor changes
for administrative, tax or other regulatory purposes.

Subject to this Policy, performance conditions of awards already granted may be amended in accordance with their terms or if
anything happens which causes the Committee reasonably to consider it appropriate to do so.

Performance metrics used, weighting and time period applicable
See notes 4 and 5 on page 124 regarding the selection and weighting of performance metrics.

119

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Executive directors’ policy table continued

Long-Term Incentives (LTI) continued

Maximum opportunity
Over the lifetime of this Policy, the Committee will have discretion to vary the weighting of different types of awards within the
framework set out below, but the overall LTI Expected Value (EV) will remain the same (assuming the LTI EV is calculated as 50%
of face value for Performance Shares, 20% of face value for Share Options and 100% of face value for Restricted Shares):
– UK executive directors’ awards will consist of a mix of Performance Shares and Share Options (with Share Options comprising

no more than 50% of overall LTI EV).

– US executive directors’ awards will consist of a mix of Performance Shares and Restricted Shares (with Restricted Shares comprising

no more than 50% of overall LTI EV).

Performance metrics used, weighting and time period applicable
See below in relation to Performance Shares and Share Options.

In addition to the primary performance tests set out below, the Committee confirms and recognises its obligation to judge the
overall reasonableness of the rewards received relative to the overall business actions and results achieved. When determining the
final performance condition outcome under Performance Share and Share Option awards, the Committee will have discretion over
the number of awards vesting in light of other important factors in the business (reasonable discretion). The discretion may result in
vesting of awards going upwards (subject to maximum 100% vesting of awards) as well as downwards. Any factors will be properly
considered as they arise and any discretion to the calculated results will be applied in a highly disciplined manner and the rationale
and impact will be reported transparently. The use of reasonableness discretion would apply to LTI awards granted to executive
directors after the commencement of this Policy.

See notes 4 and 5 on page 124.

Long-Term Incentives – Performance Shares

Purpose and link to strategy
Drive and reward delivery of sustained long-term EPS and TSR performance aligned to the interests of shareholders.

Operation
For non-US executive directors, awards, typically in the form of nil-cost options, will vest subject to performance and service conditions
on the fifth anniversary of grant. These will be exercisable between the fifth and tenth anniversary of grant or such shorter period as
may be specified by the Committee.

For US executive directors, awards are delivered as conditional share awards (RSUs). To maintain the competitiveness of the LTI offering
in the US, awards will vest automatically on the third, fourth and fifth anniversary of grant, subject to performance conditions.

Policy maximum opportunity
Award levels applicable to UK executive directors for normal annual grants (assuming the current LTI EV weightings in Performance
Shares and Share Options) are as follows:

Chief Executive: 250% of salary

Chief Operating Officer: 230% of salary

Group Finance Director: 215% of salary

Award levels applicable to US executive directors for normal annual grants (assuming the current LTI EV weightings in Performance
Shares and Restricted Shares) are as follows:

President and Chief Executive Officer of BAE Systems, Inc.: 298% of salary

Note the percentages above could be exceeded if the LTI EV weightings were to be varied (see above).

Where a new executive director role is established, the maximum opportunity will not exceed that of the Chief Operating Officer
role as set out above.

120

BAE SystemsAnnual Report 2018Long-Term Incentives – Performance Shares continued

Performance metrics used, weighting and time period applicable
Metrics and weightings will be as follows (subject to the Committee’s ability to adjust as set out below):
– 50% of award based on TSR relative to one or more appropriate comparator groups over the three-year performance period as

selected by the Committee at the time of grant:

– Vesting of each comparator group is determined as: nil vesting if TSR ranked below median in the peer group; 25% vesting if

TSR ranked at the median; 100% vesting if TSR ranked in the upper quintile; pro-rata vesting for performance between median
and upper quintile.

– If more than one comparator group is used, vesting of the TSR portion of the award will be determined by the average of the

vesting outcomes from each comparator group.

– Award subject to a secondary financial measure as set out on page 112.

– 50% of award based on average annual EPS growth over the three financial years starting with that in which the award is granted,
with 25% vesting for threshold performance, 50% vesting for target performance and 100% vesting for stretch performance.
Pro-rata vesting for intermediate performance.

The metrics and weightings applicable in 2017 are as follows:
– 50% of award based on TSR relative to the following two comparator groups over the three-year performance period:

– At least ten other international defence companies selected by the Committee at the time of grant.
– All companies in the FTSE 100 index.

– 50% of award based on average annual EPS growth over the three financial years starting with that in which the award is granted,
with threshold performance requirement as average annual EPS growth of 3%, target performance requirement as average annual
EPS growth of 5% and stretch performance requirement as average annual EPS growth of 7%.

Note that awards granted to executive directors from the date of the 2017 AGM would be subject to application of reasonableness
discretion in light of other important factors in the business as described earlier.

The Committee can adjust the weighting of the EPS and TSR conditions and, if considered appropriate, the Committee may introduce
an alternate performance condition aligned to the Company’s strategy.

See notes 4 and 5 on page 124.

Long-Term Incentives – Share Options

Purpose and link to strategy
Drive and reward delivery of sustained long-term EPS and TSR performance and sustained improvement in the Company’s
share price.

Operation
Share Options have an exercise price set at market value at grant.

For non-US executive directors, awards vest subject to performance and service conditions on the fifth anniversary of grant and will
be exercisable between the fifth and tenth anniversary of grant.

US executive directors are not eligible.

Policy maximum opportunity
Award levels applicable to UK executive directors for normal annual grants (assuming the current LTI EV weightings in Performance
Shares and Share Options) are as follows:

Chief Executive: 300% of salary

Chief Operating Officer: 300% of salary

Group Finance Director: 300% of salary

Note the percentages above could be exceeded if the LTI EV weightings were to be varied (see page 120).

Where a new executive director role is established, the maximum opportunity will not exceed that of the Chief Operating Officer
role as set out above.

Performance metrics used, weighting and time period applicable
For Share Option awards made to the executive directors, exercise is subject to the TSR and EPS performance conditions (subject to any
adjustment described above) and application of reasonableness discretion as set out above.

Note that for Share Option awards granted to the executive directors prior to the 2017 AGM, exercise is subject to the TSR performance
conditions as set out in our policy approved at the 2014 AGM.

See notes 4 and 5 on page 124.

121

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Executive directors’ policy table continued

Long-Term Incentives – Restricted Shares

Purpose and link to strategy
Provide long-term reward through time-vesting awards principally in the Company’s US market.

Operation
The shares are subject only to the condition that the participant remains employed by the Group on the vesting date (three years
after the award date). These awards are not subject to a performance condition as it is designed to address competitive market
practice and retention issues principally in the US. Non-US executive directors are not eligible.

Policy maximum opportunity
Award levels applicable to US executive directors for normal annual grants (assuming the current LTI EV weightings in Performance
Shares and Restricted Shares) are as follows:

President and Chief Executive Officer of BAE Systems, Inc.: 150% of salary

Performance metrics used, weighting and time period applicable
None.

See notes 4 and 5 on page 124.

Benefits

Purpose and link to strategy
Provide employment benefits which ensure that the overall package is market competitive when these elements are
taken into account.

Operation
Benefits include provision of a company car (or cash equivalent), life assurance and ill-health benefit cover which are provided directly
or through membership of the Company’s pension schemes. The main benefits in the UK include a car allowance (currently £16,000
per annum), private use of a chauffeur-driven car and annual medical screening, plus life assurance and ill-health benefit cover provided
through membership of the Company’s pension schemes.

Opportunity for UK executive directors to participate in the Share Incentive Plan, a tax approved all-employee plan.

In the US, benefits include a cash allowance for car and parking (currently $20,900 per annum) and private use of a chauffeur-driven
car, medical and dental benefits, and insured life and disability benefits.

Additional benefits, such as relocation assistance, may also be provided in certain circumstances if considered reasonable and
appropriate by the Committee. Relocation assistance comprises reimbursement for direct items of expenditure, such as legal,
estate agency, removals and temporary accommodation.

Directors’ and Officers’ insurance cover is also provided for all executive directors.

Maximum opportunity
Benefits are set at a level which the Committee considers to be appropriate against comparable roles in companies of similar size
in the relevant market.

Benefits are as reported and itemised within the single total figure shown as part of the Annual remuneration report on page 99.
The maximum cost of such benefits will reflect the associated market-competitive cost of provision. Relocation assistance is based
on actual costs incurred which are linked to the size and value of the property, plus a maximum relocation allowance of £2,500.

Participation limits for the Share Incentive Plan are those set by the UK tax authorities from time-to-time.

Performance metrics used, weighting and time period applicable
None.

122

BAE SystemsAnnual Report 2018Pension

Purpose and link to strategy
Provide competitive post-retirement benefits or cash allowance equivalent.

Operation
The current Chief Executive1 and Group Finance Director as at 22 February 20172 are members of the BAE Systems Executive Pension
Scheme and members of an underlying employee pension plan, which together provide a target benefit for executive directors
payable at normal retirement age (62) of 1/30th of final pensionable earnings (FPE) for each year of service up to a maximum of
two-thirds of FPE. Member contributions are currently 8% of salary. Further detail is provided on page 107 as part of the Annual
remuneration report.
The current Chief Operating Officer1 as at 22 February 20172 is a member of the defined contribution section of the BAE Systems
Executive Pension Scheme (EPS DCRP). In line with our policy, Company contributions are 19% of salary and member contributions
are 6% of salary. Where the Annual Allowance (AA) is breached, as is the case with the Chief Operating Officer, he will pay member
contributions up to the AA limit and the Company contributions will be paid as a salary supplement.

For any new externally-appointed UK executive directors, or internally appointed UK executive directors who are not members of
a BAE Systems defined benefit scheme, membership of the BAE Systems EPS DCRP is offered with contribution requirements set
as a percentage of base salary dependent on grading. Individuals may elect to receive some or all of their Company contributions as
a cash allowance. For any internally-appointed UK executive directors who are already members of a BAE Systems defined benefit
scheme, the Company may offer to maintain their membership in that pension arrangement (with the contribution rates appropriate
to that arrangement), or the choice of membership of the BAE Systems EPS DCRP as set out above.

Where UK executive directors’ pension entitlement or accrual is restricted to the Lifetime Allowance (LTA) and/or the AA, the
Company may offer an unfunded pension promise or salary supplement to offset the impact of these restrictions.
The current President and Chief Executive Officer of BAE Systems, Inc. as at 22 February 20172 participates in a Section 401(k)
defined contribution arrangement in which the company matches his contributions up to a maximum of 6% of salary, subject
to US regulatory limits.

Any new externally-appointed US executive directors, or internally-appointed US executive directors who are not members of a pension
plan, would be offered membership of the US Section 401(k) defined contribution plan. For any internally-appointed US executive
directors who are members of the 2006 Plan and Non-Qualified Plan, these plans provide a cash sum at retirement equal to the sum
of the annual accruals, currently set at $1,000 from the 2006 Plan and $500 from the Non-Qualified Plan. The Company may offer
to maintain membership of the 2006 Plan and Non-Qualified Plan, in addition to membership of the US Section 401(k) defined
contribution plan.

Maximum opportunity
The BAE Systems EPS DCRP provides a maximum Company contribution of 19% (in addition to employee contribution of 6%)
of base salary.

Under the existing executive defined benefit scheme, a maximum of two-thirds of FPE is accrued at 1/30th for each year of service.

Where UK executive directors’ pension entitlement or accrual is restricted to the LTA and/or the AA, the Company may offer an
unfunded pension promise or salary supplement to offset the impact of these restrictions.

The US Section 401(k) defined contribution plan provides 100% company matching contributions up to a maximum of 6% of base
salary, subject to US statutory limits.

For US executive directors who are members of the 2006 Plan and Non-Qualified Plan, these plans provide a cash sum at retirement
equal to the sum of the annual accruals, currently set at $1,000 from the 2006 Plan and $500 from the Non-Qualified Plan.

1. Ian King, Chief Executive as at 22 February 2017, retired on 30 June 2017. Charles Woodburn, Chief Operating Officer as at 22 February 2017, was

appointed as Chief Executive with effect from 1 July 2017.

2. Date of approval of the Company’s 2016 Annual Report in which this policy was originally published.

123

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Executive directors’ policy table continued

Notes to the executive directors’ policy table

Remuneration policy for other employees
1. The Company’s approach to annual salary reviews is consistent across the Group, with consideration given to the scope of the role,

level of experience, performance and market data for similar roles in other companies.

2. All leaders may participate in an annual bonus scheme with similar metrics to those used for the executive directors. Other employees
may participate in performance-based incentive plans which vary by organisational level and with relevant metrics for the particular
area of the business.

3. LTI grants may be made to the most senior managers in the business (approximately 400 individuals globally). The nature of the

awards depends on the individual’s location, roles and responsibilities, in particular:
– performance conditions and targets for performance share grants made to UK and Rest of World participants are made

in line with those applying to executive directors;

– for US participants below Executive Committee level, performance share grants are normally subject to BAE Systems, Inc.

operating cash flow and EPS performance conditions and targets;

– Performance Shares applicable to participants below executive director level vest on the third anniversary subject to performance
conditions and are exercisable (or released in the case of US participants) in equal tranches on the third, fourth and fifth anniversary
of grant;

– Share Options are granted to participants below executive director level; there are no performance conditions attached and they

vest and are exercisable after three years; and

– Restricted Share grants are currently made to the most senior managers in the US businesses reflecting competitive market practice

and vest after three years.

Performance measures and targets
4. The Committee selected the performance conditions because these are central to the Company’s overall strategy and are the

key metrics used by the executive directors to oversee the operation of the business. Any non-financial performance targets are
determined by the Committee in consultation with the Corporate Responsibility Committee.

5. The performance conditions and targets are determined annually by the Committee (within the parameters set out above), taking
account of the Group’s strategic objectives, the internal business plan and budgets, as well as external market expectations and
general economic conditions. The Committee is of the view that the performance targets for the annual bonus are commercially
sensitive and that it would be detrimental to the interests of the Company to disclose them before the start of the financial year.
The targets will be disclosed retrospectively after the end of the relevant financial year.

Minimum Shareholding Requirement (MSR)
6. The Committee has agreed a policy whereby the executive directors are required to establish and maintain a minimum personal

shareholding equal to a set percentage of base salary. An Initial Value must be achieved as quickly as possible using shares vesting or
options exercised through the executive share option schemes and other LTI schemes by retaining 50% of the net value (i.e. the value
after deduction of exercise costs and tax) of shares acquired under these schemes. Once the Initial Value is achieved, a Subsequent
Value must be achieved in the same way, except that a minimum of 25% of the net value must be retained on each exercise or
acquisition. The Committee has discretion to increase the Initial Value and/or Subsequent Value (see below). Shares owned beneficially
by the director and his/her spouse count towards the MSR. The MSR does not apply after the individual has ceased to be a director.
Any case of non-compliance would be dealt with by the Committee.

The following table sets out MSR Initial Value and Subsequent Value applicable from 2018:

Initial Value

Subsequent Value

Chief Executive

Chief Operating Officer

Group Finance Director

President and Chief Executive Officer of BAE Systems, Inc.

150%

100%

212.5%

300%

200%

425%

124

BAE SystemsAnnual Report 2018Illustration of application of remuneration policy
The charts below show the value of the package each of the executive directors would receive in the first year of operation of the
Policy. The values are based on 2017 levels for base salaries, benefits and pension and assume that the office-holders at the date of this
Policy coming into effect are employed throughout the first year of operation of the Policy. Annual and long-term incentives are based
on awards applying in 2018. The charts assume the following scenarios: minimum fixed pay (including salary, benefits and pension
as provided in the single figure table on page 85 of the 2016 Annual Report); pay receivable assuming on-target performance is met;
and maximum pay assuming variable elements pay out in full. The scenarios below exclude any share price appreciation and dividends.

Chief Executive1 (£’000)

Chief Executive designate1 (£’000)

Maximum

23%

32%

On-target

42%

Minimum

100%

28%
1,643
2,000

45%
3,945

30%

4,000
Value of package (£’000)

6,000

7,045

Maximum

18%

34%

On-target

34%

Minimum

100%

34%

32%
1,068

48%
3,119

5,881

8,000

2,000
4,000
Value of package (£’000)

6,000

Chief Operating Officer1 (£’000)

Maximum

19%

32%

On-target

36%

Minimum

100%

30%
919

34%

49%
2,527

4,707

2,000
4,000
Value of package (£’000)

6,000

Executive directorship changes
As announced on 22 February 2017, Ian King will retire as Chief
Executive on 30 June 2017 and Charles Woodburn, Chief Operating
Officer, will be appointed as Chief Executive on 1 July 20171. The
left-hand chart above illustrates Ian King’s remuneration if he were
Chief Executive throughout the year, and the right hand chart above
illustrates Charles Woodburn’s remuneration if he were Chief Executive
throughout the year. The chart to the left illustrates Charles Woodburn’s
remuneration if he were Chief Operating Officer throughout the year.

Group Finance Director (£’000)

Maximum

28%

26%

46%

On-target

48%

Minimum

100%

30%

22%
1,025

2,129

1,000

2,000
Value of package (£’000)

3,000

President and Chief Executive Officer
of BAE Systems, Inc. ($’000)

Maximum

33%

On-target

52%

Minimum

100%

29%

24%
2,605

24%

38%
4,907

2,000

4,000
Value of package ($’000)

6,000

3,658

4,000

7,976

8,000

Fixed elements of remuneration
Annual bonus
Performance Shares and Share Options

1. Ian King, Chief Executive as at 22 February 2017, retired on 30 June 2017.
Charles Woodburn, Chief Operating Officer as at 22 February 2017, was
appointed as Chief Executive with effect from 1 July 2017.

125

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Non-executive directors’ (NEDs) policy table

Fees

Purpose and link to strategy
To attract NEDs who have a broad range of experience and skills to provide independent judgement on issues of strategy,
performance, resources and standards of conduct.

Operation
NEDs’ fees are set by the Non-Executive Directors’ Fees Committee.

NEDs receive a basic fee with an additional fee for those who are chairmen of committees and/or undertake the role of Senior
Independent Director.

NEDs also receive a travel allowance per meeting on each occasion that a scheduled Board meeting necessitates air travel of more
than five hours (one way) to the meeting location, subject to a maximum of six travel allowances per year.

Fees are typically reviewed annually, taking into account time commitment requirements and responsibility of the individual roles,
and after reviewing practice in other comparable companies.

The Chairman’s fees are set by the Remuneration Committee on a three-year basis and not normally subject to review during
that period.

Maximum opportunity
Actual fee levels are disclosed in the Annual remuneration report for the relevant financial year.

The current Chairman’s fee has been set at £700,000 from 1 February 2017 and is fixed at this level for three years.

The aggregate cost of fees and benefits paid to NEDs (including the Chairman) will not exceed an annual limit of £2.5m and the cost
of fees and benefits paid to the Chairman will not exceed £1.25m annually.

Performance metrics used, weighting and time period applicable
None.

Benefits

Purpose and link to strategy
Reimbursement for reasonable and documented expenses incurred in the performance of duties.

Operation
NEDs are not eligible to participate in any pension benefits provided by the Company, nor do they participate in any performance-
related incentives.

The Chairman is provided with a chauffeur-driven car. This may be used for non-Company business, but the cost of the benefit
of such usage shall be paid by the Chairman.

Reimbursement of travel and subsistence costs (including payment of the associated tax cost) incurred by the director or his/her
spouse whilst undertaking duties on behalf of the Company that may be assessed as a benefit for tax purposes. Directors’ and
Officers’ insurance cover is also provided for all directors.

Maximum opportunity
See the aggregate limit under ‘Fees’ above.

Prior commitments
For the duration of this Policy, the Company will honour any commitments made in respect of executive director and non-executive
director remuneration and benefits before the date on which either: (i) the Directors’ remuneration policy becomes effective; or (ii) an
individual becomes a director, even where such commitments are not consistent with the policy set out in this report or prevailing at
the time any such commitment is fulfilled. This includes (without limitation) all existing share awards as detailed on page 102 of the
2013 Annual Report under the PSP, SMP, RSP, ExSOP and ExSOP2012 that remain outstanding, Peter Lynas’ second residence allowance
as detailed on page 93 of the 2013 Annual Report, and any commitments entered into (such as grants of share awards) consistent with
a previously approved Directors’ remuneration policy that was applicable at the relevant time.

126

BAE SystemsAnnual Report 2018Approach to recruitment remuneration
The recruitment policy provides an appropriate framework within which to attract individuals of the required calibre to lead a company
of BAE Systems’ size, scale and complexity. The Remuneration Committee determines the remuneration package for any appointment
to an executive director position, either from within or outside BAE Systems.

Operation
The Remuneration Committee will take into consideration all relevant factors, including overall total remuneration, the type of
remuneration being offered and the jurisdiction from which the candidate was recruited, and will operate in order to ensure that
arrangements are in the best interests of the Company and its shareholders without paying more than is necessary to secure the
individual of the required calibre.

The fees and benefits applicable to the appointment of any new non-executive directors will be in accordance with the policy table
on page 126.

Opportunity
The Committee seeks to align the remuneration package offered with the policy set out in the executive directors’ policy table above
recognising that participation under the policy above varies by geography.
– For UK and other non-US executive director appointments, participation in annual incentive plans will not exceed 225% of annual

salary and long-term awards under this Policy will not exceed 550% of annual salary.

– For US executive director appointments, participation in annual incentive plans will not exceed 225% of annual salary and long-term

awards under this Policy will not exceed 500% of annual salary.

The Committee may make awards on hiring an external candidate to ‘buy-out’ existing equity or, in exceptional circumstances, other
elements of remuneration forfeited on leaving the previous employer. In doing so, the Committee will take account of relevant factors
including any performance conditions attached to these awards, the form in which they were granted (e.g. cash or shares) and the
time over which they would have vested. Buy-out awards would be capped to be no higher, on recruitment, than the fair value of
those forfeited. Full details will be disclosed in the next Annual remuneration report following recruitment which will include details
of the need to grant a buy-out award.

Fixed elements (base salary, retirement and other benefits)
The salary level will be set in accordance with the principles for setting base salary described in the executive directors’ policy
table above.

The executive director shall be eligible to participate in applicable BAE Systems’ employee benefit plans, including coverage under
applicable executive and employee pension and benefit programmes in accordance with the terms and conditions of such plans, as
may be amended by the Company in its sole discretion from time to time.

In the case of promotion of an existing Group employee to an executive directorship on the Board, commitments made before such
promotion will continue to be honoured whether or not they are consistent with the remainder of this Policy.

Annual Incentive Plan
The appointed executive director will be eligible to earn a discretionary annual bonus in accordance with the annual incentive
framework as described in the executive directors’ policy table above.

The level of opportunity will be consistent with the policy disclosed in the executive directors’ policy table in this report and subject
to the maximums referred to therein and under ‘Opportunity’ above.

Long-Term Incentive Plan
The executive director will be eligible for equity awards in such amounts as the Committee may determine in its sole discretion,
subject to this Policy and the rules of the Long-Term Incentive Plan.

The level of opportunity will be consistent with the policy set out in the executive directors’ policy table above and subject to the
maximums referred to therein and under ‘Opportunity’ above.

Other
For internal and external appointments, the Committee may agree that the Company will meet certain relocation expenses in
accordance with the provisions described under the Benefits section of the policy table on page 122.

127

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsDirectors’ remuneration policy
continued

Service contracts and letters of appointment

Executive directors

Operation
In accordance with long-established policy, all executive directors have rolling service agreements which may be terminated in
accordance with the terms of these agreements.

Dates of appointment for executive directors
Name

Date of appointment

Ian King1

Charles Woodburn2

Peter Lynas

Jerry DeMuro

1 September 2008

1 July 2017

1 April 2011

1 February 2014

Notice period

12 months either party

90 days either party3

1. Retired on 30 June 2017.
2. Appointed to the Board as Chief Operating Officer on 9 May 2016; appointed as Chief Executive with effect from 1 July 2017.
3. Jerry DeMuro’s contract of employment automatically renews for one-year periods from 31 December each year, unless one party gives at least

90 days’ notice of non-renewal.

Notice period
The Committee’s policy is that the service contracts of executive directors will not exceed 12 months. In exceptional circumstances, in
relation to newly recruiting an executive director operating in a US environment, the notice period may be extended to a maximum of
24 months and structured such that it reduces to no more than 12 months by no later than the end of the first complete year of service.

Change of control
No executive director has provisions in his service contract that relate to a change of control of the Company.

Chairman
The Chairman’s appointment is documented in a letter of appointment and he is required to devote no fewer than two days a week
to his duties as Chairman. His appointment as Chairman (which commenced on 1 February 2014) will automatically terminate if he
ceases to be a director of the Company. The Chairman’s appointment was reviewed by the Nominations Committee prior to the end
of his initial three-year term and has been extended until February 2020, unless it is terminated earlier in accordance with the Company’s
Articles of Association or by the Company or the Chairman giving not less than six months’ notice.

Non-executive directors
The non-executive directors do not have service contracts but do have letters of appointment detailing the basis of their appointment.
The dates of their original appointment are shown below:
Name

Date of appointment

Expiry of current term

Revathi Advaithi1

Elizabeth Corley

Harriet Green

Chris Grigg

Paula Rosput Reynolds

Nick Rose

Ian Tyler

01.01.2018

01.02.2016

01.11.2010

01.07.2013

01.04.2011

08.02.2010

08.05.2013

31.12.2020

01.02.2022

31.10.2019

30.06.2022

31.03.2020

31.12.2019

07.05.2022

1. Appointed to the Board on 1 January 2018.

The non-executive directors are normally appointed for an initial three-year term that, subject to review, may be extended subsequently
for further such terms. Any third term of three years is subject to rigorous review, taking into account the need progressively to refresh
the Board. Non-executive directors do not have periods of notice.

In accordance with the UK Corporate Governance Code, all directors are subject to annual election or re-election at the Company’s AGM.

Policy on payment for loss of office

Operation
The policy on payment for loss of office provides a clear set of principles that govern the payments that will be made for loss of office,
and take account of the need to ensure a smooth transition for leadership roles during times of change. The policy that will apply for
a specific executive director’s payments for loss of office will be the policy that was in place at the point when the payments for loss
of office were agreed for the executive director in question.

Any termination payment made in connection with the departure of an executive director will be subject to approval by the
Committee, having regard to the terms of the service contract or other legal obligations and the specific circumstances surrounding
the termination, including whether the scenario aligns to an example under the approved leaver criteria, performance, service and
health or other circumstances that may be relevant.

In addition to payments described below, the Committee may pay such amounts as are necessary to settle or compromise any claim
or by way of damages, where the Committee views it as in the best interests of the Company to do so. In the event of the termination
of an executive director’s contract, it is the Committee’s policy to seek to limit any payment to not more than one year’s base salary.

128

BAE SystemsAnnual Report 2018Notice and pay in lieu of notice
Executive directors’ contracts allow for termination with contractual notice from either party or termination by way of payment of base
salary in lieu of notice, at the Company’s discretion. Neither notice nor a payment in lieu of notice will be given in the event of gross
misconduct. Any new executive director contracts since 2016 (including the Chief Operating Officer) concerning payment in lieu of
notice provisions allow for the Committee to exercise discretion to apply phased payments and mitigation on that executive director
securing alternative employment.

Jerry DeMuro’s contract of employment automatically renews for one-year periods from 31 December each year, unless one party
gives at least 90 days’ notice of non-renewal. If the employment is (a) terminated by the Company (other than for cause as defined
in the contract) or (b) he resigned for a ‘Good Reason’ (as defined in his contract), he is entitled to a termination payment equal to
(i) one year’s base salary and (ii) a bonus payable at target level pro-rated for service for the relevant financial year. He will also be
entitled to a continuation of medical benefits for 18 months (or a cash payment in lieu).

Other than notice payments, the Company has no obligation to make any termination payments when the Chairman’s appointment
terminates. Non-executive directors do not have periods of notice and the Company has no obligation to make any termination
payments when their appointment terminates, other than to pay fees in accordance with the appointment letters.

Retirement benefits
As governed by the rules of the relevant pension plan. No enhancement for leavers will be made.

Annual Incentive Plan
Where an executive director’s employment is terminated after the end of a performance year but before the payment is made, the
executive director will remain eligible for an annual incentive award for that performance year subject to an assessment based on
performance achieved over the period. No award will be made in the event of gross misconduct.

The Committee may, as set out below, exercise its discretion to allow an annual incentive payment for the year of cessation as part
of the termination package for executive directors. Where it does so, the exercise of the discretion and reason why the Committee
considered such action appropriate will be disclosed.

Where an executive director leaves during the relevant performance year by reason of death, ill-health, disability, retirement, a transfer
of business or redundancy, the Committee may use its discretion to determine that an executive director will remain entitled to receive
a bonus (subject to an assessment based on performance over the performance year and pro-rated for time) in respect of the financial
year in which the individual ceased employment. One third of the bonus will be subject to compulsory deferral as set out previously,
unless the Committee decides otherwise.

The Committee’s policy is not to award an annual incentive for any portion of the notice period not served.

The treatment set out above does not apply to the President and Chief Executive Officer of BAE Systems, Inc.

Long-Term Incentive Plans
The treatment of outstanding share awards in the event that an executive director leaves is governed by the relevant share plan rules.

Under the Long-Term Incentive Plan, where an executive director leaves the Group by reason of ill-health, injury, disability, retirement
with the agreement of the Company, sale of a business or employing company, redundancy or leaving in such circumstances as the
Committee determines (each an ‘approved leaver’), unvested awards and options generally continue and vest on the normal vesting
date (or, in the case of Performance Shares held by US executive directors, the first normal vesting date or, if later, cessation), unless
the Committee determines that the awards should vest on cessation. Any performance conditions will be applied at the time of vesting.

On vesting, the number of shares under award will, unless the Committee decides otherwise, be reduced pro-rata to reflect the
period in which the executive director was in employment as a proportion of the relevant vesting period (or in the case of Performance
Shares held by US executive directors or Performance Shares granted prior to the 2017 AGM, as a proportion of the initial three-year
vesting period).

In the event of death, awards generally vest at the time of death subject to the satisfaction of any performance conditions at that time.
Awards are then pro-rated as set out above.

Where an executive director’s employment is terminated for any other reason, his unvested awards and options will lapse. Options
normally remain exercisable for six months after cessation (or vesting, if later) and 12 months after death.

If the Committee exercises its discretion to treat a director as an approved leaver as permissible under the leaver provisions of the share
plan rules, the exercise of the discretion and reason why the Committee considered such action appropriate will be disclosed.

Where an executive director’s employment is terminated or an executive director is under notice of termination for any reason at the
date of award of any Long-Term Incentive awards, no Long-Term Incentive awards will be made.

Consideration of employment conditions elsewhere in the Company
The Committee does not consult directly with employees as part of the process for reviewing executive pay. When considering
salary increases for the executive directors, the Committee considers the general level of salary increase across the Group and
in the external market.

Stakeholder considerations
The Committee conducts an annual programme of consultation with major shareholders in order to seek their input to the
development of remuneration policy or plans.

129

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsStatutory and other
information

Company registration
BAE Systems plc is a public company limited
by shares registered in England and Wales
with the registered number 1470151.

Directors
The current directors who served during
the 2018 financial year are listed on pages
78 and 79. Revathi Advaithi was appointed
to the Board on 1 January 2018.

The Board has agreed to appoint Nicole
Piasecki and Stephen Pearce as non-executive
directors with effect from 1 June 2019.

Dividend
An interim dividend of 9.0p per share was
paid on 30 November 2018. The directors
propose a final dividend of 13.2p per ordinary
share. Subject to shareholder approval, the
final dividend will be paid on 3 June 2019
to shareholders on the share register on
23 April 2019. Information on dividend
waivers is given on page 190.

Annual General Meeting (AGM)
The Company’s AGM will be held on
9 May 2019. The Notice of Annual General
Meeting is enclosed with this Annual Report
and details the resolutions to be proposed
at the meeting.

Office of Fair Trading undertakings
As a consequence of the merger between
British Aerospace and the former Marconi
Electronic Systems businesses in 1999, the
Company gave certain undertakings to the
Secretary of State for Trade and Industry
(now the Secretary of State for Business,
Energy and Industrial Strategy). In February
2007, the Company was released from the
majority of these undertakings and the
remainder have been superseded and varied
by a new set of undertakings. Compliance
with the undertakings is monitored by a
compliance officer. Further information
regarding the undertakings and the contact
details of the compliance officer may be
obtained through the Company Secretary
at the Company’s registered office or
through the Company’s website.

Profit forecast
In its half-year results announcement
on 1 August 2018, the Group made the
following statement, which is regarded
as a profit forecast for the purposes of the
Financial Conduct Authority’s Listing Rule
9.2.18 (and which amended the profit
forecast made in the Group’s full-year results
announcement on 22 February 2018 and
in the Annual Report 2017):

Certain information in the Strategic report
The following items are set out in the Strategic
report on pages 1 to 71:

– disclosures in relation to the use of financial

instruments;

“In aggregate, we expect the Group’s
underlying earnings per share for 2018
to be in line with the full-year underlying
earnings per share for 2017, with some small
additional benefit from exchange translation.*

– particulars of important events affecting
the Group which have occurred since
31 December 2018;

– an indication of likely future developments

in the business of the Group;

– an indication of the activities of the Group
in the field of research and development;

– actions taken to introduce, maintain
or develop arrangements aimed at
employees; and

– greenhouse gas emissions.

*Compared with the Group’s actual
performance for 2017 as re-presented
to reflect the impact of the adoption of
IFRS 15 from 43.5p to 42.1p and assuming
a US$1.35 to sterling exchange rate.”

Underlying earnings per share was 42.9p
in 2018.

Employees
The Group is committed to giving full and
fair consideration to applications for
employment from disabled people who
meet the requirements for roles, and
making available training opportunities and
appropriate accommodation to disabled
people employed by the Group.

Political donations
No political donations were made in 2018.

Issued share capital
As at 31 December 2018, BAE Systems’
issued share capital of £86,686,002 comprised
3,467,440,044 ordinary shares of 2.5p each
and one Special Share of £1.

Treasury shares
As at 1 January 2018, the number of shares
held in treasury totalled 281,232,739 (having
a total nominal value of £7,030,818 and
representing 8.1% of the Company’s called up
share capital at 1 January 2018). During 2018,
the Company used 9,582,602 treasury shares
(having a total nominal value of £239,565 and
representing 0.3% of the Company’s called up
share capital at 31 December 2018) to satisfy
awards under the Free and Matching elements
of the Share Incentive Plan (5,739,686 shares
in aggregate), awards under the Free and
Matching elements of the International Share
Incentive Plan (763,754 shares in aggregate),
awards vested under the Performance Share
Plan and Performance Shares element of the
Long-Term Incentive Plan (1,098,521 shares),
awards vested under the Restricted Shares
element of the Long-Term Incentive Plan
(1,123,760 shares), and options exercised
under the Executive Share Option Plan
(856,881 shares). The treasury shares utilised
in respect of the Share Incentive Plan, the
International Share Incentive Plan, and the
Performance Share Plan and the Performance
and Restricted Shares elements of the
Long-Term Incentive Plan were disposed
of by the Company for nil consideration.
The 856,881 shares disposed of by the
Company in respect of the Executive Share
Option Plan were disposed of by the Company
for an aggregate consideration of £3,735,882.
As at 31 December 2018, the number of
shares held in treasury totalled 271,650,137
(having a total nominal value of £6,791,253
and representing 7.8% of the Company’s
called up share capital at 31 December 2018).

The rights to treasury shares are restricted
in accordance with the Companies Act and,
in particular, the voting and dividend rights
attaching to these shares are automatically
suspended.

130

BAE SystemsAnnual Report 2018Rights and obligations of ordinary shares
On a show of hands at a general meeting
every holder of ordinary shares present in
person and entitled to vote shall have one
vote, and every proxy entitled to vote shall
have one vote (unless the proxy is appointed
by more than one member in which case the
proxy has one vote for and one vote against
if the proxy has been instructed by one or
more members to vote for the resolution and
by one or more members to vote against the
resolution; or if the proxy has been instructed
by one or more shareholders to vote either
for or against a resolution and by one or more
of those shareholders to use his discretion
how to vote). On a poll, every member present
in person or by proxy and entitled to vote shall
have one vote for every ordinary share held.
Subject to the relevant statutory provisions
and the Company’s Articles of Association,
holders of ordinary shares are entitled to a
dividend where declared or paid out of
profits available for such purposes. Subject
to the relevant statutory provisions and the
Company’s Articles of Association, on a
return of capital on a winding-up, holders of
ordinary shares are entitled, after repayment
of the £1 Special Share, to participate in such
a return. There are no redemption rights in
relation to the ordinary shares.

Rights and obligations of the Special Share
The Special Share is held on behalf of the
Secretary of State for Business, Energy and
Industrial Strategy (the ‘Special Shareholder’).
Certain provisions of the Company’s Articles
of Association cannot be amended without
the consent of the Special Shareholder. These
provisions include the requirement that no
foreign person, or foreign persons acting in
concert, can have more than a 15% voting
interest in the Company, the requirement that
the majority of the directors are British, and
the requirement that the Chief Executive and
any executive Chairman are British.

The holder of the Special Share is entitled to
attend a general meeting, but the Special Share
carries no right to vote or any other rights
at any such meeting, other than to speak
in relation to any business in respect of the
Special Share. Subject to the relevant statutory
provisions and the Company’s Articles of
Association, on a return of capital on a
winding-up, the holder of the Special Share
shall be entitled to repayment of the £1 capital
paid up on the Special Share in priority to any
repayment of capital to any other members.

The holder of the Special Share has the
right to require the Company to redeem the
Special Share at par or convert the Special
Share into one ordinary share at any time.

Restrictions on transfer of securities
The restrictions on the transfer of shares in
the Company are as follows:

– the Special Share may only be issued to,
held by and transferred to the Special
Shareholder or his successor or nominee;

– the directors shall not register any allotment
or transfer of any shares to a foreign person,
or foreign persons acting in concert, who
at the time have more than a 15% voting
interest in the Company, or who would,
following such allotment or transfer, have
such an interest;

– the directors shall not register any person
as a holder of any shares unless they have
received: (i) a declaration stating that upon
registration, the share(s) will not be held by
foreign persons or that upon registration
the share(s) will be held by a foreign person
or persons; (ii) such evidence (if any) as
the directors may require of the authority
of the signatory of the declaration; and
(iii) such evidence or information (if any) as
to the matters referred to in the declaration
as the directors consider appropriate;

– awards of shares made under the Company’s
Long-Term Incentive Plan 2014, Deferred
Bonus Plan, Performance Share Plan, Share
Incentive Plan, International Share Incentive
Plan, Group All-Employee Free Shares Plan
and International Profit Sharing Scheme are
subject to restrictions on the transfer of
shares prior to vesting and/or release.

The Company is not aware of any
arrangements between its shareholders
that may result in restrictions on the transfer
of shares and/or voting rights.

Significant direct and indirect holders
of securities
As at 31 December 2018 (and unchanged as
at 20 February 2019), the Company had been
advised of the following significant direct and
indirect interests in the issued ordinary share
capital of the Company:

Name of shareholder

AXA S.A. and its group of companies

Barclays PLC

BlackRock, Inc.

– the directors may, in their absolute

discretion, refuse to register any transfer
of shares which are not fully paid up
(but not so as to prevent dealings in listed
shares from taking place);

The Capital Group Companies, Inc.

Franklin Resources Inc., and affiliates

Invesco Limited

Silchester International Investors LLP

Percentage
notified

5.00%

3.98%

5.00%

9.94%

4.92%

4.97%

3.01%

Exercise of rights of shares in employee
share schemes
The trustees of the employee trusts do not
seek to exercise voting rights on shares held
in the employee trusts other than on the
direction of the underlying beneficiaries.
No voting rights are exercised in relation to
shares unallocated to individual beneficiaries.

Restrictions on voting deadlines
The notice of any general meeting shall specify
the deadline for exercising voting rights and
appointing a proxy or proxies to vote in
relation to resolutions to be proposed at the
general meeting. The number of proxy votes
for, against or withheld in respect of each
resolution are publicised on the Company’s
website after the meeting.

– the directors may also refuse to register any
instrument of transfer of shares unless the
instrument of transfer is in respect of only
one class of share and it is lodged at the
place where the register of members is kept,
accompanied by a relevant certificate or
such other evidence as the directors may
reasonably require to show the right of the
transferor to make the transfer;

– the directors may refuse to register an

allotment or transfer of shares in favour
of more than four persons jointly;

– where a shareholder has failed to provide
the Company with certain information
relating to their interest in shares, the
directors can, in certain circumstances,
refuse to register a transfer of such shares;

– certain restrictions may from time to time
be imposed by laws and regulations (for
example, insider trading laws);

– restrictions may be imposed pursuant to
the Listing Rules of the Financial Conduct
Authority whereby certain of the Group’s
employees require the Company’s approval
to deal in shares; and

131

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsStatutory and other information
continued

Appointment and replacement of directors
Subject to certain nationality requirements
mentioned below, the Company may by
ordinary resolution appoint any person to
be a director.

The directors also have the power to make
appointments to the Board at any time.
Any individual so appointed will hold office
until the next AGM and shall then be eligible
for re-election.

The majority of directors holding office must
be British. Otherwise, the directors who are
not British shall vacate office in such order
that those who have been in office for the
shortest period since their appointment shall
vacate their office first, unless all of the
directors otherwise agree among themselves.
Any director who holds the office of either
Chairman (in an executive capacity) or Chief
Executive shall also be British.

The Company must have not less than six
directors holding office at all times. If the
number is reduced to below six, then such
number of persons shall be appointed as
directors as soon as is reasonably practicable
to reinstate the number of directors to six.
The Company may by ordinary resolution
from time to time vary the minimum number
of directors.

At each AGM of the Company, any director
who was elected or last re-elected at or
before the AGM held in the third calendar
year before the then current calendar year
must retire by rotation and such further
directors must retire by rotation so that in
total one-third of the directors retire by
rotation each year. A retiring director is
eligible for re-election. It is the Board’s
intention that all directors will stand for
election or re-election in 2019 in compliance
with the UK Corporate Governance Code.

Amendment of the Company’s Articles
of Association
The Company’s Articles of Association may
only be amended by a special resolution at a
general meeting of shareholders. Where class
rights are varied, such amendments must be
approved by the members of each class of
shares separately.

In addition, certain provisions of the Articles
of Association cannot be amended without
the consent of the Special Shareholder. These
provisions include the requirement that no
foreign person, or foreign persons acting in
concert, can have more than a 15% voting
interest in the Company, the requirement that
the majority of the directors are British, and
the requirement that the Chief Executive and
any executive Chairman are British.

Powers of the directors
The directors are responsible for the
management of the business of the Company
and may exercise all powers of the Company
subject to applicable legislation and
regulation, and the Articles of Association.

At the 2018 AGM, the directors were given
the power to buy back a maximum number
of 318,730,061 ordinary shares at a minimum
price of 2.5p each. The maximum price
was the higher of (i) an amount equal to
105% of the average of the middle market
quotations of the Company’s ordinary shares
as derived from the London Stock Exchange
Daily Official List for the five business days
immediately preceding the day on which
such ordinary shares are contracted to be
purchased, and (ii) the higher of the price
of the last independent trade and the
highest current independent bid on the
London Stock Exchange as stipulated by
Regulatory Technical Standards adopted
by the European Commission pursuant to
article 5(6) of the Market Abuse Regulation.

This power will expire at the earlier of the
conclusion of the 2019 AGM or 30 June 2019.
A special resolution will be proposed at the
2019 AGM to renew the Company’s authority
to acquire its own shares.

At the 2018 AGM, the directors were given
the power to issue new shares up to a nominal
amount of £26,558,182. This power will expire
on the earlier of the conclusion of the 2019
AGM or 30 June 2019. Accordingly, a
resolution will be proposed at the 2019 AGM
to renew the Company’s authority to issue
further new shares.

Conflicts of interest
As permitted under the Companies Act 2006,
the Company’s Articles of Association contain
provisions which enable the Board to authorise
conflicts or potential conflicts that individual
directors may have.

To avoid potential conflicts of interest the
Board requires the Nominations Committee
to check that any individuals it nominates for
appointment to the Board are free of potential
conflicts. In addition, the Board’s procedures
and the induction programme for new
directors emphasise a director’s personal
responsibility for complying with the duties
relating to conflicts of interest. The procedure
adopted by the Board for the authorisation
of conflicts reminds directors of the need to
consider their duties as directors and not grant
an authorisation unless they believe, in good
faith, that this would be likely to promote the
success of the Company. As required by law,
the potentially conflicted director cannot vote
on an authorisation resolution or be counted
in the quorum. Any authorisation granted may
be terminated at any time and the director is
informed of the obligation to inform the

Company without delay should there be any
material change in the nature of the conflict
or potential conflict so authorised.

Directors’ indemnities
The Company has entered into deeds of
indemnity with all its current directors and
those persons who were directors for any
part of 2018 which are qualifying indemnity
provisions for the purpose of the Companies
Act 2006.

The directors of BAE Systems Pension Funds
Trustees Limited, BAE Systems 2000 Pension
Plan Trustees Limited, BAE Systems Executive
Pension Scheme Trustees Limited and
Alvis Pension Scheme Trustees Limited
benefit from indemnities in the governing
documentation of the BAE Systems Pension
Scheme, the BAE Systems 2000 Pension Plan,
the BAE Systems Executive Pension Scheme
and the Alvis Pension Scheme, respectively,
which are qualifying indemnity provisions
for the purpose of the Companies Act 2006.

All such indemnity provisions are in force as
at the date of this Directors’ report.

Change of control – significant agreements
The following significant agreements contain
provisions entitling the counterparties to
exercise termination, alteration or other similar
rights in the event of a change of control of
the Company:
– The Group entered into a £2bn Revolving
Credit Facility dated 12 December 2013
which was amended and restated on
30 April 2018. The facility provides that,
in the event of a change of control of
the Company, the lenders are entitled
to renegotiate terms, or if no agreement
is reached on negotiated terms within a
certain period, to call for the repayment
or cancellation of the facility. The Revolving
Credit Facility was undrawn as at
31 December 2018.

– The Company has entered into a Restated
and Amended Shareholders Agreement
with European Aeronautic Defence and
Space Company EADS N.V. (EADS) and
Finmeccanica S.p.A. (Finmeccanica) relating
to MBDA S.A.S. dated 18 December 2001
(as amended). In the event that control of
the Company passes to certain specified
third-party acquirors, the agreement allows
EADS and Finmeccanica to exercise an
option to terminate certain executive
management level nomination and voting
rights, and certain shareholder information
rights of the Company in relation to the
MBDA joint venture. Following the exercise
of this option, the Company would have
the right to require the other shareholders
to purchase its interest in MBDA at fair
market value.

132

BAE SystemsAnnual Report 2018– In September 2016, BAE Systems Marine
Limited entered into a contract with the
MoD for the initial phase of manufacturing
activities for the Dreadnought Class
programme. This contract was extended
and amended to include additional
manufacturing activities in March 2018.
Where the MoD considers that a proposed
change of control of BAE Systems Marine
Limited would be contrary to the defence,
national security or national interest of the
UK, then the change of control shall not
proceed until agreement is established with
the MoD. In the event that there is a change
of control of BAE Systems Marine Limited,
notwithstanding the objection of the MoD
on such grounds, the MoD shall be entitled
to terminate the agreements immediately.
– In December 2018, BAE Systems’ subsidiary,
ASC Shipbuilding Pty Limited, entered into
a contract providing the framework for the
design and manufacture of Hunter Class
frigates for the Royal Australian Navy
(Head Contract). As part of the acquisition
of ASC Shipbuilding Pty Limited from the
Australian Commonwealth, BAE Systems
Australia Limited entered into a Sovereign
Capability and Option Deed (SCOD). Under
the Head Contract and the SCOD, if there is
a change of control of ASC Shipbuilding Pty
Limited, BAE Systems Australia Limited or
BAE Systems plc, consent is required from
the Australian Commonwealth Government
prior to any change of control occurring.
If there is a change of control without
notice or notwithstanding an objection,
the Commonwealth may terminate the
Head Contract, take any action to mitigate
an actual or potential threat to Australia’s
national security interests, or exercise its
call option under the SCOD and regain
ownership of ASC Shipbuilding Pty Limited.

In addition, the Company’s share plans
contain provisions as a result of which options
and awards may vest and become exercisable
on a change of control of the Company in
accordance with the rules of the plans.

The Company and EADS have agreed
that if Finmeccanica acquires a controlling
interest in the Company, EADS will increase
its shareholding in MBDA to 50% by
purchasing the appropriate number of
shares in MBDA at fair market value.

– The Company, BAE Systems, Inc.,

BAE Systems (Holdings) Limited and
BAE Systems Holdings Inc. entered into
a Special Security Agreement dated
23 October 2015 with the US Department
of Defense regarding the management
of BAE Systems, Inc. in order to comply
with the US government’s national security
requirements. In the event of a change
of control of the Company, the Agreement
may be terminated or altered by the US
Department of Defense.

– In June 2017, BAE Systems Surface Ships
Limited entered into a contract with the
UK Ministry of Defence (MoD) for the
manufacture of the first batch of three
Type 26 frigates. Where the MoD
considers that a proposed change of
control of BAE Systems Surface Ships Limited
would be contrary to the defence, national
security or national interest of the UK or
where the change of control would result
in increased costs to the MoD under the
contract, then the change of control shall
not proceed until agreement with the
MoD is established. If there is a change of
control without notice or notwithstanding
the objection of the MoD on such grounds,
then the MoD may terminate the contract
with immediate effect.

– The MSDF agreement between BAE Systems
Surface Ships Limited and the MoD became
effective on 1 October 2014 and establishes
a framework until March 2019 for the
provision of surface ship support work
and services relating to HM Naval Base
Portsmouth. Where the MoD considers
that a proposed change of control of
BAE Systems Surface Ships Limited would
be contrary to the defence, national security
or national interest of the UK, then the
change of control shall not proceed until
agreement with the MoD is established.
If there is a change of control without
notice or notwithstanding the objection
of the MoD, the MoD shall be entitled
to terminate the MSDF.

– In August 2008, BAE Systems Land

Systems (Munitions & Ordnance) Limited
(now BAE Systems Global Combat Systems
Munitions Limited) and the MoD entered
into a 15-year partnering agreement for
the provision of ammunition to UK Forces
(the Munitions Acquisition Supply Solution
(MASS) partnering agreement). Where
the MoD considers that a proposed change
of control of BAE Systems Global Combat
Systems Munitions Limited would be
contrary to the defence, national security
or national interest of the UK, then the
change of control shall not proceed until
agreement with the MoD is established.
In the event that there is a change of control
of BAE Systems Global Combat Systems
Munitions Limited, notwithstanding the
objection of the MoD on such grounds,
the MoD may, having followed the dispute
resolution process, terminate the MASS
agreement for default.

– In November 2012, BAE Systems Marine
Limited entered into a contract with the
MoD for the design, construction, testing
and commissioning of Boat 4 of the Astute
Class programme. In November 2015,
BAE Systems Marine Limited entered into
a contract with the MoD for the design,
construction, testing and commissioning
of Boat 5 of the Astute Class programme.
In March 2016, BAE Systems Marine
Limited entered into a contract with the
MoD for the design, construction, testing
and commissioning of Boat 6 of the
Astute Class Programme. In March 2018,
BAE Systems Marine Limited entered into
a contract with the MoD for the design,
construction, testing and commissioning
of Boat 7 of the Astute Class Programme.
Where the MoD considers that a proposed
change of control of BAE Systems Marine
Limited would be contrary to the defence,
national security or national interest of the
UK, then the change of control shall not
proceed until agreement is established with
the MoD. In the event that there is a change
of control of BAE Systems Marine Limited,
notwithstanding the objection of the MoD
on such grounds, the MoD shall be entitled
to terminate the agreements immediately.

– In December 2011, BAE Systems Marine
Limited entered into a contract with the
MoD for the design of the Dreadnought
submarines. Where the MoD considers that
a change of control of BAE Systems Marine
Limited would be contrary to the defence,
national interest or national security of the
UK, then the change of control shall not take
place until agreement is reached with the
MoD on how to proceed. In the event that
there is a change of control notwithstanding
the objection of the MoD on such grounds,
the MoD shall be entitled to terminate the
contract with immediate effect.

133

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsStatutory and other information
continued

The directors are responsible for keeping
adequate accounting records that are
sufficient to show and explain the parent
company’s transactions and disclose with
reasonable accuracy at any time the financial
position of the parent company and enable
them to ensure that its financial statements
comply with the Companies Act 2006. They
are responsible for such internal control as
they determine is necessary to enable the
preparation of financial statements that are
free from material misstatement, whether
due to fraud or error, and have general
responsibility for taking such steps as are
reasonably open to them to safeguard the
assets of the Group and to prevent and
detect fraud and other irregularities.

Under applicable law and regulations,
the directors are also responsible for
preparing a strategic report, directors’
report, directors’ remuneration report
and corporate governance statement that
comply with that law and those regulations.

The directors are responsible for the
maintenance and integrity of the corporate
and financial information included on the
company’s website. Legislation in the UK
governing the preparation and dissemination
of financial statements may differ from
legislation in other jurisdictions.

Statement of disclosure of information
to auditor
The directors who held office at the date
of approval of this Directors’ report confirm
that, so far as they are each aware, there is
no relevant audit information of which the
Company’s auditor is unaware; and each
director has taken all the steps that he/she
ought to have taken to make himself/herself
aware of any relevant audit information and
to establish that the Company’s auditor is
aware of that information.

Auditor
Deloitte LLP have indicated their willingness to
be re-appointed as the Company’s auditor and
a resolution proposing their re-appointment
will be put to the 2019 AGM.

Statement of directors’ responsibilities
in respect of the Annual Report and the
financial statements
The directors are responsible for preparing
the Annual Report, and the Group and parent
company financial statements in accordance
with applicable law and regulations.

Company law requires the directors to
prepare Group and parent company financial
statements for each financial year. Under
that law, they are required to prepare the
Group financial statements in accordance
with International Financial Reporting
Standards as adopted by the European Union
(IFRSs as adopted by the EU) and applicable
law, and have elected to prepare the parent
company financial statements in accordance
with UK accounting standards, including
Financial Reporting Standard (FRS) 101,
Reduced Disclosure Framework.

Under company law, the directors must not
approve the financial statements unless they
are satisfied that they give a true and fair view
of the state of affairs of the Group and parent
company, and of their profit or loss for that
period. In preparing each of the Group and
parent company financial statements, the
directors are required to:
– select suitable accounting policies and

then apply them consistently;

– make judgements and estimates that are

reasonable, relevant, reliable and prudent;

– for the Group financial statements,

state whether they have been prepared
in accordance with IFRSs as adopted by
the EU;

– for the parent company financial

statements, state whether applicable UK
accounting standards have been followed,
subject to any material departures disclosed
and explained in the parent company
financial statements;

– assess the Group and parent company’s
ability to continue as a going concern,
disclosing, as applicable, matters related
to going concern; and

– use the going concern basis of accounting
unless they either intend to liquidate the
Group or the parent company or to cease
operations, or have no realistic alternative
but to do so.

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

Ian Tyler

Non-executive director

On behalf of the Board

Sir Roger Carr
Chairman
20 February 2019

Directors’ report
The Directors’ report was approved by the board of directors on 20 February 2019.

David Parkes
Company Secretary

134

BAE SystemsAnnual Report 2018Independent Auditor’s report
to the members of BAE Systems plc only

Opinion
In our opinion:
– the financial statements of BAE Systems plc
(the Parent company) and its subsidiaries
(the Group) give a true and fair view of the state
of the Group’s and of the Parent company’s affairs
as at 31 December 2018 and of the Group’s profit
for the year then ended;

– the Group financial statements have been

properly prepared in accordance with International
Financial Reporting Standards (IFRSs) as adopted
by the European Union;

– the Parent company financial statements have

been properly prepared in accordance with United
Kingdom Generally Accepted Accounting Practice,
including Financial Reporting Standard 101
Reduced Disclosure Framework; and

– the financial statements have been prepared
in accordance with the requirements of the
Companies Act 2006 and, as regards the
Group financial statements, Article 4 of the
IAS Regulation.

We have audited the financial statements
which comprise:
– the consolidated income statement;
– the consolidated and Parent company statement

of comprehensive income;

– the consolidated and Parent company statements

of changes in equity;

– the consolidated and Parent company balance

sheets;

– the consolidated cash flow statement; and
– the related notes 1 to 38, including the associated

accounting policies.

The financial reporting framework that has been
applied in the preparation of the Group financial
statements is applicable law and IFRSs as adopted
by the European Union. The financial reporting
framework that has been applied in the preparation
of the Parent company financial statements is
applicable law and United Kingdom Accounting
Standards, including FRS 101 Reduced Disclosure
Framework (United Kingdom Generally Accepted
Accounting Practice).

Basis for opinion
We conducted our audit in accordance with
International Standards on Auditing (UK)
(ISAs (UK)) and applicable law. Our responsibilities
under those standards are further described in
the auditor’s responsibilities for the audit of the
financial statements section of our report.

We are independent of the Group and the
Parent company in accordance with the ethical
requirements that are relevant to our audit of
the financial statements in the UK, including the
Financial Reporting Council’s (the FRC’s) Ethical
Standard as applied to listed public interest entities,
and we have fulfilled our other ethical responsibilities
in accordance with these requirements. We confirm
that the non-audit services prohibited by the FRC’s
Ethical Standard were not provided to the Group
or the Parent company.

We believe that the audit evidence we have
obtained is sufficient and appropriate to provide
a basis for our opinion.

Summary of our audit approach
Key audit matters
The key audit matters that we identified
in the current year were:
– revenue and margin recognition on long-term

contracts;

– valuation of goodwill; and
– valuation of retirement benefit obligations.
These key audit matters were also identified by the
Group’s auditor in the prior year, KPMG. In addition,
they also identified key audit matters in relation to
tax accruals and deferred tax assets, and, with respect
to the Parent company, amounts relating to Group
affiliates. We did not consider these matters to have
the greatest effect on our overall audit strategy and
consequently on the allocation of resources or the
engagement team’s audit efforts in the current year.

Materiality
The materiality that we used for the Group financial
statements was £70m, which was determined on
the basis of adjusted profit before tax on continuing
operations as defined on page 138 below. Our
materiality equates to 4.7% of adjusted profit
before tax and 5.7% of profit before tax.

Scoping
18 components were subject to audit. Of these,
six were subjected to a full-scope audit whilst
the remaining 12 were subject to an audit of
specified account balances. These components
give us audit coverage of 89% of revenue and
88% of profit before tax.

First year audit transition
We developed a detailed audit transition plan,
designed to deliver an effective transition from
the Group’s predecessor auditor, KPMG. Our
transition activities were performed across the
Group’s business units and included, but were not
limited to, meeting with management across all
business units, obtaining an understanding of the
Group’s system of internal control and evaluating
the Group’s accounting policies and areas of
accounting judgement.

The key transition activities included
(but were not limited to) the following:

1. In May 2017 we established a detailed

audit transition plan in conjunction with
BAE Systems’ management, including setting
key milestone dates to monitor transition
progress. This was monitored with
management on at least a monthly basis;

2. On 1 October 2017 we confirmed our
independence to the Audit Committee
and commenced our audit planning in
relation to the 2018 audit;

3. In October 2017, a global transition workshop
was held with senior members of our Group
and global component audit teams in order
to develop our audit strategy. Senior members
of client management also participated in
this workshop;

4. We shadowed KPMG throughout the 2017

year-end audit and attended key audit meetings.
This included, but was not limited to, attendance
at the business unit year-end audit close
meetings in January 2018 and the Audit
Committee meeting in February 2018 where
the final report on the audit was presented;

5. We reviewed KPMG’s 2017 audit work papers
and met with relevant partners and senior staff
from KPMG to further our understanding of the
predecessor auditor’s approach;

6. We attended key management and contract
meetings throughout the 2018 financial year
across the business to deepen our understanding
of BAE Systems’ key contract judgements and
continue to develop our understanding of the
business and audit risks; and

7. In May 2018 a second global workshop was

held with senior members of our global Group
and component teams as part of our audit
planning, in order to further develop our audit
strategy and deep dive into certain areas of
our audit approach.

This transition process helped us build an
understanding of the Group, which, in turn,
informed our risk assessment process and
identification of the risks of material misstatement
to the Group’s financial statements.

We presented our proposed audit plan to the
Audit Committee in June 2018 and re-confirmed
the scope, significant risks and audit approach
at the meeting in December 2018.

Conclusions relating to going concern,
principal risks and viability statement
Going concern
We have reviewed the directors’ statement
in the Basis of Preparation on page 142 to the
financial statements about whether they considered
it appropriate to adopt the going concern basis of
accounting in preparing them and their identification
of any material uncertainties to the Group’s and
Parent company’s ability to continue to do so over
a period of at least twelve months from the date
of approval of the financial statements.

We considered as part of our risk assessment the
nature of the Group, its business model and related
risks including, where relevant, the impact of the
applicable political and economic environments
including Brexit, the requirements of the applicable
financial reporting framework and the system
of internal control. We evaluated the directors’
assessment of the Group’s ability to continue
as a going concern, including challenging the
underlying data and key assumptions used to
make the assessment, and evaluated the directors’
plans for future actions in relation to their going
concern assessment.

We are required to state whether we have anything
material to add or draw attention to in relation to
that statement required by Listing Rule 9.8.6R(3)
and report if the statement is materially inconsistent
with our knowledge obtained in the audit.

We confirm that we have nothing material to report,
add or draw attention to in respect of these matters.

135

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsIndependent Auditor’s report
continued

Principal risks and viability statement
Based solely on reading the directors’ statements
and considering whether they were consistent with
the knowledge we obtained in the course of the
audit, including the knowledge obtained in the
evaluation of the directors’ assessment of the
Group’s and the Parent company’s ability to
continue as a going concern, we are required to
state whether we have anything material to add
or draw attention to in relation to:
– the disclosures on pages 68 to 71 that describe

the principal risks and explain how they are being
managed or mitigated;

– the directors’ confirmation on page 81 that

they have carried out a robust assessment of
the principal risks facing the Group, including
those that would threaten its business model,
future performance, solvency or liquidity; or

– the directors’ explanation on page 81 as to how
they have assessed the prospects of the Group,
over what period they have done so and why they
consider that period to be appropriate, and their
statement as to whether they have a reasonable
expectation that the Group will be able to continue
in operation and meet its liabilities as they fall due
over the period of their assessment, including any
related disclosures drawing attention to any
necessary qualifications or assumptions.

We are also required to report whether the
directors’ statement relating to the prospects
of the Group required by Listing Rule 9.8.6R(3)
is materially inconsistent with our knowledge
obtained in the audit.

We confirm that we have nothing material to report,
add or draw attention to in respect of these matters.

Key audit matters
Key audit matters are those matters that, in our
professional judgement, were of most significance
in our audit of the financial statements of the
current period and include the most significant
assessed risks of material misstatement (whether or
not due to fraud) that we identified. These matters
included those that had the greatest effect on: the
overall audit strategy; the allocation of resources in
the audit; and directing the efforts of the
engagement team.

These matters were addressed in the context of our
audit of the financial statements as a whole, and in
forming our opinion thereon, and we do not provide
a separate opinion on these matters.

Revenue and margin recognition
on long-term contracts
Refer to page 84 (Audit Committee report), note 1
(accounting policy and financial disclosure) and note 37
(for IFRS 15 restatement disclosure)

Revenue:
£16,821m (2017 restated £17,224m)

Key audit matter description
The estimation of both overall lifetime contract
margin and the appropriate level of revenue and
profit to recognise in any single accounting period
require the exercise of management judgement.
Within BAE Systems’ contract portfolio there are
a number of programmes where the estimates
required in reaching these judgements are highly
complex and could lead to a material error within
the financial statements if reached incorrectly.
Consequently, we consider that revenue and margin
recognition represents a significant risk to our audit
and a key audit matter. This risk is further heightened
in 2018 owing to it being the first year that the
businesses will be required to account for the
contracts under IFRS 15. The standard has a
number of judgements that the Group is required
to apply to its contracts, including the identification
of performance obligations and estimation of the
amount of consideration to be recognised.

We focus a greater proportion of audit effort on
a number of contracts where we consider there to
be the highest degree of management judgement
required, and design contract specific tests and
procedures to mitigate the associated risks.

In order to identify the key contracts over which
there is a significant risk of material misstatement,
we undertook a contract risk assessment process
at each component, utilising the latest contract
information and our understanding of the business.
We held meetings with key finance and contract
managers, attended Quarterly Business Reviews
and other key management meetings, read and
understood underlying contract documentation
and reviewed management support for key
contract judgements (from both a qualitative
and quantitative perspective). In addition we
looked for contracts that might have higher levels
of judgement associated with the risk of schedule
delivery or technical complexity, fixed price contracts
which increase the risk of contract losses and other
indicators that could increase the risk of a material
impact on the financial statements.

As a result of our risk assessment we identified
a number of contracts where we consider there
to be the highest degree of management
judgement required. These are:
– Astute Class submarines;
– Queen Elizabeth Class (QEC) aircraft carrier;
– Offshore Patrol Vessel (OPV);
– Saudi Salam Typhoon (Salam);
– Saudi British Defence Co-operation Programme

(SBDCP); and

– Radford Nitrocellulose plant.

How the scope of our audit responded
to the key audit matter
Our contract testing approach included:

Testing the relevant controls
– We assessed the design and implementation
and, where deemed appropriate, tested the
operating effectiveness of key controls within
management’s Lifecycle Management (LCM)
Framework and project accounting processes
which management have established to ensure
that contracts are appropriately managed,
challenged and accounted for.

– As part of this we observed the controls in
operation by attending a sample of project
contract status review meetings, Quarterly
Business Review meetings and Group-level
meetings to validate the various levels of
challenge applied to the contracts.

Challenging management’s assumptions
and estimates
To gain assurance over the contract judgements
and estimates made, our work included:
– making enquiries of contract project teams and
other personnel to obtain an understanding of
the performance of the project throughout the
year and at year-end;

– analysing historical contract performance and

understanding the reason for in-year movements
or changes;

– testing the underlying calculations used in
the contract assessments for accuracy and
completeness, including the estimated costs
to complete the contract;

– examining external correspondence to support
the timeframe for delivery of the product or
service and any judgements made in respect
of these;

– examining external evidence to support contract
status and recoverability of receivables, such as
customer correspondence and for certain
contracts, meeting with the customer directly;
– enquiring with in-house and external legal counsel
regarding contract-related litigation and claims;
– using Deloitte subject matter experts to provide

support in evaluating specific contract judgements
taken; and

– considering whether there were any indicators
of management override of controls or bias in
arriving at their reported position.

Assessing the impact of IFRS 15
In respect of ensuring that the Group
is appropriately applying IFRS 15 we:
– reviewed and challenged management’s

accounting papers on the impact of the transition;

– reviewed and challenged management’s updated

accounting policies manual;

– embedded IFRS 15 considerations in our contract
review work, in particular determining whether
management had appropriately considered the
existence of performance obligations and
elements of variable consideration; and
– reviewed the Annual Report disclosures.

136

BAE SystemsAnnual Report 2018Key observations
The results of our testing were satisfactory.

Through our testing of significant risk contracts
we did not identify any audit adjustments and
consider the judgements made by management
in recognising revenue and profit to be balanced.

Our testing of the remaining population identified
certain immaterial audit adjustments but we
conclude overall that the judgements made by
management are reasonable.

Valuation of goodwill
Refer to page 84 (Audit Committee report) and note 8
(accounting policy and financial disclosures)

Goodwill:
£10,239m (2017 £9,996m)

Key audit matter description
The Group holds material goodwill balances
relating to UK and overseas acquisitions, the
majority of which are in the US. Management
performs an impairment review of the carrying value
of each Cash-Generating Unit (CGU) on an annual
basis in line with the requirements of IAS 36.

The impairment assessment involves management
judgement in considering whether the carrying
value of the cash-generating units is recoverable and
hence we considered this to be a key audit matter.
Determining the recoverable amount involves
significant estimation including:
– forecasting future cash flows;
– determining the discount rate; and
– determining future growth rates.

In planning our audit, we determined there to be
a significant risk in relation to the valuation of the
Applied Intelligence (AI) CGU which has a carrying
value of £257m, including goodwill of £237m, at
31 December 2018. In 2017, the Group recorded
a goodwill impairment charge of £384m in relation
to this CGU. Given the goodwill is now held at
fair value based on forecast future cash flows,
small changes in assumptions could trigger
further impairment.

Through our risk assessment we determined
that the key drivers of future growth in AI are
the Government and Technology & Commercial
divisions. As a result, we have performed additional
procedures over the revenue and cost assumptions
in these divisions.

How the scope of our audit responded
to the key audit matter
We have performed a series of specific audit
procedures to address the key audit matter
identified in relation to the AI CGU. This included
the following:
– we obtained a detailed understanding

of management’s process for identifying
indicators of impairment and for performing
the CGU impairment assessment. As part of
this we assessed the design and implementation
of the key controls. Specific focus was given
to understanding management’s process and
controls over forecasting future cash flows
and determination of the key assumptions
as detailed above;

– we evaluated and challenged underlying

assumptions and cash flows, including forecast
revenue and cost assumptions, with reference
to the recent and historical performance of
the AI CGU, external industry benchmarks
and specific forecast events. This included
performing sensitivity analysis to evaluate
the impact of changing a range of assumptions
including suppressed growth and changes in
the discount rate;

– we tested the integrity of management’s
impairment model used to derive the
recoverable amount; and

– we involved Deloitte valuation specialists to

support our challenge of the applicable discount
rate and other assumptions.

Key observations
We completed our audit of the forecasts of the
AI business and are satisfied that management’s
assumptions are reasonable and supportable based
on available evidence, both internal and external.

Valuation of retirement benefit obligations
Refer to page 84 (Audit Committee report) and note 22
(accounting policy and financial disclosures)

Group’s share of the net IAS 19 deficit:
£3,932m (2017 £4,022m)

Valuation of retirement benefit scheme assets:
£25,653m (2017 £26,883m)

Valuation of retirement benefit scheme liabilities:
£29,889m (2017 £31,237m)

Key audit matter description
The principal retirement benefit schemes are held
in the UK and US and are funded defined benefit
schemes, with assets held in separate trustee-
administered funds.

We identified the following areas which were the
focus of our procedures in auditing the Group’s net
retirement benefit obligations as a key audit matter:

Liabilities
The key judgements relating to the retirement
benefit obligations include inflation assumptions,
discount rates and mortality assumptions applied
to its members. Given the significant size of the
deficit at year-end, small changes to these input
assumptions can lead to large changes in the
valuation. Assumptions are also made in the
determination of the Group’s share of assets
and liabilities of multi-employer schemes in which
it participates and the corresponding amounts
attributed to other participating employers.

Assets
Given the size of the scheme assets there
is significant audit effort required in ensuring
the valuation of assets is supportable.

GMP equalisation
During the year, the High Court ruled that
companies are required to equalise Guaranteed
Minimum Pensions (GMPs) between men and
women. Previously, the Group made no allowance
in the accounting liabilities for GMP equalisation
and therefore for 2018 the Group is required to
estimate the impact of equalising GMP payments.
This was estimated to be £114m. Given the high
level of estimation required in determining the
impact of GMP and the size of the Group’s deficit
this has also been considered a key audit matter
in the period.

Restatement
During the year, management identified an error
in relation to the treatment of asset collateral on
longevity swaps that impacted previously reported
asset values of the Group’s pension schemes. It was
determined that the prior year asset values had been
overstated by £108m leading to a corresponding
understatement of the net retirement benefit
obligation as at 31 December 2017. Given the size
of the adjustment, the Group has restated the 2017
comparatives as described in note 37.

How the scope of our audit responded
to the key audit matter

Liabilities
In relation to the retirement benefit obligation
we have performed the following procedures:
– we obtained a detailed understanding and
performed walkthroughs of management’s
process, with specific focus on assessing the
design and implementation of key controls
relating to the valuation of the retirement
benefit obligation;

– in conjunction with Deloitte actuarial specialists,

we challenged the assumptions used in the IAS 19
valuation, including assessing and challenging
the reasonableness of the assumptions against
available market data and benchmarking
against their peers; and

– we assessed the objectivity, independence
and competence of the actuaries engaged
by management to perform the valuations
of the schemes.

Assets
We performed audit procedures relating to the
assets held within the pension schemes through
seeking third party confirmation from asset
managers and/or custodians or other supporting
evidence as appropriate. Our work has included
reviewing publicly available information on these
assets, comparing to internal benchmarks and
reconciling inputs used by management to
determine the asset values.

GMP equalisation
In conjunction with Deloitte actuarial specialists,
we challenged the methodology and assumptions
applied by management to estimate the impacts
of GMP equalisation in the current year.

Restatement
We audited management’s restatement of the
2017 financial statements for the prior year error
identified and are satisfied with the treatment
and disclosure made.

Disclosure
We also audited the disclosures made in the 2018
financial statements for compliance with IAS 19.

Key observations
We have completed our audit work in line with
the procedures outlined above. Overall we consider
the discount rate and other key pension assumptions
used by management in calculating the retirement
benefit obligation to be within our independently
developed reasonable range. The Group’s
approach to estimating the impacts of GMP
equalisation was also considered to be reasonable
and in line with market practice. We concluded
our testing of the assets and are satisfied they
are appropriately valued.

137

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsIndependent Auditor’s report
continued

Our application of materiality
We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable
person would be changed or influenced. We use materiality both in planning the scope of our audit work and in evaluating the results of our work.

Based on our professional judgement, we determined materiality for the financial statements as a whole as follows:

Group financial statements

Parent company financial statements

Materiality

£70m (2017 £55m)

Basis for determining
materiality

4.7% of adjusted profit before tax of £1,484m. This includes adjustment for non-recurring
items of £154m (see note 1), impairment of intangible assets of £33m (see note 8) and fair
value and foreign exchange adjustments on financial instruments and investments of £73m
(see note 5).

The predecessor auditor determined materiality using 4.9% of Group profit before taxation.

£38.5m (2017 £32m)

Materiality has been set with
reference to the net assets of
the Parent company.

Rationale for the
benchmark applied

Adjusted profit before tax from continuing operations was considered to be the most relevant
benchmark as it is considered the most stable and comparable profit metric. The adjustments
excluded relate to items that are considered one-off in nature or relate to complex financial
instrument valuations, which are volatile and not reflective of the underlying performance
of the business.

We consider the measure suitable having also considered the other relevant benchmarks:
our materiality equates to 5.7% of profit before tax and 1.2% of net assets.

The increase in the materiality is driven by the increase in profit before tax and adjusted
profit before tax.

This represents 0.9% of the Parent
company net assets. In addition, we
consider the materiality of the Parent
company in the context of the Group
materiality and have capped this at
55% of that of the Group.

We consider net assets the key
benchmark used by members of
the Parent company in assessing
financial performance.

Adjusted
proﬁt before tax
£1,484m

Group
materiality
£70m

Component
materiality range
£38.5m to £18m

Audit Committee
reporting threshold
£3.5m

We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £3.5m (2017 £3m), as well as differences below
that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified
when assessing the overall presentation of the financial statements.

An overview of the audit scope
Our Group audit was scoped by obtaining an
understanding of the Group and its environment,
including Group-wide controls, and assessing the
audit risks. This exercise has considered the relative
size of each reporting unit’s contribution to revenue,
profit before tax and adjusted profit before tax,
alongside further financial or contractual risks which
we consider to be present. In doing this, we also
considered the impact of the reorganisation of
reporting lines in the business to ensure that we
have appropriate coverage across the new
segments, as well as the Group as a whole.

We have considered units that contribute more
than 10% of the Group’s revenue or adjusted

profit before tax to be ‘financially significant’,
and requiring a full-scope audit. In addition, we
have used our knowledge of the business obtained
throughout transition and as part of our risk
assessment procedures to assess where else we
consider it appropriate to perform a full-scope
audit. This resulted in full-scope audits for six
business units located in the UK, Saudi Arabia
and the US, as well as the Group’s largest joint
venture, MBDA.

of material misstatement in specific balances within
the financial statements. Accordingly, we have
directed component auditors to perform an audit
of specified account balances and additional
analytical procedures on the respective income
statements and balance sheets for these
components. For all in-scope components, whether
designated financially significant or subject to an
audit of specified account balances, revenue was
determined to be in scope for the audit.

Additionally our audit planning identified
12 non-financially significant components, located
in the UK, Saudi Arabia, Australia and the US, where
we consider there to be a reasonable possibility

For all other reporting units not included in
full-scope or audit of specified account balance
scope, we performed centrally-directed analytical
review procedures.

The scope of our work gives us coverage over the following proportions of the total Group results:

Review at a
Group level
11%

Full audit
scope
89%

Review at a
Group level
12%

Full audit
scope
63%

Review at a
Group level
17%

Full audit
scope
66%

Revenue

Proﬁt
before tax

Speciﬁed
account
balances
17%

Net assets

Speciﬁed
account
balances
25%

138

BAE SystemsAnnual Report 2018Responsibilities of directors
As explained more fully in the directors’
responsibilities statement, the directors are
responsible for the preparation of the financial
statements and for being satisfied that they give
a true and fair view, and for such internal control
as the directors determine is necessary to enable
the preparation of financial statements that are
free from material misstatement, whether due
to fraud or error.

In preparing the financial statements, the directors
are responsible for assessing the Group’s and the
Parent company’s ability to continue as a going
concern, disclosing as applicable, matters related
to going concern and using the going concern
basis of accounting unless the directors either intend
to liquidate the Group or the Parent company or
to cease operations, or have no realistic alternative
but to do so.

Auditor’s responsibilities for the audit
of the financial statements
Our objectives are to obtain reasonable assurance
about whether the financial statements as a whole
are free from material misstatement, whether due
to fraud or error, and to issue an auditor’s report
that includes our opinion. Reasonable assurance
is a high level of assurance, but is not a guarantee
that an audit conducted in accordance with
ISAs (UK) will always detect a material misstatement
when it exists. Misstatements can arise from fraud
or error and are considered material if, individually or
in the aggregate, they could reasonably be expected
to influence the economic decisions of users taken
on the basis of these financial statements.

Details of the extent to which the audit was
considered capable of detecting irregularities,
including fraud are set out below.

A further description of our responsibilities for
the audit of the financial statements is located
on the FRC’s website at: www.frc.org.uk/
auditorsresponsibilities. This description forms
part of our auditor’s report.

As each of the business units maintains separate
financial records, we have engaged component
auditors from the Deloitte member firms in the
US, UK, Saudi Arabia and Australia to perform
procedures at all the wholly-owned components
under our direction and supervision. This approach
also allows us to engage local auditors who have
appropriate knowledge of local regulations to
perform the audit work, under a common Deloitte
audit approach.

In respect of MBDA, we have engaged with the
entity’s non-Deloitte auditor to perform a full-scope
audit under our direction and supervision.

We have issued detailed instructions to the
component auditors, directed and supervised
their work through a number of visits to each
of the component auditors during the transition,
planning and performance stages of our audit,
alongside frequent remote communication and
review of their work.

Our oversight of component auditors focused on
the planning of their audit work and understanding
of their risk assessment process to identify key areas
of estimates and judgement, as well as the execution
of their audit work in line with our Group-issued
referral instructions. All teams were involved in our
transition workshops and other transition activities
as outlined on page 135, which were overseen and
directed by the Group audit team. We are satisfied
that the level of involvement of the Group audit
partner and team in the component audits has been
extensive and has enabled us to conclude that
sufficient appropriate audit evidence has been
obtained in support of our opinion on the Group
financial statements as a whole.

The BAE Systems, Inc. business units in the US
are subject to a Department of Defense Special
Security Arrangement (SSA), which is a government
requirement setting out specific protocol that
foreign-controlled companies must comply with in
order to be able to undertake government defence
contracts. As part of this there is restriction on the
flow of information outside of the US. Therefore,
for the US components there are restrictions around
access to the audit file and specific workpapers
for non-US nationals. As such we have designed
alternative procedures, including involvement of
an additional independent US national partner,
to ensure that appropriate oversight of the
US component team is obtained.

In addition to the work performed at a component
level, at Group level we have audited the
consolidation process and carried out analytical
procedures over the residual financial information
of the remaining components not subject to audit
or audit of specified account balances. At a Group
level we also perform audit procedures on centrally
held balances including treasury, retirement benefit
obligations, goodwill, tax, head office costs and
litigation and claims.

Other information
The directors are responsible for the other
information. The other information comprises
the information included in the Annual Report,
other than the financial statements and our
auditor’s report thereon.

Our opinion on the financial statements does
not cover the other information and, except
to the extent otherwise explicitly stated in our
report, we do not express any form of assurance
conclusion thereon.

In connection with our audit of the financial
statements, our responsibility is to read the other
information and, in doing so, consider whether
the other information is materially inconsistent
with the financial statements or our knowledge
obtained in the audit or otherwise appears to
be materially misstated.

If we identify such material inconsistencies
or apparent material misstatements, we are
required to determine whether there is a material
misstatement in the financial statements or a
material misstatement of the other information.
If, based on the work we have performed, we
conclude that there is a material misstatement
of this other information, we are required to
report that fact.

In this context, matters that we are specifically
required to report to you as uncorrected material
misstatements of the other information include
where we conclude that:
– Fair, balanced and understandable –
the statement given by the directors that
they consider the annual report and financial
statements taken as a whole is fair, balanced and
understandable and provides the information
necessary for shareholders to assess the Group’s
position and performance, business model and
strategy, is materially inconsistent with our
knowledge obtained in the audit; or

– Audit Committee reporting – the section

describing the work of the Audit Committee does
not appropriately address matters communicated
by us to the Audit Committee; or

– Directors’ statement of compliance with the
UK Corporate Governance Code – the parts of
the directors’ statement required under the Listing
Rules relating to the Group’s compliance with the
UK Corporate Governance Code containing
provisions specified for review by the auditor in
accordance with Listing Rule 9.8.10R(2) do not
properly disclose a departure from a relevant
provision of the UK Corporate Governance Code.

We have nothing to report in respect of these matters.

139

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsIndependent Auditor’s report
continued

Extent to which the audit was
considered capable of detecting
irregularities, including fraud
We identify and assess the risks of material
misstatement of the financial statements, whether
due to fraud or error, and then design and perform
audit procedures responsive to those risks, including
obtaining audit evidence that is sufficient and
appropriate to provide a basis for our opinion.

Identifying and assessing potential
risks related to irregularities
In identifying and assessing risks of material
misstatement in respect of irregularities, including
fraud and non-compliance with laws and
regulations, our procedures included the following:
– enquiring of management, internal legal

counsel, internal audit and the Audit Committee,
including obtaining and reviewing supporting
documentation, concerning the Group’s policies
and procedures relating to:

– identifying, evaluating and complying with laws
and regulations and whether they were aware
of any instances of non-compliance;

– detecting and responding to the risks of fraud
and whether they have knowledge of any
actual, suspected or alleged fraud; and

– the internal controls established to mitigate
risks related to fraud or non-compliance
with laws and regulations, including obtaining
an understanding of the Group’s bribery &
corruption and whistleblowing policies;
– discussing among the engagement team,

including significant component audit teams
and involving relevant internal specialists,
including tax, valuations, pensions and IT
specialists regarding how and where fraud
might occur in the financial statements and
any potential indicators of fraud. As part of
this discussion, we identified potential for fraud
in relation to the level of judgement involved
in estimating costs to complete on long-term
contracts and the subsequent impact on
revenue and margin recognition; and

– obtaining an understanding of the legal and

regulatory frameworks that the Group operates
in, focusing on those laws and regulations that
had a direct effect on the financial statements,
including the UK Companies Act, Listing Rules,
pension and taxation legislation. In addition, owing
to the sector the Group operates in, we considered
laws and regulations that had a fundamental
effect on the operations of the Group, including
in respect of export controls, defence contracting
and anti-bribery and corruption legislation.
These areas were identified through enquiries
with directors, management and legal counsel,
our knowledge and understanding of the Group
accumulated throughout the audit and our
sector-specific experience.

Audit response to risks identified
As a result of performing the above, we identified
revenue and margin recognition on long-term
contracts as a key audit matter. The key audit
matters section of our report explains the matters
in more detail and also describes the specific
procedures we performed in response to the
key audit matter.

In addition to the above, our procedures to respond
to risks identified included the following:
– reviewing the financial statement disclosures
and testing of supporting documentation to
assess compliance with relevant laws and
regulations discussed above;

– enquiring of management, the Audit Committee
and in-house legal counsel concerning actual
and potential litigation and claims;

– performing analytical procedures to identify
any unusual or unexpected relationships that
may indicate risks of material misstatement
due to fraud;

– reading minutes of meetings of those charged

with governance, reviewing internal audit reports
and reviewing correspondence with HMRC;
– obtaining a detailed understanding of and

performing process walkthroughs in relation
to the Group’s process for engaging third
parties to support business development;

– in addressing the risk of fraud through

management override of controls, testing
the appropriateness of journal entries and
other adjustments;

– assessing whether the judgements made

in making accounting estimates are indicative
of a potential bias; and

– evaluating the business rationale of any
significant transactions that are unusual
or outside the normal course of business.

We also communicated relevant identified laws
and regulations and potential fraud risks to all
engagement team members including internal
specialists and significant component audit teams
and remained alert to any indications of fraud or
non-compliance with laws and regulations
throughout the audit.

Report on other legal and regulatory
requirements
Opinions on other matters prescribed
by the Companies Act 2006
In our opinion the part of the directors’
remuneration report to be audited has been
properly prepared in accordance with the
Companies Act 2006.

In our opinion, based on the work undertaken
in the course of the audit:
– the information given in the strategic report

and the directors’ report for the financial year
for which the financial statements are prepared
is consistent with the financial statements; and

– the strategic report and the directors’ report

have been prepared in accordance with applicable
legal requirements.

In the light of the knowledge and understanding
of the Group and of the Parent company and their
environment obtained in the course of the audit,
we have not identified any material misstatements
in the strategic report or the directors’ report.

Matters on which we are required
to report by exception
Adequacy of explanations received
and accounting records
Under the Companies Act 2006 we are required
to report to you if, in our opinion:
– we have not received all the information and

explanations we require for our audit; or
– adequate accounting records have not been

kept by the Parent company, or returns adequate
for our audit have not been received from
branches not visited by us; or

– the Parent company financial statements are

not in agreement with the accounting records
and returns.

We have nothing to report in respect of these matters.

Directors’ remuneration
Under the Companies Act 2006 we are also
required to report if in our opinion certain
disclosures of directors’ remuneration have not been
made or the part of the directors’ remuneration
report to be audited is not in agreement with the
accounting records and returns.

We have nothing to report in respect of these matters.

Other matters
Auditor tenure
Following the recommendation of the Audit
Committee, we were appointed by the members
on 10 May 2018 to audit the financial statements
for the year ending 31 December 2018 and
subsequent financial periods. The period of total
uninterrupted engagement including previous
renewals and reappointments of the firm is
therefore one year.

Consistency of the audit report with the
additional report to the Audit Committee
Our audit opinion is consistent with the additional
report to the Audit Committee we are required to
provide in accordance with ISAs (UK).

Use of our report
This report is made solely to the Parent company’s
members, as a body, in accordance with Chapter 3
of Part 16 of the Companies Act 2006. Our audit
work has been undertaken so that we might state
to the Parent company’s members those matters
we are required to state to them in an auditor’s
report and for no other purpose. To the fullest
extent permitted by law, we do not accept or
assume responsibility to anyone other than
the Parent company and the Parent company’s
members as a body, for our audit work, for this
report, or for the opinions we have formed.

John Adam
Senior Statutory Auditor

For and on behalf of
Deloitte LLP
Statutory Auditor

London, United Kingdom
20 February 2019

140

BAE SystemsAnnual Report 2018Financial statements

Group accounts

Preparation

Consolidated income statement

Consolidated statement
of comprehensive income

Consolidated statement
of changes in equity

Consolidated balance sheet

Consolidated cash flow statement

1. Segmental analysis

2. Operating costs

3. Employees

4. Other income

5. Net finance costs

6. Taxation expense

7. Earnings per share

Intangible assets

9. Property, plant and equipment

10. Investment property

11. Equity accounted investments

142

144

18. Assets and liabilities of disposal
groups classified as held for sale

19. Geographical analysis of assets

145

20. Loans and overdrafts

21. Trade and other payables

22. Retirement benefits

23. Provisions

24. Share capital and other reserves

25. Operating business cash flow

26. Movement in assets and liabilities
arising from financing activities

27. Net debt

28. Fair value measurement

29. Financial risk management

30. Share-based payments

31. Related party transactions

32. Contingent liabilities

33. Commitments

34. Acquisition of subsidiary

145

146

147

148

153

155

156

157

160

161

164

167

168

12. Trade, other and contract receivables 170

35. Information about

related undertakings

36. Events after the reporting period

37. Changes in accounting policies

and restatements

38. Adoption of IFRS 16 Leases

13. Other financial assets and liabilities

14. Deferred tax

15. Inventories

16. Current tax

17. Cash and cash equivalents

Company accounts

Company statement of
comprehensive income

Company statement
of changes in equity

Company balance sheet

Notes to the Company accounts

171

172

174

175

212

213

214

175

176

177

178

189

190

192

193

194

195

198

199

200

201

205

210

Group accounting policies
Accounting policies are included within
the relevant note to the Group accounts.

BAE Systems
Annual Report 2018

141

Strategic reportGovernanceFinancial statementsGroup accounts

Preparation

Basis of preparation
The consolidated financial statements of BAE Systems plc have been prepared on a going concern basis, as discussed in the Directors’ report
on page 82, and in accordance with EU-endorsed International Financial Reporting Standards (IFRS) and the Companies Act 2006 applicable
to companies reporting under IFRS.

The consolidated financial statements are presented in pounds sterling and, unless stated otherwise, rounded to the nearest million. They have
been prepared under the historical cost convention, as modified by the revaluation of certain financial assets and financial liabilities (including
derivative instruments).

Transactions in foreign currencies are translated at the exchange rates ruling at the dates of the transactions. Monetary assets and liabilities
denominated in foreign currencies are retranslated at the exchange rates ruling at the balance sheet date, with the resulting exchange differences
recognised in the income statement.

Significant accounting policies
The significant accounting policies applied in the preparation of these consolidated financial statements are set out in the relevant notes. These
policies have been applied consistently to all the years presented, unless otherwise stated. The directors believe that the consolidated financial
statements reflect appropriate judgements and estimates, and provide a true and fair view of the Group’s financial performance and position.

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. The critical accounting policies are listed
below and explained in more detail in the relevant notes to the Group accounts:

Critical accounting policy

Description

Revenue and profit
recognition

The Group accounts for revenue in accordance with IFRS 15 Revenue from Contracts with Customers.
For most of the Group’s contracts, revenue and associated margin are recognised progressively over time
as costs are incurred, and as risks have been mitigated or retired.

Carrying value of goodwill

Deferred tax asset on
retirement benefit obligations

Tax provisions

Valuation of retirement
benefit obligations

The ultimate profitability of contracts is based on estimates of revenue and costs, including allowances
for technical and other risks, which are reliant on the knowledge and experience of the Group’s project
managers, engineers and finance and commercial professionals. Material changes in these estimates
could affect the profitability of individual contracts. Revenue and cost estimates are reviewed and
updated at least quarterly, and more frequently as determined by events or circumstances.

Goodwill is not amortised, but is tested annually for impairment and carried at cost less accumulated
impairment losses. For the purposes of impairment testing, goodwill is allocated to Cash-Generating
Units on a consistent basis.
The impairment review calculations require the use of estimates of the future profitability and
cash-generating ability of the acquired businesses based on the Group’s five-year Integrated Business
Plan and the pre-tax discount rate used in discounting these projected cash flows.

The Group has recognised a deferred tax asset in respect of the deficits in its pension/retirement schemes.
It is management’s judgement that the Group will generate sufficient taxable profits to recover the
net deferred tax asset recognised. This judgement requires the use of estimates of future taxable
profits based on the Group’s Integrated Business Plan.

Provision is made for known issues based on management’s interpretation of country-specific legislation
and management’s assessment of the likely outcome of negotiations or litigation. The Group’s approach
is to consider each uncertain tax position separately. Where management considers it is probable that
there will be a future outflow of funds to a tax authority, a provision is recognised. The position is
reviewed on an ongoing basis.
Provisions are measured using management’s best estimate of the most likely amount, being the
single most likely amount in a range of possible outcomes. The Group discloses any significant
uncertainties in relation to tax matters to the relevant tax authority. The resolution of tax positions
taken by the Group can take a considerable period of time to conclude and, in some cases, it is
difficult to predict the outcome.

Defined benefit pension scheme accounting valuations are prepared by independent actuaries.
The liabilities of the pension schemes are valued based on a number of actuarial assumptions.
For each of the actuarial assumptions used there is a range of possible values and management
estimates the point within that range that most appropriately reflects the Group’s circumstances.
Small changes in these assumptions can have a significant impact on the size of the deficit.

Notes

Judgements made in applying accounting policies
In the course of preparing the financial statements, no judgements have been made in the process of applying the Group’s accounting
policies, other than those involving estimates, that have had a significant effect on the amounts recognised in the financial statements.

142

BAE SystemsAnnual Report 2018Preparation continued

Sources of estimation uncertainty
The application of the Group’s accounting policies requires the use of estimates. In the event that these estimates prove to be incorrect, there
may be an adjustment to the carrying amounts of assets and liabilities within the next financial year. The key significant risks of a material
adjustment to the carrying amounts of assets and liabilities during 2019 have been considered and assessed as relating to the following:
– The determination of the discount rate and inflation assumptions underpinning the valuation of the liabilities of the Group’s defined benefit

pension schemes, where there is a range of possible values for each of the actuarial assumptions and small changes in assumptions may have
a significant impact on the size of the deficit. Note 22 provides information on the key assumptions and analysis of their sensitivities.

– The consideration of the carrying value of goodwill for impairment requires an assessment of future cash flows expected to be generated

from the associated cash-generating unit, as well as the appropriate discount rate to apply to these projections. Note 8 provides information
on the key assumptions adopted by the Group and associated sensitivity analysis.

– Revenue and profit recognition on contracts is based on estimates of future costs as well as an assessment of contingencies for technical and

other risks, such as the Group’s inability to obtain or maintain the necessary export licences. Note 1 includes information on revenue recognised
in the year in respect of performance obligations satisfied or partially satisfied in previous periods providing an indication of the range of
outcomes relating to these estimates.

– Tax provisioning is based on estimates of the potential outcomes of tax litigation or negotiations, the amount recorded being the single most
likely amount in a range of possible outcomes. Such provisions can be difficult to estimate due to the complexity involved and the uncertainty
in the process for their resolution. Note 16 provides information relating to potential material changes regarding tax provisions in the next
financial year.

Changes in accounting policies
IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers became effective on 1 January 2018. The impact of adoption
is set out in note 37.

IFRS 16 Leases will be effective from 1 January 2019. The expected impact of adoption is set out in note 38.

The following other standards, interpretations and amendments to existing standards became effective on 1 January 2018 and have not had
a material impact on the Group:
– Amendments to IFRS 2: Classification and Measurement of Share-based Payment Transactions;
– Amendments to IAS 40: Transfers of Investment Property;
– IFRIC 22 Foreign Currency Transactions and Advance Consideration; and
– Annual Improvements to IFRS Standards 2014–2016 Cycle.

The following other standards, interpretations and amendments to existing standards have been issued but were not mandatory for accounting
periods beginning on 1 January 2018 and are not expected to have a material impact on the Group:
– IFRIC 23 Uncertainty over Income Tax Treatments, effective from 1 January 2019;
– Amendments to IFRS 9: Prepayment Features with Negative Compensation, effective from 1 January 2019;
– Amendments to IAS 28: Long-term Interests in Associates and Joint Ventures, effective from 1 January 2019;
– Amendments to IAS 19: Plan Amendment, Curtailment or Settlement, effective from 1 January 2019 (not yet endorsed by the EU);
– Annual Improvements to IFRS Standards 2015–2017 Cycle, effective from 1 January 2019 (not yet endorsed by the EU);
– Amendments to IFRS 3: Definition of a Business, effective from 1 January 2020 (not yet endorsed by the EU);
– Amendments to References to the Conceptual Framework in IFRS Standards, effective 1 January 2020 (not yet endorsed by the EU);
– Amends to IAS 1 and IAS 8: Definition of Material, effective from 1 January 2020 (not yet endorsed by the EU);
– IFRS 17 Insurance Contracts, effective from 1 January 2021; and
– Amendments to IFRS 10 and IAS 28: Sale or contribution of assets between an investor and its associate or joint venture, effective date

deferred indefinitely.

Consolidation
The financial statements of the Group consolidate the results of the Company and its subsidiary entities, and include its share of its joint ventures’
results accounted for under the equity method.

A subsidiary is an entity controlled by the Group. The Group controls a subsidiary when it is exposed, or has the rights, to variable returns from
its involvement with the subsidiary and has the ability to affect those returns through its power over the subsidiary. The results of subsidiaries are
included in the income statement from the date of acquisition.

Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated in preparing
the consolidated financial statements.

Joint ventures are accounted for under the equity method where the Consolidated income statement includes the Group’s share of their profits
and losses, and the Consolidated balance sheet includes its share of their net assets within equity accounted investments.

The assets and liabilities of overseas subsidiaries and equity accounted investments are translated at the exchange rates ruling at the balance sheet
date. The income statements of such entities are translated at average rates of exchange during the year. All resulting exchange differences are
recognised directly in a separate component of equity. Translation differences that arose before the transition date to IFRS (1 January 2004) are
presented in equity, but not as a separate component. When a foreign operation is sold, the cumulative exchange differences recognised in equity
since 1 January 2004 are recognised in the income statement as part of the profit or loss on sale.

143

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsConsolidated income statement
for the year ended 31 December

Continuing operations
Sales
Deduct Share of sales by equity accounted investments
Add Sales to equity accounted investments
Revenue
Operating costs
Other income
Group operating profit
Share of results of equity accounted investments

Underlying EBITA
Non-recurring items
EBITA
Amortisation of intangible assets
Impairment of intangible assets
Financial expense of equity accounted investments
Taxation expense of equity accounted investments

Operating profit

Financial income
Financial expense
Net finance costs
Profit before taxation
Taxation expense
Profit for the year

Attributable to:

Equity shareholders
Non-controlling interests

Earnings per share

Basic earnings per share
Diluted earnings per share

2018

2017 (restated)1

Notes

£m

Total
£m

£m

Total
£m

1
1
1
1
2
4

1
1

1
1
5
6
1

18,407
(2,812)
1,226

18,487
(2,534)
1,271

16,821
(15,514)
158
1,465
140

17,224
(16,043)
131
1,312
107

1,928
(154)
1,774
(85)
(33)
(13)
(38)

228
(609)

1,974
(13)
1,961
(86)
(384)
(34)
(38)

1,605

1,419

416
(762)

(381)
1,224
(191)
1,033

1,000
33
1,033

31.3p
31.2p

(346)
1,073
(216)
857

827
30
857

26.0p
25.9p

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

144

BAE SystemsAnnual Report 2018Consolidated statement of comprehensive income
for the year ended 31 December

Profit for the year
Other comprehensive income
Items that will not be reclassified to the income statement:

Subsidiaries:

Remeasurements on retirement benefit schemes
Tax on items that will not be reclassified to the income statement

Equity accounted investments (net of tax)

Items that may be reclassified to the income statement:

Subsidiaries:

Currency translation on foreign currency net investments
Amounts (charged)/credited to hedging reserve
Tax on items that may be reclassified to the income statement

Equity accounted investments (net of tax)

Total other comprehensive income for the year (net of tax)
Total comprehensive income for the year

Attributable to:

Equity shareholders
Non-controlling interests

Other
reserves2
£m
–

2018

Retained
earnings
£m
1,033

Notes

–
–
–

400
(25)
5
15
395
395

391
4
395

74
5
6

–
–
–
–
85
1,118

1,085
33
1,118

2017 (restated)1

Other
reserves2
£m
–

Retained
earnings
£m
857

Total
£m
857

–
–
–

2,056
(481)
52

(630)
59
(11)
(18)
(600)
(600)

(595)
(5)
(600)

–
–
–
–
1,627
2,484

2,454
30
2,484

(630)
59
(11)
(18)
1,027
1,884

1,859
25
1,884

Total
£m
1,033

74
5
6

400
(25)
5
15
480
1,513

1,476
37
1,513

Consolidated statement of changes in equity
for the year ended 31 December

Balance at 1 January 2018 as originally presented
Restatement1
Restated total equity at 1 January 2018

Profit for the year
Total other comprehensive income for the year

Total comprehensive income for the year
Share-based payments (inclusive of tax)
Net sale of own shares
Ordinary share dividends
Partial disposal of shareholding in subsidiary undertaking
At 31 December 2018

Balance at 1 January 2017 as originally presented
Restatement1
Restated total equity at 1 January 2017

Profit for the year
Total other comprehensive income for the year

Total comprehensive income for the year
Share-based payments (inclusive of tax)
Net purchase of own shares
Ordinary share dividends
At 31 December 2017

Notes

Attributable to equity holders of BAE Systems plc

Issued
share
capital
£m
87
–
87
–
–
–
–
–
–
–
87

87
–
87
–
–
–
–
–
–
87

Share
premium
£m
1,249
–
1,249
–
–
–
–
–
–
–
1,249

1,249
–
1,249
–
–
–
–
–
–
1,249

Other
reserves2
£m
6,098
(8)
6,090
–
391
391
–
–
–
–
6,481

6,685
–
6,685
–
(595)
(595)
–
–
–
6,090

Retained
earnings
£m
(2,693)
(21)
(2,714)
1,000
85
1,085
63
1
(703)
(3)
(2,271)

(4,583)
47
(4,536)
827
1,627
2,454
53
(1)
(684)
(2,714)

Non-
controlling
interests
£m
43
–
43
33
4
37
–
–
(28)
20
72

26
–
26
30
(5)
25
–
–
(8)
43

Total
£m
4,741
(29)
4,712
1,000
476
1,476
63
1
(703)
(3)
5,546

3,438
47
3,485
827
1,032
1,859
53
(1)
(684)
4,712

Total
equity
£m
4,784
(29)
4,755
1,033
480
1,513
63
1
(731)
17
5,618

3,464
47
3,511
857
1,027
1,884
53
(1)
(692)
4,755

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

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

145

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsConsolidated balance sheet
as at 31 December

Non-current assets
Intangible assets
Property, plant and equipment
Investment property
Equity accounted investments
Other investments
Other receivables
Retirement benefit surpluses
Other financial assets
Deferred tax assets

Current assets
Inventories
Trade, other and contract receivables
Current tax
Other financial assets
Cash and cash equivalents
Assets held for sale

Total assets
Non-current liabilities
Loans
Other payables
Retirement benefit obligations
Other financial liabilities
Deferred tax liabilities
Provisions

Current liabilities
Loans and overdrafts
Trade and other payables
Other financial liabilities
Current tax
Provisions
Liabilities held for sale

Total liabilities
Net assets

Capital and reserves
Issued share capital
Share premium
Other reserves
Retained earnings – deficit
Total equity attributable to equity holders of BAE Systems plc
Non-controlling interests
Total equity

2018
£m

2017
(restated)1
£m

2016
(restated)1
£m

Notes

8
9
10
11

12
22
13
14

15
12
16
13
17
18

20
21
22
13
14
23

20
21
13
16
23
18

10,658
2,365
98
429
13
352
308
245
702
15,170

774
5,177
81
166
3,232
146
9,576
24,746

(3,514)
(1,536)
(4,240)
(104)
–
(427)
(9,821)

(785)
(7,740)
(74)
(334)
(334)
(40)
(9,307)
(19,128)
5,618

87
1,249
6,481
(2,271)
5,546
72
5,618

10,378
2,230
101
322
6
387
302
226
702
14,654

733
4,244
20
89
3,271
26
8,383
23,037

(4,069)
(1,723)
(4,324)
(133)
(4)
(435)
(10,688)

(14)
(6,755)
(104)
(305)
(400)
(16)
(7,594)
(18,282)
4,755

87
1,249
6,090
(2,714)
4,712
43
4,755

11,264
2,098
110
250
6
351
223
345
1,181
15,828

776
3,959
5
204
2,769
2
7,715
23,543

(4,425)
(1,040)
(6,330)
(102)
(10)
(392)
(12,299)

–
(6,917)
(212)
(311)
(291)
(2)
(7,733)
(20,032)
3,511

87
1,249
6,685
(4,536)
3,485
26
3,511

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

Approved by the Board on 20 February 2019 and signed on its behalf by:

C N Woodburn
Chief Executive

P J Lynas
Group Finance Director

146

BAE SystemsAnnual Report 2018Consolidated cash flow statement
for the year ended 31 December

Profit for the year
Taxation expense
Research and development expenditure credits
Share of results of equity accounted investments
Net finance costs
Depreciation, amortisation and impairment
Gain on investment revaluation
Profit on disposal of property, plant and equipment, and investment property
Loss in respect of held for sale assets and business disposals
Cost of equity-settled employee share schemes
Movements in provisions
Decrease in liabilities for retirement benefit obligations
(Increase)/decrease in working capital:

Inventories
Trade, other and contract receivables
Trade and other payables

Taxation paid
Net cash flow from operating activities
Dividends received from equity accounted investments
Interest received
Purchase of property, plant and equipment, and investment property
Purchase of intangible assets
Proceeds from sale of property, plant and equipment, and investment property
Proceeds from sale of intangible assets
Purchase of subsidiary undertakings
Purchase of equity accounted investment
Partial disposal of shareholding in subsidiary undertaking
Equity accounted investment funding
Cash and cash equivalents acquired with subsidiary undertakings
Cash flow in respect of held for sale assets and business disposals
Cash and cash equivalents disposed of with subsidiary undertakings
Net cash flow from investing activities
Interest paid
Net sale/(purchase) of own shares
Equity dividends paid
Dividends paid to non-controlling interests
Cash flow from matured derivative financial instruments (excluding cash flow hedges)
Cash flow from movement in cash collateral
Cash flow from repayment of loans
Net cash flow from financing activities
Net (decrease)/increase in cash and cash equivalents
Cash and cash equivalents at 1 January
Effect of foreign exchange rate changes on cash and cash equivalents
Cash and cash equivalents at 31 December
Comprising:

Cash and cash equivalents
Overdrafts

Cash and cash equivalents at 31 December

Notes

6
4
1
5
2

2,4
2

11
34

17
20

2018
£m
1,033
191
(27)
(140)
381
411
(7)
(18)
9
64
(101)
(153)

(16)
(757)
530
(200)
1,200
57
25
(358)
(139)
34
–
–
(2)
17
(1)
14
12
–
(341)
(203)
1
(703)
(28)
6
2
(7)
(932)
(73)
3,264
41
3,232

3,232
–
3,232

2017
(restated)1
£m
857
216
(20)
(107)
346
728
–
(10)
13
61
150
(138)

(29)
(397)
454
(227)
1,897
72
23
(389)
(87)
34
1
(3)
–
–
(3)
–
(6)
(2)
(360)
(204)
(1)
(684)
(8)
(83)
(15)
–
(995)
542
2,771
(49)
3,264

3,271
(7)
3,264

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

147

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsNotes to the
Group accounts

1. Segmental analysis

Revenue and profit recognition
Revenue represents income derived from contracts for the provision of goods and services, over time or at a point in time, by the Group to
customers in exchange for consideration in the ordinary course of the Group’s activities.

Performance obligations
Upon approval by the parties to a contract, the contract is assessed to identify each promise to transfer either a distinct good or service or a series
of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Goods and services are distinct
and accounted for as separate performance obligations in the contract if the customer can benefit from them either on their own or together
with other resources that are readily available to the customer and they are separately identifiable in the contract.

The Group provides warranties to its customers to give them assurance that its products and services will function in line with agreed-upon
specifications. Warranties are not provided separately and, therefore, do not represent separate performance obligations.

Transaction price
At the start of the contract, the total transaction price is estimated as the amount of consideration to which the Group expects to be entitled in
exchange for transferring the promised goods and services to the customer, excluding sales taxes. Variable consideration, such as price escalation,
is included based on the expected value or most likely amount only to the extent that it is highly probable that there will not be a reversal in the
amount of cumulative revenue recognised. The transaction price does not include estimates of consideration resulting from contract modifications,
such as change orders, until they have been approved by the parties to the contract. The total transaction price is allocated to the performance
obligations identified in the contract in proportion to their relative stand-alone selling prices. Given the bespoke nature of many of the Group’s
products and services, which are designed and/or manufactured under contract to the customer’s individual specifications, there are typically
no observable stand-alone selling prices. Instead, stand-alone selling prices are typically estimated based on expected costs plus contract margin
consistent with the Group’s pricing principles.

Whilst payment terms vary from contract to contract, on many of the Group’s contracts, an element of the transaction price is received in advance
of delivery. The Group therefore has significant contract liabilities (note 21). The Group’s contracts are not considered to include significant financing
components on the basis that there is no difference between the consideration and the cash selling price. UK Ministry of Defence contracting
rules prohibit the inclusion of financing in the sales price. Negotiations on competitive international export contracts do not make allowance for
the cash payment profile.

Revenue and profit recognition
Revenue is recognised as performance obligations are satisfied as control of the goods and services is transferred to the customer.

For each performance obligation within a contract, the Group determines whether it is satisfied over time or at a point in time. Performance
obligations are satisfied over time if one of the following criteria is satisfied:

– the customer simultaneously receives and consumes the benefits provided by the Group’s performance as it performs;

– the Group’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or

– the Group’s performance does not create an asset with an alternative use to the Group and it has an enforceable right to payment

for performance completed to date.

The Group has determined that most of its contracts satisfy the over time criteria, either because the customer simultaneously receives and
consumes the benefits provided by the Group’s performance as it performs (typically services or support contracts) or the Group’s performance
does not create an asset with an alternative use to the Group and it has an enforceable right to payment for performance completed to date
(typically development or production contracts).

For each performance obligation to be recognised over time, the Group recognises revenue using an input method, based on costs incurred
in the period. Revenue and attributable margin are calculated by reference to reliable estimates of transaction price and total expected
costs, after making suitable allowances for technical and other risks. Revenue and associated margin are therefore recognised progressively
as costs are incurred, and as risks have been mitigated or retired. The Group has determined that this method appropriately depicts the
Group’s performance in transferring control of the goods and services to the customer.

If the over time criteria for revenue recognition are not met, revenue is recognised at the point in time that control is transferred to the customer,
which is usually when legal title passes to the customer and the business has the right to payment, for example, on delivery.

When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised immediately as an expense.

148

BAE SystemsAnnual Report 20181. Segmental analysis continued

Software licences
The Group sells software licences either separately or together with other goods and services, including computer hardware and implementation,
hosting and support. Revenue recognition in respect of software licences sold as part of a bundle of goods and services is considered separately
when the licence is determined to be a separate performance obligation. Software licences either represent a right to access the Group’s
intellectual property as it exists throughout the licence period or a right to use the Group’s intellectual property as it exists at the point in time
at which the licence is granted. Revenue in respect of right to access licences is recognised over the licence term or, in relation to perpetual
licences, over the related customer relationship and revenue in respect of right to use licences is recognised upfront on delivery to the customer.
A software licence is considered to be a right to access the Group’s intellectual property as it exists throughout the licence period if all of the
following criteria are satisfied:

– the contract requires, or the customer reasonably expects, that the Group will undertake activities that significantly affect the intellectual

property; and

– the licence directly exposes the customer to the effects of those activities; and

– those activities do not result in the transfer of a good or service to the customer.

Contract modifications
The Group’s contracts are often amended for changes in customers’ requirements and specifications. A contract modification exists when the
parties to the contract approve a modification that either changes existing or creates new enforceable rights and obligations. The effect of a
contract modification on the transaction price and the Group’s measure of progress towards the satisfaction of the performance obligation to
which it relates is recognised in one of the following ways:

1. prospectively, as an additional, separate contract;

2. prospectively, as a termination of the existing contract and creation of a new contract; or

3. as part of the original contract using a cumulative catch-up.

The majority of the Group’s contract modifications are treated under either 1 (for example, the requirement for additional distinct goods or
services) or 3 (for example, a change in the specification of the distinct goods or services for a partially completed contract), although the facts
and circumstances of any contract modification are considered individually as the types of modifications will vary contract-by-contract and may
result in different accounting outcomes.

Costs to obtain a contract
The Group expenses pre-contract bidding costs which are incurred regardless of whether a contract is awarded. The Group does not typically
incur costs to obtain contracts that it would not have incurred had the contracts not been awarded, such as sales commission.

Costs to fulfil a contract
Contract fulfilment costs in respect of over time contracts are expensed as incurred. Contract fulfilment costs in respect of point in time contracts
are accounted for under IAS 2 Inventories.

Reporting segments
With effect from 1 January 2018, the Group revised its reporting segments to reflect the organisational changes announced in 2017. The five
principal reporting segments are Electronic Systems; Cyber & Intelligence; Platforms & Services (US); Air; and Maritime. These align with the
strategic direction of the Group. Financial information for 2017 has been re-presented to reflect these new reporting segments.

– 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;

– 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;

– 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 and operation of government-owned munitions facilities;

– 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 European MBDA joint venture;

– Maritime comprises the Group’s UK-based maritime and land activities; and

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

The Board (the chief operating decision maker as defined by IFRS 8 Operating Segments) monitors the results of these reporting segments
to assess performance and make decisions about the allocation of resources. Segmental performance is evaluated based on Key Performance
Indicators – sales (see page 150) and underlying EBITA (see page 151). Finance costs and taxation expense are managed on a Group basis.

149

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements1. Segmental analysis continued

Key Performance Indicator – Sales
Definition Revenue plus the Group’s share of revenue of equity accounted investments.

Purpose Allows management to monitor the sales performance of subsidiaries and equity accounted investments.

Sales and revenue by reporting segment1

Sales

Deduct
Share of sales by equity
accounted investments

Add
Sales to equity
accounted investments

Revenue

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ

Intra-group sales/revenue

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ

2018
£m
3,965
1,678
3,005
6,712
2,975
350
18,685
(278)
18,407

2017
(restated)2
£m
3,598
1,818
2,951
7,210
2,877
336
18,790
(303)
18,487

2018
£m
(101)
–
(141)
(2,224)
(37)
(309)
(2,812)
–
(2,812)

2017
(restated)2
£m
(95)
–
(103)
(2,006)
(41)
(289)
(2,534)
–
(2,534)

2018
£m
101
–
–
1,091
2
–
1,194
32
1,226

2017
(restated)2
£m
95
–
–
1,108
9
–
1,212
59
1,271

2018
£m
3,965
1,678
2,864
5,579
2,940
41
17,067
(246)
16,821

2017
(restated)2
£m
3,598
1,818
2,848
6,312
2,845
47
17,468
(244)
17,224

Intra-group revenue

Revenue from
external customers

2018
£m
54
91
39
10
40
12
246

2017
(restated)2
£m
73
88
23
9
40
11
244

2018
£m
3,911
1,587
2,825
5,569
2,900
29
16,821

2017
(restated)2
£m
3,525
1,730
2,825
6,303
2,805
36
17,224

1. Reporting segments have been re-presented to reflect the organisational changes which took effect on 1 January 2018.
2. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

Sales and revenue by customer location

UK
Rest of Europe2
US
Canada
Saudi Arabia
Rest of Middle East
Australia
Rest of Asia and Pacific
Africa, and Central and South America

Sales

Revenue

2018
£m
3,819
2,007
7,729
115
2,593
801
562
636
145
18,407

2017
(restated)1
£m
3,623
2,046
7,460
100
3,085
912
608
503
150
18,487

2018
£m
3,622
1,176
7,713
115
2,464
694
560
430
47
16,821

2017
(restated)1
£m
3,390
1,472
7,457
100
2,964
826
607
314
94
17,224

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
2.

Includes £0.7bn (2017 £0.9bn) generated under the Typhoon workshare agreement with Eurofighter Jagdflugzeug GmbH.

150

BAE SystemsAnnual Report 2018Notes to the Group accounts continued1. Segmental analysis continued

Revenue by major customer
Revenue from the Group’s three principal customers, which individually represent over 10% of total revenue, is as follows:

US Department of Defense
UK Ministry of Defence2
Kingdom of Saudi Arabia Ministry of Defence and Aviation

2018
£m
5,148
3,848
2,366

2017
(restated)1
£m
4,543
3,933
2,799

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
2.

Includes £0.7bn (2017 £0.9bn) generated under the Typhoon workshare agreement with Eurofighter Jagdflugzeug GmbH.

Revenue from the UK Ministry of Defence and the US Department of Defense was generated by the five principal reporting segments. Revenue
from the Kingdom of Saudi Arabia Ministry of Defence and Aviation was generated by the Air and Maritime reporting segments.

Key Performance Indicator – Underlying EBITA
Definition Operating profit excluding amortisation and impairment of intangible assets, finance costs and taxation expense of equity accounted
investments (EBITA), and non-recurring items.

Purpose Provides a measure of operating profitability that is comparable over time.

Amortisation and impairment of intangible assets are excluded because they are not related to the in-year operational performance of the
business, being driven by the timing and amount of investment in acquired businesses and software.

Finance costs and taxation expense of equity accounted investments are excluded for consistency with pre-interest, pre-tax business performance.

Non-recurring items are items of financial performance which have been determined by management as being material by their size or incidence
and not relevant to an understanding of the Group’s underlying business performance. The Group’s definition of non-recurring items includes
profit or loss on business transactions, and costs incurred which are one-off in nature, for example non-routine costs or income relating to
post-retirement benefit schemes, and other exceptional items which management has determined as not being relevant to an understanding
of the Group’s underlying business performance.

2018
The non-recurring loss of £154m represents a Guaranteed Minimum Pension equalisation charge of £114m (see note 22), and a loss on disposal
of the Mobile, Alabama, shipyard of £40m.

2017
The non-recurring loss of £13m represented the loss on disposal of the BAE Systems San Francisco Ship Repair business.

Operating profit/(loss) by reporting segment1

Underlying EBITA

Non-recurring items

Amortisation
and impairment
of intangible assets

Financial and
taxation expense
of equity accounted
investments

2018
£m
606
111
210
859
209
(67)
1,928

2017
(restated)2
£m
541
58
237
967
251
(80)
1,974

2018
£m
–
–
(40)
–
–
(114)
(154)

2017
£m
–
–
(13)
–
–
–
(13)

2018
£m
(16)
(52)
(8)
(12)
(16)
(14)
(118)

2017
£m
(20)
(419)
(9)
(8)
(8)
(6)
(470)

2018
£m
–
–
(1)
(37)
(2)
(11)
(51)

2017
(restated)2
£m
–
–
(2)
(41)
(3)
(26)
(72)

Operating
profit/(loss)

2018
£m
590
59
161
810
191
(206)
1,605
(381)
1,224
(191)
1,033

2017
(restated)2
£m
521
(361)
213
918
240
(112)
1,419
(346)
1,073
(216)
857

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ

Net finance costs
Profit before taxation
Taxation expense
Profit for the year

151

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements1. Segmental analysis continued

Share of results of equity accounted investments within reporting segments1

Electronic Systems
Platforms & Services (US)
Air
Maritime
HQ

Underlying EBITA

Non-recurring items

Amortisation
of intangible assets

Financial and
taxation expense

2018
£m
9
23
150
7
13
202

2017
(restated)2
£m
6
13
132
8
24
183

2018
£m
–
–
–
–
(4)
(4)

2017
£m
–
–
–
–
–
–

2018
£m
–
–
(7)
–
–
(7)

2017
£m
–
–
(4)
–
–
(4)

2018
£m
–
(1)
(37)
(2)
(11)
(51)

2017
(restated)2
£m
–
(2)
(41)
(3)
(26)
(72)

Share of results
of equity accounted
investments

2018
£m
9
22
106
5
(2)
140

2017
(restated)2
£m
6
11
87
5
(2)
107

Key Performance Indicator – Order backlog
Definition Funded and unfunded unexecuted customer orders including the Group’s share of order backlog of equity accounted investments.
Unfunded orders include the elements of US multi-year contracts for which funding has not been authorised by the customer.

Purpose Supports future years’ sales performance of subsidiaries and equity accounted investments.

Performance obligations
The Group’s order book1, reconciled to order backlog as defined by the Group, is shown below.

Order backlog as defined by the Group
Deduct Unfunded order backlog
Deduct Share of order backlog of equity accounted investments
Add Order backlog in respect of orders from equity accounted investments
Order book1

1. Order book represents the transaction price allocated to unsatisfied and partially satisfied performance obligations as defined by IFRS 15 Revenue from Contracts

with Customers. As permitted under the transitional provisions of IFRS 15, comparative information in respect of the Group’s order book is not disclosed.

The Group expects that approximately 35% of the order book as at 31 December 2018 will be recognised as revenue during the next year,
with the remainder largely recognised over the following four years.

2018
£bn
48.4
(2.0)
(9.9)
3.3
39.8

152

BAE SystemsAnnual Report 2018Notes to the Group accounts continued2. Operating costs

Leases
Lease payments made under operating leases, including any incentives granted, are recognised in the income statement on a straight-line basis
over the lease term.

Research and development
The Group undertakes research and development activities either on its own behalf or on behalf of customers.

Group-funded expenditure on research, and on development activities not meeting the conditions for capitalisation, is written off as incurred
and charged to the income statement.

Customer-funded expenditure on research and development activities is recognised in the income statement in accordance with the Group’s
revenue recognition policy.

Raw materials, subcontracts and other bought-in items used
Change in inventories of finished goods and work-in-progress
Staff costs (note 3)
Guaranteed Minimum Pension equalisation charge (note 22)
Depreciation
Amortisation
Impairment – property, plant and equipment (note 9), and investment property (note 10)
Impairment – intangible assets (note 8)
Lease expense
Loss on disposal of property, plant and equipment, and investment property
Loss in respect of held for sale assets and business disposals
Other operating charges
Operating costs

2018
£m
5,816
44
5,876
110
269
78
31
33
287
1
9
2,960
15,514

2017
(restated)1
£m
6,098
(74)
5,830
–
263
82
(1)
384
295
1
13
3,152
16,043

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

Operating costs includes research and development expenditure of £212m (2017 £238m) funded by the Group. Development investment
of £10m (2017 £nil) was capitalised during the year (see note 8).

153

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements2. Operating costs continued

Fees payable to the Company’s auditor and its associates included in operating costs1

Fees payable to the Company’s auditor for the audit of the

Company’s annual accounts

Fees payable to the Company’s auditor and its associates

for other services to the Group:
The audit of the Company’s subsidiaries

Total audit fees

Audit-related assurance services2
Tax compliance services
Tax advisory services
Other assurance services
Other services3

Total non-audit fees
Total fees payable to the Company’s auditor and its associates

Fees in respect of BAE Systems pension schemes:

Audit
Tax compliance
Tax advisory

2018

UK
£’000

Overseas
£’000

Total
£’000

UK
£’000

2017

Overseas
£’000

Total
£’000

2,000

–

2,000

2,034

–

2,034

2,687
4,687
690
–
–
175
1,776
2,641
7,328

–
–
–
–

4,091
4,091
–
–
–
–
–
–
4,091

–
–
–
–

6,778
8,778
690
–
–
175
1,776
2,641
11,419

–
–
–
–

2,809
4,843
1,086
–
–
–
38
1,124
5,967

–
–
–
–

4,471
4,471
108
107
35
–
53
303
4,774

292
5
–
297

7,280
9,314
1,194
107
35
–
91
1,427
10,741

292
5
–
297

1. 2017 fees are payable to KPMG LLP. Deloitte LLP replaced KPMG LLP as the Company’s auditor at the Annual General Meeting on 10 May 2018. 2018 fees are payable

to Deloitte LLP.

2. 2018 primarily relates to the review of the half-yearly financial report. 2017 includes advice from KPMG LLP in respect of IFRS 15.
3. 2018 primarily relates to consultancy work undertaken by Deloitte LLP in relation to the Group’s Submarines business (see page 83).

154

BAE SystemsAnnual Report 2018Notes to the Group accounts continued3. Employees

The weekly average and year-end numbers of employees, excluding those in equity accounted investments, were as follows:

Weekly average

At year end

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ

2018
Number
’000
15
10
11
22
16
2
76

20171
Number
’000
14
11
11
22
16
2
76

1. Reporting segments have been re-presented to reflect the organisational changes which took effect on 1 January 2018.

The aggregate staff costs of Group employees, excluding employees of equity accounted investments, were as follows:

Wages and salaries
Social security costs
Share-based payments (note 30)
Pension costs – defined contribution plans (note 22)
Pension costs – defined benefit plans (note 22)
US healthcare costs (note 22)

4. Other income

Leases
Lease income under operating leases is recognised in the income statement on a straight-line basis over the lease term.

Research and development expenditure credits
Rental income from operating leases – investment property
Rental income from operating leases – other
Profit on disposal of property, plant and equipment
Profit on disposal of investment property
Management recharges to equity accounted investments (note 31)
Royalties
Other 1
Other income

2018
Number
’000
16
10
11
23
16
2
78

2018
£m
5,019
367
63
203
223
1
5,876

20171
Number
’000
14
11
11
22
16
2
76

2017
£m
4,972
360
61
193
242
2
5,830

2018
£m
27
22
15
13
6
18
11
46
158

2017
£m
20
23
16
2
9
16
9
36
131

Includes £15m for capital spend recovery in respect of Saudi Arabia Industrial Participation investments and an £8m (2017 £11m) recovery of site development costs
for the Dreadnought programme in Barrow. There are no other individual amounts in excess of £10m.

155

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements5. Net finance costs

Interest income and borrowing costs
Interest income and borrowing costs are recognised in the income statement in the period in which they are incurred.

Interest income
Gain on remeasurement of financial instruments at fair value through profit or loss1
Foreign exchange gains2
Financial income
Interest expense on bonds and other financial instruments
Facility fees
Net present value adjustments
Net interest expense on retirement benefit obligations (note 22)
Loss on remeasurement of financial instruments at fair value through profit or loss1
Foreign exchange losses2
Financial expense
Net finance costs

2018
£m
26
186
16
228
(204)
(4)
(31)
(103)
(40)
(227)
(609)
(381)

2017
£m
24
54
338
416
(202)
(4)
(44)
(165)
(317)
(30)
(762)
(346)

1. Comprises gains and losses on derivative financial instruments, including derivative instruments to manage the Group’s exposure to interest rate fluctuations on external

borrowings and exchange rate fluctuations on balances with the Group’s subsidiaries and equity accounted investments.
2. The foreign exchange gains and losses primarily reflect exchange rate movements on US dollar-denominated borrowings.

Additional analysis

Net finance costs:

Group
Share of equity accounted investments

Analysed as:

Underlying net interest expense1:

Group
Share of equity accounted investments

Other:

Group:

Net interest expense on retirement benefit obligations
Fair value and foreign exchange adjustments on financial instruments and investments2

Share of equity accounted investments:

Net interest expense on retirement benefit obligations
Fair value and foreign exchange adjustments on financial instruments and investments

2018
£m

(381)
(13)
(394)

(213)
(2)
(215)

(103)
(65)

(3)
(8)
(394)

2017
£m

(346)
(34)
(380)

(226)
(19)
(245)

(165)
45

(8)
(7)
(380)

1. Underlying net interest expense is defined as finance costs for the Group and its share of equity accounted investments, excluding net interest expense on retirement

benefit obligations and fair value and foreign exchange adjustments on financial instruments and investments.

2. The net loss (2017 gain) primarily reflects foreign exchange translational losses (2017 gains) on US dollar-denominated bonds held by BAE Systems plc.

156

BAE SystemsAnnual Report 2018Notes to the Group accounts continued6. Taxation expense

Income tax expense comprises current and deferred tax. Current and deferred tax is recognised in profit or loss except to the extent that it relates
to a business combination or items recognised directly in equity or other comprehensive income.

Current tax
Current tax is the expected tax payable or receivable on the taxable profit or loss for the year, using tax rates enacted or substantively enacted
at the reporting date, and any adjustment to tax payable in respect of previous years.

Deferred tax
Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for taxation purposes. Deferred tax is not recognised for temporary differences:
– on the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects neither accounting nor

taxable profit or loss;

– related to investments in subsidiaries and equity accounted investments to the extent that it is probable that they will not reverse in the

foreseeable future; and

– arising on the initial recognition of goodwill.

Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that
have been enacted or substantively enacted by the reporting date.

Taxation expense

Current taxation
UK:

Current year
Adjustments in respect of prior years

Overseas:

Current year
Adjustments in respect of prior years

Total current taxation
Deferred taxation
UK:

Origination and reversal of temporary differences
Adjustments in respect of prior years
Tax rate adjustment

Overseas:

Origination and reversal of temporary differences
Adjustments in respect of prior years
Tax rate adjustment2

Total deferred taxation
Taxation expense

UK
Overseas
Taxation expense

2018
£m

2017
(restated)1
£m

(64)
(2)
(66)

(183)
42
(141)
(207)

15
15
–
30

(1)
(18)
5
(14)
16
(191)

(36)
(155)
(191)

(132)
(21)
(153)

(160)
40
(120)
(273)

52
3
(1)
54

(42)
(13)
58
3
57
(216)

(99)
(117)
(216)

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding

the restatement.

2. The US federal tax rate was reduced from 35% to 21% with effect from 1 January 2018, while the estimated state tax rate increased from 5% to 6%. In line with this
change, the rate applying to US deferred tax assets and liabilities at 31 December 2017 was reduced from 40% to 27%, creating a rate adjustment in 2017, which was
partly reflected in the Consolidated income statement and partly in the Consolidated statement of comprehensive income. The rate applying to US deferred tax assets
and liabilities has been further reduced to 25.7% at 31 December 2018, creating a rate adjustment in 2018, which is partly reflected in the Consolidated income statement
and partly in the Consolidated statement of comprehensive income.

157

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements6. Taxation expense continued

Reconciliation of taxation expense
The following table reconciles the theoretical income tax expense, using the UK corporation tax rate, to the reported tax expense. The reconciling
items represent, besides the impact of tax rate differentials and changes, non-taxable benefits or non-deductible expenses arising from differences
between the local tax base and the reported financial statements.

Profit before taxation

UK corporation tax rate
Expected income tax expense
Effect of tax rates in foreign jurisdictions, including US state taxes
Effect of intra-group financing
Expenses not tax effected
Income not subject to tax
Research and development tax credits and patent box benefits
Non-deductible goodwill impairment
Chargeable gains
Utilisation of previously unrecognised tax losses
Adjustments in respect of prior years
Adjustments in respect of equity accounted investments
Tax rate adjustment2
Other
Taxation expense

2018
£m
1,224

2017
(restated)1
£m
1,073

19% 19.25%
(207)
(233)
(95)
(43)
15
14
(8)
(14)
46
18
18
14
(74)
–
(2)
(1)
3
1
9
37
21
27
57
5
1
(16)
(216)
(191)

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
2. 2017 included a £58m credit in respect of US tax reform enacted in December 2017.

Calculation of the underlying effective tax rate

Profit before taxation
Add back:

Taxation expense of equity accounted investments
Goodwill impairment (note 8)
Adjusted profit before taxation

Taxation expense
Taxation expense of equity accounted investments
Exclude: Impact of US tax reform enacted in December 2017
Adjusted taxation expense (including equity accounted investments)

Underlying effective tax rate

2018
£m
1,224

38
–
1,262

(191)
(38)
–
(229)

2017
(restated)1
£m
1,073

38
384
1,495

(216)
(38)
(58)
(312)

18%

21%

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

158

BAE SystemsAnnual Report 2018Notes to the Group accounts continued6. Taxation expense continued

Tax recognised in other comprehensive income

Items that will not be reclassified to the income statement:

Subsidiaries:

Remeasurements on retirement benefit schemes
Tax rate adjustment2

Equity accounted investments

Items that may be reclassified to the income statement:

Subsidiaries:

Currency translation on foreign currency net investments
Amounts (charged)/credited to hedging reserve

Equity accounted investments

2018

Tax
benefit/
(expense)
£m

Before
tax
£m

Net of tax
£m

2017 (restated)1

Before
tax
£m

Tax
(expense)/
benefit
£m

Net of tax
£m

74
–
8

400
(25)
16
473

3
2
(2)

–
5
(1)
7

77
2
6

400
(20)
15
480

2,056
–
65

(630)
59
(17)
1,533

(398)
(83)
(13)

–
(11)
(1)
(506)

1,658
(83)
52

(630)
48
(18)
1,027

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

2. 2017 comprised £67m in relation to the US and £16m in relation to the UK.

Current tax
Subsidiaries:

Remeasurements on retirement benefit schemes

Deferred tax
Subsidiaries:

Remeasurements on retirement benefit schemes
Tax rate adjustment2
Amounts charged to hedging reserve

Equity accounted investments

Tax on other comprehensive income

Other
reserves
£m

2018

Retained
earnings
£m

2017 (restated)1

Other
reserves
£m

Retained
earnings
£m

Total
£m

–
–

–
–
5
(1)
4
4

24
24

(21)
2
–
(2)
(21)
3

24
24

(21)
2
5
(3)
(17)
7

–
–

–
–
(11)
(1)
(12)
(12)

23
23

(421)
(83)
–
(13)
(517)
(494)

Total
£m

23
23

(421)
(83)
(11)
(14)
(529)
(506)

1. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s defined

benefit pension schemes. See note 37 for details regarding the restatement.
2. 2017 comprised £67m in relation to the US and £16m in relation to the UK.

159

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements7. Earnings per share

Key Performance Indicator – Underlying earnings per share
Definition Basic earnings per share excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions
and financial derivatives, non-recurring items and, in 2017, the impact of US tax reform enacted in December 2017.

Purpose Provides a measure of underlying performance that is comparable over time.

Amortisation and impairment of intangible assets are excluded because they are not related to the in-year operational performance of the
business, being driven by the timing and quantum of investment in acquired businesses and software.

Non-cash finance movements on pensions are excluded because they are driven by external factors, such as corporate bond yields and inflation.

Non-cash finance movements on financial derivatives are excluded because they are driven by external factors, such as foreign exchange rates
and interest rates.

Non-recurring items (as defined in note 1) are items of financial performance which have been determined by management as being material
by their size or incidence and not relevant to an understanding of the Group’s underlying performance.

In 2017, the impact of US tax reform enacted in December 2017 was excluded because it did not reflect the Group’s in-year underlying tax rate.

Profit for the year attributable to equity shareholders
Add back/(deduct):

Amortisation and impairment of intangible assets, post tax2
Impairment of goodwill
Non-cash movements, being net interest expense on retirement

benefit obligations, post tax2

Non-cash movements, being fair value and foreign exchange

adjustments on financial instruments and investments, post tax2

Non-recurring items, post tax2
Impact of US tax reform enacted in December 20173

Underlying earnings, post tax

Weighted average number of shares used in calculating basic

earnings per share

Incremental shares in respect of employee share schemes
Weighted average number of shares used in calculating diluted

earnings per share

2018

2017 (restated)1

Basic
pence
per share
31.3

Diluted
pence
per share
31.2

£m
1,000

97
–

60
126
–
1,370

42.9

42.8

£m
827

68
384

137

(30)
10
(58)
1,338

Basic
pence
per share
26.0

Diluted
pence
per share
25.9

42.1

41.9

Millions

3,192

3,192
9

3,201

3,182

3,182
15

3,197

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
2. The tax impact is calculated using the underlying effective tax rate of 18% (2017 21%).
3. Prior year comparatives have been restated to exclude an additional £18m benefit in respect of the impact of US tax reform enacted in December 2017 resulting from the

restatement of prior year comparatives upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers.

160

BAE SystemsAnnual Report 2018Notes to the Group accounts continued8. Intangible assets

Intangible assets are carried at cost or valuation, less accumulated amortisation and impairment losses.

Cost or valuation
Goodwill
Under the acquisition method for business combinations, goodwill is the acquisition-date fair value of the consideration transferred, less the net
of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed. Goodwill on acquisitions of subsidiaries is included
in intangible assets. Goodwill on acquisitions of joint ventures and associates is included in the carrying value of equity accounted investments.
Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

Software
Software includes:
– Computer software licences acquired for use within the Group are capitalised as an intangible asset on the basis of the costs incurred to

acquire and bring to use the specific software; and

– Software development costs that are directly associated with the production of identifiable and unique software products controlled by the
Group, and that will probably generate economic benefits exceeding costs beyond one year, are recognised as intangible assets. Group-funded
expenditure associated with enhancing or maintaining computer software programs for sale is recognised as an expense as incurred.

Development costs
Development costs funded by the Group on activities applied to a plan or design for the production of new or substantially improved products
are capitalised as an internally-generated intangible asset if certain conditions are met. The costs capitalised include materials, direct labour and
related overheads.

Programme and customer-related
Intangible assets recognised by the Group include those relating to ongoing programmes within businesses acquired, mainly in respect
of customer relationships and order backlog. These assets are initially recognised at their fair value at the acquisition date.

Other
Other intangible assets includes patents, trademarks and licences.

Amortisation
Goodwill is not amortised. Amortisation on intangible assets, excluding goodwill, is charged to the income statement on a straight-line basis
over their estimated useful lives.

For programme-related intangibles, amortisation is set on a programme-by-programme basis over the life of the individual programme.
Amortisation for customer-related intangibles is also set on an individual basis.

The estimated useful lives are as follows:

Software
Development costs
Programme and customer-related
Other

2 to 10 years
up to 10 years
up to 15 years
up to 20 years

The Group has no indefinite-life intangible assets other than goodwill.

Impairment of intangible assets, property, plant and equipment, investment property and equity accounted investments
The carrying amounts of the Group’s intangible assets (excluding goodwill), property, plant and equipment, investment property and equity
accounted investments are reviewed at each balance sheet date to determine whether there is any indication of impairment as required by IAS 36
Impairment of Assets. If any such indication exists, the asset’s recoverable amount is estimated. For goodwill and intangible assets that are not yet
available for use, impairment testing is performed annually.

An impairment loss is recognised whenever the carrying amount of an asset or its Cash-Generating Unit (CGU) exceeds its recoverable amount.

The recoverable amount is the greater of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are
discounted to their present value using an appropriate pre-tax discount rate. For an asset that does not generate largely independent cash flows,
the recoverable amount is determined for the CGU to which the asset belongs.

Impairment losses are recognised in the income statement.

An impairment loss in respect of goodwill is not reversed. An impairment loss in respect of other intangible assets, property, plant and equipment,
investment property and equity accounted investments is reversed if the subsequent increase in recoverable amount can be related objectively to
an event occurring after the impairment loss was recognised or if there has been a change in the estimate used to determine the recoverable
amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have
been determined, net of depreciation or amortisation, if no impairment loss had been recognised.

161

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements8. Intangible assets continued

Cost or valuation
At 1 January 2017
Additions:

Acquired separately
Internally developed
Business acquisitions
Disposals1
Reclassification as held for sale
Transfer from property, plant and equipment
Foreign exchange adjustments
At 31 December 2017
Additions:

Acquired separately
Internally developed

Disposals1
Reclassification as held for sale
Net transfer from property, plant and equipment
Foreign exchange adjustments
At 31 December 2018
Amortisation and impairment
At 1 January 2017
Amortisation2
Impairment charge
Disposals1
Reclassification as held for sale
Transfer from property, plant and equipment
Foreign exchange adjustments
At 31 December 2017
Amortisation2
Impairment charge3
Disposals1
Transfer to property, plant and equipment
Reclassification as held for sale
Reclassification between categories
Foreign exchange adjustments
At 31 December 2018
Net book value
At 31 December 2018
At 31 December 2017
At 1 January 2017

Goodwill
£m

Software
£m

Development
costs
£m

Programme
and
customer-
related
£m

15,403

–
–
3
–
–
–
(684)
14,722

–
–
–
(80)
–
436
15,078

4,501
–
384
–
–
–
(159)
4,726
–
–
–
–
–
–
113
4,839

10,239
9,996
10,902

558

42
45
–
(13)
–
33
(18)
647

98
28
(16)
(10)
13
15
775

298
43
–
(13)
–
7
(13)
322
63
–
(16)
(3)
(3)
23
14
400

375
325
260

101

–
–
–
–
–
–
(11)
90

–
10
–
–
–
5
105

59
8
–
–
–
–
(5)
62
7
–
–
–
–
–
4
73

32
28
42

544

–
–
–
(259)
–
–
(20)
265

5
–
(43)
–
–
9
236

496
20
–
(259)
–
–
(17)
240
11
33
(43)
–
–
(23)
9
227

9
25
48

Other
£m

Total
£m

16,705

–
–
–
(10)
(4)
8
(4)
89

2
–
(2)
–
–
4
93

87
14
–
(9)
(4)
–
(3)
85
3
–
(2)
–
–
–
4
90

3
4
12

42
45
3
(282)
(4)
41
(737)
15,813

105
38
(61)
(90)
13
469
16,287

5,441
85
384
(281)
(4)
7
(197)
5,435
84
33
(61)
(3)
(3)
–
144
5,629

10,658
10,378
11,264

Includes intangible assets with nil net book value no longer used by the Group.

1.
2. Amortisation of £84m (2017 £85m) includes £78m (2017 £82m) charged to the income statement as an amortisation expense and £6m (2017 £3m) recoverable

on customer contracts.

3. The impairment charge in Cyber & Intelligence relates to Silversky customer-related intangible assets.

162

BAE SystemsAnnual Report 2018Notes to the Group accounts continued8. Intangible assets continued

Impairment testing
The recoverable amount of the Group’s goodwill is based on value in use estimated using risk-adjusted future cash flow projections from the
five-year Integrated Business Plan (IBP) and a terminal value based on the projections for the final year of that plan, with growth rate assumptions
in the range 0% to 2% applied. The IBP process includes the use of historical experience, available government spending data and the Group’s
order backlog. Pre-tax discount rates, derived from the Group’s post-tax weighted average cost of capital of 7.24% (2017 6.60%) (adjusted for
risks specific to the market in which the Cash-Generating Unit (CGU) operates), have been used in discounting these projected risk-adjusted
cash flows.

Significant CGUs
Goodwill allocated to CGUs which are largely dependent on US government spending on defence, aerospace and security represents £8.2bn
(2017 £7.9bn) of the Group’s total goodwill balance. The Group monitors changes in defence budgets on an ongoing basis.

Cash-Generating Unit
Electronic Systems

Intelligence & Security

(within Cyber & Intelligence)

Platforms & Services (US)

Key assumptions
Continued demand from the US government for
electronic warfare systems (where the business has
a leadership position), other technology-based solutions
and growth in the commercial avionics market
Continued demand in the US for the Group’s services
in the areas of homeland security, law enforcement
and counter-intelligence
Continued demand in the Group’s principal markets for
existing and successor military tracked vehicles, naval guns,
missile launchers, artillery systems, munitions, upgrade
programmes and support, and in the US for complex
infrastructure, maritime and aviation services

Allocated goodwill

Pre-tax discount rate

2018
£bn
4.0

2017
£bn
3.8

2018
%
9

2017
%
8

0.7

3.5

3.4

The headroom, calculated as the difference between net assets including allocated goodwill as at 31 December 2018 and the value in use
calculations, for the CGUs listed above, is shown below. The table also shows the headroom assuming a 1% reduction in the terminal value
growth rate assumption and a 1% and 2% increase in the discount rate used in the value in use calculations.

Cash-Generating Unit
Electronic Systems
Intelligence & Security
Platforms & Services (US)

Headroom as at
31 December

2018
£bn
4.4
0.7
1.8

2017
£bn
5.7
0.6
3.5

Headroom assuming
a 1% reduction in the
terminal value growth
rate assumption

2018
£bn
3.0
0.5
0.9

2017
£bn
4.0
0.4
2.2

Headroom assuming
a 1% increase in the
discount rate

Headroom assuming
a 2% increase in the
discount rate

2018
£bn
2.8
0.5
0.8

2017
£bn
3.7
0.4
2.0

2018
£bn
1.6
0.4
0.1

2017
£bn
2.4
0.2
1.0

Other CGUs
The remaining goodwill balance of £2.0bn (2017 £2.1bn) is allocated across multiple CGUs, including £0.2bn (2017 £0.2bn) in the Applied
Intelligence CGU, with no individual CGU exceeding 10% of the Group’s total goodwill balance. The majority of the projected cash flows within
these CGUs are underpinned by expected levels of primarily UK government spending on defence, aerospace and security, and the Group’s ability
to capture a broadly consistent market share. In the case of Applied Intelligence, the future cash flow projections are based on the expectation
of growth in cyber and intelligence, in the UK and overseas government markets, together with increasing demand for products and services
in commercial markets.

Impairment
In 2017, the impairment charge of £384m reflected lower growth assumptions in the Applied Intelligence CGU. The recoverable amount
of the Applied Intelligence CGU was based on value in use calculated using a pre-tax discount rate of 16%.

Software
The software intangible assets balance includes £135m (2017 £107m) relating to an Enterprise Resource Planning transformation programme
currently being implemented across the Air segment. In line with the Group’s amortisation policy, the intangible asset will be amortised over
a period of 10 years as the programme becomes operational from 2019.

163

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements9. Property, plant and equipment

Cost
Items of property, plant and equipment are stated at cost less accumulated depreciation and impairment losses. The cost of self-constructed
assets includes the cost of materials, direct labour and an appropriate proportion of production overheads. The cost of demonstration assets
is written off as incurred. The reimbursement of the cost of an item of property, plant and equipment by way of a government grant is presented
as deferred income and recognised in the income statement on a basis consistent with the depreciation of the asset over its estimated useful life.

Assets held for leasing out under operating leases are included in property, plant and equipment at cost less accumulated depreciation and
impairment losses.

Depreciation
Depreciation is provided, normally on a straight-line basis, to write off the cost of items of property, plant and equipment over their estimated
useful lives to any estimated residual value, using the following rates:

Buildings
Plant and machinery:

Computing equipment and motor vehicles
Other equipment

up to 50 years, or the lease term if shorter

4 to 5 years
10 to 20 years, or the project life if shorter

For certain items of plant and equipment in the Group’s US businesses, depreciation is normally provided on a basis consistent with cost
reimbursement profiles under US government contracts. Typically, this provides for a faster rate of depreciation than would otherwise arise
on a straight-line basis.

No depreciation is provided on freehold land and assets in the course of construction.

The assets’ residual values, useful lives and depreciation methods are reviewed, and adjusted if appropriate, at each balance sheet date.

Impairment
The carrying amounts of the Group’s property, plant and equipment are reviewed at each balance sheet date to determine whether there
is any indication of impairment in accordance with the policy shown in note 8.

164

BAE SystemsAnnual Report 2018Notes to the Group accounts continued9. Property, plant and equipment continued

Cost
At 1 January 2017
Additions1
Reclassification as held for sale
Transfer to other intangible assets
Reclassification between categories
Disposals
Foreign exchange adjustments
At 31 December 2017
Additions1
Reclassification as held for sale
Transfer (to)/from other intangible assets
Reclassification between categories
Disposals
Foreign exchange adjustments
At 31 December 2018
Depreciation and impairment
At 1 January 2017
Depreciation charge for the year
Impairment charge for the year
Impairment write back
Reclassification as held for sale
Transfer to other intangible assets
Reclassification between categories
Disposals
Foreign exchange adjustments
At 31 December 2017
Depreciation charge for the year
Impairment charge for the year2
Reclassification as held for sale
Transfer from other intangible assets
Reclassification between categories
Disposals
Foreign exchange adjustments
At 31 December 2018
Net book value
At 31 December 2018
At 31 December 2017
At 1 January 2017

Land and
buildings
£m

Plant and
machinery
£m

2,176
218
–
(2)
(42)
(41)
(97)
2,212
154
(11)
(17)
44
(117)
50
2,315

1,148
66
–
(4)
–
–
(33)
(39)
(55)
1,083
84
27
(7)
–
18
(89)
29
1,145

1,170
1,129
1,028

3,229
306
(16)
(39)
42
(144)
(146)
3,232
288
(12)
4
(60)
(141)
87
3,398

2,159
194
1
–
(11)
(7)
33
(139)
(99)
2,131
183
4
(6)
3
(34)
(136)
58
2,203

1,195
1,101
1,070

Total
£m

5,405
524
(16)
(41)
–
(185)
(243)
5,444
442
(23)
(13)
(16)
(258)
137
5,713

3,307
260
1
(4)
(11)
(7)
–
(178)
(154)
3,214
267
31
(13)
3
(16)
(225)
87
3,348

2,365
2,230
2,098

Includes £70m (2017 £109m) of land and buildings, and £20m (2017 £42m) of plant and machinery at Barrow-in-Furness, UK, relating to the Dreadnought submarine
programme funded by the UK government.

2. The impairment charge in Platforms & Services (US) relates to the Mobile shipyard prior to its disposal.

165

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements9. Property, plant and equipment continued

Net impairment

Electronic Systems
Platforms & Services (US)
Air

2018
The impairment charge in Platforms & Services (US) relates to the Mobile shipyard prior to its disposal.

2017
The impairment write back in Electronic Systems related to the carrying value of a property in New Jersey, US.

Assets in the course of construction

At 31 December 2018
At 31 December 2017

2018
£m
–
31
–
31

Land and
buildings1
£m
198
259

Plant and
machinery
£m
230
296

2017
£m
(4)
–
1
(3)

Total
£m
428
555

Includes £129m (2017 £178m) at Barrow-in-Furness, UK, relating to the Dreadnought submarine programme funded by the UK government.

Operating leases
The future aggregate minimum lease income from the non-cancellable elements of operating leases for assets capitalised (including investment
property – see note 10) are as follows:

Receipts due:

Not later than one year
Later than one year and not later than five years
Later than five years

2018
£m

2017
£m

24
95
28
147

24
95
51
170

Under the terms of the lease agreements, no contingent rents are receivable. The leases have varying terms including escalation clauses and
renewal rights. None of these terms represent unusual arrangements or create material onerous or beneficial rights or obligations.

166

BAE SystemsAnnual Report 2018Notes to the Group accounts continued10. Investment property

Cost
Land and buildings that are leased to non-Group entities are classified as investment property. The Group measures investment property at its
cost less accumulated depreciation and impairment losses.

Depreciation
Depreciation is provided, on a straight-line basis, to write off the cost of investment property over its estimated useful life of up to 50 years.

The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Impairment
The carrying amounts of the Group’s investment property are reviewed at each balance sheet date to determine whether there is any indication
of impairment in accordance with the policy shown in note 8.

Cost
At 1 January 2017
Additions
Disposals
At 31 December 2017
Additions
Disposals
At 31 December 2018
Depreciation and impairment
At 1 January 2017
Depreciation charge for the year
Impairment charge
Disposals
At 31 December 2017
Depreciation charge for the year
At 31 December 2018
Net book value
At 31 December 2018
At 31 December 2017
At 1 January 2017

Fair value
At 31 December 2018
At 31 December 2017

£m

170
15
(24)
161
8
(9)
160

60
3
2
(5)
60
2
62

98
101
110

176
173

The fair values above are based on and reflect current market values as prepared by in-house professionals who have the appropriate professional
qualifications and recent experience of valuing properties in the location and of the type being valued.

167

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements11. Equity accounted investments

Equity accounted investments comprises joint ventures and associates. A joint venture is a joint arrangement whereby the parties that have
joint control have rights to the net assets of the arrangement. An associate is an entity over which the Group has significant influence.

The Group recognises its share of the profit or loss and other comprehensive income of equity accounted investments as a separate line in the
Consolidated income statement and Consolidated statement of comprehensive income, respectively.

The carrying value of an equity accounted investment comprises the Group’s share of net assets and purchased goodwill, and is assessed for
impairment as a single asset. The carrying amounts of the Group’s equity accounted investments are reviewed at each balance sheet date to
determine whether there is any indication of impairment in accordance with the policy shown in note 8.

Principal equity accounted investments

Joint venture
Eurofighter Jagdflugzeug
MBDA

Principal activities
Management and control of the European Typhoon programme
Development and manufacture of guided weapons

Shareholding
33%
37.5%

Principally
operates in
Germany
Europe

The following tables summarise the financial information of the Group’s principal equity accounted investments included in their own financial
statements, as adjusted for fair value adjustments at acquisition and differences in accounting policies, and reconcile this to the Group’s interest
in those equity accounted investments.

Revenue (100%)
Underlying EBITA2 excluding depreciation
Non-recurring items
Depreciation and amortisation
Financial income
Financial expense
Taxation expense
Profit/(loss) for the year (100%)
Remeasurements on retirement benefit schemes, net of tax
Amounts charged to hedging reserve, net of tax
Foreign exchange adjustments
Total comprehensive income for the year (100%)

2018

Eurofighter
Jagdflugzeug
£m
3,110
12
–
(1)
–
–
(2)
9
–
–
–
9

2017 (restated)1

Eurofighter
Jagdflugzeug
£m
3,011
10
–
(1)
2
–
(4)
7
–
–
–
7

MBDA
£m
2,614
330
–
(46)
64
(82)
(87)
179
139
(6)
(8)
304

MBDA
£m
2,799
398
(11)
(95)
(63)
60
(86)
203
15
(11)
9
216

Group’s share of total comprehensive income for the year

114

Non-current assets

Cash and cash equivalents
Current assets excluding cash and cash equivalents

Current assets

Non-current financial liabilities excluding trade and other payables, and provisions
Other non-current liabilities

Non-current liabilities

Current financial liabilities excluding trade and other payables, and provisions
Other current liabilities

Current liabilities
Net assets (100%)

14
32
1,006
1,038
–
(33)
(33)
–
(988)
(988)
31

2,190
2,324
4,537
6,861
(8)
(719)
(727)
–
(7,808)
(7,808)
516

12
30
1,144
1,174
–
(29)
(29)
(3)
(1,130)
(1,133)
24

2,065
2,420
3,807
6,227
(4)
(795)
(799)
–
(7,136)
(7,136)
357

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

2. Operating profit excluding amortisation and impairment of intangible assets (EBITA), and non-recurring items.

168

BAE SystemsAnnual Report 2018Notes to the Group accounts continued11. Equity accounted investments continued

Group’s share of net assets
Goodwill adjustment
Carrying value

2018

2017 (restated)1

Eurofighter
Jagdflugzeug
£m
10
–
10

MBDA
£m
193
6
199

Total
£m
203
6
209

Eurofighter
Jagdflugzeug
£m
8
–
8

MBDA
£m
134
6
140

Total
£m
142
6
148

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

Dividends received

2018

2017

Eurofighter
Jagdflugzeug
£m
2

MBDA
£m
24

Total
£m
26

Eurofighter
Jagdflugzeug
£m
–

MBDA
£m
47

Total
£m
47

Group summary
The Group also has a number of individually immaterial joint ventures and associates, the carrying values of the most significant of which
at 31 December 2018 are as follows: Advanced Electronics Company (£70m), FADEC International (£47m), Air Astana (£33m), FNSS (£33m)
and Panavia Aircraft (£20m). The following table shows a reconciliation of opening to closing carrying value for both the Group’s principal
and immaterial joint ventures in aggregate.

At 1 January 2017

Group’s share of profit for the year
Group’s share of remeasurements on retirement benefit schemes
Tax on items that will not be reclassified to the income statement
Foreign exchange adjustments
Amounts (charged)/credited to hedging reserve
Tax on items that may be reclassified to the income statement

Group’s share of total comprehensive income for the year
Equity accounted investment funding
Dividends received from equity accounted investments
Foreign exchange adjustments
At 31 December 2017

Group’s share of total comprehensive income for the year
Purchase of equity accounted investments
Equity accounted investment funding
Dividends received from equity accounted investments
Foreign exchange adjustments
At 31 December 2018

Principal equity
accounted
investments1
£m
77
70
65
(13)
(4)
(2)
–
116
–
(47)
2
148
79
8
(2)
3
(4)
–
84
–
–
(26)
3
209

Other
£m
173
37
–
–
(5)
4
(1)
35
3
(25)
(12)
174
61
–
–
–
4
(1)
64
2
1
(31)
10
220

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.

Contingent liabilities
The Group is not aware of any material contingent liabilities in respect of its equity accounted investments.

Total
£m
250
107
65
(13)
(9)
2
(1)
151
3
(72)
(10)
322
140
8
(2)
3
–
(1)
148
2
1
(57)
13
429

169

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements12. Trade, other and contract receivables

Trade receivables are stated at amortised cost including a provision for expected credit losses. The Group measures the provision at an amount
equal to lifetime expected credit losses, estimated by reference to past experience and relevant forward-looking factors.

Contract receivables represent amounts for which the Group has an unconditional right to consideration in respect of unbilled revenue recognised
at the balance sheet date and comprise costs incurred plus attributable margin.

US deferred compensation plan assets are measured at fair value in accordance with IAS 19 Employee Benefits.

Non-current
Prepayments and accrued income
US deferred compensation plan assets
Other receivables2

Current
Contract receivables
Trade receivables
Amounts owed by equity accounted investments (note 31)
Prepayments and accrued income
Other receivables3

2018
£m

2017
(restated)1
£m

25
306
21
352

2,331
1,427
67
1,025
327
5,177

5
302
80
387

1,484
1,664
86
704
306
4,244

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
Includes £11m (2017 £45m) which is reimbursable in respect of reorganisation costs.
2.
3. Includes £35m (2017 £44m) which is reimbursable in respect of reorganisation costs.

Contract receivables increased in 2018, primarily as a result of build up of costs incurred on US Combat Vehicles, Electronic Systems and Saudi
Arabian support programmes, ahead of invoicing customers.

Trade receivables are stated net of a provision for expected credit losses. Disclosures relating to the ageing of trade receivables and movements
in the provision for expected credit losses are provided in note 29.

Current prepayments and accrued income increased in 2018 as a result of increased payments made into the supply chain including payments
relating to the Qatar Typhoon and Hawk programme.

Disclosed as required on transition to IFRS 15 Revenue from Contracts with Customers, contract receivables as at 1 January 2017 were £1,609m.

170

BAE SystemsAnnual Report 2018Notes to the Group accounts continued13. Other financial assets and liabilities

Derivative financial instruments and hedging activities
The international nature of the Group’s business means it is exposed to volatility in currency exchange rates. In order to protect itself against
currency fluctuations, the Group’s policy is to hedge all material firm transactional exposures.

The Group uses interest rate derivative instruments to manage the Group’s exposure to interest rate fluctuations on its borrowings and deposits
by varying the proportion of fixed rate debt relative to floating rate debt over the forward time horizon.

The Group uses foreign exchange derivative instruments to manage the Group’s exposure to currency fluctuations on its borrowings and deposits
with the Group’s subsidiaries and equity accounted investments.

In accordance with its treasury policy, the Group does not hold derivative financial instruments for trading purposes.

The Group aims to achieve hedge accounting treatment for all derivatives that hedge material foreign currency exposures.

Derivative financial instruments are recognised initially at fair value. Subsequent to initial recognition, such instruments are stated at fair value
at the balance sheet date. The fair values are estimated by discounting expected future cash flows.

Fair value through profit or loss
Gains and losses on derivative financial instruments that are not designated as cash flow hedges are recognised within finance costs in the
income statement for the period.

Cash flow hedges
Where a derivative financial instrument is designated as a hedge of the exposure to variability in cash flows relating to a highly probable forecast
transaction (income or expense) or recognised asset or liability, the effective portion of any change in the fair value of the instrument is recognised
in other comprehensive income and presented in the hedging reserve in equity. Amounts recognised in equity are reclassified from the hedging
reserve into the cost of the underlying transaction and recognised in the income statement when the underlying transaction affects profit or loss.
The ineffective portion of any change in the fair value of the instrument is recognised in the income statement immediately. The Group treats the
foreign currency basis element of the designated foreign exchange derivative hedging instruments as a cost of hedging and as such it is excluded
from the hedge designation.

Fair value hedges
Where a derivative financial instrument is designated as a fair value hedge, changes in the fair value of the underlying asset or liability attributable
to the hedged risk, and gains and losses on the derivative instrument, are recognised within finance costs in the income statement for the period.

Non-current
Cash flow hedges – foreign exchange contracts
Other foreign exchange/interest rate contracts
Debt-related derivative financial instruments

Current
Cash flow hedges – foreign exchange contracts
Other foreign exchange/interest rate contracts
Debt-related derivative financial instruments1

1. Liabilities include fair value hedges of £2m (2017 £nil).

2018

2017

Assets
£m

Liabilities
£m

Assets
£m

Liabilities
£m

125
33
87
245

79
9
78
166

(95)
(9)
–
(104)

(63)
(9)
(2)
(74)

147
–
79
226

77
12
–
89

(114)
(19)
–
(133)

(48)
(37)
(19)
(104)

Debt-related derivative financial instruments
The debt-related derivative financial instruments represent the fair value of cross-currency, interest rate and foreign exchange derivatives
relating to the US$500m 2.85% bond, repayable 2020, the US$800m 3.8% bond, repayable 2024, the US$750m 3.85% bond, repayable
2025, the US$500m 7.5% bond, repayable 2027, and the US$550m 4.75% bond, repayable 2044 (see note 20). These derivatives have
been entered into specifically to manage the Group’s exposure to foreign exchange or interest rate risk.

Additional information on the Group’s financial risk management strategies and hedge accounting is provided in note 29.

171

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements14. Deferred tax

A deferred tax asset is recognised for unused tax losses, tax credits and deductible temporary differences to the extent that it is probable that
future taxable profits will be available against which they can be utilised. Deferred tax assets are reviewed at each reporting date and reduced
to the extent that it is no longer probable that the related tax benefit will be realised.

The most significant recognised deferred tax assets relate to the deficits on the Group’s pension/retirement schemes (see below). This is because
retirement benefit costs are deducted in determining accounting profit as service is provided by employees, but deducted in determining taxable
profit either when contributions are paid to the pension/retirement schemes or when retirement benefits are paid. In reviewing the probability
that taxable profits will be available in the future against which such contributions/payments can be deducted, account has been taken of the
deficit recovery plans agreed with the trustees of the relevant schemes in November 2017 under which the deficits are expected to be cleared
between 2021 and 2026 (see note 22).

Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to
income taxes levied by the same tax authority on the same taxable entity, or on different taxable entities, but they intend to settle current tax
liabilities and assets on a net basis or their tax assets and liabilities will be realised simultaneously.

Deferred tax assets/(liabilities)

Property, plant and equipment
Intangible assets
Provisions and accruals
Goodwill
Pension/retirement schemes:

Deficits
Additional contributions and other2

Share-based payments
Financial instruments
Other items
Rolled over capital gains
Capital losses carried forward
Trading losses carried forward
Deferred tax assets/(liabilities)
Set off of tax
Net deferred tax assets/(liabilities)

Deferred tax assets

Deferred tax liabilities

Net balance at
31 December

2018
£m
28
2
202
–

722
97
12
–
14
–
10
17
1,104
(402)
702

2017
(restated)1
£m
16
13
205
–

728
100
14
–
27
–
10
12
1,125
(423)
702

2018
£m
(85)
(3)
–
(283)

–
(1)
–
(12)
(8)
(10)
–
–
(402)
402
–

2017
(restated)1
£m
(94)
(14)
–
(275)

–
(1)
–
(11)
(22)
(10)
–
–
(427)
423
(4)

2018
£m
(57)
(1)
202
(283)

722
96
12
(12)
6
(10)
10
17
702
–
702

2017
(restated)1
£m
(78)
(1)
205
(275)

728
99
14
(11)
5
(10)
10
12
698
–
698

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers and to correct a prior year error in respect
of the accounting valuation of a longevity swap held by one of the Group’s defined benefit pension schemes. See note 37 for details regarding the restatement.
Includes deferred tax assets on US deferred compensation plans.

172

BAE SystemsAnnual Report 2018Notes to the Group accounts continued14. Deferred tax continued

Movement in temporary differences during the year

Property, plant and equipment
Intangible assets
Provisions and accruals
Goodwill
Pension/retirement schemes:

Deficits
Additional contributions and other1

Share-based payments
Financial instruments
Other items
Rolled over capital gains
Capital losses carried forward
Trading losses carried forward

Property, plant and equipment
Intangible assets
Provisions and accruals4
Goodwill
Pension/retirement schemes:

Deficits5
Additional contributions and other1

Share-based payments
Financial instruments
Other items4
Rolled over capital gains
Capital losses carried forward
Trading losses carried forward

At
1 January
2018
£m
(78)
(1)
205
(275)

Foreign
exchange
adjustments
£m
(5)
–
9
(16)

Recognised
in income
£m
26
–
(12)
8

Recognised
in equity
£m
–
–
–
–

At
31 December
2018
£m
(57)
(1)
202
(283)

728
99
14
(11)
5
(10)
10
12
698

9
6
–
–
(1)
–
–
1
3

4
(9)
(1)
(6)
2
–
–
4
16

(19)
–
(1)
5
–
–
–
–
(15)

722
96
12
(12)
6
(10)
10
17
702

At
1 January
2017
£m
(99)
(10)
304
(428)

Foreign
exchange
adjustments
£m
9
(1)
(19)
31

Recognised
in income2
£m
12
10
(80)
122

Recognised
in equity3
£m
–
–
–
–

At
31 December
2017
£m
(78)
(1)
205
(275)

1,221
149
23
(5)
(1)
(11)
11
17
1,171

(17)
(12)
–
–
2
–
–
–
(7)

28
(38)
(1)
5
4
1
(1)
(5)
57

(504)
–
(8)
(11)
–
–
–
–
(523)

728
99
14
(11)
5
(10)
10
12
698

Includes deferred tax assets on US deferred compensation plans.
Includes a credit of £57m recognised in income in respect of tax rate adjustments.

1.
2.
3. Includes a debit of £83m recognised in equity in respect of tax rate adjustments.
4. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
5. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s defined

benefit pension schemes. See note 37 for details regarding the restatement.

Unrecognised deferred tax assets and liabilities
Deferred tax assets have not been recognised in respect of the following items:

Deductible temporary differences, including tax credits
Capital losses carried forward
Trading and other losses carried forward

2018

2017

Gross
amount
£m
2
233
217
452

Unrecognised
deferred
tax asset
£m
2
41
26
69

Gross
amount
£m
1
207
389
597

Unrecognised
deferred
tax asset
£m
1
36
38
75

These assets have not been recognised as the incidence of future profits in the relevant countries and legal entities cannot be accurately predicted
at this time.

The Group has not recognised any deferred tax liability on temporary differences totalling £354m (2017 £237m) relating to potentially taxable
unremitted earnings of overseas subsidiaries and equity accounted investments because any withholding tax due on the remittance of those
earnings is expected to be insignificant.

173

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements14. Deferred tax continued

Changes in tax rates
The US federal tax rate was reduced from 35% to 21% with effect from 1 January 2018. Recognised US deferred tax balances have been
calculated at a combined federal and state tax rate of 25.7% (2017 27%).

The UK current tax rate reduced from 20% to 19% with effect from 1 April 2017 and will reduce to 17% with effect from 1 April 2020. This will
reduce future UK current tax charges accordingly. Both recognised and unrecognised UK deferred tax balances as at 31 December 2018 have
been calculated at a blended rate of 17.5% (2017 17.5%).

15. Inventories

Inventories are stated at the lower of cost, including all relevant overhead expenditure, and net realisable value.

Raw materials and consumables
Work-in-progress
Finished goods and goods for resale

2018
£m
354
319
101
774

2017
(restated)1
£m
297
350
86
733

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

The Group recognised £11m (2017 £9m) as a write down of inventories to net realisable value.

16. Current tax

Current tax for the current and prior periods is recognised as a liability to the extent that it has not yet been settled, and as an asset to the extent
that the amounts already paid exceed the amount due or the benefit of a tax loss can be carried back to recover current tax of a prior period.
Current tax assets and liabilities are measured at the amount expected to be paid to or recovered from taxation authorities, using the rates that
have been enacted or substantively enacted by the balance sheet date.

Tax provisions
Research and development expenditure credits receivable
Other

Represented by:

Current tax assets
Current tax liabilities

2018
£m
(361)
163
(55)
(253)

81
(334)
(253)

2017
£m
(351)
131
(65)
(285)

20
(305)
(285)

Tax provisions of £361m (2017 £351m) are in respect of known tax issues, of which £316m (2017 £292m) relates to non-UK jurisdictions. Whilst
there is inherent uncertainty regarding the timing of any resolution of tax positions, the Group considers there to be a possibility of a material
change in overseas tax positions in the next financial year.

The Group continues to monitor developments in relation to the EU’s State Aid investigation into the UK’s Controlled Foreign Company regime.
The Group has calculated its maximum potential liability relating to this issue to be around £86m as at 31 December 2018. The Group does not
currently consider that any provision is required in respect of this amount.

174

BAE SystemsAnnual Report 2018Notes to the Group accounts continued17. Cash and cash equivalents

Cash and cash equivalents includes cash in hand, call and term deposits, investments in money market funds and other short-term liquid
investments with original maturities of three months or less and which are subject to an insignificant risk of change in value. For the purpose
of the cash flow statement, cash and cash equivalents also includes bank overdrafts that are repayable on demand.

Cash
Money market funds
Short-term deposits

2018
£m
735
908
1,589
3,232

2017
£m
913
899
1,459
3,271

Cash and cash equivalents includes £278m (2017 £228m) which is subject to regulatory restrictions and is therefore not available for general use
by other entities within the Group.

18. Assets and liabilities of disposal groups classified as held for sale

Assets and liabilities of disposal groups classified as held for sale comprise assets and liabilities that are expected to be recovered primarily through
sale rather than continuing use. Assets and liabilities of disposal groups classified as held for sale are measured at the lower of their carrying value
and fair value less costs to sell.

UK-based combat vehicles
In January 2019, the Group announced an agreement with Rheinmetall to create a joint UK-based military land vehicle design, manufacturing
and support business. Rheinmetall will purchase a 55% stake in the existing BAE Systems UK-based combat vehicles business, with BAE Systems
retaining 45%. The establishment of the new joint venture is subject to regulatory approvals which are anticipated to be completed in the first
half of 2019. Accordingly, the UK-based combat vehicles business is presented as held for sale at 31 December 2018.

The UK-based combat vehicles business is included in the Maritime segment.

AACC
As a part of a planned reorganisation of the Group’s portfolio of interests in a number of industrial companies in Saudi Arabia, the Group
completed the disposal of its 75.6% shareholding in Aircraft Accessories and Components Company (AACC) in January 2019. Accordingly,
AACC is presented as held for sale at 31 December 2018.

AACC is included in the Air segment.

Intangible assets
Property, plant and equipment
Inventories
Trade, other and contract receivables
Assets held for sale

Trade and other payables
Provisions
Liabilities held for sale

UK-based
combat
vehicles
£m
87
9
2
16
114

(19)
(7)
(26)

2018

2017

AACC
£m
–
6
17
9
32

(14)
–
(14)

Total
£m
87
15
19
25
146

(33)
(7)
(40)

AACC
£m
–
5
16
5
26

(16)
–
(16)

175

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements19. Geographical analysis of assets

Analysis of non-current assets by geographical location

Asset location
UK
Rest of Europe
US
Saudi Arabia
Australia
Rest of Asia and Pacific
Non-current segment assets
Retirement benefit surpluses
Other financial assets
Tax
Inventories
Current trade, other and contract receivables
Cash and cash equivalents
Assets held for sale
Consolidated total assets

Notes

22
13
14,16
15
12
17
18

2018
£m
3,610
909
8,466
503
420
7
13,915
308
411
783
774
5,177
3,232
146
24,746

2017
(restated)1
£m
3,405
807
8,309
439
459
5
13,424
302
315
722
733
4,244
3,271
26
23,037

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers (see note 37) and to more appropriately allocate

certain of the Group’s non-current assets between geographical locations.

20. Loans and overdrafts

Loans and overdrafts are recognised initially at fair value, less attributable transaction costs. Subsequent to initial recognition, loans and overdrafts
are stated at either amortised cost or, where hedge accounting has been adopted, fair value in respect of the hedged risk. Any difference
between the amount initially recognised and the redemption value is recognised in the income statement over the period of the borrowings.

2018
£m

2017
£m

–
391
392
399
626
583
391
311
421
3,514

785
–
–
785

741
368
369
398
590
548
368
292
395
4,069

–
7
7
14

Non-current
US$1bn 6.375% bond, repayable 2019
US$500m 2.85% bond, repayable 2020
US$500m 4.75% bond, repayable 2021
£400m 4.125% bond, repayable 2022
US$800m 3.8% bond, repayable 2024
US$750m 3.85% bond, repayable 2025
US$500m 7.5% bond, repayable 2027
US$400m 5.8% bond, repayable 2041
US$550m 4.75% bond, repayable 2044

Current
US$1bn 6.375% bond, repayable 2019
Albertville Hangar bond, repayable 2018
Overdrafts

176

BAE SystemsAnnual Report 2018Notes to the Group accounts continued
20. Loans and overdrafts continued

US$500m of the US$1bn 6.375% bond, repayable 2019, has been converted to a floating rate bond by utilising interest rate swaps that mature
in June 2019 and give an effective rate during 2018 of 6.6%.

The US$500m 2.85% bond, repayable 2020, has been converted to a sterling fixed rate bond by utilising foreign exchange swaps that mature
in February 2019 and give an effective rate during 2018 of 1.3%.

US$500m of the US$800m 3.8% bond, repayable 2024, has been converted to a floating rate bond by utilising interest rate swaps that mature
in October 2024 and give an effective rate during 2018 of 4.0%. US$500m of the US$800m bond is measured at amortised cost as adjusted for
the fair value of the interest rate risk.

US$734m of the US$750m 3.85% bond, repayable 2025, has been converted to a sterling fixed rate bond by utilising cross-currency swaps that
mature in June 2019 and give an effective rate during 2018 of 3.4%.

The US$500m 7.5% bond, repayable 2027, was converted at issue to a sterling fixed rate bond by utilising cross-currency swaps and has an
effective rate of 7.7%.

The US$400m 5.8% bond, repayable 2041, has been converted to a floating rate bond by utilising interest rate swaps that mature in October
2024 and give an effective rate during 2018 of 5.8%.

US$244m of the US$550m 4.75% bond, repayable 2044, has been converted to a sterling fixed rate bond by utilising cross-currency swaps
that mature in June 2019 and give an effective rate during 2018 of 4.6%.

21. Trade and other payables

Trade and other payables are stated at amortised cost.

Contract liabilities represent the obligation to transfer goods or services to a customer for which consideration has been received, or consideration
is due, from the customer.

US deferred compensation plan liabilities represent the present value of expected future payments required to settle the obligation to employees
in accordance with IAS 19 Employee Benefits.

Non-current
Contract liabilities
Amounts owed to equity accounted investments (note 31)
Accruals and deferred income2
US deferred compensation plan liabilities
Other payables

Current
Contract liabilities
Trade payables
Amounts owed to equity accounted investments (note 31)
Other taxes and social security costs
Accruals and deferred income
Other payables

2018
£m

2017
(restated)1
£m

560
–
534
333
109
1,536

3,496
911
955
130
1,993
255
7,740

802
15
469
318
119
1,723

2,717
596
912
239
1,997
294
6,755

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.
Includes £439m (2017 £344m) of funding received from the UK government for property, plant and equipment at Barrow-in-Furness, UK, relating to the Dreadnought
2.
submarine programme.

Contract liabilities increased in 2018, driven by customer advance payments in excess of contract expenditure and before advance
funding into the supply chain, primarily related to the Qatar Typhoon and Hawk programme.

Revenue recognised in the year includes £2,571m (2017 £2,743m) that was included in the opening contract liabilities balance.

Disclosed as required on transition to IFRS 15 Revenue from Contracts with Customers, non-current and current contract liabilities
as at 1 January 2017 were £163m and £3,624m, respectively.

177

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits

Pension schemes
Defined contribution
Obligations for contributions are recognised as an expense in the income statement as incurred.

Defined benefit
The cost of providing benefits is determined periodically by independent actuaries and charged to the income statement in the period in which
those benefits are earned by the employees. Remeasurements, including actuarial gains and losses, are recognised in the Consolidated statement
of comprehensive income in the period in which they occur. Past service costs resulting from a plan amendment or curtailment are recognised
immediately in the income statement.

The retirement benefit surpluses and obligations recognised in the Group’s balance sheet represent the fair value of scheme assets, less the
present value of the defined benefit obligations calculated using a number of actuarial assumptions as set out on page 182. The bid values of
scheme assets are not intended to be realised in the short term and may be subject to significant change before they are realised. The present
values of scheme liabilities are derived from cash flow projections over long periods and are, therefore, inherently uncertain.

IAS 19 Employee Benefits, limits the measurement of a defined benefit surplus to the lower of the surplus in the defined benefit scheme and the
asset ceiling. The asset ceiling is the present value of any economic benefits available in the form of refunds from the scheme or reductions in future
contributions to the scheme. IFRIC 14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, issued
in 2007, provides an interpretation of the requirements of IAS 19, clarifying that a refund is available if the entity has an unconditional right to a
refund in certain circumstances. The Group has applied IFRIC 14 and has determined that there is no limit on the recognition of the surpluses in
its defined benefit pension schemes as at 31 December 2018.

MBDA participates in the Group’s defined benefit schemes and, as these are multi-employer schemes, the Group has allocated a share of the
IAS 19 pension surpluses and deficits to MBDA based on the relative payroll contributions of active members, which is consistent with prior years.
Whilst this methodology is intended to reflect a reasonable estimate of the share of the deficit, it may not accurately reflect the obligations of the
participating employers.

In the event that an employer who participates in the Group’s pension schemes fails or cannot be compelled to fulfil its obligations as a participating
employer, the remaining participating employers are obliged to collectively take on its obligations. The Group considers the likelihood of this event
arising as remote.

The Group’s share of the IAS 19 pension deficit allocated to equity accounted investments is included in the balance sheet within equity
accounted investments.

178

BAE SystemsAnnual Report 2018Notes to the Group accounts continued22. Retirement benefits continued

Background
Pension schemes
BAE Systems plc operates pension schemes for the Group’s qualifying employees in the UK, US and other countries. The principal schemes in the
UK and US are funded defined benefit schemes, and the assets are held in separate trustee-administered funds. The two largest funded defined
benefit schemes are the BAE Systems Pension Scheme (Main Scheme) and the BAE Systems 2000 Pension Plan (2000 Plan) which, in aggregate,
represent 82% (2017 81%) of the UK IAS 19 defined benefit obligation at 31 December 2018. The schemes in other countries are primarily
defined contribution schemes.

At 31 December 2018, the weighted average durations of the UK and US defined benefit pension obligations were 17 years (2017 18 years)
and 11 years (2017 12 years), respectively.

The split of the defined benefit pension liability on a funding basis between active, deferred and pensioner members for the Main Scheme,
2000 Plan and US schemes in aggregate is set out below:

Main Scheme1
2000 Plan2
US schemes3

1. Source: Main Scheme actuarial valuation report as at 31 March 2017.
2. Source: 2000 Plan actuarial valuation report as at 31 March 2017.
3. Source: Annual updates of the US schemes as at 1 January 2018.

Active
%
35
16
30

Deferred
%
20
30
17

Pensioner
%
45
54
53

Regulatory framework
The funded UK schemes are registered and subject to the statutory scheme specific-funding requirements outlined in UK legislation, including
the payment of levies to the Pension Protection Fund as set out in the Pension Act 2004. These schemes were established under trust and the
responsibility for their governance lies jointly with the trustees and the Group.

The funded US schemes are tax-qualified pension schemes regulated by the Pension Protection Act 2006 and insured by the Pension Benefit
Guaranty Corporation (PBGC) up to certain limits. These schemes were established under, and are governed by, the US Employee Retirement
Income Security Act 1974 and the BAE Systems Administrative Committee is a named fiduciary with the authority to manage their operation.

Benefits
The UK defined benefit schemes provide benefits to members in the form of a set level of pension payable for life based on members’ final
salaries. The benefits attract inflation-related increases both in deferment and payment. All UK defined benefit schemes are closed to new
entrants, with benefits for new employees being provided through a defined contribution scheme. The Normal Retirement Age for active
members of the Main Scheme and 2000 Plan is 65. Specific benefits applicable to members differ between schemes. Further details on the
benefits provided by each scheme are provided on the BAE Systems Pensions website: baesystemspensions.com.

A UK High Court judgment was delivered on 26 October 2018 concerning gender equalisation for the effect of Guaranteed Minimum Pensions
(GMPs) for occupational pension schemes. It is expected that the impact of GMP equalisation will be in the region of £121m based on an estimate
as at 26 October 2018 for the UK schemes that were contracted out of the State Earnings Related Pension Scheme between 1990 and 1997.
This has been treated for IAS 19 purposes as a plan amendment and resulted in an increase in the pension deficit in the balance sheet and
a corresponding non-recurring past service cost in the income statement.

The Group has allocated a share of the past service cost to MBDA based on the relative payroll contributions of active members. The Group’s
share of the £121m is £110m in respect of the Group’s subsidiaries, plus £4m for the Group’s share of MBDA’s allocation. The remaining £7m
relates to the share allocated to other participating employers.

The US defined benefit schemes ceased to be final salary schemes in January 2013. The benefits accrued based on the final salaries of members
at that point will become payable on retirement. The Normal Retirement Age for the largest scheme in the US is 65.

Other retirement benefits
The Group operates a number of non-pension retirement benefit schemes, under which certain employees are eligible to receive benefits after
retirement, the majority of which relate to the provision of medical benefits to retired employees of the Group’s subsidiaries in the US.

179

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits continued

Funding
Introduction
Disclosures in respect of pension funding are provided below. Disclosures in respect of pension accounting under IAS 19 are provided on pages
182 to 188.

The majority of the UK and US defined benefit pension schemes are funded by the Group’s subsidiaries and equity accounted investments.
The individual pension schemes’ funding requirements are based on actuarial measurement frameworks set out in their funding policies.

For funding valuation purposes, pension scheme assets are included at market value at the valuation date, whilst the liabilities are measured
on an actuarial funding basis using the projected unit credit method and discounted to their present value based on prudent assumptions set
by the trustees following consultation with scheme actuaries.

The funding valuations are performed by professionally qualified independent actuaries and include assumptions which differ from the actuarial
assumptions used for IAS 19 accounting purposes shown on page 182. The purpose of the funding valuations is to design funding plans which
ensure that the schemes have sufficient funds available to meet future benefit payments.

UK valuations
Funding valuations of the Group’s nine UK defined benefit pension schemes are performed every three years. The latest valuations were
performed as at 31 March 2017. The next funding valuations will have an effective date of no later than 31 March 2020.

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

The results of the most recent triennial valuations are shown below:

Market value of assets
Present value of liabilities
Funding deficit
Percentage of accrued benefits covered by the assets at the valuation date

The valuations were determined using the following mortality assumptions:

Life expectancy of a male currently aged 65 (years)
Life expectancy of a female currently aged 65 (years)
Life expectancy of a male currently aged 45 (years)
Life expectancy of a female currently aged 45 (years)

At 31 March 2017

Main
Scheme
£bn
12.8
(14.4)
(1.6)
89%

2000
Plan
£bn
4.3
(4.6)
(0.3)
93%

Other
£bn
4.5
(4.7)
(0.2)
96%

Total
£bn
21.6
(23.7)
(2.1)
91%

2017
86 – 89
88 – 90
88 – 92
91 – 93

The discount rate assumptions used in the 2017 valuations were directly based on prudent levels of expected returns for the assets held by
the schemes, reflecting the planned investment strategies and maturity profiles of each scheme. The discount rates are curves which provide
a different rate for each year into the future.

The inflation assumptions were derived using data from the Bank of England which is based on the difference between the yields on index-linked
and fixed interest long-term government bonds. The inflation assumption is a curve which provides a different rate for each year into the future.

In aggregate, the net funding deficit across the UK schemes at 31 March 2017 was £2.1bn. The funding valuations resulted in a significantly
lower deficit than under IAS 19, largely due to lower liabilities reflecting the higher discount rate assumption. Under IAS 19, the discount rate
for accounting purposes is based on third-party AA corporate bond yields whereas, for funding valuation purposes, the discount rate is based
on a prudent level of expected returns from the broader and mixed types of investments reflected in the schemes’ investment strategies, which
are expected overall to yield higher returns than bonds.

The agreements reached are underpinned by contingency plans, which include a commitment by the Group to a further £50m of deficit funding
into the largest scheme prior to the next triennial valuation in the event that the scheme funding level was to fall below pre-determined parameters.
In addition, the Group would be required to pay £187m across its schemes with deficits at the valuation date if the funding levels for those
schemes were to fall significantly and were to remain at or below those levels for nine months.

There have been no changes to the contributions or benefits, as set out in the rules of the schemes, for pension scheme members as a result
of the new funding valuations.

The results of future triennial valuations and associated funding requirements will be impacted by a number of factors, including the future
performance of investment markets and anticipated members’ longevity.

US valuations
The Group’s US pension schemes are valued annually, with the latest valuations performed as at 1 January 2018.

180

BAE SystemsAnnual Report 2018Notes to the Group accounts continued22. Retirement benefits continued

Funding continued

Contributions
Under the terms of the trust deeds of the UK schemes, the Group is required to have a funding plan determined at the conclusion of the triennial
funding valuations.

Equity accounted investments make regular contributions to the schemes in which they participate in line with the schedule of contributions
and are allocated a share of deficit funding contributions.

In 2018, total employer contributions to the Group’s pension schemes were £554m (2017 £433m), including amounts funded by equity accounted
investments of £38m (2017 £31m), and included approximately £211m (2017 £209m) of deficit recovery payments in respect of the UK schemes,
and £119m (2017 £62m) in respect of the US schemes.

Deficit contributions will further increase in line with any percentage growth in dividend payments made by the Group. Under the deficit recovery
plans, these annual payments would subsequently fall by approximately £50m in 2022 as the deficits on certain schemes are expected to be
cleared. The annual payments are expected to end in 2026 when all deficits are projected to be cleared. Under the last agreement made in 2014,
all scheme deficits were projected to be cleared in 2026.

In 2019, the Group expects that contributions to its UK pension schemes will be broadly in line with 2018, whilst contributions to its US pension
schemes are expected to reduce.

Risk management
The defined benefit pension schemes expose the Group to actuarial risks, including market (investment) risk, interest rate risk, inflation risk
and longevity risk.

Risk

Mitigation

Market (investment) risk
Asset returns may not move
in line with the liabilities and
may be subject to volatility.

The investment portfolios are highly diversified, investing in a wide range of assets, in order to reduce
the exposure of the total portfolio to a materially adverse impact from a single security or type of security.
To reduce volatility, certain assets are held in a matching portfolio, which largely consists of index-linked
bonds, gilts and swaps, designed to mirror movements in corresponding liabilities.

Interest rate risk
Liabilities are sensitive to
movements in interest rates,
with lower interest rates leading
to an increase in the valuation
of liabilities.

Inflation risk
Liabilities are sensitive to
movements in inflation, with
higher inflation leading to
an increase in the valuation
of liabilities.

Some 43% (2017 47%) of the Group’s pension scheme assets are held in equities and pooled investment
vehicles due to the higher expected level of return over the long term.

Some of the Group’s pension schemes use derivative financial instruments as part of their investment
strategy to manage the level of market risk. The Main Scheme and one of the Group’s other UK defined
benefit pension schemes jointly have an equity option strategy protecting £1.8bn of assets against a
significant fall in equity markets. In February 2019 this protection was extended to cover £2.6bn of assets.

In addition to investing in bonds as part of the matching portfolio, some of the UK schemes invest in
interest rate swaps to reduce the exposure to movements in interest rates. The swaps are held with several
banks to reduce counterparty risk.

The discount rate assumptions set as part of the 2017 UK funding valuations more directly reflect the
expected returns on assets held by the schemes and, therefore, the liabilities are less sensitive to interest
rate risk than they were in the 2014 funding valuation. Accordingly, the 2017 approach provides a more
natural hedge against interest rate risk. The planned investment strategy, which is reflected in the discount
rate and liability calculation, is for the schemes to increase their investments in bonds or other assets
which match the liabilities as the schemes mature. Under the 2017 UK funding valuation, the Group
expects the schemes to be fully hedged against interest rate movements following a five-year transition
period to the planned investment strategy.

In addition to investing in index-linked bonds as part of the matching portfolio, the principal UK schemes
invest in long-term inflation swaps to reduce the exposure to movements in inflation. The swaps are held
with several banks to reduce counterparty risk. The Group’s US schemes are not indexed with inflation.

The approach to the 2017 UK funding valuation provides a more natural hedge against inflation
movements and, therefore, the liabilities are less sensitive to inflation risk than they were in the 2014
funding valuation. Under the 2017 UK funding valuation approach, the Group is already fully hedged
against inflation movements and, under the planned investment strategy, the Group aims to maintain
a fully hedged position.

In 2014, the Main Scheme implemented a pension increase exchange to allow retired members to elect
for a higher current pension in exchange for foregoing certain rights to future pension increases.

Longevity risk
Liabilities are sensitive to
life expectancy, with increases
in life expectancies leading
to an increase in the valuation
of liabilities.

Longevity adjustment factors are used in the majority of the UK pension schemes in order to adjust
the pension benefits payable so as to share the cost of people living longer with employees.

In 2013, with the agreement of the Company, the trustees of the 2000 Plan, Royal Ordnance Pension
Scheme and Shipbuilding Industries Pension Scheme entered into arrangements with Legal & General
to insure against longevity risk for the current pensioner population, covering a total of £4.4bn of pension
scheme liabilities. These arrangements reduce the funding volatility relating to increasing life expectancy.

181

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits continued

IAS 19 accounting
The disclosures below relate to post-retirement benefit schemes in the UK, US and other countries which are accounted for as defined benefit
schemes in accordance with IAS 19.

Principal actuarial assumptions
The assumptions used are estimates chosen from a range of possible actuarial assumptions which, due to the long-term nature of the obligation
covered, may not necessarily occur in practice.

Financial assumptions
Discount rate – past service (%)
Discount rate – future service (%)
Retail Prices Index (RPI) inflation (%)
Rate of increase in salaries (%)
Rate of increase in deferred pensions (%)
Rate of increase in pensions in payment (%)
Demographic assumptions
Life expectancy of a male currently aged 65 (years)
Life expectancy of a female currently aged 65 (years)
Life expectancy of a male currently aged 45 (years)
Life expectancy of a female currently aged 45 (years)

2018

2017

2016

2018

2017

2016

2.9
3.0
3.1
3.1
2.1/3.1

2.7
2.6
2.7
2.7
3.2
3.1
3.2
3.1
2.2/3.2
2.1/3.1
1.6 – 3.7 1.6 – 3.7 1.7 – 3.7

86 – 88
88 – 90
88 – 90
90 – 91

86 – 88
88 – 90
88 – 90
90 – 92

86 – 89
89 – 90
88 – 91
91 – 92

4.2
4.2
n/a
n/a
n/a
n/a

87
89
87
89

3.7
3.7
n/a
n/a
n/a
n/a

87
89
87
89

4.2
4.2
n/a
n/a
n/a
n/a

87
89
87
89

Discount rate
The discount rate assumptions are derived through discounting the projected benefit payments using a third-party AA corporate bond yield
curve to produce a single equivalent discount rate for the UK and US territories. This inherently captures the maturity profile of the expected
benefit payments. For the UK territory, the discount rate used for future service differs from that used for past service as it only uses the cash
flows relating to active members, which have a different duration. Further information on the duration of the schemes is detailed on page 179.

Retail Prices Index (RPI) inflation
In the UK, the inflation assumptions are derived by reference to the difference between the yields on index-linked and fixed-interest long-term
government bonds, or advice from the local actuary depending on the available information. In the US, inflation assumptions are not relevant
as the Group’s US pension schemes are not indexed with inflation.

Rate of increase in salaries
The rate of increase in salaries for the UK schemes is assumed to be RPI inflation of 3.1% (2017 RPI inflation of 3.1%), plus a promotional scale.
From 1 January 2013, employees in the US schemes no longer accrue salary-related benefits.

Rate of increase in deferred pensions
The rate of increase in deferred pensions for the UK schemes is based on Consumer Prices Index (CPI) inflation of 2.1% (2017 CPI inflation
of 2.1%), with the exception of the 2000 Plan, which is based on RPI inflation of 3.1% (2017 RPI inflation of 3.1%). For all UK schemes, the rate
of increase in deferred pensions is subject to inflation caps.

Rate of increase in pensions in payment
The rate of increase in pensions in payment differs between UK schemes. Different tranches of the schemes’ benefits increase at rates based
on either RPI or CPI inflation, and some are subject to an inflation cap. With the exception of two smaller schemes, the rate of increase in
pensions in payment is based on RPI inflation.

Life expectancy
For its UK pension schemes, the Group has used the Self-Administered Pension Schemes S2 mortality tables based on year of birth (as published
by the Institute of Actuaries) for both pensioner and non-pensioner members in conjunction with the results of an investigation into the actual
mortality experience of scheme members and information on the demographic profile of the scheme’s membership. In addition, to allow for
future improvements in longevity, the Continuous Mortality Investigation 2017 tables (published by the Institute of Actuaries) have been used
(in 2017, the Continuous Mortality Investigation 2016 tables were used), with an assumed long-term rate of future annual mortality improvements
of 1.25% (2017 1.25%), for both pensioner and non-pensioner members.

In October 2015, the Society of Actuaries in the US released updated mortality assumptions reflecting the results of its comprehensive mortality
study. For the majority of the US schemes, the mortality tables used at 31 December 2018 are a blend of the fully generational RP-2014 Aggregate
table and the RP-2014 White Collar table, both projected using Scale MP-2018. The IRS have approved the new mortality tables to be adopted
for funding valuation purposes from 2019.

US healthcare schemes
The latest valuations of the principal schemes, covering retiree medical and life insurance schemes in certain US subsidiaries, were performed by
independent actuaries as at 1 January 2018. These valuations were rolled forward to reflect the information at 31 December 2018. The method
of accounting for these is similar to that used for defined benefit pension schemes.

The assumption for long-term healthcare cost increases is 4.9% (2017 4.9%) based on the assumptions that the increases are 7.8% in 2018
reducing to 4.5% by 2026 and 4.5% each year thereafter for pre-retirement, and 8.5% in 2018 reducing to 4.5% by 2026 and 4.5% each
year thereafter for post-retirement.

182

BAE SystemsAnnual Report 2018Notes to the Group accounts continued22. Retirement benefits continued

IAS 19 accounting continued

Summary of movements in retirement benefit obligations

Total net IAS 19 deficit at 1 January 20181
Actual return on assets excluding amounts included in net interest expense
Decrease in liabilities due to changes in financial assumptions
Decrease in liabilities due to changes in demographic assumptions
Experience losses
Contributions in excess of service cost
Past service cost – plan amendments
Net interest expense
Foreign exchange adjustments
Movement in US healthcare schemes
Total net IAS 19 deficit at 31 December 2018
Allocated to equity accounted investments
Group’s share of net IAS 19 deficit excluding Group’s share of amounts

allocated to equity accounted investments at 31 December 2018

UK
£m
(3,788)
(1,022)
1,295
171
(176)
185
(131)
(88)
–
–
(3,554)
304

US and
other
£m
(566)
(422)
265
17
(17)
105
–
(24)
(38)
(2)
(682)
–

Total
£m
(4,354)
(1,444)
1,560
188
(193)
290
(131)
(112)
(38)
(2)
(4,236)
304

(3,250)

(682)

(3,932)

1. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s defined

benefit pension schemes. See note 37 for details regarding the restatement.

Amounts recognised on the balance sheet
The table below shows a reconciliation between the gross assets and liabilities of the Group’s UK, US and other post-retirement benefit schemes
and the amounts recognised on the Group’s balance sheet after allocation to equity accounted investments.

Present value of unfunded obligations
Present value of funded obligations
Fair value of scheme assets
Total net IAS 19 (deficit)/surplus
Allocated to equity accounted investments
Group’s share of net IAS 19 (deficit)/surplus
Represented by:

Retirement benefit surpluses
Retirement benefit obligations

UK defined
benefit
pension
schemes
£m
(100)
(24,700)
21,246
(3,554)
304
(3,250)

2018

US and
other
pension
schemes
£m
(142)
(4,782)
4,213
(711)
–
(711)

US
healthcare
schemes
£m
–
(165)
194
29
–
29

UK defined
benefit
pension
schemes1
£m
(49)
(26,071)
22,332
(3,788)
332
(3,456)

Total
£m
(242)
(29,647)
25,653
(4,236)
304
(3,932)

2017

US and
other
pension
schemes
£m
(146)
(4,803)
4,352
(597)
–
(597)

US
healthcare
schemes
£m
–
(168)
199
31
–
31

Total
£m
(195)
(31,042)
26,883
(4,354)
332
(4,022)

219
(3,469)
(3,250)

48
(759)
(711)

41
(12)
29

308
(4,240)
(3,932)

209
(3,665)
(3,456)

54
(651)
(597)

39
(8)
31

302
(4,324)
(4,022)

Group’s share of net IAS 19 deficit of equity

accounted investments

(119)

–

(119)

(128)

–

(128)

1. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s defined

benefit pension schemes. See note 37 for details regarding the restatement.

Total cumulative actuarial losses recognised in equity since the transition to IFRS are £4.6bn (2017 £4.7bn).

183

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits continued

IAS 19 accounting continued

Changes in the fair value of scheme assets before allocation to equity accounted investments

Value of scheme assets at 1 January 20171

Interest income
Actual return on assets excluding amounts included in interest income1

Actual return on assets

Contributions by employer
Contributions by employer in respect of employee salary sacrifice arrangements

Total contributions by employer
Members’ contributions
Administrative expenses
Foreign exchange translation
Benefits paid
Value of scheme assets at 31 December 20171

Interest income
Actual return on assets excluding amounts included in interest income

Actual return on assets

Contributions by employer
Contributions by employer in respect of employee salary sacrifice arrangements

Total contributions by employer
Members’ contributions
Administrative expenses
Foreign exchange translation
Benefits paid
Value of scheme assets at 31 December 2018

UK defined
benefit
pension
schemes
£m
21,339
568
1,030
1,598
352
84
436
8
–
–
(1,049)
22,332
575
(1,022)
(447)
423
80
503
7
(14)
–
(1,135)
21,246

US and
other
pension
schemes
£m
4,313
169
444
613
81
–
81
–
(16)
(394)
(245)
4,352
156
(422)
(266)
131
–
131
–
(14)
248
(238)
4,213

US
healthcare
schemes
£m
198
8
19
27
2
–
2
–
–
(19)
(9)
199
7
(12)
(5)
1
–
1
–
(1)
12
(12)
194

Total
£m
25,850
745
1,493
2,238
435
84
519
8
(16)
(413)
(1,303)
26,883
738
(1,456)
(718)
555
80
635
7
(29)
260
(1,385)
25,653

1. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s defined

benefit pension schemes. See note 37 for details regarding the restatement.

184

BAE SystemsAnnual Report 2018Notes to the Group accounts continued22. Retirement benefits continued

IAS 19 accounting continued

Assets of defined benefit pension schemes

UK1

2018

US and other

Total

Equities:
UK2
Overseas

Pooled investment vehicles3
Fixed interest securities:

UK gilts
UK corporates
Overseas government
Overseas corporates
Index-linked securities:

UK gilts
UK corporates

Property 4
Derivatives5
Cash:

Sterling
Foreign currency

Other
Total

Equities:
UK2
Overseas

Pooled investment vehicles3
Fixed interest securities:

UK gilts
UK corporates
Overseas government
Overseas corporates
Index-linked securities:

UK gilts
UK corporates

Property 4
Derivatives5
Cash:

Sterling
Foreign currency

Other
Total

Quoted
£m

Unquoted
£m

Total
£m

Quoted
£m

Unquoted
£m

Total
£m

Quoted
£m

Unquoted
£m

Total
£m

3,192
1,882
1,280

1,500
1,543
47
1,260

2,156
526
–
–

270
10
46
13,712

3,193
1,894
4,993

1,500
3,492
47
1,303

2,333
1,179
1,935
(1,121)

303
15
180
21,246

1
12
3,713

–
1,949
–
43

177
653
1,935
(1,121)

33
5
134
7,534

UK1

–
284
659

–
–
19
3,074

–
–
–
–

–
49
–
4,085

–
–
2

–
–
–
–

–
–
125
–

–
–
1
128

–
284
661

–
–
19
3,074

–
–
125
–

–
49
1
4,213

2017

US and other

3,192
2,166
1,939

1,500
1,543
66
4,334

2,156
526
–
–

270
59
46
17,797

3,193
2,178
5,654

1,500
3,492
66
4,377

2,333
1,179
2,060
(1,121)

303
64
181
25,459

1
12
3,715

–
1,949
–
43

177
653
2,060
(1,121)

33
5
135
7,662

Total

Quoted
£m

Unquoted
£m

Total
£m

Quoted
£m

Unquoted
£m

Total
£m

Quoted
£m

Unquoted
£m

Total
£m

4,453
3,074
1,327

1,556
2,214
50
1,319

2,164
928
–
–

221
–
138
17,444

1
287
2,269

25
1,213
–
8

54
375
1,648
(1,119)

46
3
78
4,888

4,454
3,361
3,596

1,581
3,427
50
1,327

2,218
1,303
1,648
(1,119)

267
3
216
22,332

–
346
797

–
–
97
2,953

–
–
–
–

–
27
–
4,220

–
–
2

–
–
–
–

–
–
129
–

–
–
1
132

–
346
799

–
–
97
2,953

–
–
129
–

–
27
1
4,352

4,453
3,420
2,124

1,556
2,214
147
4,272

2,164
928
–
–

221
27
138
21,664

1
287
2,271

25
1,213
–
8

54
375
1,777
(1,119)

46
3
79
5,020

4,454
3,707
4,395

1,581
3,427
147
4,280

2,218
1,303
1,777
(1,119)

267
30
217
26,684

1. The Main Scheme and two of the Group’s smaller UK defined benefit pension schemes participate in a Combined Investment Fund (CIF), covering £13.6bn (2017 £13.6bn)

of assets. The purpose of the CIF is to provide economies of scale for the CIF schemes’ investment administration.
Includes £24m (2017 £33m) of the Company’s own ordinary shares.

2.
3. Primarily invested in private markets and exchange traded funds. The amounts classified as unquoted primarily comprise investments in private markets, with the majority

held in infrastructure, alternatives and direct funds, valued in accordance with International Private Equity and Venture Capital Valuation Guidelines.

4. Valued on the basis of open market value at the end of the year determined in accordance with the Royal Institution of Chartered Surveyors’ Appraisal and Valuation

Standards and the Practice Note contained therein. Includes £245m (2017 £243m) of property occupied by Group companies.

5. Includes equity protection options, forward foreign exchange contracts, futures, and interest rate, inflation and longevity swaps. In addition, the total derivative figures
shown are net of £479m (2017 £474m) of repurchase agreements. The valuations are based on valuation techniques using underlying market data and discounted cash
flows. Prior year comparatives have been restated to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Group’s
defined benefit pension schemes. See note 37 for details regarding the restatement.

185

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits continued

IAS 19 accounting continued

Changes in the present value of the defined benefit obligations before allocation to equity accounted investments

Defined benefit obligations at 1 January 2017

Current service cost
Contributions by employer in respect of employee salary sacrifice arrangements

Total current service cost
Members’ contributions
Past service cost – plan amendments
Actuarial loss due to changes in financial assumptions
Actuarial gain due to changes in mortality assumptions
Actuarial gain due to changes in other demographic assumptions
Experience gains/(losses)
Interest expense
Foreign exchange translation
Benefits paid
Defined benefit obligations at 31 December 2017

Current service cost
Contributions by employer in respect of employee salary sacrifice arrangements

Total current service cost
Members’ contributions
Past service cost – plan amendments
Actuarial gain due to changes in financial assumptions
Actuarial gain due to changes in demographic assumptions
Experience losses
Interest expense
Foreign exchange translation
Benefits paid
Defined benefit obligations at 31 December 2018

UK defined
benefit
pension
schemes
£m
(27,173)
(254)
(84)
(338)
(8)
(2)
(242)
971
202
136
(715)
–
1,049
(26,120)
(224)
(80)
(304)
(7)
(131)
1,295
171
(176)
(663)
–
1,135
(24,800)

US and
other
pension
schemes
£m
(5,134)
(12)
–
(12)
–
–
(291)
24
–
(29)
(201)
449
245
(4,949)
(12)
–
(12)
–
–
265
17
(17)
(180)
(286)
238
(4,924)

US
healthcare
schemes
£m
(169)
(1)
–
(1)
–
(1)
(13)
1
–
(1)
(7)
14
9
(168)
(1)
–
(1)
–
–
9
–
(1)
(6)
(10)
12
(165)

Total
£m
(32,476)
(267)
(84)
(351)
(8)
(3)
(546)
996
202
106
(923)
463
1,303
(31,237)
(237)
(80)
(317)
(7)
(131)
1,569
188
(194)
(849)
(296)
1,385
(29,889)

186

BAE SystemsAnnual Report 2018Notes to the Group accounts continued22. Retirement benefits continued

IAS 19 accounting continued

Amounts recognised in the income statement after allocation to equity accounted investments

2018

2017

UK defined
benefit
pension
schemes
£m

US and
other
pension
schemes
£m

US
healthcare
schemes
£m

Included in operating costs:

Current service cost
Past service cost – plan amendments

Guaranteed Minimum Pension equalisation charge
Administrative expenses

(201)
(10)
(211)
(110)
(13)
(334)

(12)
–
(12)
–
(14)
(26)

Included in net finance costs:

Net interest (expense)/income on retirement benefit

obligations

(80)

(24)

Group defined benefit schemes included in share

of results of equity accounted investments:
Group’s share of equity accounted investments’

operating costs1

Group’s share of equity accounted investments’

finance costs

(15)

(3)

–

(1)
–
(1)
–
(1)
(2)

–

UK defined
benefit
pension
schemes
£m

US and
other
pension
schemes
£m

US
healthcare
schemes
£m

Total
£m

(214)
(10)
(224)
(110)
(28)
(362)

(228)
(2)
(230)
–
–
(230)

(12)
–
(12)
–
(16)
(28)

(103)

(134)

(32)

(15)

(3)

(12)

(5)

–

(1)
(1)
(2)
–
–
(2)

–

1. The 2018 Group’s share of equity accounted investments’ operating costs includes £4m relating to the Guaranteed Minimum Pension equalisation charge.

The Group incurred a charge of £203m (2017 £193m) in relation to defined contribution schemes for employees.

Total
£m

(241)
(3)
(244)
–
(16)
(260)

(165)

(12)

(5)

187

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements22. Retirement benefits continued

IAS 19 accounting continued

Sensitivity analysis
The sensitivity information has been derived using scenario analysis from the actuarial assumptions as at 31 December 2018 and keeping all other
assumptions as set out on page 182.

Financial assumptions
The estimated impact of changes in the discount rate and inflation assumptions on the defined benefit pension obligation, together with the
estimated impact on scheme assets, is shown in the table below. The estimated impact on scheme assets takes into account the Group’s risk
management activities in respect of interest rate and inflation risk. The sensitivity analysis on the defined benefit obligation is measured on
an IAS 19 accounting basis and, therefore, does not reflect the natural hedging in the discount rate used for funding valuation purposes.

Discount rate:

0.1 percentage point increase
0.1 percentage point decrease

Inflation:

0.1 percentage point increase
0.1 percentage point decrease

1. Before allocation to equity accounted investments.

(Increase)/decrease
in pension obligation1
£bn

Increase/(decrease)
in scheme assets1
£bn

0.5
(0.5)

(0.4)
0.4

(0.2)
0.2

0.2
(0.2)

The sensitivity of the valuation of the liabilities to changes in the inflation assumption presented above assumes that a 0.1 percentage point
change to expectations of future inflation results in a 0.1 percentage point change to all inflation-related assumptions (rate of increase in salaries,
rate of increase in deferred pensions and rate of increase in pensions in payment) used to value the liabilities. However, upper and lower limits
exist on the majority of inflation-related benefits such that a change in expectations of future inflation may not have the same impact on the
inflation-related benefits, and hence will result in a smaller change to the valuation of the liabilities. Accordingly, extrapolation of the above results
beyond the specific sensitivity figures shown may not be appropriate. To illustrate this, the (increase)/decrease in the defined benefit pension
obligation resulting from larger changes in the inflation assumption would be as follows:

Inflation:

0.5 percentage point increase
0.5 percentage point decrease
1.0 percentage point increase
1.0 percentage point decrease

1. Before allocation to equity accounted investments.

(Increase)/decrease
in pension obligation1
£bn

(1.3)
1.3
(2.8)
2.5

Demographic assumptions
Changes in the life expectancy assumption, including the benefit of longevity swap arrangements (see longevity risk on page 181), would have
the following effect on the total net IAS 19 deficit:

Life expectancy:
One-year increase
One-year decrease

1. Before allocation to equity accounted investments.

(Increase)/decrease
in net deficit1
£bn

(1.1)
1.1

188

BAE SystemsAnnual Report 2018Notes to the Group accounts continued23. Provisions

A provision is recognised in the balance sheet when the Group has a present legal or constructive obligation as a result of a past event, it is probable
that an outflow of economic benefits will be required to settle the obligation and the amount has been reliably estimated. If the effect is material,
provisions are determined by discounting the expected future cash flows at an appropriate pre-tax discount rate.

Warranties and after-sales service
Warranties and after-sales service are provided in the normal course of business with provisions for associated costs being made based on an
assessment of future claims with reference to past experience. A provision for warranties is recognised when the underlying products and services
are sold. The provision is based on historical warranty data and a weighting of possible outcomes against their associated probabilities.

Reorganisations
A provision for restructuring is recognised when the Group has approved a detailed and formal restructuring plan, and the restructuring has either
commenced or has been announced to those affected. The costs associated with the reorganisation programmes are supported by detailed plans
and based on previous experience as well as other known factors. Future operating costs are not provided for.

Legal, contractual and environmental
The Group holds provisions for expected legal, contractual and environmental costs that it expects to incur over an extended period. Management
exercises judgement to determine the amount of these provisions. Provision is made for known issues based on past experience of similar items
and other known factors. Each provision is considered separately and the amount provided reflects the best estimate of the most likely amount,
being the single most likely amount in a range of possible outcomes.

Non-current
Current
At 1 January 2018 (restated)1
Created
Utilised
Reclassified between categories
Transfer from other balance sheet categories
Transfer to held for sale
Released
Net present value adjustments
Foreign exchange adjustments
At 31 December 2018
Represented by:
Non-current
Current

Warranties
and
after-sales
service
£m
51
51
102
52
(37)
–
–
(5)
(11)
–
3
104

46
58
104

Legal,
contractual
and
environmental1
£m
281
190
471
127
(67)
(3)
14
(2)
(59)
15
10
506

Reorganisations
£m
73
118
191
8
(53)
–
–
–
(65)
–
–
81

51
30
81

294
212
506

Other
£m
30
41
71
15
(11)
3
–
–
(15)
5
2
70

36
34
70

Total
£m
435
400
835
202
(168)
–
14
(7)
(150)
20
15
761

427
334
761

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

Warranties and after-sales service
Warranty and after-sales service costs are generally incurred within three years post-delivery. Whilst actual events could result in potentially
significant differences to the quantum, but not the timing, of the outflows in relation to the provisions, management has reflected current
knowledge in assessing the provision levels.

Reorganisations
Reorganisation costs are generally incurred within one to three years. There is limited volatility around the timing and amount of the ultimate
outflows related to these provisions.

Other debtors includes £46m (2017 £89m) which is reimbursable in respect of reorganisation costs.

Legal, contractual and environmental
Reflecting the inherent uncertainty within many legal proceedings, the amount of the outflows could differ significantly from the amount
provided and the timing of the outflows cannot be estimated reliably.

Other
There are no individually significant provisions included within other provisions.

189

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements24. Share capital and other reserves

Share capital

Equity

Non-equity

Total

Ordinary shares of 2.5p each

Special Share of £1

Number of
shares
m

Nominal
value
£m

Number of
shares

Nominal
value
£

Nominal
value
£m

Issued and fully paid
At 1 January 2017, 31 December 2017 and 31 December 2018

3,467

Special Share
One Special Share of £1 in the Company is held on behalf of the Secretary of State for Business, Energy and Industrial Strategy (the Special
Shareholder). Certain provisions of the Company’s Articles of Association cannot be amended without the consent of the Special Shareholder.
These provisions include the requirement that no foreign person, or foreign persons acting in concert, can have more than a 15% voting interest
in the Company, the requirement that the majority of the directors are British, and the requirement that the Chief Executive and any executive
Chairman are British citizens. The effect of these requirements can also be amended by regulations made by the directors and approved by the
Special Shareholder.

The Special Shareholder may require the Company at any time to redeem the Special Share at par or to convert the Special Share into one
ordinary voting share. The Special Shareholder is entitled to receive notice of and to attend general meetings and class meetings of the Company’s
shareholders, but has no voting right, nor other rights, other than to speak in relation to any business in respect of the Special Share.

Treasury shares
As at 31 December 2018, 271,650,137 (2017 281,232,739) ordinary shares of 2.5p each with an aggregate nominal value of £6,791,253
(2017 £7,030,818) were held in treasury. During 2018, 9,582,602 (2017 10,216,622) treasury shares were used to satisfy awards and options
under the Share Incentive Plan, International Share Incentive Plan, Performance Share Plan, the Performance Shares and Restricted Shares
elements of the Long-Term Incentive Plan, and the Executive Share Option Plan.

Own shares held
Own shares held, including treasury shares and shares held by BAE Systems Employee Share Option Plan (ESOP) Trust, are recognised as a deduction
from retained earnings.

BAE Systems ESOP Trust
The Group has an ESOP discretionary trust to administer the share plans and to acquire Company shares, using funds loaned by the Group, to meet
commitments to Group employees. Dividend waivers were in operation for shares within the ESOP Trust, other than those owned beneficially by
the participants, for the dividends paid in June and November 2018.

At 31 December 2018, the ESOP held 2,299,585 (2017 1,680,035) ordinary shares of 2.5p each, with a market value of £11m (2017 £10m). The
shares held by the ESOP are recorded at cost and deducted from retained earnings until such time as the shares vest unconditionally to employees.

A dividend waiver was also in operation for the dividends paid in June and November 2018 over shares within the Company’s share incentive plan
trusts other than those shares owned beneficially by the participants.

Equity dividends

Equity dividends on ordinary share capital are recognised as a liability in the period in which they are declared. The interim dividend is recognised
when it has been approved by the Board and the final dividend is recognised when it has been approved by the shareholders at the Annual
General Meeting.

Prior year final 13.0p dividend per ordinary share paid in the year (2017 12.7p)
Interim 9.0p dividend per ordinary share paid in the year (2017 8.8p)

2018
£m
415
288
703

2017
£m
404
280
684

After the balance sheet date, the directors proposed a final dividend of 13.2p per ordinary share. The dividend, which is subject to shareholder
approval, will be paid on 3 June 2019 to shareholders registered on 23 April 2019. The ex-dividend date is 18 April 2019.

Shareholders who do not at present participate in the Company’s Dividend Reinvestment Plan and wish to receive the final dividend in shares
rather than cash should complete a mandate form for the Dividend Reinvestment Plan and return it to the registrars no later than 10 May 2019.

190

BAE SystemsAnnual Report 2018Notes to the Group accounts continued24. Share capital and other reserves continued

Other reserves

At 1 January 2017
Subsidiaries:

Currency translation on foreign currency net investments

(restated)1

Amounts credited to hedging reserve
Tax on other comprehensive income

Equity accounted investments, net of tax (restated)1
At 1 January 20181
Subsidiaries:

Currency translation on foreign currency net investments
Amounts charged to hedging reserve
Tax on other comprehensive income
Equity accounted investments, net of tax
At 31 December 2018

Merger
reserve
£m
4,589

Statutory
reserve
£m
202

Revaluation
reserve
£m
10

Capital
redemption
reserve
£m
3

Hedging
reserve
£m
10

Translation
reserve
£m
1,871

–
–
–
–
4,589

–
–
–
–
202

–
–
–
–
10

–
–
–
–
3

–
59
(11)
1
59

–
(25)
5
(1)
38

(625)
–
–
(19)
1,227

396
–
–
16
1,639

Total
£m
6,685

(625)
59
(11)
(18)
6,090

396
(25)
5
15
6,481

1. Prior year comparatives have been restated upon the Group’s adoption of IFRS 15 Revenue from Contracts with Customers. See note 37 for details regarding the restatement.

Merger reserve
The merger reserve arose on the acquisition of the Marconi Electronic Systems (MES) business by British Aerospace in 1999 to form BAE Systems,
and represents the amount by which the fair value of the shares issued by British Aerospace as consideration exceeded their nominal value.

Statutory reserve
Under Section 4 of the British Aerospace Act 1980, this reserve may only be applied in paying up unissued shares of the Company to be allotted
to members of the Company as fully paid bonus shares.

Revaluation reserve
The revaluation reserve relates to the revaluation at fair value of the net assets of the BVT joint venture previously held as an equity accounted
investment on the acquisition of the remaining 45% interest in 2009.

Capital redemption reserve
The capital redemption reserve represents the cumulative nominal value of the Company’s ordinary shares repurchased and subsequently cancelled.

Hedging reserve
The hedging reserve comprises the effective portion of the cumulative net change in the fair value of cash flow hedging instruments related
to hedged transactions that have not yet occurred.

Translation reserve
The translation reserve comprises all foreign currency differences arising from the translation of the financial statements of foreign operations.

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

At 31 December 2018, the Group’s capital was £5,580m (2017 £4,696m), which comprises total equity of £5,618m (2017 £4,755m),
excluding amounts accumulated in equity relating to cash flow hedges of £38m (2017 £59m). Net debt was £904m (2017 £752m).

The capital structure of the Group reflects the judgement of the directors of an appropriate balance of funding required. The Group’s policy
is to maintain an investment grade credit rating 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 (see note 7);

– 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.

191

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements25. Operating business cash flow

Key Performance Indicator – Operating business cash flow
Definition Net cash flow from operating activities excluding taxation and including net capital expenditure, financial investment and dividends
from equity accounted investments.

Purpose Allows management to monitor the operational cash generation of the Group.

Taxation is excluded because it is not relevant to the pre-tax operational cash generation of the Group.
Net capital expenditure and financial investment are included as a measure of the investment in the business to support the operational
performance of the Group.
Dividends received from equity accounted investments are included as a measure of the operating cash generation of the Group’s equity
accounted investments.

Reconciliation of net cash flow from operating activities to operating business cash flow

Net cash flow from operating activities
Add back Taxation paid

Purchase of property, plant and equipment, and investment property
Purchase of intangible assets
Proceeds from sale of property, plant and equipment, and investment property
Proceeds from sale of intangible assets
Equity accounted investment funding

Net capital expenditure and financial investment
Dividends received from equity accounted investments
Operating business cash flow

2018
£m
1,200
200
(358)
(139)
34
–
(1)
(464)
57
993

2017
£m
1,897
227
(389)
(87)
34
1
(3)
(444)
72
1,752

Reconciliation of operating business cash flow to net cash flow from operating activities by reporting segment1

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ

Taxation paid2
Net cash flow from operating activities

Operating business
cash flow

Deduct
Dividends received
from equity accounted
investments

Add back
Net capital
expenditure and
financial investment

Net cash flow from
operating activities

2018
£m
431
85
(30)
666
67
(226)
993

2017
£m
450
116
222
832
278
(146)
1,752

2018
£m
(7)
–
(7)
(36)
(3)
(4)
(57)

2017
£m
(3)
–
(8)
(57)
(4)
–
(72)

2018
£m
151
11
68
89
126
19
464

2017
£m
122
11
72
113
122
4
444

2018
£m
575
96
31
719
190
(211)
1,400
(200)
1,200

2017
£m
569
127
286
888
396
(142)
2,124
(227)
1,897

1. Reporting segments have been re-presented to reflect the organisational changes which took effect on 1 January 2018.
2. Taxation is managed on a Group-wide basis.

192

BAE SystemsAnnual Report 2018Notes to the Group accounts continued26. Movement in assets and liabilities arising from financing activities

Non-cash movements

As at
1 January
2017
£m

Cash
(inflow)/
outflow
£m

Foreign
exchange
movements
£m

Fair value
and other
movements
£m

As at
31 December
2017
£m

Cash
(inflow)/
outflow
£m

Foreign
exchange
movements
£m

Fair value
and other
movements
£m

As at
31 December
2018
£m

Non-current assets
Other financial assets1

Current assets
Other financial assets1

Non-current liabilities
Loans
Other financial liabilities1
Cash collateral2

Current liabilities
Loans
Other financial liabilities1

Interest paid
Net purchase/(sale)
of own shares

Equity dividends paid
Dividends paid to

non-controlling interests

Net cash flow from
financing activities

207

53
260

(4,425)
–
(32)

–
(28)
(4,485)

–

(164)
(164)

–
6
15

–
241
262
98
204

1
684

995

–

–
–

350
–
–

–
–
350

(128)

123
(5)

6
(25)
–

(7)
(269)
(295)

12
91

(4,069)
(19)
(17)

(7)
(56)
(4,168)

–

(112)
(112)

–
–
(2)

7
106
111
(1)
203

(1)
703

932

–

–
–

(229)
–
–

–
–
(229)

187
228

784
10
–

(785)
(61)
(52)

120

87
207

(3,514)
(9)
(19)

(785)
(11)
(4,338)

1. Excluding cash flow hedges, for which the cash flow is reported within cash flow from operating activities.
2. Reported in other payables.

27. Net debt

Key Performance Indicator – Net debt
Definition Cash and cash equivalents, less loans and overdrafts (including debt-related derivative financial instruments).

Purpose Allows management to monitor the indebtedness of the Group.

Components of net debt

Cash and cash equivalents
Debt-related derivative financial instrument assets – non-current
Debt-related derivative financial instrument assets – current
Loans – non-current
Loans and overdrafts – current
Debt-related derivative financial instrument liabilities – current
Net debt

Notes
17
13
13
20
20
13

2018
£m
3,232
87
78
(3,514)
(785)
(2)
(904)

2017
£m
3,271
79
–
(4,069)
(14)
(19)
(752)

193

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements28. Fair value measurement

Fair value of financial instruments
Certain of the Group’s financial instruments are held at fair value.

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the balance sheet date.

The fair values of financial instruments held at fair value have been determined based on available market information at the balance sheet date,
and the valuation methodologies listed below:

– the fair values of forward foreign exchange contracts are calculated by discounting the contracted forward values and translating at the

appropriate balance sheet rates;

– the fair values of both interest rate and cross-currency swaps are calculated by discounting expected future principal and interest cash flows

and translating at the appropriate balance sheet rates; and

– the fair values of money market funds are calculated by multiplying the net asset value per share by the investment held at the balance

sheet date.

Due to the variability of the valuation factors, the fair values presented at 31 December may not be indicative of the amounts the Group would
expect to realise in the current market environment.

Fair value hierarchy
The fair value measurement hierarchy is as follows:

– Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities;

– Level 2 – Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices)

or indirectly (i.e. derived from prices); and

– Level 3 – Inputs for the asset or liability that are not based on observable market data (i.e. unobservable inputs).

Carrying amounts and fair values of certain financial instruments

Financial instruments measured at fair value:

Non-current
Available for sale
Equity investments at fair value through profit and loss
Other financial assets
Other financial liabilities
Current
Other financial assets
Money market funds
Other financial liabilities

Financial instruments not measured at fair value:

Non-current
Loans1
Current
Cash and cash equivalents (excluding money market funds)
Loans and overdrafts

2018

2017

Carrying
amount
£m

Fair
value
£m

Carrying
amount
£m

Notes

–
13
245
(104)

166
908
(74)

–
13
245
(104)

166
908
(74)

13
13

13
17
13

6
–
226
(133)

89
899
(104)

Fair
value
£m

6
–
226
(133)

89
899
(104)

(3,514)

(3,597)

(4,069)

(4,478)

17
20

2,324
(785)

2,324
(794)

2,372
(14)

1. US$500m of the US$800m 3.8% bond, repayable 2024, has been converted to a floating rate bond by utilising interest rate swaps. These derivatives have been designated
as fair value hedges. Changes in the fair value of the bond attributable to interest rate risk, and gains and losses on the derivatives are recognised in the income statement.
The bond has been included in financial instruments not measured at fair value because its carrying value has only been adjusted for the fair value attributable to interest
rate risk on a portion of the bond, which has been calculated by discounting the future cash flows and translating at the appropriate balance sheet rate.

All of the financial assets and liabilities measured at fair value are classified as level 2 using the fair value hierarchy, except for money market funds,
which are classified as level 1. There were no transfers between levels during the year.

Financial assets and liabilities in the Group’s Consolidated balance sheet are either held at fair value or their carrying value approximates to fair
value, with the exception of loans, most of which are held at amortised cost. The fair value of loans presented in the table above is derived from
market prices.

194

BAE SystemsAnnual Report 2018Notes to the Group accounts continued29. Financial risk management

Interest rate risk
The Group’s objective is to manage its 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.

The Group’s interest rate management policy is that a minimum of 50% (2017 50%) and a maximum of 90% (2017 90%) of gross debt is
maintained at fixed interest rates. At 31 December 2018, the Group had 81% (2017 82%) of fixed rate debt and 19% (2017 18%) of floating
rate debt based on a gross debt of £4.1bn, including debt-related derivative financial assets (2017 £4.0bn).

The only derivatives that have been designated as fair value hedges are the fixed-to-floating interest rate swaps converting US$500m of the
US$800m 3.8% bond, repayable 2024. These derivative liabilities have a fair value of £2m (2017 £nil) and will mature in October 2019. Changes
in the fair value of the bond attributable to interest rate risk, and gains and losses on the derivatives are recognised in the income statement.

The loss arising in the income statement on fair value hedging instruments was £2m (2017 £4m). The gain arising in the income statement on
the fair value of the underlying hedged item was £1m (2017 £4m). The accumulated fair value loss included within the carrying amount of the
hedged item is £nil (2017 £1m).

Based on contracted maturities and/or repricing dates, the following amounts are exposed to interest rate risk over the future as shown below:

Cash and cash equivalents
Loans and overdrafts

Less than
one year
£m
3,232
(784)

Between one
and two years
£m
–
(702)

More than
two years
£m
–
(702)

The floating rate debt has been predominantly achieved by entering into interest rate swaps which swap the fixed rate US dollar interest payable
on debt into either floating rate sterling or US dollars. At the end of 2018, the Group had a total of $1.0bn (2017 $1.0bn) of this type of swap
outstanding with a weighted average duration of 5.8 years (2017 5.6 years). In respect of the fixed rate debt, the weighted average period in
respect of which interest is fixed was 8.5 years (2017 9.5 years). Given the level of short-term interest rates during the year, the average cost
of the floating rate debt was 5.5% (2017 4.6%) on US dollars. The cost of the fixed rate debt was 4.8% (2017 4.9%).

Sensitivity analysis
A change of 100 basis points in short-term rates applied to the average fixed/floating mix and level of borrowings would vary the interest cost
to the Group by approximately £7m (2017 £7m).

In respect of cash deposits, given the fluctuation in the Group’s working capital requirements, cash is generally invested for short-term periods
based at floating interest rates. A change of 100 basis points in the average interest rates during the year applied to the average cash deposits
would vary the interest receivable by approximately £20m (2017 £14m).

Liquidity risk
Contractual cash outflows on financial liabilities
The contracted cash outflows on loans and overdrafts, and derivative financial instruments at the reporting date are shown below, classified
by maturity. The cash outflows are shown on a gross basis, are not discounted, are translated at the spot rate and include estimated interest
payments where applicable. Contracted cash outflows reflects the gross cash outflow on derivative financial instruments and excludes the
broadly offsetting cash inflows for the receive leg of derivatives that are settled separately to the pay leg.

31 December 2018

Contracted cash outflow

Less
than
one
year
£m
(971)

Between
one and
five
years
£m
(1,742)

More
than
five
years
£m
(3,301)

Carrying
amount
£m
(4,299)

Total
£m
(6,014)

Carrying
amount
£m
(4,083)

31 December 2017

Contracted cash outflow

Less
than
one
year
£m
(213)

Between
one and
five
years
£m
(2,474)

More
than
five
years
£m
(3,217)

Total
£m
(5,904)

204
(158)

(3,754)
(3,897)

(2,722)
(3,253)

(376)
(345)

(6,852)
(7,495)

224
(162)

(2,582)
(2,681)

(2,121)
(2,166)

(118)
(106)

(4,821)
(4,953)

(756)

–

(756)

(619)

(1)

–

(620)

(816)
(1,109)
(14)

(154)
(93)
–

(36)
(393)
–

(1,006)
(1,595)
(14)

(18)
165
(2)
233

(56)
79
(19)
78

(1,458)
(38)
(399)

(102)
(793)
(8)

(54)
(416)
–

(1,614)
(1,247)
(407)

Loans and overdrafts

Cash flow hedges – financial assets
Cash flow hedges – financial liabilities
Other foreign exchange/interest
rate contracts – financial assets
Other foreign exchange/interest

rate contracts – financial liabilities

Debt-related derivatives – financial assets
Debt-related derivatives – financial liabilities
Other financial assets and liabilities

Contractual cash outflows in respect of all other financial liabilities are equal to the balance sheet carrying amount. Current contractual amounts
relating to other non-derivative financial liabilities, such as trade payables, are settled within the normal operating cycle of the business (within
one year for current liabilities and within two years for the majority of non-current liabilities).

195

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements29. Financial risk management continued

Borrowing facilities
The Group’s objective is to maintain adequate undrawn committed borrowing facilities.

At 31 December 2018, the Group had a committed Revolving Credit Facility (RCF) of £2bn (2017 £2bn). The RCF was undrawn throughout the
year. The RCF also acts as a backstop to Commercial Paper issued by the Group. At 31 December 2018, the Group had no Commercial Paper
in issue (2017 £nil).

Cash management
Cash flow forecasting is performed by the businesses on a monthly basis. The Group monitors a rolling forecast of its liquidity requirements
to ensure that there is sufficient cash to meet operational needs and maintain adequate headroom.

Surplus cash held by the businesses over and above balances required for working capital management is loaned to the Group’s centralised
treasury department. Surplus cash is invested in instant-access current accounts, short-term deposits and money market funds, choosing
instruments with appropriate maturities or sufficient liquidity to provide adequate headroom as determined by cash forecasts.

The Group’s objective is to monitor and control counterparty credit risk and credit limit utilisation. The Group adopts a conservative approach
to the investment of its surplus cash which is deposited with financial institutions with strong credit ratings for short periods. The cash and
cash equivalents balance at 31 December 2018 of £3,232m (2017 £3,271m) was invested with 31 (2017 33) financial institutions. A credit limit
is allocated to each institution taking account of its market capitalisation, credit rating and credit default swap price.

The cash and cash equivalents of the Group are invested in non-speculative financial instruments which are usually highly liquid, such
as short-term deposits. The Group, therefore, believes it has reduced its exposure to counterparty credit risk through this process.

Currency risk
The Group’s objective is to reduce its exposure to transactional volatility in earnings and cash flows from movements in foreign currency
exchange rates, mainly the US dollar, euro, Saudi riyal and Australian dollar.

The Group is exposed to movements in foreign currency exchange rates in respect of foreign currency denominated transactions. All material
firm transactional exposures are hedged using foreign exchange forward contracts and the Group aims, where possible, to apply cash flow
hedge accounting to these transactions.

The currency and notional amount of the designated hedging instruments match the currency and principal amounts of the forecast
transactions being hedged, therefore the hedging instruments and hedged items have values which will generally move in opposite directions
because of the same hedged risk. As the critical terms of the hedging instruments match those of the hedged items, an economic relationship
can be demonstrated on an ongoing basis.

The hedge ratio is 1:1 on the basis that the notional amount of the designated hedging instruments matches the principal amount of the
forecast foreign currency sales/purchases designated as the hedged items.

The Group considers the potential sources of hedge ineffectiveness to be:
– valuation adjustments for credit risk made to derivative hedging instruments at each hedge effectiveness measurement date;
– foreign currency basis inherent in the ongoing re-pricing of designated foreign currency derivative hedging instruments which

are not present in the ongoing re-pricing of the hedged items;

– changes in the timing of the designated hedged items;
– non-occurrence of the designated hedged items.

The effect of cash flow hedges on the Group’s financial position and performance for the year ended 31 December 2018 is as follows:

Purchase/(sale) contracts:

Sterling/US dollar
Sterling/euro
Other

Cash flow hedges – foreign exchange contracts

Weighted
average
hedged
rate

1.37
1.17

Change in
the value of
hedging
instruments
since 1 January
£m

Change in
the value of
hedged items
since 1 January
£m

25
6
(17)
14

(25)
(6)
17
(14)

Notional
amount
£m

(872)
(475)
(35)
(1,382)

The Notional amount is the sterling equivalent of the net currency amount purchased or sold. For example, for designated sterling/US dollar cash
flow hedges, the Group has purchased a net $1,195m at a weighted average rate of 1.37 costing £872m.

The hedged, highly probable forecast transactions denominated in foreign currency are predominantly expected to occur at various stages during
the next five years.

Amounts charged to the hedging reserve in respect of cash flow hedges were £25m (2017 £61m), including a £39m charge (2017 £24m credit)
on reclassification to profit and loss, and a £14m credit (2017 £37m credit) on contracts held at 31 December 2018.

Additional information on the Group’s derivative financial instruments is provided in note 13.

196

BAE SystemsAnnual Report 2018Notes to the Group accounts continued29. Financial risk management continued

Sensitivity analysis
The Group is exposed to movements in foreign currency exchange rates in respect of the translation of net assets and income statements of
foreign subsidiaries and equity accounted investments. 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.

The estimated impact on foreign exchange gains and losses in net finance costs of a ten cent movement in the closing sterling to US dollar
exchange rate on the retranslation of US dollar-denominated bonds held by BAE Systems plc is approximately £56m (2017 £49m).

Credit risk
For trade receivables, contract receivables and amounts due from equity accounted investments, the Group measures a provision for expected
credit losses at an amount equal to lifetime expected credit losses, estimated by reference to past experience and relevant forward-looking factors.

The Group’s assessment is that credit risk in relation to defence-related sales to government customers or sub-contractors to governments is
extremely low as the probability of default is insignificant; therefore the provision for expected credit losses is immaterial in respect of receivables
from these customers. For all non-government commercial customers, the Group assesses expected credit losses, however this is not considered
material to the financial statements. The Group considers that default has occurred when a receivable is past 180 days overdue, because historical
experience indicates that these receivables are generally not recoverable. The Group recognises a provision of 100% against all receivables over
180 days past due unless there is objective evidence that individual receivables in this category are recoverable.

Excluding the UK, US and Saudi Arabian governments where credit risk is not considered an issue, no one counterparty constitutes more than 7%
of the trade receivables balance (2017 2%).

The carrying amount of the Group’s financial assets represents the maximum exposure to credit risk.

Movements on the provision for expected credit losses are as follows:

At 1 January
Net remeasurement of loss allowance
Amounts written off
Foreign exchange gains and losses
At 31 December

2018
£m
35
(3)
(2)
–
30

2017
£m
40
(3)
(1)
(1)
35

For contract receivables and amounts due from equity accounted investments the expected credit loss provision is immaterial as the probability
of default is insignificant.

The Group writes off a trade receivable when there is objective evidence that the debtor is in significant financial difficulty and there is no realistic
prospect of recovery, for example, when a debtor enters bankruptcy or financial reorganisation. None of the trade receivables that were written
off during the year are still subject to enforcement activity. The ageing of trade receivables is detailed below:

Not past due
Up to 180 days overdue
Past 180 days overdue

2018

Provision
£m
–
–
(30)
(30)

Gross
£m
873
304
280
1,457

Net
£m
873
304
250
1,427

Gross
£m
1,119
369
211
1,699

2017

Provision
£m
–
–
(35)
(35)

Net
£m
1,119
369
176
1,664

Trade receivables past 180 days overdue primarily relate to contracts in Saudi Arabia. The Group has assessed the risk of default and recoverability
of these receivables at the balance sheet date and the expected credit losses in respect of these balances are not considered to be material.

Offsetting financial assets and liabilities

2018

2017

Gross
balances1
£m

Amounts
offset2
£m

Balance
sheet3
£m

Amounts
not offset4
£m

Net
balances5
£m

Gross
balances1
£m

Amounts
offset2
£m

Balance
sheet3
£m

Amounts
not offset4
£m

Net
balances5
£m

Notes

Assets
Cash and cash
equivalents

Other financial assets
Liabilities
Overdrafts
Other financial liabilities

17
13

20
13

3,244
411

(12)
(178)

(12)
–

12
–

3,232
411

–
(172)

3,232
239

–
(178)

–
153

–
(25)

3,287
315

(23)
(237)

(16)
–

16
–

3,271
315

(7)
(237)

–
(204)

3,271
111

–
187

(7)
(50)

1. The gross amounts of the recognised financial assets and liabilities.
2. The amounts offset in accordance with paragraph 42 of IAS 32.
3. The net balances presented in the Consolidated balance sheet.
4. The amounts subject to a master netting arrangement not offset in the Consolidated balance sheet in accordance with paragraph 42 of IAS 32. Includes £153m

(2017 £187m) in respect of recognised financial instruments and £19m (2017 £17m) in respect of cash collateral.

5. The net balances after deducting the amounts in (4) from (3).

197

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements30. Share-based payments

The Group has granted equity-settled share options and Long-Term Incentive Plan arrangements which are measured at fair value at the date
of grant using an option pricing model. The fair value is expensed on a straight-line basis over the vesting period, based on the Group’s estimate
of the number of shares that will actually vest.

Details of the terms and conditions of each share-based payment plan are given in the Annual remuneration report on pages 97 to 115.

Expense in year

Executive Share Option Plan
Performance Share Plan
Restricted Share Plan

2018
£m
7
13
7
27

2017
£m
6
12
6
24

The Group also incurred a charge of £36m (2017 £37m) in respect of the equity-settled all-employee Free Shares and Matching Partnership Shares
elements of the Share Incentive Plan.

Executive Share Option Plan

2018

2017

Outstanding at the beginning of the year
Granted during the year
Exercised during the year
Expired during the year
Outstanding at the end of the year
Exercisable at the end of the year

Range of exercise price of outstanding options (£)
Weighted average remaining contracted life (years)
Weighted average fair value of options granted (£)

Performance Share Plan and Restricted Share Plan

Outstanding at the beginning of the year
Granted during the year
Exercised during the year
Expired during the year
Outstanding at the end of the year
Exercisable at the end of the year

Weighted average remaining contracted life (years)
Weighted average fair value of awards granted (£)

Number of
shares
’000
32,907
8,971
(3,174)
(2,540)
36,164
9,482

Weighted
average
exercise
price
£
5.28
5.83
4.74
5.60
5.44
4.52

Number of
shares
’000
34,315
9,816
(7,491)
(3,733)
32,907
5,835

Weighted
average
exercise
price
£
4.59
6.48
3.92
4.86
5.28
3.81

2018
3.01 – 6.49
7
0.86

2017
3.01 – 6.49
8
0.88

Performance Share Plan

Restricted Share Plan

2018
Number of
shares
’000
20,758
7,851
(965)
(5,264)
22,380
250

2018
5
4.63

2017
Number of
shares
’000
22,992
6,979
(456)
(8,757)
20,758
38

2017
5
5.36

2018
Number of
shares
’000
3,769
1,540
(1,012)
(197)
4,100
–

2018
5
5.83

2017
Number of
shares
’000
3,328
1,463
(766)
(256)
3,769
–

2017
5
6.49

The exercise price for the Performance Share Plan and Restricted Share Plan is £nil (2017 £nil).

198

BAE SystemsAnnual Report 2018Notes to the Group accounts continued30. Share-based payments continued

Details of options/awards granted in the year
The fair value of equity-settled options/awards granted in the year has been measured using the weighted average inputs below and the following
valuation models:

Executive Share Option Plan – Binomial
Performance Share Plan – Monte Carlo
Restricted Share Plan – Dividend valuation

Range of share price at date of grant (£)
Expected option/award life (years)
Volatility (%)
Risk free interest rate (%)

2018
5.82 – 6.07
3 – 10
19
0.8

2017
6.05 – 6.49
3 – 10
19
0.2

Volatility was calculated with reference to the Group’s weekly share price volatility, after allowing for dividends, for the greater of 30 weeks or for
the period until vest date.

The average share price in the year was £5.89 (2017 £6.11).

31. 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 22).

Transactions with related parties occur 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:

Related party
Advanced Electronics Company Limited
CTA International SAS
Eurofighter Jagdflugzeug GmbH
FADEC International LLC
FAST Training Services Limited
MBDA SAS
Panavia Aircraft GmbH
Reaction Engines Limited
BAE Systems Pensions Trust Limited2

Sales to
related parties

Purchases from
related parties

Amounts owed by
related parties

Amounts owed to
related parties1

Management
recharges1

2018
£m
38
1
1,028
101
2
23
32
1
–
1,226

2017
£m
86
8
1,004
95
2
28
48
–
–
1,271

2018
£m
166
–
–
–
–
199
26
–
19
410

2017
£m
158
–
–
–
–
199
51
–
17
425

2018
£m
18
–
37
–
–
8
4
–
4
71

2017
£m
24
3
47
–
–
9
3
–
4
90

2018
£m
24
15
52
–
–
864
–
–
10
965

2017
£m
5
–
49
–
–
873
–
–
11
938

2018
£m
–
–
–
–
–
18
–
–
–
18

2017
£m
–
–
–
–
–
16
–
–
–
16

1. Also relates to disclosures under IAS 24 Related Party Disclosures, for the parent company, BAE Systems plc. At 31 December 2018, £869m (2017 £884m) was owed

by BAE Systems plc and £96m (2017 £54m) by other Group subsidiaries.

2. Transactions with BAE Systems Pensions Trust Limited represent lease arrangements for land and buildings leased by the Group.

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 97 to 115. Total emoluments for directors and key management personnel charged to the Consolidated income statement were:

Short-term employee benefits
Post-employment benefits
Share-based payments

2018
£’000

2017
£’000
15,140 16,878
1,661
5,123
22,845 23,662

1,127
6,578

199

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements32. Contingent liabilities

Contingent liabilities are potential future cash outflows which are either not probable or cannot be measured reliably.

The Group has entered into a number of guarantee and performance bond arrangements in the normal course of business and regards these
as insurance contracts. Various Group undertakings are parties to legal actions and claims which arise in the normal course of business. Provision
is made for any amounts that the directors consider may become payable (see note 23).

The Group has no individually significant contingent liabilities.

33. Commitments

Operating lease commitments
The Group leases land, buildings, vehicles and equipment under non-cancellable operating lease agreements. The leases have varying terms,
including escalation clauses, renewal rights and purchase options. None of these terms represent unusual arrangements or create material
onerous or beneficial rights or obligations.

The future aggregate minimum lease payments under non-cancellable operating leases and associated future minimum sublease income are
as follows:

Payments due:

Not later than one year
Later than one year and not later than five years
Later than five years

Total of future minimum sublease income under non-cancellable subleases

Capital commitments
Capital expenditure contracted for but not provided for in the accounts is as follows:

Property, plant and equipment, and investment property1
Intangible assets

2018
£m

2017
£m

281
891
534
1,706

251
769
626
1,646

101

2018
£m
253
21
274

2017
£m
310
18
328

Includes £83m (2017 £100m) at Barrow-in-Furness, UK, relating to the Dreadnought submarine programme funded by the UK government.

34. Acquisition of subsidiary

On 14 December 2018, the Group acquired 100% of the issued share capital of ASC Shipbuilding Pty (ASCS) for consideration of A$1. Following
the acquisition, ASCS was awarded the contract for the Australian Hunter Class Future Frigate programme.

The Group has determined that it controls ASCS; therefore the acquisition has been accounted for as a business combination and its results and
financial position have been consolidated from the date of acquisition.

The provisionally determined fair values of the assets and liabilities of ASCS at the date of acquisition are as follows:

Cash and cash equivalents
Trade and other receivables
Trade and other payables
Net identifiable assets acquired
Goodwill arising
Net assets acquired

£m
14
1
(15)
–
–
–

Acquisition-related costs of £1m have been included in operating expenses in the Consolidated income statement in the year ending
31 December 2018.

ASCS contributed £1m to the Group’s revenue and £nil to the Group’s operating profit between the date of acquisition and the balance
sheet date.

If ASCS had been acquired on 1 January 2018, the Group’s revenue and operating profit would have been £16,904m and £1,604m, respectively,
for the year ending 31 December 2018.

200

BAE SystemsAnnual Report 2018Notes to the Group accounts continued35. Information about related undertakings

In accordance with Section 409 of the Companies Act 2006, a full list of subsidiaries and equity accounted investments as at 31 December 2018
is disclosed below. Unless otherwise stated, the Group’s shareholding represents ordinary shares held indirectly by BAE Systems plc, the year end
is 31 December and the address of the registered office is Warwick House, PO Box 87, Farnborough Aerospace Centre, Farnborough, Hampshire
GU14 6YU, United Kingdom. For companies incorporated outside of the United Kingdom, the country of incorporation is shown in the address.
No subsidiary undertakings have been excluded from the consolidation.

Subsidiaries – wholly-owned
4219 Lafayette, LLC1
4219 Lafayette Center Drive, Chantilly VA 20151, United States

Aerosystems International Limited
Lupin Way, Alvington, Yeovil, Somerset BA22 8UZ,
United Kingdom

Alvis Limited

Alvis Pension Scheme Trustees Limited

Alvis Vickers Limited
Armstrong Whitworth Aircraft Limited2
ASC Shipbuilding Pty Limited
Level 2, 80 Flinders Street, Adelaide SA 5000, Australia

Australian Marine Engineering Corporation
(Finance) Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

Avro International Aerospace Limited2
BAE Systems (Al Diriyah C4i) Limited2
BAE Systems (Aviation Services) Limited

BAE Systems (Canada) Inc.
220 Laurier Avenue West, Suite 1200, Ottawa ON K1P 5Z9,
Canada

BAE Systems (Combat and Radar Systems) Limited
4th Floor, St. Paul’s Gate, 22-24 New Street, St. Helier JE1 4TR,
Jersey

BAE Systems (Consultancy Services) Limited

BAE Systems (Corporate Air Travel) Limited
BAE Systems (CS&SI – Qatar) Limited2
BAE Systems (Defence Systems) Limited

BAE Systems (Dynamics) Limited

BAE Systems (Farnborough 1) Limited

BAE Systems (Farnborough 2) Limited

BAE Systems (Farnborough 3) Limited

BAE Systems (Finance) Limited

BAE Systems (Funding Three) Limited

BAE Systems (Funding Two) Limited

BAE Systems (Gripen Overseas) Limited

BAE Systems (Hawk Synthetic Training) Limited
BAE Systems (Holdings) Limited2
BAE Systems (Insurance) Limited

BAE Systems (International) Limited

BAE Systems (Kazakhstan) Limited
BAE Systems (Land and Sea Systems) Limited3
BAE Systems (Malaysia) Sdn Bhd
16th Floor, Wisma Sime Darby, Jalan Raja Laut, 50350
Kuala Lumpur, Malaysia

BAE Systems (MEH) Limited

BAE Systems (Military Air) Overseas Limited
BAE Systems (Nominees) Limited2
BAE Systems (Oman) Limited
BAE Systems (Operations) Limited4
BAE Systems (Operations) Singapore Pte Limited
One Marina Boulevard #28-00, Singapore 018989, Singapore

BAE Systems (Overseas Holdings) Limited

BAE Systems (Poland) Sp. z o.o.
ul. Abp. A. Baraniaka 88, 61-131 Poznan, Poland

BAE Systems (Projects) Limited

BAE Systems (Property Investments) Limited

BAE Systems (Vehicles and Equipment) Limited

BAE Systems 2000 Pension Plan Trustees Limited2
BAE Systems AB5
Box 5676, SE-114 86 Stockholm, Sweden

BAE Systems Al Diriyah Programme Limited2
BAE Systems Applied Intelligence (Asia Pacific)
Pte Limited
United Square, 101 Thomson Road, #25-03/04, 307591,
Singapore

BAE Systems Applied Intelligence (Australia) Pty Limited
Level 12, 16-20 Bridge Street, Sydney NSW 2000, Australia

BAE Systems Applied Intelligence (Belgium) NV
Geldenaaksebaan 329, B-3001, Heverlee, Leuven, Belgium

BAE Systems Applied Intelligence (Connect) A/S
c/o Kromann Reumert, Sundkrogsgade 5, Copenhagen East,
2100, Denmark

BAE Systems Applied Intelligence (GCS) Limited
Surrey Research Park, Guildford, Surrey GU2 7YP,
United Kingdom

BAE Systems Applied Intelligence (Germany) GmbH
Mainzer Landstrasse 50, 60325 Frankfurt am Main, Germany

BAE Systems Applied Intelligence (Integration) Limited
Surrey Research Park, Guildford, Surrey GU2 7YP,
United Kingdom

BAE Systems Applied Intelligence (International) Limited
Priestley Road, Surrey Research Park, Guildford,
Surrey GU2 7YP, United Kingdom

BAE Systems Applied Intelligence (Ireland) Limited
Level 5, Block 4, Dundrum Town Centre, Sandyford Road,
Dundrum, Dublin 16, D16 A4W6, Ireland

BAE Systems Applied Intelligence (Japan) KK
12/F Ark Mori Building, 1-12-32 Akasaka, Minato-ku, Tokyo,
Japan 107-6024

BAE Systems Applied Intelligence (Luxembourg) SARL
412F Route d’Esch, L-2086, Luxembourg

BAE Systems Applied Intelligence (Spain) S.A.
Paseo de la Castellana, 141, Cuzco IV, 28046 Madrid, Spain

BAE Systems Applied Intelligence (UK) Limited

BAE Systems Applied Intelligence A/S
c/o Kromann Reumert, Sundkrogsgade 5, Copenhagen East,
2100, Denmark

BAE Systems Applied Intelligence Canada Inc.
1959 Upper Water Street, Suite 900, Halifax NS B3J 2X2,
Canada

BAE Systems Applied Intelligence France SAS
19 Boulevard Malesherbes, 75008, Paris, France

BAE Systems Applied Intelligence GCS Inc.6
1676 International Drive, 10th Floor, Suite 1000,
McLean VA 22102, United States

BAE Systems Applied Intelligence Inc.7
5th Floor, Suite 1920, 256 Franklin Street, Boston MA 02110,
United States

BAE Systems Applied Intelligence Limited
Surrey Research Park, Guildford, Surrey GU2 7YP,
United Kingdom

BAE Systems Applied Intelligence LLC1
5th Floor, Suite 1920, 256 Franklin Street, Boston MA 02110,
United States

BAE Systems Applied Intelligence Malaysia Sdn Bhd
Level 25, Menara Hong Leong, No. 6 Jalan Damanlela,
Bukit Damansara, 50490 Kuala Lumpur, Malaysia

BAE Systems Applied Intelligence New Zealand Limited
c/o Russell McVeagh, Vero Centre, 48 Shortland Street,
Auckland Central, 1140, New Zealand

BAE Systems Applied Intelligence Pty Limited
Level 12, 16-20 Bridge Street, Sydney NSW 2000, Australia

BAE Systems Applied Intelligence US Corp6
440 Wheelers Farms Road, Suite 202, Milford CT 06461,
United States

BAE Systems Australia (Electronic Systems) Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia (NSW) Holdings Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia (NSW) Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia (Singapore) Pte Limited8
60 Paya Lebar Road, #08-43 Paya Lebar Square, 409051,
Singapore

BAE Systems Australia Datagate Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Defence Holdings Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Defence Pty Limited9
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Holdings Limited2
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Logistics Pty Limited4
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Australia Sea Sentinel Project Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Avionics Singapore Pte Limited
One Marina Boulevard, #28-00, Singapore 018989, Singapore

BAE Systems Bofors AB
SE-691 80 Karlskoga, Sweden

BAE Systems Bofors Holdings Sdn Bhd
Level 21, Suite 21.01, The Gardens South Tower, Mid Valley City,
Lingkaran Syed Putra, 59200 Kuala Lumpur, Malaysia

BAE Systems C-ITS AB
Box 5676, SE-114 86 Stockholm, Sweden

BAE Systems China (Exports) Limited
BAE Systems Communications Limited2
BAE Systems Communications Solutions, LLC1
Knowledge Oasis, Building 4, Second Floor, 0402-Z427,
Knowledge Oasis Muscat, PO Box 16, Postal Code 135,
Muscat, Oman

BAE Systems Controls Inc.7
1098 Clark Street, Endicott NY 13760, United States

BAE Systems Creole Inc.10
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems Datagate Holdings Limited

BAE Systems Datagate Limited
BAE Systems Deployed Systems Limited11
BAE Systems Display Technologies Limited

BAE Systems do Brasil Ltda
SCN Quadra 5 Bloco A, Ed. Brasilia Shopping, Torre Norte,
Sala 426, Brasilia, DF CEP:70715-900, Brazil

BAE Systems Electronic Systems (Overseas) Limited

BAE Systems Electronics Limited

BAE Systems Enterprises Limited
BAE Systems Executive Pension Scheme Trustees Limited2

201

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsBAE Systems Land & Armaments L.P.1
2000 North 15th Street, 11th Floor, Arlington VA 22201,
United States

BAE Systems Land Systems (Finance) Limited

BAE Systems Saudi Arabia (Vehicles and
Equipment Nominees) Limited2
BAE Systems Saudi Limited
PO Box 1732, Riyadh 11441, Saudi Arabia

35. Information about related undertakings continued

Subsidiaries – wholly-owned continued
BAE Systems Finance (Ireland) Unlimited Company12
Level 5, Block 4, Dundrum Town Centre, Sandyford Road,
Dundrum, Dublin 16, D16 A4W6, Ireland

BAE Systems Finance B.V.
c/o SGG Netherlands N.V., Hoogoorddreef 15,
1101 BA Amsterdam, Netherlands

BAE Systems Finance Inc.6
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems Flight Training (Australia) Pty Limited4
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

BAE Systems Funds Management2,12
BAE Systems Global Combat Systems Bridging Limited

BAE Systems Global Combat Systems Limited

BAE Systems Global Combat Systems Munitions Limited

BAE Systems Hägglunds AB
SE-691 80, Karlskoga, Sweden

BAE Systems Hawaii Shipyards Inc.6
3049 Ualena Street, Suite 915, Honolulu HI 96819, United States

BAE Systems Holding GmbH13
Hauptstrasse 48, 82433 Bad Kohlgrub, Germany

BAE Systems Holdings (South Africa) (Pty) Limited
Central Office Park No. 5, 257 Jean Avenue, Centurion,
Gauteng, 0157, South Africa

BAE Systems Holdings B.V.
c/o SGG Netherlands N.V., Hoogoorddreef 15,
1101 BA Amsterdam, Netherlands

BAE Systems Holdings Inc.7
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems Land Systems (Investments South Africa)
Limited

BAE Systems Land Systems (Investments) Limited

BAE Systems Land Systems (Logistics) Limited

BAE Systems Land Systems (Ranges) Limited

BAE Systems Land Systems (Singapore Investments)
Limited

BAE Systems Land Systems ATF Limited
BAE Systems Land Systems FMTV International Inc.10
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems Land Systems Pinzgauer (Holdings) Limited

BAE Systems Land Systems Pinzgauer Limited

BAE Systems Logistica Ltda
SCN Quadra 5 Bloco A, Ed. Brasilia Shopping, Torre Norte,
Sala 426, Brasilia, DF CEP:70715-900, Brazil

BAE Systems MAI Turkey Hava Sistemleri A.S¸
Kizilimak Mahallesi, 1445. Sok No: 2, The Paragon B Blok K: 23,
iç Kapi No: 113 Çukurambar, Çankaya, Ankara, Turkey

BAE Systems Marine (Holdings) Limited

BAE Systems Marine (YSL) Limited

BAE Systems Marine Limited
BAE Systems Norfolk Ship Repair Inc.6
750 West Berkley Avenue, Norfolk VA 23523, United States

BAE Systems Holdings International LLC1
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems Oman LLC1
PO Box 74, Postal Code 111, Seeb, Oman

BAE Systems IAP Research, Inc.6
CT Corporation System, 4400 Easton Commons Way, Ste 125,
Columbus OH 43219, United States

BAE Systems Ordnance Systems Inc.6
4509 West Stone Drive, Kingsport TN 37660-9982,
United States

BAE Systems Imaging Solutions Inc.7
1841 Zanker Road, Suite 50, San Jose CA 95112, United States

BAE Systems Overseas Inc.6
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems India (Homeland Security) Private Limited14
#201, 2nd Floor, World Mark 2, Asset No. 8, Aerocity, NH-8,
New Delhi – 110037, India

BAE Systems India (Services) Private Limited14
#201, 2nd Floor, World Mark 2, Asset No. 8, Aerocity, NH-8,
New Delhi – 110037, India

BAE Systems India (Technology) Private Limited14
#201, 2nd Floor, World Mark 2, Asset No. 8, Aerocity, NH-8,
New Delhi – 110037, India

BAE Systems India (Ventures) Private Limited14
#201, 2nd Floor, World Mark 2, Asset No. 8, Aerocity, NH-8,
New Delhi – 110037, India

BAE Systems Information and Electronic Systems
Integration Inc.2
65 Spit Brook Road, Nashua NH 03061, United States

BAE Systems Insurance (Isle of Man) Limited
Tower House, Loch Promenade, Douglas, IM1 2LZ,
Isle of Man, United Kingdom

BAE Systems Integrated System Technologies
(KSA) Limited

BAE Systems Integrated System Technologies
(Overseas) Limited
BAE Systems Integrated System Technologies GmbH15
Hans-Stießberger-Str. 2b, 85540 Haar, Germany

BAE Systems Integrated System Technologies Limited
BAE Systems International Inc.7
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE Systems Jacksonville Ship Repair LLC1
8500 Heckscher Drive, Jacksonville FL 32226, United States

BAE Systems Land & Armaments Holdings LLC6
2000 North 15th Street, 11th Floor, Arlington VA 22201,
United States

BAE Systems Land & Armaments Inc.6
2000 North 15th Street, 11th Floor, Arlington VA 22201,
United States

BAE Systems Pension Funds CIF Trustees Limited2
BAE Systems Pension Funds Investment
Management Limited2,16
BAE Systems Pension Funds Trustees Limited2
BAE Systems Project Services Limited

BAE Systems Projects (Canada) Limited

BAE Systems Properties Limited
BAE Systems Quest Limited2
BAE Systems Regional Aircraft (Japan) KK6
Minami Azabu T&F Building 8th Floor,
4-11-22 Minami Azabu, Minato-ku, Tokyo, Japan

BAE Systems Regional Aircraft Colombia SAS
c/o Brigard & Urrutia, Calle 70 A No. 4-41, Bogota, Colombia

BAE Systems Resolution Inc.10
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems Rokar International Limited
PO Box 45059, 11 Hartom Street, Mount Hotzvim,
91450 Jerusalem, Israel

BAE Systems S&S Operations Inc.6
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems San Diego Ship Repair Inc.6
2205 East Belt Street, Foot of Sampson Street, San Diego
CA 92113, United States

BAE Systems Saudi America Limited
Business Gate Building 7, Floor 1, Riyadh 11482, Saudi Arabia

BAE Systems Saudi Arabia (Maintenance
and Equipment Services) Limited
PO Box 1732, Riyadh 11441, Saudi Arabia

BAE Systems Saudi Arabia (Vehicles and
Equipment Holdings) Limited2

202

BAE Systems Serviços de Aviônicos Ltda.
Rua Boa Vista, No. 254, 13th Floor, Suite 15, Centro, São Paulo,
São Paulo 01014-907, Brazil

BAE Systems Share Plans Trustee Limited2
BAE Systems Shared Services (Overseas) Limited
BAE Systems Shared Services Inc.6
11215 Rushmore Drive, Charlotte NC 28277, United States

BAE Systems Ship Repair Inc.6
750 West Berkley Ave., Norfolk VA 23523, United States

BAE Systems Southeast Shipyards AMHC Inc.1,6
8500 Heckscher Drive, Jacksonville FL 32226, United States

BAE Systems Surface Ships (Holdings) Limited

BAE Systems Surface Ships (Overseas) Limited

BAE Systems Surface Ships (Projects) Limited

BAE Systems Surface Ships Integrated Support Limited

BAE Systems Surface Ships Intermediate Holdings
Limited
BAE Systems Surface Ships International Limited5
BAE Systems Surface Ships Limited

BAE Systems Surface Ships Maritime Limited
BAE Systems Surface Ships Portsmouth Limited5
BAE Systems Surface Ships Projects (Malaysia) Sdn Bhd
Level 14, West Block, Wisma Golden Eagle Realty, 142-C,
Jalan Ampang, 50450 Kuala Lumpur, Malaysia

BAE Systems Surface Ships Property Services Limited
BAE Systems Surface Ships Support Limited4
BAE Systems SWS Defence AB
SE-691 80 Karlskoga, Sweden

BAE Systems Tactical Vehicle Systems LP1
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems Technology Solutions & Services Inc.6
520 Gaither Road, Rockville, MD 20850, United States

BAE Systems Training Services Limited
BAE Systems TVS Holdings Inc.6
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems TVS Holdings LLC1
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems TVS Inc.10
3701 Outlet Ctr. Drive, Suite 15, Sealy TX 77474-4904,
United States

BAE Systems Zephyr Corporation7
c/o The Corporation Trust Company, Corporation Trust Center,
1209 Orange Street, City of Wilmington, County of New Castle
DE 19801, United States

BAE Systems Zephyr Fifth Corporation7
c/o The Corporation Trust Company, Corporation Trust Center,
1209 Orange Street, City of Wilmington, County of New Castle
DE 19801, United States

BAE Systems Zephyr Fourth Corporation7
c/o The Corporation Trust Company, Corporation Trust Center,
1209 Orange Street, City of Wilmington, County of New Castle
DE 19801, United States

BAE Systems Zephyr Second Corporation7
c/o The Corporation Trust Company, Corporation Trust Center,
1209 Orange Street, City of Wilmington, County of New Castle
DE 19801, United States

BAE Systems Zephyr Third Corporation7
c/o The Corporation Trust Company, Corporation Trust Center,
1209 Orange Street, City of Wilmington, County of New Castle
DE 19801, United States

BAE Systems, Inc.6
1101 Wilson Blvd, Ste 2000, Arlington VA 22209, United States

BAE SystemsAnnual Report 2018Notes to the Group accounts continuedThe Blackburn Aeroplane & Motor Co Limited2
The Bristol Aviation Company Limited2
The British & Colonial Aeroplane Co. Limited2
The Leeds Partnership Limited4
The Supermarine Aviation Works Limited2,3
Thomas Sopwith Aviation Company Limited2
VSEL Birkenhead Limited

Warship Design Services Limited
Westover Controls Incorporated6
1098 Clark Street, Endicott NY 13760, United States

35. Information about related undertakings continued

Subsidiaries – wholly-owned continued
Brabazon Limited
British Aerospace (Far East) Limited17
Level 54, Hopewell Centre, 183 Queen’s Road East, Hong Kong

British Aerospace (Malaysia) Sdn Bhd17
Unit 30-01, Level 30, Tower A, Vertical Business Suite,
Avenue 3, Bangsar South, No.8, Jalan Kerinchi,
59200 Kuala Lumpur, Malaysia

British Aircraft Corporation (Pension Fund Trustees)
Limited2
British Aircraft Corporation Limited2
Buckfield Properties Limited
Cashhold Limited2,4
CPS International, Inc.10
c/o Benedetti & Benedetti, Comosa Building, 21st Floor,
Ave. Samuel Lewis, PO Box 850120, Panama 5, Panama

Creole (Nigeria) Limited4
Tapa House (2nd Floor), 45, Imman Dauda St (Abosede Kuboye
Crescent Entrance) Surulere, Lagos, Nigeria

Detica B.V.
Luna ArenA, Herikerbergweg 238, 1101 CM Amsterdam,
Netherlands

Detica Group Holdings (Ireland) Limited
Level 5, Block 4, Dundrum Town Centre, Sandyford Road,
Dundrum, Dublin 16, D16 A4W6, Ireland

Detica Group Limited
Detica Ireland Limited5
Level 5, Block 4, Dundrum Town Centre, Sandyford Road,
Dundrum, Dublin 16, D16 A4W6, Ireland

Detica Mexico S. de R.L. de C.V.
Torre Esmeralda II, Blvd Manuel Avila Camacho No. 36
Piso 18, Lomas de Chapultepec, 11000 D.F., Mexico

Detica Patent Limited
Level 5, Block 4, Dundrum Town Centre, Sandyford Road,
Dundrum, Dublin 16, D16 A4W6, Ireland

Detica Services, Inc.
5th Floor, Suite 1920, 256 Franklin Street, Boston MA 02110,
United States

ETI Engineering, Inc.6
1676 International Drive, 10th Floor, Suite 1000,
McLean VA 22102, United States

Gloster Aircraft Limited2
Granada Enterprises Limited
PO Box 1732, Riyadh 11441, Saudi Arabia

H-B Utveckling, H-B Development AB
Nybrogatan 7, SE-114 34 Stockholm, Sweden

Lemacrown Limited19
MES Holdco Limited
4th Floor, St. Paul’s Gate, 22-24 New Street, St. Helier JE1 4TR,
Jersey

MES Interco12
Meslink Limited

Newcombe Properties Limited

Piper Group plc

Pitch Technologies AB
Repslagaregatan 25, SE-582 22 Linköping, Sweden

Pitch Technologies Limited
Sweden House, 5 Upper Montagu Street, London W1H 2AG,
United Kingdom

Port Solent Limited

Port Solent Marina Limited
PT. BAE Systems Services6
Wisma 46, Kota BNI, 34th Floor, Suite 34.01.A,
Jl. Jenderal Sudirman Kavling 71, Jakarta 10220, Indonesia

Representaciones SSTS, CA10
Ave Francisco de Miranda, Centro Lido El Rosal Oficina 71B,
Caracas, Venezuela

Royal Ordnance (Crown Service) Pension Scheme
Trustees Limited

Royal Ordnance B.V.
c/o SGG Netherlands N.V., Hoogoorddreef 15,
1101 BA Amsterdam, Netherlands

Royal Ordnance Senior Staff Pension Scheme
Trustees Limited
Royal Ordnance Speciality Metals Limited2
RWT Limited2
Salford Electrical Instruments Limited

Scentcivil Limited
Scottish Aviation Limited2
Prestwick International Airport, Prestwick, Ayrshire KA9 2RW,
United Kingdom

Sepia, LLC1
4219 Lafayette Center Drive, Chantilly VA 20151, United States

Shipbuilding (MSF) Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

Shipbuilding (VIC) Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

Hadrian Holdings, Inc.14
521 Fifth Avenue, New York NY 101075, United States

Stephen Howe Systems Limited18
Alvington, Yeovil, Somerset BA22 8UZ, United Kingdom

Hadrian Trustees Limited2,14
Hägglunds Vehicle GmbH
Ernst-Grote Strasse 13, 30916 Isernhagen, Germany

Hawker Siddeley Aviation Limited2
Hawker Siddeley Dynamics Limited2
Hertfordshire Estates Limited4
HSA/HSD Pension Fund Trustees Limited2
Hunter Aerospace Corporation Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

International Military Sales Limited
Jetstream Aircraft Limited2
Prestwick International Airport, Prestwick, Ayrshire KA9 2RW,
United Kingdom

Kalamind Limited18

Stewart & Stevenson Operations (Nigeria) Limited10
Tapa House (2nd Floor), 45, Imman Dauda St (Abosede Kuboye
Crescent Entrance), Surulere, Lagos, Nigeria

Stewart & Stevenson TVS UK Limited

Stratsec.net Sdn Bhd
Unit F-3-1, Blok F, Third Floor, CBD Perdana 3, Jalan Perdana,
Cyber 12, 63000 Cyberjaya, Selangor Darul Ehsan, Malaysia

Support Solutions General Services and Contracting
Company/Limited Liability company1,13
House No. 145, Street No. 1, Qtr. 611, Al Andulous Area,
Al Mansour, Baghdad, Iraq

TDS International Holdings Pty Limited20
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

TDS International Pty Limited
Evans Building, Taranaki Road, Edinburgh Parks, Edinburgh
SA 5111, Australia

203

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements35. Information about related undertakings continued

Subsidiaries – not wholly-owned
Advanced National Company for Aircraft Maintenance
Limited (88.1%)
PO Box 1732, Riyadh 11441, Saudi Arabia

Aircraft Accessories & Components Co Limited (75.6%)
PO Box 13532, Jeddah 21434, Saudi Arabia

Aircraft Research Association Limited (87.1%)2
Manton Lane, Bedford MK41 7PF, United Kingdom

ARA Pension Fund Trustees Limited (87.1%)
Manton Lane, Bedford MK41 7PF, United Kingdom

BAE Systems Saudi Development and Training
Company Limited (87.3%)21
PO Box 67775, Riyadh 11517, Saudi Arabia

BAE Systems SDT (UK) Limited (87.3%)
Flight Control System Management GmbH (66.6%)22
PO Box 801109, 81663 Munich, Germany

Hadrian Properties, Inc. (95%)14
521 Fifth Avenue, New York NY 101075, United States

International Systems Engineering Company Limited
(79.9%)
PO Box 54002, Riyadh 11514, Saudi Arabia

Overhaul and Maintenance Company Holding (88.1%)
PO Box 1732, Riyadh 11441, Saudi Arabia

Saudi Maintenance & Supply Chain Management
Company Limited (51%)
PO Box 1732, Riyadh 11441, Saudi Arabia

Saudi Technology & Logistics Services Limited (65%)2
PO Box 1732, Riyadh 11441, Saudi Arabia

SMSCMC (UK) Limited (51%)

Notes
1.

Unincorporated entity for which the address
given is the principal place of business.

2. Directly owned by BAE Systems plc.
3. Ownership held in class of A shares, B shares

and preference shares.

4. Ownership held in class of A shares and B shares.
5. Ownership held in ordinary shares and

preference shares.

6. Ownership held in common shares.
7. Ownership held in common stock.
8. Year end 30 June.
9. Ownership held in ordinary shares and

redeemable preference shares.

10. Ownership held in authorized shares.
11. 40% owned by BAE Systems plc.
12. Unlimited company.
13. In liquidation.
14. Year end 31 March.
15. In members’ voluntary liquidation.
16. Year end 5 April.
17. Year end 30 September.
18. In strike off.
19. Ownership held in ordinary shares and class

of A shares.

20. Ownership held in class of A shares.
21. 1% owned by BAE Systems plc.
22. 33.3% owned by BAE Systems plc.
23. Ownership held in class of B shares.
24. Ownership held in common shares and

B Preferred shares.

Equity accounted investments
Abercromby Property International (20.42%)
521 Fifth Avenue, New York NY 101075, United States

Advanced Electronics Company Limited (44%)
PO Box 90916, Riyadh 11623, Saudi Arabia

Air Astana (49%)7
Zakarpatskaya Str 4A, 050039 Almaty, Kazakhstan

AMSH B.V. (50%)23
Weena 210-212, 3012 NJ Rotterdam, Netherlands

BAeHAL Software Limited (40%)2,14
Airport Lane, HAL Estate, Bangalore 560010, India

BHIC Bofors Defense Asia Sdn Bhd (49%)
Level 21, Suite 21.01, The Gardens South Tower, Mid Valley
City, Lingkaran Syed Putra, 59200 Kuala Lumpur, Malaysia

Canadian Naval Support Limited (50%)24
3099 Barrington Street, Halifax NS B3K 5M7, Canada

CTA International SAS (50%)
13 Route De La Miniere, 78034 Versailles Cedex, France

Data Link Solutions L.L.C. (50%)1,17
400 Collins Ave, Cedar Rapids IA 52498, United States

Eurofighter Aircraft Management GmbH (33%)2,13
Am Soldnermoos 17, 85399 Hallbergmoos, Germany

Eurofighter Jagdflugzeug GmbH (33%)2
Am Soldnermoos 17, 85399 Hallbergmoos, Germany

European Aerosystems Limited (50%)2,20
FADEC International LLC (50%)1
1098 Clark Street, Endicott NY 13760, United States

FAST Holdings Limited (50%)14,20
FAST Training Services Limited (50%)14
FNSS Savunma Sistemleri A.S (49%)20
PK 37, Golbasi 06830, Ankara, Turkey

Gripen International KB (50%)1,13
SE-581 88 Linköping, Sweden

MBDA Holdings SAS (25%)
1 Avenue Réaumur, 92350 Le Plessis-Robinson, France

Nobeli Business Support AB (34%)
SE-691 80 Karlskoga, Sweden

Nurol BAE Systems Hava Sistemleri Anonim S¸ irketi (49%)23
Üniversiteler Mah, 1605.Cad, No:3/1-3, 06800, Ankara, Turkey

Panavia Aircraft GmbH (42.5%)2
Am Soldnermoos 17, 85399 Hallbergmoos, Germany

Reaction Engines Limited (18%)23
Hill House, 1 Little New Street, London EC4A 3TR,
United Kingdom

Saab Bofors Test Center AB (30%)
SE-691 80 Karlskoga, Sweden

Saab-BAe Systems Gripen AB (50%)2
SE-581 88 Linköping, Sweden

Sealand Support Services Limited (33.3%)9
MoD Sealand, Welsh Road, Sealand, Deeside, Flintshire
CH5 2LS, United Kingdom

Seele-Alvis Fenestration Limited (43.5%)8,20
Unit A44, Jack’s Place, 6 Corbett Place, London E1 6NN,
United Kingdom

SIKA International Limited (50%)15,20
Spectrum Technologies Limited (20%)2,14
Western Avenue, Bridgend Industrial Estate, Bridgend,
Mid Glamorgan CF31 3RT, United Kingdom

Winner Developments Limited (33.3%)

204

BAE SystemsAnnual Report 2018Notes to the Group accounts continued36. Events after the reporting period

In January 2019, the Group announced an agreement with Rheinmetall to create a joint UK-based military land vehicle design, manufacturing
and support business. Rheinmetall will purchase a 55% stake in the existing BAE Systems UK-based combat vehicles business, with BAE Systems
retaining 45%. The establishment of the new joint venture is subject to regulatory approvals which are anticipated to be completed in the first
half of 2019. Once the approvals have been completed, the joint venture will be known as Rheinmetall BAE Systems Land (RBSL). The UK-based
combat vehicles business is presented as held for sale at 31 December 2018 (see note 18).

As a part of a planned reorganisation of the Group’s portfolio of interests in a number of industrial companies in Saudi Arabia, the Group
completed the disposal of its 75.6% shareholding in Aircraft Accessories and Components Company (AACC) in January 2019. AACC is presented
as held for sale at 31 December 2018 (see note 18).

37. Changes in accounting policies and restatements

This note explains the impact of changes in accounting policies and the correction of a prior year error on the Group’s financial statements.

Impact on financial statements
As a result of changes in the Group’s accounting policies, prior year comparative information has been restated for the adoption of
IFRS 15 Revenue from Contracts with Customers. As explained below, IFRS 9 Financial Instruments was adopted without restating
comparative information.

Following an internal review of the third-party accounting valuation of a longevity swap held by one of the Group’s pension schemes, the
Group became aware of an error in respect of the treatment of experience collateral in the accounting valuation. This resulted in a material
error in the value of pension scheme assets included in the financial statements for the years ended 31 December 2017 and 31 December 2016.
This error has been corrected retrospectively by restating the comparative amounts presented in these financial statements.

The following tables show the adjustments recognised for each individual line item. Line items that are not affected by the changes have
not been included. As a result, the sub-totals and totals disclosed cannot be recalculated from the numbers provided.

Consolidated balance sheet (extract)

Non-current assets
Equity accounted investments
Deferred tax assets

Current assets
Inventories
Trade and other receivables including amounts due from customers for contract work
Trade, other and contract receivables

Total assets
Non-current liabilities
Trade and other payables
Retirement benefit obligations
Provisions

Current liabilities
Trade and other payables
Provisions

Total liabilities
Net assets

Capital and reserves
Other reserves
Retained earnings
Total equity attributable to equity holders of BAE Systems plc
Non-controlling interests
Total equity

As
previously
reported
£m

As at 31 December 2017

Impact of
IFRS 15
£m

Valuation of
longevity
swap
£m

384
724
14,738

723
3,586
–
7,715
22,453

(1,722)
(4,222)
(413)
(10,563)

(6,322)
(345)
(7,106)
(17,669)
4,784

6,098
(2,693)
4,741
43
4,784

(60)
(40)
(100)

10
(3,586)
4,244
668
568

(1)
–
(22)
(23)

(433)
(55)
(488)
(511)
57

(8)
65
57
–
57

(2)
18
16

–
–
–
–
16

–
(102)
–
(102)

–
–
–
(102)
(86)

–
(86)
(86)
–
(86)

Restated
£m

322
702
14,654

733
–
4,244
8,383
23,037

(1,723)
(4,324)
(435)
(10,688)

(6,755)
(400)
(7,594)
(18,282)
4,755

6,090
(2,714)
4,712
43
4,755

205

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements37. Changes in accounting policies and restatements continued

Consolidated balance sheet (extract)

Non-current assets
Equity accounted investments
Deferred tax assets

Current assets
Inventories
Trade and other receivables including amounts due from customers for contract work
Trade, other and contract receivables

Total assets
Non-current liabilities
Trade and other payables
Retirement benefit obligations
Provisions

Current liabilities
Trade and other payables
Provisions

Total liabilities
Net assets

Capital and reserves
Retained earnings
Total equity attributable to equity holders of BAE Systems plc
Non-controlling interests
Total equity

As
previously
reported
£m

As at 31 December 2016

Impact of
IFRS 15
£m

Valuation of
longevity
swap
£m

299
1,251
15,947

744
3,305
–
7,029
22,976

(1,027)
(6,277)
(372)
(12,213)

(6,540)
(234)
(7,299)
(19,512)
3,464

(4,583)
3,438
26
3,464

(48)
(79)
(127)

32
(3,305)
3,959
686
559

(13)
–
(20)
(33)

(377)
(57)
(434)
(467)
92

92
92
–
92

(1)
9
8

–
–
–
–
8

–
(53)
–
(53)

–
–
–
(53)
(45)

(45)
(45)
–
(45)

Restated
£m

250
1,181
15,828

776
–
3,959
7,715
23,543

(1,040)
(6,330)
(392)
(12,299)

(6,917)
(291)
(7,733)
(20,032)
3,511

(4,536)
3,485
26
3,511

206

BAE SystemsAnnual Report 2018Notes to the Group accounts continued37. Changes in accounting policies and restatements continued

Consolidated income statement

Operating profit

Financial income
Financial expense
Net finance costs
Profit before taxation
Taxation expense
Profit for the year

Attributable to:

Equity shareholders
Non-controlling interests

Earnings per share

Basic earnings per share
Diluted earnings per share
Underlying earnings per share1

Year ended 31 December 2017

As
previously
reported
£m

Impact of
IFRS 15
£m

Restated on
adoption of
IFRS 15
£m

19,626
(2,575)
1,271
18,322
(17,089)
131
1,364
116

(1,139)
41
–
(1,098)
1,046
–
(52)
(9)

18,487
(2,534)
1,271
17,224
(16,043)
131
1,312
107

2,034
(13)
2,021
(86)
(384)
(34)
(37)
1,480

416
(762)
(346)
1,134
(250)
884

854
30
884

26.8p
26.7p
43.5p

(60)
–
(60)
–
–
–
(1)
(61)

–
–
–
(61)
34
(27)

(27)
–
(27)

(0.8)p
(0.8)p
(1.4)p

1,974
(13)
1,961
(86)
(384)
(34)
(38)
1,419

416
(762)
(346)
1,073
(216)
857

827
30
857

26.0p
25.9p
42.1p

1. Restated underlying earnings per share excludes an additional £18m benefit in respect of the impact of US tax reform enacted in December 2017 included in the restated

taxation expense above.

207

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements37. Changes in accounting policies and restatements continued

Consolidated statement of comprehensive income

Profit for the year
Other comprehensive income
Items that will not be reclassified to the income statement:

Subsidiaries:

Remeasurements on retirement benefit schemes
Tax on items that will not be reclassified to the income statement

Equity accounted investments (net of tax)

Items that may be reclassified to the income statement:

Subsidiaries:

Currency translation on foreign currency net investments
Amounts credited to hedging reserve
Tax on items that may be reclassified to the income statement

Equity accounted investments (net of tax)

Other comprehensive income for the year (net of tax)
Total comprehensive income for the year

Attributable to:

Equity shareholders
Non-controlling interests

Year ended 31 December 2017

As
previously
reported
£m
884

Impact of
IFRS 15
£m
(27)

Valuation of
longevity
swap
£m
–

Restated
£m
857

2,105
(490)
53

(625)
59
(11)
(15)
1,076
1,960

1,935
25
1,960

–
–
–

(5)
–
–
(3)
(8)
(35)

(35)
–
(35)

(49)
9
(1)

–
–
–
–
(41)
(41)

(41)
–
(41)

2,056
(481)
52

(630)
59
(11)
(18)
1,027
1,884

1,859
25
1,884

IFRS 9 Financial instruments – impact of adoption
IFRS 9 replaces the provisions of IAS 39 that relate to recognition,
classification and measurement of financial assets and financial
liabilities, de-recognition of financial instruments, impairment
of financial assets and hedge accounting. The adoption of IFRS 9
Financial Instruments from 1 January 2018 resulted in changes in
accounting policies; however, no adjustments were required to the
amounts recognised in the financial statements in previous periods.
The accounting policies applied from 1 January 2018 are set out in
the relevant notes.

Classification and measurement
On 1 January 2018, the Group has classified its financial instruments
in the appropriate IFRS 9 categories.

The derivative financial instruments designated as cash flow hedges
and fair values hedges under IAS 39 at 31 December 2017 continue
to qualify for hedge accounting under IFRS 9 at 1 January 2018 and
are therefore treated as continuing hedges.

Derivative financial instruments that were not designated as hedges
under IAS 39 were classified in the fair value through profit or loss
category and gains and losses were recognised in the income
statement in the period. There is no change to the classification of
these financial instruments under IFRS 9 as they fail the contractual
cash flow characteristics test in IFRS 9 (4.1.2(b)) and (4.1.2A(b)).

Trade receivables and amounts owed by equity accounted
investments, previously classified in the loans and receivables category
and measured at amortised cost under IAS 39, continue to be classified
in the amortised cost category under IFRS 9 as they are held within a
business model to collect contracted cash flows and these cash flows
consist solely of payments of principal and interest.

Money market funds previously classified in the available for sale
category under IAS 39 were previously measured at fair value with any
change in fair value recognised in other comprehensive income. Under
IFRS 9, money market funds are measured at fair value through profit

and loss. However, fair value approximates to amortised cost for
these financial assets; therefore the impact on transition to IFRS 9
is immaterial. Money market funds continue to be presented within
cash and cash equivalents in the Consolidated balance sheet.

Equity investments previously classified in the available for sale category
under IAS 39 were previously measured at fair value with any change
in fair value recognised in other comprehensive income. Under IFRS 9,
equity investments are measured at fair value through profit and loss.

Impairment of financial assets
The Group has three types of financial asset that are subject to IFRS 9’s
new expected credit loss model: trade receivables; contract receivables;
and amounts owed by equity accounted investments.
Trade receivables and contract receivables do not contain a significant
financing element and therefore expected credit losses are measured
using the simplified approach permitted by IFRS 9, which requires
expected lifetime losses to be recognised from the initial recognition
of the receivables.

The Group has assessed credit risk in relation to defence-related
sales to government customers or sub-contractors to governments
and believes it to be extremely low as the probability of default is
insignificant; therefore the provision for expected credit losses is
immaterial in respect of receivables from these customers. The Group
considers expected credit losses for non-government commercial
customers, however this risk is not material to the financial statements.

Amounts due from equity accounted investments primarily relate to
trading balances with no significant financing element, in accordance
with IFRS 15. The simplified approach is therefore used for these
balances. The identified impairment loss was immaterial.

While cash and cash equivalents are also subject to the impairment
requirements of IFRS 9, the identified impairment loss was immaterial.

There was minimal IFRS 9 impact on retained earnings at 1 January 2018
and therefore no restatement was required.

208

BAE SystemsAnnual Report 2018Notes to the Group accounts continued37. Changes in accounting policies and restatements continued

IFRS 15 Revenue from Contracts with Customers – impact of adoption
The Group has adopted IFRS 15 fully retrospectively in accordance with paragraph C3(a). Comparatives for the year ended 31 December 2017
have been restated. The following expedients have been used in accordance with paragraph C5:

– revenue in respect of completed contracts that begin and end in the same accounting period has not been restated;

– revenue in respect of completed contracts with variable consideration reflects the transaction price at the date the contracts were completed;

and

– the transaction price allocated to unsatisfied and partially unsatisfied performance obligations as at 31 December 2017 is not disclosed.

The accounting policy in respect of revenue applied from 1 January 2018 is set out in note 1.

As a result of the adoption of IFRS 15 Revenue from Contracts with Customers from 1 January 2018, the following adjustments were made
to restate the amounts recognised in the balance sheet at 31 December 2017:

Equity accounted investments
Deferred tax assets
Inventories
Trade and other receivables including amounts due from customers for contract work
Trade, other and contract receivables
Non-current other payables
Current trade and other payables
Non-current provisions
Current provisions

As
previously
reported
£m
384
724
723
3,586
–
(1,722)
(6,322)
(413)
(345)

As at 31 December 2017

Reclassification
£m
–
–
10
(3,586)
4,055
22
(424)
(22)
(55)

Remeasurement
£m
(60)
(40)
–
–
189
(23)
(9)
–
–

Restated on
adoption of
IFRS 15
£m
324
684
733
–
4,244
(1,723)
(6,755)
(435)
(400)

The impact of adoption on the Group’s retained earnings at 31 December 2017 and 31 December 2016 is as follows:

Retained earnings – as previously reported

Recognition of revenue for over time contracts based on costs incurred and including attributable margin
Equity accounted investments – separation of development and production margin, net of tax
Licence revenue – deferral of revenue over the licence term
Deferred tax
Adjustment to retained earnings upon adoption of IFRS 15

Retained earnings – IFRS 15 (restated)

2017
£m
(2,693)

2016
£m
(4,583)

201
(59)
(32)
(45)
65

259
(48)
(39)
(80)
92

(2,628)

(4,491)

209

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements38. Adoption of IFRS 16 Leases

IFRS 16 is effective from 1 January 2019 and replaces IAS 17 Leases and
related interpretations. It will result in almost all leases being recognised
on the balance sheet by lessees, as the distinction between operating
and finance leases is removed. Under the new standard, a right-of-use
asset and a financial liability for future lease payments are recognised.
The only exceptions are short-term leases, low-value leases and leases
of intangible assets.

The Group will apply the Standard from 1 January 2019. The Group
has applied the modified retrospective transition approach and will
not restate comparative amounts for the year ended 31 December
2018. In the majority of cases the Group has elected to measure
right-of-use assets at the amount of the lease liability on adoption
(adjusted for any lease prepayments or accrued lease expenses,
onerous lease provisions, and leased assets which have subsequently
been sub-leased). For a number of property leases the Group has
elected to measure the right-of-use asset as if IFRS 16 had been
applied since the start of the lease, but using the incremental
borrowing rate at 1 January 2019, with the difference between the
right-of-use asset and the lease liability taken to retained earnings.

The Group has elected to adopt the following practical expedients
on transition:
– not to capitalise a right-of-use lease asset or related lease liability

where the lease expires before 31 December 2019;

– not to reassess contracts to determine if the contract contains
a lease and not to separate lease and non-lease elements;
– where an onerous lease provision is in existence, to utilise this
provision to reduce the right-of-use asset value rather than
undertaking an impairment review;

– to use hindsight in determining the lease term;
– to exclude initial direct costs from the measurement of the

right-of-use asset; and

– to apply the portfolio approach where a group of leases has

similar characteristics.

Impact of adoption of IFRS 16 Leases
Balance sheet
Upon transition on 1 January 2019, the Group will recognise a
right-of-use lease asset of £1,300m (after adjustments for onerous
lease provisions, lease prepayments and accrued lease expenses at
31 December 2018), and lease liabilities of £1,486m (non-current
£1,270m; current £216m), along with a deferred tax asset of £2m.
A sub-lease finance receivable of £70m will also be recognised.
A transition adjustment of £92m will be recognised as a debit to
retained earnings. The Group will not capitalise low-value leases
on transition, or those which expire before 31 December 2019, and
has opted not to apply IFRS 16 to leases relating to intangible assets.
The right-of-use lease asset principally consists of property.

Income statement
Under IFRS 16 the Group will see a different pattern of expense
within the income statement, as the IAS 17 operating lease expense
is replaced by depreciation and interest charges. In 2019, the Group’s
EBITA metric will improve by an estimated £50m under IFRS 16 as
the new depreciation expense is expected to be lower than the IAS 17
operating lease charge; however the new finance costs are expected
to broadly offset this, such that net profit after tax and the underlying
earnings metric are not expected to be materially different compared
to the previous IAS 17 reporting basis.

Cash flow statement
The change in presentation as a result of the adoption of IFRS 16
will see an improvement in 2019 of an estimated £46m in cash flow
generated from operating activities, offset by a corresponding decline
in cash flow from financing activities. There is no overall cash flow
impact from the adoption of the new Standard.

Lessor accounting under IFRS 16 is largely unchanged from IAS 17.

Estimated 2019 IFRS 16 Leases impact on underlying EBITA by segment

£m
4
3
3
19
2
19
50

Electronic Systems
Cyber & Intelligence
Platforms & Services (US)
Air
Maritime
HQ
Group

210

BAE SystemsAnnual Report 2018Notes to the Group accounts continued38. Adoption of IFRS 16 Leases continued

Impact on Consolidated balance sheet at 1 January 2019 (extract)
The following table shows the effect of adopting IFRS 16 on the Consolidated balance sheet at 1 January 2019.

Non-current assets
Right-of-use assets
Investment property
Equity accounted investments
Finance lease receivable
Deferred tax assets

Current assets
Finance lease receivable
Trade, other and contract receivables

Total assets
Non-current liabilities
Lease liabilities
Provisions

Current liabilities
Lease liabilities
Trade and other payables
Provisions

Total liabilities
Net assets

Capital and reserves
Retained earnings
Total equity attributable to equity holders of BAE Systems plc
Non-controlling interests
Total equity

£m

1,255
45
(11)
61
2
1,352

9
(26)
(17)
1,335

(1,270)
24
(1,246)

(216)
28
7
(181)
(1,427)
(92)

(92)
(92)
–
(92)

The weighted average incremental borrowing rate applied to lease liabilities was 3.43%.

Reconciliation between operating lease commitments and lease liability
The following table explains the difference between the operating lease commitments disclosed applying IAS 17 at 31 December 2018 and the
lease liability recognised on adoption of IFRS 16 at 1 January 2019.

Total minimum lease payments reported at 31 December 2018 under IAS 17 (note 33)
Change in assessment of lease term under IFRS 16
Leases outside the scope of IFRS 16
Impact of discounting lease liability under IFRS 16
Lease liability recognised on transition to IFRS 16 at 1 January 2019

£m
1,706
107
(81)
(246)
1,486

211

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsCompany statement of comprehensive income
for the year ended 31 December

Profit for the year
Other comprehensive income
Items that will not be reclassified to the income statement:

Remeasurements on retirement benefit schemes1

Items that may be reclassified to the income statement:

Amounts credited/(charged) to hedging reserve

Total other comprehensive income for the year (net of tax)
Total comprehensive income for the year

2018
£m
890

2017
£m
962

(27)

142

2
(25)
865

(2)
140
1,102

1. 2018 includes a charge of £7m to correct a prior year error in respect of the accounting valuation of a longevity swap held by one of the Company’s defined benefit

pension schemes (see note 37 to the Group accounts). This error has not been corrected retrospectively because it is not material to the Company financial statements.

Company statement of changes in equity
for the year ended 31 December

At 1 January 2017
Profit for the year
Total other comprehensive income for the year

Total comprehensive income for the year
Share-based payments
Net purchase of own shares
Ordinary share dividends2
At 31 December 2017
Profit for the year
Total other comprehensive income for the year

Total other comprehensive income for the year
Share-based payments
Net sale of own shares
Ordinary share dividends2
At 31 December 2018

1. The non-distributable portion of retained earnings is £707m (2017 £649m).
2. Details of ordinary share dividends are provided in note 24 to the Group accounts.

Notes

Issued share
capital
£m
87
–
–
–
–
–
–
87
–
–
–
–
–
–
87

Share
premium
£m
1,249
–
–
–
–
–
–
1,249
–
–
–
–
–
–
1,249

Other
reserves
£m
205
–
(2)
(2)
–
–
–
203
–
2
2
–
–
–
205

Retained
earnings1
£m
2,126
962
142
1,104
55
(1)
(684)
2,600
890
(27)
863
69
1
(703)
2,830

Total
equity
£m
3,667
962
140
1,102
55
(1)
(684)
4,139
890
(25)
865
69
1
(703)
4,371

212

BAE SystemsAnnual Report 2018Company balance sheet
as at 31 December

Non-current assets
Intangible assets
Property, plant and equipment
Investments in subsidiary undertakings and participating interests
Other receivables
Retirement benefit surpluses
Other financial assets

Current assets
Trade and other receivables
Current tax
Other financial assets
Cash and cash equivalents

Total assets
Non-current liabilities
Loans
Other payables
Retirement benefit obligations
Other financial liabilities
Provisions

Current liabilities
Loans and overdrafts
Trade and other payables
Other financial liabilities
Provisions

Total liabilities
Net assets

Capital and reserves
Issued share capital
Share premium
Other reserves
Retained earnings1
Total equity

1. The Company’s profit for the year is £890m (2017 £962m).

Approved by the Board on 20 February 2019 and signed on its behalf by:

C N Woodburn
Chief Executive

P J Lynas
Group Finance Director

Registered number: 1470151

Notes

2018
£m

2017
£m

8
4

8
4
7

6
4
7

62
13
8,497
3
44
278
8,897

3,102
14
207
2,563
5,886
14,783

(1,102)
(22)
(228)
(164)
(105)
(1,621)

–
(8,645)
(126)
(20)
(8,791)
(10,412)
4,371

38
29
8,439
3
27
280
8,816

2,653
14
145
2,707
5,519
14,335

(1,059)
(19)
(186)
(216)
(101)
(1,581)

(7)
(8,416)
(172)
(20)
(8,615)
(10,196)
4,139

87
1,249
205
2,830
4,371

87
1,249
203
2,600
4,139

213

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsNotes to the
Company accounts

1. Preparation
Basis of preparation
The financial statements of BAE Systems plc have been prepared on
a going concern basis, as discussed in the Directors’ report on page 82,
and in accordance with Financial Reporting Standard (FRS) 101, Reduced
Disclosure Framework, issued in September 2015. The amendments to
FRS 101 (2015/16 cycle), issued in July 2016, and FRS 101 (2016/17 cycle),
issued in July 2017, have no impact on the Company.

In preparing these financial statements, the Company applies the
recognition, measurement and disclosure requirements of International
Financial Reporting Standards (IFRS) as adopted by the EU (EU-adopted
IFRS), but makes amendments where necessary in order to comply with
the Companies Act 2006 and has set out below where advantage of
the FRS 101 disclosure exemptions has been taken:
– the requirements of paragraphs 45(b) and 46 to 52 of IFRS 2

Share-based Payment;

– the requirements of paragraphs 62, B64(d), B64(e), B64(g), B64(h),
B64(j) to B64(m), B64(n)(ii), B64(o)(ii), B64(p), B64(q)(ii), B66 and
B67 of IFRS 3 Business Combinations;

– the requirements of paragraph 33(c) of IFRS 5 Non-current Assets

Held for Sale and Discontinued Operations;

– the requirements of IFRS 7 Financial Instruments: Disclosures;
– the requirements of paragraphs 91 to 99 of IFRS 13 Fair Value

Measurement;

– the requirements of the second sentence of paragraph 110 and

paragraphs 113(a), 114, 115, 118, 119(a) to (c), 120 to 127 and 129
of IFRS 15 Revenue from Contracts with Customers;

– the requirement in paragraph 38 of IAS 1 Presentation of Financial

Statements, to present comparative information in respect of:
paragraph 79(a)(iv) of IAS 1; paragraph 73(e) of IAS 16 Property, Plant
and Equipment; paragraph 118(e) of IAS 38 Intangible Assets; and
paragraphs 76 and 79(d) of IAS 40 Investment Property;

– the requirements of paragraphs 10(d), 10(f), 16, 38A, 38B, 38C, 38D,
40A, 40B, 40C, 40D, 111 and 134 to 136 of IAS 1 Presentation of
Financial Statements;

– the requirements of IAS 7 Statement of Cash Flows;
– the requirements of paragraphs 30 and 31 of IAS 8 Accounting

Policies, Changes in Accounting Estimates and Errors;

– the requirements of paragraphs 17 and 18A of IAS 24 Related Party

Disclosures;

– the requirements in IAS 24 Related Party Disclosures, to disclose
related party transactions entered into between two or more
members of a group, provided that any subsidiary which is a party
to the transaction is wholly owned by such a member; and

– the requirements of paragraphs 130(f)(ii), 130(f)(iii), 134(d) to 134(f)

and 135(c) to 135(e) of IAS 36 Impairment of Assets.

The Company intends to continue to prepare its financial statements
in accordance with FRS 101.

In accordance with Section 408(3) of the Companies Act 2006, the
Company is exempt from the requirement to present its own income
statement. The amount of profit for the year of the Company is
disclosed in the Company statement of comprehensive income and
Company balance sheet.

The financial statements have been prepared under the historical cost
convention, as modified by the revaluation of relevant financial assets
and financial liabilities (including derivative instruments).

Significant accounting policies
The significant accounting policies applied in the preparation of
these individual financial statements are set out below. These policies
have been applied consistently to all the years presented, unless
otherwise stated.

Investments in subsidiary undertakings and participating interests
Fixed asset investments in shares in subsidiary undertakings and
participating interests are stated at cost less provision for impairment.

The Company recognises an increase in its investments in subsidiary
undertakings in respect of the cost of share-based payment awards
issued by the Company to employees of the Company’s operating
subsidiaries, with a corresponding entry to equity.

Amounts owed by subsidiary undertakings
Amounts owed by subsidiary undertakings are stated at amortised
cost including a provision for expected credit losses. The Company
measures the provision at an amount equal to lifetime expected
credit losses, but this is not material to the financial statements
as the probability of default is insignificant.

Other significant accounting policies
Other significant accounting policies are consistent with the
Group accounts.

Changes in accounting policies
IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts
with Customers became effective on 1 January 2018.

The impact of the adoption of IFRS 9 is set out in note 37 to the
Group accounts. In addition to the information presented in note 37,
the Company has receivables from subsidiary undertakings that are
within the scope of IFRS 9. These were previously classified in the loans
and receivables category and measured at amortised cost under IAS 39
and continue to be classified in the amortised cost category under
IFRS 9 as they are held within a business model to collect contracted
cash flows and these cash flows consist solely of payments of principal
and interest. While receivables from subsidiary undertakings are subject
to the impairment requirements of IFRS 9, the identified impairment
loss was immaterial as the probability of default is insignificant.

The adoption of IFRS 15 did not have any impact on the Company
because the Company does not have any revenue from contracts
with customers.

214

BAE SystemsAnnual Report 20182. Investments in subsidiary undertakings and participating interests

Cost
At 1 January 2018
Additions
At 31 December 2018
Impairment provisions
At 1 January and 31 December 2018
Net carrying value
At 31 December 2018
At 31 December 2017

3. Trade and other receivables

Current
Amounts owed by subsidiary undertakings
Amounts owed by Group joint ventures
Prepayments and accrued income
Other receivables

4. Other financial assets and liabilities

Non-current
Cash flow hedges – foreign exchange contracts
Other foreign exchange/interest rate contracts
Debt-related derivative financial instruments – assets

Current
Cash flow hedges – foreign exchange contracts
Other foreign exchange/interest rate contracts
Debt-related derivative financial instruments – assets/(liabilities)

£m

8,458
58
8,516

8,497
8,439

2018
£m

2017
£m

3,026
7
56
13
3,102

2,571
5
62
15
2,653

2018

2017

Assets
£m

Liabilities
£m

Assets
£m

Liabilities
£m

–
191
87
278

–
129
78
207

–
(164)
–
(164)

–
(126)
–
(126)

–
201
79
280

–
145
–
145

(1)
(215)
–
(216)

(1)
(152)
(19)
(172)

215

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements5. Loans

Non-current
US$500m 4.75% bond, repayable 2021
£400m 4.125% bond, repayable 2022
US$400m 5.8% bond, repayable 2041

6. Trade and other payables

Current
Amounts owed to subsidiary undertakings
Amounts owed to Group joint ventures
Accruals and deferred income
Other payables

7. Provisions

Non-current
Current
At 1 January 2018
Created
Utilised
Released
Net present value adjustments
At 31 December 2018
Represented by:
Non-current
Current

2018
£m

2017
£m

392
399
311
1,102

369
398
292
1,059

2018
£m

2017
£m

7,555
869
140
81
8,645

7,299
884
120
113
8,416

Contractual
and other
£m
101
20
121
4
(6)
(1)
7
125

105
20
125

The Company holds provisions for contractual costs that it expects to incur over an extended period. These costs are based on past experience
of similar items and represent management’s best estimate of the likely outcome, but the amount of the outflows could differ significantly from
the amount provided and the timing of the outflows cannot be estimated reliably.

216

BAE SystemsAnnual Report 2018Notes to the Company accounts continued8. Retirement benefits

The Company participates in all of the Group’s UK pension schemes. Regular contributions to the schemes are made in line with the schedule
of contributions and a share of deficit funding is allocated to participating employers. The deficit allocation methodology is based on the relative
payroll contributions of active members. Full disclosures relating to these schemes are given in note 22 to the Group accounts.

Amounts recognised on the balance sheet
The table below shows the Company’s share of the Group’s UK pension schemes after allocation to other participating employers.

Present value of unfunded obligations
Present value of funded obligations
Fair value of scheme assets
Company’s share of net IAS 19 deficit
Represented by:

Retirement benefit surpluses
Retirement benefit obligations

9. Share capital and other reserves

Share capital
Disclosures in respect of the Company’s share capital are provided in note 24 to the Group accounts.

Other reserves

At 1 January 2017
Amounts charged to hedging reserve
At 31 December 2017
Amounts credited to hedging reserve
At 31 December 2018

2018
£m
(62)
(1,292)
1,170
(184)

44
(228)
(184)

2017
£m
(33)
(1,326)
1,200
(159)

27
(186)
(159)

Statutory
reserve
£m
202
–
202
–
202

Capital
redemption
reserve
£m
3
–
3
–
3

Hedging
reserve
£m
–
(2)
(2)
2
–

Total
£m
205
(2)
203
2
205

Capital redemption reserve
The capital redemption reserve represents the cumulative nominal value of the Company’s ordinary shares repurchased and subsequently cancelled.

217

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statements10. Share-based payments

Options over shares of the Company have been granted to employees of the Company under various plans. Details of the terms and conditions
of each share-based payment plan are given in the Annual remuneration report on pages 97 to 115.

2018

2017

Range of
exercise price
of outstanding
options
£
3.01 – 6.49
–

Weighted
average
remaining
contracted life
Years
8
5

Range of
exercise price
of outstanding
options
£
3.01 – 6.49
–

Weighted
average
remaining
contracted life
Years
8
5

Executive Share Option Plan
Performance Share Plan

The average share price in the year was £5.89 (2017 £6.11).

11. Employees

The total number of employees of the Company at 31 December 2018 was 1,509 (2017 1,134). All of the Company’s employees work within
the Group’s HQ segment.

Total staff costs, excluding charges for share-based payments, were as follows:

Wages and salaries
Social security costs
Pension costs – defined contribution plans
Pension costs – defined benefit plans

12. Commitments

2018
£m
103
11
3
21
138

2017
£m
86
9
2
11
108

Operating lease commitments
The Company leases land, buildings and vehicles under non-cancellable operating lease agreements. The leases have varying terms, and none
of these terms represent unusual arrangements or create material onerous or beneficial rights or obligations.

The future aggregate minimum lease payments under non-cancellable operating leases and associated future minimum sublease income are
as follows:

Payments due:

Not later than one year
Later than one year and not later than five years
Later than five years

Total of future minimum sublease income under non-cancellable subleases

2018
£m

2017
£m

15
62
19
96

14
56
13
83

218

BAE SystemsAnnual Report 2018Notes to the Company accounts continued13. Other information

Company audit fee
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts totalled £2,000,000 (2017 £2,034,000). Fees payable
to Deloitte LLP and its associates for non-audit services to the Company are not required to be disclosed because the Group accounts disclose
such fees on a consolidated basis (see note 2 to the Group accounts).

Related party transactions
Disclosures in respect of related party transactions are provided in note 31 to the Group accounts.

The Company also has amounts receivable from Aircraft Accessories and Components Co Limited of £9m (2017 £7m) and Aircraft Research
Association Limited of £4m (2017 £4m) which are not wholly-owned subsidiaries.

Directors’ emoluments
Under Schedule 5 of the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008 (Schedule 5), total
directors’ emoluments, excluding Company pension contributions, were £6,997,880 (2017 £8,748,961); these amounts are calculated on
a different basis to emoluments in the Annual remuneration report which are calculated under Schedule 8 of the Large and Medium-Sized
Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 (Schedule 8 (2013)). These emoluments were paid for their
services on behalf of the BAE Systems Group. No emoluments related specifically to their work for the Company. Under Schedule 5, the
aggregate gains made by the directors from the exercise of share options in 2018 as at the date of exercise was £113,745 (2017 £1,002,325)
and the net aggregate value of assets received by directors in 2018 from Long-Term Incentive Plans as calculated at the date of vesting was
£908,911 (2017 £1,016,511); these amounts are calculated on a different basis from the valuation of share plan benefits under Schedule 8
(2013) in the Annual remuneration report. Retirement benefits are accruing to one director in respect of defined benefit schemes and to two
directors in respect of defined contribution schemes.

Company guaranteed borrowings
Borrowings by subsidiary undertakings totalling £3,197m (2017 £3,010m), which are included in the Group’s borrowings, have been
guaranteed by the Company.

Information about related undertakings
In accordance with Section 409 of the Companies Act 2006, a full list of the Company’s subsidiaries and significant holdings is included
in note 35 to the Group accounts.

219

BAE SystemsAnnual Report 2018Strategic reportGovernanceFinancial statementsShareholder
information

Registered office
6 Carlton Gardens
London
SW1Y 5AD
United Kingdom
Telephone: +44 (0)1252 373232
Company website: baesystems.com
Registered in England and Wales, No. 1470151

Registrars
Equiniti Limited (0140)
Aspect House
Spencer Road
Lancing
West Sussex
BN99 6DA
United Kingdom

If you have any queries regarding your shareholding or need to notify
any changes to your personal details, please contact Equiniti.

Equiniti’s website (help.shareview.co.uk) includes a comprehensive
set of answers to many frequently asked questions relating to managing
a shareholding. If you cannot find the answer to your question, there
is an online email form, which will help to ensure your question is
directed to the most appropriate team for a response. Alternatively,
you can call the BAE Systems Helpline on 0371 384 2044 or, from
outside the UK, +44 121 415 7058. Lines are open from 8.30am
to 5.30pm Monday to Friday, excluding UK bank holidays.

In addition, the following services are offered to shareholders:

– Shareview – online access to your shareholding, including
balance movements, indicative share prices and information
on recent payments

– Dividend mandates – have your dividends paid directly into
either your UK bank/building society account or an overseas
bank account

– Dividend reinvestment plan (DRIP) – have your dividend

reinvested in shares purchased on the stock market

More information on all these services can be found on Equiniti’s
website (shareview.co.uk).

Beware of share fraud
Investment scams are often sophisticated and difficult to spot.

Spot the warning signs
Fraudsters will often:
– contact you out of the blue;
– apply pressure to invest quickly;
– downplay the risks to your money;
– promise tempting returns that sound too good to be true;
– say that they’re only making the offer available to you

or even ask you to not tell anyone else about it.

If you’re suspicious, report it
You can report the firm or scam to the FCA by contacting
their Consumer Helpline on 0800 111 6768 or using the
reporting form using the link shown here.

If you’ve lost money in a scam, contact Action Fraud
on 0300 123 2040 or www.actionfraud.police.uk

220

American Depositary Receipts
BAE Systems plc American Depositary Receipts (ADRs) are traded
on the Over The Counter market (OTC) under the symbol BAESY.
One ADR represents four BAE Systems plc ordinary shares.
JP Morgan Chase Bank N.A. is the depositary. If you should have
any queries please contact:
JP Morgan Chase Bank N.A.
PO Box 64504
St Paul
MN 55164-0504, USA
Email: jpmorgan.adr@eq-us.com
Telephone (toll free from within US and Canada): +1 800 990 1135
Telephone from outside US and Canada: +1 651 453 2128

ShareGift
ShareGift, the share donation charity (registered charity number
1052686), accepts donations of small parcels of shares which may
be uneconomic to sell. Details of the scheme are available from
ShareGift at sharegift.org, by telephone on 020 7930 3737
or by email: help@sharegift.org

Share price information
The middle market price of the Company’s ordinary shares on
31 December 2018 was 589.2p and the range during the year
was 445.5p to 676.4p.

For more information
Visit the Shareholder information section of our website:
investors.baesystems.com

FINANCIAL CALENDAR
Financial year end
Annual General Meeting
2018 final ordinary dividend payable
2019 half-yearly results announcement
2019 interim ordinary dividend payable
2019 full-year results:
– preliminary announcement
– Annual Report
2019 final ordinary dividend payable

31 December
9 May 2019
3 June 2019
31 July 2019
2 December 2019

February 2020
March 2020
June 2020

How to avoid investment scams
1 Reject unexpected offers
Scammers usually cold call, but contact can also come by email,
post, word of mouth or at a seminar. If you’ve been offered an
investment out of the blue, chances are it’s a high risk investment
or a scam.

2 Check the FCA Warning List
Use the FCA Warning List to check the risks of a potential investment
– you can also search to see if the firm is known to be operating
without our authorisation.

3 Get impartial advice
Get impartial advice before investing – don’t use an adviser from
the firm that contacted you.

Be ScamSmart and visit
www.fca.org.uk/scamsmart

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BAE Systems plc
6 Carlton Gardens
London
SW1Y 5AD
United Kingdom
Telephone: +44 (0)1252 373232
baesystems.com

Registered in England and Wales, No. 1470151

BAE SYSTEMS is a registered trade mark of BAE Systems plc.