BAE Systems : Doc re. Annual Financial Report

BAE Systems plc

Annual Report 2013

BAE Systems plc has today published its Annual Report and Accounts for the year ended 31 December 2013 ('Annual Report 2013'). The full document can be viewed on the Company's website at:

Copies of the Annual Report 2013 will be posted to those shareholders who have requested to receive communications from the Company in printed form on 27 March 2014.

In compliance with section 9.6.1 of the Listing Rules, a copy of the Annual Report 2013 has also been submitted to the National Storage Mechanism and will shortly be available for inspection at www.morningstar.co.uk/uk/NSM

This announcement contains regulated information issued in accordance with section 6.3 of the Financial Services Authority's Disclosure and Transparency Rules and accordingly contains certain sections of the Annual Report 2013 in unedited full text. Page and chart references within the text of this announcement are references to pages and charts in the Annual Report 2013 that can be viewed as detailed above.

The financial information for the year ended 31 December 2013 contained in this announcement was approved by the Board on 19 February 2014. This announcement does not constitute statutory accounts of the Company within the meaning of section 435 of the Companies Act 2006, but is derived from those accounts.

Statutory accounts for the year ended 31 December 2012 have been delivered to the Registrar of Companies. Statutory accounts for the year ended 31 December 2013 will be delivered to the Registrar of Companies following the Company's Annual General Meeting.

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

The Annual Report 2013 contains the following responsibility statement:

Responsibility statement of the directors in respect of the Annual Report and financial statements

Each of the directors listed below confirms that to the best of their knowledge:

‑ the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company, and the undertakings included in the consolidation taken as a whole; and

‑ the Strategic Report and Directors' Report, taken together, include a fair review of the development and performance of the business, and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.

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

On behalf of the Board

Sir Roger Carr , Chairman

19 February 2014

CHIEF EXECUTIVE'S REVIEW

"BAE Systems has built strong momentum in delivering on its strategy."

Ian King Chief Executive

Overview

Overall, the Group delivered a solid performance in 2013, against the background of reduced government spending and tough market conditions. A proactive focus on costs and enhanced competitiveness allowed us to protect our margins across the majority of the business and we secured further contract wins in the US, Saudi Arabia and internationally. Our results also benefited from the satisfactory conclusion of price escalation negotiations with the Kingdom of Saudi Arabia, relating to an existing contract to supply Typhoon aircraft. We have continued to invest in research and technology and to develop business in international markets, and our strong order backlog and robust balance sheet as we enter 2014 are testament to our business health.

US

In the US, budget uncertainties continued to impact government spending and procurement decisions throughout 2013. Sequestration measures resulting from the 2011 Budget Control Act either reduced or delayed many US activities. The Sequestration measures were targeting savings of approximately $450bn (£272bn) from US defence budgets over a ten-year period, equivalent to an approximately 10% overall reduction. As certain areas of spending were protected from these reductions, such as military personnel accounts, the budgets funding much of the US defence industrial base are likely to be disproportionately impacted.

In addition to the Sequestration measures, in October, the political disagreements over the terms of a Continuing Resolution to cover the remainder of the 2013 fiscal year resulted in a partial US government shutdown. Following the brief shutdown, a Continuing Resolution was passed to fund the government until 15 January 2014. Whilst some disruption resulted from the shutdown, the impact to the Group's overall financial performance was not material.

In December, a bipartisan budget proposal for a two-year federal budget agreement was approved by Congress and signed into law. The resulting spending bill was approved in January 2014, far earlier in the fiscal cycle than in previous years, and whilst this legislation does not eliminate the Sequester completely, it does ease the significant and indiscriminate cuts that were expected in 2014 and 2015.

Given this environment, we based our planning assumptions on a progressive reduction in our US defence and security businesses of approximately 15% for 2013 and 2014. The recent budget developments return some clarity to near-term US government spending, although pressures to reduce spending and address the US deficit are expected to continue.

Nonetheless, there does seem to be clear support for some key programmes, including the F-35 Lightning II in which BAE Systems has a significant participation.

Some of the Group's US activities are not directly exposed to US government budgets. Our commercial electronics business continues to grow and we anticipate a rising contribution from US Foreign Military Sales. In December, the Republic of Korea finalised an agreement with the US government for BAE Systems to perform upgrades and systems integration for its fleet of more than 130 F-16 aircraft. This business opportunity, potentially worth approximately $1.3bn (£0.8bn), is not yet included in our order backlog.

The Group also continues to be successful in winning competitive new business. In March, BAE Systems was awarded a five-year contract for the operation and management of the Holston Army Ammunition Plant in the US. In August, the Group was awarded an eight-year contract to maintain the readiness of Minuteman III intercontinental ballistic missiles in the US. In October, the Group received a US Army contract for Low-Rate Initial Production on the Paladin Integrated Management programme, a tracked artillery system. In December, the US Navy awarded BAE Systems a three-year, $171m (£103m) contract to continue providing engineering and integration support to Trident II D-5 submarine-launched ballistic missiles.

In Land & Armaments, we have refocused the business on core markets and our capabilities in combat vehicles, amphibious vehicles, artillery systems and naval surface fires. We have also rationalised the land facilities more broadly, reducing 51 sites to 15 centres. Against a background of substantially reduced demand, we are working to protect key industrial capabilities and margins.

Performance issues recently emerged in the multi-year Radford Army Ammunition Plant support contract. Customer volume reductions require this contract to be restructured and we aim to renegotiate an agreement on this key military capability.

UK

Notwithstanding the continued pressure on many areas of government spend in the UK, our business is in good shape and the outlook remains stable. Much of the Group's UK business is concentrated on a small number of large programmes where multi-year contracts provide good visibility, as evidenced by the large UK order backlog.

In the air sector, the first Tranche 3 Typhoon has flown and we have recently been able to reveal previously classified footage of the successful flight trials of the Taranis unmanned aerial vehicle. Deliveries of Typhoon continued to European partner nations.

In the maritime sector, in November, BAE Systems reached agreement with the UK government on measures to enable the implementation of a restructuring of its UK naval ships business. The measures included a restructuring of the Queen Elizabeth Class aircraft carrier contract to accommodate changes to the programme and to reflect its increased maturity. In addition, a programme to build three Offshore Patrol Vessels for the Royal Navy was announced. Consultation with trade union and employee representatives commenced regarding the rationalisation of the naval ships business to address anticipated reduced workload levels beyond the current high volume of activity on the aircraft carrier programme. Contracts to enact this overall agreement are forecast to be finalised in 2014.

Good progress has been made in defining the Type 26 frigate programme to replace Type 23 vessels, with over 600 employees now working on the contract.

Submarines activity continues to progress on the Astute Class programme and workload is increasing on the Successor programme in preparation for a possible replacement of the Vanguard Class boats.

In September 2014, Scotland will hold an independence referendum. The decision on independence from the UK is a matter for the people of Scotland. However, BAE Systems has significant interests and employees in Scotland, and it is clear that continued union offers greater certainty and stability for our business. In the event that Scotland voted to become independent, we would need to discuss the way forward with the Ministry of Defence and UK government, and work with them to deliver the best solution in those circumstances.

Our Applied Intelligence business (formerly BAE Systems Detica), which is well-positioned in the fast-growing commercial cyber security sector, has substantially increased its order backlog.

In February 2013, Applied Intelligence and Vodafone agreed the formation of a five-year partnership to provide businesses with a range of advanced mobile communications security products and services, initially focused on smartphones and tablets.

Applied Intelligence signed, in September, a framework contract with the Foreign & Commonwealth Office (FCO) to deliver service management integration services across the FCO's global IT estate.

International

Building on the strong international order intake performance in 2012, a further £9.3bn of non-UK/US order intake1 was achieved in the year.

While the opportunity was not included in our business plans, we were disappointed that the government of the United Arab Emirates (UAE) elected not to proceed with proposals regarding a range of defence and security capabilities including the potential supply of Typhoon aircraft. Nonetheless, the aircraft fully met the customer's exacting requirements and BAE Systems stands ready to work with the UAE to address any future requirements.

We continue to pursue a number of opportunities in international markets. Building on the successful sale of Typhoon and Hawk aircraft in Saudi Arabia and Oman, a number of military aircraft-related opportunities have been identified.

Aircraft deliveries on the Salam Typhoon programme to Saudi Arabia re-commenced in April.

In February 2014, the governments of the UK and Kingdom of Saudi Arabia agreed price escalation terms relating to the Typhoon aircraft under the Salam programme and these have been reflected in contractual arrangements between the UK government and BAE Systems. The terms of the agreement are broadly consistent with the Group's prior trading outlook for 2013. Cash settlement is expected to follow this pricing agreement, commencing in the early part of 2014. The Group believes this to be an equitable outcome for all parties and is pleased to conclude this negotiation which builds on the long-standing relationship with this much-valued customer.

The significant flow of new contract awards with the Kingdom of Saudi Arabia continued through 2013. Contracts valued at approximately £6.4bn have been signed in the year, including a five-year, £1.8bn follow-on support contract on the Salam Typhoon programme and a further £1.5bn contract for Tornado aircraft upgrades and weapons under the Saudi British Defence Co-operation Programme.

In December, the Swedish government exercised its option to buy 102 more BvS10 all-terrain vehicles in an order worth approximately $120m (£72m). In December, FNSS, BAE Systems' Turkish joint venture, received a $360m (£217m) contract from the land forces of a Middle Eastern country for the upgrade of M113 tracked armoured personnel carriers.

The Group was disappointed that the Canadian government decided to cancel its Close Combat Vehicle programme. However, we continue to pursue opportunities for combat vehicles with the Swedish CV90 tracked infantry fighting vehicle forming the basis for a current bid in Denmark. In addition, BAE Systems is working with Polish Defence Holdings to address substantial replacement vehicle requirements expected to emerge later this decade in Poland.

BAE Systems continues to develop opportunities for Bradley fighting vehicles in Saudi Arabia and, more recently, another emerging requirement in the region.

The success in South Korea on the F-16 upgrade programme is a significant competitive win.

Balance sheet and capital allocation

The Group's balance sheet continues to be managed conservatively in line with our policy to retain an investment grade credit rating and to ensure operating flexibility.

Consistent with this approach, the Group expects to continue to meet its pension obligations, pursue organic investment opportunities, pay dividends in line with its policy of long-term sustainable cover of around two times underlying earnings and to make accelerated returns of capital to shareholders when the balance sheet allows. Investment in value-enhancing acquisitions will be considered where market conditions are right and where they deliver on the Group's strategy.

In February 2013, the Group initiated a share repurchase programme of up to £1bn over three years. Implementation of the programme has been influenced by the timing of a satisfactory resolution of the Salam Typhoon price escalation negotiations. As at 19 February 2014, BAE Systems had purchased 65 million shares for approximately £271m under the programme.

Consistent with previous share buybacks, the Group has agreed with the trustees of its UK pension schemes to pay £340m of cash contributions into the schemes over the three-year period of a full implementation of the share repurchase programme.

Inspired Work

Our employees have a key role to play in the success of our business. Their contribution is never more important than when the Group is facing significant market pressures. BAE Systems' people have continued to rise to the challenge, demonstrating their commitment to meeting the needs of customers with increasingly more cost-effective and innovative solutions. There are many examples of our people's inspired work highlighted across this publication.

Responsible conduct

The way the Group undergoes its business is equally as important as the delivery of the output and great emphasis continues to be placed on business conduct throughout the Group.

The safety of our employees and those using our products is critical to our business, a key priority and a fundamental responsibility for the Group. Regrettably, there were two work-related employee fatalities in 2013. Each accident is thoroughly investigated and lessons learnt are applied across the Group. We continue to drive safety improvements and achieved a 17% reduction in the Recordable Accident Rate, which represents the sixth consecutive year of improvement.

Board and management

Sir Richard Olver stepped down as Chairman of the Group in February 2014 and has been succeeded by Sir Roger Carr. Sir Richard has been a tremendous supporter of our Company and our industry over the last decade and has led wide-ranging cultural and governance changes within the Company. He leaves with our best wishes for the future.

I am delighted to welcome Sir Roger Carr as Chairman. Sir Roger has two decades of Board-level experience leading international businesses and most recently was Chairman of Centrica plc and President of the Confederation of British Industry, the UK's main business lobbying group. He is also Deputy Chairman and Senior Independent Director of the Court of the Bank of England and a member of the UK Prime Minister's Business Advisory Group.

Jerry DeMuro took up his role as President and Chief Executive Officer of BAE Systems, Inc. from 1 February 2014. Jerry joins the Group from General Dynamics and succeeded Linda Hudson, who announced her intention to retire from the Company in August. He is also an executive director of BAE Systems plc and a member of BAE Systems' Executive Committee.

On 5 February 2014, Tom Arseneault, formerly Executive Vice President, Product Sectors, was appointed as Chief Operating Officer for BAE Systems, Inc. and Dave Herr, formerly Executive Vice President, Service Sectors, for BAE Systems, Inc. and Executive Committee member, will retire from the Group on 31 March 2014.

In January 2014, Claire Divver joined the Group from Xstrata plc as Group Communications Director and a member of the Executive Committee. She replaced Charlotte Lambkin who left the Group in September.

Summary and outlook

Budget pressures in some of the Group's larger markets are expected to prevail but BAE Systems has a broad-based portfolio. Good progress has been made to grow the order backlog, providing a solid basis for growth over the medium term. The Group's continued focus on cost and targeted investment aims to enhance competitiveness and affordability for the benefit of customers and sustain attractive returns for shareholders.

Ian King , Chief Executive

Extract from
CHAIRMAN'S LETTER

Directors

Sir Peter Mason, a non-executive director, retired from the Board of BAE Systems plc on 8 May. Ian Tyler joined the Board as a non-executive director of the Company on that date.

In June, Chris Grigg was appointed a non-executive director of the Company with effect from 1 July.

Lee McIntire, a non-executive director, resigned from the Board of BAE Systems plc on 20 August.

I joined the Board as a non-executive director of BAE Systems plc and Chairman designate on 1 October and succeeded Sir Richard Olver as Chairman on 1 February 2014. Sir Richard stepped down from the Board on that date.

On 1 February 2014, Linda Hudson retired as President and Chief Executive Officer of BAE Systems, Inc. and as an executive director of BAE Systems plc. On the same date, Jerry DeMuro was appointed as President and Chief Executive Officer of BAE Systems, Inc. and as an executive director of BAE Systems plc. He will also serve on BAE Systems' Executive Committee.

Dividend

The Board has recommended a final dividend of 12.1p per share making a total of 20.1p per share for the year, an increase of 3% over 2012. At this level, the annual dividend is covered 2.1 times by underlying earnings (2012 2.0 times). Subject to shareholder approval at the 2014 Annual General Meeting, the dividend will be paid on 2 June 2014 to holders of ordinary shares registered on 22 April 2014.

GROUP FINANCIAL PERFORMANCE

Financial highlights

‑ Sales3 increased by 2%

‑ Underlying EBITA4 increased by 3% to £1,925m

‑ Underlying earnings5 per share increased by 9%

‑ Order backlog3,6 maintained, with non-UK/US order intake3 of £9.3bn

‑ Operating business cash inflow8 of £147m

‑ Net debt9 of £699m

‑ Goodwill impairment charge of £865m relating to the US Intelligence & Security and Land & Armaments businesses

‑ £212m expended in 2013 on the three-year share repurchase programme

‑ Total dividend increased by 3% to 20.1p

Critical accounting policies

Certain of the Group's principal 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.

See page 126

Accounting change

With effect from 1 January 2013, the Group has adopted the revised International Accounting Standard 19, Employee Benefits. This replaces interest cost on gross pension liabilities and expected return on gross pension assets with a finance cost on the net pension deficit calculated using the rate currently used to discount defined benefit pension liabilities and requires certain administrative costs to be included within underlying EBITA4. Comparative financial information has been restated accordingly.

See page 126 and note 23 to the Group accounts on page 162

Income statement

Sales3increased by 2% to £18,180m (2012 £17,905m). Volume reductions in the US businesses and, in particular, at Land & Armaments were more than offset by the resumption of Typhoon aircraft deliveries and trading of the price escalation on the Salam programme. The movements driving this increase are illustrated in the bridge chart above.

Underlying EBITA4increased by 3%, to £1,925m (2012 £1,862m), giving a return on sales of 10.6% (2012 10.4%).

Profit on disposal of businesses of £6m includes the disposal of the Commercial Armored Vehicles business, which was part of Land & Armaments. The profit of £103m in 2012 included the disposals of Safety Products and Safariland, and assets comprising the Tensylon business, which were also Land & Armaments businesses.

Amortisation of intangible assets is £37m lower at £189m mainly reflecting intangible assets on programmes in the Land & Armaments business becoming fully amortised in 2012.

Impairment of intangible assets of £887m includes goodwill impairment of £865m relating to the US Intelligence & Security and Land & Armaments businesses as a result of an increase in the Group's post-tax weighted average cost of capital and an estimate of reductions in US defence spending. The £86m charge in 2012 mainly related to the Safariland and Tensylon businesses sold in 2012, and the Commercial Armored Vehicles business sold in 2013.

Finance costs3were £392m (2012 £410m). The underlying interest charge, which excludes pension accounting, marked-to-market revaluation of financial instruments and foreign currency movements, is £25m lower at £179m. A full year of interest on the £400m of debt issued in June 2012 is more than offset by the lower level of net present value charges on long-term liabilities in 2013.

Taxation expense3reflects an effective tax rate of 22% (2012 24%). The calculation of the effective tax rate is shown in note 6 to the Group accounts on page 137. The underlying tax rate for 2014 is expected to be between 21% and 23%, with the final number dependent on the geographical mix of profits.

Earnings per share

Underlying earnings5 per share was 42.0p, an increase of 9% on 2012. The movements driving this increase are illustrated in the bridge chart above.

Basic earnings per share , in accordance with International Accounting Standard 33, Earnings per Share, was 5.2p (2012 29.3p). The reduction on 2012 mainly reflects the £887m of impairment charges taken in 2013 (2012 £86m) which are excluded from underlying earnings5 per share.

Cash flow

Cash inflow from operating activities7was £205m (2012 £2,916m). As anticipated, advances received in 2012 on the Omani Typhoon and Hawk, Saudi training aircraft and Saudi Tornado upgrade programmes are being utilised. Advances were also consumed in the year on the European Typhoon Tranche 2 programme. Provisions created in previous years were utilised on the Oman Offshore Patrol Vessel contract and on rationalisation. The £131m Trinidad and Tobago termination settlement was paid during the year.

Cash contributions in respect of deficit funding, over and above service costs to the UK and US pension schemes, were £389m (2012 £507m).

There was an outflow from net capital expenditure and financial investment of £153m (2012 £293m).

Dividends received from equity accounted investments , primarily Gripen and MBDA, totalled £95m (2012 £94m).

Interest payments were £19m higher at £166m reflecting a full year of interest on the £400m of debt issued in June 2012.

Taxation payments were £23m higher primarily reflecting tax refunds in 2012 following the 2011 UK Research & Development tax settlement, partly offset by lower US taxable profits and timing differences on US tax payments.

Net cash inflow in respect of acquisitions and disposals of £96m in 2012 mainly comprised the disposals of Safety Products and Safariland, and assets comprising the Tensylon business.

The net purchase of own shares of £212m represents 51.6 million shares purchased under the buyback programme (including transaction costs).

As a consequence of movements in US dollar and Euro exchange rates during the year, there has been a cash outflow from matured derivative financial instruments of £47m (2012 £119m) from rolling hedges on balances with the Group's subsidiaries and equity accounted investments.

Net debt (as defined by the Group)9is £699m, a net outflow from the net cash9 position of £387m at the start of the year. Cash and cash equivalents of £2,222m (2012 £3,355m) are held primarily for the share repurchase programme, pension deficit funding, payment of the 2013 final dividend, repayment of £0.4bn of debt securities maturing in 2014 and management of working capital. The maturity profile of the borrowings component of net debt9 is illustrated in the chart above. Details of the Group's objectives and policies regarding net (debt)/cash9 are provided in note 28 to the Group accounts on page 175.

Balance sheet

The £1.2bn reduction in intangible assets to £9.7bn (2012 £10.9bn) mainly reflects the impairment of goodwill in the US business (£0.9bn) and amortisation (£0.2bn).

Property, plant and equipment, and investment property reduced to £2.1bn (2012 £2.4bn) mainly reflecting the classification of a residential and office facility in Saudi Arabia as held for sale at the balance sheet date. A sale and leaseback transaction for the facility was completed on 9 January 2014.

Equity accounted investments and other investments are £286m (2012 £270m). The Group's share of results of equity accounted investments (£111m) was largely offset by dividends received (£95m).

The £1.1bn decrease in the Group's share of the pre-tax pension deficit mainly reflects asset returns. The impact of a 0.5 percentage point reduction in the UK real discount rate to 1.1% was offset by the impact of the rate of increase in salaries being held at Retail Prices Index (RPI) inflation (2012 0.5% above RPI), a 0.8 percentage point increase in the US nominal discount rate to 4.9% and deficit funding. The movement in the pension deficit during the year is illustrated in the bridge chart above.

A net deferred tax asset of £0.7bn (2012 £1.1bn) relating to the Group's pension deficit is included within net tax assets and liabilities .

There was a £1.6bn increase in working capital mainly reflecting a net reduction in advance contract funding and utilisation of provisions.

1 On adoption of the revised International Accounting Standard 19, Employee Benefits.

2 Re-presented on classification of the Regional Aircraft line of business as a continuing operation (see note 7 to the Group accounts).

3 Including share of equity accounted investments.

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

5 Earnings excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, and non-recurring items (see note 8 to the Group accounts).

6 Order backlog comprises funded and unfunded unexecuted customer orders, and is stated after the elimination of intra-group orders.

7 2012 excludes the £428m contribution from Trust to the UK pension schemes and the £29.5m charitable contribution for the benefit of the people of Tanzania in connection with the global settlement with the UK's Serious Fraud Office in 2010, both made in 2012, as the amounts had been deducted from the Group's net (debt)/cash.

8 See note 9 to the Group accounts.

9 See note 10 to the Group accounts.

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

Note and page references used above refer to the Annual Report 2013 that can be viewed on the Company's website.

PRINCIPAL RISKS

The Group's principal risks are identified below, together with a description of how the Group mitigates those risks.

Defence spending

The Group is dependent on defence spending.

Description

The Group's core businesses are primarily defence-related, selling products and services directly and indirectly, mainly to the US, UK, Saudi Arabian and other national governments. Defence spending depends on a complex mix of political considerations, budgetary constraints, and the ability of the armed forces to meet specific threats and perform certain missions, and, as such, may be subject to significant fluctuations from year to year. With constraints on government expenditure in a number of the Group's markets and countries in the Eurozone area experiencing serious financial difficulties, affordability continues to be a key focus for customers.

Impact

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

Mitigation

The Group's business is geographically spread across UK, US and international markets and its products are marketed across a range of defence markets. The Group has a highly sustainable services business, which is an area for growth as customers' operations and maintenance budgets come under pressure. The Group continues to use realistic assumptions to underpin its financial and operational planning.

Efforts to reduce the US government's budget deficit are expected to continue to impact government spend. A bipartisan budget proposal was approved in December 2013 that mitigates the full impact of the Sequester for 2014 and 2015. The Group expects lower defence spending than previously programmed, but the cuts are not expected to be as significant or indiscriminate as they would have been under Sequestration.

Notwithstanding the continued pressure on many areas of government spend in the UK, the outlook for the Group's UK defence business remains stable.

In Saudi Arabia, regional tensions continue to dictate that defence remains a high priority.

For more information on the Group's multiple markets see page 14

Government customers

The Group's largest customers are governments.

Description

Companies engaged in the supply of defence and security-related equipment and services to government agencies are subject to certain business risks particular to the defence and security industries. These governments could modify contracts or terminate them at short notice and at their convenience. For example, long-term US government contracts are normally funded annually and are subject to cancellation or delay if funding appropriations for subsequent performance periods are not made. Terms and risk sharing agreements can also be amended. In addition, the Group, as a government contractor, is subject to financial audits and other reviews by some of its governmental customers with respect to the performance of, and the accounting and general practices relating to, government contracts.

As a result of these audits and reviews, costs and prices under these contracts may be subject to adjustment.

Impact

The termination of one or more of the contracts for the Group's programmes by governments, the failure of the relevant agencies to obtain expected funding appropriations for the Group's programmes, or a deterioration in the Group's relationship with any of its key government customers and corresponding reduction in contract awards, could have a material adverse effect on the Group's future results and financial condition.

Mitigation

The Group regularly reviews performance in its markets and the Executive Committee continues to work closely with the government customers in these markets to ensure the Group's strategy is aligned with theirs.

In the event of a customer termination for convenience, the Group would typically be paid for work done and commitments made at the time of termination. Having sovereign governments as major customers offers the benefits of dealing with mature procurement organisations with which the Group can have long-standing business relationships, and well-established and understood terms of trade.

For more information on the Group's strategy see page 7

Global market

The Group operates in a global market.

Description

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

Impact

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

Mitigation

The Group has a balanced portfolio of businesses across its markets.

For more information on the Group's multiple markets see page 14

Contract award timing

The Group is dependent on the timing of award of defence contracts.

Description

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

Impact

Amounts receivable under the Group's defence contracts can be substantial and, therefore, the timing of awards, or failure to receive anticipated awards, could materially affect the Group's profits and cash flows for the periods affected.

Mitigation

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

For more information on the Group's major programmes see page 37

Large contracts

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

Description

A significant proportion of the Group's revenue comes from a small number of large contracts. Each of these contracts, which are primarily in the Platforms & Services (UK) and Platforms & Services (International) reporting segments, is typically worth or potentially worth over £1bn.

Impact

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

Mitigation

To mitigate risk on UK Ministry of Defence contracts, development programmes are normally contracted with appropriate levels of risk being initially held by the customer. Subsequent production programmes are priced when a platform's development has reached sufficient maturity. A variety of contract structures are used to mitigate risk on production programmes, such as incentive arrangements, whereby 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 long-term visibility. The Board regularly reviews the Group's performance on these large contracts and the Executive Committee continues to work closely with the relevant customers to ensure the Group's strategy is aligned with theirs.

For more information on the Group's order backlog by major programme and reporting segment see page 37

Fixed-price contracts

The Group has fixed-price contracts.

Description

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

Impact

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

Mitigation

The Group has reduced its exposure to fixed-price design and development activity which is in general more risk intensive than fixed-price production activity. To manage contract-related risks and uncertainties, contracts are managed under the Group's mandated Lifecycle Management (LCM) process at the operational level.

Robust bid preparation and approvals processes are well established throughout the Group, with decisions required to be taken at the appropriate level in line with clear delegations of authority. The consistent application of metrics is used to support the review of individual contract performance.

For more information on LCM which mandates project management processes see page 69

Component availability, subcontractor performance and key suppliers

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

Description

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

Impact

Some of the Group's suppliers or subcontractors may be impacted by the economic environment and constraints on available financing, which could impair their ability to meet their obligations to the Group. In addition, some products require relatively scarce raw materials. The Group is generally subject to specific procurement requirements which may, in effect, limit the suppliers and subcontractors it may utilise. In some instances, the Group is dependent on one or a limited number of suppliers. If any of these suppliers or subcontractors fails to meet the Group's needs, the Group may not, in the short term, have readily available alternatives, thereby impacting its ability to complete its customer obligations satisfactorily and in a timely manner, which could have a negative impact on the Group's future results and financial condition.

Mitigation

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

For more information on suppliers see page 118

Laws and regulations

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

Description

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

Impact

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

Mitigation

During the year, the Group has continued to add resources dedicated to legal and regulatory compliance in order to enhance further its capability to identify and manage the risk of compliance failure. Internal and external market risk assessments form an important element of the ongoing corporate development and training processes.

A uniform global policy and process for the appointment of advisers engaged in business development is in effect.

Pursuant to its commitments concerning ongoing regulatory compliance made in the course of the 2011 settlement with the US Department of State, the Group appointed a Special Compliance Official in 2011 for a period of not less than three years to monitor the Group's compliance with its commitments under that settlement and its compliance obligations going forward.

For more information on the Group's approach to business conduct see page 112

Competition

The Group's business is subject to significant competition.

Description

The Group's businesses are subject to competition from national and multi-national firms with substantial resources and capital, and many contracts are obtained through a competitive bidding process, including contracts where the Group is the current incumbent.

The Group's ability to compete for contracts depends in particular on: the strength of its intellectual property rights and technical know-how; the effectiveness and innovation of its research and development programmes; its ability to offer better programme performance than its competitors at a lower cost to its customers; and the readiness of its facilities, equipment and personnel to undertake the programmes for which it competes.

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

Impact

The Group's business and future results may be adversely impacted if it is unable to compete adequately in the markets in which it operates.

Mitigation

The Group's global, multi-market presence, balanced portfolio of businesses, leading capabilities and performance continue to address this risk. In particular, the Group invests in research and development, continues to reduce its cost base and improve efficiencies, and has the mandated Lifecycle Management process that promotes the application of best practice programme execution.

For more information on the Group's multiple markets see page 14

Pension funding

The Group has an aggregate funding deficit in its defined benefit pension schemes.

Description

The Group operates certain defined benefit and defined benefit/defined contribution hybrid pension schemes. At present, in aggregate, there is an actuarial deficit between the value of the projected liabilities of these schemes and the assets they hold.

Impact

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

Mitigation

Following triennial funding valuations of the Group's two largest UK pension schemes in 2011, revised deficit recovery plans were agreed in 2012. The performance of the Group's pension schemes and deficit recovery plans are regularly reviewed by both the Group and the trustees of the schemes, taking actuarial and investment advice as appropriate. The results of these reviews are discussed with the Board and appropriate action taken.

In future, the growth of the defined benefit liabilities is expected to be curtailed as follows:

‑ With effect from April 2012, new employees in the UK are offered defined contribution pension benefits rather than the previous defined benefit/defined contribution hybrid pension benefits;

‑ With effect from January 2013, all employees in the US are offered membership of a defined contribution scheme (401(k)) and no longer accrue salary-related benefits in defined benefit schemes;

‑ In February 2013, with the agreement of the Company, the trustees of the BAE Systems 2000 Pension Plan entered into an arrangement with Legal & General to insure against longevity risk for the current pensioner population, covering £2.7bn of pension scheme liabilities. In December 2013, similar arrangements were entered into, with Legal & General, by the trustees of the Royal Ordnance Pension Scheme and Shipbuilding Industries Pension Scheme, covering £0.9bn and £0.8bn of pension scheme liabilities, respectively. These arrangements will reduce the funding volatility relating to increasing life expectancy; and

‑ In August 2013, with the support of the trustees of the BAE Systems Pension Scheme, the Group launched a pension increase exchange, offering pensioners the option to exchange increases on part of their pensions for higher immediate non-increasing pensions. For those who take up the offer, all future inflation risk to the Group is removed in respect of part of their pensions. Exchangeable pension forms approximately 50% of the scheme's pensions in payment and the option was given to approximately 18,000 pensioners in 2013. It is expected that, once the exercise concludes, the take-up rate amongst this group will be approximately one-third.

For more information on the Group's pension accounting and funding valuations, and deficit recovery plans see page 162

Export controls and other restrictions

The Group is subject to export controls and other restrictions.

Description

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

Impact

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

Mitigation

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

For more information on exports see page 14

Acquisitions

The anticipated benefits of acquisitions may not be achieved.

Description

The Group considers investment in value-enhancing acquisitions where market conditions are right and where they deliver on its strategy. Whether the Group realises the anticipated benefits from these transactions depends upon the successful integration of the acquired businesses, as well as their post-acquisition performance in the markets in which they operate.

Impact

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

Mitigation

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

For more information on the Group's recent M&A activity see page 173

Consortia and joint ventures

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

Description

The Group participates in various consortia, joint ventures and equity holdings, exercising varying degrees of control. The risk of failure or the risk of disagreement, particularly in those that require the unanimous consent of all members with regard to major decisions, is inherent in any jointly controlled entity.

Impact

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

Mitigation

The Group seeks to participate only in ventures in which its interests are complementary to those of its partners, and has formal systems and procedures in place to monitor the performance of such business arrangements.

For more information on the Group's principal joint ventures see page 153

Exchange rates

The Group is exposed to volatility in currency exchange rates.

Description

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

Impact

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

Mitigation

In order to protect itself against currency fluctuations, the Group's policy is to hedge all material firm transactional exposures, unless otherwise approved as exceptions by the Treasury Review Management Committee. The Group does not hedge the translation effect of exchange rate movements on the income statement or balance sheet of foreign subsidiaries and equity accounted investments it regards as long-term investments.

For more information on financial risk management see page 176

Cyber security

The Group could be negatively impacted by information technology security threats.

Description

As a defence, aerospace and security company, 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.

Impact

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.

Mitigation

The Group has a broad range of measures in place, including appropriate tools and techniques, to monitor and mitigate this risk.

For more information on the Group's Cyber & Intelligence reporting segment see page 43

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.

Page references used above refer to the Annual Report 2013 that can be viewed on the Company's website.

REPORTING SEGMENTS PERFORMANCE REVIEW

ELECTRONIC SYSTEMS

Electronic Systems, with 12,500 employees1, comprises the US and UK-based electronics activities, including electronic warfare systems and electro-optical sensors, military and commercial digital engine and flight controls, next-generation military communications systems and data links, persistent surveillance capabilities, and hybrid electric drive systems.

2013 EXECUTIVE COMMITTEE OBJECTIVE

Be agile, sustain revenues and deliver strong bottom line performance

KEY CHARACTERISTICS

‑ Broad base of programmes, with more than 5,000 active contracts

‑ No programme greater than 5% of sales

‑ Cutting-edge technology and capabilities, with significant levels of research and development invested in the business

‑ 21% of total sales are to commercial customers

FINANCIAL KEY POINTS

‑ 6% like-for-like increase in order backlog1,4

‑ Sales1 reduced by 2%, with growth in the commercial business mitigating the defence decline

‑ Return on sales maintained at around 14%

OPERATIONAL KEY POINTS

‑ Maintained a leadership position in the electronic warfare market, with strong performance on the Group's components for F-35 Lightning II

‑ Won a development contract on the US Army's Joint Effects Targeting System programme

‑ Strengthened position in the Identification Friend or Foe market

‑ Strengthened position in the high-growth commercial aircraft electronics market

‑ Not selected on the US Army's next-generation Mid-tier Networking Vehicular Radio programme

‑ £0.2bn of research and development expenditure5 in 2013

SUSTAINABILITY KEY POINTS

‑ Increase in Recordable Accident Rate primarily due to an increase in outside slips, trips or falls

‑ Reduced energy and water usage, and quantity of waste produced

Financial performance

Despite US budget pressures, order backlog1,4 of £3.7bn was up from the start of the year, benefiting from production awards on the Terminal High-Altitude Area Defence programme.

Sales1 compared with 2012 decreased by 2% to £2,466m (2012 £2,507m). The commercial areas of the business amount to 21%, having seen sales growth in the year of 8%. This helped to offset some of the pressures on the defence side, which reduced by 5% in the year.

The return on sales achieved was 14.0% (2012 14.2%). Programme execution remained strong, with good risk retirement and in-year benefit from continued cost reduction actions.

Cash flow3 conversion of underlying EBITA2 for the year was 68%, but excluding pension deficit funding, that conversion rate was 89%.

1 Including share of equity accounted investments.

2 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 33).

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

4 Comprises funded and unfunded unexecuted customer orders.

5 Includes both Group-funded and customer-funded expenditure.

Operational performance

Electronic Combat

Electronic Systems maintains its leadership position in the US electronic warfare market. Under the flight test programme for the electronic warfare suite on the F-35 Lightning II programme, initial design verification testing of the system was completed. Low-Rate Initial Production (LRIP) Lot 6 deliveries continued throughout the year and initial Lot 7 deliveries commenced. The business was awarded a not-to-exceed contract of $143m (£86m) for LRIP Lot 8.

Under contracts totalling over $0.9bn (£0.5bn), the Digital Electronic Warfare System (DEWS) will be installed on 84 new F-15 aircraft with upgrades to 70 existing F-15 aircraft for the Royal Saudi Air Force. Initial flight testing began in November. The business continues to pursue other export opportunities for the DEWS suite.

The business was successful in demonstrating the Long-Range Anti-Ship Missile (LRASM) prototype in a direct-hit live missile shot test under a joint programme of the Defense Advanced Research Projects Agency and the Office of Naval Research. Offering capabilities not available in current cruise missile systems, LRASM is a next-generation, anti-ship missile for which the business provides a radio frequency sensor used for targeting. LRASM is being developed as an advanced prototype for rapid transition to the US Navy's Offensive Anti-Surface Weapon programme.

BAE Systems was not awarded the technology development contract for the Next-Generation Jammer.

Survivability & Targeting

Electronic Systems continues to execute its $38m (£23m) technology development contract in a competition to provide the Common Infrared Countermeasures capability for the US Army, meeting or exceeding every programme milestone. The programme is now in a government-led test phase.

The Advanced Precision Kill Weapon System™ continues to demonstrate its versatility, completing qualification and successful testing on almost a dozen fixed and rotary wing platforms for the US armed forces. The business continues to execute its $69m (£42m) Full-Rate Production contract. More than 2,000 systems have been delivered, with continued positive feedback from performance in theatre.

The Terminal High-Altitude Area Defence programme provides a transportable, rapidly deployable, ground-based capability to intercept and destroy ballistic missiles inside or outside the atmosphere during their final phase of flight. BAE Systems has received orders of $340m (£205m) in combined US government and Foreign Military Sales to the United Arab Emirates.

BAE Systems was awarded a $15m (£9m) contract to support the US Army's Joint Effects Targeting System programme in March with its HAMMER™ precision targeting system, which has been designed to enhance soldiers' ability to rapidly identify, precisely locate and accurately mark targets for Global Positioning System-guided and laser-guided munitions in all weather and lighting conditions. The contract initiates a three-year engineering and manufacturing development phase, and is a key win that advances BAE Systems' market leadership in precision targeting systems.

Communications & Control

The F-35 Lightning II programme continues to be a key platform for the Group's avionics products with deliveries on plan for the active inceptor and vehicle management systems. The US Air Force has discontinued second sourcing efforts for the advanced helmet system that was being provided by BAE Systems.

BAE Systems was not selected on the US Army's next-generation Mid-tier Networking Vehicular Radio competition.

Intelligence, Surveillance & Reconnaissance (ISR)

The business continues to provide Airborne Surveillance capability for the US Air Force and US Army. These key programmes are based on two wide-area, high-resolution imaging sensor systems, the Airborne Wide Area Persistent Surveillance System, which has been operational for more than 16,000 hours in theatre, and the Autonomous Real-time Ground Ubiquitous Surveillance - Imaging System.

The business is providing state-of-the-art processing capabilities to Boeing for the US Navy's P-8A Poseidon programme, which has entered Full-Rate Production. Sixteen production mission computer and display systems have been delivered to the US Navy. Eight systems have been delivered to the Indian Navy, the first international customer.

In the Identification Friend or Foe market, BAE Systems has been awarded a $34m (£21m) contract to provide its enhanced Combined Interrogator Transponder system to the US Air Force and participating European air force partners. Deliveries of the Reduced Size Transponder have been completed for the US Navy's Triton System Design and Development programme and BAE Systems is now under contract for Low-Rate Initial Production.

In 2013, BAE Systems achieved a cumulative equivalent of 7,000 years in space across its three generations of space computers. The third-generation RAD750® computer has now been launched on more than 35 satellites supporting civil, national and commercial missions. The business is continuing to innovate in the space processing market with the development of its next-generation space computer.

The business continues to provide Signal Intelligence (SIGINT) capability for the US Army and Special Operations Command. These programmes are based on the Group's S-3000 family of SIGINT systems and have successfully deployed with multiple customers.

Commercial Aircraft electronics

The business continues to expand its market opportunities for Full Authority Digital Engine Controls (FADEC). FADEC Alliance, a joint venture between FADEC International, the Group's joint venture with Sagem, and GE Aviation, delivered the Leap FADEC and successfully completed testing on GE's Passport 20 engine. Entry into service of the Passport engine, which will power Bombardier's Global 7000 and 8000 jets, is scheduled for 2016. The Leap FADEC will be used on the Boeing 737 MAX and Airbus A320neo.

Following successful first flights of Embraer's mid-size business jet, Legacy, and Bombardier's CSeries regional aircraft, enabled by several flight control subsystems provided by BAE Systems, efforts are now focused on both aircraft entering full revenue service.

BAE Systems is a supplier on the Boeing 737 MAX, notably with the fly-by-wire spoiler controls. Contracts awarded to the Group have a total potential value of $1bn (£0.6bn) over the life of the aircraft programme.

The business has opened a new office in Shanghai which will enable it to expand its commercial aftermarket presence in China, whilst strengthening existing and developing new partnerships with in-country suppliers and airframe manufacturers.

HybriDrive® propulsion

Dijon, France, a new customer for the business, has taken delivery of 102 buses from Iveco powered by HybriDrive® propulsion systems, making it the largest hybrid fleet in mainland Europe. King County Metro, Seattle, Washington, purchased 120 New Flyer buses powered by HybriDrive® Series-E systems, the county's latest hybrid product, to add to its existing HybriDrive®-powered fleet.

Sustainability performance

Safety

The business experienced a 21% increase in the Recordable Accident Rate, which was driven largely by an increase in outside slips, trips or falls. Safety remains a key value and the business continues to maintain long-term injury rates better than benchmarked world-class companies. Updated ergonomics and injury/illness prevention plans were rolled out in 2013.

Diversity and inclusion

The business supported US-wide diversity and inclusion activities, including inclusive leadership training, the launch of employee resource groups, and introducing diverse candidate shortlists and interview panels for executive roles. Leadership involvement and multiple activities within the business have advanced the diversity maturity level in 2013.

Environment

BAE Systems, partnering with the City of Austin, Texas, installed a new water treatment process which uses water from a local waste water treatment plant to run the site's chilled water condenser systems, rather than potable water. The process is expected to save the business $65,000 per year and reduce annual potable water consumption in the drought-ridden region by an estimated ten million gallons.

Engagement

In addition to its successful quarterly 'One Team Award' programme, Electronic Systems introduced a special employee recognition award this year, the 'PathFinder' award. The 'One Team Award' recognises teams for exemplifying one or more of five imperatives demonstrated through end-user impact: community focus; technology innovation; collaboration; best practices; and overall value to the business. The quarterly 'PathFinder' award recognises those teams or individuals whose innovative contributions helped to lead the way and grow the business.

For Group sustainability performance, see Sustainability section on pages 112 to 119

Looking forward

Efforts to reduce the US government's budget deficit are expected to continue to impact government spend. A bipartisan budget proposal was approved in December 2013 that mitigates the full impact of the Sequester for 2014 and 2015. The Group expects lower defence spending than previously programmed, but the cuts are not expected to be as significant or indiscriminate as they would have been under Sequestration.

Whilst further funding reductions and the resultant slow down or cancellation of ongoing and new programmes could impact the business, Electronic Systems continues to be well-positioned to address the changing US Department of Defense priorities with its balanced portfolio of programmes and customers, and its sustained emphasis on cost reduction and research and development.

The business expects to benefit from its incumbent positions and ability to provide capability upgrades on platforms. The business anticipates increased activity on international defence programmes and continued growth in the commercial aviation market.

CYBER & INTELLIGENCE

Cyber & Intelligence, with 7,700 employees1, comprises the US-based Intelligence & Security business and UK-headquartered Applied Intelligence (formerly BAE Systems Detica) business, and covers the Group's cyber, secure government, and commercial and financial security activities.

2013 EXECUTIVE COMMITTEE OBJECTIVE

Enhance and grow our positions in cyber, intelligence and security

KEY CHARACTERISTICS

Intelligence & Security

‑ Delivers real-time threat assessments that rapidly inform critical security actions. The business is a leading provider of specialised security and intelligence operational support and solutions in the US

‑ Delivers automated, efficient and reliable intelligence processing, data management systems and imagery mapping tools for the US intelligence and defence communities

‑ Delivers cost-effective IT solutions that solve complex problems of collaboration and security for the US national security community

Applied Intelligence

‑ Delivers solutions which protect and enhance clients' operations across the areas of cyber security, financial crime, communications intelligence and digital transformation

‑ Portfolio of solutions which help governments and commercial enterprises to address threats to national security, detect sophisticated cyber attacks, counteract fraud, safeguard mobile communications, manage risk, ensure compliance and derive insight from data

‑ Provides managed services to help clients optimise and protect both mobile and fixed data networks

FINANCIAL KEY POINTS

‑ Order backlog1,4 reduced by 24% reflecting delayed awards in the US business. Order backlog1 in Applied Intelligence increased by 60%

‑ Sales1 reduced by 11% reflecting an 18% decrease in Intelligence & Security and a 9% increase in Applied Intelligence

‑ Return on sales of 9.3% includes continued high levels of spend to support organic growth in Applied Intelligence

OPERATIONAL KEY POINTS

Intelligence & Security

‑ Awarded a three-year follow-on contract to the Counter-Improvised Explosive Device programme

‑ Maintained a leadership position in activity-based intelligence

‑ Continued to invest in differentiating technologies to support a bid pipeline of $2.4bn (£1.4bn) at the end of 2013

‑ US business significantly impacted by US budget pressures and partial government shutdown

Applied Intelligence

‑ Named as cyber security partner to Vodafone for provision of secure mobile services

‑ Achieved launch of new product for detection of sophisticated cyber threats, CyberReveal™, adopted by one major investment bank

‑ A number of important customer wins for NetReveal® OnDemand services

‑ Awarded framework contracts for IT services to the Foreign & Commonwealth Office and Network Rail

‑ Awarded integrated cyber security services contracts to three Middle Eastern countries

SUSTAINABILITY KEY POINTS

‑ Reduced Recordable Accident Rate by 17%

‑ Reduced energy and water usage, and quantity of waste produced

Financial performance

Order backlog1,4 reduced to £0.7bn (2012 £1.0bn). The US business continued to be impacted by budget-induced delays to award decisions of competitive bids. At 31 December 2013, there were some $2.4bn (£1.4bn) of competitive bids of which more than half were overdue against decision timescales. In addition, some $320m (£193m) of backlog has been removed following customer de-scoping across a large number of programmes. By contrast, order backlog1 in the Applied Intelligence business grew by 60%.

Sales1 in the year reduced by 11% to £1,243m (2012 £1,402m). The US business saw an 18% decrease, including the reduction from the Counter-Improvised Explosive Device programme, and the impacts from budget reductions were experienced more quickly than expected, with competitive award decisions continuing to be delayed. Growth in the Applied Intelligence business was at 9%.

The return on sales achieved of 9.3% (2012 8.8%) includes the continued organic investment in the Applied Intelligence business in support of targeted future growth in commercial and international markets.

Cash flow3 conversion of underlying EBITA2 for the year was at 103%.

1 Including share of equity accounted investments.

2 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 33).

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

4 Comprises funded and unfunded unexecuted customer orders.

Operational performance

Intelligence & Security

The US-based Intelligence & Security business delivers a broad range of solutions and services, including systems development, IT, cyber operations and intelligence analysis to enable the US military and government to recognise, manage and defeat threats. The business is structured into three key business areas that provide specific domain expertise, whilst working closely together to provide enterprise-wide support to a range of customers and key agencies in the intelligence, defence, homeland security and civilian markets.

The business has been impacted by uncertainty in future programme budget levels, driven first by Sequestration and then by the partial US government shutdown in October, which had greater impacts on services and support programmes. Some customers have chosen to reduce contractor volumes significantly on existing programmes, delay award activity on pending programmes or simply cancel others. The level of impact has been much higher than anticipated.

Global Analysis and Operations provides mission-enabled analytic solutions and support to operations across the US homeland security, law enforcement, defence, intelligence and counter-intelligence communities.

The business won all task orders competed in the market for Full Motion Video Analysis during the year and continues to execute awarded contracts, which are worth over $400m (£242m), with over 300 analysts supporting mission critical activities.

In August, the $450m (£272m) Counter-Improvised Explosive Device programme ended and the follow-on programme, Combat Intelligence Augmentation Teams, began. Orders on the new programme totalling approximately $150m (£91m) are expected over the next three years. The business continues to provide almost 300 security-cleared intelligence analysts working alongside forward deployed US defence personnel in Afghanistan.

GEOINT-ISR (Geospatial Intelligence - Intelligence, Surveillance and Reconnaissance) develops and supports software systems and mission applications for geospatial tasking, including data collection, processing, exploitation and dissemination, as well as mission planning, Intelligence, Surveillance and Reconnaissance (ISR), precision targeting, and command and control for the US defence and intelligence communities.

In October, the business received authorisation to proceed on a $16m (£10m) M151 Engineering Change Proposal (ECP) that continues its leadership in activity-based intelligence. The scope of the ECP includes analytics automation for complex mission problems across the intelligence community.

In September, the business was awarded the first ECP on the Mobility Air Force Automated Flight Planning Service programme to develop and sustain a new air vehicle flight planning and route optimisation capability for the US Air Force's Tanker Airlift Control Center under the $62m (£37m) contract awarded in April. The ECP focuses on the Aero Advisory Notification Tool capability in support of the Air Force's transition to a consolidated mission planning architecture.

IT Solutions develops, deploys and maintains mission applications focused on information sharing, knowledge management and enhanced enterprise mission IT solutions for the US federal, civilian and defence intelligence communities. The business also provides analytics, cyber analysis and real-time network forensics.

Work increased on the $70m (£42m) Next-Generation Desktop Environment programme for the US Defense Intelligence Agency by providing global networking solutions in US Korea Command and US Africa Command, based on virtual desktop infrastructure and multiple-security-level access.

On the Solutions for the Information Technology Enterprise Indefinite Delivery, Indefinite Quantity contract, with task orders worth $344m (£208m), the business has transitioned the customer from a costly regional support model to an efficient enterprise support model. Through the implementation of the Global Enterprise Operation Center, the business has enabled the US Defense Intelligence Agency to provide reliable, cost-effective and highly secure IT services to over 50,000 Department of Defense personnel worldwide with no impact to mission.

Under the $0.5bn (£0.3bn) Centralized Operations, Maintenance and Management Information Technology Indefinite Delivery, Indefinite Quantity contract, the business won a task order to provide 24/7 monitoring support for the Federal Emergency Management Agency Security Operations Center. The award brings total task orders under the contract to over $110m (£66m) and maintains BAE Systems' position as the largest provider of IT services on the contract.

In January 2013, the business was awarded a $127m (£77m) contract to support the US National Security Agency's High Performance Computing Infrastructure Group with architecture, installation and administration for a complex networking environment supporting multiple network enclaves and high-speed data centre access. Under the contract, both server and desktop computer support will be provided to more than 3,000 end users.

Applied Intelligence (formerly BAE Systems Detica)

The business continues to grow through selling its portfolio of products and services to domestic and international governments, financial institutions, communications service providers, energy and utility operators and other commercial enterprises.

The business is demonstrating its ability to win large, multi-year contracts. It has extended its portfolio of products and services, and is responding to demand for solutions which combine capabilities from across its portfolio, where client requirements are converging. Market awareness and recognition continue to grow, evidenced through a number of industry analyst and association awards during the year. The business has opened a Global Delivery Centre in Malaysia to augment capability alongside existing centres in the UK and Poland.

Cyber Security

New additions to the product portfolio in 2013 have included: CyberReveal™, an advanced cyber threat monitoring solution, already sold to a major global financial institution; MobileProtect™, a cloud-based service for securing smart mobile devices, launched alongside a five-year strategic partnership with Vodafone; and IndustrialProtect™, a military-grade solution to protect organisations' industrial control systems. MobileProtect™ subscribers are expected to exceed 100,000 during 2014.

Managed security services continue to gain traction, with the business named as official cyber security partner to McLaren in April. In December, the business won new cyber security and services contracts totalling £48m in the Middle East.

Financial Crime

The business continues to provide enterprise risk, fraud and compliance solutions internationally.

NetReveal® has been selected by CANATICS (Canadian National Insurance Crime Services) to provide a five-year managed analytics service to detect auto insurance claims fraud. It has been selected as preferred vendor by an Eastern European government to detect tax fraud and non-compliance, and has been selected by HMRC to extend its risk and fraud system to cover VAT repayment transactional fraud. The business has also broadened its offering to tackle emerging risks, such as unauthorised trading, including a significant sale to the investment banking division of a major global banking group. Other customer wins during the year include Commerzbank and Home Trust, contributing to a total order intake of £102m.

Communications Solutions

The business is a provider of end-to-end communications intelligence solutions internationally. It is addressing changes in market conditions which presented operational challenges in 2013. However, in 2014, it is pursuing opportunities in the Middle East and Asia Pacific regions and, in late 2013, won strategically important deals with both governments and communications service providers in Europe and North America.

UK Services

The consulting, systems integration and managed services business had a successful year. It signed a framework contract with the Foreign & Commonwealth Office (FCO) to deliver service management integration services across the FCO's global IT estate, worth around £40m over a five-year period. The business also signed a framework agreement with Network Rail to provide IT solutions and systems integration over a four-year period.

The business continues to expand its relationships with communications service providers, including Vodafone and EE, providing solutions from across its portfolio.

Sustainability performance

Safety

The Intelligence & Security business experienced a decrease in its injury rates as a result of direct leadership engagement and active employee involvement.

Diversity and inclusion

Applied Intelligence has increasingly focused on diversity and inclusion to understand, and raise awareness of, the merits of a genuinely diverse team and inclusive working environment. One example is the introduction of diverse panels for employment interviews.

Environment

Intelligence & Security has four LEED (Leadership in Energy and Environmental Design - US Green Building Council) sites and has implemented water reduction measures at three facilities. The business also removed hundreds of desktop printers across its US locations to reduce costs related to paper, ink and maintenance.

Engagement

Intelligence & Security launched an internal skills and training programme for employees. The business benefits from this investment by ensuring employees have the skills necessary to solve customers' toughest challenges. Around 70 different courses were offered in 2013 with nearly 2,000 employees completing over 22,000 hours of training.

Applied Intelligence conducted an awareness campaign in September focused on improving understanding about health issues faced by individuals within the business, including stroke, muscular dystrophy, diabetes and cystic fibrosis.

For Group sustainability performance, see Sustainability section on pages 112 to 119

Looking forward

Efforts to reduce the US government's budget deficit are expected to continue to impact government spend. A bipartisan budget proposal was approved in December 2013 that mitigates the full impact of the Sequester for 2014 and 2015. The Group expects lower defence spending than previously programmed, but the cuts are not expected to be as significant or indiscriminate as they would have been under Sequestration.

The US market continues to experience delays in procurement awards. Customers will continue to look for opportunities to achieve efficiencies in IT services through consolidation and cloud computing, areas in which the US business has deep domain expertise and experience. Big data continues to pose a challenge for the US government and commercial businesses, which also provides an opportunity for growth.

Intelligence & Security is well-positioned to pursue opportunities in cyber, special operations and Intelligence, Surveillance and Reconnaissance, which remain priority activities in the US. Other avenues for growth exist across the intelligence analysis spectrum. The US business is also exploring international opportunities where its IT, cyber and analysis capabilities can be implemented by governments or in commercial markets.

Applied Intelligence expects continued growth both in the UK and internationally, with increasing demand from government and commercial sector customers for products and services which protect and enhance operations in the areas of cyber security, financial crime, communications intelligence and digital transformation.

PLATFORMS & SERVICES (US)

Platforms & Services (US), with 19,200 employees1, comprises the US-headquartered Land & Armaments business,with operations in the US, UK, Swedenand South Africa, and the US-based services and sustainment activities, including ship repairand munitions services.

2013 EXECUTIVE COMMITTEE OBJECTIVE

Drive value from our land portfolio and deliver sustainable, profitable growth in the services sector

KEY CHARACTERISTICS

Land & Armaments

‑ Tracked combat vehicles

‑ Artillery and naval weapons

‑ Ammunition and new directed weapon technologies

‑ Support and sustainment of original equipment manufacturer platforms

Support Solutions

‑ US naval ship repair and modernisation

‑ Complex infrastructure services and operations support

‑ Aircraft sustainment and modernisation

‑ Commercial shipbuilding

‑ Soldier survivability products

FINANCIAL KEY POINTS

‑ Sales1 reduced by 17% in Land & Armaments and increased by 2% in Support Solutions

‑ Return on sales increased to 9.3% in Land & Armaments and reduced to 3.0% in Support Solutions

OPERATIONAL KEY POINTS

Land & Armaments

‑ Strong operational performance

‑ Continued focus on cost reduction actions

‑ Contract for Low-Rate Initial Production received on the Paladin Integrated Management programme

‑ Integration work ceased on Caiman Multi-Terrain Vehicles and Sealy, Texas, facility to close in 2014

Support Solutions

‑ Performance impacted by charges taken on the Radford Army Ammunition Plant contract, commercial shipbuilding activity and not being awarded follow-on options on the US Navy aircraft maintenance contract

‑ Follow-on awards on US munitions facilities management contracts

‑ Significant multi-year contracts to support ballistic missiles in the US

‑ Letter of Agreement finalised for upgrades and systems integration for South Korean F-16 aircraft

SUSTAINABILITY KEY POINTS

‑ Reduced Recordable Accident Rate by 3%

‑ Reduced energy and water usage, and quantity of waste produced

Financial performance

Order backlog1,4 was £7.4bn (2012 £8.4bn). At Land & Armaments, order backlog1,4 reduced to £4.3bn (2012 £5.1bn) reflecting trading on M777 and long-term UK munitions contracts. Disappointingly, the CV90 prospect in Canada was cancelled by the customer and no procurement decision has yet been taken by the Indian authorities with regard to the M777 lightweight howitzer acquisition. At Support Solutions, order backlog1,4 reduced to £3.1bn (2012 £3.3bn) as the five-year ship repair Multi-Ship, Multi-Option contracts are traded through.

In aggregate, sales1 were £4.2bn (2012 £4.5bn), representing a like-for-like reduction of 5%. At Land & Armaments, sales1 declined by 10% on a like-for-like basis, taking into account exchange translation, the impact of last year's business disposals and the transfer of the Combat Vehicles (UK) business to Platforms & Services (UK). The sales1 reduction was largely from completion of contracts for Mine Resistant Ambush Protected vehicle upgrades and lower Bradley reset work. In the Support Solutions business, sales1 were 2% higher than in 2012. The business benefited from higher volumes in the ship repair and munitions facilities management businesses.

Underlying EBITA2 was £265m (2012 £394m). Return on sales reduced to 6.3% (2012 8.7%). Return on sales at Land & Armaments of 9.3% (2012 8.6%) benefited from ongoing cost reduction actions and good programme execution, and includes the charge taken for the closure of the wheeled vehicle facility at Sealy. Return on sales at Support Solutions of 3.0% (2012 8.8%) includes a charge of $46m (£29m) taken against overhead under-absorption relating to 2013 and future years as the business seeks to restructure the Radford Army Ammunition Plant contract. In addition, a charge of $30m (£19m) has been taken against cost overruns on commercial shipbuild activity.

Operating cash flow3 reduced to £192m (2012 £314m). Cash flow3 conversion of underlying EBITA2, excluding pension deficit funding, was 86% and 68% at Land & Armaments and Support Solutions, respectively. Operating cash flow3 in Support Solutions was impacted by short-term US government payment delays.

1 Including share of equity accounted investments.

2 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 33).

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

4 Comprises funded and unfunded unexecuted customer orders.

Operational performance

Land & Armaments

US Combat Vehicles

Despite significant down-sizing and ongoing uncertainties in the US market, the business has continued to maintain key industrial base capabilities based on the US Army's stated requirements at the Bradley production line in York, Pennsylvania. In addition to domestic Bradley reset and conversion programmes, the business continues to make progress in securing international business, primarily in the Middle East. In November, Land & Armaments signed a joint venture agreement to pursue Bradley opportunities in Saudi Arabia.

Although uncertainty remains with respect to the future of the US Army's Ground Combat Vehicle programme, the business continues to support the US Army and execute its technology maturation and risk reduction contract. The Hybrid Electric Drive system successfully completed 2,000 miles of testing four months ahead of schedule.

In October, the Paladin Integrated Management (PIM) programme received a $195m (£118m) contract to begin Low-Rate Initial Production. During this phase, BAE Systems will produce 18.5 vehicle sets, comprising 19 PIM howitzers and 18 PIM Carrier Ammunition Tracked vehicles.

Through future options, the US Army intends to purchase a total of 66.5 vehicle sets, plus spares, kits and technical documentation for a total contract value of $688m (£416m).

During 2013, Land & Armaments continued to streamline its US business. The sale of the Commercial Armored Vehicles business completed in February and the Fayette, Pennsylvania, facility closed in December.

Whilst Land & Armaments remains a committed member of the Lockheed Martin Joint Light Tactical Vehicle (JLTV) programme, in August, the business received a notice of termination for convenience from the US government, ceasing all integration work on Caiman Multi-Terrain Vehicles. Following this notice, the business announced closure of the Sealy, Texas, facility by the end of June 2014. Work under the JLTV programme is in the process of transitioning to the York, Pennsylvania, facility.

Weapon Systems

The business was awarded a $40m (£24m) contract to produce vertical launching system canisters for the US Navy. If all options under the contract are exercised, the total value could exceed $400m (£242m).

The business secured a $57m (£34m) contract with the Royal Malaysian Navy for six naval guns that will equip the country's second-generation patrol vessels, Littoral Combat Ships.

The first five pre-serial Archer artillery systems were delivered to the Swedish Defence Materiel Administration (FMV). In December, Norway announced its intent to end its co-operation with Sweden on the Archer system. BAE Systems remains committed to the programme and continues to work with its customer, the FMV, to deliver the system to the Swedish armed forces.

BAE Systems Hägglunds

The business continues to have success with its CV90 programme. Work on the $750m (£453m) contract for the Norwegian Army remains on schedule, with delivery of pre-series vehicles in February 2013 and series manufacture starting in September. A CV90 vehicle was delivered to the Danish Army to participate in a competitive evaluation to meet the requirement for future armoured personnel vehicles. The business signed a teaming agreement in May with Polish Defence Holdings to offer a new family of armoured vehicles based on CV90 technology.

In December, the business was notified of the Canadian government's decision to cancel its proposed Close Combat Vehicle programme.

In December, the Swedish government exercised its option to buy 102 more BvS10 all-terrain vehicles in an order worth approximately $120m (£72m). This order follows its January 2012 purchase of 48 BvS10 vehicles that are under delivery to the Swedish Army.

FNSS

FNSS, BAE Systems' Turkish joint venture, continues to produce and upgrade tracked and wheeled military vehicles for international customers.

Production has commenced under the $559m (£338m) programme to produce 259 8x8 wheeled armoured vehicles for the Royal Malaysian Army and the first vehicles were delivered in 2013.

In December, FNSS received a $360m (£217m) contract from the land forces of a Middle Eastern country for the upgrade of M113 tracked armoured personnel carriers. The business is pursuing other armoured vehicle prospects elsewhere in the region.

Munitions

A pricing proposal for the next five years (2018 to 2022) of the Munitions Acquisition Supply Solution partnering agreement was submitted to the UK Ministry of Defence in September. Orders totalling £105m were received from the UK Ministry of Defence, US Navy, Kingdom of Saudi Arabia government and the French Ministry of Defence in the year.

The Munitions business will be reported in the financial results of the Platforms & Services (UK) reporting segment from 1 January 2014.

Support Solutions

Whilst strategic contracts were won during the period, the US-based services businesses were impacted materially by budget uncertainties and operational challenges. There were operational challenges in commercial shipbuilding and on start-up activity on the Radford Army Ammunition Plant contract. In addition, the business was not awarded follow-on options under the US Navy training aircraft maintenance and logistics support contract, under which work continued until 1 December.

The conditional Worker Adjustment and Retraining Notification (WARN) Act notices issued in February to nearly 3,600 ship repair employees were largely mitigated by the funding legislation passed in March.

The US-based ship repair business achieved its commitments under Multi-Ship, Multi-Option contract vehicles with the US Navy, receiving orders totalling $1.2bn (£0.7bn) for the repair, maintenance and modernisation of various vessels during the year.

BAE Systems continues to co-operate with ongoing government investigations regarding the employee fatality at the Mobile, Alabama, shipyard that occurred on 4 April when the Carnival Triumph cruise ship came free from its moorings during unexpected severe weather.

The business continues to manage the operations of the Holston Army Ammunition Plant in the US. In March, the US Army awarded an Indefinite Delivery, Indefinite Quantity contract valued at up to $780m (£471m) over five years to operate and manage the Holston Army Ammunition Plant, as well as purchase explosives from the plant.

South Korea down-selected BAE Systems to upgrade avionics and electronic systems, as well as perform systems integration for its fleet of more than 130 F-16 aircraft. The US Congressional Notification process was completed with the Letter of Acceptance put in place in December.

In August, BAE Systems was awarded an eight-year, $534m (£323m) contract from the US Air Force to maintain the readiness of Minuteman III intercontinental ballistic missiles in the US. The Group will provide systems engineering, integration, testing, logistics and other services to support the missile, ground and launch systems for 450 deployed missiles. In December, the US Navy awarded BAE Systems a three-year, $171m (£103m) contract to continue providing engineering and integration support to Trident II D-5 submarine-launched ballistic missiles.

The US Army awarded Support Systems Associates, Inc., with BAE Systems as a subcontractor, the Logistics Support Facilities Management Activity contract to provide flexible, timely and cost-effective facilities, personnel and expertise to support aircraft modifications and other support services.

In protection systems, BAE Systems produced its one millionth combat helmet since the 1980s. A $28m (£17m) order from the US Marine Corps for the production of lightweight combat helmets was received in February 2013.

In October, the business was awarded a $60m (£36m) order from the US Defense Logistics Agency to produce additional tactical vests equipped with body armour and incorporating a number of benefits for the soldier, including a 10% weight reduction in the armour system.

In the maritime defence solutions business, BAE Systems was awarded an $80m (£48m) contract to continue providing systems engineering and other technical services to support the operational readiness of US Navy submarine torpedoes and other weapons systems.

Under the Concepts and Operations for Space and Missile Defence Integration Capabilities contract, the business was awarded an $85m (£51m), two-year extension to continue its support of the US Army in providing services for developing and understanding missile defence methods and technologies.

Sustainability performance

Safety

In April, Support Solutions held its first Safety Stand Down, engaging more than 12,000 employees across the business in interactive discussions regarding workplace safety. The employee response was positive, with more than 200 suggestions for improvement implemented across the organisation. The success of these activities is reflected in a 7% reduction in the Recordable Accident Rate.

Diversity and inclusion

Land & Armaments has made progress in bringing diversity and inclusion awareness to its employees. The Diversity & Inclusion Council, Multi-Cultural Network, Women's Leadership Network and the formation of numerous Employee Resource Groups have fostered awareness, respect and inclusion across the organisation. In addition to the annual Diversity & Inclusion Conference, these groups hosted many open forums, conferences and workshops that provided a deeper understanding about the diversity that exists in the workforce.

Environment

The ship repair business in Norfolk, Virginia, has been certified by the Virginia Department of Environmental Quality as an 'Extraordinary Environmental Enterprise' for its leadership and commitment to environmental stewardship.

Engagement

Land & Armaments' leadership has put significant emphasis on retaining and attracting key talent within the organisation, as well as communicating more frequently and in more transparent ways with employees. In 2013, the president of the business instituted a bi-annual 'State of the Sector' address. Participation in the employee engagement survey of 76% represented an increase from 58% in 2012.

For Group sustainability performance, see Sustainability section on pages 112 to 119

Looking forward

Efforts to reduce the US government's budget deficit are expected to continue to impact government spend. A bipartisan budget proposal was approved in December 2013 that mitigates the full impact of the Sequester for 2014 and 2015. The Group expects lower defence spending than previously programmed, but the cuts are not expected to be as significant or indiscriminate as they would have been under Sequestration.

In the near term, Land & Armaments continues to operate in a challenging environment. To remain viable in the future, the business is investing to protect franchise programmes, including Bradley modernisation and the CV90 family, and establish new franchise programmes, such as Paladin Integrated Management. In addition, the business continues to offer export products to international markets and invest in new technology fast lanes, such as directed energy weapons and hybrid electric drives for combat vehicles. The business continues to drive rationalisation efforts to maximise efficiency and remain competitive.

Whilst potential cancellations and delays in new programmes could affect the business, Support Solutions may be able to offset the impact through additional opportunities to sustain and modernise existing platforms.

PLATFORMS & SERVICES (UK)

Platforms & Services (UK), with 28,300 employees1, comprises the Group's UK-based air, maritime, combat vehicle, munitions and certain shared services activities.

2013 EXECUTIVE COMMITTEE OBJECTIVE

Deliver sustainably profitable through-life businesses in the air, maritime and combat vehicles sectors

KEY CHARACTERISTICS

Military Air & Information

‑ Multi-year through-life programmes

‑ Military aircraft capabilities include design, development, manufacture, in-service support and training for combat and trainer aircraft, and design and development of Unmanned Air Systems

‑ Defence information systems, such as the Falcon secure deployable communication system

‑ Managed solutions for aircraft support services and engineering

Maritime

‑ Maritime capabilities include design, build, integration and commissioning, in-service support and training for naval ships, submarines, radar and combat management systems, and underwater systems

Combat Vehicles (UK)

‑ Design, build, demonstration and through-life support of armoured vehicles

Munitions

‑ Design, test, qualification, production, supply and through-life support of general munitions and the cased telescopic ammunition system

FINANCIAL KEY POINTS

‑ Sales2 increased by 21% on resumption of Salam Typhoon aircraft deliveries and trading of price escalation

‑ Return on sales of 12.8% benefited from the trading of price escalation and strong programme execution

‑ Operating cash flow4 reflects the utilisation of advances and provisions

OPERATIONAL KEY POINTS

‑ 34 Typhoon Tranche 2 and the first Tranche 3 aircraft delivered to the European partner nations

‑ First Hawk jets delivered to the Indian Navy

‑ Naval sector restructuring agreement reached with the UK Ministry of Defence

‑ Two Khareef Class corvettes for the Royal Navy of Oman achieved interim acceptance

‑ Sixth and final Type 45 destroyer accepted off-contract

‑ Third and final Offshore Patrol Vessel delivered to the Brazilian Navy

‑ £0.1bn of funding for ongoing design and development of the Royal Navy's Successor submarine

‑ Increased funding for the fifth, sixth and seventh Astute Class submarines

SUSTAINABILITY KEY POINTS

‑ Reduced Recordable Accident Rate by 43%

‑ Reduced energy and water usage, and quantity of waste produced

Financial performance

Order backlog2 reduced to £20.3bn (2012 £21.3bn) on trading of aircraft deliveries under the contracts for European and Saudi Typhoon aircraft and the Indian Hawk contract.

The year's sales2 of £6.9bn (2012 £5.7bn) were 21% higher than 2012, benefiting from the ten aircraft deliveries made on the Salam Typhoon programme and trading of the price escalation. There were no Salam aircraft deliveries made in 2012.

The return on sales of 12.8% (2012 12.2%) was strong, benefiting from not only the trading of the Salam Typhoon price escalation, but also another year of strong programme execution and risk reduction across the business.

There was a cash inflow4 of £59m (2012 £1,717m) in the year reflecting the consumption of customer advances on the Omani Typhoon and Hawk programme, the European Typhoon contract and the Saudi training aircraft contract. In addition, provisions were utilised against costs incurred on rationalisation, on the Oman Offshore Patrol Vessel programme and for the Trinidad and Tobago termination settlement payment.

1 Re-presented on classification of the Regional Aircraft line of business as a continuing operation (see note 7 to the Group accounts).

2 Including share of equity accounted investments.

3 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 33).

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

Operational performance

Military Air & Information

In the year, deliveries of Typhoon Tranche 2 aircraft to the four partner nations totalled 34, bringing the total number of Tranche 2 aircraft delivered to 203 of the contracted 236. Sixteen Tranche 3 front fuselage sub-assemblies were manufactured in the year and the first Tranche 3 aircraft was delivered to the Royal Air Force (RAF).

Initial mobilisation under the Omani Typhoon and Hawk aircraft contract, awarded in December 2012, has commenced with the first aircraft deliveries scheduled for 2017.

The business continues to support its UK and European customers' Typhoon and Tornado aircraft and their operational commitments. The business supports its UK customer through availability-based service contracts.

On the F-35 Lightning II programme, the business has continued to deliver aircraft fuselages for the sixth Low-Rate Initial Production (LRIP) contract, delivering 26 aircraft sets to Lockheed Martin in 2013. Production for the seventh LRIP contract has commenced. A bid proposal for LRIP 8 has been submitted and negotiations have commenced.

Support continues to be provided to users of Hawk trainer aircraft around the world. The Indian Navy has received its first five Hawk aircraft from Hindustan Aeronautics Limited, built under the Batch 2 licence for 57 aircraft. Commercial discussions continue on the proposal for an additional 20 Hawk aircraft.

A response to the competitive proposal to supply eight Hawk trainer aircraft, support and training to Poland was submitted in November. Following evaluation by the Polish Ministry of Defence, the Group has been informed that it will not be down-selected for the next phase of this competition.

Working with UK industry partners and the Ministry of Defence, BAE Systems has designed and built a stealthy unmanned combat air vehicle demonstrator named Taranis. The aircraft made its maiden flight in August 2013 and has undertaken a number of successful trial flights.

Progress continued, to plan, on the joint BAE Systems and Dassault Aviation Future Combat Air System demonstration programme preparation contract to mature and demonstrate critical technology and operational aspects for an Unmanned Combat Air System.

In January 2014, it was announced that there would be further joint UK/French Future Combat Air System technology development under a two-year feasibility study worth £120m.

In the defence information domain, final deliveries of the Falcon secure deployable communication system for the British Army and RAF were completed in 2013, and the business continues to provide support for the system.

In the Regional Aircraft business, engineering revenues have remained under pressure reflecting the current trading conditions. This has been offset by a good performance within the support business.

Maritime

Following detailed discussions about how best to sustain the long-term capability to deliver complex warships, BAE Systems has proposed and agreed with the UK Ministry of Defence that Glasgow would be the most effective location for the manufacture of the future Type 26 frigates. Subject to consultation with trade union and employee representatives, the Group announced in November that it proposes to consolidate its shipbuilding operations in Glasgow and that shipbuilding operations at Portsmouth will cease in the second half of 2014. Consultation has commenced on a total employee reduction of up to 1,775, including up to 940 in Portsmouth in 2014 and up to 835 across Filton, Glasgow and Rosyth, progressively through to 2016. The relevant cost of the restructuring will be borne by the Ministry of Defence.

A significant reduction in workload will follow the peak of activity on the aircraft carrier programme, the six Type 45 destroyers and two export contracts. The anticipated Type 26 programme will, in future years, address some of that workload reduction. In the interim period, a proposed contract for the manufacture of three Offshore Patrol Vessels was announced in November, which, as well as providing interim shipbuilding workload, will provide additional capability for the Royal Navy and sustain key shipbuilding skills.

Cumulative savings of £457m have been reported to the Ministry of Defence against commitments made under the Terms of Business Agreement (ToBA), which remains ahead of target. The agreements announced in November, together with the anticipated contract for the design and manufacture of the Type 26, will progressively replace the ToBA.

Progress continues on assembly of the first aircraft carrier, HMS Queen Elizabeth, whilst block build for the second ship, HMS Prince of Wales, is underway. BAE Systems, with the other participants in the Aircraft Carrier Alliance, announced in November that it had agreed changes to the contract to accommodate both programme changes and activities previously excluded. Under the new target cost arrangements, the industrial participants' fee includes a 50:50 risk share arrangement providing greater cost performance incentives.

HMS Duncan, the sixth and final Type 45 destroyer, was accepted by the Ministry of Defence in March. The Type 45 support contract met all ship deployment dates in the year.

The assessment phase contract for the Type 26 is proceeding and there are now over 600 employees working on the contract, which will complete in 2014.

Following the agreement in December 2011 for the sale of Offshore Patrol Vessels to the Brazilian Navy, the third and final vessel was delivered on schedule in June.

Progress continues on the Khareef Class corvettes for Oman, with the first two ships achieving interim acceptance in 2013 and the final ship scheduled for interim acceptance in 2014.

The Warship Support Modernisation Initiative contract, for delivery of services at Portsmouth Naval Base, was extended for one year in April, while discussions continue on the new Maritime Support Delivery Framework.

The Advanced Radar Target Indication Situational Awareness Navigation (ARTISAN) 3D radar programme continues towards full qualification, with the first of class now fitted to HMS Iron Duke, a Type 23 frigate, and further installations underway in line with the production plan.

The Maritime Composite Training System, a shore-based warfare operator training solution for the Royal Navy, has now achieved full operating capability. Training has been delivered to over 2,000 personnel and to warfare teams from every major warship.

HMS Astute and HMS Ambush, the first and second of class attack submarines for the Royal Navy, achieved operational handover in 2013. Artful, the third of class, is planned to launch in 2014, and a further £441m of orders have been secured for Boats 5, 6 and 7.

Progress continues on the design and development phase of the Successor submarine programme, the replacement to the Vanguard Class fleet. Over 1,300 people are now employed on this programme.

Combat Vehicles (UK)

The Terrier® combat engineer vehicle was declared 'in service' by the Ministry of Defence in April, with 43 of the 60 contracted vehicles delivered in 2013. Final vehicle deliveries are expected during the first half of 2014.

The Newcastle facility will close in the second half of 2014 following completion of final vehicle deliveries.

Munitions

The Munitions business will be reported in the financial results of the Platforms & Services (UK) reporting segment from 1 January 2014. The business is reported in Platforms & Services (US) in 2013.

Sustainability performance

Safety

Naval Ships and Maritime Services both picked up International Safety Awards during 2013 from the British Safety Council, which is a reflection of a collective commitment to high standards of safety.

Diversity and inclusion

BAE Systems in the UK works in partnership with Opportunity Now, the gender campaign from Business in the Community. The campaign's three priorities are a better gender balance for leadership progression; unbiased recognition and reward for all; and agile work cultures that are fit for the future. This supports the Group's diversity and inclusion strategic goals, including strengthening its competitive position as an attractive employer.

Environment

At Military Air & Information's Warton and Samlesbury sites in the UK, a campaign to reduce energy usage and minimise environmental impacts used floor art to get the message across to employees. Spray-painted with biodegradable chalk, the innovative artworks highlighted how much gas and electricity the business uses and encouraged employees to think about how they could help to reduce energy consumption.

Engagement

Mental health conditions cost UK employers billions of pounds each year. Fear of stigma and discrimination can also make people with mental health conditions unwilling to disclose their illness and thus prevent them from being adequately supported at work. Military Air & Information won a Gold BAE Systems Chairman's Award for the work it has done in developing a suite of tools, self-help material, website content and support to improve the way it deals with mental health issues.

For Group sustainability performance, see Sustainability section on pages 112 to 119

Looking forward

Platforms & Services (UK) has a strong order backlog of long-term committed programmes and an enduring support business.

In Military Air & Information, sales are underpinned by combat aircraft production on Typhoon and F-35 Lightning II, and in-service support for existing and legacy combat and Hawk trainer aircraft. There are a number of significant opportunities to secure future Typhoon export contracts, including to Saudi Arabia, Malaysia and Bahrain.

In Maritime, sales are underpinned by the Queen Elizabeth Class aircraft carrier and Astute Class submarine manufacturing programmes, the Warship Support Modernisation Initiative contract, and the design and future manufacture of the Successor submarine and Type 26 frigate. Support of these platforms and Type 45, together with their associated command and combat systems, is expected to provide sustainable business in technical services and mid-life upgrades.

In Combat Vehicles (UK), following completion of deliveries on the Terrier® programme, sales are expected to be derived from through-life support of legacy platforms.

The Munitions business is underpinned by the 15-year Munitions Acquisition Supply Solution partnering agreement with the UK Ministry of Defence, together with a number of international contracts and potential opportunities.

PLATFORMS & SERVICES (INTERNATIONAL)

Platforms & Services (International), with 14,600 employees1, comprises the Group's businesses in Saudi Arabia, Australia, India and Oman, together with its 37.5% interest in the pan-European MBDA joint venture.

2013 EXECUTIVE COMMITTEE OBJECTIVE

Grow our Platforms & Services (International) business

KEY CHARACTERISTICS

Saudi Arabia

‑ Long-term contracts from the Royal Saudi Air Force for equipment, training and support, including Salam Typhoon aircraft

‑ Support to the Royal Saudi Navy minehunter programme

Australia

‑ Strategic capability and sustainment provider to the Australian Defence Force

‑ Delivering defence contracts across the air, land, maritime and electronics domains

India

‑ Long-standing military aircraft relationships

Oman

‑ In-service base across air, land and maritime products

MBDA

‑ Pan-European guided weapons joint venture

FINANCIAL KEY POINTS

‑ Order backlog1 increased by 32% on multi-year support awards and weapons procurement in Saudi Arabia

‑ Operating cash outflow3 of £189m on utilisation of customer advances and pending receipt of Salam settlement proceeds

OPERATIONAL KEY POINTS

‑ Salam Typhoon price escalation negotiations concluded

‑ Resumption of Typhoon aircraft deliveries to Saudi Arabia under the Salam programme

‑ Five-year, £1.8bn output-based Salam Typhoon support contract received

‑ £1.5bn of orders received for Tornado aircraft upgrades and weapons procurement under the Saudi British Defence Co-operation Programme

‑ Integration and trials of the first Landing Helicopter Dock (LHD) in Australia ongoing

‑ Second LHD hull arrived in Australia for consolidation to commence in the first quarter of 2014

‑ Five-year, A$342m (£185m) support contract for Royal Australian Air Force Hawk training aircraft received

‑ MBDA secured significant contracts with its UK and French government customers

SUSTAINABILITY KEY POINTS

‑ Reduced Recordable Accident Rate by 22%

‑ Reduced energy and water usage, and quantity of waste produced

Financial performance

Order backlog1 has increased to £12.3bn (2012 £9.3bn) following awards in Saudi Arabia for five years of support on Typhoon and further weapons packages on Tornado, together with renewal of the Australian Hawk support programme.

Sales1 of £4.1bn were almost unchanged from 2012. The deferred trading arising from the Salam price escalation and increased levels of support for Typhoon aircraft now in service were offset by reductions in the Australian business as the Landing Helicopter Dock build programme ramps down.

Underlying EBITA2 of £429m (2012 £417m) generated a return on sales of 10.6% (2012 10.2%).

The operating cash outflow3 reflects the utilisation of advances received in 2012 on the Saudi Tornado upgrade programme.

1 Including share of equity accounted investments.

2 Earnings before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items (see page 33).

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

Operational performance

Saudi Arabia

Through the entry into service of Typhoon and the continued development of the in-country industrial base, the Group remains committed to developing a greater indigenous capability in Saudi Arabia.

On the Salam Typhoon programme, UK final assembly of 72 Typhoon aircraft continues. Aircraft deliveries re-commenced in April. At 31 December 2013, 34 aircraft had been delivered to the customer. Work is progressing to schedule on the provision of a multi-role capability for the aircraft.

A five-year, £1.8bn output-based contract was received to support the Royal Saudi Air Force (RSAF) Typhoon aircraft as they progressively enter into service. In addition, a four-year contract to deliver scheduled maintenance and upgrade to 30 Typhoon aircraft by the end of 2017 was received.

Discussions on Typhoon price escalation reached agreement with the Saudi Arabian government.

Under the Saudi British Defence Co-operation Programme (SBDCP), the business continues to support the operational capability of both the RSAF and Royal Saudi Naval Forces (RSNF). Under a £1.6bn contract awarded in 2012 to upgrade the RSAF's aircrew training aircraft, the production of Hawk and Pilatus PC-21 training aircraft continues to programme. Under contracts totalling £3.4bn awarded in 2012 for support to the RSAF to the end of 2016, the first graduation ceremony of cadets from the King Faisal Air Academy took place in May.

Weapon deliveries were completed and orders worth £1.5bn for the upgrade of Tornado aircraft and additional weapons procurement were received.

Work was completed on the first ship re-fit on the RSNF minehunter mid-life update programme. The ship was accepted back into the RSNF fleet during the second half of 2013 and the second ship has entered the update programme.

Australia

Consolidation of the first of two Landing Helicopter Docks (LHD) was completed at the Williamstown shipyard following the arrival of the hull from subcontractor Navantia in Spain. Integration and test of the ship's systems and the initial stages of ship acceptance trials are progressing. Consolidation of the second LHD hull will begin in Melbourne in the first quarter of 2014. In April, the business opened a new simulation and training facility in Sydney for training future LHD crew.

Under the Air Warfare Destroyer programme, all 11 hull blocks have been accepted by the customer and nine delivered. Seven additional blocks have now been contracted for A$69m (£37m) and are under construction.

Under the initial ANZAC frigate anti-ship missile defence system contract awarded in 2004, the operational trials process was concluded on HMAS Perth. Under the follow-on contract awarded in 2012, the second frigate, HMAS Arunta, is continuing its refurbishment and construction to fit the new masts and systems, and the third frigate, HMAS ANZAC, is progressing through its own refurbishment and upgrade programme.

The business was awarded a five-year, A$342m (£185m) contract, with options to extend through to 2026, to continue to support the Royal Australian Air Force Hawk Lead-In Fighter aircraft fleet.

The first upgraded AP-3C Orion maritime surveillance aircraft to be fitted with a new Electronic Support Measures system was delivered in November, marking a significant milestone in the delivery of the project to the Royal Australian Air Force.

Tigerair Australia awarded BAE Systems a five-year contract to provide base maintenance services for its fleet of Airbus A320 aircraft. The business continues to examine opportunities to expand further its commercial aviation maintenance footprint in Australia.

The business incurred operating losses on the JP 2008 Phase 3F programme which provides strategic and tactical satellite communications capabilities to support Australian Defence Force operations.

The business was not down-selected for the Defence Logistics Transformation Programme.

India

The business sold its 26% shareholding in Defence Land Systems India to Mahindra & Mahindra, the holder of the other 74% of the shares in the joint venture.

In March, the US government issued a Letter of Acceptance to the Indian government under the US Foreign Military Sales (FMS) process for the supply of 145 M777 howitzers to the Indian Army. The Indian government has yet to progress the M777 FMS case through all levels of its procurement process. As a result of this and with no other new orders for M777, in October, the business took the decision to suspend M777 manufacture in Barrow-in-Furness, UK.

A fixed-price proposal has been submitted to Hindustan Aeronautics Limited (HAL) for a third batch of Hawk trainer aircraft for the Indian Air Force and discussions with HAL continue.

Whilst the Indian government deemed Dassault to be the lowest priced compliant bidder in the Medium Multi-Role Combat Aircraft competition, contract negotiations that began in early 2012 have not been concluded. The Group continues to monitor the competition and stands ready to support the Indian government's procurement process.

Oman

Following the signature of the contract to supply 12 Typhoon and eight Hawk aircraft in 2012, initial mobilisation has commenced. The business continues to focus on strengthening its close relationship with the Royal Oman Air Force, Navy and Army, and to address their future requirements.

MBDA

Following publication of the 2013 Livre Blanc in France, a €433m (£360m) contract was secured from the French customer for the development and production of the Missile Milieu de Trame system. In January 2014, the UK and French governments signed an agreement worth €500m (£416m) for the joint development and production of the MBDA Future Anti-Ship Guided Weapon - AntiNavire Léger (FASGW-ANL) missile for their armed forces.

In export markets, significant orders have been awarded in the Middle East and Far East.

MBDA continues to support the various aircraft procurement campaigns around the world and is well placed to respond to any associated weapon requirements.

Sustainability performance

Safety

Two employee-driven initiatives highlight the positive changes in Australia's safety culture and performance that contributed to a 29% reduction in the Recordable Accident Rate during 2013. The first was the introduction of aircraft protective edge padding and use of bump caps across the aerospace business. The second involved the development of a safety device for handling cut steel in shipyards.

Diversity and inclusion

In 2011, the Saudi business opened a female business support centre employing locally-recruited Saudi national women for the first time. The business plans to increase the number of Saudi female employees in 2014.

In 2013, the Indian business was recognised by the Indian National Human Resource Development Network as exhibiting best practice in its programme to support career development for female employees.

Environment

The Australian business has implemented initiatives to improve energy efficiency. At a programme office in Cairns, a 7% reduction in electricity consumption was observed in 2013 after implementing initiatives, including installing improved temperature controls to reduce the use of air conditioning. Similarly, at the Williamtown fast jet maintenance base, an 8% reduction in electricity consumption was observed in 2013 following improvements, including modifications to the air conditioning system.

Engagement

BAE Systems Saudi Arabia increased further the Saudisation of its workforce in 2013, achieving a level of 62%. Initiatives in this area were recognised by an award from the Saudi Ministry of Labour.

The Mustakbal Management Development Programme provides leadership development and management qualifications preparing high-potential employees for executive roles within the business. In 2013, 13 employees were enrolled onto the programme.

For Group sustainability performance, see Sustainability section on pages 112 to 119

Looking forward

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

In Australia, the change of government following a federal election in September is not anticipated to affect materially the future outlook for defence spending. The new administration has committed to the release of a revised white paper and to make, within 18 months of the election, the decisions necessary to ensure that Australia has no submarine capability gap. The Group is continuing to explore and secure opportunities in adjacent markets, particularly in the oil and gas industry in Western Australia.

In India, aircraft and artillery opportunities continue to be pursued.

In Oman, following signature of the Typhoon and Hawk contract in 2012, the Group will work with the customer to strengthen further its close ties and to address their future requirements.

MBDA continues to build on the effective partnerships it has established with its domestic customers and is actively pursuing a significant number of export opportunities.

Note and page references used above refer to the Annual Report 2013 that can be viewed on the Company's website.

Consolidated income statement

for the year ended 31 December

1 On adoption of the revised IAS 19, Employee Benefits.

2 Re-presented on classification of the Regional Aircraft line of business as a continuing operation (see note 7).

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

4 Comprises profit on disposal of businesses of £6m (2012 £103m).

Note references used above are references to notes to the Group accounts in the Annual Report 2013 that can be viewed on the Company's website.

Consolidated statement of comprehensive income

for the year ended 31 December

1 On adoption of the revised IAS 19, Employee Benefits.

2 An analysis of other reserves is provided in note 25.

Note references used above are references to notes to the Group accounts in the Annual Report 2013 that can be viewed on the Company's website.

Consolidated cash flow statement

for the year ended 31 December

1 On adoption of the revised IAS 19, Employee Benefits.

Note references used above are references to notes to the Group accounts in the Annual Report 2013 that can be viewed on the Company's website.

Consolidated balance sheet

as at 31 December

Approved by the Board on 19 February 2014 and signed on its behalf by:

I G King                       P J Lynas

Chief Executive              Group Finance Director

Note references used above are references to notes to the Group accounts in the Annual Report 2013 that can be viewed on the Company's website.

Consolidated statement of changes in equity

for the year ended 31 December

1 An analysis of other reserves is provided in note 25.

2 Restated on adoption of the revised IAS 19, Employee Benefits.

Note references used above are references to notes to the Group accounts in the Annual Report 2013 that can be viewed on the Company's website.

30. Related party transactions

The Group has a related party relationship with its directors and key management personnel (see below), equity accounted investments (note 14) and pension schemes (note 23).

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

1 Also relates to disclosures under Financial Reporting Standard 8, Related Party Disclosures, for the parent company, BAE Systems plc. At 31 December 2013, £560m (2012 £705m) was owed by BAE Systems plc and £3m (2012 £3m) by other Group subsidiaries.

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 92 to 104. Total emoluments for directors and key management personnel charged to the consolidated income statement were:

Note and page references used above refer to the Annual Report 2013 that can be viewed on the Company's website.

Cautionary statement: All statements other than statements of historical fact included in this document, including, without limitation, those regarding the financial condition, results, operations and businesses of BAE Systems and its strategy, plans and objectives and the markets and economies in which it operates, are forward-looking statements. Such forward-looking statements which reflect management's assumptions made on the basis of information available to it at this time, involve known and unknown risks, uncertainties and other important factors which could cause the actual results, performance or achievements of BAE Systems or the markets and economies in which BAE Systems operates to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. BAE Systems plc and its directors accept no liability to third parties in respect of this report save as would arise under English law. Accordingly, any liability to a person who has demonstrated reliance on any untrue or misleading statement or omission shall be determined in accordance with schedule 10A of the Financial Services and Markets Act 2000. It should be noted that schedule 10A and section 463 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.