Half-yearly Report 2017

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1 Half-yearly Report

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3 BAE Systems plc Half-yearly Report Results in brief Financial performance measures as defined by the Group 1 Financial performance measures defined in IFRS 2 Year Year 31 December 31 December Sales 9,565m 8,714m 19,020m Revenue 9,012m 8,278m 17,790m Underlying EBITA 945m 849m 1,905m Operating profit 865m 776m 1,742m Underlying earnings per share 19.8p 17.4p 40.3p Basic earnings per share 17.5p 12.9p 28.8p Operating business cash flow 277m (20)m 1,004m Net debt (1,741)m (2,036)m (1,542)m Order intake 10,650m 7,053m 22,443m Order backlog 42.3bn 36.3bn 42.0bn Other financial highlights Year 31 December Group s share of the net pension deficit (5.9)bn (6.1)bn (6.1)bn Dividend per share 8.8p 4 8.6p 21.3p Net cash flow from operating activities 341m 77m 3 1,229m Charles Woodburn, Chief Executive, said: BAE Systems performance in the first half was consistent with our expectations and guidance for the year. We have a sound platform for mediumterm growth underpinned by a clear and consistent strategy. Strong programme execution, technology and enhanced competitive positions will be key in driving the business forward, and we will continue to focus on efficiency and meeting our customers affordability challenges. With the expected improvement in the defence budget outlook in a number of our markets, the Group is well placed to continue to generate good returns for shareholders. Financial highlights Financial performance measures as defined by the Group 1 Sales increased to 9.6bn, up 4% on a constant currency basis 5. Underlying EBITA increased by 11% to 945m, or 5% on a constant currency basis 5. Underlying earnings per share increased by 14% to 19.8p. Operating business cash flow of 277m. Net debt of 1.7bn. Order intake increased by 3.6bn to 10.7bn and includes award of a production contract for the initial batch of three Type 26 frigates. Order backlog increased to 42.3bn after adverse exchange translation of 0.4bn. Financial performance measures defined in IFRS 2 Revenue increased to 9.0bn, up 3% on a constant currency basis 5. Operating profit increased by 11% to 865m, or 5% on a constant currency basis 5. Basic earnings per share increased by 36% to 17.5p. Net cash flow from operating activities of 341m. Other financial highlights Group s share of the pre-tax accounting net pension deficit reduced to 5.9bn (31 December 6.1bn). Interim dividend increased by 2% to 8.8p per share. 1. We monitor the underlying financial performance of the Group using alternative performance measures. These measures are not defined in International Financial Reporting Standards (IFRS) and, therefore, are considered to be non-gaap (Generally Accepted Accounting Principles) measures. Accordingly, the relevant IFRS measures are also presented where appropriate. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. 3. Re-presented to reclassify interest paid from operating to financing activities. 4. Interim dividend declared (see note 6). 5. Current period compared with prior period translated at current period exchange rates. BAE Systems Half-yearly Report 1

4 Operational and strategic highlights The full 3.7bn production contract for the initial batch of three Type 26 frigates was signed in June, with order intake of 2.8bn in the period. Received the full 1.4bn contract for the sixth Astute Class submarine from the Royal Navy in March and, in April, the fourth Astute boat, Audacious, was launched. Secured a $542m ( 417m) contract in January to provide 145 M777 ultra-lightweight howitzers to India. The first two Typhoon aircraft for Oman arrived in the Sultanate of Oman in June. Final four aircraft delivered on the Salam Typhoon programme. Typhoon support contracts in Saudi Arabia meeting contractual requirements. Secured further awards for APKWS laser-guided rockets worth $240m ( 185m). Following operational certification in February, the new San Diego dry dock accepted its first docking. The US ship repair business received orders of $511m ( 393m) in the first half of. In February, the acquisition of IAP Research, Inc. was completed. This technology insertion enhances our position in advanced weapon systems, such as the electromagnetic railgun. In June, selected as the preferred tenderer for the Jindalee Operational Radar Network upgrade programme in Australia. In July, the UK High Court ruled that the UK government has been acting lawfully in granting defence export licences to the Kingdom of Saudi Arabia. Guidance for In aggregate, we expect the Group s underlying earnings per share for to be 5% to 10% higher than full-year underlying earnings per share in of 40.3p. This outlook remains unchanged despite moving the US$ planning rate for the year from $1.25 to $1.28. Whilst there is no change to the Group-level earnings guidance, some softening in the top line of, and an anticipated second-half restructuring charge in, Cyber & Intelligence (comprising the US Intelligence & Security sector and Applied Intelligence) are expected to be offset across the rest of the business. We expect the Applied Intelligence business to be close to an underlying break-even position by the year end excluding the anticipated restructuring charge. In, we continue to expect a small reduction in net debt compared with 31 December. This guidance is based on the measures used to monitor the underlying financial performance of the Group. Reconciliations from these measures to the financial performance measures defined in International Financial Reporting Standards for the six months are provided on pages 8 to BAE Systems Half-yearly Report

5 For further information please contact: Investors Martin Cooper, Investor Relations Director Telephone: +44 (0) Media Relations Rowan Pearman, Director, Media Relations Telephone: +44 (0) Analyst and investor presentation A presentation, for analysts and investors, of the Group s first half results for will be available via webcast at 9.00am today (2 August ). Details can be found on investors.baesystems.com, together with presentation slides and a pdf copy of this report. A recording of the webcast will be available for replay later in the day. About BAE Systems At BAE Systems, our advanced defence technology protects people and national security, and keeps critical information and infrastructure secure. We search for new ways to provide our customers with a competitive edge across the air, maritime, land and cyber domains. We employ a skilled workforce of 83,500 people 1 in over 40 countries, and work closely with local partners to support economic development by transferring knowledge, skills and technology. 1. Including share of equity accounted investments. BAE Systems Half-yearly Report 3

6 Interim management report In the first half of, BAE Systems delivered a solid performance consistent with our expectations and guidance for the year. We continue to take the actions necessary to address costs and to meet our customers affordability challenges. Despite economic and political uncertainties, governments in our major markets continue to prioritise defence and security, with strong demand for our capabilities. We continue to invest in our business, our people and in the technology and skills we need to drive the business forward. With an improving outlook for defence budgets in a number of our markets, we are well placed to continue to generate good returns for shareholders. US The US Department of Defense fiscal year budget and 2018 budget proposal support the medium-term planning assumptions for our US businesses as we see the ramp up of production on a number of our long-term programmes. Our US electronics business has strong franchise positions in the high-technology areas of electronic warfare, electro-optics and Intelligence, Surveillance and Reconnaissance. As the electronic warfare system supplier on the F-35 Lightning II combat aircraft programme, we are increasing production and are also well positioned to meet increases in production output over the coming years to meet the requirements of US and international customers. The Eagle Passive Active Warning Survivability System electronic warfare upgrade for US Air Force F-15 aircraft is progressing through its engineering and manufacturing development phase. The Advanced Precision Kill Weapon System (APKWS ) laser-guided rocket is increasing production under the extant US Navy contract to meet growing demand from domestic and international customers. The Group s US-based combat vehicles business is underpinned by the Armored Multi-Purpose Vehicle, M109A7 self-propelled howitzer and Bradley upgrade programmes. The business is also experiencing US and international demand on amphibious programmes. All 16 prototypes have been delivered to the US Marine corps under the Amphibious Combat Vehicle 1.1 programme. We are one of two competitors for this programme, with down-selection expected in The contract for M777 howitzers to India under a Foreign Military Sale was signed in January. The first two guns have been shipped and are progressing through in-country testing. FNSS, the Turkish land systems business in which BAE Systems holds a 49% interest, continued to win business and holds an order book of $1.1bn ( 0.8bn) at. One of the final two commercial ships is nearing completion and being marketed for sale following the original customer s decision not to purchase the vessel. Construction of the final ship is planned to be completed in the second half of the year. The US business has not contracted for any more commercial ship-build. BAE Systems is the leading supplier of ship repair services to the US Navy and continues to adjust its workforce and facilities to meet evolving demand. Additional dry dock capacity at our San Diego shipyard became operational in February. Whilst market conditions remain highly competitive and continue to evolve, our US-based Intelligence & Security business is focused on delivering on its contracts and maintaining a high level of bid activity. The implementation of additional IT services for customers in the intelligence community has been deferred to the second half of the year due to a delay in the acceptance of an intelligence community programme. UK The result of the UK general election on 8 June has given rise to the formation of a minority government, but one for which defence and security is expected to remain a priority. Negotiations on the terms of the UK s exit from the EU will provide greater clarity as to the economic outlook in the medium term. In the air domain, Typhoon aircraft deliveries for the Royal Air Force continued alongside airframe sub-assembly deliveries to European partner nations and work under the Kuwaiti Air Force subcontract. The first two aircraft deliveries under the Oman Typhoon programme were achieved, with the 4 BAE Systems Half-yearly Report

7 remaining deliveries scheduled for the second half of and The first two Hawk trainer aircraft for the Omani Royal Air Force have completed manufacture, with delivery of all eight aircraft scheduled for the second half of. Discussions with current and prospective operators of the Typhoon aircraft continue to support the Group s expectations for additional Typhoon contract awards. However, there can be no certainty as to the timing of these orders and, in any event, any new orders are unlikely to positively impact production delivery rates for at least 24 months. The balance of customer demand for aircraft and production rates will be under constant review with adjustments made as appropriate. Typhoon s capabilities continue to be enhanced. Work on the integration of Storm Shadow, Meteor and Brimstone 2 missiles is progressing and this furthers development towards the Royal Air Force Centurion standard, which will enable transition of capability from Tornado to Typhoon as the UK Tornado fleet is scheduled to come out of service at the end of the decade. The Captor E-scan radar integration also continues. UK-based production of rear fuselage assemblies for the F-35 Lightning II aircraft is increasing, with most of the advanced manufacturing investment in place to achieve the planned production volumes. Unmanned air systems activity benefited from the announcement in by the UK and French governments of a new 2bn ( 1.8bn) project to build an unmanned combat air system demonstrator following a successful joint study phase. The feasibility and definition phase is under way, and a proposal for the first phase of the demonstrator programme was submitted in March. Funding of 16m has been received to date. In the maritime domain, there remains pressure on the Navy s near-term budgets. Submarine activity is increasing with the Astute and Dreadnought class submarines now both in production and major redevelopment of the Barrow, UK, site to deliver the Dreadnought programme under way. The first three Astute Class submarines are in operational service with the Royal Navy and the fourth, Audacious, was launched in April, with the remaining three in build. The full 3.7bn production contract for the first batch of three Type 26 frigates was signed in June, with order intake of 2.8bn in the period after order intake in previous periods for long-lead items. The cut steel ceremony was held in July. On the Queen Elizabeth Class aircraft carrier programme, assembly of the second ship is well under way and, in June, sea trials commenced on the first of the two ships. Activity to prepare the support solution in advance of the arrival of HMS Queen Elizabeth at HM Naval Base, Portsmouth, is continuing. On the River Class Offshore Patrol Vessels for the Royal Navy, revised delivery dates have been agreed with the Ministry of Defence and the first vessel, HMS Forth, will commence sea trials in the third quarter. All five ships are now in build. International In Saudi Arabia, BAE Systems continues to address current and potential new requirements as part of long-standing agreements between the UK government and the Kingdom. Our In-Kingdom Industrial Participation programme also continues apace. On the Salam Typhoon programme, the final four of the contracted 72 aircraft have been delivered. Deliveries continue under the Hawk training aircraft contracts for 44 aircraft. The Royal Saudi Air Force has achieved high utilisation and aircraft availability across its Typhoon, Tornado and training aircraft fleets. In Australia, the business is underpinned by long-term support contracts. Following the announcement in that we were one of two down-selected on the Land 400 Phase 2 Combat Reconnaissance Vehicle programme, vehicle evaluation and testing is under way. In June, we were selected as the preferred tenderer for the Jindalee Operational Radar Network upgrade programme. The MBDA joint venture has continued to win orders and, with its order book, forecasts sales growth over the medium term. In India, BAE Systems has a long-standing relationship with Hindustan Aeronautics Limited (HAL) and an order for a third batch of HAL-built Hawk aircraft for the Indian Air Force remains under discussion. BAE Systems Half-yearly Report 5

8 Cyber security Applied Intelligence achieved double-digit sales growth in the period. Following a review of market priorities and our competitive position, an increasingly focused investment programme in engineering capabilities and product development, in particular in our commercial cyber business, will support the future growth profile for the business. In the first half of the year, Applied Intelligence made a loss of 27m, but the business is expected to be close to an underlying break-even position across the year excluding an anticipated restructuring charge. Sales growth is expected to continue, as cyber security is an increasingly important part of government security and a core element of stewardship for commercial enterprises in a sophisticated and persistent threat environment. Balance sheet and capital allocation The Group s balance sheet is managed conservatively in line with its policy to retain its investment grade credit rating and to ensure operating flexibility. Consistent with this approach, the Group expects to continue to meet its pension obligations, invest in research and technology and other organic investment opportunities, and plans to pay dividends in line with its policy of long-term sustainable cover of around two times underlying earnings. Investment in value-enhancing acquisitions will be considered where market conditions are right and where they deliver on the Group s strategy. Pension schemes The Group s share of the pre-tax accounting net pension deficit reduced to 5.9bn (31 December 6.1bn). The UK triennial funding reviews commenced in April and, in conjunction with the trustees of the schemes and other stakeholders, we are currently in the process of agreeing the various technical provisions which form the basis of calculating the funding deficit. Once the deficit and the future investment strategy have been agreed, we will then enter into discussions as to the deficit funding arrangements. We aim to complete these by the end of the year and we have already engaged with the UK Pensions Regulator as we move through this process. Research and technology BAE Systems has developed some of the world s most innovative technologies and invests in research and development to generate future products and capabilities. We embrace disruptive technology, drive innovation and invest appropriately in research and development both on a self-funded basis and in conjunction with our customers, universities, and small and medium-sized enterprises. Company-funded research and development often leads to customer-funded development activity as requirements mature, with spend focused in areas such as defence and commercial electronics, military aircraft, precision weapons and cyber security. Summary Our business benefits from a large order backlog, with established positions on long-term programmes in the US, UK, Saudi Arabia and Australia. Our strategy is clear and well defined with governments in our major markets continuing to prioritise defence and security, with strong demand for our capabilities. As the overall business environment in our major markets improves and through execution of our strategy, we are well placed to maximise opportunities, deal with the challenges and continue to generate good shareholder returns. Directors and the Board With effect from 1 July, Charles Woodburn succeeded Ian King as Chief Executive. Ian King retired from the Company at the end of June having served for over 40 years, including leading BAE Systems as Chief Executive since Dividend The Board has declared a 2% increase in the interim dividend to 8.8p for the half year to. 6 BAE Systems Half-yearly Report

9 Glossary We monitor the underlying financial performance of the Group using alternative performance measures. These measures are not defined in International Financial Reporting Standards (IFRS) and, therefore, are considered to be non-gaap (Generally Accepted Accounting Principles) measures. Accordingly, the relevant IFRS measures are also presented where appropriate. Definition Financial performance measures as defined by the Group Sales Revenue including the Group s share of revenue of equity accounted investments. Underlying EBITA Underlying earnings per share Operating business cash flow Net debt Order intake Order backlog Profit for the period before amortisation and impairment of intangible assets, finance costs and taxation expense (EBITA) excluding non-recurring items*. Basic earnings per share excluding amortisation and impairment of intangible assets, non-cash finance movements on pensions and financial derivatives, and non-recurring items*. Net cash flow from operating activities excluding taxation after net capital expenditure, financial investment and dividends from equity accounted investments. Cash and cash equivalents, less loans and overdrafts (including debt-related derivative financial instruments). Funded orders received from customers including the Group s share of order intake of equity accounted investments. Funded and unfunded unexecuted customer orders including the Group s share of order backlog of equity accounted investments. Unfunded orders include the elements of US multi-year contracts for which funding has not been authorised by the customer. Financial performance measures defined in IFRS Revenue Income derived from the provision of goods and services by the Company and its subsidiary undertakings. Operating profit Profit for the period before finance costs and taxation expense. This measure includes finance costs and taxation expense of equity accounted investments. Basic earnings per share Basic earnings per share in accordance with International Accounting Standard 33, Earnings per Share. Net cash flow from operating activities Net cash flow from operating activities in accordance with International Accounting Standard 7, Statement of Cash Flows. Other financial measures Net pension deficit Net International Accounting Standard 19, Employee Benefits, deficit excluding amounts allocated to equity accounted investments. Dividend per share Interim dividend paid and final dividend proposed per share. Purpose Allows management to monitor the sales performance of subsidiaries and equity accounted investments. Provides a measure of operating profitability that is comparable over time. Provides a measure of underlying performance that is comparable over time. Allows management to monitor the operating cash generation of the Group. Allows management to monitor the indebtedness of the Group. Allows management to monitor the order intake of subsidiaries and equity accounted investments. Supports future years sales performance of subsidiaries and equity accounted investments. N/a N/a N/a N/a N/a N/a * Items that are relevant to an understanding of the Group s performance with reference to their materiality and nature (see page 10). BAE Systems Half-yearly Report 7

10 Financial performance Income statement Financial performance measures as defined by the Group 1 Sales 9,565 8,714 Underlying EBITA Return on sales 9.9% 9.7% Financial performance measures defined in IFRS 2 Revenue 9,012 8,278 Operating profit Return on revenue 9.6% 9.4% Reconciliation of sales to revenue Sales 9,565 8,714 Deduct Share of sales by equity accounted investments (1,155) (996) Add Sales to equity accounted investments Revenue 9,012 8,278 Reconciliation of underlying EBITA to operating profit Underlying EBITA Non-recurring items (4) Amortisation of intangible assets (41) (43) Financial expense of equity accounted investments (26) (15) Taxation expense of equity accounted investments (9) (15) Operating profit Net finance costs (151) (248) Taxation expense (155) (110) Profit for the period BAE Systems Half-yearly Report

11 Segmental analysis Financial performance measures as defined by the Group 1 Sales Underlying EBITA Electronic Systems 1,726 1, Cyber & Intelligence Platforms & Services (US) 1,433 1, Platforms & Services (UK) 3,913 3, Platforms & Services (International) 1,771 1, HQ (48) (36) Deduct Intra-group (329) (356) 9,565 8, Revenue Operating profit/(loss) Electronic Systems 1,726 1, Cyber & Intelligence Platforms & Services (US) 1,400 1, Platforms & Services (UK) 3,864 3, Platforms & Services (International) 1,381 1, HQ (68) (43) Deduct Intra-group (282) (312) 9,012 8, Exchange rates Average /$ / /A$ Period end /$ / /A$ Year end 31 December /$ / /A$ Sensitivity analysis Estimated impact on annual sales of a ten cent movement in the average exchange rate: $ A$ 35 BAE Systems Half-yearly Report 9

12 Sales in the first half increased to 9.6bn ( 8.7bn), up 4% on a constant currency basis 3. Some second half bias in sales is expected this year. Underlying EBITA was 945m ( 849m), 11% up on last year, or 5% on a constant currency basis 3. Revenue increased to 9.0bn ( 8.3bn), up 3% on a constant currency basis 3. Operating profit was 865m ( 776m), 11% up on last year, or 5% on a constant currency basis 3. Non-recurring items in of 4m ( nil) represents a loss on the disposal of the BAE Systems San Francisco Ship Repair business. Amortisation of intangible assets reduced to 41m ( 43m). Net finance costs were 151m ( 248m). The underlying interest charge, excluding pension accounting, and fair value and foreign exchange adjustments on financial instruments and investments, was 111m ( 114m). There was a credit in respect of fair value and foreign exchange adjustments of 44m ( charge 48m) on exchange translation of US dollar-denominated bonds. Taxation expense, including equity accounted investments, of 164m ( 125m) reflects the Group s effective tax rate for the period of 23% ( 23%). The effective tax rate for the full year is expected to be around 22% with some dependency on the geographical mix of profits. 1. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. 3. Current period compared with prior period translated at current period exchange rates. 10 BAE Systems Half-yearly Report

13 Earnings per share Financial performance measures as defined by the Group 1 Underlying earnings Underlying earnings per share 19.8p 17.4p Financial performance measures defined in IFRS 2 Profit for the period attributable to equity shareholders Basic earnings per share 17.5p 12.9p Reconciliation of underlying earnings to profit for the period attributable to equity shareholders Underlying earnings Non-recurring items (4) Amortisation and impairment of intangible assets, post tax (32) (33) Net interest expense on retirement benefit obligations, post tax (67) (69) Fair value and foreign exchange adjustments on financial instruments and investments, post tax 30 (41) Profit for the period attributable to equity shareholders Non-controlling interests 4 10 Profit for the period Underlying earnings per share for the period increased by 14% to 19.8p ( 17.4p). Basic earnings per share for the period increased by 36% to 17.5p ( 12.9p). There was a credit in respect of fair value and foreign exchange adjustments on financial instruments and investments reflecting exchange translation of US dollar-denominated bonds compared with a charge in the prior period. 1. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. BAE Systems Half-yearly Report 11

14 Cash flow 12 BAE Systems Half-yearly Report 1 Financial performance measures as defined by the Group 2 Operating business cash flow 277 (20) Financial performance measures defined in IFRS 3 Net cash flow from operating activities Reconciliation from operating business cash flow to net cash flow from operating activities Operating business cash flow 277 (20) Add back Net capital expenditure and financial investment Deduct Dividends received from equity accounted investments (32) (23) Deduct Taxation (106) (66) Net cash flow from operating activities Net capital expenditure and financial investment (202) (186) Dividends received from equity accounted investments Interest received 6 4 Acquisitions and disposals (5) Net cash flow from investing activities (169) (159) Interest paid (107) (107) Net (purchase)/sale of own shares (1) 1 Equity dividends paid (404) (397) Dividends paid to non-controlling interests (8) (6) Cash flow from matured derivative financial instruments (43) 240 Cash flow from cash collateral (5) 25 Net cash flow from financing activities 1 (568) (244) Net decrease in cash and cash equivalents (396) (326) Foreign exchange translation 176 (339) Other non-cash movements Increase in net debt (199) (614) Opening net debt (1,542) (1,422) Net debt (1,741) (2,036) Segmental analysis 1 Financial performance measures as defined by the Group 2 Electronic Systems Cyber & Intelligence Platforms & Services (US) 38 (33) Platforms & Services (UK) 107 (154) Platforms & Services (International) HQ (134) (149) Operating business cash flow 277 (20) Financial performance measures defined in IFRS 3 Electronic Systems Cyber & Intelligence Platforms & Services (US) 66 (19) Platforms & Services (UK) 186 (55) Platforms & Services (International) HQ (134) (149) Deduct Taxation 4 (106) (66) Net cash flow from operating activities

15 Operating business cash inflow was 277m ( outflow 20m), which includes cash contributions in respect of pension deficit funding, over and above service costs, for the UK and US schemes totalling 86m ( 148m). Residual advances are being consumed on the Omani and European Typhoon production contracts. Costs are being incurred against provisions created in previous years as we close out the US commercial shipbuilding programmes. There was an operating cash flow benefit from accelerated receipts of approximately 250m received in December, which reversed in the first half of. Net cash flow from operating activities 1 was 341m ( 77m). Taxation payments increased to 106m ( 66m) primarily reflecting higher payments in the US due to higher US taxable profits and timing differences. Net capital expenditure and financial investment increased to 202m ( 186m) largely reflecting purchases of software intangibles and the proceeds from the sale of investment property in the prior year. Dividends received from equity accounted investments of 32m ( 23m) is primarily receipts from MBDA, FNSS and Advanced Electronics Company. The cash outflow in respect of acquisitions and disposals in of 5m primarily reflects the purchase of IAP Research, Inc. Equity dividends paid in represents the final dividend. As a consequence of movements in US dollar and euro exchange rates, there was a cash outflow from matured derivative financial instruments of 43m ( inflow 240m) from rolling hedges on balances with the Group s subsidiaries and equity accounted investments. Foreign exchange translation primarily arises in respect of the Group s US dollar-denominated borrowing. 1. Re-presented to re-classify interest paid from operating to financing activities. 2. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. 4. Taxation is managed on a Group basis. BAE Systems Half-yearly Report 13

16 Net debt 31 December Components of net debt Cash and cash equivalents 2,360 2,769 Debt-related derivative financial instrument assets less liabilities Loans non-current (4,230) (4,425) Loans and overdrafts current (4) Net debt (1,741) (1,542) The Group s net debt at is 1,741m, a net increase of 199m from the net debt position of 1,542m at the start of the year. There are no material debt maturities before Cash and cash equivalents of 2,360m (31 December 2,769m) are held primarily for the repayment of debt securities, pension deficit funding, payment of the interim dividend and management of working capital. Going concern After making due enquiries, the directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for at least 12 months from the date of approval of this report and, therefore, continue to adopt the going concern basis in preparing the accounts. Principal risks The principal risks facing the Group for the remainder of the year are unchanged from those reported in the Annual Report. The result of the UK general election on 8 June has given rise to the formation of a minority government, but one for which defence and security is expected to remain a priority. Negotiations on the terms of the UK s exit from the EU will provide greater clarity as to the economic outlook in the medium term. The Group s principal risks are detailed on pages 60 to 63 of the Annual Report, and relate to the following areas: defence spending; government customers; international markets; competition in international markets; laws and regulations; contract risk and execution; contract cash profiles; pension funding; information technology security; and people. 14 BAE Systems Half-yearly Report

17 Segmental performance: Electronic Systems Electronic Systems, with 14,200 employees 1, comprises the US and UK-based electronics activities, including electronic warfare systems, 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. Financial performance Financial performance measures as defined by the Group 2 Financial performance measures defined in IFRS 3 Year Year 31 December 31 December Sales 1,726m 1,443m 3,282m Revenue 1,726m 1,443m 3,282m Underlying EBITA 257m 209m 494m Operating profit 247m 200m 474m Return on sales 14.9% 14.5% 15.1% Return on revenue 14.3% 13.9% 14.4% Operating business cash flow 118m 105m 469m Order intake 1,848m 1,470m 3,322m Order backlog 5.1bn 4.7bn 5.2bn Cash flow from operating activities 167m 138m 568m Sales increased by 5% to $2.2bn ( 1.7bn). There is a second-half weighting of deliveries of F-35 electronic warfare systems, Advanced Precision Kill Weapon System (APKWS ) laser-guided rockets and Terminal High-Altitude Area Defence systems. Return on sales was 14.9% ( 14.5%). Cash conversion of underlying EBITA in the first half of the year reflects a build-up of inventory ahead of stronger sales expected in the second half and timing of receivables. Order backlog of $6.6bn ( 5.1bn) is broadly unchanged from the start of the year. 1. Including share of equity accounted investments. 2. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. Operational performance Electronic Combat BAE Systems has sustained its leadership position in the US electronic warfare market and production is ramping up across a number of programmes. Low-Rate Initial Production hardware deliveries for the F-35 Lightning II programme continue with Lot 10 and 11 deliveries. We have received initial Lot 12 funding with an anticipated final award value in excess of $300m ( 231m). We have also received a Request for Proposal for a potential block buy encompassing multiple lots. The business is under contracts, from Boeing and Warner Robins Air Logistics Complex, totalling more than $1.0bn ( 0.8bn) to install the Digital Electronic Warfare System on select new F-15 aircraft, upgrade existing F-15 aircraft, and to provide spare units and modules for an international customer. The programme remains on schedule. Following our selection by Boeing in 2015 to develop and manufacture the next-generation digital electronic warfare system for the US Air Force s Eagle Passive Active Warning Survivability System programme to upgrade up to 400 F-15 aircraft, we are currently executing the $146m ( 112m) engineering and manufacturing development contract. In January, we were awarded a $67m ( 52m) modification to a competitively awarded contract for an electronic warfare system for the US Air Force Special Operations Command s fleet of C-130J aircraft. The total value of the contract, including all options, could exceed $300m ( 231m). In the multi-billion dollar electronic warfare market, this award extends our position to include our capabilities on large, fixed-wing aircraft. We have been awarded an $81m ( 62m) contract for the Network Tactical Common Data Link programme to provide the US Navy with the ability to simultaneously transmit and receive real-time intelligence, surveillance and reconnaissance data across disparate networks. BAE Systems Half-yearly Report 15

18 Due to the sensitive nature of electronic combat systems and technology, many of our programmes are classified. As a world leader in electronic warfare, we continue to experience growth in these increasingly important areas. Survivability, Targeting & Sensing Our Advanced Precision Kill Weapon System (APKWS ) laser-guided rocket is experiencing growing demand, with deliveries exceeding 9,000 units to date. In addition to expanding its use in the US military, the system is generating strong international attention, with 17 nations expressing interest. In the first half of the year, orders totalling $240m ( 185m) were received. We continue to perform well on the Terminal High-Altitude Area Defence programme and expect to receive a further production contract for Lots 9 and 10 in the second half of the year. On the $249m ( 192m) Common Missile Warning System Indefinite Delivery, Indefinite Quantity contract, we continue to deliver to schedule. Under the five year, $434m ( 334m) Enhanced Night Vision Goggle III and Family of Weapon Sights Individual Indefinite Delivery, Indefinite Quantity contract, we are now progressing the production qualification testing. On the US Army s Family of Weapon Sights Crew Served programme, a seven-year contract with a potential value of up to $384m ( 296m), we are executing to plan, completing the Preliminary Design Review and Component Critical Design Review in the first half of the year. The LiteHUD head-up display has been selected by critical launch customers for integration on multiple platforms, including the Textron Scorpion jet. Intelligence, Surveillance & Reconnaissance Since winning the Geospatial Data Services Foundational GEOINT Content Management programme in 2014, we have been awarded orders valued at $180m ( 139m). The business is meeting all delivery requirements in assisting US intelligence community customers with the development of advanced geospatial intelligence data collection and processing solutions. As a provider of signals intelligence capabilities for the US Army and other US Department of Defense customers, we are executing the $132m ( 102m) Tactical Signals Intelligence Payloads programme for the US Army s Gray Eagle unmanned aircraft. Work continues on the US Navy s P-8A Poseidon maritime surveillance aircraft programme to provide state-of-the-art processing capabilities. The programme could be worth $1.2bn ( 0.9bn) over its life. Controls & Avionics BAE Systems is a major supplier of flight controls, and cabin and flight deck systems. The development of the integrated flight control electronics and remote electronic units for Boeing s next-generation 777X aircraft remains on schedule and systems integration testing is progressing to plan. On the Boeing 737 MAX aircraft, a successful first flight was completed on the MAX9 with our spoiler controls, flight deck systems and utilities electronics. The development of our civil active inceptors is progressing, with Gulfstream G500 and Embraer KC390 aircraft flight tests, and we received industry recognition with the Aviation Week Laureate Award for Technology. FADEC Alliance, a joint venture between FADEC International (our joint venture with Safran Electronics & Defense) and GE Aviation, is delivering on contracts to provide the full authority digital engine controls for: the Leap engine for the Airbus A320neo, the Boeing 737 Max and the Comac C919; the Passport 20 engine for the Bombardier Global 7000/8000; the GE9x engine for the Boeing 777X; and a new generation of advanced turboprop engines. On the F-35 Lightning II programme, we are in production for vehicle management computer and active inceptor system equipment for Low-Rate Initial Production Lot 10 and are now under contract for Lot 11. Power & Propulsion We expect to deliver another 1,000 hybrid and electric transit bus systems in. As the transit bus market continues to shift towards more electric bus systems, we have expanded our product portfolio to include a hybrid-electric system capable of emission-free driving up to half of the time and an 16 BAE Systems Half-yearly Report

19 all-electric system providing zero-emission travel all of the time. Transit operators in major cities, such as Seattle, Boston, Quebec, London and Paris, are adopting our electric technologies to meet their green initiatives. Looking forward The US Department of Defense fiscal year budget and 2018 budget proposal support the medium-term planning assumptions for our US businesses as we see the ramp up of production on a number of our long-term programmes. Electronic Systems is well positioned to address current and evolving priority programmes from its strong franchise positions in electronic warfare, electro-optics and Intelligence, Surveillance and Reconnaissance. Electronic Systems has a long-standing programme of research and development, and its focus remains on maintaining a diverse portfolio of defence and commercial products and capabilities for US and international customers. The business expects to benefit from its franchise positions, particularly on the F-35 Lightning II and F-15 upgrade programmes, and its ability to apply innovative technology solutions that meet defence customers changing requirements. In the commercial aviation market, Electronic Systems technology innovations are enabling the business to renew long-standing customer positions and to compete for and win new business. BAE Systems Half-yearly Report 17

20 Segmental performance: Cyber & Intelligence Cyber & Intelligence, with 11,400 employees 1, comprises the US-based Intelligence & Security business and UK-headquartered Applied Intelligence business, and covers the Group s cyber security, secure government, and commercial and financial security activities. Financial performance Financial performance measures as defined by the Group 2 Financial performance measures defined in IFRS 3 Year Year 31 December 31 December Sales 923m 833m 1,778m Revenue 923m 833m 1,778m Underlying EBITA 35m 18m 90m Operating profit 20m 59m Return on sales 3.8% 2.2% 5.1% Return on revenue 2.2% 0.0% 3.3% Operating business cash flow 46m 33m 83m Order intake 940m 874m 1,885m Order backlog 2.2bn 2.2bn 2.4bn Cash flow from operating activities 56m 43m 106m Sales were almost unchanged on a constant currency basis 4 at $1.2bn ( 0.9bn). Sales in the Intelligence & Security business were down 6%. Take up on the programme to provide additional IT services to the intelligence community is biased to the last quarter. Growth in the Applied Intelligence business was 21%, benefiting from increases in all three divisions, in particular in UK Services and International Services & Solutions. Return on sales was marginally improved at 3.8% ( 2.2%). The loss in the first half at Applied Intelligence was 27m, only slightly lower than last half year. We are in the process of refocusing both the product portfolio and market priorities in the Commercial Solutions division. Cash flow conversion continues to improve on reduced working capital requirements in the Applied Intelligence business. Order backlog reduced slightly to $2.9bn ( 2.2bn). In the Intelligence & Security business, order backlog reduced on trading out of certain longer-term classified contracts. 1. Including share of equity accounted investments. 2. For alternative performance measure definitions see glossary on page International Financial Reporting Standards. 4. Current period compared with prior period translated at current period exchange rates. Operational performance Intelligence & Security Global Analysis & Operations In Full Motion Video and Intelligence, Surveillance and Reconnaissance analysis, we secured a new four-year, $58m ( 45m) contract to increase the number of expert full-motion video analysts we have supporting the intelligence community. We are pursuing additional task orders to further expand our work in motion-imagery analysis, analytic training, multi-media support and research under a new Indefinite Delivery, Indefinite Quantity contract with an estimated value of more than $400m ( 308m). The US Department of Treasury awarded BAE Systems a position on its programme to support the Office of Terrorism and Financial Intelligence in safeguarding the country s financial system against national security threats. The maximum lifecycle value of all task orders to be awarded under the programme is estimated at $135m ( 104m). We are fulfilling the second year of a five-year contract with an estimated ceiling value of $75m ( 58m) to provide the US Army with geospatial intelligence data analysis support services, and our experts are executing on the third year of a five-year contract worth up to $143m ( 110m) to provide counterterrorism analysis services to the US government. 18 BAE Systems Half-yearly Report

21 Integrated Electronics & Warfare Systems We have nearly 1,000 employees working on a number of Strategic Weapon System programmes on contracts that cover multiple classes of US and UK submarines, as well as the US Air Force Intercontinental Ballistic Missile Integration Support Contract. We are executing on the first year of a five-year, sole-source contract worth up to $368m ( 283m) to provide systems engineering services to the US Navy s Strategic Systems Programs office. The programme assists with weapons system integration and provides test engineering services and special test equipment for weapons systems on board US Ohio and UK Vanguard Class submarines, as well as future Ohio Class replacement and UK Dreadnought Class submarines. The US Air Force issued a contract modification to the Integration Support Contract to increase the total ceiling value from $918m ( 707m) to $1,011m ( 778m). In addition to overall programme management and systems sustainment, our work on the contract includes cyber security assessment and defence. We were selected for a position on a new nine-year Indefinite Delivery, Indefinite Quantity contract to support the US Army in developing next-generation technologies for space, high-altitude and missile defence. IT Solutions We are executing on several task orders to provide IT services to high-priority US government agencies under a ten-year, single-award Indefinite Delivery, Indefinite Quantity contract with a potential value of over $1.0bn ( 0.8bn). The total value of the task orders awarded to date is $270m ( 208m). The implementation of additional IT services for customers in the intelligence community has been deferred to the second half of the year due to a delay in the acceptance of an intelligence community programme. We received a contract increase of $160m ( 123m) extending the period of performance of a major software development and IT support contract for a US intelligence community customer. We are executing on the first year of a five-year, $58m ( 45m) task order awarded by the Defense Intelligence Agency to design, develop, engineer, install and sustain IT resources. Work is under way on the first year of a new five-year, $49m ( 38m) contract with the US Air Force Research Laboratory to develop, deploy and maintain cross domain solutions for safeguarding the sharing of sensitive information between government networks. Applied Intelligence The business has delivered revenue growth driven by continued investment in product development, sales and marketing. We have continued to build our cyber skills, global engineering and delivery capabilities, including launching our Security Operations Centre and client-facing nerve centre in Fort Lauderdale, Florida, to deliver Managed Security Services to clients in North America. Our work in supporting counter-terrorism efforts to analyse intelligence that helps predict and prevent physical and cyber attacks remains highly relevant in today s environment. Commercial Solutions We have continued to grow our counter-fraud and regulatory compliance business with further contract wins for NetReveal, including: an insurance claims fraud solution for the Irish operations of Zurich Insurance; a solution for a leading insurance firm in the US to identify suspicious activity and protect against identity fraud and theft; and a multi-year contract to deliver compliance services and support for a global bank based in Asia-Pacific. As part of our regular commercial product review cycle, we are refocusing our threat analytics capability from being sold as a software product (CyberReveal ) towards Managed Detection and Response services as part of our Managed Security Services portfolio, reflecting how commercial customers are looking to buy their cyber defence solutions. We have announced a partnership with O 2 to protect its customers from cyber crime, under which we will provide O 2 s enterprise customers with access to Managed Security Services, as well as threat intelligence, security testing and cyber incident response services. BAE Systems Half-yearly Report 19

22 UK Services The business continues to be a key supplier to national security agencies in the UK, with a range of services contracts won in support of a variety of national security intelligence and cyber defence programmes. Demand for cyber services from large enterprises has continued, with contract awards including the provision of secure IT transformation services for a large financial institution. The business has won a number of contracts to provide data and digital services, including: being selected by a UK telecommunications operator to undertake an assessment against the incoming EU General Data Protection Regulation; being selected by one of the world s largest building societies to help develop and implement an Enterprise Data Architecture strategy; and undertaking a technology transformation programme for a central UK government department. International Services & Solutions We have seen continued demand in Asia-Pacific and the Middle East for national security intelligence and national-scale cyber defence capabilities. A contract was secured to provide cyber defence capabilities for a Middle Eastern customer and there were a number of cyber consultancy contract wins with government agencies in Australia. The first half of the year saw go-live of the most complex data retention programme delivered by Applied Intelligence, for a global telecommunications operator based in Asia-Pacific, based around our DataRetain solution. Looking forward Intelligence & Security The outlook for the US government services sector is stable, although market conditions remain highly competitive. The Intelligence & Security business has continued to reduce costs to address government budget pressures, whilst pursuing growth opportunities, particularly in critical, mission-focused areas. Applied Intelligence Following a review of market priorities and our competitive position, an increasingly focused investment programme in engineering capabilities and product development, in particular in our commercial cyber business, will support the future growth profile for the business. Sales growth is expected to continue, as cyber security is an increasingly important part of government security and a core element of stewardship for commercial enterprises in a sophisticated and persistent threat environment. The business continues to migrate towards a multi-year managed service and subscription-based model, providing enhanced predictability of revenues, and grow further the order backlog and pipeline of opportunities from commercial and government customers in North America, Europe, Asia-Pacific and the Middle East. 20 BAE Systems Half-yearly Report