BAE Systems has performed well against its objectives in 2005. Financial results have been delivered in line with plan and further significant steps have been taken to implement the Company’s strategy. In particular, the acquisition of United Defense builds on the Company’s strong defence technology business in the United States and complements its established position as the largest defence company in the UK and Europe.

The United Defense acquisition has elevated BAE Systems to the second largest supplier in the global land systems market. The former United Defense activities have been integrated with BAE Systems Land Systems, which comprised the former RO Defence and Alvis activities including Hagglunds. Integration of these operations has resulted in a single US headquartered global land systems business with operations in the US, UK, Sweden and South Africa.

In 2005, the Company has continued to improve performance through a combination of good project execution, cost and productivity improvements within the business operations together with the benefit of actions over recent years to eliminate inappropriate risk and improve returns, especially in its UK Ministry of Defence (MoD) Programmes business.

Sales increased 17% from £13,222m to £15,411m. The growth reflects sales of £789m from the acquired United Defense business together with the benefit of 2004 acquisitions and increased deliveries across the majority of the Group. This was partially offset by the impact of the reduced Saab shareholding.

EBITA increased 16% from £1,016m to £1,182m. EBITA has been reduced by rationalisation provisions of £89m and is stated after United Defense acquisition accounting adjustments of £44m. Losses at Regional Aircraft amounted to £95m.

Underlying earnings per share from continuing operations for 2005 increased by 29.3% to 22.5p compared with 2004. Basic earnings per share in accordance with IAS 33 from continuing operations increased by 28.9% to 18.3p (2004 14.2p).

The outlook for the UK Programmes business is now good. Following agreement on the way forward for the Typhoon programme, it is now making a significant contribution to the Company’s performance. Other UK platform programmes such as the Type 45 destroyer,Nimrod MRA4, Hawk and Astute submarine are also expected to progress to make good contributions when they transition from design to production.

Alongside the good operational execution now being delivered we continue to strive to further embed a high performance culture across the Company.

The formation of the Centre for Performance Excellence will help ensure consistency of performance measurement and provide leadership and focus for the sharing of best practice across the Company.

In December, the Company welcomed the publication by the UK government of a Defence Industrial Strategy following extensive consultation with industry. The strategy paper recognises the need for government and industry to work in partnership to secure the best technologies to meet the needs of the UK’s armed forces. The paper also identifies the skills and capabilities required to equip and support the UK armed forces whilst ensuring the UK maintains a world class defence industry. BAE Systems recognises that implementing the Defence Industrial Strategy sets challenges for both the MoD and industry.

Addressing pension deficits is a challenge. Reduced discount rates used to value scheme liabilities and the need to address changes in assumptions for increased life-expectancy combined to create a significant deficit in the funding of the Company’s pension schemes.

The Company has recently finalised a plan for the largest of its funds, the Main Scheme. The plan addresses the deficit through increased contributions and benefit concessions from employee scheme members and contributions of cash and property assets from the Company. These actions enable the Company to maintain this defined benefit pension scheme for existing scheme members, at a cost acceptable to the Company, eliminating the substantial funding deficit and introducing flexibility into the benefit structure to self fund any further increases in employee longevity going forward.

A continuing success for the Company is the provision of defence support solutions. The Company has a large and growing business providing support for armed forces and government agencies. Through-life support and upgrades for in-service defence equipment is expected to become an increasingly important activity for BAE Systems as air, naval and land sector platforms are expected to remain in service for many decades and require progressive upgrades in capability with advances in technology.

In partnership with the MoD’s Defence Logistics Organisation (DLO) the Company has continued to develop and grow its support solutions activities for the UK’s armed forces. The successful delivery of cost savings, together with improved equipment availability across a number of pilot air systems activities, has enabled the Company to broaden the scope of its DLO support activities to the UK land sector. Further support opportunities have been identified with the potential to deliver further cost savings and improved system availability for the UK customer and to deliver future profitable growth for the benefit of shareholders.

BAE Systems continues to provide extensive support in Saudi Arabia, principally to the Royal Saudi Air Force, building on a relationship spanning several decades. BAE Systems employs some 4,600 people within the Kingdom on wideranging activities including flying training and support for aircraft previously supplied. The Company has recently invested in facilities to enhance in-kingdom capability for the maintenance and sustainment of capability of in-service aircraft.

In December 2005, the governments of the Kingdom of Saudi Arabia and the UK signed an Understanding Document, intended to establish a greater partnership in modernising the Saudi Arabian Armed Forces and developing close service-to-service contacts especially through joint training and exercises. Under the terms of the Understanding, the two governments recognise the requirement to provide enhanced capabilities to existing military assets and ensure that they can be supported by local industry. It is also intended that Typhoon aircraft will replace Tornado Air Defence Variant aircraft and other aircraft in service with the Royal Saudi Air Force. The details of these arrangements are confidential.

Support is also now a substantial component of the Company’s business in the US. Following the acquisition of United Defense, its marine repair business has been added to the Company’s established US Navy and federal systems support activities to form an integrated support solutions business in the US.

Drawing on the depth of experience now residing on both sides of the Atlantic, a cross-company support solutions council has been formed to share best practice.

A number of actions have been taken to rationalise the Company’s portfolio of activities in Europe and to manage nonstrategic businesses for optimum value.

In March 2005, BAE Systems agreed a reduced involvement in marketing the Gripen combat aircraft and reduced its equity interest in Saab AB from 34.2% to 20.5%.

Under the Eurosystems transaction, completed in April 2005, the AMS joint venture was restructured with BAE Systems acquiring the UK based operations of AMS and Finmeccanica acquiring the Italian operations. In a related transaction BAE Systems sold its UK based sensor systems and electronic warfare avionics activities to Finmeccanica. The agreement includes the deferred sale of a retained 25% interest in the resulting enlarged avionics business, Selex. The wholly owned UK activities of the former AMS business have been combined with BAE Systems’ other C4ISR activities to form Integrated System Technologies (Insyte).

The integration of systems into digital networks, or Network Enabled Capability (NEC), is transforming defence capabilities.

Insyte is working in partnership with the UK MoD, to deliver transformational capabilities to the UK armed forces through the application of emerging NEC technologies.

The sale of Atlas Elektronik, the naval electronics business based in Germany, jointly to ThyssenKrupp and EADS was agreed in December 2005 and is expected to complete in the first half of 2006, subject to regulatory approval.

BAE Systems has valuable interests in the MBDA guided weapons joint venture and Airbus.

MBDA continues to perform well with good order intake. A further step in the consolidation of the European guided weapons industry was achieved with the agreement to fully integrate the German missile business LFK into MBDA.

Airbus produced another strong financial performance despite a continued high level of investment in new product development. Order intake was substantially ahead of plan, benefiting from strength in a number of markets including China, India and the Middle East. Aircraft demand has also been stimulated by the enhanced operating economics of new products such as the A380 and A350 airliners now under development.

Cash inflow from operating activities was £2,099m (2004 £2,350m).

Operating business cash flow was £1,937m (2004 £2,134m). Good conversion of EBITA to operating cash flow was experienced across much of the Group together with the cash benefits of securing advance payments at Land & Armaments and programme debt reduction at Customer Solutions & Support.

Free cash flow, after interest, preference dividends and taxation,was £1,758m (2004 £1,924m).

The net cash outflow on acquisitions and disposals was £1,548m. In addition, debt acquired on acquisitions was £288m. During the year the Group completed the acquisition of 100% of the issued share capital of United Defense Industries, Inc, in the US, for a total consideration of £2,205m. In addition the Group completed the Eurosystems transaction resulting in a net cash inflow of £402m.

Finance costs, including the Group’s share of the finance costs of equity accounted investments,were £215m (2004 £176m). The underlying interest charge of £210m (2004 £200m) was increased by a net charge of £5m (2004 gain £24m) arising from pension accounting, marked to market revaluations of financial instruments and foreign currency movements.

The net debt of the Group at 31 December 2005 was £1,277m, an increase of £326m from £951m at the start of the year, after adjusting for IAS 32 and IAS 39. Interest cover based on EBITA decreased from 5.8 times to 5.5 times.

The Group’s effective tax rate for the year was 29% (2004 32%).

The tax rate in the 2006 financial year is expected to be in line with 2005.

The Board is recommending a final dividend of 6.3p per share (2004 5.8p), bringing the total dividend for the year to 10.3p per share (2004 9.5p) an increase of 8.4%. The proposed dividend is covered 2.2 times by earnings from continuing operations (2004 1.8 times).

In summary, BAE Systems has had a good year, delivering a strong set of financial results and meeting its overall objectives for 2005.

BAE Systems is successfully executing its strategy and has further strengthened its position in the US, restructured its portfolio of business interests in Europe and, through a combination of factors now has a much enhanced outlook for the business in the UK. Shareholder value is being delivered by the premier transatlantic defence and aerospace company.

The Company is now very well balanced, not overly dependent on any one sector but generating good returns for shareholders from a broad base of operations in the world’s key defence and aerospace markets.

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I am pleased to report that BAE Systems has made further good progress in the first half of 2005.

We have grown the company’s position in the US and refocused our business interests in Europe. In particular, the acquisition of United Defense has firmly established BAE Systems as a leading supplier of defence systems in the United States.

We are now also seeing the benefits of the work over recent years to eliminate inappropriate risk and improve returns from our major programmes business with the UK Ministry of Defence.

In addition to the recovery in our UK businesses we have built a strong position in the US; the world’s largest defence market. Through a combination of organic growth and a series of strategic acquisitions the company will have grown the sales of its US business at a compound annual rate of 27% between 2000 and the end of 2005.

This successful implementation of our strategy is now benefiting the company’s operational performance, strengthening our position as the premier transatlantic aerospace and defence company and underpinning the plan for future growth.

BAE Systems has come a long way in recent years. Shareholders are now benefiting from our strong portfolio of businesses with good profitable growth.

Three new non-executive directors have been appointed to the Board. In June,Peter Weinberg, a senior director of Goldman Sachs Inc. and former CEO of Goldman Sachs International, joined the Board. Mr Weinberg has dual US and UK citizenship.

I am also pleased to welcome Philip Carroll and Roberto Quarta who have joined the Board with effect from today. Mr Carroll, a US citizen, is the former chairman and chief executive officer of Fluor Corporation and the former president and chief executive officer of Shell Oil Company Inc. Mr Quarta is chairman and was formerly chief executive of BBA plc and is a partner of the private equity firm Clayton, Dubilier & Rice. Based in the UK, Mr Quarta was born in Italy and is a naturalised US citizen.

Together these appointments bring a wealth of relevant experience from a US, UK and international perspective and will make a significant contribution to furthering BAE Systems strategy of being the premier transatlantic aerospace and defence company.

The improved performance reflected in the financial results for the first half, together with the improving growth outlook, have enabled the Board to declare an increased interim dividend of 4.0p. As we go forward we are all committed to improve our performance in everything we do and to continue the clean execution of our strategy.

Dick Olver Chairman

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BAE Systems performed well in 2004, both in delivering good financial results and executing actions that will underpin performance improvement over the longer term.

Profit before interest increased to £1,013m from £980m in 2003, on sales of £13,479m (2003 £12,572m). Adjusted earnings per share2 for 2004 increased by 8.4% to 18.0p compared with 2003.

These earnings were underpinned by strong cash generation with operating cash inflow totalling £2,071m (2003 £836m).

The weakening US dollar and Euro reduced reported sales and profit on translation by £424m and £31m respectively.

After deducting goodwill amortisation and impairment and exceptional items, the loss per share was 16.0p compared with a loss per share of 0.5p in 2003. This was primarily due to an increased charge for goodwill impairment.

The signing of contracts for the next, Tranche 2, phase of the Eurofighter Typhoon programme established a way forward for the programme. This completes the actions taken over recent years to address excessive risk in our UK Ministry of Defence programmes businesses.

These actions will result in a sustainable growth in profitability in an area of our business that, in the past, had overshadowed the performance of the majority of the company’s portfolio.

The 2.2% return on sales for Programmes continues to reflect the substantial sales generating no profit contribution from the Nimrod and Astute programmes. In addition, a higher level of sales on Typhoon was recognised with no profit. Increased Type 45 destroyer sales were recognised at zero margin, with the programme at an early stage of maturity.

Positive contributions to profit were made by Underwater Systems and sustaining engineering activity on Tornado and Harrier. The F-35 Joint Strike Fighter (JSF), a cost plus award fee systems design and development contract, also made a positive contribution.

BAE Systems has the leading naval systems business in the UK. Like its UK air systems activities,the performance of the naval business in recent times has been affected by the company having agreed, in prior years, to contracts for programmes with excessive risk.

In addition, over many years, the UK naval shipbuilding industry has suffered from a lack of strategic planning and the company commenced an evaluation of the options for its shipyards. Whilst that evaluation was underway the company welcomed the UK government initiative to determine a strategy for naval shipbuilding in the UK, in dialogue with all industry participants. BAE Systems welcomes this dialogue as a real opportunity to secure a future for the UK’s naval shipbuilding capabilities that will deliver value for money to the UK government and an acceptable return to shareholders of the companies concerned.

CS&S continued to perform well and delivered on all its key targets in 2004. The benefit to the Al Yamamah programme of the high oil price has flowed through to operating cash flow.

Building on the company’s record in growing support business in the air sector, BAE Systems identified a substantial support opportunity in the land sector. The acquisition of Alvis plc was a key step in delivering a land sector support strategy.

Support solutions lie at the heart of BAE Systems relationship with the Kingdom of Saudi Arabia. BAE Systems has a long and successful history providing integrated support to the Saudi armed forces. The company has for some time adopted a strategy to integrate progressively greater local Saudi content in the programme.

Consistent with this in-Kingdom strategy BAE Systems has invested in aerospace and defence companies in Saudi Arabia which will enable the company to work in partnership with Saudi investors whilst undertaking aircraft and avionics maintenance and upgrade work in-Kingdom. Whilst this trend to greater indigenous content will reduce margins, these partnerships will provide significant technology and employment benefits to the Kingdom and long-term value for BAE Systems.

The North America business produced organic sales growth of 12% with 8.4% return on sales. In sterling terms, sales and profits were reduced by the translation effect of the weakening dollar by £334m and £25m respectively. The order book increased to $4.9bn, resulting from successful re competes, new contract wins and acquisitions, pro viding a good foundation for future organic sales growth.

In the US, five acquisitions were completed. The largest transaction, DigitalNet, ele vates BAE Systems to rank as a top 10 provider of IT systems support to the US Department of Defense and other government agencies. With these acquisitions BAE Systems now generates annualised sales of some $5.6bn in its North America business and now employs over 27,000 people across the US.

Profitability in International Partnerships continued to improve. All of the joint venture companies contributed to that improvement.

Good progress was also made in re-focusing our joint businesses in Europe.

Recognising the complexity of the earlier proposed Eurosystems transaction with Finmeccanica a simpler model has now been agreed. The revised agreement, signed in January 2005, provides for BAE Systems to take full ownership of the UK activities of the former AMS joint venture in exchange for the group’s existing 50% of the Italian activities and a cash equalisation payment. The group has also agreed to sell to Finmeccanica its defence communications business and certain avionics activities comprising principally the UK-based airborne radar and electronic warfare business.

When completed, this transaction will generate substantial cash and improve management control and business performance in the strategically important field of network-enabled capability.

Airbus continues to build upon the strong performance of 2003 despite a number of challenges in the current commercial aircraft market and against a backdrop of rising fuel prices and adverse US dollar exchange rates.

Driven by increasing demand from the low cost carrier sector,Airbus secured net new orders for a further 366 commercial aircraft, which represents a 57% market share of orders placed during 2004.

Group operating cash inflow was £2,071m (2003 £836m). Net capital expenditure and financial investment was £256m (2003 £248m) including increases in capital expenditure together with the investment in aerospace and defence companies in Saudi Arabia (2003 included the initial £74m investment in Alvis plc).

Group operating business cash inflow3 was £1,884m compared with £625m in 2003. Cash flow improvements were achieved at Programmes as customer stage payments were received on the renegotiated Typhoon contract and the Indian Hawk contract. CS&S cash flow benefitted from the strong oil price during 2004. North America cash flow was also strong. Commercial Aerospace included an outflow on the regional aircraft recourse provision, almost entirely offset by another strong cash performance by Airbus despite product development and capital expenditure on the A380 programme. Avionics cash outflows were mainly due to some increase in working capital on Typhoon equipment and cash outflows on prior year rationalisation programmes.

Free cash inflow, after interest and preference dividends and taxation, was £1,733m compared with £562m in 2003.

Cash outflow on acquisitions was £550m comprising cash consideration of £663m less cash, net of overdrafts, acquired of £113m. In addition, loans acquired were £80m.

Foreign currency translation movements in net debt of £57m primarily comprises the benefit of translating US dollar denominated debt at the closing rate of £1/$1.932.

Net cash was £5m (2003 net debt £870m) at the end of the year.

The net interest charge decreased to £207m from £220m in 2003. This reflected lower net interest payable on loans, overdrafts and financial instruments of £110m (2003 £122m) due to lower gross borrowings when compared with 2003 and net present value adjustments on aircraft lease provisions of £28m (2003 £41m) and other net present value adjustments of £11m (2003 £7m). There was also a charge of £28m (2003 £24m) relating to a net present value adjustment to aircraft financing liabilities due to changes in the expected timing of receipts and payments. Share of net interest of joint ventures was £30m (2003 £26m). Interest was covered 4.9 times by earnings2 (2003 4.5 times).

The group has continued to account for retirement benefits under SSAP 24. The pension charge for the year on UK and US defined benefit schemes, excluding the group’s share of pension costs charged by joint venture companies, on a SSAP 24 basis was £192m (2003 £127m). FRS 17 requires the group to calculate its net pension liabilities, valuing assets and liabilities at a point in time rather than matching expectations of assets and liabilities over time. The deficit on UK and US schemes calculated on an FRS 17 basis was £3.0bn after tax (2003 £2.1bn after tax). Investment returns were better than expected, but were offset by an increase in liabilities due to changes in mortality assumptions and a reduction in real discount rates during 2004.

Full adoption of FRS 17 would have resulted in a charge to operating profit of £151m (2003 £172m), a reduction of £41m (2003 increase of £45m) when compared with the pension charge on a SSAP 24 basis. Reserves would have been reduced by £3.3bn (2003 £2.4bn).

The effective rate of tax was 29% (2003 30%) which compares with the UK corporation tax rate of 30% for the calendar year 2004 (2003 30%) and remains our planning rate for the foreseeable future.

The Board is recommending an increased final ordinary dividend of 5.8p per share, making a total of 9.5p for the year. At this level the annual dividend is covered 1.9 times by earnings2 (2003: 1.8 times).

Lord Hesketh will retire from the board of directors immediately after the company’s AGM to be held on 4 May 2005. BAE Systems is greatly indebted to Lord Hesketh for his unflagging support over the last 11 years. This period has seen the organisation develop from being a European aerospace company into a global player in defence systems integration. His knowledge of the realities of politics coupled with a genuine enthusiasm for engineering has given him a unique understanding of the business and ensured that his contribution has always been much valued. It is for this reason that the group has asked him to remain on the Board until the AGM to assist the Board in choosing suitable additions to the Board and he has kindly agreed to do so.

The last few years have seen our business turned around, with clear management targets set and consistently delivered. Scale is being achieved in the US and our business with the UK MoD has been de-risked to acceptable and manageable levels. We look forward with confidence to delivering growing returns for our shareholders in the future.

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