2004 Preliminary Results Statement (24 February 2005)
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.
