Major developments in 2007

In June, we completed the sale of our 24.5% interest in Devonport Management Limited (DML) to Babcock International. Long-term involvement in DML was not core to our strategy and the sale, part of a wider rationalisation in the ownership of the defence supply industry, represented excellent value to shareholders.

Towards the end of the year, Balfour Beatty Utilities and Balfour Beatty Power Networks were merged to form Balfour Beatty Utility Solutions. Subsequent reorganisation has created a structure designed to optimise the service levels which the business offers to its UK utility customers.

Our markets

In UK civil and ground engineering, regional markets are showing the first signs of real growth for some time, particularly in Scotland and the south-east. Prospects for the major project business include major opportunities on Crossrail, M25 widening and the Olympics. The UK utilities market, conditioned as it is by the five-year regulatory cycle, is largely fixed for the next 2½ years and remains strong. The market for professional and technical services continues to grow in a number of sectors.

Outside the UK, the Dubai market continues to grow strongly, as do those in Macau and Singapore in South-East Asia. Markets in Hong Kong and the US are relatively flat, but continue to offer significant opportunity.

Our 2007 performance

Profits for the year improved substantially, with particularly strong progress in the UK from the regional civil engineering business and the utility businesses and significantly improved performance in South-East Asia, Dubai and the United States.

Review of operations

Professional and technical services

Balfour Beatty Management continued to make good progress in 2007 with another strong performance and significant expansion. By the end of the year the company employed over 500 professional and technical staff and had increased its order book by 50%. The market for professional and technical services continued to be buoyant, in particular in the area of sophisticated, blue-chip infrastructure owners.

Two small acquisitions were made during the year – a commercial development specialist based in London and a 130-strong commercial services business based in the north-east of England.

The company now leads and co-ordinates a range of the Group’s major long-term contract activities including the overhead line and cabling alliance and the Greater Manchester Gas Alliance for National Grid, the Group’s work as complex build integrator for BAA and the Group’s major facilities management contract for British Energy. It also has substantial open market business in its own right including for Transport for London at King’s Cross Underground Station, for Candy in the residential development of the Chelsea Barracks and at the Pollock retail centre in Glasgow. At King’s Cross, all programme elements have been delivered on time with the remaining work due for 2009 completion. Work on the Victoria Line upgrade is progressing well and the company is leading Group bids for the M25 widening and maintenance PPP and for the Group’s Olympic work.

UK infrastructure

Results in Balfour Beatty Civil Engineering improved significantly, largely as a result of organic growth in the regional civil engineering business, augmented by a first full year’s contribution from Birse which was acquired in mid 2006.

Our work on the Forth Rail Bridge has been extended for a further three years and we have been awarded the contract for the Isle of Man Airport, following the successful completion of a similar job in the Shetlands. Frameworks for County Councils, for BAA in Scotland and for the Environment Agency continued satisfactorily. A new framework contract for roads in the east midlands was secured during the year, as was the Sadlers Farm highway project. The Liverpool Cruise Liner Terminal was completed successfully.

In the major projects sector, good progress was made on the widening project on the M1 between junctions 6a–10, on the Northern Ticket Hall contract at King’s Cross Underground Station and on the civil engineering works for the East London line. Construction work began on the £200m + A3 Hindhead project, one of several Early Contractor Involvement schemes won by the Group in recent years. Birse Rail, which carries out civil engineering works in the rail sector, made a good contribution, with strong performance on Network Rail frameworks in the midlands and the north-west and for local maintenance depots and disabled access work on a wide range of stations. A major project at Nuneaton Station was fully mobilised during the year. The complete recovery and restitution following the Grayrigg derailment was completed.

Bidding activity has been intense during the year and 2008 will see the outcomes of major tenders for the M25 PPP project, work on Thameslink and for a number of contracts related to the 2012 Olympics.

Balfour Beatty Ground Engineering, which comprises Stent Foundations and Pennine, had another very satisfactory year with a strong performance in both bored and pre-cast piling. Pennine, acquired in 2005, secured its first contract in Canada to add to established export business in Dubai. The company has excellent prospects for a range of 2012 Olympics-related work, building on its successful experience for the new Wembley and Emirates stadia in London.

Balfour Beatty Infrastructure Services, the road and other infrastructure management and maintenance specialist, performed well in a highly competitive market, albeit with slightly lower profits than 2006’s particularly strong results. Performance within the existing portfolio of Highways Agency, local authority, and Balfour Beatty PPP contracts was good and the most recently won major contracts in Essex and north-west Scotland progressed well following a successful mobilisation period. New contracts for Windsor and Maidenhead, and Wokingham were secured and are currently in mobilisation. Other notable successes included the award of preferred bidder status for the Carlisle Northern Relief Road, which involves an extensive maintenance network, and contracting responsibility for all Balfour Beatty Capital’s street lighting projects.

Contracts for Hampshire County Council and Highways Agency Area 3 were lost in competitive tender and will be handed over during the course of 2008.

The contract for Westminster continues to perform well. A number of new local authority contracts will be bid during the year, as will a number of Highways Agency Areas.

UK utilities

In the electricity sector, Balfour Beatty Power Networks’ volumes and profits improved. This was largely as a result of the first period of work on the £550m Eastern Overhead and Cable Alliance contract for National Grid, signed in March 2007, an increasing workload in Scotland and growing volumes in Australia. The Eastern Alliance contract is for an extensive programme of work to upgrade and develop the electricity transmission network in the eastern half of England.

Increasing pressure on the power infrastructure around the world and the relative scarcity of expert resource in new power line construction and existing system upgrade is offering the company a wide range of international bidding opportunities.

It was another very good year for Balfour Beatty Utilities as work progressed on a large, settled portfolio of long-term contracts in the gas and water sectors, which represents a full order book until at least 2010. All the contracts are proceeding well, with particularly strong strategic relations developing further with both United Utilities and National Grid. Preparation for the next round of AMP bids will begin during the course of 2009.

During the year, we were successful in securing a new contract for Yorkshire Water, and the £420m Northern Gas Networks contract has been successfully mobilised and is performing well.

Towards the end of the year, the merger of Balfour Beatty Utilities and Balfour Beatty Power Networks to form Balfour Beatty Utility Solutions was announced. This business is, by some distance, the largest utilities provider in the UK and has been organised into three units – Power Solutions, which will work on National Grid and other network owners’ major electricity projects; Network Solutions, which will include the majority of our regional water and low and medium voltage electrical activities; and Integrated Solutions, which will be responsible for the complex, long-term multi-disciplinary relationships with United Utilities and the North-West Gas Alliance with National Grid.

International infrastructure

Good progress was made on all fronts outside the UK during the year. In the US, Balfour Beatty Infrastructure Inc’s performance improved sharply and the company is now profitable after several years of losses arising from contract problems on the eastern seaboard and in its central division.

The actions taken to address performance issues in the company’s central division have proved effective during 2007, with residual projects proceeding to satisfactory conclusions and good progress made in the resolution of outstanding accounts. Settlements have been achieved on a number of the eastern seaboard bridge projects which have contributed to losses in past years.

The company has a healthy order backlog and is pursuing selective bidding strategies in its chosen markets, most notably the West Coast and Texas. It is also looking at broadening its activities within these regions, where it has substantial knowledge and connections.

It was an excellent year in the water sector, particularly in California with three major and several minor new contracts contributing positively. Highways work in both California and Texas proceeded satisfactorily, particularly on the $1.3bn SH130 project near Austin, which is now nearing completion. The $140m SH45 project, also adjacent to Austin, was won during the year.

The Texas roads market is highly competitive and the potential for PPP procurement is being explored, with several projects coming to the market through this route. The traditionally procured market in Texas is also healthy.

Two major projects were completed successfully in New England during the year – the $350m Greenbush commuter rail project, which had a high civil engineering content, and the Narragansett Water tunnel at Providence, Rhode Island. Substantial bidding activity is underway in Texas and on the West Coast in healthy transport and water markets.

In Hong Kong, Gammon Construction, in which we have a 50% interest, had an excellent year with a number of projects being completed to time and budget and final settlements achieved on a number of projects completed in previous periods. Bidding opportunities in Hong Kong, Macau and particularly Singapore are plentiful and the order book has almost doubled during the year.

Shortly after the year end, we announced the award of the £320m Tamar project to build a new Hong Kong Government complex in the period to 2011. Other notable project wins in Hong Kong included civil engineering and construction works for the university and at the airport and major building projects for Hong Kong Land and other developers. Good progress was made on major works on the Hong Kong rail system, most notably the Kowloon Southern Loop station project and for Swire Properties.

In Macau, the £200m Venetian Hotel and Casino project was completed on time and work is now underway on a new 42-storey, 2,000 room hotel tower for Venetian Orient as part of Macau’s rapid development as a regional leisure and recreational centre.

In Singapore, the market is now strong and bidding activity is extensive. We were awarded the new Chinatown Interchange Station, the first stage of the new downtown mass transit line in late summer in addition to a major road improvement project at Woodsville interchange. Preparatory work commenced on the ITE PPP project in Singapore where we are the preferred bidder.

In Dubai, Dutco Balfour Beatty and BK Gulf, in which we have 49% interests, both had very good years in a strong market. The marine and construction businesses continued to grow strongly with several major project awards. The newly established interior fit-out business also had a very successful year and the company’s operations have now been extended into Abu Dhabi.

Substantial progress was made on the Burj Mall project, the world’s largest shopping mall, which is due to open during 2008. Final settlement was agreed on the highly complex Royal Air Wing contract and several major road schemes, most notably the Jumeirah Lake Tower Interchange and the Emirates Road widening, progressed well. A new camel racing track was delivered on time and early works have begun on the new Tiger Woods Championship Golf Course and Sports Complex.

BK Gulf had an outstanding year and grew substantially. Complex mechanical and electrical work on the Atlantis Hotel and the Palms leisure complex progressed well and long-term framework agreements were signed for the company to be the M & E partner for work carried out by both Carillion and Multiplex. Major works at the airport are coming to a satisfactory conclusion. The facilities management business is set for a period of strong growth with contracts secured for the Atlantis complex and the National Bank of Dubai.

Outlook

Our markets continue to offer substantial opportunity, with Dubai, Singapore and regional markets in the UK particularly buoyant. We expect to see another year of good progress in the sector in 2008.

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