The Lowdown: Once it went ballistic, now it goes by rail. How AEA dropped the bomb for transport

Peter Watson, chairman of the old Atomic Energy Research, talks to Clayton Hirst about trains, bicycles and hip replacements

It runs the Government's National Cycling Strategy, with the aim of quadrupling the number of bike journeys in Britain. It is creating a database of people with hip and knee replacements to identify potential future problems. And if that wasn't challenging enough, the company behind these projects is attempting to make Britain's trains run on time.

But AEA Technology has a dark secret. Set up in 1946 as a division of the Atomic Energy Research Establishment during the Cold War, the company worked on a raft of classified schemes, notably a project to develop an atomic bomb.

AEA today is a quoted company, floated in 1996 out of the renamed UK Atomic Energy Authority, and it is turning its back on the past. It has sold off virtually all its nuclear facilities, with just a small team of 53 scientists left at Winfrith in Dorset. Once made up of 23 different businesses, after a drawn-out restructure, AEA now has just three divisions: rail, environmental and a stand- alone business making lithium batteries.

Its biggest market is in rail, where it employs 1,070 people offering consulting and technology to companies in the UK and continental Europe. It is no coincidence that the chairman, Peter Watson, is a former director of British Rail.

Hanging above his desk in his cramped London office is a slice of rail history - an old BR logo designed in the 1950s. But he is no BR apologist. Having personally made £4m in 1996 from the sale of the train leasing firm Porterbrook, which he chaired, Watson supported the Tory sale of the railways because he thought it would make the industry less bureaucratic. "I was strongly in favour of privatisation. I assumed it would allow the people running the railways to focus all their attention on doing just that. During the BR days, we spent most of our time negotiating with the civil service and ministers. Unfortunately, since privatisation, things have got worse."

Watson has been involved in nearly every big twist of the railways since he joined the BR board as technical director in 1991. For example, Railtrack was a customer of AEA. When the former transport secretary, Stephen Byers, pulled the plug on Railtrack, the administrator, Alan Bloom, turned to AEA to guide him though the railway maze.

Today, AEA supplies Network Rail with signalling services and equipment. And now, another overhaul of the industry is on the cards, after the Secretary of State for Transport, Alistair Darling, announced a further review on Monday, AEA is sure to be stepping up its role again.

Watson is in no doubt what is wrong with the system. "The structure of the industry makes it difficult for people to put their energies into solving the small but numerous problems that affect performance. Structurally, the railways are as bad as they have ever been. It is mind boggling when you think how many organisations are involved," he says. "Too much energy is spent on making the case for more investment, debating with Tom Winsor [the regulator], getting involved with Richard Bowker [the Strategic Rail Authority chairman] et al."

As a consequence, he adds, the people running the railways have little time to focus on the basics. When, for example, Railtrack was placed into administration, it emerged the company didn't have a register of its assets. It was widely assumed no one had conducted an audit. But Watson says: "When I was at BR, there was an enormous amount of work done to make a record of the assets. Quite what's happened to that I don't know."

Before joining BR's board, Watson spent 15 years at defence and engineering company GKN. A trained civil engineer, he started his career at BR as a research and scientific officer.

Raised in Northumberland, Watson, 60, speaks with a strong North-east accent. Despite his polite demeanour and easy-going attitude, there are signs that he has been hardened by decades in business. On top of a chest of drawers in his office is an unopened bottle of whisky and hanging on his wall is a framed cartoon that was presented to him when he left GKN. Full of company in-jokes, one sketch shows some train passengers hurling a beer can through a window. "Ah, yes," he says, in an embarrassed tone. "That refers to a journey where I had a few beers. But I can assure you no windows were broken."

The City has criticised Watson for failing to take decisive action at AEA to give it an aggressive commercial edge. The result of this, some analysts point out, is the company's pendulum-like swing between profit and loss. In December, AEA announced a £1.2m first-half operating profit after an earlier £12.4m loss. Watson admits: "We didn't shift quickly enough from the broad base to the focused business. We got the timing wrong. I guess the weakness is that we are still technical people. On a Friday afternoon, after a long week, some people revert to being technical not business people - not that often, but occasionally. There is still a little bit to do I guess."

Like rail, AEA's environmental business, which employs 870 people, is skewed towards operating public contracts. As well as managing the cycling strategy for the Department for Transport, and the hip and knee database for the Department of Health, AEA provided consultancy services to the Department of Trade and Industry during the formulation of the Energy White Paper.

The company is a leader in measuring air and marine pollution, with a 300-strong team of scientists. AEA, in effect, acquired this business for nothing when, in 1992, the then president of the board of trade, Michael Heseltine, decided that the so-called Warren Spring laboratory needed new premises. "In order to avoid investing in new facilities, he decided to move these people from Welwyn Garden City to near Harwell [in Oxfordshire]. It was a cashless acquisition. We acquired all the people and their technologies for nothing," says Watson.

AEA may have all but left the nuclear industry, but it is attempting to make money out of a technology it developed at Dounreay in Scotland when it was part of the UK Atomic Energy Authority. The invention, called Silver II, is a way of destroying harmful chemical materials, including the nerve agent VX and mustard gas. AEA tried to sell the technology last year to the US government, which has a huge arsenal of chemical weapons that needs to be disposed of. But the Americans have instead chosen to incinerate some of the weapons.

"If you have no environmental objections then you, sadly, incinerate. It is the quickest and easiest technique and you just hope [the emissions] go far enough into the atmosphere not to bother you. If you have a committed environmental policy, you will not do this. Silver II is a clever technology and our hope is that someone will realise it offers the solution to their problems," says Watson.

This takes AEA full circle. While its origins lie in the Cold War arms race, the company today is attempting to make money out of clearing up the legacy of that era, as well as fixing the railways and encouraging people to get on their bikes.