Source - RNS
RNS Number : 0088L
Smiths Group PLC
28 September 2016
 

News release
Smiths Group plc announces results for the year ended 31 July 2016

London, Wednesday 28 September 2016

Robust results lay foundations for future growth

Highlights

·     Growth in reported revenue and headline operating profit in four out of five divisions

·     Group revenue declined 2% on an underlying1 basis; up 2% on a reported basis

·     53% of Group revenues derived from aftermarket and consumables

·     Headline operating profit declined 4% on an underlying1 basis, driven by tough global energy market conditions for John Crane

·     Good margin expansion in Smiths Medical, Smiths Detection and Smiths Interconnect

·     John Crane margins resilient at 21.9%; Flex-Tek margins stable 

·     Earnings per share of 85.2 pence fell 1% year-on-year driven by higher finance costs

·     102% cash conversion drove an underlying reduction in net debt

·     Proposed final dividend of 28.75 pence per share. Full year dividend growth of 2.4%

·     $710m acquisition of Morpho Detection expected to complete in early 2017, subject to regulatory clearances 

 

Results for the year ended 31 July 2016

 

Headline*

 

Statutory

 

2016
£m

2015
£m

Reported growth

Underlying growth#

 

2016
£m

2015
£m

Revenue

2,949

2,897

2%

(2)%

 

2,949

2,897

Operating profit

510

511

-

(4)%

 

387

394

Operating margin

17.3%

17.6%

(30) bps

(40)bps

 

13.1%

13.6%

Pre-tax profit

451

459

(2)%

(5)%

 

346

325

Basic EPS

85.2p

86.1p

(1)%

 

 

65.6p

62.4p

Headline free cash-flow

400

339

18%

 

 

 

 

Dividend

42.00p

41.00p

2%

 

 

 

 

Return on capital employed

15.3%

16.0%

(70)bps

 

 

 

 

*In addition to statutory reporting, Smiths Group reports its continuing operations on a headline basis.  Definitions of headline metrics, and information about the adjustments to statutory measures are provided in the notes to the financial statements

#Organic growth adjusting for foreign exchange translation

 

Andy Reynolds Smith, Group Chief Executive, commented:

"Smiths Group delivered a robust performance this year. We achieved good growth in headline operating profits with associated margin expansion in our Medical, Detection and Interconnect divisions, driven by revenue growth and business improvement initiatives. However, significant headwinds in the global energy markets impacted John Crane, primarily in the sales of first-fit equipment; aftermarket was more resilient with underlying revenue down 4%. For Smiths Group as a whole, more than half of our revenue continued to come from the recurring aftermarket for our products and services.

"In the first year as CEO, my aim has been to lay the foundations for future value creation through stronger growth, improved competitiveness, more robust and consistent execution and a better focused portfolio. We have undertaken a strategic review across the Group to examine in detail the sustainable growth characteristics of the markets we serve and our competitive positioning within those markets. We start from a solid base with a Group of well-run and well-positioned businesses, with nearly two-thirds of Group revenues coming from market segments that have attractive growth rates. We see clear potential to increase our exposure to faster growing market segments and to improve our overall market competitiveness in the medium term as we take steps to focus our portfolio.

"Our strategic review gives us a clearer sense of where to focus investment in order to drive future growth and technological differentiation, and we have aligned our capital allocation process accordingly. As a result, we were able to commit $710m for the acquisition of Morpho Detection, and to make progress on the disposal of non-core assets. We will increase expenditure on research and development by around £20m in the coming year to invest in future growth opportunities, with a particular focus on our digital future. In parallel, we are implementing measures across the business to ensure continuous improvement and greater consistency of execution in everything we do in order to deliver productivity improvements across the Group. I am confident that, over the long term, our strategy will drive Smiths to become one of the world's leading technology companies.

"We anticipate a broad continuation of the trends experienced in 2016, with ongoing challenges in John Crane's end markets being more than offset by moderate underlying revenue growth in our other divisions. As is typically the case, Group performance in 2017 is expected to be weighted towards the second half. We expect cash conversion to continue to be strong in the coming year and the recent depreciation of sterling is expected to provide a tailwind to reported revenue and operating profit, should current rates prevail." 

 

_______________________________________________________

1 Underlying excludes the impact of acquisitions and divestments, and the effects of foreign exchange translation

 

Statutory reporting

Statutory reporting takes account of all items excluded from headline performance. On a statutory basis, pre-tax profit from continuing operations was £346m (2015: £325m) and earnings per share were 65.6p (2015: 62.4p).

See Accounting policies for an explanation of the presentation of results and note 3 to the accounts for an analysis of non-headline items.



 

Contact details

Investor enquiries

Andrew Lappin, Smiths Group
+44 (0)20 7004 1657
+44 (0)78 0500 7035
[email protected]

Kirsty Law, Smiths Group
+44 (0)20 7004 1672
+44 (0)75 8315 4386
[email protected]

Media enquiries

Andrew Lorenz, FTI Consulting
+44 (0)20 3727 1323

+44 (0)77 7564 1807

[email protected]

Presentation

The presentation slides and a live webcast of the presentation to analysts are available at www.smiths.com/results at 09.00 (UK time) on Wednesday 28 September. A recording of the webcast is available later that day. A live audio broadcast of the presentation is also available by dialling (no access code required):

UK toll free: 0808 237 0035

International: +44 (0)20 3426 2887

US/Canada toll free: +1 877 841 4558

An audio replay is available for seven days on the following numbers (access PIN 676001#):

UK toll free: 0808 237 0026

International: +44 (0)20 3426 2807

US/Canada toll free: +1 866 535 8030

Photography

Original high-resolution photography and broadcast quality video is available to the media from the media contacts above or from http://www.smiths.com/images.aspx.

 

This document contains certain statements that are forward-looking statements. They appear in a number of places throughout this document and include statements regarding our intentions, beliefs or current expectations and those of our officers, directors and employees concerning, amongst other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the business we operate. By their nature, these statements involve uncertainty since future events and circumstances can cause results and developments to differ materially from those anticipated. The forward-looking statements reflect knowledge and information available at the date of preparation of this document and, unless otherwise required by applicable law, the Company undertakes no obligation to update or revise these forward-looking statements. Nothing in this document should be construed as a profit forecast. The Company and its directors accept no liability to third parties in respect of this document save as would arise under English law.

This press release contains brands that are trademarks and are registered and/or otherwise protected in accordance with applicable law.

 

Chief Executive's review

Group results overview

Group revenue fell 2% on an underlying1 basis, a robust performance highlighting the benefits of our broad range of end market exposures. Good growth was reported in Smiths Medical and Smiths Detection. John Crane experienced tough trading conditions as volatility in the global energy markets continued to reduce demand. Revenue in Smiths Interconnect and Flex-Tek was slightly down on the prior year on an underlying1 basis. On a reported basis, Group revenue grew 2%, benefitting from foreign exchange, and in particular the strength of the US dollar.

Reported Group headline operating profit of £510m was in line with the prior year, although on an underlying basis this fell 4%. The Group's operating profit margin fell 40 basis points on an underlying basis. Margin expansion in Smiths Medical, Smiths Detection and Smiths Interconnect reflected strong trading performance in addition to cost control and restructuring activities, but was offset by weakness in John Crane's end markets.

The Group delivered an improvement in cash generation with a cash conversion rate of 102%. We have made progress in improving stock turns this year, with £30m cash in-flow from inventory reductions. Headline free cash flow of £400m increased 18%. Net debt of £978m reduced by £23m on an underlying basis, despite a significantly higher pension contribution in the year.

Dividend

The Board has a progressive dividend policy for future payouts, with the aim of increasing dividends in line with the long term underlying growth in earnings. This policy will enable us to retain sufficient cash flow to finance our investment in the drivers of growth and to meet our financial obligations. In setting the level of dividend payments, the Board will take into account prevailing economic conditions and future investment plans, along with the objective to maintain minimum dividend cover of around 2.0. The Board is recommending a final dividend per share of 28.75 pence, giving a total dividend for the year of 42 pence, an increase of 2.4% year-on-year. The final dividend will be paid on 18 November to shareholders registered at close of business on 21 October. The ex-dividend date is 20 October.

Outlook

We anticipate a broad continuation of the trends experienced in 2016, with ongoing challenges in John Crane's end markets being more than offset by moderate underlying1 revenue growth in our other divisions. As is typically the case, Group performance in 2017 is expected to be weighted towards the second half. We expect cash conversion to continue to be strong in the coming year and the recent depreciation of sterling is expected to provide a tailwind to reported revenue and operating profit, should current rates prevail.



 

Strategy update

Introduction

Everything I felt about Smiths Group on my first day as Chief Executive - strength in depth but great opportunity for improvement - I now believe even more passionately. The Group has a number of businesses, grouped into five high-quality divisions. Many of the businesses occupy leading positions in the markets they serve. This forms a solid platform, and provides a clear opportunity to build on the Group's innate DNA to take us to the next level of growth, innovation and competitive differentiation.

In my first few months, I set up a strategic review of our businesses to identify the drivers for future growth and value creation, with a particular focus on market attractiveness and our competitiveness - essentially asking the question 'How good can it be?' The review has provided clarity on the 'doability' - the risks, costs and time required - and we have aligned its findings with a more robust capital allocation process. As a result of our detailed knowledge of our businesses and the actions we have taken to date, our ambitions for Smiths Group are well-founded.

Vision

My vision is to establish Smiths as one of the world's leading technology companies, with sustainable outperformance in our chosen markets. We will achieve this by focusing on our two strategic priorities:

Outperforming our chosen markets - the Growth Framework

Achieving world-class competitiveness - the Smiths Excellence system

As we target leadership positions in our chosen markets, everything we do in pursuit of these priorities will be based on the quality of our people, doing the right thing and the rigour of our financial discipline.

Outperforming our chosen markets - the Growth Framework

In order to achieve sustainable growth, it is important to target the right segments within markets, the right geographies and the right customers, and to increase the value of the content we have with our customers. All of these, of course, should be underpinned by world-class competitiveness. We call this our Growth Framework. As a result of our strategic review's detailed assessment of our divisions by market sub-segment, we now have a much more granular understanding of the growth characteristics of the markets that each of our divisions serves. For example: 

John Crane's performance this year has demonstrated the importance of maintaining exposure to a broad range of end markets. While oil and gas capital expenditure has been a catalyst for growth and margin expansion over the past decade, and this segment accounted for 57% of John Crane's revenues in 2016, we will do more to expand into non-oil and gas verticals which make up the remaining 43%, such as the chemical, pharmaceutical, and pulp and paper industries. We will also consider organic and inorganic means to expand into adjacent mission-critical products and components with similar business characteristics to our current offering, as well as investing in digital solutions such as predictive diagnostics and reviewing potential breakthrough disruptive technologies, particularly in the field of advanced materials and 3D printing. We will do more to improve our market positioning in key geographies, such as China, and John Crane must also position itself better to take advantage of the long-term implications of increasing environmental regulations and the drive towards lower emissions and higher energy efficiency. Many of our products, including dry gas seals, have demonstrable benefits in this regard. With 59% of revenue derived from aftermarket products and services, we view John Crane as a 20%+ margin business.

Smiths Medical's portfolio incorporates several strong brands and market leadership positions, particularly within Infusion Systems, Vascular Access and Vital Care. Our market sub-segmentation review has led us to identify with more precision the areas that are growing and those that are not, so that we can focus our significantly increased investment in higher-growth categories. We will position ourselves better to address key global trends, such as increasing digitalisation and the growth of alternate sites of care, which we expect to do by strengthening our category leadership positions through greater innovation and competitive differentiation and by building our 'pump to patient' strategy - and beyond. We view Smiths Medical as a 20%+ margin business.

Smiths Detection's strong revenue growth and margin expansion this year comes from high new business wins, increasing initiatives to capture aftermarket service revenues, and sustained management action to improve productivity and operations. With a broad portfolio in a global homeland security market which we estimate will grow at a mid-single digits CAGR to 2021, the business benefits from a global reach and strong existing relationships with some customers. We view Smiths Detection as a mid-teens margin business. In April, I announced that we had agreed to purchase Morpho Detection from Safran S.A., for an enterprise value of $710m. Morpho Detection is a high quality business, with a strong management team, and this combination provides a compelling competitive platform for product, service and technology leadership. The acquisition will better position us to meet customer requirements for high-technology, cost-efficient solutions and services, including software. We continue to anticipate completion of the acquisition to take place in early 2017, subject to regulatory clearances.

Smiths Interconnect provides high reliability electronic components to multiple industries, including the defence, telecoms, aerospace and medical end verticals. Our review has given us clarity on the most attractive customer segments within these verticals, and led us to conclude that Smiths Interconnect is better positioned to serve those customers who seek more sophisticated and differentiated technology solutions. We will therefore focus increasingly on select customer types in the most attractive verticals, and align our investment in new product development accordingly to meet electronics industry trends such as miniaturisation, power efficiency and processing speed. We view Smiths Interconnect as a low to mid-teens margin business.

Flex-Tek provides a range of engineered components for the aerospace, medical, industrial, construction and domestic appliance end markets. With a more in-depth understanding of the relative attractiveness of these end markets, we will prioritise areas of faster growth and where Flex-Tek can deliver competitive differentiation, including in technology expertise and customer service. We view Flex-Tek as a mid-teens margin business.

Achieving world-class competitiveness - the Smiths Excellence system

A key conclusion of our strategic review is that there is material opportunity to improve competitiveness by ensuring robust and consistent execution across Smiths Group - achieving excellence. We have defined six core pillars of Excellence at Smiths, which will be leveraged across the Group: Customer, People, Technology, Production, Programme, and Supply Chain. Each pillar has an Executive Committee sponsor. Employees throughout the organisation have been engaged in how they can play their role in this agenda, and in April we held the inaugural Smiths Excellence Awards to recognise outstanding examples of initiatives and behaviours in each of the Excellence categories.

The Smiths Excellence System will drive continuous improvement and consistent execution across our businesses, focused on speed and efficiency. Key priorities over the next year include:

Customer Excellence

Increasing our service offering through initiatives on pricing and channel management.

People Excellence

Recognising that people are our one true source of sustainable competitive advantage, we are implementing a People Plan along with culture change initiatives to build a learning organisation that attracts, retains, develops, engages and inspires the very best people.

Technology Excellence

To build a culture of innovation, we are investing in a Group-wide New Product Innovation process that will ensure our product and service vitality is strong and will sharpen our focus on commercialisation. We are reviewing the efficiency and quantum of total R&D spend and I am also leading the implementation of the Group-wide i3 innovation forum. We plan to invest in building digital capabilities in the coming year through a central Innovation Fund and expect to invest increasingly in this area over time.

Production Excellence

Developing a culture of Continuous Improvement and lean enterprise, supported by the correct structures, processes, enablers, measures and people capabilities and skills.

Programme Excellence

Executing complex programmes is critical to our customer relationships, and we are developing a gated programme management process and an ever-increasing focus on rigorous contract management.

Supply Chain Excellence

Improving the speed of flow through the business from the supplier through to our plants and the customer will reduce lead times, reduce working capital and ensure customers get what they want when they want it.

 

Conclusion

As we take action to develop market leadership positions and to improve our own competitiveness, we will continue to take a disciplined approach to balance sheet management. We have increased the focus on cash generation as a primary measure of performance, and have taken steps to improve inventory management across our businesses which will ultimately improve working capital. By adopting a Group-wide approach to capital allocation in order to maximise risk-adjusted returns, we will apply strong financial discipline to acquisition and disposal activities where opportunities present a compelling strategic rationale, aligned with our focus on investing in attractive technology-led areas.

As we position Smiths Group for long-term growth, we will target organic and inorganic opportunities that offer the best levels of sustainable growth and value creation. We will build market-leading positions in our chosen markets with a more focused portfolio of businesses that embody the essential characteristics of where Smiths Group creates value.

These characteristics include having:

•  good competitive positioning in attractive growth markets;

•  strength in technology differentiation, including digital capabilities;

•  asset-light operations; and

•  a high proportion of aftermarket service revenues.

By pursuing this strategy, I am confident that over the long term Smiths can outperform our chosen markets and achieve world-class competitiveness as we realise our vision of becoming one of the world's leading technology companies.

 

Business review

John Crane

John Crane provides engineered products and services to global energy and process industry customers. John Crane's revenue is currently comprised of 59% aftermarket sales. Approximately 60% of revenue is derived from the energy sector (downstream, midstream and upstream oil & gas, power generation) with approximately 40% coming from other industries including Chemicals, Pharmaceuticals and Pulp & Paper.

 

 

2016
£m

2015
£m

Reported
growth

Underlying
growth

Revenue

830

905

(8)%

(10)%

Headline operating profit

181

225

(19)%

(20)%

Headline operating margin

21.9%

24.8%

(290)bps

 

Statutory operating profit

151

165

(9)%

 

Return on capital employed

20.3%

25.8%

(550)bps

 

 

Performance

Revenue fell 10% on an underlying1 basis as difficult market conditions continued throughout global energy markets. The decline was driven by reduced sales in both the first-fit and aftermarket business. Reported revenue declined 8%, after £13m of foreign exchange benefit.

Underlying1 aftermarket revenue declined 4%, with continued economic uncertainty driving slower customer upgrades and retrofits, especially with oil and gas customers. Activity levels stabilised in the second half and a number of significant contract wins led to a growing aftermarket order book, reflecting the resilience of this business. While there were pockets of relative strength within certain regions, such as Latin America and Asia Pacific, weakness in the sector was fairly widespread. Underlying1 first-fit sales fell 16%, as continued volatility in energy prices put pressure on the business across most geographies. Lower underlying1 revenue was driven in particular by a sharp revenue decline in John Crane Production Solutions and weakness in North America. We continued to focus on expanding the installed base and increased our investment in first-fit projects.

Revenue from emerging markets represented 24% of John Crane sales, in line with the prior year, as headwinds in certain Latin American markets and challenging conditions in China offset efforts to increase our sales into emerging markets.

Headline operating profit fell 20% on an underlying1 basis, driven primarily by lower sales volumes as well as high levels of investment in first-fit strategic projects, partially offset by favourable foreign exchange. Strong cost control actions included a reduction in headcount of more than 400 people. Headline operating profit margin fell 290 basis points to 21.9%. Return on capital declined 550 basis points to 20.3%, principally due to lower profitability. The difference between statutory and headline operating profit primarily reflects a £23m charge in relation to John Crane, Inc. asbestos litigation, a £10m impairment of John Crane Production Solutions goodwill and property, plant and equipment, and £10m of restructuring charges, offset by the recovery of £16m through a settlement with insurers.

During the year the decision was made to sell John Crane's artificial lift business. John Crane Production Solutions is held for sale at the year ended 31 July 2016. The business performance of John Crane Production Solutions is included within the financial summary and results presented above.

John Crane continued to invest in research and development projects in 2016. This included innovation for engineered solutions and technology advancements to meet customers' increasing demands for rotating equipment availability in extreme environments, while providing intelligence about performance and improving energy efficiency and cost savings. Specific developments included:

•  Two additions to the AURA™ line of gas seals - the AURA 100 and AURA 180. These seals will provide increased reliability, reduce customers' operating costs, extend maintenance intervals and reduce spares inventory.

•  The launch of 48VBF, a critical boiler feed system for power generation in large utility scale plants or smaller onsite steam plants, reducing costs by eliminating the heat exchanger and preventing leakage.

•  Customer trials have succeeded in proving the value of SENSE™, a Predictive Diagnostics solution.  Manual inspection of equipment is now replaced by continuous performance monitoring, providing intelligence that diagnoses problems, guides decisions about maintenance, and helps to resolve issues with critical pumps and compressors.



 

Smiths Medical

Smiths Medical supplies medical devices and consumables that are vital to patient care globally. Our products include Infusion Systems, Vascular Access, Vital Care and Specialty Products. 83% of Smiths Medical's sales are from consumable and disposable products.

 

 

2016
£m

2015
£m

Reported
growth

Underlying
growth

Revenue

874

836

5%

1%

Headline operating profit

187

166

13%

7%

Headline operating margin

21.4%

19.8%

160bps

 

Statutory operating profit

166

142

17%

 

Return on capital employed

15.7%

14.7%

100bps

 

 

Performance

Revenue grew 1% on an underlying1 basis, driven in particular by growth in Vital Care revenue of 3%. Reported revenue grew 5% with favourable foreign exchange adding to strong business performance. Smiths Medical is now the largest division of the Group by both revenue and profit.

Vital Care underlying1 revenue growth was driven by tracheostomy and bronchial hygiene products. Vascular Access underlying1 revenue was broadly flat as sales of cardiothoracic and port products were partly offset by price pressure on peripheral intravenous catheters (PIVC). Infusion Systems underlying1 revenue was also flat as increased sales of hospital syringe infusion hardware and ambulatory infusion disposables were offset by a decline in sales of ambulatory infusion hardware following the strong prior-year performance in that segment. Specialty Products underlying1 revenue declined 2% as growth from in vitro fertilisation and animal health was offset by declines in patient monitoring and emergency medicine.

Sales into emerging markets increased 10% during the year, with direct sales into China and India up 22% and 21% respectively. Sales into distributor markets in South East Asia also performed well, growing 3%. Economic challenges in Russia, the Middle East and South America led to reduced sales into these markets. 

Headline operating profit grew 7% on an underlying1 basis, boosted by revenue gains, operational efficiencies, tight cost controls and restructuring programmes, which more than offset the downward pricing pressure in the sector and £5m adverse transactional foreign exchange. The headline operating margin of 21.4% was 160bps higher than the prior year, with £8m coming from favourable translational foreign exchange. The difference between statutory and headline operating profit reflects £14m of restructuring charges and £6m amortisation of intangible assets.

Return on capital employed increased 100bps to 15.7%, reflecting improved profitability that supported greater capital expenditure in new product development, capacity and manufacturing tooling.

Research and development expenditure of £52m (2015: £45m) represented 6.0% of sales (2015: 5.4%), of which £30m was expensed (2015: £29m). This increased investment, alongside improvements in our new product development processes and productivity over the past two years, has resulted in a robust line-up of new products coming through the pipeline. In 2016, we saw an increase in product launches that will increase our competiveness and expand our served markets. In particular:

•  The Graseby C8 syringe pump, developed by Smiths Medical's R&D team in Shanghai, was launched in China, contributing to 22% growth in that market.

•  CADD Solis VIP and wireless pumps fuelled geographic market expansion and wireless connectivity respectively.

•  Medfusion expansion into Australia, New Zealand, UK and the Middle East.

•  The paraPAC plus transport ventilator was released in Japan, contributing to 15% growth of Pneupac products in that market.

We continue to focus on streamlining the R&D organisation while driving improvements in efficiency, programme discipline and execution, and prioritisation of resources. Further product launches across our portfolio are planned in the coming year.



 

Smiths Detection

Smiths Detection designs and manufactures technology solutions that detect and identify explosives, narcotics, weapons, chemical agents, biohazards, nuclear and radioactive material and contraband. 37% of sales are from the aftermarket.

 

 

2016
£m

2015
£m

Reported
growth

Underlying
growth

Revenue

526

467

13%

9%

Headline operating profit

69

55

24%

20%

Headline operating margin

13.0%

11.9%

110bps

 

Statutory operating profit

63

45

40%

 

Return on capital employed

11.9%

9.6%

230bps

 

 

Performance

Revenue grew 9% on an underlying1 basis, with growth in all end-use markets other than transportation. Initiatives to drive service attach rates and sales of premium service contracts led to a 14% increase in underlying1 aftermarket revenue, which represented 37% of sales. On a reported basis, revenue grew 13%, boosted by favourable foreign exchange.

Underlying1 transportation revenue fell 6% due to a lull in US activity levels, offset by strong sales into EMEA which included deliveries to London Heathrow, Abu Dhabi Airport and continued progress in the Middle East. Major contract wins in Saudi Arabia and Egypt were made in the period. Critical infrastructure underlying1 revenue grew 13%, driven by strength in aftermarket sales. Our revised product offering contributed to 75% underlying1 revenue growth in Ports & Borders, including deliveries for major programmes in Indonesia, Nicaragua, Kuwait and for the US Customs and Border Protection agency. Ongoing success in the US under the long-running JCAD and CBPS programmes, in addition to deliveries of RadSeeker detectors to the Domestic Nuclear Detection Office, led to underlying Military and Emergency Responder revenue1 growth of 9%.

Headline operating profit grew 20% on an underlying1 basis as increased sales, aftermarket strength and favourable business mix were augmented by a number of value engineering and programme management initiatives. The difference between statutory and headline operating profit includes a £4m restructuring charge.

Return on capital employed improved 230 basis points to 11.9%, driven by higher profitability.

Total research and development expenditure of £28m was in line with the prior year, of which £25m was company funded (2015: £25m). Investment was concentrated on fewer projects to drive a strong product pipeline that will deliver competitive advantage for our customers. This included:

•  X-ray machines for the aviation market capable of meeting the new EU/ECAC Standard C3, as well as a new version of our Checkpoint.Evo remote screening software and, following the successful launch of the IONSCAN 600 this year, the next generation of explosive trace detectors.

•  For the military end-use market, the next generation of chemical warfare detection devices.

•  A new focus on software development and value engineering projects which will deliver products better able to compete in some cost-critical sectors, as well as country-specific versions of some of our most successful products.



 

Smiths Interconnect

Smiths Interconnect develops electronic components and sub-systems that connect, protect and control critical systems for wireless telecommunications, aerospace, defence, space, test, medical, rail, data centres and industrial markets.

 

 

2016
£m

2015
£m

Reported
growth

Underlying
growth

Revenue

435

420

4%

(1)%

Headline operating profit

57

49

16%

9%

Headline operating margin

13.1%

11.6%

150bps

 

Statutory operating profit

26

28

(7)%

 

Return on capital employed

10.3%

9.1%

120bps

 

 

Performance

Revenue declined 1% on an underlying1 basis with good growth in the Power business offset by defence programme slowdowns and lower demand for semiconductors. Revenue grew 4% on a reported basis, boosted by £21m foreign exchange benefits.

Underlying1 revenue growth of 3% in the Power business was driven by strong data centre expansion in North America and an increased focus on preventative maintenance service contracts. Underlying1 Microwave revenue declined 5% due to lower customer demand and defence programme delays, although major new defence contracts for microwave assemblies were secured. Underlying1 Connectors revenue remained flat year-on-year as a decline in defence sales was offset by good demand in the commercial aerospace and space markets, which included the supply of high-reliability connectors to the NASA Orion exploration spacecraft.

Headline operating profit grew 9% on an underlying1 basis and the headline operating margin increased 150bps to 13.1%, with accretion in all three business areas. Significant benefits came from improvements in productivity through value engineering, lean manufacturing and automation initiatives and from restructuring and procurement savings, which more than offset wage inflation and negative operational gearing from lower volumes and mix effects. The difference between statutory and headline operating profit primarily reflects an £18m goodwill impairment for Microwave, £8m amortisation of acquired intangible assets and £4m for restructuring.

Return on capital employed increased 120 basis points to 10.3% predominantly driven by the higher profitability.

Total research and development expenditure of £26m was in line with the prior year, representing 6.0% of revenue, of which £24m was company-funded (2015: £23m).  Investments were focused on higher growth sectors, supporting key customers' needs or accessing new customers, regions or markets. Highlights included:

•  In Microwave, we invested in new telecoms test products targeted at the Asian market, broadened our range of passive components to provide increased functionality and developed millimetre wave products for advanced radar systems and nascent higher frequency commercial applications.

•  In Connectors, we launched new high reliability connector solutions for commercial aerospace and high pressure and temperature oil and gas drilling applications. Elastomeric contact technology was added to our portfolio through a partnership agreement.

•  In Power, we developed higher-efficiency transformers in compliance with a US Department of Energy regulation that entered into force in early 2016, as well as a new power distribution unit, and remote power panel and busway range extensions.



 

Flex-Tek

Flex-Tek provides engineered components that heat and move fluids and gases for the aerospace, medical, industrial, construction and domestic appliance markets.

 

 

2016
£m

2015
£m

Reported
growth

Underlying
growth

Revenue

284

269

6%

0%

Headline operating profit

51

50

3%

(3)%

Headline operating margin

18.0%

18.5%

(50)bps

 

Statutory operating profit

37

41

(10)%

 

Return on capital employed

31.6%

33.6%

(200)bps

 

 

Performance

Revenue was in line with the prior year on an underlying1 basis. On a reported basis, foreign exchange benefits led to revenue growth of 6%.

Construction revenue grew 3% on an underlying1 basis, with both Gastite and Thermaflex benefitting from the growing US housing market. A softening of orders in aerospace led to a 1% underlying1 decline in Fluid Management revenue. Heat Solutions revenue fell 5% on an underlying1 basis, principally due to lower nickel prices reducing our own selling prices to customers. Flexible Solutions underlying1 revenue growth of 1% was driven by increased demand from the medical sector, although this was offset by a decline in the floorcare segment.

Headline operating profit of £51m delivered a margin of 18.0%, slightly lower than the prior year. A Gastite product transition was the primary driver of lower performance, even though Gastite margins were better than expected due to lower material costs. Profits and margins in Heat Solutions, Thermaflex, and Flexible Solutions improved slightly over last year. The difference between statutory and headline operating profit primarily reflects a £12m charge to extend the provision for litigation in relation to damage allegedly caused by lightning strikes.

Return on capital employed decreased 200 basis points to 31.6%, driven by the slightly lower rate of return on sales and by investment in expanding site capacity.

Spending on research and development remained constant, focused on innovation to meet specific customer needs. We continued our focus on the development of specialty heating elements, expanded applications for gas tubing products and on products to meet the requirements of the next generation of quieter, more fuel-efficient aircraft.

 

Financial review

2016 performance review

As a global business Smiths Group is exposed to a number of different industries and macroeconomic trends but the nature of our diversified portfolio means that we are well placed to mitigate exposure to any specific sector or industry. This can be seen in a solid set of 2016 results with strong performance in four of our five divisions mostly offsetting the impact of turmoil in the oil and gas market on John Crane. It was particularly pleasing to see continued revenue growth, albeit it at a modest rate, in Smiths Medical, a good improvement in profitability at Smiths Interconnect, and the continuation of the strong recovery in Smiths Detection, which gave us the confidence to commit over $700 million of capital to the acquisition of Morpho Detection from Safran.  We expect that acquisition to complete during 2017, subject to regulatory clearances.

Revenue

Reported revenue increased by £52m (2%) to £2,949m, including the positive effects of foreign currency translation (£98m). On an underlying basis, revenue declined 2% as growth in Smiths Detection (+£43m; 9%) and Smiths Medical (+£6m; 1%) was offset by declines in John Crane (£87m; 10%) and Smiths Interconnect (£6m; 1%). In John Crane the reduction in revenue was more pronounced in the sales of original equipment, where revenues declined by 16% on an underlying basis; the aftermarket business was more resilient where the underlying revenue decline was 4%.

Headline operating profit

Reported headline operating profit of £510 million was in line with the prior year (2015: £511m) including the positive effects of foreign currency translation (£19m). On an underlying basis operating profit declined 4%, driven principally by a £47m fall in John Crane. Operating margin decreased by 30 basis points to 17.3% (2015: 17.6%), driven by continued challenging conditions in global energy markets which impacted performance in John Crane, where margin declined 290 basis points to 21.9% (2015: 24.8%). Despite this decline, John Crane's margins remain the highest in the Group, demonstrating the underlying quality of this business.

Smiths Detection and Smiths Medical delivered strong margin improvement. Smiths Medical increased 160 basis points to 21.4% (2015: 19.8%) boosted by higher revenue, particularly in Vital Care, as well as a continued focus on cost management. Smiths Detection increased operating margin by 110 basis points to 13.0% (2015: 11.9%) supported by a strong revenue performance, a focus on operational efficiencies and strong cost management. Smiths Interconnect improved operating margin by 150 basis points to 13.1% (2015: 11.6%) by focusing on higher value customers, coupled with a range of productivity, efficiency and cost reduction initiatives. Operating margins of 18% in Flex-Tek were marginally lower than last year (2015: 18.5%) reflecting the impact of a product transition in the Gastite business.

Operating profit on a statutory basis, after taking account of the items excluded from the headline figures, was £387m (2015: £394m) - see notes 3 and 28 for information on the excluded items. The decrease was driven by an increase in non-headline charges of £6m reflecting an increase in the charge relating to legacy pension schemes, partially offset by a reduction in the charge for legacy liabilities due to settlement in our favour of a claim against an insurer relating to the John Crane, Inc. asbestos litigation.

Headline finance costs

Headline finance cost during the year totalled £59m, £7m higher than the previous year.  This was principally due to an increase in interest payable on bonds of £7m, due to a full year's interest expense on the €600m bond issued at April 2015.

Non-headline items relating to continuing activities excluded from headline profit before tax

These items amounted to a charge of £105m compared to a charge of £134m in 2015. They comprised:

•  amortisation of intangible assets acquired in business combinations of £15m (2015: £33m). The ongoing amortisation charge relates principally to technology and customer relationships;

•  £23m goodwill impairment charge (2015: £27m), a £6m impairment charge on property, plant and equipment and a £2m charge on impairment of a trade investment. Goodwill impairment included impairment for John Crane Production Solutions (£5m), Smiths Interconnect Microwave Components (£7m) and Smiths Interconnect Microwave Telecoms (£11m);

•  £27m charge (2015: £23m) and £16m cost recovery in connection with John Crane, Inc. asbestos litigation;

•  £12m charge (2015: £9m) in connection with Titeflex Corporation litigation including a change the provision length;

•  £37m charge for restructuring (2015: £38m) in respect of the Fuel for Growth programme;

•  £9m charge for changes to post-retirement benefits including the cost of a buy-out of retirees in the US pension scheme (2015: £14m gain);

•  £3m gain on retirement benefit finance (2015: £8m charge);

•  £7m charge for legacy retirement benefit administration (2015: £8m);

•  £1m of financing gains (2015: £4m loss);

•  £19m fair value gain on contributing government bonds to a pension scheme; and

•  £6m net loss (2015: £2m gain) on disposals and other acquisition costs.

Taxation

The principles of the Group's approach to taxation remain unchanged. The Group seeks to manage the cost of taxation in a responsible manner to enhance its competitive position on a global basis while managing its relationships with tax authorities on the basis of full disclosure, co-operation and legal compliance. A semi-annual tax report is reviewed by the Audit Committee to monitor compliance with these principles to ensure the Group delivers its tax objectives.

The headline tax charge for 2016 of £113m (2015: £117m) represented an effective rate of 25% on the headline profit before taxation (2015: 25.5%). On a statutory basis, the tax charge on continuing activities was £85m (2015: £77m).

The Group continues to take advantage of global manufacturing, research and development and other tax incentives, the tax-efficient use of capital and tax compliance management.

In 2016, Smiths Group paid £62m in direct corporate tax on profits and £105m in employment and other taxes. The Group additionally collected £210m on behalf of tax authorities, primarily from employees but also other indirect taxes such as VAT. The total amount of tax paid over to tax authorities during the year totalled £377m. A rate of between 26% and 27% is expected in the year ending 31 July 2017.

Earnings per share

Basic headline earnings per share from continuing activities were 85.2p (2015: 86.1p). The reported 1% decline was mainly driven by higher finance charges for the year (£59m vs £52m), partly offset by a reduction in the effective tax rate to 25% from 25.5% in 2015 reflecting the successful conclusion of a number of historic tax disputes.

On a statutory basis, the basic earnings per share from continuing activities were 65.6p (2015: 62.4p), reflecting the recognition of a gain in non-headline finance costs relating to the contribution to the SIPS pension scheme of a portfolio of GILTS previously held in escrow for the scheme.

Cash generation and net debt

Operating cash generation remained strong, with headline operating cash-flow of £520m (2015: £484m), representing 102% (2015: 95%) of headline operating profit. See note 26 to the accounts for a reconciliation of headline operating cash and free cash-flow to statutory cash-flow measures.

Headline free cash-flow increased by £61m to £400m, reflecting the £36m increase in headline operating cash-flow, a reduction in cash tax payments of £29m to £62m (2015:£91m), partially offset by an increase in net interest payments of £4m, from £54m in 2015 to £58m in 2016. Total free cash-flow, stated after all legacy costs, interest and taxes but before acquisitions and dividends increased by £85m to £243m, reflecting the increase of £61m in headline free cash-flow and a reduction of £24 million in the cash outflows on non-headline items principally due to cash inflows on foreign exchange hedging transactions of £41 million partially offset by increased contributions to legacy defined benefit pension schemes.

On a statutory basis, net cash inflow from operations was £358m (2015: £266m).

Net debt at 31 July 2016 was £978m, an increase of £160m in the year.  With the majority of the Group's net debt held in currencies other than pounds sterling to hedge the underlying asset base of the Group, the sharp decline in the value of sterling at the end of the financial year resulted in a foreign exchange translation-driven increase of £187m in net debt. The underlying debt in foreign currencies was unaffected by the change in the value of sterling.  On an underlying basis, excluding the impact of foreign exchange movements, net debt reduced by £23m, reflecting good operational cash generation and a reduction in tax payments, partially offset by an increase in pension contributions.

At the end of the period, the Group had gross debt of £1,409m (2015: £1,313m) and cash reserves of £431m (2015: £495m).  Of this gross debt, £270m (2015: £163m) falls due for repayment within one year.  The maturity profile of the major tranches of the remaining £1,139m debt is as follows:

2018 - £132m ($175m 7.37% bond)
2019 - £189m ($250m 7.20% bond)
2022 - £304m ($400m 3.625% bond)
2023 - £512m (€600m 1.25% bond)

Acquisitions and Disposals

During the year we completed the purchase of XPD8, a conditioning monitoring business in John Crane, for £8m. In April 2016 we announced the acquisition of Morpho Detection for US$710m. The transaction is expected to complete during 2017, subject to regulatory clearances, and on completion will be merged with Smiths Detection. In September 2016 we announced the disposal of our Artificial lift business in John Crane for US$39.5m. This transaction is expected to conclude during 2017.

Dividend

Dividends paid in the year on ordinary shares amounted to £163m (2015: £160m). The Board has recommended a final dividend of 28.75 pence per share to be paid on 18 November 2016 to shareholders on the register at close of business on 21 October. When added to the 2016 interim dividend of 13.25p per share paid on 22 April 2016, this represents an increase of 2.4% on the 2015 full year dividend of 41 pence per share.

Retirement benefits

During the year agreement was reached on the triennial valuations with the Trustees of both major UK pension schemes.  As a result, total required cash contributions to defined benefit pension schemes will fall substantially from £124m in 2016 to around £50m in 2017.

Following the transfer of all current US pensioners to Voya Retirement Insurance and Annuity Company in August 2015, around 60% of the gross liabilities of the US scheme are insured through a buy-out contract. See note 8 for information on pension transactions.

As required by IFRS, the balance sheet reflects the net surplus or deficit in retirement benefit plans, taking assets at their market values at 31 July 2016 and evaluating liabilities at period-end AA corporate bond interest rates.

The tables below disclose the net status across a number of individual plans. Where any individual plan shows a surplus under IAS 19, this is disclosed on the balance sheet as a retirement benefit asset. The IAS 19 surplus of any one plan is not available to fund the IAS 19 deficit of another plan. The net pension position has improved to a surplus of £80m at 31 July 2016 from a deficit of £108m at 31 July 2015.

The accounting basis under IAS 19 does not necessarily reflect the funding basis agreed with the Trustees and, should the schemes be wound up while they had members, they would need to buy out the benefits of all members. The buyouts would cost significantly more than the present value of scheme liabilities calculated in accordance with IAS 19.

 

 

31 July
2016

31 January
2016

31 July
2015

Funded plans

 

 

 

 

UK plans - funding status

 

109%

111%

104%

US plans - funding status

 

69%

61%

78%

Other plans - funding status

 

88%

85%

86%

Total - funding status

 

105%

107%

100%

 

 

31 July
2016

31 January
2016

31 July
2015

Surplus/(deficit)

 

 

 

 

Funded plans

 

218

249

7

Unfunded plans

 

(137)

(120)

(115)

Total deficit

 

80

129

(108)

 

 

 

 

 

Retirement benefit assets

 

328

361

170

Retirement benefit liabilities

 

(248)

(232)

(278)

 

 

80

129

(108)

 

The approximate pension membership for the three main schemes at 31 July 2016 is set out in the table below:

Pension scheme members as at 31 July 2015

SIPS

TIGPS

US plans

Total

Deferred active

350

240

2,250

2,840

Deferred

10,310

12,160

3,020

25,490

Pensioners

12,560

16,300

250

29,110

Total

23,220

28,700

5,520

57,440

 

Goodwill and intangibles

Goodwill on acquisitions has been capitalised since 1998. Until 1 August 2004 it was amortised over a maximum 20-year period. Under IFRS goodwill is no longer amortised but instead is subject to annual reviews to test for impairment.

Intangible assets arising from business combinations ('acquired intangibles') are assessed at the time of acquisition in accordance with IFRS 3 (Revised) and are amortised over their expected useful life. This amortisation is excluded from the measure of headline profits. When indicators of impairments are identified, the intangible assets are tested and any impairment identified is charged in full. The impairment charge is excluded from the measure of headline profits. Other intangible assets comprise development costs or software which are capitalised as intangible assets as required by IFRS. Amortisation charged on these assets is deducted from headline profits.

Return on capital employed

The return on capital employed (ROCE) is calculated over a rolling 12-month period and the percentage that headline operating profit comprises of monthly average capital employed. Capital employed comprises total equity adjusted for goodwill recognised directly in reserves, post-retirement benefit-related assets and liabilities net of tax, litigation provisions relating to non-headline items net of tax, and net debt. ROCE decreased 70 basis points to 15.3% (2015: 16.0%) as a result of reduced profitability in John Crane and Flex-Tek. ROCE in Smiths Medical, Smiths Detection and Smiths Interconnect have improved.

Exchange rates

The results of overseas operations are translated into sterling at average exchange rates. The net assets are translated at year-end rates. The principal exchange rates, expressed in terms of the value of sterling, are shown in the following table.

 

31 July
2016

31 July
2015

 

31 January
2016

Average rates:

 

 

 

 

US dollar

1.46

1.56

Dollar strengthened 6%

1.51

Euro

1.32

1.33

Euro strengthened 1%

1.37

Year-end rates:

 

 

 

 

US dollar

1.32

1.56

Dollar strengthened 15%

1.42

Euro

1.19

1.42

Euro strengthened 17%

1.31

 

Financial information

The financial information in this preliminary announcement which comprises the consolidated income statement, consolidated statement of comprehensive income, consolidated balance sheet, consolidated cash-flow statement, consolidated statement of changes in equity, accounting policies and related notes does not constitute statutory accounts within the meaning of Section 434 of the Companies Act 2006.

The statutory accounts for the year ended 31 July 2015 have been filed with the Register of Companies. The auditors have reported on those accounts and on the statutory accounts for the year ended 31 July 2016, which will be filed with the Registrar of Companies following the Annual General Meeting. Both the audit reports were unqualified and did not contain any statement under section 498 of the Companies Act 2006.

 

_______________________________________________________

 

Consolidated income statement

 

 

Year ended 31 July 2016

Year ended 31 July 2015

 

Notes

Headline
£m

Non-headline
(note 3)
£m

Total
£m

Headline
£m

Non-headline
(note 3)
£m

Total
£m

Continuing operations

 

 

 

 

 

 

 

Revenue

1

2,949

 

2,949

2,897

 

2,897

Cost of sales

 

(1,600)

 

(1,600)

(1,564)

 

(1,564)

Gross profit

 

1,349

 

1,349

1,333

 

1,333

Sales and distribution costs

 

(403)

 

(403)

(406)

 

(406)

Administrative expenses

 

(436)

(139)

(575)

(416)

(117)

(533)

Other operating income

 

 

16

16

 

 

 

Operating profit

2

510

(123)

387

511

(117)

394

Interest receivable

 

3

 

3

3

 

3

Interest payable

 

(62)

 

(62)

(55)

 

(55)

Other financing gains/(losses)

 

 

15

15

 

(9)

(9)

Other finance income/(charges) - retirement benefits

8

 

3

3

 

(8)

(8)

Finance costs

4

(59)

18

(41)

(52)

(17)

(69)

Profit before taxation

 

451

(105)

346

459

(134)

325

Taxation

6

(113)

28

(85)

(117)

40

(77)

Profit for the period

 

338

(77)

261

342

(94)

248

Attributable to

 

 

 

 

 

 

 

Smiths Group shareholders

 

336

(77)

259

340

(94)

246

Non-controlling interests

 

2

 

2

2

 

2

 

 

338

(77)

261

342

(94)

248

Earnings per share

5

 

 

 

 

 

 

Basic

 

 

 

65.6p

 

 

62.4p

Diluted

 

 

 

64.9p

 

 

61.8p

 

Consolidated statement of comprehensive income

 



Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Profit for the period

 

261

248

Other comprehensive income

 

 

 

Actuarial (losses)/gains on retirement benefits

8

(40)

60

Taxation recognised on actuarial movements

6

10

21

Other comprehensive income and expenditure which will not be reclassified to the consolidated income statement

 

(30)

81

 

 

 

 

Other comprehensive income which will be reclassified and reclassifications

 

 

 

Exchange gains

 

420

9

 

 

 

 

Fair value gains/(losses) and reclassification adjustments

 

 

 

- deferred on available for sale financial assets

 

(2)

11

- reclassified to income statement on available for sale financial assets

4

(19)

 

- deferred in the period on cash-flow and net investment hedges

 

(238)

(6)

- reclassified to income statement on cash-flow and net investment hedges

 

 

1

Total other comprehensive income

 

131

96

Total comprehensive income

 

392

344

Attributable to

 

 

 

Smiths Group shareholders

 

386

343

Non-controlling interests

 

6

1

 

 

392

344

 

Consolidated balance sheet

 

Notes

31 July 2016
£m

31 July 2015
£m

Non-current assets

 

 

 

Intangible assets

10

1,742

1,518

Property, plant and equipment

12

315

259

Financial assets - other investments

16

9

156

Retirement benefit assets

8

328

170

Deferred tax assets

6

246

218

Trade and other receivables

14

51

40

Financial derivatives

19

29

4

 

 

2,720

2,365

Current assets

 

 

 

Inventories

13

478

454

Current tax receivable

6

62

30

Trade and other receivables

14

745

616

Cash and cash equivalents

17

431

495

Financial derivatives

19

13

20

 

 

1,729

1,615

Assets of business held for sale

27

24

 

Total assets

 

4,473

3,980

Non-current liabilities

 

 

 

Financial liabilities

 

 

 

- borrowings

17

(1,139)

(1,150)

- financial derivatives

19

(1)

(6)

Provisions for liabilities and charges

22

(305)

(253)

Retirement benefit obligations

8

(248)

(278)

Deferred tax liabilities

6

(95)

(71)

Trade and other payables

15

(29)

(24)

 

 

(1,817)

(1,782)

Current liabilities

 

 

 

Financial liabilities

 

 

 

- borrowings

17

(270)

(163)

- financial derivatives

19

(19)

(12)

Provisions for liabilities and charges

22

(94)

(79)

Trade and other payables

15

(536)

(466)

Current tax payable

6

(72)

(50)

 

 

(991)

(770)

Liabilities of business held for sale

27

(5)

 

Total liabilities

 

(2,813)

(2,552)

Net assets

 

1,660

1,428

Shareholders' equity

 

 

 

Share capital

23

148

148

Share premium account

 

352

349

Capital redemption reserve

 

6

6

Revaluation reserve

 

1

1

Merger reserve

 

235

235

Retained earnings

 

1,205

743

Hedge reserve

25

(301)

(63)

Total shareholders' equity

 

1,646

1,419

Non-controlling interest equity

 

14

9

Total equity

 

1,660

1,428

 

Consolidated statement of changes in equity

 



Notes

Share capital
 and share
premium
£m

Other
 reserves
£m

Retained earnings
£m

Hedge
reserve
£m

Equity
shareholders'
funds
£m

Non-controlling
Interest
£m

Total
equity
£m

At 31 July 2015

 

497

242

743

(63)

1,419

9

1,428

Profit for the period

 

 

 

259

 

259

2

261

Other comprehensive income

 

 

 

 

 

 

 

 

Actuarial loss on retirement benefits and tax

 

 

 

(30)

 

(30)

 

(30)

Exchange gains

 

 

 

416

 

416

4

420

Fair value gains/(losses)

 

 

 

(21)

(238)

(259)

 

(259)

Total comprehensive income for the period

 

 

 

624

(238)

386

6

392

Transactions relating to ownership interests

 

 

 

 

 

 

 

 

Exercises of share options

23

3

 

 

 

3

 

3

Purchase of own shares

25

 

 

(8)

 

(8)

 

(8)

Dividends

 

 

 

 

 

 

 

 

- equity shareholders

24

 

 

(163)

 

(163)

 

(163)

- non-controlling interests

 

 

 

 

 

 

(1)

(1)

Share-based payment

9

 

 

9

 

9

 

9

At 31 July 2016

 

500

242

1,205

(301)

1,646

14

1,660

 


Notes

Share capital
 and share
premium
£m

Other
 reserves
£m

Retained earnings
£m

Hedge
reserve
£m

Equity shareholders'
funds
£m

Non-controlling
Interest
£m

Total
equity
£m

At 31 July 2014

 

494

242

559

(58)

1,237

8

1,245

Profit for the year

 

 

 

246

 

246

2

248

Other comprehensive income

 

 

 

 

 

 

 

 

Actuarial losses on retirement benefits and related tax

 

 

 

81

 

81

 

81

Exchange (losses)/gains

 

 

 

10

 

10

(1)

9

Fair value gains/(losses) and related tax

 

 

 

11

(5)

6

 

6

Total comprehensive income for the year

 

 

 

348

(5)

343

1

344

Transactions relating to ownership interests

 

 

 

 

 

 

 

 

Exercises of share options

23

3

 

 

 

3

 

3

Taxation recognised on share options

6

 

 

(1)

 

(1)

 

(1)

Purchase of own shares

25

 

 

(11)

 

(11)

 

(11)

Dividends

 

 

 

 

 

 

 

 

- equity shareholders

24

 

 

(160)

 

(160)

 

(160)

- non-controlling interest

 

 

 

 

 

 

 

 

Share-based payment

9

 

 

8

 

8

 

8

At 31 July 2015

 

497

242

743

(63)

1,419

9

1,428

 

Consolidated cash-flow statement

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Net cash inflow from operating activities

26

358

266

Cash-flows from investing activities

 

 

 

Expenditure on capitalised development

 

(23)

(18)

Expenditure on other intangible assets

 

(11)

(18)

Purchases of property, plant and equipment

12

(74)

(59)

Disposals of property, plant and equipment

 

1

11

Investment in financial assets

 

(9)

(27)

Acquisition of businesses

 

(8)

 

Disposals of businesses

 

 

2

Net cash-flow used in investing activities

 

(124)

(109)

 

 

 

 

Cash-flows from financing activities

 

 

 

Proceeds from exercise of share options

23

3

3

Purchase of own shares

 

(8)

(11)

Dividends paid to equity shareholders

24

(163)

(160)

Cash (outflow)/inflow from matured derivative financial instruments

 

(14)

4

Increase in new borrowings

 

1

568

Reduction and repayment of borrowings

 

(151)

(257)

Net cash-flow used in financing activities

 

(332)

147

 

 

 

 

Net (decrease)/increase in cash and cash equivalents

 

(98)

304

Cash and cash equivalents at beginning of year

 

495

189

Exchange differences

 

33

2

Cash and cash equivalents at end of year

17

430

495

Cash and cash equivalents at end of year comprise

 

 

 

- cash at bank and in hand

 

161

104

- short-term deposits

 

270

391

- bank overdrafts

 

(1)

 

 

 

430

495

 

 

 

 

Included in cash and cash equivalents per the balance sheet

 

431

495

Included in overdrafts per the balance sheet

 

(1)

 

 

 

430

495

 

Reconciliation of net cash-flow to movement in net debt

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Net debt at start of year

17

(818)

(804)

Net (decrease)/increase in cash and cash equivalents

 

(98)

304

Increase in borrowings 

 

(1)

(568)

Reduction and repayment of borrowings

 

151

257

Movement in net debt resulting from cash-flows

 

52

(7)

Capitalisation, interest accruals and unwind of capitalisation fees

 

(2)

(1)

Movement from fair value hedging

 

(23)

7

Exchange differences

 

(187)

(13)

Movement in net debt in the year

 

(160)

(14)

Net debt at end of year

17

(978)

(818)

 

Accounting policies

Basis of preparation

The accounts have been prepared in accordance with the Companies Act 2006 applicable to companies reporting under International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee (IFRS IC) interpretations, as adopted by the European Union, on a going concern basis and under the historical cost convention modified to include revaluation of certain financial instruments, share options and pension assets and liabilities, held at fair value as described below.

The accounting policies adopted are consistent with those of the previous financial year.

Significant judgements, key assumptions and estimates

The preparation of the accounts in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates. The key estimates and assumptions used in these consolidated financial statements are set out below.

Revenue recognition

The timing of revenue recognition on contracts depends on the assessed stage of completion of contract activity at the balance sheet date. This assessment requires the expected total contract revenues and costs to be estimated based on the current progress of the contract. Revenue of £42m (2015: £39m) has been recognised in the period in respect of contracts in progress at the period end with a total expected value of £175m (2015: £137m) and cumulative revenue recognised to date of £137m (2015: £100m). A 5% reduction in the proportion of the contract activity recognised in the current period would have reduced operating profit by less than £1m for both Smiths Detection and Smiths Interconnect (2015: less than £1m).

Smiths Detection also has multi-year contractual arrangements for the sale of goods and services. Where these contracts have separately identifiable components with distinct patterns of delivery and customer acceptance, revenue is accounted for separately for each identifiable component. Judgement is applied in the identification of the components of the contract, and the allocation of contract revenue to each component.

Smiths Medical has rebate arrangements in place with some distributors in respect of sales to end customers where sales prices have been negotiated by Smiths Medical. Rebates are estimated based on the level of discount derived from sales data from distributors, the amount of inventory held by distributors and the time lag between the initial sale to the distributor and the rebate being claimed. The rebate accrual at 31 July 2016 was £28m (2015: £21m).

Contract profitability

Smiths Detection has multi-year contractual arrangements for the sale of goods and services. Margins achieved on these contracts can reflect the impact of commercial decisions made in different economic circumstances. In addition, contract delivery is subject to commercial and technical risks which can affect the outcome of the contract. At 31 July 2016 there was £4m (2015: £7m) balance sheet liability in respect of ongoing onerous contracts and no other contracts had been assessed as at significant risk of becoming onerous.

Taxation

The Group has recognised deferred tax assets of £87m (2015: £28m) relating to losses and £120m (2015: £99m) relating to the John Crane, Inc. and Titeflex Corporation litigation provisions. The recognition of assets pertaining to these items involves judgement by management as to the likelihood of realisation of these deferred tax assets. This is based on a number of factors, which seek to assess the expectation that the benefit of these assets will be realised, including expected future levels of operating profit, expenditure on litigation, pension contributions and the timing of the unwind of other tax positions. It has been concluded that there are sufficient taxable profits in future periods to support recognition. A 5% reduction in expected future operating profits would reduce the level of deferred tax recognised by £9m (2015: £10m), and a 5% increase in expected future operating profits would increase the level of deferred tax recognised by £11m (2015: £10m). Further detail on the Group's deferred taxation position is included in note 6.

Retirement benefits

The consolidated financial statements include costs in relation to, and provision for, retirement benefit obligations. The costs and the present value of any related pension assets and liabilities depend on such factors as life expectancy of the members, the returns that plan assets generate and the discount rate used to calculate the present value of the liabilities. The Group uses previous experience and independent actuarial advice to select the values of critical estimates. The estimates, and the effect of variances in key estimates, are disclosed in note 8.

At 31 July 2016 there is a retirement benefit asset of £328m (2015: £170m), principally relating to UK schemes, which arises from the rights of the employers to recover the surplus at the end of the life of the scheme. If the pension schemes were wound up while they still had members, the schemes would need to buy out the benefits of all members. The buyouts would cost significantly more than the present value of the scheme liabilities calculated in accordance with IAS 19: Employee benefits.

Receivables provisions

If the carrying value of any receivable is higher than the fair value, the Group makes provisions writing down the balance to its fair value. The fair value of receivables is considered individually for each customer and incorporates past experience and progress with collecting receivables.

At 31 July 2016 the gross value of receivables partly provided for or more than three months overdue was £83m (2015: £57m) and there were provisions of £31m (2015: £22m) against these receivables. Consequently, these receivables were carried at a net value of £52m (2015: £35m). See note 14 for disclosures on credit risk and ageing of trade receivables.

Inventory provisions

The calculation of inventory provisions requires judgement by management of the expected value of future sales. If the carrying value of inventory is higher than the expected recoverable value, the Group makes provisions writing inventory down to its net recoverable value. Inventory is initially assessed for impairment by comparing inventory levels to recent utilisation rates and carrying values to historical selling prices. A detailed review is completed for inventory lines identified in the initial assessment considering sales activity, order flow, customer contracts and current selling prices.

At 31 July 2016, there were provisions of £70m (2015: £72m) against gross inventory of £548m (2015: £528m). See note 13 for a breakdown of inventory.

A 10% increase in the proportion of raw materials provided for would increase the provision by £20m (2015: £18m) and a 10% increase in the proportion of finished goods provided for would increase the provision by £23m (2015: £24m).

Impairment

Goodwill is tested at least annually for impairment and other assets, including intangible assets acquired in business combinations, are tested if there are any indications of impairment, in accordance with the accounting policy set out below. The recoverable amounts of cash generating units and assets are determined based on value in use calculations unless future trading projections cannot be adjusted to eliminate the impact of a major restructuring. The value in use calculations require the use of estimates including projected future cash-flows and other future events.  

See note 11 for details of the critical assumptions made, including the sales and margin volatility in Smiths Interconnect and disclosures on the sensitivity of the impairment testing to these key assumptions, including details of the changes in assumptions which would be required to trigger an impairment in Smiths Interconnect Power.

Provisions for liabilities and charges

As previously reported, John Crane, Inc., a subsidiary of the Group, is currently one of many co-defendants in litigation relating to products previously manufactured which contained asbestos. Provision of £252m (2015: £216m) has been made for the future defence costs which the Group is expected to incur and the expected costs of future adverse judgments against John Crane, Inc. Whilst published incidence curves can be used to estimate the likely future pattern of asbestos related disease, John Crane, Inc.'s claims experience is significantly impacted by other factors which influence the US litigation environment. These can include: changing approaches on the part of the plaintiffs' bar; changing attitudes amongst the judiciary at both trial and appellate levels; and legislative and procedural changes in both the state and federal court systems. Therefore, because of the significant uncertainty associated with the future level of asbestos claims and of the costs arising out of the related litigation, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred. John Crane, Inc. takes account of the advice of an expert in asbestos liability estimation in quantifying the expected costs.

As previously reported, Titeflex Corporation, a subsidiary of the Group in the Flex-Tek division, has received a number of claims from insurance companies seeking recompense on a subrogated basis for the effects of damage allegedly caused by lightning strikes in relation to its flexible gas piping product. It has also received a number of product liability claims regarding this product, some in the form of purported class actions. Titeflex Corporation believes that its products are a safe and effective means of delivering gas when installed in accordance with the manufacturer's instructions and local and national codes; however some claims have been settled on an individual basis without admission of liability. Provision of £94m (2015: £71m) has been made for the costs which the Group is expected to incur in respect of these claims. However, because of the significant uncertainty associated with the future level of claims, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred.

The Group has on occasion been required to take legal action to protect its intellectual property and other rights against infringement. It has also had to defend itself against proceedings brought by other parties, including product liability and insurance subrogation claims. Provision is made for any expected costs and liabilities in relation to these proceedings where appropriate, though there can be no guarantee that such provisions (which may be subject to potentially material revision from time to time) will accurately predict the actual costs and liabilities that may be incurred.

All provisions may be subject to potentially material revisions from time to time if new information becomes available as a result of future events. See note 22 for details of the assumptions and disclosures on the sensitivity of the provision calculations.

Presentation of results

In order to provide users of the accounts with a clear and consistent presentation of the underlying performance of the Group's ongoing trading activity, Smiths Group plc presents its results in the income statements with amounts relating to costs of acquisitions and disposals, amortisation of acquired intangibles, impairments, legacy liabilities, significant restructuring, material one-off items and certain re-measurements in a separate column. See note 3 for a breakdown of the items excluded from headline operating profit and headline finance costs.

Measures of the underlying performance of the Group's ongoing trading activity are described as 'headline' and used by management to measure and monitor performance. See note 1 for disclosures of headline operating profit and note 28 for more information about the calculation of return on capital employed and credit metrics.

Accounting policies

Basis of consolidation

The consolidated accounts incorporate the financial statements of Smiths Group plc ("the Company") and its subsidiary undertakings, together with the Group's share of the results of its associates.

Subsidiaries are all entities controlled by the Company. Subsidiaries are fully consolidated from the date on which control is obtained by the Company to the date that control ceases.

Associates are entities over which the Group has significant influence but does not control, generally accompanied by a share of between 20% and 50% of the voting rights. Investments in associates are accounted for using the equity method.

Foreign currencies

The Company's presentational currency is sterling. The results and financial position of all subsidiaries and associates that have a functional currency different from sterling are translated into sterling as follows:

▪ assets and liabilities are translated at the rate of exchange at the date of that balance sheet;

▪ income and expenses are translated at average exchange rates for the period; and

▪ all resulting exchange differences are recognised as a separate component of equity.

On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders' equity. When a foreign operation is sold, the cumulative amount of such exchange differences is recognised in the income statement as part of the gain or loss on sale.

Exchange differences arising on transactions are recognised in the income statement. Those arising on trading are taken to operating profit; those arising on borrowings are classified as finance income or cost.

For the convenience of users, supplementary primary financial statements translated into US dollars have been presented after the Group financial record. Assets and liabilities have been translated into US dollars at the exchange rate at the date of that balance sheet and income, expenses and cash-flows are translated at average exchange rates for the period.

Revenue

Revenue is measured at the fair value of the consideration received, net of trade discounts (including distributor rebates) and sales taxes. Revenue is discounted only where the impact of discounting is material.

When the Group enters into complex contracts with multiple, separately identifiable components, the terms of the contract are reviewed to determine whether or not the elements of the contract should be accounted for separately. If a contract is being split into multiple components, the contract revenue is allocated to the different components at the start of the contract. The basis of allocation depends on the substance of the contract. The Group considers relative stand-alone selling prices, contractual prices and relative cost when allocating revenue.

Sale of goods

Revenue from the sale of goods is recognised when the risks and rewards of ownership have been transferred to the customer, the amount of revenue can be measured reliably and recovery of the consideration is probable. For established products with simple installation requirements, revenue is recognised when the product is delivered to the customer in accordance with the agreed delivery terms. For products which are technically innovative, highly customised or require complex installation, revenue is recognised when the customer has completed its acceptance procedures.

Services

Revenue from services is recognised in accounting periods in which the services are rendered, by reference to completion of the specific transaction, assessed on the basis of the actual service provided as a proportion of the total services to be provided. Depending on the nature of the contract, revenue will be recognised on the basis of the proportion of the contract term completed, the proportion of the contract costs incurred or the specific services provided to date.

Construction contracts

Contracts for the construction of substantial assets are accounted for as construction contracts if the customer specifies major structural elements of the design, including the ability to amend the design during the construction process. These projects normally involve installing customised systems with site-specific integration requirements.

Where the outcome of a construction contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date. The Group uses the 'percentage of completion method' to determine the appropriate amount to recognise in a given period. The assessment of the stage of completion is dependent on the nature of the contract, but will generally be based on the estimated proportion of the total contract costs which have been incurred to date. If a contract is expected to be loss-making, a provision is recognised for the entire loss.

Leases

Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.

Taxation

The charge for taxation is based on profits for the year and takes into account taxation deferred because of temporary differences between the treatment of certain items for taxation and accounting purposes.

Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to taxation authorities. Tax benefits are not recognised unless it is likely that the tax positions are sustainable. Once considered to be likely, tax benefits are reviewed to assess whether a provision should be made based on prevailing circumstances. Tax provisions are included in current tax labilities, including any anticipated interest & penalties. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted, at the reporting date in the countries where the Group operates and generates taxable income.

Deferred tax is provided in full using the balance sheet liability method. A deferred tax asset is recognised where it is probable that future taxable income will be sufficient to utilise the available relief. Tax is charged or credited to the income statement except when it relates to items charged or credited directly to equity, in which case the tax is also dealt with in equity.

Deferred tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the timing of the reversal of the temporary differences is controlled by the Company and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax liabilities and assets are not discounted.

Employee benefits

Pension obligations and post-retirement benefits

The Group has defined benefit plans, defined contribution plans and post-retirement healthcare schemes.

For defined benefit plans and post-retirement healthcare schemes the liability for each scheme recognised in the balance sheet is the present value of the obligation at the balance sheet date less the fair value of any plan assets. The obligation is calculated annually by independent actuaries using the projected unit credit method. The present value is determined by discounting the estimated future cash outflows using interest rates of AA-rated corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related liability. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recognised in full in the period in which they occur, outside of the income statement, and are presented in the statement of comprehensive income. Past service costs are recognised immediately in the income statement.

For defined contribution plans, the Group pays contributions to publicly or privately administered pension insurance plans on a mandatory, contractual or voluntary basis. Contributions are expensed as incurred.

Discontinued operations

A discontinued operation is a component of the Group's business that represents a separate major line of business or geographical area of operations that has been disposed of, has been abandoned or meets the criteria to be classified as held for sale.

Discontinued operations are presented on the income statement as a separate line and are shown net of tax.

Intangible assets

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the Group's share of the identifiable net assets of the acquired subsidiary at the date of acquisition.

Goodwill arising from acquisitions of subsidiaries after 1 August 1998 is included in intangible assets, tested annually for impairment and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. Goodwill arising from acquisitions of subsidiaries before 1 August 1998 was set against reserves in the year of acquisition.

Goodwill is tested for impairment at least annually. Any impairment is recognised immediately in the income statement. Subsequent reversals of impairment losses for goodwill are not recognised.

Research and development

Expenditure on research and development is charged to the income statement in the year in which it is incurred with the exception of:

▪ amounts recoverable from third parties; and

▪ expenditure incurred in respect of the development of major new products where the outcome of those projects is assessed as being reasonably certain as regards viability and technical feasibility. Such expenditure is capitalised and amortised over the estimated period of sale for each product, commencing in the year that sales of the product are first made. Amortisation is charged straight line or based on the units produced, depending on the nature of the product and the availability of reliable estimates of production volumes.

The cost of development projects which are expected to take a substantial period of time to complete, and commenced after 1 August 2009, includes attributable borrowing costs.

Intangible assets acquired in business combinations

The identifiable net assets acquired as a result of a business combination may include intangible assets other than goodwill. Any such intangible assets are amortised straight line over their expected useful lives as follows:

Patents, licences and trademarks

up to 20 years

Technology

up to 12 years

Customer relationships

up to 7 years

 

The assets' useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Software, patents and intellectual property

The estimated useful lives are as follows:

Software

up to 7 years

Patents and intellectual property

shorter of the economic life and the period the right is legally enforceable

 

The assets' useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Property, plant and equipment

Property, plant and equipment is stated at historical cost less accumulated depreciation and any recognised impairment losses.

Land is not depreciated. Depreciation is provided on other assets estimated to write off the depreciable amount of relevant assets by equal annual instalments over their estimated useful lives. In general, the rates used are: Freehold and long leasehold buildings - 2%; Short leasehold property - over the period of the lease; Plant, machinery, etc. - 10% to 20%; Fixtures, fittings, tools and other equipment - 10% to 33%.

The cost of any assets which are expected to take a substantial period of time to complete and whose construction began after 1 August 2009 includes attributable borrowing costs.

The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount.

Inventories

Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). The cost of items of inventory which take a substantial period of time to complete includes attributable borrowing costs for all items whose production began after 1 August 2009. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses.

Trade and other receivables

Trade receivables are initially recognised at fair value and subsequently measured at amortised cost, less any appropriate provision for estimated irrecoverable amounts. A provision is established for irrecoverable amounts when there is objective evidence that amounts due under the original payment terms will not be collected.

Provisions

Provisions for warranties and product liability, disposal indemnities, restructuring costs, vacant leasehold property and legal claims are recognised when: the Company has a legal or constructive obligation as a result of a past event; it is probable that an outflow of resources will be required to settle the obligation; and the amount has been reliably estimated. Provisions are not recognised for future operating losses.

Provisions are discounted where the time value of money is material.

Where there are a number of similar obligations, for example where a warranty has been given, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognised even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

Assets and businesses held for sale

Assets and businesses classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. Impairment losses on initial classification as held for sale and gains or losses on subsequent remeasurements are included in the income statement. No depreciation is charged on assets and businesses classified as held for sale.

Assets and businesses are classified as held for sale if their carrying amount will be recovered or settled principally through a sale transaction rather than through continuing use. The asset or business must be available for immediate sale and the sale must be highly probable within one year.

Cash and cash equivalents

Cash and cash equivalents include cash at bank and in hand and highly liquid interest-bearing securities with maturities of three months or less.

In the cash-flow statement, cash and cash equivalents are shown net of bank overdrafts, which are included as current borrowings in liabilities on the balance sheet.

Financial assets

The classification of financial assets depends on the purpose for which the assets were acquired. Management determines the classification of an asset at initial recognition and re-evaluates the designation at each reporting date. Financial assets are classified as: loans and receivables, available for sale financial assets or financial assets where changes in fair value are charged (or credited) to the income statement.

Financial assets are initially recognised at transaction price when the Group becomes party to contractual obligations. The transaction price used includes transaction costs unless the asset is being fair valued through the income statement.

The subsequent measurement of financial assets depends on their classification. Loans and receivables are measured at amortised cost using the effective interest rate method. Available for sale financial assets are subsequently measured at fair value, with unrealised gains and losses being recognised in other comprehensive income. Financial assets where changes in fair value are charged (or credited) to the income statement are subsequently measured at fair value. Realised and unrealised gains and losses arising from changes in the fair value of the 'financial assets at fair value through the income statement' category are included in the income statement in the period in which they arise.

Financial assets are derecognised when the right to receive cash-flows from the assets has expired, or has been transferred, and the Company has transferred substantially all of the risks and rewards of ownership. When securities classified as available for sale are sold or impaired, the accumulated fair value adjustments previously taken to reserves are included in the income statement.

Financial assets are classified as current if they are expected to be realised within 12 months of the balance sheet date.

Financial liabilities

Borrowings are initially recognised at the fair value of the proceeds, net of related transaction costs. These transaction costs, and any discount or premium on issue, are subsequently amortised under the effective interest rate method through the income statement as interest over the life of the loan, and added to the liability disclosed in the balance sheet. Related accrued interest is included in the borrowings figure.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least one year after the balance sheet date.

Derivative financial instruments and hedging activities

Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured at their fair value. The method of recognising any resulting gain or loss depends on whether the derivative is designated as a hedging instrument and, if so, the nature of the item being hedged.

Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognised immediately in the income statement.

Fair value hedge

Changes in the fair values of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair values of the hedged assets or liabilities that are attributable to the hedged risk.

Net investment hedge

Hedges of net investments in foreign operations are accounted for similarly to cash-flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income; the gain or loss relating to any ineffective portion is recognised immediately in the income statement.

When a foreign operation is disposed of, gains and losses accumulated in equity related to that operation are included in the income statement.

Cash-flow hedge

The effective portions of changes in the fair values of derivatives that are designated and qualify as cash-flow hedges are recognised in equity. The gain or loss relating to any ineffective portion is recognised immediately in the income statement.

Amounts accumulated in the hedge reserve are recycled in the income statement in the periods when the hedged items will affect profit or loss (for instance when the forecast sale that is hedged takes place). If a forecast transaction that is hedged results in the recognition of a non-financial asset (for example, inventory) or a liability, the gains and losses previously deferred in the hedge reserve are transferred from the reserve and included in the initial measurement of the cost of the asset or liability.

When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in the hedge reserve at that time remains in the reserve and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in other comprehensive income is immediately transferred to the income statement.

Fair value of financial assets and liabilities

The fair values of financial assets and financial liabilities are the amounts at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.

'IFRS 13: Fair value measurement' requires fair value measurements to be classified according to the following hierarchy:

▪ level 1 - quoted prices in active markets for identical assets or liabilities;

▪ level 2 - valuations in which all inputs are observable either directly (ie as prices) or indirectly (ie derived from prices); and

▪ level 3 - valuations in which one or more inputs that are significant to the resulting value are not based on observable market data.

See note 20 for information on the methods the Group uses to estimate the fair values of its financial instruments.

Dividends

Dividends are recognised as a liability in the period in which they are authorised. The interim dividend is recognised when it is paid and the final dividend is recognised when it has been approved by shareholders at the Annual General Meeting.

Recent accounting developments

The following standards and interpretations have been issued by the IASB and will affect future annual reports and accounts.

▪ 'IFRS 9: Financial instruments'

▪ 'IFRS 15: Revenue from contracts with customers'

▪ 'IFRS 16: Leases'

A review of the impact of these standards and interpretations is being undertaken, and the impact of adopting them will be determined once this review has been completed. In particular the review of the impact of 'IFRS 15: Revenue from contracts with customers' will require an assessment at contract level for the military and long-term service businesses, and the impact of adopting this standard cannot be reliably estimated until this work is substantially complete.

These standards are under review by the EU and Smiths currently applies IFRS as adopted by the EU. Smiths will confirm their adoption date when the standards are applicable to Smiths, depending on the EU approval process and developments in the relationship between the UK and the EU.

Notes to the accounts

1 Segment information

Analysis by operating segment

The Group is organised into five divisions: John Crane, Smiths Medical, Smiths Detection, Smiths Interconnect and Flex-Tek. These divisions design and manufacture the following products:

▪ John Crane - mechanical seals, seal support systems, engineered bearings, power transmission couplings and specialist filtration systems;

▪ Smiths Medical - infusion systems, vascular access (including safety needles), patient airway and temperature management equipment and specialty devices in areas of in vitro fertilisation, diagnostics and emergency patient transport;

▪ Smiths Detection - sensors that detect and identify explosives, narcotics, weapons, chemical agents, biohazards and contraband;

▪ Smiths Interconnect - specialised electronic and radio frequency components and sub-systems that connect, protect and control critical systems;

▪ Flex-Tek - engineered components that heat and move fluids and gases, flexible hosing and rigid tubing.

The position and performance of each division is reported at each Board meeting to the Board of Directors. This information is prepared using the same accounting policies as the consolidated financial information except that the Group uses headline operating profit to monitor divisional results and operating assets to monitor divisional position. See note 3 for an explanation of which items are excluded from headline measures.

Intersegment sales and transfers are charged at arm's length prices.

Segment trading performance

 

 

Year ended 31 July 2016

 

John Crane
£m

Smiths
Medical
£m

Smiths
 Detection
£m

Smiths Interconnect
£m

Flex-Tek
£m

Corporate
costs
£m

Total
£m

Revenue

830

874

526

435

284

 

2,949

Divisional headline operating profit

181

187

69

57

51

 

545

Corporate headline operating costs

 

 

 

 

 

(35)

(35)

Headline operating profit/(loss)

181

187

69

57

51

(35)

510

Items excluded from headline measures (note 3)

(30)

(21)

(6)

(31)

(14)

(21)

(123)

Operating profit/(loss)

151

166

63

26

37

(56)

387

 

 

 

Year ended 31 July 2015

 

John Crane
£m

Smiths
Medical
£m

Smiths
 Detection
£m

Smiths Interconnect
£m

Flex-Tek
£m

Corporate
costs
£m

Total
£m

Revenue

905

836

467

420

269

 

2,897

Divisional headline operating profit

225

166

55

49

50

 

545

Corporate headline operating costs

 

 

 

 

 

(34)

(34)

Headline operating profit/(loss)

225

166

55

49

50

(34)

511

Items excluded from headline measures (note 3)

(60)

(24)

(10)

(21)

(9)

7

(117)

Operating profit/(loss)

165

142

45

28

41

(27)

394



 

Divisional headline operating profit is stated after charging/(crediting) the following items:


Year ended 31 July 2016


John Crane
£m

Smiths
Medical
£m

Smiths
 Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Reconciling
items
£m

Total
£m

Depreciation

15

20

6

8

3

1

53

Amortisation of capitalised development

 

14

12

 

 

 

26

Amortisation of software, patents and intellectual property

2

4

3

2

 

6

17

Amortisation of acquired intangibles

 

 

 

 

 

15

15

Impairment of goodwill

 

 

 

 

 

23

23

Impairment of trade investments

 

 

 

 

 

2

2

Impairment of property, plant and equipment

 

 

 

 

 

6

6

Share-based payment

1

2

1

1

1

4

10

 

 

Year ended 31 July 2015

 

John Crane
£m

Smiths
Medical
£m

Smiths
 Detection
£m

Smiths Interconnect
£m

Flex-Tek
£m

Reconciling
items
£m

Total
£m

Depreciation

14

18

4

9

3

1

49

Amortisation of capitalised development

 

13

10

 

 

 

23

Amortisation of software, patents and intellectual property

3

3

2

1

 

6

15

Amortisation of acquired intangibles

 

 

 

 

 

33

33

Impairment of goodwill

 

 

 

 

 

27

27

Share-based payment

2

1

1

 

1

4

9

 

The reconciling items are central costs and charges that are treated as non-headline (see note 3).

Segment assets and liabilities

Segment assets

 

31 July 2016

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
Interconnect
£m

Flex-Tek
£m

Corporate and
non-headline
£m

Total
£m

Property, plant, equipment, development projects,
other intangibles and investments

100

221

95

46

33

15

510

Inventory, trade and other receivables

364

280

316

189

99

26

1,274

Segment assets

464

501

411

235

132

41

1,784

 

 

31 July 2015

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Corporate and
non-headline
£m

Total
£m

Property, plant, equipment, development projects,
other intangibles and investments

96

175

84

38

22

167

582

Inventory, trade and other receivables

351

247

260

160

83

9

1,110

Segment assets

447

422

344

198

105

176

1,692



 

Segment liabilities

 

31 July 2016

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Corporate and
non-headline
£m

Total
£m

Divisional liabilities

(124)

(121)

(196)

(78)

(37)

 

(556)

Corporate and non-headline liabilities

 

 

 

 

 

(408)

(408)

Segment liabilities

(124)

(121)

(196)

(78)

(37)

(408)

(964)

 

 

31 July 2015

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Corporate and
non-headline
£m

Total
£m

Divisional liabilities

(141)

(108)

(156)

(64)

(37)

 

(506)

Corporate and non-headline liabilities

 

 

 

 

 

(316)

(316)

Segment liabilities

(141)

(108)

(156)

(64)

(37)

(316)

(822)

 

Non-headline liabilities comprise provisions and accruals relating to non-headline items, acquisitions and disposals.

Reconciliation to segment assets and liabilities to statutory assets and liabilities

 

 

Assets

 

Liabilities

 

31 July
2016
£m

31 July
2015
£m

31 July
2016
£m

31 July
2015
£m

Segment assets and liabilities

1,784

1,692

(964)

(822)

Goodwill and acquired intangibles

1,556

1,351

 

 

Derivatives

42

24

(20)

(18)

Current and deferred tax

308

248

(167)

(121)

Retirement benefit assets and obligations

328

170

(248)

(278)

Cash and borrowings

431

495

(1,409)

(1,313)

Assets and liabilities of business held for sale

24

 

(5)

 

Statutory assets and liabilities

4,473

3,980

(2,813)

(2,552)

 

Segment capital expenditure

The capital expenditure for each division is:

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Reconciling
items
£m

Total
£m

Capital expenditure year ended 31 July 2016

14

53

19

12

9

3

110

Capital expenditure year ended 31 July 2015

19

44

11

12

5

6

97

 

The reconciling items include corporate capital expenditure through Smiths Business Information Services on IT equipment and software.



 

Segment capital employed

Capital employed is a non-statutory measure of invested resources. It comprises statutory net assets adjusted to add goodwill recognised directly in reserves in respect of subsidiaries acquired before 1 August 1998 of £815m (31 July 2015: £815m) and eliminate post-retirement benefit assets and liabilities and litigation provisions relating to non-headline items, both net of related tax, and net debt. See note 28 for a reconciliation of net assets to capital employed.

The 12-month rolling average capital employed by division, which Smiths use to calculate divisional return on capital employed, is:

 

31 July 2016

 

John Crane
£m

Smiths
Medical
£m

Smiths
Detection
£m

Smiths
Interconnect
£m

Flex-Tek
£m

Total
£m

Average divisional capital employed

895

1,190

578

549

162

3,374

Average corporate capital employed

 

 

 

 

 

(50)

Average total capital employed

 

 

 

 

 

3,324

 

 

31 July 2015

 

John Crane
£m

Smiths
Medical
£m

Smiths
 Detection
£m

Smiths
 Interconnect
£m

Flex-Tek
£m

Total
£m

Average divisional capital employed

872

1,126

577

535

148

3,258

Average corporate capital employed

 

 

 

 

 

(61)

Average total capital employed

 

 

 

 

 

3,197

 

Analysis of revenue

The revenue for the main product and service lines for each division is:

John Crane

 

 

 

 

First-fit
£m

Aftermarket
£m

Total
£m

Revenue year ended 31 July 2016

 

 

 

 

338

492

830

Revenue year ended 31 July 2015

 

 

 

 

396

509

905

 

The detail in the John Crane revenue split has been reduced because the Group considers focusing on the split between First-Fit and Aftermarket revenue provides greater insight into trends affecting John Crane.

Smiths Medical

 

 

 

Infusion
systems
£m

Vascular
access
£m

Vital care
£m

Specialty
products
£m

Total
£m

Revenue year ended 31 July 2016

 

 

 

273

289

240

72

874

Revenue year ended 31 July 2015

 

 

 

262

279

225

70

836

 

Smiths Detection

 

 

 

Transportation
£m

Ports and
borders
£m

Military
£m

Critical
infrastructure
£m

Total
£m

Revenue year ended 31 July 2016

 

 

 

235

89

79

123

526

Revenue year ended 31 July 2015

 

 

 

243

50

69

105

467

 

Smiths Interconnect

 

 

 

 

Connectors
£m

Microwave
£m

Power
£m

Total
£m

Revenue year ended 31 July 2016

 

 

 

 

155

192

88

435

Revenue year ended 31 July 2015 (restated)

 

 

 

 

149

192

79

420

 

The allocation of Smiths Interconnect revenue for the year ended 31 July 2015 has been restated following a reorganisation that moved a business from Power to Microwave.

Flex-Tek

 

 

 

Fluid
Management
£m

Flexible
Solutions
£m

Heat
Solutions
£m

Construction
Products
£m

Total
£m

Revenue year ended 31 July 2016

 

 

 

72

54

66

92

284

Revenue year ended 31 July 2015

 

 

 

69

51

65

84

269



 

The Group's statutory revenue is analysed as follows:

 

 

 

 

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Sale of goods

 

 

 

 

2,607

2,600

Services

 

 

 

 

312

268

Contracts qualifying as construction contracts

 

 

 

 

30

29

 

 

 

 

 

2,949

2,897

 

Analysis by geographical areas

The Group's revenue by destination and non-current operating assets by location are shown below:

 

 

Revenue

Intangible assets and
property plant and
equipment

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

31 July 2016
£m

31 July 2015
£m

United Kingdom

114

121

129

119

Germany

131

128

325

270

France

85

81

17

16

Other European

291

290

70

58

Total European

621

620

541

463

United States of America

1,396

1,378

1,349

1,172

Canada

106

111

14

14

Other North American

33

40

10

9

Total North American

1,535

1,529

1,373

1,195

Japan

101

93

21

14

China (excluding Hong Kong)

95

98

63

57

Rest of the World

597

557

59

48

 

2,949

2,897

2,057

1,777



 

2 Operating profit is stated after charging

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Research and development expense

87

84

Operating leases

 

 

- land and buildings

30

31

- other

8

9

 

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Audit services

 

 

Fees payable to the Company's auditors for the audit of the Company's annual financial statements

3

3

Fees payable to the Company's auditors and its associates for other services

 

 

- the audit of the Company's subsidiaries

2

2

 

5

5

 

 

 

All other services

 

1

 

Other services comprise audit-related assurance services £0.1m (2015: £nil), tax advisory services £0.1m (2015: £0.1m), tax compliance services £nil (2015: £0.1m), one-off IT and consulting projects £nil (2015: £0.4m) and other services £0.1m (2015: £nil). Total fees for non-audit services comprise 6% (2015: 12%) of audit fees. Audit-related assurance services include the review of the Interim Report.

3 Non-statutory profit measures

Headline profit measures

The Company seeks to present a measure of underlying performance which is not impacted by material non-recurring items or items considered non-operational in nature. This measure of profit is described as 'headline' and is used by management to measure and monitor performance. See the disclosures on presentation of results in accounting policies for an explanation of the excluded items. The excluded items are referred to as 'non-headline' items.

Headline operating profit

The non-headline items included in statutory operating profit are as follows:

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Restructuring programmes

 

(37)

(38)

Changes to post-retirement benefits

 

(9)

14

Acquisition and disposal costs and profits on disposal

 

(6)

2

Provision for Titeflex Corporation subrogation claims

 

(11)

(8)

Provision for John Crane, Inc. asbestos litigation

 

(23)

(19)

Cost recovery for John Crane, Inc. asbestos litigation

 

16

 

Legacy retirement benefits administration costs

8

(7)

(8)

Impairment of goodwill, property, plant and equipment and trade investments

 

(31)

(27)

Amortisation of acquired intangible assets

10

(15)

(33)

Non-headline items in operating profit

 

(123)

(117)

 

Material items for the year ended 31 July 2016

Restructuring costs comprise £37m in respect of Fuel for Growth. This programme, which involves redundancy, relocation and consolidation of manufacturing, is considered a material non-recurring item by virtue of its size.

The £9m charge relating to post-retirement benefits comprises the £10m settlement cost for the buy-out of retiree liabilities completed by the US pension scheme on 14 August 2015, net of a £1m settlement gain on closing a small scheme in Holland.

An additional provision of £12m has been recognised by Titeflex Corporation in respect of changes to the estimated cost of future claims from insurance companies seeking recompense for damage allegedly caused by lightning strikes, and £1m overprovision for the costs of settling claims in the year has been released, generating a net charge of £11m.

The operating charge for John Crane, Inc. litigation comprises a charge of £8m in respect of the net increased provision for adverse judgments and legal defence costs, a charge of £7m arising from the decrease in US risk free rates, and £8m costs for litigation management, defence strategy and legal fees in connection with litigation against insurers. This is offset in the income statement by the recovery of £16m through a settlement with one insurer.

Impairments comprise £23m goodwill write-downs (see note 11), £6m on property plant and equipment and £2m on trade investments.

Material items for the year ended 31 July 2015

Restructuring costs included £39m in respect of Fuel for Growth and a £1m credit for provisions relating to earlier restructuring programmes which were released in the period.

Gains of £14m on changes to post-retirement benefits arose from a settlement offer by the US defined benefit pension plans - allowing deferred members a one-off option to elect to cash out their retirement entitlements rather than receive a pension at retirement - which was completed in September 2014.

A charge of £8m was made by Titeflex Corporation in respect of changes to the estimated cost of future claims including those from insurance companies seeking recompense for damage allegedly caused by lightning strikes. The change comprised £7m in respect of movements in the gross provision and £1m relating to changes in discounting.

The operating charge in respect of John Crane, Inc. litigation comprised £14m in respect of increased provision, £4m in respect of litigation management and legal fees in connection with litigation against insurers, and £1m arising from the decrease in US risk-free rates.

Headline finance costs

The non-headline items included in statutory operating profit are as follows:

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Adjustment to discounted provisions

22

(5)

(5)

Fair value gain realised on contributing government bonds to Smiths Industries Pension Scheme

4

19

 

Other financing gains/(losses)

 

1

(4)

Other finance income/(costs) - retirement benefits

8

3

(8)

Non-headline gains/(losses) in finance costs

 

18

(17)

 

See note 4 for an explanation of the fair value gain on bonds and note 8 for details of the impact of this transaction on the pension funding position.

4 Net finance costs

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Interest receivable

 

3

3

Interest payable

 

 

 

- bank loans and overdrafts, including associated fees

 

(8)

(8)

- other loans

 

(54)

(47)

Interest payable

 

(62)

(55)

Other financing gains/(losses)

 

 

 

- fair value (losses)/gains on hedged debt

 

(23)

8

- fair value gains/(losses) on fair value hedges

 

23

(8)

- fair value gain realised on contributing government bonds to Smiths Industries Pension Scheme

 

19

 

- net foreign exchange gains/(losses)

 

1

(4)

- adjustment to discounted provisions

 

(5)

(5)

Other financing losses

 

15

(9)

Net interest income/(expense) on retirement benefit obligations

8

3

(8)

Net finance costs

 

(41)

(69)

 

The government bonds were accounted for as available for sale financial assets, and the cumulative fair value gains of £19m on these assets were recycled from other comprehensive income to the income statement when the bonds were contributed to the Smiths Industries Pension Scheme.

5 Earnings per share

Basic earnings per share are calculated by dividing the profit for the year attributable to equity shareholders of the Parent Company by the average number of ordinary shares in issue during the year.

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Profit attributable to equity shareholders for the year

 

 

- total

259

246

Average number of shares in issue during the year

395,095,591

394,742,972

 

Diluted earnings per share are calculated by dividing the profit attributable to ordinary shareholders by 398,957,837(2015: 398,552,818) ordinary shares, being the average number of ordinary shares in issue during the year adjusted by the dilutive effect of employee share schemes. For the year ended 31 July 2016, 223,993 options (2015: no options) were excluded from this calculation because their effect was anti-dilutive for continuing operations.

A reconciliation of basic and headline earnings per share is as follows:

 

Year ended 31 July 2016

Year ended 31 July 2015

 

£m

EPS
(p)

£m

EPS
(p)

Profit attributable to equity shareholders of the Parent Company

259

65.6

246

62.4

Exclude

 

 

 

 

Non-headline items and related tax

77

19.6

94

23.7

Headline profit  attributable to equity shareholders for the year

336

85.2

340

86.1

Statutory earnings per share - diluted (p)

 

64.9

 

61.8

Headline earnings per share - diluted (p)

 

84.3

 

85.3

 

6 Taxation

The Group's approach to taxation is set out in the CFO report. This note only provides information about corporate income taxes under IFRS. Smiths companies operate in over 50 countries across the world. They pay and collect many different taxes in addition to corporate income taxes including: payroll taxes; value added and sales taxes; property taxes; product-specific taxes and environmental taxes. The costs associated with these other taxes are included in profit before tax.


 

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

The taxation charge in the consolidated income statement for the year comprises

 

 

 

 

- current income tax charge

 

 

56

71

- current tax adjustments in respect of prior periods

 

 

 

(1)

Current taxation

 

 

56

70

- deferred taxation

 

 

29

7

Total taxation expense in the consolidated income statement

 

 

85

77



 

Reconciliation of the tax charge

The tax expense on the profit for the year for continuing operations is different from the standard rate of corporation tax in the UK of 20.0% (2015: 20.7%). The difference is reconciled as follows:

 

 

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Profit before taxation - continuing operations

 

 

346

325

Notional taxation expense at UK rate of 20.0% (2015: 20.7%)

 

 

69

67

Different tax rates on non-UK profits and losses

 

 

9

6

Non-deductible expenses

 

 

16

10

Tax credits and non-taxable income

 

 

(11)

(16)

Adjustments to unrecognised deferred tax

 

 

2

11

Prior year true-up

 

 

 

(1)

 

 

 

85

77

Comprising

 

 

 

 

- taxation on headline profit

 

 

113

117

- tax on non-headline loss

 

 

(34)

(44)

- change in deferred tax recognition treated as non-headline

 

 

6

4

Taxation expense in the consolidated income statement

 

 

85

77

 

The head office of Smiths Group is domiciled in the UK, so the tax charge has been reconciled to UK tax rates. In recent years, Smiths has made substantial payments to its UK defined benefit pension plans, which generated significant UK tax losses.

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Tax on items charged/(credited) to equity

 

 

Deferred tax charge/(credit)

 

 

- retirement benefit schemes

(10)

(21)

- share options

 

1

 

(10)

(20)

 

The net retirement benefit charge to equity includes £4m (2015: £nil) relating to UK schemes. The main UK defined benefit pension plans are now in surplus, producing a deferred tax liability.

Current taxation

 

 

 

 

Current tax
£m

At 31 July 2014

 

 

 

(41)

(Charge)/credit to income statement

 

 

 

(70)

Tax paid

 

 

 

91

At 31 July 2015

 

 

 

(20)

Foreign exchange gains and losses

 

 

 

4

(Charge)/credit to income statement

 

 

 

(56)

Tax paid

 

 

 

62

At 31 July 2016

 

 

 

(10)

Current tax receivable

 

 

 

62

Current tax payable

 

 

 

(72)

At 31 July 2016

 

 

 

(10)

 

Provisions included in current tax liabilities are established based on reasonable estimates for the possible consequences of tax authority audits in the various countries in which the Group operates. Management judgement is used to determine the amount of such provisions based on an understanding of the relevant local tax law, taking into account the differences of interpretation that can arise on a wide variety of issues, depending on the prevailing circumstances, including the nature of current tax audits and the experience of previous enquiries.

Deferred taxation

 

Property, plant and equipment and intangible assets
£m

Employment
benefits
£m

Losses
carried
forward
£m

Provisions
£m

Other
£m

Total
£m

At 1 August 2014

(106)

49

21

117

46

127

Credit/(charge) to income statement

(2)

(10)

5

1

(1)

(7)

Credit/(charge) to equity

 

20

 

 

 

20

Exchange adjustments

(8)

2

2

8

3

7

At 31 July 2015

(116)

61

28

126

48

147

Deferred tax assets

(23)

61

26

112

42

218

Deferred tax liabilities

(93)

 

2

14

6

(71)

At 31 July 2015

(116)

61

28

126

48

147

Credit/(charge) to income statement

(7)

(72)

53

(10)

7

(29)

Credit/(charge) to equity

 

10

 

 

 

10

Acquisitions

(1)

 

 

 

 

(1)

Exchange adjustments

(21)

9

6

24

6

24

At 31 July 2016

(145)

8

87

140

61

151

Deferred tax assets

(24)

8

84

134

44

246

Deferred tax liabilities

(121)

 

3

6

17

(95)

At 31 July 2016

(145)

8

87

140

61

151

 

The deferred tax asset relating to losses carried forward has been recognised on the basis:

▪ utilisation against offsetting deferred tax liabilities, including £49m relating to UK losses that has been recognised to offset an equivalent liability on the UK pension surplus; or

▪ evidence that operations show a consistent pattern of improving results and the Group has implemented plans to support continuing improvements or the losses relate to specific, identified non-recurring events.

Deferred tax relating to provisions includes £84m (2015: £72m) relating to the John Crane, Inc. litigation provision, and £36m (2015: £27m) relating to Titeflex Corporation. See note 22 for additional information on provisions; and

Included in other deferred tax balances above is a deferred tax asset of £25m (2015: £26m) relating to inventory where current tax relief is only available when the inventory is sold.

The Group has not recognised deferred tax relating to deductible temporary differences in the UK amounting to £402m (2015: £400m) and non-UK losses amounting to £93m (2015: £126m).

The expiry date of operating losses carried forward is dependent upon the law of the various territories in which the losses arise. A summary of expiry dates for losses in respect of which deferred tax has not been recognised is set out below.

Restricted losses

 

2016
£m

Expiry of
losses

2015
£m

Expiry of
losses

Territory

 

 

 

 

- Americas

36

2019-2036

36

2019-2035

- Asia

11

2017-2023

12

2016-2022

Total restricted losses

47

 

48

 

Unrestricted losses

 

 

 

 

- operating losses

211

No expiry

453

No expiry

Total

258

 

501

 



 

7 Employees

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Staff costs during the period

 

 

Wages and salaries

745

731

Social security

84

86

Share-based payment (note 9)

10

9

Pension costs (including defined contribution schemes) (note 8)

33

31

 

872

857

 

The average number of persons employed, rounded to the nearest 50 employees, was:

 

Year ended
 31 July 2016

Year ended
 31 July 2015

John Crane

6,550

6,950

Smiths Medical

7,600

7,950

Smiths Detection

2,050

2,150

Smiths Interconnect

3,400

3,850

Flex-Tek

2,050

2,050

Smiths Business Information Services

250

250

Corporate

100

50

 

22,000

23,250

 

Smiths Business Information Services directly employs people working in its operations. All the costs of IT infrastructure and support, including these employment costs, are reflected in reported divisional operating profit.

Key management

The key management of the Group comprises Smiths Group plc Board directors and Executive Committee members. Their aggregate compensation is shown below.

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Key management compensation

 

 

Salaries and short-term employee benefits

12.8

12.7

Cost of post-retirement benefits

0.1

 

Cost of share-based incentive plans

4.5

2.7

 

No member of key management had any material interest during the period in a contract of significance (other than a service contract or a qualifying third-party indemnity provision) with the Company or any of its subsidiaries. Options and awards held at the end of the period by key management in respect of the Company's share-based incentive plans were:

 

Year ended 31 July 2016

Year ended 31 July 2015

 

Number of
instruments
'000

Weighted
average price

Number of
instruments
'000

Weighted
average price

CIP

468

 

589

 

ESOS

 

 

18

£10.97

LTIP

1,185

 

1,374

 

Restricted stock

261

 

 

 

SAYE

15

£8.99

11

£9.19

 

Related party transactions

The only related party transactions in the year ended 31 July 2016 were key management compensation (31 July 2015: no other transactions).

8 Post-retirement benefits

Smiths provides post-retirement benefits to employees in a number of countries. This includes defined benefit and defined contribution plans and, mainly in the United Kingdom (UK) and United States of America (US), post-retirement healthcare.

Defined contribution plans

The Group operates a number of defined contribution plans across many countries. In the UK a defined contribution plan has been offered since the closure of the UK defined benefit pension plans. In the US a 401k defined contribution plan operates. The total expense recognised in the consolidated income statement in respect of all these plans was £30m (2015: £28m).

Defined benefit and post-retirement healthcare plans

The principal defined benefit pension plans are in the UK and in the US and these have been closed so that no future benefits are accrued.

For all schemes, pension costs are assessed in accordance with the advice of independent, professionally qualified actuaries. These valuations have been updated by independent qualified actuaries in order to assess the liabilities of the schemes as at 31 July 2016. Scheme assets are stated at their market values. Contributions to the schemes are made on the advice of the actuaries, in accordance with local funding requirements.

The changes in the present value of the net pension liability in the period were:

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

At beginning of period

(108)

(242)

Exchange adjustment

(31)

(3)

Reclassification of small unfunded obligations

 

(2)

Current service cost

(3)

(3)

Scheme administration costs

(7)

(8)

Past service cost, curtailments, settlements

(9)

14

Finance income/(charges) - retirement benefits

3

(8)

Contributions by employer

275

84

Actuarial (loss)/gain

(39)

60

Movement in surplus restriction

(1)

 

Net retirement benefit asset/(liability)

80

(108)

 

UK pension schemes

Smiths funded UK pension schemes are subject to a statutory funding objective, as set out in UK pension legislation. Scheme trustees need to obtain regular actuarial valuations to assess the scheme against this funding objective. The trustees and sponsoring companies need to agree funding plans to improve the position of a scheme, when it is below the acceptable funding level.

The UK Pensions Regulator has extensive powers to protect the benefits of members, promote good administration and reduce the risk of situations arising which may require compensation to be paid from the Pension Protection Fund. These powers include imposing a schedule of contributions or the calculation of the technical provisions, where a trustee and company fail to agree appropriate calculations.

Smiths Industries Pension Scheme ("SIPS")

This scheme was closed to future accrual effective 1 November 2009. SIPS provides index-linked pension benefits based on final earnings at date of closure. SIPS is governed by a corporate trustee (SI Trustee Limited, a wholly owned subsidiary of Smiths Group plc). The board of trustee directors comprises five company-nominated trustees and four member-nominated trustees, with an independent chairman selected by Smiths Group plc. Trustee Directors are responsible for the management, administration, funding and investment strategy of the scheme.

The most recent actuarial valuation of this scheme has been performed using the Projected Unit Method as at 31 March 2015, and experience gains and losses identified during this valuation have been incorporated into the IAS 19 valuation. Under the funding plan for SIPS agreed in November 2015 Smiths pays cash contributions of £2m a month until June 2020. As part of this agreement, Smiths contributed the index-linked gilts previously held in an escrow account. Under the governing documentation of the SIPS, any future surplus would be returnable to Smiths Group plc by refund, assuming gradual settlement of the liabilities over the lifetime of the scheme.

SIPS will implement Guaranteed Minimum Pensions equalisation in respect of members contracted out of the State Earnings Related Pensions Scheme prior to 6 April 1997, once the government has completed its consultations and confirmed an approach. It is not yet possible to reliably quantify the impact of this adjustment.

The duration of the SIPS liabilities is around 23 years (2015: 23 years) for active deferred members, 24 years (2015: 23 years) for deferred members and 12 years (2015: 12 years) for pensioners and dependants.

TI Group Pension Scheme ("TIGPS")

This scheme was closed to future accrual effective 1 November 2009. TIGPS provides index-linked pension benefits based on final earnings at the date of closure. TIGPS is governed by a corporate trustee (TI Pension Trustee Limited, an independent company). The board of trustee directors comprises five company-nominated trustees and four member-nominated trustees, with an independent trustee director selected by the Trustee. The Trustee is responsible for the management, administration, funding and investment strategy of the scheme.

The most recent actuarial valuation of this scheme has been performed using the Projected Unit Method as at 5 April 2015. Under the funding plan for TIGPS agreed in March 2016 Smiths pays cash contributions of £3m a year until April 2018. Under the governing documentation of the TIGPS, any future surplus would be returnable to Smiths Group plc by refund, assuming gradual settlement of the liabilities over the lifetime of the scheme.

TIGPS will implement Guaranteed Minimum Pensions equalisation in respect of members contracted out of the State Earnings Related Pensions Scheme prior to 6 April 1997, once the government has completed its consultations and confirmed an approach. It is not yet possible to reliably quantify the impact of this adjustment.

The duration of the TIGPS liabilities is around 25 years (2015: 21 years) for active deferred members, 24 years (2015: 19 years) for deferred members and 11 years (2015: 11 years) for pensioners and dependants.

US pension plans

The most recent valuations of the six principal US pension and post-retirement healthcare plans were performed at 1 January 2015.

The pension plans were closed with effect from 30 April 2009 and benefits were calculated as at that date and are not revalued. Governance of the US pension plans is managed by a Settlor Committee appointed by Smiths Group Services Corp, a wholly owned subsidiary.

The duration of the liabilities for the largest US plan is around 20 years (2015: 14 years) for active deferred members, 20 years (2015: 19 years) for deferred members and 12 years (2015: 10 years) for pensioners and dependants.

On 14 August 2015 the US funded plans completed a buy-out of retiree liabilities for $527m, transferring the obligation to pay pensions to Voya Retirement Insurance and Annuity Company. A settlement loss of £10m has been recognised on this transaction (see note 3). In August 2014, the US pension plans offered deferred members a one-off option to elect to cash out their retirement entitlements rather than receive a pension at retirement. Lump sum payments of $150m were made in August and September 2014. This programme generated a settlement gain of £14m in the year ended 31 July 2015.

Risk management

The pensions schemes are exposed to risks that:

▪ investment returns are below expectations, leaving the scheme with insufficient assets in future to pay all its pension obligations;

▪ members and dependants live longer than expected, increasing the value of the pensions the scheme has to pay;

▪ inflation rates are higher than expected, so amounts payable under index-linked pensions are higher than expected; and

▪ increased contributions may be required to meet regulatory funding targets if lower interest rates increase the current value of liabilities.

These risks are managed separately for each pension scheme. However Smiths has adopted a common approach of closing defined benefit schemes to cap members' entitlements and supporting trustees in adopting investment strategies which match assets to future obligations, after allowing for the funding position of the scheme.

TI Group Pension Scheme ("TIGPS")

TIGPS with a mature member profile, and a strong funding position, has been able to progress its matching strategy to the point where roughly 50% of liabilities are covered by matching annuities, eliminating investment return, longevity, inflation and funding risks.

Smiths Industries Pension Scheme ("SIPS")

In August 2014 SIPS adjusted the scheme investment strategy. The scheme has investments in diversified growth funds and a portfolio of exchange traded equity index futures managed by BlackRock. The risk and return characteristics of equity index futures are similar to physical equities, but provide the scheme with improved liquidity. As at 31 July 2016 the SIPS portfolio of exchange traded equity index futures generated a £163m (2015: £497m) exposure to equities.

Following the company contribution of £152m UK government bonds to SIPS in December 2015 and the resulting improvement in the funding position, the trustees have adopted a leveraged liability matching strategy. The scheme uses repurchase arrangements, total return swaps, inflation swaps and interest rate swaps to hedge the interest and inflation risks of the scheme liabilities. Repurchase agreements exchange government bonds held by the scheme for cash with an obligation to buy back the asset at a fixed future date and price. The cash is invested in liability matching assets, reducing funding risk. A total return swap exchanges the return on a specified asset (for example an index-linked bond) and an interest payment (fixed or floating). Contracts are spread across a panel of banks. To minimise the risk that counterparties fail to settle obligations, positions are collateralised. For repurchase agreements, collateral is the difference between the present value of the repurchase obligation and the value of the asset exchanged. For swaps, collateral is based on market values. At 31 July 2016 scheme assets were net of £720m (2015: £nil) repurchase obligations, and nominal exposure from interest rate swaps of £293m, inflation swaps of £263m and total return swaps of £14m.

The principal assumptions used in updating the valuations are set out below:

 

2016
UK

2016
US

2016
Other

2015
UK

2015
US

2015
Other

Rate of increase in salaries

n/a

n/a

2.8%

n/a

n/a

2.6%

Rate of increase for active deferred members

3.6%

n/a

n/a

4.1%

n/a

n/a

Rate of increase in pensions in payment

2.7%

n/a

1.6%

3.2%

n/a

1.0%

Rate of increase in deferred pensions

2.7%

n/a

0.1%

3.2%

n/a

0.1%

Discount rate

2.3%

3.45%

2.8%

3.5%

4.35%

3.3%

Inflation rate

2.7%

n/a

2.3%

3.2%

n/a

1.6%

Healthcare cost increases

4.2%

n/a

1.4%

4.7%

n/a

2.1%

 

The assumptions used in calculating the costs and obligations of the Group's defined benefit pension plans are set by Smiths after consultation with independent professionally qualified actuaries. The assumptions used are estimates chosen from a range of possible actuarial assumptions which, due to the timescale covered, may not necessarily occur in practice. For countries outside the UK and USA assumptions are disclosed as a weighted average.

Discount rate assumptions

The UK schemes use a discount rate based on the yield on the iBOXX over 15-year AA-rated corporate bond index, adjusted if necessary to better reflect the shape of the yield curve considering the Aon Hewitt GBP Select AA curve. For the USA, the discount rate is based on the Towers Watson cash-flow matching models and set with reference to Moody's Aa annualised yield, the Citigroup High Grade Index and the Merrill Lynch 15+ years High Quality Index.

Mortality assumptions

The mortality assumptions used in the principal UK schemes are based on the new "SAPS S2" All Birth year tables with relevant scaling factors based on the recent experience of the schemes. The assumption allows for future improvements in life expectancy in line with the 2015 CMI projections, blended to a long-term rate of 1.25%. The mortality assumptions used in the principal US schemes are based on the RP-2014 table adjusted backward to 2006 with MP-2014 and projected forward using MP-2015 as of 31 July 2016. The table selected allows for future mortality improvements and applies an adjustment for job classification (blue collar versus white collar).

Expected further years of life

UK schemes

US schemes

 

Male
31 July 2016

Female
31 July 2016

Male
31 July 2015

Female
31 July 2015

Male
31 July 2016

Female
31 July 2016

Male
31 July 2015

Female
31 July 2015

Member who retires next year at age 65

23

24

23

24

21

23

22

24

Member, currently 45, when they retire
in 20 years' time

24

26

25

27

23

25

23

26

 

Sensitivity

Sensitivities in respect of the key assumptions used to measure the principal pension schemes as at 31 July 2016 are set out below. These sensitivities show the hypothetical impact of a change in each of the listed assumptions in isolation, with the exception of the sensitivity to inflation which incorporates the impact of certain correlating assumptions. In practice, such assumptions rarely change in isolation.

 

Profit before tax
 for year ended
 31 July 2016
£m

Increase/
(decrease) in
scheme assets
 31 July 2016
£m

(Increase)/
decrease in
scheme
liabilities
 31 July 2016
£m

Profit before tax
 for year ended
 31 July 2015
£m

Increase/
(decrease) in
scheme assets
 31 July 2015
£m

(Increase)/
decrease in
scheme
liabilities
 31 July 2015
£m

Rate of mortality - 1 year increase in life expectancy

(3)

53

(183)

(4)

47

(157)

Rate of mortality - 1 year decrease in life expectancy

3

(53)

183

4

(47)

160

Rate of inflation - 0.25% increase

(2)

16

(119)

(3)

13

(89)

Discount rate - 0.25% increase

4

(19)

168

5

(19)

139

Market value of scheme assets - 2.5% increase

2

86

 

3

80

 

 

The effect on profit before tax reflects the impact of current service cost and net interest cost. The value of the scheme assets is affected by changes in mortality rates, inflation and discounting because they affect the carrying value of the insurance assets.

Asset valuation

Liquidity funds, equities and bonds are valued using quoted market prices in active markets. Exchange traded equity index futures are valued at market prices.

Total return, interest and inflation swaps are bilateral agreements between counterparties and do not have observable market prices. These derivative contracts are valued using observable market inputs.

Insured liabilities comprise annuity policies matching the scheme obligation to identified groups of pensioners. These assets are valued at the actuarial valuation of the corresponding liability, reflecting this matching relationship. Property is valued by specialists applying recognised property valuation methods incorporating current market data on rental yields and transaction prices.

Retirement-benefit plan assets

 

31 July 2016
£m

31 July 2015
£m

 

UK
schemes

US
schemes

Other
countries

Total

UK
schemes

US
schemes

Other
countries

Total

Cash and cash equivalents

 

 

 

 

 

 

 

 

- cash

57

1

 

58

41

17

 

58

- liquidity funds

89

 

 

89

172

1

 

173

- cash collateral and liquidity funds held to support exchange traded futures

53

 

 

53

29

 

 

29

Equities

 

 

 

 

 

 

 

 

- UK funds

111

 

3

114

123

 

1

124

- North American funds

124

 

2

126

129

110

2

241

- other regions and global funds

214

 

5

219

227

47

16

290

Government bonds

 

 

 

 

 

 

 

 

- index-linked bonds

1,410

 

 

1,410

1,052

 

 

1,052

- fixed-interest bonds

599

70

20

689

171

71

11

253

Corporate bonds

861

145

5

1,011

284

199

2

485

Insured liabilities

802

 

1

803

783

 

 

783

Property

 

 

 

 

 

 

 

 

- UK property

149

 

 

149

174

 

 

174

- other property

 

 

1

1

 

 

 

 

Other

 

 

 

 

 

 

 

 

- diversified growth funds and scheme receivables

285

 

25

310

338

 

17

355

- repurchase obligations

(720)

 

 

(720)

 

 

 

 

Total market value

4,034

216

62

4,312

3,523

445

49

4,017

 

SIPS has a portfolio of exchange traded equity index futures, which are valued at market prices. These futures increase "leverage" in SIPS, creating additional asset exposure. At 31 July 2016, the gross equity exposure generated by these exchange traded futures was £163m (2015: £497m). At 31 July 2016 the aggregate value of this strategy, including cash received as collateral, was £9m (2015: a liability of less than £1m). The scheme was holding £44m (2015: £29m) in liquidity funds to meet potential future obligations to collateralise equity index futures.

UK other investments at 31 July 2016 included £162m (2015: £330m) of investments in diversified growth funds held by SIPS, £107m of investments in leveraged index linked UK government bond funds held by TIGPS and £9m (2015: £nil) SIPS interest and inflation swaps.

At 31 July 2016 SIPS assets were net of £720m (2015: £nil) repurchase obligations, and included £11m (2015: £nil) gains on interest rate swaps and £2m (2015: £nil) losses on inflation swaps. See risk management disclosures for information on how the scheme is using repurchase arrangements and swap contracts to match the interest rate and inflation exposures of its assets to the interest rate and inflation exposures of the scheme liabilities. The scheme was holding £45m (2015: £nil) in liquidity funds to meet potential future obligations to collateralise repurchase arrangements or swap agreements.

The scheme assets do not include any property occupied by, or other assets used by, the Group. Equities include investments in broad-based equity indices, some of which hold ordinary equity shares in Smiths Group plc.

Present value of funded scheme liabilities and assets for the main UK and US schemes

 

31 July 2016
£m

31 July 2015
£m

 

SIPS

TIGPS

US
schemes

SIPS

TIGPS

US
schemes

Present value of funded scheme liabilities

 

 

 

 

 

 

- Active deferred members

(82)

(82)

(124)

(92)

(76)

(102)

- Deferred members

(881)

(688)

(175)

(756)

(625)

(130)

- Pensioners

(1,086)

(869)

(16)

(995)

(823)

(336)

Present value of funded scheme liabilities

(2,049)

(1,639)

(315)

(1,843)

(1,524)

(568)

Market value of scheme assets

2,227

1,787

216

1,813

1,693

445

Surplus/(deficit)

178

148

(99)

(30)

169

(123)



 

Net retirement benefit obligations

 

31 July 2016
£m

31 July 2015
£m

 

UK
schemes

US
schemes

Other
countries

Total

UK
schemes

US
schemes

Other
countries

Total

Market value of scheme assets

4,034

216

62

4,312

3,523

445

49

4,017

Present value of funded scheme liabilities

(3,709)

(315)

(70)

(4,094)

(3,385)

(568)

(57)

(4,010)

Surplus/(deficit)

325

(99)

(8)

218

138

(123)

(8)

7

Unfunded pension plans

(56)

(8)

(52)

(116)

(52)

(7)

(37)

(96)

Post-retirement healthcare

(8)

(12)

(1)

(21)

(7)

(11)

(1)

(19)

Present value of unfunded obligations

(64)

(20)

(53)

(137)

(59)

(18)

(38)

(115)

Unrecognised asset due to surplus restriction

 

 

(1)

(1)

 

 

 

 

Net pension liability

261

(119)

(62)

80

79

(141)

(46)

(108)

Post-retirement assets

327

 

1

328

169

 

1

170

Post-retirement liabilities

(66)

(119)

(63)

(248)

(90)

(141)

(47)

(278)

Net pension liability

261

(119)

(62)

80

79

(141)

(46)

(108)

 

Where any individual scheme shows a recoverable surplus under IAS 19, this is disclosed on the balance sheet as a retirement benefit asset. The IAS 19 surplus of any one scheme is not available to fund the IAS 19 deficit of another scheme. The retirement benefit asset disclosed arises from the rights of the employers to recover the surplus at the end of the life of the scheme.

Amounts recognised in the consolidated income statement

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Amounts charged/(credited) to operating profit

 

 

Current service cost

3

3

Settlement loss/(gain)

9

(14)

Scheme administration costs

7

8

 

19

(3)

The operating cost is charged/(credited) as follows:

 

 

Cost of sales

1

1

Sales and distribution costs

1

1

Headline administrative expenses

1

1

Non-headline administrative expenses

16

(6)

 

19

(3)

Amounts charged to finance costs

 

 

Net interest (income)/cost

(3)

8

 

Amounts recognised directly in the consolidated statement of comprehensive income

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Actuarial gains/(losses)

 

 

Difference between interest credit and return on assets

395

239

Experience gains and (losses) on scheme liabilities

58

46

Actuarial gains/(losses) arising from changes in demographic assumptions

47

(15)

Actuarial gains/(losses) arising from changes in financial assumptions

(539)

(210)

Movements in surplus restriction

(1)

 

 

(40)

60



 

Changes in present value of funded scheme assets

 

31 July 2016
£m

31 July 2015
£m

 

UK
schemes

US
schemes

Other
countries

Total

UK
schemes

US
schemes

Other
countries

Total

At beginning of period

3,523

445

49

4,017

3,249

500

51

3,800

Interest on assets

124

9

3

136

128

20

2

150

Actuarial gain on scheme assets

372

20

3

395

242

(6)

3

239

Employer contributions

199

68

2

269

53

23

3

79

Assets distributed on settlement

 

(360)

 

(360)

 

 

(1)

(1)

Scheme administration costs

(4)

(3)

 

(7)

(4)

(4)

 

(8)

Exchange adjustments

 

51

8

59

 

40

(5)

35

Benefits paid

(180)

(14)

(3)

(197)

(145)

(128)

(4)

(277)

At end of period

4,034

216

62

4,312

3,523

445

49

4,017

 

Changes in present value of funded defined benefit obligations

 

31 July 2016
£m

31 July 2015
£m

 

UK
schemes

US
schemes

Other
countries

Total

UK
schemes

US
schemes

Other
countries

Total

At beginning of period

(3,385)

(568)

(57)

(4,010)

(3,275)

(595)

(65)

(3,935)

Current service cost

 

 

(1)

(1)

 

 

(1)

(1)

Interest on obligations

(115)

(12)

(2)

(129)

(128)

(23)

(3)

(154)

Actuarial (loss)/gain on liabilities

(389)

(31)

(3)

(423)

(127)

(43)

1

(169)

Liabilities extinguished on settlement

 

350

1

351

 

14

 

14

Exchange adjustments

 

(68)

(11)

(79)

 

(49)

7

(42)

Benefits paid

180

14

3

197

145

128

4

277

At end of period

(3,709)

(315)

(70)

(4,094)

(3,385)

(568)

(57)

(4,010)

 

Changes in present value of unfunded defined benefit pensions and post-retirement healthcare plans

 

 

Assets

 

Obligations

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

At beginning of period

 

 

(115)

(107)

Reclassification of small unfunded obligations

 

 

 

(2)

Current service cost

 

 

(2)

(2)

Interest on obligations

 

 

(4)

(4)

Actuarial loss

 

 

(11)

(10)

Employer contributions

6

6

 

 

Exchange adjustments

 

 

(11)

4

Benefits paid

(6)

(6)

6

6

At end of period

 

 

(137)

(115)

 

Cash contributions

Company contributions to the defined benefit pension plans and post-retirement healthcare plans for 2016 totalled £275m (2015: £84m). This comprised regular contributions to funded schemes of £32m (2015: £36m) to SIPS, £11m (2015: £17m) to TIGPS, £34m (2015: £23m) to US Schemes, £6m to other schemes and additional contributions of $50m to fund the buy-out arrangement for US pensioners in August 2015 and the contribution of £152m UK government bonds to SIPS in December 2015. In addition, £6m (2015: £6m) was spent on providing benefits under unfunded defined benefit pension and post-retirement healthcare plans.

In 2017 the following cash contributions to the Group's principal defined benefit schemes are expected: £24m to SIPS; £3m to TIGPS; approximately £29m to other defined benefit plans, including the US scheme; and £6m to unfunded schemes and post-retirement healthcare. Adding £4m planned buy-out funding for small UK and Canadian schemes, expected cash payments for 2017 total £66m.

9 Employee share schemes

The Group operates share schemes and plans for the benefit of employees. The nature of the principal schemes and plans, including general conditions, is set out below:

Long-Term Incentive Plan (LTIP)

The LTIP is a share plan under which an award over a capped number of shares will vest after the end of the three-year performance period if performance conditions are met. LTIP awards are made to selected senior executives, including the executive directors. Awards made prior to 2016 were made with different targets for corporate executives and divisional executives. From 2016 onwards, all LTIP awards will have one set of targets.

LTIP performance conditions

Each performance condition has a threshold below which no shares vest and a maximum performance target at or above which the award vests in full. For performance between 'threshold' and 'maximum', awards vest on a straight-line sliding scale. The performance conditions are assessed separately, so performance on one condition does not affect the vesting of the other elements of the award. To the extent that the performance targets are not met over the three-year performance period, awards will lapse. There is no re-testing of the performance conditions.

Group LTIP awards have performance conditions relating to underlying revenue growth, growth in headline EPS adjusted to exclude tax, ROCE, cash conversion and, for awards made before 2015, TSR relative to the FTSE 100 (excluding financial services companies).

Divisional LTIP awards have performance conditions relating to divisional performance against headline KPIs, including underlying revenue and operating profit growth, operating margins, ROCE, operating cash conversion, employee engagement and quality metrics.

Smiths Group Co-Investment Plan (CIP) and Smiths Share Matching Plan (SMP)

In 2015 the CIP was replaced by the SMP. Under the CIP and SMP participants are required to invest between 25% and 50% of their post-tax bonus purchasing the Company's shares at the prevailing market price. At the end of a three-year period, if the executive is still in office and provided the performance test is passed, matching shares will be awarded in respect of any invested shares retained for that period. The number of matching shares to be awarded is determined by the Remuneration Committee at the end of the year in which the bonus is earned by reference to annual bonus, and other corporate financial criteria. The maximum award will not exceed the value, before tax, of the bonus or salary invested in shares by the executive.

For the CIP, vesting of matching shares will occur, and the matching shares will be released, at the end of the three-year period if the Group's Return on Capital Employed ('ROCE') over the performance period exceeds the Group's weighted average cost of capital ('WACC') over the performance period by an average margin of at least 1% per annum. If ROCE exceeds WACC by an average margin of 3% per annum, the enhanced performance condition is met, and a second matching share will be issued for every purchased share. For the SMP, vesting of matching shares will occur, and the matching shares will be released, at the end of the three-year period depending on the performance of the Group LTIP issued for the same performance period. The first matching share is awarded if the Group LTIP vests under any performance condition.

No future awards will be made under the CIP or SMP.

Restricted stock

The restricted stock is used by the Remuneration Committee, as a part of the recruitment strategy, to make awards in recognition of incentive arrangements forfeited on leaving a previous employer. If an award is considered appropriate, the award will take account of relevant factors including the fair value of awards forfeited, any performance conditions attached, the likelihood of those conditions being met and the proportion of the vesting period remaining. See the Directors' Remuneration Report pages 94 to 114 for details of the awards made to executive directors recruited in the year.

 

CIP

Long-term
 incentive
 plans

Restricted
stock

Other share
schemes

Total

Weighted
average
price
£

Ordinary shares under option ('000)

 

 

 

 

 

 

1 August 2014

1,568

2,695

 

1,744

6,007

£2.67

Granted

533

1,240

 

302

2,075

£1.31

Exercised

(580)

(258)

 

(418)

(1,256)

£2.62

Lapsed

(152)

(1,028)

 

(134)

(1,314)

£0.97

31 July 2015

1,369

2,649

 

1,494

5,512

£2.57

Granted

635

1,628

303

329

2,895

£0.99

Exercised

(530)

(199)

(30)

(380)

(1,139)

£2.95

Lapsed

(35)

(724)

 

(222)

(981)

£2.20

31 July 2016

1,439

3,354

273

1,221

6,287

£1.83



 

Options were exercised on an irregular basis during the period. The average closing share price over the financial year was 1,049.61p (2015: 1,176.19p). There has been no change to the effective option price of any of the outstanding options during the period.

Range of exercise prices

Total shares
under option at
 31 Jul 2016
('000)

Weighted
average
remaining
contractual life at
31 July 2016
(months)

Total shares
under option at
 31 Jul 2015
('000)

Weighted
average
remaining
contractual life at
31 July 2015
(months)

Options
exercisable at
31 July 2016
('000)

Exercisable
weighted
average
exercise price
for options
exercisable at
31 July 2016

Options
exercisable at
31 July 2015
('000)

Exercisable
weighted
average
exercise price
for options
exercisable at
31 July 2015

£0.00 - £2.00

5,066

18

4,018

15

 

 

 

 

£2.01 - £6.00

17

6

18

17

 

 

 

 

£6.01 - £10.00

924

33

1,091

27

60

£9.04

263

£8.97

£10.01 - £14.00

280

13

385

25

175

£10.95

257

£10.96

 

For the purposes of valuing options to arrive at the share-based payment charge, the Binomial option-pricing model has been used for most schemes and the Monte Carlo method is used for schemes with total shareholder return performance targets. The key assumptions used in the models for 2016 and 2015 are volatility of 25% to 30% (2015: 20% to 25%) and dividend yield of 3.75% (2015: 3.75%), based on historical data, for the period corresponding with the vesting period of the option. These generated a weighted average fair value for SMP/CIP of £10.34 (2015: £12.47), Group LTIP of £10.33 (2015: £10.78) and divisional LTIP of £10.33 (2015: £12.55), and restricted stock of £10.03 (2015: no grants). The fair value disclosed for the SMP/CIP award treats the two matching shares as separate options.

Included within staff costs is an expense arising from share-based payment transactions of £10m (2015: £9m), of which £9m (2015: £8m) relates to equity-settled share-based payment.

10 Intangible assets

 

Goodwill
£m

Development
costs
£m

Acquired
intangibles
(see table
 below)
£m

Software,
 patents and intellectual property
£m

Total
£m

Cost

 

 

 

 

 

At 1 August 2014

1,395

216

386

164

2,161

Exchange adjustments

26

9

19

2

56

Additions

 

20

 

18

38

Disposals

 

(8)

(2)

(7)

(17)

At 31 July 2015

1,421

237

403

177

2,238

Exchange adjustments

253

43

71

17

384

Business combinations

5

 

3

 

8

Additions

 

25

 

11

36

Disposals

 

(3)

 

(6)

(9)

At 31 July 2016

1,679

302

477

199

2,657

Amortisation

 

 

 

 

 

At 1 August 2014

86

102

313

116

617

Exchange adjustments

2

4

14

1

21

Charge for the year

 

23

33

15

71

Impairment charge

27

 

 

 

27

Disposals

 

(8)

(2)

(6)

(16)

At 31 July 2015

115

121

358

126

720

Exchange adjustments

24

22

65

11

122

Charge for the year

 

26

15

17

58

Impairment charge

23

 

 

 

23

Disposals

 

(3)

 

(5)

(8)

At 31 July 2016

162

166

438

149

915

Net book value at 31 July 2016

1,517

136

39

50

1,742

Net book value at 31 July 2015

1,306

116

45

51

1,518

Net book value at 1 August 2014

1,309

114

73

48

1,544



 

In addition to goodwill, the acquired intangible assets comprise:

 

Patents, licences
and trademarks
£m

Technology
£m

Customer
relationships
£m

Total acquired intangibles
£m

Cost

 

 

 

 

At 1 August 2014

68

128

190

386

Exchange adjustments

4

10

5

19

Business combinations

 

 

 

 

Disposals

 

(2)

 

(2)

At 31 July 2015

72

136

195

403

Exchange adjustments

13

24

34

71

Business combinations

 

 

3

3

Transfers to disposal group held for sale at the year end

 

 

 

 

At 31 July 2016

85

160

232

477

Amortisation

 

 

 

 

At 1 August 2014

41

101

171

313

Exchange adjustments

2

8

4

14

Charge for the year

6

13

14

33

Disposals

 

(2)

 

(2)

At 31 July 2015

49

120

189

358

Exchange adjustments

9

22

34

65

Charge for the year

3

7

5

15

Transfers to disposal group held for sale at the year end

 

 

 

 

At 31 July 2016

61

149

228

438

Net book value at 31 July 2016

24

11

4

39

Net book value at 31 July 2015

23

16

6

45

Net book value at 1 August 2014

27

27

19

73

 

11 Impairment testing

Goodwill

Goodwill is not amortised but is tested for impairment at least annually. Value in use or fair value less cost to sell calculations are used to determine the recoverable amount of goodwill held allocated to each group of cash generating units (CGU). Value in use is calculated as the net present value of the projected risk-adjusted cash-flows of the CGU. These forecast cash-flows are based on the 2017 budget, the five-year strategic plan approved by the Board and detailed divisional strategic projections, where these have been prepared and approved by the Board. Fair value less cost to sell is calculated using available information on past and expected future profitability, valuation multiples for comparable quoted companies (adjusted as required for significant differences) and information on costs of similar transactions. Fair value less costs to sell models are used when trading projections in the strategic plan cannot be adjusted to eliminate the impact of a major restructuring

Goodwill is allocated by division as follows:

 

2016
£m

2016
Number of
CGUs

2015
£m

2015
Number of
CGUs

John Crane

108

3

92

3

Smiths Medical

591

1

508

1

Smiths Detection

410

1

343

1

Smiths Interconnect

381

5

340

5

Flex-Tek

27

2

23

2

 

1,517

12

1,306

12

 

The goodwill allocated to Smiths Interconnect Power has been split, and part of it allocated to Smiths Interconnect Microwave Telecoms, following the transfer of the protection business from Smiths Interconnect Power to Smiths Interconnect Microwave Telecoms to increase synergies from the customer base of these businesses. Goodwill was also reallocated from Smiths Interconnect Microwave Subsystems to Smiths Interconnect Microwave Components when a business was transferred between the two business units. These changes were made to reflect how the businesses were being managed. If goodwill had not been reallocated, the impairment recognised for Smiths Interconnect Microwave Telecoms and Smiths Interconnect Microwave Components would have been smaller.

Goodwill impairment

John Crane Production Solutions ("JCPS")

JCPS is a business unit of John Crane focused on the servicing and provision of onshore down-hole 'artificial lift' pumping hardware and systems. Goodwill of £nil (2015: £5m) is allocated to JCPS. An impairment test was carried out following completion of the annual strategic planning process because the significant decline in oil prices had adversely affected JCPS customers. JCPS anticipate that customers will continue to scale back expansion plans and reduce running costs. Following this impairment test, the JCPS goodwill has been impaired by £5m (2015: £27m) and property, plant and equipment where the value is expected to be recovered at a CGU level has been impaired by £5m (2015: no impairment). The impairment has occurred because JCPS is now expected to have lower levels of trading activity, operating margins and growth in the future, significantly reducing the value in use of the business.

The impairment loss has been recognised in John Crane administration expenses, and excluded from headline operating profit for the division.

 

Year ended
31 July 2016

Year ended
31 July 2015

Impairment loss recognised

£5m

£27m

Property, plant the equipment impairment loss

£5m

 

Basis of valuation

value in use

value in use

Discount rate used for impairment test

13.7%

12.9%

Long-term growth rates

2.3%

2.2%

 

Sales assumptions for JCPS are based on:

▪ anticipated levels of maintenance and repair activities based on the current forward curve for oil prices; and

▪ expected North American drilling activity.

The gross margins included in the projections are lower than historical due to lower levels of activity. As required by 'IAS 36: Impairment of assets', margin projections for JCPS are based on the current fixed cost base, and do not incorporate any future restructuring.

At 31 July 2016 the Artificial lift business, comprising the US and Romanian activities of JCPS, was classified as held for sale (see note 27).

Smiths Interconnect Microwave Components

Goodwill of £66m (2015: £52m) is allocated to Smiths Interconnect Microwave Components. The underlying increase in goodwill is due to a reorganisation that moved a business from Smiths Interconnect Microwave Subsystems to Smiths Interconnect Microwave Components. An impairment test was carried out following the completion of the annual strategic planning process, which identified increased execution risks affecting the long-term strategy.

 

Year ended
31 July 2016

Year ended
31 July 2015

Impairment loss recognised

£7m

 

Basis of valuation

value in use

value in use

Discount rate used for impairment test

13.6%

15.6%

Long-term growth rates

2.3%

2.4%

 

Sales assumptions for Smiths Interconnect Microwave Components are based on:

▪ the current order book;

▪ sales projections from major customers; and

▪ developments in key customer markets including smartphone testing equipment.

Margin projections for Smiths Interconnect Microwave Components incorporate the variable cost structure of the current production capacity.

Smiths Interconnect Microwave Telecoms

Goodwill of £11m (2015: £7m) is allocated to Smiths Interconnect Microwave Telecoms. The underlying increase in goodwill is due to a reorganisation that moved the protection business from Smiths Interconnect Power to Smiths Interconnect Microwave Telecoms. An impairment test was carried out following the completion of the annual strategic planning process, which identified execution risks affecting this CGU. The impairment testing used a fair value less costs to sell model to value the businesses, because the Board approved forecasts for this business fundamentally incorporated significant reorganisation activity.

 

Year ended
31 July 2016

Year ended
31 July 2015

Impairment loss recognised

£11m

 

Basis of valuation

fair value

value in use

Discount rate used for impairment test

n/a

14.1%

Long-term growth rates

n/a

2.2%

 

The estimate of fair value less costs to sell incorporated projected 2017 revenue and profitability. Sales assumptions for Smiths Interconnect Microwave Telecoms are based on the current order book, sales projections from major customers, technology developments, and competitor strategies.

Fair value was calculated using a level 3 valuation model. Valuation multiples were based on adjusted valuation multiples for listed comparator companies, validated against publically available information on transaction multiples. Costs to sell were estimated based on Group experience of transactions involving businesses of a similar size.

Impairment testing assumptions

John Crane and Smiths Medical have strong aftermarket and consumables businesses, with consistent sales trends. Smiths Detection and Smiths Interconnect have greater sales and margin volatility due to lower levels of recurring revenue and involvement in government-funded programmes, particularly defence, and customer-led technology innovation. The key assumptions used in value in use calculations are:

▪ Sales: projected sales are built up with reference to markets and product categories. They incorporate past performance, historical growth rates and projections of developments in key markets.

▪ Margins: projected margins reflect historical performance and the impact of all completed projects to improve operational efficiency and leverage scale. The projections do not include the impact of future restructuring projects to which the Group is not yet committed.

▪ Discount rate: the discount rates have been calculated based on the Group's weighted average cost of capital and risks specific to the CGU being tested. The discount rates disclosed incorporate risk adjustments where the projected sales and margins are affected by significant delivery risks. Pre-tax rates of 11.0% to 14.3% (2015: 10.7% to 16.2%) have been used for the impairment testing.

▪ Long-term growth rates: as required by IAS 36, growth rates for the period after the detailed forecasts are based on the long-term GDP projections of the primary market for the CGU. The average growth rate used in the testing was 2.19% (2015: 2.16%). These rates do not reflect the long-term assumptions used by the Group for investment planning.

The assumptions used in the impairment testing of significant CGUs are as follows:

 

 

 

 

 

Year ended 31 July 2016

 

 

John Crane

Smiths
 Medical

Smiths
Detection

Smiths Interconnect

 

 

Core Rotating Equipment

 

 

Microwave
Subsystems

Connectors

Power

Net book value of goodwill (£m)

 

104

591

410

75

100

128

Discount rate

 

13.4%

11.0%

13.9%

11.8%

13.5%

11.7%

Period covered by management projections

 

5 years

5 years

5 years

5 years

5 years

5 years

Long-term growth rates

 

2.3%

2.1%

2.0%

2.3%

2.0%

2.3%



 

 

 

 

 

Year ended 31 July 2015

 

John Crane

Smiths
 Medical

Smiths
Detection

Smiths Interconnect

 

Core Rotating Equipment

 

 

Microwave
Subsystems

Connectors

Power

Net book value of goodwill (£m)

82

508

343

72

85

123

Discount rate

11.9%

10.7%

14.4%

12.6%

15.4%

12.2%

Period covered by management projections

5 years

5 years

5 years

5 years

5 years

5 years

Long-term growth rates

2.0%

2.2%

2.2%

2.5%

1.5%

2.5%

 

The remaining balance of the goodwill represents smaller individual amounts which have been allocated to smaller CGUs.

Sensitivity analysis

Smiths Interconnect Power

Smiths Interconnect Power's value in use exceeds its carrying value by £1m (2015: £14m). Sensitivity analysis performed around the base case assumptions has indicated that for Smiths Interconnect Power, the following changes in assumptions (in isolation), would cause the value in use to fall below the carrying value. The 2015 sensitivities relate to the combined business of Smiths Interconnect Power and Smiths Interconnect Microwave Telecoms Protection, since they were only split in the current year.

 

Year ended 31 July 2016
Change required to trigger impairment

Year ended 31 July 2015
Change required to trigger impairment

Forecast revenue

1% reduction

10% reduction

Forecast margins

10 basis points lower

120 basis points lower

Discount rate

10 basis points higher

100 basis points higher

Long-term growth rates

10 basis points lower

190 basis points lower

 

Sales assumptions for Smiths Interconnect Power are based on:

▪ the current order book;

▪ proportion of recent tenders which have been successful; and

▪ independent projections of the expected growth of the data centre market in North America.

Margin projections for Smiths Interconnect Power are based on current variable costs and production capacity, and the expected costs of increasing capacity to support higher levels of sales.

The directors also reviewed the fair value less costs to sell for the division when considering the results of the impairment testing, which also supported the conclusion that the Smiths Interconnect Power goodwill was not impaired.

Other CGUs

For the other CGUs, sensitivity analysis performed around the base case assumptions has indicated that no reasonable changes in key assumptions would cause the carrying amount of any of the CGUs to exceed their respective recoverable amounts.

Other intangible assets

The Group has no indefinite life intangible assets other than goodwill. During the year impairment tests were carried out for development projects which have not yet started to be amortised and acquired intangibles where there were indications of impairment. Value in use calculations were used to determine the recoverable values of these assets.

No impairment charges have been incurred (2015: £nil).

Property, plant and equipment

Impairment charges of £5m for property, plant and equipment of John Crane Production Solutions have been recognised in the year, principally relating to property. Please see disclosures above under goodwill for an explanation of the circumstances affecting this business.

There are £1m impairment charges for sites affected by the Fuel for Growth restructuring (see note 3).

12 Property, plant and equipment

 

Land and
buildings
£m

Plant and
machinery
£m

Fixtures,
fittings,
tools and
equipment
£m

Total
£m

Cost or valuation

 

 

 

 

At 1 August 2014

184

520

212

916

Exchange adjustments

3

13

(3)

13

Additions

7

37

15

59

Disposals

(13)

(33)

(25)

(71)

Business disposals

 

(1)

 

(1)

At 31 July 2015

181

536

199

916

Exchange adjustments

31

91

30

152

Additions

19

42

13

74

Disposals

(2)

(35)

(21)

(58)

Transfers to disposal group held for sale at the year end

(6)

(3)

(1)

(10)

At 31 July 2016

223

631

220

1,074

Depreciation

 

 

 

 

At 1 August 2014

95

393

170

658

Exchange adjustments

2

11

(2)

11

Charge for the year

7

28

14

49

Disposals

(7)

(28)

(25)

(60)

Business disposals

 

(1)

 

(1)

At 31 July 2015

97

403

157

657

Exchange adjustments

16

68

24

108

Charge for the year

8

31

14

53

Impairments (note 11)

5

1

 

6

Disposals

(1)

(34)

(20)

(55)

Transfers to disposal group held for sale at the year end

(6)

(3)

(1)

(10)

At 31 July 2016

119

466

174

759

Net book value at 31 July 2016

104

165

46

315

Net book value at 31 July 2015

84

133

42

259

Net book value at 1 August 2014

89

127

42

258

 

13 Inventories

 

31 July 2016
£m

31 July 2015
£m

Inventories comprise

 

 

Raw materials and consumables

174

157

Work in progress

102

96

Finished goods

202

203

 

478

456

Less: payments on account

 

(2)

 

478

454

 

The Group consumed £1,319m (2015: £1,293m) of inventories during the period. In the year to 31 July 2016, £16m (2015: £13m) was charged for the write-down of inventory and £4m (2015: £4m) was released from inventory provisions no longer required.

Inventory provisioning

 

31 July 2016
£m

31 July 2015
£m

Gross inventory carried at full value

436

415

Gross value of inventory partly or fully provided for

112

113

 

548

528

Inventory provision

(70)

(72)

Inventory after provisions

478

456



 

14 Trade and other receivables

 

31 July 2016
£m

31 July 2015
£m

Non-current

 

 

Trade receivables

31

29

Accrued income

3

5

Prepayments

1

 

Other receivables

16

6

 

51

40

Current

 

 

Trade receivables

665

560

Accrued income

18

17

Prepayments

21

14

Other receivables

41

25

 

745

616

 

Trade receivables include unbilled balances of £47m (2015: £27m) relating to Smiths Detection contracts, where revenue recognition does not align with the agreed billing schedule. The Group also has cash received of £41m (2015: £38m) deferred in trade and other payables relating to these Smiths Detection contracts.

Trade receivables do not carry interest. Management considers that the carrying value of trade and other receivables approximates to the fair value. Trade and other receivables, including prepayments, accrued income and other receivables qualifying as financial instruments are classified as 'loans and receivables'. The maximum credit exposure arising from these financial assets is £745m (2015: £611m).

Trade receivables are disclosed net of provisions for bad and doubtful debts. The provisions for bad and doubtful debts are based on specific risk assessment and reference to past default experience.

Credit risk is managed separately for each customer and, where appropriate, a credit limit is set for the customer based on previous experience of the customer and third party credit ratings. The Group has no significant concentration of credit risk, with exposure spread over a large number of customers. The largest single customer is the US Federal Government, representing less than 5% (2015: less than 5%) of Group revenue.

Ageing of trade receivables

 

31 July 2016
£m

31 July 2015
£m

Trade receivables which are not impaired and not yet due

535

468

Trade receivables which are not impaired and less than three months overdue

109

86

Trade receivables which are not impaired and more than three months overdue

45

32

Gross value of partially and fully provided receivables

38

25

 

727

611

Provision for bad and doubtful debts

(31)

(22)

Trade receivables

696

589

 

15 Trade and other payables

 

31 July 2016
£m

31 July 2015
£m

Non-current

 

 

Other payables

29

24

Current

 

 

Trade payables

202

192

Other payables

11

11

Other taxation and social security costs

25

18

Accruals

231

191

Deferred income

67

54

 

536

466

 

Trade and other payables, including accrued expenses and other payables qualifying as financial instruments, are accounted for at amortised cost and are categorised as other financial liabilities.

16 Financial assets

The Group invests in early stage businesses that are developing or commercialising related technology. In the current year £2m was invested in Detection businesses. In 2015 £2m was invested in John Crane and £1m was invested in interconnect businesses.

In December 2015, £152m of UK government bonds previously held as available for sale financial assets were contributed to Smiths Industries Pension Scheme. At 31 July 2015, the Group held £147m UK government bonds as part of the deficit-funding plan agreed with the trustee of this pension schemes. See note 8 for additional details.

17 Borrowings and net debt

This note sets out the calculation of net debt, an important measure in explaining our financing position. The net debt figure includes accrued interest and the fair value adjustments relating to hedge accounting.

 

31 July 2016
£m

31 July 2015
£m

Cash and cash equivalents

 

 

Net cash and deposits

431

495

Short-term borrowings

 

 

Bank overdrafts

(1)

 

£150m 7.25% Sterling Eurobond 2016

 

(150)

€300m 4.125% Eurobond 2017

(255)

 

Bank and other loans

(1)

(1)

Interest accrual

(13)

(12)

 

(270)

(163)

Long-term borrowings

 

 

€300m 4.125% Eurobond 2017

 

(214)

$175m 7.37% US$ Private placement 2018

(132)

(112)

$250m 7.20% US$ Guaranteed notes 2019

(189)

(159)

$400m 3.625% US$ Guaranteed notes 2022

(304)

(253)

€600m 1.25% Eurobond 2023

(512)

(410)

Bank and other loans

(2)

(2)

 

(1,139)

(1,150)

Borrowings

(1,409)

(1,313)

Net debt

(978)

(818)

 

Borrowings are accounted for at amortised cost and are categorised as other financial liabilities. See note 18 for a maturity analysis of borrowings.

Interest of £47m (2015: £42m) was charged to the consolidated income statement in this period in respect of public bonds.

Net cash and cash equivalents

 

31 July 2016
£m

31 July 2015
£m

Cash at bank and in hand

161

104

Short-term deposits

270

391

Cash and cash equivalents

431

495

Bank overdrafts

(1)

 

Net cash and cash equivalents

430

495

 

Cash and cash equivalents include highly liquid investments with maturities of three months or less.

Netting

Cash and overdraft balances in interest compensation cash pooling systems are reported gross on the balance sheet. The cash pooling agreements incorporate a legally enforceable right of net settlement. However, there is no intention to settle the balances net, so these arrangements do not qualify for net presentation. At 31 July 2016 and 31 July 2015 the total value of overdrafts on accounts in interest compensation cash pooling systems was less than £1m.

The balances held in zero balancing cash pooling arrangements have daily settlement of balances, so netting is not relevant.

Movements in net debt

 

 

 

Net cash
and cash equivalents
£m

Other
short-term borrowings
£m

Long-term borrowings
£m

Net debt
£m

At 31 July 2015

 

 

495

(163)

(1,150)

(818)

Foreign exchange gains and losses

 

 

33

 

(220)

(187)

Net cash outflow

 

 

(98)

 

 

(98)

Repayment of borrowings

 

 

 

151

 

151

Drawdown of borrowings

 

 

 

 

(1)

(1)

Capitalisation, interest accruals and unwind of capitalised fees

 

 

 

(1)

(1)

(2)

Fair value movement from interest rate hedging

 

 

 

 

(23)

(23)

Change in maturity analysis

 

 

 

(256)

256

 

At 31 July 2016

 

 

430

(269)

(1,139)

(978)

 

Secured loans

Loans amounting to £3m (2015: £3m) were secured on plant and equipment with a book value of £3m (2015: £3m).

18 Financial risk management

The Group's international operations and debt financing expose it to financial risks which include the effects of changes in foreign exchange rates, changes in debt market prices, interest rates, credit risks and liquidity risks.

Treasury and risk management policies are set by the Board. The policy sets out specific guidelines to manage foreign exchange risk, interest rate risk, credit risk and the use of financial instruments to manage risk. The instruments and techniques used to manage exposures include foreign currency derivatives, debt and other interest rate derivatives. The central treasury function monitors financial risks and compliance with risk management policies. The management of operational credit risk is discussed in note 14.

(a) Foreign exchange risk

Transactional currency exposure

The Group is exposed to foreign currency risks arising from sales or purchases by businesses in currencies other than their functional currency. It is Group policy that, when the net foreign exchange exposure to known future sales and purchases is material, this exposure is hedged using forward foreign exchange contracts. The net exposure is calculated by adjusting the expected cash-flow for payments or receipts in the same currency linked to the sale or purchase. This policy minimises the risk that the profits generated from the transaction will be affected by foreign exchange movements which occur after the price has been determined.

Hedge accounting documentation and effectiveness testing are only undertaken if it is cost effective.

The following table shows the currency of financial instruments. It excludes loans and derivatives designated as net investment hedges.

 

At 31 July 2016

 

Sterling
£m

US$
£m

Euro
£m

Other
£m

Total
£m

Financial assets and liabilities

 

 

 

 

 

Financial instruments included in trade and other receivables

38

391

136

180

745

Financial instruments included in trade and other payables

(48)

(203)

(72)

(79)

(402)

Cash and cash equivalents

189

129

41

72

431

Borrowings not designated as net investment hedges

1

(12)

(5)

(1)

(17)

 

180

305

100

172

757

Exclude balances held in operations with the same functional currency

(180)

(188)

(101)

(167)

(636)

Exposure arising from intra-group loans

 

(165)

(70)

(77)

(312)

Forward foreign exchange contracts

(286)

112

119

55

 

 

(286)

64

48

(17)

(191)



 

 

 

At 31 July 2015

 

Sterling
£m

US$
£m

Euro
£m

Other
£m

Total
£m

Financial assets and liabilities

 

 

 

 

 

Financial instruments included in trade and other receivables

34

316

111

150

611

Financial instruments included in trade and other payables

(41)

(185)

(55)

(55)

(336)

Cash and cash equivalents

311

115

20

49

495

Borrowings not designated as net investment hedges

(151)

(11)

(3)

 

(165)

 

153

235

73

144

605

Exclude balances held in operations with the same functional currency

(155)

(149)

(72)

(138)

(514)

Exposure arising from intra-group loans

 

(101)

(28)

(49)

(178)

Forward foreign exchange contracts

(163)

48

79

36

 

 

(165)

33

52

(7)

(87)

 

Financial instruments included in trade and other receivables comprise trade receivables, accrued income and other receivables which qualify as financial instruments. Similarly, financial instruments included in trade and other payables comprise trade payables, accrued expenses and other payables that qualify as financial instruments.

Based on the assets and liabilities held at the year-end, if the specified currencies were to strengthen 10% while all other market rates remained constant, the change in the fair value of financial instruments not designated as net investment hedges would have the following effect:

 

Impact on profit
 for the year
31 July 2016
£m

Gain/(loss)
 recognised in
 reserves
31 July 2016
£m

Impact on profit
 for the year
31 July 2015
£m

Gain/(loss)
 recognised in
 reserves
31 July 2015
£m

US dollar

3

2

4

(2)

Euro

(6)

(3)

 

4

Sterling

16

(2)

1

 

 

These sensitivities were calculated before adjusting for tax and exclude the effect of quasi-equity intra-group loans.

Cash-flow hedging

The Group uses foreign currency contracts to hedge future foreign currency sales and purchases. At 31 July 2016 contracts with a nominal value of £393m (2015: £317m) were designated as hedging instruments. In addition, the Group had outstanding foreign currency contracts with a nominal value of £529m (2015: £314m) which were being used to manage transactional foreign exchange exposures, but were not accounted for as cash-flow hedges. The fair value of the contracts is disclosed in note 19.

The majority of hedged transactions will be recognised in the consolidated income statement in the same period that the cash flows are expected to occur, with the only differences arising because of normal commercial credit terms on sales and purchases. Of the foreign exchange contracts designated as hedging instruments 91% are for periods of 12 months or less (2015: 92%).

The movements in the cash-flow hedge reserve during the period are summarised in the table below:

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Brought forward cash-flow hedge reserve at start of year

3

 

Gains/(losses) on effective cash-flow hedges recognised in equity

(10)

2

Amounts removed from the hedge reserve and recognised in the following lines on the income statement

 

 

- revenue

(1)

 

- cost of sales

1

1

Carried forward cash-flow hedge reserve at end of year

(7)

3



 

Translational currency exposure

The Group has significant investments in overseas operations, particularly in the United States and Europe. As a result, the sterling value of the Group's balance sheet can be significantly affected by movements in exchange rates. The Group seeks to mitigate the effect of these translational currency exposures by matching the net investment in overseas operations with borrowings denominated in their functional currencies, except where significant adverse interest differentials or other factors would render the cost of such hedging activity uneconomic. This is achieved by borrowing primarily in the relevant currency or in some cases indirectly using forward foreign exchange contracts and cross-currency swaps.

Net investment hedges

The table below sets out the currency of loans and swap contracts designated as net investment hedges:

 

 

 

 

 

At 31 July 2016

 

Sterling
£m

US$
£m

Euro
£m

Other
£m

Total
£m

Loans designated as net investment hedges

 

(625)

(767)

 

(1,392)

Cross-currency swap contracts

 

(358)

373

 

15

Currency swap contracts

111

 

 

(111)

 

 

111

(983)

(394)

(111)

(1,377)

 

 

 

 

 

 

At 31 July 2015

 

Sterling
£m

US$
£m

Euro
£m

Other
£m

Total
£m

Loans designated as net investment hedges

 

(524)

(624)

 

(1,148)

Cross-currency swap contracts

 

(306)

302

 

(4)

Currency swap contracts

90

 

 

(90)

 

 

90

(830)

(322)

(90)

(1,152)

 

At 31 July 2016 swap contracts hedged the Group's exposure to Canadian dollars, Japanese yen and Chinese renminbi (31 July 2015: Canadian dollars, Japanese yen and Chinese renminbi).

All the currency swap contracts designated as net investment hedges are current (2015: current). The cross-currency swap contracts will mature in April 2023.

The gains and losses that have been deferred in the net investment hedge reserve are shown in the table below:

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Brought forward net investment hedge reserve at start of year

(66)

(58)

Amounts deferred in the period on effective net investment hedges

(228)

(8)

Carried forward net investment hedge reserve at end of year

(294)

(66)

 

The fair values of these net investment hedges are subject to exchange rate movements. Based on the hedging instruments in place at the year-end, if the specified currencies were to strengthen 10% while all other market rates remained constant, it would have the following effect:

 

 

 

 Loss
 recognised in
hedge reserve
31 July 2016
£m

Loss
 recognised in
hedge reserve
31 July 2015
£m

US dollar

 

 

98

80

Euro

 

 

35

35

 

These movements would be fully offset by an opposite movement on the retranslation of the net assets of the overseas subsidiaries. These sensitivities were calculated before adjusting for tax.

 (b) Interest rate risk

The Group operates an interest rate policy designed to optimise interest cost and reduce volatility in reported earnings. The Group's current policy is to require interest rates to be fixed for greater than 70% of the level of gross debt. This is achieved through fixed rate borrowings and interest rate swaps. At 31 July 2016 59% (2015: 57%) of the Group's gross borrowings were at fixed interest rates, after adjusting for interest rate swaps and the impact of short maturity derivatives designated as net investment hedges. The Group monitors its fixed rate risk profile against both gross and net debt. For medium-term planning, it now focuses on gross debt to eliminate the fluctuations of variable cash levels over the cycle.

The weighted average interest rate on borrowings and cross-currency swaps at 31 July 2016, after interest rate swaps, is 3.68% (2015: 3.98%).

Interest rate profile of financial assets and liabilities and the fair value of borrowings

The following table shows the interest rate risk exposure of investments, cash and borrowings, with the borrowings adjusted for the impact of interest rate hedging. The other financial assets and liabilities do not earn or bear interest and for all financial instruments except for borrowings the carrying value is not materially different from their fair value.

 

Available
for sale
investments
31 July 2016
£m

Cash and
cash
 equivalents
31 July 2016
£m

Borrowings
31 July 2016
£m

Fair value of
borrowings
31 July 2016
£m

Available
for sale
investments
31 July 2015
£m

Cash and
cash equivalents
31 July 2015
£m

Borrowings
31 July 2015
£m

Fair value of
 borrowings
31 July 2015
£m

Fixed interest

 

 

 

 

 

 

 

 

Less than one year

 

 

(153)

(158)

 

 

(151)

(158)

Between one and five years

 

 

(322)

(362)

 

 

(399)

(443)

Greater than five years

 

 

(353)

(362)

147

 

(296)

(290)

Total fixed interest financial assets/(liabilities)

 

 

(828)

(882)

147

 

(846)

(891)

Floating rate interest financial assets/(liabilities)

 

390

(581)

(581)

 

467

(467)

(467)

Total interest-bearing financial assets/(liabilities)

 

390

(1,409)

(1,463)

147

467

(1,313)

(1,358)

Non-interest-bearing assets/(liabilities) in the same category

9

41

 

 

9

28

 

 

9

431

(1,409)

(1,463)

156

495

(1,313)

(1,358)

 

Interest rate hedging

At 31 July 2016 and 31 July 2015 the Group has designated the following fair value hedges

▪ US$150m interest rate swap which matures on 12 October 2022 partially hedging the US$ 2022 Guaranteed notes;

▪ €120m interest rate swaps which mature on 5 May 2017 partially hedging the € 2017 Eurobond; and

▪ the fixed/floating element of €400m of €/US$ interest rate swaps which mature on 28 April 2023 partially hedging the € 2023 Eurobond.

These positions hedge the risk of variability in the fair value of borrowings arising from fluctuations in base rates.

The fair values of the hedging instruments are disclosed in note 19. The effect of the swaps is to convert £552m (2015: £462m) debt from fixed rate to floating rate.

Sensitivity of interest charges to interest rate movements

The Group has exposure to sterling, US dollar and euro interest rates. However the Group does not have a significant exposure to interest rate movements for any individual currency. Based on the composition of net debt and foreign exchange rates at 31 July 2016, and taking into consideration all fixed rate borrowings and interest rate swaps in place, a one percentage point (100 basis points) change in average floating interest rates for all three currencies would have a £2.1m (2015: £0.2m) impact on the Group's profit before tax.

Following the contribution of the UK Gilts to the pension scheme, the sensitivity of investments to changes in interest rates is no longer material.

 (c) Financial credit risk

The Group is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but does not currently expect any counterparties to fail to meet their obligations. Credit risk is mitigated by the Board-approved policy of only placing cash deposits with highly rated relationship bank counterparties within counterparty limits established by reference to their Standard & Poor's long-term debt rating. In the normal course of business, the Group operates cash pooling systems, where a legal right of set-off applies.

The maximum credit risk exposure in the event of other parties failing to perform their obligations under financial assets, excluding trade and other receivables and derivatives, totals £440m at 31 July 2016 (2015: £651m).

 

31 July 2016
£m

31 July 2015
£m

UK government bonds with at least a AA credit rating (note 16)

 

147

Cash at banks with at least a AA- credit rating

215

268

Cash at banks with a A+ credit rating

126

194

Cash at other banks

90

33

Other investments

9

9

 

440

651

 

At 31 July 2016 the maximum exposure with a single bank for deposits and cash is £97m (2015: £108m), whilst the maximum mark to market exposure for derivatives is £10m (2015: £4m). These banks have AA- and AA- credit rating, respectively (2015: AA- and AA-).

(d) Liquidity risk

Borrowing facilities

The Board policy specifies the maintenance of unused committed credit facilities of at least £200m at all times to ensure it has sufficient available funds for operations and planned development, which is provided by a multi-currency revolving credit facility.

On 19 February 2014 Smiths completed the refinancing of its existing $800m Revolving Credit Facility. The two uncommitted extension options have been exercised on 4 February 2015 and 3 February 2016. The facility now matures on 19 February 2021. At the balance sheet date, the Group had the following undrawn credit facilities:

 

31 July 2016
£m

31 July 2015
£m

Expiring within one year

 

 

Expiring between one and two years

 

 

Expiring after more than two years

605

512

 

605

512

 

Cash deposits

As at 31 July 2016, £270m (2015: £391m) of cash and cash equivalents was on deposit with various banks of which £119m (2015: £301m) was on deposit in the UK.

Gross contractual cash-flows for borrowings

 

Borrowings
(Note 17)
31 July 2016
£m

Fair value
 adjustments
31 July 2016
£m

Contractual
 interest
 payments
31 July 2016
£m

Total
 contractual
cash-flows
31 July 2016
£m

Borrowings
(Note 17)
31 July 2015
£m

Fair value
 adjustments
31 July 2015
£m

Contractual
 interest
payments
31 July 2015
£m

Total
 contractual
cash-flows
31 July 2015
£m

Less than one year

(270)

2

(39)

(307)

(163)

(1)

(41)

(205)

Between one and two years

(133)

 

(41)

(174)

(215)

3

(43)

(255)

Between two and three years

(190)

(1)

(32)

(223)

(113)

 

(34)

(147)

Between three and four years

 

 

(18)

(18)

(159)

(1)

(26)

(186)

Between four and five years

 

 

(18)

(18)

 

 

(15)

(15)

Greater than five years

(816)

8

(30)

(838)

(663)

(16)

(39)

(718)

Total

(1,409)

9

(178)

(1,578)

(1,313)

(15)

(198)

(1,526)

 

The figures presented in the borrowings column include the non-cash adjustments which are highlighted in the adjacent column. The contractual interest reported for borrowings is before the effect of interest rate swaps.

Gross contractual cash-flows for derivative financial instruments

 

Receipts
31 July 2016
£m

Payments
31 July 2016
£m

Net cash-flow
31 July 2016
£m

Receipts
31 July 2015
£m

Payments
31 July 2015
£m

Net cash-flow
31 July 2015
£m

Assets

 

 

 

 

 

 

Less than one year

425

(415)

10

326

(304)

22

Greater than one year

378

(374)

4

20

(18)

2

Liabilities

 

 

 

 

 

 

Less than one year

467

(485)

(18)

470

(483)

(13)

Greater than one year

28

(29)

(1)

326

(320)

6

Total

1,298

(1,303)

(5)

1,142

(1,125)

17

 

This table presents the undiscounted future contractual cash-flows for all derivative financial instruments. For this disclosure, cash-flows in foreign currencies are translated using the spot rates at the balance sheet date. The fair values of these financial instruments are presented in note 19.

Gross contractual cash-flows for other financial liabilities

The contractual cash-flows for financial liabilities included in trade and other payables are: £388m (2015: £324m) due in less than one year, £9m (2015: £7m) due between one and five years and £5m (2015: £5m) due after more than five years.

19 Derivative financial instruments

The tables below set out the nominal amount and fair value of derivative contracts held by the Group, identifying the derivative contracts which qualify for hedge accounting treatment:

 

 

 

 

 

At 31 July 2016

 

Contract or underlying
nominal amount

 

 

Fair value

 

 


£m

Assets
£m

Liabilities
£m

Net
£m

Foreign exchange contracts (cash-flow hedges)

 

393

8

(15)

(7)

Foreign exchange contracts (not hedge accounted)

 

529

3

(4)

(1)

Total foreign exchange contracts

 

922

11

(19)

(8)

Currency swaps (net investment hedges)

 

111

 

(1)

(1)

Cross currency swaps (fair value and net investment hedges)

 

326

25

 

25

Interest rate swaps (fair value hedges)

 

214

6

 

6

Total financial derivatives

 

1,573

42

(20)

22

Balance sheet entries

 

 

 

 

 

Non-current

 

473

29

(1)

28

Current

 

1,100

13

(19)

(6)

Total financial derivatives

 

1,573

42

(20)

22



 

 

 

 

 

 

At 31 July 2015

 

Contract or underlying
nominal amount

 

 

Fair value

 

 


£m

Assets
£m

Liabilities
£m

Net
£m

Foreign exchange contracts (cash-flow hedges)

 

317

8

(5)

3

Foreign exchange contracts (not hedge accounted)

 

314

2

(2)

 

Total foreign exchange contracts

 

631

10

(7)

3

Currency swaps (net investment hedges)

 

97

7

 

7

Currency swaps (not hedge accounted)

 

157

3

(5)

(2)

Total currency swaps

 

254

10

(5)

5

Cross currency swaps (fair value and net investment hedges)

 

276

 

(4)

(4)

Interest rate swaps (fair value hedges)

 

180

4

(2)

2

Total financial derivatives

 

1,341

24

(18)

6

Balance sheet entries

 

 

 

 

 

Non-current

 

 

4

(6)

(2)

Current

 

 

20

(12)

8

Total financial derivatives

 

 

24

(18)

6

 

Currency swaps not hedge accounted

These contracts comprise derivatives which were previously part of the net investment hedging programme and matching contracts to eliminate this exposure. There is no further net exposure arising from these contracts.

Accounting for other derivative contracts

Any foreign exchange contracts which are not formally designated as hedges and tested are classified as 'held for trading' and not hedge accounted.

Netting

International Swaps and Derivatives Association (ISDA) master netting agreements are in place with derivative counterparties except for contracts traded on a dedicated international electronic trading platform used for operational foreign exchange hedging. Under these agreements if a credit event occurs, all outstanding transactions under the ISDA are terminated and only a single net amount per counterparty is payable in settlement of all transactions. The ISDA agreements do not meet the criteria for offsetting, since the offsetting is enforceable only if specific events occur in the future, and there is no intention to settle the contracts on a net basis.

 

 

 

Assets
31 July 2016
£m

Liabilities
31 July 2016
£m

Assets
31 July 2015
£m

Liabilities
31 July 2015
£m

Gross value of assets and liabilities

 

 

42

(20)

24

(18)

Related assets and liabilities subject to master netting agreements

 

 

(2)

2

(4)

4

Net exposure

 

 

40

(18)

20

(14)



 

20 Fair value of financial instruments

 

 

Notes

Carrying value
31 July 2016
£m

Fair value
31 July 2016
£m

Carrying value
31 July 2015
£m

Fair value
31 July 2015
£m

Level 1 valuations

 

 

 

 

 

 

Financial assets - other investments

 

16

 

 

147

147

Level 2 valuations

 

 

 

 

 

 

Financial derivatives - assets

 

19

42

42

24

24

Borrowings

 

17

(1,409)

(1,463)

(1,313)

(1,358)

Financial derivatives - liabilities

 

19

(20)

(20)

(18)

(18)

Level 3 valuations

 

 

 

 

 

 

Financial assets - other investments

 

16

9

9

9

9

 

Investments with level 1 valuations at 31 July 2015 comprise quoted government bonds.

Derivatives, including forward exchange contracts, currency swaps, interest rate instruments, and embedded derivatives, are valued at the net present value of the future cash-flows calculated using market data at the balance sheet date (principally exchange rates and yield curves).

Borrowings are valued at the net present value of the future cash-flows using credit spreads and yield curves derived from market data. Borrowings are carried on the balance sheet at amortised cost adjusted for fair value interest rate hedging. The fair value of fixed rate borrowings is only used for supplementary disclosures.

Cash, trade receivables and trade payables are excluded from this table because carrying value is a reasonable approximation to fair value for all these assets and liabilities.

21 Commitments

Operating lease commitments - minimum lease payments

The minimum uncancellable lease payments which the Group is committed to make are:

 

 

31 July 2016

 

31 July 2015

 

Land and
buildings
£m

Other
£m

Land and
buildings
£m

Other
£m

Payments due

 

 

 

 

- not later than one year

35

7

31

7

- later than one year and not later than five years

76

6

57

7

- later than five years

22

 

22

 

 

133

13

110

14

 

Other commitments

At 31 July 2016, commitments, comprising bonds and guarantees arising in the normal course of business, amounted to £174m (2015: £159m), including pension commitments of £54m (2015: £54m).

22 Provisions and contingent liabilities

 

 

Trading

 

Non-headline and legacy

 

Total

 

 

£m

 

John Crane, Inc.
litigation
£m

Titeflex
Corporation
litigation
£m

Other
£m

 

£m

Current liabilities

 

21

 

27

17

14

 

79

Non-current liabilities

 

5

 

189

54

5

 

253

At 31 July 2015

 

26

 

216

71

19

 

332

Exchange adjustments

 

5

 

39

14

2

 

60

Provision charged

 

21

 

16

12

15

 

64

Provision released

 

(4)

 

(1)

(1)

(2)

 

(8)

Unwind of provision discount

 

 

 

4

1

 

 

5

Utilisation

 

(16)

 

(22)

(3)

(13)

 

(54)

At 31 July 2016

 

32

 

252

94

21

 

399

Current liabilities

 

26

 

32

20

16

 

94

Non-current liabilities

 

6

 

220

74

5

 

305

At 31 July 2016

 

32

 

252

94

21

 

399

 

The John Crane, Inc. and Titeflex Corporation litigation provisions are the only provisions that are discounted.

Trading

Warranty provision and product liability

At 31 July 2016 there are warranty and product liability provisions of £29m (2015: £24m). Warranties over the Group's products typically cover periods of between one and three years. Provision is made for the likely cost of after-sales support based on the recent past experience of individual businesses.

Commercial disputes and litigation in respect of ongoing business activities

The Group has on occasion been required to take legal action to protect its intellectual property and other rights against infringement. It has also had to defend itself against proceedings brought by other parties, including product liability and insurance subrogation claims. Provision is made for any expected costs and liabilities in relation to these proceedings where appropriate, though there can be no guarantee that such provisions (which may be subject to potentially material revision from time to time) will accurately predict the actual costs and liabilities that may be incurred. Trading provisions include £1m (2015: £1m) in connection with ongoing price audits of overhead cost recovery charges associated with certain historical supply arrangements and royalty claims linked to customer funded development projects.

Contingent liabilities

In the ordinary course of its business, the Group is subject to commercial disputes and litigation such as government price audits, product liability claims, employee disputes and other kinds of lawsuits, and faces different types of legal issues in different jurisdictions. The high level of activity in the US, for example, exposes the Group to the likelihood of various types of litigation commonplace in that country, such as 'mass tort' and 'class action' litigation, legal challenges to the scope and validity of patents, and product liability and insurance subrogation claims. These types of proceedings (or the threat of them) are also used to create pressure to encourage negotiated settlement of disputes. Any claim brought against the Group (with or without merit), could be costly to defend. These matters are inherently difficult to quantify. In appropriate cases a provision is recognised based on best estimates and management judgement but there can be no guarantee that these provisions (which may be subject to potentially material revision from time to time) will result in an accurate prediction of the actual costs and liabilities that may be incurred. There are also contingent liabilities in respect of litigation for which no provisions are made.

The Group operates in some markets where the risk of unethical or corrupt behaviour is material and has procedures, including an employee 'Ethics Alertline', to help it identify potential issues. Such procedures will, from time to time, give rise to internal investigations, sometimes conducted with external support, to ensure that Smiths Group properly understands risks and concerns and can take steps both to manage immediate issues and to improve its practices and procedures for the future. The Group also co-operates with relevant authorities in investigating business conduct issues whenever requested to. The Group is not aware of any issues which are expected to generate material financial exposures.

Non-headline and legacy

John Crane, Inc.

John Crane, Inc. ("JCI") is one of many co-defendants in numerous lawsuits pending in the United States in which plaintiffs are claiming damages arising from alleged exposure to, or use of, products previously manufactured which contained asbestos. Until 2006, the awards, the related interest and all material defence costs were met directly by insurers. In 2007, JCI secured the commutation of certain insurance policies in respect of product liability. Provision is made in respect of the expected costs of defending known and predicted future claims and of adverse judgments in relation thereto, to the extent that such costs can be reliably estimated.

The JCI products generally referred to in these cases consist of industrial sealing product, primarily packing and gaskets. The asbestos was encapsulated within these products in such a manner that causes JCI to believe, based on tests conducted on its behalf, that the products were safe. JCI ceased manufacturing products containing asbestos in 1985.

John Crane, Inc. litigation provision

While JCI has excess liability insurance, the availability of such insurance and scope of the cover are currently the subject of litigation in the United States. Pending the outcome of that litigation, JCI has met defence costs directly. JCI has recognised the recovery of £16m through a settlement with an insurer (see note 3) but this agreement does not provide any cover for future costs. The calculation of the provision does not take account of any potential recoveries from insurers.

JCI continues to actively monitor the conduct and effect of its current and expected asbestos litigation, including the most efficacious presentation of its 'safe product' defence, and intends to continue to resist these asbestos claims based upon this defence. Approximately 247,000 claims (2015: 242,000 claims) against JCI have been dismissed before trial over the last 37 years. JCI is currently a defendant in cases involving approximately 74,000 claims (2015: 76,000 claims). Despite the large number of claims brought against JCI, since the inception of the litigation it has had final judgments against it, after appeals, in 137 cases (2015: 133 cases) over the period, and has had to pay awards amounting to approximately US$158m (2015: US$153m). JCI has also incurred significant additional defence costs. The litigation involves claims for a number of allegedly asbestos related diseases, with awards, when made, for mesothelioma tending to be larger than those for the other diseases JCI's ability to defend mesothelioma cases successfully is, therefore, likely to have a significant impact on its annual aggregate adverse judgment and defence costs. The provision is based on past history and published tables of asbestos incidence projections and is determined using asbestos valuation experts, Bates White LLC. Whilst published incidence curves can be used to estimate the likely future pattern of asbestos related disease, John Crane, Inc.'s claims experience is significantly impacted by other factors which influence the US litigation environment. These can include: changing approaches on the part of the plaintiffs' bar; changing attitudes amongst the judiciary at both trial and appellate levels; and legislative and procedural changes in both the state and federal court systems. The projections use a 10 year time horizon on the basis that Bates White LLC consider that there is substantial uncertainty in the asbestos litigation environment so probable expenditures are not reasonably estimable beyond this time horizon.

The assumptions made in assessing the appropriate level of provision include: the period over which the expenditure can be reliably estimated; the future trend of legal costs; the rate of future claims filed; the rate of successful resolution of claims; and the average amount of judgments awarded.

The provision in respect of JCI is a discounted pre-tax provision using discount rates, being the risk-free rate on US debt instruments for the appropriate period. The deferred tax asset related to this provision is shown within the deferred tax balance (note 6). Set out below is the gross, discounted and post-tax information relating to this provision:

 

31 July 2016
£m

31 July 2015
£m

Gross provision

267

236

Discount

(15)

(20)

Discounted pre-tax provision

252

216

Deferred tax

(84)

(72)

Discounted post-tax provision

168

144

 

John Crane, Inc. litigation provision sensitivities

However, because of the significant uncertainty associated with the future level of asbestos claims and of the costs arising out of related litigation, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred and, as a result, the provision may be subject to potentially material revision from time to time if new information becomes available as a result of future events.

Statistical analysis of the provision indicates that there is a 50% probability that the total future spend will fall between £250m and £280m (2015: between £221m and £248m), compared to the gross provision value of £267m (2015: £236m).

The projections use a 10 year time horizon. Reducing the time horizon by one year would reduce the provision by £18m (2015: £15m) and reducing it by five years would reduce the provision by £107m (2015: £91m).

John Crane, Inc. contingent liabilities

Provision has been made for future defence costs and the cost of adverse judgments expected to occur. JCI's claims experience is significantly impacted by other factors which influence the US litigation environment. These can include: changing approaches on the part of the plaintiffs' bar; changing attitudes amongst the judiciary at both trial and appellate levels; and legislative and procedural changes in both the state and federal court systems. As a result, whilst the Group anticipates that asbestos litigation will continue beyond the period covered by the provision, the uncertainty surrounding the US litigation environment beyond this point is such that the costs cannot be reliably estimated.

Although the methodology used to calculate the JCI litigation provision can in theory be applied to show claims and costs for longer periods, the Directors consider, based on advice from Bates White, that the level of uncertainty regarding the factors used in estimating future costs is too great to provide for reasonable estimation of the numbers of future claims, the nature of such claims or the cost to resolve them for years beyond the 10 year time horizon.

Titeflex Corporation

In recent years Titeflex Corporation, a subsidiary of the Group in the Flex-Tek division, has received a number of claims from insurance companies seeking recompense on a subrogated basis for the effects of damage allegedly caused by lightning strikes in relation to its flexible gas piping product. It has also received a number of product liability claims regarding this product, some in the form of purported class actions. Titeflex Corporation believes that its products are a safe and effective means of delivering gas when installed in accordance with the manufacturer's instructions and local and national codes; however some claims have been settled on an individual basis without admission of liability. Equivalent third-party products in the US marketplace face similar challenges.

Titeflex Corporation litigation provision

The continuing progress of claims and the pattern of settlement, together with the recent market place activity, provide sufficient evidence to recognise a liability in the accounts. Therefore provision has been made for the costs which the Group is expected to incur in respect of future claims to the extent that such costs can be reliably estimated. Titeflex Corporation sells flexible gas piping with extensive installation and safety guidance (revised in 2008) designed to assure the safety of the product and minimise the risk of damage associated with lightning strikes.

The assumptions made in assessing the appropriate level of provision, which are based on past experience, include: the period over which expenditure can be reliably estimated; the number of future settlements; the average amount of settlements; and the impact of statutes of repose and safe installation initiatives on the expected number of future claims. This is the first year that the company has had sufficient evidence of the impact of statutes of repose and safe installation initiatives to incorporate them into the provision calculation. Reflecting work completed in the year on streamlining the settlement process, and dismissing claims covered by statutes of repose, the Directors consider that the pattern of resolution of future potential claims by Titeflex Corporation is now more predictable. As a result, the provision model has been extended. Incorporating the two additional assumptions and extending the time period generated a net £16m increase in the provision.

The provision of £94m (2015: £71m) is a discounted pre-tax provision using discount rates, being the risk-free rate on US debt instruments for the appropriate period. The deferred tax asset related to this provision is shown within the deferred tax balance (note 6).

 

31 July 2016
£m

31 July 2015
£m

Gross provision

140

77

Discount

(46)

(6)

Discounted pre-tax provision

94

71

Deferred tax

(36)

(27)

Discounted post-tax provision

58

44

 

Titeflex Corporation litigation provision sensitivities

However, because of the significant uncertainty associated with the future level of claims and of the costs arising out of related litigation, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred and, as a result, the provision may be subject to potentially material revision from time to time if new information becomes available as a result of future events.

The projections incorporate a long-term assumption about the impact of safe installation initiatives on the level of future claims. If the assumed annual benefit of bonding and grounding initiatives was 0.5% higher the provision would be £6m lower, and if the benefit was 0.5% lower, the provision would increase by £7m.

Other non-headline and legacy

Legacy provisions comprise provisions relating to former business activities and properties no longer used by Smiths. Non-headline provisions comprise all provisions that were disclosed as non-headline items when they were charged to the consolidated income statement.

These provisions cover non-headline reorganisation, vacant properties, disposal indemnities and litigation in respect of old products and discontinued business activities.

Reorganisation and property

At 31 July 2016 there were provisions of £11m (2015: £6m) related to Fuel for Growth, £3m (2015: £6m) related to onerous leases and dilapidations provisions, and £2m (2015: £1m) related to actual and potential environmental issues for sites which were no longer occupied by Smiths operations.

The Fuel for Growth provisions are expected to be utilised in 2017.

Disposal

Other provisions include disposal provisions of £3m (2015: £3m) relating to warranties and other obligations in respect of the disposal of the Marine Systems and Aerospace businesses. Most of the balance is expected to be utilised within the next three years.

23 Share capital

 

Number of shares

Issued capital
£m

Consideration
£m

Ordinary shares of 37.5p each

 

 

 

Total share capital at 31 July 2014

394,456,135

148

 

Exercise of share options

403,869

 

3

Total share capital at 31 July 2015

394,860,004

148

 

Exercise of share options

363,068

 

3

Total share capital at 31 July 2016

395,223,072

148

 

 

At 31 July 2016 all of the issued share capital was in free issue. All issued shares are fully paid.

24 Dividends

The following dividends were declared and paid in the period:

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Ordinary final dividend of 28.00p for 2015 (2014: 27.50p) paid 20 November 2015

111

108

Ordinary interim dividend of 13.25p for 2016 (2015: 13.00p) paid 22 April 2016

52

52

 

163

160

 

The final dividend for the year ended 31 July 2016 of 28.75p per share was recommended by the Board on 27 September 2016 and will be paid to shareholders on 18 November 2016, subject to approval by the shareholders. This dividend has not been included as a liability in these accounts and is payable to all shareholders on the register of Members at close of business on 21 October 2016.

25 Reserves

Retained earnings include the value of Smiths Group plc shares held by the Smiths Industries Employee Benefit Trust. In the year the Company issued nil (2015: nil) shares to the Trust, and the Trust purchased 760,218 shares (2015: 838,032 shares) in the market. At 31 July 2016 the Trust held 852 (2015: 852) ordinary shares.

The capital redemption reserve, revaluation reserve and merger reserve arose from: share repurchases; revaluations of property, plant and equipment; and merger accounting for business combinations before the adoption of IFRS, respectively.

Capital management

Capital employed comprises total equity adjusted for goodwill recognised directly in reserves, net post-retirement benefit related assets and liabilities, net litigation provisions relating to non-headline items and net debt. The efficiency of the allocation of the capital to the divisions is monitored through the return on capital employed (ROCE). This ratio is calculated over a rolling 12-month period and is the percentage that headline operating profit comprises of monthly average capital employed. The ROCE was 15.3% (2015: 16.0%), see note 28.

The capital structure is based on the directors' judgement of the balance required to maintain flexibility while achieving an efficient cost of capital.

The ratio of net debt to headline EBITDA of 1.6 (2015: 1.4) is within the Group's stated policy of less than 2.0 over the medium term. The Group's robust balance sheet and record of strong cash generation is more than able to fund the immediate investment needs and other legacy obligations.

As part of its capital management the Group strategy is to maintain a solid investment grade credit rating to ensure access to the widest possible sources of financing and to minimise the resulting cost of capital. At 31 July 2016 the Group had a credit rating of BBB+/Baa2 (2015: BBB+/Baa2) with Standard & Poor's and Moody's respectively.

The Board has a progressive dividend policy for future payouts, with the aim of increasing dividends in line with the long-term underlying growth in earnings. In setting the level of dividend payments, the Board will take into account prevailing economic conditions and future investment plans, along with the objective to maintain minimum dividend cover of around 2.0.

Hedge reserve

 

 

31 July 2016
£m

31 July 2015
£m

The hedge reserve on the balance sheet comprises

 

 

 

- cash-flow hedge reserve

 

(7)

3

- net investment hedge reserve

 

(294)

(66)

 

 

(301)

(63)

 

See transactional currency exposure risk management disclosures in note 18 for additional details of cash-flow hedges, and translational currency exposure risk management disclosure also in note 18 for additional details of net investment hedges.

26 Cash-flow

Cash-flow from operating activities

 

Year ended 31 July 2016

Year ended 31 July 2015

 

Headline
£m

Non-headline
£m

Total
£m

Headline
£m

Non-headline
£m

Total
£m

Operating profit

510

(123)

387

511

(117)

394

Amortisation of intangible assets

43

15

58

38

33

71

Impairment of intangible assets

 

23

23

 

27

27

Impairment of trade investments

 

2

2

 

 

 

Depreciation of property, plant and equipment

53

 

53

49

 

49

Impairment of property, plant and equipment

 

6

6

 

 

 

Loss on disposal of property, plant and equipment

2

 

2

1

 

1

Loss/(profit) on disposal of business

 

 

 

 

1

1

Share-based payment expense

9

 

9

8

 

8

Retirement benefits

1

(104)

(103)

2

(87)

(85)

Decrease/(increase) in inventories

30

 

30

(30)

 

(30)

(Increase)/decrease in trade and other receivables

(21)

(16)

(37)

11

 

11

Increase/(decrease) in trade and other payables

1

 

1

(4)

 

(4)

Increase/(decrease) in provisions

(1)

3

2

(15)

(7)

(22)

Cash generated from operations

627

(194)

433

571

(150)

421

Interest paid

(61)

 

(61)

(56)

(10)

(66)

Interest received

3

45

48

2

 

2

Tax paid

(62)

 

(62)

(91)

 

(91)

Net cash inflow from operating activities

507

(149)

358

426

(160)

266

 

Retirement benefit contributions comprise cash contributions of £123m and a non-cash transaction where £152m of financial assets were contributed to the Smiths Industries Pension Scheme. See note 8 for details.

Interest received in the period includes £41m cash inflows (2015: interest paid includes £10m cash outflows) on foreign exchange contracts hedging exposures on intra-group loans, and £4m exchange gains realised on internal interest.

The split of tax payments between headline and non-headline only considers the nature of payments made. No adjustment has been made for reductions in tax payments due to tax relief received on non-headline items.

Headline cash measures

The Group measure of headline operating cash excludes interest and tax and includes capital expenditure supporting organic growth.

 

Year ended 31 July 2016

Year ended 31 July 2015

 

Headline
£m

Non-headline
£m

Total
£m

Headline
£m

Non-headline
£m

Total
£m

Net cash inflow from operating activities

507

(149)

358

426

(160)

266

Include

 

 

 

 

 

 

Expenditure on capitalised development, other intangible assets and property, plant and equipment

(108)

 

(108)

(95)

 

(95)

Disposals of property, plant and equipment

1

 

1

8

3

11

Investment in financial assets relating to pensions financing

 

(8)

(8)

 

(24)

(24)

Headline free cash-flow

400

(157)

243

339

(181)

158

Exclude

 

 

 

 

 

 

Interest paid

61

 

61

56

10

66

Interest received

(3)

(45)

(48)

(2)

 

(2)

Tax paid

62

 

62

91

 

91

Headline operating cash-flow

520

(202)

318

484

(171)

313

 

Reconciliation of headline free cash-flow to total movement in cash and cash-equivalents

 

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Headline free cash-flow

400

339

Non-headline free cash-flows

(157)

(181)

Investment in other financial assets

(1)

(3)

Acquisition of businesses

(8)

 

Disposal of businesses

 

2

Net cash-flow used in financing activities

(332)

147

Net (decrease)/increase cash and cash equivalents

(98)

304

 

27 Business held for sale

At 31 July 2016 the Group had invited offers for the purchase of the John Crane Artificial lift business. Agreement to sell the business was announced on 23 September 2016 and, subject to regulatory clearance, the disposal is expected to complete in the first half of 2016/17. In the year ended 31 July 2016 the business had headline losses of $10m (2015: $2m) on sales of $53m (2015: $91m).

As required by IFRS 5, the assets and liabilities to be sold have been disclosed as held for sale in the consolidated balance sheet as at 31 July 2016. No impairment loss was recognised on writing assets down to fair value less disposal costs although impairments were recognised earlier in the year relating to this business, see notes 11 and 12.

 

 

 

31 July 2016
£m

Current assets

 

 

 

Inventories

 

 

17

Trade and other receivables

 

 

7

Total assets of business held for sale

 

 

24

Current liabilities

 

 

 

Trade and other payables

 

 

(5)

Total liabilities of business held for sale

 

 

(5)



 

28 Non-statutory capital and credit metrics

In addition to the non-statutory profit measures explained in note 3, the Company calculates credit metrics and return on capital employed incorporating the same adjustments. See the disclosures on presentation of results in accounting policies for an explanation of the excluded items.

Return on capital employed (ROCE)

Smiths ROCE is calculated over a rolling 12-month period and is the percentage that headline operating profit comprises of monthly average capital employed.

See note 1 for the divisional headline operating profit and average divisional capital employed used to calculate divisional ROCE.

Capital employed

Capital employed is a non-statutory measure of invested resources. It comprises statutory net assets adjusted to add goodwill recognised directly in reserves in respect of subsidiaries acquired before 1 August 1998 of £815m (31 July 2015: £815m) and eliminate post-retirement benefit assets and liabilities and litigation provisions relating to non-headline items, both net of related tax, and net debt.

 

Notes

31 July 2016
£m

31 July 2015
£m

Net assets

 

1,660

1,428

Adjust for

 

 

 

Goodwill recognised directly in reserves

 

815

815

Post-retirement benefit assets and liabilities

8

(80)

108

Tax related to post retirement benefit assets and liabilities

 

(4)

(55)

Investments related to post retirement benefit assets and liabilities

 

 

(147)

John Crane, Inc. litigation provisions and related tax

22

168

144

Titeflex Corporation litigation provisions and related tax

22

58

44

Net debt

17

978

818

Capital employed

 

3,595

3,155

 

Return on capital employed

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Headline operating profit for previous twelve months

 

510

511

Average capital employed

1

3,324

3,197

ROCE

 

15.3%

16.0%

 

Credit metrics

Smiths Group monitors the ratio of net debt to Headline EBITDA as part of its management of credit ratings, see note 25 for details. This ratio is calculated as follows.

Headline earnings before interest, tax depreciation and amortisation (Headline EBITDA)

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Headline operating profit

 

510

511

Exclude

 

 

 

- depreciation

12

53

49

- amortisation of development costs

10

26

23

- amortisation of software, patents and intellectual property

10

17

15

Headline EBITDA

 

606

598

 

Ratio of net debt to headline EBITDA

 

Notes

Year ended
31 July 2016
£m

Year ended
31 July 2015
£m

Headline EBITDA

 

606

598

Net debt

17

978

818

Ratio of net debt to headline EBITDA

 

1.6

1.4

 


This information is provided by RNS
The company news service from the London Stock Exchange
 
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