Preliminary Results

CHAIRMAN AND CHIEF EXECUTIVE'S STATEMENT

 

Results overview

In 2012 IMI delivered organic revenue growth of 3%, operating margins of 17%, strong cash conversion and adjusted earnings per share of 84.3p, up 3% over last year despite currency headwinds associated with stronger sterling.

 

This was an encouraging performance, with growth from new products and emerging markets more than offsetting the impact of weaker economic conditions in the second half; and good underlying progress on margins in a number of areas reflecting continued improvements in the quality and differentiation of our products.

 

Our Fluid Controls business recorded organic revenue growth of 3%, with double digit revenue growth in Severe Service offsetting second half weakness in Fluid Power and a flat year in Indoor Climate.  Margins for the Fluid Controls businesses reduced from 18.7% to 17.7%, impacted primarily by the shipment of a large backlog of lower margin projects within Severe Service secured in earlier years.  As indicated in the Interim Results, prospects going forward are much improved, with margins in the Severe Service order book at the year-end notably higher than 12 months ago.  Margins in Fluid Power and Indoor Climate reflected pleasing resilience in the face of weaker end-markets, supporting increased investments in emerging markets and in new products which continue to improve their differentiated positions.

 

Within Retail Dispense we made further good progress in improving the underlying quality of the Beverage Dispense and Merchandising businesses, accelerating the development of new products at higher margins and exiting low margin or commoditised product lines.  As a result operating margins for the Retail Dispense businesses increased to 14.7% from 13.7% last year.  Overall revenues increased 2% on an organic basis, despite a number of low margin product exits, pointing to a reasonably healthy level of underlying demand.

 

Contributions from our two acquisitions during the year, Remosa and InterAtiva, were encouraging, with both businesses recording an  improvement in margins and both providing scope for considerable growth over the coming years.

 

These results together with a strong performance on cash conversion and a high level of confidence in the future prospects of the Group lead the Board to recommend that the final dividend be increased by 9% to 20.7p.  This makes a total dividend for the year of 32.5p, an increase of 8% over last year's 30.0p.

 

Accelerating our strategic plans

Over the last few years we have developed a very detailed understanding of the end-market niches that offer the greatest scope for IMI in terms of growth, margins and long-term resilience - our so-called 'sweetspot' of operation.  For IMI this sweetspot is where we can deploy our differentiated fluid technologies in global market niches where we already have, or can aspire to, a leadership position and which benefit from a heightened exposure to the long-term mega-trends of climate change, resource scarcity, urbanisation and an ageing population. 

 

We understand the long-term drivers for growth, the key requirements for establishing barriers to the competition and the scope for building market share.  Furthermore, we have established clear customer and technology roadmaps to take full advantage of the new product opportunities arising from favourable mega-trends and to deliver market share gain. Accordingly, sweetspot convergence and the prioritisation of assets and resources is the central theme in progressing both the quality, as reflected by operating margins, and growth of the business over the medium-term.

 

We have set out an objective to increase the proportion of our revenues in this sweetspot of operation, which was 58% in 2012, to around 75% over five years.  The pathway to that convergence requires an acceleration in output from new product development, greater participation in the higher growth emerging markets, a highly disciplined approach to the allocation of internal resources, and a step change in corporate activity, involving both acquisitions and disposals.

 

Over the period we expect to increase our investments in both new products, as framed by the sweetspot and technology roadmaps we have developed, and in greater penetration of the emerging markets.  These investments for higher growth will be funded through a continued determination to keep winning our 'inflation equation', with a focus on value-selling techniques and on driving down manufacturing and supply chain costs.  We are also targeting a significant increase in investment in acquisitions, firmly positioned in our sweetspot, and have boosted our internal M&A resource accordingly.

 

Retail Dispense reorganisation

As part of the convergence process, since the year-end we have concluded that the majority of the Merchandising business should be divested, and we are exploring options accordingly.  The part of the Merchandising business serving the beverage market, contained within our Display Technologies subsidiary, presents a number of synergies with the Beverage Dispense business, including a shared customer base and significant potential to develop a more compelling and high impact interface between the consumer and our beverage dispense equipment.  Accordingly this beverage activity has been transferred to the Beverage Dispense business with effect from the start of this year.  In 2012, Display Technologies had revenues in these product areas of £36m and segmental operating profit of £8.5m.

 

Capital allocation priorities

As part of our strategic acceleration plans we have reviewed our capital allocation priorities.  The Group continues to be very cash generative and net debt at the year-end reduced from the half-year to £144m, with net debt to EBITDA at 0.4 times, after having financed £105m for the acquisitions earlier in the year of Remosa and InterAtiva. 

 

Our priorities for capital allocation are the acceleration of investments for growth in new product development and emerging markets, the maintenance of a progressive dividend policy, with dividend cover being maintained at above two times earnings and an increase in acquisition activity to support sweetspot convergence. 

 

The Board remains focused on maintaining an efficient balance sheet and given the uncertainty over the timing of  acquisitions, there may be periods when net debt falls below current levels which becomes inefficient.  Accordingly we intend to commence a share buyback programme over the next 12 months of up to £175m to ensure that gearing remains at or above the current level.

 

People and organisation

In support of efforts to accelerate growth and deliver against our sweetspot convergence objectives, we are making a change to the senior leadership team.  Peter Spencer, who has a track record of delivering significant growth, including a very successful period in charge of the Merchandising business, will lead the Indoor Climate Group with effect from 7 March, reporting directly to Martin Lamb.  Sean Toomes, who has made an excellent contribution to the Group over a long career with IMI, stepped down from the Board on 6 March, and will be leaving the company at the end of June.  We would like to thank Sean for his significant contribution to IMI over many years. 

 

Our ongoing success is fundamentally linked to the skills, energy, initiative and commitment of our people across the world.  We are again grateful to them for their continued hard work and enthusiasm which have helped to deliver another good set of results in 2012. 

 

The IMI Way

The IMI Way is our code of responsible business which sets the very highest standards of ethical business and compliance. The Group has been reinforcing the core values and messages of the IMI Way since its launch in 2009.  On 13 June 2012, we held our first global IMI Way day when the vast majority of our workforce, which encompasses over 15,000 employees, participated in interactive training and engaged in a number of worthwhile projects in their local communities.  

 

Outlook

IMI has proved itself to be a strong and resilient business, capable of securing growth even in difficult markets. Whilst the macro-economic environment has stabilised over recent months, we expect market conditions to remain subdued in the first half of 2013, but to improve gradually as the year progresses, with increased momentum in the second half, benefitting from an improving sales mix and the commercialisation of a number of new products.  Over the longer term, we remain confident of delivering organic revenue growth well in excess of global GDP, with very attractive margins, as the benefits from the execution of our strategy fully materialise.

 

OPERATIONS AND FINANCIAL REVIEW

 

Operations review

 

The following review of our business areas for the year ended 31 December 2012 compares the performance of our operations, as reported under IFRS8: Operating Segments, with the year ended 31 December 2011.  References to organic growth exclude the results of acquisitions for the period in which they were not in the comparators and are on a constant currency basis.  This section also comments on current market conditions in each of our businesses.

 

Severe Service
Revenue	£686m	(2011: £572m)
Operating profit	£96.3m	(2011: £88.9m)
Operating margin	14.0%	(2011: 15.5%)

 

Our Severe Service business delivered revenue growth of 20% on a reported basis, including the results of Remosa and InterAtiva since acquisition. Revenue, on an organic basis, increased by 14% for the full year, reflecting a strong shipment performance throughout the year. We saw good growth in shipments in Fossil Power, Oil & Gas and in the aftermarket, whilst shipments in the Petrochemical market were down.  Shipments also benefitted from a catch up in backlog that existed at the end of 2011.

 

The order book remained unchanged from a year ago despite record shipments, and overall order intake was down 1% for the year on an organic basis.  Bookings momentum has been particularly positive in the Petrochemical sector which has offset lower activity in the Nuclear sector and reduced bookings for new construction fossil power projects in China and India where we continue to exercise greater selectivity on project bids.

 

Operating margins of 14.0% were down on the 15.5% achieved in 2011.  As we explained in our Interim Results, this reflects an adverse mix of lower margin projects secured in prior years and higher than expected costs associated with our Brno manufacturing facility in the Czech Republic.  Margins in the order book continued to improve throughout the year as the backlog of lower margin projects was shipped, and was replaced by new projects at better margins.  In addition we have continued to achieve improvements in productivity in the second half at the Brno facility.  Whilst there remain some lower margin contracts still to ship in 2013, mainly in the first half, we continue to expect margins to show progressive improvement through 2013. 

 

The acquisition of Remosa in February 2012 significantly strengthened our capabilities in the downstream Petrochemical sector which is enjoying renewed investment in North America on the back of the availability of low cost shale gas.  The acquisition of InterAtiva, also completed in February 2012, has significantly improved our sales and service infrastructure in South America, opening up new sales opportunities across the Severe Service business.

 

The strong order book position at the beginning of the year gives us confidence that the business will deliver modest growth in 2013.

 

Fluid Power
Revenue	£717m	(2011: £767m)
Operating profit	£142.3m	(2011: £150.5m)
Operating margin	19.8%	(2011: 19.6%)

 

As anticipated, Fluid Power markets weakened in the second half after a flat performance in the first half.  Overall revenues declined, on an organic basis, by 5% in the second half and by 3% for the full year. 

 

Our sector business, which focuses on bespoke solutions for key original equipment manufacturer (OEM) customers in global niche markets, continued to show greater resilience.  This was down 1% on an organic basis, compared to 4% down for the rest of Fluid Power. The Commercial Vehicle sector was down around 10% in the second half and 2% down for the full year.  The US truck market was notably weaker in the second half after a strong performance in the first half.  We saw good revenue growth in the Energy sector, more stable performances in Food & Beverage and Life Sciences and a decline in the Rail sector.  Overall our sector businesses represented 46% of total Fluid Power revenues in 2012. 

 

We continued to make good progress with the ongoing development of our internet, phone and catalogue-based aftermarket solution, Norgren Express.

 

Fluid Power has continued to demonstrate good underlying margin momentum, with value engineering and supplier rationalisation initiatives, together with our ongoing transfers of production to lower cost sites, delivering further cost reductions.  This has resulted in a further improvement in margins, despite lower activity levels, with full year margins of 19.8% compared to 19.6% last year.   Second half margins were slightly down at 19.6% compared to 20.0% in the second half of last year on the reduced volumes. 

 

We are seeing more optimistic feedback from major customers in our regular conversations with them, although there has been a slow start to the year in the Commercial Vehicle sector as some destocking continues.  Based on our latest customer insight and current order trends we expect revenues in the first half to be similar to the second half of last year with first quarter destocking in the Commercial Vehicle sector offsetting a gradually improving trend elsewhere.  We expect a return to stronger growth in the second half, as Commercial Vehicle volumes normalise, and the contribution from a number of recently launched products accelerates.

 

Indoor Climate
Revenue	£293m	(2011: £310m)
Operating profit	£61.5m	(2011: £68.2m)
Operating margin	21.0%	(2011: 22.0%)

 

Indoor Climate revenues were flat on an organic basis for the full year, with growth in a number of emerging markets offsetting a decline in Western Europe, which suffered from some wholesaler destocking at the year-end after a more positive third quarter.  The new construction market in Europe remained subdued, whilst refurbishment activity continued to be more resilient.

 

During the year we significantly increased our investments in sales resource outside of Europe, opening up four new hydronic demonstration centres and increasing the number of new seminar participants by 16%.  This investment is starting to gain some traction, with strong double digit growth in Turkey, Russia, China and Brazil, but disappointing results thus far in North America.  We also invested heavily in a new range of control valves with integrated balancing, which is being rolled out to the global market in the first half of 2013, opening up a new and adjacent market sector for the Indoor Climate business.

 

Operating margins in the second half of 22.8% were in line with our expectations, leaving full year margin at 21.0%, down from the 22.0% achieved in 2011.  As previously highlighted this reflects the incremental investments for growth and some additional costs associated with the centralising of the management structure in Switzerland.

 

Looking at the general macro-economic background, and taking note of customer sentiment, we expect the new construction market in Europe to remain subdued but refurbishment activity to remain resilient.  We do however expect an improving trend in both Asia and the Americas which, coupled with the increased sales presence we now have in these markets and a progressively improving contribution from the newly launched control valves, should mark a return to growth in 2013.

 

Beverage Dispense
Revenue	£313m	(2011: £317m)
Operating profit	£45.0m	(2011: £41.1m)
Operating margin	14.4%	(2011: 13.0%)

 

Full year revenues in Beverage Dispense were down 1% on both an organic and reported basis.  The continued focus on improving the quality of the business delivered a 9% increase in operating profit to £45.0m and resulted in another strong uplift in returns with an overall operating margin for the year of 14.4% (2011: 13.0%).  Operating margins in the second half were ahead of the long held target of 15%.   

  

The important Americas market ended the year flat and we achieved a more positive performance in continental Europe.  We saw good growth in Asia Pacific, with a particularly strong performance in China.   The most challenging market for Beverage Dispense was in the UK where revenues were significantly below last year, reflecting in part the exit of a low margin contract at the half year.  We have recently taken actions to restructure the UK business, reducing the cost base and concentrating our efforts on a more focused customer base.  Our parts business, 3Wire, has continued to win new national food-service accounts in North America.

 

During the year we remained focused on improving the quality of the overall sales mix in the business, accelerating the growth of higher margin new products and continuing to exit commoditised low margin product lines, like the UK contract referenced above.  These low margin exits reduced revenues by around 2% and have resulted in an exit from around 10% of the product portfolio over the last three years.  This programme is now largely complete, notwithstanding the full year impact in 2013 of actions taken partway through 2012.

 

We continue to focus our efforts on delivering successful new products for our customers to meet their growing demand for innovative solutions to dispense health and wellness beverages such as smoothies, water, juice and frozen beverages and also a greater variety and choice of drinks. We are working on several major new product development opportunities which have the potential to accelerate growth and drive further margin improvement over the medium term.  We were recently awarded the contract to design and manufacture the next generation of automated beverage dispensers to be sited in McDonald's drive-thru restaurants on a global basis over the next few years.

 

Merchandising
Revenue	£183m	(2011: £169m)
Operating profit	£27.9m	(2011: £25.4m)
Operating margin	15.2%	(2011: 15.0%)

 

Merchandising performed strongly throughout the year with revenues up 8% on an organic basis.  In the summer we commenced shipments for two large multi-year contracts secured in our European cosmetics business.   We have also continued to perform well in the US automotive sector where customers are upgrading their showrooms. 

 

We continue to focus on higher value projects where we are able to leverage our extensive consumer insight in our target end-markets to deliver valuable and compelling merchandising solutions for our customers.  This focus is being supported by further investment in developing our In-Vision retail science laboratory which opened in the US in 2011. 

 

Segmental operating profits increased by 10% to £27.9m and operating margins at 15.2% were ahead of last year.   

 

As mentioned in the Chairman and Chief Executive's statement, with effect from January 2013 the beverage business of Display Technologies has been transferred into Beverage Dispense and we are exploring options for the divestment of the remainder of the Merchandising business.

 

Financial Review

 

Results summary

Reported revenues increased by 3% to £2,190m (2011: £2,131m).  After adjusting for an exchange rate impact of £63m and the contribution from acquisitions, the organic revenue increase was also 3%. 

 

Segmental operating profit was £373.0m, compared to £374.1m last year.  At constant exchange rates and excluding acquisitions segmental operating profit rose by 1%.  The segmental operating margin was 17.0% (2011: 17.5%). Operating profit was £317.9m (2011: £314.2m), after restructuring costs of £23.3m, acquired intangible amortisation of £29.6m and reversing net economic hedge contract gains of £6.8m. Other acquisition-related costs were £6.3m and there was a net credit on special pension events of £10.9m.  The restructuring charge principally reflects ongoing costs associated with the moves to lower cost manufacturing centres in our Severe Service business (which were higher than expected) and the closure of one of our Merchandising sites in the US. The Group expects to continue to incur restructuring costs in 2013 of around £15m resulting from additional initiatives to move manufacturing to lower cost sites. 

 

Interest costs on net borrowings were £17.7m (2011: £16.9m).  The net pension financing credit under IAS19 was £11.0m (2011: £6.2m). After adding the net credit on derivatives of £5.8m (2011: net expense of £2.1m), the total net financing costs were £0.9m (2011: £12.8m).

 

Adjusted basic earnings per share (excluding the after tax impact of exceptional items) were 84.3p (2011: 81.5p), an increase of 3%.  Adjusted fully diluted earnings per share were 83.2p (2011: 80.1p). Profit before tax was 5% higher at £317.0m (2011: £301.4m).  Basic earnings per share increased 15% to 72.6p (2011: 63.2p).

 

The revision to IAS19 'Employee Benefits' will apply to the Group from 1 January 2013. The principal revision to this standard is to change the basis for the calculation of the return on assets reported as financial income in the Group's income statement, whereby the amount reported in the income statement is reduced and the amount reported in other comprehensive income is increased by an equivalent amount. Had this change been effective for the year ended 31 December 2012, we estimate that the net finance income reported of £11.0m would have been a net finance charge of £7.8m, which after tax, would have resulted in a 4.6p reduction in basic and adjusted earnings per share. The equivalent finance charge is estimated at £8m for 2013.

 

Return on invested capital

Post tax return on invested capital (ROIC) was 19.2% compared to 20.3% in 2011.  We have amended our headline definition of ROIC this year to add back all accumulated amortisation of acquired intangibles to invested capital.

 

Mergers and acquisitions

On 16 February 2012, the Group acquired Remosa SpA and related companies (collectively Remosa), a leading engineering business specialising in valves and related flow control products for severe applications primarily in the Petrochemical market, for an enterprise value of £83.1m, being cash consideration of £68.4m and net debt assumed of approximately £14.7m.  The consideration was funded out of IMI's existing resources and banking facilities. The main Remosa manufacturing facility is located in Sardinia.

 

On 17 February 2012, the Group acquired the InterAtiva Group (InterAtiva), a Brazilian isolation valve business located in Sorocaba, near Sao Paolo, from its founding partners for an initial cash consideration of £22.0m and contingent consideration up to a maximum of BR$55.5m (£16.7m) to be paid based on its performance over the next three years.  The consideration was funded out of IMI's existing resources and banking facilities.

 

Exchange rates

The movement in average exchange rates between 2011 and 2012 resulted in our reported 2012 segmental revenue and segmental operating profit being 3% and 4% lower respectively.  Whilst the average US Dollar rate against Sterling was similar to 2011, the Euro was 7% weaker.

 

If the exchange rates as at 4 March 2013 of US$1.51 and €1.16 had been applied to our 2012 results, it is estimated that segmental revenue and segmental operating profit would have been 4% and 3% higher respectively.

 

Cash flow

The net cash inflow from operating activities was £211m, compared to £217m last year.  Capital expenditure on property, plant and equipment amounted to £39m (2011: £52m) and was 0.9 (2011: 1.3) times depreciation and impairment of £42m (2011: £41m).  Other major cash outflows in the year included tax of £103m, dividends of £98m and £83m relating to the acquisitions made in Severe Service. The Group made additional contributions of £17m into the UK pension fund in line with the agreed funding recovery plan.  These items were financed from current facilities and a net repayment of borrowing of £25m (2011: £16m) was also made during the year. The total cash outflow for the year was £25m (2011: inflow £44m).

 

Balance sheet

The balance sheet remains strong with net debt of £144m (2011: £108m). The cash outflow during the year was £25m, and £21m of debt was taken on as part of the acquisitions. There was a favourable translation impact of £10m on the revaluation of net foreign currency debt. The ratio of net debt to EBITDA was 0.4 times at the end of the year (2011: 0.3).

 

Intangible assets increased to £545m from £498m in the prior year, reflecting the acquired intangibles and goodwill recognised on the acquisitions which was partially offset by £30m of amortisation of acquired intangibles during the year relating to these and previous acquisitions. Expenditure capitalised during the year on non-acquired intangible assets (development costs and software) totalled £8m.

 

The net book value of the Group's investment in property, plant and equipment at 31 December 2012 was £245m (2011: £248m).  The decrease arose because depreciation and impairments of £42m (2011: £41m) more than offset capital expenditures of £39m (2011: £52m).

 

Net working capital balances increased by £31m during the year as the decrease in inventories of £29m was more than offset by a decrease in payables of £41m and an increase in receivables of £19m. The decrease in inventories reflects good reductions in stock days in both Severe Service and Beverage Dispense leading to an overall reduction of nine stock days across the Group.  The reduction in creditors was somewhat greater than the reduction in inventories reflecting additional consignment stock arrangements that we have negotiated with suppliers. The increase in receivables represents two additional debtor days for the Group and was driven by both the increase in Severe Service revenues and their geographic mix.

 

Shareholders' equity at the end of December was £636m, an increase of £71m since the end of 2011, which includes the profit attributable to the shareholders for the year of £231m, less an after-tax actuarial loss on the defined benefit pension plans of £64m and the 2011 final and 2012 interim dividends totalling £98m.

 

Tax

The effective tax rate for the Group before exceptional items reduced to 26% (2011: 28%) during the year as a result of further business reorganisation, a strong focus on global tax incentives, tax compliance management and the reduction in the UK corporation tax rate.  In addition, exceptional tax relief of £11.9m (2011: £4.1m) arose in connection with business restructuring and other exceptional costs.  The total tax charge for the year was therefore £83.3m (2011: £97.7m) and profit after tax was £233.7m (2011: £203.7m).  Taxes of £102.9m (2011: £90.9m) were paid in the year.

 

Pensions

The IAS19 net pension deficit was £232m which compares to the deficits of £208m at June 2012 and £204m at December 2011.  Of this amount, the main UK fund represents our largest employee benefit obligation which had a year-end net accounting liability of £109m (2011: £98m). This fund was closed to new entrants at the end of 2005 and to future accrual on 31 December 2010.   The increase in the UK defined benefit obligation arose as the strong asset returns, liability management initiatives and cash contributions did not quite offset our adoption of a slightly lower long-term inflation assumption and a lower discount rate.

 

In accordance with the latest recovery plan agreed in 2011, a payment of £16.8m was made to the UK fund in July 2012. These contributions will continue until 2016 or full funding if sooner.  The next actuarial valuation is scheduled to take place as at March 2014.  

 

The deficit relating to the overseas obligations rose by £19m in the year principally as a result of falls in the discount rates applied.