Smiths Group plc Interim Results 2021

Smiths Group plc - Interim Results for the half year ended 31 January 2021

Robust first half performance with improving trends

Highlights

·      Robust performance despite market disruption

o  Underpinned by our market-leading positions and high proportion of aftermarket revenues

·      Good profit conversion and excellent cash generation

o  Group-wide operating model driving efficiency, innovation and consistent execution

o  Strategic restructuring on track to deliver full £70m annualised benefit from FY2022

·      Further portfolio strengthening for long-term value creation

o  Continued investment in new technologies

o  Flex-Tek acquisition of Royal Metal in February 2021

·      Smiths Group of the future - aligned to long-term trends of sustainability and digitisation

o  All businesses united by the shared purpose of making a safer, cleaner and more efficient world

·      Smiths Medical - continuing to strengthen ahead of separation in Q4 FY2021

o  Finalising key separation workstreams

The differences between headline and statutory operating profit are non-headline items as defined in note 3 to the condensed financial statements, of which the largest constituents are the amortisation of acquired intangibles, cost recovery for asbestos litigation in John Crane, Inc and subrogation claims in Titeflex Corporation.

Outlook

·      Improving H2 trends

·      Restructuring benefits supporting further good profit conversion

·      Continued strong cash generation

·      Dividend increase reflects our confidence in the medium and longer term prospects

·      Subject to continued market recovery, Group is confident of meeting market expectations for the full year

Andy Reynolds Smith, Group Chief Executive, commented:

"This is a robust set of results relative to our end markets, with a resilient top line, good profit conversion and excellent cash generation. This has been delivered by our exceptional people in very challenging circumstances and my sincere thanks go to them. We have continued to position Smiths in the very best way - strategically, operationally, and financially - to enable us to take full advantage of market recovery when it comes. 

The Group is united by the shared purpose of making a safer, cleaner and more efficient world.  The accelerating global trends of sustainability and digitisation play to the core strengths and capabilities of Smiths' existing business model. We continue to enhance the positioning of the Group for outperformance through targeted investment in innovation and disciplined transactions - including the planned separation of Smiths Medical by the end of FY2021, which will focus and simplify the Group and maximise value for all stakeholders.

Whilst economic uncertainty remains, against the backdrop of our robust first half performance and the improving second half trends, the Group is confident of meeting market expectations for the full year and delivering long-term sustainable value."

Statutory reporting

Definitions

Presentation

The management presentation via webcast will begin at 09.00 (UK time) today at  https://smiths.com/investors/results-reports-and-presentations, with a  recording available from 13.00 (UK time).

Legal Entity Identifier (LEI): 213800MJL6IPZS3ASA11

This document contains certain statements that are forward-looking statements. They appear in a number of places throughout this document and include statements regarding the intentions, beliefs and/or current expectations of Smiths Group plc (the "Company") and its subsidiaries (together, the "Group") and those of their respective officers, directors and employees concerning, amongst other things, the results of operations, financial condition, liquidity, prospects, growth, strategies and the businesses operated by the Group. 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. This document contains brands that are trademarks and are registered and/or otherwise protected in accordance with applicable law.

Smiths (continuing operations)

The commentary below refers to continuing operations (excluding Smiths Medical), unless otherwise stated.

Revenue

Revenue for continuing operations was down £(57)m or (5)%, on an underlying basis, against a very challenging market backdrop and pre-COVID comparators. The robust results reflect the Group's market-leading positions and high proportion of aftermarket revenues.  Aftermarket represented 49% of underlying revenue during the period.

Revenue declined (7)% on a reported basis, to £1,150m (HY 2020: £1,240m). This included £(34)m of adverse foreign exchange translation and +£1m from PathSensors, a leading bio-technology solutions and environmental-testing company acquired by Smiths Detection in August 2020.

Operating profit and margin

The Group delivered good profit conversion, with headline operating profit down £(12)m or (6)% on an underlying basis. Central costs decreased by £(7)m to £(20)m, as the Group continues to focus on optimising operational efficiency. 

Headline operating profit decreased (11)% on a reported basis, to £166m (HY 2020: £186m).  This included £(7)m of adverse foreign exchange translation, and £(1)m of restructuring costs.

Headline operating margin decreased (20)bps on an underlying basis, reflecting the strong cost controls, and (60)bps on a reported basis to 14.4%.

The £(23)m difference between headline operating profit of £166m and statutory operating profit of £143m is non-headline items as defined in note 3 of the condensed financial statements. The largest constituents relate to amortisation of acquired intangible assets, cost recovery for asbestos litigation in John Crane, Inc and subrogation claims in Titeflex Corporation. On a statutory basis, after taking into account all items excluded from headline performance, operating profit of £143m was £(2)m lower than last year (HY 2020: £145m), reflecting the lower headline profit.

Finance costs

Headline finance costs of £(21)m (HY 2020: £(26)m) were £5m lower than last year. This reflects the impact of lower US dollar interest rates. Statutory finance costs were £(59)m (HY 2020: £(99)m) mainly due to a £(38)m foreign exchange loss on an intercompany loan with Smiths Medical (HY 2020: £(68)m) ; the matching credit in discontinued operations nets out to zero in Total Group earnings.

Taxation

The headline tax charge for the half year of £(41)m (HY 2020: £(43)m) represents an effective rate of 28% (FY2020: 28%).  The Total Group headline effective tax rate was 27% (FY2020: 26%).

Non-headline taxation items of £(21)m (HY 2020: £(9)m) related to the write-off of deferred tax driven by pension movements. The statutory effective tax rate was 74.4% (HY 2020: 74.3%) due to the non-headline items. Please refer to notes 3 and 6 of the condensed financial statements for further details.

R&D and capex

Technology and innovation are driving the future of Smiths.  To support that, we have increased Group-wide R&D spend by 34% in the last five years.  Through our Group-wide innovation framework we selectively invest in future-focused projects that are aligned with our purpose and strategy.  Due to the timing of some large R&D projects, the income statement cost of R&D of £(41)m was below prior year (HY 2020: £(46)m). The cash cost decreased to £(48)m or 4.2% of sales (HY 2020: £(62)m or 5.0%).

Capex of £(29)m (HY 2020: £(37)m) represented 1.2x depreciation and amortisation (HY 2020: 1.4x).

Portfolio

The Group continues to enhance its strategic positioning through the recycling of capital out of lower growth and lower return businesses into higher growth and higher return opportunities.  Since 2016 the Group has completed 11 disposals with proceeds of c.£540m and 12 acquisitions for c.£1bn.

In February 2021, the Group acquired Royal Metal Products LLC ("Royal Metal"), a leading manufacturer of residential and light commercial HVAC products for $107m.  Royal Metal will be integrated into Flex-Tek with adjacent product offerings for the air distribution market and access to a larger customer base, including wholesalers.  The acquisition will complement the organic growth that Flex-Tek is already driving through the development of innovative air distribution products that support improved energy efficiency and indoor air quality.  For more information, please see note 18 of the condensed financial statements.

Smiths Medical (discontinued operations)

The Group is committed to completing the separation of Smiths Medical by the end of the financial year, with the primary focus on ensuring we maximise shareholder value. We are finalising the key separation workstreams including governance, tax planning, debt structure, transaction documents and pensions.

Accounting standards require the Group to stop charging depreciation and amortisation within Smiths Medical, since it has been reclassified as discontinued operations. For comparability purposes, depreciation and amortisation of £21m (HY 2020: £23m) have been included in the calculation of underlying measures.

Smiths Medical delivered revenue of £427m, up +0.2% on an underlying basis, with good growth held back by the impact of fewer elective procedures as a result of COVID-19.   Revenue was down (2)% on a reported basis, including £(8)m of adverse foreign exchange translation.

Headline operating profit of £89m was up +2% on an underlying basis. Headline operating profit was down (5)% on a reported basis, due to £(2)m of adverse foreign exchange and £(3)m of restructuring costs. Restructuring costs include site consolidation, as well as delayering and decentralisation to increase efficiency and effectiveness. Headline operating margin was up +30bps on an underlying basis, but down (80)bps to 20.9% on a reported basis due to restructuring charges.

The difference between statutory and headline operating profit is £1m of separation costs.

Further detail on Smiths Medical's performance can be found in the divisional section later in the release.

Total Group

The commentary below refers to Total Group, unless otherwise stated.

COVID-19

The health, safety and wellbeing of our people and our operations have always been our number one priority. During the COVID-19 pandemic we have put in place measures to ensure that our colleagues and others are kept safe and well while continuing to serve our customers.  We have maintained business continuity throughout with minimal interruption to our aftermarket support.

We adopted a Group-led approach to managing the global challenges; as a result we were able to respond better, faster and more cost effectively.  This unified response supported our robust performance in the first half of FY2021 despite the challenging market backdrop. Pleasingly we are beginning to see improvements in some end markets and improving order books in some of our businesses. We are very well positioned to maximise the growth opportunities when they come.

Restructuring costs

The Group announced last year that it was undertaking a strategic restructuring programme; this brings together a number of pre-COVID initiatives to ensure that the Group is better positioned for long-term growth and consistent outperformance. The programme supports the achievement of our goal to deliver operating margins of 18-20%.

The programme impacts all divisions and is on track to deliver full annualised benefits of at least £70m from FY2022 onwards. The total cost of the programme is  now anticipated to be c.£(60)-(65)m spread across FY2020 and FY2021. In H1 2021 the restructuring benefits were ahead of the programme's costs but are still expected to be neutral for the full year. In the first half we incurred £(4)m of P&L costs and a cash outflow of £(10)m.  The overall programme is on track, despite some phasing changes related to local consultations.

Total profit and EPS

Total headline profit after tax decreased by (9)% on a reported basis. Headline basic EPS was down (3)% on an underlying basis and (9)% on a reported basis. Total statutory profit after tax decreased by (11)% to £129m (HY 2020: £145m), with non-headline items flat to HY 2020. Statutory basic EPS was also down (11)% to 32.3p (HY 2020: 36.3p).

Cash-flow

Strong cash generation is a key characteristic of our business. The Group delivered an excellent cash performance in the first half.  Operating cash-flow* was £301m (HY 2020: £252m). This was achieved despite ongoing disruption associated with the COVID-19 pandemic. Operating headline cash conversion was 129% (HY 2020: 98%), or 131% excluding restructuring costs.

Free cash-flow of £188m (HY 2020 restated to include lease payments: £110m) increased by £78m, underpinned by the strong operating cash-flow.  Free cash-flow as a percentage of operating profit has now been added as a key performance measure to our long-term incentive programmes, to ensure closer alignment with shareholder interests.

Net cash inflow from operating activities was £262m (HY 2020: £187m). See note 15 to the condensed financial statements for a reconciliation of headline operating cash-flow to statutory cash-flow.

Debt

Net debt* (including leases) at 31 January 2021 was £1,075m, a decrease of £(66)m in the period. Annualised headline EBITDA* from continuing and discontinued operations was £582m. Net debt to EBITDA was 1.7x after inclusion of lease liabilities under IFRS16 (1.8x including restructuring costs).

Gross debt* was £1,574m (FY2020: £1,609m). There are no covenants associated with this debt. The weighted average maturity was 3.7 years and there are no maturities before October 2022. Cash balances increased to £399m (FY2020: £386m).

An $800m (c.£584m at the period-end exchange rate) revolving credit facility ('RCF') remains undrawn and matures in November 2024. The only covenant relates to interest cover which must be greater than or equal to 3 times, compared with 11 times for the half year. Taking cash and the RCF together, total liquidity was approximately £1bn at the end of the period.

Strong cash conversion and a conservative balance sheet are the foundations of our strong financial framework, ensuring we are well positioned to deliver sustainable, long-term shareholder value.

* APMs are defined in note 19 to the condensed financial statements

Pensions

On 27 October 2020, the Smiths Industries Pension Scheme ('SIPS') secured an additional £146.5m bulk annuity buy-in agreement with Canada Life, which insured the benefits of a further c.1,000 pensioners.  This followed the TI Group Pension Scheme ('TIGPS') securing a buy-in bulk annuity with Aviva in September 2020 (as previously announced). Both buy-ins demonstrate continued progress in the de-risking of the Company's pension liabilities.

The two main UK pension schemes and the US pension plan are well positioned to withstand a volatile market environment. They are well hedged against changes in interest and inflation rates.  Approximately 90% of assets are invested in third-party annuities, government bonds and investment grade credit. Approximately 1% of assets is invested in equities.   As at 31 January 2021 approximately 40% of the UK liabilities had been de-risked through the purchase of annuities from third party insurers.

The net accounting surplus decreased to £293m (FY2020: £372m) principally driven by asset returns underperforming the discount rate over the period and the accounting treatment of the UK schemes' recent bulk annuity purchases.

The formal triennial valuation for TIGPS at 5 April 2020 has recently concluded.  It shows a surplus on a technical provsions basis and further progress towards full buy-out.  Barring unforeseen events, we now expect to reach a full buy-out of TIGPS ahead of the target date of 2028 and without any further cash cost to the company.  As a result pension contributions are expected to reduce by £4m this year and by £12m in FY2022.

The triennial valuation for SIPS is still being finalised and is due to be completed by the end of June 2021.

Dividend

The Group maintains a progressive dividend policy, aiming to increase dividends in line with long-term underlying growth in earnings and cash-flow. The policy enables us to retain sufficient cash-flow to finance investment in the drivers of growth to meet our financial obligations.  In setting the level of dividend payments, the Board considers prevailing economic conditions and future investment plans, along with the objective to maintain minimum dividend cover* of around 2 times.

In FY2020 the Board recommended a total dividend of 35.0p per share for the year.  This included a delayed interim dividend of 11.0p.  The Board has declared an interim FY2021 dividend of 11.7p per share, up 6% reflecting the Board's confidence in the Group's performance and improving trajectory.  The interim dividend will be paid on 14 May 2021 to shareholders on the register at close of business on 9 April 2021.

The Company offers a Dividend Reinvestment Plan (DRIP) - see our website for details.  To participate in the DRIP shareholders must submit their election notice to be received by 23 April 2021 (the Election Date). Elections received after the Election Date will apply to dividends paid after 14 May 2021.  Purchases under the DRIP are made on or as soon as practicable after the dividend payment date and at prevailing market prices. 

Return on Capital Employed (ROCE)*

ROCE was 11.2% (HY 2020: 14.7%). This is calculated using the Group's 12-month rolling average capital employed and therefore includes 10 months of COVID-related disruption. The decrease reflects lower profitability and restructuring costs during that 12-month period. For further detail of its calculation, please refer to note 19 to the condensed financial statements.

Foreign exchange

The results of overseas operations are translated into sterling at average exchange rates. The net assets are translated at period-end rates. The Group is exposed to foreign exchange movements, mainly the US Dollar and the Euro. The principal exchange rates, expressed in terms of the value of sterling, are shown in the following table.

Brexit

Given that over 95% of Group revenue originates outside the UK, the impact of Brexit was, as anticipated, very limited.

* APMs are defined in note 19 to the condensed financial statements

Outlook

Whilst economic uncertainty remains, against the backdrop of a robust first half performance and the improving second half trends, the Group is confident of meeting market expectations for the full year.  This is supported by improving order books and the benefits of the strategic restructuring programme.  The Group is well positioned to maximise growth opportunities and deliver long-term sustainable outperformance and value creation.  

John Crane

John Crane is a leading provider of mission-critical engineered solutions for global energy and process industries, supporting improved efficiency and emission reductions. c.59% of revenue is derived from the energy sector (downstream and midstream oil & gas and power generation, including renewable and sustainable sources of energy). c.41% comes from other process industries (including chemical, pharmaceutical, mining, water treatment, and pulp & paper). 68% of John Crane revenue comes from aftermarket sales. John Crane represents 36% of continuing Group revenue.

Revenue

John Crane's market-leading positions and the strength of its global service network continued to underpin its performance, despite the challenges in the energy market and COVID-19 disruptions.  As anticipated, revenue was down (10)% on an underlying basis. Revenue was down (14)% on a reported basis, as foreign exchange had a £(16)m adverse impact.

Underlying revenue from John Crane's Energy segment was down (16)%,  impacted by the market downturn and pandemic related disruptions. Underlying revenue from Industrial activities was marginally down at c.(1)%, with good growth in chemical processing offset by a slowdown in general industry.

Underlying revenue from Original Equipment ('OE') declined (14)%, as volatility in energy prices and COVID-19 disruptions put pressure on customers across all geographies.  However, the rate of orders is improving, and John Crane secured multiple new contracts during the period.  These include some important wins for midstream upgrade projects, using our new pipeline technologies that reduce emissions, as well as further liquified natural gas projects incorporating our digital sensor technology and methane reduction solutions.  These contracts draw on John Crane's core capabilities of supporting our customers' enhanced efficiency, performance and sustainability.  These are examples of where our leading technology, asset management capabilities and global footprint drive competitive advantage and ensure we are well positioned to capture growth opportunities when markets recover.

Underlying aftermarket revenue declined (9)%, with continued economic uncertainty driving slower customer upgrades and retrofits.  In previous cycles postponed maintenance has typically lasted 6-9 months and this cycle is following a similar pattern.  John Crane's large installed base and leading service offering positions it well to meet the pent-up demand for aftermarket repairs, maintenance and upgrades. Customer need for improving overall equipment effectiveness is driving increased commercial interest for our unique digital solutions, including John Crane Sense^TM.  Aftermarket now represents 68% of John Crane's revenue (HY 2020: 67%).

Operating profit

Headline operating profit of £81m decreased by (16)% on an underlying basis, reflecting the lower volumes and adverse programme mix.  Headline operating profit declined (20)% on a reported basis, due to £(4)m of adverse foreign exchange. John Crane continues to make good progress on its restructuring actions, which are focused on enhancing its flexibility to withstand the cyclicality of its end markets and improve its efficiency. Some restructuring projects planned for the first half were delayed until later this year as we engage in the necessary consultation processes.

Headline operating margin was 19.8%, down (150)bps on a reported basis and (130)bps on an underlying basis. The difference between statutory and headline operating profit includes the net cost in relation to the provision for John Crane, Inc. asbestos litigation.

ROCE

ROCE was down (640)bps at 16.9%, due to the lower profitability in the last twelve months.

R&D

Cash R&D expenditure during the period represented 2.1% of sales, +20bps higher than last year. John Crane's innovation is primarily focused on enhancing efficiency, performance and sustainability by using materials science advancements, coatings and additive manufacturing. John Crane is also leveraging the Group's digital expertise to support the development of predictive diagnostic platforms and other innovative digital technologies.  During the first half of the year, John Crane introduced several new technologies, including a booster and filter to support dry gas seals on turbo compressors and further product developments to reduce the effects of friction and extreme pressure on pipeline applications.

Smiths Detection

Smiths Detection is a global leader in the detection and identification of threats and contraband, supporting safety, security and freedom of movement. It produces equipment for customers in the Aviation market and Other Security Systems for ports & borders, defence and urban security markets. 48% of Smiths Detection's sales are derived from the aftermarket. Smiths Detection represents 30% of continuing Group revenue.

Revenue

The strength of Smiths Detection's market position and its leading technology drove its resilient performance, with revenue down (6)% on an underlying basis, and a continued strong performance in its Aviation segment. 

The delivery of previously announced contract wins underpinned Original Equipment ('OE'), down (6)% on an underlying basis despite the significant declines in its markets. Aftermarket revenue also declined (6)% on an underlying basis, as service and maintenance levels reduced during the COVID-19 pandemic.  Revenue was down (7)% on a reported basis, including £(6)m of adverse foreign exchange translation and £1m contribution from PathSensors Inc,  a leading bio-technology solutions and environmental-testing company acquired in August 2020.

Revenue from Aviation increased +4% on an underlying basis as a result of the division's existing strong order book. Aviation is Smiths Detection's largest segment, representing 74% of total revenue.  Deliveries included computed tomography ('CT') hold baggage systems for AENA in Spain and CT cabin baggage screening systems for the TSA in the US.  

Despite a slower rate of new tenders, Smiths Detection continues to secure new contracts.  It is announced today that Smiths Detection has been selected by London Heathrow to be the supplier of their new integrated checkpoint systems throughout the airport incorporating CT cabin baggage scanners and integrated lane and tray return technology with installation beginning later this year.

Other recent orders for its CT cabin baggage systems include Milan Airports Malpensa and Linate, Kuwait International Airport and Hamad International Airport (HIA) in Qatar.  HIA also placed an order for ultraviolet light kits, capable of destroying up to 99.9% of microorganisms present on baggage trays at the security checkpoint. This new technology supports heightened hygiene standards which will be important as airports seek to restore the confidence of travellers and staff during and after the COVID-19 pandemic. 

Revenue from Other Security Systems declined by (27)% on an underlying basis. This performance reflects both the strong comparator and a slowdown in urban security markets due to the pandemic.  Smiths Detection secured new contracts with U.S. and French customs agencies and the Greek police force for mobile x-ray inspection systems.  It also won an order from the Phoenix Suns Arena, Arizona for systems that include our digital iCMORE weapons detection technology; this enhances the arena's security and reduces the need for hands-on searches.

Smiths Detection continues to respond to the pandemic by driving its digital portfolio and investing selectively in chemical and biological detection capabilities that will support a safer post COVID-19 world. This response has been strengthened by the successful integration of PathSensors Inc which brought additional capability in the areas of environment monitoring, food safety and mail screening. Smiths Detection's environment monitoring tool, BioFlash®, has been proven to detect and identify the COVID-19 virus in the air.  Further testing is underway to understand how this technology can be used in environments such as hospitals, schools and commercial buildings, representing an important future opportunity for the division.  Smiths Detection also gained certification for a pathogen identifier that gives food and beverage companies a new, rapid solution to ensure food safety.  There continues to be good demand for Smiths Detection's mail room screening solutions that can detect dangerous biological agents as well as other hazards.

Operating profit

Headline operating profit decreased (21)% on an underlying basis, reflecting programme volume and mix.  Headline operating profit of £44m was down (23)% on a reported basis, including £(1)m adverse foreign exchange translation. Headline operating margin was 12.6%, down (240)bps on a reported and underlying basis. The difference between statutory and headline operating profit primarily reflects amortisation of acquired intangibles.

ROCE

ROCE decreased by (520)bps to 6.3%, impacted by reduced profitability.

R&D

Cash R&D expenditure was 7.6% of sales, (290)bps lower than last year. R&D excluding customer funding was 6.5% for HY 2021 (HY 2020: 7.9%). We continue to invest in the development of the next generation of detection devices for the defence market, new algorithms to improve the detection of dangerous goods for cargo applications and digital solutions to strengthen our aftermarket proposition to make people and infrastructure safer. Certain programmes are co-funded by strategic customers seeking next-generation solutions to security challenges.

Flex-Tek

Flex-Tek provides innovative components to heat and move fluids and gases for aerospace and industrial applications that support energy efficiency and improved air quality. 80% of Flex-Tek's revenue is derived from Industrials and 20% from the Aerospace sector. 46% of Flex-Tek's revenue comes from aftermarket sales. Flex-Tek represents 21% of continuing Group revenue.

Revenue

Flex-Tek's revenue decreased (1)% on an underlying basis, as strong revenue growth in Industrials offset almost all of the downturn in Aerospace.  Revenue declined (4)% on a reported basis, including £(8)m adverse foreign exchange translation.

Industrials underlying revenue was up +14%.  This strong growth was driven by demand for our construction related products in the US, particularly for HVAC applications, where we continued to outperform the underlying market. Other drivers included good growth of our industrial heat applications. Aerospace revenue was down (35)%, driven by the sharp downturn in commercial aerospace, however defence aerospace remained more resilient. 

Operating profit

Headline operating profit was flat on an underlying basis, with lower volumes offset by strong cost controls.  Headline operating profit was down (4)% at £44m on a reported basis, including £(2)m adverse foreign exchange translation.  Headline operating margin was up 10bps to 18.5%, on a reported basis.  The difference between statutory and headline operating profit is due to amortisation of acquired intangible assets and provision for Titeflex Corporation subrogation claims. 

In February 2021, the Group acquired Royal Metal Products LLC ("Royal Metal"), a leading manufacturer of residential and light commercial HVAC products for $107m.  Royal Metal will be integrated into Flex-Tek with adjacent product offerings for the air distribution market and access to a larger customer base, including wholesalers.  The acquisition will complement the organic growth that Flex-Tek is already driving through the development of innovative air distribution products that support improved energy efficiency and indoor air quality.  For more information, please see note 18 of the condensed financial statements.

ROCE

ROCE decreased (270)bps to 17.9%, mainly driven by lower profitability in the second half of FY2020.

R&D

Cash R&D expenditure remained consistent at 0.5% of sales. R&D is focused on developing new products for construction, and an expanded product offering in aerospace.

Smiths Interconnect

Smiths Interconnect designs solutions for high-speed, secure connectivity in demanding applications for various end markets including defence, semiconductor test, medical, space, commercial aerospace, and rail. Smiths Interconnect represents 13% of continuing Group revenue.

Revenue

Smiths Interconnect delivered a strong first half performance with revenue up +11% on an underlying basis, reflecting the division's continued good momentum. Revenue increased by +9% on a reported basis, including £(4)m adverse foreign exchange translation.

This strong performance reflects high growth in the semiconductor test business, as customers increased capacity for the production of graphics chips and other microprocessors to support demand for laptops, data centres and games consoles, as well as new customer wins.  There was also growth in the space and defence market segments from specific projects and satellite programmes.  This growth was partly offset by a slight decline in the industrials market driven in part by the timing of medical orders.

During the period, Smiths Interconnect received significant orders for its space qualified products for space exploration projects and commercial satellite constellations.  Smiths Interconnect is proud that its high-performance connectors are onboard NASA's six-wheeled science rover, Perseverance, which recently landed safely on Mars to begin the search for traces of ancient microbial life.

Operating profit

Headline operating profit increased +109% on an underlying basis, reflecting strong volumes and the benefits of restructuring actions. Headline operating profit was up +89% to £17m on a reported basis, including £(1)m of restructuring costs to further optimise the operational footprint. Headline operating margin was 11.2%, up +470bps on a reported basis and +560bps to 12.1% on an underlying basis, excluding the impact of the restructuring costs. The difference between statutory and headline operating profit reflects adjustments for amortisation of acquired intangibles.

ROCE

ROCE decreased (190)bps to 8.2%, driven by lower profitability in the second half of  FY2020.

R&D

Cash R&D expenditure decreased to 7.1% of sales (6.7% excluding customer funded R&D, HY 2020: 7.4%), as we continued to invest in technology-led growth. R&D is focused on bringing to market new products that improve connectivity and product integrity in demanding operating environments. Product launches included the new Volta 180 wafer test solution for semiconductor test customers.

Smiths Medical - discontinued operations

Smiths Medical supplies quality, cost-effective medical devices and consumables vital to patient care globally. Its portfolio incorporates established brands, with strong positions in select segments of the Infusion Systems, Vascular Access, and Vital Care markets. 82% of Smiths Medical's sales are from consumable and disposable products.

Accounting standards require the Group to stop charging depreciation and amortisation within Smiths Medical, from the point of reclassifcation as discontinued operations. For comparability purposes, depreciation and amortisation of £21m (HY 2020: £23m) have been included in the calculation of underlying measures.

Update on separation

The Group is committed to completing the separation of Smiths Medical by the end of the financial year with the primary focus on ensuring we maximise shareholder value. We are finalising key separation workstreams including governance, tax planning, debt structure, transaction documents and pensions. 

Smiths Medical is pursuing a focused strategy to accelerate growth and drive enhanced performance to deliver the medium-term ambition to grow ahead of its markets, with operating margin in excess of 20% and attractive returns.  The division's first half performance demonstrated an uninterrupted focus on these underlying improvement plans.

Revenue

Smiths Medical delivered a resilient performance with revenue of £427m, up 0.2% on an underlying basis.  Good growth was held back by the impact of fewer elective procedures due to COVID-19.  Revenue was down (2)% on a reported basis, including £(8)m of adverse foreign exchange translation.

Underlying revenue from Infusion Systems was up +5% driven by increased sales to alternate care environments such as emergency medical services, clinics, hospices and homes.  Underlying revenue from Vital Care grew +2% with growth driven by tracheostomy tubes and respiratory products.  Underlying revenue from Vascular Access decreased (6)% with good growth of syringe and needle products offset by the impact of fewer elective procedures as a result of COVID-19.  Smiths Medical is successfully delivering on its agreement with the U.S. Government to expand syringe and needle device production to support COVID-19 vaccine efforts.  Smiths Medical has also received large orders for vaccination devices for Australia and Japan to be delivered throughout the remainder of 2021.  

Operating profit

Headline operating profit of £89m was up +2% on an underlying basis, reflecting the drive for enhanced performance. Headline operating profit was down (5)% on a reported basis, due to £(2)m of adverse foreign exchange and £(3)m of restructuring costs. Restructuring costs include site consolidation, as well as delayering and decentralisation to increase efficiency and effectiveness. Headline operating margin was up +30bps on an underlying basis, but down (80)bps to 20.9% on a reported basis due to restructuring charges.

The difference between statutory and headline operating profit is £1m of separation costs.

ROCE

ROCE remained at 13.2% in HY 2021.

R&D

Cash R&D expenditure was 5.6% of sales, down (50)bps year on year. Smiths Medical continues to invest in the development of innovative, commercially focused products across the portfolio to support long-term, sustainable growth. Product launches included:

·      PharmGuard software enhancements for the CADD^TM Solis Infusion Pump

·      Comprehensive pain management solutions with new dedicated connectors

·      A new endotracheal tube range

·      DeltaVen Fast Flash, expanding our PIVC offering

Risk management

The Group's principal risks and uncertainties and relevant mitigating activities were set out on pages 67-76 of the FY2020 Annual Report. In the view of the Board, the principal risks and uncertainties affecting the Group for the remaining six months of the financial year continue to be those set out briefly below and more fully in the Annual Report.

COVID-19: COVID-19 is impacting our colleagues, customers, suppliers and operations to varying degrees across different territories and different parts of our business. This includes, but is not limited to: risks to the wellbeing of our people, their families and communities; our customers, who have in many cases revised their demand forecasts; our suppliers, whose businesses have had challenges maintaining continuity of supply; and our own operations which have had to deal with all the combined challenges of the pandemic.

Technology: Differentiated new products and services are critical to our success. We may be unable to maintain technological differentiation or to meet customers' needs and may face disruptive innovation by a competitor.

Economy and geopolitics: COVID-19 has triggered a highly significant global economic downturn. In many sectors, demand has reduced. There is a likelihood that the impact on demand will be prolonged, especially in commercial aerospace. A global recession may also lead to an increase in bankruptcies of both customers and suppliers. Conversely, the crisis is opening up new opportunities, most obviously in Smiths Medical and Smiths Detection; and inorganic opportunities are likely to arise more frequently and at better values. Geopolitical tensions continue to rise, most notably between China and the US, but also affecting other Governments, which pose threats to the free movement of goods, capital and people.

Group Portfolio: Our strategy is predicated primarily on organic growth. However, acquisitions/divestments can also play a role in building and/or strengthening competitive positions. Acquisitions bring risk as well as opportunity. We may invest substantial funds and resources in acquisitions which fail to deliver on expectations - due to incorrect appraisal of the target and/or poor execution. The opposite risk is that (perhaps through an excess of caution) we miss out on opportunities to build market-leading positions and growth. Divestments also carry risk. We may divest an asset at the wrong time, or may not realise appropriate value for the asset. Separation may be complex and, if poorly executed, may impact the wider business.

Liquidity: COVID-19 has triggered a highly significant global economic downturn. In many sectors, demand has reduced, in some cases close to zero. We, along with our customers and suppliers, have also faced disruption to operations and higher costs. If disruption were to be deep and sustained over many months, our financial position could be eroded by lower revenues, higher costs and cash write-offs (e.g. non-payment by customers). We might not be able to rely on access to committed facilities, either through breach of our financial covenant or because lenders were unable to meet their obligations.

Product quality: In the ordinary course of business, we are potentially subject to product liability claims and lawsuits, including potential class actions. The mission-critical nature of many of our solutions makes the potential consequences of failure more serious than may otherwise be the case.

Customers: Our markets are evolving at a fast pace, creating potential for customers to change their business models as they look to deliver products and services at higher quality, with better service and at lower cost. Failure of the Group to keep pace with customer changes/requirements (innovation, go-to-market strategies) could have a materially adverse impact on Group performance.

People: People are our only truly sustainable source of competitive advantage and competition for key skills is intense, especially around science, technology, engineering and mathematics (STEM) disciplines. We may not be successful in attracting, retaining, developing, engaging and inspiring the right people with the right skills to achieve our growth ambitions

Cyber security: Cyber attacks seeking to compromise the confidentiality, integrity and availability of IT systems and the data held on them are a continuing risk. We operate in markets and product areas which are known to be of interest to criminals.

Integrated Supply chain: Timely, efficient supply of raw materials and purchased components is critical to our ability to deliver to our customers. Manufacturing and supply chain continuity are exposed to external events that could have significant adverse consequences, including natural catastrophes, civil or political unrest, changes in regulatory conditions, terrorist attacks and disease pandemics - this applies to our own manufacturing sites and those of our key component suppliers.

Markets: A significant proportion of our revenue comes from the US and European markets, with a notable proportion coming from governments. In addition to geographical markets, there is a risk we do not focus on attractive sectors where we have, or could have, a sustainable position.

Ethical breach: We operate in highly regulated markets requiring strict adherence to laws with risk areas including: Bribery and corruption; Anti-trust matters; International trade laws and sanctions; Human rights, modern slavery and international labour standards; General Data Protection Regulation (GDPR); and Government contracting regulations. There is a risk that a significant ethical or compliance breach may occur which could seriously harm our reputation and impact our financial performance, customer relationships and ability to retain talent.

Contractual obligations: We may fail to deliver the products and services or fail in our contractual execution due to delays or breaches by our suppliers or other counterparties.