Notes to the accounts

31 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:

Smiths Group Sharesave Scheme (SAYE)

The SAYE scheme is an HM Revenue & Customs-approved all-employee savings-related share option scheme which is open to all UK employees, including directors, with 12 months’ service or more. Participants enter into a contract to save a fixed amount per month of up to £250 in aggregate for three or five years and are granted an option over shares at a fixed option price, set at a 20% discount to market price at the date of invitation to participate. In the case of five-year savings contracts, participants can elect to delay maturity of the contract until its seventh anniversary. The number of shares comprising the option is determined by the monthly amount saved and the bonus paid on maturity of the savings contract. Options granted under the SAYE scheme are not subject to any performance conditions.

Smiths Group Sharesave Scheme (US Sharesave)

The US Sharesave scheme is a savings-related share appreciation rights scheme which is open to all US employees with 12 months’ service or more. Participants enter into a contract to save a fixed amount per month for two years and are granted share appreciation rights based on a fixed initial price determined using the market price and the US dollar exchange rate at the date of invitation to participate. The number of shares used in the calculation is based on the monthly amount saved and the bonus paid on maturity of the savings contract. Rights granted under the US Sharesave scheme are not subject to any performance conditions.

Smiths Industries 1995 Executive Share Option Scheme (95 ESOS)

Options granted under the 95 ESOS can only be exercised after three years if a performance requirement, determined by the Remuneration Committee, has been met. Options granted under the 95 ESOS up to 2001 are subject to performance testing based on total shareholder return of the Group versus the total return of the General Industrials Sector of the FTSE All-Share Index. Options granted from 2002 are subject to a performance test based on growth in the Group’s earnings per share. If the performance requirement is not satisfied at the end of the third year, the performance period may be extended for up to two further years so that performance is tested over a four-year period at the end of the fourth year and a five-year period at the end of the fifth year. The performance requirement is that the growth in the Group’s normalised earnings per share over the three/four/five financial years beginning immediately prior to the option grant must exceed the increase in the UK Retail Prices Index over the same period by 3% per annum (for options up to one times base salary) and by 4% per annum (for the excess up to two times base salary). Executive directors received their final grants of options under the 95 ESOS in October 2003. From 2004 senior executives, including directors, have received awards under the PSP (see below). Grants under the 95 ESOS continue to be made to other executives.

Smiths Group Performance Share Plan (PSP)

The PSP was introduced in 2004 and replaced the 95 ESOS for executive directors and senior executives. Conditional awards of up to 1.5 times salary (and exceptionally three times salary) are granted annually. The awards will be released following the third anniversary of the date of grant to the extent the PSP’s performance tests have been met. One-third of the award is subject to a total shareholder return ‘TSR’) target relative to other FTSE 100 companies (excluding financial companies and investment trusts). For full vesting, the company’s TSR must be at or above the 75th percentile over the three year performance period. 25% of the award will vest if the company’s TSR is at median. Awards will vest on a straight-line pro-rata basis between median and 75th percentile. The remaining two-thirds of the award is subject to an earnings per share (‘EPS’) growth target (measured before exceptional items). Full vesting will occur if the compound annual growth in EPS is equivalent to 12% per annum. 25% vesting will occur if the compound annual growth in EPS is equivalent to 5% per annum, with vesting on a straight-line basis between 5% and 12%. The PSP has been replaced by the VSP (see below).

Value Sharing Plan (VSP)

The VSP is a one-off long-term incentive plan approved by the shareholders in July 2008 rewarding executives for value creation at Group and Divisional levels over three-year and four-year periods commencing with the financial year 2008/09. Corporate participants will be rewarded under the VSP for value creation at a Group level, whereas the executives with divisional responsibilities will be rewarded for value creation within the division for which they are responsible. For the Group scheme, one-third of the award will depend on the growth in Smiths’ TSR over and above the median for the companies comprising the FTSE-100 (excluding financial services companies) and the remaining two-thirds of each award will be determined by the growth in internal value in excess of 9.5% a year. The growth in internal value is calculated as follows: adjusted profit before tax (‘PBT’) times the ratio of PBT to market capitalisation determined at the date of grant plus net equity cash-flows to shareholders. The divisional awards will depend on meeting an internal value growth target set for the division in which the participant works.

The participants in the VSP will not be eligible for awards under the Performance Share Plan in 2008/09 or 2009/10.

Smiths Group Co-Investment Plan (CIP)

Under the CIP, as introduced in October 2005, the executive directors and senior executives are able, if invited, to use their after tax bonus or 25% of their basic salary after tax, whichever is the greater, to invest in 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, he will be awarded matching shares 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. 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.

In July 2008 the CIP was amended. From 2009 participants will be required to invest 50% of their post tax bonus in purchased shares. The performance conditions have been expanded to include an enhanced performance condition of RoCE exceeding WACC by an average margin of 3% per annum. If the enhanced performance condition is met, two matching shares will be issued for every purchased share.

	SAYE and Sharesave	ESOS (inc. SARS)	DSS and CIP	PSP	Total	Weighted average price for option plans £
Ordinary shares under option ('000)
6 August 2006	4,283	19,307	1,363	1,934	26,887	£6.50
Granted	917	2,795	459	1,070	5,241	£6.23
Exercised	(599)	(11,789)	(363)		(12,751)	£7.03
Lapsed	(573)	(963)	(53)	(72)	(1,661)	£7.18
31 July 2007	4,028	9,350	1,406	2,932	17,716	£5.98
Granted	639	1,838	245	743	3,465	£7.32
Exercised	(2,159)	(1,455)	(235)	(645)	(4,494)	£5.67
Lapsed	(992)	(1,101)	(9)	(369)	(2,471)	£7.32
31 July 2008	1,516	8,632	1,407	2,661	14,216	£6.23

Options were exercised on an irregular basis during the period. The average closing share price over the financial year was 1,014.32p (2007: 1,012.15p). 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 (’000)	Weighted average remaining contractual life (months)	Options exercisable at 31 July 2008 (’000)	Options exercisable at 31 July 2007 (’000)	Exercisable weighted average exercise price for options exercisable at 31 July 2008
£0.00 – £2.00	4,068	14	19	1	£0.00
£2.01 – £4.00
£4.01 – £6.00	234	18	2	956	£5.25
£6.01 – £8.00	2,518	57	1,735	2,236	£7.40
£8.01 – £10.00	5,505	73	587	633	£8.77
£10.01 – £12.00	1,891	108	129	185	£2.42
£12.01 – £14.00				175

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 assumptions used in the models for 2008 and 2007 are as follows:

	Period ended 31 July 2008				Period ended 31 July 2007
	SAYE	95 ESOS	DSS/CIP	PSP	SAYE	95 ESOS	DSS/CIP	PSP
Weighted average fair value (£)	2.48	1.73	8.60	7.14	2.19	1.94	7.81	6.40
Key assumptions used:
Weighted average share price	9.14	8.69	9.61	9.51	8.25	8.32	8.72	8.66
Range of exercise prices (£)	5.25-9.12	6.69-10.97			5.25-8.68	6.69-9.01
Range of expected volatility	17%-33%	18%-30%		17%-20%	17%-36%	18%-34%		16%-18%
Risk-free interest rate	3.9%-5.6%	4.3%-5.2%		4.3%-4.8%	3.7%-5.6%	4.3%-5.5%		4.3%-4.8%
Range of expected option term (life)	2.2-7.2 yrs	5 yrs	3 yrs	3 yrs	2.2-7.2 yrs	5 yrs	3 yrs	3 yrs
Dividend yield	3.75%	3.75%	3.75%	3.75%	3.75%	3.75%	3.75%	3.75%

Assumptions on expected volatility and expected option term have been made on the basis of historical data, wherever available, for the period corresponding with the vesting period of the option. Best estimates have been used where historical data is not available in this respect.

Included within staff costs is an expense arising from share-based payment transactions of £12.9m (2007: £19.3m), of which £11.8m (2007: £17.3m) relates to equity-settled share-based payment. The charge in respect of continuing operations is £12.9m (2007: £10.4m). The total share-based payment charge includes £nil (2007: £3.5m) relating to discontinued operations and £nil (£2007: £5.4m) relating to the accelerated vesting of share options on business disposals.

At 31 July 2008 the creditor relating to cash-settled schemes is £1.5m (2007: £1.9m).

Smiths Group divisions:
Smiths Detection, Smiths Medical, John Crane, Smiths Interconnect, Flex-Tek