Chief Executive's statement
The past year has been marked by significant economic instability affecting most companies across the world. Although Smiths Group has not been immune from the associated challenges, we have continued to make solid progress in driving operational improvements and better cash generation. The breadth of our portfolio and its exposure to a wide range of end markets and geographies has provided both resilience in these testing times and support for sales and profit growth.
Many parts of Smiths Group have benefited from the defensive nature of their end markets or have been able to respond quickly in cutting costs to preserve margins and increase cash generation. John Crane has succeeded in growing its underlying margins through cost savings despite its sales of original equipment coming under pressure during the year. At the same time, two-thirds of John Crane’s sales are in aftermarket servicing which has proved more resilient. We have made further progress in improving the supply chain in Smiths Medical and in reshaping its product portfolio. Although demand for medical devices increases steadily as populations age and become more prosperous, reduced hospital capital budgets and our exit from the diabetes market curtailed Smiths Medical's hardware revenues during the year. However, sales of single-use consumable items have been more robust. Smiths Detection is driven by security risks that demand increased protection and detection capability. However, as previously announced, its order flow was significantly lower this year – particularly in the ports and borders segment – as some governments have delayed projects or airport operators have reviewed their infrastructure plans. Smiths Interconnect has benefited from continued growth in its largest end market which serves several long-term military programmes, while investment by telecom wireless infrastructure providers has slowed. Flex-Tek is exposed to more cyclical markets such as US housing and domestic appliances, but it has also made solid progress in preserving margins through cost management and pricing.
A year ago, I outlined several opportunities for Smiths Group to improve performance progressively over a three-year period and generate value for shareholders. We have made excellent progress towards these goals:
- The restructuring programme announced last year has delivered savings in the year of £17m which reflects the successful implementation of several initiatives;
- The improvement of our business systems to support better data-driven decision-making is on schedule, with ERP programmes progressing well in Smiths Detection, John Crane and Smiths Medical;
- Our investment in better operational data is enabling us to leverage our scale more effectively across the Group with a new procurement initiative which delivered £9m of savings in the year;
- We have strengthened the product portfolio and extended our geographic reach through three acquisitions;
- Smiths Medical is rationalising its portfolio of low-margin and loss-making products with the first 3,000 to be eliminated by the end of October 2009;
- We have also significantly increased our investment in R&D to drive future growth through new product initiatives;
- While the pension deficit increased in the year as a result of falling stock markets, we have taken positive action to reduce our liabilities by limiting our exposure to post-retirement benefit obligations; and
- Our balance sheet has been strengthened through the issue of $675m of long-term debt while we have also substantially increased free cash-flow.
At the end of last year we launched a major restructuring programme across the Group which has delivered savings of £17m in the year. The reorganisation of the corporate HQ is now complete and, as a result, we have delivered savings of £5m. To date we have delivered overall annualised savings of £17m and have spent £28m, with £24m in the year. Together, the programmes are expected to produce annual savings of £50m when completed in 2011, slightly ahead of the £47m originally forecast. The total cost of delivering these programmes is expected to be £45m, lower than the £48m originally planned.
Our investment in better information systems to enhance data flow and speed up decision-making is starting to deliver results. ERP systems are currently being deployed in Detection, John Crane and Medical where, in the past year, we achieved successful implementations at a total of 36 sites across these divisions. As a result, we are on track to complete the on-going projects during the current financial year.
Improved data at a Group and divisional level is creating opportunities to leverage the Group’s scale through Group-wide procurement initiatives. In the year, this programme delivered £9m savings from IT, utilities, freight, packaging, ceramics and injection moulding, among others. Looking ahead, there are further opportunities in these areas as well as travel, raw materials, printed circuit boards and many others. Overall, the programme is expected to deliver further savings of £11m in the current financial year and enhance margins across the business.
Over the past two years, we have made 10 acquisitions, five of which have been in Asia, and all of which have helped to build our portfolio through a combination of adding complementary technologies, supporting geographic expansion or leveraging existing infrastructure. During this year, Smiths Medical acquired a Chinese syringe pump manufacturer, Zhejiang Zheda Medical Instrument Co. Ltd, which gives us access to the fast-growing Chinese healthcare market. Smiths Interconnect purchased Shenzhen Dowin Lightning Technologies, a manufacturer of power and signal protection devices operating mainly in the wireless telecoms market. John Crane also extended the presence and capabilities of its engineered bearings offering through the acquisition in May of Orion Corporation, a leading US designer and manufacturer of hydrodynamic bearings.
We have also begun a programme to enhance profitability of the Smiths Medical portfolio by reviewing our customer base and range of stock-keeping units (SKUs). The analysis has already highlighted significant opportunities in pricing, minimum order quantities, customer management and complexity reduction. An early decision from this review was our decision in March 2009 to exit the diabetes business. At the same time, we are working through a programme to reduce the number of low margin, low volume products, which will help improve the overall profitability of the Smiths Medical portfolio over time.
Our investment in research and development is a key priority as we seek to deliver new product launches and higher levels of organic revenue growth. We are focusing our investment on growth areas that will deliver superior returns. R&D investment for the Group increased by 3%, at constant currency, to £105m; or 22% at reported exchange rates. In Detection, we launched an advanced people-screener which uses patented millimetre-wave technology to reveal a far wider range of threat items than currently possible with traditional technologies. In Medical, we have extended the launch of CADD®-Solis, a leading ambulatory infusion pump, to newmarkets.
The pension deficit increased during the year as stock markets and asset values have fallen. The impact has been further exaggerated by the downward pressure on yields driven by government quantitative easing programmes. The timing of our interim results made us among the first of what has been many companies to break the news about the deteriorating pension position. As a result, our share price reacted particularly adversely following our interim results. However, since then we have successfully reduced the Company’s exposure to these liabilities by closing the defined benefit pension plan in the US and capping our obligations for post-retirement healthcare benefits in the UK and US. Consultation is underway to close the defined benefit pension plan in the UK during the newfinancial year.
During the year,we have significantly improved our cash generation and strengthened the balance sheet. The maturity profile of our debt was extended through the issue of long-term debt capital: $175m through a US private placement with a fixed nine-year maturity and via a US bond offering with two tranches of $250m, with a fixed maturity of five and 10 years respectively. This followed a thorough review of the Group’s financing strategy with the objective of extending the maturity of its debt and reducing its dependency on the banking market.
Last September, we set out ranges for sales growth and margins for each of the divisions based on what we believed the businesses could achieve over the medium term in a financial and commercial environment consistent with that of recent years. Since then, the global economy has slowed significantly and, while our businesses are comparatively well placed, it will be harder to operate within these ranges in the near term. In the current environment, the sales growth targets will bemore difficult to achieve than the margin targets where we have greater control over delivering cost reductions and efficiencies. However, we remain committed to improving performance and delivering shareholder value consistent with achieving these ranges as the financial markets stabilise and world economies return to growth.
Delivering operational efficiencies
In 2008, we launched a major restructuring programme to reduce costs and deliver operational efficiencies which has achieved £17m of cost savings in the year. As part of these plans, a streamlined corporate office was opened in central London saving £5m.
Outlook
Our priority for the coming year is to deliver the cost saving initiatives and build on the improvements in cash-flow while investing in future growth through R&D and expansion in developing markets. Whilst we have yet to see any real evidence of increased demand across our businesses, we are now better positioned to benefit from improved levels of activity when world economies return to more normal levels of growth. Meanwhile, Smiths Detection has had a positive start to the year although we are cautious about how the current economic environment may affect the timing of orders from governments, given that some of their finances remain under significant pressure. Even though John Crane sales have slowed, primarily due to lower OEM sales, margins should continue to improve through its restructuring and efficiency initiatives. Smiths Medical margins should also benefit from the restructuring and cost reduction measures implemented last year while sales will continue to be affected by the exit from diabetes. Several long-term military programmes support over a third of Smiths Interconnect sales while the wireless telecoms and other industrial sectors are likely to continue to be challenging. Flex-Tek sales will be affected by the US residential construction market while its focus on cost control will help maintain margins and make it strongly leveraged to any recovery.