Business review: Smiths Detection

Smiths Detection is a world leading designer and manufacturer of sensors that detect and identify explosives, weapons, chemical agents, biohazards, narcotics and contraband.

Our technology helps customers in the global transportation, ports and borders, critical infrastructure, military and emergency responder markets. We have the most comprehensive range of detection technologies in the world, including X-ray, trace detection, millimetre-wave, infra-red, biological detection and diagnostics.

Principal operating regions

Our eight manufacturing centres are concentrated in North America, Germany, France and the UK. We sell to over 100 markets around the world either through a sales and marketing company or a third-party distributor.

Customers

A significant majority of sales are influenced by more than 100 governments and their agencies, including homeland security authorities, customs authorities, emergency responders and the military. These include the US Department of Defense, US Transportation Security Administration (TSA), UK Ministry of Defence, and airport operators such as BAA in the UK.

Competitors

Data published by IMS Research* shows that, in the combined transportation, critical infrastructure and ports & borders sectors, Smiths Detection has a 31% market share, compared to its main competitors being L3 Security & Detection Systems (10.5%), Rapiscan Systems (9.7%), Nuctech (8.6%) and AS&E (6.4%). In the Military and Emergency responder markets, which are not included in this data, the main competitors are General Dynamics, Bruker, Environics and Canberra.

*The World Market for Explosives, Weapons & Contraband Detection Equipment 2009 Edition

Suppliers

We are redesigning our supply chain model to maximise shared component parts and reduce costs across the division while taking into account the growing demand for local sourcing, particularly in North America. Our supplier base is being adapted accordingly while ensuring quality and delivery requirements are maintained.

Expanding in the US

Our Edgewood, Maryland, facility almost doubled in size to 130,000 square feet in a $3.5m expansion designed to meet the record level of orders from the Department of Defense. These include vehicle integration programmes, such as the Chemical Biological Protective Shelter and the Profiler which gathers real-time meteorological data to assist the accuracy of military operations. The plant expansion has also allowed increased production of JCAD, the advanced chemical agent detector designed to help safeguard troops by automatically detecting chemical threats and toxic industrial chemicals.

Markets and trends

Smiths Detection products serve the transportation, ports and borders, military, emergency responder and critical infrastructure markets. The business also adapts technology developed for these markets for carefully selected industrial applications in diagnostics, life sciences, food quality and safety.

Homeland security remains a priority in western countries, with 11% annual growth expected over the long term. However, government spending and airport operator investment have been affected by the current global economic downturn which has in turn caused delays to orders. As a result, recent growth rates have been lower in certain segments of the wider homeland security market. The worldwide market for Smiths Detection products and services is worth an estimated £3.5 billion.

The transportation sector, which includes airports, is the largest representing 36% of total sales. In the short term, airport investment has slowed in certain markets as passenger and air cargo traffic has declined. However, over the long term the airport security market is expected to grow in response to:

  • projected long term growth in air traffic;
  • new security threats; and
  • customer pressure for faster throughput at checkpoints and an improved passenger experience.

The ports and borders market has been affected by the global slowdown in container traffic and delays to infrastructure investment by customers. However, over the long term, this is expected to be a growth sector driven by government objectives of enhancing security screening and protecting tax revenues. Customers require mobile and fixed units capable of detecting explosives, weapons, radioactive materials, narcotics and contraband.

The military market for UK and US technology is restricted by export controls, and these two governments comprise a major slice of the market which is characterised by tendering opportunities for large individual contracts that typically run for several years. Smiths Detection continues to develop new business by increasing systems integration activity, offering improved functionality in protective shelters and introducing new technologies through government-funded partnerships.

Within the emergency responder sector, the US accounts for more than 50% of global demand. This market is characterised by more localised purchasing decisions and stable market trends.

The critical infrastructure market is diversified with varying growth rates in the different segments. Smiths Detection focuses on three key areas: mass transit, sports and events, and government and military facilities. Smiths Detection has a growing involvement in helping protect a number of important metro systems in both the US and Europe. Demand for greater hotel security has also increased substantially in the wake of the Mumbai attacks in November 2008.

A possible future market is with biological detection and its application to veterinary diagnostics. Smiths Detection’s expertise in producing rugged, portable sensor equipment has enabled the development of a field-based device which can detect a range of animal infections such as foot-and-mouth and avian flu. It could also be developed for clinical applications such as combating the spread of the H1N1 flu virus.

The markets served by Smiths Detection are influenced by specific events and the perception of threat from terrorist activity or other security issues. This perception itself has been and is likely to remain variable.

Performance

 

2009
£m

2008
£m

Reported
growth

Underlying
growth

Sales

501

509

(2%)

(17%)

Headline operating profit

63

93

(32%)

(43%)

Headline operating margin

12.6%

18.3%

 

 

Statutory operating profit

63

93

 

 

 

Reported sales declined 2%, or £8m, reflecting a currency benefit of £91m offset by a decrease in underlying sales of £99m, or 17%. As previously announced, this reflects the increasingly variable nature of the order flow of this largely government contracting business. The majority of this decline is caused by the ports and borders segment which has seen repeated delays to several contract tender processes underway in different markets. In addition, the prior period benefited from a large Russian contract. Excluding ports and borders, underlying sales for Smiths Detection declined by 5%. This decline reflects lower sales primarily in transportation and non-security, offset by strong growth in the military area which has had its best ever year.

The fall in sales volumes together with the associated lower cost absorption is the principal driver of the lower margins and the 43% (£47m) decline in underlying headline operating profit. We are taking action to address the cost base and have begun a restructuring project that will rationalise our manufacturing facilities. We have announced the closure of a satellite site in Wiesbaden, the consolidation of two existing New Jersey sites into a new facility and the closure of two UK sites. We are currently assessing opportunities for further site rationalisation. We have already reorganised the business into Security & Inspection, which will focus on airports, ports and borders and critical infrastructure, and Military and Emergency Response.

Underlying sales in transportation fell by 19% which reflects good growth in the US offset by weaker sales in EMEA. US sales have benefited from the introduction of a new generation of airport checkpoint explosive detection systems which, unlike conventional systems, can capture multiple views of carry-on bags in a single sweep. The systems also include software algorithms that help the operator detect potential threat items and they can easily be upgraded to meet future threats. Airports in Europe and other markets have been slower to adopt the new technology while trials are still underway, and the current economic downturn has prompted governments and airport operators to review the timing of some projects.

The ports and borders market has seen a 59% underlying decline in sales following a strong performance in the first six months of last year which benefited from a large contract in Russia. Average contract size has grown over recent years as governments have become more co-ordinated in their approach to border security and customs revenue protection. As a result, the sales profile in this business has become more variable and the working capital requirement has also increased. Our leading-edge technology leaves us well placed to benefit from long-term growth prospects. For instance the US has mandated that 100% of arriving cargo be scanned by 2012. We continue to tender on some substantial projects in several markets. In July 2009, we won a $10.6m order for mobile, high-energy cargo screeners. Since the year end, we have won confirmed orders for a further £20m from several different markets.

Military sales enjoyed their strongest year on record with underlying sales up 42% through the ongoing JCAD programme. We received further orders from the US Department of Defense amounting to $179m during the year. The lightweight JCAD is an advanced chemical point detector designed to help safeguard troops by automatically detecting, identifying and quantifying both chemical warfare agents and toxic industrial chemicals. We also won a $19m contract from the US Army for Meteorological Measuring Set-Profiler (MMS-P) systems, taking the total programme value to over $89m to date. The MMS-P gathers real-time meteorological data to assist the accuracy of military operations.

The implementation of a new ERP system began during 2008 and will complete by the end of calendar year 2009. This single system replaces 14 legacy business software systems and provides a common information platform to support data-driven decision-making. Sixteen sites representing 70% of sales have now gone live with the new system. Investment to date has been £24m. We anticipate that once complete the project will generate efficiencies in working capital of £11m and annual cost savings of £8m.

Scanner nets record drug haul

Advanced HCV cargo scanners are tested at the new Alcoa, Tennessee, facility. Smiths Detection recently won a $10.6m order from the US Government. Their high-energy x-rays can penetrate steel as thick as 280mm (11 inches) and a range of fixed and mobile versions are used by customs authorities across the world to detect threat items, contraband and drugs. In June 2009, a Smiths Detection mobile HCV helped the French authorities uncover the biggest haul of illegal drugs ever seized on a road in France. Almost 700 kilos of cocaine, with a street value of around $70m, was discovered hidden in a truckload of potting soil near the Spanish border.

Research and development

Smiths Detection has maintained its leadership in the sector through a consistent commitment to product innovation developed by in-house R&D, government-funded research and through partnerships and licences. Company-funded R&D increased by 21% to £35m or 6.9% of sales (2008: 5.6% of sales). This includes £10m of capitalised projects. Smiths Detection actively seeks customer and government support for R&D which totalled £10m in the period (2008: £9m). Total R&D spend was £45m (2008: £38m) or 8.9% of sales.

The principal focus for R&D investment continues to be X-ray for a variety of applications, including baggage scanning at airports and cargo screening at ports and borders. The next generation of cargo screening equipment is able to discriminate between different materials in a single pass. Our airport checkpoint explosive detectors are currently undergoing trials for the software that would allow automatic detection of suspect liquids in carry-on baggage.

We have also launched an advanced people-screener which for the first time uses electronic, real-time imaging in a standard checkpoint layout to detect weapons or explosives concealed under layers of clothing, without physical contact. The new system, called 'eqo', is based on patented millimetre-wave technology.

Our techniques in chemical and trace detection have continued to develop and have supported the launch of several new products during the year including the High-Performance Radioisotope Identifier (HPRID) and the Multi-Mode Threat Detector (MMTD).

Diagnostics continues to be an area of focus with development of a portable biological detection system that enables veterinarians to carry out rapid on-site diagnosis of animal diseases. The same technology is now being developed for clinical applications such as the detection and identification of MRSA, clostridium difficile and other infectious diseases.

Outlook

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. Longer term, we believe that the sector is set for sustained growth and Smiths Detection will benefit from its leadership position and the roll-out of innovative products. As a result, we shall continue to invest in research and development to launch new products while restructuring the business to lower costs and support margin improvement.



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

 

Smiths Group plc:
Registered office 2nd Floor, Cardinal Place, 80 Victoria Street, London SW1E 5JL, UK
Incorporated in England No. 137013
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