Smiths : Earnings Document

HY2023 Financial Results

Friday, 24th March 2023

Opening Remarks

Paul Keel

Chief Executive Officer, Smiths Group

Good morning everyone, and thanks for joining us. With me in London today is our CFO, Clare Scherrer. In terms of our agenda, I will make a few opening comments before turning it over to Clare to walk us through the numbers. I will come back and provide an update on our strategic and operational progress and then we'll open it up to all of you for Q&A.

HY2023 - Material Progress Resulting in Higher Performance

By way of overview, we saw a continued improvement in the first half, resulting in meaningfully higher performance. We posted record organic revenue growth of 13.5%, which translated to nearly 26% on a reported basis. We have now delivered seven consecutive quarters of accelerating growth as we capitalise on strong underlying demand in most of our end markets. Our earnings conversion was stronger still as we also delivered record EPS growth of 52%. And given this strong momentum, we have once again raised our full year guidance, now to at least 8% organic revenue growth.

Operating margins grew 20 basis points, reflecting strong volume as well as continued investment in future growth. ROCE expanded by a point, while Smiths Excellence System is the centrepiece of our stronger execution and the impact of SES is now visible in our financial statements as we are on track to deliver over £25 million of annualised operating profit from SES.

Our people make this progress possible and we have a number of initiatives underway across our company to advance our inclusive and high-performing culture. Our ESG plan is also progressing at pace, as detailed in our inaugural sustainability report, which is available on our website. In summary, we delivered another period of higher performance, enabled by our strategy of accelerating growth, improving execution, and investing in our people, the focal point of our Smiths Value Engine, which I will recap on the next slide.

Smiths Value Engine

Our value engine connects the three components of our success: our purpose, our strengths, and our priorities. We are grounded in our purpose of improving the world through smarter engineering. This has been the North Star for Smiths for over 172 years and continues to guide and inspire us today. Our strengths are unique and compelling: world-class engineering, leading positions in critical markets, global capabilities, and a robust financial framework. You'll see evidence in the coming slides of how each of these is contributing to an ever stronger Smiths.

Our purpose and our strengths are then directed towards advancing the three priorities I mentioned on the previous slide: accelerating growth, improving execution, and doing even more to inspire and empower our wonderful people.

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Significant progress against 4 of our 5 medium term financial commitments

We first shared this slide with you in November 2021, my first Capital Markets event with Smiths, when we laid out five medium-term financial commitments by which to measure our progress.

This chart provides a summary of how we are tracking. We are making good progress on organic growth and for the first half, we are well ahead of our 4-6% committed range. About half our growth is coming from volume and the remainder from price, which we expect will subside at some point as the world eventually returns to more normalised inflation levels.

As mentioned, we are also having good success converting revenue to EPS. We commit to 7-10% earnings per share growth over time and are tracking above the range here as well.

Higher profitability naturally supports higher ROCE, and you can see this in our 120 basis point gain, which brings us into our 15-17% range.

Operating margins were up 20 basis points in the half on top of the 150 basis points expansion in the same period last year. We see further upside available to us in this category as we will continue to progress into the 18-20% range moving forward.

The only area where we did not post year-over-year improvement was operating cash conversion. We continue to see record demand across several of our end markets and we are naturally supporting this growth with investment. Cash generation has long been a calling card of Smiths with 100% cash conversion over the past five years. We expect to return to these levels as growth and supply chains normalise.

With that as an overview, I will turn it over to Clare to walk us through our first half results in greater detail.

HY 2023 Financial Results

Clare Scherrer

Chief Financial Officer, Smiths Group

Thank you, Paul. Good morning everyone, and thank you for dialling in. I am pleased to share the half year results; a half which provides more evidence of the progress we are making.

HY2023 - A Strong Start

On revenue, as Paul said, we delivered record organic growth of 13.5% with FX increasing reported growth to 25.6%. We generated £241 million of operating profit, which equates to organic growth of 12.7% and a margin of 16.1%, up 20 bps over the same period last year. EPS growth of 52.1% was a record for Smiths. Cash conversion was impacted by investment in working capital, and I will talk later about the actions we are taking to drive improvement. ROCE expanded by 120 bps, reflecting our increased profitability. And as planned, we are rebuilding our dividend cover post the sale of Smiths Medical and are recommending an interim dividend of 12.9p, an increase of 5%. In the first half, we returned ₤241 million to shareholders, including both our share buyback and the FY22 final dividend.

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Record organic revenue growth

Now looking at the results in more detail and starting with our record organic revenue growth. We have posted seven consecutive quarters of organic revenue growth and both Q1 and Q2 delivered growth in excess of 13%. First-half growth was driven equally by price and volume, and we delivered growth across all divisions, geographic areas, and major customer end markets. Revenue for the half also surpassed our pre-COVID revenue, up 12% compared to the first half of FY20.

Moderate operating margin improvement

As per our guidance, this revenue growth translated into moderate operating margin improvement of 20 bps to 16.1%. We delivered 60 bps of margin expansion from increased volume and 50 bps of margin improvement from the targeted savings projects, which we announced at the full year, primarily in John Crane and Smiths Detection. These programmes remain on track, with expected benefits for the full year of approximately £15 million and annualised benefits in line with our previous guidance of between £25 million and 30 million.

On pricing, we more than offset cost inflation thanks to the positive pricing actions that we took throughout last year and going into this year. FX translation had a positive impact on margin of 30 bps. SES projects in this period primarily focused on pricing, customer service and productivity, and generated £5 million of incremental profit.

Offsetting these gains were three headwinds. Supply chain disruption in some key parts of the business, resulting in 10 bps of impact, although overall we did see supply chains trending positively. We continued to invest in growth to support increasing demand, which had a 90 bps impact. The largest impact on margin was mix, reflecting rapid growth in original equipment in Smiths Detection. This will support future growth from the associate aftermarket services. And the final impact, in Flex-Tek, was from product mix.

Record EPS growth in the first half

This strong profit performance drove record EPS growth, up more than 52%. The largest contributor to this was organic profit growth, which drove roughly a third of the increase or 5.1p. Our share buyback, which was 88% complete at the half, had a 4.6p benefit on EPS, about a quarter of the total. Weaker sterling through the first half had a positive FX translation impact of 4.3p. Our effective tax rate reduced 200 bps to 26%, resulting in a 1.4p benefit on EPS. We also had reduced interest expense as a result of repaying our £300 million bond in February 2022. All of these drivers resulted in basic EPS of 46.6p for the first half.

Cash generation

Smiths has a strong track record of delivering over 100% operating cash conversion over time. Our operating cash conversion during this half reflects the impact of both strong customer demand and our continuing investment to secure supply. Two of our fastest growing businesses in the half were Smiths Detection and John Crane, which accounted for over 85% of our £106 million working capital outflow and 60% of our £36 million of CAPEX investment. These investments not only ensure that we meet customer demand, but also underpin the large order books that both businesses have going into the second half. Working capital also reflects where we have secured supply to overcome specific supply chain

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challenges for critical electronic components in Smiths Detection and for elastomers and ceramics used in some John Crane products.

That being said, while we continue to prioritise customer delivery, at the same time, we are taking targeted reduction actions where we can. These targeted plans and SES projects include improving demand planning, optimising our global network, and continuing to reduce sole source supplier positions. We know that we have a hard road ahead on inventory reduction, but we remain committed to our medium-term target of 100% operating cash conversion and we are confident that the actions we are taking now will put us back on this path.

Business Update

Let us now look at our divisional performance in more detail.

John Crane - delivered accelerating growth and strong operating leverage

Starting with our largest business, John Crane, which delivered accelerating growth and strong operating leverage. Organic revenue grew 14.6%, driven by strong demand across all parts of the business. OE and aftermarket grew in both the energy and industrial segments. We have improved order to revenue conversion as the actions we have taken to manage the supply chain have had a positive effect. Operating profit grew even faster than revenue, up 24.6%, to deliver margin expansion of 200 bps. This was achieved as higher volumes drove good operational gearing and our pricing actions more than offset inflation.

Looking ahead to the second half, John Crane's order book remains very strong with order intake in the first half of 14.2%, and we are excited by the critical role that our products play in supporting energy transition, particularly in methane emission reduction, carbon capture and hydrogen applications. We are well positioned in these areas with over 40 years' experience in providing stealing solutions for hydrogen and with an installed base today of over 5,000 units. Key wins in the half include multiple orders supplying the largest hydrogen project in Canada and dry gas seal upgrades in Oman. As we go through the second half, we will continue to deliver against a strong order book and our margins will benefit from SES and productivity programmes.

Smiths Detection - growth across all segments

Next to Smiths Detection, which has solidly returned to growth, up 14% and with revenue growth in all segments. Aviation was up 10.3% and other security systems up 22.9%. It is especially good to see the return to growth in OE. Although this has a near-term impact on margin, it puts Detection in a strong position in the medium term, given that aftermarket revenue directly results from growing our installed base. Operating profit increased 4.5% with margins of 10.5%, reflecting the fact that lower margin OE was up 20.7% while higher margin aftermarket was up 8.4%. Again, this OE investment will be margin accretive in the aftermarket going forward.

Order book conversion is also improving in Smiths Detection, although supply chain constraints continue, especially with some electronic components. And we also took action in the first half to simplify our organisation, which will improve efficiency and reduce cycle times going forward.

And looking to the second half, our order book includes a number of airport CT checkpoint upgrades. At airports which install CT at their checkpoints, passengers will no longer need to

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