Smiths Group Regulatory News (SMIN)

News releaseSmiths Group plc announces results for the year ended 31 July 2017

London, Friday 22 September 2017

Good progress in executing our strategy for sustainable growth

Highlights

· Group underlying revenue broadly in line with prior year, up 11% on a reported basis

· Underlying headline operating profit up 3%, and up 16% on a reported basis

· Margin expansion in all divisions combined with increased investment.

· Operational excellence supporting strong cash conversion of 118%

· Significant portfolio upgrading

o c.75% of the Group now well-positioned in growth markets

o Increased investment in all divisions to drive future growth, up 60bps to 4.6% of sales

o Four non-core businesses sold

o Morpho Detection acquisition integration on track

· Balance sheet remains strong with further investment capacity for sustainable growth

· ROCE up 90bps with increases in all divisions

· Headline basic EPS up 15% at 97.6 pence per share

· Proposed final dividend of 29.70 pence per share. Full year dividend growth of 3%

Results for the year ended 31 July 2017

Continuing Operations

*In addition to statutory reporting, Smiths Group reports its continuing operations on a headline basis. Definitions of headline metrics, and information about the adjustments to statutory measures are provided in the notes to the financial statements

#Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Andy Reynolds Smith, Group Chief Executive, commented:

"Smiths has made good progress this year as we continue to execute our strategy for sustainable growth. We are well underway in repositioning the business through organic and inorganic investment with approximately 75% of the Group now well positioned in attractive markets. The disposal of four non-core businesses and the acquisition of Morpho Detection has supported the significant upgrading of the portfolio as we increasingly focus on scalable, technology-differentiated leadership positions in our chosen markets.

Underlying revenue was broadly in line with the prior year, with growth across the portfolio offset by John Crane's oil & gas business and in Smiths Medical due to market challenges in John Crane and a delay in some new product launches in Smiths Medical. The underlying quality of our businesses and the increasing impact of the Smiths Excellence System supported a strong operating profit performance. We delivered margin expansion in all divisions while making increased, smarter investment in R&D and innovation. This has delivered a strong pipeline of new products due to be launched in FY2018 and beyond. Our relentless focus on operational efficiency and cash generation is delivering results with significant reductions in working capital and strong cash conversion supporting continued investment for growth.

The progress delivered in executing our strategy ensures that we're well positioned for the Group to return to growth in FY2018. As in previous years, we expect Group performance to be weighted towards the second half. Growth in John Crane's non-oil & gas business, as well as an increase in aftermarket is expected to more than offset the challenging market conditions in oil & gas. We expect the introduction of new products during the year to support a gradual improvement in Smiths Medical. In Smiths Detection we anticipate a strong second half driven by air transportation, which should generate good growth for the year as a whole. In Smiths Interconnect, our focus on fewer, higher-growth end markets is anticipated to support further good progress in this division. Flex-Tek is expected to deliver continued steady growth.

We're confident that our focus on attractive growth markets, increasing investment in technology and new products, our established operating model for excellence and strong financial framework will deliver long-term sustainable growth and attractive returns."

Contact details

Jemma Spalton, Smiths Group+44 (0)20 7004 1637+44 (0)78 6739 0350jemma.spalton@smiths.com

Marion Le Bot, Smiths Group+44 (0)20 7004 1672+44 (0)75 8315 4386marion.lebot@smiths.com

+44 (0)77 7564 1807

smiths@fticonsulting.com

Deborah Scott, FTI Consulting+44 (0)203 727 1459+44 (0)797 953 7449smiths@fticonsulting.com

The presentation slides and a live webcast of the analyst presentation will be available at www.smiths.com/results at 09.00 (UK time) today. A recording of the webcast will be made available from 13.00 (UK time).

Original high-resolution photography and broadcast quality video is available to the media from the media contacts above or from http://www.smiths.com/images.aspx.

This document contains certain statements that are forward-looking statements. They appear in a number of places throughout this document and include statements regarding our intentions, beliefs or current expectations and those of our officers, directors and employees concerning, amongst other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the business we operate. 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 in respect of this document save as would arise under English law. This press release contains brands that are trademarks and are registered and/or otherwise protected in accordance with applicable law.

Smiths Group delivered a good performance in 2017, with the ongoing execution of our strategy to deliver sustainable above-market growth in our chosen markets and achieve world-class competitiveness, supported by our strong financial framework. We made significant progress on the strategic repositioning of our portfolio in attractive growth markets globally, and in improving our overall market competitiveness by focusing on robust and consistent execution across the Group to drive operational excellence. Group investment in R&D increased to 4.6% of sales (2016: 4.0%) to support future growth with the development of innovative, commercially focused products.

Group headline revenue fell 1% on an underlying1 basis with growth in all divisions, offset by John Crane's oil & gas activities and in Smiths Medical due to a delay in some new product launches as we continue to refresh and expand our product portfolio.

Group revenue grew 11% on a reported basis, benefiting from foreign exchange, and in particular the strength of the US dollar, partially offset by the net impact of the four divestitures and the acquisition of Morpho Detection ('Morpho').

Group headline operating profit of £589m was up 3% on an underlying1 basis and up 16% on a reported basis. The Group's operating profit margin increased 70 basis points on a reported basis, with margin expansion in all divisions reflecting the focus on operational efficiency and the upgrading of the portfolio. 

The Group delivered strong cash generation with a cash conversion rate of 118%. We made further progress in improving stock turns during the year, with £52m cash in-flow from inventory reductions. Free cash flow of £370m increased 52%. Net debt of £967m reduced by £11m reflecting the benefits of the disposal of non-core assets, strong operating profit conversion, the reduction in working capital and a significantly lower pension contribution compared to the prior year.

The headline tax charge for 2017 of £140m (2016: £113m) represented an effective tax rate of 26.5% (2016: 25.0%). In 2017, 52% of the Group's revenue originated in the US, where a higher tax rate exists. A tax rate of between 29.5% and 30.0% is expected in the year ending 31 July 2018. 

ROCE improved 90 basis points to 16.2% (2016: 15.3%) with improvement in all divisions, offsetting the dilutive impact of the acquisition of Morpho in April 2017.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Strategy implementation

In September 2016 we set out our ambition to establish Smiths as one of the world's leading technology companies, based on a strategy to deliver sustainable above-market growth in our chosen markets and achieve world-class competitiveness, supported by our strong financial framework. During 2017 we made good progress to deliver against these strategic objectives.

Our priority through this year has been to better position the business for growth through organic investment, with inorganic development to accelerate our move towards scalable, technology-differentiated leadership positions in our chosen markets. 

In the last 18 months we have moved the Group portfolio from c.60% of our business units which are well positioned by market and competitiveness to c.75%. To support this repositioning, during the course of the year we divested four non-core assets generating proceeds of £399m and completed the acquisition of Morpho. This portfolio upgrading exchanged similar annual revenue that was declining for growing revenue with a higher margin. 

We are focusing the Group on higher growth market segments globally to support the delivery of long-term organic growth. To support this we have recently relocated one of our Group Executive Committee members, Roland Carter, to Asia as Smiths Group Asia President to drive our focus and pace on growing the Group's activities in the region. John Crane has made further progress on diversifying its end markets, with its non-oil & gas business now representing around 45% of the division's revenue. Smiths Medical continued its work to reposition its product portfolio with increased investment in R&D supporting an accelerated rate of new product launches in FY2018 and beyond. In addition to the Morpho acquisition, Smiths Detection has secured a number of world-first certifications and significant new contracts which will support future growth, particularly in the high growth air transportation market. At Smiths Interconnect we undertook a significant repositioning to focus on fewer, higher growth markets. We divested non-core assets accounting for c.40% of the division's revenue, with the remaining core now a faster-growing leader in high-speed, secure connectivity in markets such as space and commercial aerospace. Post year-end, Flex-Tek's Tutco LLC business signed an agreement to acquire the heating element division of Osram, broadening its portfolio into faster growing engineered heating solutions.

Smiths Group's operating model is founded on strong and consistent execution. It is critical that we enhance our capabilities to ensure continuous improvement in everything we do. This has been a key priority for us during the year as we continue to focus on operational effectiveness, innovation and people.

The implementation of the Smiths Excellence System is focused on building a culture of continuous improvement and sharing best practice globally. Results are already being delivered with our efforts on strategic sourcing delivering c.£40m of procurement savings and improved speed and efficiency supporting working capital reductions that delivered an £85m cash improvement, of which £52m came from inventory. The reduction in working capital and our focus on cash generation supported the strong cash conversion of 118%.

We are energising the innovation agenda through the new Group-wide i3 innovation framework. This framework aims to increase internal capability in both hardware and software and to lay the foundations in the areas of software monetisation, machine learning, Internet of Things (IoT), cloud platforms and high-speed data transmission. i3 has sponsored six important projects to build digital and other technology capabilities that can be leveraged across Smiths Group.

To help accelerate the Group's digital transformation we're opening two Digital Forges, with one in Silicon Valley and another planned in London. These forges are global centres of excellence, helping us define new digital business models and build Group-wide capability in areas of focus including artificial intelligence, analytics and data security. This is not just about developing digital technology to complement existing business models - it's about defining new business models for the future and ensuring we are ahead on the capabilities they will require.

Recognising that people are the true source of competitive advantage, we continued to invest in our people and have established a global strategic people plan across the Group to help attract, retain, develop and engage the very best people and to support the diversity of experience and best practice sharing across the Group.

These strategic objectives are underpinned by our strong financial framework.

We are inherently an asset light business with healthy sustainable margins. Our financial discipline is evidenced by our superior returns and strong balance sheet, allowing us to invest in growth opportunities.

We are a strong cash flow generator and are making significant improvements to the quality and consistency of our cash flow generation, with our focus on operational efficiency and working capital reduction.

Finally, we are very disciplined on how we use the cash that we generate: we invest organically in future growth and we pursue value creative acquisitions that support the accelerated implementation of our strategy for growth and market competitiveness, consistent with our strong financial framework on a risk adjusted basis. In 2017, we deployed the cash we generated to fund further organic investment, the dividend and self-funded the acquisition of Morpho.

Our strong balance sheet ensures that we have significant further investment capacity to support sustainable growth with Net Debt to EBITDA of 1.4x at year end.

Dividend

The Board has a progressive dividend policy, with the aim of increasing dividends in line with the long-term underlying growth in earnings and cash flow. This policy will enable us to retain sufficient cash flow to finance our investment in the drivers of growth and to meet our financial obligations. In setting the level of dividend payments, the Board will take into account prevailing economic conditions and future investment plans, along with the objective to maintain minimum dividend cover of around 2.0. The Board is recommending a final dividend per share of 29.70 pence, giving a total dividend for the year of 43.25 pence, an increase of 3% year-on-year. The final dividend will be paid on 17 November to shareholders registered at close of business on 20 October. The ex-dividend date is 19 October.

Outlook

The progress delivered in executing our strategy ensures that we're well positioned for the Group to return to growth in FY2018. As in previous years, we expect Group performance to be weighted towards the second half. Growth in John Crane's non-oil & gas business, as well as an increase in aftermarket is expected to more than offset the challenging market conditions in oil & gas. We expect the introduction of new products during the year to support a gradual improvement in Smiths Medical. In Smiths Detection we anticipate a strong second half driven by air transportation, which should generate good growth for the year as a whole. In Smiths Interconnect, our focus on fewer, higher-growth end markets is anticipated to support further good progress in this division. Flex-Tek is expected to deliver continued steady growth.

We're confident that our focus on attractive growth markets, increasing investment in technology and new products, our established operating model for excellence and strong financial framework will deliver long-term sustainable growth and attractive returns.

Performance

Growth in John Crane's non-oil & gas and aftermarket revenue was offset by declines in its oil & gas activities that were impacted by the difficult conditions throughout global energy markets. On an underlying1 basis total revenue fell 4%. Reported revenue increased 7%, with favourable foreign exchange translation benefits partially offset by the impact of the divestment of the Artificial Lift business that refocused John Crane on to its core end markets and higher margin businesses.

John Crane continued its expansion into non-oil & gas industries, which now represent c.45% of total revenue, with sales up 2%, on an underlying1 basis. This was offset by reduced oil & gas underlying1 sales, down 7% reflecting the challenging market conditions. These market conditions also impacted total Original Equipment ('OE') underlying1 sales that fell 11% during the year. We remain focused on increased investment in OE projects and expanding the installed base with multiple new project agreements secured during the year, particularly in the Middle East. John Crane's large installed base and market leading service offering ensured it is well positioned to satisfy the pent-up aftermarket requirements for repairs, maintenance and upgrades, driving 1% growth in underlying1 aftermarket revenue. Aftermarket represented 64% of total revenue during the year (2016: 59%). A number of significant contract wins across oil & gas customers, as well as smaller retrofit and upgrades with municipal water companies and power plants led to an increased aftermarket order book.

Revenue from higher-growth regions represented 24% of sales, broadly in line with the prior year on an underlying1 basis, despite lower activity in certain parts of Latin America.

Headline operating profit was down 4% on an underlying1 basis, as lower sales and strategic investments in OE projects were only partially offset by operational efficiencies. Headline operating profit margin increased by 110 basis points to 23.0% benefiting from the disposal of Artificial Lift and continued operational efficiencies. The difference between statutory and headline operating profit primarily reflects £7m restructuring and £9m litigation costs net of the £4m gain on the sale of the Artificial Lift business.

Return on capital increased 260 basis points to 22.9%, principally due to reduced assets following the disposal of Artificial Lift.

The divestiture of the Artificial Lift business in November 2016 significantly reduced John Crane's exposure to the commoditised aspects of upstream oil & gas and was margin accretive. Prior to the sale in November, Artificial Lift sales were £12m, with an operating loss of £2m, and net assets were £24m. The business performance of Artificial Lift up to the date of divestiture is included within the financial summary and results presented above.

Research and development expenditure increased by 17% to £10m resulting in several new product launches, including:

- The introduction of a range of high performance aftermarket replacement filter elements

- An innovative new pipeline seal engineered to withstand the harsh abrasive and clogging fluid properties of crude oil

- Two new coupling designs that enhance the protection of critical rotating equipment assets

Active areas of research include: the use of nano-materials to enhance seal face performance, and investment in our dry gas seal development facilities enabling ultra-high pressure gas seal testing capability. We continue to further develop Sense, our predictive diagnostics platform, with the installed base of around 30 field trial units, which has grown from 5 units in 2016, demonstrating excellent performance results and a fast growing customer demand for additional units.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Performance

During the year Smiths Medical made progress on the ongoing repositioning of its portfolio, and increased targeted investment in its key product categories to address the historic underperformance in its product portfolio to support core-market category leadership. Underlying1 revenue was down 3%, driven by softer performances in Infusion Systems and Vascular Access where the product portfolios are in the process of being revitalised and expanded. Reported revenue grew 9%, with favourable foreign exchange translation benefits partially offset by the impact of the divestment of the Wallace product line and the underlying revenue softness.

Underlying1 revenue declined by 3% in Infusion Systems due to lower sales in hospital infusion hardware and disposables, and a slower than anticipated transition to advanced technology ambulatory pumps in the home infusion market. Vascular Access underlying1 revenue declined by 4% as growth in cardio thoracic was offset by declines in sharps safety and peripheral intravenous catheters ('PIVC'). Underlying1 revenue from Vital Care and Specialty Products was down 2%, with continued growth in tracheostomy and respiratory chronic obstructive pulmonary disease ('COPD') products being offset by declines in temperature management and commoditised anaesthesia products.

Sales into higher-growth regions decreased 12% on an underlying1 basis. This decrease was driven by a one-off regulatory situation in China which has now been resolved.

Headline operating profit grew 8% on an underlying1 basis with operational efficiencies and a medical device tax refund more than offsetting the impact of the revenue declines and downward pricing pressure on older products. The headline operating margin of 22.0% was 60bps higher than the prior year. The difference between statutory and headline operating profit reflects £16m of restructuring charges, £6m amortisation of intangible assets, and a £100m gain on the sale of Wallace.

Return on capital employed increased 100bps to 16.7%, reflecting improved profitability that supported greater capital expenditure in new product development, capacity and manufacturing efficiency.

In November 2016 Smiths Medical divested the Wallace product line as part of an ongoing programme to focus the portfolio on scalable, technology differentiated leadership positions in its chosen markets. Prior to the sale, Wallace revenue was £5m, with operating profit of £4m and net assets sold were £32m. The business performance of Wallace up to the date of divestiture is included within the financial summary and results presented above.

During the year Smiths Medical increased investment in research and development to support future growth, with the development of innovative, commercially focused products across the portfolio generating a strong pipeline of products due to be launched in FY2018 and beyond. Research and development expenditure increased to £61m (2016: £52m) representing 6.4% of sales (2016: 6.0%). Specific developments included:

- Within Infusion Systems, enhanced digital and information security capabilities, in particular wirelessly enabling the CADD line of ambulatory infusion pumps to connect to the PharmGuard server software, which received FDA clearance post year end.

- Differentiated technology developments in Vascular Access including the Closed Blood Sampling System, the Jelco Seriva and ViaValve Winged Safety peripheral catheters, and the Delta Ven Closed System catheter.

- A strong pipeline of new products in Vital Care, particularly in the Tracheostomy product lines.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Smiths Detection

Performance

Smiths Detection's market-leading position in growing markets drove an underlying1 revenue increase of 4%, in particular in the air transportation market and in the Asia Pacific region. Focus on aftermarket supported growth in revenue and aftermarket revenue now accounts for 39% of total revenue (2016: 37%). On a reported basis, revenue grew by 31%. This included £62m revenue from the acquisition of Morpho Detection ('Morpho'), which completed in April 2017 and is now being integrated, as well as favourable foreign exchange translation benefits.

Underlying1 revenue in air transportation increased 9% with strong growth in EMEA and Asia, including deliveries to Berlin Brandenburg Airport and revenue from long-term contracts in Abu Dhabi. Contract wins during the year include orders for 85 CT hold baggage scanners for Amsterdam Airport Schiphol, London Gatwick Airport, Cochin International Airport, EL AL Airlines and by the US Transportation Security Administration ('TSA'). Post year end we have also won two additional contracts for orders totalling 55 CT scanners for Frankfurt Airport and Narita International Airport. Future growth in air transportation was also underpinned by key regulatory certifications achieved in the period. Revenue from ports & borders decreased by 2% on an underlying1 basis as growth in EMEA, including major deliveries in Africa, Italy and the Middle East, was offset by last year's strong comparator due to the completion of a number of key programmes. Underlying1 revenue in military decreased by 2% as a number of US military programmes started to wind down, partly offset by stronger growth in EMEA. Urban security revenues were flat on an underlying1 basis with strong growth in Asia and sales to emergency responders in the US, offset by lower sales elsewhere. We continued to experience pressure on government budgets in all regions, which was most marked in the US due to the effect of the Continuing Budget Resolution.

Revenue from higher-growth regions represented 21% of sales broadly in line with prior year on an underlying1 basis.

Headline operating profit grew 21% on an underlying1 basis, reflecting the strong sales growth, increased focus on aftermarket and improved business mix. This growth in profitability was despite continued competitive pricing pressure on large programme contracts and the ongoing challenge from lower-priced competitors in unregulated parts of the market. Headline operating margin increased by 200 basis points to 15.0%. Headline reported operating profit improved 50%, including £8m profit contribution from the Morpho acquisition and £10m of favourable foreign exchange translation benefit. The difference between statutory and headline operating profit includes a £4m restructuring charge, £8m amortisation of intangibles and the £18m costs of the acquisition of Morpho.

Return on capital employed improved 70 basis points to 12.6% with higher profitability offsetting the dilutive impact of the acquisition of Morpho.

The acquisition of Morpho completed on 6 April 2017 and significantly enhances Smiths Detection's position in attractive growth markets and expands the product portfolio. Regulatory clearance for this acquisition was conditional on the post-completion divestment of Morpho's explosive trace detection business which completed on 7 July 2017. For the four months since completion Morpho delivered headline revenue of £62m and headline operating profit of £8m with good air transportation sales during the second half of the year, including deliveries to the US TSA. The integration of Morpho is progressing well and we are confident that we will be able to drive even more benefits from the combination than initially anticipated and expect the acquisition to drive future margin expansion for the division overall.

Smiths Detection increased its investment in research and development during the year, accounting for 7.1% of sales, or 6.0% excluding customer funded R&D (2016: 5.2% and 4.7% respectively). Specific highlights include:

- For the air transportation market, x-ray machines capable of meeting the new EU/ECAC Standard C3, new versions of our CheckPoint.Evo remote screening software and faster CT machines for hold baggage screening.

- In the military market, the development of the next generation of chemical warfare detection devices.

- In ports & borders we launched CORSYS, our large-scale enterprise platform that connects an entire ports & border security operation and supports the need for digital expansion in this market.

- We continue to focus on software development, building on the strengths of our existing business and Morpho's software expertise, as well as value engineering projects to deliver competitive products in cost-critical sectors as well as country-specific versions of some of our most successful products.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Smiths Interconnect

Performance

During the year Smiths Interconnect completed significant strategic and structural change to focus on fewer, higher-growth end markets. This included the divestments of the Power and Microwave Telecoms businesses and a major reorganisation of the business structure. In a period of considerable change the business was able to deliver an underlying1 revenue increase of 1%, driven by growth in both the space and aerospace segments. On a reported basis, revenue declined by 3%, as favourable foreign exchange translation benefits were offset by the impact of the divestments. Isolating the performance of the remaining core business, underlying1 revenue grew 3%.

Underlying1 revenue grew by 20% in the space segment driven by increased spending on Low Earth Orbit constellations and increased content of the next generation high throughput satellites using flexible digital payloads. In aerospace, underlying1 revenue grew by 44% driven by the continued deployment of our SATCOM antenna products and connector and component solutions on military and commercial airframes tied to new higher efficiency engines. The strong, double digit growth in both these segments was offset by small declines in the defence, semiconductor test and rail segments. Underlying1 revenue decline in defence of 4% reflected a slowdown in deliveries on several key defence programmes approaching end of life that was not offset by revenues from new programme wins. The medical segment grew, with underlying1 revenue up 4% tied to increased volume at one of our leading customers. Industry consolidation impacted the buying patterns of several of our key customers in the semiconductor test segment with underlying1 revenue down 4%.

Operating profit grew 5% on an underlying1 basis and the headline operating margin increased 30bps to 13.4% driven by the benefits of restructuring activity in the prior year combined with a continued procurement and operational efficiency focus. The difference between statutory and headline operating profit primarily reflects a £72m profit on business disposals.

Return on capital employed increased 110 basis points to 11.4% driven by the higher profitability during the year and the positive mix impact of the two disposals.

During the course of the year Smiths Interconnect disposed of both its Power and Microwave Telecoms businesses to concentrate on its remaining core with scalable, top 3 leadership positions in its chosen markets. Prior to the sale of the Power business in January 2017 sales were £47m, with headline operating profit of £7m and net assets were £157m. Prior to the sale of the Microwave Telecoms business in May 2017 sales were £55m, headline operating profit was £1m and net assets were £41m. The performance of both the Power and Microwave Telecoms businesses are included within the financial summary and results presented above. 

Total research and development expenditure of £28m was £2m higher than the prior year, representing 6.7% of revenue. During the year Smiths Interconnect's engineering function was realigned with our strategic market segments of Defence, Aerospace, Space, Rail, Medical and Semiconductor test, with significant emphasis on driving improved time to market for new product development and an increased focus on developing product platforms over bespoke solutions. Product developments during the year included:

- For the space market, the development of the K2TVA Series to our Thermopad® portfolio with an improved thick-film thermistor technology to enable more temperature compensation and mitigate the degradation at higher frequencies typical of this type of technology.

- In semiconductor test we introduced a higher performance version of our DaVinci test socket which can now be used to test the most advanced CPU and GPU semiconductor devices.

- We also expanded our Outrigger resistor line with the CRHB 1216 product series, improving the power-to-size ratio of our resistor line, which has applications in most of our core markets.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Performance

Flex-Tek delivered a strong performance with revenue up 3% on an underlying1 basis, driven by growth in all segments except Fluid Management. On a reported basis, foreign exchange translation benefits led to revenue growth of 19%.

Construction revenue grew 2% on an underlying1 basis, with both Gastite and Thermaflex benefiting from growth in the US housing market and Gastite's increasing European presence. Heat Solutions revenue increased by 12% on an underlying1 basis, principally due to growth in its engineered solutions. Flexible Solutions underlying1 revenue growth of 3% was driven by increased demand from the medical sector, partially offset by a decline in the floor care segment. Fluid Management revenue was down 2% on an underlying1 basis, primarily due to order timing issues associated with a specific customer. The aerospace market for components otherwise remained strong.

Headline operating profit increased 11% on an underlying1 basis to £65m and the headline operating margin increased 130bps to 19.3%. Margins expanded in all segments with the exception of Thermaflex due to pricing pressure. Improvements in profitability were driven by positive mix in Heat Solutions, procurement savings in Gastite and Flexible Solutions, and continued strong operating cost control. The difference between statutory and headline operating profit is primarily due to the £4m release in the provision for Titeflex Corporation subrogation claims due to increasing US discount rates.

Return on capital employed increased 420 basis points to 35.8%, driven by improved profitability.

Since the year end Tutco LLC, part of the Heat Solutions business, has signed an agreement to purchase the heating element division of Osram, broadening its portfolio into faster growing engineered heating solutions.

Total research and development expenditure remained broadly consistent at 0.6% of sales, focused on market-leading innovative solutions to meet specific customer needs. In particular:

- The continued development of 5000psi aerospace tubing for a broader range of applications. 

- In Gastite, the further development of its technology leading FlashShield product to improve ease of installation.

- Heat Solutions re-focused development of flexible heaters, with a new production cell for this product now operational. 

- Flexible Solutions expanded the use of its heated wire hose technology in medical hose applications.

1Underlying excludes the effects of foreign exchange translation and acquisitions but includes divested business for the period they were owned in the reported financial year and adjusts the prior financial year comparator as if the divested business were owned for the same period in that financial year to aid comparability

Headline revenue

Reported revenue increased by £331m (11%) to £3,280m, including the positive effects of foreign currency translation (£421m) and the net impact of acquisitions and disposals (-£65m). On an underlying basis, revenue declined 1% as growth in Smiths Detection (+£22m; 4%), Smiths Interconnect (+£4m; 1%) and Flex-Tek (+£11m; 3%) was offset by declines in John Crane (-£33m; -4%) and Smiths Medical (-£29m; -3%).

Operating profit

Headline operating profit of £589m was £79m higher than prior year (2016: £510m) including the positive effects of foreign currency translation (£71m) and the net impact of acquisitions and disposals (-£10m). On an underlying basis operating profit increased 3%, with improvements in all divisions except John Crane. Headline operating margin increased by 70 basis points to 18.0% (2016: 17.3%), with improvements in all divisions reflecting operational efficiencies.

John Crane margin improved by 110 basis points to 23.0% (2016: 21.9%) benefiting from the disposal of the Artificial Lift business, favourable mix and operational efficiencies. Smiths Medical increased 60 basis points to 22.0% (2016: 21.4%) as the benefits of cost control, efficiencies and a medical device tax refund, offset lower revenue and pricing pressures. Smiths Detection delivered a 200 basis points improvement to 15.0% (2016: 13.0%), reflecting sales growth, increased focus on aftermarket and favourable mix. Morpho contributed £8m of operating profit in the period post acquisition. Smiths Interconnect improved operating margin by 30 basis points to 13.4% (2016: 13.1%) due to increased revenue, coupled with benefits from restructuring and a range of productivity and efficiency initiatives. Operating margins in Flex-Tek improved by 130 basis points to 19.3% (2016: 18.0%), reflecting the impact of increased revenue and efficiencies. Central costs increased by £13m including investment in corporate development activities, resources to support the Smiths Excellence System, and investment in people development, to build capabilities to support sustainable growth.

Operating profit on a statutory basis, after taking account of the items excluded from the headline figures, was £674m (2016: £387m) - see notes 3 and 28 to the accounts for information on the excluded items. The increase was driven by the £175m profit on disposal of businesses during the year, coupled with a decrease in charges for legacy liabilities and no impairment charges being recorded in the current year.

Finance costs

Headline finance costs during the year totalled £61m, £2m higher than the previous year. This was principally due to adverse foreign exchange movements, partly offset by lower interest payable due to the repayment of the higher rate £150m 7.25% Eurobond which matured in June 2016. Statutory finance costs totalled £73m (2016: £41m).

Non-headline items relating to continuing activities excluded from headline profit before tax

These items amounted to a gain of £73m compared to a charge of £105m in 2016. They comprised:

· £175m gain on the four disposals made in the year: £4m on John Crane Artificial Lift, £100m on Smiths Medical Wallace, £22m on Smiths Interconnect Power and £50m on Smiths Interconnect Microwave Telecoms;

· £37m charge for restructuring (2016: £37m), which included £33m in respect of the Fuel for Growth programme which completed in the year (2016: £37m) and £4m of restructuring costs associated with the integration of Morpho Detection and the existing Smiths Detection business. The four-year Fuel for Growth programme has now concluded with total spend of £185m and cumulative benefits to date totalling £70m. Ongoing restructuring costs will be recorded in headline operating profit in 2018;

· £19m charge for acquisition costs (2016: £6m);

· £9m net charge (2016: £7m) in connection with John Crane, Inc. asbestos litigation;

· £4m credit (2016: £11m charge) in connection with Titeflex Corporation litigation;

· £9m charge for changes to post retirement benefits and administration costs (2016: £16m);

· £nil impairment of goodwill, property, plant and equipment and trade investments (2016: £31m); amortisation of intangible assets acquired in business combinations of £17m (2016: £15m). The ongoing amortisation charge relates principally to technology and customer relationships;

· £3m charge for the unwind of fair value uplift of inventory on the acquisition balance sheet (2016: £nil)

· £6m charge related to the unwind of discounts on provisions (2016: £5m)

· £nil fair value gain on contributing government bonds to a pension scheme (2016: £19m);

· £8m of financing losses (2016: £1m gain); and

· £2m gain on retirement benefit finance (2016: £3m gain).

Discontinued operations

Discontinued operations comprised the Morpho Detection explosive trace business generating a loss after tax of £8m in the year (2016: £nil).

Taxation

The principles of the Group's approach to taxation remain unchanged. The Group seeks to manage the cost of taxation in a responsible manner to enhance its competitive position on a global basis while managing its relationships with tax authorities on the basis of full disclosure, co-operation and legal compliance. A semi‑annual tax report is reviewed by the Audit Committee to monitor compliance with these principles to ensure the Group delivers its tax objectives. The headline tax charge for 2017 of £140m (2016: £113m) represented an effective rate of 26.5% on the headline profit before taxation (2016: 25.0%). On a statutory basis, the tax charge on continuing activities was £29m (2016: £85m), representing an effective tax rate of 4.8% (2016: 24.6%), impacted by the recognition of UK deferred tax assets and gains on sale of businesses which were either non-taxable or sheltered by previously unrecognised losses.

The Group aims to utilise global manufacturing, research and development and other tax incentives, to allocate its capital in the most tax efficient manner where the regulatory environment allows, and to ensure the effective and timely management of its tax filings and compliance.

In 2017, the Group paid £82m in direct corporate tax on profits (2016: £62m) and £116m in employment and other taxes (2016: £105m). The Group additionally collected £224m on behalf of tax authorities, primarily from employees but also other indirect taxes such as VAT (2016: £210m). The total amount of tax paid over to tax authorities during the year totalled £422m (2016: £377m). A rate of between 29.5% and 30.0% is expected in the year ending 31 July 2018.

Earnings per share

Basic headline earnings per share from continuing activities were 97.6p (2016: 85.2p). The reported 15% increase was driven by favourable foreign exchange movements and higher operating profit partly offset by an increase in the effective tax rate to 26.5% from 25.0% in 2016.

On a statutory basis, the basic earnings per share from continuing activities was 144.1p (2016: 65.6p), reflecting the profit on disposal of businesses of £175m and lower non headline costs compared to 2016.

Cash generation and net debt

Operating cash generation remained strong, with headline operating cash-flow of £695m (2016: £520m), representing 118% (2016: 102%) of headline operating profit (see note 29 to the accounts for a reconciliation of headline operating cash and free cash flow to statutory cash-flow measures). Movement in working capital was an inflow of £85m (2016: inflow of £9m) reflecting a reduction in inventory and receivables.

Total free cash-flow, stated after all legacy costs, interest and taxes but before acquisitions, divestitures and dividends, increased by £127m to £370m (2016: £243m), reflecting the higher operating cash generated and reduced pension payments. Continued strong cash generation is expected in 2018.

On a statutory basis, net cash inflow from operations was £479m (2016: £358m).

Net debt at 31 July 2017 was £967m, a decrease of £11m in the year. On an underlying basis, excluding the impact of foreign exchange movements, net debt reduced by £72m, reflecting strong operational cash generation and the Morpho acquisition being largely financed from business disposals.

At the end of the period, the Group had gross debt of £1,749m (2016: £1,409m) and cash reserves of £782m (2016: £431m). Of this gross debt, £151m (2016: £270m) falls due for repayment within one year including the $175m 7.37% Notes due in February 2018. On 11 August 2017, the Group prepaid these Notes in full from cash resources.

The maturity profile of the major tranches of the debt in issue is as follows;

2018 - £133m ($175m 7.37% bond)*

2019 - £189m ($250m 7.20% bond)

2022 - £301m ($400m 3.625% bond)

2023 - £533m (€600m 1.25% bond)

2027 - £574m (€650m 2.00% bond)

 *prepaid in August 2017

Acquisitions and Disposals

On 6 April 2017 we completed our acquisition of Morpho Detection for final consideration of £590m. A condition of this transaction receiving regulatory approval, was the subsequent disposal of Morpho Detection's explosive trace detection business. This was sold to OSI Systems, Inc. on 7 July 2017 for £63m.

The Group has completed the disposal of a number of non-core businesses: our Artificial Lift business in John Crane for £29m in November 2016; our Wallace business in Smiths Medical for £132m in November 2016; our Power business in Smiths Interconnect for £164m in January 2017; and our Microwave Telecoms business in Smiths Interconnect for £85m in May 2017.

Dividend

Dividends paid in the year on ordinary shares amounted to £167m (2016: £163m). The Board has recommended a final dividend of 29.70 pence per share to be paid on 17 November 2017 to shareholders on the register at close of business on 20 October. When added to the 2017 interim dividend of 13.55p per share paid on 28 April 2017, the 2017 full year dividend of 43.25p represents an increase of 3.0% on the 2016 full year dividend of 42.0 pence per share.

Retirement benefits

As required by IFRS, the balance sheet reflects the net surplus or deficit in retirement benefit plans, taking assets at their market values at 31 July 2017 and evaluating liabilities at period-end AA corporate bond interest rates.

The tables below disclose the net status across a number of individual plans. Where any individual plan shows a surplus under IAS 19, this is disclosed on the balance sheet as a retirement benefit asset. The IAS 19 surplus of any one plan is not available to fund the IAS 19 deficit of another plan. The net pension position has improved to a surplus of £224m at 31 July 2017 from a surplus of £80m at 31 July 2016, benefitting from £105m of contributions in the year, the matching between assets and liabilities and changes in the UK and US mortality assumptions. The accounting basis under IAS 19 does not necessarily reflect the funding basis agreed with the Trustees and, should the schemes be wound up while they had members, they would need to buy out the benefits of all members. The buyouts would cost significantly more than the present value of scheme liabilities calculated in accordance with IAS 19.

The retirement benefit position is shown below:

The approximate pension membership for the three main schemes at 31 July 2017 is set out in the table below:

Goodwill and intangibles

Goodwill from acquisitions has been capitalised since 1998. Until 1 August 2004 it was amortised over a maximum 20-year period. Under IFRS goodwill is no longer amortised but instead is subject to annual reviews to test for impairment.

Intangible assets arising from business combinations ('acquired intangibles') are assessed at the time of acquisition in accordance with IFRS 3 (Revised) and are amortised over their expected useful life. This amortisation is excluded from the measure of headline profits. When indicators of impairments are identified, the intangible assets are tested and any impairment identified is charged in full. The impairment charge is excluded from the measure of headline profits. Other intangible assets comprise development costs or software which are capitalised as intangible assets as required by IFRS. Amortisation charged on these assets is deducted from headline profits.

Return on capital employed

The return on capital employed (ROCE) is calculated over a rolling 12-month period and is the percentage that headline operating profit comprises of monthly average capital employed. Capital employed comprises total equity adjusted for goodwill recognised directly in reserves, post‑retirement benefit-related assets and liabilities net of tax, litigation provisions relating to exceptional items net of tax, and net debt. ROCE increased 90 basis points to 16.2% (2016: 15.3%) as a result of increased profitability across the group.

Exchange rates

The results of overseas operations are translated into sterling at average exchange rates. The net assets are translated at year-end rates. The principal exchange rates, expressed in terms of the value of sterling, are shown in the following table.

Financial information

The financial information in this preliminary announcement which comprises the consolidated income statement, consolidated statement of comprehensive income, consolidated balance sheet, consolidated cash-flow statement, consolidated statement of changes in equity, accounting policies and related notes does not constitute statutory accounts within the meaning of Section 434 of the Companies Act 2006.

The statutory accounts for the year ended 31 July 2016 have been filed with the Register of Companies. The auditors have reported on those accounts and on the statutory accounts for the year ended 31 July 2017, which will be filed with the Registrar of Companies following the Annual General Meeting. Both the audit reports were unqualified and did not contain any statement under section 498 of the Companies Act 2006.

_______________________________________________________

Reconciliation of net cash-flow to movement in net debt

Basis of preparation

The accounts have been prepared in accordance with the Companies Act 2006 applicable to companies reporting under International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee (IFRS IC) interpretations, as adopted by the European Union, on a going concern basis and under the historical cost convention modified to include revaluation of certain financial instruments, share options and pension assets and liabilities, held at fair value as described below.

The accounting policies adopted are consistent with those of the previous financial year.

Significant judgements, key assumptions and estimates

The preparation of the accounts in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates. The key estimates and assumptions used in these consolidated financial statements are set out below.

Revenue recognition

The timing of revenue recognition on contracts depends on the assessed stage of completion of contract activity at the balance sheet date. This assessment requires the expected total contract revenues and costs to be estimated based on the current progress of the contract. Revenue of £24m (2016: £42m) has been recognised in the period in respect of contracts in progress at the period end with a total expected value of £48m (2016: £175m) and cumulative revenue recognised to date of £36m (2016: £137m). A 5% reduction in the proportion of the contract activity recognised in the current period would have reduced operating profit by less than £1m for both Smiths Detection and Smiths Interconnect (2016: less than £1m).

Smiths Detection also has multi-year contractual arrangements for the sale of goods and services. Where these contracts have separately identifiable components with distinct patterns of delivery and customer acceptance, revenue is accounted for separately for each identifiable component. Judgement is applied in the identification of the components of the contract, and the allocation of contract revenue to each component.

Smiths Medical has rebate arrangements in place with some distributors in respect of sales to end customers where sales prices have been negotiated by Smiths Medical. Rebates are estimated based on the level of discount derived from sales data from distributors, the amount of inventory held by distributors and the time lag between the initial sale to the distributor and the rebate being claimed. The rebate accrual at 31 July 2017 was £27m (2016: £28m).

Contract profitability

Smiths Detection has multi-year contractual arrangements for the sale of goods and services. Margins achieved on these contracts can reflect the impact of commercial decisions made in different economic circumstances. In addition, contract delivery is subject to commercial and technical risks which can affect the outcome of the contract. At 31 July 2017 there was £nil (2016: £4m) balance sheet liability in respect of ongoing onerous contracts and no other contracts had been assessed as at significant risk of becoming onerous.

Taxation

The Group has recognised deferred tax assets of £129m (2016: £87m) relating to losses and £112m (2016: £120m) relating to the John Crane, Inc. and Titeflex Corporation litigation provisions. The recognition of assets pertaining to these items involves judgement by management as to the likelihood of realisation of these deferred tax assets. This is based on a number of factors, which seek to assess the expectation that the benefit of these assets will be realised, including expected future levels of operating profit, expenditure on litigation, pension contributions and the timing of the unwind of other tax positions. It has been concluded that there are sufficient taxable profits in future periods to support recognition. A 5% reduction in expected future operating profits would reduce the level of deferred tax recognised by £8m (2016: £9m), and a 5% increase in expected future operating profits would increase the level of deferred tax recognised by £11m (2016: £11m). Further detail on the Group's deferred taxation position is included in note 6.

Retirement benefits

The consolidated financial statements include costs in relation to, and provision for, retirement benefit obligations. The costs and the present value of any related pension assets and liabilities depend on such factors as life expectancy of the members, the returns that plan assets generate and the discount rate used to calculate the present value of the liabilities. The Group uses previous experience and independent actuarial advice to select the values of critical estimates. The estimates, and the effect of variances in key estimates, are disclosed in note 8.

At 31 July 2017 there is a retirement benefit asset of £390m (2016: £328m), principally relating to UK schemes, which arises from the rights of the employers to recover the surplus at the end of the life of the scheme. If the pension schemes were wound up while they still had members, the schemes would need to buy out the benefits of all members. The buyouts would cost significantly more than the present value of the scheme liabilities calculated in accordance with IAS 19: Employee benefits.

Receivables provisions

If the carrying value of any receivable is higher than the fair value, the Group makes provisions writing down the balance to its fair value. The fair value of receivables is considered individually for each customer and incorporates past experience and progress with collecting receivables.

At 31 July 2017 the gross value of receivables partly provided for or more than three months overdue was £73m (2016: £83m) and there were provisions of £33m (2016: £31m) against these receivables. Consequently, these receivables were carried at a net value of £40m (2016: £52m). See note 14 for disclosures on credit risk and ageing of trade receivables.

Inventory provisions

The calculation of inventory provisions requires judgement by management of the expected value of future sales. If the carrying value of inventory is higher than the expected recoverable value, the Group makes provisions writing inventory down to its net recoverable value. Inventory is initially assessed for impairment by comparing inventory levels to recent utilisation rates and carrying values to historical selling prices. A detailed review is completed for inventory lines identified in the initial assessment considering sales activity, order flow, customer contracts and current selling prices.

At 31 July 2017, there were provisions of £55m (2016: £70m) against gross inventory of £507m (2016: £548m). See note 13 for a breakdown of inventory.

A 10% increase in the proportion of raw materials provided for would increase the provision by £17m (2016: £20m) and a 10% increase in the proportion of finished goods provided for would increase the provision by £22m (2016: £23m).

Impairment

Goodwill is tested at least annually for impairment and other assets, including intangible assets acquired in business combinations, are tested if there are any indications of impairment, in accordance with the accounting policy set out below. The recoverable amounts of cash generating units and assets are determined based on value in use calculations unless future trading projections cannot be adjusted to eliminate the impact of a major restructuring. The value in use calculations require the use of estimates including projected future cash-flows and other future events.

See note 11 for details of the critical assumptions made, including the forecast earnings and valuation multiples for Morpho Detection and disclosures on the sensitivity of the impairment testing to these key assumptions, including details of the changes in assumptions which would be required to trigger an impairment in Morpho Detection.

Provisions for liabilities and charges

As previously reported, John Crane, Inc. ("JCI"), a subsidiary of the Group, is currently one of many co-defendants in litigation relating to products previously manufactured which contained asbestos. Provision of £237m (2016: £252m) has been made for the future defence costs which the Group is expected to incur and the expected costs of future adverse judgments against JCI. Whilst well-established incidence curves can be used to estimate the likely future pattern of asbestos related disease, JCI's claims experience is significantly impacted by other factors which influence the US litigation environment. These can include: changing approaches on the part of the plaintiffs' bar; changing attitudes amongst the judiciary at both trial and appellate levels; and legislative and procedural changes in both the state and federal court systems. Therefore, because of the significant uncertainty associated with the future level of asbestos claims and of the costs arising out of the related litigation, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred.

JCI takes account of the advice of an expert in asbestos liability estimation in quantifying the expected costs. The following judgements were made in preparing the provision calculation:

▪ the period over which the expenditure can be reliably estimated is judged to be ten years, based on past experience regarding significant changes in the litigation environment that have occurred every few years and on the amount of time taken in the past for some of those changes to impact the broader asbestos litigation environment. See note 22 for a sensitivity showing the impact on the provision of reducing or increasing this time horizon;

▪ the future trend of legal costs; the rate of future claims filed; the rate of successful resolution of claims; and the average amount of judgments awarded have been projected based on the past history of JCI claims and well-established tables of asbestos incidence projections, since this is the best available evidence. Claims history from other defendants is not used to calculate the provision because JCI's defence strategy generates a significantly different pattern of legal costs and settlement expenses. See note 22 for a sensitivity showing the range of expected future spend.

As previously reported, Titeflex Corporation, a subsidiary of the Group in the Flex-Tek division, has received a number of claims from insurance companies seeking recompense on a subrogated basis for the effects of damage allegedly caused by lightning strikes in relation to its flexible gas piping product. It has also received a number of product liability claims regarding this product, some in the form of purported class actions. Titeflex Corporation believes that its products are a safe and effective means of delivering gas when installed in accordance with the manufacturer's instructions and local and national codes; however some claims have been settled on an individual basis without admission of liability. Provision of £84m (2016: £94m) has been made for the costs which the Group is expected to incur in respect of these claims. In preparing the provision calculation, judgements were made about the impact of safe installation initiatives on the level of future claims. See note 22 for a sensitivity showing the impact on the provision of reducing or increasing the expected impact. However, because of the significant uncertainty associated with the future level of claims, there can be no guarantee that the assumptions used to estimate the provision will result in an accurate prediction of the actual costs that may be incurred.

The Group has on occasion been required to take legal action to protect its intellectual property and other rights against infringement. It has also had to defend itself against proceedings brought by other parties, including product liability and insurance subrogation claims. Provision is made for any expected costs and liabilities in relation to these proceedings where appropriate, though there can be no guarantee that such provisions (which may be subject to potentially material revision from time to time) will accurately predict the actual costs and liabilities that may be incurred.

All provisions may be subject to potentially material revisions from time to time if new information becomes available as a result of future events.

Presentation of results

Non-statutory performance measures, described as 'headline', are presented to give a clear and consistent presentation of the performance of the Group's ongoing trading activity. These measures are used by management to measure and monitor performance. Headline measures exclude amounts relating to costs of acquisitions and disposals, amortisation of acquisition fair value adjustments, including the recognition of acquired intangibles, impairments, legacy liabilities, significant restructuring, material one-off items and certain re-measurements. Smiths Group plc presents its results in the income statements with items excluded from headline measures in a separate column. See note 1 for divisional headline operating profit, note 3 for a breakdown of the items excluded from headline operating profit and headline finance costs and note 30 for information on the calculation of return on capital employed and credit metrics.

In addition, the Group reports underlying growth rates for sales and profit measures, which exclude the impact of acquisitions and divestments and the effects of foreign exchange translation, by making the following adjustments:

▪ Retranslate the comparative to current year exchange rates before calculating growth measures

▪ Exclude acquisitions from the current period for the first 12 months of ownership; and

▪ Exclude the divested businesses performance after the date of disposal from comparative period.

For the convenience of users, supplementary primary financial statements translated into US dollars have been presented after the Group financial record. Assets and liabilities have been translated into US dollars at the exchange rate at the date of that balance sheet and income, expenses and cash-flows are translated at average exchange rates for the period.

Accounting policies

Basis of consolidation

The consolidated accounts incorporate the financial statements of Smiths Group plc (the 'Company') and its subsidiary undertakings, together with the Group's share of the results of its associates. A list of the subsidiaries of Smiths Group plc is provided on pages 207 to 214.

Subsidiaries are all entities controlled by the Company. Subsidiaries are fully consolidated from the date on which control is obtained by the Company to the date that control ceases.

Associates are entities over which the Group has significant influence but does not control, generally accompanied by a share of between 20% and 50% of the voting rights. Investments in associates are accounted for using the equity method.

Foreign currencies

The Company's presentational currency is sterling. The financial position of all subsidiaries and associates that have a functional currency different from sterling are translated into sterling at the rate of exchange at the date of that balance sheet, and the income and expenses are translated at average exchange rates for the period. All resulting exchange differences are recognised as a separate component of equity.

On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders' equity. When a foreign operation is sold, the cumulative amount of such exchange differences is recognised in the income statement as part of the gain or loss on sale.

Exchange differences arising on transactions are recognised in the income statement. Those arising on trading are taken to operating profit; those arising on borrowings are classified as finance income or cost.

Revenue

Revenue is measured at the fair value of the consideration received, net of trade discounts (including distributor rebates) and sales taxes. Revenue is discounted only where the impact of discounting is material.

When the Group enters into complex contracts with multiple, separately identifiable components, the terms of the contract are reviewed to determine whether or not the elements of the contract should be accounted for separately. If a contract is being split into multiple components, the contract revenue is allocated to the different components at the start of the contract. The basis of allocation depends on the substance of the contract. The Group considers relative stand-alone selling prices, contractual prices and relative cost when allocating revenue.

Sale of goods

Revenue from the sale of goods is recognised when the risks and rewards of ownership have been transferred to the customer, the amount of revenue can be measured reliably and recovery of the consideration is probable. For established products with simple installation requirements, revenue is recognised when the product is delivered to the customer in accordance with the agreed delivery terms. For products which are technically innovative, highly customised or require complex installation, revenue is recognised when the customer has completed its acceptance procedures.

Services

Revenue from services is recognised in accounting periods in which the services are rendered, by reference to completion of the specific transaction, assessed on the basis of the actual service provided as a proportion of the total services to be provided. Depending on the nature of the contract, revenue will be recognised on the basis of the proportion of the contract term completed, the proportion of the contract costs incurred or the specific services provided to date.

Construction contracts

Contracts for the construction of substantial assets are accounted for as construction contracts if the customer specifies major structural elements of the design, including the ability to amend the design during the construction process. These projects normally involve installing customised systems with site-specific integration requirements.

Where the outcome of a construction contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date. The Group uses the 'percentage of completion method' to determine the appropriate amount to recognise in a given period. The assessment of the stage of completion is dependent on the nature of the contract, but will generally be based on the estimated proportion of the total contract costs which have been incurred to date. If a contract is expected to be loss-making, a provision is recognised for the entire loss.

Leases

Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.

Taxation

The charge for taxation is based on profits for the year and takes into account taxation deferred because of temporary differences between the treatment of certain items for taxation and accounting purposes.

Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to taxation authorities. Tax benefits are not recognised unless it is likely that the tax positions are sustainable. Once considered to be likely, tax benefits are reviewed to assess whether a provision should be made based on prevailing circumstances. Tax provisions are included in current tax labilities, including any anticipated interest & penalties. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted, at the reporting date in the countries where the Group operates and generates taxable income.

Deferred tax is provided in full using the balance sheet liability method. A deferred tax asset is recognised where it is probable that future taxable income will be sufficient to utilise the available relief. Tax is charged or credited to the income statement except when it relates to items charged or credited directly to equity, in which case the tax is also dealt with in equity.

Deferred tax is provided on temporary differences arising on investments in subsidiaries and associates, except where the timing of the reversal of the temporary differences is controlled by the Company and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax liabilities and assets are not discounted.

Employee benefits

Share-based compensation

The fair value of the shares or share options granted is recognised as an expense over the vesting period to reflect the value of the employee services received. The fair value of options granted, excluding the impact of any non-market vesting conditions, is calculated using established option pricing models, principally binomial models. The probability of meeting non-market vesting conditions, which include profitability targets, is used to estimate the number of share options which are likely to vest.

For cash-settled share-based payment, a liability is recognised based on the fair value of the payment earned by the balance sheet date. For equity-settled share-based payment, the corresponding credit is recognised directly in reserves.

Pension obligations and post-retirement benefits

The Group has defined benefit plans, defined contribution plans and post-retirement healthcare schemes.

For defined benefit plans and post-retirement healthcare schemes the liability for each scheme recognised in the balance sheet is the present value of the obligation at the balance sheet date less the fair value of any plan assets. The obligation is calculated annually by independent actuaries using the projected unit credit method. The present value is determined by discounting the estimated future cash outflows using interest rates of AA-rated corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related liability. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recognised in full in the period in which they occur, outside of the income statement, and are presented in the statement of comprehensive income. Past service costs are recognised immediately in the income statement.

For defined contribution plans, the Group pays contributions to publicly or privately administered pension insurance plans on a mandatory, contractual or voluntary basis. Contributions are expensed as incurred.

Intangible assets

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the Group's share of the identifiable net assets of the acquired subsidiary at the date of acquisition.

Goodwill arising from acquisitions of subsidiaries after 1 August 1998 is included in intangible assets, tested annually for impairment and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. Goodwill arising from acquisitions of subsidiaries before 1 August 1998 was set against reserves in the year of acquisition.

Goodwill is tested for impairment at least annually. Any impairment is recognised immediately in the income statement. Subsequent reversals of impairment losses for goodwill are not recognised.

Research and development

Expenditure on research and development is charged to the income statement in the year in which it is incurred with the exception of:

▪ amounts recoverable from third parties; and

▪ expenditure incurred in respect of the development of major new products where the outcome of those projects is assessed as being reasonably certain as regards viability and technical feasibility. Such expenditure is capitalised and amortised over the estimated period of sale for each product, commencing in the year that sales of the product are first made. Amortisation is charged straight line or based on the units produced, depending on the nature of the product and the availability of reliable estimates of production volumes.

The cost of development projects which are expected to take a substantial period of time to complete includes attributable borrowing costs.

Intangible assets acquired in business combinations

The identifiable net assets acquired as a result of a business combination may include intangible assets other than goodwill. Any such intangible assets are amortised straight line over their expected useful lives as follows:

The assets' useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Software, patents and intellectual property

The estimated useful lives are as follows:

The assets' useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Property, plant and equipment

Property, plant and equipment is stated at historical cost less accumulated depreciation and any recognised impairment losses.

Land is not depreciated. Depreciation is provided on other assets estimated to write off the depreciable amount of relevant assets by equal annual instalments over their estimated useful lives. In general, the rates used are: Freehold and long leasehold buildings - 2%; Short leasehold property - over the period of the lease; Plant, machinery, etc. - 10% to 20%; Fixtures, fittings, tools and other equipment - 10% to 33%.

The cost of any assets which are expected to take a substantial period of time to complete includes attributable borrowing costs.

The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. An asset's carrying amount is written down immediately to its recoverable amount if the asset's carrying amount is greater than its estimated recoverable amount.

Inventories

Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). The cost of items of inventory which take a substantial period of time to complete includes attributable borrowing costs. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses.

Trade and other receivables

Trade receivables are initially recognised at fair value and subsequently measured at amortised cost, less any appropriate provision for estimated irrecoverable amounts. A provision is established for irrecoverable amounts when there is objective evidence that amounts due under the original payment terms will not be collected.

Provisions

Provisions for warranties and product liability, disposal indemnities, restructuring costs, vacant leasehold property and legal claims are recognised when: the Company has a legal or constructive obligation as a result of a past event; it is probable that an outflow of resources will be required to settle the obligation; and the amount has been reliably estimated. Provisions are not recognised for future operating losses.

Provisions are discounted where the time value of money is material.

Where there are a number of similar obligations, for example where a warranty has been given, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognised even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.

Assets and businesses held for sale

Assets and businesses classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. Impairment losses on initial classification as held for sale and gains or losses on subsequent remeasurements are included in the income statement. No depreciation is charged on assets and businesses classified as held for sale.

Assets and businesses are classified as held for sale if their carrying amount will be recovered or settled principally through a sale transaction rather than through continuing use. The asset or business must be available for immediate sale and the sale must be highly probable within one year.

Discontinued operations

A discontinued operation is either:

▪ a component of the Group's business that represents a separate major line of business or geographical area of operations that has been disposed of, has been abandoned or meets the criteria to be classified as held for sale; or

▪ a business acquired solely for the purpose of selling it.

Discontinued operations are presented on the income statement as a separate line and are shown net of tax.

Cash and cash equivalents

Cash and cash equivalents include cash at bank and in hand and highly liquid interest-bearing securities with maturities of three months or less.

In the cash-flow statement, cash and cash equivalents are shown net of bank overdrafts, which are included as current borrowings in liabilities on the balance sheet.

Financial assets

The classification of financial assets depends on the purpose for which the assets were acquired. Management determines the classification of an asset at initial recognition and re-evaluates the designation at each reporting date. Financial assets are classified as: loans and receivables, available for sale financial assets or financial assets where changes in fair value are charged (or credited) to the income statement.

Financial assets are initially recognised at transaction price when the Group becomes party to contractual obligations. The transaction price used includes transaction costs unless the asset is being fair valued through the income statement.

The subsequent measurement of financial assets depends on their classification. Loans and receivables are measured at amortised cost using the effective interest rate method. Available for sale financial assets are subsequently measured at fair value, with unrealised gains and losses being recognised in other comprehensive income. Financial assets where changes in fair value are charged (or credited) to the income statement are subsequently measured at fair value. Realised and unrealised gains and losses arising from changes in the fair value of the 'financial assets at fair value through the income statement' category are included in the income statement in the period in which they arise.

Financial assets are derecognised when the right to receive cash-flows from the assets has expired, or has been transferred, and the Company has transferred substantially all of the risks and rewards of ownership. When securities classified as available for sale are sold or impaired, the accumulated fair value adjustments previously taken to reserves are included in the income statement.

Financial assets are classified as current if they are expected to be realised within 12 months of the balance sheet date.

Financial liabilities

Borrowings are initially recognised at the fair value of the proceeds, net of related transaction costs. These transaction costs, and any discount or premium on issue, are subsequently amortised under the effective interest rate method through the income statement as interest over the life of the loan, and added to the liability disclosed in the balance sheet. Related accrued interest is included in the borrowings figure.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least one year after the balance sheet date.

Derivative financial instruments and hedging activities

Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured at their fair value. The method of recognising any resulting gain or loss depends on whether the derivative is designated as a hedging instrument and, if so, the nature of the item being hedged.

Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognised immediately in the income statement.

Fair value hedge

Changes in the fair values of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair values of the hedged assets or liabilities that are attributable to the hedged risk.

Net investment hedge

Hedges of net investments in foreign operations are accounted for similarly to cash-flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income; the gain or loss relating to any ineffective portion is recognised immediately in the income statement.

When a foreign operation is disposed of, gains and losses accumulated in equity related to that operation are included in the income statement.

Cash-flow hedge

The effective portions of changes in the fair values of derivatives that are designated and qualify as cash-flow hedges are recognised in equity. The gain or loss relating to any ineffective portion is recognised immediately in the income statement.

Amounts accumulated in the hedge reserve are recycled in the income statement in the periods when the hedged items will affect profit or loss (for instance when the forecast sale that is hedged takes place). If a forecast transaction that is hedged results in the recognition of a non-financial asset (for example, inventory) or a liability, the gains and losses previously deferred in the hedge reserve are transferred from the reserve and included in the initial measurement of the cost of the asset or liability.

When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in the hedge reserve at that time remains in the reserve and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in other comprehensive income is immediately transferred to the income statement.

Fair value of financial assets and liabilities

The fair values of financial assets and financial liabilities are the amounts at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.

'IFRS 13: Fair value measurement' requires fair value measurements to be classified according to the following hierarchy:

▪ level 1 - quoted prices in active markets for identical assets or liabilities;

▪ level 2 - valuations in which all inputs are observable either directly (ie as prices) or indirectly (ie derived from prices); and

▪ level 3 - valuations in which one or more inputs that are significant to the resulting value are not based on observable market data.

See note 20 for information on the methods the Group uses to estimate the fair values of its financial instruments.

Dividends

Dividends are recognised as a liability in the period in which they are authorised. The interim dividend is recognised when it is paid and the final dividend is recognised when it has been approved by shareholders at the Annual General Meeting.

Recent accounting developments

The following standards and interpretations have been issued by the IASB and will affect future annual reports and accounts.

▪ 'IFRS 9: Financial instruments'

▪ 'IFRS 15: Revenue from contracts with customers'

▪ 'IFRS 16: Leases'

A review of the impact of these standards and interpretations is being undertaken, and the impact of adopting them will be determined once this review has been completed. Smiths will adopt IFRS 9 and IFRS 15 on 1 August 2018 and IFRS 16 on 1 August 2019 unless developments in the relationship between the UK and the EU change the reporting requirements for UK companies.

IFRS 9: Financial instruments

Adopting IFRS 9 will impact hedge accounting and receivables provisioning. The basis of documentation and effectiveness testing of hedges under the new standard will be linked more closely to the risk management objectives, which may generate different levels of ineffectiveness than the current testing under IAS 39. Receivables provisioning will move from an incurred to an expected loss model. The Group's largest exposure is trade receivables, which had a gross value of £716m at 31 July 2017. No impact is anticipated for high credit quality balances settled on agreed terms. However, the new model will impact the timing and value of provision recognition on higher risk balances. Under the current methodology, provisions of £33m have been recognised on £73m of receivables which are more than three months overdue or considered to be high risk.

IFRS 15: Revenue from contracts with customers

The review of the impact of 'IFRS 15: Revenue from contracts with customers' requires an assessment at contract level to confirm the full impact of adopting this standard.

Based on the analysis completed to date, we consider that the new standard is unlikely to have a material impact on revenue recognition for the following business activities, which had revenue of circa £1.7bn this year:

▪ Smiths branded products sold under basic PO terms;

▪ Customer specific products where the Group is manufacturing at risk with no contractual rights to recovery;

▪ Smiths Interconnect military contracts accounted for on a percentage of completion basis using proportion of costs incurred;

▪ Detection programs currently accounted for as multi-element contracts with consideration allocated on the relative fair value of the components; and

▪ Spares and ad hoc service callouts to repair or replace equipment.

The basis of revenue recognition may change for the following revenue streams:

▪ Customer specific products where the contractual terms include rights to payment for work performed to date. Revenue for most of these contracts is expected to be recognised rateably over the manufacturing period, depending on the specific rights in the contract; and

▪ Product development contracts where revenue is recognised on reaching development milestones. Revenue for recognition for some of these contracts is expected to move to a percentage of completion basis using proportion of costs incurred.

▪ John Crane has service contracts, which include bonuses and penalties based on the performance of the asset being maintained. Depending on the evidence available to estimate the levels of performance achieved, bonuses may be recognised earlier under IFRS 15.

IFRS 16: Leases

The review of this standard is at an early stage. This standard will require a lease liability and corresponding asset to be recognised on the balance sheet for leases currently classified as operating leases and not recognised on the balance sheet. IFRS 16 can require changes to the valuation of lease liabilities. However, preliminary work has not identified any material leases with contingent rentals. The total value of operating lease commitments at 31 July 2017 was £140m (2016: £146m).

Analysis by operating segment

The Group is organised into five divisions: John Crane, Smiths Medical, Smiths Detection, Smiths Interconnect and Flex-Tek. These divisions design, manufacture and support the following products:

▪ John Crane - mechanical seals, seal support systems, engineered bearings, power transmission couplings and specialised filtration systems;

▪ Smiths Medical - infusion systems, vascular access products (including safety needles), patient airway and temperature management equipment and specialised devices in areas of diagnostics and emergency patient transport;

▪ Smiths Detection - sensors and systems that detect and identify explosives, narcotics, weapons, chemical agents, biohazards and contraband;

▪ Smiths Interconnect - specialised electronic and radio frequency board-level and waveguide devices, connectors, cables, test sockets and sub-systems used in high-speed, high reliability, secure connectivity applications;

▪ Flex-Tek - engineered components flexible hosing and rigid tubing that heat and move fluids and gases.

The position and performance of each division is reported at each Board meeting to the Board of Directors. This information is prepared using the same accounting policies as the consolidated financial information except that the Group uses headline operating profit to monitor divisional results and operating assets to monitor divisional position. See note 3 for an explanation of which items are excluded from headline measures.

Intersegment sales and transfers are charged at arm's length prices.

Segment trading performance

Divisional headline operating profit is stated after charging the following items:

The reconciling items are central costs and charges that are treated as non-headline (see note 3).

Segment assets and liabilities

Segment assets

Segment liabilities

Non-headline liabilities comprise provisions and accruals relating to non-headline items, acquisitions and disposals.

Reconciliation to segment assets and liabilities to statutory assets and liabilities

Segment capital expenditure

The capital expenditure on property, plant and equipment, capitalised development and other intangible assets for each division is:

The reconciling items include corporate capital expenditure through Smiths Business Information Services on IT equipment and software.

Segment capital employed

Capital employed is a non-statutory measure of invested resources. It comprises statutory net assets adjusted to add goodwill recognised directly in reserves in respect of subsidiaries acquired before 1 August 1998 of £787m (31 July 2016: £815m) and eliminate post-retirement benefit assets and liabilities and litigation provisions relating to non-headline items, both net of related tax, and net debt. See note 30 for a reconciliation of net assets to capital employed.

The 12-month rolling average capital employed by division, which Smiths use to calculate divisional return on capital employed, is:

Analysis of revenue

The revenue for the main product and service lines for each division is:

John Crane original equipment revenue was previously described as "First Fit". This has been changed to provide a description relevant to a broader range of end markets, as John Crane expands its non-oil and gas revenues.

Smiths Detection previously reported its air transportation revenue as "transportation". The description has been expanded to avoid any confusion with the "Transportation" market discussed on page 29, since Smiths Detection operates in the Security and defence market. Smiths Detection previously reported its urban security revenue as "critical infrastructure". This has been changed to reflect the range of opportunities developing in this area.

The Group's statutory revenue is analysed as follows:

Analysis by geographical areas

The Group's revenue by destination and non-current operating assets by location are shown below:

Other services comprise audit-related assurance services £0.2m (2016: £0.1m), tax advisory services £0.1m (2016: £0.1m), one-off IT and consulting projects £0.2m (2016: £nil) and other services £nil (2016: £0.1m). Total fees for non-audit services comprise 8% (2016: 6%) of audit fees. Audit-related assurance services include the review of the Interim Report.

Headline profit measures

The Company seeks to present a measure of trading performance which is not impacted by material non-recurring items or items considered non-operational in nature. This measure is described as 'headline' and used by management to measure and monitor performance. See the disclosures on presentation of results in accounting policies for an explanation of the excluded items, which are referred to as 'non-headline'.

Headline revenue

The agreement to sell Smiths Medical's Wallace product line included an obligation to continue manufacturing products for the acquirer for 12 months after the date of disposal. In the Interim results to 31 January 2017, revenue arising from this activity was treated as non-headline because it was not expected to contribute to Smiths Medical's ongoing business. This treatment was reviewed in response to developments in the commercial relationship with CooperSurgical, Inc. and the activity is now being reported within headline activity.

Headline operating profit

The non-headline items included in statutory operating profit are as follows:

Items for the year ended 31 July 2017

Restructuring costs include £33m in respect of Fuel for Growth. This programme, which involves redundancy, relocation and consolidation of manufacturing, is considered a material non-recurring item by virtue of its size. No further costs are expected in respect of this program. In addition, there are £4m of initial costs in respect of the integration of Morpho Detection and the existing Smiths Detection business. The integration is expected to take two years. The total costs over the two years are projected to be material and non-recurring.

Acquisition costs have been treated as non-headline because they depend on the level of acquisition activity in the year. Only incremental costs directly linked to the transaction are reported as non-headline. They do not include the costs of the employees working on transactions.

See note 22 for details of the costs, and cost recoveries relating to Titeflex Corporation subrogation claims and John Crane, Inc asbestos litigation. These costs and recoveries have been treated as non-headline because the provision were treated as non-headline when they were originally recognised and the subrogation claims and litigation relate to products that the Group no longer sells in these markets.

Post-retirement benefit changes and costs relate to closed schemes, so the costs are a legacy of previous employee pension arrangements.

The impacts of business combination fair value adjustments, including amortisation of intangible assets, impairment or unwinding, have been excluded from headline measures on the basis that these charges result from acquisition accounting and do not relate to current trading activity. 

See note 28 for a breakdown of the profit by transaction. It is non-headline since the profit and cash impact is material and non-recurring.

Items for the year ended 31 July 2016

Restructuring costs comprise £37m in respect of Fuel for Growth. This programme, which involves redundancy, relocation and consolidation of manufacturing, is considered a material non-recurring item by virtue of its size.

The £9m charge relating to post-retirement benefits comprises the £10m settlement cost for the buy-out of retiree liabilities completed by the US pension scheme on 14 August 2015, net of a £1m settlement gain on closing a small scheme in Holland.

Impairments comprise £23m goodwill write-downs (see note 11), £6m on property plant and equipment and £2m on trade investments.

Headline finance costs

The non-headline items included in finance costs are as follows:

The unwind of discounting on provisions has been excluded from headline finance costs because these provisions were originally recognised as non-headline and this treatment has been maintained for ongoing costs and credits.

The fair value gain realised on contributing government bonds to Smiths Industries Pension Scheme was excluded from headline finance costs because it was a large, on-off item relating to funding previous employee pension arrangements.

Other financing gains and losses represent the potentially volatile gains and losses on derivatives, loans inside the group and other financial instruments which are not hedge accounted under IAS 39. They have been excluded from headline finance costs because they do not accurately reflect the aggregate risks of the group, since offsetting gains have been recognised in reserves or deferred in assets and liabilities which are not held at fair value.

Financing credits relating to retirement benefits are excluded from headline finance costs because the ongoing costs and credits are a legacy of previous employee pension arrangements.

The government bonds contributed to the Smiths Industries Pension Scheme in December 2015 were accounted for as available for sale financial assets, and cumulative fair value gains of £19m on these assets were recycled from other comprehensive income to the income statement.

Basic earnings per share are calculated by dividing the profit for the year attributable to equity shareholders of the Parent Company by the average number of ordinary shares in issue during the year.

Diluted earnings per share are calculated by dividing the profit attributable to ordinary shareholders by 400,518,049 (2016: 398,957,837) ordinary shares, being the average number of ordinary shares in issue during the year adjusted by the dilutive effect of employee share schemes. For the year ended 31 July 2017, zero options (2016: 223,993) were excluded from this calculation because their effect was anti-dilutive for continuing operations.

A reconciliation of basic and headline earnings per share - continuing is as follows:

The Group's approach to taxation is set out in the Financial review. This note only provides information about corporate income taxes under IFRS. Smiths companies operate in over 50 countries across the world. They pay and collect many different taxes in addition to corporate income taxes including: payroll taxes; value added and sales taxes; property taxes; product-specific taxes and environmental taxes. The costs associated with these other taxes are included in profit before tax.

The net retirement benefit charge to equity includes £6m (2016: £4m credit) relating to UK schemes and £5m (2016: £4m credit) relating to US schemes.

Reconciliation of the tax charge

The tax expense on the profit for the year for continuing operations is different from the standard rate of corporation tax in the UK of 19.7% (2016: 20.0%). The difference is reconciled as follows:

The head office of Smiths Group is domiciled in the UK, so the tax charge has been reconciled to UK tax rates.

In recent years, Smiths has made substantial payments to its UK defined benefit pension plans, which generated significant UK tax losses. This resulted in the non-recognition of deferred tax on UK losses and other temporary differences. The current position of the UK pension schemes has significantly improved and the pension contributions envisaged going forwards are significantly reduced. Reduced pension contributions and increased trading and investing profits have made the UK tax group structurally profitable, resulting in the recognition of all UK deferred tax assets and generating a non-headline credit of £69m in the current year.

Included in other adjustments to unrecognised deferred tax is recognition of £17m deferred tax following the reorganisation of a US business.

As a result of changes in tax legislation and the reorganisation of finance activities, the credit for closed financing arrangements will not be repeated in future years.

Current taxation

Provisions included in current tax liabilities are established based on reasonable estimates for the possible consequences of tax authority audits in the various countries in which the Group operates. Management judgement is used to determine the amount of such provisions based on an understanding of the relevant local tax law, taking into account the differences of interpretation that can arise on a wide variety of issues, depending on the prevailing circumstances, including the nature of current tax audits and the experience of previous enquiries.

Deferred taxation

The deferred tax asset relating to losses carried forward has been recognised on the basis that evidence demonstrates a consistent pattern of improving results and the Group has implemented plans to support continuing improvements or the losses relate to specific, identified non-recurring events. 

In 2012 UK deferred tax was written off as a deteriorating position in legacy pension plans made UK activities structurally loss making. As a result of an improvement in the UK pension position and restructuring financing activities, the UK is now expected to earn taxable profits and a £69m deferred tax asset has been recognised as a non-headline gain in the period. The closing deferred tax balance related to UK activities at 31 July 2017, including the benefit of losses brought forward and deferred tax liabilities on UK pension schemes, amounted to £64m.

Deferred tax relating to provisions includes £79m (2016: £84m) relating to the John Crane, Inc. litigation provision, and £33m (2016: 36m) relating to Titeflex Corporation. See note 22 for additional information on provisions; and

Included in other deferred tax balances above is a deferred tax asset of £14m (2016: £25m) relating to inventory where current tax relief is only available when the inventory is sold.

The Group has unrecognised deferred tax relating to deductible temporary differences in the UK amounting to £nil (2016: £402m) and non-UK losses amounting to £68m (2016: £93m).

The expiry date of operating losses carried forward is dependent upon the law of the various territories in which the losses arise. A summary of expiry dates for losses in respect of which deferred tax has not been recognised is set out below.

Restricted losses

Franked Investment Income Group Litigation Order

Smiths Group is one of the companies enrolled in the FII GLO litigation against HMRC. The court cases and appeals are nearing the end and some claimants, with different fact patterns, have received payments. Smiths claims amount to around £30m (after deducting 45% withholding tax). However, there are further relevant legal actions that could impact the claims. The benefit of this claim has not been recognised in the current or previous financial statements due to the uncertainty of the eventual outcome.

The average number of persons employed, rounded to the nearest 50 employees, was:

Key management

The key management of the Group comprises Smiths Group plc Board directors and Executive Committee members. Their aggregate compensation is shown below. Details of directors' remuneration are contained in the report of the Remuneration Committee.

No member of key management had any material interest during the period in a contract of significance (other than a service contract or a qualifying third-party indemnity provision) with the Company or any of its subsidiaries. Options and awards held at the end of the period by key management in respect of the Company's share-based incentive plans were:

Related party transactions

The only related party transactions in the year ended 31 July 2017 were key management compensation (31 July 2016: key management compensation).

Smiths provides post-retirement benefits to employees in a number of countries. This includes defined benefit and defined contribution plans and, mainly in the United Kingdom (UK) and United States of America (US), post-retirement healthcare.

Defined contribution plans

The Group operates a number of defined contribution plans across many countries. In the UK a defined contribution plan has been offered since the closure of the UK defined benefit pension plans. In the US a 401k defined contribution plan operates. The total expense recognised in the consolidated income statement in respect of all these plans was £33m (2016: £30m).

Defined benefit and post-retirement healthcare plans

The principal defined benefit pension plans are in the UK and in the US and these have been closed so that no future benefits are accrued.

For all schemes, pension costs are assessed in accordance with the advice of independent, professionally qualified actuaries. These valuations have been updated by independent qualified actuaries in order to assess the liabilities of the schemes as at 31 July 2017. Scheme assets are stated at their market values. Contributions to the schemes are made on the advice of the actuaries, in accordance with local funding requirements.

The changes in the present value of the net pension asset in the period were:

UK pension schemes

Smiths funded UK pension schemes are subject to a statutory funding objective, as set out in UK pension legislation. Scheme trustees need to obtain regular actuarial valuations to assess the scheme against this funding objective. The trustees and sponsoring companies need to agree funding plans to improve the position of a scheme, when it is below the acceptable funding level.

The UK Pensions Regulator has extensive powers to protect the benefits of members, promote good administration and reduce the risk of situations arising which may require compensation to be paid from the Pension Protection Fund. These powers include imposing a schedule of contributions or the calculation of the technical provisions, where a trustee and company fail to agree appropriate calculations.

Smiths Industries Pension Scheme ("SIPS")

This scheme was closed to future accrual effective 1 November 2009. SIPS provides index-linked pension benefits based on final earnings at date of closure. SIPS is governed by a corporate trustee (SI Trustee Limited, a wholly owned subsidiary of Smiths Group plc). The board of trustee directors comprises five company-nominated trustees and four member-nominated trustees, with an independent chairman selected by Smiths Group plc. Trustee Directors are responsible for the management, administration, funding and investment strategy of the scheme.

The most recent actuarial valuation of this scheme has been performed using the Projected Unit Method as at 31 March 2015, and experience gains and losses identified during this valuation have been incorporated into the IAS 19 valuation. Under the funding plan for SIPS agreed in November 2015 Smiths pays cash contributions of £2m a month until June 2020. As part of this agreement, Smiths contributed the index-linked gilts previously held in an escrow account. Under the governing documentation of the SIPS, any future surplus would be returnable to Smiths Group plc by refund, assuming gradual settlement of the liabilities over the lifetime of the scheme.

SIPS will implement Guaranteed Minimum Pensions equalisation in respect of members contracted out of the State Earnings Related Pensions Scheme prior to 6 April 1997, once the government has completed its consultations and confirmed an approach. It is not yet possible to reliably quantify the impact of this adjustment.

The duration of the SIPS liabilities is around 23 years (2016: 23 years) for active deferred members, 22 years (2016: 24 years) for deferred members and 11 years (2016: 12 years) for pensioners and dependants.

TI Group Pension Scheme ("TIGPS")

This scheme was closed to future accrual effective 1 November 2009. TIGPS provides index-linked pension benefits based on final earnings at the date of closure. TIGPS is governed by a corporate trustee (TI Pension Trustee Limited, an independent company). The board of trustee directors comprises five company-nominated trustees and four member-nominated trustees, with an independent trustee director selected by the Trustee. The Trustee is responsible for the management, administration, funding and investment strategy of the scheme.

The most recent actuarial valuation of this scheme has been performed using the Projected Unit Method as at 5 April 2015. Under the funding plan for TIGPS agreed in March 2016 Smiths pays cash contributions of £3m a year until April 2018. Under the governing documentation of the TIGPS, any future surplus would be returnable to Smiths Group plc by refund, assuming gradual settlement of the liabilities over the lifetime of the scheme.

TIGPS will implement Guaranteed Minimum Pensions equalisation in respect of members contracted out of the State Earnings Related Pensions Scheme prior to 6 April 1997, once the government has completed its consultations and confirmed an approach. It is not yet possible to reliably quantify the impact of this adjustment.

The duration of the TIGPS liabilities is around 24 years (2016: 25 years) for active deferred members, 22 years (2016: 24 years) for deferred members and 11 years (2016: 11 years) for pensioners and dependants.

US pension plans

The most recent valuations of the principal US pension and post-retirement healthcare plans were performed at 1 January 2017.

The pension plans were closed with effect from 30 April 2009 and benefits were calculated as at that date and are not revalued. Governance of the US pension plans is managed by a Settlor Committee appointed by Smiths Group Services Corp, a wholly owned subsidiary.

The duration of the liabilities for the largest US plan is around 19 years (2016: 20 years) for active deferred members, 19 years (2016: 20 years) for deferred members and 12 years (2016: 12 years) for pensioners and dependants.

Last year the US funded plans completed a buy-out of retiree liabilities for $527m, transferring the obligation to pay pensions to Voya Retirement Insurance and Annuity Company. A settlement loss of £10m was recognised on this transaction (see note 3).

Risk management

The pensions schemes are exposed to risks that:

▪ investment returns are below expectations, leaving the scheme with insufficient assets in future to pay all its pension obligations;

▪ members and dependants live longer than expected, increasing the value of the pensions the scheme has to pay;

▪ inflation rates are higher than expected, so amounts payable under index-linked pensions are higher than expected; and

▪ increased contributions may be required to meet regulatory funding targets if lower interest rates increase the current value of liabilities.

These risks are managed separately for each pension scheme. However Smiths has adopted a common approach of closing defined benefit schemes to cap members' entitlements and supporting trustees in adopting investment strategies which match assets to future obligations, after allowing for the funding position of the scheme.

TI Group Pension Scheme ("TIGPS")

TIGPS with a mature member profile, and a strong funding position, has been able to progress its matching strategy to the point where roughly 50% of liabilities are covered by matching annuities, eliminating investment return, longevity, inflation and funding risks.

Smiths Industries Pension Scheme ("SIPS")

In August 2014 SIPS adjusted the scheme investment strategy. The scheme has investments in diversified growth funds and a portfolio of exchange traded equity index futures managed by BlackRock. The risk and return characteristics of equity index futures are similar to physical equities, but provide the scheme with improved liquidity. As at 31 July 2017 the SIPS portfolio of exchange traded equity index futures generated a £73m (2016: £163m) exposure to equities.

Following the company contribution of £152m UK government bonds to SIPS in December 2015 and the resulting improvement in the funding position, the trustees have adopted a leveraged liability matching strategy. The scheme uses repurchase arrangements, total return swaps, inflation swaps and interest rate swaps to hedge the interest and inflation risks of the scheme liabilities. Repurchase agreements exchange government bonds held by the scheme for cash with an obligation to buy back the asset at a fixed future date and price. The cash is invested in liability matching assets, reducing funding risk. A total return swap exchanges the return on a specified asset (for example an index-linked bond) and an interest payment (fixed or floating). Contracts are spread across a panel of banks. To minimise the risk that counterparties fail to settle obligations, positions are collateralised. For repurchase agreements, collateral is the difference between the present value of the repurchase obligation and the value of the asset exchanged. For swaps, collateral is based on market values. At 31 July 2017 scheme assets were net of £773m (2016: £720m) repurchase obligations, and nominal exposure from interest rate swaps of £340m (2016: £293m), inflation swaps of £293m (2016: £263m) and total return swaps of £14m (2016: £14m).

The principal assumptions used in updating the valuations are set out below:

The assumptions used in calculating the costs and obligations of the Group's defined benefit pension plans are set by Smiths after consultation with independent professionally qualified actuaries. The assumptions used are estimates chosen from a range of possible actuarial assumptions which, due to the timescale covered, may not necessarily occur in practice. For countries outside the UK and USA assumptions are disclosed as a weighted average.

Discount rate assumptions

The UK schemes use a discount rate based on the yield on the iBOXX over 15-year AA-rated corporate bond index, adjusted if necessary to better reflect the shape of the yield curve considering the Aon Hewitt GBP Select AA curve. For the USA, the discount rate is based on the Towers Watson cash-flow matching models and set with reference to Moody's Aa annualised yield, the Citigroup High Grade Index and the Merrill Lynch 15+ years High Quality Index.

Mortality assumptions

The mortality assumptions used in the principal UK schemes are based on the new "SAPS S2" All Birth year tables with relevant scaling factors based on the recent experience of the schemes. The assumption allows for future improvements in life expectancy in line with the 2016 CMI projections, blended to a long-term rate of 1.25%. The mortality assumptions used in the principal US schemes are based on the RP-2014 table adjusted backward to 2006 with MP-2014 and projected forward using MP-2016 as of 31 July 2017. The table selected allows for future mortality improvements and applies an adjustment for job classification (blue collar versus white collar).