Operator:

Paul Keel: Good morning, everyone, and thanks for joining us. As we typically do, I'll provide a short recap of our first half results and then turn it over to Clare to walk us through the numbers. I'll come back and update you on our progress with respect to strategy and operations, and then we'll open up for your questions. Before we get to results, though, let me say a few words about today's announcement regarding our CEO transition. As you will have seen, I am leaving Smiths to take a new role in the U.S., and our Board has appointed Roland Carter as my successor. The last 3 years have been a period of strong progress for Smiths. We completed a transformative portfolio action in FY '22, we delivered record performance in FY '23 and we've now posted 11 consecutive quarters of growth with, as we'll cover in just a moment, significant momentum for the second half of FY '24 and beyond. Roland is the right leader to build on all this momentum. Clare and I will cover results in Q&A today, but I did want to take this opportunity to introduce and personally congratulate Roland. Roland, over to you.

Roland Carter: Thank you very much. Hello. I'm Roland Carter. I am delighted to have been appointed as CEO of Smiths Group. I'm a chartered engineer, and I have been at Smiths for over 3 decades. In this time, I've had the opportunity and the privilege to lead many parts of this company. This has enabled me to develop an in-depth operational and strategic understanding of Smiths and its fundamental growth drivers. For the past 6 years, I have been President of Smiths Detection. Prior to that, I was President of Smiths Interconnect and Asia Pacific. I've worked for Smiths in the U.K., China, France, Germany and several other places. And I'm responsible for some of the acquisitions that form part of Smiths and also for some of the divestments that have reshaped us. Smiths is a fantastic business with great people and a wonderful culture. It has a hugely exciting growth potential. I would like to thank Paul for all he has done for Smiths. We are making great strategic progress and our operational and financial performance has improved, with Smiths well-positioned to deliver on its significant potential. Thank you.

Paul Keel: Thank you, Roland. And again, congratulations. Okay. Having covered the CEO transition, let's now turn to our first half results. I will open with a short recap of our first half performance before turning it over to Clare to walk us through the numbers. I'll then come back and update you on our progress with respect to strategy and operations. And as always, we'll have plenty of time at the end for Q&A. We delivered 3.9% organic revenue growth in the first half, building on a record year in FY '23. We've now posted our 11th consecutive quarter of growth, extending our track record of consistent performance, driven by strong underlying demand in energy, security and aerospace our orders grew 16.5% in H1, providing good momentum for the second half and beyond. Our execution focus and Smiths Excellence System are delivering further tangible benefits. Organic operating profit increased over 5%, resulting in a 20 basis point increase in operating margin and a 50 basis point improvement in ROCE. Our balance sheet remains strong, and cash flow is much improved. Operating cash conversion increased 26 percentage points to 89% and free cash flow more than doubled. As such, we increased our dividend by 5% and have announced a new £100 million share buyback program. With respect to people, we continue to actively develop our global talent. For example, we more than doubled our investment in leadership development and our wave 1 cohort of Black Belts and Master Black Belt are now completing their assignments and reentering into high-impact leadership roles across our company, backfilled by an even larger cohort of Wave 2 talent. We're also continuing to make good progress on advancing our sustainability strategy as the Science Based Targets initiative, SBTi, validated our net zero targets and plans last December. In support of our communities, I mentioned the launch of our new Smiths Foundation on our FY '23 call in September. I'm now excited to share that we are making our first wave of grants in support of charitable causes that linked to our purpose of improving our world through smarter engineering. In summary, we're off to a successful start in fiscal 2024 and carry strong momentum into the second half. And as such, we are reaffirming our full year guidance of 4% to 6% organic revenue growth with continued margin expansion. You are familiar with our Smiths Value Engine, which connects the 3 components of our success

Clare Scherrer: Thank you, Paul. As previously mentioned, organic revenue growth for the half was 3.9%. Acquisitions added 2.2% and there was a negative 5.4% FX impact bringing reported growth to 0.7%. We grew our operating profit to £246 million, up 5.3% organically. And we improved margin by 20 basis points while at the same time, investing for growth. This operating profit growth, combined with the net impact of the previous share buyback program and FX contributed to EPS growth of 4.5%. We increased cash conversion by 26 percentage points to 89%, with improvements in working capital. ROCE was up 50 basis points to 15.7%, reflecting increased profitability. In line with our progressive dividend policy, we're announcing a 5% interim dividend increase. And I'm also pleased to announce a new share buyback program of £100 million. We launched the initial tranche of up to £50 million to be completed by the end of September. We continue to extend our track record of delivering growth. Now having grown revenue on an organic basis for 11 consecutive quarters, with growth in the first half against strong comparators last year. Notably, 8 of those quarters were in or above our medium-term target range. H1 performance reflected growth in our 2 largest divisions

Paul Keel: Thank you, Clare. I will now give an update on some of our strategic and operational progress, beginning with growth. Building on what Clare said earlier, underlying demand remained strong in 3 of our largest end markets

Paul Keel: Thank you, Allyssa and Team. Another 50 or so projects like this are currently underway across the company, and we're on track for £20 million in SES contribution for the full year. Consistent with this, our Smiths Excellence Awards, which we celebrated last fall, recognized distinctive contributions in support of the highest priorities you see here. They are organized around our strategies for growth, execution and people. The excellence awards are one of a broad array of initiatives that continually reinforce and advance our high-performing and inclusive culture. You've seen a marked uptick in Smiths performance over the past 3 years. The many actions we've taken across this time, for example, strengthening our leadership team, revitalizing our new product engine, improving our portfolio and embedding SES and the Smiths leadership behaviors are all interconnected building blocks of a much broader, stronger and more stable foundation for Smiths. It is our culture of continuous improvement that underpins our sustained performance. And it is this foundation that will provide continued success as we move forward. I'll close my comments on H1 with a quick update on people and culture before wrapping things up with a look forward to H2. With an eye to supporting all stakeholders, we launched the Smiths Group Foundation last summer. Across the first half of this fiscal, employees from around the world nominated close to 100 different causes for funding consideration. And after a rigorous selection process, the first wave of grants are now being made. We've asked Hannah Constantine, Group Director of Legal Operations and Chair of the Smiths Group Foundation to say a few words about how we're advancing our purpose and supporting stakeholder success.

Paul Keel: Thank you, Hannah. Exciting to think about the positive impact that these grants will support. Now just a few comments by way of summary, and then we'll open it up for your questions. double-digit order growth in H1, coupled with gradually improving market conditions has us well on track to deliver our full year organic growth guidance of 4% to 6%. The operating leverage that comes with us alongside additional benefits from SES and other productivity initiatives has us reaffirming our guidance of continued margin expansion. And on the back of our strong balance sheet and much improved cash flow, we're announcing a 5% dividend increase and a new £100 million share buyback. In short, a good start in H1 and with even more to come in H2. Our wonderful people make all this progress possible. And I want to recognize my colleagues around the world for doing what we do best, improving our world through smarter engineering. In the same way, we're grateful for the strong support that we enjoy from customers and shareholders. And with that, I'll ask the operator to please open it up for Q&A. Thank you.

Operator: [Operator Instructions]. We will now take the first question, it comes from the line of Lushanthan Mahendrarajah from JPMorgan.

Lushanthan Mahendrarajah: I've got two, I think. The first is just on margins. And I guess, going back to that operating bridge you showed in terms of both the 80 basis point headwind, I think from Interconnect volumes and then the 30 basis points from Detection and sort of field service engineers. I guess how do we think about both those moving parts going forward, presumably, interconnect that reversed in the second half, perhaps not fully. And in Detection, I guess, how much do you have to go in terms of the field service engineers. Is that going to be an incremental headwind going forward as well? Or have you sort of done that?

Paul Keel: Thanks for the question. Let's see, with respect to margins, you asked about interconnect and detection. Let me take the 2 in sequence. For Interconnect, yes, your hypothesis is correct as that business gradually returns to growth here in the second half. Margins will gradually return as well. You'll remember that was an 18% margin business in FY '22. And as it gets back to the same sort of volume levels, that same ballpark is about right for what you should expect. With respect to Detection, we're clearly prioritizing growth over margin in that business right now, and that's for 2 reasons. First, we're as interested in operating profit growth as we are in operating margin for Detection. It had double-digit operating profit growth, both in '23 and in the first half. Just that the top line is growing so quickly that the margin percentage probably isn't as pronounced as you would typically think with that much top line growth. The second important thing is the market share piece for detection. The world is going through an upgrade of all checkpoint systems from 2D to 3D scanners. Those machines will be in service for 10 years and the gross margin on the service is better than 2x what it is on the OE. So we're pleased with our market share performance there. As I mentioned in my earlier comments, the world is maybe 40% through the total upgrade, and we've won better than half of all tenders. So the NPV of those awards will generate a lot of value moving forward.

Lushanthan Mahendrarajah: Okay. Helpful. And the second one is just on sort of the orders, which are very strong in the first half and for some of these divisions a bit more obvious than the others, but it would be helpful just to get a reminder in terms of the sort of timing of orders and sort of for each division in terms of when that sort of leads to sales and also particularly for Interconnect and Flex-Tek, what percentage of revenue is -- do you have visibility on orders? I guess I'm just trying to get an idea of H2 and the underpinning there that order growth you've seen in H1.

Paul Keel: Yes. Let's see, a couple of questions in there. Let me see if I can remember them. The first is orders were up 17% in the first half, and we expect roughly half of that to convert to revenue in fiscal '24. A little bit different business by business. The largest percent of order book conversion or the shortest cycle time is in John Crane. Almost all of their double-digit order growth will convert here in fiscal '24. Probably the lowest number would be detection. Those are typically multiyear contracts. In particular, the 2 large defense contracts, those are 8- to 10-year contracts. So maybe 1/3 of Detection's record order book will convert in this fiscal and then it's about half for Flex-Tek and for Interconnect. Let's see, you asked how much of Flex and Interconnect is covered by orders roughly 1/3 of Flex-Tek is order-driven and roughly 2/3 of Interconnect.

Operator: We will now take the next question coming from Mark Davies Jones from Stifel.

Mark Jones: Can I ask a bigger picture one to start. Paul, as you're first to part. Firstly -- sorry, to see you go, but can you tell us any more hints about where you're heading to? And can you give us a little reflection on where you think Smiths is relative to that U.S. industrial peer group operationally. I know you did some benchmarking when you turned up, where are we now, do you think? Because obviously, there is still quite a big valuation to get.

Paul Keel: Yes, thanks for the question, Mark. So as I mentioned in my introductory comments, I'm going back to the U.S. to lead a U.S.-listed company and doing so principally for personal reasons. I come from a big and close-knit family and our kids, our siblings, our parents are all in the States, and this is just a great opportunity to be closer to them. With respect to U.S. versus U.K. industrials, I took this job, and you and I talked a lot about that when I did because I saw an opportunity for a fundamentally good company to perform at a higher level. In line with Smiths vast potential. And as I reflect back on the last 3 years, that proved to be even more true than I imagined at the time. And my second reflection would build on that for all Smiths has accomplished over the last 3 years. I haven't a shred of doubt that our brightest days are still ahead. I don't see any meaningful performance difference between the high-performing U.K. industrials and our peers in the U.S. I think you're accurate, though that there is a valuation different in aggregate, but there isn't in specific, the highest valued U.K. engineering companies trade at multiples as good or better than what they would trade in the U.S.

Mark Jones: Can I ask one slightly more specific one around Flex-Tek, very impressive margins there in the period. You talked about mix within industrial. What's driving that?

Paul Keel: Our industrial business is 80% of total Flex-Tek. Of the 80%, 2/3 of that or 60% is HVAC and 20% or 1/3 of it is other industrial and a big part of that is our process electrification business. So the mix comment we made there would be specific to process electrification. In particular, we talk about the H2 green steel project, that very high margin. The last 20% then of Flex-Tek is aerospace and of course, that is margin accretive as well.

Operator: We will now take the next question coming from the line of Christian Hinderaker from Goldman Sachs.

Christian Hinderaker: Can I just ask firstly on the interconnect business in terms of the mix, 19% semi-test 26% other industrial, 40% safety security and the rest aerospace. I think the semi-test and Sat-Com dynamics made a bit better understood. Can you just remind us of the technology applications and growth dynamics for the other parts? And then also maybe add some color on which of those areas drove that sharp inflection in orders in the second quarter.

Paul Keel: Yes, you set the table well roughly half of all Interconnect is connectors. I'll come back to that. Maybe 1/4 is Sat-Com and then 1/4 is semi-test. You're also right that the dynamics are well understood. Sat-Com market strong, double-digit growth and no signs of softening. I spoke about semi-test earlier. Gradually recovering, we expect it to return to growth in the second half. Now for the connectors part, there's a couple of different pieces to that. We have a industrial connectors business, a typical application would be rail. Our connectors are good in high vibration environments. So the connectors between 2 railcars is a typical example. That market is still in recovery kind of up and down. We have a medical connector business that we gave an example of the SES project for. That's going well because of these big contracts that we're winning. And then we have a small defense electronics piece of that as well, connectors that go into those applications. And as you would expect, that market is growing, but they're typically forward-dated contacts.

Christian Hinderaker: Well, I've got two now on the capital allocation. I guess, the buyback, £100 million and how we think about that in the context of the £70 million proceeds from the IC state sale. Should we assume that 1 sort of spurred the other? And how do we think about the remaining equity stake in ICU?

Paul Keel: Clare, do you want to take that?

Clare Scherrer: Yes. So thanks, Christian. The decision to initiate a new buyback program reflects our improved cash conversion and also our commitment to return excess capital to shareholders. So we took that decision looking holistically at our anticipated sources and uses of cash. So we took into account, firstly, our first priority for capital allocation, which is organic investment. We looked at our anticipated acquisition [audio gap].

Christian Hinderaker: And maybe just if you could add to that, what are the sort of views here in terms of comfort levels on leverage, I think, 0.9x net debt to EBITDA today. And then in terms of the M&A piece, are there particular priorities across the portfolio that we should be thinking of?

Clare Scherrer: At 0.9x net debt-to-EBITDA, we're sitting very comfortably. We feel that, that is a balance sheet that allows us to pursue all of the organic and inorganic opportunities that we have in our site. It's a very comfortable place for us to be. In terms of our M&A pipeline, I would describe that as active and growing. And you have seen the successful acquisitions we've made recently since the start of FY '23, we deployed £90 million for acquisitions, the largest of which was HCP and Flex Tech which is performing ahead of plan, and we're really happy with that integration. We would love to do more acquisitions like that.

Operator: We will now take the next question from the line of Jonathan Hurn from Barclays.

Jonathan Hurn: Just three questions from me. Firstly, I just wondered if we can just come back to the margin rich for '24, but sort of take it up to a group level. Maybe clear, could you just give us a little bit of color about how we should think on a full year basis, the impacts from mix some investment on growth? And also, what kind of tailwinds on a full year basis we could see from price cost in SES, please.

Clare Scherrer: Yes. So when you think about the full year, we reiterate our guidance for continued margin expansion. We will continue to save where we can in order to spend where we want. And that is what you see when you look at the group level margin bridge. We will continue to achieve more in price than in input inflation. We intend to continue to deliver SES benefits. We have almost 50 Black Belt projects in flight. You saw 1 of those described here today that will continue to deliver benefit. We also have the full year benefit of the savings programs that we put in place last year. And then on the other side, we will, of course, have the benefit of the order books coming through in Crane and Detection and gradual recovery in Flex-Tek and Interconnect, which will improve volume and operating leverage. And as Paul mentioned, though, we're going to continue to lean into growth. And that's where you saw the investment in field service engineers for Detection. You also saw the investment, primarily in John Crane, in commercial aftermarket support and systems and marketing because we have momentum, and we want to continue to build that momentum.

Jonathan Hurn: Okay. But just on a sort of a basis point impact, is it going to be any significant difference full year relative to what we saw in the half year bridge?

Clare Scherrer: It will not be significantly different.

Jonathan Hurn: Okay. That's very clear. The second question was just on, obviously, the defense contracts that you won. I think you sort of alluded to them being mix beneficial. Can you just talk a little bit about the margins of those defense contracts, please?

Paul Keel: Go ahead.

Clare Scherrer: I was going to say, we certainly don't talk about margin by contract, but that segment, the Defense segment within Detection is margin accretive.

Jonathan Hurn: Okay. And is that significantly above where the current margin for Detection is in terms of relative to those defense contracts?

Paul Keel: Yes. Jonathan, these are chemical detector contracts to develop the next generation of lightweight mobile chemical detector to be used in defense and civil applications. Again, 1 is with the U.S. DoD, 1 is with the U.K. MoD. So the first piece of it is development revenue that tends to be high margin, and then it turns into production units. Those units are also accretive -- margin accretive to Detection.

Jonathan Hurn: Okay. That's clear. And just finally, just maybe on John Crane. Obviously, you talked about the order book and most of that being delivered, not all of that being delivered in the second half. If we look to John Crane to next year, FY '25, I mean, obviously, you're coming up against tougher comps. How do we think about that sort of growth of that business? Do you think it starts to slow down to sort of mid-single digits growth? Or do you think next year could be another year of high to maybe double-digit growth for John Crane?

Paul Keel: I'd say two things. First is, we don't see any evidence in the market data that we get in our order book or in our customer behavior of near-term slowing in that market. Both the traditional energy side and certainly the new energy side are buoyant right now. With respect to the second half, as I mentioned, half of our order book -- of our total order book for Smiths will convert in FY '24, but almost all of the John Crane order book. So we have good visibility to the second half. Rolling into FY '25, it's a little early to provide guidance on that. We expect the market to remain strong. we expect John Crane to be accretive to group growth. So if the group is going to be at 4% to 6%, we expect John Crane to be at the north end of that or a little bit higher.

Operator: [Operator Instructions] We will now take the next question coming from the end of Andrew Douglas from Jefferies.

Andrew Douglas: Three questions from me, please. Can you talk about the kind of broader investments in the group? You got 30 basis points and then 120 basis points headwinds this year. We got Flex-Tek recovering clearly. We've got John Crane staying strong. Is this business under invested. What's the rationale behind putting a 150 basis points of cost into business or is it -- last year? On cash flow, can you just talk about the building blocks going towards 100%, you double free cash flow is a good improvement in the first half against the low base. But can you just talk about how we get to that 100%? And then second -- and lastly, sorry, on the M&A buyback debate, buy back is a little less than 2% of your market cap. You've probably got over £1 billion of firepower, yet you appear Clare to talk about kind of more bolt-ons in terms of future M&A. Is that right? Or is there any kind of maybe on transformational, but kind of large-scale M&A that could be happening. Otherwise, I don't quite understand the £100 million.

Paul Keel: All right, Andy. Let me take the first one, group growth. Clare to handle cash flow. And then I guess you called it a debate between M&A and buyback. I'm not sure there's a debate. I think our allocation strategy is clear, but I'll let Clare answer that one. Investments in growth, the answer to your question is embedded in the question itself. Market demand is so strong in 70% of the company right now. John Crane and in Detection and in the aerospace part of Flex-Tek that I think would be silly not to be investing in that growth. I mean all of these businesses have a combination of an original equipment in a higher-margin aftermarket component to it and capturing share now from an NPV perspective is the easiest math you'll run. So taking advantage of that opportunity to us seems like a value accretive decision. That's why we're doing it.

Andrew Douglas: Does that continue into '25, Paul, sorry?

Paul Keel: Will that continue into '25?

Andrew Douglas: Yes.

Paul Keel: If the market dynamics continue to give opportunity, we will continue to prioritize growth. And along with that comes not just top line growth, Andy, but the operating profit growth. Over the last 3 years, the company has a compounded annual growth rate of operating profit of 14% alongside the 7% CAGR on organic growth. So we're getting strong top line growth and converting it to even stronger profit growth. We're very pleased with that dynamic.

Clare Scherrer: And then, Andy, in terms of your other questions, as we look to the second half, we do have the opportunity to continue to improve working capital. We also specifically have the opportunity to improve inventory and our inventory turns. So that's why I said that we do believe as we go to the second half, we will continue to improve upon the 89% operating cash conversion. From an M&A perspective, primarily what we look at are what you would describe as bolt-ons, consistent with what we've done in the past, most recently, HCP and Plastronics. Of course, we look at opportunities for all of the divisions across all geographies. We're always looking to see if there are new technologies that enhance our core or strengthen us in adjacencies. We do, of course, look at larger for opportunities when they come along, but our primary focus continues to be on bolt-on opportunities. And then finally, in terms of your question around the balance sheet. Prior to the sale of medical, we ran the balance sheet at around 1.5x leverage. We're now at 0.9x. So we have ample headroom if we were to find an interesting and larger acquisition. But right now, I think it's a very comfortable place for us to be. I think it allows us to execute on what we've consistently communicated as the priority ranking

Operator: There are no further questions on the phone at this time. I would like to hand back over to Paul for closing remarks.

Paul Keel: Okay. Well, thanks, everyone, for tuning in today. As we mentioned, we're with the start to FY '24, good top line growth, again, converting to even higher EPS growth on a constant currency basis. And the very strong order growth in the first half leaves us confident of continued margin expansion and acceleration in the second half, causing us to reaffirm guidance of 4% to 6% for the year. So with that, well, thank you for your kind attention, and I will leave it at that.

Earnings Transcript for SMIN.L - Q2 Fiscal Year 2024

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