Smiths Group plc Annual report and accounts 2005 How we do what we do Total activities Statutory basis 2005 2004 £m £m Sales 3,017 2,733 Operating profit 311 292 Pre-tax 310 300 EPS 39.3p 38.0p Continuing activities Headline performance – excluding amortisation and impairment of goodwill and other intangible assets, and exceptional items. 2005 2004 £m £m Sales 3,017 2,678 +13% Headline: – operating profit 420 360 +17% – pre-tax 413 350 +18% – EPS 54.3p 45.9p +18% Contents 2 Chairman’s statement 4 Chief Executive’s statement 7 Our strengths 14 Summary performance 15 Operating and financial review 15 Group activities 17 Aerospace 19 Detection 21 Medical 23 Specialty Engineering 25 Other financial matters 27 Legal issues 28 International Financial Reporting Standards 30 Risks and uncertainties 32 Corporate responsibility 38 Board of directors 40 Directors’ report 44 Corporate governance report 48 Directors’ remuneration report 57 Statement of directors’ responsibilities 58 Independent auditors’ report 59 Consolidated profit and loss account 59 Statement of total recognised gains and losses 60 Balance sheet 61 Cash-flow statement 62 Accounting policies 63 Notes to the accounts 84 Five year review ibc Financial calendar Contact details Shareholder information 1 Smiths Group plc Annual report and accounts 2005 Introduction Smiths has had a good year. Sales on continuing activities are up 13%, while, on a headline basis, operating profit has risen by 17% and earnings per share are up 18%. The increase in earnings came from a good performance across all our businesses. Keith Butler-Wheelhouse Chief Executive This Annual Report describes the fundamental strengths that made this possible. 2 Smiths Group plc Annual report and accounts 2005 Chairman’s statement Chairman’s statement The past year has seen good progress in Smiths with both sales and headline earnings ahead of the previous year. This growth has come from across our business indicating the underlying strength of the Company. I am also encouraged by the breadth of the progress I see throughout Smiths. Not only are our markets growing, but also new product development and other initiatives are enhancing the Company’s position. At the same time, our acquisitions have strengthened the Donald Brydon Company, making an immediate financial contribution, as Chairman well as broadening and deepening our technology base. It is the excellence of the Smiths management that has made this progress possible. During my first year as Chairman I have visited many of the Group’s operations both in the United Kingdom and overseas. I have been struck by the dedication and professionalism of our employees. There is a restless atmosphere throughout our operations born of a belief that improvement in all that we do is always possible. I have found Headline earnings per share pence that focus on improved production techniques, technology developments, innovative customer-oriented solutions and a passion for efficiency is common throughout all Smiths +18% businesses. 2005 54.3 2004 45.9 Elsewhere in this report the Chief Executive sets out the principal strengths that apply across our business. These strengths are helping us focus on markets and technologies to deliver growth, both in sales and profit. Since I became Chairman in Dividend pence September 2004, I have asked the Board to concentrate on two issues: creating shareholder value from our existing activities +7.4% and ensuring that we have the right businesses to continue to 2005 29 build shareholder value. These themes have underscored the 2004 27 work of the Board over the past 12 months, and will continue to do so looking forward. Smiths has a tradition of successful and timely disposals and Statutory earnings per share of using capital wisely in its acquisition strategy. I have been impressed by the disciplines applied to both and, of course, 2005 2004 they will continue to underpin both activities going forward. 39.3p 38.0p +3.4% 3 Smiths Group plc Annual report and accounts 2005 Chairman’s statement continued As to the Board itself, there have been several changes since The Board has also been pleased with the progress made in last year’s report. Keith Orrell-Jones retired last September respect of environment, health and safety (EHS) issues. We are after an important period as Smiths Group Chairman. He made continuing to reduce the environmental impact of operations a considerable contribution to Smiths and during his period by successfully meeting new targets. At the same time, the as Chairman he made many friends. We all wish him well. number of work-related accidents is also falling. A full EHS report is issued annually offering a comprehensive review of Sir Colin Chandler, formerly Deputy Chairman, stepped down at this important aspect of our corporate footprint. the Annual General Meeting. His wisdom and counsel will be missed. On the executive side, Einar Lindh and Lawrence Kinet With effect from 1 August 2005, Smiths will prepare its accounts both retired. I thank them for all their various contributions to using International Financial Reporting Standards (IFRS). the Company’s development. I am pleased to say that Einar’s Further details on this topic are outlined on pages 28 to 30. 27 years of experience at Smiths is not yet lost to us: he has Returning to performance in the past year, the consolidated agreed to act as head of our medical business until the current results show an increase in sales from continuing activities search process is concluded. of 13% and of headline earnings per share of 18%. As a result Looking forward, Alan Thomson will retire next year, and we of this good performance, the Board is recommending that the have announced that John Langston will be our next Finance dividend for the full year be increased by 7% to 29p. This means Director. Alan will be a hard act to follow, and we are fortunate the final dividend is raised to 19.75p. to have already on the Board such a well-qualified successor. It is a privilege to chair any major British company. To lead Along with other changes, these steps are an integral part of such a dedicated company built on technical excellence and our phased succession programme, for which we have the high-quality employees is an even greater privilege. I would like appropriate plans. to thank everyone who works for Smiths for their commitment, Much has been said and written about the Combined Code on determination and loyalty during the last 12 months. On such Corporate Governance. The Smiths Board currently complies strong foundations there is every reason to be optimistic about with the Code with one exception. The Board has concluded that the future. I should be a member of the Remuneration Committee and Donald Brydon participate in discussions. Should circumstances so dictate, Chairman the Board would have no compunction but to explain the need to deviate further. The relationship between the Chairman and the Chief Executive is central to successful governance and I am delighted to say that there is good rapport between Keith and myself, and our working relationship is proving highly productive. Boards – suitably independently minded – must do what is right in the interest of shareholders and I am in no doubt that your Board has the necessary independence to behave in this manner. 4 Smiths Group plc Annual report and accounts 2005 Chief Executive’s statement Chief Executive’s statement Smiths has had a good year. Sales on continuing activities are up 13%, while, on a headline basis, operating profit has risen by 17% and earnings per share are up 18%. The increase in earnings came from a good performance across all our businesses. This is the result of both growth in the markets we serve, and the success of action taken over the past few years. Our markets are expanding robustly. At the same time, we are Keith Butler-Wheelhouse reaping the rewards of investing for growth over recent years, Chief Executive and keeping the cost base competitive. Our acquisitions also performed well, with current year acquisitions contributing £21m to headline operating profit. In this Annual Report our objective is to explain how our business has developed over the last financial year and to provide a clear description of our activities. In this statement, I explain how we are managing the business for growth, as well as summarising the performance highlights of 2005, and commenting on the Company’s prospects. The Operating Group sales from continuing activities £m and Financial Review, which runs from page 15 to page 37, contains details of Smiths performance by division. +13% How we do what we do 2005 3,017 2004 2,678 We have decided to make the theme of this year’s report ‘How we do what we do’ in order to provide shareholders and other stakeholders with greater insight into our activities and organisational strengths. In the past, we have described Group headline pre-tax profit £m Smiths chiefly through details of our divisions’ activities. I will set these activities in context by explaining the six fundamental +18% strengths that underpin everything we do. Each of these is 2005 413 important, and the order in which I have listed them does not 2004 350 imply any priority: • We place great emphasis on creating opportunities for growth. We have a strong preference for markets with above average Statutory pre-tax profit long-term growth. Medical devices, commercial aerospace, defence electronics and detection are all markets that are 2005 2004 expanding rapidly. We also build advantageous competitive £m £m positions that allow us to achieve significant profitable 310 300 +3% expansion in sectors where overall growth is more modest.