Final Results

RNS Number : 5010R

Smiths Group PLC

22 September 2017

News release
Smiths 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

	Headline*				Statutory
	2017 £m	2016 £m	Reported growth	Underlying^# growth	2017 £m	2016 £m
Revenue	3,280	2,949	11%	(1)%	3,280	2,949
Operating profit	589	510	16%	3%	674	387
Operating margin	18.0%	17.3%	70bps		20.5%	13.1%
Pre-tax profit	528	451	17%		601	346
Free cash-flow	370	243	52%
Return on capital employed	16.2%	15.3%	90bps
Continuing basic EPS	97.6p	85.2p	15%		144.1p	65.6p
Dividend	43.25p	42.00p	3%

*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."

Statutory reporting

Statutory reporting takes account of all items excluded from headline performance. On a statutory basis, pre-tax profit from continuing operations was £601m (2016: £346m) and continuing basic earnings per share were 144.1p (2016: 65.6p).

See Accounting policies for an explanation of the presentation of results and note 3 to the accounts for an analysis of non-headline items.

Contact details

Investor enquiries

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

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

Media enquiries

Andrew Lorenz, FTI Consulting
+44 (0)20 3727 1323

+44 (0)77 7564 1807

smiths@fticonsulting.com

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

Presentation

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).

Photography

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.

Group results overview

	Headline revenue		Headline operating profit margin		Headline return on capital employed
	Underlying growth¹	Reported growth	2017	2016	2017	2016
John Crane	(4)%	7%	23.0%	21.9%	22.9%	20.3%
Smiths Medical	(3)%	9%	22.0%	21.4%	16.7%	15.7%
Smiths Detection	4%	31%	15.0%	13.0%	12.6%	11.9%
Smiths Interconnect	1%	(3)%	13.4%	13.1%	11.4%	10.3%
Flex-Tek	3%	19%	19.3%	18.0%	35.8%	31.6%
Group	(1)%	11%	18.0%	17.3%	16.2%	15.3%

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.

Outperforming our chosen markets

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.

Achieving world-class competitiveness

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.

Strong Financial Framework

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

Business review

John Crane

John Crane is a leading provider of mission-critical engineered solutions for global energy and process industries. John Crane's revenue is currently comprised of 64% aftermarket sales. c.55% of revenue is derived from the energy sector (downstream and midstream oil & gas, power generation) with c.45% coming from other process industries, including chemical, power generation, water and wastewater, and pulp and paper. John Crane represents 27% of Group revenue.

	2017 £m	2016 £m	Reported growth	Underlying¹ growth
Revenue	885	830	7%	(4)%
Headline operating profit	204	181	12%	(4)%
Headline operating margin	23.0%	21.9%	110bps
Statutory operating profit	190	151	26%
Return on capital employed	22.9%	20.3%	260bps

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.

Smiths Medical

Smiths Medical supplies high-quality, cost effective medical devices and consumables that are vital to patient care globally. Our portfolio incorporates established brands and strong positions in select segments of the Infusion Systems, Vascular Access, and Vital Care markets. 82% of Smiths Medical's sales are from consumable and disposable products. Smiths Medical represents 29% of Group revenue.

	2017 £m	2016 £m	Reported growth	Underlying¹ growth
Revenue	951	874	9%	(3)%
Headline operating profit	209	187	12%	8%
Headline operating margin	22.0%	21.4%	60bps
Statutory operating profit	286	166	72%
Return on capital employed	16.7%	15.7%	100bps

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.

Smiths Detection

Smiths Detection is a leader in detection and identification of security threats and contraband. It produces equipment for customers in the air transportation, ports and borders, military and urban security end-use markets. 39% of Smiths Detection's sales are from the aftermarket. Smiths Detection represents 21% of Group revenue.

	2017 £m	2016 £m	Reported growth	Underlying¹ growth
Revenue	687	526	31%	4%
Headline operating profit	103	69	50%	21%
Headline operating margin	15.0%	13.0%	200bps
Statutory operating profit	70	63	12%
Return on capital employed	12.6%	11.9%	70bps

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.

Smiths Interconnect

Smiths Interconnect designs solutions for high-speed, secure connectivity in reliability applications in the defence, aerospace, space, rail, medical and semiconductor test markets. Smiths Interconnect represents 13% of Group revenue.

	2017 £m	2016 £m	Reported growth	Underlying¹ growth
Revenue	419	435	(3)%	1%
Headline operating profit	56	57	(1)%	5%
Headline operating margin	13.4%	13.1%	30bps
Statutory operating profit	124	26	372%
Return on capital employed	11.4%	10.3%	110bps

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.

Flex-Tek

Flex-Tek provides engineered components that heat and move fluids and gases for the aerospace, medical, industrial, construction and domestic appliance markets. Flex-Tek represents 10% of Group revenue.

	2017 £m	2016 £m	Reported growth	Underlying¹ growth
Revenue	338	284	19%	3%
Headline operating profit	65	51	28%	11%
Headline operating margin	19.3%	18.0%	130bps
Statutory operating profit	68	37	85%
Return on capital employed	35.8%	31.6%	420bps

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.

Financial review

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:

	31-Jul-17	31-Jul-16
Funded plans
UK plans - funding status	111%	109%
US plans - funding status	91%	69%
Other plans - funding status	81%	88%
Total - funding status	109%	105%

	31-Jul-17	31-Jul-16
Surplus / (deficit)
Funded plans	354	217
Unfunded plans	(130)	(137)
Total surplus / (deficit)	224	80

Retirement benefit assets	390	328
Retirement benefit liabilities	(166)	(248)
	224	80

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

Pension scheme members as at 31 July 2017
	SIPS	TIGPS	US plans	Total
Deferred active	276	161	2,090	2,527
Deferred	9,880	11,496	2,922	24,298
Pensioners	13,023	15,761	384	29,168
Total	23,179	27,418	5,396	55,993

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.

	31 July 2017	31 July 2016
Average rates:
US dollar	1.27	1.46	Dollar strengthened 13%
Euro	1.16	1.32	Euro strengthened 12%
Year-end rates:
US dollar	1.32	1.32	No change
Euro	1.12	1.19	Euro strengthened 6%

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.

_______________________________________________________

Consolidated income statement

		Year ended 31 July 2017			Year ended 31 July 2016
	Notes	Headline £m	Non-headline (note 3) £m	Total £m	Headline £m	Non-headline (note 3) £m	Total £m
Continuing operations
Revenue	1	3,280		3,280	2,949		2,949
Cost of sales		(1,755)		(1,755)	(1,600)		(1,600)
Gross profit		1,525		1,525	1,349		1,349
Sales and distribution costs		(449)		(449)	(403)		(403)
Administrative expenses		(487)	(90)	(577)	(436)	(139)	(575)
Other operating income						16	16
Profit on business disposal	28		175	175
Operating profit	2	589	85	674	510	(123)	387
Interest receivable		5		5	3		3
Interest payable		(66)		(66)	(62)		(62)
Other financing (losses)/gains			(14)	(14)		15	15
Other finance income - retirement benefits	8		2	2		3	3
Finance costs	4	(61)	(12)	(73)	(59)	18	(41)
Continuing operations - Profit before taxation		528	73	601	451	(105)	346
Taxation	6	(140)	111	(29)	(113)	28	(85)
Continuing operations - Profit for the year		388	184	572	338	(77)	261
Discontinued operations
(Loss)/profit - discontinued operations	27		(8)	(8)
Profit for the year		388	176	564	338	(77)	261
Profit for the year attributable to
Smiths Group shareholders - continuing operations		386	184	570	336	(77)	259
Smiths Group shareholders - discontinued operations			(8)	(8)
Non-controlling interests in respect of continuing operations		2		2	2		2
		388	176	564	338	(77)	261
Earnings per share	5
Basic				142.1p			65.6p
Basic - continuing				144.1p			65.6p
Diluted				140.3p			64.9p
Diluted - continuing				142.3p			64.9p

Consolidated statement of comprehensive income

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Profit for the period		564	261
Other comprehensive income
Actuarial gains/(losses) on retirement benefits	8	55	(40)
Taxation recognised on actuarial movements	6	(13)	10
Other comprehensive income and expenditure which will not be reclassified to the consolidated income statement		42	(30)

Other comprehensive income which will be reclassified and reclassifications
Exchange gains		25	420
Cumulative exchange gains recycled on business disposals		(41)
Fair value gains/(losses) and reclassification adjustments
- deferred on available for sale financial assets		1	(2)
- reclassified to income statement on available for sale financial assets	4		(19)
- deferred in the period on cash-flow and net investment hedges		(14)	(238)
- reclassified to income statement on cash-flow and net investment hedges		25
Taxation recognised on fair value gains	6	(1)
Total other comprehensive income		37	131
Total comprehensive income		601	392
Attributable to
Smiths Group shareholders		600	386
Non-controlling interests		1	6
		601	392

Consolidated balance sheet

	Notes	31 July 2017 £m	31 July 2016 £m
Non-current assets
Intangible assets	10	2,015	1,742
Property, plant and equipment	12	315	315
Financial assets - other investments	16	21	9
Retirement benefit assets	8	390	328
Deferred tax assets	6	272	246
Trade and other receivables	14	57	51
Financial derivatives	19	56	29
		3,126	2,720
Current assets
Inventories	13	452	478
Current tax receivable	6	62	62
Trade and other receivables	14	722	745
Cash and cash equivalents	17	782	431
Financial derivatives	19	13	13
		2,031	1,729
Assets of business held for sale	27		24
Total assets		5,157	4,473
Non-current liabilities
Financial liabilities
- borrowings	17	(1,598)	(1,139)
- financial derivatives	19	(2)	(1)
Provisions for liabilities and charges	22	(283)	(305)
Retirement benefit obligations	8	(166)	(248)
Deferred tax liabilities	6	(111)	(95)
Trade and other payables	15	(26)	(29)
		(2,186)	(1,817)
Current liabilities
Financial liabilities
- borrowings	17	(151)	(270)
- financial derivatives	19	(10)	(19)
Provisions for liabilities and charges	22	(85)	(94)
Trade and other payables	15	(576)	(536)
Current tax payable	6	(45)	(72)
		(867)	(991)
Liabilities of business held for sale	27		(5)
Total liabilities		(3,053)	(2,813)
Net assets		2,104	1,660
Shareholders' equity
Share capital	23	148	148
Share premium account		355	352
Capital redemption reserve		6	6
Revaluation reserve		1	1
Merger reserve		235	235
Retained earnings		1,634	1,205
Hedge reserve	25	(290)	(301)
Total shareholders' equity		2,089	1,646
Non-controlling interest equity		15	14
Total equity		2,104	1,660

Consolidated statement of changes in equity

	Notes	Share capital and share premium £m	Other reserves £m	Retained earnings £m	Hedge reserve £m	Equity shareholders' funds £m	Non-controlling Interest £m	Total equity £m
At 31 July 2016		500	242	1,205	(301)	1,646	14	1,660
Profit for the period				562		562	2	564
Other comprehensive income
Actuarial gains on retirement benefits and related tax				42		42		42
Exchange losses				(15)		(15)	(1)	(16)
Fair value gains/(losses) and related tax					11	11		11
Total comprehensive income for the period				589	11	600	1	601
Transactions relating to ownership interests
Exercises of share options	23	3				3		3
Taxation recognised on share options	6			3		3		3
Purchase of own shares	25			(10)		(10)		(10)
Dividends
- equity shareholders	24			(167)		(167)		(167)
Share-based payment	9			14		14		14
At 31 July 2017		503	242	1,634	(290)	2,089	15	2,104

	Notes	Share capital and share premium £m	Other reserves £m	Retained earnings £m	Hedge reserve £m	Equity shareholders' funds £m	Non-controlling Interest £m	Total equity £m
At 31 July 2015		497	242	743	(63)	1,419	9	1,428
Profit for the year				259		259	2	261
Other comprehensive income
Actuarial losses on retirement benefits and related tax				(30)		(30)		(30)
Exchange gains				416		416	4	420
Fair value losses				(21)	(238)	(259)		(259)
Total comprehensive income for the year				624	(238)	386	6	392
Transactions relating to ownership interests
Exercises of share options	23	3				3		3
Purchase of own shares	25			(8)		(8)		(8)
Dividends
- equity shareholders	24			(163)		(163)		(163)
- non-controlling interest							(1)	(1)
Share-based payment	9			9		9		9
At 31 July 2016		500	242	1,205	(301)	1,646	14	1,660

Consolidated cash-flow statement

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Net cash inflow from operating activities	29	479	358
Cash-flows from investing activities
Expenditure on capitalised development		(37)	(23)
Expenditure on other intangible assets	10	(8)	(11)
Purchases of property, plant and equipment	12	(62)	(74)
Disposals of property, plant and equipment		9	1
Investment in financial assets	16, 27	(18)	(9)
Acquisition of businesses	26	(580)	(8)
Disposals of businesses - continuing operations	28	399
Disposals of businesses - discontinued operations	27	63
Net cash-flow used in investing activities		(234)	(124)

Cash-flows from financing activities
Proceeds from exercise of share options	23	3	3
Purchase of own shares	25	(10)	(8)
Dividends paid to equity shareholders	24	(167)	(163)
Cash inflow/(outflow) from matured derivative financial instruments			(14)
Increase in new borrowings	17	546	1
Reduction and repayment of borrowings	17	(256)	(151)
Net cash-flow used in financing activities		116	(332)

Net increase/(decrease) in cash and cash equivalents		361	(98)
Cash and cash equivalents at beginning of year		430	495
Exchange differences		(10)	33
Cash and cash equivalents at end of year	17	781	430
Cash and cash equivalents at end of year comprise
- cash at bank and in hand		226	161
- short-term deposits		556	270
- bank overdrafts		(1)	(1)
		781	430

Included in cash and cash equivalents per the balance sheet		782	431
Included in overdrafts per the balance sheet		(1)	(1)
		781	430

Reconciliation of net cash-flow to movement in net debt

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Net debt at start of year	17	(978)	(818)
Net increase/(decrease) in cash and cash equivalents		361	(98)
Increase in borrowings		(546)	(1)
Reduction and repayment of borrowings		256	151
Movement in net debt resulting from cash-flows		71	52
Capitalisation, interest accruals and unwind of capitalisation fees		(4)	(2)
Movement from fair value hedging		5	(23)
Exchange differences		(61)	(187)
Movement in net debt in the year		11	(160)
Net debt at end of year	17	(967)	(978)

Accounting policies

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:

Patents, licences and trademarks	up to 20 years
Technology	up to 13 years
Customer relationships	up to 11 years

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:

Software	up to 7 years
Patents and intellectual property	shorter of the economic life and the period the right is legally enforceable

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).

Notes to the accounts

1 Segment information

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

		Year ended 31 July 2017
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate costs £m	Total £m
Revenue	885	951	687	419	338		3,280
Divisional headline operating profit	204	209	103	56	65		637
Corporate headline operating costs						(48)	(48)
Headline operating profit/(loss)	204	209	103	56	65	(48)	589
Items excluded from headline measures (note 3)	(17)	(23)	(33)	(4)	3	(16)	(90)
Profit on disposal of businesses	3	100		72			175
Operating profit/(loss)	190	286	70	124	68	(64)	674

		Year ended 31 July 2016
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate costs £m	Total £m
Revenue	830	874	526	435	284		2,949
Divisional headline operating profit	181	187	69	57	51		545
Corporate headline operating costs						(35)	(35)
Headline operating profit/(loss)	181	187	69	57	51	(35)	510
Items excluded from headline measures (note 3)	(30)	(21)	(6)	(31)	(14)	(21)	(123)
Operating profit/(loss)	151	166	63	26	37	(56)	387

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

	Year ended 31 July 2017
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Reconciling items £m	Total £m
Depreciation	15	21	8	8	4	1	57
Amortisation of capitalised development		14	13				27
Amortisation of software, patents and intellectual property	2	5	4	2		5	18
Amortisation of acquired intangibles						17	17
Share-based payment	3	2	1	1	1	7	15

	Year ended 31 July 2016
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Reconciling items £m	Total £m
Depreciation	15	20	6	8	3	1	53
Amortisation of capitalised development		14	12				26
Amortisation of software, patents and intellectual property	2	4	3	2		6	17
Amortisation of acquired intangibles						15	15
Impairment of goodwill						23	23
Impairment of trade investments						2	2
Impairment of property, plant and equipment						6	6
Share-based payment	1	2	1	1	1	4	10

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

Segment assets and liabilities

Segment assets

	31 July 2017
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate and non-headline £m	Total £m
Property, plant, equipment, development projects, other intangibles and investments	96	233	107	40	35	20	531
Inventory, trade and other receivables	337	256	389	118	104	27	1,231
Segment assets	433	489	496	158	139	47	1,762

	31 July 2016
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate and non-headline £m	Total £m
Property, plant, equipment, development projects, other intangibles and investments	100	221	95	46	33	15	510
Inventory, trade and other receivables	364	280	316	189	99	26	1,274
Segment assets	464	501	411	235	132	41	1,784

Segment liabilities

	31 July 2017
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate and non-headline £m	Total £m
Divisional liabilities	(124)	(120)	(246)	(48)	(39)		(577)
Corporate and non-headline liabilities						(393)	(393)
Segment liabilities	(124)	(120)	(246)	(48)	(39)	(393)	(970)

	31 July 2016
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Corporate and non-headline £m	Total £m
Divisional liabilities	(124)	(121)	(196)	(78)	(37)		(556)
Corporate and non-headline liabilities						(408)	(408)
Segment liabilities	(124)	(121)	(196)	(78)	(37)	(408)	(964)

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

Assets

Liabilities

	31 July 2017 £m	31 July 2016 £m	31 July 2017 £m	31 July 2016 £m
Segment assets and liabilities	1,762	1,784	(970)	(964)
Goodwill and acquired intangibles	1,820	1,556
Derivatives	69	42	(12)	(20)
Current and deferred tax	334	308	(156)	(167)
Retirement benefit assets and obligations	390	328	(166)	(248)
Cash and borrowings	782	431	(1,749)	(1,409)
Assets and liabilities of business held for sale		24		(5)
Statutory assets and liabilities	5,157	4,473	(3,053)	(2,813)

Segment capital expenditure

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

	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Reconciling items £m	Total £m
Capital expenditure year ended 31 July 2017	12	58	22	10	6	1	109
Capital expenditure year ended 31 July 2016	14	53	19	12	9	3	110

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:

	31 July 2017
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Total £m
Average divisional capital employed	890	1,257	820	492	182	3,641
Average corporate capital employed						(2)
Average total capital employed						3,639

	31 July 2016
	John Crane £m	Smiths Medical £m	Smiths Detection £m	Smiths Interconnect £m	Flex-Tek £m	Total £m
Average divisional capital employed	895	1,190	578	549	162	3,374
Average corporate capital employed						(50)
Average total capital employed						3,324

Analysis of revenue

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

John Crane	Original equipment £m	Aftermarket £m	Total £m
Revenue year ended 31 July 2017	314	571	885
Revenue year ended 31 July 2016	338	492	830

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 Medical	Infusion systems £m	Vascular access £m	Vital care £m	Specialty products £m	Total £m
Revenue year ended 31 July 2017	302	318	273	58	951
Revenue year ended 31 July 2016	273	289	240	72	874

Smiths Detection	Air transportation £m	Ports and borders £m	Military £m	Urban security £m	Total £m
Revenue year ended 31 July 2017	355	100	94	138	687
Revenue year ended 31 July 2016	235	89	79	123	526

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.

Smiths Interconnect	Connectors £m	Microwave £m	Power £m	Total £m
Revenue year ended 31 July 2017	177	195	47	419
Revenue year ended 31 July 2016	155	192	88	435

Flex-Tek	Fluid Management £m	Flexible Solutions £m	Heat Solutions £m	Construction Products £m	Total £m
Revenue year ended 31 July 2017	81	64	84	109	338
Revenue year ended 31 July 2016	72	54	66	92	284

The Group's statutory revenue is analysed as follows:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Sale of goods	2,865	2,607
Services	394	312
Contracts qualifying as construction contracts	21	30
	3,280	2,949

Analysis by geographical areas

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

		Revenue	Intangible assets and property plant and equipment
	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m	31 July 2017 £m	31 July 2016 £m
United Kingdom	118	114	92	129
Germany	160	131	363	325
France	96	85	16	17
Other European	355	291	72	70
Total European	729	621	543	541
United States of America	1,531	1,396	1,627	1,349
Canada	114	106	13	14
Other North American	33	33	12	10
Total North American	1,678	1,535	1,652	1,373
Japan	119	101	19	21
China (excluding Hong Kong)	93	95	49	63
Rest of the World	661	597	67	59
	3,280	2,949	2,330	2,057

2 Operating profit is stated after charging

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Research and development expense	98	87
Operating leases
- land and buildings	34	30
- other	8	8

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Audit services
Fees payable to the Company's auditors for the audit of the Company's annual financial statements	4	3
Fees payable to the Company's auditors and its associates for other services
- the audit of the Company's subsidiaries	2	2
	6	5

All other services	1

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.

3 Non-statutory profit measures

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:

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Restructuring programmes		(37)	(37)
Acquisition costs		(19)	(6)
Provision for Titeflex Corporation subrogation claims	22	4	(11)
Provision for John Crane, Inc. asbestos litigation	22	(15)	(23)
Cost recovery for John Crane, Inc. asbestos litigation		6	16
Post-retirement benefits changes to schemes and administration costs	8	(9)	(16)
Impairment of goodwill, property, plant and equipment and trade investments			(31)
Amortisation of acquired intangible assets	10	(17)	(15)
Unwind of fair value uplift of inventory on the acquisition balance sheet		(3)
Profit on disposal of businesses	28	175
Non-headline items in operating profit		85	(123)

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:

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Adjustment to discounted provisions	22	(6)	(5)
Fair value gain realised on contributing government bonds to Smiths Industries Pension Scheme	4		19
Other financing (losses)/gains		(8)	1
Other finance income - retirement benefits	8	2	3
Non-headline (losses)/gains in finance costs		(12)	18

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.

4 Net finance costs

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Interest receivable		5	3
Interest payable
- bank loans and overdrafts, including associated fees		(9)	(8)
- other loans		(57)	(54)
Interest payable		(66)	(62)
Other financing gains/(losses)
- fair value gains/(losses) on hedged debt		6	(23)
- fair value on (losses)/gains fair value hedges		(6)	23
- fair value gain realised on contributing government bonds to Smiths Industries Pension Scheme			19
- net foreign exchange (losses)/gains		(8)	1
- adjustment to discounted provisions		(6)	(5)
Other financing (losses)/gains		(14)	15
Net interest income on retirement benefit obligations	8	2	3
Net finance costs		(73)	(41)

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.

5 Earnings per share

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.

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Profit attributable to equity shareholders for the year
- continuing	570	259
- total	562	259
Average number of shares in issue during the year	395,422,421	395,095,591

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:

	Year ended 31 July 2017		Year ended 31 July 2016
	£m	EPS (p)	£m	EPS (p)
Profit attributable to equity shareholders of the Parent Company	570	144.1	259	65.6
Exclude
Non-headline items and related tax	(184)	(46.5)	77	19.6
Headline profit attributable to equity shareholders for the year	386	97.6	336	85.2
Statutory earnings per share - diluted (p)		142.3		64.9
Headline earnings per share - diluted (p)		96.3		84.3

6 Taxation

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.

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
The taxation charge in the consolidated income statement for the year comprises
Continuing operations
- current income tax charge	58	56
- current tax adjustments in respect of prior periods	3
Current taxation	61	56
- deferred taxation	(32)	29
Total taxation expense - continuing operations	29	85
Discontinued operations
- current income tax credit	(9)
- deferred taxation	6
Total taxation expense in the consolidated income statement	26	85

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Tax on items charged/(credited) to equity
Deferred tax charge/(credit)
- retirement benefit schemes	13	(10)
- cash flow hedge accounting	1
- share options	(3)
	11	(10)

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:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Profit before taxation	602	346
Notional taxation expense at UK rate of 19.7% (2016: 20.0%)	118	69
Different tax rates on non-UK profits and losses	55	24
Non-deductible expenses	14	16
Tax credits and non-taxable income	(15)	(11)
Non-headline recognition of UK deferred tax	(69)
Other adjustments to unrecognised deferred tax	(23)	2
Current and deferred benefits from closed financing arrangement	(19)	(15)
Effect of non-taxable profits on business disposals	(35)
Prior year true-up	3
Tax on discontinued activities	(3)
	26	85
Comprising
- taxation on headline profit	140	113
- tax on non-headline loss	(27)	(34)
- change in deferred tax recognition treated as non-headline	(84)	6
- taxation on discontinued operation	(3)
Taxation expense in the consolidated income statement	26	85

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

				Current tax £m
At 1 August 2015				(20)
Foreign exchange gains and losses				4
(Charge)/credit to income statement				(56)
Tax paid				62
At 31 July 2016				(10)
Foreign exchange gains and losses				2
(Charge)/credit to income statement - continuing				(61)
(Charge)/credit to income statement - discontinued				9
Business combinations				(1)
Business disposals				(4)
Tax paid				82
At 31 July 2017				17
Current tax receivable				62
Current tax payable				(45)
At 31 July 2017				17

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

	Property, plant and equipment and intangible assets £m	Employment benefits £m	Losses carried forward £m	Provisions £m	Other £m	Total £m
At 1 August 2015	(116)	61	28	126	48	147
Credit/(charge) to income statement	(7)	(72)	53	(10)	7	(29)
Credit/(charge) to equity		10				10
Business combinations	(1)					(1)
Exchange adjustments	(21)	9	6	24	6	24
At 31 July 2016	(145)	8	87	140	61	151
Deferred tax assets	(24)	8	84	134	44	246
Deferred tax liabilities	(121)		3	6	17	(95)
At 31 July 2016	(145)	8	87	140	61	151
Reallocation				4	(4)
(Charge)/credit to income statement - continuing	11	(9)	43	(7)	(6)	32
(Charge)/credit to income statement - discontinued	(6)					(6)
Credit/(charge) to equity		(10)			(1)	(11)
Business combinations	(6)				2	(4)
Business disposals	(3)					(3)
Exchange adjustments	1	1	(1)	1		2
At 31 July 2017	(148)	(10)	129	138	52	161
Deferred tax assets	(4)	(10)	127	133	26	272
Deferred tax liabilities	(144)		2	5	26	(111)
At 31 July 2017	(148)	(10)	129	138	52	161

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

	2017 £m	Expiry of losses	2016 £m	Expiry of losses
Territory
- Americas			36	2019-2036
- Asia	12	2018-2024	11	2017-2023
Total restricted losses	12		47
Unrestricted losses
- operating losses	55	No expiry	211	No expiry
Total	67		258

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.

7 Employees

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Staff costs during the period
Wages and salaries	833	745
Social security	94	84
Share-based payment (note 9)	15	10
Pension costs (including defined contribution schemes) (note 8)	36	33
	978	872

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

	Year ended 31 July 2017	Year ended 31 July 2016
John Crane	6,050	6,550
Smiths Medical	7,700	7,600
Smiths Detection	2,450	2,050
Smiths Interconnect	3,250	3,400
Flex-Tek	2,100	2,050
Corporate	350	350
	21,900	22,000

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.

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Key management compensation
Salaries and short-term employee benefits	13.2	12.8
Cost of post-retirement benefits	0.1	0.1
Cost of share-based incentive plans	5.3	4.5

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:

	Year ended 31 July 2017		Year ended 31 July 2016
	Number of instruments '000	Weighted average exercise price	Number of instruments '000	Weighted average exercise price
CIP	204		468
SEP	134
LTIP	1,041		1,185
Restricted stock	254		261
SAYE	7	£10.87	15	£8.99

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).

8 Post-retirement benefits

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:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
At beginning of period	80	(108)
Exchange adjustment	(6)	(31)
Reclassification of small unfunded obligations
Current service cost	(4)	(3)
Scheme administration costs	(7)	(7)
Past service cost, curtailments, settlements	(1)	(9)
Finance income - retirement benefits	2	3
Contributions by employer	105	275
Actuarial gain/(loss)	55	(40)
Net retirement benefit asset	224	80

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:

	2017 UK	2017 US	2017 Other	2016 UK	2016 US	2016 Other
Rate of increase in salaries	n/a	n/a	2.8%	n/a	n/a	2.8%
Rate of increase for active deferred members	4.1%	n/a	n/a	3.6%	n/a	n/a
Rate of increase in pensions in payment	3.2%	n/a	1.5%	2.7%	n/a	1.6%
Rate of increase in deferred pensions	3.2%	n/a	0.1%	2.7%	n/a	0.1%
Discount rate	2.6%	3.85%	2.6%	2.3%	3.45%	2.8%
Inflation rate	3.2%	n/a	2.2%	2.7%	n/a	2.3%
Healthcare cost increases	4.2%	n/a	1.8%	4.2%	n/a	1.4%

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).

Expected further years of life	UK schemes				US schemes
	Male 31 July 2017	Female 31 July 2017	Male 31 July 2016	Female 31 July 2016	Male 31 July 2017	Female 31 July 2017	Male 31 July 2016	Female 31 July 2016
Member who retires next year at age 65	23	24	23	24	21	23	21	23
Member, currently 45, when they retire in 20 years' time	24	25	24	26	23	24	23	25

Sensitivity

Sensitivities in respect of the key assumptions used to measure the principal pension schemes as at 31 July 2017 are set out below. These sensitivities show the hypothetical impact of a change in each of the listed assumptions in isolation, with the exception of the sensitivity to inflation which incorporates the impact of certain correlating assumptions. In practice, such assumptions rarely change in isolation.

	Profit before tax for year ended 31 July 2017 £m	Increase/ (decrease) in scheme assets 31 July 2017 £m	(Increase)/ decrease in scheme liabilities 31 July 2017 £m	Profit before tax for year ended 31 July 2016 £m	Increase/ (decrease) in scheme assets 31 July 2016 £m	(Increase)/ decrease in scheme liabilities 31 July 2016 £m
Rate of mortality - 1 year increase in life expectancy	(3)	67	(177)	(3)	53	(183)
Rate of mortality - 1 year decrease in life expectancy	3	(66)	177	3	(53)	183
Rate of inflation - 0.25% increase	(2)	20	(97)	(2)	16	(119)
Discount rate - 0.25% increase	4	(27)	151	4	(19)	168
Market value of scheme assets - 2.5% increase	2	79		2	86

The effect on profit before tax reflects the impact of current service cost and net interest cost. The value of the scheme assets is affected by changes in mortality rates, inflation and discounting because they affect the carrying value of the insurance assets.

Asset valuation

Liquidity funds, equities and bonds are valued using quoted market prices in active markets. Exchange traded equity index futures are valued at market prices.

Total return, interest and inflation swaps are bilateral agreements between counterparties and do not have observable market prices. These derivative contracts are valued using observable market inputs.

Insured liabilities comprise annuity policies matching the scheme obligation to identified groups of pensioners. These assets are valued at the actuarial valuation of the corresponding liability, reflecting this matching relationship. Property is valued by specialists applying recognised property valuation methods incorporating current market data on rental yields and transaction prices.

Retirement-benefit plan assets

	31 July 2017 £m				31 July 2016 £m
	UK schemes	US schemes	Other countries	Total	UK schemes	US schemes	Other countries	Total
Cash and cash equivalents
- cash	33	1	1	35	57	1		58
- liquidity funds	271			271	89			89
- cash collateral and liquidity funds held to support exchange traded futures	4			4	53			53
Equities
- UK funds	1		3	4	111		3	114
- North American funds					124		2	126
- other regions and global funds	94		1	95	214		5	219
Government bonds
- index-linked bonds	1,298			1,298	1,410			1,410
- fixed-interest bonds	393	81	3	477	599	70	20	689
Corporate bonds	1,048	184		1,232	861	145	5	1,011
Insured liabilities	1,050		1	1,051	802		1	803
Property	133		1	134	149		1	150
Other
- diversified growth funds and scheme receivables	407		24	431	285		25	310
- repurchase obligations	(773)			(773)	(720)			(720)
Total market value	3,959	266	34	4,259	4,034	216	62	4,312

SIPS has a portfolio of exchange traded equity index futures, which are valued at market prices. These futures increase "leverage" in SIPS, creating additional asset exposure. At 31 July 2017, the gross equity exposure generated by these exchange traded futures was £73m (2016: £163m). At 31 July 2017 the aggregate value of this strategy, including cash received as collateral, was £3m (2016: £9m). The scheme was holding £10m (2016: £44m) in liquidity funds to meet potential future obligations to collateralise equity index futures.

UK other investments at 31 July 2017 included £70m (2016: £162m) of investments in diversified growth funds held by SIPS, £184m (2016: £107m) of investments in leveraged index linked UK government bond funds held by TIGPS and £12m (2016: £9m) SIPS interest and inflation swaps.

At 31 July 2017 SIPS assets were net of £773m (2016: £720m) repurchase obligations, and included £4m (2016: £11m) gains on interest rate swaps, £8m gains (2016: £2m losses) on inflation swaps and £1m gains (2016: £nil) on total return swaps. See risk management disclosures on page 160 for information on how the scheme is using repurchase arrangements and swap contracts to match the interest rate and inflation exposures of its assets to the interest rate and inflation exposures of the scheme liabilities. The scheme was holding £1m (2016: £45m) in liquidity funds to meet potential future obligations to collateralise repurchase arrangements or swap agreements.

The scheme assets do not include any property occupied by, or other assets used by, the Group. Equities include investments in broad-based equity indices, some of which hold ordinary equity shares in Smiths Group plc.

Present value of funded scheme liabilities and assets for the main UK and US schemes

	31 July 2017 £m			31 July 2016 £m
	SIPS	TIGPS	US schemes	SIPS	TIGPS	US schemes
Present value of funded scheme liabilities
- Active deferred members	(81)	(92)	(101)	(82)	(82)	(124)
- Deferred members	(891)	(625)	(160)	(881)	(688)	(175)
- Pensioners	(1,053)	(809)	(31)	(1,086)	(869)	(16)
Present value of funded scheme liabilities	(2,025)	(1,526)	(292)	(2,049)	(1,639)	(315)
Market value of scheme assets	2,238	1,703	266	2,227	1,787	216
Surplus/(deficit)	213	177	(26)	178	148	(99)

Net retirement benefit obligations

	31 July 2017 £m				31 July 2016 £m
	UK schemes	US schemes	Other countries	Total	UK schemes	US schemes	Other countries	Total
Market value of scheme assets	3,959	266	34	4,259	4,034	216	62	4,312
Present value of funded scheme liabilities	(3,571)	(292)	(42)	(3,905)	(3,709)	(315)	(70)	(4,094)
Surplus/(deficit)	388	(26)	(8)	354	325	(99)	(8)	218
Unfunded pension plans	(55)	(8)	(48)	(111)	(56)	(8)	(52)	(116)
Post-retirement healthcare	(6)	(11)	(2)	(19)	(8)	(12)	(1)	(21)
Present value of unfunded obligations	(61)	(19)	(50)	(130)	(64)	(20)	(53)	(137)
Unrecognised asset due to surplus restriction							(1)	(1)
Net pension asset/(liability)	327	(45)	(58)	224	261	(119)	(62)	80
Post-retirement assets	390			390	327		1	328
Post-retirement liabilities	(63)	(45)	(58)	(166)	(66)	(119)	(63)	(248)
Net pension asset/(liability)	327	(45)	(58)	224	261	(119)	(62)	80

Where any individual scheme shows a recoverable surplus under IAS 19, this is disclosed on the balance sheet as a retirement benefit asset. The IAS 19 surplus of any one scheme is not available to fund the IAS 19 deficit of another scheme. The retirement benefit asset disclosed arises from the rights of the employers to recover the surplus at the end of the life of the scheme.

Amounts recognised in the consolidated income statement

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Amounts charged to operating profit
Current service cost	4	3
Settlement loss	1	9
Scheme administration costs	7	7
	12	19
The operating cost is charged as follows:
Cost of sales	1	1
Sales and distribution costs	1	1
Headline administrative expenses	2	1
Non-headline administrative expenses	8	16
	12	19
Amounts (credited) to finance costs
Net interest income	(2)	(3)

Amounts recognised directly in the consolidated statement of comprehensive income

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Actuarial gains/(losses)
Difference between interest credit and return on assets	(31)	395
Experience gains on scheme liabilities	22	58
Actuarial gains arising from changes in demographic assumptions	69	47
Actuarial losses arising from changes in financial assumptions	(6)	(539)
Movements in surplus restriction	1	(1)
	55	(40)

Changes in present value of funded scheme assets

	31 July 2017 £m				31 July 2016 £m
	UK schemes	US schemes	Other countries	Total	UK schemes	US schemes	Other countries	Total
At beginning of period	4,034	216	62	4,312	3,523	445	49	4,017
Interest on assets	91	9	2	102	124	9	3	136
Actuarial (loss)/gain on scheme assets	(15)	(14)	(2)	(31)	372	20	3	395
Employer contributions	27	67	5	99	199	68	2	269
Assets distributed on settlement			(32)	(32)		(360)		(360)
Scheme administration costs	(5)	(2)		(7)	(4)	(3)		(7)
Exchange adjustments		(1)	2	1		51	8	59
Benefits paid	(173)	(9)	(3)	(185)	(180)	(14)	(3)	(197)
At end of period	3,959	266	34	4,259	4,034	216	62	4,312

Changes in present value of funded defined benefit obligations

	31 July 2017 £m				31 July 2016 £m
	UK schemes	US schemes	Other countries	Total	UK schemes	US schemes	Other countries	Total
At beginning of period	(3,709)	(315)	(70)	(4,094)	(3,385)	(568)	(57)	(4,010)
Current service cost			(2)	(2)			(1)	(1)
Interest on obligations	(83)	(11)	(3)	(97)	(115)	(12)	(2)	(129)
Actuarial gain/(loss) on liabilities	48	27	1	76	(389)	(31)	(3)	(423)
Liabilities extinguished on settlement			31	31		350	1	351
Exchange adjustments		(2)	(2)	(4)		(68)	(11)	(79)
Benefits paid	173	9	3	185	180	14	3	197
At end of period	(3,571)	(292)	(42)	(3,905)	(3,709)	(315)	(70)	(4,094)

Changes in present value of unfunded defined benefit pensions and post-retirement healthcare plans

		Assets		Obligations
	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
At beginning of period			(137)	(115)
Reclassification of small unfunded obligations
Current service cost			(2)	(2)
Interest on obligations			(3)	(4)
Actuarial gain/(loss)			9	(11)
Employer contributions	6	6
Exchange adjustments			(3)	(11)
Benefits paid	(6)	(6)	6	6
At end of period			(130)	(137)

Cash contributions

Company contributions to the defined benefit pension plans and post-retirement healthcare plans for 2017 totalled £105m (2016: £275m). This comprised regular contributions to funded schemes of £24m (2016: £32m) to SIPS, £3m (2016: £11m) to TIGPS, £67m (2016: £34m) to funded US Schemes, £2m to other schemes and additional contributions of £3m to fund the closure of a scheme in Canada. In addition, £6m (2016: £6m) was spent on providing benefits under unfunded defined benefit pension and post-retirement healthcare plans.

In 2018 the cash contributions to the Group's principal funded defined benefit schemes are expected to total about £50m, including £24m to SIPS and £3m to TIGPS, with the balance relating mainly to the US scheme. Group contributions in respect of the unfunded schemes and post-retirement healthcare are expected to be in line with 2017.

9 Employee share schemes

The Group operates share schemes and plans for the benefit of employees. The nature of the principal schemes and plans, including general conditions, is set out below:

Long-Term Incentive Plan (LTIP)

The LTIP is a share plan under which an award over a capped number of shares will vest after the end of the three-year performance period if performance conditions are met. LTIP awards are made to selected senior executives, including the executive directors. Awards made prior to 2016 were made with different targets for corporate executives and divisional executives. Since 2016 all LTIP awards have had one set of targets.

LTIP performance conditions

Each performance condition has a threshold below which no shares vest and a maximum performance target at or above which the award vests in full. For performance between 'threshold' and 'maximum', awards vest on a straight-line sliding scale. The performance conditions are assessed separately, so performance on one condition does not affect the vesting of the other elements of the award. To the extent that the performance targets are not met over the three-year performance period, awards will lapse. There is no re-testing of the performance conditions.

Group LTIP awards have performance conditions relating to underlying revenue growth, growth in headline EPS adjusted to exclude tax, ROCE, cash conversion and, for awards made before 2015, TSR relative to the FTSE 100 (excluding financial services companies).

Divisional LTIP awards have performance conditions relating to divisional performance against headline KPIs, including underlying revenue and operating profit growth, operating margins, ROCE, operating cash conversion, employee engagement and quality metrics.

Smiths Group Co-Investment Plan (CIP) and Smiths Share Matching Plan (SMP)

In 2015 the CIP was replaced by the SMP. Under the CIP and SMP participants are required to invest between 25% and 50% of their post-tax bonus purchasing the Company's shares at the prevailing market price. At the end of a three-year period, if the executive is still in office and provided the performance test is passed, matching shares will be awarded in respect of any invested shares retained for that period. The number of matching shares to be awarded is determined by the Remuneration Committee at the end of the year in which the bonus is earned by reference to annual bonus, and other corporate financial criteria. The maximum award will not exceed the value, before tax, of the bonus or salary invested in shares by the executive.

For the CIP, vesting of matching shares will occur, and the matching shares will be released, at the end of the three-year period if the Group's Return on Capital Employed ('ROCE') over the performance period exceeds the Group's weighted average cost of capital ('WACC') over the performance period by an average margin of at least 1% per annum. If ROCE exceeds WACC by an average margin of 3% per annum, the enhanced performance condition is met, and a second matching share will be issued for every purchased share. For the SMP, vesting of matching shares will occur, and the matching shares will be released, at the end of the three-year period depending on the performance of the Group LTIP issued for the same performance period. The first matching share is awarded if the Group LTIP vests under any performance condition.

No future awards will be made under the CIP or SMP.

Smiths Excellence Plan (SEP)

In September 2016 the Smiths Excellence plan (SEP) was introduced. The SEP is designed to reinforce value creation over the medium term by focusing on specific objectives in key areas of operational performance. Awards vest after two years, depending on performance on the operational objectives during the first year and continued employment with the Group. There is no retesting of performance. However the Remuneration Committee has discretion to adjust vesting rates if material misstatements in reported performance are subsequently identified and awards are subject to clawback provisions in the event of mis-conduct.

Directors are not eligible to participate in the SEP.

Restricted stock

The restricted stock is used by the Remuneration Committee, as a part of the recruitment strategy, to make awards in recognition of incentive arrangements forfeited on leaving a previous employer. If an award is considered appropriate, the award will take account of relevant factors including the fair value of awards forfeited, any performance conditions attached, the likelihood of those conditions being met and the proportion of the vesting period remaining.

	SEP	CIP and SMP	Long-term incentive plans	Restricted stock	Other share schemes	Total	Weighted average exercise price £
Ordinary shares under option ('000)
1 August 2015		1,369	2,649		1,494	5,512	£2.57
Granted		635	1,628	303	329	2,895	£0.99
Exercised		(530)	(199)	(30)	(380)	(1,139)	£2.95
Lapsed		(35)	(724)		(222)	(981)	£2.20
31 July 2016		1,439	3,354	273	1,221	6,287	£1.83
Granted	817		1,581	58	218	2,674	£1.06
Exercised		(339)	(198)	(119)	(259)	(915)	£2.77
Lapsed	(69)	(174)	(939)	(7)	(70)	(1,259)	£0.51
31 July 2017	748	926	3,798	205	1,110	6,787	£1.64

Options were exercised on an irregular basis during the period. The average closing share price over the financial year was 1,499.95p (2016: 1,049.61p). There has been no change to the effective option price of any of the outstanding options during the period.

Range of exercise prices	Total shares under option at 31 Jul 2017 ('000)	Weighted average remaining contractual life at 31 July 2017 (months)	Total shares under option at 31 Jul 2016 ('000)	Weighted average remaining contractual life at 31 July 2016 (months)	Options exercisable at 31 July 2017 ('000)	Exercisable weighted average exercise price for options exercisable at 31 July 2017	Options exercisable at 31 July 2016 ('000)	Exercisable weighted average exercise price for options exercisable at 31 July 2016
£0.00 - £2.00	5,677	17	5,066	18
£2.01 - £6.00			17	6
£6.01 - £10.00	791	24	924	33	42	£9.20	60	£9.04
£10.01 - £14.00	319	32	280	13	90	£10.96	175	£10.95

For the purposes of valuing options to arrive at the share-based payment charge, the Binomial option-pricing model has been used for most schemes and the Monte Carlo method is used for schemes with total shareholder return performance targets. The key assumptions used in the models for 2017 and 2016 are volatility of 20% to 25% (2016: 25% to 30%) and dividend yield of 3.50% (2016: 3.75%), based on historical data, for the period corresponding with the vesting period of the option. These generated a weighted average fair value for SEP of £12.86p (2016: no grant), LTIP of £12.68 (2016: £10.33), and restricted stock of £12.59 (2016: £10.03).

Included within staff costs is an expense arising from share-based payment transactions of £15m (2016: £10m), of which £14m (2016: £9m) relates to equity-settled share-based payment.

10 Intangible assets

	Goodwill £m	Development costs £m	Acquired intangibles (see table below) £m	Software, patents and intellectual property £m	Total £m
Cost
At 1 August 2015	1,421	237	403	177	2,238
Exchange adjustments	253	43	71	17	384
Business combinations	5		3		8
Additions		25		11	36
Disposals		(3)		(6)	(9)
At 31 July 2016	1,679	302	477	199	2,657
Exchange adjustments	23	4	(2)	1	26
Business combinations (note 26)	210		240	6	456
Additions		39		8	47
Disposals		(15)		(5)	(20)
Business disposals (note 28)	(254)		(141)	(3)	(398)
At 31 July 2017	1,658	330	574	206	2,768
Amortisation
At 1 August 2015	115	121	358	126	720
Exchange adjustments	24	22	65	11	122
Charge for the year		26	15	17	58
Impairment charge	23				23
Disposals		(3)		(5)	(8)
At 31 July 2016	162	166	438	149	915
Exchange adjustments	5	2	9	1	17
Charge for the year		27	17	18	62
Disposals		(15)		(5)	(20)
Business disposals (note 28)	(79)		(140)	(2)	(221)
At 31 July 2017	88	180	324	161	753
Net book value at 31 July 2017	1,570	150	250	45	2,015
Net book value at 31 July 2016	1,517	136	39	50	1,742
Net book value at 1 August 2015	1,306	116	45	51	1,518

In addition to goodwill, the acquired intangible assets comprise:

	Patents, licences and trademarks £m	Technology £m	Customer relationships £m	Total acquired intangibles £m
Cost
At 1 August 2015	72	136	195	403
Exchange adjustments	13	24	34	71
Business combinations			3	3
At 31 July 2016	85	160	232	477
Exchange adjustments	2	(3)	(1)	(2)
Business combinations (note 26)		103	137	240
Business disposals (note 28)	(30)	(49)	(62)	(141)
At 31 July 2017	57	211	306	574
Amortisation
At 1 August 2015	49	120	189	358
Exchange adjustments	9	22	34	65
Charge for the year	3	7	5	15
At 31 July 2016	61	149	228	438
Exchange adjustments	1	2	6	9
Charge for the year	3	8	6	17
Business disposals (note 28)	(29)	(49)	(62)	(140)
At 31 July 2017	36	110	178	324
Net book value at 31 July 2017	21	101	128	250
Net book value at 31 July 2016	24	11	4	39
Net book value at 1 August 2015	23	16	6	45

11 Impairment testing

Goodwill

Goodwill is not amortised but is tested for impairment at least annually. Value in use or fair value less cost to sell calculations are used to determine the recoverable amount of goodwill held allocated to each group of cash generating units (CGU). Value in use is calculated as the net present value of the projected risk-adjusted cash-flows of the CGU. These forecast cash-flows are based on the 2018 budget, the five-year strategic plan approved by the Board and detailed divisional strategic projections, where these have been prepared and approved by the Board. Fair value less cost to sell is calculated using available information on past and expected future profitability, valuation multiples for comparable quoted companies and similar transactions (adjusted as required for significant differences) and information on costs of similar transactions. Fair value less costs to sell models are used when trading projections in the strategic plan cannot be adjusted to eliminate the impact of a major restructuring.

Goodwill is allocated by division as follows:

	2017 £m	2017 Number of CGUs	2016 £m	2016 Number of CGUs
John Crane	111	1	108	3
Smiths Medical	561	1	591	1
Smiths Detection	629	2	410	1
Smiths Interconnect	242	2	381	5
Flex-Tek	27	2	27	2
	1,570	8	1,517	12

Following the disposal of the John Crane Artificial Lift business (see note 28) and a restructuring to integrate China into the global John Crane management structure, John Crane is now a single CGU. Impairment testing has been completed on this basis for 2017.

Morpho Detection was acquired in April 2017 (see note 26). At 31 July 2017 a single management team was in place covering Continuing Smiths Detection and Morpho Detection. However, the integration of the two businesses was not sufficiently advanced to support treating them as a single CGU for impairment testing. Based on the current integration plan, it is anticipated that there will be single CGU in 2018.

Following the disposal of Smiths Interconnect Power and Smiths Interconnect Microwave Telecoms (see note 28) and the integration of Smiths Interconnect Connectors and Smiths Interconnect Microwave Components, Smiths Interconnect now has two CGUs, Smiths Interconnect Connectors and Components and Smiths Interconnect Microwave Subsystems.

Impairment testing assumptions

John Crane and Smiths Medical have strong aftermarket and consumables businesses, with consistent sales trends. Smiths Detection and Smiths Interconnect have greater sales and margin volatility due to lower levels of recurring revenue and involvement in government-funded programmes, particularly defence, and customer-led technology innovation. The key assumptions used in value in use calculations are:

▪ Sales: projected sales are built up with reference to markets and product categories. They incorporate past performance, historical growth rates and projections of developments in key markets.

▪ Margins: projected margins reflect historical performance and the impact of all completed projects to improve operational efficiency and leverage scale. The projections do not include the impact of future restructuring projects to which the Group is not yet committed.

▪ Discount rate: the discount rates have been calculated based on the Group's weighted average cost of capital and risks specific to the CGU being tested. The discount rates disclosed incorporate risk adjustments where the projected sales and margins are affected by significant delivery risks. Pre-tax rates of 12.2% to 16.9% (2016: 11.0% to 14.3%) have been used for the impairment testing.

▪ Long-term growth rates: as required by IAS 36, growth rates for the period after the detailed forecasts are based on the long-term GDP projections of the primary market for the CGU. The average growth rate used in the testing was 2.1% (2016: 2.2%). These rates do not reflect the long-term assumptions used by the Group for investment planning.

The assumptions used in the impairment testing of significant CGUs are as follows:

					Year ended 31 July 2017
	John Crane	Smiths Medical	Smiths Detection		Smiths Interconnect
			Original Smiths Detection	Morpho Detection	Microwave Subsystems	Connectors and Components
Net book value of goodwill (£m)	111	561	429	200	75	167
Basis of valuation	Value in use	Value in use	Value in use	Fair value less costs to sell	Value in use	Value in use
Discount rate	14.9%	12.2%	14.1%	n/a	12.2%	16.9%
Period covered by management projections	5 years	5 years	5 years	1 year	5 years	5 years
Long-term growth rates	2.2%	2.1%	2.0%	n/a	2.2%	2.1%

The discount rate for Smiths Interconnect Connectors and Components includes a risk adjustment.

				Year ended 31 July 2016
	John Crane	Smiths Medical	Smiths Detection	Smiths Interconnect
	Core Rotating Equipment		Original Smiths Detection	Microwave Subsystems	Connectors	Power
Net book value of goodwill (£m)	104	591	410	75	100	128
Basis of valuation	Value in use	Value in use	Value in use	Value in use	Value in use	Value in use
Discount rate	13.4%	11.0%	13.9%	11.8%	13.5%	11.7%
Period covered by management projections	5 years	5 years	5 years	5 years	5 years	5 years
Long-term growth rates	2.3%	2.1%	2.0%	2.3%	2.0%	2.3%

The remaining balance of the goodwill represents smaller individual amounts which have been allocated to smaller CGUs.

Sensitivity analysis

Morpho Detection explosive detection business

Morpho Detection's fair value less costs to sell exceeds its carrying value by £38m. Fair value was calculated using a level 3 valuation model. Sensitivity analysis performed around the base case assumptions has indicated that for Morpho Detection, the following changes in assumptions (in isolation), would cause the fair value less costs to sell to fall below the carrying value. The business was acquired in the year, so there are no comparatives.

		Year ended 31 July 2017 Change required to trigger impairment
Forecast earnings before interest, tax, depreciation and amortisation		8% reduction in EBITDA
Valuation multiple		0.9 reduction in multiple

Forecast earnings before interest, tax, depreciation and amortisation have been projected using:

▪ expected future sales, based on orders, projected sales under framework agreements, sales opportunities and current contract win rates;

▪ current cost structure and production capacity; and

▪ adjustments to profit which a market participant would normally make in assessing a business of this nature, including market participant synergies.

The valuation multiple has been estimated using current share prices for similar listed companies, multiples paid in recent transactions and advice on current market pricing.

Other CGUs

For the other CGUs, sensitivity analysis performed around the base case assumptions has indicated that no reasonable changes in key assumptions would cause the carrying amount of any of the CGUs to exceed their respective recoverable amounts.

Goodwill impairment

No impairment charges have been incurred (2016: £23m). In 2016 the following goodwill impairments were recognised: £5m for John Crane Production Solutions, £7m for Smiths Interconnect Microwave Components and £11m for Smiths Interconnect Microwave Telecoms. All three of these businesses were sold in the current year, see note 28.

Other intangible assets

The Group has no indefinite life intangible assets other than goodwill. During the year impairment tests were carried out for development projects which have not yet started to be amortised and acquired intangibles where there were indications of impairment. Value in use calculations were used to determine the recoverable values of these assets.

No impairment charges have been incurred (2016: £nil).

Property, plant and equipment

Impairment charges of £5m for John Crane Production Solutions, principally relating to property, and £1m for sites affected by the Fuel for Growth restructuring were recognised in 2016.

12 Property, plant and equipment

	Land and buildings £m	Plant and machinery £m	Fixtures, fittings, tools and equipment £m	Total £m
Cost or valuation
At 1 August 2015	181	536	199	916
Exchange adjustments	31	91	30	152
Additions	19	42	13	74
Disposals	(2)	(35)	(21)	(58)
Transfers to disposal group held for sale at the year end	(6)	(3)	(1)	(10)
At 31 July 2016	223	631	220	1,074
Exchange adjustments	5	10	5	20
Business combinations (note 26)		7	1	8
Additions	6	44	12	62
Disposals	(24)	(42)	(24)	(90)
Business disposals (note 28)	(6)	(15)	(5)	(26)
At 31 July 2017	204	635	209	1,048
Depreciation
At 1 August 2015	97	403	157	657
Exchange adjustments	16	68	24	108
Charge for the year	8	31	14	53
Impairments (note 11)	5	1		6
Disposals	(1)	(34)	(20)	(55)
Transfers to disposal group held for sale at the year end	(6)	(3)	(1)	(10)
At 31 July 2016	119	466	174	759
Exchange adjustments	2	8	4	14
Charge for the year	9	34	14	57
Disposals	(18)	(36)	(23)	(77)
Business disposals (note 28)	(5)	(11)	(4)	(20)
At 31 July 2017	107	461	165	733
Net book value at 31 July 2017	97	174	44	315
Net book value at 31 July 2016	104	165	46	315
Net book value at 1 August 2015	84	133	42	259

13 Inventories

	31 July 2017 £m	31 July 2016 £m
Inventories comprise
Raw materials and consumables	148	174
Work in progress	86	102
Finished goods	218	202
	452	478

The Group consumed £1,470m (2016: £1,319m) of inventories during the period. In the year to 31 July 2017, £17m (2016: £16m) was charged for the write-down of inventory and £6m (2016: £4m) was released from inventory provisions no longer required.

Inventory provisioning

	31 July 2017 £m	31 July 2016 £m
Gross inventory carried at full value	414	436
Gross value of inventory partly or fully provided for	93	112
	507	548
Inventory provision	(55)	(70)
Inventory after provisions	452	478

14 Trade and other receivables

	31 July 2017 £m	31 July 2016 £m
Non-current
Trade receivables	41	31
Accrued income	2	3
Prepayments		1
Other receivables	14	16
	57	51
Current
Trade receivables	642	665
Accrued income	11	18
Prepayments	28	21
Other receivables	41	41
	722	745

Trade receivables include balances not yet due of £75m (2016: £47m) relating to multi-year Smiths Detection contracts, where revenue recognition does not align with the agreed payment schedule. The Group also has cash received of £78m (2016: £41m) deferred in trade and other payables relating to Smiths Detection contracts.

Trade receivables do not carry interest. Management considers that the carrying value of trade and other receivables approximates to the fair value. Trade and other receivables, including prepayments, accrued income and other receivables qualifying as financial instruments are classified as 'loans and receivables'. The maximum credit exposure arising from these financial assets is £720m (2016: £745m).

Trade receivables are disclosed net of provisions for bad and doubtful debts. The provisions for bad and doubtful debts are based on specific risk assessment and reference to past default experience.

Credit risk is managed separately for each customer and, where appropriate, a credit limit is set for the customer based on previous experience of the customer and third party credit ratings. The Group has no significant concentration of credit risk, with exposure spread over a large number of customers. The largest single customer is the US Federal Government, representing less than 5% (2016: less than 5%) of Group revenue.

Ageing of trade receivables

	31 July 2017 £m	31 July 2016 £m
Trade receivables which are not impaired and not yet due	539	535
Trade receivables which are not impaired and less than three months overdue	104	109
Trade receivables which are not impaired and more than three months overdue	30	45
Gross value of partially and fully provided receivables	43	38
	716	727
Provision for bad and doubtful debts	(33)	(31)
Trade receivables	683	696

15 Trade and other payables

	31 July 2017 £m	31 July 2016 £m
Non-current
Other payables	26	29
Current
Trade payables	202	202
Other payables	17	11
Other taxation and social security costs	27	25
Accruals	247	231
Deferred income	83	67
	576	536

Trade and other payables, including accrued expenses and other payables qualifying as financial instruments, are accounted for at amortised cost and are categorised as other financial liabilities.

16 Financial assets

At 31 July 2017 £11m (2016: £nil) was held on deposit with banks as security for liabilities or letters of credit.

The Group invests in early stage businesses that are developing or commercialising related technology. In 2016, £2m was invested in Detection businesses.

17 Borrowings and net debt

This note sets out the calculation of net debt, an important measure in explaining our financing position. The net debt figure includes accrued interest and the fair value adjustments relating to hedge accounting.

	31 July 2017 £m	31 July 2016 £m
Cash and cash equivalents
Net cash and deposits	782	431
Short-term borrowings
Bank overdrafts	(1)	(1)
€300m 4.125% Eurobond 2017		(255)
$175m 7.37% US$ Private placement 2018	(133)
Bank and other loans	(1)	(1)
Interest accrual	(16)	(13)
	(151)	(270)
Long-term borrowings
$175m 7.37% US$ Private placement 2018		(132)
$250m 7.20% US$ Guaranteed notes 2019	(189)	(189)
$400m 3.625% US$ Guaranteed notes 2022	(301)	(304)
€600m 1.25% Eurobond 2023	(533)	(512)
€650m 2.00% Eurobond 2027	(574)
Bank and other loans	(1)	(2)
	(1,598)	(1,139)
Borrowings	(1,749)	(1,409)
Net debt	(967)	(978)

The $175m 7.37% US$ Private placement 2018 was repaid early in August 2017.

Cash and cash equivalents include highly liquid investments with maturities of three months or less.

Borrowings are accounted for at amortised cost and are categorised as other financial liabilities. See note 18 for a maturity analysis of borrowings.

Interest of £45m (2016: £47m) was charged to the consolidated income statement in this period in respect of public bonds.

Secured loans

Loans amounting to £2m (2016: £3m) were secured on plant and equipment with a book value of £3m (2016: £3m).

Net cash and cash equivalents

	31 July 2017 £m	31 July 2016 £m
Cash at bank and in hand	226	161
Short-term deposits	556	270
Cash and cash equivalents	782	431
Bank overdrafts	(1)	(1)
Net cash and cash equivalents	781	430

Netting

Cash and overdraft balances in interest compensation cash pooling systems are reported gross on the balance sheet. The cash pooling agreements incorporate a legally enforceable right of net settlement. However, there is no intention to settle the balances net, so these arrangements do not qualify for net presentation. At 31 July 2017 the total value of overdrafts on accounts in interest compensation cash pooling systems was £nil (2016: less than £1m). The balances held in zero balancing cash pooling arrangements have daily settlement of balances, so netting is not relevant.

Movements in net debt

	Net cash and cash equivalents £m	Other short-term borrowings £m	Long-term borrowings £m	Net debt £m
At 31 July 2016	430	(269)	(1,139)	(978)
Foreign exchange gains and losses	(10)	5	(56)	(61)
Net cash inflow	361			361
Repayment of borrowings		256		256
Drawdown of borrowings			(546)	(546)
Capitalisation, interest accruals and unwind of capitalised fees		(3)	(1)	(4)
Fair value movement from interest rate hedging		1	4	5
Change in maturity analysis		(140)	140
At 31 July 2017	781	(150)	(1,598)	(967)

18 Financial risk management

The Group's international operations and debt financing expose it to financial risks which include the effects of changes in foreign exchange rates, changes in debt market prices, interest rates, credit risks and liquidity risks.

Treasury and risk management policies are set by the Board. The policy sets out specific guidelines to manage foreign exchange risk, interest rate risk, credit risk and the use of financial instruments to manage risk. The instruments and techniques used to manage exposures include foreign currency derivatives, debt and other interest rate derivatives. The central treasury function monitors financial risks and compliance with risk management policies. The management of operational credit risk is discussed in note 14.

(a) Foreign exchange risk

Transactional currency exposure

The Group is exposed to foreign currency risks arising from sales or purchases by businesses in currencies other than their functional currency. It is Group policy that, when the net foreign exchange exposure to known future sales and purchases is material, this exposure is hedged using forward foreign exchange contracts. The net exposure is calculated by adjusting the expected cash-flow for payments or receipts in the same currency linked to the sale or purchase. This policy minimises the risk that the profits generated from the transaction will be affected by foreign exchange movements which occur after the price has been determined. Hedge accounting documentation and effectiveness testing are only undertaken if it is cost effective.

The following table shows the currency of financial instruments. It excludes loans and derivatives designated as net investment hedges.

	At 31 July 2017
	Sterling £m	US$ £m	Euro £m	Other £m	Total £m
Financial assets and liabilities
Financial instruments included in trade and other receivables	55	351	143	171	720
Financial instruments included in trade and other payables	(57)	(214)	(69)	(72)	(412)
Cash and cash equivalents	5	512	80	184	781
Borrowings not designated as net investment hedges	1	(12)	(275)	(2)	(288)
	4	637	(121)	281	801
Exclude balances held in operations with the same functional currency	(5)	(220)	(102)	(195)	(522)
Exposure arising from intra-group loans		(352)	(85)	(83)	(520)
Impact of fair value hedging of exchange exposure	(269)		269
Forward foreign exchange contracts	(88)	19	50	19
	(358)	84	11	22	(241)

	At 31 July 2016
	Sterling £m	US$ £m	Euro £m	Other £m	Total £m
Financial assets and liabilities
Financial instruments included in trade and other receivables	38	391	136	180	745
Financial instruments included in trade and other payables	(48)	(203)	(72)	(79)	(402)
Cash and cash equivalents	189	129	41	72	431
Borrowings not designated as net investment hedges	1	(12)	(5)	(1)	(17)
	180	305	100	172	757
Exclude balances held in operations with the same functional currency	(180)	(188)	(101)	(167)	(636)
Exposure arising from intra-group loans		(165)	(70)	(77)	(312)
Forward foreign exchange contracts	(286)	112	119	55
	(286)	64	48	(17)	(191)

Financial instruments included in trade and other receivables comprise trade receivables, accrued income and other receivables which qualify as financial instruments. Similarly, financial instruments included in trade and other payables comprise trade payables, accrued expenses and other payables that qualify as financial instruments.

Based on the assets and liabilities held at the year-end, if the specified currencies were to strengthen 10% while all other market rates remained constant, the change in the fair value of financial instruments not designated as net investment hedges would have the following effect:

	Impact on profit for the year 31 July 2017 £m	Gain/(loss) recognised in reserves 31 July 2017 £m	Impact on profit for the year 31 July 2016 £m	Gain/(loss) recognised in reserves 31 July 2016 £m
US dollar	(5)	(5)	3	2
Euro	(3)	2	(6)	(3)
Sterling	1	(1)	16	(2)

These sensitivities were calculated before adjusting for tax and exclude the effect of quasi-equity intra-group loans.

Cash-flow hedging

The Group uses foreign currency contracts to hedge future foreign currency sales and purchases. At 31 July 2017 contracts with a nominal value of £407m (2016: £393m) were designated as hedging instruments. In addition, the Group had outstanding foreign currency contracts with a nominal value of £243m (2016: £529m) which were being used to manage transactional foreign exchange exposures, but were not accounted for as cash-flow hedges. The fair value of the contracts is disclosed in note 19.

The majority of hedged transactions will be recognised in the consolidated income statement in the same period that the cash flows are expected to occur, with the only differences arising because of normal commercial credit terms on sales and purchases. Of the foreign exchange contracts designated as hedging instruments 86% are for periods of 12 months or less (2016: 91%).

The movements in the cash-flow hedge reserve during the period are summarised in the table below:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Brought forward cash-flow hedge reserve at start of year	(7)	3
Gains/(losses) on effective cash-flow hedges recognised in equity	3	(10)
Amounts removed from the hedge reserve and recognised in the following lines on the income statement
- revenue	9	(1)
- cost of sales	(4)	1
Carried forward cash-flow hedge reserve at end of year	1	(7)

Translational currency exposure

The Group has significant investments in overseas operations, particularly in the United States and Europe. As a result, the sterling value of the Group's balance sheet can be significantly affected by movements in exchange rates. The Group seeks to mitigate the effect of these translational currency exposures by matching the net investment in overseas operations with borrowings denominated in their functional currencies, except where significant adverse interest differentials or other factors would render the cost of such hedging activity uneconomic. This is achieved by borrowing primarily in the relevant currency or in some cases indirectly using forward foreign exchange contracts and cross-currency swaps.

Net investment hedges

The table below sets out the currency of loans and swap contracts designated as net investment hedges:

					At 31 July 2017
	Sterling £m	US$ £m	Euro £m	Other £m	Total £m
Loans designated as net investment hedges		(621)	(840)		(1,461)
Cross-currency swap contracts	254	(568)	359		45
Currency swap contracts	109			(109)
	363	(1,189)	(481)	(109)	(1,416)

					At 31 July 2016
	Sterling £m	US$ £m	Euro £m	Other £m	Total £m
Loans designated as net investment hedges		(625)	(767)		(1,392)
Cross-currency swap contracts		(358)	373		15
Currency swap contracts	111			(111)
	111	(983)	(394)	(111)	(1,377)

At 31 July 2017 swap contracts hedged the Group's exposure to Canadian dollars, Japanese yen and Chinese renminbi (31 July 2016: Canadian dollars, Japanese yen and Chinese renminbi).

All the currency swap contracts designated as net investment hedges are current (2016: current). The cross-currency swap contracts are non-current. Swaps generating £327m of the US dollar exposure (2016: £358m) will mature in April 2023 and swaps generating £241m of the US dollar exposure (2016: £nil) will mature in February 2027.

The gains and losses that have been deferred in the net investment hedge reserve, and recycled in the period, are shown in the table below:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Brought forward net investment hedge reserve at start of year	(294)	(66)
Amounts removed from the hedge reserve and recognised in the income statement	20
Amounts deferred in the period on effective net investment hedges	(17)	(228)
Carried forward net investment hedge reserve at end of year	(291)	(294)

The fair values of these net investment hedges are subject to exchange rate movements. Based on the hedging instruments in place at the year-end, if the specified currencies were to strengthen 10% while all other market rates remained constant, it would have the following effect:

	Loss recognised in hedge reserve 31 July 2017 £m	Loss recognised in hedge reserve 31 July 2016 £m
US dollar	132	98
Euro	53	35

These movements would be fully offset by an opposite movement on the retranslation of the net assets of the overseas subsidiaries. These sensitivities were calculated before adjusting for tax.

(b) Interest rate risk

The Group operates an interest rate policy designed to optimise interest cost and reduce volatility in reported earnings. The Group's current policy is to require interest rates to be fixed for greater than 70% of the level of gross debt. This is achieved through fixed rate borrowings and interest rate swaps. At 31 July 2017 57% (2016: 59%) of the Group's gross borrowings were at fixed interest rates, after adjusting for interest rate swaps and the impact of short maturity derivatives designated as net investment hedges. The Group monitors its fixed rate risk profile against both gross and net debt. For medium-term planning, it now focuses on gross debt to eliminate the fluctuations of variable cash levels over the cycle.

The weighted average interest rate on borrowings and cross-currency swaps at 31 July 2017, after interest rate swaps, is 3.52% (2016: 3.68%).

Interest rate profile of financial assets and liabilities and the fair value of borrowings

The following table shows the interest rate risk exposure of investments, cash and borrowings, with the borrowings adjusted for the impact of interest rate hedging. The other financial assets and liabilities do not earn or bear interest and for all financial instruments except for borrowings the carrying value is not materially different from their fair value.

	Available for sale investments 31 July 2017 £m	Cash and cash equivalents 31 July 2017 £m	Borrowings 31 July 2017 £m	Fair value of borrowings 31 July 2017 £m	Available for sale investments 31 July 2016 £m	Cash and cash equivalents 31 July 2016 £m	Borrowings 31 July 2016 £m	Fair value of borrowings 31 July 2016 £m
Fixed interest
Less than one year			(134)	(140)			(153)	(158)
Between one and five years			(190)	(206)			(322)	(362)
Greater than five years			(672)	(693)			(353)	(362)
Total fixed interest financial assets/(liabilities)			(996)	(1,039)			(828)	(882)
Floating rate interest financial assets/(liabilities)	6	711	(753)	(753)		390	(581)	(581)
Total interest-bearing financial assets/(liabilities)	6	711	(1,749)	(1,792)		390	(1,409)	(1,463)
Non-interest-bearing assets/(liabilities) in the same category	15	71			9	41
Total	21	782	(1,749)	(1,792)	9	431	(1,409)	(1,463)

Interest rate hedging

At 31 July 2017 and 31 July 2016 the Group has designated the following hedges against variability in the fair value of borrowings arising from fluctuations in base rates:

▪ US$150m interest rate swap which matures on 12 October 2022 partially hedging the US$ 2022 Guaranteed notes; and

▪ the fixed/floating element of €400m of €/US$ interest rate swaps which mature on 28 April 2023 partially hedging the € 2023 Eurobond.

At 31 July 2017 the Group has designated the following hedge against variability in the fair value of borrowings arising from fluctuations in base rates and exchange rates:

▪ the fixed/floating and € exchange exposure of €300m of €/US$ interest rate swaps which mature on 23 February 2027 partially hedging the € 2027 Eurobond.

The fair values of the hedging instruments are disclosed in note 19. The effect of the swaps is to convert £741m (2016: £552m) debt from fixed rate to floating rate.

Sensitivity of interest charges to interest rate movements

The Group has exposure to sterling, US dollar and euro interest rates. However the Group does not have a significant exposure to interest rate movements for any individual currency. Based on the composition of net debt and investments at 31 July 2017, and taking into consideration all fixed rate borrowings and interest rate swaps in place, a one percentage point (100 basis points) change in average floating interest rates for all three currencies would have less than £1m impact (2016: impact of £2m) on the Group's profit before tax.

The Group is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but does not currently expect any counterparties to fail to meet their obligations. Credit risk is mitigated by the Board-approved policy of only placing cash deposits with highly rated relationship bank counterparties within counterparty limits established by reference to their Standard & Poor's long-term debt rating. In the normal course of business, the Group operates cash pooling systems, where a legal right of set-off applies.

The maximum credit risk exposure in the event of other parties failing to perform their obligations under financial assets, excluding trade and other receivables and derivatives, totals £803m at 31 July 2017 (2016: £440m).

	31 July 2017 £m	31 July 2016 £m
Cash in AAA+ liquidity funds	376
Cash at banks with at least a AA- credit rating	226	215
Cash at banks with a A+ credit rating	98	126
Cash at other banks	82	90
Investments in bank deposits	11
Other investments	10	9
	803	440

At 31 July 2017 the maximum exposure with a single bank for deposits and cash is £126m (2016: £97m), whilst the maximum mark to market exposure for derivatives is £20m (2016: £10m). These banks have AA- and AA- credit rating, respectively (2016: AA- and AA-).

(d) Liquidity risk

Borrowing facilities

The Board policy specifies the maintenance of unused committed credit facilities of at least £200m at all times to ensure it has sufficient available funds for operations and planned development, which is provided by a multi-currency revolving credit facility.

Smiths has a $800m Revolving Credit Facility that matures on 19 February 2021. At the balance sheet date, the Group had the following undrawn credit facilities:

	31 July 2017 £m	31 July 2016 £m
Expiring within one year
Expiring between one and two years
Expiring after more than two years	607	605
	607	605

Cash deposits

As at 31 July 2017, £556m (2016: £270m) of cash and cash equivalents was on deposit with various banks of which £83m (2016: £119m) was on deposit with UK banks, £375m (2016: £nil) was in liquidity funds and £11m (2016: £nil) of investments comprised bank deposits held to secure liabilities and letters of credit.

Gross contractual cash-flows for borrowings

	Borrowings (Note 17) 31 July 2017 £m	Fair value adjustments 31 July 2017 £m	Contractual interest payments 31 July 2017 £m	Total contractual cash-flows 31 July 2017 £m	Borrowings (Note 17) 31 July 2016 £m	Fair value adjustments 31 July 2016 £m	Contractual interest payments 31 July 2016 £m	Total contractual cash-flows 31 July 2016 £m
Less than one year	(151)	1	(38)	(188)	(270)	2	(39)	(307)
Between one and two years	(190)		(43)	(233)	(133)		(41)	(174)
Between two and three years			(29)	(29)	(190)	(1)	(32)	(223)
Between three and four years			(29)	(29)			(18)	(18)
Between four and five years			(29)	(29)			(18)	(18)
Greater than five years	(1,408)	(1)	(71)	(1,480)	(816)	8	(30)	(838)
Total	(1,749)		(239)	(1,988)	(1,409)	9	(178)	(1,578)

The figures presented in the borrowings column include the non-cash adjustments which are highlighted in the adjacent column. The contractual interest reported for borrowings is before the effect of interest rate swaps.

Gross contractual cash-flows for derivative financial instruments

	Receipts 31 July 2017 £m	Payments 31 July 2017 £m	Net cash-flow 31 July 2017 £m	Receipts 31 July 2016 £m	Payments 31 July 2016 £m	Net cash-flow 31 July 2016 £m
Assets
Less than one year	315	(310)	5	425	(415)	10
Greater than one year	710	(642)	68	378	(374)	4
Liabilities
Less than one year	279	(287)	(8)	467	(485)	(18)
Greater than one year	51	(54)	(3)	28	(29)	(1)
Total	1,355	(1,293)	62	1,298	(1,303)	(5)

This table presents the undiscounted future contractual cash-flows for all derivative financial instruments. For this disclosure, cash-flows in foreign currencies are translated using the spot rates at the balance sheet date. The fair values of these financial instruments are presented in note 19.

Gross contractual cash-flows for other financial liabilities

The contractual cash-flows for financial liabilities included in trade and other payables are: £400m (2016: £388m) due in less than one year, £8m (2016: £9m) due between one and five years and £4m (2016: £5m) due after more than five years.

19 Derivative financial instruments

The tables below set out the nominal amount and fair value of derivative contracts held by the Group, identifying the derivative contracts which qualify for hedge accounting treatment:

					At 31 July 2017
	Contract or underlying nominal amount				Fair value
		£m	Assets £m	Liabilities £m	Net £m
Foreign exchange contracts (cash-flow hedges)		407	11	(10)	1
Foreign exchange contracts (not hedge accounted)		243	2	(1)	1
Total foreign exchange contracts		650	13	(11)	2
Currency swaps (net investment hedges)		109
Cross currency swaps (fair value and net investment hedges)		569	56		56
Interest rate swaps (fair value hedges)		113		(1)	(1)
Total financial derivatives		1,441	69	(12)	57
Balance sheet entries
Non-current		745	56	(2)	54
Current		696	13	(10)	3
Total financial derivatives		1,441	69	(12)	57

					At 31 July 2016
	Contract or underlying nominal amount				Fair value
		£m	Assets £m	Liabilities £m	Net £m
Foreign exchange contracts (cash-flow hedges)		393	8	(15)	(7)
Foreign exchange contracts (not hedge accounted)		529	3	(4)	(1)
Total foreign exchange contracts		922	11	(19)	(8)
Currency swaps (net investment hedges)		111		(1)	(1)
Cross currency swaps (fair value and net investment hedges)		326	25		25
Interest rate swaps (fair value hedges)		214	6		6
Total financial derivatives		1,573	42	(20)	22
Balance sheet entries
Non-current		473	29	(1)	28
Current		1,100	13	(19)	(6)
Total financial derivatives		1,573	42	(20)	22

Currency swaps not hedge accounted

These contracts comprise derivatives which were previously part of the net investment hedging programme and matching contracts to eliminate this exposure. There is no further net exposure arising from these contracts.

Accounting for other derivative contracts

Any foreign exchange contracts which are not formally designated as hedges and tested are classified as 'held for trading' and not hedge accounted.

Netting

International Swaps and Derivatives Association (ISDA) master netting agreements are in place with derivative counterparties except for contracts traded on a dedicated international electronic trading platform used for operational foreign exchange hedging. Under these agreements if a credit event occurs, all outstanding transactions under the ISDA are terminated and only a single net amount per counterparty is payable in settlement of all transactions. The ISDA agreements do not meet the criteria for offsetting, since the offsetting is enforceable only if specific events occur in the future, and there is no intention to settle the contracts on a net basis.

	Assets 31 July 2017 £m	Liabilities 31 July 2017 £m	Assets 31 July 2016 £m	Liabilities 31 July 2016 £m
Gross value of assets and liabilities	69	(12)	42	(20)
Related assets and liabilities subject to master netting agreements	(1)	1	(2)	2
Net exposure	68	(11)	40	(18)

20 Fair value of financial instruments

	Notes	Carrying value 31 July 2017 £m	Fair value 31 July 2017 £m	Carrying value 31 July 2016 £m	Fair value 31 July 2016 £m
Level 2 valuations
Financial assets - other investments	16	11	11
Financial derivatives - assets	19	69	69	42	42
Borrowings	17	(1,749)	(1,792)	(1,409)	(1,463)
Financial derivatives - liabilities	19	(12)	(12)	(20)	(20)
Level 3 valuations
Financial assets - other investments	16	10	10	9	9

Investments in bank deposits are valued at the bank balance, adjusted for accrued interest.

Derivatives, including forward exchange contracts, currency swaps, interest rate instruments, and embedded derivatives, are valued at the net present value of the future cash-flows calculated using market data at the balance sheet date (principally exchange rates and yield curves).

Borrowings are valued at the net present value of the future cash-flows using credit spreads and yield curves derived from market data. Borrowings are carried on the balance sheet at amortised cost adjusted for fair value interest rate hedging. The fair value of fixed rate borrowings is only used for supplementary disclosures.

Cash, trade receivables and trade payables are excluded from this table because carrying value is a reasonable approximation to fair value for all these assets and liabilities.

21 Commitments

Operating lease commitments - minimum lease payments

The minimum uncancellable lease payments which the Group is committed to make are:

		31 July 2017		31 July 2016
	Land and buildings £m	Other £m	Land and buildings £m	Other £m
Payments due
- not later than one year	34	7	35	7
- later than one year and not later than five years	68	7	76	6
- later than five years	24		22
	126	14	133	13

Other commitments

At 31 July 2017, commitments, comprising bonds and guarantees arising in the normal course of business, amounted to £186m (2016: £174m), including pension commitments of £54m (2016: £54m).

22 Provisions and contingent liabilities

	Trading	Non-headline and legacy			Total
	£m	John Crane, Inc. litigation £m	Titeflex Corporation litigation £m	Other £m	£m
Current liabilities	26	32	20	16	94
Non-current liabilities	6	220	74	5	305
At 31 July 2016	32	252	94	21	399
Exchange adjustments	1	1	1		3
Business combinations (note 26)	2				2
Provision charged	21	5	8	8	42
Provision released	(9)	(1)	(13)	(2)	(25)
Unwind of provision discount		4	2		6
Utilisation	(14)	(24)	(8)	(11)	(57)
Business disposals	(2)				(2)
At 31 July 2017	31	237	84	16	368
Current liabilities	25	30	21	9	85
Non-current liabilities	6	207	63	7	283
At 31 July 2017	31	237	84	16	368

The John Crane, Inc. and Titeflex Corporation litigation provisions are the only provisions that are discounted.

Trading

Warranty provision and product liability

At 31 July 2017 there are warranty and product liability provisions of £28m (2016: £29m). Warranties over the Group's products typically cover periods of between one and three years. Provision is made for the likely cost of after-sales support based on the recent past experience of individual businesses.

Commercial disputes and litigation in respect of ongoing business activities

Contingent liabilities

In the ordinary course of its business, the Group is subject to commercial disputes and litigation such as government price audits, product liability claims, employee disputes and other kinds of lawsuits, and faces different types of legal issues in different jurisdictions. The high level of activity in the US, for example, exposes the Group to the likelihood of various types of litigation commonplace in that country, such as 'mass tort' and 'class action' litigation, legal challenges to the scope and validity of patents, and product liability and insurance subrogation claims. These types of proceedings (or the threat of them) are also used to create pressure to encourage negotiated settlement of disputes. Any claim brought against the Group (with or without merit), could be costly to defend. These matters are inherently difficult to quantify. In appropriate cases a provision is recognised based on best estimates and management judgement but there can be no guarantee that these provisions (which may be subject to potentially material revision from time to time) will result in an accurate prediction of the actual costs and liabilities that may be incurred. There are also contingent liabilities in respect of litigation for which no provisions are made.

The Group operates in some markets where the risk of unethical or corrupt behaviour is material and has procedures, including an employee 'Ethics Alertline', to help it identify potential issues. Such procedures will, from time to time, give rise to internal investigations, sometimes conducted with external support, to ensure that Smiths Group properly understands risks and concerns and can take steps both to manage immediate issues and to improve its practices and procedures for the future. The Group also co-operates with relevant authorities in investigating business conduct issues whenever requested to. The Group is not aware of any issues which are expected to generate material financial exposures.

Non-headline and legacy

John Crane, Inc.

John Crane, Inc. ("JCI") is one of many co-defendants in numerous lawsuits pending in the United States in which plaintiffs are claiming damages arising from alleged exposure to, or use of, products previously manufactured which contained asbestos. Until 2006, the awards, the related interest and all material defence costs were met directly by insurers. In 2007, JCI secured the commutation of certain insurance policies in respect of product liability. Provision is made in respect of the expected costs of defending known and predicted future claims and of adverse judgments in relation thereto, to the extent that such costs can be reliably estimated.

The JCI products generally referred to in these cases consist of industrial sealing product, primarily packing and gaskets. The asbestos was encapsulated within these products in such a manner that causes JCI to believe, based on tests conducted on its behalf, that the products were safe. JCI ceased manufacturing products containing asbestos in 1985.

JCI continues to actively monitor the conduct and effect of its current and expected asbestos litigation, including the most efficacious presentation of its 'safe product' defence, and intends to continue to resist these asbestos claims based upon this defence. The table below summarises the JCI claims experience over the last 38 years since the start of this litigation:

	Year ended 31 July 2017	Year ended 31 July 2016	Year ended 31 July 2015	Year ended 31 July 2014	Year ended 31 July 2013
JCI claims experience
Claims against JCI that have been dismissed	273,000	247,000	242,000	235,000	230,000
Claims JCI is currently a defendant in	50,000	74,000	76,000	80,000	81,000
Cumulative final judgments, after appeals, against JCI since 1979	138	137	133	131	121
Cumulative value of awards ($'m) since 1979	160	158	153	149	120

The number of claims outstanding at 31 July 2017 reflects the benefit of 26,000 claims being dismissed in the year.

JCI has also incurred significant additional defence costs. The litigation involves claims for a number of allegedly asbestos related diseases, with awards, when made, for mesothelioma tending to be larger than those for the other diseases. JCI's ability to defend mesothelioma cases successfully is, therefore, likely to have a significant impact on its annual aggregate adverse judgment and defence costs.

John Crane, Inc. litigation provision

The provision is based on past history of JCI claims and well-established tables of asbestos-related disease incidence projections. The provision is determined using advice from asbestos valuation experts, Bates White LLC. The assumptions made in assessing the appropriate level of provision include: the period over which the expenditure can be reliably estimated; 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.

Established incidence curves can be used to estimate the likely future pattern of asbestos related disease. However, JCI's claims experience is also 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 in specific jurisdictions which move the balance of risk and opportunity for claimants; and legislative and procedural changes in both the state and federal court systems. The build-up of assets in trusts established by asbestos defendants in Chapter 11 restructuring ("524(g) trusts") will increase the influence of these trusts on the behaviour of claimants. Developments in the Garlock Sealing Technologies LLC Chapter 11 proceedings have provided additional data on plaintiff claims to 524 (g) trusts. Given the evidence that emerged of inconsistent duplicate claims, there is a significant likelihood that this will lead to changes in the pattern of claims made in the future, and the costs arising from claims.

The projections use a limited time horizon on the basis that Bates White LLC consider that there is substantial uncertainty in the asbestos litigation environment so probable expenditures are not reasonably estimable beyond this time horizon. Asbestos is the longest running mass tort litigation in American history which is constantly evolving in ways that cannot be anticipated. JCIs defence strategy also generates a significantly different pattern of legal costs and settlement expenses from other defendants, so JCI is in an extremely rare position, and evidence from other litigation cannot be used to improve the reliability of the projections. A ten year (2016: ten years) time horizon has been used 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, and recent events, like the Garlock Sealing Technologies LLC Chapter 11 proceedings, which may lead to further major changes.

The rate of future claims filed has been estimated using well-established tables of asbestos incidence projections to determine the likely population of potential claimants, and JCI's past experience to determine what proportion of this population will make a claim against JCI. The JCI products generally referred to in claims had industrial and marine applications. As a result, the incidence curve used for JCI projections excludes construction workers, and is a composite of the curves that predict asbestos exposure-related disease from shipyards and other occupations. This is consistent with JCI's litigation history.

The rate of successful resolution of claims and the average amount of any judgments awarded are projected based on the past history of JCI claims, since this is the best available evidence, given JCI's unusual strategy of defending all claims.

The future trend of legal costs is estimated based on JCI's past experience, adjusted to reflect the assumed levels of claims and trial activity, since the number of trials is a key driver of legal costs.

John Crane, Inc. litigation insurance recoveries

While JCI has excess liability insurance, the availability of such insurance and scope of the cover are currently the subject of litigation in the United States. Pending the outcome of that litigation, JCI has met defence costs directly. The calculation of the provision does not take account of any potential recoveries from insurers.

John Crane, Inc. litigation provision history

The JCI asbestos litigation provision has developed over the last five years as follows:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m	Year ended 31 July 2015 £m	Year ended 31 July 2014 £m	Year ended 31 July 2013 £m
John Crane, Inc. litigation provision
Gross provision	260	267	236	227	233
Discount	(23)	(15)	(20)	(23)	(23)
Discounted provision	237	252	216	204	210
Operating profit charge/(credit)
Increased provisions for adverse judgments and legal defence costs	17	8	14	49	23
Change in US risk free rates	(13)	7	1	(2)	(9)
Litigation management, legal fees in connection with litigation against insurers and defence strategy	11	8	4	1
Recoveries from insurers	(6)	(16)
Operating profit charge	9	7	19	48	14
Cash-flow
Provision utilisation	(24)	(22)	(24)	(36)	(27)
John Crane, Inc. litigation spend	32	32	27	25	29

The reduction in 2017 is due to increasing US dollar discount rates, with no material movement in the gross provision.

The significant increase in the provision in 2016 is primarily due to the weakening of Smiths reporting currency against the US dollar (£39m increase in the provision) and lower US discount rates (£7m charge to the income statement).

The operating charge for John Crane, Inc. litigation comprises:

▪ a charge of £17m (2016: £8m) in respect of the net increased provision for adverse judgments and legal defence costs,

▪ a credit of £13m arising from an increase in US risk free rates (2016: charge of £7m), and

▪ £11m (2016: £8m) costs for litigation management, defence strategy and legal fees in connection with litigation against insurers.

In the year ended 31 July 2016 JCI recognised the recovery of £16m through a settlement with an insurer. This agreement does not provide any cover for future costs, so there is no material impact on the closing litigation provision. A further settlement was agreed in the current year.

John Crane, Inc. litigation provision sensitivities

The provision may be subject to potentially material revision from time to time if new information becomes available as a result of future events. 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 because of the significant uncertainty associated with the future level of asbestos claims and of the costs arising out of related litigation.

Statistical reliability of projections over the ten year time horizon

In order to evaluate the statistical reliability of the projections, a population of outcomes is modelled using randomised verdict outcomes. This generated a distribution of outcomes with future spend at the 5th percentile of £231m and future spend at the 95th percentile of £304m (2016: £236m and £311m, respectively). Statistical analysis of the distribution of these outcomes indicates that there is a 50% probability that the total future spend will fall between £243m and £272m (2016: between £250m and £280m), compared to the gross provision value of £260m (2016: £267m).

Sensitivity of the projections to changes in the time horizon used

If the asbestos litigation environment becomes more volatile and uncertain, for example if defendants are successful in legal cases against plaintiff law firms and this impacts the nature of claims filed, the time horizon over which the provision can be calculated may reduce. Conversely, if the environment became more stable, or JCI changed approach and committed to long term settlement arrangements, the time period covered by the provision might be extended.

The projections use a 10 year time horizon. Reducing the time horizon by one year would reduce the provision by £17m (2016: £18m) and reducing it by five years would reduce the provision by £98m (2016: £107m).

We consider, after obtaining advice from Bates White LLC, that to forecast beyond ten years requires that the litigation environment remains largely unchanged with respect to the historical experience used for estimating future asbestos expenditures. Historically, the asbestos litigation environment has undergone significant changes more often than every ten years. If one assumed that the asbestos litigation environment would remain unchanged for longer and extended the time horizon by one year it would increase the provision by £14m (2016: £16m) and extending it by five years would increase the provision by £58m (2016: £67m). However, there are also reasonable scenarios that, given certain recent events in the US asbestos litigation environment, would result in no additional asbestos litigation for JCI beyond ten years. At this time, how the asbestos litigation environment may evolve beyond 10 years is not reasonably estimable.

John Crane, Inc. contingent liabilities

Provision has been made for future defence costs and the cost of adverse judgments expected to occur. 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. As a result, whilst the Group anticipates that asbestos litigation will continue beyond the period covered by the provision, the uncertainty surrounding the US litigation environment beyond this point is such that the costs cannot be reliably estimated.

Although the methodology used to calculate the JCI litigation provision can in theory be applied to show claims and costs for longer periods, the Directors consider, based on advice from Bates White LLC, that the level of uncertainty regarding the factors used in estimating future costs is too great to provide for reasonable estimation of the numbers of future claims, the nature of such claims or the cost to resolve them for years beyond the 10 year time horizon.

Titeflex Corporation

In recent years 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. Equivalent third-party products in the US marketplace face similar challenges.

Titeflex Corporation litigation provision

The continuing progress of claims and the pattern of settlement, together with the recent market place activity, provide sufficient evidence to recognise a liability in the accounts. Therefore provision has been made for the costs which the Group is expected to incur in respect of future claims to the extent that such costs can be reliably estimated. Titeflex Corporation sells flexible gas piping with extensive installation and safety guidance (revised in 2008) designed to assure the safety of the product and minimise the risk of damage associated with lightning strikes.

The assumptions made in assessing the appropriate level of provision, which are based on past experience, include: the period over which expenditure can be reliably estimated; the number of future settlements; the average amount of settlements; and the impact of statutes of repose and safe installation initiatives on the expected number of future claims.

The provision of £84m (2016: £94m) is a discounted pre-tax provision using discount rates, being the risk-free rate on US debt instruments for the appropriate period. The deferred tax asset related to this provision is shown within the deferred tax balance (note 6).

	31 July 2017 £m	31 July 2016 £m
Gross provision	136	140
Discount	(52)	(46)
Discounted pre-tax provision	84	94
Deferred tax	(33)	(36)
Discounted post-tax provision	51	58

Titeflex Corporation litigation provision history

An additional provision of £8m (2016: £12m) has been recognised by Titeflex Corporation in respect of changes to the estimated cost of future claims from insurance companies seeking recompense for damage allegedly caused by lightning strikes. The offsetting provision release of £13m is principally due to increasing discount rates.

In 2016, a £1m overprovision for the costs of settling claims was released, generating a net charge for the year of £11m.

Titeflex Corporation litigation provision sensitivities

However, because of the significant uncertainty associated with the future level of claims and of the costs arising out of 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 and, as a result, the provision may be subject to potentially material revision from time to time if new information becomes available as a result of future events.

The projections incorporate a long-term assumption about the impact of safe installation initiatives on the level of future claims. If the assumed annual benefit of bonding and grounding initiatives was 0.5% higher the provision would be £5m (2016: £6m) lower, and if the benefit was 0.5% lower, the provision would increase by £5m (2016: £7m).

Other non-headline and legacy

Legacy provisions comprise provisions relating to former business activities and properties no longer used by Smiths. Non-headline provisions comprise all provisions that were disclosed as non-headline items when they were charged to the consolidated income statement.

These provisions cover non-headline reorganisation, vacant properties, disposal indemnities and litigation in respect of old products and discontinued business activities.

Reorganisation and property

At 31 July 2017 there were provisions of £8m (2016: £11m) related to Fuel for Growth, £3m (2016: £3m) related to onerous leases and dilapidations provisions, and £2m (2016: £2m) related to actual and potential environmental issues for sites which were no longer occupied by Smiths operations. The Fuel for Growth provisions are expected to be utilised in 2018.

Disposal

Other provisions include disposal provisions of £3m (2016: £3m) relating to warranties and other obligations in respect of the disposal of the Marine Systems and Aerospace businesses. Most of the balance is expected to be utilised within the next five years.

23 Share capital

	Number of shares	Issued capital £m	Consideration £m
Ordinary shares of 37.5p each
Total share capital at 31 July 2015	394,860,004	148
Exercise of share options	363,068		3
Total share capital at 31 July 2016	395,223,072	148
Exercise of share options	253,590		3
Total share capital at 31 July 2017	395,476,662	148

At 31 July 2017 all of the issued share capital was in free issue. All issued shares are fully paid.

24 Dividends

The following dividends were declared and paid in the period:

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Ordinary final dividend of 28.75p for 2016 (2015: 28.00p) paid 18 November 2016	114	111
Ordinary interim dividend of 13.55p for 2017 (2016: 13.25p) paid 28 April 2017	53	52
	167	163

The final dividend for the year ended 31 July 2017 of 29.70p per share was recommended by the Board on 21 September 2017 and will be paid to shareholders on 17 November 2017, subject to approval by the shareholders. This dividend has not been included as a liability in these accounts and is payable to all shareholders on the register of Members at close of business on 20 October 2017.

25 Reserves

Retained earnings include the value of Smiths Group plc shares held by the Smiths Industries Employee Benefit Trust. In the year the Company issued nil (2016: nil) shares to the Trust, and the Trust purchased 658,217 shares (2016: 760,218 shares) in the market for a consideration of £10m (2016: £8m). At 31 July 2017 the Trust held 766 (2016: 852) ordinary shares.

The capital redemption reserve, revaluation reserve and merger reserve arose from: share repurchases; revaluations of property, plant and equipment; and merger accounting for business combinations before the adoption of IFRS, respectively.

Capital management

Capital employed comprises total equity adjusted for goodwill recognised directly in reserves, net post-retirement benefit related assets and liabilities, net litigation provisions relating to non-headline items and net debt. The efficiency of the allocation of the capital to the divisions is monitored through the return on capital employed (ROCE). This ratio is calculated over a rolling 12-month period and is the percentage that headline operating profit comprises of monthly average capital employed. The ROCE was 16.2% (2016: 15.3%), see note 30.

The capital structure is based on the directors' judgement of the balance required to maintain flexibility while achieving an efficient cost of capital.

The ratio of net debt to headline EBITDA of 1.4 (2016: 1.6) is within the Group's stated policy of 2.0 or less over the medium term. The Group's robust balance sheet and record of strong cash generation is more than able to fund the immediate investment needs and other legacy obligations. See note 30 for the definition of headline EBITDA and the calculation of this ratio.

As part of its capital management the Group strategy is to maintain a solid investment grade credit rating to ensure access to the widest possible sources of financing and to minimise the resulting cost of capital. At 31 July 2017 the Group had a credit rating of BBB+/Baa2 (2016: BBB+/Baa2) with Standard & Poor's and Moody's respectively.

The Board has a progressive dividend policy for future payouts, with the aim of increasing dividends in line with the long-term underlying growth in earnings. 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.

Hedge reserve

	31 July 2017 £m	31 July 2016 £m
The hedge reserve on the balance sheet comprises
- cash-flow hedge reserve	1	(7)
- net investment hedge reserve	(291)	(294)
	(290)	(301)

See transactional currency exposure risk management disclosures in note 18 for additional details of cash-flow hedges, and translational currency exposure risk management disclosure also in note 18 for additional details of net investment hedges.

26 Acquisitions

The Group acquired the Morpho Detection business from Safran S. A. on 6 April 2017. The terms of the competition clearance for this transaction required the Group to sell the Morpho Detection explosive trace detection business. Consequently, the Morpho Detection explosive trace detection business was treated as a business acquired for resale, and the trading result during the period of ownership and the loss on disposal have been reported in discontinued operations, see note 27.

The intangible assets recognised on this acquisition comprise technology, in process research and development, customer and service relationships and the order book on acquisition. Goodwill represents the potential future technology developments and the cost savings that can be realised by integrating Morpho Detection with the continuing Smiths Detection business. The goodwill recognised is expected to be deductible for tax purposes.

From the date of acquisition to 31 July 2017, Morpho Detection, excluding its explosive trace detection business, contributed £62m to revenue, £5m to headline profit before taxation and a loss of £24m to profit before taxation due to the unwind of inventory fair value adjustments £3m, the amortisation of acquired intangible assets £8m and integration and acquisition costs £18m. If Smiths had acquired Morpho Detection at the beginning of the financial period, the acquisition, excluding its explosive trace detection business, would have contributed £184m to revenue, £19m to headline profit before taxation and a loss of £22m to profit before taxation.

The provisional balance sheet of Morpho Detection on the date of acquisition is:

		Morpho Detection
		£m
Non-current assets
- acquired intangible assets		240
- software		6
- plant and equipment		8
Current assets
- inventory		50
- trade and other receivables		49
- cash and cash equivalent		12
Morpho Detection explosive trace detection business		68
Non-current liabilities
- deferred taxation		(5)
Current liabilities
- other current liabilities		(48)
Net assets acquired		380
Goodwill on current year acquisitions		210
Total consideration		590
Cash paid during the year		592
Recycling of cash-flow hedging on consideration		(2)
Total consideration		590

27 Discontinued operations and businesses held for sale

The Group acquired the Morpho Detection explosive trace detection business on 6 April 2017 after making commitments to the European Commission and the US Departments of Justice to sell this business to an approved purchaser. The Group began marketing this business for sale once the terms of the competition clearance were known. Consequently, this business was treated as a business acquired for resale, and the assets and liabilities were classified as held for sale during the period the business was owned by the Group. The sale was completed on 7 July 2017 for a cash consideration of £63m.

A loss after tax of £8m (2016: £nil) was generated by discontinued operations, giving a loss per share from discontinued operations, basic and diluted, of 2.0p (2016: nil). Cash invested in financial assets includes £7m (2016: £nil) relating to discontinued operations.

There were no assets or businesses held for sale at 31 July 2017. At 31 July 2016 the assets and liabilities of the John Crane Artificial lift business were disclosed as held for sale. No impairment loss was recognised on writing these assets down to fair value less disposal costs although impairments were recognised earlier in the year relating to this business, see note 11.

			31 July 2016 £m
Current assets
Inventories			17
Trade and other receivables			7
Total assets of business held for sale			24
Current liabilities
Trade and other payables			(5)
Total liabilities of business held for sale			(5)

28 Disposals

In the year, the Group has sold the John Crane Artificial Lift business (US: 31 October 2016, Romania: 23 November 2016), Smiths Medical's Wallace product line (7 November 2016), the Smiths Interconnect Power business (25 January 2017) and Smiths Interconnect Microwave Telecoms (28 April 2017).

Smiths Medical's Wallace product line was fully integrated, so products will continue to be manufactured on behalf of the acquirer under a Manufacturing Transition Services Agreement while the acquirer is setting up their manufacturing capacity. This activity has been treated as ongoing trading activity.

	John Crane Artificial lift £m	Smiths Medical Wallace £m	Smiths Interconnect Power £m	Smiths Interconnect Microwave Telecoms £m	Other £m	Total £m
Consideration	30	134	170	91		425
Less: transaction costs	(1)	(2)	(6)	(6)		(15)
Net consideration received	29	132	164	85		410
Net assets disposed of:
- intangible assets		(32)	(134)	(12)		(178)
- property, plant and equipment			(2)	(4)		(6)
- inventory	(17)		(12)	(16)		(45)
- trade and other receivables	(11)		(19)	(20)	(1)	(51)
- tax	(1)		(3)	(3)		(7)
- cash and cash equivalents			(5)	(6)		(11)
- liabilities	5		18	20		43
Net assets	(24)	(32)	(157)	(41)	(1)	(255)
Recycling of foreign exchange	(1)		15	6		20
Profit on disposals	4	100	22	50	(1)	175

29 Cash-flow

Cash-flow from operating activities

	Year ended 31 July 2017			Year ended 31 July 2016
	Headline £m	Non-headline £m	Total £m	Headline £m	Non-headline £m	Total £m
Operating profit	589	85	674	510	(123)	387
Amortisation of intangible assets	44	18	62	43	15	58
Impairment of intangible assets					23	23
Impairment of trade investments					2	2
Depreciation of property, plant and equipment	57		57	53		53
Impairment of property, plant and equipment					6	6
Loss on disposal of property, plant and equipment	4		4	2		2
Profit on disposal of business		(175)	(175)
Share-based payment expense	13	1	14	9		9
Retirement benefits	1	(94)	(93)	1	(104)	(103)
Decrease in inventories	52		52	30		30
Decrease/(increase) in trade and other receivables	31	8	39	(21)	(16)	(37)
Increase/(decrease) in trade and other payables	8	8	16	1		1
(Decrease)/Increase in provisions	(6)	(34)	(40)	(1)	3	2
Cash generated from operations	793	(183)	610	627	(194)	433
Interest paid	(65)		(65)	(61)		(61)
Interest received	5	11	16	3	45	48
Tax paid	(82)		(82)	(62)		(62)
Net cash inflow from operating activities	651	(172)	479	507	(149)	358

Interest received in the period includes £6m (2016: Interest received includes £41m cash inflows) on foreign exchange contracts hedging exposures on intra-group loans, and £5m exchange gains (2016: £4m exchange gains) realised on internal interest.

The split of tax payments between headline and non-headline only considers the nature of payments made. No adjustment has been made for reductions in tax payments due to tax relief received on non-headline items.

Retirement benefit contributions in 2016 included cash contributions of £123m and a non-cash transaction where £152m of financial assets were contributed to the Smiths Industries Pension Scheme

Headline cash measures

The Group measure of headline operating cash excludes interest and tax and includes capital expenditure supporting organic growth.

	Year ended 31 July 2017			Year ended 31 July 2016
	Headline £m	Non-headline £m	Total £m	Headline £m	Non-headline £m	Total £m
Net cash inflow from operating activities	651	(172)	479	507	(149)	358
Include
Expenditure on capitalised development, other intangible assets and property, plant and equipment	(107)		(107)	(108)		(108)
Disposals of property, plant and equipment	9		9	1		1
Investment in financial assets relating to operating activities and pensions financing	(5)	(6)	(11)		(8)	(8)
Free cash-flow	548	(178)	370	400	(157)	243
Exclude
Investment in financial assets relating to operating activities and pensions financing outstanding at the balance sheet	5	6	11
Interest paid	65		65	61		61
Interest received	(5)	(11)	(16)	(3)	(45)	(48)
Tax paid	82		82	62		62
Headline operating cash-flow	695	(183)	512	520	(202)	318

Reconciliation of headline free cash-flow to total movement in cash and cash-equivalents

	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Free cash-flow	370	243
Investment in other financial assets	(7)	(1)
Acquisition of businesses	(580)	(8)
Disposal of businesses and discontinued operations	462
Net cash-flow used in financing activities	116	(332)
Net increase/(decrease) cash and cash equivalents	361	(98)

30 Non-statutory capital and credit metrics

In addition to the non-statutory profit measures explained in note 3, the Company calculates credit metrics and return on capital employed incorporating the same adjustments. See the disclosures on presentation of results in accounting policies for an explanation of the excluded items.

Return on capital employed (ROCE)

Smiths ROCE is calculated over a rolling 12-month period and is the percentage that headline operating profit comprises of monthly average capital employed.

See note 1 for the divisional headline operating profit and average divisional capital employed used to calculate divisional ROCE.

Capital employed

	Notes	31 July 2017 £m	31 July 2016 £m
Net assets		2,104	1,660
Adjust for
Goodwill recognised directly in reserves		787	815
Post-retirement benefit assets and liabilities	8	(224)	(80)
Tax related to post retirement benefit assets and liabilities		22	(4)
John Crane, Inc. litigation provisions and related tax	22	158	168
Titeflex Corporation litigation provisions and related tax	22	51	58
Net debt	17	967	978
Capital employed		3,865	3,595

Return on capital employed

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Headline operating profit for previous twelve months		589	510
Average capital employed	1	3,639	3,324
ROCE		16.2%	15.3%

Credit metrics

Smiths Group monitors the ratio of net debt to Headline EBITDA as part of its management of credit ratings, see note 25 for details. This ratio is calculated as follows.

Headline earnings before interest, tax depreciation and amortisation (Headline EBITDA)

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Headline operating profit		589	510
Exclude
- depreciation	12	57	53
- amortisation of development costs	10	27	26
- amortisation of software, patents and intellectual property	10	17	17
Headline EBITDA		690	606

£1m of software amortisation was charged to restructuring projects, so treated as a non-headline cost.

Ratio of net debt to headline EBITDA

	Notes	Year ended 31 July 2017 £m	Year ended 31 July 2016 £m
Headline EBITDA		690	606
Net debt	17	967	978
Ratio of net debt to headline EBITDA		1.4	1.6

This information is provided by RNS

The company news service from the London Stock Exchange

END

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Smiths Group (SMIN)

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Final Results

London, Friday 22 September 2017

Good progress in executing our strategy for sustainable growth

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Andrew Lorenz, FTI Consulting +44 (0)20 3727 1323

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Outperforming our chosen markets

Achieving world-class competitiveness

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