Well, good morning, everyone. I appreciate you joining us as we discuss our 2019 interim operating results. I'd also like to welcome those joining us via WebEx. I'm joined here today by Jonathan Davis, our Group Finance Director, as well as Martin Lamb, our Chairman, and Andrew Carter, our Investor Relations Director. We'll follow our usual format for today. I'll begin with a few highlights from our first half of 2019, then we'll have Jonathan walk us through the financials in a bit more detail. I'll then return and discuss the progress we're making on our Growth Acceleration Programme and say a few words regarding our outlook for 2019.
As I reflect on our progress for the first half of 2019, it can be characterized as one of continued focused execution towards our previously stated ambition of delivering sustainable mid to high single-digit revenue growth and mid-20s adjusted operating margins over time. We're now 18 months into our five-year journey, which continues to build upon the best elements within Rotork while adding management-driven improvements to stimulate the growth and the margin we desire. Against a backdrop of macroeconomic conditions that continue to be uncertain, once again, we have delivered strong operating performance. Against a demanding comparison period and absent orders and revenues from sanctioned countries, H1 order intake was down less than 1% on a reported basis, and revenues declined 3.7%. This revenue decline was partially the result of a difference in the timing of orders received.
You'll recall in 2018, our first quarter was significantly larger than our second quarter, with the receipt of several large project orders within our downstream business in the Far East. This year, encouragingly, our second quarter order intake was ahead sequentially and year-on-year on an OCC basis, indicative of the gradual improvement in overall activity levels we've seen in recent quarters. I'm pleased with our first half execution, as evidenced by continued progress on operating margins rising 130 basis points on a decline in revenues to end of 21.1%. Strong cash conversion of 117%, with period ending net cash of GBP 43 million. This level of cash generation continues to demonstrate our ability to self-fund our Growth Acceleration Programme. A 250 basis point increase in return on capital employed to end at almost 30%.
Once again, a strong outcome demonstrating our team's continued ability to drive day-to-day execution while implementing the initiatives identified through our Growth Acceleration Programme. We'll have Jonathan walk us through our detailed first half financial results.
Thank you, Kevin. Good morning, everybody. We're pleased to report progress with the Growth Acceleration Programme, particularly in respect of margins and cash generation, especially against a backdrop of continued macro uncertainty. Order intake in the second quarter was higher sequentially and compared with the second quarter of last year. The impact of currency, which started the year as a headwind, switched to a tailwind in the second quarter, and over the first half as a whole was roughly a 1% tailwind to revenue and profit. The businesses disposed of in 2018 reported GBP 2 million of orders, GBP 2.5 million of revenue, and GBP 0.4 million of adjusted operating profit in H1 2018. Both the currency and 2018 disposals were adjusted in arriving at organic constant currency or OCC results. Order intake of GBP 362 million is 1.3% lower on an OCC basis.
The order book is 1.6% lower than June last year, but 24% or £44 million higher than the start of the year. Revenue was £319 million, 4.3% lower on an OCC basis. Adjusted operating profit of £67.2 million grew 1.7%, and margins on an OCC basis were 120 basis points higher than H1 2018 at 21%. Adjusted earnings per share was £0.058, a 1.5% increase, and the interim dividend is £0.023, up 4.5%. The order book increased £44 million in the period on an OCC basis. Compared with last June, the most noticeable change is the mix in the order book between Fluid Systems and Controls. Controls saw good growth in order intake, but the order book currently has a greater proportion of orders for delivery in the following financial year than it did in June 2018.
Fluid systems, on the other hand, has seen the sharpest reduction in order intake compared with a very strong H1 2018. The 2018 order intake pattern was unusual, and this year looks likely to revert to the more normal pattern such as we saw in 2017. This would typically mean fluid systems is the division where revenue is most highly H2 weighted. Instruments benefited from an uptick in subsea activity, which with longer delivery time frames has boosted the order book. The adjusted operating profit bridge on an OCC basis shows that the reduction in volume has more than been compensated for by lower costs in all areas as we see pleasing momentum from the Growth Acceleration Programme. Materials were 80 basis points lower compared with H1 2018, with nearly half of this due to positive divisional mix and the remainder due to improvements in three of the divisions.
This is where we see the positive impact of sourcing and pricing, as well as the negative impact of tariffs. Improving direct labor productivity and reductions to the fixed cost element of the factories added a further 100 basis points. These improvements totaled GBP 5.3 million, and on an OCC basis, gross margin improved 100 basis points to 45.7%. Overheads reduced GBP 4 million or 5.1%, half of which was due to lower headcount, with the balance spread over many cost headings. As a result, adjusted operating margins increased 120 basis points to 21%. Overall, headcount reduced 4% in the period. We've added in some key areas and reduced in other areas, either through productivity improvements, rebalancing resources geographically, or establishing a solid base from which to grow. Some of these cost reductions will reverse in the second half as we build headcount in certain focus areas and disciplines.
We started the year with net cash of GBP 43.6 million, but the introduction of IFRS 16 on leases reduced this by GBP 12 million. Cash conversion in the period was 117%. Working capital in the cash flow, which uses average exchange rates, was an inflow of GBP 11.5 million, with inventory the main driver. CapEx was GBP 8 million, as we see an increase in IT investment, but no major spend on facilities in the first half. We closed the period with net cash of GBP 43.1 million. Net working capital has decreased GBP 10 million compared with either December or June 2018. The Growth Acceleration Programme inventory reduction initiatives began to gain traction in the period, and inventory has reduced GBP 7 million since December and GBP 14 million since last June. As a function of revenue, it is 13.8% compared with 15.3% last June or 13.6% in December, which benefits from the higher H2 revenue.
Net working capital as a whole is 28.6% of revenue based on two times H1 sales, an increase from 27.7% for the full year 2018, but slightly below the 29% last June. Return on capital employed has increased 250 basis points over the last 12 months to 29.7%, 50 basis points higher than the year to December, driven by both the increased profitability and reduced asset base. The adjustments to profit in the period comprise redundancy and restructuring costs, and intangible amortization. Restructuring costs largely relate to the two manufacturing sites we've closed this year in Taunton and Tulsa. Activities have been transferred to other locations, but redundancies and asset write-downs at both sites totaled GBP 3.9 million. The payback on the GBP 2.7 million cash cost of these two site consolidations is within our two-year target for such activities.
These costs are weighted to the first half. We anticipate full-year costs to be circa GBP 6 million. Looking to the full year, let me provide some guidance on some key points. The effective tax rate for 2019 on adjusted operating profit is 20 basis points lower than 2018 at 23.5%. There are no significant changes within this reduction, but it is driven by the geographic mix of profits plus tax rate reductions in some specific markets. Our focus on the global supply chain continues to yield results, and we remain on track to deliver the GBP 5 million of targeted savings this year. The second half will see an increase in people costs compared with the first half, as having reduced in some areas to balance geographic coverage and skills, we will begin to invest in support of our growth ambitions in our emerging markets.
Bonus and share scheme costs are also H2 weighted in line with profit. Whilst our guidance is based on OCC numbers, currency will impact the headline results. Using a US dollar rate of $1.22 and euro rate of €1.10 for the remainder of 2018 would result in around a 2.2% tailwind to revenue and operating profit for the year as a whole. The investment in the new ERP system is progressing as planned. However, site development plans are being reassessed as our lean initiatives gain momentum. As a result, CapEx for the full year is likely to be lower than the range we guided to in March, and more like GBP 25 million in 2019. In our preparation for Brexit, we've looked at the risk of a hard Brexit.
Whilst the timing of this has changed, it still has the potential to impact our results by circa GBP 1 million this year if we move to WTO tariffs from 31st of October. U.S.-China tariffs are already having an impact, largely on the Gears division, costing GBP 0.6 million in H1. Based on the current position, the costs will rise to around GBP 1.8 million for the full year. Turning to the operational review. This slide summarizes the group's key markets and geographies. These slides are on an as reported basis. North America and Latin America were the two regions which grew. Asia-Pacific and Eastern Europe faced much tougher comparatives with the larger projects reflected there in 2018. Midstream was the fastest-growing end market, as a result, oil and gas increased from 53% to 54% of group sales. Downstream declined, at a slower rate than group sales as a whole.
Water grew, this was compared with a relatively slow start to water in 2018 in North America. Power sales fell by 19%, led by India and China, this reduction also includes the impact from the sale of our nuclear actuator business last year. Industrial process was flat with growth in Asia-Pacific offset by declines elsewhere. Turning now to the divisions. In controls, order intake was up 3.7%, revenue was 2.5% lower on an OCC basis. Gross margins improved 150 basis points. The lower material costs were the result of procurement savings as well as favorable product mix, the large high material cost projects in 2018 were not repeated this year. Labor productivity improved, contributing 30 basis points, but other factory costs did not reduce quite as fast as revenue, a 40 basis point headwind. At an adjusted operating profit level, OCC margins improved 210 basis points.
Water and wastewater sales grew the fastest in the period, up GBP 4 million. Most of this was in North America and due to weak comparatives. Industrial process sales in Asia Pacific led this market to increase to 18% of the division. Oil and gas remained 50% of sales, with small increases in downstream offset by a larger decline in upstream. Downstream growth was largest in North America, and the upstream reductions largest in Eastern Europe, where we delivered a major project in H1 2018. The declines in power, which reduced to 14% of the divisional sales, was principally thermal plants in India and China. Fluid systems order intake was 17% lower on an OCC basis. The comparative period was very strong, particularly in Q1, and the lower large project activity and closure of markets due to sanctions contributed to the reduction.
Underlying day-to-day business remains at good levels, the larger projects continue to suffer delays to order placement. With lower order intake, particularly in Q1, and a smaller order book coming into the current year, revenue was down 15%. Material costs are 190 basis points lower, this has been added to by productivity gains. However, whilst actions were taken to reduce the cost of the factories by GBP 0.6 million, this was a smaller rate of reduction than revenue. The net impact was a 120 basis point improvement in gross margins despite the revenue reduction. Cost control activities were also applied to overheads, reducing them by GBP 1.1 million, this did not fully compensate for the lower revenue, net margins were 130 basis points lower. Looking at the end markets, midstream grew in the period led by Eastern Europe and Latin America.
Latin America was the only region to show overall growth, with North America showing the greatest decline, largely in oil and gas. The large projects delivered last year, with downstream in Asia Pacific and upstream in Eastern Europe the most prominent, were not repeated in the current period. The sharp decline in power was the result of the sale of our nuclear actuator business last year. On an OCC basis, order intake in Gears was 4.8% lower, but underlying revenue increased 3.2%. Despite improved labor productivity and factory efficiencies, gross margin fell 440 basis points. Material costs rose GBP 2.7 million or 500 basis points, due largely to supplier cost increases and the U.S.-China tariffs, with some impact also from the mix of sales between external customers and the other divisions. Overheads reduced 12% in the period and also benefited from the closure of the ValveK its facility last year.
The net result was a £0.6 million reduction in adjusted operating profit, a 210 basis point reduction in adjusted operating margin. Margins in H2 faced the increased impact of tariffs, which I mentioned earlier. These affect Gears more than the other divisions. Midstream and downstream sales drove the increase in overall oil and gas sales from 48% to 60% of divisional sales, with activity in North America most positive. Water and industrial sales were slightly lower. North America was the strongest growth region, with Middle East, Asia Pacific, and Eastern Europe all showing some growth as well. Instruments order intake increased 8.3% on an OCC basis, boosted by an uptick late in the period in subsea activity. Revenue was slightly lower. Underlying gross margins increased 230 basis points, benefiting from improved material costs, labor productivity, and a reduction in factory costs.
When combined with a GBP 0.7 million reduction in overheads, this led to a 330 basis points increase in adjusted operating margin to 24.8%. Both H2 2018 and the current period benefited from the increased focus on managing the cost base, including the closure of the Regional Engineering Center in Q3 2018. These results are slightly ahead of the 23.6% adjusted operating margin in the second half of 2018. Upstream and midstream sales grew in the period, but a larger reduction in downstream means oil and gas reduced by 1% to 46% of the division sales. The other end markets were fairly consistent with H1 2018, and the only change is industrial increased by 1% to 22% of sales. Geographically, Asia Pacific and Middle East increased slightly, and Western Europe decreased slightly. All other regions were very similar to H1 2018. I want to hand back to Kevin.
Thank you. Thank you, Jonathan. Let me now say a few words about our current markets and environment. I'm on slide 16 in the deck for those online. Oil prices remained volatile in the first half, but above what we consider as incentive levels of GBP 50 per barrel for WTI and GBP 60 per barrel for Brent Crude. Current CapEx forecasts for the oil and gas sector are tempering somewhat and are now reflective of an overall increase of low to mid-single digits year-on-year versus prior predictions of mid to high single-digit increases. For Rotork, oil and gas accounted for 54% of group revenue, with a significant increase in the percentage of midstream sales as a proportion of revenue, offsetting a small reduction in the percentage of contribution from upstream.
Rotork's upstream growth continues to be driven by Middle East wellhead expansions and an overall drive to increase operating efficiencies, the initial signs of the return of the subsea business, partially offset by reductions in spending in Eastern Europe. The midstream segment for Rotork is largely about pipelines and LNG. We see pipeline expansion serving the U.S. shale market and pipeline expansion specifically related to LNG, as well as general LNG-related expansion beyond pipelines on a global basis. Midstream sales growth was also evident in the Far East, Eastern Europe, and Latin America. Within our downstream business, we continued positive momentum in both refinery expansion and petrochem, driven largely by a growing population and increasing prosperity. Downstream sales were lower overall despite encouraging growth in North America, largely due to the prior year's significant project orders in Asia.
While much has been said about the current volatility in the U.S. shale market, I'll remind you historically, this has not been an area of focus for Rotork. In our other end markets, we expect water to be mixed geographically, with modest expansion in the North American market, strong expansion in India, and moderating growth in the near term in China. Whilst our sales in the power market declined double digits, contributing to this decline, as Jonathan indicated, was the sale of our nuclear actuator business last year. Industrial process sales were flat, reflecting the general industrial sector moderating as growth in China and the U.S. slows as a result of their current trade disputes and the carry-on impact this is having on global markets. Let's take a closer look at our workstream progress. I'm on slide 17.
I'm pleased to report our Growth Acceleration Programme remains on track, and our team's execution on our priorities is very strong. The overriding themes of our workstreams continue to include re-engaging, reinvesting in, and strengthening our customer focus and intimacy, driving operational and supply chain efficiencies, improving our processes and focus within our innovation and new product development efforts, improving our talent acquisition and development and cultural programs, a renewed emphasis on headcount productivity, and a critical review of our strategy, our portfolio, and our current product lines. Our four pillars and our underlying set of portfolio assessments each continue to have a role driving the growth and margin enhancements we desire. Let's take a closer look at our execution in the first half of 2019 within each of these pillars. As is our usual practice, we'll begin with our customers first and start with our commercial excellence pillar.
Turning to slide 18. We initiated our migration from a product-based organization to an organization more closely aligned around market segments in the first half of 2019. We successfully completed our North Asia transition in the second quarter, and we've initiated the transitions in South Asia, Europe, and the Middle East. We continue to expect that we'll be largely complete with our phased-in approach by the second quarter of 2020. Our efforts to streamline our quoting, sales, and back-office processes are going well, demonstrating the power of applying lean techniques beyond the manufacturing shop floor. We've kicked off our Value-Selling Process, fully developing our Rotork Value-Selling Toolkit in order to drive price yield through a deeper understanding of the value our products and services provide our customers. By year-end, we will have trained the vast majority of our field sales team. In our site service business, our focus is twofold.
We are streamlining our processes and our organizational structure to allow further scale and service capabilities, including regionalizing or centralizing some of the support functions. This, while simultaneously accelerating our broader aftermarket and lifetime management functions. We continue to add and rebalance our resources geographically to ensure we're providing the necessary service personnel in our highest opportunity regions. Under the leadership of our new site services director, we'll continue driving the comprehensive lifetime management of our installed base as we progress through our migration from reactive to preventative to ultimately predictive maintenance programs. Turning to our innovation and new product development, we continue increasing our emphasis on new product development efforts to drive organic growth.
We are driving efficiencies within our new product and innovation efforts through improved project selection at the group level, increased resources applied to fewer and larger revenue opportunities, and a more disciplined and programmatic approach, bringing additional functions into our development efforts. All of these activities are now supported by a robust set of KPIs to monitor and drive continuous improvement in our ongoing NPD effectiveness. Our engineering leadership team is now in place, and we've launched seven new products in the first half of 2019, and we have eight additional products launching in the second half of 2019. Turning to our operations excellence pillar. Our global operations teams lead our efforts to drive safe, organized, efficient, and sustainable workplace on our factory floors, in our offices, and at our customers' site within our site services business.
At the beginning of this year, we introduced our Safety Spots program, which includes representatives from all departments regularly doing Gemba Walks involving going to where the work is done and looking for operational improvements as well as potential safety issues. Let me take a moment to provide just a few statistics on our year-to-date progress for the first half of 2019 versus the first half of 2018. Our total number of lost time incidents has declined 61%. Our total number of lost days has declined 78%. Our first-aid injuries have declined over 50%, and year to date, we've identified over 650 Safety Spots. Our electricity consumption is down 6%, which equates to powering 144 U.K. homes for a full year. Our water consumption is down 20%, and lastly, our CO2 emissions are down 11%.
These are great metrics demonstrating the increasing level of efficiency, safety, and sustainability we are driving in our operations. As we've now rolled out our Rotork Lean program to our largest facilities, we've completed 28 Rapid Improvement Events, or RIEs, in the first half of 2019. These emphasized either increasing production efficiencies or safety. These 28 events yield GBP 600,000 of hard savings in 2019. We expect to drive at least as many events in the second half of 2019. Depicted here is our factory in Shanghai, China, a shining example of where we've deployed the Rotork Lean program very effectively, totally reorganizing our production lines for flow with the required sub-assembly workstations aligned and providing just-in-time sub-assemblies for our main production line for the IQ series of actuators.
This results in a reduction of work in process inventories, reduced material handling and goods transportation, and a dramatic increase in our throughput. We continue to execute on our supply chain improvements. We are on course to drive our committed GBP 5 million of savings in 2019. At the end of 2018, we kick off our Rotork Inventory Management program. I'm pleased to say we're off to an encouraging start with just over 7% or GBP 7 million reduction in inventory in our first six months of the program. This while increasing our customer service levels. Our inventory is down just over GBP 14 million on an H1 2019 to H1 2018 basis. In relation to our footprint optimization and our ongoing commitment to improve our cyclical resilience, we continue to execute well on our site consolidations.
We've completed an additional facility closure in the first half, and our second facility closure of 2019 is in its very final stages. At the end of 2019, we will have reduced our manufacturing locations by over 30% in a roughly two-year timeframe. Let's turn now to our talent and culture pillar and our key enablers. We continue to strengthen our senior team with the addition of several members with the direct experiences and skills required to be successful in our Growth Acceleration Program. After defining our vision, mission, and direction in the second half of 2018, our efforts transitioned to defining our purpose, values, and cultural behaviors in the first half of 2019. These efforts included participation from staff in 37 countries. Our new values and behaviors program formally launches company-wide in September. Our company's purpose is keeping the world flowing for future generations.
You may recognize the first half of this statement, keeping the world flowing, which has been used by Rotork for many years. After debating a number of new and revised purpose statements, this one kept pulling us back. It's still a great description of why we exist. However, we felt it important to incorporate a second element for future generations to reflect Rotork's longevity and our intentions as a responsible company. The quality of the products and services we provide help reduce environmental risks while simultaneously providing life-affirming fluids to those who need them. While we clearly have more to do, we've made significant progress in our diversity commitments over the last 12 months. I'm pleased to state that at least 20% of our PLC board, our management board, and our senior leaders population are now female. Turning to our fourth pillar, IT and core business processes.
We continue to develop our capabilities in presenting management with clear and easily digestible information, allowing faster and improved decision-making. In the first half of 2019, we've added to our business intelligence platforms, including global sourcing, innovation and NPD effectiveness and program management, and a global property dashboard which allows centralized visibility to all our properties and leases in all regions of the world. Our focus in the first half of 2019 has been on the design of our global blueprint for our chosen enterprise technology platform, Microsoft Dynamics 365. We've implemented our D365 field service application in our U.K. service centers, and we'll roll this package out to North America in Q4 of 2019. This common field service platform allows us to share infrastructure resources between sites and then reduces our administrative cost structure.
We've also designed our early release candidates, which are subsystems including a global CRM solution and a global HR platform, which are scheduled to go live in Q1 of 2020. I'll close out by summarizing our first half and making a few comments on our outlook for this year. In summary, I'm very pleased with the team's continued execution across our Growth Acceleration Programme. We've strengthened our management team. Our transition to a market-oriented company is well underway. Our innovation and NPD efforts are accelerating, and our operations and supply chain organizations are delivering. We've launched our new purpose as a company, and perhaps most importantly, our recent company-wide pulse surveys reinforce that we are bringing the company along in our journey.
Turning to our outlook. Whilst macroeconomic uncertainty remains, with our recent order intake and the momentum of our Growth Acceleration Programme, we now expect to deliver flat sales on an OCC basis in 2019, with full year adjusted operating margins showing clear progress year-on-year. With this, Jonathan and I would be delighted to take any questions you may have.
Morning. Michael Blogg from Investec. Excuse me, if the clues were lost in your review of progress so far. What is the expected timing now of the redevelopment of the Bath site, please?
That's a great question. I think it's going to be delayed sometime. If you think about when we started a couple of years ago, we were looking at a combined headquarters and manufacturing facility. What we found was the rate at which the company was growing, we were going to outpace the size for the location that we had. We then embarked on a plan to build a new factory separate of the headquarters. What we're finding through our aggressive deployment of lean within the Bath facility, we don't need nearly as large of a site as we had envisioned as recent as six months ago. What we've decided to do is to take a pause while we continue the lean progression within that facility and understand what our true needs are as we go forward.
We want to really avoid building a facility that's larger than we need, just simply due to our efficiencies we're gaining in the operations.
Strategically, do you see any logic in reducing the amount that you're manufacturing in the U.K. for export?
I would say not at this time. We still manufacture products in all regions of the world. Our flagship products we can currently manufacture in all three regions of the world.
Thanks very much.
Morning, Kevin. Morning, Jonathan. It's Ed Marinkovic . I just had a question, I guess, end markets. What's the trigger, you think, to get those as-yet unsanctioned large projects over the line? As a follow-up, where would you position your kind of current oil and gas end markets relative to the previous cycle peak?
I'll let Jonathan answer the second part. I think we've talked before that it's not necessarily that particular incentive level of that $50-$60 a barrel we've talked about, but it's the stability in that. Once again, if you think about the first half of this year, we've had a highly volatile oil pricing. If you think about declines shifting 5%, 7% in weeks. May, we had a massive slide in the price of a barrel of oil. I think what's interesting is that what's shifting in the oil and gas sector is it's now largely related to supply rather than demand. You have events like if you go back a couple of years ago when a ship in the Straits of Hormuz was attacked, you'd see a 7% spike in the price of oil. It would stay there for days.
You saw that this year for about seven and a half minutes. Right? Oil spiked for seven minutes, and then the market realized that the threat of war in the Middle East is smaller as it relates to a price of a barrel of oil than the global trade issues we're facing with China. That's really how the market settled. That being said, that we've just seen this massive ups and downs in terms of a price of a barrel of oil. It's that stability that our customers ultimately want in order to say these projects should go forward. Over 80% of these projects are already sanctioned. They're in the FID program, and over 80% of these projects are profitable above those incentive levels we've just mentioned. It's really about the stability in that pricing. Can these oil companies predict it'll stay above that level?
Once we see that stability, I think those projects will get released. We do see some of those projects being split into smaller portions, such that the proportion of our mid-size projects, if you will, are going up. Those large, big programs that we had last year, I mean, think about last year in the first quarter, we talked about three programs total at GBP 17 million. Those were not repeated this year.
I guess in terms of your second question, Ed, in terms of overall value of sales for oil and gas in the current year versus peak, I think to Rotork, we're probably at a fairly similar pound value. The shape of what those orders are and where they're coming from is quite different. The other big difference is the pace with which the projects were proceeding at previous peak. They were going through these approval processes much, much quicker. Now that's just not the case. We have, I guess, a greater proportion of smaller projects. Rotork is a different business from where it was at previous peak in terms of our exposure to different pieces as well. If we look at the product development and we look at some of the acquisitions since 2014, we have a different exposure profile as well.
Thank you.
Thanks. William Turner from Goldman Sachs. Clearly, you've done quite a lot on the operating efficiencies within the business. But going forward, do you see the incremental operational benefits that you can achieve as becoming smaller? Have you do you consider you've completed the low-hanging fruit? Secondly, if we were to, for example, if you were to not grow for the next couple of years or into a low growth world, do you think you could hit your targets of the mid 20% margin range just by operating efficiencies?
I think we're in the very early stages. What you're seeing now in the results that we've been able to provide in the first half are the very early stages of our programs. If you think about the Rotork Inventory Management program, we just kicked it off six months ago. If you think about Rotork Lean and the operational improvement focus, it's only a year in. As you would expect, the rate of adoption differs greatly within the sites that we have. It is somewhat of a normal distribution. You have pieces of the company that are truly embracing it and accelerating it, and others that are further behind that are getting additional support and leadership from the operations teams that we've brought in. I think we have several years of continuous improvement in our operations yet ahead of us.
I think that's a statement I could make about operations. I think that applies to our supply chain and procurement efforts as well. I think when we've structured this program from the outset, internally, we said that at least 70-plus% of that return has to be driven by discrete, identifiable, quantifiable management actions, not economics. We embarked on this journey with the expectation that it's not just flow-through on top-line revenue growth that's going to get us back to those margins. It's hard work and execution of management-driven activities, and that's what you're seeing. I think that we can go a very long way towards a return if in fact, we are entering into a low-growth environment still.
Thanks.
Thank you. Mark Davies-Jones from Stifel. A few things, if I may. Firstly, you mentioned the impact of areas that you can't sell to now because of sanctions. Can you quantify what that was in the mix? Secondly, the margin pressure in gears related to the tariff issues, are you not able to pass that on? Are you able to pass it on with a lag? What's going on in terms of selling that through? Finally, midstream is obviously strong. You're talking about pipelines. There's a lot of new capacity coming on stream at the moment in the Permian. How long do you think the business remains robust with for you, or is that a bit of a peak?
Shall I take the first two?
Yeah.
In terms of the markets we're no longer serving, I guess they probably average around 1% of revenue for recent years. That'll be the guide on that one. I think in terms of gears, tariffs, and our ability to pass that on, I suppose the early part of the year, there was a question mark around whether the tariffs would indeed increase or whether they were going to stay at 10%. The plans in terms of how to mitigate that cost increase was another moving target to aim at to some extent. Those tariffs, the third wave that do affect us have now increased to 25% in April, and that's really the impact we're seeing at the moment.
The mitigating actions to deal with that are not really about passing price on because those price increases at that tariff impact doesn't necessarily affect all the people we are competing with in North America. The mitigating actions really are with us and managing our supply chain. That thought process is underway, but it's not a particularly quick process to pick up tooling, find and qualify for safety, quality and all those things, new suppliers in other parts of the world. Those activities are underway and will impact next year more than they would this year. If I could add on. Our largest competitor in the gears is a company that operates out of South Korea. You can imagine they are not currently facing the same level of tariffs that we are with our gears manufactured in China.
I think it would be an unfair knee-jerk reaction to go to our customers, pass through that short-term tariffs. I think we would risk losing market share on that. I think we need to understand that we're going to have a short-term impact on those tariffs until we have more clarity over the longer term into the tariff situation and what we need to do. We do have an ability to transfer that manufacturing to other manufacturing locations. We have those plans, as you could imagine, documented, written up, ready to go. Waiting to see if that's a more permanent situation, then we will enact that and relocate some of that manufacturing to a different low-cost country, if you will, where we operate in.
I think it would be premature to go to our customers and ask them to take that hit relative to the alternative supply not having that price impact. I think there's a lot we can do within the gears business to continue to focus on improving the profitability of that business. They've been a key focus of our Rotork Lean, and we've just relayed out the entire manufacturing process for that gears business that'll yield, I think, some substantial productivity improvements. We're attacking it through our own operations programs first while we wait out and see how long this tariff is going to last.
The midstream one, the pipeline one.
The midstream is not only North American related to Permian, to be clear. We're seeing midstream pipelines throughout Eastern Europe, Asia. Pipelines in general are increasing, and largely not only the oil pipelines in the Permian, but gas pipelines throughout the world are increasing for us. I would say the Permian is a very small piece of what we're seeing the increase in.
Hi, Sandy Wilson from J.P. Morgan. A couple, please. On the site services business, it seems like there's quite a lot that you're doing in terms of reshaping some of the focus there. Can you talk a little bit about what you're seeing in the market in terms of level of activity in terms of spend, but also what, if anything, you're seeing in terms of changes?
We haven't seen many changes from the competitive landscape. We're seeing nice growth in our services business continuing. We're seeing customers willing to spend money on preventative maintenance programs in particular, as well as that turnaround spend. That's a business that's still performing quite well for us. We're excited about that, but no real fundamental changes in the competitive landscape.
Just thinking about internally, obviously, I think one of the previous questions kind of alluded to how much is going on, which I think is fair. It seems you might be running a little bit ahead maybe where you thought you were going to be given, I guess, the guidance at the start of 2021. Can you give us a sense of kind of where, I guess, the rate of change has been quicker and maybe link to that? Just how important has been some of the changes that you've made in terms of people and whether that be just culturally more generally or specific in terms of new business?
Sure. I think it all begins with the people. We've imparted a significant amount of change on the company in that we've been able to attract some additional talent into the company, in particular in areas in terms of supply chain and operation. You're seeing those results very directly. That's probably the area of the fastest rate of change is the quick deployment of the Rotork Lean program. Deploying that in our top 10 facilities as well as the supply chain, bringing in a supply chain group very effectively. Those are two new organizations to Rotork that have substantial amount of people brought in from the outside that are driving that change down through the organization. I think that's the fastest area of growth.
HR is another area of fast growth where we've been able to shift HR from what was historically a transaction-oriented, where do I get my pay slip and I need to get my benefits, to truly serving as a business partner. Going out and assessing and recruiting talent and looking at working with teams to identify the optimum structure of their team, which in some cases eliminates some layers of management, others increases spans of control, for example. That worked. I would say IT is probably the third-largest area of change where we've brought in, certainly Paul Burke, who was brought in to lead our IT efforts just prior to me coming on board, has done a phenomenal job shaping the IT program and giving us a great deal of confidence in the deployment of our IT platform.
It's not lost that many of those areas of improvement are improving because of the additional talent that we brought into the company.
Morning, Richard Page from Numis. Can I just ask on end market mix? I guess for a while we've been waiting for diversification away from oil and gas, and you talked about opportunities. Is there any hint in the change in the order book or new product that you're releasing in the market or this realignment about of the sales team around end markets that makes that happen?
Yes, absolutely. The purpose of realigning the sales organization around end markets is really about to balance our oil and gas business with some faster-growing. The rate of growth will be faster than some of our chemical and process and industrial pieces of the company. If you look at our new product development efforts, there's been a lot of development efforts targeted at those segments as well that launched this year. I think it's probably 30%-40% of the products we're launching this year are targeting at those market segments that are non-oil and gas. I think the realignment of the front-end focus with the additional new products targeting that will help us with that balance. Again, it wouldn't surprise me if three years we're sitting here and 50% of our business is still oil and gas.
It is the part of the market that we have the strongest brand position, the strongest specification. We have the best price yield. It's a very nice segment for us to continue to operate in.
Just to follow up on the U.S. water-
Are those opportunities gone?
No, our U.S. water business is up this year, substantially over prior years. We do see the U.S. water business just starting to return. If you think about last year in the first half, it wasn't there. The U.S. water business was very muted and our team said, "Don't worry bosses, we'll get that back and the back half is going to be great." Of course, we don't usually believe those forecasts, but they did. They came in and delivered a really strong back half, which led to a nice overall pickup in the water business. Again, the first half of this year, we're seeing a pickup in the water business in North America as well.
Thank you.
Morning again, Michael Bloggs from Investec. Could you say how much of the uplift in operating margin comes from IFRS 16, please?
Very little indeed. It's as we said back in March, it's about a quarter of a million pound increase. It's a tiny adjustment in terms of EPSA.
You can annualize that as well. Thank you.
Ed again from Citi. Just asking on the new sort of market segment orientation, what's the feedback? Is there any pushback or resistance from customers or employees alike?
No, it's actually been really well received. We're very pleased. Our process includes a formalized feedback loop that we go back and talk to employees, customers, and that's gone very well. The feedback has been very positive. This has been kind of a pent-up desire of our customers for some time. I think from our sales focus, our sales team's focus, them understanding how they could drive value in the company is also resonating with them. We've had no loss of customers, not a single resignation of a sales individual as a result of this. That's gone very well so far. We're going to continue to monitor that. I think as we get to Southern Asia and then Europe may be a little bit harder to change some of that. We'll continue to monitor that as we go.
Certainly going to be more complex when we get to the European model at the end of the year.
Just a final question on power markets. Is there any flicker of light or life there?
No, I think as we said, the main decrease in power is split into 2 elements at a group level. You've got the sale of the nuclear-actuated business. We've also seen a decline in the other aspects of power, driven by lower levels of new build spend in thermal plants. There is still a good level of refurbishment upgrade stuff taking place in those facilities, but it's just not at the levels we've seen in the past.
Hi. Mark Fielding from RBC. You've got a reasonable amount of cash in your balance sheet. You're generating more cash. I assume there's still no desperate rush on your side to do anything with that sum.
Given this current uncertainty in the economic backdrop, there is no rush to go out and spend that. We spent a lot of time in the first half of this year, as many of you know, we've brought on board a new head of strategy in M&A, Vijay Rao. Vijay's joined us. We've spent a good part of the first six months really redefining the strategy for Rotork as we go forward in terms of understanding those most attractive near adjacencies. We're working on that body of work literally now. We're reassessing some of those candidates that we've had in our funnel. We're going to continue that. I think multiples are still fairly rich out there. There's a lot of money still sitting on the sidelines.
We're going to be very disciplined in our approach, and we're going to ensure that those fit into our long-term strategy for our shareholders. No absolute desire to run out and do anything in the immediate term. We're working on it, and it is going to be a part of our future for sure.
Secondly, you touched on site services a couple of times. How big do you feel now as you get more into this sort of untapped aftermarket opportunity might be?
I think for us, as we define our aftermarket, it goes beyond the field service work that we do today. If you think about the evolution into the field service work that we do today, we're out there repairing on, again, on either a reactive or a preventive basis. We see that evolution to the predictive maintenance continuing. We've talked about our IM program in the past. We purposely have toned down our discussion about it until we actually are generating a significant revenue stream from that. I will tell you that we do have now seven sites up and running on that program.
These are either water treatment facilities in a couple of occasions, large fuel terminals in a couple that we are running that entire site and monitoring the status of their valves through that to be able to predict when they're going to have a failure. That's a program we're going to continue to run, and that can be a very substantial alternative business model as we go forward. I think in addition to the aftermarket, getting smarter about our parts program and our repair kits programs and all those other elements of a robust aftermarket is what the team is focusing now in the near term. The team is kind of split, as I mentioned in my prepared comments, between looking at our core processes and remapping those core processes, looking at the infrastructure.
Meaning, if you think about in the U.K., for example, we dispatch service in five separate locations. We have five separate administrative people sending out service technicians. Now that we're on one common platform that we just launched this year, we've been able to reduce that to be able to dispatch service from one centralized location. That's the type of work that the team is working on now. Again, it's about improving the core process as we scale. This two-pronged approach to growth as well as improving the underlying profitability of the business. That's going to continue. I think the aftermarket business can be a substantial part of our portfolio as we go forward. Certainly margins are accretive, growth is accretive, and we're going to continue to put resources behind that.
There's major pieces of regions of the world that we could continue to grow that disproportionately, and that's where we're reallocating investment from other more mature markets to those emerging markets.
Morning, it's Robert from Morgan Stanley. A few questions. First one, you mentioned acquisitions, but what about disposals? Is there anything in your current portfolio, having had 18 months to sort of look over the business that you think maybe doesn't fit as well as you'd hoped or another two to three of you might not stay with you?
Maybe a couple of small non-meaningful ones. Yes. As we continue to evaluate the portfolio, we're going to continue to do that on an evolving basis. There certainly are small pieces of the business that don't quite fit with our long-term strategy. They would be fairly insignificant.
Then, you put up a slide, I think it was seven new products that you were bringing to market. How is the evolution on your R&D plans and your R&D spending? You'd originally sort of talked about ramping it and then said you could kind of cover it from the savings you've got. Where are you in terms of that slide?
What have we done in engineering and R&D? We've realigned the organization, now we no longer have divisional R&D. We now have a global R&D team. We've brought in every ongoing development activity in for a kind of re-review, kind of re-tollgating everything in flight. That yielded a reduction, a dramatic reduction in the number of programs in flight. We killed about 65% of the in-flight new product development initiatives, meaning we didn't have confidence that they were going to hit the market, hit the return that we expect. Maybe they were an idea from an individual salesperson. We felt they weren't market-driven, we killed 65% of them, reallocated and redistributed the workforce to really get that remaining pocket of new product development over the line. We remapped out our entire internal tollgate process and relaunched that company-wide.
Now we have tollgate meetings that for major programs involve the senior executive team, that we sit around a room and validate that we want this major program to go through the next tollgate, that we believe in this level of expenditure and program. I think we've done quite a bit there, and that's going to continue. Our spend is down in the first half, because again, gaining those efficiencies. I will tell you, the output from that spend is going up. It's accelerating.
Thanks. Maybe just the last one. You put up a slide showing the number of sites you had globally coming down in the last couple of years. Is there a target for Rotork globally in terms of manufacturing or sales offices that you've got in mind at the moment?
There is not one that we'll say publicly.
That's a terrible idea for us, right?
Yep.
I think within the company, there are sites that have identified that have kind of understood that what we're looking to do is to increase our cyclical resilience. Those smaller sites that have a high cost of operating and will not get to our margin ambitions, that those sites understand that we're going to be working with them to consolidate and put them into a larger site. I think within the company, there's a pretty good level of momentum. I'll also take a moment to say I think I'm really proud of the team that are working on facility consolidations in terms of the people aspect of that. In our Tulsa consolidation, 33 out of 35 of the employees had new jobs before the site was finally closed. In our Taunton facility, it's 100% of the employees had new jobs before we closed the site.
We're working very aggressively on making sure that we pay attention to that people element in the facility closures, and I think that's going really well and maybe adding a bit of calm through the network of our facilities.
Thanks.
Thanks. Just a final one from me. Could you say, is there anything in the order backlogs in any of the divisions that point to a significant movement in gross margin in the second half and next year, please?
I suppose the only thing I would say in there, Michael, is that within a division, no, but clearly the divisional mix is slightly different in the backlog from where it was June last year.
I think otherwise, when you look within the divisions, there's nothing substantially shifting within them.
One last question.
Thanks. The first one, I had two, actually.
Oh, two last questions. Okay.
I can try and combine them into one, but.
Yeah.
The first one with Jonathan on delivery times. You made a few comments about fewer projects, which I presume are longer delivery times, but you've also got reduced your sales growth guidance for this year and saying more next year. Can you just give me a hand?
Yeah. Both in controls and in instruments I made that comment because there are, if you look at the. Those are the two divisions which have the higher order book at June versus June last year. In both those, the pattern of the orders and when they fell in the first half, we just know that some of those are for extended delivery time frames. We will see the deliveries on some of the Subsea stuff and instruments into next year. Some of the orders that came into controls are already for delivery next year. We track at each month the proportion of order book for delivery in the current year. I can just see there's a difference in those two divisions compared with 12 months previous.
Okay. The second quick one was on pricing. A quick word on pricing, given you've got some new products coming in, but I suppose that my understanding was always it's quite difficult to shift customers onto the new products for Rotork as a specification and things like that. What does it mean for pricing for these new products and I guess for the legacy products?
We always set the new product pricing, as you can imagine, with the product life cycle curve higher than the products that they're replacing. Many of the new products that we're launching now are really about protecting our premium price position. If you think about some of the new targeted water applications, that's really about providing the market an alternative to an AUMA actuator at a price point that makes sense to compete with an AUMA actuator so that we don't use our IQ3 premium position product to compete. It's about creating that firewall that says this is an absolute different premium product, and if you want that, you have to pay, but we're not going to sell you this to compete with an AUMA that is a de-featured product down at this level.
I think a lot of our thinking in some of the new products we've launched have been to drive price yield in terms of protecting our IQ premium positioning, as well as providing alternatives to those others in the marketplace. Outside of that, if you look at the new product slide and you think about the gear set that's pictured on the bottom in the center, that's really about optimizing a gear set that would allow us, this answers that question of some of the things we're doing to contend with the tariff piece. By redesigning that gear set and optimizing it, we're able to, in some cases, scale down an entire size classification of that to compete more effectively at a better price point with some of the others that are out there in the gear set.
We're doing some activity to increase our price yield, increase our margins, not just coming out with products at a lower price. That's not at all our intention. Great. Well, thank you everyone for your time today. I'm sure we'll see some of you on our tour as we balance out the week.