Good morning, everyone. I appreciate you all joining us today as we discuss our full year 2018 operating results. I'm joined today by Jonathan Davis, our Group Finance Director, as well as Martin Lamb, our Chairman, and Andrew Carter, our newly appointed Investor Relations Director, who are in the audience today. I'll begin with a few highlights from 2018, and then, as usual, 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 about our outlook for 2019. My first year at Rotork has been one of change and significant progress. We've strengthened our global leadership team, we've defined our next generation operating model, and we are now well into the execution phase of our Growth Acceleration Programme.
I'll take this moment to remind everyone of our previously stated ambitions to deliver sustainable mid to high single digit revenue growth, and to return to mid-20s margins over time. As our Growth Acceleration Programme progresses, we continue to identify opportunities for management driven improvements within Rotork to stimulate both the growth and the margin we desire. I'll also remind you we're on a multi-year journey, and that this journey is one of transition, building upon the best elements of Rotork. Let's take a look at our full year highlights. Once again, we've delivered a strong set of results driven by management actions against a backdrop of macroeconomic conditions that became more uncertain as the year progressed. Our business was supported by increasing activity within our oil and gas markets, notably evident in smaller to mid-size projects such as retrofits and upgrades.
In the first half of 2018, we also experienced several major project wins, principally in Asia, which we delivered upon in the third and fourth quarters. We saw hesitation in the release of similar larger projects in the second half of 2018, largely due to significant fluctuations in oil prices and increasing uncertainty on a variety of economic fronts. Additionally, I'll highlight the significant progress made in our penetration of the industrial process segments, driven by our increased focus on these markets, coupled with a continuing increase in general automation.
I'm particularly pleased with our 2018 progress as evidenced by organic constant currency growth of 11%, adjusted profit drop-through on incremental revenues of 30%, operating margin expansion of 70 basis points to 21%, and a 430 basis point increase in return on capital employed to end at just over 29%, all of which are indicative of the high quality of business Rotork represents. All in all, a strong outcome demonstrating our continued ability to drive day-to-day execution whilst implementing the initiatives identified through our work streams. Now, let's have Jonathan walk us through our detailed financial results.
Thank you, Kevin. Good morning, everybody. Progress has been made on a number of fronts in 2018, and this is reflected in these results. Order intake in the fourth quarter was 4% higher than the third quarter of 2018, but 2.5% lower than fourth quarter of 2017. The impact of currency diminished towards the end of the year, but was a 2% headwind for the year as a whole. The businesses we disposed of in 2018 contributed GBP 3 million of revenue and very little profit. We've presented organic constant currency numbers to remove both these impacts. Order intake of GBP 682 million was up 5.4% on an OCC basis. The order book is 6.8% lower than last December. Revenue was GBP 696 million, up 11.3% on an OCC basis. Adjusted operating profit of GBP 146 million grew 14.8%, and margins on an OCC basis were 60 basis points higher than 2017 at 21.0%.
Adjusted earnings per share was GBP 0.126, a 29% increase, and the final dividend was GBP 0.037, up 10.4%, giving a full year dividend of GBP 0.059, a 9.3% increase. The order book was reduced by GBP 16 million in the year on an OCC basis. GBP 4 million of this is an impact of sanctions, and in Controls, we see the change arising from shortening lead times during the year. The remainder of the reduction is in Fluid Systems, our most project-orientated division. As we've discussed with a number of you, we're intending to provide less information on orders going forward. The lumpy nature of our project businesses means that particularly when looking at quarters, the information is difficult to interpret.
The OCC adjusted operating profit bridge shows revenue growth has been a significant positive with labor and factory costs a small gain, but offset by material costs and growth in overheads. Materials were 90 basis points higher compared with 2017, with negative divisional mix and fractionally higher material costs in Controls and Gears. Improving direct labor productivity and the fixed cost element of the factories more than offset the small headwinds on materials. The OCC gross margin improved by GBP 32 million or 30 basis points. Overheads increased by GBP 12.8 million. GBP 2 million of the increase relates to IT, GBP 2 million to R&D, and around GBP 5 million to wage increases and higher bonus payments across the other areas of the business. Overall, headcount increased by less than 1% in the year. We've added in key areas and reduced in other areas through productivity improvements.
Our revenue per head has increased 7.5%, and adjusted operating profit per head has increased 11.5% in the year. We started the year with net debt of GBP 12.6 million and finished with net cash of GBP 43.6 million. Cash conversion is 110.7%. Dividends and tax are two of the largest outflows in the period, totaling GBP 78 million. Net CapEx was GBP 10.2 million, and the cash restructuring costs were GBP 7.8 million compared with a GBP 10.5 million P&L charge. Working capital in the cash flow, which uses average exchange rates, is an outflow of GBP 3.2 million. The disposal of the Hiller business and assets of Valvekits realized GBP 4.3 million. Net working capital has increased GBP 4.6 million or 2.4% in the year, which as a percentage of sales, is a 160 basis point improvement to 27.7%. Inventory is GBP 2.8 million higher and has decreased as a percentage of revenue from 14.3% to 13.6%.
This is equivalent to an increase from 2.7 to 2.8 turns. Receivables are the same value as last December and have reduced by one debtor day to 62. The pension scheme deficit decreased GBP 21 million to GBP 27.3 million, a funding level of 87%, due in part to closure of both the U.K. and U.S. schemes to future benefit. Return on capital employed increased 430 basis points to 29%. The adjustments to profit in the period comprise a pension curtailment gain, restructuring costs, and intangible amortization. After the U.K. DB pension scheme closed to future accrual in April, the U.S. scheme followed suit at the end of the year. The pension adjustment of GBP 2.2 million in the second half is net of a GBP 0.9 million cost related to GMP equalization for the U.K. scheme. The restructuring costs are broken down on the next slide.
Restructuring costs were a similar run rate in each half of the year. The run rate for consultancy costs reduced from GBP 3.3 million in H1 to GBP 0.7 million in H2 as we moved into the implementation phase and developed internal resource to carry out site improvement reviews. Redundancy costs in respect of a number of locations which have downsized as part of product rationalization changes, or through efficiency improvements, or where roles have disappeared as we reorganize the management team. At the same time, disposal or closure of the three businesses resulted in a loss of GBP 0.7 million. Other restructuring costs include R&D write-offs on discontinued product lines and asset write-offs in respect of the footprint rationalization program. We are anticipating around a GBP 5 million charge in respect of these items in full year 2019.
Turning to the financial impact of the Growth Acceleration Programme, of the GBP 10.5 million restructuring costs in the year, GBP 1.4 million derive ongoing benefits. The business closure and disposals have already generated cash well in excess of the costs incurred. The site improvement initiatives have generated a P&L and cash gain in excess of the cost in the year. GBP 0.7 million of the GBP 1.1 million gain is one-off gains from utilization of slow-moving inventory, whilst the remainder are ongoing savings, which we will build on in 2019. Procurement savings were GBP 1.7 million in 2018, and are expected to generate a further GBP 5 million of savings in 2019. Finally, the GBP 13 million cash from working capital has been calculated against 2017 as the base year and at constant exchange rates. Stock turns increased from 2.7 to 2.8, generating GBP 16 million.
Debtor days reduced by one day to 62 days, generating GBP 5 million. Trade payables decreased, an outflow of GBP 9 million. Order patterns in 2019 are unlikely to match those of 2018, which were unusual with Q1 an exceptionally strong quarter. With this, disposals, which contributed GBP 3 million of revenue in 2018 and the lower opening order book, we're anticipating a slightly higher H2 weighting than 2018. The previous slide showed the impact of the 2018 initiatives of the Growth Acceleration Programme in 2019. We'll provide additional color on the 2019 initiatives in due course. The effective tax rate on an adjusted operating profit is 260 basis points lower than 2017 at 23.7%. 90 basis points are due to the U.S. deferred tax change in 2017, and the reduction in the U.S. corporate tax rate in 2018 is the largest other factor in this change.
We expect the 2019 effective tax rate to be between 23% and 24%. Sterling is experiencing considerable volatility at the moment, the assumptions made could provide a wide range of forecasts. Using a US dollar rate of 133 and euro rate of 117 for the remainder of 2019, would result in around a 1% headwind to revenue and operating profit for the year as a whole. With investment in the new ERP system well underway and a number of site improvement investments being initiated to facilitate future site consolidation, CapEx is likely to be in the GBP 30 million-GBP 40 million range in 2019. IFRS 16 on leases is effective from 1st of January 2019. It will not have a material impact on our income statement and will only increase net debt by GBP 12 million. In our preparation for Brexit, we have looked at the risk of a hard Brexit.
We've accelerated some purchase of components into the U.K. and deliveries out of the U.K. This is to combat practical import-export challenges in the short term. Our sales within the U.K. are a relatively small percentage for the group total. With around GBP 65 million of flows between the U.K. and EU, a move to WTO tariffs would cost an additional GBP 1.5 million per annum. The US-China tariffs are already impacting our business with a cost of around GBP 0.5 million in 2018, this would increase to more than GBP 2 million under the current announced program. Turning to the operational review. This slide summarizes the group's key markets and geographies. These slides are on an as-reported basis. Revenue increased in all divisions and in all regions, except the Middle East and Africa. Oil and gas increased from 50% to 54% of group sales.
The fastest growing end markets were downstream oil and gas, up 30%, and industrial, which grew 14%. Midstream grew in line with group revenue, remained 9% of group sales, whilst upstream and water markets grew, but at a slower rate than the group. Power sales fell by 11% as sales in the Far East declined and projects in the Middle East and Africa in 2017 weren't repeated in 2018. This was one of the contributors to the lower sales in the Middle East and Africa, where upstream also declined after an active 2017. All other regions reported higher revenue with a strong downstream oil and gas growth being instrumental in the growth of the Far East, which was the fastest growing region and increased from 28% to 32% of group revenue. Turning to the divisions.
In the Controls division, order intake was up 8% and revenue grew 11.6% on an OCC basis. Gross margins improved 30 basis points, on an OCC basis were 20 basis points lower. The improved labor productivity wasn't sufficient to offset a 70 basis point increase in material costs, which was the result of increases in some commodity costs, but also some further revenue from the large low margin projects which impacted the first half. At an adjusted operating profit level, OCC margins are the same as 2017, with overheads growing slower than revenue. Controls oil and gas exposure is greatest in downstream. The growth in that market, up 35% in the year, has therefore benefited the division and boosted its sales, particularly in the Far East and to a lesser extent, North America.
Upstream and midstream were broadly flat overall. Within this, upstream was positive in Eastern Europe, but declined in the Middle East. Midstream was positive in the Far East as a result of improved pipeline sales. Power declined due to lower activity in the Middle East and Africa and Far East, with the Far East also reporting the largest reduction in water. Industrial process, including HVAC and marine, grew as a result of positive performances in Europe and the Far East. Fluid Systems order intake increased 0.9% on an OCC basis, with revenue up 14.2%. The strong revenue increase, combined with a 10 basis point reduction in the material cost percentage, has driven an improvement in underlying gross margin of 300 basis points. With continued tight controls overheads, the adjusted operating margin has increased 380 basis points to 9.7%.
The strongest growth came in downstream, increasing it from 22% to 26% of divisional sales, whilst upstream midstream both reduced by 1% to 31% and 12%, respectively. The downstream growth came in the Middle East and Far East, where some of the projects are the same as those seen in Controls division. Upstream saw a positive North America and Far East region offset by a decline in the Middle East. Whilst water and industrial grew in line with the division as a whole, power declined. The reduction in power was in the Middle East following a large project there in 2017, and the sale of the Hiller Nuclear Actuator business at the half year. On an OCC basis, order intake in Gears was up 3.8% and underlying revenue increased 4.7%. Despite improved labor productivity and factory efficiencies, gross margin fell by 140 basis points.
Material costs rose by 160 basis points, the result of GBP 1.5 million higher warranty costs and inventory write-offs, without which material costs would be on a par with 2017. Overheads reduced in the year and were also improved by the closure of the Valvekits facility, resulted in an adjusted operating margin only 70 basis points lower than 2017. Midstream and downstream sales drove the increase in overall oil and gas sales from 52% to 54% of divisional sales, with activity in the Middle East, Far East, and North America most positive. Instruments order intake has increased 1.9% on an OCC basis, whilst revenue increased 7.5%. Underlying gross margin increased by 130 basis points, benefiting from operational gearing and having held direct costs at prior year levels. Adjusted operating margin improved and was up 190 basis points.
The strongest growth in percentage terms was in upstream, followed by midstream, which increased the oil and gas share of revenue to 48%, despite a fall in downstream. The growth was most significant in Western Europe, which was also responsible for the decline in downstream. The other end markets all grew, at a slower rate than the division as a whole. The Middle East was the only region not to show growth compared with 2017. I'll now hand you back to Kevin.
Thanks, Jonathan. Let me begin this section by saying a few words about our outlook for 2019. Firstly, we do welcome the recent stabilization of the oil prices. Our view is the current CapEx forecast for the oil and gas sector are now coming in at between 4% and 6% year-on-year. Having said this, it's important to remember this growth rate varies dramatically between sub-segments of the market, between geographic regions, and between the specific application sets. We see upstream growth driven by Middle East wellhead expansions and a drive to increase operating efficiencies, and the beginning of the return of the subsea business. While much has been said of the upstream U.S. shale expansion, I'll remind you that this has not been an area of historical focus for Rotork.
I will note, however, a few of our recent new product development efforts allow significant operating efficiencies here, and we will be increasing our focus here as we progress. The midstream segment for Rotork is largely about pipelines and LNG. We see pipeline expansion in the U.S. shale market and pipeline expansion specifically related to LNG, as well as a general LNG-related expansion beyond pipelines on a global basis. Within our downstream business, we see continued positive momentum in both refinery expansion and petrochem. This is driven largely by growing global population and increasing prosperity. We expect water to be mixed geographically, modest expansion in the North American market, strong expansion in India, and a moderating growth in the near term in China. We see power declining in the year.
We also see the general industrial sector moderating slightly with the growth in China and the U.S. slowing as a result of their current trade disputes. We'll take a closer look at our workstream progress. I'm on slide 19 for those on the Webex. The overriding themes of our workstreams continue to include reengaging, reinvesting in, and strengthening our customer focus and intimacy, driving operational and supply chain efficiencies, improving our process and focus within our innovation and new product development efforts, improving our talent acquisition and development programs, as well as increasing the alignment between our long-term strategy, our near-term goals, and our desired behaviors and reward systems, a renewed emphasis on headcount productivity, and a critical review of our strategy, our portfolio, and our current product lines.
Our four pillars comprised of over 12 distinct initiatives and an underlying set of portfolio assessments each have a role in driving the growth and margin enhancement we desire. Let's take a closer look at our execution in 2018 and our 2019 focus within each of these pillars. As you'd expect, we'll begin with our customers first and start with the ComEx pillar. We're pleased to have our new head of group strategy and M&A on board, who will take the lead for many of our commercial initiatives relating to improving our strategic market management, improving our product and category segmentation and positioning, and driving increasing price yield through a deeper understanding of the value our products and services provide our customers.
As we migrate from a product-based organization to an organization more closely aligned around targeted market segments, our teams will bring forward a broader solution set to our customers' needs, irrespective of the historical division responsible for that product. We're being very methodical in our approach, ensuring we preserve the best parts of the front end of our business. As previously noted, we're taking a phased approach region by region, ensuring we have strong alignment and business processes well defined and tested before moving on to additional regions. Our migration begins with our first three sub-regions in the second quarter of this year, and our expectation is that we will be largely complete with our phased-in approach by the second quarter of 2020.
Within our Rotork Site Services business, we successfully expanded our site services organization by an additional 45 field service technicians in 2018, and we ended the year, once again, with 10% more actuators under a defined preventative maintenance program. For these initiatives, our 2019 focus will be to continue and build upon our strong progress to date. We'll continue to expand our key account program beyond oil and gas, and under the leadership of our new Rotork Site Services director, we'll continue to add field resources while 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 new product development. To be absolutely clear, we're increasing our emphasis on new product development efforts to drive organic growth.
In the last two years, we've increased our spending on innovation and R&D by over 30% to over GBP 15 million. As I previously communicated, it's my belief that at least for now, this amount, which again only represents the innovation and R&D portion of our overall engineering spend, is sufficient to drive near and mid-term organic growth. We will continue to drive efficiencies in the management of our new product and innovation efforts through improved project selection at the group level rather than our historic individual division views, increased resources applied to fewer and larger revenue opportunities in order to accelerate our development cycle times, 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 improvements in our ongoing new product development effectiveness.
We've taken a significant step forward in appointing our group head of engineering to lead these efforts. We've launched three new products in the second half of 2018, and we've depicted here three of the nine additional new products launching in the first half of 2019. At full penetration, in their third year of sales, the products depicted here will account for over GBP 30 million of incremental revenues at accretive margins. Moving on to operational excellence. We began 2018 utilizing third-party consultants to assist in the assessment of our operations and the identification of targeted improvement activities. As our year progressed, we added our own experienced and dedicated operational process improvement and supply chain experts. We are now driving both the assessments and program management of our targeted initiatives with only very limited support from third parties.
Our team has worked closely together in defining and bringing forward our Rotork Mixed-Model Lean program, comprised of over 16 training and development modules with accompanying assessments and improvement toolkits. We've begun rolling this toolkit out throughout Rotork, beginning with the largest facilities, and those facilities representing the largest improvement opportunities. We've appointed our global Group Director of Operations, we've identified our regional operations leadership teams, and we've hired additional subject matter experts to assist us in key areas targeted for improvement. A few examples of these areas include inventory management, global procurement and logistics, and production engineering. In relation to our footprint optimization and our ongoing commitment to improve our cyclical resilience, we continue to execute on our site consolidations. Our early efforts are focused on small and mid-size locations with high infrastructure costs and an inherent dilutive impact to our margin ambitions.
To date, we reduced our manufacturing footprint by six locations from 30 to 24 at the end of 2018. The team continues their strong execution into our plan for 2019, and at the end of 2019, we will have reduced our manufacturing locations by over 30% in a roughly two-year timeframe. Each of these consolidations are continued to be evaluated on a risk-adjusted return basis with the desire to average a payback period of less than two years. Turning to our supply chain efforts. In 2018, we formalized our global supply chain organization and began attacking our wave 1 and wave 2 categories. Each of these categories are providing net savings ranging between 5% and 8%. We've been actively staffing the procurement organization, and we are now at 80% of our expected staffing levels.
Our initial savings achieved in 2018 was GBP 1.7 million, and we've set our target for 2019 at GBP 5 million. In 2019, we've also launched our targeted improvement efforts in three additional locations, namely Korea, Leeds, and our India operations. We are actively rolling out the Rotork Mixed-Model Lean program to our nine largest factories, which represent over 70% of our overall output, and also to 10 subsidiary offices, demonstrating lean expanding beyond operations. Now turning to our key enablers. The execution within our next two pillars is critical to the achievement of our aspirations. After bringing on board our Group Director of Human Resources mid-year, we quickly implemented several programs, taking our HR function from that of a purely transactional organization to one which recognizes the value in and power of our human capital and serves as a true partner to our business.
Our first order of business was to strengthen our senior team with the addition of several key members with the direct experiences and skills required to be successful in our Growth Acceleration Programme. After our external assessment of our senior leaders in the first half of 2018, we quickly developed and implemented our internal talent review and succession planning programs. We've strengthened our internal communications to ensure we allow a broader global organization to assist in the leadership of our change efforts, ensuring we are behaving as One Rotork and bring the entire organization along our change journey. We also executed quickly in changing our compensation programs, ensuring each of our subsidiaries are incentivized to make decisions on behalf of One Rotork overall, rather than their individual location. We provided additional incentives and resources to those regions which could drive incremental growth well into our future.
We've instituted a performance management program with an emphasis on personal objectives cascading from our targeted aspirations, which enables a clear linkage between our strategy, our behaviors, and our reward systems. In 2019, we'll continue our efforts in talent acquisition and development across our senior and middle management population. Further, we'll continue our commitment to bring additional diversity into our business. One example of this is our joining of the 30% Club, which entails a commitment between our chairman, our board, and our entire senior executive team to strive for increasing the gender diversity in our workplace. Now turning to IT and core business processes. Within this pillar, we continue to develop our capabilities in presenting management clear and easily digestible information, allowing faster and improved decision-making.
A few examples of this include the launching of a standardized set of operational KPIs visible by location to all our executives and operations team members. This visibility promotes root cause investigation and corrective actions, as well as best practice sharing between all entities and locations. A Rotork Site Services dashboard allowing visibility to field service utilization, productivity, warranty efforts, and overall profitability for each individual technician, location, and region. This program serves as the fact basis for our continued programmatic expansion of our field services organization. Lastly, a quote responsiveness dashboard, allowing us to track quote turnaround times for each category of products at each location. It's this enhanced visibility which facilitates the dramatic improvement in our quote turnaround times by reallocating needed resources between locations in order to raise our overall One Rotork effectiveness.
Many of you may recall in our customer survey work done in the first half of 2018, the issue of quote turnaround times rose to the top in a list of concerns in increasing our responsiveness to our customers and overall ease of doing business with Rotork. I'm pleased to announce we've selected our go-forward enterprise technology platform as the Microsoft Dynamics 365 platform, and Hitachi Solutions as our systems integrator and our implementation partner. In January, we formally kicked off our program, and we're active in the definition and design phases of our solution. It's important to note, utilizing our strategic data platform, we'll be implementing business critical elements of our solution more quickly than others, increasing the productivity and effectiveness prior to getting the full final solution set.
A few of these key elements that we deem priority that will be rolled out this year include the CRM, global project tracking and pricing management, and an HRIS system. Again, all to be deployed company-wide in 2019. Lastly, the pillars we've discussed are supported by our strategy portfolio and product line assessment activities. In 2018, we previously announced the planned exits from three businesses, the Nuclear Island Actuation business, the Valve Adaptation business, and a small regional engineering center. These exits are now complete. Additionally, we initiated a detailed product line review identifying a number of product lines to be withdrawn from production over the next 18 months. In 2018, we discontinued 28 product lines, representing over 4,000 individual parts and accounting for less than GBP 3 million of revenue. In 2019, we've also announced the discontinuation of an additional 20 product lines by year-end.
It's important to note that the vast majority of these revenues, meaning greater than 90%, will ship to newer generation products with improved margins and reduced manufacturing complexities. Exiting these businesses and our product line rationalization efforts are significant steps in decreasing the complexity of our business. These activities are indicative of our commitment to continually improve the quality of our overall portfolio. I'll close out by making a few comments on the outlook for this year. 2018 began with very strong oil prices, which supported expansion in larger programs and stimulated the return of small to mid-size maintenance and upgrade programs throughout the oil and gas spectrum. Towards the end of 2018, we saw a high degree of oil price instability, causing some of the larger programs to pause for what we believe is a short-term.
We've said it many times, over a particular price in a barrel of oil, say GBP 55 to GBP 60, the stability in the price of a barrel of oil is more important than the overall discrete price levels. Despite a slowing global economic environment and these dramatic fluctuations in oil prices witnessed in our fourth quarter, we continue to execute on our specific growth initiatives to drive our results. As demonstrated in 2018, our management-driven growth initiatives are driving growth beyond the underlying market conditions. Following double-digit OCC revenue growth in 2018 and mindful of the macroeconomic uncertainty, we're planning for a slower growth in 2019. Based on our current assessment of project phasing, we expect to deliver modest sales growth on an OCC basis in 2019, with lower year-on-year sales in the first half reflecting the strong comparative period.
Margins will benefit from the restructuring plans under our Growth Acceleration Programme and the implementation of additional cost savings initiatives. Overall, we expect full year margins to show progress on 2018. I remain very enthusiastic to be leading Rotork, and I'm very pleased with the level of execution our team is continuing to demonstrate. With this, Jonathan and I would be delighted to take any questions you have. Go ahead.
Good morning. It's Michael Blogg from Investec. Could I just drill down on one of your segments? Slower growth looks to be a bit of an understatement for Fluid Systems. The starting point looks a bit thin.
Fluid Systems is, as we've often talked about, our most project-reliant business. Therefore, it is by its very nature lumpy. I think therefore it's starting the year with a smaller order book, still it remains a question of input in the current year is by far the most important thing. Fluid Systems still has opportunities to do well this year, it's reliant on, as all the divisions are, the order patterns in this year. There are a number of markets which Fluid Systems which are certainly exposed to, which we anticipate improving through this year, LNG being one of those.
Do you have any particular contingency plans around improving flexibility in the event that the order intake doesn't pick up as early as you hope?
Clearly, one of the major parts of the Growth Acceleration Programme and the things we're focusing on that is about cyclical resilience. The whole drive around site consolidation, gaining greater critical mass in those manufacturing areas is focused on exactly that, building flexibility.
Thank you.
Good morning. It's Andrew Douglas from Jefferies. A few questions if I may. On the guidance for modest underlying growth for the full year, without wishing to give absolute numbers, am I right in thinking small, low single-digit decline in the first half, mid-single improvement in the second half to get to that number? Is that the shape, or are the extremities around the first and second half a bit bigger?
The shape is certainly down first half, up second half.
Okay.
That's, I think, as much as we can really say at this point. Clearly, this early in the year, there's a long way to go. That's the shape of how we expect things to play out.
Okay. The first slide you talked about a 30% drop through. I'm assuming your contribution margin is a lot higher than that. Going forward, what should we assume for operational gearing? I'm assuming it's not 30%. If it is, that's quite an interesting number. I mean, clearly there's lots of moving parts there, what should we think as operational gearing going forward?
I think a 30% drop through is our target, I guess, and I think we're very pleased with that as the performance in the period. The different moving parts in terms of savings out of procurement and all of those things, though, do have an impact in the short term as we go through the Growth Acceleration. I think as a longer-term sustainable level, 30% is a good outcome. 30%-35%, let's say.
Thank you. One just on the strategy. With respect to the IT rollout, sounds like you've got a lot of work to do in terms of 2019. I think you could go do all. Is there any business risk that you're concerned about there, or are you guys reasonably relaxed that you can-
Business interruption risk?
Yeah, quite possibly.
I think the bulk of that is behind us. We've completed 32 out of 39 workshops where we're defining the standard out of the package solution, comparing that to how we do business. At the end of March, all of that work is done, and they come back and present to the leadership team the rollout plan. Which again, they'll take three months thereafter to design and then begin rolling it out. I think the approach we took of creating this strategic data platform, which links the multiple disparate systems we have in the interim basis. If you imagine we have this layer of all these disparate systems, different platforms in all our businesses. We created, for lack of a better word, a data warehouse that's linking all of those together.
That data warehouse feeds a lot of the new improvement levels we're putting in place. What we didn't want to wait, we didn't want to say we're going to wait three years for these key enabling pieces of the solution to come. We took that step and developed that middle layer, which gives us those Power BI dashboards that allow us to run the business more effectively, gives us the project management and pricing tracking system globally, all those things that we want in place now. The global HRIS system is really critical for us. Having some of those critical layers coming in now very quickly will help us. As we roll out the final solution set, those individual links to that middleware, if you will, just go away, and they're seamless.
I think the approach we've taken allows us to roll it out on a very fair timescale using some really tried and true business practices with, of course, the appropriate controls and everything already built into the system. I think the biggest disruption from a managerial bandwidth occurred in January and February. It'll be done by next week with 39 of these workshops pulling lots of the most talented people in the company together to ensure we're defining the platform of how we want to operate Rotork going forward. Most of that's behind us.
Okay.
Hi, good morning. It's Andy Wilson from J.P. Morgan. Just a couple on the market to start with. You mentioned some orders had been, I think it was deferred or delayed as a result in the Q4.
Yeah.
Can you just talk about which parts of the market they were in, please?
Quite a few in the RFS business, for example. As you would expect, we keep a very good, robust understanding of projects we're tracking, we're bidding on, we're working on. I can tell you that the overall dollar value of that project system has not gone down from last year. The quality, that meaning the expected hit rate of that set of projects have gone up, in fact. We haven't had any changing market share in that in a negative manner, meaning there's no projects that are coming on, "Oh my God, we're losing at a faster pace." Our view on those projects, and because they're very discrete projects that we know the order was supposed to be let in November of this year, and then the order didn't get let. No one else got that order.
We're still expecting it, but we're expecting it now later than originally planned. That's what we're seeing. We're seeing that on a very discrete project by project basis.
If you think about the markets as you sort of discuss them and segment them, it feels as if subsea is probably the one that over, I guess, maybe the last 6-12 months, probably feels more positive sooner.
I guess. Can you talk about where your expectations have changed across those kind of market verticals? Just give us a sense of, I guess, where you were maybe three to six months ago versus where you are today.
I think we're still very positive on subsea. I think we're still very positive on LNG. The core spending seems to be holding up in terms of the maintenance and upgrade spending. That's still, I think it's just some of the larger upstream and some larger downstream. Those are the projects that are in hold in the short term.
Just final one, just on kind of the internal actions. When you look across those four pillars, as Andy alluded to earlier, there's an awful lot going on in terms of moving parts.
Yeah.
Can you talk about where you're, I guess, either, again, have been pleasantly surprised in terms of the opportunity that you've found and anywhere where it feels a bit more difficult than maybe where you outlined at the interims back in July?
I would say largely we're on track to our expectations, with much more opportunity we're finding on the operational side of the business than maybe we anticipated at this time a year ago. Lots of opportunities in inventory reduction, additional cash generation. Obviously, we went from GBP 2.7 to GBP 2.8, and we generated some additional cash and inventory. I'll be very mindful of that our inventory program didn't even kick off until the end of November. We did our global new training. To give you a sense of the type of programs we're doing there, we develop an inventory training module and a set of tools to assess an individual site's inventory. We have a room full of people running that modular toolkit, if you will, against every site we have.
Each one of those sites get on a conference call with our inventory expert teams we brought in, we talk about specific targeted improvement plans for each 1 of these categories of inventory. Each site then goes away, they had January to write a documented improvement plan, now those plans are back, and they're executing to those plans. A lot of those type of opportunities, while we planned it throughout 2018, are just now getting kicked off. I think operations is still a great example. I think on supply chain, lots of opportunities, I think we're tempering this year to that GBP 5 million number simply because of the inventory reduction program that we have, right? You have two opposing goals. One, generate additional cash, reduce inventory, which may then reduce the overall purchases required this year to get to our target.
Those are kind of those programs. I think the front end of the business, the route to market and getting that realignment done, I would say the one thing the team did that we weren't anticipating before was to slow down and let me describe. The front end of our business has two pieces. It has the customer-facing sales piece, there's a very significant infrastructure piece in terms of sales offices, where we're doing sales orders, financial functions, value-added centers, where we're adding our actuators to valves, for example. What the team did, rather than just focus on that front end, getting the sales force realigned, they took on the bigger project of doing both at the same time. That probably slowed us down about 60 days.
What it's done for us is allowed us to accelerate that back end of the front end, if you will. Now, as we're reorganizing the front orientation of the sales force, we really have further defined how we're going to reorient those sales offices and consolidations and what have you. That's frankly something we weren't going to do until the end of this year. I think the team said, "Let's spend time and do them both at the same time." I think we're probably 60 days behind, in the end, we'll be months and months ahead.
Thank you.
Good opportunities.
Hi. Good morning. It's Jack O'Brien.
Hey. Hi, Jack.
from Goldman Sachs. Can we just start with your largest market downstream? Obviously, there's been good retrofit and service activity there, and I guess new construction perhaps in the balance at the moment.
some of the larger projects. As you see those opportunities, I think predominantly they're Far East based, perhaps Middle East. Are you positioned in that new construction Far East market sort of as you would like, i.e., what's your market share? Is there a propensity to go for perhaps more domestic players?
Let me unwrap a few of those questions. Typically, in the application set that we're playing in particular in the Far East, again, we're in the critical application. Our strength is in the explosion-proof electric actuators. Those are in critical applications with critical high-value fluids and gases, and therefore, it's not the type of application set where you're going to go out and cheapen out on price. When we're in meetings with those companies, they will draw a very clear distinction between what they call the Tier 1a pieces of the project, and then others that maybe on some of the water circulating around a facility for cooling water, may not be as critical to them as the application set with the pipeline having the gas, right?
They're very clear about these sites having kind of a 2-tier strategy of having Rotork, A level up here on all critical applications. These are the meetings that I've sat in a couple of them last year in China with some of this expansion, and they were very clear about this 2-tiered strategy and sticking to the highest quality for those critical applications. We can't be cavalier and think that some of those other up-and-coming companies aren't going to get better and improve. We have to be very mindful of and sure we're delivering that strong value. I think we are well positioned as evidenced by the overall growth rate that we've seen in that market compared to the growth rate of downstream in Asia. Downstream in Asia was 35% growth rate this year?
About 30% for us.
Yeah, 30% for us compared to the overall market, which is about a third of that. I think we're very well positioned, and by virtue of us having won three out of three major program expansions in that market that we were going after, I think that's indicative of our strength in that region.
Perhaps if we can think about how you see your business evolving over the next five years. Clearly, a huge internal plan underway.
which looks very promising. Your balance sheet's strong.
Yep.
Where do you see the most interesting opportunities? If we think over the last decade, you've predominantly bought businesses in more, say, the Instruments and Controls section. Where do you see the gaps? Where do you think you're a bit underweight? Where would you like to bolster?
I think it's a little premature to have that conversation. I think we just brought on board Vijay, our new strategy in M&A, and Vijay, as many of you know, Vijay Rao, came from that similar role in the Honeywell Flow Control group. Vijay and I have been working on exactly that question and retesting all of our prior assumptions at Rotork in terms of subsegments with both of our experiences coming together and looking at all those opportunities. I think it's just premature to foreshadow our thinking there. Suffice to say that M&A will be part of our future for sure. We're going to continue to build our balance sheet and continue to put some dry powder to work. In the near term, it's really about furthering our definitional understanding of where we want to go next.
Good morning. It's Ed from Citi.
Hi, Ed.
I just had a question on new product development, just wondering, over the next two, three, five years, what sort of revenue numbers or what sort of contribution you expect from new product?
I don't think we've guided specifically on that, Ed. I think if you look at the products that we depicted in the first half of the year. Let me back up and say that we had 167 initiatives in flight when I came on, which is a massive amount of new product development initiatives. Now, in my tenure in the last several months, we've killed 35% of those. 35% of those weren't going to hit our aspirations in terms of margin, revenue, and frankly, were distracting the teams from some of the bigger, higher dollar, higher margin opportunities. We killed 35% of those programs to refocus on a smaller set.
We'll probably cull through another line of that and kill another round of them, because again, if you take these off in layers and say the bar continues to rise each time you take a layer of these off. Now that the team is focused on a fewer, more meaningful set, I think that's where we're going to be. I don't think we've gone out and given you a number of guidance in terms of percentage points to do that. If you just look at those projects that we had on the page, GBP 30 million of incremental revenue on those six programs alone I think are pretty significant.
Just while I've got the mic. Just think in August, Jonathan, you mentioned the U.S. water spend had kind of gone a bit quiet. Has there been any tick-up since or?
It was quiet early on in the year. Certainly, in the second half was slightly better. Water did grow overall, including in the U.S., but Looked at the year as a whole, did not grow in line with the group revenue as a whole. It was relatively modest growth in that market last year.
I think it's indicative of the strong understanding our teams have down in the field, where we were worried in the first half because water had declined in North America versus, we of course, look at our other companies out that are in that segment and say, "Well, they're not declining." We reached out to our team, they said, "Don't worry, we've got all these projects. They're coming in the back half, and our year's going to be fine." Jonathan and I were quite nervous at the mid-year, and sure enough, if they really had their finger on the pulse of the market, and all those programs came in in the back half quite nicely, as they expected. We ended the year up.
Thank you.
Thank you. It's Mark Davies Jones at Stifel. A few things, please. You mentioned the importance of stability in the oil price rather than just the recovery we've seen.
Yeah
over the last few months. Do you have an internal rule of thumb how long stability is required before activity begins to change again?
No, I don't think there's a rule of thumb. I think if you look at what happened in October and November, in a 5 to 6-week period, it was the most volatile period decline in oil prices that we've seen in over 20 years. That was incredibly significant, representing over a 30% decline in a five-week period or some crazy number. That's certainly what's going to cause. Now, most of these programs, once they've gone through FEED stage, they've committed, they're going to spend the money, they're going to go. It's not a question of are they going to rejigger these programs. These oil companies, they've lowered their break-even points now, largely below $40 a barrel. They know these programs are profitable, and they're going to go forward. They're through the approval stage.
When it comes down to actually releasing that purchase order, they are looking at that short-term environment. Right. That's what we saw in November, in particular, right on the back of October. When you look at the oil price decline in October, that'll have a direct translation into our October input. December was back strong again.
Okay. Are we confident that the slowing trends you're seeing on the top line and in orders are entirely market related, and this isn't partly what you're doing internally?
Yeah
having an effect? Clearly there's a lot of refocusing of the product on the.
level. You're confident that's not impacting your growth?
That's a great question, and that's a question we ask ourselves internally. Ensure we're not distracting the sales team, for example, ensure people are focused on driving their day jobs, if you will. The closest thing we could look at there is the individual project funnels that make up our sales forecasts. When we go back and look at those individual project funnels line by line, we are seeing exactly what we disclosed earlier, where some of those projects that we had scheduled for November got pushed out. The underlying day-to-day trading, I think is staying fairly consistent. It's really about the project business coming in.
Thank you.
If I can be allowed one more. It seems to be a bit more focused on the industrial side, I guess, partly because power is so weak.
Within industrial, any specific verticals where you're increasing focus?
Certainly the HVAC.
Marine is the other one.
Marine
that was positive in 2018. Shipboard use of electric actuators in that instance.
HVAC, an example where we acquired a company several years ago, and now we're adding additional sales resources that are specifically targeted at selling those products in other markets and other regions.
Yeah. Hi, Mark Fielding from RBC. Just actually one follow-up from an earlier answer, I think it was to Ed's question on the R&D side. In terms of those nine new products and the GBP 30 million sales, is that truly incremental revenue or is some of it replacing existing products? Generally, how do you think about that mix going forward?
The number I gave you was incremental. Some of those are additional upgrades. Some are pure incremental and some are upgrades, but the total sum I gave you was the incremental revenues, to be clear.
A second question, if I may. Just obviously you've settled into the business now. Instruments in particular has been built out in recent years. It's a little bit of a collection of different businesses. As you look at that portfolio, how do you think about that specifically going forward and how it integrates with the group?
There's been a huge focused effort on integrating Instruments, in particular with the RFS business that utilizes a lot of them. We've had many sessions with those two teams coming together, having joint new product development efforts, and looking at how we more standardize on use of Instruments products within our RFS business. I would say those two teams are working very closely together at this point in not only developing new products in the engineering functions of designing new things that would simplify our RFS offering. We've talked about that in the past, that a lot of the RFS is bespoke engineering every time. If you think about the front-end control panels that we utilize next to our actuators in the RFS business, it's the Instruments engineering team working with the RFS team in designing 10 standardized packages that cover 90% of our range, for example.
That's a major ongoing new product development initiative that we pulled resources from other areas on to focus on that particular program. That's a great example of those two working together to really drive an improvement in our business. They're getting much more integrated.
Thank you.
Great. Looks like that's it. Thank you very much, everybody. Appreciate your attendance.