Review of Operations

• Chairman's Statement
• Chief Executive's Review
• Financial Review
• Statement of Directors' Responsibilities
• Principal Risks and Uncertainties

Introduction

Spectris experienced challenging market conditions during the first half of the year as the global economy continued to deteriorate. On a reported basis, sales increased by 4%, with acquisitions contributing 7% and currency having a favourable impact of 17%. Operating profit declined by 57% as a result of the sales decline and a one-off charge of £7 million in the first half for post-acquisition integration costs and restructuring activities, partially offset by overhead cost savings of £24 million. Research and environment-related areas showed greater resilience in customer activity; however, demand was particularly weak in the automotive and mining sectors. On a regional basis, China grew and the emerging economies fared relatively better than Europe and North America. As a consequence, we continue to build our presence and distribution channels in these markets.

Our strategy for the group remains unchanged, although in the short term our emphasis is on operational excellence. We sought to act fast and determinedly in the face of rapidly declining markets. Restructuring and post-acquisition integration activities were focused on consolidating production facilities and streamlining sales channels, as well as aligning overhead costs to revenues. The total restructuring costs, previously estimated at around £10 million for the full year, are now expected to be slightly higher at £10.8 million. These actions will result in increased benefits for 2009 now estimated to be £14.9 million, with a further £8.5 million in 2010. We have also identified further restructuring actions at a cost of £3 million which will generate additional benefits of £6 million in 2010. Of these costs, £7.0 million were incurred in the first half and we expect to incur £6.8 million in the second half.

Despite the challenging economic climate, we decided to maintain our commitment to research and development. On an organic constant currency basis, expenditure was £25 million, a decline of 5% compared with the prior year period. The group re‑prioritised programmes in favour of projects which will deliver benefits in the short term.

The integration of the businesses acquired in 2008, as well as Lochard, acquired in February 2009, is proceeding well. In particular, demand for Lochard’s portfolio of environmental monitoring services has been strong.

Operating review

Overview
Materials Analysis provides a wide range of analytical instrumentation to the metals and mining, pharmaceutical and life sciences, and semiconductor industries. Our products help customers to improve accuracy and speed of materials analysis in the laboratory and in process manufacturing applications. The operating companies in this segment are Malvern Instruments, PANalytical and Particle Measuring Systems.

Segment performance
Sales in Materials Analysis showed a slight increase compared with the prior year period at £116.1 million (down 15% at constant currencies). Operating profit declined by 25% to £10.1 million. Operating margins declined from 11.7% to 8.7%.

Demand from the pharmaceutical and life sciences industries was relatively good, with good growth in academic research and development. This benefited both Malvern and Particle Measuring Systems. In the case of Malvern, the Morphologi and Zetasizer Nano range of products serve these applications. Sales of Malvern’s Mastersizer systems have now exceeded the 10,000 instruments mark, and these systems are now used by more than 90% of the world’s leading chemical and pharmaceutical companies.

For Particle Measuring Systems, demand from the pharmaceutical sector was particularly strong for the newly-launched Lasair III and for facility monitoring systems. The latter include the microbial air sampling products marketed as part of the distribution rights for the Biotrace MicroSafe family of products. Particle Measuring Systems has established a direct sales and service organisation in Japan and is capitalising on the direct presence it established in China in 2008, leading to a number of orders from customers in Asia and the Middle East. Following its investment in Naneum Limited in 2008, the company launched the Nano-ID, the first of the Naneum contamination monitoring products to be marketed. Aimed at the industrial hygiene market, the Nano-ID is designed for applications associated with nano-particle risks to worker health and safety, product quality and environmental control.

This segment saw weaker demand from the metals, minerals and mining industries, with the exception of China and India, where infrastructure developments and upgrading of inefficient cement plants led to good demand. PANalytical extended its family of successful MiniPal compact spectrometers with the introduction of the MiniPal 4 Cement. This product is designed specifically to address the analysis requirements of the building materials industry. PANalytical also saw good demand for food and environmental safety applications, for example for screening toxic elements, and received a number of orders for its Epsilon 5 X-ray analysis system from China and Japan. Demand is also growing for applications in new technology areas such as solar power equipment.

In the semiconductor industry, investment in capital equipment continued to be weak throughout the period and some consolidation within the customer base has begun. Particle Measuring Systems is, however, winning important orders for both its particulate and molecular contamination monitoring products from major semiconductor manufacturers throughout the world.

Outlook
Demand for our products from the pharmaceutical sector continues to be driven by their research activities, with increasing opportunities in the fields of nano-materials and biotechnology. We expect that academic research and development institutions will continue to provide good demand for the Materials Analysis segment. Industrial markets remain weak, particularly mining and metals; however, the semiconductor industry appears to be showing some signs of activity, albeit from a very low base.

Overview
Test and Measurement supplies test, measurement and analysis equipment and software for product design optimisation and manufacturing control, principally to the aerospace, automotive and consumer electronics industries. For customers in the automotive and aerospace industries, our products and applications help them to design safer, more fuel-efficient, environmentally-friendly vehicle platforms whilst reducing time to market. In consumer electronics, our equipment and software enable customers to refine the performance and accuracy of their products. Further applications are in the environmental monitoring market, where the desire for higher standards of community comfort drives increasing demand. The operating companies in this segment are Brüel & Kjær Sound & Vibration and HBM.

Segment performance
Sales in Test and Measurement increased by 11% (decrease of 26% at organic constant currencies) to £126.1 million. The organic sales decrease was due to a significant decline in demand from automotive customers as research and development spending was severely curtailed. The segment made an operating loss of £6.2 million, of which £4.0 million is attributable to restructuring actions and accelerated post-acquisition integration costs. Operating margins were –4.9% compared with 10.1% in the prior year period.

Recent acquisitions have enhanced our position as a single source of supply for noise, vibration and harshness testing applications and have already resulted in some large orders for integrated hardware and software solutions for aerospace customers. Brüel & Kjær launched PULSE Reflex, the latest version of the popular PULSE noise analysis software for the LAN-XI hardware platform, for acoustic testing in the aerospace and automotive industries. HBM’s QuantumX, the new compact, fast data acquisition family launched in 2008, is gaining wide acceptance in test rig applications. A recent customer is the Swiss Rail network, where the QuantumX is used for mobile testing of freight cars. Demand from the aerospace and defence market was relatively good, with significant orders received for PULSE systems for a satellite manufacturer in Malaysia and a naval shipyard in India.

In the automotive sector, weak consumer demand has led car manufacturers to take a range of cost saving measures, including delaying investment in research and development programmes. However, China and other parts of Asia continued to grow, with several significant orders won. Recent acquisitions have extended our software capabilities in the area of modelling and simulation of new vehicle designs, providing customers with the technology to carry out fatigue and durability testing and life prediction.

As in Materials Analysis, the Test and Measurement segment also benefited from stronger demand in the academic research area, largely as a result of the increase in government investment to stimulate the economy through research. Our systems are used, for example, in acoustics laboratories within universities.

The environmental noise monitoring business, strengthened by the acquisition of Lochard, saw good demand for its airport noise monitoring systems and secured a number of orders from major airports around the world. This business also benefits from service and maintenance income from long-term contracts with customers and provides opportunities for us to add new service contracts to airports where we had previously only sold monitoring products. We delivered on a contract to supply noise monitoring systems to New Zealand’s largest producer of electrical energy for a wind farm where our Noise Monitoring Terminals will be used to determine the change in the overall noise levels to ensure that the wind farm complies with its planning conditions.

Outlook
We remain cautious about prospects for recovery in automotive markets. We expect demand to continue for academic research and for environmental-based projects. Aerospace and defence projects, as well as growing requirements for environmental noise monitoring, are also expected to continue to generate good opportunities for this segment.

Overview
In-line Instrumentation provides process analytical measurement, asset monitoring and on-line controls for both primary processing and the converting industries. Our products and applications provide precision measurement in challenging operating environments, ensuring process quality, asset uptime, safety, and improved yield. The operating companies in this segment are Beta LaserMike, Brüel & Kjær Vibro, BTG Group, Fusion UV Systems, NDC Infrared Engineering and Servomex.

Segment performance
Sales in In-line Instrumentation declined by 1% (18% at constant currencies) to £107.4 million. Operating profit decreased by 8% to £15.5 million and operating margins decreased from 15.5% in the first half of 2008 to 14.4%.

In the pulp and paper industry, despite widespread temporary papermill shutdowns at the beginning of 2009, increasing market share in tissue production continued to provide strong demand both for BTG’s high performance creping blades and in-line instrument applications. BTG launched a range of new analytical instruments designed to improve mill productivity which have been well received in the market.

In the industrial gas and hydrocarbon sector, greenfield investment projects in the Middle East, India and Asia maintained demand. Servomex signed a technology licensing agreement with Norsk Elektro Optikk to incorporate its industry-leading laser measurement technology into its global product range. This technology is suitable for a wide range of process and combustion control applications and enables Servomex to provide a combination of world-leading gas analysis technologies.

Oil and gas and petrochemical processing also provided good demand for remote monitoring systems and safety systems. Furthermore, in the power industry, hydro and wind energy projects have been less affected by the general economic downturn. Brüel & Kjær Vibro received large orders for remote monitoring systems, including retrofitting 80 wind turbines for one of the world’s largest wind farms in the North Sea, and a further 120 turbines in North America. The company continued to experience strong demand for its enhanced Compass 6000 condition and performance monitoring software for a range of industrial applications and launched the Vibrocontrol 1500 compact monitor, which provides a cost-effective solution for smaller machines, combining safety, analysis and predictive monitoring.

In the converting industry, good demand for food packaging benefited NDC as a result of the growth in packaged food products as people eat at home more, and a large order was received for sensors from a major food producer in North America. Activity also increased in the tyre market in China, where car sales are increasing, helped by government incentives.

Beta LaserMike saw good demand from the speciality metal and medical tubing sector and secured orders for new applications in North America. The LaserSpeed product continued to perform well, sustained by investment in the steel-making sector in China and also in Vietnam. The company also secured significant orders for its ultrasonic measurement system from the energy sector for plants in Malaysia and Brazil.

Investments in infrastructure in both China and India have stimulated demand for optical fibre for the telecommunications industry, resulting in increased production of fibre and fibre cable products. This expansion has benefited both Fusion and Beta LaserMike whose UV curing products and measuring equipment, respectively, are used in optical fibre production. The decline in the flat panel display market in Japan impacted sales at Fusion; however, demand is growing in Korea and Taiwan where investment in new capacity is beginning to take place.

Outlook
In the oil and gas industry, we anticipate that the main areas of continuing investment activity will be in large petrochemical projects in Asia, the Middle East and Latin America. The hydro and wind energy industries appear to be relatively unaffected by the economic conditions and continue to present opportunities, and the initiative by the US government to promote renewable energy has increased the rate of growth in the US market. The outlook for the pulp and paper market remains uncertain in the short term, although demand for tissue is expected to continue to grow. In converting, although core metals and wire markets remain weak, opportunities exist in China in optical fibre as well as speciality metal and medical tubing.

Overview
Industrial Controls supplies automation and control products for the discrete manufacturing industries. Our products provide identification and tracking solutions during the manufacturing process, displays for process monitoring and control, and data interfaces for a broad range of manufacturing industries. Sales are indirectly to end users via distributors as well as directly to original equipment manufacturers, with a significant proportion of repeat business. The operating companies in this segment are Microscan and Red Lion Controls.

Segment performance
Sales in Industrial Controls showed a slight increase from £21.1 million to £21.9 million (down 19% at constant currencies). Operating profit was down from £4.6 million to £0.6 million. Operating margins were 2.7% compared with 21.8% in the first half of 2008.

The electronics and general manufacturing sectors started the year with weak conditions on a worldwide basis due to overall de-stocking and low capacity utilisation. At Microscan, the integration of the recent machine vision acquisition is progressing well and two new direct part mark readers were launched. The Visionscape GigE, featuring the industry-leading Visionscape machine vision software, brings quality and productivity benefits to manufacturers. The MiniHawk is a miniature imager which is powerful yet easy to use for barcode and 2D track, trace and control applications and can read damaged or difficult symbols.

In the healthcare market, Red Lion Controls secured an order to provide remote detection of air conditioning failure for mobile MRI scanners, with the company’s Data Station within the air handling system helping to keep the scanner on the road. Sales via catalogue channels continued to perform well.

Outlook
Towards the end of the first half we saw some limited recovery in demand as manufacturing output increased, particularly in China. We expect further progress from our extended product portfolio of track, trace and control solutions, which is enabling us to address new opportunities in the industrial controls sector.

Conclusion

After a challenging first half, visibility of customer demand remains limited. However, we expect to see an improving performance in the second half resulting from the benefits of the restructuring and post-acquisition integration actions, a continuation of recent market trends, and contributions from new products. We have a good strategic and financial position, the planned restructuring and acquisition integration actions are on track, and we remain confident that we are well placed for a more sustained recovery when our markets return to growth.

Chief Executive