SMITH & NEPHEW PLC annual report, Q4 FY2023

Business context and reporting period

Smith & Nephew plc filed its Form 20-F annual report for the fiscal year ended December 31, 2023; this is a full-year report, not a standalone fourth-quarter filing. The UK-incorporated medical technology group sells in more than 100 countries across Orthopaedics, Sports Medicine & ENT, and Advanced Wound Management. Financial statements are prepared under IFRS as issued by the IASB, in US dollars.

Key financial metrics

Cash and cash equivalents were $300m at year-end, versus $344m. Committed debt facilities totaled $3.6bn, of which $2.9bn was drawn. The $1bn revolving credit facility was refinanced in late 2023, extending its maturity to 2028 with options to extend to 2030. The Group reported covenant compliance and forecast headroom under its severe-but-plausible scenarios.

Revenue by business unit was $2,214m for Orthopaedics (+5.7% underlying), $1,729m for Sports Medicine & ENT (+10.0%), and $1,606m for Advanced Wound Management (+6.4%). R&D investment was $339m. The proposed final dividend is 23.1¢ per share; with the 14.4¢ interim dividend, the full-year distribution is 37.5¢, unchanged from 2022.

Material changes versus 2022

• Underlying revenue growth accelerated from 4.7% to 7.2%; all three business units recorded underlying growth above 5%.
• Trading profit and margin improved, while IFRS operating profit and margin declined. Higher restructuring, acquisition-related, and other excluded charges contributed to the difference.
• Operating cash generation strengthened and inventory growth moderated: inventories rose $190m, compared with a $361m increase in 2022. However, inventory remained elevated at $2,395m.
• Net debt rose, with debt reclassified to current liabilities for amounts due in 2024 and a drawdown on the revolving credit facility.
• Attributable profit increased partly as the share-of-associates loss fell to $30m from $141m, including a $109m Bioventus impairment in 2022; 2023 interest expense also increased to $132m from $80m.

Outlook, commentary, risks and unusual items

Management targets 2024 underlying revenue growth of 5.0%–6.0% (approximately 4.6%–5.6% reported at exchange rates prevailing February 21, 2024) and a trading profit margin of at least 18.0%. It expects a slower first quarter, followed by higher growth through the rest of the year. The 2025 target remains at least a 20% trading profit margin, alongside consistently 5%+ underlying revenue growth. Management cites inflation, foreign exchange, China volume-based procurement and execution as headwinds, with productivity and the 12-Point Plan expected to offset them. The plan was approximately 65% complete against milestones; management expects further benefits in 2024 and 2025.

• Exceptional and non-IFRS items: 2023 restructuring and rationalisation costs were $220m; the Group expects around $275m of 12-Point Plan restructuring costs over three years. Trading profit excludes acquisition/disposal items ($60m), acquired-intangible amortisation and impairment ($207m), and legal and other items ($58m), as well as restructuring costs.
• Engage Surgical: The Group decided to discontinue the acquired products and wrote off $109m of assets and liabilities, including $84m goodwill, $37m intangible assets and $21m inventory, partly offset by a $33m contingent-consideration remeasurement credit.
• CartiHeal: The acquisition completed on January 9, 2024, after year-end. Smith+Nephew paid $180m, with up to a further $150m contingent on future financial performance.
• Legal contingency: A $149m provision remained for known and anticipated metal-on-metal hip claims; approximately 276 claims were pending globally. The eventual liability may differ materially from the estimate, and insurance coverage is subject to limits and exclusions.
• Other risks: Management highlights Orthopaedics’ slower US recovery and remaining product-availability issues, supply-chain and inventory execution, pricing and reimbursement pressure (including China procurement), regulatory approvals, product liability, cybersecurity, foreign exchange, geopolitical disruption and talent retention. The Orthopaedics goodwill valuation is sensitive to assumptions, although reported headroom increased to $1.2bn.
• Tax and governance: The 2024 trading-results tax-rate forecast is 19%–20%; the Group estimates Pillar Two rules could increase its tax rate by around 1.5 percentage points, subject to actual 2024 results. CFO Anne-Françoise Nesmes was due to depart in Q1 2024; John Rogers was designated to succeed her.

KPMG issued unmodified opinions on the IFRS financial statements and internal control over financial reporting. The report identifies significant audit focus areas including Orthopaedics goodwill, inventory provisions and the metal-on-metal hip provision.

Important facts for investors to verify

• Whether Orthopaedics product availability and US reconstruction performance improve, and whether inventory continues to fall without constraining sales.
• Whether 2024 revenue and margin guidance is met, including the impact of inflation, China procurement and foreign exchange, and whether cash conversion improves.
• Debt repayment and refinancing needs, facility availability, covenant headroom and the effect of the January 2024 pension buy-out payment.
• Future changes in the $149m metal-on-metal provision, claim outcomes and insurance recoveries.
• CartiHeal integration, commercial uptake and any contingent payments; also the financial consequences of discontinuing Engage Surgical.
• Shareholder approval and implementation of proposed 2024 US executive incentive changes, and the company’s progress toward its 2025 margin target.