SNN

Business Context and Reporting Period

Company: Smith & Nephew plc
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2003
Business Overview: Smith & Nephew is a global medical devices company operating in three core segments: Orthopaedics (reconstructive joints, trauma), Endoscopy (minimally invasive surgery), and Advanced Wound Management. The company is incorporated in England and Wales, with shares listed on the London Stock Exchange and the New York Stock Exchange (as American Depositary Shares).

Key Financial Metrics (2003)

Material Changes vs. Prior Period

• Revenue Growth: Turnover increased by 6% to £1,178.9m. Underlying sales growth (excluding currency and acquisitions) was 11%.
• Profitability: Profit before taxation rose 29% to £230.1m. Operating profit margins (before goodwill amortisation and exceptional items) improved from 18.1% to 18.7%.
• Segment Performance:
  • Orthopaedics: Sales grew 12% (16% underlying) driven by OXINIUM technology and trauma focus.
  • Endoscopy: Sales grew 3% (4% underlying); US sales declined due to blade re-use trends and customer issues, offset by growth outside the US.
  • Advanced Wound Management: Sales grew 10% (9% underlying) driven by DERMAGRAFT and ACTICOAT, though margins compressed due to DERMAGRAFT integration costs.
• Exceptional Items: Net costs of £22.4m were incurred, primarily £17.6m related to unsuccessful public offers to acquire Centerpulse AG and InCentive Capital AG.
• Disposals: The company disposed of its 21.5% interest in AbilityOne for a net profit of £31.5m.
• Liquidity: Net debt decreased significantly by £149.8m to £127.1m, aided by strong operating cash flow and favorable currency translation effects.

Guidance, Outlook, and Risks

• 2004 Outlook: Management expects strong underlying sales growth. Targets include high-teens growth for Orthopaedics and high-single-digit growth for Endoscopy and Advanced Wound Management. Operating margins are targeted to increase by approximately 1%.
• Investment Plans: The company plans to expand its sales force by at least 10% in 2004 and continue investing in R&D and manufacturing capacity.
• Key Risks:
  • Currency Fluctuations: Significant exposure to USD and Euro exchange rates against Sterling.
  • Product Liability: Potential for substantial claims, particularly in the US market.
  • Regulatory Approvals: Delays in FDA or other regulatory approvals could impact new product launches.
  • Competition: Highly competitive markets with potential for price pressure and consolidation.
• Unusual Items: A voluntary withdrawal of the macrotextured femoral knee component occurred in August 2003 due to higher-than-normal revision rates. The company also faced a patent infringement injunction in the US regarding bipolar radio frequency products (Endoscopy segment).

Investor Verification Checklist

• Underlying Growth vs. Reported Growth: Verify the impact of currency translation (stronger Sterling reduced reported turnover) on the 11% underlying sales growth.
• Exceptional Costs: Review the £17.6m cost associated with the failed Centerpulse acquisition and its impact on future M&A strategy.
• Product Liability Exposure: Assess the status of the macrotextured femoral knee component recall and the ArthroCare patent infringement litigation.
• Pension Deficits: Note the SSAP 24 deficit of £55m (estimated) and the potential impact of FRS 17 adoption (deferred until 2005) which could recognize a larger liability.
• Acquisition Integration: Monitor the integration of the Midland Medical Technologies (MMT) acquisition completed in March 2004 and the ORATEC acquisition.