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Smith & Nephew plc: 2002 Annual Report (Form 20-F) Summary

Business Context and Reporting Period

This Form 20-F covers the fiscal year ended December 31, 2002. Smith & Nephew plc is a global medical device company headquartered in London, England, with operations in over 90 countries. The company focuses on three core growth sectors: Orthopaedics, Endoscopy, and Advanced Wound Management. Financial statements are prepared under UK GAAP, with reconciliations to US GAAP provided in the notes.

Key Financial Metrics (Fiscal Year 2002)

Material Changes vs. Prior Period

• Revenue Growth: Group turnover increased 3% to £1,109.9 million. Excluding discontinued operations and joint venture contributions, ongoing operations grew 15% (14% underlying growth, 4% from acquisitions, offset by 3% currency headwinds).
• Profitability: Operating profit for ongoing operations before goodwill amortization and exceptional items rose 15% to £196.0 million. However, reported profit before tax declined 8% due to exceptional items and lower gains on disposals compared to 2001.
• Acquisitions: The company acquired ORATEC Interventions, Inc. in March 2002 for a net £191.2 million, expanding its endoscopy portfolio. It also acquired remaining interests in the DERMAGRAFT joint arrangement for £7.8 million.
• Disposals: The rehabilitation business was disposed of in March 2002 for a net cash consideration of £71.3 million and a 21.5% equity stake in AbilityOne, resulting in a £18.0 million gain on disposal.
• Exceptional Items: Operating exceptional items totaled £29.9 million, primarily driven by a £17.5 million write-down of the investment in Advanced Tissue Sciences, Inc. (ATS) following its Chapter 11 bankruptcy filing, and £8.4 million in integration costs.
• Liquidity: Net borrowings increased to £276.9 million from £243.5 million, reflecting acquisition spending and dividend payments, partially offset by exchange adjustments.

Guidance, Outlook, and Risks

• Strategic Acquisition: On March 20, 2003, the company announced a combination with Centerpulse AG and InCentive Capital AG. The transaction involves a share exchange and cash payment of approximately £400 million, expected to complete in July 2003. This aims to create the global number three player in orthopaedics.
• 2003 Outlook: Management expects sales to increase by approximately £10 million due to the full-year impact of the ORATEC acquisition. Conversely, the divestiture of the rehabilitation business will reduce sales by £26 million. Currency translation remains a significant variable.
• Pension Deficit: The company estimates a combined net deficit of £80 million in its major defined benefit pension plans due to falling stock market values, which will impact future pension expenses and cash flow.
• Risk Factors: Key risks include reliance on new technology, regulatory approvals (FDA/CE), product liability claims, currency fluctuations (particularly Sterling vs. USD), and the successful integration of acquired businesses.

Investor Verification Checklist

• Centerpulse Transaction: Verify the status of regulatory approvals and shareholder votes required to close the Centerpulse/InCentive acquisition.
• US GAAP Reconciliation: Review Note 35 for significant differences between UK and US GAAP, particularly regarding goodwill amortization, pension accounting, and derivative hedging, which significantly alter reported net income and equity.
• Pension Funding: Assess the impact of the £80 million pension deficit on future cash flows and the adequacy of planned contribution increases.
• Exceptional Items: Confirm the final status of the Advanced Tissue Sciences, Inc. (ATS) bankruptcy proceedings and the recoverability of any remaining investments.
• Currency Exposure: Monitor the Sterling/USD exchange rate, as a significant portion of revenue and assets is denominated in foreign currencies, impacting reported earnings.