SNN

Business Context and Reporting Period

Smith & Nephew plc is a global medical devices company incorporated in England and Wales, with operations in orthopaedic reconstruction, orthopaedic trauma and clinical therapies, endoscopy, and advanced wound management. The reporting period covers the fiscal year ended December 31, 2006. Effective January 1, 2006, the Group changed its functional and reporting currency from Pounds Sterling to US Dollars to align with its principal assets and operations.

Key Financial Metrics

Note: The 2006 Attributable Profit includes a $351 million net profit from the disposal of the BSN Medical joint venture, classified as a discontinued operation. Adjusted Attributable Profit excludes this gain, as well as restructuring costs, bid-related costs, and amortisation of acquisition intangibles.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 9% to $2.779 billion. Underlying growth (excluding acquisitions and currency effects) was 8%. Currency translation added 1% due to the strengthening of the Euro and Sterling against the US Dollar.
• Profitability: Operating profit rose 27% to $537 million. This increase was driven by a $68 million reduction in restructuring charges compared to 2005 (which included a $68 million charge for exiting tissue engineering operations) and improved performance in Advanced Wound Management.
• Discontinued Operations: The Group sold its 50% interest in the BSN Medical joint venture in February 2006 for net cash proceeds of $562 million, resulting in a $351 million net profit on disposal.
• Acquisitions: The Group acquired OsteoBiologics Inc. (OBI) in July 2006 for $73 million to expand its endoscopy portfolio. Discussions to acquire Biomet Inc. were terminated in December 2006, resulting in $20 million of bid-related costs.
• Liquidity: The Group moved from a net debt position of $306 million in 2005 to a net cash position of $210 million in 2006, primarily due to the BSN Medical disposal proceeds.

Guidance, Outlook, and Risks

• Outlook: Management expects to exceed market growth in 2007 driven by new product launches (e.g., JOURNEY knee, BHR hip resurfacing) and demographic trends (ageing population, obesity). An "Earnings Improvement Project" is underway to enhance margins.
• Share Buyback: In February 2007, the Group announced a share buyback programme of up to $1.5 billion over two years.
• Acquisition: In March 2007, the Group agreed to acquire Plus Orthopedics Holding AG for approximately $889 million, subject to regulatory approval.
• Legal Proceedings:
  • Macrotextured Knee Claim: A provision of $42 million remains for the macrotextured OXINIUM knee component revisions. Five insurers have declined coverage; the Group is pursuing breach of contract suits. Management estimates future cash outflows of approximately $25 million in 2007.
  • Antitrust Investigation: The US Department of Justice issued a subpoena in June 2006 regarding potential antitrust violations in the orthopaedic implant market. Six class-action lawsuits have been filed alleging price-fixing.
• Risks: Key risks include product liability claims, reimbursement policy changes, currency fluctuations, and the outcome of ongoing litigation.

Investor Verification Checklist

• Verify the sustainability of the $351 million gain from the BSN Medical disposal and its impact on the reported EPS versus the Adjusted EPS (EPSA).
• Confirm the status of the $42 million provision for macrotextured knee claims and the progress of litigation against insurers who declined coverage.
• Assess the impact of the $1.5 billion share buyback and the $889 million Plus Orthopedics acquisition on future leverage and interest costs.
• Review the outcome of the US Department of Justice antitrust investigation and associated class-action lawsuits.
• Monitor the integration of the OsteoBiologics acquisition and the performance of new product launches (JOURNEY, BHR) in driving underlying revenue growth.