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Business Context and Reporting Period

Company: Smith & Nephew plc
Reporting Period: Fiscal year ended December 31, 2004
Business Overview: A global medical devices company operating in three primary segments: Orthopaedics (reconstructive joints, trauma, clinical therapies), 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 American Depositary Shares (ADSs) on the New York Stock Exchange.

Key Financial Metrics (2004)

Material Changes vs. Prior Period

• Revenue Growth: Reported turnover increased by 6% to £1,248.5 million. Underlying sales growth (excluding currency and acquisitions) was 11.5%. Growth was driven by the Orthopaedics segment (12% reported growth) and the acquisition of Midland Medical Technologies (MMT).
• Profitability: Reported profit before taxation decreased by 23% to £177.9 million, primarily due to a significant exceptional charge. However, underlying operating profit (before goodwill amortisation and exceptional items) increased by 14% to £278.4 million.
• Exceptional Items: The company recorded an exceptional charge of £80.0 million related to the macrotextured OXINIUM femoral knee component. This charge covers unsettled insurance claims and estimated future settlement costs after two insurers declined coverage.
• Currency Impact: A stronger Sterling against the US Dollar (12% stronger) and Euro (2% stronger) negatively impacted reported sales by approximately 7%.

Guidance, Outlook, and Risks

• 2005 Outlook: Management expects high teens sales growth in Orthopaedics and high single-digit growth in Endoscopy and Wound Management. Underlying mid-teens growth in Adjusted EPS is anticipated.
• Macrotextured Knee Contingency: The company withdrew the macrotextured OXINIUM femoral knee component in August 2003. As of February 2005, 782 revisions had been performed. While £80 million has been provisioned, the company estimates that if all implants required revision and insurance coverage remained unavailable, the total cost could reach £190 million. Management expects an adverse cash flow impact of approximately £40 million in 2005 due to unreimbursed settlements.
• Legal Proceedings: An injunction was granted in June 2004 prohibiting the sale of certain bipolar radio frequency products due to a patent dispute with ArthroCare Inc. Sales of affected products prior to the injunction were £3 million.
• Acquisitions: The acquisition of MMT (metal-on-metal hip resurfacing) for £70 million (plus contingent payments) contributed £20 million to 2004 turnover.
• Accounting Transition: The company is transitioning to International Financial Reporting Standards (IFRS) for 2005 reporting, which will impact pension accounting and goodwill treatment (no longer amortised).

Key Facts for Investor Verification

• Insurance Coverage Status: Verify the status of negotiations with the two insurers who declined coverage for the macrotextured knee claims and the potential for restoring coverage.
• Revision Rates: Monitor the ongoing rate of revisions for the macrotextured OXINIUM knee components to assess if the £80 million provision remains adequate.
• Patent Litigation: Track the outcome of the patent infringement lawsuit with ArthroCare Inc. regarding bipolar radio frequency products.
• MMT Integration: Assess the integration progress and regulatory approval status (specifically FDA) for the Birmingham Hip Resurfacing (BHR) product acquired via MMT.
• Currency Hedging: Review the effectiveness of hedging strategies given the significant exposure to US Dollar and Euro fluctuations relative to the reporting currency (Sterling).