Smith & Nephew PLC (SNN) 2005 Q3 法說會逐字稿

Ladies and gentlemen you on hold for the Smith & Nephew third quarter results conference call. We are currently awaiting the arrival of additional participants and should be commencing shortly. Thank you for your patience and please continue to hold.

Please stand by we are about to begin. Good day ladies and gentlemen and welcome to today's Smith & Nephew third quarter results conference call. For your information this conference is being recorded.

This presentation contains certain forward looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995. In particular statements regarding planned growth in our business and in our operating margins discussed in our outlook are forward looking statements as are discussions of our products pipeline. These statements as well the phrases aim, plan, intend, anticipate, well placed, believe, estimate, expect, target, consider and similar expressions are generally intended to identify forward looking statements. Such forward looking statements involve known and unknown risks, uncertainties and other important factors including, but limited to, the outcome of litigation and regulatory approval that could cause the actual results, performance or achievements of Smith & Nephew or industry results to differ materially from any future results, performance or achievements expressed or implied by such forward looking statements.

Please refer to the documents that Smith & Nephew have filed with the US Securities and Exchange Commission under the US Securities Exchange Act of 1934 as amended including Smith & Nephew's most recent annual report on form 20F for a discussion of certain of these factors.

All forward looking statements in this presentation are based on information available to Smith & Nephew as of the date hereof. All written or oral forward looking statements attributable to Smith & Nephew or any person acting on behalf of Smith & Nephew are expressly qualified in their entirety by the foregoing. Smith & Nephew does not undertake any obligation to update or revise any forward looking statement contained herein to reflect any change in Smith & Nephew's expectation with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

I will now pass you on to Sir Christopher O'Donnell, chief executive officer of Smith & Nephew.

Well good morning everybody on our quarter three results call. I'm Chris O'Donnell, I'm the chief executive of Smith & Nephew and I have with me here Peter Hooley, our Group finance director, and Liz Hewitt, Group corporate affairs for Smith & Nephew.

What we'd like to do is to take you through the highlights of the call. Peter will talk through the financial numbers; we do have slides available, we always have done that at full year and the half year, we're now making these available at the quarter one and quarter three, so we're hope you'll find that helpful.

From the point of view of the overall business, we grew our revenue in the third quarter by 10% in a tighter market. The fundamentals of the business remain strong, and pricing trends continue, pricing is holding overall. The drivers of Smith & Nephew's business have not changed; we'll talk about them as we go through the call -- our pipeline and our introductions of new products and our continuing investment in our sales forces through their specialized channels in each of our businesses.

I'd like to emphasize that we are reaffirming the 2005 guidance that we gave in our trading update in September.

We have made an exit decision on DERMAGRAFT; Peter will talk you through the numbers related to that, and when he's done that, I'll talk a little bit more about that decision.

We're on plan for realizing our investment in BSN; we've got a significant amount of interest from a number of parties and would expect to complete that in the first part of 2006.

We've also announced that we intend to move to dollar reporting as opposed to sterling reporting from January 1 2006. That does not imply any movement of the company, we are already quoted on the London exchange, and we'll still be quoted there in sterling. We're already quoted on the New York exchange and will remain quoted there in dollars, and dividends will be available in either sterling or dollars as investors prefer. But this in fact is a measure which enables us, given our substantial preponderance of business in the US in every respect, this in fact enables us to align our currency reporting much more closely with our actual business and therefore reduce variability on a go forward basis.

So, with that, I'd like to hand over to Peter who will take you through the numbers for quarter three 2005. Peter.

Thank you Chris and hello good day everyone. As usual, I will talk to revenue growths in underlying terms, that is exclusive of the effects of translational currency. Underlying revenue growth was 10% in Q3, 2% lower in the first half as we experienced tighter trading conditions in orthopedics in the US in reconstruction. This held back margin progression such that the margin at 19.2 is the same as in Q3 last year.

As you have heard, we've decided to exit DERMAGRAFT; this has involved us taking an impairment charge this quarter of 15.5 million sterling against the carrying value of tangible and intangible fixed assets. This charge is additional to the manufacturing rationalization charge of 8.5 million for endoscopy which we announced last quarter end. And I'll cover this later, I have a full slide on that.

EPSA growth was 10% in line with revenue.

Now looking at our trading results' highlights. These to remind you are before amortization of acquisition intangibles and this time before the restructuring and rationalization costs just referred to. 1% of positive translational currency increase reported revenue growth in Q3 by 11% to 341 million sterling; trading profit increased 11% in line with reported revenues, 65.5 million; tax was 19.5 million being a rate of just under 30%, which is 1% higher than last year and is the rate being used for the full year. The JV profit on BSN after tax was 5 million. BSN is now classified as a discontinued operation following our decision to realize our investment in it.

EPSA growth was 10%, 1% less than the revenue growth because essentially of the 1% higher tax rate. Year to date EPSA growth is 14% reflecting reported year to date revenue growth of 12% and the margin expansion of the previous quarters.

Turning now to the revenue growth slide. Here we have the usual reconciliation of reported to underlying revenue growth which I won't dwell on, given the simplicity of the across the board strengthening of the US dollar on a year ago, worth 1% of reported sales.

I won’t comment on pricing; pricing overall remained positive and continued in low single digits in orthopedics in the US.

Turning now to the geographic revenue slide; US revenue growth was 10% in Q3, Europe and the rest of the world were 6% and 14%, respectively. Orthopedics' global growth was 15%, 13% outside the US and 16% in the US with some effect from hurricane Katrina felt in the quarter. Knees grew 13%, 10% in the US somewhat lower than in previous quarters as we experienced competitor activity ahead of the launch of two new OXINIUM products.

Hips grew 10% both in the US and outside the US and trauma grew 19% in the US and 10% outside the US, which incidentally is ahead of the market growth for both hips and trauma. Clinical therapies again outperformed at 35% growth. Endoscopy's revenue growth picked up in the US to 5% and growth outside the US was again strong at 12%. Repair continued to be the major driver, with 23% growth and blades grew 6%. The new camera was launched in the quarter and with installations now scheduled for Q4.

Wound management's revenues grew 6% outside the US and continued to decline by 6% in the US where the contraction and distributor inventories continued for longer than expected. We now have better visibility of this factor and believe it is nearing its completion. Of the year to date sales decline in the US, 8% arises from lower intermediate product sales direct from our factories to other industry users and 6% arises from inventory reductions at the four principal stocking distributors used by us in the US. Correcting for these two factors would give 8% underlying growth a figure which actually ties in with the returns we are getting from the distributors for end customer sales. The effect of both factors will, however, continue in Q4 and we are expecting a sales decline of around 3% in the US for wound in Q4.

The intermediates effect should be lower, but the distributor inventory effect will be higher due to anniversarying the initial stocking effect in Q4 last year. Outside the US, wounds' revenue growth was a little slower due to healthcare spending pressures holding back market growth in parts of Europe, but we expect O-US growth to pick up in Q4.

Turning now to profitability, margins. These were flat in Q3 on a year ago; this was essentially the drop through effect of lower than anticipated sales at orthopedics and wound management on normal margin progression.

Turning to cash flow; the conversion of trading profit into cash flow is 47% for the year to date. We expect this to rise to around 65% by the year end. This is lower than our 70% target and reflects the impact on inventories of slightly slower sales growth expectation at the back end of this year. Cash flow continues to finance settlements for patients in respect of their macrotextured revisions; this is 19 million in the year to date and we expect this to be around 30 million for the full year. Macrotextured revisions were running in the mid tends per month rate in Q3, a useful reduction on Q2's low 20s per month rate. The number of revisions now stands at 923 at the end of September. Suffice to say we remain in discussions with the insurers over our claim.

Interest and cash tax is higher because profits are something like 30 million higher, and because last year we had the benefit of a catch up usage of the ORATEC NOLs. Use around 60 million for interest and cash tax for the full year. Currency reflects the dollar at 1.77; at this rate net debt should be around 110 million sterling at the year end except that we have decided to apply 50 million sterling in topping up our UK and US pension schemes, thus taking expected debt to 160 million at the year end. This shot up in pension schemes will be EPSA neutral next year.

Turning now to restructuring and rationalization. Following our decision to exit from DERMAGRAFT and its related products, we have two restructuring and rationalization items to book in Q3 and Q4 this year. The first relates to endoscopy where we have already announced their rationalization of manufacturing in the US down from three sites to two. This project is underway and on schedule and will cost 8.5 million. The second relates to our decision to exit DERMAGRAFT and comes after the recent receipt of a non-approval letter from the FDA; effectively more clinical work was required to bring the product to market which in turn pushes out the break even date too far forward for the product to have ongoing economic viability.

The exit involves 40 million of restructuring which has to be accounted for across Q3 and Q4 under IFRS. First, the impairment of the facilities and intangible fixed assets has to be backdated to the end of Q3 and this amounts to 15.5 million, whereas the actual cash cost of exit of something like 25 million are bookable in Q4, namely when the decision to exit was made. Thus, 24 million is booked in Q3, 8.5 of endoscopy and 15.5 of DERMAGRAFT and a further 25 million is bookable on DERMAGRAFT in Q4. Tax relief on these are 9 million in Q3 and 10 million in Q4, respectively. The cash costs of both of these items amounts to something like 33 million and will mostly fall into 2006.

The revenues and trading profit of wound management should be largely unaffected in 2005 from the exit from DERMAGRAFT whereas in 2006 we expect revenues will be adversely affected by around 14 million sterling; this is a 4% adverse effect to wound management's global revenue line, and something like 19% adverse effect to its US revenue line. On the other hand, trading profit will benefit by around 7 million from the elimination of costs in 2006. Both of these effects will fall mostly into quarters 2, 3 and 4 in 2006.

Turning now to the year as a whole; we continue to expect revenue growth of around 17% for orthopedics on the back of its sales force traction and new products. Likewise, endoscopy's new product flow should enable it to achieve 8% revenue growth for the full year, and wound management should deliver 5% for the year as a whole. With the US dollar at Q3's end rate of 1.77 currency translation will be positive by around 1.5% for the full year.

With Q4, our seasonally stronger margin quarter, we expect the margin to pick up in Q4 and close the year at 20.5%. Interest less IFRS financing costs should net out at 1 million positive for 2005 as a whole. Our share of the BSN joint venture, net of its interest and tax, remains at 16 million for 2005. The tax rate stays at 29.75% on Group profits before the BSN, JV, amortization and the restructuring and rationalization charges. Thus EPSA growth is expected to be in the range of 12 to 13 million for 2005 before restructuring and rationalization and amortization, acquisition amortization. The number of shares in issue should average 940 across 2005.

Finally, looking at our results on the basis that we have done a dollar consolidation here our reported growth and the EPSA growth would have been 1% lower at 10% and 9%, respectively, for the quarter, this coming largely from the US dollar averaging 1.795 in the quarter compared to 1.81 in Q3 last year. As you see from the announcement, and as Chris has just said, we intend to change our functional currency to US dollars from the start of next year. I think you all appreciate that we have half our operations in the US which opens up our sterling reporting and capital base to undue currency risk. This re-domination will significantly mitigate this; there's also the incidental benefit of making our reporting more compatible with that of our US MedTech peers. The announcement contains a restatement of this year's and last year's quarterly results as if they had been consolidated in US dollars at the average rates of exchange than prevailing. At today's 1.77 dollar rate we estimate that the EPSA growth in 2006 would be 3% lower under dollar reporting than under sterling reporting.

An extraordinary general meeting will be convened in December to re-denominate the share capital of the parent company into US dollars to be followed by a High Court confirmatory hearing in January. As Chris said, future dividends will be declared in US dollars, but paid to UK residents at their election in sterling. The Group shares will continue to be listed on the London exchange, priced in sterling and on the New York exchange, priced in dollars. And with that I'll hand you back to Chris.

Okay thank you Peter. Well just to summarize first of all; we still see very favorable trends in our markets, they are growing and expanding and driving our revenue base. The orthopedics market continues fundamentally strong; demographics, well informed and interested consumers and people seeking active lifestyles, active people are demanding better treatments and better prosthesis. So we see the basis for growth in orthopedics to continue to be strong.

We have looked at the market for this quarter, and it does seem to be lower in terms of growth. The market in total looks to be growing at about 11; we grew 4% faster than that at 15 which we're very pleased about. If you look at the changes clearly in aggregate, Katrina and the other hurricanes in the US have had some impact on the market. Katrina is something that clearly has had much more substantial an impact because essentially it's taken out surgery for a period of months as opposed to weeks, and of course, unfortunately, there are four hurricanes in the US every year. There were a couple of quite nasty ones last year too. So we do think that is a temporary depressant on the market, but that's the only feature that we can identify at this point in time.

We see our growth prospects in endoscopy based on the new products; we've introduced the camera, we've introduced a new arthroscopic pump; we're reproducing a discography product as we speak; and a continued stream of new repair products being very positive. Wound management, we will benefit from the margin uplift post the DERMAGRAFT decision which I'm going to come back to in a minute, and the three drivers of this business going forward will be Allevyn, which will be very close to 100 million sterling this year in sales; Acticoat, where we're continuing to introduce upgraded products as we go forward; and not really so much this year and 2006, but in 2007, we're really going to see a substantial impact from Versajet, our water powered debridment tool which is growing at a dramatic rate, but is actually a small amount of actual sterling sales at this point in time. So, our new product launches are both taking share and expanding the markets, and we continue to believe that that's the philosophy which is a winning formula in the marketplace.

We continue to invest in sales force; we are specializing that sales force, and that is delivering the strong growth that we anticipate. And in terms of our earnings growth, we have indicated and confirmed today guidance of 12 to 13% earnings growth this year and underlying we expect to be back to mid teens in 2006.

Well, before we go to questions, I'd like to just talk a little bit about DERMAGRAFT because I'm sure many of you will have questions about this. First of all, as you know, we applied for a PMA supplement for use on the venous leg ulcers in the US to the FDA around a year ago. We received in the last ten days a non-approvable letter from the FDA relating to this. The area of contention revolves around the way the results were interpreted statistically. In our protocol we had allowed for looking at the sub-sets of patients. As you know wound care trials are very difficult to do statistically, and we had agreed with the FDA that we would look at the sub-sets to determine statistical adequacy.

In terms of the major sub-set, which are the wounds below 12 months in duration, hard to heal ulcers below 12 months in duration, the FDA has requested us to expand this pool of patients to provide further statistical assurance. To get that done reopening the trials, doing the trials, getting the thing into review would take between 18 to 24 months. As I think most of you know, DERMAGRAFT is currently running at a loss of around 10 million sterling a year, and to extend this for another couple of years against this background we've decided is not something we wish to do.

We have therefore decided to exit DERMAGRAFT. We brought forward the release of our announcement so that we could talk to our employees about this who are principally on the west coast of the US, and we therefore put the announcement out after the close of play of the New York Stock Exchange last night. It is our aim to see if we can find another home for this technology, particularly related to DERMAGRAFT and Transcyte, which is the burns version, and will seek to do this between now and the end of the year.

However, given the financial profile, which is challenging for these products as opposed to the clinical profile, which continues to be excellent in terms of performance, we think it's going to be difficult to find a buyer and therefore we have indicated to the market substantially what the costs of actual closure would be. And that’s the basis for the figures we've given to you. We are in the process of talking to the affected employees, and we've got some work to do to work our way through that; we have some other opportunities we may be able to offer in many cases, but in some cases unfortunately we won't be able to do that.

So we've reached this decision after a great deal of reflection; it isn't solely to do with this issue of the FDA because, on a global basis, the regulatory framework for tissue engineering products are not sufficiently well defined, and we have not been able to get approval for DERMAGRAFT or Transcyte in either Europe or Japan. And those remain significant challenges, so we have decided that we need to exit this programme, and we've reached that decision with a good deal of regret and that gives you more background on it.

In terms of wound management they do remain the leading player in their sector; they do have significant growth products, and we expect to redirect some of the resources that were behind the DERMAGRAFT and Transcyte programs into driving growth faster in other products. But as Peter said, we will have to overcome a 14 million pound revenue comparator year on year as a result of existing DERMAGRAFT and Transcyte, but the underlying growth behind that we think will pick up.

So with that I'm going to turn the call over to questions and Nina, I'd be grateful if you could alert people as to the question procedure.

Thank you sir. [OPERATOR INSTRUCTIONS] We will pause for just a moment to give everyone an opportunity to signal for questions. We will now take our first question from Milton Hsu with Bear Stearns. Please go ahead.

Hi good afternoon guys.

Hi Milton.

Two questions. Peter perhaps can you sort of give us an idea where wound management EBIT margins are headed in '06 and '07 now that DERMAGRAFT is out of the picture?

I can, but they're going to go -- obviously they're going to go up. I prefer frankly not to be just guiding too precisely, but 7 million on wound management sales is 2% so you can put that in the bag on a roll forward basis. And quite clearly wound management is going to progress its margins going forward, and it won't have, let's call it, the fairly expensive SG&A lines which have been associated with DERMAGRAFT. But just at this moment in time I think I just want to limit my comments to the quite clear 2% on DERMAGRAFT. But as we get into next year I will obviously be guiding further forward.

Okay, and you also mentioned that healthcare spending in some of the European markets was a little bit pressured in the third quarter. Why would that pick up in the fourth quarter?

We've seen some pressures in European markets; the UK has changed some of its pharmacy related regimes, and we've also seen some challenges to the growth in Germany. We think that the market growth may not pick up in the fourth quarter, but we've put initiatives into place to drive our sales faster related to those climate issues. So we do expect our sales to pick up slightly, not massively, in the fourth quarter.

And just in that context, you were talking about that relative to the wound management business, but not to ortho? I'm talking about the --

Correct, that's a comment that relates to wound. The German market as a whole is a relatively difficult market at this point in time as the transition to DRGs continues, but the comment specifically related to wound in the announcement.

Okay thanks a lot.

Right thank you. Next call please.

We will now take our next question from Charles Weston with Morgan Stanley please go ahead.

Good morning. I have three questions, firstly could you, Peter, be a little bit more specific on your comment about pricing in the orthopedics industry in the US in terms of what you've seen in the third quarter and your outlook for the full year? And in fact can you comment on how you expect that to progress globally as well?

Secondly, can you tell us the contribution of mix to your orthopedics growth in the third quarter? And lastly can you split out your Exogen and Supartz growth please?

Right okay.

Can I make some sort of general comments on orthopedic pricing. You will all note that we have not put, for the first time for some time, any specifics related to pricing on the face of our announcement, and we won't be doing that in future just to make it clear. We will hopefully give you general indications of pricing on the face of the announcement.

Right now our pricing trends in orthopedics continue to be favorable; we're going to indicate those as low single digits, which is in the ballpark of around 2% just stroke 3%, so we're seeing a continuing trend in that area. We are not seeing the price pressures that some of the other participants have reported. Quite frankly we believe that's because we're introducing more new products which gives you an ability to have a different discussion with the purchasers. And broadly we'll be giving that sort of level of guidance going forward.

That particularly relates to the US, and the sensitivity is that customers are more sensitized to price, and our reporting of significant -- decent price improvement really gets our customers annoyed in this climate, so we're actually going to give a bit less profile to this. Globally for orthopedics, price is variable by market. Some markets are down; Japan and Germany are probably the two where -– are the most negative price pressures, Japan driven by the government pricing tariffs, Germany driven by the DRGs that I talked about earlier. Our exposures to these markets by comparison with some of the bigger players, is lower, and because of our acquisition of [Leading] Medical in Japan we actually believe that to be a terrific opportunity for us. Other markets, such as the UK and Australia, pricing remains positive and we do have significant benefits from mix.

Outside the US in orthopedics our current profile hasn't changed; price is flat and we anticipate that going forward. We will be looking to continue low single digits in the US, but we do believe that we will continue to see something slightly positive in that arena on a go forward basis. Will that be more challenging as we go forward? Well quite frankly we don't really know, but our going in assumption is that, because of our profile in the business and our new product flow, that we can actually maintain a modest, but positive, price position overall in orthopedics. And I have to say our guys are doing a very good job on that. So it’s a slightly long winded answer. Peter can you give some indication of mix?

Yes, mix overall has been running this year at about 2 to 3% positive; I think it was 3% positive in Q3, but those are sort of quite estimate numbers.

Okay and the third part of the question was Exogen and Supartz. Do you have the data to find the growth out of those two products?

I do if you just bear with me; I took my finger out of the file as as I was listening to Chris. Right okay, Q3 growth on Exogen, let me just check, Q3 yes okay. Exogen grew at 37% and Supartz grew at 33 so they're all in the 30 plus.

So very close plus or minus two over 35%. Okay?

Thank you could I have one quick follow up? In the orthopedics business in the US specifically, what would you say is a proportion of your fixed costs versus floating in terms or your cost of goods plus SG&A? How much of that would you say is fixed versus floating?

I really don't think we can give an off the cuff estimate on that Charles.

It depends on whether you're talking sort of long or short term frankly; everything is variable in the long to medium term when you're growing a business at the rates that we are growing. Business is growing at 15% plus; the traditional relationships of fixed and variable frankly don't really exist. You have to invest ahead of growth which actually produces another dynamic. The majority of costs on a long run basis are quite clearly variable.

Right. In any given quarter they're substantially fixed, so it's kind of a difficult question. Anyway a good question Charles, I hope that satisfies you.

I could occupy a [lunch] talking about that.

Right okay can I take the next question please.

From Cazanove we'll now take our next question from [David Edlington]. Please go ahead.

Morning Chris, morning Peter. Just a very quick question on wound management; clearly the exit from DERMAGRAFT helped margins in the near to medium term. I was wondering how we should think about longer term top line growth now, and I think in particular for Acticoat and Allevyn? How much of the slack do you think those products can take up?

Well let me have a shot at that; currently Acticoat and Allevyn are roughly 40% of the wound management business absent DERMAGRAFT and Transcyte. Over the next year or so at their growth rate they'll probably get to be, together with Versajet, more than 50%. If we look at what's going on and we take out all these intermediate things, we take out the de-stocking in the US impact which will be through the balance of this year, the underlying growth rate in wound management will probably be around 7 or 8% next year Peter?

Yes.

And we'd expect that to pick upwards as these higher growth products become a higher proportion of sales. We will also be looking for, same as we are everywhere else, acquisitions at this stage.

Now against the 7% as Peter said, you need to back off the DERMAGRAFT impact which is about 4%, so the reported growth in wound management next year could be in the 3 to 4% mark. The issue for wound management though is that the baby boomers have yet to hit that market; we've seen the impact of baby boomers hitting orthopedics. So with our product profile improving, with baby boomers starting to get into their 60s, then we do expect to see a progressive uptick in wound management.

I think the way we think about this is, our product line will be one or two steps ahead of the competition in terms of its profile and its technology rather than if you will DERMAGRAFT and Transcyte were, which is a whole staircase ahead. Which has proved to be -- they're products that if you will are ten years ahead of their time in terms of regulatory profile. Does that give you some help thinking about it?

Yes thank you.

Thank you, next question?

We will now take our next question from Raj Denhoy with Piper Jaffray. Please go ahead.

Great thanks good morning guys. I'm curious, I know you haven't talked at all about '06, 2006, but given the performance in the quarter and some of the trends maybe that some of the other companies are pointing to in orthopedics going into next year, do you still think you can sustain orthopedics growth in that sort of 17% range next year?

Well this is going to be a very short answer. Of course. Can we have the next question? Seriously, basically why are we doing better than the other competitors? We are bringing more innovative products to the market place and we are building a structured and specialized sales force which we're investing in.

We have seen a slowdown in this third quarter; our new knee products are going to come through and address this area progressively, starting with the launch of LEGION and going onto the launch of JOURNEY. We have the BHR application with the FDA and we hope to see a positive conclusion to that for next year. We have the upper extremity for PERI-LOC going through its now clinical evaluations ready for launch next year. So it's about new products, it's about sales force investment, and it's about bringing that innovation to the market place that the surgeons and the medical communities as a whole are looking for.

So would it be fair to characterize then that a lot of the rhetoric that's coming out of the other companies is quite a bit more negative than yours looking forward? But you're basically basing that on your ability to bring better products to market. Is that fair enough?

Yes indeed, and providing excellent customer service behind them. And you've seen that we made a substantial investment, further investment in inventory to back that up. So we believe the business model that we have in orthopedics that we're building is a sustainable model which will give us high teens growth on a go forward basis.

Okay if I could just ask about two events; you mentioned the Birmingham Hip; is there any update on how that's progressing at the FDA post the panel meeting?

No, we're going through the expected discussions and audits and so on and we don't have anything further to add at this point in time. We'd be delighted if we had, but it's too early to call and we continue to think that the right timeframe is sometime in the first half of next year.

Okay and just lastly on the deal you signed with Arthrocare in the radio frequency products. I'm curious if you have any comments around the rationale in entering into that deal having Arthrocare manufacture your radio frequency products, and also how much that could potentially impact now that you're back in the bipolar market for next year?

Well I think our view of the Arthrocare thing is that you could say it was a win/win. It turned out to be a high scoring draw with the benefit of the gold going to the lawyers. The issue for us is to get back in the market; we did agree, and there's a benefit to Arthrocare of having them manufacture key products in this area for us, and we're looking to take that forward on that basis. I think the other benefit to Arthrocare is that now Smith & Nephew is back in the market with bipolar ablation the market will probably swing back more towards bipolar because of our market place strength. So we regard that as a decently satisfactory conclusion from both sides.

Great thank you.

Next question please.

We will now take our next question from Michael Jungling with Merrill Lynch. Please go ahead.

Thank you very much, I've got three questions. Firstly for the guidance of 2006, you mentioned mid teens EPS growth, and I was just curious whether you could provide some more assumptions that you're making for that guidance in terms of constant currency growth rate for orthopedics, specifically recon and trauma, and also endoscopy? And also if you can give some kind of margin guidance on orthopedics and endoscopy.

Secondly on the margins; we saw for the first time in many years a decline in your orthopedic EBITDA margins in the third quarter. Now I'm just curious if the top line perhaps does not quite develop as positively as you think, how fast can you adjust your spending habits to protect the EBITDA margins going forward?

And thirdly on wound care; you mentioned the slowdown was partly driven by inventory de-stocking, and I'm curious whether you've seen any impact in the last couple of quarters from KCI's [vac] technology?

Right okay let's -- Peter 2006.

Well, what we've said is that -- our announcement says -- because it is early in the days, we have our budget objectives firmed up, but we are at this point going through the hard knockings as most companies do at this time of the year on their budgets. But the first thing that you try and fix is the top line, and then you try and fix the profit objectives, so we feel that we are in a position to be able to say that we do see underlying EPSA growth in the mid teens again. But we do stress that this is before the consequences of realizing BSN, and before going to dollar reporting.

What we say is we view 2006 positively; I think Chris has said that he sees orthopedics with the product launches having the motor to continue the same growth rate into next year. I think we are saying here that we are seeing improved revenue growth looking forward to come from endoscopy. Endoscopy has got three motors or sort of momentum drivers; it's got the new camera; we've now got, let's call it, schedules going forward for installations; they've recently launched a new pump, they last launched a pump must have been about three or four years ago. What the pump does is that it gets itself placed in hospitals and then it pulls through consumables, which is really the business which we are in, and it helps the total franchise along with bipolar; we're really re-enforcing the arthroscopy franchise which perhaps there was some scope for us to improve what we're doing.

And I think Chris has talked you through really in some detail wound; you can see wound growth in its underlying form in the US on the -- sales tracings is running at about 8%. Outside the US we have a reasonably steady beat rate; we can move that forward into next year and the adjustor on all of that is DERMAGRAFT, and Chris is talking about let's call it, a reported constant currency sales growth number of somewhere in the range of about 3% for wound management next year.

So I think you've got a pretty -- if you interpret, let's call it, the words on the paper and what we're saying now I think you've got quite a good steer as to where the top line is. We will expand our margins; we've invested a lot in sales force expansion over the last couple of years, and payback time is around the corner from those investments. And you've got basically a 0.5% extra to come from DERMAGRAFT.

So the drivers really of margin expansion of 1% underlying plus DERMAGRAFT with 1.5, if you put that together with the top line you can see where we come to with the EPS growth number. Yes, if sales are unexpectedly in pretty short order come after the growth profile when you're loading resources into the business you cannot address your cost base, and that's just the real world. But if you're driving the business forward, which is what we're trying to do, you've obviously got to drive on the longer term that we are going to continue to expand our margins.

Okay Q3 and ortho's EBITDA; just at the management level as opposed to the financial level, if you have a sudden slowdown in sales, such as the Katrina impact, and actually a pick up in competitive activity which we haven't seen quite as strongly before, then our ability to react over the quarter is limited. The discussion we had before is about fixed and variable and what it really means. And therefore that ability to make those changes is limited. Clearly we're watchful going forward; we've actually reduced the expectations for orthopedics and our guys have done a good job in managing this from a P&L point of view. Do you want to add anything to that Peter?

To just put it into perspective, if you just said the margin had slipped by 0.2% that's 300,000 sterling, it’s a relatively small number. And frankly we don't drive the business to that sort of micro management style; we'd just destroy the business if we did that.

Okay, wound and KCI. It's slightly difficult to do this, but we reckon that KCI is probably being used on somewhere between 2 and 3% of the US wounds. It’s a high value treatment, now it may be that the revenue related to those wounds is higher than that because they are the more difficult wounds to treat, so maybe you'd double that or even triple it, but actually it's having a little impact on the distribution of revenue for other companies.

What we have seen particularly, and I think we've talked about this before, is the issue of a large number of silver entrants to the market place. There are now 16 silver products on the market with varying degrees of actual antimicrobial activity, and the way you, as you well know Michael, introduce wound care products is you give lots of samples. So what actually happens is the financial growth rate of the market drops while people use free product instead of the product that they would normally use.

We have increased our selling activity on Acticoat pushing the capability and the fast kill and sustained kill rate of Acticoat on all types of bacteria, and we're seeing growth both in absolute terms and in market share terms on Acticoat against the other 15 competitors. So the KCI impact on the balance on the market is not particularly material; the biggest driver is the battle for share in the antimicrobial market. Okay?

Thank you.

Next we will take a question from Hans Bostrom with Goldman Sachs. Please go ahead.

Hi I have three questions as well. Could you just clarify what you said about the switch to US dollar reporting? I understood that you talked about a 3% negative impact, but I just want to confirm that.

And secondly, could you also give us a sense of what -- the contribution from the hip resurfacing product outside United States whether that has stayed at the same level, whether you continue to see the same rate of progress, and if that is the case what is it that really brought the growth down so significantly in the third quarter from what has been a mid teens growth rate in the previous many quarters?

And then lastly could you also comment on this pension top up you're doing and financially how it works that you see a neutral impact on the EPSA level in 2006. Thank you.

Okay, Pete? Can you deal with one and three?

Right I'll deal with three and go backwards because it’s the one I can remember. Right the pension top up basically, as you know now these days pension liabilities are really, by all the regulators now, are treated as liabilities of the company. If we put money into the pension fund basically what happens is that we get an interest benefit in the pension fund, and we get an increased cost in, let's call it, the contributing company. Those two are all reported to you through the interest and finance charges line, and they actually really in the very, very short term they wash out. They are perhaps technically accretive to EPS, but the number is so small that we wouldn't claim credit for that when we're talking to you guys.

It's essentially just moving cash from the company pot into the pension fund pot to reduce the liability. Regulators now are requiring companies to address their deficits over shorter timeframes than perhaps companies have traditionally been doing and we want to be ahead of the pack in doing that. And also we are a company who can frankly afford to do that, and it's just part of good human resources management.

The switch to US dollars; I don't want to over complicate this, but if we didn't switch to US dollars next year we would have a small positive currency I would guess of about 1 to 1.5%, but if you actually switch to US dollars you'll actually see year on year a negative of about 1.5%. So when you put the two together the actual switch is basically a 3% dilution in the growth rate.

Our view is that investors are sufficiently sophisticated that they look through all of this because obviously the value of the company does not change because of this, it's purely a manifestation of reporting and reporting conventions.

On hips; O-US, the growth rate on hips O-US, let me just turn up my sheet, has basically been -- has been running at about the mid teens. It popped up in '05, Q2 '05, which is really a manifestation of some of the smaller distributors coming on BHR. It is down at 10%; I think Chris has said that Germany is one market where our growth rate has come off, I think in common with other people in Germany.

Is that also the case for the BHR product then in Germany, because that has obviously been one of the relatively developed markets for hip resurfacing?

Yes BHR is doing well on a global basis outside the US. I think we do have a slower quarter on BHR in Germany, and that is part of the issue related to the German sales. So it’s a bit of BHR and it’s a bit of standard hips.

And just one follow up on the EPS guidance for next year; could you be also prepared to give some type of steer of what impact the divestiture of BSN could have on your earnings per share next year?

No we’re not ready to do that at this stage, and we’ve decided we need to get through the next stage before we’re willing to do that Hans.

I mean we’d like to be helpful but I think you have to realize we are in the process of negotiating price in a competitive environment, and I can’t believe that you guys are going to get the numbers that wrong because there are some pretty good EBIT or EBITDA multipliers out there, and so it’s quite a simple matter of taking this year's number, multiplying it by that number and knocking off the interest.

Okay, we can’t help you on that one. Next question?

We'd like to but --

We will now move to Ed Ridley-Day with Lehman Brothers. Please go ahead.

Hi, thanks. Just a couple of questions first on endoscopy. Could you give me the visualization and the ORATEC growth? I don’t think you broke those out. On DERMAGRAFT technically, I’m presuming DERMAGRAFT sales are going to continue for the rest of the quarter, or are you literally going to stop them fairly quickly?

And more generally I think longer term, you mentioned that you might look to, with the wound business, now look for some acquisitions in this area. Could you give us a little bit more detail on the direction you would like to move wound in? Is there still any space in biologics and indeed are you going to move the people involved in R&D in DERMAGRAFT and Transcyte, would you move them potentially into your orthopedic biologic operation?

Okay, let me start with the DERMAGRAFT pieces and come back to the other one.

I’ll deal with endoscopy then.

Right. First of all with regard to DERMAGRAFT; the key thing that we need to do is, we need to work through the patients who are in treatment sequences on DERMAGRAFT and Transcyte. [inaudible] all service and sales capabilities, certainly through the end of the year and maybe through the first quarter or more of next year as necessary to do that. That’s our obligation to the patients and the surgeons, which we’ll absolutely fulfill under any circumstances.

Secondly, our biologics -- we should particularly make the point that DERMAGRAFT is working as a product very well; it’s the regulatory and reimbursement climate for this particular dermal fibroblast technology where we’ve decided that we need to exit this in whichever way that finally plays out. We do believe that biologics in the longer term will play a role, and our research people, as opposed to our production manufacturing people, have actually virtually all been working in other areas, ie ortho-endo and broader wound going forward. So, it’s not really a case of switching them, they’re already working on a wider franchise.

So we do regard this as an issue that’s specific to dermal fibroblast in this technology. We think that going forward biologic solutions will need to pursue different regulatory pathways to get through the regulatory program, and we’re looking at ways of doing that in our research program across wound-endo and ortho.

In terms of acquisitions for wound, we are more particularly looking at those acquisitions which would easily and quickly connect to range expansion in terms of technology that is one or two steps ahead of the competition rather than a whole staircase ahead at this point in time.

Okay. Thanks.

Peter, endoscopy [inaudible]

Endoscopy, visualization and DOR grew 2%. The total radio frequency range, including spine, grew at 2%, and spine I think was there or might have been 1%. But basically I know that spine grew very modestly and RF arthroscopy started to get its growth back again with some bipolar.

Yes, just on visualization though, that’s obviously -- are you still having some of the [principal] slowdown with the -- is demand not picking up at all in terms of, is it just a comp year on year?

We had a fairly strong quarter three last year with our 360 camera. We’ve matched that broadly with the 460 which was launched in July or back end of June, but typically it takes a 30, 60, 90 day evaluation period from when you bring a new camera on board to when you really start getting purchase orders through. So the lift we are looking for we did expect to see in quarter four. So this is in line with our expectations.

Okay, thanks.

Okay. Do we have another question?

From Deutsche Bank we will now move to Yi-Dang Wang. Please go ahead.

Okay, thank you very much. I have several questions. Would you be able to provide the volume mix and price components of the sales growth for each of your divisions and the outlook for them perhaps into 2006? And if you can’t comment on that for your business specifically, for some of the divisions? Would you be able to talk about that for the general market?

And the second question is, would you be able to provide an update on what has been done at wound management in the US? What remains to be achieved to get this business back on track? And whether your growth -- whether the sales stats that have been de-stocked for most of 2005 will come back to you as those distributors restock, or have you lost those sales?

And the third question is, the significance of hurricane Wilma to Smith & Nephew and whether your guidance reflects that already.

Right, Peter do you want to start with possibilities of future guidance?

Right, okay. As Chris alluded to, basically price for all our business segments, apart from ortho in the US, is broadly flat across the world and we see that really going forward. That’s been the case, I won’t say forever that I can remember, but certainly since we’ve been doing quarterly reporting. Chris has said that we have not really seen any change in the pricing environment here in the US in the orthopedic side which has basically been running in low single digits. I think Chris has guided that we would see that shading back a little bit next year, but we still see that being positive.

De-stocking; are they lost sales? No, because we had those sales a year ago and that’s been the problem. Let’s say 4 or perhaps $5 million worth went into the distributors sometime at the back end of last year, and has basically come out and caused the pain this year. When that basically gets itself sorted, which we do generally believe is getting close, that really US sales should start to grow at the market rate, and we have seen the end tracing sales now actually steadily pick up across the year. The average for the year is, although the running average is eight. We would certainly see that number going forward into the next year. It might be a little bit stronger; but in terms of let's call it giving you guys sensible guidance which we feel that we can hit, 8 is a sort of number. But as Chris said though that you do need to take into account the fact that DERMAGRAFT obviously sales will be a negative. So, I think --

Let me just -- you asked about wound or what are we doing. Peter’s dealt with the supply chain related issues. One thing you need to remember is the build up in the distributors' inventory. And I’ll just make the point here, these are logistic distributors, they’re not promotional distributors, so they’re not discriminating between or promoting our products or somebody else's products, they’re supplying against demand which is driven by our sales force which, as Peter said, is broadly, it’s up around 8% in the quarter which is a pick-up.

We will be talking to our sales force who are involved with DERMAGRAFT and Transcyte later on today; we only talked to the west coast employees yesterday, and we’ll be looking to utilise those very skilled people going forward in some of our other product areas, particularly Versajet. But that’s yet to do; there’s more work to be done in that respect, but we do believe as we indicated, we've spent a lot of time with the distributors in quarter three; we and they are pretty clear what they’ve got in their pipeline; we have not lost any business as a result of this. What we have had, entirely caused by their own supply chain changes, is an imbalance in in-market, in customer sales and our sales out of the door, which has persisted for the last three quarters, and whilst we’ll see that being redressed in this quarter, it was in quarter four last year that the distributors drew in more products into their newly built warehouses, so we’ve actually got a very tough comparator in quarter four in wound management. We are guiding overall to 5% for wound for the year. So I hope that’s helpful.

Yes that’s great and my question over the -- how much mix is there in endoscopy or wound, in those two businesses, is there much in there?

No, frankly we don’t count it. The only one where we really count mix is ortho.

Okay?

Right.

Right, we’ve probably got time for about two more questions.

I have to catch a flight.

Can we take the next question please?

Certainly. Our next question comes from Sebastian [Booth] with [Newman] Investments. Please go ahead.

Hi there. Thank you for taking my question. Maybe could you help me out on your page 6 outlook statement? You are saying that the exit of DERMAGRAFT would contribute positively to your overall Group margin by 1.5 percentage points. It seems to me a bit high as an enhancement doesn’t it?

It’s contributing to -- broadly our model is that our margin we would expect to increase by around 1%. Peter explained earlier, DERMAGRAFT will be additional for that and will probably add another 0.5% of the 7 million level.

That’s right. Okay DERMAGRAFT -- the 7 million on the sales is 0.5% and then there’s the usual 1% and --

Continued price mix, new products and leverage of our cost base is providing the other 1%.

Excellent, thanks. One further please on DERMAGRAFT again. Why shall we see the positive effect of leaving this business starting in the second quarter next year only and not earlier?

I don’t think we’ve actually said that, have we?

I think that in the beginning you said that the positive effect of stopping DERMAGRAFT should be expected by asking investors in the second, third and fourth quarter this year, didn’t you?

Well we have said we’ll continue to supply patients where necessary through the end of this year and into the first quarter, so that’s probably the reason the numbers work out that way.

Yes, the sales won’t drop -- well the trouble is we don’t know; we will continue because you’ve got patients who are still taking -- are still in treatment and obviously we’ve got to finish those patients. There’ll still be sales in Q1, but frankly the extent of those sales in Q1 is a bit of a hard one to guess. But certainly Q2, Q3 and Q4 we don’t expect any sales. So you can see that’s what’s driving that sort of comment, but you can’t get these things to within a million type thing.

Excellent. Thank you.

Okay. Can we take a final question please?

Our last question today will come from Martin Wales with UBS. Please go ahead.

Good afternoon. Given that it’s the final question perhaps you could talk a little bit more about what you intend to do with the monies you receive from BSN. You talked a little bit about M&A and wound management; what timeframe would you look to make some kind of investment of that money and if you don’t identify suitable investments, at what point would you consider returning it to shareholders or would you simply sit with the cash on the balance sheet for an extended period of time?

Well I think from a policy point of view Martin, this is pretty straightforward. We looked at this in a longer timeframe rather than a shorter timeframe. We do expect cash receipts from BSN, we also are continuing to look for acquisitions. We’ve said that if over a reasonable period of time we do not see those acquisitions taking place, or the prospect of that, then we would seriously consider returning cash to shareholders. We’re not seeing it that way at this point in time.

We continue to have discussions with other potential acquisitions, if you will, are no different from the ones that we are seeing at the present time, and the issue is okay, well, which are going to close and when? And the two criteria are, they’ve got to be a really good strategic fit, and they’ve got to be the right value.

And I think we’ve commented to the market before that we’ve seen what we call a disc effect on price expectation from smaller companies. Everybody thinks they’ve got a new spinal disc and they’re looking for spinal disc multiples, not just spinal companies, but anything in the space and spinal disc multiples approach infinity.

So, we’ve actually had a number of discussions where we’ve talked to companies that are good strategic fits, but at this point in time price expectations haven’t met with reality as far as we’re concerned. So, we continue to think there are good prospects for acquisitions, and we’ll take a look at that, but our policy is if it doesn’t happen then we will return cash to shareholders.

To come back to your comments on a reasonable timeframe; I think you previously indicated that you look at these things on a two to three year time horizon [inaudible] VHR back in the beginning of 2004. Is that the sort of timeframe we should be thinking, ie if nothing happens by the beginning of 2007, or if there’s no prospect of something happening [imminently] by 2007, that’s the sort of timeframe you’d consider returning cash?

I wouldn’t like to be specifically drawn on that timeframe, but you’re on the right track there. It’s that sort of timeframe. And obviously at the point where we have a definitive result from BSN, then we’ll tackle that on an as and when, and really think about timeframes going forward. Okay?

Okay. Thank you very much.

Thank you. Alright, well that closes our conference call for today. Liz Hewitt our corporate affairs director is available to take calls and will try and get any further questions promptly answered if you haven’t had the chance to participate directly. I’d like to thank you all for attending and look forward to talking to you all with our full year results which are coming out early in February 2006. Thank you all very much.