Smith & Nephew PLC (SNN) 2006 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to today's Smith & Nephew 2006 first quarter results conference call. For your information today's conference will be recorded. Before we begin we would like to read out the safe harbor statement.

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 under outlook are forward looking statements as are discussions of our products pipeline. These statements as well as 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 not limited to, the outcome of litigation and regulatory approvals 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 expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

At this time I would like turn the call over to Sir Christopher O'Donnell, chief executive. Please go ahead.

Good morning everybody. This is the Smith & Nephew conference call for our quarter 1 results for 2006. In terms of our business highlights, our revenue growth was 6% for the quarter in tougher market conditions overall. We have a very, very strong new product launch program, LEGION and JOURNEY knees are now both out on the market and being very well received in the business; the ANTHOLOGY hip is also out on the market equally doing well, and we have two further new hip products for the balance of the year, BHR for approval in the US and EMPERION which we expect to launch in the second half.

In endoscopy, our CALAXO osteoconductive bioabsorbable screw has really had an excellent start following its launch at the Orthopedic Academy. We've had the roll out of our total hip arthroscopy range and the launch of our CONDOR product for digital operating room use.

Overall however we have toned down our guidance for the year and will give you details of this on the call as we go through. I'm joined on the call by Peter Hooley, our finance director and by David Illingworth, our chief operating officer who took up this post earlier in the quarter. We'll have the opportunity of all talking to you and answering your questions later.

Right now I'm going to turn the call over to Peter Hooley who is going to take you through the financial aspects of our results for the first quarter. Peter.

Thank you Chris and good morning everyone. Dealing with the financial highlights; this is the first quarter our results have been reported in US dollars. Comparative figures have been retranslated and all 2005's quarters in dollars are to be found on our website including cash flow. It is also the first quarter we are reporting orthopedic reconstruction separate from trauma. The website comparatives likewise have been updated for them.

Reported revenues were $643 million for quarter one which is slightly behind where we would like to have been due to tougher trading conditions, not only in the US, but also in the UK and Germany, both of which have been affected by healthcare budget constraints. In addition the restructuring of our orthopedic management and sales force into separate businesses contributed to slower growth in the US.

EPSA growth has come in slightly under where we previously guided due to slower revenue growth and greater adverse currency. The BSN disposal was successfully concluded realizing $562 million on gross proceeds and a book gain of $332 million.

If you are on the web, I'm now going through the slides and I'm on the slide, trading results Q1 2006. This basically summarizes the results in adjusted terms, that is before a fair value loss of $3 million on hedging; the proceeds of the BSN disposal; 2 million of amortization of acquisition intangibles and a gain of 332 million on the disposal of BSN which have all been passed through the face of the income statement. A reconciliation to adjust this is to be found in note 2 of the announcement. 2% reported revenue growth is equivalent to 6% in constant currency underlying terms and to remind you, all revenue growth references hereafter are in underlying terms.

Margin expansion was flat on a year ago reflecting slower revenue growth at recon and trauma; 2% trading profit growth was thus in line with reported revenue growth. EPSA however was 5% negative due to the dilution effects of the BSN disposal, higher US interest rates and a higher tax charge.

Turning now to reconstruction; reconstruction revenues grew by 7%, 2% in the US where the market was tougher and where revenue growth also suffered as we reorganized the previously combined orthopedic sale force into two separate businesses. Outside the US, revenue growth continued as strong as previously at 15%. Knee revenues grew 9%; within the US 4% growth was achieved with the LEGION revision knee making a promising start. Outside the US, OXINIUM and GENESIS II continue to secure market share with 18% growth and at the end of the quarter we launched the JOURNEY anatomical knee of the AAOS. Hip revenues grew 5%, 14% outside the US again from the breadth of our range including BHR, but in the US hip revenues declined 1%. We continue to await the PMA for BHR in the US.

Turning to trauma; trauma revenues grew by 8%; 10% in the US and 5% outside the US. Fixation products grew 7% both in the US and outside the US. This is a slower rate of revenue growth in the US from last year, and largely reflects the effects of the business split already referred to. At 12% clinical therapies revenue growth came off somewhat as we simplified our reimbursement procedure with healthcare insurers in the US, but this has now picked up again.

Endoscopy; endoscopy revenue growth was 7%; 5% in the US and 10% outside the US. Repair revenues continue to drive the business with 19% growth; reception and access revenues together grew at 3%. Spinal growth improved to 6%; digital operating room and visualization growth was 1%, but compares with a very strong 21% first quarter growth last year. The CALAXO osteoconductive screw and the expansion of our hip arthroscopy range with our notable product launches in the first quarter and at the AAOS.

Advanced wound management grew its revenues 1%; this was after a dilution effect from existing of DERMAGRAFT. US growth was 4% before the effect of exiting DERMAGRAFT; outside the US revenue growth was 2% reflecting revenue declines of 5% and 8% respectively in the UK and Germany as a result of significant healthcare spending constraints in both these countries. ALLEVYN and ACTICOAT continued to drive underlying revenues with growth rates of 7% and 20% respectively and ACTICOAT moisture control is now launched in Europe.

Just looking at profitability; margins overall were broadly flat compared to a year ago with the effect of slower revenue growth impacting margins at recon and endo whereas wound management's profitability started to reflect the benefit of its exit from DERMAGRAFT.

Cash flow. Cash flow generation improved in a year ago with a 37% trading profit conversion ratio and we continue to target around 70% conversion of trading profit into trading cash flow for the full year. Macrotextured claims are now running at mid single digits per month; claims payments are expected to amount to around 30 million this year. 20 million will also be spent on endoscopy's rationalization program for its US manufacturing plants which incidentally remains on track, and on the closure of DERMAGRAFT. The big number in the cash flow is the 551 million net cash proceeds we received on the disposal of the BSN joint venture, this turning the Group cash positive and substantially enhancing our acquisition capacity. Absent any acquisitions, we're looking to a year end net cash position of around $330 million, that’s positive net cash, $330 million.

Now before I hand you back to Chris, I'll deal with guidance for 2006, which just to remind you is in US dollars and I'll try to do this in exactly the same format as we did at the preliminaries. As our announcement sets out, we are now expecting recon and trauma to grow in low double digits; recon perhaps a bit slower than trauma; endo to grow just under double digits and wound to grow in low single digits until it anniversaries its exit from DERMAGRAFT at the back end of this year. We are targeting for year margin expansion of around 1%. Together these expected revenue growths and margin expansion should enable us to achieve a low teens trading profit growth in 2006 before currency. Interest and finance income is expected to be $13 million for the full year and the tax rate as previously indicated that 30.5%.

Thus we expect EPSA growth of around 4 to 6% before translational currency. This remember is after a number of specific one-off factors which we went through at the preliminaries, mainly the divestment of BSN which dilutes earnings by around 4%, the loss of favorable interest rate differentials between the US and the UK which dilutes earnings by between 3 and 4% and the increased tax charge which dilutes earnings by about 1.5%.

Finally, just looking at quarter 2, we're expecting underlying revenue growth to increase very slightly on Q1 and margin expansion of around 0.5% leading to flat EPSA growth before currency in Q2. Dealing with currency; at Q1's currency rates, the impact of translational currency will be around 1.5% adverse in the second quarter and also for the full year.

And just before I hand you over the Chris, I'll just remind you to say that this presentation is available on our website for those of you who are not on that already. Thank you. Chris.

Okay. Thank you Peter. We'd now like to turn the call over to questions and if I could ask you, Keith as the operator to tell people the question procedure, we'll go into that mode. Thank you.

Thank you sir. Ladies and gentlemen the question and answer session will be conducted electronically. [OPERATOR INSTRUCTIONS]. We take our first question from Milton Hsu from Bear Sterns. Please go ahead.

Hi, how are you guys this morning?

Hi Milton.

This is Gerard in for Milton.

Okay.

First question on gross margins. They fell 70 basis points this quarter; just want to understand what you can attribute it to, if you think it's pricing pressures, any volume issues and where you [technical difficulty]?

Can you hear me?

Yes.

Sorry, something happened to this phone here just for a second.

Oh sorry.

You're looking for what's happened to gross margins --

Exactly.

Which we can answer. And the second part of the question was?

Just where we can see gross margins going; whether you expect them to stay at this level or if there's any opportunity for expansion throughout the year?

Peter, can you answer that question for us?

Yes okay. Looking back at gross margins, really Q1 last year is not a particularly representative one to compare. I think really you need to look at COGS overall particularly at the -- I refer to sort of gross margins as COGS which is the cost of goods sold. They in the second half of the year were running at 25.9, just under 26. Quite a few things have happened since Q1 a year ago particularly DERMAGRAFT has gone out and also the mix of the business has changed. So if you're just trying to compare COGS, let's call it fairly recently, actually the COGS number has gone down from about 25.9 to 25.5 which is basically cost and efficiency savings which we'd expect to see. Prices overall across the Group have basically been neutral. What you have actually seen is, if you look at the SG&A line you can see that it’s the lack of sales growth or the shortfall in sales growth is more painful to deal with immediately on the SG&A line. And the SG&A line has actually just gone up marginally from the H2 numbers to the Q1 numbers.

Okay does that give you a feel?

Yes actually hi guys it's Milton here. Just one quick question, Chris or maybe Dave Illingworth, where do you think the recon market is going? You've seen some lower than expected growth rates out of Zimmer and last night, the J&J numbers weren’t that great, and then a bit of a drop off in your business there, where's is it all going forward?

Hi Milton, this is Dave. I'll tell you what my take on it is. We are seeing very consistent volume numbers in this market in orthopedics as you probably are aware, as well as everybody else on the call is aware of. We have seen a very consistent volume of around 7% over the last couple of years and this price mix thing is a bit cyclic and we have seen the price of mix largely play itself out for us and we expect that dynamic to strengthen in the second half of this year as we start rolling out a very strong complement of new products and so we fully expect to take advantage of some of those dynamics again. Price and mix is not going to wait forever in the orthopedics industry. We need some innovation, we need new products etc. So I think as far as I am concerned with the volumes remaining pretty steady and the basic drivers in this market still there as far as demographics I think it's really incumbent on us to bring the innovative products out to the marketplace that we can get a premium for and also save our customers time and money on.

Great thanks for your time.

Thanks Milton. Can we take the next question?

Thank you. Our next question is coming from Jason Wittes from Leerink Swann & Co. Please go ahead.

Hi thank you very much. First question is, you talked about restructuring in trauma and orthopedics impacting this quarter. I thought that was done a while ago. Could you explain to us the specifics there?

Sure, I'm sure Dave would be happy to do that.

Yes. We have been working on -- you are correct, we have been working on this for a while now. We've been -- I guess the analogy I use is that we have been changing the fan belt on the car as we have been going down the highway. We've been working towards the divisionalization of these businesses now for over a year.

What we did in the first quarter of this year is we made a very firm decision to go ahead and split these businesses up. We had been adding sales reps, for instance, full line sales -- direct sales reps on the trauma side of the business and supplementing the work that we had been doing with our full line reps. So we had a minimal amount of disruption with a lot of those full line people and we were actually putting our direct trauma reps in the level one and level two trauma centers scattered around the US. What we did in the first quarter is we made a decision to go ahead and separate those two businesses because we think it is absolutely critical as a long term strategic move for us to do this to get the right kind of customer focus. And our feeling was with the strong complement of products that we have in the second half of the year there was really no better time to go ahead and start the completion of this activity and we went ahead and bit the bullet and did that in Q1.

Okay. And do we see lingering effects into Q2? And then I guess recovering in the second half as a result of this restructuring? Or is this really a Q1 event, in your opinion?

In my opinion is we will be still working through a little bit of this in Q2. We've largely made the tough calls and the tough decisions but we will have some of the after effects in Q2. We are going to see some improvement in Q2 for sure but we -- our big goal is that we are absolutely ready for the roll-out of these products in the second half of the year.

Okay, switching gears a little bit, you mentioned volumes being very healthy. Could you give us indication of what hip and knee volume was in the US and internationally? Or outside the US?

Hip and knee volume per se, I'm not sure we actually can split that out easily. We have given you an indication of what the total revenue numbers are. I think you're seeing still some slight favorable mix in the US, a bit of price and mix. So if you were to knock 1 or 2 percentage points off those you'd probably be reasonably accurate.

Sorry, that's 1 or 2% price and mix, it contributed to the revenue growth?

Yes.

And a little stronger in the US versus the rest of the world?

It's a little stronger in the US, yes. But you've got the BHR impact and mix is probably more favorable internationally. So it's probably not much in it. We don’t actually have a break out at that level of detail Jason.

Okay, thank you very much.

Okay, next question please.

Thank you. We will take our next question from Ed Ridley from Leman Brothers. Please go ahead.

Hi yes, good afternoon. First of all in orthopedics, you talk about the timing of new products but looking at your release everything seems to be coming through pretty much on track. Can you just go into a bit more detail about how the timing of new product launches has maybe potentially affected your numbers?

And also in terms of pricing in Europe, could you give a little bit in terms of orthopedic and wound pricing in the UK? We have had a difficult first quarter; how much of the problems first of all in wound do you see going on through the rest of the year in UK and Germany? But also in terms of the UK, in the second quarter so far are you seeing any pick up in volumes under the NHS in terms of orthopedic volumes?

Let's try and split that up. Dave, do you just want to make some comments on the orthopedic new product launch programs?

Well, thanks for crediting us with having these things on track. They pretty much have been on track. We have one wildcard which of course is the BHR, that timing we can't control. The product's ready. We have a plan to introduce that into the market in the US that literally we are ready to push the button on. It's really dependent on what happens with the FDA. We would be expecting that soon. The other major introduction is the hip revision system in the [quarter] and we're pretty much on track with that. And then we also have a new cup that we will be introducing early next [inaudible].

Okay?

Yes, that's very helpful. But just going back to one of the previous questions, what I am trying to reconcile is, your launch is seen on track and we know that although you are obviously restructuring the management arm of the ortho and trauma businesses, the sales offices were split up previously. And so what I am really trying to get to the bottom of is, really what is causing the weakness in your US business in recon.

Well the recent introductions were really just at the academy meeting which was just a couple of weeks ago, with the JOURNEY knee for instance which we had an excellent introduction at the academy. And in fact one of the analyst houses -- research houses voted it the most innovative product at this year's [inaudible]. So most of the things that we have produced we have recently introduced so we're working through the product introduction there in the field. And that typically takes a few months to get that product -- those products out in the market.

So final question is then are potentially some of your surgeons actually waiting for your new products? Could that have affected your numbers in the first quarter?

Sure.

Absolutely. A huge amount of time and effort has gone into the preparatory work for both BHR and JOURNEY which we regard as major flagship products in hips and knees respectively. And obviously you can't start delivering on that until the product is actually out there. So we have started on that with JOURNEY. We are awaiting approval for the BHR to start on that in hips.

Of course. Right okay, thanks. And in terms of European pricing and the outlook for the rest of the year?

European pricing per se isn’t the issue. The issue is healthcare cost pressures in the UK which is manifesting itself in terms of general very very strict cost control and some aggressive pushing by the health service procurement. In Germany it’s all part of the cost control and finalization and the move to DRGs. But the issue is more about volume usage. Volume is down in the UK -- sorry, it’s not down. Volume has not grown fast in the first quarter in the UK, but it has in previous quarters in the year, so we’ve seen endo and ortho still positive but much lower than we'd normally expect in the first quarter.

And are you seeing any pick up under NHS contracts in the second quarter?

Well, we’re not commenting on the second quarter per se, because we don’t have second quarter numbers per se but --

But yet, so far.

We've yet to see continued health service pressure in the UK and in Germany. There are changes to the market conditions. We’ve made changes to what we do and if I give you some examples of that; we’ve restructured our UK wound management sales force to focus on economic benefits. We have an economic benefits group selling in there, so we’re aiming to get more market share. We're focusing very clearly on BHR which fortunately for us is primarily a private sector product in the UK which is why our UK recon sales are continuing to grow. And we’ve got similar initiatives in Germany to particularly drive the trauma range which did very nicely because it’s less sensitive to issues related to DRGs and elective surgery.

So a lot of opportunities for us, but changes in the market take a little time to adjust to, and it certainly was a tough quarter. We do expect improved performance from wound who bore the main brunt of this, in the coming quarters of the year, but it’s not going to be a stellar year for either of those two countries.

Thanks, that’s very helpful.

Okay?

Thank you.

Next question please?

Thank you. We’ll take our next question from Hans Bostrom from Goldman Sachs. Please go ahead.

Thank you, I have three questions please. Firstly, in light of the weak performance in the first quarter, have you been looking into revising your targets with regards to sales force hirings for the full year? Or is that still the, I think, lower double digit growth in the orthopedics division that you had discussed at the AOS analysts meeting?

Secondly, if you could comment on what you could expect the contribution from product mix and price to be for the remainder of the year, whether this is an important contributor to the acceleration in the second half. Or whether it’s more volume driven.

And thirdly, if you could also give us an update on where you stand with regard to the training infrastructure for the Birmingham hip resurfacing device in the United States. Thank you.

Okay. Well, presumably Hans, you’re really thinking about sales force hiring in terms of orthopedics particularly.

Yes.

In principle. Okay, could I ask Dave to deal with that and also the training for BHR? And I’ll ask Peter to deal with the mix in price.

We are not really changing our forecasts for sales force hiring, that’s the simple answer Hans. We’re expecting a lot of activity with a pick up in the second half and we’re expecting a lot of activity with BHR excitement. So no, we don’t have any plans to change those numbers, so whatever we told you last time still stands.

And as far as the BHR training and -- you call it restructuring but I call it just getting ready to push the button here, we are absolutely ready to go. We have our alpha sites in place. We’ve trained a large percentage of those. We have a timeline which sets out when we’ll be doing the first surgery and who’s going to do it and how it’s going to be communicated and how we're going to be training others doctors and surgeons. So we probably have the most well baked plan in the history of this company for a roll out of a product, and we are ready to go.

Okay, Peter?

I mean, where price and mix is going to go in the second half. The driver to the pick up in the revenue line in the second half is basically going to be the new products. And some of them will obviously, let’s call it, replace existing products, but I mean, by and large there’s not going to be any big shift in price. It’s going to be basically volume and mix, and how you divide the two in the real world is actually quite difficult. But obviously BHR is going to be a clear, clear mix and this clearly will be a mix and a volume component when JOURNEY and the other problems get themselves moving through the sales force.

Put simply, the orthopedic product line mix impact is potentially very strong with LEGION, JOURNEY, BHR and EMPERION all have a positive mix component. Anthology probably not. And in endoscopy CALAXO strong mix component. The whole issue of the high value products we’re putting into hip arthroscopy and our new pump and information systems for the digital operating room and visualization are all premium products. The big launch in wound management is ACTICOAT moisture control which is a significant price point pick up. So there is a lot of mix -- positive mix, quite deliberately, in our forward product launches that we believe they’re all structured so they have a strong cost and benefit argument for the hospital and healthcare community. So that we can actually demonstrate economic benefits in simplistic ways. Okay?

Thank you.

Okay, can we take another question please?

Thank you, and the next question is coming from Mark Mullikin from Piper Jaffray. Please go ahead.

Good afternoon. My first question is on clinical therapies. Can you please provide a little more color on the reasons for the deceleration and what’s going on with the insurers and the outlook for that going forward?

Yes, we essentially decided that we needed to re-engineer our process for reimbursement. The business was getting to the point where we needed to overhaul it and put some processes in place and in doing so, we changed some of the procedures and we lost about six weeks or so momentum on the Exogen product line for instance. And essentially we -- in March we got back to our historical levels as far as run rate. So essentially we lost a piece of business in the first part of the year as we went ahead and made those changes, but we were leaving a lot of money on the table in our collections, in collecting some of the [inaudible] and some of the things that were going on with that product. And as we got bigger we decided that we needed to go ahead and bite the bullet and change that process. That created a little bit of confusion in the marketplace with our sales force and our customers and we got it basically changed. And like I said, we’re back to our historical run rate in March. So we feel like we actually -- it’s going to be a win win for us.

So you would expect the growth rate to bounce back pretty nicely in the second quarter to historical levels?

It already has.

Okay.

Yes it already has, and we’re fully expecting that to continue.

Great. And in endoscopy, what were the radio frequency sales in the quarter and can you provide the growth rates? I think that’s been on the sheet in the past but I didn’t see it on there this quarter.

Peter can do radio frequency for you.

We're not splitting out radio frequency at the arthroscopy level now. What we’re doing is you can see the spine numbers. Basically radio frequency and blades really sell very much as part and parcel of the -- if you call it the same package. And there is, particularly now we’ve got ElectroBlade back on the market, it becomes -- when you're try to give people, let’s call it fine point and percentages, you’re always having to explain one percentage against the other. So what we are doing now is we are -- the business basically is repair, what you could call re-section arthroscopy and then you’ve got spine, which are the procedures. And then you’ve basically got the infrastructure side which is DOR and visualization. And those are going to be the four bands as we go forward; basically arthroscopy, spine and capital goods.

So where would the radio frequency products outside of spine, be grouped in?

In re-section.

In re-section, okay.

Yes, because they are an alternative to mechanical re-section. And as you know we have ElectroBlade which basically combines bi-polar and mechanical cutting on one blade.

Okay, so that’s the model we hope to use going forward Mark.

Okay, and just one more. The endoscopy restructuring. Can you just provide an update on the progress on that as far as -- I think you were shutting down one plant and moving some manufacturing?

I can basically say that that’s going to plan. I mean it’s basically, as you say, it’s exiting one and basically, optimizing the placement of production both inside and outside Smith & Nephew.

Is it mostly complete at this point?

No it's aimed to be complete by late on in the year so we get the financial benefits in 2007.

Which is consistent with what we said when we put up the project.

Okay, very good thank you.

Thank you. Can we have another question please?

Thank you. Your next question's coming from Ilan Chaitowitz from Redburn Partners, please go ahead.

Good afternoon. Just a few questions. Firstly Zimmer recently announced an agreement with HCA a pricing with volume agreement. I was wondering if you are in discussions with HCA for anything similar? And also if not what you think the implications are of that agreement for your business?

Second question relates to your target for growing above the market. In recon you grew in line in the US in the first quarter. Now your competitors are also planning on coming up with some product launches in the second half so it's going to be a harder [comp] maybe to beat the market by 50% then. Are you still guiding or do you still think you can maintain 50% growth above the market?

And also just some clarification, are you still hoping for a launch on the Birmingham hip resurfacing device in H1 this year?

Okay, let's try and sort of run through these and let me make a start, but Dave you could chip in. HCA, we're very pleased and proud to have HCA as a significant customer for Smith & Nephew but they are not a significant customer in recon and we don't anticipate that that's going to change much in the near future because they clearly have focused on three of their larger vendors. Nonetheless HCA are a very valued customer of the other parts of our business.

In terms of your question about BHR, yes we do believe and we've consistently forecast that we would expect to get approval from the FDA in quarter 2 of this year and we hope very much that will be the case.

In terms of the growth going forward, yes there are other companies who have indicated they're going to launch new products. It depends how really innovative these new products are and I'd like Dave to really comment on that. But if you look at the nature of products like BHR and JOURNEY in particular, you've got such a high innovative content that we're very clear that we can expect to accelerate growth in terms of the marketplace itself which is a large marketplace and is ripe for the introduction of some new and innovative products. Dave what's your thoughts on this one?

Well I think ultimately you have to make the call whether or not we are going to continue to outperform the market and to what degree. We are very very bullish on our product introductions, the level of innovation that's there and the level of differentiation that it's going to give us in the marketplace. We have been outperforming the market for the last 16 quarters and this quarter we essentially performed at the market and I would hope that we get some credit for history here. How much we're going to outperform the market I think will depend on the ultimate acceptance of these products. Clearly it's our goal to continue to outperform the market and we're very very bullish on the products that are coming.

Thank you. Just at the last conference call you guys mentioned that you were going to outpace the market by 50%. Are you sticking to that guidance or is that not the case any more?

No I said -- I think what we actually said is that we are working to the -- in fact specifically at the last conference call we couldn't have said that. What we've said is, over a significant period of time we have been growing at rates of up to 50% faster than the market. We indicated at the last conference call that that rate was going to be something more in the 25 to 30% this year. Now depending on whether the market works out, or whether we work out, we still think we should get up to those sort of rates certainly in the second half. Clearly in the first quarter we have not done that but when you accumulate the year up you've got to work the percentages out.

But the key to that as we've said is new product performance and the indicators that we're giving is that we are looking to do better than the market in the second half and as a result of that pull through the first half behind it.

Yes just one additional comment, we have a slide that we use frequently at the analyst meetings that we have which shows our quarterly growth versus the market and we've been showing it now for the four years that I've been associated with the company. We're very proud of that chart. You -- I'm sure it won't be hard for you to get your hands on it. And there has been some very strong growth relative to the market and it's our intent and the way that we put our strategy together in order to continue to do that. But I don't believe that we've ever given guidance as to a certain number above the market rate that we're committing to.

Okay?

Okay thank you very much.

Another question please?

Thank you, we'll take our next question from David Adlington from Cazenove, please go ahead.

Good afternoon chaps, a couple of questions. I just really wanted to get a handle on what's changed from late January for you to reduce your guidance for both -- well for trauma, recon and endo? And really if what's changed since late January has really changed your longer term outlook and particularly your impact on that mid-teens EPS growth goal?

Right just -- broadly the things that we have seen since then is we've definitely seen a more negative market climate in the UK and in Germany than quite frankly was evident in January. And because we have significant shares of those markets we have seen a bigger impact on our businesses than we have foreseen. And you can see that most dramatically in wound care but also to a lesser extent in ortho and endo. So that's a particular part.

It is also the case that we said we believed the recon market would be slower in 2006 than 2005 and we said that it would be -- maybe around 10% for the year was our best guess, but it will be slower in the first half than the second half. The first quarter has probably turned out to be marginally slower than we thought it was going to be at around 7 maybe 8% and roughly also the level of our performance in recon. But those are essentially the tonal scenes.

As far as the rest of the year and the guidance going forward is concerned, if you actually take our forward guidance now, which is in the 4 to 6% EPSA range, and you add back the items that Peter put in there plus the adverse currency impact, you're not far away from mid teens earnings growth; you're in the 12 to 14% range. When you add those factors back to the underlying beat rate of the business in terms of its performance as an economic engine, it remains very solid. We told the market at prelims there were some significant impacts that we were going to take on a one-off basis this year for strategic reasons and for the divestment of BSN which is the final cleanup of the portfolio. But yes we are confident we have the engine working to continue to drive those earnings per share going forward.

That's great, thanks guys.

Anything to that?

Very eloquently put Chris.

Well thank you, I've got a compliment from Peter. Okay, can we take another question please?

Thank you, we'll take our next question from Steven Lichtman from Banc of America, please go ahead.

Thanks, hi guys.

Hello Steven.

Most of my questions have been answered. Just a couple just on the visualization and DOR of the 1% growth in the quarter. Did you mention you attributed that all to the comps or was there anything else going on there in the quarter?

It's a mixture of comps. We had a very very strong -- if you go back and look it was an exceptionally strong number a year ago. But it's capital goods and you always get a tiny -- we have a strong backlog and it's certainly stated on the spreadsheets to pick up in the second half.

Okay great. And then Peter on the impact of FX, can you talk about -- you spell out specifically the growth impact, is that both to the top and bottom line?

Yes, the way we've -- if you read carefully through our model which we write in the outlook, everything excludes currency, all the guidance excludes currency and then we give you the currency number right at the bottom which effectively means you plug it in at the top and it drops down the revenue line and then it drops automatically down to the EPSA line.

Okay and what's the tax rate expectation for the year?

30.5.

Thanks guys.

Thank you. Another question?

Thank you. We take our next question from Yi-Dan Wang from Deutsche Bank, please go ahead.

Thank you I have several questions. First of all with regard to the orthopedic restructuring. Could you comment on whether you’ve actually lost business permanently or it's just a temporary slowdown and we would expect that business to, eventually once you’ve finished that process to get back to the sort of beat rate that we should expect?

And in terms of the investments you are making in your products, can you comment on how much investments in your new product launches you've already made? And therefore I suppose by implication the sort of margin trends we could expect as we move through the quarters and some of the sales starts to contribute?

And the third question is now that JOURNEY's been in the market for almost a month, can you comment on the uptake of that product relative to your expectations?

Why don’t we start with the ortho related part of this Yi-Dan and I'll ask Dave to give you his comments on JOURNEY and the nature of the blip in the quarter.

Hi Yi-Dan, how are you?

Alright, how are you?

You know I think the best way to look at this on the restructuring, what we did is that we're always in a mode where we're winning and losing business in this marketplace. We have very good competitors and we're all out fighting for the same accounts and the same customers and there's times when we're winning them and there's times when we're losing them and we're always scrapping. I think what happened in the first quarter, to simplify it, is that we didn’t spend a lot of time on going out and getting the new business because we were preoccupied with getting the territory split up and making some changes and there was folks preoccupied on other things. So I would hope that we didn’t lose a lot of business but we certainly did and I don’t think we got our fair share of going out and cultivating new business. That's the simplistic way that I would describe it to you.

Okay and obviously we've got new products coming through like JOURNEY. Can you give Yi-Dan some flavor of how you feel the response to JOURNEY is?

Well the response from JOURNEY has been very strong. We have wonderful clinicals that are ongoing in Europe and the data is very, very encouraging and very strong. The introduction has created a lot of buzz in the US although it's fairly new. As you know we just introduced it at the academy meeting this year and the buzz around the academy meeting was loud. So we have strong expectations of us continuing to ramp that business in the second quarter.

And in terms of the instrumentation required for that product, are they all out in the market now or is there going to be placement of that? And therefore a delay in the uptake of that product in the way we would see it in your financials?

We are not at a point where we -- we're phasing the instrumentation out into the marketplace as we always do. We would not be able to have a major platform introduction like this and just instantaneously have all of the instrumentation that we need in the field. I think we've got to taste pretty well. We have to work around systems that allow us to get the instruments at the right place at the right time. So it's probably not the -- we're not at a steady state perfect situation but it's right on plan with the way that we had envisioned the introduction of this with instruments.

I've got to say Yi-Dan I'm extremely excited about JOURNEY. I'm excited about BHR because I think it's a terrific prospect for us. In the surgeries that I've talked to and the excitement that's been generated, I think JOURNEY is every bit as big a product as BHR because it just conveys such benefits. And it's going to take us, it's going to be a long progressive build up because it'll be a big product for Smith & Nephew the balance of this year, 2007/2008. It's a long, long roll through and does help our mix.

With regard to the investment issues, what we've done going forward is really say look, this has been a slow quarter and we need to pace very carefully therefore our investments going forward. We're focusing on the R&D programs and the pipelines that we have coming through there, on the launch of the new product, the JOURNEYs, the BHRs, the LEGIONS etc, and obviously the lead endoscopy products and wound management products and making sure they get to the market with properly backed up instruments, marketing materials etc. And looking to really focus our investments in that area and then really pace our investments because this business is still growing significantly in the other areas so that we really manage the return characteristics effectively. I can't give you a pinpoint investment figure at this point in time but clearly those launch monies are committed and will be maintained.

I have one more question. In terms of your guidance for the full year, obviously some of the decisions that you made in the first quarter that we weren't aware of and therefore we couldn’t really pinpoint how that will impact your business. Now with some of those decisions already made, would you be able to comment on the amount of visibility and the confidence that you have over the guidance that you've just issued?

I think the thing that is much clearer is the likely forward picture in the UK and Germany and we have taken a more pessimistic view there. I think we have also, as Dave explained earlier, in something like clinical therapies we've had a discrete one time hit as a result of changing the authorization and reimbursement systems for the Exogen product.

I think in terms of the pickup going forward, I think we've got better visibility, we've got two of our -- three of our main new products in orthopedics in recon out to the market. We've got three endo products and the ACTICOAT moisture control out there so we've got much better visibility and we've got those hurdles ticked off. We still some to hit. BHR is a very important one for us and we do expect to get approval. If that approval was delayed then obviously we would see some impact of that but currently we still expect to get the approval in Q2.

So I think we have better visibility for the balance of the year and we've got some more building blocks in place so we are more confident. So overall we are giving -- we believe as we've indicated, more cautious guidance for the year based prudently on the current environment. Okay?

Okay thank you.

We'll perhaps just take a couple more questions because we're going to run out of time, Do we have more questions Keith?

Yes sir. The next question is coming from [Jack Scannell] from Sanford Bernstein, please go ahead.

Yes Jack Scannell from Sanford Bernstein here. Two questions. The first is, I would just really like to understand the sort of two or three factors that explain why you seem to have lost a little bit of share this quarter. I mean year on year you seem to have performed about the same pace as the market in reconstruction but that's been based on three quarters gaining share and then one quarter actually losing quite a chunk of share. Just was there just two or three main reasons for that do you think?

Well we don’t think we've lost share in the quarter here Jack, let's just start with that. In recon, broadly the recon market is somewhere between 7 and 8% of the global level and that's broadly our recon growth rate. What we have seen, as Dave explained, is the issue of we've had a slower quarter in the US where the bulk of our activity in separating out the recon and trauma business has taken place and that has had an effect of slowing down our gain of new business in recon and in trauma also. So in that sense, in the US marketplace we have arguably lost -- well we have lost some share in the quarter but that awaits the launch of, and the promotion of, our new products in subsequent quarters. We only had really one big new product out for the whole of the first quarter. So I think we see it rather differently there. And the issue is what we want to do is grow faster than the market, and we need to get back to doing that. And it's the new products that are the key to it.

I guess that's touches on my question in a way, in that is it primarily because the new product flows slowed down? Is it mainly because some of the sales reps maybe have been -- some of the reorganization is focused on the sales force and other things? I am just trying to get a sense as to what the actual causes of the -- whether it is a transient slowdown, just to know what they are.

I think you've got them. I think you have just said them.

Okay.

I think you are absolutely right on.

Is there an absolutely single point we could point our fingers on, the answer is no. It's a little bit about markets, it's timing of new products and it’s the fact that we ask the management to make sure they've got through the whole of the necessary reorganization ahead of the major new product launches. And that's what they've done. We are pleased with that, we don't like the fact we haven't grown our business as much as we should, but the prospects for the growth going forward are improved.

Yes, we have essentially introduced new sets of line and field management and it just causes some disruption with these folks. They're are interested in other areas and they aren't as focused on going out and cultivating new business as they are trying to protect their existing turf. And I think that's the factor. I mean it's really not a whole lot more difficult to understand than that and that's where we are.

Okay, thanks very much.

Good. Do you have another question Keith?

Thank you sir. The next question is coming from Michael Jungling from Merrill Lynch. Please go ahead.

Thank you kindly. I've got three questions. Firstly, was your first quarter affected by additional sales days because we had Easter in Q1 last year and Easter's in the second quarter this year? As traditional sales days it could add up to three [finish] points of growth. So I am just curious as to whether you had a benefit of that in the first quarter?

Secondly, how confident are you that your guidance of double digit sales growth for trauma and recon is achievable given that the negative reimbursement environment for some of the regions will only commence in the second quarter, like Japan. And we'll see now the roll out of a number of DRG systems in Europe and France, Germany, UK and Holland.

And then thirdly, I got the impression that the pricing environment is still positive generally speaking. Can you then explain why your gross margin declined by 70 basis points in the first quarter of this year compared to the same period last year?

Right. Peter, sales days and gross margins.

We've looked at sales days and we don't believe that there is a distortion on sales days. We've been the only company I think who has adjusted for sales days and we've looked very carefully at that. It would have been misleading to have adjusted for sales days.

I did talk right at the beginning of the conference about the gross margin -- bear with me, I've just turned the papers over. I think the best thing, you need to look at the gross margin really on gross margin as it was, or the COGS as they were at the back end of last year. Look at the COGS as they stand today and you will actually find that the COGS, I think I said there was about 0.5% down, that you are seeing the cost and efficiencies coming through.

Going back a year, the business mix has changed and DERMAGRAFT is in and out of the business. So I think if you want to draw the comparison you ought to draw the comparison with Q3 and Q4, because those were the latest. We are talking about moving factors around in endoscopy, we've got rid of DERMAGRAFT, the mix of the business has changed. So I think that's really the better comparison, Mike.

And Peter just a follow up question on that. If we were to do like for like, is it fair to say that gross margins would have not declined, they would have been at least stable?

I can only talk to you in COGS terms and the COGS have gone down. And looking at H2 COGS last year to Q1 COGS this year basically, I'll turn over the numbers, but I've just literally turned the sheet down, they are down -- where are they, they are down. There's was a 25.9 average COGS for H2 last year and they are 25.5 now. So they are basically down just over 0.5%.

What has gone up relatively is the SG&A line which is a mixture of investment going into the launches and the fact that, we are quite open about it, the sales growth is slower than it was. And whilst the business has a variable cost base in the long run, it does impact you on a quarter if sales come off. And when you are looking at our margins you know how our margins strengthened very dramatically right at the back end of the year; in Q4 there is always a very very strong quarter. Because what happens is the incremental sales drop right the way through in short term. Or the lack of incremental sales drop right the way through.

Okay. Dealing with the issue of how confident are we on our guidance on recon and trauma. And have we taken account of the price pressures in Japan and the healthcare systems in Continental Europe. Dave.

We are confident in the guidance that we're giving now. We are seeing some very strong growth even though there are some pricing pressures in Japan. We took some action last year in Japan with the addition of a new sales channel and an acquisition there. And that's paying off for us now and we are actually seeing some very good growth, so we feel good about that market. And as you know it is the second largest potential market for us. So that's actually going well for us.

As far as the pricing environment, we don't agree with the assertion that there's price uplift in the market currently and it's still positive. For us we think it is essentially flat. And that's how we see it.

Okay.

Alright?

Just one last question. On the guidance, if you said -- listening to you as you speak now, would it be fair to say that, at this stage the guidance is almost bulletproof?

No guidance is bulletproof, Michael. It's a [inaudible] flak jacket here I think. No guidance is bulletproof. It is guidance, it can go up, it can go down. I think we have spent a lot of the call talking about new products. We are on schedule for the launch of all our new products. They need to carry on marching to that schedule and we believe they will, in which case our guidance is good. If there is something unexpected that happens in that challenge, then that might make a difference. And clearly we continue to work for opportunities that give us upside on this. So our view of the guidance is balanced rather than bulletproof.

Yes, be assured that we take a lot of care over guidance. These are not casual numbers, they are carefully worked out numbers.

Okay right. Well I think we are going to close the call here. And this has been a call which, for the first time for, we reckon eight years we've actually got lower earnings than as reported in the previous quarter. There are some one-off reasons why that is the case. We aren't dismayed by this, we've flagged up the directional issue here at our prelims and we are very confident that we have a very good product program, that we've bitten the bullet as Dave said in terms of organizing the recon and trauma businesses to be charged up and structured to deal with the growth opportunities the new products bring them. And we are very confident about our new product program. So we are not dismayed, we are not happy, we want to take this forward and deliver some very good quarters in the balance of the year.

So thank you all very much for joining us.

That will conclude today's conference call. Thank you for your participation ladies and gentlemen.