Smith & Nephew PLC (SNN) 2007 Q3 法說會逐字稿

This presentation contains certain forward-looking statements within the meaning of the U.S. 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 product pipelines.

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 U.S. Securities and Exchange Commission under the U.S. Securities Exchange Act of 1934, as amended, including Smith & Nephew's most recent Annual Report on Form 20-F, 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.

I would now like to hand the call over to Mr. David Illingworth, Chief Executive of Smith & Nephew.

Good morning everyone, and welcome to our Q3 results presentation. With me is Adrian Hennah, our Chief Financial Officer.

Our third quarter results show very steady progress as we continue to generate sustainable growth in revenues and profits. We've had a good quarter, particularly since, as you will remember, we had a very strong Q3 in 2006 for all of our businesses except for Advanced Wound Management, giving us tough comparators this time around.

I'm going to start with the highlights, and then I'll turn it over to Adrian to cover the financials in detail, and then I'll come back and make some final comments about the individual businesses. So, starting with the financial highlights. Overall, a good quarter with double-digit revenue growth. Recon continues its remarkable track record of outpacing the market, which we estimate is growing at 9% globally.

BHR, our Hip Resurfacing product, continues to deliver share gains for us in the U.S., where hip revenue growth was a full 35%. Knee revenues were as we expected; a little soft in Q3. Trauma and clinical therapies had revenue growth of 11%, benefiting from good volume growth in external fixation, and also our number one position in the bone stimulation market.

Endoscopy delivered 9% growth overall and our focus, outside the U.S., delivered 17% growth. A very, very good result. We're pleased with the continued strengthening of our Advanced Wound Management business. Advanced Wound Management has grown -- add growth in the U.S. of 9% and 8% globally as this business executes on its strategy and delivered balanced growth across all geographies.

Group margins improved by 60 basis points, after 100 basis points of dilution from Plus and BlueSky. Adjusted earnings per share increased by 16% as we again delivered double-digit growth in earnings.

Next, a few comments on the business highlights. We've had a very active quarter, with several key events. First, our Hip Resurfacing system, BHR, had its tenth anniversary, and we now have nearly 80,000 hips implanted, further distancing itself from the competition. Outstanding clinical results supported by 10-year data, widespread clinical acceptance and a compelling track record have firmly entrenched the BHR as the gold standard in Hip Resurfacing. We've also had three Knee systems approved as gender specific by the FDA this quarter; a tribute to the quality of our product design.

EIP, or our Earnings Improvement Program, is being driven by each of our businesses. We announced two major events this quarter, first, the move of our manufacturing facility in Florida to a new factory of our own in China. And second, we also announced the new agreement for the marketing of ACTICOAT, which both improves our earnings and has allowed us to launch several new silver-based dressings.

We also settled with the DOJ this quarter, and we've started to work with the monitor, David Samson, and we expect this relationship to work well. Now, I'm going to hand you over to Adrian, who will take you through the numbers.

Thank you, Dave, and good morning ladies and gentlemen. If we can turn firstly to slide six, and the income statement, revenue in the quarter was $845m. This is a headline growth rate of 24% and an underlying growth rate, after adjusting for changes in exchange rates and for the acquisition of Plus and BlueSky, of 10% on the comparable period last year.

Trading profit in the quarter was $169m. This represents an underlying growth of 19%. The underlying increase in the trading margin was 160 basis points. In the appendix to the presentation you will find an analysis of the Plus and BlueSky sales and trading profit included in these numbers.

We've provided for, and paid, costs of $30m in the quarter, in respect to the legal settlement with the U.S. Department of Justice. Within the $26m restructuring and integration costs, we've provided the cost of $4m in respect to our Earnings Improvement Program and costs of $23m in respect of the Plus integration. We've spent $9m on the EIP in cash, and $3m on the Plus integration.

The $45m inventory revaluation item is a non-cash acquisition item required under IFRS. It arises as we must revalue the acquired Plus inventory from cost to essentially its selling price, less some directly connected selling costs; an increase of $92m from the $106m valuation at cost. You can see this preliminary revaluation in note six of the accounts with the announcement, net of a $20m increase in the provision for excess and obsolete inventory.

This increase must be taken to the P&L as the inventory is used. We expect the charge to be about $30m in quarter four and about $17m in quarter one of next year. We will continue to show it separately and exclude it in the adjusted earnings number so that you can get a clear view of the Company's performance.

The amortization cost of $15m includes $11m attributable to Plus. This is based on the preliminary assessment of the value of the Plus intangibles of $314m, and of their useful lives. We aim for the final figure with our full-year numbers. Net interest expense in the quarter was $13m.

Moving then to slide seven (sic - see presentation) and a bit further down the income statement, the tax charge before exceptional and amortization in quarter three is 30%, in line with our expectations for the full year. Adjusted earnings, or adjusted attributable profit for quarter three was $108m, a 13% growth on quarter three last year. Adjusted earnings per share grew slightly faster, at 16%, reflecting the reduction in shares in issue as a result of the share buyback program.

EPSA growth is less than underlying trading profit growth of 19%, due to the diluting effect in the quarter of the Plus and BlueSky acquisitions, and a small impact from the increase in the tax rate, from 29% in quarter three last year. The share buyback was essentially earnings neutral.

Turning, then, to the next slide, slide eight (sic - see presentation) and an analysis of revenue by business segment. You will hear from Dave in a moment more detail behind the numbers for each business. I will therefore make only a couple of financial points in respect of this and the next two slides.

On this schedule, you can see the growth rates in the quarter for each of our business segments. And on the next slide, slide nine (sic - see presentation), you can see an analysis of revenue growth rates by segment and by geography. The underlying growth rate in our Reconstruction business was 11%. This was down from the 15% rate at half one.

The principal reasons for the slower growth were the expected impact of Plus integration to synergies, especially in Europe, as the sales forces have been combined, tougher comparatives, especially for BHR in the U.S.A. which was launched in Q2 2006 and, as expected, continued below-market growth in Knees in the U.S.A.

Growth in the U.S.A. was 15%, driven by volume and mix gains. Pricing in our Reconstruction business in the U.S.A. was essentially flat. Pricing outside the U.S.A. was, on average, slightly negative.

The Trauma and Clinical Therapies business growth rate was 11%. Fixation sales grew at 9% in quarter three worldwide, slightly behind the market growth which we estimate at 10%. Clinical Therapies sales growth was 15%. We have signaled that Clinical Therapies growth in the last four quarters was boosted by the in-license of [Duralin] sales, starting in quarter three last year.

In addition to the ending of this effect, we have seen falling U.S.A market growth in joint fluid therapy and in long-bone stimulation, which has impacted our sales of [SUPARTZ] and EXOGEN.

The Endoscopy growth rate was 9%. The Arthroscopy growth rate, within that, was 11%. Within this, re-section sales grew in mid single digits in the quarter, and our repair area at slightly under 20%. Visualization and DOR sales, which are lumpy, grew at [3%].

Endo sales outside the U.S.A. continued to be strong, with 17% growth, and now account for over one half of Endoscopy sales. Sales growth in the U.S.A., at 2%, was impacted by the voluntary withdrawal of CALAXO from the market and by the lower DOR visualization growth.

Wound sales grew at an underlying 8%. This is an increase on first-half growth of 4% as reported. Sales, excluding negative pressure wound therapy, grew 9% in the U.S.A., down from 11% in half one. Sales growth in Europe improved to 7%. NPWT sales in quarter three were, in line with expectations, modest at $2m. As Dave will discuss in a moment, preparations for a launch in early [2003] are on track.

Turning now to slide 10, (sic - see presentation) this shows the usual analysis of revenue and trading profit by business segment. We've again shown separately the impact of the Plus and BlueSky acquisitions on the quarter's numbers. As we've already noted, underlying trading margin for the Group overall increased in the quarter by 160 basis points, and this was diluted by 100 basis points by the Plus and BlueSky acquisitions.

Trading margin improved at all business units in the quarter, and we continue firmly on track with our Earnings Improvement Program. It is too early to be evident in reported margin numbers, but we also continued on track with the cost savings from the integration of Plus.

Turning to slide 11 (sic - see presentation), and a quick update on our share buyback program. As you know, we said in February that based on an assumption that we used about $2b on acquisitions over two years, we plan to buy back up to $1.5b worth of our shares over the same period. This remains our plan and we continue to keep the level of the buyback program under review as our acquisitions program proceeds.

As at the end of last week, we bought back a total of about 44m shares for an outlay of about $537m. This means that with something over one third -- with two years of the program elapsed, it bought back something of a one third, a $1.5b total.

Turning then to slide 12 (sic - see presentation), and the outlook for the rest of the year, our view of the Company's overall outlook has not changed. In the Recon area, we see current global market growth of about 9% per annum for the third quarter in a row. We continue to expect a sustained sales growth benefit from our recent product launch program.

Based on these launches, we continue to expect our revenue growth, including Plus sales, to exceed market growth in 2007. With regard to the Plus integration, we have signaled previously that we expected to see the impact of the anticipated sales dis-synergies quite early in the integration, and that we expected the growth rate of Plus sales in the second half to be lower than in the first half, and quite possibly lower than market growth.

This remains our expectation. We are also now expecting slightly higher sales to synergies than previously in 2008. This does not, however, impact our net sales synergies target of about 15% of the acquired revenue, or $45m in the third year.

In Fixation, which accounts for about two thirds of sales within the Trauma and Clinical Therapies business, we see current global market growth of about 10%. We continue to expect to remain close to market growth for 2007 as a whole. Within Clinical Therapies, we do not expect market growth in the U.S.A. to return quickly to the levels in recent quarters. The lower market growth will continue to impact our sales growth.

In the Endo area, Arthroscopy revenue grew at 11% in quarter three. We believe that this was slightly below market growth. We expect to continue slightly below the market through 2007. The Visualization and DOR business within Endoscopy is much more lumpy.

As already mentioned, we saw strong growth in quarter one, and a more modest level in quarter two, and 2% in quarter three. We expect growth rates to continue to be volatile, quarter by quarter. Quarter four 2006 was particularly strong for the Endo business, and we do expect this to impact the growth rate in quarter four for this year.

In the Wound area, we continue to see a current growth rate for the market, excluding Negative Pressure Wound Therapy, of about 6%. We grew slightly ahead of the market in quarter three. We expect to continue to grow slightly ahead of the market for the rest of this year. We continue to expect negative pressure Wound sales to have a limited impact this year ahead of the full launch of the BlueSky product range in early 2008.

We are on track for our Earnings Improvement Program of an increase in trading margin of an average of at least 1% per annum to the end of 2010, before the impact of acquisitions. We have a year-to-date increase in trading margin this year of 130 basis points before the impact of acquisitions, and had a relatively high margin in quarter four last year. You should, therefore, not expect a significant quarter four-on-quarter four improvement this year.

We continue to expect the Plus and BlueSky acquisitions, together, to dilute Group margins by about 1% in the full year. We expect that the reported EPSA growth rate in 2007 for the full year will be reduced by the increase in the tax charge from its low level in 2006.

Based on the expected full-year tax charge of 30%, the 200 basis points increase from the 28% tax rate last year would reduce full-year EPSA growth by about 4%. The EPSA growth in Q4 will be particularly impacted, as the tax rate in Q4 2006 was 25%. Based again on the expected 30% tax rate, the 500 basis points increase on the tax rate in Q4 will reduce EPSA growth by about 8%.

We continue to expect the BlueSky acquisition to be about 1% dilutive to EPSA in the full year. And with that update on the outlook, I'll hand back to Dave to talk about the business behind the numbers. Dave?

Thank you, Adrian. Let me start my review of the businesses with the Reconstruction segment. As it says on this first slide, we believe our products make us the first choice for the active/informed arthritis patient. In detail for this quarter, the Reconstruction continued to gain market share globally, outpacing market growth, which we estimate at 9%, achieving 11% for the quarter; a very good result.

Hip revenues in the U.S. achieved continued strong growth as BHR performs well, and completed its first year in the U.S. market. The 10-year data shows industry-leading 10-year survivability, and its clinical acceptance has established it as the global gold standard in Hip Resurfacing.

Knee revenues performed, as expected, at 5% globally and 4% in the U.S. Let me just take a moment to make a few comments about our Knee business. We have, or will have shortly, cobalt chrome versions of our leading products, JOURNEY and LEGION. And we have now gotten FDA approval for three of our Knee systems to be marketed as gender-specific.

This will give our sales force and surgeons a much wider range of options, as we work to regain momentum over the next couple of quarters. Given our innovative product range, our expectations are for stronger momentum in our Knee sales.

The integration of Plus is going well, as we reorganize our European sales force and start the selling of Plus products by the Smith & Nephew sales force, and the selling of Smith & Nephew products by the previous Plus sales force. We've also made good progress with Earnings Improvement Program, or EIP, in Recon this quarter and we've seen market increase by over 200 basis points to 25.3%.

New product revenues were 20% in the quarter; a good indicator of the vitality of this business. We now have our monitor in place, as I mentioned earlier, and this is working well so far, as he works with us to create a level playing field across this industry.

Now, moving on to Trauma and Clinical Therapies. Our fixation revenues grew at 9% globally in Q3, just a tad behind the market growth of 10%, growing by some 7% outside the U.S. and 11% inside the U.S., as the benefits of a complete product range are being realized. In Clinical Therapies, our bone stimulation product, EXOGEN, has done very well, driving this business to 15% growth in the quarter. We get real benefit from our market leadership position in this marketplace.

The joint fluid therapy market as a whole is a little under pressure from the combination of reimbursement and pricing. Against this backdrop, Clinical Therapies has performed well, with 15% revenue growth. The margin of 19.2% in this business, which is an improvement of 60 basis points over the same quarter last year, demonstrates the strong progress being made within the business and working on the Earnings Improvement Program.

Now, let's move over to Endoscopy. Our Endoscopy revenues grew by 9% in the quarter overall. Our business outside the U.S. grew by 17%, as a very strong performance was delivered by our sales force. Revenues outside the U.S. now exceed U.S. revenues.

Our U.S. revenues, at 2% growth, were impacted by the voluntary withdrawal of CALAXO, and low DOR and Visualization revenues, as that business is lumpy. We also had a tough hill to climb with the comparator as, in the same quarter last year, U.S. revenues grew by 14%, having grown by 4% or 5% in each of the other quarters in 2006.

Arthroscopy, the major proportion of our business in this business unit, performed well, at 11% growth. Knee and shoulder products are performing strongly and repair revenues are now larger than re-section, as our focus on fast-growing segments is working for us.

Endoscopy's margin, at 19.3% for the quarter, an increase of over 2% over last year, is a great performance and it's showing the benefit of the completion of the reorganization of our manufacturing which we completed earlier this year. New product revenues were 21%, as new products continue to generate good revenue growth for the Endoscopy business.

Now, moving on to Advanced Wound Management. The Advanced Wound Management's global revenue growth of 8% came from good performance in both the U.S., with growth of 9%, and outside the U.S. which grew by 8%. We estimate that the U.S. growth was well ahead of the market growth rate of 6% for wounds, excluding negative topical pressure.

The renegotiation of our silver product licensing agreements in the quarter had two clear benefits. First, the launch of new silver products, which we expect will be a substantial addition to the product portfolio and, second, a change in the cost structure which will have long-term benefits for us.

We've also announced our reorganization plans for our Largo facility, which will see us open our own facility in China and make more use of subcontractors in the U.S. We expect to close the Largo manufacturing facility in 2009. However, non-manufacturing functions will continue to be based there.

Many of you are very interested to hear what we've been doing with BlueSky and our plan for the negative pressure market. I will touch on some highlights, but the more substantive detail will just have to wait for the launch in 2008. We have done a number of things so far. First, we've integrated the business into our Largo facility. Second, we're putting a lot of thought, a lot of effort into how we operate in this fast-growing segment, and have made detailed plans.

And just after the end of the quarter, we signed with United Hospital Services, UHS, as a strategic partner who will be working on our behalf in the acute care setting.

We are making good progress with BlueSky, and I'm sure you'll appreciate the commercial sensitivities that don't allow a lot of detail. But be assured, we are very pleased with this acquisition. Wound's margins were up 90 basis points this quarter; a very good performance.

So, how do we see the quarter overall? I think, to sum it up, this has been a very good quarter for us; a sound performance against some very tough comparators. BHR had its tenth anniversary and is delivering outstanding clinical results, and continues to establish itself as the clear gold standard in Hip Resurfacing.

Advanced Wound Management has started to gain momentum and is delivering balanced growth. And we've made clear, measurable progress with our Earnings Improvement Program. We're clearly focused on delivering long-term, sustainable, profitable growth in this Group. And at this point in time, I will go ahead and open it up for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS). We have our first question from Raj Denhoy with Bear Stearns. Please go ahead.

Hello, good morning, guys.

Yes, Raj, we can hardly hear you, so speak up as much as you can.

Sorry, is that a little bit better?

Yes, that's great. Thanks.

I was curious on the Hip side. Maybe our numbers are a little bit off, but it looks like BHR may have been down a little bit sequentially in the U.S., and I'm curious to see if that is, in fact, the case?

Well, Raj, we're very -- we don't give out actual numbers on individual product lines, which makes it a little bit difficult to answer your question. I can tell you that we're very satisfied with where we are at BHR.

We think we continue to take market share with that product in our Hip portfolio overall, and it's growing. We had -- if you think back, we had a pretty healthy third quarter of '06 with the BHR product. We were in full launch mode at that point in time, so even though we can't give you exact numbers, we're very pleased, and that business is still growing.

Okay, maybe I can ask a little bit then about your preparations, then, for having a competitor on that market? Are you seeing much now at this point, as far as activities on the part of Stryker? Are there accounts now that have started to switch back? And maybe you could just talk about the dynamic that's going on.

Well, we are -- this may sound a little strange to you, but we're so -- we're so busy trying to continue to get this product launched in the marketplace that we're not putting a lot of thought into what some of the other competitors are doing. I think it's clear to say that we will have competitors in the U.S. market.

This is a great technology. It deserves to be in this marketplace. It has a great track record. And there is a long way to go in order to develop this market overall, and I think having multiple competitors is a good thing for the industry.

We -- what our charter is, is to try and maintain the same type of global market shares that we have for the U.S. market. And if we do that, it will be a great success for us, and that's what we're focused on. And I think we're going a long way to establishing ourselves there. I haven't seen any of the numbers that have been reported by our competition so, I guess, when those come out we'll know a little bit more.

Okay, then just maybe one last one on the Knee side. You outlined some of the product initiatives you have there, to hopefully get that business accelerated a little bit. What about on the sales side? Obviously, I think in the past you've mentioned a focus from the sales force on Firming and Hip may have taken a little bit away from the Knee side. Is that still the case, and what are you doing on that side to address the slowness there?

Well, I think it definitely has an impact. I think there are a couple of factors that have had an impact, and we've been trying to be as transparent as we can about this over the last couple of quarters as we've talked through it.

I think the reality of it is that we are taking share in the Hip side, and I think the competitive response is to put more pressure on the Knee side of the business. That's what I would be doing if I was losing chunks of share on the Hip side. I'd be focusing my effort somewhere else, and I think that's happening and -- which puts a little bit of a strain on our sales force. I think that will moderate over time.

And the second thing is, if you think about our new product introductions in Knees over the last year, we've really brought out premium segment products. These are high performance knees, like JOURNEY, and the high performance revision system, like LEGION. And both of those products were initially brought out in OXINIUM, which was a premium material as well.

And us bringing the Cobalt Chrome versions of those products into the marketplace in the third and fourth quarter of -- or the fourth quarter and the first quarter of next year into the marketplace, I think it's going to be a healthy restart for us in both of those product lines.

And I think the third factor is that there might be some things that we can do to put some additional emphasis through our variable compensation plans and measurement systems etc., and those things are hard to change during the course of a year.

You really don't want to change targets for your sales forces during the middle of the year, so we'll be looking very hard at how do we get the right types of behavior to get balanced selling. And that's why we think that we'll start seeing the majority of the impact as we work through our -- work through the first quarter of '08.

Great, thank you very much.

You're welcome, Raj.

Ladies and gentlemen, our next question will come from Michael Junging with Merrill Lynch. Please go ahead.

Yes, good morning, and good afternoon to everybody. I have three questions. The first question is also on BHR, but slightly different. Although I haven't got all the information necessary, it seems that the actual sales, not the sales growth, but the actual sales in the third quarter were less than they were in the second quarter, perhaps, even in the first quarter. I'm just wondering whether you can confirm this.

And then, secondly, on the Earnings Improvement Plan, you've indicated in the past that it's [expanding] margin slightly one percentage point. What price cuts have you reflected for Japanese price cuts in 2008?

Then thirdly, on Plus Orthopedics, you've highlighted in your results today that you're seeing some revenue dis-synergies earlier than expected. With this development, do you still think it's reasonable to expect the 15% revenue synergies which you indicated in your announcement on March 12, 2007 when you bought Plus Orthopedics? Thank you.

Great, well, thanks for those questions, Michael. The first -- the answer to the first question on BHR is, no, we're not seeing lower growth. We're seeing -- we're actually seeing growth in that product line, so I don't know where the basis of the analysis but we'd be more than happy to talk with you offline and try to figure out where the modeling is coming from. So, we're not seeing the same thing that you're implying.

As far as EIP goes, we have factored in the different plus and minuses, the puts and takes, on the benefits and the things that are negative for us in the different marketplaces, so we still expect to deliver the 1% on average per year margin enhancement across the business. So we're not coming off that at all, regardless of what happens in Japan.

And your third question, in terms of revenue dis-synergies is, we're not changing our model, and we're not changing our guidelines, and we're not changing our guidance. We have seen some earlier dis-synergies in Plus due to a couple of different factors. One is just the amount of time that it's taken us to get the contractual obligations behind us in terms of the some of the minority interests etc., which has accelerated some of the dis-synergies that we were expecting.

But as far as our guidelines for overall revenue synergies for that business, we expect them to be the same [in] the same period of time. It's just the phasing, which we said the phasing might change a little bit.

And just a quick follow up. Sorry, can I just confirm that in the third quarter, in the United States for BHR, you sold more in absolute dollar value than you did in the second quarter of 2007?

Yes.

Great. And then, just on Japan again, can you actually tell us what your assumptions are for price cuts in Japan for 2008?

You know what, Michael, I don't think I have that in front of me, to be honest with you. And off the top of my head, I don't want to give you a bad number. So if you -- if you'd give us a ring, we could clearly give you an indication as to where we are on that.

Lovely, thank you.

We now move to Yi-Dan Wang with Deutsche Bank. Please go ahead.

Can you hear me?

Yes.

Sorry, can you hear me?

Yes.

Right, you can? Okay, great, thank you. Sorry about that. I have several questions. First of all, can you tell us what your Hip growth rate outside the U.S. is, please? If you said it and I missed it, then I apologize.

And in terms of, I suppose your Hip business, you've indicated that the business grew by 2% ex BHR in the U.S. So it suggests to us that you're probably not seeing that much pull-through sales at the moment. When do you expect those pull-through sales to come through? And also could you tell us how BHR is performing outside the U.S., where the penetration continues to increase outside the U.S.?

Regarding the reimbursement for joint fluid therapy, if you could provide us with some additional details there on the changes that you're seeing, that would be great. Thank you.

Great. Well, I'll tell you what, I'm going to split this up, because I couldn't write fast enough to get all those questions down, Yi-Dan. Our Hip growth outside the U.S. was 2%.

No, 6%.

2% outside the U.S. And the second question?

Pull-through sales.

Yes. Well, I think the answer on the pull-through sales is no different than what we've been communicating over the last couple of quarters. We think it's going to take longer than we originally expected. And we still believe that, penetrating competitive accounts that we traditionally have not been in is going to be a good thing for us long term, especially with a -- with products like BHR, which is truly a gold standard in Hip Resurfacing.

So it's a little bit tougher, given the fact that our competition really tries hard to defend their turf, especially when we come in and take business on the Hip Resurfacing side. And I think it takes time to build the relationships, and I think those relationships will get built and we will see pull-through. But it's not something that we're counting in large numbers at this point in time.

In terms of joint fluid therapy, I think we are seeing some pricing pressures in general from the competition. There has been some reduction in pricing in the marketplace by some of the competition.

My guess is it's in response to some of the market share gains that we've made over the last year or so, and that clearly is having an impact on the business. And I think also there is at least a question that there's going to be some pressure in the areas of reimbursement, and we continue to monitor that.

We don't have a real good visibility as to what that is, but we thought we would tee it up for the Group here that we think it is something well, it is definitely something that's on our radar.

Okay, in terms of -- just following up on your answers, what sort of price cuts are your competitions making?

And in terms of sales for Hips outside the U.S., why is the growth there a lot more moderate than what we would expect Group -- sorry, market growth rate to be, and how are you doing for -- in BHR? How are you doing with BHR in those markets?

We're looking at --

Is it still trading at the 25%+ level outside the U.S.?

Yes, Yi-Dan, I don't really know exactly the absolute numbers that our competition is -- what they're doing with their pricing. But I can tell you that we are feeling price pressure in the marketplace, and it is our belief it is coming from reduced average selling prices from some of the competition. And if we can get a better handle on that over the next couple of quarters, we have no issue in sharing that.

In terms of the growth of the Hips outside the U.S., hang on a second. Let me look for some -- hang on one second. Bear with me. The market growth was -- yes, we do have some dis-synergies to deal with in terms of the integration with Plus.

In the European market, as you know, we are taking roughly two equal sized businesses and putting them together, and we've talked a little bit about some of the accelerated sales dis-synergies there. And clearly on the Hip side, it's probably more pronounced because they -- Plus was known more as a hip business than they were anything else.

Thanks. I'm sorry, BHR outside the U.S.?

What was the question?

How is BHR doing outside the U.S.?

Yes, I think it's doing well. The -- do you have the exact numbers? Yes, I think it's fairly flat, Yi-Dan, would be the best way to describe it. There is some competition outside the U.S. in the European markets that do exert some pricing pressure in some of the larger markets, and we deal with that on a continuous basis, but I have to say that it's fairly flat.

Great, thank you.

You're welcome.

Our next question will come from Martin Wales from UBS. Please go ahead.

Good afternoon, two quick questions. Firstly, coming back to the U.S. Knees business, given that it sounds like even with these new product launches we'll see a limited impact before 2008, how much longer do you give this business before you think about doing something more radical in terms of returning to growth?

A second question on the Arthroscopy side. Obviously, it's contributed very little to the Earnings Improvement Program, or will contribute very little. Have you revisited the Arthroscopy business on the cost side, and is there anything more that could be done, perhaps, with or on top of the Earnings Improvement Program to improve margins in that business?

Well, we're far from panicking on the Knee side. We think we have an incredibly strong portfolio of products and, at the risk of repeating myself on the factors that we're dealing with, I think they're very manageable but I think they're real.

I'll take our overall growth historically in our Reconstructive business against any of the competitors over almost any quarter over the last five years. And there's always some balance and some decisions to be made about where do you put your focus. And right now I think we're doing the right thing. We're very, very proud of the efforts that are being put in by the, not only the marketing and the launch teams, but also the field sales forces.

So I think there's not a lot of radical movement that needs to take place in our Knee business to strengthen that up. I think that if we --- we have a good plan, I think we will see some good growth and a returnof momentum in that business. And we're very -- we're quite happy with the plans that we have in front of us and we're very happy with the overall growth in this Reconstructive business.

We have been consistently outgrowing the market overall in the Reconstructive business and that is the number that we're shooting for and, obviously, you'd like to have every single piece of your business firing on every cylinder. And that's obviously the goal and we'll continue to work and strive in that -- for that -- in that direction.

On the Arthroscopy, do you want to because I didn't --?

On the Arthroscopy question, you're absolutely right, we signaled when we launched the IP that you saw less scope in Arthroscopy in the other divisions. It really is a function of the history in the way that business has been managed historically. That isn't to say no potential, indeed, you can there's [80] basis points year to date there, driven from manufacturing improvements that they've been making.

But going forward we do see less, and I think that is a function of history and the way that it's been run. In the DOR and Visualization parts of Endoscopy we have consistently informed you -- signaled that those are much less profitable than the Arthroscopy side. And there is potential there although, frankly, it's not one we've yet quantified or clarified specifically. So yes, in summary, there is less opportunity. We said there was. It's a function of history.

But do you see you can do any more than you've currently factored in EIP now that you've had a chance to look at it in more detail?

We haven't crystallized any other specific things, although there are areas we're working on, Martin.

Okay, thank you very much, guys.

We have Mark Mullikin of Piper Jaffray next. Please go ahead, sir.

Thanks for taking my questions. I just wanted to talk more about the U.S. Hip business. Is BHR cannibalizing the total Hip business at this point? And what are your expectations for that going forward?

Well, I don't think it's a different answer than I gave to this question last quarter. It's hard for us to quantify exactly what's happening, because we don't have the granularity of the data in order to quite figure it out yet.

But we do know enough about what's going on in the marketplace to know that there are some -- if what you're describing as cannibalization is somebody who might get a traditional Hip Stem implanted versus expanding the market to the younger, more active patient, I think there clearly is some of that going on. What exact percentage of that is substitution, BHR for a traditional Hip Stem in a 65 year-old patient, let's say, we just don't know exactly what that number is but, clearly, there is a percentage of that in the marketplace, without a doubt.

And it could be fairly substantial. We don't have a clear view of it as of yet. We do know that we are expanding the market. I think you can take a look at the market growth rates over the last five or six quarters and make that same conclusion for yourself, that the BHR introduction is expanding the growth rate in the U.S. for Hips. And that's an area that we're clearly focused on. We want to continue to be involved in segments that expand this marketplace for ourselves.

Do you have enough sales reps in the U.S. at this time, or is it just an issue of how they allocate their time?

The number of sales reps that we have currently is not an issue for us. There's always instances where you wish you had one more here and one less there and balancing it out. But right now that is not an open issue for us, the number of sales reps, so we're happy with where we are. And then that continues to grow.

And then just over on the Advanced Wound Management side, will there be any stocking of BlueSky pumps associated with the UHS deal?

We are not going to give out any details on that business model until we launch it. And I know I sound like a broken record on this, but it's important for us to have a launch that is done in a very disciplined way in order for us to take full advantage of this marketplace.

Okay. I guess what I'm just to get at is whether or not we would expect any lumpiness in the AWM line in '08 as a result of that?

Well, I think the answer is (technical difficulty) we'll let you know when we get to the launch.

Okay, thank you.

Obviously, we can't talk about what lumpiness you might expect because that would be business models implicit in that. So, clearly, I don't think we can say anything more at the moment, Mark.

Okay. Thanks.

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

Hello, thank you. Firstly, on Endoscopy in the Visualization business, obviously, you've just had a number of launches there, particularly obviously with the new HD Camera. Can you talk a little around what benefit those had and how you see Visualization sales maybe moving, both into the fourth quarter and, indeed, next year?

And I'll probably go back -- just back to the dis-synergies in Europe with Plus, can you give us a little more granularity about the timeline that you expect that business -- the European Recon business to move back to, should we say, a more normalized growth rate?

In terms of the HD Camera, Ed, the launch is proceeding to plan. The [team-borer] of the question how we do we see the future of the Visualization business. I think we've signaled to you on several occasions over recent quarters that this area is less profitable, significantly less profitable than the bulk of the Arthroscopy business. And that inevitably makes us think about it. We don't have any significant crystallized plans that are different but we're looking at it for opportunities, as you'd expect us to. I'm not sure there's anything more we can say beyond that at this stage, though, Ed.

In terms of time lines for Plus, I don't think there is any major change from what we've said before. We are going through this period of sales dis-synergies. They are slightly higher than -- we're experiencing now than we'd originally anticipated.

But do not see that as any fundamental issue. That's really just a question as you get down to the absolute granularity of combining sales forces and, as Dave mentioned, and dealing with issues like minorities who could somewhat, unpredictably, slow you up on occasions or Works Council issues in Europe and so on. You just get down to some really quite granular stuff which is a little different from what we expected. But there's nothing that we've come across, nothing at all that we've come across that tells us in the round this thing is different from the guidance we gave in any way, shape or form.

Exact quarter by quarter through 2008, it's too hard for us to predict it, to be honest. We'll just take that as it goes but, fundamentally, this acquisition is going absolutely fine and we're very, very pleased with it.

Okay, thank you. And just a quick follow up. One of your competitors, obviously, [from] the DOJ investigation was talking about rather large fees that they were going to be paying for around consultancy, around dealing with the settlement and I take it that you aren't seeing that kind of cost around the settlement?

Yes, we are in discussions with our monitor now about exactly how much time he and his firm are going to spend on things. I think it would be unwise of us to pre-judge the outcome of those discussions. And obviously, on top of that, there are some internal costs for ourselves. Not really so much in changing our practices, which are very close indeed to the ones that the settlement requires, but there is a number of process changes that obviously are imposed upon us.

So, we -- it will be silly for us to pre-judge, working that through in the monitor which we're doing in a very positive way. I think, however, we can say that we will be very surprised if we ended up with numbers of the size that Zimmer apparently indicated on their call.

Okay, thanks.

The next question will come from Michael Matson with Wachovia. Please go ahead.

Hello. First of all, I think you'd mentioned you had $2m in BlueSky revenue. Is that correct? And I assume that's from NPWT sales domestically, or internationally or --?

Yes, we had $2m. Yes, it is overwhelmingly in the U.S.A.

Okay. And then in your Clinical Therapies business, your EXOGEN product, it sounds like that really outperformed the other product there. The growth of that, I assume, was well above 15%. Is that a fair -- the overall growth of that category. Is that a fair assessment?

I'm not sure if I'm answering your question exactly but, certainly, we took significant share in long bone stimulation in the U.S. with EXOGEN, no question about that.

Okay. And are there any plans to ever try to enter the Spinal Fusion market with your EXOGEN technology?

Well, I'm not sure we're ready, or willing, or even able to comment on that question at this point in time. I -- let me take it from a different level, because this is something that's been asked of us pretty consistently, and that is our interest in the Spine business in general.

I think that we're always looking for high-growth, segments especially ones that have strong adjacencies to the ones that we're in, in order to compete in. And it's one of the reasons why we went into Topical Negative Pressure, for instance, because we felt like we had a right to win in that marketplace, given our access to the large Wound Treatment market.

And I think the same thing goes in Spine. Spine would be a great market to be involved in. I think I've said that pretty consistently quarter after quarter. The key for us is how do we do it? And then what technologies do we bring to the table and how do we distinguish and differentiate ourselves in that marketplace. And it's an ongoing investigation for us.

We are quite interested in the Spine market in general; it's a high-growth segment. It's an area that would be very natural for us to be a part of. And as far as actually entering into the Spinal Stimulation market, I think that's a little bit of stretch at this point in time. We think more in terms of how do we get into the market in general.

Okay, that makes sense. And then, can you give some clarification on the reimbursement pressures that you were talking about? Do you see that as more of an outside U.S., a European issue, or do you see coming pressures in the U.S. as well?

In what segment are you referring to?

More, I guess, in the Recon side.

I don't think there's been a substantive change in the pricing environment. I think this is something that we've been debating and it's better played out in your analysts' reports amongst yourselves as to how you evaluate what is going on in this marketplace.

I think it's the same debate we've been having for the last year and a half. There are healthier systems around the world that have price -- that have pressures on them. I think its incumbent on us to develop clinical products that not only give great clinical results, but have an economic benefit as well.

And I think that if you look at products like BHR, yes, it's a premium priced product, but if you can get a 40 year-old productive person back to their job, it's actually a very, very cost effective way to deliver healthcare in a system if it can be captured properly. And that's what we're trying to do. We always look at our products in terms of the economic value and the economic benefit, and we will continue to do that.

Will there be pricing pressures? Sure, absolutely, there will be. And I think the majority of the pricing pressure is going to come in those commoditized -- quote, unquote, commoditized-type products, the traditional Hip Stem, the traditional Knee products or whatever. And that's one of the reasons why we work so hard at innovation and so hard at expanding our marketplace to the high-value areas that are outside some of those traditional areas.

Products like JOURNEY DEUCE the bi-compartmental Knee System, the high-performance Knee, the BHR, and the list goes on and on. These are products that we talk about all the time. We don't talk about our standard products that do have the majority of the pricing pressure associated with [us]. It's a model and a business plan and a strategy that's been working well for us and we're going to continue with it.

Okay, and then just one last question. On your Knee business you mentioned that you're launching Cobalt Chrome versions of the JOURNEY and LEGION, so I assume that you haven't had this out before. Is there any risk that there could be -- I assume those will be cheaper than the OXINIUM version, so is there a risk that there could be some negative mix shift there?

Well, I think that -- we're not worried about it, I guess is the simple answer. We need to have a more price-competitive version of those leading products. We have products that have wonderful performance characteristics associated with them. They're being well accepted, but they're pricey. Not only are they high-performance products, but they also are made in a material that's very expensive to produce.

And the plan was always to get the brand introduced at those premium levels and then bring in the other products as well. This is not something that we've reacted to; it's something that was planned all along. And I do think it is going to reinvigorate our business on the Knee side. I think not everybody is going -- believes that a super premium product is the appropriate product in 100% of the cases. And in those cases where they're looking for a more cost-effective option, we're at a disadvantage. So we won't be at a disadvantage any more.

All right. That's all I've got. Thanks a lot.

Thank you.

The next question will come from Steven Lichtman with Banc of America. Please go ahead.

Thank you, good morning, guys. A few questions. First of all, on Hip Resurfacing, now a little over a year into the U.S. launch, any change in views on the market opportunities here? Do you still see it as a 10%+ of the market over time, or more than that now? Do you think that you took some initial pent-up demand and now it's more incremental? Just your qualitative comments would be great.

Steven, I really don't think there's anything that leads us to start predicting that it will be more than 10% to 15% of the marketplace. I think that it would be a pleasant development if it happened, but we're too early in the penetration of this product in this marketplace in the U.S. to really predict anything more than penetration rates based on some historical data that we've seen in some of the other developed countries. So I think we're sticking with that number. I think that's a good number to stick with at this point in time.

And in terms of the early experience, do you get the sense there was this big pent-up demand that you've worked through, or are working through and it may be a little bit more incremental from here?

On BHR.

Yes, just actually on this question, actually, Michael asked a very specific question earlier about sales levels, and I think we may have slightly confused you in the answer. Because there is no question that quarter three's sales in BHR was substantially above quarter one, but they were in fact in absolute terms in the U.S.A. slightly underneath quarter two because we got the holiday effect of having particularly August and parts of July in that. So just the absolutely factual question go back to Michael. But in terms of [boldness], no, [they are absolutely right].

Okay. And then you were commenting earlier about whether this is a market substituting or expansion. It is fair to say early on this has, certainly, been more substitution for you guys, because you mentioned that your ex-BHR sales were up about 2%. Is that fair early on here?

Yes.

Yes, that is correct.

Okay. And then on the Knee side, as you roll out the cobalt/ chrome here, any concern about mixed messages, OXINIUM versus the Cobalt Chrome? How are you going to pitch this, so to speak, to your customers in terms of why they should -- why they still should purchase the OXINIUM?

I think it will be dead simple. We have, in our other product lines like Genesis 2 etc., we have both OXINIUM and Cobalt Chrome versions and our sales force is quite used to selling the whole value range. There are different benefits. One is a benefit in terms of wear characteristics and the other is the benefit in the knee design in general. The benefit of that is it's an anatomical knee, it's a high-performance knee, it's a natural-feeling knee. So, it's a choice by the surgeon. If he has an older patient who -- he feels like the wear characteristics of OXINIUM don't warrant it, then they have an option to put in the Cobalt Chrome. And I think our sales force is very adept at doing this.

Okay. And then also on the Knee side, any anticipation of doing an [ATC] campaign for the new gender indications, or is this going to more for something for your surgeons to have in hand as they discuss with patients?

The latter at this point.

Yes, and then one more on the Hip side, and then one on Endo. On the Hip side, is it fair to say that you don't believe you've gained market share -- primary market share as a result of BHR? In other words, bringing over a doctor and having them now become, quote, unquote, Smith & Nephew doctors in total beyond just the Hip Resurfacing procedures? Do you think you have not done that yet?

I don't know what the new definition of primary market share is. We're gaining market share. And you know what, wherever it comes from we're happy to get it. It's nice to come in our direction. I think to slice and dice it that way, for us, isn't helpful. It's a total market out there, we're going to try to address it and that's what we're doing. Yes, there's some substitution in this and that, puts and takes. But when it's all said and done the market grows X percent and we're taking share, and that's what we're all about.

Okay, fair enough. And then lastly on the Endo side, Adrian, just your commentary about the fourth quarter. If you can revisit what you mentioned. You were saying something about the comps, you said the fourth quarter comps are tougher here. Is that what you're referring to?

Yes, it was quite simply that.

Okay. And are they any tougher than they were in the third? I thought they were about the same, or is it a little tougher? Maybe I'm incorrect.

Certainly, where we've got them, they're a little tougher. Particularly --

In Endo?

Yes, in Endo.

Yes, they were much tougher in Q3.

Okay. I can follow up. Thanks a lot. Thanks, guys.

You're welcome.

Moving now to Jason Wittes of Leerink Swann. Please go ahead.

Hello, thank you very much. First off, in terms of the DOJ charges relating to the monitor, I understand that you're still negotiating, but should we assume that this has any impact on your EIP program? Or is that already priced in whatever impact might be, especially given the ranges that you're at least discussing right now?

I don't think this number should be a major focus for you guys in putting your spreadsheets together. It's clearly going to be a number --

(Inaudible) at this point in time we do not believe it's going to impact what we committed on earnings improvement. And if it changes, we'll clearly indicate that. But we do not believe -- we had some estimates in our models and we were expecting to absorb them. Given some of the press that we read as well, if something changes, which we don't expect it too, then we'll communicate it as quickly as we can.

Okay.

We're going to have to probably take one more question because of timing here on this end. We're all catching airplanes, so we'll take one more please.

Certainly, sir. The last question will come from Hans Bostrom from Goldman Sachs. Please go ahead, sir.

Good afternoon, gentlemen. I had a couple of questions, if I may. First, relating to Adrian's comment on the Visualization and Digital OR business, am I hearing that you are considering disentangling this business from the Company, or was that a complete misunderstanding on my part? And if so, what type of evaluation horizon do you have for that?

Secondly, if you could repeat what comment you made regarding the fourth quarter EBITDA margin. Was it the case that that wouldn't improve on the last year's fourth quarter? Just a check on that.

And then lastly, if you could comment on how you've seen pricing in the United States develop for BHR in the course of 2007, that would also be very helpful. Thank you.

Yes. It's Adrian. Yes. In terms of the Visualization DOR, we were simply referring to the fact that the question was in response to where do you see margin opportunities in Endoscopy. And we're pointing out that there is -- when we launched EIP we said that the Arthroscopy margins we had we felt were quite good ones, due to -- the way the business has been managed historically. So we saw limited opportunity there, other than the manufacturing program they were then embarked upon.

But within our DOR Visualization business the margins were much lower and, therefore, it was an area we're obviously giving attention to. And there is really no more to it than that. We are giving attention to it. There are a number of options. Nothing's crystallized yet. No more comment than that, Hans.

But are there any cross-selling benefits between the two? That is what I thought was part of the strength of the digital operating room concept.

Absolutely, that's part of the complexity of it. And therefore when one looks at margins one has to take those sort of things into account. You shouldn't read any more into the comment than that, Hans, really.

In terms of your second question on what did we say about Q4 EBITDA margins, really just, yes, we were I think reaffirming our -- the longer-term guidance of around 1%, or at least 1% per annum -- on average per annum, pointing out that we are ahead of that year to date and pointing out that we have a strong quarter four margin comparative. And, therefore, exactly what it will be in [quarter] four I can't predict but you need to be more -- it needs to be significantly lower than the gains year to date. Exactly what it is, Hans, I don't know. I'm not going to stick to within fractions of a decimal point.

And then, I think you were asking about price evolution on BHR in the U.S.A. as your first question. And yes, I think it's as you would expect. We started off with some pretty robust pricing. We signaled then that we wouldn't expect that to stay at that high level forever. And the exact way that's evolving over time and how it will evolve with new competitors on the market, we will have to see exactly, frankly. But we've been quite clear it isn't going to go up.

But are we talking about the double-digit percentage change downwards on pricing from first quarter to third quarter, or is it less than that?

We're not talking about in very precise terms, Hans, for reasons I'm sure you can understand. But you can imagine that in the mix there's prices not moving favorably, let's say. And that -- we expect that to continue to be the case going forward, and that should really come as no surprise.

Okay. Thank you.

Great. I'd like to thank everyone for joining us today. We are going to sign off at this point in time. Thanks for all your attention, and have a great day.

Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect.