Smith & Nephew PLC (SNN) 2010 Q4 法說會逐字稿

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Well, good morning, and welcome, everybody. Before Dave and Adrian take you through the full-year results, I thought in the light of the other announcement this morning that I should say a few words.

You've seen the announcement of the succession, CEO succession at Smith & Nephew, and the announcement of Dave's retirement. The Board is very sorry to see Dave go. Some evidence, I could go much beyond this, and that might come out in questions you have, but this is what's been happening under Dave's tenure as CEO.

Just to highlight one point, our earnings per share, 13% compound over four years, and we all recall this was probably the most difficult business environment any of us have been through. This is a stunning achievement, and not at the expense of growth. What Dave leaves behind are platforms for growth, both at the business level and a wider geographical footprint. Dave's nine years at Smith & Nephew have been characterized by a customer-oriented approach, and of course aimed at creating shareholder value. You can see from those numbers the compounding of value under his tenure has been excellent.

But Dave's also evolved the culture of the Company, deepening the innovative skills that are so essential, and you'll hear more of that later, but also the focus on efficiency, efficiency not as a program but as a deeply embedded process, in order to fund future growth opportunities.

So we thank Dave very much. And we'll have lots of time for celebration and wish him well for the future.

But looking to the future of Smith & Nephew, of course, we're delighted to recruit an excellent successor from the healthcare segment. Olivier Bohuon, who has worked with GSK and more recently with Abbott in the States for a number of years, running their pharmaceutical business, is an impressive healthcare professional. His leadership skills, together with the team that Dave has created, the foundations for growth that have been established, we are very excited about.

The underlying foundations of this industry and the segments we're in are of course enormously powerful, those demographic trends now expanded into the emerging markets. That, with our skillset, the leadership team that's been developed and the products coming through, make us very excited. So we look forward to introducing you to Olivier in due course.

With those few remarks, let me pass it over to Dave and Adrian. Thank you.

Well, thank you. I did have a little bit of a nightmare last night. I kind of woke up in the middle of the night thinking that I had arrived here this morning, it was just me and the sound guy; no-one else was here. So I'm glad to see that you all made it in.

First of all, we'll obviously make a couple of comments later on, but I do want to focus on the significant achievements of this Company in the last quarter and the momentum that we have going into 2011. I'll go ahead and run through those and we're going to go through the normal process. And then I'm going to hand it over to Adrian, to take you through the numbers. And then I'll come back and talk about our industry, our strategy, and give you some details about how we're planning on delivering on our strategy in 2011.

So, starting out with the financial -- with the highlights for 2010 and Q4, 2010 was a very, very good year for us. We gained momentum in the second half of the year, as we had forecasted and expected, and ended with a very strong finish, having generated revenues just shy of $4b. And that represented 4% growth for the year. Our focus on our customers and on innovation paid off, leading to our out-performance of the market.

Now, the fourth quarter was particularly strong for us pretty much across the board, with revenues of over $1b and 5% average daily sales growth. Now, I'm going to talk a little bit about average daily sales throughout the presentation, and it's because we uniquely had a significant fewer number of sales days in the fourth quarter than we had in the previous year.

We have delivered on our commitment to strengthen our margins across our businesses, as all of you are aware. And we've done this in the toughest market conditions that we've experienced for many years. And we've done it while increasing our revenues, with the majority of our businesses outperforming their respective markets. And at the same time, we've made major investments in our businesses. We achieved this by developing a culture capable of using efficiency to free up resources, which then allows us, the management team, to make high-quality decisions and investments for sustainable growth.

As a result, we generated a margin of 26% in the quarter and 24.5% for the year, giving us the flexibility to make choices that optimize investment with return and growth. Our adjusted earnings per share were $0.736, an increase of 12%. And we are proposing a final dividend of $0.0982, which is in line with our longstanding policy, an increase of 10%.

We generated over $500m of free cash in the year, reducing our debt to just under $0.5b. And we reorganized our banking facilities at the end of the year.

Now, let me move on as we look at the business highlights for the year, and starting with Orthopedics. Our Knee business ended the year with phenomenal momentum. For the year, our Knee business outperformed the market and saw revenues grow by 5% and had an extremely strong fourth quarter, with 9% growth in the US and 4% globally. Our Trauma business continues its steady performance and has improved consistently throughout the year.

In Endoscopy, we maintained our strong momentum while we reshaped our US sales force. Emerging markets was again a very bright spot in this business. It is notable that Sports Medicine Repair had double-digit growth for the year as well.

In Advanced Wound Management, we have consistently grown revenues above market and have seen our ongoing investment in Negative Pressure Wound Therapy pay off, as that business has developed momentum and made a substantial contribution to our overall growth. In emerging markets, this is a growth engine for us. It's seen excellent growth and we continue to invest in several high-potential geographies.

Overall, this year, we've seen the benefits of having a balanced business, balanced geographically and balanced across a number of market segments. Our developing businesses are complemented by established ones, giving us the ability to make choices about where to invest. And this year we had a substantial program for that growth. All in all, a real good finish to the year.

All right. Well, let me take a look at each of the businesses in turn, and this time I'm going to start with Advanced Wound Management. I usually start somewhere else. I'm going to start with Advanced Wound Management. This business has clearly been transformed in the last four years and continues to deliver significant value to the Group.

Four years ago, this business was an issue for us. Its revenues reflected its product range, and its approach to customer service and its margins reflected a lack of focus on value and efficiency.

So we made some changes. We made some management changes. We invested some money. And we focused the business on efficiency, innovation and outperforming the market. And the management team responded brilliantly by rejuvenating product lines, introducing new products, such as ALLEVYN AG and GENTLE BORDER, entering the Negative Pressure Wound Therapy market and establishing a market presence so that in a very short period of time we have over 5% market share with a continued strong growth trajectory.

The investment in Negative Pressure Wound Therapy has involved the development of products, sales channels, logistics, manufacturing, legal, regulatory work. This is a major effort and a highly successful one.

We also turned our attention with the establishment of global operations -- our global operations team to production efficiencies. As part of this, we closed the factory -- our Wound Care factory in Florida and opened up our new factory in Suzhou, gaining substantial margin benefits in the process. We think that the team has done a great job and I congratulate all those involved.

So let's look at Wound Care in a little bit more detail in 2010. We grew our revenues by 7% in the year, nearly double our estimate of the global market growth rate of somewhere around 4%. In the fourth quarter, our Advanced Wound Care business performed well, very much holding its own in tougher conditions, and when combined with the Negative Pressure Wound Therapy business grew revenues by 7% in the quarter, well above the market rate.

Negative Pressure Wound Therapy had another fantastic quarter, driving revenue growth in all geographies, and now has a revenue run rate of over $100m. And that's from nothing, zero, in 2006. Margin performance for the quarter and the year was substantial, and we're very pleased with the margin for the year as a whole. Again, before I move on to Orthopedics, I'd just like to thank all the people in the Advanced Wound Management business who have created this great success. My thank you and my congratulations.

So, moving on to Orthopedics, in Orthopedics market conditions were pretty much as we expected, and I think pretty much as all of you expected. A bit softer throughout the year. In the medium term, we do know -- we do believe that demographics will continue to drive this market, that we believe also that the number of patients that are waiting for procedures is still present, and we also are seeing volumes grow and strengthen.

I believe we have managed within these market conditions pretty well. We have innovated with products like VERILAST, our knee with an FDA-cleared 30-year wear claim that has clear clinical evidence demonstrating its longevity. And consequently, patient and healthcare systems benefit. Also VISIONAIRE, which speeds up surgery, provides better patient outcomes, takes costs out of the procedure. Innovations such as these have generated mix benefits for us, which have broadly offset the pricing pressure of 1% to 2%.

In the last quarter, however, we saw significant volume growth in knees and also in traditional hips. While our Hip business overall continued to be impacted by lower BHR volumes, our traditional hip range has continued to outperform the market.

The performance of our Knee business this year has been truly great. We've outperformed the market in Q4 and for the year. We have some great new products, VERILAST, as I mentioned earlier, and VISIONAIRE, our patient-specific cutting blocks. We've now completed, by the way, over 10,000 procedures using VISIONAIRE. These two products have driven our US Knee revenues up 7% in the year and 15% average daily sales growth in the quarter.

Against the backdrop of competitive products being withdrawn from the market and a continuing debate over metal on metal, the recent Australian data clearly shows the great long-term performance of OXINIUM. And this, combined with the excellent clinical data for BHR, gives us continued confidence for our Hip business going forward.

In Trauma, Trauma has grown every quarter this year, and ended the year with 10% growth in the quarter and 3% for the year, a good performance as the improved quality and tenure of the sales force delivered positive results. And we approach market growth rate in that business. It's great to see the positive results now being consistently achieved, quarter after quarter, by the management team.

We continue to provide focus to the way we manage our inventory and instrument sets in the field. This is a longer-term program and its value to the business is critical. We've made some good progress, and we have a lot more to do. We expect to see the continued benefit of this over the next few years.

As a final note, Orthopedics increased its trading margin by 130 basis points in the quarter and 60 basis points for the year, as it benefited from manufacturing improvements and expense controls.

Now I'm going to go ahead and move on to Endoscopy. Our Arthroscopy segment grew by 9% in the full year and 8% average daily sales in the quarter. Capital equipment revenues have reduced to 13% of Endoscopy revenues, as we continue to align our capital products with the segments that we actually are serving most aggressively in Arthroscopy.

Emerging markets has historically been a very strong performer in the Endoscopy business and this year was no different, as our investments have paid off, and we finished with a particularly strong Q4, growing revenues outside the US and Europe by 14%.

It was great for me personally to be at the global sales meeting in Florida recently, just last month, and to see the sales rep from Beijing win the global sales person of the year award for 2010. This is a clear sign of the energy and the traction that we are now getting in our emerging markets.

While knee and shoulder products, such as FAST-FIX and OSTEORAPTOR continue to drive the repair business to double-digit growth, DYONICS RF drove resection to mid-single-digit revenue growth for the year.

Hip arthroscopy is a market that we have created. We've developed it and we are leading the way. We have a clear market leadership position in this segment. Our revenues continue to grow strongly from a small base, and are an increasingly important part of Endoscopy's revenues. Endoscopy's margins were 60 basis points lower for the year, a reflection of our investment in new products and our sales channels.

So, moving on, how do we see 2010 as a whole? In summary, against a backdrop of challenging market conditions, we delivered overall revenue growth of 4%, and at the same time strengthened our margins and made some pretty big investments in the year, a balance that we're quite proud of.

We've achieved much in our revenue growth in 2010. Advanced Wound Management has outperformed the market and Negative Pressure Wound Therapy is gaining real momentum. Reconstructive Orthopedics has used innovation and clinical data to dramatically offset pricing pressure and drive real revenue growth in this business. Trauma has grown its revenues every quarter of the year. And our Sports Medicine business grew at 9% for the year.

We've improved our working capital. We've improved our cash management. The efficiency improvements that we committed to four years ago has not only been achieved, but we've also made the necessary culture changes to sustain this and invest for the future.

As I change places at the podium with Adrian, I will leave you a bit of an eye chart as a backdrop, with a few of our achievements in 2010. Adrian?

Well, thank you, Dave, and good morning, ladies and gentlemen.

If you can turn firstly to slide 15 and the income statement, as you can see, revenue in the quarter was just over $1b. This represents flat underlying sales, after adjusting for exchange rates on quarter four last year. There were of course four fewer sales days in quarter two (sic) this year. We estimate that average daily sales were about 5% higher than in the corresponding period.

Trading profit in the quarter was $278m, underlying growth of 9%. The reported trading margin of 26% was 220 basis points higher than quarter four last year.

For the full year, underlying sales grew at 4% and underlying trading profit grew at 11%. Full-year trading margin was 24.5%. This benefited, as you know, from a $25m accounting gain in respect of the purchase of Blue Sky. Adjusting for this, the full-year margin was 23.9%, a 120 basis points increase. Interest costs are down on last year, reflecting both the lower debt and the lower interest rate.

Turning to the next slide, slide 16, and moving further down the income statement, the tax charge for quarter four was 28.6%, giving a rate of 30.8% for the full year. The tax charge in quarter four last year was reduced to 25% and for the full year to 27.9%, as a result of the favorable settlement of some tax disputes.

Adjusted earnings per share in quarter four were $0.216, an increase of 6%, slightly lower than trading profit growth, principally due to the lower tax charge last year. Adjusted earnings per share for the full year were 12% higher than in 2009.

Turning to the next slide, slide 17, an analysis of revenue by business segment. You've heard from Dave on the progress of each business. This schedule gives the growth rates in the quarter to which Dave referred. As there was an unusually large difference in the number of business days, year on year, in quarter four, we've also shown our estimate of the growth in average daily sales in the column headed ADS on this slide.

The adjustment is relatively straightforward in the Ortho and Endo businesses, as fewer business days translate reasonably directly into fewer procedures and fewer sales. We estimate the four fewer sales days equates to about 6% sales growth. In Wound, where we sell mostly to wholesalers, the translation is less direct. We estimate the business grew at an effective 7%, 3% higher than the reported growth. As we mentioned in previous quarters, the Orthopedic growth rate was also reduced by 1% by the discontinuation of the Spine activities.

In quarter four, the value of the US dollar was similar, year on year, against the average of the currencies in which we operate.

Turning then to the next slide, 18, and analysis of revenue growth rates by business and by geography. As well as the numbers on this slide, we will also refer to the growth rates of our main product types, which are included, as usual, in an appendix. These numbers are not adjusted for the number of sales days unless specifically stated.

Market conditions across our businesses continued in line with our broad expectations for this stage of the cycle. We saw no major change from earlier in the year in the United States, with continued modest price pressures offset by mix and with volume demand solid. In April -- excuse me, in April -- in Europe we experienced tightening market conditions, with an increase in the impact of governmental austerity measures across the continent. In the rest of the world, we saw similar pressures to earlier in the year in the more developed economies, and continued buoyant demand in emerging markets.

At constant currency, sales in our Orthopedic business in the quarter were down 1% on quarter four last year, before the ADS adjustment. Knee sales grew at 4%, Hips were 5% lower, Trauma Fixation grew at 4% and Clinical Therapies declined by 12%. Across Orthopedics, we saw price pressure in line with the previous quarter. Like-for-like price reductions were steady at about 2%. We again achieved positive mix, offsetting the price reductions. Adjusting for the sales days, we believe this was market-leading growth in Knees, slightly above-market growth in Trauma and market growth in Hips.

We saw demand for our knees strengthening during quarter three, especially VISIONAIRE knee cutting blocks and VERILAST total knees in the United States. This continued through quarter four, and strengthened our Reconstructive growth.

Sales of our traditional hips grew at above the market rate, with another strong performance from R3. But as discussed in previous quarters, however, total Hip growth was held back by continued headwinds for our BHR product, caused by the broader discussion around metal-on-metal implants. BHR sales accounted for around 15% of our Hip sales worldwide. BHR sales continued to be strong in the larger, more specialized higher-volume hospitals, and we remain very confident in a strong future for the product.

Continued focus on operational delivery allowed us to show a further steady improvement in Trauma. In Clinical Therapies, EXOGEN continued to perform well, with positive trial data driving sales in several countries. SUPARTZ continued to be under pressure.

In the United States, overall Ortho sales were 1% lower, an excellent performance. US Reconstructive sales were up 2%. Growth in our US Knee business was strong at 9%. US Hip sales were 6% lower. Trauma Fixation sales in the United States were down 1%, and CT sales in the United States were down 10%, a decline of 6% excluding the impact of the small Spine disposal.

In Europe, Orthopedic sales were 4% lower. We saw a solid performance in a weak European market, offset by some weakness in BHR. The exit from the Spine business reduced European growth also by about 1%.

In the rest of the world, Orthopedic sales grew by 3%. The positive underlying trends in the emerging markets continue, and economic pressures continue to be evident in Japan and Australia.

Sales in our Endoscopy business were flat before the ADS adjustment. Arthroscopy sales, which include both repair and resection, grew strongly again at 2%. Visualization-related sales were 12% lower. This reduction is in line with our strategy to focus our capital sales more closely on equipment related to our Arthroscopy activities. Visualization sales accounted in 2010 for about 13% of global Endo sales.

Sales in Endoscopy in Europe were 3% lower before the ADS adjustment. This represented a weakening from earlier in the year, and was due to the increased economic pressures. Endo sales in the rest of the world were again strong, with good growth in emerging markets.

Wound sales grew by 4% in the quarter, again before the ADS adjustment. We continue to see clear signs of good progress with NPWT. Total Wound sales grew 7% including that ADS adjustment, and of this NPWT sales contributed 5%. We saw weak non-NPWT sales growth in Europe, again due to economic pressures. In the United States, sales growth of 17% was boosted by an increase in the level of inventory in the wholesale chain, but still represented a steady underlying improvement, led again by further strong NPWT growth.

Turning to the next slide, slide 19, and this shows the usual analysis of trading profit by business segment. As we've already noted, the reported trading margin for the Group was up 220 basis points in the quarter, and by an effective Blue Sky-adjusted 120 basis points in the full year.

In Orthopedics, margin increased by 130 basis points compared to quarter four last year and by 60 basis points in the full year. And, very importantly, focused work is continuing to capture the significant opportunities available to improve further the efficiency of our field processes.

As signaled in previous quarters, the Endo margin decreased by 190 basis points in the quarter and by 60 basis points in the full year. We have been investing in the substantial opportunities in our Endo business, and we plan to continue to do so in 2011.

In Wound, we again saw a significant 830 basis points increase in the margin. We continue to benefit in particular from the lower costs in our China factory. And in this quarter the year-on-year increase also reflects heavy NPWT investment in the comparative period. For the year as a whole, the reported Wound margin is increased by 280 basis points by that Blue Sky accounting adjustment, which will of course not be repeated next year. Investments in NPWT, including in legal costs, continued to impact the Wound margin.

Turning to the next slide, slide 20, and the cash flow statement. We had another good quarter of cash generation, with $150m of free cash flow in the quarter. We continue to make steady progress in improving the efficiency with which we use our inventory and instruments.

Restructuring spends continued in line with guidance and are now small, as we come to the end of the programs announced four years ago. We include, as usual, analysis of the total spend on the restructuring programs in an appendix.

Net debt decreased to below $500m in the quarter, as a result of the free cash flow generation.

Then, turning to the next slide, slide 21, and the last slide in this part of the presentation, the outlook for the next 12 months. As you know, it is our policy not to give numerical guidance on the outlook, but to focus on revenue trends compared to the market and on efficiency and investment plans.

In the Orthopedic area, Reconstructive and Trauma together, we believe that underlying global market growth was the same in quarter four as in quarter three, at 2%.

Within Orthopedic Reconstruction, we expect continued strong momentum in our own sales, driven by recently launched products, especially VERILAST and VISIONAIRE, and by continued focus on operational performance. We expect to grow faster than the market over the next 12 months.

Within Orthopedic Trauma, we made substantial improvements in 2010 and we are committed to sustaining this performance.

Within Orthopedic Clinical Therapies, we expect competitive pressures to continue. The discontinuation of our Spine activities reduced total Orthopedic sales growth by 1% in the quarter. We expect a similar impact in quarter one, before this annualizes in quarter two of this year.

Within Endo, we continue to expect to grow ahead of the market in Arthroscopy.

Within Wound, we continue to expect good progress with NPWT to push growth ahead of the market.

With regard to margin, as already mentioned, we continue to see significant efficiency improvements in especially our field-based activities in our Orthopedic business.

We also continue to see significant opportunities to invest for growth in new geographies and in new products, and intend to take these opportunities. We also continue to see modest price pressures through this stage of the cycle, as western governments deal with their large deficits and borrowing.

In the short to medium term, we expect our efficiency improvements, including the impact of that modest price pressure, will broadly match our additional investments. We do, of course, continue to expect some variation in margin, quarter on quarter, depending in particular on the timing of investment.

And please, again, remember that $25m credit from our Wound business arising from the acquisition of Blue Sky, equivalent to 60 basis points of margin, will not be repeated this year.

We expect amortization of acquisition intangibles to continue at about $9m a quarter. We expect net interest costs to continue to fall, as net debt declines, though our new borrowing facility has a slightly higher cost than the one it replaced. We include a summary of the new facility in an appendix. We expect other finance costs to continue at about $2m to $3m per quarter.

We expect a tax rate for 2011 similar to 2010, at around 31%. And we have, as usual, included in the appendices a table setting out the number of business days in each quarter. And if focusing on the next quarter, please do remember that the Blue Sky credit fell in quarter one last year.

And with that brief look at the outlook, I will hand back to Dave.

Okay. Thanks, Adrian. In the last few minutes before we go to Q&A, I'm going to talk about our ongoing strategy and our plans for the year.

In 2010, our strategy clearly drove market out-performance, improvement of our margins and helped us increase our generation of cash. At the same time, we made substantial investments, as I talked about earlier, including China and Negative Pressure Wound Therapy. We now have a strong base from which to move into the next phase of growth, and our consistent strategy supports that.

For example, last month in Fort Lauderdale, we held our annual leadership conference, where we bring our top 100 leaders together to talk about strategic issues for our business. And we worked for two days to challenge our approach to innovation, in line with our strategy in 2011. I left that conference very excited about our people, the high level of energy in the business and our plans for 2011.

I'd like to share with you just a few of the plans on the investment agenda for 2011, and I'll start with Orthopedics. First, we are leveraging our strengths across the Company. One of the examples is we're linking our SUPARTZ marketing with the 'Rediscover Your Go' campaign in Reconstructive Orthopedics, giving us a broader and deeper presence in the market for knee repair. We formed a series of cross-functional 'Tiger teams' in the business, to work on new product development. And we already have a new cross-linked polyethylene product in limited launch as a result of that effort.

Our VISIONAIRE and VERILAST will continue to be the core of our efforts in the knee market, as we look at options to extend some of the benefits of those technologies into our hip products as well.

Our continued focus on margin includes the rollout of LEAN manufacturing principles to 100% of our factories, from Memphis to [Arrou] to Beijing. And we have nearly finished our Orthopedics head office, our brand new Orthopedics head office within Memphis, to improve the services specifically that we offer to our customers.

In Endoscopy, we have an in-house new product incubator process called INVENTURES. And this is intended to drive a very quick process of turning customer feedback into new products, literally within 24 hours. We're starting the development of new products for China and other emerging markets, to fuel growth in these regions. And last year we appointed a new head of Healthcare Systems. He's now built a team that is winning contracts for all of our businesses across the US. Our customers love this service, and we will continue to work on expanding this program in the current year.

In Advanced Wound Management, Negative Pressure Wound Therapy will be a continued area of investment for 2011, particularly as we know that less than 5% of acute wounds are treated using NPWT technology. We are now poised to capitalize on our success in this segment, and we are working on new products to meet the ongoing market demand for not only growth but for choice.

We strengthened the emerging markets management team. And we did this specifically for Wound Care in 2010 and this is going to help drive our growth in 2011, as well as are additional investments in Europe.

The outlook for the business is certainly strong. In terms of the market, we know that Healthcare Systems are under pressure. And in the short term, we expect market conditions to be much the same as they were in 2010. We are certainly not immune to the market factors, but we do have the products and the people to help us to continue to outperform, as we did in 2010. And at the same time, we expect that demographics will continue to drive underlying demand for the foreseeable future.

The sales momentum that we generated in the second half of 2010 gives us great confidence that we will continue to grow in 2011 and beyond. Although austerity measures may affect us in some of the developed markets, this will be in contrast to stronger emerging markets, where we see significant growth prospects.

We do believe our continuing work with customers to identify and then meet their needs better, faster and more economically than before differentiates us, and is helping us win in markets around the world. I'm also sure that we have the right disciplines in place, and more importantly the right people in place, to deliver on our strategy. The investments that we have made in the last few quarters are paying off now, and our improvement in margin is giving us the ability to invest for the longer term.

We certainly had more challenges than we expected in 2010, but the real momentum that we have and the many investment opportunities that we plan to execute on in 2011 gives us confidence in our business moving forward. Our target four years ago was to create a company with a culture of efficiency, market out-performance and investment for growth. I think we've achieved this, and are very excited about the opportunities and the ability Smith & Nephew now has to increase investment and growth for the future.

With that, John, Adrian and I will now take any questions that you have. We're going to use the -- I guess we have both the questions from the floor and also questions from the telephone, so we'll take a couple of questions from the floor and then a couple of questions from the telephone. I would ask you, given the number of people that we have on the phone line, to please limit your questions to a reasonable number, maybe two. Thanks.

It's Navid Malik from Matrix. Just on the emerging markets and China growth, could you give us a flavor of some of the trends that you're seeing on both volume growth, the margins you expect around that and the strategic options you have, because obviously in Wound Care you've made some great decisions in getting into China, but how does that impact the strategy on Endoscopy and Orthopedics and where could this market grow to?

That's a great question. I think you have to understand what our strategy -- again, I'll remind you, and you have to understand what our strategy is in China.

The first -- it's a multi-phased strategy. The first phase is getting a presence with a significant enough critical mass that we start learning the capabilities, that we get people on the ground, that we start understanding what the market forces are. Because it's not good enough and it's not sustainable to take products that are built in Boston and Memphis and Hull and ship them to India or China or any other market in the world and expect those products to be relevant. It just isn't going to happen.

So the first step of our strategy was to use manufacturing, use our desire to get lower cost of goods. We didn't go to the lowest manufacturing cost site in the world. We went to a lower cost site in China. We have two factories now in China. The Wound Care business is producing tens of millions of products a year and they're all being exported out of China. It's not a market penetration strategy. Today, it's purely a way for us to lower our cost of goods.

But with a factory in China comes -- you then have to hire people to run that factory. Then, all of a sudden, you start hiring engineers and then sustaining engineers. And then, before you know it, you start making relationships with the local officials, and then you get involved with the folks who are setting policy for expansion of healthcare in these many cities around China.

And the next phase that we're in right now is how do we start developing the right kind of localized products for sale into China, and then we'll have the critical mass and the organization to really capitalize on it. I think it's a very sustainable strategy.

We're doing the same exact thing in Orthopedics. We have a factory in Beijing and we will start by making some lower cost instrument sets, some lower cost of goods products that we'll be shipping all over the world. It will be a factory just like any other factory we have in our system. And then we'll quickly move on to making sure that we have the people on the ground, waking up every day, reading the Asian Wall Street Journal, not the New York Wall Street Journal or the London Wall Street Journal or the Financial Times, but reading the local newspapers and being involved with the local issues, so that we can capitalize on that market.

Now, I know that's a very long answer, but it's a very, very important strategy. I think it really, truly differentiates us from what the competitors do. The competitors go over and try to figure out how can they sell -- most companies go to these countries and figure out how can they most effectively sell what they already are selling somewhere else in a developed part of the world, and the needs are completely different.

So that's our strategy, and I think it's going to work brilliantly.

Yes. Michael?

I have two questions. One is for the Chairman, one is for Adrian. For the Chairman, can you talk a little bit about the selection process that you went through for the new CEO? When did it start? Are you looking more for a strategic or for an operational person? And also, what importance does the background of the CEO have being in pharma rather than medical devices? That would be the question for you.

And then, for Adrian, in terms of your margin outlook, when you say that some of the investment opportunities may be offset by further efficiencies, should we be thinking about the margins in 2011 being similar to 2010, or should we still expect some sort of margin improvement?

Well, Michael, let me start. The process of selection, over a period of months, defining, as you correctly point out, the need. Then of course it's an and/and/and approach, with a wish list. Walking on water is an optional extra, but you don't always get that. But we wanted a global player of stature in the healthcare industry, someone who'd achieved, not just a good salesman, someone who'd demonstrated in various parts of the world. And like Dave, Olivier has performed in mainland Europe, in the States, and significant achievements in the developing parts of the world.

A healthcare professional. The leadership and inspirational skills are as important as specific knowledge, we believe. So the pharma, who are probably leading us in terms of the environment we're finding ourselves in day to day, with increasing regulation, etc., etc., I think will be good for Smith & Nephew.

At the next level, of course, the team that Dave has created is absolutely infused in medical devices technology. That's right in the genes. So you want someone who can pull that leadership team together, someone who can operate at the strategic level, but also bring other things, marketing, operations and so on.

So we were very fortunate -- I'm not going to reveal any names, of course -- to have had an excellent shortlist, and Olivier stood out even above that list. So I hope that answers your question.

And from the sublime to the ridiculous, the margins, Michael. As you know, we don't give numerical guidance. You I know don't like that, but that's the way it is, Michael.

The elements to the guidance I will just repeat. We do see -- and each element is important. We do see significant further improvements -- potential for efficiency improvements. They're not ended. We are very committed to getting those. We also see significant opportunities for investment. We're also very committed to taking them. We broadly think they'll be equal, therefore broadly flat, broadly.

Thank you.

Great. We'll take two questions from the phone lines then.

Thank you, sir. Our first question is from Matt Miksic from Piper Jaffray. Please go ahead.

Hi. Good morning. Thanks for taking my questions.

One follow-up, Dave, on pricing. It seems like some of your peers (inaudible) have talked about sequentially toughening price environment in Q4. It's something that -- it sounds like you're seeing something more stable. Is it -- just to be clear, the comments that you made about 2% independent of mix, is that like for like or why is it that you think that you might be seeing something that's maybe better than some of your competitors?

Well, we can't speak for the competitors, but just to clarify what we said, yes, we said in the Orthopedic space we'd seen broadly constant pricing pressure. If you take it together around the world, around minus 2%, and we'd seen this pretty much offset by mix.

Okay. So 2% is roughly a similar kind of number for mix.

Yes.

Okay. And then a follow-up on knees and VERILAST. Wondering if you could talk about maybe what some of the impact of direct-to-consumer was in the fourth quarter, if you were to drive that back up again.

And then, just in general, understanding that it's through differentiated technology, it's a little bit of a higher cost technology, how big could this be I guess in knees, how big of a part of your business could VERILAST be?

Good question. Let me try to take a shot at it.

Let me first comment on the direct-to-consumer, because I can't give you an absolutely definitive answer because we don't know what the answer is. We're making some -- we're drawing some conclusions based upon the results that we're seeing. Clearly, we believe that our direct-to-consumer campaign is paying off for us in knees. But I'll also remind you, Michael, that we've been investing in direct-to-consumer for quite a while, kind of off and on, and we've been somewhat skeptical about how much impact that would actually have.

I think the difference this time, at least the assumption we're making and the conclusion that we're drawing is that the difference this time is that it's not just direct-to-consumer advertising for the sake of getting our name out, that it really, truly is a product and a feature and a benefit to the customer that's meaningful.

This FDA wear claim of 30 years is creating a real buzz in the marketplace. People are talking about it. Clearly, I think the younger, more active patient who is putting off decision making is -- it's getting their attention. And although we can't quantify it for you, we just can't, we just don't have the visibility into actually what's driving what here, but we are drawing some conclusions and we think that given the clear differentiation in the product that the direct-to-customer is probably having an accelerator effect on our success.

So we're going to continue to test that theory. We'll continue to have some very focused marketing campaigns with direct-to-consumer advertising, both with our VERILAST and some of the potentially other highly differentiated products that Smith & Nephew has.

What was the other? There was another?

How big could it be?

I think the custom bespoke implants and instrument sets are the way of the future. If you think about what we're struggling with right now as a company, in terms of how we run our business, we have lots of inventory out there in the field, in order to support lots of different types of surgery and lots of different models and types of implants. And if you saw a surgical suite, if you were fortunate enough to be able to witness what goes on in a surgical theater, in the surgical suite, you'd see multiple instrument sets that are worth hundreds of thousands of dollars. You would see multiple implants, because the surgeon doesn't really quite know exactly what they're going to need at any given time.

And we consign all of that inventory, whether it be the implants or the instrument sets, and the entire industry has set that as a way of working. If we could get to the point where we can take an image for a joint replacement, for instance, and we could send out an instrument set and an implant that is going to fit perfect, I think it could dramatically improve the efficiency of how we deliver these products to our customers.

So I'm pretty excited about it. I think that that real need will drive the adoption of this in the future. And you're seeing it now with something as simple as cutting blocks with VISIONAIRE.

Thanks for the color on VISIONAIRE. I was actually looking for how big maybe VERILAST could be, I'm sorry.

Oh, how big VERILAST could be? Well, I think it's still a -- I think it still has to be applied in the right place at the right time. It is a more expensive technology, clearly has -- there are some cost/benefit trade-offs that people have to be considerate of, and I think that is happening in today's healthcare world. So it's not going to completely take over our sales in knees, but I believe that if you are a high-demand, younger, more active patient it's going to be pretty meaningful for you to consider this technology.

Thanks so much.

Yes, you bet, Michael. One more question from the phones.

Thank you. We're moving to Julien Dormois from Exane. Please go ahead.

Hi. Good morning, guys. Two quick questions, if I may. The first one would be on the SG&A costs in Q4 that were really low in terms of percentage of sales. So how do you plan to evolve around that in the next few years?

And the second one is about the use of cash. You will be virtually debt free, or let's say cash positive somewhere in 2011. What are your plans for using the substantial cash generation you forecast in the next few years?

I'm afraid I didn't understand that first question.

The first was the SG&A costs in Q4 as a percent of sales. Do you have anything to comment on?

No, there was nothing unusual in there. It was a perfectly straightforward evolution from previous quarters. There's no unusual releases or extra costs in the SG&A in quarter four.

In terms of the use of cash, yes, I think an important consideration as the Board considers borrowing and the use of cash is that we are fundamentally in a growth industry. And we believe that a strong balance sheet is an important thing for a successful player to have in this industry, so we wish to have a strong balance sheet. We've still got $0.5b of borrowing, which is more borrowing than most of our peers.

So as at the moment, our use of cash is very much focused on paying that debt down. Clearly, if we get to the point when we have significant net cash, we'll look at it again. But at the moment the focus is on paying that debt down and ensuring we have a strong balance sheet, so that we can, over the next medium-term period of time, use that cash sensibly for shareholders.

Okay. Thank you.

Okay. Yi-Dan?

Thank you very much. I have two questions. A first question on the customized technologies that you're rolling out. Can you comment on how that would change the barriers to entry to your Orthopedic markets?

And then, secondly, in terms of your -- the new products that you're going to launch, you usually have a slide showing what your key product launches will be in the coming year. Can you comment on what are the key things we should be focusing on for you there? Thank you.

Okay. Well, a couple of good but tough questions. Let me take the second one first.

The reason why we haven't put that slide in there is because next week is the AAOS. Most of you will be at the large Orthopedics convention in San Diego, would be my guess, and we'll be showcasing new products at that meeting. So we -- typically, at this time of the year, we don't talk too much about new products because we'll be doing it 24 hours a day, starting on Monday.

In terms of the -- you know it's an interesting question about barriers to entry. I'm not sure that I can give you a really good answer, but I would invite Adrian to supplement my comments here.

I think it probably is going to be about the same. I think there's pretty high barriers to entry today in the industries that we're in. That's one of the reasons why you see almost 95% of the market is with the top five companies in the space. It's quite concentrated. It has very high costs associated with it. And the costs are not just the inventory costs, Yi-Dan, of having those instruments out in the field, but it's also have the high-touch service levels that we have with our customers. And I think that those high-touch levels are going to continue for the foreseeable future.

You could make an argument that if the custom implants worked extremely well, that you might not need some of that high touch in the operating theater, and I think we're just going to have to wait and see how that evolves. But if I was going to place a bet right now, I'd bet that the barriers to entry are going to remain pretty high for the foreseeable future.

Yes. Maybe just one thing, Dave, because, as we've discussed this in the Company, most of the aspects (inaudible) do not change fundamentally because of direct-to-patient. But one area that is potentially slightly different is how capital intensive it is, because a large amount of the capital is deployed in the field. And if you need less capital, that is potentially a reduction of the barrier, although we see the use of capital as being a fairly small element of the total barriers to entry. However, it might shift the balance between smaller players and bigger players, which is something we would look favorably upon, of course.

I think the other thing that you have to consider is that just because you have custom implants I don't think they're going to be fundamentally -- they're not going to be -- not every implant's going to be unique. There is a strong consideration for quality and longevity and wear, and all of these things that go into any kind of customization are going to impact that. And I believe that the healthcare community, certainly our surgeons and the patients, are going to want to make sure that there is an assurance that we can be predictive about the quality and how well these implants are going to actually perform and wear.

Yes. I'm just giving Hennah a workout there, just opposite ends of the room.

Thank you very much. Peter Cartwright at Fiske. You continually stressed the demographic driver for demand with these low volumes. Does this mean there's a huge inventory of patients with wonky knees and hips, and is it rising? What are the trends there?

I think so. I think so. I think that -- we've been saying this for some time now. I don't think that because of an economic recession that -- an economic recession cures osteoarthritis. I just don't believe it. I think that if you had osteoarthritis before the recession, you probably have it now.

And I think what happens is that the earlier stage that you have the issue, and maybe the younger that you are, you might make choices about delaying the procedure. And I think that's what's going on and I think it is linked to consumer confidence.

I believe we're starting to see some of that rebound. I don't think it's in a huge way yet. I think we still are working through this. But I think those volumes are out there, Peter. I do believe that.

Yes. That was three, sorry.

Thank you. First, Dave, congratulations and wish you all the best. Just two quick questions, if I can, one for Adrian on NPWT and Wound specific -- Wound in general. Can you give us a sense in terms of the significant margin improvement that we've seen in the fourth quarter, how much has come from manufacturing versus other parts of the business, whether it's the legal costs declining or you getting better efficiencies out of your sales force?

And then for you, Dave, just one final time, pricing in Europe, austerity, that's a bit of a change in tone from your part. How are you thinking about 2011? And what have your discussions with governments and experiences in tenders have been in Europe so far this year? Thank you.

Clearly, it was a very substantial increase in margin in Wound in the quarter. Both were significant. In manufacturing it's been consistently through the year and you get a sense of that and the more ongoing stuff, if you look through the whole year. There was a bump from the fact that we had very significant NPWT investment in quarter four last year.

I think on pricing, look, it's no secret the pricing in Europe has been tough. It's been under quite a bit of pressure.

The thing that we have going for us, that we worked very hard to achieve, it's not because we're just lucky, is this balance, is this geographic balance and the balance within our businesses. We're seeing some real mix uplift, with some very unique products. That's getting us some price in some areas. And in markets like Europe we're seeing continued price pressure.

We're seeing very good success and high growth rates in areas like China and India and other developing parts of the world. So we've worked hard at having a balanced business and a balanced portfolio of businesses in geographies, and it's working out for us.

I think we're going to continue to see pressure in Europe on pricing. I don't think it's going to work itself out in the next quarter. I think we'll continue to deal with it, but we've been managing it pretty well.

Okay. We'll go back to the phones. Do we have --?

Thank you. We're moving to Ilan Chaitowitz from Redburn Partners. Please go ahead.

Good morning. Thanks for taking the question. It's Ilan Chaitowitz from Redburn Partners. Just a couple of housekeeping questions, I guess.

Could you maybe -- going back to the last question, could you give us a split out of the legal costs that you incurred in Q4 and 2010 for the full year, just to give us some sort of idea what the impact of that was and how you might see that playing out in 2011?

The second question relates to BHR and what the quarter-on-quarter trajectory is in the US. Just trying to get a feel for how the pressure is playing out on metal-on-metal and if you are seeing that consistent or improving or worsening versus Q3.

And the final question is just on the receivables. Could you just talk about why those ticked up in Q4, if there's any particular reason for that?

How do you want to take -- do you want to split it up?

As you wish. You do receivables.

You want me to do receivables, you do BHR? Well, let me take the BHR one first.

I think we are certainly working through the weakness in the BHR product. I think it's been multi-factorial in its genesis and nature. I think clearly there's been some pricing pressure. The fact that we are -- I won't say we're the only resurfacing competitor in the US, but we're the one with the most credible position and we have the vast majority of the market share.

And I've always said, and I think I've said to this Group, that I wish we had more competitors for this product, because we're sitting here with 12% market share in hips. So it means 88% of the market is trying to discredit our BHR product, because we're quite unique. But the fact of the matter is -- and it's been exacerbated by the fact that a couple of our competitors, very large competitors and credible competitors, have withdrawn their metal-on-metal offerings from the marketplace, and it's created this swirl of controversy around metal ions, in particular.

This issue about metal ions and the production of metal ions is really nothing new. What is clear is that unless you have the right product design and the right metallurgy, then you potentially could have issues.

We have had this product on the market for a very long period of time, over a decade, with over 100,000 procedures being done. We have well-documented registry data that shows the survivability of this product. And right now, what we're doing in BHR is reeducating and remarketing this product, to make sure that the facts get out, that metal-on-metal does not equate to the BHR and the resurfacing product that Smith & Nephew has, that these issues are product specific, not technology specific.

And we feel very, very strong about it. And it's been a little bit of an uphill climb for us and it hasn't been an easy thing to do, but we are committed to it. We think it's a great technology and we'll continue to stand by it. So I think we're working through most of those issues as we speak.

So, with that, I'll let you talk about the legal costs and the receivables.

We're not going to give a figure for the legal costs, for a whole variety of reasons. They have been substantial. There's no question about that. And as for what they'll be going forward, I guess you could probably ask KCI that question better than you can ask us, since we tend to be on the defensive side of most of those legal costs, not the offensive side. There clearly has been a lessening in intensity of that legal action, but essentially it's driven by them not by us.

And on receivables, yes, you're quite right. Quarter four did see a little bit of a tick-up and there really are two components. One of them just is warp and weft. You do get quarterly variation. But there is an underlying slight kick-up, not unassociated with the European pressure, because most of the kick-up is across Europe. Not alarming from our point of view in the sense of recoverability, but it's another manifestation of European governments being under pressure.

Thank you. Could I just push back on the BHR trend? My question was more about what was going on in Q4 versus Q3.

Yes. I'll just -- yes, more numerically on quarter four, there clearly was -- around the time of AAOS last year, when the metal-on-metal debate took a surge up, was a catalyst for a lot of metal-on-metal products to have a bit of a hit, so -- and our product BHR was no exception there. So we are getting on to be a year away from that, so you might expect some sort of lessening of the decline.

That's certainly consistent with what we see, but it wasn't just AAOS. It was a more protracted impact than that. So you shouldn't expect a clean annualization, but you should expect some. Because of our confidence in the product, which is firmly based on what we see in the marketplace, we should translate that gradually into numbers.

Right. Has demand for BHR improved in Q4 2010 versus Q3 2010?

We're not going to go into quarter-on-quarter changes in that granular way.

Okay. Thank you.

How are we doing, Phil, on -- one more question? Okay. You're the lucky one.

Ladies and gentleman, Florian Gaiser of Kepler will have our next question (multiple speakers).

Oh, sorry, you're not the lucky one.

Thank you for taking my question.

A lot of good questions have been asked, obviously. The question is in hips. You make a lot of progress in knees, with good clinical data and good product. What do you think it takes in hips to have a similar revival, and also from R&D strategy point of view?

And secondly, you mentioned adjacent technologies as growth drivers going forward. If you could comment on that, please.

Sure. Well, I think actually we're seeing it in hips. We're growing our Hip business -- our overall Hip business at market growth rates, with still a bit of a drag from the metal-on-metal controversy that's impacting our BHR. If you look at our core hips, we're outgrowing the market. So we feel pretty darn good about it. So I think you're seeing it now. And as we work through some of this other controversy on BHR, I think it will have an uplift effect on it. So we're claiming victory in that regard.

In terms of the adjacencies, I'm not sure I understand the question, but can you help me understand the adjacency question?

Okay. You mentioned investing for growth, slide 23, adjacent technologies. What did you mean by that?

Oh, okay. Well, I think what we're referring to there is, for instance, in our Endoscopy business we're taking the technology that we have and investing in the gynecology market, for instance, and that market has -- that business has grown about 40% for us in 2010. Now, it's from a very small base, but we really see some great opportunities.

Hip arthroscopy is another area. That's a joint that was never addressed in terms of arthroscopic repair, because it was so hard to access. And we worked with surgeons in the field and essentially created devices that allowed us to get better access, that we could do these arthroscopic procedures. And that adjacent space, that anatomical adjacency, is beginning to take off.

We also look at other technology adjacencies along the way, but we're not ready to really talk about those. Some of the more common adjacencies might be spine, might be dental, things that have technology similarities across the businesses that we might be able to leverage as we go forward. So that's what we were referring to.

Okay. Well, look, I think that's all we have time for. We're on an extremely short schedule. I would like to thank all of you for being so kind.

This has been without doubt the most fun phase in my life, working for this Company. And a big piece of that is because of all the relationships with the folks in this room and that are on the telephone lines. So I thank you very much for that. It's been terrific. And this Company has got a great future and I'll be around for a few more months and I look forward to talking with all of you.