Smith & Nephew PLC (SNN) 2011 Q3 法說會逐字稿

Good day and welcome to the Smith and Nephew Plc Q3 2011 results conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Olivier Bohuon. Please go ahead, sir.

Good morning everyone. I am Olivier Bohuon and I'm the Chief Executive Officer of Smith and Nephew and I welcome you to our third-quarter results presentation. I will speak about our results for the third quarter and then hand over to Adrian to take you through the numbers.

When Adrian is finished, I will come back and update you on the progress we are making against our new strategic priorities and the programs we're initiating to generate efficiencies and liberate resources for investment vital to growth. As usual, we will take questions at the end of the formal presentation.

The trading environment in the established market continues to be difficult. Despite this, Smith and Nephew has had another strong quarter of revenue growth and we gained market share in many of our product franchises and geographies. Overall, our revenues were up 10%, to just over $1b, an underlying improvement of 5%.

Orthopedic Reconstruction generated revenue growth above market rate for the fifth quarter in a row. Endoscopy grew 7%, with a strong improved performance in Europe. Advanced Wound Management grew at more than double the market rate. This was driven by our negative pressure wound therapy franchise and a steady flow of new products across our wound care range.

Our trading profit, trading margin, was 19.8%. Endoscopy and Advanced Wound Management delivered strong margin and both achieved improvement year on year.

The Orthopedic margin was disappointing, at 15.6%. Some of this was due to the continuing negative sales mix we highlighted in the first half. Some is due to an unusually high level of periodic expenses, on which Adrian will give more detail. However, a significant amount is due to orthopedic having a cost base, which is structurally too high, given the challenges and changes in the established market.

When I explained my rationale for our new strategic priorities last quarter, I highlighted these dynamics in the established market. Lower growth, better pricing pressure, has been a fundamental backdrop to our strategy. Actions have been underway for some time, to address this issue but to date, they have been inadequate, ultimately resulting in the $10m overspend this fall. I have worked with the new combined Orthopedic Endoscopy management team, to instigate tighter cost controls as well as addressing the necessary structural cost base changes required for the future.

Hence we expect to deliver material improvement in the orthopedic margin from Q4 and that the Q4 Group trading margin will be above 24%. As a management team we have not and will not shy away from taking the actions necessary to ensure that all of our businesses maximize their growth and margin.

Adjusted earnings per share were $0.162, essentially flat on last year's $0.161. Our cash generation continued to be strong and we now have net debt of $196m.

Turning to look at the performance of each business in turn. The first slide, on the Ortho business. The Orthopedic revenue in the quarter were up 3% on Q3 last year. In the US, our business was slightly softer against stronger comparables. This was balanced by another strong performance in the emerging markets.

Market conditions in orthopedic were broadly consistent with those we saw during the first half of the year. We believe that the US reconstructive market was, again, flat to slightly negative in dollar terms, that the European market was flat to slightly positive and that the emerging markets collectively grew in double digits. Adrian will give you more specifics on Smith and Nephew pricing changes.

Against this market background, I am pleased with our revenue performance. As I said, orthopedic reconstruction grew at above the market rate for the fifth quarter in a row. [Driven] our global knee franchise, which grew at 6%. In our knee and hip franchise, we saw similar trends as in the last few quarters. In the US, we grew knee at 5%. This continues to be a market leading performance albeit at a slower pace as we annualize the full launch of our VERILAST and VISIONAIRE products in Q3 last year.

Our global hips sales declined 2%. Sales of the BHR system continue to be disappointing and declined at a similar rate to the previous quarter. In our traditional hip range we're seeing double-digit growth from our OXINIUM surface. This is supported by strong registry data, as well as association with the various brands we have for knees.

Trauma grew at 4%, the same as the previous quarter. Within this, our limb restoration of Hex-Fix franchise, where we have a strong market position had a better quarter. In clinical therapy, we grew at 7% and EXOGEN, again, achieved a good growth rate.

Turning to our Endoscopy business. Sales in Endoscopy grew by 7%, up from 5% in the previous quarter, as Europe delivered an improved performance. Our repair sales continue to be led by very strong growth from our shoulder and hip product range. In our knee franchise, we have now widened the launch of FAST-FIX 360, which is the latest generation of our market-leading meniscal repair system. We expect this to materially benefit this franchise.

In resection, or blades, we had a better quarter, particularly outside the US, where we won a couple of large tenders. We anticipate our new range of Dyonics Platinum blades to make an increasing contribution going forwards.

Visualization revenues declined marginally, a marked improvement on the last few quarters. Last week we completed disposal of our remaining digital operating room systems -- sorry, digital operating systems business to (inaudible) Corporation. We have now delivered on our strategy to optimize the size of our Visualization business so they directly support our sports medicine franchise. Visualization now represents about 10% of the endoscopy.

Turning to Advanced Wound Management. Here again, the Advanced Wound Management business grew revenue by 5% in the quarter, more than double the market rate of 2%. Market conditions, particularly in Europe, have worsened from Q2, with UK and Spanish markets declining significantly. Against this background, I am pleased that we have delivered growth in all our geographic regions. It also reinforced our belief in the value of innovation and our aim of delivering products, which reduce uneconomic cost efforts.

We had a strong quarter for product launch, releasing 11 in total. Half of these were in Exudate and in infection management, including extension to our ALLEVYN, ACTICOAT (inaudible) brands. We have also just relaunched DURAFIBER in the UK. This is a highly absorbent gel for [mid field] dressing. In September, we released the next generation of our popular VERSAJET system, which is a leading surgical wound debridement product.

NPWT continues to drive our performance. PICO, the first canister-free disposable negative pressure wound therapy product, was well received in all of its launch markets across Europe, Canada, Australia and New Zealand. The UK Drug Tariff and other national reimbursements were completed in the quarter.

We are also continuing to innovate in our traditional NPWT product range, with the launch in Germany of the RENASYS Soft Port, a simplified interface for the application and use of the RENASYS negative pressure one therapy system.

Finally, we won the letters for mitigation this time in Australia, having already won in Europe and the US. With that, I will hand over to Adrian.

Thank you, Olivier, and good morning, ladies and gentlemen. Turning firstly to slide nine on the presentation, the income statement. Revenue in the quarter was $1.032b. As Olivier mentioned, this represents 5% underlying sales growth after adjusting for exchange rates on quarter three last year.

Trading profit in the quarter was $205m, an underlying reduction of 9%. The reported trading margin of 19.8%, or 310 basis points lower than quarter three last year. This profit and margin were lower than we had expected. The progress in Wound and Endo was in line with, or slightly ahead of, our expectations. But the progress in Ortho was not. And we'll give some more detail on this in a moment. Interest costs are down on last year, mainly reflecting our lower debt.

Moving to the next slide, that's slide 10 and moving further down the income statement. We now expect a 30.2% tax rate for the full year. This is a slight reduction on the 30.8% rate we had been expecting. Accordingly, the rate in quarter three is 28.5%, including an adjustment for the higher rate we had originally booked in half one. EPSA in quarter three were $0.162, essentially flat on last year but is stronger than trading profit growth, due to the weaker dollar, the lower interest charge and the lower tax charge.

Turning to the next slide, slide 11 and an analysis of revenue by business segment. This slide shows the reported growth rates by division and the impact of currency movements on those growth rates. The impact of currency was quite material in the quarter. In quarter three the value of the US dollar was 5% weaker year on year against the average of the currencies in which we operate. And, as usual, the impact in Wound was slightly higher than the other divisions, due to its higher proportion of non-dollar revenue.

Turning to slide 12, an analysis of revenue growth rates by business and by geography. Olivier has covered the performance of our main products and geographies. I'll simply add, therefore, a few comments on the price changes we experienced in the quarter and a couple of technical points around the numbers.

Market conditions remained, as we expected, challenging. Across our businesses, we saw pricing pressure increase slightly in the quarter. In our Orthopedic business, we saw a like-for-like price reduction of around 3%, up from close to 2% earlier in the year. This was partially offset by mix gains.

In our Wound business, we saw similar price pressure. In our Endoscopy business we saw slightly less price pressure. Within the Orthopedic business, an agreement under which we receive about $8m per annum in royalties in the trauma area expired. This reduced worldwide trauma sales growth by about 2% in quarter three and United States trauma growth by about 3%.

In our Wound business, sales grew by 5% in the quarter, again, well above the market rate. Within that 5%, NPWT sales again grew strongly and contribute 3% of the total wound growth. Wound sales growth in the rest of the world was -- of 10%, was increased slightly for a second quarter, by a change to our distribution arrangements in Canada. This change increased total Wound division growth by about 1%.

Turning to slide 13, this shows the usual analysis of trading profit by business segment. As mentioned earlier, trading margin in the quarter decreased by 310 basis points and was below our expectation. Why was this? Well, margin increased in Wound by 80 basis points, as we continue to drive efficiency and as NPWT sales grow strongly.

Margin increased in Endo by 90 basis points, with a benefit of strong cost discipline and strong sales and despite a continued significant increase in the level of investment in biomaterial projects.

Margin, however, decreased in Ortho by 660 basis points. The drivers for the reduction in margin in Ortho were threefold. Firstly, as was the case at Q2 and Q1, we continue to experience a decrease in gross margin, as a result of mix pressures. Much of our growth continued to be driven by products and geographies where we achieved lower margins.

Emerging market sales, including Eastern Europe, grew strongly. And within the United States, although sales of premium products, especially VERILAST and VISIONAIRE, are driving top line growth, they are dilutive to gross margin. These mix pressures reduced gross profit by about $10m and Ortho margin by about 200 basis points.

Secondly, we experienced an unusual bunching of periodic costs in Ortho in the quarter, totaling about $10m above a normal level. These comprised legal, inventory and receivables costs.

Thirdly, we experienced in Q3 the impact of an inadequate execution over the last several quarters of our ongoing program to reduce the Ortho cost base in line with the market conditions in the established markets. This is now being corrected, but not in time to benefit quarter three. We estimate that this led to an overspend of about $10m in the quarter.

We have added a column on the right hand side of the slide, which deducts for the year-to-date numbers, the $25m Blue Sky credit from last year's AWM and Group margin. As you can see from this adjustment, the reported trading margin for the Group was down 150 basis points in the year to date.

Turning to the next slide, slide 14 and the cash flow statement. We had another good quarter of cash generation, with $138m of free cash flow in the quarter. Our trading cash conversion rate was again strong, this time at 102% and net debt at the end of the quarter was down to $196m, down from $600m at this time last year.

Turning to slide 15, and the outlook. Our revenue outlook for the full year is unchanged from last quarter and, indeed, from when we presented our full-year numbers in February. In Q4, we expect to improve our margins in Ortho substantially such that we expect the Q4 Group margin to be above 24%. This will, however, leave the full-year margin beneath the level we expected at the start of the year.

Our medium-term margin intent remains unchanged. The causes of the fallen margin over the last couple of quarters do not impact our intention to deliver a margin of around 24% in the medium term. They do impact margin in the shorter term. You'll hear from Olivier in a few moments about the action plans we are developing, to improve the efficiency of all parts of our operations in order to deal with the pricing mix and inflationary pressures in the environment and in order to fund investment in growth areas.

It remains our intention to deliver a sustainable trading profit margin of around 24% per annum in the medium term. Although we will give formal guidance for 2012 with our full-year results, our current expectation is that the efficiency improvements we achieve in 2012 will modestly exceed the effects of the investments we will make to drive growth and the effect of continued modest pricing pressures.

On a more technical note, the recent strength of the dollar means that, if the end-Q3 exchange rates were to remain the same until the end of the year, we estimate that there will be relatively little impact of currency movement in the Q4 reported numbers. We would expect reported full-year sales and trading profit growth to increase by 4%.

Also, on a technical note, I would confirm that we plan to maintain the current segmental reporting for Q4 and will change from Q1 2012 to a segmental reporting reflecting the new organizational structure that is being put in place. We plan to continue to report sales broadly as we currently do. We'll no longer report the Ortho and Endo trading separately. We will include with the Q4 numbers, a pro forma analysis of 2011, in the format that we'll use in 2012. And on that note, I'll hand back to Olivier.

Thanks, Adrian. I would now like to remind you of the strategic priorities to drive growth I set out for Smith and Nephew last quarter and update you on the progress we have made in adding (inaudible).

Starting with a reminder of the five strategic priorities I set as a framework. So, in our established market, we now have management teams focused on a small number of priorities. Firstly, is to optimize our sales and services in order to gain market share. Secondly, to deliver greater efficiencies. And thirdly, to support the emerging market, international market organization through R&D, marketing and regulatory.

In emerging markets we'll allocated better resources and focus to capture the growth opportunities here. This includes developing product portfolios specific to these countries. From the four largest emerging market countries, we have set ourselves a challenging target of delivering over $500m of revenues by 2015.

Innovation remains core. We'll increase our investment and ensure it is focused in the areas which would offer greatest growth and value. In R&D, we have committed to spend additional [$300m] over the next five years. We will prioritize investment in developing a larger emerging market portfolio, patient machine plant and instruments, minimally invasive techniques and negative pressure wound therapy.

We are simplifying and improving our operation mode. This is to liberate resources, to redirect them to the highest growth areas. We'll also become more agile and faster in execution.

Finally, we'll supplement and accelerate our organic growth with appropriate acquisitions.

As I said, I'm setting an ambitious, achievable agenda for growth, one which allows Smith and Nephew to deliver strong returns for its shareholders and benefit for its wider stakeholders.

Turning to progress we have been making against these priorities. So, what have we achieved since I spoke to you in August? At that time we had just started by uniting Orthopedic and Endoscopy under a single leader. Since then, the new Advanced Surgical Devices division has established a new leadership team. They have started to reorganize the ASD structure and operating mode, to meet the unique needs of the established market as well as serving the needs of the emerging markets and international markets organization.

All our leadership teams in ASD, Advanced Wound management and our emerging market and international market organization, are embracing the new strategic priorities. We have been strengthening our support functions, such as HR, QA and operations, to better meet the needs of the new divisions and organizations.

At our Q2 presentation, I gave some of the high level areas where we saw opportunities for greater efficiency. We have been working on the action plans to realize the opportunities and are targeting savings of at least $150m per annum. We'll provide the detail and expected costs when we report our full-year results in February 2012.

But, let me highlight to you some of the areas that we are addressing. I will start with cost of goods. We believe that we can improve our cost of goods, combat persistent pricing pressures in our established markets. We are reviewing the best configuration of our manufacturing portfolio to support our growth strategy. In terms of our existing manufacturing plants, we have been successful in making significant improvements to our processes and can still improve them further.

We are going to accelerate the rationalization of our product portfolio to gain better focus and efficiency. We have spoken many times before about the $1b of field-based capital we have in orthopedics. We are continuing our programs to tackle this opportunity.

Our programs cover all aspects of inventory management, from increased data and processes scheduling, improving our logistics between operating inventory management aspect in future product design. You can already see this program saving impact in our inventory and improved cash flow. And this will continue.

Turning to sales force productivity. Firstly, I want to assure you that we are being very conscious to avoid any disruption to our sales team. Actually, you have seen the good growth which is a reflection of this lack of disruption. By and large, we are continuing with our customer-specific sales channel.

This does not mean that we cannot improve our sales force effectiveness. By combining our Orthopedic and Endoscopy management teams, we have started breaking down silos in our business. It's allowing us to have a fresh perspective on how we serve our customers in the best and most efficient way.

We are also adding new talent to drive this improvement. For example, we recently appointed a new head of advanced recon devices in Europe. Similarly, now that the leadership of our Advanced Wound Management division is solely focused on the established market, they are reviewing their customers and business model with renewed purpose.

Finally, our general and administrative expense base, the G&A. As I said before, our decision to combine Orthopedics and Endoscopy offers significant scope to simplify our operating model and achieve efficiency. For example, we have initiated programs in the US to streamline operations and realize the benefits of supporting the sales team with a single admin structure.

In Europe, we are assessing our pricing structure and the most efficient use of our infrastructure and support function across emerging countries. These necessary changes will not come without a lot of hard work nor without cost. But they are necessary to ensure a business that is fit for the future. One that has the right cost structure and one where our resources are focused on the growth drivers of our business.

So, let me summarize our presentation, as I recognize that there is a lot here to digest. I see our Q3 result as mixed. Much of the Q3 performance was pleasing, given the challenging market. Our revenue growth across all our business was strong and in many areas, we gained market share. Both Endoscopy and Advanced Wound Management delivered good year on year improvement in their margins.

The Orthopedic margin is disappointing. We understand the issue well and are addressing it with urgency from both a short-term and long-term standpoint. I expect to show you improvement from Q4 onwards.

From a longer term perspective, we are making good progress on the strategic priorities I set out last quarter. I look forward to giving you significantly more details on our action plans in February 2012.

Our management teams are taking shape and we are energized by the opportunities we can see. We are planning the necessary programs, which will provide the resource to fund the additional investment, which will drive Smith and Nephew's future growth.

Thank you. This ends the formal presentation and we will now take questions. Thank you.

Thank you, sir. (Operator Instructions). We take our first question today from Mr. Ed Ridley of Bank of America. Please go ahead, sir.

Good morning. Thank you. If I can start just on the guidance, Adrian, that you've given. The guidance (inaudible) for 2012 in terms of saying, your current expectation is efficiency improvements will modestly exceed headwinds for next year. Does that relate to the full-year number -- the full-year margin this year, or your 24% long-term margin?

The follow-on question I had was particularly relating to, you're looking at the cost savings that you have outlined today, briefly, but also in your release. Can you give us a very rough idea of the sort of relative opportunities that you see in savings and COGS, versus the sales force, versus G&A? Or is it too early to do so?

Yes. Hi, Ed. On the first one, the intention of the guidance that we were giving in respect of the 2012 margin was basically to say that absent some dramatic changes in the pricing structure, which we absolutely do not expect, then we would expect a modest improvement in the margin on the outturn for 2011.

Okay. Great.

Again, cost savings?

Oh, the cost savings, too? Okay, well the question was which do we see as the relatively bigger ones and which do we see as the relatively smaller ones? Frankly, we see opportunities in all of them.

In terms of perhaps the least one we see in terms of magnitude of cost savings per se is the sales force where Olivier has mentioned and repeated on several occasions. Major changes to the sales force and the way they interface with customers, is not part of our current focus. That doesn't mean to say that there's not a lot of effectiveness in improving the way the sales force operates that's available. That's certainly a major focus. But in terms of dollar reduction in sales spend, that is not our priority.

The other two areas are both the cost of sales and the G&A excluding the S part. In terms of cost of sales, the themes are -- we have been actually very successful in wins over the last three or so years in low-cost sourcing and what's been behind that.

Frankly, we see more of the same across the business and we do see significant opportunities in that area. Important opportunities because obviously in established markets, we've signaled on several occasions, our core assumption is to see continued modest price pressure for a longer period. One absolutely has to be a lot more efficient with cost of sales to deal with that.

So, we see, basically by reinvigorating and extending some of the same sort of things we have been doing to further and other parts of the business, we see significant opportunity. But also, and perhaps even more so in the G&A area, and part of those potential things do stem directly from putting together Ortho and Endo. There are straightforward de-duplication opportunities in that. But it goes beyond that.

I think you heard last quarter very clearly from Olivier that our focus is very different and going to be very different in established markets from growth markets. One needs to craft an organization and organization mentality and organization infrastructure in the established markets is appropriate for the established markets. And that's different from the one we have today.

So, this program really is about that reshaping and, in that reshaping unquestionably comes significant and material cost savings. Cost reductions. No doubt about that.

Thank you, Adrian. That's very helpful. Just one follow up. Can you give us a rough idea of how much of your cost of sales you believe, in terms of sourcing, is from shall we say low-cost emerging developing countries and how much is still from developed markets?

I think, at the moment, we roughly think teens percent is from low cost. I don't want to give you a fuzzy answer but of course, you then depend on whether it's sourced, or is it in your in your own production. But roughly in the teens is what it is now, from low cost sources. And we do absolutely see potential to increase that.

Great. Thanks very much.

We'll take our next question today from Matt Miksic of Piper Jaffray. Please go ahead, sir. Hello, Mr. Miksic. Your line is now open.

Have we lost you, Matt?

Yes. Can we take another question before?

We'll take our next question from Michael Jungling of Morgan Stanley. Please go ahead.

Great. Thank you and good morning. I have three questions. Firstly, on the target savings of $150m, can you give us a sense of how much of the savings will be realized already in 2011? And whether the $150m in savings will hit 2012 in totality or will be more a proportion of it? And then also, how the savings will impact 2013?

Question two, can you give us a sense of the -- what we should expect for the Q4 EBIT, or the Group EBITA margin for the fourth quarter?

And question number three is, when you give guidance in 2012 with respect to the top line, will you need to reflect a tougher environment because of the incremental news of austerity measures in Europe and the perhaps more difficult environment in the United States? Thank you.

Okay, Michael. So, let me -- we are going to share the answer but, regarding the first question on the target of savings. We will definitely have a significant improvement in Q4 and the action plan I've started. So, we expect, as mentioned by Adrian, to have a quarter four which will be above 24%.

Regarding then timing of the $150m, well, this will be a speeding cruise of roughly $150m of savings. So, 2012 definitely will have a significant amount of savings and then we expect onwards to have this amount of savings at least generated on a yearly basis.

So, Olivier, so 2013 will be the first year where you will have the full $150m in savings?

Well, I'm expecting more than $150m of savings in 2013 actually but, yes, the speeding cruise will start really at the end of 2012.

Speeding cruise, for those who don't speak French, means cruising speed.

Yes, that's right. That's right. Thank you.

But it will not all be there in 2012, is another way of putting it, Michael.

Yes.

Great and Adrian, a guidance for Q4 Group EBITA margins? Is it 24% for the entire Group?

Yes. It is. I wasn't clear what -- yes. The guidance we've given is 24% for the entire Group. Yes. For quarter four, at least.

All right.

Regarding your question on 2012 top line, we do not foresee any type of additional austerity measures. So we believe, however, that what is happening will remain, that we will still have pricing pressure, we will still have government pressure but we do not see any deterioration of this situation.

Okay. And a follow up for Adrian. Adrian, if I have to put 24% margins in for Group EBITA, that's a monster improvement in the fourth quarter. How likely is it that you can do 24%? Or, is it about 24% -- I mean, could it be 30 or 40 bps less than that?

Michael, I think you need to make your own judgments. We're quite clearly saying we expect to be at least 24%. Don't forget, there is a seasonality in our business. Quarter four is always a strong margin. It's less than where we would have hoped it would have been if you had been asking the question at the start of the year, Michael, materially so.

Alright. Thank you.

We'll take our next question today from Ingeborg Oie of Jefferies International.

Yes, good morning and thank you for taking my questions. Two questions, if I may. Firstly on the third quarter orthopedic margin, if I understood it correctly, it was about $10m here which would be ongoing margin pressure, because we shouldn't expect to have been any special effects in the quarter, which was the lower gross margin, or the product mix and geographic mix, whereas the periodic and the other costs are not ongoing. First of all, could you confirm that?

And secondly, on the $150m targeted savings, that looks to me like a -- something like a 300-basis-points margin improvement, potentially. And given that the Wound Care and Endoscopy division seems to be making very good headwind already, I'm wondering if this 24% medium-term margin guidance with an included 300 basis improvement in the cost base, is reflecting an expectation of the Orthopedic division. Will have something like 600 basis point lower margins without these cost savings on an ongoing basis?

Yes, okay. On the first question, you can take the second one, if you want? On the weak Ortho margin, you are right, actually. You have three main items here to explain the deterioration of the margin of the Orthopedic business in Q3.

The first point is the mix pressure, which is around 200 basis points at $10m. Then, product mix, lower margin products like VISIONAIRE and VERILAST. Geographic mix, especially with emerging market growth and Eastern Europe.

Then, we have had an unusual bunching of periodic cost, about $10m above the normal level and these are legal costs, royalties and IP settlements and some write-off of some slow-moving inventory.

And then as I was mentioning, there was definitely an inadequate execution of the existing programs, savings programs. So, the cost base (inaudible) is high and that's been about $10m. So, roughly, this is what we have to explain the 15.4% margin off Q3.

As well, Inge, actually only one of those three goes away, immediately, without doing anything.

Yes.

And that's the bunching of periodic costs. We have these periodic costs; we just got an unusual number in quarter three, annoyingly. That one, you should not expect to recur. The mix isn't going to go away overnight. That's a mix we've got to deal with and we've got to deal with it by running the business well and running the costs well.

And the issue of the cost structure in Orthopedics, you don't snap your fingers and it goes away. It needs working at and it will take time. It will go, it will be reduced for sure, but it isn't going to disappear overnight completely in quarter four.

If I may, on this one, we have had the structure for a while and we have built this structure, which was a good structure at the right time. But now, the market is what it is, the growth is not as strong as it was in the past, as you know. So, we need to adjust it and we had a plan which was supposed to have raised it and I don't think that we have managed this on the appropriate basis. So, that's why now, I and I say I here. I have embraced that with the management team to be sure this will happen. And actually, it has started to move now.

Your second question on longer-term margins, no question, if you divide $150m into our revenue, you're looking at north of 300 basis points. However, there are obviously other variables that play into where the margin is going to be in the future.

There is the price pressure that Michael pointed out in the previous question and we'll has to make judgments about what that is. We're very clearly in the camp, they're not going away quickly. Although, in our core scenario, we don't see them increasing dramatically, we certainly don't see them going away.

There's investment for growth, I we are absolute we see growth potential geographically and in some segments of our business, technological investments in some senses of our business, which need to be invested in and must be invested in. That's important.

And also, there is, on the positive side, ongoing productivity. That doesn't necessarily just bundle up and put in a program but it's part of day-to-day operational management. All those come in as you think about the future longer term margin. Hence, you need to make judgments on a set of variables, not just the $150m you have to make a judgment on a future margin.

Okay. Thank you and just a follow up. Is it mainly in Orthopedics that you expect it given that the margins have progressed very nicely in the two other divisions? And am I then right in assuming that, suddenly now, you're expecting a 600-basis-point lower margin in orthopedics on an ongoing basis?

The answer is no, actually. We plan to improve wherever we can, obviously and do not focus only on the recovery of the Ortho because we can improve and we believe we can improve margin in the other businesses also with obviously many factors.

Yes, cost savings have to come from the whole business on an ongoing basis. There's no question about it.

Thank you.

Our next question today comes from David Adlington of JP Morgan. Please go ahead, sir.

Morning. Thanks for taking the questions. I just wanted to focus a bit more on the margins, I'm afraid. On my math this morning, I think you're going to finish this year with about, I don't know, 22.2% margins. And then you're guiding next year for modest improvement. When you talk about that modest improvement, is that relative to the 22.2% and what do you mean by modest?

And, secondly, does that include any contribution from the $150m that you've talked about, there? The savings?

I think we have said, yes, the modest improvement will be on 22 point something. We said that it will be above 24%. So, you made a calculation. So, I do expect to have something around 22.2% and I expect above 22.2%. So, we will definitely have a modest improvement above this figure.

This includes a part and I was talking about this cruising speed of $150m in 2013 and definitely this will have an impact -- positive impact in 2012, but certainly not for the total of $150m of savings.

Okay, thank you and then maybe just a follow up in terms of that. That $10m of cost base that was too high in the third quarter. Was that in any way related to you investing ahead of an anticipated rebound in the recon market that didn't come through?

Not at all. Absolutely not. We talk about structure costs here and it is not at all additional investment. So, this is something which, again we -- and we see very clearly now that mixing the two divisions, the Orthopedic division and the Endoscopy division help us definitely to manage this. And that's why, when I was saying in my talk that, we have the cost savings plan as a part of the strategic priorities implementation. It is definitely what is happening. So, it's not additional investment here. It is just something which we are doing.

Okay. Thank you.

And our next question today comes from Lisa Clive from Sanford Bernstein. Please go ahead.

Hi. First question on Advanced Wound Management, you mentioned in particular that Spain and the UK were down pretty significantly. If we think about 2012, what are the markets that you are most concerned about? And perhaps maybe if you could just comment on which markets have actually held up and whether you think they could at some point crack.

Number two, again, back on margins, you've mentioned VERILAST and VISIONAIRE are dilutive to gross margins. My understanding is those are two of your faster-growing products. I'm just trying to understand how perhaps the gross margin progresses into next year with that as a backdrop on the product mix.

And then lastly, Olivier, you had mentioned there will be costs associated with the restructuring. So when you say 24% medium-term margin, is this on an underlying basis? And perhaps it's a bit too early to give the guidance to us now, but in February, will you be giving us guidance for the year, both on a reported and on an underlying basis?

Okay, Lisa. Thank you. Let me address the first question. When you were mentioning the Wound, so you talk about the wound management here, about the market? Okay, so in Wound, okay, I said that we have faced in Q3 a pretty negative market. Actually when you look at the market of wound, the market is globally up 2% for the wound business. Okay? In the US it's up 5%. Outside of the US it's 1%. And in Europe it's minus 2%. So you see that this minus percent is basically due to a very low market growth in -- a negative market growth in Spain and negative market growth in UK and a low market in France also.

So if you ask me what are my worries for next year, I will say definitely Europe. That's something which is pretty clear. We do not see any type of strong recovery of the market in Europe for next year. The market we are mentioning will be the same market as next year. And I don't foresee any better news in the US or in general more globally. Okay?

And then on your other two questions, Lisa, how do we see VISIONAIRE, VERILAST and products like that driving gross margin next year? Well, you've rightly highlighted the mechanic that has been a powerful mechanic driver this year, that they are higher -- they are premium products. They do drive our sales. They do help the top line, but they are lower gross margin so they depress our gross margin. That particular dynamic around those products we don't see changing quickly.

Slightly more broadly, we do still see the ability to put premium price in for premium products, and that needs careful margins to make sure one puts the appropriate price at the right place in the market. But nonetheless, clearly it is a market with these austerity measures which is one where there is a higher degree of price and mix pressure than there has been for some, and one has to be cognizant of that. And one has to deal with -- in the established markets, one has to deal with one's cost base facing that reality.

As regards to cost of the program, yes, there will be costs to the program. Yes, we do expect to describe them when we stand up with our full-year results in February. Yes, we -- the margins we're quoting are before incurring those costs. We would expect to regard those costs as exceptional and beneath the line, as it were, in delivering those margins. And thank you for clarifying that; that's an important clarification.

And actually then I guess if that will lower reported margins next year, is that something that you think would carry on into 2013 as well? I'm just trying to figure out when that 24% is actually going to be a reported figure.

Yes, we -- the reason -- we are well advanced on this program. Actions are happening, but we're not so advanced that we wanted to be able to put it out to you guys today. And that includes looking at the phasing of the expenditure and the detailed phasing of the benefit, although we have given you some sense, which is where we believe it is now in terms of 2012 versus 2013. So therefore I think I'd prefer to duck about the degree of granularity until we stand up in March, excuse me, in February, when we will have it ready as a package.

Okay. Great. I will ask again in February then.

We'll look forward to it.

And we'll answer.

We'll take our next question today from Veronika Dubajova of Goldman Sachs. Please go ahead.

Yes. Good morning. Veronika Dubajova here from Goldman Sachs. Three questions, if I can. One, I was hoping you can help us understand where exactly that $10m reduction is coming from. Are we talking G&A? Is this selling and marketing? Or is there something else you're focusing on within Ortho to get the margin back to where you think it should be?

Second, in terms of your commentary on like-for-like pricing pressure in Ortho, you were the first company to highlight deterioration in this quarter. I was hoping, Adrian, maybe you can give us a sense for how the US versus Europe developed in the quarter. And where is this slight increase coming from that you're seeing?

And lastly, on your medium-term 24% EBITDA margin. I just wanted to understand the progression. When you say medium term, we all have a different number in mind. So if I were to think about your business over the next three years, is this a end of 2012, end of 2013, end of 2014 target or can you give us some sense in terms of how the acceleration of expenditures offset or combines with the reduction in spending and when we can expect you to hit that target? That'd be great. Thank you.

We'll do our best, Veronika. In terms of where is this, where was this GBP10m (sic) reduction in quarter three, I think the way to understand this, I've set out quite clearly that programs have been in place, of course they've been in place to deal with the cost base, but they have not been executed as well as we would like them to have done. So the $10m number in mathematical terms comes from the difference with where the plan we expected to be executed would have got us to and where it actually got us to. There are a number of types of expenditure between those two, across the G&A area, across people cost and more discretionary cost. It is a range of costs associated with the execution of that program.

In terms of the like-for-like price deterioration, frankly, we're not signaling anything major here. It was closer to 2% last quarter and for a couple of quarters before that. It's closer to 3% this quarter. In fact, the change has been broadly the same in the US and Europe. It's not been a question of one standing out from the other. They've both been, for us, slightly weaker. You're quite right, we've noticed also that others have been reporting broadly the same. But we don't think we're experiencing any real difference in that.

And in terms of the -- what is for the medium term, yes, again, Veronika, although we are well advanced into this program, the program is -- parts of it are being delivered, we don't want to package it up for you and give you a total view until February. I would however point out on 2013 specifically, although we do expect pretty much the full benefits, so $150m per annum to be there in 2013, I would point out that 2013, subject to legislative changes in the United States, does have a medical device levy coming in, which of course is going to provide a margin headwind for everyone in this industry. But that's something which, as we go forward, everyone is going to factor into their models, including us.

Okay. So just to clarify, Adrian, I'm sorry to be nitpicky about this, but the 24% number does not include the potential hit of the med-tech tax?

No. It doesn't.

Okay. That's great. Thank you very much.

And our next question comes from Martin Wales of UBS. Please go ahead.

Sorry, yes, thank you. If we actually get away from restructuring and Ortho for a second, your performance in Endoscopy and arthroscopy in particular seems to be very strong and you've seen a good recovery in blades. I guess the underlying driver of this is really your ability to penetrate the ex-US market, which is growing faster than the US. How much more room is there for you to continue to do well in these markets? And where can margins get to in this business?

Well, I think that we definitely see an improvement in Europe, as I was mentioning, and we've had a very good growth in Europe in this business. We don't know about the market, as you know, in endoscopy so difficult to say. But we believe we're gaining share on this one. We believe there is a big space actually for improvement. Whether it is again in the emerging market portfolio and we are working on, as I said, on redefining an appropriate portfolio for the emerging market, again, manufactured at the right cost and sold at the right price because when I am mentioning emerging market growth, I'm mentioning profitable growth in emerging markets, which is absolutely important for us.

So yes, I do believe that we have more space. We have space in cost of goods improvement. We have space in maximizing the growth in different geographies. I do believe we still have other things to do in the US, so we have invested also, as you know, and I was mentioning that in Q2, in the biomaterials. And these biomaterials are absolutely critical for the future. They will be part of the innovations of tomorrow. So I'm very confident that we can improve, even on top of what we have now, the Endoscopy business.

And in Wound Management, if I do the calculation correctly, your negative pressure therapy business delivered just under $30m of sales in the quarter, I would estimate. I know you're not giving a precise number. That seems not much different to Q2. Should we expect that growth to accelerate again in Q4? Obviously it's the first real quarter of PICO, which sort of implies it hasn't had much impact so far.

The -- Martin, the -- we are very comfortable with the growth rate of NPWT. You do get slight -- we do get slight quarter-on-quarter variations to do with the timing of rental versus pump sales and the like. But underlying, there is no doubt in our mind at all that underlying NPWT, i.e. without PICO, is going extremely well, extremely well across all geographies where we sell it. And PICO is on top of that. So no, we have absolutely no concern about the growth. Absolutely no concern about the growth rate of our NPWT range.

And sorry, one question just to understand your comments on this $150m and the timeframe it's going to come through. 2014 is the first full year we should see the benefit of it on the basis of what you said. Is that the correct interpretation?

No, sorry. If I was unclear, forgive me. 2013 we see the benefit of it. We were just pointing out that --.

The full benefit in '13? So it's going to take you less than -- just over a year to execute on this?

Pretty much. Not -- 100%, maybe not. But certainly overwhelmingly we're going to see it coming. We're going to see it in 2013. The sort of stuff we are staring at is not -- the bulk of it is not very long lead time implementation stuff. Some bits will take longer, but the majority we expect to see there in 2013. And again, we'll give you more flesh in February. But just in broad brush terms, I want you think of 2013 the bulk being there.

Why I was just being slightly -- caveating the last question from, I think it was Inge, or whoever it was, no, Lisa, no, Veronika, the -- it was around don't forget there is this particular additional headwind for the whole industry in terms of margin in 2013 called the medical device levy. And we're going to have to deal with that one way or another. And as we get closer to the time we'll understand more about it and more about the business.

So we should think of it as some sort of, at the risk of sounding like a scientist, I thought a sigmoid curve, i.e. a little bit, or an S curve a little bit next year, the bulk of it 2013, and the absolute full benefit in '14.

Yes. That's a reasonable way. Thank you, Mr. Scientist Wales, yes.

Thanks very much. Cheers.

And we'll take our next question from Matt Miksic of Piper Jaffray. Please go ahead, sir.

Good morning. Can you hear me?

Morning.

Can this time, Matt.

Thanks. I've got -- having some connectivity problems here so I apologize if I drop off here. The coverage is a little choppy where I am. But I had a follow-up question. I just want to make sure I understand your comments on knees and margins generally in Orthopedics. As we head -- and I know you're not giving specifics here, but as we head into the next couple of quarters, are the changes that you're making expected to have an impact on the gross margin there, on the operating profit line there or both? Or is it going to take a longer period of time to start turning those margins up given what's going on in your hip and knee business.

You're going to see a bottom-line effect, Matt. You'll see, we expect, and again we'll give you more detail in February, again we're active in this program but it's not ready to be packaged to you guys yet. But absolutely our feeling is you're going to see an earlier and quicker impact in SG&A. Cost of sales stuff just takes longer to deliver for a whole sort of reasons that I'm sure is fairly obvious to you. But we will ultimately see them both.

Okay. So faster on the operating line, not so fast on the gross margin line for those businesses. And then, and I'm not sure if I missed it, but your comments on the visualization side of sports medicine, slightly better but still kind of a tough market. In terms of capital or the capital exposure to that part of your business, can you help us understand maybe the trends that you're seeing heading into the end of the year?

We -- the capital's down to about 10% of our portfolio in Endoscopy. And we are -- we're asked this question sometimes, and frankly we are not good people to have a perspective because we sell relatively low-cost-per-unit capital and it's a relatively small part of our business. So we continue to see it being choppy, but I frankly don't think you should look to us for any significant insight in that area.

And in your business line specifically, is that something that's getting to be a less important part of your business? Is that the right way to read it?

Yes. And that's absolutely, Matt, and that's been our approach consistently over the last several years. We've been focusing our attention on capital to being capital -- precisely connected or definitively connected to our minimally invasive business, whereas a few years ago we had a much broader focus. And we've been doing that in a very measured way to make sure customers get fully supported. And we're pretty much at the end of that focusing road and we're now at the part of the capital which is very important to us, the bit that sits very close to the arthroscopy business, imaging in particular, where there is -- we see a great deal of interest and exciting stuff going forward. So now it's reached pretty much the size we see. But that is relatively small. That is not a large part of our business. It's an important part, but it's not a huge part.

And one follow-up, if I might, for Olivier. It sounds like the next several quarters, perhaps the next year, year and a half, there will be a certain amount of focus on this margin and restructuring that you talked about. Can you talk a little bit about how you're thinking strategically about the business in terms of pieces that you have in the portfolio, additions you might make to the portfolio, or is that something that because of what you're doing, it gets pushed out, say, six to 12 months from where you are?

Okay. That's an interesting question. The focus, yes, the core focus of the year to come, and this has started actually when we have decided to implement these strategic priorities, will be to capture the growth where we can capture growth and to have a profitable growth. I do believe that on top of all this SG&A management, all these cost savings, we have to improve our manufacturing footprint. We have to really optimize our cost of goods structure. So we have many things to do here. But it's not the only one.

I think that what I want to say that I believe in this business. I think that there is a very good dynamic despite the fact that we are all claiming that the markets are difficult. Actually they are difficult, but they are, I would say, not very difficult. So we can still be good. We can still be strong. We can still generate a good margin in this business. It's a question of adapting the sail to the wind. And so that's what we are doing now.

Now we -- coming back to your second point, what do we want to do? Well I'm not very keen having a lot of diversification of our business. So I think it's important for us to reinforce our strengths and reinforce the field where we believe the future will be bright. And again, I can tell you that I do believe in the Advanced Wound Management, especially in this negative pressure wound therapy and other parts of this business, as well as the minimally invasive surgery, which is for the joint extremely important for us and where we see a bright future.

Thank you.

We'll take our next question today from Mr. Tom Jones of Berenberg Bank. Please go ahead, sir.

Good morning. Thanks for taking my questions. Sorry to harp back to it, but I had a few more questions about the $150m. I was wondering if you could try and break it down for me in a slightly different way to how we've been talking about so far. Over the $150m, how much of it would you say is risk-free cost savings? And by that I mean manufacturing rationalization, cheaper paperclip supply, whatever it may be. And how much of the $150m comes with some degree of business risk from sales force rationalization, that kind of thing? Just trying to get a sense of the potential impact of revenues. We've seen many companies engage in cost cutting in med tech and what often happens is the top line just falls away as a result. So some comfort around that would be helpful.

Let me answer to you a simple way. The first thing we have tried to do since the beginning actually and since the implementation of the strategic priorities is to avoid business disruption and keep on track with the growth that we have or used to have. So I'm very keen in minimizing the risk, which means that, and Adrian, I think, was mentioning this, on the savings part we do not plan to significantly impact the sales force. So that's very important.

So what we believe that we have structured actually, which are pretty heavy, and again we see that combining Ortho and Endo. And we see that there's a mechanical improvement to do. When we think about HR, when we think about some admin function, having two structures into one structure makes a lot of difference. I give you an example -- another example that we have announced recently in Europe. We now have one head of Europe. And obviously the structure, which was a mix of Endo structure and Ortho structure at management level, and now just one structure.

So I think it's important to see that the risk-free part, I think, is the most important part of this cost-saving program. And I do not expect, and I tell you I would be extremely cautious in avoiding any type of business disruption in the implementation of this program.

Okay. And a second question, maybe more for Adrian rather than Olivier because you weren't around at the time, but you spent the bulk of the 2006 to 2010 timeframe under the EIP, squeezing out cost savings and efficiencies. Now I'm sure many of the things that you found under this $150m program you also found under the EIP, which begs the question, if you found them under the EIP and decided not to do them, why have they suddenly become acceptable to do at the current time? What's changed? Is it the revenue growth outlook? What's different between now and then? Or did you just miss them in the EIP program?

Let me answer quickly. It's Olivier again. I think it's a key question. And when you think about the structure and the cost base of a company, you need to adapt it. It's not a one shot. The EIP was an extremely good program, very well managed, extremely well done. It's not sufficient because it's not done because the world is changing and we need to be fit and we have to anticipate this. So even the one we're treating under cost saving, it's maybe not the end, because I don't know what will be the future in the years to come. So I think a good company today should be agile and ready to make the changes and anticipate the market changes.

So I think that's important to say too, Adrian, and maybe you want to add something, but it's --?

I was going to say exactly the same thing, Olivier. For us, the framework which Olivier articulated last quarter to you guys of emerging markets, we need to be fit. We have structures fit for serving emerging markets that are focused -- excuse me, on established markets that are appropriate for established markets and the reality of established markets today, and ones that are, in our organization structure that are appropriate for serving emerging markets where the growth is bigger, and also recognizing that even within established markets, some segments have got more potential going forward than others.

You don't -- you've got to make organizations change to reflect those opportunities. They don't change automatically. And making them change is what these programs are about. So yes, it's fit for the future, making the organization fit is what it's about.

So, ladies and gentlemen, I will take the last question, if we may.

Sorry, I just had one very quick follow-up question on a totally different matter, if I may. Just the $8m royalty, I assume -- is that a 100% drop through to the P&L? There's no sub-royalty on that because that would, I guess, make another 60, 70 basis points of difference to the Ortho margin. Is my thinking about right on that?

Tom, you're thinking's spot on.

Okay. Perfect.

Thank you. The one last question.

Ladies and gentlemen, we take our last question from Charles Weston of Numis. Please go ahead.

Hello. Thank you for taking my questions. Two themes to the question. First of all, on the top line, just on the US Orthopedics business, in hips there was a notable trend down in the growth rate, even though obviously we started to see the Birmingham Hip and metal-on-metal issues well over a year ago now.

And in the US in knees, you mentioned in the press release about headwind essentially annualizing the product launch. Actually growth in the third quarter of last year wasn't particularly strong. Growth in the fourth quarter was very strong. So does that mean that we're likely to see a big step down in growth in US knees next year because of this annualization of the launch? So that's on the sales side.

On the margin side, Adrian, I know you love talking about quarterly margins, particularly by divisions. But I just wanted to get a feel, the unusual bunching of costs, where have they bunched from? Either they've bunched from Q1 and Q2 this year, in which case you benefited from them and we can think about unwinding that, or they're all taken from the fourth quarter, in which case we need to think about it that way.

Yes. Fine, Charles. I'll have a go at that. In terms of the US Ortho hips, yes, you're absolutely right, Charles, if you'd asked, well, you did, and your colleagues did ask us a year ago what did we think was the prognosis for BHR. We did expect there to be a flattening in the second half of this year and it hasn't happened. We are continuing to see the rate of decline in BHR that we have for some significant time.

And frankly the reason for that is the context out there, the environment out there remains very negative to metal on metal. And while the data on BHR continues to be extremely good, whether it's the new Australian registry data, whether it's the NICE data in the UK, for our product continues to be good, but the noise around the sector, even including questions from -- within the US Congress about metal on metal are just not helping. So we are battling in that area, sadly. But that's the way it is and it's a reality.

In terms of US knees, yes, you're quite right. Growth kicked up. I'm looking at this actually with US knees, yes, it kicked up from -- what am I looking at?

5% in the third quarter and 15% in the fourth quarter, I think.

Yes. That's exactly right. So there is an impact there. And yes, we do expect the annualization effect to be ongoing. There are other dynamics at play, not least obviously there are more competitors out there now with their own patient-matched instruments. And they're receiving good results and the whole class is growing extremely strongly. But yes, you're quite right in terms of the progressive nature of that annualization.

And the last question about -- apart from recalling I don't like talking about quarterly margins by division. The -- yes, the bunching. The sort of costs were small receivables, write-offs associated with the most favorite country in Europe at the moment. The -- a couple of small inventory write-offs and a couple of small legal provisions are the sort you have on an ongoing basis. These are the sort of things you get on an ongoing basis. We just had an unusually large number, by, we estimate, around $10m in quarter three.

Where did they come from? They came from the rest of the year. So yes, to some extent there would have been a benefit earlier on. To some extent we hope that there will be a benefit in quarter four. It's just one of those things. You can't really say where did they come from. These things come along and you've just got to deal with them when they come along as an unusual number.

Okay. Thanks very much.

Thank you, Charles. So, ladies and gentlemen, thank you for -- thank you all for your time today. And I look forward to seeing many of you in person at the sell side meetings we have planned in the coming weeks. So thanks, and we wish you a good day. Thank you.

Ladies and gentlemen, that concludes our conference call today. Thank you for your participation. You may disconnect your lines.