Smith & Nephew PLC (SNN) 2013 Q1 法說會逐字稿

Good day, and welcome to the Smith & Nephew Q1 2013 results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Olivier Bohuon. Please go ahead.

Thank you. Good morning, everyone. This is Olivier Bohuon, and I'm here with Julie Brown, our new CFO. Welcome our first quarter results.

I will cover the highlights and then hand over to Julie to take you through the numbers, including the new capital allocation framework for our Company. As usual, we'll take questions at the end.

Our first quarter results built on our investments and achievements of last year. Our Q1 revenues were just over $1 billion. This was up an underlying 1%, assuming we had [owned] Healthpoint last year, and excluding the Bioventus transaction.

Those areas where we have focused our recent investment all started the year very well. Trauma continued to build momentum as we progressed the expansion of the sales force. In the emerging markets, we delivered double-digit growth.

In Advanced Wound Management, Healthpoint excelled in the first quarter as a Smith & Nephew business, supplementing the continuing share gains in Negative Pressure Wound Therapy.

Our Recon Implant business in the established market was slightly weaker than what we expected. Following our restructuring program in this area and with new products beginning to come through, we expect performance to improve for the second half of this year.

Trading profit was $241 million, giving a trading profit margin of 22.4%, which was in line with our expectations.

Adjusted earnings per share were $0.185 compared to $0.193 last year, mainly reflecting the Bioventus dilution effect previously highlighted.

Today we announce the agreement to acquire an Indian trauma business. This acquisition gives us an entry point into India's fast-growing mid-tier trauma segment. Together with the recent agreement to buy a Brazilian distributor, you can see how we're selectively adding to our emerging market platform.

Smith & Nephew has consistently delivered growth and strong cash generation in challenging markets over the last few years. We also have confidence in the continued execution of our strategic priorities.

In light of this, we have undertaken a major review of our capital allocation framework. We'll continue to invest in the growth drivers we have identified and maintain adequate headroom for further significant acquisitions. We are also announcing today a $300 million share buyback program.

This slide captures our underlying growth in the quarter; on the left-hand side, geographically, and on the right, by product franchise. The quarter had two fewer selling days, an impact of around minus 3% on underlying growth rate.

In the US, we grew at 4%. Healthpoint was a significant contributor to this, growing at 49%. I will talk about this in detail in a couple of slides.

In the rest of our established market, growth was down 5%. The market in Europe has weakened sequentially across the majority of our market segments.

Our growth in the emerging international markets was very strong at 19%. This was led by growth in China, our largest market, and other regions where we have been investing, such as Mexico and the Middle East.

I will now turn to look at each franchise in more detail, starting with Hips and Knees.

Our global Recon Implant revenue fell by minus 6%, and this compares to the market growth rate which we estimate to be minus 1%.

We have talked before about the three short-term headwinds we face; namely our position in the product cycle, particularly in knees, our disproportionate exposure to Europe relative to our peers, and our exposure to metal-on-metal hips; and these dynamics remain.

In Europe, this weakness was most marked in Germany, our largest market, where we believe the recon market was down almost 10%. Over the last few quarters, we have seen increased pressure from German payers and healthcare providers to reduce the number of procedures.

Over the last 18 months, as you know, we have been successfully restructuring our ASD business in the established market to be leaner and to be more efficient.

The benefits of this program are clear. It has both given us a better commercial platform and identified areas for making targeted investments to improve our customer-facing services. These outweigh some short-term disruption towards that channel that we are seeing.

We are accelerating our investment behind JOURNEY II following its very successful US launch at the Academy meeting in Chicago. This truly differentiated product has had great surgeon feedback.

We are also making further sales force effectiveness improvements and increasing medical education and marketing.

Our Sports Medicine Joint Repair franchise performed well, growing at 4%, effectively the same rate as recent quarters.

In Arthroscopic Enabling Technologies, we declined by 7%, and the current economic conditions continue to impact the sales of capital-related items such as cameras and, to a lesser extent, the blades used in resection.

In Trauma, our actions to refine our US Trauma commercial model have delivered a third quarter of improved performance.

During the quarter, we hired over 50 new sales reps in Trauma and Extremities. We introduced new products, including a full foot and ankle instrument [set], which allows surgeon to address both soft and hard tissue repair. We also reinforced our leadership position in the limb restoration segment with the launch of a modular rail system. Finally, we continue to benefit from the residual impact of a nail recall by one of our competitors.

Advanced Wound Management grew by 12% in the quarter, above the market rate of around 2%, which we have now adjusted to include the bioactive products.

During the period, we launched seven new products, in particular ACTICOAT Flex for PICO. This will benefit our recent focus on products to combat surgical site infections. We have also changed the disclosure of our Advanced Wound Management business to make it easier for you to analyze our performance.

Our largest business unit, Advanced Wound Care, grew at 1%, which is around the market rate. We benefited from a strong performance in the emerging and international markets, as we seek to build wider adoption of advanced wound management techniques and protocols in these markets.

The second unit, Advanced Wound Devices, which is mainly our Negative Pressure Wound Therapy range, here in the quarter we grew by 26%, and took market share in an increasingly competitive marketplace. In particular, we're establishing our portfolio in Japan, where we have recruited more sales reps. We're also starting to target the emerging markets where we see many opportunities.

Advanced Wound Bioactives is currently just the Healthpoint revenues; up 49% this quarter to $67 million. I have to say, I've been very impressed by the management team and the sales organization there. This quarter is a testament to that strength. The integration of Healthpoint is going very well, and the teams are on track to achieve the synergy targets.

We implemented a price increase for SANTYL, which took effect in the quarter, and this had a material impact on Q1 revenues, as customers took advantage of stocking opportunities ahead of the change. I now expect growth for the full year to be over 20%

And now over to Julie.

Thank you, Olivier, and good morning, ladies and gentlemen. Before I talk you through the financial performance, I wanted to make a couple of comments about my first three months at Smith & Nephew.

I joined from AstraZeneca, where I had experience of a broad range of financial, strategic and commercial roles. I look forward to working with Olivier and the team given the transformation underway at Smith & Nephew.

Since I joined the Company, I have spent much of time meeting senior leaders and as many employees and customers as possible. I have found the people incredibly passionate about what they do.

The five strategic pillars are now firmly embedded in the business, and it's exciting to see the growth generated through innovation and emerging markets. I'm looking forward to meeting you over the coming months and happy to take further questions after the presentation.

So turning to the Q1 results, I have three agenda items; first, revenue, income statement and cash flow; second, our capital and distribution policy; and third, the outlook for the rest of 2013.

Before I turn to the financial performance, I would like to remind you that we have two major changes in our Company in the last 12 months; the acquisition of Healthpoint and the Bioventus transaction.

When I refer to underlying growth rates, I am including the like-for-like growth of Healthpoint. I am excluding Bioventus, and excluding the effects of currency. This treatment gives you a measure of the underlying performance of the Group.

Revenue in the quarter grew by 1% on an underlying basis. By division, Advanced Surgical Devices declined by 2%, and Wound grew by 12%. Sales days impacted this headline performance, as we had 62 days in the quarter, two fewer than the comparable period last year. And we estimate this adversely impacted growth rates by 3 percentage points.

The Bioventus transaction reduced reported sales growth by 4 percentage points. The acquisition of Healthpoint increased our reported sales growth by 4 percentage points in addition to the 2% increase in underlying.

Currency impacted the Group adversely by 1% due to the strengthening of the dollar. In reported terms, sales were flat on prior year, with a decline of 9% in Advanced Surgical Devices, and 32% growth in Advanced Wound.

In terms of price, we saw, essentially, the same like-for-like picture as last year, namely a low single-digit price decline.

Turning to the income statement, revenue in the quarter was $1.075 billion. Trading profit in the quarter was $241 million, flat on an underlying basis. The 4% decline on a reported basis is due to the inclusion of clinical therapies in Q1 2012.

Operating profit declined to $207 million.

We completed the acquisition of Healthpoint last December, and this [resulted in] $5 million of acquisition-related costs and a step change in the amortization of acquisition intangibles to $21 million, as we guided.

Restructuring costs charged in the quarter were $8 million, and this relates to our structural efficiency program which is on track to deliver benefits of $150 million.

Moving down the income statement. Following the profit before tax and associates of $206 million, the associates represents our share of the loss from Bioventus of $2 million. We expect to see some volatility in this number quarter to quarter, but our guidance of around zero for the year is unchanged.

The tax rate for Q1 was 29.8%, the expected full year rate. Adjusted EPS in Q1 was $0.185, a decrease of 4% on last year, mainly due to the dilutive effect of the Bioventus transaction, as guided.

Turning to the analysis of trading profit by business segment. As mentioned earlier, trading margin in the quarter was 22.4%. Margin increased in ASD by 20 basis points] o 24.3%, and this is mainly due to the continuing benefits from our structural efficiency program which is enabling us to offset the impact of the US medical device excise tax.

Margin decreased in Advanced Wound Management to 17.9%, and this was principally due to the dilution from Healthpoint and additional targeted investments, including the launch of NPWT in Japan.

I would now like to turn to the cash flow statement. We had another strong quarter of cash generation, with operating cash flow of $191 million in the quarter. Trading cash conversion was 90% compared with the 76% in the comparable quarter. Cash management is an important part of the way we run the business, with regular monitoring of inventory levels, DSO and days payable.

Net debt at the end of the quarter was $137 million, having reduced from $288 million at the end of 2012, demonstrating the highly cash generative nature of our business.

And now on to my second agenda item, the capital and distribution policy, where I will cover the capital allocation framework, what this means in practice, and what this means for our investors.

So consistent with the Group's strategy, we have four priorities for our cash. First, we will reinvest in the business to drive organic growth. Second, we will maintain our progressive dividend policy, building from the base of a 50% increase in the dividend declared in 2012. Third, we will continue to pursue acquisitions in line with our stated strategy, retaining sufficient financial headroom to execute further transactions. And four, to the extent that there is surplus capital to these needs, it will be returned to shareholders.

Underpinning these priorities is our decision to maintain a strong balance sheet. In practice, this means we will maintain reported debt ratios at the level consistent with a solid investment grade credit rating. In broad terms, we expect this to be less than 1.5 times reported net debt to EBITDA.

Now what does this mean in practice? This example using 2012 data shows how our policy will be put into practice and how we think about the priorities for the use of our cash.

In 2012, the business had strong cash generation, with over $900 million before capital expenditure. We then prioritized our investments. First, we reinvest to drive organic growth. Capital expenditure has averaged 7% to 8% of sales per annum over the last three years, and is expected to remain in this range in 2013.

Second, we are committed to our progressive dividend policy. This means that dividends will grow broadly in line with earnings. We monitor our dividend closely, and run our Company with a healthy dividend cover.

Third, our stated strategy of seeking value-enhancing acquisitions. Of course, in 2012, we completed Healthpoint. At the end of 2012, we had net debt of $288 million. So let's now turn to what this means for our investors.

The dividend cash payout in 2013 is expected to be $241 million, subject to final Board approval of the 2013 interim. We have increased cash returns to shareholders and will start to repurchase shares to the value of $300 million. This brings the total cash to be distributed in 2013 to be in the order of $0.5 billion, subject to the timing of the share buyback. This distribution will approach 3 times the level in the previous year.

And finally, I would like to turn to my third agenda item, the 2013 outlook.

We see the outlook for the Group as a whole for 2013 as unchanged. We do expect, however, to see some variation in performance at the product franchise level. In particular, Healthpoint is performing more strongly than we previously guided; and conversely, we're seeing slightly lower Hip and Knee growth relative to the market than we had expected.

In terms of margin, as you know, we expect to be below the 2012 level. We highlighted three factors in February which will reduce our margin, and these will partially be offset by our efficiency programs.

A few comments on Q2 and the phasing of our revenue growth and margin this year.

We expect the revenue trends of Q1 to continue into Q2. We expect the second half of the year to be stronger as we benefit from new product introductions. The two sales days we lost in Q1 we will make up for in Q2 and Q4 this year, and we expect Healthpoint growth to be over 20% for the full year.

In terms of margin, the cost of this accelerated investment will start to come through in Q2 ahead of the benefits.

And with that, I will hand back to Olivier.

Thank you, Julie. So turning to a summary of the first quarter, our revenue and trading profit performance was in line with our expectations. It was a good performance, given that underlying markets remain challenging.

Our strategic priorities are very simple. They are about on the one hand being as efficient as possible, and on the other, investing appropriate amounts in appropriate areas to drive growth.

I'm pleased that this quarter continues to show the clear benefits of the investment we have chosen to make in products, in geographies, and in acquisitions.

But we'll not rest here. Just as important as high level strategic priorities is the day to day execution in the management of our business, seeing and reacting to opportunities, our customers and market forces. This is what we are doing in our Recon franchise.

This year, we are increasing further our R&D spend. In Q1, underlying spend was 4.9% of sales, an increase of 4.3% a year ago. In the short term, Sports Medicine and Joint Repair will have several new products in late 2013. In addition, the first of our Advanced Wound Management ranges for the emerging market mid-tier will be launched.

Looking further out, the phase 3 multi-year trial for Healthpoint venous leg ulcers is underway. I would also like to highlight the agreed acquisition in India and Brazil which occurred just at the quarter end. These directly support our strategic priorities to build leadership positions in the emerging markets and to supplement our organic growth through acquisitions.

As you can tell from the acquisitions we have made and the outcome of our capital allocation review, we have made -- we have material but major aspirations in this area. I will keep you updated as we progress.

Finally, our capital allocation priorities. There are two key messages I want to leave you with regarding this, balance and discipline. I believe that a company like ours must strike a balance between investment for future growth and returning the benefits of surplus capital to our shareholders.

In 2012, we returned $186 million to shareholders. In the next 12 months, it could approach 3 times this amount, as Julie said.

And on discipline, we continue to apply vigorous discipline to use of our cash flow. Our future growth will come from organic investments, supplemented I believe by growth from acquisitions. Where such opportunities are not available in the medium term, as you can see from today's actions, we'll return the surplus capital.

Thank you for listening. I hope you can see the clear see the clear path activities we are taking to transition and reshape the Group for future growth.

And, Caroline, we'll now take questions. Thank you.

(Operator Instructions). Matt Miksic, Piper Jaffray. It appears that the question has been removed. Chris Gretler, Credit Suisse.

I have a few questions. First, could you elaborate on this [now] situation in Germany? And in particular, I was wondering whether you think you are losing share here as there is [now off-bundling] going on and that you're not in such a good position with respect to that, I was just wondering, given that this is a very steep decline in the market you're reporting, that it's something to look into.

Then the second question is generally with respect strategically and given your reorganization, is there basically now a certain trade-off between margin gains and growth in Hip and Knee? And is there now a sense that you have under-invested in some areas or cut too much costs that it has an impact on your overall top line performance in these two product groups in particular? So I was -- that's probably now the main two questions I have at the moment.

Okay, Chris, thank you for the questions. Let me start by the second one on the Recon Knee and Hip business.

Again, I think it's a -- there's nothing non-expected here. I've been pretty clear in Q4 that the situation will be this. Now we are some -- it's slightly weaker than what we're expecting; that is true. But we're aware that we were supposed to lose market share during the first part of the year until the launch of JOURNEY II, and this is happening.

On top of this, and that will rebound on your second -- your first question, we are over-exposed in Europe and Europe is pretty weak, and actually weaker than what we were expecting; Germany particularly, which is your first question.

And what is happening in Germany, actually, the market is minus 10% in Germany, German payers have been putting pressure on providers to reduce the number of hip and knee procedures. And they have been highlighting the high rate of utilization in Germany compared to other countries and there was much more use of recon procedures in Germany than in the rest of Europe, and the pressure is there, so the market is about minus 10%.

As you know, we have acquired a few years ago Plus in Germany. We have a big exposure in Germany, and that's one of the reasons why we are struggling in this moment.

On top of this, you have always the metal-on-metal, which is still important for us. It's about 30% decline again this quarter, as in 29%. What is happening there, nothing surprising, nothing new, but still it's a big headwind, and in the US and in Europe.

So I think this is -- what I can tell you now the good news is that we have done the restructuring. We have had -- it's true, actually. You were mentioning some slight disruption in the sales channel, despite the fact that we're not touching the sales force. But you know when you reorganize, you always have a small disruption. [Geo] managers are leaving; instead of two we have one. So it changes things.

So now this is behind us. We are now lean, we are ready, and that's why I was mentioning that we plan to do some targeted investments in medical litigation, in marketing, whether it is in Europe or the US. And so we expect that this will support strongly the launch of JOURNEY II, which is again essential, and the rest of our portfolio in Hip and Knees.

Okay, fair enough. Now maybe one quick follow-up question. What was the price increase for SANTYL you did in Q1?

Well, obviously, as you can imagine, we don't disclose it. And it varies, actually. You have price increase; then you have the discounts you make, and so on. So it varies from one account to another one. So it's not something that I'm going to disclose, Chris.

But, basically, the 20% growth now you think is more of a fair underlying growth for that business? Because, at least relative to my expectation, the price is a bit on the upside.

Yes. We have done the price increase at the end of January, so you have had a significant amount of stocking before. So when you see the 49% growth in this quarter, a part of this is due to the stocking.

We see a destocking at the end of the quarter, we have seen it, and we will certainly see that again a little bit in Q2. We believe that the growth will be over 20% for the rest of the year; full year, actually, including this 49%.

Okay, good. Thank you.

Chris, I want to insist on the fact that we are very happy with this business. It's a very healthy, very strong business, and we have a great management team there.

It looks like now. Thanks. Have a good day.

Thank you, Chris.

Veronika Dubajova, Goldman Sachs.

I have three, if I can, one just on the overall competitive environment in Europe. One of your larger competitors has been making a lot of investments into reaccelerating growth in Europe, and I'm wondering if that is having any impact at all on your overall European performance.

My second question is on the acquisitions, and congratulations on achieving some of the targets, Olivier, that you set out. I'm just wondering if you can give us a better sense of what the revenue and margin impact might be of these going forward.

And then as you look about the strategic goals that you laid out for the business a while back, how much further to do you have go in emerging markets before you get to an infrastructure level that you're happy with?

And my last question hopefully just on housekeeping, but if you can give us a detail on pricing pressure in Hips and Knees in US and OUS, that would be very helpful.

Thank you very much.

Veronika, good morning. A number of questions, as usual; good questions. So let's start by the last one on the price pressure.

Nothing new here; very similar to what we have seen in the quarter 1 -- in the Q4, so nothing to comment on this. We are still with our guess, which is around 3% to 4% price decrease on a year-to-year basis; so nothing new here.

On the acquisitions side, no, I'm not going to disclose the impact on margin and on the revenue. Again, I think the most important, Veronika, here is to think about our goal of $500 million in 2015, which is what we want to build.

Margin-wise, we do well in the emerging markets. I believe that we now have a very good structure, whether it is in Brazil now with the acquisition of the distributor; in Russia, where we have now a legal entity; in India, where we have also a new management, in India, we have strong management plus now the acquisition of this business; and obviously in China, where we have a very significant growth.

On top of this, we have decided to invest last year in few other geographies. Middle East is important for us and is doing extremely well, as well as Mexico, which has a very, very important growth this quarter.

So I tell you, I'm very happy with what is happening in the emerging market. I think it's on track with our expectations. And the acquisitions in India and in Brazil are just the cherry on the cake because they are important and they will really help us to have a good platform for the growth.

In Europe, maybe the additional investment that our competitor has done has an impact. Obviously, it's a -- we have decided that this was not the right time for us to over-invest in Europe, for different reasons. And I'm talking about ASD here, because that's the competitor you mention. We have decided it was not the right time to do it in Q4 or Q1 because there was not in the Knees any type of innovation to support.

So now, as I said, it's the right time to target investments, so we are going to do more investment, targeted in medical education in Europe, to support the launch of JOURNEY II. So that's what I can tell you.

Do we have an impact? For sure. When a competitor is increasing his share of voice, there is no doubt that there is an impact on the dynamic.

Understood, Olivier. And if I could, just a quick follow up on the emerging market side. Are you happy now with the infrastructure that you have? Or do you foresee the need for further incremental add-on deals in the breaks to get you to a point where you can achieve the $500 million?

Well, we'll certainly do more acquisitions in the emerging market in the year to come, yes.

That's very clear. Thank you very much.

Julien Dormois, Exane.

Three questions on my side, please. The first one is about cash flow distribution. Do you now expect to make a decision on that virtually every year; so between, I would say, full year and Q1? So is it something that we should now be factoring in our estimates?

The second question is related to the price increase for SANTYL, so not so much about the magnitude of the price increase, but more if you see room for doing that now every year.

And the third question is about the situation, the competitive situation in Trauma. I don't know if you've already addressed that in the call, but I was just wondering if the issues from your competitor are still there, or if they are back. And if yes, how could this impact your [overall] growth prospective in Trauma for the next few quarters?

Thank you, Julien. Let me answer the two last questions, and then I will ask Julie to answer on the cash redistribution.

Trauma, first, yes, we are still benefitting from the problems of one of our competitors, which is back on track now, by the way. But in the Q1 figures, yes, there is a part of it which is due to this. I don't think it's a big part, but it's a part.

They are back. However, as you know, when you have been away for a while, you leave an empty seat. And I think that we are now strongly anchored in a few accounts, and I hope that we are going to stay there.

So despite this, the dynamic of the Trauma business is very good due to, A, the reorganization that we have done with Trauma Extremities in the US last year, it was in September; and plus now the fact that we have hired in Q1 on this new base [50] new reps, and obviously, they will start to generate business in the future. So I'm very confident that Trauma will go well for the rest of the year.

If you remember, last year, I was pretty nervous about the dynamic, or the lack of dynamic of the Trauma business. So I think we have handled that pretty well, and things are now back on track.

On the price increase of SANTYL, again, is it a year -- a permanent price increase? No, it's not, actually. That depends on market conditions, it depends on many things. I think it's a pretty complex product to do, and so we wanted to reflect this and have the right price, actually.

So that's why we have done this price increase at the start of the year, which it's always important, but I think it's pretty well managed, and we are happy with the outcome.

Now Julie, you want to --?

Yes, thanks, Olivier. Thank you very much. And thanks for the question, Julien. So in terms of our capital allocation and the start of our share buyback, we've deliberately said that this is not an annual or a regular review. Clearly, as any good company would, we'll keep our position under review, obviously reflecting changes in the business as we execute our strategy.

So what we've done with yourselves and our investors is laid out the capital allocation framework that we'll use so that you know how we'll think about this. And as we've said, there are a number of key priorities that we see. First, investment in organic growth; second, our progressive dividend; third, our acquisition policy; fourth, our return of surplus cash. But this is all underpinned by the Company maintaining a strong balance sheet with solid investment grade credit rating.

So we're making no commitment for next year, but at least you know exactly the way that we'll think about this in the future.

Okay. Thank you very much.

Michael Jungling, Morgan Stanley.

I've got three questions. Firstly, in Orthopedics, should we be concerned that the growth gap between Hips and Knees to your peers is expanding more and more quarter after quarter? If I look at sales days adjusted numbers in the first quarter, and also look at sales days adjusted numbers for yours, we're looking at a 6 point difference, which is unheard of I would argue in the area of orthopedics, at least the last 10 years that I've followed the space. It's very concerning.

Should I be concerned that this is a more structural problem and that it's not just a product cycle but that you need to do some other things to make this work?

Question number two on the definition of underlying sales growth, has there been a change in the way that you look at underlying sales growth? Because if look at the note on page 2 of this quarter -- the last quarter, it seems that the definition has changed. If it has, what would have been the underlying organic constant currency growth rate by division? That would be useful.

And then the third question I have is on Wound Care. How large was the stocking effect in the first quarter as a result of the increase in price? I think you mentioned materials. So is it $3 million, $4 million, $5 million, or 10 million? That also would be very useful.

Thank you.

Okay, Michael, thank you for the questions. On the Wound Care, there is a material stocking; yes, it's true. You can make the calculation. I'm going to give you the figure, but you can very quickly make the calculation. If we believe that our full-year guideline will be over 20%, you know that the quarter has been 49% so you'll be able to deduct what has been the part of this increase.

Regarding the gap with our competitors, you are right. I think that's definitely something which is true. We are in the global recon market at minus 6%. The market is minus 1%. It's definitely one of the worst quarter we have had. This is true, but again, it's not a surprise.

And what I'm telling you is that this should not last because of what I just talked about, which is, A, the JOURNEY II launch; B, the fact that BHR is now less and less important for us in the Hips business; 3, because we have target investments we decide to do now that we have definitely a structure which is appropriate.

So I'm not very anxious about what is going on this quarter on the return. I know it's not a good quarter, but again, it doesn't mean that this will remain like this for the rest of the year, and we'll see that during the next quarters.

So I believe that we have had, and I've said that, we have had some disruptions in the sales. I was mentioning it before in Europe. We have had some slight disruptions also in the US. There is no doubt about this. And this on top of BHR, on top of the Knees cycle, and so on. I think everything is behind us now and we should start again on a good dynamic.

Julie, do you want to add on the other question on underlying sales growth?

Absolutely. Thanks Michael for the question. So in terms of the definition, what we're doing is including Healthpoint on a like-for-like basis (inaudible) in both years, and excluding Bioventus, obviously, assumed we hadn't owned the Company in both years. And the reason for that is acquisitions are such an important part of our strategy, and management are very focused on delivering value through our acquisitions, so we're comparing apples with apples, but assuming when we take on a new company that it gets incorporated into our results.

So just to answer the question about what would the growth have been for the divisions, so obviously ASD, there's no change to ASD as a result of Healthpoint. If take Wound, we've reported underlying growth on Wound of 12%. And if you exclude Healthpoint, that underlying growth would have been 5%. And if you look at the total Company, we're reporting underlying growth of 1%. And if you exclude Healthpoint from our total organization, then it would have been a decline of 1%.

So Healthpoint at the Group level makes 2 percentage points difference.

Thank you, Julie. But I think, Michael, this is exactly the point here, and that's why we have had two years ago this decision, taken the decision to acquire a good growing business.

I think it's very important for the re-balance of the Company. And you see, whether it's in Wound or even the impact on the global Company, the importance and the value of good acquisitions in our business.

Great. Just a further question on the growth rates then for the new definition. Is it fair to say that every time you make an acquisition, that will then be included in the base effect, or the base year, to work out what the underlying growth would have been?

Yes, it will, Michael. So this is our stated policy. Obviously, we've looked at what other companies do. And since it's a non-GAAP measure, we're making it very clear that this is our policy going forward and now.

Okay. So what then this means is if you're including acquisitions which are faster growth, for this quarter, the underlying growth probably is as a result of the definition slightly better than it perhaps would have been under the old definition?

Yes, that's true; that's absolutely true. But we'll always do is give you the comparative figures should you want them. And especially during the year of transition, that will always be available to you.

Great. Thank you.

Ed Ridley-Day, Bank of America.

I'd also like to ask around investment in Orthopedics. Obviously, very positive to see the increase in R&D spending in the quarter, but really have you waited too long?

As Mike was saying, really quite a divergence in performance now. And although, Olivier, yes, you have been very clear that you expected a weak performance in this half, as you know, it is difficult to turn around quickly sometimes. So my concern is how much more are you going to have to invest? Could you give us some color on that about how much you're going to increase R&D investment and how much you're going to increase the sales investment to support the journey?

That will be my first question.

Okay. Thank you, Ed. I think that years ago, we have decided to rebalance the Company and invest on high-growth businesses which were Advanced Wound Management, Negative Pressure, emerging markets, because we believed it was the place where the business on long-term basis would be the best for the Company -- which doesn't mean we have stopped investing on Recon and Ortho. Actually, we have done a lot of things in the Endo business, developing and preparing the future of the Biomaterials, launching in Sports Medicine a number of products.

In the Recon Hip and Knee, we have decided to focus on a few important innovations. We didn't want to just invest money and not be able to invest in the big places we wanted to be, because we wanted to be everywhere.

So we have specifically decided to be strong in the [vision area], in the (inaudible), to be strong in the JOURNEY II, the future of JOURNEY II also; the very last for Hip, and so on and so forth.

But it's not -- I would say we have not put all the investments in the Recon business. They have been spread according to what we believed were important fields of the future.

So, yes, have we been late? One can say we have been late in investing more in R&D in Recon. I think that for me, it's more important to bring few good products, despite the fact that we have some downside in the cycle, like we have now. But you bring good innovation rather than just bringing products which do not bring value to the patients or to the payers. And in the environment that we face, if you do not bring good innovations, you will get no price premium and you will result -- the result will be a loss of margin.

So my view is we have done what we were supposed to do. It is true this quarter is not the best quarter for Recon. Let me remind you again that Recon is a bit more than 30% of our business, and we are not a pure recon Company. We are a global medical device company with Wound, with Sports Medicine and with Recon.

So again, I don't think it's appropriate to compare Smith & Nephew to a pure recon company, because that is not what we are.

No, okay. I understand. And just in terms of the R&D spending, should we see that continue to move up slightly towards the 5% to 6% range?

Yes, it is true. And you'll remember also that I've announced that two years ago that the target was 5%. We are obviously on track to this and to be more than 5%.

Obviously, a part of it is the reason -- the reason of that is mainly the HP802, which is a new product for the venous leg ulcer that we develop through the acquisition of Healthpoint. But globally, will be more than 5% for sure in the short term.

Thank you very much. And then just a -- I've got a question for Julie on the capital allocation. Could you maybe give us more color on what you define as a solid investment grade rating?

And related to that, clearly, you don't have any outstanding debt, but you have, as you have shown again this quarter, a fantastic cash flow and a very strong balance sheet. So could you also potentially talk with relation to solid investment grade ratings about your perhaps desire to leverage your balance sheet?

Okay, Michael; thank you. In terms of solid investment grade rating, we see this as definitely being BBB, a high BBB rating. In looking at the ratios that credit rating agencies use, the key ratio that we would refer to would be the reported net debt to EBITDA ratio. And here, we've set out very clearly that we expect our net debt to EBITDA to be lower than 1.5 times on a reported basis. So that we've set as a line in the sand for the Company to follow.

As you know, we've got $137 million at the moment of net debt at the end of March, and basically, what we're doing is we're using the capital allocation framework that I outlined in the presentation to decide how much to distribute to shareholders and how much to set aside for acquisitions.

So clearly, because acquisitions are a key part of our strategy, we're leaving sufficient headroom to be able to conduct those.

Thank you. Just one final follow-up. Would you feel comfortable accessing the credit markets given the very low rates that a company such as yours would be able to achieve?

I think, obviously, what we'll do is follow the Group strategy and the Company strategy in terms of what we're doing. So I always believe the financing strategy should follow the Group strategy. So clearly, if acquisitions follow, we would clearly use that probably as one of the mechanisms.

But at this stage, we haven't decided on the balance yet that we would use between bank and non-bank debt. So no firm decisions have been taken by the Board yet in this respect.

Very clear. Thank you.

Ingeborg Oie, Jefferies.

Firstly, a slightly long-term one. You talk about rebalancing of the Company. Could you maybe give us a vision of what the Company might look like in terms of the importance of Recon in five years to 10 years' time from now?

Secondly, on the dividend, you have set what you seem to think is an appropriate dividend level which will now be progressive. Could you explain a bit what went into the decision that this was the appropriate dividend level, since it's neither a high-paying dividend or a company that's saying that it's going to be fully investing in growth? So it's sitting somewhere in between, and I was just wondering what discussions had gone in to deciding on this specific level.

Thank you.

Hi, Ingeborg, thank you for your questions. Do you want to start with dividend?

Yes, I can start with dividends. Okay, so thank you very much. So in terms of our dividend, obviously, as you know, we've been -- we increased the dividend significantly in 2012 by 50%, and for the four years to five years prior to that, the Company had been growing the dividend by 10 percentage points.

So the key metric that we use when deciding to set the dividend is the level of cover that's appropriate for Smith & Nephew given our position in the FTSE, and also given the position in the med tech sector.

And so using that dividend cover, as you know, in 2012, our dividend cover was 2.9 times, which is a very healthy dividend cover, and because really the policy was reviewed by the Board and set in the middle of 2012, we will continue with that policy. But as any good Company does, in the future, obviously, it may be under review.

But at the moment, we're very happy with the dividend cover; it's very healthy. And we'll continue with our progressive dividend policy.

Thank you, Julie. So regarding the question which I think is a very interesting question on rebalancing the Company. When I say it's a very interesting question because we are thinking a lot about this for many months.

I think it's not very interesting to give you the split of what it will become. I can give you a flavor, actually. Today, roughly, ASD is at 68% of the Company, 70%; Wound is about 20%; and emerging markets is about 12%. So that's where we are now.

So what can you imagine for the future? Well, you can imagine that the emerging markets will be much bigger, obviously, and the Advanced Wound Management with the growth that we have in this field will be also bigger. So what will be the exact proportion, I cannot tell you, but you can very easily imagine how I want this Company to be.

And what is happening here? If you think about today's business, well, 60% of the Company is a low-growth business, and 40%, or slightly less actually, is a high-growth business. So my view here and my strategy is to increase the proportion of high-growth business, investing more on these businesses, and that's definitely what is going to make the changes.

That's why when you think about the split of the investment of the Company, you see that we invest in some geographies, in some specific portfolios, and in some produce franchises. So that's what I can tell you, Ingeborg.

Great. Thank you.

[Alex Gibbons, Bradley's]. It appears that the question has been removed. Tom Jones, Berenberg.

The first question, I hate to harp back to it, but the Orthopedics business, it is still a significant chunk of your business and a particularly significant chunk of your cash flow. I wonder if you'd care to comment on the drivers of the differential between your performance and that of your competitors, particularly with respect to how much of the 5-point gap between you and your peers is a result of you just having to yield on price to maintain volume as your portfolio ages. How much is a consequence of you losing accounts or losing volume to your peers, and how much of it is really a factor of your geographic mix where you may happen to be overexposed in weaker markets?

And the reason I ask is it really -- it goes to our confidence that with some new products you'll be able to recover this business quickly. If it's just price you're having to yield in the short term, one would think that new products would allow you to get that back, but if you're losing whole accounts, then you're dependent on winning those back, which is always a bigger task. Or if it's a geographic mix effect, then you're reliant on the market conditions picking back up. And new products will help, but they certainly might not drive as quick a recovery.

So that's the first question. The second one I'll ask in a minute.

Yes. Thank you, Tom. This is a good question. We obviously have had to play on price in a few accounts, because, as you said, the portfolio is older, and obviously I've always said that there's a bigger price erosion for other portfolios and when you bring innovation on the market. So it is true that there is [this].

That's why when I think about the future, when I think about the new products we bring, I'm confident that this will come back pretty quickly.

Geographically, it's a fact. Europe is there. We are strong in Europe. It's about 30% of the business of the Company, Europe. And obviously, the market is very weak. I was mentioning specifically the German market, but it is absolutely the case in most of the countries, [South] Europe, and the rest of the businesses. So it's the second point.

Product cycle, I've mentioned it. It's a fact also. We expect now the full launch of JOURNEY II to change this game. And I said to you before also, and don't forget that, and I think that we were a little bit maybe candid two years ago believing that we'll not get any business disruption in reorganizing and putting the Company on a more lean base.

We have seen some business disruption. When you have two general managers in one country and you finally leave just one, well, one guy is leaving and it brings some potential disruption.

So it's true that all this together have been generating in ASD and partly in Recon some slight issues.

Now, again, is it structural? No, it's not, because now our structure is there; it's ready. Investments are there ready; new products are there ready. The only thing which is not changing is our weight in Europe, but I do believe that we are going to be able to come back on track in this business.

Great. That's very helpful. And the second question --

Sorry, we'll take two more questions from two more people, please.

Okay.

Charles Weston, Numis.

First of all, on the capital allocation, you've talked about headroom being sufficient for acquisitions at the moment, and I'm just wondering precisely what that means. If you're looking up to 1.5 times debt to EBITDA, it implies that you've got about $2 billion headroom. Is that the kind of level that you're looking to maintain? So in a year's time, if you have an additional $0.5 billion on the balance sheet, would it be fair to say that that could be distributed out and you maintain that $2 billion level?

Secondly, on Hips. We've talked a lot about Knees in the new products. I can see that you've got REDAPT coming out in the second quarter, but is that likely to be much of a game-changer in Hips in the same way that you're expecting JOURNEY II to be in Knees? And if not, what do you expect to be the timeline for a major upgrade in terms of the Hip portfolio?

And lastly on the sales force disruption that you mentioned, you've been asked probably every quarter about whether there is any disruption in the sales force, and the answer has pretty much uniformly been no up to this quarter. So I was wondering has something happened in this last quarter that has surprised you with regard to the sales team.

Charles, just reacting on this one, then going back to capital allocation. I've always said there was no sales force disruption, and I think there's no sales force disruption. I'm talking about business disruption linked to changes in the G&A that we have changed, in the senior management.

As you know, in this business people are leaving, and customers are leaving also. It's not a question of sales force. We have not touched the sales force, so there is no pure sales force --. On the contrary. We have worked a lot in improving the sales force effectiveness through big programs of sales force efficiencies, sales force effectiveness, and so on.

I'm very consistent with that. I'm not talking about sales force; I'm talking about business disruption.

Actually, I'll give you a few examples. When you reorganize your business, you obviously think about your margin. And in a few places we have stopped dealing with some distributors because we believe they were not efficient for us. So when you stop dealing with a distributor, you obviously have one hole in your business which is now starting to come back. So we are there, but it is not a question of sales force.

Okay, thanks for clarifying that.

Okay. Thanks, Charles, for the question on the capital allocation. So, yes, our EBITDA was $1,246 million in 2012. And if you take a multiple of that of 1.5, obviously all this is on a reported basis, then we would have debt capacity of about $1.8 billion/$1.9 billion.

If you take into account then our net debt and our cash flow generated in the year, because we need to see this on an annual basis, then the headroom following the share buyback we just announced will be about $1.5 billion. So that's basically how it works.

Clearly, the equation is all dependent on the amount we decide to set aside for acquisitions, and we see that being flexible depending on the acquisition pipeline that we have got, and also the strategy for the Company, and timing. So those are the factors that go into it.

Okay, Charles, on the question on Hip, I think that in Hip we have a good portfolio in Hip. There is no doubt. We also believe that REDAPT will definitely help the revision. We also have, as you know, the potential of the VERILAST for Hips, which can obviously drive sales, with a potential 30-years [claim].

So definitely, we have some good things in front of us also in the Hip business as well as in the Knee business. So that's what I can tell you.

Okay. Thank you.

Lisa Clive, Sanford Bernstein.

Two questions. On Europe, clearly, it's a tough market. It's tough in Orthopedics; it's tough in Wound Management. My understanding is that historically, Sports Medicine has actually been a bit of a bright spot in Europe for you. Could you just talk about how you see the trends developing in that market? And if that market still is relatively underdeveloped, how much longer do you think we could see fairly strong growth from that market?

And then second question on Negative Pressure Wound Therapy. That business clearly continues to do well for you. Could you give a sense of what you think your market share is today, both in the US and in Europe in those markets and where you think you could get to ultimately?

Thank you, Lisa. Start with the Negative Pressure. Yes, it's a good market for us, even though it is a competitive market and more and more competitive with price erosion in this market. So for us, the game is to gain share actually in this, as you mentioned.

So what is our growth? Well, the growth of what we call the Advanced Wound Devices, which is mainly the Negative Pressure, is 26% this quarter. So it shows you how strong we are in this business.

We do well in Europe; we do well in the US; we do well in Japan where we have launched the product in September. We also do well in investigating in new geographies, actually. We launched Negative Pressure Wound Therapy in China, which has also very extensive business potential for us.

So you imagine that for us, it's really a fantastic place to be with a great range of products. You know we have launched the ACTICOAT -- sorry the ACTICOAT dressing for PICO this quarter. We have a number of things happening there.

Now market share-wise, we are over 20% for sure in Europe. In Japan, I have mentioned to you that the end of the year was very strong so we gain market share again. We are at 20% market share in Japan. And in the US, we are slightly lower than this 20% but we are en route for a great trend. So that's what I can tell you.

Okay, thanks. Very helpful.

Okay. In Sports Medicine, your second question, in Europe. As you know, we do not have data for the market in Sports Medicine. We are very happy with what we see. We see almost no price erosion in Sports Medicine, which is very important, at the contrary of the Recon business.

We bring a lot of innovations and the pace of innovation is higher in Sports Medicine than in the rest of the ASD business. And here again, we believe that Europe has still big potential, so I don't foresee a drop in the dynamic of this market in Europe in the future.

Okay? So thanks a lot. Thank you all for your time today, and wish you a good day.

Thank you.

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