Smith & Nephew PLC (SNN) 2014 Q1 法說會逐字稿

Good day, and welcome to the Smith & Nephew Q1 2014 results conference call. For your information, today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Olivier Bohuon, Chief Executive Officer. Please go ahead.

Good morning, everyone. It's Olivier, and I'm here with Julie. Welcome to our first quarter results presentation. I will cover the highlights, and then hand over to Julie, to take you through the numbers. And as usual, we'll take the questions at the end.

We delivered revenue growth of 1% underlying, and much of this performance relates to specific Q1 headwinds. We have previously highlighted the market dynamics in the US, and some tough comparables.

Our revenue growth this quarter essentially reflect a slower performance in established market hip and knee reconstruction, and advanced wound care. This is been offset by our faster-growing franchises, products and geographic areas.

As I have said in previous quarters, we're making significant investment in the areas with the opportunity to drive growth.

As we go through today's presentation we'll highlight our strong lineup new product, particularly in our ASD franchise. This is in addition to our investments in marketing and sales, and [education]. Hence, I am confident of an improved performance for 2014 as a whole, and of delivering our full-year guidance.

We'll also talk about the outcome of the detailed review to optimize our Group structure; the continuation of our campaign to make Smith & Nephew more fit and more effective for the future. In doing so, we not only strengthen and simplify our structure, but we drive greater efficiencies, of which we have identify at least $120 million of savings.

The trading profit was $229 million, giving a trading profit margin of 21.3%, which was in line with our expectations.

Adjusted earning per share was $0.177, compared to $0.185 last year, tracking the change in trading profit.

Finally, a quick update on our $1.7 billion acquisition of ArthroCare. We have achieved our antitrust clearance in the US and in Germany, and the UK process is ongoing. The ArthroCare shareholder meeting is set for May 8, and we continue to expect completion in mid-2014.

This slide capture our underlying growth in the quarter; on the left-hand side geographically, and on the right by product franchise.

In the US, revenue fell by 2% and, in the other established market, growth was plus 1%. I will talk more about geographic factors by franchise in the following slides.

Emerging and international markets grew by 9%. Within this, China continued its strong growth trend, being up over 30% in the quarter.

The integration of our Turkish and Indian acquisitions have been straightforward, and are both progressing well.

Overall growth was partly held back by disruption in Brazil, as we move from a distributor model to a direct business, and the disruption will continue for a couple of quarters. Excluding Brazil, our emerging market business grew at 12%.

I will now turn to look at each franchise in more detail, starting with hip and knee implants.

Our global recon implant revenue was flat in a market we estimate grew at plus 3%. The weak US market dynamics, [excellent] in Q1, following a very strong Q4, have been reported extensively by our peers. Principally, we saw the pulling-forward of procedures into Q4 from Q1, due to concerns about the start of changes to US healthcare insurance.

In addition, Smith & Nephew came off a very strong Q4, which benefited from an extra selling day, when most of our competitors had an extra sales day this quarter.

Our US knee growth was minus 1% and it's due to a number of factors. And as ever, it can be difficult to attribute specific weight to each one.

At product level, our JOURNEY II rollout continues to be very strong. However, our core knee range was better in Q4 2013, some of which we attribute to the impact of the successful knee DTC campaign, boosting our Q4 performance. As I have said many times in the past, hip and knee trends should be judged over many quarters, and not just one.

During the quarter, we launched an important addition to our JOURNEY II knee system, the CR, or cruciate-retaining option. The new implant allows surgeons to preserve the posterior cruciate ligament, a procedure which accounts for approximately half of all knee replacement.

In US hips, we started a TV campaign, highlighting the advantages of VERILAST bearing surface when used in hips. This is the first campaign focused on hips for many years, and we should start to see a benefit in the Q2.

Outside of the US, our recon business has remained relatively stable.

Turning now to sports medicine joint repair. This franchise performed well, growing at 5% in the quarter, considering the US market dynamics I have already mentioned.

Our trauma and extremities revenue fell by 1%. The US performance was soft, as expected, against a very strong comparable period which benefited from a nail recall by a competitor.

Looking across 2014, we have a very strong pipeline of new product launches across all of these franchises. Just highlighting a few; in joint repair we continue to launch new anchors. For example, we extended our unique HEALICOIL range.

In extremities, we're certain to launch a more comprehensive hand and wrist range to complement our ALL28 foot and ankle offering. We started with a distal radius plating system, packaged for efficient operating room use. We are also extending our leading FAST-FIX system to address cartilage repair in the wrist.

In our DYONICS platform, we recently introduced a first of its kind hip impingement planning system. This 3D software system allows greater preoperative planning and is built on technology we acquired a couple of years ago. In addition, we have a resection access [and video] products all in the pipeline.

Turning to advanced wound management, which was flat in the quarter, this compares the market, which we have seen it grow at 3%. The advanced wound care revenues fell by 6%. Our sales channel includes wholesale distributors and, typically, stocking and destocking patterns roughly equal out. However, this quarter saw an unusual combination of distributor destocking in multiple countries, notably in the US, in the UK and in Japan.

In addition, there are some areas of wound care where I'm looking for improved performance, mainly the US and in the emerging markets. Both are areas where we can make much more of our very strong portfolio in the positive market environment.

The advanced wound devices grew at 13% and is now growing from a larger sales base of over $200 million a year. This quarter, we benefited from a stronger than normal VERSAJET performance as we launched in China. Negative pressure, PICO growth continues to be very strong, although the traditional negative pressure market remains difficult.

In advanced wound bioactives, we grew at 8% and I'm very satisfied with the improving volume trend for SANTYL. And our biotherapeutic business is absolutely on track for our 2014 mid-teens percentage growth expectation.

We are over a year into the Healthpoint acquisition. We have started the next phase of our integration, namely looking at ways of leveraging our broader sales channel. We're now selling some of the other smaller biotherapeutic products in Europe; in particular ProShield, a skin protector and cleanser made a contribution this quarter.

And now, I turn over to Julie.

Thank you, Olivier. So turning to the Q1 results, I will focus on five items; revenue and profitability analysis by business segment; income statement and cash flow; the outcome of our review to optimize our Group, which we've been working on for some time now and I'm pleased to be able to share it with you; the outlook for the rest of 2014; and a reminder of the guidance on ArthroCare and an update on the transaction.

Firstly, the analysis of revenue growth by business segment. Revenue in the quarter grew 1% on an underlying basis. By division, advanced surgical devices grew by 1% and wound was flat, against the prior year. The Bioventus transaction reduced ASD segmental revenues by 1%.

The emerging market acquisitions in Brazil, India and Turkey added 1 percentage point to our reported Group sales growth rate. And currency impacted the Group adversely by 1%, largely due to a strengthening of the US dollar against the Japanese yen and the Australian dollar. In reported terms, Group revenue in the quarter was flat and there were no adjustments for sales days versus the same quarter last year.

This slide shows underlying revenue growth by geography and business segment. Revenue is shown at the top half and growth rates are shown in the lower section.

Oliver has covered ASD and, therefore, I'll give more information on wound, given our flat results in the quarter. Looking at the bottom right-hand section of the slide, wound in the US declined by 4%. And here, we saw wholesaler consolidation leading to destocking in the quarter, and we also faced a strong comparator following stocking ahead of the SANTYL price increase in Q1 2013.

Wound, in other established markets, grew by 3%, and this reflects a strong underlying performance with high single- to double-digit growth in many of our European countries. This was partially offset by destocking in the UK and in Japan; the former due to wholesaler consolidation and the latter due to Japanese wholesalers reducing inventory ahead of the biennial price decrease.

Given Q1 results, we expect to see further destocking in the US and Europe in Q2.

Wound, in emerging markets, was flat compared with the prior year. This somewhat unusual result partly reflects the timing of tenders and importation delays following our distributor acquisition in Brazil.

Overall, adjusting for the above factors, the growth rate in wound would have been approximately 3 percentage points higher, reflecting in-market demand. And one final comment on this slide; we have seen similar pricing trends as in previous quarters.

Turning to profitability by business segment; as expected and noted in our Q4 guidance, the Group margin of 21.3% represented a decrease of 110 basis points, compared with last year. This reflects our continuing investment in our business.

ASD margin was 22.9%, 140 basis point decline compared with 2013, and this reflects the impact of investments made in our sales force over the last year and direct to consumer advertising of our VERILAST hip in the US.

Advanced wound management profitability fell by 30 basis points, and this partly reflects the investment in HP802 phase III trials, which are now underway in the US and in Europe.

Finally, a comment on our structural efficiency program. It is on track to deliver benefits slightly ahead of plan and has now delivered annualized benefits of over $135 million.

Looking at the income statement for Q1, trading profit in the quarter was $229 million, a 5% decrease on an underlying basis. The adjusting items were; restructuring costs reflecting our efficiency program, acquisition-related costs, primarily Healthpoint and now ArthroCare, and finally, amortization of acquisition intangibles of $24 million.

In addition, there was one new item, a $35 million credit, which is due to our decision to close the US defined benefit pension scheme to future accrual. There will be an ongoing benefit to the Group in terms of lower service costs, but this will not have a significant impact on reported margins.

Please note that we've improved our disclosure of adjusting items to our income statement, and the full details of this are disclosed in note 8 to our announcement.

Moving down the income statement, our effective tax rate for the quarter is 28.9%, the expected full rate for the year. We continue to seek efficiencies in all areas of our Group, including taxation, and the estimated effective tax rate on adjusted profit for the full year has been reduced by approximately 1 percentage point, when compared with the same period last year.

EPSA declined by 4%, benefiting slightly from the share buyback we announced last May.

Now, I will turn to cash flow. In the quarter, we generated trading cash of $78 million, giving a cash conversion of 34%. This rate is lower than usual, largely due to increased working capital caused by a combination of factors.

We have built inventory to support sales plans from our reconstruction business. In particular, instrument sets for JOURNEY II, and support for emerging market growth, and the supply of tenders.

In wound, there has been some rebuilding of safety stock, following the flood in Hull last December. And in bioactives, we have increased inventory holdings of SANTYL and Regranex to meet anticipated demand.

Finally, receivables and payables moved diversely in the quarter, partly due to a deliberate decision to stop debt factoring in Italy. And also, due to the quarter-end close date and pattern of trading this quarter.

Our outlook for full-year cash conversion remains at around 80%, as some of the one-off items we've seen in Q1, such as the building of instrument sets before deployment, are worked through our supply chain.

Now, turning to Group optimization. As signalled, we've started our review of this last September, with two primary objectives. First, it is in line with our strategic priority to simplify and improve our operating model, and builds on the work we completed when we combined orthopedics and endoscopy into ASD. This work has been more comprehensive. We've included wound in emerging markets, and it's encompassed all global support functions.

Our second objective has been to drive out inefficiencies and unnecessary G&A, and invest this money into frontline commercial activities. We've selected four levers to drive this change, and taking each in turn.

First, optimizing functions. We're now driving transformation programs across finance, HR, legal and IT, to more effectively support the Group.

Second, procurement savings. We're broadening the scope of procurement, and driving discipline and best practice through our organization. We've initiated more than 70 procurement programs, targeting nine categories of spend, including professional services, logistics, travel, fleet, and facility management.

Third, we're simplifying our management structure. We've simplified our organization in Europe, moving to a single general manager per country. This drives efficiency and a holistic approach to our customers. This is also acting as a catalyst for reporting best practice bands and layers throughout our organization.

And finally, locations. We're reviewing our locations, and optimizing our global facility footprint.

In terms of the financial implications of the program, the benefits will be, at least, $120 million annual savings, with around half achieved by the end of 2015. The costs of implementation are expected to be $150 million, with around 85% incurred by the end of 2015.

And as mentioned in our Q4 announcement, our bias is to reinvest the savings, to drive additional revenue, where we can see a strong return on our investment.

Next, our outlook for the remainder of 2014. Our previous guidance for the full year is confirmed, both for revenue and trading profit margin. We expect the business to improve its trajectory during the course of the year, with the second half being stronger than the first.

As you model the quarterly saving, please remember that Q2 has one fewer sales day than the same quarter last year, and some investments are still annualizing through Q2.

Exchange rates, though a slight headwind in Q1, are expected to be neutral for the full year, assuming the rates prevalent at the end of the quarter continue.

And regarding the number of shares, we intend to repurchase an equivalent number of shares to those issued for employee share schemes. This will keep the issued share capital broadly constant throughout 2014.

Finally, we have signed a new five-year committed $1 billion revolving credit facility, with a maturity date of 2019. We now expect the average interest payable on our debt to be in the range of 3% to 4%.

Finally, as some of you have started modeling the impact of the ArthroCare acquisition, I want to remind you of the guidance we issued on the announcement.

First, on synergies, we expect cost and revenue synergies to add approximately $85 million to the trading profit in 2017, with three-quarters derived from cost savings. We expect net revenue synergies of more than $50 million 2017, with around 40% dropping through to trading profit.

As we've said before, you would typically expect to see some disruption in the early months of integration.

On the cost side, we expect total integration costs of around $60 million, and transaction costs of $40 million. And overall, we expect the transaction to be broadly neutral, in EPSA terms, in 2014, and accretive thereafter.

Our integration team is fully formed. It is led by one of our most experienced ASD leaders, and complemented with a cross-functional dedicated global team. Day one and day 90 plans have been developed, as well as key milestones for the longer-term post-acquisition period. The team is now ready to go, once the final shareholder and antitrust approval is obtained.

And with that, I will hand back to Olivier.

Thank you, Julie. So turning to the summary of our first quarter, I would like to add a few comments to Julie's explanation of the actions we're taking to optimize the Group structure. These programs reinforce all aspects of our strategic priorities. And I see them as very, very important for Smith & Nephew, for three main reasons.

First, as a business, we must always strive to be more efficient. And for me, efficient is not just saving costs, it's about doing things differently and doing things better, through behaviors, processes, structures, and so on. And ultimately, [it gives you] to being faster, more agile in responding to customers.

The second reason is, this additional $120 million saving gives us flexibility to invest, if and where we see opportunities. It will drive growth over the coming years, much as the $150 million efficiency program has supported our investment in the emerging markets, and help us to have higher levels of R&D spend.

And thirdly, we have refined our management structure, as part of the review. As I have said before, I believe that the management teams work best and more efficiently when they are focused on few priorities that make the most impact.

To further simplify and focus our management structure, I am forming a single European team, by having a single leader across all franchises, and single country general managers, with benefit from closer management of key markets and, with no doubt, realized greater efficiencies.

In addition, as many of you know, Roger Teasdale, our President of Advanced Wound Management, has announced his decision to leave Smith & Nephew, a couple of months ago. I want to thank him for his many contributions to the Company, and I'd like to wish him also continued success as he takes the next step in his career. Our new Advanced Wound Management President has been appointed, and will join in June.

To summarize our performance this quarter; I think we had a slow start to the year, as we anticipated, there was no surprise, but many of the underlying trends are positive. More important than a single quarter's result, our investment over the last few years make me optimistic for 2014 as a whole, and for the future in general.

We have many new products coming out, several of which I highlighted this morning. We have been adding to our sales channels and marketing initiatives. And finally, we benefit, and will benefit, from the acquisitions we've made in bioactives and in the emerging markets. And we look forward to completion of ArthroCare.

As a result of the investments and the many other changes we have made in support of our priorities, Smith & Nephew is a better business than it was three years ago. We have better teams, working in a better structure, delivering better products and better services. And fundamentally, it is this which makes me confident of further progress and long-term success.

So thank you, and that ends the formal presentation. And as usual, we'll now take questions.

Lisa Clive, Sanford Bernstein.

Three questions. First of all, your commentary on ortho sounded pretty cautious; as you implied the weakness in the US in Q1 was entirely due to a pull-forward effect. You didn't even mention the bad weather in the US, which clearly has had an impact on a whole bunch of different medtech markets. Is there any reason why you don't think Q2 could see a bump from deferred procedures from Q1?

Second question, the big drop in AWC sales, due to destocking. Do you think this was a one-time effect, or will it affect Q2 and potentially beyond as well?

And then, third question, negative pressure. You mentioned the challenges in the traditional canister-based business; obviously with the patents going off, there are a lot more competitors in that market. But are there opportunities in this market as well? My understanding is the EU market is still a lot smaller than the US, and it seems like there's the potential that that can change. So maybe just if you could talk about some of the growth prospects for the traditional negative pressure business.

Thank you, Lisa. Thank you for asking these good question. Yes, Q1 was already mentioned because it has been reported everywhere. Obviously, the weather has been one of the reasons why, on top of the Obamacare misunderstanding I would say, responsible of this low dynamic in the market. There is no doubt, so that's something that we have noticed in all parts of the US.

The destocking of advanced wound care is it going to continue, well, it's a mix of a few things actually. It's a destocking per se, which means that the level of stock has dropped for different reasons, a) because I think that the wholesalers have [restrained]; b) it could be a specific reason like Japan where we have, as Julie has mentioned, this biennial price cut.

So there is destocking of the Japanese wholesaler before this price decrease, and in some of the places like in the UK you have a consolidation also of wholesalers, in the US also sometimes. So this has basically been the driver of this destocking for the quarter.

Will that continue or not? Well, I tell you, I don't really know if this will end in Q1, or if we will have still some effect in Q2; frankly, it's difficult to say. So we are cautious about this for the short term.

Regarding the negative pressure wound therapy business, first of all, don't worry, it's a 13% growth business, which basically is equivalent of 14% we have had in H2, so it's a good business for us.

Second, we are very happy with the PICO dynamic everywhere actually. It is building month after month [its pick], and we have launched a number of extensions to PICO, and we are very happy with what is happening there.

The negative pressure wound therapy, the classic one I would say, is truly difficult in the US and in Europe, actually, in some places because of price, and price war generated by KCI. I think it's still a very interesting market; the volumes are growing. I don't believe that the prices will go to the bottom, and I also think that there is a number of opportunities all across the world; Japan is one of them.

As you know, we have launched negative pressure in September a year and a half ago. We plan to launch also PICO in Japan in the future. We have launched negative pressure in China, and so far we're pretty happy with what we see. We have launched VERSAJET also in China, which is not exactly a negative pressure, but part of this.

So yes, I do believe that there is a number of markets in the world where the opportunity of growth are strong, so this is what I can tell you, Lisa.

Okay great. And one, sorry, one very quick last question; on PICO, what's the patent situation like, basically I just want to understand when you may see a competitor. I understand there's something similar in the market from a very small company, but it's not very good quality, but I'm really more interested in whether your very large competitor could bring our something similar?

We have seen some competitors coming here and there. Again it's a market between two players, mainly. We have a very strong patent coverage, and as you can imagine, we launch a number of new PICO on a regular basis and we have very strong protection.

Great. Thank you very much.

Bill Plovanic, Canaccord.

I'm going to keep this broader picture, so obviously a lot of news last week. How do you project the purchase of Biomet by Zimmer, how do you think that's going to impact the global recon market? And then I have a follow-up.

Okay, well, on the acquisitions front, it's true that we have been -- I mean in the move during the last six weeks we saw the healthcare mergers, acquisitions, deals and everything. There is with no doubt a consolidation in this market; there is either you can see deals, or deals like what we seen in pharma, which tried to bring growth where growth doesn't exist.

So I think the Zimmer Biomet deal, I cannot comment the deal per se because it's not my job to do that. But what I can tell you is I see it as a defensive deal; it is not at all what we, Smith & Nephew, are looking for.

We, as you know, are looking for growth opportunities, and I think that what we have done during the last three years has shown that, whether it is ArthroCare, or Healthpoint or small deals in emerging markets, we are looking for a development of the Company, and not for cost cutting. So this is what I can tell you.

Now, what does that mean for us? Well, I do believe that, on the short term, it will bring us a number of opportunities, there is no doubt about this, opportunities due to disruption.

And second, on a more midterm, long-term I don't think it -- I call it neutral; I don't think it will change anything. Big is not beautiful, I don't think this is really what matters, so my view of this is great on short, midterm and neutral [then].

But my follow-up on that is, I understand your positioning, but how do you compete in a recon market where those top three players are going to own 20-plus-% share of that market, especially in the US, and you're sitting at a lower level with the consolidation and bundling of the markets, and bundling. How do you continue to compete in the US markets as that stand-alone fourth position player?

The first good news that we become -- we were fifth and we become fourth now, so that's good news for us, but the point is not size again. You guys talk about bundling every time; bundling what does that mean, what do you think that Smith & Nephew cannot bundle? Smith & Nephew has more bundling power than an ortho company just doing bundling with his hips and knee.

Just look at the CNS publication yesterday night, what do they say? They say that they will extend, actually, the bundling to the different businesses of the company.

So it means that, for us, we have more bundling powers than any other ortho company because of the wound, because of sports medicine and so on and so forth.

It is not at all a concern; you guys were mentioning also the bundling when J&J have done the acquisition of Synthes, nothing is happening there. We don't see any issue with this, so it's not really a problem. For me, and for Smith & Nephew, what matters is to bring on the market disruptive innovations; this is what matters.

It's not bringing me tools; it's just trying to bring products in, like what I was mentioning with the JOURNEY II CR, where we can get premium prices, where we can avoid price erosion, where we can make a difference. We value our customers and our patients.

Great. Thank you very much for taking my questions.

Ed Ridley-Day, Bank of America.

Firstly on bioactives; Olivier, could you talk a little bit more to those improving volume trends in that business and what proportion of the volume versus price in the first quarter that we're seeing there, that would be helpful?

And then, Julie, second question on the destocking effects globally, just really for modeling purposes; the 300 basis point headwind, was that just destocking, or did that include the Brazilian effect as well?

Okay, Ed, thank you. I will answer the first question; Julie will take the second one.

So Healthpoint, Smith & Nephew Biotherapeutics now, I was very happy with the dynamic actually. You remember that the last year growth has been mainly due to the price increase. The volume of SANTYL last year was actually dropping a bit, and what we have seen in Q1 is a good recovery of the volume of SANTYL, which makes me extremely confident that the product is doing extremely well.

Price increase in 2014, this is a commercial discussion and I'm not going to talk about this; it's not the point. I think what matters is that we have put everything together in the field to extend the coverage of Smith & Nephew Biotherapeutics. We have put resources, marketing investments and it goes very well. Regranex is doing very well, OASIS is doing well, so I'm very happy with what is happening there.

And I'm also very happy with the clinicals of the 802, it isn't the question, but I will like to preempt a question, we are in the phase III, as you know, totally on track with our expectations with European clinical so everything is doing good so far.

Okay. Thank you. And on the destocking?

Yes, so in the destocking, Ed, we've had impact in three of the countries, UK, US, and Japan largely. And the number I quoted, which was the 3 percentage point increase in the wound performance, did include the impact that we had in Brazil due to the importation licenses.

Thank you. That's clear. Just to be -- you've talked about second quarter, but at this point in time, and looking at the numbers that you can see, should we assume that this destocking should stabilize in the second half, or is it really going to be a full-year effect year on year?

Obviously, we can't prejudge what our wholesalers do, but what we've seen is we've seen some structural changes in the US market. We've seen a number of the leading wholesalers, McKesson, Cardinal, and Medline, undertaking some consolidation and, therefore, running the stock days down as far as our business with them is concerned.

We see that could be more of a structural change. We certainly see it impacting the second quarter. We can't really predict any further than that. Japan, clearly we expect that to reverse following the price decrease taking effect at the beginning of April.

The UK, again, we consolidated some of our wholesalers in the UK and that caused a perturbation. There may be some impact on that in Q2, but we expect not to see too much in the second half.

Okay, very good. Thanks. Just a quick follow-up on ArthroCare; obviously, it's great you've got German and US approval, is there any reason why the UK would be delayed, or do you just think it's a standard delay, if you will?

There is no delay, actually. The UK has been part of the normal process and we don't have any delay so far, nor expected delay.

Okay, great. Thanks.

Michael Jungling, Morgan Stanley.

I have two questions. The first one's on strategy and it's not meant to be confrontational but it's an honest question. And that is, over the past 2½ years, we get told that you prefer to reinvest costs into the business to drive sales growth rather than to improve margins. But as an outsider, it's becoming difficult to reconcile those results.

If I look at your three largest business units; hips, eight quarters below market growth; knees, eight quarters below market growth; advanced wound care, probably, at best, market growth, if not below. And hence, I think there's a question; do you feel your strategy of reinvesting as heavily is paying the dividends that you typically talk about?

Then question number two, if I look at your ortho business, at what point do you feel that the opportunity of growing in line with the market has been lost, because if you look at knees, you've had now JOURNEY II in the US market probably since about Q1/Q2 of 2013. Even in Q1 in the US, you're growing below market; that's four, five quarters after introduction. It seems to me the opportunity is starting to fade, that JOURNEY II is starting to do what it's meant to do. That's all, just those two questions. Thank you.

Thank you, Michael; those are good questions. Let me start with the strategy. You mentioned the three fields, which are mainly ortho, reconstruction, and sports medicine. This is not where we have done the investment with the $135 million of saving that we have generated since the start of this [job.]

We have invested heavily in R&D, number one. R&D is for the future, and I tell you, I start to see the results of this portfolio. We have in our hands, and you've mentioned JOURNEY II, definitely JOURNEY II, the CR, all the products that mentioned between HEALICOIL and all this, here they are. That's number one.

Number two, the big investment has been in the emerging markets and in the international arena; [was it] in China, in India, in Brazil, Turkey, Middle East, in South Africa, and I do believe that the results are here. Actually, the growth is extremely high. It will represent 25% of the sales of the Company at the end of 2017/2018. So I'm not, like you, challenging the value and the return of the investment which have been done. They have been done in the right places, geographic or product franchises.

Now, we are proposing a new program, which is a [must-do]. And you remember that this is not new; it's actually aligned with one of the strategic pillars of the Company, which is to simplify the organization, and we need to do things. Julie has mentioned, I'm not going to come back on the four things that we are going to do, but it is clear that this will generate additional savings. We have mentioned more than $120 million of potential savings coming out of this.

What are we going to do with this money? Well, I don't know. I don't know. We said reinvestment, yes. But again, I think it's maybe not clear enough, and I want to reinforce the message that reinvestment will be done if we have strong business cases. If we do not have strong business cases, we're not going to reinvest this money; we're going to keep it and save it.

This is what I want to tell you. Don't believe that the $120 million will be invested here and there without a very clear expectation of what it will bring to us. I hope this is clear and that there is no confusion about that.

Now, your second question on the reconstruction business. You mentioned JOURNEY II. First of all, it has not been launched in Q1 last year; it has been launched after the academy. It was just disclosed actually at the academy, so the real launch of JOURNEY II BCS has been starting maybe in May or June of last year.

As you know, we have built a lot behind this. You don't launch it on a big scale without knowing the value of this. So we have done that on a small launch at the start and then we accelerated this at the end of the quarter. And it goes extremely well. We don't disclose the results of JOURNEY II BCS per se, but I tell you, they grow high, high and strong.

Now, we have also the CR, which is being presented at the academy also this year. I am extremely confident that the launch of JOURNEY II BCS in Europe, which has started slowly, slowly because we wanted to make it slowly in the first quarter, we will benefit.

Again, if you look at this quarter, I think it was clear that the [explanation] of the quarter is not at all the problem of the product. We don't doubt. I think the only product issue we have had this quarter, if any, is the core knee business, which was lower than Q4, Q4 having been pushed by the DTC campaign that we have done. So obviously we have, with all the factors, weather and all the stuff, Obamacare, this is why the situation has been like this, this quarter.

Believe me, the reconstruction, and I reaffirm the guidance, which is that we will grow at market in 2014 with reconstruction. This is absolutely clear for us.

Just one follow-up. Olivier, when you came on board in 2011, did you think that your three largest divisions would underperform the market for so long? Was that something that you think would happen?

You know, Michael, first of all, wound division has never underperformed the market; it has always been over the market. So you talk here, sports medicine, which is second division, has been overperforming the market.

The only division which has been lower than the market is reconstruction and orthopedic. I knew that; I said that. I said that this will take time because we had a cycle product issue at this time, and until the new products will come on board, we will not be in a position to grow better than the market. This has been very clear and said everywhere.

Now, what I tell you is that I'm happy because, for the first time, and I said that in Q4, the reconstruction business is going up. We have had issues, you remember the BHR, which is still a problem for us, and the hip business. BHR is minus 14% this quarter again, so it drops 1 point, the growth of hip. It is now lower and lower.

I'm confident again that the hip business, pushed also and that's why we have done the DTC campaign on [the knee and hip] in the first quarter. You will see the result of this. I'm confident and I said that, I say it again, that this business is a strong business for us in 2014.

Great. Really appreciate those answers. Thank you.

Chris Gretler, Credit Suisse.

Actually I have two questions. The first, I'm looking at your first quarter, was it actually now below your internal budget? That will be my first question.

And the second question relates to your optimization program. I think we have seen another one, and colleague, Tom Jones, noted one in all the calculation how many we've seen already over the last couple of years, do you think it's actually fair that we always now take out the costs as one-off costs and then basically keep the benefit on the trading profit line? Or would it actually probably be more fair to reflect that in for both sides in your underlying performance? And actually specifically, what's the cash cost portion of your optimization program?

Okay, thank you, Chris. The first question is, obviously, a question that we do not usually answer, but I'm going to give you a few answers though. Number one, I've tried to say that during my presentation, the quarter is as anticipated. It's [bad] to make a guess of where we are versus our budget.

I think the only place -- and we knew that the Q1 will be low, and I said that clearly, I remember. I said don't extrapolate Q4; the market is not going like this on a permanent basis, we will see a reaction. It is happening.

The only surprise I would say I have had was the destocking, which maybe could be a surprise. That's all. The rest, we knew that we had timing; we knew that the trauma will be low because of the strong comparator; we knew that the emerging market would be a little bit handicapped by the Brazilian disruption that Julie has mentioned. We knew that we have had a very strong tender last year in the Middle East and so on. We knew everything.

So this is not a surprise for us, and that's why we're extremely confident in our ability to go and to confirm the guidance we gave. I hope I answer your question more or less.

I knew, Chris, would ask this question on [under the line], because you asked me the same question two years and a half ago when we did the first saving program. And my answer is the same; I don't think we can afford to jeopardize the P&L with $150 million of costs. I think it would be a mistake.

It will handicap strongly our judgment and our ability to invest where we see opportunities in terms of investment and of return, so I think we have done the right thing in doing that. It's not something we're going to do every day. It is something which is called one-off, because it's one-off.

It is the follow-up and, I hope, the last program that we do for a while of improvement of the Company. And it's a long-term improvement; it's very important to do it.

So what is the cash portion of this? Well, it's mainly cash, I would say. I don't want to give you a precise number, but it's mainly cash.

Just for us, it's basically probably more fair to look at the reported number in that end because it looks like this is an optimization. I fully appreciate that you are doing and I think that's completely correctly, but just for us, to evaluate the performance it's probably we should take in both sides, because it's some kind of one time, but it's basically an ongoing optimization of the Company over the years, isn't it?

Hi Chris, it's Julie. I think the key thing we want to say is this is a very, very major program for Smith & Nephew. This is the first time we've looked at the functions globally and this is a transformation of four major supporter enabling functions in this business.

And we're also moving to a single GM model in Europe, which is a different model, a completely different model from where we've been. I would say that we make full disclosure of these amounts, so in the adjustments between trading and operating profit, EPS and EPSA, so if you want to make the adjustments and put them back into the P&L, feel free to do so, it's entirely your choice. We have full disclosure of all these amounts.

But we believe, and very, very firmly believe, that this is a major program for Smith & Nephew. We want to be able to accelerate this program and move quickly. You've seen that about 85% of the costs will be incurred for the first two years, so you can see the pace at which we plan to move this. And we feel it's better to treat this as a one-off exceptional item, but will be fully disclosed to you.

I fully appreciate that. Thank you very much for your time.

Charles Weston, Numis.

Two questions focused on your knee business. First of all, again just focusing on the US sub-market growth, I understand you're saying that much of the weakness has come from the non-JOURNEY II knees. And if JOURNEY II did really well, then these knees must have done really quite badly, which you seem to say is due to the positive effect of the DTC campaign.

So I was just wondering whether you could give us some sense of the bang for buck that you get from DTC. Is it worth doing more of this, going forwards? Obviously, you're doing some with the hips now, but if it has a one quarter effect and then falls back, are you getting the sustained benefit from the program?

And secondly, also on knees, just referring back to the hazard alert in Australia for the JOURNEY I, I'm just wondering if you'd seen any knock-on effect with any other regulatory bodies taking a look at that product in any other country?

Okay. So regarding Australia first will be a quick answer. The answer is no, we have not seen any issue with JOURNEY I in any other countries.

Your second question on the knees; the knee has been in the US, growing at minus 1%, and it's strange. If you look at what was at Q4 which was 11%, so it's a movement of 12 points between Q4 and Q1, when the market movement has been 7 points, which is going from 9% to 2%.

First of all, I think you have to consider two things. A, the fact that Q4 was an exceptionally high quarter for us. We had one extra day in Q4 last year and the competitors have one extra day in Q1, so make the calculation, it basically gives that there are three points between us and them.

Having said that, I don't believe that -- it's different than what the market has done. We are roughly at market. Q4 was strong because, as you say, well, you're a little bit tough on us to say that DTC is just one quarter of value; it is not actually. We have started, it is a dynamic, we have started the campaign in May; it creates a momentum for sure, especially when the market is good which is the case in Q4.

We could see still some DTC impact now. We don't because the market has been a disaster in the quarter, but I do believe that this is a very important thing to do, especially when you have new products. Actually we are doing, as we said, the hip, which has started in February.

We expect to see at the end of Q2 the result and the impact of this very last hip campaign. We are also thinking about doing new campaigns in knee, just to tell you that we believe that the payoff is good and the return is good. We monitor, as you can imagine, extremely closely the value of this type of investment, and all the indicators are telling us that it's a good way of investing our money.

Okay, thank you. So in terms of the timing, you haven't -- that's not set in stone yet on the knee side? Are you still deciding?

Yes, it's still under discussion.

Okay. Thank you.

Tom Jones, Berenberg.

I have two questions. The first is on the wound business. I fully understand and accept why the consolidation amongst your distributors is causing a bit of a stocking effect, but what's perhaps more concerning to me is why you're seeing consolidation amongst the distributors and what potential impact that might have on the wound business downstream.

Are they consolidating because conditions in the end-user markets are getting significantly more tough and, therefore, should we expect down the line more pressure to feed up the chain to you? So I suppose that's the first question.

The second question is a little bit of a follow-up to Michael's question, really. I notice that the 24% trading margin target that you put at the start of the last restructuring program is not a feature of the language around this current one.

I do fully appreciate the arguments that what matters is the absolute amount of trading profit and not the margin. But the problem we have is we have to build a model and stick a margin target in and stick some revenue numbers in.

So maybe you can address that issue, perhaps with reference to where you expect returns to go over the next few years. If you're investing and all this is paying off, we would have expected to start to see return on capital starting to improve, but, in fact, return on invested capital has only deteriorated in the last three years.

So are we at the bottom now, or is there going to be another couple of years of pressure on your return on invested capital before we start to see the benefit? And maybe is it fair that we should focus more on the ROIC now, rather than the absolute sales growth or trading margin that you produce? Is that a fair comment?

No, I don't think so, Tom. Good morning. I think it's a -- the 24% margin has been said, has been announced and will happen, so what I said to you during the last call, when answering your question, is that we are not driven by this goal of 24%, but it will happen. We have guided the Street last quarter in saying that the margin of 2014 will be better than the margin of 2013 and this is the case; it will happen.

You cannot be guided by a Q1 which doesn't represent at all what is the trend of the Company. We expect, and I expect with no doubt, the permanent improvement of trading margin in the years to come. That's why also we do this optimization exercise. They are important because it will help us to go at 24% and further.

So I don't see the point here, because we have not changed anything. It's not because I was telling you, well no, we are never going to achieve 24%; that's not the case. We are on track, as expected, to reach 24%, and we are on track of making a margin in 2014 which is better than 2013.

So for me, there is no issue there. It could be 25%, 26%, 27%, I don't know. The point is, we are making the choices to either invest where we believe it makes sense to invest to protect the long-term revenue of the Company, and revenue will come also; again, the strategy of the Company is clearly to [move] on higher growth businesses, you know that, and we go there whether it's through acquisition or through organic investment in the right fields, geography or per franchises. It doesn't come the one; you need to have product and we start to have products to do that.

Now, on the wound question, the consolidation of the wholesalers. Well, when you have two players becoming one, usually, you see a drop in inventory and this is what is happening.

Now, is it going to be a trend, the consolidation? I don't think so. I think that it's something which is happening now. It could have been the case last year or at the end of the year. I don't think this is a trend that you can say, oh my God, this will happen again and again and again, no it doesn't. It doesn't.

What Julie was explaining that what we don't know yet is what visibility can we have for Q2 on this. Again, we are extremely confident in the quality of our business and the quality of revenues for 2014. So that's what I would like you to keep in mind.

Okay. I was just a bit more interested in why they're consolidating, really, and what's going on in the end-user markets because they're a bit -- of all the markets you operate in, the wound care market is probably the hardest for us to have any visibility on.

Yes, I did not talk to them, so I don't know why you have got some consolidation. I just don't know. Is it a defensive that they do like what is happening with BIOMET and Zimmer? I don't know, Tom, frankly.

Okay. And then just quickly, if I may come back on the margin return target, ask the question again really about the return side of the equation. Returns have been under pressure, as you've invested both through the P&L and through the balance sheet.

Are we approaching a floor in your return on invested capital and should start to expect that to increase in coming years, or really, is it going to stay at this level for a period of time before it accelerates sometime in the medium term? I'm just trying to get a bit of a reconciliation for how you expect your return profile to pan out.

Yes, it is [with] the return profile. As you mentioned, we've been through a period of investment. As Olivier said, we do expect -- and our margin will improve, our plans are exactly on track. So if we exclude any large acquisitions, then yes, the return on capital in the business will improve and you will also see the margin improve over the course of the next few years.

Okay. I'll leave it at that.

Alex Kleban, Barclays.

Just one quick question on the BIOMET and Zimmer. Do you think you can benefit in any way from disruption in their business, should the integration move forward? And do you have plans in place and how aggressive do you think you can be in terms of maybe poaching some of the key talent that they have?

I think this is exactly what is going to happen. I'm very, very happy actually to see this, because it gives us huge opportunities here and there. Whether, as you said, in new talent leaving the company because jobs will be cut, so we have opportunities there; or business disruption, which is always happening in this type of merger, due to cost cutting; or distributors or whatever.

So I said, I think it's on a short-term, midterm, a very good opportunity for us. And on a longer term, it is neutral.

Any chance you could try to quantify that at this stage, or maybe just too early to tell?

It's too early. We are looking at that, obviously, as you can imagine, in depth, but it's too early to quantify that.

Okay. Thank you very much.

Thank you very much. So this ends this Q&A session. Good day to everyone. Thank you.

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