Smith & Nephew PLC (SNN) 2014 Q3 法說會逐字稿

Hello, everyone. This is Olivier Bohuon and I am here with Julie Brown. Welcome to our third-quarter results presentation. I will cover the highlights and then hand over to Julie to take you through the numbers. I will then come back to discuss a few business updates. As usual, we will take questions at the end.

We delivered underlying revenue growth of 3% this quarter. After adjusting for currency and the impact of ArthroCare, this represents a reported growth of 12%. The quarter positively reflects our strategies, rebalanced towards higher-growth franchises and geographies. Within our higher-growth franchises, we grew 11% in Sports Medicine Joint Repair; 8% in Trauma & Extremities; and 14% in Advanced Wound Bioactives.

In our higher-growth geographies, our emerging market business, we grew about 20%. The integration of our recent acquisition, ArthroCare, is progressing well. In our lower-growth franchises, US Recon has grown at or above the market rate for the second consecutive quarter, driven this quarter by standout growth in US Hips. We have more work to do in Europe and Wound, which partially offset this performance, but we have measures in place.

Trading profit was $246 million, giving a trading profit margin of 21.4%, a decrease of only 20 basis points over last year, despite the headwind from US Renasys. We achieved EPSA growth of 14%, mainly reflecting the addition of ArthroCare, the positive operational performance, and the result of a lower tax rate. I will spend time later in the presentation updating you on our progress on developing a mid-tier offering for the emerging market and some exciting developments at Bioventus, our associate in the biologic arena.

This slide captures our underlying growth in the quarter. On the left-hand side, geographically, and on the right, by product franchise. A full quarter of ArthroCare sales is included in this revenue split. In the US, revenue growth was up 2%, driven by our ASD franchise and Bioactives. In the other established markets, sales declined by 2%, primarily due to a weak quarter in Europe.

Emerging markets grew by 20% and we are pleased with our performance across the majority of countries, with China continuing its strong growth trend. 12 months on for acquiring our distributor, Turkey is also growing very well, and the acquisition is ahead of plan. In Brazil, the integration of our distributor acquisitions are now delivering the expected benefit. Our Other ASD segments, which include the ENT business together with gynecology, delivered a combined underlying growth rate of 6%.

I will now turn to look at each franchise in more detail, starting with Hip and Knee Implants. Our growth performance in US Recon has continued. Demand for our VERILAST hip technology drove strong volume growth, with US Hips growing 6%. In US Knees, we delivered 3% growth and continued to see strong traction and uptake of JOURNEY II and growth in our REDAPT Revision system.

Globally, our Reconstruction implant revenue was up 1%, which we estimate is below the market growth rate. The market itself remains stable. The dynamics in Europe continue to impact performance. As you know, we have made Organization changes and reinforced the Management team; however, this quarter we also faced the packaging issue impacting the RT-PLUS Knee, which has now been addressed. This is an important product for us in several European countries, mainly Germany.

Turning to Sports Medicine Joint Repair and Enabling Technologies, both include ArthroCare sales for the full period. Sport Medicine Joint Repair had an excellent quarter, growing at 11%. We benefited from the success of a number of recent product launches, such as HEALICOIL REGENESORB, our bio-composite suture anchor. Enabling Technologies now include the faster-growing Coblation technology from ArthroCare, which has helped lift the underlying growth of this franchise to 3%.

Our Trauma & Extremities revenue grew by 8%, reflecting the strengthened sales channeland new product launches. Our new hammertoe product, HAT-TRICK, has been well-received. In addition, we are seeing our US-dedicated Trauma & Extremities reps becoming increasingly productive and contributing to the strong growth. We expect our recent product launches and investment to underpin continued momentum.

Turning to Advanced Wound Management, which was down 1% in the quarter; this compares to the market, which we estimate grew at 2%. Advanced Wound Care revenues were down 3%, which is an improvement on the Q2 due ALLEVYN Life and strong sales in the emerging markets. The overall performance is still weaker than I would like, and we are addressing this with a strengthened Management team, greater resources on focused products, and close alignment across Wound Care, Devices, and Bioactives.

Advanced Wound Devices was up double-digit outside of the US; however the US distribution hold on RENASYS pushed global sales growth down 17%. As you remember, we made a commercial decision to maintain and transition the RENASYS sales force to other products, but it is too early to see the benefit. PICO growth continued to be very strong.

In Advanced Wound Bioactives, we grew at 14%. This was slightly higher than we were expecting, as SANTYL continued to benefit from wholesale stocking partners in the quarter. REGRANEX, the growth factor therapy, which was relaunched about 12 months ago, is showing a very good momentum through the year.

And now over to Julie.

Thank you, Olivier. Good morning, good afternoon, ladies and gentlemen. Turning to the Q3 results, I will focus on four items: revenue and profitability analysis by business segment, the income statement, cash flow, and an outlook for the final quarter of 2014.

My first agenda item is an analysis of revenue growth by business segment, and as a reminder, the numbers I run through include the results from our acquisition of ArthroCare. Overall, group revenue in the quarter grew 3% on an underlying basis. By division, Advanced Surgical Devices grew by 4% and Wound Management declined by 1% compared to the same quarter last year. Acquisitions added 9% to our growth rate, driven by ArthroCare in ASD and our acquisitions in Brazil. Currency was neutral for the group in the quarter. And finally, in reported terms, group revenue growth was 12%.

This slide shows revenue by geography and business segment. Growth rates are shown in the lower section. Turning to ASD, revenues were $816 million in the quarter, representing a worldwide growth of 4%, the same growth rate as we saw in Q2. In the US, all franchises contributed towards our growth. The Enabling Technology segment within ASD was enhanced by our radio frequency Coblation portfolio, acquired with ArthroCare. In emerging markets, our ASD products grew by 21%, driven by China, the Middle East, India, and Turkey.

Looking at the right-hand side of the chart, our Wound sales declined by 1%. In the US, where we declined 8%, we saw a significant impact from the distribution at hold on RENASYS, our negative pressure wound product. Excluding this, US AWM was up 4%. Bioactives were strong worldwide, with 14% growth in the quarter, albeit this included some stocking from our leading wholesaler. In emerging markets, we grew strongly at 19%, with China and South Africa, in particular, driving our growth. Finally on pricing, we continue to see similar pressure to previous quarters.

Turning to profitability by business segment, the Q3 group margin was 21.4%, a decline of 20 basis points compared to the same quarter last year. Our ASD margin was 22.8%, an increase of 30 basis points. Advanced Wound Management had a margin of 17.9%, a decline of 200 basis points, largely due to RENASYS. As you know, we decided to redeploy the RENASYS resources to PICO and other products in the Wound Care portfolio, impacting our margin short-term.

Now to provide some more context around the margin and an update on our group efficiency program. Our structural efficiency program announced in 2011 has delivered annualized savings of almost $145 million. But we're not stopping there. As we announced in Q1, we've launched our group optimization program, which is driving savings through four levers: optimizing functions, driving procurement savings, simplifying the operating model, and finally, optimizing our locations.

All the areas of the program are progressing well and I will give you an update on locations to give you some understanding of the nature of actions we're taking. In some countries where we have multiple sites, we have recently announced that we are consolidating our commercial operations. This includes, for example, our offices in Australia, that will now be consolidated into Sydney, and our US Wound business, that will now be consolidated into Fort Worth.

The overall group optimization program will deliver benefits of over $120 million over a four-year period. As Olivier said in Q2, we expect the majority of the benefits of the program to drop through to margin over time. And of course, where we see material return opportunities; for example, Syncera or the mid-tier, we will make selective investments.

Now to my second agenda item, the income statement, trading profit in the quarter was $246 million, a 3% increase on an underlying basis, driven by sales growth combined with cost control. As in the past, we make a number of adjustments between reported and trading results to give a better reflection of the underlying performance of the business.

Taking each adjustment in turn: restructuring costs relate to our group optimization and efficiency programs; acquisition and integration costs have increased due to ArthroCare, and this acquisition has also driven higher intangible amortizations. A full bridge of our adjusting items is given in note 8 to our announcements.

Moving down the income statement, our expected tax rate for the full year has remained at 28%, which represents a reduction of approximately 200 basis points from our tax rate in 2012. EPSA has increased 14% in Q3 and this is driven by the impact of ArthroCare, underlying profit growth of 3%, a tax rate improvement, and a reduced share count. As a reminder of the number of shares, we continue with our commitment to repurchase the number of shares equivalent to those issued under employee share schemes.

I will now turn to my third agenda item, the cash flow, where I will also make two points on the group balance sheet. In the quarter, we generated trading cash of $158 million compared to the $191 million in the same quarter last year. Trading cash conversion was 64%, lower than the 86% last year, and this is due to higher working capital and capital expenditure, as we have mentioned in previous announcements.

Turning to the balance sheet, closing net debt at the end of the quarter was $1.9 billion. I wanted to raise two additional points on the balance sheet. Firstly, in the quarter, we entered into an agreement to secure future supply of the active pharmaceutical ingredient for REGRANEX. This has resulted in an increase in inventory of $36 million at the quarter-end, which is offset by payables in the quarter.

Secondly, in October, we received a receipt of $188 million from Bioventus, representing the repayment of debt and accrued interest from our associate following their refinancing. This receipt will reduce our net debt from $1.9 billion to $1.7 billion, excluding any other movement.

Next, our outlook for the final quarter of 2014. Our previous guidance on sales and margin remains unchanged. We have an extra sales day in Q4 compared to the same quarter last year, which falls during the holiday period. While Q4 has typically seen higher sales driven by seasonality in previous years, in ASD there is a strong comparative due to the usually high number of orthopedic procedures in December 2013 due to the Affordable Care Act.

As a reminder we continue to maintain our guidance for Advanced Would Bioactives for the full year, being mid- teen growth. Regarding trading margin, as we said at Q2, we have decided to maintain our field force in the US despite the commercial hold on RENASYS. We are working to offset this headwind through actions within US Advanced Wound Care and our cost saving program.

Regarding exchange rates, many of you will have seen that the US dollar strengthened at the end of the quarter. Were those rates to continue throughout Q4, we would expect a significant adverse exchange of minus 3% in Q4 on sales, which would lead to an adverse impact for the full year of minus 1%.

As last quarter, we have included technical guidance in the appendix to assist with your modeling. We draw your attention to the net interest cost, which is impacted by two factors. Firstly, following the cash settlement received from Bioventus, we will no longer receive interest on the loan note. Secondly, our mix of debt has changed, which will combine to give a net interest charge of approximately $10 million in Q4.

Finally, as reminder, in Q2, we updated our tax rate guidance for the year. We expect to it achieve a 28% tax rate for the full year and we also expect an additional 150 to 200 basis point benefit to the effective tax rate over the next two years, barring any changes to tax legislation. I'll take any questions at the end, and with that, hand back to Olivier.

Thank you. Two of the macro trends we see in our industry are the growth potential for the emerging market and the desire for models which offer access to healthcare at a lower cost. In the established market, we are addressing these in through our Syncera offering, which I talked about last quarter. This quarter, I would like to expand on how we are accelerating our development in the emerging markets.

Today, we already have a substantial business in the emerging markets and a clear strategy to drive this further: one, focus on those countries, which offer the greatest opportunity; two, in the countries we choose, ensure we have a more direct relationship with our customers, surgeons, and nurses, and other [CI] professionals; and three, and finally, offer these customers the right products.

Over the last five years, we have created a business with revenues well over $600 million, growing in the high teens percentage. A portion of our group revenue from the emerging market, as you know, has doubled to 15% today and we aspire to 25%. Important message for you is that virtually all of this growth has come from bringing premium product to high-tier customers, essentially the very well-off

However, we believe it is the mid-tier, made up of the wealthier middle class, which will grow faster, and ultimately will become much larger than the high-tier market. Addressing this mid-tier market requires a different commercial model, and often different products that the high-tier. Why? Because customers are demanding good quality product at significantly lower prices. This is achieved through a combination of manufacturing and design efficiency, a different service model to the customers, and a more streamlined sales and marketing organization.

Taking this into account, we quickly concluded premium and mid-tier products cannot be effectively and profitably sold through the same sales organizations. Hence, we have now established an independent mid-tier sales organization in many countries, reporting to a separate leader. Where we use distributors, they will usually be different to those in our premium product channel.

The service and capital model for the customer is also designed to reduce costs, for example, with greater use of web-based ordering and less support beyond the essential product training. Apart from the streamlined sales and marketing infrastructure, we also ensure efficiency by sharing the support services with existing local country teams. As a result, we expect the mid-tier business to ultimately generate good net margins similar to our emerging market high-tier business.

We have put in place the infrastructure to sell to customers. Let me talk about the mid-tier products themselves. Currently, we are have a range of products designated mid-tier, which amount to about $50 million of annual sales. Include some of our ASD and Advanced Wound Management franchise products, which are appropriate for the mid-tier. In addition we have some products in the PLUS Recon range we acquired some years ago, and the more recent Adler trauma acquisition in India.

We are actively seeking to expand the portfolio and sources include developing of our own products and we have R&D hubs in China in India and in Dubai; licensing and distribution agreements; and also further acquisitions. This slide sets out our current mid-tier portfolio and some of the upcoming launches and let me highlight a few.

During the first half of 2015, we launched a new initiative. In addition to being specifically design for a broad range of anatomies, the implant and streamlined instrumentation system allow a more attractive price point. In trauma, Adler is now fully integrated and our extension plans are underway. A key part of our strategy for Adler and other products is to roll them out geographically. For Adler, this means appointing additional distributors and we now have a presentation in a further seven countries.

In Sports Medicine, we have been successfully license product, and I have spoken before about the low-cost camera we have in India, but more broadly, our licensing and distribution team is very active, but as you would expect our quality bar is high. In Advanced Wound Care, we are expanding our offering, with a full launch of foam range around the end of this year.

In summary, the mid-tier has a huge potential for us. Our growth will not only come from the underlying market. Our strategy includes revitalizing sales of our mid-tier portfolio through a focused organization, expanding the penetration of our product geographically, and the creation of a broader portfolio to properly address this opportunity.

Just over two years ago, we formed a business consisting of our Biologics and Clinical Therapy business, partnering with a venture capital consortium led by Essex Woodlands in the US. This was to enable Bioventus to focus on longer-term R&D opportunities, while releasing the resources for Smith & Nephew to invest in near-term programs. So I want to update you on the significant progress of Bioventus, in which Smith & Nephew retains, as you know, a 49% holding.

Bioventus is focused on being a leader in Orthobiologics and active orthopedic healing. Commercially, Bioventus continues to deliver steady returns, selling EXOGEN and two joint fluid therapy products. As originally intended, a significant proportion of the profits and cash flow are invested in R&D.

In executing on its strategy, Bioventus has made a number of acquisitions, and I'm going to highlight two. In 2013, Bioventus acquired exclusive rights to Pfizer bone morphogenetic proteins, BMP portfolio, and this includes a next-generation BMP in development. Bioventus has commenced a multi-year program aimed at developing and commercializing this promising growth factor. More recently, it agreed to acquire the OsteoAMP product line from Advanced Biologics. OsteoAMP is a biologic product that is used by spine surgeons to promote natural bone growth and healing.

Strategically, Bioventus has reinforced its near-term commercial strength and its long-term R&D pipeline. Financially, Bioventus has also been successful. On in its creation, we received a loan note, and earlier this month, Bioventus refinanced and repaid Smith & Nephew in full, a total of $188 million.

So let me summarize the quarter. It's a good quarter and our outlook for the full-year is unchanged. For me, the results reflect the improving profile of the Company that I talked about last quarter. Our higher-growth franchises have great momentum. Our Sports Medicine and Trauma & Extremities started improving in the second half, as we said they would.

In our higher-growth emerging market geographies, our strong performance continues, and now supported by benefits of our acquisitions in Brazil, in Turkey, and in India. In our lower growth areas, there is much encouragement. Our US Recon business has delivered its second quarter good growth, and this again is a result of innovative products and great execution.

We still have more work to do, as I said, in Advanced Wound Care and in Europe, but our execution track record has been established I am very confident that things will improve. Acquisitions are clearly adding to our organic growth. Advanced Wound Bioactives is again double-digits, and we are looking forward to talking more about ArthroCare at our next capital market event in a couple of weeks.

Serving our customers, understanding their needs is at the heart of what we do. Their desire for solutions offering greater value is arguably the biggest issue facing healthcare today and through our Syncera solution in the established market and our mid-tier model in the emerging market, we are targeting this ambitious goal.

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

(Operator Instructions)

Ed Ridley-Day, Bank of America.

Thank you very much. I have two questions. Firstly, for Julie, you highlight, obviously the strong progress on your margin efficiency program, your cost efficiency program. Could you perhaps give a little more color on how we should expect, or how you are thinking about what you learned are allowed to drop through, and to what extent investments are exceptions? And related to that, in view of the recent HP802 data that was slightly disappointing, could you update us on how much you are spending on that program, and potentially, your views on the investment in that project? That would be my first question.

We can take that now, Ed. I'll take the first part about the margin progression and the drop-through and Olivier wants to pick up on HP802. In terms of the margin progression, as you know, the group optimization program that was recently announced, will deliver over $120 million of benefit. This program is absolutely on track. It's doing incredibly well, we're expecting approximately 50% of those benefits to come through on an annualized basis in 2015.

What we decided to do with the business is -- this will drop through to the bottom line. It's a question of the timing. It will drop through over time. The only thing that Olivier and I want to do is, where we've got clear opportunities, and we've called out in the presentation two examples of that, Syncera and the mid-tier; where we've got clear selective opportunities we may reinvest some of those funds. But essentially, we're very committed to improving the margin at Smith & Nephew. The Company is capable of delivering more than it currently is in terms of the margin and we will deliver it. And Olivier will move on with HP802.

Yes, Ed, thank you. First of all let me -- HP802 is not dead. We are reviewing the full program. We're reviewing the reasons of why the US clinical has not shown the expected results. So for the moment, it is not a question of setting [money] of the R&D program, but more of investigating of the reasons of the failure of the US clinical. As you maybe know, we still have the clinical ongoing in Europe. So at this stage, that's what I can tell you, Ed.

That's fair. Thank you very much for those answers. My second question regards more your investment. Olivier, you've said on recent calls, obviously after ArthroCare, you are looking for new investment opportunities externally. Areas that you've highlighted historically are Wound Care and Extremities. In light of the recently announced merger of the two leading extremity companies, can you give us your view on that market and whether -- if you are comfortable saying -- whether or not you were interested in those assets?

It's a great question. But as I said before, regarding the merger of Tornier and Wright Medical, we do not see that as a threat, as we didn't see the acquisition of [Cinset] three years ago as a threat for our business, actually -- we believe -- it's always the same problem here. We believe we have the right portfolio; we believe we have the right coverage; and we believe that we have the right [execution].

So now, is big beautiful is a big question and I cannot give you more than what I said. So the answer is no, we don't fear that. And as usual, in this type of merger, we believe we can get some opportunities because of business disruption at the start and then we see that as neutral.

That's absolutely fair, but can you say whether you were interested, potentially, given that one or other of those assets would have significantly enhanced your position?

We are always interested in good opportunities. I don't think that this one was an opportunity for us. So we are still interested in extremities, in high-growth businesses, in trauma, in wound care, also [share-of-voice] in the US, as I've said many times. But this was not something which was on our agenda.

Thank you. I'll leave it there. Thank you very much.

Thank you.

Michael Jungling, Morgan Stanley.

Thank you very much. I have three questions please. Firstly, on the Hip and Knees, you mentioned some growth initiatives in Europe after the growth rates are not so inspiring. Could you perhaps provide some more details of what initiatives you're looking at and how much impact the packaging issue was for you in the third quarter?

Question number two is on RENASYS. Can you update us on the dialogue with the FDA, on how the 510(k) submission is going and whether you have had any issues with the FDA on the filing?

And then thirdly, also on Negative Pressure wound therapy, in the last quarterly guidance you said $30 million of lost sales in the second half. In the third quarter, we have lost $9 million. Is it realistic to assume that we'll lose another $20 million of sales in the fourth quarter, given that Q3 should have been a full quarter, with your announcement of a -- not recall -- but a rule [of the pack] on June 23, meaning it should have been a full quarter? Thank you.

Thank you, Michael. I would answer the first questions and then Julie will answer the third question of the impact of RENASYS. On RENASYS, actually, talking about this, you asked if we have any issue with the FDA with the filing of 510(k). Actually, we don't. And we expect the approval to happen, as we said, in Q2, during Q1, Q2 of 2015.

Regarding the Hip and Knee, I am not going to disclose the value of the RT-PLUS Knee quality issue that we have had. What I can tell you what significance and it has been a problem in a few countries, mainly in Germany, where the product is pretty important. Regarding what we do there -- well, no, in Europe, I said that in my presentation, I'm not extremely happy with the dynamic we have in Europe.

And, again, you certainly know that two countries in Europe, mainly UK and Germany, are representing more than 40% of the business of the Company and so we have to redynamize the business. Here it's not a question of portfolio, it's a question of execution and drive of the Management.

So what we have done, we have, as you know, reorganized. This is done. It has been finalized in the last quarter and we have now a single managing director in place. And I tell you, they have a pretty clear view of what has to be done. If you take Wound Management, we know that we have to refocus on the growth brands, like ALLEVYN Life, like PICO, which has an amazing dynamic and there is huge potential.

Regarding the Hip and Knee, mainly the issue is in Germany. I have been there actually two weeks ago and I have met the team. I've discussed with our leaders. I don't think we have a portfolio issue again here at all, so it's just a question of execution. I'm very confident that you will see in the next quarters, a new dynamic in Europe. The new head of Europe is extremely dedicated and extremely seasoned and I'm confident that we have put in place the right measure to change the trend in Europe. Julie?

Thanks for the question, Michael, relating to RENASYS. We are exactly, in the third quarter, we're exactly on the estimate that we made in terms of the loss of RENASYS sales. We said $30 million for the second half and it's approximately half of that has come through in the third quarter.

In terms of the device growth rate, or the device decline in the quarter, was minus 17%. If we adjust for US RENASYS, then we would have grown 10%. The reason for that is we still -- as you know, the RENASYS issue is only in the US, so we are still getting strong growth in Europe. We are still getting growth in emerging markets. And we've also got PICO and VERSAJET in that category that are driving strong growth, so that may explain the figures that you are looking at.

Great. Thank you very much. Maybe a follow-up question to the US Hips and Knees. Very strong. I suspect they were influenced by your DTC campaigns. Are they continuing in the fourth quarter or will they expire, and therefore we should expect a slowdown in your US Hip and Knee business?

Michael, we are very happy with the dynamic of Hip and Knee, as you rightly said. It shows, first of all, that again, we have innovative products, we have the right portfolio, and the campaigns that we have done this year are working extremely well. As you know, it's not the campaign we have to stop and go, so the program of the future campaign is not yet defined. But we believe there is still a very good tailwind in both actually, in both implants in Hip and Knee.

So, I'm very confident to see significant results in the next quarter. Despite the fact that last quarter, as you know, and as Julie has said, a year ago was extremely artificially high due to the Obamacare and anticipation of surgery. So it was, as you remember we grew 11% in Q4 2013. So it will be a very difficult comparison.

Great, thank you.

Veronika Dubajova, Goldman Sachs.

I will keep it to two. My first one is just, Julie, on your commentary around 4Q and I appreciate that you have tough comparisons, but the general industry consensus has been that you should still see some pretty good [bolus] of growth in 4Q from the deductibles issues in the US. So I'm just wondering if you were seeing something else because all of your competitors, as they reported have been pretty consistent in highlighting 4Q acceleration and utilization. So if you could share anything on that, that would be really helpful?

And my second question is, you have been doing a terrific job with the gross margin, and I'm just wondering if you have any guidance for the rest of the year. And if we should still be thinking about gross margins being broadly flat in the medium-term or do think you might be able to do a bit better than that? Thank you so much.

First of all, the question on the US market. We certainly saw this [bolus], as you quite rightly mentioned in Q4 last year, where the US growth rate in Recon peaked up at the 8% level. The previous year, it went up to 4%, so what we are saying is we don't know. We think last year may have been an exceptional year, certainly it seemed high at 8%.

We expect some sort of seasonality to occur. That's the consensus in the market but will it be at the same level of 2013? We are not sure, at this stage, Veronika, is the best answer to that. Certainly, as Olivier mentioned, we had an extremely strong Knee performance, with 11%. So what we are saying really, is just watch for the strong comparison that we've got there in ASD.

Relating to your second question about the growth margin, there is price pressure clearly in our industry. We see around 3% to 4% price pressure in the Recon business, and overall in our business, it's about 1% to 1.5%. Clearly, there is pressure on our gross margin in the business.

Offsetting that, we have got a very, very compelling cost of goods improvement program that's led by our operations team. As you know, we are moving manufacture from the UK to China. This is the Wound portfolio. This is giving us significant cost benefit. Together with that, we are using procurement much more actively and direct spend, looking at the supplier channel, to try and improve the cost of goods.

So we are delivering in the order of -- on average, been delivering 3% cost of goods improvement. This year, it will be in the range of 3% to 4% cost of goods improvement. So overall, we'd say gross margins, we are able to offset the price falls with cost of goods improvement; so we expect that to continue for some time.

And Julie, if I just may follow-up on that, and that was extremely helpful, do you feel that the efficiencies that you are finding are consistent with your expectations or are you maybe tracking ahead of that so far? Are you finding new places to save is my question?

Yes, we estimated around 3% cost of goods improvement. This year it will be closer to 4%. So this year, certainly, we're very pleased with the performance, but expecting it to be around a 3% range is the right thing going forward on the gross margin.

Understood. Very clear. Thank you so much.

Thanks.

Matt Miksic, Piper Jaffray.

Thanks so much for taking our questions. One follow-up on the Hip and Knee business in the US. The Hip performance was obviously very strong and Knees maybe looked a little closer to market. But overlaying the Syncera initiative that you put into play, if you could comment on, whether we're seeing in these numbers any affect of that program, whether you've seen in uptick on one side of the business versus the other, Hips versus Knees. Any additional color as to what you've seen so far? And then I have one follow-up.

Thank you, Matt. I'm not sure I understood fully the question. Could you repeat what you want exactly? Because I'm not sure I have the answer for you.

Sure. Just wondering if you could comment on whether the numbers in Q3 reflect any notable contribution from Syncera at this point. Or on an anecdotal basis, whether you have an uptick on one side versus the other?

Okay. Thank you. I'm sorry. I missed the Syncera point on this one. On Syncera, no. The answer is absolutely zero. As you know, we are not -- we are in pilot for Syncera at this stage, so it's marginal and we do not have a significant impact on this. What I can tell you for the moment that we are growing exactly aligned to our plan on Syncera. Extremely happy with the pilot so far, so we come back to you mid-next year to give you more flavor of what is happening on Syncera.

The Hip and Knee dynamic, as you have said, is extremely good. The Hip 6% growth reflects also a BHR impact, which was significant this quarter. You remember that last quarter, we were saying that it was plateauing, and actually we have seen a new drop in the BHR, so excluding BHR, the Hip dynamics is even better.

That's great. Then one follow-up, maybe a more strategic question. You commented earlier on how you see or saw the extremities businesses that are coming together, Wright and Tornier, and how they maybe were not the right opportunity for you in extremities, although you'd find that business interesting and attractive.

If you could maybe step back and give us a sense of how you see the Smith & Nephew Orthopedics and Sports Medicine, maybe Extremities, over time, fitting into the landscape? Just because the conventional wisdom is converging around this idea that big is better, scale matters, [ongoing] is important in the future, and I often -- it seems as though you maybe see the world through a different lens. I love to get a sense of how you see yourself fitting in?

That's a good question, actually. The way I look at the world and it's something we share in the Company, is again big is not the answer. Especially in business like reconstruction, where we think that the two levers of the growth will be in the future, not certainly, it's not the size. But as I said, we have to have one thing, which is to have a right portfolio and then we have to have a right coverage of our customers.

On top of this, for me, the two big important things that we have to keep in mind is: A, you have to have a disruptive research and development bringing innovations on the market, market innovation is a product for which a payer will pay a premium; and second, to bring to customers disruptive models.

And I really believe that what we have done with Syncera is a good example of addressing a need, which is an unmet need. And Smith & Nephew is extremely agile, and able to bring great innovation and great new models to the field. And that's the way I look at the success tomorrow in the reconstruction -- simply not because you are big; because that doesn't mean that you will bring more product to the market.

Very helpful, thank you.

Lisa Clive, Sanford Bernstein.

Hi. Thanks. I have three questions. First on price pressure, Julie just commented that it's about 3% to 4% for the Ortho business. This definitely is a notable step-down from the 2%ish that perhaps the industry was talking about maybe two years ago. Do think 3% to 4% is a sustainable level? Do think it can get better, could it potentially get worse from here? And also just any commentary on pricing pressure differences between the major regions?

Second question on AWM in Europe, that being down, which was a bit surprising, as it sounded like Negative Pressure had a good quarter. Apologies if I missed it, but could you just give us the specific growth rates for Negative Pressure in Europe versus traditional AWC in Europe. On the back of that, could you explain what's going on with AWC, whether this is transitory, is it due to market share losses? I know you have talked about refocusing the Organization, but just getting a sense of whether it's market share or pricing pressure at the heart of it?

And then third, Olivier, as was discussed around Q2, around the AWC underperformance in the US, you mentioned this was a problem within your control, and certainly a near-term focus. Is that business turning around? And, perhaps, if you could comment on how quickly the AWC market is growing in the US this year and when your division will reach market growth rates?

I would need a full day to answer these questions, Lisa, but I will try to make it simple and short. Price pressure, first. We have always said 3% to 4% so I am surprised to hear your 2%. That has never been mentioned in the past, at least from us. We have always said that the 3% to 4% price erosion in the established market was the trend. And it is a trend and we believe it will remain as it is, at least for a while.

Regarding the Advanced Wound Management in Europe. You have again here, a diversity of situations according to the country in Europe, but I can tell you that the Advanced Wound Care in Europe is going to recover. As you remember, we have had some issues at the start of the year. Most of the issues were linked to, despite a great portfolio, a lot of refocused sales force on the product which matters.

And there was a lot of things. We also have the impact on the Advanced Wound Management of the RENASYS price, which is -- sorry, the [integration] Negative Pressure, which is at a price, which is very aggressively going down in some geographies.

In Advance Wound Care in the US, which is the third part of your question, yes, we have had different issues. Again, here we have a problem of management. This has been solved. We are extremely confident that a turnaround of Advanced Wound Care will happen very quickly. We see the first results, now it starts to move and move well.

Again, you can expect to see a very strong recovery in 2015 in this business. As Julie said, we have, following the stop of RENASYS, reallocated our sales reps but you don't reallocate a Negative Pressure rep on a Wound Care without proper training, so we have been able to do these, but it's tough. So that's why it takes some time, but we see the movement and things are going on the right way. In short, I'm confident that European Advanced Wound Care business, US Advanced Wound Care business will turn around very quickly.

Okay, thanks very much.

Alex Kleban, Barclays.

Thanks for taking the questions. For the tax rate, could you just give more color on exactly where the improvements are coming from and how much scope you might have to reduce the tax rate further, once you get the additional 200 basis point improvement? Then I have two more after that.

Thanks, Alex. In terms of the tax rate, first of all, I don't want to guide on the tax rate further out than I already have. The current year plus two years forward is enough to guide on the tax rate, largely because the tax environment is changing and I don't want to predict further out than I have already.

The major change is, clearly some of this is confidential information, but what I can say is that we have embedded tax in Smith & Nephew much more now in when we're taking business decisions, so our tax always follows the business where we have got economic activities taking place in the business. But we are far more embedded now, as a function, in terms of where we place our intellectual property, where we place our manufacturing and our commercial strategy and execution.

Clearly, there been changes to the UK tax rate and that has benefited us. There's the UK Patent Box, which has benefited us. And also, we've got the ArthroCare acquisition, which has allowed us to look at the overall structure of the group. And net net, as you know, we are very pleased to say, that from a history of a 30% tax rate for many years, we've delivered a 200 basis point decline in two years and we're on track to deliver another 150 -200 basis points in the next two years. We are really, really pleased with the performance of this. Thanks, Alex.

Okay. Thanks. Second question, then, on Bioventus, and just given the developments there, would you be maybe looking to divest the remainder of that business at some point? Potentially you can achieve a better valuation than when you first created it? Or should we be thinking more about a much greater contribution from associates going forward?

At this stage, what we can say is we are very happy with what is happening with Bioventus. Happy that they have been able to pay back our debt. It is a better company now than what it was before. What they have done, the focus on orthobiologics, and the solid commercial performance that they have, they have increased investment in R&D, and now the acquisitions of the BMP portfolio of Pfizer and the OsteoAMP, makes this company extremely attractive. So we are partners, [it's a good long] and very happy to be partners. We will certainly benefit for the [rifle] of products in the future.

Okay fair enough. And then just last, just in terms of acquisitions, you mentioned that Wright, Tornier was maybe not the right fit for you. But maybe stepping back on, just thinking about your deal pipeline and things you have been looking at, would your next move be something along the lines of the Healthpoint, ArthroCare in terms of size? Or would it be just a combination of smaller bolt-on deals that would be maybe one-third or 1/5 or something like that of the size of a Healthpoint or a ArthroCare?

I cannot comment on that because, again, we don't have anything today in our hands that I can talk to you about. Again, size is not part of the problem here. What the problem is that does that fit strategy and financially to our Company. And that's what we are looking at. Again, we are looking at growth in markets or growth franchises and we're looking at actively on this. So now, will that be big, will that be small, I cannot answer.

Would you be opposed, let's say you had three deals that were $300 million each, financially it wasn't an issue, all very good, strategic fits, would you go for all three at one time? Or would you be more thinking about not taking too many deals on at one time, just given the integration challenges and things like that?

Alex, it depends. If three different deals in three different divisions, why not. But if it is three different deals in one single division, as you know, one of -- success of an acquisition is integration and the ability to integrate the company in our Company. So as you can imagine, it's not possible to acquire three different companies with three different cultures at the same time.

Okay. Very clear. Thanks a lot.

You have anything in mind or (laughter) --?

I will send you an e-mail (laughter).

William Plovanic, Canaccord Genuity.

Great, thank you, good morning. Just -- I don't know if this is a new nuance or something that I have just picked up on. But you talked about your distribution strategy into the mid-tier segment of the market internationally, and needing to build a distribution channel to address that market. Does that change our thinking or your thinking on the amount of leverage that you are going to be able to bring down to the bottom line of improving operating margins? One hundred, 150 basis points per year going forward?

It's a nuance, because my English is improving quarter after quarter so that's maybe why (laughter) I am now able to explain that precisely. No, I'm kidding. It's just -- what I want to tell you, Bill here, is that when you are in the mid-tier you need to offer products of the right price at the middle class who cannot afford high-priced products.

Obviously, what we try to do is to optimize the middle part of the P&L and have a bottom line, which I already said is aligned to the emerging markets, which by the way, is aligned more and more to the Company margin. So we take all the levers possible and one of them is distribution and we try to go on web-based products, we try to simplify the shortcut in the distribution [circuit] and so on and so forth.

So we try to find everything, and by the way, this is different in every country. That is why the mid-tier model is complex is because you cannot apply what you do in China, in South Africa, or in South Korea. They are all different, so we optimize it but net net we really minimize the SG&As and that's why we can bring a very good bottom line in the mid-tier business.

But as you go after these different distribution strategies, does this add cost to the P&L? Because before if you would have sold those products through your current distribution, it would have levered -- provided more leverage, I would have assumed?

Yes and no, because again, the distributors are not distributing in the same type of [center in sense] of customers, you cannot ask a distributor of high-tier to suddenly go in the mid-tier hospitals or third-tier hospital. That doesn't work this way. So you have to have a different distribution system. That's what we have done in India, for example. That is what is happening in China. So this doesn't work the same way. So it's not all the same type of distribution.

Okay. And then, as we look at REGRANEX and now we're annualizing price increases, we're annualize the deal. How should we think about this business as we move into 2015?

The REGRANEX business in 2015 should be a good business, a growing business. As I said, we're extremely happy with the relaunch of these products so we are extremely encouraged for 2015 when we look at the REGRANEX development.

That's all I had. Thank you.

Thank you, Bill.

Yi-Dan Wang, Deutsche Bank.

Thank you very much. My questions relate to the mid-tier segment that you discussed. The first question is, in terms of pricing, can you give us some sense of how those products are priced relative to the high-tier products that you currently sell in those countries?

The second question relates to infrastructure. If you could give us some idea of how much infrastructure you've actually already built for the mid-tier and how much more there is to go? And then the third question is, can you comment on how you are positioned in the mid-tier segment versus all of your key competitors in the various product areas that you are addressing? Thank you.

Good to hear from you. The price varies according to the ranges of product, but I can give you an idea. It's roughly 30%, 40% cheaper than what you can find in the rest of the high-tier. Again, you cannot compare because the products are not the same. We see if you take a hit in the mid-tier, it will be 30% to 40% cheaper than a high-tier hit, but it's not the same product. That's the first thing to understand. But the idea is to be affordable for the mid-tier customers.

Regarding the infrastructure, we have build infrastructure in most of the big countries in the emerging market. I'll give you a few examples. We have built an infrastructure in China. We have built an infrastructure in South Africa, for example. We have built an infrastructure -- we are building in south Korea also. So we are developing all these important countries and with a pretty good base actually, now.

And we use, as I said -- it's really a different structure, reporting to the head of the mid-tier, which he is based in Dubai in the headquarters of our international operations. It's a light structure; it's a commercial structure. But they also work with the R&D; they work with the licensing department; and so on and so forth. And they do not support the cost of the infrastructure because that is shared by (inaudible) it's shared, finance is shared, so it's really a commercial organization that we have, which is independent.

Your third question was the mid-tier versus our competitors. Again, we don't have a lot of data on this, but what I can tell you is, I do believe that we are certainly very advanced versus our competitors. I don't know any of our competitors, having been in a position to develop its own R&D dedicated to the mid-tier. I don't know anybody having really worked on acquiring small hubs in small companies.

I know that Stryker has acquired in China and so on, but it doesn't mean they are mid-tier. They can be mid-tier in China, but they are not mid-tier globally. This is where we are. I tell you, it took us while to build that and I really think the very biggest competitive advantage, understanding and looking at the growth and the dynamic of this mid-tier market in this geography.

This will be the last person and do you want to add anything?

I wanted a follow-up. Pricing 30% to 40% cheaper. What about manufacturing, given that these are designed and presumably manufactured differently?

It depends. Again, as you know, the manufacturing costs are franchise-dependent. Some are headcount-dependent. Some are more good-dependent. If you take, Hip and Knee, manufacturing is more due to the product, and if you take Wound it's more the people, so it varies a lot. In any case, we try to optimize, and that's what I said before. So we optimize gross margin in minimizing the cost of manufacturing, either because we're manufacturing in lower-cost countries when we can or because we optimize the cost of goods of the product.

Okay so effectively the (multiple speakers)--

It's a mix of good model, it's a mix of good portfolio, and good gross margin, which is a combination of many things, and a proper SG&A management, which is extremely important to deliver what we can expect. Okay?

Okay, so the gross margin is a bit higher, but your SG&A is a bit lower and overall the EBIT margin is similar?

Exactly.

Thank you, perfect.

That was the last question. Thank you very much for your questions and I look forward to seeing most of you, I hope, at the capital market event in a couple of weeks. Thanks a lot and this concludes our session. Thank you.

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