Smith & Nephew PLC (SNN) 2012 Q2 法說會逐字稿

This document contains certain forward-looking statements that may or may not prove accurate. For example, statements regarding expected revenue growth and trading margins, market trends and our product pipeline are forward-looking statements. Phrases such as aim, plan, intend, anticipate, well placed, believe, estimate, expect, target, consider, and similar expressions, are generally intended to identify forward-looking statements.

Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from what is expressed or implied by the statements.

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Please refer to the documents that Smith & Nephew have filed with the US Securities and Exchange Commission, under the US Securities Exchange Act of 1934 as amended, including Smith & Nephew's most recent annual report form 20F for a discussion of certain of these factors.

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Good morning, ladies and gentlemen, and welcome to Smith & Nephew's 2012 Q2 and half-year results. For your information, this conference is being recorded.

At this time, I'll turn the call over to your host today, Mr. Olivier Bohuon. Please go ahead, sir.

Good morning, everyone. This is Olivier Bohuon, and I am here with Adrian Hennah, and welcome to our second quarter results call.

I will cover the highlights, and then hand over to Adrian to take you through the numbers, and when he has finished, I will update you on how we have progressed on delivering our strategic priorities. As usual, we will take questions at the end.

This quarter, Smith & Nephew again delivered underlying top line growth and an improved trading profit margin in challenging markets, completing a good first half.

We are delivering on our financial commitments, and implementing our strategic priorities, to reshape Smith & Nephew to provide the right commercial models, innovation and efficiencies to win in our markets today, and the future.

Taking into account this combination, we are pleased to announce a substantial step change in our dividend.

Our Q2 revenues were up an underlying 2%, to $1.029 billion. This is against challenging markets, particularly in Europe. This revenue growth is after the formation of Bioventus, which we completed in the early part of Q2, and Adrian will take you through the financial implications.

For us, the transaction realized value for reinvestment in [near-term] opportunities, while retaining access to the exciting area of [auto] biologics.

Trading profit increased 6% underlying, to $234 million, giving a 80 basis point improvement in our trading profit margin, to 22.7%.

This is evidence that the structural improvements we have made to our organization, particularly creating the Advanced Surgical Devices, are beginning to come through.

Adjusted earnings per share were $0.181. Our cash generation remains excellent, and the Group now has a net cash of $150 million.

We have consistently delivered revenue and earnings growth and strong cash generation in the challenging markets over the last few years. This financial strength, and our confidence in delivering against our strategic priorities, has enabled us to announce a 50% increase in our dividend and a progressive policy for the future.

Our focus on pursuing and evaluating acquisitions of a range of size to generate shareholder value, and our ability to fund them, is unchanged. Of course, the Board will continue to keep and review the appropriate capital structure for the Group, including the potential for capital return to shareholders.

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

Geographically, our revenue growth rates in Q2 were very similar to those we achieved in Q1. In the US, we again grew at 2%. In the rest of our established market, growth was slightly slower, reflecting the volatility of the macro environment in Europe.

Growth in our emerging international market was again double digit, with a very strong growth in China, India and in the Middle East.

On the right, across our product franchises; hip implant sales reflecting ongoing metal-on-metal headwinds. But, on a more positive note, Sports Medicine Joint Repair returned to double-digit growth, and Trauma had a much better quarter. I will now turn to look at each of these in more details.

First, looking at Knee and Hip Implants, our global Knee Implant growth was plus 3%; tracking the overall market growth rate. This was in line with our guidance. It is in the context of the very strong growth we achieved in the comparable period last year.

As we said at our joint reconstruction seminar last month, we have now launched our LEGION hinge product. Not only does this fill a need within our portfolio, it redefines the interpretation of what a hinged knee should deliver for a patient.

In the same seminar we also announced the limited market release of our next generation of the JOURNEY knee. Early feedback from both surgeons and patients has been very positive.

In Hips, the negative commentary on [stem] metal-on-metal total hips intensified, partly after the [FDA hearing] in late June. Hence sales of our BHR system were down globally 3%.

Outside of that, we continue to achieve good growth in many of our total hip products, such as ANTHOLOGY steps, OXINIUM bearing surface, the POLARCUP System and SMF stem.

We also announced the limited market release of our new REDAPT revision hip system which significantly improved our hip revision product offering.

Turning to Sports Medicine Joint Repair, we returned to double-digit growth. All segments contributed to this growth; knee, shoulder, hip and extremities, with knee repair being particularly strong, driven by the Fast-Fix 360.

In Arthroscopic Enabling Technologies, which consists primarily of our resection and visualization products, sales of capital [riveted] items, such as cameras, slowed.

Our Trauma growth was 3%, or 5% excluding the expiring royalty payments in the US, and this compares with market growth of around 3%, which is a much better performance, but still early days.

Finally in Trauma, we launched two new plating systems for ankle fractures. They are both designed to provide additional options for surgeons and treat ankle fusion.

Advanced Wound Management grew at 4%, double the market trend of around 2%. The global market growth rate has slowed slightly, reflecting increased price pressure across all product groups and the macroeconomic issues in Southern Europe.

We had a strong quarter of launching new products; 11 in total, including ALLEVYN Life. ALLEVYN Life is a next generation of our core ALLEVYN foam range. It has many unique benefits to deliver improved patient and economic outcomes.

These innovative features include a change indicator to avoid unnecessary dressing changes, the hyper-absorbent core to prevent leakage of exudates, and masking to prevent patient embarrassment caused by visible exudates through the dressing. This is all combined with unique shapes to ensure better dressing retention, and our Gentle Border (inaudible) to minimize pain at dressing change.

The growth from our Negative Pressure Wound Therapy portfolio remains strong in all geographies. In traditional Negative Pressure Wound Therapy we continue to win major hospital accounts, backed up by steady release of new products.

PICO sales are increasing, supported by additional clinical data and a broadening product range. Its unique design was recognized in the International Design Excellence Awards in May.

In the quarter we announced the acquisition of Kalypto Medical, adding further innovation and IP to our Negative Pressure Wound Therapy portfolio.

And finally, the acquisition of ADERMA last quarter is proceeding ahead of its integration and sales plan.

And last, but not least, I am happy to report that we have received the approval on July 31 of RENASYS, a negative pressure wound therapy in Japan, and this opens a very significant market for us in this geography.

And now over to Adrian.

Thank you, Olivier, and good morning, ladies and gentlemen. If you could perhaps turn now to slide 10 in the pack, and the income statement.

Revenue in the quarter was $1.029 billion. As Olivier mentioned, this represents 2% underlying sales growth on quarter 2 last year, after adjusting for exchange rates and for the Bioventus transaction.

Trading profit in the quarter was $234 million, an underlying increase of 6%. The trading margin was 22.7%; 80 basis points higher than quarter 2 last year.

Restructuring cost charged in the quarter were $14 million; all relate to the efficiency program announced in October. Olivier will give you an update on our progress with this program in a moment.

Turning then to slide 11, and moving further down the income statement, the Bioventus transaction completed on May 4 for a total consideration of $367 million. This gave the profit on disposal of $251 million that you can see here on this chart.

The loss on associates of $1 million that you can see here is essentially the Group's share of the Bioventus loss in the quarter. The entity made a loss due to start-up costs. On May 4 United States CT business transferred to Bioventus. The much smaller OUS, outside the United States businesses, will transfer progressively over the next 18 months.

These Q2 numbers therefore include a part quarter's trading for the US business of CT Biologics, a full quarter's trading for the small OUS components, a gain on the disposal, two months' interest receivable on the vendor loan note to Bioventus, and two months of our share of the associates' results.

We have set out in two appendices to this presentation the trading history of the CT business for the last six quarters, and each of the individual P&L and balance sheet items arising from this transaction. The appendix also shows the minus 3% EPSA dilution in Q2 from the transaction.

Looking forward, we expect interest income of about $3 million per quarter on the loan note owing by the venture.

With regard to the associate line, the goal of Bioventus is to build a strong entity in bio-orthopedics. We expect this to involve material early investment. This is likely to restrict short-term profitability and, hence. our associate income.

As a consequence of this, and the low yield earned on the cash received as part of the consideration, we expect the venture to have a 3% to 4% dilutive effect on our EPSA in the near term.

The tax rate for quarter 2 on trading profit was 30.2%, in line with the rate in quarter 1 and the expected full-year rate.

EPSA in quarter 2 were $0.181; flat on last year. This is lower than the underlying growth in trading profit, due to the strength of the US dollar and the impact of the Bioventus transaction, offset by the lower interest charge and a small reduction in the tax rate.

Turning to the next slide, slide 12, and an analysis of revenue by business segment, the impact of currency was quite material in the quarter. In Q2 the value of the US dollar was 3% stronger year on year against the average of the currencies in which we operate. The effect in our Wound business was slightly larger, due to its higher proportion of non-dollar, especially euro, sales.

And you can also see that the Bioventus transaction reduced reported Group revenue growth by 3% in the quarter, and we expect that it will reduce it by 5% in half 2.

Turning to the next page, slide 13, an analysis of revenue growth rates by division and by geography. Olivier has talked to the shape of our revenue, and I will add only a few more detailed points.

Across our business as a whole, we saw essentially the same price picture in quarter 2 as in recent quarters. Across our reconstructive and trauma implant range, we saw a like-for-like price reduction of around 2%. We continue to see this reduction partially offset by positive mix changes.

In Sports Medicine, the pricing environment continued to be slightly easier than implants, with the like-for-like pricing broadly flat.

In Wound, we continue to see modest price reductions across Advanced Wound care.

The worldwide ASD growth of 2% comprised a growth of 3% in Knees; a 5% decline in Hips; a 3% growth in Trauma; 10% growth in Sports Medicine; and a 4% decline in Arthroscopic Enabling Technologies. These numbers are all shown in the appendix to your pack.

Hip sales continued to be held back by metal-on-metal concerns. The HR sales declined by 37% in the quarter and now account for less than 8% of our Hip sales, and a little over 1% of total Group sales.

As noted in previous quarters, sales growth in Trauma was reduced by the progressive expiry over the last year of several agreements, under which we received about $10 million per annum in royalties. This reduced worldwide Trauma sales growth by 2%, and USA Trauma sales growth by 3%. There will be a smaller impact in quarter 3 and quarter 4, before the expiries fully annualize.

In our worldwide Wound business, sales grew by 4% in the quarter. Growth was reduced by 1% by wholesale ordering patterns, giving an in-market growth rate of around 5%.

NPWT sales again grew very strongly, and contributed most of the reported Wound growth.

Growth in the emerging and international markets was 10%, in line with quarter 1. In quarter 2, the growth of these markets contributed over 40% of the Group's revenue growth.

Turning to the next slide, slide 14, this shows the usual analysis of trading profit by business segment. As you are aware, it is important not to over analyze quarterly movements in the margin. As mentioned earlier, Group trading margin in the quarter was 22.7%; 80 basis points above quarter 2 last year. This is slightly higher than we expected at the end of quarter 1.

Broadly, we continue to see margin uplift from efficiency programs. We continue to need to deal with modest, but widespread, pricing pressure. And we continue to invest in new products, and in our capability to bring those products to customers.

Specifically, margin continued to increase in ASD by 120 basis points in quarter 2. We saw improvement in gross margin. In SG&A, we saw the benefit of actions taken since quarter 4 of last year under our restructuring program. And we saw normal quarterly variation.

Margin decreased in Wound by 60 basis points in the quarter. This reflects the phasing we highlighted in quarter 1, and also, of course, normal quarterly variation.

Spend in the quarter on R&D increased from 4% to 4.1% of sales.

Turning to slide 15, and the cash flow statement, we had another good quarter of cash generation. Like many healthcare companies, we benefited from an effort by the Spanish Government to pay pre-2012 receivables. We received $51 million under this heading in quarter 2.

Inventory levels continued to improve in ASD. Inventory levels were broadly flat in Wound after the modest increase in quarter 1.

We had net cash of $150 million at the end of the quarter; improved from $28 million net debt at the end of quarter 1, and improved from $346 million net debt a year ago.

Turning to slide 16,and the dividend, as Olivier has mentioned, the Board has decided to change the Company's dividend policy; increasing the interim dividend by 50%, and moving to a progressive dividend policy going forward, with future dividend increases broadly in line with growth in adjusted earnings per share.

For the avoidance of doubt, we would expect the 2012 final dividend increase to be in line with the increase in the interim dividend.

From 2013 onwards, the Board will review the appropriate level of total annual dividend each year, in light of the full-year results and the outlook for the Group. The Board intends that the interim dividend will be set by a formula, and will be equivalent to 40% of the total dividend for the previous year.

Turning then briefly to the last slide in this part of the presentation; slide 17 and the outlook. As is normal, we have seen some variation in performance at the franchise level in the first half. We do not, however, see any change in the outlook for the Group as a whole for 2012 from the view which we set out with our full-year numbers in February.

In terms of the market served, we saw significant challenge in Europe, where we had one-third of our revenues. Judging from the pressures on the ground, we expect this to continue, and possibly get tougher, through half 2.

We continue to expect a modest increase in margin for the full year. However, as the implementation of the restructuring program continues to proceed well, we do expect a margin improvement at the higher end of the modest range. Importantly, this does not change our view of the medium-term margin potential of this business.

On a more detailed note, we've hopefully given you all the information needed to model the impact of the Bioventus transactions, including a 3% to 4% dilution in EPSA in the short term.

And lastly, on the outlook. If the exchange rates at the end of quarter 2 were to be sustained for the rest of the year, we would expect reported sales and profit to be reduced by about 3% by translation exchange effects in the full year.

And, with that, I'll hand back to Olivier.

Thank you, Adrian. I want to spend a few minutes reminding you of our achievements to date, and our task for the rest of 2012.

Hopefully, after 12 months, you are now all clear on our five strategic priorities. By narrowing the focus of our management on markets with similar dynamics, we are seeking to drive better growth by concentrating them more effectively on fewer priorities.

Innovation is, and remains more than ever, at the heart of our business. And [finding] these] areas is a need to simplify and improve our operating model; not only to deliver resources for investment, but also to make our execution more agile and faster.

And through acquisitions, we believe we can add further growth to our platform, as well as significant value for our stakeholders.

So looking in more detail at these priorities. So winning in established markets, which is the first one, our ASD and Advanced Wound Management teams are in place and are stable.

The creation of ASD has been executed to plan. We have progressed well. We saw a significant US restructuring, and are on track in Europe.

Financially, we have seen the benefits in our improved trading profit margin, while, importantly, maintaining revenue growth.

Regarding the second point, which is accelerating development in emerging markets, we have created this emerging market organization; uniquely focused on Brazil, Russia, India and China.

We're investing in the infrastructure and in people to drive the better growth we believe we can achieve. For example, we have made progress registering and selling more of our existing products; thus approaching 40 new introductions in the first half of 2012 alone across our full range of product franchise.

Regarding specific products for the middle demographic tier in these countries, we are doing detailed work on both the right product categories and right business model to serve these customers effectively.

In the last couple of years, we have made a number of small bolt-on acquisitions, and, actually, complementary technology acquisitions, ranging from Tenet Medical and LifeModeler in ASD, to ADERMA and Kalypto in Advanced Wound Management. All have been integrated to plan and are performing at, or ahead of, our expectations.

We have strengthened both our business development teams and, as importantly, our skill set around integrating acquisitions. This gives us great confidence in our ability to supplement our organic growth through acquisitions.

We have a number of exciting opportunities under review, and we are working in a very disciplined manner to ensure we move these forward appropriately; mindful of our responsibility to deliver shareholder value.

Innovating for value. As we have said before, I am particularly pleased we are maintaining our high level of innovation during this period of change and restructuring. And Q2 was not an exception, with 11 new products launched in Wound and exciting new additions in our Hip and Knee Implants, and also in the Trauma franchise.

We have established a robust Group-wide R&D evaluation process. From this platform, we will now be accelerating our R&D investment; in line with our previously disclosed plan.

Regarding the simplifying and improving our operating model, here a strong operational platform allows us, our commercial team, to focus on what they do best; meeting our customers' needs through innovative products and exceptional service. We have significantly strengthened our team across IT, supply chain and logistics, to name a few.

We have initiated a number of process-improvement programs. For example, a European-wide project to standardize and simply our key businesses processes, as well as provide better data, with which to make the right commercial decisions.

We have identified substantial opportunities in our cost of goods sold base, which we are acting on.

Our work to optimize our manufacturing footprint is gathering pace. This quarter, we announced proposals to move more of the manufacturing of some Wound products from Hull to Suzhou in China. We expect to complete the transfer of all manufacturing from the old (inaudible) plant in Beijing to our new facility there by the end of this year.

In terms of the financial benefits, we expect to complete the structural efficiency programs to deliver annual savings of at least $150 million. We are delivering on these programs, and expect to achieve about half of the total of these benefits by the end of this year.

In summary, Smith & Nephew has completed a good first half. In Q2, we continued to grow revenues, and again improved our trading margins, as the programs focused on liberating resources for investment are delivering.

When I set out our strategic priorities, I said this was an ambitious achievable agenda, focusing on the things which will make our business fit and effective for the future. I am pleased by the manner and pace of our progress.

In our established markets, we combine orthopedic and endoscopic to increase efficiency, without disrupting the sales team.

In the emerging markets, we have softly built resources and are refining our business models.

Regarding innovating for value, we have brought more discipline to our R&D processes and are now ready to increase investment, in line with the plan.

We have many programs underway to simplify and improve our operating model; not just cost control, but sustainable improvements. And we are approaching acquisition opportunities in a very disciplined way.

Our cash generation is strong, and our priority remains on using this to drive greater organic and inorganic growth. This has not changed and the increasing dividend should be taken as a reinforcement of our financial strength and our confidence in delivering against our strategic priorities.

Our markets remain challenging, but we are delivering on our near-term commitments and we are transforming our Group to take advantage of how our markets are changing and the opportunity this creates.

Thank you and this ends the formal presentation. We'll now take questions. George?

Thank you very much, sir. (Operator Instructions). Veronika Dubajova, Goldman Sachs.

I've three questions, if I can; first on the pricing pressure. Given that like for like was at around minus 2% and that you did see biannual pricing cut in Japan, I'm just wondering is it fair to assume that actually pricing pressure in the US and Europe moderated slightly?

My second question is regarding the Wound manufacturing relocation. Just wondering what additional proportion of the portfolio you're moving to Suzhou and where that puts the overall proportion of Wound products manufactured there versus rest of the world.

And the last one, which should be quick, is financial. Just wondering what the retirement benefit obligation there, the $50 million increase versus Q1, just wondering what drove that. Thank you.

Yes, the retirement benefit obligations, I will just look it up there to make sure I give you a technically accurate answer, Veronika. It was almost completely driven by the reduction in the US discount rate in the quarter. There were other ups and downs with regard to the UK, but, in fact, the discount rate movements and the expected inflation in the UK just about netted each other out.

So in our case, the bulk of the increase was USA discount rate reduction from 4.6% to 4.1% and also a small weaker asset performance than we'd expected but absolutely nothing out of the usual, Veronika.

Okay, that's great. Thank you, Adrian.

On the question regarding the Wound relocation, actually it's a very small proportion so it's not a step change. So I think it's not -- it's, I would say, marginal this one.

Regarding the pricing pressure, well, it's not improving actually. It is stabilized in the US, no doubt, and, as expected, between 3% and 4% and you have seen that this seems to be pretty well shared within the industry.

Regarding Europe, I think that Europe is difficult. The Wound pressure, for example, has been higher than what we used to see in the past. We have not seen a lot of increased pressure in the (inaudible) surgery in terms of price, but I think that there is not much change actually. So I do not make any type of extrapolation on what could become the price pressure in the future. I think it's stable.

And if I may just add to the mechanical part of your question, Veronika, yes, clearly, in our numbers is now a high single-digit reduction for orthopedics in Japan because that was the announced numbers. The fact is, in the round, it doesn't disturb the notion of like for like. That does not mean there's been an offsetting improvement in Europe and in the United States. That's not the way we're seeking to portray it at all.

That's very clear. Thank you.

Yi-Dan Wang, Deutsche Bank.

Just to cover the question Veronika asked, can you give us a sense of what proportion of Wound care products Smith & Nephew makes versus what it buys from OEM manufacturers?

And what percentage of these are manufactured in low-cost countries now versus what would be at the end of the additional amount it's proposed to transfer from Hull? And how will this transfer impact the margins in this business?

And then the second question I have is, can you -- with you guys obviously delivering efficiency benefits, which seems to be ahead of expectations, and increasing your margin outlook for the year slightly, Adrian, can you help us with your indication that -- hopefully quantifying it, if you can, what you mean by at the upper end of your original guidance?

And then to what extent has this been a function of your ability to place the investments that you planned at the beginning of the year? Is that proceeding also ahead of expectations or is that a bit behind expectations? Thank you.

I think we're going to disappoint you slightly on the first one in terms of -- well, probably both of them actually, Yi-Dan, but certainly the first one in terms of the level of quantification we think it's sensible to give.

One of the reasons for that is conceptual. When you say what proportion is sourced from outside, the fact is you source from outside a whole set of products at different stages of their manufacture. So some you can just source the very basic raw material, others half-way through and then a few, in our case not very many, that you buy in the final good. We do not have very many in that category.

What's happening here in Suzhou is -- Suzhou had already become a material part of our Wound footprint and established itself very successfully under good leadership of our Wound team over the last several years. And what we've done now is to expand that Suzhou facility, both in terms of its capacity to do stuff but also up skilling it in terms of the sort of things it's capable to do.

We retain, however, the philosophy that Hull is the core manufacturing unit where the bulk of our development is done and Suzhou, although it will begin to do development relative to its markets or its type of markets, is still the sort of daughter unit at the moment.

And so what we're doing here, there is indeed some movement of production from Hull to Suzhou, which does have economic advantages, but there's also stuff coming into Hull too.

So, for us, this is part of being a multinational company and optimizing our footprint, and we're not going to give specific percentages of what does what. These are now both very material, very important and, particularly in the case of Suzhou, getting ever more capable factories.

In terms of your second question Yi-Dan, I knew that when Phil and I suggested we were at the higher end of modest that we'd have Yi-Dan, among others, saying, well, what is the range of modest and all that sort of stuff?

We're not going to give a range. The fact is that we are -- well, the most important fact is that, although we are, indeed, slightly ahead of our expectations on margin in quarter 2, ahead of the expectations we had when we stood up in quarter 1, that does not in any way impact our view of the margin potential of this business. It's just the pace at which the program has been going.

It has been slightly ahead of what we expected; that is good news. But we remain very, very focused on the investments we want to do in emerging markets. We remain very, very focused on investments we want to do in new products. And we also remain very, very conscious that it is our core scenario that we're going to face modest like-for-like price reduction for a long time to come.

So, yes, it has been a tweak up. Yes, there may well be a tweak up in our expectations for the full year too. But it really doesn't change the shape of this business in margin sense in any way at all.

Okay. And in terms of the investments are you -- where are you according to your plans there?

Well one of the doubly good news is, if you like, you can see that actually at $14 million in the quarter, the restructuring spend has been relatively modest to date. So we have double good news. The program has been going, time wise, in line with our expectations but actually in spend [wise] is slightly slower than we expected.

That doesn't not affect, however, our view of where the -- A, the total cost of the program or the total benefits of the program. We are working very hard on fleshing out the next and subsequent phases. They will become -- we will use the cost up, it will just be phased slightly later than we'd originally expected, Yi-Dan.

Right, my question -- thank you very much for that, that was really useful. My question was actually on the investments that you -- having got the efficiencies, how the investments side are progressing, according to your plans?

Okay, I'm sorry, well I'm pleased to have answered a question you didn't ask, but the -- well, two main categories investments. They are both progressing well, but they both take time if you're going to do them well and be solid about them.

So our investment in R&D, as we've signaled on several occasions, a couple of major categories of new types or new focuses for investment. One is around the emerging markets and products for that.

We have been working very hard, and, I think, very successfully, on the underpinnings that that requires; the skill sets you need to have in the market place, the connections you need to have between those skills in the marketplace and the core engineering talent in the organization in order to properly define products of use to the marketplace and then move through to deliver them.

So lots of good underpinning work is going on ahead. That underpinning work is less expensive than the work that when we actually get fully into it will be, and that's reflected in what you see as the R&D spend as a percent of sales, which has not gone up that very much. We do expect it to increase faster going forward.

And the same applies to the other important switch of emphasis we're engaged in, and that's the switch towards the buying material type stuff, particularly in our arthroscopic business, which, again, it's for us a new skill set.

We have some of it, but we are pushing the boundaries of our skill set. That takes time to make sure one does it thoroughly and thoughtfully and, as you get into that area -- so, again, we've been very focused on the underpinnings and very thoughtful on the programs we're [bidding] for.

And you will over time, and I don't mean here, quarter 3, quarter 4, you're going to see step changes, but you will over coming quarters see that R&D rate tick up as we've got the underpinnings in place that the resources flow there.

And on SG&A?

What do you mean by on SG&A?

So on SG&A, so you've talked about the investments in R&D, but hopefully you guys are also planning SG&A investments as well?

Yes, let me take this, Yi-Dan. I think that in SG&A you have the G&As, and the G&As we have been working hard on these G&As, as you can see, to avoid the duplication following the restructuring and so on.

We are committed to invest in the sales part of the SG&As very strongly, whether it is in the emerging markets or to keep a good share of voice in the established markets. So there is no change, actually.

To summarize what Adrian said, I think that we are just trying to have a very disciplined way of spending the money. We have prepared the base of the programs for the emerging markets R&D programs, here they are.

We slightly increased the amount of money spent in R&D. We are still on track to spend 5% on sales at the end of the plan of the period I was announcing. So this is -- there's no change here. We are just committed to spend the money investing on the right place to deliver the best revenue.

Okay. So would it then be fair for me to say that your efficiency benefits are coming through faster than you expected, but then the investments that you're placing are not coming -- are not going as fast as you had originally planned? So the margin improvement that we have seen come through this year, which has ended up being a bit higher than expected, that will then reverse as those pace of investments pick up.

We have done better in terms of the savings, okay. But we have spent what we had to spend this quarter.

Actually, if you look at the end of the year we have to spend money in many things and then we, as Adrian said, we will be on track to deliver what we are supposed to deliver in terms of cost savings and we are going to invest.

That's why when we are talking about the modest improvement we remain committed to this modest improvement versus last year; again the range of modest can vary. So it's -- whether it's high modest or low modest, it's still modest.

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

Ed Ridley-Day, Merrill Lynch.

Just to start with the increase in your payout ratio, obviously very welcome, and two questions related to this. Firstly, what would be the criteria, if there are any, for another raise in the payout ratio? So whether there would be a timetable for that or whether-- how related to another increase in the payout ratio is your -- the acquisition timetable that you're looking at?

And the second question is related to M&A. I know, obviously, you've said that it hasn't got an effect on what you do. But does this perhaps mean that your -- we should be thinking more about small and mid-sized deals and that you are not now looking at, shall we say, very large strategic deals, for example, in the Wound space?

Actually let me start by your second one. No, it doesn't change anything. So, again, if we have the right opportunities, the big opportunity, we'll take the big opportunity. If it's a small one, we'll take the small one. It doesn't change at all our focus. It doesn't change at all our strategy, so there is -- it's absolutely not significant here.

Regarding the payout ratio, the criteria for another raise, again, the Board is looking at that very seriously, as you can imagine, and we have a very strong balance sheet. If we do not do acquisitions, we will certainly have to look at that again in the first half of 2013.

But, at this stage, we have done this interim increase. We are committed to acquire good opportunities, making financial sense and strategic sense for the Company and for the shareholders. So that's where we are.

Just -- yes. And just a quick follow up. Would you be -- to what extent are your prepared to gear the balance sheet to address your acquisition potential?

Ed, I would think the most important thing we have to do is no change in the approach that we have, I've been articulating now for several quarters, reflected by this dividend change. This dividend change is now because we have an interim dividend to announce, and so why not do it now, was essentially the Board's logic. So there is no change.

And then it's part of what we said previously. We've said it is our Board's absolute intention that whatever we do on acquisitions, we will retain a solid investment grade rating. We don't have a rating at the moment, but if we were to have one, or if we didn't have one, the equivalent to a solid investment grade rating. So that is the parameter in which the Board is very clear that we will work; and obviously puts a parameter around it.

But, basically, Ed, no change. There is no change. This dividend, it's -- our dividend in the year is $150-million-odd last year, so a 50% increase is a $75 million increase. It doesn't affect the shape of our ability to pursue the acquisitions that we have been work on or the possibility that we're working --

No, I understand that. No, I was just really fishing on your, shall we say, willingness to borrow for the right acquisition.

Yes, we will borrow for the right acquisition. It will be within the context of an unquestionable solid investment grade rating, and we will flesh that out as part of the total statement on our review of the balance sheet that we've said we'd do for the first half of next year. But I think you should be able to get enough of a feel for it, from what we've been saying over the last few quarters.

Okay. Understood. And secondly, in terms of the Hips business, just in terms of getting back to -- not so much market growth, but through re-taking share in that business, and I'm talking away from BHR here. Is there anything you can point to, in terms of you're confident on new products you're developing, or actions that you're taking, that are potential timeline to re-taking share in the core Hip business?

Regarding the Hip business, it is true that we have not been performing very strongly, actually, this quarter. If you take the figures I was mentioning, we're minus 5% for the Hip business, and the market is at 2%. So this is true.

Now, we have a number of reasons. Again the headwind that we are facing in the BHR, due to the metal-on-metal issue, is very strong. As I was telling you, it's minus 37% for the BHR. So we definitely brings us some negative headwinds.

We are, however, not unhappy with many of our Hip products, actually. And, again, it shows you why innovation's important. When you talk about the products like OXINIUM, ANTHOLOGY, Stem, [arthry], all these products are doing very well, actually, and growing for most of them at double-digit growth.

So it's -- we have cycles in the Hip business. It is true that we are down here, but I'm very confident that we will be able to come back on track soon.

Okay. Thanks.

Martin Wales, UBS.

If one looks at the top line performance of your businesses, and I think the previous questioner partly alluded to this, you're under growing the market in Hips, excluding BHR; your Knee growth has dropped to market growth. If you take out negative pressure within therapy you're not growing in Wound Management at all, and, by definition, under growing the market.

When -- I'm guessing you're not particularly satisfied with any of these performances. So in what timeframe can we expect to see you return to market growth more generally?

Okay. Hip, I think we just gave the comment on Hip, so I'm not going to come back on the Hip business.

Knee, again we have been growing 3% in a market growing at 3%. Again, the problem here is a very strong comparable last year, so I don't see why, with all the products that we plan to launch in the business, we'll not be able to grow better than the market, or at least at the market rate for the recon business as a whole.

Regarding Advanced Wound Management, we have been basically doubling the market trade, this is a fact, for a while now. I do expect that this will continue, so we expect a full year doing much better than the market for the Advanced Wound Management business.

Regarding the Trauma, you have seen that we are back on track in Trauma, which is a good sign of the real focus that we have on this business. So I'm not as pessimistic as you are on the situation, so I do believe that we will do well, and we plan to do better.

And in what timeframe do you think you can start to do better, then, given the planned timeframe of investments that some of the previous questions alluded to?

Well, I think, Martin, I guess we come from a slightly different place. We have a portfolio of different areas, and it's a fact of life that to get every single one of them going at peak performance at the same time isn't usually the way that it works.

There are some areas which today we are very pleased in, but you single out half of Wound. In fact, the other half of Wound is doing extremely well, and we're growing at twice the market rate. And you can see great dynamic going on there. We're very pleased with the way that Joint Repair is going. It's a strong market, and we're growing strongly within it.

So there are some elements of strong markets growing very strongly, and, at the other end of the spectrum, you rightly call out Hips, which is something that which we are confident about will revert back and overtake that. But it isn't going to happen tomorrow. These things take time, and these things take work. So, in the round, we're very happy.

There are individual elements of the portfolio, of course, we've got to work on, and, of course, we are working on; that's part of business. I think it's a little unrealistic to expect us to sit here and give you for each part of the portfolio, this is the evolution, quarter by quarter. I don't think that's (multiple speakers)

No, and I agree. That's not what I'm looking for. I guess I'm just slightly concerned that organic sales growth, the trend has been, for the Group as a whole, has been, if anything, the organic sales growth has slowed, even relative to the markets you operate in.

And, clearly, while you're delivering cost savings, the investment [buys] as you keep on at is, you're being very careful in how you get to try and make sure you get that investment right. So I'm just curious as to when we should start seeing the fruits of that investment.

Well, when? I do hope as soon as possible. Again, the pace of investment is good. I do believe we invest in the right place. If I take the negative pressure Wound therapy, for example, I think that's a good example of what we do well.

If you look at the US market, for example, where we used to fight one against 10 with KCI, one of the good news that KCI has reported cuts of 300-plus people, so will now have to be at one against six, which is very good news. So I think we have -- we're doing very well, actually, against a very tough market.

We are increasing the R&D. This is a strong commitment. We are happy with the pace of launch of the new products, whether it is in Advanced Wound Management; again I would mention the 11 new products which is the same number than what we had in Q1. I remind you also that we have launched 35 new products last year in the Advanced Wound Management.

If you take the ASD business we have launched also products in all the parts of our business, so yes it will come.

Again, Martin, I'm not going to tell you that you have cycles and you have quarters which are higher and some lower, depending also the comparative. We have had some strong comparatives last year, particularly in the Knee business.

There is not, for us, any issue there and we're very confident that we spend the right amount of money, that we spend well the money and much better than we were in the past. And I do believe also that the sales will come.

Okay, that's very good. Thank you.

Michael Jungling, Morgan Stanley.

Three questions, please; firstly on associates. Given what you mentioned, should we assume that associates will be a loss-making proposition in the second half of this year? And if it is, could it be more loss making than we saw in the second quarter?

Question number two is on the cost savings. Have we seen -- I presume we have not seen any material cost savings yet in Europe as a result of the restructuring. I think last time you mentioned that the restructuring for Europe would be completed by the end of the second quarter.

And the last question I have is on VERILAST Hips. How would you assess the progress that you're making in trying to give a [30y-year] claim for VERILAST Hips in the United States. Is this something that you think is possible this year?

On the VERILAST -- let me take the last question, then I will hand it to Adrian.

On VERILAST we don't comment this, and so this is, obviously, as you can imagine, commercially sensitive.

Regarding the cost-saving program, you are absolutely right. I think that the -- what has been done so far is mainly US and we plan to implement -- we are actually exactly on track in Europe to implement the program as stated and as discussed previously. So this is really on track.

On the associates, Michael, it's important to remember that this is now not an entity we control. So they will do what they will do. Clearly we have representation on the Board, but they will do what they will do.

Notwithstanding that, Michael, no, we would not expect it to be loss making in the second half. Can't obviously guarantee that, because it's not our entity, but we would expect it to be loss making in the second half.

But we would expect it to be less profitable than the CT business would have been if they weren't going to this venture; A, because they've still got start-up costs over immediately, and B, because they are going to front-end load.

They have a seven-year horizon, or whatever it is, to make this business successful. They are going to front-end load their investments in some of the science and other activities. So we do expect this to be less profitable than it otherwise would have been.

And Adrian, on the cost savings for Europe, if I look at the first half, you've improved your EBITA margins by 70 basis points with little help from Europe. Even if you were to make some adjustments, or increase your investments in the second half, with the European savings coming through, why would it not be reasonable to assume that you can sustain a 70 basis point margin improvement for the full year?

Because you forget one thing; it's the investment that we want to do in geographies and in the different parts of our business. So that's why we are always talking about a modest improvement.

Great. Thank you.

Tom Jones, Berenberg Bank.

Just want to focus a bit on the ASD business. Just on the Arthroscopic Enabling Technologies, I'm sure you won't give a quantitative answer but a quality one would be helpful.

I was just wondering whether that minus 4% that you reported was coming from what you used to call the visualization and DOR business, or was coming from softness on the consumable side, on the shaver blades and the like?

And then the second question was just on the Hip business. With the metal-on-metal, I'm guessing that you're probably selling less than 2,000 metal hips a quarter now, if you back out the numbers that you've given.

Is there a risk that this business becomes so low volume that it starts to become unprofitable to continue to produce and sell those hips? Or is that not a significant concern for you?

And the second follow-on question to that is just on the modular hip side. There's some bubbling concern about modular hips in general. I just wondered how your short modular femoral hip is getting on against that backdrop at the moment.

To your first question, Tom, on AAT, Advanced Arthroscopic Technologies, and what's driving the minus 4%, I'm just turning to the number, the minus 4% in the quarter. You're quite right Tom, there's two elements to this business; one is the -- well, two main elements.

One is the blades business and the [pump] that sits behind it, which, as you know, is within our arthroscopic franchise; a very solid but lowest growing part of the franchise because of the lower nature of technological improvement there than there is in the core joint repair, the Sports Medicine Joint Repair sector. So that's one underlying driver.

But then on top of that there is the camera element, which, although far, far more restricted and limited that the old DOR days, because, as you know, we've pretty much completely got out of that now, is still a lumpy business. We do still have ups and downs when there are some big camera deliveries. And so that's what you're seeing playing out here; the slight variability in this line. So you're absolutely right to infer that, Tom.

On the other question, Tom, you were asking about the modular hip systems and I guess you're referring to the recall of Stryker, of Rejuvenate and ABG II Modular-neck.

So, again, we have three modular hip systems in our portfolio; the SMF, the EMPERION and the new REDAPT that we have launched. And we have no reason, actually -- when we have seen this recall we have looked at that. We have no reason to be concerned about any of our products.

But, as you know, we take the safety very seriously, and, as always, we keep all production datasets under review. So I think that, net-net, no worries on this; we are absolutely clear and fine.

Regarding the metal-on-metal, well it's true that this is not -- BHR is not a big part of our business now because I think it's about 7%, 8%, Adrian, of Hip sales. So it is less than 1% of the total sales of the Company.

We still believe it's a great product. So I do believe, and I do hope, that one day we will see this product coming back, and all the feedback we get is very good. You remember the registries are excellent. So I'm not really concerned at this stage about the profitability of this product.

And maybe just one quick follow up, and I'm probably chancing my arm here, but would you be prepared to quantify what percentage of your Hip business is modular versus non-modular hips?

On the modular hip, it's pretty small actually. So I don't give you the right exact number, but it's a small part of our Hip business.

Okay.

So we'll take one more question.

Ingeborg Oie, Jefferies.

Two questions, if I may. Firstly on the manufacturing footprint where you're stating that you're gathering pace. Could you elaborate on what the key objectives you're trying to achieve in the process are, and what the key considerations you're making when deciding on the appropriate place to manufacture some of your -- well, the specific products that you're looking at?

Second question is on the R&D and the investments that you're making. Could you just help us understand the timeframe over which we should see the projects coming to fruition, maybe the two specific ones you mentioned; the products for emerging markets and biomaterials? Thank you.

Okay, let me start with the second question on the R&D. So when are we going to see products coming? Well, I think that you see products coming on a pretty regular basis.

Again, it comes in every part of the Company. We are very happy with the pace of innovation that we have. We do it better, we allocate better the resources. We'll spend more money. Again I've been very cautious in asking the teams to present projects which make sense for us and want to use well our R&D money.

So the programs are starting to appear, more and more; including the emerging markets project. We have registered 40 products recently in the emerging markets. That is very significant.

Now, the portfolio, the mid tier for the emerging markets, is obviously extremely important and, actually, very related to your question regarding manufacturing footprint. We have not launched mid-tier products in the emerging markets. When I talk emerging markets, it is mostly the BRIC countries.

We are working in defining a portfolio which could be, and will be, a mix of acquisitions or/and organic products that we are going to develop specifically for these geographies.

So, obviously, if you want to be in Brazil, you'd better manufacture in Brazil; that's, for the mid tier, absolutely important. So that could be one of the geographies.

And we look at not putting all the eggs in one basket, so that's very important. So we look at the places where it makes sense, where we can fulfill the local needs, let's take in India, or we can also use it as a base for exporting the products. So we work on that.

Actually you will be happy to know that we have now a head of manufacturing for the emerging markets in place and this is really his mission with the manufacturing team.

Thank you. So it sounds like costs is not one of the key concerns when you look at the manufacturing footprint, if I understood you correctly.

No, you didn't understand him correctly, Ingeborg. Just to give you a slightly more systematic answer, I would say there's four criteria.

Quality is clearly pre-eminent; we aren't going to do anything in terms of location which jeopardizes quality. Security of supply is clearly very important, and Olivier very much alluded to that one. And then there are, I think, two related more directly to economics in different ways.

One of them, which Olivier absolutely rightly focused on, is there is an element in locational decisions that talks to support in the marketplace. And that sometimes is logistics driven, such as Brazil where you have tariff barriers and things to deal with. But also it's to do with development driven.

If there aren't tariff barriers type things, logistics actually isn't a huge driver in our business, but thinking about how you effectively develop products for a market is a factor in our thinking of the location of capabilities that we have round the world.

And then lastly, but not leastly, is, indeed, the cruder economics, the arbitrage of the various costs that go into cost of goods sold, labor and the costs associated with labor in location in particular.

So all of those are things we play in and are becoming more systematic about.

Perfect. That's very clear.

So thanks a lot. So this ends this call and wishing you good day. Thank you.

Ladies and gentlemen, we thank you very much for your participation. You may now disconnect.