Smith & Nephew
Date 09/13/05
Page 1
Smith & Nephew
Moderator: Milton Hsu
September 13, 2005
Milton Hsu: OK. Good morning, everyone. Milton Hsu from Bear Stearns. Here to just give us an update on story and, I guess, on some guidance is Christopher-- Sir Christopher O'Donnell, Chief Executive Officer. Chris?
Christopher O'Donnell: Right. Well, good morning, everybody, and welcome to the Smith & Nephew presentation at the Bear Stearns conference. I'm going to run through the presentation and I'm going to update you on some guidance changes that we've issued this morning and I'll do that as I go through the-- through the presentation.
Overall -- I have to, unfortunately, look at the forward-looking statement that I'm sure you're intimately familiar with that -- our strategy is to exploit positive market dynamics and build on our technology leadership. We do focus on organic growth. We've got an innovative product pipeline this year and next year and into the future. And we're continuing to invest strongly in sales force, particularly in orthopedics and selectively in our other two businesses, endoscopy and wound management.
We're continuing to pursue synergistic technology acquisitions and look to build on our overall Smith & Nephew brand.
Let's just see if we can find any more seats for anybody. There's--
Unidentified Participant: [unintelligible]
Christopher O'Donnell: Yeah. Probably best to circulate across the back. There's a little bit more room against that wall, but I'm afraid that's about it.
What is our business? Well, obviously, orthopedics is hip and knee implants, trauma products and clinical therapies. Endoscopy -- products for minimally invasive surgery, particularly for the joints, spine and digital operating room equipment, an increasing part of our business. Advanced wound management focuses on hard-to-heal or serious wounds, typically hospital wounds or long-term care wounds rather than cuts and grazes that you might see domestically.
Overall, our sales last year were $2.3 billion and our market cap is just over $9 billion. We're listed on the London and the New York Stock Exchanges.
The shape of our business is that half of it is orthopedics, our biggest and fastest-growing business, with roughly a quarter each wound management and endoscopy. Geographically, almost half the business is in the U.S. with the next strongest markets being the UK, at almost 10 percent, and Japan, Australia and Germany. We're particularly investing in Japan, so we pick that out particularly. It's a very global business in every respect.
In terms of our performance, underlying revenue growth moves up from 11.5 to 12 percent between 2004 and the first half of 2005. Operating margin pretty consistent at 20 percent. Earnings per share growth moves up from 14 to 16 percent in the first half and, under dollar reporting, we would have reported, actually, that as 18 percent. We, obviously, report in sterling as our currency.
What's driving our business? This is probably the most important slide in the-- in the presentation. The emerging baby boomers are clearly a major factor. They're there in orthopedics. They're not yet there in wound management. The reason they're there in orthopedics is the reducing age threshold for joint reconstruction through new technologies and that's reducing the operating age, particularly with our Oxinium products for knees and, outside the U.S., our BHR hip resurfacing product for hips.
Also favored by lifestyle trends, increasingly active styles will lead to increased injuries, which is a factor driving our endoscopy business, but, on the other hand, more obesity leads to more product applications, particularly for reconstructive joints and also for the more difficult ulceration-type wounds that our wound management business is a specialist in.
Overall, health care spending continues to increase, in the main despite governments' efforts to control it, although there are countries like the UK and Australia where there is a policy to improve the health of the population and, therefore, increase health care spending. In the U.S., Germany and Japan, particularly, and also France, this is a major topic of concern and governments are trying to control health care spending but, nonetheless, in virtually all cases, it is increasing.
Consumer awareness, both of health treatments and involvement in payment, is also affecting demand and we do see this, particularly in orthopedics, and, to a lesser extent, endoscopy, particularly as the knowledge of newer technologies gets greater.
In Q2 2005 our revenue growth, as I said, stepped up to 12 percent. Orthopedics continued to put in a market-leading performance at 18 percent growth. Endoscopy, as predicted, had a slower quarter at 7 percent. Advanced wound management was 6. The margin stepped up from the quarter one number sequentially to 20 percent. The earnings per share growth was 16 percent for the quarter and the half-year and we increased our dividend by 10 percent in the first half. Now that's the interim dividend.
We also announced -- and we'll touch base on this later -- that endoscopy will close one of its three U.S. manufacturing facilities, distributing the manufacturing there between its other facility in Massachusetts and its warehousing activities in Oklahoma City.
I'd like to turn and look at each of the businesses and as I do this, I'll talk to you about prospects for the second half of the year. Orthopedics is growing as a market around 13 percent in constant currency and we've seen this number for the whole of 2004 and the first half of 2005. Our orthopedic business is delivering growth substantially ahead of the market. These numbers for the first-- the chart for the first half of 2005 shows that Smith & Nephew have, for roughly the fifth successive year, outgrown the competition and we've done so consistently.
Our revenue growth was up to 18 percent for the first half and our U.S. growth at 22 percent. Our growth outside the U.S. was slower, particularly affected by a slower market place in continental Europe.
The drivers for this at the product level were minimally invasive surgery, particularly for knees, but also for hips, and our Oxinium or oxidized zirconium components, which roughly equate to 40 percent of our U.S. turnover in hips and knees.
Outside the U.S., our Birmingham Hip Resurfacing product is the market leader. We acquired this in March of 2004. It's been a great success outside the U.S. and we'll talk about its prospects going forward.
Our newly introduced Peri-Loc locking compression plate is the big driver for trauma, together with the enhanced sales force. We've now got 180 dedicated sales people in the U.S. and we're splitting the sales force between reconstructive and trauma outside the U.S. We've done this is in the UK; we've done it in Japan; we're on with it in Germany and the other European countries.
In addition to Peri-Loc, we have upgraded our strongest product sector, the long intramedullary nails and the intramedullary hip screws and I'm pleased to note that the courts here in the U.S. agreed that we are the innovator in this nail field by recently making it clear to Synthes that they were, in fact, copying our products in many important respects in a court verdict about a month ago.
New product revenues in this area are about 17 percent. As Peri-Loc gets more traction we expect that number to go up and get more close to the 25 percent we've seen historically.
What are the growth prospects for orthopedics? Well, we're continuing to invest in the sales force and segment it between reconstructive and trauma on a global basis and a separate and strongly growing clinical therapy sales force selling our unique Exogen ultrasound product and our Supartz joint fluid injection product in the U.S., currently growing in excess of 40 percent per annum. Oxinium technology will be extended to the revision knee and that product will come out in the back end of this quarter and roll out in quarter four.
Our hip resurfacing, the Birmingham Hip, product we expect to continue to grow outside the U.S. It's beat rate is in the low 20s and we have the good news last week from the FDA panel that they recommended approval of this product to the FDA conditional on a post-marketing trial.
We do believe this is a significant long-term opportunity for us, but we don't expect a quick bullet up in sales in 2006. Our expectation is we'll get approval sometime in the first half and we'll do between $5 and $10 million in 2006 as we establish reference centers to get the necessary surgeon training done in this area. Obviously, that is conditional on final U.S. approval and the steps to achieve that largely relate to plant inspections and to final labeling agreements.
The Peri-Loc plating system, the lower extremity system, was launched in the first quarter. The targeter, which you see here, this system here, is another innovation, which enables the surgeon to put the locking screws in much less invasively but accurately and this has helped the interest of surgeons in this product and we expect it to boost sales. We do expect to launch the upper extremity in the first half-- system of Peri-Loc in the first half of 2006.
Also, we are extending the indications for our Exogen ultrasound bone-healing therapy. Just recently the surgical-- the removal of the caveat which only allowed this to be used on non-union fractures which had previous surgery was removed, the caveat being which had previous surgery. So now if the physician believes that this is a non-union he may now apply Exogen and it will be reimbursed.
We have a number of other applications for Exogen following our discovery of the mode of action of ultrasound on which we published 19 papers at the Orthopaedic Academy in February of this year.
So a very strong fundamental position for our orthopedic business. In our announcement this morning, however, we told the market that we were going to reduce its guidance from 18 percent growth for the year as a whole to 17 percent for the year as a whole.
Two reasons -- we have a strong market share in Louisiana and Mississippi and it is clear that there's going to be no elective surgery done in that area for some considerable period of time and we expect that to last, broadly, through the end of the year. That's the first reason.
The second reason is that in terms of our products versus the competitors in knees, we've seen some very strong rollouts particularly from J&J and Biomet, and our knee sales have been slower than we anticipated in the third quarter. So we're reducing guidance from a market-leading 18 percent to probably a market-leading 17 percent, but we felt that we should talk to the market about that ahead of a visit we're holding for investors and analysts to Memphis later this week.
If we look at endoscopy, it is a slower-growing market. We have a very strong market share position. We are the market leaders in endoscopy. Global revenue growth was just ahead of market in 2004 and the first half of-- first half of 2005. U.S. growth was slower in the second quarter awaiting the launch of our new camera system, the 460-series camera, which refines our previous model.
This is now well in the market and is being very, very well accepted. Picture quality is excellent and the-- it has a number of features that make it easier to switch from one type of surgery to another.
Most of our products are solely for arthroscopy but our camera products and our digital operating room products are sold for all surgeries. Hospitals want to standardize on one type of camera and on their digital operating rooms.
Growth outside the U.S. is strong for endoscopy. We'd like to get back to the 14 percent we saw in 2002 and 2003 as new products roll out and that's certainly our aim, but it's a very solid performance and the market is less penetrated for arthroscopy outside the U.S.
Within the business as a whole, knee and shoulder tissue repair products are driving growth. They're easier and faster to use than the previous generation. New products -- a particular feature of this -- is at 22 percent in the first half.
However, as I said earlier, we did restructure manufacturing to reduce costs with approximately a 1 percent benefit to endoscopy margins coming through in 2007. The manufacturing transfer needs to be carefully managed over the next 18 months.
What are the growth prospects in this business? Well, we are segmenting the sales force and here adding specialists for the repair sector in shoulder and knee and the item at the bottom here, hip arthroscopy. This is a very small but emerging field where the instrumentation we have developed for easy and fast knee and shoulder access and repair can be utilized, once modified to some extent, in the hip, which has not been an area where surgeons have had the tools before to work with.
Our new 400-series camera is getting good traction. Our market acceptance of our digital operating room, which is a fully electronic control system for all the endoscopic instrumentation and the audio-visual and information recording systems in the operating room, is going very well. Surgeons really like this concept and they're boosting the growth in this sector.
We talked to the market about a 15 percent growth on an annualized basis. It is possible, because it's a lumpy growth, that it's actually over 20 percent.
And the good news is the surgeons are asking for it. The hospitals want it to keep the surgeons and actually to market it to their patients. It comes right to consumer awareness of the latest technology and we're participating in this growth with a very, very good offering. So good prospects for endoscopy to step up their growth progressively above the market growth rate of 8 percent.