Global

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Financial review

Revenue

Group revenue in 2016 was $4,669 million (2015: $4,634 million), an increase of 1% on a reported basis and 2% on an underlying basis1.

In 2016, we delivered reported revenue growth of 4% and underlying revenue growth1 of 3% in the United States. Revenue growth on a reported basis was -1% and on an underlying basis1 was flat across our other Established Markets, although Japan and France delivered strong performances. In our Emerging Markets reported revenue growth was -3% and underlying growth1 was flat in 2016. Most of our Emerging Markets businesses generated double-digit growth which was offset by weakness in China and the Gulf States. In China, the slow-down in endmarkets seen since mid-2015 was compounded by destocking in the distributor channel during 2016. By the end of 2016 most franchises in China had returned to growth as the level of stock in the channel was adjusted, although we expect Advanced Wound Management to continue to be impacted in the first half of 2017. In the oil-dependent Gulf States we saw very difficult trading conditions, particularly in our tender business, which are likely to persist. As a matter of course we expect to see some volatility in the Emerging Markets, but we continue to see significant long-term growth potential and are very well positioned in our chosen markets.

The global product franchise highlights in 2016 included our strong performance across Sports Medicine, where we continue to reap the benefits of the acquisition of ArthroCare. PICO™, our novel single-use NPWT system, is transforming the use of this therapy option. Our world class Knee Implant portfolio was further strengthened by the acquisition of NAVIO™, an exciting robotics platform, from  which we delivered more than 50% reported revenue growth in 2016. 

Profit

Operating profit of $801 million (2015: $628 million) includes acquisition and disposal related items, as well as restructuring and rationalisation costs, amortisation and impairment of acquisition intangibles and legal and other items incurred in the year. The 2016 operating profit is before a one-off $326 million gain from the disposal on the Gynaecology business in August 2016. The operating profit margin increased to 17.2% (2015: 13.6%) primarily driven by the costs in 2015 relating to anticipated and settled metal-on-metal hip claims.

Trading profit1 was $1,020 million (2015: $1,099 million). The trading profit margin1 was 21.8% (2015: 23.7%). This reduction primarily reflects the significant transactional currency headwind seen in 2016 resulting from the sustained strength of the US dollar. Additionally, we lost some operational leverage from the lower than anticipated sales growth and our investment in Blue Belt Technologies was dilutive. These factors were somewhat offset by the Group Optimisation programme.

Selling, general and administrative expenses decreased by $275 million (10%) from $2,641 million in 2015 to $2,366 million in 2016. In 2016, administrative expenses included amortisation of software and other intangible assets of $61 million (2015: $66 million), $62 million of restructuring and rationalisation expenses (2015: $65 million), an amount of $178 million relating to amortisation and impairment of acquired intangibles (2015: $204 million), $9 million of acquisition related costs (2015: $12 million) and $30m net credit primarily related to a $44m curtailment credit on UK post-retirement benefits (2015: $190m charge for legal and other charges). Excluding the above items, selling, general and administrative expenses were $2,086m in 2016, a decrease of $18m from $2,104m in 2015.

Research and development expenditure as a percentage of revenue remained broadly consistent at 4.9% in 2016 (2015: 4.8%). Actual expenditure was $230 million in 2016 compared to $222 million in 2015. The Group continues to invest in innovative technologies and products to differentiate it from competitors.

Profit on disposal 

The Group realised a profit on the disposal of its Gynaecology business of $326 million. The business had been primarily internally generated and the disposed assets had a net book value of $10 million. The proceeds were $350 million with associated disposal related costs of $7 million and liabilities of $7 million.

Taxation

Our reported tax rate of 26.2% (2015: 26.7%) includes the one-off benefit of a US tax settlement which is partly offset by the tax rate on the disposal of the predominantly US Gynaecology business.

Capital returns

The efficient use of capital on behalf of shareholders is important to Smith & Nephew. The Board believes in maintaining an efficient, but prudent, capital structure, while retaining the flexibility to make value enhancing acquisitions. This approach is set out in our Capital Allocation Framework which we used to prioritise the use of cash and ensure an appropriate capital structure.

Our commitment, in order of priority, is to:

  1. continue to invest in the business to drive organic growth;
  2. maintain our progressive dividend policy;
  3. realise acquisitions in-line with strategy; and
  4. return any excess capital to shareholders.

This is underpinned by maintaining leverage ratios commensurate with solid investment grade credit metrics.

Enhancing Group efficiency

In 2016 we continued to simplify and improve our operating model and delivered significant efficiencies. In Manufacturing, our Global Operations leadership team is focused on supporting the Group’s strategic priorities by ensuring our footprint and expertise are ready to respond to geographical growth, new product development, greater external regulatory scrutiny and the commercial pressure to be ever more efficient. We made good progress across these areas in the year. The Group Optimisation Plan was announced in May 2014 with a stated savings target of annualised benefits of $120 million by the end of 2017. We delivered ahead of plan and reached our target at the end of 2016. These savings have been driven by our focus on efficient procurement, the greater agility of the single country managing director model and rationalisation of our facility footprint in a number of countries. 

Successful acquisition track record

In recent years we have undertaken a number of acquisitions, strengthening both our technology and product portfolio, and our Emerging Markets business. We have delivered good returns, establishing a strong track record in M&A. With Healthpoint, acquired in 2012 for $782 million, our third year return on capital exceeded our expectations. ArthroCare, acquired in 2014 for $1.5 billion, is performing well. We have achieved our targeted cost savings and are ahead of our plan to deliver $85 million of synergies by the end of 2017.

In 2016, we continued to invest in acquisitions such as Blue Belt Technologies with its NAVIO robotics surgical platform. In addition, we created compelling value by selling our Gynaecology business for $350 million (2015 revenue: $56 million). We had built this business rapidly on the back of Smith & Nephew’s resection technology and expertise. We completed the associated $300 million share buy-back programme in December 2016, returning the value created directly to shareholders.

Measuring performance 

In 2016 we have worked to develop Return On Invested Capital (ROIC) as a performance metric for the Group. In response to feedback from investors, this metric is proposed as an element of our Performance Share Plan beginning in 2017.

New CFO

Julie Brown was the CFO during 2016 until she left Smith & Nephew in January 2017. During her time at Smith & Nephew the Finance function was refocused as a global function supporting the commercial business and providing excellence in finance operations and specialist areas. From March 2017 the Finance function will be led by Graham Baker who will join Smith & Nephew from Alvogen. 

Outlook 

We expect the dynamics in our markets to be similar in 2017 to those seen in 2016. Against this backdrop, the Group expects to deliver higher underlying revenue growth and an improved trading profit margin in 2017.

Our reported revenue growth is a combination of underlying revenue growth, impact of acquisitions and disposals and foreign exchange. We expect reported revenue growth in the range of 1.2%-2.2% at prevailing1 exchange rates. We expect 2017 underlying revenue growth to be in the 3-4% range, reflecting not only the dissipation of the headwinds we faced in China and the Gulf States but also, most importantly, our improving execution.

1 Prevailing exchange rates as at 31 January 2017.