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Chief Financial Officer's review

Dear Shareholder,

I am delighted to address you for the first time in the Annual Report as your Chief Financial Officer.

Under Olivier’s leadership, Smith & Nephew has made significant organisational changes to create a strong global business. I believe that we are just starting to see the benefits
of these changes, and I am excited by the prospects for 2018 and beyond as we realise the opportunities in front of us. I am very much looking forward to working with Olivier and, in due course, his successor, to make this happen.

2017 performance

Group revenue in 2017 was $4,765 million, an increase of 2% on a reported basis and 3% on an underlying basis1. This was an improvement from underlying growth of 2% in 2016. Trading profit1 was $1,048 million, and the trading profit margin1 was 22.0%, up 20bps on 2016. I am pleased to report that both our underlying revenue growth and trading profit margin improvements were in-line with our guidance.

The reported operating profit for 2017 was $934 million, up from $801 million in 2016, with the year-on-year increase primarily reflecting a gain of $54 million from the settlement of an intellectual property matter, no restructuring charges and lower amortisation and impairment of acquisition intangibles in 2017.

The tax rate on trading results1 was 17.1% (2016: 23.8%). This is a considerable  reduction on the 2016 rate and is mainly due  to a one-off benefit following the conclusion  of a US tax audit, further progress in improving our tax rate, tax provision releases following expiry of statute of limitations and a beneficial geographical mix of profits. The reported
tax rate of 12.7% was a result of the lower tax rate on trading results and also included a $32 million net benefit from US tax reform.

Adjusted earnings per share1 (EPSA) was up 14% at 94.5¢ as a result, and this is reflected in the 14% increase in our full year dividend distribution for 2017. Basic earnings per share (EPS) was 87.8¢ in line with the previous year.

I am pleased to report that trading cash flow1 was $940 million, up from $765 million in 2016, with a higher trading profit to cash conversion ratio1 of 90% as we improved our working capital management.

As the result of improved operating profit, the lower tax rate and a stable asset base we saw an improvement in Return On Invested Capital1 (ROIC – as defined on page 39) from 11.5% in 2016 to 14.3% in 2017.

Capital returns

The appropriate 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:

  • Continue to invest in the business to drive organic growth; 
  • Maintain our progressive dividend policy;
  • Realise acquisitions in-line with strategy; and
  • Return any excess capital to shareholders.

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

Improving competitiveness

On joining Smith & Nephew I was asked by Olivier and the Board to look afresh at efficiency opportunities within our business. Some preliminary analysis highlighted a number of areas of opportunity, and we conducted a detailed assessment of these during the final months of 2017.

Our conclusion was that we now have the Group structure in place which lets us act on these further opportunities. Through better execution and efficiency we can and will strengthen our competitive position.

We are calling this work the APEX programme, standing for ‘Accelerating Performance and Execution’, and we completed our planning and started to take action in early 2018.
Our three workstreams are focused on clear and obtainable improvements in the Group’s manufacturing, warehousing and distribution footprint, reducing our general and administrative expenses, and driving greater commercial effectiveness. More details on APEX and each of these workstreams can be found on page 14.

APEX is expected to deliver an annualised benefit of $160 million by 2022, with at least half of this expected by 2020, for a one-off cash cost of up to $240 million.

Successful acqusition

During the year, we continued to seek further opportunities to strengthen our technology and product portfolio. In December we acquired Rotation Medical, Inc., the developer of a novel tissue regeneration technology for shoulder rotator cuff repair, for an initial cash consideration of $125 million and up to a further $85 million over the next five years, contingent on financial performance. I am excited by the potential for this new technology and we remain alert to further opportunities to bring other disruptive innovations into
the Group.


We expect the overall dynamics in our markets to be similar in 2018 to those seen in 2017. Against this backdrop, the Group expects to continue to deliver an improved performance in 2018 driven by our by our strong product portfolio and pipeline of innovative products.

In terms of revenue, we expect our underlying growth to be in the range of 3% to 4% (which equates to 7% to 8% in reported terms at exchange rates prevailing on 2 February 2018). In terms of trading profit margin we expect to drive a further 30-70bps improvement over 2017. As a result of the recently enacted US tax reform, we expect a tax rate on trading results in the range 20% to 21%, barring any changes to tax legislation or other one-off items.

In 2018, we will continue to push for further success as we build a more competitive Smith & Nephew. I look forward to helping to drive this, and to delivering on our commitments for the benefit of all of our stakeholders.

Yours sincerely,

Graham Baker

Chief Financial Officer