| | | Cumulative free cash flow | | Award vesting as % of salary | Below $1.64bn$1,482m | | Nil | $1.64bn1,482m (‑13% of target) | 11.875% | $1,703m | 23.75% | $1.88bn1,924m or more (+13% of target) | 47.5% |
Awards will vest on a straight-line basis between these points.
Revenue in Emerging & International Markets is defined as cumulative revenue over a three-year period opening 1 January 2014 from our Emerging & International Markets. The 25% of the award that will be subject to revenue in Emerging & International Market performance will vest as follows:
| | | | | | | | | | | | | | | | Revenue in Emerging &
International Markets
| | Award vesting as % of salary | | | | | Below Threshold | | Nil | | | | | Threshold | | 11.875% | | | | | Target | | 23.75% | | | | | Maximum or above | | 47.5% | | |
It is not possible to disclose precise targets for revenue growth in Emerging & International Markets as this will give commercially sensitive information to our competitors concerning our growth plans in Emerging & International Markets, which they could use against us to launch new products and enter new markets. This would be detrimental to our business in Emerging & International Markets, which are key to our success overall. ‘Target’ is set at target cumulative revenues from Emerging & International Markets in the corporate plan approved by the Board for the three years commencing 1 January 2014. ‘Threshold’ and ‘Maximum’ are set at +/– 15% from target. At present, the Board would not be in a position to declare these targets at a later date, but will keep this under review.
25% of the award will vest based on the Company’s Total shareholder Return (TSR) performance relative to a bespoke peer group of companies in the medical devices sector over a three-year period commencing 1 January 2014 as follows:
| | | Relative TSR ranking | | Award vesting as % of salary | | | | | | | | Below median90
| GOVERNANCE | NilSMITH & NEPHEW ANNUAL REPORT 2017 |
| | | Median
| | 11.875% | Upper quartileREMUNERATION IMPLEMENTATION REPORT
| | 47.5% |
Awards will vest on a straight-line basis between these points. If the Company’s TSR performance is below median, none of this part of the award will vest.
The bespoke peer group for the 2014 awards comprises of the following companies: Baxter, Becton Dickinson, Boston Scientific, CR Bard, Coloplast, Conmed, Covidien, Edwards life Sciences, Medtronic, Nobel Biocare, Nuvasive, Orthofix, Stryker, St Jude Medical, Wright Medical and Zimmer.
The Group’s TSR performance and its performance relative to the comparator group is independently monitored and reported to the remuneration Committee by Towers Watson. TSR is calculated in common currency using a three-month averaging period at the start and end of the performance period. The Company has established protocols for dealing with companies that cease to be listed or merger and acquisition activity within the peer group.
Performance Share Programme 20152018 PerformanceA performance share awardsaward will be made in 20152018 to Executive DirectorsGraham Baker under the Global Share Plan 2010 to a maximum value of 190% of salary (95% for target performance). No performance share award will be made to Olivier Bohuon in 2018.
Performance will be measured over the three financial years commencing 1 January 2015 and will vest subject to performance and continued employment in 2018. Vesting will be subject to2018 against the same threefour equally weighted performance measures as appliesin 2017: relative TSR, return on invested capital, sales growth and cumulative free cash flow. On vesting, sufficient shares will be sold to cover taxation obligations and Graham Baker will be required to hold the awards madenet shares for a further period of two years. TSR performance will be measured in 2014 using the same definitions andway as in 2017 as described on page 88 against the same comparator group. 50% of the award will vest subject to free cash flow performance, 25% to revenue in Emerging & International Markets and 25% to TSR.two peer groups. The 50% of the award thatReturn on invested capital (ROIC) will be subject to free cash flow performancemeasured in the same way as in 2017, as described on page 89. The targets will vestbe as follows:
| | | Cumulative free cash flowReturn on Invested Capital | | Award vesting as % of salary | Below $1.58bnThreshold 11.6% | Nil | Threshold 11.6% (‑1.25% of target) | 11.875% | Target 12.9% (as derived from the Strategic Plan) | 23.75% | Maximum or above 14.1% (+1.25% of target) | 47.5% |
Awards will vest on a straight-line basis between these points. Sales growth will be measured in the same way as in 2017, as described on page 89. The targets will be as follows: | | Sales growth over three-year period commencing 1 January 2018 | Award vesting as % of salary | Below Threshold | Nil | Threshold (‑2.7% of target) | 11.875% | Target | 23.75% | Maximum or above (+2.7% of target) | 47.5% |
It is not possible to disclose precise targets for sales growth as this will give commercially sensitive information to our competitors concerning our growth plans and is potentially price sensitive information. This target however will be disclosed in the 2020 Annual Report, when the Committee will discuss performance against the target. Cumulative free cash flow will be measured in the same way as in 2017, as described on page 89. The targets will be as follows: | | Cumulative free cash flow | Award vesting as % of salary | Below $1,575m | Nil | $1.58bn1,575m (‑13% of target) | 11.875% | $1,810m | 23.75% | $1.81bn2,046m or more (+13% of target) | 47.5% |
| 47.5% | | $2.05bn or moreSMITH & NEPHEW ANNUAL REPORT 2017
| GOVERNANCE | 95%91 |
The free cash flow performance measure target for 2015 is lower than the same target in 2014, primarily due to exchange rate movement, as well as the continued impact of the RENASYS hold in the US and restructuring charges associated with the Group Optimisation Plan, both of which were not factored in when setting the prior year target.
Vesting of Awards made in 2012
VESTING OF AWARDS MADE IN 2015 Performance Share Programme 2015 Since the end of the year, the Remuneration Committee has reviewed the vesting of conditional awards made to Executive Directors under the Global Share Plan 2010 in 2012.2015. Vesting of the conditional awards made in 20122015 was subject to performance conditions based on TSR, revenue in Emerging Markets and cumulative free cash flow measured over a three-year period commencing 1 January 2012.2015. 50%25% of the award was based on the Company’s TSR performance relative to a bespoke group of 12 Medical Devices companies. This group comprised of the following companies: Baxter, Becton Dickinson, Boston Scientific, Coloplast, Conmed, Edwards Life Sciences, Medtronic, NuVasive, Orthofix, Stryker, Wright Medical and Zimmer. The following companies delisted during the period and were therefore removed: Covidien, C R Bard, Nobel Biocare and St Jude Medical. Against this peer group, the Company’s TSR performance ranked below median meaning that this part of companiesthe award therefore vested at 0%.
25% of the award was based on revenues in the medical devices sector.Emerging Markets. The threshold set in 2015 was $2,395 million with a target of $2,818 million. Over the three-year period, ending 31 December 2014, the Company was ranked 7th out of 17 companiesadjusted revenues in the comparator group.Emerging Markets were $2,411 million. These adjustments include translational foreign exchange and Board-approved M&A . This part of the award therefore vested at 58.5%.13% out of the 25% target. 50% of the award was based on cumulative free cash-flowcash flow performance. Over the same three-year period, the adjusted cumulative free cash free cash-flowflow was $1.642 billion.$2,024 million which is between target and maximum. These adjustments include items such as Board approvedBoard-approved M&A, including the acquisition of HealthpointBlueBelt and ArthroCare but do not include itemsBoard-approved Business Plans such as the proceeds of the sale of the Gilberdyke business or the repayment of the Bioventus loan which are excluded from free cash.metal-on-metal settlements. This part of the award therefore vested at 55.5%95%. | | | | | | | Threshold | Target | Maximum | Actual | Percentage Vesting | TSR | Median | – | Upper Quartile | Below Median | 0% | Emerging Markets Sales | $2,395m | $2,818m | $3,240m | $2,411m | 13% | Cumulative Free Cash Flow | $1,578m | $1,814m | $2,050m | $2,024m | 95% |
Overall therefore, the conditional awards made in 20122015 will vest at 57%54% of maximum (108% of target) on 89 March 20152018 as follows: | | | | | | | | | | | Director | | Date of grant | | Number of shares under award | | Number vesting | | | Date of grant | Number of shares under award at maximum | Number vesting | Olivier Bohuon | | 8 March 2012 | | 267,304 | | 152,363 | | | 9 March 2015 | 133,156 | 71,904 |
| 88Smith & Nephew Annual report 2014 |
Summary of scheme interests awarded during the financial year
| | | | | | | | | | | | Olivier Bohuon | | Julie Brown | | | | | | Basis on which award is made | | Number of shares | | Face value | | Number of shares | | Face value | | Annual Equity Incentive Award (see page 86) | | | | | | | | | | | 61,683 | | €702,975 | | 26,497 | | £250,000 | Performance Share Award (see page 88) | | | | | | | | | 190% base salary at maximum | | 180,304 | | €2,054,850 | | 100,688 | | £950,000 | 95% base salary at target | | 90,152 | | €1,027,425 | | 50,344 | | £475,000 |
Please see Policy Table on pages 96 to 97 for details of how the above plans operate. The number of shares is calculated using the closing share price on the day before the grant, which for the awards granted on 7 March 2014 was 943.5 pence.
Details of awards made under the Performance Share ProgrammeDETAILS OF OUTSTANDING AWARDS MADE UNDER THE PERFORMANCE SHARE PROGRAMME
Details of conditional awards over shares granted to Executive Directors subject to performance conditions are shown below. These awards were granted under the Global Share Plan 2010. The performance conditions and performance periods applying to these awards are detailed on pages 96 to 97.88 and 89. | | | | | | | | | | Date granted | | Number of ordinary shares under award | | Date of vesting | | Olivier Bohuon | | 8 March 2012(i) | | 267,304 | | 8 March 2015 | | | | | | 7 March 2013 | | 240,928 | | 7 March 2016 | | | Date granted | Number of ordinary shares under award at maximum | Date of vesting | Olivier Bohuon | 9 March 2015 | 7133,1561 | 9 March 2014 | | 180,304 | | 7 March 20172018 | | Julie Brown | | 7 March 2013 | | 132,866 | | 7 March 2016 | 146,620 | 7 March 2019 | | | | 7 March 2014 | | 100,688 | | 7 March 2017 | 158,328 | 7 March 2020 | Graham Baker | 7 March 2017 | 79,166 | 7 March 2020 |
(i) On 3
1On 6 February 2015, 43%2018, 46% of the award granted at maximum to Olivier Bohuon lapsed following completion of the performance period. DetailsSUMMARY OF SCHEME INTERESTS AWARDED DURING THE FINANCIAL YEAR
| | | | | | Olivier Bohuon | Graham Baker1 | | Number of shares | Face value | Number of shares | Face value | Annual Equity Incentive Award (see page 87) | 41,665 | €589,745 | – | – | Performance Share Award at maximum (see page 91) | 158,328 | €2,241,030 | 79,166 | £969,000 |
1 Annual Equity Incentive Awards for 2017 were based on performance for 2016, hence Graham Baker received no award. Please see Policy Table on pages 99 and 100 for details of option grants underhow the All-Employee ShareSave Planabove plans operate. The number of shares is calculated using the closing share price on the day before the grant, which for the awards granted on 7 March 2017 was 1,224p. Details of options held by Executive Directors under the Smith & Nephew ShareSave Plan (2012) are shown below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Director | | Date granted | 92 | Number of shares
under option GOVERNANCE
| SMITH & NEPHEW ANNUAL REPORT 2017 |
| Date of vesting | | Exercise period | | Option price | | | | | | | | | | 1 November 2018 to | | | Julie Brown | | 17 September 2013 | | 2,400 ordinary shares | | 1 November 2018 | | 30 April 2019 | | £6.25 |
Details of one-off awards
Details of the award granted to Julie Brown on joining the Company to compensate her for shares forfeited on leaving her former company are shown below. This award was made under Listing Rule 9. There are no performance conditions attaching to these shares other than continued service.
| | | | | | | | DirectorREMUNERATION IMPLEMENTATION REPORT | | Date granted | | Number of shares under award | | Date of vesting |
SINGLE TOTAL FIGURE ON REMUNERATION Chairman and Non-Executive Directors | | | | | | | | | | | | | | | | | | | | | | | | | | | Basic annual fee1 | | Committee Chairman / Senior Independent Director fee | | Intercontinental travel fee | | | | Total | Director | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 | Roberto Quarta | | £ | 412,000 | | £ | 409,750 | | | – | | | – | | £ | 7,000 | | £ | 3,500 | | £ | 419,000 | | £ | 413,250 | Vinita Bali2 | | £ | 36,750 | | £ | 63,000 | | | – | | | – | | £ | 7,000 | | £ | 21,000 | | £ | 43,750 | | £ | 84,000 | | | $ | 59,780 | | $ | 9,780 | | | | | | | | $ | 21,000 | | | – | | $ | 80,780 | | $ | 9,780 | Ian Barlow | | £ | 68,135 | | £ | 68,135 | | £ | 20,000 | | £ | 18,750 | | £ | 7,000 | | £ | 3,500 | | £ | 95,135 | | £ | 90,385 | Virginia Bottomley | | £ | 68,135 | | £ | 68,135 | | | – | | | – | | £ | 7,000 | | £ | 3,500 | | £ | 75,135 | | £ | 71,635 | Erik Engstrom | | £ | 68,135 | | £ | 68,135 | | | – | | | – | | £ | 7,000 | | £ | 3,500 | | £ | 75,135 | | £ | 71,635 | Robin Freestone | | £ | 68,135 | | £ | 68,135 | | £ | 16,667 | | | – | | £ | 7,000 | | £ | 3,500 | | £ | 91,802 | | £ | 71,635 | Michael Friedman | | $ | 129,780 | | $ | 129,780 | | $ | 35,000 | | $ | 33,000 | | $ | 42,000 | | $ | 35,000 | | $ | 206,780 | | $ | 197,780 | Brian Larcombe3 | | £ | 20,750 | | £ | 68,135 | | £ | 1,277 | | £ | 18,750 | | | – | | £ | 3,500 | | £ | 22,027 | | £ | 90,385 | Marc Owen4 | | $ | 30,000 | | | – | | | – | | | – | | $ | 14,000 | | | – | | $ | 44,000 | | | – | Joseph Papa | | $ | 129,780 | | $ | 129,780 | | $ | 35,000 | | $ | 33,000 | | $ | 35,000 | | $ | 35,000 | | $ | 199,780 | | $ | 197,780 | Angie Risley5 | | £ | 18,173 | | | – | | | – | | | – | | £ | 7,000 | | | – | | £ | 25,173 | | | – |
1The basic annual fee includes shares purchased for the Chairman and Non-Executive Directors in lieu of part of the annual fee, details of which can be found on the table on page 104. 2Vinita Bali elected to receive the payment of her fee in US$ in August 2017 having previously been in GBP. 3Brian Larcombe retired from the Board with effect from 6 April 2017. 4Marc Owen was appointed to the Board with effect from 1 October 2017. 5Angie Risley was appointed to the Board with effect from 18 September 2017. Chairman and Non-Executive Director Fees In February 2018, the Remuneration Committee reviewed the fees paid to the Chairman and determined that with effect from 1 April 2018 the fees paid would increase by 2%. The Board reviewed the fees paid to the Non-Executive Directors and determined that with effect from 1 April 2018, the fees paid in GBP would be increased by 2% and the fees paid in US$ would remain unchanged as follows: | | Julie Brown | | 7 March 2013 | | 25,000 ordinary shares | | 4 February 2016 |
Single total figure on remuneration – Chairman and Non-executive Directors
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Director | | Basic annual fee(i) | | Senior Independent Director/ Committee fee | | Intercontinental travel fee | | Total | | | | | | | | | | | | 2013 | | 2014 | | 2013 | | 2014 | | 2013 | | 2014 | | 2013 | | 2014 | | | | | | | | | | Roberto Quarta(ii) | | £4,846 | | £334,673 | | N/A | | N/A | | £0 | | £7,000 | | £4,846 | | £341,673 | | | | | | | | | | Vinita Bali(iii) | | N/A | | £5,250 | | N/A | | N/A | | N/A | | £3,500 | | N/A | | £8,750 | | | | | | | | | | Ian Barlow | | £66,150 | | £66,150 | | £15,000 | | £15,000 | | £7,000 | | £7,000 | | £88,150 | | £88,150 | | | | | | | | | | Virginia Bottomley | | £66,150 | | £66,150 | | N/A | | N/A | | £7,000 | | £7,000 | | £73,150 | | £73,150 | | | | | | | | | | Sir John Buchanan(iv) | | £420,000 | | £112,307 | | N/A | | N/A | | N/A | | N/A | | £420,000 | | £112,307 | | | | | | | | | | Michael Friedman | | $126,000 | | $126,000 | | N/A | | $11,250 | | $28,000 | | $35,000 | | $154,000 | | $172,250 | | | | | | | | | | Pamela Kirby(v) | | £66,150 | | £36,750 | | £15,000 | | £8,750 | | £7,000 | | N/A | | £88,150 | | £45,500 | | | | | | | | | | Brian Larcombe | | £66,150 | | £66,150 | | N/A | | £10,865 | | £7,000 | | £7,000 | | £73,150 | | £84,015 | | | | | | | | | | Joseph Papa | | $126,000 | | $126,000 | | $27,000 | | $27,000 | | $28,000 | | $35,000 | | $181,000 | | $188,000 | | | | | | | | | | Ajay Piramal(vi) | | £66,150 | | £10,500 | | N/A | | N/A | | £10,500 | | N/A | | £76,650 | | £10,500 | | | | | | | | | | Richard De Schutter(vii) | | $126,000 | | $33,692 | | $27,000 | | $7,580 | | $35,000 | | $14,000 | | $188,000 | | $55,273 | | | | | | | |
(i) | The basic annualAnnual fee includes shares purchased forpaid to the Chairman and Non-executive Directors in lieu of part of the annual fee, details | £420,240 of which can be found on the table on page 101.£105,060 paid in shares | Annual fee paid to Non-Executive Directors | £69,500 of which £6,500 paid in shares Or $129,780 of which $9,780 paid in shares | Intercontinental travel fee (per meeting) | £3,500 or $7,000 | Fee for Senior Independent Director and Committee Chairman | £20,000 or $35,000 |
(ii) | Appointed to the Board on 4 December 2013 and as Chairman of the Company on 10 April 2014. (iii) Appointed to the Board on 1 December 2014. (iv) Retired from the Board on 10 April 2014. |
(v) | Retired from the Board on 31 July 2014 (vi) Retired from the Board on 24 March 2014 (vii) Retired from the Board on 10 April 2014 (vi) Erik Engstrom is not included in the table because he joined the Board on 1 January 2015. |
Smith & Nephew Annual report 2014 89
CORPORATE GOVERNANCE
Remuneration reportcontinued
Chief Executive Officer’s remuneration compared to employees generally The percentage change in the remuneration of the Chief Executive Officer between 20132016 and 20142017 compared to that of employees generally is as follows: | | | | | Base salary % change 2017 | Benefits % change 2017 | Annual cash bonus % change 2017 | Chief Executive Officer | 0% | 6.6% | 103.9% | Average for all employees | 3.3% | N/A | N/A |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Base salary | | | | Benefits | | | | Annual cash bonus | | | | | | | | | % change 2014 | | | | % change 2014 | | | | % change 2014 | | | | | | Chief Executive Officer | | | 3.0 | | | | 154.0 | | | | -46.9 | | | | | | Average for all employees | | | 3.0 | | | | N/A | | | | – | | | |
The average cost of wages and salaries for employees generally decreased by 10% in 2017 (see Note 3.1 to the Group accounts). Figures for annual cash bonuses are included in the numbers. The Committee is mindful that the Government now requires quoted companies to publish their Chief Executive Officer’s pay in relation to its workforce. The Committee awaits the Government’s advice on the exact method of calculation, but aims to publish this information in the 2018 Annual Report. (i) | The average cost of wages and salaries for employees generally increased by 1.57% in 2014 (see Notes 2.4 and 3.1 of the Notes to the Group accounts.) Figures for annual cash bonuses are included in the numbers. | | SMITH & NEPHEW ANNUAL REPORT 2017 | GOVERNANCE | 93 |
Payments made to past Directors No payments were made to former directorsDirectors in the year.year, other than base payments made to Julie Brown for the 11 days worked in January 2017, as disclosed on page 83. Payments for loss of office No payments were made in respect of a Director’s loss of office in 2014.2017. Service contracts Executive Directors are employed on rolling service contracts with notice periods of up to 12 months from the Company and six months from the Executive Director. Further information can be found on page 102 of the Policy Report. Outside Directorshipsdirectorships Olivier Bohuon is a Non-executiveNon-Executive Director of Virbac SA and received€21,000 €21,000 in respect of this appointmentappointment. He is also a Non-Executive Director of Shire Plc and received €107,466 in 2014.cash and £24,053 in shares in respect of this appointment. Julie Brown is a Non-Executive Director of Roche Holding Ltd and received a fee of CHF10,849 until 11 January 2017. Directors’ interests in ordinary shares Beneficial interests of the Executive Directors in the ordinary shares of the Company are as follows: | | | | | | | | | | | | Olivier Bohuon | | Graham Baker | | Julie Brown | | 1 January 2017 | 31 December 2017 | 16 February 20181 | | 1 March 20172 | 31 December 2017 | 16 February 20181 | | 1 January 2017 | 11 January 20173 | Ordinary shares | 424,288 | 467,811 | 467,811 | 4 | – | – | –4 | | 90,040 | 90,040 | Share options | – | – | – | | – | – | – | | 2,400 | – | Performance share awards5 | 460,080 | 423,680 | 362,428 | | – | 79,166 | 79,166 | | 273,598 | – | Equity Incentive awards | 96,417 | 87,956 | 87,956 | | – | – | – | | 50,649 | – | Other awards | – | – | – | | – | – | – | | – | – |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Olivier Bohuon | | | | | | | | | Julie Brown | | | | | | | | | | | | | | | | | 1 January 2014 | | | | 31 December 2014 | | | | 23 February 2015 | (i) | | | 1 January 2014 | | | | 31 December 2014 | | | | 23 February 2015 | (i) | Ordinary shares | | | 111,238 | | | | 210,974 | | | | 210,974 | (iii) | | | 0 | | | | 25,000 | | | | 38,211 | (iv) | Share options | | | 151,698 | | | | 0 | | | | 0 | | | | 2,400 | | | | 2,400 | | | | 2,400 | (v) | Performance share awards(ii) | | | 735,779 | | | | 688,536 | | | | 573,595 | | | | 132,886 | | | | 233,554 | | | | 233,554 | | Equity Incentive awards | | | 143,387 | | | | 147,114 | | | | 147,114 | | | | 0 | | | | 26,497 | | | | 26,497 | | Other awards | | | 66,666 | | | | 0 | | | | 0 | | | | 75,000 | | | | 50,000 | | | | 25,000 | |
1 The latest practicable date for this Annual Report. (i) | The latest practicable date for this Annual Report. |
(ii) | These share awards are subject to further performance conditions before they may vest, as detailed on pages 96 to 97. |
(iii) | The ordinary shares held by Olivier Bohuon on 23 February 2015 represent 304.9% of his base annual salary. |
(iv) | The ordinary shares held by Julie Brown on 23 February 2015 represent 87.8% of her base annual salary. |
(v) | This option was granted under the Smith & Nephew ShareSave Plan (2012). |
2 Graham Baker was appointed to the Board from 1 March 2017. 3 Julie Brown retired from the Board on 11 January 2017. 4 The ordinary shares held by Olivier Bohuon on 16 February 2018 represent 571.6% of his base annual salary and for Graham Baker 0% of his base salary. 5 These share awards are subject to further performance conditions before they may vest, as detailed on pages 88–90. The beneficial interest of each Executive Director is less thatthan 1% of the ordinary share capital of the Company. In addition, Olivier Bohuon holds 50,000 deferred shares. Following the redenomination of ordinary shares into US dollarsUS$ on 23 January 2006, the Company issued 50,000 deferred shares. These shares are normally held by the Chief Executive Officer and are not listed on any Stockstock exchange and have extremely limited rights attached to them. Beneficial interests of the Chairman and Non-executiveNon-Executive Directors in the ordinary shares of the Company are as follows: | | | | | Director | 1 January 2017 (or date of appointment if later) | 31 December 2017 (or date of retirement if earlier) | 16 February 20181 | Shareholding as % of annual fee2 | Roberto Quarta3 | 24,156 | 28,261 | 28,261 | 87.8 | Vinita Bali4 | 6,522 | 6,836 | 6,836 | 130.7 | Ian Barlow | 18,786 | 19,009 | 19,009 | 357 | Virginia Bottomley | 18,473 | 18,714 | 18,714 | 351.4 | Erik Engstrom | 15,350 | 15,547 | 15,547 | 292 | Robin Freestone | 15,310 | 15,525 | 15,525 | 291.5 | Michael Friedman4 | 9,476 | 9,910 | 9,910 | 139.4 | Brian Larcombe⁵ | 40,718 | 40,718 | N/A | N/A | Marc Owen | – | – | 7,000 | 98.5 | Joseph Papa4 | 13,547 | 13,860 | 13,860 | 195 | Angie Risley | – | – | 1,601 | 30.1 |
| | | | | | | | | | | | | | | | | Director | | | 1 January 2014 (or date of appointment) if later | | | | 31 December (or date of retirement if earlier) | | | | 23 February 2015(i) | | | | Shareholding as % of annual fee(ii) | | Roberto Quarta | | | 0 | | | | 15,136 | | | | 15,136 | | | | 44.7% | | Vinita Bali | | | 0 | | | | 0 | | | | 0 | | | | 0% | | Ian Barlow | | | 18,232 | | | | 18,403 | | | | 18,403 | | | | 328.6% | | Virginia Bottomley | | | 17,820 | | | | 18,056 | | | | 18,056 | | | | 322.4% | | Sir John Buchanan | | | 166,337 | | | | 166,337 | | | | – | | | | – | | Erik Engstrom | | | N/A | | | | 15,000 | | | | 15,000 | | | | 267.8% | | Michael Friedman(iii) | | | 8,624 | | | | 8,822 | | | | 8,822 | | | | 127.7% | | Pamela Kirby | | | 15,232 | | | | 15,232 | | | | – | | | | – | | Brian Larcombe | | | 40,212 | | | | 40,368 | | | | 40,368 | | | | 720.7% | | Joseph Papa(iii) | | | 12,799 | | | | 12,997 | | | | 12,997 | | | | 188.2% | | Ajay Piramal | | | 240 | | | | 240 | | | | – | | | | – | | Richard De Schutter | | | 220,299 | | | | 220,299 | | | | – | | | | – | |
1 The latest practicable date for this Annual Report. (i) | The latest practicable date for this Annual Report. |
(ii) | Calculated using the closing share price of 1,181p per ordinary share and $36.49 per ADS on 23 February 2015, and an exchange rate of £1/$1.5449. |
(iii) | Michael Friedman and Joseph Papa hold some of their shares in the form of ADS. |
2 Calculated using the closing share price of 1,279.50p per ordinary share and $36.54 per ADS on 16 February 2018, and an exchange rate of £1/$1.4027. 3 All Non-Executive Directors in office since 1 January 2017 held the required shareholding during the year except the Chairman. 4 Vinita Bali, Michael Friedman and Joseph Papa hold some of their shares in the form of ADS. 5 Brian Larcombe retired from the Board on 6 April 2017. The beneficial interest of each Non-executiveNon-Executive Director is less thatthan 1% of the ordinary share capital of the Company.
90Smith & Nephew Annual report 2014
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 94 | GOVERNANCE | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | | | | REMUNERATION IMPLEMENTATION REPORT | | |
Relative importance of spend on pay The following table sets out the total amounts spent in 20142017 and 20132016 on remuneration, the attributable profit for each year and the dividends declared and paid in each year. | | | | | | | | | For the year to 31 December 20142017 | | For the year to 31 December 20132016 | | % change | | | | | Attributable profit for the year | $767m | $501m $784m
| | $556m-2%
| | -9.89%
| | | | | Dividends paid during the year | $269m | $250m $279m
| | $239m-4%
| | 4.60%
| | | | | Share buyback(i) | $52m¹ | $75m $368m²
| | $226m
| | -66.81%
| | | | 86% | Total Group spend on remuneration | $1,157m | $1,237m $1,227m
| | $998m
| | 23.95%-6%
|
(i) | Share buy-back programme ceased during 2014 following the acquisition of ArthroCare. Shares are bought in the market in respect of shares issued as part of the executive and employee share plans. |
| See note 19.2 on page 154 for further information. |
1 Shares are bought in the market in respect of shares issued as part of the executive and employee share plans. 2 Following the disposal of the Gynaecology business in August 2016, the Company commenced a $300m share buy-back programme which completed during 2016. See Note 19.2 for further information. Total Shareholder Return A graph of the Company’s TSR performance compared to that of the FTSE 100 index is shown below in accordance with Schedule 8 to the Regulations. Six Year Total Shareholder Return
(measured in UK sterling, based on monthly spot values)
However, as we compare the Company’s performance to a tailored sector peer group of medical devices companies (see page 88,88), when considering TSR performance in the context of the Global Share Plan 2010, we feel that the following graph showing the TSR performance of this peer group is also of interest. Six Year Total Shareholder Return
(measured in US dollars, based on monthly spot values)
| | | SMITH & NEPHEW ANNUAL REPORT 2017 | GOVERNANCE | 95 |
Smith & Nephew Annual report 2014 91
CORPORATE GOVERNANCE
Remuneration reportcontinued
Table of historic data The following table details information about the pay of the Chief Executive Officer in the previous fivenine years: | | | | | | | | | | | | | Long-term incentive vesting rates against maximum opportunity | Long-term incentive vesting rates against maximum opportunity | | | Year | | | Chief Executive Officer | | | | Single figure of total remuneration | | | | Annual Cash Incentive payout against maximum % | | | | Performance shares % | | | | Options % | | Chief Executive Officer | Single figure of total remuneration $ | | Annual Cash Incentive payout against maximum % | Performance shares % | Options % | 2017 | | Olivier Bohuon | $5,032,925 | | 60.67⁵ | 54 | – | 2016 | | Olivier Bohuon | $3,332,850⁴ | | 30 | 8 | – | 2015 | | Olivier Bohuon | $5,342,377 | | 75 | 33.5 | – | 2014 | | | Olivier Bohuon | | | | $6,594,989 | | | | 65 | | | | 57 | | | | N/A | | Olivier Bohuon | $6,785,121 | | 43 | 57 | – | 2013 | | | Olivier Bohuon | | | | $4,692,858 | (iv) | | | 84 | | | | N/A | | | | N/A | | Olivier Bohuon | $4,692,858 | | 84 | 0 | – | 2012 | | | Olivier Bohuon | | | | $4,956,771 | | | | 84 | | | | N/A | | | | N/A | | Olivier Bohuon | $4,956,771 | | 84 | N/A | – | 2011 | | | Olivier Bohuon | (i),(iii) | | | $7,442,191 | | | | 68 | | | | N/A | | | | N/A | | Olivier Bohuon1,2 | $7,442,191 | | 68 | N/A | – | 2011 | | | David Illingworth | (ii) | | | $3,595,787 | | | | 37 | | | | 27 | | | | 27 | | David Illingworth3 | $3,595,787 | | 37 | 27 | 27 | 2010 | | | David Illingworth | | | | $4,060,707 | | | | 57 | | | | 70 | | | | 61 | | David Illingworth | $4,060,707 | | 57 | 70 | 61 | 2009 | | | David Illingworth | | | | $4,406,485 | | | | 59 | | | | 46 | | | | 59 | | |
(i) | Appointed Chief Executive Officer on 1 April 2011 |
(ii) | Resigned as Chief Executive Officer on 1 April 2011 |
(iii) | 1 Appointed Chief Executive Officer on 1 April 2011. 2 Includes recruitment award of€1,400,000 cash and a share award over 200,000 ordinary shares with a value of€1,410,000 on grant |
(iv) | Prior years are restated to reflect amounts not known at the date of signing the previous annual report. |
Implementation of remuneration policy in 2015€1,400,000 cash and a share award over 200,000 ordinary shares with a value of €1,410,000 on grant.
The Remuneration Committee proposes3 Resigned as Chief Executive Officer on 1 April 2011.
4 Prior years are restated to make no changes toreflect amounts not known at the way thatdate of signing the remuneration policy is implemented in 2015 from how it was implemented in 2014, other than increasing base salaries in line with salary increases across the Group,previous Annual Report. 5 Calculated as explained91% (actual payout) disclosed on page 85 and setting new targets for87 divided by the Annual Incentive Plan and the Performance Share Programme, as explained on page 88. maximum potential payout of 150%. Statement of voting at Annual General Meeting held in 20142017 At the Annual General Meeting held on 106 April 2014,2017, votes cast by proxy and at the meeting and votes with-heldwithheld in respect of the two votes on the Directors’ Remuneration Policy and the Directors’ remuneration reportReport were as follows: | | | | | | | Resolution | Votes for | % for | Votes against | % against | Total votes validly cast | Votes withheld | Approval of the Directors’ Remuneration Policy | 578,383,031 | 98.30 | 10,003,885 | 1.70 | 588,386,916 | 1,422,700 | Approval of the Directors’ Remuneration Report | 581,873,387 | 98.85 | 6,787,211 | 1.15 | 588,660,598 | 1,149,020 |
| | | | | | | | | | | | | | | | | | | | | | | | | Resolution | | | Votes for | | | | % for | | | | Votes against | | | | % against | | | | Total votes validly cast | | | | Votes withheld | | Approval of Directors’ Remuneration Policy | | | 586,941,104 | | | | 93.50% | | | | 40,818,512 | | | | 6.50% | | | | 627,759,616 | | | | 1,990,842 | | Approval of Directors’ remuneration report | | | 615,870,158 | | | | 97.97% | | | | 12,774,146 | | | | 2.03% | | | | 628,644,304 | | | | 1,106,154 | |
Joseph Papa, ChairmanThe Remuneration Committee is mindful of the RemunerationGovernment’s new requirements to engage more with employee stakeholders on all matters of remuneration. The Committee has metis currently reviewing how best to implement this and will communicate with employees accordingly. Gender pay is also a number of shareholders2018 focus for the Committee, a programme to ensure women are fully supported in previous years to discuss remuneration matters and met and held calls with the holders of around 28%their careers at Smith & Nephew will be part of the shares in 2013. In 2014, he offered againCommittee’s agenda during this time of improvement as we look to meet with shareholders to discuss remuneration matters. Very few shareholders accepted his invitation to meet, acknowledging that shareholders were broadly happy with our remuneration arrangements and had no concerns that they wished to discuss. He did however meet with shareholders holding around 2% of the share capital, who also indicated their broad support for our remuneration arrangements. Joseph Papa is always happy to meet and talk to shareholders who wish to discuss remuneration matters with him.
92Smith & Nephew Annual report 2014
Other remuneration mattersfuture.
Senior Managementmanagement remuneration The Group’s administrative, supervisory and management body (the ‘Senior Management’)(senior management) is comprised for US reporting purposes, of Executive Directors and Executive officers.Officers. Details of the current Executive Directors and Executive Officers are given on pages 54 to 59.50 and 54-55. Compensation paid to Senior Managementsenior management in respect of 2014, 20132015, 2016 and 20122017 was as follows: | | | | | 2017 | 2016 | 2015 | Total compensation (excluding pension emoluments, but including cash payments under the performance-related incentive plans) | $13,573,000 | $12,874,000 | $13,971,000 | Total compensation for loss of office | $2,711,000 | – | – | Aggregate increase in accrued pension scheme benefits | – | – | – | Aggregate amounts provided for under supplementary schemes | $872,000 | $1,112,000 | $698,000 |
| | | | | | | | | | | | | | | | 2012 | | | | 2013 | | | | 2014 | | Total compensation (excluding pension emoluments, but including cash payments under the performance-related incentive plans) | | | $15,249,000 | | | | $14,186,000 | | | | $12,725,000 | | Total compensation for loss of office | | | $0 | | | | $0 | | | | $2,664,000 | | Aggregate increase in accrued pension scheme benefits | | | $229,000 | | | | $257,000 | | | | $16,000 | | Aggregate amounts provided for under supplementary schemes | | | $537,000 | | | | $414,000 | | | | $507,000 | |
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| | | | | | REMUNERATION IMPLEMENTATION REPORT | | |
As at 2316 February 2015, the Senior Management2018, senior management owned 376,202720,897 shares and 100,8553,015 ADSs, constituting less than 0.1% of the share capital of the Company. Details of share awards granted during the year and held as at 2316 February 20152018 by members of Senior Managementsenior management are as follows: | Share awards granted during the year | Total share awards held as at 16 February 2018 | Equity Incentive awards | 306,903 | 319,377 | Performance Share awards at maximum | 617,156 | 1,033,315 | Conditional share awards under the Global Share Plan 2010 | 190,464 | 197,510 | Options under Employee ShareSave plans | 0 | 4,559 | Options under the Global Share Plan 2010 | 0 | 0 |
| | | | | | | | | | | | Share awards granted during the year | | | | Total share awards held as at 23 February 2015 | | Equity Incentive awards | | | 209,623 | | | | 400,695 | | Performance Share awards | | | 582,474 | | | | 1,397,597 | | Conditional share awards under the Global Share Plan 2010 | | | 11,596 | | | | 87,830 | | Options under Employee ShareSave plans and under the Global Share Plan 2010 | | | 2,042 | | | | 4,442 | |
Dilution headroom The Remuneration Committee ensures that at all times the number of new shares which may be issued under any share-based plans, including all-employee plans, does not exceed 10% of the Company’s issued share capital over any rolling ten-year10‑year period (of which up to 5% may be issued to satisfy awards under the Company’s discretionary plans). The Company monitors headroom closely when granting awards over shares taking into account the number of options or shares that might be expected to lapse or be forfeited before vesting or exercise. In the event that insufficient new shares are available, there are processes in place to purchase shares in the market to satisfy vesting awards and to net-settle option exercises. Over the previous 10 years (2005(2008 to 2014)2017), the number of new shares issued under our share plans has been as follows: | | | All-employee share plans | | 7,991,875 (0.89%7,275,468 (0.83% of issued share capital as at 2316 February 2015)2018) | Discretionary share plans | | 37,853,815 (4.23%33,119,507 (3.79% of issued share capital as at 2316 February 2015)2018) |
By order of the Board, on 2522 February 20152018
Joseph Papa Chairman of the Remuneration Committee
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Smith & Nephew Annual report 2014 93
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Remuneration reportcontinued
| | | | | | REMUNERATION THE POLICY REPORT | | |
The Policy Report
The Remuneration Committee presents the Directors’ remuneration policy report, which was approved by shareholders at the Annual General Meeting held on 10 April 2014.
Future policy table
Executive DirectorsFUTURE POLICY TABLE – EXECUTIVE DIRECTORS
The following table and accompanying notes explain the different elements of remuneration we pay to our Executive Directors: All figures in this policy table are as at 2014 when the Policy ReportDirectors. It was approved by shareholders at the 2017 Annual General Meeting on 6 April 2017.
BASE SALARY AND BENEFITS | | | How the component supports the short- | | | and long-term strategy of the Company
| | How the component operates | Base salary and benefits
| | | Base salary | | | We are a FTSE 50 listed company, operating in over 100 countries around the world. Our strategy to generate cash from Established Markets in order to invest for growth in Emerging Marketshigher growth geographies and franchises means that we are competing for international talent and our base salaries therefore need to reflect what our Executive Directors would receive if they were to work in another international company of a similar size, complexity and geographical scope. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | Salaries are normally reviewed annually, with any increase applying from 1 April. Salary levels and increases take account of: | | – marketMarket movements within a peer group of similarly sized UK listed companies; | | – scopeScope and responsibility of the position; | | – skill/Skill/experience and performance of the individual Director; | | – generalGeneral economic conditions in the relevant geographic market; and | | – averageAverage increases awarded across the Company, with particular regard to increases in the market in which the Executive is based. | Payment in lieu of pension
| | | In order to attract and retain Executive Directors with the capability of driving our corporate strategy, we need to provide market-competitive retirement benefits similar to the benefits they would receive if they were to work for one of our competitors.
| | Current Executive Directors receive an allowance in lieu of membership of a Company-run pension scheme.
Base salary is the only component of remuneration that is pensionable.
| At the same time, we seek to avoid exposing the Company to defined benefit pension risks, and where possible will make payments in lieu of providing a pension.
| | | Benefits
| | | In order to attract and retain Executive Directors with the capability of driving our corporate strategy, we need to provide a range of market-competitive benefits similar to the benefits they would receive if they were to work for one of our competitors.
It is important that our Executive Directors are free to focus on the Company’s business without being diverted by concerns about medical provision, risk benefit cover or, if required, relocation issues.
| | A wide range of benefits may be provided depending on the benefits provided for comparable roles in the location in which the Executive Director is based. These benefits will include, as a minimum, healthcare cover, life assurance, long-term disability, annual medical examinations, company car or car allowance. The Committee retains the discretion to provide additional benefits where necessary or relevant in the context of the Executive’s location.
Where applicable, relocation costs may be provided in line with Company’s relocation policy for employees, which may include removal costs, assistance with accommodation, living expenses for self and family and financial consultancy advice. In some cases such payments may be grossed up.
| All-employee arrangements
| | | All-employee share plans
| | | To enable Executive Directors to participate in all-employee share plans on the same basis as other employees.
| | ShareSave Plans are operated in the UK and 27 other countries internationally. In the US, an Employee Stock Purchase Plan is operated. These plans enable employees to save on a regular basis and then buy shares in the Company. Executive Directors are able to participate in such plans on a similar basis to other employees, depending on where they are located.
|
94Smith & Nephew Annual report 2014
| | | | | | | Maximum levels of payment
| | Framework in which performance is assessed
| | | | | | | | | | | | | The base salary of the Executive Directors with effect from 1 April 20142017 will be as follows: – Olivier Bohuon€ €1,179,490.1,111,782 Julie Brown £514,000
– Graham Baker £510,000. The factors noted in the previous column will be taken into consideration when making increases to base salary and when appointing a new Director. In normal circumstances, base salary increases for Executive Directors will relate to the geographic market and peer group. In addition, the average increases for employees across the Group will be taken into account. The Remuneration Committee retains the right to approve higher increases when there is a substantial change in the scope of the Executive Director’s role. A full explanation will be provided in the Implementation Report should higher increases be approved in exceptional cases. | | Performance in the prior year is one of the factors taken into account and poor performance is likely to lead to a zero salary increase. | | | Payment in lieu of pension | | | In order to attract and retain Executive Directors with the capability of driving our corporate strategy, we need to provide market-competitive retirement benefits similar to the benefits they would receive if they were to work for one of our competitors. At the same time, we seek to avoid exposing the Company to defined benefit pension risks, and where possible will make payments in lieu of providing a pension. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | Current Executive Directors receive an allowance in lieu of membership of a Company-run pension scheme. Base salary is the only component of remuneration which is pensionable. | Up to 30% of base salary. | | The level of payment in lieu of a pension paid to Executive Directors is not dependent on performance. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 98 | GOVERNANCE | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | | | | REMUNERATION THE POLICY REPORT | | |
| | | Benefits | In order to attract and retain Executive Directors with the capability of driving our corporate strategy, we need to provide a range of market-competitive benefits similar to the benefits they would receive if they were to work for one of our competitors. It is important that our Executive Directors are free to focus on the Company’s business without being diverted by concerns about medical provision, risk benefit cover or, if required, relocation issues. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | A wide range of benefits may be provided depending on the benefits provided for comparable roles in the location in which the Executive Director is based. These benefits will include, as a minimum, healthcare cover, life assurance, long-term disability, annual medical examinations, company car or car allowance. The Committee retains the discretion to provide additional benefits where necessary or relevant in the context of the Executive’s location. Where applicable, relocation costs may be provided in-line with Company’s relocation policy for employees, which may include removal costs, assistance with accommodation, living expenses for self and family and financial consultancy advice. In some cases such payments may be grossed up. | The policy is framed by the nature of the benefits that the Remuneration Committee is willing to provide to Executive Directors. The maximum amount payable will depend on the cost of providing such benefits to an employee in the location at which the Executive Director is based. shareholdersShareholders should note that the cost of providing comparable benefits in different jurisdictions may vary widely. As an indication, the cost of such benefits provided in 20132016 was as follows: – Olivier Bohuon€ €150,511.80,705 – Julie Brown £14,400 £22,244. The maximum amount payable in benefits to an Executive Director, in normal circumstances, will not be significantly more than amounts paid in 20132016 (or equivalent in local currency). The Remuneration Committee retains the right to pay more than this should the cost of providing the same underlying benefits increase or in the event of a relocation. A full explanation will be provided in the Implementation Report should the cost of benefits provided be significantly higher. | | The level and cost of benefits provided to Executive Directors is not dependent on performance but on the package of benefits provided to comparable roles within the relevant location. |
ALL-EMPLOYEE ARRANGEMENTS | | | | | | | | | | All-employee share plans | To enable Executive Directors to participate in all-employee share plans on the same basis as other employees. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | ShareSave Plans are operated in the UK and 31 other countries internationally. In the US, an Employee Stock Purchase Plan is operated. These plans enable employees to save on a regular basis and then buy shares in the Company. Executive Directors are able to participate in such plans on a similar basis to other employees, depending on where they are located. | Executive Directors may currently invest up to £250£500 per month in the UK ShareSave Plan. The Remuneration Committee may exercise its discretion to increase this amount up to the maximum permitted by the HM Revenue & Customs. Similar limits will apply in different locations. | | The potential gains from all-employee plans are not based on performance but are linked to growth in the share price. |
Smith & Nephew Annual report 2014 95
| |
CORPORATE GOVERNANCE
Directors’ remuneration reportcontinued
Future policy table
Executive Directorscontinued
| | | SMITH & NEPHEW ANNUAL REPORT 2017 | How the component supports the short-GOVERNANCE
| and long-term strategy of the Company99
|
| | How the component operates
| Annual incentives
| | | | | | |
ANNUAL INCENTIVES | | | Annual Incentive Plan – Cash Incentive | | | To motivate and reward the achievement of specific annual financial and business objectives related to the Company’s strategy and sustained through a clawback mechanism explained more fully in the notes. The objectives which determine the payment of the annual cash incentive and the level of the annual equity award are linked closely to the Group strategy. The financial measures of revenue, trading profitRevenue, Trading Profit Margin and cash flow underlieTrading Cash Flow underline our strategy for growth and the need to generate cash to fund future growth. The business objectives are also linked to the Group strategy. These change from year to year to reflect the evolving strategy, but will typically be linked to the Strategic Priorities set out in this Annual Report. The Implementation Report each year will explain how each objective is linked to a specific strategic priority. | For example, a Reinvestment objective links toHow the prioritycomponent operates
| Maximum levels of improving the efficiency of the business model and investmentpayment | Framework in higher growth segments and geographies and Processes and People objectives link to developing the right organisation. which performance is assessed | | The Annual Incentive Plan comprises a cash and an equity component, both based on the achievement of financial and business objectives set at the start of the year. The cash component is paid in full after the end of the performance year. At the end of the year, the Remuneration Committee determines the extent to which performance against these has been achieved and sets the award level. | The total maximum payable under the Annual Incentive Plan is 215% of base salary (150% Cash Incentive and 65% Equity Incentive). In respect of the Cash Incentive: – 150% salary awarded for maximum performance. – 100% salary awarded for target performance. – 50% salary awarded for threshold performance. – Performance assessed against individual objectives and Group financial targets. | The cash and share awards are subject to malus and clawback as detailed in the notes following this table. 75% of the cash component is based on financial performance measures, which currently include Revenue (35%), Trading Profit Margin (25%) and Trading Cash Flow (15%). 25% of the cash component is based on other business goals linked to the Company’s strategy, which could include financial and non-financial measures. The Remuneration Committee retains the discretion to adjust the relative weightings of the financial and business components, and to adopt any performance measure that is relevant to the Company. | Annual Incentive Plan – Equity Incentive | | | To drive share ownership and encourage sustained high standards through the application of a ‘malus’ provision over three years, explained more fully in the notes. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | The equity award component comprises conditional share awards (made at the time of the cash award), with vesting phased over the following three years. The equity component vests 1⁄ 1⁄3,, 1⁄ 1⁄3,, 1⁄ 1⁄3 on successive award anniversaries, only if performance remains satisfactory over each of these three years; otherwise the award will lapse. Participants will receive an additional number of shares equivalent to the amount of dividend payable per vested share during the relevant performance period.
| Long-term incentives (awards actively being made)
| | | Performance Share Programme
| | | To motivate and reward longer term performance linked to the long-term strategy and share price of the Company.
The performance measures which determine the level of vesting of the Performance Share Awards are linked to our corporate strategy.
Our strategy requires the generation of cash in order to invest for growth. Cash flow is therefore a key performance measure in our performance share plan.
Growth in our Emerging & International Markets is a key part of our strategy. Revenue in our Emerging & International Markets is therefore included as one of our performance share plan measures.
If our strategy succeeds, the total return to our shareholders will also increase and therefore we include a relative TSR measure in our long-term share plan.
| | The Performance Share Programme comprises conditional share awards which vest after three years, subject to the achievement of stretching performance targets linked to the Company’s strategy.
Awards may be subject to clawback in the event of material financial misstatement or misconduct.
Participants will receive an additional number of shares equivalent to the amount of dividend payable per vested share during the relevant performance period. | One-off share awards
| | | In order to implement our Group strategy, we recognise that it is not always possible to promote from within the Company. In the event that we recruit an Executive Director who is currently employed by another company, we recognise that we might be required to compensate that Executive Director for cash or share awards, they may forfeit on leaving their former employer. Our policy regarding such awards is detailed in the notes. | | One-off share awards may be made under the provisions of Listing Rule 9.4.2 to facilitate the appointment of a new Executive Director. Such awards will be made on a case-by-case basis depending on the circumstances at the time to take account of amounts forfeited elsewhere on accepting appointment. |
96Smith & Nephew Annual report 2014
| | | | | | | | | | | Maximum levels of payment
| | | | Framework in which performance is assessed
| | | | | | | | | | | | | | | | | | | | | The total maximum payable under the Annual Incentive Plan is 215% of base salary (150% Cash Incentive and 65% Equity Incentive).
50% salary awarded for threshold performance.
100% salary awarded for target performance.
150% salary awarded for maximum performance.
Performance assessed against individual objectives and Group financial targets.
| | | | The cash and share awards are subject to malus and clawback as detailed in the notes following this table.
70%respect of the cash componentEquity Incentive:
– Performance is based on financial performance measures, which currently include revenue, trading profit and trading cash. The Remuneration Committee retains the discretion to adopt any financial performance measure that is relevant to the Company. 30% of the cash component is based on other business goals linked to the Company’s strategy, which could include financial and non-financial measures.
The Remuneration Committee has the discretion to apply a multiplier, adjusting the outcome up or down by 10% to reward or penalise conduct in respect of leadership, corporate reputation, ethics, organisational behaviours and representing the Company both internally and externally.
The maximum opportunity shown to the left cannot be exceeded through the application of the multiplier.
| | | | | | | | | | | | 0% of salary awarded for performance below target.
50% of salary awarded for target performance.
65% of salary awarded for maximum performance.
Performance assessed against individual performance, which includes an element of Group financial targets.
– 65% of salary awarded for maximum performance. – 50% of salary awarded for target performance. – 0% of salary awarded for performance assessed to be below target. | | | | The Remuneration Committee will use theirits judgement of the individual’s performance based both on what has been achieved during the year and how it has been achieved in determining the level of equity award that may be awarded within the range of 50%0% to 65% of salary. The equity component will vest in three equal tranches over a three-year period, provided that the annualsatisfactory performance conditions set at the beginning of each year continue to be met.is sustained. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Annual awards:
| | | | Currently:
| | | | | 100 | GOVERNANCE | SMITH & NEPHEW ANNUAL REPORT 2017 |
| 47.5% of salary for threshold performance.
95% of salary for target performance.
190% of salary for maximum performance.
| | | | – | | 50% of the award vests on achievement of a three-year cumulative free cash-flow target | | | | | –
| | 25% of the award vests subject to three-year Total Shareholder Return (‘TSR’) at median performance relative to industry peers
| | | | | –
| | 25% of the award vests subject to the achievement of revenue targets in Emerging & International Markets
| | | | | –
| | These measures are described in more detail in the notes and the targets and performance against them will be disclosed in the Implementation Report if appropriate
| | | | | –
| | The Performance Share Award will vest on the third anniversary of the date of grant, depending on the extent to which the performance conditions are met over the three-year period commencing in the year the award was made
| | | | | –
| | The Remuneration Committee retains the discretion to change the measures and their respective weightings to ensure continuing alignment with the Company’s strategy
| | | | | –
| | The cash and share awards are subject to malus and clawback as detailed in the notes following this table.
| | | | | Awards made prior to 2014 were subject to TSR and cash flow targets.
| | | | | REMUNERATION THE POLICY REPORT | | | | | | | | | | Each award will be determined on a case-by-case basis. In normal circumstances such awards will be no more beneficial than the value of amounts forfeited by the Executive Director on leaving a previous company to join the Board.
| | | | The Remuneration Committee has the discretion to apply performance conditions to one-off awards if appropriate. However, if it is impossible to replicate the vesting conditions applicable to awards granted by other companies, awards may be made without performance conditions.
|
Smith & Nephew Annual report 2014 97
CORPORATE GOVERNANCE
Remuneration reportcontinued
LONG-TERM INCENTIVES (AWARDS ACTIVELY BEING MADE) Notes to Future policy table – Executive Directors
Changes to remuneration policy
The remuneration policy described in the future policy table – Executive Directors is the same remuneration policy in respect of Executive Directors that has been in force since the beginning of 2012. It is anticipated that this policy will apply at least until the Annual General Meeting in 2017. The only change made has been to introduce a third performance measure to our Performance Share Programme.
Performance measures – Annual Incentive Plan
The performance measures which apply to the Annual Incentive Plan for Executive Directors comprise 70% financial measures and 30% business goals linked to the Company’s strategy, which could include financial and non-financial measures.
The financial measures may differ from year to year to provide continued alignment with the Company strategy. Measures to be used in 2014 are detailed in the Implementation Report. Each year the measures are chosen in order to relate to our Strategic Priorities and in turn to our key performance indicators, which are set out in this Annual report. The performance targets are set by taking into account the strategy of the Company and are designed to be realistic yet stretching.
The business measures will differ from year to year as the evolving corporate strategy means that we will wish to set Executive Directors different business objectives in order to meet the current corporate needs. The business objectives are personal to each Executive Director, and are tailored to reflect their role and responsibilities during the year. These are set at the start of the year and reflect the most important areas of strategic focus for the Company. The Remuneration Committee sets annual measurement criteria (performance targets) that are appropriate to motivate and measure an Executive Director’s performance in any one year. The factors taken into consideration include the three-year strategic plan, prior years’ delivered performance and budgeted performance. In the past, measures have included R&D investment, succession planning, employee engagement, compliance, development of product portfolio, M&A activity and shared services implementation.
Performance measures –
Performance Share Programme | To motivate and reward longer-term performance linked to the long-term strategy and share price of the Company. The performance measures which apply todetermine the level of vesting of the Performance Share Awards are linked to our corporate strategy. | How the component operates | Maximum levels of payment | Framework in which performance is assessed | The Performance Share Programme comprises conditional share awards madewhich vest after three years, subject to the achievement of stretching performance targets linked to the Company’s strategy. Awards may be subject to clawback in 2014 relatethe event of material financial misstatement or misconduct. Participants will receive an additional number of shares equivalent to the amount of dividend payable per vested share during the relevant performance period. On vesting, a number of shares are sold to cover the tax liability. The remaining shares are required to be held by the Executive Director for a further two-year holding period. | Annual awards: – 190% of salary for maximum performance. – 95% of salary for target performance. – 47.5% of salary for threshold performance. | Currently: – 25% of the award vests on achievement of a three-year cumulative free cash flow revenue in Emerging & International Markets and Total Shareholder Return. We have chosen three measures which are relevant for the long-term successtarget. – 25% of the Company. The free cash flow measure is important for us in a period of growth, when we needaward vests subject to generate cash to fund both organic and inorganic investment.
Revenue in Emerging & International Markets is important for us when we are seeking to generate profitable revenue in new markets and from new products.
Thethree-year Total Shareholder Return measure, which compares our long-term(TSR) at median performance relative to Global Healthcare companies and to FTSE 100 companies.
– 25% of the award vests subject to the achievement of return on invested capital targets. – 25% of the award vests subject to total sales growth. – These measures, the targets and performance against that of our peers, seeks to alignthem are described more fully in the payoutImplementation Report. – The Performance Share Award will vest on the third anniversary of the Performance Share Programme withdate of grant, depending on the experience of our shareholders. This helps Executive Directors relateextent to which the shareholder experience and ensure that vesting is aligned toperformance conditions are met over the out-performance of our sector.three-year period commencing in the year the award was made. – The Remuneration Committee will keep these performance measures under review and retains the discretion to alterchange the measures orand their respective weightings to ensure continuing alignment with the Company’s strategy. – The cash and share awards are subject to the corporate strategy. Malusmalus and clawback
The Remuneration Committee may determine that an unvested award or part of an award may not vest (regardless of whether or not the performance conditions have been met) or may determine that any cash bonus, vested shares, or their equivalent value in cash be returned to the Company as detailed in the event that any of thenotes following matters is discovered:this table.
Awards made prior to 2017 were subject to TSR against a sector peer group, cash flow and revenue in Emerging Markets targets. |
– | A material misstatement of the Company’s financial results; or |
– | A material error in determining the extent to which any performance condition has been satisfied; or |
– | A significant adverse change in the financial performance of the Company, or a significant loss at a general level or at the division or function in which a participant worked; or |
– | Inappropriate conduct (for example reputational issues), capability or performance by a participant, or within a team business area or profit centre. |
These provisions apply to share awards under the Global Share Plan 2010 and cash amounts under the Annual Cash Incentive Plan.
98Smith & Nephew Annual report 2014
| | | SMITH & NEPHEW ANNUAL REPORT 2017 | GOVERNANCE | 101 |
Illustrations of the application of the remuneration policy
The following charts show the potential split between the different elements of the Executive Directors’ remuneration under three different performance scenarios:
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ILLUSTRATIONS OF THE APPLICATION OF THE REMUNERATION POLICY 2017 The following charts show the potential split between the different elements of the Executive Directors’ remuneration under three different performance scenarios. | | Figures as at salary levels in 2014,2017, when the Policy reportReport was approved by shareholders | Chief Executive Officer
| Chief Financial Officer | | | |
| | Total Remuneration by Performance Scenario for 20142017 Financial Year (percentage split) | Chief Executive Officer | Chief Financial Officer | |
| Data for the Chief Executive Officer assumes an exchange rate of€1 = £0.8494.
Policy on recruitment arrangements
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MALUS AND CLAWBACK The Remuneration Committee may determine that an unvested award or part of an award may not vest (regardless of whether or not the performance conditions have been met) or may determine that any cash bonus, vested shares, or their equivalent value in cash be returned to the Company in the event that any of the following matters is discovered: – A material misstatement of the Company’s financial results; or – A material error in determining the extent to which any performance condition has been satisfied; or – A significant adverse change in the financial performance of the Company, or a significant loss at a general level or at the country business unit or function in which a participant worked; or – Inappropriate conduct (for example reputational issues), capability or performance by a participant, or within a team business area or profit centre. These provisions apply to share awards under the Global Share Plan 2010 and cash amounts under the Annual Cash Incentive Plan. POLICY ON RECRUITMENT ARRANGEMENTS Our policy on the recruitment of Executive Directors is to pay a fair remuneration package for the role being undertaken and the experience of the Executive Director appointed. In terms of base salary, we will seek to pay a salary comparable, in the opinion of the Committee, to that which would be paid for an equivalent position elsewhere. The Remuneration Committee will determine a base salary in-line with the policy and having regard to the parameters set out on in the future policy table. Incoming Executive Directors will be entitled to pension, benefit and incentive arrangements which are the same as provided to existing Executive Directors. On that basis, incentive awards would not exceed 405% of base salary. We recognise that in the event that we require a new Executive Director to relocate to take up a position with the Company, we will also pay relocation and related costs as described in the future policy table, which is in-line with the relocation arrangements we operate across the Group. We also recognise that in many cases, an external appointee may forfeit sizeable cash bonuses and share awards if they choose to leave their former employer and join us. The Remuneration Committee therefore believes that we need the ability to compensate new hires for incentive awards they give up on joining us. The Committee will use its judgement in determining any such compensation, which will be decided on a case-by-case basis. We will only provide compensation which is no more beneficial than that given up by the new appointee and we will seek evidence from the previous employer to confirm the full details of bonus or share awards being forfeited. As far as possible, we will seek to replicate forfeited share awards using Smith & Nephew incentive plans or through reliance on Rule 9.4.2 in the Listing Rules, whilst at the same time aiming for simplicity. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 102 | GOVERNANCE | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | | | | REMUNERATION THE POLICY REPORT | | |
If we appoint an existing employee as an Executive Director of the Company, pre-existing obligations with respect to remuneration, such as pension, benefits and legacy share awards, will be honoured. Should these differ materially from current arrangements, these will be disclosed in the next Implementation Report. We will supply details via an announcement to the London Stock Exchange of an incoming Executive Director’s remuneration arrangements at the time of their appointment. SERVICE CONTRACTS We employ Executive Directors on rolling service contracts with notice periods of up to 12 months from the Company and six months from the Executive Director. On termination of the contract, we may require the Executive Director not to work their notice period and pay them an amount equivalent to the base salary and payment in lieu of pension and benefits they would have received if they had been required to work their notice period. Under the terms of the Executive Director’s service contract, Executive Directors are restricted for a period of 12 months after leaving the employment of the Company from working for a competitor, soliciting orders from customers and offering employment to employees of Smith & Nephew. The Company retains the right to waive these provisions in certain circumstances. In the event that these provisions are waived or the former Executive Director commences employment earlier than at the end of the notice period, no further payments shall be made in respect of the portion of notice period not worked. Directors’ service contracts are available for inspection at the Company’s registered office: 15 Adam Street, London WC2N 6LA. POLICY ON PAYMENT FOR LOSS OF OFFICE Our policy regarding termination payments to departing Executive Directors is to limit severance payments to pre-established contractual arrangements. In the event that the employment of an Executive Director is terminated, any compensation payable will be determined in accordance with the terms of the service contract between the Company and the Executive Director, as well as the rules of any incentive plans. Under normal circumstances (excluding termination for gross misconduct) all leavers are entitled to receive termination payments in lieu of notice equal to base salary, payment in lieu of pension, and benefits. In some circumstances additional benefits may become payable to cover reimbursement of untaken holiday leave, repatriation and outplacement fees, legal and financial advice. In addition, we may also in exceptional circumstances exercise our discretion to pay the Executive Director a proportion of the annual cash incentive they would have received had they been required to work their notice period. Any entitlement or discretionary payment may be reduced in-line with the Executive Director’s duty to mitigate losses, subject to applying our non-compete clause. We will supply details via an announcement to the London Stock Exchange of a departing Executive Director’s termination arrangements at the time of departure. In the case of a change of control which results in the termination of an Executive Director or a material alteration to their responsibilities or duties, within 12 months of the event, the Executive Director would be entitled to receive 12 months’ base salary plus payment in lieu of pension and benefits. In addition, the Remuneration Committee has discretion to pay an Executive Director in these circumstances an annual cash incentive. For Directors appointed prior to 1 November 2012, an automatic annual cash incentive is payable at target. In the event that an Executive Director leaves for reasons of ill-health, death, redundancy or retirement in agreement with the Company, then the vesting of any outstanding annual cash incentive and equity incentive awards will generally depend on the Remuneration Committee’s assessment of performance to date. Performance share awards will be pro-rated for the time worked during the relevant performance period, and will remain subject to performance over the full performance period. For all other leavers, the annual cash incentive will generally be forfeited and outstanding equity incentive awards and performance share awards will lapse. One-off awards granted on appointment will normally lapse on leaving except in cases of death, retirement, redundancy, or ill-health. The Remuneration Committee has discretion to permit such awards to vest in other circumstances and will be subject to satisfactorily meeting performance conditions if applicable. The Remuneration Committee retains discretion to alter these provisions on a case-by-case basis following a review of circumstances and to ensure fairness for both shareholders and Executive Directors. We will supply details via an announcement to the London Stock Exchange of an out-going Executive Director’s remuneration arrangements around the time of leaving. | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GOVERNANCE | 103 |
CHANGES TO POLICY The 2017 Remuneration Policy makes the following changes to the 2014 Remuneration policy: – Introduction of a two-year holding period for vested Performance shares; – Flexibility to change measures; – Increased emphasis on financial objectives in the Annual Incentive Plan, increases from 70% to 75%; and – Increased shareholding requirement to 300% of salary for the Chief Executive Officer. Further details can be found in the letter from the Chairman of the Remuneration Committee on pages 79-80 of the 2017 Annual Report. POLICY ON SHAREHOLDING REQUIREMENTS The Remuneration Committee believes that one of the best ways our Executive Directors can have a greater alignment with shareholders is for them to hold a significant number of shares in the Company. The Chief Executive Officer is therefore expected to build up a holding of Smith & Nephew shares worth three times their base salary and the Chief Financial Officer is expected to build up a holding of two times their basic salary. In order to reinforce this expectation, we require them to retain 50% of the shares (after tax) vesting under the equity incentive programmes until this holding has been met, recognising that differing international tax regimes affect the pace at which an Executive Director may fulfil the shareholding requirement. When calculating whether or not this requirement has been met, we will include ordinary shares or ADRs held by the Executive Director and their immediate family. Ordinarily, we would expect this required shareholding to have been built up within a period of five years from the date of appointment. Furthermore, from awards made in 2017, we require our Executive Directors to retain all the shares (after tax) vesting under the Performance Share Programme for a period of two years after vesting. STATEMENT OF CONSIDERATION OF EMPLOYMENT CONDITIONS ELSEWHERE IN THE COMPANY AND DIFFERENCES TO THE EXECUTIVE DIRECTOR POLICY All employees across the Group have performance-based pay linked to objectives derived from the strategic priorities, which underpin the performance metrics in the Executive Director Incentive Plans. Executive Director base salaries will generally increase at a rate in-line with the average salary increases awarded across the Company. Given the diverse geographic markets within which the Company operates, the Committee will generally be informed by the average salary increase in both the market local to the Executive and the UK, recognising the Company’s place of listing, and will also consider market data periodically. A range of different pension arrangements operate across the Group depending on location and/or length of service. Executive Directors and Executive Officers either participate in the legacy pension arrangements relevant to their local market or receive a cash payment of 30% of salary in lieu of a pension. Senior executives who do not participate in a local Company pension plan receive a cash payment of 20% of salary in lieu of pension. Differing amounts apply for lower levels within the Company. The Company has established a benefits framework under which the nature of benefits varies by geography. Executive Directors participate in benefit arrangements similar to those applied for employees within the applicable location. All employees are set objectives at the beginning of each year, which link through to the objectives set for the Executive Directors. Annual cash incentives payable to employees across the Company depend on the satisfactory completion of these objectives as well as performance against relevant Group and country business unit financial targets relating to revenue, trading profit and trading cash, similar to the financial targets set for the Executive Directors. Executive Officers and senior executives (61 as at 2017) participate in the annual Equity Incentive Programme and the Performance Share Programme. The maximum amounts payable are lower, but the performance conditions are the same as those that apply to the Executive Directors. No specific consultation with employees has been undertaken relating to Director remuneration. However, regular employee surveys are conducted across the Group, which cover a wide range of issues relating to local employment conditions and an understanding of Group-wide strategic matters. As at 2017, around 5,000 employees in 63 countries participate in one or more of our global share plans. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 104 | GOVERNANCE | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | | | | REMUNERATION THE POLICY REPORT | | |
FUTURE POLICY TABLE – CHAIRMAN AND NON-EXECUTIVE DIRECTORS The following table and accompanying notes explain the different elements of remuneration we pay to our Chairman and Non-Executive Directors. No element of their remuneration is subject to performance. All payments made to the Chairman are determined by the Remuneration Committee, whilst payments made to the Non-Executive Directors are determined by the Directors who are not themselves Non-Executive Directors, currently the Chairman, the Chief Executive Officer and the Chief Financial Officer. | | Annual fees | Basic annual fee | To attract and retain Directors by setting fees at rates comparable to what would be paid in an equivalent position elsewhere. The Remuneration Committee will determine a base salary in line with the policy and having regard to the parameters set out on in the future policy table. Incoming Executive Directors will be entitled to pension, benefit and incentive arrangements which are the same as provided to existing Executive Directors. On that basis, awards would not exceed 405% of base salary. We recognise that in the event that we require a new Executive Director to relocate to take up a position with the Company, we will also pay relocation and related costs as described in the future policy table, which is in line with the relocation arrangements we operate across the Group.
We also recognise that in many cases, an external appointee may forfeit sizeable cash bonuses and share awards if they choose to leave their former employer and join us. The Remuneration Committee therefore believes that we need the ability to compensate new hires for incentive awards they give up on joining us. The Committee will use its discretion in setting any such compensation, which will be decided on a case-by-case basis. We will only provide compensation which is no more beneficial than that given up by the new appointee and we will seek evidence from the previous employer to confirm the full details of bonus or share awards being forfeited. As far as possible, we will seek to replicate forfeited share awards using Smith & Nephew incentive plans or through reliance on 9.4.2 in the Listing Rules, whilst at the same time aiming for simplicity.
If we appoint an existing employee as an Executive Director of the Company, pre-exisiting obligations with respect to remuneration, such as pension, benefits and legacy share awards, will be honoured. Should these differ materially from current arrangements, these will be disclosed in the next Implementation Report.
We will supply details via an announcement to the London Stock Exchange of an incoming Executive Director’s remuneration arrangements at the time of their appointment.
Service contracts
We employ Executive Directors on rolling service contracts with notice periods of up to 12 months from the Company and six months from the Executive Director. On termination of the contract, we may require the Executive Director not to work their notice period and pay them an amount equivalent to the base salary and payment in lieu of pension and benefits they would have received if they had been required to work their notice period.
Under the terms of the Executive Director’s service contract, Executive Directors are restricted for a period of 12 months after leaving the employment of the Company from working for a competitor, soliciting orders from customers and offering employment to employees of Smith & Nephew. The Company retains the right to waive these provisions in certain circumstances. In the event that these provisions are waived and the former Executive Director commences employment earlier than at the end of the notice period, no further payments shall be made in respect of the portion of notice period not worked. Directors’ service contracts are available for inspection at the Company’s registered office: 15 Adam Street, London WC2N 6LA.
Smith & Nephew Annual report 2014 99
CORPORATE GOVERNANCE
Remuneration reportcontinued
Policy on payment for loss of office
Our policy regarding termination payments to departing Executive Directors is to limit severance payments to pre-established contractual arrangements. In the event that the employment of an Executive Director is terminated, any compensation payable will be determined in accordance with the terms of the service contract between the Company and the Executive Director, as well as the rules of any incentive plans.
Under normal circumstances (excluding termination for gross misconduct) all leavers are entitled to receive termination payments in lieu of notice equal to base salary, payment in lieu of pension, and benefits. In some circumstances additional benefits may become payable to cover reimbursement of untaken holiday leave, repatriation and outplacement fees, legal and financial advice.
In addition, we may also in exceptional circumstances exercise our discretion to pay the Executive Director aA proportion of the annual cash incentive they would have received had they been required to work their notice period. Any entitlement or discretionary payment may be reducedfees are paid in line with the Executive Director’s duty to mitigate losses, subject to applying our non-compete clause.
We will supply details via an announcement to the London Stock Exchange of a departing Executive Director’s termination arrangements at the time of departure.
In the case of a change of control which results in the termination of an Executive Director or a material alteration to their responsibilities or duties, within 12 months of the event, the Executive Director would be entitled to receive 12 months’ base salary plus payment in lieu of pension and benefits. In addition, the Remuneration Committee has discretion to pay an Executive Director in these circumstances an annual cash incentive. For Directors appointed prior to 1 November 2012, an automatic annual cash incentive is payable at target.
In the event that an Executive Director leaves for reasons of ill-health, death, redundancy or retirement in agreement with the Company, then the vesting of any outstanding annual cash incentive and equity incentive awards will generally depend on the Remuneration Committee’s assessment of performance to date. Performance share awards will be pro-rated for the time worked during the relevant performance period, and will remain subject to performance over the full performance period.
For all other leavers, the annual cash incentive will generally be forfeited and outstanding equity incentive awards and performance share awards will lapse.
One-off awards granted on appointment will normally lapse on leaving except in cases of death, retirement, redundancy, or ill-health. The Remuneration Committee has discretion to permit such awards to vest in other circumstances and will be subject to satisfactorily meeting performance conditions if applicable.
The Remuneration Committee retains discretion to alter these provisions on a case-by-case basis following a review of circumstances and to ensure fairness for both shareholders and Executive Directors.
We will supply details via an announcement to the London Stock Exchange of an out-going Executive Director’s remuneration arrangements around the time of leaving.
Policy on shareholding requirements
The Remuneration Committee believes that one of the best ways our Executive Directors can have a greater alignment with shareholders is for them to hold a significant number of shares in the Company. Executive Directors are therefore expected to build up a holding of Smith & Nephew shares worth two-times their base salary. In order to reinforce this expectation, we require them to retain 50% of all shares vesting under the Company share plans (after tax) until this holding has been met recognising that differing international tax regimes affect the pace at which an Executive Director may fulfil the shareholding requirement. When calculating whether or not this requirement has been met, we will include ordinary shares or ADRs held by the Executive Director and their immediate family and the intrinsic value of any vested but unexercised options.
Statement of consideration of employment conditions elsewhere in the Company and differences to the Executive Director Policy
All employees across the Group including the Executive Directors are incentivised in a similar manner. Although the salary levels and maximum opportunities under bonus and share plans differ, generally speaking the same targets and performance conditions relating to the Company’s strategy apply throughout the organisation.
Executive Director base salaries will generally increase at a rate in line with the average salary increases awarded across the Company. Given the diverse geographic markets within which the Company operates, the Committee will generally be informed by the average salary increase in both the market local to the Executive and the UK, recognising the Company’s place of listing, and will also consider market data periodically.
A range of different pension arrangements operate across the Group depending on location and/or length of service. Executive Directors and Executive Officers either participate in the legacy pension arrangements relevant to their local market or receive a cash payment of 30% of salary in lieu of a pension. Senior Executives who do not participate in a local Company pension plan receive a cash payment of 20% of salary in lieu of pension. Differing amounts apply for lower levels within the Company.
The Company has established a benefits framework under which the nature of benefits varies by geography. Executive Directors participate in benefit arrangements similar to those applied for employees within the applicable location.
All employees are set objectives at the beginningthird quarter of each year which link throughin order to align Non-Executive Directors’ fees with the objectives set for the Executive Directors. Annual cash incentives payable to employees across the Company depend on the satisfactory completioninterests of these objectives as well as performance against relevant Group and divisional financial targets relating to revenue, trading profit and trading cash, similar to the financial targets set for the Executive Directors.shareholders.
Executive Officers and Senior Executives (72 as at 2014) participate in the annual Equity Incentive Programme and the Performance Share Programme. The maximum amounts payable are lower, but the performance conditions are the same as those that apply to the Executive Directors.
No specific consultation with employees has been undertaken relating to Director remuneration. However, regular employee surveys are conducted across the Group, which cover a wide range of issues relating to local employment conditions and an understanding of Group-wide strategic matters. As at 2014, over 4,500 employees in 32 countries participate in one or more of our global share plans.
100Smith & Nephew Annual report 2014
Future policy table
Chairman and Non-executive Directors
The following table and accompanying notes explain the different elements of remuneration we pay to our Chairman and Non-executive Directors. No element of their remuneration is subject to performance. All payments made to the Chairman are determined by the Remuneration Committee, whilst payments made to the Non-executive Directors are determined by the Directors who are not themselves Non-executive Directors, currently the Chairman, the Chief Executive Officer and the Chief Financial Officer.
| | | | | How the component supports the short-
and long-term strategy of the Company
| | How the component operates | | Maximum levels of payment | Annual fees | | | | | Basic annual fee | | | | | To attract and retain Directors by setting fees at rates comparable to what would be paid in an equivalent position elsewhere.
A proportion of the fees are paid in shares in the third quarter of each year in order to align Non-executive Directors’ fees with the interest of shareholders.
| | Fees will be reviewed periodically. In future, any increase will be paid in shares until 25% of the total fee is paid in shares. Fees are set in line with market practice for fees paid by similarly sized UK listed companies.
Annual fees are set and paid in UK sterling or US dollars depending on the location of the Non-executive Director. If appropriate, fees may be set and paid in alternative currencies.
| | Annual fees are currently as follows:
£63,000 in cash plus £3,150 in shares; or
$120,000 in cash plus $6,000 in shares.
Chairman fee:
£400,000 plus £20,000 in shares (to April 2014).
£300,000 plus £100,000 in shares (from April 2014).
Whilst it is not expected to increase the fees paid to the Non-executive Directors and the Chairman by more than the increases paid to employees generally, in exceptional circumstances, higher fees might become payable.
The total maximum aggregate fees payable to the Non-executive Directors will not exceed £1.5m as set out in the Company’s articles of association.
| Fee for Senior Independent Director and Committee Chairmen | To compensate Non-executive Directors for the additional time spent as Committee Chairmen or as the Senior Independent Director.
| | A fixed fee is paid, which is reviewed periodically.
| | £15,000 in cash; or
$27,000 in cash.
Whilst it is not expected that the fees paid to the Senior Independent Director or Committee Chairman will exceed the increases paid to employees generally, in exceptional circumstances, higher fees might become payable.
| Intercontinental travel fee | To compensate Non-executive Directors for the time spent travelling to attend meetings in another continent.
| | A fixed fee is paid, which is reviewed periodically.
| | £3,500 in cash; or
$7,000 in cash.
Whilst it is not expected to increase these fees by more than the increases paid to employees generally, in exceptional circumstances, higher fees might become payable.
|
Figures as at salary levels in 2014, when the Policy report was approved by shareholders
Smith & Nephew Annual report 2014 101
CORPORATE GOVERNANCE
Remuneration reportcontinued
Notes to Future policy table – Non-executive Directors
Changes to remuneration policy
The Board has altered the policy regarding the payment of Non-executive Directors and to the Chairman in one respect in 2013, by introducing the payment of a proportion of the fees in the form of shares. The fees paid to the Non-executive Directors and to the Chairman were reviewed in July 2013 and it was agreed that the basic fee should be increased by 5% (there having been no increase to these fees since August 2011) and that the increase be paid in the form of shares. The amount of the increase less applicable taxes was used to purchase shares in the market on 15 August 2013. Going forward any increase in the level of fees paid to a Non-executive Director will be paid in the form of shares until 25% of the Non-executive Director’stotal fee is paid in shares.
Fees are set in-line with market practice for fees paid by similarly sized UK listed companies. Annual fees are set and paid in UK Sterling or US Dollars depending on the formlocation of shares. We have made this changethe Non-Executive Director. If appropriate, fees may be set and paid in orderalternative currencies. | Annual fees are currently as follows: – £63,000 in cash plus £5,135 in shares; or – $120,000 in cash plus $9,780 in shares. Chairman fee: – £309,000 plus £103,000 in shares. Whilst it is not expected to alignincrease the fees paid to Non-executivethe Non-Executive Directors withand the experience of our shareholders. WithChairman by more than the appointment of Roberto Quartaincreases paid to employees generally, in exceptional circumstances higher fees might become payable. The total maximum aggregate fees payable to the Non-Executive Directors will not exceed £1.5 million as Chairman of the Company with effect from the Annual General Meeting, we have taken the opportunity to pay 25% of his feesset out in the formCompany’s Articles of shares immediately.Association. | Fee for Senior Independent Director and Committee Chairmen | To compensate Non-Executive Directors for the additional time spent as Committee Chairmen or as the Senior Independent Director. | How the component operates | Maximum levels of payment | A fixed fee is paid, which is reviewed periodically. | – £20,000 in cash; or Policy on recruitment arrangements– $35,000 in cash.
Any new Non-executiveWhilst it is not expected that the fees paid to the Senior Independent Director or Committee Chairmen will exceed the increases paid to employees generally, in exceptional circumstances, higher fees might become payable.
| Intercontinental travel | To compensate Non-Executive Directors for the time spent travelling to attend meetings in another continent. | How the component operates | Maximum levels of payment | A fixed fee is paid, which is reviewed periodically. | – £3,500 in cash; or – $7,000 in cash. Whilst it is not expected to increase these fees by more than the increases paid to employees generally, in exceptional circumstances, higher fees might become payable. |
| | | SMITH & NEPHEW ANNUAL REPORT 2017 | GOVERNANCE | 105 |
NOTES TO FUTURE POLICY TABLE – NON-EXECUTIVE DIRECTORS Changes to Remuneration Policy There have been no changes to our Remuneration Policy as it applies to Non-Executive Directors, since the Policy was initially approved by shareholders in April 2014. Additional duties undertaken by Non-Executive Directors In the event that the Chairman or a Non-Executive Director is required to undertake significant additional executive duties in order to support the Executive Directors during a period of absence due to illness or a gap prior to the appointment of a permanent Executive Director, the Remuneration Committee is authorised to determine an appropriate level of fees which shall be payable. These fees will not exceed the amounts which would normally be paid to a permanent Executive Director undertaking such duties and shall not include participation in short- or long-term incentive arrangements or benefit plans. Policy on recruitment arrangements Any new Non-Executive Director shall be paid in accordance with the current fee levels on appointment, in line with the Policy set out above. With respect to the appointment of a new Chairman, fee levels will take into account market rates, the individual’s profile and experience, the time required to undertake the role and general business conditions. In addition, the Remuneration Committee retains the right to authorise the payment of relocation assistance or an accommodation allowance in the event of the appointment of a Chairman not based within the UK. Letters of appointment The Chairman and Non-Executive Directors have letters of appointment which set out the terms under which they provide their services to the Company and are available for inspection at the Company’s registered office: 15 Adam Street, London WC2N 6LA. The appointment of Non-Executive Directors is not subject to a notice period, nor is there any compensation payable on loss of office, for example, should they not be re-elected at an Annual General Meeting. The appointment of the Chairman is subject to a notice period of six months. The Chairman and Non-Executive Directors are required to acquire a shareholding in the Company equivalent in value to one times their basic fee within two years of their appointment to the Board. STATEMENT OF CONSIDERATION OF SHAREHOLDER VIEWS The broad outline of our remuneration arrangements have remained largely unchanged since 2012. As our strategy has evolved, we have altered some of the measures we use in our short- and long-term incentive plans, but the overall structure of our remuneration arrangements has remained the same. Shareholders formally approved the Remuneration Policy in respect of our Executive Directors at the Annual General Meeting in 2014. Joseph Papa, Chairman of the Remuneration Committee, has met with shareholders before the policy was approved and every year since, in order to ascertain shareholder views on our remuneration arrangements. Ahead of the Annual General Meeting in 2016, Mr Papa held meetings and calls with 28 shareholders holding approximately 33% of the Company’s Share Capital. Although the holders of 53% of our shares voted against the Remuneration Report in 2016, our engagement ahead of the 2016 Annual General Meeting had shown us that shareholders were broadly supportive of our Remuneration Policy and those who opposed the Remuneration Report were primarily voting against the use of discretion rather than any aspect of the Remuneration Policy. During 2016, following the Annual General Meeting, Mr Papa continued to engage extensively with shareholders. In Autumn 2016, he met with or held telephone calls with 28 shareholders holding around 41% of the Company’s shares. The shareholders he met ranged from some of our top 20 shareholders down to smaller active and engaged shareholders holding fewer than one million shares. He discussed our proposals to continue with the same overall remuneration arrangements, whilst altering the performance measures used in the short- and long-term incentive plans. We found the discussions with shareholders at this time useful in helping to understand the measures and targets which were important to our shareholders, and those which shareholders did not support. As a result of these discussions, some updated performance measures have been incorporated into our incentive plans for 2017 and a two-year holding period will now apply on the vesting of performance shares for our Executive Directors. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 106 | ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS | 107 |
GROUP FINANCIAL STATEMENTS STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE ANNUAL REPORT AND THE FINANCIAL STATEMENTS The Directors are responsible for preparing this Annual Report and Form 20‑F Information and the Group and Parent Company Financial Statements, in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and Parent Company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IASB) and as adopted by the European Union (IFRSs as adopted by the EU) and applicable law and have elected to prepare the Parent Company financial statements in accordance with UK accounting standards, including FRS 101 Reduced Disclosure Framework. Under company law Directors must not approve Financial Statements unless they are satisfied that they give a true and fair view of the state of affairs of a group and Parent Company and of their profit or loss for that period. In preparing each of the Group and Parent Company Financial Statements, the Directors are required to: select suitable accounting policies and then apply them consistently; make judgements and estimates that are reasonable, relevant, reliable and prudent; for the Group financial statements, state whether they have been prepared in accordance with IFRSs, as issued by the IASB and adopted by the EU; for the Parent Company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the Parent Company Financial Statements; assess the Group and Parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and use the going concern basis of accounting unless they either intend to liquidate the Group or the Parent Company or to cease operations, or have no realistic alternative but to do so. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Parent Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Parent Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They are responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error, and have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, Directors’ Report, Directors’ Remuneration Report and Corporate Governance Statement that complies with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. RESPONSIBILITY STATEMENT OF THE DIRECTORS IN RESPECT OF THE ANNUAL REPORT We confirm that to the best of our knowledge: | - | | the financial statements, prepared in accordance with the current fee levels on appointment, in line with the policyapplicable set out above. With respect to the appointment of a new Chairman, fee levels will take into account market rates, the individual’s profile and experience, the time required to undertake the role and general business conditions. In addition, the Remuneration Committee retains the right to authorise the payment of relocation assistance or an accommodation allowance in the event of the appointment of a Chairman not based within the UK. Letters of appointment
The Chairman and Non-executive Directors have letters of appointment which set out the terms under which they provide their services to the Company and are available for inspection at the Company’s registered office: 15 Adam Street, London WC2N 6LA. The appointment of Non-executive Directors is not subject to a notice period, nor is there any compensation payable on loss of office, for example, should they not be re-elected at an Annual General Meeting. The appointment of the Chairman is subject to a notice period of six months.
The Chairman and Non-executive Directors are required to acquire a shareholding in the Company equivalent in value to one times their basic fee within two years of their appointment to the Board.
Statement of consideration of shareholder views
This policy report sets out the remuneration policy in relation to Executive Directors, which has been in place since 2012. As this policy evolved at the end of 2011 and during 2012, we engaged actively with shareholders to explain our remuneration arrangements and to discuss their views on our proposals. At the time, Joseph Papa, the Chairman of the Remuneration Committee and members of the Senior Executive Team met with the holders of around 30% of our shares, including collectively with a number of smaller engaged investors, as well as shareholder advisory bodies. We discussed the structure of our remuneration package, our policies on termination, recruitment, shareholding requirements and the operation of Annual Incentive Plan. The Directors’ remuneration report was approved by 96% of shareholders who voted at the Annual General Meeting in 2013 and we received feedback from shareholders around the time of this meeting that they understood and approved of our remuneration arrangements. Although the remuneration policy has remained essentially unchanged as in previous years, given the changes in remuneration reporting, we also conducted an engagement programme with our larger shareholders in 2013. Joseph Papa met with the holders of around 20% of our shares, and with a number of shareholder advisory bodies. He has also been available to discuss any aspect of our remuneration programme with shareholders throughout the year. The shareholders who have engaged with us have all been supportive of our approach to remuneration, recognising the link between the corporate strategy and executive reward.
102Smith & Nephew Annual report 2014
Directors’ responsibilities for the accounts
The Directors are responsible for preparing the Group and Company accounts in accordance with applicable UK law and regulations. As a consequence of the Company’s ordinary shares being traded on the New York Stock Exchange (in the form of American Depositary Shares) the Directors are responsible for the preparation and filing of an annual report on Form 20-F with the US Securities and Exchange Commission.
The Directors are required to prepare Group accounts for each financial year, in accordance with the International Financial Reporting Standards (‘IFRS’) as adopted by the European Union which present fairly the financial position of the Group and the financial performance and cash flows of the Group for that period. In preparing those Group accounts, the Directors are required to:
– | select suitable accounting policies in accordance with IAS 8Accounting Policies, Changes in Accounting Estimates and Errors and then apply them consistently; |
– | present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; |
– | provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Group’s financial position and financial performance; and |
– | state that the Group has complied with IFRS, subject to any material departures disclosed and explained in the accounts. |
Under UK law the Directors have elected to prepare the Company accounts in accordance with UK Generally Accepted Accounting Practice (UK Accounting Standards and applicable law), which are required by law toaccounting standards, give a true and fair view of the state of affairs of the Companyassets, liabilities, financial position and of the profit or loss of the Company for that period. In preparingand the Company accounts,undertakings included in the Directors are required to:consolidation taken as a whole; and
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– | select suitable accounting policies and then apply them consistently; |
- – | make judgements and estimates that are reasonable and prudent; |
– | state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the accounts; and |
– | prepare the accounts on a going concern basis unless it is inappropriate to presume that the Company will continue in business. |
The Directors confirm that they have complied with the above requirements in preparingStrategic Report and Directors’ Report include a fair review of the accounts.
The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any timedevelopment and performance of the financialbusiness and the position of the Groupissuer and the Company and enable them to ensure that the accounts comply with the Companies Act 2006 and,undertakings included in the case of the Group accounts, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Group and the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Group’s website. It should be noted that information published on the internet is accessible in many countries with different legal requirements. Legislation in the UK governing the preparation and dissemination of accounts may differ from legislation in other jurisdictions.
Fair, Balanced and Understandable
As required by the UK Corporate Governance Code, the Directors confirm that they consider that the Annual Report,consolidation taken as a whole, is fair, balancedtogether with a description of the principal risks and understandableuncertainties that they face.
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The Strategic Report, which has been prepared in accordance with the requirements of the Companies Act 2006, comprises the following sections: | - | | Our Business and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy. When arriving at this conclusion the Board was assisted by a number of processes including:Marketplace (pages 8-17); |
– | The Annual Report is drafted and comprehensively reviewed by appropriate senior management with overall co-ordination by the Head of Financial Reporting; |
– | An extensive verification process is undertaken to ensure factual accuracy, with third party review by legal advisers; and |
- – | The final draft is reviewed by the Audit Committee prior to consideration by the Board. |
Directors’ responsibility statement pursuant to disclosure and transparency Rule 4
| The Directors confirm that, to the best of each person’s knowledge:Operational Review (pages 18-35);
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| - | | Financial Review (pages 38-39); |
The Directors’ Report has also been prepared in accordance with the Companies Act 2006 and The Small Companies and Groups (Accounts and Directors’ Report) Regulations 2008 comprising of pages 6, 16-17, 25-28, 33-39, 42-78, 107, 140-142, 158 and pages 171-192 of the Annual Report. And has been approved and signed on behalf of the Board. We consider the Annual Report and financial statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Group’s position and performance, business model and strategy. By order of the Board, 22 February 2018 Susan Swabey Company Secretary – | the Group accounts in this report, which have been prepared in accordance with IFRS as adopted by the European Union and those parts of the Companies Act 2006 applicable to companies reporting under IFRS, give a true and fair view of the assets, liabilities, financial position and profit of the Group taken as a whole; |
– | the Company accounts in this report, which have been prepared in accordance with UK Generally Accepted Accounting Practice and the Companies Act 2006, give a true and fair view of the assets, liabilities, financial position and profit of the Company; and |
– | the ‘Financial review and principal risks’ section and commentary on pages 34 to 39 contained in the accounts includes a fair review of the development and performance of the business and the financial position of the Company and the Group taken as a whole, together with a description of the principal risks and uncertainties that they face. |
Going concern
The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the ‘Financial review and principal risks’ section on pages 34 to 39. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are described under ‘Commentary on the Group cash flow statement’ section set out on page 115.
In addition, the Notes to the Group accounts include the Group’s objectives, policies and processes for managing its capital; its financial risk management objectives; details of its financial instruments and hedging activities; and its exposure to credit risk and liquidity risk.
The Group has considerable financial resources and its customers and suppliers are diversified across different geographic areas. As a consequence, the directors believe that the Group is well placed to manage its business risk successfully despite the on-going uncertain economic outlook.
The directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Thus they continue to adopt the going concern basis for accounting in preparing the annual financial statements.
Management also believes that the Group has sufficient working capital for its present requirements.
Directors’ Report
The Directors’ Report has been prepared in accordance with the requirements of the Companies Act 2006.
By order of the Board, 25 February 2015
Susan Swabey
Company Secretary
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GROUP FINANCIAL STATMENTS INDEPENDENT AUDITOR’S US REPORT REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the shareholders and board of directors Smith & Nephew plc: Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying Group balance sheets of Smith & Nephew plc and subsidiaries (the “Group”) as of 31 December 2017 and 2016, the related Group income statements, Group statements of comprehensive income, Group cash flow statements and Group statements of changes in equity for each of the years in the three-year period ended 31 December 2017, and the related notes (collectively, the “consolidated financial statements”). We also have audited the Group’s internal control over financial reporting as of 31 December 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Group as of 31 December 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended 31 December 2017, in conformity with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board and in conformity with IFRS as adopted by the European Union. Also in our opinion, the Group maintained, in all material respects, effective internal control over financial reporting as of 31 December 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinion The Group’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Evaluation of Internal Controls. Our responsibility is to express an opinion on the Group’s consolidated financial statements and an opinion on the Group’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Group in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. KPMG LLP We have served as the Group’s auditor since 2015. London, United Kingdom 22 February 2018 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 109 |
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GROUP FINANCIAL STATEMENTS CRITICAL JUDGEMENTS AND ESTIMATES
FINANCIAL STATEMENTS
Critical accounting policies
The Group prepares its consolidated financial statements in accordance with IFRS as issued by the IASB and IFRS as adopted by the EU, the application of which often requires judgements and estimates to be made by management when formulating the Group’s financial position and results. Under IFRS, the Directors are required to adopt those accounting policies most appropriate to the Group’s circumstances for the purpose of presenting fairly the Group’s financial position, financial performance and cash flows. The Group’s accounting policies do not include any critical judgements. The Group’s accounting policies are set out in Notes 1-23 of the Notes to the Group accounts. Of those, the policies which require the most use of management’s estimation are as follows: VALUATION OF INVENTORIES A feature of the Orthopaedic Reconstruction and Trauma & Extremities franchises (whose finished goods inventory make up approximately 79% of the Group’s financial position and results. Under IFRS, the Directors are required to adopt those accounting policies most appropriate to the Group’s circumstances for the purpose of presenting fairly the Group’s financial position, financial performance and cash flows. In determining and applying accounting policies, judgement is often required in respect of items where the choice of specific policy, accounting estimate or assumption to be followed could materially affect the reported results or net asset position of the Group; it may later be determined that a different choice would have been more appropriate.
The Group’s significant accounting policies are set out in Notes 1 to 23 of the Notes to the Group accounts. Of those, the policies which require the most use of management’s judgement are as follows:
Valuation of inventories
A feature of the Orthopaedic Reconstruction and Trauma & Extremities franchises (whose finished goods inventory makes up approximately 79% of the Group total finished goods inventory) is the high level of product inventory required, some of which is located at customer premises and is available for customers’ immediate use. Complete sets of products, including large and small sizes, have to be made available in this way. These sizes are used less frequently than standard sizes and towards the end of the product life cycle are inevitably in excess of requirements. Adjustments to carrying value are therefore required to be made to orthopaedic inventory to anticipate this situation. These adjustments are calculated in accordance with a formula based on levels of inventory compared with historical usage. This formula is applied on an individual product line basis and is first applied when a product group has been on the market for two years. This method of calculation is considered appropriate based on experience, but it does require management estimate in respect of customer demand, effectiveness of inventory deployment, length of product lives, phase-out of old products and efficiency of manufacturing planning systems.
IMPAIRMENT In carrying out impairment reviews of intangible assets, a number of significant assumptions have to be made when preparing cash flow projections. These include the future rate of market growth, discount rates, the market demand for the products acquired, the future profitability of acquired businesses or products, levels of reimbursement and success in obtaining regulatory approvals. If actual results should differ or changes in expectations arise, impairment charges may be required which would adversely impact operating results. LIABILITY PROVISIONING The recognition of provisions for legal disputes is subject to a significant degree of estimation. Provision is made for loss contingencies when it is considered probable that an adverse outcome will occur and the amount of the loss can be reasonably estimated. In making its estimates, management takes into account the advice of internal and external legal counsel. Provisions are reviewed regularly and amounts updated where necessary to reflect developments in the disputes. The ultimate liability may differ from the amount provided depending on the outcome of court proceedings and settlement negotiations or if investigations bring to light new facts. TAXATION The Group operates in numerous tax jurisdictions around the world and it is Group policy to submit its tax returns to the relevant tax authorities as promptly as possible. At any given time, the Group is involved in disputes and tax audits and will have a number of tax returns potentially subject to audit. Significant issues may take several years to resolve. In estimating the probability and amount of any tax charge, management takes into account the views of internal and external advisers and updates the amount of tax provision whenever necessary. The ultimate tax liability may differ from the amount provided depending on interpretations of tax law, settlement negotiations or changes in legislation. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 115 |
GROUP INCOME STATEMENT | | | | | | | | | | | | | | Year ended | | Year ended | | Year ended | | | | | | 31 December | | 31 December | | 31 December | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Revenue | | 2 | | 4,765 | | 4,669 | | 4,634 | | Cost of goods sold | | | | (1,248) | | (1,272) | | (1,143) | | Gross profit | | | | 3,517 | | 3,397 | | 3,491 | | Selling, general and administrative expenses | | 3 | | (2,360) | | (2,366) | | (2,641) | | Research and development expenses | | 3 | | (223) | | (230) | | (222) | | Operating profit | | 2 & 3 | | 934 | | 801 | | 628 | | Interest income | | 4 | | 6 | | 6 | | 11 | | Interest expense | | 4 | | (57) | | (52) | | (49) | | Other finance costs | | 4 | | (10) | | (16) | | (15) | | Share of results of associates | | 11 | | 6 | | (3) | | (16) | | Profit on disposal of business | | 21 | | – | | 326 | | – | | Profit before taxation | | | | 879 | | 1,062 | | 559 | | Taxation | | 5 | | (112) | | (278) | | (149) | | Attributable profit for the year1 | | | | 767 | | 784 | | 410 | | Earnings per ordinary share1 | | 6 | | | | | | | | Basic | | | | 87.8¢ | | 88.1¢ | | 45.9¢ | | Diluted | | | | 87.7¢ | | 87.8¢ | | 45.6¢ | |
GROUP STATEMENT OF COMPREHENSIVE INCOME | | | | | | | | | | | | | | Year ended | | Year ended | | Year ended | | | | | | 31 December | | 31 December | | 31 December | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Attributable profit for the year1 | | | | 767 | | 784 | | 410 | | Other comprehensive income: | | | | | | | | | | Items that will not be reclassified to income statement | | | | | | | | | | Re-measurement of net retirement benefit obligations | | 18 | | 64 | | (81) | | (8) | | Taxation on other comprehensive income | | 5 | | (9) | | 10 | | 10 | | Total items that will not be reclassified to income statement | | | | 55 | | (71) | | 2 | | | | | | | | | | | | Items that may be reclassified subsequently to income statement | | | | | | | | | | Cash flow hedges – forward foreign exchange contracts | | | | | | | | | | – (losses)/gains arising in the year | | | | (45) | | (15) | | 34 | | – losses/(gains) transferred to inventories for the year | | | | 21 | | 20 | | (50) | | Fair value remeasurement of available for sale asset | | | | (10) | | 10 | | – | | Exchange differences on translation of foreign operations | | | | 181 | | (134) | | (176) | | Total items that may be reclassified subsequently to income statement | | | | 147 | | (119) | | (192) | | Other comprehensive income/(loss) for the year, net of taxation | | | | 202 | | (190) | | (190) | | Total comprehensive income for the year1 | | | | 969 | | 594 | | 220 | |
| 1 | | Attributable to equity holders of the Company and wholly derived from continuing operations. |
The Notes on pages 119-162 are an integral part of these accounts. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 116ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
GROUP FINANCIAL STATEMENTS GROUP BALANCE SHEET | | | | | | | | | | | | At | | At | | | | | | 31 December | | 31 December | | | | | | 2017 | | 2016 | | | | Notes | | $ million | | $ million | | Assets | | | | | | | | Non-current assets | | | | | | | | Property, plant and equipment | | 7 | | 1,049 | | 982 | | Goodwill | | 8 | | 2,371 | | 2,188 | | Intangible assets | | 9 | | 1,371 | | 1,411 | | Investments | | 10 | | 21 | | 25 | | Investments in associates | | 11 | | 118 | | 112 | | Other non-current assets | | 13 | | 16 | | – | | Retirement benefit assets | | 18 | | 62 | | – | | Deferred tax assets | | 5 | | 127 | | 97 | | | | | | 5,135 | | 4,815 | | Current assets | | | | | | | | Inventories | | 12 | | 1,304 | | 1,244 | | Trade and other receivables | | 13 | | 1,258 | | 1,185 | | Cash at bank | | 15 | | 169 | | 100 | | | | | | 2,731 | | 2,529 | | Total assets | | | | 7,866 | | 7,344 | | | | | | | | | | Equity and liabilities | | | | | | | | Equity attributable to owners of the Company | | | | | | | | Share capital | | 19 | | 178 | | 180 | | Share premium | | | | 605 | | 600 | | Capital redemption reserve | | | | 17 | | 15 | | Treasury shares | | 19 | | (257) | | (432) | | Other reserves | | | | (228) | | (375) | | Retained earnings | | | | 4,329 | | 3,970 | | Total equity | | | | 4,644 | | 3,958 | | Non-current liabilities | | | | | | | | Long-term borrowings | | 15 | | 1,423 | | 1,564 | | Retirement benefit obligations | | 18 | | 131 | | 164 | | Other payables | | 14 | | 128 | | 82 | | Provisions | | 17 | | 97 | | 134 | | Deferred tax liabilities | | 5 | | 97 | | 94 | | | | | | 1,876 | | 2,038 | | Current liabilities | | | | | | | | Bank overdrafts and loans | | 15 | | 27 | | 86 | | Trade and other payables | | 14 | | 957 | | 884 | | Provisions | | 17 | | 129 | | 147 | | Current tax payable | | 5 | | 233 | | 231 | | | | | | 1,346 | | 1,348 | | Total liabilities | | | | 3,222 | | 3,386 | | Total equity and liabilities | | | | 7,866 | | 7,344 | |
The accounts were approved by the Board and authorised for issue on 22 February 2018 and are signed on its behalf by: | | Roberto Quarta | Olivier Bohuon | Graham Baker | Chairman | Chief Executive Officer | Chief Financial Officer |
The Notes on pages 119-162 are an integral part of these accounts. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 117 |
GROUP CASH FLOW STATEMENT | | | | | | | | | | | | | | Year ended | | Year ended | | Year ended | | | | | | 31 December | | 31 December | | 31 December | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Cash flows from operating activities | | | | | | | | | | Profit before taxation | | | | 879 | | 1,062 | | 559 | | Net interest expense | | 4 | | 51 | | 46 | | 38 | | Depreciation, amortisation and impairment | | | | 447 | | 463 | | 493 | | Loss on disposal of property, plant and equipment and software | | | | 13 | | 15 | | 15 | | Distribution from trade investments | | | | – | | – | | 3 | | Share-based payments expense (equity settled) | | 23 | | 31 | | 27 | | 29 | | Share of results of associates | | 11 | | (6) | | 3 | | 16 | | Profit on disposal of business | | 21 | | – | | (326) | | – | | Net movement in post-retirement benefit obligations | | | �� | (40) | | (85) | | (57) | | Increase in inventories | | | | (17) | | (47) | | (83) | | Increase in trade and other receivables | | | | (40) | | (74) | | (26) | | (Decrease)/increase in trade and other payables and provisions | | | | (45) | | (49) | | 216 | | Cash generated from operations1 | | | | 1,273 | | 1,035 | | 1,203 | | Interest received | | | | 2 | | 3 | | 8 | | Interest paid | | | | (50) | | (48) | | (44) | | Income taxes paid | | | | (135) | | (141) | | (137) | | Net cash inflow from operating activities | | | | 1,090 | | 849 | | 1,030 | | Cash flows from investing activities | | | | | | | | | | Acquisitions, net of cash acquired | | 21 | | (159) | | (214) | | (44) | | Capital expenditure | | 2 | | (376) | | (392) | | (358) | | Investment in associate | | 11 | | – | | – | | (25) | | Purchase of investments | | 10 | | (8) | | (2) | | (2) | | Proceeds on disposal of business | | 21 | | – | | 343 | | – | | Tax on disposal of business | | | | – | | (118) | | – | | Net cash used in investing activities | | | | (543) | | (383) | | (429) | | Cash flows from financing activities | | | | | | | | | | Proceeds from issue of ordinary share capital | | | | 5 | | 10 | | 16 | | Purchase of own shares | | | | (52) | | (368) | | (77) | | Proceeds from borrowings due within one year | | 20 | | 53 | | 34 | | 42 | | Settlement of borrowings due within one year | | 20 | | (64) | | (38) | | (26) | | Proceeds from borrowings due after one year | | 20 | | 570 | | 890 | | 831 | | Settlement of borrowings due after one year | | 20 | | (706) | | (759) | | (1,062) | | Proceeds from own shares | | | | 5 | | 6 | | 5 | | Settlement of currency swaps | | 20 | | 24 | | (25) | | (15) | | Equity dividends paid | | 19 | | (269) | | (279) | | (272) | | Net cash used in financing activities | | | | (434) | | (529) | | (558) | | Net increase/(decrease) in cash and cash equivalents | | | | 113 | | (63) | | 43 | | Cash and cash equivalents at beginning of year | | 20 | | 38 | | 102 | | 65 | | Exchange adjustments | | 20 | | 4 | | (1) | | (6) | | Cash and cash equivalents at end of year2 | | | | 155 | | 38 | | 102 | |
| 1 | | Includes $15m (2016: $62m, 2015: $52m) of outgoings on restructuring and rationalisation expenses, $3m (2016: $24m, 2015: $36m) of acquisition-related costs and $25m (2016: $36m, 2015: $3m) of legal and other costs. |
| 2 | | Cash and cash equivalents is net of bank overdrafts of $14m (2016: $62m, 2015: $18m). |
The Notes on pages 119-162 are an integral part of these accounts. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 118ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
GROUP FINANCIAL STATEMENTS GROUP STATEMENT OF CHANGES IN EQUITY | | | | | | | | | | | | | | | | | | | | | | Capital | | | | | | | | | | | | Share | | Share | | redemption | | Treasury | | Other | | Retained | | Total | | | | capital | | premium | | reserve | | shares2 | | reserves3 | | earnings | | equity | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 31 December 2014 | | 184 | | 574 | | 11 | | (315) | | (64) | | 3,650 | | 4,040 | | Attributable profit for the year1 | | – | | – | | – | | – | | – | | 410 | | 410 | | Other comprehensive (expense)/income | | – | | – | | – | | – | | (192) | | 2 | | (190) | | Equity dividends declared and paid | | – | | – | | – | | – | | – | | (272) | | (272) | | Share-based payments recognised | | – | | – | | – | | – | | – | | 29 | | 29 | | Taxation on share-based payments | | – | | – | | – | | – | | – | | 5 | | 5 | | Purchase of own shares | | – | | – | | – | | (77) | | – | | – | | (77) | | Cost of shares transferred to beneficiaries | | – | | – | | – | | 38 | | – | | (33) | | 5 | | Cancellation of treasury shares | | (1) | | – | | 1 | | 60 | | – | | (60) | | – | | Issue of ordinary share capital4 | | – | | 16 | | – | | – | | – | | – | | 16 | | At 31 December 2015 | | 183 | | 590 | | 12 | | (294) | | (256) | | 3,731 | | 3,966 | | Attributable profit for the year1 | | – | | – | | – | | – | | – | | 784 | | 784 | | Other comprehensive expense | | – | | – | | – | | – | | (119) | | (71) | | (190) | | Equity dividends declared and paid | | – | | – | | – | | – | | – | | (279) | | (279) | | Share-based payments recognised | | – | | – | | – | | – | | – | | 27 | | 27 | | Taxation on share-based payments | | – | | – | | – | | – | | – | | 2 | | 2 | | Purchase of own shares | | – | | – | | – | | (368) | | – | | – | | (368) | | Cost of shares transferred to beneficiaries | | – | | – | | – | | 40 | | – | | (34) | | 6 | | Cancellation of treasury shares | | (3) | | – | | 3 | | 190 | | – | | (190) | | – | | Issue of ordinary share capital4 | | – | | 10 | | – | | – | | – | | – | | 10 | | At 31 December 2016 | | 180 | | 600 | | 15 | | (432) | | (375) | | 3,970 | | 3,958 | | Attributable profit for the year1 | | – | | – | | – | | – | | – | | 767 | | 767 | | Other comprehensive income | | – | | – | | – | | – | | 147 | | 55 | | 202 | | Equity dividends declared and paid | | – | | – | | – | | – | | – | | (269) | | (269) | | Share-based payments recognised | | – | | – | | – | | – | | – | | 31 | | 31 | | Taxation on share-based payments | | – | | – | | – | | – | | – | | (3) | | (3) | | Purchase of own shares | | – | | – | | – | | (52) | | – | | – | | (52) | | Cost of shares transferred to beneficiaries | | – | | – | | – | | 26 | | – | | (21) | | 5 | | Cancellation of treasury shares | | (2) | | – | | 2 | | 201 | | – | | (201) | | – | | Issue of ordinary share capital4 | | – | | 5 | | – | | – | | – | | – | | 5 | | At 31 December 2017 | | 178 | | 605 | | 17 | | (257) | | (228) | | 4,329 | | 4,644 | |
| 1 | | Attributable to equity holders of the Company and wholly derived from continuing operations. |
| 2 | | Refer to Note 19.2 for further information. |
| 3 | | Other reserves comprises gains and losses on cash flow hedges, foreign exchange differences on translation of foreign operations and net changes on fair value of trading investments. The cumulative translation loss within other reserves at 31 December 2017 was $207m (2016: $388m loss, 2015: $254m loss). |
| 4 | | Issue of ordinary share capital as a result of options being exercised. |
The Notes on pages 119-162 are an integral part of these accounts. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 119 |
NOTES TO THE GROUP ACCOUNTS 1 BASIS OF PREPARATION Smith & Nephew plc (the Company) is a public limited company incorporated in England and Wales. In these accounts, the ‘Group’ means the Company and all its subsidiaries. The principal activities of the Group are to develop, manufacture, market and sell medical devices and services. As required by the European Union’s IAS Regulation and the Companies Act 2006, the Group has prepared its accounts in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) effective as at 31 December 2017. The Group has also prepared its accounts in accordance with IFRS as issued by the International Accounting Standards Board (IASB) effective as at 31 December 2017. IFRSs as adopted by the EU differs in certain respects from IFRS as issued by the IASB. However, the differences have no impact for the periods presented. The preparation of accounts in conformity with IFRS requires management to use estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the year. The accounting policies requiring management to use significant estimates and assumptions are: inventories, impairment, taxation and liability provisions. These are discussed on page 114. Although these estimates are based on management’s best knowledge of current events and actions, actual results ultimately may differ from those estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to estimates are recognised prospectively. The Directors continue to adopt the going concern basis for accounting in preparing the annual financial statements. The Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Further information regarding the Group’s business activities, together with the factors likely to affect its future development, performance and position, are set out in Our Business & Marketplace on pages 8-17. As described in Note 15, the Group meets its funding requirements through a mixture of shareholders’ funds, bank borrowings and private placement notes. At 31 December 2017, the Group had committed borrowing facilities of $2.4bn and total liquidity of $1.2bn, including net cash and cash equivalents of $155m and undrawn committed borrowing facilities of $1bn. The earliest expiry date of the Group’s committed borrowing facilities is in respect of a $300m bilateral term loan facility due to expire in April 2020. In addition, Note 16 includes the Group’s objectives, policies and processes for managing its capital; our financial risk management objectives; details of our financial instruments and hedging activities; and our exposures to foreign exchange, interest rates and credit risk. The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show that the Group has sufficient financial resources. The Directors have reasonable expectation that the Company and the Group are well placed to manage their business risks and to continue in operational existence for a period of at least three years from the date of the approval of the financial statements. Accordingly, the Directors continue to adopt the going concern basis (in accordance with the guidance ‘Guidance on Risk Management, Internal Control and Related Financial and Business Reporting’ issued by the FRC) in preparing the consolidated financial statements. There have been no new accounting pronouncements impacting the Group in 2017. New accounting standards effective 2018 A number of new standards, amendments to standards and interpretations are effective for the Group’s annual periods beginning on or after 1 January 2018, and have not been applied in preparing these consolidated accounts. These include IFRS 15 Revenue from contracts with customers and IFRS 9 Financial Instruments which will be adopted from 1 January 2018. IFRS 15 The Group has undertaken a detailed impact assessment applying IFRS 15 to all the current ways in which the Group delivers products or services to customers to identify divergence with current practice and has concluded that IFRS 15 will not have a significant impact on the timing and recognition of revenue. The performance obligations involved in the sale of an orthopaedic implant are all considered to occur at the time of procedure giving rise to no difference in the timing of revenue recognition. The instrument set and implant used in an orthopaedic procedure are considered to be part of a single performance obligation. In line with past practice we will continue to measure and recognise revenue based on invoiced amounts at the time of the procedure. Revenue recognised on the sale of products in our other surgical and wound businesses have also been considered with reference to IFRS 15 with no impact identified in relation to the timing and measurement of revenue. The Group has also considered the impact on provisions for returns, trade discounts and rebates and has determined that the current policy is aligned with IFRS 15. The Group intends to apply the practical expedients in IFRS 15 to not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when the Group expects to recognise that amount as revenue for all reporting periods presented before 1 January 2018. The Group also intends to apply the practical expedients in relation to contracts with variable consideration and contracts that were completed at the beginning of the earliest period presented and/or modified before the beginning of the earliest period presented. The Group has concluded that applying these practical expedients will not have a significant impact on the timing, measurement and recognition of revenue. The Group has assessed the disclosure requirements of IFRS 15 and has preliminarily determined that the majority of the disclosures are either currently included in the financial statements or can be prepared using data currently available. The Group continues to assess the disclosure requirements in relation to unsatisfied performance obligations and the disaggregation of revenue. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 120ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued IFRS 9 The amendments to IFRS 9 mainly relate to the classification and measurement of financial instruments, and will not have a significant impact to the Group financial statements. When initially applying IFRS 9, the Group may choose as its accounting policy to continue to apply the hedge accounting requirements of IAS 39 instead of the requirements in IFRS 9. The Group will continue to apply the hedge requirements of IAS 39 on transition. The Group has considered the expected credit loss model and has determined that it will not have a significant impact on the provision for bad and doubtful debts. The Group has elected, from 1 January 2018, to present changes in the fair value of trade investments in the income statement. New accounting standards effective 2019 IFRS 16 IFRS 16 Leases will be adopted retrospectively with the cumulative effect of initially applying the standard recognised at 1 January 2019 and the Group is currently assessing the application and impact of the standard. 1.1 Consolidation The Group accounts include the accounts of Smith & Nephew plc and its subsidiaries for the periods during which they were members of the Group. Subsidiaries are entities controlled by the Group. The Group controls an entity when it is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are consolidated in the Group accounts from the date that the Group obtains control, and continue to be consolidated until the date that such control ceases. Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated on consolidation. All subsidiaries have year ends which are co-terminus with the Groups, with the exception of jurisdictions whereby a different year end is required by local legislation. When the Group loses control over a subsidiary, it derecognises the assets and liabilities of the subsidiary and any related components of equity. Any resulting gain or loss is recognised in profit or loss. Any retained interest in the former subsidiary is measured at fair value. 1.2 Foreign currencies Functional and presentation currency The Group accounts are presented in US Dollars. The Company’s functional currency is US Dollars. Foreign currency transactions Transactions in foreign currencies are translated to the respective functional currencies of Group companies at exchange rates at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are retranslated to the functional currency as at the exchange rate at the reporting date. Non-monetary items are not retranslated. Foreign operations Balance sheet items of foreign operations, including goodwill and fair value adjustments arising on acquisition are translated into US Dollars on consolidation at the exchange rates at the reporting date. Income statement items and the cash flows of foreign operations are translated at average rates as an approximation to actual transaction rates, with actual transaction rates used for large one off transactions. Foreign currency differences are recognised in ‘Other comprehensive income’ and accumulated in ‘Other reserves’ within equity. These include: exchange differences on the translation at closing rates of exchange of non-US Dollar opening net assets; the differences arising between the translation of profits into US Dollars at actual (or average, as an approximation) and closing exchange rates; to the extent that the hedging relationship is effective, the difference on translation of foreign currency borrowings or swaps that are used to finance or hedge the Group’s net investments in foreign operations; and the movement in the fair value of forward foreign exchange contracts used to hedge forecast foreign exchange cash flows. The exchange rates used for the translation of currencies into US Dollars that have the most significant impact on the Group results were: | | | | | | | | | | 2017 | | 2016 | | 2015 | | Average rates | | | | | | | | Sterling | | 1.29 | | 1.35 | | 1.53 | | Euro | | 1.13 | | 1.11 | | 1.11 | | Swiss Franc | | 1.02 | | 1.02 | | 1.04 | | Year end rates | | | | | | | | Sterling | | 1.35 | | 1.23 | | 1.48 | | Euro | | 1.20 | | 1.05 | | 1.09 | | Swiss Franc | | 1.02 | | 0.98 | | 1.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 121 |
2 BUSINESS SEGMENT INFORMATION The Group is engaged in a single business activity, being the development, manufacture and sale of medical technology products and services. Development, manufacturing, supply chain and central functions are managed globally for the Group as a whole. Sales are managed through two geographical selling regions: US and International; with a president for each who is responsible for the commercial review of that region. The Executive Committee (‘ExCo’), comprises geographical presidents and certain heads of function and is chaired by the Chief Executive Officer (‘CEO’). ExCo is the body through which the CEO uses the authority delegated to him by the Board of Directors to manage the operations and performance of the Group. All significant operating decisions regarding the allocation and prioritisation of the Group’s resources and assessment of the Group’s performance are made by ExCo, and whilst the members have individual responsibility for the implementation of decisions within their respective areas, it is at the ExCo level that these decisions are made. Accordingly, ExCo is considered to be the Group’s chief operating decision maker as defined by IFRS 8 Operating Segments. In making decisions about the prioritisation and allocation of the Group’s resources, ExCo reviews financial information on an integrated basis for the Group as a whole and determines the best allocation of resources to Group-wide projects. This information is prepared substantially on the same basis as the Group’s IFRS financial statements aside from the adjustments described in Note 2.2. In assessing performance, ExCo also considers financial information presented on a geographical selling region and product franchise basis for revenue. Financial information for corporate and functional costs is presented on a Group-wide basis. The types of products and services offered by the Group’s global business segment are as follows: | - | | Sports Medicine Joint Repair, which offers surgeons a broad array of instruments, technologies and implants necessary to perform minimally invasive surgery of the joints; |
| - | | Arthroscopic Enabling Technologies, which offers healthcare providers a variety of technologies such as fluid management equipment for surgical access, high definition cameras, digital image capture, scopes, light sources and monitors to assist with visualisation inside the joints, radio frequency, electromechanical and mechanical tissue resection devices, and hand instruments for removing damaged tissue; |
| - | | Trauma & Extremities, consisting of internal and external devices used in the stabilisation of severe fractures and deformity correction procedures; |
| - | | Other Surgical Businesses, which includes robotics-assisted surgery, various products and technologies to assist in surgical treatment of the ear, nose and throat, and gynaecological instrumentation, until the Gynaecology business disposal in August 2016; |
| - | | Knee Implants, which offers an innovative range of products for specialised knee replacement procedures; |
| - | | Hip Implants, which offers a range of specialist products for reconstruction of the hip joint; |
| - | | Advanced Wound Care, which includes products for the treatment and prevention of acute and chronic wounds, including leg, diabetic and pressure ulcers, burns and post-operative wounds; |
| - | | Advanced Wound Bioactives, which includes biologics and other bioactive technologies that provide unique approaches to debridement and dermal repair/regeneration; and |
| - | | Advanced Wound Devices, which consists of traditional and single-use Negative Pressure Wound Therapy and hydrosurgery systems. |
The segment information is prepared in conformity with the accounting policies of the Group and the accounting standard IFRS 8 Operating Segments. The segment profit measure reported to the Chief Executive Officer and the ExCo for the purposes of resource allocation and assessment is trading profit and excludes the effects of non-recurring, infrequent, non-cash and other items that management does not otherwise believe are indicative of the underlying performance of the consolidated Group as discussed in Note 2.2. Group financing (including interest receivable and payable) is managed on a net basis outside the business segment. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 122ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 2.1 Revenue by business segment and geography Accounting policy Revenue comprises sales of products and services to third parties at amounts invoiced net of trade discounts and rebates, excluding taxes on revenue. Revenue from the sale of products is recognised upon transfer to the customer of the significant risks and rewards of ownership. This is generally when goods are delivered to customers. There is no significant revenue associated with the provision of discrete services. In Established Markets we typically sell direct to healthcare institutions while in our Emerging Markets we typically sell to distributors and intermediaries. In general our surgical business is more direct to hospitals and ambulatory service centres whereas in our wound business, and in particular products used in community and homecare facilities, it is through wholesalers. Sales of inventory located at customer premises and is available for customers’ immediate use. Complete setsuse are recognised when notification is received that the product has been implanted or used. Appropriate provisions for returns, trade discounts and rebates are deducted from revenue. Rebates comprise retrospective volume discounts granted to certain customers on attainment of products, including largecertain levels of purchases from the Group. These are accrued over the course of the arrangement based on estimates of the level of business expected and small sizes, have to be made available in this way. These sizes are used less frequently than standard sizes and towardsadjusted at the end of the arrangement to reflect actual volumes. |
Segment revenue reconciles to statutory revenues from continuing operations as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Reportable segment revenue | | | | | | | | Revenue from external customers | | 4,765 | | 4,669 | | 4,634 | |
In presenting information on the basis of geographical segments, segment revenue is based on location of Smith & Nephew businesses: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Geographical segment revenue | | | | | | | | United Kingdom | | 244 | | 266 | | 301 | | United States of America | | 2,332 | | 2,299 | | 2,217 | | Other1 | | 2,189 | | 2,104 | | 2,116 | | Consolidated revenue from continuing operations | | 4,765 | | 4,669 | | 4,634 | |
| 1 | | No other country represents more than 6% of consolidated sales revenue from continuing operations. |
The table below shows revenue by product type from continuing operations. Included within the 2015 analysis is a reclassification of $58m of product sales formerly included in the Sports Medicine Joint Repair franchise which has now been included in the Arthroscopic Enabling Technologies franchise in order to present analysis in line with 2017 management reporting on a consistent basis. | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Revenue by product from continuing operations | | | | | | | | Knee Implants | | 984 | | 932 | | 883 | | Hip Implants | | 599 | | 597 | | 604 | | Trauma & Extremities | | 495 | | 475 | | 497 | | Sports Medicine Joint Repair | | 627 | | 587 | | 548 | | Arthroscopic Enabling Technologies | | 615 | | 631 | | 631 | | Other Surgical Businesses | | 189 | | 214 | | 205 | | Advanced Wound Care | | 720 | | 719 | | 755 | | Advanced Wound Bioactives | | 342 | | 342 | | 344 | | Advanced Wound Devices | | 194 | | 172 | | 167 | | Consolidated revenue from continuing operations | | 4,765 | | 4,669 | | 4,634 | |
Major customers No single customer generates revenue greater than 10% of the consolidated revenue. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 123 |
2.2 Trading and operating profit by business segment Trading profit is a trend measure which presents the long-term profitability of the Group excluding the impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. The Group has identified the following items, where material, as those to be excluded from operating profit when arriving at trading profit: acquisition and disposal-related items; amortisation and impairment of acquisition intangibles; significant restructuring programmes; gains and losses arising from legal disputes; and other significant items. Further detail is provided in Notes 2.3, 2.4 and 2.5. Operating profit reconciles to trading profit as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Operating profit of the business segment | | 934 | | 801 | | 628 | | Acquisition-related costs | | (10) | | 9 | | 12 | | Restructuring and rationalisation expenses | | – | | 62 | | 65 | | Amortisation and impairment of acquisition intangibles | | 140 | | 178 | | 204 | | Legal and other | | (16) | | (30) | | 190 | | Trading profit of the business segment | | 1,048 | | 1,020 | | 1,099 | |
2.3 Acquisition-related costs Acquisition-related costs credit of $10m (2016: $9m charge, 2015: $12m charge) relates to a remeasurement of contingent consideration for a prior year acquisition partially offset by costs associated with the acquisition of Rotation Medical, Inc. 2.4 Restructuring and rationalisation expenses No restructuring and rationalisation costs were incurred in 2017 (2016: $62m, 2015: $65m). In 2016 and 2015, these costs primarily related to the ongoing implementation of the Group Optimisation Plan which was completed in 2016. 2.5 Legal and other The legal and other credit within operating profit of $16m (2016: $30m credit, 2015: $190m charge) primarily related to a $54m credit recognised following a settlement payment received from Arthrex relating to patent litigation, partially offset by legal expenses for patent litigation with Arthrex and ongoing metal-on-metal hip claims. In 2017 there was a $10m increase in the provision that reflects the present value of the estimated costs to reduce all other known and anticipated metal-on-metal hip claims. 2.6 Assets and liabilities by business segment and geography | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Reconciliation of assets of the business segment to the consolidated group | | | | | | | | Assets of the business segment | | 7,508 | | 7,147 | | 6,929 | | Unallocated corporate assets: | | | | | | | | – Deferred tax assets | | 127 | | 97 | | 105 | | – Retirement benefit assets | | 62 | | – | | 13 | | – Cash at bank | | 169 | | 100 | | 120 | | Total assets of the consolidated group | | 7,866 | | 7,344 | | 7,167 | |
In presenting information on the basis of geographical segments, non-current segment assets are based on their location: | | | | | | | | Geographic segment assets | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | United Kingdom | | 364 | | 335 | | 366 | | United States of America | | 3,295 | | 3,145 | | 2,982 | | Other | | 1,287 | | 1,238 | | 1,226 | | Total non-current assets of the consolidated group1 | | 4,946 | | 4,718 | | 4,574 | |
| 1 | | Non-current assets excludes retirement benefit assets and deferred tax assets. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 124ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Reconciliation of liabilities of the business segment to the consolidated group | | | | | | | | Liabilities of the business segment | | 1,311 | | 1,247 | | 1,197 | | Unallocated corporate liabilities: | | | | | | | | – Long-term borrowings | | 1,423 | | 1,564 | | 1,434 | | – Retirement benefit obligations | | 131 | | 164 | | 184 | | – Deferred tax liabilities | | 97 | | 94 | | 77 | | – Bank overdrafts and loans - current | | 27 | | 86 | | 46 | | – Current tax payable | | 233 | | 231 | | 263 | | Total liabilities of the consolidated group | | 3,222 | | 3,386 | | 3,201 | | | | | | | | | | Depreciation, amortisation and impairment of the business segment | | | | | | | | Depreciation of property, plant and equipment | | 243 | | 224 | | 226 | | Amortisation of acquisition intangibles | | 130 | | 130 | | 153 | | Amortisation of other intangible assets | | 62 | | 61 | | 66 | | Total depreciation and amortisation | | 435 | | 415 | | 445 | | Impairment losses on acquisition intangibles1 | | 10 | | 48 | | 51 | | Impairment loss/(reversal) on trade investments1 | | 2 | | – | | (3) | | Total depreciation, amortisation and impairment | | 447 | | 463 | | 493 | |
| 1 | | Impairments recognised in operating profit, within the administrative expenses line. |
Segment acquisition of property, plant and equipment and intangibles reconciles to that of the consolidated group, and comprises the following: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Additions to property, plant and equipment | | 308 | | 320 | | 303 | | Additions to intangibles | | 68 | | 72 | | 55 | | Capital expenditure (excluding business combinations) | | 376 | | 392 | | 358 | | Trade investments | | 8 | | 2 | | 2 | | Acquisitions – Goodwill | | 132 | | 211 | | 34 | | Acquisitions – Intangible assets | | 61 | | 85 | | 19 | | Acquisitions – Property, plant and equipment | | 1 | | 2 | | 6 | | Capital and acquisition expenditure | | 578 | | 692 | | 419 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 125 |
3 OPERATING PROFIT Accounting policies Research and development Research expenditure is expensed as incurred. Internal development expenditure is only capitalised if the recognition criteria in IAS 38 Intangible Assets have been satisfied. The Group considers that the regulatory, technical and market uncertainties inherent in the development of new products mean that in most cases development costs should not be capitalised as intangible assets until products receive approval from the appropriate regulatory body. Payments to third parties for research and development projects are accounted for based on the substance of the arrangement. If the arrangement represents outsourced research and development activities the payments are generally expensed except in limited circumstances where the respective development expenditure would be capitalised under the principles established in IAS 38. By contrast, the payments are capitalised if the arrangement represents consideration for the acquisition of intellectual property developed at the risk of the third party. Capitalised development expenditures are amortised on a straight-line basis over their useful economic lives from product life cyclelaunch. Advertising costs Advertising costs are inevitablyexpensed as incurred. |
| | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Revenue | | 4,765 | | 4,669 | | 4,634 | | Cost of goods sold | | (1,248) | | (1,272) | | (1,143) | | Gross profit | | 3,517 | | 3,397 | | 3,491 | | Research and development expenses | | (223) | | (230) | | (222) | | Selling, general and administrative expenses: | | | | | | | | Marketing, selling and distribution expenses | | (1,781) | | (1,712) | | (1,735) | | Administrative expenses1,2,3,4 | | (579) | | (654) | | (906) | | | | (2,360) | | (2,366) | | (2,641) | | Operating profit | | 934 | | 801 | | 628 | |
| 1 | | 2017 includes $62m of amortisation of software and other intangible assets (2016: $61m, 2015: $66m). |
| 2 | | 2017 includes $140m of amortisation and impairment of acquisition intangibles (2016: $62m of restructuring and rationalisation expenses and $178m of amortisation and impairment of acquisition intangibles, 2015: $65m of restructuring and rationalisation expenses and $204m of amortisation and impairment of acquisition intangibles). |
| 3 | | 2017 includes $16m credit relating to legal and other items (2016: $30m credit, 2015: $190m charge). |
| 4 | | 2017 includes $10m credit of acquisition-related costs (2016: $9m charge, 2015: $12m charge). |
Note that items detailed in 2, 3, 4 are excluded from the calculation of trading profit, the segment profit measure. Operating profit is stated after charging/(crediting) the following items: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Other operating income | | (66) | | (25) | | (41) | | Amortisation of intangibles | | 192 | | 191 | | 219 | | Impairment of intangible assets | | 10 | | 48 | | 51 | | Depreciation of property, plant and equipment | | 243 | | 224 | | 226 | | Loss on disposal of property, plant and equipment and intangible assets | | 13 | | 15 | | 15 | | Operating lease payments for land and buildings | | 36 | | 39 | | 37 | | Operating lease payments for other assets | | 21 | | 19 | | 20 | | Advertising costs | | 102 | | 88 | | 91 | |
In 2017 other operating income primarily relates to a gain relating to patent litigation (2016: insurance recovery relating to metal-on-metal claims, 2015: net gain relating to patent litigation). | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 126ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 3 OPERATING PROFIT continued 3.1 Staff costs and employee numbers Staff costs during the year amounted to: | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Wages and salaries | | | | 1,157 | | 1,227 | | 1,193 | | Social security costs | | | | 178 | | 129 | | 135 | | Pension costs (including retirement healthcare)1 | | 18 | | 64 | | 23 | | 58 | | Share-based payments | | 23 | | 31 | | 27 | | 30 | | | | | | 1,430 | | 1,406 | | 1,416 | |
1 In 2016, pension costs include the past service cost credit of $49m arising primarily from the closure of the UK defined benefit scheme to future accrual. During the year ended 31 December 2017, the average number of employees was 16,333 (2016: 15,584, 2015: 14,686). 3.2 Audit Fees – information about the nature and cost of services provided by the auditor | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Audit services: | | | | | | | | Group accounts | | 2.4 | | 2.0 | | 2.1 | | Local statutory audit pursuant to legislation | | 2.0 | | 2.0 | | 2.0 | | Other services: | | | | | | | | Non-audit services | | 0.1 | | 0.5 | | 0.5 | | Taxation services: | | | | | | | | Compliance services | | – | | 0.1 | | 0.5 | | Advisory services | | – | | – | | – | | Total auditor’s remuneration | | 4.5 | | 4.6 | | 5.1 | | Arising: | | | | | | | | In the UK | | 2.5 | | 2.5 | | 2.5 | | Outside the UK | | 2.0 | | 2.1 | | 2.6 | | | | 4.5 | | 4.6 | | 5.1 | |
4 INTEREST AND OTHER FINANCE COSTS 4.1 Interest income/(expense) | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Interest income | | 6 | | 6 | | 11 | | Interest expense: | | | | | | | | Bank borrowings | | (11) | | (9) | | (9) | | Private placement notes | | (38) | | (37) | | (37) | | Other | | (8) | | (6) | | (3) | | | | (57) | | (52) | | (49) | | Net interest expense | | (51) | | (46) | | (38) | |
4.2 Other finance costs | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Retirement benefit net interest expense | | 18 | | (5) | | (7) | | (11) | | Unwinding of discount | | | | (5) | | (9) | | (3) | | Other | | | | – | | – | | (1) | | Other finance costs | | | | (10) | | (16) | | (15) | |
Foreign exchange gains or losses arose primarily on the translation of intercompany and third party borrowings and amounted to a net $25m loss in 2017 (2016: net $22m gain, 2015: net $11m gain). These amounts were matched by the fair value gains or losses on currency swaps held to manage this currency risk. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 127 |
5 TAXATION Accounting policy The charge for current taxation is based on the results for the year as adjusted for items which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. The Group operates in excessnumerous tax jurisdictions around the world and it is Group policy to submit its tax returns to the relevant tax authorities as promptly as possible. At any given time, the Group is involved in disputes and tax audits and will have a number of requirements. Adjustmentstax returns potentially subject to audit. Significant issues may take several years to resolve. In estimating the probability and amount of any tax charge, management takes into account the views of internal and external advisers and updates the amount of tax provision whenever necessary. The ultimate tax liability may differ from the amount provided depending on interpretations of tax law, settlement negotiations or changes in legislation. Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is not recognised for: temporary differences related to investments in subsidiaries and associates where the Group is able to control the timing of the reversal of the temporary difference and it is probable that this will not reverse in the foreseeable future; on the initial recognition of non-deductible goodwill; and on the initial recognition of an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, does not affect the accounting or taxable profit. Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which they can be used. Deferred tax assets are reviewed at each reporting date. Deferred tax is measured on an undiscounted basis, and at the tax rates that have been enacted or substantively enacted by the reporting date that are expected to apply in the periods in which the asset or liability is settled. It is recognised in the income statement except when it relates to items credited or charged directly to other comprehensive income or equity, in which case the deferred tax is also recognised within other comprehensive income or equity respectively. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority, when the Group intends to settle its current tax assets and liabilities on a net basis and that authority permits the Group to make a single net payment. |
5.1 Taxation charge attributable to the Group | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Current taxation: | | | | | | | | UK corporation tax | | 23 | | 23 | | 31 | | Overseas tax | | 177 | | 261 | | 219 | | Current income tax charge | | 200 | | 284 | | 250 | | Adjustments in respect of prior periods | | (60) | | (53) | | (56) | | Total current taxation | | 140 | | 231 | | 194 | | Deferred taxation: | | | | | | | | Origination and reversal of temporary differences | | 32 | | 24 | | (73) | | Changes in tax rates | | (49) | | – | | (3) | | Adjustments to estimated amounts arising in prior periods | | (11) | | 23 | | 31 | | Total deferred taxation | | (28) | | 47 | | (45) | | Total taxation as per the income statement | | 112 | | 278 | | 149 | | Taxation in other comprehensive income | | 9 | | (10) | | (10) | | Taxation in equity | | 3 | | (2) | | (5) | | Taxation attributable to the Group | | 124 | | 266 | | 134 | |
The 2017 and 2016 net prior period adjustment benefits of $71m and $30m respectively mainly relate to provision releases following agreement reached with the IRS on US tax matters after the conclusion of US tax audits in 2017 and 2016, provision releases on the expiry of statute of limitations and tax accrual to tax return adjustments, partially offset by an increase in certain other tax provisions. The 2015 net prior period adjustment benefit of $25m mainly relates to provision releases after settlement with tax authorities or the expiry of statute of limitations and tax accrual to tax return adjustments. Included in the total tax charge is a $32m net benefit as a result of the new US tax reform legislation enacted in December 2017, which comprises a benefit from a revaluation of deferred tax balances included within changes in tax rates, partially offset by a current tax charge relating to the deemed repatriation of foreign profits not previously taxed in the US. Total taxation as per the income statement of $112m includes a $58m net credit (2016: $48m net charge, 2015: $130m net credit) as a consequence of the net benefit from US tax reform, acquisitions and disposals, amortisation and impairment of acquisition intangibles and legal and other. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 128ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued Factors affecting future tax charges The Group operates in numerous tax jurisdictions around the world and is subject to factors that may affect future tax charges including the recently enacted US tax reform, the review by the European Commission into whether the UK CFC financing exemption rules constitute illegal State Aid, implementation of the OECD’s BEPS actions, tax rate changes, tax legislation changes, expiry of the statute of limitations and resolution of tax audits and disputes. At any given time the Group has unagreed years outstanding in various countries and is involved in tax audits and disputes, some of which may take several years to resolve. Current tax payable of $233m includes $201m of provisions for uncertain tax positions in respect of various countries. The Group believes that it has made adequate provision in respect of additional tax liabilities that may arise from these unagreed years, tax audits and disputes, the majority of which relate to transfer pricing matters as would be expected for a Group operating internationally. However, the actual liability for any particular issue may be higher or lower than the amount provided resulting in a negative or positive effect on the tax charge in any given year, including a reduction in the tax charge because of an expiry of the relevant statute of limitations. Whilst the impact can vary from year to year, the negative or positive effect on the tax charge for 2018 is not expected to result in a net prior period adjustment for 2018 which is greater than that realised in 2017. The Group has completed its review of the new US tax reform legislation, as enacted, including the reduction of the US federal tax rate from 35% to 21%, which came into effect on 1 January 2018. As a result, the Group expects a positive impact on its tax charge for future years in addition to the one-off net tax benefit of $32m in 2017. However, it should be noted that parts of the new legislation are subject to questions of interpretation, and further regulations may be issued in the future to clarify or change certain elements, which may affect future tax charges. In December 2016, the Group appealed to the First Tier Tribunal in the UK against a decision by HM Revenue and Customs (HMRC) relating to the tax deductibility of certain historical foreign exchange losses. The decision of the Tribunal was released on 8 February 2017 and it upheld the Group’s appeal. HMRC appealed against this decision and their appeal will be heard by the Upper Tribunal in June 2018. No tax benefit has been recognised to date in respect of these foreign exchange losses. In the event that the Group is ultimately successful in the Courts, then the Group’s tax charge would be reduced, in the year of success, as a result. In 2016, the UK Government enacted legislation to reduce the main rate of UK statutory corporation tax to 19.0% from 1 April 2017 and 17.0% from 1 April 2020. The UK standard rate of corporation tax for 2017 is 19.3% (2016: 20.0%, 2015: 20.3%). Overseas taxation is calculated at the rates prevailing in the respective jurisdictions. The table below reconciles the expected tax charge at the UK statutory rate with the actual tax charge: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Profit before taxation | | 879 | | 1,062 | | 559 | | Expected taxation at UK statutory rate of 19.3% (2016: 20.0%, 2015: 20.3%) | | 169 | | 212 | | 113 | | Differences in overseas taxation rates1 | | 48 | | 34 | | 52 | | Disposal of the Gynaecology business (mainly at the US tax rate) | | – | | 56 | | – | | Benefit of US Manufacturing deduction | | (9) | | (7) | | (7) | | R&D credits | | (3) | | (3) | | (6) | | Tax losses not recognised | | 10 | | 1 | | 11 | | Utilisation of previously unrecognised tax losses | | (6) | | (9) | | – | | Impact of US tax reform | | (32) | | – | | – | | Expenses not deductible for tax purposes | | 11 | | 23 | | 14 | | Changes in tax rates | | (5) | | 1 | | (3) | | Adjustments in respect of prior years2 | | (71) | | (30) | | (25) | | Total taxation as per the income statement | | 112 | | 278 | | 149 | |
| 1 | | Mainly relates to profits taxed in the US at a rate higher than the UK statutory rate and includes the impact of intra-group loans provided to finance US acquisitions and business operations. |
| 2 | | The adjustments in respect of prior years are explained on the previous page. |
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5.2 Deferred taxation Movements in the main components of deferred tax assets and liabilities were as follows: | | | | | | | | | | | | | | | | | | | | | | | | Inventory, | | | | | | Accelerated | | | | Retirement | | | | provisions, | | | | | | tax | | | | benefit | | | | losses and other | | | | | | depreciation | | Intangibles | | obligation | | Macrotexture | | differences | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 31 December 2015 | | (62) | | (223) | | 39 | | 52 | | 222 | | 28 | | Exchange adjustment | | – | | 2 | | – | | – | | (3) | | (1) | | Movement in income statement – current year | | – | | 34 | | (16) | | – | | (42) | | (24) | | Movement in income statement – prior years | | (11) | | 6 | | (2) | | – | | (16) | | (23) | | Movement in other comprehensive income | | – | | – | | 7 | | – | | (1) | | 6 | | Movement in equity | | – | | – | | – | | – | | 2 | | 2 | | Changes in tax rate | | – | | 1 | | – | | – | | (1) | | – | | Acquisitions | | – | | (29) | | – | | – | | 44 | | 15 | | At 31 December 2016 | | (73) | | (209) | | 28 | | 52 | | 205 | | 3 | | Exchange adjustment | | 1 | | (2) | | 2 | | – | | 13 | | 14 | | Movement in income statement – current year | | (9) | | 15 | | (6) | | (1) | | (31) | | (32) | | Movement in income statement – prior years | | 2 | | 4 | | – | | – | | 5 | | 11 | | Movement in other comprehensive income | | – | | – | | (17) | | – | | 4 | | (13) | | Movement in equity | | – | | – | | – | | – | | (3) | | (3) | | Changes in tax rate | | 29 | | 71 | | – | | (18) | | (33) | | 49 | | Acquisitions | | – | | (22) | | – | | – | | 23 | | 1 | | At 31 December 2017 | | (50) | | (143) | | 7 | | 33 | | 183 | | 30 | |
Represented by: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Deferred tax assets | | 127 | | 97 | | Deferred tax liabilities | | (97) | | (94) | | Net position at 31 December | | 30 | | 3 | |
The Group has gross unused trading and non-trading tax losses of $271m (2016: $230m) and gross unused capital losses of $113m (2016: $122m) available for offset against future profits of which $32m of trading losses will expire within 3-8 years from the balance sheet date if not utilised. A deferred tax asset of $38m (2016: $45m) has been recognised in respect of $132m (2016: $109m) of the trading and non-trading tax losses. No deferred tax asset has been recognised on the remaining unused tax losses as they are not expected to be realised in the foreseeable future. There are no temporary differences in respect of investments in subsidiaries and associates for which deferred tax liabilities have not been recognised (2016: temporary differences of approximately $483m). | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 130ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 6 EARNINGS PER ORDINARY SHARE Accounting policies Earnings per share Basic earnings per share is calculated by dividing the profit attributable to equity holders by the weighted average number of ordinary shares in issue during the year, excluding shares held by the Company in the Employees’ Share Trust or as treasury shares. Diluted earnings per share Diluted earnings per share is calculated by adjusting the basic earnings per share for the effect of conversion to ordinary shares associated with dilutive potential ordinary shares, which comprise share options and awards granted to employees. Adjusted earnings per share Adjusted earnings per share is a trend measure, which presents the long-term profitability of the Group excluding the impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure. The Group has identified the following items as those to be excluded when arriving at adjusted attributable profit: acquisitions and disposals related items including amortisation and impairment of acquisition intangible assets; significant restructuring programmes; significant gains and losses arising from legal disputes and other significant items (including US tax reform) and taxation thereon. |
The calculations of the basic, diluted and adjusted earnings per ordinary share are based on the following attributable profit and numbers of shares: | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | | | $ million | | $ million | | $ million | | Earnings | | | | | | | | | | Attributable profit for the year | | | | 767 | | 784 | | 410 | | Adjusted attributable profit (see below) | | | | 826 | | 735 | | 761 | |
Attributable profit is reconciled to adjusted attributable profit as follows: | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | Notes | | $ million | | $ million | | $ million | | Attributable profit for the year | | | | 767 | | 784 | | 410 | | Acquisition-related costs | | | | (10) | | 9 | | 25 | | Restructuring and rationalisation expenses | | 3 | | – | | 62 | | 65 | | Amortisation and impairment of acquisition intangibles | | 9 | | 140 | | 178 | | 204 | | Legal and other1 | | | | (13) | | (20) | | 187 | | Profit on disposal of business | | 21 | | – | | (326) | | – | | US tax reform | | 5 | | (32) | | – | | – | | Taxation on excluded items | | 5 | | (26) | | 48 | | (130) | | Adjusted attributable profit | | | | 826 | | 735 | | 761 | |
| 1 | | Legal and other credit in 2017 includes $16m within operating profits (refer to Note 2.5), and a $3m charge within other finance costs for unwinding of the discount on the provision for known, anticipated and settled metal-on-metal hip claims. In 2016 the legal and other credit includes $30m within operating profits (refer to Note 2.5), a $5m charge within other finance costs for unwinding of the discount on the provision for known, anticipated and settled metal-on-metal hip claims, and a $5m charge within share of results of associates for expenses incurred by Bioventus for an aborted initial public offering of shares. In 2015, legal and other costs include $190m within operating profit (refer to Note 2.5) and a $3m net interest credit. |
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The numerators used for basic and diluted earnings per ordinary share are the same. The denominators used for all categories of earnings for basic and diluted earnings per ordinary share are as follows: | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | Number of shares (millions) | | | | | | | | | | Basic weighted number of shares | | | | 874 | | 890 | | 894 | | Dilutive impact of share options outstanding | | | | 1 | | 3 | | 5 | | Diluted weighted average number of shares | | | | 875 | | 893 | | 899 | | Earnings per ordinary share | | | | | | | | | | Basic | | | | 87.8¢ | | 88.1¢ | | 45.9¢ | | Diluted | | | | 87.7¢ | | 87.8¢ | | 45.6¢ | | Adjusted2 | | | | 94.5¢ | | 82.6¢ | | 85.1¢ | |
| 2 | | Adjusted earnings per share is calculated using the basic weighted number of shares. |
7 PROPERTY, PLANT AND EQUIPMENT Accounting policies Property, plant and equipment Items of property, plant and equipment are stated at cost less accumulated depreciation and any accumulated impairment losses. Depreciation is calculated to write off the cost of items of property, plant and equipment less their estimated residual values using the straight-line method over their estimated useful lives, and is ultimately recognised in profit or loss. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Group will obtain ownership by the end of the lease term. Freehold land is not depreciated. The estimated useful lives of items of property, plant and equipment is 3–20 years and for buildings is 20–50 years. Assets in course of construction are not depreciated until they are available for use. Depreciation methods, useful lives and residual values are reviewed at each reporting date and adjusted if appropriate. Finance costs relating to the purchase or construction of property, plant and equipment and intangible assets that take longer than one year to complete are capitalised based on the Group weighted average borrowing costs. All other finance costs are expensed as incurred. Impairment of assets The carrying values of property, plant and equipment are reviewed for impairment when events or changes in circumstances indicate the carrying value may be impaired. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss. Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which it belongs. An asset’s recoverable amount is the higher of an asset’s or cash-generating unit’s fair value less costs to sell and its value-in-use. In assessing value-in-use, its estimated future cash flow is discounted to its present value using a pre-tax discount rate that reflects the current market assessment of the time value of money and the risks specific to the asset. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 132ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued | | | | | | | | | | | | | | | | | | | | Land and buildings | | Plant and equipment | | Assets in | | | | | | | | | | | | | | | | course of | | | | | | | | Freehold | | Leasehold | | Instruments | | Other | | construction | | Total | | | | Notes | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Cost | | | | | | | | | | | | | | | | At 1 January 2016 | | | | 154 | | 58 | | 1,042 | | 1,003 | | 156 | | 2,413 | | Exchange adjustment | | | | (6) | | – | | (22) | | (46) | | (5) | | (79) | | Acquisitions | | 21 | | – | | – | | 2 | | – | | – | | 2 | | Additions | | | | 1 | | 1 | | 166 | | 72 | | 80 | | 320 | | Disposals | | 21 | | – | | – | | (76) | | (39) | | (3) | | (118) | | Transfers | | | | 16 | | 60 | | 4 | | 33 | | (113) | | – | | At 31 December 2016 | | | | 165 | | 119 | | 1,116 | | 1,023 | | 115 | | 2,538 | | Exchange adjustment | | | | 6 | | 1 | | 63 | | 33 | | 3 | | 106 | | Acquisitions | | 21 | | – | | – | | – | | 1 | | – | | 1 | | Additions | | | | 1 | | – | | 176 | | 28 | | 103 | | 308 | | Disposals | | | | – | | (27) | | (73) | | (79) | | (12) | | (191) | | Transfers | | | | 56 | | (20) | | 2 | | 56 | | (115) | | (21) | | At 31 December 2017 | | | | 228 | | 73 | | 1,284 | | 1,062 | | 94 | | 2,741 | | Depreciation and impairment | | | | | | | | | | | | | | | | At 1 January 2016 | | | | 48 | | 35 | | 732 | | 655 | | 11 | | 1,481 | | Exchange adjustment | | | | (3) | | – | | (15) | | (34) | | – | | (52) | | Charge for the year | | | | 5 | | 7 | | 131 | | 81 | | – | | 224 | | Disposals | | | | – | | – | | (67) | | (30) | | – | | (97) | | At 31 December 2016 | | | | 50 | | 42 | | 781 | | 672 | | 11 | | 1,556 | | Exchange adjustment | | | | 3 | | – | | 45 | | 24 | | – | | 72 | | Charge for the year | | | | 6 | | 7 | | 146 | | 84 | | – | | 243 | | Disposals | | | | – | | (22) | | (67) | | (74) | | (11) | | (174) | | Transfers | | | | 2 | | 3 | | (1) | | (9) | | – | | (5) | | At 31 December 2017 | | | | 61 | | 30 | | 904 | | 697 | | – | | 1,692 | | Net book amounts | | | | | | | | | | | | | | | | At 31 December 2017 | | | | 167 | | 43 | | 380 | | 365 | | 94 | | 1,049 | | At 31 December 2016 | | | | 115 | | 77 | | 335 | | 351 | | 104 | | 982 | |
Land and buildings includes land with a cost of $21m (2016: $19m) that is not subject to depreciation. There were no assets held under finance leases at 31 December 2017 (2016: assets held under finance leases with a net book value of $5m were included within land and buildings). Transfers from assets in course of construction includes $4m (2016: $nil) of software and $12m (2016: $nil) net book value of other non-current assets. Group capital expenditure relating to property, plant and equipment contracted but not provided for amounted to $26m (2016: $55m). The amount of borrowing costs capitalised in 2017 and 2016 was minimal. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 133 |
8 GOODWILL Accounting policy Goodwill is not amortised but is reviewed for impairment annually. Goodwill is allocated to the cash-generating unit (CGU) that is expected to benefit from the acquisition. The goodwill is tested annually for impairment by comparing the recoverable amount to the carrying value of the CGUs. The CGUs identified by management are therefore required to be made to orthopaedic inventory to anticipate this situation. These adjustments are calculated in accordance with a formula based onat the aggregated product franchise levels of inventory compared with historical usage. This formulaOrthopaedics, Other Surgical Devices and Advanced Wound Management, in the way the core assets are used to generate cash flows. If the recoverable amount of the CGU is applied onless than its carrying amount then an individual product line basisimpairment loss is determined to have occurred. Any impairment losses that arise are recognised immediately in the income statement and isare allocated first applied when a product group has been onto reduce the market for two years. This methodcarrying amount of calculation is considered appropriate based on experience, but it does involve management judgements on customer demand, effectivenessgoodwill and then to the carrying amounts of inventory deployment, lengththe other assets of product lives, phase-out of old products and efficiency of manufacturing planning systems. Impairmentthe CGU.
In carrying out impairment reviews of goodwill intangible assets and property, plant and equipment, a number of significant assumptions have to be made when preparing cash flow projections. These include the future rate of market growth, discount rates, the market demand for the products acquired, the future profitability of acquired businesses or products, levels of reimbursement and success in obtaining regulatory approvals. If actual results should differ, or changes in expectations arise, impairment charges may be required which would adversely impact operating results. |
| | | | | | | | | | | | 2017 | | 2016 | | | | Notes | | $ million | | $ million | | Cost | | | | | | | | At 1 January | | | | 2,188 | | 2,012 | | Exchange adjustment | | | | 51 | | (35) | | Acquisitions | | 21 | | 132 | | 211 | | At 31 December | | | | 2,371 | | 2,188 | | Impairment | | | | | | | | At 1 January and 31 December | | | | – | | – | | Net book amounts | | | | 2,371 | | 2,188 | |
Management has identified four CGUs in applying the provisions of IAS 36 Impairment of Assets: Orthopaedics (Reconstruction and Trauma), Other Surgical Devices, Advanced Wound Care & Devices and Bioactives. For the purpose of goodwill impairment testing, the Advanced Wound Care & Devices and Bioactives CGUs have been aggregated (Advanced Wound Management), as this is the level at which goodwill is monitored and level at which the economic benefits relating to the goodwill within these CGUs is realised. Goodwill is allocated to the Group’s CGUs as follows: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Orthopaedics | | 566 | | 551 | | Other Surgical Devices | | 1,501 | | 1,351 | | Advanced Wound Management | | 304 | | 286 | | | | 2,371 | | 2,188 | |
Impairment reviews were performed in September 2017 and September 2016 by comparing the recoverable amount of each CGU with its carrying amount, including goodwill. These were updated during December, taking into account any significant events that occurred between September and December. For each CGU, the recoverable amounts are based on value-in-use which is calculated from pre-tax cash flow projections for five years using data from the Group’s budget and strategic planning process, the results of which are reviewed and approved by the Board. These projections exclude any estimated future cash inflows or outflows expected to arise from future restructurings. The five-year period is in line with the Group’s strategic planning process. In determining the growth rates used in the calculations of the value-in-use, management considered annual revenue growth. Projections are based on anticipated volume and value growth in the markets served by the Group and assumptions as to market share movements. Each year the projections for the previous year are compared to actual results and variances are factored into the assumptions used in the current year. The discount rates used in the value-in-use calculations reflect management’s assessment of risks specific to the assets of each CGU. 8.1 Orthopaedics CGU The sales growth and trading profit margin used in the value-in-use calculation for the Orthopaedics CGU, which includes the Reconstruction and Trauma businesses, reflects management’s distinctive orthopaedic reconstruction strategy, which combines cutting edge innovation, disruptive business models and a strong Emerging Markets platform to drive outperformance. Revenue growth rates for the five-year period ranged from 1.0% to 10.6% for the various components of the Orthopaedics CGU. The average growth rate used to extrapolate the cash flows beyond the five-year period in calculating the terminal value is 2.0%. The pre-tax discount rate used in the Orthopaedics CGU value-in-use calculation reflects the geographical mix and is 10.0%. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 134ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 8.2 Other Surgical Devices CGU The value-in-use calculation for the Other Surgical Devices CGU reflects growth rates and trading profit margins consistent with management’s strategy to rebalance Smith & Nephew towards higher growth areas such as, for example, Sports Medicine. Revenue growth rates for the five-year period ranged from 1.0% to 9.0% for the various components of the Other Surgical Devices CGU. The weighted average growth rate used to extrapolate the cash flows beyond the five-year period in calculating the terminal value is 2.0%. The pre-tax discount rate used in the Other Surgical Devices CGU value-in-use calculation reflects the geographical mix of the revenues and is 10.0%. 8.3 Advanced Wound Management CGU The aggregated Advanced Wound Management CGU comprises the Advanced Wound Care & Devices and Bioactives CGUs. In performing the value-in-use calculation for this combined CGU, management considered the Group’s focus across the wound product franchises, focusing on widening access to the customer, the higher added value sectors of healing chronic wounds and tissue repair using bioactives, and by continuing to improve efficiency. Revenue growth rates for the five-year period ranged from 2.0% to 17.3% for the various components of the Advanced Wound Management CGU. The weighted average growth rate used to extrapolate the cash flows beyond the five-year period in calculating the terminal value is 2.0%. The pre-tax discount rate used in the Advanced Wound Management CGU value-in-use calculation reflects the geographical mix and industry sector and is 10.0%. 8.4 Sensitivity to changes in assumptions used in value-in-use calculations The calculations of value-in-use for the identified CGUs are most sensitive to changes in discount and growth rates. Management’s consideration of these sensitivities is set out below: | - | | Growth of market and market share – management has considered the impact of a variance in market growth and market share. The value-in-use calculations shows that if the assumed long-term growth rates were reduced to nil, the recoverable amount of each CGU would still be greater than its carrying value. |
Liability provisioning
| - | | Discount rate – management has considered the impact of an increase in the discount rate applied to the value-in-use calculations. This sensitivity analysis shows that for the recoverable amount of each CGU to be less than its carrying value, the discount rate would have to be increased to 29.5% for the Orthopaedics CGU, 16.6% for the Other Surgical Devices CGU and 26.3% for the Advanced Wound Management CGU. |
9 INTANGIBLE ASSETS Accounting policies Intangible assets Intangible assets acquired separately from a business combination (including purchased patents, know-how, trademarks, licences and distribution rights) are initially measured at cost. The cost of intangible assets acquired in a material business combination (referred to as acquisition intangibles) is the fair value as at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. All intangible assets are amortised on a straight-line basis over their estimated useful economic lives. The estimated useful economic life of an intangible asset ranges between three and 20 years depending on its nature. Internally-generated intangible assets are expensed in the income statement as incurred. Purchased computer software and certain costs of information technology projects are capitalised as intangible assets. Software that is integral to computer hardware is capitalised as plant and equipment. Contingent consideration Contingent consideration receivable associated with the sale of product rights and other assets outside of a business combination is recognised at the time of purchase to the extent that the future event upon which the contingent consideration is conditional is within the Group’s control, or to the extent that is it considered to be virtually certain that the contingent consideration will become due. If the contingent consideration is outside of the Group’s control or it cannot be considered virtually certain that it will become due, an asset and corresponding entry in profit and loss is recognised only once it becomes virtually certain that the contingent consideration will become due. Contingent consideration payable associated with the purchase of product rights and other assets outside of a business combination is recognised at the time of sale to the extent that the future event upon which the contingent consideration is conditional is under the control of the seller and it is considered probable that the contingent consideration will become due. Contingent consideration associated within a contingent condition that is within the Group’s control is recognised at the point when the contingent condition is met. Impairment of intangible assets The carrying values of intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may be impaired. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss. Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the CGU to which it belongs. An asset’s recoverable amount is the higher of an asset’s or CGU’s fair value less costs to sell and its value-in-use. In assessing value-in-use, its estimated future cash flow is discounted to its present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the asset. In carrying out impairment reviews of intangible assets a number of significant assumptions have to be made when preparing cash flow projections. These include the future rate of market growth, discount rates, the market demand for the products acquired, the future profitability of acquired businesses or products, levels of reimbursement and success in obtaining regulatory approvals. If actual results should differ, or changes in expectations should arise, impairment charges may be required which would adversely impact operating results. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 135 |
| | | | | | | | | | | | | | | | | | Customer and | | | | | | | | | | Product- | | distribution | | | | | | | | Technology | | related | | related | | Software | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | Cost | | | | | | | | | | | | At 1 January 2016 | | 235 | | 1,864 | | 119 | | 289 | | 2,507 | | Exchange adjustment | | (2) | | (20) | | 2 | | (8) | | (28) | | Acquisitions1 | | 68 | | 17 | | – | | – | | 85 | | Additions | | – | | 24 | | – | | 48 | | 72 | | Disposals | | – | | (36) | | – | | – | | (36) | | At 31 December 2016 | | 301 | | 1,849 | | 121 | | 329 | | 2,600 | | Exchange adjustment | | 10 | | 38 | | 1 | | 12 | | 61 | | Acquisitions1 | | 59 | | 2 | | – | | – | | 61 | | Additions | | – | | 2 | | 3 | | 63 | | 68 | | Disposals | | (6) | | (43) | | (5) | | (5) | | (59) | | Transfers | | (6) | | 6 | | – | | 4 | | 4 | | At 31 December 2017 | | 358 | | 1,854 | | 120 | | 403 | | 2,735 | | Amortisation and impairment | | | | | | | | | | | | At 1 January 2016 | | 21 | | 759 | | 69 | | 156 | | 1,005 | | Exchange adjustment | | – | | (16) | | 1 | | (4) | | (19) | | Charge for the year – amortisation2 | | 15 | | 131 | | 10 | | 35 | | 191 | | Charge for the year – impairment | | – | | 48 | | – | | – | | 48 | | Disposals | | – | | (36) | | – | | – | | (36) | | At 31 December 2016 | | 36 | | 886 | | 80 | | 187 | | 1,189 | | Exchange adjustment | | 2 | | 21 | | 1 | | 6 | | 30 | | Charge for the year – amortisation | | 6 | | 133 | | 15 | | 38 | | 192 | | Charge for the year – impairment | | – | | 10 | | – | | – | | 10 | | Disposals | | 11 | | (61) | | (3) | | (4) | | (57) | | Transfers | | (4) | | 4 | | – | | – | | – | | At 31 December 2017 | | 51 | | 993 | | 93 | | 227 | | 1,364 | | Net book amounts | | | | | | | | | | | | At 31 December 2017 | | 307 | | 861 | | 27 | | 176 | | 1,371 | | At 31 December 2016 | | 265 | | 963 | | 41 | | 142 | | 1,411 | |
| 1 | | In 2017 this relates to technology and product-related intangibles acquired with the purchase of Rotation Medical, Inc. In 2016 this relates to technology and product related intangibles acquired with the purchase of Blue Belt Technologies Inc. and BST-CarGel. |
| 2 | | The amortisation charge between technology and product-related intangibles has been restated by $33m with no impact on the total net book value of intangible assets. |
Amortisation and impairment of acquisition intangibles is set out below: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Technology | | 6 | | 48 | | Product-related | | 124 | | 126 | | Customer and distribution related | | 10 | | 4 | | Total | | 140 | | 178 | |
Group capital expenditure relating to software contracted but not provided for amounted to $nil (2016: $9m). In 2017, a product-related intangible asset was determined to have a value in use below its carrying value, resulting in an impairment charge of $10m being recognised. In determining the recoverable amount of the Coblation technology asset acquired with the purchase of ArthoCare in 2014, revenue from products utilising this technology was assumed to have a growth rate of 4-5% in the medium term. This supported the carrying value of the Coblation technology asset but a reduction of 4% would give rise to there being no headroom. In 2016, two product-related intangible assets were determined to have a value in use below their carrying value, resulting in an impairment charge being recognised. The impairment charge primarily relates to $32m from Oasis, calculated using a discount rate of 10.3%, a product right acquired with the Healthpoint acquisition in 2012. The continued reimbursement pressure in 2016 resulted in revenues not increasing at the previously expected rate. The second product-related intangible asset has no residual carrying value. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 136ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 10 INVESTMENTS Accounting policy Investments, other than those related to associates, are initially recorded at fair value plus any directly attributable transaction costs on the trade date. The Group has investments in unquoted entities and an entity that holds mainly unquoted equity securities, which by their nature have no fixed maturity date or coupon rate. These investments are classed as ‘available-for-sale’ carried at fair value. The fair value of these investments are based on the underlying fair value of the equity securities: marketable securities are valued by reference to closing prices in the market; and non-marketable securities are estimated considering factors including the purchase price; prices of recent significant private placements of securities of the same issuer and estimates of liquidation value. Changes in fair value are recognised in other comprehensive income except where management considers that there is objective evidence of an impairment of the underlying equity securities. Objective evidence would include a significant or prolonged decline in the fair value of the investment below its cost less any impairment loss previously recognised. Impairment losses are recognised by reclassifying the losses accumulated in other reserves to profit or loss. |
| | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | At 1 January | | 25 | | 13 | | Additions | | 8 | | 2 | | Fair value remeasurement | | (10) | | 10 | | Impairment | | (2) | | – | | At 31 December | | 21 | | 25 | |
11 INVESTMENTS IN ASSOCIATES Accounting policy Investments in associates, being those entities over which the Group has a significant influence and which is neither a subsidiary nor a joint venture, are accounted for using the equity method, with the Group recording its share of the associates’ profit and loss and other comprehensive income. The Group’s share of associates’ profit or loss is included in one separate income statement line and is calculated after deduction of their respective taxes. |
At 31 December 2017 and 31 December 2016, the Group holds 49% of Bioventus LLC (Bioventus). Bioventus is a limited liability company operating as a partnership. The company’s headquarters is located in Durham, North Carolina, US. Bioventus focuses its medical product development around its core competencies of orthobiologic therapies and orthopaedic diagnostics from which it develops and markets clinically proven orthopaedic therapies and diagnostic tools, including osteoarthritis pain treatments, bone growth stimulators and ultrasound devices. Bioventus sells bone healing stimulation devices and is a provider of osteoarthritis injection therapies. The Group’s ability to recover the value of its investment is dependent upon the ongoing clinical and commercial success of these products. The profit after taxation recognised in the income statement relating to Bioventus was $6m (2016: loss after taxation $3m). The carrying amount of this investment was reviewed for impairment as at the balance sheet date. For the purposes of impairment testing the recoverable amount of this investment was based on its fair value less cost to sell, estimated using discounted cash flows. The amounts recognised in the balance sheet and income statement for associates are as follows: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Balance sheet | | 118 | | 112 | | Income statement profit/(loss) | | 6 | | (3) | |
Summarised financial information for significant associates Set out below is the summarised financial information for Bioventus, adjusted for differences with Group accounting policies: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Summarised statement of comprehensive income | | | | | | Revenue | | 301 | | 282 | | Attributable profit/(loss) for the year | | 1 | | (21) | | Group adjustments1 | | 11 | | 15 | | Total comprehensive profit/(loss) | | 12 | | (6) | | Group share of profit/(loss) for the year at 49% | | 6 | | (3) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 137 |
| | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Summarised balance sheet | | | | | | Non-current assets | | 332 | | 364 | | Current assets | | 122 | | 105 | | Non-current liabilities | | (246) | | (258) | | Current liabilities | | (47) | | (53) | | Net assets | | 161 | | 158 | | Group’s share of net assets at 49% | | 79 | | 77 | | Group adjustments1 | | 35 | | 32 | | Group’s carrying amount of investment at 49% | | 114 | | 109 | |
1 Group adjustments include an adjustment to align the useful life of intangible assets with Group policy. At December 2017, the Group held an equity investment in one other associate (2016: one) with a carrying value of $3m (2016: $3m). 12 INVENTORIES Accounting policy Finished goods and work-in-progress are valued at factory cost, including appropriate overheads, on a first-in first-out basis. Raw materials and bought-in finished goods are valued at purchase price. All inventories are reduced to net realisable value where lower than cost. Inventory acquired as part of a business acquisition is valued at selling price less costs to sell and a profit allowance for selling efforts. Orthopaedic instruments are generally not sold but provided to customers and distributors for use in surgery. They are recorded as inventory until they are deployed at which point they are transferred to plant and equipment and depreciated over their useful economic lives of between three and seven years. A feature of the orthopaedic business is the high level of product inventory required, some of which is located at customer premises and is available for customers’ immediate use (referred to as consignment inventory). Complete sets of product, including large and small sizes, have to be made available in this way. These outer sizes are used less frequently than standard sizes and towards the end of the product life cycle are inevitably in excess of requirements. Adjustments to carrying value are therefore required to be made to orthopaedic inventory to anticipate this situation. These adjustments are calculated in accordance with a formula based on levels of inventory compared with historical or forecast usage. This formula is applied on an individual product line basis and is first applied when a product group has been on the market for two years. This method of calculation is considered appropriate based on experience but it involves management judgements on effectiveness of inventory deployment, length of product lives, phase-out of old products and efficiency of manufacturing planning systems. |
| | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Raw materials and consumables | | 207 | | 213 | | 205 | | Work-in-progress | | 69 | | 55 | | 84 | | Finished goods and goods for resale | | 1,028 | | 976 | | 928 | | | | 1,304 | | 1,244 | | 1,217 | |
Reserves for excess and obsolete inventories were $296m (2016: $303m, 2015: $322m). The decrease in reserves of $7m in the year comprised a $20m reduction in the reserve relating to the write-off of inventory which was partially offset by foreign exchange movements of $13m. The determination of the estimate of excess and obsolete inventory is a critical accounting estimate and includes assumptions on the future usage of all different items of finished goods. This estimate is not considered to have a range of potential outcomes that is significantly different to the $296m held at 31 December 2017. The cost of inventories recognised as an expense and included in cost of goods sold amounted to $1,013m (2016: $1,131m, 2015: $961m). In addition, $68m was recognised as an expense within cost of goods sold resulting from inventory write-offs (2016: $85m, 2015: $73m). Notwithstanding inventory acquired within acquisitions, no inventory is carried at fair value less costs to sell in any year. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 138ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 13 TRADE AND OTHER RECEIVABLES Accounting policy Trade and other receivables are carried at amortised cost, less any allowances for uncollectible amounts. They are included in current assets, except for maturities greater than 12 months after the balance sheet date. These are classified as non-current assets. The Group manages credit risk through credit limits which require authorisation commensurate with the size of the limit and which are regularly reviewed. Credit limit decisions are made based on available financial information and the business case. Significant receivables are regularly reviewed and monitored at Group level. The Group has no significant concentration of credit risk, with exposure spread over a large number of customers and geographies. Furthermore, the Group’s principal customers are backed by government and public or private medical insurance funding, which historically represent a lower risk of default. The maximum exposure to credit risk at the reporting date is the fair value of each class of receivable. The Group does not hold any collateral as security. |
| | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Trade and other receivables due within one year | | | | | | | | Trade receivables | | 1,125 | | 1,042 | | 1,003 | | Less: provision for bad and doubtful debts | | (69) | | (54) | | (64) | | Trade receivables – net | | 1,056 | | 988 | | 939 | | Derivatives – forward foreign exchange, currency swaps and interest rate contracts | | 28 | | 48 | | 33 | | Other receivables | | 92 | | 76 | | 83 | | Prepayments | | 82 | | 73 | | 83 | | | | 1,258 | | 1,185 | | 1,138 | | Due after more than one year | | | | | | | | Other non-current assets | | 16 | | – | | – | | | | 1,274 | | 1,185 | | 1,138 | |
Trade receivables are classified as loans and receivables. Management considers that the carrying amount of trade and other receivables approximates to the fair value. The provision for bad and doubtful debts is based on specific assessments of risk and reference to past default experience. The bad debt expense for the year was $17m (2016: $7m expense, 2015: $25m expense). Other non-current assets primarily relate to long-term prepayments. The amount of trade receivables that were past due was as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Past due not more than three months | | 225 | | 142 | | 154 | | Past due more than three months and not more than six months | | 65 | | 51 | | 45 | | Past due more than six months and not more than one year | | 66 | | 70 | | 57 | | Past due more than one year | | 105 | | 54 | | 53 | | | | 461 | | 317 | | 309 | | Neither past due nor impaired | | 664 | | 725 | | 694 | | Provision for bad and doubtful debts | | (69) | | (54) | | (64) | | Trade receivables – net | | 1,056 | | 988 | | 939 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 139 |
Movements in the provision for bad and doubtful debts were as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | At 1 January | | 54 | | 64 | | 47 | | Exchange adjustment | | 3 | | (3) | | (3) | | Acquisitions | | 1 | | – | | – | | Net receivables provided during the year | | 17 | | 7 | | 25 | | Utilisation of provision | | (6) | | (14) | | (5) | | At 31 December | | 69 | | 54 | | 64 | |
Trade receivables include amounts denominated in the following major currencies: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | US Dollar | | 418 | | 416 | | 362 | | Sterling | | 54 | | 57 | | 58 | | Euro | | 212 | | 193 | | 192 | | Other | | 372 | | 322 | | 327 | | Trade receivables – net | | 1,056 | | 988 | | 939 | |
14 TRADE AND OTHER PAYABLES | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Trade and other payables due within one year | | | | | | Trade and other payables | | 873 | | 807 | | Derivatives – forward foreign exchange, currency swaps and interest rate contracts | | 48 | | 39 | | Acquisition consideration | | 36 | | 38 | | | | 957 | | 884 | | Other payables due after one year | | | | | | Acquisition consideration | | 124 | | 82 | | Other payables | | 4 | | – | | | | 128 | | 82 | |
The acquisition consideration includes $104m (2016: $56m) contingent upon future events. The acquisition consideration due after more than one year is expected to be payable as follows: $50m in 2019, $24m in 2020, $43m in 2021, $2m in 2022, and $5m due in over five years (2016: $29m in 2018, $8m in 2019 and $20m in 2020, $11m in 2021, and $14m due in over five years). | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 140ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 15 CASH AND BORROWINGS 15.1 Net debt Net debt comprises borrowings and credit balances on currency swaps less cash at bank. | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Bank overdrafts and loans due within one year | | 27 | | 86 | | Long-term bank borrowings and finance leases | | 300 | | 440 | | Private placement notes | | 1,123 | | 1,124 | | Borrowings | | 1,450 | | 1,650 | | Cash at bank | | (169) | | (100) | | (Debit)/credit balance on derivatives – currency swaps | | (2) | | 1 | | Credit/(debit) balance on derivatives – interest rate swaps | | 2 | | (1) | | Net debt | | 1,281 | | 1,550 | |
Borrowings are repayable as follows: | | | | | | | | | | | | | | | | | | Within | | Between | | Between | | Between | | Between | | | | | | | | one year or | | one and | | two and | | three and | | four and | | After | | | | | | on demand | | two years | | three years | | four years | | five years | | five years | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 31 December 2017: | | | | | | | | | | | | | | | | Bank loans | | 13 | | – | | 300 | | – | | – | | – | | 313 | | Bank overdrafts | | 14 | | – | | – | | – | | – | | – | | 14 | | Private placement notes | | – | | 124 | | – | | 264 | | 125 | | 610 | | 1,123 | | | | 27 | | 124 | | 300 | | 264 | | 125 | | 610 | | 1,450 | | At 31 December 2016: | | | | | | | | | | | | | | | | Bank loans | | 22 | | – | | 300 | | – | | 135 | | – | | 457 | | Bank overdrafts | | 62 | | – | | – | | – | | – | | – | | 62 | | Finance lease liabilities | | 2 | | 2 | | 3 | | – | | – | | – | | 7 | | Private placement notes | | – | | – | | 125 | | – | | 264 | | 735 | | 1,124 | | | | 86 | | 2 | | 428 | | – | | 399 | | 735 | | 1,650 | |
15.2 Assets pledged as security Assets are pledged as security under normal market conditions. Secured borrowings and pledged assets are as follows: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Finance lease liabilities – due within one year | | – | | 2 | | Finance lease liabilities – due after one year | | – | | 5 | | Total amount of secured borrowings | | – | | 7 | | Total net book value of assets pledged as security: | | | | | | Property, plant and equipment | | – | | 5 | | | | – | | 5 | |
15.3 Liquidity risk exposures The Board has established a set of policies to manage funding and currency risks. The Group uses derivative financial instruments only to manage the financial risks associated with underlying business activities and their financing. Liquidity risk is the risk that the Group is not able to settle or meet its obligations on time or at a reasonable price. The Group’s policy is to ensure that there is sufficient funding and facilities in place to meet foreseeable borrowing requirements. The Group manages and monitors liquidity risk through regular reporting of current cash and borrowing balances and periodic preparation and review of short and medium-term cash forecasts, having regard to the maturities of investments and borrowing facilities. The Group has available committed facilities of $2.4bn (2016: $2.4bn). The interest payable on borrowings under committed facilities is either at fixed or floating rates. Floating rates are typically based on the LIBOR (or other reference rate) relevant to the term and currency concerned. The Company is subject to restrictive covenants under its principal facility agreements. These financial covenants are tested at the end of each half year for the 12 months ending on the last day of the testing period. As of 31 December 2017, the Company was in compliance with these covenants. The facilities are also subject to customary events of default, none of which are currently anticipated to occur. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 141 |
The Group’s committed facilities are: | | | | Facility | | Date due | | $80 million 2.47% Senior Notes | | November 2019 | | $45 million Floating Rate Senior Notes | | November 2019 | | $300 million bilateral, term loan facility | | April 2020 | | $75 million 3.23% Senior Notes | | January 2021 | | $1.0 billion syndicated, revolving credit facility | | March 2021 | | $190 million 2.97% Senior Notes | | November 2021 | | $75 million 3.46% Senior Notes | | January 2022 | | $50 million 3.15% Senior Notes | | November 2022 | | $105 million 3.26% Senior Notes | | November 2023 | | $100 million 3.89% Senior Notes | | January 2024 | | $305 million 3.36% Senior Notes | | November 2024 | | $25 million Floating Rate Senior Notes | | November 2024 | | $75 million 3.99% Senior Notes | | January 2026 | |
15.4 Year end financial liabilities by contractual maturity The table below analyses the Group’s year end financial liabilities by contractual maturity date, including contractual interest payments and excluding the impact of netting arrangements: | | | | | | | | | | | | | | Within one | | Between | | Between | | | | | | | | year or on | | one and | | two and | | After | | | | | | demand | | two years | | five years | | five years | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | At 31 December 2017 | | | | | | | | | | | | Non-derivative financial liabilities: | | | | | | | | | | | | Bank overdrafts and loans | | 27 | | – | | 300 | | – | | 327 | | Trade and other payables | | 873 | | 1 | | 1 | | 2 | | 877 | | Private placement notes | | 36 | | 161 | | 476 | | 647 | | 1,320 | | Acquisition consideration | | 36 | | 50 | | 69 | | 5 | | 160 | | Derivative financial liabilities: | | | | | | | | | | | | Currency swaps/forward foreign exchange contracts – outflow | | 2,737 | | – | | – | | – | | 2,737 | | Currency swaps/forward foreign exchange contracts – inflow | | (2,739) | | – | | – | | – | | (2,739) | | | | 970 | | 212 | | 846 | | 654 | | 2,682 | | At 31 December 2016 | | | | | | | | | | | | Non-derivative financial liabilities: | | | | | | | | | | | | Bank overdrafts and loans | | 86 | | – | | 435 | | – | | 521 | | Trade and other payables | | 807 | | – | | – | | – | | 807 | | Finance lease liabilities | | 3 | | 3 | | 3 | | – | | 9 | | Private placement notes | | 36 | | 36 | | 491 | | 800 | | 1,363 | | Acquisition consideration | | 38 | | 30 | | 46 | | 16 | | 130 | | Derivative financial liabilities: | | | | | | | | | | | | Currency swaps/forward foreign exchange contracts – outflow | | 2,284 | | – | | – | | – | | 2,284 | | Currency swaps/forward foreign exchange contracts – inflow | | (2,285) | | – | | – | | – | | (2,285) | | | | 969 | | 69 | | 975 | | 816 | | 2,829 | |
The amounts in the tables above are undiscounted cash flows, which differ from the amounts included in the balance sheet where the underlying cash flows have been discounted. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 142ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 15.5 Finance leases Accounting policy Leases are classified as finance leases when the terms of the lease transfer substantially all the risks and rewards of ownership to the Group. All other leases are classified as operating leases. The leased assets are measured initially at an amount equal to the lower of their fair value and the present value of the minimum lease payments. Assets held under finance leases are capitalised as property, plant or equipment and depreciated accordingly. Minimum lease payments are apportioned between the finance expense and the reduction in the outstanding liability. The finance expense is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. |
Future minimum lease payments under finance leases together with the present value of the minimum lease payments are as follows: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Within one year | | – | | 3 | | After one and within two years | | – | | 3 | | After two and within three years | | – | | 3 | | After three and within four years | | – | | – | | After four and within five years | | – | | – | | After five years | | – | | – | | Total minimum lease payments | | – | | 9 | | Discounted by imputed interest | | – | | (2) | | Present value of minimum lease payments | | – | | 7 | |
In 2017, the Group terminated its finance lease. Present value of minimum lease payments can be split out as: $nil (2016: $2m) due within one year, $nil (2016: $5m) due between one to five years and $nil (2016: $nil) due after five years. Liquidity and capital resources The Group’s policy is to ensure that it has sufficient funding and facilities to meet foreseeable borrowing requirements. At 31 December 2017, the Group held $155m (2016: $38m, 2015: $102m) in cash net of bank overdrafts. The Group had committed facilities available of $2,425m at 31 December 2017 of which $1,425m was drawn. Smith & Nephew intends to repay the amounts due within one year using available cash and drawing down on the longer-term facilities. The principal variations in the Group’s borrowing requirements result from the timing of dividend payments, acquisitions and disposals of businesses, timing of capital expenditure and working capital fluctuations. Smith & Nephew believes that its capital expenditure needs and its working capital funding for 2018, as well as its other known or expected commitments or liabilities, can be met from its existing resources and facilities. The Group’s net debt decreased from $1,550m at the beginning of 2017 to $1,281m at the end of 2017, representing an overall decrease of $269m. The Group’s planned future contributions are considered adequate to cover the current underfunded position in the Group’s defined benefit plans. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 143 |
16 FINANCIAL INSTRUMENTS AND RISK MANAGEMENT Accounting policy Derivative financial instruments Derivative financial instruments are initially recognised at fair value on the date a derivative contract is entered into and are subsequently re-measured at their fair value at subsequent balance sheet dates. Changes in the fair value of derivative financial instruments that are designated and effective as cash flow hedges of forecast third party and intercompany transactions are recognised in other comprehensive income until the associated asset or liability is recognised. Amounts taken to other comprehensive income are transferred to the income statement in the period in which the hedged transaction affects profit and loss. Where the hedged item is the cost of a non-financial asset, the amounts taken to other comprehensive income are transferred to the initial carrying value of the asset. Currency swaps to match foreign currency net assets with foreign currency liabilities are fair valued at the balance sheet date. Changes in the fair values of currency swaps that are designated and effective as net investment hedges are matched in other comprehensive income against changes in value of the related net assets. Interest rate derivatives transacted to fix interest rates on floating rate borrowings are accounted for as cash flow hedges and changes in the fair values resulting from changes in market interest rates are recognised in other comprehensive income. Amounts taken to other comprehensive income are transferred to the income statement when the hedged transaction affects profit and loss. Interest rate derivatives transacted to convert fixed rate borrowings into floating rate borrowings are accounted for as fair value hedges and changes in the fair values resulting from changes in market interest rates are recognised in the income statement. Any ineffectiveness on hedging instruments and changes in the fair value of derivative financial instruments that do not qualify for hedge accounting are recognised in the income statement within other finance costs as they arise. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. At that point in time, any cumulative gain or loss on the hedging instrument recognised in other comprehensive income is retained there until the forecast transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in other comprehensive income is transferred. |
16.1 Foreign exchange exposures The Group operates in many countries and as a consequence has transactional and translational foreign exchange exposure. It is Group policy for operating units not to hold material unhedged monetary assets or liabilities other than in their functional currencies. Foreign exchange variations affect trading results in two ways. Firstly, on translation of overseas sales and profits into US Dollars and secondly, transactional exposures arising where some, or all of the costs of sale are incurred in a different currency from the sale. The principal transactional exposures arise as the proportion of costs in US Dollars, Sterling and Swiss Francs exceed the proportion of sales in each of these currencies and correspondingly the proportion of sales in Euros exceeds the proportion of costs in Euros. The impact of currency movements on the cost of purchases is partly mitigated by the use of forward foreign exchange contracts. The Group uses forward foreign exchange contracts, designated as cash flow hedges, to hedge forecast third party and intercompany trading cash flows up to one year. When a commitment is entered into, forward foreign exchange contracts are normally used to increase the hedge to 100% of the exposure. Cash flows relating to cash flow hedges are expected to occur within 12 months of inception and profits and losses on hedges are expected to enter into the determination of profit (within cost of goods sold) within a further 12‑month period. The principal currencies hedged by forward foreign exchange contracts are US Dollars, Euros, Sterling and Singapore Dollars. At 31 December 2017, the Group had contracted to exchange within one year the equivalent of $2.3bn (2016: $1.8bn). Based on the Group’s net borrowings as at 31 December 2017, if the US Dollar were to weaken against all currencies by 10%, the Group’s net borrowings would decrease by $3m (2016: decrease by $1m) as the Group held a higher amount of foreign denominated cash than foreign denominated borrowings. If the US Dollar were to weaken by 10% against all other currencies, then the fair value of the forward foreign exchange contracts as at 31 December 2017 would have been $53m lower (2016: $51m lower). Similarly, if the Euro were to weaken by 10% against all other currencies, then the fair value of the forward foreign exchange contracts as at 31 December 2017 would have been $12m higher (2016: $17m higher). Movements in the fair value of forward foreign exchange contracts would be recognised in other comprehensive income and accumulated in the hedging reserve. A 10% strengthening of the US Dollar or Euro against all other currencies at 31 December 2017 would have had the equal but opposite effect to the amounts shown above, on the basis that all other variables remain constant. The Group’s policy is to hedge all actual foreign exchange exposures and the Group’s forward foreign exchange contracts are designated as cash flow hedges. The net impact of transaction related foreign exchange on the income statement from a movement in exchange rates on the value of forward foreign exchange contracts is not significant. In addition, the movements in the fair value of other financial instruments used for hedging such as currency swaps for which hedge accounting is not applied, offset movements in the values of assets and liabilities and are recognised through the income statement. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 144ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 16.2 Interest rate exposures The Group is exposed to interest rate risk on cash, borrowings and certain currency and interest rate swaps which are at floating rates. When required the Group uses interest rate derivatives to meet its objective of protecting borrowing costs within parameters set by the Board. These interest rate derivatives are accounted for as cash flow hedges and, as such, changes in fair value resulting from changes in market interest rates are recognised in other comprehensive income and accumulated in the hedging reserve, with the fair value of the interest rate derivatives recorded in the balance sheet. Additionally, the Group uses interest rate swaps to reduce the overall level of fixed rate debt, within parameters set by the Board. When used in this way, interest rate derivatives are accounted for as fair value hedges. The fair value movement of the derivative is offset in the income statement against the fair value movement in the underlying fixed rate debt. Based on the Group’s gross borrowings as at 31 December 2017, if interest rates were to increase by 100 basis points in all currencies then the annual net interest charge would increase by $6m (2016: $7m). A decrease in interest rates by 100 basis points in all currencies would have an equal but opposite effect to the amounts shown above. 16.3 Credit risk exposures The Group limits exposure to credit risk on counterparties used for financial instruments through a system of internal credit limits. The financial exposure of a counterparty is determined as the total of cash and deposits, plus the risk on derivative instruments, assessed as the fair value of the instrument plus a risk element based on the nominal value and the historic volatility of the market value of the instrument. The Group does not anticipate non-performance of counterparties and believes it is not subject to material concentration of credit risk as the Group operates within a policy of counterparty limits designed to reduce exposure to any single counterparty. The maximum credit risk exposure on derivatives at 31 December 2017 was $28m (2016: $48m), being the total debit fair values on forward foreign exchange contracts and currency swaps. The maximum credit risk exposure on cash at bank at 31 December 2017 was $169m (2016: $100m). The Group’s exposure to credit risk is not material as the amounts are held in a wide number of banks in a number of different countries. Credit risk on trade receivables is detailed in Note 13. 16.4 Currency and interest rate profile of interest bearing liabilities and assets Short-term debtors and creditors are excluded from the following disclosures. Currency and interest rate profile of interest bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fixed rate liabilities | | | | | | | | | | | | | | | | | | Weighted | | | | | | | | | | | | | | | | | | average | | | | | | | | Interest | | | | | | | | Weighted | | time | | | | Gross | | Currency | | rate | | Total | | Floating | | Fixed rate | | average | | for which | | | | borrowings | | swaps | | swaps | | liabilities | | rate liabilities | | liabilities | | interest rate | | rate is fixed | | | | $ million | | $ million | | $million | | $ million | | $ million | | $ million | | % | | Years | | At 31 December 2017 | | | | | | | | | | | | | | | | | | US Dollar | | (1,428) | | (291) | | (2) | | (1,721) | | (866) | | (855) | | 3.4 | | 5.8 | | Other | | (22) | | (95) | | – | | (117) | | (117) | | – | | – | | – | | Total interest bearing liabilities | | (1,450) | | (386) | | (2) | | (1,838) | | (983) | | (855) | | | | | | At 31 December 2016 | | | | | | | | | | | | | | | | | | US Dollar | | (1,588) | | (367) | | (1) | | (1,956) | | (1,108) | | (862) | | 3.5 | | 6.8 | | Other | | (62) | | (81) | | – | | (143) | | (129) | | – | | – | | – | | Total interest bearing liabilities | | (1,650) | | (448) | | (1) | | (2,099) | | (1,237) | | (862) | | | | | |
At 31 December 2017, $nil (2016: $7m) of fixed rate liabilities related to finance leases. In 2017, the Group also had liabilities due for deferred and contingent acquisition consideration (denominated in US Dollars, Euros, Turkish Lira and Russian Rubles) totalling $160m (2016: $120m, 2015: $27m) on which no interest was payable (see Note 14). There were no other significant interest bearing financial liabilities. Floating rates on liabilities are typically based on the one, three or six-month LIBOR (or other reference rate) relevant to the currency concerned. The weighted average interest rate on floating rate borrowings as at 31 December 2017 was 3% (2016: 2%). | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 145 |
Currency and interest rate profile of interest bearing assets: | | | | | | | | | | | | | | | | Interest | | Cash | | Currency | | | | Floating | | Fixed | | | | rate swaps | | at bank | | swaps | | Total assets | | rate assets | | rate assets | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 31 December 2017 | | | | | | | | | | | | | | US Dollars | | – | | 110 | | 94 | | 204 | | 204 | | – | | Other | | – | | 59 | | 294 | | 353 | | 353 | | – | | Total interest bearing assets | | – | | 169 | | 388 | | 557 | | 557 | | – | | At 31 December 2016 | | | | | | | | | | | | | | US Dollars | | – | | 29 | | 83 | | 112 | | 112 | | – | | Other | | – | | 71 | | 366 | | 437 | | 437 | | – | | Total interest bearing assets | | – | | 100 | | 449 | | 549 | | 549 | | – | |
Floating rates on assets are typically based on the short-term deposit rates relevant to the currency concerned. 16.5 Fair value of financial assets and liabilities Accounting policy Measurement of fair values A number of the Group’s accounting policies and disclosures require the measurement of fair values, for both financial assets and liabilities and non-financial assets acquired in a business combination (see Note 21). When measuring the fair value of an asset or liability, the Group uses market observable data as far as possible. Fair values are categorised into different levels in the fair value hierarchy based on the inputs used in the valuation techniques as follows: Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2: inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and Level 3: inputs for the asset or liability that are not based on observable data (unobservable inputs). The Group recognises transfers between the levels of the fair value hierarchy at the end of the reporting period during which the change has occurred. |
There has been no change in the classification of financial assets and liabilities, the method and assumptions used in determining fair value and the categorisation of financial assets and liabilities within the fair value hierarchy from those disclosed in the Annual Report for the year ended 31 December 2016. The Group enters into derivative financial instruments with financial institutions with investment grade credit ratings. The fair value of forward foreign exchange contracts is calculated by reference to quoted market forward exchange rates for contracts with similar maturity profiles. The fair value of currency swaps is determined by reference to quoted market spot rates. As a result, foreign forward exchange contracts and currency swaps are classified as Level 2 within the fair value hierarchy. The changes in counterparty credit risk had no material effect on the hedge effectiveness for derivatives designated in hedge relationships and other financial instruments recognised at fair value. The fair value of investments is based upon third party pricing models for share issues. As a result, investments are considered Level 3 in the fair value hierarchy. There were no transfers between Levels 1, 2 and 3 during 2017 and 2016. For cash and cash equivalents, short-term loans and receivables, overdrafts and other short-term liabilities which have a maturity of less than three months, the book values approximate the fair values because of their short-term nature. Long-term borrowings are measured in the balance sheet at amortised cost. As the Group’s long-term borrowings are not quoted publicly and as market prices are not available, their fair values are estimated by discounting future contractual cash flows to net present values at the current market interest rates available to the Group for similar financial instruments as at the year end. The fair value of the private placement notes is determined using a discounted cash flow model based on prevailing market rates. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 146ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued The following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy. It does not include fair value information for financial assets and financial liabilities not measured at fair value if the carrying amount is a reasonable approximation of fair value. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Carrying | | | | | | | | | | | | | | | | | | | | amount | | | | | | Fair value | | | | Designated | | Fair value – | | Loans | | | | Other | | | | | | | | | | | | at fair | | hedging | | and | | Available | | financial | | | | | | | | | | | | value | | instruments | | receivables | | for sale | | liabilities | | Total | | Level 2 | | Level 3 | | Total | | At 31 December 2017 | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Financial assets measured at fair value | | | | | | | | | | | | | | | | | | | | Forward foreign exchange contracts | | – | | 25 | | – | | – | | – | | 25 | | 25 | | – | | 25 | | Investments | | – | | – | | – | | 21 | | – | | 21 | | – | | 21 | | 21 | | Currency swaps | | 3 | | – | | – | | – | | – | | 3 | | 3 | | – | | 3 | | | | 3 | | 25 | | – | | 21 | | – | | 49 | | | | | | | | Financial liabilities measured at fair value | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | (104) | | – | | – | | – | | – | | (104) | | – | | (104) | | (104) | | Forward foreign exchange contracts | | – | | (45) | | – | | – | | – | | (45) | | (45) | | – | | (45) | | Currency swaps | | (1) | | – | | – | | – | | – | | (1) | | (1) | | – | | (1) | | Interest rate swaps | | – | | (2) | | – | | – | | – | | (2) | | (2) | | – | | (2) | | Private placement debt | | – | | – | | (198) | | – | | – | | (198) | | (198) | | – | | (198) | | | | (105) | | (47) | | (198) | | – | | – | | (350) | | | | | | | | Financial assets not measured at fair value | | | | | | | | | | | | | | | | | | | | Trade and other receivables | | – | | – | | 1,148 | | – | | – | | 1,148 | | | | | | | | Cash at bank | | – | | – | | 169 | | – | | – | | 169 | | | | | | | | | | – | | – | | 1,317 | | – | | – | | 1,317 | | | | | | | | Financial liabilities not measured at fair value | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | (56) | | – | | – | | – | | – | | (56) | | | | | | | | Bank overdrafts | | – | | – | | – | | – | | (14) | | (14) | | | | | | | | Bank loans | | – | | – | | – | | – | | (313) | | (313) | | | | | | | | Private placement debt | | – | | – | | – | | – | | (925) | | (925) | | (931) | | – | | (931) | | Trade and other payables | | – | | – | | – | | – | | (877) | | (877) | | | | | | | | | | (56) | | – | | – | | – | | (2,129) | | (2,185) | | | | | | | |
Total acquisition consideration measured at fair value increased from $56m at 31 December 2016 to $104m at 31 December 2017 due to the addition of $72m relating to the Rotation Medical, Inc. acquisition which was partially offset by $14m of acquisition payments and a remeasurement reduction of $10m. The fair value of contingent consideration is estimated using a discounted cash flow model. The valuation model considers the present value of expected payment, discounted using a risk-adjusted discount rate. The expected payment is determined by considering the possible scenarios, which relate to the achievement of established milestones and targets, the amount to be paid under each scenario and the probability of each scenario. As a result, contingent consideration is classified as Level 3 within the fair value hierarchy. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 147 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Carrying | | | | | | | | | | | | | | | | | | | | amount | | | | | | Fair value | | | | Designated | | Fair value – | | Loans | | | | Other | | | | | | | | | | | | at fair | | hedging | | and | | Available | | financial | | | | | | | | | | | | value | | instruments | | receivables | | for sale | | liabilities | | Total | | Level 2 | | Level 3 | | Total | | At 31 December 2016 | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Financial assets measured at fair value | | | | | | | | | | | | | | | | | | | | Forward foreign exchange contracts | | – | | 45 | | – | | – | | – | | 45 | | 45 | | – | | 45 | | Investments | | – | | – | | – | | 25 | | – | | 25 | | – | | 25 | | 25 | | Currency swaps | | 3 | | – | | – | | – | | – | | 3 | | 3 | | – | | 3 | | Interest rate swaps | | – | | – | | – | | – | | – | | – | | – | | – | | – | | | | 3 | | 45 | | – | | 25 | | – | | 73 | | | | | | | | Financial liabilities measured at fair value | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | (56) | | – | | – | | – | | – | | (56) | | – | | (56) | | (56) | | Forward foreign exchange contracts | | – | | (36) | | – | | – | | – | | (36) | | (36) | | – | | (36) | | Currency swaps | | (2) | | – | | – | | – | | – | | (2) | | (2) | | – | | (2) | | Interest rate swaps | | – | | (1) | | – | | – | | – | | (1) | | (1) | | – | | (1) | | Private placement debt | | – | | – | | (199) | | – | | – | | (199) | | (199) | | – | | (199) | | | | (58) | | (37) | | (199) | | – | | – | | (294) | | | | | | | | Financial assets not measured at fair value | | | | | | | | | | | | | | | | | | | | Trade and other receivables | | – | | – | | 1,064 | | – | | – | | 1,064 | | | | | | | | Cash at bank | | – | | – | | 100 | | – | | – | | 100 | | | | | | | | | | – | | – | | 1,164 | | – | | – | | 1,164 | | | | | | | | Financial liabilities not measured at fair value | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | (64) | | – | | – | | – | | – | | (64) | | | | | | | | Bank overdrafts | | – | | – | | – | | – | | (62) | | (62) | | | | | | | | Bank loans | | – | | – | | – | | – | | (457) | | (457) | | | | | | | | Private placement debt | | – | | – | | – | | – | | (925) | | (925) | | (935) | | – | | (935) | | Finance lease liabilities | | – | | – | | – | | – | | (7) | | (7) | | | | | | | | Trade and other payables | | – | | – | | – | | – | | (807) | | (807) | | | | | | | | | | (64) | | – | | – | | – | | (2,258) | | (2,322) | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 148ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 17 PROVISIONS AND CONTINGENCIES Accounting policy In the normal course of business the Group is involved in various legal disputes. Provisions are made for loss contingencies when it is deemed probable that an adverse outcome will occur and the amount of the losses can be reasonably estimated. Where the Group is the plaintiff in pursuing claims against third parties, legal and associated expenses are charged to the income statement as incurred. The recognition of provisions for legal disputes is subject to a significant degree of estimation. Provision is made for loss contingencies when it is considered probable that an adverse outcome will occur and the amount of the loss can be reasonably estimated. In making its estimates management takes into account the advice of internal and external legal counsel. Provisions are reviewed regularly and amounts updated where necessary to reflect developments in the disputes. The ultimate liability may differ from the amount provided depending on the outcome of court proceedings andor settlement negotiations or if investigations bringas new facts emerge. A provision for onerous contracts is recognised when the expected benefits to light new facts.be derived by the Group from a contract are lower than the unavoidable cost of meeting its obligations under the contract. For the purpose of calculating any onerous lease provision, the Group takes the discounted future lease payments (if any), net of expected rental income. Before a provision is established, the Group recognises any impairment loss on the assets associated with that contract. TaxationA provision for rationalisation is recognised when the Group has approved a detailed and formal restructuring plan, and the restructuring either has commenced or has been announced publicly. Future operating losses are not provided for.
|
17.1 Provisions | | | | | | | | | | | | Rationalisation | | | | Legal and other | | | | | | provisions | | Metal-on-metal | | provisions | | Total | | | | $ million | | $ million | | $ million | | $ million | | At 1 January 2016 | | 23 | | 185 | | 118 | | 326 | | Net charge to income statement | | 12 | | – | | (1) | | 11 | | Acquisitions | | – | | – | | 10 | | 10 | | Unwinding of discount | | – | | 5 | | – | | 5 | | Utilised | | (14) | | (27) | | (30) | | (71) | | Exchange adjustment | | (1) | | – | | 1 | | – | | At 31 December 2016 | | 20 | | 163 | | 98 | | 281 | | Net charge to income statement | | – | | 10 | | 2 | | 12 | | Unwinding of discount | | – | | 3 | | – | | 3 | | Utilised | | (15) | | (19) | | (28) | | (62) | | Transfers | | – | | – | | (9) | | (9) | | Exchange adjustment | | 1 | | – | | – | | 1 | | At 31 December 2017 | | 6 | | 157 | | 63 | | 226 | | Provisions – due within one year | | 6 | | 73 | | 50 | | 129 | | Provisions – due after one year | | – | | 84 | | 13 | | 97 | | At 31 December 2017 | | 6 | | 157 | | 63 | | 226 | | Provisions – due within one year | | 20 | | 43 | | 84 | | 147 | | Provisions – due after one year | | – | | 120 | | 14 | | 134 | | At 31 December 2016 | | 20 | | 163 | | 98 | | 281 | |
The principal elements within rationalisation provisions relate to the Group Optimisation programme (mainly severance) announced in May 2014. Following the settlement of a large part of the US metal-on-metal hip claims (discussed below) the Group has estimated a provision of $157m (2016: $163m) relating to the present value at 31 December 2017 of the estimated costs to resolve all other known and anticipated metal-on-metal hip claims. The estimated value of the provision has been determined using an actuarial model. Given the inherent uncertainty in assumptions relating to factors such as the number of claims and outcome the actual costs may differ significantly from this estimate. A range of expected outcomes between the 25th and 75th percentile generated by the actuarial model would not give rise to a significantly different outcome in 2018. The provision does not include any possible insurance recoveries on these claims or legal fees associated with defending claims. The Group carries considerable product liability insurance, and will continue to defend claims vigorously. The legal and other provisions mainly relate to various other product liability and intellectual property litigation matters. All provisions are expected to be substantially utilised within five years of 31 December 2017 and none are treated as financial instruments. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 149 |
17.2 Contingencies The Company and its subsidiaries are party to various legal proceedings, some of which include claims for substantial damages. The outcome of these proceedings cannot readily be foreseen, but except as described herein management believes none of them is likely to result in a material adverse effect on the financial position of the Group. The Group provides for outcomes that are deemed to be probable and can be reliably estimated. There is no assurance that losses will not exceed provisions or will not have a significant impact on the Group’s results of operations in the period in which they are realised. In August 2003, the Group withdrew voluntarily from all markets the macrotextured versions of its OXINIUM femoral knee components. A charge of $154m was recorded in 2004 for anticipated expenses in connection with macrotexture claims. Most of that amount has since been applied to settlements of such claims, and all claims have now been resolved. The aggregate cost at 31 December 2017 related to this matter is approximately $205m. The Group has sought recovery from its primary and excess insurers for costs of resolving the claims. The primary insurance carrier has paid $60m in full settlement of its policy liability. However, the excess carriers have denied coverage, citing defences relating to the wording of the insurance policies and other matters. In December 2004, the Group brought suit against them in the US district court for the Western District of Tennessee, for which a trial has not yet begun. An additional $22m was received during 2007 from a successful settlement with a third party. 17.3 Legal proceedings Product liability claims The Group faces claims from time to time for alleged defects in its products and has on occasion recalled or withdrawn products from the market. Such claims are endemic to the medical device industry. The Group maintains product liability insurance subject to limits and deductibles that management believes are reasonable. All policies contain exclusions and limitations, however, and there can be no assurance that insurance will be available or adequate to cover all claims. In recent years, there has been heightened concern about possible adverse effects of hip implant products with metal-on-metal bearing surfaces, and the Group has incurred, and will continue to incur expenses to defend claims in this area. As of February 2018, and giving effect to the US settlements described below, approximately 740 such claims were pending with the Group around the world, of which approximately 430 had given rise to pending legal proceedings. Most claims relate to the Group’s Birmingham Hip Resurfacing (BHR) product and its two modular metal-on-metal components: the Birmingham Hip Modular Head (BHMH) and the optional metal liner component of the R3 Acetabular System (R3ML). The BHMH and R3ML are no longer on the market: the R3ML was withdrawn in 2012 and the BHMH was phased out in 2014. In 2015, the Group ceased offering smaller sizes of the BHR and restricted instructions for BHR use in female patients. These actions were taken to ensure that the BHR is only used in those patient groups where it continues to demonstrate strong performance. In 2015 and 2016, the Group’s US subsidiary settled a large part of the majority of its US metal-on-metal hip lawsuits in two group settlements, without admitting liability. Insurance receipts covered most of the amounts paid, with the net cash cost being $25m. In November 2017, the Group’s US subsidiary entered into a memorandum of understanding to settle a third group of claims, without admitting liability. The third settlement is expected to be finalised in 2018. These cases principally related to the Group’s modular metal-on-metal hip components, which are no longer on the market. On 5 April 2017, the Judicial Panel on Multidistrict Litigation (MDL) ordered Smith & Nephew BHR cases pending or later filed in US federal court to be consolidated for pre-trial proceedings and transferred to the federal court in Baltimore, Maryland. There are currently 253 cases pending in the MDL in the United States. In England and Wales, the Group’s UK subsidiary entered into a group settlement in 2017 to settle 150 claims principally related to the Group’s modular metal-on-metal hip component, which are no longer on the market. Metal-on-metal hip implant claims against various companies in England and Wales have been consolidated for trials under group litigation orders in the High Court in London. The BHR and other claims pending against the Group have been stayed and will not be reactivated until the outcome of those trials is known. The Group has requested indemnity from its product liability insurers for most of these metal-on-metal hip implant claims. Each insurer makes its own decision as to coverage issues, and the liability of some insurers depends on exhaustion of lower levels of coverage. Insurers of the lower layers of the Group’s insurances have indemnified the Group in respect of these claims up to the limits of those insurances. The Group has commenced arbitration proceedings against another insurer in respect of that insurer’s share of the claims and associated defence costs in the amount of $50m. Litigation outcomes are difficult to predict and defence costs can be significant. The Group takes care to monitor the clinical evidence relating to its metal hip implant products and ensure that its product offerings are designed to serve patients’ interests. Intellectual property disputes The Group is engaged, as both plaintiff and defendant, in litigation with various competitors and others over claims of patent infringement and other intellectual property matters. These disputes are being heard in courts in the US and other jurisdictions and also before agencies that examine patents. Outcomes are rarely certain and costs are often significant. The Group prosecuted and defended a series of patent infringement suits against Arthrex in US federal courts in Oregon and Texas starting in 2004, principally relating to suture anchors for use in shoulder surgery. Arthrex paid $99m in June 2015 in connection with the Oregon litigation, and most of that award (net of various expenses) was recognised in the Group’s operating profit at that time. The Group asserted the same patent against additional Arthrex products in a follow-up suit that was scheduled for trial in February 2017 in the Oregon court. Arthrex asserted its own suture anchor patents against Smith & Nephew in 2014 and 2015 in the US District Court for the Eastern District of Texas. In December 2016, the jury in that case decided that two of the Group’s US subsidiaries infringed two asserted Arthrex patents and awarded Arthrex $17.4m. In February 2017, the parties reached a settlement resulting in the dismissal of all patent litigation in Oregon and Texas. Smith & Nephew agreed to pay Arthrex $8m, and each party agreed to additional payments contingent on the outcome of patent validity proceedings currently pending at the US Patent & Trademark Office relating to the asserted patents. In November 2017, the US Patent & Trademark Office issued a Reexamination Certificate confirming validity of certain claims of US Patent No. 5,601,557 asserted by Smith & Nephew against Arthrex in the Oregon litigation. The issuing of the Reexamination Certificate triggered a payment of $80m which was received by Smith & Nephew in December 2017, and $54m (net of various expenses) is recognised in the Group’s 2017 operating profit. The Group has fully provided for any possible additional payment relating to its historical sales. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 150ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued In February 2016, ConforMIS, Inc. filed suit against the Group’s US subsidiary in the Eastern Division of the US District Court for the District of Massachusetts, alleging that a number of its patents (generally directed to patient specific instrumentation associated with knee arthroplasty) are infringed by Smith & Nephew’s VISIONAIRE cutting guides and associated knee implants. The suit requests damages and an injunction. Smith & Nephew seeks to invalidate the asserted patents at the US Patent & Trademark Office and has also filed counterclaims for infringement by ConforMIS of the Group’s US patents. 17.4 Tax Matters At any given time the Group has unagreed years outstanding in various countries and is involved in tax audits and disputes, some of which may take several years to resolve. The Group believes that it has made adequate provision in respect of related additional tax liabilities that may arise. See Note 5 for further details. 18 RETIREMENT BENEFIT OBLIGATIONS Accounting policy The Group operates in numerous tax jurisdictions around the world. Although it is Group policy to submit its tax returns to the relevant tax authorities as promptly as possible, at any given time the Group has unagreed years outstanding and is involved in disputes and tax audits. Significant issues may take several years to resolve. In estimating the probability and amount of any tax charge, management takes into account the views of internal and external advisers and updates the amount of provision whenever necessary. The ultimate tax liability may differ from the amount provided depending on interpretations of tax law, settlement negotiations or changes in legislation. Business combinations
The group has identified “growth through acquisitions” as one of its Strategic Priorities. During 2014, we acquired ArthroCare Corporation; the determination of the balance sheet fair value acquired is dependent upon the understanding of the circumstances at acquisition and estimates of the future results of the acquired business and management judgement is a factor in making these determinations.
104Smith & Nephew Annual report 2014
Independent auditor’s US reports
Report of Independent Registered Public Accounting Firm to the Board of Directors and shareholders of Smith & Nephew plc
We have audited the accompanying group balance sheets of Smith & Nephew plc as of 31 December 2014 and 2013, and the related group income statements, group statements of comprehensive income, group cash flow statements and group statements of changes in shareholder’s equity for each of the three years in the period ended 31 December 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Auditor’s responsibility
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Smith & Nephew plc at 31 December 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended 31 December 2014, in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board and International Financial Reporting Standards as adopted by the European Union.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Smith & Nephew plc’s internal control over financial reporting as of 31 December 2014, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organisations of the Treadway Commission (2013 framework) and our report dated 25 February 2015 expressed an unqualified opinion thereon.
Ernst & Young LLP
London, England
25 February 2015
Report of Independent Registered Public Accounting Firm to the Board of Directors and shareholders of Smith & Nephew plc
We have audited Smith & Nephew plc’s internal control over financial reporting as of 31 December 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), (the COSO criteria). Smith & Nephew plc’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying ‘Evaluation of Internal Controls’. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Smith & Nephew plc maintained, in all material respects, effective internal control over financial reporting as of 31 December 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the group balance sheets of Smith & Nephew plc as of 31 December 2014 and 2013, and the related group income statements, group statements of comprehensive income, group cash flow statements and group statements of changes in equity for each of the three years in the period ended 31 December 2014 of Smith & Nephew plc and our report dated 25 February 2015 expressed an unqualified opinion thereon.
Ernst & Young LLP
London, England
25 February 2015
Smith & Nephew Annual report 2014 105
FINANCIAL STATEMENTS
Independent auditor’s UK report
Independent auditor’s report to the members
of Smith & Nephew plc
Opinion on financial statements
In our opinion:
– | the financial statements give a true and fair view of the state of the group and of the parent company’s affairs as at 31 December 2014; |
– | the group financial statements give a true and fair view of the profit for the year ended 31 December 2014; |
– | the group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and IFRSs as adopted by the International Accounting Standards Board (IASB); |
– | the parent company financial statements have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; |
– | the group and the parent company financial statements have been prepared in accordance with the requirements of the Companies Act 2006; and |
– | the group financial statements have been prepared in accordance with Article 4 of the IAS Regulation. |
What we have audited
We have audited the financial statements of Smith & Nephew plc for the year ended 31 December 2014 which comprise:
| | | Group
| | Company
| The Group income statement
| | The Company balance sheet
| The Group statement of comprehensive income
| | The related notes 1 to 9.
| The Group balance sheet
| | | The Group cash flow statement
| | | The Group statement of changes in equity
| | | The related notes 1 to 23.
| | |
As explained in Note 1 to the consolidated financial statements, the group in addition to applying IFRS as adopted by the European Union has also applied IFRS as issued by the International Accounting Standards Board (IASB). The financial reporting framework that has been applied in the preparation of the Company financial statements is the provisions of the Companies Act 2006 and United Kingdom Generally Accepted Accounting Practice.
| | | Overview
| | | Materiality | | Overall Group materiality of $45 million which represents 5% of adjusted profit before tax
| Audit scope
| | We performed an audit of the complete financial information of two components and audit procedures on specific balances for a further ten components.
The 12 reporting components where we performed audit procedures accounted for 81% of the group’s total assets, 64% group revenue and 85% of the group’s profit before tax and 86% of the group’s adjusted profit before tax.
| Areas of focus
| | Recognition and measurement of provisions for litigation reserves and contingent liabilities
Recognition and measurement of provisions for taxation
Existence and valuation of inventory
Timing of revenue recognition and measurement of related reserves
Judgements determining purchase price allocation on acquisitions
|
Our application of materiality
We determined materiality for the group to be $45 million (2013: $45 million), which is calculated as 5% of adjusted profit before tax. We believe that profit before tax, adjusted for the items, as described below, provides us with a consistent year on year basis for determining materiality and is the most relevant performance measure to the stakeholders of the entity. Adjustments are made to profit before tax for acquisition related costs of $118m and restructuring and rationalisation expenses of $61m as highlighted in note 2.2 of the financial statements, as well as acquisition-related finance costs of $7m. This provided a basis for identifying and assessing the risk of material misstatement and determining the nature, timing and extent of further audit procedures.
On the basis of our risk assessments, together with our assessment of the group’s overall control environment and other qualitative considerations, our judgement was that overall performance materiality (i.e. our tolerance for misstatement in an individual account or balance) for the group should be 75% (2013: 75%) of planning materiality, namely $33.75 million (2013: $33.75 million). Our objective in adopting this approach was to reduce to an appropriately low level the probability that the aggregate of total undetected and uncorrected misstatements for the accounts as a whole did not exceed our planning materiality.
Audit work at individual components is undertaken based on a percentage of our total performance materiality. The performance materiality set for each component is based on the relative size of the component and our view of the risk of misstatement at that component. In the current year the range of performance materiality allocated to components was $3.32m to $21.58m.
We agreed with the Audit Committee that we would report to the
Committee all audit differences in excess of $2.25 million (2013: $2.25 million), as well as differences below that threshold that, in our view warranted reporting on qualitative grounds.
We evaluate any uncorrected misstatements against both the quantitative measures of materiality discussed above and in the light of other relevant qualitative considerations.
This page does not form part of Smith & Nephew’s Annual Report and Form 20-F as filed with the SEC.
106Smith & Nephew Annual report 2014
Scope of our audit
An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the group’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Following our assessment of the risk of material misstatement to the group financial statements, we selected 12 components which represent the principal business units within the group’s two reportable segments. Two of these components were subject to a full audit and ten were subject to a partial scope audit where the extent of audit work was based on our assessment of the risks of material misstatement outlined below and the materiality of the location’s business operations relative to the group. The scope of these components may not have included testing of all significant accounts of the location but will have contributed to the coverage of significant accounts tested for the group. Partial scope component testing of significant risks is primarily focused on the inventory and revenue recognition risks as tax, litigation
and purchase price allocation risks are audited centrally. For the remaining components, we performed other procedures to test or assess that there were no significant risks of material misstatement in these components in relation to the group financial statements. The components subject to full audit or partial scope audit procedures make up 81% of the group’s total assets, 64% of the group’s revenue, 85% of the group’s profit before tax and 86% of the group’s adjusted profit before tax, although for countries where a partial scope audit was performed, not all balances that comprise these coverage percentages have been audited.
The group audit team continued to follow a programme of planned visits that has been designed to ensure that the Senior Statutory Auditor or his designate visits each of the locations where the Group audit scope was focused at least once every two years and the most significant of them at least once a year. For all full scope entities, in addition to the location visit, the group audit team participated in the component team’s planning, including the component team’s discussion of fraud and error. The group audit team have also reviewed key working papers and challenged conclusions on significant risk areas, as identified at the scoping stage, primarily inventory and revenue recognition. The group audit team visited nine locations in total over the course of the current year audit.
Our assessment of risks of material misstatement
We consider that the following areas present the greatest risk of material misstatement in the financial statements and consequently have had the greatest impact on our audit strategy, the allocation of resources and the efforts of the engagement team, including the more senior members of the team:
| | | Principal risk area and rationale
| | Audit response
| Recognition and measurement of provisions for litigation reserves and contingent liabilities
| The development, manufacture and sale of medical devices entails risk of product liability claims and patent infringement issues due to the surgical nature of the products and the competitive nature of the industry.
Determining the impact and likely outcome of any litigation matters requires significant judgement due to the uncertainty of the litigation process and the level of royalty that may be payable for infringed products and raises the risk that those legal provisions may be incorrect.
| | The litigation reserve at 31 December 2014, included in legal and other provisions of $118m in note 17.1 to the financial statements, covers a number of open legal matters as described in detail in note 17.3 to the financial statements. We held discussions with in-house legal counsel to understand the status of litigation cases. We read legal invoices and corresponded directly with external legal advisors to understand the fact patterns of the cases. We reviewed management’s calculations of provisions, including their assessment of potential royalties payable for past sales and challenged and corroborated key assumptions.
| Recognition and measurement of provisions for taxation
| The tax charge of profits is determined according to complex tax laws and regulations. Where the effect of these tax laws and regulations is unclear, judgements are used in determining the liability for the tax to be paid.
As a multinational Company, tax audits can be ongoing in a number of jurisdictions at any point in time and tax returns are subject to possible challenge in most locations in which the Company operates.
There can be significant judgement involved in determining the provision for tax liabilities.
| | The details of the tax charge are included in note 5.1 to the financial statements.
We involved tax specialists in the US and the UK to assist us in assessing and challenging the assumptions and judgements made by the company in their recognition and measurement of provisions for taxation. We tested tax calculations and challenged the company’s transfer pricing arrangements, tax planning activities and status and findings from ongoing tax audits to assess the reasonableness of the provisions recorded. This included an assessment of the likelihood that known uncertain tax positions would result in a tax liability to the company.
|
This page does not form part of Smith & Nephew’s Annual Report and Form 20-F as filed with the SEC.
Smith & Nephew Annual report 2014 107
FINANCIAL STATEMENTS
Independent auditor’s UK reportcontinued
| | | Principal risk area and rationale
| | Audit response
| Existence and valuation of inventory | | | The Company has high levels of finished goods inventory, as detailed in note 12 to the financial statements, some of which are located at customer premises to be available for immediate use.
Complete sets of products, including outsizes, have to be made available in this way, with these sizes used less frequently. Towards the end of a product’s life cycle, these inventory levels are more than is required and therefore excess to requirements.
In estimating the appropriate value for inventory, management has to apply judgement on how much of the inventory on hand will ultimately be used, considering the length of product lives predicted, product usage and how quickly products will be phased out.
| | We carried out tests of controls over routine inventory processes, including cycle counts and period end counts.
We independently counted or confirmed inventory levels at key component locations and also reviewed the results of management’s testing results for a sample of counts that we did not attend.
We challenged management’s judgements and assumptions used in determining the inventory excess and obsolescence provision in order to assess that their calculation represents excess and obsolete inventory. We understood their plans for launching new product lines or discontinuing product lines to assess the adequacy of the provision, as well as reflecting on the adequacy of prior year provisions.
We tested management’s calculation to eliminate intercompany profit held in inventory as goods are sold between group companies, including the recalculation and vouching of margins on a sample basis.
| Timing of revenue recognition and measurement of related reserves
| | | Revenue recognition is one of the key areas of audit focus, particularly in respect of the risk of management override and the risk of cut-off of revenue for sales to distributors with the need for the risks and rewards of ownership to have passed before revenue is recognised. | | We carried out tests of controls over revenue recognition, including the timing of revenue recognition, as well as substantive testing, analytical procedures and assessing whether the revenue recognition policies adopted complied with IFRS as detailed in note 2.1 to the financial statements.
Procedures included independent confirmation with distributors, reviewing shipping terms for items despatched to test that the risk and reward of ownership had passed, cut off testing of items despatched close to the year end date and a review of returns and credit notes issued subsequent to the year end.
We also performed detailed trend analysis by period and by major customer to identify unusual fluctuations.
| Judgements determining purchase price allocation on acquisitions
| | | On 27 May 2014, the Group acquired ArthroCare Corporation for $1.7bn.
The acquisition accounting includes the need to determine the fair value of the acquired assets and liabilities at the acquisition date. This included complex valuation considerations and required the use of specialists.
The most significant judgements relate to the valuation of intangible assets acquired, the uplift to the value of inventory and property, plant and equipment and the value of any provisions recorded.
| | We focused on this area given the significant judgements involves in assessing the fair values of assets and liabilities acquired as this directly impacts the amount of goodwill recognised on acquisition. The fair values are based on valuation techniques built, in part, on assumptions around the future performance of the business. We challenged the assumptions underpinning the valuations, assessed the fair value of the identified assets and liabilities, audited the accounting differences upon IFRS conversion and evaluated the adequacy of the disclosures.
We also discussed the specialist valuations with the specialists and read their reports, with involvement of our own specialists to conclude on the appropriateness of the valuation.
|
This page does not form part of Smith & Nephew’s Annual Report and Form 20-F as filed with the SEC.
108Smith & Nephew Annual report 2014
Opinion on other matter prescribed by
the Companies Act 2006
In our opinion the information given in the Strategic Report and the Directors’ Report for the financial year for which the group financial statements are prepared is consistent with the group financial statements.
Respective responsibilities of directors and auditor
As explained more fully in the Directors’ Responsibilities Statement set out on page 103, the directors are responsible for the preparation of the group financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the group financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed.
Matters on which we are required to report
by exception
We have nothing to report in respect of the following:
Under the ISAs (UK and Ireland), we are required to report to you if, in our opinion, information in the annual report is:
– | materially inconsistent with the information in the audited financial statements; or |
– | apparently materially incorrect based on, or materially inconsistent with, our knowledge of the Group acquired in the course of performing our audit; or |
– | is otherwise misleading. |
In particular, we are required to consider whether we have identified any inconsistencies between our knowledge acquired during the audit and the directors’ statement that they consider the annual report is fair, balanced and understandable and whether the annual report appropriately discloses those matters that we communicated to the audit committee which we consider should have been disclosed.
Under the Companies Act 2006 we are required to report to you if, in our opinion:
– | certain disclosures of directors’ remuneration specified by law are not made; or |
– | we have not received all the information and explanations we require for our audit. |
Under the Listing Rules we are required to review:
– | the directors’ statement, set out on page 103, in relation to going concern. |
– | the part of the Corporate Governance Statement relating to the company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review. |
Michael Rudberg (Senior statutory auditor)
for and on behalf of Ernst & Young LLP, Statutory Auditor
London
25 February 2015
This page does not form part of Smith & Nephew’s Annual Report and Form 20-F as filed with the SEC.
Smith & Nephew Annual report 2014 109
FINANCIAL STATEMENTS
Group income statement
| | | | | | | | | | | | | | | | | | | | Notes | | | | Year ended 31 December 2014 $ million | | | | Year ended 31 December 2013 $ million | | | | Year ended 31 December 2012 $ million | | Revenue | | | 2 | | | | 4,617 | | | | 4,351 | | | | 4,137 | | Cost of goods sold | | | | | | | (1,162 | ) | | | (1,100 | ) | | | (1,070 | ) | Gross profit | | | | | | | 3,455 | | | | 3,251 | | | | 3,067 | | Selling, general and administrative expenses | | | 3 | | | | (2,471 | ) | | | (2,210 | ) | | | (2,050 | ) | Research and development expenses | | | 3 | | | | (235 | ) | | | (231 | ) | | | (171 | ) | Operating profit | | | 2 & 3 | | | | 749 | | | | 810 | | | | 846 | | Interest receivable | | | 4 | | | | 13 | | | | 14 | | | | 11 | | Interest payable | | | 4 | | | | (35 | ) | | | (10 | ) | | | (9 | ) | Other finance costs | | | 4 | | | | (11 | ) | | | (11 | ) | | | (11 | ) | Share of results of associates | | | 11 | | | | (2 | ) | | | (1 | ) | | | 4 | | Profit on disposal of net assets held for sale | | | 3 | | | | – | | | | – | | | | 251 | | Profit before taxation | | | | | | | 714 | | | | 802 | | | | 1,092 | | Taxation | | | 5 | | | | (213 | ) | | | (246 | ) | | | (371 | ) | Attributable profit for the year (i) | | | | | | | 501 | | | | 556 | | | | 721 | | Earnings per ordinary share (i) | | | 6 | | | | | | | | | | | | | | Basic | | | | | | | 56.1¢ | | | | 61.7¢ | | | | 80.4¢ | | Diluted | | | | | | | 55.7¢ | | | | 61.4¢ | | | | 80.0¢ | |
Group statement of comprehensive income
| | | | | | | | | | | | | | | | | | | | Notes | | | | Year ended 31 December 2014 $ million | | | | Year ended 31 December 2013 $ million | | | | Year ended 31 December 2012 $ million | | Attributable profit for the year (i) | | | | | | | 501 | | | | 556 | | | | 721 | | Other comprehensive income: | | | | | | | | | | | | | | | | | Items that will not be reclassified to income statement | | | | | | | | | | | | | | | | | Actuarial (losses)/gains on retirement benefit obligations | | | 18 | | | | (94 | ) | | | 12 | | | | (5 | ) | Taxation on other comprehensive income | | | 5 | | | | 19 | | | | (16 | ) | | | 20 | | Total items that will not be reclassified to income statement | | | | | | | (75 | ) | | | (4 | ) | | | 15 | | | | | | | Items that may be reclassified subsequently to income statement | | | | | | | | | | | | | | | | | Cash flow hedges – interest rate derivatives | | | | | | | | | | | | | | | | | – losses arising in the year | | | | | | | (5 | ) | | | – | | | | – | | Cash flow hedges – forward foreign exchange contracts | | | | | | | | | | | | | | | | | – gains/(losses) arising in the year | | | | | | | 31 | | | | 8 | | | | (1 | ) | – gains transferred to inventories for the year | | | | | | | (14 | ) | | | (3 | ) | | | (6 | ) | Exchange differences on translation of foreign operations | | | | | | | (196 | ) | | | (6 | ) | | | 36 | | Exchange on borrowings classified as net investment hedges | | | | | | | – | | | | – | | | | 1 | | Total items that may be reclassified subsequently to income statement | | | | | | | (184 | ) | | | (1 | ) | | | 30 | | Other comprehensive (expense)/income for the year, net of taxation | | | | | | | (259 | ) | | | (5 | ) | | | 45 | | Total comprehensive income for the year (i) | | | | | | | 242 | | | | 551 | | | | 766 | |
(i) | Attributable to equity holders of the Company and wholly derived from continuing operations. |
The Notes on pages 117 to 165 are an integral part of these accounts.
110Smith & Nephew Annual report 2014
Commentary on the Group income statement and Group statement of comprehensive income
Revenue
Group revenue increased by $266m (6% on a reported basis), from $4,351m in 2013 to $4,617m in 2014.
The underlying increase is 2%, after adjusting for the 5% impact of the acquisitions of ArthroCare and a Brazilian distributor and 1% attributable to the unfavourable impact of currency movements. Despite flat growth in the Established Markets, growth of 17% in the Emerging & International Markets contributed to this underlying increase of 2%.
Cost of goods sold
Cost of goods sold increased by $62m (6% on a reported basis) from $1,100m in 2013 to $1,162m in 2014. The underlying movement is 5% after adjusting for the net impact of 4% from the ArthroCare acquisition and 3% attributable to the unfavourable impact of currency movements. The movement in underlying costs of goods sold of 5% is largely attributable to the increase in underlying trading.
During 2014, $12m of restructuring and rationalisation expenses (2013 – $12m) and $23m of acquisition related costs (2013 – $5m) were charged to cost of goods sold.
Selling, general and administrative expenses
Selling, general and administrative expenses increased by $261m (12% on a reported basis) from $2,210m in 2013 to $2,471m in 2014. The underlying movement is 5% after adjusting for the net impact of 7% from the ArthroCare acquisition. Currency movements had no impact.
The underlying increase of 5% is due to the promotion of new product and costs associated with the RENASYS distribution hold and HP802 termination and the underlying increase in trading.
In 2014, administrative expenses included $62m of amortisation of other intangible assets (2013 – $64m), $49m of restructuring and rationalisation expenses (2013 – $46m), an amount of $129m relating to amortisation of acquisition intangibles (2013 – $88m) and $95m of acquisition related costs (2013 – $26m).
Research and development expenses
Research and development expenditure as a percentage of revenue remained broadly consistent at 5.1% in 2014 (2013 – 5.3%). Actual expenditure was $235m in 2014 compared to $231m in 2013. The Group continues to invest in innovative technologies and products to differentiate it from competitors.
Operating profit
Operating profit decreased by $61m to $749m from $810m in 2013. This comprised an increase of $6m in Advanced Surgical Devices and a decrease of $67m in Advanced Wound Management.
The movement in Advanced Surgical Devices is attributable to the continuing pressure on margins and its investment in the Emerging & International Markets. Advanced Wound Management has been adversely impacted by the costs assocaited with the RENASYS distribution hold and the impairment and costs associated with the termination of the HP802 programme.
Net interest receivable/(payable)
Net interest payable increased by $26m, from a net $4m receivable in 2013 to a net payable of $22m in 2014. This movement is primarily due to an increase in interest payable as a result of financing the ArthroCare acquisition. Interest receivable also decreased following the repayment by Bioventus LLC of their loan note in October 2014.
Other finance costs
Other finance costs in 2014 remained at $11m and principally relate to costs associated with the Group’s retirement benefit schemes.
Taxation
The taxation charge decreased, by $33m, to $213m from $246m in 2013. The rate of tax was 29.9%, compared with 30.5% in 2013.
After adjusting for specific transactions that management considers affect the Group’s short-term profitability, restructuring and rationalisation expenses, amortisation of acquisition intangibles, acquisition related costs and legal and other items) the tax rate was 27.7% (2013 – 29.2%).
The financial commentary on this page forms part of the business review and is unaudited.
See pages 180 to 183 for commentary on the 2013 financial year.
Smith & Nephew Annual report 2014 111
FINANCIAL STATEMENTS
Group balance sheet
| | | | | | | | | | | | | | | | Notes | | |
| At
31 December 2014 $ million |
| | | At 31 December 2013 $ million | | Assets | | | | | | | | | | | | | Non-current assets: | | | | | | | | | | | | | Property, plant and equipment | | | 7 | | | | 891 | | | | 816 | | Goodwill | | | 8 | | | | 2,027 | | | | 1,256 | | Intangible assets | | | 9 | | | | 1,747 | | | | 1,054 | | Investments | | | 10 | | | | 5 | | | | 2 | | Investments in associates | | | 11 | | | | 112 | | | | 107 | | Loans to associates | | | 11 | | | | – | | | | 178 | | Retirement benefit asset | | | 18 | | | | 7 | | | | 5 | | Deferred tax assets | | | 5 | | | | 77 | | | | 145 | | | | | | | | | 4,866 | | | | 3,563 | | Current assets: | | | | | | | | | | | | | Inventories | | | 12 | | | | 1,181 | | | | 1,006 | | Trade and other receivables | | | 13 | | | | 1,166 | | | | 1,113 | | Cash at bank | | | 15 | | | | 93 | | | | 137 | | | | | | | | | 2,440 | | | | 2,256 | | Total assets | | | | | | | 7,306 | | | | 5,819 | | | | | | | | | | | | | | | Equity and liabilities | | | | | | | | | | | | | Equity attributable to owners of the Company: | | | | | | | | | | | | | Share capital | | | 19 | | | | 184 | | | | 184 | | Share premium | | | | | | | 574 | | | | 535 | | Capital redemption reserve | | | | | | | 11 | | | | 10 | | Treasury shares | | | 19 | | | | (315 | ) | | | (322 | ) | Other reserves | | | | | | | (64 | ) | | | 120 | | Retained earnings | | | | | | | 3,650 | | | | 3,520 | | Total equity | | | | | | | 4,040 | | | | 4,047 | | Non-current liabilities: | | | | | | | | | | | | | Long-term borrowings | | | 15 | | | | 1,666 | | | | 347 | | Retirement benefit obligations | | | 18 | | | | 233 | | | | 230 | | Other payables | | | 14 | | | | 44 | | | | 7 | | Provisions | | | 17 | | | | 63 | | | | 65 | | Deferred tax liabilities | | | 5 | | | | 98 | | | | 50 | | | | | | | | | 2,104 | | | | 699 | | Current liabilities: | | | | | | | | | | | | | Bank overdrafts and loans | | | 15 | | | | 39 | | | | 44 | | Trade and other payables | | | 14 | | | | 838 | | | | 785 | | Provisions | | | 17 | | | | 67 | | | | 60 | | Current tax payable | | | | | | | 218 | | | | 184 | | | | | | | | | 1,162 | | | | 1,073 | | Total liabilities | | | | | | | 3,266 | | | | 1,772 | | Total equity and liabilities | | | | | | | 7,306 | | | | 5,819 | |
The accounts were approved by the Board and authorised for issue on 25 February 2015 and are signed on its behalf by:
| | | | | | | | | Roberto Quarta | | Olivier Bohuon | | Julie Brown | | | | | Chairman | | Chief Executive Officer | | Chief Financial Officer | | | | |
The Notes on pages 117 to 165 are an integral part of these accounts.
112Smith & Nephew Annual report 2014
Commentary on the Group balance sheet
Non-current assets
Non-current assets increased by $1,303m to $4,866m in 2014 from $3,563m in 2013. This is principally attributable to the following:
– | Property, plant and equipment increased by $75m from $816m in 2013 to $891m in 2014. Depreciation of $222m was charged during 2014, assets with a net book value of $15m were disposed of and $14m was impaired relating to HP802. These movements were offset by $298m of additions relating primarily to instruments and other plant & machinery and $62m of additions arising on the acquisitions of ArthroCare. The balance relates to unfavourable currency movements totalling $34m. |
– | Goodwill increased by $771m from $1,256m in 2013 to $2,027m in 2014. Of this movement, $829m arose on the acquisition of ArthroCare and $15m on the acquisition in Brazil. The remaining balance relates to unfavourable currency movements totalling $73m. |
– | Intangible assets increased by $693m from $1,054m in 2013 to $1,747m in 2014. Intangible assets totalling $817m and $16m arose on the acquisition of ArthroCare and Brazil respectively. Amortisation of $191m was charged during the year and assets with a net book value of $1m were disposed of. A total of $77m relates to the cost of intellectual property, distribution rights and software acquired. The balance relates to unfavourable currency movements totalling $25m. |
– | Investment in associates of $112m in 2014 has increased from $107m in 2013. The loan to the associate was fully repaid in the year. |
– | Deferred tax assets decreased by $68m in the year from $145m in 2013 to $77m in 2014. |
Current assets
Current assets increased by $184m to $2,440m from $2,256m in 2013. The movement relates to the following:
– | Inventories rose by $175m to $1,181m in 2014 from $1,006m in 2013. This movement is principally attributable to the acquisitions of ArthroCare and distributor in Brazil which increased inventory by $70m and $36m relating to the purchase of an advanced quantity of an ingredient to ensure continued supply of REGRANEX. |
– | The level of trade and other receivables increased by $53m to $1,166m in 2014 from $1,113m in 2013. The movement primarily relates to the increase in underlying revenues and $54m from the ArthroCare acquisition offset by $75m of unfavourable currency movements. |
– | Cash at bank has fallen by $44m to $93m from $137m in 2013. |
Non-current liabilities
Non-current liabilities increased by $1,405m from $699m in 2013 to $2,104m in 2014. This movement relates to the following items:
– | Long-term borrowings have increased from $347m in 2013 to $1,666m in 2014 as a result of the $1.1bn private placements and $400m additional long-term facility use to fund the acquisition of ArthroCare. |
– | The Retirement benefit obligation increased by $3m to $233m in 2014 from $230m in 2013. |
– | Deferred tax liabilities increased by $48m in the year from $50m in 2013 to $98m in 2014. |
Current liabilities
Current liabilities increased by $89m from $1,073m in 2013 to $1,162m in 2014. This movement is attributable to:
– | Bank overdrafts and current borrowings have decreased by $5m from $44m in 2013 to $39m in 2014. |
– | Trade and other payables have increased by $53m to $838m in 2014 from $785m in 2013. This increase includes $75m of trade and other payables arising on the acquisition of ArthroCare and distributor in Brazil offset by $34m of favourable currency movements. |
– | Current tax payable is $218m at the end of 2014 compared to $184m in 2013. |
Total equity
Total equity decreased by $7m from $4,047m in 2013 to $4,040m in 2014. The principal movements were:
| | | | | | |
| Total equity
$ million |
| 1 January 2014 | | | 4,047 | | Attributable profit | | | 501 | | Currency translation losses | | | (196 | ) | Hedging reserves | | | 12 | | Actuarial losses on retirement benefit obligations | | | (94 | ) | Dividends paid during the year | | | (250 | ) | Purchase of own shares | | | (75 | ) | Taxation on Other Comprehensive Income and equity items | | | 19 | | Net share-based transactions | | | 76 | | 31 December 2014 | | | 4,040 | |
The financial commentary on this page forms part of the business review and is unaudited.
See pages 180 to 183 for commentary on the 2013 financial year.
Smith & Nephew Annual report 2014 113
FINANCIAL STATEMENTS
Group cash flow statement
| | | | | | | | | | | | | | | | | | | | Notes | | | | Year ended 31 December 2014 $ million | | | | Year ended 31 December 2013 $ million | | | | Year ended 31 December 2012 $ million | | Cash flows from operating activities | | | | | | | | | | | | | | | | | Profit before taxation | | | | | | | 714 | | | | 802 | | | | 1,092 | | Net interest payable/(receivable) | | | 4 | | | | 22 | | | | (4 | ) | | | (2 | ) | Depreciation, amortisation and impairment | | | | | | | 427 | | | | 361 | | | | 312 | | Loss on disposal of property, plant and equipment and software | | | | | | | 11 | | | | 23 | | | | 12 | | Distribution from investment | | | | | | | 1 | | | | – | | | | – | | Share-based payments expense | | | 23 | | | | 32 | | | | 28 | | | | 34 | | Share of results of associates | | | 11 | | | | 2 | | | | 1 | | | | (4 | ) | Dividends received from associates | | | 11 | | | | – | | | | 1 | | | | 7 | | Profit on disposal of manufacturing facility | | | 21 | | | | (9 | ) | | | – | | | | – | | Profit on disposal of net assets held for sale | | | 3 | | | | – | | | | – | | | | (251 | ) | Net movement in post retirement benefit obligations | | | | | | | (81 | ) | | | (27 | ) | | | (28 | ) | (Increase)/Decrease in inventories | | | | | | | (168 | ) | | | (99 | ) | | | 12 | | Increase in trade and other receivables | | | | | | | (76 | ) | | | (70 | ) | | | (5 | ) | Increase in trade and other payables and provisions | | | | | | | 86 | | | | 122 | | | | 5 | | Cash generated from operations (i) (ii) | | | | | | | 961 | | | | 1,138 | | | | 1,184 | | Interest received | | | | | | | 3 | | | | 4 | | | | 4 | | Interest paid | | | | | | | (36 | ) | | | (10 | ) | | | (8 | ) | Income taxes paid | | | | | | | (245 | ) | | | (265 | ) | | | (278 | ) | Net cash inflow from operating activities | | | | | | | 683 | | | | 867 | | | | 902 | | Cash flows from investing activities | | | | | | | | | | | | | | | | | Acquisitions, net of cash acquired | | | 21 | | | | (1,572 | ) | | | (74 | ) | | | (782 | ) | Proceeds on disposal of net assets held for sale | | | | | | | – | | | | – | | | | 103 | | Capital expenditure | | | 2 | | | | (375 | ) | | | (340 | ) | | | (265 | ) | Investment in associate | | | 11 | | | | (2 | ) | | | – | | | | (10 | ) | Purchase of investments | | | 10 | | | | (4 | ) | | | – | | | | – | | Proceeds from associate loan redemption | | | 11 | | | | 188 | | | | – | | | | – | | Proceeds on disposal of manufacturing facility | | | 21 | | | | 20 | | | | – | | | | – | | Cash received on disposal of associate | | | | | | | – | | | | 7 | | | | – | | Net cash used in investing activities | | | | | | | (1,745 | ) | | | (407 | ) | | | (954 | ) | Cash flows from financing activities | | | | | | | | | | | | | | | | | Proceeds from issue of ordinary share capital | | | | | | | 40 | | | | 48 | | | | 77 | | Purchase of own shares | | | | | | | (75 | ) | | | (231 | ) | | | – | | Proceeds of borrowings due within one year | | | 20 | | | | 30 | | | | 12 | | | | 40 | | Settlement of borrowings due within one year | | | 20 | | | | (52 | ) | | | (6 | ) | | | (296 | ) | Proceeds on borrowings due after one year | | | 20 | | | | 3,390 | | | | 695 | | | | 415 | | Settlement of borrowings due after one year | | | 20 | | | | (2,068 | ) | | | (779 | ) | | | (1 | ) | Proceeds from own shares | | | | | | | 4 | | | | 3 | | | | 6 | | Settlement of currency swaps | | | 20 | | | | (11 | ) | | | (1 | ) | | | (1 | ) | Equity dividends paid | | | 19 | | | | (250 | ) | | | (239 | ) | | | (186 | ) | Net cash from/(used in) financing activities | | | | | | | 1,008 | | | | (498 | ) | | | 54 | | Net (decrease)/increase in cash and cash equivalents | | | | | | | (54 | ) | | | (38 | ) | | | 2 | | Cash and cash equivalents at beginning of year | | | 20 | | | | 126 | | | | 167 | | | | 161 | | Exchange adjustments | | | 20 | | | | (7 | ) | | | (3 | ) | | | 4 | | Cash and cash equivalents at end of year | | | | | | | 65 | | | | 126 | | | | 167 | |
(i) | Includes $60m (2013 – $54m, 2012 – $55m) of outgoings on restructuring and rationalisation expenses. |
(ii) | Includes $112m (2013 – $25m, 2012 – $3m) of acquisition-related costs and $23m (2013 – $nil, 2012 – $22m) of legal and other costs |
The Notes on pages 117 to 165 are an integral part of these accounts.
114Smith & Nephew Annual report 2014
Commentary on the Group cash flow statement
The main elements of the Group’s cash flow and movements in net debt can be summarised as follows:
Net cash inflow from operating activities
Cash generated from operations in 2014 of $961m (2013 – $1,138m, 2012 – $1,184m) is after paying out $112m (2013 – $25m, 2012 – $3m) of acquisition-related costs, $60m (2013 – $54m, 2012 – $55m) of restructuring and rationalisation expenses and $23m (2013 – $nil, 2012 – $22m) relating to legal and other exceptional costs.
Capital expenditure
The Group’s ongoing capital expenditure and working capital requirements were financed through cash flow generated by business operations and, where necessary, through short-term committed and uncommitted bank facilities. In 2014, capital expenditure on tangible and intangible fixed assets represented approximately 8% of continuing Group revenue (2013 – 8%, 2012 – 6%).
In 2014, capital expenditure amounted to $375m (2013 – $340m, 2012 – $265m). The principal areas of investment were the placement of orthopaedic instruments with customers, patents and licences, plant and equipment and information technology.
At 31 December 2014, $34m (2013 – $41m, 2012 – $4m) of capital expenditure had been contracted but not provided for which will be funded from cash inflows.
Acquisitions and disposals
In the three-year period ended 31 December 2014, $2,428m was spent on acquisitions, funded from net debt and cash inflows. This comprised, $782m for Healthpoint acquired in December 2012, $74m relating to acquisitions in Turkey, Brazil and India completed in quarter four of 2013, $1,546m for ArthroCare acquired in May 2014 and $26m for the acquisition in Brazil completed in quarter one 2014.
During 2012, the Group completed the transfer of its Biologics and Clinical Therapies business (‘CT’) to Bioventus for total consideration of $367m. As part of this transaction the Group received a 49% interest in Bioventus with a value of $104m and subsequently invested a further $10m.
During 2014, the Group received repayment of the $160m loan note to Bioventus and $28m of accrued interest.
Proceeds of $20m have been received on the disposal of the Group’s manufacturing plant in Gilberdyke, UK.
Liquidity and capital resources
The Group’s policy is to ensure that it has sufficient funding and facilities in place to meet foreseeable borrowing requirements.
At 31 December 2014, the Group held $65m (2013 – $126m, 2012 $167m) in cash net of bank overdrafts. The group had committed facilities available of $2,525m at 31 December 2014 of which $1,655m was drawn. Smith & Nephew intends to repay the amounts due within one year by using available cash and drawing down on the longer term facilities. In addition, Smith & Nephew has finance lease commitments of $12m.
During the year ended 31 December 2014, the Group refinanced its principal banking facilities. The Group has signed a new five-year committed $1 billion multi-currency revolving credit facility with a maturity date of March 2019. In addition, the Group signed a $1.4 billion committed term loan facility with a maturity date of February 2016. The Group drew down its $1.4 billion committed term loan facility to fund the acquisition of ArthroCare. $1 billion of this loan was repaid during the year partly from private placement proceeds.
During the year ended 31 December 2014, the Group received the entire proceeds of the $325 million private placement debt agreement signed in December 2013. The funds have a weighted average fixed rate of 3.7% and mature between 2021 and 2026. The Group also received $800 million of proceeds from a second private placement agreement signed in November 2014. The funds have a weighted average fixed rate of 3.1% and mature between 2019 and 2024.
The principal variations in the Group’s borrowing requirements result from the timing of dividend payments, acquisitions and disposals of businesses, timing of capital expenditure and working capital fluctuations. Smith & Nephew believes that its capital expenditure needs and its working capital funding for 2015, as well as its other known or expected commitments or liabilities, can be met from its existing resources and facilities. The Group’s net debt increased from $288m at the beginning of 2013 to $1,613m at the end of 2014, representing an overall increase of $1,325m.
The Group’s planned future contributions are considered adequate to cover the current underfunded position in the Group’ssponsors defined benefit plans.
The financial commentary on this page forms part of the business review and is unaudited.
See pages 180 to 183 for commentary on the 2013 financial year.
Smith & Nephew Annual report 2014 115
FINANCIAL STATEMENTS
Group statement of changes in equity
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Share capital $ million | | | | Share premium $ million | | | | Capital redemption reserve $ million | | | | Treasury shares (ii) $ million | | | | Other reserves (iii) $ million | | | | Retained earnings $ million | | | | Total equity $ million | | At 31 December 2011 | | | 191 | | | | 413 | | | | – | | | | (766 | ) | | | 91 | | | | 3,258 | | | | 3,187 | | Total comprehensive income (i) | | | – | | | | – | | | | – | | | | – | | | | 30 | | | | 736 | | | | 766 | | Equity dividends declared and paid | | | – | | | | – | | | | – | | | | – | | | | – | | | | (186 | ) | | | (186 | ) | Share-based payments recognised | | | – | | | | – | | | | – | | | | – | | | | – | | | | 34 | | | | 34 | | Cost of shares transferred to beneficiaries | | | – | | | | – | | | | – | | | | 31 | | | | – | | | | (25 | ) | | | 6 | | Issue of ordinary share capital (iv) | | | 2 | | | | 75 | | | | – | | | | – | | | | – | | | | – | | | | 77 | | At 31 December 2012 | | | 193 | | | | 488 | | | | – | | | | (735 | ) | | | 121 | | | | 3,817 | | | | 3,884 | | Total comprehensive income (i) | | | – | | | | – | | | | – | | | | – | | | | (1 | ) | | | 552 | | | | 551 | | Equity dividends declared and paid | | | – | | | | – | | | | – | | | | – | | | | – | | | | (239 | ) | | | (239 | ) | Share-based payments recognised | | | – | | | | – | | | | – | | | | – | | | | – | | | | 28 | | | | 28 | | Deferred taxation on share-based payments | | | – | | | | – | | | | – | | | | – | | | | – | | | | 3 | | | | 3 | | Purchase of own shares | | | – | | | | – | | | | – | | | | (231 | ) | | | – | | | | – | | | | (231 | ) | Cost of shares transferred to beneficiaries | | | – | | | | – | | | | – | | | | 21 | | | | – | | | | (18 | ) | | | 3 | | Cancellation of treasury shares | | | (10 | ) | | | – | | | | 10 | | | | 623 | | | | – | | | | (623 | ) | | | – | | Issue of ordinary share capital (iv) | | | 1 | | | | 47 | | | | – | | | | – | | | | – | | | | – | | | | 48 | | At 31 December 2013 | | | 184 | | | | 535 | | | | 10 | | | | (322 | ) | | | 120 | | | | 3,520 | | | | 4,047 | | Total comprehensive income (i) | | | – | | | | – | | | | – | | | | – | | | | (184 | ) | | | 426 | | | | 242 | | Equity dividends declared and paid | | | – | | | | – | | | | – | | | | – | | | | – | | | | (250 | ) | | | (250 | ) | Share-based payments recognised | | | – | | | | – | | | | – | | | | – | | | | – | | | | 32 | | | | 32 | | Purchase of own shares | | | – | | | | – | | | | – | | | | (75 | ) | | | – | | | | – | | | | (75 | ) | Cost of shares transferred to beneficiaries | | | – | | | | – | | | | – | | | | 25 | | | | – | | | | (21 | ) | | | 4 | | Cancellation of treasury shares | | | (1 | ) | | | – | | | | 1 | | | | 57 | | | | – | | | | (57 | ) | | | – | | Issue of ordinary share capital (iv) | | | 1 | | | | 39 | | | | – | | | | – | | | | – | | | | – | | | | 40 | | At 31 December 2014 | | | 184 | | | | 574 | | | | 11 | | | | (315 | ) | | | (64 | ) | | | 3,650 | | | | 4,040 | |
(i) | Attributable to equity holders of the Company and wholly derived from continuing operations. |
(ii) | Refer to Note 19.2 for further information. |
(iii) | Other reserves comprises gains and losses on cash flow hedges, foreign exchange differences on translation of foreign operations and the difference arising as a result of translating share capital and share premium at the rate ruling on the date of redenomination instead of the rate at the balance sheet date. The cumulative translation adjustments within Other Reserves at 31 December 2014 were $(78)m (2013 – $118m, 2012 – $124m). |
(iv) | Issue of ordinary share capital as a result of options being exercised. |
The Notes on pages 117 to 165 are an integral part of these accounts.
116Smith & Nephew Annual report 2014
Notes to the Group accounts
1 Basis of preparation
Smith & Nephew plc (the ‘Company’) is a public limited company incorporated in England and Wales. In these accounts, the ‘Group’ means the Company and all its subsidiaries. The principal activities of the Group are to develop, manufacture, market and sell medical devices in the sectors of Advanced Surgical Devices and Advanced Wound Management.
As required by the European Union’s IAS Regulation and the Companies Act 2006, the Group has prepared its accounts in accordance with International Financial Reporting Standards (‘IFRS’) as adopted by the European Union (‘EU’) effective as at 31 December 2014. The Group has also prepared its accounts in accordance with IFRS as issued by the International Accounting Standards Board (‘IASB’) effective as at 31 December 2014. IFRS as adopted by the EU differs in certain respects from IFRS as issued by the IASB. However, the differences have no impact for the periods presented.
The preparation of accounts in conformity with IFRS requires management to use estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the reporting period. The accounting policies requiring management to use significant estimates and assumptions are; inventories, impairment, taxation, liability provisions and business combinations. These are discussed under Critical accounting policies on page 104. Although these estimates are based on management’s best knowledge of current events and actions, actual results ultimately may differ from those estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to estimates are recognised prospectively.
The Directors continue to adopt the going concern basis for accounting in preparing the annual financial statements. The Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future.
There have been no new accounting pronouncements impacting the Group in 2014.
A number of new standards, amendments to standards and interpretations are effective for the Group’s annual periods beginning on or after 1 January 2015, and have not been applied in preparing these consolidated accounts. With the exception of IFRS 9Financial Instruments and IFRS 15Revenue, which the Group does not intend to early adopt and for which the extent of the impact is still being determined, none of these is expected to have a significant effect on the consolidated accounts of the Group.
Consolidation
The Group accounts include the accounts of Smith & Nephew plc and its subsidiaries for the periods during which they were members of the Group.
Subsidiaries are entities controlled by the Group. The Group controls an entity when it is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are consolidated in the Group accounts from the date that the Group obtains control, and continue to be consolidated until the date that such control ceases. Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated on consolidation. All subsidiaries have year ends which are co-terminus with the Group’s.
When the Group loses control over a subsidiary, it derecognises the assets and liabilities of the subsidiary and any related components of equity. Any resulting gain or loss is recognised in profit or loss. Any retained interest in the former subsidiary is measured at fair value.
Foreign currencies
Functional and presentation currency
The Group accounts are presented in US Dollars, which is the Company’s functional currency.
Foreign currency transactions
Transactions in foreign currencies are translated to the respective functional currencies of Group companies at exchange rates at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are retranslated to the functional currency at the exchange rate at the reporting date. Non-monetary items are not retranslated.
Foreign operations
Balance sheet items of foreign operations, including goodwill and fair value adjustments arising on acquisition are translated into US Dollars on consolidation at the exchange rates at the reporting date. Income statement items and the cash flows of foreign operations are translated at average rates as an approximation to actual transaction rates, with actual transaction rates used for large one off transactions.
Foreign currency differences are recognised in Other comprehensive income and accumulated in ‘Other reserves’ within equity. These include: exchange differences on the translation at closing rates of exchange of non-US Dollar opening net assets; the differences arising between the translation of profits into US Dollars at actual (or average, as an approximation) and closing exchange rates; to the extent that the hedging relationship is effective, the difference on translation of foreign currency borrowings or swaps that are used to finance or hedge the Group’s net investments in foreign operations; and the movement in the fair value of forward foreign exchange contracts used to hedge forecast foreign exchange cash flows.
The exchange rates used for the translation of currencies into US Dollars that have the most significant impact on the Group results were:
| | | | | | | | | | | | | | | | 2014 | | | | 2013 | | | | 2012 | | Average rates | | | | | | | | | | | | | Sterling | | | 1.65 | | | | 1.56 | | | | 1.58 | | Euro | | | 1.33 | | | | 1.33 | | | | 1.28 | | Swiss Franc | | | 1.09 | | | | 1.08 | | | | 1.07 | | Year-end rates | | | | | | | | | | | | | Sterling | | | 1.56 | | | | 1.66 | | | | 1.63 | | Euro | | | 1.21 | | | | 1.38 | | | | 1.32 | | Swiss Franc | | | 1.01 | | | | 1.12 | | | | 1.09 | |
Smith & Nephew Annual report 2014 117
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
2 Business segment information
During 2014 for management purposes the Group was organised into two global divisions according to the nature of its products which represented two reportable business segments – Advanced Surgical Devices and Advanced Wound Management.
As part of the Reinvestment & Group Optimisation programme management have created a single unified operating structure with a single cost base, led by a managing director in each major country (outside the US). The change in structure took effect on 1 January 2015 and as such the Group will report as a single segment from this date.
The types of products and services offered by each business segment in 2014 are:
– | Smith & Nephew’s Advanced Surgical Devices (‘ASD’) business offers the following products and technologies: |
| – | Orthopaedic Reconstruction which includes Hip Implants, Knee Implants and ancillary products such as bone cement and mixing systems used in cemented reconstruction joint surgery |
| – | Trauma & Extremities consisting of internal and external devices used in the stabilisation of severe fractures and deformity correction procedures |
| – | Sports Medicine Joint Repair, which offers surgeons a broad array of instruments, technologies and implants necessary to perform minimally invasive surgery of the joints |
| – | Arthroscopy Enabling Technologies which offer healthcare providers a variety of technologies such as fluid management equipment for surgical access, high definition cameras, digital image capture, scopes, light sources and monitors to assist with visualisation inside the joints, radio frequency wands, electromechanical and mechanical blades, and hand instruments for removing damaged tissue |
| – | Other ASD which includes gynaecological instrumentation and the remaining Clinical Therapies geographies which are in the process of being transferred to Bioventus. |
– | Smith & Nephew’s Advanced Wound Management (‘AWM’) business offers a range of products: |
| – | Advanced Wound Care includes products for the treatment of acute and chronic wounds, including leg, diabetic and pressure ulcers, burns and post-operative wounds |
| – | Advanced Wound Devices consists of traditional and single-use Negative Pressure Wound Therapy and hydrosurgery systems |
| – | Advanced Wound Bioactives includes biologics and other bioactive technologies that provide unique approaches to debridement and dermal repair/regeneration. |
Management monitors the operating results of its business segments separately for the purposes of making decisions about resource allocation and performance assessment. Group financing (including interest receivable and payable) and income taxes are managed on a Group basis and are not allocated to business segments.
The following tables present revenue, profit, asset and liability information regarding the Group’s operating segments as they existed during the year. Investments in associates and loans to associates are segmentally allocated to Advanced Surgical Devices.
2.1 Revenue by business segment and geography
| | | | | | | ACCOUNTING POLICY
| | | | | Revenue comprises sales of products and services to third parties at amounts invoiced net of trade discounts and rebates, excluding taxes on revenue. Revenue from the sale of products is recognised upon transfer to the customer of the significant risks and rewards of ownership. This is generally when goods are delivered to customers. Sales of inventory located at customer premises and available for customers’ immediate use are recognised when notification is received that the product has been implanted or used. Appropriate provisions for returns, trade discounts and rebates are deducted from revenue. Rebates comprise retrospective volume discounts granted to certain customers on attainment of certain levels of purchases from the Group. These are accrued over the course of the arrangement based on estimates of the level of business expected and adjusted at the end of the arrangement to reflect actual volumes.
| | |
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Revenue by business segment | | | | | | | | | | | | | Advanced Surgical Devices | | | 3,298 | | | | 3,015 | | | | 3,108 | | Advanced Wound Management | | | 1,319 | | | | 1,336 | | | | 1,029 | | | | | 4,617 | | | | 4,351 | | | | 4,137 | | | There are no material sales between business segments. | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Revenue by geographic market | | | | | | | | | | | | | United States | | | 2,012 | | | | 1,862 | | | | 1,651 | | United Kingdom | | | 299 | | | | 293 | | | | 297 | | Other Established Markets | | | 1,629 | | | | 1,633 | | | | 1,706 | | Emerging & International Markets | | | 677 | | | | 563 | | | | 483 | | | | | 4,617 | | | | 4,351 | | | | 4,137 | |
Revenue has been allocated by basis of destination. No revenue from a single customer is in excess of 10% of the Group’s revenue.
118Smith & Nephew Annual report 2014
2.2 Trading and operating profit by business segment
Trading profit is a trend measure which presents the long-term profitability of the Group excluding the impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. The Group has identified the following items, where material, as those to be excluded from operating profit when arriving at trading profit: acquisition and disposal related items including amortisation of acquisition intangibles and impairments; significant restructuring events; gains and losses arising from legal disputes; and significant uninsured losses. Operating profit reconciles to trading profit as follows:
| | | | | | | | | | | | | | | | | | | | Notes | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Operating profit | | | | | | | 749 | | | | 810 | | | | 846 | | Acquisition-related costs | | | 3 | | | | 118 | | | | 31 | | | | 11 | | Restructuring and rationalisation expenses | | | 3 | | | | 61 | | | | 58 | | | | 65 | | Amortisation of acquisition intangibles and impairments | | | 9 | | | | 129 | | | | 88 | | | | 43 | | Legal and other | | | 3 | | | | (2 | ) | | | – | | | | – | | Trading profit | | | | | | | 1,055 | | | | 987 | | | | 965 | | Trading profit by business segment | | | | | | | | | | | | | | | | | Advanced Surgical Devices | | | | | | | 810 | | | | 712 | | | | 728 | | Advanced Wound Management | | | | | | | 245 | | | | 275 | | | | 237 | | | | | | | | | 1,055 | | | | 987 | | | | 965 | | Operating profit by business segment reconciled to attributable profit for the year | | | | | | | | | | | | | | | | | Advanced Surgical Devices | | | | | | | 626 | | | | 620 | | | | 632 | | Advanced Wound Management | | | | | | | 123 | | | | 190 | | | | 214 | | Operating profit | | | | | | | 749 | | | | 810 | | | | 846 | | Net interest (payable)/receivable | | | | | | | (22 | ) | | | 4 | | | | 2 | | Other finance costs | | | | | | | (11 | ) | | | (11 | ) | | | (11 | ) | Share of results of associates | | | | | | | (2 | ) | | | (1 | ) | | | 4 | | Profit on disposal on net assets held for sale | | | | | | | – | | | | – | | | | 251 | | Taxation | | | | | | | (213 | ) | | | (246 | ) | | | (371 | ) | Attributable profit for the year | | | | | | | 501 | | | | 556 | | | | 721 | | | 2.3 Assets and liabilities by business segment and geography | | | | | | | | | 2014 $ million | | |
| 2013
$ million |
| |
| 2012
$ million |
| Balance sheet | | | | | | | | | | | | | | | | | Assets: | | | | | | | | | | | | | | | | | Advanced Surgical Devices | | | | | | | 5,368 | | | | 3,684 | | | | 3,518 | | Advanced Wound Management | | | | | | | 1,761 | | | | 1,848 | | | | 1,776 | | Operating assets by business segment | | | | | | | 7,129 | | | | 5,532 | | | | 5,294 | | Unallocated corporate assets | | | | | | | 177 | | | | 287 | | | | 348 | | Total assets | | | | | | | 7,306 | | | | 5,819 | | | | 5,642 | | Liabilities: | | | | | | | | | | | | | | | | | Advanced Surgical Devices | | | | | | | 697 | | | | 609 | | | | 530 | | Advanced Wound Management | | | | | | | 315 | | | | 308 | | | | 256 | | Operating liabilities by business segment | | | | | | | 1,012 | | | | 917 | | | | 786 | | Unallocated corporate liabilities | | | | | | | 2,254 | | | | 855 | | | | 972 | | Total liabilities | | | | | | | 3,266 | | | | 1,772 | | | | 1,758 | |
Smith & Nephew Annual report 2014 119
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
2 Business segment informationcontinued
Unallocated corporate assets and liabilities comprise the following:
| | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Deferred tax assets | | | 77 | | | | 145 | | | | 164 | | Retirement benefit asset | | | 7 | | | | 5 | | | | 6 | | Cash at bank | | | 93 | | | | 137 | | | | 178 | | Unallocated corporate assets | | | 177 | | | | 287 | | | | 348 | | Long-term borrowings | | | 1,666 | | | | 347 | | | | 430 | | Retirement benefit obligations | | | 233 | | | | 230 | | | | 266 | | Deferred tax liabilities | | | 98 | | | | 50 | | | | 61 | | Bank overdrafts and loans due within one year | | | 39 | | | | 44 | | | | 38 | | Current tax payable | | | 218 | | | | 184 | | | | 177 | | Unallocated corporate liabilities | | | 2,254 | | | | 855 | | | | 972 | | | | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Capital expenditure (including acquisitions) | | | | | | | | | | | | | Advanced Surgical Devices | | | 2,045 | | | | 327 | | | | 188 | | Advanced Wound Management | | | 73 | | | | 124 | | | | 839 | | | | | 2,118 | | | | 451 | | | | 1,027 | | | | | | Capital expenditure segmentally allocated above comprises: | | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Additions to property, plant and equipment | | | 298 | | | | 242 | | | | 197 | | Additions to intangible assets | | | 77 | | | | 98 | | | | 68 | | Capital expenditure (excluding business combinations) | | | 375 | | | | 340 | | | | 265 | | Trade investments | | | 4 | | | | – | | | | – | | Acquisitions – Goodwill | | | 844 | | | | 53 | | | | 73 | | Acquisitions – Intangible assets | | | 833 | | | | 53 | | | | 662 | | Acquisitions – Property, plant and equipment | | | 62 | | | | 5 | | | | 27 | | Capital expenditure | | | 2,118 | | | | 451 | | | | 1,027 | | | | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Depreciation, amortisation and impairment | | | | | | | | | | | | | Advanced Surgical Devices | | | 320 | | | | 268 | | | | 274 | | Advanced Wound Management | | | 107 | | | | 93 | | | | 38 | | | | | 427 | | | | 361 | | | | 312 | |
120Smith & Nephew Annual report 2014
Amounts comprise depreciation of property, plant and equipment, amortisation of other intangible assets, impairment of investments and amortisation of acquisition intangibles and impairments as follows:
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Amortisation of acquisition intangibles | | | 129 | | | | 88 | | | | 43 | | Depreciation of property, plant and equipment | | | 222 | | | | 209 | | | | 212 | | Impairment of property, plant and equipment | | | 14 | | | | – | | | | – | | Impairment of goodwill and investments | | | – | | | | – | | | | 6 | | Amortisation of other intangible assets | | | 62 | | | | 64 | | | | 51 | | | | | 427 | | | | 361 | | | | 312 | | | $14m impairments were recognised within operating profit in 2014 (2013 – $nil, 2012 – $6m, recognised within the administrative expenses line). In 2014, the impairment was segmentally allocated to Advanced Wound Management (2012: Advanced Surgical Devices). Geographic | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Assets by geographic location | | | | | | | | | | | | | United States | | | | | | | 3,104 | | | | 2,086 | | United Kingdom | | | | | | | 379 | | | | 255 | | Other Established Markets | | | | | | | 1,101 | | | | 902 | | Emerging & International Markets | | | | | | | 198 | | | | 170 | | Non-current operating assets by geographic location | | | | | | | 4,782 | | | | 3,413 | | United States | | | | | | | 1,104 | | | | 1,121 | | United Kingdom | | | | | | | 234 | | | | 288 | | Other Established Markets | | | | | | | 706 | | | | 486 | | Emerging & International Markets | | | | | | | 303 | | | | 224 | | Current operating assets by geographic location | | | | | | | 2,347 | | | | 2,119 | | Unallocated corporate assets (see page 120) | | | | | | | 177 | | | | 287 | | Total assets | | | | | | | 7,306 | | | | 5,819 | | | | | | 2.4 Other business segment information | | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Other significant expenses recognised within operating profit | | | | | | | | | | | | | Advanced Surgical Devices | | | 106 | | | | 51 | | | | 57 | | Advanced Wound Management | | | 71 | | | | 38 | | | | 19 | | | | | 177 | | | | 89 | | | | 76 | | The $177m incurred in 2014 relates to $61m restructuring and rationalisation expenses and $118m acquisition related costs and a net $2m credit related to legal and other (2013 – $58m relates to restructuring and rationalisation expenses and $31m acquisition related costs, 2012 – $65m relates to restructuring and rationalisation expenses and $11m acquisition related costs). | | | | | 2014 numbers | | | | 2013 numbers | | | | 2012 numbers | | Average number of employees | | | | | | | | | | | | | Advanced Surgical Devices | | | 9,273 | | | | 7,066 | | | | 7,194 | | Advanced Wound Management | | | 4,195 | | | | 3,970 | | | | 3,283 | | | | | 13,468 | | | | 11,036 | | | | 10,477 | |
Smith & Nephew Annual report 2014 121
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
3 Operating profit
| | | | | | | ACCOUNTING POLICIES
| | | | | | | | | | Research and development
Research expenditure is expensed as occurred. Internal development expenditure is only capitalised if the recognition criteria in IAS 38Intangible Assets have been satisfied. The Group considers that the regulatory, technical and market uncertainties inherent in the development of new products mean that in most cases development costs should not be capitalised as intangible assets until products receive approval from the appropriate regulatory body.
Payments to third parties for research and development projects are accounted for based on the substance of the arrangement. If the arrangement represents outsourced research and development activities the payments are generally expensed except in limited circumstances where the respective development expenditure would be capitalised under the principles established in IAS 38. By contrast, the payments are capitalised if the arrangement represents consideration for the acquisition of intellectual property developed at the risk of the third party.
Capitalised development expenditures are amortised on a straight-line basis over their useful economic lives from product launch.
Advertising costs
Expenditure on advertising costs is expensed as incurred.
| | |
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Revenue | | | 4,617 | | | | 4,351 | | | | 4,137 | | Cost of goods sold (i)(ii) | | | (1,162 | ) | | | (1,100 | ) | | | (1,070 | ) | Gross profit | | | 3,455 | | | | 3,251 | | | | 3,067 | | Research and development expenses | | | (235 | ) | | | (231 | ) | | | (171 | ) | Selling, general and administrative expenses: | | | | | | | | | | | | | Marketing, selling and distribution expenses | | | (1,670 | ) | | | (1,535 | ) | | | (1,440 | ) | Administrative expenses (iii) (iv) (v) (vi) | | | (801 | ) | | | (675 | ) | | | (610 | ) | | | | (2,471 | ) | | | (2,210 | ) | | | (2,050 | ) | Operating profit | | | 749 | | | | 810 | | | | 846 | | (i) 2014 includes $12m of restructuring and rationalisation expenses (2013 – $12m, 2012 – $3m). (ii) 2014 includes $23m of acquisition-related costs (2013 – $5m, 2012 – $nil). (iii) 2014 includes $62m of amortisation of other intangible assets (2013 – $64m, 2012 – $51m). (iv) 2014 includes $49m of restructuring and rationalisation expenses and $129m of amortisation of acquisition intangibles (2013 – $46m of restructuring and rationalisation expenses and $88m of amortisation of acquisition intangibles, 2012 – $62m of restructuring and rationalisation expenses and $43m of amortisation of acquisition intangibles). (v) 2014 includes $2m credit relating to legal and other exceptionals (2013 – $nil, 2012 – $nil). (vi) 2014 includes $95m of acquisition-related costs (2013 – $26m, 2012 – $11m). Note that items detailed in (i), (ii), (iv), (v) and (vi) are excluded from the calculation of trading profit. Operating profit is stated after charging the following items: | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Amortisation of acquisition intangibles | | | 129 | | | | 88 | | | | 43 | | Amortisation of other intangible assets | | | 62 | | | | 64 | | | | 51 | | Impairment of goodwill and investments | | | – | | | | – | | | | 6 | | Depreciation of property, plant and equipment | | | 222 | | | | 209 | | | | 212 | | Loss on disposal of property, plant and equipment and software | | | 25 | | | | 23 | | | | 12 | | Minimum operating lease payments for land and buildings | | | 38 | | | | 32 | | | | 29 | | Minimum operating lease payments for other assets | | | 18 | | | | 19 | | | | 21 | | Advertising costs | | | 96 | | | | 91 | | | | 74 | |
122Smith & Nephew Annual report 2014
3.1 Staff costs
Staff costs during the year amounted to:
| | | | | | | | | | | | | | | | | | | | Notes | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Wages and salaries | | | | | | | 1,237 | | | | 998 | | | | 886 | | Social security costs | | | | | | | 127 | | | | 106 | | | | 97 | | Pension costs (including retirement healthcare) | | | 18 | | | | 17 | | | | 72 | | | | 72 | | Share-based payments | | | 23 | | | | 32 | | | | 28 | | | | 34 | | | | | | | | | 1,413 | | | | 1,204 | | | | 1,089 | |
3.2 Audit Fees – information about the nature and cost of services provided by auditors
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Audit services: Group accounts | | | 2 | | | | 1 | | | | 1 | | Other services: | | | | | | | | | | | | | Local statutory audit pursuant to legislation | | | 1 | | | | 2 | | | | 2 | | Taxation services: | | | | | | | | | | | | | Compliance services | | | 1 | | | | 2 | | | | 1 | | Advisory services | | | 1 | | | | 1 | | | | 1 | | Total auditors’ remuneration | | | 5 | | | | 6 | | | | 5 | | Arising: | | | | | | | | | | | | | In the UK | | | 3 | | | | 3 | | | | 2 | | Outside the UK | | | 2 | | | | 3 | | | | 3 | | | | | 5 | | | | 6 | | | | 5 | |
3.3 Acquisition related costs
Acquisition related costs of $118m (2013 – $31m, 2012 – $11m) were incurred within operating profit in the twelve month period to 31 December 2014. These costs relate to professional and adviser fees and integration costs in connection with the acquisitions of ArthroCare and the distributor in Brazil completed in 2014, the acquisitions in Turkey, Brazil and India during 2013 and the acquisition of Healthpoint Biotherapeutics completed in 2012. In addition, $7m of debt-related acquisition costs were incurred in the year.
3.4 Restructuring and rationalisation expenses
Restructuring and rationalisation costs of $61m (2013 – $58m, 2012 – $65m) were incurred in the twelve month period to 31 December 2014. These related mainly to charges of $49m (2013 – $nil, 2012 – $nil) incurred in relation to the Group Optimisation programme announced in May 2014. Charges of $12m (2013 – $58m, 2012 – $65m) were also incurred relating to people costs and contract termination costs associated with the structural and process changes announced in August 2011.
3.5 Legal and other
The legal and other net credit within operating profit of $2m (2013 – $nil, 2012 – $251m) relates to a settlement credit and past service gain on the closure of the US Pension Plan of $46m and a gain on the disposal of a UK manufacturing facility of $9m, offset by a charge of $25m relating to the likely costs of a distribution hold on RENASYS in the US pending new regulatory approvals, and a charge of $28m relating to the HP802 programme which was stopped in the fourth quarter.
In 2012, a profit on disposal of $251m was recorded relating to the disposal of our Clinical Therapies business.
Smith & Nephew Annual report 2014 123
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
4 Interest and other finance costs
4.1 Interest receivable/(payable)
| | | | | | | | | | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Interest receivable | | | | | | | 13 | | | | 14 | | | | 11 | | Interest payable: | | | | | | | | | | | | | | | | | Bank borrowings | | | | | | | (19 | ) | | | (8 | ) | | | (7 | ) | Private placement notes | | | | | | | (14 | ) | | | – | | | | – | | Other | | | | | | | (2 | ) | | | (2 | ) | | | (2 | ) | | | | | | | | (35 | ) | | | (10 | ) | | | (9 | ) | Net interest (payable)/receivable | | | | | | | (22 | ) | | | 4 | | | | 2 | | | | | | | 4.2 Other finance costs | | | | | | | | | | | | | | | | | | | | Notes | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Retirement benefit net interest expense | | | 18 | | | | (10 | ) | | | (11 | ) | | | (11 | ) | Other | | | | | | | (1 | ) | | | – | | | | – | | Other finance costs | | | | | | | (11 | ) | | | (11 | ) | | | (11 | ) |
Foreign exchange gains or losses recognised in the income statement arose primarily on the translation of intercompany and third party borrowings and amounted to a net $21m gain in 2014 (2013 – net $1m gain, 2012 – net $5m loss). These amounts were fully matched in the income statement by the fair value gains or losses on currency swaps (carried at fair value through profit and loss) held to manage this currency risk.
5 Taxation
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | The charge for current taxation is based on the results for the year as adjusted for items which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
The Group operates in multiple tax jurisdictions around the world and records provisions for taxation liabilities and tax audits when it is considered probable that a tax charge will arise and the amount can be reliably estimated. Although Group policy is to submit its tax returns to the relevant tax authorities as promptly as possible, at any time the Group has un-agreed years outstanding and is involved in disputes and tax audits. Significant issues may take many years to resolve. In estimating the probability and amount of any tax charge, management takes into account the views of internal and external advisers and updates the amount of the provision whenever necessary. The ultimate tax liability may differ from the amount provided depending on interpretations of tax law, settlement negotiations or changes in legislation.
Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes.
Deferred tax is not recognised for: temporary differences related to investments in subsidiaries and associates where the Group is able to control the timing of the reversal of the temporary difference and it is probable that this will not reverse in the foreseeable future; on the initial recognition of non-deductible goodwill; and on the initial recognition of an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, does not affect the accounting or taxable profit.
Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which they can be used.
Deferred tax assets are reviewed at each reporting date.
Deferred tax is measured on an undiscounted basis, and at the tax rates that have been enacted or substantively enacted by the reporting date that are expected to apply in the periods in which the asset or liability is settled. It is recognised in the income statement except when it relates to items credited or charged directly to other comprehensive income or equity, in which case the deferred tax is also recognised within other comprehensive income or equity respectively.
Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority, when the Group intends to settle its current tax assets and liabilities on a net basis and that authority permits the Group to make a single net payment.
| | |
124Smith & Nephew Annual report 2014
5.1 Taxation charge attributable to the Group
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Current taxation: | | | | | | | | | | | | | UK corporation tax at 21.5% (2013 – 23.3%, 2012 – 24.5%) | | | 39 | | | | 50 | | | | 53 | | Overseas tax | | | 235 | | | | 229 | | | | 248 | | Current income tax charge | | | 274 | | | | 279 | | | | 301 | | Adjustments in respect of prior periods | | | (6 | ) | | | (5 | ) | | | (17 | ) | Total current taxation | | | 268 | | | | 274 | | | | 284 | | Deferred taxation: | | | | | | | | | | | | | Origination and reversal of temporary differences | | | (52 | ) | | | (23 | ) | | | 88 | | Changes in tax rates | | | – | | | | (4 | ) | | | (3 | ) | Adjustments to estimated amounts arising in prior periods | | | (3 | ) | | | (1 | ) | | | 2 | | Total deferred taxation | | | (55 | ) | | | (28 | ) | | | 87 | | Total taxation as per the income statement | | | 213 | | | | 246 | | | | 371 | | Deferred taxation in other comprehensive income | | | (19 | ) | | | 16 | | | | (20 | ) | Deferred taxation in equity | | | – | | | | (3 | ) | | | – | | Taxation attributable to the Group | | | 194 | | | | 259 | | | | 351 | |
The tax charge was reduced by $71m as a consequence of restructuring and rationalisation expenses, amortisation of acquisition intangibles and acquisition related costs and legal and other. In 2013, the tax charge was reduced by $40m as a consequence of restructuring and rationalisation expenses, amortisation of acquisition intangibles and acquisition related costs. In 2012, the tax charge was increased by $82m as a consequence of restructuring and rationalisation expenses, amortisation of acquisition intangibles and legal provision.
The applicable tax for the year is based on the UK standard rate of corporation tax of 21.5% (2013 – 23.3%, 2012 – 24.5%). Overseas taxation is calculated at the rates prevailing in the respective jurisdictions. The average effective tax rate differs from the applicable rate as follows:
| | | | | | | | | | | | | | | | 2014 % | | | | 2013 % | | | | 2012 % | | UK standard rate | | | 21.5 | | | | 23.3 | | | | 24.5 | | Non-deductible/non-taxable items | | | 0.5 | | | | (1.0 | ) | | | 0.4 | | Prior year items | | | (1.2 | ) | | | (0.5 | ) | | | (1.3 | ) | Tax losses incurred not relieved | | | 1.6 | | | | 0.9 | | | | 0.8 | | Overseas income taxed at other than UK standard rate | | | 7.5 | | | | 7.8 | | | | 9.3 | | Total effective tax rate | | | 29.9 | | | | 30.5 | | | | 33.7 | |
The enacted UK tax rate applicable from 1 April 2014 is 21%. The UK Government have enacted legislation to reduce the tax rate to 20% from 1 April 2015.
Smith & Nephew Annual report 2014 125
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
5 Taxationcontinued
5.2 Deferred taxation
Movements in the main components of deferred tax assets and liabilities were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | Accelerated tax deprecation $ million | | | | Intangibles $ million | | | | Retirement benefit obligation $ million | | | | Macrotexture $ million | | | | Inventory, provisions and other differences $ million | | | | Total $ million | | At 1 January 2013 | | | (90 | ) | | | (28 | ) | | | 87 | | | | 52 | | | | 82 | | | | 103 | | Exchange adjustment | | | – | | | | 1 | | | | – | | | | – | | | | (5 | ) | | | (4 | ) | Movement in income statement – current year | | | (3 | ) | | | 5 | | | | (3 | ) | | | – | | | | 28 | | | | 27 | | Movement in income statement – prior years | | | 2 | | | | (1 | ) | | | – | | | | – | | | | – | | | | 1 | | Movement in other comprehensive income | | | – | | | | – | | | | (16 | ) | | | – | | | | – | | | | (16 | ) | Charge to equity | | | – | | | | – | | | | – | | | | – | | | | 3 | | | | 3 | | Acquisition | | | – | | | | – | | | | – | | | | – | | | | (19 | ) | | | (19 | ) | Transfers | | | – | | | | 1 | | | | – | | | | – | | | | (1 | ) | | | – | | At 31 December 2013 | | | (91 | ) | | | (22 | ) | | | 68 | | | | 52 | | | | 88 | | | | 95 | | Exchange adjustment | | | 2 | | | | 1 | | | | (2 | ) | | | – | | | | (10 | ) | | | (9 | ) | Movement in income statement – current year | | | 18 | | | | 16 | | | | (18 | ) | | | – | | | | 36 | | | | 52 | | Movement in income statement – prior years | | | 1 | | | | (1 | ) | | | – | | | | – | | | | 3 | | | | 3 | | Movement in other comprehensive income | | | – | | | | – | | | | 22 | | | | – | | | | (3 | ) | | | 19 | | Acquisition | | | – | | | | (220 | ) | | | – | | | | – | | | | 39 | | | | (181 | ) | At 31 December 2014 | | | (70 | ) | | | (226 | ) | | | 70 | | | | 52 | | | | 153 | | | | (21 | ) | | | | | | | | Represented by: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Deferred tax assets | | | 77 | | | | 145 | | Deferred tax liabilities | | | (98 | ) | | | (50 | ) | Net position at 31 December | | | (21 | ) | | | 95 | |
The Group has unused tax losses of $92m (2013 – $31m) available for offset against future profits. A deferred tax asset has been recognised in respect of $47m (2013 – $3m) of these losses. No deferred tax asset has been recognised on the remaining unused tax losses as they are not expected to be realised in the foreseeable future. The aggregate amount of temporary differences in respect of investments in subsidiaries and associates for which deferred tax liabilities have not been recognised is approximately $449m (2013 – $nil).
126Smith & Nephew Annual report 2014
6 Earnings per ordinary share
| | | | | | | ACCOUNTING POLICIES
| | | | | | | | | | Earnings per share
Basic earnings per share is calculated by dividing the profit attributable to equity holders by the weighted average number of Ordinary shares in issue during the year, excluding shares held by the Company in the Employees’ Share Trust or as treasury shares.
Adjusted earnings per share
Adjusted earnings per share is a trend measure, which presents the long-term profitability of the Group excluding the impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure. The Group has identified the following items as those to be excluded when arriving at adjusted attributable profit: acquisition and disposal related items including amortisation of acquisition intangible assets and impairments; significant restructuring events; significant gains and losses arising from legal disputes and significant uninsured losses; and taxation thereon.
| | |
The calculations of the basic, diluted and adjusted earnings per ordinary share are based on the following attributable profit and numbers of shares:
| | | | | | | | | | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Earnings | | | | | | | | | | | | | | | | | Attributable profit for the year | | | | | | | 501 | | | | 556 | | | | 721 | | Adjusted attributable profit (see below) | | | | | | | 743 | | | | 693 | | | | 671 | | Attributable profit is reconciled to adjusted attributable profit as follows: | | | | | Notes | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Attributable profit for the year | | | | | | | 501 | | | | 556 | | | | 721 | | Acquisition-related costs | | | 3 | | | | 125 | | | | 31 | | | | 11 | | Restructuring and rationalisation expenses | | | 3 | | | | 61 | | | | 58 | | | | 65 | | Amortisation of acquisition intangibles and impairments | | | 9 | | | | 129 | | | | 88 | | | | 43 | | Profit on disposal of net assets held for sale | | | 3 | | | | – | | | | – | | | | (251 | ) | Legal and other | | | 3 | | | | (2 | ) | | | – | | | | – | | Taxation on excluded items | | | 5 | | | | (71 | ) | | | (40 | ) | | | 82 | | Adjusted attributable profit | | | | | | | 743 | | | | 693 | | | | 671 | | The numerators used for basic and diluted earnings per ordinary share are the same. The denominators used for all categories of earnings for basic and diluted earnings per ordinary share are as follows: | | | | | | | | | 2014 | | | | 2013 | | | | 2012 | | Number of shares (millions) | | | | | | | | | | | | | | | | | Basic weighted number of shares | | | | | | | 893 | | | | 901 | | | | 897 | | Dilutive impact of share options outstanding | | | | | | | 6 | | | | 5 | | | | 4 | | Diluted weighted average number of shares | | | | | | | 899 | | | | 906 | | | | 901 | | Earnings per ordinary share | | | | | | | | | | | | | | | | | Basic | | | | | | | 56.1¢ | | | | 61.7¢ | | | | 80.4¢ | | Diluted | | | | | | | 55.7¢ | | | | 61.4¢ | | | | 80.0¢ | | Adjusted: Basic | | | | | | | 83.2¢ | | | | 76.9¢ | | | | 74.8¢ | | Adjusted: Diluted | | | | | | | 82.6¢ | | | | 76.5¢ | | | | 74.5¢ | |
There were no share options which were not included in the diluted EPS calculation because they were non-dilutive in the period (2013 – 0.5m, 2012 – 8.2m).
Smith & Nephew Annual report 2014 127
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
7 Property, plant and equipment
| | | | | | | ACCOUNTING POLICIES
| | | | | | | | | | Property, plant and equipment
Items of property, plant and equipment are stated at cost less accumulated depreciation and any accumulated impairment losses.
Depreciation is calculated to write off the cost of items of property, plant and equipment less their estimated residual values using the straight-line method over their estimated useful lives, and is generally recognised in profit or loss. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Group will obtain ownership by the end of the lease term. Freehold land is not depreciated. The estimated useful lives of items of property, plant and equipment is 3–20 years and for buildings is 20–50 years.
Assets in course of construction are not depreciated until they are available for use.
Depreciation methods, useful lives and residual values are reviewed at each reporting date and adjusted if appropriate.
Finance costs relating to the purchase or construction of property, plant and equipment and intangible assets that take longer than one year to complete are capitalised based on the Group weighted average borrowing costs. All other finance costs are expensed as incurred.
Impairment of assets
The carrying values of property, plant and equipment are reviewed for impairment when events or changes in circumstances indicate the carrying value may be impaired. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss. Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which it belongs.
An asset’s recoverable amount is the higher of an asset’s or cash-generating unit’s fair value less costs to sell and its value-in-use. In assessing value-in-use, its estimated future cash flow is discounted to its present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the asset.
| | |
128Smith & Nephew Annual report 2014
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Land and buildings | | | | | | Plant and equipment | | | | Assets in | | | | | | | | | Freehold $ million | | | | Leasehold $ million | | | | | | Instruments $ million | | | | Other $ million | | | | course of construction $ million | | | | Total $ million | | Cost | | | | | | | | | | | | | | | | | | | | | | | | | | | At 1 January 2013 | | | 143 | | | | 52 | | | | | | 1,042 | | | | 919 | | | | 73 | | | | 2,229 | | Exchange adjustment | | | 1 | | | | (1 | ) | | | | | (16 | ) | | | 6 | | | | – | | | | (10 | ) | Acquisitions (see Note 21) | | | – | | | | 1 | | | | | | 2 | | | | 2 | | | | – | | | | 5 | | Additions | | | 2 | | | | 1 | | | | | | 139 | | | | 23 | | | | 77 | | | | 242 | | Disposals | | | (3 | ) | | | – | | | | | | (102 | ) | | | (80 | ) | | | (2 | ) | | | (187 | ) | Transfers | | | – | | | | – | | | | | | – | | | | 68 | | | | (68 | ) | | | – | | At 31 December 2013 | | | 143 | | | | 53 | | | | | | 1,065 | | | | 938 | | | | 80 | | | | 2,279 | | Exchange adjustment | | | (4 | ) | | | (1 | ) | | | | | (68 | ) | | | (35 | ) | | | (2 | ) | | | (110 | ) | Acquisitions (see Note 21) | | | 11 | | | | 4 | | | | | | 9 | | | | 17 | | | | 21 | | | | 62 | | Additions | | | – | | | | – | | | | | | 158 | | | | 57 | | | | 83 | | | | 298 | | Disposal of business | | | – | | | | – | | | | | | – | | | | (12 | ) | | | – | | | | (12 | ) | Disposals | | | (2 | ) | | | (3 | ) | | | | | (108 | ) | | | (40 | ) | | | (4 | ) | | | (157 | ) | Transfers | | | 1 | | | | 1 | | | | | | 4 | | | | 38 | | | | (44 | ) | | | – | | At 31 December 2014 | | | 149 | | | | 54 | | | | | | 1,060 | | | | 963 | | | | 134 | | | | 2,360 | | Depreciation and impairment | | | | | | | | | | | | | | | | | | | | | | | | | | | At 1 January 2013 | | | 46 | | | | 29 | | | | | | 738 | | | | 623 | | | | – | | | | 1,436 | | Exchange adjustment | | | (1 | ) | | | (1 | ) | | | | | (10 | ) | | | 5 | | | | – | | | | (7 | ) | Charge for the year | | | 1 | | | | 3 | | | | | | 135 | | | | 70 | | | | – | | | | 209 | | Disposals | | | (3 | ) | | | – | | | | | | (99 | ) | | | (73 | ) | | | – | | | | (175 | ) | At 31 December 2013 | | | 43 | | | | 31 | | | | | | 764 | | | | 625 | | | | – | | | | 1,463 | | Exchange adjustment | | | (2 | ) | | | – | | | | | | (50 | ) | | | (24 | ) | | | – | | | | (76 | ) | Charge for the year | | | 5 | | | | 4 | | | | | | 137 | | | | 76 | | | | – | | | | 222 | | Impairment | | | – | | | | – | | | | | | – | | | | 3 | | | | 11 | | | | 14 | | Disposal of business | | | – | | | | – | | | | | | – | | | | (7 | ) | | | – | | | | (7 | ) | Disposals | | | (1 | ) | | | (3 | ) | | | | | (107 | ) | | | (36 | ) | | | – | | | | (147 | ) | At 31 December 2014 | | | 45 | | | | 32 | | | | | | 744 | | | | 637 | | | | 11 | | | | 1,469 | | Net book amounts | | | | | | | | | | | | | | | | | | | | | | | | | | | At 31 December 2014 | | | 104 | | | | 22 | | | | | | 316 | | | | 326 | | | | 123 | | | | 891 | | At 31 December 2013 | | | 100 | | | | 22 | | | | | | 301 | | | | 313 | | | | 80 | | | | 816 | |
Land and buildings includes land with a cost of $20m (2013 – $15m) that is not subject to depreciation. Assets held under finance leases with a net book amount of $8m (2013 – $10m) are included within land and buildings.
The impairment charge in the year relates to certain assets which related to the production of HP802, which the Group has decided not to continue.
Historically, capital expenditure represents the Group’s expected annual investment in property, plant and equipment and other intangible assets. This varies between 6% and 8% (2013 – 6% and 8%) of annual revenue.
Group capital expenditure relating to property, plant and equipment contracted but not provided for amounted to $27m (2013 – $20m).
The amount of borrowing costs capitalised in 2014 and 2013 was minimal.
Smith & Nephew Annual report 2014 129
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
8 Goodwill
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Goodwill is not amortised but is reviewed for impairment annually. Goodwill is allocated to the cash-generating unit (‘CGU’) that is expected to benefit from the acquisition. The recoverable amount of CGUs to which goodwill has been allocated is tested for impairment annually. The CGUs, monitored by management, are at the business segment level, Advanced Surgical Devices and Advanced Wound Management.
If the recoverable amount of the cash-generating unit is less than its carrying amount then an impairment loss is determined to have occurred. Any impairment losses that arise are recognised immediately in the income statement and are allocated first to reduce the carrying amount of goodwill and then to the carrying amounts of the other assets of the CGU.
In carrying out impairment reviews of goodwill a number of significant assumptions have to be made when preparing cash flow projections. These include the future rate of market growth, discount rates, the market demand for the products acquired, the future profitability of acquired businesses or products, levels of reimbursement and success in obtaining regulatory approvals. If actual results should differ, or changes in expectations arise, impairment charges may be required which would adversely impact operating results.
| | |
| | | | | | | | | | | | | | | | | | | | Notes | | |
| 2014
$ million |
| |
| 2013
$ million |
| Cost | | | | | | | | | | | | | | | At 1 January | | | | | | | | | 1,256 | | | | 1,186 | | Exchange adjustment | | | | | | | | | (73 | ) | | | 17 | | Acquisitions (i) | | | | | 21 | | | | 844 | | | | 53 | | At 31 December | | | | | | | | | 2,027 | | | | 1,256 | | Impairment | | | | | | | | | | | | | | | At 1 January and 31 December | | | | | | | | | – | | | | – | | Net book amounts | | | | | | | | | 2,027 | | | | 1,256 | | | | (i) 2013 includes an adjustment of $16m following the finalisation of the Healthpoint acquisition balance sheet. | | | | | | | | Each of the Group’s business segments represent a CGU and include goodwill as follows: | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| | | | | | | | | | | | | | | | Advanced Surgical Devices | | | | | | | | | 1,686 | | | | 918 | | Advanced Wound Management | | | | | | | | | 341 | | | | 338 | | | | | | | | | | | 2,027 | | | | 1,256 | |
In September 2014 and 2013 impairment reviews were performed by comparing the recoverable amount of each CGU with its carrying amount, including goodwill. These are updated during December, taking into account significant events that occurred between September and December.
For each CGU, the recoverable amounts are based on value-in-use which is calculated from pre-tax cash flow projections for five years using data from the Group’s budget and strategic planning process, the results of which are reviewed and approved by the Board. These projections exclude any estimated future cash inflows or outflows expected to arise from future restructurings. The five-year period is in-line with the Group’s strategic planning process.
The calculation of value-in-use for the identified CGUs is most sensitive to discount and growth rates as set out below:
The discount rate reflects management’s assessment of risks specific to the assets of each CGU. The pre-tax discount rate used in the Advanced Surgical Devices business is 10% (2013 – 10%) and for the Advanced Wound Management business it is 11% (2013 – 10%).
In determining the growth rate used in the calculation of the value-in-use, the Group considered annual revenue growth. Projections are based on anticipated volume and value growth in the markets served by the Group and assumptions as to market share movements. Each year the projections for the previous year are compared to actual results and variances are factored into the assumptions used in the current year. Revenue growth rates for the five-year period for the Advanced Surgical Devices business franchises vary from 2% to 15% (2013 – 1% to 20%) and for the Advanced Wound Management business franchises from 4% to 19% (2013 – 2% to 22%).
130Smith & Nephew Annual report 2014
Specific considerations and strategies taken into account in determining the sales growth and trading profit margin for each CGU are:
– | Advanced Surgical Devices – Management intends to deliver growth through continuing to focus on widening access to the customer, strengthening our portfolio and global presence, innovative product development and through continuing to make efficiency improvements |
– | Advanced Wound Management – Management intends to develop this CGU by focusing on widening access to the customer, the higher added value sectors of healing chronic wounds and tissue repair using bioactives, and by continuing to improve efficiency. |
Following the detailed first 5 years, management has used an unchanged size of the market and Group’s share thereof in the pre-tax cash flows used to calculate the terminal value of both the Advanced Surgical Devices business (2013 – increase at 3% per year) and Advanced Wound Management businesses (2013 – increase at 5% per year), which were considered to be the Group’s CGUs in 2014.
Management has considered the following sensitivities:
– | Growth of market and market share – Management has considered the impact of a variance in market growth and market share. The value-in-use calculation shows that if the assumed long-term growth rate was reduced to nil, the recoverable amount of all of the CGUs independently would still be greater than their carrying values |
– | Discount rate – Management has considered the impact of an increase in the discount rate applied to the calculation. The value-in-use calculation shows that for the recoverable amount of the CGU to be less than its carrying value, the discount rate would have to be increased to 28% (2013 – 33%) for the Advanced Surgical Devices business and 17% (2013 – 65%) for the Advanced Wound Management business. |
9 Intangible assets
| | | | | | | ACCOUNTING POLICIES
| | | | | | | | | | Intangible assets
Intangible assets acquired separately from a business combination (including purchased patents, know-how, trademarks, licences and distribution rights) are initially measured at cost. The cost of intangible assets acquired in a material business combination (referred to as acquisition intangibles) is the fair value as at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. All intangible assets are amortised on a straight-line basis over their estimated useful economic lives. The estimated useful economic life of an intangible asset ranges between three and 20 years depending on its nature. Internally generated intangible assets are expensed in the income statement as incurred.
Purchased computer software and certain costs of information technology projects are capitalised as intangible assets. Software that is integral to computer hardware is capitalised as plant and equipment.
Impairment of intangible assets
The carrying values of intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may be impaired. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss. Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which it belongs.
An asset’s recoverable amount is the higher of an asset’s or cash-generating unit’s fair value less costs to sell and its value-in-use. In assessing value-in-use, its estimated future cash flow is discounted to its present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the asset.
In carrying out impairment reviews of intangible assets a number of significant assumptions have to be made when preparing cash flow projections. These include the future rate of market growth, discount rates, the market demand for the products acquired, the future profitability of acquired businesses or products, levels of reimbursement and success in obtaining regulatory approvals. If actual results should differ, or changes in expectations arise, impairment charges may be required which would adversely impact operating results.
| | |
Smith & Nephew Annual report 2014 131
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
9 Intangible assetscontinued
| | | | | | | | | | | | | | | | | | | | | | | | Acquisition intangibles $ million | | |
| Software
$ million |
| | | Distribution rights $ million | | | | Patents & Intellectual property $ million | | | | Total $ million | | Cost | | | | | | | | | | | | | | | | | | | | | At 1 January 2013 | | | 1,109 | | | | 205 | | | | 43 | | | | 176 | | | | 1,533 | | Exchange adjustment | | | 3 | | | | – | | | | – | | | | – | | | | 3 | | Acquisitions | | | 53 | | | | – | | | | – | | | | – | | | | 53 | | Additions | | | – | | | | 53 | | | | 27 | | | | 18 | | | | 98 | | Disposals | | | – | | | | (29 | ) | | | – | | | | – | | | | (29 | ) | At 31 December 2013 | | | 1,165 | | | | 229 | | | | 70 | | | | 194 | | | | 1,658 | | Exchange adjustment | | | (44 | ) | | | (11 | ) | | | – | | | | (2 | ) | | | (57 | ) | Acquisitions (ii) | | | 830 | | | | 3 | | | | – | | | | – | | | | 833 | | Additions | | | – | | | | 49 | | | | 5 | | | | 23 | | | | 77 | | Disposals | | | – | | | | (3 | ) | | | – | | | | – | | | | (3 | ) | At 31 December 2014 | | | 1,951 | | | | 267 | | | | 75 | | | | 215 | | | | 2,508 | | Amortisation and impairment | | | | | | | | | | | | | | | | | | | | | At 1 January 2013 | | | 283 | | | | 91 | | | | 27 | | | | 68 | | | | 469 | | Exchange adjustment | | | 1 | | | | – | | | | – | | | | – | | | | 1 | | Charge for the year | | | 88 | | | | 31 | | | | 14 | | | | 19 | | | | 152 | | Disposals | | | – | | | | (18 | ) | | | – | | | | – | | | | (18 | ) | At 31 December 2013 | | | 372 | | | | 104 | | | | 41 | | | | 87 | | | | 604 | | Exchange adjustment | | | (27 | ) | | | (3 | ) | | | – | | | | (2 | ) | | | (32 | ) | Charge for the year | | | 129 | | | | 31 | | | | 10 | | | | 21 | | | | 191 | | Disposals | | | – | | | | (2 | ) | | | – | | | | – | | | | (2 | ) | At 31 December 2014 | | | 474 | | | | 130 | | | | 51 | | | | 106 | | | | 761 | | Net book amounts | | | | | | | | | | | | | | | | | | | | | At 31 December 2014 | | | 1,477 | | | | 137 | | | | 24 | | | | 109 | | | | 1,747 | | At 31 December 2013 (i) | | | 793 | | | | 125 | | | | 29 | | | | 107 | | | | 1,054 | |
(i) | The majority of this balance relates to product rights acquired with Healthpoint Biotherapeutics. |
(ii) | The majority of this balance relates to technology and product rights acquired with ArthroCare Corp, which are being amortised over 6-20 years. See Note 21. |
Group capital expenditure relating to software contracted but not provided for amounted to $7m (2013 – $21m).
The carrying values of acquisition intangibles are reviewed for impairment and it was noted that an intangible asset relating to a distribution agreement for a brand within our US Advanced Wound Management business had headroom which was highly sensitive to management’s estimate of future related earnings growth. Changes in those assumptions of either a decrease in the medium term growth rate from 4% to 1% or an increase in the discount rate of 1% to 11.1% would give rise to a $3 million impairment.
132Smith & Nephew Annual report 2014
10 Investments
| | | | | | | | | | ACCOUNTING POLICY
| | | | | | | | Investments, other than those related to associates, are initially recorded at fair value plus any directly attributable transaction costs on the trade date. The Group has an investment in an entity that holds mainly unquoted equity securities, which by their very nature have no fixed maturity date or coupon rate. The investment is classed as ‘available-for-sale’ and carried at fair value. The fair value of the investment is based on the underlying fair value of the equity securities: marketable securities are valued by reference to closing prices in the market;non-marketable securities are estimated considering factors including the purchase price, prices of recent significant private placements of securities of the same issuer and estimates of liquidation value. Changes in fair value are recognised in other comprehensive income except where management considers that there is objective evidence of an impairment of the underlying equity securities. Objective evidence would include a significant or prolonged decline in the fair value of the investment below its cost less any impairment loss previously recognised. Impairment losses are recognised by reclassifying the losses accumulated in other reserves to profit or loss.
| | |
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | At 1 January | | | 2 | | | | 2 | | Additions | | | 4 | | | | – | | Distribution | | | (1 | ) | | | – | | | | At 31 December | | | 5 | | | | 2 | | | |
11 Investments in associates
| | | | | | | | | | ACCOUNTING POLICY
| | | | | | | | Investments in associates, being those entities over which the Group has a significant influence and which is neither a subsidiary nor a joint venture, are accounted for using the equity method, with the Group recording its share of the associate’s profit and loss and other comprehensive income. The Group’s share of associates profit or loss is included in one separate income statement line and is calculated after deduction of their respective taxes.
| | |
At 31 December 2014 and 31 December 2013, the Group holds 49% of Bioventus LLC (‘Bioventus’). Bioventus is a limited liability company operating as a partnership. The Company’s headquarters is located in Durham, North Carolina, US. Bioventus focuses its medical product development around its core competencies of orthobiologic therapies and orthopaedic diagnostics from which it develops and markets clinically proven orthopaedic therapies and diagnostic tools, including osteoarthritis pain treatments, bone growth stimulators and ultrasound devices. Bioventus sells bone stimulation devices and is a provider of osteoarthritis injection therapies. The loss after taxation recognised in the income statement relating to Bioventus was $2m (2013 – loss after taxation $2m).
The carrying amount of this investment was reviewed for impairment as at the balance sheet date. For the purposes of impairment testing the recoverable amount of this investment was based on its fair value less cost to sell, estimated using discounted cash flows. The fair value measurement was categorised as a level 3 fair value based on the inputs and valuation technique used.
In addition to its 49% ownership interest in Bioventus, the Group held a senior secured five year loan note with Bioventus. The loan note was created in May 2012 with a principal amount of $160m and an annual coupon rate of LIBOR plus 5%. In October 2014, the loan note of $160 million plus $28m of accrued interest was repaid by Bioventus following a successful external refinancing. The Group continues to hold 49% of investor equity in Bioventus.
The amount recognised in the balance sheet and income statement for associates are as follows:
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Balance sheet | | | 112 | | | | 107 | | Income statement loss | | | (2 | ) | | | (1 | ) | | |
Smith & Nephew Annual report 2014 133
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
11 Investments in associatescontinued
Summarised financial information for associates
Set out below is the summarised financial information for Bioventus, adjusted for differences with Group accounting policies:
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Summarised balance sheet | | | | | | | | | Non-current assets | | | 339 | | | | 315 | | Current assets | | | 90 | | | | 129 | | Non-current liabilities | | | (220 | ) | | | (194 | ) | Current liabilities | | | (48 | ) | | | (59 | ) | Net assets | | | 161 | | | | 191 | | Group’s share of net assets at 49% | | | 79 | | | | 93 | | | | Group adjustments (i) | | | 26 | | | | 14 | | Group’s carrying amount of investment at 49% | | | 105 | | | | 107 | | | | | | | | | | | Summarised statement of comprehensive income | | | | | | | | | Revenue | | | 242 | | | | 231 | | Attributable loss for the year | | | (5 | ) | | | (4 | ) | Total comprehensive loss | | | (5 | ) | | | (4 | ) | Group share of loss for the year at 49% | | | (2 | ) | | | (2 | ) | | |
(i) Group adjustments primarily relate to an adjustment to align the useful life of intangible assets with Group policy.
At December 2014, the Group holds equity investments in two other associates (2013 – none) which are immaterial. The Group’s aggregate carrying amount of these investments at 31 December 2014 is $7m (2013 – nil) and the Group’s aggregate share of profits from these investments was $nil (2013 – nil). The Group’s share of loss in 2013 includes a gain of $1m from two Austrian associates. The Group disposed of the Austrian associates during the year ended 31 December 2013.
12 Inventories
| | | | | | | ACCOUNTING POLICY
| | | | | Finished goods and work-in-progress are valued at factory cost, including appropriate overheads, on a first-in first-out basis. Raw materials and bought-in finished goods are valued at purchase price. All inventories are reduced to net realisable value where lower than cost. Inventory acquired as part of a business acquisition is valued at selling price less costs of disposal and a profit allowance for selling efforts.
Orthopaedic instruments are generally not sold but provided to customers and distributors for use in surgery. They are recorded as inventory until they are deployed at which point they are transferred to plant and equipment and depreciated over their useful economic lives of between three and five years.
A feature of the orthopaedic business is the high level of product inventory required, some of which is located at customer premises and is available for customers’ immediate use (referred to as consignment inventory). Complete sets of product, including large and small sizes, have to be made available in this way. These outer sizes are used less frequently than standard sizes and towards the end of the product life cycle are inevitably in excess of requirements. Adjustments to carrying value are therefore required to be made to orthopaedic inventory to anticipate this situation. These adjustments are calculated in accordance with a formula based on levels of inventory compared with historical or forecast usage. This formula is applied on an individual product line basis and is first applied when a product group has been on the market for two years. This method of calculation is considered appropriate based on experience but it involves management judgements on effectiveness of inventory deployment, length of product lives, phase-out of old products and efficiency of manufacturing planning systems.
| | |
| | | | | | | | | | | | | | | | 2014 $ million | | |
| 2013
$ million |
| | | 2012 $ million | | Raw materials and consumables | | | 214 | | | | 151 | | | | 138 | | Work-in-progress | | | 82 | | | | 72 | | | | 45 | | Finished goods and goods for resale | | | 885 | | | | 783 | | | | 718 | | | | | | | 1,181 | | | | 1,006 | | | | 901 | | | |
Reserves for excess and obsolete inventories were $317m (2013 – $354m, 2012 – $332m). The decrease in reserves of $37m in the year comprised releases of $29m, inventory write-offs of $4m and foreign exchange movements of $4m.
The cost of inventories recognised as an expense and included in cost of goods sold amounted to $1,013m (2013 – $958m, 2012 – $906m). In addition, $55m was recognised as an expense within cost of goods sold resulting from inventory write offs (2013 – $73m, 2012 – $84m).
Notwithstanding inventory acquired within acquisitions, no inventory is carried at fair value less costs to sell in any year.
134Smith & Nephew Annual report 2014
13 Trade and other receivables
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Trade and other receivables are carried at amortised cost, less any allowances for uncollectible amounts. They are included in current assets, except for maturities greater than 12 months after the balance sheet date. These are classified as non-current assets.
The Group manages credit risk through credit limits which require authorisation commensurate with the size of the limit and which are regularly reviewed. Credit limit decisions are made based on available financial information and the business case. Significant receivables are regularly reviewed and monitored at Group level. The Group has no significant concentration of credit risk, with exposure spread over a large number of customers and geographies. Furthermore the Group’s principal customers are backed by government and public or private medical insurance funding, which historically represent a lower risk of default. The maximum exposure to credit risk at the reporting date is the fair value of each class of receivable. The Group does not hold any collateral as security.
| | |
| | | | | | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Trade receivables | | | | | 1,015 | | | | 992 | | | | 964 | | Less: provision for bad and doubtful debts | | | | | (47 | ) | | | (57 | ) | | | (49 | ) | Trade receivables – net (loans and receivables) | | | | | 968 | | | | 935 | | | | 915 | | Derivatives – forward foreign exchange contracts | | | | | 49 | | | | 28 | | | | 12 | | Other receivables | | | | | 51 | | | | 60 | | | | 65 | | Prepayments and accrued income | | | | | 98 | | | | 90 | | | | 73 | | | | | | | 1,166 | | | | 1,113 | | | | 1,065 | | | Management considers that the carrying amount of trade and other receivables approximates to the fair value. | | | The provision for bad and doubtful debts is based on specific assessments of risk and reference to past default experience. The bad debt credit for the year was $4m (2013 – expense $15m, 2012 – expense $16m). Amounts due from insurers in respect of the macro textured claim of $143m (2013 – $138m, 2012 – $137m) are included within other receivables and have been provided in full. | | | The amount of trade receivables that were past due were as follows: | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| Past due not more than three months | | | | | 181 | | | | 206 | | | | 225 | | Past due more than three months and not more than six months | | | | | 49 | | | | 52 | | | | 52 | | Past due more than six months and not more than one year | | | | | 51 | | | | 61 | | | | 52 | | Past due more than one year | | | | | 42 | | | | 70 | | | | 80 | | | | | | | 323 | | | | 389 | | | | 409 | | Neither past due nor impaired | | | | | 692 | | | | 603 | | | | 555 | | Provision for bad and doubtful debts | | | | | (47 | ) | | | (57 | ) | | | (49 | ) | Trade receivables – net (loans and receivables) | | | | | 968 | | | | 935 | | | | 915 | | | Movements in the provision for bad and doubtful debts were as follows: | | At 1 January | | | | | 57 | | | | 49 | | | | 36 | | Exchange adjustment | | | | | (4 | ) | | | 1 | | | | – | | Net receivables (provision released)/provided for during the year | | | | | (4 | ) | | | 15 | | | | 16 | | Utilisation of provision | | | | | (2 | ) | | | (8 | ) | | | (3 | ) | At 31 December | | | | | 47 | | | | 57 | | | | 49 | | | Trade receivables include amounts denominated in the following major currencies: | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| US Dollar | | | | | 353 | | | | 293 | | | | 258 | | Sterling | | | | | 92 | | | | 103 | | | | 100 | | Euro | | | | | 225 | | | | 271 | | | | 276 | | Other | | | | | 298 | | | | 268 | | | | 281 | | Trade receivables – net (loans and receivables) | | | | | 968 | | | | 935 | | | | 915 | |
Smith & Nephew Annual report 2014 135
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
14 Trade and other payables
| | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| Trade and other payables due within one year | | | | | | | | | | | Trade and other payables | | | | | 807 | | | | 751 | | Derivatives – forward foreign exchange contracts | | | | | 21 | | | | 20 | | Acquisition consideration | | | | | 10 | | | | 14 | | | | | | | 838 | | | | 785 | | Other payables due after one year: | | | | | | | | | | | Acquisition consideration | | | | | 23 | | | | 7 | | Other payables | | | | | 21 | | | | – | | | | | | | 44 | | | | 7 | | The acquisition consideration due after more than one year is expected to be payable as follows: $5m in 2016, $8m in 2017 and $10m in 2018 (2013 – $4m in 2015 and $3m in 2016). 15 Cash and borrowings 15.1 Net debt Net debt comprises borrowings and credit balances on currency swaps less cash at bank. | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| Bank overdrafts and loans due within one year | | | | | 39 | | | | 44 | | Long-term bank borrowings | | | | | 541 | | | | 347 | | Private placement notes | | | | | 1,125 | | | | – | | Borrowings | | | | | 1,705 | | | | 391 | | Cash at bank | | | | | (93 | ) | | | (137 | ) | Credit/(debit) balance on derivatives – currency swaps | | | | | 1 | | | | (1 | ) | Net debt | | | | | 1,613 | | | | 253 | |
Borrowings are repayable as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Within
one year or on demand $ million |
| | | Between one and two years $ million | | | | Between two and three years $ million | | | | Between three and four years $ million | | | | Between four and five years $ million | | | | After five years $ million | | |
| Total
$ million |
| At 31 December 2014: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Bank loans | | | 9 | | | | 400 | | | | – | | | | – | | | | 131 | | | | – | | | | 540 | | Bank overdrafts | | | 28 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 28 | | Finance lease liabilities | | | 2 | | | | 2 | | | | 2 | | | | 3 | | | | 3 | | | | – | | | | 12 | | Private placement notes | | | – | | | | – | | | | – | | | | – | | | | 125 | | | | 1,000 | | | | 1,125 | | | | | 39 | | | | 402 | | | | 2 | | | | 3 | | | | 259 | | | | 1,000 | | | | 1,705 | | At 31 December 2013: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Bank loans | | | 31 | | | | 335 | | | | – | | | | – | | | | – | | | | – | | | | 366 | | Bank overdrafts | | | 11 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 11 | | Finance lease liabilities | | | 2 | | | | 2 | | | | 2 | | | | 2 | | | | 3 | | | | 3 | | | | 14 | | | | | 44 | | | | 337 | | | | 2 | | | | 2 | | | | 3 | | | | 3 | | | | 391 | |
136Smith & Nephew Annual report 2014
15.2 Assets pledged as security
Assets are pledged as security under normal market conditions. Secured borrowings and pledged assets are as follows:
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Finance lease liabilities – due within one year | | | 2 | | | | 2 | | Finance lease liabilities – due after one year | | | 10 | | | | 12 | | Total amount of secured borrowings | | | 12 | | | | 14 | | Total net book value of assets pledged as security: | | | | | | | | | Property, plant and equipment | | | 8 | | | | 10 | | | | | 8 | | | | 10 | |
15.3 Currency swap analysis
All currency swaps are stated at fair value. Gross US Dollar equivalents of $279m (2013 – $146m) receivable and $280m (2013 – $145m) payable have been netted. Currency swaps comprise foreign exchange swaps and forward contracts and were used in 2014 and 2013 to hedge intragroup loans and other monetary items.
Currency swaps mature as follows:
| | | | | | | | | At 31 December 2014 | |
| Amount receivable
$ million |
| |
| Amount payable
Currency million |
| Within one year:
| | | | | | | | | Canadian Dollar
| | | 14 | | | | CAD 16 | | Chinese Renminbi
| | | 16 | | | | CNY 100 | | Euro
| | | 17 | | | | EUR 14 | | Hong Kong Dollar
| | | 3 | | | | HKD 20 | | Japanese Yen
| | | 8 | | | | JPY 950 | | Swedish Krona
| | | – | | | | SEK 3 | | | | | 58 | | | | | | | | | | | | | | | | | | At 31 December 2014 | |
| Amount receivable
Currency million |
| |
| Amount payable
$ million |
| Within one year:
| | | | | | | | | Australian Dollar
| | | AUD 78 | | | | 64 | | Swiss Franc
| | | CHF 22 | | | | 22 | | Euro
| | | EUR 62 | | | | 76 | | Sterling
| | | GBP 26 | | | | 40 | | Japanese Yen
| | | JPY 200 | | | | 2 | | New Zealand Dollar
| | | NZD 18 | | | | 14 | | Swedish Krona
| | | SEK 3 | | | | – | | Singapore Dollar
| | | SGD 5 | | | | 4 | | | | | | | | | 222 | |
Smith & Nephew Annual report 2014 137
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
15 Cash and borrowingscontinued
| | | | | | | | | At 31 December 2013 | |
| Amount receivable
$ million |
| |
| Amount payable
Currency million
|
| Within one year:
| | | | | | | | | Euro
| | | 28 | | | | EUR 20 | | Japanese Yen
| | | 13 | | | | JPY 1,315 | | Chinese Renminbi
| | | 17 | | | | CNY 100 | | Sterling
| | | 11 | | | | GBP 7 | | | | | 69 | | | | | | | | | | | | | | | | | | At 31 December 2013 | |
| Amount receivable
Currency million |
| |
| Amount payable
$ million |
| Within one year:
| | | | | | | | | New Zealand Dollar
| | | NZD 9 | | | | 7 | | Swiss Franc
| | | CHF 14 | | | | 16 | | Swedish Krona
| | | SEK 31 | | | | 5 | | Australian Dollar
| | | AUD 41 | | | | 36 | | Canadian Dollar
| | | CAD 3 | | | | 3 | | Sterling
| | | GBP 6 | | | | 10 | | | | | | | | | 77 | |
15.4 Liquidity risk exposures
The Board has established a set of policies to manage funding and currency risks. The Group uses derivative financial instruments only to manage the financial risks associated with underlying business activities and their financing.
Liquidity risk is the risk that the Group is not able to settle or meet its obligations on time or at a reasonable price. The Group’s policy is to ensure that there is sufficient funding and facilities in place to meet foreseeable borrowing requirements. The Group manages and monitors liquidity risk through regular reporting of current cash and borrowing balances and periodic preparation and review of short and medium term cash forecasts, having regard to the maturities of investments and borrowing facilities.
The Group has available committed facilities of $2.5bn (2013 – $1.7bn). The interest payable on borrowings under committed facilities is either at fixed or floating rates. Floating rates are typically based on the LIBOR (or other reference rate) relevant to the term and currency concerned.
The Company is subject to restrictive covenants under its principal facility agreements. These financial covenants are tested at the end of each half year for the 12 months ending on the last day of the testing period. As of 31 December 2014, the Company was in compliance with these covenants. The facilities are also subject to customary events of default, none of which are currently anticipated to occur.
The Group’s principal facilities are:
| | | | | Facility | | | Date due | | $400 million syndicated, term loan facility
| | | February 2016 | | $1.0 billion syndicated, revolving credit facility
| | | March 2019 | | $80 million 2.47% Senior Notes
| | | November 2019 | | $45 million Floating Rate Senior Notes
| | | November 2019 | | $75 million 3.23% Senior Notes
| | | January 2021 | | $190 million 2.97% Senior Notes
| | | November 2021 | | $75 million 3.46% Senior Notes
| | | January 2022 | | $50 million 3.15% Senior Notes
| | | November 2022 | | $105 million 3.26% Senior Notes
| | | November 2023 | | $100 million 3.89% Senior Notes
| | | January 2024 | | $305 million 3.36% Senior Notes
| | | November 2024 | | $25 million Floating Rate Senior Notes
| | | November 2024 | | $75 million 3.99% Senior Notes
| | | January 2026 | |
138Smith & Nephew Annual report 2014
15.5 Year-end financial liabilities by contractual maturity
The table below analyses the Group’s year-end financial liabilities by contractual maturity date, including interest payments and excluding the impact of netting arrangements:
| | | | | | | | | | | | | | | | | | | | | | | | Within one year or on demand $��million | | | | Between one and two years $ million | | | | Between two and five years $ million | | | | After five years $ million | | | | Total $ million | | At 31 December 2014 | | | | | | | | | | | | | | | | | | | | | Non-derivative financial liabilities: | | | | | | | | | | | | | | | | | | | | | Bank overdrafts and loans | | | 37 | | | | 400 | | | | 131 | | | | – | | | | 568 | | Trade and other payables | | | 807 | | | | 21 | | | | – | | | | – | | | | 828 | | Finance lease liabilities | | | 3 | | | | 3 | | | | 9 | | | | – | | | | 15 | | Private placement notes | | | – | | | | – | | | | 125 | | | | 1,000 | | | | 1,125 | | Acquisition consideration | | | 10 | | | | 13 | | | | 10 | | | | – | | | | 33 | | Derivative financial liabilities: | | | | | | | | | | | | | | | | | | | | | Currency swaps/forward foreign exchange contracts – outflow | | | 1,811 | | | | – | | | | – | | | | – | | | | 1,811 | | Currency swaps/forward foreign exchange contracts – inflow | | | (1,810 | ) | | | – | | | | – | | | | – | | | | (1,810 | ) | | | | 858 | | | | 437 | | | | 275 | | | | 1,000 | | | | 2,570 | | At 31 December 2013 | | | | | | | | | | | | | | | | | | | | | Non-derivative financial liabilities: | | | | | | | | | | | | | | | | | | | | | Bank overdrafts and loans | | | 42 | | | | 335 | | | | – | | | | – | | | | 377 | | Trade and other payables | | | 751 | | | | – | | | | – | | | | – | | | | 751 | | Finance lease liabilities | | | 3 | | | | 3 | | | | 9 | | | | 3 | | | | 18 | | Acquisition consideration | | | 14 | | | | 4 | | | | 3 | | | | – | | | | 21 | | Derivative financial liabilities: | | | | | | | | | | | | | | | | | | | | | Currency swaps/forward foreign exchange contracts – outflow | | | 1,734 | | | | – | | | | – | | | | – | | | | 1,734 | | Currency swaps/forward foreign exchange contracts – inflow | | | (1,733 | ) | | | – | | | | – | | | | – | | | | (1,733 | ) | | | | 811 | | | | 342 | | | | 12 | | | | 3 | | | | 1,168 | |
The amounts in the tables above are undiscounted cash flows, which differ from the amounts included in the balance sheet where the underlying cash flows have been discounted.
Smith & Nephew Annual report 2014 139
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
15 Cash and borrowingscontinued
15.6 Finance leases
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Leases are classified as finance leases when the terms of the lease transfer substantially all the risks and rewards of ownership to the Group. All other leases are classified as operating leases.
The leased assets are measured initially at an amount equal to the lower of their fair value and the present value of the minimum lease payments. Assets held under finance leases are capitalised as property, plant or equipment and depreciated accordingly. Minimum lease payments are apportioned between the finance expense and the reduction in the outstanding liability. The finance expense is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability.
| | |
Future minimum lease payments under finance leases together with the present value of the minimum lease payments are as follows:
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Within one year | | | 3 | | | | 3 | | After one and within two years | | | 3 | | | | 3 | | After two and within three years | | | 3 | | | | 3 | | After three and within four years | | | 3 | | | | 3 | | After four and within five years | | | 3 | | | | 3 | | After five years | | | – | | | | 3 | | Total minimum lease payments | | | 15 | | | | 18 | | Discounted by imputed interest | | | (3 | ) | | | (4 | ) | Present value of minimum lease payments | | | 12 | | | | 14 | |
Present value of minimum lease payments can be split out as: $2m (2013 – $2m) due within one year, $10m (2013 – $9m) due between one to five years and $nil (2013– $3m) due after five years.
16 Financial instruments and risk management
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Derivative financial instruments
Derivative financial instruments are initially recognised at fair value on the date a derivative contract is entered into and are subsequently re-measured at their fair value at subsequent balance sheet dates.
Changes in the fair value of derivative financial instruments that are designated and effective as cash flow hedges of forecast third party and intercompany transactions are recognised in other comprehensive income until the associated asset or liability is recognised. Amounts taken to other comprehensive income are transferred to the income statement in the period in which the hedged transaction affects profit and loss. Where the hedged item is the cost of a non-financial asset, the amounts taken to other comprehensive income are transferred to the initial carrying value of the asset.
Currency swaps to match foreign currency net assets with foreign currency liabilities are fair valued at year-end. Changes in the fair values of currency swaps that are designated and effective as net investment hedges are matched in other comprehensive income against changes in value of the related net assets.
Interest rate derivatives transacted to fix interest rates on floating rate borrowings are accounted for as cash flow hedges and changes in the fair values resulting from changes in market interest rates are recognised in other comprehensive income. Amounts taken to other comprehensive income are transferred to the income statement when the hedged transaction affects profit and loss.
Any ineffectiveness on hedging instruments and changes in the fair value of derivative financial instruments that do not qualify for hedge accounting are recognised in the income statement within other finance income/(costs) as they arise.
Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. At that point in time, any cumulative gain or loss on the hedging instrument recognised in other comprehensive income is retained there until the forecast transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in other comprehensive income is transferred to the income statement for the period.
| | |
140Smith & Nephew Annual report 2014
16.1 Foreign exchange exposures
The Group operates in over 100 countries and as a consequence has transactional and translational foreign exchange exposure. It is Group policy for operating units not to hold material unhedged monetary assets or liabilities other than in their functional currencies.
Foreign exchange variations affect trading results in two ways. Firstly, on translation of overseas sales and profits into US Dollars and secondly, transactional exposures arising where some or all of the costs of sale are incurred in a different currency from the sale. The principal transactional exposures arise as the proportion of costs in US Dollars, Sterling and Swiss Francs exceed the proportion of sales in each of these currencies and correspondingly the proportion of sales in Euros exceeds the proportion of costs in Euros.
The impact of currency movements on the cost of purchases is partly mitigated by the use of forward foreign exchange contracts. The Group uses forward foreign exchange contracts, designated as cash flow hedges, to hedge forecast third party and intercompany trading cash flows for forecast foreign currency inventory purchases for up to one year. When a commitment is entered into, forward foreign exchange contracts are normally used to increase the hedge to 100% of the exposure. Cash flows relating to cash flow hedges are expected to occur within 12 months of inception and profits and losses on hedges are expected to enter into the determination of profit (within cost of goods sold) within a further 12-month period. The principal currencies hedged by forward foreign exchange contracts are US Dollars, Euros and Sterling. At 31 December 2014, the Group had contracted to exchange within one year the equivalent of $1.5bn (2013 – $1.6bn).
Based on the Group’s net borrowings as at 31 December 2014, if the US Dollar were to weaken against all currencies by 10%, the Group’s net borrowings would decrease by $6m (2013 – decrease by $2m) as the Group held a higher amount of foreign denominated cash than foreign denominated borrowings. In respect of borrowings held in a different currency to the relevant reporting entity, if the US Dollar were to weaken by 10% against all other currencies, the Group’s borrowings would increase by $1m (2013 – increase by $4m).
If the US Dollar were to weaken by 10% against all other currencies, then the fair value of the forward foreign exchange contracts as at 31 December 2014 would have been $37m lower (2013 – $34m). Similarly, if the Euro were to weaken by 10% against all other currencies, then the fair value of the forward foreign exchange contracts as at 31 December 2014 would have been $26m higher (2013 – $27m). Movements in the fair value of forward foreign exchange contracts would be recognised in other comprehensive income and accumulated in the hedging reserve.
A 10% strengthening of the US Dollar or Euro against all other currencies at 31 December 2014 would have had the equal but opposite effect to the amounts shown above, on the basis that all other variables remain constant.
The Group’s policy to hedge all actual foreign exchange exposures and the Group’s forward foreign exchange contracts are designated as cash flow hedges. The net impact of transaction related foreign exchange on the income statement from a movement in exchange rates on the value of forward foreign exchange contracts is not significant. In addition, the movements in the fair value of other financial instruments used for hedging such as currency swaps for which hedge accounting is not applied, offset movements in the values of assets and liabilities and are recognised through the income statement.
16.2 Interest rate exposures
The Group is exposed to interest rate risk on cash, borrowings and certain currency swaps which are all at floating rates. When required the Group uses interest rate derivatives to meet its objective of protecting borrowing costs within parameters set by the Board. Interest rate derivatives are accounted for as cash flow hedges and, as such, changes in fair value resulting from changes in market interest rates are recognised in other comprehensive income and accumulated in the hedging reserve, with the fair value of the interest rate derivatives recorded in the balance sheet. The cash flows resulting from interest rate derivatives match cash flows on the underlying borrowings so that there is no net cash flow from movements in market interest rates on the hedged items.
Based on the Group’s gross borrowings as at 31 December 2014, if interest rates were to increase by 100 basis points in all currencies then the annual net interest charge would increase by $6m (2013 – $4m). A decrease in interest rates by 100 basis points in all currencies would have an equal but opposite effect to the amounts shown above.
16.3 Credit risk exposures
The Group limits exposure to credit risk on counterparties used for financial instruments through a system of internal credit limits which, with certain minor exceptions due to local market conditions, require counterparties to have a minimum ‘A’ rating from one of the major ratings agencies. The financial exposure of a counterparty is determined as the total of cash and deposits, plus the risk on derivative instruments, assessed as the fair value of the instrument plus a risk element based on the nominal value and the historic volatility of the market value of the instrument. The Group does not anticipate non-performance of counterparties and believes it is not subject to material concentration of credit risk as the Group operates within a policy of counterparty limits designed to reduce exposure to any single counterparty.
The maximum credit risk exposure on derivatives at 31 December 2014 was $49m (2013 – $29m), being the total debit fair values on forward foreign exchange contracts and currency swaps. The maximum credit risk exposure on cash at bank at 31 December 2014 was $93m (2013 – $137m). The Group’s exposure to credit risk is not material as the amounts are held in a wide number of banksplans in a number of different countries.
Credit risk on trade receivables is detailed in Note 13.
Smith & Nephew Annual report 2014 141
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
16 Financial instruments and risk managementcontinued
16.4 Currency and interest rate profile of interest bearing liabilities and assets
Short-term debtors and creditors are excluded from the following disclosures.
Currency and Interest Rate Profile of Interest Bearing Liabilities:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Fixed rate liabilities | | | | | Gross borrowings $ million | | | | Currency swaps $ million | | | | Total liabilities $ million | | | | Floating rate liabilities $ million | | | | Fixed rate liabilities $ million | | |
| Weighted average Interest rate
% |
| | | Weighted average time for which rate is fixed Years | | At 31 December 2014: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | US Dollar | | | 1,685 | | | | 208 | | | | 1,893 | | | | 826 | | | | 1,067 | | | | 3.4 | | | | 8.3 | | Euro | | | 10 | | | | 35 | | | | 45 | | | | 45 | | | | – | | | | – | | | | – | | Other | | | 10 | | | | 37 | | | | 47 | | | | 47 | | | | – | | | | – | | | | – | | Total interest bearing liabilities | | | 1,705 | | | | 280 | | | | 1,985 | | | | 918 | | | | 1,067 | | | | | | | | | | At 31 December 2013: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | US Dollar | | | 297 | | | | 77 | | | | 374 | | | | 360 | | | | 14 | | | | 7.1 | | | | 4 | | Euro | | | 59 | | | | 28 | | | | 87 | | | | 87 | | | | – | | | | – | | | | – | | Other | | | 35 | | | | 40 | | | | 75 | | | | 75 | | | | – | | | | – | | | | – | | Total interest bearing liabilities | | | 391 | | | | 145 | | | | 536 | | | | 522 | | | | 14 | | | | | | | | | |
At 31 December 2014, $12m (2013 – $14m) of fixed rate liabilities relate to finance leases. In 2014, the Group also had liabilities due for deferred acquisition consideration (denominated in US Dollars and Brazilian Real) totalling $33m (2013 – $21m, 2012 – $8m) on which no interest was payable (see Note 14). There are no other significant interest bearing financial liabilities.
Floating rates on liabilities are typically based on the one or three-month LIBOR (or other reference rate) relevant to the currency concerned. The weighted average interest rate on floating rate borrowings as at 31 December 2014 was 1% (2013 – 1%).
Currency and Interest Rate Profile of Interest Bearing Assets:
| | | | | | | | | | | | | | | | | | | | Cash at bank $ million | | | | Currency swaps $ million | | | | Total assets $ million | | | | Floating rate assets $ million | | At 31 December 2014: | | | | | | | | | | | | | | | | | US Dollars | | | 13 | | | | 79 | | | | 92 | | | | 92 | | Other | | | 80 | | | | 200 | | | | 280 | | | | 280 | | Total interest bearing assets | | | 93 | | | | 279 | | | | 372 | | | | 372 | | At 31 December 2013: | | | | | | | | | | | | | | | | | US Dollars | | | 8 | | | | 69 | | | | 77 | | | | 77 | | Other | | | 129 | | | | 77 | | | | 206 | | | | 206 | | Total interest bearing assets | | | 137 | | | | 146 | | | | 283 | | | | 283 | |
Floating rates on assets are typically based on the short-term deposit rates relevant to the currency concerned. There were no fixed rate assets at 31 December 2014 or 31 December 2013.
142Smith & Nephew Annual report 2014
16.5 Fair value of financial assets and liabilities
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Measurement of fair values
A number of the Group’s accounting policies and disclosures require the measurement of fair values, for both financial assets and liabilities and non-financial assets acquired in a business combination (see Note 21).
When measuring the fair value of an asset or liability, the Group uses market observable data as far as possible. Fair values are categorised into different levels in the fair value hierarchy based on the inputs used in the valuation techniques as follows: Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2: inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); Level 3: inputs for the asset or liability that are not based on observable data (unobservable inputs).
The Group recognises transfers between the levels of the fair value hierarchy at the end of the reporting period during which the change has occurred.
| | |
The following table shows the carrying amounts and fair values of financial assets and financial liabilities, including their levels in the fair value hierarchy. It does not include fair value information for financial assets and financial liabilities not measured at fair value if the carrying amount is a reasonable approximation of fair value.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Carrying amount | | | | | Fair value | | | | Designated at fair value | | | Fair value – hedging instruments | | | Loans and receivables | | | Available for sale | | | Other financial liabilities | | | Total | | | | | Level 2 | | | Level 3 | | | Total | | At 31 December 2014 | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | | | $ million | | | | $ million | | | | $ million | | Financial assets measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Forward foreign exchange contracts | | | – | | | | 48 | | | | – | | | | – | | | | – | | | | 48 | | | | | | 48 | | | | – | | | | 48 | | Investments | | | – | | | | – | | | | – | | | | 5 | | | | – | | | | 5 | | | | | | – | | | | 5 | | | | 5 | | Currency swaps | | | 1 | | | | – | | | | – | | | | – | | | | – | | | | 1 | | | | | | 1 | | | | – | | | | 1 | | | | | 1 | | | | 48 | | | | – | | | | 5 | | | | – | | | | 54 | | | | | | 49 | | | | 5 | | | | 54 | | Financial liabilities measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | | (33 | ) | | | – | | | | – | | | | – | | | | – | | | | (33 | ) | | | | | – | | | | (33 | ) | | | (33 | ) | Forward foreign exchange contracts | | | – | | | | (19 | ) | | | – | | | | – | | | | – | | | | (19 | ) | | | | | (19 | ) | | | – | | | | (19 | ) | Currency swaps | | | (2 | ) | | | – | | | | – | | | | – | | | | – | | | | (2 | ) | | | | | (2 | ) | | | – | | | | (2 | ) | | | | (35 | ) | | | (19 | ) | | | – | | | | – | | | | – | | | | (54 | ) | | | | | (21 | ) | | | (33 | ) | | | (54 | ) | Financial assets not measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Trade and other receivables | | | – | | | | – | | | | 1,117 | | | | – | | | | – | | | | 1,117 | | | | | | | | | | | | | | | | Cash at bank | | | – | | | | – | | | | 93 | | | | – | | | | – | | | | 93 | | | | | | | | | | | | | | | | | | | – | | | | – | | | | 1,210 | | | | – | | | | – | | | | 1,210 | | | | | | | | | | | | | | | | Financial liabilities not measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Bank overdrafts | | | – | | | | – | | | | – | | | | – | | | | (28 | ) | | | (28 | ) | | | | | | | | | | | | | | | Bank loans | | | – | | | | – | | | | – | | | | – | | | | (540 | ) | | | (540 | ) | | | | | | | | | | | | | | | Private placement debt | | | – | | | | – | | | | – | | | | – | | | | (1,125 | ) | | | (1,125 | ) | | | | | (1,144 | ) | | | – | | | | (1,144 | ) | Finance lease liabilities | | | – | | | | – | | | | – | | | | – | | | | (12 | ) | | | (12 | ) | | | | | | | | | | | | | | | Trade and other payables | | | – | | | | – | | | | – | | | | – | | | | (828 | ) | | | (828 | ) | | | | | | | | | | | | | | | | | | – | | | | – | | | | – | | | | – | | | | (2,533 | ) | | | (2,533 | ) | | | | | | | | | | | | | | |
Smith & Nephew Annual report 2014 143
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
16 Financial instruments and risk managementcontinued
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Carrying amount | | | | | | | Fair value | | At 31 December 2013 | |
| Designated
at fair value $ million |
| |
| Fair value –
hedging instruments $ million |
| |
| Loans
and receivables $ million |
| |
| Available
for sale $ million |
| |
| Other
financial liabilities $ million |
| | Total $ million | | | | | |
| Level 2
$ million |
| |
| Level 3
$ million |
| |
| Total
$ million |
| Financial assets measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Forward foreign exchange contracts | | | – | | | | 28 | | | | – | | | | – | | | | – | | | 28 | | | | | | | 28 | | | | – | | | | 28 | | Investments | | | – | | | | – | | | | – | | | | 2 | | | | – | | | 2 | | | | | | | – | | | | 2 | | | | 2 | | Currency swaps | | | 1 | | | | – | | | | – | | | | – | | | | – | | | 1 | | | | | | | 1 | | | | – | | | | 1 | | | | | 1 | | | | 28 | | | | – | | | | 2 | | | | – | | | 31 | | | | | | | 29 | | | | 2 | | | | 31 | | Financial liabilities measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Acquisition consideration | | | (21 | ) | | | – | | | | – | | | | – | | | | – | | | (21) | | | | | | | – | | | | (21 | ) | | | (21 | ) | Forward foreign exchange contracts | | | – | | | | (20 | ) | | | – | | | | – | | | | – | | | (20) | | | | | | | (20 | ) | | | – | | | | (20 | ) | | | | (21 | ) | | | (20 | ) | | | – | | | | – | | | | – | | | (41) | | | | | | | (20 | ) | | | (21 | ) | | | (41 | ) | Financial assets not measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Trade and other receivables | | | – | | | | – | | | | 1,085 | | | | – | | | | – | | | 1,085 | | | | | | | | | | | | | | | | | Cash at bank | | | – | | | | – | | | | 137 | | | | – | | | | – | | | 137 | | | | | | | | | | | | | | | | | | | | – | | | | – | | | | 1,222 | | | | – | | | | – | | | 1,222 | | | | | | | | | | | | | | | | | Financial liabilities not measured at fair value | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Bank overdrafts | | | – | | | | – | | | | – | | | | – | | | | (11 | ) | | (11) | | | | | | | | | | | | | | | | | Bank loans | | | – | | | | – | | | | – | | | | – | | | | (366 | ) | | (366) | | | | | | | | | | | | | | | | | Finance lease liabilities | | | – | | | | – | | | | – | | | | – | | | | (14 | ) | | (14) | | | | | | | | | | | | | | | | | Trade and other payables | | | – | | | | – | | | | – | | | | – | | | | (751 | ) | | (751) | | | | | | | | | | | | | | | | | | | | – | | | | – | | | | – | | | | – | | | | (1,142 | ) | | (1,142) | | | | | | | | | | | | | | | | |
The Group enters into derivative financial instruments with financial institutions with investment grade credit ratings. The fair value of forward foreign exchange contracts is calculated by reference to quoted market forward exchange rates for contracts with similar maturity profiles. The fair value of currency swaps is determined by reference to quoted market spot rates. As a result, foreign forward exchange contracts and currency swaps are classified as Level 2 within the fair value hierarchy.
As at 31 December 2014 and 31 December 2013, the fair value of derivatives is net of a credit valuation adjustment attributable to derivative counterparty default risk. The changes in counterparty credit risk had no material effect on the hedge effectiveness for derivatives designated in hedge relationships and other financial instruments recognised at fair value.
The fair value of contingent consideration is estimated using a discounted cash flow model. The valuation model considers the present value of expected payment, discounted using a risk-adjusted discount rate. The expected payment is determined by considering the possible scenarios, which relate to the achievement of established milestones and targets, the amount to be paid under each scenario and the probability of each scenario. As a result, contingent consideration is classified as Level 3 within the fair value hierarchy.
There were no transfers between level 1, 2 and 3 during 2014 and 2013.
For cash and cash equivalents, short-term loans and receivables, overdrafts and other short-term liabilities which have a maturity of less than three months the book values approximate the fair values because of their short-term nature.
Long-term borrowings are measured in the balance sheet at amortised cost. As the Group’s long-term borrowings are not quoted publicly and as market prices are not available their fair values are estimated by discounting future contractual cash flows to net present values at the current market interest rates available to the Group for similar financial instruments as at the year-end.
144Smith & Nephew Annual report 2014
17 Provisions and contingencies
| | | | | | | ACCOUNTING POLICY
| | | | | In the normal course of business the Group is involved in various legal disputes. Provision is made for loss contingencies when it is deemed probable that an adverse outcome will occur and the amount of the loss can be reasonably estimated. Where the Group is the plaintiff in pursuing claims against third parties legal and associated expenses are charged to the income statement as incurred.
The recognition of provisions for legal disputes is subject to a significant degree of estimation. In making its estimates management takes into account the advice of internal and external legal counsel. Provisions are reviewed regularly and amounts updated where necessary to reflect developments in the disputes. The ultimate liability may differ from the amount provided depending on the outcome of court proceedings or settlement negotiations or as new facts emerge.
A provision for onerous contracts is recognised when the expected benefits to be derived by the Group from a contract are lower than the unavoidable cost of meeting its obligations under the contract. For the purpose of calculating any onerous lease provision, the Group has taken the discounted future lease payments, net of expected rental income. Before a provision is established, the Group recognises any impairment loss on the assets associated with that contract.
A provision for rationalisation is recognised when the Group has approved a detailed and formal restructuring plan, and the restructuring either has commenced or has been announced publicly. Future operating losses are not provided for.
| | |
17.1 Provisions
| | | | | | | | | | | | | | | | Rationalisation provisions $ million | | | | Legal and other provisions $ million | | | | Total $ million | | At 1 January 2013 | | | 25 | | | | 97 | | | | 122 | | Charge to income statement | | | 15 | | | | 22 | | | | 37 | | Utilised | | | (22 | ) | | | (12 | ) | | | (34 | ) | At 31 December 2013 | | | 18 | | | | 107 | | | | 125 | | Acquisitions | | | – | | | | 24 | | | | 24 | | Charge to income statement | | | 17 | | | | 15 | | | | 32 | | Utilised | | | (22 | ) | | | (28 | ) | | | (50 | ) | Exchange adjustment | | | (1 | ) | | | – | | | | (1 | ) | At 31 December 2014 | | | 12 | | | | 118 | | | | 130 | | Provisions – due within one year | | | 12 | | | | 55 | | | | 67 | | Provisions – due after one year | | | – | | | | 63 | | | | 63 | | At 31 December 2014 | | | 12 | | | | 118 | | | | 130 | | Provisions – due within one year | | | 18 | | | | 42 | | | | 60 | | Provisions – due after one year | | | – | | | | 65 | | | | 65 | | At 31 December 2013 | | | 18 | | | | 107 | | | | 125 | |
The principal provisions within rationalisation provisions relate to the Group Optimisation programme (mainly severance) announced in May 2014 and people costs associated with the structural and efficiency programme announced in August 2011.
Included within the legal and other provisions are:
– | A provision of $10m (2013 – $nil) relating to the distribution hold on RENASYS. |
– | A provision of $7m (2013 – $nil) relating to the HP802 programme which was stopped in the fourth quarter of 2014. |
– | The remaining balance largely represents provisions for various patent disputes and other litigation. |
All provisions are expected to be substantially utilised within three years of 31 December 2014 and none are treated as financial instruments.
Smith & Nephew Annual report 2014 145
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
17 Provisions and contingenciescontinued
17.2 Contingencies
The Company and its subsidiaries are parties to various legal proceedings, some of which include claims for substantial damages. The outcome of these proceedings cannot readily be foreseen, but management believes none of them are likely to result in a material adverse effect on the financial position of the Group. The Group provides for outcomes that are deemed to be probable and can be reliably estimated. There is no assurance that losses will not exceed provisions or will not have a significant impact on the Group’s results of operations in the period in which they are realised.
In August 2003, the Group withdrew voluntarily from all markets the macrotextured versions of its OXINIUM femoral knee components. A charge of $154m was recorded in 2004 for anticipated expenses in connection with macrotexture claims. Most of that amount has since been applied to settlements of such claims, and almost all have been resolved. The aggregate cost at 31 December 2014 related to this matter is approximately $215m. The Group has sought recovery from its primary and excess insurers for costs of resolving the claims. The primary insurance carrier has paid $60m in full settlement of its policy liability. However, the excess carriers have denied coverage, citing defences relating to the wording of the insurance policies and other matters. In December 2004, the Group brought suit against them in the US district court for the Western District of Tennessee. Trial has not yet begun. An additional $22m was received during 2007 from a successful settlement with a third party.
17.3 Legal proceedings
Product liability claims
The Group faces other claims from time to time for alleged defects in its products and has on occasion recalled or withdrawn products from the market. Such claims are endemic to the orthopaedic device industry. The Group maintains product liability insurance subject to limits and deductibles that management believes are reasonable. All policies contain exclusions and limitations, however, and there can be no assurance that insurance will be available or adequate to cover all claims.
In recent years, there has been heightened concern about possible adverse effects of hip implant products with metal-on-metal bearing surfaces, and the Group has incurred and will continue to incur expenses to defend claims in this area. As of January 2015 approximately 930 such claims were pending with the Group around the world, of which 539 had given rise to pending legal proceedings. Most of the pending legal proceedings are in the United States. Most claims relate to the Group’s Birmingham Hip Resurfacing (‘BHR’) product and the Birmingham Hip Modular Head (‘BHMH’) and R3 Metal Liner (‘R3ML’) components. In 2012, the Group restricted instructions for use of the BHMH and ceased offering the R3ML. In 2013, the Group’s US subsidiary agreed with lawyers representing metal-on-metal claimants to consolidate pre-trial proceedings (such as discovery) in their lawsuits in a state court in Memphis, Tennessee, and those lawsuits account for most of the US proceedings. These lawsuits are being vigorously defended, but outcomes are difficult to predict and defence costs can be significant. The Group takes care to monitor the clinical evidence relating to its metal hip implant products and ensure that its product offerings and training are designed to serve patients’ interests.
The Group has requested indemnity from its product liability insurers for most of these metal-on-metal hip implant claims. In general, the insurers are investigating the claims and have reserved rights under their respective policies. As noted above, there can be no assurance that insurance will be available or adequate to cover all claims.
Business practice investigations
Business practices in the healthcare industry are subject to regulation and review by various government authorities. From time to time authorities undertake investigations of the Group’s activities to verify compliance. In September 2007, the SEC notified the Group that it was conducting an informal investigation of companies in the medical devices industry, including the Group, regarding possible violations of the Foreign Corrupt Practices Act (‘FCPA’) in connection with the sale of products in certain countries outside of the US. The US Department of Justice (‘DOJ’) subsequently joined the SEC’s request.
On 6 February 2012, Smith & Nephew announced that it had reached settlement with the SEC and DOJ in connection with this matter. Smith & Nephew paid slightly less than $23m in fines and profit disgorgement and committed to maintain an enhanced compliance programme and appoint an independent monitor for at least 18 months to review and report on its compliance programme. The monitor’s final report was filed in late 2013, and the independent monitorship was terminated. The settlement agreements had three-year terms. The deferred prosecution agreement with the DOJ expired on 6 February 2015 and the DOJ moved to dismiss a related court action against Smith & Nephew. The agreement with the SEC is scheduled to expire on 3 March 2015.
Intellectual property disputes
The Group is engaged, as both plaintiff and defendant, in litigation with various competitors and others over claims of patent infringement and other intellectual property matters. These disputes are being heard in courts in the US and other jurisdictions and also before agencies that examine patents. Outcomes are rarely certain and costs are often significant.
The Group has won a jury verdict in the US district court for Oregon against Arthrex Inc. for infringement of the Group’s patents relating to suture anchors. A number of issues have been disputed and appealed since the case was first filed in 2003; Arthrex’s latest appeal was argued in January 2015. Arthrex asserted other patents against the Group in 2014 in the US district court for the Eastern District of Texas.
Other matters
In April 2009, the Group was served with a subpoena by the US Department of Justice in Massachusetts requiring the production of documents from 1995 to 2009 associated with the marketing and sale of the Group’s EXOGEN bone growth stimulator. Similar subpoenas have been served on a number of competitors in the bone growth stimulator market. Around the same time a qui tam or ‘whistle-blower’ complaint concerning the industry’s sales and marketing of those products, originally filed in 2005 against the primary manufacturers of bone growth stimulation products (including Smith & Nephew), was unsealed in federal court in Boston, Massachusetts. A motion to dismiss that complaint was denied in December 2010.
146Smith & Nephew Annual report 2014
The Group is subject to country of origin requirements under the US Buy American and Trade Agreements Acts with regard to sales to certain US government customers. In 2008 the Group voluntarily disclosed to the US Veterans Administration and the US Department of Defense that a small percentage of the products sold to the US government may have originated from countries that are not eligible for such sales except with government consent. In December 2008, three months after Smith & Nephew’s initial voluntary disclosure, a whistle-blower suit was filed in the US district court for the Western District of Tennessee alleging these violations. Smith & Nephew’s motion to dismiss the suit was denied in November 2010, and it was settled in 2014.
In January 2014, before agreeing to be acquired by the Group, ArthroCare announced a settlement of charges by the US DOJ relating to securities fraud in which certain members of prior management were implicated. ArthroCare paid a $30m fine and signed a deferred prosecution agreement that imposes reporting, compliance and other requirements on ArthroCare for a two-year term.
18 Retirement benefit obligations
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | The Group’s major pension plans are of the defined benefit type. A defined benefit pension plan defines an amount of pension benefit that an employee will receive on retirement or a minimum guaranteed return on contributions, which is dependent on various factors such as age, years of service and final salary. The Group’s obligation is calculated separately for each plan by discounting the estimated future benefit that employees have earned in return for their service in the current and prior periods. The fair value of any plan assets is deducted to arrive at the net liability.
The calculation of the defined benefit obligation is performed annually by external actuaries using the projected unit credit method. Re-measurements arising from defined benefit plans comprise actuarial gains and losses and the return on the plan assets net of the costs of managing the plan assets. The Group recognises these immediately in other comprehensive income (‘OCI’) and all other expenses, such as service cost, net interest cost, administration costs and taxes, are recognised in the income statement.
A number of key assumptions are made when calculating the fair value of the Group’s defined benefit pension plans. These assumptions impact the balance sheet asset and liabilities, operating profit and finance income/costs. The most critical assumptions are the discount rate, the rate of inflation and mortality assumptions to be applied to future pension plan liabilities. The discount rate is based on the yield at the reporting date on bonds that have a credit rating of AA, denominated in the currency in which the benefits are expected to be paid and have a maturity profile approximately the same as the Group’s obligations. In determining these assumptions management take into account the advice of professional external actuaries and benchmarks its assumptions against external data.
The Group determines the net interest expense/(income) on the net defined benefit liability/(asset) for the period by applying the discount rate used to measure the defined benefit obligation at the beginning of the annual period to the net defined benefit liability/(asset).
The Group also operates a number of defined contribution plans. A defined contribution plan is a pension plan under which the Group and employees pay fixed contributions to a third party financial provider. The Group has no further payment obligations once the contributions have been paid. Contributions are recognised as an employee benefit expense when they are due.
| | |
18.1 Retirement benefit net (assets)/obligations
The Group’s retirement benefit obligations comprise:
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Funded plans: | | | | | | | | | UK Plan | | | 16 | | | | 50 | | US Plan | | | 74 | | | | 65 | | Other Plans | | | 42 | | | | 28 | | | | | 132 | | | | 143 | | Unfunded Plans: | | | | | | | | | Other Plans | | | 48 | | | | 39 | | Retirement Healthcare | | | 46 | | | | 43 | | | | | 226 | | | | 225 | | Amount recognised on the balance sheet – liability | | | 233 | | | | 230 | | Amount recognised on the balance sheet – asset | | | (7 | ) | | | (5 | ) |
The Group sponsors pension plans for its employees in 16 countries and these are established under the laws of the relevant country. Funded plans are funded by the payment of contributions and the assets are held by separate trust funds or insurance companies. In countries where there is no Company-sponsored pension plan, state benefits are considered by management to be adequate. Employees’ retirement benefits are the subject of regular management review. The Group’s defined benefit plans provide employees with an entitlement to retirement benefits varying between 1.3% and 66.7% of final salary on attainment of retirement rage. The level of entitlement is dependent on the year of service of the employee.
The Group’s two major defined benefit pension plans are in the UK and US. Both these plans were closed to new employees in 2003 and defined contribution plans are offered to new joiners. The US Plan was closed to future accrual in March 2014.
Smith & Nephew Annual report 2014 147
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
18 Retirement benefit obligationscontinued
The UK Plan operates under trust law and responsibility for its governance lies with a Board of Trustees. This Board is composed of representatives of the Group, plan participants and an independent trustee who act on behalf of members in accordance with the terms of the Trust Deed and Rules and relevant legislation. The UK Plan’s assets are held by the trust. Annual increases on benefits in payment are dependent on inflation. The main uncertainties affecting the level of benefits payable under the UK Plan are future inflation levels (including the impact of inflation on future salary increase) and the actual longevity of the membership.
The US Plan is governed by a US Pension Committee which is composed of both plan participants and representatives of the Group. In the US, the Pension Protection Act (2006) established both a minimum required contribution and a maximum deductible contribution. Failure to contribute at least the minimum required amount will subject the Company to significant penalties and contributions in excess of the maximum deductible have negative tax consequences. The minimum funding requirement is intended to fully fund the present value of accrued benefits over seven years.
18.2 Reconciliation of benefit obligations and pension assets
The movement in the Group’s pension benefit obligation and pension assets is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2014 | | | | | | 2013 | | | | | Obligation $ million | | | | Asset $ million | | | | Total $ million | | | | | | Obligation $ million | | | | Asset $ million | | | | Total $ million | | Amounts recognised on the balance sheet at beginning of the period | | | (1,581 | ) | | | 1,356 | | | | (225 | ) | | | | | (1,487 | ) | | | 1,227 | | | | (260 | ) | Income statement expense: | | | | | | | | | | | | | | | | | | | | | | | | | | | Current service cost | | | (22 | ) | | | – | | | | (22 | ) | | | | | (29 | ) | | | – | | | | (29 | ) | Past service cost | | | 36 | | | | – | | | | 36 | | | | | | – | | | | – | | | | – | | Settlements | | | 71 | | | | (60 | ) | | | 11 | | | | | | – | | | | – | | | | – | | Interest (expense)/income | | | (67 | ) | | | 60 | | | | (7 | ) | | | | | (59 | ) | | | 51 | | | | (8 | ) | Administration costs and taxes | | | (3 | ) | | | – | | | | (3 | ) | | | | | (3 | ) | | | – | | | | (3 | ) | Costs recognised in Income statement | | | 15 | | | | – | | | | 15 | | | | | | (91 | ) | | | 51 | | | | (40 | ) | Re-measurements: | | | | | | | | | | | | | | | | | | | | | | | | | | | Actuarial gain due to liability experience | | | 5 | | | | – | | | | 5 | | | | | | 1 | | | | – | | | | 1 | | Actuarial (loss)/gain due to financial assumptions change | | | (179 | ) | | | – | | | | (179 | ) | | | | | 16 | | | | – | | | | 16 | | Actuarial loss due to demographic assumptions | | | (30 | ) | | | – | | | | (30 | ) | | | | | (42 | ) | | | – | | | | (42 | ) | Return on plan assets greater than discount rate | | | – | | | | 110 | | | | 110 | | | | | | – | | | | 37 | | | | 37 | | Re-measurements recognised in OCI | | | (204 | ) | | | 110 | | | | (94 | ) | | | | | (25 | ) | | | 37 | | | | 12 | | Cash: | | | | | | | | | | | | | | | | | | | | | | | | | | | Employer contributions | | | – | | | | 65 | | | | 65 | | | | | | – | | | | 67 | | | | 67 | | Employee contributions | | | (5 | ) | | | 5 | | | | – | | | | | | (4 | ) | | | 4 | | | | – | | Benefits paid directly by the Group, taxes and administration costs paid from scheme assets | | | 3 | | | | – | | | | 3 | | | | | | 3 | | | | (3 | ) | | | – | | Benefits paid | | | 51 | | | | (54 | ) | | | (3 | ) | | | | | 45 | | | | (45 | ) | | | – | | Net cash | | | 49 | | | | 16 | | | | 65 | | | | | | 44 | | | | 23 | | | | 67 | | | | | | | | | | Exchange rates | | | 84 | | | | (71 | ) | | | 13 | | | | | | (22 | ) | | | 18 | | | | (4 | ) | Amount recognised on the balance sheet | | | (1,637 | ) | | | 1,411 | | | | (226 | ) | | | | | (1,581 | ) | | | 1,356 | | | | (225 | ) | Amount recognised on the balance sheet – liability | | | (1,611 | ) | | | 1,378 | | | | (233 | ) | | | | | (1,548 | ) | | | 1,318 | | | | (230 | ) | Amount recognised on the balance sheet – asset | | | (26 | ) | | | 33 | | | | 7 | | | | | | (33 | ) | | | 38 | | | | 5 | | | | | | | | | | Represented by: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2014 | | | | | | 2013 | | | | | Obligation $ million | | | | Asset $ million | | | | Total $ million | | | | | | Obligation $ million | | | | Asset $ million | | | | Total $ million | | UK Plan | | | (879 | ) | | | 863 | | | | (16 | ) | | | | | (855 | ) | | | 805 | | | | (50 | ) | US Plan | | | (482 | ) | | | 408 | | | | (74 | ) | | | | | (482 | ) | | | 417 | | | | (65 | ) | Other Plans | | | (276 | ) | | | 140 | | | | (136 | ) | | | | | (244 | ) | | | 134 | | | | (110 | ) | Total | | | (1,637 | ) | | | 1,411 | | | | (226 | ) | | | | | (1,581 | ) | | | 1,356 | | | | (225 | ) |
All benefits are vested at the end of each reporting period. The weighted average duration of the defined benefit obligation at the end of the reporting period is 20 years and 14 years for the UK and US plans respectively. For 2013, this was 20 years for the UK Plan and 16 years for the US Plan.
148Smith & Nephew Annual report 2014
18.3 Plan assets
The market value of the US, UK and Other Plans assets are as follows:
| | | | | | | | | | | | | | | 2014 $ million | | | 2013 $ million | | | 2012 $ million | | UK Plan: | | | | | | | | | | | | | Assets with a quoted market price: | | | | | | | | | | | | | Cash and cash equivalents | | | 6 | | | | 8 | | | | 11 | | Equity securities | | | 237 | | | | 220 | | | | 249 | | Government bonds – fixed interest | | | – | | | | 61 | | | | 92 | | – index linked | | | – | | | | 109 | | | | 282 | | Liability driven investments | | | 227 | | | | – | | | | – | | Diversified growth funds | | | 155 | | | | 159 | | | | 110 | | | | | 625 | | | | 557 | | | | 744 | | Other assets: | | | | | | | | | | | | | Insurance contract | | | 238 | | | | 248 | | | | – | | Market value of assets | | | 863 | | | | 805 | | | | 744 | | US Plan: | | | | | | | | | | | | | Assets with a quoted market price: | | | | | | | | | | | | | Cash and cash equivalents | | | – | | | | 6 | | | | 1 | | Equity securities | | | 167 | | | | 181 | | | | 242 | | Government bonds – fixed interest | | | 121 | | | | 64 | | | | 106 | | Corporate bonds | | | 120 | | | | 151 | | | | – | | Hedge funds | | | – | | | | 15 | | | | 10 | | Market value of assets | | | 408 | | | | 417 | | | | 359 | | Other Plans: | | | | | | | | | | | | | Assets with a quoted market price: | | | | | | | | | | | | | Cash and cash equivalents | | | 6 | | | | 6 | | | | 5 | | Equity securities | | | 33 | | | | 32 | | | | 26 | | Government bonds – fixed interest | | | 7 | | | | 9 | | | | 7 | | – index linked | | | 13 | | | | 11 | | | | 34 | | Corporate bonds | | | 12 | | | | 13 | | | | 2 | | Insurance contracts | | | 31 | | | | 24 | | | | – | | Property | | | 6 | | | | 6 | | | | 5 | | Other quoted securities | | | 3 | | | | 3 | | | | 11 | | | | | 111 | | | | 104 | | | | 90 | | Other assets: | | | | | | | | | | | | | Equities | | | – | | | | – | | | | 2 | | Insurance contracts | | | 29 | | | | 29 | | | | 31 | | Investment property | | | – | | | | 1 | | | | 1 | | Market value of assets | | | 140 | | | | 134 | | | | 124 | | Total market value of assets | | | 1,411 | | | | 1,356 | | | | 1,227 | |
No plans invest directly in property occupied by the Group or in financial securities issued by the Group.
The US and UK plan assets are invested in a diversified range of industries across a broad range of geographies. These assets include liability matching assets and annuity policies purchased by the trustees of each plan, which aim to match the benefits to be paid to certain members from the plan and therefore remove the investment, inflation and demographic risks in relation to those liabilities.
In December 2014, the low risk asset portfolio held by the UK Plan was transferred into liability driven investments (LDI) in order to maintain the same level of hedging against interest rate and inflation risks.
The UK Plan also has an insurance contract with Rothesay Life covering a subset of the UK Plan pensioner liabilities. The terms of this policy define that the contract value exactly matches the amount and timing of the pensioner obligations covered by the contract. In accordance with IAS19REmployee Benefits, the fair value of the insurance contract is deemed to be the present value of the related obligations which is discounted at the AA corporate bond rate.
Smith & Nephew Annual report 2014 149
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
18 Retirement benefit obligationscontinued
18.4 Expenses recognised in the income statement
The total expense relating to retirement benefits recognised for the year is $17m (2013 – $72m, 2012 – $72m). Of this cost recognised for the year, $32m (2013 – $32m, 2012 – $32m) relates to defined contributions and $15m net income (2013 – $40m expense, 2012 – $40m expense) relates to defined benefit plans.
The cost charged in respect of the Group’s defined contribution plans represents contributions payable to these plans by the Group at rates specified in the rules of the plans. These were charged to operating profit in selling, general and administrative expenses. There were $nil outstanding payments as at 31 December 2014 due to be paid over to the plans (2013 – $nil, 2012 – $nil).
Included in the $15m net income recognised for defined benefits plans are a $35m past service cost credit which arose on the closure of the US plan to future accrual in March 2014 and a $11m gain on settlement of benefits as a result of a member buyout in December 2014.
Defined benefit plan costs comprise service cost which is charged to operating profit in selling, general and administrative expenses and net interest cost and administration costs and taxes which are reported as other finance costs.
The defined benefit pension costs charged for the UK and US plans are:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2014 | | | | | 2013 | | | | | | 2012 | | | |
| UK Plan
$ million |
| | US Plan $ million | | | |
| UK Plan
$ million |
| |
| US Plan
$ million |
| | | |
| UK Plan
$ million |
| |
| US Plan
$ million |
| Service cost | | | 10 | | | 2 | | | | | 7 | | | | 10 | | | | | | 8 | | | | 11 | | Past service cost | | | – | | | (35) | | | | | – | | | | – | | | | | | – | | | | – | | Settlement gain | | | – | | | (11) | | | | | – | | | | – | | | | | | – | | | | – | | Net interest cost, administration and taxes | | | 3 | | | 3 | | | | | 1 | | | | 7 | | | | | | 1 | | | | 7 | | | | | 13 | | | (41) | | | | | 8 | | | | 17 | | | | | | 9 | | | | 18 | | 18.5 Principal actuarial assumptions The following are the principal financial actuarial assumptions used at the reporting date to determine the UK and US defined benefit obligations and expense. | | | | | | | | | | | | | | | |
| 2014
% per annum |
| | | |
| 2013
% per annum |
| |
| 2012
% per annum |
| UK Plan: | | | | | | | | | | | | | | | | | | | | | | | | | | | Discount rate | | | | | | | | | | | | | | | 3.7 | | | | | | 4.4 | | | | 4.5 | | Future salary increases | | | | | | | | | | | | | | | 3.5 | | | | | | 3.9 | | | | 3.5 | | Future pension increases | | | | | | | | | | | | | | | 3.0 | | | | | | 3.4 | | | | 3.0 | | Inflation (RPI) | | | | | | | | | | | | | | | 3.0 | | | | | | 3.4 | | | | 3.0 | | Inflation (CPI) | | | | | | | | | | | | | | | 2.0 | | | | | | 2.4 | | | | 2.2 | | US Plan: | | | | | | | | | | | | | | | | | | | | | | | | | | | Discount rate | | | | | | | | | | | | | | | 4.0 | | | | | | 4.9 | | | | 4.0 | | Future salary increases | | | | | | | | | | | | | | | n/a | | | | | | 3.0 | | | | 3.0 | | Inflation | | | | | | | | | | | | | | | n/a | | | | | | 2.5 | | | | 2.5 | |
150Smith & Nephew Annual report 2014
Actuarial assumptions regarding future mortality are based on mortality tables. The UK uses the S1NA with projections in line with the CMI 2011 table and the US uses the RP2000 table with scale AA. The current longevities underlying the values of the obligations in the defined benefit plans are as follows:
| | | | | | | | | 2014 years | | 2013 years | | 2012 years | Life expectancy at age 60 | | | | | | | UK Plan: | | | | | | | Males | | 29.4 | | 29.3 | | 28.7 | Females | | 31.2 | | 31.1 | | 30.2 | US Plan: | | | | | | | Males | | 26.0 | | 23.8 | | 22.9 | Females | | 28.5 | | 25.5 | | 25.0 | Life expectancy at age 60 in 20 years’ time | | | | | | | UK Plan: | | | | | | | Males | | 32.4 | | 32.2 | | 31.2 | Females | | 33.3 | | 33.2 | | 31.9 | US Plan: | | | | | | | Males | | 27.8 | | 23.8 | | 24.6 | Females | | 30.2 | | 25.5 | | 25.0 |
18.6 Sensitivity analysis
The calculation of the defined benefit obligation is sensitive toperformed annually by external actuaries using the assumptions used. The following table summarisesprojected unit credit method. Re-measurements arising from defined benefit plans comprise actuarial gains and losses and the increase/decreasereturn on the UKplan assets net of the costs of managing the plan assets. The Group recognises these immediately in other comprehensive income (OCI) and USall other expenses, such as service cost, net interest cost, administration costs and taxes, are recognised in the income statement. A number of key assumptions are made when calculating the fair value of the Group’s defined benefit obligationpension plans. These assumptions impact the balance sheet asset and pension liabilities, operating profit, finance income/costs as a resultand other comprehensive income. The most critical assumptions are the discount rate, the rate of reasonably possible changes in some of theinflation and mortality assumptions while holding all other assumptions consistent. The sensitivity to the inflation assumption change includes corresponding changesbe applied to the future salary increases and future pension increase assumptions.plan liabilities. The analysis does notdiscount rate is based on the yield at the reporting date on bonds that have a credit rating of AA, denominated in the currency in which the benefits are expected to be paid and have a maturity profile approximately the same as the Group’s obligations. In determining these assumptions management take into account the full distributionadvice of cash flows expected under the plan. Changes to the inflation assumption will not have any affect on the US Pension plan as it was closed to future accrual in 2014.
| | | | | | | | | | | Increase in pension obligation | | Increase in pension cost | | | | | | $ million | | +50bps/+1yr | | -50bps/-1yr | | +50bps/+1 yr | | -50bps/-1yr | UK Plan: | | | | | | | | | Discount rate | | -80 | | +91 | | -4 | | +4 | Inflation | | +90 | | -78 | | +4 | | -4 | Mortality | | +31 | | -31 | | +1 | | -1 | US Plan: | | | | | | | | | Discount rate | | -33 | | +36 | | -2 | | +1 | Inflation | | n/a | | n/a | | n/a | | n/a | Mortality | | +12 | | -12 | | – | | – |
Smith & Nephew Annual report 2014 151
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
18 Retirement benefit obligationscontinued
18.7 Risk
The pension plans expose the Group to the following risks:
| | | Interest rate risk | | Volatility in financial markets can change the calculations of the obligation dramatically as the calculation of the obligation is linked to yields on AA-rated corporate bonds. A decrease in the bond yield will increase the measure of plan liabilities, although this will be partially offset by increases in the value of matching plan assets such as bonds and insurance contracts.
In the UK, the liability matching portfolio held in conventional and index-linked gilts was transferred into liability driven investments in order to reduce interest rate risk.
| Inflation risk | | The UK Plan is linked to inflation. A high rate of inflation will lead to a higher liability. This risk is managed by holding inflation-linked bonds and an inflation-linked insurance contract in respect of some of the obligation. In the UK, the liability matching portfolio held in conventional and index-linked gilts was transferred into liability driven investments in order to reduce inflation risk.
The US Plan has been closed to future accrual which eliminates the exposure to this risk.
| Investment risk | | If the return on plan assets is below the discount rate, all else being equal, there will be an increase in the plan deficit.
In the UK, this risk is partially managed by a portfolio of liability matching assets and a bulk annuity, together with a dynamic de risking policy to switch growth assets into liability matching assets over time.
The US Plan has a dynamic de-risking policy to shift plan assets into longer term stable asset classes. The policy established ten pre-determined funded status levels and when each trigger point is reached, the plan assets are re-balanced accordingly.
| Longevity risk | | The present value of the plans defined benefit liability is calculated by reference to the best estimate of the mortality of the plan participants both during and after their employment. An increase in the life expectancy of plan participants above that assumed will increase the benefit obligation.
The UK Plan, in order to minimise longevity risk, entered into an insurance contract which covers a portion of pensioner obligations.
| Salary risk | | The calculation of the defined benefit obligation uses the future estimated salaries of plan participants. Increases in the salary of plan participants above that assumed will increase the benefit obligation. The exposure to salary risk in the US has been eliminated with the closure of the US Plan to future accrual. |
18.8 Funding
A full valuation is performed byprofessional external actuaries for the Trustees of each plan to determine the level of funding required. Employer contributions rates, based on these full valuations, are agreed between the trustees of each plan and the Group. Thebenchmarks its assumptions used in the funding actuarial valuations may differ from those assumptions above. Employees are required to contribute to the plans.
UK Plan
The most recent full actuarial valuation of the UK Plan was undertaken as at 30 September 2012. Valuations are performed every two years, however in 2014, the Trustees have agreed that they will defer the 2014 valuation for one year and it will be performed in September 2015. Contributions to the UK Plan in 2014 were $33m (2013 – $37m, 2012 – $39m). This included supplementary payments of $23m (2013 – $31m, 2012 – $30m).
The Group has agreed to pay the supplementary payments each year until 2017. The agreed supplementary contributions for 2015 are $37m.
US Plan
Full actuarial valuations were performed annually for the US Plan with the last undertaken as at 20 September 2013 before the closure of the Plan to future accrual. Contributions to the US Plan were $22m (2013 – $20m, 2012 – $27m) which included supplementary payments of $20m. The agreed contributions for 2015 are $22m.
152Smith & Nephew Annual report 2014
19 Equity
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | Incremental costs directly attributable to the issue of ordinary shares, net of any tax effects, are recognised as a deduction from equity.
When shares recognised as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, net of any tax effects, is recognised as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. When treasury shares are sold or reissued subsequently, the amount received is recognised as an increase in equity and the resulting surplus or deficit on the transaction is presented within share premium.
| | |
19.1 Share capital
| | | | | | | | | | | | | | | | | | | | | | | | Ordinary shares (20¢) | | | | Deferred shares (£1.00) | | | | Total | | | | | | | | | | | | | | | | | | Thousand | | | | $ million | | | | Thousand | | | | $ million | | | | $ million | | Authorised | | | | | | | | | | | | | | | | | | | | | At 31 December 2012 | | | 1,223,591 | | | | 245 | | | | 50 | | | | – | | | | 245 | | At 31 December 2013 | | | 1,223,591 | | | | 245 | | | | 50 | | | | – | | | | 245 | | At 31 December 2014 | | | 1,223,591 | | | | 245 | | | | 50 | | | | – | | | | 245 | | Allotted, issued and fully paid | | | | | | | | | | | | | | | | | | | | | At 1 January 2012 | | | 954,828 | | | | 191 | | | | 50 | | | | – | | | | 191 | | Share options | | | 8,752 | | | | 2 | | | | – | | | | – | | | | 2 | | | | At 31 December 2012 | | | 963,580 | | | | 193 | | | | 50 | | | | – | | | | 193 | | Share options | | | 5,587 | | | | 1 | | | | – | | | | – | | | | 1 | | Shares cancelled | | | (51,000 | ) | | | (10 | ) | | | – | | | | – | | | | (10 | ) | | | At 31 December 2013 | | | 918,167 | | | | 184 | | | | 50 | | | | – | | | | 184 | | Share options | | | 4,180 | | | | 1 | | | | – | | | | – | | | | 1 | | Shares cancelled | | | (4,405 | ) | | | (1 | ) | | | – | | | | – | | | | (1 | ) | At 31 December 2014 | | | 917,942 | | | | 184 | | | | 50 | | | | – | | | | 184 | |
The deferred shares were issued in 2006 in order to comply with English Company law. They are not listed on any stock exchange and have extremely limited rights and effectively have no value. These rights are summarised as follows:
– | The holder shall not be entitled to participate in the profits of the Company; |
– | The holder shall not have any right to participate in any distribution of the Company’s assets on a winding up or other distribution except that after the return of the nominal amount paid up on each share in the capital of the Company of any class other than the deferred shares and the distribution of a further $1,000 in respect of each such share there shall be distributed to a holder of a deferred share (for each deferred share held by him) an amount equal to the nominal value of the deferred share; |
– | The holder shall not be entitled to receive notice, attend, speak or vote at any general meeting of the Company; and |
– | The Company may create, allot and issue further shares or reduce or repay the whole or any part of its share capital or other capital reserves without obtaining the consent of the holders of the deferred shares. |
The Group’s objectives when managing capital are to ensure the Group has adequate funds to continue as a going concern and sufficient flexibility within the capital structure to fund the ongoing growth of the business and to take advantage of business development opportunities including acquisitions.against external data.
The Group determines the amountnet interest expense/income on the net defined benefit liability/asset for the period by applying the discount rate used to measure the defined benefit obligation at the beginning of capital taking into account changes in business risks and future cash requirements. the annual period to the net defined benefit liability/asset. The Group reviews its capital structurealso operates a number of defined contribution plans. A defined contribution plan is a pension plan under which the Group and employees pay fixed contributions to a third party financial provider. The Group has no further payment obligations once the contributions have been paid. Contributions are recognised as an employee benefit expense when they are due. |
18.1 Retirement benefit net obligations/(assets) The Group’s retirement benefit obligations/(assets) comprise: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Funded plans: | | | | | | UK Plan | | (53) | | 4 | | US Plan | | (9) | | 27 | | Other plans | | 46 | | 52 | | | | (16) | | 83 | | Unfunded plans: | | | | | | Other plans | | 60 | | 55 | | Retirement healthcare | | 25 | | 26 | | | | 69 | | 164 | | Amount recognised on the balance sheet – liability | | 131 | | 164 | | Amount recognised on the balance sheet – asset | | (62) | | – | |
The Group sponsors defined benefit pension plans for its employees or former employees in 16 countries and these are established under the laws of the relevant country. Funded plans are funded by the payment of contributions and the assets are held by separate trust funds or insurance companies. The provision of retirement and related benefits across the Group is kept under regular review. Employees’ retirement benefits are the subject of regular management review. The Group’s defined benefit plans provide employees with an entitlement to retirement benefits varying between 1.3% and 66.7% of final salary on attainment of retirement age. The level of entitlement is dependent on the years of service of the employee. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 151 |
The Group’s two major defined benefit pension plans are in the UK and US. Both these plans were closed to new employees in 2003 and defined contribution plans are offered to new joiners. The US and UK Plans were closed to future accrual in March 2014 and December 2016 respectively. The UK Plan operates under trust law and responsibility for its governance lies with a Board of Trustees. This Board is composed of representatives of the Group, plan participants and an independent trustee, who act on behalf of members in accordance with the terms of the Trust Deed and Rules and relevant legislation. The UK Plan’s assets are held by the trust. Annual increases on benefits in payment are dependent on inflation. There is no legislative minimum funding requirement in the UK, however the Group has agreed with the Board of Trustees to pay a schedule of supplementary payments (see Note 18.8). The Trust Deed of the UK Plan and the Plan Document of the US Plan provide the Group with a right to a refund of surplus assets assuming the full settlement of plan liabilities in the event of a plan wind-up. Furthermore, in the ordinary course of business the UK trustee and US committee have no rights to unilaterally wind up, or otherwise augment the benefits due to members of the plans. Based on these rights, any net surplus in the UK and US Plans is recognised in full. The US Plan is governed by a US Pension Committee which is comprised of both plan participants and representatives of the Group. In the US, the Pension Protection Act (2006) established both a minimum required contribution and a maximum deductible contribution. Failure to contribute at least the minimum required amount will subject the Company to significant penalties, and contributions in excess of the maximum deductible have negative tax consequences. The minimum funding requirement is intended to fully fund the present value of accrued benefits over seven years. 18.2 Reconciliation of benefit obligations and pension assets The movement in the Group’s pension benefit obligation and pension assets is as follows: | | | | | | | | | | | | | | | | | | | | 2017 | | | | | | 2016 | | | | Obligation | | Asset | | Total | | Obligation | | Asset | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Amounts recognised on the balance sheet at beginning of the period | | (1,577) | | 1,413 | | (164) | | (1,521) | | 1,350 | | (171) | | Income statement expense: | | | | | | | | | | | | | | Current service cost | | (12) | | – | | (12) | | (19) | | – | | (19) | | Past service credit | | 4 | | – | | 4 | | 51 | | – | | 51 | | Settlements | | – | | – | | – | | 7 | | (7) | | – | | Interest (expense)/income | | (44) | | 42 | | (2) | | (52) | | 48 | | (4) | | Administration costs and taxes | | (3) | | – | | (3) | | (3) | | – | | (3) | | Costs recognised in income statement | | (55) | | 42 | | (13) | | (16) | | 41 | | 25 | | Re-measurements: | | | | | | | | | | | | | | Actuarial gain due to liability experience | | 1 | | – | | 1 | | 7 | | – | | 7 | | Actuarial loss due to financial assumptions change | | (38) | | – | | (38) | | (301) | | – | | (301) | | Actuarial gain due to demographic assumptions | | 42 | | – | | 42 | | 33 | | – | | 33 | | Return on plan assets greater than discount rate | | – | | 59 | | 59 | | – | | 180 | | 180 | | Re-measurements recognised in OCI | | 5 | | 59 | | 64 | | (261) | | 180 | | (81) | | Cash: | | | | | | | | | | | | | | Employer contributions | | – | | 53 | | 53 | | – | | 60 | | 60 | | Employee contributions | | (4) | | 4 | | – | | (4) | | 4 | | – | | Benefits paid directly by the Group | | 2 | | (2) | | – | | 3 | | (3) | | – | | Benefits paid, taxes and administration costs paid from scheme assets | | 102 | | (102) | | – | | 61 | | (61) | | – | | Net cash | | 100 | | (47) | | 53 | | 60 | | – | | 60 | | | | | | | | | | | | | | | | Exchange rate movements | | (98) | | 89 | | (9) | | 161 | | (158) | | 3 | | Amount recognised on the balance sheet | | (1,625) | | 1,556 | | (69) | | (1,577) | | 1,413 | | (164) | | Amount recognised on the balance sheet – liability | | (290) | | 159 | | (131) | | (1,577) | | 1,413 | | (164) | | Amount recognised on the balance sheet – asset | | (1,335) | | 1,397 | | 62 | | – | | – | | – | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 152ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued Represented by: | | | | | | | | | | | | | | | | | | | | 2017 | | | | | | 2016 | | | | Obligation | | Asset | | Total | | Obligation | | Asset | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | UK Plan | | (854) | | 907 | | 53 | | (844) | | 840 | | (4) | | US Plan | | (481) | | 490 | | 9 | | (461) | | 434 | | (27) | | Other Plans | | (290) | | 159 | | (131) | | (272) | | 139 | | (133) | | Total | | (1,625) | | 1,556 | | (69) | | (1,577) | | 1,413 | | (164) | |
All benefits are vested at the end of each reporting period. The weighted average duration of the defined benefit obligation at the end of the reporting period is 20 years and 11 years for the UK and US Plans respectively. 18.3 Plan assets The market value of the US, UK and Other Plans assets are as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | UK Plan: | | | | | | | | Assets with a quoted market price: | | | | | | | | Cash and cash equivalents | | 8 | | 6 | | 5 | | Equity securities | | 235 | | 213 | | 234 | | Other bonds | | 43 | | 38 | | 43 | | Liability driven investments | | 192 | | 239 | | 171 | | Diversified growth funds | | 152 | | 130 | | 144 | | | | 630 | | 626 | | 597 | | Other assets: | | | | | | | | Insurance contract | | 277 | | 214 | | 214 | | Market value of assets | | 907 | | 840 | | 811 | | US Plan: | | | | | | | | Assets with a quoted market price: | | | | | | | | Cash and cash equivalents | | – | | – | | – | | Equity securities | | 88 | | 178 | | 166 | | Government bonds – fixed interest | | 201 | | 128 | | 119 | | Corporate bonds | | 201 | | 128 | | 119 | | Market value of assets | | 490 | | 434 | | 404 | | Other Plans: | | | | | | | | Assets with a quoted market price: | | | | | | | | Cash and cash equivalents | | 4 | | 4 | | 9 | | Equity securities | | 43 | | 35 | | 35 | | Government bonds – fixed interest | | 4 | | 3 | | 5 | | – index linked | | 3 | | 3 | | 9 | | Corporate and other bonds | | 11 | | 11 | | 13 | | Insurance contracts | | 36 | | 34 | | 28 | | Property | | 19 | | 12 | | 8 | | Other quoted securities | | 2 | | 2 | | 1 | | | | 122 | | 104 | | 108 | | Other assets: | | | | | | | | Insurance contracts | | 37 | | 35 | | 27 | | Market value of assets | | 159 | | 139 | | 135 | | Total market value of assets | | 1,556 | | 1,413 | | 1,350 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 153 |
No plans invest directly in property occupied by the Group or in financial securities issued by the Group. Both the UK and US Plans hold a mixture of growth assets and matching assets. The growth assets of the UK and US Plans are invested in a diversified range of industries across a broad range of geographies. The UK Plan matching assets include liability matching assets and annuity policies purchased by the trustees, which aim to match the benefits to be paid to certain members from the plan and therefore remove the investment, inflation and demographic risks in relation to those liabilities. The terms of the policy define that the contract value exactly matches the amount and timing of the pensioner obligations covered by the contract. In accordance with IAS19R Employee Benefits, the fair value of the insurance contract is deemed to be the present value of the related obligations which is discounted at the AA corporate bond rate. In December 2014, the low risk asset portfolio held by the UK Plan was transferred into liability driven investments (LDI) which invests in a mixture of gilts and swaps. 18.4 Expenses recognised in the income statement The total expense relating to retirement benefits recognised for the year is $64m (2016: $23m, 2015: $58m). Of this cost recognised for the year, $51m (2016: $48m, 2015: $49m) relates to defined contribution plans and $13m (2016: $25m net credit, 2015: $9m net expense) relates to defined benefit plans. The cost charged in respect of the Group’s defined contribution plans represents contributions payable to these plans by the Group at rates specified in the rules of the plans. These were charged to operating profit in selling, general and administrative expenses. There were $nil outstanding payments as at 31 December 2017 due to be paid over to the plans (2016: $nil, 2015: $nil). In 2016, the $25m net credit for the year includes a $44m curtailment gain arising from the closure of the UK Plan to future accrual and $5m past service credit relating to redundancies. In 2015, the $9m net expense for the year includes a $16m past service cost credit arising from amendments to the US Retirement Healthcare plan and a $5m gain arising from benefit options offered to members of the UK Plan. Defined benefit plan costs comprise service cost which is charged to operating profit in selling, general and administrative expenses and net interest cost and administration costs and taxes which are reported as other finance costs. The defined benefit pension costs charged for the UK and US Plans are: | | | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | UK Plan | | US Plan | | UK Plan | | US Plan | | UK Plan | | US Plan | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Service cost | | – | | – | | 7 | | – | | 9 | | – | | Past service credit | | – | | – | | (49) | | – | | (7) | | – | | Settlement loss | | – | | – | | 1 | | – | | 2 | | – | | Net interest cost, administration and taxes | | 1 | | 2 | | – | | 3 | | 3 | | 4 | | | | 1 | | 2 | | (41) | | 3 | | 7 | | 4 | |
18.5 Principal actuarial assumptions The following are the principal financial actuarial assumptions used at the reporting date to determine the UK and US defined benefit obligations and expense. | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | % per annum | | % per annum | | % per annum | | UK Plan: | | | | | | | | Discount rate | | 2.4 | | 2.6 | | 3.8 | | Future salary increases | | n/a | | 3.8 | | 3.6 | | Future pension increases | | 3.2 | | 3.3 | | 3.1 | | Inflation (RPI) | | 3.2 | | 3.3 | | 3.1 | | Inflation (CPI) | | 2.2 | | 2.3 | | 2.1 | | US Plan: | | | | | | | | Discount rate | | 3.5 | | 4.0 | | 4.3 | | Future salary increases | | n/a | | n/a | | n/a | | Inflation | | n/a | | n/a | | n/a | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 154ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued Actuarial assumptions regarding future mortality are based on mortality tables. The UK uses the S2NA with projections in line with the CMI 2016 table and the US uses the RP2014 table with MP2016 scale. The current longevities underlying the values of the obligations in the defined benefit plans are as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | years | | years | | years | | Life expectancy at age 60 | | | | | | | | UK Plan: | | | | | | | | Males | | 28.8 | | 29.7 | | 29.6 | | Females | | 30.3 | | 31.1 | | 31.3 | | US Plan: | | | | | | | | Males | | 25.2 | | 25.1 | | 25.8 | | Females | | 27.4 | | 27.4 | | 28.2 | | Life expectancy at age 60 in 20 years’ time | | | | | | | | UK Plan: | | | | | | | | Males | | 31.0 | | 32.5 | | 32.6 | | Females | | 31.8 | | 33.0 | | 33.4 | | US Plan: | | | | | | | | Males | | 25.5 | | 25.4 | | 27.6 | | Females | | 28.0 | | 27.9 | | 29.9 | |
18.6 Sensitivity analysis The calculation of the defined benefit obligation is sensitive to the assumptions used. The following table summarises the increase/decrease on the UK and US defined benefit obligation and pension costs as a result of reasonably possible changes in some of the assumptions while holding all other assumptions consistent. The sensitivity to the inflation assumption change includes corresponding changes to the future salary increases and future pension increase assumptions. The analysis does not take into account the full distribution of cash flows expected under the plan. Changes to the inflation assumption will not have any effect on the US Pension Plan as it was closed to future accrual in 2014. | | | | | | | | | | | | Increase in pension obligation | | Increase in pension cost | | $ million | | +50bps/+1yr | | ‑50bps/‑1yr | | +50bps/+1yr | | ‑50bps/‑1yr | | UK Plan: | | | | | | | | | | Discount rate | | -80.9 | | +92.6 | | -2 | | +2 | | Inflation | | +88.1 | | -77.3 | | +2 | | -2 | | Mortality | | +38.0 | | -37.7 | | +1 | | -1 | | US Plan: | | | | | | | | | | Discount rate | | -25.5 | | +27.9 | | -1 | | +1 | | Inflation | | n/a | | n/a | | n/a | | n/a | | Mortality | | +11.4 | | -11.6 | | – | | – | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 155 |
18.7 Risk The pension plans expose the Group to the following risks: Interest rate risk | Volatility in financial markets can change the calculations of the obligation significantly as the calculation of the obligation is linked to yields on AA-rated corporate bonds. A decrease in the bond yield will increase the measure of plan liabilities, although this will be partially offset by increases in the value of matching plan assets such as bonds and insurance contracts. In the UK, the liability matching portfolio held in conventional and index-linked gilts was transferred into liability driven investments in order to reduce interest rate risk. | Inflation risk | The UK Plan is linked to inflation. A high rate of inflation will lead to a higher liability. This risk is managed by holding inflation-linked bonds and an ongoing basisinflation-linked insurance contract in respect of some of the obligation. In the UK, the liability matching portfolio held in conventional and index-linked gilts was transferred into liability driven investments in order to reduce inflation risk. The UK and US Plans have been closed to future accrual which eliminates the exposure to this risk. | Investment risk | If the return on plan assets is below the discount rate, all else being equal, there will be an increase in the plan deficit. In the UK, this risk is partially managed by a portfolio of liability matching assets and a bulk annuity, together with a dynamic de-risking policy to switch growth assets into liability matching assets over time. The US Plan has a dynamic de-risking policy to shift plan assets into longer-term stable asset classes. The policy established 10 pre-determined funded status levels and when each trigger point is reached, the plan assets are re‑balanced accordingly. In 2017, two trigger points were reached and the plan assets were re-balanced such that there was reduced investment in equity securities and increased investment in government and corporate bonds. | Longevity risk | The present value of the plans defined benefit liability is calculated by reference to the best estimate of the mortality of the plan participants both during and after their employment. An increase in the life expectancy of plan participants above that assumed will increase the benefit obligation. The UK Plan, in order to minimise longevity risk, has entered into an insurance contract which covers a portion of pensioner obligations. | Salary risk | The calculation of the defined benefit obligation uses share buy-backs, dividendsthe future estimated salaries of plan participants. Increases in the salary of plan participants above that assumed will increase the benefit obligation. The exposure to salary risk in the UK and US has been eliminated with the closure of these Plans to future accrual. |
18.8 Funding A full valuation is performed by actuaries for the Trustees of each plan to determine the level of funding required. Employer contributions rates, based on these full valuations, are agreed between the Trustees of each plan and the Group. The assumptions used in the actuarial valuations used for funding purposes may differ from those assumptions above. UK Plan The most recent full actuarial valuation of the UK Plan was undertaken as at 30 September 2015. The next full actuarial valuation will take place as at 30 September 2018. Contributions to the UK Plan in 2017 were $24m (2016: $32m, 2015: $37m). This included supplementary payments of $24m (2016: $26m, 2015: $29m). The Group has currently agreed to pay annual supplementary payments of $25m until 2021. These supplementary payments will be reviewed when the 30 September 2018 valuation has been completed. US Plan A full actuarial valuation for the US Plan was last undertaken as at 20 September 2013 before the closure of the Plan to future accrual. Contributions to the US Plan were $20m (2016: $20m, 2015: $20m) which represented supplementary payments of $20m. The planned supplementary contribution for 2018 is being kept under review given the funding status. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 156ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 19 EQUITY Accounting policy Incremental costs directly attributable to the issue of newordinary shares, to adjustnet of any tax effects, are recognised as a deduction from equity. When shares recognised as equity are repurchased, the retained capital.amount of the consideration paid, which includes directly attributable costs, net of any tax effects, is recognised as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. When treasury shares are sold or reissued subsequently, the amount received is recognised as an increase in equity and the resulting surplus or deficit on the transaction is presented within share premium. |
19.1 Share capital | | | | | | | | | | | | | | Ordinary shares (20¢) | | Deferred shares (£1.00) | | Total | | | | Thousand | | $ million | | Thousand | | $ million | | $ million | | Authorised | | | | | | | | | | | | At 31 December 2015 | | 1,223,591 | | 245 | | 50 | | – | | 245 | | At 31 December 2016 | | 1,223,591 | | 245 | | 50 | | – | | 245 | | At 31 December 2017 | | 1,223,591 | | 245 | | 50 | | – | | 245 | | Allotted, issued and fully paid | | | | | | | | | | | | At 1 January 2015 | | 917,942 | | 184 | | 50 | | – | | 184 | | Share options | | 1,855 | | – | | – | | – | | – | | Shares cancelled | | (4,350) | | (1) | | – | | – | | (1) | | At 31 December 2015 | | 915,447 | | 183 | | 50 | | – | | 183 | | Share options | | 1,283 | | – | | – | | – | | – | | Shares cancelled | | (13,007) | | (3) | | – | | – | | (3) | | At 31 December 2016 | | 903,723 | | 180 | | 50 | | – | | 180 | | Share options | | 655 | | – | | – | | – | | – | | Shares cancelled | | (13,523) | | (2) | | – | | – | | (2) | | At 31 December 2017 | | 890,855 | | 178 | | 50 | | – | | 178 | |
The deferred shares were issued in 2006 in order to comply with English Company law. They are not listed on any stock exchange and have extremely limited rights and effectively have no value. These rights are summarised as follows: | - | | The Group considersholder shall not be entitled to participate in the capital that it managesprofits of the Company; |
| - | | The holder shall not have any right to be as follows: | | | | | | | | | | | | | | | | 2014 | | | | 2013 | | | | 2012 | | | | | $ million | | | | $ million | | | | $ million | | Share capital | | | 184 | | | | 184 | | | | 193 | | Share premium | | | 574 | | | | 535 | | | | 488 | | Capital redemption reserve | | | 11 | | | | 10 | | | | – | | Treasury shares | | | (315 | ) | | | (322 | ) | | | (735 | ) | Retained earnings and other reserves | | | 3,586 | | | | 3,640 | | | | 3,938 | | | | | 4,040 | | | | 4,047 | | | | 3,884 | |
Smith & Nephew Annual report 2014 153
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
19 Equitycontinued
19.2 Treasury shares
Treasury shares represents the holdingparticipate in any distribution of the Company’s ownassets on a winding up or other distribution except that after the return of the nominal amount paid up on each share in the capital of the Company of any class other than the deferred shares and the distribution of a further $1,000 in respect of the Smith & Nephew Employee’s Share Trust and shares bought back as part of theeach such share buy-back programme. On 2 May 2013, as part of the new Capital Allocation Framework, the Group announced the startthere shall be distributed to a holder of a newdeferred share buy-back programme(for each deferred share held) an amount equal to return $300m of surplus capital to its shareholders. The programme was suspended in February 2014 following the annoucement of the ArthroCare acquisition. Shares issued in connection with the Group’s share incentive plans are brought back on a quarterly basis. During 2014, a total of 4.4m ordinary shares (0.5%) had been purchased at a cost of $72m and 4.4m ordinary shares (0.5%) had been cancelled. The maximum number of ordinary shares held in treasury during 2014 was 26.9m (2.8%) with a nominal value of $5.4m.the deferred share;
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| - | | The Smith & Nephew 2004 Employees’ Share Trust (‘Trust’) was establishedholder shall not be entitled to hold shares relating to the long-term incentive plans referred to in the ‘Directors’ Remuneration Report’. The Trust is administered by an independent professional trust company resident in Jersey and is funded by a loan from the Company. The costreceive notice, attend, speak or vote at any general meeting of the Trust is charged toCompany; and |
| - | | The Company may create, allot and issue further shares or reduce or repay the income statement as it accrues. A partial dividend waiver is in place in respectwhole or any part of those shares held underits share capital or other capital reserves without obtaining the long-term incentive plans. The trust only accepts dividends in respect of nil-cost options and deferred bonus plan shares. The waiver represents less than 1%consent of the total dividends paid. The movements in Treasury shares andholders of the Employees’ Share Trust are as follows:deferred shares.
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The Group’s objectives when managing capital are to ensure the Group has adequate funds to continue as a going concern and sufficient flexibility within the capital structure to fund the ongoing growth of the business and to take advantage of business development opportunities including acquisitions. The Group determines the amount of capital taking into account changes in business risks and future cash requirements. The Group reviews its capital structure on an ongoing basis and uses share buy-backs, dividends and the issue of new shares to adjust the retained capital. The Group considers the capital that it manages to be as follows: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Share capital | | 178 | | 180 | | 183 | | Share premium | | 605 | | 600 | | 590 | | Capital redemption reserve | | 17 | | 15 | | 12 | | Treasury shares | | (257) | | (432) | | (294) | | Retained earnings and other reserves | | 4,101 | | 3,595 | | 3,475 | | | | 4,644 | | 3,958 | | 3,966 | |
| | | | | | | | | | | | | | | | | | | | Treasury $ million | | |
| Employees’
Share Trust $ million |
| |
| Total
$ million |
| At 1 January 2013 | | | | | 730 | | | | 5 | | | | 735 | | Shares purchased | | | | | 226 | | | | 5 | | | | 231 | | Shares transferred from treasury | | | | | (8 | ) | | | 8 | | | | – | | Shares transferred to Group beneficiaries | | | | | (7 | ) | | | (14 | ) | | | (21 | ) | Shares cancelled | | | | | (623 | ) | | | – | | | | (623 | ) | At 31 December 2013 | | | | | 318 | | | | 4 | | | | 322 | | Shares purchased | | | | | 72 | | | | 3 | | | | 75 | | Shares transferred from treasury | | | | | (11 | ) | | | 11 | | | | – | | Shares transferred to Group beneficiaries | | | | | (8 | ) | | | (17 | ) | | | (25 | ) | Shares cancelled | | | | | (57 | ) | | | – | | | | (57 | ) | At 31 December 2014 | | | | | 314 | | | | 1 | | | | 315 | | | | | | | | | | | | | | | | | | | | |
| Number of shares
million |
| |
| Number
of shares million |
| | | Number of shares million | | At 1 January 2013 | | | | | 59.5 | | | | 0.5 | | | | 60.0 | | Shares purchased | | | | | 18.2 | | | | 0.4 | | | | 18.6 | | Shares transferred from treasury | | | | | (0.6 | ) | | | 0.6 | | | | – | | Shares transferred to Group beneficiaries | | | | | (0.6 | ) | | | (1.2 | ) | | | (1.8 | ) | Shares cancelled | | | | | (51.0 | ) | | | – | | | | (51.0 | ) | At 31 December 2013 | | | | | 25.5 | | | | 0.3 | | | | 25.8 | | Shares purchased | | | | | 4.4 | | | | 0.2 | | | | 4.6 | | Shares transferred from treasury | | | | | (0.9 | ) | | | 0.9 | | | | – | | Shares transferred to Group beneficiaries | | | | | (0.6 | ) | | | (1.3 | ) | | | (1.9 | ) | Shares cancelled | | | | | (4.4 | ) | | | – | | | | (4.4 | ) | At 31 December 2014 | | | | | 24.0 | | | | 0.1 | | | | 24.1 | | 19.3 Dividends | | | | | | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | The following dividends were declared and paid in the year: | | | | | | | | | | | | | | | Ordinary final of 17.0¢ for 2013 (2012 – 16.20¢, 2011 – 10.80¢) paid 7 May 2014 | | | | | 152 | | | | 146 | | | | 97 | | Ordinary interim of 11.0¢ for 2014 (2013 – 10.40¢, 2012 – 9.90¢) paid 11 November 2014 | | | | | 98 | | | | 93 | | | | 89 | | | | | | | 250 | | | | 239 | | | | 186 | |
A final dividend for 2014 of 18.6 US cents per ordinary share was proposed by the Board on 4 February 2015 and will be paid, subject to shareholder approval, on 6 May 2015 to shareholders on the Register of Members on 17 April 2015. The estimated amount of this dividend on 23 February 2015 is $166m.
154Smith & Nephew Annual report 2014
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 157 |
19.2 Treasury shares Treasury shares represent the holding of the Company’s own shares in respect of the Smith & Nephew Employees’ Share Trust and shares bought back as part of the share buy-back programme. In 2017 the Group purchased a total of 3.2m shares for a cost of $52m as part of the ongoing programme to buy back an equivalent number of shares to those vesting as part of the employee share plans. During 2016, a total of 24.0m (2.7%) ordinary shares were purchased at a cost of $368m and 13.0m (1.5%) ordinary shares were cancelled. This included a $300m share buy-back programme following the sale of the Group’s Gynaecology business that completed in December 2016. The Smith & Nephew 2004 Employees’ Share Trust (Trust) was established to hold shares relating to long-term incentive plans. The Trust is administered by an independent professional trust company resident in Jersey and is funded by a loan from the Company. The cost of the Trust is charged to the income statement as it accrues. A dividend waiver is in place in respect of those shares held under the long-term incentive plans. The Trust only accepts dividends in respect of nil-cost options and deferred bonus plan shares. The waiver represents less than 1% of the total dividends paid. The movements in Treasury shares and the Employees’ Share Trust are as follows: | | | | | | | | | | | | Employees’ | | | | | | Treasury | | Share Trust | | Total | | | | $ million | | $ million | | $ million | | At 1 January 2016 | | 264 | | 30 | | 294 | | Shares purchased | | 368 | | – | | 368 | | Shares transferred from treasury | | (18) | | 18 | | – | | Shares transferred to Group beneficiaries | | (13) | | (27) | | (40) | | Shares cancelled | | (190) | | – | | (190) | | At 31 December 2016 | | 411 | | 21 | | 432 | | Shares purchased | | 52 | | – | | 52 | | Shares transferred from treasury | | (19) | | 19 | | – | | Shares transferred to Group beneficiaries | | (9) | | (17) | | (26) | | Shares cancelled | | (201) | | – | | (201) | | At 31 December 2017 | | 234 | | 23 | | 257 | |
| | | | | | | | | | Number | | Number | | Number | | | | of shares | | of shares | | of shares | | | | million | | million | | million | | At 1 January 2016 | | 18.9 | | 2.3 | | 21.2 | | Shares purchased | | 24.0 | | – | | 24.0 | | Shares transferred from treasury | | (1.2) | | 1.2 | | – | | Shares transferred to Group beneficiaries | | (0.9) | | (2.0) | | (2.9) | | Shares cancelled | | (13.0) | | – | | (13.0) | | At 31 December 2016 | | 27.8 | | 1.5 | | 29.3 | | Shares purchased | | 3.2 | | – | | 3.2 | | Shares transferred from treasury | | (1.3) | | 1.3 | | – | | Shares transferred to Group beneficiaries | | (0.6) | | (1.2) | | (1.8) | | Shares cancelled | | (13.5) | | – | | (13.5) | | At 31 December 2017 | | 15.6 | | 1.6 | | 17.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 158ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 19.3 Dividends | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | The following dividends were declared and paid in the year: | | | | | | | | Ordinary final of 18.5¢ for 2016 (2015: 19.0¢, 2014: 18.6¢) paid 10 May 2017 | | 162 | | 170 | | 166 | | Ordinary interim of 12.3¢ for 2017 (2016: 12.3¢, 2015: 11.8¢) paid 1 November 2017 | | 107 | | 109 | | 106 | | | | 269 | | 279 | | 272 | |
A final dividend for 2017 of 22.7¢ per ordinary share was proposed by the Board on 8 February 2018 and will be paid, subject to shareholder approval, on 9 May 2018 to shareholders on the Register of Members on 6 April 2018. The estimated amount of this dividend is $198m.The Group pursues a progressive dividend policy, with the aim of increasing the US Dollar value of ordinary dividends over time broadly based on the Group’s underlying growth in earnings, while taking into account capital requirements and cash flows. Future dividends will be dependent upon future earnings, the future financial condition of the Group and the Board’s dividend policy. The Board reviews the appropriate level of total annual dividend each year at the time of the full year results. 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. Smith & Nephew plc, the Parent Company of the Group, is a non trading investment holding company which derives its distributable reserves from dividends paid by subsidiary companies. The distributable reserves of the parent company approximate to the balance on the profit and loss account reserve, less treasury shares and exchange reserves, which at 31 December 2017 amounted to $2,569m. 20 CASH FLOW STATEMENT Accounting policy In the Group cash flow statement, cash and cash equivalents includes cash at bank, other short-term liquid investments with original maturities of three months or less and bank overdrafts. In the Group balance sheet, bank overdrafts are shown within bank overdrafts and loans under current liabilities. | | |
Analysis of net debt
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Borrowings | | | | | Cash $ million | | | | Overdrafts $ million | | | | Due within one year $ million | | | | Due after one year $ million | | | | Net currency swaps $ million | | | | Total $ million | | At 1 January 2012 | | | 184 | | | | (23 | ) | | | (283 | ) | | | (16 | ) | | | – | | | | (138 | ) | Net cash flow | | | (10 | ) | | | 12 | | | | 256 | | | | (414 | ) | | | 1 | | | | (155 | ) | Exchange adjustment | | | 4 | | | | – | | | | – | | | | – | | | | 1 | | | | 5 | | At 31 December 2012 | | | 178 | | | | (11 | ) | | | (27 | ) | | | (430 | ) | | | 2 | | | | (288 | ) | Net cash flow | | | (38 | ) | | | – | | | | (6 | ) | | | 84 | | | | 1 | | | | 41 | | Exchange adjustment | | | (3 | ) | | | – | | | | – | | | | (1 | ) | | | (2 | ) | | | (6 | ) | At 31 December 2013 | | | 137 | | | | (11 | ) | | | (33 | ) | | | (347 | ) | | | 1 | | | | (253 | ) | Net cash flow | | | (35 | ) | | | (19 | ) | | | 22 | | | | (1,322 | ) | | | 11 | | | | (1,343 | ) | Exchange adjustment | | | (9 | ) | | | 2 | | | | – | | | | 3 | | | | (13 | ) | | | (17 | ) | At 31 December 2014 | | | 93 | | | | (28 | ) | | | (11 | ) | | | (1,666 | ) | | | (1 | ) | | | (1,613 | ) |
Reconciliation of net cash flow to movement in net debt
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Net cash flow from cash net of overdrafts | | | (54 | ) | | | (38 | ) | | | 2 | | Settlement of currency swaps | | | 11 | | | | 1 | | | | 1 | | Net cash flow from borrowings | | | (1,300 | ) | | | 78 | | | | (158 | ) | Change in net debt from net cash flow | | | (1,343 | ) | | | 41 | | | | (155 | ) | Exchange adjustment | | | (17 | ) | | | (6 | ) | | | 5 | | Change in net debt in the year | | | (1,360 | ) | | | 35 | | | | (150 | ) | Opening net debt | | | (253 | ) | | | (288 | ) | | | (138 | ) | Closing net debt | | | (1,613 | ) | | | (253 | ) | | | (288 | ) |
Cash and cash equivalents
For the purposes of the Group Cash Flow Statement cash and cash equivalents at 31 December 2014 compriseincludes cash at bank, netother short-term liquid investments with original maturities of three months or less and bank overdrafts.
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Cash at bank | | | 93 | | | | 137 | | | | 178 | | Bank overdrafts | | | (28 | ) | | | (11 | ) | | | (11 | ) | Cash and cash equivalents | | | 65 | | | | 126 | | | | 167 | |
Smith & Nephew Annual report 2014 155
FINANCIAL STATEMENTS
Notes to In the Group accountscontinuedbalance sheet, bank overdrafts are shown within bank overdrafts and loans under current liabilities.
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Analysis of net debt | | | | | | | | | | | | | | | | | Borrowings | | | | | | | | Due within | | Due after | | Net | | Net | | | | | | Cash | | Overdrafts | | one year | | one year | | currency swaps | | interest swaps | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 1 January 2015 | | 93 | | (28) | | (11) | | (1,666) | | (1) | | – | | (1,613) | | Net cash flow impact | | 34 | | 9 | | (17) | | 231 | | 15 | | 1 | | 273 | | Exchange adjustment | | (7) | | 1 | | – | | 1 | | (16) | | – | | (21) | | At 31 December 2015 | | 120 | | (18) | | (28) | | (1,434) | | (2) | | 1 | | (1,361) | | Net cash flow impact | | (18) | | (45) | | 4 | | (129) | | 25 | | (2) | | (165) | | Exchange adjustment | | (2) | | 1 | | – | | (1) | | (22) | | – | | (24) | | At 31 December 2016 | | 100 | | (62) | | (24) | | (1,564) | | 1 | | (1) | | (1,550) | | Net cash flow impact | | 64 | | 49 | | 9 | | 139 | | (24) | | (1) | | 236 | | Termination of finance lease | | – | | – | | 2 | | 3 | | – | | – | | 5 | | Exchange adjustment | | 5 | | (1) | | – | | (1) | | 25 | | – | | 28 | | At 31 December 2017 | | 169 | | (14) | | (13) | | (1,423) | | 2 | | (2) | | (1,281) | |
Reconciliation of net cash flow to movement in net debt | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Net cash flow from cash net of overdrafts | | 113 | | (63) | | 43 | | Settlement of currency swaps | | (24) | | 25 | | 15 | | Net cash flow from borrowings | | 147 | | (127) | | 215 | | Change in net debt from net cash flow | | 236 | | (165) | | 273 | | Termination of finance lease | | 5 | | – | | – | | Exchange adjustment | | 28 | | (24) | | (21) | | Change in net debt in the year | | 269 | | (189) | | 252 | | Opening net debt | | (1,550) | | (1,361) | | (1,613) | | Closing net debt | | (1,281) | | (1,550) | | (1,361) | |
| | 21 Acquisitions and disposals
| | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 159 |
Cash and cash equivalents For the purposes of the Group cash flow statement cash and cash equivalents at 31 December 2017 comprise cash at bank net of bank overdrafts. | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Cash at bank | | 169 | | 100 | | 120 | | Bank overdrafts | | (14) | | (62) | | (18) | | Cash and cash equivalents | | 155 | | 38 | | 102 | |
The Group operates in over 100 countries around the world, some of which impose restrictions over cash movement. These restrictions have only a minimal impact of the management of the Group’s cash. Cash (inflows)/outflows arising from financing activities | | | | | | | | | | | | | | | | | 2017 | | | | Repayment | | Borrowing | | Cash | | | | | | Proceeds from own | | | | | | of bank | | of bank | | (inflow)/outflow | | | | Purchase of | | Shares/issue of | | �� | | | | loans | | loans | | from other | | Dividends | | own shares | | ordinary shares | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Debt | | 770 | | (623) | | (24) | | – | | – | | – | | 123 | | Equity | | – | | – | | – | | 269 | | 52 | | (10) | | 311 | | Total | | 770 | | (623) | | (24) | | 269 | | 52 | | (10) | | 434 | |
| | | | | | | | | | | | | | | | | 2016 | | | | Repayment | | Borrowing | | Cash | | | | | | Proceeds from own | | | | | | of bank | | of bank | | (inflow)/outflow | | | | Purchase of | | Shares/issue of | | | | | | loans | | loans | | from other | | Dividends | | own shares | | ordinary shares | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Debt | | 797 | | (924) | | 25 | | – | | – | | – | | (102) | | Equity | | – | | – | | – | | 279 | | 368 | | (16) | | 631 | | Total | | 797 | | (924) | | 25 | | 279 | | 368 | | (16) | | 529 | |
| | | | | | | | | | | | | | | | | 2015 | | | | Repayment | | Borrowing | | Cash | | | | | | Proceeds from own | | | | | | of bank | | of bank | | (inflow)/outflow | | | | Purchase of | | Shares/issue of | | | | | | loans | | loans | | from other | | Dividends | | own shares | | ordinary shares | | Total | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | Debt | | 1,088 | | (873) | | 15 | | – | | – | | – | | 230 | | Equity | | – | | – | | – | | 272 | | 77 | | (21) | | 328 | | Total | | 1,088 | | (873) | | 15 | | 272 | | 77 | | (21) | | 558 | |
| | | | | | | ACCOUNTING POLICY
| | | | | 21 ACQUISITIONS AND DISPOSALS Accounting policy The Group accounts for business combinations using the acquisition method when control is transferred to the Group. The consideration transferred in the acquisition is measured at fair value, as are the identifiable net assets acquired. Any goodwill that arises is tested annually for impairment. Any gain on a bargain purchase is recognised in profit or loss immediately. Transaction costs are expensed as incurred, except if related to the issue of debt or equity securities. Any contingent consideration payable is measured at fair value at the acquisition date. If the contingent consideration is classified as equity, then it is not re-measured and settlement is accounted for within equity. Otherwise, subsequent changes in the fair value of the contingent consideration are recognised in profit or loss. | | |
21.1 Acquisitions
Year ended 31 December 2014
Acquisition of ArthroCare
On 29 May 2014, the Group acquired 100% of the shares of ArthroCare Corporation, an innovative medical device company with a highly complementary sports medicine portfolio. The purchase price was $48.25 per share, paid in cash with the fair value of the totalcontingent consideration equalling $1,715m. The acquisition was financed through existing debt facilitiesare recognised in profit or loss.
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 160ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE GROUP ACCOUNTS continued 21.1 Acquisitions Year ended 31 December 2017 During the year ended 31 December 2017, the Group acquired one medical technology business deemed to be a business combination within the scope of IFRS 3 BusinessCombinations. On 5 December 2017, the Group completed the acquisition of 100% of the share capital of Rotation Medical Inc., a developer of a novel tissue regeneration technology for shoulder rotator cuff repair. The acquisition furthers our strategy to invest in disruptive technologies that accelerate the transformation of Smith & Nephew to higher growth. The maximum consideration payable of $210m has a fair value of $196m and includes $17m of deferred and $72m of contingent consideration. The fair value of the contingent consideration is determined from the acquisition agreement, the Board-approved acquisition model and a risk-free discount rate of 2.5%. The maximum contingent consideration is $85m. The provisional fair values of assets acquired and liabilities assumed are set out below: | | | | | | $ million | | Intangible assets | | 61 | | Property, plant & equipment and inventory | | 3 | | Trade and other receivables | | 2 | | Trade and other payables | | (3) | | Net deferred tax assets | | 1 | | Net assets | | 64 | | Goodwill | | 132 | | Consideration (net of $nil cash balances, including an existing $1 billion revolving credit facility and a new two-year $1.4 billion term loan facility, established in February 2014.acquired) | The acquisition is deemed to be a business combination within the scope of IFRS 3Business Combinations. The fair values shown below are provisional. If new information is obtained within the measurement period about facts and circumstances that existed at the acquisition date, the acquisition accounting will be revised. The provisional estimate of the goodwill arising on the acquisition is $829m. It relates to the value of the additional economic benefits expected from the transaction, including synergies and the assembled workforce. The goodwill recognised is not expected to be deductible for tax purposes.
| The following table summarises the consideration transferred, and the recognised amounts196
| |
The goodwill is attributable to the control premium, the acquired workforce and the synergies that can be expected from integrating Rotation Medical, Inc. into the Group’s existing business. The goodwill is not expected to be deductible for tax purposes. During the year ended 31 December 2017, the contribution to revenue and attributable profit from this acquisition is immaterial. If the acquisition had occurred at the beginning of the year, its contribution to revenue and attributable profit would have also been immaterial. Year ended 31 December 2016 During the year ended 31 December 2016, the Group acquired two medical technology businesses deemed to be business combinations within the scope of IFRS 3 BusinessCombinations. The acquisition accounting was completed during 2017 with no measurement adjustments made. On 4 January 2016, the Group completed the acquisition of 100% of the share capital of Blue Belt Holdings Inc., a business specialising in robotic technologies. The acquisition secures a leading position in the fast growing area of Orthopaedic robotics-assisted surgery. The fair value of consideration is $265m and includes $51m deferred consideration. The fair values of assets acquired were: | | | | | | $ million | | Aggregate identifiable assets acquired and liabilities assumed at the acquisition date. | | | | | | | Intangible assets | | 70 | | Property, plant & equipment and inventory | | 13 | | Trade and other payable | | (11) | | Provisions | | (10) | | Deferred tax assets | | 16 | | Net assets | | 78 | | Goodwill | | 184 | | Consideration (net of $3m cash acquired) | | 262 | | | | | $ million | |
The goodwill is attributable to the revenue synergies of providing a full robotic surgery offering and future applications of the technological expertise. The goodwill is not expected to be deductible for tax purposes. On 8 January 2016 the Group completed the acquisition of BST-CarGel, a first-line cartilage repair product from Piramal Healthcare (Canada) Limited. The fair value of the consideration is $42m and included $37m of deferred and contingent consideration. The fair values of net assets acquired are: product intangible assets of $15m, inventory of $1m, and a deferred tax liability of $1m. The goodwill, which is expected to be deductible for tax purposes, arising on the acquisition is $27m, is attributable to the future penetration into new markets expected from the transaction. During the year ended 31 December 2016, the contribution to revenue and attributable profit from these acquisitions is immaterial. If the acquisitions had occurred at the beginning of the year, their contribution to revenue and attributable profit would have also been immaterial. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 161 |
Year ended 31 December 2015 During the year ended 31 December 2015, the Group acquired its distributor in Colombia and its distributor and a manufacturer in Russia. The acquisitions are deemed to be business combinations within the scope of IFRS 3 Business Combinations. The aggregated total fair value of the consideration was $68m and included $23m of contingent consideration and $13m through the settlement of working capital commitments. The acquisition accounting was completed in 2016 with no measurement adjustments being made. The following table summarises the aggregate consideration transferred and the aggregate fair value amounts of assets acquired and liabilities assumed at the acquisition date: | | | | | | $ million | | Identifiable assets acquired and liabilities assumed | | | | | Property, plant and equipment
| | | 60 | | Inventories
| | | 66 | | Trade receivables and prepayments
| | | 54 | | Identifiable intangible assets
| | | 817 | | Investments in associates
| | | 4 | | Trade and other payables
| | | (74 | ) | Provisions
| | | (19 | ) | Current tax payable
| | | (18 | ) | Deferred tax liabilities | | | (173 | ) | Net assets
| | | 717 | | Goodwill | | | 829 | | Consideration (net of $169m of cash acquired) | | | 1,546 | |
The recognised amounts of assets acquired and liabilities assumed are different from those disclosed previously as adjustments to provisional values continue to be recorded during the measurement period. None of the adjustments posted to date are material.
The Group incurred acquisition related costs of $21m relating to professional and advisor fees. These costs have been recognised in administrative expenses in the income statement.
ArthroCare’s contribution to Group revenue was $207m for the year ended 31 December 2014, representing approximately seven months of sales. This gave rise to a pre-tax profit of $28m after amortisation of acquisition intangibles. Had ArthroCare been acquired on 1 January 2014, the Group’s revenues would have been $147m higher and pre-tax profit would have been $5m higher.
Acquisition of Brazilian distributor
On 17 March 2014 the Group acquired certain assets and liabilities related to the distribution business for its sports medicine, orthopaedic reconstruction, and trauma products in Brazil. The acquisition is deemed to be a business combination within the scope of IFRS 3Business Combinations. The acquisition date fair value of the consideration was $31m and included deferred consideration of $26m and $5m in relation to the settlement of working capital commitments. The deferred consideration was subsequently settled during the second quarter.
| | | | 156Smith & Nephew Annual report 2014Intangible assets
| | 19 | | As at the acquisition date, the estimated value of the netOther assets acquired was $16m, which included trade and other receivables of $12m, identifiable intangible1
| | 29 | | Liabilities | | (14) | | Net assets of $16m, inventory of $4m, property, plant and equipment of $2m, trade payables | | 34 | | Goodwill | | 34 | | Consideration (net of $1m provisions of $5m, current tax payable of $4m and deferred tax liabilities of $8m. As a result, the provisional estimate of goodwill arising on the acquisition was $15m. This is attributable to the additional economic benefits expected from the acquisition, including the assembled workforce, which has been transferred as part of the acquisition. The goodwill is not expected to be deductible for tax purposes. The recognised amounts of assets acquired and liabilities assumed have been determined on a provisional basis. If new information is obtained within the measurement period about facts and circumstances that existed at the acquisition date, the acquisition accounting will be revised.
The contribution to revenue and attributable profit from this acquisition for the year ended 31 December 2014 was immaterial. If the acquisition had occurred at the beginning of the year its contribution to revenue and attributable profit for the year ended 31 December 2014 would also have been immaterial.
Year ended 31 December 2013
Acquisition of Turkish distributor
On 30 September 2013, the Group acquired certain assets and liabilities in respect of a Turkish business, which distributes products related to orthopaedic reconstruction, trauma, sports medicine and arthroscopic technologies.
The acquisition is deemed to be a business combination within the scope of IFRS 3.
The estimated fair value of the consideration is $63m and included $12m of contingent consideration in respect of agreed milestones and $36m through the settlement of working capital commitments. The accounting for acquisition was completed during 2014, with no change to the provisional values as at 31 December 2013.
The goodwill arising on the acquisition is $12m. It is attributable to the additional economic benefits expected from the transaction, including the assembled workforce, which has been transferred as part of the acquisition. The goodwill recognised is expected to be deductible for tax purposes.
The following table summarises the consideration transferred, and the recognised amounts of assets acquired and liabilities assumed at the acquisition date.
| | | | | | | | $ million | | Identifiable assets acquired and liabilities assumed
| | | | | Property, plant and equipment
| | | 4 | | Inventories
| | | 8 | | Trade receivables and prepayments
| | | 24 | | Identifiable intangible assets
| | | 17 | | Payables and accruals | | | (2 | ) | Net assets
| | | 51 | | Goodwill | | | 12 | | Cost of acquisition | | | 63 | |
The Group incurred acquisition-related costs of $4m, primarily related to external legal fees and due diligence costs. These costs have been recognised in administrative expenses in the Group’s income statement.
In 2013, the contribution to revenue and attributable profit from the acquisition was immaterial. If the acquisition had occurred at the beginning of the year the contribution to revenue and attributable profit would have also been immaterial.
Other acquisitions
During the year ended 31 December 2013, the Group acquired a Brazilian distributor of its advanced wound management products and a business based in India primarily engaged in the manufacture and distribution of trauma products. These acquisitions are deemed to be business combinations within the scope of IFRS 3.
The aggregated total fair value of the consideration was $63m and included $2m of contingent consideration and $2m through the settlement of working capital commitments. The accounting for both acquisitions was completed during 2014, with no change to the provisional values as at 31 December 2013.
As at the acquisition date, the aggregated fair value of the net assets acquired was $38 million, which included property, plant and equipment of $1m, inventory of $4m, trade receivables and prepayments of $3m, identifiable intangible assets of $47m, payables and accruals of $3m and deferred tax liabilities of $14m.
The goodwill arising on the acquisitions is $25m. This is attributable to the additional economic benefits expected from the transactions, including the assembled workforces, which have been transferred as part of the acquisitions. The goodwill recognised is not expected to be deductible for tax purposes.
In 2013, the contribution to revenue and attributable profit from these acquisitions was immaterial. If these acquisitions had occurred at the beginning of 2013 their contribution to revenue and attributable profit would have also been immaterial.
Smith & Nephew Annual report 2014 157
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
21 Acquisitions and disposalscontinued
21.2 Disposal of business
Year ended 31 December 2014
During the fourth quarter of 2014, the Group disposed of a manufacturing facility in the UK for cash consideration of $20 million, resulting in a pre-tax gain on disposal of $9 million. The 2014 revenue and profit contribution of the disposed business was immaterial.acquired)
22 Operating leases
| 1 | | Including net cash of $1m. |
The aggregated goodwill arising on the acquisitions is $34m. This is attributable to the additional economic benefits expected from the transactions, including the assembled workforces, which have been transferred as part of the acquisitions. The goodwill recognised is not deductible for tax purposes. The contribution to revenue and attributable profit from these acquisitions for the year ended 31 December 2015 was immaterial. If the acquisitions had occurred at the beginning of the year, their contributions to revenue and attributable profit for the year ended 31 December 2015 would also have been immaterial. 21.2 Disposal of business During the year ended 31 December 2016, the Group disposed of its Gynaecology business for cash consideration of $350m. The net assets disposed included $6m plant and equipment, and $4m inventory. Disposal related costs of $7m and liabilities of $7m resulted in a pre-tax gain on disposal of $326m. For the years ended 31 December 2015 and 31 December 2017, the Group did not dispose of any businesses. 22 OPERATING LEASES Accounting policy Leases are classified as finance leases when the terms of the lease transfer substantially all the risks and rewards of ownership to the Group. All other leases are classified as operating leases. Payments under operating leases are expensed in the income statement on a straight line basis over the term of the lease. Lease incentives received are recognised as an integral part of the total lease expense, over the term of the lease.
| | |
Future minimum lease payments under non-cancellable operating leases fall due as follows:
| | | | | | | 2014 $ million | | 2013 $ million | Land and buildings: | | | | | Within one year | | 34 | | 30 | After one and within two years | | 25 | | 22 | After two and within three years | | 18 | | 16 | After three and within four years | | 12 | | 13 | After four and within five years | | 8 | | 7 | After five years | | 8 | | 5 | | | 105 | | 93 | Other assets: | | | | | Within one year | | 15 | | 15 | After one and within two years | | 9 | | 9 | After two and within three years | | 4 | | 4 | After three and within four years | | 3 | | 2 | | | 31 | | 30 |
158Smith & Nephew Annual report 2014
23 Other Notes to the accounts
23.1 Share-based payments
| | | | | | | ACCOUNTING POLICY
| | | | | | | | | | The Group operates a number of equity-settled executive and employee share plans. For all grants of share options and awards, the fair value at the grant date is calculated using appropriate option pricing models. The grant date fair value is recognised over the vesting period as an expense, with a corresponding increase in retained earnings.
| | |
Employee plans
The Smith & Nephew Sharesave Plan (2002) (adopted by shareholders on 3 April 2002) (the Save As You Earn (‘SAYE’) plan), the Smith & Nephew International Sharesave Plan (2002), Smith & Nephew France Sharesave Plan (2002), Smith & Nephew Sharesave Plan (2012) (the Save As You Earn (‘SAYE 2012’) plan) (adopted by shareholders on 12 April 2012), Smith & Nephew International Sharesave Plan (2012) (adopted by shareholders on 12 April 2012) and Smith & Nephew France Sharesave Plan (2012) (adopted by shareholders on 12 April 2012) are together termed the “Employee Plans”.
The SAYE and SAYE 2012 plans are available to all employees in the UK employed by participating Group companies, subject to three months’ service. The schemes enable employees to save up to £250 per month and give them an option to acquire shares based on the committed amount to be saved. The option price is not less than 80% of the average of middle market quotations of the ordinary shares on the three dealing days preceding the date of invitation. The Smith & Nephew International Sharesave Plan (2002) and Smith & Nephew International Sharesave Plan (2012) are available to employees in Australia, Austria, Belgium, Canada, China, Denmark, Finland, France, Germany, Hong Kong, India, Ireland, Italy, Japan, South Korea, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Singapore, South Africa, Spain, Sweden, Switzerland and the United Arab Emirates. Puerto Rico participants were eligible to receive options under the International Plans up to 2011 and were eligible to receive phantom options from 2013 onwards. The Smith & Nephew France Sharesave Plans were available to all employees in France up to 2012. The International and French plans operate on a substantially similar basis to the SAYE plans.
Employees in the US are able to participate in the Employee Stock Purchase Plan, which gives them the opportunity to acquire shares, in the form of ADSs, at a discount of 15% (or more if the shares appreciate in value during the plan’s quarterly purchase period) to the market price, through a regular savings plan.
Executive plans
The Smith & Nephew 2001 UK Approved Share Option Plan, the Smith & Nephew 2001 UK Unapproved Share Option Plan, the Smith & Nephew 2001 US Share Plan (adopted by shareholders on 4 April 2001), the Smith & Nephew 2004 Executive Share Option Plan (adopted by shareholders on 6 May 2004) and the Smith & Nephew Global Share Plan 2010 (adopted by shareholders on 6 May 2010) are together termed the ‘Executive Plans’.
Under the terms of the Executive Plans,lease transfer substantially all the Remuneration Committee, consistingrisks and rewards of Non-Executive Directors, may at their discretion approveownership to the grant of options to employeesGroup. All other leases are classified as operating leases.
Payments under operating leases are expensed in the income statement on a straight-line basis over the term of the Group to acquire ordinary shares inlease. Lease incentives received are recognised as an integral part of the Company. Options granted undertotal lease expense, over the Smithterm of the lease. |
Future minimum lease payments under non-cancellable operating leases fall due as follows: | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Land and buildings: | | | | | | Within one year | | 40 | | 33 | | After one and within two years | | 35 | | 27 | | After two and within three years | | 27 | | 23 | | After three and within four years | | 23 | | 16 | | After four and within five years | | 19 | | 13 | | After five years | | 56 | | 41 | | | | 200 | | 153 | | Other assets: | | | | | | Within one year | | 17 | | 15 | | After one and within two years | | 11 | | 11 | | After two and within three years | | 5 | | 6 | | After three and within four years | | 1 | | 2 | | | | 34 | | 34 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 162ACCOUNTS | SMITH & Nephew 2001 US Share Plan (the ‘US Plan’) and the Smith & Nephew 2004 Executive Share Option Plan are to acquire ADSs or ordinary shares. For Executive Plans adopted in 2001 and 2004, the market value is the average quoted price of an ordinary share for the three business days preceding the date of grant or the average quoted price of an ADS or ordinary share, for the three business days preceding the date of grant or the quoted price on the date of grant if higher. For the Global Share Plan adopted in 2010 the market value is the closing price of an ordinary share or ADS on the last trading day prior to the grant date. With the exception of options granted under the 2001 US Plan and the Global Share Plan 2010, the vesting of options granted from 2001 is subject to achievement of a performance condition. Options granted under the 2001 US Plan and the Global Share Plan 2010 are not subject to any performance conditions. Prior to 2008, the 2001 US Plan options became cumulatively exercisable as to 10% after one year, 30% after two years, 60% after three years and the remaining balance after four years. With effect from 2008, options granted under the 2001 US Plan became cumulatively exercisable as to 33.3% after one year, 66.7% after two years and the remaining balance after the third year. The 2001 UK Unapproved Share Option Plan was open to certain employees outside the US and the US Plan was open to certain employees in the US, Canada, Mexico and Puerto Rico. The Global Share Plan 2010 is open to employees globally. The 2004 Plan was open to Senior Executives only.NEPHEW ANNUAL REPORT 2017 |
23 OTHER NOTES TO THE ACCOUNTS 23.1 Share-based payments Accounting policy The maximum termGroup operates a number of options granted, underequity-settled executive and employee share plans. For all plans, is 10 years from the date of grant. All share option plans are settled in shares. From 2012 onwards Senior Executives were granted share awards insteadgrants of share options and from 2013 executives were granted conditional share awards, instead of share options. The awards vest 33.3% after one year, 66.7% after two years and the remaining balance after the third year subject to continued employment. There are no performance conditions for executives. Vesting for senior executives is subject to personal performance levels. The market value used to calculate the number of awards is the closing price of an ordinary share on the last trading day prior to the grant date.
Smith & Nephew Annual report 2014 159
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
23 Other Notes to the accountscontinued
23.1 Share based payments continued
At 31 December 2014 8,708,000 (2013 – 13,601,000, 2012 – 19,690,000) options were outstanding under share option plans as follows:
| | | | | | | | | | | | | | | | | | | | Number of shares Thousand | | | | Range of option exercise prices Pence | | | | Weighted average exercise price Pence | | Employee Plans: | | | | | | | | | | | | | | | Outstanding at 1 January 2012 | | | | | 3,580 | | | | 348.0 – 640.0 | | | | 432.8 | | Granted | | | | | 947 | | | | 535.0 – 535.0 | | | | 535.0 | | Forfeited | | | | | (402 | ) | | | 348.0 – 609.0 | | | | 434.5 | | Exercised | | | | | (925 | ) | | | 348.0 – 609.0 | | | | 396.0 | | Expired | | | | | (38 | ) | | | 348.0 – 640.0 | | | | 496.2 | | Outstanding at 31 December 2012 | | | | | 3,162 | | | | 380.0 – 609.0 | | | | 473.1 | | Granted | | | | | 1,178 | | | | 625.0 | | | | 625.0 | | Forfeited | | | | | (174 | ) | | | 380.0 – 625.0 | | | | 488.2 | | Exercised | | | | | (751 | ) | | | 380.0 – 609.0 | | | | 453.8 | | Expired | | | | | (128 | ) | | | 380.0 – 625.0 | | | | 490.0 | | Outstanding at 31 December 2013 | | | | | 3,287 | | | | 380.0 – 625.0 | | | | 530.5 | | Granted | | | | | 799 | | | | 831.0 | | | | 831.0 | | Forfeited | | | | | (289 | ) | | | 380.0 – 831.0 | | | | 533.8 | | Exercised | | | | | (743 | ) | | | 380.0 – 625.0 | | | | 436.2 | | Expired | | | | | (18 | ) | | | 461.0 – 556.0 | | | | 465.7 | | Outstanding at 31 December 2014 | | | | | 3,036 | | | | 380.0 – 831.0 | | | | 632.7 | | Options exercisable at 31 December 2014 | | | | | 94 | | | | 380.0 – 585.0 | | | | 439.6 | | Options exercisable at 31 December 2013 | | | | | 71 | | | | 461.0 – 556.0 | | | | 467.8 | | Options exercisable at 31 December 2012 | | | | | 152 | | | | 380.0 – 609.0 | | | | 400.8 | | Executive Plans: | | | | | | | | | | | | | | | Outstanding at 1 January 2012 | | | | | 23,736 | | | | 409.5 – 703.0 | | | | 561.2 | | Granted | | | | | 3,046 | | | | 642.0 – 650.0 | | | | 650.0 | | Forfeited | | | | | (954 | ) | | | 479.0 – 703.0 | | | | 569.0 | | Exercised | | | | | (8,740 | ) | | | 434.0 – 651.0 | | | | 547.7 | | Expired | | | | | (560 | ) | | | 435.5 – 637.8 | | | | 588.7 | | Outstanding at 31 December 2012 | | | | | 16,528 | | | | 409.5 – 680.5 | | | | 583.3 | | Forfeited | | | | | (118 | ) | | | 514.0 – 650.0 | | | | 618.8 | | Exercised | | | | | (5,540 | ) | | | 435.5 – 671.0 | | | | 568.0 | | Expired | | | | | (556 | ) | | | 435.5 – 650.0 | | | | 582.3 | | Outstanding at 31 December 2013 | | | | | 10,314 | | | | 409.5 – 680.5 | | | | 591.1 | | Forfeited | | | | | (115 | ) | | | 599.0 – 650.0 | | | | 645.0 | | Exercised | | | | | (4,114 | ) | | | 454.0 – 671.0 | | | | 583.0 | | Expired | | | | | (413 | ) | | | 409.5 – 650.0 | | | | 587.8 | | Outstanding at 31 December 2014 | | | | | 5,672 | | | | 470.0 – 680.5 | | | | 596.2 | | Options exercisable at 31 December 2014 | | | | | 4,713 | | | | 470.0 – 680.5 | | | | 585.3 | | Options exercisable at 31 December 2013 | | | | | 6,631 | | | | 409.5 – 680.5 | | | | 571.1 | | Options exercisable at 31 December 2012 | | | | | 8,512 | | | | 409.5 – 680.5 | | | | 562.7 | |
The weighted average remaining contractual life of options outstanding at 31 December 2014 was 5.8 years (2013 – 6.2 years, 2012 – 6.6 years) for Executive Plans and 2.5 years (2013 – 2.5 years, 2012 – 2.6 years) for Employee Plans.
160Smith & Nephew Annual report 2014
| | | | | | | | | | | | | | | | | 2014 pence | | 2013 pence | | 2012 pence | Weighted average share price | | 994.4 | | 764.7 | | 640.5 | Options granted during the year were as follows: | | | | | | | Options granted Thousand | | Weighted average fair value per option at grant date Pence | | Weighted average share price at grant date Pence | | Weighted average exercise price Pence | | Weighted average option life Years | Employee Plans | | 799 | | 255.8 | | 1069.0 | | 831.0 | | 3.9 |
The weighted average fair value of options granted under Employee Plans during 2013 was 203.9p (2012 – 184.0p) and those under Executive Plans during 2013 was nil (2012 – 148.7p).
Options granted under Employee Plans are valued using the Black-Scholes option model as management consider that options granted under these plans are exercised within a short period of time after the vesting date.
For all plans the inputs to the option pricing models are reassessed for each grant. The following assumptions were used in calculating the fair value of options granted:
| | | | | | | | | | | | | | | | | Employee plans | | | | Executive plans | | | 2014 | | 2013 | | 2012 | | | | 2014 | | 2013 | | 2012 | Dividend yield % | | 2.0 | | 2.0 | | 1.5 | | | | – | | – | | 1.5 | Expected volatility % (i) | | 20.0 | | 25.0 | | 25.0 | | | | – | | – | | 25.0 | Risk free interest rate % (ii) | | 1.3 | | 1.3 | | 1.3 | | | | – | | – | | 1.2 | Expected life in years | | 3.9 | | 3.8 | | 3.8 | | | | – | | – | | 10.0 |
(i) | Volatilityat the grant date is assessed on a historic basis primarily based on past share price movements over the expected life of the options. |
(ii) | The risk free interest rate reflects the yields available on zero coupon government bonds over the option term and currency. |
Smith & Nephew Annual report 2014 161
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
23 Other Notes to the accountscontinued
23.1 Share based payments continued
Share-based payments – long-term incentive plans
In 2004, a share-based incentive plan was introduced for Executive Directors, Executive Officers and the next level of Senior Executives. The plan included a Performance Share Plan (‘PSP’) and a Bonus Co-Investment Plan (‘CIP’).
Vesting of the PSP awards is dependent upon performance relative to the FTSE 100 and an index based on major international companies in the medical devices industry.
Under the CIP, participants could elect to use up to a maximum of one-half of their annual bonus to purchase shares. If the shares are held for three years and the Group’s EPSA growth targets are achieved participants receive an award of matching shares for each share purchased.
From 2009, the CIP was replaced by the Deferred Bonus Plan. This plan was designed to encourage Executives to build up and maintain a significant shareholding in the Company. Under the plan, up to one-third of any bonus earned at target level or above by an eligible employee was compulsorily deferred into shares which vested, subject to continued employment, in equal annual tranches over three years (ie one-third each year). No further performance conditions applied to the deferred shares.
From 2010, Performance Share awards were granted under the Global Share Plan 2010 for all Executives other than Executive Directors. Awards granted under both plans are combined to provide the figures below.
From 2012, Deferred Bonus Plan and GSP 2010 options for Executive Directors, Executive Officers and the next level of Senior Executives were replaced by Equity Incentive Awards (‘EIA’). EIA are designed to encourage Executives to build up and maintain a significant shareholding in the Company. EIA will vest, in equal annual tranches over three years (ie one-third each year), subject to continued employment and personal performance. No further performance conditions apply to the EIA.
The fair values of awards granted under long-term incentive plans are calculated using a binomial model. Performance Share awards under both the PSP and Global Share Plan 2010 contain vesting conditions based on TSR versus a comparator group which represent market-based performance conditions for valuation purposes and an assessment of vesting probabilityappropriate option pricing models. The grant date fair value is therefore factored into the award date calculations. The assumptions include the volatilities for the comparator groups. A correlation of 40% (2013 – 40%, 2012 – 35%) has also been assumed for the companies in the medical devices sector as they are impacted by similar factors. The Performance Target for the Global Share Plan 2010 is a combination of Free Cash Flow growth, Revenue in Emerging & International Markets and the Group’s TSR performancerecognised over the three-year performance period.
The other assumptions used are consistentvesting period as an expense, with the Executive scheme assumptions disclosed earliera corresponding increase in this note.
At 31 December 2014 the maximum number of shares that could be awarded under the Group’s long-term incentive plans was:
| | | | | | | | | | | | | | | | | | | Number of shares in Thousands | | | Other | | | | | | Deferred | | | | | Awards | | EIA | | PSP | | Bonus Plan | | Total | Outstanding at a January 2012 | | 794 | | – | | 6,268 | | 492 | | 7,554 | Awarded | | 187 | | 1,060 | | 2,190 | | – | | 3,437 | Vested | | (263) | | (49) | | (1,785) | | (287) | | (2,384) | Forfeited | | – | | (82) | | (1,431) | | (41) | | (1,554) | Outstanding at 31 December 2012 | | 718 | | 929 | | 5,242 | | 164 | | 7,053 | Awarded | | 1,179 | | 785 | | 1,963 | | – | | 3,927 | Vested | | (437) | | (379) | | (411) | | (115) | | (1,342) | Forfeited | | (11) | | (51) | | (1,597) | | (5) | | (1,664) | Outstanding at 31 December 2013 | | 1,449 | | 1,284 | | 5,197 | | 44 | | 7,974 | Awarded | | 751 | | 642 | | 1,510 | | – | | 2,903 | Vested | | (583) | | (751) | | – | | (44) | | (1,378) | Forfeited | | (96) | | (24) | | (2,188) | | – | | (2,308) | Outstanding at 31 December 2014 | | 1,521 | | 1,151 | | 4,519 | | – | | 7,191 |
Other awards mainly comprises of conditional share awards granted under the Global Share Plan 2010.
The weighted average remaining contractual life of awards outstanding at 31 December 2014 was 1.1 years (2013 – 1.4 years, 2012 – 0.8 years) for the PSP, nil years (2013 – 0.2 years, 2012 – 0.9 years) for the Deferred Bonus Plan, 1.5 years (2013 – 1.8 years) for the EIA and 2.0 years (2013 – 2.1 years, 2012 – 0.9 years) for the other awards.
162Smith & Nephew Annual report 2014
Share-based payments – charge to income statement
The expense charged to the income statement for share-based payments is as follows:
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Granted in current year | | | 9 | | | | 10 | | | | 9 | | Granted in prior years | | | 23 | | | | 18 | | | | 25 | | Total share-based payments expense for the year | | | 32 | | | | 28 | | | | 34 | |
Under the Executive Plans, PSP, EIA and CIP the number of ordinary shares over which options and share awards may be granted is limited so that the number of ordinary shares issued or that may be issued during the 10 years preceding the date of grant shall not exceed 5% of the ordinary share capital at the date of grant. The total number of ordinary shares which may be issuable in any 10-year period under all share plans operated by the Company may not exceed 10% of the ordinary share capital at the date of grant.
23.2 Related party transactions
Trading transactions
In the course of normal operations, the Group traded with its associates detailed in Note 11. The aggregated transactions, which have not been disclosed elsewhere in the financial statements, are summarised below:
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Sales to the associates | | | – | | | | 5 | | | | 14 | | Purchases from the associates | | | 1 | | | | 2 | | | | 8 | |
All sale and purchase transactions occur on an arm’s length basis.
Key management personnel
The remuneration of executive officers (including Non-executive Directors) during the year is summarised below:
| | | | | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | | | 2012 $ million | | Short-term employee benefits | | | 14 | | | | 15 | | | | 16 | | Share-based payments expense | | | 8 | | | | 11 | | | | 10 | | Pension and post-employment benefit entitlements | | | 1 | | | | 1 | | | | 1 | | Other benefits | | | 3 | | | | – | | | | – | | | | | 26 | | | | 27 | | | | 27 | |
Smith & Nephew Annual report 2014 163
FINANCIAL STATEMENTS
Notes to the Group accountscontinued
23 Other Notes to the accountscontinued
23.3 Principal subsidiary undertakings
The information provided below is given for principal trading and manufacturing subsidiary undertakings, all of which are 100% owned, in accordance with Section 410 of the Companies Act 2006. A full list will be appended to Smith & Nephew’s next annual return to Companies House:
| | | | | Company Name | | Activity | | Country of operation and incorporation | UK:
| | | | | T. J. Smith & Nephew, Limited
| | Medical Devices | | England & Wales | Smith & Nephew ARTC Limited | | Medical Devices | | England & Wales | | | | Continental Europe:
| | | | | Smith & Nephew GmbH
| | Medical Devices
| | Austriaretained earnings.
| ArthroCare Belgium SPRL
| | Medical Devices
| | Belgium
| Smith & Nephew SA-NV
| | Medical Devices
| | Belgium
| Smith & Nephew A/S
| | Medical Devices
| | Denmark
| Smith & Nephew Oy
| | Medical Devices
| | Finland
| Smith & Nephew SAS
| | Medical Devices
| | France
| Smith & Nephew Orthopaedics GmbH
| | Medical Devices
| | Germany
| Smith & Nephew GmbH
| | Medical Devices
| | Germany
| Smith & Nephew Hellas SA
| | Medical Devices
| | Greece
| Smith & Nephew Limited
| | Medical Devices
| | Ireland
| Smith & Nephew Srl
| | Medical Devices
| | Italy
| Smith & Nephew Nederland CV
| | Medical Devices
| | Netherlands
| Smith & Nephew A/S
| | Medical Devices
| | Norway
| Smith & Nephew Sp Zoo
| | Medical Devices
| | Poland
| Smith & Nephew Lda
| | Medical Devices
| | Portugal
| Smith & Nephew SAU
| | Medical Devices
| | Spain
| Smith & Nephew AB
| | Medical Devices
| | Sweden
| Smith & Nephew Manufacturing AG
| | Medical Devices
| | Switzerland
| Smith & Nephew Orthopaedics AG
| | Medical Devices
| | Switzerland
| Smith & Nephew Schweiz AG
| | Medical Devices | | Switzerland | | | | US:
| | | | | ArthroCare Corporation
| | Medical Devices | | United States | ArthroCare Medical Corporation
| | Medical Devices | | United States | Smith & Nephew Inc.
| | Medical Devices | | United States |
164Smith & Nephew Annual report 2014
|
The Group operates the following equity-settled executive and employee share plans: Smith & Nephew 2001 US Share Plan, Smith & Nephew Global Share Plan 2010, Smith & Nephew ShareSave Plan (2012), Smith & Nephew International ShareSave Plan (2012) and the Smith & Nephew France ShareSave plan (2012). At 31 December 2017, 5,277,000 options (2016: 5,780,000, 2015: 7,235,000) were outstanding with a range of exercise prices from 535 to 1,092 pence. At 31 December 2017, the maximum number of shares that could be awarded under the Group’s long-term incentive plans was 5,854,000 (2016: 5,807,000; 2015: 6,402,000). These include conditional share awards granted to senior employees and equity and performance share awards granted to senior executives under the Global Share Plan 2010. The expense charged to the income statement for share-based payments for the year is $31m (2016: $27m, 2015: $30m). 23.2 Related party transactions Trading transactions In the course of normal operations, the Group traded with its associates detailed in Note 11. The aggregated transactions, which have not been disclosed elsewhere in the financial statements are $nil (2016: $nil, 2015: $nil). Key management personnel The remuneration of executive officers (including Non-Executive Directors) during the year is summarised below: | | | | | | | | | | 2017 | | 2016 | | 2015 | | | | $ million | | $ million | | $ million | | Short-term employee benefits | | 15 | | 15 | | 16 | | Share-based payments expense | | 7 | | 7 | | 8 | | Pension and post-employment benefit entitlements | | 1 | | 1 | | 1 | | Compensation for loss of office | | 3 | | – | | – | | | | 26 | | 23 | | 25 | |
24 POST BALANCE SHEET EVENTS Subsequent to the year end the Group announced its Accelerating Performance and Execution (APEX) programme. This is a five-year effort to make key enhancements to the Group’s business and ways of working in Manufacturing, Warehousing and Distribution, General and Administrative Expenses and Commercial Effectiveness. The programme is expected to require a one-off cash cost of $240m of which a charge of around $100m is expected in 2018. No provisions have been recorded in respect of this programme as at 31 December 2017. A constructive obligation in relation to this programme had not arisen at 31 December 2017 as the Group had not announced the main features of the programme nor raised a valid expectation in those employees affected by the programme. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 163 |
COMPANY FINANCIAL STATEMENTS COMPANY BALANCE SHEET | | | | | | | | | | | | At 31 December | | At 31 December | | | | | | 2017 | | 2016 | | | | Notes | | $ million | | $ million | | Fixed assets: | | | | | | | | Investments | | 2 | | 7,092 | | 5,322 | | Current assets: | | | | | | | | Debtors | | 3 | | 1,084 | | 824 | | Cash and bank | | 5 | | 88 | | 14 | | | | | | 1,172 | | 838 | | Creditors: amounts falling due within one year: | | | | | | | | Borrowings | | 5 | | (4) | | (41) | | Other creditors | | 4 | | (1,202) | | (814) | | | | | | (1,206) | | (855) | | Net current liabilities | | | | (34) | | (17) | | Total assets less current liabilities | | | | 7,058 | | 5,305 | | Creditors: amounts falling due after one year: | | | | | | | | Borrowings | | 5 | | (1,423) | | (1,559) | | Total assets less total liabilities | | | | 5,635 | | 3,746 | | | | | | | | | | Equity shareholders’ funds: | | | | | | | | Called up equity share capital | | | | 178 | | 180 | | Share premium account | | | | 605 | | 600 | | Capital redemption reserve | | | | 17 | | 15 | | Capital reserve | | | | 2,266 | | 2,266 | | Treasury shares | | | | (257) | | (432) | | Exchange reserve | | | | (52) | | (52) | | Profit and loss account | | | | 2,878 | | 1,169 | | Shareholders’ funds | | | | 5,635 | | 3,746 | |
The accounts were approved by the Board and authorised for issue on 22 February 2018 and signed on its behalf by: Roberto Quarta | Olivier Bohuon | Graham Baker | Chairman | Chief Executive Officer | Chief Financial Officer |
| | | | | Company Name | | Activity | | Country of operation and incorporation | Africa, Asia, Australasia and Other America:
| | | | | Smith & Nephew Pty Limited
| | Medical Devices
| | Australia
| Smith & Nephew Surgical Pty Limited
| | Medical Devices
| | Australia
| Smith & Nephew Comercio de Productos Medicos LTDA
| | Medical Devices
| | Brazil
| Smith & Nephew Inc.
| | Medical Devices
| | Canada
| Smith & Nephew (Alberta) Inc.
| | Medical Devices
| | Canada
| Tenet Medical Engineering Inc.
| | Medical Devices
| | Canada
| Smith & Nephew Medical (Shanghai) Limited
| | Medical Devices
| | China
| Smith & Nephew Medical (Suzhou) Limited
| | Medical Devices
| | China
| Smith & Nephew Orthopaedics (Beijing) Limited
| | Medical Devices
| | China
| ArthroCare Costa Rica SRL
| | Medical Devices
| | Costa Rica
| Smith & Nephew Curaçao NV
| | Medical Devices
| | Curaçao
| Smith & Nephew Limited
| | Medical Devices
| | Hong Kong
| Adler Mediequip Private Limited
| | Medical Devices
| | India
| Smith & Nephew Healthcare Private Limited
| | Medical Devices
| | India
| Smith & Nephew Endoscopy KK
| | Medical Devices
| | Japan
| Smith & Nephew Orthopaedics KK
| | Medical Devices
| | Japan
| Smith & Nephew Wound Management KK
| | Medical Devices
| | Japan
| Smith & Nephew Chusik Hoesia
| | Medical Devices
| | Korea
| Smith & Nephew Healthcare Sdn Berhad
| | Medical Devices
| | Malaysia
| Smith & Nephew SA de CV
| | Medical Devices
| | Mexico
| Smith & Nephew Limited
| | Medical Devices
| | New Zealand
| Smith & Nephew Surgical Limited
| | Medical Devices
| | New Zealand
| Smith & Nephew Inc.
| | Medical Devices
| | Puerto Rico
| LLC Smith & Nephew
| | Medical Devices
| | Russia
| Smith & Nephew Pte Limited
| | Medical Devices
| | Singapore
| Smith & Nephew (Pty) Limited
| | Medical Devices
| | South Africa
| Smith & Nephew Limited
| | Medical Devices
| | Thailand
| Smith ve Nephew Medikal Cihazlar Ticaret Limited Sirketi
| | Medical Devices
| | Turkey
| Smith & Nephew FZE
| | Medical Devices
| | United Arab Emirates
|
Smith & Nephew Annual report 2014 165
FINANCIAL STATEMENTS
Company balance sheet
| | | | | | | | | | | | | | | | Notes | | |
| At 31 December 2014
$ million |
| |
| At 31 December 2013
$ million |
| Fixed assets: | | | | | | | | | | | | | Investments | | | 3 | | | | 5,322 | | | | 3,597 | | Current assets: | | | | | | | | | | | | | Debtors | | | 4 | | | | 2,143 | | | | 2,140 | | Cash and bank | | | 6 | | | | 1 | | | | 6 | | | | | | | | | 2,144 | | | | 2,146 | | Creditors: amounts falling due within one year: | | | | | | | | | | | | | Borrowings | | | 6 | | | | (40 | ) | | | (2 | ) | Other creditors | | | 5 | | | | (1,287 | ) | | | (1,590 | ) | | | | | | | | (1,327 | ) | | | (1,592 | ) | Net current assets | | | | | | | 817 | | | | 554 | | Total assets less current liabilities | | | | | | | 6,139 | | | | 4,151 | | Creditors: amounts falling due after one year: | | | | | | | | | | | | | Borrowings | | | 6 | | | | (1,655 | ) | | | (335 | ) | Total assets less total liabilities | | | | | | | 4,484 | | | | 3,816 | | | | | | Equity shareholders’ funds: | | | | | | | | | | | | | Called up equity share capital | | | 7 | | | | 184 | | | | 184 | | Share premium account | | | 7 | | | | 574 | | | | 535 | | Capital redemption reserve | | | 7 | | | | 11 | | | | 10 | | Capital reserve | | | 7 | | | | 2,266 | | | | 2,266 | | Treasury shares | | | 7 | | | | (315 | ) | | | (322 | ) | Exchange reserve | | | 7 | | | | (52 | ) | | | (52 | ) | Profit and loss account | | | 7 | | | | 1,816 | | | | 1,195 | | Shareholders’ funds | | | | | | | 4,484 | | | | 3,816 | |
The accounts were approved by the Board and authorised for issue on 25 February 2015 and signed on its behalf by:
| | | | | | | | | | | Roberto Quarta | | Olivier Bohuon | | Julie Brown | | | | | | | Chairman | | Chief Executive Officer | | Chief Financial Officer | | | | | | |
The Parent Company financial statements of Smith & Nephew plc on pages 166 to 169 do not form part of the Smith & Nephew’s
Annual Report on Form 20-F as filed with the SEC.
166Smith & Nephew Annual report 2014 THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 164 | ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
COMPANY FINANCIAL STATEMENTS STATEMENT OF CHANGES IN EQUITY | | | | | | | | | | | | | | | | | | | | | | | | Capital | | | | | | | | | | Total | | | | Share | | Share | | redemption | | Capital | | Treasury | | Exchange | | Profit and | | shareholders’ | | | | capital | | premium | | reserve | | reserves | | shares | | reserves | | loss account | | funds | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | At 1 January 2016 | | 183 | | 590 | | 12 | | 2,266 | | (294) | | (52) | | 1,589 | | 4,294 | | Attributable profit for the year | | – | | – | | – | | – | | – | | – | | 58 | | 58 | | Net gain on cash flow hedges | | – | | – | | – | | – | | – | | – | | 1 | | 1 | | Exchange adjustments | | – | | – | | – | | – | | – | | – | | (3) | | (3) | | Equity dividends paid in the year | | – | | – | | – | | – | | – | | – | | (279) | | (279) | | Share-based payments recognised1 | | – | | – | | – | | – | | – | | – | | 27 | | 27 | | Cost of shares transferred to beneficiaries | | – | | – | | – | | – | | 40 | | – | | (34) | | 6 | | New shares issued on exercise of share options | | – | | 10 | | – | | – | | – | | – | | – | | 10 | | Cancellation of treasury shares | | (3) | | – | | 3 | | – | | 190 | | – | | (190) | | – | | Treasury shares purchased | | – | | – | | – | | – | | (368) | | – | | – | | (368) | | At 31 December 2016 | | 180 | | 600 | | 15 | | 2,266 | | (432) | | (52) | | 1,169 | | 3,746 | | Attributable profit for the year | | – | | – | | – | | – | | – | | – | | 2,167 | | 2,167 | | Net gain on cash flow hedges | | – | | – | | – | | – | | – | | – | | 1 | | 1 | | Exchange adjustments | | – | | – | | – | | – | | – | | – | | 1 | | 1 | | Equity dividends paid in the year | | – | | – | | – | | – | | – | | – | | (269) | | (269) | | Share-based payments recognised1 | | – | | – | | – | | – | | – | | – | | 31 | | 31 | | Cost of shares transferred to beneficiaries | | – | | – | | – | | – | | 26 | | – | | (21) | | 5 | | New shares issued on exercise of share options | | – | | 5 | | – | | – | | – | | – | | – | | 5 | | Cancellation of treasury shares | | (2) | | – | | 2 | | – | | 201 | | – | | (201) | | – | | Treasury shares purchased | | – | | – | | – | | – | | (52) | | – | | – | | (52) | | At 31 December 2017 | | 178 | | 605 | | 17 | | 2,266 | | (257) | | (52) | | 2,878 | | 5,635 | |
| 1 Basis of preparation Smith & Nephew plc (the ‘Company’) is a public limited company incorporated in England and Wales.
The separate accounts of the Company are presented as required by the Companies Act 2006. The accounts have been prepared under the historical cost convention, modified to include revaluation to fair value of certain financial instruments as described below, and in accordance with applicable UK accounting standards. As consolidated financial information has been disclosed under IFRS 7 Financial Instruments: Disclosures, the Company is exempt from FRS 29 Financial Instruments: Disclosures. The Group accounts have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union and are presented on pages 110 to 165.
The Company has taken advantage of the exemption in FRS 8 Related Party Disclosures not to present its related party disclosures as the Group accounts contain these disclosures. In addition, the Company has taken advantage of the exemption in FRS 1 Cash Flow Statements not to present its own cash flow statement as the Group accounts contain a consolidated cash flow.
In applying these policies management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on management’s best knowledge of current events and actions, actual results ultimately may differ from those estimates.
Foreign currencies
Transactions in foreign currencies are initially recorded at the exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated at the rate of exchange ruling at the balance sheet date. All exchange differences are dealt with in arriving at profit before taxation.
Deferred taxation
Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date where transactions or events have occurred at that date that will result in an obligation to pay more, or a right to pay less or to receive more, tax.
Deferred tax is measured on an undiscounted basis at the tax rates that are expected to apply in the periods in which timing differences are expected to reverse. These are based on tax rates and laws substantively enacted at the balance sheet date.
2 Results for the year
As permitted by Section 408(4) of the Companies Act 2006, the Company has not presented its own profit and loss account. Profit for the year was $922m (2013 – $198m).
3 Investments
| | | | | | | | | | ACCOUNTING POLICY
| | | | | Investments in subsidiaries are stated at cost less provision for impairment.
| | |
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | At 1 January | | | 3,597 | | | | 3,597 | | Additions | | | 1,725 | | | | – | | At 31 December | | | 5,322 | | | | 3,597 | |
Investments represent holdings in subsidiary undertakings.
The information provided below is given for the principal direct subsidiary undertakings, all of which are 100% owned and, in accordance with Section 410 of the Companies Act 2006, a full list will be appended to Smith & Nephew’s next annual return to Companies House.
| | | | | | | | | | | | Activity | | |
| Country of operation
and incorporation |
| Company Name
| | | | | | | | | Smith & Nephew UK Limited
| | | Holding Company | | | | England & Wales | | Smith & Nephew (Overseas) Limited | | | Holding Company | | | | England & Wales | |
Refer to Note 23.3 of the Notes to the Group accounts for the principal trading and manufacturing subsidiary undertakings of the Group.
The Parent Company financial statements of Smith & Nephew plc on pages 166 to 169 do not form part of the Smith & Nephew’s
Annual Report on Form 20-F as filed with the SEC.
Smith & Nephew Annual report 2014 167
FINANCIAL STATEMENTS
Notes to the Company accountscontinued
4 Debtors
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Amounts falling due within one year: | | | | | | | | | Amounts owed by subsidiary undertakings | | | 2,074 | | | | 2,091 | | Prepayments and accrued income | | | 3 | | | | 3 | | Current asset derivatives – forward foreign exchange contracts | | | 65 | | | | 45 | | Current asset derivatives – currency swaps | | | – | | | | 1 | | Current taxation | | | 1 | | | | – | | | | | 2,143 | | | | 2,140 | |
5 Other creditors
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Amounts falling due within one year: | | | | | | | | | Amounts owed to subsidiary undertakings | | | 1,212 | | | | 1,533 | | Other creditors | | | 9 | | | | 10 | | Current taxation | | | – | | | | 2 | | Current liability derivatives – forward foreign exchange contracts | | | 65 | | | | 45 | | Current liability derivatives – currency swaps | | | 1 | | | | – | | | | | 1,287 | | | | 1,590 | |
6 Cash and borrowings
| | | | | | | ACCOUNTING POLICY
| | | | | Financial instruments
Currency swaps are used to match foreign currency net assets with foreign currency liabilities. They are initially recorded at fair value and then for reporting purposes remeasured to fair value at exchange rates and interest rates at subsequent balance sheet dates.
| | |
Changes in the fair value of derivative financial instruments are recognised in the profit and loss account as they arise.
| | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Bank loans and overdrafts due within one year or on demand | | | 40 | | | | 2 | | Bank loans due after one year | | | 1,655 | | | | 335 | | Borrowings | | | 1,695 | | | | 337 | | Cash and bank | | | (1 | ) | | | (6 | ) | Credit/(debit) balance on derivatives – currency swaps | | | 1 | | | | (1 | ) | Net debt | | | 1,695 | | | | 330 | |
All currency swaps are stated at fair value. Gross US Dollar equivalents of $261m (2013 – $146m) receivable and $262m (2013 – $145m) payable have been netted. Currency swaps comprise foreign exchange swaps and were used in 2014 and 2013 to hedge intragroup loans.
The Parent Company financial statements of Smith & Nephew plc on pages 166 to 169 do not form part of the Smith & Nephew’s
Annual Report on Form 20-F as filed with the SEC.
168Smith & Nephew Annual report 2014
7 Equity and reserves
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2014 | | | | 2013 | | | | | Share capital $ million | | | | Share premium $ million | | | | Capital redemption reserve $ million | | | | Capital reserves $ million | | | | Treasury shares $ million | | |
| Exchange
reserves $ million |
| | | Profit and loss account $ million | | | | Total shareholders’ funds $ million | | | | Total shareholders’ funds $ million | | At 1 January | | | 184 | | | | 535 | | | | 10 | | | | 2,266 | | | | (322 | ) | | | (52 | ) | | | 1,195 | | | | 3,816 | | | | 4,009 | | Attributable profit for the year | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 922 | | | | 922 | | | | 198 | | Net losses on cash flow hedges | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | (5 | ) | | | (5 | ) | | | – | | Equity dividends paid in the year | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | (250 | ) | | | (250 | ) | | | (239 | ) | Share-based payments recognised | | | – | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 32 | | | | 32 | | | | 28 | | Cost of shares transferred to beneficiaries | | | – | | | | – | | | | – | | | | – | | | | 25 | | | | – | | | | (21 | ) | | | 4 | | | | 3 | | New shares issued on exercise of share options | | | 1 | | | | 39 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 40 | | | | 48 | | Cancellation of treasury shares | | | (1 | ) | | | – | | | | 1 | | | | – | | | | 57 | | | | – | | | | (57 | ) | | | – | | | | – | | Treasury shares purchased | | | – | | | | – | | | | – | | | | – | | | | (75 | ) | | | – | | | | – | | | | (75 | ) | | | (231 | ) | At 31 December | | | 184 | | | | 574 | | | | 11 | | | | 2,266 | | | | (315 | ) | | | (52 | ) | | | 1,816 | | | | 4,484 | | | | 3,816 | |
Further information on the share capital of the Company can be found in Note 19.1 of the Notes to the Group accounts.
The total distributable reserves of the Company are $1,449m (2013 – $821m). In accordance with the exemption permitted by Section 408 of the Companies Act 2006, the Company has not presented its own profit and loss account. The attributable profit for the year dealt with in the accounts of the Company is $922m (2013 – $198m).
Fees paid to Ernst & Young LLP for audit and non-audit services to the Company itself are not disclosed in the individual accounts because Group financial statements are prepared which are required to disclose such fees on a consolidated basis. The fees for the consolidated Group are disclosed in Note 3.2 of the Notes to the Group accounts.
8 Share-based payments
The Company operates a number of equity-settled executive and employee share plans. For all grants of share options and awards, the fair value as at the date of grant is calculated using an appropriate option pricing model and the corresponding expense is recognised over the vesting period. Subsidiary companies are recharged for the fair value of share options that relate to their employees. The disclosure relating to the Company is detailed in Note 23.1 of the Notes to the Group accounts. 9 Contingencies
|
Further information on the share capital of the Company can be found in Note 19.1 of the Notes to the Group accounts. The total distributable reserves of the Company are $2,569m (2016: $685m). In accordance with the exemption permitted by Section 408 of the Companies Act 2006, the Company has not presented its own profit and loss account. The attributable profit for the year dealt with in the accounts of the Company is $2,167m (2016: $58m). Fees paid to KPMG LLP for audit and non-audit services to the Company itself are not disclosed in the individual accounts because Group financial statements are prepared which are required to disclose such fees on a consolidated basis. The fees for the consolidated Group are disclosed in Note 3.2 of the Notes to the Group accounts. THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | 2014 $ million | | | | 2013 $ million | | Guarantees in respect of subsidiary undertakings | | | 11 | | | | 25 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 165 |
NOTES TO THE COMPANY ACCOUNTS 1 BASIS OF PREPARATION Smith & Nephew plc (the Company) is a public limited company incorporated in England and Wales. The separate accounts of the Company are presented as required by the Companies Act 2006. On 1 January 2015, the Company transitioned from previously extant UK Generally Accepted Accounting Practices to Financial Reporting Standard 101 Reduced Disclosure Framework (‘Reduced Disclosure Framework’). These financial statements and accompanying notes have been prepared in accordance with the Reduced Disclosure Framework for all periods presented. There were no transitional adjustments required on adoption of the new standard. The financial information for the Company has been prepared on the same basis as the consolidated financial statements, applying identical accounting policies as outlined throughout the Notes to the Group accounts. The Directors have determined that the preparation of the Company financial statements on a going concern basis is appropriate as the Company receives dividend cash receipts from its subsidiary undertakings which enable it to meet its liabilities as they fall due. In applying these policies, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the accounts and the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on management’s best knowledge of current events and actions, actual results ultimately may differ from those estimates. In these financial statements, the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: | - | | A Cash Flow Statement and related notes; |
| - | | Comparative period reconciliations for share capital and tangible fixed assets; |
| - | | Disclosures in respect of transactions with wholly-owned subsidiaries; |
| - | | Disclosures in respect of capital management; |
| - | | The Company has given guaranteeseffects of new but not yet effective IFRSs; and |
| - | | Disclosures in respect of the compensation of key management personnel. |
As the consolidated financial statements include the equivalent disclosures, the Company has also taken the exemptions under FRS 101 available in respect of the following disclosures: | - | | IFRS 2 Share Based Payments in respect of group settled share based payments; and |
| - | | Certain disclosures required by IFRS 13 Fair Value Measurement and the disclosures required by IFRS 7 Financial Instrument Disclosures. |
The Company proposes to continue to adopt the reduced disclosure framework of FRS 101 in its next financial statements. 2 INVESTMENTS ACCOUNTING POLICY Investments in subsidiaries are stated at cost less provision for impairment |
| | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | At 1 January | | 5,322 | | 5,322 | | Additions | | 1,770 | | – | | At 31 December | | 7,092 | | 5,322 | |
Investments represent holdings in subsidiary undertakings. In 2017, the Company increased its investment in Smith & Nephew (Overseas) Limited. In accordance with Section 409 of the Companies Act 2006, a listing of all entities invested in by the consolidated Group is provided in Note 9. 3 DEBTORS | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Amounts falling due within one year: | | | | | | Amounts owed by subsidiary undertakings | | 1,007 | | 735 | | Prepayments and accrued income | | 3 | | 3 | | Current asset derivatives – forward foreign exchange contracts | | 25 | | 45 | | Current asset derivatives – forward foreign exchange contracts – subsidiary undertakings | | 45 | | 36 | | Current asset derivatives – currency swaps | | 3 | | 1 | | Current taxation | | 1 | | 4 | | | | 1,084 | | 824 | |
THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 166ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE COMPANY ACCOUNTS continued 4 OTHER CREDITORS | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Amounts falling due within one year: | | | | | | Amounts owed to subsidiary undertakings | | 1,119 | | 715 | | Other creditors | | 10 | | 17 | | Current liability derivatives – forward foreign exchange contracts | | 45 | | 36 | | Current liability derivatives – forward foreign exchange contracts – subsidiary undertakings | | 25 | | 45 | | Current liability derivatives – currency swaps | | 1 | | – | | Current liability derivatives – interest rate swaps | | 2 | | 1 | | | | 1,202 | | 814 | |
5 CASH AND BORROWINGS ACCOUNTING POLICY Financial instruments Currency swaps are used to banksmatch foreign currency net assets with foreign currency liabilities. They are initially recorded at fair value and then for reporting purposes remeasured to support liabilities under foreignfair value at exchange rates and other contracts and cross guarantees to support overdrafts. Such guarantees are not considered to be liabilities as all subsidiary undertakings are trading as going concerns.interest rates at subsequent balance sheet dates. |
Changes in the fair value of derivative financial instruments are recognised in the profit and loss account as they arise. | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Bank loans and overdrafts due within one year or on demand | | 4 | | 41 | | Borrowings due after one year | | 1,423 | | 1,559 | | Borrowings | | 1,427 | | 1,600 | | Cash and bank | | (88) | | (14) | | (Debit)/credit balance on derivatives – currency swaps | | (2) | | 1 | | Credit/(debit) balance on derivatives - interest rate swaps | | 2 | | (1) | | Net debt | | 1,339 | | 1,586 | |
All currency swaps are stated at fair value. Gross US Dollar equivalents of $388m (2016: $449m) receivable and $386m (2016: $448m) payable have been netted. Currency swaps comprise foreign exchange swaps and were used in 2017 and 2016 to hedge intra-group loans. 6 CONTINGENCIES | | | | | | | | 2017 | | 2016 | | | | $ million | | $ million | | Guarantees in respect of subsidiary undertakings | | 1 | | – | |
The Company gives guarantees to banks to support liabilities and cross guarantees to support overdrafts. The Company operated defined benefit pension plans in 2004 but at the end of 2005 its pension plan obligations were transferred to Smith & Nephew UK Limited. The Company has provided guarantees to the trustees of the pension plans to support future amounts due from participating employers (see Note 18 of the Notes to the Group accounts). 7 DEFERRED TAXATION The Company has gross unused capital losses of $90m (2016: $100m) available for offset against future chargeable gains. No deferred tax asset has been recognised on these unused losses as they are not expected to be realised in the foreseeable future. 8 RESULTS FOR THE YEAR As permitted by Section 408(4) of the Companies Act 2006, the Company has not presented its own profit and loss account. Profit for the year was $2,167m (2016: $58m). THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 167 |
9 GROUP COMPANIES In accordance with Section 409 of the Companies Act 2006, a full list of subsidiaries, associates, joint arrangements, joint ventures and partnerships are listed below, including their country of incorporation. All companies are 100% owned, unless otherwise indicated. Unless otherwise stated, the share capital disclosed comprises ordinary shares which are indirectly held by Smith & Nephew plc. | | | | | | | | | | | Company name | | Country of operation and incorporation | | Registered Office | | Company name | | Country of operation and incorporation | | Registered Office | UK | | | | | | Rest of Europe | | | | | Blue Belt Technologies UK Limited2 | | England & Wales | | London | | Smith & Nephew GmbH | | Austria | | Vienna | Michelson Diagnostic Limited3 (13.4%) | | England & Wales | | Kent | | ArthroCare Belgium SPRL2 | | Belgium | | Zaventem | Neotherix Limited3 (24.9%) | | England & Wales | | York | | Smith & Nephew S.A.-N.V | | Belgium | | Zaventem | Plus Orthopedics (UK) Limited2 | | England & Wales | | London | | Smith & Nephew A/S | | Denmark | | Hoersholm | Smith & Nephew (Overseas) Limited1 | | England & Wales | | London | | A2 Surgical2 | | France | | Neuilly-sur-Seine | Smith & Nephew ARTC Limited | | England & Wales | | London | | Smith & Nephew France SAS1 | | France | | Neuilly-sur-Seine | Smith & Nephew Beta Limited2 | | England & Wales | | London | | Smith & Nephew S.A.S. | | France | | Neuilly-sur-Seine | Smith & Nephew China Holdings UK Limited1 | | England & Wales | | London | | Smith & Nephew Oy | | Finland | | Helsinki | Smith & Nephew Employees Trustees Limited2 | | England & Wales | | London | | Smith & Nephew Business Services GmbH & Co. KG1 | | Germany | | Hamburg | Smith & Nephew ESN Limited2 | | England & Wales | | London | | Smith & Nephew Business Services Verwaltungs GmbH1 | | Germany | | Hamburg | Smith & Nephew Extruded Films Limited2 | | England & Wales | | Hull | | Smith & Nephew Deutschland (Holding) GmbH1 | | Germany | | Hamburg | Smith & Nephew Finance2 | | England & Wales | | London | | Smith & Nephew GmbH | | Germany | | Hamburg | Smith & Nephew Finance Oratec2 | | England & Wales | | London | | Smith & Nephew Orthopaedics GmbH | | Germany | | Tuttlingen | Smith & Nephew Healthcare Limited2 | | England & Wales | | Hull | | Plus Orthopedics Hellas SA2 | | Greece | | Athens | Smith & Nephew Investment Holdings Limited1 | | England & Wales | | London | | Smith & Nephew Hellas S.A.2 | | Greece | | Athens | Smith & Nephew Medical Fabrics Limited2 | | England & Wales | | London | | Smith & Nephew Limited | | Ireland | | Dublin 2 | Smith & Nephew Medical Limited2 | | England & Wales | | Hull | | Smith & Nephew Finance Ireland Limited2 | | Ireland | | Dublin 1 | Smith & Nephew Nominee Company Limited2 | | England & Wales | | London | | Smith & Nephew S.r.l. | | Italy | | Milan | Smith & Nephew Nominee Services Limited2 | | England & Wales | | London | | ArthroCare Luxembourg Sarl2 | | Luxembourg | | Luxembourg | Smith & Nephew Orthopaedics Limited2 | | England & Wales | | London | | Smith & Nephew Finance S.a.r.l.2 | | Luxembourg | | Luxembourg | Smith & Nephew Pensions Nominees Limited2 | | England & Wales | | London | | Smith & Nephew International S.A.1 | | Luxembourg | | Luxembourg | Smith & Nephew Pharmaceuticals Limited2 | | England & Wales | | Hull | | Smith & Nephew (Europe) B.V.1 | | Netherlands | | Amsterdam | Smith & Nephew Raisegrade Limited2 | | England & Wales | | London | | Smith & Nephew B.V.1 | | Netherlands | | Amsterdam | Smith & Nephew Rareletter Limited2 | | England & Wales | | London | | Smith & Nephew Management B.V.1 | | Netherlands | | Amsterdam | Smith & Nephew Trading Group Limited1 | | England & Wales | | London | | Smith & Nephew Nederland CV | | Netherlands | | Amsterdam | Smith & Nephew UK Limited. The Company has provided guarantees to the trustees of the pension plans to support future amounts due from participating employers (see Note 18 of the Notes to the Group accounts).Executive Pension Scheme Trustee Limited2 | | The Parent Company financial statements of England & Wales
| | London | | Smith & Nephew plc on pages 166 to 169 do not form part of the Smith & Nephew’sOptics B.V.4 Annual Report on Form 20-F as filed with the SEC.
| | Netherlands | | Amsterdam |
Smith & Nephew Annual report 2014 UK Limited1691 | | England & Wales
OTHER INFORMATION
Group information
| | London | Business overview and Group history
| Smith & Nephew’s operations are organised into two primary divisions that operate globally: AdvancedNephew A/S | | Norway | | Oslo | Smith & Nephew UK Pension Fund Trustee Limited2 | | England & Wales | | London | | Smith & Nephew sp. z.o.o. | | Poland | | Warsaw | Smith & Nephew USD Limited1 | | England & Wales | | London | | Smith & Nephew Lda | | Portugal | | Lisbon | Smith & Nephew USD One Limited1 | | England & Wales | | London | | D-Orthopaedics LLC | | Russian Federation | | Moscow | T.J. Smith and Nephew, Limited | | England & Wales | | Hull | | DC LLC | | Russian Federation | | Puschino | The Albion Soap Company Limited2 | | England & Wales | | London | | Smith & Nephew LLC | | Russian Federation | | Moscow 2 | TP Limited1 | | Scotland | | Edinburgh | | Smith & Nephew S.A.U | | Spain | | Barcelona | | | | | | | Smith & Nephew Atkiebolag | | Sweden | | Molndal | | | | | | | Lumina Adhesives AB3 (11%) | | Sweden | | Gothenberg | | | | | | | Plus Orthopedics Holding AG1 | | Switzerland | | Baar | | | | | | | Smith & Nephew Manufacturing AG | | Switzerland | | Aarau | | | | | | | Smith & Nephew Orthopaedics AG | | Switzerland | | Baar | | | | | | | Smith & Nephew Schweiz AG | | Switzerland | | Baar | | | | | | | Smith & Nephew AG | | Switzerland | | Baar | | | | | | | | | | | |
THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 168ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE COMPANY ACCOUNTS continued | | | | | | | | | | | Company name | | Country of operation and incorporation | | Registered Office | | Company name | | Country of operation and incorporation | | Registered Office | US | | | | | | | | | | | Arthrocare Corporation1 | | United States | | San Jose | | Smith & Nephew Orthopaedics | | China | | Beijing | Bioventus LLC3 (49%) | | United States | | Wilmington | | (Beijing) Co., Ltd | | | | Economic and | Blue Belt Holdings, Inc.1 | | United States | | Minneapolis | | | | | | Technical | Blue Belt Technologies, Inc. | | United States | | Pittsburgh | | | | | | Development | Delphi Ventures V, L.P.3 (6.9%) | | United States | | San Mateo | | | | | | Area | Healicoil, Inc. | | United States | | Wilmington | | S&N Holdings SAS1 | | Colombia | | Bogota | Hipco, Inc. | | United States | | Wilmington | | Smith & Nephew Colombia S.A.S | | Colombia | | Bogota | Leaf Healthcare Inc.3 (11%) | | United States | | Delaware | | ArthroCare Costa Rica Srl | | Costa Rica | | Costa Rica | Memphis Biomed Ventures I, LP3 (4.61%) | | United States | | Delaware | | Smith & Nephew Curaçao N.V. | | Curaçao | | Willemstad | Oratec Interventions, Inc. | | United States | | Concord | | Smith & Nephew Beijing Holdings Limited1 | | Hong Kong | | Hong Kong | Orthopaedic Biosystems Ltd., Inc. | | United States | | Phoenix | | Smith & Nephew Limited | | Hong Kong | | Hong Kong | OsteoBiologics, Inc. | | United States | | Dallas | | Smith & Nephew Suzhou Holdings Limited1 | | Hong Kong | | Hong Kong | Plus Orthopedics LLC | | United States | | Andover | | Adler Mediequip Private Limited | | India | | Pune | Rotation Medical, Inc. | | United States | | Andover | | ArthroCare India Medical Device Private Limited2 | | India | | Mumbai | Sinopsys Surgical, Inc.3 (12.4%) | | United States | | Boulder | | Smith & Nephew Healthcare Private Limited | | India | | Mumbai‑59 | Smith & Nephew Consolidated, Inc.1 | | United States | | Wilmington | | Ortho-Space Ltd.3 (16.8%) | | Israel | | Caesarea | Smith & Nephew OUS, Inc.3 | | United States | | Wilmington | | Smith & Nephew KK | | Japan | | Tokyo | Smith & Nephew, Inc. | | United States | | Wilmington | | Smith & Nephew Chusik Hoesia | | Korea, Republic of | | Seoul | Surgical Frontiers Series I, LLC3 (32%) | | United States | | Dover | | Smith & Nephew Healthcare Sdn Berhad | | Malaysia | | Kuala Lumpur | Trice Medical Inc.3 (6%) | | United States | | Delaware | | Smith & Nephew S.A. de C.V. | | Mexico | | Mexico City | Africa, Asia, Australasia and Other America | | | | | | Smith & Nephew Limited | | New Zealand | | Auckland | Smith & Nephew Argentina S.R.L.2 | | Argentina | | Buenos Aires | | Smith & Nephew Superannuation Scheme Limited | | New Zealand | | Auckland 2 | ArthroCare (Australasia) Pty Ltd2 | | Australia | | North Ryde | | Smith & Nephew, Inc. | | Puerto Rico | | San Juan | Smith & Nephew Pty Limited | | Australia | | North Ryde | | Smith & Nephew Pte Limited | | Singapore | | Singapore | Smith & Nephew Surgical Holdings Pty Limited2 | | Australia | | North Ryde | | Smith & Nephew (Pty) Limited | | South Africa | | Westville | Smith & Nephew Surgical Pty Limited2 | | Australia | | North Ryde | | Smith & Nephew Pharmaceuticals (Proprietary) Limited2 | | South Africa | | Westville | Smith & Nephew Comercio de Produtos Medicos LTDA | | Brazil | | São Paulo | | Smith & Nephew Limited | | Thailand | | Huai Khwang District, Bangkok | Smith & Nephew (Alberta) Inc.2 | | Canada | | Calgary | | Sri Siam Medical Limited1,3 (48.99%) | | Thailand | | Lumpini Phatumwan, Bangkok | Smith & Nephew Inc. | | Canada | | Toronto | | Smith ve Nephew Medikal Cihazlar Ticaret Limited Sirketi | | Turkey | | Sariyer, Istanbul | Tenet Medical Engineering, Inc. | | Canada | | Calgary | | Smith & Nephew FZE | | United Arab Emirates | | Jebel Ali, Dubai | Smith & Nephew Finance Holdings Limited2 | | Cayman Islands | | South Church Street, George Town | | | | | | | ArthoCare Medical Devices (Beijing) Co. Limited4 | | China | | Chao Yang District, Beijing | | 1 Holding company. 2 Dormant company. | | | | | Plus Orthopedics (Beijing) Co. Limited4 | | China | | Shunyi District, Beijing | | 3 Not 100% owned by Smith & Nephew Group. 4 In liquidation. | | | | | Plus Trading (Beijing) Co Limited4 | | China | | East City, Beijing | | | | | | | Smith & Nephew Medical (Shanghai) Limited | | China | | Shanghai Free Trade Test Zone | | | | | | | Smith & Nephew Medical (Suzhou) Limited | | China | | Suzhou City | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | ACCOUNTS 169 |
| | | | | | | Registered Office addresses | | Registered Office addresses | UK | | | | US | | | London | | 15 Adam Street, London, WC2N 6LA | | San Jose | | 595 North Pastoria Avenue, Sunnyvale, California, 94086, USA | Kent | | Ground Floor, Eclipse House, Eclipse Park, Sittingbourne Road, Maidstone, Kent, ME14 3EN | | Minneapolis | | 2905 Northwest Blvd, Suite 40, Plymouth MN 55441, USA | York | | 25 Carr Lane, York, YO26 5HT | | Pittsburgh | | 2828 Liberty Ave, Suite 100, Pittsburgh PA 15222, USA | Hull | | 101 Hessle Road, Hull, HU3 2BN | | Boulder | | 5480 Valmont Road, Suite 215, Boulder, Colorado, 80301, USA | Edinburgh | | 4th Floor, 115 George Street, Edinburgh, EH2 4JN | | Wilmington | | CT Corporation, 1209 Orange Street, Wilmington, DE 19801, USA | Rest of Europe | | | | Concord | | C T Corporation, 9 Capitol Street, Concord, New Hampshire, 03301, USA | Vienna | | Concorde Business Park, 1/C/3 2320, Schwechat, Austria | | Phoenix | | CT Corporation System, 3225 North Central Avenue, Phoenix AZ 85012, USA | Zaventem | | Hector Heenneaulaan 366, 1930 Zaventem, Belgium | | Dallas | | CT Corporation System, 350 North St. Paul Street, Dallas TX 75201, USA | Hoersholm | | Slotsmarken 14, Hoersholm, DK‑2970, Denmark | | Andover | | 150 Minuteman Road, Andover, MA, 01810, USA | Neuilly-sur-Seine | | 40, Boulevard du Parc, 92200 Neuilly-sur-Seine, France | | San Mateo | | 160 Bovet Road, Suite 408, San Mateo, CA 94402, USA | Helsinki | | Ayritie 12 C, 01510, Vantaa, Finland | | Memphis | | 6075 Poplar Avenue, Suite 335, Memphis, Tennessee, 38119, USA | Hamburg | | Friesenweg 4, Haus 21, 22763, Hamburg, Germany | | Tustin | | 3002 Dow Avenue, Building 100, Unit 138, Tustin, California, 92780, USA | Tuttlingen | | Alemannenstrasse 14, 78532, Tuttlingen, Germany | | Dover | | 160 Greentree Drive, Suite 101, Dover, Delaware, 19904, USA | Athens | | Protopappa Street 43, GR 16346, Ilioupoli, Athens, Greece | | Africa, Asia, Australasia and Advanced Wound Management.Other America | | | Dublin 1 | | 3rd Floor, Kilmore House, Park Lane,Spencer Dock, Dublin 1, Ireland | | Buenos Aires | | Maipu 1300, 13th Floor, City of Buenos Aires, Argentina | Dublin 2 | | Molyneux House, Bride Street,Dublin 2, Ireland | | North Ryde | | 85 Waterloo Road, North Ryde NSW 2113, Australia | Milan | | Via de Capitani 2A, 20864, Agrate Brianza (MI), Italy | | São Paulo | | Avenida do Cafe, 277, Centro Empresarial do Aco, Centro Empresarial do Aco, Torre B, 4 andar, conjuto, CEP 04311-000, São Paulo 403, Jabaquara, Brazil | Luxembourg | | 163, Rue de Kiem, L‑8030 Strassen, Luxembourg | | Calgary | | 3500‑855‑2 Street SW, Calgary AB AB T2P 4J8, Canada | Amsterdam | | Kruisweg 637, 2132 NB Hoofddorp, The Group has a history dating back over 150Netherlands | | Toronto | | 199, Bay Street, 4000, Toronto, Ontario M5L 1A9, Canada | Oslo | | Nye Vakas vei 64, 1395, Hvalsted, Norway | | South Church Street, Georgetown | | c/o M&C Corporate Services Limited, Ugland House, South Church Street, P.O. Box 309, George Town, Grand Cayman, Cayman Islands | Warsaw | | Ul Osmanska 12, 02‑823, Warsaw, Poland | | Chao Yang District, Beijing | | Room 17‑021, Internal B17 floor, B3‑24th floor, No 3 Xin Yuan South Rd, Chao Yang District, Beijing, China | Lisbon | | Estrada Nacional no 10 ao Km. 131, Parque Tejo – Bloco C, 2625‑445 Forte de Casa, Vila Franca de Xira, Portugal | | | | | Moscow | | 9a, Bld, 10, 2nd Sinichkina Street, Moscow 111020, Russian Federation | | | | | Moscow 2 | | 2nd Syromyatnichesky lane, Moscow, 105120, Russian Federation | | | | | Puschino | | 8/1 Stroiteley Street, 142290, City of Puschino,Moscow Region, Russian Federation | | | | | Barcelona | | Edificio Conata I, c/ Fructuos Gelabert 2 y 4, San Joan Despi – 08970, Barcelona, Spain | | | | | Molndal | | PO Box 143, S‑431 22 Molndal, Sweden | | | | | Baar | | Oberneuhofstr 10d, Baar, 6340 | | | | | Aarau | | Schachenallee 29, 5000, Aarau, Switzerland | | | | | Gothenburg | | Varbergsgatan 2A / 412 65 Göteborg / Sweden | | | | |
THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 170ACCOUNTS | SMITH & NEPHEW ANNUAL REPORT 2017 |
NOTES TO THE COMPANY ACCOUNTS continued | | | | | | | Registered Office addresses | | Registered Office addresses | Shunyi District, Beijing | | 22 Linhe Avenue, Linhe Economic Development Zone, Shunyi District, Beijing, 101300, China | | Mexico City | | Av. Insurgentes Sur, numero 1602, Piso No.7, Oficina 702, Colonia Credito, Constructor, Delegacion Benito Juarez, C.P. 03940, Mexico | East City, Beijing | | No. B-D, Floor 2, A Building, Beijing East Gate Plaza, No. 9, Dong Zhong Street, East City, Beijing, China | | Auckland | | 621 Rosebank Road, Avondale, Auckland 6, New Zealand | Guangzhou | | Room 2502 No 33, 6th Jian She Rd, Yue Xiu District, Guangzhou, China | | Auckland 2 | | 36a Hillside Road, Wairau Valley, Auckland, 0627 NZ, New Zealand | Shanghai | | Room 1208‑1209, No 168 Middle Xi Zang Rd, Shanghai, China | | San Juan | | Edificio Cesar Castillo, Calle Angel Buonomo #361, Hato Rey, 00917, Puerto Rico | Shanghai Free Trade Test Zone | | Part B, 4th Floor, Tong Yong Building, No 188 Ao Na Rd, Shanghai Free Trade Test Zone, Shanghai, China | | Singapore | | 50 Raffles Place, #32‑01 Singapore Land Tower, 048623, Singapore | Dong Cheng District, Beijing | | Unit B1, 2/F, Tower A, East Gate Plaza No.9, Dongshong Street, Dong Cheng District, Beijing, China | | Westville | | 30 The Boulevard, Westway Office Park, Westville, 3629, South Africa | Chengdu | | No 5. 15th Floor, Unit 1, Building, 1 Li Bao Building, No 62 North Ke Hua Rd, Wu Hou District, Chengdu, China | | Huai Khwang District, Bangkok | | 16th Floor Building A, 9th Tower Grand Rama 9, 33/4 Rama 9 Road, Huai Khwang District, Bangkok, 10310, Thailand | Middle Xi Zang Rd, Shanghai | | Room 1201‑1207, No168 Middle Xi Zang Rd, Shanghai, China | | Lumpini Phatumwan, Bangkok | | 16th Floor, GPF Witthayu Tower A, 93/1 Wireless Road, Lumpini, Phatumwan, Bangkok, 10330, Thailand | Suzhou City | | 12, Wuxiang Road, West Area of Comprehensive Bonded Zone, Suzhou Industrial Park, Suzhou City, SIP, Jiangsu Province, China | | Sariyer, Istanbul | | Bahcekoy Mah., Orkide Sok., No:8/E Bahcekoy, Sariyer Istanbil, Turkey | Beijing Economic and Technical Development Area | | No. 98 Kechuang Dongliujie, Beijing Economic and Technical Development Area, Beijing, China | | Jebel Ali, Dubai | | PO Box 16993 LB02016, Jebel Ali, Dubai, United Arab Emirates | Bogota | | Calle 100 No. 7 – 33 to 1 P3, Bogota D.C., 0, Colombia | | | | | Costa Rica | | Building B32, 50 meters South of Revisión Téchnica Vehicular, Province de Alajuela, Canton Alajuela, Coyol Free Zone, District San José, Costa Rica | | | | | Willemstad | | Pietermaai 15, PO Box 4905, Curaçao | | | | | Hong Kong | | Unit 813 – 816, 8/F, Delta House, 3 On Yiu Street, Shatin, New Territories, Hong Kong | | | | | Pune | | Sushrut House, Survey no.288, Phase II next to MIDC, Hinjewadi, at Mann, Taluka Mulshi, Pune, 411057, India | | | | | Mumbai | | 5A, Bakhtawar, 5th Floor, behind The Oberoi, Nariman Point, Mumbai, Maharashtra, 400021, India | | | | | Mumbai‑59 | | 501‑B – 509‑B Dynasty Business Park, Andheri Kurla Road, Andheri East, Mumbai‑59, Maharashtra, India | | | | | Caesarea | | 7 Halamarish, Caesarea, 3088900, Israel | | | | | Tokyo | | 2‑4‑1, Shiba -Koen, Minato-Ku, Tokyo 105‑0011, Japan | | | | | Seoul | | 13th Floor, ASEM Tower, Gangnam-gu 13th Floor, ASEM Tower, 159‑1 Samsung-dong, Seoul, Korea | | | | | Kuala Lumpur | | Unit 10-02(A), Level 10, Menara TJB, 9, Jalan Syed Mohd Mufti, Johor Bahru, Johor 8000, Malaysia | | | | |
THE PARENT COMPANY FINANCIAL STATEMENTS OF SMITH & NEPHEW PLC ON PAGES 163-170 DO NOT FORM PART OF SMITH & NEPHEW’S ANNUAL REPORT ON FORM 20-F AS FILED WITH THE SEC. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 171 |
Group information BUSINESS OVERVIEW AND GROUP HISTORY Smith & Nephew’s operations are organised into geographical selling regions and product franchises within the medical technology industry. The Group has a history dating back 160 years to the family enterprise of Thomas James Smith who opened a small pharmacy in Hull, UK in 1856. Following his death in 1896, his nephew Horatio Nelson Smith took over the management of the business. By the late 1990s, Smith & Nephew had expanded into being a diverse healthcare conglomerate with operations across the globe, producing various medical devices, personal care products and traditional and advanced wound care treatments. In 1998, Smith & Nephew announced a major restructuring to focus management attention and investment on three global business units – Advanced Wound Management, Endoscopy and Orthopaedics – which offered high growth and margin opportunities. In 2011, the Endoscopy and Orthopaedics businesses were brought together to create an Advanced Surgical Devices division. In 2015, the Advanced Wound Management and Advanced Surgical Devices divisions were brought together to form a global business across nine product franchises, managed as three geographical selling regions with global functions for operations, R&D and corporate support functions. Smith & Nephew was incorporated and listed on the London Stock Exchange in 1937 and in 1999 the Group was also listed on the New York Stock Exchange. In 2001, Smith & Nephew became a constituent member of the FTSE 100 index in the UK. This means that Smith & Nephew is included in the top 100 companies traded on the London Stock Exchange measured in terms of market capitalisation. Today, Smith & Nephew is a public limited company incorporated and headquartered in the UK and carries out business around the world. PROPERTIES The table below summarises the main properties which the Group uses and their approximate areas. | | | | | | Approximate area | | | | (square feet 000’s) | | Group head office in London, UK | | 13 | | UK office and surgical training facility in Watford, UK | | 60 | | Manufacturing and office facilities in Memphis, Tennessee, US | | 968 | | Wound management manufacturing, research and office facility in Hull, UK | | 473 | | Manufacturing facility in Suzhou, China | | 288 | | Manufacturing facility in Alajuela, Costa Rica | | 265 | | Distribution facility in Memphis, Tennessee, US | | 248 | | Manufacturing facility in Beijing, China | | 192 | | Bioactives headquarters and laboratory space in Fort Worth, Texas, US | | 165 | | Manufacturing, research and office facility in Austin, Texas, US | | 157 | | Manufacturing facility in Oklahoma City, Oklahoma, US | | 155 | | Regional headquarters in Andover, Massachusetts, US | | 144 | | Manufacturing facility in Aarau, Switzerland | | 121 | | Manufacturing facility in Mansfield, Massachusetts, US | | 98 | | Manufacturing facility in Devrukh, India | | 74 | | Regional headquarters and distribution facility in Baar, Switzerland | | 71 | | Manufacturing facility in Tuttlingen, Germany | | 50 | |
The Group Global Operations strategy includes ongoing assessment of the optimal facility footprint. The Orthopaedics manufacturing facilities in Memphis, Tennessee are largely freehold, a portion of Tuttlingen and the Advanced Wound Management facilities in Hull are freehold while other principal locations are leasehold. The Group has freehold and leasehold interests in real estate in other countries throughout the world, but no other is individually significant to the Group. Where required, the appropriate governmental authorities have approved the facilities. OFF-BALANCE SHEET ARRANGEMENTS Management believes that the Group does not have any off-balance sheet arrangements, as defined by the SEC in item 5E of Form 20‑F, that have or are reasonably likely to have a current or future effect on the Group’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. RELATED PARTY TRANSACTIONS Except for transactions with associates (see Note 23.2 of Notes to the Group accounts), no other related party had material transactions or loans with Smith & Nephew over the last three financial years. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 172GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
GROUP INFORMATION continued RISK FACTORS There are known and unknown risks and uncertainties relating to Smith & Nephew’s business. The factors listed on pages 172-175 could cause the Group’s business, financial position and results of operations to differ materially and adversely from expected and historical levels. In addition, other factors not listed here that Smith & Nephew cannot presently identify or does not believe to be equally significant could also materially adversely affect Smith & Nephew’s business, financial position or results of operations. Highly competitive markets The Group competes across a diverse range of geographic and product markets. Each market in which the Group operates contains a number of different competitors, including specialised and international corporations. Significant product innovations, technical advances or the intensification of price competition by competitors could adversely affect the Group’s operating results. Some of these competitors may have greater financial, marketing and other resources than Smith & Nephew. These competitors may be able to initiate technological advances in the field, deliver products on more attractive terms, more aggressively market their products or invest larger amounts of capital and research and development (R&D) into their businesses. There is a possibility of further consolidation of competitors, which could adversely affect the Group’s ability to compete with larger companies due to insufficient financial resources. If any of the Group’s businesses were to lose market share or achieve lower than expected revenue growth, there could be a disproportionate adverse impact on the Group’s share price and its strategic options. Competition exists among healthcare providers to gain patients on the basis of quality, service and price. There has been some consolidation in the Group’s customer base and this trend is expected to continue. Some customers have joined group purchasing organisations or introduced other cost containment measures that could lead to downward pressure on prices or limit the number of suppliers in certain business areas, which could adversely affect Smith & Nephew’s results of operations and hinder its growth potential. Continual development and introduction of new products The medical devices industry has a rapid rate of new product introduction. In order to remain competitive, the Group must continue to develop innovative products that satisfy customer needs and preferences or provide cost or other advantages. Developing new products is a costly, lengthy and uncertain process. The Group may fail to innovate due to low R&D investment, a R&D skills gap or poor product development. A potential product may not be brought to market or not succeed in the market for any number of reasons, including failure to work optimally, failure to receive regulatory approval, failure to be cost-competitive, infringement of patents or other intellectual property rights and changes in consumer demand. The Group’s products and technologies are also subject to marketing attack by competitors. Furthermore, new products that are developed and marketed by the Group’s competitors may affect price levels in the various markets in which the Group operates. If the Group’s new products do not remain competitive with those of competitors, the Group’s revenue could decline. The Group maintains reserves for excess and obsolete inventory resulting from the potential inability to sell its products at prices in excess of current carrying costs. Marketplace changes resulting from the introduction of new products or surgical procedures may cause some of the Group’s products to become obsolete. The Group makes estimates regarding the future recoverability of the costs of these products and records a provision for excess and obsolete inventories based on historical experience, expiration of sterilisation dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favourable than projected by management, additional inventory write-downs may be required. Dependence on government and other funding In most markets throughout the world, expenditure on medical devices is ultimately controlled to a large extent by governments. Funds may be made available or withdrawn from healthcare budgets depending on government policy. The Group is therefore largely dependent on future governments providing increased funds commensurate with the increased demand arising from demographic trends. Pricing of the Group’s products is largely governed in most markets by governmental reimbursement authorities. Initiatives sponsored by government agencies, legislative bodies and the private sector to limit the growth of healthcare costs, including price regulation, excise taxes and competitive pricing, are ongoing in markets where the Group has operations. This control may be exercised by determining prices for an individual product or for an entire procedure. The Group is exposed to government policies favouring locally sourced products. The Group is also exposed to changes in reimbursement policy, tax policy and pricing which may have an adverse impact on revenue and operating profit. Provisions in US healthcare legislation which previously imposed significant taxes on medical device manufacturers are suspended until 1 January 2020 but may be reinstated. There may be an increased risk of adverse changes to government funding policies arising from deterioration in macro-economic conditions from time to time in the Group’s markets. The Group must adhere to the rules laid down by government agencies that fund or regulate healthcare, including extensive and complex rules in the US. Failure to do so could result in fines or loss of future funding. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 173 |
World economic conditions Demand for the Group’s products is driven by demographic trends, including the ageing population and the incidence of osteoporosis and obesity. Supply of, use of and payment for the Group’s products are also influenced by world economic conditions which could place increased pressure on demand and pricing, adversely impacting the Group’s ability to deliver revenue and margin growth. The conditions could favour larger, better capitalised groups, with higher market shares and margins. As a consequence, the Group’s prosperity is linked to general economic conditions and there is a risk of deterioration of the Group’s performance and finances during adverse macro-economic conditions. During 2017, economic conditions worldwide continued to create several challenges for the Group, including deferrals of joint replacement procedures, heightened pricing pressure, significant declines in capital equipment expenditures at hospitals and increased uncertainty over the collectability of government debt, particularly those in the Emerging Markets and the oil-dependent Gulf States. These factors tempered the overall growth of the Group’s global markets and could have an increased impact on growth in the future. Political uncertainties The Group operates on a worldwide basis and has distribution channels, purchasing agents and buying entities in over 100 countries. Political upheaval in some of those countries or in surrounding regions may impact the Group’s results of operations. Political changes in a country could prevent the Group from receiving remittances of profit from a member of the Group located in that country or from selling its products or investments in that country. Furthermore, changes in government policy regarding preference for local suppliers, import quotas, taxation or other matters could adversely affect the Group’s revenue and operating profit. War, economic sanctions, terrorist activities or other conflict could also adversely impact the Group. These risks may be greater in Emerging Markets, which account for an increasing portion of the Group’s business. In June 2016 the UK voted to leave the European Union. The UK’s withdrawal will be effective from 29 March 2019 at 11pm GMT. As negotiations regarding the terms of the withdrawal continue, the nature of the trade agreements and the closeness of the economic ties between the UK and the EU beyond the withdrawal date remains uncertain. We continue to monitor the situation. Among the potential impacts of Brexit, the regulatory framework for medical devices could be affected, as it is unclear whether the UK will ascribe to the new Medical Devices Regulation which will become applicable in May 2020. Currency fluctuations Smith & Nephew’s results of operations are affected by transactional exchange rate movements in that they are subject to exposures arising from revenue in a currency different from the related costs and expenses. The Group’s manufacturing cost base is situated principally in the US, the UK, China and Switzerland, from which finished products are exported to the Group’s selling operations worldwide. Thus, the Group is exposed to fluctuations in exchange rates between the US Dollar, Sterling and Swiss Franc and the currency of the Group’s selling operations, particularly the Euro, Australian Dollar and Japanese Yen. If the US Dollar, Sterling or Swiss Franc should strengthen against the Euro, Australian Dollar and the Japanese Yen, the Group’s trading margin could be adversely affected. The Group manages the impact of exchange rate movements on revenue and cost of goods sold by a policy of transacting forward foreign currency commitments when firm purchase orders are placed. In addition, the Group’s policy is for forecast transactions to be covered between 50% and 90% for up to one year. However, the Group is exposed to medium to long-term adverse movements in the strength of currencies compared to the US Dollar. The Group uses the US Dollar as its reporting currency. The US Dollar is the functional currency of Smith & Nephew plc. The Group’s revenues, profits and earnings are also affected by exchange rate movements on the translation of results of operations in foreign subsidiaries for financial reporting purposes. See ‘Liquidity and capital resources’ on page 39. Manufacturing and supply The Group’s manufacturing production is concentrated at main facilities in Memphis, Mansfield and Oklahoma City in the US, Hull and Warwick in the UK, Aarau in Switzerland, Tuttlingen in Germany, Devrukh in India, Suzhou and Beijing in China, Alajuela in Costa Rica, Puschino in Russia and Curaçao, in Dutch Caribbean. If major physical disruption took place at any of these sites, it could adversely affect the results of operations. Physical loss and consequential loss insurance is carried to cover such risks but is subject to limits and deductibles and may not be sufficient to cover catastrophic loss. Management of orthopaedic inventory is complex, particularly forecasting and production planning. There is a risk that failures in operational execution could lead to excess inventory or individual product shortages. The Group is reliant on certain key suppliers of raw materials, components, finished products and packaging materials or in some cases on a single supplier. These suppliers must provide the materials and perform the activities to the Group’s standard of quality requirements. A supplier’s failure to meet expected quality standards could create liability for the Group and adversely affect sales of the Group’s related products. The Group may be forced to pay higher prices to obtain raw materials, which it may not be able to pass on to its customers in the form of increased prices for its finished products. In addition, some of the raw materials used may become unavailable, and there can be no assurance that the Group will be able to obtain suitable and cost effective substitutes. Any interruption of supply caused by these or other factors could negatively impact Smith & Nephew’s revenue and operating profit. The Group will, from time to time including as part of the APEX programme, outsource or insource the manufacture of components and finished products to third parties and will periodically relocate the manufacture of product and/or processes between existing and/or new facilities. While these are planned activities, with these transfers there is a risk of disruption to supply. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 174GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
GROUP INFORMATION continued Attracting and retaining key personnel The Group’s continued development depends on its ability to hire and retain highly-skilled personnel with particular expertise. This is critical, particularly in general management, research, new product development and in the sales forces. If Smith & Nephew is unable to retain key personnel in general management, research and new product development or if its largest sales forces suffer disruption or upheaval, its revenue and operating profit would be adversely affected. Additionally, if the Group is unable to recruit, hire, develop and retain a talented, competitive workforce, it may not be able to meet its strategic business objectives. Proprietary rights and patents Due to the technological nature of medical devices and the Group’s emphasis on serving its customers with innovative products, the Group has been subject to patent infringement claims and is subject to the potential for additional claims. Claims asserted by third parties regarding infringement of their intellectual property rights, if successful, could require the Group to expend time and significant resources to pay damages, develop non-infringing products or obtain licences to the products which are the subject of such litigation, thereby affecting the Group’s growth and profitability. Smith & Nephew attempts to protect its intellectual property and regularly opposes third party patents and trademarks where appropriate in those areas that might conflict with the Group’s business interests. If Smith & Nephew fails to protect and enforce its intellectual property rights successfully, its competitive position could suffer, which could harm its results of operations. Product liability claims and loss of reputation The development, manufacture and sale of medical devices entail risk of product liability claims or recalls. Design and manufacturing defects with respect to products sold by the Group or by companies it has acquired could damage, or impair the repair of, body functions. The Group may become subject to liability, which could be substantial, because of actual or alleged defects in its products. In addition, product defects could lead to the need to recall from the market existing products, which may be costly and harmful to the Group’s reputation. There can be no assurance that customers, particularly in the US, the Group’s largest geographical market, will not bring product liability or related claims that would have a material adverse effect on the Group’s financial position or results of operations in the future, or that the Group will be able to resolve such claims within insurance limits. As at 31 December 2017, a provision of $157m is recognised relating to the present value of the estimated costs to resolve all unsettled known and unknown anticipated metal-on-metal hip implant claims. Regulatory standards and compliance in the healthcare industry Business practices in the healthcare industry are subject to regulation and review by various government authorities. In general, the trend in many countries in which the Group does business is towards higher expectations and increased enforcement activity by governmental authorities. While the Group is committed to doing business with integrity and welcomes the trend to higher standards in the healthcare industry, the Group and other companies in the industry have been subject to investigations and other enforcement activity that have incurred and may continue to incur significant expense. Under certain circumstances, if the Group were found to have violated the law, its ability to sell its products to certain customers could be restricted. International regulation The Group operates across the world and is subject to extensive legislation, including anti-bribery and corruption and data protection, in each country in which the Group operates. Our international operations are governed by the UK Bribery Act and the US Foreign Corrupt Practices Act which prohibit us or our representatives from making or offering improper payments to government officials and other persons or accepting payments for the purpose of obtaining or maintaining business. Our international operations in the Emerging Markets which operate through distributors increase our Group exposure to these risks. The Group will also be required to comply with the requirements of the EU General Data Protection Regulation (GDPR) concerning personal data of data subjects residing in the EU when it comes into force in May 2018. Enforcement of such legislation has increased in recent years with significant fines and penalties being imposed on companies and individuals where breaches are found to have occurred. Regulatory approval The international medical device industry is highly regulated. Regulatory requirements are a major factor in determining whether substances and materials can be developed into marketable products and the amount of time and expense that should be allotted to such development. National regulatory authorities administer and enforce a complex series of laws and regulations that govern the design, development, approval, manufacture, labelling, marketing and sale of healthcare products. They also review data supporting the safety and efficacy of such products. Of particular importance is the requirement in many countries that products be authorised or registered prior to manufacture, marketing or sale and that such authorisation or registration be subsequently maintained. The major regulatory agencies for Smith & Nephew’s products include the Food and Drug Administration (FDA) in the US, the Medicines and Healthcare products Regulatory Agency in the UK, the Ministry of Health, Labour and Welfare in Japan, the China Food and Drug Administration and the Australian Therapeutic Goods Administration. At any time, the Group is awaiting a number of regulatory approvals which, if not received, could adversely affect results of operations. In 2017, the European Union reached agreement on a new set of Medical Device Regulations which entered into force on 25 May 2017. These have a three-year transition period; therefore will fully apply in EU Member States from 26 May 2020. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 175 |
The trend is towards more stringent regulation and higher standards of technical appraisal. Such controls have become increasingly demanding to comply with and management believes that this trend will continue. Regulatory requirements may also entail inspections for compliance with appropriate standards, including those relating to Quality Management Systems or Good Manufacturing Practices regulations. All manufacturing and other significant facilities within the Group are subject to regular internal and external audit for compliance with national medical device regulation and Group policies. Payment for medical devices may be governed by reimbursement tariff agencies in a number of countries. Reimbursement rates may be set in response to perceived economic value of the devices, based on clinical and other data relating to cost, patient outcomes and comparative effectiveness. They may also be affected by overall government budgetary considerations. The Group believes that its emphasis on innovative products and services should contribute to success in this environment. Failure to comply with these regulatory requirements could have a number of adverse consequences, including withdrawal of approval to sell a product in a country, temporary closure of a manufacturing facility, fines and potential damage to Company reputation. Failure to make successful acquisitions A key element of the Group’s strategy for continued growth is to make acquisitions or alliances to complement its existing business. Failure to identify appropriate acquisition targets or failure to conduct adequate due diligence or to integrate them successfully would have an adverse impact on the Group’s competitive position and profitability. This could result from the diversion of management resources towards the acquisition or integration process, challenges of integrating organisations of different geographic, cultural and ethical backgrounds, as well as the prospect of taking on unexpected or unknown liabilities. In addition, the availability of global capital may make financing less attainable or more expensive and could result in the Group failing in its strategic aim of growth by acquisition or alliance. Relationships with healthcare professionals The Group seeks to maintain effective and ethical working relationships with physicians and medical personnel who assist in the research and development of new products or improvements to our existing product range or in product training and medical education. If we are unable to maintain these relationships our ability to meet the demands of our customers could be diminished and our revenue and profit could be materially adversely affected. Reliance on sophisticated information technology The Group uses a wide variety of information systems, programmes and technology to manage our business. Our systems are vulnerable to a cyber attack, malicious intrusion, loss of data privacy or any other significant disruption. Our systems have been and will continue to be the target of such threats. We have systems in place to minimise the risk and disruption of these intrusions and to monitor our systems on an ongoing basis for current or potential threats. There can be no assurance that these measures will prove effective in protecting Smith & Nephew from future interruptions and as a result the performance of the Group could be materially adversely affected. Other risk factors Smith & Nephew is subject to a number of other risks, which are common to most global medical technology groups and are reviewed as part of the Group’s Risk Management process. FACTORS AFFECTING SMITH & NEPHEW’S RESULTS OF OPERATIONS Government economic, fiscal, monetary and political policies are all factors that materially affect the Group’s operation or investments of shareholders. Other factors include sales trends, currency fluctuations and innovation. Each of these factors is discussed further in the ‘Our Marketplace’ on pages 16-17, ‘Financial review’ on pages 38-39 and ‘Taxation information for shareholders’ on pages 190-191. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 176GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
Other Financial information SELECTED FINANCIAL DATA | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | | | | $ million | | $ million | | $ million | | $ million | | $ million | | Income statement | | | | | | | | | | | | Revenue | | 4,765 | | 4,669 | | 4,634 | | 4,617 | | 4,351 | | Cost of goods sold | | (1,248) | | (1,272) | | (1,143) | | (1,162) | | (1,100) | | Gross profit | | 3,517 | | 3,397 | | 3,491 | | 3,455 | | 3,251 | | Selling, general and administrative expenses | | (2,360) | | (2,366) | | (2,641) | | (2,471) | | (2,210) | | Research and development expenses | | (223) | | (230) | | (222) | | (235) | | (231) | | Operating profit1 | | 934 | | 801 | | 628 | | 749 | | 810 | | Net interest (payable)/receivable | | (51) | | (46) | | (38) | | (22) | | 4 | | Other finance costs | | (10) | | (16) | | (15) | | (11) | | (11) | | Share of results of associates | | 6 | | (3) | | (16) | | (2) | | (1) | | Profit on disposal of business | | – | | 326 | | – | | – | | – | | Profit before taxation | | 879 | | 1,062 | | 559 | | 714 | | 802 | | Taxation | | (112) | | (278) | | (149) | | (213) | | (246) | | Attributable profit for the year | | 767 | | 784 | | 410 | | 501 | | 556 | | Earnings per ordinary share | | | | | | | | | | | | Basic earnings per share | | 87.8¢ | | 88.1¢ | | 45.9¢ | | 56.1¢ | | 61.7¢ | | Diluted earnings per share | | 87.7¢ | | 87.8¢ | | 45.6¢ | | 55.7¢ | | 61.4¢ | | Average number of shares used in basic earnings per share (millions) | | 874 | | 890 | | 894 | | 893 | | 901 | | Average number of shares used in diluted earnings per share (millions) | | 875 | | 893 | | 899 | | 899 | | 906 | | Adjusted attributable profit2 | | | | | | | | | | | | Attributable profit for the year | | 767 | | 784 | | 410 | | 501 | | 556 | | Acquisition related costs | | (10) | | 9 | | 25 | | 125 | | 31 | | Restructuring and rationalisation expenses | | – | | 62 | | 65 | | 61 | | 58 | | Legal and other | | (13) | | (20) | | 187 | | (2) | | – | | Amortisation and impairment of acquisition intangibles | | 140 | | 178 | | 204 | | 129 | | 88 | | Profit on disposal of business | | – | | (326) | | – | | – | | – | | US tax reform | | (32) | | – | | – | | – | | – | | Taxation on excluded items | | (26) | | 48 | | (130) | | (71) | | (40) | | Adjusted attributable profit | | 826 | | 735 | | 761 | | 743 | | 693 | | Adjusted earnings per ordinary share (EPSA)3 | | 94.5¢ | | 82.6¢ | | 85.1¢ | | 83.2¢ | | 76.9¢ | |
1 Reconciliation of operating to trading profit is presented below. 2 Non-IFRS financial measures are explained and reconciled to the most directly comparable financial measure prepared in accordance with IFRS on pages 178-181. 3 Adjusted earnings per ordinary share is calculated by dividing adjusted attributable profit by the basic weighted number of shares. Reconciliation of operating profit to trading profit | | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | | | | $ million | | $ million | | $ million | | $ million | | $ million | | Operating profit | | 934 | | 801 | | 628 | | 749 | | 810 | | Acquisition related costs | | (10) | | 9 | | 12 | | 118 | | 31 | | Restructuring and rationalisation costs | | – | | 62 | | 65 | | 61 | | 58 | | Amortisation and impairment of acquisition intangibles | | 140 | | 178 | | 204 | | 129 | | 88 | | Legal and other | | (16) | | (30) | | 190 | | (2) | | – | | Trading profit | | 1,048 | | 1,020 | | 1,099 | | 1,055 | | 987 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 177 |
| | | | | | | | | | | | | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | | | | $ million | | $ million | | $ million | | $ million | | $ million | | Group balance sheet | | | | | | | | | | | | Non-current assets | | 5,135 | | 4,815 | | 4,692 | | 4,866 | | 3,563 | | Current assets | | 2,731 | | 2,529 | | 2,475 | | 2,440 | | 2,256 | | Total assets | | 7,866 | | 7,344 | | 7,167 | | 7,306 | | 5,819 | | Share capital | | 178 | | 180 | | 183 | | 184 | | 184 | | Share premium | | 605 | | 600 | | 590 | | 574 | | 535 | | Capital redemption reserve | | 17 | | 15 | | 12 | | 11 | | 10 | | Treasury shares | | (257) | | (432) | | (294) | | (315) | | (322) | | Retained earnings and other reserves | | 4,101 | | 3,595 | | 3,475 | | 3,586 | | 3,640 | | Total equity | | 4,644 | | 3,958 | | 3,966 | | 4,040 | | 4,047 | | Non-current liabilities | | 1,876 | | 2,038 | | 1,857 | | 2,104 | | 699 | | Current liabilities | | 1,346 | | 1,348 | | 1,344 | | 1,162 | | 1,073 | | Total liabilities | | 3,222 | | 3,386 | | 3,201 | | 3,266 | | 1,772 | | Total equity and liabilities | | 7,866 | | 7,344 | | 7,167 | | 7,306 | | 5,819 | | | | | | | | | | | | | | Group cash flow statement | | | | | | | | | | | | Cash generated from operations | | 1,273 | | 1,035 | | 1,203 | | 961 | | 1,138 | | Net interest paid | | (48) | | (45) | | (36) | | (33) | | (6) | | Income taxes paid | | (135) | | (141) | | (137) | | (245) | | (265) | | Net cash inflow from operating activities | | 1,090 | | 849 | | 1,030 | | 683 | | 867 | | Capital expenditure (including trade investments and net of disposals of property, plant and equipment) | | (384) | | (394) | | (360) | | (379) | | (340) | | Acquisitions and disposals | | (159) | | (214) | | (44) | | (1,552) | | (67) | | Proceeds on disposal of business (net of tax) | | – | | 225 | | – | | – | | – | | Investment in associate | | – | | – | | (25) | | (2) | | – | | Proceeds from associate loan redemption | | – | | – | | – | | 188 | | – | | Proceeds from own shares | | 5 | | 6 | | 5 | | 4 | | 3 | | Equity dividends paid | | (269) | | (279) | | (272) | | (250) | | (239) | | Issue of ordinary capital and treasury shares purchased | | (47) | | (358) | | (61) | | (35) | | (183) | | Net cash flow from operating, investing and financing activities | | 236 | | (165) | | 273 | | (1,343) | | 41 | | Termination of finance lease | | 5 | | – | | – | | – | | – | | Exchange adjustments | | 28 | | (24) | | (21) | | (17) | | (6) | | Opening net debt | | (1,550) | | (1,361) | | (1,613) | | (253) | | (288) | | Closing net debt | | (1,281) | | (1,550) | | (1,361) | | (1,613) | | (253) | | Selected financial ratios | | | | | | | | | | | | Gearing (closing net debt as a percentage of total equity) | | 27.6% | | 39% | | 34% | | 40% | | 6% | | Dividends per ordinary share | | 35.0¢1 | | 30.8¢ | | 30.8¢ | | 29.60¢ | | 27.40¢ | | Research and development costs to revenue | | 4.7% | | 4.9% | | 4.8% | | 5.1% | | 5.3% | | Capital expenditure (including intangibles but excluding goodwill and trade investments) to revenue | | 7.9% | | 8.4% | | 7.7% | | 8.1% | | 7.8% | |
1 The Board has proposed a final dividend of 22.7 US cents per share which together with the first interim dividend of 12.3 US cents makes a total for 2017 of 35.0 US cents. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 178GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
OTHER FINANCIAL INFORMATION continued NON-IFRS FINANCIAL INFORMATION – ADJUSTED MEASURES These Financial Statements include financial measures that are not prepared in accordance with International Financial Reporting Standards (IFRS). These measures, which include trading profit, trading profit margin, tax rate on trading results, EPSA, ROIC, trading cash flow, free cash flow, trading profit to trading cash conversion ratio, and underlying growth, exclude the effect of certain cash and non-cash items that Group management believes are not related to the underlying performance of the Group. These non-IFRS financial measures are also used by management to make operating decisions because they facilitate internal comparisons of performance to historical results. Non-IFRS financial measures are presented in these Financial Statements as the Group’s management believe that they provide investors with a means of evaluating performance of the business segment and the consolidated Group on a consistent basis, similar to the way in which the Group’s management evaluates performance, that is not otherwise apparent on an IFRS basis, given that certain non-recurring, infrequent, non-cash and other items that management does not otherwise believe are indicative of the underlying performance of the consolidated Group may not be excluded when preparing financial measures under IFRS. These non-IFRS measures should not be considered in isolation from, as substitutes for, or superior to financial measures prepared in accordance with IFRS. Underlying revenue growth ‘Underlying growth in revenue’ is used to compare the revenue in a given year to the previous year on a like-for-like basis. This is achieved by adjusting for the impact of sales of products acquired in material business combinations or disposed of and for movements in exchange rates. Underlying growth in revenue is considered by the Group to be an important measure of performance in terms of local functional currency since it excludes those items considered to be outside the influence of local management. The Group’s management uses this non-IFRS measure in its internal financial reporting, budgeting and planning to assess performance on both a business and a consolidated Group basis. Revenue growth at constant currency is important in measuring business performance compared to competitors and compared to the growth of the market itself. The Group considers that revenue from sales of products acquired in material business combinations results in a step-up in growth in revenue in the year of acquisition that cannot be wholly attributed to local management’s efforts with respect to the business in the year of acquisition. Depending on the timing of the acquisition, there will usually be a further step change in the following year. A measure of growth excluding the effects of business combinations also allows senior management to evaluate the performance and relative impact of growth from the existing business and growth from acquisitions. The process of making business acquisitions is directed, approved and funded from the Group corporate centre in line with strategic objectives. The material limitation of the underlying growth in revenue measure is that it excludes certain factors, described above, which ultimately have a significant impact on total revenues. The Group compensates for this limitation by taking into account relative movements in exchange rates in its investment, strategic planning and resource allocation. In addition, as the evaluation and assessment of business acquisitions is not within the control of local management, performance of acquisitions is monitored centrally until the business is integrated. The Group’s management considers that the non-IFRS measure of underlying growth in revenue and the IFRS measure of growth in revenue are complementary measures, neither of which management uses exclusively. ‘Underlying growth in revenue’ reconciles to growth in revenue reported, the most directly comparable financial measure calculated in accordance with IFRS by making two adjustments, the ‘constant currency exchange effect’ and the ‘acquisitions and disposals effect’, described below. The ‘constant currency exchange effect’ is a measure of the increase/decrease in revenue resulting from currency movements on non-US Dollar sales and is measured as the difference between: 1) the increase/decrease in the current year revenue translated into US Dollars at the current year average exchange rate and the prior revenue translated at the prior year rate; and 2) the increase/decrease being measured by translating current and prior year revenues into US Dollars using the prior year closing rate. The ‘acquisitions and disposals effect’ is the measure of the impact on revenue from newly acquired material business combinations and recent material business disposals. This is calculated by comparing the current year, constant currency actual revenue (which include acquisitions and exclude disposals from the relevant date of completion) with prior year, constant currency actual revenue, adjusted to include the results of acquisitions and exclude disposals for the commensurate period in the prior year. These sales are separately tracked in the Group’s internal reporting systems and are readily identifiable. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 179 |
Reported revenue growth, the most directly comparable financial measure calculated in accordance with IFRS, reconciles to underlying growth in revenue as follows: | | | | | | | | | | | | | | | | Reconciling items | | 2017 | | Reported growth | | Underlying growth | | Acquisitions/disposals | | Currency impact | | Consolidated revenue by franchise | | % | | % | | % | | % | | Sports Medicine, Trauma & Other | | 1 | | 3 | | (2) | | – | | Sports Medicine Joint Repair | | 7 | | 6 | | – | | 1 | | Arthroscopic Enabling Technologies | | (3) | | (3) | | – | | – | | Trauma & Extremities | | 4 | | 4 | | – | | – | | Other Surgical Businesses | | (11) | | 7 | | (19) | | 1 | | Reconstruction | | 4 | | 3 | | – | | 1 | | Knee Implants | | 6 | | 5 | | – | | 1 | | Hip Implants | | – | | – | | – | | – | | Advanced Wound Management | | 2 | | 2 | | – | | – | | Advanced Wound Care | | – | | – | | – | | – | | Advanced Wound Bioactives | | – | | – | | – | | – | | Advanced Wound Devices | | 13 | | 13 | | – | | – | | Total | | 2 | | 3 | | (1) | | – | |
| | | | | | | | | | | | | | | | Reconciling items | | 2016 | | Reported growth | | Underlying growth | | Acquisitions/disposals | | Currency impact | | Consolidated revenue by franchise | | % | | % | | % | | % | | Sports Medicine, Trauma & Other | | 1 | | 3 | | (1) | | (1) | | Sports Medicine Joint Repair | | 7 | | 8 | | – | | (1) | | Arthroscopic Enabling Technologies | | – | | 2 | | – | | (2) | | Trauma & Extremities | | (4) | | (4) | | 1 | | (1) | | Other Surgical Businesses | | 5 | | 15 | | (9) | | (1) | | Reconstruction | | 3 | | 2 | | 2 | | (1) | | Knee Implants | | 6 | | 4 | | 3 | | (1) | | Hip Implants | | (1) | | (1) | | – | | – | | Advanced Wound Management | | (3) | | (1) | | – | | (2) | | Advanced Wound Care | | (5) | | (3) | | – | | (2) | | Advanced Wound Bioactives | | (1) | | – | | – | | (1) | | Advanced Wound Devices | | 3 | | 5 | | – | | (2) | | Total | | 1 | | 2 | | – | | (1) | |
Trading profit, trading profit margin, trading cash flow and trading profit to cash conversion ratio Trading profit, trading profit margin (trading profit expressed as a percentage of revenue), trading cash flow and trading profit to cash conversion ratio (trading cash flow expressed as a percentage of trading profit) are trend measures, which present the long-term profitability of the Group excluding the impact of specific transactions that management considers affect the Group’s short-term profitability and cash flows. The Group has identified the following items, where material, as those to be excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively: acquisition and disposal related items arising in connection with business combinations, including amortisation of acquisition intangible assets, impairments and integration costs; restructuring events; gains and losses resulting from legal disputes and uninsured losses. In addition to these items, gains and losses that materially impact the Group’s profitability or cash flows on a short-term or one-off basis and the cash cost to fund defined benefit pension schemes that are closed to future accrual are excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively. Adjusted earnings per ordinary share (EPSA) EPSA is a trend measure, which presents the long-term profitability of the Group excluding the post-tax impact of specific transactions that management considers affect the Group’s short-term profitability and the one-off impact of US tax reform. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure and is determined by adjusting attributable profit for the items that are excluded from operating profit when arriving at trading profit and items that are recognised below operating profit that affect the Group’s short-term profitability. The most directly comparable financial measure calculated in accordance with IFRS is basic earnings per ordinary share (‘EPS’). | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 180GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
OTHER FINANCIAL INFORMATION continued | | | | | | | | | | | | | | | | | | | | | | | | | | | | Cash generated | | | | | | | | Operating | | Profit before | | | | Attributable | | from operating | | Earnings | | | | Revenue | | profit1 | | tax2 | | Taxation3 | | profit4 | | activities5 | | per share6 | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | ¢ | | 2017 Reported | | 4,765 | | 934 | | 879 | | (112) | | 767 | | 1,273 | | 87.8 | | Acquisition-related costs and profit on disposal | | – | | (10) | | (10) | | 2 | | (8) | | 3 | | (0.9) | | Restructuring and rationalisation costs | | – | | – | | – | | – | | – | | 15 | | – | | Amortisation and impairment of acquisition intangibles | | – | | 140 | | 140 | | (40) | | 100 | | – | | 11.4 | | Legal and other7 | | – | | (16) | | (13) | | 12 | | (1) | | 25 | | (0.1) | | US tax reform | | – | | – | | – | | (32) | | (32) | | – | | (3.7) | | Capital expenditure | | – | | – | | – | | – | | – | | (376) | | – | | 2017 Adjusted | | 4,765 | | 1,048 | | 996 | | (170) | | 826 | | 940 | | 94.5 | |
Acquisition-related costs and cash flows: For the year to 31 December 2017 the credit relates to a remeasurement of contingent consideration for a prior year acquisition partially offset by costs associated with the acquisition of Rotation Medical, Inc. Restructuring and rationalisation costs: There were no restructuring and rationalisation costs in the year to 31 December 2017. The restructuring and rationalisation cash flows relate to the implementation of the Group Optimisation plan that was announced in May 2014 and completed at the end of 2016. Amortisation and impairment of acquisition intangibles: For the year to 31 December 2017 the charge relates to the amortisation of intangible assets acquired in material business combinations and an impairment charge of $10m. Legal and other: For the year to 31 December 2017 the charge relates primarily to legal expenses for patent litigation with Arthrex, ongoing metal-on-metal hip claims and an increase of $10m in the provision that reflects the present value of the estimated costs to resolve all other known and anticipated metal-on-metal hip claims. A $54m credit has been recognised in the year to 31 December 2017 following a settlement payment received from Arthrex relating to patent litigation. For the year to 31 December 2017 $44m of cash funding to closed defined benefit pension schemes is excluded from trading cash flow following the closure of the UK scheme to future accrual in December 2016. | | | | | | | | | | | | | | | | | | | | | | | | | | | | Cash generated | | | | | | | | Operating | | Profit before | | | | Attributable | | from operating | | Earnings | | | | Revenue | | profit1 | | tax2 | | Taxation3 | | profit4 | | activities5 | | per share6 | | | | $ million | | $ million | | $ million | | $ million | | $ million | | $ million | | ¢ | | 2016 Reported | | 4,669 | | 801 | | 1,062 | | (278) | | 784 | | 1,035 | | 88.1 | | Acquisition-related costs | | – | | 9 | | (317) | | 120 | | (197) | | 24 | | (22.2) | | Restructuring and rationalisation costs | | – | | 62 | | 62 | | (14) | | 48 | | 62 | | 5.4 | | Amortisation and impairment of acquisition intangibles | | – | | 178 | | 178 | | (59) | | 119 | | – | | 13.4 | | Legal and other | | – | | (30) | | (20) | | 1 | | (19) | | 36 | | (2.1) | | Capital expenditure | | – | | – | | – | | – | | – | | (392) | | – | | 2016 Adjusted | | 4,669 | | 1,020 | | 965 | | (230) | | 735 | | 765 | | 82.6 | |
Acquisition-related costs and cash flows: For the year to 31 December 2016 these costs relate to the costs associated with the integration of Blue Belt Technologies and other acquisitions. Taxation and attributable profit include the effect of the disposal of the Gynaecology business. Restructuring and rationalisation costs: For the year to 31 December 2016 these costs primarily relate to the ongoing implementation of the Group Optimisation plan that was announced in May 2014. Amortisation and impairment of acquisition intangibles: For the year to 31 December 2016 these charges relate to the amortisation of intangible assets acquired in material business combinations and a total impairment of $48m including $32m relating to Oasis, a product acquired with the Healthpoint acquisition in 2013. Legal and other: For the year to 31 December 2016 the net credit of $30m primarily relates to a $44m curtailment credit on post-retirement benefits in the UK pension scheme partially offset by legal expenses incurred for patent litigation with Arthrex. Also included is a net $1m credit in respect of insurance recoveries of $24m and legal expenses of $23m, relating to the ongoing metal-on-metal hip claims. 1 Represents a reconciliation of operating profit to trading profit. 2 Represents a reconciliation of reported profit before tax to trading profit before tax. 3 Represents a reconciliation of reported tax to trading tax. 4 Represents a reconciliation of reported attributable profit to adjusted attributable profit. 5 Represents a reconciliation of cash generated from operations to trading cash flow. 6 Represents a reconciliation of basic earnings per ordinary share to adjusted earnings per ordinary share (EPSA). 7 From 1 January 2017, the ongoing funding of closed defined benefit pension schemes is not included in management’s definition of trading cash flow as there is no defined benefit service cost for these schemes. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 181 |
Free Cash Flow Free cash flow is a measure of the cash generated for the Group to use after capital expenditure according to its capital allocation framework, it is defined as the net cash flow from operating activities less: capital expenditure and cash flows from interest and income taxes. A reconciliation from net cash flow from operating activities, the most comparable IFRS measure, to free cash flow is set out below: | | | | | | | | | 2017 | | 2016 | | 2015 | | | $ million | | $ million | | $ million | Net cash flow from operating activities | | 1,273 | | 1,035 | | 1,203 | Capital expenditure | | (376) | | (392) | | (358) | Interest received | | 2 | | 3 | | 8 | Interest paid | | (50) | | (48) | | (44) | Income taxes paid | | (135) | | (141) | | (137) | Free cash flow | | 714 | | 457 | | 672 |
Return on invested capital (ROIC) Return on invested capital (ROIC) is a measure of the return generated on capital invested by the Group. It provides a metric for long-term value creation and encourages compounding reinvestment within the business and discipline around acquisitions with low returns and long payback. ROIC is defined as: Net Operating Profit less Adjusted Taxes/((Opening Net Operating Assets + Closing Net Operating Assets)/2). | | | | | | | | | 2017 | | 2016 | | 2015 | | | $ million | | $ million | | $ million | Operating profit | | 934 | | 801 | | | Taxation | | (112) | | (278) | | | Taxation adjustment1 | | (10) | | 107 | | | Net operating profit less adjusted taxes | | 812 | | 630 | | | | | | | | | | Total equity | | 4,644 | | 3,958 | | 3,966 | Retirement benefit asset | | (62) | | – | | (13) | Investments | | (21) | | (25) | | (13) | Investments in associates | | (118) | | (112) | | (115) | Cash at bank | | (169) | | (100) | | (120) | Long term borrowings | | 1,423 | | 1,564 | | 1,434 | Retirement benefit obligation | | 131 | | 164 | | 184 | Bank drafts and loans | | 27 | | 86 | | 46 | Net operating assets | | 5,855 | | 5,535 | | 5,369 | Average net operating assets | | 5,695 | | 5,452 | | | Return on invested capital | | 14.3% | | 11.5% | | |
1 Being the taxation on interest income, interest expense, other finance costs, share of results of associates and profit on disposal of business | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 182GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
OTHER FINANCIAL INFORMATION continued CONTRACTUAL OBLIGATIONS Contractual obligations at 31 December 2017 were as follows: | | | | | | | | | | | | Payments due by period | | | | Less than | | One to | | Three to | | More than | | | | one year | | three years | | five years | | five years | | | | $ million | | $ million | | $ million | | $ million | | Debt obligations | | 27 | | 300 | | – | | – | | Private placement notes | | 36 | | 194 | | 443 | | 647 | | Operating lease obligations | | 57 | | 78 | | 43 | | 56 | | Retirement benefit obligation | | 25 | | 50 | | 25 | | – | | Purchase obligations | | 164 | | 7 | | – | | – | | Capital expenditure | | 26 | | – | | – | | – | | Other | | 81 | | 74 | | 45 | | 5 | | | | 416 | | 703 | | 556 | | 708 | |
Other contractual obligations represent $45m of foreign exchange contracts and $160m of acquisition consideration. Provisions that do not relate to contractual obligations are not included in the above table. The agreed contributions for 2018 in respect of the Group’s defined benefits plans are $25m for the UK Plan. There are a number of agreements that take effect, alter or terminate upon a change in control of the Company or the Group following a takeover, such as bank loan agreements and Company share plans. None of these are deemed to be significant in terms of their potential impact on the business of the Group as a whole. In addition, there are service contracts between the Company and its Executive Directors which provide for the automatic payment of a bonus following loss of office or employment occurring because of a successful takeover bid. Further details are set out on page 102. The Company does not have contracts or other arrangements which individually are essential to the business. EXCHANGE RATES The Group publishes its consolidated financial statements expressed in US Dollars. The following tables provide certain information concerning the exchange rates between Sterling and US Dollars based on the Bank of England rate. | | | | | | | | | | | Year ended 31 December | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | Year end | | 1.35 | | 1.23 | | 1.48 | | 1.56 | | 1.66 | Average1 | | 1.30 | | 1.35 | | 1.53 | | 1.65 | | 1.56 | High | | 1.36 | | 1.48 | | 1.59 | | 1.72 | | 1.66 | Low | | 1.21 | | 1.21 | | 1.46 | | 1.55 | | 1.48 |
1 The average of the Bank of England rates in effect on the last day of each month during the relevant period. | | | | | | | | | | | | | | | February 20181 | | January 2018 | | December 2017 | | November 2017 | | October 2017 | | September 2017 | High | | 1.42 | | 1.43 | | 1.35 | | 1.35 | | 1.33 | | 1.36 | Low | | 1.38 | | 1.35 | | 1.33 | | 1.31 | | 1.31 | | 1.30 |
1 Up to 16 February 2018, the latest practicable date for this Annual Report. On 16 February 2018, the latest practicable date for this Annual Report, the Bank of England rate was US$1.40 per £1.00. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION183 |
2016 FINANCIAL HIGHLIGHTS COMMENTARY ON THE INCOME STATEMENT – Group revenue increased by $35m, 1% on a reported basis, from $4,634m in 2015 to $4,669m in 2016. The underlying increase is 2%, after adjusting for 1% attributable to the unfavourable impact of currency movements. – Cost of goods sold increased by $129m, 11% on a reported basis, from $1,143m in 2015 to $1,272m in 2016. The movement is primarily due to underlying trading. – Selling, general and administrative expenses decreased by $275m (10% on a reported basis) from $2,641m in 2015 to $2,366m in 2016. In 2016, administrative expenses included amortisation of software and other intangible assets of $61m (2015: $66m), $62m of restructuring and rationalisation expenses (2015: $65m), an amount of $178m relating to amortisation and impairment of acquired intangibles (2015: $204m), $9m of acquisition related costs (2015: $12m) 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%). Expenditure was $230m in 2016 compared to $222m in 2015. The Group continues to invest in innovative technologies and products to differentiate it from competitors. – Operating profit increased by $173m from $628m in 2015 to $801m in 2016. This movement in 2016 was primarily driven by the absence of costs recognised in 2015 relating to anticipated and settled metal-on-metal hip claims. – Net interest expense increased by $8m from a net $38m expense in 2015 to a net $46m expense in 2016. This movement is primarily due to an increase in the effective interest rate and the increase in net debt due to the acquisition of Blue Belt Technologies. – Other finance costs in 2016 increased by $1m and principally relates to costs associated with the Group’s retirement benefit schemes. – The taxation charge increased by $129m to $278m from $149m in 2015 principally due to the tax charge on the disposal of the Gynaecology business. 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. COMMENTARY ON THE GROUP BALANCE SHEET Non-current assets increased by $123m to $4,815m in 2016 from $4,692m in 2015. This is principally attributable to the following: – Property, plant and equipment increased by $50m from $932m in 2015 to $982m in 2016. There were $320m of additions together with $2m acquired with the Blue Belt acquisition which was partially offset by $21m of assets disposed. Depreciation of $224m was charged during 2016 and there were unfavourable currency movements of $27m. – Goodwill increased by $176m from $2,012m in 2015 to $2,188m in 2016. This movement relates to additions of $211m from the acquisition of Blue Belt and BST-CarGel. This was partially offset by unfavourable currency movements of $35m. – Intangible assets decreased by $91m from $1,502m in 2015 to $1,411m in 2016. There were additions of $72m in 2016 relating to intellectual property, distribution rights and software acquired together with $85m acquired with the Blue Belt and BST-CarGel acquisitions. Amortisation and impairment during 2016 was $239m and there were unfavourable currency movements of $9m. – Investments increased to $25m from $13m in 2015. The increase was attributable to additions of $2m and fair value remeasurement of $10m. – Deferred tax assets decreased by $8m in the year from $105m in 2015 to $97m in 2016. The net deferred tax asset position is $3m (2015: asset of $28m). The decrease of $25m is due to tax accrual to tax return adjustments and current year utilisation of net deferred tax assets offset by the impact of acquisitions of $15m. Current assets increased by $54m to $2,529m from $2,475m in 2015. The movement relates to the following: – Inventories rose by $27m to $1,244m in 2016 from $1,217m in 2015. This movement is driven by inventory increases in distribution hubs and general increase across the Emerging Markets. This was offset by unfavourable currency movements of $26m. – The level of trade and other receivables increased by $47m to $1,185m in 2016 from $1,138m in 2015. The movement primarily relates to increased trade receivables of $39m and $10m decrease in the bad debt provision as well as unfavourable currency movements. – Cash at bank has decreased by $20m from $120m in 2015 to $100m in 2016. Current liabilities increased by $4m from $1,344m in 2015 to $1,348m in 2016. This movement is attributable to: – Bank overdrafts and loans increased by $40m from $46m in 2015 to $86m in 2016. – Trade and other payables increased by $42m from $842m in 2015 to $884m in 2016 primarily due to deferred consideration for acquisitions made in 2016. – Provisions decreased by $46m from $193m in 2015 to $147m in 2016 primarily due to utilisation of the legal provision for known and anticipated metal-on-metal hip claims. – Current tax payables decreased by $32m from $263m in 2015 to $231m, mainly attributable to differences in the timing of cash tax payments year-on-year. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 184GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS FINANCIAL CALENDAR Annual General Meeting | 12 April 2018 | First quarter Trading Report | 3 May 2018 | Payment of 2017 final dividend | 9 May 2018 | Half year results announced | 26 July 20181 | Third quarter Trading Report | 1 November 2018 | Payment of 2018 interim dividend | November 2018 | Full year results announced | February 20191 | Annual Report available | February/March 2019 | Annual General Meeting | April 2019 |
1Dividend declaration dates. Annual General Meeting The Company’s Annual General Meeting (AGM) will be held on Thursday, 12 April 2018 at 2pm at No.11 Cavendish Square, London W1G 0AN. Registered shareholders have been sent either a Notice of Annual General Meeting or notification of availability of the Notice of Annual General Meeting. Corporate headquarters and registered office The corporate headquarters is in the UK and the registered office address is: Smith & Nephew plc, 15 Adam Street, London W2N 6LA, UK. Registered in England and Wales No. 324357. Tel. +44 (0)20 7401 7646 website: www.smith-nephew.com. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION185 |
ORDINARY SHAREHOLDERS Registrar All general enquiries concerning shareholdings, dividends, changes to shareholders’ personal details and the AGM should be addressed to: Computershare Investor Services plc, The Pavilions, Bridgwater Road, Bristol, BS99 6ZZ. Tel: 0370 703 0047 Tel: +44 (0) 117 378 5450 from outside the UK Website: www.investorcentre.co.uk * Lines are open from 8:30am to 5:30pm Monday to Friday, excluding public holidays in England and Wales. SHAREHOLDER COMMUNICATIONS We make quarterly financial announcements which are made available through Stock Exchange announcements and on the Group’s website (www.smith-nephew.com). Copies of recent Annual Reports, press releases, institutional presentations and audio webcasts are also available on the website. We send paper copies of the Notice of Annual General Meeting and Annual Report only to those shareholders and ADS holders who have elected to receive shareholder documentation by post. Electronic copies of the Annual Report and Notice of Annual General Meeting are available on the Group’s website at www.smith-nephew.com. Both ordinary shareholders and ADS holders can request paper copies of the Annual Report, which the Company provides free of charge. The Company will continue to send to ordinary shareholders by post the Form of Proxy notifying them of the availability of the Annual Report and Notice of Annual General Meeting on the Group’s website. If you elect to receive the Annual Report and Notice of Annual General Meeting electronically you are informed by e-mail of the documents’ availability on the Group’s website. ADS holders receive the Form of Proxy by post, but will not receive a paper copy of the Notice of Annual General Meeting. INVESTOR COMMUNICATIONS The Company maintains regular dialogue with individual institutional shareholders, together with results presentations. To ensure that all members of the Board develop an understanding of the views of major investors, the Executive Directors review significant issues raised by investors with the Board. Non-Executive Directors are sent copies of analysts’ and brokers’ briefings. There is an opportunity for individual shareholders to question the Directors at the Annual General Meeting and the Company regularly responds to letters from shareholders on a range of issues. UK CAPITAL GAINS TAX For the purposes of UK capital gains tax, the price of the Company’s ordinary shares on 31 March 1982 was 35.04p. SMITH & NEPHEW SHARE PRICE The Company’s ordinary shares are quoted on the London Stock Exchange under the symbol SN. The Company’s share price is available on the Smith & Nephew website www.smith-nephew.com and at www.londonstockexhchange.com where the live financial data is updated with a 15-minute delay. AMERICAN DEPOSITARY SHARES (‘ADSs’) AND AMERICAN DEPOSITARY RECEIPTS (‘ADRs’) In the USA, the Company’s ordinary shares are traded in the form of ADSs, evidenced by ADRs, on the New York Stock Exchange under the symbol SNN. Each American Depositary Share represents two ordinary shares. Deutsche Bank is the authorised depositary bank for the Company’s ADR programme. ADS ENQUIRIES All enquiries regarding ADS holder accounts and payment of dividends should be addressed to: Deutsche Bank Shareholder Services American Stock Transfer and Trust Company Operations Centre 6201 15th Avenue Brooklyn, New York NY 11219 Tel: +1 866 249 2593 (toll free) E-mail: db@astfinancial.com Website: www.adr.db.com The Deutsche Bank Global Direct Investor Services Program is available for US residents, enabling investment directly in ADSs with reduced brokerage commissions and service costs. For further information on Global Direct contact Deutsche Bank Shareholder Services (as above) or visit www.adr.db.com. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 186GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued SMITH & NEPHEW ADS PRICE The Company’s ADS price can be obtained from the official New York Stock Exchange website at www.nyse.com and the Smith & Nephew website www.smith-nephew.com where the live financial data is updated with a 15-minute delay, and is quoted daily in the Wall Street Journal. ADS PAYMENT INFORMATION The Company hereby discloses ADS payment information for the year ended 31 December 2017 in accordance with the Securities and Exchange Commission rules 12.D.3 and 12.D.4 relating to Form 20‑F filings by foreign private issuers. The depositary collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors, including payment of dividends by the Company by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fee for those services are paid. | | Persons depositing or withdrawing shares must pay | For | $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) $0.05 (or less) per ADS | Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates Any cash distribution to ADS registered holders, including payment of dividend | $0.05 (or less) per ADS per calendar year Registration or transfer fees | Depositary services Transfer and registration of shares on our share register to or from the name of the depositary or its agent when shares are deposited or withdrawn | Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes | As necessary | Any charges incurred by the depositary or its agents for servicing the deposited securities | As necessary |
During 2017, a fee of one US cent per ADS was collected on the 2016 final dividend paid in May and a fee of one US cent per ADS was collected on the 2017 interim dividend paid in October. In the period 1 January 2017 to 16 February 2018, the total program payments made by Deutsche Bank Trust Company Americas were $599,992. DIVIDEND HISTORY Smith & Nephew has paid dividends on its ordinary shares in every year since 1937. Following the capital restructuring and dividend reduction in 2000, the Group adopted a policy of increasing its dividend cover (the ratio of EPSA, as set out in the ‘Selected financial data’, to ordinary dividends declared for the year). This was intended to increase the financing capability of the Group for acquisitions and other investments. From 2000 to 2004, the dividend increased in line with inflation and, in 2004, dividend cover stood at 4.1 times. Having achieved this level of dividend cover the Board changed its policy, from that of increasing dividends in line with inflation, to that of increasing dividends for 2005 and after by 10%. Following the redenomination of the Company’s share capital into US Dollars, the Board re-affirmed its policy of increasing the dividend by 10% a year in US Dollar terms. On 2 August 2012, the Board announced its intention to pursue a progressive dividend policy, with the aim of increasing the US Dollar value of ordinary dividends over time broadly based on the Group’s underlying growth in earnings, while taking into account capital requirements and cash flows. At the time of the full year results, the Board reviews the appropriate level of total annual dividend each year. 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. Dividends will continue to be declared in US Dollars with an equivalent amount in Sterling payable to those shareholders whose registered address is in the UK, or who have validly elected to receive Sterling dividends. An interim dividend in respect of each fiscal year is normally declared in July or August and paid in November. A final dividend will be recommended by the Board of Directors and paid subject to approval by shareholders at the Company’s Annual General Meeting. Future dividends of Smith & Nephew will be dependent upon: future earnings; the future financial condition of the Group; the Board’s dividend policy; and the additional factors that might affect the business of the Group set out in ‘Special note regarding forward-looking statements’ and ‘Risk Factors’. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 187 |
DIVIDENDS PER SHARE The table below sets out the dividends per ordinary share in the last five years. | | | | | | | | | | | | | | Year ended 31 December | | | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | | Pence per share: | | | | | | | | | | | | Interim | | 9.340 | | 10.080 | | 8.533 | | 7.578 | | 7.211 | | Final | | 16.1831 | | 14.420 | | 14.300 | | 13.574 | | 11.121 | | Total | | 25.523 | | 24.500 | | 22.833 | | 21.152 | | 18.332 | | US cents per share: | | | | | | | | | | | | Interim | | 12.300 | | 12.300 | | 13.111 | | 12.222 | | 11.556 | | Final | | 22.700 | | 18.500 | | 19.000 | | 20.667 | | 18.889 | | Total | | 35.000 | | 30.800 | | 32.111 | | 32.889 | | 30.445 | |
1 Translated at the Bank of England rate on 16 February 2018. From 6 April 2016 dividends below £5,000 per tax year became tax free and dividends above £5,000 per tax year became subject to personal income tax at the rate of 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. A self‑assessment form will therefore be required if your dividend income exceeds £5,000 per tax year. This will apply to both cash and dividend reinvestment plan (‘DRIP’) dividends, although dividends paid on shares held within pensions and ISAs will be unaffected, remaining tax free. Please note, with effect from 6 April 2018, the tax free allowance for dividend income will reduce from £5,000 to £2,000. This will impact the 2017 final dividend, which will be payable on 9 May 2018, subject to shareholder approval. Dividends shown in the table above, prior to 6 April 2016, include the associated UK tax credit of 10%, but exclude the deduction of withholding taxes. Since the second interim dividend for 2005, all dividends have been declared in US cents per ordinary share. In respect of the proposed final dividend for the year ended 31 December 2017 of 22.7 US cents per ordinary share, the record date will be 6 April 2018 and the payment date will be 9 May 2018. The Sterling equivalent per ordinary share will be set following the record date. Shareholders may elect to receive their dividend in either Sterling or US Dollars and the last day for election will be 20 April 2018. The ordinary shares will trade ex-dividend on both the London and New York Stock Exchanges from 5 April 2018. The proposed final dividend of 22.7 US cents per ordinary share, which together with the interim dividend of 12.3 US cents, makes a total for 2017 of 35.00 US cents. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 188GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued SHARE PRICES The table below sets out, for the periods indicated, the highest and lowest middle market quotations for the Company’s ordinary shares (as derived from the Daily Official List of the UK Listing Authority) and the highest and lowest sales prices of its ADSs (as reported on the New York Stock Exchange composite tape). | | | | | | | | | | | | Ordinary shares | | ADSs | | | | High | | Low | | High | | Low | | | | £ | | £ | | US$ | | US$ | | Year ended 31 December: | | | | | | | | | | 2013 | | 8.68 | | 6.80 | | 71.85 | | 52.90 | | 20141 | | 11.93 | | 8.57 | | 97.27 | | 29.39 | | 2015 | | 12.12 | | 10.60 | | 37.78 | | 32.48 | | 2016 | | 13.10 | | 10.51 | | 35.06 | | 27.11 | | 2017 | | 14.31 | | 11.70 | | 38.50 | | 29.90 | | Quarters in the year ended 31 December: | | | | | | | | | | 2016: | | | | | | | | | | 1st Quarter | | 11.79 | | 10.51 | | 34.80 | | 30.55 | | 2nd Quarter | | 12.67 | | 11.12 | | 34.97 | | 31.43 | | 3rd Quarter | | 13.10 | | 12.11 | | 35.06 | | 32.37 | | 4th Quarter | | 12.81 | | 10.67 | | 32.97 | | 27.11 | | 2017: | | | | | | | | | | 1st Quarter | | 12.52 | | 11.70 | | 31.71 | | 29.90 | | 2nd Quarter | | 13.82 | | 12.16 | | 35.71 | | 30.98 | | 3rd Quarter | | 13.99 | | 12.94 | | 37.17 | | 33.87 | | 4th Quarter | | 14.31 | | 12.79 | | 38.50 | | 34.62 | | 2018: | | | | | | | | | | 1st Quarter (to 16 February 2018) | | 12.94 | | 12.15 | | 37.20 | | 34.12 | | Last six months: | | | | | | | | | | August 2017 | | 13.97 | | 13.16 | | 36.40 | | 34.99 | | September 2017 | | 13.99 | | 13.08 | | 37.17 | | 35.53 | | October 2017 | | 14.31 | | 13.59 | | 38.50 | | 36.10 | | November 2017 | | 14.12 | | 13.10 | | 37.42 | | 35.50 | | December 2017 | | 13.24 | | 12.79 | | 36.13 | | 34.62 | | January 2018 | | 12.94 | | 12.31 | | 37.20 | | 34.58 | | February 2018 (to 16 February 2018) | | 12.80 | | 12.15 | | 36.54 | | 34.12 | |
1 On 14 October 2014, the ratio of ordinary shares per ADS changed from five ordinary shares per ADS to two ordinary shares per ADS. SHARE CAPITAL The principal trading market for the ordinary shares is the London Stock Exchange. The ordinary shares were listed on the New York Stock Exchange on 16 November 1999, trading in the form of ADSs evidenced by ADRs. Each ADS represents two ordinary shares from 14 October 2014, before which time one ADS represented five ordinary shares. The ADS facility is sponsored by Deutsche Bank acting as depositary. All the ordinary shares, including those held by Directors and Executive Officers, rank pari passu with each other. On 23 January 2006, the ordinary shares of 122/9p were redenominated as ordinary shares of US 20 cents (following approval by shareholders at the Extraordinary General Meeting in December 2005). The new US Dollar ordinary shares carry the same rights as the previous ordinary shares. The share price continues to be quoted in Sterling. In 2006, the Company issued £50,000 of shares in Sterling in order to comply with English law. These were issued as deferred shares, which are not listed on any stock exchange. They have extremely limited rights and therefore effectively have no value. These shares were allotted to the Chief Executive Officer, although the Board reserves the right to transfer them to another member of the Board should it so wish. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 189 |
Shareholdings As at 16 February 2018, to the knowledge of the Group, there were 14,877 registered holders of ordinary shares, of whom 96 had registered addresses in the USA and held a total of 207,045 ordinary shares (0.023% of the total issued). Because certain ordinary shares are registered in the names of nominees, the number of shareholders with registered addresses in the USA is not representative of the number of beneficial owners of ordinary shares resident in the USA. As at 16 February 2018, 33,740,645 ADSs equivalent to 67,481,290 ordinary shares or approximately 7.7% of the total ordinary shares in issue, were outstanding and were held by 87 registered ADS holders. Major shareholders As far as is known to Smith & Nephew, the Group is not directly or indirectly owned or controlled by another corporation or by any Government and the Group has not entered into arrangements, the operation of which may at a subsequent date result in a change in control of the Group. As at 16 February 2018, no persons are known to Smith & Nephew to have any interest (as defined in the Disclosure and Transparency Rules of the FCA) in 3% or more of the ordinary shares, other than as shown below. The following tables show changes over the last three years in the percentage and numbers of the issued share capital owned by shareholders holding 3% or more of ordinary shares, as notified to the Company under the Disclosure and Transparency Rules: | | | | | | | | | | | | As at 31 December | | | | 16 February 2018 | | 2017 | | 2016 | | 2015 | | | | % | | % | | % | | % | | BlackRock, Inc. | | 5.2 | | 5.2 | | 5.2 | | 5.2 | |
| | | | | | | | | | | | As at 31 December | | | | 16 February 2018 | | 2017 | | 2016 | | 2015 | | | | ‘000 | | ‘000 | | ‘000 | | ‘000 | | BlackRock, Inc. | | 46,427 | | 46,427 | | 46,427 | | 46,427 | |
The Company is not aware of any person who has a significant direct or indirect holding of securities in the Company, and is not aware of any persons holding securities which may control the Company. There are no securities in issue which have special rights as to the control of the Company. Purchase of ordinary shares on behalf of the Company At the AGM, the Company will be seeking a renewal of its current permission from shareholders to purchase up to 10% of its own shares. In order to avoid shareholder dilution, shares allotted to employees through employee share schemes are bought back on a quarterly basis and subsequently cancelled by the Company. From 1 January 2017 to 16 February 2018, in the months listed below, the Company has purchased 2,907,586 ordinary shares at a cost of $50,112,844.04. | | | | | | | | | | Total shares | | Average price | | Approximate US$ value | | | | purchased | | paid per share | | of shares purchased | | | | 000s | | pence | | under the plan | | 20-21 February 2017 (partial Q4 2016) | | 429 | | 1,205.0589 | | $ 6,451,301 | | 18-22 May 2017 (Q1 2017) | | 960 | | 1,324.2686 | | $ 16,520,793 | | 2 August 2017 (Q2 2017) | | 309 | | 1,319.9881 | | $ 5,410,073 | | 7-8 November 2017 (Q3 2017) | | 652 | | 1,384.7434 | | $ 11,837,805 | | 14-15 February 2018 (Q4 2017) | | 557 | | 1,261.6308 | | $ 9,892,872 | |
The shares were purchased in the open market by J.P. Morgan Securities plc and Merrill Lynch International on behalf of the Company. Exchange controls and other limitations affecting security holders There are no UK governmental laws, decrees or regulations that restrict the export or import of capital or that affect the payment of dividends, interest or other payments to non-resident holders of Smith & Nephew’s securities, except for certain restrictions imposed from time to time by Her Majesty’s Treasury of the United Kingdom pursuant to legislation, such as the United Nations Act 1946 and the Emergency Laws Act 1964, against the Government or residents of certain countries. There are no limitations, either under the laws of the UK or under the Articles of Association of Smith & Nephew, restricting the right of non-UK residents to hold or to exercise voting rights in respect of ordinary shares, except that where any overseas shareholder has not provided to the Company a UK address for the service of notices, the Company is under no obligation to send any notice or other document to an overseas address. It is, however, the current practice of the Company to send every notice or other document to all shareholders regardless of the country recorded in the register of members, with the exception of details of the Company’s dividend reinvestment plan, which are not sent to shareholders with recorded addresses in the USA and Canada. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 190GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued TAXATION INFORMATION FOR SHAREHOLDERS The comments below are of a general and summary nature and are based on the Group’s understanding of certain aspects of current UK and US federal income tax law and practice relevant to the ADSs and ordinary shares not in ADS form. The comments address the material US and UK tax consequences generally applicable to a person who is the beneficial owner of ADSs or ordinary shares and who, for US federal income tax purposes, is a citizen or resident of the USA, a corporation (or other entity taxable as a corporation) created or organised in or under the laws of the USA (or any State therein or the District of Columbia), or an estate or trust the income of which is included in gross income for US federal income tax purposes regardless of its source (each a US Holder). The comments set out below do not purport to address all tax consequences of the ownership of ADSs or ordinary shares that may be material to a particular holder and in particular do not deal with the position of shareholders who directly or indirectly own 10% or more of the Company’s issued ordinary shares. This discussion does not apply to (i) persons whose holding of ADSs or ordinary shares is effectively connected with or pertains to either a permanent establishment in the UK through which a US Holder carries on a business in the UK or a fixed base from which a US Holder performs independent personal services in the UK, or (ii) persons whose registered address is inside the UK. This discussion does not apply to certain investors subject to special rules, such as certain financial institutions, tax-exempt entities, insurance companies, broker-dealers and traders in securities that elect to use the mark-to-market method of tax accounting, partnerships or other entities treated as partnerships for US federal income tax purposes, US Holders holding ADSs or ordinary shares as part of a hedging, conversion or other integrated transaction or US Holders whose functional currency for US federal income tax purposes is other than the US Dollar. In addition, the comments below do not address the potential application of the provisions of the United States Internal Revenue Code, known as the Medicare Contribution Tax, any alternative minimum tax consequences, any US federal tax and other than income tax or any US state, local or non-US (other than UK) taxes. The summary deals only with US Holders who hold ADSs or ordinary shares as capital assets for tax purposes. The summary is based on current UK and US law and practice which is subject to change, possibly with retroactive effect. US Holders are recommended to consult their own tax advisers as to the particular tax consequences to them of the ownership of ADSs or ordinary shares. The Company believes, and this discussion assumes, that the Company was not a passive foreign investment company for its taxable year ended 31 December 2017. This discussion is based in part on representations by the depositary and assumes that each obligation under the deposit agreement and any related agreement will be performed in accordance with its terms. For purposes of US federal income tax law, US Holders of ADSs will generally be treated as owners of the ordinary shares represented by the ADSs. However, the US Treasury has expressed concerns that parties to whom depositary shares are released before shares are delivered to the depositary (pre-released) may be taking actions that are inconsistent with the claiming of foreign tax credits by owners of depositary shares. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate US Holders. Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate US Holders of ADSs could be affected by actions that may be taken by parties to whom ADSs are pre-released. Taxation of distributions in the UK and the USA The UK does not currently impose a withholding tax on dividends paid by a UK corporation, such as the Company. Distributions paid by the Company will generally be taxed as foreign source dividends to the extent paid out of the Company’s current or accumulated earnings and profits as determined for US federal income tax purposes. Because the Company does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions generally will be reported to US Holders as dividends. Such dividends will not be eligible for the dividends-received deduction generally allowed to corporate US Holders. Dividends paid to certain non-corporate US Holders of ordinary shares or ADSs may be subject to US federal income tax at lower rates than those applicable to other types of ordinary income if certain conditions are met. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at these favourable rates. Taxation of capital gains US Holders, who are not resident or ordinarily resident for tax purposes in the UK, will not generally be liable for UK capital gains tax on any capital gain realised upon the sale or other disposition of ADSs or ordinary shares unless the ADSs or ordinary shares are held in connection with a trade carried on in the UK through a permanent establishment (or in the case of individuals, through a branch or agency). Furthermore, UK resident individuals who acquire ADSs or ordinary shares before becoming temporarily non-UK residents may remain subject to UK taxation of capital gains on gains realised while non-resident. For US federal income tax purposes, gains or losses realised upon a taxable sale or other disposition of ADSs or ordinary shares by US Holders generally will be US source capital gains or losses and will be long-term capital gains or losses if the ADSs or ordinary shares were held for more than one year. The amount of a US Holder’s gain or loss will be equal to the difference between the amount realised on the sale or other disposition and such holder’s tax basis in the ADSs, or ordinary shares, each determined in US Dollars. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 191 |
Inheritance and estate taxes The HM Revenue & Customs imposes inheritance tax on capital transfers which occur on death, and in the seven years preceding death. The HM Revenue & Customs considers that the US/UK Double Taxation Convention on Estate and Gift Tax applies to inheritance tax. Consequently, a US citizen who is domiciled in the USA and is not a UK national or domiciled in the UK will not be subject to UK inheritance tax in respect of ADSs and ordinary shares. A UK national who is domiciled in the USA will be subject to UK inheritance tax but will be entitled to a credit for any US federal estate tax charged in respect of ADSs and ordinary shares in computing the liability to UK inheritance tax. Special rules apply where ADSs and ordinary shares are business property of a permanent establishment of an enterprise situated in the UK. US information reporting and backup withholding Payments of dividends on, or proceeds from the sale of, ADSs or ordinary shares that are made within the USA or through certain US-related financial intermediaries generally will be subject to US information reporting, and may be subject to backup withholding, unless a US Holder is an exempt recipient or, in the case of backup withholding, provides a correct US taxpayer identification number and certain other conditions are met. Any backup withholding deducted may be credited against the US Holder’s US federal income tax liability, and, where the backup withholding exceeds the actual liability, the US Holder may obtain a refund by timely filing the appropriate refund claim with the US Internal Revenue Service. US Holders who are individuals or certain specified entities may be required to report information relating to securities issued by a non-US person (or foreign accounts through which the securities are held), subject to certain exceptions (including an exception for securities held in accounts maintained by US financial institutions). US Holders should consult their tax advisers regarding their reporting obligations with respect to the ADSs or ordinary shares. UK stamp duty and stamp duty reserve tax UK stamp duty is charged on documents and in particular instruments for the transfer of registered ownership of ordinary shares. Transfers of ordinary shares in certificated form will generally be subject to UK stamp duty at the rate of ½% of the consideration given for the transfer with the duty rounded up to the nearest £5. UK stamp duty reserve tax (SDRT) arises when there is an agreement to transfer shares in UK companies ‘for consideration in money or money’s worth’, and so an agreement to transfer ordinary shares for money or other consideration may give rise to a charge to SDRT at the rate of ½% (rounded up to the nearest penny). The charge of SDRT will be cancelled, and any SDRT already paid will be refunded, if within six years of the agreement an instrument of transfer is produced to HM Revenue & Customs and the appropriate stamp duty paid. Transfers of ordinary shares into CREST (an electronic transfer system) are exempt from stamp duty so long as the transferee is a member of CREST who will hold the ordinary shares as a nominee for the transferor and the transfer is in a form that will ensure that the securities become held in uncertificated form within CREST. Paperless transfers of ordinary shares within CREST for consideration in money or money’s worth are liable to SDRT rather than stamp duty. SDRT on relevant transactions will be collected by CREST at ½%, and this will apply whether or not the transfer is effected in the UK and whether or not the parties to it are resident or situated in the UK. A charge of stamp duty or SDRT at the rate of 1½% of the consideration (or, in some circumstances, the value of the shares concerned) will arise on a transfer or issue of ordinary shares to the depositary or to certain persons providing a clearance service (or their nominees or agents) for the conversion into ADRs and will generally be payable by the depositary or person providing clearance service. In accordance with the terms of the Deposit Agreement, any tax or duty payable by the depositary on deposits of ordinary shares will be charged by the depositary to the party to whom ADRs are delivered against such deposits. No liability for stamp duty or SDRT will arise on any transfer of, or agreement to transfer, an ADS or beneficial ownership of an ADS, provided that the ADS and any instrument of transfer or written agreement to transfer remains at all times outside the UK, and provided further that any instrument of transfer or written agreement to transfer is not executed in the UK and the transfer does not relate to any matter or thing done or to be done in the UK (the location of the custodian as a holder of ordinary shares not being relevant in this context). In any other case, any transfer of, or agreement to transfer, an ADS or beneficial ownership of an ADS could, depending on all the circumstances of the transfer, give rise to a charge to stamp duty or SDRT. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 192GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued ARTICLES OF ASSOCIATION The following summarises certain material rights of holders of the Company’s ordinary shares under the material provisions of the Company’s Articles of Association and English law. This summary is qualified in its entirety by reference to the Companies Act and the Company’s Articles of Association. In the following description, a ‘shareholder’ is the person registered in the Company’s register of members as the holder of an ordinary share. The Company is incorporated under the name Smith & Nephew plc and is registered in England and Wales with registered number 324357. The Company’s ordinary shares may be held in certificated or uncertificated form. No holder of the Company’s shares will be required to make additional contributions of capital in respect of the Company’s shares in the future. In accordance with English law, the Company’s ordinary shares rank equally. Directors Under the Company’s Articles of Association, a Director may not vote in respect of any contract, arrangement, transaction or proposal in which he, or any person connected with him, has any material interest other than by virtue of his interests in securities of, or otherwise in or through, the Company. This is subject to certain exceptions relating to proposals (a) indemnifying him in respect of obligations incurred on behalf of the Company, (b) indemnifying a third party in respect of obligations of the Company for which the Director has assumed responsibility under an indemnity or guarantee, (c) relating to an offer of securities in which he will be interested as an underwriter, (d) concerning another body corporate in which the Director is beneficially interested in less than 1% of the issued shares of any class of shares of such a body corporate, (e) relating to an employee benefit in which the Director will share equally with other employees and (f) relating to any insurance that the Company is empowered to purchase for the benefit of Directors of the Company in respect of actions undertaken as Directors (and/or officers) of the Company. A Director shall not vote or be counted in any quorum present at a meeting in relation to a resolution on which he is not entitled to vote. The Directors are empowered to exercise all the powers of the Company to borrow money, subject to the limitation that the aggregate amount of all monies borrowed after deducting cash and current asset investments by the Company and its subsidiaries shall not exceed the sum of $6,500,000,000. Any Director who has been appointed by the Directors since the previous Annual General Meeting of shareholders, either to fill a casual vacancy or as an additional Director holds office only until the conclusion of the next Annual General Meeting and then shall be eligible for re-election by the shareholders. The other Directors retire and are eligible for re-appointment at the third Annual General Meeting after the meeting at which they were last re-appointed. If not re-appointed, a Director retiring at a meeting shall retain office until the meeting appoints someone in his place, or if it does not do so, until the conclusion of the meeting. The Directors are subject to removal with or without cause by the Board or the shareholders. Directors are not required to hold any shares of the Company by way of qualification. Under the Company’s Articles of Association and English law, a Director may be indemnified out of the assets of the Company against liabilities he may sustain or incur in the execution of his duties. Rights attaching to ordinary shares Under English law, dividends are payable on the Company’s ordinary shares only out of profits available for distribution, as determined in accordance with accounting principles generally accepted in the UK and by the Companies Act 2006. Holders of the Company’s ordinary shares are entitled to receive final dividends as may be declared by the Directors and approved by the shareholders in general meeting, rateable according to the amounts paid up on such shares, provided that the dividend cannot exceed the amount recommended by the Directors. The Company’s Board of Directors may declare such interim dividends as appear to them to be justified by the Company’s financial position. If authorised by an ordinary resolution of the shareholders, the Board may also direct payment of a dividend in whole or in part by the distribution of specific assets (and in particular of paid up shares or debentures of the Company). Any dividend unclaimed after 12 years from the date the dividend was declared, or became due for payment, will be forfeited and will revert to the Company. There were no material modifications to the rights of shareholders under the Articles during 2017. Voting rights of ordinary shares Voting at any general meeting of shareholders is by a show of hands unless a poll, which is a written vote, is duly demanded and held. On a show of hands, every shareholder who is present in person at a general meeting has one vote regardless of the number of shares held. On a poll, every shareholder who is present in person or by proxy has one vote for each ordinary share held by that shareholder. A poll may be demanded by any of the following: – The chairman of the meeting; – At least five shareholders present or by proxy entitled to vote on the resolution; – Any shareholder or shareholders representing in the aggregate not less than one-tenth of the total voting rights of all shareholders entitled to vote on the resolution; or – Any shareholder or shareholders holding shares conferring a right to vote on the resolution on which there have been paid-up sums in aggregate equal to not less than one-tenth of the total sum paid up on all the shares conferring that right. A Form of Proxy will be treated as giving the proxy the authority to demand a poll, or to join others in demanding one, as above. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 193 |
The necessary quorum for a general meeting is two shareholders present in person or by proxy carrying the right to vote upon the business to be transacted. Matters are transacted at general meetings of the Company by the processing and passing of resolutions of which there are two kinds; ordinary or special resolutions: – Ordinary resolutions include resolutions for the re-election of Directors, the approval of financial statements, the declaration of dividends (other than interim dividends), the appointment and re-appointment of auditors or the grant of authority to allot shares. An ordinary resolution requires the affirmative vote of a majority of the votes of those persons voting at the meetings at which there is a quorum. – Special resolutions include resolutions amending the Company’s Articles of Association, dis-applying statutory pre-emption rights or changing the Company’s name; modifying the rights of any class of the Company’s shares at a meeting of the holders of such class or relating to certain matters concerning the Company’s winding up. A special resolution requires the affirmative vote of not less than three-quarters of the votes of the persons voting at the meeting at which there is a quorum. Annual General Meetings must be convened upon advance written notice of 21 days. Other general meetings must be convened upon advance written notice of at least 14 clear days. The days of delivery or receipt of notice are not included. The notice must specify the nature of the business to be transacted. Meetings are convened by the Board of Directors. Members with 5% of the ordinary share capital of the Company may requisition the Board to convene a meeting. Variation of rights If, at any time, the Company’s share capital is divided into different classes of shares, the rights attached to any class may be varied, subject to the provisions of the Companies Act, with the consent in writing of holders of three-quarters in nominal value of the issued shares of that class or upon the adoption of a special resolution passed at a separate meeting of the holders of the shares of that class. At every such separate meeting, all the provisions of the Articles of Association relating to proceedings at a general meeting apply, except that the quorum is to be the number of persons (which must be two or more) who hold or represent by proxy not less than one-third in nominal value of the issued shares of the class and at any such meeting a poll may be demanded in writing by any person or their proxy who hold shares of that class. Where a person is present by proxy or proxies, he is treated as holding only the shares in respect of which the proxies are authorised to exercise voting rights. Rights in a winding up Except as the Company’s shareholders have agreed or may otherwise agree, upon the Company’s winding up, the balance of assets available for distribution: – After the payment of all creditors including certain preferential creditors, whether statutorily preferred creditors or normal creditors; and – Subject to any special rights attaching to any other class of shares; – Is to be distributed among the holders of ordinary shares according to the amounts paid-up on the shares held by them. This distribution is generally to be made in US Dollars. A liquidator may, however, upon the adoption of any extraordinary resolution of the shareholders and any other sanction required by law, divide among the shareholders the whole or any part of the Company’s assets in kind. Limitations on voting and shareholding There are no limitations imposed by English law or the Company’s Articles of Association on the right of non-residents or foreign persons to hold or vote the Company’s ordinary shares or ADSs, other than the limitations that would generally apply to all of the Company’s shareholders. Transfers of shares The Board may refuse to register the transfer of shares held in certificated form which: – Are not fully paid (provided that it shall not exercise this discretion in such a way as to prevent stock market dealings in the shares of that class from taking place on an open and proper basis); – Are not duly stamped or duly certified or otherwise shown to the satisfaction of the Board to be exempt from stamp duty, lodged at the Transfer Office or at such other place as the Board may appoint and (save in the case of a transfer by a person to whom no certificate was issued in respect of the shares in question) accompanied by the certificate for the shares to which it relates, and such other evidence as the Board may reasonably require to show the right of the transferor to make the transfer and, if the instrument of transfer is executed by some other person on his behalf, the authority of that person so to do; – Are in respect of more than one class of shares; or – Are in favour of more than four transferees. Deferred shares Following the re-denomination of share capital on 23 January 2006, the ordinary shares’ nominal value became 20 US cents each. There were no changes to the rights or obligations of the ordinary shares. In order to comply with the Companies Act 2006, a new class of Sterling shares was created, deferred shares, of which £50,000 were issued and allotted in 2006 as fully paid to the Chief Executive Officer though the Board reserves the right to transfer them to another member of the Board should it so wish. These deferred shares have no voting or dividend rights and on winding up only are entitled to repayment at nominal value only if all ordinary shareholders have received the nominal value of their shares plus an additional $1,000 each. Amendments The Company does not have any special rules about amendments to its Articles of Association beyond those imposed by law. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 194GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued CROSS REFERENCE TO FORM 20‑F This table provides a cross reference from the information included in this Annual Report to the requirements of Form 20‑F. Part I | | Page | Item 1 | Identity of Directors, Senior Management and Advisers | n/a | Item 2 | Offer Statistics and Expected Timetable | n/a | Item 3 | Key Information | | | A – Selected Financial Data | 176–177 | | B – Capitalization and Indebtedness | n/a | | C – Reason for the Offer and Use of Proceeds | n/a | | D – Risk Factors | 172–175 | Item 4 | Information on the Company | | | A – History and Development of the Company | 165–171, 184 | | B – Business Overview | 2–47, 121–124, 169–175, 183 | | C – Organizational Structure | 7, 136–137, 167–168 | | D – Property, Plant and equipment | 131–132, 171 | Item 4A | Unresolved Staff Comments | None | Item 5 | Operating and Financial Review and Prospects | | | A – Operating results | 6–7, 36–39, 172–175, 183 | | B – Liquidity and Capital Resources | 39, 140–142, 158–159 | | C – Research and Development, patents and licences, etc. | 3, 5, 13, 125 | | D – Trend information | 16–17, 38–39 , 171–175 | | E – Off Balance Sheet Arrangements | 171 | | F – Tabular Disclosure of Contractual Obligations | 182 | | G – Safe Harbor | 200 | Item 6 | Directors, Senior Management and Employees | | | A – Directors and Senior Management | 50–55 | | B – Compensation | 79–105 | | C – Board Practices | 50–78 | | D – Employees | 25–28, 126 | | E – Share Ownership | 91, 93, 162 | Item 7 | Major shareholders and Related Party Transactions | | | A – Major shareholders | 189 | | – Host Country shareholders | 189 | | B – Related Party Transactions | 162, 171 | | C – Interests of experts and counsel | n/a | Item 8 | Financial information | | | A – Consolidated Statements and Other Financial Information | 107–162 | | – Legal Proceedings | 149–150 | | – Dividends | 186–187 | | B – Significant Changes | None | Item 9 | The Offer and Listing | | | A – Offer and Listing Details | 188–189 | | B – Plan of Distribution | n/a | | C – Markets | 188 | | D – Selling shareholders | n/a | | E – Dilution | n/a | | F – Expenses of the Issue | n/a |
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Part I | | Page | Item 10 | Additional Information | | | A – Share capital | n/a | | B – Memorandum and Articles of Association | 192–193 | | C – Material Contracts | n/a | | D – Exchange Controls | 189 | | E – Taxation | 190–191 | | F – Dividends and Paying Agents | n/a | | G – Statement by Experts | n/a | | H – Documents on Display | 200 | | I – Subsidiary Information | 167–170 | Item 11 | Quantitative and Qualitative Disclosure about Market Risk | 143–147, 171–175 | Item 12 | Description of Securities Other than Equity Securities | | | A – Debt securities | n/a | | B – Warrants and rights | n/a | | C – Other securities | n/a | | D – American Depositary shares | 185–186 | Part II | | | Item 13 | Defaults, Dividend Arrearages and Delinquencies | None | Item 14 | Material Modifications to the Rights of Security Holders and Use of Proceeds | None | Item 15 | Controls and Procedures | 71–78 | Item 16 | (Reserved) | n/a | | A – Audit Committee Financial Expert | 71 | | B – Code of Ethics | 78 | | C – Principal Accountant Fees and Services | 75–76, 126 | | D – Exemptions from the Listing Standards for Audit Committees | n/a | | E – Purchases of Equity Securities by the Issuer and Affiliated Purchasers | 157, 189 | | F – Change in Registrant’s Certifying Accountant | n/a | | G – Corporate Governance | 56 | | H – Mine Safety Disclosure | n/a | Part III | | | Item 17 | Financial Statements | n/a | Item 18 | Financial Statements | 107–162 | Item 19 | Exhibits | 201-206 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 196GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued GLOSSARY OF TERMS Unless the context indicates otherwise, the following terms have the meanings shown below: Term | Meaning | ACL | The anterior cruciate ligament (ACL) is one of the four major ligaments in the human knee. | ADR | In the US, the Company’s ordinary shares are traded in the form of American Depositary Shares evidenced by American Depositary Receipts (ADRs). | ADS | In the US, the Company’s ordinary shares are traded in the form of American Depositary Shares (ADSs). | Arthroscopic Enabling Technologies | A product group which includes a variety of technologies such as fluid management equipment for surgical access, high definition cameras, digital image capture, scopes, light sources and monitors to assist with visualisation inside the joints, radio frequency, electromechanical and mechanical tissue resection devices, and hand instruments for removing damaged tissue. | Advanced Wound Bioactives | A product group which includes biologics and other bioactive technologies that provide unique approaches to debridement and dermal repair/regeneration. | Advanced Wound Care | A product group which includes products for the treatment and prevention of acute and chronic wounds, including leg, diabetic and pressure ulcers, burns and post-operative wounds. | Advanced Wound Devices | A product group which includes traditional and single-use Negative Pressure Wound Therapy and hydrosurgery systems. | AGM | Annual General Meeting of the Company. | Arthroscopy | Endoscopy of the joints is termed ‘arthroscopy’, with the principal applications being the knee and shoulder. | Basis Point | One hundredth of one percentage point. | Chronic wounds | Chronic wounds are those with long or unknown healing times including leg ulcers, pressure sores and diabetic foot ulcers. | Company | Smith & Nephew plc or, where appropriate, the Company’s Board of Directors, unless the context otherwise requires. | Companies Act | Companies Act 2006, as amended, of England and Wales. | Emerging Markets | Emerging Markets include Greater China, India, Brazil and Russia. | EPSA | EPSA (Adjusted earnings per ordinary share) is a trend measure, which presents the long-term profitability of the Group excluding the post-tax impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure and is determined by adjusting attributable profit for the items that are excluded from operating profit when arriving at trading profit and items that are recognised below operating profit that affect the Group’s short-term profitability. | Endoscopy | Through a small incision, surgeons are able to see inside the body using a monitor and identify and repair defects. | Established Markets | Established Markets include United States of America, Europe, Australia, New Zealand, Canada and Japan. | Euro or € | References to the common currency used in the majority of the countries of the European Union. | FDA | US Food and Drug Administration. | Financial statements | Refers to the consolidated Group Accounts of Smith & Nephew plc. | FTSE 100 | Index of the largest 100 listed companies on the London Stock Exchange in 1937 and in 1999 the by market capitalisation. | Group was also listed on the New York Stock Exchange. In 2001,or Smith & Nephew became a constituent member | Used for convenience to refer to the Company and its consolidated subsidiaries, unless the context otherwise requires. | Health economics | A branch of economics concerned with issues related to efficiency, effectiveness, value and behaviour in the production and consumption of health and healthcare. | Hip Implants | A product group which includes specialist products for reconstruction of the FTSE-100 index inhip joint. | IFRIC | International Financial Reporting Interpretations as adopted by the UK. This means that Smith & Nephew is included inEU and as issued by the top 100 companies traded onInternational Accounting Standards Board. | IFRS | International Financial Reporting Standards as adopted by the EU and as issued by the International Accounting Standards Board. | Knee implants | A product group which includes an innovative range of products for specialised knee replacement procedures. | LSE | London Stock Exchange measured in terms of market capitalisation.Exchange. | Today, Smith & Nephew is a public limited company incorporated and headquartered in the UK and carries out business around the world.MHRA
Property, plant and equipment
| The table below summarises the main properties which the Group uses and their approximate areas. | | | | | Approximate area (square feet 000’s) | Group head office in London, UK
| | 20 | Group research facility in York, UK
| | 84 | Advanced Surgical Devices headquarters in Andover, Massachusetts, US
| | 144 | Advanced Wound Management headquarters and manufacturing facility in Hull, UK
| | 473 | Advanced Surgical Devices manufacturing facilities in Memphis, Tennessee, US
| | 971 | Advanced Surgical Devices distribution facility in Memphis, Tennessee, US
| | 210 | Advanced Surgical Devices manufacturing facility in Aarau, Switzerland
| | 121 | Advanced Surgical Devices manufacturing facility in Beijing, China
| | 192 | Advanced Surgical Devices manufacturing and warehouse facility in Warwick, UK
| | 90 | Advanced Surgical Devices manufacturing and warehouse facility in Tuttlingen, Germany
| | 64 | Advanced Surgical Devices distribution facility and European headquarters in Baar, Switzerland
| | 67 | Advanced Surgical Devices manufacturing facility in Mansfield, Massachusetts, US
| | 98 | Advanced Surgical Devices manufacturing facility in Oklahoma City, Oklahoma, US
| | 155 | Advanced Surgical Devices manufacturing facility in Calgary, Canada
| | 17 | Advanced Surgical Devices manufacturing facility in Austin, Texas, US
| | 198 | Advanced Surgical Devices manufacturing facility in La Aurora, Costa Rica
| | 36 | Advanced Surgical Devices research facility in Irvine, California, US
| | 23 | Advanced Surgical Devices manufacturing facility in Sangameshwar, India
| | 39 | Advanced Wound Management manufacturing facility in Suzhou, China
| | 288 | Advanced Wound Management manufacturing facility in Fort Saskatchewan, Canada
| | 76 | Advanced Wound Management US headquarters in St. Petersburg, Florida, US
| | 44 | Advanced Wound Bioactives headquarters and laboratory space in Fort Worth, Texas, US
| | 105 | Advanced Wound Bioactives manufacturing facility in Curaçao, Dutch Caribbean
| | 16 |
The Group Global Operations strategy includes ongoing assessment of the optimal facility footprint. The Advanced Surgical Devices manufacturing facilities in Memphis, Tennessee are largely freehold, a portion of Tuttlingen and the Advanced Wound Management facilities in Hull are freehold while other principal locations are leasehold. The Group has freehold and leasehold interests in real estate in other countries throughout the world, but no other is individually significant to the Group. Where required, the appropriate governmental authorities have approved the facilities.
Off-balance sheet arrangements
Management believes that the Group does not have any off-balance sheet arrangements, as defined by the SEC in item 5E of Form 20-F, that have or are reasonably likely to have a current or future effect on the Group’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Related party transactions
Except for transactions with associates (see Note 23.2 of Notes to the Group accounts), no other related party had material transactions or loans with Smith & Nephew over the last three financial years.
170Smith & Nephew Annual report 2014
Risk factors
There are known and unknown risks and uncertainties relating to Smith & Nephew’s business. The factors listed below could cause the Group’s business, financial position and results of operations to differ materially and adversely from expected and historical levels. In addition, other factors not listed here that Smith & Nephew cannot presently identify or does not believe to be equally significant could also materially adversely affect Smith & Nephew’s business, financial position or results of operations.
Highly competitive markets
The Group’s business segments compete across a diverse range of geographic and product markets. Each market in which the business segments operate contains a number of different competitors, including specialised and international corporations. Significant product innovations, technical advances or the intensification of price competition by competitors could adversely affect the Group’s operating results.
Some of these competitors may have greater financial, marketing and other resources than Smith & Nephew. These competitors may be able to initiate technological advances in the field, deliver products on more attractive terms, more aggressively market their products or invest larger amounts of capital and research and development (‘R&D’) into their businesses.
There is a possibility of further consolidation of competitors, which could adversely affect the Group’s ability to compete with larger companies due to insufficient financial resources. If any of the Group’s businesses were to lose market share or achieve lower than expected revenue growth, there could be a disproportionate adverse impact on the Group’s share price and its strategic options.
Competition exists among healthcare providers to gain patients on the basis of quality, service and price. There has been some consolidation in the Group’s customer base and this trend is expected to continue. Some customers have joined group purchasing organisations or introduced other cost containment measures that could lead to downward pressure on prices or limit the number of suppliers in certain business areas, which could adversely affect Smith & Nephew’s results of operations and hinder its growth potential.
Continual development and introduction
of new products
The medical devices industry has a rapid rate of new product introduction. In order to remain competitive, each of the Group’s business segments must continue to develop innovative products that satisfy customer needs and preferences or provide cost or other advantages. Developing new products is a costly, lengthy and uncertain process. The Group may fail to innovate due to low R&D investment, a R&D skills gap or poor product development. A potential product may not be brought to market or not succeed in the market for any number of reasons, including failure to work optimally, failure to receive regulatory approval, failure to be cost-competitive, infringement of patents or other intellectual property rights and changes in consumer demand. The Group’s products and technologies are also subject to marketing attack by competitors. Furthermore, new products that are developed and marketed by the Group’s competitors may affect price levels in the various markets in which the Group’s business segments operate. If the Group’s new products do not remain competitive with those of competitors, the Group’s revenue could decline.
The Group maintains reserves for excess and obsolete inventory resulting from the potential inability to sell its products at prices in excess of current carrying costs. Marketplace changes resulting from the introduction of new products or surgical procedures may cause some of the Group’s products to become obsolete. The Group makes estimates regarding the future recoverability of the costs of these products and records a provision for excess and obsolete inventories based on historical experience, expiration of sterilisation dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favourable than projected by management, additional inventory write-downs may be required.
Dependence on government and other funding
In most Established Markets throughout the world, expenditure on medical devices is ultimately controlled to a large extent by governments. Funds may be made available or withdrawn from healthcare budgets depending on government policy. The Group is therefore largely dependent on future governments providing increased funds commensurate with the increased demand arising from demographic trends.
Pricing of the Group’s products is largely governed in most Established Markets by governmental reimbursement authorities. Initiatives sponsored by government agencies, legislative bodies and the private sector to limit the growth of healthcare costs, including price regulation, excise taxes and competitive pricing, are ongoing in markets where the Group has operations. This control may be exercised by determining prices for an individual product or for an entire procedure. The Group is exposed to government policies favouring locally sourced products. The Group is also exposed to changes in reimbursement policy, tax policy and pricing which may have an adverse impact on revenue and operating profit. In particular, changes to the healthcare legislation in the US have imposed significant taxes on medical device manufacturers from 2013. There may be an increased risk of adverse changes to government funding policies arising from the deterioration in macro-economic conditions in some of the Group’s markets.
The Group must adhere to the rules laid down by government agencies that fund or regulate healthcare, including extensive and complex rules in the US. Failure to do so could result in fines or loss of future funding.
World economic conditions
Demand for the Group’s products is driven by demographic trends, including the ageing population and the incidence of osteoporosis and obesity. Supply of, use of and payment for the Group’s products are also influenced by world economic conditions which could place increased pressure on demand and pricing, adversely impacting the Group’s ability to deliver revenue and margin growth. The conditions could favour larger, better capitalised groups, with higher market shares and margins. As a consequence, the Group’s prosperity is linked to general economic conditions and there is a risk of deterioration of the Group’s performance and finances during adverse macro economic conditions.
During 2014, economic conditions worldwide continued to create several challenges for the Group, including deferrals of joint replacement procedures, heightened pricing pressure, significant declines in capital equipment expenditures at hospitals and increased uncertainty over the collectability of European government debt, particularly those in certain parts of southern Europe. These factors tempered the overall growth of the Group’s global markets and could have an increased impact on growth in the future.
Smith & Nephew Annual report 2014 171
OTHER INFORMATION
Group informationcontinued
Political uncertainties
The Group operates on a worldwide basis and has distribution channels, purchasing agents and buying entities in over 100 countries. Political upheaval in some of those countries or in surrounding regions may impact the Group’s results of operations. Political changes in a country could prevent the Group from receiving remittances of profit from a member of the Group located in that country or from selling its products or investments in that country. Furthermore, changes in government policy regarding preference for local suppliers, import quotas, taxation or other matters could adversely affect the Group’s revenue and operating profit. War, economic sanctions, terrorist activities or other conflict could also adversely impact the Group. These risks may be greater in emerging markets, which account for an increasing portion of the Group’s business.
Currency fluctuations
Smith & Nephew’s results of operations are affected by transactional exchange rate movements in that they are subject to exposures arising from revenue in a currency different from the related costs and expenses. The Group’s manufacturing cost base is situated principally in the US, the UK, China and Switzerland, from which finished products are exported to the Group’s selling operations worldwide. Thus, the Group is exposed to fluctuations in exchange rates between the US Dollar, Sterling and Swiss Franc and the currency of the Group’s selling operations, particularly the Euro, Australian Dollar and Japanese Yen. If the US Dollar, Sterling or Swiss Franc should strengthen against the Euro, Australian Dollar and the Japanese Yen, the Group’s trading margin could be adversely affected.
The Group manages the impact of exchange rate movements on revenue and cost of goods sold by a policy of transacting forward foreign currency commitments when firm purchase orders are placed. In addition, the Group’s policy is for forecast transactions to be covered between 50% and 90% for up to one year.
The Group uses the US Dollar as its reporting currency and the US Dollar is the functional currency of Smith & Nephew plc. The Group’s revenues, profits and earnings are also affected by exchange rate movements on the translation of results of operations in foreign subsidiaries for financial reporting purposes. See ‘Liquidity and capital resources’ on page 115.
Manufacturing and supply
The Group’s manufacturing production is concentrated at 15 main facilities in Austin, Memphis, Mansfield and Oklahoma City in the US, Hull and Warwick in the UK, Aarau in Switzerland, Tuttlingen in Germany, Fort Saskatchewan and Calgary in Canada, Sangameshwar in India, Suzhou and Beijing in China, La Aurora in Costa Rica and Curaçao. If major physical disruption took place at any of these sites, it could adversely affect the results of operations. Physical loss and consequential loss insurance is carried to cover such risks but is subject to limits and deductibles and may not be sufficient to cover catastrophic loss. Management of orthopaedic inventory is complex, particularly forecasting and production planning. There is a risk that failures in operational execution could lead to excess inventory or individual product shortages.
Each of the business segments is reliant on certain key suppliers of raw materials, components, finished products and packaging materials or in some cases on a single supplier.
These suppliers must provide the materials and perform the activities to the Group’s standard of quality requirements.
Consequently, the Group may be forced to pay higher prices to obtain raw materials, which it may not be able to pass on to its customers in the form of increased prices for its finished products. In addition, some of the raw materials used may become unavailable, and there can be no assurance that the Group will be able to obtain suitable and cost effective substitutes. Any interruption of supply caused by these or other factors could negatively impact Smith & Nephew’s revenue and operating profit.
The Group will, from time to time, outsource the manufacture of components and finished products to third parties and will periodically relocate the manufacture of product and/or processes between existing facilities. While these are planned activities, with these transfers there is a risk of disruption to supply.
Attracting and retaining key personnel
The Group’s continued development depends on its ability to hire and retain highly-skilled personnel with particular expertise. This is critical, particularly in general management, research, new product development and in the sales forces. If Smith & Nephew is unable to retain key personnel in general management, research and new product development or if its largest sales forces suffer disruption or upheaval, its revenue and operating profit would be adversely affected. Additionally, if the Group is unable to recruit, hire, develop and retain a talented, competitive workforce, it may not be able to meet its strategic business objectives.
Proprietary rights and patents
Due to the technological nature of medical devices and the Group’s emphasis on serving its customers with innovative products, the Group has been subject to patent infringement claims and is subject to the potential for additional claims.
Claims asserted by third parties regarding infringement of their intellectual property rights, if successful, could require the Group to expend time and significant resources to pay damages, develop non-infringing products or obtain licences to the products which are the subject of such litigation, thereby affecting the Group’s growth and profitability. Smith & Nephew attempts to protect its intellectual property and regularly opposes third party patents and trademarks where appropriate in those areas that might conflict with the Group’s business interests. If Smith & Nephew fails to protect and enforce its intellectual property rights successfully, its competitive position could suffer, which could harm its results of operations.
Product liability claims and loss of reputation
The development, manufacture and sale of medical devices entail risk of product liability claims or recalls. Design and manufacturing defects with respect to products sold by the Group or by companies it has acquired could damage, or impair the repair of, body functions. The Group may become subject to liability, which could be substantial, because of actual or alleged defects in its products. In addition, product defects could lead to the need to recall from the market existing products, which may be costly and harmful to the Group’s reputation.
There can be no assurance that customers, particularly in the US, the Group’s largest geographical market, will not bring product liability or related claims that would have a material adverse effect on the Group’s financial position or results of operations in the future, or that the Group will be able to resolve such claims within insurance limits.
172Smith & Nephew Annual report 2014
Regulatory standards and compliance in the healthcare industry
Business practices in the healthcare industry are subject to regulation and review by various government authorities. In general, the trend in many countries in which the Group does business is towards higher expectations and increased enforcement activity by governmental authorities. While the Group is committed to doing business with integrity and welcomes the trend to higher standards in the healthcare industry, the Group and other companies in the industry have been subject to investigations and other enforcement activity that have incurred and may continue to incur significant expense. See Note 17 to the Group accounts. Under certain circumstances, if the Group were found to have violated the law, its ability to sell its products to certain customers could be restricted.
International regulation
The Group operates across the world and is subject to legislation, including anti-bribery and corruption and data protection, in each country in which we operate. Our international operations are governed by the UK Bribery Act and the US Foreign Corrupt Practices Act (FCPA) which prohibit us or our agents from making, or offering, improper payments to foreign governments and their officials for the purpose of obtaining or maintaining business or product approvals. Enforcement of such legislation has increased in recent years with significant fines and penalties being imposed on companies and individuals. Our international operations, particularly in the emerging markets, expose the Group to the risk that our employees or agents will engage in prohibited activities.
Regulatory approval
The international medical device industry is highly regulated. Regulatory requirements are a major factor in determining whether substances and materials can be developed into marketable products and the amount of time and expense that should be allotted to such development.
National regulatory authorities administer and enforce a complex series of laws and regulations that govern the design, development, approval, manufacture, labelling, marketing and sale of healthcare products. They also review data supporting the safety and efficacy of such products. Of particular importance is the requirement in many countries that products be authorised or registered prior to manufacture, marketing or sale and that such authorisation or registration be subsequently maintained. The major regulatory agencies for Smith & Nephew’s products include the Food and Drug Administration (‘FDA’) in the US, the Medicines and Healthcare products Regulatory Agency in the UK,UK.
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 197 |
Term | Meaning | Negative Pressure Wound Therapy | A technology used to treat chronic wounds such as diabetic ulcers, pressure sores and post-operative wounds through the Ministryapplication of Health, Labour and Welfare in Japan, the China Food and Drug Administration and the Australian Therapeutic Goods Administration.sub-atmospheric pressure to an open wound. | At any time, the Group is awaiting a number of regulatory approvals which, if not received, could adversely affect results of operations.NHS
| The trendUK National Health Service. | NYSE | New York Stock Exchange. | Orthopaedic products | Orthopaedic reconstruction products include joint replacement systems for knees, hips and shoulders and support products such as computer-assisted surgery and minimally invasive surgery techniques. Orthopaedic trauma devices are used in the treatment of bone fractures including rods, pins, screws, plates and external frames. Clinical therapies products include joint fluid therapy for pain reduction of the knee and an ultrasound treatment to accelerate the healing of bone fractures. | Other Surgical Businesses | A product group which includes robotics-assisted surgery, various products and technologies to assist in surgical treatment of the ear, nose and throat, and gynaecological instrumentation, until the Gynaecology business disposal in August 2016. | OXINIUM | OXINIUM material is towards more stringent regulationan advanced load bearing technology. It is created through a proprietary manufacturing process that enables zirconium to absorb oxygen and higher standardstransform to a ceramic on the surface, resulting in a material that incorporates the features of technical appraisal. Such controls have become increasingly demanding to comply withceramic and managementmetal. Management believes that this trend will continue. Regulatory requirements may also entail inspections for compliance with appropriate standards, including those relating to Quality Management Systems or Good Manufacturing Practices regulations. All manufacturing and other significant facilities within the Group are subject to regular internal and external audit for compliance with national and Group medical device regulation and policies.
Payment for medical devices may be governed by reimbursement tariff agencies in a number of countries. Reimbursement rates may be set in response to perceived economic value of the devices, based on clinical and other data relating to cost, patient outcomes and comparative effectiveness. They may also be affected by overall government budgetary considerations. The Group believes that its emphasis on innovative products and services should contribute to success in this environment.
Failure to comply with these regulatory requirements could have a number of adverse consequences, including withdrawal of approval to sell a product in a country, temporary closure of a manufacturing facility, fines and potential damage to company reputation.
Failure to make successful acquisitions
A key element of the Group’s strategy for continued growth is to make acquisitions or alliances to complement its existing business. Failure to identify appropriate acquisition targets or failure to conduct adequate due diligence or to integrate them successfully would have an adverse impact on the Group’s competitive position and profitability. This could result from the diversion of management resources towards the acquisition or integration process, challenges of integrating organisations of different geographic, cultural and ethical backgrounds, as well as the prospect of taking on unexpected or unknown liabilities. In addition, the availability of global capital may make financing less attainable or more expensive and could resultOXINIUM material used in the Group failing inproduction of components of knee and hip implants exhibits unique performance characteristics due to its strategic aim of growth by acquisition or alliance.
Relationships with healthcare professionals
The Group seekshardness, low-friction and resistance to maintain effectiveroughening and ethical working relationships with physicians and medical personnel who assist in the research and development of new products or improvements to our existing product range or in product training and medical education. If we are unable to maintain these relationships our ability to meet the demands of our customers could be diminished and our revenue and profit could be materially adversely affected.abrasion.
| Reliance on sophisticated information technologyParent Company
The Group uses a wide variety of information systems, programmes and technology to manage our business. Our systems are vulnerable to a cyber-attack, malicious intrusion, loss of data privacy or any other significant disruption. Our systems have been and will continue to be the target of such threats. We have systems in place to minimise the risk and disruption of these intrusions and to monitor our systems on an ongoing basis for current or potential threats. There can be no assurance that these measures will prove effective in protecting Smith & Nephew from future interruptions and as a result the performance of the Group could be materially adversely affected.
Other risk factors
| Smith & Nephew plc. | Pound Sterling, Sterling, £, pence or p | References to UK currency. 1p is subjectequivalent to a numberone hundredth of other risks, which are common to most global medical technology groups£1. | SEC | US Securities and are reviewed as part of the Group’s risk management process.Exchange Commission. | Factors affecting Smith & Nephew’s results of operationsSports Medicine Joint Repair
Government economic, fiscal, monetary and political policies are all factors that materially affect the Group’s operation or investments of shareholders. Other factors include sales trends, currency fluctuations and innovation. Each of these factors is discussed further in the ‘Our marketplace’ on pages 18 to 20, ‘Segment performance’ on pages 26 to 33 and ‘Taxation information for shareholders’ on pages 190 to 191.
Smith & Nephew Annual report 2014 173
OTHER INFORMATION
Other financial information
Selected financial data
| | | | | | | | | | | | | | | | | | | | | | | | 2014 $ million | | |
| 2013
$ million |
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| 2012
$ million |
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| 2011
$ million |
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| 2010
$ million |
| Income statement | | | | | | | | | | | | | | | | | | | | | Revenue | | | 4,617 | | | | 4,351 | | | | 4,137 | | | | 4,270 | | | | 3,962 | | Cost of goods sold | | | (1,162 | ) | | | (1,100 | ) | | | (1,070 | ) | | | (1,140 | ) | | | (1,031 | ) | Gross Profit | | | 3,455 | | | | 3,251 | | | | 3,067 | | | | 3,130 | | | | 2,931 | | Selling, general and administrative expenses | | | (2,471 | ) | | | (2,210 | ) | | | (2,050 | ) | | | (2,101 | ) | | | (1,860 | ) | Research and development expenses | | | (235 | ) | | | (231 | ) | | | (171 | ) | | | (167 | ) | | | (151 | ) | Operating profit | | | 749 | | | | 810 | | | | 846 | | | | 862 | | | | 920 | | Net interest (payable)/receivable | | | (22 | ) | | | 4 | | | | 2 | | | | (8 | ) | | | (15 | ) | Other finance (costs)/income | | | (11 | ) | | | (11 | ) | | | (11 | ) | | | (13 | ) | | | (16 | ) | Share of results of associates | | | (2 | ) | | | (1 | ) | | | 4 | | | | – | | | | – | | Profit on disposal of net assets held for sale | | | – | | | | – | | | | 251 | | | | – | | | | – | | Profit before taxation | | | 714 | | | | 802 | | | | 1,092 | | | | 841 | | | | 889 | | Taxation | | | (213 | ) | | | (246 | ) | | | (371 | ) | | | (266 | ) | | | (280 | ) | Attributable profit for the year | | | 501 | | | | 556 | | | | 721 | | | | 575 | | | | 609 | | Earnings per ordinary share | | | | | | | | | | | | | | | | | | | | | Basic | | | 56.1¢ | | | | 61.7¢ | | | | 80.4¢ | | | | 64.5¢ | | | | 68.6¢ | | Diluted | | | 55.7¢ | | | | 61.4¢ | | | | 80.0¢ | | | | 64.2¢ | | | | 68.5¢ | | Adjusted attributable profit | | | | | | | | | | | | | | | | | | | | | Attributable profit for the year | | | 501 | | | | 556 | | | | 721 | | | | 575 | | | | 609 | | Acquisition-related costs | | | 125 | | | | 31 | | | | 11 | | | | – | | | | – | | Restructuring and rationalisation expenses | | | 61 | | | | 58 | | | | 65 | | | | 40 | | | | 15 | | Legal and other | | | (2 | ) | | | – | | | | – | | | | 23 | | | | – | | Amortisation of acquisition intangibles and impairments | | | 129 | | | | 88 | | | | 43 | | | | 36 | | | | 34 | | Profit on disposal of net assets held for sale | | | – | | | | – | | | | (251 | ) | | | – | | | | – | | Taxation on excluded items | | | (71 | ) | | | (40 | ) | | | 82 | | | | (17 | ) | | | (10 | ) | Adjusted attributable profit | | | 743 | | | | 693 | | | | 671 | | | | 657 | | | | 648 | | Adjusted basic earnings per ordinary share (‘EPSA’) (i) | | | 83.2¢ | | | | 76.9¢ | | | | 74.8¢ | | | | 73.7¢ | | | | 73.0¢ | | Adjusted diluted earnings per ordinary share (ii) | | | 82.6¢ | | | | 76.5¢ | | | | 74.5¢ | | | | 73.4¢ | | | | 72.9¢ | |
(i) | Adjusted basic earnings per ordinary share is calculated by dividing adjusted attributable profit by the average number of shares. |
(ii) | Adjusted diluted earnings per ordinary share is calculated by dividing adjusted attributable profit by the diluted number of shares. |
174Smith & Nephew Annual report 2014
| | | | | | | | | | | | | | | | | | | | | | |
| 2014
$ million |
| |
| 2013
$ million |
| |
| 2012
$ million |
| |
| 2011
$ million |
| |
| 2010
$ million |
| Group balance sheet | | | | | | | | | | | | | | | | | | | | | Non-current assets | | | 4,866 | | | | 3,563 | | | | 3,498 | | | | 2,542 | | | | 2,579 | | Current assets | | | 2,440 | | | | 2,256 | | | | 2,144 | | | | 2,080 | | | | 2,154 | | Assets held for sale | | | – | | | | – | | | | – | | | | 125 | | | | – | | Total assets | | | 7,306 | | | | 5,819 | | | | 5,642 | | | | 4,747 | | | | 4,733 | | Share capital | | | 184 | | | | 184 | | | | 193 | | | | 191 | | | | 191 | | Share premium | | | 574 | | | | 535 | | | | 488 | | | | 413 | | | | 396 | | Capital redemption reserve | | | 11 | | | | 10 | | | | – | | | | – | | | | – | | Treasury shares | | | (315 | ) | | | (322 | ) | | | (735 | ) | | | (766 | ) | | | (778 | ) | Retained earnings and other reserves | | | 3,586 | | | | 3,640 | | | | 3,938 | | | | 3,349 | | | | 2,964 | | Total equity | | | 4,040 | | | | 4,047 | | | | 3,884 | | | | 3,187 | | | | 2,773 | | Non-current liabilities | | | 2,104 | | | | 699 | | | | 828 | | | | 422 | | | | 1,046 | | Current liabilities | | | 1,162 | | | | 1,073 | | | | 930 | | | | 1,119 | | | | 914 | | Liabilities directly associated with assets held for sale | | | – | | | | – | | | | – | | | | 19 | | | | – | | Total liabilities | | | 3,266 | | | | 1,772 | | | | 1,758 | | | | 1,560 | | | | 1,960 | | Total equity and liabilities | | | 7,306 | | | | 5,819 | | | | 5,642 | | | | 4,747 | | | | 4,733 | | Group cash flow statement | | | | | | | | | | | | | | | | | | | | | Cash generated from operations | | | 961 | | | | 1,138 | | | | 1,184 | | | | 1,135 | | | | 1,111 | | Net interest paid | | | (33 | ) | | | (6 | ) | | | (4 | ) | | | (8 | ) | | | (17 | ) | Income taxes paid | | | (245 | ) | | | (265 | ) | | | (278 | ) | | | (285 | ) | | | (235 | ) | Net cash inflow from operating activities | | | 683 | | | | 867 | | | | 902 | | | | 842 | | | | 859 | | Capital expenditure (including trade investments and net of disposals of property, plant and equipment) | | | (375 | ) | | | (340 | ) | | | (265 | ) | | | (321 | ) | | | (307 | ) | Acquisitions and disposals | | | (1,556 | ) | | | (67 | ) | | | (782 | ) | | | (33 | ) | | | – | | Proceeds on disposal of net assets held for sale | | | – | | | | – | | | | 103 | | | | – | | | | – | | Investment in associate | | | (2 | ) | | | – | | | | (10 | ) | | | – | | | | – | | Proceeds from associate loan redemption | | | 188 | | | | – | | | | – | | | | – | | | | – | | Proceeds from own shares | | | 4 | | | | 3 | | | | 6 | | | | 7 | | | | 8 | | Equity dividends paid | | | (250 | ) | | | (239 | ) | | | (186 | ) | | | (146 | ) | | | (132 | ) | Issue of ordinary capital and treasury shares purchased | | | (35 | ) | | | (183 | ) | | | 77 | | | | 11 | | | | 10 | | | | | (1,343 | ) | | | 41 | | | | (155 | ) | | | 360 | | | | 438 | | Exchange adjustments | | | (17 | ) | | | (6 | ) | | | 5 | | | | (6 | ) | | | 13 | | Opening (net debt)/net cash | | | (253 | ) | | | (288 | ) | | | (138 | ) | | | (492 | ) | | | (943 | ) | Closing net debt | | | (1,613 | ) | | | (253 | ) | | | (288 | ) | | | (138 | ) | | | (492 | ) | Selected financial ratios | | | | | | | | | | | | | | | | | | | | | Gearing (closing net debt as a percentage of total equity) | | | 40% | | | | 6% | | | | 7% | | | | 4% | | | | 18% | | Dividends per ordinary share (i) | | | 29.60¢ | | | | 27.40¢ | | | | 26.10¢ | | | | 17.40¢ | | | | 15.82¢ | | Research and development costs to Revenue | | | 5.1% | | | | 5.3% | | | | 4.1% | | | | 3.9% | | | | 3.8% | | Capital expenditure (including intangibles but excluding goodwill) to revenue | | | 8.1% | | | | 7.8% | | | | 6.4% | | | | 7.5% | | | | 7.7% | |
(i) | The Board has proposed a final dividend of 18.6 US cents per share which together with the first interim dividend of 11.0 US cents makes a total for 2014 of 29.6 US cents. |
Smith & Nephew Annual report 2014 175
OTHER INFORMATION
Other financial informationcontinued
Non-GAAP Financial Information
These Financial Statements include financial measures that are not prepared in accordance with International Financial Reporting Standards (‘IFRS’). These measures, which include trading profit, trading profit margin, EPSA and underlying growth, exclude the effect of certain cash and non-cash items that Group management believes are not related to the underlying performance of the Group. These non-IFRS financial measures are also used by management to make operating decisions because they facilitate internal comparisons of performance to historical results on both a business segment and a consolidated Group basis.
Non-IFRS financial measures are presented in these Financial Statements as the Group’s management believe that they provide investors with a means of evaluating performance of the business segments and the consolidated Group on a consistent basis, similar to the way in which the Group’s management evaluates performance, that is not otherwise apparent on an IFRS basis, given that certain non-recurring, infrequent or non-cash items that management does not otherwise believe are indicative of the underlying performance of the consolidated Group may not be excluded when preparing financial measures under IFRS. These non-IFRS measures should not be considered in isolation from, as substitutes for, or superior to financial measures prepared in accordance with IFRS.
Revenue
‘Underlying growth in revenue’ is used to compare the revenue in a given year to the previous year on a like-for-like basis. This is achieved by adjusting for the impact of sales of products acquired in material business combinations and for movements in exchange rates. Underlying growth in revenue is not presented in the accounts prepared in accordance with IFRS and is therefore a measure not in accordance with Generally Accepted Accounting Principles (a ‘non-GAAP’ measure).
The Group believes that the tabular presentationSports Medicine Joint Repair franchise includes instruments, technologies and reconciliationimplants necessary to perform minimally invasive surgery of reported revenue growth to underlying revenue growth assists investors in their assessment of the Group’s performance in each business segment and for the Group as a whole.joints. | Underlying growth in revenue is considered by the Group to be an important measure of performance in terms of local functional currency since it excludes those items considered to be outside the influence of local management. The Group’s management uses this non-GAAP measure in its internal financial reporting, budgeting and planning to assess performance on both a business segment and a consolidated Group basis. Revenue growth at constant currency is important in measuring business performance compared to competitors and compared to the growth of the market itself.Trading results
The Group considers that revenue from sales of products acquired in material business combinations results in a step-up in growth in revenue in the year of acquisition that cannot be wholly attributed to local management’s efforts with respect to the business in the year of acquisition. Depending on the timing of the acquisition, there will usually be a further step change in the following year. A measure of growth excluding the effects of business combinations also allows senior management to evaluate the performance and relative impact of growth from the existing business and growth from acquisitions. The process of making business acquisitions is directed, approved and funded from the Group corporate centre in line with strategic objectives.
The material limitation of the underlying growth in revenue measure is that it excludes certain factors, described above, which ultimately have a significant impact on total revenues. The Group compensates for this limitation by taking into account relative movements in exchange rates in its investment, strategic planning and resource allocation. In addition, as the evaluation and assessment of business acquisitions is not
within the control of local management, performance of acquisitions is monitored centrally until the business is integrated.
The Group’s management considers that the non-GAAP measure of underlying growth in revenue and the GAAP measure of growth in revenue are complementary measures, neither of which management uses exclusively.
‘Underlying growth in revenue’ reconciles to growth in revenue reported, the most directly comparable financial measure calculated in accordance with IFRS by making two adjustments, the ‘constant currency exchange effect’ and the ‘acquisitions and disposals effect’, described below.
The ‘constant currency exchange effect’ is a measure of the increase/ decrease in revenue resulting from currency movements on non-US Dollar sales and is measured as the difference between: 1) the increase/decrease in the current year revenue translated into US Dollars at the current year average exchange rate and the prior revenue translated at the prior year rate; and 2) the increase/decrease being measured by translating current and prior year revenues into US Dollars using the prior year closing rate.
The ‘acquisitions and disposals effect’ is the measure of the impact on revenue from newly acquired material business combinations and recent material business disposals. This is calculated by comparing the current year, constant currency actual revenue (which include acquisitions and exclude disposals from the relevant date of completion) with prior year, constant currency actual revenue, adjusted to include the results of acquisitions and exclude disposals for the commensurate period in the prior year. These sales are separately tracked in the Group’s internal reporting systems and are readily identifiable.
Reported revenue growth, the most directly comparable financial measure calculated in accordance with IFRS, reconciles to underlying growth in revenue as follows:
| | | | | | | | | | | | | | | | 2014 | | | | 2013 | | | | 2012 | | | | | % | | | | % | | | | % | | Reported revenue growth | | | 6 | | | | 5 | | | | (3 | ) | Constant currency exchange effect | | | 1 | | | | 1 | | | | 2 | | Acquisition/Disposals effect | | | (5 | ) | | | (2 | ) | | | 3 | | Underlying revenue | | | 2 | | | | 4 | | | | 2 | |
A reconciliation of reported revenue growth to underlying revenue growth, by business segment, can be found on page 35.
| Trading profit, trading profit margin and(trading profit expressed as a percentage of revenue), trading cash flow Trading profit, and trading profit margin andto cash conversion ratio (trading cash flow expressed as a percentage of trading cash flowprofit) are trend measures, which present the long-term profitability of the Group excluding the impact of specific transactions that management considers affect the Group’s short-term profitability and cash flows. The Group has identified the following items, where material, as those to be excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively: acquisition and disposal related items arising in connection with business combinations, including amortisation of acquisition intangible assets, impairments and integration costs; restructuring events; gains and losses resulting from legal disputes and significant uninsured losses. In addition to these items, gains orand losses that materially impact the Group’s profitability or cash flows on a short-term or one-off basis and the cash cost to fund defined benefit pension schemes that are closed to future accrual are excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively.
| 176SmithTrauma & Nephew Annual report 2014Extremities
| A product group which includes internal and external devices used in the stabilisation of severe fractures and deformity correction procedures. | UK | United Kingdom of Great Britain and Northern Ireland. | Underlying growth in trading profit and trading profit margin (trading profit expressed as a percentage of revenue and trading cash flow) are measures, which present the growth trend in the long-term profitability of the Group. | Underlying growth in trading profit is used to compare the period-on-period growth in trading profit on a like-for-like basis. This is achieved by adjusting for the impact of material business combinations and disposals and for movements in exchange rates in the same manner as underlying revenue growth is determined, as described above.
Adjusted earnings per ordinary share (‘EPSA’)
EPSA is a trend measure, which presents the long-term profitability of the Group excluding the post-tax impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure and is determined by adjusting attributable profit for the items that are excluded from operating profit when arriving at trading profit and items that are recognised below operating profit that affect the Group’s short-term profitability. The most directly comparable financial measure calculated in accordance with IFRS is earnings per ordinary share (‘EPS’).
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | For the year ended 31 December 2014 | |
| Trading results
2014 $ million |
| |
| Acquisition related costs
$ million |
| |
| Restructuring and rationalisation costs
$ million |
| |
| Amortisation of acquisition intangibles
$ million |
| |
| Legal and other
$ million |
| | | Capital expenditure $ million | | |
| Reported results 2014
$ million |
| Revenue | | | 4,617 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 4,617 | | Cost of goods sold | | | (1,127 | ) | | | (23 | ) | | | (12 | ) | | | – | | | | – | | | | – | | | | (1,162 | ) | Gross profit | | | 3,490 | | | | (23 | ) | | | (12 | ) | | | – | | | | – | | | | – | | | | 3,455 | | Selling, general and administration expenses | | | (2,200 | ) | | | (95 | ) | | | (49 | ) | | | (129 | ) | | | 2 | | | | – | | | | (2,471 | ) | Research and development expenses | | | (235 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (235 | ) | Trading/operating profit | | | 1,055 | | | | (118 | ) | | | (61 | ) | | | (129 | ) | | | 2 | | | | – | | | | 749 | | Trading/operating profit margin | | | 22.9% | | | | | | | | | | | | | | | | | | | | – | | | | 16.2% | | Interest receivable | | | 13 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 13 | | Interest payable | | | (28 | ) | | | (7 | ) | | | – | | | | – | | | | – | | | | – | | | | (35 | ) | Other finance costs | | | (11 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (11 | ) | Share of loss from associates | | | (2 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (2 | ) | Profit before taxation | | | 1,027 | | | | (125 | ) | | | (61 | ) | | | (129 | ) | | | 2 | | | | – | | | | 714 | | Taxation | | | (284 | ) | | | 30 | | | | 15 | | | | 35 | | | | (9 | ) | | | – | | | | (213 | ) | Adjusted attributable/attributable profit | | | 743 | | | | (95 | ) | | | (46 | ) | | | (94 | ) | | | (7 | ) | | | – | | | | 501 | | EPSA/EPS | | | 83.2¢ | | | | (10.6¢ | ) | | | (5.2¢ | ) | | | (10.5¢ | ) | | | (0.8¢ | ) | | | – | | | | 56.1¢ | | Weighted average number of shares (m) | | | 893 | | | | | | | | | | | | | | | | | | | | | | | | 893 | | Diluted EPSA/EPS | | | 82.6¢ | | | | (10.5¢ | ) | | | (5.1¢ | ) | | | (10.5¢ | ) | | | (0.8¢ | ) | | | – | | | | 55.7¢ | | Diluted weighted average number of shares (m) | | | 899 | | | | | | | | | | | | | | | | | | | | | | | | 899 | | Trading cash flow/cash generated from operating activities | | | 781 | | | | (112 | ) | | | (60 | ) | | | – | | | | (23 | ) | | | 375 | | | | 961 | | Trading profit to cash conversion ratio (%) | | | 74% | | | | | | | | | | | | | | | | | | | | | | | | | |
Acquisition related costs:For the year ended 31 December 2014, these costs primarily relate to transaction and integration costs associated with the ArthroCare acquisition with a small portion of costs relating to the continued integration of Healthpoint and the recent acquisitions in the Emerging & International Markets. In addition, trading results eliminate the short-term increase in cost of goods sold from recognising acquired inventory at fair value rather than standard cost. For the year ended 31 December 2013, these costs primarily relate to the integration of the Healthpoint business.
Restructuring and rationalisation costs:For the year ended 31 December 2014, these costs relate to the Group optimisation programme that was announced in May 2014 and the structural and efficiency programme announced in August 2011.
Amortisation of acquisition intangibles:This charge relates to the amortisation of intangible assets acquired in material business combinations.
Legal and other:For the year ended 31 December 2014 this net credit relates to a past service gain and a settlement credit on the closure of US Pension Plan of $46m and a gain on disposal of a UK manufacturing facility of $9m, offset by a charge of $25m relating to the likely costs of a distribution hold on RENASYS in the US pending new regulatory approvals and a charge of $28m relating to the HP802 programme which was stopped in the fourth quarter.
Smith & Nephew Annual report 2014 177
OTHER INFORMATION
Other financial informationcontinued
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Restructuring | | | | | | | | | | | | | | | | Trading | | | Acquisition | | | and | | | Amortisation | | | Legal | | | | | | Reported | | | | results | | | related | | | rationalisation | | | of acquisition | | | and | | | Capital | | | results | | | | 2013 | | | costs | | | costs | | | intangibles | | | other | | | expenditure | | | 2013 | | For the year ended 31 December 2013 | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | Revenue | | | 4,351 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 4,351 | | Cost of goods sold | | | (1,083 | ) | | | (5 | ) | | | (12 | ) | | | – | | | | – | | | | – | | | | (1,100 | ) | Gross profit | | | 3,268 | | | | (5 | ) | | | (12 | ) | | | – | | | | – | | | | – | | | | 3,251 | | Selling, general and administration expenses | | | (2,050 | ) | | | (26 | ) | | | (46 | ) | | | (88 | ) | | | – | | | | – | | | | (2,210 | ) | Research and development expenses | | | (231 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (231 | ) | Trading/operating profit | | | 987 | | | | (31 | ) | | | (58 | ) | | | (88 | ) | | | – | | | | – | | | | 810 | | Trading/operating profit margin | | | 22.7% | | | | | | | | | | | | | | | | | | | | – | | | | 18.6% | | Interest receivable | | | 14 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 14 | | Interest payable | | | (10 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (10 | ) | Other finance costs | | | (11 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (11 | ) | Share of loss from associates | | | (1 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (1 | ) | Profit before taxation | | | 979 | | | | (31 | ) | | | (58 | ) | | | (88 | ) | | | – | | | | – | | | | 802 | | Taxation | | | (286 | ) | | | 6 | | | | 11 | | | | 23 | | | | – | | | | – | | | | (246 | ) | Adjusted attributable/attributable profit | | | 693 | | | | (25 | ) | | | (47 | ) | | | (65 | ) | | | – | | | | – | | | | 556 | | EPSA/EPS | | | 76.9¢ | | | | (2.8¢ | ) | | | (5.2¢ | ) | | | (7.2¢ | ) | | | – | | | | – | | | | 61.7¢ | | Weighted average number of shares (m) | | | 901 | | | | | | | | | | | | | | | | | | | | | | | | 901 | | Diluted EPSA/EPS | | | 76.5¢ | | | | (2.8¢ | ) | | | (5.2¢ | ) | | | (7.1¢ | ) | | | – | | | | – | | | | 61.4¢ | | Diluted weighted average number of shares (m) | | | 906 | | | | | | | | | | | | | | | | | | | | | | | | 906 | | Trading cash flow/cash generated from operating activities | | | 877 | | | | (25 | ) | | | (54 | ) | | | – | | | | – | | | | 340 | | | | 1,138 | | Trading profit to cash conversion ratio (%) | | | 89% | | | | | | | | | | | | | | | | | | | | | | | | | |
Acquisition related costs:For the year ended 31 December 2013, these costs primarily relate to the integration of the Healthpoint business.
Restructuring and rationalisation costs:For the year ended 31 December 2013 these costs primarily relate to the structural and efficiency programme announced in August 2011.
Amortisation of acquisition intangibles:This charge relates to the amortisation of intangible assets acquired in material business combinations.
178Smith & Nephew Annual report 2014
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Restructuring | | | | | | | | | | | | | | | | Trading | | | Acquisition | | | and | | | Amortisation | | | Legal | | | | | | Reported | | | | results | | | related | | | rationalisation | | | of acquisition | | | and | | | Capital | | | results | | | | 2012 | | | costs | | | costs | | | intangibles | | | other | | | expenditure | | | 2012 | | For the year ended 31 December 2012 | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | Revenue | | | 4,137 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 4,137 | | Cost of goods sold | | | (1,067 | ) | | | – | | | | (3 | ) | | | – | | | | – | | | | – | | | | (1,070 | ) | Gross profit | | | 3,070 | | | | – | | | | (3 | ) | | | – | | | | – | | | | – | | | | 3,067 | | Selling, general and administration expenses | | | (1,934 | ) | | | (11 | ) | | | (62 | ) | | | (43 | ) | | | – | | | | – | | | | (2,050 | ) | Research and development expenses | | | (171 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (171 | ) | Trading/operating profit | | | 965 | | | | (11 | ) | | | (65 | ) | | | (43 | ) | | | – | | | | – | | | | 846 | | Trading/operating profit margin | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Interest receivable | | | 11 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 11 | | Interest payable | | | (9 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (9 | ) | Other finance costs | | | (11 | ) | | | – | | | | – | | | | – | | | | – | | | | – | | | | (11 | ) | Share of loss from associates | | | 4 | | | | – | | | | – | | | | – | | | | – | | | | – | | | | 4 | | Profit on disposal of net asset held for sale | | | – | | | | – | | | | – | | | | – | | | | 251 | | | | – | | | | 251 | | Profit before taxation | | | 960 | | | | (11 | ) | | | (65 | ) | | | (43 | ) | | | 251 | | | | – | | | | 1,092 | | Taxation | | | (289 | ) | | | 1 | | | | 5 | | | | 7 | | | | (95 | ) | | | – | | | | (371 | ) | Adjusted attributable/attributable profit | | | 671 | | | | (10 | ) | | | (60 | ) | | | (36 | ) | | | 156 | | | | – | | | | 721 | | EPSA/EPS | | | 74.8¢ | | | | (1.1 | ) | | | (6.7 | ) | | | (4.0 | ) | | | 17.4 | | | | – | | | | 80.4¢ | | Weighted average number of shares (m) | | | 897 | | | | | | | | | | | | | | | | | | | | | | | | 897 | | Diluted EPSA/EPS | | | 74.5¢ | | | | (1.1 | ) | | | (6.7 | ) | | | (4.0 | ) | | | 17.3 | | | | – | | | | 80.0¢ | | Diluted weighted average number of shares (m) | | | 901 | | | | | | | | | | | | | | | | | | | | | | | | 901 | | Trading cash flow/cash generated from operating activities | | | 999 | | | | (3 | ) | | | (55 | ) | | | – | | | | (22 | ) | | | 265 | | | | 1,184 | | Trading profit to cash conversion ratio (%) | | | 104% | | | | | | | | | | | | | | | | | | | | | | | | | |
Acquisition related costs: For the year ended 31 December 2012, these costs primarily relate to professional and advisor fees in connection with the acquisition of Healthpoint Biotherapeutics which was completed on 21 December 2012.
Restructuring and rationalisation costs: For the year ended 31 December 2012, these costs relate mainly to people costs and contract termination costs associated with the structural and process changes announced in August 2011.
Amortisation of acquisition intangibles: This charge relates to the amortisation of intangible assets acquired in material business combinations.
Legal and other: This credit relates to the profit on disposal of the Clinical Therapies business.
Transactional and translational exchange
The Group’s principal markets outside the US are, in order of significance, Continental Europe, UK, Australia and Japan. Revenues in these markets fluctuate when translated into US Dollars on consolidation. During the year, the average rates of exchange against the US Dollar used to translate revenues and profits arising in these markets changed compared to the previous year as follows: the Euro remained flat at $1.33 (+0%), Sterling strengthened from $1.56 to $1.65 (+6%), the Swiss Franc strengthened from $1.08 to $1.09 (1%), the Australian Dollar weakened from $0.96 to $0.90 (-6%) and the Japanese Yen weakened from ¥97.6 to ¥105.8 (-8%).
The Group’s principal manufacturing locations are in the US (Advanced Surgical Devices), Switzerland (Advanced Surgical Devices), UK (Advanced Wound Management and Advanced Surgical Devices) and China (Advanced Surgical Devices and Advanced Wound Management). The majority of the Group’s selling and distribution subsidiaries around the world purchase finished products from these locations. As a result of currency movements compared with the previous year, sales from the US became relatively more profitable to all of these countries. The Group’s policy of purchasing forward a proportion of its currency requirements and the existence of an inventory pipeline reduce the short-term impact of currency movements.
Contractual obligations
Contractual obligations at 31 December 2014 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | Payments due by period | | | | Less than | | | | | | More than | | | | | Total | | | | 1 year | | | | 1–3 years | | | | 3–5 years | | | | 5 years | | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | | | $ million | | Debt obligations | | | 568 | | | | 37 | | | | 400 | | | | 131 | | | | – | | Finance lease obligations | | | 12 | | | | 2 | | | | 4 | | | | 6 | | | | – | | Operating lease obligations | | | 136 | | | | 49 | | | | 56 | | | | 23 | | | | 8 | | Retirement benefit obligation | | | 74 | | | | 74 | | | | – | | | | – | | | | – | | Purchase obligations | | | 40 | | | | 32 | | | | 8 | | | | – | | | | – | | Capital expenditure | | | 34 | | | | 34 | | | | – | | | | – | | | | – | | Other | | | 52 | | | | 29 | | | | 23 | | | | – | | | | – | | | | | 916 | | | | 257 | | | | 491 | | | | 160 | | | | 8 | |
Smith & Nephew Annual report 2014 179
OTHER INFORMATION
Other financial informationcontinued
Other contractual obligations represent $19m of foreign exchange contracts and $33m of acquisition consideration. Provisions that do not relate to contractual obligations are not included in the above table.
The agreed contributions for 2015 in respect of the Group’s defined benefits plans are: $46m for the UK (including $37m of supplementary payments), $22m for the US Plan and $6m for other funded defined benefit plans. The table above does not include amounts payable in respect of 2016 and beyond as these are subject to future agreement and amounts cannot be reasonably estimated.
There are a number of agreements that take effect, alter or terminate upon a change in control of the Company or the Group following a takeover, such as bank loan agreements and Company share plans. None of these are deemed to be significant in terms of their potential impact on the business of the Group as a whole. In addition, there are service contracts between the Company and its Executive Directors which provide for the automatic payment of a bonus following loss of office or employment occurring because of a successful takeover bid. Further details are set out on page 100.
The Company does not have contracts or other arrangements which individually are essential to the business.
2013 Financial highlights
Revenue
Group revenue increased by $214m (5% on a reported basis), from $4,137m in 2012 to $4,351m in 2013. The underlying increase is 4%Growth after adjusting for the net impact of 2% on the Healthpoint acquisition and Clinical Therapies disposal and 1% attributable to the unfavourable impacteffects of currency movements.
Cost of goods sold
Cost of goods sold increased by $30m (3% on a reported basis) from $1,070m in 2012 to $1,100m in 2013. The underlying movement is 2% after adjusting for the net impact of 2% on the Healthpoint acquisition and Clinical Therapies disposal and 1% attributable to the favourable impact of currency movements. The movement in underlying costs of goods sold of 2% is largely attributable to the increase in underlying trading.
During 2013, $12m of restructuring and rationalisation expenses (2012 – $3m) and $5m of acquisition related costs (2012 – $nil) were charged to cost of goods sold.
Selling, general and administration expenses
Selling, general and administrative expenses increased by $160m (8% on a reported basis) from $2,050m in 2012 to $2,210m in 2013. The underlying movement is 6% after adjusting for the net impact of 3% on the Healthpoint acquisition and Clinical Therapies disposal and 1% attributable to the favourable impact of currency movements.
The underlying increase of 6% is due to the continuing investment in Emerging & International Markets, promotion of new products in ASD and AWMtranslation and the underlying increase in trading.
In 2013, administrative expenses included $64m of amortisation of other intangible assets (2012 – $51m), $46m of restructuring and rationalisation expenses (2012 – $62m), an amount of $88m relating to amortisation of acquisition intangibles (2012 – $43m) and $26m of acquisition related costs (2012 – $11m).
Research and development expenses
Research and development expenditure as a percentage of revenue increased by 1.2% to 5.3% in 2013 (2012 – 4.1%). Actual expenditure was $231m in 2013 compared to $171m in 2012. The Group continues to invest in innovative technologies and products to differentiate it from competitors.
Operating profit
Operating profit decreased by $36m to $810m from $846m in 2012. This comprised a decrease of $12m in Advanced Surgical Devices and a decrease of $24m in Advanced Wound Management.
The movement in Advanced Surgical Devices is attributable to the continuing pressure on margins and its investment in the Emerging & International Markets. Advanced Wound Management has continued to invest in new products and new geographic markets throughout the year.
Net interest receivable/(payable)
Net interest receivable increased, by $2m, from net $2m receivable in 2012 to a net receivable of $4m in 2013. This increase is principally a consequenceinclusion of the interest receivable on the Bioventus LLC (‘Bioventus’) loan note issued following the disposal of the Clinical Therapies business which has been in place for a full year in 2013 compared to eight months in 2012. This loan note was repaid in full in 2014.
Other finance cost
Other finance costs in 2013 remained at $11m and principally relate to costs associated with the Group’s retirement benefit schemes.
Taxation
The taxation charge decreased, by $125m, to $246m from $371m in 2012. The rate of tax was 30.5%, compared with 33.7% in 2012.
After adjusting for specific transactions that management considers affect the Group’s short-term profitability (profit on disposal of the Clinical Therapies business, restructuring and rationalisation expenses, amortisation of acquisition intangibles and acquisition-related costs) the tax rate was 29.2% (2012 – 29.9%).
Group balance sheet
The following table sets out certain balance sheet data as at 31 December of the years indicated:
| | | | | | | | | | | | 2013 $ million | | | | 2012 $ million | | Non-current assets | | | 3,563 | | | | 3,498 | | Current assets | | | 2,256 | | | | 2,144 | | Total assets | | | 5,819 | | | | 5,642 | | Non-current liabilities | | | 699 | | | | 828 | | Current liabilities | | | 1,073 | | | | 930 | | Total liabilities | | | 1,772 | | | | 1,758 | | Total equity | | | 4,047 | | | | 3,884 | | Total equity and liabilities | | | 5,819 | | | | 5,642 | |
180Smith & Nephew Annual report 2014
Non-current assets
Non-current assets increased by $65m to $3,563m in 2013 from $3,498m in 2012. This is principally attributable to the following:
– | Property, plant and equipment increased by $23m from $793m in 2012 to $816m in 2013. Depreciation of $209m was charged during 2013 and assets with a net book value of $12m were disposed of. These movements were offset by $242m of additions relating primarily to instruments and other plant & machinery and $5m of additions arising on acquisitions in Turkey, Brazil and India. The balance relates to unfavourable currency movements totalling $3m |
– | Goodwill increased by $70m from $1,186m in 2012 to $1,256m in 2013. Of this movement, $37m arose on acquisitions in Turkey, Brazil and India. An additional $16m arose on finalisation of the Healthpoint opening balance sheet. The remaining balance relates to favourable currency movements totalling $17m |
– | Intangible assets decreased by $10m from $1,064m in 2012 to $1,054m in 2013. Intangible assets totalling $64m arose on the acquisition in Turkey, Brazil and India. There was a reduction of $11m on finalisation of the Healthpoint opening balance sheet. Amortisation of $152m was charged during the year and assets with a net book value of $11m were disposed of. A total of $98m relates to the cost of intellectual property, distribution rights and software acquired. The balance relates to favourable currency movements totalling $2m |
– | Investment in associates (including a loan to an associate of $178m in 2013, up from $167m in 2012) has increased from $283m in 2012 to $285m in 2013. This movement relates to the interest of $11m arising on the Bioventus loan note which was largely offset from the disposal of the Group’s 49% interest in the Austrian entities Plus Orthopedics GmbH and Intraplant GmbH and its 20% interest in the German entity Intercus GmbH |
– | Deferred tax assets decreased by $19m in the year from $164m in 2012 to $145m in 2013. |
Current assets
Current assets increased by $112m to $2,256m from $2,144m in 2012. The movement relates to the following:
– | Inventories rose by $105m to $1,006m in 2013 from $901m in 2012. This movement is principally attributable to an increase of $48m in the US due to inventory build prior to the launch of JOURNEY II BCS and an increase of $17m due to inventory build in our Hull factory prior to the transfer of part of our Wound production to China. A further increase of $12m arose on the acquisitions in Turkey, Brazil and India. The movement also includes $6m of unfavourable currency movement |
– | The level of trade and other receivables increased by $48m to $1,113m in 2013 from $1,065m in 2012. The movement primarily relates to the increase in underlying revenues and includes $9m of unfavourable currency movements |
– | Cash at bank has fallen by $41m to $137m from $178m in 2012. |
Non-current liabilities
Non-current liabilities decreased by $129m from $828m in 2012 to $699m in 2013. This movement relates to the following items:
– | Long-term borrowings have decreased from $430m in 2012 to $347m in 2013 |
– | The Retirement benefit obligation decreased by $36m to $230m in 2013 from $266m in 2012. This was largely due to the Group’s additional pension contributions, together with net actuarial gains for the year |
– | Deferred tax liabilities decreased by $11m in the year from $61m in 2012 to $50m in 2013. |
Current liabilities
Current liabilities increased by $143m from $930m in 2012 to $1,073m in 2013. This movement is attributable to:
– | Bank overdrafts and current borrowings have increased by $6m from $38m in 2012 to $44m in 2013 |
– | Trade and other payables have increased by $129m to $785m in 2013 from $656m in 2012. This increase includes $50m largely driven from strong sales performance in the US in quarter four and a $23m increase in Europe associated with promotional activities in Advanced Surgical Devices. A total of $19m of trade and other payables arose on the acquisitions in Turkey, Brazil and India and an amount of $5m is attributable to favourable currency movements. |
– | Current tax payable is $184m at the end of 2013 compared to $177m in 2012. |
Total equity
Total equity increased by $163m from $3,884m in 2012 to $4,047m in 2013. The principal movements were:
| | | | | | |
| Total equity
$ million |
| 1 January 2013
| | | 3,884 | | Attributable profit
| | | 556 | | Currency translation gains
| | | (6 | ) | Hedging reserves
| | | 5 | | Actuarial gains on retirement benefit obligations
| | | 12 | | Dividends paid during the year
| | | (239 | ) | Purchase of own shares
| | | (231 | ) | Taxation benefits on Other Comprehensive Income and equity items
| | | (16 | ) | Net share-based transactions
| | | 82 | | 31 December 2013 | | | 4,047 | |
Smith & Nephew Annual report 2014 181
OTHER INFORMATION
Other financial informationcontinued
2013 Financial performance by business segment
Revenue by market
The underlying increase in each division’s revenues, by market, reconciles to reported growth, the most directly comparable financial measure calculated in accordance with IFRS, as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2013 $ million | | | | 2012 $ million | | | | | | Reported growth in revenue % | | |
| Constant currency exchange effect
% |
| |
| Acquisition/ Disposal effect
% |
| | | Underlying growth in revenue % | | Advanced Surgical Devices | | | | | | | | | | | | | | | | | | | | | | | | | | | US | | | 1,391 | | | | 1,449 | | | | | | (4 | ) | | | – | | | | 5 | | | | 1 | | Other Established Markets | | | 1,204 | | | | 1,298 | | | | | | (7 | ) | | | 2 | | | | 2 | | | | (3 | ) | Established Markets | | | 2,595 | | | | 2,747 | | | | | | (6 | ) | | | 1 | | | | 4 | | | | (1 | ) | Emerging & International Markets | | | 420 | | | | 361 | | | | | | 16 | | | | 2 | | | | – | | | | 18 | | Advanced Surgical Devices | | | 3,015 | | | | 3,108 | | | | | | (3 | ) | | | 1 | | | | 3 | | | | 1 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Advanced Wound Management | | | | | | | | | | | | | | | | | | | | | | | | | | | US | | | 471 | | | | 202 | | | | | | 133 | | | | – | | | | (111 | ) | | | 22 | | Other Established Markets | | | 722 | | | | 705 | | | | | | 3 | | | | 1 | | | | (1 | ) | | | 3 | | Established Markets | | | 1,193 | | | | 907 | | | | | | 32 | | | | 1 | | | | (23 | ) | | | 10 | | Emerging & International Markets | | | 143 | | | | 122 | | | | | | 17 | | | | 3 | | | | – | | | | 20 | | Advanced Wound Management | | | 1,336 | | | | 1,029 | | | | | | 30 | | | | 1 | | | | (20 | ) | | | 11 | |
Advanced Surgical Devices
Revenue
ASD revenue decreased by $93m (-3% on a reported basis) from $3,108m in 2012 to $3,015m in 2013. The underlying increase of 1% is after adjusting for a net 3% adverse impact from the disposal of the Clinical Therapies business in 2012 and the acquisitions completed in quarter four 2013, and a 1% unfavourable foreign currency translation.
In the US, revenue decreased by $58m to $1,391m in 2013 from $1,449m in 2012 (-4% on a reported basis). The underlying increase of 1% is after adjusting 5% for the adverse impact of the Clinical Therapies disposal in 2012. In Other Established Markets, revenue was $1,204m in 2013, a decrease of $94m from $1,298m in 2012 (-7% on a reported basis). The underlying decrease was 3% after adjusting for the adverse impact of 2% on the Clinical Therapies disposal in 2012, and 2% from unfavourable foreign currency translation. Our Emerging & International Markets revenue increased by $59m to $420m in 2013 from $361m in 2012 (16% increase on a reported basis). The underlying increase was 18% after adjusting 2% for unfavourable foreign currency translation.
In the global Knee Implant franchise, revenue decreased by $9m from $874m in 2012 to $865m in 2013 (-1% on a reported basis), representing flat underlying revenue performance after 1% of unfavourable currency translation. Growth has been impacted by exposure to a weakening European market with conditions continuing to deteriorate in Germany, our largest European market, and our position in the product life cycle versus our peers. Growth improved in the second half of the year driven by sales of the Journey II BCS Knee System and benefits from the VERILAST bearing surface TV advertising campaign in the US.
Global revenue from the Hip Implant franchise decreased by $13m from $666m in 2012 to $653m in 2013 (-2% on a reported basis), which represented an underlying revenue decline of 1% after 1% unfavourable foreign currency translation. Continuing metal-on-metal headwinds have contributed to this decline.
Trauma & Extremities revenue increased by $12m from $474m in 2012 to $486m in 2013 (3% on a reported basis). This represents underlying revenue growth of 4% after 1% of unfavourable foreign currency translation. During 2013, benefits were seen from the additional extremities US sales representatives recruited earlier in the year.
Sports Medicine Joint Repair revenue increased by $22m from $474m in 2012 to $496m in 2013 (5% on reported basis), representing underlying revenue growth of 7% and 2% of unfavourable foreign currency translation. This reflects a strong contribution across all key joint types and geographies.
Global revenue from Arthroscopic Enabling technologies decreased by $17m from $458m in 2012 to $441m in 2013 (-4% on a reported basis). This decrease represents an underlying revenue decline of 2% and 2% of unfavourable foreign currency translation.
The revenue in the Other ASD franchise fell by $88m from $162m in 2012 to $74m in 2013 following the disposal of the Clinical Therapies business in 2012. Excluding the impact of this disposal, underlying revenue in the Other ASD franchise, which includes gynaecology, grew by 14% with the remaining Clinical Therapies geographies contributing $9m.
182Smith & Nephew Annual report 2014
Trading and operating profit
Operating profit, the most directly comparable financial measure in accordance with IFRS, reconciles to trading profit as follows:
| | | | | | | | | | | | 2013 $ million | | | | 2012 $ million | | Operating profit | | | 620 | | | | 632 | | Acquisition related costs | | | 7 | | | | – | | Restructuring and rationalisation costs | | | 44 | | | | 57 | | Amortisation of acquisition intangibles and impairments | | | 41 | | | | 39 | | Trading profit | | | 712 | | | | 728 | |
Trading profit margin increased from 23.4% to 23.6%. Trading profit decreased by $16m to $712m from $728m in 2012. This decrease reflects the impact of the CT disposal in May 2012, the impact of the US medical device excise tax and the cost of planned investments in the Knee Implants and Trauma franchises and Emerging & International Markets offset by benefits from our structural efficiency programme.
Operating profit decreased by $12m from $632m in 2012 to $620m in 2013. This comprises the decrease in trading profit of $16m discussed above, an increase in acquisition related costs of $7m, an increase in amortisation of acquisition intangibles of $2m, partially offset by a decrease in restructuring and rationalisation costs of $13m.
Advanced Wound Management
Revenue
AWM revenue increased by $307m (30% on a reported basis), from $1,029m in 2012 to $1,336m in 2013. The underlying increase of 11% is after adjusting for an increase of 20% for the acquisitions completed in the year and a 1% unfavourable foreign currency translation.
In the US, revenue increased by $269m to $471m in 2013 from $202m in 2012 (133% on a reported basis). The underlying increase of 22% is after adjusting 111% for the impact of acquisitions. In Other Established Markets, revenue was $722m in 2013, an increase of $17m from $705m in 2012 (3% on a reported basis). The underlying revenue increase was also 3% with the 1%comparative impact of acquisitions offset by 1%and exclusion of unfavourable foreign currency translation. Our Emerging & International Markets revenue increased by $21m in 2012 (17% on a reported basis). The underlying increase was 20% after adjusting 3% for unfavourable foreign currency translation.disposals.
| Advanced Wound Care revenue decreased by $6m (-1% on a reported basis) from $849m in 2012 to $843m in 2013. The underlying growthUS
| United States of 1% is after adjusting for foreign currency translation. Conditions across many European markets remain challenging but the introduction of the ALLEVYN Life range continues to make good progress across Europe following product introductions and investment in marketing. Advance Wound Devices revenue increased from $180m in 2012 to $213m in 2013, a reported increase of $33m and 18%. The underlying growth of 20% is after adjusting for unfavourable foreign currency translations of 2%. This growth was impacted by continued gain in market share in NPWT, and our recent expansion into the emerging markets.
Advanced Wound Bioactives revenue of $280m in 2013 (2012 – $nil) relates to Healthpoint acquired in December 2012. The underlying increase, adjusted to include the results of Healthpoint for the commensurate period in 2012, was 47%.
Trading and operating profit
Operating profit, the most directly comparable financial measure in accordance with IFRS, reconciles to trading profit as follows:
| | | | | | | | | | | | 2013 $ million | | | | 2012 $ million | | Operating profit | | | 190 | | | | 214 | | Acquisition related costs | | | 24 | | | | 11 | | Restructuring and rationalisation costs | | | 14 | | | | 8 | | Amortisation of acquisition intangibles and impairments | | | 47 | | | | 4 | | Trading profit | | | 275 | | | | 237 | |
Trading profit margin decreased from 23.1% to 20.6%. Trading profit increased by $38m to $275m from $237m in 2012. The increase in the year is primarily attributable to the full year benefit of the Healthpoint acquisition and growth in the Emerging & International Markets, partially offset by additional investment in R&D and sales and marketing. The decrease in trading margin reflects these same investments, combined with price and mix changes at a gross margin level.
Operating profit decreased by $24m from $214m in 2012 to $190m in 2013. This comprises of the increase in trading profit of $38m discussed above, offset by an increase of $43m in amortisation of acquisition intangibles and an increase in acquisition related costs of $13m, both due to the Healthpoint acquisition which completed in December 2012, and an increase in restructuring and rationalisation costs of $6m.
Smith & Nephew Annual report 2014 183
OTHER INFORMATION
Information for shareholders
| | | Financial calendar
| | | Annual General Meeting | | 9 April 2015 | First quarter trading report | | 30 April 2015 | Payment of 2014 final dividend | | 6 May 2015 | Half year results announced | | 30 July 2015 (i) | Third quarter trading report | | 29 October 2015 | Payment of 2015 interim dividend | | November 2015 | Full year results announced | | February 2016 (i) | Annual Report available | | February/March 2016 | Annual General Meeting | | April 2016 |
(i) | Dividend declaration dates. |
Annual General Meeting
The Company’s Annual General Meeting (AGM) will be held on 9 April 2015 at 2pm at No. 11 Cavendish Square, London, W1G 0AN. Registered shareholders have been sent either a Notice of Annual General Meeting or notification of availability of the Notice of Annual General Meeting.
Corporate Headquarters and Registered Office
The corporate headquarters is in the UK and the registered office address is: Smith & Nephew plc, 15 Adam Street, London, W2N 6LA, UK. Registered in England and Wales No. 324357. Tel. +44 (0)20 7401 7646 website: www.smith-nephew.com
Ordinary shareholders
Registrar
All general enquiries concerning shareholdings, dividends, changes to shareholders’ personal details and the AGM should be addressed to:
Equiniti, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA
Tel: 0871 384 2081 *
Tel: +44 (0) 121 415 7072 from outside the UK
Website: www.shareview.co.uk
* | Calls to this number are charged at 8p per minute plus network extras. Lines are open from 8.30am to 5.30pm Monday to Friday, excluding UK public holidays. |
Shareholder facilities
Shareview
Equiniti’s on-line enquiry and portfolio management service for shareholders. To view information about your shareholdings online, register at www.shareview.co.uk. Once registered for Shareview, you will also be able to elect to receive future shareholder communications via the Company’s website (www.smith-nephew.com), update your address details or dividend payment instructions and register your proxy instructions on-line.
E-communications
We encourage you to elect to receive communications via e-mail as this has significant environmental and cost benefits. You may register for this service through Equiniti, at www.shareview.co.uk. You will receive a confirmation letter from Equiniti at your registered address, containing an Activation Code for future use.
Payment of dividends direct to your bank or building society account
If you who wish to avoid the risk of your dividend awards getting lost or mislaid you can arrange to have your cash dividends paid directly to a bank or building society account. This facility is available to UK resident shareholders who receive sterling dividends. If you do not live in the UK you may be able to register for the overseas payment service. Further information is available at www.shareview.co.uk or by contacting Equiniti (UK and overseas helpline numbers as above).
Dividend reinvestment plan (DRIP)
The Company offers shareholders (except those in North America) the opportunity to participate in a DRIP. This enables you to reinvest your cash dividends in further ordinary shares of Smith & Nephew plc. These are purchased in the market at competitive dealing costs. For further details plus an application form to reinvest future dividends, contact Equiniti.
Duplicate accounts
If you have more than one account due to inconsistency in account details you may avoid duplicate mailings by contacting Equiniti and requesting an amalgamation of your share accounts.
Keep your personal details up to date
Please remember to tell Equiniti if you move house or change bank details or there is any other change in your account information. You can update your information on-line via the Shareview portfolio if you are a Smith & Nephew Shareview member. If you do not have a portfolio you will need to write to Equiniti or complete a change of address form which can be downloaded from Shareview. If you hold 2,500 shares or fewer, you can also change your address or update your bank details quickly and easily over the phone using the contact details provided.
Individual savings account (ISA)
Shareholders who are UK resident may hold Smith & Nephew plc shares in an Individual Savings Account (ISA), which is administered by the Company’s registrar. For information about this service please contact Equiniti.
Shareholder communications
We make quarterly financial announcements which are made available through Stock Exchange announcements and on the Group’s website (www.smith-nephew.com). Copies of recent Annual Reports, press releases, institutional presentations and audio webcasts are also available on the website.
We send paper copies of the Notice of Annual General Meeting and Annual Report only to those shareholders and ADS holders who have elected to receive shareholder documentation by post. Electronic copies of the Annual Report and Notice of Annual General Meeting are available on the Group’s website at www.smith-nephew.com. Both ordinary shareholders and ADS holders can request paper copies of the Annual Report, which the Company provides free of charge. The Company will continue to send to ordinary shareholders by post the Form of Proxy notifying them of the availability of the Annual Report and Notice of Annual General Meeting on the Group’s website. If you elect to receive the Annual Report and Notice of Annual General Meeting electronically you are informed by e-mail of the documents’ availability on the Group’s website. ADS holders receive the Form of Proxy by post, but will not receive a paper copy of the Notice of Annual General Meeting.
184Smith & Nephew Annual report 2014
Investor communications
The Company maintains regular dialogue with individual institutional shareholders, together with results presentations. To ensure that all members of the Board develop an understanding of the views of major investors, the Executive Directors review significant issues raised by investors with the Board. Non-executive Directors are sent copies of analysts’ and brokers’ briefings. There is an opportunity for individual shareholders to question the Directors at the Annual General Meeting and the Company regularly responds to letters from shareholders on a range of issues.
UK capital gains tax
For the purposes of UK capital gains tax the price of the Company’s ordinary shares on 31 March 1982 was 35.04p.
Smith & Nephew share price
The Company’s ordinary shares are quoted on the London Stock Exchange under the symbol SN. The Company’s share price is available on the Smith & Nephew website www.smith-nephew.com and at www.londonstockexchange.com where the live financial data is updated with a 15-minute delay.
ShareGift
If you hold a small number of shares, which would cost more to sell than they are worth, you may wish to consider donating them to the charity ShareGift (registered charity 1052686) which specialises in accepting such shares as donations. There are no implications for Capital Gains Tax purposes (no gain or loss) and it may also be possible to obtain income tax relief. The relevant stock transfer form may be obtained from Equiniti at the address given on page 184.
Further information about ShareGift is available at www.sharegift.org or by contacting ShareGift at:
ShareGift, PO BOX 72253 London SW1P 9LQ
Tel: (+44) (0) 20 7930 3737
Unauthorised brokers (boiler room scams)
You are advised to be very wary of any unsolicited advice, offers to buy shares at a discount or offers of free company reports. These are typically from overseas-based ‘brokers’ who target UK shareholders offering to sell them what often turn out to be worthless or high-risk shares in US or UK investments. These operations are commonly known as ‘boiler rooms’.
If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme if things go wrong. If you receive any unsolicited investment advice, obtain the correct name of the person and organisation and check that they are properly authorised by the FCA by visiting www.fca.org.uk/register/.
If you think you have been approached by an unauthorised firm you should contact the FCA consumer helpline on 0800 111 6768 or e-mail consumer.queries@fca.org.uk.
More detailed information can be found on the FCA website at www.fca.org.uk/consumers/protect-yourself/unauthorised-firms.
Social media
Smith & Nephew has a presence across a range of social media channels, including Twitter, Facebook and LinkedIn, which are linked below. Information provided by Smith & Nephew through social media channels is not incorporated by reference herein and does not form part of our annual report on Form 20-F.
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| | https://twitter.com/SmithNephewPLCAmerica.
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| | www.facebook.com/SmithNephewPlc
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| | http://www.linkedin.com/company/smith-&-nephew
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American Depositary Shares (ADSs) and American Depositary Receipts (ADRs)
In the USA, the Company’s ordinary shares are traded in the form of ADSs, evidenced by ADRs, on the New York Stock Exchange under the symbol SNN. Each American Depositary Share represents two ordinary shares. Deutsche Bank is the authorised depositary bank for the Company’s ADR programme.
ADS enquiries
All enquiries regarding ADS holder accounts and payment of dividends should be addressed to:
Deutsche Bank Shareholder Services
American Stock Transfer and Trust Company
Operations Centre 6210 15th Avenue
Brooklyn, New York
Tel: +1 800 937-5449 (toll free from US)
Tel: +1 718 921-8124 (direct dial)
E-mail: DB@amstock.com
Website: www.adr.db.com
The Company provides Deutsche Bank, as depositary, with copies of Annual Reports containing Consolidated Financial Statements and the opinion expressed thereon by its independent auditor. Such financial statements are prepared under IFRS. Deutsche Bank will send these reports to recorded ADS holders who have elected to receive paper copies. The Company also provides to Deutsche Bank all notices of shareholders’ meetings and other reports and communications that are made generally available to shareholders of the Company. Deutsche Bank makes such notices, reports and communications available for inspection by recorded holders of ADSs and sends voting instruction forms by post to all recorded holders of ADSs.
Smith & Nephew Annual report 2014 185
OTHER INFORMATION
Information for shareholderscontinued
Smith & Nephew ADS price
The Company’s ADS price can be obtained from the official New York Stock Exchange website at www.nyse.com, the Smith & Nephew website www.smith-nephew.com, and is quoted daily in the Wall Street Journal where the live financial data is updated with a 15-minute delay.
ADS payment information
The Company hereby discloses ADS payment information for the year ended 31 December 2014 in accordance with the Securities and Exchange Commission rules 12.D.3 and 12.D.4 relating to Form 20-F filings by foreign private issuers. The depositary collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors, including payment of dividends by the Company by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depository services by deductions from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fee for those services are paid.
| | | Persons depositing or withdrawing shares must pay: | | For: | $5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
$0.05 (or less) per ADS
| | Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property
Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates
Any cash distribution to ADS registered holders, including payment of dividend
| $0.05 (or less) per ADS per calendar year
Registration or transfer fees
| | Depositary services
Transfer and registration of shares on our share register to or from the name of the depositary or its agent when shares are deposited or withdrawn
| Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes | | As necessary | Any charges incurred by the depositary or its agents for servicing the deposited securities | | As necessary |
During 2014, a fee of two US cents per ADS was paid on the 2013 final dividend by The Bank of New York Mellon which totaled $111,563.54.
On 1 October 2014 Smith & Nephew changed ADR bank to Deutsche Bank Trust Company Americas. A fee of one US cent per ADS was deducted from the 2014 interim dividend paid in November which totaled $178,537.00. Therefore, for the period 1 January 2014 to 23 February 2015, the total reimbursed by The Bank of New York Mellon and Deutsche Bank Trust Company Americas was $290,100.54.
On 14 October 2014 the ratio for ordinary shares per ADS changed from five ordinary shares per ADS to two ordinary shares per ADS.
186Smith & Nephew Annual report 2014
Dividend history
Smith & Nephew has paid dividends on its ordinary shares in every year since 1937. Following the capital restructuring and dividend reduction in 2000 the Group adopted a policy of increasing its dividend cover (the ratio of EPSA, as set out in the ‘Selected financial data’, to ordinary dividends declared for the year). This was intended to increase the financing capability of the Group for acquisitions and other investments. From 2000 to 2004 the dividend increased in line with inflation and, in 2004, dividend cover stood at 4.1 times. Having achieved this level of dividend cover the Board changed its policy, from that of increasing dividends in line with inflation, to that of increasing dividends for 2005 and after by 10%. Following the redenomination of the Company’s share capital into US Dollars, the Board re-affirmed its policy of increasing the dividend by 10% a year in$ or cents or ¢
| References to US Dollar terms. On 2 August 2012, the Board announced its intention to pursue a progressive dividend policy, with the aim of increasing the US Dollar value of ordinary dividends over time broadly based on the Group’s underlying growth in earnings, while taking into account capital requirements and cash flows.
At the time of the full year results the Board reviews the appropriate level of total annual dividend each year. The Board intends that the interim dividend will be set by a formula and will becurrency. 1 cent is equivalent to 40%one hundredth of the total dividend for the previous year. Dividends will continue to be declared in US Dollars with an equivalent amount in sterling payable to those shareholders whose registered address is in the UK, or who have validly elected to receive sterling dividends.US$1.
|
An interim dividend in respect of each fiscal year is normally declared in August and paid in November. A final dividend will be recommended by the Board of Directors and paid subject to approval by shareholders at the Company’s Annual General Meeting.
| Future dividends of Smith
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | 198GROUP AND OTHER INFORMATION | SMITH & Nephew will be dependent upon: future earnings; the future financial condition of the Group; the Board’s dividend policy; and the additional factors that might affect the business of the Group set out in ‘Special note regarding forward-looking statements’ and ‘Risk Factors’.NEPHEW ANNUAL REPORT 2017 Dividends per share
The table below sets out the dividends per Ordinary Share in the last five years.
| | | | | | | | | | | | | Years ended 31 December | | | 2014 | | 2013 | | 2012 | | 2011 | | 2010 | Pence per share: | | | | | | | | | | | Interim | | 7.578 | | 7.211 | | 6.811 | | 4.639 | | 4.233 | Final (i) | | 13.377 | | 11.233 | | 11.778 | | 7.444 | | 6.639 | Total | | 20.995 | | 18.444 | | 18.589 | | 12.083 | | 10.872 | US cents per share: | | | | | | | | | | | Interim | | 12.222 | | 11.556 | | 11.000 | | 7.333 | | 6.667 | Final | | 20.667 | | 18.889 | | 18.000 | | 12.000 | | 10.911 | Total | | 32.889 | | 30.445 | | 29.000 | | 19.333 | | 17.578 |
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INFORMATION FOR SHAREHOLDERS continued (i) | Translated at the Bank of England rate on 23 February 2015. |
Dividends above include the associated UK tax credit of 10%, but exclude the deduction of withholding taxes. All dividends, up to the second interim dividend for 2005, were declared in pence per ordinary share and translated into US cents per ordinary share at the Noon Buying Rate on the payment date. Since the second interim dividend for 2005 all dividends have been declared in US cents per ordinary share.
The 2014 final dividend will be payable on 6 May 2015, subject to shareholder approval.
In respect of the proposed final dividend for the year ended 31 December 2014 of 18.6 US cents per ordinary share, the record date will be 17 April 2015 and the payment date will be 6 May 2015. The sterling equivalent per ordinary share will be set following the record date. Shareholders may elect to receive their dividend in either sterling or US Dollars and the last day for election will be 17 April 2015. The ordinary shares will trade ex-dividend on both the London and New York Stock Exchanges from 16 April 2015.
The proposed final dividend of 18.6 US cents per ordinary share, which together with the interim dividend of 11 US cents, makes a total for 2014 of 29.6 US cents.
Smith & Nephew Annual report 2014 187
OTHER INFORMATION
Information for shareholderscontinued
Share prices
The table below sets out, for the periods indicated, the highest and lowest middle market quotations for the Company’s ordinary shares (as derived from the Daily Official List of the UK Listing Authority) and the highest and lowest sales prices of its ADSs (as reported on the New York Stock Exchange composite tape).
| | | | | | | | | | | | | | | | | | | | | | Ordinary shares | | | | | | ADSs | | | | High | | | Low | | | | | High | | | Low | | | | | £ | | | | £ | | | | | | US$ | | | | US$ | | Year ended 31 December: | | | | | | | | | | | | | | | | | | | 2010 | | | 6.97 | | | | 5.38 | | | | | | 53.94 | | | | 41.29 | | 2011 | | | 7.42 | | | | 5.21 | | | | | | 60.19 | | | | 42.17 | | 2012 | | | 6.93 | | | | 5.80 | | | | | | 56.13 | | | | 45.13 | | 2013 | | | 8.68 | | | | 6.80 | | | | | | 71.85 | | | | 52.90 | | 2014* | | | 11.93 | | | | 8.57 | | | | | | 97.27 | | | | 29.39 | | Quarters in the year ended 31 December: | | | | | | | | | | | | | | | | | | | 2013: | | | | | | | | | | | | | | | | | | | 1st Quarter | | | 7.60 | | | | 6.80 | | | | | | 58.00 | | | | 52.90 | | 2nd Quarter | | | 7.95 | | | | 7.18 | | | | | | 60.17 | | | | 54.83 | | 3rd Quarter | | | 8.00 | | | | 7.30 | | | | | | 63.06 | | | | 56.01 | | 4th Quarter | | | 8.68 | | | | 7.48 | | | | | | 71.85 | | | | 60.05 | | 2014: | | | | | | | | | | | | | | | | | | | 1st Quarter | | | 9.60 | | | | 8.57 | | | | | | 80.18 | | | | 70.84 | | 2nd Quarter | | | 11.00 | | | | 8.61 | | | | | | 97.27 | | | | 73.17 | | 3rd Quarter | | | 10.80 | | | | 9.86 | | | | | | 90.45 | | | | 82.91 | | 4th Quarter* | | | 11.93 | | | | 9.06 | | | | | | 83.14 | | | | 29.39 | | 2015: | | | | | | | | | | | | | | | | | | | 1st Quarter (to 23 February 2015) | | | 12.00 | | | | 11.48 | | | | | | 36.71 | | | | 35.07 | | Last six months: | | | | | | | | | | | | | | | | | | | August 2014 | | | 10.65 | | | | 9.86 | | | | | | 89.50 | | | | 82.91 | | September 2014 | | | 10.80 | | | | 10.23 | | | | | | 88.15 | | | | 83.29 | | October 2014 (1 to 14 October 2014)* | | | 10.32 | | | | 9.74 | | | | | | 83.14 | | | | 77.36 | | October 2014 (15 to 31 October 2014) | | | 10.57 | | | | 9.06 | | | | | | 33.83 | | | | 29.39 | | November 2014 | | | 11.38 | | | | 10.45 | | | | | | 36.12 | | | | 33.21 | | December 2014 | | | 11.93 | | | | 10.19 | | | | | | 38.52 | | | | 32.06 | | January 2015 | | | 12.00 | | | | 11.48 | | | | | | 36.40 | | | | 35.07 | | February 2015 (to 23 February 2015) | | | 11.98 | | | | 11.55 | | | | | | 36.71 | | | | 35.17 | |
* On 14 October 2014 the ratio of ordinary shares per ADS changed from five ordinary shares per ADS to two ordinary shares per ADS.
188Smith & Nephew Annual report 2014
Share Capital
The principal trading market for the ordinary shares is the London Stock Exchange. The ordinary shares were listed on the New York Stock Exchange on 16 November 1999, trading in the form of ADSs evidenced by ADRs. Each ADS represents two ordinary shares from 14 October 2014, before which time one ADS represented five ordinary shares. The ADS facility is sponsored by Deutsche Bank acting as depositary.
All the ordinary shares, including those held by Directors and Executive Officers, rank pari passu with each other. On 23 January 2006 the ordinary shares of 12 2⁄9p were redenominated as ordinary shares of US 20 cents (following approval by shareholders at the extraordinary general meeting in December 2005). The new US dollar ordinary shares carry the same rights as the previous ordinary shares. The share price continues to be quoted in sterling. In 2006 the Company issued £50,000 of shares in sterling in order to comply with English law. These were issued as deferred shares, which are not listed on any stock exchange. They have extremely limited rights and therefore effectively have no value. These shares were allotted to the Chief Executive Officer, although the Board reserves the right to transfer them to another member of the Board should it so wish.
As at 23 February 2015, to the knowledge of the Group, there were 17,824 registered holders of ordinary shares, of whom 90 had registered addresses in the USA and held a total of 168,578 ordinary shares (less than 0.02% of the total issued). Because certain ordinary shares are registered in the names of nominees, the number of shareholders with registered addresses in the USA is not representative of the number of beneficial owners of ordinary shares resident in the USA.
Shareholdings
As at 23 February 2015, 26,707,860 ADSs equivalent to 53,415,720 ordinary shares or approximately 5.97% of the total ordinary shares in issue, were outstanding and were held by 92 registered ADS holders.
Major shareholders
As far as is known to Smith & Nephew, the Group is not directly or indirectly owned or controlled by another corporation or by any government and the Group has not entered into arrangements, the operation of which may at a subsequent date result in a change in control of the Group.
As at 23 February 2015, no persons are known to Smith & Nephew to have any interest (as defined in the Disclosure and Transparency Rules of the FCA) in 3% or more of the ordinary shares, other than as shown below. The following tables show changes over the last three years in the percentage and numbers of the issued share capital owned by shareholders holding 3% or more of ordinary shares, as notified to the Company under the Disclosure and Transparency Rules:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | As at 31 December | | | | | 23 February 2015 | | | | 2014 | | | | 2013 | | | | 2012 | | | | | % | | | | % | | | | % | | | | % | | BlackRock, Inc. | | | 5.5 | | | | 5.5 | | | | 4.7 | | | | 5.0 | | Invesco | | | 5.0 | | | | 5.3 | | | | 12.1 | | | | 11.9 | | Legal & General Group plc | | | – | | | | – | | | | – | | | | 3.0 | | Newton Investment Management Limited | | | – | | | | – | | | | – | | | | 4.9 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | As at 31 December | | | | | 23 February 2015 | | | | 2014 | | | | 2013 | | | | 2012 | | | | | ’000 | | | | ’000 | | | | ’000 | | | | ’000 | | BlackRock, Inc. | | | 49,206 | | | | 49,008 | | | | 41,870 | | | | 44,811 | | Invesco | | | 44,918 | | | | 47,508 | | | | 107,823 | | | | 107,823 | | Legal & General Group plc | | | – | | | | – | | | | – | | | | 26,906 | | Newton Investment Management Limited | | | – | | | | – | | | | – | | | | 8,432 | |
The Company is not aware of any person who has a significant direct or indirect holding of securities in the Company, and is not aware of any persons holding securities which may control the Company. There are no securities in issue which have special rights as to the control of the Company.
Smith & Nephew Annual report 2014 189
OTHER INFORMATION
Information for shareholderscontinued
Purchase of ordinary shares on behalf of the Company
At the AGM, the Company will be seeking a renewal of its current permission from shareholders to purchase up to 10% of its own shares. In order to avoid shareholder dilution, shares allotted to employees through employee share schemes are bought back on a quarterly basis and subsequently cancelled by the Company. From 1 January 2014 to 23 February 2015, in the months listed below, the Company has purchased 5,455,000 ordinary shares at a cost of US$91,595,439.
| | | | | | | | | | | | | | | | Total shares purchased (000s | ) | | | Average price paid per share (p | ) | | | Approximate US$ value of shares purchased under the plan | | 12-22 May 2014 | | | 1,825 | | | | 926.1138 | | | | 28,687,538 | | 6-19 August 2014 | | | 1,380 | | | | 1,026.3662 | | | | 23,833,629 | | 4-14 November 2014 | | | 1,200 | | | | 1,056.5981 | | | | 20,198,882 | | 13-18 February 2015 | | | 1,050 | | | | 1,168.3047 | | | | 18,875,390 | |
The shares were purchased in the open market by UBS Limited and JP Morgan Cazenove Limited on behalf of the Company.
Exchange controls and other limitations affecting security holders
There are no UK governmental laws, decrees or regulations that restrict the export or import of capital or that affect the payment of dividends, interest or other payments to non-resident holders of Smith & Nephew’s securities, except for certain restrictions imposed from time to time by Her Majesty’s Treasury of the United Kingdom pursuant to legislation, such as the United Nations Act 1946 and the Emergency Laws Act 1964, against the government or residents of certain countries.
There are no limitations, either under the laws of the UK or under the Articles of Association of Smith & Nephew, restricting the right of non-UK residents to hold or to exercise voting rights in respect of ordinary shares, except that where any overseas shareholder has not provided to the Company a UK address for the service of notices, the Company is under no obligation to send any notice or other document to an overseas address. It is, however, the current practice of the Company to send every notice or other document to all shareholders regardless of the country recorded in the register of members, with the exception of details of the Company’s dividend reinvestment plan, which are not sent to shareholders with recorded addresses in the USA and Canada.
Taxation information for shareholders
The comments below are of a general and summary nature and are based on the Group’s understanding of certain aspects of current UK and US federal income tax law and practice relevant to the ADSs and ordinary shares not in ADS form. The comments address the material US and UK tax consequences generally applicable to a person who is the beneficial owner of ADSs or ordinary shares and who, for US federal income tax purposes, is a citizen or resident of the USA, a corporation (or other entity taxable as a corporation) created or organised in or under the laws of the USA (or any State therein), or an estate or trust the income of which is included in gross income for US federal income tax purposes regardless of its source (each a ‘US Holder’). The comments set out below do not purport to address all tax consequences of the ownership of ADSs or ordinary shares which may be material to a particular holder and in particular do not deal with the position of shareholders who directly or indirectly own 10% or more of the Company’s issued ordinary shares. This discussion does not apply to (i) persons whose holding of ADSs or ordinary shares is effectively connected with or pertains to either a permanent establishment in the UK through which a US Holder carries on a business in the UK or a fixed base from which a US Holder performs independent personal services in the UK, or (ii) persons whose registered address is inside the UK. This discussion does not apply to certain investors subject to special rules, such as certain financial institutions, tax-exempt entities, insurance companies, broker-dealers, traders in securities that elect to
use the mark to market method of tax accounting, partnerships or other entities treated as partnerships for US federal income tax purposes, US Holders holding ADSs or ordinary shares as part of a hedging, conversion or other integrated transaction or whose functional currency for US federal income tax purposes is other than the US dollar and US Holders liable for alternative minimum tax. In addition, the comments below do not address the potential application of the provisions of the United States Internal Revenue Code, known as the Medicare contribution tax, or any US state, local or non-US (other than UK) taxes. The summary deals only with US Holders who hold ADSs or ordinary shares as capital assets. The summary is based on current UK and US law and practice which is subject to change, possibly with retroactive effect. US Holders are recommended to consult their own tax advisers as to the particular tax consequences to them of the ownership of ADSs or ordinary shares. The Company believes, and this discussion assumes, that the Company was not a passive foreign investment company for its taxable year ended 31 December 2014.
This discussion is based in part on representations by the depositary and assumes that each obligation under the deposit agreement and any related agreement will be performed in accordance with its terms. For purposes of US federal income tax law, US Holders of ADSs will generally be treated as owners of the ordinary shares represented by the ADSs. However, the US Treasury has expressed concerns that parties to whom depositary shares are released before shares are delivered to the depositary (‘pre-released’) may be taking actions that are inconsistent with the claiming of foreign tax credits by owners of depositary shares. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate US Holders. Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate US Holders of ADSs could be affected by actions that may be taken by parties to whom ADSs are pre-released.
Taxation of dividends in the UK and the USA
The UK does not currently impose a withholding tax on dividends paid by a UK corporation, such as the Company.
Distributions paid by the Company will be treated for US federal income tax purposes as foreign source ordinary dividend income to a US Holder to the extent paid out of the Company’s current or accumulated earnings and profits as determined for US federal income tax purposes. Because the Company does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions generally will be reported to US Holders as dividends. Such dividends will not be eligible for the dividends-received deduction generally allowed to corporate US Holders.
190Smith & Nephew Annual report 2014
Dividends paid to certain non-corporate US Holders of ordinary shares or ADSs may be subject to US federal income tax at lower rates than those applicable to other types of ordinary income if certain conditions are met. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at these favourable rates.
Taxation of capital gains
US Holders, who are not resident or ordinarily resident for tax purposes in the UK, will not generally be liable for UK capital gains tax on any capital gain realised upon the sale or other disposition of ADSs or ordinary shares unless the ADSs or ordinary shares are held in connection with a trade carried on in the UK through a permanent establishment (or in the case of individuals, through a branch or agency). Furthermore, UK resident individuals who acquire ADSs or ordinary shares before becoming temporarily non-UK residents may remain subject to UK taxation of capital gains on gains realised while non-resident.
For US federal income tax purposes, gains or losses realised upon a taxable sale or other disposition of ADSs or ordinary shares by US Holders generally will be US source capital gains or losses and will be long-term capital gains or losses if the ADSs or ordinary shares were held for more than one year. The amount of a US Holder’s gain or loss will be equal to the difference between the amount realised on the sale or other disposition and such holder’s tax basis in the ADSs, or ordinary shares, determined in US dollars.
Inheritance and estate taxes
The HM Revenue & Customs imposes inheritance tax on capital transfers which occur on death, and in the seven years preceding death. The HM Revenue & Customs considers that the US/UK Double Taxation Convention on Estate and Gift Tax applies to inheritance tax. Consequently, a US citizen who is domiciled in the USA and is not a UK national or domiciled in the UK will not be subject to UK inheritance tax in respect of ADSs and ordinary shares. A UK national who is domiciled in the USA will be subject to both UK inheritance tax and US federal estate tax but will be entitled to a credit for US federal estate tax charged in respect of ADSs and ordinary shares in computing the liability to UK inheritance tax. Conversely, a US citizen who is domiciled or deemed domiciled in the UK will be entitled to a credit for UK inheritance tax charged in respect of ADSs and ordinary shares in computing the liability for US federal estate tax. Special rules apply where ADSs and ordinary shares are business property of a permanent establishment of an enterprise situated in the UK.
US information reporting and backup withholding
A US Holder may be subject to US information reporting and backup withholding on dividends paid on or the proceeds of sales of ADSs or ordinary shares made within the USA or through certain US-related financial intermediaries, unless the US Holder is an exempt recipient or, in the case of backup withholding, provides a correct US taxpayer identification number and certain other conditions are met. US backup withholding may apply if there has been a notification from the US Internal Revenue Service of a failure to report all interest or dividends.
Any backup withholding deducted may be credited against the US Holder’s US federal income tax liability, and, where the backup withholding exceeds the actual liability, the US Holder may obtain a refund by timely filing the appropriate refund claim with the US Internal Revenue Service.
Certain US Holders who are individuals (and under proposed Treasury regulations, certain entities) may be required to report information relating to securities issued by a non-US person (or foreign accounts through which the securities are held), subject to certain exceptions (including an exception for securities held in accounts maintained by US financial institutions). US Holders should consult their tax advisers regarding their reporting obligations with respect to the ordinary shares or ADSs.
UK stamp duty and stamp duty reserve tax
UK stamp duty is charged on documents and in particular instruments for the transfer of registered ownership of ordinary shares. Transfers of ordinary shares in certificated form will generally be subject to UK stamp duty at the rate of 1⁄2% of the consideration given for the transfer with the duty rounded up to the nearest £5.
UK stamp duty reserve tax (‘SDRT’) arises when there is an agreement to transfer shares in UK companies ‘for consideration in money or money’s worth’, and so an agreement to transfer ordinary shares for money or other consideration may give rise to a charge to SDRT at the rate of 1⁄2% (rounded up to the nearest penny). The charge of SDRT will be cancelled, and any SDRT already paid will be refunded, if within six years of the agreement an instrument of transfer is produced to HM Revenue & Customs and the appropriate stamp duty paid.
Transfers of ordinary shares into CREST (an electronic transfer system) are exempt from stamp duty so long as the transferee is a member of CREST who will hold the ordinary shares as a nominee for the transferor and the transfer is in a form that will ensure that the securities become held in uncertificated form within CREST. Paperless transfers of ordinary shares within CREST for consideration in money or money’s worth are liable to SDRT rather than stamp duty. SDRT on relevant transactions will be collected by CREST at 1⁄2%, and this will apply whether or not the transfer is effected in the UK and whether or not the parties to it are resident or situated in the UK.
A charge of stamp duty or SDRT at the rate of 1 1⁄2% of the consideration (or, in some circumstances, the value of the shares concerned) will arise on a transfer or issue of ordinary shares to the depositary or to certain persons providing a clearance service (or their nominees or agents) for the conversion into ADRs and will generally be payable by the depositary or person providing clearance service. In accordance with the terms of the Deposit Agreement, any tax or duty payable by the depositary on deposits of ordinary shares will be charged by the depositary to the party to whom ADRs are delivered against such deposits.
No liability for stamp duty or SDRT will arise on any transfer of, or agreement to transfer, an ADS or beneficial ownership of an ADS, provided that the ADS and any instrument of transfer or written agreement to transfer remains at all times outside the UK, and provided further that any instrument of transfer or written agreement to transfer is not executed in the UK and the transfer does not relate to any matter or thing done or to be done in the UK (the location of the custodian as a holder of ordinary shares not being relevant in this context). In any other case, any transfer of, or agreement to transfer, an ADS or beneficial ownership of an ADS could, depending on all the circumstances of the transfer, give rise to a charge to stamp duty or SDRT.
Smith & Nephew Annual report 2014 191
OTHER INFORMATION
Information for shareholderscontinued
INDEX x | | | | | 2016 Financial highlights | 183 | | Information for shareholders | 184–200 | Accounting Policies | 114, 119–120 | | Intangible assets | 134–135 | Accounts Presentation | 199 | | Intellectual property | 149–150 | Acquisitions | 15, 37, 159–161 | | Interest and other finance costs | 126 | Acquisition related costs | 123, 180 | | Inventories | 137 | American Depositary Shares | 185–186 | | Investments | 136 | Articles of Association | The following summarises certain material192–193
| | Investment in associates | 136–137 | Audit fees | 76, 126 | | Key Performance Indicators | 11–15, 39 | Board | 50–53 | | Leases | 142, 161 | Business overview | 6–7, 171–175 | | Legal and other | 123, 180 | Business segment information | 18–24, 121–124 | | Legal proceedings | 149–150 | Cash and borrowings | 140–142 | | Liquidity and capital resources | 39, 142 | Chairman’s statement | 2–3 | | Manufacturing and quality | 29–30 | Chief Executive Officer’s review | 4–5 | | New accounting standards | 119–120 | Chief Financial Officer’s review | 36–37 | | Off-balance sheet arrangements | 171 | Company balance sheet | 163 | | Operating profit | 125–126 | Company notes to the accounts | 165–170 | | Other finance costs | 126 | Contingencies | 148–150, 166 | | Our marketplace | 16–17 | Contractual obligations | 182 | | Outlook and trend information | 16–17, 38–39, 171–175 | Corporate Governance Statement | 56 | | Parent Company accounts | 163–170 | Critical judgements and estimates | 114 | | People/Employees | 25–28 | Cross Reference to Form 20‑F | 194–195 | | Provisions | 148–150 | Currency fluctuations | 173 | | Property, plant and equipment | 131–132 | Currency translation | 120 | | Regulation | 17, 43 | Deferred taxation | 129 | | Related party transactions | 162, 171 | Directors’ Remuneration Report | 79–105 | | Research and development | 28–29 | Directors’ responsibility statement | 107 | | Restructuring and rationalisation expenses | 123, 180 | Dividends | 158, 186–187 | | Retirement benefit obligation | 150–155 | Earnings per share | 3, 37, 38, 130–131 | | Risk factors | 172–175 | Employees/People | 25–28 | | Risk report | 40–49 | Employees Share Trust | 162 | | Sales and marketing | 30–31 | Ethics and compliance | 32, 69–70 | | Selected financial data | 176–177 | Executive Officers | 54–55 | | Share based payments | 162 | Factors affecting results of operations | 175 | | Share capital | 156–158 , 188–189 | Financial instruments | 143–147 | | Strategic priorities | 10–15 | Financial review | 38–39 | | Sustainability | 33–35 | Glossary of terms | 196–197 | | Taxation | 127–129 | Goodwill | 133–134 | | Taxation information for shareholders | 190–191 | Group balance sheet | 116 | | Total shareholder return | 94 | Group cash flow statement | 117 | | Trade and other payables | 139 | Group companies | 167–168 | | Trade and other receivables | 138–139 | Group history | 171 | | Training and education | 32 | Group income statement | 115 | | Treasury shares | 157 | Group notes to the accounts | 119–162 | | | | Group overview | 6–7, 171 | | | | Group statement of changes in equity | 118 | | | | Group statement of comprehensive income | 115 | | | | Independent auditor’s reports | 108–113 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | GROUP AND OTHER INFORMATION 199 |
IRAN NOTICE Section 13(r) of the Exchange Act requires issuers to make specific disclosure in their annual reports of certain types of dealings with Iran, including transactions or dealings with Iranian government-owned entities, as well as dealings with entities sanctioned for activities related to terrorism or proliferation of weapons of mass destruction, even when those activities are not prohibited by US law and do not involve US persons. The Group does not have a legal entity based in Iran, but in 2017 it exported certain medical devices to Iran, via sales by non-US entities, to a new privately owned Iranian distributor for sale in Iran. Prior to 2017, the Group had sold products via non-US entities to a privately owned distributor based in the UAE who sold products into Iran. In both cases, sales were to hospitals that we understand are owned or controlled by the Government of Iran. The Group’s direct and indirect sales of US origin medical devices into Iran are permitted pursuant to section 560.530(a)(3)(i) of the Iranian Transactions and Sanctions Regulations, and its indirect sales of non-US origin medical devices into Iran are made in accordance with applicable law. The Group also provides training to its distributor(s) and surgeons in Iran as necessary and ordinarily incident to the safe and effective use of the medical devices, which is also permitted by applicable law. In 2017, the Group’s gross revenues from sales to Iran were approximately $5.2m and net losses were approximately $4.0m, due in part to the transition to the new distributor. For prior years, approximate gross revenues and net profits of the Group from sales to Iran were: 2016: gross revenues $1.2m, net losses $0.4m; 2015: gross revenues $4.0m, net profits $0.8m; 2014: gross revenues $3.8m, net profits $1.1m; and 2013: gross revenues $3.5m, net profits $1.2m. The Group is reporting the entire gross revenues and net profits for the activities described above, which figures include sales of US origin medical devices. The Group has included sales of US origin medical devices in the total gross revenue and net profit figures above as it does not separately break out revenues and profits by country of origin. The Group intends to continue to engage in the activities described above in accordance with applicable law. ABOUT SMITH & NEPHEW The Smith & Nephew Group (the Group) is a global medical devices business operating in the markets for advanced surgical devices comprising orthopaedic reconstruction and trauma, sports medicine and advanced wound management, with revenue of approximately $4.8bn in 2017. Smith & Nephew plc (the Company) is the Parent Company of the Group. It is an English public limited company with its shares listed on the premium list of the UK Listing Authority and traded on the London Stock Exchange. Shares are also traded on the New York Stock Exchange in the form of American Depositary Shares (ADSs). This is the Annual Report of Smith & Nephew plc for the year ended 31 December 2017. It comprises, in a single document, the Annual Report and Accounts of the Company in accordance with UK requirements and the Annual Report on Form 20‑F in accordance with the regulations of the United States Securities and Exchange Commission (SEC). Smith & Nephew operates on a worldwide basis and has distribution channels in over 100 countries. The Group is engaged in a single business activity, being the development, manufacture and sale of medical technology products and services. The Group is structured as two geographical selling regions: US and International; with a president for each who is responsible for the commercial view of that region. Research & Development, Manufacturing, Supply Chain and Central functions are managed globally for the Group as a whole. Smith & Nephew’s corporate website, www.smith-nephew.com, gives additional information on the Group, including an electronic version of this Annual Report. Information made available on this website, or other websites mentioned in this Annual Report, are not and should not be regarded as being part of, or incorporated into, this Annual Report. For the convenience of the reader, a Glossary of technical and financial terms used in this document is included on pages 196 – 197. The product names referred to in this document are identified by use of capital letters and TM (on first occurrence) and are trademarks owned by or licensed to members of the Group. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 200GROUP AND OTHER INFORMATION | SMITH & NEPHEW ANNUAL REPORT 2017 |
INFORMATION FOR SHAREHOLDERS continued PRESENTATION The Group’s fiscal year end is 31 December. References to a particular year in this Annual Report are to the fiscal year, unless otherwise indicated. Except as the context otherwise requires, ‘Ordinary Share’ or ‘share’ refer to the ordinary shares of Smith & Nephew plc of 20 US cents each. The Group Accounts of Smith & Nephew in this Annual Report are presented in US Dollars. Solely for the convenience of the reader, certain parts of this Annual Report contain translations of amounts in US Dollars into Sterling at specified rates. These translations should not be construed as representations that the US Dollar amounts actually represent such Sterling amounts or could be converted into Sterling at the rate indicated. Unless stated otherwise, the translation of US Dollars and cents to Sterling and pence in this Annual Report has been made at the Bank of England exchange rate on the date indicated. On 16 February 2018, the latest practicable date for this Annual Report, the Bank of England rate was US$1.40 per £1.00. The results of the Group, as reported in US Dollars, are affected by movements in exchange rates between US Dollars and other currencies. The Group applied the average exchange rates prevailing during the year to translate the results of companies with functional currency other than US Dollars. The currencies which most influenced these translations in the years covered by this report were Sterling, Swiss Franc and the Euro. The Accounts of the Group in this Annual Report are presented in millions (m) unless otherwise indicated. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS The Group’s reports filed with, or furnished to, the US Securities and Exchange Commission (SEC), including this document and written information released, or oral statements made, to the public in the future by or on behalf of the Group, contain ‘forward-looking statements’ within the meaning of the US Private Securities Litigation Reform Act of 1995, that may or may not prove accurate. For example, statements regarding expected revenue growth and trading profit margins discussed under ‘Outlook’ and ‘Strategic Priorities’, 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. For Smith & Nephew, these factors include: economic and financial conditions in the markets we serve, especially those affecting healthcare providers, payers and customers; price levels for established and innovative medical devices; developments in medical technology; regulatory approvals, reimbursement decisions or other government actions; product defects or recalls; litigation relating to patent or other claims; legal compliance risks and related investigative, remedial or enforcement actions; strategic actions, including acquisitions and dispositions and our success in performing due diligence, valuing and integrating acquired businesses; disruption that may result from transactions or other changes we make in our business plans or organisation to adapt to market developments and numerous other matters that affect us or our markets, including those of a political, economic, business, competitive or reputational nature; relationships with healthcare professionals; reliance on information technology. Specific risks faced by the Group are described under ‘Risk factors’ on pages 172–175 of this Annual Report. Any forward-looking statement is based on information available to Smith & Nephew as of the date of the statement. All written or oral forward-looking statements attributable to Smith & Nephew are qualified by this caution. Smith & Nephew does not undertake any obligation to update or revise any forward-looking statement to reflect any change in circumstances or in Smith & Nephew’s expectations. PRODUCT DATA Product data and product share estimates throughout this report are derived from a variety of sources including publicly available competitors’ information, internal management information and independent market research reports. DOCUMENTS ON DISPLAY It is possible to read and copy documents referred to in this Annual Report at the Registered Office of the Company. Documents referred to in this Annual Report that have been filed with the Securities and Exchange Commission in the US may be read and copied at the SEC’s public reference room located at 450 Fifth Street, NW, Washington DC 20549. Please call the SEC at 1‑800‑SEC‑0330 for further information on the public reference rooms and their copy charges. The SEC also maintains a website at www.sec.gov that contains reports and other information regarding registrants that file electronically with the SEC. This Annual Report and some of the other information submitted by the Group to the SEC may be accessed through the SEC website. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | EXHIBITS201 |
EXHIBIT INDEX Exhibit No. | Description of Document | Incorporated Herein by Reference To | Filed Herewith | | | | | | 1 | | Articles of Association | Form 20-F for the year ended December 31, 2011 filed on March 1, 2012 (File No. 1-14978) | | | | | | | 2 | | Smith & Nephew plc is not party to any single instrument relating to long-term debt pursuant to which a total amount of securities exceeding 10% of Smith & Nephew plc’s total assets (on a consolidated basis) is authorized to be issued. Smith & Nephew plc hereby agrees to furnish to the SEC, upon its request, a copy of any instrument defining the rights of holders of its long-term debt or the rights of holders of the Company’s ordinary shares underlong-term debt of any of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the material provisionsSEC. | | | | | | | | 4 | (a) (i) | Material contract: Agreement and Appendices dated 3 February 2014 by and among Smith & Nephew plc, Barclays Bank Plc, The Financial Institutions in Schedule 1, Barclays Bank Plc and J.P. Morgan Chase Bank, N.A. and J.P. Morgan Europe Limited. | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | (ii) | Material contract: Agreement and Plan Merger dated 2 February 2014 by and among ArthroCare Corporation Smith & Nephew, Inc. and Smith & Nephew plc. | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | (iii) | Material contract: Agreement and Appendices dated 24 March 2014 by and among Smith & Nephew plc, Barclays Bank Plc; J.P. Morgan Limited; Bank Of America Merrill Lynch International Limited; Bank Of China Limited, London Branch; The Bank Of Tokyo-Mitsubishi Ufj, Ltd.; HSBC Bank Plc; Mizuho Bank, Ltd.; National Australia Bank Limited; The Royal Bank Of Scotland Plc; Societe Generale; Sumitomo Mitsui Banking Corporation; Wells Fargo Bank International and Deutsche Bank Ag, London Branch. | Form 20-F for the year ended December 31, 2014 filed on March 5, 2015 (File No.1-14978) | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 202EXHIBITS | SMITH & NEPHEW ANNUAL REPORT 2017 |
Exhibit No. | Description of the Company’s Articles of AssociationDocument | Incorporated Herein by Reference To | Filed Herewith | | | | | | 4 | (a) (iv) | Material contract: Agreement and English law. This summary is qualified in its entiretyAppendices dated 19 November 2014 by reference to the Companies Act and the Company’s Articles of Association. In the following description, a ‘shareholder’ is the person registered in the Company’s register of members as the holder of an ordinary share. The Company is incorporated under the nameamong Smith & Nephew plc and is registeredthe purchasers listed in England and Wales with registered number 324357.Schedule A.
| The Company’s ordinary shares may be held in certificated or uncertificated form. No holder of the Company’s shares will be required to make additional contributions of capital in respect of the Company’s shares in the future. In accordance with English law the Company’s ordinary shares rank equally.
Directors
Under the Company’s Articles of Association, a Director may not vote in respect of any contract, arrangement, transaction or proposal in which he, or any person connected with him, has any material interest other than by virtue of his interests in securities of, or otherwise in or through, the Company. This is subject to certain exceptions relating to proposals (a) indemnifying him in respect of obligations incurred on behalf of the Company, (b) indemnifying a third party in respect of obligations of the Company for which the Director has assumed responsibility under an indemnity or guarantee, (c) relating to an offer of securities in which he will be interested as an underwriter, (d) concerning another body corporate in which the Director is beneficially interested in less than 1% of the issued shares of any class of shares of such a body corporate, (e) relating to an employee benefit in which the Director will share equally with other employees and (f) relating to any insurance that the Company is empowered to purchaseForm 20-F for the benefityear ended December 31, 2014 filed on March 5, 2015 (File No.1-14978)
| | | | | | | 4 | (c) (i) | Service Agreement of DirectorsOlivier Bohuon | Form 20-F for the year ended December 31, 2010 filed on March 3, 2011 (File No. 1-14978) | | | | | | | | | | | | | (ii) | Service Agreement of Julie Brown | Form 20-F for the Company in respect of actions undertaken as Directors (and/or officers) of the Company. A Director shall not vote or be counted in any quorum present at a meeting in relation to a resolutionyear ended December 31, 2012 filed on which he is not entitled to vote.February 28, 2013 (File No. 1-14978)
| The Directors are empowered to exercise all the powers of the Company to borrow money, subject
| | | | | | | (iii) | Side Letter to the limitation thatService Agreement of Julie Brown | Form 20-F for the aggregate amountyear ended December 31, 2012 filed on February 28, 2013 (File No. 1-14978) | | | | | | | | (iv) | Letter of all monies borrowed after deducting cash and current asset investments byAppointment of Ian Barlow | Form 20-F for the Company and its subsidiaries shall not exceedyear ended December 31, 2009 filed on March 26, 2010 (File No. 1-14978) | | | | | | | | (v) | Letter of Appointment of The Rt. Hon Baroness Virginia Bottomley | Form 20-F for the sumyear ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | | | | | | | (vi) | Letter of $6,500,000,000.Appointment of Michael Friedman | Any Director who has been appointed byForm 20-F for the Directors since the previous Annual General Meeting of shareholders, either to fill a casual vacancy or as an additional Director holds office only until the conclusion of the next Annual General Meeting and then shall be eligible for re-election by the shareholders. The other Directors retire and are eligible for re-appointment at the third Annual General Meeting after the meeting at which they were last re-appointed. If not re-appointed a Director retiring at a meeting shall retain office until the meeting appoints someone in his place, or if it does not do so, until the conclusion of the meeting. The Directors are subject to removal with or without cause by the Board or the shareholders. Directors are not required to hold any shares of the Company by way of qualification.year ended December 31, 2012 filed on February 28, 2013 (File No.1-14978)
| Under the Company’s Articles of Association and English law, a Director may be indemnified out of the assets of the Company against liabilities he may sustain or incur in the execution of his duties.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | EXHIBITS 203 |
Rights attaching to ordinary shares
Under English law, dividends are payable on the Company’s ordinary shares only out of profits available for distribution, as determined in accordance with accounting principles generally accepted in the UK and by the Companies Act 2006. Holders of the Company’s ordinary shares are entitled to receive final dividends as may be declared by the Directors and approved by the shareholders in general meeting, rateable according to the amounts paid up on such shares, provided that the dividend cannot exceed the amount recommended by the Directors.
The Company’s Board of Directors may declare such interim dividends as appear to them to be justified by the Company’s financial position. If authorised by an ordinary resolution of the shareholders, the Board may also direct payment of a dividend in whole or in part by the distribution of specific assets (and in particular of paid up shares or debentures of the Company).
Any dividend unclaimed after 12 years from the date the dividend was declared, or became due for payment, will be forfeited and will revert to the Company.
There were no material modifications to the rights of shareholders under the Articles during 2014.
Voting rights of ordinary shares
Voting at any general meeting of shareholders is by a show of hands unless a poll, which is a written vote, is duly demanded and held. On a show of hands, every shareholder who is present in person at a general meeting has one vote regardless of the number of shares held. On a poll, every shareholder who is present in person or by proxy has one vote for each ordinary share held by that shareholder. A poll may be demanded by any of the following:
– | the chairman of the meeting; |
– | at least five shareholders present or by proxy entitled to vote on the resolution; |
– | any shareholder or shareholders representing in the aggregate not less than one-tenth of the total voting rights of all shareholders entitled to vote on the resolution; or |
– | any shareholder or shareholders holding shares conferring a right to vote on the resolution on which there have been paid-up sums in aggregate equal to not less than one-tenth of the total sum paid up on all the shares conferring that right. |
A form of proxy will be treated as giving the proxy the authority to demand a poll, or to join others in demanding one, as above.
The necessary quorum for a general meeting is two shareholders present in person or by proxy carrying the right to vote upon the business to be transacted.
| | Exhibit No. | Description of Document | Incorporated Herein by Reference To | Filed Herewith | | 192
| | | | 4 | C (vii) | Letter of Re-Appointment of Brian Larcombe | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | (viii) | Letter of Re-Appointment of Joseph Papa | Form 20-F for the year ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (ix) | Letter of Appointment of Roberto Quarta | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | (x) | Letter of Appointment of Vinita Bali | Form 20-F for the year ended December 31, 2014 filed on March 5, 2015 (File No.1-14978) | | | | | | | | (xi) | Letter of Appointment of Erik Engstrom | Form 20-F for the year ended December 31, 2014 filed on March 5, 2015 (File No.1-14978) | | | | | | | | (xii) | Letter of Re-Appointment of Brian Larcombe | Form 20-F for the year ended December 31, 2014 filed on March 5, 2015 (File No.1-14978) | | | | | | | | (xiii) | Letter of Re-Appointment of The Rt. Hon Baroness Virginia Bottomley DL | Form 20-F for the year ended December 31, 2014 filed on March 5, 2015 (File No.1-14978) | | | | | | | | (xiv) | Letter of Appointment of Robin Freestone | Form 20-F for the year ended December 31, 2015 filed on March 4, 2016 (File No.1-14978) | | | | | | | | (xv) | Letter of Re-Appointment of Ian Barlow | Form 20-F for the year ended December 31, 2015 filed on March 4, 2016 (File No.1-14978) | | | | | | | | (xvi) | Letter of Re-Appointment of Michael Friedman | Form 20-F for the year ended December 31, 2015 filed on March 4, 2016 (File No.1-14978) | | | | | | | | (xvii) | Letter of Re-Appointment of Brian Larcombe | Form 20-F for the year ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xviii) | The Smith & Nephew Annual report 2014 2001 UK Approved Share Option Plan | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 204EXHIBITS | SMITH & NEPHEW ANNUAL REPORT 2017 |
Matters are transacted at general meetingsExhibit No.
| Description of the CompanyDocument | Incorporated Herein by the processing and passing of resolutions of which there are two kinds; ordinary or special resolutions:Reference To | Filed Herewith | – | Ordinary resolutions include resolutions for the re-election of Directors, the approval of financial statements, the declaration of dividends (other than interim dividends), the appointment and re-appointment of auditors or the grant of authority to allot shares. An ordinary resolution requires the affirmative vote of a majority of the votes of those persons voting at the meetings at which there is a quorum. |
– | Special resolutions include resolutions amending the Company’s Articles of Association, dis-applying statutory pre-emption rights or changing the Company’s name; modifying the rights of any class of the Company’s shares at a meeting of the holders of such class or relating to certain matters concerning the Company’s winding up. A special resolution requires the affirmative vote of not less than three-quarters of the votes of the persons voting at the meeting at which there is a quorum. |
Annual General Meetings must be convened upon advance written notice of 21 days. Other general meetings must be convened upon advance written notice of at least 14 clear days. The days of delivery or receipt of notice are not included. The notice must specify the nature of the business to be transacted. Meetings are convened by the Board of Directors. Members with 5% of the ordinary share capital of the Company may requisition the Board to convene a meeting.
Variation of rights
If, at any time, the Company’s share capital is divided into different classes of shares, the rights attached to any class may be varied, subject to the provisions of the Companies Act, with the consent in writing of holders of three-quarters in nominal value of the issued shares of that class or upon the adoption of a special resolution passed at a separate meeting of the holders of the shares of that class. At every such separate meeting, all the provisions of the articles of association relating to proceedings at a general meeting apply, except that the quorum is to be the number of persons (which must be two or more) who hold or represent by proxy not less than one-third in nominal value of the issued shares of the class and at any such meeting a poll may be demanded in writing by any person or their proxy who hold shares of that class. Where a person is present by proxy or proxies, he is treated as holding only the shares in respect of which the proxies are authorised to exercise voting rights.
Rights in a winding up
Except as the Company’s shareholders have agreed or may otherwise agree, upon the Company’s winding up, the balance of assets available for distribution:
– | after the payment of all creditors including certain preferential creditors, whether statutorily preferred creditors or normal creditors; and |
– | subject to any special rights attaching to any other class of shares; |
– | is to be distributed among the holders of ordinary shares according to the amounts paid-up on the shares held by them. This distribution is generally to be made in US dollars. A liquidator may, however, upon the adoption of any extraordinary resolution of the shareholders and any other sanction required by law, divide among the shareholders the whole or any part of the Company’s assets in kind. |
Limitations on voting and shareholding(xix)
| There are no limitations imposed by English law or the Company’s Articles of Association on the right of non-residents or foreign persons to hold or vote the Company’s ordinary shares or ADSs, other than the limitations that would generally apply to all of the Company’s shareholders.
Transfers of shares
The Board may refuse to register the transfer of shares held in certificated form which: – | are not fully paid (provided that it shall not exercise this discretion in such a way as to prevent stock market dealings in the shares of that class from taking place on an open and proper basis); |
– | are not duly stamped or duly certified or otherwise shown to the satisfaction of the Board to be exempt from stamp duty, lodged at the Transfer Office or at such other place as the Board may appoint and (save in the case of a transfer by a person to whom no certificate was issued in respect of the shares in question) accompanied by the certificate for the shares to which it relates, and such other evidence as the Board may reasonably require to show the right of the transferor to make the transfer and, if the instrument of transfer is executed by some other person on his behalf, the authority of that person so to do; |
– | are in respect of more than one class of shares; or |
– | are in favour of more than four transferees. |
Deferred shares
Following the re-denomination of share capital on 23 January 2006 the ordinary shares’ nominal value became 20 US cents each. There were no changes to the rights or obligations of the ordinary shares. In order to comply with the Companies Act 2006, a new class of sterling shares was created, deferred shares, of which £50,000 were issued and allotted in 2006 as fully paid to the Chief Executive Officer though the Board reserves the right to transfer them to another member of the Board should it so wish. These deferred shares have no voting or dividend rights and on winding up only are entitled to repayment at nominal value only if all ordinary shareholders have received the nominal value of their shares plus an additional $1,000 each.
Amendments
The Company does not have any special rules about amendments to its Articles of Association beyond those imposed by law.
Smith & Nephew Annual report 2014 193 2001 UK Unapproved Share Option Plan | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) |
OTHER INFORMATION
Cross Reference to Form 20-F
| | This table provides a cross reference from the information included in this Annual Report to the requirements of Form 20-F.
| | | | | | Part I
| | | | (xx) | | | | Page | Item 1 | | Identity of Directors, Senior Management and Advisers | | n/a | Item 2 | | Offer Statistics and Expected Timetable | | n/a | Item 3
| | Key Information
| | | | | A – Selected Financial Data | | 174–175 | | | B – Capitalization and Indebtedness | | n/a | | | C – Reason for the Offer and Use of Proceeds | | n/a | | | D – Risk Factors | | 171–173 | Item 4
| | Information on the Company
| | | | | A – History and Development of the Company | | 170 | | | B – Business Overview | | 3–4, 8–15, 18–39, 118–121, 171–173, 180–183 | | | C – Organizational Structure | | 10–11, 133–134, 164–165 | | | D – Property, Plant and equipment | | 128–129, 170, 172 | Item 4A | | Unresolved Staff Comments | | None | Item 5
| | Operating and Financial Review and Prospects
| | | | | A – Operating results | | 8–15, 26, 30, 34–36, 111, 113, 115, 180–183 | | | B – Liquidity and Capital Resources | | 115, 136–140, 155 | | | C – Research and Development, patents and licences, etc. | | 14, 21–22 | | | D – Trend information | | 18–20, 104, 171–173 | | | E – Off Balance Sheet Arrangements | | 170 | | | F – Tabular Disclosure of Contractual Obligations | | 179–180 | | | G – Safe Harbor | | 199 | Item 6
| | Directors, Senior Management and Employees
| | | | | A – Directors and Senior Management | | 54–59, 63 | | | B – Compensation | | 81–102 | | | C – Board Practices | | 54–59, 62–80 | | | D – Employees | | 10–11, 25, 121 | | | E – Share Ownership | | 90, 159–162 | Item 7
| | Major shareholders and Related Party Transactions
| | | | | A – Major shareholders | | 189 | | | – Host Country shareholders | | 189 | | | B – Related Party Transactions | | 163, 170 | | | C – Interests of experts and counsel | | n/a | Item 8
| | Financial information
| | | | | A – Consolidated Statements and Other Financial Information | | 103–165 | | | – Legal Proceedings | | 145–147 | | | – Dividends | | 187 | | | B – Significant Changes | | None | Item 9
| | The Offer and Listing
| | | | | A – Offer and Listing Details | | 188–189 | | | B – Plan of Distribution | | n/a | | | C – Markets | | 189 | | | D – Selling shareholders | | n/a | | | E – Dilution | | n/a | | | F – Expenses of the Issue | | n/a |
194Smith & Nephew Annual report 2014
| | | | | | | | | Page | Item 10 | | Additional Information | | | | | A – Share capital | | n/a | | | B – Memorandum and Articles of Association | | 192–193 | | | C – Material Contracts | | 115, 156–157 | | | D – Exchange Controls | | 190 | | | E – Taxation | | 190–191 | | | F – Dividends and Paying Agents | | n/a | | | G – Statement by Experts | | n/a | | | H – Documents on Display | | 199 | | | I – Subsidiary Information | | 164–165 | Item 11 | | Quantitative and Qualitative Disclosure about Market Risk | | 140–144, 171–173 | Item 12 | | Description of Securities Other than Equity Securities | | | | | A – Debt securities | | n/a | | | B – Warrants and rights | | n/a | | | C – Other securities | | n/a | | | D – American Depository shares | | 185–186 | Part II | | | | | Item 13 | | Defaults, Dividend Arrearages and Delinquencies | | None | Item 14 | | Material Modifications to the Rights of Security Holders and Use of Proceeds | | None | Item 15 | | Controls and Procedures | | 75 – 80, 105 | Item 16 | | (Reserved) | | n/a | Item 16A | | Audit Committee Financial Expert | | 75 | Item 16B | | Code of Ethics | | 80 | Item 16C | | Principal Accountant Fees and Services | | 78–79, 123 | Item 16D | | Exemptions from the Listing Standards for Audit Committees | | n/a | Item 16E | | Purchases of Equity Securities by the Issuer and Affiliated Purchasers | | 154, 190 | Item 16F | | Change in Registrant’s Certifying Accountant | | 78 | Item 16G | | Corporate Governance | | 60, 82 | Item 16H | | Mine Safety Disclosure | | n/a | Part III | | | | | Item 17 | | Financial Statements | | n/a | Item 18 | | Financial Statements | | 103–165 | Item 19 | | Exhibits | | |
Smith & Nephew Annual report 2014 195
OTHER INFORMATION
Glossary of terms
Unless the context indicates otherwise, the following terms have the meanings shown below:
| | | Term | | Meaning | ACL | | The anterior cruciate ligament (ACL) is one of the four major ligaments in the human knee. | ADR | | In the US, the Company’s ordinary shares are traded in the form of ADSs evidenced by American Depository Receipts (‘ADRs’). | ADS | | In the US, the Company’s ordinary shares are traded in the form of American Depositary Shares (‘ADSs’). | Advanced Surgical Devices | | A product group comprising products for orthopaedic replacement and reconstruction, endoscopy devices and trauma devices. Products for orthopaedic replacement include systems for knees, hips, and shoulders. Endoscopy devices comprise of support products for orthopaedic surgery such as computer assisted surgery and minimally invasive surgery techniques using specialised viewing and access devices, surgical instruments and powered equipment. Orthopaedics trauma devices are used in the treatment of bone fractures including rods, pins, screws, plates and external frames. | Advanced Wound Management | | A product group comprising products associated with the treatment of skin wounds, ranging from products that provide moist wound healing using breathable films and polymers to products providing active wound healing by biochemical or cellular action. | AGM | | Annual General Meeting of the Company. | Arthroscopy | | Endoscopy of the joints is termed ‘arthroscopy’, with the principal applications being the knee and shoulder. | ASD | | Advanced Surgical Devices division. | AWM | | Advanced Wound Management division. | Basis Point | | One hundredth of one percentage point. | Chronic wounds | | Chronic wounds are those with long or unknown healing times including leg ulcers, pressure sores and diabetic foot ulcers. | Company | | Smith & Nephew plc or, where appropriate, the Company’s Board of Directors, unless the context otherwise requires. | Companies Act | | Companies Act 2006, as amended, of England and Wales. | EBITA | | Earnings before interest, tax and amortisation. | EBITDA | | Earnings before interest, tax, depreciation and amortisation. | Emerging markets | | Emerging markets include Greater China, India, Brazil and Russia. | EPSA | | EPSA is a trend measure, which presents the long-term profitability of the Group excluding the post-tax impact of specific transactions that management considers affects the Group’s short-term profitability. The Group presents this measure to assist investors in their understanding of trends. Adjusted attributable profit is the numerator used for this measure and is determined by adjusting attributable profit for the items that are excluded from operating profit when arriving at trading profit and items that are recognised below operating profit that affect the Group’s short-term profitability. | Endoscopy | | Through a small incision, surgeons are able to see inside the body using a monitor and identify and repair defects. | ERP | | Enterprise Resource Planning: a software system which integrates internal and external management information, facilitating the flow of information across an organisation. | Established Markets | | Established Markets include United States of America, Europe, Australia, New Zealand, Canada and Japan. | Euro or € | | References to the common currency used in the majority of the countries of the European Union. | External fixation | | The use of wires or pins transfixed through bone to hold a frame to the position of a fracture. | FDA | | US Food and Drug Administration. | Financial statements | | Refers to the consolidated Group Accounts of Smith & Nephew plc. | FTSE 100 | | Index of the largest 100 listed companies on the London Stock Exchange by market capitalisation. | GMP | | Good manufacturing practice or ‘GMP’ is the guidance that outlines the aspects of production and testing that can impact the quality of a product. | Group or Smith & Nephew | | Used for convenience to refer to the Company and its consolidated subsidiaries, unless the context otherwise requires. | Health economics | | A branch of economics concerned with issues related to efficiency, effectiveness, value and behaviour in the production and consumption of health and healthcare. |
196Smith & Nephew Annual report 2014
| | | Term | | Meaning | IFRIC | | International Financial Reporting Interpretations as adopted by the EU and as issued by the International Accounting Standards Board. | IFRS | | International Financial Reporting Standards as adopted by the EU and as issued by the International Accounting Standards Board. | International markets | | International Markets include Middle East, North Africa, Southern Africa, Latin America, ASEAN, South Korea and Eastern Europe. | LSE | | London Stock Exchange. | Metal-on-metal hip resurfacing | | A less invasive surgical approach to treating arthritis in certain patients whereby only the surfaces of the hip joint are replaced leaving the hip head substantially preserved. | Negative Pressure Wound Therapy | | A technology used to treat chronic wounds such as diabetic ulcers, pressure sores and post-operative wounds through the application of sub-atmospheric pressure to an open wound. | NYSE | | New York Stock Exchange. | Orthobiologics products | | Any product that is primarily intended to act as a scaffold and/or actively stimulates bone growth. | Orthopaedic products | | Orthopaedic reconstruction products include joint replacement systems for knees, hips and shoulders and support products such as computer-assisted surgery and minimally invasive surgery techniques. Orthopaedic trauma devices are used in the treatment of bone fractures including rods, pins, screws, plates and external frames. Clinical therapies products include joint fluid therapy for pain reduction of the knee and an ultrasound treatment to accelerate the healing of bone fractures. | OXINIUM | | OXINIUM material is an advanced load bearing technology. It is created through a proprietary manufacturing process that enables zirconium to absorb oxygen and transform to a ceramic on the surface, resulting in a material that incorporates the features of ceramic and metal. Management believes that OXINIUM material used in the production of components of knee and hip implants exhibits unique performance characteristics due to its hardness, low-friction and resistance to roughening and abrasion. | Parent Company | | Smith & Nephew plc. | Pound Sterling, Sterling, £, pence or p | | References to UK currency. 1p is equivalent to one hundredth of £1. | Repair | | A product group within ASD comprising specialised devices, fixation systems and bio-absorbable materials to repair joints and associated tissue. | Resection | | Products that cut or ablate tissue within ASD comprising mechanical blades, radio frequency wands, electromechanical and hand instruments for resecting tissue. | SEC | | US Securities and Exchange Commission | Trading results | | Trading profit, trading profit margin and trading cash flow are trend measures, which present the long-term profitability of the Group excluding the impact of specific transactions that management considers affect the Group’s short-term profitability and cash flows. The Group has identified the following items, where material, as those to be excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively: acquisition and disposal related items arising in connection with business combinations, including amortisation of acquisition intangible assets, impairments and integration costs; restructuring events; gains and losses resulting from legal disputes and significant uninsured losses. In addition to these items, gains or losses that materially impact the Group’s profitability or cash flows on a short-term or one-off basis are excluded from operating profit and cash generated from operations when arriving at trading profit and trading cash flow, respectively | UK | | United Kingdom of Great Britain and Northern Ireland. | UK GAAP | | Accounting principles generally accepted in the United Kingdom. | Underlying growth | | Growth after adjusting for the effects of currency translation and the inclusion of the comparative impact of acquisitions and exclusion of disposals. | US | | United States of America. | US Dollars, US $ or cents | | References to US currency. 1 cent is equivalent to one hundredth of US$1. | US GAAP | | Accounting principles generally accepted in the United States of America. | Visualisation | | Products within ASD comprising digital cameras, light sources, monitors, scopes, image capture, central control and multimedia broadcasting systems for use in endoscopic surgery with visualisation. | Wound bed | | An area of healthy dermal and epidermal tissue of a wound. |
Smith & Nephew Annual report 2014 197
OTHER INFORMATION
Index
| | | 2013 Financial highlights | | 180 | 2014 Financial highlights | | 4 | Accounting Policies | | 117 | Accounts Presentation | | 199 | Acquisitions | | 156 | Acquisition related costs | | 123 | Advanced Surgical Devices – Business segment review | | 26 | Advanced Wound Management –
Business segment review
| | 30 | American Depository Shares | | 185 | Articles of Association | | 192 | Audit fees | | 123 | Board | | 54 | Business overview | | 12 | Business segment information | | 26 | Cash and borrowings | | 136 | Chairman’s statement | | 5 | Chief Executive Officer’s review | | 6 | Company Balance Sheet | | 166 | Company Notes to the Accounts | | 167 | Contingencies | | 146 | Contractual obligations | | 179 | Corporate Governance Statement | | 62 | Critical accounting policies | | 104 | Cross Reference to Form 20-F | | 194 | Currency fluctuations | | 172 | Currency translation | | 117 | Deferred taxation | | 126 | Directors’ Remuneration Report | | 81 | Directors’ responsibilities for the accounts | | 103 | Directors’ responsibility statement | | 103 | Dividends | | 154, 187 | Earnings per share | | 127 | Employees/People | | 25, 121 | Employees’ Share Trust | | 154 | Ethics and compliance | | 22 | Executive officers | | 58 | Factors affecting results of operations | | 173 | Financial instruments | | 140 | Financial position, liquidity and capital resources | | 115 | Glossary of terms | | 196 | Goodwill | | 130 | Group Balance Sheet | | 112 | Group Cash Flow Statement | | 114 | Group history | | 170, 200 | Group Income Statement | | 110 | Group Notes to the Accounts | | 117 | Group overview | | 12 |
| | | Group Statement of Changes in Equity | | 116 | Group Statement of Comprehensive Income | | 110 | Independent Auditor’s Reports | | 105 | Information for shareholders | | 184 | Intangible assets | | 131 | Intellectual property | | 22 | Interest | | 124 | Inventories | | 134 | Investments | | 133 | Investment in associates | | 133 | Key Performance Indicators | | 14 | Leases | | 140, 158 | Legal and other | | 123 | Legal proceedings | | 146 | Manufacturing | | 23 | Marketplace | | 18 | Medical education | | 24 | New accounting standards | | 117 | Off-Balance Sheet arrangements | | 170 | Operating profit | | 122 | Other finance (costs)/income | | 124 | Outlook and trend information | | 17, 18 | Parent Company accounts | | 166 | Payables | | 136 | People/Employees | | 25 | Principal subsidiary undertakings | | 164 | Provisions | | 145 | Property, plant and equipment | | 128 | Receivables | | 135 | Regulation | | 18, 22, 29, 33 | Related party transactions | | 163 | Research and development | | 21 | Restructuring and rationalisation expenses | | 123 | Retirement benefit obligation | | 147 | Risk factors | | 171 | Risk management | | 36, 79 | Sales and marketing | | 24 | Selected financial data | | 174 | Share based payments | | 159 | Share capital | | 189 | Shareholder return | | 91 | Strategy | | 13 | Sustainability | | 40 | Taxation | | 124 | Taxation information for shareholders | | 190 | Treasury shares | | 154 |
198Smith & Nephew Annual report 2014
About Smith & Nephew
The Smith & Nephew Group (the ‘Group’) is a global medical devices business operating2001 US Share Plan | Registration Statement on Form S-8 No. 333-13694 filed on July 9, 2001 (File No. 1-14978) | | | | | | | | (xxi) | The Smith & Nephew Sharesave Plan (2002) | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | (xxii) | The Smith & Nephew International Sharesave Plan (2002) | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) | | | | | | | | (xxiii) | The Smith & Nephew Italian Sharesave Plan (2002) | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | (xxiv) | The Smith & Nephew Dutch Sharesave Plan (2002) | Form 20-F for the year ended December 31, 2002 filed in April 25, 2003 (File No. 1-14978) | | | | | | | | (xxv) | The Smith & Nephew Belgian Sharesave Plan (2002) | Form 20-F for the marketsyear ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | (xxvi) | The Smith & Nephew French Sharesave Plan (2002) | Form 20-F for advanced surgical devices comprising orthopaedic reconstruction, trauma and sports medicine and advanced wound management, with revenuethe year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | (xxvii) | Smith & Nephew Irish Employee Share Option Scheme | Form 20-F for the year ended December 31, 2003 filed on March 26, 2004 (File No. 1-14978) | | | | | | | | (xxviii) | Smith & Nephew 2004 Executive Share Option Scheme | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | | | | | | | (xxix) | Smith & Nephew 2004 Performance Share Plan | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | | | | | | | (xxx) | Smith & Nephew 2004 Co-investment Plan | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | | | | | | | (xxxi) | Smith & Nephew U.S. Employee Stock Purchase Plan | Registration statement on Form S-8 No. 333-12052 filed on May 30, 2000 (File No. 1-14978) | | | | | | | | (xxxii) | Smith & Nephew Long Service Award Scheme | Registration Statement on Form S-8 No. 33-39814 filed on April 5, 1991 (File No. 1-14978) | | | | | | | | (xxxiii) | Smith & Nephew 2004 Performance Share Plan | Registration statement on Form S-8 No. 333-155172 filed on November 7, 2008 (File No. 1-14978) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | EXHIBITS 205 |
Exhibit No. | Description of approximately $4.6 billion in 2014. Document | Incorporated Herein by Reference To | Filed Herewith | | | | | | 4 | c (xxxiv) | Smith & Nephew 2001 US Share Plan | Registration statement on Form S-8 No. 333-155173 filed on November 7, 2008 (File No. 1-14978) | | | | | | | | (xxxv) | Smith & Nephew plc (the ‘Company’) is the parent company of the Group. It is an English public limited company with its shares listedDeferred Bonus Plan | Registration statement on the premium list of the UK Listing Authority and tradedForm S-8 No. 333-158239 filed on the London Stock Exchange. Shares are also traded on the New York Stock Exchange in the form of American Depositary Shares (‘ADSs’).March 27, 2009 (File No. 1-14978) | This is the Annual Report of
| | | | | | | (xxxvi) | Smith & Nephew plc Global Share Plan 2010 | Form 20-F for the year ended December 31, December 2014. It comprises, in a single document, the Annual Report and Accounts of the Company in accordance with UK requirements and the Annual Report2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xxxvii) | Smith & Nephew ShareSave Plan (2012) | Form 20-F in accordance withfor the regulationsyear ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | | | | | | | (xxxviii) | Smith & Nephew International ShareSave Plan (2012) | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | | | | | | | (xxxix) | Service Agreement of Graham Baker | Form 20-F for the United States Securitiesyear ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xl) | Letter of Appointment of Robin Freestone as Audit Committee Chairman | Form 20-F for the year ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xli) | Letter of Appointment of Ian Barlow as Senior Independent Director | Form 20-F for the year ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xlii) | Letter of Re-Appointment of Roberto Quarta | Form 20-F for the year ended December 31, 2016 filed on March 6, 2017 (File No.1-14978) | | | | | | | | (xliii) | Letter of Appointment of Marc Owen | | X | | | | | | | (xliv) | Letter of Appointment of Angie Risley | | X | | | | | | | (xlv) | Letter of Appointment of Roland Diggelmann | | X | | | | | | | (xlvi) | Letter of Re-Appointment of Vinita Bali | | X | | | | | | | (xlvii) | Letter of Re-Appointment of The Rt. Hon Baroness Virginia Bottomley | | X | | | | | | | (xlviii) | Letter of Re-Appointment of Erik Engstrom | | X |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 206EXHIBITS | SMITH & NEPHEW ANNUAL REPORT 2017 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | SMITH & NEPHEW ANNUAL REPORT 2017 | SIGNATURE 207 |
SIGNATURE The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and has duly caused and authorized the undersigned to sign this Annual Report on its behalf. | Smith & Nephew operates on a worldwide basis and has distribution channels in over 100 countries. In the more established countries by revenue, the Group’s business operations are organised by divisions. In the majority of the remaining markets, operations are managed by country managers who are responsible for sales and distribution of the Group’s entire product range. These comprise the Emerging Markets & International Markets.plc Smith & Nephew’s corporate website, www.smith-nephew.com, gives additional information on the Group, including an electronic version of this Annual Report. Information made available on this website, or other websites mentioned in this Annual Report, are not and should not be regarded as being part of, or incorporated into, this Annual Report.
For the convenience of the reader, a Glossary of technical and financial terms used in this document is included on pages 196 to 197. The product names referred to in this document are identified by use of capital letters and theà symbol (on first occurence) and are trademarks owned by or licensed to members of the Group.
Presentation
The Group’s fiscal year end is 31 December. References to a particular year in this Annual Report are to the fiscal year, unless otherwise indicated. Except as the context otherwise requires, ‘Ordinary Share’ or ‘share’ refer to the ordinary shares of Smith & Nephew plc of 20 US cents each.
The Group Accounts of Smith & Nephew in this Annual Report are presented in US Dollars. Solely for the convenience of the reader, certain parts of this Annual Report contain translations of amounts in US Dollars into Sterling at specified rates. These translations should not be construed as representations that the US Dollar amounts actually represent such Sterling amounts or could be converted into Sterling at the rate indicated.
Unless stated otherwise, the translation of US Dollars and cents to Sterling and pence in this Annual Report has been made at the Bank of England exchange rate on the date indicated. On 23 February 2015, the Bank of England rate was US$1.5449 per £1.
The results of the Group, as reported in US Dollars, are affected by movements in exchange rates between US Dollars and other currencies. The Group applied the average exchange rates prevailing during the year to translate the results of companies with functional currency other than US Dollars. The currencies which most influenced these translations in the years covered by this report were Sterling, Swiss Franc and the Euro.
The Accounts of the Group in this Annual Report are presented in millions (‘m’) unless otherwise indicated.
Special note regarding forward-looking statements
The Group’s reports filed with, or furnished to, the US Securities and Exchange Commission (‘SEC’), including this document and written information released, or oral statements made, to the public in the future by or on behalf of the Group, contain ‘forward-looking statements’ within the meaning of the US Private Securities Litigation Reform Act of 1995, that may or may not prove accurate. For example, statements regarding expected revenue growth and trading profit margins discussed under ‘Outlook’, ‘Global Outlook’ and ‘Strategic performance’, 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.
For Smith & Nephew, these factors include: economic and financial conditions in the markets we serve, especially those affecting health care providers, payers and customers; price levels for established and innovative medical devices; developments in medical technology; regulatory approvals, reimbursement decisions or other government actions; product defects or recalls; litigation relating to patent or other claims; legal compliance risks and related investigative, remedial or enforcement actions; strategic actions, including acquisitions and dispositions and our success in performing due diligence, valuing and integrating acquired businesses; disruption that may result from transactions or other changes we make in our business plans or organisation to adapt to market developments and numerous other matters that affect us or our markets, including those of a political, economic, business, competitive or reputational nature; relationships with healthcare professionals; reliance on information technology. Specific risks faced by the Group are described under ‘Risk factors’ on pages 171 to 173 of this Annual Report. Any forward-looking statement is based on information available to Smith & Nephew as of the date of the statement. All written or oral forward-looking statements attributable to Smith & Nephew are qualified by this caution. Smith & Nephew does not undertake any obligation to update or revise any forward-looking statement to reflect any change in circumstances or in Smith & Nephew’s expectations.
Division data
Division data and division share estimates throughout this report are derived from a variety of sources including publicly available competitors’ information, internal management information and independent market research reports.
Documents on display
It is possible to read and copy documents referred to in this Annual Report at the Registered Office of the Company. Documents referred to in this Annual Report that have been filed with the Securities and Exchange Commission in the US may be read and copied at the SEC ’s public reference room located at 450 Fifth Street, NW, Washington DC 20549. Please call the SEC at 1-800-SEC -0330 for further information on the public reference rooms and their copy charges. The SEC also maintains a web site at www.sec.gov that contains reports and other information regarding registrants that file electronically with the SEC. This Annual Report and some of the other information submitted by the Group to the SEC may be accessed through the SEC website.
| | (Registrant) | | | By: | /s/ Susan Swabey | | Susan Swabey
Smith & Nephew Annual report 2014 199
| |
Smith & Nephew plc
15 Adam Street
London WC2N 6LA
United Kingdom
T +44 (0) 20 7401 7646
F +44 (0) 20 7960 2356
www.smith-nephew.com
SIGNATURE
The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and has duly caused and authorized the undersigned to sign this Annual Report on its behalf.
| | | | | Smith & Nephew plc
(Registrant)Company Secretary
| | | By: | | /s/ Susan Swabey | | | Susan Swabey
Company Secretary
|
London, England
March 5, 2015
EXHIBIT INDEX
|
London, England March 5, 2018 | | | | | | | | | Exhibit No. | | Description of Document | | Incorporated Herein by Reference To | | Filed
Herewith | | | | | | 1
| | | | Articles of Association | | Form 20-F for the year ended December 31, 2011 filed on March 1, 2012 (File No. 1-14978) | | | | | | | | 2
| | | | Smith & Nephew plc is not party to any single instrument relating to long-term debt pursuant to which a total amount of securities exceeding 10% of Smith & Nephew plc’s total assets (on a consolidated basis) is authorized to be issued. Smith & Nephew plc hereby agrees to furnish to the SEC, upon its request, a copy of any instrument defining the rights of holders of its long-term debt or the rights of holders of the long-term debt of any of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the SEC. | | | | | | | | | | 4
| | (a) (i)
| | Material contract: Agreement and Appendices dated 3 February 2014 by and among Smith & Nephew plc, Barclays Bank Plc, The Financial Institutions in Schedule 1, Barclays Bank Plc and J.P. Morgan Chase Bank, N.A. and J.P. Morgan Europe Limited. | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (ii)
| | Material contract: Agreement and Plan Merger dated 2 February 2014 by and among Arthrocare Corporation Smith & Nephew, Inc. and Smith & Nephew plc. | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (iii)
| | Material contract: Agreement and Appendices dated 24 March 2014 by and among Smith & Nephew plc, Barclays Bank Plc; J.P. Morgan Limited; Bank Of America Merrill Lynch International Limited; Bank Of China Limited, London Branch; The Bank Of Tokyo-Mitsubishi Ufj, Ltd.; HSBC Bank Plc; Mizuho Bank, Ltd.; National Australia Bank Limited; The Royal Bank Of Scotland Plc; Societe Generale; Sumitomo Mitsui Banking Corporation; Wells Fargo Bank International and Deutsche Bank Ag, London Branch | | | | X | | | | | | | | (iv)
| | Material contract: Agreement and Appendices dated 19 November 2014 by and among Smith & Nephew plc and the purchasers listed in Schedule A. | | | | X | | | | | | 4
| | (c) (i)
| | Service Agreement of Olivier Bohuon | | Form 20-F for the year ended December 31, 2010 filed on March 3, 2011 (File No. 1-14978) | | | | | | | | | | (ii)
| | Retirement provisions for David J Illingworth | | Form 20-F for the year ended December 31, 2010 filed on March 3, 2011 (File No. 1-14978) | | | | | | | | | | (iii)
| | Service Agreement of Julie Brown | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No. 1-14978) | | | | | | | | | | (iv)
| | Side Letter to the Service Agreement of Julie Brown | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No. 1-14978) | | | | | | | | | | (v)
| | Letter of Appointment of Ian Barlow | | Form 20-F for the year ended December 31, 2009 filed on March 26, 2010 (File No. 1-14978) | | | | | | | | | | (vi)
| | Letter of Appointment of The Rt. Hon Baroness Virginia Bottomley | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | | | | | | | | | (vii)
| | Letter of Appointment of Michael Friedman | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | |
| | | | | | | | | Exhibit No. | | Description of Document | | Incorporated Herein by Reference To | | Filed
Herewith | | | | | | 4
| | (c) (viii)
| | Letter of Appointment of Ajay Piramal | | Form 20-F for the year ended December 31, 2011 filed on March 1, 2012 (File No. 1-14978) | | | | | | | | | | (ix)
| | Letter of Re-Appointment of Rolf Stomberg | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No.1-14978) | | | | | | | | | | (x)
| | Letter of Re-Appointment of Richard De Schutter | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (xi)
| | Letter of Re-Appointment of Pamela Kirby | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (xii)
| | Letter of Re-Appointment of Brian Larcombe | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (xiii)
| | Letter of Re-Appointment of Joseph Papa | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (xiv)
| | Letter of Appointment of Roberto Quarta | | Form 20-F for the year ended December 31, 2013 filed on March 6, 2014 (File No.1-14978) | | | | | | | | | | (xv)
| | Letter of Appointment of Vinita Bali | | | | X | | | | | | | | (xvi)
| | Letter of Appointment of Erik Engstrom | | | | X | | | | | | | | (xvii)
| | Letter of Re-Appointment of Brian Larcombe | | | | X | | | | | | | | (xviii)
| | Letter of Re-Appointment of The Rt. Hon Baroness Virginia Bottomley DL | | | | X | | | | | | | | (xix)
| | The Smith & Nephew 2001 UK Approved Share Option Plan | | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) | | | | | | | | | | (xx)
| | The Smith & Nephew 2001 UK Unapproved Share Option Plan | | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) | | | | | | | | | | (xxi)
| | The Smith & Nephew 2001 US Share Plan | | Registration Statement on Form S-8 No. 333-13694 filed on July 9, 2001 (File No. 1-14978) | | | | | | | | | | (xxii)
| | The Smith & Nephew Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | | | (xxiii)
| | The Smith & Nephew International Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2004 filed on March 16, 2005 (File No. 1-14978) | | | | | | | | | | (xxiv)
| | The Smith & Nephew Italian Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | | | (xxv)
| | The Smith & Nephew Dutch Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2002 filed in April 25, 2003 (File No. 1-14978) | | | | | | | | | | (xxvi)
| | The Smith & Nephew Belgian Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | | | (xxvii)
| | The Smith & Nephew French Sharesave Plan (2002) | | Form 20-F for the year ended December 31, 2002 filed on April 25, 2003 (File No. 1-14978) | | | | | | | | | | (xxviii)
| | Smith & Nephew Irish Employee Share Option Scheme | | Form 20-F for the year ended December 31, 2003 filed on March 26, 2004 (File No. 1-14978) | | | | | | | | | | (xxix)
| | Smith & Nephew 2004 Executive Share Option Scheme | | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | | | | | | | | | (xxx)
| | Smith & Nephew 2004 Performance Share Plan | | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | | | | | | | | | (xxxi)
| | Smith & Nephew 2004 Co-investment Plan | | Registration statement on Form S-8 No. 333-122801 filed on February 14, 2005 (File No. 1-14978) | | |
| | | | | | | | | Exhibit No. | | Description of Document | | Incorporated Herein by Reference To | | Filed
Herewith | | | | | | 4
| | (c) (xxxii)
| | Smith & Nephew U.S. Employee Stock Purchase Plan | | Registration statement on Form S-8 No. 333-12052 filed on May 30, 2000 (File No. 1-14978) | | | | | | | | | | (xxxiii)
| | Smith & Nephew Long Service Award Scheme | | Registration Statement on Form S-8 No. 33-39814 filed on April 5, 1991 (File No. 1-14978) | | | | | | | | | | (xxxiv)
| | Smith & Nephew 2004 Performance Share Plan | | Registration statement on Form S-8No. 333-155172 filed on November 7, 2008(File No. 1-14978) | | | | | | | | | | (xxxv)
| | Smith & Nephew 2001 US Share Plan | | Registration statement on Form S-8No. 333-155173 filed on November 7, 2008(File No. 1-14978) | | | | | | | | | | (xxxvi)
| | Smith & Nephew plc Deferred Bonus Plan | | Registration statement on Form S-8No. 333-158239 filed on March 27, 2009(File No. 1-14978) | | | | | | | | | | (xxxvii)
| | Smith & Nephew plc Global Share Plan 2010 | | Registration statement on Form S-8No. 333-168544 filed on August 5, 2010(File No. 1-14978) | | | | | | | | | | (xxxviii)
| | Smith & Nephew ShareSave Plan (2012) | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No. 1-14978) | | | | | | | | | | (xxxix)
| | Smith & Nephew International ShareSave Plan (2012) | | Form 20-F for the year ended December 31, 2012 filed on February 28, 2013 (File No. 1-14978) | | | | | | | | 8
| | | | Principal Subsidiaries | | | | X | | | | | | 12
| | (a)
| | Certification of Olivier Bohuon, filed pursuant to Exchange Act Rule 13a -14(a) | | | | X | | | | | | | | (b)
| | Certification of Julie Brown filed pursuant to Exchange Act Rule 13a -14(a) | | | | X | | | | | | 13
| | (a)
| | Certification of Olivier Bohuon and Julie Brown furnished pursuant to Exchange Act Rule 13a – 14(b) | | | | X | | | | | | 15.1
| | | | Consent of Independent Registered Public Accounting Firm | | | | X |
|