UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

(Mark One)

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

or

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

or

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-14978

Smith & Nephew plc

(Exact name of Registrant as specified in its charter)

England and Wales

(Jurisdiction of incorporation or organization)

15 Adam Street, London WC2N 6LA

(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class	Name on each exchange on which registered
American Depositary Shares Ordinary Shares of 20¢ each	New York Stock Exchange New York Stock Exchange*

* Not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.

Securities registered or to be registered pursuant to Section 12(g) of the Act: None.

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None.

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 963,580,098 Ordinary Shares of 20¢ each

Indicate by check mark if the registrant is a well seasoned issuer, as defined in Rule 405 of the Securities Act  x Yes   ¨ No

If this Report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  ¨ Yes   x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  x Yes   ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ¨ Yes   ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer:

Large Accelerated Filer   x                         Accelerated Filer   ¨                         Non-accelerated filer   ¨                        

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.

U.S. GAAP  ¨ International Financial Reporting Standards as issued by the International Accounting Standards Board  x Other  ¨

If “Other” has been checked to the previous question indicate by check mark which financial statement item the registrant has elected to follow:   Item 17 ¨   Item 18 ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨ Yes   x No

Smith & Nephew Annual Report 2012

Contents
1	Overview	Our business today	2
		Financial highlights	4
		Chairman’s statement	5
2	Strategy and performance	Creating sustainable value	7
		Chief Executive Officer’s review of strategy	8
		How the group measures its strategic performance	16
3	Marketplace and Business segment review	Our marketplace	19
		Business segment review	22
		Advanced Surgical Devices	22
		Advanced Wound Management	28
4	Sustainability review	Sustainability strategy	35
		Healthy economic performance	36
		Healthy social performance	37
		Healthy environmental performance	40
		Sustainability progress	41
5	Financial review and principal risks	Financial review	43
		Outlook and trend information	53
		Principal risks and risk management	54
6	Corporate Governance	Governance introduction	57
		Our Board of Directors	58
		Our Executive Officers	60
		Corporate governance statement	62
		Directors’ remuneration report	74
7	Accounts and other information	Directors’ responsibilities for the accounts	89
		Independent auditor’s UK report	90
		Independent auditor’s US report	91
		Group accounts	92
		Notes to the Group accounts	96
		Independent auditor’s report for the Company	139
		Company accounts	140
		Notes to the Company accounts	141
		Group information	144
		Investor information	151

Section 1 Overview                                                     1

Reshaping Smith & Nephew

“Smith & Nephew delivered good underlying revenue and profit growth and a strong trading profit margin in 2012.

“There is no doubt that we are benefiting from implementing our Strategic Priorities. Our choices to invest in higher growth products, franchises and geographies are enabling us to drive greater value for our Company and stakeholders.”

Olivier Bohuon

Chief Executive Officer

2           Smith & Nephew Annual Report 2012

Our business today

Smith & Nephew is a global medical

technology business dedicated to

helping improve people’s lives.

Group
Revenue2			Average number of employees3
$4.1bn		+2%	10,477
Revenue by geography $m			Employees by geography3
A      United States	1,651		A      United States	4,000
B      Other Established markets	2,003		B      Continental Europe	2,098
C      Emerging and International         markets	483		C       UK D      China	1,706 801
			E       Other	1,872

  Section 1 Overview   3

We have leadership positions in Orthopaedic Reconstruction, Advanced Wound Management, Sports Medicine and Trauma. We group these product franchise areas into two global divisions; Advanced Surgical Devices and Advanced Wound Management.	Revenue by business division $bn
	A	Advanced Surgical Devices	3.1
	B	Advanced Wound Management	1.0

Advanced Surgical Devices				Advanced Wound Management
Smith & Nephew’s Advanced Surgical Devices global business has leadership positions in Orthopaedic Reconstruction, Sports Medicine and Trauma. It is headquartered in the USA in Andover, MA and Memphis, TN.				Smith & Nephew’s Advanced Wound Management global business is a leader in advanced wound care dressings, negative pressure wound therapy and other advanced wound management technologies. It is headquartered in Hull, UK.
Revenue2				Revenue2
$3.1bn		+2%		$1.0bn		+4%
2011: $3.3bn				2011: $1.0bn
Revenue by franchise $m				Revenue by franchise $m
A	Knee Implants	874		A	Infection management	127
B	Hip Implants	666		B	Exudate management	269
C	Sports Medicine Joint Repair	521		C	Other AWM	633
D	Arthroscopic Enabling Technologies	409
E	Trauma	462
F	Other ASD	176
Revenue by geography $m				Revenue by geography $m
A	United States	1,449		A	United States	202
B	Other Established markets	1,298		B	Other Established markets	705
C	Emerging and			C	Emerging and
	International markets	361			International markets	122

Operating profit2		Trading profit1,2		Operating profit2		Trading profit1,2
$0.6bn	+7%	$0.7bn	+8%	$0.2bn	nil%	$0.2bn	-1%
2011: $0.6bn		2011: $0.7bn		2011: $0.2bn		2011: $0.2bn
Employees				Employees3
7,194	-5%			3,283	+5%
2011: 7,611				2011: 3,132

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.

3 Healthpoint was acquired in December 2012. The average employee number does not include the 460 Healthpoint employees who joined us through this acquisition.

4           Smith & Nephew Annual Report 2012

Financial highlights

Revenue2	Trading profit1,2
$4.137bn+2%	$965m+6%
Adjusted earnings per share1 (EPSA)	Trading profit margin1
75.7 cents+2%	23.3%+80bps
	Trading profit to cash conversion
	104%
Earnings per share (EPS)	Operating profit2
81.3 cents+25%	$846m +5%
Dividend per share	Operating profit margin
26.10 cents+50%	20.4%+20bps
	Operating profit as a percentage of cash generated from operations 71%
Research & development expenditure
$171m +2%

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.

  Section 1 Overview   5

Chairman’s statement

“Our financial strength – and confidence in continued

strategic progress – enabled the Board to review the

dividend policy during the year.”

Dear shareholder,

Smith & Nephew made good progress in 2012, both financially and strategically, as we delivered on our commitments to reshape the Company.

Our underlying revenues were up 2% to $4,137m, with reported revenue reflecting the successful transaction to create Bioventus. Trading profit was up 6% underlying at $965m, giving an 80 basis points increase in trading profit margin, which was up at 23.3%. Free cash flow, at $637m, was again healthy, demonstrating the vitality of our business.

This performance shows the effects of the major strategic programme announced last year to make Smith & Nephew fit and effective for the future. Throughout the year we made great progress driving efficiencies and liberating resources. This has allowed us to invest to realise the opportunities we see in our higher growth markets and sectors.

We have achieved all this and maintained our commitment to health and safety, ethics and the environment.

Enhanced returns for shareholders

Our financial strength – and confidence in continued strategic progress – enabled the Board to review the dividend policy during the year.

As a result, we increased the level of the Interim Dividend payment by 50% to 9.9¢ per share. The Board is pleased to propose a Final Dividend for the year of 16.2¢ per share, also up 50% on 2011. We intend to pursue a progressive dividend policy going forward.

Board changes

We were very pleased that Julie Brown joined us as Chief Financial Officer in February 2013. She brings top-level financial expertise, commercial experience and a deep knowledge of the healthcare sector. Julie replaces Adrian Hennah who left with our very best wishes and thanks for his significant contribution to Smith & Nephew.

We have also welcomed two new Non-Executive Directors during 2012. Ajay Piramal is one of India’s most impressive businessmen and Baroness Bottomley brings a wealth of experience from her successful career across both private and public sectors. We said farewell to Rolf Stomberg and Geneviève Berger, who we also thank for their valuable input.

In April, we shall welcome Michael Friedman to our Board who is renowned for his US healthcare expertise, in particular gained leading the prestigious City of Hope cancer institution in California.

Thank you

My Board colleagues and I visited a number of our global sites during the year. We welcome these opportunities to meet our employees, and would like to thank everyone at Smith & Nephew for their continued dedication to serving our customers.

We are also fortunate to meet and hear from shareholders regularly, both institutional and private. Your support and feedback are both appreciated, and continue to inform our thinking.

Smith & Nephew is evolving. We are already seeing the material benefits of our choices and actions. There is much more to come and we look forward to continuing to build ever more value for you into the future.

Sir John Buchanan

Chairman

6           Smith & Nephew Annual Report 2012

2	Strategy and performance
	This section outlines the Group’s growth strategy, and what has been done to deliver against this strategy.

Creating sustainable value	7
Chief Executive Officer’s review of strategy	8
How the Group measures its strategic performance	16

  Section 2 Strategy and performance   7

Creating sustainable value
At Smith & Nephew we believe that being a sustainable company, in every sense of the word, truly sets us apart. Positively contributing to the needs of our stakeholders at the economic, social and environmental level is important. This is seen in our values, in how we support our customers, and the way our products improve the quality of life of patients.
Smith & Nephew’s quality products are selected because it has built trusted relationships.
Smith & Nephew continues to create value through our core values:	The decision to use our products can be influenced by many parties, including:	The value of our products is recognised by many, including:
Perform	Healthcare professionals	Surgeons
Innovate	Hospitals	Nurses
Trust	Government spending	Patients
	Procurement	Caregivers
	Distributors	Healthcare systems
	Health departments

8           Smith & Nephew Annual Report 2012

Chief Executive Officer’s review of strategy

Our strategy Smith & Nephew’s strategic priorities are about making choices for the long term benefit of the Group, delivering higher returns to shareholders than its peer group.
1	Established markets	In Established markets (US, Europe, Japan, Australia, New Zealand and Canada), Smith & Nephew sees opportunities to build upon existing strong positions, to win market share through greater innovation and drive efficiencies to liberate resources. Through these actions the Group seeks to meet the challenges of subdued markets and maximise both revenue growth and profit margins.
2	Emerging and International markets	Smith & Nephew believes it can secure market leadership in the Emerging markets, building upon its initial success in China and expanding to create sustainable businesses in India, Brazil and Russia. In particular, the Group sees significant opportunities to build value through augmenting its existing portfolio with new products specifically designed for, and manufactured in, these markets.
3	Innovate for value	The Group’s future success depends upon continuing to offer new technologies and innovative business models to customers around the world. Smith & Nephew is accelerating its rate of innovation by increasing the research & development budget and identifying and investing in the projects that will deliver maximum value.
4	Simplify and improve our operating model	Smith & Nephew will work to ensure the business structure and processes support our innovation agenda, and the Group seeks to maximise efficiency in everything it does. There are opportunities to streamline the Group’s operations and manufacturing processes and to remove duplication. Smith & Nephew is building strong global functions – human capital, regulatory, quality, compliance, sustainability, finance and legal affairs – to support its management teams in their quest to serve the Group’s markets and customers better.
5	Supplement organic growth through acquisitions	The Group aims to augment its organic growth through acquisitions. Smith & Nephew will continue with its successful strategy of acquiring complementary technologies, seek to support our Emerging markets ambitions by acquiring local manufacturing and distribution businesses and remain alert to larger opportunities to support expansion in attractive sectors, such as advanced woundcare, extremities or minimally invasive surgery.

  Section 2 Strategy and performance   9

“We are investing in higher-growth products, franchises and geographies

and adapting our commercial models and cost structure.”

Dear Shareholder,

In August 2011, we announced an ambitious set of Strategic Priorities to make Smith & Nephew stronger, faster growing, better balanced and fit and effective for the future. Across the Group we are implementing this programme. We are investing in higher-growth products, franchises and geographies and adapting our commercial models and cost structure.

Emerging markets

In the Emerging markets we are delivering strong revenue growth, benefitting from our investments to strengthen the management team and sales force, and the successful registration of more of our existing products for sale.

Our strategy is to build upon this platform by expanding our distribution capability and delivering portfolios for the mid-tier segments. We will develop these through our own R&D, and by acquisition, and we expect to bring our first products to market in 2013.

We are also investing to ensure that all employees and third party representatives follow our Code of Conduct and local requirements. We have, what I believe to be, a world-class compliance programme. Sharing this expertise is integral to building a sustainable business everywhere we operate.

Investing for growth

In the Established markets we continue to successfully deliver a high rate of innovation. In 2012 we launched new hip, knee and trauma systems and more than 30 advanced wound management products. We increased our R&D budget, and expect to do so again in 2013.

We are also putting more resources into our higher-growth franchises and geographies. In trauma and extremities our actions to refine the commercial model and build the sales force is delivering good results. In Japan we are strengthening our leadership position in advanced wound management following the launch of Negative Pressure Wound Therapy.

These, and other investments like them, are possible because we are making Smith & Nephew more efficient. We generated annualised savings of around $100 million by the end of 2012 and are continuing to implement further improvements.

Healthpoint Biotherapeutics

The acquisition of Healthpoint Biotherapeutics expands our platform by giving us a strong position in bioactives, the fastest growing area of advanced wound

management. This perfectly complements our exudate and infection management and negative pressure expertise. The integration is proceeding to plan.

Corporate social responsibility

Whilst working to transform Smith & Nephew, we have not lost sight of the importance of our social, ethical and environmental obligations. Our commitment to customers, patients, employees, shareholders and communities remains strong. In 2012 we again earned the distinction of being featured in both the FTSE4Good Index and the Dow Jones Sustainability Index.

Delivering value

In 2013 we are continuing to build, delivering efficiency improvements and accelerating investment – in our higher-growth portfolios, in geographic expansion, in more R&D and in further acquisitions. I am pleased at the progress we have made, excited about the opportunities that we see, and confident we will continue to deliver greater value for our company and stakeholders.

Olivier Bohuon

Chief Executive Officer

12           Smith & Nephew Annual Report 2012

Chief Executive Officer’s review of strategy continued

Section 2 Strategy and performance                            13

14           Smith & Nephew Annual Report 2012

Chief Executive Officer’s review of strategy continued

Section 2 Strategy and performance                            15

16           Smith & Nephew Annual Report 2012

How the Group measures its strategic performance
	Strategic priority		Measurement
	1.	Established markets	Revenue from Established markets2
			$3.654bn +1%
	2.	Emerging and International markets	Revenue from Emerging and International markets2 $483m+11%	As a % of Group revenue
	3.	Innovate for value	R&D expense as a percentage of Group revenue	R&D expenditure $171m(2011: $167m)
	4.	Simplify and improve our operating model	Trading profit2 $965m+6%	Trading profit margin 23.3%+80bps
	5.	Supplement organic growth through acquisitions	Acquisition spend4 $813m
	2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.
	4 Includes complementary technology spend.

  Section 2 Strategy and performance   17

Performance	Global outlook	Why we measure
Smith & Nephew businesses in the Established markets grew by 2% in the US and 1% in the Other Established markets, where a weak macro environment in Europe partially offset strong results in Japan and Australia. –  By franchise, our performance relative to estimated global market growth was below in hip reconstruction, at market in knee reconstruction, sports medicine and trauma and above in advanced wound management –  For more detail on the market and competition (see pages 19 to 33)	Established markets for Smith & Nephew are the US, Europe, Japan, Australia, New Zealand and Canada. In these markets we expect the challenging economic conditions to continue, requiring realigned business models and focused investment.	–  Track the relative strength of our market positions
Emerging/International markets grew at 11%, exceeding Established markets rates and contributing over 40% of annual revenue growth for the Group. These geographies now represent 12% of the Group’s overall revenue. During 2012: –  China, successful model, revenues above $120m –  Significant infrastructure, operational and talent investment –  Refined new R&D model to develop mid-tier product portfolio	Emerging/International markets represent those outside of the Established markets including Brazil, China, India and Russia. The healthcare environment in these markets is rapidly expanding and with the right investments offers significant opportunities for the Group.	–  Track underlying growth of Emerging markets to global growth –  Monitor progress in key market segments
R&D investment now represents 4.1% of revenue, an increase in spending of 2%. We have maintained our momentum of introducing new products: –  Over 30 new AWM products launched –  In ASD, extensions to our established LEGION knee and PERI-LOC plate ranges, a new Hip revision system and further innovation in sports medicine –  Over 230 existing products now available for Emerging/International markets –  Innovation Centre opened in Memphis	Innovation offers the key to meeting the realities of healthcare and economic paradigm in both Established and Emerging markets. New products, technologies and surgical techniques hold the promise and potential of reducing the overall cost of healthcare.	–  Monitor the impact from innovation –  Monitor the underlying investment in R&D
Trading profit grew by 6%, aided by targeted efficiency and cost initiatives, which offset market pressures and enabled continued targeted organic investments. Trading profit margin was 23.3%, an 80bps improvement. Key initiatives included: –  On track to deliver $150m efficiency savings by end of 2014 –  Reorganisation of ASD and realignment of AWM –  Refining our manufacturing footprint (expansion of the Suzhou facility; move and closure of Linhe plant, both in China) –  Reduction in cost of goods –  Reduction in energy use and increased waste recycling	By simplifying and improving our operating model we can liberate resources to invest in growth opportunities and meet the persistent price pressure. A simpler and more efficient organisation allows us to make faster and better decisions.	–  Track our underlying trading profit growth and trading profitability –  Reduce the amount of energy and waste for the Group, our customers and the environment
2012 has been an active year from a business development perspective. We have invested in talent and capability, which has delivered several exciting opportunities including: –  Acquisition of Healthpoint Biotherapeutics –  Acquisition of complementary technology businesses (LifeModeler Inc, Kalypto Medical Inc, Aderma range of Dermal Pads) –  Bioventus venture formed and divestment of Biologics and Clinical Therapies business	Acquisition and partnerships are important elements which supplement the organic investment and provide increased opportunity for high growth and value.	–  Monitor value created for shareholders

18           Smith & Nephew Annual Report 2012

3	Marketplace and Business segment review
	We look at our business in relation to issues in the wider marketplace in which we operate.

Our marketplace	19
Business segment review	22
Advanced Surgical Devices	22
Advanced Wound Management	28

  Section 3 Marketplace and Business segment review   19

Our marketplace

Smith & Nephew operates in a complex marketplace. Spending is heavily influenced by governments, who are seeking to balance the demands placed upon healthcare systems from long-term trends, such as ageing populations and obesity, with requirements to restrain budgets. Patients are becoming more discerning and demanding, and healthcare providers are increasingly making choices based on both clinical outcomes and cost.

Smith & Nephew’s sales and marketing models reflect these factors. The Group invests in developing innovative products and services and in marketing these through the most appropriate direct or in-direct channels. Sales trends reveal a number of longer-term forces at work within our markets. The importance of government funding to our business remains and there is a need to meet ever more stringent regulation. Global manufacturing, supply and distribution operations seek to maximise their efficiency whilst supporting the sales and marketing process. Innovative new products are brought to market through highly focused research and development, and there is a robust policy of protecting intellectual property. The Group seeks to minimise the impact of currency on its business.

Sales and marketing

Smith & Nephew’s customers are the providers of medical and surgical services worldwide.

Competition exists among healthcare providers to gain patients on the basis of quality, service and price. Providers are under pressure to reduce the total cost of healthcare delivery. There has been some consolidation in the Group’s customer base, as well as amongst the Group’s competitors, and these trends are expected to continue in the long term. Smith & Nephew competes against both local and multinational corporations, including some with greater financial, marketing and other resources.

The Group’s business reflects a wide range of distribution channels, purchasing agents and buying entities in over 90 countries worldwide. The largest single customer worldwide is a purchasing group based in the UK that represented 6% of the Group’s worldwide revenue in 2012.

In certain parts of the world, including the UK, much of Continental Europe, Canada and Japan, the healthcare providers are largely government organisations funded by tax revenues. In the US, the Group’s major customers are public and private hospitals, which receive revenue from private health insurance and government reimbursement programmes. Medicare is the major source of reimbursement in the US, for knee and hip reconstruction procedures and for wound healing treatment regimes.

In the US, the Group’s products are marketed directly to healthcare providers, hospitals and other healthcare facilities with each business segment operating dedicated sales forces. The US sales forces consist of a mixture of independent contract workers and employees. Sales agents are contractually prohibited from selling products that compete with Smith & Nephew products. Our Advanced Surgical devices are principally shipped and invoiced to healthcare providers, hospitals and other healthcare facilities. Certain Advanced Wound Management products are shipped and invoiced to wholesale distributors and others are consigned to distributors that lease the devices to healthcare providers, hospitals and other healthcare facilities and end-users. In most other Established markets, each division typically manages employee sales forces directly, and also ships and invoices products both directly to healthcare providers, hospitals and other healthcare facilities and to wholesale distributors.

In Emerging markets and International markets the Group operates through direct selling and marketing operations, and through distributors. In these markets, Orthopaedics and Sports Medicine frequently share sales resources. The Advanced Wound Management sales force may be separate where it calls on different customers.

Sales trends

Smith & Nephew’s divisions participate in the global medical devices market and share a common focus on the repair of the human body. Smith & Nephew’s principal geographic markets are in our Established markets healthcare economies of the US, Europe, Japan, Canada, Australia and New Zealand. In addition, we are building our business in the Emerging markets (Brazil, Russia, India and China) and our International markets such as South Africa, Mexico and Turkey.

Global population

1950	2000	2050
2.5bn	6.0bn	9.0bn

Population by age %

Global obesity %

20           Smith & Nephew Annual Report 2012

Our marketplace continued

Smith & Nephew’s markets are characterised by increased longevity, more active lifestyles, obesity, increased affluence and an increase in the average age of the population caused by the immediate post-World War II ‘baby boomer’ generation approaching retirement.

Together these factors have created significant demand for more effective healthcare products which deliver improved outcomes through technology advances. Furthermore, pressure to resist increases in overall healthcare spending has led healthcare providers to demand products which minimise the length of hospital stays and use of surgeon and nursing resources.

Increasing patient awareness of available healthcare treatments through the internet and direct-to-customer advertising has led to some increased patient influence over product purchasing decisions.

For a description of the impact on each division refer to the ‘Business Segment reviews’ on pages 22 to 33.

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 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 changes in reimbursement policy, tax policy and pricing which may have an adverse impact on sales and operating profit. In particular, changes to the healthcare legislation in the US are due to impose 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.

Regulatory standards and compliance in the healthcare industry

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.

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.

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 and the State Food and Drug Administration in China.

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 ‘Legal proceedings’ on page 52.

Manufacturing, supply & distribution

The Group’s manufacturing production is concentrated at 12 main facilities in Memphis, Mansfield and Oklahoma City in the US, Hull, Warwick and Gilberdyke in the UK, Aarau in Switzerland, Tuttlingen in Germany, Fort Saskatchewan and Calgary in Canada and Suzhou and Beijing in China.

The Group operates a number of central distribution facilities in the key geographical areas in which it operates. Products are shipped to Group companies which hold small amounts of inventory locally for immediate or urgent customer requirements.

The Advanced Surgical Devices division operates a distribution facility in Baar, Switzerland which acts as the main holding and consolidation point for markets in Europe. In the US, the Advanced Surgical Devices distribution hub is located in Memphis.

Advanced Wound Management distribution hubs are located in Neunkirchen, Germany; Derby, UK; and Atlanta, US.

The Group has a central Operations function which continues to implement Lean Manufacturing throughout the factories and the supply chain which is designed to improve and sustain higher levels of service, quality, productivity and efficiency.

Core competencies include: materials technology; high precision machining in Advanced Surgical Devices; and high-volume, automated manufacturing in Advanced Wound Management.

Each business segment purchases raw materials, components, finished products and packaging materials from certain key suppliers. These principally include metal forgings and stampings for orthopaedic products, optical and electronic sub-components and finished goods for Sports Medicine products, active ingredients and finished goods for Advanced Wound Management and packaging materials across all businesses. Suppliers are selected, and contracts negotiated, by a centralised Group procurement team wherever possible, with a view to ensure value for money based on the total spending across the Group.

  Section 3 Marketplace and Business segment review   21

The Group outsources manufacturing where necessary to obtain specialised expertise or where it is possible to gain lower cost without undue risk to intellectual property. Suppliers of outsourced products and services are selected based on their ability to deliver products and services to specification, and establish and maintain a quality system. Suppliers are trained and are monitored through on-site assessments and performance audits that include quality, service and delivery. Finished goods purchased for resale include screen displays, optical and electrical devices in the Advanced Surgical Devices division and skincare products in the Advanced Wound Management division.

Research and development

Smith & Nephew manages a portfolio of short and long-term product development projects designed to meet the future needs of customers and continue to provide growth opportunities for the business. The Group’s research and development is directed towards each business segment. Expenditure on research and development amounted to $171m in 2012 (2011 – $167m, 2010 – $151m), representing approximately 4.1% of Group revenue (2011 – 3.9%, 2010 – 3.8%).

The Group continues to invest in future technology opportunities for clinical needs identified from across the Smith & Nephew businesses.

Research and development expenditure $m

$171m

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. 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.

Research and development is primarily carried out at the Group’s principal locations, notably in Memphis, US (Orthopaedics), Mansfield, US (Endoscopy) and Hull, UK (Advanced Wound Management). There are a number of other smaller research and development units situated at other locations around the Group. In-house research is supplemented by work performed by academic institutions and other external research organisations in Europe, America and Asia.

Following the acquisition of Healthpoint Biotherapeutics the Group has a research and development capability in next-generation bioactive therapies for the treatment of chronic wounds. The principal pipeline product is HP802-247 for the treatment of venous leg ulcers which has entered Phase 3 trials.

Intellectual property

Smith & Nephew has a policy of protecting the results of research and development carried out by the Group. Patents have been obtained in a wide range of fields, including orthopaedic reconstruction and trauma, sports medicine and advanced wound management. Patent protection for Group products is sought routinely in the Group’s principal markets. Currently, the Group’s patent portfolio stands at approximately 4,700 patents in force and patent applications pending.

Smith & Nephew also has a policy of protecting the Group’s products by registering trademarks under local laws of markets in which such products are sold. The Group vigorously protects its trademarks against infringement.

In addition to protecting its market position by filing and enforcing patents and trademarks, Smith & Nephew may oppose third-party patents and trademark filings where appropriate in those areas that might conflict with the Group’s business interests.

In the ordinary course of its business, the Group enters into a number of licensing arrangements with respect to its products. None of these arrangements individually is considered material to the current operations and the financial results of the Group.

Currency fluctuations

Smith & Nephew operates across many jurisdictions and therefore the Group’s 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 intra-group sales 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 ‘Financial position, liquidity and capital resources’ on page 50.

22           Smith & Nephew Annual Report 2012

Business segment review

Advanced Surgical Devices

Smith & Nephew has leadership

positions in Orthopaedic Reconstruction,

Sports Medicine and Trauma.

Revenue2		Trading profit1,2
$3,108m	+2%	$728m	+8%
Operating profit2		Trading profit margin1
$632m	+7%	23.4%	+150 bps

Revenue by franchise $m				Product franchise growth2 %
A	Knee Implants	874
B	Hip Implants	666
C	Sports Medicine Joint Repair	521
D	Arthroscopic Enabling Technologies	409
E	Trauma	462
F	Other ASD	176

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.

  Section 3 Marketplace and Business segment review   23

Overview

In 2012, the Advanced Surgical Devices global division (ASD) developed, manufactured and sold products in the following franchise areas:

– Knee Implants

– Hip Implants

– Sports Medicine Joint Repair

– Arthroscopic Enabling Technologies

– Trauma

Products are manufactured at sites around the world. The main facilities are located in Memphis, TN, Mansfield, MA and Oklahoma City, OK in the US. Products are also manufactured in Aarau, Switzerland, Tuttlingen, Germany, Leamington Spa (Warwick), UK, Beijing, China and Calgary, Canada, as well as by third-party manufacturers. Major service centres are located in the US, UK, Germany, Japan and Australia.

Strategy

ASD was created in 2011 with the merger of the orthopaedic and endoscopy business units. The momentum gained from this merger continued in 2012. The division continues to take a disciplined and objective approach to resource allocation among its core (Hip Implant, Knee Implant and Arthroscopic Enabling Technologies) and growth (Sports Medicine Joint Repair, Trauma and Other, including Gynaecology) franchises. In the core franchise areas, ASD will continue to position itself through innovation and process improvement to grow with the market and deliver earnings. In the growth franchises, the division is investing increasing amounts in innovation, rapid iterations and market development to take both share and leadership positions.

The Emerging and International markets have become an increasingly important opportunity for Advanced Surgical Device products. Significant progress was made in these markets in 2012 with investment in division management, local management, sales teams and products.

In April, ASD, along with the Advanced Wound Management division, announced the start of a major initiative to align and optimise the infrastructure and operational activities across Smith & Nephew in Europe. Known as the European Process Optimisation, this multi-year commitment will deliver a standard and simplified set of processes underpinned by a common enterprise resource planning platform and business intelligence system.

ASD also began phasing out slow and non-moving product components in 2012. The division has plans to address the number of product components further by reducing the number of platforms.

ASD provides medical education through a variety of training and education services tailored to individual surgeon needs. The Group also focuses on knowledge sharing, utilising the world’s top specialists and key opinion leaders. The ASD business supports its medical education strategy with investment in surgeon education programmes, global fellowship support initiatives, partnerships with professional associations and surgeon advisory boards.

In January 2012, the Group announced its intention to sell its Biologics and Clinical Therapies business (CT) to Bioventus LLC (‘Bioventus’). The creation of Bioventus gave CT the resources to address longer term development projects. Smith & Nephew has a 49% shareholding in the new venture, maintaining access to the area of orthobiologics, whilst realising value for reinvestment in nearer term opportunities. This transaction was completed on 4 May 2012 for a total consideration of $367m and resulted in a profit before taxation of $251m. CT’s revenue in the four month period to disposal was $69m and profit before taxation was $12m. CT was reported within the Other franchise.

Acquisitions

In 2012, the Group acquired LifeModeler, Inc. (LMI).

LMI is the leading provider of biomechanical human body simulation tools and services and the developer of the groundbreaking software used in creating the JOURNEY BCS knee system. With this new software, orthopaedic innovations can be tested and validated faster and more cost effectively prior to the production of a physical prototype, potentially shortening the time it takes to develop new products and take to market.

Market and competition

In 2012, weaker economic conditions worldwide continued to create several challenges for the overall surgical devices market, including continued deferrals of joint replacement procedures and heightened pricing pressures.

These factors contributed to the lower overall growth of the worldwide surgical devices market versus historic comparables. However, over the medium term, several catalysts are expected to continue to drive sustainable growth in surgical device procedures, including the growing and ageing population with active lifestyles, rising rates of co-morbidities such as obesity and diabetes, patient desire for minimally invasive procedures, technology improvements allowing surgeons to treat younger, more active patients, and the increasing strength of the demand for healthcare in Emerging markets.

Global orthopaedic reconstruction segment

Smith & Nephew estimates that the global orthopaedic reconstruction segment is worth approximately $13.6bn and the segment served by Smith & Nephew grew by approximately 3% in 2012. Competitors in the orthopaedics reconstruction segment include Zimmer, Stryker, Johnson & Johnson and Biomet.

Global orthopaedic trauma segment

Smith & Nephew estimates that the global orthopaedic trauma segment is worth approximately $4.5bn and the segment served by Smith & Nephew grew by approximately 3% in 2012. Competitors in the orthopaedics trauma segment include Zimmer, Stryker and Johnson & Johnson.

24           Smith & Nephew Annual Report 2012

Business segment review continued

Global Sports Medicine segment

Smith & Nephew estimates that the global sports medicine segment (representing access, resection and repair products) is worth approximately $4.1bn and the segment served by Smith & Nephew grew by approximately 7% in 2012. Competitors in the sports medicine segment include Arthrex, Johnson & Johnson and Stryker.

Financial performance

Revenue

2012

Revenue $m
A	Knee Implants	874
B	Hip Implants	666
C	Sports Medicine Joint Repair	521
D	Arthroscopic Enabling Technologies	409
E	Trauma	462
F	Other ASD	176

ASD revenue decreased by -4% to $3,108m from $3,251m in 2011. Of this decrease, underlying growth of 2% is offset by -2% due to unfavourable currency movements and -4% due to the effect of disposal of the Clinical Therapies business.

The underlying increase in ASD revenue reconciles to reported growth, the most directly comparable financial measure calculated in accordance with IFRS, as follows:

	2012  %	2011  %
Reported growth	(4)	8
Constant currency exchange effect	2	(4)
Disposals effect	4	–
Underlying growth	2	4

In the Established markets, revenue decreased by $163m to $2,747m (-6%).

In the US, revenue decreased by $118m to $1,449m (-8%). This movement is attributable to underlying growth of 1% and -9% due to the effect of the disposal of the Clinical Therapies business. In the Established markets outside of the US revenue decreased by $45m to $1,298m (-3%). Underlying growth was 1% with -4% due to unfavourable currency movements.

In Emerging and International markets, revenue increased by $20m to $361m (6%). Underlying growth was 10% with -4% due to unfavourable currency.

2011

ASD revenue increased by 7% to $3,251m from $3,050m in 2010. Of this increase, 3% was attributable to underlying growth and 4% was due to favourable currency movements.

In the Established markets, revenue was $2,910m. This represented an underlying increase of 2% from 2010.

In the US, revenue was $1,567m, which represents an underlying growth of 2% from 2010. In the Established markets outside of the US, revenue was $1,343m which represented an underlying increase of 1% from 2010.

In the Emerging and International markets revenue was $341m which represents an underlying increase of 21% from 2010.

Trading profit

2012

Trading profit increased by $14m (2%) to $728m from $714m in 2011. Trading profit margin increased from 21.9% to 23.4%. These increases reflect the early benefits of implementing the Strategic Priorities, in particular, restructuring the Group to provide the right commercial models and cost structure.

2011

Trading profit decreased by $22m (8%) to $714m from $736m in 2010. Trading profit margin decreased from 24.1% to 21.9%. This decrease was due to continuing pricing pressure, adverse mix and some delay in the execution of our efficiency programme.

Operating profit

2012

Operating profit increased by $2m from $630m in 2011 to $632m in 2012. This comprises the increase in trading profit of $14m discussed above and the recognition of a legal claim of $23m in 2011, offset by an increase of $10m in the amortisation of acquisition intangibles and a $25m increase in restructuring and rationalisation costs. Operating profit, the most directly comparable financial measure calculated in accordance with IFRS, reconciles to trading profit as follows:

	2012 $m	2011 $m
Operating profit	632	630
Restructuring and rationalisation costs	57	32
Amortisation of acquisition intangibles	39	29
Legal settlement	–	23
Trading profit	728	714

  Section 3 Marketplace and Business segment review   25

ASD Revenue2		Trading profit1,2
$3.1bn	+2%	$728m	+8%
2011: $3.3bn		2011: $714m

Advanced Surgical Devices trading profit and operating profit as a percentage of Group trading profit and operating profit was as follows:

	2012		2011		2010
	%		%		%
Trading profit		75		74		76
Operating profit		75		73		76

2011

Operating profit decreased by $70m to $630m from $700m in 2010. This comprised of a decrease in trading profit of $22m discussed above, an increase of $3m in the amortisation of acquisition intangibles, a $22m increase in restructuring and rationalisation costs and $23m in respect of the legal provision.

Regulatory approvals

In 2012, the Advanced Surgical Devices division obtained regulatory clearances/approvals for several key products and instrumentations.

In the US, 510(k) clearance was obtained for Hip, Knee and Trauma franchise products including POLARCUP with Ti/HA Coating, REDAPT Revision Femoral System, JOURNEY II CR Knee System and JOURNEY II Deep Dished Articular Inserts. In addition, 510(k) clearance was obtained for Twinfix Ultra PK, TI, HA gluteal tendon indications; Footprint Ultra PK gluteal tendon indications; BIORAPTOR, OSTEORAPTOR labral reconstruction indications; and allograft transplant indications.

Several products were approved in Japan including ANTHOLOGY Hip Stems, LEGION VERILAST CR, PS and Revision Knee Systems, BIOLOX Delta Ceramic Femoral Heads, GENESIS II Constrained Articular Inserts and TRIGEN Low Profile Bone Screws.

In Europe, the division renewed approval for JOURNEY BCS Knee System and obtained approval for JOURNEY II BCS Knee System. In Canada, POLARCUP XLPE Acetabular Liners were approved.

Franchises

Underlying revenue growth for key product lines are:

	2012		2011
	%		%
Reconstruction
– Knee implants		3		5
– Hip implants		(3)		(1)
Sports Medicine		8		11
Arthroscopic Enabling Technologies		(2)		–
Trauma		3		3

Orthopaedic and sports medicine procedures tend to be higher in the winter months (quarter one and quarter four) when accidents and sports related injuries are highest. Conversely, elective procedures tend to slow down in the summer months due to holidays.

Orthopaedic reconstruction

The division offers a range of specialist products for orthopaedic reconstruction through its Hip implant and Knee implant franchises.

Both the knee and hip implant markets continue to experience economic pressure. Knee implant franchise revenue increased by 1% to $874m in 2012 which represented an underlying revenue growth of 3% and unfavourable foreign currency translation of -2%. This compared to a market growth rate of 3%. Growth slowed in the second half of 2012 as a result of a weakening of the overall knee market in Europe and the division’s knee product cycle. Between 2009 and 2011, when the division materially outperformed the knee market, it benefited from the launch of VERILAST Technology and VISIONAIRE Patient Matched Instrumentation. This benefit has now been annualised.

In the global Hip implant franchise revenue decreased by $39m to $666m (-6%) in 2012, representing a -3% underlying revenue decline in the face of the continuing metal-on-metal headwinds and -2% due to unfavourable foreign currency translation. The Hip implant franchise, led by the ANTHOLOGY Hip with VERILAST Technology, has also continued to perform well in its focus product areas.

Sales of our BIRMINGHAM Hip Resurfacing system continued to decline during the year. The BIRMINGHAM HIP Resurfacing System is a clinically proven system for hip resurfacing which preserves bone and is particularly suited for younger, more active male patients.

ASD launched several new products across its Orthopaedic Reconstruction portfolio in 2012.

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.

26    Smith & Nephew Annual Report 2012

Business segment review continued

In the Hip implant franchise, the REDAPT Revision Femoral Hip System was launched, offering surgeons one reproducible system for any type of hip revision. Also, the POLARCUP Dual Mobility Hip System, widely available in Europe, was introduced in the US. In Knee implants, the launch of the LEGION HK Hinge Knee System and the LEGION Narrow Femoral Components continue to expand the versatility of the LEGION Total Knee System. In Japan, the LEGION Revision knee system and VERILAST Technology for primary knee replacements were approved to market.

Implant bearing surfaces such as the proprietary OXINIUM Oxidized Zirconium continue to be a point of differentiation for Smith & Nephew. OXINIUM Technology combines the enhanced wear resistance of a ceramic bearing with the superior toughness of a metallic bearing. When combined with highly cross-linked polyethylene (XLPE) it results in ASD’s proprietary VERILAST Technology. In hip implants, the combination of a ceramicised metal head and a polyethylene lined cup have been shown in joint registry data to have superior five-year survivorship (97.9%) compared to implants made from any other material. In knees, the LEGION Primary Knee with VERILAST Technology is the only knee implant with a 30-year wear performance claim – more than double the length of wear performance testing of conventional technologies.

Another driver of Knee implant growth has been VISIONAIRE Patient Matched Instrumentation. With VISIONAIRE Instrumentation, a patient’s MRI and X-rays are used to create customised cutting blocks that allow the surgeon to achieve optimal mechanical axis alignment of the new implant. In addition, VISIONAIRE also helps save time by reducing the number of steps and instruments needed in the operating room.

The LEGION/GENESIS II Total Knee System is a comprehensive system designed to allow surgeons to address a wide range of knee procedures from primary to revision. The JOURNEY Active Knee Solutions is a family of advanced, customised products designed to treat early to mid-stage osteoarthritis patients, and provide more normal feeling and motion through bone ligament preservation and anatomic replication. In 2012, the second iteration of the JOURNEY Knee System, the JOURNEY II BCS, commenced a limited commercial release.

For Hip implants, core systems include the ANTHOLOGY Hip System, SYNERGY Hip System, the SMF Short Modular Femoral Hip System, the R3 Acetabular System, the POLARCUP Dual Mobility Hip System and the SL-PLUS Hip Family System.

Trauma

The division’s Trauma franchise offers both internal and external devices, as well as other products such as orthobiological materials used in the stabilisation of severe fractures and deformity correction procedures.

In the US the division is implementing a refined commercial model that increases the focus and resources needed to address the opportunities in the high-growth trauma and extremities markets.

Global Trauma revenue increased by $5m to $462m (1%), representing underlying revenue growth of 3% and -2% unfavourable foreign currency translation.

In 2012, both the VLP FOOT Percutaneous Calcaneus Plating System and the PERI-LOC Ankle Fusion Plating System were launched as part of the Group’s ALL 28 Foot and Ankle Portfolio. Both systems are available to surgeons in North America, Europe and Australia and offer solutions for increasingly popular surgical approaches. The VLP FOOT Percutaneous Calcaneus System is designed for the percutaneous approach and is the only plating system to offer variable-angle locking technology. The PERI-LOC Ankle Fusion Plating System is the only system to offer surgeons options for the posterior approach which minimises soft tissue irritation and preserves the fibula.

For trauma, the principal internal fixation products are the TRIGEN family of IM nails (TRIGEN META-NAIL System, TRIGEN Humeral Nail System, TRIGEN SURESHOT, and TRIGEN INTERTAN). For extremities and limb restoration, the franchise offers the TAYLOR SPATIAL FRAME Circular Fixation System as well as a range of plates, screws, arthroscopes, instrumentation, resection, and suture anchor products for foot & ankle surgeons and hand & wrist surgeons.

  Section 3 Marketplace and Business segment review   27

Sports Medicine Joint Repair

The division’s Sports Medicine Joint Repair franchise offers surgeons a broad array of instruments, technologies and implants necessary to perform minimally invasive surgery of the joints, including knee, hip and shoulder repair.

Global revenue from Sports Medicine Joint Repair increased by $30m to $521m (6%), of which 8% was underlying growth and -2% unfavourable foreign currency translation.

The franchise benefited from the launch of several class-leading products during the year. These included The HEALICOIL PK Suture Anchor for both shoulder and hip repair, ENDOBUTTON CL Ultra 10mm Fixation Device, CLANCY Flexible Drill System and ACUFEX PINPOINT Anatomic ACL Guide System. The Group also obtained US FDA clearance for expanding the indications of the HEALICOIL PK Suture Anchor and the OSTEORAPTOR Suture Anchor for use in hip arthroscopy.

The HEALICOIL PK Suture Anchor features a revolutionary open-architecture design that uses less material than traditional, solid-core anchors while still providing significantly more thread engagement and greater pullout strength than its competitors. The ENDOBUTTON CL Ultra 10mm Fixation Device is the franchise’s shortest continuous loop. It is designed for the growing number of surgeons who want to maximise the interface between the graft and the femoral tunnel, a feature especially important when using the anatomic technique to repair the ACL.

Joining other offerings such as the ACUFEX PINPOINT Anatomic ACL Guide System, CLANCY Anatomic Cruciate Guide, and BIOSURE Interference Screws, the ENDOBUTTON CL Ultra 10mm Fixation Device is part of a complete portfolio of options for surgeons performing a wide variety of anatomic ACL reconstructions.

Arthroscopic Enabling Technologies (AET)

The division’s Arthroscopic Enabling Technologies franchise 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; radiofrequency (RF) probes, electromechanical and mechanical blades, and hand instruments for removing damaged tissue.

AET revenue decreased by $16m to $409m (-4%) in 2012, which represented an underlying revenue decline of -2% and -2% of unfavourable foreign currency translation.

Key AET products include the wide range of DYONICS shaver blades, ACUFEX handheld instruments, and a wide range of radiofrequency probes. Launched in 2011, the DYONICS Platinum Series Shaver Blades are single-use blades that provide superior resection due to their unequalled sharpness and virtually eliminate clogging due to their improved debris evacuation capabilities.

In 2012, the AET business obtained regulatory clearance in the United States and Europe for the DYONICS Platinum Blades 4.5/5.5mm.

Other

The division’s Other franchise includes smaller businesses such as Gynaecology, and the Clinical Therapies business, the latter of which was transferred to Bioventus in May 2012.

The revenue in this Other franchise (excluding Clinical Therapies) increased by $2m to $69m (5%), which represented an underlying revenue growth of 7% and -2% of unfavourable foreign currency translation.

The franchise’s key gynaecology product is the TRUCLEAR System, a first-of-its-kind hysteroscopic morcellator that pairs continuous visualisation capabilities with minimally invasive tissue removal providing safe and efficient removal of endometrial polyps and submucousal fibroids. The Group also sells a hysteroscopic fluid management system, which provides uterine distension and clear visualisation during hysteroscopic procedures.

In 2012, the franchise introduced two additions to the TRUCLEAR System, the smaller-sized TRUCLEAR 5.0 System and the TRUCLEAR ULTRA Reciprocating Morcellator 4.0.

28           Smith & Nephew Annual Report 2012

Business segment review continued

Advanced Wound Management

Smith & Nephew has leadership

positions in Exudate and Infection

management, Negative Pressure

Wound Therapy and Bioactives

Revenue2		Trading profit1,2
$1,029m	+4%	$237m	-1%
Operating profit2		Trading profit margin1
$214m	nil%	23.1%	-120 bps

Revenue by franchise $m				Product franchise growth2 %
A	Infection management	127
B	Exudate management	269
C	Other AWM	633

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation.

  Section 3 Marketplace and Business segment review   29

Overview

Smith & Nephew’s Advanced Wound Management division (AWM) offers a range of products from initial wound bed preparation through to full wound closure. These products are targeted at chronic wounds associated with the older population, such as pressure sores and venous leg ulcers. There are also products for the treatment of wounds such as burns and invasive surgery that impact the wider population.

The main products within the AWM business are for Exudate management (predominantly the ALLEVYN brand and the recently added DURAFIBER products), Infection management (including the ACTICOAT brand) and Negative Pressure Wound Therapy (NPWT).

At the end of 2012, Smith & Nephew announced the completion of the acquisition of substantially all the assets of Healthpoint Biotherapeutics (‘Healthpoint’). The acquisition gives Smith & Nephew a leading position in bioactives, the fastest growing area of advanced wound management. The purchase price of $782m in cash has been financed from Smith & Nephew’s existing cash resources and bank facilities.

The AWM business has its global headquarters in Hull, UK and its North American headquarters in St Petersburg, Florida. The products are manufactured at facilities in Hull and Gilberdyke, UK, Suzhou in China, Fort Saskatchewan in Canada and also by third-party manufacturers around the world.

Strategy

AWM’s strategy is to be customer-led and invest for growth by focusing on high growth, high value segments, in particular exudate and infection management, through improved wound bed preparation, moist and active healing; further penetration of the NPWT market; and building its bioactives platform.

There has been a continued focus on operational efficiency and excellence. Since 2007, efficiency improvements have been delivered through various projects including support function consolidation, outsourcing of manufacturing to low cost suppliers, distribution rationalisation projects and the start of manufacturing in Suzhou, China.

Our strategic focus builds from an understanding of the increasing tensions between clinical and financial imperatives – and looks for the optimistic ground that resolves them. Our commitment is to improve wound outcomes for patients, and at the same time conserve resources for healthcare systems.

An aligned approach across AWM is designed to ensure that our employees are developed and work on common objectives to deliver consistent execution of the Group’s plan.

Acquisitions

Healthpoint

In December 2012, Smith & Nephew completed the acquisition of substantially all the assets of Healthpoint for $782m in cash. Healthpoint is a leader in bioactive debridement, dermal repair and regeneration wound care treatments. Its headquarters are in Fort Worth, Texas and it has approximately 460 employees, including an established sales force of 215.

This acquisition had compelling strategic and financial rationale for Smith & Nephew.

It gives the Group a strong position in bioactives, the fastest growing area of advanced wound management. Bioactives offer novel treatments for a range of hard-to-heal wounds, including the large and increasing prevalence of diabetic foot ulcers.

It brought a complementary range of bioactive debridement, dermal repair and regeneration products. Its principal marketed product is Collagenase SANTYL Ointment (‘SANTYL’), an enzymatic debrider for dermal ulcers and burns. Healthpoint’s offering also includes the OASIS family of leading acellular skin substitutes for venous leg ulcers and diabetic foot ulcers and REGRANEX, a growth factor for treating diabetic foot ulcers. These products generated revenues of around $190m in 2012 (not included in Smith & Nephew revenues for 2012). Its revenues are growing at a double digit percentage rate, driven by SANTYL ointment.

It added an established R&D capability in next-generation bioactive therapies for the treatment of chronic wounds. The principal pipeline product is HP802-247 for the treatment of venous leg ulcers, using cell-based therapy containing keratinocytes and fibroblasts. In August 2011, Healthpoint reported positive data from a Phase 2b clinical trial for HP802-247 in the treatment of venous leg ulcers, demonstrating that the compound met both its primary and secondary endpoints. The compound has recently entered Phase 3 trials for this indication and commercial launch could occur as early as 2017.

The Healthpoint acquisition will double our US AWM sales and strengthen our commercial scale and capabilities.

The combination creates a wound business which is unique – having leadership positions across exudate and infection management, negative pressure and bioactive wound care.

The agreement for the acquisition of Healthpoint’s assets contains customary representations and warranties by the parties.

30           Smith & Nephew Annual Report 2012

Business segment review continued

ADERMA

The purchase of the ADERMA Dermal Pads range in January 2012 gave us a leading position in the market to treat pressure ulcers. Up to one in 10 patients admitted to hospitals in the UK will suffer this debilitative condition, costing approximately £2.1bn per year. Developing skin damage causes great discomfort to the patient and depending on the grade of the ulcer can take many weeks to heal whilst the majority of pressure ulcers can be prevented. ADERMA Dermal Pads are made from a unique polymer gel that redistributes pressure, allowing clinicians to protect bony prominences to help prevent skin damage.

Kalypto

In 2012, the Company acquired Kalypto Medical, securing innovative complementary technology to expand our NPWT platform.

Market and competition

In 2012, weaker economic conditions worldwide continued to create several challenges for the overall advanced wound management market including significant price pressures and increased austerity measures in Europe.

The AWM market is focused on the treatment of chronic wounds of the older population and other hard-to-heal wounds such as burns and certain surgical wounds and is therefore also expected to benefit from demographic trends. Growth is driven by an ageing population and by a steady advance in technology and products that are more clinically efficient and cost effective than their conventional counterparts. The market for advanced wound treatments is relatively unpenetrated and it is estimated that the potential market is significantly larger than the current market. Management believes that the market will continue the trend towards advanced wound products with its ability to accelerate healing rates, reduce hospital stay times and cut the cost of clinician and nursing time as well as aftercare in the home.

Smith & Nephew estimates that the global wound management segment is worth approximately $6.0bn and the segment served by Smith & Nephew grew by 1% in 2012. Global competitors vary across the various product areas and include Kinetic Concepts, Molnlycke, Convatec and Coloplast.

Financial performance

Revenue

2012

AWM continues to outperform the market, with revenue growing at 4% in 2012 on an underlying basis (excluding a -3% unfavourable currency impact) to $1,029m. Management estimates that the overall market grew at 1%.

Underlying growth in Advanced Wound Management revenue reconciles to reported growth, the most directly comparable financial measure calculated in accordance with IFRS, as follows:

	2012		2011
		%		%
Reported growth		1		12
Constant currency exchange effect		3		(5)
Underlying growth		4		7

In the Established markets, revenue increased from $906m to $907m in 2012. This represents an underlying growth of 3% which was offset by unfavourable currency movements of -3%.

In the US, revenue increased by 7% from $189m to $202m. In the Established markets outside of the US, revenues decreased -2% from $717m in 2011 to $705m in 2012. This represents an underlying growth of 2% after adjusting for -4% of unfavourable currency movements.

Revenue in the Emerging and International markets increased from $113m in 2011 to $122m in 2012 (8%). The underlying movement was 11% offset by -3% of unfavourable currency movements. Exudate management grew at 1% and Infection management was down -2%, impacted by a distributor consolidation project in Canada.

2011

Revenue increased by $107m, or 12%, to $1,019m from $912m in 2010, comprising 5% favourable currency translation and 7% underlying growth. Exudate management grew in underlying terms by 2% and infection management by 4%, as targeted marketing investments in Europe delivered good returns. The Group’s NPWT portfolio has had another good year with excellent feedback since the launch of PICO during 2011. This was launched in the US during January 2012.

In the US, revenue increased by $11m to $189m (6%), all of which is attributable to underlying revenue growth.

Outside the US, revenue increased by $96m to $830m (13%). This is represented by an underlying growth of 7% and 6% of favourable foreign currency translation. European revenue increased by $39m to $493m (9%) of which 4% was underlying growth coupled with 5% of favourable currency translation.

  Section 3 Marketplace and Business segment review   31

AWM Revenue2		Trading profit1,2
$1.0bn	+4%	$237m	-1%
2011: $1.0bn		2011: $247m

Trading profit

2012

Trading profit reduced by $10m to $237m from $247m and trading profit margin decreased from 24.3% to 23.1%. The decrease in the year is primarily attributable to the additional costs arising from investment in new products throughout the year.

2011

Trading profit increased by $14m (6%) to $247m from $233m in 2010 and trading profit margin decreased from 25.6% to 24.3%. The comparative was assisted by a $25m settlement in respect of BlueSky. Ignoring the impact of this in the comparatives, the equivalent margin for 2010 was 22.8%. The increase in margin in 2011 was driven by the increase in underlying revenues.

Operating profit

2012

Operating profit decreased by $18m to $214m in 2012. This comprises a decrease in trading profit of $10m discussed above and an increase of $11m in connection with the acquisition related costs on the purchase of Healthpoint. These costs were partially offset by a reduction of $3m in the amortisation of acquisition intangibles.

Operating profit, the most directly comparable financial measure calculated in accordance with IFRS, reconciles to trading profit as follows:

	2012		2011
	$m		$m
Operating profit		214		232
Acquisition related costs		11		–
Restructuring and rationalisation costs		8		8
Amortisation of acquisition intangibles		4		7
Trading profit		237		247

Advanced Wound Management trading profit and operating profit as a percentage of Group trading profit and operating profit was as follows:

	2012		2011		2010
	%		%		%
Trading profit		25		26		24
Operating profit		25		27		24

2011

Operating profit increased by $12m to $232m. This comprises an increase in trading profit of $14m and a reduction of $1m in the amortisation of acquisition intangibles. These were offset by an increase of $3m in restructuring and rationalisation costs.

Regulatory approvals

In 2012 regulatory clearance for sale was obtained for ALLEVYN Life in the EU, US, Canada and Australia and for the introduction of a range of German specific ALLEVYN variants.

DURAFIBER Ag was approved as a Class III medical device in the EU.

VERSAJET and the RENASYS product range were both approved in Japan enabling Smith & Nephew to extend its operations into this important space. The RENASYS Go pump also received regulatory approval in China. In 2012 sterile pump versions of the PICO product launched in 2011 obtained regulatory approval in the US, EU, Canada & Australia.

PICO and VERSAJET II were both certified as compliant with the 3rd Edition of IEC 60601 an important new standard for the safety of electro-medical devices which is now required to comply with regulations in the EU.

Additional AWM products approved in the Emerging markets in 2012 include OPSITE Flexifix and LEUKOSTRIP in China and eight new products in India (ALLEVYN and ALLEVYN Ag variants, DURAFIBER and ACTICOAT Flex).

1 Explanations of these non-GAAP financial measures are provided on pages 44 to 46.

2 Underlying growth percentage after adjusting for the effect of currency translation and disposals.

32           Smith & Nephew Annual Report 2012

Business segment review continued

Franchises

Underlying revenue growth for key product lines are:

	2012			2011
	%			%
Exudate management		1			2
Infection management		(2	)		4
Other AWM		7			10

Due to the nature of its product range there is little seasonal impact on the Advanced Wound Management business.

Advanced Wound Care

Exudate management

Exudate management revenues decreased by -2% from $275m in 2011 to $269m in 2012. This represents an underlying growth of 1% offset by -3% in unfavourable currency exchange.

Exudate management products focus on efficient fluid management and creating the optimal moist wound environment that helps promote faster healing of the wound and reduces the risk of maceration. The principal technologies in this franchise are foam (ALLEVYN family) and gelling fibre dressings (DURAFIBER).

The ALLEVYN Gentle Border success story has continued with above market growth in 2012, becoming the largest variant of the ALLEVYN family this year. This was possible through focus on market share gains and further expansion of the range through new product development. In particular, the lite and shaped versions have further enhanced our ability to offer customers unique products that meet their clinical and economic needs. DURAFIBER commercialisation has also gained momentum in 2012.

ALLEVYN Life was launched in 2012. This is the latest generation of ALLEVYN products offering unique benefits and a significant advancement in managing wounds that diminish the quality of life of hundreds of thousands of patients every year. The product was born out of extensive international ethnographic research to understand how product design and performance can improve patient wellbeing, leading to improvements in concordance, clinical outcomes and, as a result, improved economic outcomes. Both clinician and patient feedback have been overwhelmingly positive.

Infection management

Infection management revenues have fallen from $133m in 2011 to $127m in 2012 (-5%). This also represents an underlying decline of -2% along with -3% of unfavourable currency exchange.

AWM has two significant technologies in its infection management portfolio, silver (ACTICOAT and ALLEVYN Ag) and iodine (IODOSORB). Market conditions for silver containing products have continued to be difficult in Europe but our focus on appropriate use, evidence based outcomes and cost effectiveness have demonstrated the differentiation within our products and stabilised our business in 2012. The iodine-based IODOSORB product has benefited from new evidence, claims and geography expansion, adding growth to our infection management portfolio.

ACTICOAT Flex continues to perform well following its introduction in 2009 by offering the customer benefits of ease of use, class leading efficacy and patient comfort. The ACTICOAT brand was further expanded in 2012 with ACTICOAT Surgical, delivering the antimicrobial performance of ACTICOAT in a specialist format designed for incision management – for use as part of strategies to reduce surgical site infections – a significant and costly post-surgical complication.

Other

Advanced Wound Management also offers a wide range of other wound care products, which means we offer one of the most comprehensive ranges of wound care solutions in the industry. These other products include our film and post-operative dressing offerings, skincare products and gels.

IV3000, AWM’s specialist IV dressing, utilises REACTIC film technology and a unique patterned adhesive to create a highly breathable product which by keeping the IV site dry helps to reduce the risk of bacterial growth and infection. IV3000 has continued to grow, especially through expansion into our Emerging markets and a continued focus on product training and education in 2012.

OPSITE Post Op visible is an incision management dressing innovation that combines the attributes of the ideal dressing with the ability to see the incision without having to remove the dressing. This unique product has gone from strength to strength since its introduction, bringing it to new customers and countries, significantly contributing to the Advanced Wound Care brands growth in 2012.

  Section 3 Marketplace and Business segment review   33

Advanced Wound Devices

Negative Pressure Wound Therapy (NPWT) delivers vacuum-assisted pressure to help promote healing. It consists of a wound dressing, a drainage tube, and a transparent film that is connected to a suction device. Smith & Nephew offers the RENASYS EZ and RENASYS GO pump systems together with a range of foam and gauze dressing kits. The NPWT range was enhanced with the introduction of PICO, the first of its kind – a fully disposable NPWT system.

The NPWT strategy is to be customer-led and invest for growth by offering the flexibility and simplicity within the product range to help address both the clinical and cost considerations of the customer. Within the traditional NPWT segment the Group is focusing on gaining share through offering a flexible RENASYS portfolio range of NPWT product offerings including foam, gauze, speciality kits, and portable and institutional pump systems. Within the disposable NPWT segment, the Group offers the simplified PICO portfolio range and is investing in creating this new market segment.

Smith & Nephew’s NPWT business continued strong growth in 2012, reflecting share gains continuing across North America and Europe, and new product introductions in Japan and Emerging markets. In addition, the recently launched PICO system (disposable NPWT) accelerated sales growth as the product gained awareness and adoption across a range of therapeutic areas (incision sites, chronic indications) and care settings (OR, discharge environment and community care).

The global NPWT market growth for 2012 showed modest decline compared to 2011. The increase in patient therapy and volumes was offset by price declines in most markets.

Within North America, market price declines are a reflection of business model changes to a single purchase transaction and away from the rental revenue model. In addition, unit price pressure continues in various care settings in response to pay or pressure and changing healthcare delivery dynamics. Therapy days increased slightly as a result of new technology offerings to provide greater therapy availability in transition care and discharge environment – offset by general trends in reduced hospital stay. For Europe, price pressure is a reflection of increased competition in key markets and the general economic environment across most markets. NPWT therapy was introduced in Japan in 2010 and the market continues to reflect strong growth as the therapy adoption increases across the market.

The Group continues to invest in medical education across the therapy category. Investment in clinical trials, consensus papers and general customer education and training remains a component to the overall value the Group brings to the advanced wound device market space.

During 2012, Smith & Nephew entered into a global settlement agreement with Wake Forest University that resolved all existing NPWT patent litigation between the two parties.

VERSAJET (hydro-surgery debridement) system sales were slightly down for 2012 over 2011. Revenue performance is a reflection of business model changes transitioning customers from a loaner to purchase equipment which positions the product line for better future growth. The transition phasing is effected by capital budget cycles, but allows for improved therapy adoption within facilities and thus providing a better platform for future growth. In addition, the economic conditions within health systems to pay for higher price capital equipment limits the ability to effect the change in business models.

New in 2012, was the introduction of RENASYS and VERSAJET systems to the Japan market. Japan is one of the world’s largest healthcare markets, where the NPWT and hydrosurgery segments are relatively new and growing. The early presence of the Group product offerings in these growing market segments provide a platform from which to sustain future growth.

Throughout 2012, the Group continued to invest and introduce a range of product improvements across the portfolio designed to improve adoption and customer satisfaction. The PICO range was extended to include new incision site shapes and RENASYS system adaptions were introduced, to make the pumps easier to operate in the hospital environment.

34           Smith & Nephew Annual Report 2012

4	Sustainability review
	As a business dedicated to helping improve people’s lives, our approach to sustainability focuses on positively contributing to the needs of stakeholders through improved environmental, social and economic performance.

Sustainability strategy	35
Healthy economic performance	36
Healthy social performance	37
Healthy environmental performance	40
Sustainability progress	41

  Section 4 Sustainability review   35

Sustainability strategy

Smith & Nephew continues to make progress

in achieving the objectives in our sustainability strategy,

which seeks to meet stakeholder expectations of a

sustainable business.

Smith & Nephew has been measuring, reporting and improving on its sustainability performance since 2001. During this time, the Group has made good progress and has been looking for ways to align sustainability more closely with our overall strategic priorities.

With this objective in mind, and under the leadership of Chief Executive Officer, Oliver Bohuon, Smith & Nephew developed a new sustainability strategy in 2011 as described below. The strategy aims to reinforce a healthy brand and strengthen corporate reputation by focusing on three distinct priorities:

– Healthy economic performance

– Healthy social performance

– Healthy environmental performance

Objectives

Smith & Nephew developed a comprehensive set of 2015 targets across each of these areas. These are outlined below:

Sustainability vision

Smith & Nephew will continue to build a sustainable business based on a global commitment to healthy environmental, social and economic performance. By working with stakeholders and inspiring employees, the vision will create shared value for all people that come into contact with the business by:

–   Reducing risk and cost

–   Building a better place to work

–   Innovating differentiated products and services, and increasing engagement with customers

–   Increasing shareholder value

Sustainability is a healthy business – the journey to 2015

Our sustainability aim

Build on our brand and corporate reputation
Be an industry leader incorporating sustainability objectives to reduce costs, innovate and differentiate our products and solutions.	Better engage with our customers. Be a ‘best place to work’. Increase our shareholder value.

Our sustainability priorities

Healthy economic performance	Healthy social performance	Healthy environmental performance
Delivering revenue growth and shareholder value through efficiency, performance and innovation.	Delivering a safe and healthy work environment with strong ethics and values, which embraces diversity and plays a leadership role in the communities where the Group operates.	Minimising environmental impact by reducing use of energy, carbon, water and other key resources.

36           Smith & Nephew Annual Report 2012

Sustainability review continued

Research & Development expenditure	Research & Development % of revenue
$171m	4.1%
2011: $167m	2011: 3.9%

Healthy economic performance

Our sustainability targets

Achieving Healthy Economic Performance will also yield cost savings and increased revenue

Deliver a higher return to our shareholders than our peer group over the longer term

Incorporate sustainability considerations into 100% of new product design by 2015

Incorporate sustainability considerations with 100% of our major supply chain partners by 2015

Smith & Nephew makes a major contribution to the health and well-being of individuals and communities across the world. Our pioneering technologies enable nurses, surgeons and other medical practitioners to provide effective treatment quickly and affordably. More than this, they help increase accessibility and save and improve the quality of people’s lives – all while helping the business thrive.

Product design

Revenue growth through innovation

In order to grow, thrive and combat some of the world’s most widespread health issues Smith & Nephew place a strong emphasis on new product development and innovation.

By designing products, instruments and techniques that provide both clinical and cost benefits, the Group’s work in this area has a major impact on improving the efficiency of health services. From reducing the frequency of dressing changes and shortening operating room time, to reducing infection rates and length of time spent in hospital – the Group’s efforts in this area have a significant impact on the lives of people across more than 90 countries.

In 2012, Smith & Nephew launched an entirely new concept in advanced wound care management with ALLEVYN Life, which focuses on the patient’s overall quality of life. Patient-centric in design, and considering the entire healthcare chain from provider to patient, ALLEVYN Life allows more healthcare providers the opportunity to help patients with hard to heal or hard to manage wounds. Research has shown that improving patient well-being is fundamental to reducing the economic cost of wound care. ALLEVYN Life offers unique benefits that help deliver this and is a significant advancement in preventing wounds that diminish the quality of life of many patients every year.

Smith & Nephew also introduced the REDAPT Femoral Revision System which was specifically designed to bring the concept of personalised patient treatments to the revision hip market. The REDAPT system allows surgeons to recreate a patient’s specific functionality effectively while quickly and easily addressing issues such as poor bone quality and proximal/distal mismatch. The REDAPT instruments maximise surgical efficiency and improve accuracy and reproducibility of implant position.

Business continuity

By creating a more sustainable business, Smith & Nephew is building resilience and flexibility to adapt to change. With the demand for medical technology set to increase well into the future, we are applying more sustainable ways of behaving to ensure long-term business continuity.

Product Development is driven by three specific considerations on healthcare systems and patients: Cost, Outcomes and Access. Design teams look at the overall cost of a product and how it impacts healthcare stakeholders, consider the benefits or outcome of new products and question how to enable new patients access to our new products and capabilities.

Supply chain

Our major supply chain partners have clearly spelled out sustainability targets, mostly around reducing carbon footprint. In addition we are working on initiatives that will deliver further improvements by switching distribution freight services where possible to lower carbon emissions such as from air to road and deep sea container service.

We now require sustainability reports to be provided for new suppliers and for each contract renewal and these are weighted in our assessments. There are challenges with small local suppliers in some countries but we are making progress.

  Section 4 Sustainability review   37

Lost time injury rate	Corporate citizenship/philanthropy spend
-17%	$14m
2011: +1%	2011: $14m

Healthy social performance

Our sustainability targets

A safe and healthy work environment. Strive for zero injuries and attain a position in top quartile of industry for safety performance through 2015

A healthy workforce. Implement wellness programmes in at least 60% of our major facilities by 2015

A diverse workforce. At least 40% of our global talent pool will be women by 2015

An ethical work environment. Employees must continue to complete annually assigned compliance training and certify adherence to our Code of Conduct and Business Principles

A responsible leader in the community. Contribute more than 1% of adjusted pre-tax profits annually towards corporate citizenship/philanthropy through 2015

Smith & Nephew touches the lives of millions of customers, communities and people across 90 countries. To deliver our technological innovations, we rely on the commitment and hard work of a network of more than 10,000 employees.

A safe and healthy working environment

Smith & Nephew has a longstanding commitment to the safety and health of employees, visitors and contractors. By reinforcing the responsibility of employees and contractors to work safely and follow our policies, standards and procedures, we are building a safe and healthy place to work.

In 2012 we achieved a 9% improvement in the Occupational Safety and Health Administration Total Recordable Incident Rate (TIR) and a 17% improvement in the Lost Time Injury Frequency Rate (LTIFR). In addition the severity of lost time injuries, as measured by number of days lost reduced by 10%. These improvements were achieved through determined management leadership and engagement of our employees.

Group safety rates

Wellness programmes

By the end of 2012 structured wellness programmes were in place at eight out of 18 of our major facilities covering 46% of our employees. Smith & Nephew defines major facilities as those in which more than 100 people report to work. Wellness programmes typically include lifestyle screenings and health assessments and preventative programmes based on nutrition and fitness advice. In some locations there are on site fitness facilities and classes.

Diversity at Smith & Nephew

Smith & Nephew believes that diversity fuels innovation. We focus on creating an inclusive, engaging environment where employees are valued and drive achievement of our goals. Such an environment fosters strength in our business because the variety of perspectives, experiences and work styles enhance creativity and innovation. We are committed to employment practices based on equality of opportunity, regardless of colour, creed, race, national origin, sex, age, marital status, sexual orientation or mental or physical disability unrelated to the ability of the person to perform the essential functions of the job.

The Board and Executive continue to recognise the importance of diversity and over the last two years have expanded their own diversity profile.

An ethical work environment

We earn trust

Trust is the foundation on which Smith & Nephew is built and it is the hallmark of its interactions with stakeholders both inside and outside the Group. A Code of Conduct and Business Principles defines the standards of behaviour for the Group’s employees as well as suppliers, contractors and distributors authorised to do business on the Group’s behalf.

Smith & Nephew fosters trust through open communication and a collaborative environment where ideas are encouraged, recognised and rewarded. Communication channels include group-wide newsletters and intranet platforms as well as a variety of forums for open dialogue including quarterly reports from the CEO and quarterly employee meetings on the state of the Group and important initiatives.

38         Smith & Nephew Annual Report 2012

Sustainability review continued

Code of Conduct and Business Principles

Smith & Nephew aims to be honest and fair in all aspects of its operations and expects the same from those with whom it does business. Our Code of Conduct and Business Principles governs the way we operate so that we respect stakeholders and seek to build open, honest and constructive relationships.

Smith & Nephew takes account of ethical, social, environmental, legal and financial considerations as part of its operating methods. We have a robust whistle-blowing system in all jurisdictions in which Smith & Nephew operates and where we have the necessary regulatory approvals. Our Code also states that we have a non-retaliation policy against anyone who makes a report in good faith.

New employees receive training on our Code of Conduct and Business Principles. We also assign annual compliance training to employees. In 2012, we created two courses: ‘I earn trust’ and ‘Data privacy’ to use for our annual training. The ‘I earn trust’ module focused on the key elements that make up trust – goodwill, ability and integrity – and gave employees an opportunity to practice earning trust in different scenarios.

Global Compliance Programme

Smith & Nephew aims to have a world-class, Global Compliance Programme that helps our business mitigate risk and comply with global laws. In 2012, Smith & Nephew continued to strengthen its comprehensive compliance programme which includes global policies and procedures, on-boarding and annual training for its employees and managers around the world, monitoring and auditing processes, and reporting channels. We provide resources and tools to guide employees through a global intranet web site. We require approvals for any significant interactions with healthcare professionals or government officials. New distributors are subject to due diligence, required to commit to compliance with our Code and take training.

In 2012, under the terms of the Company’s FCPA settlement (see Legal Proceedings), we retained an independent monitor to review the effectiveness of our compliance programme and make recommendations, as appropriate, for further enhancements to the programme. The monitor completed his initial review in August, and we are now in the process of implementing the recommended enhancements.

A responsible leader in the community

For Smith & Nephew, corporate citizenship and philanthropy play an integral role in the achievement of the Group’s strategic objectives of creating commercial value, building a strong reputation and creating deeper engagement for employees.

Smith & Nephew adopts a shared value approach to philanthropy and citizenship which focuses on leveraging the Group’s resources to be a force for good. The principal focus is on support for research, prevention, treatment and recovery of joint and bone health and wound care. In 2012, a new philanthropy policy was agreed and will be deployed in 2013. Details of this will be given in the full Sustainability Report to be published later this year.

In 2012, Smith & Nephew’s support for community charitable causes, grants, sponsorships and medical education was approximately $14m including $2m in product donations. As a matter of policy, Smith & Nephew makes no political contributions.

Smith & Nephew has developed relationships through healthcare professionals around the globe to support medical missions and medical education. In 2012 this charitable outreach included mission work in Vietnam through the Prosthetics Outreach Foundation, in Ecuador and Guatemala and the US through Operation Walk and Canvasback Missions in Majuro, Republic of the Marshall Islands.

Our initiatives into medical education included being the first sole sponsor of an Orthopaedic facility when the KwaZulu-Natal Orthopaedic Training Centre at the Inkosi Albert Luthuli Central Hospital, South Africa opened its doors in June 2012. This Centre provides training and education opportunities for surgeons from across Africa looking to learn minimally-invasive arthroscopic techniques.

Employees help raise community

awareness for Child Survival Programme

Our employees participated in many volunteer programmes during 2012 including the Manly-Manado Walk to raise funds for Compassion’s Child Survival Programme in Manado, Indonesia. Employees from our offices in Sydney, New South Wales, Australia joined others in the community to help raise awareness of why water, sanitation and hygiene matter in a developing community.

  Section 4 Sustainability review   39

Our people and communities

Our people strategy, which outlines our approach to leading our workforce and supports the delivery of our business strategy, is built on three key pillars: attract, recruit and retain talent; develop leaders; and engage employees through value driven strategies.

Smith & Nephew’s vision is to be the best at improving people’s lives and this vision extends to our employees. Our employees are dedicated to our core values of Performance, Innovation and Trust which represent the foundation of our culture.

Investing in our people and communities will help us ensure the long-term sustainability of our business. In 2012, our workforce included more than 10,000 employees, based in 32 countries. Our employment practices are designed to help us create the right workplace culture in which all employees feel valued, respected, empowered and inspired.

We strive to have the communities in which we work prosper as our business grows. Our community investment strengthens our business by supporting the local economies where we operate, helping us build strong relationships and capitalising on the philanthropic spirit of our workforce.

Attracting the best talent and developing and engaging our employees is critical to achieving and sustaining our business objectives and overall performance. Our appointments are made on merit and in alignment with a core set of competencies and values of which ethics and integrity are central. Our priority lies in the development and promotion of our employees whenever possible.

Each year, Smith & Nephew conducts a comprehensive global development and capability review process to identify high potential employees and ensure they have solid development plans. We continue to work on succession plans for critical positions across our business and have taken proactive steps to recruit specialist and leadership talent to augment our current team. We pride ourselves in maintaining a robust leadership strategy to identify and develop our leaders and offer a wide range of learning opportunities to our employees. Current programmes include the CEO forum designed to develop talent and provide exposure to the broader business and the General Managers Meeting held annually to align these key leaders with the Group’s strategy and goals. In addition the Board reviews succession plans for key executive roles.

Our performance management process means employees are set business aligned objectives and behavioural goals that are rewarded on high performance. Reward systems are focused on promoting high performance and helping to attract and retain the best people.

Smith & Nephew strives to create a more engaged and productive workforce and focuses on four measures to drive employee engagement. These include an understanding of the Group’s mission and direction, sense of employee involvement, focus and adaptability to customers and market place. We continue to listen to our employees and value their opinions. In 2012, more than 90% of our workforce responded to our Global Survey.

40           Smith & Nephew Annual Report 2012

Sustainability review continued

Energy usage	Water consumption
-1.5%	+2.6%

Healthy environmental performance

Our sustainability targets

Reduce non-renewable energy use by 15% by 2015

Reduce CO₂ emissions by 15% by 2015

Reduce water use by 15% by 2015

Reduce packaging materials by 15% by 2015

Reduce total waste by 15% by 2015

Increase the percentage of total waste recycled by 15% by 2015 (all normalised for growth)

Smith & Nephew is committed to reducing the impact of its activities on the environment to create a healthier planet. By focusing on energy and waste reduction, the Group is also reducing costs and becoming more efficient.

2012 Key performance compared

to normalised 2011 baseline %*

* Smith & Nephew uses a normalisation process based on cost of production which is defined as the cost of goods sold adjusted for opening and closing inventory levels. As production efficiencies are realised the cost of goods sold reduces and this can distort the effects of real environmental benefits making them appear less than actually achieved. Smith & Nephew will include a longer commentary on the normalisation process in its full Sustainability Report published later this year.

Reduction in CO₂ emissions of 100 metric tonnes: by re-routing vehicles for improved efficiency

Our Advanced Surgical Devices facility in Alberta, Canada has reduced the number of miles that materials and products are transported by re-routing some vehicles for improved efficiency. This initiative has reduced the number of journeys and therefore the overall distances driven by 120,000 miles per year. This equates to an approximate reduction in CO₂ emissions of 100 metric tonnes.

Energy and carbon reduction

Smith & Nephew recognises that emissions resulting from its global operations represent one of the key environmental impacts arising from the business. In 2012, initiatives to reduce our energy consumption and associated carbon emissions have resulted in a reduction in energy usage of -1.5% and -1.8% reduction in carbon emissions.

There has been tracking of energy savings initiatives at all of the major facilities. These range from lighting to heating and air handling to water cooling.

Lighting upgrades in warehousing and manufacturing centres have contributed to significant energy savings. Improvements to equipment and processes have resulted in reduced power consumption across a number of production facilities.

Water

Water consumption has risen by 2.6% in 2012. Achieving a reduction in water usage is particularly challenging as the majority of the water used wthin the Group is consumed at one individual facility where water is used for many key processes. This will be reviewed in 2013.

Packaging, waste and recycling

Waste reduction, including that related to product packaging, is a priority for Smith & Nephew. Given that a large amount of medical products are shipped and transported it is vital to ensure that these are protected from the point of manufacture through to the point of delivery. Product packaging plays a critical role in ensuring this safe delivery.

Establishing an effective strategy to meet our target for reduction in packaging materials is challenging due to the highly regulated environment and long lead times for change approvals. However by considering design, exploring ways to reduce and using new, more sustainable materials we are making progress in this area.

In 2012, one of our supply chain teams developed a specific process to optimise how our products are shipped and reduce shipping ‘air around the world’. By implementing this process for outbound packaging operations, corrugated cardboard usage was reduced by over 6 tonnes and CO₂ emissions reduced by 6,148kg in 2012. These reductions will have a further positive impact in 2013 when the process is fully implemented.

  Section 4 Sustainability review   41

Waste recycled	Total waste produced
+21.3%	+5.1%

In 2012, our overall waste rose by 5.1% largely due to equipment and layout changes, inventory adjustments arising from relocations and some building and demolition work. We are not satisfied with this and in 2013 we will increase our focus on the waste hierarchy, in particular prevention at source.

Significant improvements have been made in recycling waste which rose in 2012 by 21.3% and now stands at 58%.

Sustainability progress

Smith & Nephew retained its membership of the FTSE4Good. The FTSE4Good Index and Ratings have been designed to measure the performance of companies that meet or exceed globally recognised standards.

The Dow Jones Sustainability Index (DJSI World) was established to track the performance of the world’s largest companies that lead the field in terms of corporate sustainability. Smith & Nephew’s score improved this year and our inclusion in the Index was maintained.

Suzhou: 55% energy saving for facility lighting

The lighting in the warehouse at the Advanced Wound Management facility in Suzhou, China has been upgraded by fitting electrodeless lamps resulting in a 55% energy saving. This equates to a reduction in use of over 85,000 kWh per annum and associated annual cost savings. The advantages also include extended lamp life and therefore lower maintenance and replacement costs.

Smith & Nephew has been commended by the Carbon Disclosure Project (CDP), which represents 655 institutional investors with $78 trillion in assets, for its approach to the disclosure of climate change information. For the first time in 2012 Smith & Nephew is featured in CDP’s ‘Carbon Disclosure Leadership Index.’ This index, a key component of CDP’s annual FTSE 350 report, highlights the constituent companies within the FTSE 350 Index which have displayed a strong approach to information disclosure regarding climate change. Companies are scored on their climate change disclosure and high scores indicate good internal data management and understanding of climate change related issues affecting the Company.

Our Goodlett Farms Innovation Centre in Memphis, TN, USA, achieved the internationally recognised LEED (Leadership in Energy and Environmental Design) Gold Certification from the U.S. Green Building Council. This is the first LEED certified building in the global Smith & Nephew portfolio.

Looking ahead

A more detailed review of Smith & Nephew’s 2012 sustainability performance will be featured in our 2012 Sustainability Report to be published later this year.

Since 2001, Smith & Nephew has proudly reported on corporate sustainability. You may access our past and current Sustainability Reports through our corporate website www.smith-nephew.com

Contact us directly regarding Sustainability at sustainability@smith-nephew.com

42           Smith & Nephew Annual Report 2012

5	Financial review and principal risks
	The Group remains in a strong cash generative position, with a healthy balance sheet to fund further growth.

Financial review	43
Outlook and trend information	53
Principal risks and risk management	54

  Section 5 Financial review and principal risks   43

Financial review

Group revenue2		Basic earnings per Ordinary Share
$4.1bn	+2%	81.3c	+24.5%
2011: $4.3bn		2011: 65.3c

Financial highlights

Group revenue was $4,137m for the year ended 31 December 2012, representing a -3% decline compared to 2011. This comprised of underlying revenue growth of 2%, unfavourable currency translation of -2% and the disposal impact from the sale of the Clinical Therapies business totalling -3%.

Attributable profit in 2012 was $729m compared to $582m in 2011. Adjusted attributable profit (calculated as set out in ‘Selected financial data’ on pages 156 to 157) increased 2% to $679m in 2012, from $664m in 2011.

Basic earnings per Ordinary Share were 81.3¢, compared to 65.3¢ for 2011. EPSA (as set out in ‘Selected financial data’) was 75.7¢ in 2012 compared to 74.5¢ for 2011, representing a 2% increase.

	2012		2011		2010
	$m		$m		$m
Financial highlights (i) (iii)
Revenue		4,137		4,270		3,962
Underlying growth in revenue (%)		2%		4%		4%
Trading profit		965		961		969
Underlying growth in trading profit (%)		6%		(4)%		11%
Trading profit margin (%)		23.3%		22.5%		24.5%
Operating profit		846		862		920
Attributable profit for the year		729		582		615
Adjusted attributable profit		679		664		654
Basic earnings per Ordinary Share		81.3¢		65.3¢		69.3¢
EPSA		75.7¢		74.5¢		73.6¢
Growth in EPSA (%)		2%		1%		12%
Dividends per Ordinary Share (ii)		26.1¢		17.40¢		15.82¢
Cash generated from operations		1,184		1,135		1,111
Trading cash flow		999		838		825
Trading profit to cash conversion (%)		104%		87%		85%

(i) Items shown in italics are non-GAAP measures. Reconciliations to reported figures are on pages 44 to 46.

(ii) The Board has proposed a final dividend of 16.2 US cents per share which together with the first interim dividend of 9.9 US cents makes a total for 2012 of 26.1 US cents. The final dividend is expected to be paid, subject to shareholder approval, on 8 May 2013 to shareholders on the Register of Members at the close of business on 19 April 2013.

(iii) All items are $m unless otherwise indicated.

2 Underlying growth percentage after adjusting for the effect of a currency translation and disposal.

44           Smith & Nephew Annual Report 2012

Financial review continued

Measuring performance

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 International Financial Reporting Standards (‘IFRS’) and is therefore a measure not in accordance with Generally Accepted Accounting Principles (a ‘non-GAAP’ measure).

The Group believes that the tabular presentation and reconciliation 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.

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.

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 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. This is measured as the difference between the increase in revenue translated into US Dollars on a GAAP basis (ie current year revenue translated at the current year average rate, prior year revenue translated at the prior year average rate) and the increase measured by translating current and prior year revenue into US Dollars using the prior year closing rate.

The ‘acquisitions effect’ is the measure of the impact on revenue from newly acquired business combinations. This is calculated by excluding the revenue from sales of products acquired as a result of a business combination consummated in the current year, with non-US Dollar sales translated at the prior year average rate. Additionally, prior year revenue is adjusted to include a full year of revenue from the sales of products acquired in those business combinations consummated in the previous year, calculated by adding back revenue from sales of products in the period prior to the Group’s ownership. These sales are separately tracked in the Group’s internal reporting systems and are readily identifiable.

The ‘disposals effect’ is the measure of the impact on revenue from the disposal of business operations during the year. This is calculated by excluding the revenue from sales of products the Group no longer sells as a result of the disposal in the current year, with non-US Dollar sales translated at the prior year average rate. Additionally, prior year revenue is adjusted to remove a full year of revenue from the sales of products disposed. 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:

	2012			2011			2010
	%			%			%
Reported revenue growth		(3	)		8			5
Constant currency exchange effect		2			(4	)		(1	)
Disposals effect		3			–			–
Underlying revenue growth		2			4			4

Operating profit, the most directly comparable financial measure calculated in accordance with IFRS, reconciles to trading profit as follows:

	2012		2011		2010
	$m		$m		$m
Operating profit		846		862		920
Acquisition related costs		11		–		–
Restructuring and rationalisation costs		65		40		15
Amortisation of acquisition intangibles and impairments		43		36		34
Legal claim (see page 53)		–		23		–
Trading profit		965		961		969

A reconciliation of reported revenue growth to underlying revenue growth, by business segment, can be found on pages 22 to 33.

  Section 5 Financial review and principal risks   45

Trading profit

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 intangible assets and impairments; significant restructuring events; acquisition costs; and gains and losses resulting from legal disputes and uninsured losses.

A reconciliation of operating profit to trading profit, by business segment, can be found on pages 22 to 33.

Adjusted earnings per Ordinary Share

Growth in ‘adjusted earnings per Ordinary Share (‘EPSA’)’ is another measure which presents the trend in the long-term profitability of the Group. EPSA is not a recognised measure under IFRS and is therefore a non-GAAP financial measure. The most directly comparable financial measure calculated in accordance with IFRS is earnings per Ordinary Share.

EPSA excludes the same impact of specific transactions or events that management considers affect the Group’s short-term profitability, is used by the Group for similar purposes, and is subject to the same material limitations, as set out and discussed in the above section on trading profit.

Adjusted attributable profit represents the numerator used in the EPSA calculation. Adjusted attributable profit is reconciled to attributable profit, the most directly comparable financial measure in accordance with IFRS, as follows:

Growth in ‘trading profit’ and ‘trading profit margin’ (trading profit expressed as a percentage of revenue) are measures which present the growth trend in the long-term profitability of the Group excluding the impact of specific transactions or events that management considers affect the Group’s short-term profitability. The Group presents these measures to assist investors in their understanding of the trends. The Group’s international financial reporting (budgets, monthly reporting, forecasts, long-term planning and incentive plans) focuses primarily on profit and earnings before these items. Trading profit and trading profit margin are not recognised measures under IFRS and are therefore non-GAAP financial measures.

	2012			2011			2010
	$m			$m			$m
Attributable profit for the year		729			582			615
Acquisition related costs		11			–			–
Restructuring and rationalisation expenses		65			40			15
Amortisation of acquisition intangibles and impairments		43			36			34
Profit on disposal of net assets held for sale		(251	)		–			–
Legal claim (see page 53)		–			23			–
Taxation on excluded items (see page 104)		82			(17	)		(10	)
Adjusted attributable profit		679			664			654

The material limitation of these measures is that they exclude significant income and costs that have a direct impact on current and prior years’ profit attributable to shareholders. They do not, therefore, measure the overall performance of the Group presented by the GAAP financial measure of operating profit. The Group considers that no single measure enables it to assess overall performance and therefore it compensates for the limitation of the trading profit measure by considering it in conjunction with its GAAP equivalent. The gains or losses which are identified separately arise from irregular events or transactions. Such events or transactions are authorised centrally and require a strategic assessment which includes consideration of financial returns and generation of shareholder value. Amortisation of acquisition intangibles will occur each year, whilst other excluded items arise irregularly depending on the events that give rise to such items.

Earnings per Ordinary share	2012		2011		2010
Basic		81.3¢		65.3¢		69.3¢
Diluted		80.9¢		65.0¢		69.2¢
Adjusted: Basic		75.7¢		74.5¢		73.6¢
Adjusted: Diluted		75.4¢		74.2¢		73.6¢

Trading cash flow and trading profit to cash conversion ratio

Growth in trading cash flow and improvement in the trading profit to cash conversion ratio are measures which present the trend growth in the long-term cash generation of the Group excluding the impact of specific transactions or events that management considers affect the Group’s short-term performance.

Trading cash flow is defined as cash generated from operations less net capital expenditure but before acquisition related cash flows, restructuring and rationalisation cash flows and cash flows arising from legal disputes and uninsured losses. Trading profit to cash conversion ratio is trading cash flow expressed as a percentage of trading profit. The nature and material limitations of these adjusted items are discussed above.

The Group presents those measures to assist investors in their understanding of trends. The Group’s internal financial reporting (budgets, monthly reporting, forecasts, long-term planning and incentive plans) focuses on cash generation before these items. Trading cash flow and trading profit to cash conversion ratio are not recognised measures under IFRS and are therefore considered non-GAAP financial measures.

The material limitation of this measure is that it could exclude significant cash flows that have had a direct impact on the current and prior years’ financial performance of the Group. It does not, therefore, measure the financial performance of the Group presented by the GAAP measure of cash generated from operations. The Group considers that no single measure enables it to assess financial performance and therefore it compensates for the limitation of the trading cash flow measure by considering it in conjunction with the GAAP equivalents. Cash flows excluded relate to irregular events or transactions including acquisition related costs, restructuring and rationalisation costs and cash flows arising from legal disputes and uninsured losses.

46           Smith & Nephew Annual Report 2012

Financial review continued

Trading cash flow reconciles to cash generated from operations, the most directly comparable financial measure calculated in accordance with IFRS, as follows:

	2012			2011			2010
	$m			$m			$m
Cash generated from operations		1,184			1,135			1,111
Less: Capital expenditure		(265	)		(321	)		(315	)
Add: Cash received on disposal of fixed assets		–			–			8
Add: Acquisition related costs		3			1			–
Add: Restructuring and rationalisation related expenditure		55			20			16
Add: Legal settlement		22			–			–
Add: Macrotexture expenditure		–			3			5
Trading cash flow		999			838			825
Trading profit		965			961			969
Trading profit to cash conversion ratio		104%			87%			85%

2012 Financial highlights

The following table sets out certain income statement data for the periods indicated:

	2012			2011
	$m			$m
Revenue (i)		4,137			4,270
Cost of goods sold (ii)		(1,070	)		(1,140	)
Gross profit		3,067			3,130
Marketing, selling and distribution expenses		(1,440	)		(1,526	)
Administrative expenses (iii), (iv), (v)		(610	)		(575	)
Research and development expenses		(171	)		(167	)
Operating profit (i)		846			862
Net interest receivable/(payable)		2			(8	)
Other finance costs		(3	)		(6	)
Share of profit from associates		4			–
Profit on disposal of net assets held for sale		251			–
Profit before taxation		1,100			848
Taxation		(371	)		(266	)
Attributable profit for the year		729			582

(i) Group revenue and operating profit are derived wholly from continuing operations and discussed on a segment basis on pages 22 to 33.

(ii) In 2012, $3m of restructuring and rationalisation expenses were charged to cost of goods sold (2011 – $7m).

(iii) 2012 includes $51m of amortisation of other intangible assets (2011 – $42m).

(iv) 2012 includes $nil relating to legal provision (2011 – $23m).

(v) 2012 includes $62m of restructuring and rationalisation expenses, $43m relating to amortisation of acquisition intangibles and $11m acquisition related costs (2011 – $33m of restructuring and rationalisation expenses and $36m relating to amortisation of acquisition intangibles).

Revenue

Group revenue decreased by $133m (-3%) from $4,270m in 2011 to $4,137m in 2012. Underlying revenue growth was 2% of which -2% growth was attributable to unfavourable currency translation and -3% was attributable to the effect of disposing of the Clinical Therapies business. Advanced Surgical Devices revenues decreased by $143m (-4%), underlying growth was 2% of which -2% was due to unfavourable currency translation and -4% due to the disposal of the Clinical Therapies business. Advanced Wound Management revenues increased by $10m (1%), underlying growth was 4% with -3% due to unfavourable currency translation.

A more detailed analysis is included within the ‘Revenue’ sections of the individual business segments that follow on pages 22 and 33.

Cost of goods sold

Cost of goods sold decreased by $70m to $1,070m from $1,140m in 2011 which represents a 6% decrease. Of this movement, 1% is due to favourable currency translation movements. The remaining movement is largely attributable to the continued focus on costs, and partly attributable to the sale of the Clinical Therapies business in May 2012 which impacted both sales and cost of sales.

Further margin analysis is included within the ‘Trading profit’ sections of the individual business segments that follow on pages 22 to 33.

Marketing, selling and distribution expenses

Marketing, selling and distribution expenses decreased by $86m (-6%) to $1,440m from $1,526m in 2011. The underlying movement of -4% is after adjusting for favourable currency movement of -2%. Increased cost savings in Established markets were partly offset by investment in Emerging and International markets and promotion of new products particularly in Advanced Wound Management.

Administrative expenses

Administrative expenses increased by $35m (6%) to $610m from $575m in 2011. Favourable currency movements offset 2% of this increase. The main factors contributing to the underlying movement of 8% were an increase of $16m in amortisation on acquisition and other intangibles and an increase of $11m in acquisition costs.

Research and development expenses

Expenditure as a percentage of revenue increased by 0.2% to 4.1% in 2012 (2011 – 3.9%). Actual expenditure was $171m in 2012 compared to $167m in 2011. The Group continues to invest in innovative technologies and products to differentiate it from competitors.

Operating profit

Operating profit decreased by $16m to $846m from $862m in 2011. This comprised an increase of $2m in Advanced Surgical Devices and a decrease of $18m in Advanced Wound Management. Advanced Surgical Devices started to see the benefits of its focus on costs (more than offsetting the additional restructuring expense) whilst Advanced Wound Management has continued to invest in new products throughout the year and also acquired Healthpoint Biotherapeutics in December 2012, both increasing costs.

Net interest receivable/(payable)

Net interest payable reduced by $10m from $8m payable in 2011 to a receivable of $2m in 2012. This is a consequence of the overall reduction of borrowings within the Group, a reduction in the applicable interest rates and the $7m interest receivable on the Bioventus loan note issued following the disposal of the Clinical Therapies business.

  Section 5 Financial review and principal risks   47

Other finance cost

Other finance costs in 2012 were $3m compared to $6m in 2011. This decrease is attributable to an increase in the expected return on pension plan assets.

Taxation

The taxation charge increased by $105m to $371m from $266m in 2011. The rate of tax was 33.7%, compared with 31.4% in 2011.

The tax charge increased by $82m in 2012 (2011 – $17m reduction) as result of the profit on disposal of the Clinical Therapies business partially offset by an increase in restructuring and rationalisation expenses, amortisation of acquisition intangibles and acquisition related costs. The tax rate was 29.9% (2011 – 29.9%) after adjusting for these items and the tax thereon.

Group balance sheet

The following table sets out certain balance sheet data as at 31 December of the years indicated:

	2012		2011
	$m		$m
Non-current assets		3,498		2,542
Current assets		2,144		2,080
Assets held for sale		–		125
Total assets		5,642		4,747
Non-current liabilities		828		422
Current liabilities		930		1,119
Liabilities directly associated with assets held for sale		–		19
Total liabilities		1,758		1,560
Total equity		3,884		3,187
Total equity and liabilities		5,642		4,747

Non-current assets

Non-current assets increased by $956m to $3,498m in 2012 from $2,542m in 2011. This is principally attributable to the following:

– Goodwill increased by $90m from $1,096m in 2011 to $1,186m in 2012. Of this movement $73m arose on the acquisition of Healthpoint. The balance relates to favourable currency movements totalling $17m.

– Intangible assets increased by $641m from $423m in 2011 to $1,064m in 2012. Intangible assets totalling $662m arose on the Healthpoint acquisition. Amortisation of $94m was charged during the year and assets with a net book value of $3m were written-off. A total of $68m relates to the cost of intellectual property and software acquired. The balance relates to favourable currency movements totalling $8m.

– Property, plant and equipment increased by $10m from $783m in 2011 to $793m in 2012. Depreciation of $212m was charged during 2012 and assets with a net book value of $9m were written-off. These movements were largely offset by $197m of additions relating primarily to instruments and other plant & machinery and $27m of additions arising on the Healthpoint acquisition. The balance relates to favourable currency movements totalling $7m.

– Deferred tax assets decreased by $59m in the year.

– The total investment in associates has increased from $13m in 2011 to $283m in 2012. This movement predominately relates to the acquisition of Bioventus during the year totalling $114m plus $160m in the form of a loan note to Bioventus.

Current assets

Current assets increased by $64m to $2,144m from $2,080m in 2011. The movement relates to the following:

– Inventories rose by $42m to $901m in 2012 from $859m in 2011. Of this movement, $46m arose on the Healthpoint acquisition and it includes $9m relating to favourable currency movements.

– The level of trade and other receivables increased by $28m to $1,065m in 2012 from $1,037m in 2011. This movement includes $31m arising on the Healthpoint acquisition and $8m related to favourable currency movements.

– Cash and cash equivalents have fallen by $6m to $178m from $184m in 2011.

Non-current liabilities

Non-current liabilities increased by $406m from $422m in 2011 to $828m in 2012. This movement relates to the following items:

– Long-term borrowings have risen from $16m in 2011 to $430m in 2012. This increase of $414m is attributable to the acqusition of Healthpoint for $782m cash in December 2012.

– The net retirement benefit obligation decreased by $21m to $266m in 2012 from $287m in 2011. This was largely due to the Group’s additional pension contributions which were partialy offset by net actuarial losses for the year.

– Deferred acquisition consideration remains at $8m at the end of 2012. This relates to the acquisition of Tenet Medical Engineering during 2011.

– Provisions increased from $45m in 2011 to $63m in 2012. The principal component of this movement is $13m arising on the Healthpoint acquisition.

– Deferred tax liabilities decreased by $5m in the year.

Current liabilities

Current liabilities decreased by $189m from $1,119m in 2011 to $930m in 2012. This movement is attributable to:

– Bank overdrafts and current borrowings have decreased by $268m from $306m in 2011 to $38m in 2012.

– Trade and other payables have increased by $92m to $656m in 2012 from $564m in 2011. The primary cause of this increase is the acqusition of Healthpoint which increased trade and other payables by $49m.

– Provisions have decreased by $19m from $78m in 2011 to $59m in 2012. The most significant item contributing to this decrease is the payment of $22m to settle the legal provision (see Note 3).

– Current tax payable is $177m at the end of 2012 compared to $171m in 2011.

48           Smith & Nephew Annual Report 2012

Financial review continued

Total equity

Total equity increased by $697m from $3,187m in 2011 to $3,884m in 2012. The principal movements were:

	Total equity
	$m
1 January 2012		3,187
Attributable profit		729
Currency translation gains		37
Hedging reserves		(7	)
Actuarial loss on retirement benefit obligations		(13	)
Dividends paid during the year		(186	)
Taxation benefits on Other Comprehensive Income and equity items		20
Net share based transactions		117
31 December 2012		3,884

2011 Financial highlights

The following table sets out certain income statement data for the periods indicated:

	2011			2010
	$m			$m
Revenue (i)		4,270			3,962
Cost of goods sold (ii)		(1,140	)		(1,031	)
Gross profit		3,130			2,931
Marketing, selling and distribution expenses (iii)		(1,526	)		(1,414	)
Administrative expenses (iv, v, vi)		(575	)		(446	)
Research and development expenses		(167	)		(151	)
Operating profit (i)		862			920
Net interest payable		(8	)		(15	)
Other finance costs		(6	)		(10	)
Profit before taxation		848			895
Taxation		(266	)		(280	)
Attributable profit for the year		582			615

(i) Group revenue and operating profit are derived wholly from continuing operations and discussed on a segment basis on pages 22 to 33.

(ii) In 2011, $7m of restructuring and rationalisation expenses were charged to cost of goods sold (2010 – $nil).

(iii) In 2011, no restructuring and rationalisation expenses were charged to marketing, selling and distribution expenses (2010 – $3m).

(iv) 2011 includes $42m of amortisation of other intangible assets (2010 – $34m).

(v) 2011 includes $23m relating to legal provision (2010 – $nil).

(vi) 2011 includes $33m of restructuring and rationalisation expenses and $36m relating to amortisation of acquisition intangibles (2010 – $12m of restructuring and rationalisation expenses and $34m relating to amortisation of acquisition intangibles).

Revenue

Group revenue increased by $308m (8%) from $3,962m in 2010 to $4,270m in 2011. Underlying revenue growth was 4% and 4% growth was attributable to favourable currency translation.

Advanced Surgical Devices revenue increased by $201m (7%) to $3,251m in 2011 from $3,050m in 2010. The underlying revenue growth was 3% with favourable currency movements also contributing 4% to the growth in the year. Advanced Wound Management revenues increased by $107m (12%), of which 7% was attributable to underlying growth and 5% due to favourable currency translation.

A more detailed analysis is included within the ‘Revenue’ sections of the individual business segments that follow on pages 22 and 33.

Cost of goods sold

Cost of goods sold increased by $109m to $1,140m from $1,031m in 2010 which represents an 11% increase. Of this movement, 4% is due to adverse translation movements leaving an underlying movement of 7% compared to an increase in underlying revenue of 4%. The residual movement is largely attributable to continued pricing pressure across all of the Group’s markets which Smith & Nephew was not able to pass on to suppliers and an adverse movement in the mix of products sold, towards lower gross margin product.

Further margin analysis is included within the ‘Trading profit’ sections of the individual business segments on pages 22 to 33.

Marketing, selling and distribution expenses

Marketing, selling and distribution expenses increased by $112m (8%) to $1,526m from $1,414m in 2010. After adjusting for an unfavourable currency movement of 3% the underlying movement of 5% is broadly in line with increased Group revenues.

Administrative expenses

Administrative expenses increased by $129m (29%) to $575m from $446m in 2010. Unfavourable currency movements contributed towards 5% of this increase. The factors contributing to the underlying movement of 24% were; the non-recurrence of the one-off benefit of $25m arising from the BlueSky settlement in 2010, a charge of $23m relating to legal provision, an increase of $21m in restructuring and rationalisation expenses, an increase of $12m in the bad debt expense and an $8m increase in the amortisation charge on intangible assets. Other factors contributing to this increase included the additional investment in China and Emerging markets during 2011.

Research and development expenses

Expenditure as a percentage of revenue increased by 0.1% to 3.9% in 2011 (2010 – 3.8%). Actual expenditure was $167m in 2011 compared to $151m in 2010. The Group continues to invest in innovative technologies and products to differentiate it from competitors.

Operating profit

Operating profit decreased by $58m to $862m from $920m in 2010 comprising a decrease of $70m in Advanced Surgical Devices, offset by an increase of $12m in Advanced Wound Management.

Net interest payable

Net interest payable reduced by $7m from $15m in 2010 to $8m in 2011. This is a consequence of the overall reduction of borrowings within the Group and a reduction in the applicable interest rates.

Other finance cost

Other finance costs in 2011 were $6m compared to $10m in 2010. This decrease is attributable to an increase in the expected return on pension plan assets.

  Section 5 Financial review and principal risks   49

Taxation

The taxation charge decreased by $14m to $266m from $280m in 2010. The effective rate of tax was 31.4%, compared with 31.3% in 2010.

The tax charge was reduced by $17m in 2011 (2010 – $10m) as a consequence of restructuring and rationalisation expenses, amortisation of acquisition intangibles and legal provision. The effective tax rate was 29.9% (2010 – 30.8%) after adjusting for these items and the tax thereon.

Group balance sheet

The following table sets out certain balance sheet data as at 31 December of the years indicated:

	2011		2010
	$m		$m
Non-current assets		2,542		2,579
Current assets		2,080		2,154
Assets held for sale		125		–
Total assets		4,747		4,733
Non-current liabilities		422		1,046
Current liabilities		1,119		914
Liabilities directly associated with assets held for sale		19		–
Total liabilities		1,560		1,960
Total equity		3,187		2,773
Total equity and liabilities		4,747		4,733

Non-current assets

Non-current assets decreased by $37m to $2,542m in 2011 from $2,579m in 2010. This is attributable to the following:

– Goodwill decreased by $5m from $1,101m in 2010 to $1,096m in 2011. Goodwill totalling $37m was transferred to assets held for sale. Following the acquisition of Tenet Medical Engineering during 2011, an amount of $44m was capitalised as goodwill. The balance relates to unfavourable currency movements totalling $12m.

– Intangible assets decreased by $3m from $426m in 2010 to $423m in 2011. Intangible assets totalling $14m were transferred to assets held for sale. Amortisation of $78m was charged during the year and assets with a net book value of $2m were written-off. A total of $92m relates to the addition of intellectual property and software. The balance relates to unfavourable currency movements totalling $1m.

– Property, plant and equipment decreased by $4m from $787m in 2010 to $783m in 2011. Property, plant and equipment totalling $3m were transferred to assets held for sale. Depreciation of $217m was charged during 2011 and assets with a net book value of $7m were written-off. These movements were largely offset by $229m of additions relating primarily to instruments and other plant and machinery. The balance relates to unfavourable currency movements totalling $6m.

– Trade and other receivables decreased by $22m to $nil in 2011 from $22m in 2010 due to non-current receivables switching to current receivables during the year.

– Deferred tax assets and other non-current assets decreased by $3m in the year.

Current assets

Current assets decreased by $74m to $2,080m from $2,154m in 2010.

The movement relates to the following:

– Inventories fell by $64m to $859m in 2011 from $923m in 2010. Inventories totalling $15m were transferred to assets held for sale. Of the remaining movement, $10m related to unfavourable currency movements.

– The level of trade and other receivables increased by $13m to $1,037m in 2011 from $1,024m in 2010. Trade and other receivables totalling $49m were transferred to assets held for sale. Of the movement in the year, $18m related to unfavourable currency movements.

– Cash and bank has fallen by $23m to $184m from $207m in 2010. Of the movement, $2m related to unfavourable currency movements.

Assets held for sale

Assets held for sale totalling $125m relate to the underlying assets of the Clinical Therapies business, the proposed sale of which was announced on 4 January 2012 and completed on 4 May 2012.

Non-current liabilities

Non-current liabilities decreased by $624m from $1,046m in 2010 to $422m in 2011. This movement relates to the following items:

– Long-term borrowings have fallen from $642m in 2010 to $16m in 2011. This decrease of $626m is mainly attributable to the long-term loan repayable in May 2012 switching to a current liability.

– The net retirement benefit obligation increased by $25m to $287m in 2011 from $262m in 2010. This was largely due to actuarial losses of $70m which were only partly offset by pension contributions.

– Deferred acquisition consideration was $8m at the end of 2011, an increase of $8m from $nil at the end of 2010 as a result of the acquisition of Tenet Medical Engineering during the year.

– Provisions decreased from $73m in 2010 to $45m in 2011 which is largely due to a number of settlements during the year.

– Deferred tax liabilities decreased by $3m in the year.

Current liabilities

Current liabilities increased by $205m from $914m in 2010 to $1,119m in 2011. This movement is attributable to:

– Bank overdrafts and current borrowings have increased by $249m from $57m in 2010 to $306m in 2011 mainly as a result of the long-term loan repayable in May 2012 switching to a current liability.

– Trade and other payables have decreased by $53m to $564m in 2011 from $617m in 2010. Trade and other payables totalling $19m were transferred to liabilities directly associated with assets held for sale. An amount of $8m is attributable to favourable currency movements.

– Provisions have increased by $41m from $37m in 2010 to $78m in 2011. The most significant item contributing to this increase is the $23m legal provision (see Note 3).

– Current tax payable is $171m at the end of 2011 compared to $203m in 2010. Of the $32m reduction, $1m is attributable to favourable currency movements.

50           Smith & Nephew Annual Report 2012

Financial review continued

Liabilities directly associated with assets held for sale

Liabilities held for sale totalling $19m relate to the underlying liabilities of the Clinical Therapies business, the proposed sale of which was announced on 4 January 2012 and completed on 4 May 2012.

Total equity

Total equity increased by $414m from $2,773m in 2010 to $3,187m in 2011. The principal movements were:

	Total equity
	$m
1 January 2011		2,773
Attributable profit		582
Currency translation losses		(36	)
Hedging reserves		14
Actuarial loss on retirement benefit obligations		(70	)
Dividends paid during the year		(146	)
Taxation benefits on Other Comprehensive Income and equity items		22
Net share based transactions		48
31 December 2011		3,187

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 strengthened from $1.39 to $1.28 (+8%), Sterling weakened from $1.60 to $1.58 (-1%), the Swiss Franc weakened from $1.13 to $1.07 (-5%), the Australian Dollar strengthened from $1.03 to $1.04 (1%) and the Japanese Yen stayed flat at ¥80.

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 less 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.

Financial position, liquidity and capital resources

Cash flow and net debt

The main elements of Group cash flow and movements in net debt can be summarised as follows:

	2012			2011			2010
	$m			$m			$m
Cash generated from operations		1,184			1,135			1,111
Net interest paid		(4	)		(8	)		(17	)
Income taxes paid		(278	)		(285	)		(235	)
Net cash inflow from operating activities		902			842			859
Capital expenditure (net of disposal of property, plant and equipment)		(265	)		(321	)		(307	)
Acquisitions (net of cash acquired)		(782	)		(33	)		–
Equity dividends paid		(186	)		(146	)		(132	)
Proceeds from own shares		6			7			8
Issue of ordinary share capital		77			17			15
Treasury shares purchased		–			(6	)		(5	)
Change in net debt from net cash flow (see
Note 21 of the Notes to the Group accounts)		145			360			438
Exchange adjustment		5			(6	)		13
Opening net debt		(138	)		(492	)		(943	)
Closing net debt		(288	)		(138	)		(492	)

Net cash inflow from operating activities

Cash generated from operations in 2012 of $1,184m (2011 – $1,135m, 2010 – $1,111m) is after paying out $nil (2011 – $3m, 2010 – $5m) of macrotextured claim settlements unreimbursed by insurers, $3m (2011 – $1m, 2010 – $nil) of acquisition related costs, $55m (2011 – $20m, 2010 – $16m) of restructuring and rationalisation expenses and $22m (2011 – $nil, 2010 – $nil) relating to a legal settlement.

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 recent years, capital expenditure on tangible and intangible fixed assets represented approximately 6% of continuing Group revenue.

In 2012, gross capital expenditure amounted to $265m (2011 – $321m, 2010 – $315m). 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 2012, $4m (2011 – $9m, 2010 – $15m) 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 2012, $815m was spent on acquisitions, funded from net debt and cash inflows. This comprised, $33m for Tenet Medical Engineering during 2011 and $782m for Healthpoint acquired in December 2012. There were no acquisitions in 2010.

During 2012 the Group completed the transfer of its Biologics and Clinical Therapies business (CT) to Bioventus LCC (‘Bioventus’) for total consideration of $367m. As part of this transaction the Group paid $104m for 49% of Bioventus and subsequently invested a further $10m.

  Section 5 Financial review and principal risks   51

Liquidity

The Group’s policy is to ensure that it has sufficient funding and facilities in place to meet foreseeable borrowing requirements. In December 2010, the Group entered into a five-year $1bn multi-currency revolving facility with an initial interest of 70 basis points over LIBOR.

At 31 December 2012, the Group held $178m (2011 – $184m, 2010 – $207m) in cash and balances at bank. The Group has committed and uncommitted facilities of $1.0bn and $0.3bn respectively. The undrawn committed facilities totalling $0.6bn expires after two but within five years (2011 – $1.0bn expires after two but within five years). 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 $16m (of which $6m extends beyond five years).

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 2013, 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 $943m at the beginning of 2010 to $288m at the end of 2012, representing an overall decrease of $655m.

The Group’s planned future contributions are considered adequate to cover the current underfunded position in the Group’s defined benefit plans.

Further disclosure regarding borrowings, related covenants and the liquidity risk exposures is set out in Note 15 of the Notes to the Group accounts. The Group believes that its borrowing facilities do not contain restrictions that would have significant impact on its funding or investment policy for the foreseeable future.

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 54 to 55. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are described under ‘Financial position, liquidity and capital resources’ within the ‘Financial review’ section set out on page 50. In addition, the notes to the financial statements 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 ongoing 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.

Payment policies

It is the Group’s and Company’s policy to ensure that suppliers are paid within agreed terms. At the year-end the Company had no trade creditors.

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 ‘Marketplace and Business Segment review’ on pages 19 to 33 and ‘Taxation information for shareholders’ on pages 154 to 155.

Critical accounting policies

The Group’s significant accounting policies are set out in Notes 1 to 24 of the Notes to the Group accounts. Of those, the policies which require the most use of management’s judgment are as follows:

Inventories

A feature of the Advanced Surgical Devices division (whose finished goods inventory makes up approximately 83% 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 product, 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 involve management judgments on 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 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.

52           Smith & Nephew Annual Report 2012

Financial review continued

Retirement benefits

A number of key judgments have to be made in calculating the fair value of the Group’s defined benefit pension plans. These assumptions impact the Balance Sheet liability, operating profit and other finance income/costs. The most critical assumptions are the discount rate and mortality assumptions to be applied to future pension plan liabilities. For example as of 31 December 2012, a 0.5% increase in discount rate would have reduced the combined UK and US pension plan deficit by $28m whilst a 0.5% decrease would have increased the combined deficit by $33m. A 0.5% increase in discount rate would have decreased profit before taxation by $1m whilst a 0.5% decrease would have increased it by $1m. A one-year increase in the assumed life expectancy of the average 60 year old male pension plan member in both the UK and US would have increased the combined deficit by $23m. In making these judgments, management takes into account the advice of professional external actuaries and benchmarks its assumptions against external data.

The discount rate is determined by reference to market yields on high quality corporate bonds, with currency and term consistent with those of the liabilities. In particular for the UK and US, the discount rate is derived by reference to an AA yield curve derived by the Group’s actuarial advisers.

See Note 19 of the Notes to the Group accounts for a summary of how the assumptions selected in the last five years have compared with actual results.

Contingencies and provisions

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 or settlement negotiations or if new facts come to light.

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.

Legal proceedings

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 the provision or will not have a significant impact on the Group’s results of operations or financial condition in the period in which they are realised.

Product liability claims

In August 2003, the Group withdrew voluntarily from all markets the macrotextured versions of its Oxinium femoral knee components.

A number of related claims have been filed, most of which have been settled. The aggregate cost at 31 December 2012 related to this matter is approximately $214m. 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, and trial is expected to commence in 2014. An additional $22m was received in 2007 from a successful settlement with a third party.

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. Management believes that the $17m provision remaining is adequate to cover remaining claims. Given the uncertainty inherent in such matters, there can be no assurance on this point.

The Group faces other claims from time to time for alleged defects in its products and has on occasion recalled or withdrawn products to minimise risk of harm or claims. 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.

Currently, there is heightened concern about possible adverse effects of hip implant products with metal-on-metal bearing surfaces and the Group expects to incur expenses to defend claims in this area. 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.

Business practice investigations

In March 2005 the US attorney’s office in Newark, New Jersey issued subpoenas to the five largest sellers of hip and knee implants to US orthopaedic surgeons, including the Group’s orthopaedic business, asking for information regarding arrangements with orthopaedic reconstructive surgeons. In September 2007, the Group (and the other four companies involved) settled the charges that could have resulted from this investigation, without admitting any wrongdoing as part of the settlement. At the same time, the Group entered into a Corporate Integrity Agreement (‘CIA’) with the Office of the Inspector General (‘OIG’) of the US Department of Health and Human Services which requires certain compliance efforts. This agreement was for a five-year term.

On 11 December 2012 the OIG notified the group that it had met its CIA requirements and that the five-year term of the CIA had concluded.

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.

  Section 5 Financial review and principal risks   53

On 6 February 2012, Smith & Nephew announced that it had reached settlement with the SEC and DOJ in connection with this matter. Smith & Nephew has 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 to both the SEC and DOJ. The settlement agreements impose detailed reporting, compliance and other requirements on Smith & Nephew for a three-year term. Failure to comply with these requirements, or any other violation of law, could have severe consequences for the Group.

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 United States and other jurisdictions and also before agencies that examine patents. Outcomes are rarely certain and costs are often significant.

From the Group’s entry into the negative pressure wound therapy business in 2007, Kinetic Concepts, Inc. (‘KCI’) pursued claims of patent infringement against the Group in the US, UK, Germany and other jurisdictions, asserting both its own patents and others exclusively licensed to KCI by Wake Forest University. During the course of 2012, the Group reached agreements with KCI and Wake Forest to resolve all pending claims.

The Group has twice won jury verdicts in the US district court for Oregon against Arthrex Inc. for infringement of the Group’s patents relating to suture anchors. Judgement was entered in favour of the Group after the first verdict but reversed on appeal and remanded for a new trial. The verdict in the new trial was overturned by the district court but then (in January 2013) reinstated on appeal.

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 ‘whistleblower’ 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.

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. The Group has 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 in the past, primarily from the orthopaedics business, may have originated from countries that are not eligible for such sales except with government consent. Government auditors subsequently conducted an on-site visit at the Group’s orthopaedics business. In December 2008, three months after Smith & Nephew’s initial voluntary disclosure, a whistleblower 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.

Outlook and trend information

The discussion below contains certain forward-looking statements that may or may not prove accurate. For example, statements regarding expected revenue growth and trading margins, market trends and our product pipeline are forward-looking statements. Phrases such as ‘aim’, ‘plan’, ‘intend’, ‘anticipate’, ‘well placed’, ‘believe’, ‘estimate’, ‘target’, ‘consider’, and similar expressions are generally intended to identify forward-looking statements. Forward-looking statements involve known and unknown risks and uncertainties and other important factors that could cause actual results to differ materially from those projected in forward-looking statements. For Smith & Nephew, these factors include: economic and financial conditions in the markets we serve, especially those affecting healthcare providers, payors and customers; price levels for established and innovative medical devices; developments in medical technology; regulatory approvals; reimbursement decisions or other government actions; products 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 depositions and our success in integrating acquired businesses; and numerous other matters which affect us or our markets, including those of a political, economic business or competitive nature.

Additional information on factors that could cause the Group’s actual results to differ from estimates reflected in these forward-looking statements, can be found under ‘Principal risks and risk management’ section on pages 54 to 55.

Information regarding the recent and longer term market growth trends is given for each of the Group’s divisions in the relevant ‘Market and competition’ sections under ‘Business segment reviews’ on pages 22 to 33.

Smith & Nephew expects the market conditions seen in 2012 broadly to continue in 2013.

During 2013, the Group expects to maintain its excellent record in Advanced Wound Management and again grow at above the market rate.

Trauma and Extremities are expected to continue to build upon recent investments and grow slightly ahead of the market rate.

In Sports Medicine, the Group anticipates growing at around the market rate, with a stronger finish to the year, as new products are introduced in the second half of 2013.

Orthopaedic Reconstruction is likely to grow more slowly than the market, reflecting the Group’s position in the product cycle and the metal-on-metal headwinds, albeit with performance improving throughout the year as we realise the benefits of recent and planned product launches.

The Group exceeded its trading profit margin expectation for 2012 and remains focused on creating a business capable of delivering a sustainable 24% margin.

During 2013, the Group expects further benefits will be gained from our efficiency programme and will continue investing for growth. The first effects of the US Medical Device excise tax and the Healthpoint acquisition, which is initially dilutive to the Group margin, will be seen in 2013. Taking all these factors together, our trading profit margin in 2013 is expected to be below the 23.3% achieved in 2012.

Smith & Nephew exited 2012 with a much stronger platform than we entered the year. In 2013 we will continue to focus on our Strategic Priorities to deliver greater value for our Company and stakeholders.

54           Smith & Nephew Annual Report 2012

Principal risks and risk management

As an integral part of planning and review, Group and business area management seek to identify the significant risks involved in the business, and to review the risk management action plans for those risks. The Group Risk Committee, which is comprised of the CEO and senior executives, meets twice a year to review the risks identified by the businesses and corporate functions and any risk management actions being taken. As appropriate, the Risk

Committee may re-categorise risks or require further information on the risk management action plans. The Risk Committee reports to the Board on an annual basis detailing all principal risks. In addition, the Board considers risk as part of the development of strategy. Internal audit reviews and reports on the effectiveness of the operation of the risk management process.

Risk	Context	Specific risks we face
Disruptive technologies	The medical devices industry has a rapid rate of new product introduction. The Group must be adept at monitoring the landscape for technological advances, make good investment/acquisition choices, have an efficient and valuable product development pipeline and secure protection for its intellectual property.	–  Competitors may introduce a disruptive technology, or obtain patents or other intellectual property rights, that affect the Group’s competitive position –  Claims by third parties regarding infringement of their intellectual property rights –  Lack of innovation due to low R&D investment, R&D skills gap or poor product development execution for established and emerging markets –  Failure to successfully commercialise a pipeline product, or failure to receive regulatory approval
Government action, pricing and reimbursement pressure	In most markets throughout the world, expenditure on medical devices is controlled to a large extent by governments, many of which are facing increasingly intense budgetary constraints. The Group is therefore largely dependent on governments providing increased funds commensurate with the increased demand arising from demographic trends. 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. Political upheaval in the countries where the Group operates or surrounding regions could adversely affect Group operations or turnover. Group operations are affected by transactional exchange rate movements. The Group’s manufacturing cost base is situated in the US, UK, China and Switzerland and finished products are exported worldwide.	–  Reduced reimbursement levels and increasing pricing pressures –  Reduced demand for elective surgery –  Increased focus on health economics –  Government policies favouring lower priced products –  Political upheavals prevent selling of products, receiving remittances of profit from a member of the Group or future investments in that country –  The Group is exposed to fluctuations in exchange rates. If the manufacturing country currencies strengthen against the selling currencies, the trading margin may be affected –  Economic downturn impacts demand and collections
Supply, system and site disruption	Unexpected events could disrupt the business by affecting either a key facility or system or a large number of employees. The business is also reliant on certain key suppliers of raw materials, components, finished products and packaging materials.	–  Catastrophe could render one of the Group’s production facilities out of action –  A significant event could impact key leadership or a large number of employees –  Issues with a single source supplier of a key component and failure to secure critical supply –  A severe IT fault could disable critical systems
Product safety, regulation, and litigation	National regulatory authorities 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 and may also inspect for compliance with appropriate standards, including those relating to Quality Management Systems (‘QMS’) or Good Manufacturing Practice (‘GMP’) regulations.	–  Non-compliance with product regulations and standards could result in fines, penalties, and prosecutions –  Product defect could result in lost sales and inventory write-offs –  Third party liability claims –  Damage to reputation
Compliance with laws and regulations	Business practices in the healthcare industry are subject to increasing scrutiny by government authorities. The trend in many countries is towards increased enforcement activity. The Group is also subject to increased regulation of personal information. Acquisitions and expansion into Emerging markets could also pose additional compliance risks.	–  Violation of healthcare, data privacy or anti-corruption laws could result in fines, loss of reimbursement and impact reputation –  Serious breaches could potentially prevent the Group from doing business in a certain market –  Failure to conduct adequate due diligence or to integrate appropriate internal controls into acquired businesses could result in fines and impact return on investment

  Section 5 Financial review and principal risks   55

There are known and unknown risks and uncertainties relating to Smith & Nephew’s business. The table below provides an overview of what the Board considers the most significant risks that could cause the Group’s business, financial position and results of operations to differ materially and adversely from expected and

historical levels, and how these risks relate to the Group’s strategic priorities. 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.

Possible impacts	Risk Management actions	Link to strategic priority
–  Loss of market share, profit and long-term growth	–  Increasing productivity, prioritisation and allocation of R&D funds –  Increasing R&D investment in order to enhance clinical capability, invest in biomaterials –  Strengthen intellectual property rights and support an Emerging Market portfolio –  Business development to augment the portfolio –  Increasing speed to market of new products	–  Innovate for value –  Simplify and improve our operating model –  Supplement the organic growth through acquisitions
–  Loss of revenue, profit and cash flows	–  Develop innovative economic product and service solutions for both Established and Emerging markets –  Incorporate health economic component into design and development of new products –  Enhanced expertise supporting reimbursement strategy and guidance –  Optimise cost to serve to protect margins and liberate funds for investment –  Streamline COGS, SKUs, and inventory management –  The Group transacts forward foreign currency commitments when firm purchase orders are placed to reduce exposure to currency fluctuations	–  Simplify and improve our operating model Established markets –  Innovate for value
–  Loss of revenue, profit and cash flows	–  Ensure crisis response/business continuity plans at all major facilities and for key products –  Audit programme for critical suppliers and second sources or increased inventories for critical components –  Implement enhanced travel security and protection programme –  IT disaster and data recovery plans are in place and support overall business continuity plans	–  Simplify and improve our operating model –  Established markets
–  Loss of profit and reduction in share price –  Negative impact on brand/reputation	–  Enhanced leadership and resources –  Standardise the Group’s quality management and practice –  Maintain auditing programmes to assure compliance –  Group-wide practices to drive design, and production line performance and dependability –  Post launch review of product safety and complaint data	–  Simplify and improve our operating model –  Innovate for value
–  Loss of profit and reduction in share price –  Negative impact on brand/reputation	–  Strong compliance expertise and infrastructure –  Code of Conduct/Global Policies and Procedures (‘GPPs’) providing controls for significant compliance risks –  Training and e-resources to guide employees and third parties with compliance responsibilities –  Monitoring and auditing programmes to verify implementation –  Independent reporting channels for employees and third parties to report concerns with confidentiality –  Due diligence reviews and integration plans required for acquisitions	–  Simplify and improve our operating model –  Emerging markets –  Established markets

56        Smith & Nephew Annual Report 2012

6	Corporate Governance
	Ethics and compliance are at the heart of everything we do, and underline our commitment to strong Governance. We believe effective Governance requires both leadership and collaboration.

Governance introduction	57
Our Board of Directors	58
Our Executive Officers	60
Corporate Governance Statement	62
Directors’ Remuneration Report	74

  Section 6 Corporate Governance   57

Governance introduction

Dear Shareholder,

I am pleased to present the Corporate Governance Statement for 2012. Before we get into the technical detail of specific corporate goverance requirements, I wanted to highlight the governance areas we have focused on in 2012.

Board changes

We have continued to make changes to our Board throughout the year. As you will have read elsewhere in this Annual Report, we are delighted that Julie Brown has joined us as Chief Financial Officer on 4 February 2013. She will continue to build on the strong foundations laid by Adrian Hennah who left the Board on 31 December 2012. Adrian has contributed enormously to the success of the Company over the past six years and we are sorry to see him leave but wish him well in his future career.

We have also made a number of changes to our Non-Executive team. On 12 April 2012, Rolf Stomberg left the Board following 14 years’ service as a Non-Executive Director, during which time he served periods as Senior Independent Director and Chairman of the Remuneration Committee. On 1 November 2012, Geneviève Berger left the Board owing to other time commitments. During the year, we were pleased to welcome Ajay Piramal to the Board on 1 January 2012 and Baroness Bottomley on 12 April 2012. Finally, we shall be appointing Michael Friedman to the Board in April. These three new appointments reflect the changing focus of the Group, as we build a Board that will take us into the future. Ajay brings experience of Emerging markets and Baroness Bottomley brings her knowledge and experience of European public healthcare systems whilst Michael Friedman brings exceptional experience of the US Healthcare market. These are all areas vital to our future growth and prospects.

Ethics and compliance

Ethics and compliance remain at the very heart of our business and everything that we do. The independent monitor appointed to review our efforts recognised and supported the enhancements we have made over the past five years to our ethics and compliance programme, whilst making some very valuable suggestions about further improvements in what is a constantly evolving aspect of our business. We continue to remain vigilant in these areas and the Ethics & Compliance Committee of the Board sets the tone at the top in overseeing our ethics and compliance programme, which pervades the entire organisation.

Nomination & Governance Committee

In recognition of all the external developments in corporate governance, we have expanded the remit of the Nominations Committee to cover governance matters and to rename the committee, the Nomination & Governance Committee. For some time the Committee has considered certain governance matters such as the independence of Non-Executive Directors, diversity and the Board Evaluation process. This change of remit formalises the role of the Committee, which now includes Board succession planning, independence of Non-Executive Directors, diversity, conflicts of interest, oversight of the effective governance of the Board and its committees, the Board Evaluation process, the induction of new directors and directors training in general, as well as keeping abreast of external governance activities.

Review of the Board’s Effectiveness

Having conducted our own internal evaluation of the Board’s effectiveness in 2010 and 2011, we asked Independent Audit to facilitate the review process in 2012. This took the form of a series of interviews with each member of the Board, the Company Secretary and other members of the senior management team who interact with our Board. Independent Audit also reviewed the Board and Committee papers over the past year and observed our December Board meeting. Their comments and observations gave us a useful perspective into the way we operate as a Board. You can read more about this review in the statement that follows. A key takeaway for us was the need to give even greater focus to succession at Board level.

As ever, whilst we recognise the importance of sound governance, we are continually focused on the Board’s responsibility to promote the long-term success of the Company for the benefit of customers, employees and shareholders.

Sir John Buchanan

Chairman

20 February 2013

58           Smith & Nephew Annual Report 2012

Our Board of Directors

Our Board has the depth and breadth of experience

necessary to help the business take full advantage

of the opportunities and challenges ahead.

Board Gender				Board Nationality				Balance of Non-Executive and Executive Directors
A B	Male Female	8 3		A B C D E	American British French Indian New Zealand	3 5 1 1 1		A B C	Chairman Executive Director Non-Executive Director	1 2 8

Board Committee Membership
	Audit	Nomination & Governance	Ethics & Compliance	Remuneration
1 Sir John Buchanan		•
2 Olivier Bohuon		•
3 Julie Brown
4 Ian Barlow	•
5 Baroness Bottomley				•
6 Richard De Schutter	•	•	•	•
7 Michael Friedman
8 Pamela Kirby			•	•
9 Brian Larcombe	•	•		•
10 Joseph Papa	•		•	•
11 Ajay Piramal

Susan Swabey (51)

Company Secretary

Susan was appointed Company Secretary in May 2009. She has nearly 30 years’ experience as a company secretary in a wide range of companies including Prudential plc, Amersham plc and RMC Group plc. Her work has covered Board support, corporate governance, corporate transactions, share registration, listing obligations, corporate social responsibility, pensions, insurance and employee and executive share plans. Susan is a member of the GC100 Group Executive Committee and the CBI Companies Committee and is a frequent speaker on corporate governance related matters.

Nationality

British

  Section 6 Corporate Governance   59

1 Sir John Buchanan (69)

Chairman

Sir John was appointed Independent Non-Executive Director in 2005 and was appointed Chairman and Chairman of the Nominations Committee in April 2006 (now the Nomination & Governance Committee).

Sir John has broad international experience gained in large and complex international businesses. He has substantial experience in the petroleum industry and knowledge of the international investor community. He has held various leadership roles in strategic, financial, operational and marketing positions, including executive experience in different countries. He is a former Executive Director and Group Financial Officer of BP, serving on the BP Board for six years until 2003.

Other Directorships

– Chairman of ARM Holdings plc

– Senior Independent Director of BHP Billiton Plc

– Chairman of International Chamber of Commerce (UK) Limited

– Chairman of UK Trustees for the Christchurch Earthquake appeal

Nationality

British/New Zealand

2 Olivier Bohuon (54)

Chief Executive Officer

Olivier joined the Board and was appointed Chief Executive Officer in April 2011. He is a member of the Nomination & Governance Committee.

Olivier has had extensive international and leadership experience within a number of pharmaceutical and healthcare companies. Prior to joining Smith & Nephew, he was President of Abbott Pharmaceuticals, a division of Abbott Laboratories based in the US, where he was responsible for the entire business, including R&D, Global Manufacturing and global support functions.

Other Directorships

– Non-Executive Director of Virbac Group

Nationality

French

3 Julie Brown (50)

Chief Financial Officer

Julie joined the Board on 4 February 2013 as Chief Financial Officer. Julie is a Chartered Accountant and Fellow of the Institute of Taxation with international experience and a deep understanding of the healthcare sector. She trained with KPMG and then worked for AstraZeneca plc, where she served as Vice President Group Finance, and more recently, as Interim Chief Financial Officer. Prior to that she was Regional Vice President Latin America, Marketing Company President AstraZeneca Portugal and Vice President Corporate Strategy and R&D Chief Financial Officer. She has previously held Vice President Finance positions in all areas of the healthcare value chain including Commercial, Operations, R&D and Business Development.

Nationality

British

4 Ian Barlow (61)

Independent Non-Executive Director Chairman of the Audit Committee

Ian was appointed Non-Executive Director in March 2010 and Chairman of the Audit Committee in May 2010.

Ian is a Chartered Accountant and has had considerable financial experience both internationally and in the UK. Prior to his retirement in 2008, he was a Partner at KPMG, latterly Senior Partner, London. During his career with KPMG, he was Head of their UK tax and legal operations, and he acted as Lead Partner for many large international organisations operating extensively in North America, Europe and Asia.

Other Directorships

– Lead Non-Executive Director chairing the Board of Her Majesty’s Revenue and Customs

– Non-Executive Director of The Brunner Investment Trust

– Chairman of The Racecourse Association

Nationality

British

5 The Rt Hon Baroness Bottomley of Nettlestone DL (64)

Independent Non-Executive Director

Baroness Bottomley was appointed Non-Executive Director on 12 April 2012.

Baroness Bottomley has extensive experience and understanding of healthcare. She was appointed a Life Peer in 2005 following her career as a Member of Parliament between 1984 and 2005 and served successively as Secretary of State for Health and then National Heritage. She holds a number of positions within the public and private healthcare sector.

Other Directorships

– Director of International Resources Group Limited

– Member of the International Advisory Board of Chugai Pharmaceutical Company Limited

– Chancellor of University of Hull

– Pro Chancellor of the University of Surrey

– Governor of the London School of Economics

– Trustee of The Economist

Nationality

British

6 Richard De Schutter (72)

Senior Independent Non-Executive Director

Richard was appointed Non-Executive Director in January 2001 and Senior Independent Director in April 2011.

Richard has had extensive US corporate experience at Chief Executive and Chairman level in a number of major corporations with primarily a scientific, chemical, engineering or pharmaceutical focus including G.D. Searle & Co., Monsanto Company, Pharmacia Corporation and DuPont Pharmaceuticals Company.

Other Directorships

– Non-Executive Chairman of Incyte Corporation

– Non-Executive Director of Durata Therapeutics, Inc.

– Non-Executive Director of Navicure, Inc.

– Non-Executive Director of Sprout Pharmaceuticals

– Non-Executive Director of Celtic Therapeutics

Nationality

American

7 Michael A Friedman (69)

Independent Non-Executive Director

Michael will be appointed Non-Executive Director in April 2013 and will immediately offer himself to shareholders for re-election.

Michael has been Chief Executive Officer of City of Hope, the prestigious cancer research and treatment institution in California. He also serves as director of the institution’s comprehensive cancer centre and holds the Irell & Manella Cancer Center Director’s Distinguished Chair. He was formerly senior vice president of research, medical and public policy for Pharmacia Corporation and has served as Deputy Commissioner and Acting Commissioner at the US Food and Drug Administration. He has also served on a number of Boards in a Non-Executive capacity, including RiteAid Corporation.

Other Directorships

– Chief Executive Officer of City of Hope

– Non-Executive Director of Celgene Corporation

– Non-Executive Director of MannKind Corporation

Nationality

American

8 Pamela Kirby (59)

Independent Non-Executive Director Chairman of the Ethics & Compliance Committee

Pamela was appointed Non-Executive Director in March 2002 and Chairman of the Ethics & Compliance Committee in April 2011.

Pamela has extensive commercial and product development experience within the international pharmaceutical and healthcare industry. Her last executive position was Chief Executive of Quintiles Transnational Corp. in the US, having previously held senior positions in various pharmaceutical companies including AstraZeneca and F. Hoffmann-La Roche. She is now a Non-Executive Director of a number of international companies.

Other Directorships

– Non-Executive Chairman of Scynexis, Inc.

– Non-Executive Director of Informa plc

– Non-Executive Director of Victrex plc

– Non-Executive Member of the Board of Simmons & Simmons LLP

Nationality

British

9 Brian Larcombe (59)

Independent Non-Executive Director

Brian was appointed Non-Executive Director in March 2002. Brian spent his career in private equity with 3i Group. After leading the UK investment business for a number of years, he became Finance Director and then Chief Executive of the Group following its flotation. He is well known in the City and has held a number of Non-Executive Directorships.

Other Directorships

– Non-Executive Director of gategroup Holding AG

– Non-Executive Director of Incisive Media Holdings Limited

Nationality

British

10 Joseph Papa (57)

Independent Non-Executive Director Chairman of the Remuneration Committee

Joseph was appointed Non-Executive Director in August 2008 and Chairman of the Remuneration Committee in April 2011.

Joseph has had nearly 30 years’ experience in the pharmaceutical industry working for a number of companies both in the US and Switzerland. He is now Chairman and Chief Executive of Perrigo, one of the largest over the counter pharmaceutical companies in the US, having held senior positions at Novartis, Cardinal Health, Inc. and Pharmacia Corporation.

Other Directorships

– Chairman and Chief Executive of Perrigo Company

Nationality

American

11 Ajay Piramal (57)

Independent Non-Executive Director

Ajay was appointed Non-Executive Director on 1 January 2012. Ajay is one of India’s most respected businessmen. He enabled the Piramal Group to transform from a textile-centric group to a US$2.0bn conglomerate in diversified areas. He has extensive industry and market knowledge and international experience. He has held a number of global healthcare leadership positions in both India and internationally.

Other Directorships

– Chairman of Piramal Enterprises Limited, Piramal Glass Limited, Allergan India Pvt. Limited, IndiaREIT Fund Advisers Pvt. Limited and Director of DB Corp. Limited

– Chairman of the Board of Governors of Indian Institute of Technology, Indore

– Member of the Board of Dean’s Advisers at Harvard Business School

– Chairman of Pratham India

Nationality

Indian

60           Smith & Nephew Annual Report 2012

Our Executive Officers

Olivier Bohuon is supported in the day-to-day

management of the Group by a strong team of

Executive Officers:

  Section 6 Corporate Governance   61

1 Julie Brown (50)

Chief Financial Officer

Julie joined the Board on 4 February 2013 as Chief Financial Officer. Julie is a Chartered Accountant and Fellow of the Institute of Taxation with international experience and a deep understanding of the healthcare sector. She trained with KPMG and then worked for AstraZeneca plc, where she served as Vice President Group Finance, and more recently, as Interim Chief Financial Officer. Prior to that she was Regional Vice President Latin America, Marketing Company President AstraZeneca Portugal and Vice President Corporate Strategy and R&D Chief Financial Officer. She has previously held Vice President Finance positions in all areas of the healthcare value chain including Commercial, Operations, R&D and Business Development.

Nationality

British

2 Jack Campo (58)

Chief Legal Officer

Joined Smith & Nephew in June 2008 and heads up the Global Legal function. Initially based in London, he has been based in Andover, Massachusetts since late 2011.

Previous Experience

Prior to joining Smith & Nephew, Jack held a number of senior legal roles within the General Electric Company, including seven years at GE Healthcare (GE Medical Systems) in the US and Asia. He began his career with Davis Polk & Wardwell.

Nationality

American

3 Francisco Canal Vega (51)

President, Emerging markets

Joined Smith & Nephew in January 2012 and leads the Emerging markets division, focusing particularly on achieving market leading growth in Brazil, Russia, China and India. He is based in Dubai.

Previous Experience

Francisco has held senior management positions in global companies including Gambro AB and Baxter International. He has lived and worked in many countries including Switzerland, Germany, China, Japan, US and Spain. Francisco was also formerly a Board Member of EUCOMED.

Nationality

Spanish

4 Mike Frazzette (50)

President, Advanced Surgical Devices

Joined Smith & Nephew in July 2006 as President of the Endoscopy business. Since July 2011, he has headed up our Advanced Surgical Devices division and is responsible for the Orthopaedic, Trauma and Endoscopy business in Established markets. He is based in Andover, Massachusetts.

Previous Experience

Mike has held a number of senior positions within the US medical devices industry. He was President and Chief Executive Officer of Micro Group, a US manufacturer of medical devices and spent 15 years at Tyco Healthcare becoming President of each of the Patient Care and Health Systems divisions.

Nationality

American

5 Gordon Howe (50)

Senior Vice President, Global Planning and Development

Joined Smith & Nephew in 1998 and, since August 2007, has headed up the Global Planning and Business Development teams. He is based in Memphis, Tennessee.

Previous Experience

Gordon has held a number of senior management positions within the Smith & Nephew Group first in the Orthopaedics division and more recently at Group level. Prior to joining the Company, he held senior roles at United Technologies Corporation.

Nationality

American

6 Kelvin Johnson (61)

President, International markets

Joined Smith & Nephew in 1980 and was appointed to lead the International markets division, covering all countries outside the Established and Emerging markets in 2011. He is based in Dubai.

Previous Experience

Kelvin has held a number of key international roles with Smith & Nephew, firstly in South Africa and then leading the Emerging Market strategy. He has spent some time leading the Group’s increased focus in China.

Nationality

South African

7 Helen Maye (53)

Chief Human Resources Officer

Joined Smith & Nephew in July 2011 and leads the Global Human Resources and Internal Communications functions. She is based in London.

Previous Experience

Helen has more than 35 years’ experience across a variety of international and global roles in medical devices and pharmaceuticals, including manufacturing, supply chain and human resources. Previously, she was Divisional Vice President of Human Resources at Abbott Laboratories.

Nationality

Irish

8 Cyrille Petit (42)

Chief Corporate Development Officer

Joined Smith & Nephew in May 2012 and leads the Corporate Development function. He is based in London.

Previous Experience

Cyrille spent the previous 15 years of his career with General Electric, where he held progressively senior positions beginning with GE Capital, GE Healthcare and more recently as the General Manager, Global Business Development of their Transportation Division. Cyrille’s career began in investment banking at BNP Paribas and then Goldman Sachs.

Nationality

French

9 Ros Rivaz (57)

Chief Technology Officer

Joined Smith & Nephew in November 2011. She is responsible for manufacturing, supply chain and procurement, IT systems, Corporate Sustainability and Regulatory and Quality Affairs and is focused on improving efficiency in Smith & Nephew processes. She is based in London.

Previous Experience

Ros has held senior management positions in global companies in the areas of supply chain management, logistics, manufacturing, procurement and systems, including, ExxonMobil, ICI, Tate & Lyle and Diageo. She has 30 years’ experience across all areas of operational excellence.

Nationality

British

10 Roger Teasdale (45)

President, Advanced Wound Management

Joined Smith & Nephew in 1989 within the Wound Management business. He was appointed President of Advanced Wound Management in May 2009. He is based in Hull, UK.

Previous Experience

Roger has held a number of key roles within the Smith & Nephew Group in both the UK and the US and has been responsible for leading the transformation of the wound business in recent years.

Nationality

British

62           Smith & Nephew Annual Report 2012

Corporate Governance Statement

Compliance statement

We are committed to the highest standards of corporate governance and comply with all the provisions of the UK Corporate Governance Code (the ‘Code’). The Company’s American Depositary Shares are listed on the NYSE and we are therefore subject to the rules of the NYSE as well as to the US securities laws and the rules of the SEC applicable to foreign private issuers. We comply with the requirements of the SEC and NYSE except that the Nomination & Governance Committee is not comprised wholly of independent Directors, as required by the NYSE, but consists of a majority of independent Directors in accordance with the Code. We shall explain in this Corporate Governance Statement and in the Directors’ Remuneration Report, how we have applied the provisions and principles of the FSA’s Listing Rules, Disclosure & Transparency Rules (‘DTR’) and the Code throughout the year.

Board

The Board is responsible for determining the strategy of the Chief Executive Officer and his Executive team implement that strategy. More detail about the structure of the Board, the matters we deal with and the key activities we undertook in 2012 is on page 63.

Roles of Directors

Whilst we all share collective responsibility for the activities of the Board, some of our roles have been defined in greater detail. In particular, the roles and responsibilities of the Chairman and Chief Executive Officer are clearly defined.

Chairman

–  Building a well balanced Board

–  Chairing Board meetings and setting Board agenda

–  Ensuring effectiveness of the Board and ensuring annual review undertaken

–  Encouraging constructive challenge and facilitating effective communication in the Board

–  Promoting effective Board relationships

–  Ensuring appropriate induction and development programmes

–  Ensuring effective two way communication and debate with shareholders

–  Setting the tone at the top with regard to compliance and sustainability matters

–  Promoting high standards of corporate governance

–  Maintaining appropriate balance between stakeholders

Chief Executive Officer

–  Developing and implementing Group strategy

–  Recommending the annual budget and five-year strategic and financial plan

–  Ensuring coherent leadership of the Group

–  Managing the Group’s risk profile and establishing effective internal controls

–  Regularly reviewing organisational structure, developing executive team and planning for succession

–  Ensuring the Chairman and Board are kept advised and up to date regarding key matters

–  Maintaining relationships with shareholders and advising the Board accordingly

–  Setting the tone at the top with regard to compliance and sustainability matters

The Non-Executive Directors meet regularly prior to each Board meeting without management in attendance. The roles of Non-Executive Directors and, in particular, the Senior Independent Non-Executive Director are defined as follows:

Non-Executive Directors

–  Providing effective challenge to management

–  Assisting in development of strategy

–  Serving on the Board Committees

Senior Independent Non-Executive Director

–  Chairing meetings in the absence of the Chairman

–  Acting as sounding board for the Chairman on Board-related matters

–  Acting as an intermediary for the other Directors where necessary

–  Available to shareholders on matters which cannot otherwise be resolved

–  Leading annual evaluation into the Board’s effectiveness

–  Leading search for a new Chairman, as necessary

Independence of Non-Executive Directors

We are sensitive to the need for our Non-Executive Directors to remain independent from management in order to exercise our independent oversight and effectively challenge management as necessary. We are mindful that some of our Non-Executive Directors have served on our Board for periods that some might regard as likely to impact their independence. We therefore continually assess the independence of each of our Non-Executive Directors and have determined that all our Non-Executive Directors are independent in accordance with both UK and US requirements. None of our Non-Executive Directors or their immediate families has ever had a material relationship with the Group. None of them receive additional remuneration apart from Directors’ fees, nor do they participate in the Group’s share plans or pension schemes. None of them serve as directors of any companies or affiliates in which any other Director is a director.

However, more importantly, each of our Non-Executive Directors is prepared to question and challenge management, to request more information and to ask the difficult question. They insist on robust responses both within the Board room and sometimes between Board meetings. The Chief Executive Officer is open to challenge from the Non-Executive Directors and uses this positively to provide more detail and to reflect further on issues.

We value the input we receive from our long-serving Directors given their deep understanding of the Group. We are however focused on planning for the future to build a balanced board with the skills and experience fit to face the challenges that lie ahead. We have identified the key skills and experiences we need and have welcomed the specific experience that Ajay Piramal and Baroness Bottomley have brought to the Board since their appointment in 2012. Ajay brings his skills as a successful businessman within the Emerging markets, where growth in Emerging markets is one of our Strategic Priorities. Baroness Bottomley brings her in-depth knowledge of UK governmental healthcare policies and processes, which is also of key importance for us given the pricing pressure we face from European governmental authorities purchasing our products. Following his appointment in April 2013, Michael Friedman will bring his exceptional experience of the US Healthcare market and the challenges we face in Established markets. We continue to search for other suitable Non-Executive Directors, whose experience will align with our strategic objectives and, in due course, our longer serving directors will step down.

  Section 6 Corporate Governance   63

Board Membership

Non-Executive Chairman Sir John Buchanan

Chief Executive Officer Olivier Bohuon

Chief Financial Officer Adrian Hennah

(resigned 31 December 2012)

Chief Financial Officer Julie Brown (appointed 4 February 2013)

Eight Independent Non-Executive Directors

–  Richard De Schutter (Senior Independent Director)

–  Ian Barlow

–  Baroness Bottomley (appointed 12 April 2012)

–  Geneviève Berger (retired 1 November 2012)

–  Michael Friedman (to be appointed 11 April 2013)

–  Pamela Kirby

–  Brian Larcombe

–  Joseph Papa

–  Ajay Piramal (appointed 1 January 2012)

–  Rolf Stomberg (retired 12 April 2012)

Role of the Board

Strategy

–  Approving the Group strategy including major changes to corporate and management structure, acquisitions, mergers, disposals, capital transactions over $10m, annual budget, financial plan, business plan, major borrowings and finance and banking arrangements

–  Approving changes to the size and structure of the Board, overseeing succession planning and the appointment and removal of Directors and the Company Secretary

–  Approving Group polices relating to corporate social responsibility, health and safety, Code of Conduct and Code of Share Dealing and other matters

Performance

–  Reviewing performance against strategy, budgets and financial and business plans

–  Overseeing Group operations and maintaining a sound system of internal control

–  Determining dividend policy and dividend recommendations

–  Approving the appointment and removal of the auditors and other professional advisers and approving significant changes to accounting policies or practices

–  Approving the use of the Company’s shares in relation to employee and executive incentive plans

Risk

–  Determining risk appetite, regularly reviewing risk register and risk management processes

Shareholder Communications

–  Approving preliminary announcement of annual results, annual report, half yearly report, quarterly financial announcements, the release of price sensitive announcements and any listing particulars, circulars or prospectuses

–  Maintaining relationships and continued engagement with shareholders

Key activities in 2012

(in addition to regular annual activities)

–  Review and oversight of the implementation of new strategy and organisational structure

–  Oversight of risk management process and review of strategic risk

–  Approval of five-year plan

–  Review of effectiveness of Board

–  Review of ongoing Board composition and appointment of Ajay Piramal and Baroness Bottomley to the Board

–  Consideration and approval of the acquisition of Healthpoint, LifeModeller and Kalypto

–  Approval and oversight of European Process Optimisation programme

–  Six physical scheduled meetings, three scheduled telephone meetings and two unscheduled telephone meetings.

–  Four Day Strategy Review and visit to our Emerging and International markets Head Office and Middle Eastern business

–  Two Day visit to our Memphis operations

64           Smith & Nephew Annual Report 2012

Corporate Governance Statement continued

Board and Committee attendance

The table below details attendance of Directors at Board and Committee meetings held throughout the year:

	Board 11 meetings	Audit Committee 8 meetings	Nomination & Governance Committee 7 meetings	Ethics & Compliance Committee 5 meetings	Remuneration   Committee   7 meetings
Sir John Buchanan (i)	9	–	7	–	–
Olivier Bohuon	11	–	7	–	–
Adrian Hennah (ii)	11	–	–	–	–
Ian Barlow (i)	10	8	–	–	–
Geneviève Berger (iii)	7	–	–	3	–
Baroness Bottomley (iv)	6	–	–	–	2
Pamela Kirby	11	–	–	5	7
Brian Larcombe (i)(v)	9	7	5	–	7
Joseph Papa (i)	11