Annual Report and Accounts 1999 Performance Innovation Trust Corporate governance Combined Code The Board considers that the company has complied throughout the year with the Combined Code of Best Practice on Corporate Governance. The Board The Board meets regularly during the year and is responsible for the strategic direction, policies and overall management of the group. There is a clear division of responsibilities between the Chairman and Chief Executive. The Board consists of an independent non-executive Chairman, three executive directors and five independent non-executive directors. All directors have full and timely access to all relevant information and independent professional advice. The Board is assisted by the following committees: The Audit Committee The Audit Committee monitors the operation and effectiveness of the internal financial controls and ensures that the accounts meet statutory and other requirements. The Remuneration Committee The Remuneration Committee sets the pay and benefits of the executive directors and other members of the Executive Committee and approves their terms of employment. The Nominations Committee The Nominations Committee oversees plans for management succession and recommends appointments to the Board. The Charities and Community Committee The Charities and Community Committee co-ordinates environmental, charity and community programmes. The Executive Committee The Executive Committee assists the Chief Executive in the day-to-day management of the group. The Scientific Advisory Panel The Scientific Advisory Panel provides an independent perspective on the new product development process from research to manufacture and comprises leading authorities from the scientific community. Membership of Board committees and of the Executive Committee is shown with the biographical details of directors on pages 24 and 25. Directors All directors are subject to re-election at least every three years, and in accordance with the Articles of Association, Alan Fryer, Peter Hooley and Sir Timothy Lankester retire by rotation and, being eligible, offer themselves for re-election at the forthcoming AGM. Dudley Eustace was appointed Deputy Chairman with effect from 10 November 1999 and Chairman from 1 January 2000 and will be proposed for re-election at the AGM. No director had a material beneficial interest in any contract involving the company or its subsidiaries in 1999. Shareholders The group issues summary financial statements in place of full annual accounts unless shareholders request the latter. The summary financial statement is received by over 90% of shareholders. At the half year, an interim report is sent to all shareholders. There is a regular dialogue with individual institutional shareholders together with results presentations twice a year. There is an opportunity for individual shareholders to question directors at the AGM and the company regularly responds to letters from shareholders on a range of issues. Internal control The Board is responsible for the maintenance of the group’s system of internal control and for reviewing its effectiveness. It has established an ongoing process of identifying, evaluating and managing key risks by a system of functional reports to the Board, the review of internal financial controls by the Audit Committee, augmented by risk reports to be completed by each business unit and reviewed by the Chief Executive and Finance Director. These procedures will enable the Board to report on the effectiveness of its system of internal control for 2000. Share capital The company has been informed of the following interests in its ordinary share capital as at 22 February 2000: • Sanford C Bernstein 6.82% • Sun Life and Provincial Holdings 6.13% • Hermes 4.04% • Fidelity 3.97% • T Rowe Price Associates 3.15% • Legal & General 3.12% At the AGM, the company will be seeking a renewal of its current permission from shareholders to purchase its own shares. No shares have been purchased or contracted for or are the subject of an option under the expiring authority. Auditors Ernst & Young have expressed their willingness to continue as auditors and a resolution proposing their reappointment will be put to the AGM. 26 Smith & Nephew 1999 Remuneration report The Remuneration Committee The Remuneration Committee comprises Sir Brian Pearse (Chairman), Sir Anthony Cleaver, Sir Timothy Lankester and Dr Rolf Stomberg. Remuneration policy The Remuneration Committee aims to ensure that remuneration packages are competitive enough to attract, retain and motivate executive directors and Executive Committee members of a calibre that meets the group’s needs, and that they reflect the group’s performance against financial objectives. In framing its policy the committee has given full consideration to the requirements set out in Schedule A of the Combined Code. It is advised by independent consultants and uses data from external research into companies of similar size, technologies and international complexity. Remuneration throughout the group is designed to be competitive locally. The principal components of remuneration for executive directors and Executive Committee members are: Basic salary and benefits Basic salary reflects the responsibility of the job and individual performance. The company also provides private healthcare cover and a company car or allowance. Performance-related bonus The company operates an annual bonus scheme based on three criteria for executive directors: annual growth in adjusted basic earnings per share, annual growth in adjusted basic earnings per share measured at constant average exchange rates and return on operating capital employed. Over time, achievement of targets should produce a bonus of 30% of annual salary with a maximum of 100% for over achievement against targets that would demonstrably generate a step change in performance. Bonuses are not pensionable. Share options and long-term incentives Executive directors have been eligible for grants of share options under executive share option schemes, subject to a maximum value of four times salary in any ten-year period. The company operates a long-term incentive plan (LTIP) for executive directors and members of the Executive Committee. Under this plan, shares are transferred to participants depending on the company’s performance in relation to a comparator group of 58 other companies, using total shareholder return (TSR) over a three-year period as the prime measure. The maximum value of shares awarded will not exceed the participants’ current annual rate of basic salary at the date the award is made. Shares will only be transferred to the participants if the company’s TSR performance is at or above the median performance of the comparator companies and if there has been real growth in the company’s adjusted earnings per share in the same three-year period. At the median level, 25% of the award shares will vest. If the company’s performance is ranked in the top quartile, all the shares will vest. If the company’s performance lies between the median and the top quartile, the proportion of shares vesting will vary on a straight-line basis. The earnings per share performance target for the 1997 award has not been met. As a result the award has lapsed and no shares will be transferred to participants. The following outstanding conditional awards have been granted under the LTIP: Maximum number of shares 1999 183,040 134,502 116,959 Maximum number of shares 1998 161,263 108,435 102,874 year to 31 December C.J. O’Donnell A.R. Fryer P. Hooley Under the executive share option schemes, options granted since 1997 may not normally be exercised unless the company’s average annual growth in adjusted basic earnings per share has exceeded that of the UK retail price index by 2% in any period of three consecutive financial years from the date of grant. Executive options are not offered at a discount. Directors continue to be eligible to participate in the savings related share option scheme. Service contracts Executive directors are appointed on contracts terminable by the company on not more than 12 months’ notice and by the director on six months’ notice. Non-executive directors are appointed for terms of three years. Their remuneration is determined by the Board on the recommendation of the Nominations Committee. Pensions Executive directors participate in the defined benefit Smith & Nephew UK Pension Fund and Smith & Nephew UK Executive Pension Scheme, under which normal retirement is at age 62 and pension has been accrued in the year at an annual rate of 1/30 of final pensionable salary, up to a limit of two thirds of final pensionable salary. Pensions in payment are guaranteed to increase by 5% per annum or inflation if lower. The company and the trustees of the pension plans have a policy of granting discretionary increases, particularly at times of high inflation. Death in service cover of four times salary and spouse’s pension at the rate of two thirds of the member’s pension are provided on death. Transfer values on leaving service would be calculated on the minimum funding requirement basis with allowance for pension increases in line with price inflation. A supplementary defined contribution plan partially compensates for the Inland Revenue earnings cap on final pensionable salary. Smith & Nephew 1999 27 Remuneration report Directors’ emoluments and pensions Chairman (non-executive) J.H. Robinson (to 31 December 1999) Deputy Chairman (non-executive) D.G. Eustace (from 10 November 1999) Executive C.J. O’Donnell A.R. Fryer P. Hooley J.R. Blair (to 31 December 1998) Non-executive Sir Anthony Cleaver Dr N.J. Lane Sir Timothy Lankester Sir Brian Pearse Dr R.W.H. Stomberg Salaries & fees £’000 Benefits £’000 Annual Pension bonus entitlements £’000 £’000 Total 1999 £’000 Total 1998 £’000 156 21 313 230 202 – 24 29 24 24 24 – – 7 8 15 – – – – – – – – 266 196 172 – – – – – – – – 17 18 43 – – – – – – 156 154 21 – 603 452 432 – 24 29 24 24 24 337 263 240 450 23 28 23 23 23 John Robinson received an annual fee of £156,000 as Chairman, including a non-executive director’s fee of £24,000. 1,047 30 634 78 1,789 1,564 Dudley Eustace was appointed Chairman from 1 January 2000 and receives an annual fee of £150,000 including a non-executive director’s fee of £24,000. The figure for pension entitlements consists of any increase in accrued pension benefit in the year (excluding inflation), together with a contribution of £41,000 to a supplementary plan for Peter Hooley. During 1999 executive directors paid contributions to the pension plans as follows: Christopher O’Donnell £15,000, Alan Fryer £11,000 and Peter Hooley £4,000. The accumulated total amount of the accrued pension benefit for directors as of 31 December 1999 was as follows: Christopher O’Donnell £75,000 (1998 – £57,000), Alan Fryer £117,000 (1998 – £96,000) and Peter Hooley £20,000 (1998 – £17,000). Jack Blair retired on 31 December 1998. The Remuneration Committee retains the discretion of allowing the vesting of his LTIP award of up to a maximum of 36,145 shares in respect of 1998 if the performance conditions are met. The ages of the executive directors are set out on page 24. 28 Smith & Nephew 1999 Directors’ share options Number of options Granted during the year 1 Jan 1999 C.J. O’Donnell 367,862 A.R. Fryer 228,339 P. Hooley 405,362 – – – – Exercised – 30,000 2,800 – Exercise price – 137.00 123.20 – Market price at date of exercise (p) Profit on exercise £ Number of options 31 Dec 1999 Average exercise price (p) Range of exercisable dates of options held at 31 Dec 1999 – – 367,862 190.50 197.75 16,050 2,087 – 195,539 – – 405,362 1.67 – 1.68 1.55 9/1994-8/2006 – 9/1994-8/2006 9/1994-8/2006 The range in the market price of the company’s shares during the year was 150p to 217.5p and the market price at 31 December 1999 was 208p. All outstanding options at 31 December 1999 were below 208p. The total profit on exercise of options during the year was £18,137 as set out above (1998 – £89,004: Alan Fryer £65,468, John Robinson £23,536). Directors’ interests Beneficial interests of the directors in the company’s ordinary shares C.J. O’Donnell A.R. Fryer P. Hooley Sir Anthony Cleaver Dr N.J. Lane Sir Timothy Lankester Sir Brian Pearse Dr R.W.H. Stomberg 31 December 1999 Options Shares 19,490 69,993 5,000 16,782 2,934 6,389 20,000 1,035 367,862 195,539 405,362 – – – – – 1 January 1999 Shares 17,885 66,873 5,000 16,782 2,838 1,803 10,000 1,014 Options 367,862 228,339 405,362 – – – – – There was no change in the interests of directors between 31 December 1999 and 23 February 2000. The register of directors’ interests, which is open to inspection at the company’s registered office, contains full details of directors’ shareholdings and share options. By order of the Board, 23 February 2000 Michael Parson Secretary Smith & Nephew 1999 29 Financial review Trading results Sales during the year amounted to £1,120m, a 6% increase. Adjusting for currency and putting acquisitions and disposals on a like-for-like basis, this was an underlying growth of 8%, an improvement on the 5% of recent years – led by the strong performance in our orthopaedics business. Pre-tax profit before exceptional items amounted to £171m, an increase of 12% coming from improved sales growth and programmes to improve operating margins. Margins were stronger, nearly 1% ahead before 0.3% of transactional currency costs, in an operating environment where sales prices overall improved slightly. Margin improvement reflects our established programme of cost and efficiency savings and the management and workforce restructuring started at the end of 1998, which together delivered cost savings of £27m and more than offset the impact of cost inflation. Margins % Operating profit before exceptional items to sales 18.0 17.6 15.7 14.6 15.0 1995 1996 1997 1998 1999 After a number of years in which the relative strength of sterling and the US dollar have adversely affected the group, the negative impact on profit abated in the year to a more modest £2m – £4m from adverse transactional currency offset by a £2m translational gain. Nevertheless over the last three years currency has taken £38m off our profit base. 30 Smith & Nephew 1999 The effect of acquisitions in the second half of the year was broadly neutral, whereas the bracing disposal diluted pre- tax profit by 2%. Exceptional items During the year we launched our programme to rationalise manufacturing facilities worldwide to concentrate production on fewer centres. Our wound management, casting and bandaging and consumer healthcare businesses are in the process of closing their Australian and Canadian factories and we are constructing a new casting manufacturing facility in Mexico. We have also exited manufacturing of orthopaedics products in France. We expect the manufacturing rationalisation programme to produce cost and efficiency savings of £25m a year by 2002 with benefits starting to feed through in 2000. This together with the management and workforce restructuring largely completed in 1999 will yield the cost savings needed to meet our goal of a three percentage point increase in underlying operating margins by 2001. Last year we charged £18m by way of an exceptional item for the cost of the restructuring and rationalisation programmes. This year we have provided £34m and over the next two years we expect to charge a further £24m as we complete the programme. The total expenditure of £76m is anticipated to provide annual benefits of £40m by 2002. The sale of the bracing business in the middle of the year realised an exceptional gain of £63m after charging £34m of goodwill previously set off against reserves on the original acquisition of the business. We have also provided £5m to integrate Exogen, acquired in September, with our orthopaedics business. Because of delays in obtaining regulatory approval for Dermagraft, we have provided £7m against the cost of the joint arrangement with Advanced Tissue Sciences (ATS) in respect of the product. We have also provided £6m against our equity investment in ATS. The result is a net exceptional gain of £11m, increasing profit before tax to £182m, compared with £135m last year. EPS and taxation Earnings per share before exceptional items were 10.72p, a 12% increase on 1998. The underlying tax charge of £51m remains at 30%. Tax on exceptional items amounted to a net charge of £26m. This is higher than the net exceptional gain due to the write back of goodwill previously set off against reserves on the original acquisition of the bracing business, and the write down of asset values involved in the manufacturing rationalisation programme and in respect of our involvements with ATS not being deductible for tax purposes. Dividends and shareholders’ funds The recommended final dividend of 4.0p per ordinary share, together with the interim dividend of 2.5p, makes a total for the year of 6.5p, an increase of 0.3p on 1998. The cost of dividends will be £73m, representing 61% of earnings before exceptional items. Retained profit of £32m has been taken to reserves, and shareholders’ funds have also been augmented by £4m of new shares issued for share options and £34m of goodwill on the bracing business on its disposal previously set off against reserves on acquisition. Currency translation of £4m was charged to reserves. The net movement in shareholders’ funds was an increase of £66m. Employees The average number of employees during the year declined 9% to 11,213 largely as a result of the management and work force restructuring programme and the disposal of the bracing business. As a consequence sales per employee improved 17% to £100,000, compared with a total staff cost per employee increase of 9%. Investment Capital expenditure of £65m on tangible and intangible fixed assets amounted to 6% of sales, lower than recent years. The principal projects were the continued renovation and expansion of facilities at Hull, further investment in hospital based surgical instruments for orthopaedic implants and the completion of year 2000 information technology projects. Gearing % 20 We continue to invest 4% of sales in R&D as well as investing in sales and marketing worldwide and in enhancing our cost- competitiveness. The Dermagraft programme involved revenue investment of £8m in 1999. Year 2000 and the euro The conversion of our systems to cope with the changeover to the year 2000 went satisfactorily. Our transactional systems converted on time and the work with suppliers and customers has proven worthwhile. The revenue cost of conversion was £5m spread over 1998 and 1999 and £15m of capital expenditure on systems renewal was brought forward into these years to ensure year 2000 compliance. The group trades in all 11 European countries which have adopted the euro. The cost of modifications to administration and systems as a result of the new currency is not expected to be significant. Cash flow and facilities Conversion of operating profit to operating cash flow was 79%, an improvement on last year’s 65%. This was after £18m of outgoings on the management and workforce restructuring and manufacturing rationalisation programmes and on acquisition integration costs. Of the net proceeds of £122m from the disposal of the bracing business, £42m was applied in acquisitions, the principal of which was Exogen acquired in September and £9m was paid for further Dermagraft rights. 10 10 10 Nil 1995 1996 1997 1998 1999 Net cash flow and movement in net borrowings during the year were: Operating cash flow Interest, tax and dividends Disposals net of acquisitions Issues of share capital Net cash flow Exchange adjustments Opening net borrowings Closing net cash £m 133 (127) 71 4 81 (9) (50) 22 The group’s year end position of net cash balances and thus no gearing provides considerable financing flexibility. Capital structure and treasury policy The directors have established a set of policies to manage funding, currency and interest rate risks. The group only uses financial instruments to manage the financial risks associated with underlying business activities and their financing. Our policy is to ensure that there is sufficient funding and facilities in place to meet foreseeable borrowing requirements. Unused bank facilities amounted to £425m of which £140m were committed. Our policy is to protect shareholders’ funds by matching foreign currency assets, including acquisition goodwill, with foreign currency liabilities where practicable. These liabilities take the form of either borrowings or currency swaps. At the year end group borrowings were £78m, mainly in foreign currency. Cash and bank balances were £100m. Currency swaps amounted to £484m, of which 80% were to re-denominate internal borrowings into US dollars. Most group borrowings are due within one year and take advantage of short-term interest rates. We use interest rate swaps to protect borrowing costs and the differentials between borrowing and deposit rates, fixing interest rates on major exposures by the beginning of the financial year. At the year end the majority of interest costs and differentials have been protected through to December 2000 with some protection carrying over into 2003. The group trades in over 90 countries and as a consequence manages £250m of foreign currency transactions using forward foreign exchange contracts. Our policy is for firm commitments to be fully covered and forecasts to be covered between 50% and 90% for up to one year. There are therefore no currency exposures on monetary assets and liabilities that could give rise to material gains or losses in the profit and loss account. It is group policy for operating units not to hold unhedged monetary assets or liabilities other than in their functional operating currencies. It is company policy to ensure that suppliers are paid within agreed terms. At the year end the company’s trade creditors amounted to £2m the equivalent of 21 days credit. Peter Hooley Finance Director Smith & Nephew 1999 31 Directors’ responsibilities for the accounts and auditors’ report Basis of audit opinion We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the accounts. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the accounts, and of whether the accounting policies are appropriate to the group’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the accounts are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the accounts. Opinion In our opinion the accounts give a true and fair view of the state of affairs of the company and of the group as at 31 December 1999 and of the profit of the group for the year then ended and have been properly prepared in accordance with the Companies Act 1985. Ernst & Young Registered auditor London, 23 February 2000 Directors’ responsibilities for the accounts The directors are required by company law to prepare accounts for each financial year that give a true and fair view of the state of affairs of the company and of the group as at the end of the financial year and of the results of the group for the year. In preparing the accounts, suitable accounting policies have been used and applied consistently, and reasonable and prudent judgements and estimates have been made. Applicable accounting standards have been followed. The directors have satisfied themselves from internal forecasts and available bank facilities that the group continues as a going concern. The directors are also responsible for the group’s system of internal financial controls. These are designed to give reasonable assurance that proper procedures exist for the maintenance of adequate accounting records, safeguarding the assets of the group and for preventing and detecting fraud and other irregularities. To this end the company has identified and documented minimum internal financial control standards. Annual budgets are prepared and approved by the directors, and the directors have reserved capital expenditure and treasury authority levels to the Board and its delegated committees. The group operates a system of regular monthly reporting including revised profit and cash forecasts. Business risks are identified and monitored on a regular basis. The group operates an internal audit function which monitors the adequacy of internal financial controls and systems and compliance with group standards. The internal auditor gives a report to the Audit Committee and the Audit Committee reviews the operation and effectiveness of internal financial controls and reporting of the group. 32 Smith & Nephew 1999 Report of the auditors to the members of Smith & Nephew plc We have audited the accounts on pages 33 to 55 which have been prepared under the historical cost convention and on the basis of the accounting policies set out on page 38. Respective responsibilities of directors and auditors As described on this page, the company’s directors are responsible for the preparation of the accounts in accordance with applicable United Kingdom law and accounting standards. Our responsibilities, as independent auditors, are established in the United Kingdom by statute, the Auditing Practices Board, the Listing Rules of the London Stock Exchange and by our profession’s ethical guidance. We report to you our opinion as to whether the accounts give a true and fair view and are properly prepared in accordance with the Companies Act. We also report to you if, in our opinion, the directors’ report is not consistent with the accounts, if the company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if the information specified by law or the Listing Rules regarding directors’ remuneration and transactions with the company is not disclosed. We read the other information in the Annual Report and Accounts and consider whether it is consistent with the audited accounts. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the accounts. We review whether the corporate governance statement on page 26 reflects the company’s compliance with the seven provisions of the Combined Code specified for our review by the Stock Exchange, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of either the company’s corporate governance procedures or its risk and control procedures. Group profit and loss account for the year ended 31 December 1999 Turnover Continuing operations Discontinued operations Operating profit Continuing operations: Before exceptional items Exceptional items* Discontinued operations Discontinued operations: Net profit on disposals* Profit on ordinary activities before interest Interest receivable/(payable) Profit on ordinary activities before taxation Taxation Attributable profit for the year Dividends Retained profit for the year Basic earnings per ordinary share Diluted earnings per ordinary share Results before exceptional items (*) Profit before taxation Adjusted basic earnings per ordinary share Notes 1,2 1,2 3 3 4 7 8 22 10 10 9 10 1999 £ million 1998 £ million 1,075.7 44.2 1,119.9 977.8 75.6 1,053.4 162.0 (51.7) 110.3 5.5 115.8 62.9 178.7 3.4 182.1 77.3 104.8 72.5 32.3 9.39p 9.37p 170.9 10.72p 144.4 (17.9) 126.5 9.7 136.2 – 136.2 (1.7) 134.5 40.8 93.7 69.2 24.5 8.42p 8.40p 152.4 9.58p Smith & Nephew 1999 33 Group balance sheet at 31 December 1999 Fixed assets Intangible assets Tangible assets Investments Current assets Stocks Debtors Cash and bank Creditors: amounts falling due within one year Borrowings Other creditors Net current assets Total assets less current liabilities Creditors: amounts falling due after more than one year Borrowings Provisions for liabilities and charges Capital and reserves Called up share capital: Equity share capital Non-equity share capital Share premium account Profit and loss account Approved by the Board on 23 February 2000 Dudley Eustace Chairman Peter Hooley Finance Director Notes 1999 £ million 1998 £ million 11 12 13 14 15 16 16 17 16 18 20 20 22 22 74.0 270.5 16.6 361.1 237.6 281.1 100.5 619.2 58.0 312.4 370.4 248.8 609.9 20.2 38.0 58.2 28.3 291.7 14.4 334.4 242.4 278.6 49.9 570.9 86.6 289.0 375.6 195.3 529.7 12.8 31.4 44.2 551.7 485.5 111.8 0.3 118.3 321.3 551.7 111.4 0.3 114.3 259.5 485.5 34 Smith & Nephew 1999 Group cash flow for the year ended 31 December 1999 Net cash inflow from operating activities* Interest received Interest paid Net cash inflow/(outflow) from returns on investments and servicing of finance Tax paid Capital expenditure and financial investment Capital expenditure Disposal of fixed assets Trade investment Acquisitions and disposals Acquisitions Disposals Equity dividends paid Cash inflow/(outflow) before use of liquid resources and financing Management of liquid resources Financing Issues of ordinary share capital Net decrease in borrowings and currency swaps Net cash (outflow)/inflow from financing Decrease in cash Notes 23 25 23 23 23 *After £18.5m (1998 – £9.5m) of outgoings on rationalisation programme and acquisition integration costs. 1999 £ million 198.1 10.3 (6.9) 3.4 (60.1) 141.4 (67.1) 8.7 (6.7) (65.1) (50.9) 121.8 70.9 (70.3) 76.9 (72.3) 4.4 (24.1) (19.7) (15.1) 1998 £ million 161.9 8.1 (9.8) (1.7) (20.6) 139.6 (69.3) 7.4 – (61.9) (21.2) 4.8 (16.4) (69.0) (7.7) 1.5 3.0 (2.4) 0.6 (5.6) Smith & Nephew 1999 35 Statement of gains and losses Movements in shareholders’ funds Group statement of total recognised gains and losses for the year ended 31 December 1999 Profit for the financial year Currency translation differences on foreign currency net investments Total gains and losses related to the year Group reconciliation of movements in shareholders’ funds for the year ended 31 December 1999 Profit for the financial year Dividends Retained profit for the year Exchange adjustments Issue of shares Goodwill on disposals Net addition to shareholders’ funds Opening shareholders’ funds Closing shareholders’ funds 1999 £ million 1998 £ million 104.8 (4.0) 100.8 93.7 (3.3) 90.4 1999 £ million 1998 £ million 104.8 72.5 32.3 (4.0) 4.4 33.5 66.2 485.5 551.7 93.7 69.2 24.5 (3.3) 3.0 – 24.2 461.3 485.5 36 Smith & Nephew 1999 Parent company balance sheet at 31 December 1999 Fixed assets Tangible assets Investments Current assets Debtors Cash and bank Creditors: amounts falling due within one year Borrowings Other creditors Net current assets Total assets less current liabilities Creditors: amounts falling due after more than one year Borrowings Provisions for liabilities and charges Capital and reserves Called up share capital: Equity share capital Non-equity share capital Share premium account Profit and loss account Approved by the Board on 23 February 2000 Dudley Eustace Chairman Peter Hooley Finance Director Notes 1999 £ million 1998 £ million 12 13 15 16 16 17 16 18 20 20 22 22 8.1 413.9 422.0 476.8 77.2 554.0 28.9 299.8 328.7 225.3 647.3 4.5 0.9 5.4 9.8 413.9 423.7 662.0 24.0 686.0 55.0 369.3 424.3 261.7 685.4 5.8 1.3 7.1 641.9 678.3 111.8 0.3 118.3 411.5 641.9 111.4 0.3 114.3 452.3 678.3 Smith & Nephew 1999 37 Accounting policies The accounts have been prepared under the historical cost convention and in accordance with Financial Reporting Standards 15 and 16 and other applicable accounting standards. Consolidation The consolidated accounts include the accounts of the company and the accounts of all the subsidiary and associated undertakings during the year ended 31 December 1999 for the periods during which they were members of the group. Foreign currencies Balance sheet items of overseas companies and foreign currency borrowings are translated into sterling at the year end rates of exchange. Profit and loss items and the cash flows of overseas subsidiary and associated undertakings are translated at the average rates for the year. Forward currency contracts entered into in respect of contracted and anticipated amounts payable on purchase transactions are accounted for as hedges. Changes in the fair value of these forward contracts are recognised in the profit and loss account on the ultimate sale of the item purchased. Exchange differences on the translation at closing rates of exchange of the opening net assets, including acquisition goodwill, of overseas subsidiary and associated undertakings are recorded as adjustments to reserves. Where foreign currency borrowings or swaps are used to finance or hedge group equity investments, the difference on translation of these borrowings or swaps is offset as an adjustment to reserves. The differences arising between the translation of profits at average and closing rates of exchange are also recorded as adjustments to reserves. All other exchange differences are dealt with in arriving at profit before taxation. 38 Smith & Nephew 1999 Intangible fixed assets Goodwill, representing the excess of purchase consideration over fair value of net assets acquired prior to 31 December 1997, was written off direct to reserves in the year of acquisition. Goodwill acquired since 1 January 1998 is capitalised and written off over a period not exceeding 20 years. Goodwill previously written off to reserves is included in the calculation of profits and losses on disposals. Purchased patents, know-how, trade marks, licences and distribution rights are capitalised and amortised over a period not exceeding 20 years. Tangible fixed assets Tangible fixed assets are stated at cost and, except for freehold and long leasehold land (leases 50 years or over), are depreciated as wasting assets. Freehold and long leasehold buildings are depreciated on a straight-line basis at between 1% and 5% per annum. Short leasehold land and buildings (leases of under 50 years) are depreciated by equal annual instalments over the term of the lease. Plant and equipment are depreciated over lives ranging between three and 20 years by equal annual instalments to write down the assets to their estimated disposal value at the end of their working lives. Assets held under finance leases are capitalised as tangible fixed assets and depreciated accordingly. The capital element of future lease payments is included in borrowings and interest is charged to profit before taxation on a reducing balance basis over the term of the lease. Investments Associated undertakings are those companies in which the group has a beneficial interest of 50% or less in the equity capital and where the group exercises significant influence over commercial and financial policy decisions. The consolidated balance sheet includes the group’s share of the underlying net assets of associated undertakings. Trade investments are stated at the lower of cost and the recoverable amount. Stocks Finished goods and work in progress are valued at factory cost, including appropriate overheads, on a first- in first-out basis. Raw materials are valued at purchase price and all stocks are reduced to net realisable value where lower. Deferred taxation Deferred taxation is provided under the liability method on timing differences between tax and accounting treatments where these are likely to crystallise in the foreseeable future. Deferred taxation is not provided on undistributed profits retained overseas. Financial instruments Currency swaps entered into to match foreign currency assets with foreign currency liabilities are translated into sterling at the year end rate of exchange. Changes in the principal values of currency swaps are matched in reserves against changes in the values of the related assets. Interest rate swaps used to protect interest costs and income are accounted for as hedges. Changes in the values of interest rate swaps are offset against the interest in the period relating to the hedge. The group has taken advantage of the dispensation of not disclosing short term debtors and creditors as financial instruments. Research and development Revenue expenditure on research and development is written off as incurred. Post-retirement benefits The group’s major pension plans are of the defined benefit type. For these plans, costs are charged to operating profit so as to spread the expense of providing future pensions to employees over their working lives with the group. Where defined contribution plans operate the contributions to these plans are charged to operating profit as they become payable. Where the group provides healthcare benefits after retirement the expected cost of these is charged to operating profit over the employees’ working lives with the group. Notes to the accounts Note 1 Segmental analysis Analysis by activity Medical devices Consumer healthcare Discontinued operations Turnover 1999 £ million 889.5 186.2 1,075.7 44.2 1,119.9 Operating Operating assets 1999 £ million profit 1999 £ million 92.7 17.6 110.3 5.5 115.8 581.8 66.2 648.0 (6.5) 641.5 Turnover 1998 £ million 809.9 167.9 977.8 75.6 1,053.4 Operating profit 1998 £ million Operating assets 1998 £ million 102.9 23.6 126.5 9.7 136.2 573.5 59.0 632.5 (5.2) 627.3 Exceptional costs of £51.7m (1998 – £17.9m) have been charged as follows: medical devices £42.0m (1998 – £16.3m) and consumer healthcare £9.7m (1998 – £1.6m). Analysis by geographic origin United Kingdom Continental Europe America Africa, Asia and Australasia Discontinued operations Less intragroup sales 286.4 243.3 561.2 191.8 1,282.7 44.2 1,326.9 (207.0) 1,119.9 37.6 11.8 48.7 12.2 110.3 5.5 115.8 – 115.8 160.3 88.3 324.3 75.1 648.0 (6.5) 641.5 – 641.5 274.8 242.3 484.2 163.9 1,165.2 75.6 1,240.8 (187.4) 1,053.4 39.6 9.4 65.8 11.7 126.5 9.7 136.2 – 136.2 177.1 79.6 292.9 82.9 632.5 (5.2) 627.3 – 627.3 Exceptional costs of £8.6m have been charged to the UK (1998 – £5.3m), £3.0m to Continental Europe (1998 – £4.7m), £31.4m to America (1998 – £5.2m) and £8.7m to Africa, Asia and Australasia (1998 – £2.7m). Analysis of turnover by geographic market United Kingdom Continental Europe America Africa, Asia and Australasia Discontinued operations Analysis of turnover by product Orthopaedics Endoscopy Wound management Casting, support and ENT Medical devices Consumer healthcare Discontinued operations 1999 £ million 1998 £ million 205.8 212.4 459.3 198.2 1,075.7 44.2 1,119.9 276.4 192.8 230.8 189.5 889.5 186.2 1,075.7 44.2 1,119.9 190.6 204.7 414.5 168.0 977.8 75.6 1,053.4 237.7 173.9 212.1 186.2 809.9 167.9 977.8 75.6 1,053.4 Smith & Nephew 1999 39 Notes to the accounts Note 2 Operating profit Turnover Cost of sales Gross profit Marketing, selling and distribution Administration Research and development Other Operating profit Continuing Discontinued operations operations 1999 1999 £ million £ million 1,075.7 459.2 616.5 (330.7) (118.8) (44.2) (12.5) 110.3 44.2 20.4 23.8 (10.5) (6.8) (1.0) – 5.5 Total 1999 £ million 1,119.9 479.6 640.3 (341.2) (125.6) (45.2) (12.5) 115.8 Continuing Discontinued operations operations 1998 1998 £ million £ million 977.8 418.1 559.7 (298.6) (95.1) (41.6) 2.1 126.5 75.6 35.2 40.4 (18.7) (10.5) (1.5) – 9.7 Total 1998 £ million 1,053.4 453.3 600.1 (317.3) (105.6) (43.1) 2.1 136.2 Operating profit includes loss on sales of fixed assets of £1.9m (1998 – gain of £1.9m). Results of continuing operations have been stated after charging exceptional costs of £51.7m (1998 – £17.9m), which have been allocated in total as follows: cost of sales £12.0m (1998 – £5.7m), marketing, selling and distribution £6.4m (1998 – £2.7m), administration £20.8m (1998 – £9.5m) and other £12.5m (1998 – nil). Operating profit is stated after charging: Depreciation Amortisation of goodwill Amortisation of other intangibles Exceptional asset provisions Operating lease rentals for land and buildings Auditors’ remuneration 1999 £ million 1998 £ million 50.3 1.8 4.0 28.6 8.2 1.1 48.6 0.3 0.8 – 9.2 1.1 Payments made to the group’s auditors for non-audit services amounted to £0.5m (1998 – £0.4m) in the UK and £0.8m (1998 – £0.8m) outside the UK. Of these payments £0.8m (1998 – £0.7m) relate to taxation services and £0.5m (1998 – £0.5m) to statutory and other certifications and accountancy services. Unrecognised gains and losses relating to forward foreign exchange contracts in respect of anticipated purchases over the next 12 months amounted to £3.9m and £2.2m respectively. The group’s policy on currency risk management is set out on page 31. The group’s operating units hold no material unhedged monetary assets or liabilities other than in their functional operating currency. Note 3 Exceptional items Operating exceptional items comprise the cost of the manufacturing rationalisation begun in April 1999 of £34.0m, a £6.5m provision against the cost of intangible fixed assets as set out in Note 11, a £6.0m provision against the group’s equity investment in Advanced Tissue Sciences Inc as set out in Note 13 and acquisition integration costs of £5.2m, principally in connection with the Exogen business acquired in September 1999. In 1998 exceptional costs of £17.9m were incurred on a management and work force restructuring programme. The net profit on disposal relates to the sale of the bracing business in July 1999 for cash consideration of £121.8m. The net profit comprises a gain of £96.4m on net assets realised less £33.5m of acquisition goodwill previously written off to reserves. 40 Smith & Nephew 1999 Note 4 Interest Interest receivable Interest payable: On bank borrowings On other borrowings 1999 £ million 10.3 6.1 0.8 6.9 3.4 1998 £ million 8.1 9.2 0.6 9.8 (1.7) Interest payable on currency swaps amounting to £25.8m (1998 – £24.8m) has been set off against interest receivable. At 31 December 1999 the group held sterling interest bearing assets of £560m on which interest has been fixed on £390m at 5.7% for one year and £37m on which interest has been fixed for a further three years at 5.6%, a weighted average of 5.7% for a weighted average period of 1.2 years. The remainder was cash balances held on short term deposit at floating rates. The group also held £14m of foreign currency interest bearing assets as cash or on short term deposit at floating rates. The group’s interest bearing liabilities at 31 December 1999 included £409m of US dollars and £80m of euros on which interest has been fixed for one year on £288m of US dollars and £62m of euros at weighted average rates of 5.7% and 3.0% respectively. Interest has also been fixed on £34m of euros for a further three years at 3.6%. The remaining interest bearing liabilities totalled £62m of various currencies of which the largest was £16m of Australian dollars on which interest has been fixed at 6.0% for one year. Where interest has not been fixed the rates are typically based on the three month interest rate relevant to the currency concerned. Details of financial instruments as defined by Financial Reporting Standard 13 are set out in Notes 13, 15, 16 and 20. At 31 December 1999 unrecognised gains and losses on the value of interest rate swaps were £3.2m and £3.3m respectively (1998 – gains £7.8m, losses £3.6m). Unrecognised gains of £2.4m will be realised in 2000 and £0.8m between 2001 and 2003. Unrecognised losses on interest rate swaps will be realised in 2000. The unrecognised net losses on interest rate swaps at 31 December 1998 were realised in 1999. The group’s interest rate risk management policy is set out on page 31. Note 5 Employees The average number of employees during the year was: United Kingdom Continental Europe America Africa, Asia and Australasia Staff costs during the year amounted to: Wages and salaries Social security costs Other pension costs (Note 28) 1999 2,973 1,602 3,370 3,268 1998 3,209 1,618 4,123 3,406 11,213 12,356 £ million £ million 232.1 25.1 9.1 266.3 234.7 25.5 7.8 268.0 Smith & Nephew 1999 41 Notes to the accounts Note 6 Directors’ emoluments Aggregate emoluments of the directors, including pension entitlements of £78,000 (1998 – £151,000), were £1,789,000 (1998 – £1,564,000). The emoluments of the highest paid director excluding pension entitlement were £586,000 (1998 – £350,000). The accrued pension benefit of the highest paid director at the end of the year was £75,000 (1998 – £29,000). Information concerning individual directors’ emoluments, pension entitlements, shareholdings and share options is shown on pages 27 to 29. Note 7 Taxation United Kingdom: Corporation tax at 30.25% (1998 – 31%) Double taxation relief Deferred taxation Overseas: Current taxation Tax on gain on disposal Deferred taxation Adjustments in respect of prior years 1999 £ million 1998 £ million 29.7 – (3.8) 25.9 12.1 35.5 3.8 – 51.4 77.3 39.4 (7.0) (3.2) 29.2 15.8 – (2.7) (1.5) 11.6 40.8 The tax charge has been reduced by £9.5m (1998 – £4.9m) as a consequence of the exceptional costs of the rationalisation programme and acquisition integration costs and increased by £35.5m (1998 – nil) as a result of the exceptional profit on disposal, leaving the tax charge on ordinary activities at £51.3m (1998 – £45.7m). If full provision had been made for deferred tax, the tax charge would have increased by £5.7m (1998 – £5.8m) as follows: Fixed asset timing differences Other timing differences Note 8 Dividends Ordinary interim of 2.5p (1998 – 2.4p) paid 8 December 1999 Proposed ordinary final of 4.0p (1998 – 3.8p) payable 2 June 2000 Non-equity preference dividends amounting to £13,000 were paid (1998 – £10,000). 1999 £ million 1998 £ million 2.0 3.7 5.7 3.1 2.7 5.8 1999 £ million 1998 £ million 27.8 44.7 72.5 26.7 42.5 69.2 42 Smith & Nephew 1999 Note 9 Results before exceptional items In order to provide a trend measure of underlying performance, profit before taxation is adjusted below to exclude exceptional items, and basic earnings per share has been recalculated as set out in Note 10. Profit on ordinary activities before taxation Adjustments: Discontinued operations: net gain on disposal Continuing operations: exceptional items Profit before taxation and exceptional items Taxation on profit before exceptional items 1999 £ million 182.1 1998 £ million 134.5 (62.9) 51.7 (11.2) 170.9 51.3 – 17.9 17.9 152.4 45.7 Note 10 Earnings per ordinary share Basic earnings per ordinary share of 9.39p (1998 – 8.42p) are based on profit on ordinary activities after taxation and preference dividends of £104.8m (1998 – £93.7m) and on 1,116m ordinary shares being the basic weighted average number of shares in issue during the year (1998 – 1,113m). The calculation of diluted earnings per ordinary share is based on basic earnings as defined above and on 1,119m ordinary shares (1998 – 1,115m) calculated as follows: Basic weighted average number of shares Weighted average number of shares under option Number of shares that would have been issued at fair value Diluted weighted average number of shares Diluted earnings per ordinary share Shares 1999 million 1,116 16 (13) 1,119 Shares 1998 million 1,113 15 (13) 1,115 9.37p 8.40p The calculation of adjusted basic earnings per ordinary share is based on the basic weighted average number of shares, together with basic earnings as defined above, adjusted to exclude exceptional items as follows: Basic earnings Discontinued operations: net gain on disposal Continuing operations: exceptional items Exceptional taxation Adjusted basic earnings Adjusted basic earnings per ordinary share 1999 £ million 1998 £ million 104.8 (62.9) 51.7 26.0 119.6 10.72p 93.7 – 17.9 (4.9) 106.7 9.58p Smith & Nephew 1999 43 Notes to the accounts Note 11 Intangible fixed assets Group Cost: At 1 January 1999 Exchange adjustment Acquisitions Additions Discontinued operations At 31 December 1999 Amortisation: At 1 January 1999 Exchange adjustment Charge for the year Exceptional provision Discontinued operations At 31 December 1999 Net book amounts: At 31 December 1999 At 31 December 1998 Goodwill £ million Other £ million Total £ million 7.6 0.4 41.1 – – 49.1 0.3 – 1.8 – – 2.1 47.0 7.3 24.9 0.6 9.3 7.3 (1.2) 40.9 3.9 0.1 4.0 6.5 (0.6) 13.9 27.0 21.0 32.5 1.0 50.4 7.3 (1.2) 90.0 4.2 0.1 5.8 6.5 (0.6) 16.0 74.0 28.3 The cost of intangible fixed assets includes £15.5m in respect of milestone payments to Advanced Tissue Sciences Inc for a 50% interest in the intellectual property rights for Dermagraft. A £6.5m provision has been taken against this investment. This has been based on current projections of product sales over the expected life cycle of the technology, which include annual sales increasing significantly above the long term average applicable GDP growth rates in the first ten years and declining thereafter. Resultant net cash flows have been discounted at an appropriate rate. Note 12 Tangible fixed assets Group Cost: At 1 January 1999 Exchange adjustment Additions Disposals Discontinued operations Transfers At 31 December 1999 Depreciation: At 1 January 1999 Exchange adjustments Charge for the year Exceptional provision Disposals Discontinued operations At 31 December 1999 Net book amounts: At 31 December 1999 At 31 December 1998 Land and buildings freehold £ million leasehold £ million Plant and In course of equipment construction £ million £ million Total £ million 85.6 0.7 0.8 (3.3) (0.2) 0.1 83.7 14.8 – 1.2 3.6 (1.4) – 18.2 65.5 70.8 15.1 0.1 0.5 (1.6) (3.2) 0.3 11.2 4.0 0.1 0.6 – (0.4) (1.1) 3.2 8.0 11.1 443.5 2.8 32.4 (26.9) (8.6) 38.5 481.7 266.3 1.6 48.5 12.5 (20.0) (6.9) 302.0 179.7 177.2 32.6 0.3 23.9 (0.6) – (38.9) 17.3 – – – – – – – 17.3 32.6 576.8 3.9 57.6 (32.4) (12.0) – 593.9 285.1 1.7 50.3 16.1 (21.8) (8.0) 323.4 270.5 291.7 Fixed assets include land with a cost of £5.8m (1998 – £7.2m) that is not subject to depreciation. Leases with less than 50 years to run amounted to £5.1m (1998 – £7.6m). Included in the amounts above are assets held under finance leases with a net book amount of £3.0m (1998 – £3.4m). 44 Smith & Nephew 1999 Note 12 Tangible fixed assets continued Parent company The opening net book amount of £9.8m represented £1.9m land and buildings and £7.9m plant and equipment, with a cost of £2.5m and £17.1m respectively. Movements in the year comprised £2.0m of additions and £2.3m of disposals. The depreciation charged in the year was £1.4m (1998 – £1.4m). The closing net book value of £8.1m represented plant and equipment with a cost of £17.1m. Note 13 Investments At 1 January 1999 Exchange adjustment Acquisitions Transfers Exceptional provision At 31 December 1999 Group associated Group trade undertakings investments £ million £ million Group Parent subsidiary total undertakings £ million £ million 0.6 0.1 – – – 0.7 13.8 0.4 6.7 1.0 (6.0) 15.9 14.4 0.5 6.7 1.0 (6.0) 16.6 413.9 – – – – 413.9 Principal subsidiary and associated undertakings are listed on pages 54 and 55. Trade investments are US dollar denominated and include an 8% equity investment in Advanced Tissue Sciences Inc, quoted on the Nasdaq exchange in the US. An exceptional provision of £6.0m has been taken to state the carrying cost of this investment at £13.1m, equivalent to $4.90 per share. The quoted market price of the company at 31 December 1999 and 22 February 2000 was $2.50 and $8.50 respectively. Note 14 Stocks Raw materials and consumables Work in progress Finished goods and goods for resale Note 15 Debtors Amounts falling due within one year: Trade and other debtors Amounts owed by subsidiary undertakings Prepayments and accrued income Advance corporation tax Amounts falling due after more than one year: Pension prepayments (Note 28) Other debtors Deferred taxation (Note 19) Group 1999 £ million 52.1 16.1 169.4 237.6 Group 1998 £ million 56.9 17.9 167.6 242.4 Group 1999 £ million Group 1998 £ million Parent 1999 £ million Parent 1998 £ million 241.8 – 23.6 – 265.4 5.7 2.7 7.3 233.1 – 19.9 3.3 256.3 5.8 9.4 7.1 2.4 466.7 7.4 – 476.5 – – 0.3 1.4 653.4 7.2 – 662.0 – – – 281.1 278.6 476.8 662.0 Other debtors falling due after more than one year are non interest bearing, denominated in various currencies and are stated at fair value. Smith & Nephew 1999 45 Notes to the accounts Note 16 Borrowings Net borrowings Gross borrowings: Due within one year Due after one year Cash and bank Gross borrowings Bank loans and overdrafts Other loans wholly repayable within five years: 51⁄2% US dollar convertible bonds 2000 Other Other loans wholly repayable after five years Group 1999 £ million Group 1998 £ million Parent 1999 £ million Parent 1998 £ million 58.0 20.2 78.2 (100.5) (22.3) 86.6 12.8 99.4 (49.9) 49.5 28.9 4.5 33.4 (77.2) (43.8) 55.0 5.8 60.8 (24.0) 36.8 75.9 95.4 33.0 59.3 0.2 1.8 2.0 0.3 1.1 2.2 3.3 0.7 0.2 0.2 0.4 – 1.1 0.4 1.5 – 78.2 99.4 33.4 60.8 Bank loans and overdrafts represent drawings under committed and uncommitted facilities of £170m and £320m respectively. £150m of the committed facilities expire within one year. Borrowings secured on fixed and current assets were £1.7m (1998 – £2.2m). Borrowings are shown at fair value. The group’s liquidity risk management policy is set out on page 31. The group and parent company have currency swaps which are revalued at year end exchange rates and have maturities ranging from 1999 to 2005. For the group, gross sterling equivalents of £477.6m (1998 – £442.3m) receivable and £484.3m (1998 – £450.1m) payable have been netted. The balance of £6.7m is included as £4.4m in cash and bank and as £11.1m in borrowings (1998 – £2.7m in cash and bank and £10.5m in borrowings). For the parent company, gross sterling equivalents of £446.5m (1998 – £406.1m) receivable and £453.9m (1998 – £415.7m) payable have been netted, the balance of £7.4m (1998 – £9.6m) is included as £3.7m in cash and bank and as £11.1m in borrowings (1998 – £0.9m in cash and bank and £10.5m in borrowings). Currency swaps comprise floating interest rate contracts and forward foreign exchange contracts and are used for hedging foreign investments. The 51⁄2% US dollar convertible bonds are convertible into ordinary shares at 109p per share at a fixed exchange rate of US dollar 1.4202 to £1. If not converted the bonds are repayable by 18 December 2000. 46 Smith & Nephew 1999 Note 16 Borrowings continued Gross borrowings are repayable as follows: Within one year: Bank loans and overdrafts Other loans Total within one year Bank loans and overdrafts: After one year and within two years After two years and within five years Other loans: After one year and within two years After two years and within five years After five years Total after one year Group 1999 £ million Group 1998 £ million Parent 1999 £ million Parent 1998 £ million 57.5 0.5 58.0 3.5 14.9 18.4 0.3 1.2 0.3 1.8 20.2 78.2 86.2 0.4 86.6 4.3 4.9 9.2 0.3 2.6 0.7 3.6 12.8 99.4 28.7 0.2 28.9 2.5 1.8 4.3 – 0.2 – 0.2 4.5 55.0 – 55.0 4.3 – 4.3 – 1.5 – 1.5 5.8 33.4 60.8 In addition to the above gross borrowings, other financial liabilities are £0.3m being 51⁄2% undated cumulative preference shares as set out in Note 20. Note 17 Other creditors Trade creditors Amounts owed to subsidiary undertakings Social security costs and other taxes Accruals and deferred income Current taxation Ordinary share dividends Note 18 Provisions for liabilities and charges Group At 1 January 1999 Exchange adjustments Profit and loss account Utilisation At 31 December 1999 Group 1999 £ million Group 1998 £ million Parent 1999 £ million Parent 1998 £ million 128.5 – 14.8 49.7 74.7 44.7 312.4 128.4 – 16.3 41.6 60.2 42.5 289.0 2.4 221.2 0.3 11.0 20.2 44.7 299.8 2.0 295.8 0.2 9.0 19.8 42.5 369.3 Rationalisation and integration £ million Retirement healthcare £ million Other £ million Total £ million 14.3 0.2 17.0 (13.3) 18.2 8.5 0.2 0.7 (0.6) 8.8 8.6 0.1 10.9 (8.6) 11.0 31.4 0.5 28.6 (22.5) 38.0 At 31 December 1999 rationalisation and integration provisions included acquisition integration of £3.6m (1998 – £0.6m). The retirement healthcare provision is long term in nature, as is the timing of its utilisation. All other provisions are expected to be utilised within three years. There are no provisions for contractual amounts and hence none is treated as a financial instrument. Parent company The movement in provisions for liabilities and charges in the year from £1.3m to £0.9m represented expenditure of £0.4m. Smith & Nephew 1999 47 Notes to the accounts Note 19 Deferred taxation Group At 1 January 1999 Exchange adjustment At 31 December 1999 Deferred tax asset/(liability) is analysed as follows: Group Fixed asset timing differences Other timing differences £ million 7.1 0.2 7.3 Full potential liability 1998 £ million (28.3) 20.4 (7.9) Amount provided 1999 £ million Amount provided 1998 £ million (3.3) 10.6 7.3 (0.3) 7.4 7.1 Full potential liability 1999 £ million (30.2) 16.2 (14.0) Parent company The parent company has a full potential deferred tax liability of £1.5m represented by fixed asset timing differences. The full potential deferred tax liability in 1998 of £2.8m was represented by fixed asset timing differences. Note 20 Called up share capital Authorised Ordinary shares 10p 51⁄2% cumulative preference shares £1 Allotted, issued and fully paid Equity capital: ordinary shares 10p At 1 January 1999 Share options and convertible bonds At 31 December 1999 Non-equity capital: 51⁄2% cumulative preference shares £1 At 1 January 1999 and 31 December 1999 Total called up share capital at 31 December 1999 Shares 1999 ’000 1,495,500 450 Shares 1998 ’000 1,495,500 450 1999 £ million 149.5 0.5 150.0 Shares ’000 1,114,270 3,275 1,117,545 269 1998 £ million 149.5 0.5 150.0 £ million 111.4 0.4 111.8 0.3 112.1 The 51⁄2% cumulative preference shares are denominated in sterling and are shown at fair value. They are non-voting and carry preferential rights to dividends and distribution on winding up. 48 Smith & Nephew 1999 Note 21 Share option schemes At 31 December 1999 25,464,000 (1998 – 24,369,000) of the authorised but unissued ordinary shares of 10p were reserved in respect of the following options: Employee share option schemes Executive share option schemes Note 22 Reserves Group At 1 January 1999 Exchange adjustment Retained profit for the year Share options and convertible bonds Goodwill on disposals At 31 December 1999 Exercisable in stages between 2000-2005 2000-2009 Exercise prices per share range between Shares the subject of options ’000 123.2p -156.0p 93.5p -195.5p 7,421 18,043 25,464 Share Profit and premium loss account £ million £ million 114.3 – – 4.0 – 118.3 259.5 (4.0) 32.3 – 33.5 321.3 Net exchange losses of £9.5m (1998 – gains of £1.8m) arising on foreign currency net borrowings have been taken directly to reserves. The cumulative amount of goodwill (before merger relief of £116.0m) charged to reserves is £368.8m (1998 – £398.4m). The decrease is due to the goodwill written back to reserves on the disposal of the bracing business of £33.5m and exchange on acquisitions made prior to 31 December 1998 of £3.9m. Parent company At 1 January 1999 Retained loss for the year Share options and convertible bonds At 31 December 1999 Share Profit and premium loss account £ million £ million 114.3 – 4.0 118.3 452.3 (40.8) – 411.5 In accordance with the exemption permitted by Section 230(3) of the Companies Act 1985, the parent company has not presented its own profit and loss account. The attributable profit for the year dealt with in the accounts of the parent company is £31.7m (1998 – £70.5m). Smith & Nephew 1999 49 Notes to the accounts Note 23 Cash flow statement Reconciliation of operating profit to net cash flow from operating activities Operating profit Depreciation and amortisation Exceptional asset write downs Loss/(profit) on sale of tangible fixed assets Rationalisation and integration costs Decrease/(increase) in stocks Increase in debtors Increase in creditors and provisions Net cash inflow from operating activities Analysis of net borrowings Cash Overdrafts Borrowings due within one year Borrowings due after one year Net currency swaps Liquid resources: cash deposits Opening net borrowings £ million 47.2 (11.7) 35.5 (64.4) (12.8) (41.7) (7.8) – (49.5) 1999 £ million 1998 £ million 115.8 56.1 28.6 1.9 (18.5) 0.6 (14.2) 27.8 198.1 136.2 49.7 – (1.9) (9.5) (20.5) (8.3) 16.2 161.9 Cash flow adjustments £ million £ million Exchange Closing net borrowings £ million (21.7) 6.6 (15.1) 19.1 (2.3) 1.7 7.3 72.3 81.3 (1.7) – (1.7) (0.7) (0.9) (3.3) (6.2) – (9.5) 23.8 (5.1) 18.7 (46.0) (16.0) (43.3) (6.7) 72.3 22.3 Cash and bank at 31 December 1999 totals £100.5m (1998 – £49.9m) and comprises cash £23.8m (1998 – £47.2m), liquid resources £72.3m (1998 – nil) and currency swaps of £4.4m (1998 – £2.7m) as detailed in Note 16. Reconciliation of net cash flow to movement in net borrowings for the year ended 31 December 1999 Change in cash in the year Change in liquid resources Change in net currency swaps Change in borrowings Change in net cash/borrowings from cash flows Exchange adjustments Change in net cash/borrowings in the year Opening net borrowings Closing net cash/(borrowings) 1999 £ million 1998 £ million (15.1) 72.3 7.3 16.8 81.3 (9.5) 71.8 (49.5) 22.3 (5.6) (1.5) (7.3) 9.7 (4.7) 1.8 (2.9) (46.6) (49.5) Disposals The net assets of the bracing business disposed of in the year comprised fixed assets £4.6m, stocks £8.5m, debtors £10.2m and creditors and provisions £6.1m. During the year the business contributed £2.6m of the group’s net operating cash flows and incurred capital expenditure amounting to £0.9m. 50 Smith & Nephew 1999 Note 24 Currency translation The exchange rates used for the translation of currencies that have the most significant impact on the group results were: US dollar French franc German mark Australian dollar South African rand Average rate 1999 Average rate 1998 Year end rate 1999 Year end rate 1998 1.62 10.04 2.99 2.49 9.87 1.66 9.78 2.92 2.65 9.21 1.61 10.55 3.14 2.46 9.92 1.66 9.29 2.77 2.71 9.79 Note 25 Acquisitions The principal acquisitions during the year were the Exogen orthopaedic business acquired in September 1999 and an intangible fixed asset addition of £9.3m in Advanced Tissue Sciences in January 1999. Under the acquisition method of accounting the impact on the consolidated balance sheet of acquisitions in the year was: Intangible fixed assets Tangible fixed assets Current assets Current liabilities Goodwill Cash consideration Net book value £ million 9.3 0.5 4.5 (4.5) 9.8 41.1 50.9 There were no fair value adjustments with respect to the acquisitions. Note 26 Financial commitments Group capital expenditure contracted but not provided for in these accounts amounted to £2.1m (1998 – £4.9m). Under the group’s joint arrangement with Advanced Tissue Sciences for the treatment of diabetic foot ulcers and other wound indications, amounts of up to £6m could become payable in the future, subject to achievement of certain milestones related to regulatory and reimbursement approvals, with further amounts payable on future regulatory, reimbursement and sales milestones, providing profits exceed certain minimum levels. The annual commitments of the group under operating leases were: Operating leases which expire: Within one year After one year and within five years After five years Land and buildings 1999 £ million Land and buildings 1998 £ million Other assets 1999 £ million Other assets 1998 £ million 1.7 3.4 2.3 7.4 1.0 4.6 3.1 8.7 2.2 5.6 – 7.8 1.6 6.1 – 7.7 Smith & Nephew 1999 51 Notes to the accounts Note 27 Contingent liabilities Guarantees in respect of subsidiary undertakings’ borrowings Other Group 1999 £ million Group 1998 £ million Parent 1999 £ million – 3.5 3.5 – 8.5 8.5 17.3 3.5 20.8 Parent 1998 £ million 15.1 8.5 23.6 The group is party to legal proceedings in the normal course of business which it is considered will not result in any material adverse effect. Note 28 Post-retirement benefits The group sponsors pension plans for its employees in most of the countries in which it has major operating companies. In those countries where there is no company-sponsored pension plan, the state benefits are considered adequate. Employees’ retirement benefits are the subject of regular management review. The group’s major pension plans are of the defined benefit type. The group also operates defined contribution type plans appropriate to local circumstances. Pension plans are established under the laws of the relevant territory with their assets held in separate trust funds or by insurance companies. The pension cost for the group’s defined benefit plans have been determined by independent qualified actuaries, using the projected unit method to give a substantially level percentage cost on the current and expected future pensionable payroll. The excess of plan assets over plan liabilities is amortised, using the percentage of payroll method, over the weighted average of expected pensionable payroll and remaining service lives of current employees in the plan. The actuarial assumptions used vary according to local circumstances, the most significant being those in the UK and the US: UK % per annum US % per annum 8.5 5.0 3.5 5.1 3.5 9.0 6.0 nil n/a 3.0 10.0 years 13.2 years Return on investments Increase in pensionable earnings Increase in pensions Increase in dividend income Inflation Average remaining service lives 52 Smith & Nephew 1999 Note 28 Post-retirement benefits continued At the date of the most recent actuarial valuations (which took place between October 1997 and January 1999) the aggregate market value of the assets of the group’s major defined benefit plans was £256m (1998 – £234m). The actuarial value of plan assets represented 103% of plan liabilities for accrued benefits, including allowance for projected future increases in salaries. Included in debtors due after more than one year is a prepayment of £5.7m (1998 – £5.8m) relating to the excess funding of certain group pension plans. Included in creditors is an accrual of £12.0m (1998 – £9.3m) relating to the deferred funding of certain group pension plans. At the balance sheet date the unamortised balance of the actuarial value of plan assets over liabilities not recognised in the group accounts was £12.7m (1998 – £19.1m). The group recharges the group’s UK pension schemes with the costs of administration and independent advisers borne by the group. The total amount recharged in the year to 31 December 1999 was £0.5m (1998 – £0.4m). The amount receivable at 31 December 1999 was £0.1m (1998 – £0.1m). The costs of providing healthcare benefits after retirement of £0.7m (1998 – £0.7m) are determined by independent qualified actuaries. The unfunded liability of £8.8m (1998 – £8.5m) in respect of the accrued healthcare benefits is included in provisions. The principal actuarial assumptions that are most significant in determining the cost of providing healthcare benefits are those in the UK and the US: Interest rate Medical cost inflation UK % per annum 5.5 6.5 US % per annum 9.0 7.5 Smith & Nephew 1999 53 Subsidiary and associated undertakings Principal subsidiary undertakings The information provided below is given for principal subsidiary undertakings in accordance with Section 231(5)(a) of the Companies Act 1985. A full list will be appended to the company’s next annual return. Activity Country of operation and incorporation % owned United Kingdom Smith & Nephew Healthcare Limited Smith & Nephew Homecraft Limited Smith & Nephew Medical Limited Smith & Nephew Medical Fabrics Limited* TJ Smith & Nephew Limited Smith & Nephew Consumer Products Limited Continental Europe Smith & Nephew GmbH Smith & Nephew SA-NV Smith & Nephew A/S Smith & Nephew OY Smith & Nephew SA Smith & Nephew GmbH Smith & Nephew Orthopaedics GmbH Smith & Nephew Limited Smith & Nephew Srl Smith & Nephew BV Smith & Nephew A/S Smith & Nephew Lda Smith & Nephew SA Smith & Nephew AB Smith & Nephew AG America Smith & Nephew Inc Smith & Nephew SA de CV Smith & Nephew Inc Smith & Nephew Inc *Owned directly by the parent company Medical devices Medical devices Medical devices Medical devices Medical devices Consumer healthcare Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices & consumer healthcare Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices Medical devices & consumer healthcare Medical devices Medical devices Medical devices United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom United Kingdom Austria Belgium Denmark Finland France Germany Germany Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland Canada Mexico Puerto Rico United States 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 54 Smith & Nephew 1999 Principal subsidiary undertakings continued Activity Country of operation and incorporation % owned Africa, Asia and Australasia Smith & Nephew Pty Limited Smith & Nephew Limited Smith & Nephew Healthcare Limited PT Smith & Nephew Healthcare Smith & Nephew KK Smith & Nephew Limited Smith & Nephew Healthcare Sdn Berhad Smith & Nephew Limited Smith & Nephew Pakistan (Pvt) Limited Smith & Nephew Pte Limited Smith & Nephew Limited Smith & Nephew Limited Smith & Nephew FZE Medical devices & consumer healthcare Medical devices & consumer healthcare Medical devices Medical devices & consumer healthcare Medical devices Medical devices Medical devices & consumer healthcare Medical devices & consumer healthcare Medical devices & consumer healthcare Medical devices & consumer healthcare Medical devices & consumer healthcare Medical devices Medical devices Australia Hong Kong India Indonesia Japan Korea Malaysia New Zealand Pakistan Singapore South Africa Thailand United Arab Emirates 100% 100% 100% 100% 100% 100% 100% 100% 97% 100% 100% 100% 100% Principal associated undertakings and other arrangements The group owns 49% of Eurociencia CA, a Venezuelan healthcare company, which has a share capital of £0.2m (1998 – £0.2m). There are no debt securities attributable to the group’s interest. The group has interests in two joint arrangements with Advanced Tissue Sciences Inc, one relating to products for the treatment of diabetic foot ulcers and other wound indications, and the other to cartilage replacement. Smith & Nephew 1999 55 Group five year summary Profit and loss account Turnover Continuing and acquired operations Discontinued operations Operating profit Continuing and acquired operations: Before exceptional items Exceptional items* Discontinued operations Profit/(loss) on disposals* Profit before interest Interest receivable/(payable) Profit before taxation Taxation Profit after taxation Ordinary dividends Retained profit Basic earnings per ordinary share Diluted earnings per ordinary share Dividends per ordinary share Results before exceptional items (*): Profit before taxation Adjusted earnings per ordinary share Operating profit (before exceptional items) to sales Research and development costs to sales Capital investment (including intangibles) to sales 1999 £ million 1998 £ million 1997 £ million 1996 £ million 1995 £ million 1,075.7 44.2 977.8 75.6 961.2 86.9 980.2 89.0 902.8 123.5 1,119.9 1,053.4 1,048.1 1,069.2 1,026.3 162.0 (51.7) 5.5 115.8 62.9 178.7 3.4 182.1 77.3 104.8 72.5 32.3 9.39p 9.37p 6.50p 170.9 10.72p 15.0% 4.0% 5.8% 144.4 (17.9) 9.7 136.2 – 136.2 (1.7) 134.5 40.8 93.7 69.2 24.5 8.42p 8.40p 6.20p 152.4 9.58p 14.6% 4.1% 6.6% 154.4 (1.8) 10.2 162.8 (6.5) 156.3 (3.9) 152.4 38.7 113.7 69.0 44.7 10.24p 10.22p 6.20p 160.7 11.00p 15.7% 4.0% 7.1% 177.1 (4.4) 10.8 183.5 0.9 184.4 (5.7) 178.7 58.0 120.7 66.5 54.2 10.92p 10.86p 6.00p 182.2 11.21p 17.6% 3.9% 6.7% 169.9 (14.6) 15.1 170.4 11.0 181.4 (4.6) 176.8 64.0 112.8 62.3 50.5 10.29p 10.24p 5.65p 180.4 11.04p 18.0% 3.6% 6.8% 56 Smith & Nephew 1999 Balance sheet Fixed assets Working capital Provisions Capital employed Called up share capital Reserves Capital and reserves Net (cash)/borrowings Operating profit (before exceptional items) to average capital employed Gearing Cash flow Cash inflow from operating activities Capital expenditure and financial investment Interest, tax and dividends Acquisitions and disposals Issues of share capital Net cash flow Exchange adjustments Opening net borrowings Closing net cash/(borrowings) 1999 £ million 1998 £ million 1997 £ million 1996 £ million 1995 £ million 361.1 206.3 (38.0) 529.4 112.1 439.6 551.7 (22.3) 529.4 334.4 232.0 (31.4) 535.0 111.7 373.8 485.5 49.5 535.0 302.0 235.8 (29.9) 507.9 111.5 349.8 461.3 46.6 507.9 277.3 233.4 (32.3) 478.4 111.0 324.4 435.4 43.0 478.4 278.7 259.3 (51.3) 486.7 110.5 294.2 404.7 82.0 486.7 31% nil 30% 10% 33% 10% 39% 10% 40% 20% 198.1 (65.1) 133.0 (127.0) 70.9 4.4 81.3 (9.5) (49.5) 22.3 161.9 (61.9) 100.0 (91.3) (16.4) 3.0 (4.7) 1.8 (46.6) (49.5) 181.7 (66.8) 114.9 (113.0) (8.0) 4.3 (1.8) (1.8) (43.0) (46.6) 189.3 (63.4) 125.9 (106.3) (42.6) 5.2 (17.8) 56.8 (82.0) (43.0) 180.3 (61.8) 118.5 (133.4) (73.8) 11.3 (77.4) (9.6) 5.0 (82.0) Smith & Nephew 1999 57 Information for shareholders Analysis of shareholdings The number of shareholders as at 31 December 1999 was 28,285. Shareholders range: 1,000 and under 1,001 to 5,000 5,001 to 10,000 10,001 to 100,000 Over 100,000 Held by: Individuals Institutions and companies Financial calendar Annual General Meeting Payment of 1999 final dividend Interim results announced Payment of 2000 interim dividend Full year results announced Annual report posted Annual General Meeting Shareholders % Shares % 31.9 46.3 11.8 7.7 2.3 83.8 16.2 0.4 2.9 2.1 4.6 90.0 7.3 92.7 11 April 2000 2 June 2000 8 August 2000 6 December 2000 mid February 2001 early March 2001 3 April 2001 Final dividend The ordinary shares will trade ex-dividend on both the London and New York Stock Exchanges from 2 May 2000 and the record date will be 8 May 2000 in respect of this year’s proposed final dividend to be paid on 2 June 2000. Ordinary shares Payment of cash dividends Shareholders who wish their dividends to be paid directly to a bank or building society and who have not already completed a BACS mandate should contact the company’s registrars. Dividend re-investment plan The company has a dividend re-investment plan that offers shareholders the opportunity to invest their cash dividends in Smith & Nephew shares, which are purchased in the market at competitive dealing costs. Application forms for re-investing the 1999 final dividend are available from Lloyds TSB Registrars, telephone 01903 854287, who administer the plan on behalf of the company. Applications for re-investment should be returned to the company’s registrars by 15 May 2000. UK capital gains tax For the purposes of capital gains tax the price of ordinary shares on 31 March 1982 was 28.67p. Registrars Lloyds TSB Registrars are the company’s registrars and maintain the share register. Any enquiries about shareholdings in Smith & Nephew should be directed to: Lloyds TSB Registrars The Causeway Worthing West Sussex BN99 6DA Telephone: 0870 600 3996 Correspondence should refer to Smith & Nephew marked for the attention of Team 54 Reference 530 and state clearly the registered name and address of the shareholder. 58 Smith & Nephew 1999 Smith & Nephew share price The company’s share price is quoted daily in national newspapers, as well as on Ceefax and Teletext and at www.londonstockexchange.com where it is updated at intervals throughout the day. The Financial Times Cityline Service, telephone 0891 434043, provides an up to the minute share price. A fee is charged for this service. Low-cost dealing service A postal facility that provides a simple low- cost method of buying and selling Smith & Nephew shares is available through: Hoare Govett Limited 250 Bishopsgate London EC2M 4AA Telephone: 020 7678 8300 American depositary receipts (ADRs) Smith & Nephew’s ordinary shares are traded on the New York Stock Exchange (symbol: SNN) in the form of American Depositary Shares, evidenced by ADRs. ADRs are issued by the Bank of New York which acts as depositary. Each American Depositary Share represents ten ordinary shares. Voting rights as a shareholder are exercised through the depositary. All enquiries regarding ADR holder accounts and payment of dividends should be addressed to: Bank of New York Church Street Station PO Box 11258 New York New York 10286-1258 Smith & Nephew ADR price The company’s ADR price is quoted daily in the Wall Street Journal and can be obtained from the official New York Stock Exchange website (www.nyse.com). Global BuyDIRECT A Global BuyDIRECT plan for Smith & Nephew’s ADR programme will be available in March from the Bank of New York. Global BuyDIRECT is a direct ADR purchase/sale and dividend re-investment plan for ADR investors who are resident in the US. This plan enables existing and first-time investors to invest directly in ADRs with reduced brokerage commissions and service costs. For further information, contact the Bank of New York on 1-888-BNY-ADRS (toll-free) or visit www.adrbny.com. Annual General Meeting The company’s 63rd Annual General Meeting is to be held on 11 April 2000 at 11.00 am at the London Marriott Hotel, Grosvenor Square, London W1A 4AW. Notice of the meeting is enclosed with an accompanying letter from the Chairman. Registered office Smith & Nephew plc Heron House 15 Adam Street London WC2N 6LA Registered in England No. 324357 Advisers Solicitors: Auditors: Stockbrokers: Ashurst Morris Crisp Ernst & Young Cazenove & Co Dresdner Kleinwort Benson World Wide Web The company’s address on the web is www.smith-nephew.com. Recent press releases are on the website together with the latest annual and interim reports. Trademarks The product names referred to in this document are trademarks owned by or licensed to members of the Smith & Nephew group. Smith & Nephew 1999 59 Smith & Nephew plc Heron House 15 Adam Street London WC2N 6LA