Smith & Nephew

2004 Annual Report

Growing in expanding markets

Dear Shareholder

As a consequence of the Company’s Ordinary Shares being traded on the New York Stock Exchange (in the form
of American Depositary Shares) we are required to prepare and file a Form 20-F with the US Securities and
Exchange Commission. In order to provide the same information to both UK and US shareholders we have
combined the Annual Report and Accounts and the Company’s Form 20-F filing as a single document. US
shareholders receive the combined Annual Report and Form 20-F.

For non-US shareholders who have elected to receive the full Annual Report and Accounts, the combined
Annual Report and Form 20-F contains a very large amount of information and you may not wish to receive
such a large document in the future. If so, please complete the enclosed form of request to elect to receive the
Company’s Summary Financial Statement in future, which is sent to the vast majority of shareholders each
year. Shareholders electing to receive the Summary Financial Statement may subsequently choose to receive
the full combined Annual Report and Form 20-F.

Yours sincerely,

Dudley Eustace
Chairman

8 March 2005

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ii

INTRODUCTION

The Smith & Nephew Group is a global medical devices business engaged in orthopaedics, endoscopy and
advanced wound management with sales of over £1.2 billion in 2004. Smith & Nephew plc is the parent
company of the Smith & Nephew Group. It is an English public limited company with its shares listed on the
official list of the UK Listing Authority and traded on the London Stock Exchange. It is also traded on the New York
Stock Exchange in the form of ADSs.

This report is the Annual Report of Smith & Nephew plc for the year ended 31 December 2004. It comprises in a
single document the Annual Report and Accounts of the Company in accordance with UK requirements and the
Annual Report on Form 20-F in accordance with the regulations of the Securities and Exchange Commission in
the US.

A summary report on the year, the Summary Financial Statement 2004, intended for the investor not requiring the
full detail of the Annual Report, is produced as a separate document. The Summary Financial Statement includes
a summary review of operations, a summary remuneration report and summary financial statements.

Over 90% of shareholders have chosen to receive only the Summary Financial Statement. The Annual Report is
issued to shareholders who have elected to receive it. Both documents are available on Smith & Nephew’s
corporate website at www.smith-nephew.com.

The Group’s fiscal year ends on 31 December of each year. References in this Annual Report to a particular year
are to the fiscal year unless otherwise indicated. Except as the context otherwise requires, “Ordinary Share” or
“share” refer to the Ordinary Shares of Smith & Nephew plc of 12 2⁄ 9p each.

For the convenience of the reader, a Glossary of technical and financial terms used in this document is included
on page 152. The product names referred to in this document are identified by the use of capital letters and are
trademarks owned by or licensed to members of the Smith & Nephew Group.

Smith & Nephew’s corporate website, www.smith-nephew.com, gives additional
information on the Group.
Information made available on the website is not intended to be, and should not be regarded as being, part of
this Annual Report.

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CONTENTS

Report of the Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Description of the Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating and financial review, liquidity and prospects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Remuneration report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Auditors’ reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group profit and loss account
Group balance sheet
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes to the Group accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2-65
2
4
27
48
57

66-132
68
70
71
74

Investor information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

133-149

Cross reference to Form 20-F . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Glossary of Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150
152

This Annual Report including the Report of the Directors was approved by the Board of Directors on 8 March
2005.

1

FINANCIAL SUMMARY

Financial Highlights

Group turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Profit before taxation:

Before goodwill amortisation and exceptional items . . . . . . . . . . . . . . . . . . . . . .
After goodwill amortisation and exceptional items . . . . . . . . . . . . . . . . . . . . . . .
Adjusted basic earnings per Ordinary Share (“EPSA”) . . . . . . . . . . . . . . . . . . . . . . . . .
Basic earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004
£ million

1,248.5

278.4
177.9
21.14p
13.39p
5.10p

2003
£ million

1,178.9

242.2
230.1
18.49p
15.92p
4.95p

2004 Dividends
The recommended final dividend of 3.20p per share together with the interim dividend of 1.90p makes a total for
2004 of 5.10p. Approval by shareholders of the 2004 final dividend will be sought at the Annual General Meeting
to be held on 5 May 2005. If approved, the final dividend will be paid on 13 May 2005 to shareholders on the
register at the close of business on 22 April 2005.

Presentation
Smith & Nephew believes that the reporting of profit and earnings before goodwill amortisation and exceptional
items provides additional information on underlying returns and trends to shareholders. The Group’s internal
financial reporting focuses primarily on profit and earnings before goodwill amortisation and exceptional items
which are the key performance indicators used in budgets, monthly reporting, forecasts, long-term planning and
incentive plans. For this purpose exceptional items comprise operating exceptional items, share of exceptional
items of
joint venture and net profit on disposal of discontinued operations and associated undertaking.
Throughout this document earnings per share calculated in this way is termed adjusted basic earnings per
Ordinary Share (“EPSA”). The calculation of profit before goodwill amortisation and EPSA is set out in the “Five
Year Record” (page 140).

Management’s key indicator of sales performance is underlying growth in sales. This is calculated by excluding
the effects of foreign currency translation movements and acquisitions. Management believes that sales growth
on an underlying basis provides a consistent year-on-year measurement of performance without the distortions
created by the translation effect of foreign currency movements and acquisitions which are separate from the
Group’s normal operations. Underlying sales growth is used by management in its internal financial reporting,
budgeting and planning. A reconciliation of reported sales to underlying sales is provided on page 29.

The Group, as an international business, operates in many countries and earns revenues and incurs costs in
many currencies. The results of the Group, as reported in Sterling, are therefore affected by movements in
exchange rates between Sterling and overseas currencies. The Group uses the average exchange rates
prevailing during the year to translate the results of overseas companies into Sterling. The currencies which most
influence these translations are the US Dollar and the Euro. During 2004 average Sterling exchange rates were
stronger against the US Dollar by 12% and stronger against the Euro by 2%, compared with 2003.

The Group Accounts of Smith & Nephew in this Annual Report are presented in Sterling. Solely for the
convenience of the reader, certain parts of this Annual Report contain translations of amounts in Sterling into US
Dollars at specified rates. These translations should not be construed as representations that the Sterling
amounts actually represent such US Dollar amounts or could be converted into US Dollars at the rate indicated.
Except as where stated otherwise the translation of pounds Sterling and pence to US Dollars and cents appearing
in this Annual Report has been made at the noon buying rate in The City of New York for cable transfers in
Sterling as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) on
the date indicated. On 28 February 2005, the Noon Buying Rate was US$1.925 per £1.

The Accounts of the Group in this Annual Report are presented in millions (“m”) unless otherwise indicated.

2

Special Note Regarding Forward-Looking Statements
The Group’s reports filed with, or furnished to, the US Securities and Exchange Commission (“SEC”), including this
document and written information released, or oral statements made, to the public in the future by or on behalf of
the Group, constitute “forward-looking statements” within the meaning of the US Private Securities Litigation
Reform Act of 1995. In particular, statements regarding planned growth in our business and in our operating
margins discussed under “Outlook and Trend Information” are forward-looking statements as are discussions of
our product pipeline and discussions of the costs of future revisions of the macrotextured knee product under
“Recent Developments”, “Legal Proceedings” and “Operating and Financial Review, Liquidity and Prospects”.
When used in this Annual Report, the words “aim”, “anticipate”, “believe”, “consider”, “estimate”, “expect”,
“intend”, “plan”, “well-placed”, “target” and similar expressions are generally intended to identify forward-looking
statements. Such forward-looking statements involve known and unknown risks, uncertainties and other
important factors (including, but not limited to, the outcome of litigation and regulatory approvals) that could
cause the actual results, performance or achievements of Smith & Nephew, or industry results, to differ materially
from any future results, performance or achievements expressed or implied by such forward-looking statements.
Specific risks faced by the Group are described under “Risk Factors” on page 23 of this Annual Report.

All forward-looking statements in this Annual Report are based on information available to Smith & Nephew as of
8 March 2005. All written and oral forward-looking statements attributable to Smith & Nephew or any person
acting on behalf of Smith & Nephew are expressly qualified in their entirety by the foregoing. Smith & Nephew
does not undertake any obligation to update or revise any forward-looking statement contained herein to reflect
any change in Smith & Nephew’s expectation with regard thereto or any change in events, conditions or
circumstances on which any such statement is based.

Market Data
Market data and market share estimates throughout this report are derived from a variety of sources including
publicly available competitors’ information, internal management information and independent market research
reports.

3

DESCRIPTION OF THE GROUP

This section discusses the activities, resources and operating environment of the business under the following
headings:

The Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
History and development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufacture and supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Seasonality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intellectual property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The Business and the Community . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate social responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5
5
6

11
11
11
12

13
13
13
14
14
14
15
16

17
17
22

23

Discussion of
“Corporate Governance” section (pages 48 to 56).

the Group’s management structure and corporate governance procedures is set out in the

The “Remuneration Report” gives details of the Group’s policies on senior management’s remuneration in 2004
(pages 57 to 65).

Discussion of the Group’s operating and financial performance, liquidity and financial resources for 2004 and
2003 is given in the “Operating and Financial Review, Liquidity and Prospects” (pages 27 to 47).

4

THE BUSINESS

HISTORY AND DEVELOPMENT

Group Overview
Smith & Nephew is a global business engaged in the development, manufacture and marketing of medical
devices in the sectors of orthopaedics, endoscopy and advanced wound management.

The Group has a history dating back 149 years to the family enterprise of Thomas James Smith who opened a
small pharmacy in Hull, England in 1856. On his death in 1896, his nephew Horatio Nelson Smith took over the
management of the business. Smith & Nephew was incorporated and listed on the London Stock Exchange in
1937. Today it is a public limited company incorporated in the UK and registered in, and conducted under the
laws of, England and Wales. Operations in countries other than the UK are under the laws of those countries. In
November 1999, the Group was listed on the New York Stock Exchange. The corporate headquarters is in the UK
and the registered address is:

Smith & Nephew plc
15 Adam Street
London WC2N 6LA
Tel: +44 (0) 20 7401 7646
Website: www.smith-nephew.com

In 2001, Smith & Nephew became a constituent member of the FTSE-100 index in the UK. This means that
Smith & Nephew is included in the top 100 companies traded on the London Stock Exchange measured in terms
of market capitalisation.

Recent Developments
In March 2004, Smith & Nephew acquired Midland Medical Technologies (“MMT”), the global market leader in
metal-on-metal hip resurfacing for £70m in cash and notes. Additional payments of up to £30m in cash and
notes are contingent upon certain regulatory milestones being met. MMT achieved sales in the 2003 calendar
year of £20m. Including acquired distributors, MMT contributed £20m to Smith & Nephew’s turnover in 2004.
MMT is being integrated into the orthopaedics business.

In August 2003, Smith & Nephew withdrew from all markets the macrotextured version of its OXINIUM femoral
knee component. This withdrawal is specific to the macrotextured version of this OXINIUM component and does
not affect any other product using OXINIUM technology. As at that date 2,971 components had been implanted
of which approximately 2,471 were in the USA, 450 in Australia and 50 in Europe. As at 28 February 2005 782
revision surgeries had been carried out on affected patients and settlements agreed with patients in respect of
537 of these revisions. As discussed more fully under “Legal Proceedings”, due to uncertainties relating to the
amount of insurance coverage that will be available to cover certain existing claims and future claims, an
exceptional charge of £80m has been recorded, representing unsettled insurance claims and an estimate of
claims likely to arise in the future assuming that no further insurance cover is available. These estimates
constitute forward looking statements that are subject to uncertainties. Depending on the number and average
cost of actual revisions, costs to Smith & Nephew may be greater or less than the amount of this provision. See
“Legal Proceedings” and “Risk Factors”.

5

BUSINESS DESCRIPTION

Group Structure
Smith & Nephew operates on a worldwide basis. This has been achieved through a series of investments and
acquisitions, predominantly in the US but also in Europe, and through continued emphasis on the development
and introduction of new products to the Group’s principal markets.

Smith & Nephew is organised into the three global business units of orthopaedics, endoscopy and advanced
wound management and a separate indirect market unit. Each of the three global business units manages its
sales directly in ten international markets — the US, Canada, the UK, Germany, Japan, Australia, France, Italy,
New Zealand and Ireland — and takes full responsibility for strategy, research and development (“R&D”),
manufacturing, marketing, sales and financial performance. The remaining 22 markets in which the Group has
selling companies are managed by country managers, with business responsibility for the whole of the Group’s
product range, and comprise the indirect market unit.

A head office team in London, England directs the overall business and supports the business units, primarily in
the areas of business development, company secretarial, finance, human resources and investor relations, with a
legal department based in Memphis, Tennessee. A central research facility in York, England is charged with the
development of enabling technologies in both materials science and biology, particularly cell biology.

Orthopaedics

Overview
Orthopaedic products comprise reconstructive joint implants, trauma products and associated clinical therapies.
Reconstructive implants include hip, knee and shoulder joints as well as ancillary products such as bone cement
and mixing systems used in cemented reconstructive joint surgery. Trauma products consist of internal and
external fixation devices, used in the stabilisation of severe fractures. Clinical therapies consist of products
applied in an orthopaedic office or clinic setting and currently comprise bone growth stimulators and a joint fluid
therapy product.

The orthopaedics business is managed worldwide from Memphis, Tennessee, which is also the site of its main
manufacturing facility. Orthopaedic implants and trauma products are also manufactured at a small facility in
Tuttlingen, Germany. As described in “Property, Plant and Equipment”, continuing strong sales growth has
created the need for expansion in both manufacturing and administrative facilities.

The Group’s reconstructive knee business is built on two major knee systems: GENESIS II, designed to facilitate
the accuracy and efficiency of the operating procedure and provide improved long-term clinical results; and
PROFIX, a reconstructive knee system featuring simpler instruments and surgical technique.

Within the reconstructive hip line, the SPECTRON cemented hip system and the REFLECTION acetabular cup
system have documented positive long-term clinical performance. More recently, the success of SYNERGY, a
tapered titanium stem system, and ECHELON, a revision stem system, have established Smith & Nephew as a
strong player in this product segment.

The Group has developed and now manufactures knee and hip implant components made from oxidised
zirconium (OXINIUM) which is patent protected and which management believes has improved wear
characteristics which may be of significant benefit to younger, more active patients.

Within the trauma business, products in internal and external fixation, such as the TRIGEN intramedullary nail
system, PERI-LOC plating system, IMHS CP JET-X fixator and TAYLOR SPATIAL FRAME fixator, provide trauma
surgeons a comprehensive offering of products to address acute and reconstructive procedures and hip
fractures related to osteoporosis. Orthobiologic products, including demineralised bone matrix are also offered
for use in conjunction with reconstructive and trauma surgeries.

The EXOGEN ultrasonic bone healing stimulator and SUPARTZ hyaluronic acid joint fluid therapy are the main
products in the clinical therapies sector.

To compete effectively in the growing global orthopaedic market, management believes that as well as having a
leading edge product range it is important to have a skilled sales force that can build strong relationships with
surgeons and to provide high levels of customer service. Currently the global sales force numbers 1,260, of
whom 815 serve the US market.

6

Strategy
Smith & Nephew’s orthopaedics strategy is for future growth through product development in its existing core
business and expansion into the fast-growing market for less invasive therapies. Management believes that the
orthopaedic market will continue to grow for the foreseeable future. This is largely attributable to the increasing
proportion of the population aged over 55 and the increasing need for joint reconstructive products and other
orthopaedic therapies in younger, more active patients.

Management believes that its sales growth has accelerated through the creation of separate divisions for trauma
and reconstructive with separate internal resources and specialised sales forces. Smith & Nephew also intends
to further penetrate these markets by taking advantage of its portfolio of products and services, by expanding its
sales force, and by introducing less invasive and alternative therapies. The Group is also contributing to patient
education and empowerment through its websites and other direct-to-consumer activities.

NewProducts
In 2004, the orthopaedics business continued the promotion and roll-out of OXINIUM technology across the knee
and hip product line. OXINIUM is a material exclusive to Smith & Nephew which has the strength of a metal with
the wear properties of a ceramic material and expands the market for hip and knee implants. The completion of
the OXINIUM femoral head rollout was accomplished with the smaller and larger sizes being introduced in the
market. The TANDEM BIPOLAR PROSTHESIS is designed to address the needs of hip fracture patients.

In 2004, the Group released for surgical evaluation the PERI-LOC plating system for lower extremity procedures. It
is expected to launch this product in the first half of 2005.

is the Birmingham Hip Resurfacing (“BHR”)
The principal product of MMT, which was acquired in 2004,
prosthesis. Hip resurfacing is a less invasive surgical approach, and preserves more bone, than total hip
replacement and is more appropriate for use on younger and more active patients. The business is based in
Birmingham, UK and is being integrated into the reconstructive division of orthopaedics. Its sales are principally in
the UK, continental Europe and Australia. It is not approved for sale in the US. Management’s intention is to
pursue FDA approval in the US for the BHR based on the significant amount of clinical data which has been
assembled since 1997.

RecentRegulatoryApprovals
In February 2004, the Japanese Ministry approved the GENESIS II HI FLEX KNEE tibial insert and the FDA cleared
the INTERTAN nail for sale in the US. INTERTAN nails are used for fracture fixation and feature an innovative screw
design that allows two different locking options.

In July 2004, FDA cleared the OXINIUM revision femoral component for sale in the US. This product can be used
when an existing artificial knee needs to be replaced and can be used with stems and wedges which are
sometimes needed in revision surgeries.

In September 2004, the Japanese Ministry approved the Asian IMHS. This is a titanium version of the stainless
steel IMHS nail, sized for the Asian anatomy.

During 2004, the FDA issued a clearance for VERSABOND AB antibiotic loaded bone cement.

Competition
Management estimates that the worldwide orthopaedic market (excluding spine) served by the Group grew by
13% in 2004 and is currently worth more than £6.5 billion per annum. Management believes that Smith &
Nephew holds a 9% share of this market by value.

Principal global competitors in the orthopaedic market and their estimated global shares, are Zimmer (21%),
Stryker (18%), De Puy/Johnson & Johnson (17%), Biomet (11%) and Synthes-Stratec (11%).

Endoscopy

Overview
Smith & Nephew’s endoscopy business, headquartered in Andover, Massachusetts, develops and
commercialises a range of endoscopic (minimally invasive surgery) techniques, educational programmes and
value-added services for surgeons to treat and repair soft tissues, articulating joints, spinal discs and vascular
structures. The business focuses principally on the arthroscopy sector of the endoscopy market. Arthroscopy is
the minimally invasive surgery of joints, in particular the knee and shoulder.

7

The endoscopy business offers surgeons endoscopic technologies for surgery, including: fluid management and
insufflation equipment for surgical access; digital cameras, digital
image capture, central control, multimedia
radiofrequency wands,
light sources and monitors to assist with visualisation;
broadcasting, scopes,
electromechanical and mechanical blades, and hand instruments for resecting tissue; and specialised devices,
fixation systems and bioabsorbable materials to repair damaged tissue.

Manufacturing facilities are located in Andover and Mansfield, Massachusetts and Oklahoma City, Oklahoma.
Major service centres are located in the US, the UK, Germany, Japan and Australia.

Of the current global sales force of 655, 360 serve the US market.

Strategy
Smith & Nephew’s strategic intent is to establish the endoscopy business as the leading provider of endoscopic
techniques for joint and ligament repair and to use its core capabilities to penetrate other select endoscopic
markets. Management believes the business capitalises on the growing acceptance of endoscopy as a preferred
surgical choice among physicians, patients and payors.

To sustain growth and enhance its market position, the endoscopy business supports its strategy with surgeon
education programmes, financing solutions, global fellowship support initiatives, partnerships with professional
associations and surgeon advisory boards.

In February 2004, the endoscopy business expanded its Digital Operating Room product range by acquiring Reed
Medical, a leading provider of audio-visual technology and design for operating room applications. Management
believes that this will enable the Group to establish itself as a lead player in the fast growing market for operating
room modernisation.

NewProducts
In 2004, Smith & Nephew introduced a new three chip endoscopic camera system providing superior image
quality, digital output, the option of steam sterilisation, and compatibility with previous generation camera
components. The Group continued to expand its offerings in soft tissue repair with the ENDOBUTTON CL BTB and
GTS system for knee tendon repair along with the BIORAPTOR anchor, ELITE PASS suture shuttle and CLEAR-
TRAC disposable cannulas and obturators for arthroscopic shoulder repair. To encourage surgeon adoption of
arthroscopic hip techniques, Smith & Nephew introduced a new hip access system, making it easier for surgeons
to safely position instruments in the hip joint.

As the global market leader in arthroscopic resection, the Group introduced the SCULPTOR line of monopolar
ablation probes, providing safe and efficient removal of soft tissue during knee and shoulder procedures. Smith &
Nephew also introduced additional improvements and enhancements to its DYONICS power system, with more
aggressive disposable blades and additional options for its POWERMAX shaver handpiece.

The launch of the new 20S generator system allowed entry into the new spinal market of facet joint pain
treatment, complementing the Group’s position as a leader for the treatment of disc degeneration. The new
generator platform continues to advance the treatment of spine pathologies through both IDET and the new
ACUTHERM catheter for targeted disc decompression.

RecentRegulatoryApprovals
During 2004, the endoscopy business obtained regulatory approvals for the following products in most major
markets, except Japan where the approval process is traditionally slower: DURABRAID and ULTRABRAID high
strength sutures; a new RF generator for two interventional spine procedures, IDET and disc decompression, in
addition to probes for denervation of the facet joints; a graft sleeve device for intra-tunnel fixation of the ACL graft;
and various other arthroscopy fixation and vascular devices.

Competition
Management estimates that the global arthroscopy markets in which the business principally participates is worth
£780 million a year and is growing at 8% annually, driven by increasing numbers of sports injuries, longer and
more active lifestyles, patient desire for minimally invasive procedures, innovative technological developments
and a need for cost effective procedures. Management believes that Smith & Nephew has a 29% share of the
global arthroscopy market. Smith & Nephew also participates in the developing minimally invasive spinal and
minimally invasive vascular markets and continues to seek ways to leverage its knowledge, experience and core
capabilities in other selected endoscopic markets.

8

Smith & Nephew’s main competitors and their estimated shares of the global arthroscopy market are: Mitek/
Johnson & Johnson (17%), Linvatec/Conmed (14%), Arthrex (14%), Stryker (12%) and Arthrocare (7%).

Advanced Wound Management

Overview
Smith & Nephew’s advanced wound management business is headquartered in Hull, England. It supplies a range
of products and clinical support services for the treatment of chronic and acute skin wounds. It offers a range of
products from initial wound bed preparation through to full wound closure. These products are targeted
particularly at chronic wounds connected with the older population (such as pressure sores and venous leg
ulcers), diabetic foot ulcers, burns and complex surgical wounds.

Advanced wound management products are manufactured in facilities in Hull and Gilberdyke, England; Largo,
Florida; and La Jolla, California and by certain third party manufacturers.

The advanced wound management business has continued to build its sales and marketing infrastructure in the
world’s major markets, with expansion of its sales force and global brand development. These initiatives have led
to increased levels of demand on the Group’s manufacturing and global supply chain, which have been
addressed with increased investment in the production capacity in Hull and Largo.

Strategy
The strategy for advanced wound management products is to focus on the higher added value segments of
wound bed preparation and moist and active healing. The formation of a joint venture with Beiersdorf AG in 2001,
BSN Medical, enabled the advanced wound management business to exit from its traditional medical textile
woundcare business allowing it to focus its attention on higher added value advanced woundcare products.

The business has built
its sales and marketing infrastructure in the world’s major markets, both through
investment in its existing network and through the additional sales teams gained through its acquired businesses
in recent years. The integration of the acquired sales forces has increased the capability of the business
throughout the world, particularly in the key markets of the US and Germany. Currently the global sales force is
905 of whom 200 are in the US.

In January 2004, the business acquired VERSAJET, a fluid jet debridement system, from HydroCision Inc., to add
to its range of advanced wound bed preparation products.

NewProducts
Management believes that the market will continue the trend towards advanced products with their ability to
accelerate healing rates, reduce hospital stay times and cut the cost of nursing and clinician time and aftercare in
the home.

In 2002, the Group acquired the remaining 50% of its former joint arrangements with Advanced Tissue Sciences,
Inc. (“ATS”) for the rights to apply human tissue technology to the treatment of all skin wounds including two
significant products, DERMAGRAFT and TRANSCYTE. DERMAGRAFT is a human dermal replacement designed as
a treatment for diabetic foot ulcers and TRANSCYTE is a temporary wound covering for the treatment of burns.

At the end of 2002, ACTICOAT achieved Class III medical device approval in Europe and during 2003 the product
achieved a drug tariff listing in the United Kingdom. ACTICOAT, acquired from Westaim of Canada in May 2001, is
an antimicrobial barrier dressing incorporating the smallest crystallised silver (nanocrystalline silver) used in the
treatment of burns or wounds. The silver reduces the risk of bacterial colonisation and acts to kill micro-
organisms that can cause infection and prevent or retard healing. Sales have been driven by the worldwide
introduction of ACTICOAT and the application of the technology to a wide range of line extensions.

2004 was the second year of the launch of the expanded ALLEVYN hydrocellular dressing range. Management
believes that ALLEVYN is the largest selling dressing in its category in the world and that the continued focus on
the brand will aid Smith & Nephew in maintaining this position. 2004 was the first full year of the sales of
GLADASE, a papain urea ointment that was launched in the US to replace SANTYL, a collagenase product.

RecentRegulatoryApprovals
During 2004,
the advanced wound management business secured over 215 medical device and 65
pharmaceutical registration approvals in various markets throughout the world. Among the most significant

9

approvals were those for ACTICOAT ABSORBENT, an absorbent antimicrobial barrier product, in Europe as a
Class III device and the VISITRAK wound management system in Japan. VERSAJET gained new approvals in
Australia, South Korea and South Africa.

Competition
Management estimates that the sales value of the advanced wound management market worldwide is £1.9
billion a year, and that this grew 12% in 2004, and that Smith & Nephew has a 19% market share. Growth is
driven by an ageing population and by a steady advancement in technology and products that are more clinically
efficient and cost effective than their conventional counterparts. Management believes that, with approximately
half of chronic wounds globally still treated with conventional dressings, there is strong growth potential for
advanced technology products.

Worldwide competitors in advanced wound management and their estimated market shares comprise Kinetic
Concepts (21%), the Convatec division of Bristol-Myers Squibb (12%), Johnson & Johnson (9%), and 3M (8%).

Joint Ventures and Discontinued Operations

JointVentures,AssociatedUndertakings,JointArrangementsandOtherInterests
Joint ventures are those in which the Group holds an interest on a long-term basis and which are controlled by
the Group and one other entity under a contractual agreement.

Smith & Nephew owns 50% of the BSN Medical joint venture, which became operational on 1 April 2001. It is
jointly owned with Beiersdorf AG and is independently managed. BSN Medical comprises traditional woundcare,
casting and bandaging and compression hosiery businesses. Headquartered in Hamburg, Germany it has
manufacturing facilities in the US, UK, Germany, France, Republic of Ireland, South Africa, Mexico and Pakistan. In
certain markets, Smith & Nephew’s sales forces sell BSN Medical’s products on an agency basis in return for an
agency commission and in some markets, mainly in Asia, Smith & Nephew distributes BSN Medical products.
Results are accounted for under the gross equity method, whereby 50% of turnover, operating profit, interest,
taxation and attributable profit for the year are incorporated into Smith & Nephew’s profit and loss account.

During 2004 BSN Medical acquired the fracture casting and splinting business of DePuy, Inc., a Johnson &
Johnson company and has integrated it with its casting and bandaging business. This acquisition furthered the
establishment of BSN Medical as a major independent medical supplies company.

Associated undertakings are those 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. In
March 2002, the Group acquired 21.5% of AbilityOne Corporation (“AbilityOne”) as part of a transaction in which
it disposed of its rehabilitation business to AbilityOne. In September 2003, the Group disposed of its 21.5%
interest in AbilityOne to Patterson Dental Inc. From 1 April 2002 to 12 September 2003 this interest was included
in the Group’s accounts as an associated undertaking and accounted for under the equity method, whereby
21.5% of operating profit, interest, taxation and attributable profit are incorporated into Smith & Nephew’s profit
and loss account.

The Group had an interest in two joint arrangements with ATS, relating to products for the treatment of diabetic
foot ulcers (DERMAGRAFT) since 1996, and cartilage replacement (NEOCYTE) since 1994. On 25 November
2002, the Group purchased from ATS the interests it did not already own in the joint arrangements.

DiscontinuedOperations
Discontinued operations in 2002 comprise three months of results of the rehabilitation business disposed of in
March 2002. The rehabilitation business manufactured and marketed products, equipment and product systems
used to increase,
improve or maintain functional capabilities after surgery or stroke or of individuals with
disabilities.

10

OPERATING ENVIRONMENT

REGULATION

The international medical device industry is highly regulated. Regulatory requirements are a major factor in
determining whether substances and materials can be developed into marketable products and the amount of
time and expense that should be allotted to such development.

National regulatory authorities administer and enforce a complex series of laws and regulations that govern the
testing, approval, manufacturing, labelling, marketing and sale of healthcare and pharmaceutical 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 are the FDA in the US, the Medicines and Healthcare products Regulatory Agency in the UK and the
Ministry for Health Labour and Welfare in Japan. Payment for many medical device products is governed by
reimbursement tariff agencies in each individual country.

The trend in recent years has been towards greater regulation and higher standards of technical appraisal, which
lengthy inspections for compliance with appropriate standards, including regulations such as
generally entail
good manufacturing practices. Smith & Nephew believes that these recent changes will not have a material
adverse effect on the Group’s financial condition and the results of operations. All significant facilities within the
Group are subject to regular internal audit for medical device regulatory compliance with national and Group
standards and policies.

Smith & Nephew believes that the Group’s operations currently comply in all material respects with applicable
environmental laws and regulations. Although the Group continues to make capital expenditure for environmental
compliance, it is not currently aware of any significant expenditure that would be required as a result of such laws
and regulations that would have a material adverse impact upon the Group’s financial condition.

PRODUCT LIABILITY

The Group monitors the safety of its products from initial product development through to product use or
application. In addition, the businesses of the Group analyse on a worldwide basis reports of adverse reactions
and complaints relating to its products. Each business reviews these adverse reactions and complaints and any
safety matters arising with independent medical advisors. These conclusions are subsequently reviewed by the
Group’s independent medical advisor.

Product liability is a commercial risk for the industry of which the Group is a part, particularly in the US. Smith &
Nephew has implemented systems it believes are appropriate in respect of loss control techniques. These
include reporting mechanisms to ensure early notification of complaints and a legal department which manages
product liability claims and lawsuits.

The Group carries product liability insurance to cover exposure as far as practicable. With the exception of the
macrotextured product liability claim, discussed under “Legal Proceedings” and “Risk Factors”, instances of loss
to the Group arising from product liability claims have been covered either directly by the Group or by insurance.
Apart from the macrotextured claim, there are no individual product liability claims that are expected to have a
material adverse effect on the Group’s financial position.

There can be no assurance that consumers, particularly in the US or elsewhere, will not bring product liability or
related claims that would have a material adverse effect on the Group’s financial position or results of operations
in the future or that the Group will continue to resolve such claims within insurance limits in view of changing legal
doctrines and attitudes regarding such matters. See “Risk Factors — Product Liability Claims and Loss of
Reputation”.

11

RISK MANAGEMENT

Smith & Nephew’s products are not inherently high risk. However, if they malfunction, they could damage or
impair the repair of body functions. Management believes that the Group’s quality, regulatory and medical
controls and insurance cover is adequate and appropriate for this class of products. The Group’s reputation is
crucially dependent on strong performance in this area and on appropriate crisis management if a serious
medical incident or product recall should occur.

The Board is responsible for the maintenance of the Group’s systems of risk management and internal control
and for reviewing their effectiveness. These systems, which accord with the Turnbull Guidance, have been in
place for 2004 and to the date of approval of the report and accounts and involve: the identification, evaluation
and management of key risks through a Risk Committee, which reports to the Board annually; business reviews
by the Board; and the review of the Audit Committee of internal financial controls and the risk management
process. These systems are reviewed annually by the Board. Whilst not providing absolute assurance against
material misstatements or loss, these systems are designed to identify and manage those risks that could
adversely impact the achievement of the Group’s objectives.

The Group maintains insurance against product, employers’ and directors’ and officers’ liabilities, and physical
and consequential loss, subject to limits and deductibles. The Group maintains liability provisions to cover known
uninsured risks. On 17 December 2004 the Group was advised that certain insurers had declined coverage for
macrotextured knee claims. See “Legal Proceedings”.

12

OPERATING ACTIVITIES

MARKETING AND DISTRIBUTION

Smith & Nephew’s customers are the various providers of medical and surgical services worldwide. In certain
parts of the world, including the UK, much of Continental Europe, Australia, Canada and South Africa, these are
largely governmental organisations funded by tax revenues. In the US, the Group’s major customers are public
and private hospitals, many of which have combined to form large purchasing groups and receive revenue from
private health insurance and governmental reimbursement programmes. In the US, Medicare is the major source
of reimbursement for knee and hip procedures and for wound healing treatment regimes.

Competition exists among healthcare providers to gain patients on the basis of quality, service and price. In many
countries, and particularly in the US, 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 specialised
and multinational corporations, including those with greater financial, marketing and other resources.

The Group’s customers reflect the wide range of distribution channels, purchasing agents and buying entities in
over 90 countries worldwide. The largest single customers worldwide are the National Health Service in the UK
and HealthTrust in the US. Sales to these customers in 2004 each represented approximately 4% of the Group’s
worldwide total sales.

In the US the Group’s products are marketed directly to doctors, hospitals and other healthcare facilities. Each
business unit operates a separate specialised sales force. Within the orthopaedics business further
specialisation of the sales force continues to be introduced progressively for reconstructive, trauma and clinical
therapy products. In both orthopaedics and endoscopy the US sales forces consist of independent commissioned
sales agents who are managed by a mix of independent agents and the Group’s own managers. These agents
are not permitted contractually to sell products that compete with Smith & Nephew’s. In both businesses
products are shipped and invoiced direct to the ultimate customer. The advanced wound management business
in the US operates a sales force of its own employees who market direct to the ultimate customer. Advanced
wound management products in the US are shipped and invoiced to a number of large wholesale distributors.

In the other direct markets of the UK, Ireland, France, Germany, Italy, Australia, New Zealand, Canada and Japan
the business units manage separate sales forces directly. Except
in Australia and New Zealand, where
independent sales agents are used, the sales forces of the direct markets comprise employees and market
directly to the ultimate customer.

The indirect markets unit comprises direct selling and marketing operations in Austria, Belgium, Denmark, Eastern
Europe, Finland, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, China, Hong Kong, Korea,
Malaysia, Singapore, Taiwan, Thailand, the United Arab Emirates, South Africa, Mexico and Puerto Rico. In these
markets orthopaedics and endoscopy frequently share sales resources. The advanced wound management
sales force is separate since it calls on different customers. In all other countries Smith & Nephew sells to third
party distributors which market the Group’s products locally.

In Continental Europe, the Group operates three centralised distribution facilities. Orthopaedics operates a facility
in Paris which acts as a central holding and consolidation point for Continental European stock and stock returns.
Product is shipped to Group companies who hold small amounts of stock locally for immediate or urgent
the
customer
Netherlands and Gothenburg, Sweden from where stock is shipped directly to the ultimate customer in most
European markets.

requirements. Advanced wound management operates distribution centres at Nijmegen,

MANUFACTURE AND SUPPLY

Where management considers that the Group possesses a core competence its policy is to manufacture
products internally wherever possible to ensure quality, regulatory and cost goals are met. The Group invests in
the expansion of its manufacturing facilities and equipment to meet these aims.

The Group outsources its manufacturing for several possible reasons including lack of in-house expertise, lack of
a cost competitive process or due to capacity constraints.

13

Where products and services are outsourced, suppliers are determined based on a number of factors which
include the complexity of
cost
competitiveness and intellectual property. Suppliers are selected based on their capability to provide products
and services, their ability to establish and maintain a quality system and their financial stability. Suppliers are
monitored by on-site assessments and ongoing monitoring of delivered products. Ongoing product assurance is
maintained by effective quality plans.

the product, manufacturing technology, manufacturing capabilities,

Each business unit purchases raw materials, components, finished products and packaging materials from
certain key suppliers. These comprise principally metal forgings and stampings for orthopaedics, optical and
electronic sub-components for endoscopy, active ingredients and finished goods for advanced wound
management and packaging materials for all businesses. Management believes that prices of principal raw
materials and finished goods purchased are not particularly volatile and that these materials are generally
available from various specialist suppliers. Finished goods purchased for resale are primarily SUPARTZ joint
lubricant and the BHR hip resurfacing product in the orthopaedic business; monitors and electrical devices in the
endoscopy business; and enzyme debrider agents and ACTICOAT in the advanced wound management
business.

SEASONALITY

Smith & Nephew’s sales are generally at their highest in quarter four of any year. This is caused by the relatively
high number of accidents and sports injuries which occur in the North American and European autumn and
winter which increases sales of orthopaedic and endoscopy products and by the deferral of elective surgery
during the peak summer holiday period in North America and Europe during the third quarter.

RESEARCH AND DEVELOPMENT

The business units each manage a portfolio of short and long-term product development projects designed to
meet the future needs of their customers and to continue to provide growth opportunities for their businesses.
The Group’s research and development
three business segments. Expenditure on
is directed towards all
research and development amounted to £66.4m in 2004 (2003 — £66.8m, 2002 — £61.3m), representing
approximately 5% of group turnover (2003 — 6%, 2002 — 6%).

The Group’s principal research facility is located in York, England. The Group’s research programme seeks to
underpin the longer-term technology requirements for its businesses and to provide a flow of
innovative
products. The Group continues to invest in future technology opportunities, particularly bio-resorbable materials,
tissue engineering and non-invasive healing devices across the Group.

Product development programmes are carried out at the Group’s principal manufacturing locations, notably in
Memphis, Tennessee (orthopaedics), Andover and Mansfield, Massachusetts (endoscopy) and Hull, England and
La Jolla, California (advanced wound management). In-house research is supplemented by work performed by
academic institutions and other external research organisations principally in the UK and the US.

INTELLECTUAL PROPERTY

Management believes that the Group’s policy concerning intellectual property rights promotes innovation in its
businesses. Smith & Nephew has a policy of protecting, with patents,
the research and
development carried out throughout the Group. Patents have been obtained for a wide range of products,
including those in the fields of orthopaedic, endoscopic and advanced wound management technologies. Patent
protection for Group products is sought routinely in the Group’s principal markets. Currently, the Group’s patent
portfolio stands at over 2,500 existing patents and patent applications.

the results of

Smith & Nephew also has a policy of protecting the Group’s products in the markets in which they are sold by
registering trademarks as soon as possible under local
laws. The Group vigorously protects its trademarks
against infringement and currently is not aware of any significant infringement of its trademark registrations. The
present trademark portfolio of the Group consists of over 3,300 trademarks and design rights.

Smith & Nephew’s principal products are protected by intellectual property comprising patents, licences and
know how, and it strives to provide a collection of intellectual property for each major product that reduces the
risk associated with failure of any individual piece of intellectual property. In addition, most pieces of intellectual

14

property protect a relatively small proportion of the Group’s annual turnover. As a result, the Group tries to ensure
that its overall business is not sensitive to the loss (however caused) of any single piece of intellectual property.

In addition to maintaining a policy of protecting its market position by the filing and enforcement of patents and
trademarks, Smith & Nephew has a policy of opposing third party patents and trademarks 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 operations and the financial
results of the Group.

PROPERTY, PLANT AND EQUIPMENT

The Group’s principal locations are as follows:

Approximate
area
(Square feet
000’s)

Group Head Office in London, England . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group research facility in York, England . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Orthopaedics headquarters and manufacturing facility in Memphis, Tennessee . . . . . . . . . . . . . . . .
Endoscopy headquarters in Andover, Massachusetts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy manufacturing facility in Andover, Massachusetts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy manufacturing facility in Mansfield, Massachusetts . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy manufacturing facility in Oklahoma City, Oklahoma . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management headquarters and manufacturing facility in Hull, England . . . . . . . .
Advanced wound management manufacturing facility in Largo, Florida . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management manufacturing facility in La Jolla, California . . . . . . . . . . . . . . . . . . .

15
83
680
112
110
90
100
546
188
69

The facilities in Memphis, Hull and Largo and the manufacturing facility in Andover are freehold whilst all other
principal locations are leasehold. The Group has freehold and leasehold interests in real estate in other countries
throughout the world, but no other is individually significant to the Group. Where required, the appropriate
governmental authorities have approved the facilities.

During 2004 additional space of 20,000 square feet was leased at the endoscopy headquarters in Andover,
Massachusetts and endoscopy manufacturing moved to a new facility in Oklahoma City, Oklahoma which has
45,000 more square feet than the previous facility.

As a result of its rapid rate of sales growth in recent years and anticipated continuing strong demand for its
products, the orthopaedics business needs to increase its manufacturing capacity and administrative facilities. A
capacity expansion strategy has been formulated and in 2005 additional freehold manufacturing space of
105,000 square feet and leasehold administrative space of 72,000 square feet will be acquired in Memphis.

Also during 2005, in the UK, new facilities for the development, manufacture and distribution of BHR products will
be acquired in the Birmingham area and consolidated with the existing UK orthopaedics operations. Current
locations in Bromsgrove and Cambridge will be vacated.

The strategy calls for further administrative and research and development facilities to be added in Memphis
during 2006 and the identification and securing of low-cost manufacturing locations in the future.

The expansion in the Group’s facilities is not expected to have a material impact on liquidity and resources.

15

LEGAL PROCEEDINGS

The Company and its subsidiaries are parties to various legal proceedings including product liability, which are
considered to constitute ordinary and routine litigation incidental to the businesses conducted by the Group, in
some of which claims for damages in substantial amounts have been asserted. The outcome of such
proceedings cannot readily be foreseen, but other than detailed below management believes that they will not
result in any material adverse effect on the financial position or results of operations of the Group.

Smith & Nephew is in dispute with ArthroCare Inc., which alleges infringement of three US patents related to
certain bipolar radio frequency products. In June 2004 an injunction was granted against Smith & Nephew
prohibiting sales of affected products. Sales of the affected products in 2004 up to the date of the injunction were
£3m. Management believes it has meritorious defences based upon pending trial court motions, re-examinations
taking place in the US Patent and Trademark Office and an appeal to the Court of Appeals for the Federal Circuit
and intends to contest the case.

In August 2003 the Group withdrew voluntarily from all markets the macrotextured versions of its OXINIUM
femoral knee components. As at that date 2,971 components had been implanted of which approximately 2,471
were in the USA, 450 in Australia and 50 in Europe, the first component having been implanted in December
2001.

The product was withdrawn when management became aware of a higher than usual percentage of reports of
early revisions (“revisions” are implants which need to be replaced). Whilst the cause of the revisions remains
uncertain it is apparent that some patients do not achieve adequate initial fixation and that in other patients, while
there appears to be good initial fixation, this does not persevere. Extensive testing and modelling has so far failed
to identify the precise cause of the failure and, due to the large number of variables involved, it is probable that
the precise cause may never be understood fully.

As at 28 February 2005 782 implants had been revised and settlements agreed with patients in respect of 537 of
these revisions. The total amount paid out in settlements, legal costs and associated expenses was £50m of
which £32m had been or will be recovered from the insurer that provides the primary layer and 65% of the first
excess layer in the Group’s global product liability programme. The balance of £18m is due from insurers in
respect of the balance of the first excess layer and the second excess layer.

On 17 December 2004 the Group was notified that two insurance carriers who comprise 35% of the first and
80% of the second excess layers of the Group’s global product liability programme had declined coverage for
macrotextured claims. Management intends to take all steps available to it in order to enforce this coverage.
Nevertheless, in view of the uncertainty, management cannot assert that it is probable that coverage will be
restored and consequently has recorded an exceptional charge of £80m representing the amount currently
outstanding from these insurers and an estimate of the cost associated with claims likely to arise in the future
assuming that insurance cover is unavailable from these and subsequent excess layer insurers.

The charge has been calculated based on: (1) the amount outstanding at 31 December 2004 from the insurers
who have denied coverage; (2) an estimate of the average cost in respect of revisions where settlements were
unresolved at that date; and (3) an estimate of the number of settlements of future revisions based on the current
trend and decaying to zero after five years and an estimation of the average future cost per settlement.

the impact of

The Group’s assessment of
these revisions and related matters constitute forward-looking
statements that are subject to uncertainties, including uncertainties relating to the outcome of settlements as
compared to the assumptions made in estimating claim amounts. Smith & Nephew cannot provide assurance
that these estimates will prove correct. Depending on the number and average cost of future settlements, costs
may be greater or less than the amount provided (see “Risk Factors”).

16

THE BUSINESS AND THE COMMUNITY
CORPORATE SOCIAL RESPONSIBILITY

Smith & Nephew’s aim is to help people regain their lives by repairing and healing the human body. The Group
contributes to the treatment and the recovery of patients within its areas of expertise and helps clinicians treat
more patients by simplifying procedures and providing cost-effective solutions to healthcare systems. Smith &
Nephew has a relatively minor impact on the environment but is committed to making continuous improvements
to the management of its environmental, social and economic impacts so as to help develop a sustainable
business.

Smith & Nephew is dedicated to helping improve people’s lives. The Group prides itself on the strength of its
relationship with its clinicians and other healthcare professional customers with whom it has a reputation for
product innovation and high standards of customer service. Healthcare economic considerations are integrated
into the product development process to ensure that the benefits from the Group’s new products and line
extensions not only improve patient outcomes, provide better treatment and procedures for both clinician and
patient but also contribute to more cost-effective solutions for healthcare services.

The Group has published a Sustainability Report since 2001, recording its progress in corporate social
responsibility. Every year the scope of the report widens and new measurements are published to help the Group
monitor its progress and demonstrate to its stakeholders that sustainable development is taken seriously and is
considered an integral part of the way the Group does business. The fifth Sustainability Report will be published
on the Group’s website at the beginning of May 2005 at www.smith-nephew.com.

Smith & Nephew’s progress has been consistently recognised by two of the leading independent organisations
that assess sustainable development activities. In 2004, the Group was again included in the Dow Jones
Sustainability Index (“DJSI”) with improved scores, and their report named Smith & Nephew as a leader in its
sector. This is the most widely recognised arbiter of good practice and is truly international in scope. The DJSI has
again included the Group in both the World Index and the European Index. In the UK, Smith & Nephew continues
to be included in the list of FTSE4Good companies.

Business Integrity
Smith & Nephew aims to be honest and fair in all aspects of its business and expects the same from all those
with whom it does business. In 2005 it further developed its code covering the standards expected of its
suppliers and the means it uses to ensure that these standards are met. Smith & Nephew did not give or receive
improper financial inducements, either directly or indirectly, for business or financial gain. The Group works to the
high industry standards set by Eucomed in Europe and Advamed in the US. Accounting records and supporting
documents are designed to describe accurately and reflect the nature of underlying transactions and conform to
IFRS and US GAAP.

The Group’s code of business principles governs the way it operates so that it respects the rights of all
its
stakeholders and seeks to build open, honest and constructive relationships. It takes account of ethical, social,
environmental, legal and financial considerations in planning and business decisions. The code is published as
part of Smith & Nephew’s Sustainability Report and can be found on its website.

Innovation
Smith & Nephew is dedicated to developing innovative, cost-effective products and techniques that deliver
significant advantages to clinicians and patients. The Group combines scientific and technical leadership with an
understanding of the needs of clinicians and a familiarity with the emerging treatments and procedures being
explored by them. This enables Smith & Nephew to produce new products with distinct advantages in clinical
performance and cost-effectiveness.

The Group’s research and development strategy is based both on assessment of market needs and a longer
range view of
techniques are
future requirements and opportunities. Radical new treatment and surgical
developed together with technologies and fundamental scientific work that could deliver new products for up to
15 years from now.

It has long been the Group’s practice to develop platform technologies that enable the building of a product range
following the initial technology introduction. This provides an efficient and cost-effective means for product
development and the ability to deliver a stream of incremental benefits to the healthcare community.

17

The Group’s research strategy has involved gaining a biological understanding of problems and applying
materials and design expertise to provide solutions. Whilst this approach has been extremely successful and will
remain a primary route for product development, increasingly the Group is seeking solutions based on active
repair where physical or biological stimuli can enhance or accelerate the restoration of the normal function of
damaged tissue.

The Group maintains links with pioneering research being conducted in academic and external research
organisations around the world to ensure it continues to be at the forefront of innovation for the benefit of all its
stakeholders.

Environment, Health and Safety Management
the beginning of 2004, combining environment
The Group effected a policy and organisation change at
management with Health and Safety (“EHS”)
to bring improvements through a more integrated and
comprehensive approach. This policy can be found on the Group’s website. Smith & Nephew is committed to the
protection of the environment by using renewable resources wherever possible and developing manufacturing
processes and products that minimise adverse effects on the environment. The Group’s businesses take
effective action to control risks and minimise environmental impacts through systems and procedures based on a
thorough understanding of the risks and appropriate training and support. Good EHS standards and practice
ensure that the environment and Smith & Nephew employees, together with others affected by the Group’s
business and its products, are protected from harm. It is considered that good EHS practice contributes to
business performance by protecting and developing human and physical resources and by reducing costs.

The Group has environmental management systems to identify, monitor and control potential risks and adverse
impacts and to generate continuous improvements and cost savings. Manufacturing processes are relatively low
in environmental impact. Emphasis is placed on the close control of energy, water consumption and waste, the
latter being the main area of impact at manufacturing sites. Waste prevention and minimisation programmes are
in operation and sustainable development aspects of the Group’s products are assessed during the research
and development process. Smith & Nephew’s key environmental measurements over the last four years are as
follows:

Emissions to air VOCs (tonnes)
. . . . . . . . . . . . . . . . . .
Emissions to air carbon dioxide (tonnes) . . . . . . . . . . .
Waste (tonnes)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Hazardous waste (tonnes) . . . . . . . . . . . . . . . . . . . . . .
Waste recycled (tonnes) . . . . . . . . . . . . . . . . . . . . . . . .
Total energy (GwH) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Electricity (GwH)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Water usage (1,000 cu. Metres) . . . . . . . . . . . . . . . . . .
Discharges/effluent (1,000 cu. Metres) . . . . . . . . . . . .

2004

1
48,954
3,596
234
767
132
86
427
384

2003

10
50,160
4,054
275
646
145
89
457
399

2002

20
47,888
3,774
270
750
137
76
433
386

2001

18
n/a
3,024
184
813
132
71
389
342

Totals are for the Group as a whole for the year and will therefore include divested businesses e.g. the rehabilitation business which was sold
in March 2002.

Waste, energy and water consumption has been increasing since 2001 due to significantly increased
manufacturing capacity across the Group. There has been an emphasis on reversing this trend in 2004 generally
producing good results. Smith & Nephew has relatively low energy consumption as the above figures show. The
Group is monitoring its energy consumption by reference to carbon dioxide emission guidelines set out by the
Department of Environment in the UK. The 2004 hazardous waste figure excludes a spillage of chrome plating
materials which occurred at the orthopaedics manufacturing site in Memphis. Working closely with the state
authorities, prompt action was taken resulting in a total of 920 tonnes of affected soil being removed from the site
to eliminate any possible contamination.

A full analysis of these measurements are included in the Sustainability Report on the Group’s website.

Smith & Nephew monitors key health and safety performance measurements. A set of graphs together with
analysis of these movements are included in the latest Sustainability Report.

Socialresponsibility
The Smith & Nephew Code of Business Principles governs the way the Group operates with regard to all its
stakeholders. This clearly spells out the behaviours and conduct each of its stakeholders should expect from the
Group in all its dealings with them. For Smith & Nephew employees the Code of Business Principles provides a

18

framework to guide their actions and embodies the practical implementation of the Group’s values in their daily
lives. There are additional policies that cover in more detail those relating to a particular stakeholder group. All
these can be found in the Sustainability Report on the Group’s website.

Employees
Smith & Nephew operates a policy of non-discrimination and seeks to provide an open, challenging, productive
and participative environment based on constructive relationships. Smith & Nephew welcomes disabled people
and makes every effort to retain any employee who becomes disabled. The Group endeavours to maintain good
communication with employees through regular and timely dissemination of Group information and consultation.
One method it uses to do this is an employee global opinion survey every two years. 2004 was the third survey
carried out, the results of which have been the catalyst for a number of improvements.

The results of the 2004 Global Opinion Survey indicate the continued high level of employee engagement with
the values and direction of the Group demonstrated in the 2002 and 2000 surveys. Continuing high scores of
positive responses reached levels ranging from 67% to 87%. The process of analysing the data and identifying
actions required is a continuous process across the business. Activities are monitored by the GEC to ensure that
improvements are implemented.

The Group has started to measure a number of factors which relate to employee engagement including the
proportion of appointments filled by internal candidates and labour turnover. The initial measurements recorded
can be seen below. These measurements are being collected quarterly and will build to a useful monitoring tool
and alert mechanism for action, as well as enable the Group to measure annual trends as an indication of
improved performance.

InternalAppointments
In 2004 an average of 30% of vacancies in the Group’s top eight countries were filled by internal applicants with
over 21% of the entire Group’s vacancies filled by internal applicants. The Group has a policy of open advertising
and providing opportunities for existing employees wherever possible, while recognising the benefits of the new
ideas and approaches that external recruitment brings.

LabourTurnover
In 2004 the Group measured both general voluntary labour turnover and turnover relating specifically to
employees who have been with the business less than two years. The latter measure is an indication of how well
the Group recruits and then retains its employees so that they can make a contribution to the business. The
average voluntary labour turnover for the year was 2.5% with a range of 1.0% — 3.5%. The average turnover of
employees joining the Group within a rolling two year period was 5.8% with a range of 1.4% — 11.0%. The higher
number of employees leaving within two years of joining has prompted the Group to review its recruitment and
integration processes and introduce a number of improvements in this area.

TrainingandDevelopmentInvestment
The Group is committed to providing the training, information and authority needed by all employees to make the
maximum contribution possible. The Group is developing systems to collect measurements related to training
and the investment made in the development of its people to achieve improved performance. Learning and
development programmes are in place to ensure that the Group attracts, retains, and develops to their full
potential the best talent at all levels where possible. These are linked, wherever possible, to formal performance
appraisal and development planning processes. It aims to fill vacancies by internal promotion, as the internal
appointments data above suggests, but looks to strike a balance between internal appointments and external
appointments. The Group endeavours to recruit, employ and promote employees on the basis of qualifications,
behaviours and the abilities needed for the work to be performed. Discrimination is not tolerated on any grounds
and the Group provides equal opportunity based on merit.

Leadership
The Group aims to develop its current and future leaders and harness their talent to improve the performance of
the business. A set of group-wide leadership capabilities have been developed by the GEC and management
development is a standing item on their meeting agenda. Performance evaluation, coaching and attendance at
high quality leadership programmes are utilised for development purposes.

Workplace
Smith & Nephew aims to provide healthy and safe working conditions for all its employees. This is achieved by
ensuring that health and safety and the working environment are managed as an integral part of the business
and employee involvement is recognised as a key part of this process.

19

The Group does not use any form of forced, compulsory or child labour. The Universal Declaration of Human
Rights of the United Nations is supported and the Group respects human rights, the dignity and privacy of the
individual and the right of employees to freedom of association, freedom of expression and the right to be heard.

Two-wayCommunication
Smith & Nephew conducted its third bi-annual global opinion survey amongst all its employees during 2004.
Improved scores have been seen as a result of actions taken in response to previous surveys and many focused
initiatives around the businesses are working to address areas of improvement which have been identified as
priorities. These surveys are an important measure of how the Group meets its values in practice and achieves
continuous improvement.

The communications functions at Group Head Office, the Group Research facility and at the business units work
closely with human resources management at each site on all forms of internal communication. The corporate
intranet is linked to all the business intranets to form a network that promotes transparency and knowledge, not
only within each business but across the whole of the business. They allow easy two-way communication
worldwide and increase employees awareness of financial, economic and market factors affecting the Group’s
performance.

SocietyandCommunity
The Group works with national and local governments and other organisations to meet its legal and civic
obligations, manage its impact on the environment and contribute to the development of laws and regulations
that affect its business interests. Smith & Nephew strives to be a good corporate citizen by being an active
member of its local communities and by encouraging and supporting employees who undertake community work.

The Group’s principles for charitable giving are based on the criteria of being relevant to its three areas of
expertise — orthopaedics, endoscopy and advanced wound management, with the focus being on medical
education. Individual company sites also support their local communities in ways which will best meet their
needs.

As a result the Group supports a range of charitable causes, mainly at local level, by donations of money, gifts in
kind and employee time. The Group recognises a strong obligation to contribute to the communities in which it
operates. The Group’s main manufacturing sites work closely with their local communities on many initiatives
which can be medical device related, but more often focus on meeting the needs of these communities. Smith &
Nephew also targets activities where it can contribute its expertise and where its product range is relevant.

For example, project Apollo is the charitable and humanitarian service programme of Smith & Nephew
orthopaedics designed to support the charitable work of surgeons, hospitals and charitable organisations by
providing: medical products; healthcare information; medical and technical consulting; person-to-person support
through employee volunteers; grant programmes covering transportation costs of medical personnel involved in
relief efforts; award programmes recognising charitable and humanitarian activities; and medical textbooks for
students in developing areas.

The Group realises that technologies and products designed to support the process of healing for physicians and
their patients around the world appear at a fast pace and that these advancements do not reach everyone.
Project Apollo seeks to link up with physicians and non-profit groups engaged in medical philanthropy to receive
donations of Smith & Nephew products, as well as sponsorship and personal assistance from the Group’s
employees. Teamed with these individuals and organisations, Smith & Nephew believes it has found a way of
increasing the impact of the charitable giving and work it undertakes.

The Smith & Nephew Foundation is an independently administered charitable trust funded entirely by Smith &
Nephew advanced wound management. It offers awards to individuals in the nursing professions who wish to
undertake postgraduate research with the objective of improving clinical practice in nursing and midwifery in the
UK in order to enable them to further their professional training and education, thereby improving their clinical
practice, medical knowledge and patient outcomes. The Foundation is unique in being the largest single
charitable awarding body to the nursing professions in the UK.

Other examples of the programmes supported around its manufacturing sites can be found in the Performance
section of the Sustainability Report on the Group’s website.

In 2004, direct donations to charitable and community activities totalled £787,000 of which £300,000 went to the
Smith & Nephew Foundation to fund research by individual nurses. Smith & Nephew made no political
contributions in 2004.

20

Customers
The Group is committed to developing and delivering innovative, cost-effective solutions to provide benefits to
healthcare professionals and their patients through improved treatment, ease and speed of product use and
reduced healthcare costs. To underpin this commitment, it will maintain significant investment in research and
development and continue to provide education and training support for healthcare professionals.

The Group’s products are designed to be safe and reliable for their intended use and comply with or exceed all
legal and regulatory requirements, including those concerning packaging, labelling and user instructions. The aim
is to anticipate future standards and requirements so that the health and safety of its customers and patients is
enhanced.

BusinessPartners
Smith & Nephew is committed to establishing mutually beneficial relationships with its suppliers, customers and
business partners. The Group will only work with partners who it believes adhere to business principles and
health, safety, social and environmental standards consistent with its own. The Group continues to look at ways
to improve its monitoring of the standards of its suppliers, not only with regard to the quality of materials which
could impact the product range but also in their corporate social responsibility related activities so it can
encourage progress in this area in a similar manner as it seeks to make continuous improvements year by year.

EconomicContribution
The Group business policies aim to achieve long-term growth and profits — which in turn bring continued
economic benefits to shareholders, employees, suppliers and local communities. Smith & Nephew’s sustainable
development depends ultimately on its ability to provide a satisfactory economic return. In 2004, the Group
generated an improved operating return on capital employed (ratio of operating profit before goodwill
amortisation and exceptional items, as set out in the “Five Year Record”, to the average of opening and closing
capital employed plus net debt) of 34%.

Smith & Nephew continues to invest in research and development focused on delivering better outcomes for
patients and improvements in application and use for medical practitioners. The Group also aims to deliver cost
savings to healthcare systems through such benefits as reduced dressing changes and shorter surgical
operating times. Through the use of its products the Group seeks to reduce patients’ time in hospital and return
them to health faster, improving their lives and potentially bringing broader social and economic benefits.

The Group has built considerable expertise in the area of measuring healthcare economics within its advanced
wound management business and is now in the process of introducing a similar system across its other
businesses. A description of the principles of healthcare economics and how they relate to Smith & Nephew
products can be found in the Sustainability Report on the Group’s website and expanded sections for both its
orthopaedics and endoscopy businesses will be published during 2005. The integration of healthcare economic
considerations within the products and services the Group offers is evidenced in the product examples
summarised in the Product and Service Innovation section of the Sustainability Report on the Group’s website.

LookingAhead
The Group is fulfilling an important role in its three areas of expertise, orthopaedics, endoscopy and advanced
wound management. Increased demands are being made on healthcare systems that many are finding difficult to
meet. The expanding elderly population has yet to be affected by the influx of the baby boomer generation that
followed the Second World War. Obesity is bringing forward the need for replacement hips and knees and
increasing levels of diabetes. With its risk of foot ulcers, diabetes is increasing the incidence of one of the most
difficult wounds to heal. More active lifestyles are putting greater strain on joints and increasing age makes the
body more prone to injury and less able to recover quickly.

Smith & Nephew’s strategy is to build upon its technology leadership positions, expand its markets into areas
which may not have been treated before and offer the very best in products and services to the medical
profession in order to be the preferred choice for patients. The Group believes that it can achieve this by setting
and meeting ambitious performance targets, by constant innovation in products and services and by earning the
trust of everyone it deals with. In all its business activities the drive towards sustainability is an ongoing and long-
term process and Smith & Nephew is committed to maintaining a consistent effort and to improve on its output.
The Group’s aim is to maximise these benefits through the application of innovation to produce more cost
effective solutions to improve treatments and reduce healthcare costs thus contributing to sustainable and
constantly improving healthcare systems.

21

WebsiteAddresses
The following provides a list of addresses for specific pages on the Smith & Nephew website to view policies and
actions referred to in the text of “Corporate Social Responsibility”.

Code of Business Principles: www.smith-nephew.com/sustainability2004/rep-4.html
Community support examples: www.smith-nephew.com/sustainability2004/performance/rep-15.html
Energy, waste, emissions & discharges analysis: www.smith-nephew.com/sustainability2004/performance/rep-4.html
Health & Safety measurements & analysis: www.smith-nephew.com/sustainability2004/performance/rep-5.html
Social responsibility policies: www.smith-nephew.com/sustainability2004/re-12.html
Community support activities: www.smith-nephew.com/sustainability2004/performance/rep-15.html
Healthcare economics: www.smith-nephew.com/sustainability2004/performance/rep-26.html
Product and service innovation examples: www.smith-nephew.com/sustainability/2004/performance/rep-
31.html

EMPLOYEES

Smith & Nephew had an average of 7,866 full-time equivalent employees in 2004, of whom 1,679 were located
in the UK, 3,437 were located in the US and 2,750 were located in other countries. The Group does not employ a
significant number of temporary employees.

The average number of employees for the past three years by business segment:

Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

3,123
1,644
3,099

7,866
–

7,866

2003
(numbers)
2,727
1,635
3,089

7,451
–

7,451

2002

2,649
1,677
2,951

7,277
229

7,506

Smith & Nephew conducts a Group-wide employee opinion survey every two years to track and monitor
employee attitudes at all
locations worldwide. A particular purpose of the survey is to test for any shortfall
between published values and Group behaviours. The Group Executive Committee then takes responsibility for
ensuring that improvement areas are identified and that appropriate initiatives are put in place. In the 2004
survey the overall response rate was 89% with 92% of respondents saying they were proud to work for Smith &
Nephew. Where the Group has collective bargaining arrangements in place with labour unions, these reflect local
market circumstances and operate effectively.

Smith & Nephew operates share option plans that are available to the majority of employees (for further
information see Note 24 of the Notes to the Group Accounts).

Further information about Smith & Nephew employees, management principles and “Vision and Values” is set out
in the Sustainability Report on the Smith & Nephew corporate website.

22

RISK FACTORS

There are risks and uncertainties related to Smith & Nephew’s business. The factors listed below are those that
Smith & Nephew believes could cause the Group’s actual financial condition or results of operations to differ
materially from expected and historical results. Factors other than those listed here, that Smith & Nephew cannot
presently identify, could also adversely affect Smith & Nephew’s business. The factors listed below should be
considered in connection with any forward-looking statements in this report and the cautionary statements
contained in “Financial Summary — Special Note Regarding Forward-Looking Statements”.

TrendsinHealthcareExpenditure
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 governed in most major markets largely by governmental reimbursement
authorities. 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 and pricing which may have an adverse
impact on sales and operating profit. The Group must adhere to the rules laid down by funding agencies
including the US Medicare and Medicaid fraud and abuse rules. Failure to do so could result in fines or loss of
future funding.

In addition, competition exists among healthcare providers to gain patients on the basis of quality, service and
price. There has been some consolidation in the Group’s customer base, as well as among the Group’s
competitors, and these trends are expected to continue long term. Increased competition and unanticipated
actions by competitors or customers could lead to downward pressure on prices and/or a decline in market share
in any of the Group’s business areas which would adversely affect Smith & Nephew’s results of operations and
hinder its growth potential.

CurrencyFluctuations
The Group reports its results in Sterling. However only 10% of group turnover arises in the UK compared with
49% in the US, 23% in Continental Europe and 18% in Africa, Asia, Australia, Canada and Latin America.
Fluctuations in the exchange rates used to translate the financial statements of operations outside the UK into
Sterling may have a material effect on the Group. If the Sterling exchange rate should strengthen against the US
Dollar and/or Euro then group turnover and operating profit would be lower on translation into Sterling.

The Group’s manufacturing cost base is situated in the US and the UK from where 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 and Sterling and the currencies of the Group’s selling operations, particularly the Euro and
the Japanese Yen. If the US Dollar and/or Sterling should strengthen against the Euro and the Japanese Yen then
group operating margin would be adversely affected.

ProductLiabilityClaimsandLossofReputation
The development, manufacture and sale of medical devices and products entail risk of product liability claims or
recalls. Design defects and manufacturing defects with respect to products sold by the Group or by companies it
has acquired could result in damage to or impairing the repair of body functions. Smith & Nephew may become
subject to liability, which could be substantial, because of actual or alleged malfunction of its products. In
addition, product malfunction could also lead to the need to recall from the market existing products, which may
be costly and harmful to the Group’s reputation which is crucially dependent on product safety and efficacy.

Product liability is a risk in the medical devices industry, particularly in the US, the Group’s largest geographic
market where claims for pain and suffering and loss of earnings may involve substantial amounts. There is a risk
that patients bring product liability or related claims that could have a material adverse effect on the Group’s
financial position. The potential exists for claimants to join together in a class action which could have the effect
of increasing the total potential liability.

In August 2003, the Group withdrew voluntarily the macrotextured versions of
its OXINIUM femoral knee
components from all markets due to a higher than expected revision rate. At that time, 2,971 knee components
had been implanted in patients worldwide, with about 2,471 components implanted in the US, 450 in Australia

23

and 50 in Europe. As of 28 February 2005 approximately 26% of implants (782 out of 2,971 cases) required
revision surgery as a result of some patients not achieving adequate fixation.

As of 28 February 2005, the Group had entered into settlement agreements in respect of 537 revision surgeries.
The total amount paid out in settlements, legal costs and associated expenses was £50m. Of this amount, £32m
has been or will be recovered from the insurer. A balance of £18m remains to be recovered.

On 17 December 2004, the Group received notification that two insurance carriers participating in the first and
second excess layers of the Group’s global product liability programme had declined coverage. While the Group
intends to pursue all available options to obtain this coverage, it cannot be certain that coverage will be restored.
Consequently, the Group has recorded an exceptional charge of £80m, representing the amount currently
outstanding from these insurers and an estimate of the costs associated with claims likely to arise in the future
assuming that insurance coverage remains unavailable. The current quarterly run rate of revision is 20 a month
which is consistent with the assumptions used in calculating the provision.

Depending on the number and average cost of settlement, costs to the Group may be greater or less than the
amount of this provision. In the hypothetical scenario that all implants eventually need to be revised prematurely
and that insurance cover continues to be unavailable, the cost to the Group of the declined insurance cover is
estimated to be £190m (an additional £110m over the amount provided) assuming the average cost per
settlement remains approximately the same and there is a standard rate of mortality. These estimates are
forward-looking statements that are subject to uncertainties, including uncertainties relating to the outcome of
settlements as compared to the assumptions made in estimating claim amounts. See “Legal Proceedings”.

The Group maintains product liability insurance, but this insurance is subject to limits and deductibles. There is a
risk that this insurance could become unavailable at a reasonable cost or at all, or will be inadequate to cover
specific product liability claims. Insurance premiums are relatively high, particularly for coverage in the US, and
there is a risk at the medical devices industry level that insurance coverage could become increasingly costly. If
Smith & Nephew or any companies it acquires do not have adequate insurance, product liability claims and costs
associated with product recalls, could significantly limit Smith & Nephew’s available cash flow and negatively
impact product sales from any associated loss of business.

HighlyCompetitiveMarkets
The Group’s principal business units compete across a diverse range of geographic and product markets. The
markets in which each of the three business units operates each contain a number of different competitors,
including specialised and international corporations. Significant product innovations, technical advances or the
intensification of price competition by competitors could adversely affect the Group’s operating results. Some of
the Group’s competitors focus on certain specialised products, while others are large, multinational corporations.
Some of these competitors may have greater financial, marketing and other resources than Smith & Nephew.
These competitors may be able to deliver products on more attractive terms, more aggressively market their
products or invest larger amounts of capital and research and development into their businesses. A competitive
risk in the endoscopy market
is the reprocessing and re-use of single use disposable devices such as
arthroscopic resection blades.

There is a risk of further consolidation particularly in the orthopaedic industry which could adversely affect the
Group’s ability to compete with much larger companies due to insufficient financial resources. If any of the
Group’s businesses were to lose market share or achieve lower than expected sales growth there could be a
disproportionate adverse impact on the Group’s share price and its strategic options.

FailuretoMakeSuccessfulAcquisitions
A key element of the Group’s strategy for continued growth is to make acquisitions or alliances to complement its
existing businesses. Failure to identify appropriate acquisition targets or failure to integrate them successfully
would have an adverse impact on the Group’s competitive position and profitability.

AttractingandRetainingKeyPersonnel
The Group’s continued development depends on its ability to hire and retain highly skilled personnel with
particular expertise. This is critical, particularly in research and new product development and in the orthopaedics
and endoscopy sales forces of which the largest are in the US. If Smith & Nephew is unable to retain key
personnel in research and new product development or if its largest sales forces suffer disruption or upheaval, its
sales and operating profit would be adversely affected.

24

RegulatoryApprovalsandControls
The 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. At any time the Group is awaiting a number of regulatory
approvals, which if not received, could adversely affect results of operations. Regulatory approval of new
products and new materials is required in each country in which the Group operates although a single approval
may be obtained for all countries within the European Union. Regulatory approval of new products may entail a
lengthy process particularly if materials are employed which have not previously been used in similar products.
Regulatory approvals in the US, Continental Europe, Japan and the UK are the most critical to the Group’s success
in launching new products.

The Group is required to comply with a wide range of regulatory controls over the manufacturing, testing,
distribution and marketing of its products, particularly in the US, UK, Japan and Continental Europe. Such controls
have become increasingly demanding and management believes that this trend will continue. Failure to comply
with such controls could have a number of adverse consequences, including withdrawal of approval to sell a
product in a country or temporary closure of a manufacturing facility.

PatentInfringementClaims
Due to the technological nature of medical devices, the Group is subject to the potential for patent infringement
claims. Smith & Nephew attempts to protect its intellectual property and regularly opposes third party patents and
trademarks in those areas that might conflict with the Group’s business interests. If Smith & Nephew fails to
successfully enforce its intellectual property rights, its competitive position could suffer, which could harm its
operating results.

Claims asserted by third parties regarding infringement of their intellectual property rights, if successful, could
require the Group to expend significant resources to pay damages, develop non-infringing products or to obtain
licences to the products which are the subject of such litigation. The Group is currently involved in a patent
infringement suit whereby pursuant to a court-ordered injunction, the Group is prohibited from selling certain
bi-polar radio frequency products. Failure to obtain a favourable outcome in the litigation could have an adverse
impact on the Group’s competitive position and profitability. See “Legal Proceedings”.

ContinualDevelopmentandIntroductionofNewProducts
The Group operates in the medical devices industry, which has a rapid introduction rate of new products. In order
to remain competitive, each of the Group’s business units 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 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. 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 units operate. If new products do not remain competitive with competitors’
products, the Group’s sales revenue could decline.

There is a risk that a major disruptive technology could be introduced into one of the Group’s markets and
adversely affect its ability to achieve business plans and targets.

ManufacturingandSupply
The Group’s manufacturing production is concentrated at seven main facilities in Memphis, Tennessee; Andover
and Mansfield, Massachusetts; Oklahoma City, Oklahoma; La Jolla, California; and Largo, Florida in the US and
Hull in the UK. If major physical disruption took place at any of these sites, it would adversely affect the results of
operations. Physical loss and consequential loss insurance is carried to cover such risks but is subject to limits
and deductibles and may not be sufficient to cover catastrophic loss.

Each of the three business units is reliant on certain key suppliers of raw materials, components, finished
products and packaging materials. If any of these suppliers is unable to meet the Group’s needs or substantially
increases its prices, Smith & Nephew would need to seek alternative suppliers. There can be no assurance that
alternative suppliers would provide the necessary raw materials on favourable or cost-effective terms.
Consequently, the Group may be forced to pay higher prices to obtain raw materials, which it may not be able to
pass on to its customers in the form of increased prices for its finished products. In addition, some of the raw
materials used may become unavailable, and there can be no assurance that the Group will be able to obtain

25

suitable and cost-effective substitutes. Any interruption of supply or price increases caused by these or other
factors could negatively impact Smith & Nephew’s turnover and operating profit.

MedicalDeviceCompanyValuations
As a growth industry, the medical device companies currently have higher stock market valuations than other
industrial companies. If market conditions change, or other companies in its sector fail to perform, or the Group is
perceived to be performing less well than the sector, then the share price rating of the Group may be adversely
affected.

PoliticalandEconomicUncertainties
Because the Group has operations in 32 countries, political and economic upheaval in those countries or in the
regions surrounding those countries may impact the Group’s results of operation. Political changes in a country
could prevent the Group from receiving remittances of profit from a member of the Group located in that country
or from selling its investments in that country. Furthermore, legislative measures in a country could result in
changes in tariffs, import quotas or taxation that could adversely affect the Group’s turnover and operating profit.
Terrorist activities and ongoing global political uncertainties, including conflict in the Middle East, could adversely
impact the Group.

OtherRiskFactors
The Board considers that Smith & Nephew is subject to a number of other risks which are common to most global
medical technology groups and which are reviewed as part of its risk management process.

In the financial area these include interest rate volatility, share price volatility, challenges by taxation authorities,
failures in reporting and internal financial controls and uninsured losses.

Adverse events in the areas of corporate social responsibility could also adversely impact Group operating
results.

26

OPERATING AND FINANCIAL REVIEW,
LIQUIDITY AND PROSPECTS

The Operating and Financial Review, Liquidity and Prospects discusses the operating and financial performance
of the Group, including the financial outlook and the financial resources of the Group, under the following
headings:

Business overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outlook and trend information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial position, liquidity and capital resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange and interest rate risk and financial instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Contractual obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Off-balance sheet arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Related party transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International Financial Reporting Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US GAAP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28
32
36
41
42
44
45
45
45
46
47

The results for each year are compared primarily with the results for the preceding year.

27

BUSINESS OVERVIEW

Smith & Nephew’s operations are organised into three core business units that operate globally: orthopaedics,
endoscopy and advanced wound management. These three businesses comprise the Group’s “Continuing
Operations”. Smith & Nephew believes that its businesses have the opportunities for strong growth due to its
markets benefiting from an ageing population, an increase in active lifestyles and trends toward less invasive
medical procedures.

Sales by business segment as a percentage of sales of Continuing Operations were as follows:

Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

47
24
29

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100

2003
(%)
45
25
30

100

Sales by geographic region as a percentage of sales of Continuing Operations were as follows:

Europe (Continental Europe and United Kingdom) . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australia and other America . . . . . . . . . . . . . . . . . . .

2004

33
49
18

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100

2003
(%)
31
51
18

100

2002

43
27
30

100

2002

30
53
17

100

As a result of its global sales reach, Smith & Nephew’s group turnover is primarily denominated in currencies
other than its reporting currency, principally US Dollars and Euros. Sales in Sterling accounted for only 10% of
group turnover in 2004 (2003 — 8%, 2002 — 8%). Consequently, fluctuations in the exchange rates between
Sterling and the local currencies where the Group operates have a significant effect on group turnover.

Operating profit before goodwill amortisation and exceptional items by business segment as a percentage of
operating profit before goodwill amortisation and exceptional items of Continuing Operations were as follows:

Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

55
25
20

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100

2003
(%)
54
27
19

100

2002

50
27
23

100

UnderlyingGrowthinSales
Management’s key indicator of sales performance is underlying growth in sales. This is calculated by excluding
the effects of foreign currency translation movements and acquisitions (see Note 2b of the Notes to the Group
Accounts). Management believes that sales growth on an underlying basis provides a consistent year-on-year
measurement of performance without the distortions created by the translational effect of foreign currency
movements and acquisitions which are separate from the Group’s normal operations. Underlying sales growth is
used by management in its internal financial reporting, budgeting and planning.

28

Reported growth in sales by business segment reconciles to underlying growth in sales in 2004 as follows:

Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . .

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . .

Reported
growth in
sales

Foreign
currency
translation
effect

Acquisitions
effect

Underlying
growth in
sales

(%)
12
2
–

6

(%)
9
7
5

7

(%)
(4)
–
–
(1 1⁄ 2)

(%)
17
9
5
11 1⁄ 2

Reported growth in sales by business segment reconciles to underlying growth in sales in 2003 as follows:

Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . .

Reported
growth in
sales
(%)
12
3
10

Foreign
currency
translation
effect
(%)
4
3
(1)

Acquisitions
effect
(%)
–
(2)
–

Underlying
growth in
sales
(%)
16
4
9

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . .

9

2

–

11

Reported growth in sales by geographic market reconciles to underlying growth in sales in 2004 as follows:

. . .
Europe (Continental Europe and United Kingdom)
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australia and other America . . . . . . .

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . .

Reported
growth in
sales

Foreign
currency
translation
effect

Acquisitions
effect

Underlying
growth in
sales

(%)
11
2
8

6

(%)
1
12
4

7

(%)
(4)
–
(2)
(1 1⁄ 2)

(%)
8
14
10
11 1⁄ 2

Reported growth in sales by geographic market reconciles to underlying growth in 2003 as follows:

. . .
Europe (Continental Europe and United Kingdom)
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australia and other America . . . . . . .

Reported
growth in
sales
(%)
16
3
15

Foreign
currency
translation
effect
(%)
(6)
10
(3)

Acquisitions
effect
(%)
–
(2)
–

Underlying
growth in
sales
(%)
10
11
12

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . .

9

2

–

11

Factors Affecting Smith & Nephew’s Results of Operations

SalesTrends
Smith & Nephew’s business units all participate in the global medical devices market and share a common focus
on the repair of human tissue. Smith & Nephew operates predominantly in the well-developed healthcare
markets of the US (49% of group turnover), Europe (33% of group turnover) and Japan and Australia (9% of group
turnover).

These markets are characterised by an increase in the average age of the population caused by the immediate
post-World War II “baby boomer” generation approaching retirement, increased longevity, more active lifestyles,
obesity and increased affluence. Together these factors have created significant demand for more effective

29

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 surgeon and nursing resources.

A recent trend has been increasing consumer awareness of available healthcare treatments through the Internet
and direct-to-customer advertising. This has led to increased consumer influence over product purchasing
decisions.

In orthopaedics, improvements in technology have lengthened the effective life of reconstructive implants and
have facilitated the implantation of knees and hips in relatively young patients thereby improving the quality of life
for a new generation. The decision to create separate divisions for reconstructive, trauma and clinical therapy
products was a strategic move intended to generate greater customer focus. With experienced managers
responsible for sales, marketing and product development in each, management believes that divisionalisation
has resulted in increased sales momentum for Smith & Nephew in trauma in the US.

The endoscopy business is benefiting from the continued trend worldwide towards less invasive surgery with
particular focus on arthrosopic repair of the knee and shoulder using a broad range of technology. The Group
also expects to benefit from the demand for less invasive approaches to spinal disc repair and arthroscopic hip
repair.

The advanced wound management business is focused on the treatment of chronic wounds of the older
population and other hard-to-heal wounds such as diabetic foot ulcers, burns and certain surgical wounds and is
therefore also expected to benefit from demographic trends. The market for advanced wound treatments is
relatively unpenetrated and it is estimated that the potential market is significantly larger than the current market.
This increased penetration is expected to be driven by improved outcomes from new technology, health
economic benefits,
life expectations and education of healthcare
providers to convert from traditional to advanced treatments.

increasing nursing shortages, quality of

In order to take advantage of the expanding markets the Group must continually develop its existing and new
technologies and bring new products to its customers. Expenditure on research and development in 2004
represented approximately 5% of Group turnover and products launched within the last three years represented
20% of Group turnover.

SalesForce
The Group’s sales force, which includes independent commissioned sales agents, increased by 9% during 2004.
The biggest increase was 22% in orthopaedics where the most significant increase was in the US. The size of the
endoscopy sales force increased by 3% to 655. The advanced wound management sales force increased by 3%
to 905. Further sales force increases are planned in 2005 particularly in US orthopaedics.

CurrencyMovements
Smith & Nephew’s results of operations are significantly affected by exchange rate movements. A substantial
proportion of its sales and operating expenses are earned and paid in currencies other than Sterling, the Group’s
reporting currency. Accordingly, the Group is subject to exposure arising from the translation of results of
operations in foreign subsidiaries into Sterling for financial reporting purposes. The Group is also subject to
exposures arising from sales made in a currency different from the related costs and expenses. The Group
attempts to manage the impact of exchange rate movements on cost of sales by a policy of purchasing forward
all its foreign currency commitments when firm purchase orders are placed. In addition, businesses are required
to purchase forward a minimum of 50% of their forecast foreign currency requirements on a twelve-month rolling
basis. The Group also incurs interest in currencies other than Sterling on its indebtedness denominated in
currencies other than Sterling. To the extent that other currencies, particularly the US Dollar and Euro, decline in
value against Sterling, Smith & Nephew’s turnover, operating profit and effective cost of sales may be adversely
affected, this would be offset by a reduction in the effective cost of servicing debt. See “Financial Position,
Liquidity and Capital Resources.”

Other
Management is not aware of any governmental, economic, fiscal, monetary or political policies or factors that
have materially affected, directly or indirectly, the Group’s operations or investments by shareholders.

30

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

Stocks
A feature of the orthopaedic business (whose finished goods stock makes up 64% of the Group total finished
goods stock) is the high level of product stock 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 outer sizes are used less frequently than standard sizes and towards the end
of the product lifecycle are inevitably in excess of requirements. Adjustments to carrying value are therefore
required to be made to orthopaedic stock to anticipate this situation. These adjustments are calculated in
accordance with a formula based on levels of stock compared with historical or forecast usage. This formula is
applied on an individual product line basis and is first applied when a product group has been on the market for
two years. This method of calculation is considered appropriate based on experience, but it does involve
lives, phase-out of old
management
products and efficiency of manufacturing planning systems.

judgements on effectiveness of stock deployment,

length of product

IntangibleFixedAssets
In carrying out impairment reviews of goodwill and other intangible assets a number of significant assumptions
have to be made when preparing cash flow projections. These include the future rate of market growth, 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.

Post-RetirementBenefits
The cost of the Group’s defined benefit pension plans are charged to operating profit, so as to spread the
expense of providing future pensions to employees over their remaining working lives with the Group,
in
accordance with SSAP 24. In this way, actuarial variations are charged or credited to operating profit over periods
of ten to thirteen years. The principal assumptions used in calculating pension costs are set out in Note 33 of the
Notes to the Group Accounts with the most critical being the return on investments and increase in pensionable
earnings for the UK and US plans. If actual results should differ from these assumptions the Group’s financial
position or results of operations could be adversely affected. The optional alternative accounting treatment,
FRS 17, which requires immediate recognition of actuarial variations direct to reserves, has not been adopted
because management believes that it has the effect of overstating plan deficits since a short-term rate of interest
is applied to plan liabilities which are long-term in nature. If FRS 17 had been adopted a liability, net of related
deferred tax, of £89.1m would have been recognised on the balance sheet compared with a net liability of £0.5m
under SSAP 24.

ContingenciesandProvisions
The recognition of provisions for legal disputes is subject to a significant degree of estimation. Provision is made
for loss contingencies when it is deemed probable that an adverse outcome will occur and the amount of the loss
can be reasonably estimated. In making its estimates management takes into account the advice of internal and
legal counsel. Provisions are reviewed regularly and amounts updated where necessary to reflect
external
developments in the disputes. The ultimate liability may differ from the amount provided depending on the
outcome of court proceedings and settlement negotiations or if investigations bring to light new facts.

The estimation of the liability for the costs of the macrotextured product withdrawal for which insurance coverage
has been declined is dependent upon two main variables. These are the number of implant revisions that will
ultimately be required and the average cost of settlements with patients. In the hypothetical scenario that all
implants eventually need to be revised prematurely and that insurance cover continues to be unavailable, the
cost to the Group of the declined insurance cover is estimated to be £190m (an additional £110m over the
amount provided), assuming the average cost per settlement remains approximately the same and there is a
standard rate of mortality. These estimates constitute forward-looking statements that are subject
to
uncertainties.

The group operates in multiple tax jurisdictions around the world. Group policy is to submit its tax returns to the
relevant tax authorities as promptly as possible, but at any 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

31

probability and amount of any tax charge management takes into account the views of internal and external
advisors 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.

2004 YEAR

The following discussion and analysis is based upon, and should be read in conjunction with, the Group
Accounts of Smith & Nephew included elsewhere in this Annual Report. The Group’s Accounts are prepared in
accordance with UK GAAP, which differ in certain respects from US GAAP. Reconciliations reflecting the effect of
the significant differences between UK GAAP and US GAAP are set forth in Note 39 of Notes to the Group
Accounts.

New Accounting Policies in 2004
There are no new accounting policies in 2004 but the Group’s policy for contingencies and provisions has been
added to the disclosures. See “International Financial Reporting Standards” for information regarding changes to
accounting policies in 2005.

Financial Highlights of 2004
Group turnover was £1,248.5m for the year ended 31 December 2004, representing 6% growth compared to
2003. Underlying growth in sales of continuing operations was 11 1⁄ 2%.

Profit on ordinary activities before taxation was £177.9m, compared with £230.1m in 2003. Profit before taxation,
goodwill amortisation and exceptional items (calculated as set out in the “Five Year Record”), improved 15% to
£278.4m.

Basic earnings per Ordinary Share were 13.39p, a 16% decrease compared to 15.92p for 2003. Adjusted basic
earnings per Ordinary Share before goodwill amortisation and exceptional items (as set out in the “Five Year
Record”) were 21.14p compared to 18.49p for 2003, representing a 14% increase.

Fiscal 2004 Compared with Fiscal 2003
The following table sets out certain profit and loss account data for the periods indicated:

2004

2003

(£ million)

Group turnover (i)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5
(334.8)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing, selling and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
BSN agency and management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit before goodwill amortisation and exceptional items (i) . . . . . . . . . . .
Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Group operating profit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of operating profit of joint venture: before exceptional items . . . . . . . . . . . . . .
Share of operating profit of joint venture: exceptional items . . . . . . . . . . . . . . . . . . . .
Share of operating profit of associated undertaking . . . . . . . . . . . . . . . . . . . . . . . . . .
Net profit on disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on ordinary activities before interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest receivable/(payable) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on ordinary activities before taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Attributable profit for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

913.7
(476.8)
(134.0)
(66.4)
15.0

251.5
(20.5)
(80.0)

151.0
23.8
–
–
–

174.8
3.1

177.9
(52.7)

125.2

1,178.9
(345.1)

833.8
(440.1)
(125.5)
(66.8)
19.3

220.7
(18.5)
(22.4)

179.8
22.7
(2.7)
4.8
31.5

236.1
(6.0)

230.1
(82.0)

148.1

(i) Group turnover and operating profit before goodwill amortisation and exceptional items are derived wholly from Continuing Operations.

32

GroupTurnover
For the year ended 31 December 2004, underlying sales growth was 11 1⁄ 2%. Reported sales benefited by 1 1⁄ 2%
from the acquisition of MMT but adverse currency translation, particularly the weakness of the US Dollar relative
to Sterling, reduced sales by 7%. Reported group sales consequently increased by £69.6m (6%) to £1,248.5m
from £1,178.9m.

CostofSales
Cost of sales represents 26.8% of sales compared to 29.3% in 2003. This improvement arose from
manufacturing cost and efficiency savings and transactional currency benefits from the relative decline in the
value of the US Dollar which reduced the cost of purchasing finished goods in many countries, particularly in
Europe and Australia. There was also a mix benefit as the fastest growing business, orthopaedics, also has the
lowest cost of sales.

Marketing,sellinganddistributionexpenses
These costs represented 38.2% of sales, compared to 37.3% in 2003. This increase is due mainly to additions to
sales forces, particularly in orthopaedics in the US.

AdministrationExpenses
Administration expenses were 7% higher than in 2003 and represented 10.7% of sales compared with 10.6% of
sales in 2003. Administration expense items broadly grew in line with sales.

ResearchandDevelopment
There was no material change in expenditure on research and development. Smith & Nephew continues to invest
in innovative technologies and products to differentiate the Group from its competitors. In 2004, 20% of Smith &
Nephew’s sales were from products introduced in the last three years.

BSNMedicalAgencyandManagementFees
Agency and management fees were received in respect of services provided to BSN Medical for sales force
resource, physical distribution and logistics and administration in certain countries. The calculation of the fees is
designed to result in a neutral, cost-recovery position for Smith & Nephew and is for a transitional period only. In
2004 recoveries fell by £4.3m (22%) as a number of shared service agreements expired and BSN established its
own independent operations.

OperatingProfitbeforeGoodwillAmortisationandExceptionalItems
Operating profit before goodwill amortisaton and exceptional items from Continuing Operations was £251.5m, an
increase of £30.8m compared to £220.7m in 2003, resulting from an increase in gross profits of £79.9m partly
offset by higher expenses. Operating profit margins before goodwill amortisation and exceptional items from
Continuing Operations improved from 18.7% to 20.1%.

GoodwillAmortisation
The amortisation charge on acquisition goodwill increased by £2.0m to £20.5m. The increase was due to the
acquisition in March 2004 of MMT partly offset by translational currency benefits due to the decline in the value
of the US Dollar.

ExceptionalItems
Operating exceptional items of £80.0m represents provision of £13.4m for the amount due from excess layer
insurers who have declined insurance coverage for claims relating to macrotextured knee revisions together with
an estimate of £66.6m for the cost of settlements with patients likely to arise in the future and assuming that
insurance cover remains unavailable.

ShareofOperatingProfitoftheJointVenture
The Group’s share of operating profit before exceptional items increased by £1.1m from £22.7m in 2003 to
£23.8m in 2004. Operating profit margins improved from 13.8% in 2003 to 14.3% in 2004 as a result of cost and
efficiency savings and from the benefits of integrating the fracture casting and splinting business acquired from
DePuy Inc. in March 2004.

33

NetInterestReceivable/(Payable)
Interest income increased by £2.9m from £11.0m in 2003 to £13.9m in 2004. Interest expense decreased by
£5.4m from £14.8m in 2003 to £9.4m in 2004. The Group’s share of the joint venture’s and associated
undertaking’s net interest expense was £1.4m and nil respectively compared with £1.5m and £0.7m respectively
in 2003. Interest payable on currency swaps amounting to £14.6m was set off against interest receivable on
swaps. Overall interest moved favourably by £9.1m from a net interest payable position of £6.0m to a net interest
receivable position of £3.1m, due to favourable movements in interest and foreign exchange rates.

Taxation
The taxation charge decreased by £29.3m to £52.7m in 2004. The taxation charge on profit before goodwill
amortisation and exceptional items was £80.7m an increase of £10.5m on the 2003 charge due to higher profits.
The effective rate of taxation on profit before goodwill amortisation and exceptional items was 29.0% the same as
2003. The taxation charge was reduced in 2004 by £28.0m as a consequence of the exceptional item and in
2003 increased by £11.8m as a result of the profit on disposal of the associated undertaking less exceptional
costs.

Business Segment Analysis
Group sales by business segment and geographic region and operating profit by business segment are set out
below:

Salesbybusinesssegment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

588.7
304.8
355.0

525.4
300.0
353.5

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5

1,178.9

Operatingprofitbybusinesssegment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing Operations before goodwill amortisation and exceptional items . . . . . . .

Salesbygeographicregion
Europe (Continental Europe and United Kingdom) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australia and other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

138.6
61.8
51.1

251.5

409.7
608.5
230.3

118.7
59.5
42.5

220.7

369.9
595.6
213.4

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5

1,178.9

Orthopaedics

Sales
Orthopaedics sales were £588.7m in 2004, an increase of £63.3m or 12% compared to £525.4m for 2003.
Underlying sales growth was 17%. Growth in sales in the US was 10% (22% underlying less 12% adverse
currency translation). Outside the US, growth was 17% (10% underlying less 4% adverse currency translation and
including 11% from the acquisition of MMT). Sales pricing in reconstruction and trauma increased by
approximately 3% in the US.

In reconstruction, knee sales increased by 12% (21% underlying less 9% adverse currency translation). This
comprised 12% in the US (24% underlying less 12% adverse currency translation), and 14% outside the US (16%
underlying less 2% adverse currency translation). Hip sales increased globally by 21% (15% underlying less 10%
adverse currency and including 16% from the acquisition of MMT), which included 2% growth in the US (14%
underlying after 12% adverse currency translation), and 60% outside the US (17% underlying less 2% adverse
currency translation plus 45% from the acquisition of MMT). This reflects continuing strong market conditions
particularly in the US, the expansion of sales forces and the introduction of minimal
incision surgery (“MIS”)
procedures.

Trauma benefited from the substantial
investment in creating a dedicated US sales force, achieving a sales
increase of 5% in the US, ahead of the market (17% underlying less adverse currency translation of 12%). Sales

34

growth outside the US was 1% (4% underlying growth less 3% adverse currency translation). These result in 3%
global growth (11% underlying less 8% adverse currency translation). Clinical Therapy sales, which consist of the
SUPARTZ joint fluid therapy and EXOGEN ultrasound bone healing products, also benefited from sales force
investment, growing 32% (44% underlying less 12% adverse currency translation) compared with last year.

A number of new orthopaedic products are in the pipeline. Marketing approval in the US for the ceramic on
ceramic hip was received in December. Surgical evaluations for a new locking plate trauma product were started
during the year and it is expected to launch this product in the first half of 2005. US pre-market approval
application for the BHR product has been accepted for consideration by the FDA.

OperatingProfit
Operating profit from the orthopaedics business before goodwill amortisation and exceptional items increased by
£19.9m (17%) from £118.7m in 2003 to £138.6m in 2004. The operating profit margin increased from 22.6% to
23.5% as a result of improvements to gross margin from cost and efficiency savings, partly offset by investment
in sales force.

Endoscopy

Sales
Endoscopy sales in 2004 were £304.8m, an increase of £4.8m or 2% compared to £300.0m for 2003. The
underlying growth of 9%, represents a recovery from a problematic 2003. Sales in the US declined 3% (9%
underlying growth less 12% adverse currency translation), but grew 7% outside the US (10% underlying less 3%
adverse currency translation).

The new progressive scan camera system and the Group’s comprehensive integration capability for digital
operating rooms increased visualisation sales by 12% (22% underlying less 10% adverse currency translation).
Repair product sales grew by 9% (underlying 16% less 7% adverse currency translation),
led by the
comprehensive range of shoulder products. Radio frequency sales were affected by an injunction imposed on US
sales in connection with an ongoing patent dispute with a competitor, and declined by 12% (negative 2%
underlying growth and 10% adverse currency translation) (see “Legal Proceedings”). Blade sales declined 3% (3%
underlying growth less 6% adverse currency translation) following a stabilisation of the re-use of blades by US
hospitals.

OperatingProfit
Operating profit from the endoscopy business before goodwill amortisation and exceptional items increased by
£2.3m (4%) from £59.5m in 2003 to £61.8m in 2004. The operating profit margin increased from 19.8% to 20.3%
as a result of improved gross margins.

Advanced Wound Management

Sales
Advanced wound management sales were £355.0m for 2004 largely unchanged from £353.5m in 2003. This is
equivalent to 5% underlying growth less 5% adverse currency translation. Outside the US, sales grew 5% (8%
underlying less 3% adverse currency translation). However, sales in the US declined 14% (negative 4%
underlying growth and 10% adverse currency translation), where they were seriously affected by the need to
switch to another enzyme debrider product. Loss of sales of the previous enzyme debrider negatively affected
underlying global sales growth by 4%.

Globally, sales forces have refocused on the market opportunities for ALLEVYN hydrocellular dressings and
ACTICOAT antimicrobial silver dressings. In the US, a targeted approach to DERMAGRAFT tissue engineered
dermal replacement has been implemented. The benefits of this approach are evident in the sales of ALLEVYN,
which grew 11% (15% underlying less 4% adverse currency translation), ACTICOAT, which grew by 38% (47%
underlying less 9% adverse currency translation) and DERMAGRAFT, which grew by 16% (underlying 28% less
12% adverse currency translation).

OperatingProfit
Operating profit from the advanced wound management business before goodwill amortisation and exceptional
items increased by £8.6m (20%) from £42.5m in 2003 to £51.1m in 2004. The operating profit margin increased
from 12.0% to 14.4% principally as a result of higher gross margins due to manufacturing efficiencies and
expense control.

35

2003 YEAR

Financial Highlights of 2003
Group turnover was £1,178.9m for the year ended 31 December 2003, representing 6% growth compared to
2002. Underlying growth in sales of continuing operations was 11%.

Profit on ordinary activities before taxation was £230.1m, compared with £177.9m in 2002. Profit before taxation
goodwill amortisation and exceptional items (calculated as set out in the “Five Year Record”), improved 15% to
£242.2m.

Basic earnings per Ordinary Share were 15.92p, a 31% increase compared to 12.11p for 2002. Adjusted basic
earnings per Ordinary Share before goodwill amortisation and exceptional items (as set out in the “Five Year
Record”) were 18.49p compared to 16.02p for 2002, representing a 15% increase.

Fiscal 2003 Compared with Fiscal 2002
The following table sets out certain profit and loss account data for the periods indicated:

2003

2002

(£ million)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group turnover (i)
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,178.9
(345.1)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing, selling and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
BSN agency and management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit before goodwill amortisation and exceptional items (ii) . . . . . . . . . . .
Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Group operating profit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of operating profit of joint venture: before exceptional items . . . . . . . . . . . . . .
Share of operating profit of joint venture: exceptional items . . . . . . . . . . . . . . . . . . . .
Share of operating profit of associated undertaking . . . . . . . . . . . . . . . . . . . . . . . . . .
Net profit on disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on ordinary activities before interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on ordinary activities before taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Attributable profit for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

833.8
(440.1)
(125.5)
(66.8)
19.3

220.7
(18.5)
(22.4)

179.8
22.7
(2.7)
4.8
31.5

236.1
(6.0)

230.1
(82.0)

148.1

1,109.9
(329.9)

780.0
(414.1)
(127.1)
(61.3)
20.6

198.1
(17.5)
(29.9)

150.7
19.6
(2.6)
4.9
18.0

190.6
(12.7)

177.9
(65.8)

112.1

(i) Group turnover comprised £1,178.9m from Continuing Operations (2002 — £1,083.7m from Continuing Operations and £26.2m from

discontinued operations).

(ii) Operating profit before goodwill amortisation and exceptional items comprised £220.7m from Continuing Operations (2002 — £196.0m

from Continuing Operations and £2.1m from discontinued operations).

GroupTurnover
For the year ended 31 December 2003, group turnover totalled £1,178.9m, an increase of 6% or £69.0m
compared to £1,109.9m for 2002. Underlying growth of Continuing Operations was 11%. Translation of foreign
currencies had the effect of decreasing turnover by 2%, primarily due to the depreciation of the US Dollar against
Sterling. The loss of revenues from the Group’s discontinued rehabilitation business resulted in an adverse
impact to the Group’s turnover of £26.2m (3%). Selling price increases accounted for approximately 2% of the
underlying sales growth.

CostofSales
Cost of sales at £345.1m represented 29.3% of sales compared to 29.7% in 2002. This improvement arose from
manufacturing cost and efficiency savings and transactional currency benefits from the decline in the value of the
US Dollar reducing the product cost in many countries outside the US, notably in Europe and Australia. The
reduction in cost of sales would have been greater but for the acquisition, in late 2002, of the remaining
DERMAGRAFT interests not already owned which increased the Group’s production costs for this product.

36

Marketing,sellinganddistributionexpenses
At £440.1m these costs represented 37.3% of sales, the same percentage as in 2002.

AdministrationExpenses
At £125.5m, administration expenses were 1.3% lower than in 2002 and represented 10.6% of sales compared
with 11.5% of sales in 2002. Administration expenses were broadly kept level despite the increased sales.

ResearchandDevelopment
Expenditure on research and development increased by £5.5m (9%) compared with 2002. This represented 5.7%
of sales compared with 5.5% in 2002. Smith & Nephew continues to invest in innovative technologies and
products to differentiate the group from its competitors. In 2003, 20% of Smith & Nephew’s sales were from
products introduced in the last three years.

BSNMedicalAgencyandManagementFees
Agency and management fees are received in respect of services provided to BSN Medical for sales force
resource, physical distribution and logistics and administration in certain countries. The calculation of the fees is
designed to result in a neutral, cost-recovery position for Smith & Nephew and is for a transitional period only. In
2003, recoveries fell by £1.3m (6%) as a number of the shared service arrangements expired and BSN Medical
established its own stand-alone operations. This trend of lower agency fees is expected to continue as more BSN
Medical entities exit the arrangements.

OperatingProfitbeforeGoodwillAmortisationandExceptionalItems
Operating profit before goodwill amortisation and exceptional items from Continuing Operations was £220.7m,
an increase of £24.7m compared to £196.0m in 2002, resulting from profit arising from additional sales together
with cost and efficiency savings. These two factors more than offset an increase in pension costs of £7.3m due to
the need to amortise the deficits of the Group’s principal plans and increased DERMAGRAFT costs of £7.2m
following the acquisition of 50% of the joint arrangement not already owned.

Operating profit margins before goodwill amortisation and exceptional
items from Continuing Operations
improved from 18.1% to 18.7% of which 1.5% points was due to cost and efficiency savings and 0.3% points was
due to transactional currency benefits offset partly by 0.6% points in respect of higher pension costs and 0.6%
points from the effect of acquiring DERMAGRAFT.

GoodwillAmortisation
The amortisation charge on acquisition goodwill increased by £1.0m to £18.5m. The increase was due to a full
years amortisation of ORATEC goodwill compared with nine months in 2002, offset partly by the translational
currency effect of a weaker US Dollar.

ExceptionalItems
Operating exceptional items were a net cost of £22.4m compared to a net cost of £29.9m in 2002. In 2003,
£17.6m of net costs were incurred as a consequence of Smith & Nephew’s unsuccessful public offers to
purchase Centerpulse AG and InCentive Capital AG and £4.8m of costs arose on the integration of the ORATEC
acquisition, principally in the relocation of manufacturing and development operations. Exceptional items in 2002
consisted of £17.5m for the write down of the Group’s trade investment in the common stock of ATS following its
filing for bankruptcy, £4.0m for further rationalisation due to the contribution of businesses to BSN Medical and
£8.4m for integration in connection with the acquisition of ORATEC and DERMAGRAFT.

ShareofOperatingProfitoftheJointVenture
The Group’s share of operating profit before exceptional items increased by £3.1m from £19.6m in 2002 to
£22.7m in 2003. Operating profit margins improved from 12.6% in 2002 to 13.8% in 2003 as a result of cost and
efficiency savings arising from continuing manufacturing rationalisation. The Group’s share of exceptional items
of £2.7m comprised manufacturing rationalisation costs.

ShareofOperatingProfitofAssociatedUndertaking
The operating profit of AbilityOne up to the date of disposal on 12 September 2003 was £4.8m. In 2002
operating profit of £4.9m arose in the nine months following formation on 27 March 2002.

37

NetProfitonDisposalsofAssociatedUndertaking
A net profit of £31.5m arose on the disposal of the Group’s 21.5% equity interest in AbilityOne to Patterson
Dental Inc., after writing off £8.2m of acquisition goodwill previously set-off against reserves and after charging
£1.1m of adjustments in respect of previous disposals.

NetInterestPayable
Interest income increased by £4.4m from £6.6m in 2002 to £11.0m in 2003. Interest expense decreased by
£2.0m from £16.8m in 2002 to £14.8m in 2003. The Group’s share of the joint venture’s and associated
undertaking’s net interest expense was £1.5m and £0.7m respectively compared with £1.6m and £0.9m
respectively in 2002. Interest payable on currency swaps amounting to £18.5m was set off against interest
receivable on swaps. Overall interest payable decreased by £6.7m to £6.0m due to lower average net debt
during the year and lower US Dollar and Euro interest rates on borrowings and swap liabilities offset in part by
lower Sterling interest rates on cash balances and swap assets.

Taxation
The taxation charge increased by £16.2m to £82.0m in 2003. The taxation charge on profit before goodwill
amortisation and exceptional items was £70.2m an increase of £8.6m on the 2002 charge due to higher profits.
The effective rate of taxation on profit before goodwill amortisation and exceptional items was 29.0% compared
with 29.3% in 2002. The taxation charge was reduced in 2003 by £3.5m as a consequence of the exceptional
costs, by £0.8m from the exceptional costs in BSN Medical and increased by £16.1m as a result of the gain on
disposal of AbilityOne.

Business Segment Analysis
Group sales by business segment and geographic region and operating profit by business segment are set out
below:

Salesbybusinesssegment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2003

2002

(£ million)

525.4
300.0
353.5

470.2
291.8
321.7

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,178.9

1,083.7

Operatingprofitbybusinesssegment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing Operations before goodwill amortisation and exceptional items . . . . . . .

Salesbygeographicregion
Europe (Continental Europe and United Kingdom) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australia and other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

118.7
59.5
42.5

220.7

369.9
595.6
213.4

98.2
53.8
44.0

196.0

318.7
579.4
185.6

Continuing Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,178.9

1,083.7

Orthopaedics

Sales
Orthopaedics sales were £525.4m in 2003, an increase of £55.2m or 12% compared to £470.2m for 2002.
Underlying growth in sales was 16%. This increase demonstrated Smith & Nephew’s market share gains in the
global orthopaedics market (excluding spine), which is estimated to be growing at 13%. Sales pricing contributed
approximately 3% to reported growth. Products introduced within the last three years represented 25% of sales in
2003.

During 2003 the business recruited 60 dedicated trauma sales representatives, with further plans for expansion
in 2004 in the US.

Reconstructive implant sales grew by 15% (equivalent to an underlying growth rate of 19% after 4% of adverse
currency translation) following an aggressive expansion of OXINIUM products into the market. The OXINIUM
bearing material continued to be a great success and has helped surgeons successfully treat younger implant
patients due to its wear reduction properties.

38

Knee sales grew by 20%, (an underlying rate of 24% after 4% of adverse currency) driven mainly by the
promotion and rollout of OXINIUM technology; hip sales grew by 11% (an underlying rate of 16% after 5% of
adverse currency effect) driven by the launch of the OXINIUM femoral head.

More than 30,000 knees made of OXINIUM had been implanted into patients and by the end of 2003 it was
accounting for 40% of knee units being sold by the business in the US. The joint fluid therapy product SUPARTZ
contributed 3% to knee sales growth.

Growth in sales of hips resulted from the continued solid performance of the SYNERGY and ECHELON platform
systems and the introduction in 2003 of femoral heads made of OXINIUM, which by the end of 2003 were
accounting for 35% of hip heads sold by Smith & Nephew in the US.

Trauma sales increased by 6% (an underlying rate of 10% after 4% of adverse currency effect) benefiting from
increased focus following the divisionalisation of the US business. Trauma sales increased in the US by 4%
(equivalent to 13% underlying growth after 9% adverse currency). These results were helped by growth in sales of
the EXOGEN ultrasound bone stimulation products, of 14% (22% underlying growth after 8% adverse currency)
and the introduction of the JET-X unilateral fixator in 2003.

Higher than normal revision rates in respect of the macrotextured femoral knee component prompted a voluntary
withdrawal of the product from the market on 18 August 2003. The total number of components implanted was
2,971 and, to 8 March 2004, 190 revisions had been notified to the Group.

OperatingProfit
Operating profit from the orthopaedics business before goodwill amortisation and exceptional items increased by
£20.5m (21%) from £98.2m in 2002 to £118.7m in 2003. The operating profit margin increased from 20.9% to
22.6% as a result of cost and efficiency savings, additional sales volume and price increases.

Endoscopy

Sales
Endoscopy sales in 2003 were £300.0m, an increase of £8.2m or 3% compared to £291.8m for 2002. Underlying
growth in sales was 4%. Sales in the US declined by 7% with an underlying fall of 2% after adjusting for 9%
adverse currency and 4% for the benefit of ORATEC. Outside the US sales growth was 19% (14% underlying after
5% adverse currency translation).

Endoscopy was adversely affected in the US by two market issues — increased re-use of arthroscopic resection
blades and decreased business from one of its largest customers, HealthSouth. With respect to blade re-use, the
business launched an educational campaign that features research highlighting the risks of this practice to
hospitals and clinicians in the US.

Endoscopy sales growth was also affected by its decision to defer two product launches into 2004 — the digital
scanning camera and the next generation varicose vein removal system. Clinical evaluations identified the
opportunity to make improvements prior to both products’ broader launch. Both of these products were launched
in early 2004.

Sales of knee and shoulder repair products grew by 14% (an underlying rate of 18% after 4% of adverse currency
translation) while ORATEC products produced sales growth of 41% (of which 17% arose from underlying growth,
32% was the acquisition effect less 8% adverse currency translation) helping Smith & Nephew to maintain its
market leadership position in arthroscopy with a market share of 29%.

OperatingProfit
Operating profit from the endoscopy business before goodwill amortisation and exceptional items increased by
£5.7m (11%) from £53.8m in 2002 to £59.5m in 2003. The operating profit margin increased from 18.4% to
19.8% as a result of effective expense control and by accelerating the integration of the ORATEC acquisition.
During 2003 the manufacturing and development activities of ORATEC at Palo Alto, California were relocated and
integrated with endoscopy operations at Andover, Massachusetts.

Advanced Wound Management

Sales
Advanced wound management sales were £353.5m for 2003, an increase of 10% compared to £321.7m for
2002. Underlying sales growth was 9%. The advanced wound management business maintained its leadership

39

position with approximately 20% of the market for advanced treatments of hard-to-heal wounds. It further
developed the concept of wound bed preparation as a new clinical and scientific platform. DERMAGRAFT and
TRANSCYTE bioengineered human tissue products, acquired in November 2002, were integrated successfully
into the US business.

DERMAGRAFT achieved its target sales of £7m. Sales of the ALLEVYN family of products continued to grow
strongly at 24% (20% underlying growth plus 4% favourable currency translation) and ACTICOAT silver-based
antimicrobial dressing achieved sales growth of 51% (55% underlying less 4% adverse currency).

The business launched a new enzymatic wound bed preparation product, GLADASE, following the termination of
a supply arrangement for the previous equivalent US product, SANTYL. This issue adversely impacted sales in the
second half of 2003.

OperatingProfit
Operating profit from the advanced wound management business before goodwill amortisation and exceptional
items decreased by £1.5m (3%) from £44.0m in 2002 to £42.5m in 2003. The operating profit margin decreased
from 13.7% to 12.0% principally as a result of acquiring, at the end of 2002, the remaining 50% of the
DERMAGRAFT joint venture not already owned and due to increased pension costs in the UK and the US.

40

OUTLOOK AND TREND INFORMATION

The discussion below contains statements that express management’s expectations about future events or
results rather than historical facts. These forward-looking statements involve known and unknown risks and
uncertainties that could cause the Group’s actual results, performance or achievements to differ materially from
those projected in forward-looking statements. Smith & Nephew cannot give assurance that such statements will
prove correct. These risks and uncertainties include factors related to: the medical devices industry in general;
product liability claims and related insurance coverage; the geographical markets in which the Group operates;
the nature and efficiency of the Group’s products; the Group’s ability to research, develop, manufacture and
distribute its products; the translation of currencies to Sterling; and the values of international securities markets.
For additional information on factors that could cause the Group’s actual results to differ from estimates reflected
in these forward-looking statements, you should read “Risk Factors” of this document.

The markets on which the Group focuses continue to demonstrate robust growth and are expected to benefit for
many years to come from an ageing population, active lifestyles and the development of less invasive techniques
in orthopaedic and endoscopic surgery. Management believe that Smith & Nephew’s continuing innovation in
advanced wound management products and the potential for further penetration of moist wound healing and
wound bed preparation techniques should fuel expansion of this market.

The markets in which the Group operates continue to grow strongly and management expects that innovative
new product development programmes and sales force investment particularly in orthopaedics and endoscopy
will enable the Group to grow market share and drive market expansion.

For 2005, management expects to achieve high teens sales growth in orthopaedics and high single digit sales
growth at endoscopy and wound management. Management expects that continued investment and planned
margin improvements will contribute to underlying mid-teens EPSA growth going forward.

A significant external influence on Group sales and profits in 2005 and beyond will be the translational effects of
currency to the extent that average rates of exchange differ from those in year 2004. Reported sales and profits
would benefit from a strengthening in the value of the US Dollar and Euro against Sterling compared with average
rates of exchange in 2004 but would be reduced by a strengthening in the value of Sterling against those
currencies.

A further influence on profit and on operating profit margin trends in 2005 and beyond will be the transactional
effects of currency to the extent that rates of exchange differ from those in 2004. Operating profit margins will
improve if the effective rate of exchange of the Euro compared with the US Dollar increases and will be reduced
by a relative strengthening of the US Dollar. The effective rate of exchange will determine the average cost of
finished goods purchased by the Group’s selling operations from its manufacturing operations and will be
affected by actual rates of exchange, forward purchases of foreign currency and stock utilisation.

Management does not anticipate that the dispute with certain insurers over their declination of coverage of
macrotextured product liability claims will be resolved during 2005. Consequently, it is expected that settlements
with patients will not be reimbursed by insurers and that this will have an adverse impact on cash flow of
approximately £40m during 2005. There will be no impact on operating profit since these payments will be
charged to the provision established in 2004. See “Legal Proceedings” and “Risk Factors”.

41

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:

Net cash inflow from operating activities . . . . . . . . . . . . . . . . . . . . . . .
Dividends received from joint venture . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest received/(paid)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Capital expenditure and financial investment
. . . . . . . . . . . . . . . . . . .
Acquisitions and disposals (net of loan notes issued on acquisition

of £50.3m in 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issue of ordinary share capital and own shares purchased . . . . . . . .

Change in net borrowings from net cash flow . . . . . . . . . . . . . . . . . . .
Loan notes issued on acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Opening net borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Closing net borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

226.6
14.1
4.5
(37.9)
(101.1)

(34.9)
(46.7)
3.9

28.5
(50.3)
36.9
(127.1)

(112.0)

2003
(£ million)
214.5
6.8
(3.8)
(52.2)
(71.4)

48.1
(45.1)
7.2

104.1
–
45.7
(276.9)

(127.1)

2002

211.0
3.9
(10.2)
(52.3)
(85.4)

(128.8)
(43.5)
3.7

(101.6)
–
68.2
(243.5)

(276.9)

The Group’s net debt decreased by £131.5m from £243.5m at the beginning of 2002 to £112.0m at the end of
2004. Translation of foreign currency net debt into Sterling had the effect of decreasing net debt by £150.8m in
the three-year period ended 31 December 2004. Closing net borrowings includes £31.6m of net currency swap
assets (2003 — £43.4m, 2002 — £16.7m).

Acquisitions and Disposals
In the three-year period ended 31 December 2004, £165.9m (including the issuance of £50.3m of Loan Notes in
2004) was spent on acquisitions, net of disposal proceeds, funded from net debt. Acquisitions totalled £295.8m
and comprised ORATEC £191.2m, MMT £69.6m, Collagenase £9.1m, DERMAGRAFT £7.8m, Acticoat £7.3m and
other £10.8m.

In the same three-year period, £129.9m was received from the disposal of businesses and the formation of BSN
Medical. This comprised £5.7m on the formation of BSN Medical, £71.8m for the rehabilitation business and
£52.4m for AbilityOne.

Capital Expenditure
The Group’s ongoing capital expenditure and working capital requirements have been 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 has represented
approximately 7% to 8% of continuing group turnover. Capital expenditure in 2005 is expected to be
approximately the same percentage of Group turnover as 2004.

In 2004 capital expenditure of £102.3m (£101.1m net of disposals of fixed assets) was incurred. The principal
areas of investment were in the placement of orthopaedics instruments with customers, manufacturing plant and
equipment, information technology and intangible assets.

At 31 December 2004, £4.4m of capital expenditure had been contracted but not provided for.

Operating Cash Flow
Management assesses available cash flow in terms of operating cash flow before outgoings on rationalisation,
divestment, acquisition integration and other exceptional costs and after capital expenditure and financial
investments. This figure (£144.9m for 2004) is after several adjustments to net cash inflow from operating
activities, the most comparable UK GAAP figure. Management believes that this figure represents a truer
reflection of cash flow generation because it excludes exceptional cash flow items. This measure is used in the
Group’s management reporting, budgeting and planning. Management also uses as a key indicator the “cash

42

conversion ratio” i.e. the percentage of cash flow compared to group operating profit before goodwill amortisation
and exceptional items. This was 58% for 2004 (2003 — 77%, 2002 — 73%) and was lower than in previous
years as a result of an increase in orthopaedic stocks to improve customer service and meet anticipated
increases in demand for both existing and new products. Management uses this cash conversion ratio to monitor
the efficiency of its use of capital employed and to provide meaningful year-on-year cash flow trend information.
Management has set long-term targets for the Group of 70% — 75% cash conversion ratio.

The following table presents a reconciliation of net cash inflow from operating activities to operating cash flow
before outgoings on rationalisation, divestment, acquisition integration, macrotextured knee settlements
unreimbursed by insurers and Centerpulse costs.

Net cash inflow from operating activities . . . . . . . . . . . . . . . . . . . . . . .
Less: capital expenditure and financial investment . . . . . . . . . . . . . . .

Operating cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Add: exceptional outgoings:

Rationalisation, acquisition integration and divestment costs . . .
Macrotextured knee revisions unreimbursed by insurers . . . . . .
Centerpulse transaction costs . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

226.6
(101.1)

125.5

2.2
17.2
–

Operating cash flow before exceptional outgoings . . . . . . . . . . . . . . .

144.9

2003
(£ million)
214.5
(71.4)

143.1

9.6
–
17.0

169.7

2002

211.0
(85.4)

125.6

19.3
–
–

144.9

Liquidity
The Group’s policy is to ensure that it has sufficient funding and facilities in place to meet foreseeable borrowing
requirements.

At 31 December 2004,
the Group held £32.6m in cash and balances at bank and had committed and
uncommitted bank facilities of £326m and £212m respectively. Undrawn bank facilities amounted to £414m, of
which £225m were committed. Of the undrawn committed facilities, £6m expire within one year and £219m after
two but within five years. Of the drawn facilities, £31.9m expires within one year, £0.3m expires in 1-3 years and
£93.7 expires within 3-5 years. In addition Smith & Nephew has £50.3m of loan notes payable within 1-3 years.
Smith & Nephew intends to repay the amounts due within one year by using available cash and drawing down on
the longer-term facilities.

The principal variations in the Group’s borrowing requirements normally result from the timing of the bi-annual
dividend payments, acquisitions and disposals of businesses, timing of capital expenditure and working capital
fluctuations. In 2005 the settlement of macrotextured patient claims will also be a factor.

Smith & Nephew believes that its capital expenditure needs and its working capital funding for 2005, as well as
its other known or expected commitments or liabilities, can be met from its existing resources and facilities.

Further information regarding borrowings at 31 December 2004 is set out in Note 19 of the Notes to the Group
Accounts. The Group believes that the borrowing facilities do not contain restrictions that are expected to impact
on funding or investment policy for the foreseeable future.

Pension Funding
The movements in the stock market values over the last five years have adversely affected the funding levels of
Smith & Nephew’s major defined benefit plans in the UK and US. These plans continue to be accounted for under
SSAP 24 and their combined SSAP 24 deficit is estimated as £49m at 31 December 2004 (2003 — £55m). This
is less than the combined deficit under FRS 17 of £123.7m (2003 — £121.2m). The difference is due to the non-
investment return discount rate required to be applied to liabilities under FRS 17. The SSAP 24 deficit is to be
funded over members’ average future working lives. Existing provisions and planned increases in future
contributions are considered adequate to cover the current under funding position.

Payment Policies
It is Company policy to ensure that suppliers are paid within agreed terms. At the year-end, the Company’s trade
creditors represented the equivalent of 39 days’ credit.

43

EXCHANGE AND INTEREST RATE RISK AND FINANCIAL INSTRUMENTS

The Board of Directors of the Company has established a set of policies to manage funding, currency and interest
rate risks. These policies include the use of derivative financial instruments only for the management of the
financial risks associated with underlying business activities and their financing.

ForeignExchangeExposure
The Group trades in over 90 countries and as a consequence has transactional and translational foreign
exchange exposure. The Group’s policy is to protect shareholders’ funds by matching foreign currency assets,
including acquisition goodwill, with foreign currency liabilities wherever practicable. These liabilities take the form
of either borrowings or currency swaps. It is the Group’s policy for operating units not to hold unhedged monetary
assets or liabilities other than in their functional operating currencies.

Foreign exchange variations affect trading results in two ways. Firstly on translation of overseas sales and profits
into Sterling and secondly, the currency cost of purchases by Group companies of finished products and raw
materials. The principal flows of currency are purchases of US Dollars and Sterling from Euros, Japanese Yen,
Australian and Canadian Dollars, as well as cross purchases between the US and the UK.

The Group partly mitigates the translational impact on profits through the interest arising on foreign currency
borrowings or swaps. The impact of currency movements on the cost of purchases is partly mitigated by the use
of forward foreign exchange contracts.

The Group managed £320m of foreign currency purchase transactions by using forward foreign exchange
contracts, of which the major transaction flow is Euros into US Dollars. The Group’s policy is for firm commitments
to be fully covered and forecast transactions to be covered between 50% and 90% for up to one year. If the Euro
were to weaken against US Dollar by 10% on average over the year, the fair value of forward foreign exchange
contracts would increase by £5m (2003 — increase by £3m).

Had the Group not transacted forward foreign exchange purchase contracts and if Sterling were to have
weakened on average over the year by 10% against all other currencies, Smith & Nephew’s profit on ordinary
activities before taxation in 2004 would have increased by £29m on account of transactional and translational
movements; if the Euro were to have weakened on average over the year by 10% against all other currencies,
profit on ordinary activities before taxation in 2004 would have reduced by £10m; if the US Dollar were to have
weakened on average over the year by 10% against all other currencies, profit before taxation in 2004 would not
have changed materially.

The Group’s net debt is exposed to movements in exchange rates on foreign currency liabilities. Based upon the
net debt position at 31 December 2004 if Sterling were to weaken against the US Dollar by 10%, the increase in
the Group’s net debt would be £51m. If Sterling were to weaken against all currencies excluding the US Dollar by
10%, the Group’s net debt would be increased by £20m. That is, if Sterling were to weaken against all currencies
by 10%, the Group’s net debt would increase by £71m.

InterestRateRisk
The Group contracts fixed rate currency swaps and uses simple floating to fixed rate interest rate swaps to meet
its objective of protecting borrowing costs and differentials between borrowing and deposit rates within
parameters set by the Board. Interest rate swaps and the fixed interest element of currency swaps are accounted
for as hedges and, as such, changes in fair values resulting from changes to market rates are not recognised in
the Group balance sheet nor in reported profits. The cash flow effects of interest rate swaps match cash flows on
the underlying instruments such that there is no net cash flow effect from movements in market interest rates.

As at 31 December 2004,
December 2005.

the majority of

interest costs and differentials had been protected through to

If the Group had not transacted interest rate swaps or fixed interest rate cross currency swaps to hedge its
interest rate risk, based upon the net debt position at 31 December 2004, an increase in short-term interest rates
across all currencies by one percentage point would increase the Group’s annual net interest payable by £1.1m
(2003 — increase by £1.3m). The Group’s financial assets and liabilities, excluding fixed interest rate currency
swaps, were principally at floating interest rates and thus their fair values are not directly affected by movements
in market rates of interest.

44

At 31 December 2004, an increase of one percentage point in Sterling interest rates would have reduced the fair
value of Sterling interest rate swaps and the Sterling fixed interest element of currency swaps by £5m; and an
increase of one percentage point in US Dollar interest rates would have increased the fair value of US Dollar
interest rate swaps and the US Dollar fixed interest element of currency swaps by £4m. In the case of decreases
in interest rates of one percentage point the changes in the fair values of the interest rate and the fixed interest
element of currency swaps would have been an increase of £5m relating to Sterling and a decrease of £4m
relating to US Dollars.

FinancialInstruments
The Group’s financial instruments are subject to changes in fair values as a result of changes in market rates of
exchange and forward interest rates. All financial instruments are accounted for as hedges. As a result, changes
in fair values of financial instruments do not affect the Group’s profit on ordinary activities before taxation.

The Group limits exposure to credit risk on counterparties used for financial instruments through a system of
internal credit limits which, with certain minor exceptions due to local market conditions, require counterparties to
have a minimum “A” rating from the major ratings agencies. The financial exposure of a counterparty is
determined as the total of cash and deposits, plus the risk on derivative instruments, assessed as the fair value
of the instrument plus a risk element based on the nominal value and the historic volatility of the market value of
the instrument. Smith & Nephew does not anticipate non-performance of counterparties and believes it is not
subject to material concentration of credit risk.

Contractual obligations at 31 December 2004 were as follows:

CONTRACTUAL OBLIGATIONS

Short-term debt obligations . . . . . . . . .
Long-term debt obligations . . . . . . . . .
Loan Notes . . . . . . . . . . . . . . . . . . . . . .
Finance lease obligations . . . . . . . . . . .
Operating lease obligations . . . . . . . . .
Purchase obligations . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
Other

Payments due by period

Less than 1
year

1-3 years
(£ million)

3-5 years

30.4
–
–
1.5
20.7
2.3
30.8

85.7

–
–
50.3
0.3
23.1
–
15.8

89.5

–
93.7
–
–
14.0
–
–

107.7

Total

30.4
93.7
50.3
1.8
92.7
2.3
46.6

317.8

More
than 5
years

–
–
–
–
34.9
–
–

34.9

Other contractual obligations consist of credit balances on currency swaps and interest rate swaps, foreign
exchange contracts and acquisition consideration.

The agreed contributions for 2005 in respect of the Group’s principal pension plans are 11% of pensionable
earnings plus a supplementary payment of £4.3m to the UK Plan and 9% of pensionable earnings plus a
supplementary payment of £2.7m to the US Plan.

In addition, at 31 December 2004, the Group had contracted but not provided for £4.4m of capital expenditure.

OFF-BALANCE SHEET ARRANGEMENTS

Management believes that the Group does not have any off-balance sheet arrangements, as defined by the SEC
in item 5E of Form 20-F, that have or are reasonably likely to have a current or future effect on the Group’s
financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that is material to investors.

RELATED PARTY TRANSACTIONS

Except for BSN Medical and AbilityOne (see Note 36 of Notes to the Group Accounts), no other related party has
had material transactions or loans with Smith & Nephew over the last three financial years.

45

INTERNATIONAL FINANCIAL REPORTING STANDARDS (“IFRS”)

Under European regulation, from 2005 Smith & Nephew will be required to publish its financial statements under
IFRS. The transition is being managed internally by a Project Committee reporting to a Steering Committee which
is chaired by the Finance Director. Quarterly reports have been made to the Audit Committee.

The Project Committee has performed a full assessment of the extant standards and their impact on both the
reported financial statements and the underlying business processes, and continues to monitor the standards yet
to be finalised by the International Accounting Standards Board and adopted by the European Union.
Amendments to internal reporting systems and financial processes have been effected and budgeting for 2005 is
on a full IFRS basis. Training has been provided internally and will continue over the transition period.

In November 2004 the Group announced its external communication plan, explaining to investors the impact of
IFRS based on management’s expectations of the format of the final standards. A summary of the adjustments
required to restate each quarter’s earnings and net debt in 2004 to an IFRS basis was included within the 2004
preliminary announcement issued on 3 February 2004. In parallel with the issue of 2004 financial statements,
management has published the revised accounting policies which will be applied from 2005 onwards, together
with an unaudited description of the major accounting changes and quantification of how existing UK GAAP
reporting reconciles to the IFRS equivalent for 2003 and 2004 full years. This document is available on the
Group’s website and in printed copy on request from the Group’s company secretary. From Quarter 1, 2005, all
results will be presented under IFRS.

Based on the standards currently in issue and management’s understanding of future developments, the major
differences in accounting policies which will impact Smith & Nephew are for employee benefits (in particular
pensions accounting and a requirement for the expensing of all share options granted), for acquisition goodwill
which will no longer be amortised but will be subject to annual testing for impairment and increased recognition
of intangible assets arising on acquisition. In addition, management expects the recognition criteria for deferred
tax will change, resulting in a net write back of provisions, principally related to goodwill set off against reserves.
The proposed standards and interpretations on financial instruments have necessitated a change in Smith &
Nephew’s accounting practice. The Group continues to hedge the net investment value of foreign subsidiaries
and the overall hedging strategy for trading hedges remains essentially unchanged. However, management does
not believe that it will be possible to fix forward the reported interest costs of the Group with the same certainty
as could be achieved under UK GAAP, resulting in some volatility within financing costs over each quarterly
period.

Management expects to be fully prepared for the transition. However, full implementation is dependent on the
completion of the standard setting process by the International Accounting Standards Board and the adoption of
such standards by the European Commission. The failure of the European Commission to adopt all of these
standards in time for financial reporting in 2005, or the issue of further interpretations by the International
Financial Reporting Interpretation Committee (“IFRIC”) in advance of the reporting date, could result in the need to
change the basis of accounting or presentation of certain financial information from that presented in this note. In
particular, the International Accounting Standards Board has yet to provide definitive rulings and transitional
guidance on specific aspects of IAS 39 — “Recognition and Measurement of Financial Instruments” which impact
intends to continue monitoring developments as the standards and recognised
the Group. Management
practices evolve.

Had Smith & Nephew been reporting under IFRS management believe its results and shareholders funds since
the transition date would have been as follows:

Results

Attributable profit for the financial year
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Basic earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

£138.2m
14.78p
14.67p

2003

£172.4m
18.54p
18.42p

IFRS attributable profit for the financial year in 2004 is £13.0m (2003 — £24.3m) higher than UK GAAP mainly
due to the non-amortisation of goodwill of £20.5m (2003 — £18.5m), offset partly by higher amortisation of
intangible fixed assets of £4.4m (2003 — nil). Other principal adjustments to profit include: a net charge of

46

£5.0m under IFRS 2 for share based compensation (2003 — £3.5m); a net benefit of £2.7m (2003 — £1.2m) for
pensions reflecting a current service cost benefit of £3.6m (2003 — £2.7m) and £1.8m (2003 — £3.8m) finance
cost expense and a credit of £0.9m (2003 — £2.3m) on the difference in deferred taxation accounting.

Shareholders’ Funds

At 31 December . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

£702.0m

£610.4m

2004

2003

funds in 2004 are £25.0m (2003 — £30.4m)

Shareholders’
lower than UK GAAP principally due to the
recognition of the full defined benefit pension deficit of £94.1m (2003 — £88.6m) net of deferred tax offset by
the non-amortisation of goodwill of £36.7m (2003 — £17.5m) and the recognition of the final dividend £30.0m
(2003 — £28.9m) on a declared rather than a proposed basis.

US GAAP

Smith & Nephew prepares its accounts in accordance with UK GAAP which differ in certain respects from US
GAAP. Reconciliations of profit for the financial year and shareholders’ funds are set out in Note 39 of Notes to
the Group Accounts. As a consequence of the preparatory work to convert the accounts from UK GAAP to IFRS,
management has identified certain adjustments that were needed to the UK/US GAAP reconciliations in prior
years and has restated for these as disclosed in Note 39 of the Notes to the Group Accounts.

Results

Profit for the financial year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Basic earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

£142.4m
15.23p
15.12p

Restated
2003

£179.5m
19.30p
19.18p

Restated
2002

£145.2m
15.68p
15.55p

US GAAP profit for the financial year in 2004 is £17.2m higher than UK GAAP mainly due to the non-amortisation
of goodwill of £20.5m, offset partly by higher amortisation of other intangible fixed assets of £13.0m. Other
principal adjustments to profit include: a credit of £24.4m on differences in hedge accounting; a charge of £6.5m
under FAS 123 for stock based compensation; a charge of £6.4m for pensions reflecting a difference in
methodology for calculating the service cost and a credit of £2.1m on the difference in deferred taxation
accounting for intangibles and gains deferred into replacement assets.

Shareholders’ Funds

2004

Restated
2003

At 31 December . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

£781.9m

£690.7m

Shareholders’ funds in 2004 are £54.9m higher than UK GAAP principally due to the non-amortisation of
goodwill, £33.3m; different recognition criteria for intangible assets and goodwill, £76.3m; dividends on a
declared rather than a proposed basis, £30.0m; inclusion of a minimum pension liability, £93.6m; and lower
taxation provision due to these adjustments of £20.9m.

Prospects
Smith & Nephew have published expectations of
Information”.

future results on an IFRS basis in “Outlook and Trend

New accounting standards in the US which may affect US GAAP results are detailed in Note 38 of the Notes to
the Group Accounts.

47

CORPORATE GOVERNANCE

This section discusses Smith & Nephew’s structures and governance procedures.

The Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Governance and policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accountability, audit and internal control framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

49
50
51
53
56

48

The Board of Directors of Smith & Nephew as at 28 February 2005 comprised:

THE BOARD

Director

Position

Dudley G. Eustace . . . . . . . . . . . Non-Executive Chairman
John Buchanan . . . . . . . . . . . . . . Non-Executive Deputy Chairman
Sir Christopher O’Donnell . . . . . .

Peter Hooley . . . . . . . . . . . . . . . .

Executive Director, Chief
Executive
Executive Director (responsible
for Finance and Information
Technology)

Dr. Pamela J. Kirby . . . . . . . . . . . Non-Executive Director
Warren D. Knowlton . . . . . . . . . . Non-Executive Director
Brian Larcombe . . . . . . . . . . . . . . Non-Executive Director
Richard De Schutter . . . . . . . . . . Non-Executive Director
Dr. Rolf W. H. Stomberg . . . . . . . Non-Executive Director

Initially elected
or appointed

10 November 1999
3 February 2005
1 September 1992

2 April 1991

1 March 2002
1 November 2000
1 March 2002
1 January 2001
1 January 1998

Term of
appointment
expires at
AGM in

2006
2005
2007

2006

2005
2007
2005
2007
2007

Directors’ Biographies
Dudley G. Eustace, Chairman, (68) was appointed Deputy Chairman in 1999 and Chairman in January 2000. He
is Chairman of the Nominations Committee. He is non-executive Chairman of Sendo Holdings plc and non-
executive Vice Chairman of Aegon NV, Hagemeyer NV and Royal KPN NV.

John Buchanan (61) was appointed a director on 3 February 2005. He is the Deputy Chairman. He is a non-
executive director of Vodafone Group Plc, AstraZeneca PLC and BHP Billiton.

Sir Christopher O’Donnell, Chief Executive, (58) joined the Group in 1988 as managing director of the Group’s
medical division and was appointed a director of Smith & Nephew in 1992. He was appointed Chief Executive in
1997 and is a member of the Nominations Committee. He is a non-executive director of BOC Group plc.
Previously he held senior positions with UK and US companies in the medical engineering and devices industry.

Peter Hooley, Finance Director, (58) joined the Group and was appointed Finance Director in 1991. He is a non-
executive director of Cobham plc. Previously he held senior financial positions with Matthew Hall and BICC.

Dr. Pamela J. Kirby (51) was appointed a director in March 2002 and is a member of the Remuneration
Committee. She is non-executive Chairman of Oxford Immunotec Limited and a non-executive director of
T&F Informa plc, Oscient Pharmaceuticals Corporation and Scynexis Inc.

Warren D. Knowlton (58) was appointed a director in November 2000. He is Chairman of the Audit Committee
and a member of the Remuneration Committee. He is Group Chief Executive of Morgan Crucible plc.

Brian Larcombe (51) was appointed a director in March 2002 and is a member of the Audit Committee. He is a
non-executive director of F&C Asset Management plc.

Richard De Schutter (64) was appointed a director in January 2001 and is a member of the Audit Committee and
the Remuneration Committee. He is non-executive Chairman of Incyte Corporation and a non-executive director
of Varian Inc., MedPointe Pharmaceuticals, Ecolab Inc, Metaphore Pharmaceuticals and Navicure Inc.

Dr. Rolf W. H. Stomberg (64) was appointed a director in 1998. He is the Senior Independent Director, Chairman
of the Remuneration Committee and a member of the Audit and Nominations Committees. He is Chairman of
Management Consulting Group plc and Lanxess AG and a non-executive director of Scania AB, Reed Elsevier plc,
Hoyer GmbH, TPG Group plc, Deutsche BP AG and Biesterfeld AG.

49

EXECUTIVE OFFICERS

The Chief Executive of Smith & Nephew and other senior executives are responsible for the day-to-day
management of the Group. The Group Executive Committee (‘GEC’), which comprises the executive directors and
certain other senior executives of Smith & Nephew (the ‘Executive Officers’), assists the Chief Executive in the
management of the business. The following are Executive Officers of Smith & Nephew and all, apart from the
Company Secretary, are members of the GEC:

Dr. Peter Arnold (43) Group Director of Technology. He joined the Group in 1997 and worked in corporate
business development and corporate research and development roles. He was appointed to the GEC in January
2004. Prior to joining the Group he was responsible for research and development for Johnson & Johnson’s
wound care business.

James L. Dick (52) President — Advanced Wound Management. He joined the Group in 1977 and was appointed
to the GEC in January 1999. He has worked predominantly in sales, marketing and general management roles
with particular emphasis on international marketing, country management and new technology.

Peter W. Huntley (44) Group Director — Indirect Markets. He joined the Group and was appointed to the GEC in
April 1998, responsible for the Group’s strategy and business planning. He was appointed to his current role in
December 2003. Prior to joining the Group, he was a consultant with Deloitte Haskins and Sells, and the
Business Development Director for Matthew Clark plc.

David Illingworth (51) President — Orthopaedics. He joined the Group and was appointed to the GEC in May
2002. Prior to joining the Group he held posts within GE Medical, as Chief Executive Officer of a publicly traded
medical devices company, President of a respiratory/critical care company and President of a technology
incubator company.

James A. Ralston (58) Chief Legal Officer. He joined the Group in 1998 as Executive VP and Chief Legal Officer for
North America and was appointed to the GEC in February 2002. Prior to joining the Group he was in private
practice and VP General Counsel and Secretary for Eagle-Picher Industries, Inc.

James M. Taylor (48) President — Endoscopy. He joined the Group and was appointed to the GEC in June 2000.
Prior to his appointment in 2003 as President of Endoscopy, he was Group Director — Indirect Markets.
Previously he was President of DePuy International and has held senior positions with British Leyland and
Chloride Group.

Paul M. Williams (58) Group Director — Human Resources. He joined the Group and was appointed to the GEC in
December 1998. Prior to joining the Group he held senior human resources director roles with NCR, Heinz, Glaxo
and Rolls-Royce.

CompanySecretary
Paul R. Chambers (60) Company Secretary. He joined the Group in 1994 as Assistant Company Secretary and
was appointed Company Secretary in April 2002.

50

GOVERNANCE AND POLICY

The new Combined Code on Corporate Governance, as appended to the UK Listing Authority’s Listing Rules,
requires UK listed companies to make a disclosure statement on the application of the Principles and Supporting
Principles and compliance with the Provisions of the Code.

The Board is committed to the highest standards of Corporate Governance and considers that it has complied with
the new Code throughout the year with the exception that no member of the Audit Committee has ‘recent’ financial
experience. However, all members have relevant financial experience and the Board considers that the members of
the Audit Committee have the skills and experience of corporate financial matters to discharge properly the
Committee’s responsibilities. All members meet the definition of ‘financial expert’ in the Sarbanes-Oxley Act.

In accordance with the Code, the following paragraphs describe Smith & Nephew’s Corporate Governance
policies and procedures and how it applies the Principles and Supporting Principles in the new Code.

The Company’s American Depositary Shares are listed on the New York Stock Exchange (‘NYSE’) and the
Company is therefore subject to the rules of the NYSE as well as the US securities laws and the rules of the US
Securities and Exchange Commission (“SEC”) applicable to foreign private issuers. The Board believes that it has
complied throughout the year with both SEC and NYSE requirements related to corporate governance with the
exception that, in accordance with the Combined Code, the Nominations Committee consists of a majority of
independent directors and does not consist wholly of independent directors, as required by the NYSE.

The Board
The Board of Directors of Smith & Nephew consists of an independent non-executive Chairman, two executive
directors and six independent non-executive directors. In 2004, the Board met on eight occasions and individual
attendance was: Dudley Eustace (8), Sir Christopher O’Donnell (8), Peter Hooley (8), Dr Pamela Kirby (8), Warren
Knowlton (7), Brian Larcombe (8), Richard De Schutter (8) and Dr Rolf Stomberg (8). John Buchanan joined the
Board in February 2005.

The Board is responsible for the strategic direction and overall management of the Group and has a formal
schedule of matters reserved for its decisions which include the approval of certain policies, budgets, financing
plans, large capital expenditure projects, acquisitions, divestments and treasury arrangements but otherwise
delegates specific responsibilities to Board Committees, as described on page 52. It reviews the key activities of
the businesses and considers and reviews the work undertaken by the Committees.

Non-executive directors meet regularly without management in attendance and the Senior Independent Director
meets with the other non-executive directors annually to evaluate the performance of the Chairman. Board meetings
are held at the major business units enabling directors to have a greater understanding of the business and to meet
the management of these units. All directors have full and timely access to all relevant information and, if necessary,
to independent professional advice. Appropriate directors and officers liability insurance is in place and induction
programmes and training are offered to new directors. Further training for all directors, which would include such
issues as risk, is available as appropriate. All directors have access to the advice and services of the Company
Secretary who is responsible to the Board for ensuring that Board procedures are complied with.

Whilst the Chairman and Chief Executive collectively are responsible for the leadership of the Group, there is a
clear division of respective responsibilities which have been agreed by the Board. The Chairman’s primary
responsibility is for leading the Board, including ensuring its effectiveness and setting its agenda, whilst the Chief
Executive is responsible for managing and supervising the day-to-day business of the Group in accordance with
the strategy, policies, budgets and business plans approved by the Board. The GEC advises and assists the Chief
Executive in the management of the Group.

The Senior Independent Director is Dr Rolf Stomberg, whose role includes consulting with members of the Board on
issues relating to the Chairman and chairing Board meetings and meetings of the Nominations and Audit Committee
in the absence of the Chairman or Chairman of the Audit Committee. He is available to shareholders if they have
concerns that cannot be resolved through the normal channels of contact with the Chairman or Chief Executive.

In 2004, a formal evaluation of the performance of the Board and its Committees was undertaken by an external
consultant with the emphasis on continuous improvement and effectiveness of the Board and its Committees.
Each director and the Company Secretary were interviewed separately and the result of the review presented to
the whole Board. A number of recommendations were made which have been acted upon. Individual evaluation
is carried out by the Nominations Committee with particular emphasis on the evaluation of those directors
standing for re-appointment at the AGM. The non-executive directors, led by the Senior Independent Director,
evaluate the performance of the Chairman.

51

The Board has determined that none of the independent non-executive directors or their immediate families has
ever had a material relationship with the Group either directly as an employee or as a partner, shareholder or
officer of an organisation that has a relationship with the Group. With the exception of the Chairman, who is
provided with healthcare cover, they do not receive additional remuneration apart from directors’ fees, do not
participate in the Group’s share option schemes or performance related pay schemes, and are not members of
the Group’s pension schemes. No director of Smith & Nephew is a director of a company or an affiliate in which
any other director of Smith & Nephew is a director.

None of the directors or executive officers (or any relative or spouse of such person, or any relative of such
spouse, who has the same address as the director or officer, or who is a director or officer of any subsidiary of
Smith & Nephew) has a material interest in any contract to which the Company or any of its subsidiaries are or
were a party from the beginning of fiscal year 2003 to 8 March 2005.

Details of the Group’s policies on remuneration, service contracts and compensation payments are included in
the “Remuneration Report”.

Board Committees
The Board is assisted by the Audit, Remuneration and Nominations committees, each of which has its own terms
of reference, which may be found on the Group’s web site at www.smith-nephew.com. The Company Secretary is
secretary to each of the committees.

AuditCommittee
The Audit Committee met on six occasions in 2004 (individual attendance is shown in parenthesis). The Committee,
consisting entirely of independent non-executive directors, is chaired by Warren D. Knowlton (6). He was appointed
to the Committee in February 2001 and became Chairman of the Committee in July 2001. The other members of the
Committee are Brian Larcombe (6) who was appointed to the Committee in January 2003, Richard De Schutter (6)
who was appointed in February 2001 and Dr Rolf Stomberg (5) who was appointed in February 1998. The Chairman
of the Committee reports orally to the Board and minutes of the meetings are circulated to all members of the Board.

RemunerationCommittee
The Remuneration Committee, consisting entirely of independent non-executive directors, met three times in
2004 (individual attendance is shown in parenthesis) and is chaired by Dr Rolf Stomberg (3). The other members
of the Committee are Dr Pamela Kirby (3), Warren Knowlton (2) and Richard De Schutter (3). The Remuneration
Committee sets the pay and benefits of the executive directors and members of the GEC, approves their main
terms of employment and determines share options and long-term incentive arrangements. It also reviews
management succession planning. The Remuneration Report is on pages 57 to 65.

NominationsCommittee
The Nominations Committee, consisting of two independent non-executive directors and the Chief Executive, met
three times in 2004 and its chairman, Dudley Eustace, and members, Dr Rolf Stomberg and Sir Christopher
recommends
O’Donnell, attended all meetings.
appointments to the Board of Directors and determines the fees of the non-executive directors. It provides a
formal and transparent procedure for the appointment of new directors to the Board. Candidate profiles are
agreed by the Committee before external consultants are engaged to advise on prospective Board appointees.
Shortlisted candidates are interviewed by members of the Committee who then recommend candidates to be
interviewed by all members of the Board. The final decision is made by the Board. This procedure was followed
for
the appointment of John Buchanan as a non-executive director and Deputy Chairman. The Senior
Independent Director oversees the process for the appointment of a new Chairman.

It oversees plans for Board of Directors’ succession,

Directors’ Re-appointment
Under Smith & Nephew’s Articles of Association, any director who has been appointed by the Board of Directors
since the previous annual general meeting of shareholders, either to fill a casual vacancy or as an additional
director, holds office only until the next annual general meeting and then is eligible for reappointment by the
shareholders. Subsequently, directors retire and offer themselves for re-election at the third annual general meeting
after the meeting at which they were last reappointed. The directors are subject to removal with or without cause by
the Board of Directors or the shareholders. Executive Officers serve at the discretion of the Board of Directors.

On 3 February 2005 John Buchanan joined the Board as a non-executive director and Deputy Chairman and in
accordance with the Articles of Association will be proposed for re-election at the AGM to be held on 5 May
2005. Brian Larcombe and Dr Pamela Kirby retire by rotation and, being eligible, will offer themselves for
re-election at the AGM.

52

ACCOUNTABILITY, AUDIT AND INTERNAL CONTROL FRAMEWORK

Risk Management and Internal Control
The Board is responsible for the maintenance of the Group’s systems of risk management and internal control
and for reviewing their effectiveness. These systems, which accord with the Turnbull Guidance, have been in
place for 2004 and to the date of approval of the report and accounts, involving: the identification, evaluation and
management of key risks through a Risk Committee, which reports to the Board annually; business reviews by the
Board; and the review by the Audit Committee of internal financial controls and the risk management process.
These systems are reviewed annually by the Board. Whilst not providing absolute assurance against material
misstatements or loss, these systems are designed to identify and manage those risks that could adversely
impact the achievement of the Group’s objectives.

Risk Committee
The Risk Committee comprises the members of GEC and is chaired by the Chief Executive. As an integral part of
planning and review, management at each of the business units identify the risks involved in their business, the
probability of those risks occurring, the impact if they do occur and the actions being taken to manage those
risks. Areas of potential major impact are reported to the Risk Committee for review at its bi-annual meetings.

The most significant Group risks are reported to the Board quarterly, which will include new or increased risks.
The annual Group Risk Report by the Risk Committee to the Board details all principal risks categorised by
potential financial impact on profit and share price. These are detailed in “Risk Factors”.

In 2004 the effectiveness of the business unit systems put in place to identify and manage material risk were
evaluated and the findings reported to the Audit Committee.

Disclosures Committee and evaluation of Disclosure Controls and Procedures
The Disclosures Committee is chaired by the Chief Executive and also comprises the Finance Director and the
Group Director of Corporate Affairs. The secretary is the Company Secretary. The Committee approves the
releases of all major communications to investors, to the UK Listing Authority and the London and New York stock
exchanges.

The Chief Executive and Finance Director have evaluated the effectiveness of the design and operation of the
Group’s disclosure controls and procedures as at 31 December 2004. Based upon, and as of the date of, that
evaluation, the Chief Executive and Finance Director concluded that the disclosure controls and procedures were
effective, in all material respects, to ensure that information required to be disclosed in the reports the Group files
and submits under the Exchange Act in the US is recorded, processed, summarised and reported as and when
required.

As a consequence of the preparatory work to convert the accounts from UK GAAP to IFRS, management has
identified certain adjustments that were needed to the UK/US GAAP reconciliations in prior years and has
restated for these as disclosed in Note 39 of the Notes to the Group Accounts. Under US reporting these
adjustments, when taken together, are indicators of a material weakness in the disclosure controls relating to US
GAAP which management is remediating. This does not affect reporting under UK GAAP. There have been no
other changes in the Group’s internal control over financial reporting that occurred during the period covered by
this Annual Report that has materially affected, or is reasonably likely to materially affect, the Group’s internal
control over financial reporting.

Code of Business Principles
The code of business principles, which is available at www.smith-nephew.com/sustainability and is available on
request, applies to all directors, officers and employees. Any breaches of the code are directed in writing to the
Company Secretary who is obliged to raise the issue with the Chief Executive or Chairman. During 2004 and up
until 8 March 2005 there have been two breaches of the Code alleged, both of which have been investigated and
found to be unsubstantiated. No waivers have been put in place nor any amendments made to the Code.

Code of Ethics for Senior Financial Officers
The Board of Directors has adopted a Code of Ethics for Senior Financial Officers, which is available at
www.smith-nephew.com/sustainability and is available on request. It applies to the Chief Executive, Finance
Director, Group Financial Controller and the Group’s senior financial officers. There have been no waivers to any
of the Code’s provisions nor any amendments made to the Code during 2004 or up until 8 March 2005.

53

Activities of the Audit Committee for 2004
The Audit Committee’s remit, which is set out in its terms of reference, includes responsibility for:

• monitoring the integrity of the Company’s accounts, ensuring that they meet statutory and associated legal
and regulatory requirements and reviewing significant financial reporting judgments contained in them;

• monitoring announcements relating to the Company’s financial performance;

• monitoring and reviewing the effectiveness of the Company’s internal audit function;

• making recommendations to the Board,

for shareholder approval,

regarding the appointment,

re-appointment and removal of the external auditors, as appropriate;

•

approving the remuneration and terms of engagement of the external auditors;

• monitoring and reviewing the external auditors’ independence and the effectiveness of the audit process;

•

developing policy for and pre-approval of the external auditors to supply non-audit services;

• monitoring the effectiveness of internal financial controls;

•

•

reviewing the operation of the risk management process; and

reviewing arrangements by which staff may raise complaints against the Company regarding financial
reporting or other matters.

The Group has specific policies which govern:

•

•

the conduct of non-audit work by the external auditors which prohibits the auditors from performing services
which would result in the auditing of their own work, participating in activities normally undertaken by
management, acting as advocate for the Group and creating a mutuality of interest between the auditors
and the Group, for example being remunerated through a success fee structure. Each year, the Audit
Committee pre-approves the budget
including taxation
services, in accordance with a listing of particular services. In the event that limits for these services are
expected to be exceeded or the Group wants the external auditors to perform services that have not been
pre-approved, approval by the Chairman of the Audit Committee is required, together with a notification to
the Audit Committee of the service and the fees involved. All services provided by the independent auditors
during the year were pre-approved by the Audit Committee; and

for fees relating to audit and non-audit work,

audit partner rotation, which is in accordance with the Auditing Practices Board Ethical Standards in the UK
and the SEC rules in the US. Partners and senior audit staff may not be recruited by the Group unless two
years has expired since their previous involvement with the Group.

The Chief Executive, the Chief Financial Officer and other members of management attend the meetings when
necessary and the external auditors have unrestricted access to the Audit Committee.

The principal activities of the Audit Committee during the year ended 31 December 2004 included:

•

•

•

•

•

•

•

•

•

•

consideration of the reports on the quarterly reports, interim and annual accounts;

consideration of the proposed changes in UK GAAP and IFRS;

consideration of the Group’s preparation for the introduction of s404 of the Sarbanes-Oxley Act 2002;

a review of the Group’s approach to internal financial control, its processes, outcomes and disclosures;

a review of the Internal Review department’s activities for the year, together with its resource requirements
and findings;

a review of ‘whistleblowing’ procedures;

a review of the reports from the auditors, Ernst & Young LLP, on their professional and regulatory compliance
in order to maintain independence and objectivity, including the rotation of partners;

a review of the audit, audit-related and tax services provided by Ernst & Young LLP;

the pre-approval of all non-audit work performed by the auditor together with associated fees, to ensure that
the objectivity and independence of Ernst & Young LLP was not compromised. Ernst & Young LLP provided
no consultancy work;

consideration of Ernst & Young LLP’s in-depth reports to the Committee on the scope and outcome of the
annual audit and management’s response. Their reports included accounting matters, governance and
control and accounting developments;

54

•

•

•

•

recommending the re-appointment of Ernst & Young LLP as the Group’s auditors;

confirmation that no concerns were raised with the Committee about possible improprieties in matters of
financial reporting or other matters;

reviewing the Committee’s terms of reference to ensure they reflect recent developments in corporate
governance in the UK and the US; and

consideration of the Group’s risk management process.

The Committee may obtain legal and other independent professional advice, at the Company’s expense, as it
deems necessary. During the year, no such advice was sought by the Committee.

Future Reporting Developments
On 2 March 2005 the SEC announced the postponement by a further year for foreign registrants of the deadline
for compliance with s404 of the Sarbanes-Oxley Act of 2002. When s404 is effective in 2006, management will
be required to report on the Group’s internal controls over financial reporting. Work has been carried out during
2004 in preparation for reporting in accordance with the Act and will continue to be progressed during 2005.

Principal Accountant Fees and Services
Fees for professional services provided by Ernst & Young LLP, the Group’s independent auditors in each of the
last two fiscal years, in each of the following categories were:

Audit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Audit-related . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

1.7
0.5
1.0
–

3.2

1.4
0.3
0.6
3.7

6.0

Audit fees include fees associated with the annual audit and local statutory audits required internationally. Audit-
related fees principally include accounting consultation in relation to International Financial Reporting Standards
and advice regarding compliance with Sarbanes-Oxley in 2004. Tax fees include tax compliance, tax advice and
tax planning services. The amount included in Other in 2003 related to tax and corporate finance work in relation
to the unsuccessful public offer for Centerpulse AG and InCentive Capital AG. No such fees were incurred in
2004. A more detailed breakdown of audit fees may be found in Note 37 of the Notes to the Group Accounts.

55

SHAREHOLDERS

Shareholders
The Group issues a summary report on the year, the Summary Financial Statement, to shareholders outside the
US unless a shareholder requests the Group’s full Annual Report. Over 90% of shareholders have chosen to only
receive a copy of the Summary Financial Statement. At the half year, an Interim Report is sent to all shareholders
and quarterly reports are made available through Stock Exchange announcements and on the Group’s web site.
Copies of the full Annual Report, the Summary Financial Statement and the Interim Report are also available on
the Smith & Nephew web site along with press releases, institutional presentations and audio webcasts.

There is a regular dialogue with individual institutional shareholders, together with results presentations twice a
year. To ensure that all members of the Board develop an understanding of the views of major shareholders, the
executive directors review significant issues raised by investors with the Board. Non-executive directors are sent
copies of analysts’ and brokers’ briefings and are offered the opportunity to attend meetings with major
shareholders and are expected to do so if shareholders request a meeting. In 2004, no such request was
received. There is an opportunity for individual shareholders to question the directors at the AGM, at which the
level of proxy votes received are advised, and the Company regularly responds to letters from shareholders on a
range of issues. All the shares, including those held by directors and officers, rank pari passu with each other.

Share capital
At the AGM, the Company will be seeking a renewal of its current permission from shareholders to purchase up
to 10% of its own shares. No shares have been purchased or contracted for or are the subject of an option under
the current expiring authority given by shareholders at the AGM of 6 May 2004.

Auditors
Ernst & Young LLP have expressed their willingness to continue as auditors and resolutions proposing their
reappointment and to authorise the directors to fix their remuneration, which have been approved by the Audit
Committee, will be proposed at the AGM.

Documents on Display
It is possible to read and copy documents referred to in this Annual Report at the Registered Office of the
Company. Documents referred to in this Annual Report that have been filed with the Securities and Exchange
Commission in the US may be read and copied at the SEC’s public reference room located at 450 Fifth Street,
NW, Washington DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms and their copy charges. The SEC also maintains a web site at www.sec.gov that contains reports
and other information regarding registrants that file electronically with the SEC. This Annual Report and some of
the other information submitted by the Group to the SEC may be accessed through the SEC web site.

56

REMUNERATION REPORT
The Remuneration Report is divided into two sections, audited and unaudited information, in accordance with
Schedule 7A to the Companies Act 1985. The audited information may be found on pages 63 to 65. The
remaining sections are not subject to audit.

The Remuneration Committee
The compensation of executive directors, members of the GEC and the broad policy for executive remuneration is
determined by the Remuneration Committee whose terms of reference are available on the Company’s web site
at www.smith-nephew.com. The Committee comprises Dr. Rolf Stomberg (Chairman), Dr Pamela Kirby, Warren
Knowlton and Richard De Schutter. On behalf of the Board of Directors, it determines the broad policy for
executive remuneration. It reviews:

•

•

•

•

on an annual basis the remuneration, including pension entitlements, of executive directors and members of
the GEC and determines the operation of and the participants in the long-term incentive plans, share option
schemes and the executive bonus plan;

the relationship between the remuneration of executive directors and that of other employees;

the competitiveness of executive remuneration using data from independent consultants on companies of
similar size, technologies and international complexity; and

plans for management succession.

The Committee is assisted by Sir Christopher O’Donnell, Chief Executive and Paul Williams, Group Human
Resources Director, both of whom have advised on all aspects of the Group’s reward structures and policies but
neither is present at any discussion concerning their own remuneration. The terms of reference enable the
Committee to obtain its own external advice on any matter, at the Company’s expense.

It received information from a number of independent consultants appointed by the Company: Watson Wyatt on a
broad range of remuneration issues; Towers Perrin and Hay Group on salary data and PricewaterhouseCoopers
LLP on long-term incentive plan comparative performance. Watson Wyatt also acts as one of the retirement
benefit consultants to the Group and PricewaterhouseCoopers LLP provided consultancy services to the Group
including project and taxation advice.

Remuneration Policy
The remuneration policy for 2004 and future years, as approved by the Remuneration Committee, is designed to
ensure that remuneration is sufficiently competitive to attract, retain and motivate executive directors and GEC
members of a calibre that meets the Group’s needs to achieve its business objectives. Remuneration includes
base pay and benefits which are targeted at median competitive levels for acceptable performance and bonus
schemes which are designed to motivate and reward for outperformance. Individual remuneration levels are
based on measurable performance against fair and open objectives and there are no automatic pay adjustments
unless required by law or local protocol. Major changes to the remuneration policy are discussed with the
principal shareholders.

In 2004, a share based incentive plan, approved by shareholders, was introduced for executive directors,
members of the GEC and the next level of senior executives. The plan comprises a performance share plan,
share option plan and co-investment plan and increases the proportion of executive’s variable reward that is
wholly dependent on the Group’s performance. In 2004, excluding pension entitlements, the composition of
remuneration for Sir Christopher O’Donnell was: base pay (fixed) 41%, annual bonus (variable) 17% and
long-term incentives (variable) 42% and for Peter Hooley was base pay (fixed) 40%, annual bonus (variable) 16%
and long-term incentives (variable) 44%. Variable long term incentive values are based on those awards vesting
in the year.

Variable rewards will continue to be provided through a mix of performance related elements; the annual bonus
plan relates to achievement of
total
shareholder return relative to the Group’s competitors and FTSE-100 companies; and share options reward share
price growth.

the performance share plan rewards superior

financial objectives;

Senior executives are expected to build and maintain a personal equity stake in the Company. Executive directors
are required to accumulate a personal holding equivalent to 100% of basic salary within five years and members
of the GEC are required to accumulate a personal holding equivalent to 75% of basic salary within five years.

57

The principal components of remuneration of executive directors and GEC members are: basic salary and
benefits; performance-related bonus; long-term incentives consisting of a performance share plan, co-investment
plan and share options; and pensions.

Basic Salary and Benefits
Basic salary reflects the responsibility of the position and individual performance. The Group also provides certain
benefits such as private healthcare coverage and a company car or allowance in line with competitive practice.

Performance-Related Bonus
For executive directors, the Group operates an annual bonus scheme, 75% of which is based on annual growth
in EPSA and 25% of which is based on improvement in return on operating capital employed (“ROCE”). The
scheme is designed to encourage outstanding performance. In 2004, achievement of 14% EPSA growth and the
budgeted improvement in ROCE would have produced a bonus of 30% of annual salary. Achievement of 20%
EPSA growth and ROCE 5.5% over budget would have produced a bonus of 100% of annual salary. Bonuses are
not pensionable.

The actual bonus earned in 2004 represented 39.6% of annual salary as 15% EPSA growth, inclusive of an
adjustment for the dilution arising on the disposal of AbilityOne, was achieved and the budgeted ROCE was
exceeded.

For members of the GEC with corporate responsibilities, excluding executive directors, the annual bonus plan is
linked to earnings per share, ROCE and personal objectives. For those members with specific business unit
responsibilities, targets are linked to EPSA and sales, operating profit and ROCE of their respective business unit.

Long-Term Incentives (New Plan approved by Shareholders in May 2004)

(i)PerformanceSharePlan
Annual awards over shares are made under the 2004 Performance Share Plan after the announcement of the
preliminary results and only vest if defined levels of total shareholder returns are attained over three years
beginning in the year of award. There is no retesting.

The award shares are divided equally into two tranches so as to measure total shareholder return (“TSR”) relative
to the FTSE-100 and the major companies in the medical devices industry. TSR performance against both the
FTSE-100 companies and the major companies in the medical devices industry was identified as the most
suitable measure to encourage high levels of business performance and align the interests of the Group, its
shareholders and senior executives.

The medical devices companies for comparison for the 2004 award are:

Arthrocare
Bard
Baxter
Beckton Dickinson
Biomet
Boston Scientific
Coloplast Group
Conmed
D J Ortho
Edwards Life Sciences Corp

Guidant
Johnson & Johnson
Medtronic
Nobel Biocare
Orthofix
Stryker
St Jude Medical
Synthes-Stratec
Wright Medical
Zimmer

The shares of each tranche will vest if the Group’s TSR is ranked at the median level in that tranche. If, in relation
to either tranche, the Group ranks at or above the median, 25% of the award of that tranche will vest and if the
Group is at the 75th centile, then all of the shares of that tranche will vest. Between the median and 75th centiles,
the shares will vest on a straight-line basis. If the Group is above the 75th centile, then the number of shares
increases above the award on a straight-line basis up to a maximum of 150% of the award if the Group is ranked
at or above the 90th centile.

58

In relation to awards made to executive directors, the initial market value of the award shares is equivalent to
their basic annual salary and in relation to awards made to other GEC members the initial market value of the
awards is equivalent to 75% of their basic annual salary.

The Remuneration Committee has the discretion to reduce the number or percentage of shares which vest, if,
notwithstanding the Group is ranked at or above the median level in respect of either tranche of award shares,
the Remuneration Committee is of the opinion that the growth in the Group’s TSR achieved is not a genuine
reflection of the Group’s underlying financial performance. The Group’s TSR performance and its performance
relative to the comparator groups is independently monitored by PricewaterhouseCoopers LLP.

(ii)ExecutiveShareOptions
In 2004, share options were granted under the 2004 Executive Share Option Plan. Under this plan, the maximum
market value of options which may be granted each year is equivalent to the basic annual salary of the executive
director or executive. Options are exercisable up to ten years from the date of grant and are only exercisable if
graduated target levels of growth in EPSA over the three-year performance period are achieved, beginning with
that in which the option is granted.

The target levels of performance are set by the Remuneration Committee for each grant. For 2004 they were: 25%
of the option shares will vest if growth in EPSA over the three-year period ending 31 December 2006 is or
exceeds 26% (i.e. 8% compounded annually) with 50% vesting if such growth is at
least 48% (i.e. 14%
compounded annually). Only if growth in EPSA over that period exceeds 73% (i.e. 20% compounded annually) will
all of the option shares vest. Option shares will vest pro rata on a straight-line basis if growth in EPSA is between
these levels. There is no retesting of performance conditions.

(iii)Co-investmentPlan
The 2004 Co-investment Plan enables selected executives to take part of their annual bonus in the form of
shares. The participant elects the level of bonus to be used for this purpose up to a maximum of one half of the
annual gross bonus capped at 20% of basic annual salary for executive directors and members of GEC. The net
amount of the gross amount elected will then be used to purchase shares.

If such shares are held for three years, and the participant remains employed within Smith & Nephew, the
participant will be entitled to matching shares if the Company achieves a target level of growth in EPSA over that
three-year period of at least 48% (i.e. 14% p.a. compounded annually). At this level, the participant is entitled to
one matching share for every share acquired out of the gross equivalent amount of the net bonus used to acquire
shares. If growth in EPSA is 60% or more (i.e. 17% p.a. compounded annually) the participant is entitled to two
matching shares for each share acquired out of the gross equivalent amount of the net bonus applied to shares.
There is no sliding scale nor pro rata vesting of matching awards between these performance levels, nor is there
any retesting.

The performance criteria for all incentive schemes will be reviewed in 2005 to achieve a consistent measurement
of performance during the transition to International Financial Reporting Standards.

In the event of a change of control of the Company, for the 2004 Plans, the Remuneration Committee will
determine what proportion of the awards or options will vest and what proportion of the matching shares will be
transferred to the executives having regard to both the proportion of
the performance period and the
performance of the Company over that period.

59

The following table provides a comparison of variable remuneration of executive directors and GEC members and
the next level down (i.e. business unit management) shown as a percentage of salary. Except for the annual
bonus, the components are measured over a three year period.

Executive Directors

and GEC Members

Business Unit
Executives

Annual bonus

0% to 100%
depending on
performance

0% to 80%
depending on
performance

Performance
share plan

Equal to 100%
of salary (75%
for GEC
members) for
75th centile TSR

Equal to 35% of
salary for 75th
centile TSR

Share option
plan

Equal to 50% of
salary for EPSA
growth of 48%

Equal to 50% of
salary for EPSA
growth of 48%

Co-investment
plan

Maximum 20%
of salary with 1
to 1 matching
at EPSA growth
of 48%

Maximum 18%
of salary with 1
to 1 matching
at EPSA growth
of 48%

Previous Long-Term Incentive Plan (superseded by the New 2004 Plan)
The Performance Share Plan adopted in 2004 replaced the long-term incentive plan (“LTIP”) established in 1997
for executive directors and members of the GEC and no further awards will be made under this LTIP.

The last award through the LTIP was in 2003 and will vest at the end of 2005. Under the plan, shares are
transferred to participants depending on the Group’s performance relative to a group of 43 UK listed
manufacturing companies with substantial
international activities, using TSR over a three-year period as the
prime measure. The maximum value of shares awarded for executive directors has not exceeded the
participants’ annual rate of basic salary at the date the award was granted, and for members of the GEC it has not
exceeded 75% of their annual basic salary. Shares will only be transferred to the participants if the Group’s TSR
performance is at or above the median performance of the comparator companies, and growth in the Group’s
EPSA exceeds growth in the United Kingdom Retail Price Index (“RPI”) in the same three-year period. At the
median level, 25% of the award shares will vest. If the Group’s performance is in the top quartile, all the shares
will vest. For performance between the median and the top quartile, the proportion of shares vesting will vary on a
straight-line basis. TSR subject to real EPSA growth was identified and selected as the performance condition that
represented a fair measure of the Group’s performance and would reflect increases in shareholder value.

For the three-year plan period commencing 2002, the Group’s TSR of 58.79% was ranked 10th in the comparator
group and the earnings per share performance criterion was met, enabling the plan participants to be eligible for
100% of the shares awarded conditionally in 2002.

Every encouragement is given to executive directors and senior managers to build up a significant shareholding
in the Group. Accordingly, participants in the LTIP who have not left the Group will, at the fifth and seventh
anniversaries of the date of the award, be given one additional share for every five so retained.

The comparator group for the LTIP comprises the following companies:

Aga Foodservice Group
AstraZeneca Group
BAE Systems
Balfour Beatty
BBA Group
BOC Group
BPB
British Vita
Bunzl
Cadbury Schweppes
Charter

Cookson Group
Croda International
De La Rue
Delta
Elementis
FKI
GKN
GlaxoSmithKline
Halma
ICI
IMI

Invensys
Johnson Matthey
Laird Group
Low & Bonar
Morgan Crucible
Novar
Pilkington
Reckitt Benckiser
REXAM
RMC Group

Rolls-Royce
Scapa Group
Smiths Group
Spirax-Sarco Engineering
Spirent
Tate & Lyle
Tomkins
TT Electronics
Unilever (UK)
Weir Group

The Group’s TSR performance and its performance relative to the comparator group is independently monitored
by PricewaterhouseCoopers LLP. In the event of a change of control of the Company, for the 1997 LTIP, a
proportion of the award will vest corresponding to the period of measurement that has elapsed.

60

Executive Share Option Plans established prior to the new 2004 Plan (and for which executives included
in the New 2004 Plan are not eligible)
Prior to 2004, executive directors were last granted executive share options in 1996. These were not subject to
performance conditions of exercise. Members of the GEC were last granted options in 2001. Under the 2001 UK
Approved Share Option Plan, the 2001 UK Unapproved Share Option Plan and the 2001 US Share Plan, the
Remuneration Committee each year determines the maximum value of options to be granted to executives by
reference to multiples of salary. In 2004, the maximum multiples applied were one times remuneration in the UK
and one and a half times remuneration in the US.

With the exception of the 2001 US Share Plan, the exercise of options is subject to EPSA growth of not less than
RPI plus 3% per annum, on average, in a period of three consecutive years. From 2005, the retesting of the
performance conditions will no longer apply. Performance conditions were selected to be in line with market
practice at the time. Options granted under the 2001 US Share Plan, in line with US market practice, are not
subject to performance targets but are exercisable cumulatively up to a maximum of 10% after one year, 30%
after two years, 60% after three years and the remaining balance after four years.

Executive share options under all schemes are not offered at a discount to the market value at the time of grant.
For the 2001 Option Plans, all options will vest on a change in control.

Share Save Schemes
UK executive directors and members of the GEC are eligible to contribute to the Smith & Nephew Employee
Share Option Scheme (ShareSave) and US members of the GEC are eligible to participate in the Employee Stock
Purchase Plan.

Pensions
Executive directors and the UK based members of GEC have a normal retirement age of 62. Those in service pre-
2003 participate in the defined benefit Smith & Nephew UK Pension Fund and UK Executive Pension Scheme,
under which pension has been accrued in the year at an annual rate of one-thirtieth of final pensionable salary
up to a limit based on service of two-thirds of final pensionable salary, subject to Inland Revenue constraints.
Pensions in payment are guaranteed to increase by 5% per annum or the rate of inflation in the UK, if lower.
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. Those commencing employment post 2002 participate in the defined contribution
plan. Death in service cover of seven times salary (of which four times is provided as a lump sum) is provided on
death.

A supplementary unfunded defined contribution arrangement partially compensates for the UK Inland Revenue
earnings cap on final pensionable salary.

The Remuneration Committee has considered the implications of
the impending changes to UK pensions
taxation. At this stage, the Remuneration Committee is of the opinion that a non-pensionable non-bonusable
salary supplement will be offered as an alternative where an executive does not wish to have further pension
provision. Such a salary supplement would be cost neutral to the Company.

The US based members of GEC participate in either the defined benefit Smith & Nephew US Pension Plan or the
defined contribution US Savings Plan 401(k) Plus. Any new executives would enter the US Savings Plan 401(k)
Plus. Under the US Pension Plan, pensions accrue at an annual rate of approximately one-sixty second of final
pensionable salary up to a limit based on service of 60% of final pensionable salary. The plan also provides for a
spouse’s pension at the rate of one half of the member’s pension on death. Normal retirement age under the
plan is 65. A supplementary defined benefit plan is used to enable defined benefits to be payable from age 62
without reduction for early retirement as for UK executives. A supplementary defined contribution plan is used to
compensate for the earnings cap imposed by the US Internal Revenue Code and to provide additional retirement
benefits.

The Remuneration Committee considers pension consequences and costs to the Company when determining
basic salary increases for executive directors’ and members of GEC.

Service Contracts
Executive directors, in line with Group policy, are appointed on contracts terminable by the Group on not more
than twelve months notice. All new appointments of executive directors are intended to have twelve month notice
periods, but it is recognised that for some appointments a longer period may initially be necessary for competitive
reasons, reducing to twelve months thereafter.

61

Sir Christopher O’Donnell, appointed to the Board of Directors in September 1992, has a service agreement with
the Company dated January 1992 which expires on his 62nd birthday in October 2008. Peter Hooley, appointed
to the Board of Directors in April 1991 has a service contract with the Company dated January 1992 which
expires on his 62nd birthday in June 2008. Both service agreements are terminable by the Company on not more
than twelve months notice and by the executive director on six months notice. There is no enhancement of
termination rights on a change of control of the Group. Termination of the contract by the Group, except for
target of 30%, a
‘cause’, would entitle the executive directors to twelve months’ basic salary, bonus at
contribution of 30% of salary to reflect the loss of pension benefits, an amount to cover other benefits and a time
apportionment of the performance share plan entitlement. The Committee has determined not to amend the
contracts of the current executive directors for mitigation but will review for the appointment of new executive
directors.

External Non-executive Directorships
Non-executive directorships provide executive directors with valuable experience beneficial to the Company.
the Nominations Committee and are restricted to one
Such appointments are subject
appointment for each executive director. All fees receivable by a director are paid to the Company.

to the approval of

Non-executive Directors
Non-executive directors do not have service contracts but instead have letters of appointment. Non-executive
directors are normally appointed for three terms of three years terminable at will, without notice by either the
Group or the director and without compensation. The Chairman has a three month notice period. The
remuneration of the non-executive directors is determined by the Nominations Committee who aim to set fees
that are competitive with other companies of equivalent size and complexity. Non-executive directors are
expected to accumulate a personal holding in the Company equivalent to one times annual basic fee, within three
years.

In 2004, the Nominations Committee recommended, and the Board confirmed, a payment structure comprising
an additional £5,000 to the Chairmen of the Audit and Remuneration Committees and £5,000 to the Senior
Independent Director for their additional responsibilities.

Performance Graph
Schedule 7A to the Companies Act 1985 requires a graph to be published showing the Company’s TSR against
the TSR performance of a broad equity market index. As a component company of the FTSE-100 index, a graph of
the Company’s TSR performance compared to that of the TSR of the FTSE-100 index is shown below:

62

DIRECTORS’ REMUNERATION 2004

Directors’ Emoluments and Pensions

Salaries
and
fees

Benefits(i) Bonus

Total
emoluments
excluding
pension
entitlements

Pension
entitlements

(£ thousands)

Total
including
pension
entitlements
2004

Total
excluding
pension
entitlements
2003

Total
including
pension
entitlements
2003

Chairman (non-executive):
Dudley G. Eustace . . . . . . . . . . . . . . . . . . . . . .

Executive Directors:
Sir Christopher O’Donnell
. . . . . . . . . . . . . . . .
Peter Hooley . . . . . . . . . . . . . . . . . . . . . . . . . .

Non-executive Directors:
Dr. Rolf W. H. Stomberg . . . . . . . . . . . . . . . . . .
Warren D. Knowlton . . . . . . . . . . . . . . . . . . . . .
Richard De Schutter . . . . . . . . . . . . . . . . . . . . .
Dr. Pamela J. Kirby . . . . . . . . . . . . . . . . . . . . . .
Brian Larcombe . . . . . . . . . . . . . . . . . . . . . . . .
. . . . .
Sir Timothy Lankester (to 29 April 2003)

190

1

–

191

628
339

19
15

257
137

904
491

45
40
35
35
35
–

–
–
–
–
–
–

–
–
–
–
–
–

45
40
35
35
35
–

–

50
98

–
–
–
–
–
–

191

954
589

45
40
35
35
35
–

190

190

1,030
586

1,072
670

35
35
35
35
35
12

35
35
35
35
35
12

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,347

35

394

1,776

148

1,924

1,993

2,119

(i)

Includes cash allowances and benefits in kind.

Pensions

Accrued
pension
as at
1 Jan
2004

Increase in
accrued
pension
excluding
inflation

Accrued
pension
at
31 Dec
2004

Sir Christopher O’Donnell . . . . . . . . . . . . . . . . . 195,000
32,000
Peter Hooley . . . . . . . . . . . . . . . . . . . . . . . . . . .

(£ per annum)
45,000
3,000

245,000 2,805,000
466,000

36,000

Transfer
value of
accrued
pension
at 1 Jan
2004

(£)

Directors’
contributions
during
2004

(£)
31,000
5,000

Increase in
transfer
value over
year less
directors’
contributions

(£)
808,000
79,000

Transfer
value of
accrued
pension
at 31 Dec
2004

(£)
3,644,000
550,000

An amount of £94,000 (2003 — £81,000) was provided under the supplementary unfunded defined contribution
arrangement for Peter Hooley, bringing his total benefit under the plan to £494,000 (2003 — £400,000). The
increase in the transfer value is as a result of a change in the underlying factor to reflect current market
conditions, the unwinding of the previous year’s salary increase within the definition of final pensionable salary,
the accrual of an additional one year of service and the increase in pension as a result of the salary increase
granted during the year.

No amounts have been paid to third parties in respect of directors’ services and no excess retirement benefits or
compensation have been paid to past directors.

63

Directors’ Share Options

Options
1 Jan
2004

Granted
during
the year

Exercised

Exercise
price

Sir Christopher O’Donnell

. .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .

(Number)
–

(Number)
170,000(i)

(Number)
170,000
–
–
531,620(iii) 118,544(vi) 344,303

–
3,192(ii)

113,140(iv)

–

Total . . . . . . . . . . . . . . . . . .

704,812

231,684

514,303

Peter Hooley . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .

167,500(i)

–

–
3,349(ii)

60,050(iv)
2,404(v)
337,323(iii) 92,481(vii)

130,000
–
3,349
–

Total . . . . . . . . . . . . . . . . . .

508,172

154,935

133,349

(p)
187.0
–
–
–

154.0
–
289.2
–

Market
price at
date of
exercise

(p)
514.7
–
–
517.5

481.0
–
476.0
–

Profit on
exercise

(£)
557,090
–
–
1,781,768

Options
31 Dec
2004

(Number)
–
113,140
3,192
305,861

Average
exercise
price

(p)

–
574.5
296.0
–

2,338,858

422,193

Range of
exercisable
dates of
options
held at
31 Dec 2004

(Date)

–
5/07-5/14
11/05-4/06
7/03-6/11

425,100
–
6,256
–

37,500
60,050
2,404
429,804

431,356

529,758

193.8
574.5
394.0
–

8/98-9/06
5/07-5/14
11/07-4/08
2/01-6/11

(i) Options granted under Executive Share Option Plans.
(ii) Options granted under the UK ShareSave schemes.
(iii) Nil cost options acquired through vesting of LTIP awards.
(iv) Options granted on 19 May 2004 at an exercise price of 574.5p.
(v)
(vi) Comprises vesting of 2001 LTIP award (110,544 shares) and award of fifth anniversary bonus shares (8,000 shares).
(vii) Comprises vesting of 2001 LTIP award (69,090 shares) and award of fifth anniversary bonus shares (23,391 shares).

ShareSave options granted on 22 September 2004 at an exercise price of 394p.

The range in the market price of the Group’s Ordinary Shares during the year was 439p to 614p and the market
price at 31 December 2004 was 533p. The total profit on exercise of options during the year was £2,770,214 as
set out above (2003 — £162,750: Peter Hooley £162,750).

Long-Term Incentive Plan Awards

Maximum
number
of shares
awarded
at 1 Jan
2004

(Number)
371,032
–

Sir Christopher O’Donnell

. . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Awards
during
the year

Market
price

(p)

(Number)
–

–
113,140(i) 574.5

Vested
award

(Number)
110,544
–

Peter Hooley . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

218,978
–

–

–
60,050(i) 574.5

69,090
–

Market
price at
date of
award
22 Feb
2001

(p)
327.0
–

327.0
–

Market
price at
date of
vesting

(p)
535.5
–

535.5
–

Number
of shares
awarded
at 31
Dec
2004

(Number)
260,488
113,140

Latest
performance
period

31.12.2006
31.12.2007

149,888
60,050

31.12.2006
31.12.2007

(i)

Awards during the year awarded on 19 May 2004 under the 2004 Performance Share Plan. Subject to attainment of performance
conditions, a further 50% of the award may vest.

Co-investment Plan Awards
The number of matched shares to be allocated to each Executive Director is subject to the growth in EPSA over a
three-year period. Details of the Plan can be found on page 59.

Sir Christopher O’Donnell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Peter Hooley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13,057
6,979

22,286
11,828

44,572
23,656

Shares
acquired
with
maximum
allowable
net bonus

Matched
Shares
at 1 x gross
bonus

Matched
Shares
at 2 x gross
bonus

64

Directors’ Interests
Beneficial interests of the Directors in the Ordinary Shares of the Company are as follows:

28 February 2005 (i)

31 December 2004

1 January 2004

Shares(ii)

Options

Shares(ii)

Options

Shares(ii)

Options

Dudley G. Eustace . . . . . . .
Sir Christopher O’Donnell
. .
Peter Hooley . . . . . . . . . . . .
Brian Larcombe . . . . . . . . .
Dr. Pamela J. Kirby . . . . . . .
Dr. Rolf W. H. Stomberg . . .
Warren D. Knowlton . . . . . .
Richard De Schutter . . . . . .

51,064
178,061
219,861
5,000
8,500
13,014
27,001
250,000

–
422,193
529,758
–
–
–
–
–

(Number)

51,064
178,061
219,861
5,000
3,500
13,014
27,001
250,000

–
422,193
529,758
–
–
–
–
–

50,295
123,543
129,594
–
–
7,024
18,501
200,000

–
704,812
508,172
–
–
–
–
–

The latest practicable date for this Annual Report.

(i)
(ii) Holdings of the directors together represent less than 0.1% of the Ordinary Share Capital of the Company.

In addition to the above, on 8 March 2005, Sir Christopher O’Donnell will become entitled to 120,879 Ordinary
Shares and Peter Hooley to 70,818 Ordinary Shares in respect of the 100% vesting of the 2002 long-term
incentive plan award. On 17 February 2005, Dr Pamela Kirby purchased 5,000 Ordinary Shares. There were no
other changes in the interests of Directors between 31 December 2004 and 28 February 2005.

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.

Senior Management Remuneration
For US reporting purposes, it is necessary to provide information on remuneration and interests of directors and
members of the Company’s administrative, supervisory or management bodies (‘the senior management’). For the
purposes of this disclosure, senior management comprises members of GEC. In respect of the financial year
2004 the total compensation (excluding pension emoluments but including payments under the performance
related bonus plans) paid to members of GEC for the periods during which they served in that capacity was
£3,760,590, the aggregate increase in accrued pension benefits was £81,000, the aggregate payment to
defined contribution schemes was £10,000 and the aggregate amounts provided for under the supplementary
schemes was £327,000. During 2004 members of the GEC were granted options over 424,451 shares under the
2004 Share Option Plan, over 3,365 shares and 1,255 ADSs under the employee sharesave schemes and
awarded 273,708 shares and 17,582 ADSs in the 2004 Performance Share Plan. As of 28 February 2005
members of the GEC (comprised of nine persons) owned 444,307 shares and 164 ADSs, constituting less than
1% of the issued share capital of the Company. Members of the GEC also held, as of this date, options to
purchase 1,978,816 shares; 798,633 shares awarded under the LTIP; and 273,708 shares and 17,582 ADSs
awarded under the Performance Share Plan and held 37,552 shares and 1,901 ADSs under the Co-investment
Plan.

By order of the Board, 8 March 2005:

Paul Chambers
Secretary

65

ACCOUNTS

Directors’ responsibilities for the accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Independent auditors’ UK report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Independent auditors’ US report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group profit and loss account
Group balance sheet
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group statement of total recognised gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group reconciliation of movements in shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes to the group accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Parent company balance sheet
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes to the parent company accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

67
68
69
70
71
72
73
73
74
128
129

66

DIRECTORS’ RESPONSIBILITIES FOR THE ACCOUNTS

The directors are responsible for the preparation of the Annual Report, including the remuneration report, in
accordance with relevant UK legislation and other UK requirements. As a consequence of the Company’s
Ordinary Shares being traded on the New York Stock Exchange (in the form of American Depositary Shares) the
directors are responsible for the preparation and filing of an annual report on Form 20-F with the US Securities
and Exchange Commission. The directors are required by UK 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, appropriate UK accounting
policies have been used and applied consistently, and reasonable and prudent judgements and estimates have
been made. Applicable UK 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 maintenance of 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 provides a
report to the Audit Committee annually and the Audit Committee reviews the operation and effectiveness of
internal financial controls and reporting of the Group.

A copy of the Annual Report is placed on the Smith & Nephew website. It should be noted that information
published on the internet is accessible in many countries with different legal requirements. Legislation in the UK
governing the preparation and dissemination of accounts may differ from legislation in other jurisdictions.

67

INDEPENDENT AUDITORS’ UK REPORT

Independent Auditors’ Report to the Members of Smith & Nephew plc

We have audited the Group’s accounts for the year ended 31 December 2004 which comprise the Group profit
and loss account, Group balance sheet, Group cash flow statement, Group statement of total recognised gains
and losses, Group reconciliation of movements in shareholders’ funds, parent company balance sheet and the
related Notes 1 to 48. These accounts have been prepared on the basis of the accounting policies set out
therein. We have also audited the information in the remuneration report that is described as having been
audited.

RespectiveResponsibilitiesofDirectorsandAuditors
The directors’
responsibilities for preparing the annual report, remuneration report and the accounts in
accordance with applicable United Kingdom law and accounting standards are set out in the Statement of
Directors’ Responsibilities.

Our responsibility is to audit the accounts and the part of the remuneration report to be audited in accordance
with relevant legal and regulatory requirements, United Kingdom Auditing Standards and the Listing Rules of the
Financial Services Authority.

We report to you our opinion as to whether the accounts give a true and fair view and whether the accounts and
the part of the remuneration report to be audited have been properly prepared in accordance with the Companies
Act 1985. We also report to you if, in our opinion, the directors’ report is not consistent with the accounts, if the
Group 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 Group is not disclosed.

We review whether the corporate governance statement reflects the company’s compliance with the nine
provisions of the 2003 FRC Combined Code specified for our review by the Listing Rules of the Financial Services
Authority, 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 the Group’s corporate governance
procedures or its risk and control procedures.

We read other information contained in the annual report and consider whether it is consistent with the audited
accounts. This other information comprises the directors’ responsibilities for the accounts, unaudited part of the
remuneration report, corporate and social responsibility and corporate governance statement. We consider the
implications for our report if we become aware of any apparent misstatements or material inconsistencies with
the accounts. Our responsibilities do not extend to any other information.

BasisofAuditOpinion
We conducted our audit in accordance with United Kingdom 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 and the part of the remuneration report to be audited. 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 financial
statements and the part of the remuneration report to be audited 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 and the part of the remuneration report to be audited.

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 2004 and of the profit of the Group for the year then ended; and the financial statements and the
part of the remuneration report to be audited have been properly prepared in accordance with the Companies
Act 1985.

Ernst & Young LLP
Registered Auditor
London, England
8 March 2005

68

INDEPENDENT AUDITORS’ US REPORT

Report of Independent Registered Public Accounting Firm to the Board of Directors and Shareholders of
Smith & Nephew plc

We have audited the accompanying Group balance sheets of Smith & Nephew plc as of 31 December 2004 and
2003, and the related Group profit and loss accounts and Group statements of total recognised gains and losses,
movements in shareholders’ funds and cash flows for each of the three years in the period ended 31 December
2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our audits.

includes consideration of

We conducted our audits in accordance with United Kingdom auditing standards and the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
internal control over financial reporting as a basis for designing audit
An audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated
financial position of the Smith & Nephew Group as at 31 December 2004 and 2003, and the consolidated results
of its operations and its consolidated cash flows for each of the three years in the period ended 31 December
2004, in conformity with accounting principles generally accepted in the United Kingdom which differ in certain
respects from those generally accepted in the United States (see Note 39 of Notes to the Group Accounts).

Ernst & Young LLP
London, England
8 March 2005

69

GROUP PROFIT AND LOSS ACCOUNT

Turnover — (Note 2)
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit — (Notes 2 and 3)
Continuing operations:
Before goodwill amortisation and exceptional items . . . . . . . . . . . . . .
Goodwill amortisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items — (Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Group operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of operating profit of the joint venture before exceptional

items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of joint venture exceptional items — (Note 4) . . . . . . . . . . . . . .
Share of operating profit of associated undertaking . . . . . . . . . . . . . .

Net profit on disposal of discontinued operations — (Note 5)
. . . . . .
Net profit on disposal of the associated undertaking — (Note 5) . . . .
Profit on ordinary activities before interest . . . . . . . . . . . . . . . . . . .
Net interest receivable/(payable) — (Note 6)
. . . . . . . . . . . . . . . . . . .
Profit on ordinary activities before taxation . . . . . . . . . . . . . . . . . .
Taxation — (Note 9) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Attributable profit for the year (i)
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Ordinary dividends — (Note 10)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained profit for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Years ended 31 December
2004
2002
2003
(£ million, except per Ordinary Share
amounts)

1,248.5
–
1,248.5
165.9
1,414.4

1,178.9
–
1,178.9
163.9
1,342.8

1,083.7
26.2
1,109.9
155.0
1,264.9

251.5
(20.5)
(80.0)
151.0
–
151.0

23.8
–
–
174.8
–
–
174.8
3.1
177.9
(52.7)
125.2
(47.8)
77.4

220.7
(18.5)
(22.4)
179.8
–
179.8

22.7
(2.7)
4.8
204.6
–
31.5
236.1
(6.0)
230.1
(82.0)
148.1
(46.1)
102.0

196.0
(17.5)
(29.9)
148.6
2.1
150.7

19.6
(2.6)
4.9
172.6
18.0
–
190.6
(12.7)
177.9
(65.8)
112.1
(44.6)
67.5

Basic earnings per Ordinary Share — (Note 11) . . . . . . . . . . . . . . . . .
Diluted earnings per Ordinary Share — (Note 11) . . . . . . . . . . . . . . . .

13.39p
13.30p

15.92p
15.82p

12.11p
12.02p

Earnings before goodwill amortisation and exceptional items:
Profit on ordinary activities before taxation . . . . . . . . . . . . . . . . . . . . .
Continuing operations: goodwill amortisation . . . . . . . . . . . . . . . . . . .
Continuing operations: exceptional items . . . . . . . . . . . . . . . . . . . . . .
Share of joint venture exceptional items . . . . . . . . . . . . . . . . . . . . . . .
Net profit on disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Profit before taxation, goodwill amortisation and exceptional

items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Taxation on profit before goodwill amortisation and exceptional

177.9
20.5
80.0
–
–

278.4

items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(80.7)

230.1
18.5
22.4
2.7
(31.5)

242.2

(70.2)

177.9
17.5
29.9
2.6
(18.0)

209.9

(61.6)

Earnings before goodwill amortisation and exceptional items

(“Adjusted”) (ii)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

197.7

172.0

148.3

Adjusted basic earnings per Ordinary Share . . . . . . . . . . . . . . . . . . . .
Adjusted diluted earnings per Ordinary Share . . . . . . . . . . . . . . . . . .

21.14p
21.01p

18.49p
18.38p

16.02p
15.89p

(i)

(ii)

A summary of the adjustments to attributable profit for the financial year that would be required had accounting principles generally
accepted in the US been applied rather than those generally accepted in the UK is set out in Note 39 of the Notes to the Group
Accounts.
In order to provide a trend measure of underlying performance, profit before taxation is adjusted to exclude goodwill amortisation and
exceptional items and earnings per share has been recalculated.

70

GROUP BALANCE SHEET

2004

At 31 December
2004

2003

(£ million)

Fixed assets:
Intangible assets — (Note 12) . . . . . . . . . . . . . . . . . . .
Tangible assets — (Note 13) . . . . . . . . . . . . . . . . . . . .
Investments — (Note 14) . . . . . . . . . . . . . . . . . . . . . . .
Investment in joint venture — (Note 15):

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill
Share of gross assets . . . . . . . . . . . . . . . . . . . . .
Share of gross liabilities . . . . . . . . . . . . . . . . . . . .

69.5
113.4
(61.9)

332.2
282.5
4.9

121.0
740.6

Current assets:
Stocks — (Note 17)
Debtors — (Note 18)
Cash and bank — (Note 19)

. . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .

Creditors: amounts falling due within one year:
Borrowings — (Note 19) . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
Other creditors — (Note 21)

284.9
361.8
32.6
679.3

31.9
377.9
409.8

Net current assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets less current liabilities . . . . . . . . . . . . . . . .

269.5
1,010.1

Creditors: falling due after more than one year:
Borrowings — (Note 19) . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
Other creditors — (Note 21)
Provisions for liabilities and charges — (Note 22)
.

144.3
15.8
123.0

70.7
104.8
(53.9)

230.6
334.5
26.0
591.1

96.9
308.4
405.3

99.6
8.8
90.2

Equity capital and reserves
Shareholders’ funds:
Called up equity share capital — (Note 23) . . . . . . . . .
. . . . . . . . . . . . .
Share premium account — (Note 26)
Profit and loss account — (Note 26)
. . . . . . . . . . . . . .
Own shares — (Note 27) . . . . . . . . . . . . . . . . . . . . . . .
Shareholders’ funds (i) . . . . . . . . . . . . . . . . . . . . . . . . .

Approved by the Board on 8 March 2005.

283.1
727.0

114.5
159.6
457.1
(4.2)
727.0

2003

269.4
257.6
5.0

121.6
653.6

185.8
839.4

198.6
640.8

114.1
152.0
376.8
(2.1)
640.8

Dudley Eustace Chairman Christopher O’Donnell Chief Executive Peter Hooley Finance Director

(i)

A summary of the adjustments to shareholders’ funds that would be required had accounting principles generally accepted in the US
been applied rather than those generally accepted in the UK is set out in Note 39 of the Notes to the Group Accounts.

71

GROUP CASH FLOW STATEMENT

Net cash inflow from operating activities — (Note 28)

. . . . . . . . . . . . .

226.6

2004

Years ended 31 December
2003
(£ million)
214.5

2002

211.0

Dividends received from joint venture . . . . . . . . . . . . . . . . . . . . . . . . . .

14.1

6.8

3.9

Returns on investments and servicing of finance:
Interest received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13.9
(9.4)

Net cash outflow from returns on investments and servicing of

finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.5

Taxation paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(37.9)

Capital expenditure and financial investment:
Capital expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposal of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Trade investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Acquisitions and disposals:
Acquisitions (net of Loan Notes issued of £50.3m in 2004) . . . . . . . . . . . .
Cash acquired on acquisition of MMT (ORATEC in 2002) . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposal of associated undertaking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt repaid by the joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Equity dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

207.3

(102.0)
1.2
(0.3)

(101.1)

(36.7)
1.8
–
–
–

(34.9)

(46.7)

11.0
(14.8)

(3.8)

(52.2)

165.3

(73.2)
2.4
(0.6)

(71.4)

(4.3)
–
–
52.4
–

48.1

(45.1)

6.6
(16.8)

(10.2)

(52.3)

152.4

(85.2)
1.1
(1.3)

(85.4)

(245.4)
39.1
71.8
–
5.7

(128.8)

(43.5)

Cash inflow/(outflow) before use of liquid resources and financing . .

24.6

96.9

(105.3)

Financing:
Issue of ordinary share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Decrease)/increase in borrowings due within one year — (Note 28) . . . .
Increase/(decrease) in borrowings due after one year — (Note 28)
. . . . .
Settlement of currency swaps — (Note 28)
. . . . . . . . . . . . . . . . . . . . . . . .
Own shares purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net cash (outflow)/inflow from financing . . . . . . . . . . . . . . . . . . . . . . . .

Increase/(decrease) in cash net of overdrafts — (Note 28) . . . . . . . . . .

8.0
(61.9)
1.3
39.8
(4.1)

(16.9)

7.7

8.5
(47.4)
(52.9)
–
(1.3)

(93.1)

3.8

6.1
70.6
18.1
–
(2.4)

92.4

(12.9)

(i)

The significant differences between the cash flow statement presented above and that required under accounting principles generally
accepted in the US are set out in Note 39 of Notes to the Group Accounts.

72

GROUP STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES

Attributable profit for the financial year (i)
. . . . . . . . . . . . . . . . . . . . . .
Translation differences on foreign currency net investments . . . . . . .

Years Ended 31 December
2003
(£ million)
148.1
3.8

2004

125.2
3.2

2002

112.1
9.1

Total recognised gains and losses relating to the year . . . . . . . . . . . .

128.4

151.9

121.2

(i)

(ii)

Included in the attributable profit for the financial year is £15.5m (2003 — £12.5m, 2002 — £10.3m) profit relating to the joint venture
and nil (2003 — £2.8m, 2002 — £3.0m) profit relating to the associated undertaking.

The statement of comprehensive income required under accounting principles generally accepted in the US is set out in Note 39 of
Notes to the Group Accounts.

GROUP RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS

Years Ended 31 December
2003
(£ million)
148.1
(46.1)

2002

112.1
(44.6)

2004

125.2
(47.8)

77.4
3.2
–
1.7
(4.1)
8.0
–

86.2
640.8

727.0

102.0
3.8
8.2
2.7
(1.3)
8.5
–

123.9
516.9

640.8

67.5
9.1
30.0
1.6
(2.4)
8.4
(2.3)

111.9
405.0

516.9

Attributable profit for the financial year
. . . . . . . . . . . . . . . . . . . . . . . .
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Retained profit for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Translation differences on foreign currency net investments . . . . . . .
Goodwill on disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share based expense recognised in the profit and loss account . . . .
. . . . . . . . . . . . . . . . . . . . . .
Cost of own shares purchased (Note 27)
Issue of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
Movements relating to the QUEST (Note 24)

Net addition to shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . .
Opening shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Closing shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

73

NOTES TO THE GROUP ACCOUNTS

1. Accounting Policies

The accounts have been prepared under the historical cost convention and in accordance with applicable
UK accounting standards and include the disclosures required by Financial Reporting Standard 17
(“FRS 17”).

In applying these policies management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the accounts and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Consolidation
The Group accounts include the accounts of Smith & Nephew plc (the “Company”) and all the subsidiaries
and associated undertakings for the periods during which they were members of the Group. In these
financial statements, “Group” means the Company and all its subsidiaries.

Entities in which the Group holds an interest on a long-term basis and which are controlled by the Group
and one other under a contractual agreement are joint ventures. Joint ventures are included in the
consolidated accounts under the gross equity method.

Entities 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 are associated undertakings.
Associates are included in the consolidated accounts under the equity method.

Turnover
Turnover comprises sales of products and services to third parties at amounts invoiced net of trade
discounts and rebates, excluding turnover taxes. Turnover from the sale of products and services is
recognised upon transfer to the customer of the significant risks and rewards of ownership. This is generally
when goods are dispatched to, or services performed for, customers except that sales of stock located at
customer premises and available for customers immediate use are recognised as soon as notification is
received that the product has been implanted or used. Appropriate provisions for returns, trade discounts
and other allowances are deducted from turnover. Other turnover is recorded as earned or as services are
performed.

ForeignCurrencies
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
undertakings and associated undertakings are translated at the average rates for the year.

Forward currency contracts in respect of contracted and anticipated amounts payable on purchase
transactions are accounted for as hedges with the hedged transaction recorded at the rate implicit in the
contract. 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.

The following are recorded as movements in reserves: exchange differences on the translation at closing
rates of exchange of overseas opening net assets,
the difference on
translation of
foreign currency borrowings or swaps that are used to finance or hedge Group equity
investments; and the differences arising between the translation of profits at average and closing exchange
rates. All other exchange differences are dealt with in arriving at profit before taxation.

including acquisition goodwill;

IntangibleFixedAssets
Prior to 1 January 1998, goodwill representing the excess of purchase consideration over fair value of net
reserves in the year of acquisition. Goodwill acquired since
assets acquired was set-off against
31 December 1997 and other acquired intangibles are capitalised and amortised on a straight line basis
over their estimated useful economic lives, between 3 and 20 years, except for goodwill arising on the
formation of the BSN Medical joint venture and acquisition of the Group’s share of the AbilityOne associated
undertaking, which is not amortised but is subject to an annual impairment review. This treatment, which is a
departure from the requirement of the Companies Act 1985 of Great Britain (the “Companies Act”) to
amortise goodwill, is adopted in order to show a true and fair view (See Note 15 and Note 16). Where
applicable, goodwill previously set-off against reserves is deducted in the calculation of gains on disposal.

74

1. Accounting Policies — (continued)

The carrying value of goodwill and acquired intangibles is reviewed for impairment at the end of the first full
financial year following acquisition and in other periods if significant events or changes in circumstances
indicate the carrying value may be impaired.

Purchased patents, know-how, trademarks, licences and distribution rights are capitalised and amortised
over their estimated useful lives of periods between 3 and 15 years.

The carrying values of intangibles are reviewed for impairment when events or changes in circumstances
indicate the carrying value may be impaired.

ResearchandDevelopment
Revenue expenditure on research and development is written off as incurred.

AdvertisingCosts
Expenditure on advertising costs is written off as incurred.

TangibleFixedAssets
Tangible fixed assets are stated at cost less depreciation and provision for impairment where appropriate.
Freehold land is not depreciated. Freehold and long leasehold buildings are depreciated on a straight-line
basis at between 2% 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 is 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.

Finance costs relating to the purchase of fixed assets are not capitalised.

LeasingCommitments
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.

Rentals payable under operating leases are charged to the profit and loss account as incurred.

Investments
Trade investments are stated at cost less provision for any permanent diminution in value.

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. All stocks are reduced to net realisable
value where lower than cost.

Orthopaedic instruments are generally not sold but
loaned to customers and distributors for use in
orthopaedic surgery. They are recorded as stock until they are deployed at which point they are transferred
to fixed assets and depreciated over their useful lives.

FinancialInstruments
Currency swaps to match foreign currency net assets with foreign currency liabilities are translated into
Sterling at year-end exchange rates. Changes in the principal values of currency swaps are matched in
reserves against changes in the values of the related assets. The fixed rate element of currency swaps and
interest rate swaps transacted to protect interest costs and income are accounted for as hedges. Changes
in the values of interest rate hedges are recognised against interest in the period relating to the hedge.

DeferredTaxation
Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at
the balance sheet date where transactions or events have occurred at that date that will result in an
obligation to pay more, or a right to pay less or to receive more, tax.

No provision is made for deferred tax that would arise on the remittance of the retained earnings of
overseas subsidiaries, associates and joint ventures except to the extent that, at the balance sheet date,
dividends have been accrued as receivable.

75

1. Accounting Policies — (continued)

Deferred tax assets are recognised only to the extent that the directors consider that it is likely that taxable
income will be available against which future reversals of the underlying timing differences can be made.

Deferred tax is measured on an undiscounted basis at the tax rates that are expected to apply in the
periods in which timing differences are expected to reverse. These are based on tax rates and laws
substantively enacted at the balance sheet date.

Post-RetirementBenefits
The Group’s major pension plans are of the defined benefit type. For these plans, in accordance with SSAP
24, 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. For defined contribution plans, contributions 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.

ContingenciesandProvisions
In the normal course of business the Group is involved in numerous legal disputes. Provision is made for
loss contingencies when it is deemed probable that an adverse outcome will occur and the amount of the
loss can be reasonably estimated. Where the Group is the plaintiff in pursuing claims against third parties
legal and associated expenses are charged to profit and loss account as incurred.

The Group operates in multiple tax jurisdictions around the world and records provisions for taxation
liabilities and tax audits when it is deemed probable that a tax charge will arise and the amount can be
reasonably estimated.

2(a). Segmental Analysis — Information Required under UK GAAP

Group turnover by business segment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

588.7
304.8
355.0

525.4
300.0
353.5

470.2
291.8
321.7

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5
–

1,178.9
–

1,083.7
26.2

1,248.5

1,178.9

1,109.9

Discontinued operations in 2002 comprise the results of the rehabilitation business up until its disposal in
March 2002.

76

2(a). Segmental Analysis — Information Required under UK GAAP — (continued)

Group turnover by geographic origin
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: intragroup sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

242.4
313.7
745.2
35.4
177.9

196.9
302.4
723.5
33.4
166.5

179.6
250.7
702.1
28.6
144.3

1,514.6
–

1,514.6
(266.1)

1,422.7
–

1,422.7
(243.8)

1,305.3
26.2

1,331.5
(221.6)

1,248.5

1,178.9

1,109.9

Group turnover by geographic market
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

122.5
287.2
608.5
41.0
189.3

98.7
271.2
595.6
36.7
176.7

87.3
231.4
579.4
31.1
154.5

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5
–

1,178.9
–

1,083.7
26.2

Group operating profit by business segment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5

1,178.9

1,109.9

138.6
61.8
51.1
(20.5)
(80.0)

151.0
–

151.0

118.7
59.5
42.5
(18.5)
(22.4)

179.8
–

179.8

98.2
53.8
44.0
(17.5)
(29.9)

148.6
2.1

150.7

Items between Group operating profit of £151.0m (2003 — £179.8m, 2002 — £150.7m) and profit on
ordinary activities before taxation of £177.9m (2003 — £230.1m, 2002 — £177.9m) comprise share of
operating profit of the joint venture £23.8m (2003 — £20.0m, 2002 — £17.0m), share of operating profit of
the associated undertaking of nil (2003 — £4.8m, 2002 — £4.9m), net profit on disposals of nil (2003
— £31.5m, 2002 — £18.0m) and net interest receivable of £3.1m (2003 — £6.0m payable, 2002 —
£12.7m payable) which are not allocated segmentally.

Exceptional costs are allocated as follows: Orthopaedics £80.0m (2003 — £17.6m, 2002 — £0.8m),
Endoscopy nil (2003 — £4.8 m, 2002 — £7.6m) and Advanced wound management nil (2003 — nil, 2002
— £21.5m). Amortisation of goodwill of £20.5m (2003 — £18.5m, 2002 — £17.5m) arose as follows:
Orthopaedics £6.8m (2003 — £4.1m, 2002 — £4.7m), Endoscopy £7.8m (2003 — £8.5m, 2002 — £7.1m)
and Advanced wound management £5.9m (2003 — £5.9m, 2002 — £5.7m).

77

2(a). Segmental Analysis — Information Required under UK GAAP — (continued)

Group operating profit by geographic origin
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

45.0
49.1
126.7
2.6
28.1
(20.5)
(80.0)

151.0
–

151.0

26.7
35.3
131.5
1.1
26.1
(18.5)
(22.4)

179.8
–

179.8

21.7
21.1
129.8
(0.7)
24.1
(17.5)
(29.9)

148.6
2.1

150.7

Exceptional costs of £80.0m in 2004 arose as follows: £0.6m in Continental Europe, £74.1m in the United
States and £5.3m in Africa, Asia and Australasia (2003 — £22.4m: United Kingdom £17.6m and United
States £4.8m, 2002 — £29.9m: United Kingdom £1.5m, Continental Europe £2.4m, United States £25.8m,
Other America £0.1m and Africa, Asia and Australasia £0.1m).

Amortisation of goodwill of £20.5m (2003 — £18.5m, 2002 — £17.5m) arose as follows: £5.4m (2003 —
£1.3m, 2002 — £1.2m) in the United Kingdom, £2.5m (2003 — £2.6m, 2002 — £2.1m) in Continental
Europe, £12.2m (2003 — £14.1m, 2002 — £13.7m) in the United States and £0.4m (2003 — £0.5m, 2002
— £0.5m) in Africa, Asia and Australasia.

Group operating assets by business segment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

386.1
236.6
256.9

879.6

319.7
248.9
233.5

802.1

309.6
275.0
222.5

807.1

Group operating assets by geographic origin
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

244.1
84.7
461.2
16.7
72.9

879.6

161.6
72.4
487.6
14.2
66.3

802.1

153.2
70.6
511.3
13.0
59.0

807.1

Operating assets reconcile to net assets as follows:

Operating assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment in the joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment in the associated undertaking . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation creditor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred taxation debtor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ordinary share dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

879.6
121.0
–
(112.0)
(105.8)
6.3
(32.1)
(30.0)

2003
(£ million)
802.1
121.6
–
(127.1)
(69.4)
4.4
(61.9)
(28.9)

2002

807.1
115.0
8.5
(276.9)
(56.9)
4.0
(56.0)
(27.9)

Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

727.0

640.8

516.9

78

2(b). Segmental Analysis — Information Required under US GAAP

The following business and geographic segmental information is required by SFAS 131 — Disclosures about
Segments of an Enterprise and Related Information and has been derived from the Group’s management
reports.

Group management reviews and monitors business unit performance by use of key performance indicators
which differ in certain respects from the way results are reported in the Group Accounts which are
determined by UK GAAP and US GAAP.

Business units report sales of continuing operations only and at constant rates of exchange throughout a
particular year. The effects of currency movements are excluded by setting at the beginning of each year
exchange rates which remain constant throughout the year. These are termed the Management Rates (“MR”)
for the year. These are reset each year and prior year comparative data re-translated to the new rates.
Additional sales brought in by acquisitions, for which there are no prior year comparatives, are excluded
from the calculation of underlying sales growth which is management’s key indicator of sales performance.
In the tables below, underlying sales growth can be calculated by dividing current year turnover at MR by
comparative prior year turnover at MR.

Business units report operating profit of continuing operations before goodwill amortisation and exceptional
items and at constant rates of exchange during the year.

Management believes the Group’s internal reporting measures are the most appropriate since they focus on
underlying business performance and exclude the distorting effects of exchange rate translation and non-
operating items. These measures are used in financial reporting, budgets, planning and incentive plans.

Results in the Group Accounts are reported at the average rates for each year (“AR”) (See Note 1 and
Note 29).

Orthopaedics

Endoscopy

Advanced
wound
management

Continuing
Operations

(£ million)

Turnover by business segment
2004:
Turnover at 2004 MR . . . . . . . . . . . . . . . . . . . . . .
Adjustment for 2004 acquisitions . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2004 AR . . . . . . . . . . . . . . . . . . . . . .

2003:
Turnover at 2004 MR . . . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2003 AR . . . . . . . . . . . . . . . . . . . . . .

2003:
Turnover at 2003 MR . . . . . . . . . . . . . . . . . . . . . .
Adjustments for 2002 acquisitions . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2003 AR . . . . . . . . . . . . . . . . . . . . . .

2002:
Turnover at 2003 MR . . . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2002 AR . . . . . . . . . . . . . . . . . . . . . .

585.7
20.0
(17.0)

588.7

499.3
26.1

525.4

524.1
–
1.3

525.4

451.0
19.2

470.2

313.4
–
(8.6)

304.8

286.3
13.7

300.0

291.7
6.9
1.4

300.0

281.0
10.8

291.8

363.8
–
(8.8)

355.0

347.4
6.1

353.5

345.3
–
8.2

353.5

316.8
4.9

321.7

1,262.9
20.0
(34.4)

1,248.5

1,133.0
45.9

1,178.9

1,161.1
6.9
10.9

1,178.9

1,048.8
34.9

1,083.7

79

2(b). Segmental Analysis — Information Required under US GAAP — (continued)

Europe(i)

US

Africa, Asia,
Australasia
and Other
America

Continuing
Operations

(£ million)

Turnover by geographic region
2004:
Turnover at 2004 MR . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustment for 2004 acquisitions . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2004 AR . . . . . . . . . . . . . . . . . . . . . . . . . .

2003:
Turnover at 2004 MR . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2003 AR . . . . . . . . . . . . . . . . . . . . . . . . . .

2003:
Turnover at 2003 MR . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustment for 2002 acquisitions . . . . . . . . . . . . . . . .
Exchange differences . . . . . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2003 AR . . . . . . . . . . . . . . . . . . . . . . . . . .

2002:
Turnover at 2003 MR . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . . .

Turnover at 2002 AR . . . . . . . . . . . . . . . . . . . . . . . . . .

(i)

Europe comprises Continental Europe and the UK.

404.5
15.4
(10.2)

409.7

373.9
(4.0)

369.9

356.2
–
13.7

369.9

323.7
(5.0)

318.7

626.0
–
(17.5)

608.5

547.6
48.0

595.6

601.6
6.9
(12.9)

595.6

543.7
35.7

579.4

232.4
4.6
(6.7)

230.3

211.5
1.9

213.4

203.3
–
10.1

213.4

181.4
4.2

185.6

1,262.9
20.0
(34.4)

1,248.5

1,133.0
45.9

1,178.9

1,161.1
6.9
10.9

1,178.9

1,048.8
34.9

1,083.7

Orthopaedics

Endoscopy

Advanced
wound
management

Continuing
Operations

(£ million)

Operating profit by business segment
2004:
Operating profit at 2004 MR . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit at 2004 AR . . . . . . . . . . . . . . . . . . . . .

2003:
Operating profit at 2004 MR . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit at 2003 AR . . . . . . . . . . . . . . . . . . . . .

2003:
Operating profit at 2003 MR . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit at 2003 AR . . . . . . . . . . . . . . . . . . . . .

2002:
Operating profit at 2003 MR . . . . . . . . . . . . . . . . . . . .
Exchange difference . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit at 2002 AR . . . . . . . . . . . . . . . . . . . . .

142.7
(4.1)

138.6

111.3
7.4

118.7

119.7
(1.0)

118.7

93.8
4.4

98.2

63.5
(1.7)

61.8

56.4
3.1

59.5

60.0
(0.5)

59.5

51.6
2.2

53.8

51.9
(0.8)

51.1

43.1
(0.6)

42.5

40.9
1.6

42.5

43.5
0.5

44.0

258.1
(6.6)

251.5

210.8
9.9

220.7

220.6
0.1

220.7

188.9
7.1

196.0

80

2(b). Segmental Analysis — Information Required under US GAAP — (continued)

Capital expenditure by business segment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

70.7
15.6
15.7

102.0
–

102.0

42.0
14.8
16.4

73.2
–

73.2

47.4
17.2
20.4

85.0
0.2

85.2

Capital expenditure comprises additions of tangible and intangible fixed assets. In addition, in 2004, £0.3m
of additions to trade investments related to Orthopaedics (2003 — £0.6m, 2002 — £1.3m).

Depreciation and amortisation by business segment
Orthopaedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advanced wound management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45.6
19.7
19.3

84.6
–

84.6

36.7
22.5
19.1

78.3
–

78.3

35.5
19.8
18.3

73.6
0.6

74.2

Amounts comprise depreciation of tangible fixed assets and amortisation of other intangible fixed assets
and goodwill as follows:

Depreciation of tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of other intangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Long lived assets by geographic origin
United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Long lived assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Long lived assets comprise tangible and intangible fixed assets and investments.

58.4
5.7

64.1
20.5

84.6

213.1
30.8
336.1
3.3
36.3

619.6

54.8
5.0

59.8
18.5

78.3

141.6
25.2
339.5
3.2
22.5

532.0

51.6
5.1

56.7
17.5

74.2

143.4
23.8
387.2
3.2
20.4

578.0

81

3. Operating Profit

Continuing operations

2004

2003

(£ million)

Turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,248.5
(334.8)

1,178.9
(345.1)

Gross profit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing, selling and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development
BSN agency and management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of goodwill
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Group operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

913.7
(476.8)
(134.0)
(66.4)
15.0
(20.5)
(80.0)

151.0

833.8
(440.1)
(125.5)
(66.8)
19.3
(18.5)
(22.4)

179.8

Exceptional
sales £4.8m and administration £17.6m).

items of £80.0m were incurred as follows: administration £80.0m (2003 — £22.4m cost of

Continuing
operations

Turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,083.7
(313.6)

Gross profit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Marketing, selling and distribution . . . . . . . . . . . . . . . . . . . . . . . . .
Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Research and development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
BSN agency and management fees . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of goodwill
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Group operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

770.1
(408.5)
(125.0)
(61.2)
20.6
(17.5)
(29.9)

148.6

2002

Discontinued
operations
(£ million)
26.2
(16.3)

9.9
(5.6)
(2.1)
(0.1)
–
–
–

2.1

Total

1,109.9
(329.9)

780.0
(414.1)
(127.1)
(61.3)
20.6
(17.5)
(29.9)

150.7

Exceptional
distribution £2.5m, administration £22.6m and research and development £2.0m.

items of £29.9m were incurred as follows: cost of sales £2.8m, marketing, selling and

Operating profit is stated after charging the following items:

Amortisation of other intangible fixed assets . . . . . . . . . . . . . . . . .
Depreciation of tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . .
Loss on sale of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease rentals for land and buildings . . . . . . . . . . . . . . . .
Operating lease rentals for other assets . . . . . . . . . . . . . . . . . . . . .
Advertising costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.

Exceptional Items

2004

5.7
58.4
2.6
11.4
11.7
18.7

2003
(£ million)
5.0
54.8
1.9
11.2
10.9
18.9

2002

5.1
51.6
2.7
11.0
9.8
15.1

In 2004, the operating exceptional
item within continuing operations of £80.0m represents provision of
£13.4m for the amount due from excess layer insurers who have declined insurance coverage for claims
relating to macrotextured knee revisions together with an estimate of £66.6m for the cost of settlements with
patients likely to arise in the future and assuming that insurance cover remains unavailable (see Note 32).

In 2003, operating exceptional items within continuing operations of £22.4m comprise £17.6m of costs, net
of a break fee of £10.8m, written off as a consequence of the unsuccessful public offers to purchase
Centerpulse AG and Incentive Capital AG and £4.8m of acquisition integration costs. The Group’s share of
exceptional items of the joint venture relates to its share of manufacturing rationalisation costs.

82

4.

Exceptional Items — (continued)

In 2002, operating exceptional items of £29.9m comprised £17.5m for the write-down of the Group’s trade
investment in the common stock of Advanced Tissue Sciences, Inc., £8.4m for the acquisition integration of
ORATEC and Dermagraft and £4.0m for further rationalisation consequent on the contribution of businesses
to BSN Medical in 2001. The Group’s share of exceptional items of the joint venture related to its share of
manufacturing rationalisation costs.

5. Net Profit and Loss on Disposals

In 2003, net cash consideration of £52.4m was received on the disposal of the 21.5% equity interest in AbilityOne
Corporation (AbilityOne) to Patterson Dental Inc. A net profit of £31.5m arose after writing off £8.2m of acquisition
goodwill previously set-off against reserves and £1.1m of adjustments in respect of previous disposals.

In 2002, a net profit of £17.2m arose on the disposal of the rehabilitation business for a net cash
consideration of £71.3m and a 21.5% equity interest in AbilityOne. The net profit consists of a gain of
£47.2m less £30.0m of acquisition goodwill previously set-off against reserves. In addition, a net gain of
£0.8m arose on adjustments in respect of previous disposals.

6.

Interest

Interest payable:
Bank borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of joint venture’s net interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of associated undertaking’s net interest payable . . . . . . . . . . . . . . . . . . . . .

Net interest receivable/(payable)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

(6.4)
(1.1)
(1.9)

(9.4)
13.9
(1.4)
–

3.1

(14.2)
(0.6)
–

(14.8)
11.0
(1.5)
(0.7)

(16.2)
(0.6)
–

(16.8)
6.6
(1.6)
(0.9)

(6.0)

(12.7)

Interest payable on currency swaps of £14.6m (2003 — £18.5m, 2002 — £23.3m) has been set off against
interest receivable.

7.

Employees

The average number of employees during the year was:

United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Continental Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa, Asia and Australasia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Staff costs during the year amounted to:

Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Social security costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other pension costs — (Note 33)

2004

1,679
1,374
3,437
190
1,186

7,866

2003
(Number)
1,600
1,317
3,177
200
1,157

7,451

2002

1,740
1,279
3,090
201
1,196

7,506

2004

265.8
28.9
25.4

320.1

2003
(£ million)
260.0
27.2
21.6

308.8

2002

261.1
25.1
14.3

300.5

Of the other pension costs £18.8m (2003 — £16.9m, 2002 — £11.0m) relates to defined benefit plans and
£6.6m (2003 — £4.7m, 2002 — £3.3m) relates to defined contribution plans.

83

8. Directors’ Emoluments

Aggregate emoluments of the directors, including pension entitlements of £148,000 (2003 — £126,000,
2002 — £106,000), were £1,924,000 (2003 — £2,119,000, 2002 — £1,823,000). The emoluments of the
highest paid director excluding pension entitlement were £904,000 (2003 — £1,030,000, 2002 —
£856,000). Two (2003 — two) directors get defined benefit pension entitlements, the accrued pension of
the highest paid director at the end of the year was £245,000 (2003 — £195,000, 2002 — £153,000).

Information concerning individual directors’ emoluments, pension entitlements, shareholdings and share
options is shown in the “Remuneration Report”.

9.

Taxation

Current taxation:
UK corporation tax at 30% (2003 — 30%, 2002 — 30%)
. . . . . . . . . . . . . . . . . . . .
UK adjustments in respect of prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Overseas tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Overseas adjustments in respect of prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Share of joint venture’s tax charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of associated undertaking’s tax charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003
(£ million)

2002

19.9
(4.8)

15.1

57.2
(3.7)

53.5

6.4
–

6.8
0.5

7.3

53.9
3.6

57.5

6.0
1.3

8.9
(2.3)

6.6

38.5
(3.0)

35.5

4.5
1.0

Total current taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

75.0

72.1

47.6

Deferred taxation:
Origination and reversal of timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to estimated amounts arising in prior periods . . . . . . . . . . . . . . . . . . .
Share of joint venture’s deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(23.7)
0.9
0.5

(22.3)

52.7

17.1
(7.2)
–

9.9

82.0

14.6
3.0
0.6

18.2

65.8

The tax charge was reduced by £28.0m in 2004 as a consequence of the exceptional item relating to the
denial of insurance coverage for macrotextured knee revisions, resulting in a tax charge on profit before
exceptional items of £80.7m.

In 2003, the tax charge was reduced by £4.3m of which £0.8m arose in the joint venture, as a consequence
of the exceptional costs relating to the rationalisation and acquisition integration costs and the unsuccessful
public offers to purchase Centerpulse AG and Incentive Capital AG and increased by £16.1m as a result of
the exceptional profit on disposal of the associated undertaking, resulting in a tax charge on profits before
exceptional items of £70.2m.

In 2002,
the tax charge was reduced by £12.7m of which £0.6m arose in the joint venture, as a
consequence of the exceptional costs of the write-off of the Advanced Tissue Sciences, Inc., investment and
rationalisation and acquisition integration costs and increased by £16.9m as a result of the exceptional
profit on disposal, resulting in a tax charge on profits before exceptional items of £61.6m.

84

9.

Taxation — (continued)

The standard rate of tax for the year is based on the United Kingdom standard rate of corporation tax of 30%
(2003 — 30%, 2002 — 30%). The current and total tax charges differ from the standard rate as follows:

UK standard rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-deductible/non-taxable items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior year items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Overseas income taxed at other than UK standard rate . . . . . . . . . . . . . . . . . . . . .
Fixed asset timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax relief on the macrotextured exceptional item . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Effective total current tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed asset timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax relief on the macrotextured exceptional item . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

30.0
(0.1)
(4.8)
4.5
(4.1)
15.7
1.0

42.2
4.1
(15.7)
(1.0)

Total tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

29.6

2003
(%)
30.0
(4.0)
1.8
7.8
(2.7)
–
(1.6)

31.3
2.7
–
1.6

35.6

2002

30.0
3.1
(3.0)
6.9
(3.3)
–
(6.9)

26.8
3.3
–
6.9

37.0

Factors that may Affect Future Total Tax Charges
Tax rates on the Group’s overseas profits are generally higher than the UK corporation tax rate so changes
in the proportion of profits earned overseas will affect the Group’s effective tax rate over time. The current
tax charge may also be affected by differences between tax allowances and book depreciation.

No deferred tax is recognised on unremitted earnings of overseas subsidiaries and joint ventures. No
significant additional tax charges are expected to arise on amounts that are planned to be remitted in the
foreseeable future.

No provision has been made for deferred tax on gains recognised on the sale of assets where potentially
taxable gains have been rolled over into replacement assets. Such tax would become payable only if the
assets were sold without it being possible to claim rollover relief. The total amount unprovided is £35.8m
(2003 — £31.4m, 2002 — £31.4m). At present, it is not envisaged that any tax will become payable in the
foreseeable future.

10. Dividends

Ordinary interim of 1.90p (2003 — 1.85p, 2002 — 1.80p) paid 12 November

2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ordinary final of 3.20p (2003 — 3.10p, 2002 — 3.00p) payable 13 May 2005 . . .

2004

2003
(£ million)

2002

17.8
30.0

47.8

17.2
28.9

46.1

16.7
27.9

44.6

In addition, in 2003 non-equity preference dividends of £14,000 were paid (2002 — £15,000).

85

11. Earnings per Ordinary Share

The calculation of basic earnings per Ordinary Share of 13.39p (2003 — 15.92p, 2002 — 12.11p) is based
on profit on ordinary activities after taxation and preference dividends of £125.2m (2003 — £148.1m, 2002
— £112.1m) and on 935m Ordinary Shares (2003 — 930m, 2002 — 926m) being the weighted average
number of shares in issue during the year. The calculation of diluted earnings per Ordinary Share of 13.30p
(2003 — 15.82p, 2002 — 12.02p) is based on the diluted weighted average number of shares which is
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 . . . . . . . . . . . . . . . . .

2002

2004

2003
(Shares million)
930
19
(13)

935
18
(12)

926
19
(12)

Diluted weighted average number of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

941

936

933

12.

Intangible Fixed Assets

Cost
At 1 January 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Write back of deferred consideration — (Note 30)

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amortisation
At 1 January 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Charge for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Write back of deferred consideration — (Note 30)

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Charge for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Goodwill

Other
(£ million)

Total

317.9
(19.8)
2.4
0.1
–
(8.5)

292.1
(14.4)
92.2
–
–

369.9

35.4
(2.6)
18.5
(1.3)

50.0
(2.7)
20.5
–

67.8

52.3
(4.7)
(1.7)
0.3
1.5
–

47.7
(3.1)
2.7
7.4
(1.2)

53.5

17.6
(2.2)
5.0
–

20.4
(1.5)
5.7
(1.2)

23.4

370.2
(24.5)
0.7
0.4
1.5
(8.5)

339.8
(17.5)
94.9
7.4
(1.2)

423.4

53.0
(4.8)
23.5
(1.3)

70.4
(4.2)
26.2
(1.2)

91.2

Net book amounts
At 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

302.1

242.1

30.1

27.3

332.2

269.4

86

13. Tangible Fixed Assets

Land and buildings

Freehold

Leasehold

Plant and
equipment
(£ million)

In course of
construction

Total

Cost
At 1 January 2003 . . . . . . . . . . . . . . . . . . .
Exchange adjustment
. . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2003 . . . . . . . . . . . . . . . .
Exchange adjustment
. . . . . . . . . . . . . . . .
Acquisitions . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2004 . . . . . . . . . . . . . . . .

Depreciation
At 1 January 2003 . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .
Exchange adjustment
Charge for the year . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2003 . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .
Exchange adjustment
Charge for the year . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2004 . . . . . . . . . . . . . . . .

Net book amounts
At 31 December 2004 . . . . . . . . . . . . . . . .

At 31 December 2003 . . . . . . . . . . . . . . . .

60.8
(4.2)
–
0.3
(1.4)
12.5

68.0
(3.1)
–
0.7
(0.3)
4.4

69.7

11.6
(0.9)
1.8
(0.2)

12.3
(0.5)
2.6
(0.2)

14.2

55.5

55.7

10.0
(0.3)
–
0.3
(0.2)
–

9.8
(0.3)
–
1.2
(1.1)
–

9.6

3.9
(0.2)
0.5
(0.2)

4.0
(0.2)
0.4
(0.8)

3.4

6.2

5.8

462.9
(22.0)
0.3
45.3
(23.4)
24.8

487.9
(17.9)
2.5
66.1
(30.4)
18.2

526.4

292.7
(15.8)
52.5
(20.3)

309.1
(11.2)
55.4
(27.2)

326.1

200.3

178.8

30.3
(1.5)
–
25.8
–
(37.3)

17.3
(0.6)
–
26.6
(0.2)
(22.6)

20.5

–
–
–
–

–
–
–
–

–

20.5

17.3

564.0
(28.0)
0.3
71.7
(25.0)
–

583.0
(21.9)
2.5
94.6
(32.0)
–

626.2

308.2
(16.9)
54.8
(20.7)

325.4
(11.9)
58.4
(28.2)

343.7

282.5

257.6

Fixed assets include land with a cost of £6.0m (2003 — £5.9m) that is not subject to depreciation. The net
book value of leases with less than 50 years to run amounted to £6.2m (2003 — £5.8m). Included in the
amounts above are assets held under finance leases with a net book amount of £2.8m (2003 — £3.0m).
There were no properties for resale in 2004 or 2003.

14.

Investments

At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The balance is stated at cost.

2004

2003

(£ million)

5.0
(0.4)
0.3

4.9

5.0
(0.6)
0.6

5.0

Investments represent trade investments and are US Dollar denominated. There is no material difference
between the fair value and the carrying value.

87

15.

Investment in Joint Venture (BSN Medical)

At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained profit for the financial year
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment

121.6
1.4
(2.0)

At 31 December . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

121.0

115.0
5.7
0.9

121.6

The investment in joint venture is represented by:

2004

2003

(£ million)

Share of gross assets:
Fixed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of gross liabilities:
Due within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

40.9
72.5

(57.4)
(4.5)

51.5
69.5

28.4
76.4

(49.2)
(4.7)

50.9
70.7

121.0

121.6

Goodwill arising on the formation of the joint venture is considered to have an indefinite useful economic life
and is capable of separate measurement since the joint venture operates independently of the Group. It
operates in a mature sector of the medical devices industry, has high market shares, and long product life
technology, manufacturing know-how, regulatory
cycles. Significant barriers to entry exist
compliance, market reputation and customer relationships. If the goodwill had been amortised over 20
years, the Group’s operating profit would have been lower by £3.4m (2003 — £3.6m, 2002 — £3.2m) and
the investment in the joint venture would have been lower by £12.8m (2003 — £9.4m).

in terms of

16.

Investment in Associated Undertaking (AbilityOne)

At 1 January 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained profit for the financial year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(£ million)
8.5
0.3
2.8
(11.6)

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

–

The investment was disposed of in September 2003.

Goodwill in the associated undertaking was considered to have an indefinite useful economic life and to be
capable of separate measurement since the associated undertaking operated independently of the Group. It
operated in the rehabilitation industry, had high market shares, and long product life cycles. Significant
barriers to entry existed in terms of breadth of the product range, sales force size, physical distribution
capabilities, key customer and professional relationships and market reputation. If the goodwill had been
amortised over 20 years, operating profit would have been lower in 2003 by £0.6m and the profit on
disposal of the associated undertaking would have been higher by £1.2m.

17. Stocks

Raw materials and consumables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Work-in-progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Finished goods and goods for resale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

41.0
15.5
228.4

284.9

37.8
10.3
182.5

230.6

88

18. Debtors

Amounts falling due within one year:
Trade and other debtors — gross debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: non-returnable proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Trade and other debtors — net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts owed by joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepayments and accrued income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amounts falling due after more than one year:
Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pension prepayments — (Note 33) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

292.7
(19.2)

265.9
(19.9)

273.5
1.5
23.2
22.0

320.2

6.3
9.7
1.2
24.4

246.0
2.4
20.3
31.4

300.1

4.4
7.1
1.5
21.4

361.8

334.5

The Group utilises a debt factoring facility in Italy. The finance provider’s agreement states that it cannot
seek recourse in any form from the Group in the event of non-payment by the debtors. The Group is not
obliged, and does not intend, to support any such losses. The gross amount of trade debtors factored
without recourse is £19.2m (2003 — £19.9m). £0.9m (2003 — £0.9m) of
factoring charges were
recognised in the period.

Trade and other debtors are stated after deducting provisions for bad and doubtful debts of £7.3m (2003 —
£7.3m) and a provision for declined macrotextured insurance recoveries of £13.4m.

Deferred tax assets of £6.3m (2003 — £4.4m) represent recoverable short-term timing differences. Other
debtors falling due after more than one year are non-interest bearing and denominated in various
currencies. The fair value of these debtors is the same as book value.

89

19. Borrowings

Borrowings:
Due within one year or on demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash and bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

31.9
144.3

176.2

(32.6)
(46.4)
14.8

96.9
99.6

196.5

(26.0)
(52.8)
9.4

Net debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

112.0

127.1

Borrowings are analysed as follows:

Bank loans and overdrafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other loans wholly repayable within five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Borrowings are repayable as follows:

Within one year or on demand:
Bank loans and overdrafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total within one year or on demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

After one year:
Bank loans and overdrafts
after one and within two years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
after three and within four years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
after four and within five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other loans:
after one and within two years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
after two and within three years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
after three and within four years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
after four and within five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Loan Notes after one and within two years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total after one year

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

124.1
50.3
1.8

176.2

195.2
–
1.3

196.5

30.4
1.5

31.9

–
–
93.7

93.7

0.2
0.1
–
–

0.3
50.3

144.3

176.2

96.4
0.5

96.9

25.6
73.2
–

98.8

0.4
0.2
0.1
0.1

0.8
–

99.6

196.5

In September 2004 the Group entered into a US$600m 5 year committed bank facility and cancelled its
existing syndicated bank facilities.

The acquisition consideration for MMT was settled part in cash and part by the issue of loan notes. The loan
notes are denominated in Sterling, pay interest quarterly at floating rates and are repayable in full in 2006.

The Board has established a set of policies to manage funding and currency risks. The Group only uses
derivative financial instruments to manage the financial risks associated with underlying business activities
and their financing. The Group’s policy is to ensure that there is sufficient funding and facilities in place to
meet foreseeable borrowing requirements.

Bank loans and overdrafts represent drawings under committed and uncommitted facilities of £326m and
£212m, respectively. Of the undrawn committed facilities of £225m, £6m expires within one year and
£219m after two but within five years (2003 — undrawn committed facilities: £198m of which £9m expired
within one year and £189m after two but within five years). Borrowings secured on fixed and current assets
were £0.8m (2003 — £1.2m). Borrowings are shown at book value which is the same as fair value.

90

19. Borrowings — (continued)

The Group has currency swaps which have maturities in 2005 and 2006 and are translated at year-end
exchange rates. Gross Sterling equivalents of £645.7m (2003 — £603.4m) receivable and £614.1m
(2003 — £560.0m) payable have been netted. £46.4m is reported as debit balances on currency swaps
and £14.8m as credit balances on currency swaps the net of which is a debit balance of £31.6m (2003 —
£52.8m as debit balances on currency swaps and £9.4m as credit balances on currency swaps the net of
which is a debit balance of £43.4m). Currency swaps include fixed and floating interest rate contracts and
forward foreign exchange contracts and are used for hedging foreign investments.

Currency swaps mature as follows:

At 31 December 2004
Within one year:
US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Australian Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Japanese Yen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Zealand Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Canadian Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

After one year and within two years:
US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2003
Within one year:
US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Australian Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Japanese Yen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Zealand Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Canadian Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

After one year and within two years:
US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

After two years and within three years:
US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amount
receivable
(£ million)

Amount
payable
(Currency
million)

US$229.5
Aus$48.7
€126.3
Yen4,781
NZ$8.0
C$17.5

US$564.0
€80.0

US$397.8
Aus$42.7
€95.8
Yen3,821
NZ$8.0
C$17.5

US$75.0
€50.0

US$196.0
€50.0

133.7
19.2
85.4
23.9
3.1
7.7

273.0

318.2
54.5

372.7

645.7

252.7
18.2
63.0
20.9
2.8
7.9

365.5

49.7
34.2

83.9

119.9
34.1

154.0

603.4

Where the Group’s financial assets and liabilities, including currency swaps, are at floating interest rates, the
Group uses simple floating to fixed rate contract interest rate swaps to protect borrowing costs and the
differentials between borrowing and deposit rates.

91

20. Financial Instruments

funds by matching foreign currency assets,

including
The Group’s policy is to protect shareholders’
acquisition goodwill, with foreign currency liabilities where practicable. These liabilities take the form of either
borrowings or currency swaps. The Group also hedges forward its interest rate risk by fixing rates on
currency swaps and using interest rate swap contracts. 66% of the interest costs and 75% of the interest
income are protected through 31 December 2005. The Group’s risk management policies are detailed in
“Operating and Financial Review, Liquidity and Prospects — Exchange and Interest Rate Risk and Financial
Instruments.”

Short-term debtors and creditors are excluded from the following disclosures:

Currency and Interest Rate Profile of Interest Bearing Liabilities:

Gross
borrowings

Currency
swaps

Total
liabilities
(£ million)

Floating
rate
liabilities

Fixed
rate
liabilities

100.4
6.4
69.4

413.3
146.0
54.8

513.7
152.4
124.2

72.0
74.6
124.2

441.7
77.8
–

At 31 December 2004:
US Dollar
. . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . .
Other

Total interest bearing

liabilities . . . . . . . . . . .

176.2

614.1

790.3

270.8

519.5

At 31 December 2003:
US Dollar
. . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . .
Other

Total interest bearing

152.9
7.9
35.7

373.6
138.0
48.4

526.5
145.9
84.1

50.0
23.3
84.1

476.5
122.6
–

Fixed rate liabilities
Weighted
average
time for
which
rate is
fixed
(Years)

Weighted
average
interest
rate
(%)

2.7
2.5
–

2.3
2.9
–

1
1
–

1
1
–

liabilities . . . . . . . . . . .

196.5

560.0

756.5

157.4

599.1

In addition to the above, the Group has a liability due after one year for deferred acquisition consideration
(denominated in Sterling, US Dollars and Euro) totalling £13.7m (2003 — £4.0m) on which no interest is
payable (see Note 21). There are no other interest bearing financial liabilities.

Currency and Interest Rate Profile of Interest Bearing Assets:

Cash
and
bank

Currency
swaps

Total
assets
(£ million)

Floating
rate
assets

Fixed
rate
assets

Fixed rate assets

Weighted
average
interest
rate
(%)

Weighted
average
time for
which rate
is fixed
(Years)

At 31 December 2004:
Sterling . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . .
Total interest bearing

assets . . . . . . . . . . . .

At 31 December 2003:
Sterling . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . .
Total interest bearing

assets . . . . . . . . . . . .

4.2
28.4

645.7
–

649.9
28.4

139.2
28.4

510.7
–

4.9
–

32.6

645.7

678.3

167.6

510.7

4.3
21.7

603.4
–

607.7
21.7

80.7
21.7

527.0
–

4.2
–

26.0

603.4

629.4

102.4

527.0

1
–

1
–

The above interest rate analysis includes the effect of interest rate swaps.

Floating rates on both assets and liabilities are typically based on the three-month LIBOR interest rate
relevant to the currency concerned.

92

20. Financial Instruments — (continued)

At 31 December 2004, notional principal balances by currency and related interest rates under interest rate
swap agreements and the fixed interest element of currency swaps were:

Expected to mature
in 2005
(Currency million,
except interest rates)

Fair value
(£ million)

At 31 December 2004:
Principal (Sterling)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Principal (US Dollar) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Principal (Euro) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

£511

4.9%
4.8%

US$848

2.7%
3.1%

€110

2.5%
2.3%

Of which:
Interest rate swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed interest element of currency swaps . . . . . . . . . . . . . . . . . . . . . . . .

0.3

1.5

(0.2)

1.6

0.3
1.3

1.6

The fair values for interest rate swaps and the fixed interest element of currency swaps are calculated as the
net present value of the future cash flows as at 31 December 2004, discounted at market rates of interest at
that date.

At 31 December 2003, notional principal balances by currency and related interest rates under interest rate
swap agreements were:

Expected to mature
in years ending
31 December

2004
2005
(Currency million,
except interest rates)

Fair value
(£ million)

At 31 December 2003:
Principal (Sterling) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

£527

£188

(2.1)

3.9%
4.4%

4.8%
4.8%

Principal (US Dollar) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$853
Fixed rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.0%
1.4%

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal (Euro)
Fixed rate payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Variable rate receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

€174

2.9%
2.3%

US$300

(3.3)

3.1%
2.8%

–
–
–

(0.8)

(6.2)

The fair values for interest rate swaps are calculated as the net present value of the future cash flows as at
31 December 2003, discounted at market rates of interest at that date.

93

20. Financial Instruments — (continued)

Foreign Exchange and Interest Rate Exposures
The Group uses forward foreign exchange contracts to hedge trading creditors and an element of
anticipated purchases over the following 12 months. The principal currencies hedged by forward foreign
exchange contracts are Sterling and US Dollars. At 31 December 2004, the Group had contracted to
exchange within one year the equivalent of £217m.

The Group’s operating units hold no material unhedged monetary assets or liabilities other than in their
functional operating currency. Therefore, there are no currency exposures on monetary assets and liabilities
that could give rise to material gains or losses in the profit and loss account.

Fair Value of Financial Assets and Liabilities
Forward foreign exchange contracts, interest rate swap contracts and the fixed interest rate element of
currency swaps taken out as hedges are not marked to market. Gains and losses thereon are recognised
only when the exposure that is being hedged is itself recognised. The following table sets out the book and
fair values of the Group’s derivative financial instruments. Market rates have been used to determine the fair
values of interest rate swaps, currency swaps and forward contracts.

Derivative financial instruments held to manage interest rate and currency risk:

31 December 2004

31 December 2003

Book
value

Fair
value

Unrecognised
gain/(loss)

Book
value

Fair
value

Unrecognised
gain/(loss)

Interest rate swaps . . . . . . . . . . . . . . . . . .
Forward foreign exchange contracts . . . . .
Currency swaps . . . . . . . . . . . . . . . . . . . . .

–
–
31.6

0.3
(7.1)
32.9

Total unrecognised losses on hedges . . .

(£ million)

–
–
43.4

(6.2)
(5.7)
43.4

0.3
(7.1)
1.3

(5.5)

(6.2)
(5.7)
–

(11.9)

The fair values of primary financial
Note 19 are the same as book values.

instruments comprising cash and borrowings which are set out in

The following table shows the amount of unrecognised gains and losses which have been included in the
profit and loss account for the year and those gains and losses which are expected to be included in next
year’s or later profit and loss accounts.

Unrecognised
gains

Unrecognised
losses
(£ million)

Total net
unrecognised
gains/(losses)

Unrecognised gains and losses on hedges at

1 January 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: gains and losses arising in previous years that

were expected to have been recognised in 2003 . . .

Gains and losses arising before 31 December 2002

that were not recognised in 2003 . . . . . . . . . . . . . . . .

Gains and losses arising in 2003 that were not

recognised in 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unrecognised gains and losses on hedges at

31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . .

8.6

(8.1)

0.5

3.0

3.5

Less: gains and losses arising in previous years that

were expected to have been recognised in 2004 . . .

(3.5)

Gains and losses arising before 31 December 2003

that were not recognised in 2004 . . . . . . . . . . . . . . . .

Gains and losses arising in 2004 that were not

recognised in 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unrecognised gains and losses on hedges at
31 December 2004 that are expected to be
recognised in 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . .

–

4.2

4.2

94

(23.2)

22.1

(1.1)

(14.3)

(15.4)

15.0

(0.4)

(9.3)

(14.6)

14.0

(0.6)

(11.3)

(11.9)

11.5

(0.4)

(5.1)

(9.7)

(5.5)

21. Other Creditors

Amounts falling due within one year:
Trade creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts owed to joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Social security costs and other taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accruals and deferred income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ordinary share dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amounts falling due after one year:
Acquisition consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

153.2
2.9
13.2
51.7
8.4
105.8
30.0
12.7

377.9

13.7
2.1

15.8

132.8
3.4
13.6
52.7
3.0
69.4
28.9
4.6

308.4

4.0
4.8

8.8

Amounts falling due after more than one year are payable as follows: £15.8m in 2006 (2003 — £5.6m in
2005, £3.2m in 2006).

22. Provisions for Liabilities and Charges

Deferred
taxation

Rationalisation
and
integration

Retirement
healthcare Liability

Total

(£ million)

At 1 January 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . .
Profit and loss account — current year . . . . . . . . . . . .
Profit and loss account — prior years . . . . . . . . . . . . .
Fair value adjustments . . . . . . . . . . . . . . . . . . . . . . . . .
Utilisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . .
Profit and loss account — current year . . . . . . . . . . . .
Profit and loss account — prior years . . . . . . . . . . . . .
Transfers from current tax . . . . . . . . . . . . . . . . . . . . . .
Utilisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

56.0
(2.7)
17.5
(7.2)
(1.7)
–

61.9
(3.2)
(21.8)
0.9
(5.7)
–

At 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . .

32.1

11.6
(0.3)
6.0
–
–
(10.3)

7.0
–
(0.3)
–
–
(2.2)

4.5

9.4
(0.4)
1.1
–
–
(1.3)

8.8
(0.3)
1.2
–
–
(0.5)

9.2

11.1
(0.6)
2.6
–
2.8
(3.4)

12.5
(0.2)
67.8
–
–
(2.9)

77.2

88.1
(4.0)
27.2
(7.2)
1.1
(15.0)

90.2
(3.7)
46.9
0.9
(5.7)
(5.6)

123.0

At 31 December 2004, rationalisation and integration provisions include acquisition integration of £1.7m
(2003 — £2.6m). The deferred taxation and retirement healthcare provisions are long-term in nature, as is
the timing of their utilisation. Rationalisation and integration and liability provisions are expected to be
substantially utilised within two years. There are no provisions for contractual amounts and hence none are
treated as financial instruments

Included within the liability provision is £66.6m relating to the declination of
insurance coverage for
macrotextured knee revisions. In addition £13.4m has been provided against trade and other debtors
relating to this issue.

95

22. Provisions for Liabilities and Charges — (continued)

The provision for deferred taxation is made up as follows:

Goodwill timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other fixed asset timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net deferred taxation liability (above)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred taxation asset (Note 18) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

41.1
41.5
(56.8)

42.6
39.3
(24.4)

25.8

57.5

32.1
(6.3)

25.8

61.9
(4.4)

57.5

See Note 9 for information on deferred tax assets and liabilities for which no provision has been made.

23. Called Up Share Capital

2004
Shares
(‘000)

2004
(£ million)

2003
Shares
(‘000)

2003
(£ million)

2002
Shares
(‘000)

2002
(£ million)

Authorised
Ordinary Shares 12 2⁄ 9p . . . . . . . . . . . . . . . 1,223,591
–
5½% cumulative preference shares £1 . .

1,223,591
–

149.5
–

149.5

149.5
–

149.5

1,223,591
450

149.5
0.5

150.0

Allotted, issued and fully paid

Equity Capital: Ordinary shares 12 2⁄ 9p
At 1 January . . . . . . . . . . . . . . . . . . . . . . . .
Share options . . . . . . . . . . . . . . . . . . . . . . .

933,526
3,610

114.1
0.4

928,760
4,766

113.5
0.6

924,812
3,948

113.1
0.4

At 31 December . . . . . . . . . . . . . . . . . . . . .

937,136

114.5

933,526

114.1

928,760

113.5

Non-equity capital: 5 1⁄ 2% cumulative preference shares £1.00:
–
At 1 January . . . . . . . . . . . . . . . . . . . . . . . .
–
Cancellation . . . . . . . . . . . . . . . . . . . . . . . .

–
–

At 31 December . . . . . . . . . . . . . . . . . . . . .

–

–

269
(269)

–

0.3
(0.3)

–

269
–

269

0.3
–

0.3

Total called up share capital at

31 December 2004 . . . . . . . . . . . . . . . .

114.5

114.1

113.8

On 23 June 2003 the 5 1⁄ 2% £1.00 cumulative preference shares were cancelled and in consideration
shareholders were paid £1.38 per share on 7 July 2003. The 5 1⁄ 2% cumulative preference shares were
denominated in Sterling, were non-voting and carried preferential rights to dividends and distribution on
winding up.

96

24. Share Option Plans

The Smith & Nephew Sharesave Plan (2002) (adopted by shareholders on 3 April 2002) is available to all
employees in the UK employed by participating Group companies, subject to three months service. The
scheme provides for employees to save up to £250 per month and gives them an option to acquire shares
based on the committed amount to be saved. The option price is not less than 80% of the average of middle
market quotations of the Ordinary Shares on the three dealing days preceding the date of invitation. The
Smith & Nephew International Sharesave Plan (2002) is offered to employees in Australia, Austria, Canada,
Denmark, Finland, Germany, Hong Kong, Italy, Japan, South Korea, Mexico, New Zealand, Norway, Portugal,
Puerto Rico, Singapore, South Africa, Spain, Sweden, Switzerland and the United Arab Emirates. Employees
in Belgium, Italy, the Netherlands and France are able to participate respectively in the Smith & Nephew
Belgian Sharesave Plan (2002), the Smith & Nephew Italian Sharesave Plan (2002), the Smith & Nephew
Dutch Sharesave Plan (2002) and the Smith & Nephew France Sharesave Plan (2002). Participants in Ireland
are able to participate in the Smith & Nephew Irish Employee Share Option Scheme. These plans operate on
a substantially similar basis to the Smith & Nephew Sharesave Plan (2002). Options are no longer issued
under the Smith & Nephew Employee Share Option Scheme (adopted by shareholders on 14 May 1981)
and the Smith & Nephew 1991 Overseas Employee Share Option Scheme (adopted by shareholders on 25
May 1990) but options remain to be exercised under these two schemes. Together all of the plans referred
to above are termed the “Employee Schemes”.

Employees in the United States are able to participate in the Employee Stock Purchase Plan, which gives
them the opportunity to acquire shares, in the form of ADSs, at a discount of 15% (or more if the shares
appreciate in value during the plan’s quarterly purchase period) to the market price, through a regular
savings plan.

The Smith & Nephew 1985 Share Option Scheme (adopted by shareholders on 9 May 1985), the Smith &
Nephew 1990 International Executive Share Option Scheme (adopted by shareholders on 15 May 1990), the
Smith & Nephew 2001 UK Approved Share Option Plan, the Smith & Nephew 2001 UK Unapproved Share
Option Plan, the Smith & Nephew 2001 US Share Plan (adopted by shareholders on 4 April 2001) and the
Smith & Nephew 2004 Executive Share Option Plan (adopted by shareholders on 6 May 2004), together
termed the “Executive Schemes”, are operated at the discretion of the Board of Directors.

Under the terms of the Executive Schemes, the Remuneration Committee, consisting of Non-Executive
Directors, may select full-time employees of the Group for the grant of options to acquire Ordinary Shares in
the Company. Options granted under the Smith & Nephew 2001 US Share Plan (the “US Plan”) are to
acquire ADSs. For options granted prior to 2001, the option price was not less than the market value of an
Ordinary Share, or the nominal value if higher. The market value being the quoted price on the business day
preceding the date of grant or the quoted price on the date of grant. For Executive Schemes adopted in
2001 and 2004, the market value is the average quoted price of an Ordinary Share for the three business
days preceding the date of grant or, for the US Plan, the average quoted price of an ADS for the three
business days preceding the date of grant or the quoted price on the date of grant if higher. With the
exception of options granted under the 2001 US Plan, the exercise of options granted from 1997 are subject
to achievement of a performance condition. Options granted under the 2001 US Plan are not subject to
performance conditions but become exercisable as to 10% after one year, 30% after two years, 60% after
three years and the remaining balance after four years. The 1990 International Executive Share Option
Scheme and the 2004 Plan are open to senior managers worldwide. The 2001 UK Unapproved Share
Option Plan is open to senior managers outside the US and the US Plan is open to senior managers in the
US, Canada, Mexico and Puerto Rico.

Under the Executive Schemes, the number of Ordinary Shares over which options may be granted is limited
so that the number of shares issued or that may be issued under the Executive Schemes during the ten
years preceding the date of grant shall not exceed 5% of the Ordinary Share capital at the date of grant. The
total number of Ordinary Shares which may be issuable in any ten-year period under all employee share
schemes operated by the Company may not exceed 10% of the Ordinary Share capital at the date of grant.

97

24. Share Option Plans — (continued)

At 31 December 2004 18,450,000 (2003 — 17,455,000) options outstanding under share option schemes
were as follows:

Employee Schemes

Outstanding at 1 January 2002 . . . . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2002 . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2003 . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2004 . . . . . . . . . . . . . . . . . . . . .

Number
of
shares
(Thousand)
3,770
1,760
(1,017)
(267)

4,246
1,026
(998)
(212)

4,062
1,218
(779)
(248)

4,253

Range
of option
prices
(Pence)
124.0 – 289.2
296.0 – 372.7
124.0 – 304.0
124.0 – 304.0

124.0 – 372.7
321.0 – 403.0
124.0 – 304.0
124.0 – 389.0

124.0 – 403.0
391.0 – 498.0
124.0 – 321.0
124.0 – 403.0

146.8 – 498.0

Of which options exercisable at 31 December 2004 . . . . . . . .

60

146.8 – 289.2

Weighted
average
option
price
(Pence)
184.7
300.0
144.2
208.1

240.7
324.1
154.7
278.8

280.9
395.3
213.0
247.5

326.1

231.8

Weighted average fair value of options granted:

During 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
During 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
During 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

109.1
127.6
165.1

Executive Schemes

Outstanding at 1 January 2002 . . . . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2002 . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2003 . . . . . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2004 . . . . . . . . . . . . . . . . . . . . . .

Number
of
shares
(Thousand)
15,465
3,266
(2,841)
(317)

15,573
3,459
(3,775)
(1,864)

13,393
4,059
(2,826)
(429)

14,197

Range
of option
prices
(Pence)
133.0 – 375.0
359.0 – 409.5
143.0 – 327.7
133.0 – 409.5

143.0 – 409.5
347.2 – 418.0
143.0 – 382.3
143.0 – 418.0

145.0 – 418.0
475.0 – 581.5
145.0 – 360.0
145.0 – 521.0

145.0 – 581.5

Of which options exercisable at 31 December 2004 . . . . . . . .

4,639

145.0 – 375.0

Weighted
average
option
price
(Pence)
214.9
380.4
161.6
197.1

255.9
391.7
191.3
219.1

304.0
525.8
236.4
270.5

377.3

261.1

Weighted average fair value of options granted:

During 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
During 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
During 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

106.2
114.2
154.5

98

24. Share Option Plans — (continued)

Options granted in 2004 under executive schemes were valued using a binomial model provided by an
independent actuary. Options granted under employee schemes were valued using the Black-Scholes
Option pricing model. This had previously been used for all options granted in 2003 and 2002. The binomial
model was used for executive schemes so that proper allowance is made for the presence of performance
conditions and the possibility of early exercise. Options granted under each scheme are valued separately
and a weighted average fair value calculated.

The following assumptions were used in calculating the fair value of options granted:

Employee schemes
2003

2004

Dividend yield . . . . .
Expected volatility . .
Risk free rate . . . . . .
Expected life in years

1.1%
23.7%
4.8%
3.5

1.1%
23.3%
4.6%
3.6

2002

1.3%
19.6%
4.5%
3.6

Executive schemes
2003

2004

1.1%
22.0%
3.3% – 5.1%

7.0

1.1%
22.0%
4.6%
5.6

2002

1.3%
19.6%
5.2%
5.6

Because options vest over several years and there are restrictions as to exercise and additional options
grants are expected, the effects of these hypothetical calculations are not likely to be representative of
similar future calculations.

Summarised information about options outstanding under the share option schemes at 31 December 2004
is as follows:

Options outstanding
Weighted
average
remaining
contract
life
(Years)

Weighted
average
option
price
(Pence)

Number
outstanding
(Thousand)

Employee Schemes:
146.8p to 321.0p . .
354.1p to 498.0p . .

Executive Schemes:
145.0p to 326.0p . .
346.5p to 581.5p . .

2,913
1,340

4,253

5,342
8,855

14,197

2.2
2.2

4.4
6.5

295.6
392.5

254.3
451.5

Options exercisable

Weighted
average
option
price
(Pence)

231.8
–

Exercisable
in stages
up to

2005
–

232.3
359.3

2005 to 2010
2005 to 2010

Number
exercisable
(Thousand)

60
–

60

3,586
1,053

4,639

As the employee schemes are UK Inland Revenue approved Save As You Earn schemes or similar schemes,
the Company is exempt from accounting for the difference between the share option price and the market
value at the grant date.

QUEST
Until 31 December 2002 the Company used a qualifying employee share ownership trust (“QUEST”) to
acquire Smith & Nephew plc Ordinary Shares for transfer to employees exercising options under the Smith
& Nephew Employee Share Option Scheme. The QUEST was not used in 2003 and 2004 and the Company
does not intend to use it in the future. The trustee of the QUEST was Smith & Nephew Employees Trustees
Limited, a wholly-owned subsidiary of the Company. During 2002, the QUEST subscribed for 950,317
shares at a cost of £2.3m and transferred a total of 950,317 shares to employees on the exercise of options
for consideration of £1.4m. All employees of UK Group subsidiary companies, including Executive directors
of the Company, were potential beneficiaries under the QUEST.

99

25. Long-Term Incentive Plans

The Group has operated a long-term incentive plan (“LTIP”) for Executive directors and GEC members since
1997. Vesting of LTIP awards is dependent on the Group’s relative performance in a group of 43 UK listed
manufacturing companies with substantial international activities, using total shareholder return (“TSR”) over
a three year period as the prime measure.

In 2004, a new share based incentive plan was introduced for executive directors, members of the GEC and
the next level of senior executives, which replaced the LTIP. The plan includes a Performance Share Plan
(“PSP”) and a Co-Investment Plan (“CIP”).

Vesting of the PSP award shares is dependent upon performance relative to the FTSE-100 and an index
based on major companies in the medical devices industry.

Under the CIP, participants can elect to use up to a maximum of one-half of their annual bonus to purchase
shares. If the shares are held for 3 years and the Group’s EPSA growth targets are achieved participants
receive an award of matching shares for each share purchased.

Further details of these plans are available in the “Remuneration Report”.

At 31 December 2004 the maximum number of shares that could be awarded under the Group’s long-term
incentive plans were:

LTIP

PSP

CIP

Total

Outstanding at 1 January 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Awarded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(Number of Shares in
thousands)
–
–
–
–

–
–
–
–

1,638
453
(549)
(132)

1,638
453
(549)
(132)

Outstanding at 31 December 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Awarded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outstanding at 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Awarded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lapsed or cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,410
445
(660)

1,195
–
(362)
–

Outstanding at 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

833

–
–
–

–
924
–
(11)

913

–
–
–

–
291
–
–

291

1,410
445
(660)

1,195
1,215
(362)
(11)

2,037

Costs, based on intrinsic value, are accrued over the vesting periods based on the probability of vesting.
The amount charged to profit in 2004 was £1.7m (2003 — £2.7m, 2002 — £1.6m).

100

26. Reserves

2004

2003

2002

Share
premium

Profit
and loss
account

Share
premium

Profit
and loss
account

Share
premium

Profit
and loss
account

152.0

376.8

143.8

262.5

135.8

158.3

(£ million)

–
–
–

–

–
7.6

–

3.2
77.4
–

1.7

(2.0)
–

–

–
–
–

–

–
8.2

–

3.8
102.0
8.2

2.7

(2.4)
–

–

–
–
–

–

–
8.0

–

9.1
67.5
30.0

1.6

(1.7)
–

(2.3)

At 1 January . . . . . . . . . . . . . . . . .
Translation differences on foreign
currency net investments . . . . .
Retained profit for the year . . . . . .
Goodwill on disposals . . . . . . . . .
Share based expense recognised
in the profit and loss . . . . . . . . .

Cost of shares transferred to

beneficiaries . . . . . . . . . . . . . . .
Share options . . . . . . . . . . . . . . . .
Movements relating to the QUEST
(Note 24) . . . . . . . . . . . . . . . . . .

At 31 December . . . . . . . . . . . . . .

159.6

457.1

152.0

376.8

143.8

262.5

Net exchange gains of £36.9m (2003 — gains of £45.7m) arising on foreign currency net borrowings are
included within the £3.2m (2003 — £3.8m) translational differences on foreign currency net investments.
The cumulative amount of goodwill charged to reserves is £271.6m (2003 — £275.8m) against which
£116.0m of merger relief has been offset. The decrease is due to exchange movements of £4.2m.

On 23 June 2003, following the cancellation of the 5 1⁄ 2% £1.00 cumulative preference shares (Note 23), a
capital redemption reserve of £0.3m was established in the Parent Company. This reserve was extinguished
during 2003.

27. Own Shares

Own shares represent the holding of the Parent Company’s own shares in respect of the Smith & Nephew
Employees’ Share Trust (Note 35).

At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares transferred to Group beneficiaries . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2.1
4.1
(2.0)

4.2

2003
(£ million)
3.2
1.3
(2.4)

2.1

2002

2.5
2.4
(1.7)

3.2

101

28. Cash Flow Statement

Reconciliation of operating profit to net cash flow from operating activities

Group operating profit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation and amortisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss on sale of tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Write-off of investment in Advanced Tissue Sciences, Inc. . . . . . . . . . . . . . . . . . .
Increase in stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase/(Decrease) in creditors and provisions (i) (ii) . . . . . . . . . . . . . . . . . . . . . .

2004

151.0
84.6
2.6
–
(59.5)
(43.7)
91.6

2003
(£ million)
179.8
78.3
1.9
–
(9.8)
(24.5)
(11.2)

2002

150.7
74.2
2.7
17.5
(11.5)
(21.1)
(1.5)

Net cash inflow from operating activities (iii)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

226.6

214.5

211.0

(i)

(ii)

Includes £2.2m (2003 — £9.6m, 2002 — £19.3m) of outgoings on rationalisation, acquisition integration and divestment costs.

2004 includes a £66.6m exceptional provision relating to macrotextured knee revisions (see Note 4).

(iii) After £17.2m unreimbursed by insurers relating to macrotextured knee revisions in 2004 and £17.0m of Centerpulse costs in

2003.

AnalysisofNetDebt

Cash Overdrafts

Borrowings
due within
one year

Borrowings
due after
one year

Loan
Notes

Net
currency
swaps

At 1 January 2002 . . . . . . . .
Net cash flow . . . . . . . . . . . .
Exchange adjustments . . . .

At 31 December 2002 . . . . .
Net cash flow . . . . . . . . . . . .
Exchange adjustments . . . .

At 31 December 2003 . . . . .
Net cash flow . . . . . . . . . . . .
Loan Notes issued on

acquisition . . . . . . . . . . . .
. . . . .

Exchange adjustment

26.4
(4.0)
0.1

22.5
3.0
0.5

26.0
6.9

–
(0.3)

(3.7)
(8.9)
0.3

(12.3)
0.8
(0.1)

(11.6)
0.8

–
0.5

(90.3)
(70.6)
21.3

(139.6)
47.4
6.9

(85.3)
61.9

–
1.8

(£ million)

(161.2)
(18.1)
15.1

(164.2)
52.9
11.7

(99.6)
(1.3)

–
6.9

At 31 December 2004 . . . . .

32.6

(10.3)

(21.6)

(94.0)

ReconciliationofNetCashFlowtoMovementinNetDebt

Change in cash net of overdrafts in the year
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Settlement of net currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Change in net debt from net cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan Notes issued on acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

–
–
–

–
–
–

–
–

(50.3)
–

(50.3)

(14.7)
–
31.4

16.7
–
26.7

43.4
(39.8)

–
28.0

31.6

2004

2003
(£ million)

7.7
(39.8)
60.6

28.5
(50.3)
36.9

3.8
–
100.3

104.1
–
45.7

Change in net debt in the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Opening net debt

15.1
(127.1)

149.8
(276.9)

Total

(243.5)
(101.6)
68.2

(276.9)
104.1
45.7

(127.1)
28.5

(50.3)
36.9

(112.0)

2002

(12.9)
–
(88.7)

(101.6)
–
68.2

(33.4)
(243.5)

Closing net debt

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(112.0)

(127.1)

(276.9)

102

29. Currency Translation

The exchange rates used for the translation of currencies into Sterling that have the most significant impact
on the Group results were:

Average rates
2003

2004

2002

US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.84
1.47

1.65
1.45

1.51
1.59

Year-end rates
2003

2004

2002

US Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.92
1.41

1.79
1.42

1.61
1.53

30. Acquisitions

Acquisitionsin2004
On 16 March 2004, the Group acquired Midland Medical Technologies (“MMT”), at a net cost of £78.7m in
cash and loan notes. The assets and liabilities acquired are set out below. There was no material difference
between the fair value and book value of net assets acquired.

Net assets at date of acquisition:
Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors due within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill arising on acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost of acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Discharged by:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash acquired in MMT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Costs associated with acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Loan Notes issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Contingent consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(£ million)

2.2
4.6
3.4
(6.1)
(0.3)

3.8
74.9

78.7

17.2
(1.8)
3.9

19.3
50.3
9.1

78.7

For the year 1 May 2002 to 30 April 2003, MMT earned a profit after tax of £1.9m. For the period 1 May
2003 to 16 March 2004, which was the effective date of acquisition, turnover was £18.6m and the profit
after tax of £2.0m comprised £2.9m of operating profit less £0.9m of tax. There were no other recognised
gains and losses in the period ended 16 March 2004.

In the period since acquisition MMT contributed £16.2m to turnover and £4.1m to profit before goodwill
amortisation and exceptional
items and generated a net operating cash inflow of £0.2m after capital
expenditure of £0.5m. Including acquired distributors MMT contributed £20.0m to Group turnover.

103

30. Acquisitions — (continued)

The impact of other acquisitions, including the MMT distribution business in Australia, is set out below.
There was no material difference between the fair value and book value of net assets acquired.

Tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cost of acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Discharged by:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(£ million)
0.3
2.7
1.2

4.2
17.3

21.5

13.9
7.6

21.5

In addition to the cash of £13.9m, deferred consideration of £1.7m in respect of previous year’s acquisitions
was paid in the year.

Acquisitionsin2003
There were no acquisitions in 2003. The impact of additional and deferred consideration in respect of
previous year’s acquisitions was:

Tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Additional consideration in respect of previous year’s acquisitions . . . . . . . . . . . . . . . . . . . . . . . .
Deferred consideration in respect of previous acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total cost of acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(£ million)
0.3
0.3

0.6
0.1

0.7
3.6

4.3

There was no material difference between the fair value and book value of net assets acquired.

£7.2m of deferred consideration, net of amortisation, relating to the Collagenase acquisition in 2000 was
written back to goodwill as it was no longer payable (Note 12).

104

30. Acquisitions — (continued)

Acquisitionsin2002
On 28 March 2002, the Group acquired ORATEC Interventions, Inc., (“ORATEC”), at a net cost of £191.2m in
cash. Further fair value adjustments were made in the first full financial period after acquisition.

Fair values of net assets acquired as reported in 2002 and as adjusted in 2003 including explanations for
these changes are set out below:

Net book
value on
acquisition

Fair value
adjustments
2002

Provisional
fair values
2002

Adjustment
Revaluation

Adjustment
Other

(£ million)

Net assets at date of

acquisition:

Fixed assets . . . . . . . . . . . . .
Intangibles . . . . . . . . . . . . . .
Stock . . . . . . . . . . . . . . . . . .
Debtors . . . . . . . . . . . . . . . .
Creditors due within one

year

. . . . . . . . . . . . . . . . .
Provisions . . . . . . . . . . . . . . .
Deferred taxation . . . . . . . . .

Net assets . . . . . . . . . . . . . .

6.5
2.4
4.5
6.1

(4.2)
(3.9)
–

11.4

(1.8)
–
0.3
(0.2)

0.6
–
15.2

14.1

Goodwill arising on acquisition . . . . . . . . . . . . . . . . . . .

Discharged by:
Cash consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash acquired in ORATEC . . . . . . . . . . . . . . . . . . . . . . .
Costs associated with acquisition . . . . . . . . . . . . . . . . .

4.7
2.4
4.8
5.9

(3.6)
(3.9)
15.2

25.5

165.7

191.2

222.5
(39.1)
7.8

191.2

–
(1.7)(i)
–
0.4(ii)

–
–
–

(1.3)

–
–
–
–

–
(2.8)(iii)
1.7(iv)

(1.1)

Final
Fair
values
2003

4.7
0.7
4.8
6.3

(3.6)
(6.7)
16.9

23.1

168.1

191.2

(i)

Book value was used for the provisional fair value of certain intellectual property rights. On final evaluation it was considered that
fair value was lower than book value at acquisition.

(ii) Adjustment to bad debt provision on final evaluation of debtors.

(iii) Change in estimate relating to the expected outcome of legal disputes.

(iv)

Finalisation of tax losses brought forward and deferred tax on additional fair value adjustments.

The fair value adjustments in 2002 reflect the adoption of Group accounting policies and deferred taxation
arising from available trading losses in the acquired entity.

The impact of other acquisitions, including deferred consideration in respect of previous year’s acquisitions
in the year was:

Tangible fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Associated undertaking formation costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred consideration in respect of previous year’s acquisitions . . . . . . . . . . . . . . . . . . . . . . . . .

(£ million)
0.6
7.3
3.7
(3.8)

7.8
2.0

9.8
1.8
5.5

Total cost of acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

17.1

£2.0m consideration was accrued in 2002 and paid in cash in 2003. There was no material difference
between the fair value and book value of net assets acquired.

105

31. Financial Commitments

Group capital expenditure contracted but not provided for amounted to £4.4m (2003 — £2.6m).

Under the Group’s acquisition and joint development agreements with NUCRYST Pharmaceuticals Corp.,
amounts of up to £3.9m (2003 — £4.2m) could become payable on achievement of certain milestones
related to regulatory and reimbursement approvals with a further £18.2m (2003 — £25.1m) contingent on
achievement of sales milestones.

Under the Group’s acquisition agreement with MMT amounts up to a further £20.0m could become payable
contingent on the timing of receiving a regulatory product approval.

At 31 December 2004, the Group was committed to making the following payments in respect of operating
leases during 2005:

Operating leases which expire:
Within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
After one and within five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
After five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

32. Contingent Liabilities

Land and
buildings

2004

2003

Other assets
2003
2004

(£ million)

2.0
3.1
5.9

2.0
3.4
4.9

11.0

10.3

2.5
7.2
–

9.7

2.6
7.0
–

9.6

The Group is party to legal proceedings in the normal course of business. Other than as set out below the
Group considers that these will not result in any material adverse effect on the Group’s results of operations
or financial position.

In August 2003 the Group withdrew voluntarily from all markets the macrotextured versions of its OXINIUM
femoral knee components. As at that date 2,971 components had been implanted of which approximately
2,471 were in the USA, 450 in Australia and 50 in Europe, the first component having been implanted in
December 2001.

The product was withdrawn when management became aware of a higher than usual percentage of reports
of early revisions (“revisions” are implants which need to be replaced). Whilst the cause of the revisions
remains uncertain it is apparent that some patients do not achieve adequate initial fixation and that in other
patients, while there appears to be good initial fixation, this does not persevere. Extensive testing and
modelling has so far failed to identify the precise cause of the failure and, due to the large number of
variables involved, it is probable that the precise cause may never be understood fully.

As at 31 December 2004 741 implants had been revised and settlements agreed with patients in respect of
491 of these revisions. The total amount paid out in settlements, legal costs and associated expenses was
£45m of which £32m had been or will be recovered from the insurer who provides the primary layer and
65% of the first excess layer in the Group’s global product liability programme. The balance of £13m is due
from insurers in respect of the balance of the first excess layer and the second excess layer.

On 17 December 2004 the Group was notified that two insurance carriers who comprise 35% of the first and
80% of the second excess layers of the Group’s global product liability programme had declined coverage
for macrotextured claims. Management intends to take all steps available to it in order to enforce this
coverage. Nevertheless, in view of the uncertainty, management cannot assert that it is probable that
coverage will be restored and consequently has recorded an exceptional charge of £80.0m representing the
amount currently outstanding from these insurers and an estimate of the cost associated with claims likely to
arise in the future assuming that insurance cover is unavailable from these and subsequent excess layer
insurers.

106

32. Contingent Liabilities — (continued)

The charge has been calculated based on: (1) the amount outstanding at 31 December 2004 from the
insurers who have denied coverage; (2) an estimate of the average cost in respect of revisions where
settlements were unresolved at that date; and (3) an estimate of the number of settlements of future
revisions based on the current trend and decaying to zero after five years and an estimation of the average
implants eventually need to be revised
future cost per settlement. In the hypothetical scenario that all
prematurely and that insurance cover continues to be unavailable, the cost to the Group of the declined
insurance cover is estimated to be £190.0m (an additional £110.0m over the amount provided), assuming
the average cost per settlement remains approximately the same and there is a standard rate of mortality.

The Group’s assessment of the impact of these revisions and related matters constitute forward-looking
statements that are subject to uncertainties, including uncertainties relating to the outcome of settlements as
compared to the assumptions made in estimating claim amounts. Smith & Nephew cannot provide
assurance that these estimates will prove correct. Depending on the number and average cost of future
settlements, costs may be greater or less than the amount provided.

33. Post-Retirement Benefits

The Group sponsors pension plans for its employees in most of the countries in which it has major operating
companies. Pension plans are established under the laws of the relevant country, funded by the payment of
contributions to, and the assets held by, separate trust funds or insurance companies. In those countries
where there is no company-sponsored pension plan, state benefits are considered adequate. Employees’
retirement benefits are the subject of regular management review.

For many years, the Group’s major pension plans in the United Kingdom (“UK Plan”) and the United States
(“US Plan”) were of the defined benefit type. From 2003 all new employees were provided with a defined
contribution pension plan.

The pension costs for the UK Plan and the US Plan have been determined by independent qualified
actuaries, using the projected unit method. Under the projected unit method, the current service cost will
increase as the members of the defined benefit plans approach retirement. The market related actuarial
assumptions at the SSAP 24 valuation dates and a breakdown of the pension costs are as follows:

Actuarial assumptions:

Increase in pensionable earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in pensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average remaining service lives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Pension costs:

Principal defined benefit plans in the UK and the US:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Regular cost
Variations from regular cost (i)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notional net interest on deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

UK Plan

US Plan

(% per annum,
except service lives)
5.0
Nil
3.0
8.0
13 years

4.3
2.3
2.3
6.8
10 years

2004

2003
(£ million)

2002

8.1
5.9
1.3

15.3
10.1

25.4

8.3
5.1
0.8

14.2
7.4

21.6

9.8
(1.9)
(0.1)

7.8
6.5

14.3

(i)

Variations from regular costs arise from the surplus/deficit in the two principal plans and are amortised using the percentage of
payroll method over the weighted average of expected pensionable payroll and remaining service lives of current employees in the
plans.

107

33. Post-Retirement Benefits — (continued)

At the dates of the most recent actuarial valuations for the purposes of SSAP 24 in September 2002 and
December 2003, the aggregate market value of the assets of the UK Plan and the US Plan was £238m
(2003 — £230m: valuations in September and December 2002) representing 81% of plan liabilities for
accrued benefits, including allowance for projected future increases in salaries, resulting in a net deficit of
£57.2m (2003 — 78% and a net deficit of £64.5m). The estimated deficit of these plans at 31 December
2004 was £49m (2003 — £55m).

The unamortised balance of the UK Plan and US Plan deficits was £65.2m (2003 — £70.1m).

The contributions made to the UK Plan and the US Plan in the accounting period were £8.6m (2003 —
£8.5m, 2002 — £2.6m) and £9.2m (2003 — £10.4m, 2002 — £5.2m), respectively. The agreed
contribution rates for 2005 are 11% of pensionable earnings plus a supplementary payment of £4.3m to the
UK Plan and 9% of pensionable earnings plus a supplementary payment of £2.7m to the US Plan.

Included in debtors due after more than one year are prepayments of £9.7m (2003 — £7.1m) and included
in creditors are accruals due within one year of £4.7m (2003 — £4.0m) relating to the funding of certain
Group pension plans.

The Group recharges the UK pension plan with the costs of administration and independent advisers. The
amount recharged in the year was £0.6m (2003 — £0.6m, 2002 — £0.4m). The amount receivable at
31 December 2004 was £0.1m (2003 — £0.1m).

The costs of providing healthcare benefits after retirement of £1.2m (2003 — £1.1m, 2002 — £0.8m) are
determined by independent qualified actuaries. The unfunded liability of £9.2m (2003 — £8.8m) in respect
of
the accrued healthcare benefits is included in provisions. The principal actuarial assumptions in
determining the cost of providing healthcare benefits are those in the UK and the US:

Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Medical cost inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

34. Post-Retirement Benefits (FRS 17)

2004

2003

UK

5.3
6.3

US
UK
(% per annum)
5.4
5.8
6.4
7.0

US

6.0
7.5

The disclosures below show the effect on the Group’s financial statements had FRS 17 been adopted and
relate to the major defined benefit retirement plans in the UK and the US since other plans are not material.

The principal assumptions used by the independent qualified actuaries in valuing the UK and US plans at
31 December for FRS 17 purposes were:

2004

2003

2002

UK Plan

US Plan

UK Plan

US Plan

UK Plan

US Plan

Increase in pensionable earnings . . . . .
Increase in pensions . . . . . . . . . . . . . . .
Inflation . . . . . . . . . . . . . . . . . . . . . . . . .
Discount rate . . . . . . . . . . . . . . . . . . . . .

4.9
2.7
2.9
5.3

5.0
Nil
3.0
5.8

(% per annum)
5.0
4.8
Nil
2.6
3.0
2.8
6.0
5.4

4.3
2.3
2.3
5.6

5.0
Nil
3.0
7.0

108

34. Post-Retirement Benefits (FRS 17) — (continued)

The assets and liabilities in the plans and the expected rates of return on investments were:

Equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Government bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Market value of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Present value of liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deficit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Post-retirement healthcare . . . . . . . . . . . . . . . . . . . . . . . . . . .

Related deferred tax asset

. . . . . . . . . . . . . . . . . . . . . . . . . . .

Net retirement benefit liability . . . . . . . . . . . . . . . . . . . . . . . . .

Equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Government bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Market value of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Present value of liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deficit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Post-retirement healthcare . . . . . . . . . . . . . . . . . . . . . . . . . . .

Related deferred tax asset

. . . . . . . . . . . . . . . . . . . . . . . . . . .

Net retirement benefit liability . . . . . . . . . . . . . . . . . . . . . . . . .

31 December 2004

UK Plan

US Plan

Rate of
Return
(%)
7.5
4.5
5.3
6.0
4.9

Rate of
Return
(%)
9.0
6.1
6.5
–
3.8

Value
(£ million)
157.7
35.9
–
11.5
8.3

213.4
(277.2)

(63.8)
(3.9)

(67.7)
20.3

(47.4)

Value
(£ million)
56.1
5.8
9.6
–
0.3

71.8
(131.7)

(59.9)
(7.4)

(67.3)
25.6

(41.7)

31 December 2003

UK Plan

US Plan

Rate of
Return
(%)
7.8
4.8
5.4
6.6
5.1

Rate of
Return
(%)
9.0
5.7
6.6
–
3.7

Value
(£ million)
143.7
32.4
–
10.1
6.9

193.1
(253.0)

(59.9)
(3.6)

(63.5)
19.0

(44.5)

Value
(£ million)
48.2
6.9
6.1
–
1.8

63.0
(124.3)

(61.3)
(6.4)

(67.7)
25.7

(42.0)

109

34. Post-Retirement Benefits (FRS 17) — (continued)

Equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Government bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Market value of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Present value of liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deficit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Post-retirement healthcare . . . . . . . . . . . . . . . . . . . . . . . . . . .

Related deferred tax asset

. . . . . . . . . . . . . . . . . . . . . . . . . . .

Net retirement benefit liability . . . . . . . . . . . . . . . . . . . . . . . . .

31 December 2002

UK Plan

US Plan

Rate of
Return
(%)
7.8
4.5
5.6
6.2
5.0

Rate of
Return
(%)
8.7
5.8
7.0
–
4.2

Value
(£ million)
114.3
34.0
–
9.6
7.0

164.9
(221.4)

(56.5)
(3.3)

(59.8)
17.9

(41.9)

Value
(£ million)
34.4
8.0
7.0
–
1.1

50.5
(105.2)

(54.7)
(7.0)

(61.7)
23.4

(38.3)

The Group’s shareholders’ funds and profit and loss account at 31 December would have been as follows:

2004

2003

2002

Shareholders’
funds

Profit
and loss
account

Shareholders’
funds

Profit
and loss
account

Shareholders’
funds

Profit
and loss
account

As reported . . . . . . . . . . . . . . . . . .
Provided under SSAP 24 . . . . . . .
Less: related deferred tax . . . . . . .

727.0
0.8
(0.3)

727.5

FRS 17 net retirement liability

above . . . . . . . . . . . . . . . . . . . .

(89.1)

As adjusted for FRS 17 . . . . . . . . .

638.4

457.1
0.8
(0.3)

457.6

(89.1)

368.5

(£ million)

640.8
2.8
(1.1)

642.5

(86.5)

556.0

376.8
2.8
(1.1)

378.5

(86.5)

292.0

516.9
7.8
(3.0)

521.7

(80.2)

441.5

262.5
7.8
(3.0)

267.3

(80.2)

187.1

The following amounts would have been charged to operating profit:

Current service
cost –
employer’s
position

Past service
cost
(£ million)

Total operating
charge

2004:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2003:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2002:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.1
5.9

12.0

6.5
4.6

11.1

5.9
5.2

11.1

110

–
–

–

–
–

–

0.1
–

0.1

6.1
5.9

12.0

6.5
4.6

11.1

6.0
5.2

11.2

34. Post-Retirement Benefits (FRS 17) — (continued)

The following amounts would have been charged/(credited) to other finance costs:

Interest cost

Expected
return on
assets in the
plan
(£ million)

Net finance
cost/(credit)

2004:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2003:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2002:
UK Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
US Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

13.6
7.2

20.8

12.3
7.1

19.4

11.4
7.1

18.5

(13.8)
(5.4)

(19.2)

(11.4)
(4.2)

(15.6)

(16.2)
(5.3)

(21.5)

(0.2)
1.8

1.6

0.9
2.9

3.8

(4.8)
1.8

(3.0)

The combined operating and finance costs that would have been charged in 2004 under FRS 17 of £13.6m
compares with the cost under SSAP 24 of £15.3m (2003 — FRS 17 cost of £14.9m compares with the cost
under SSAP 24 of £14.2m, 2002 — FRS 17 cost of £8.2m compares with the cost under SSAP 24 of £7.8m).

The following amounts would have been included in the statement of total recognised gains and losses:

2004

2003

2002

UK Plan

US Plan

UK Plan

US Plan

UK Plan

US Plan

Differences between expected and

actual return on assets

Amount (£ million) . . . . . . . . . . . . .
Percentage of plan assets . . . . . .

5.4
2.5%

1.9
2.6%

16.9

8.8%

7.5
11.9%

(47.9)
29.0%

(13.9)
27.5%

Experience gains and losses on the

plan liabilities

Amount (£ million) . . . . . . . . . . . . .
Percentage of plan liabilities . . . . .

(1.6)
0.6%

0.1

0%

0.2

0%

(1.7)
1.4%

(2.5)
1.1%

(1.1)
1.0%

Effects of changes in demographic and
financial assumptions underlying the
present value of the plan liabilities

Amount (£ million) . . . . . . . . . . . . .

(10.4)

(6.4)

(21.6)

(21.9)

(18.6)

(1.9)

Actuarial loss recognised in the

statement of total recognised gains
and losses

Amount (£ million) . . . . . . . . . . . . .

(6.6)

(4.4)

(4.5)

(16.1)

(69.0)

(16.9)

Percentage of plan liabilities . . . . .

2.4%

3.3%

1.8%

13.0%

31.2%

16.1%

111

34. Post-Retirement Benefits (FRS 17) — (continued)

The following table reconciles the movement in the plans’ deficits:

2004

2003

2002

UK Plan

US Plan

UK Plan

US Plan

UK Plan

US Plan

(£ million)

(Deficit)/surplus in the plan at

1 January . . . . . . . . . . . . . . . . . . . . . .

(59.9)

(61.3)

(56.5)

(54.7)

10.9

(41.0)

Movement in the year:
Current service cost (employees and

employers) . . . . . . . . . . . . . . . . . . . . .
Past service cost . . . . . . . . . . . . . . . . . .
Other finance income/(cost) . . . . . . . . .
Actuarial loss . . . . . . . . . . . . . . . . . . . . .
Contributions paid (including by

employees)

. . . . . . . . . . . . . . . . . . . .
Currency adjustment . . . . . . . . . . . . . . .

(9.7)
–
0.2
(6.6)

12.2
–

(5.9)
–
(1.8)
(4.4)

9.2
4.3

(9.2)
–
(0.9)
(4.5)

11.2
–

(4.6)
–
(2.9)
(16.1)

10.4
6.6

(8.6)
(0.1)
4.8
(69.0)

5.5
–

(5.2)
–
(1.8)
(16.9)

5.2
5.0

Deficit in the plan at 31 December . . . .

(63.8)

(59.9)

(59.9)

(61.3)

(56.5)

(54.7)

The cost of providing healthcare benefits after retirement under FRS 17 of £0.9m (£1.2m charge under
SSAP 24), is determined by independent actuaries and would be charged to operating profit in 2004 (2003 —
£0.8m charged in 2003 compared with a £1.1m charge under SSAP 24). The principal actuarial assumptions in
determining the cost of providing healthcare benefits are those in the UK and the US and would be as follows:

2004

UK

US

Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Medical cost inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3
6.3

5.8
7.0

35. Smith & Nephew Employees’ Share Trust

2003

2002

US

UK
(% per annum)
5.4
6.4

6.0
7.5

UK

5.6
6.6

US

7.0
8.0

At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)
2.1
4.1
(2.0)

3.2
1.3
(2.4)

At 31 December . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.2

2.1

The Smith & Nephew Employees’ Share Trust (the “Trust”) was established to hold shares relating to the
long-term incentive plan referred to in the “Remuneration Report”. Holdings of the Parent Company’s Own
Shares in respect of the Trust are disclosed in Note 27. The Trust is administered by an independent
professional trust company resident in Jersey and is funded by a loan from the Parent Company. The costs
of the Trust are charged to the profit and loss account as they accrue. A dividend waiver is in place in
respect of those shares held under the long-term incentive plan that are yet to vest. The waiver represents
less than 1% of the total dividends paid.

At 31 December 2004, the Trust held 1.9m (2003 — 1.6m) Ordinary Shares at an aggregate cost of £8.3m
(2003 — £5.6m). 1.1m shares (2003 — 1.1m), with an original cost of £4.1m (2003 — £3.5m), have vested
and are held under option for the benefit of directors and employees. 0.8m shares, at an aggregate cost of
£4.2m, are included within shareholders’ funds on the Group and Parent balance sheets. The market value
of these shares at 31 December 2004 was £4.3m (2003 — £2.3m).

112

36. Related Party Transactions with Joint Venture and Associated Undertaking

In the course of normal operations, the Group traded on an arm’s-length basis with its joint venture BSN
Medical from 1 April 2001 and associated undertaking AbilityOne from 27 March 2002 until 12 September
2003. The aggregated transactions, which have not been disclosed elsewhere in the financial statements,
are summarised below:

With
BSN
Medical
2004

With
BSN
Medical
2003

With
BSN
Medical
2002
(£ million)

With
AbilityOne
2003

With
AbilityOne
2002

Sales to the joint venture/associate . . . . . . . .
Profit/(loss) made on sales . . . . . . . . . . . . . . .
Agency fees received . . . . . . . . . . . . . . . . . . .
Management charges received . . . . . . . . . . .
Purchases from the joint

0.5
0.2
14.3
0.7

venture/associate . . . . . . . . . . . . . . . . . . . .

10.7

(Loss)/profit made by the joint venture on

purchases . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest receivable from the joint venture . . . .

(0.6)
–

0.9
0.4
18.2
1.1

12.2

(0.3)
–

6.9
(0.3)
19.0
1.6

13.2

(0.1)
0.4

0.1
–
–
–

3.0

–
–

0.4
0.1
–
–

5.3

–
–

37.

Information About the Nature and Cost of Services Provided by Auditors

Audit services:

Group accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Local statutory audit

Statutory audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Audit-related regulatory reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Further assurance services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Tax services:

Compliance services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advisory services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total non-audit services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total auditors’ remuneration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Arising:

In the UK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outside the UK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Relating to capital transactions (included above)

. . . . . . . . . . . . . . . . . . . . . . . . . . .

Audit fees incurred by Group pension schemes (not included above)

. . . . . . . . . .

2004

2003
(£ million)

2002

1.1
0.4

1.5
0.2

1.7

0.5

0.2
0.8

1.0
–

1.5

3.2

1.6
1.6

3.2

0.2

0.1

1.0
0.3

1.3
0.1

1.4

1.9

0.2
2.5

2.7
–

4.6

6.0

4.5
1.5

6.0

–

0.1

0.9
0.3

1.2
0.1

1.3

0.9

0.3
1.5

1.8
–

2.7

4.0

2.1
1.9

4.0

1.6

0.1

In 2003 £3.7m related to the unsuccessful public offers to purchase Centerpulse AG and InCentive
Capital AG.

113

38. New Accounting Standards

Under European regulation, from 2005 Smith & Nephew is required to publish its financial statements under
International Financial Reporting Standards (“IFRS”). This represents a fundamental change in the accounting
regime under which the Group will report its results.

NewAccountingStandardsintheUK—FRS17
FRS 17 — retirement benefits was issued in November 2000. Full implementation for UK GAAP purposes is
deferred until 1 January 2005. Some disclosure requirements are effective for periods prior to this deadline.
The standard requires that financial statements reflect at fair value the assets and liabilities arising from an
employer’s retirement benefit obligations and related funding. Current and past service costs are charged to
operating expense in the period in which they are earned, the interest cost on accrued liabilities less
expected return on assets is charged as net finance costs and changes in the value of the related assets
and liabilities are taken to reserves in the period. Had FRS 17 been implemented at 31 December 2004, the
Group would have reported in respect of its two major pension plans a retirement liability, net of related
deferred tax, of £89.1m (2003 — £86.5m), which compares with £0.5m (2003 — £1.7m) recorded in the
balance sheet under the existing rules. The impact of FRS 17 on retained earnings for 2004 would have
been to reduce Group retained earnings by £88.6m (2003 — £84.8m) (Note 34).

NewAccountingStandardsintheUS–FAS123(R)
On 16 December 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123
(revised 2004)(“Statement 123(R)”), Share-Based Payment, which is a revision of FASB Statement No. 123,
Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally,
the approach in Statement 123(R) is similar to the approach described in FASB Statement No. 123. However,
Statement 123(R) requires all share-based payments to employees,
to be recognised in the income
statement based on their fair values. Pro-forma disclosure and the intrinsic value method are no longer
alternatives. Statement 123(R) also requires that the benefits of tax deductions in excess of recognised
compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required
under current literature.

Statement 123(R) must be adopted no later than 1 July 2005. The Group already adopts the fair-value
method of accounting for employee share options for US GAAP reporting purposes and does not anticipate
that the adoption of statement 123(R) will have a material impact on its results of operations or financial
position.

39. Differences Between Accounting Principles Generally Accepted in the UK and US

The Group accounts are prepared in accordance with UK GAAP which differ in certain respects from US
GAAP. Those differences which have a significant effect on the Group’s profit for the financial year and
shareholders’ funds are as follows:

Goodwill and Other Intangible Assets
Prior to 1998, goodwill arising on acquisitions was set off against reserves. On disposal of such businesses,
goodwill previously set off against reserves is charged to profit or loss on disposal. Since 1998, goodwill and
other intangible fixed assets purchased by way of acquisition have been capitalised and written off over a
period not exceeding 20 years. Under US GAAP, goodwill and other intangible fixed assets purchased prior
to 2002 would have been capitalised and amortised over their expected useful lives. Commencing 2002,
goodwill would not be amortised and would be subject to an annual impairment review, whereas other
intangible assets with finite lives would continue to be capitalised and amortised over their useful lives.

Fair value adjustments to goodwill may be made in the first full financial period after acquisition. Under US
GAAP, these may only be made within one year after acquisition. Thus, any adjustments after this period
would be taken to the profit and loss account for the year.

Under UK GAAP, purchase consideration contingent on a future event is estimated and included as part of
the cost at the date of acquisition. This estimate is revised each year until the eventual outcome is certain.
Under US GAAP, contingent consideration is not recognised until the contingency is resolved or the amount
is determinable. Upon the resolution of the contingency, the purchase price may be adjusted, resulting in an
adjustment to goodwill.

114

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Joint Venture and Associated Undertaking
One of the components of the goodwill
in the joint venture is the difference between the fair value of
consideration given and the book value of net assets acquired in the joint venture by the Group. Under US
GAAP, this gain would be unrealised and would not be recognised.

The results of the joint venture are included within turnover, operating profit, interest and taxation. The
results of the associated undertaking were included within operating profit, interest and taxation. Under US
GAAP, the Group’s share of the after tax profits of the joint venture and associated undertaking would be
reflected in the income statement as a single line item and its net investment in the joint venture would be
included as a single line item in the balance sheet with the investment
in the Group’s associated
undertaking.

Post-Retirement Benefits
Projected benefit liabilities are discounted using long-term investment returns and surpluses and deficits are
amortised over the employees’ service lives. Under US GAAP, pension liabilities would be discounted using
corporate bond rates and surpluses and deficits within 10% limits would not be amortised and would thus
have no immediate impact on pension costs. In addition, under US GAAP where the value of plan assets is
below the value of the liabilities valued on an accumulated benefit obligation basis, the deficit on this basis
would be recognised immediately through other comprehensive income.

Trade Investments
Trade investments are stated in the balance sheet at cost less provision for any permanent diminution in
value and any movements in provisions are taken to the profit and loss account for the year. Under US
GAAP, listed trade investments would be stated at market value and movements in market value would be
taken to shareholders’ equity via comprehensive income for the year.

Factoring of Debts
Trade debtors are stated in the balance sheet net of non-returnable proceeds received. Under US GAAP,
trade debtors would be stated gross and proceeds received would be included in borrowings.

Derivative Instruments and Hedging Activities
Derivative instruments in respect of anticipated future transactions, interest rate risks and intragroup equity
investments are accounted for as hedges. Under US GAAP, all derivative instruments (including those
imbedded in other contracts) are recognised as either assets or liabilities in the consolidated balance sheet
at their fair values. US GAAP prescribes requirements for designation and documentation of hedging
relationships and ongoing assessments of effectiveness in order to qualify for hedge accounting. Changes
in the fair value of derivatives that are designated and qualify as part of a hedge transaction would be
recorded each period in current earnings or other comprehensive income, depending on the type of hedge
transaction. Changes in the fair value of derivatives that do not qualify for hedge accounting would be
recognised each period in profit for the financial year.

Forward Foreign Exchange Contracts
Forward foreign exchange contracts in respect of anticipated future transactions are treated as hedges and
not marked to market. Gains and losses thereon are recognised only when the exposure that is being
hedged is itself recognised. Under US GAAP, such contracts would be valued at the forward rates at the
balance sheet date and the gains and losses which do not qualify as hedges included in profit for the
financial year. On maturity of the contract the gain/loss not recognised to date would be recognised in profit
for the financial year.

Interest Rate Swaps
Interest rate swaps used to fix interest rates on the Group’s major exposures are treated as hedges and not
marked to market. Gains and losses thereon are recognised only when the exposure that is being hedged is
itself recognised. Under US GAAP, these swaps would not be treated as hedges, as the requirements to
qualify are not met and gains and losses on valuing such contracts at the balance sheet date would be
included in profit for the financial year.

115

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Currency Rate Swaps
Currency swaps are used to hedge intra Group equity investments. Realised and unrealised gains/losses
are not recognised in profit for the year but are recorded as movements in reserves. Due to the more
prescriptive documentary requirements these swaps would not qualify to be treated as hedges under US
GAAP and the gains and losses recorded as movements in reserves would be included in the profit for the
financial year. Under UK GAAP receivables and payables on currency swaps are included within debtors
and creditors respectively. Under US GAAP, these swaps would be separately classified into current asset
derivatives, current liabilities derivatives and non-current liabilities derivatives.

Dividends
Dividends are provided in the period to which they relate and, in the case of proposed final dividends, on
the basis of proposals by the directors. Under US GAAP, dividends would be provided for in the accounts for
the period in which they are declared.

Taxation
Deferred taxation is recognised on most timing differences. This is generally consistent with US GAAP,
except that deferred taxation is provided on goodwill acquired prior to 1998, which has been set off against
reserves and on which taxation benefits have been received. Under US GAAP, as goodwill acquired prior to
1998 would not have been set off against reserves, the deferred taxation provided under UK GAAP would
not be required. Furthermore, under US GAAP, a deferred tax liability would be provided on intangible
assets acquired subject to book amortisation where no tax relief is available and a liability would be set up
for deferred tax on gains recognised on the sale of assets where potentially taxable gains have been rolled
over into replacement assets.

Acquired in-Process Research and Development
Acquired in-process research and development is not separately identified and therefore forms part of the
goodwill arising on acquisition. Under US GAAP, acquired in-process research and development would be
identified separately from goodwill and charged to the profit and loss account on the date of acquisition.

Leases
Leases which are classified as operating leases under UK GAAP could be capitalised under US GAAP due to
different recognition criteria.

Capitalised Interest
The Group does not capitalise interest incurred in financing fixed asset additions. Under US GAAP, interest
incurred as part of
the cost of constructing fixed assets under long-term projects is capitalised and
amortised over the life of the asset.

Staff Costs
Under UK GAAP, the Group does not accrue for the expected cost of future employee absences such as
vacations. Under US GAAP, the Group accrues for vacation pay when the employee renders service that
increases their entitlement to this benefit.

Stock based Compensation
The Group does not account for the cost of share options whereas it does account for the cost of share
awards. Under US GAAP, the cost of share options is recognised under the fair value recognition provisions
of FAS 123 – Accounting for Stock Based Compensation and charged to the profit and loss account over the
vesting periods, along with related deferred taxation movements. Also under US GAAP, the amount of tax
deductions for stock based compensation recognised in the profit and loss account is limited to the related
FAS 123 charge, the balance is taken directly to additional paid in capital.

Discontinued Operations
The results of operations arising from discontinued operations are presented in the profit and loss account
under the relevant captions and the profit/(loss) on their disposal is reported as a separate line item after
operating income and before interest. Under US GAAP,
the results of operations from discontinued
operations and the profit/(loss) on their disposal are reported as separate line items immediately before net
income.

116

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Exceptional Items
Certain exceptional items are shown on the face of the profit and loss account after operating profit. These
items are mainly gains and losses on the sale of businesses and the cost of fundamental reorganisations.
Under US GAAP, these items would be classified as operating profit or expenses.

Restatement of Prior Periods Reconciliations from UK to US GAAP
In the course of preparing to convert the accounts from UK GAAP to IFRS, the Group has identified additional
adjustments to its reconciliations to US GAAP. These adjustments relate to vacation pay accruals and
deferred taxation thereon, deferred taxation on gains deferred into replacement assets, deferred taxation on
tax deductible goodwill,
taxation on stock based compensation and the translational effects of net
investment hedging. As a result US GAAP reconciliations for prior years have been restated. The adjustment
in respect of net investment hedging arises from a review of supporting documentation for IFRS purposes
which has indicated that these hedges do not qualify for designation under US GAAP. The adjustment is
between the profit and loss account and translation reserves and does not affect shareholders’ funds. These
reconciliation adjustments do not affect the Group’s UK GAAP accounts.

117

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Effect of Differences
The effect of the adjustments to attributable profit for the year and to shareholders’ funds that would be
required if US GAAP were to be applied instead of UK GAAP is summarised as follows. The condensed
consolidated income presented below reflects the adjustments to attributable profit for the year.

Profit for the Financial Year
Attributable profit for the year as reported under UK GAAP . . . . . . . .
Adjustments:
Amortisation of goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of other intangible fixed assets . . . . . . . . . . . . . . . . . . .
Goodwill fair value adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on disposals: goodwill and other intangible assets previously

written off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pension expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Staff costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrecognised forward foreign exchange (losses)/gains . . . . . . . . . . .
Unrecognised gains/(losses) on interest rate swaps . . . . . . . . . . . . .
Reclassification of gains on net investment hedging . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .
Acquired in-process research and development
Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Capitalised interest
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation – on adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred taxation – on adjustments . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred taxation – methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

125.2

20.5
(13.0)
–

–
(6.4)
(6.5)
(0.3)
(1.4)
7.8
18.0
(3.9)
(0.3)
0.3
(1.2)
1.5
2.1

Restated (i) Restated (i)

2003
(£ million)
148.1

2002

112.1

18.5
(9.9)
(2.4)

7.6
(8.5)
(4.5)
0.1
0.1
2.6
15.9
–
(0.4)
0.4
(1.8)
2.3
11.4

17.5
(9.0)
–

15.2
(3.7)
(3.4)
(0.7)
(7.9)
(1.4)
18.9
(4.2)
(0.4)
0.5
(1.0)
5.2
7.5

Profit for the financial year as adjusted to accord with US GAAP . . . .

142.4

179.5

145.2

Condensed Consolidated Income Statement
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other operating costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . .
Selling, general and administrative expenses . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense net

Income before income tax expense and equity in earnings of

associated companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in earnings of associated companies . . . . . . . . . . . . . . . . . . . .

Income from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations:
Income net of tax of nil (2003 – nil, 2002 – £0.8m)
. . . . . . . . . . . . . .
Gain on sale net of tax of nil (2003 – £16.1m, 2002 – £16.9m) . . . . .

1,248.5
(336.2)
(80.0)
(672.0)
10.0

170.3
(43.4)
15.5

142.4

–
–

–

1,178.9
(345.0)
(22.4)
(618.0)
(5.6)

1,083.7
(321.5)
(29.9)
(578.0)
(9.7)

187.9
(46.7)
15.3

156.5

–
23.0

23.0

144.6
(30.3)
13.3

127.6

1.3
16.3

17.6

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

142.4

179.5

145.2

(i)

(ii)

2003 and 2002 income from continuing operations (and profit for the financial year as adjusted to accord with US GAAP) have been
restated (see page 119).
The estimated amortisation of intangible assets as at 31 December 2004 for the next five years under US GAAP is as follows:
2005 – £18.7m, 2006 – £16.9m, 2007 – £15.4m, 2008 – £15.4m and 2009 – £14.9m.

(iii) Capitalised interest in 2004 was £0.5m (2003 – £0.5m, 2002 – £0.5m).

118

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

2004

Restated (i)
2003
(£ million, except per Ordinary Share and
ADS amounts)

Restated (i)
2002

Basic earnings as so adjusted – Per Ordinary Share:
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings as so adjusted – Per Ordinary Share:
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Basic earnings as so adjusted – Per ADS (i):
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings as so adjusted – Per ADS (i):
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15.23p
–

15.23p

15.12p
–

15.12p

76.2p
–

76.2p

75.6p
–

75.6p

16.83p
2.47p

19.30p

16.72p
2.46p

19.18p

84.1p
12.4p

96.5p

83.6p
12.3p

95.9p

13.78p
1.90p

15.68p

13.66p
1.89p

15.55p

68.9p
9.5p

78.4p

68.3p
9.5p

77.8p

(i)

2003 and 2002 earnings from continuing operations and net income have been restated (see below).

Restatement of 2003 and 2002
2003 and 2002 have been restated below to reflect: (1) vacation pay accruals; (2) reclassification of gains on
net investment hedging; (3) current taxation on stock based compensation; (4) deferred taxation on vacation
pay accruals and on stock based compensation; and (5) deferred taxation on tax deductible goodwill. The
effect of the restatement on income and earnings from continuing operations is analysed as follows:

2002
2003
(£ million, except per
Ordinary Share and ADS
amounts)

Income from continuing operations (as previously reported) . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Staff costs (1)
Reclassification of gains on net investment hedging (2)
. . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation – on adjustments (3)
Deferred taxation – on adjustments (4)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred taxation – methodology (5)

Income from continuing operations restated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Basic earnings as so adjusted – Per Ordinary Share from continuing operations:
As previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of restatements (detailed above)

Restated total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings as so adjusted – Per Ordinary Share from continuing operations:
As previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of restatements (detailed above)

Restated total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Basic earnings as so adjusted – per ADS from continuing operations:
As previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of restatements (detailed above)

Restated total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings as so adjusted – per ADS from continuing operations:
As previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of restatements (detailed above)

Restated total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

144.4
0.4
15.9
(1.8)
0.3
(2.7)

156.5

15.53p
1.30p

16.83p

15.42p
1.30p

16.72p

77.6p
6.5p

84.1p

77.1p
6.5p

83.6p

110.8
(0.3)
18.9
(1.0)
0.8
(1.6)

127.6

11.97p
1.81p

13.78p

11.86p
1.80p

13.66p

59.9p
9.0p

68.9p

59.3p
9.0p

68.3p

119

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

ComprehensiveIncome
The consolidated statement of comprehensive income under US GAAP is as follows:

Profit for the financial year as adjusted to accord with US GAAP
Other comprehensive income:
Minimum pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax on minimum pension liability . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income (net of related tax of nil):
Revaluation of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Translation adjustment arising on consolidation . . . . . . . . . . . . .

2004

142.4

3.4
(1.2)

–
(20.0)

Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

124.6

Restated (i)
2003
(£ million)
179.5

(5.4)
2.0

–
(21.6)

154.5

Restated (i)
2002

145.2

(69.4)
22.3

3.2
(22.4)

78.9

Movements in other comprehensive income amounts (net of related tax) are as follows:

Minimum
Pension
Liability

Revaluation
of
investments

Restated (i)
Currency
translation
differences

Restated (i)
Total

(£ million)

At 1 January 2002 . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Movement in the year

At 31 December 2002 . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Movement in the year

At 31 December 2003 . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Movement in the year

At 31 December 2004 . . . . . . . . . . . . . . . . . . . . .

–
(47.1)

(47.1)
(3.4)

(50.5)
2.2

(48.3)

(3.2)
3.2

–
–

–
–

–

(42.4)
(22.4)

(64.8)
(21.6)

(86.4)
(20.0)

(106.4)

(45.6)
(66.3)

(111.9)
(25.0)

(136.9)
(17.8)

(154.7)

(i)

2003 and 2002 profit for the financial year as adjusted to accord with US GAAP, translation adjustments arising on consolidation
and currency translation differences have been restated (see page 119).

120

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Shareholders’Funds

Shareholders’ funds as reported in the Group balance sheet under UK GAAP .
Adjustments:
Goodwill
Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other intangible fixed assets
Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Investment in joint venture
Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Fixed assets – capital lease
Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Debtors: debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debtors: pension assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debtors: non-returnable proceeds received from debt factor . . . . . . . . . . . . . . .
Current asset derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Creditors: staff costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors: acquisition consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors: proposed final dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors: pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings due within one year: non-returnable proceeds received from debt

factor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings due within one year: capital lease payments . . . . . . . . . . . . . . . . . .
Current liabilities derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-current liabilities derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings due after one year: capital lease payments . . . . . . . . . . . . . . . . . . .
Deferred taxation—on adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred taxation—methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

Restated (i)
2003

(£ million)

727.0

640.8

(44.0)
67.8

23.8

223.7
(108.5)

115.2

(37.7)
(1.2)

(38.9)

10.5
(1.7)

8.8

(46.4)
(8.0)
19.2
50.6

15.4

(5.9)
9.5
30.0
(85.6)
12.7

(19.2)
(0.2)
(22.4)

(81.1)

2.1
(2.1)
(8.5)
41.1
(20.9)

(0.9)
50.0

49.1

198.8
(104.5)

94.3

(38.3)
(1.2)

(39.5)

10.8
(1.1)

9.7

(52.8)
(5.6)
19.9
56.3

17.8

(5.6)
–
28.9
(88.0)
4.6

(19.9)
(0.2)
(19.6)

(99.8)

4.8
(5.2)
(9.4)
40.8
(12.7)

Shareholders’ funds as adjusted to accord with US GAAP . . . . . . . . . . . . . . . . .

781.9

690.7

(i)

2003 has been restated (see page 122).

121

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Reconciliation of Changes in Shareholders’ Funds Under US GAAP

Profit for the financial year under US GAAP . . . . . . . . . . . . . . . . .
Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Currency translation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issue of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock based compensation recognised in the profit and loss

account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation on stock based compensation . . . . . . . . . . . . . . . . . . .
Cost of shares transferred to beneficiaries . . . . . . . . . . . . . . . . .
Revaluation of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Minimum pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net addition to shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . .

Opening shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Closing shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

142.4
(46.7)
(20.0)
8.0

8.2
1.2
(4.1)
–
2.2

91.2

690.7

781.9

Restated (i)
2003
(£ million)
179.5
(45.1)
(21.6)
8.5

7.2
1.8
(1.3)
–
(3.4)

125.6

565.1

690.7

Restated (i)
2002

145.2
(43.5)
(22.4)
6.1

5.0
1.0
(2.4)
3.2
(47.1)

45.1

520.0

565.1

(i)

2003 and 2002 profit for the financial year under US GAAP, currency translation, taxation on stock based compensation and
shareholders’ funds have been restated (see page 119 and below).

Restatement of Shareholders’ Funds
Shareholders’ funds have been restated below to reflect: (1) vacation pay accruals; (2) deferred taxation on
vacation pay accruals and stock based compensation; and (3) deferred taxation on gains deferred into
replacement assets and on tax deductible goodwill. The effects on shareholders’ funds are as follows:

Shareholders’ funds under US GAAP as previously reported . . .
Restatements:
Creditors: holiday pay (1)
Deferred taxation – on adjustments (2)
Deferred taxation – methodology (3)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .

2003

709.9

(3.1)
5.2
(21.3)

Shareholders’ funds as restated . . . . . . . . . . . . . . . . . . . . . . . . .

690.7

2002
(£ million)
582.3

(3.5)
4.9
(18.6)

565.1

2001

536.1

(3.2)
4.1
(17.0)

520.0

Consolidated Statement of Cash Flows
The US GAAP cash flow statement reports changes in cash and cash equivalents, which includes short-term
highly liquid investments. Under UK GAAP, cash flows are presented separately for operating activities,
dividends from joint ventures, returns on investments and servicing of finance, taxation, investing activities
and financing activities. US GAAP requires only three categories of cash flow activity to be reported:
operating, investing and financing. Cash flows from taxation and returns on investments and servicing of
finance shown under UK GAAP would be included as operating activities under US GAAP. The payment of
dividends would be included as a financing activity under US GAAP.

The categories of cash flow activity under US GAAP are summarised as follows:

Cash flows from operating activities . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities . . . . . . . . . . . . . . . . . . . . . . .

Increase/(decrease) in cash and cash equivalents . . . . . . . . . . .
Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents at beginning of year . . . . . . . . . . . . .

Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . .

122

2004

207.3
(186.3)
(14.1)

6.9
(0.3)
26.0

32.6

2003
(£ million)
165.3
(23.3)
(139.0)

3.0
0.5
22.5

26.0

2002

152.4
(214.2)
57.8

(4.0)
0.1
26.4

22.5

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Additional Information in Respect of Earnings Per Share
The following table sets out the computation of basic and diluted earnings per Ordinary Share from
continuing operations under US GAAP:

Numerator:
Profit for the financial year as adjusted to accord with US GAAP(i)

. . . . . .

Numerator for diluted earnings per Ordinary Share . . . . . . . . . . . . . . . . . .

2004

142.4

142.4

2003
(£
million)

179.5

179.5

2002

145.2

145.2

(i)

2003 and 2002 profit for the financial year as adjusted to accord with US GAAP have been restated (see page 119).

Denominator:
Denominator for basic earnings per Ordinary Share . . . . . . . . . . . . . . . . .
Effect of dilutive securities: share option schemes . . . . . . . . . . . . . . . . . .

Denominator for diluted earnings per Ordinary Share . . . . . . . . . . . . . . . .

2004

2003
(Shares million)

2002

935
7

942

930
6

936

926
8

934

Basic earnings per Ordinary Share from continuing operations(ii) . . . . . . .
Basic earnings per Ordinary Share from discontinued operations . . . . . .
Diluted earnings per Ordinary Share from continuing operations(ii)
. . . . .
Diluted earnings per Ordinary Share from discontinued operations . . . . .

15.23p
–
15.12p
–

16.83p
2.47p
16.72p
2.46p

13.78p
1.90p
13.66p
1.89p

(ii)

Earnings from continuing operations for 2003 and 2002 have been restated (see page 119).

Additional Information in Respect of Deferred Taxation
The analysis of the deferred taxation (liability)/asset required by US GAAP is summarised as follows:

Deferred taxation liabilities:
Excess of book value over taxation value of fixed assets . . . . . . . . . . . . . . . . . . . . . . .
Other temporary differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deferred taxation assets:
Taxation effect of losses carried forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other temporary differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Of which:
Current
Non-current

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

Restated(iii)
2003

(£ million)

(41.5)
(70.9)

(39.3)
(68.3)

(112.4)

(107.6)

4.0
102.8

106.8

5.1
73.1

78.2

(5.6)

(29.4)

50.0
(55.6)

(5.6)

21.6
(51.0)

(29.4)

(iii)

2003 deferred taxation asset required by US GAAP has been restated (see page 122).

The losses carried forward of £10.6m expire between 2006 and 2019 of which £0.5m expire between 2006
and 2010.

123

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Additional Information in Respect of the Group’s Two Principal Defined Benefit Pension Plans
The two principal defined benefit pension plans are those in the UK and the US. The pension cost for these
plans computed in accordance with the requirements of US GAAP comprises:

Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortisation of net actuarial loss/(gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

12.2
21.6
(19.5)
0.6
6.8

2003
(£ million)
11.3
20.1
(16.0)
0.6
6.6

2002

10.9
19.1
(21.2)
2.3
0.6

Net periodic pension cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

21.7

22.6

11.7

The major assumptions used in computing the pension cost under US GAAP for the two principal plans are:

2004

2003
(%)

2002

UK:
Expected long-term rate of return on plan assets for net benefit costs . . . . . . . . . .
Discount rate for net benefit costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discount rate for year end benefit obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected long-term rate of earnings increases for net benefit costs . . . . . . . . . . . .
Expected long-term rate of earnings increases for year end benefit obligations . . .
US:
Expected long-term rate of return on plan assets for net benefit costs . . . . . . . . . .
Discount rate for net benefit costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discount rate for year end benefit obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected long-term rate of earnings increases for net benefit costs . . . . . . . . . . . .
Expected long term rate of earnings increases for year end benefit description . . .

7.1
5.4
5.3
4.8
4.9

8.8
6.0
5.8
5.0
5.0

6.9
5.6
5.4
4.3
4.8

8.8
7.0
6.0
5.0
5.0

6.9
6.0
5.6
4.0
4.3

8.8
7.0
7.0
5.0
5.0

The assumption for the expected long-term rate of return on assets is based on separate long-term
assumptions for each of
the major assets classes weighted by the asset allocation. The long-term
assumptions for bonds are based on long-term market yields at the accounting date. The long-term rate of
return on equities is the Group’s best estimate of future returns with consideration having been given to
long-term historic real returns achieved on equities.

The following table sets out the funded status and amounts that would be recognised under US GAAP in the
balance sheet at 31 December 2004 and 2003 for the Group’s two principal plans:

2004

2003

UK
Plan

US
Plan

UK
Plan

US
Plan

(£ million)

Fair value of plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

212.3
(287.7)

71.8
(131.7)

192.1
(265.5)

63.0
(124.4)

Projected benefit obligation in excess of plan assets . . . . . . . . . . . .
Unrecognised prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrecognised net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deficit on accumulated benefit obligation basis . . . . . . . . . . . . . . . . .

Accrued pension cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(75.4)
0.4
66.8

(8.2)
(48.6)

(56.8)

(59.9)
0.1
49.5

(10.3)
(18.5)

(28.8)

(73.4)
0.9
67.3

(5.2)
(51.0)

(56.2)

(61.4)
0.2
50.9

(10.3)
(21.4)

(31.7)

124

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

The following table sets out the accumulated benefit obligation and market value of assets for the Group’s
two principal plans:

2004

UK

2003

US

UK

US
(£ million)

Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market value of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(269.1)
212.3

(100.6)
71.8

(248.3)
192.1

(94.7)
63.0

The measurement date for both Plans is 31 December.

In the UK plan, the assets principally comprise UK and other listed equities, bank deposits and UK
Government index-linked stocks. In the US plan, the assets principally comprise US equities, other listed
equities and fixed income securities.

The following table sets out the Company’s pension plan asset allocation in the UK for the last two fiscal
years, together with the target allocation for 2005:

Asset Category
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Target
Allocation
2005

60 – 80
15 – 25
0 – 8
0 – 5

Percentage of Plan
Assets at
31 December

2004
(%)

73.9
16.8
5.4
3.9

2003

74.5
16.8
5.2
3.5

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100%

100%

The long-term investment strategy for the Smith & Nephew UK Pension Fund (“the UK Plan”) is for sufficient
index-linked and fixed interest investments to be held to match in the medium-term the excess of benefits
over contributions. The balance of the UK Plan’s investments will be invested in equities and property unit
trusts.

The UK Plan is not permitted to have a direct shareholding in Smith & Nephew plc or associated companies.

The following table sets out the company’s pension plan asset allocation in the US for the last two fiscal
years, together with the target allocation for 2005:

Target
Allocation
2005

Asset Category
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

68 – 80
20 – 26
0 – 5

Percentage of Plan
Assets at
31 December

2004
(%)

78.1
21.5
0.4

2003

76.4
20.7
2.9

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

100%

100%

The long-term investment strategy for the Smith & Nephew US Pension Plan (“the US Plan”) is a long-term rate
of return on assets that is at least 5% to 6% greater than the rate of inflation as measured by the Consumer
Price Index. This target rate of return for the Plan is based upon the assumption that future real rates of return
will be close to the historical long run rates of return experienced for each asset class. Market performance
varies and a real rate of return of between 5% and 6% may not be achievable during some periods.

The US Plan is not permitted to have a direct shareholding in Smith & Nephew plc or associated companies.

125

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

A reconciliation of the projected benefit obligation and the fair value of plan assets is shown in the following
tables:

Projected benefit obligation at beginning of year . . . . . . . . . . .
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plan participant contributions . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits and expenses paid . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Projected benefit obligation at end of year

. . . . . . . . . . . . . . .

Fair value of plan assets at beginning of year . . . . . . . . . . . . .
Actual return on assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Company contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plan participant contributions . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits and expenses paid . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Fair value of plan assets at end of year . . . . . . . . . . . . . . . . . .

2004

2003

UK Plan

US Plan

UK Plan

US Plan

(£ million)

265.5
6.3
14.4
3.6
9.0
(11.1)
–

287.7

192.1
19.1
8.6
3.6
(11.1)
–

212.3

124.4
5.9
7.2
–
6.2
(2.9)
(9.1)

131.7

63.0
7.2
9.2
–
(2.9)
(4.7)

71.8

231.7
6.7
13.0
2.7
22.6
(11.2)
–

265.5

164.1
28.0
8.5
2.7
(11.2)
–

192.1

105.2
4.6
7.1
–
23.5
(2.9)
(13.1)

124.4

50.5
11.6
10.4
–
(2.9)
(6.6)

63.0

The following table sets out the benefit payments used in the calculation of the expected benefit obligation:
United
States

United
Kingdom

£ million

Actual Payments
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Expected Future Payments
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2010 — 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11.2
11.1

12.3
13.0
13.1
14.3
15.1
85.5

2.9
2.9

2.8
3.0
3.2
3.5
3.8
27.7

The employer’s best estimate of contributions expected to be paid in 2005 to the UK Plan is £8.8m and to
the US Plan is £8.9m.

Additional information in respect of the Group’s healthcare benefits after retirement in the UK and
the US

The movement in the accumulated post retirement benefit obligation under the Group’s post-retirement
healthcare schemes is as follows:

2004

2003

UK

US

UK

(£ million)

At beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.7
0.1
0.2
–
0.1
(0.2)
–

3.9

6.4
0.1
0.4
0.2
1.2
(0.4)
(0.5)

7.4

3.4
0.1
0.2
–
0.2
(0.2)
–

3.7

126

US

7.0
0.1
0.4
–
–
(0.4)
(0.7)

6.4

39. Differences Between Accounting Principles Generally Accepted in the UK and US — (continued)

Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrecognised net gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accrued healthcare cost

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

UK

3.9
(0.2)
–

3.7

US
UK
(£ million)
3.7
7.4
(0.1)
(2.6)
–
0.1

4.9

3.6

US

6.4
(1.5)
0.1

5.0

The effect of a one percentage point change in the rate of medical cost inflation would increase/(decrease)
the accumulated post retirement benefit obligation as follows:

2004

2003

1% increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1% decrease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0.1
(0.1)

UK

US
UK
(£ million)
0.1
0.6
(0.1)
(0.5)

US

0.5
(0.4)

The assumed post retirement healthcare cost trend for 2005 and thereafter is expected to be approximately
1% above the discount rate.

Additional Information Relating to Leases
Future lease payments under US GAAP at 31 December 2004 are as follows:

Within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
After one and within two years . . . . . . . . . . . . . . . . . . . . . . . . .
After two and within three years . . . . . . . . . . . . . . . . . . . . . . .
After three and within four years . . . . . . . . . . . . . . . . . . . . . . .
After four and within five years . . . . . . . . . . . . . . . . . . . . . . . . .
After five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less: imputed interest

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Present value of future lease payments . . . . . . . . . . . . . . . . . .

Operating Leases
Other
Land and
Assets
Buildings

Capital Leases

Land and
Buildings

Other
Assets

(£ million)

10.1
7.3
6.2
6.0
5.9
24.4

59.9

9.7
5.4
2.4
0.3
–
–

17.8

1.2
0.9
0.9
0.9
0.9
10.5

15.3

(6.1)

9.2

0.3
0.2
0.1
–
–
–

0.6

–

0.6

Additional Information Regarding Provisions for Bad and Doubtful Debts

Balance
at
beginning
of year

Additions
charged
to costs
and
expenses

Year ended 31 December 2004 . . . .
Year ended 31 December 2003 . . . .
Year ended 31 December 2002 . . . .

7.3
7.0
7.3

15.4
1.3
0.5

(i)

Represents the excess of amounts written off over recoveries.

Exchange
differences
(£ million)
(0.3)
(0.2)
(0.4)

Deductions(i)

(1.7)
(0.8)
(0.4)

Balance
at end of
year

20.7
7.3
7.0

127

PARENT COMPANY BALANCE SHEET

Fixed assets:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tangible assets — (Note 41)
Investments — (Note 42) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Current assets:
Debtors — (Note 43)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and bank — (Note 44) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Creditors: amounts falling due within one year:
Borrowings — (Note 44) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other creditors — (Note 45) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December
2003
2004

(£ million)

6.6
2,377.5

2,384.1

7.0
756.8

763.8

421.8
1.6

423.4

1,538.6
3.1

1,541.7

24.6
2,181.6

67.2
1,798.0

2,206.2

1,865.2

Net current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(1,782.8)

(323.5)

Total assets less current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors: amounts falling due after more than one year:
Borrowings — (Note 44) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other creditors — (Note 45) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provisions for liabilities and charges — (Note 46) . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital and reserves
Equity shareholders’ funds:
Called up equity share capital — (Note 23) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share premium account — (Note 47)
Profit and loss account — (Note 47)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Own shares — (Note 27)

Shareholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

601.3

440.3

144.0
11.6
–

155.6

445.7

114.5
159.6
175.8
(4.2)

445.7

98.3
4.8
1.2

104.3

336.0

114.1
152.0
72.0
(2.1)

336.0

Approved by the Board on 8 March 2005.

Dudley Eustace Chairman Christopher O’Donnell Chief Executive Peter Hooley Finance Director

128

NOTES TO THE PARENT COMPANY ACCOUNTS

40. Accounting Policies

The separate accounts of the parent company are presented as required by the Companies Act 1985. The
principal accounting policies are the same as those set out in Note 1 of the Notes to the Group Accounts.

41. Tangible Fixed Assets

Cost:
At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Depreciation:
At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Charge for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net book amount at 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net book amount at 31 December 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Tangible fixed assets comprise plant and equipment.

42.

Investments

At 1 January . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004
(£ million)

18.2
0.8
(1.5)

17.5

11.2
1.2
(1.5)

10.9

6.6

7.0

2004
(£ million)
756.8
1,682.0
(61.3)

At 31 December

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,377.5

Investments represent holdings in subsidiary undertakings and are stated at cost less any provision for
impairment.

129

42.

Investments — (continued)

Principal Subsidiary Undertakings
The information provided below is given for principal subsidiary undertakings, all of which are 100% owned,
in accordance with Section 231(5)(a) of the Companies Act 1985. A full list will be appended to Smith &
Nephew’s next annual return to Companies House:

Company Name

Activity

United Kingdom:
Smith & Nephew Healthcare Limited
Smith & Nephew Medical Limited
T J Smith & Nephew Limited

Continental Europe:
Smith & Nephew GmbH
Smith & Nephew SA-NV
Smith & Nephew A/S
Smith & Nephew OY
Smith & Nephew SAS
Smith & Nephew 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

Africa, Asia and Australasia:
Smith & Nephew Pty Limited
Smith & Nephew Limited
Smith & Nephew Healthcare Limited
Smith & Nephew KK
Smith & Nephew Limited
Smith & Nephew Healthcare Sdn Berhad
Smith & Nephew Limited
Smith & Nephew Pte Limited
Smith & Nephew (Pty) Limited
Smith & Nephew Limited
Smith & Nephew FZE

Medical Devices
Medical Devices
Medical Devices

Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices

Medical Devices
Medical Devices
Medical Devices
Medical Devices

Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices
Medical Devices

Country of operation and
incorporation

England & Wales
England & Wales
England & Wales

Austria
Belgium
Denmark
Finland
France
Germany
Ireland
Italy
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland

Canada
Mexico
Puerto Rico
United States

Australia
Hong Kong
India
Japan
Korea
Malaysia
New Zealand
Singapore
South Africa
Thailand
United Arab Emirates

Principal Associated Undertakings, Joint Ventures and Other Arrangements
The Group owns 50% of BSN Medical GmbH & Co KG, a medical supplies company incorporated and
located in Germany.

In 2002, the Group owned 21.5% of AbilityOne Corporation, a supplier of rehabilitation products to hospitals,
nursing homes and clinics incorporated in the United States. During 2003, the Group disposed of this
interest.

In 2001, the Group owned 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 for
cartilage replacement.
the Group acquired the interests it did not already own in the joint
arrangements from Advanced Tissue Sciences, Inc.

In 2002,

130

43. Debtors

Amounts falling due within one year:
Trade and other debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts owed by subsidiary undertakings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts owed by joint venture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepayments and accrued income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amounts falling due after more than one year:
Deferred taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

44. Borrowings

Borrowings — Bank loans and overdrafts:
Due within one year or on demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan Notes — due after one year (in 2006)

Cash and bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

2.9
365.0
0.4
1.9
6.0
21.1

397.3

0.1
24.4

24.5

1.1
1,483.3
0.5
2.1
–
30.8

1,517.8

–
20.8

20.8

421.8

1,538.6

2004

2003

(£ million)

24.6
93.7
50.3

168.6
(1.6)
(45.5)
14.8

67.2
98.3
–

165.5
(3.1)
(51.6)
9.4

Net debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

136.3

120.2

The parent company has currency swaps that have maturities ranging from 2005 to 2006 and are translated
at year-end exchange rates. Gross sterling equivalents of £640.5m (2003 — £593.1m) receivable and
£609.8m (2003 — £550.9m) payable have been netted. £45.5m is reported as debit balances on currency
swaps and £14.8m as credit balances on currency swaps the net of which is a debit balance of £30.7m
(2003 — £51.6m as debit balances on currency swaps and £9.4m as credit balances on currency swaps
the net of which is a debit balance of £42.2m). Currency swaps include fixed and floating interest rate
contracts and forward foreign exchange contracts and are used for hedging foreign investments.

45. Other Creditors

Amounts falling due within one year:
Trade creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts owed to subsidiary undertakings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accruals and deferred income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ordinary share dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Amounts falling due after one year:
Acquisition consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit balances on currency swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2004

2003

(£ million)

2.8
2,129.2
6.9
–
30.0
12.7

3.0
1,741.7
7.6
12.2
28.9
4.6

2,181.6

1,798.0

9.5
2.1

11.6

–
4.8

4.8

Amounts falling due after more than one year are payable as follows: £11.6m in 2006 (2003 — £3.6m in
2005 and £1.2m in 2006).

131

46. Provisions for Liabilities and Charges

The movement in provisions for liabilities and charges during the year from £1.2m to nil represents
utilisation of provisions and changes in deferred taxation. The provision for deferred taxation is made up as
follows:

Other fixed asset timing differences: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other timing differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net deferred taxation liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred taxation asset (Note 43) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

47. Reserves

2004

2003

(£ million)

1.2
(1.3)

(0.1)

–
(0.1)

(0.1)

1.4
(0.8)

0.6

0.6
–

0.6

Share
premium

Profit and
loss
account

(£ million)

At 1 January 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained profit for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share based expense recognised in the profit and loss . . . . . . . . . . . . . . . . . . . . . .
Cost of shares transferred to beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

At 31 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

152.0
–
–
–
7.6

159.6

72.0
104.7
1.1
(2.0)
–

175.8

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 £104.7m (2003 — £21.1m loss).

On 23 June 2003, following the cancellation of the 5½% £1.00 cumulative preference shares (Note 23), a
capital redemption reserve of £0.3m was established in the Parent Company. This reserve was extinguished
during 2003.

48. Contingent Liability

Guarantees in respect of subsidiary undertakings . . . . . . . . . . . . . . . . . . . . . . . . . .

8.7

9.9

The parent has given guarantees to banks to support liabilities under foreign exchange contracts and cross
guarantees to support overdrafts. Such guarantees are not considered to be liabilities as all subsidiary
undertakings are trading as going concerns.

2004

2003

(£ million)

132

INVESTOR INFORMATION

This section discusses shareholder return (the return to shareholders in the form of dividends and share price
movements) and provides other information for shareholders.

Shareholder return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Information for shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Five year record . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exchange rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation information for shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Memorandum and articles of association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

134
136
138
140
143
144
147

133

SHAREHOLDER RETURN

Dividend History
Following the capital restructuring and dividend reduction in 2000 the Group adopted a policy of increasing its
dividend cover (the ratio of attributable earnings before goodwill amortisation and exceptional items, as set out in
the “Five Year Record”, to ordinary dividends). This was intended to increase the financing capability of the Group
for acquisitions and other investments. Over the last three years the dividend has been increased in line with
inflation. Dividend cover has increased from 3.3 times in 2002 to 4.1 times in 2004.

Smith & Nephew has paid dividends on its Ordinary Shares in each year since 1937. An interim dividend in
respect of each fiscal year is normally declared in August and paid in November, and the final dividend for each
year is normally recommended by the Board of Directors in the following February and paid in May after approval
by shareholders at the Company’s Annual General Meeting.

Future dividends of Smith & Nephew will be dependent upon: future earnings; the future financial condition of the
Group; the Board’s dividend policy; and the additional factors that might affect the business of the Group set out
in “Special Note Regarding Forward-Looking Statements” and “Risk Factors”.

The following table shows the dividends on each Ordinary Share (as increased by the associated UK tax credit of
10%, but before deduction of withholding taxes)
If approved by
shareholders, the 2004 final dividend will be payable on 13 May 2005. The dividends are declared in pence per
Ordinary Share and have been translated into US cents per share at the Noon Buying Rate on the payment date.

for the fiscal years 2000 through 2004.

Pence per share:
Interim . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Final

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . .

US cents per share:
Interim . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Final

2004

2.111
3.556

5.667

3.916
6.845(i)

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . .

10.761

Years ended 31 December
2002

2001

2003

2.056
3.444

5.500

3.299
5.567

8.866

2.000
3.333

5.333

3.155
5.408

8.563

1.944
3.222

5.166

2.753
4.611

7.364

2000

1.889
3.111

5.000

2.714
4.459

7.173

(i)

Translated at the Noon Buying Rate on 28 February 2005 of US$ 1.925 = £1. This is equivalent to 34.225 cents per ADS.

On 11 August 2000, a special dividend of £415.6m (41.27p per old Ordinary 10p Share, including tax credit,
equivalent to US$3.105 per ADS) was paid.

134

Share Prices
The following table sets forth, for the periods indicated, the highest and lowest middle market quotations for the
Ordinary Shares, as derived from the Daily Official List of the UK Listing Authority and the highest and lowest
sales prices of ADSs as reported on the New York Stock Exchange composite tape.

Ordinary Shares

ADSs

Fiscal Year ended 31 December:
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Quarters in the Fiscal Year ended 31 December:
2003:
1st Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2nd Quarter
3rd Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4th Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004:
1st Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2nd Quarter
3rd Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4th Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2005:
1st Quarter (through 28 February 2005)

. . . . . . . . . . .

Last Six Months:
September 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
October 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
November 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
January 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
February 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

High
£

3.30(i)
4.20
4.30
4.83
6.14

4.00
4.26
4.20
4.83

5.57
5.99
6.14
5.53

5.58

5.15
5.22
5.40
5.53
5.33
5.58

Low
£

1.57
2.91
3.05
3.30
4.39

3.30
3.48
3.48
4.03

4.39
5.59
4.70
4.51

5.11

4.80
4.51
4.64
5.23
5.11
5.31

High
US$

23.07
30.46
32.30
42.18
59.20

31.55
34.73
34.19
42.18

52.64
55.64
59.20
53.79

53.25

46.77
47.50
51.95
53.79
51.90
53.25

Low
US$

12.57
20.90
23.50
26.45
40.36

26.45
28.91
28.61
33.46

40.36
49.50
41.93
41.54

47.86

43.13
41.54
42.71
50.69
47.86
49.68

(i)

This does not include the anomalous closing share price of 386p on 31 July 2000 on the London Stock Exchange.

135

INFORMATION FOR SHAREHOLDERS

Financial Calendar

Quarter One results and AGM
Payment of 2004 final dividend
Half year results announced
Quarter Three results announced
Payment of 2005 interim dividend
Full year results announced
Annual Report posted
Annual General Meeting

5 May 2005
13 May 2005
4 August 2005
27 October 2005
11 November 2005
Early February 2006
March 2006
April 2006

Final Dividend
The Ordinary Shares and ADSs will trade ex-dividend on the London and New York Stock Exchanges respectively
from 20 April 2005 and the record date will be 22 April 2005 in respect of the proposed 2004 final dividend of
3.20p per Ordinary Share to be paid on 13 May 2005.

Ordinary Shares

Paymentofcashdividends
Shareholders who wish their dividends to be paid directly to a bank or building society and who have not already
completed an electronic bank transfer mandate should contact the Company’s registrars.

Dividendre-investmentplan
The Company has a dividend re-investment plan that offers shareholders, except those in North America, the
opportunity to invest their cash dividends in further Smith & Nephew Ordinary Shares, which are purchased in
the market at competitive dealing costs. Application forms for re-investing the 2004 final dividend are available
from Lloyds TSB Registrars who administer the plan on behalf of the Company.

UKcapitalgainstax
For the purposes of UK capital gains tax the price of Ordinary Shares on 31 March 1982 was 35.04p.

Smith&Nephewshareprice
The Company’s share price is available on the Smith & Nephew website www.smith-nephew.com and at
www.londonstockexchange.com where it is updated at intervals throughout the day. It is quoted daily in UK
telephone
national newspapers, as well as on Ceefax and Teletext. The Financial Times Cityline Service,
+44 (0)906 8403 4043, provides an up to the minute share price. A fee (currently 60p per minute) is charged for
this service.

Sharedealingservice
A postal and telephone facility that provides a competitive method of buying and selling Smith & Nephew shares
is available through Hoare Govett Limited. For information contact Hoare Govett Ltd., 250 Bishopsgate, London
EC2M 4AA, UK. Telephone +44 (0)20 7678 8300. Lloyds TSB Registrars or your bank or building society may also
provide a share dealing service.

Smith&NephewcorporateISA
The Company has a corporate Individual Savings Account (ISA), for UK shareholders, administered by Lloyds TSB
Registrars. For information about this service please contact their helpline on telephone +44 (0)870 2424 244.

Shareview
To view information about your shareholdings on the internet, register at www.shareview.com, the Lloyds TSB
Registrars enquiry and portfolio management service for shareholders. When you have registered for shareview
to receive future shareholder
you will also be able to register your proxy instructions online and elect
communications via our website at www.smith-nephew.com rather than a copy in the post. Such electronic
communications cut down printing and distribution costs and are less harmful to the environment.

Shareholderenquiries
For information about the AGM, shareholdings, dividends and changes to personal details all shareholders
should contact Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6DS, UK. Telephone
+44 (0)870 600 3996.

136

American Depositary Receipts (“ADRs”)
In the US, the Company’s Ordinary Shares are traded in the form of ADSs, evidenced by ADRs, and trade on the
NYSE under the symbol SNN. Each American Depositary Share represents five Ordinary Shares. Bank of New
York is the authorised depositary bank for the Company’s ADR programme. A Global BuyDIRECT plan is available
for US residents, enabling investment directly in ADSs with reduced brokerage commissions and service costs.
For further information contact: Bank of New York on +1-888-BNY-ADRS (toll-free) or visit www.adrbny.com.

The Company furnishes the Bank of New York, as depositary, with this annual report containing Consolidated
Financial Statements and the opinion thereon by its independent auditors. Such financial statements are
prepared under UK GAAP. The annual report contains reconciliations of net income, cash flow and shareholders’
funds prepared under UK GAAP to those prepared under US GAAP. The Company also furnishes the Bank of
New York with semi-annual reports prepared in conformity with UK GAAP, which contain unaudited interim
consolidated financial information. Upon receipt thereof, the Bank of New York mails all such reports to recorded
holders. The Company also furnishes to the Bank of New York all notices of shareholders’ meetings and other
reports and communications that are made generally available to shareholders of the Company. The Bank of New
York makes such notices, reports and communications available for inspection by recorded holders of ADSs and
mails to all recorded holders of ADSs notices of shareholders’ meetings received by the Bank of New York.

Smith&NephewADSprice
The Company’s ADS price can be obtained from the official New York Stock Exchange website at www.nyse.com
and is quoted daily in the Wall Street Journal.

Annual General Meeting
The Company’s sixty-eighth Annual General Meeting is to be held on 5 May 2005 at The Institution of Mechanical
Engineers, Birdcage Walk, Westminster, London SW1H 9JJ at 1pm. Notice of the meeting is enclosed with an
accompanying letter from the Chairman.

Registered office
Smith & Nephew plc, 15 Adam Street, London WC2N 6LA, UK. Registered in England and Wales No. 324357.

Advisors
Solicitors:

Auditors:
Stockbrokers:

Ashurst
Pinsent Masons
Ernst & Young LLP
JP Morgan Cazenove
Dresdner Kleinwort Wasserstein

137

SHARE CAPITAL

The principal trading market for the Ordinary Shares is the London Stock Exchange. The Ordinary Shares were
listed on the New York Stock Exchange on 16 November 1999, trading in the form of ADSs evidenced by ADRs.
On 15 December 2003 a ratio change was effected whereby the number of Ordinary Shares represented by each
ADS changed from ten to five. All prices of ADSs prior to this date have been restated to reflect this ratio change.
The ADR facility is sponsored by the Bank of New York acting as depositary.

Shareholdings
As of 28 February 2005, 7,471,787 ADSs equivalent to 37,358,935 Ordinary Shares or approximately 4.0% of
the total Ordinary Shares in issue, were outstanding and were held by 59 registered holders.

As of 28 February 2005, to the knowledge of the Group, there were 24,877 registered holders of Ordinary
Shares, of whom 92 had registered addresses in the US and held a total of 269,506 Ordinary Shares (less than
0.1% of the total issued). Because certain Ordinary Shares are registered in the names of nominees, the number
of shareholders with registered addresses in the US is not representative of the number of beneficial owners of
Ordinary Shares resident in the US.

Until 23 June 2003 Smith & Nephew had in issue 268,500 5 1⁄ 2% Cumulative Preference Shares of £1 each,
whose right to a dividend of 5 1⁄ 2% per annum was preferred over the rights to dividends of the holders of
Ordinary Shares. The Cumulative Preference Shares were cancelled and repaid on 7 July 2003.

Major Shareholders
As far as is known to Smith & Nephew, the Group is not directly or indirectly owned or controlled by another
corporation or by any government.

As of 28 February 2005, no persons are known to Smith & Nephew to have any interest (as defined in the
Companies Act 1985) in 3% or more of the Ordinary Shares, other than AXA Investment Managers (5.2%,
48,966,535 Ordinary Shares) and Legal & General Investment Management (3.8%, 35,284,264 Ordinary Shares).

The following table shows changes over the last three years in the percentage of the issued share capital owned
by shareholders holding 3% or more of Ordinary Shares, as notified to the Company under the Companies Act
1985:

FMR Corp & Fidelity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AXA Investment Managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal and General Investment Management . . . . . . . . . . . . . . . . . . . .
Capital Group of Companies Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Purchase of Ordinary Shares on behalf of the Company

As at 31 December
2003
(%)
7.9
3.7
3.4
8.0

2004

5.5
3.7
3.3
–

2002

6.8
5.0
–
–

Date Purchased:
31 March 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15 December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total
shares
purchased
(Number)

447,709
304,772

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

752,481

Average
price
paid per
share
(p)

540
549

545

The shares detailed above were purchased in the open market by Mourant & Co Trustees Limited, trustees of the
Smith & Nephew Employees’ Share Trust Limited in connection with the long-term incentive plan referred to in the
“Remuneration Report”. No shares were purchased or contracted for or are subject of an option under the
company share repurchase programme approved by shareholders on 6 May 2004.

138

Exchange Controls and Other Limitations Affecting Security Holders
There are no UK governmental laws, decrees or regulations that restrict the export or import of capital or that
affect the payment of dividends, interest or other payments to non-resident holders of Smith & Nephew’s
securities, except for certain restrictions imposed from time to time by Her Majesty’s Treasury of the United
Kingdom pursuant to legislation, such as the United Nations Act 1946 and the Emergency Laws Act 1964,
against the government or residents of certain countries.

There are no limitations, either under the laws of the UK or under the Articles of Association of Smith & Nephew,
restricting the right of non-UK residents to hold or to exercise voting rights in respect of Ordinary Shares, except
that where any overseas shareholder has not provided to the Company a UK address for the service of notices,
the Company is under no obligation to send any notice or other document to an overseas address. It is, however,
the current practice of the Company to send every notice or other document to all shareholders regardless of the
country recorded in the register of members, with the exception of details of
the Company’s dividend
re-investment plan, which are not sent to shareholders with recorded addresses in the US and Canada.

139

FIVE YEAR RECORD

2004

2003

2002
(£ million, except per Ordinary Share amounts)

2001

2000

Amounts in accordance with UK GAAP:

Group Profit and Loss Account
Turnover:
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . .

Group turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share of joint venture . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating profit:
Continuing operations:

1,248.5
–

1,248.5
165.9

1,178.9
–

1,178.9
163.9

1,083.7
26.2

1,109.9
155.0

978.3
103.4

1,081.7
123.6

911.5
223.2

1,134.7
–

1,414.4

1,342.8

1,264.9

1,205.3

1,134.7

Before goodwill amortisation and exceptional

items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill amortisation . . . . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . .

251.5
(20.5)
(80.0)

220.7
(18.5)
(22.4)

Discontinued operations:

Before exceptional items . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . .

–
–

–
–

196.0
(17.5)
(29.9)

2.1
–

174.4
(10.4)
(21.1)

11.1
–

156.9
(6.9)
(12.4)

29.0
(3.9)

Share of operating profit of the joint venture:

Before exceptional items . . . . . . . . . . . . . . . . . . .
Exceptional items . . . . . . . . . . . . . . . . . . . . . . . . .

23.8
–

22.7
(2.7)

19.6
(2.6)

12.8
(5.0)

–
–

151.0

179.8

150.7

154.0

162.7

Share of operating profit of the associated

undertaking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Profit on ordinary activities before interest
. . . . . . . . .
Net interest receivable/(payable) . . . . . . . . . . . . . . . . .

Profit on ordinary activities before taxation . . . . . . . . .
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Attributable profit for the year

. . . . . . . . . . . . . . . . . . .

174.8

199.8

167.7

161.8

162.7

–

174.8
–

174.8
3.1

177.9
(52.7)

125.2

4.8

204.6
31.5

236.1
(6.0)

230.1
(82.0)

148.1

4.9

172.6
18.0

190.6
(12.7)

177.9
(65.8)

112.1

–

161.8
49.2

211.0
(17.4)

193.6
(64.0)

129.6

–

162.7
109.5

272.2
(7.0)

265.2
(57.7)

207.5

Basic earnings per Ordinary Share . . . . . . . . . . . . . . .
Diluted earnings per Ordinary Share . . . . . . . . . . . . . .

13.39p
13.30p

15.92p
15.82p

12.11p
12.02p

14.07p
13.95p

20.07p
19.95p

Results before goodwill amortisation and exceptional items
Profit on ordinary activities before taxation . . . . . . . . .
Adjustments:
Continuing operations: goodwill amortisation . . . . . . .
Continuing operations: exceptional items . . . . . . . . . .
Discontinued operations: exceptional items . . . . . . . .
Share of joint venture exceptional items . . . . . . . . . . .
Net profit on disposals . . . . . . . . . . . . . . . . . . . . . . . . .

20.5
80.0
–
–
–

177.9

230.1

177.9

193.6

265.2

18.5
22.4
–
2.7
(31.5)

17.5
29.9
–
2.6
(18.0)

10.4
21.1
–
5.0
(49.2)

6.9
12.4
3.9
–
(109.5)

Profit before taxation, goodwill amortisation and

exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . .

278.4

242.2

209.9

180.9

178.9

Taxation on profit before goodwill amortisation and

exceptional items . . . . . . . . . . . . . . . . . . . . . . . . . . .

(80.7)

(70.2)

(61.6)

(52.3)

(52.9)

Earnings before goodwill amortisation and

exceptional items (“Adjusted”) . . . . . . . . . . . . . . . . .

197.7

172.0

148.3

128.6

126.0

Average number of shares . . . . . . . . . . . . . . . . . . . . .
Adjusted basic earnings per Ordinary Share(i)
. . . . . .
Adjusted diluted earnings per Ordinary Share(ii) . . . . .

935
21.14p
21.01p

930
18.49p
18.38p

926
16.02p
15.89p

921
13.96p
13.84p

1,034
12.19p
12.12p

140

2004

2003

2002
(£ million, except per Ordinary Share amounts)

2001

2000

Group Profit and Loss Account — (continued)
Dividends per Ordinary Share . . . . . . . . . . . . . . . . . . .
Special dividends per Ordinary Share . . . . . . . . . . . . .

Operating profit (before goodwill amortisation and

5.10p
–

4.95p
–

4.80p
–

4.65p
–

4.50p
37.14p

exceptional items) to Group turnover . . . . . . . . . . . .

20.1%

18.7%

17.8%

17.1%

16.4%

Research and development costs to Group

turnover

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capital expenditure (including intangibles) to Group

turnover

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.3%

8.2%

5.7%

6.2%

5.5%

7.7%

4.7%

6.9%

4.0%

5.6%

Group Balance Sheet
Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Creditors falling due after more than one year
. . . . . .
Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

740.6
269.5
(160.1)
(123.0)

Capital employed . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

727.0

Called up equity and non-equity share capital
. . . . . .
Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment in own shares . . . . . . . . . . . . . . . . . . . . . .

Capital and reserves . . . . . . . . . . . . . . . . . . . . . . . . . .

114.5
616.7
(4.2)

727.0

653.6
185.8
(108.4)
(90.2)

640.8

114.1
528.8
(2.1)

640.8

701.5
74.0
(170.5)
(88.1)

516.9

113.8
406.3
(3.2)

516.9

570.0
99.8
(169.5)
(95.3)

405.0

113.4
294.1
(2.5)

405.0

426.0
132.8
(187.2)
(103.5)

268.1

112.7
158.3
(2.9)

268.1

Operating profit (before goodwill amortisation and
exceptional items) to average capital employed
plus net debt

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Group Cash Flow
Cash flow from operating activities . . . . . . . . . . . . . . .
Capital expenditure net of disposals . . . . . . . . . . . . . .

Interest, taxation and dividends . . . . . . . . . . . . . . . . . .
Acquisitions and disposals (iii) . . . . . . . . . . . . . . . . . . .
Movements in share capital and own shares . . . . . . .

Exchange adjustments . . . . . . . . . . . . . . . . . . . . . . . . .
Opening net borrowings . . . . . . . . . . . . . . . . . . . . . . .

Closing net borrowings . . . . . . . . . . . . . . . . . . . . . . . .

(112.0)

34%

32%

29%

34%

36%

226.6
(101.1)

125.5
(66.0)
(85.2)
3.9

(21.8)
36.9
(127.1)

214.5
(71.4)

143.1
(94.3)
48.1
7.2

104.1
45.7
(276.9)

(127.1)

211.0
(85.4)

125.6
(102.1)
(128.8)
3.7

(101.6)
68.2
(243.5)

(276.9)

193.5
(73.0)

120.5
(134.7)
5.0
7.8

(1.4)
(5.8)
(236.3)

(243.5)

204.0
(63.8)

140.2
(529.4)
158.7
4.8

(225.7)
(32.9)
22.3

(236.3)

Gearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15%

20%

54%

60%

88%

(i)

Adjusted basic earnings per Ordinary Share is calculated by dividing profit before taxation, goodwill amortisation and exceptional items
less taxation on profit before exceptional items by the average number of shares.

(ii) Adjusted diluted earnings per Ordinary Share is calculated by dividing profit before taxation, goodwill amortisation and exceptional items

less taxation on profit before exceptional items by the diluted number of shares.

(iii) 2004 includes £50.3m of loan notes issued on acquisition.

141

Amounts in accordance with US GAAP:
Smith & Nephew prepares its accounts in accordance with UK GAAP which differ in certain respects from US
GAAP. Reconciliations of profit for the financial year and shareholders’ funds are set out in Note 39 of Notes to
the Group Accounts. Key Profit and Loss and Balance Sheet data are as follows:

Profit from continuing operations . . . . . . . . . . . . . . . . . .
Profit from discontinued operations . . . . . . . . . . . . . . . .

2004

Restated
2003(v)

Years ended 31 December
Restated
2002(v)
(£ million, except per Ordinary Share and per ADS
amounts)
127.6
17.6

156.5
23.0

68.5
38.4

2001(vi)

142.4
–

76.3
125.9

2000(vi)

Profit for the financial year

. . . . . . . . . . . . . . . . . . . . . . .

142.4

179.5

145.2

106.9

202.2

Ordinary dividends per Ordinary Share . . . . . . . . . . . . .
Special dividend per Ordinary Share . . . . . . . . . . . . . . .

5.00p
–

4.85p
–

4.70p
–

4.55p
–

5.70p
37.14p

Basic earnings as so adjusted per Ordinary Share:
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . .

15.23p
–

16.83p
2.47p

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15.23p

19.30p

13.78p
1.90p

15.68p

7.44p
4.16p

11.60p

7.38p
12.18p

19.56p

Diluted earnings as so adjusted per Ordinary Share (i):
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . .

15.12p
–

16.72p
2.46p

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

15.12p

19.18p

13.66p
1.89p

15.55p

7.36p
4.13p

11.49p

7.33p
12.09p

19.42p

Basic earnings so adjusted per ADS(ii):
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diluted earnings as so adjusted per ADS (ii):
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . .
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . .

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

76.2p
–

76.2p

75.6p
–

75.6p

84.1p
12.4p

96.5p

83.6p
12.3p

95.9p

68.9p
9.5p

78.4p

68.3p
9.5p

77.8p

37.2p
20.8p

58.0p

36.8p
20.7p

57.5p

36.9p
60.9p

97.8p

36.6p
60.5p

97.1p

Group Balance Sheet Data

Amounts in accordance with UK GAAP:
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,419.9
727.0
Net assets (iv) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
114.5
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share capital (iii)

1,244.7
640.8
114.1

1,234.2
516.9
113.5

1,095.4
405.0
113.1

959.8
268.1
112.4

Amounts in accordance with US GAAP:
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,544.2
781.9
Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,376.1
690.7

1,379.2
565.1

1,173.9
536.1

1,091.1
460.9

(i)

(ii)

Diluted earnings per Ordinary Share is calculated on the weighted average of 942m shares, (2003 — 936m shares, 2002 — 934m
shares, 2001 — 930m shares and 2000 — 1,041m shares) after allowing for the allotment of shares under option schemes.
In 2002, 2001 and 2000 per ADS amounts have been restated to reflect each ADS representing five Ordinary Shares as the ratio
changed from ten to five in 2003.
Included in net assets.

(iii)
(iv) Net assets includes non-equity capital of £0.3m in 2002, 2001 and 2000.
(v)

2003 and 2002 profit from continuing operations, earnings per share and net assets in accordance with US GAAP have been restated as
detailed in Note 39 of Notes to the Group Accounts.

(vi) 2001 and 2000 have not been restated as detailed in (v) above because it is considered impractical.

142

EXCHANGE RATES

The following table sets forth, for the periods and dates indicated, the Noon Buying Rates expressed in US Dollars
per £1:

Year end

Average(ii)

High

Fiscal year:
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.49
1.45
1.61
1.78
1.92

1.51
1.44
1.51
1.65
1.84

(ii)

The average of the Noon Buying Rates on the last day of each month during the fiscal year.

Month:
February 2005(i)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
January 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
November 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
October 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
September 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(i)

As of 28 February 2005, the latest practicable date, the Noon Buying Rate was 1.925.

1.65
1.50
1.61
1.78
1.95

High

1.93
1.91
1.95
1.91
1.84
1.81

Low

1.40
1.37
1.41
1.55
1.75

Low

1.86
1.86
1.91
1.83
1.78
1.77

143

TAXATION INFORMATION FOR SHAREHOLDERS

The comments below are of a general and summary nature and are based on the Group’s understanding of
certain aspects of current UK and US federal income tax law and practice relevant to the ADSs and Ordinary
Shares not in ADS form. The comments address the material US and UK tax consequences generally applicable
to a person who is the beneficial owner of ADSs or Ordinary Shares and who, for US federal
income tax
purposes, is a US citizen or resident, a corporation (or other entity taxable as a corporation) created or organised
in or under the laws of the United States, or an estate or trust the income of which is included in gross income for
US federal income tax purposes (each a “US Holder”). The comments set out below do not purport to address all
tax consequences of the ownership of ADSs or Ordinary Shares which may be material to a particular holder and
in particular do not deal with the position of shareholders who directly or indirectly own 10% or more of the
issued Ordinary Shares. This discussion does not apply to persons operating clearance and/or depository
services and those whose holding of ADSs or Ordinary Shares is effectively connected with or pertains to either (i)
a permanent establishment in the United Kingdom through which a US Holder carries on a business in the United
Kingdom, or (ii) a fixed base from which a US Holder performs independent personal services in the United
Kingdom. This discussion does not apply to certain investors such as tax-exempt entities, insurance companies,
broker-dealers, traders in securities that elect to mark to market, US Holders holding ADSs or Ordinary Shares as
part of a hedging, conversion or other integrated transaction or whose functional currency is other than the US
Dollar and investors liable for alternative minimum tax. In addition, the comments below do not address US state,
local or non-US (other than UK) taxes. The summary deals only with US Holders who hold ADSs or Ordinary
Shares as capital assets. The summary is based on current UK and US law and practice which is subject to
change, possibly with retroactive effect. US Holders are recommended to consult their own tax advisors as to the
particular consequences to them of the ownership of ADSs or Ordinary Shares.

This discussion is based in part on representations by the depositary and assumes that each obligation under
the deposit agreement and any related agreement will be performed in accordance with its terms. For the
purpose of the US/UK Double Taxation Treaty (the “Treaty”) and the prior US/UK Double Taxation Treaty (the
“Prior Treaty”) and US federal income tax law, US Holders of ADSs will generally be treated as owners of the
Ordinary Shares represented by the ADSs. However, the US Treasury has expressed concerns that parties to
whom depositary shares are pre-released may be taking actions that are inconsistent with the claiming of foreign
tax credits by owners of ADSs. Such actions would also be inconsistent with the claiming of the reduced rate of
tax, described below, applicable to dividends received by certain noncorporate US Holders. Accordingly, the
analysis of the creditability of UK taxes, described below, and the availability of the reduced tax rate for dividends
received by certain noncorporate US Holders could be affected by future actions that may be taken by parties to
whom ADSs are pre-released.

Taxation of Dividends in the United Kingdom and the United States
Under the Prior Treaty, certain US Holders who are the beneficial owners of dividends on Ordinary Shares or
ADSs were generally entitled to a tax credit payment in respect of dividends equal to one-ninth of the dividend
paid (the “Tax Credit Amount”). This tax credit payment is reduced by a UK withholding (the “UK withholding”) of
up to 15% of the gross dividend paid. Therefore, a US Holder will not actually receive any payment of this credit.

Under the Treaty, US Holders are no longer entitled to the Tax Credit Amount because the Treaty does not
provide for that entitlement. Furthermore, the UK does not currently impose a withholding tax on dividends paid
by a UK corporation. The Treaty applies to dividend payments after 1 May 2003. However, if a US Holder would
have been entitled to greater benefits under the Prior Treaty, the US Holder may elect to continue to apply the
Prior Treaty until 1 May 2004.

Dividends paid and, if a US Holder elects under the Prior Treaty to claim a foreign tax credit with respect to the UK
withholding, the associated Tax Credit Amount will be treated for US federal income tax purposes as foreign
source ordinary income to a US Holder when the dividend is received to the extent paid out of the Company’s
current or accumulated earnings and profits as determined for US federal income tax purposes. Such dividends
will not be eligible for the dividends-received deduction generally allowed to corporate US Holders. The amount of
the dividend which is includible in taxable income of a US Holder is the US Dollar value of the dividend, converted
using the exchange rate on the date the depositary receives the dividend in the case of ADSs, or the date the US
Holder receives the dividend in the case of Ordinary Shares. Conversion by a US Holder of Sterling received as a
dividend into US Dollars may result in US source ordinary income to the US Holder to the extent attributable to
fluctuations in foreign currency exchange rates between the date of receipt, as discussed in the previous
sentence, and the date of conversion.

144

Dividends paid to certain noncorporate US Holders of Ordinary Shares or ADSs in taxable years beginning before
1 January 2009 may be subject to US federal income tax at lower rates than other types of ordinary income if
certain conditions are met. Noncorporate US Holders should consult their own tax advisors to determine whether
they are subject to any special rules that limit their ability to be taxed at this favourable rate.

The limitation of foreign taxes eligible for the foreign tax credit is calculated separately with respect to specific
classes of income. The UK withholding tax under the Prior Treaty is treated as foreign income tax which may,
subject to certain limitations and restrictions, be eligible for credit against a US Holder’s US federal income tax
liability for a US Holder that elects to include the associated Tax Credit Amount in income. US Holders should
consult their own tax advisors regarding the availability of foreign tax credits in their particular circumstances.

Taxation of Capital Gains
US Holders, who are not resident or ordinarily resident for tax purposes in the UK, will not generally be liable for
UK capital gains tax on any capital gain realised upon the sale or other disposition of ADSs or Ordinary Shares
unless held in connection with a trade carried on in the UK through a permanent establishment (or in the case of
individuals through a branch or agency). Furthermore, UK resident individuals who acquire ADSs or Ordinary
Shares before becoming temporarily non-UK resident, may remain subject to UK taxation of capital gains on
gains realised while non-resident.

For US federal income tax purposes, gains realised upon the sale or disposition of ADSs or Ordinary Shares by
US Holders generally will be US source capital gains and will be long-term US source capital gains if the ADSs or
Ordinary Shares were held for more than one year.

Inheritance and Estate Taxes
The UK Inland Revenue imposes inheritance tax on capital transfers which occur on death, and in the seven
years preceding death. The UK Inland Revenue considers that the US/UK Double Taxation Convention on Estate
and Gift Tax applies to inheritance tax. Consequently, a US citizen who is domiciled in the United States and is
not a UK national or domiciled in the United Kingdom will not be subject to UK inheritance tax in respect of ADSs
and Ordinary Shares. A UK national who is domiciled in the United States will be subject to both UK inheritance
tax and US federal estate tax but will be entitled to a credit for US federal estate tax charged in respect of ADSs
and Ordinary Shares in computing the liability to UK inheritance tax. Conversely, a US citizen who is domiciled or
deemed domiciled in the United Kingdom will be entitled to a credit for UK inheritance tax charged in respect of
ADSs and Ordinary Shares in computing the liability for US federal estate tax. Special rules apply where ADSs
and Ordinary Shares are business property of a permanent establishment of an enterprise situated in the United
Kingdom.

US Information Reporting and Backup Withholding Tax
A US Holder may be subject to US information reporting and backup withholding tax on dividends paid or the
proceeds of sales made within the US or through certain US-related financial
intermediaries, unless the
shareholder is a corporation or other exempt recipient or, in the case of backup withholding, provides a correct
US taxpayer identification number and certain other conditions are met. US backup withholding tax may also
apply if there has been a notification from the US Internal Revenue Service of a failure to report all interest or
dividends.

Backup withholding tax deducted may be credited against the US Holder’s US federal income tax liability, and,
where the withholding tax exceeds the actual
liability, the US Holder may obtain a refund by timely filing the
appropriate refund claim with the US Internal Revenue Service.

UK Stamp Duty and Stamp Duty Reserve Tax
UK stamp duty is charged on documents and in particular instruments for the transfer of registered ownership of
Ordinary Shares. Transfers of Ordinary Shares will generally be subject to UK stamp duty at the rate of ½% of the
consideration given for the transfer with the duty rounded up to the nearest £5 if necessary.

UK stamp duty reserve tax (“SDRT”) arises when there is an agreement to transfer shares in UK companies “for
consideration in money or money’s worth”, and so an agreement to transfer Ordinary Shares for money or other
consideration may give rise to a charge to SDRT at the rate of ½% (rounded up to the nearest penny). If an
instrument of transfer of the Ordinary Shares is subsequently executed, the instrument of transfer will generally
be subject to stamp duty. The charge of SDRT will be cancelled, and any SDRT already paid will be refunded, if
within six years of the agreement an instrument of transfer is produced to the United Kingdom Inland Revenue
and the appropriate stamp duty paid.

145

Transfers of Ordinary Shares into CREST (an electronic transfer system) are exempt from stamp duty so long as
the transferee is a member of CREST who will hold the Ordinary Shares as a nominee for the transferor and the
transfer is in a form that will ensure that the securities become held in uncertificated form within CREST. Paperless
transfers of Ordinary Shares within CREST for consideration in money or money’s worth are liable to SDRT rather
than stamp duty. SDRT on relevant transactions will be collected by CREST at ½%, and this will apply whether or
not the transfer is effected in the United Kingdom and whether or not the parties to it are resident or situated in
the United Kingdom.

A charge of stamp duty or SDRT at the rates of 1 1⁄ 2% of the consideration (or, in some circumstances, the value
of the shares concerned) will arise on a transfer or issue of Ordinary Shares to the Depositary or to certain
persons providing a clearance service (or their nominees or agents) and will generally be payable by the
Depositary or person providing clearance service. In accordance with the terms of the Deposit Agreement, any
tax or duty payable by the Depositary on deposits of Ordinary Shares will be charged by the Depositary to the
party to whom ADRs are delivered against such deposits. No liability for SDRT will arise on any agreement to
transfer an ADS or beneficial interest in an ADS.

No liability for stamp duty will arise on any transfer of, or agreement to transfer, an ADS or beneficial ownership of
an ADS, provided that the ADS and any instrument of transfer or written agreement to transfer remains at all
times outside the United Kingdom, and provided further that any instrument of transfer or written agreement to
transfer is not executed in the United Kingdom and the transfer does not relate to any matter or thing done or to
be done in the United Kingdom (the location of the custodian as a holder of Ordinary Shares not being relevant in
this context). In any other case, any transfer of, or agreement to transfer, an ADS or beneficial ownership of an
ADS could, depending on all the circumstances of the transfer, give rise to a charge to stamp duty.

146

MEMORANDUM AND ARTICLES OF ASSOCIATION

The following summarises certain material rights of holders of the Company’s Ordinary Shares under the material
provisions of the Company’s memorandum and articles of association and English law. This summary is qualified
in its entirety by reference to the Companies Act 1985 and the Company’s memorandum and articles of
association.

The Company’s Ordinary Shares may be held in certificated or uncertificated form. No holder of the Company’s
shares will be required to make additional contributions of capital in respect of the Company’s shares in the
future. In accordance with English law the Company’s Ordinary Shares rank equally.

In the following description, a “shareholder” is the person registered in the Company’s register of members as the
holder of an Ordinary Share.

The Company is incorporated under the name Smith & Nephew plc and is registered in England and Wales with
registered number 324357. The fourth clause of the Company’s memorandum of association provides that its
objects include to carry on business as an investment holding company, to carry on all or any of the businesses
of dealers in and manufacturers of surgical dressings and instruments, pharmaceutical preparations or articles,
proprietary articles of all kinds, surgical and scientific apparatus and materials of all kinds and buyers and sellers
of goods of all kinds. The memorandum grants to the Company a range of corporate capabilities to effect these
objects.

Directors
Under the Company’s articles of association, a director may not vote in respect of any contract, arrangement,
transaction or proposal in which he, or any person connected with him, has any material interest other than by
virtue of his interests in securities of, or otherwise in or through, the Company. This is subject to certain
exceptions relating to proposals (a) indemnifying him in respect of obligations incurred on behalf of the Company,
(b) indemnifying a third party in respect of obligations of the Company for which the director has assumed
responsibility under an indemnity or guarantee, (c) relating to an offer of securities in which he will be interested
as an underwriter, (d) concerning another body corporate in which the director is beneficially interested in less
than one percent of the issued shares of any class of shares of such a body corporate, (e) relating to an
employee benefit in which the director will share equally with other employees and (f) relating to any insurance
that the Company is empowered to purchase for the benefit of directors of the Company in respect of actions
undertaken as directors (and/or officers) of the Company.

A director shall not vote or be counted in any quorum concerning his own appointment or terms of his
appointment.

The directors are empowered to exercise all the powers of the Company to borrow money, subject to the
limitation that the aggregate amount of all monies borrowed after deducting cash and current asset investments
by the Company and its subsidiaries shall not exceed an amount equal to two and one half times the Company’s
consolidated share capital and aggregate reserves, but after: adjustments for the variation to share capital and
aggregate reserves since the latest audited consolidated balance sheet; deducting distributed and proposed
distributions not previously provided out of profits earned prior to the date of the latest audited consolidated
balance sheet, any amount attributable to non-Group shareholders in subsidiaries of the Company and any debit
balance on the combined or Group profit and loss account, unless sanctioned by an ordinary resolution of the
Company; adding back any goodwill on the acquisition of businesses that had been previously set off against
reserves to the extent that the businesses have not been discontinued or disposed of and after deducting any
permanent decrease in the value of these businesses; and making such adjustments as the auditors may
consider appropriate.

Any director who has been appointed by the directors since the previous Annual General Meeting of
shareholders, either to fill a casual vacancy or as an additional director, holds office only until the next Annual
General Meeting and then shall be eligible for re-election by the shareholders. The other directors retire and are
eligible for re-appointment at the third Annual General Meeting after the meeting at which they were last re-
appointed. The directors are subject to removal with or without cause by the Board or the shareholders. Any
director attaining 70 years of age retires at the next Annual General Meeting following their birthday. Such a
Director may be re-appointed at the next Annual General Meeting. Directors are not required to hold any shares
of the Company by way of qualification.

147

Rights Attaching to Shares
Under English law, dividends are payable on the Company’s Ordinary Shares only out of profits available for
distribution, as determined in accordance with accounting principles generally accepted in the United Kingdom
and by the Companies Act 1985. Holders of the Company’s Ordinary Shares are entitled to receive final
dividends as may be declared by the shareholders in general meeting, rateable according to the amounts paid
up on such shares, provided that the dividend cannot exceed the amount recommended by the Directors.

The Company’s Board of Directors may declare such interim dividends as appear to them to be justified by the
Company’s financial position. If authorised by an ordinary resolution of the shareholders, the Board may also
direct payment of a dividend in whole or in part by the distribution of specific assets (and in particular of paid up
shares or debentures of the Company).

Any dividend unclaimed after 12 years from the date the dividend was declared, or became due for payment, will
be forfeited and will revert to the Company.

Voting Rights
Voting at any general meeting of shareholders is by a show of hands unless a poll, which is a written vote, is duly
demanded and held. On a show of hands, every shareholder who is present in person at a general meeting has
one vote regardless of the number of shares held. On a poll, every shareholder who is present in person or by
proxy has one vote for each Ordinary Share held by that shareholder. A poll may be demanded by any of the
following:

•

•

•

•

the chairman of the meeting;

at least five shareholders present or by proxy entitled to vote at the meeting;

any shareholder or shareholders representing in the aggregate not less than one-tenth of the total voting
rights of all shareholders entitled to vote at the meeting; or

any shareholder or shareholders holding shares conferring a right to vote at the meeting on which there
have been paid-up sums in aggregate equal to not less than one-tenth of the total sum paid up on all the
shares conferring that right.

A proxy form will be treated as giving the proxy the authority to demand a poll, or to join others in demanding
one, as above.

The necessary quorum for a general meeting is two shareholders present in person or by proxy carrying the right
to vote upon the business to be transacted.

Matters are transacted at general meetings of the Company by the processing and passing of resolutions of
which there are three kinds of which the most frequent will be ordinary or special resolutions:

•

•

•

an ordinary resolution, which includes resolutions for the re-election of directors, the approval of financial
statements, the declaration of dividends, the appointment and re-appointment of auditors, the increase of
authorised share capital or the grant of authority to allot shares;

a special resolution, which includes resolutions amending the Company’s memorandum and articles of
association, disapplying statutory pre-emption rights or changing the Company’s name; and

an extraordinary resolution, which includes resolutions modifying the rights of any class of the Company’s
shares at a meeting of the holders of such class or relating to certain matters concerning the Company’s
winding up.

An ordinary resolution requires the affirmative vote of a majority of the votes of those persons voting at the
meeting at which there is a quorum.

Special and extraordinary resolutions require the affirmative vote of not less than three-quarters of the persons
voting at the meeting at which there is a quorum.

In the case of an equality of votes, whether on a show of hands or on a poll, the chairman of the meeting is
entitled to cast the deciding vote in addition to any other vote he may have as proxy.

Annual General Meetings must be convened upon advance written notice of 21 days. Other meetings must be
convened upon advance written notice of 21 days for the passing of a special resolution and 14 days for any

148

other resolution, depending on the nature of the business to be transacted. The days of delivery or receipt of
notice are not included. The notice must specify the nature of the business to be transacted. Meetings are
convened by the Board of Directors. Members with 10% of the Ordinary Share capital of the Company may
requisition the Board to convene a meeting.

Variation of Rights
If, at any time, the Company’s share capital is divided into different classes of shares, the rights attached to any
class may be varied, subject to the provisions of the Companies Act, with the consent in writing of holders of
three-quarters in value of the shares of that class or upon the adoption of an extraordinary resolution passed at a
separate meeting of the holders of the shares of that class. At every such separate meeting, all of the provisions
of the articles of association relating to proceedings at an Extraordinary General Meeting apply, except that the
quorum is to be the number of persons (which must be two or more) who hold or represent by proxy not less than
one-third in nominal value of the issued shares of the class and at any such meeting a poll may be demanded in
writing by any five persons who hold or represent by proxy not less than one fortieth of the nominal value of the
shares of that class.

Rights in a Winding-Up
Except as the Company’s shareholders have agreed or may otherwise agree, upon the Company’s winding up,
the balance of assets available for distribution:

•

•

after the payment of all creditors including certain preferential creditors, whether statutorily preferred
creditors or normal creditors; and

subject to any special rights attaching to any other class of shares;

is to be distributed among the holders of Ordinary Shares according to the amounts paid-up on the shares held
by them. This distribution is generally to be made in cash. A liquidator may, however, upon the adoption of any
the shareholders and any other sanction required by law, divide among the
extraordinary resolution of
shareholders the whole or any part of the Company’s assets in kind.

Limitations on Voting and Shareholding
There are no limitations imposed by English law or the Company’s memorandum or articles of association on the
right of non-residents or foreign persons to hold or vote the Company’s Ordinary Shares or ADSs, other than the
limitations that would generally apply to all of the Company’s shareholders.

149

CROSS REFERENCE TO FORM 20-F
This table has been provided as a cross reference from the information included in this Annual Report to the
requirements of Form 20-F.

PART I

Item 1
Item 2
Item 3

Item 4

Item 5

Item 6

Item 7

Item 8

Item 9

Page

n/a
n/a

140-143
n/a
n/a
12, 23-26

5
3, 6-15, 76-78
6, 130
15

Identity of Directors, Senior Management and Advisors . . . . . . . . . . . . . . . . . . . . . .
Offer Statistics and Expected Timetable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Key Information
A — Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Capitalisation and Indebtedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
C — Reason for the Offer and Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . .
D — Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Information on the Company
A — History and Development of the Company . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Business Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
C — Organisational Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
D — Property, Plants and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating and Financial Review and Prospects
A — Operating results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
— Under International Financial Reporting Standards . . . . . . . . . . . . . . . . . . . .
— Under US accounting principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Liquidity and Capital Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
C — Research and Development; Intellectual Property . . . . . . . . . . . . . . . . . . . . .
D — Trend Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
E — Off Balance Sheet Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
F — Tabular Disclosure of Contractual Obligations . . . . . . . . . . . . . . . . . . . . . . . .
G — Safe Harbor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Directors, Senior Management and Employees
49-50
A — Directors and Senior Management
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
57-65
B — Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
51-55
C — Board Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
D — Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22, 83
E — Share Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22, 56-65, 97-100
Major Shareholders and Related Party Transactions
A — Major Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
— Host Country Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Related Party Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Information
A — Consolidated Statements and Other Financial Information . . . . . . . . . . . . . .
— Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
— Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Significant Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Offer and Listing
A — Offer and Listing details . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Plan of Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
C — Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
D — Selling Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
E — Dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
F — Expenses of the Issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

28-40, 44-45
46
47
42-45
14-15
41
45
45
3

67-132
16
134
n/a

135
n/a
138
n/a
n/a
n/a

56, 138
138
45, 113

Item 10 Additional Information

A — Share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B — Memorandum and Articles of Association . . . . . . . . . . . . . . . . . . . . . . . . . . .
C — Material Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
D — Exchange Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
E — Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
F — Dividends and Paying Agents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
G — Statement by Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
H — Documents on Display . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
I — Subsidiary Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

n/a
147-149
None
139
144-146
n/a
n/a
56
130

150

PART I — (continued)

Item 11
Item 12

PART II

Item 13
Item 14
Item 15
Item 16
Item 16A
Item 16B
Item 16C
Item 16D
Item 16E

PART III

Item 17
Item 18
Item 19

Quantitative and Qualitative Disclosures about Market Risk . . . . . . . . . . . . . . . . . . .
Description of Securities Other than Equity Securities . . . . . . . . . . . . . . . . . . . . . . . .

Defaults, Dividend Arrearages and Delinquencies . . . . . . . . . . . . . . . . . . . . . . . . . . .
Material Modifications to the Rights of Security Holders and Use of Proceeds . . . . .
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
[Reserved]
Audit Committee Financial Expert
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Code of Ethics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exemptions from the Listing Standards for Audit Committees . . . . . . . . . . . . . . . . . .
Purchase of Equity Securities by the Issuer and Affiliated Purchases . . . . . . . . . . . .

Page

44-45
n/a

None
None
53

51-52
53
54-55
n/a
138

Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exhibits

n/a
67-132

151

GLOSSARY OF TERMS

Unless the context indicates otherwise, the following terms have the meanings shown below:

Term

ADR

ADS

Access

Advanced wound management

products

AGM

Arthroscopy

Bandaging

Cannula

Casting

Chronic and acute wounds

Company

Class III medical device

Companies Act

Debridement

Meaning

In the US, the Company’s Ordinary Shares are traded in the term of ADSs
evidenced by American Depository Receipts (“ADRs”).

In the US,
American Depositary Shares (“ADSs”).

the Company’s Ordinary Shares are traded in the term of

A product group within endoscopy comprising fluid management and
insufflation devices for better surgical access.

A product group comprising products associated with the treatment of skin
wounds, ranging from products that provide moist wound healing using
breathable films and polymers to products providing active wound healing
by biochemical or cellular action.

Annual general meeting of the Group.

Endoscopy of
applications being the knee and shoulder.

the joints is termed “arthroscopy”, with the principal

A product group comprising traditional adhesive and support bandaging.

A sleeve which allows an entry point for surgeons to introduce endoscopic
devices into a body cavity.

A product group comprising products that are used externally to
immobilise a bone fracture or damaged joint, usually made of plaster of
paris or synthetic materials.

Chronic wounds are those with long or unknown healing times including
leg ulcers, pressure sores and diabetic foot ulcers. Acute wounds are
those for which healing times can be reasonably predicted such as
surgical and post-operative wounds.

Smith & Nephew plc or, where appropriate,
Directors, unless the context otherwise requires.

the Company’s Board of

A medical device that
regulatory body in the US or Europe.

requires pre-market approval by the relevant

Companies Act 1985, as amended, of Great Britain.

A medical treatment or surgical procedure to remove dead tissue and
other unwanted material from a wound to aid healing.

Demineralised bone matrix

Cortical bone processed from donors; primarily used as a bone void filler.

Endoscopy

Endoscopy products

Euro or €

External fixation

FDA

FAS

FRS

Endoscopy allows surgeons to operate through coin-sized openings in the
body, rather than large incisions.

A product group comprising specialised viewing and access devices,
surgical instruments and powered equipment used in minimally invasive
incision surgeons are able to see
surgical procedures. Through a small
inside the body using a monitor and identify and repair defects.

References to the common currency used in the majority of the countries of
the European Union.

The use of wires or pins transfixed through bone to hold the position of a
fracture.

US Food and Drug Administration.

A Financial Accounting Standard which is part of US GAAP.

A Financial Reporting Standard which is part of UK GAAP.

Financial statements

Refers to the consolidated Group Accounts of Smith & Nephew plc.

152

Term

Meaning

Group or Smith & Nephew

IDET procedure

IFRS and IAS

Insufflation

Intramedullary nail system

Metal-on-metal hip resurfacing

Obturator

Orthobiologic products

Orthopaedic products

Papain urea

Parent

Used for convenience to refer to the Company and its consolidated
subsidiaries, unless the context otherwise requires.

Intradiscal Electrothermal Therapy (IDET) is a thermal procedure intended
for the shrinkage and decompression of the spinal disc to treat patients
with annular disruption of contained herniations.

International Financial Reporting Standards and International Accounting
Standards issued by the International Accounting Standards Board.

The use of carbon dioxide to inflate body cavities during endoscopic
surgery to enable surgeons to view internal organs.

Stainless or
intramedullary canal in diaphyseal fractures.

titanium implants shaped like a nail

implanted in the

A less invasive surgical approach to treating arthritis in younger patients
whereby only the surfaces of the hip joint are replaced leaving the hip
head substantially preserved.

A blunt or dull tipped instrument that gently introduces a cannula into a
body orifice.

Any product that is primarily intended to act as a scaffold and/or actively
stimulates bone growth.

Products that comprise implants, devices and systems to replace diseased
or injured hip, knee and shoulder joints, and trauma devices such as rods,
pins, screws, plates and external frames used to treat bone fractures.

Papain urea is a compound of an enzyme extracted from papaya and an
organic wound softening agent.

Smith & Nephew plc.

Pound Sterling, Sterling,

References to UK currency. 1p is equivalent to one hundredth of £1.

£, pence or p

Rehabilitation

Repair

Resection

SSAP

Sales

A business segment comprising products equipment and systems used to
increase, maintain or improve patient functional capabilities after surgery,
or stroke or of individuals with disabilities.

A product group within endoscopy comprising specialised devices, fixation
systems and bioabsorbable materials to repair joints and associated
tissue.

Products that cut or ablate tissue within endoscopy comprising mechanical
blades, radio frequency wands, electromechanical and hand instruments
for resecting tissue.

A Statement of Standard Accounting Practice which is part of UK GAAP.

Turnover.

Traditional woundcare

Product group comprising medical textile products, adhesive tapes and
fixative sheets to secure wound management products to the body.

UK

UK GAAP

US

United Kingdom of Great Britain and Northern Ireland.

Accounting principles generally accepted in the United Kingdom.

United States of America.

US Dollars, US $ or cents

References to US currency. 1 cent is equivalent to one hundredth of US$1.

US GAAP

Visualisation

Accounting principles generally accepted in the United States of America.

Products within endoscopy comprising digital cameras,
monitors, scopes,
broadcasting systems for use in endoscopic surgery with visualisation.

light sources,
image capture, central control and multimedia

Wound bed

An area of healthy dermal and epidermal tissue of a wound.

153

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