Global

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Chief Financial Officer's Review

2020 Performance and impact of COVID-19

Group revenue in 2020 was $4,560 million, a decrease of 11.2% on a reported basis and a decrease of 12.1% on an underlying basis.1

Our business was significantly impacted by the COVID-19 pandemic, first in China in the first quarter and then more broadly across the world as lockdowns took effect and elective procedures were postponed. In the second quarter this resulted in revenue growth rates of -29.8% reported (-29.3% underlying1). The business rebounded strongly in the third quarter as COVID-19 rates fell and procedures resumed with revenue declines of -3.7% reported (-4.2% underlying1). In the fourth quarter, COVID-19 infection levels increased in the US and Europe and sales declined by -5.8% reported (-7.1% underlying1) as healthcare systems were better prepared to continue procedures compared to earlier in the year.

We also took the decision early on to maintain investments behind R&D and where needed to ensure we were ready for the recovery.

In parallel, we also identified quickly the discretionary spend that could be reduced to mitigate the impact of the pandemic.

The reported operating profit for 2020 was $295 million, a 64% reduction from the previous year due to the impact of COVID-19 described above, although this was partially mitigated by cost savings.

Profit was also reduced by higher amortisation which increased from the prior year reflecting a full year amortization charge of acquisitions completed in 2019. Legal and other charges increased due to higher costs associated with EU Medical Device Regulations. Trading profit1 for the year was $683 million and the trading profit margin1 was 15.0% reflecting the impact of the sales reductions caused by COVID-19 and resulting manufacturing facility underutilization and increased inventory provisions.

Global franchise trading profit performance was impacted by COVID-19 with each franchise profit reducing from the prior year. The impact was greater in our Orthopaedics and Sports Medicine & ENT franchises as they were more exposed to postponement of elective procedures. More details on franchise performance can be found on pages 46–51.

Earnings per share

Basic earnings per share (‘EPS’) was down 25% to 51.3¢ reflecting the impact of COVID-19 partially offset by a reported tax credit. Adjusted earnings per share1 (‘EPSA’) was down 37% at 64.6¢, reflecting the lower trading performance partially offset by the lower trading tax rate.

Taxation

Reported tax for the year to 31 December 2020 was a credit of $202 million (2019: charge of $143 million). This reflects refunds and tax credits due to the successful UK tax litigation outcome, releases of provisions following the conclusion of tax audits and other settlements, and lower profits. The tax rate on trading results1 for the year to 31 December 2020 was 11.3% (2019: 19.1%). This is lower than the prior year due to releases of tax provisions following the conclusion of tax audits and other settlements.

Smith+Nephew is subject to various taxes in the many countries in which the Group operates. We seek to pay the correct amount of tax in-line with local tax laws in each jurisdiction.

Our business generates tax receipts for the governments in each of these countries. In addition to corporate income taxes, we pay and collect other taxes principally including payroll (employee) taxes, sales (indirect) taxes and customs duties.

During 2020, we made global tax payments of $637 million. This comprises $229 million of taxes borne by Smith+Nephew (corporate income taxes, employer social security contributions and customs duties) and $408 million of taxes collected from employees and customers on behalf of governments (employee income taxes and social security contributions and net indirect tax payable). Corporate income taxes, in particular, were lower than in prior years due to the impact on profits of COVID-19. These figures exclude the $100 million tax refund we received following the successful outcome of the UK tax litigation matter.

Efficiency

The APEX programme that was announced in February 2018 and the operations and commercial excellence programme that was announced in February 2020, incurred restructuring costs of $124 million in 2020, with additional benefits recognized in the 2020 income statement of around $40 million. Whilst some projects were delayed slightly by COVID-19, these programmes remain an important part of our strategy.

Goodwill increased by $139 million as a result of acquisitions of $96 million and foreign currency movements of $43 million. The primary acquisition in the year was Tusker Medical, Inc. (‘Tusker‘), a developer of an innovative in-office solution for tympanostomy (ear tubes) called Tula. 

Intangible assets decreased by $81 million primarily because of amortisation and impairment of $246 million being partially offset by acquisitions of $61 million, additions of $78 million and foreign currency movements of $17 million.

The acquisition of intangible assets mainly related to Tula from the Tusker acquisition and additions related to software.

Other non-current assets increased by $210 million primarily due to an increase of $126 million in property, plant and equipment mainly arising from additions of $452 million which are partially offset by depreciation and impairment of $316 million. Current assets increased by $1,445 million primarily as a result of an increase in cash of $1,485 million mostly. Cash generated from operations of $972 million is after paying out $24 million of acquisition and disposal related items, $117 million of restructuring and rationalisation expenses and $75 million for legal and other items. 

Trading cash flow1 decreased by $280 million driven by lower trading profit. Free cash flow1 decreased by $277 million mainly related to the lower trading cash flow.

Free cash flow includes net tax refunds of $22 million (2019: tax payments of $150 million) primarily due to a refund from the UK tax litigation matter. During the year ended 31 December 2020, the Group purchased a total of 0.6 million (2019: 3.1 million) ordinary shares at a cost of $16 million (2019: $63 million).

Return on invested capital

Return On Invested Capital1,3 (ROIC) is a measure of the return generated on capital invested by the Group. It provides a metric for long-term value creation and encourages compounding reinvestment within the business and discipline around acquisitions. ROIC decreased from 10.5% in 2019 to 7.1% in 2020 as a result of the reduction in operating profit.

Liquidity

The appropriate use of capital on behalf of shareholders is important to Smith+Nephew. The Board believes in maintaining a strong balance sheet, while retaining the flexibility to make value enhancing acquisitions. This approach is used to prioritise the use of cash and ensure an appropriate capital structure.

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

During 2020, the Group issued its first corporate bond, representing $1 billion of notes bearing an interest rate of 2.032% repayable in 2030. Whilst the Group has maintained a strong liquidity position, the low interest rate environment in 2020 presented an opportunity to further diversify our funding options at a relatively low cost. Moving forward we will be well positioned to tap a number of funding options in order to support our growth strategy.

The Group’s net debt2 increased from $1,770 million at the beginning of 2020 to $1,926 million at the end of 2020, representing an overall increase of $156 million.

At 31 December 2020, the Group held $1,751 million (2019: $257 million) in cash net of bank overdrafts. The Group had committed available facilities of $4.5 billion at 31 December 2020 of which $3.5 billion was drawn.

The principal variations in the Group’s borrowing requirements result from the timing of dividend payments, acquisitions and disposals of businesses, timing of capital expenditure and working capital fluctuations. Smith+Nephew believes that its capital expenditure needs and its working capital funding for 2021, as well as its other known or expected commitments or liabilities, can be met from its existing resources and facilities.

Going concern

The Directors have considered various scenarios in assessing the impact of COVID-19 on future financial performance and cash flows, with the key judgement applied being the speed and sustainability of the return to a normal volume of elective procedures in key markets, including the impact of a further wave of restrictions on elective procedures in the first half of 2021. Throughout these scenarios, which include a severe but plausible outcome, the Group continues to have headroom on its borrowing facilities and financial covenants.

The Directors have a reasonable expectation that the Company and the Group are well placed to manage their business risks and to continue in operational existence for a period of at least 22 months from the date of the approval of the financial statements.

Accordingly, the Directors continue to adopt the going concern basis in preparing the consolidated financial statements.

Dividends

The 2019 final dividend of 23.1 US cents per ordinary share totalling $202 million was paid on 6 May 2020. The 2020 interim dividend of 14.4 US cents per ordinary share totalling $126 million was paid on 28 October 2020.

Outlook

The impact of COVID-19 is likely to continue during the first half of 2021, and while there is still uncertainty on the timing of recovery, we have maintained our readiness and ability to respond.

In terms of revenue, we expect to deliver substantial underlying growth in 2021 compared to 2020. Within this, we expect our Hip Implants business to continue to outperform Knee Implants, our Sports Medicine & ENT franchise to perform strongly as markets recover, and for Advanced Wound Management’s growth trajectory to improve as recent commercial changes continue to deliver benefits.

In terms of profit margin, we expect an improved performance in 2021 over the prior year. Relative to 2019 (the year before COVID-19), we anticipate a headwind from the continuing impact of reduced production volumes on gross margin as well as dilution of around 100bps from the increased investment in R&D and around 150bps from the acquisitions completed in 2020 and so far in 2021.

Foreign exchange will be an additional headwind of around 100bps. The tax rate on trading results for 2021 is forecast to be in the range 18% to 19%, subject to any material changes to tax law or other one-off items.

 

Yours sincerely,

 

Anne-Francoise Nesmes

Chief Financial Officer

 

1 These non-IFRS financial measures are explained and reconciled to the most directly comparable financial measure prepared in accordance with IFRS on pages 222–226.

2 Net debt is reconciled in Note 15 to the Group accounts.

3 ROIC is defined as:Operating Profit less Adjusted Taxes (Opening Net Operating Assets + Closing Net Operating Assets)/2