Our business today

Smith & Nephew is a global medical

technology business dedicated to

helping improve people’s lives.

Group

Revenue2

Average number of employees3

$4.1bn

+2%

10,477

Revenue by geography $m

Employees by geography3

A      United States

1,651

A      United States

4,000

B      Other Established markets

2,003

B      Continental Europe

2,098

C      Emerging and International         markets

483

C       UK D      China

1,706 801

E       Other

1,872

Financial highlights

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

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

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

Chief Executive Officer’s review of strategy

Dear Shareholder,

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

Emerging markets

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

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

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

Investing for growth

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

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

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

Healthpoint Biotherapeutics

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

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

Corporate social responsibility

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

Delivering value

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

Olivier Bohuon

Chief Executive Officer

Chief Executive Officer’s review of strategy continued

Chief Executive Officer’s review of strategy continued

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

Research and development

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

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

The medical devices industry has a rapid rate of new product introduction. In order to remain competitive, each of the Group’s business segments must continue to develop innovative products that satisfy customer needs and preferences or provide cost or other advantages. Developing new products is a costly, lengthy and uncertain process. A potential product may not be brought to market or not succeed in the market for any number of reasons, including failure to work optimally, failure to receive regulatory approval, failure to be cost-competitive, infringement of patents or other intellectual property rights and changes in consumer demand. The Group’s products and technologies are also subject to marketing attack by competitors. Furthermore, new products that are developed and marketed by the Group’s competitors may affect price levels in the various markets in which the Group’s business segments operate. If the Group’s new products do not remain competitive with those of competitors, the Group’s revenue could decline.

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

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

Intellectual property

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

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

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

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

Currency fluctuations

Smith & Nephew operates across many jurisdictions and therefore the Group’s operations are affected by transactional exchange rate movements in that they are subject to exposures arising from revenue in a currency different from the related costs and expenses. The Group’s manufacturing cost base is situated principally in the US, the UK, China and Switzerland, from which finished products are exported to the Group’s selling operations worldwide. Thus, the Group is exposed to fluctuations in exchange rates between the US Dollar, Sterling and Swiss Franc and the currency of the Group’s selling operations, particularly the Euro, Australian Dollar and Japanese Yen. If the US Dollar, Sterling or Swiss Franc should strengthen against the Euro, Australian Dollar and the Japanese Yen, the Group’s trading margin could be adversely affected.

The Group manages the impact of exchange rate movements on intra-group sales and cost of goods sold by a policy of transacting forward foreign currency commitments when firm purchase orders are placed. In addition, the Group’s policy is for forecast transactions to be covered between 50% and 90% for up to one year.

The Group uses the US Dollar as its reporting currency and the US Dollar is the functional currency of Smith & Nephew plc. The Group’s revenues, profits and earnings are also affected by exchange rate movements on the translation of results of operations in foreign subsidiaries for financial reporting purposes. See ‘Financial position, liquidity and capital resources’ on page 50.

Business segment review

Advanced Surgical Devices

Smith & Nephew has leadership

positions in Orthopaedic Reconstruction,

Sports Medicine and Trauma.

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

Revenue by franchise $m

Product franchise growth2 %

A

Knee Implants

874

B

Hip Implants

666

C

Sports Medicine Joint Repair

521

D

Arthroscopic Enabling Technologies

409

E

Trauma

462

F

Other ASD

176

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

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

Overview

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

– Knee Implants

– Hip Implants

– Sports Medicine Joint Repair

– Arthroscopic Enabling Technologies

– Trauma

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

Strategy

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

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

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

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

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

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

Acquisitions

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

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

Market and competition

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

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

Global orthopaedic reconstruction segment

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

Global orthopaedic trauma segment

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

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

2011

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

Regulatory approvals

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

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

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

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

Franchises

Underlying revenue growth for key product lines are:

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

Orthopaedic reconstruction

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

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

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

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

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

Business segment review continued

Advanced Wound Management

Smith & Nephew has leadership

positions in Exudate and Infection

management, Negative Pressure

Wound Therapy and Bioactives

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

Revenue by franchise $m

Product franchise growth2 %

A

Infection management

127

B

Exudate management

269

C

Other AWM

633

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

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

Overview

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

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

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

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

Strategy

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

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

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

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

Acquisitions

Healthpoint

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

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

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

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

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

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

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

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

Trading profit

2012

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

2011

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

Operating profit

2012

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

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

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

2011

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

Regulatory approvals

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

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

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

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

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