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Smith & Nephew (NYSE:SNN)

Q1 2012 Earnings Call

May 03, 2012 3:30 am ET

Executives

Olivier Bohuon - Chief Executive officer, Director and Chairman of Disclosures Committee

Adrian Hennah - Chief Financial Officer, Executive Director, Member of Disclosures Committee and Member of Risk Committee

Analysts

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Michael K. Jungling - Morgan Stanley, Research Division

Veronika Dubajova - Goldman Sachs Group Inc., Research Division

Edward Ridley-Day - BofA Merrill Lynch, Research Division

Thomas M. Jones - Berenberg Bank, Research Division

Ingeborg Øie - Jefferies & Company, Inc., Research Division

Navid Malik - Cenkos Securities plc., Research Division

Christoph Gretler - Crédit Suisse AG, Research Division

Julien Dormois - Exane BNP Paribas, Research Division

Yi-Dan Wang - Deutsche Bank AG, Research Division

Operator

This document contains certain forward-looking statements that may or may not prove accurate. For example, statements regarding expected revenue growth and trading margins, market trends and our product pipeline are forward-looking statements. Phrases such as aim, plan, intend, anticipate, well-placed, believe, estimate, expect, target, consider and similar expressions are generally intended to identify forward-looking statements.

Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from what is expressed or implied by the statements. For Smith & Nephew, these factors include economic and financial conditions in the markets we serve, especially those affecting health; care providers; payers and customers; price levels for established and innovative medical devices; developments in medical technology; regulatory approvals; reimbursement decisions or other government actions; product defects or recalls; litigation relating to patent or other claims; legal compliance risks; and related investigative remedial or enforcement actions, strategic actions, including acquisitions and dispositions; our success in integrating acquired businesses and disruption that may result from changes we make in our business plans or organization to adapt to market developments, and numerous other matters that affect us on our markets, including those of political, economic, business or competitive nature. Please refer to the documents that Smith & Nephew have filed with the U.S. Securities and Exchange Commission under the U.S. Securities Exchange Act of 1934 as amended, including Smith & Nephew's most recent annual report on Form 20-F for a discussion of certain of these factors.

Any forward-looking statement is based on information available to Smith & Nephew as of the date of the statement. All written or oral forward-looking statements attributable to Smith & Nephew are qualified by this caution. Smith & Nephew does not undertake any obligation to update or revise any forward-looking statement to reflect any change in circumstance or in Smith & Nephew's expectations.

Good day, ladies and gentlemen, and welcome to today's conference call. Today's conference is being recorded. At this time, I would like to hand the call over to today's speakers, Mr. Olivier Bohuon, and Mr. Adrian Hennah. Please go ahead, sir.

Olivier Bohuon

Thank you. Good morning, everyone. I'm Olivier Bohuon, I'm the Chief Executive Officer of Smith & Nephew, and welcome to our first quarter results call. I will cover the highlights and then hand over to Adrian Hennah, our CFO, to take you through the numbers. When Adrian is finished, I will update you on the progress we are making to reshape Smith & Nephew to deliver against our strategic priorities. And as usual, we'll take questions at the end.

Smith & Nephew has had a good first quarter of 2012, building on our achievements in Q4 last year. We saw the first results of our actions to make Smith & Nephew more fit and more effective. We grew revenue, increased profit and improved our trading profit margin. We continued investing and maintain our high rate of product launches, while implementing the necessary efficiency programs. Our Q1 revenues were up an underlying 3% to $1,079 billion. This was in line with our expectations.

Trading profit increased 5% to $252 million, giving a 50-basis-point improvement in our trading profit margins to 23.3%. This reflects the initial results of restructuring improvements we are making, as well as the benefits of the phasing of some costs from Q1 into Q2, and Adrian will talk more about this. Adjusted earnings per share were $0.195, an increase of 6% on last year $0.184. We continue to generate good cash flow, and our net debt was $28 million at the end of the quarter, down from $351 million last year.

This slide shows our underlying growth in the quarter. It's a complex slide, but I will try to explain it, on the left-hand side, geographically, and on the right, by product franchise. There's a lot of information, but it provides a single snapshot of the quarter. Looking at the left-hand side, we are now analyzing our geographic revenues between the established market, i.e., U.S., Europe, Canada, Japan, Australia and New Zealand, and in the other hand, our emerging and international markets. This is consistent with 2 of our 5 strategic priorities, which will allow you to understand better and track our progress over the coming years.

For me, our geographic diversity is a clear positive as we are not solely dependent on a single economy. About 40% of our global revenues come from the U.S., where revenues grew by 2%. Revenues from our other established market grew by 3%, while our growth in our emerging and international markets was double-digit. Specifically, the growth in the BRIC countries was over 20%. We also have a broad product range. We are not just about hip and knee implants, which only account for just over 1/3 of our revenues. This is shown on the chart on the right. Here, you can see the relative performance of our global product franchises in particular. This clearly illustrates the good results in knee implants, Sports Medicine Joint Repair and Advanced Wound Management.

I will now turn to look at each of these in more detail. First, looking at knee and hip implants, our global Knee Implant growth was 6%, another strong performance relative to the market, which was 3%. In the U.S., we are 3% and the out of the U.S. growth was 9%. This was driven by a very strong performance in Australia, New Zealand, which was partly due to a weak comparative. We also delivered strong sales across our emerging and international market.

In Hips, we saw the same performance pattern as last year. We continue to drive double-digit growth in our VERILAST for hips bearing surface, and we benefited from the launch of the POLARCUP Dual-Mobility Hip System in the U.S. This product is designed for patients susceptible to dislocation and needing enhanced stability. BHR continues to be impacted by the negative media and industry commentary on stem metal-on-metal total hips.

Turning to the other preference sides within our Advanced Surgical Devices business. Well, in Sports Medicine Joint Repair, we grew by 7%. Knee repair was particularly strong in the U.S., where our FAST-FIX 360, the new generation of our leading meniscal repair system, is attracting new surgeons. Our innovation in the repair space continues with the launch of HEALICOIL, our new suture anchor. This offers greater pullout strength.

We also launched a new ACL repair drill and guide system, building on our strong position in ACL repair. In arthroscopic enabling technologies, which consist primarily of our reflection camera products, we continue the roll out of our innovative PLATINUM blade range.

The Trauma growth was 1% down, and it was partly due to a compressive mild winter in the U.S., which would have been plus 2%, excluding the expiring royalty payments in the U.S., and hence, in line with the market. Nevertheless, I'm not, as I said previously, very satisfied with this performance, and I do believe that I see much greater potential for Trauma, and I will be spending more time with new management team reviewing the strategy to ensure that we consistently achieve above-market growth.

Advanced Wound Management grew revenues globally by 5% in the quarter, above the market rate of around 3%. Our advanced wound care product range, including exudate and infection management, achieved another solid quarter. We continue to deliver an impressive number of product launches and through selective investment in our commercial service organization, we are well-placed to drive higher growth over time. Our Negative Pressure Wound Therapy franchise continues to achieve strong revenue growth. Three years ago, we introduced our RENASYS range. We believe we now have around 20% market share in Europe, and I see no reason why we shouldn't improve this. PICO was launched in the U.S. in the quarter, the customer feedback is very positive, but as expected, the formal adoption timetable in the U.S. remains pretty low long.

Now over to Adrian.

Adrian Hennah

Thank you, Olivier, and good morning, ladies and gentlemen. Turning firstly to Slide 10 in the presentation, and VISIONAIRE represents 3% underlying sales growth after adjusting for exchange rates on quarter one last year. Trading profit in the quarter was $252 million, underlying increase of 5%. The trading margin was 23.3%, which is 50 basis points higher than quarter 1 last year. Restructuring cost charge in the quarter was $6 million, all related to the efficiency program announced in October, and Olivier will give you an update on our progress of this program in a moment.

Turning to Slide 11, further down the income statement, the tax rate for quarter 1 on trading profit was 30.1%, the expected full year rate. EPSA in quarter one were $0.195, an increase of 6% on last year. This is close to the underlying growth in trading profit, as the impact of changes in currency rates, the interest charge and the tax rate were all small.

We expect the Bioventus transaction, which we announced in January, to close in quarter 2. The clinical therapies trading performance is included in quarter one as part of the overall group's trading performance. And we are treating the assets involved in the transaction as assets held for sale in the balance sheet. On closing, we will recognize a gain on disposal, and we'll begin to account for our 49% equity interest as an associate. We give full details of the impact of this transaction on our numbers as part of the quarter 4 2011 presentation, and we have, for convenience, included the relevant slides again as an appendix to this presentation.

Turning to Slide 12, an analysis of revenue growth rate by division and by geography. We are using the new segmental analysis explained with our full year numbers in February. We have, for convenience, included the description of the new segmentation again in the appendices. Olivier has talked to the shape of our revenue; I will add only a few more detailed points. Across our business as a whole, we saw essentially the same price picture in quarter 1 as in quarter 4 of last year. Across our Reconstructive and Trauma implant range, we saw a like-for-like price reduction of around 2%. We continue to see this reduction partially offset by positive mix changes.

The worldwide ASD growth of 3% comprised growth of 6% in Knees, 2% decline in Hips and 1% decline in Trauma, 7% growth in Sports Medicine, 1% growth in Arthroscopic Enabling Technologies and 6% growth in clinical therapies. All these numbers are shown in the appendix. Hip sales continue to be held back by metal-on-metal concerns. BHR sales declined by 28% in the quarter and now account for less than 10% of our Hip sales and less than 2% of our group sales.

As Olivier has mentioned and as noted in previous quarters, sales growth in Trauma was reduced by the expiry over the last 3 quarters of several agreements, under which we received about $10 million per annum in royalties. This reduced worldwide Trauma sales growth by 3%, and U.S. Trauma sales growth by 5%. There will be a similar level of impact in quarter 2 and smaller impacts in quarter 3 and quarter 4 before the expiries fully annualize.

In our worldwide Wound business, sales grew by 5% in the quarter. We signaled last quarter that the 8% growth reported in quarter 4 was increased by around 1% to 2% by wholesale ordering patterns. Growth in quarter 1 was, therefore, close to the levels seen throughout last year. NPWT sales, again, grew strongly and contributed most of the reported Wound growth. Growth in the emerging and international markets was 12% compared to 20% in the full 2011 year.

Because sales in these markets are still relatively small, this growth rate will vary from quarter-to-quarter as a result of quite small movements in the level of sales. Sales in quarter 1 were reduced by lower shipments to a couple of specific country distributors. We do expect sales growth in 2012 to be somewhat lower than 2011, but still very substantial. In quarter 1, the growth in these markets contributed well over 1/3 of the group's revenue growth.

Turning to Slide 13. This shows the usual analysis of trading profit by business segment. As mentioned earlier, trading margin in the quarter was 23.3%, 50 basis points above quarter 1 last year. Margin increased in ASD by 50 basis points, showing early benefit of the actions taken in quarter 4 of last year under our restructuring program. The principal year-on-year improvement in the quarter was in cost of sales. Some of this was due to planned improvement but some due to the later phasing of certain expenditures, the benefit which will unwind in quarter 2 and later.

Margin increased in Wound by 70 basis points, as we continue to drive efficiency and as NPWT sales grow strongly. There was also some benefit in higher overhead recovery from modest increase in Wound inventory level. This too will reverse in quarter 2 and later. Spend in the quarter R&D increased in both divisions. It increased by 8% for the group as a whole, from 3.8% to 4% sales.

Turning to Slide 14 and the cash flow statement, we had another good quarter of cash generation. Free cash flow of $96 million in the quarter was after payment of $23 million in respective legal issues. These payments were in line with provisions and did not impact profit. Inventory levels continue to improve in ASP, but as already mentioned, showed some increase in our Wound business. We expect Wound inventory levels to reduce during the remainder of the year. We also saw a small increase in receivables, principally in Southern Europe. Net debt, as Olivier mentioned, at the end of the quarter was down to $28 million, down from $351 million a year ago.

Turning lastly, in this part of the presentation to Slide 15 and the outlook. We do not see any change in the outlook for the group as a whole for 2012 from the view which we set out with our full year numbers in February. With regard to Q2, we would note the comment from earlier in this presentation the increase in the Q1 margin was slightly flattered by the later phasing this year of some expenditure and the increase in Wound inventory. Lastly, if the exchange rates in Q1 were to be sustained for the rest of the year, we would expect reported sales and profit to be reduced by about 1% by translation exchange effects in the full year.

And with that, I will hand back to Olivier.

Olivier Bohuon

Thank you, Adrian. I would now like to briefly update you on the progress we have made delivering on our strategic priorities since I last spoke to you in February. Let me remind you what these are: first one is winning in established market; second one is accelerating development in emerging market; the third one is innovating for value; the fourth one is simplifying and improving the operating model; and last but not least, supplementing organic growth through acquisition.

So this slide builds upon the one I gave last quarter, setting out some of the recent actions we have taken. And I want to talk about them all, just illustrate some examples. In executing our established markets strategy, we're ensuring we balance investments necessary to drive growth such as innovation, pricing, sales force effectiveness, talented people and the processes which support them, with a need for greater efficiency. The following action in ASD Europe and the U.S. illustrate these.

In ASD Europe, our senior management team is now in place. They are refining and streamlining our commercial and operational model across our territories to ensure to better serve our customers from a more efficient platform. Also in Europe, we have commenced a significant process of synchronization project. Our European operations have a diverse range of processes and IT system. This multi-year project will standardize and simplify our key business processes. In addition, it will give us better management information through common systems to support faster and better-informed decision making.

In R&D, we have invested in a new training and innovation facility in Memphis in the U.S., which has just opened. This state-of-the-art center is multi-disciplinary, reflecting our belief that there is much to be gained by more closely sharing learning and innovation experiences, between specializations.

Finally, in the area of supplementing our organic growth, we are continuing to make/consider acquisition and strengthening our executive team. In the last few months, we have purchased 3 small complementarity technology businesses. These include: LifeModeler, whose software shortens the time taken to develop new orthopedic recon products; and the Aderma Dermal Pads, which give us a leading position in the market to treat pressure ulcers. The integration of Tenet, which was acquired last June, has proceeded to plan. We also have just hired a Chief Corporate Development Officer, which completes my senior management team. He comes with global, multi-sector experience having spent the 15 years at General Electric.

So to summarize, we had a very strong start to 2012, building on our finish to 2011. Our revenue performance has started in line with our expectations. This is a good performance given the underlying market remains, on the whole, challenging. I am pleased with our trading margin improvement and that we're going on to liberate resources for investment to drive growth.

Even more pleasing is that we're achieving these efficiencies while maintaining a high pace of bringing innovation to our customers. Let me recap: This quarter, 5 new products in Wound; the HEALICOIL anchor, initial system in joint repair; the U.S. launch of POLARCUP hip and PICO. We continue also the success of recent launches, such as FAST-FIX 360, VISIONAIRE, and obviously, VERILAST.

2012 is a critical year for implementing our new strategic priorities. A start has been made on all aspect of our plan. This would be a year of transition, as we progress the various work streams, structural changes, additional investment and of course, greater efficiencies. Throughout Smith & Nephew at every level, there is a clear sense of direction as we work to reshape the group for future growth.

Just before we move to Q&A, a couple of varied points for you. Firstly, we'll be holding a seminar on our hip and knee portfolio on the afternoon of July 3 in London. We are particularly pleased to welcome Billie Jean King, who won 20 titles at Wimbledon, to speak about her experience as a patient, having had bilateral LEGION knee implant with our VERILAST bearing surface 2 years ago. Secondly, our [indiscernible] call and webcast given the potential travel restriction during the London Olympics.

So thank you, and this ends the formal presentation, and we'll now take question. [Operator Instructions] Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] We will now take our first question from Matt Miksic from Piper Jaffray.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

I wanted to ask you, if I could, one question on the knee side. The growth in the quarter was stronger than expected in the U.S. for us, anyway, and I'm wondering to what degree were there any extra selling days in the quarter? And if you could speak to maybe any sequential trends you're seeing in Q4 to Q1, and then I have one follow-up.

Olivier Bohuon

Okay. Thank you, Matt, for this question. No, we have not any more days in the Q1, so the result is just straight. We have a 3% growth for the knee business in the U.S. with the market growth of 2%. So we are gaining share. And actually, I believe in this for a while now that our franchise is very strong, the quality of product is very strong. We still have a very good momentum with our VERILAST 30 years and VISIONAIRE. So we are very happy, actually, with the quarter dynamic, and we don't see anything changing this in the future. Adrian, you want to add something on this?

Adrian Hennah

I think that's it, Olivier.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

And then -- that's helpful. One follow-up, just on the -- you mentioned, the pricing, I think, stability was your comment, in your reconstructive business. I'm wondering whether it's in Trauma or in total joint reconstruction. If you could speak maybe to a little bit about the mix trends you're seeing. I know this was an issue throughout last year. Are you able to see any positive mix? Are you annualizing maybe the mix impact of BHR on the hip side? And any tone and direction in terms of your mix will be great.

Olivier Bohuon

Will you take it?

Adrian Hennah

Yes, surely. Well, we had sort of around a year ago, obviously, a very strong phase of mix when VISIONAIRE and VERILAST were growing particularly strongly. Of course, that pickup in the growth rate's now annualized, so we're not having that level of push in positive mix. But mix is still positive, and it's still positive across the piece, just less so than it was in that particularly strong phase. I'm not sure there's a lot more. Maybe, I mean you've highlighted the distinction between recon and Trauma, we don't break down the price movements between those 2, although I think it's pretty well-known that the pricing environment in Trauma is a little more positive than it is in implants. But otherwise, I'm not sure there's a lot to add.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Would it be possible to quantify, where it makes sense -- is this a low single-digit number positive? Is it just modestly positive? How would you frame it?

Adrian Hennah

It's modestly positive and doesn't fully offset the price reduction.

Operator

We will now take our next question from Michael Jungling from Morgan Stanley.

Michael K. Jungling - Morgan Stanley, Research Division

I have 2 questions. Firstly on the Q1 trading profit and the phasing into Q2, can you give us some more details on the degree of the phasing of the costs, what this means in the -- for the second quarter? Meaning, could Q2 be substantially weaker than Q1 or is it only slightly weaker or could it be more in line? And then the second question that I have is on the share buyback. I think from my side, the investor feedback's been quite positive on the share buyback, and I believe a number of investors actually also have written to you, and I'm just curious whether this is making you feel more positive about a share buyback program within -- well, to be announced within the next 12 months?

Olivier Bohuon

Michael, so I'm going to ask Adrian to take the first question, and I will answer the second one.

Adrian Hennah

Sure, Michael. Unsurprisingly, Michael, we're not going to give quarter-by-quarter precise margin forecast. It's not -- we strongly believe that it's not a healthy and productive way to manage the business. But really, I would just reiterate what we said, which was there was an element of the improvement in margin in quarter 1, which was an element that was to do with the underlying improvement, and there was element to do which -- with phasing. And so part of that will -- you will see part of that appear as cost in in quarter 2 and a little bit thereafter. We're not going to go into any more detail than that, Michael.

Olivier Bohuon

Okay, again, second question, Michael, on the buyback. Are we going to announce buyback in the next 12 months? Answer is no. We have said in Q4, and I re-insist on this, we need a year to really look at the potential good acquisitions that the company can make to deliver the best value for the shareholders. So we have a number of ideas at this stage, and so until we have not done that, nothing will happen.

Michael K. Jungling - Morgan Stanley, Research Division

Okay. Adrian, can I just follow up on the trading profit question again? In Q1, did you have material savings from your restructuring program?

Adrian Hennah

Yes.

Michael K. Jungling - Morgan Stanley, Research Division

And could you quantify that?

Adrian Hennah

No, there was no -- not precisely. We're not going to give you numbers, again. We just -- it's not sensible to go into that granularity. But just to give you a feel, maybe 1 proxy we're sometimes asked about it is headcount issues. And we're now materially over 300 headcount reductions into the program and well on track for the next 7% headcount reduction we announced at the start. But more precise than that, it doesn't make sense for us to go into there, Michael.

Operator

We'll now take our next question from Veronika Dubajova from Goldman Sachs.

Veronika Dubajova - Goldman Sachs Group Inc., Research Division

I have 2 questions, actually. One is tangential to the one that Michael has just asked, and it relates to potential acquisition opportunities. Olivier, you've now been with the business for a little while. Having looked at some of the assets out there, have your priorities changed or has the ordering of them changed, as you think about acquisitions going forward? And the second one, hopefully, very straightforward, but Adrian, I was hoping you can break out the contribution to revenue growth from all the various modules that you've done, including Tenet and Aderma products.

Olivier Bohuon

I am happy to answer your question regarding the acquisition. Nothing has changed, actually. I'll remind you the -- that the 3 levers of this acquisition. Number one is the bolt-on, and as you have seen, we have done 3 acquisitions during the last quarter, including LifeModeler, including Aderma. And regarding the second one, you remember, it's related to the emerging market. So here, also, we are extremely active. I have now a full team, including the head of PD. We have a number of people working on this, whether it is in India or in Brazil. And for the third one, did I change anything? No, I did not. Actually, Wound, Advance Wound Management remains #1, and endoscopy field remains the second one. So there is no change here, Veronica.

Adrian Hennah

And in terms of the contribution at the revenue line of the acquisitions, the Tenet one you called out, the answer is 0, because we distributed the Tenet product, well 90-something, 99% or something of the Tenet product. We were the distributor of before we acquired it, so it was very smally [ph] accretive to margin, but very small, but not -- it didn't impact revenue at all. And in terms of LifeModeler and Aderma, they are both very small. LifeModeler, nothing, it's essentially an internal set of software for assisting our design process. And Aderma is currently very small. We expect it to be a highly significant product, but we certainly expect useful growth from it, but as of the moment, next to nothing. So you're not seeing any distortion in the growth rate. If there was, we would be calling it out, of course, Veronica.

Operator

We will now take our next question from Ed Ridley-Day from Bank of America.

Edward Ridley-Day - BofA Merrill Lynch, Research Division

Firstly, on the phasing of costs, Adrian, excuse me for playing devil's advocate to an extent, but certainly, I remember you -- there was the expectation on the previous results, you highlighted for example, fourth quarter, we had seen a -- you've done some additional cost savings that were sort of a one-off. And you had managed, as a result, to have a strong quarter on the margin. And forgive me for saying this, but are you really being too conservative here? You've clearly had a good start in terms of your restructuring there. And is the saving really going to be so material for the second quarter? And shouldn't we actually be looking for a higher margin sort of number you previously expected through the rest of the year? That would be my first question.

Adrian Hennah

Well, Ed, yes, the restructuring program has made a good start. We're absolutely serious about that program, and it has made a good start. But as we've said many times, there are also pressures the other way. You've got to deal with price, and we've got to invest in this business. We see significant opportunities to invest in R&D and in emerging markets, which are margin-dilutive at their current phase. So we do not believe. We believe our -- the guidance we have given or we gave for the quarter ago and we are maintaining now is appropriately balanced. So no, we do not think it is excessively conservative or the other way around. We believe it's balanced.

Edward Ridley-Day - BofA Merrill Lynch, Research Division

Okay. And a question for Olivier, just a follow-up on acquisitions. One of your competitors in the wound market highlighted that they had found it difficult to, perhaps, find the right deals for them. And as a result of that, had to find it to -- related also to previous questions, look at that capital structure, and potentially return more cash to shareholders. Are you -- I mean obviously, you're working very hard on this, are you also finding it hard to find the right deals or is it just a question of time?

Olivier Bohuon

Actually, no. I think it's a --I know who you're talking about, I mean -- but it's -- I think it's also a question of size and a question of portfolio. And we don't find it difficult. I mean we have a number of very interesting and good targets, and so I don't find it difficult. I just want to be sure that we do the right deal, and that's why we are not in a hurry to make it happen, okay? So that's all.

Operator

We will now take our next question from Tom Jones from Berenberg Bank.

Thomas M. Jones - Berenberg Bank, Research Division

The first question I had was just on the knee business, so I was particularly impressed by, particularly, the O.U.S. growth in knees. I was just wondering if you could give us some idea of the -- where that growth is coming from and potentially, what the sustainability of that high single-digit number might be? Was there any kind of one-off effects or launch effects in there that might have driven that number? And the second acquisition I'll ask in a minute, it's on acquisitions again.

Olivier Bohuon

Okay, okay. On the knee business, you're right, I mean that's been a very good out-of-U.S. growth because we grew 9%, which is pretty strong. We have outperformed the market, no doubt, on this one. But you have to know that -- and actually, specifically, in Australia, in New Zealand, where we have shown a very strong improvement, again, we had a weak comparator last year due to the floods in Queensland and you remember, the earthquake in New Zealand as well as the tsunami in Japan, actually, in the same period. So it was a weak comparative, so it's difficult to said 9% is a real 9%, actually. It's compared to something which is below the previous year. So despite this, we are pretty happy with what we have done in this geography.

Thomas M. Jones - Berenberg Bank, Research Division

Okay, great. And then just on the acquisition front, just a follow-up really from the previous questions, the concern I have with the acquisition strategy is that there are people out there in similar businesses with bigger balance sheets, your balance sheet's strong, but there are others out there with stronger balance sheets. And there are such companies out there whose wound businesses, in particular, are in a more desperate state than yours and more in need of acquisition-driven growth. So how can you give us and your investors some confidence that when it comes to bidding for these assets, that even if they come up for sale, that you're likely to be the successful bidder for them?

Olivier Bohuon

Again, I cannot -- I mean, I don't know what our competitors are looking at. So I just cannot comment on this. What I can tell you is that I think that we are a very serious bidder for many companies. We have, maybe, done our homework more seriously. I don't know, frankly. What I can tell you is that if we do a deal, and I hope to do a deal, this would be a good deal.

Thomas M. Jones - Berenberg Bank, Research Division

Fair enough. And then in the absence, I mean how long will you give the strategy? I mean you sort of -- you vaguely mentioned the next 12 months. But if nothing is forthcoming in the next 12 to 18 months, should that be the time that we would expect you to start thinking about returning capital to shareholders in some way, shape or form? Is that a reasonable expectation?

Olivier Bohuon

Tom, that's exactly right, actually. That's what we said in Q4. The way we are going to return the capital is not clear yet, because we are focused on something else at this stage. But I mean will it be a dividend or a buyback, we don't know yet, and we'll tell you that in right -- or in due course.

Operator

We will now take our next question from Ingeborg Øie from Jefferies.

Ingeborg Øie - Jefferies & Company, Inc., Research Division

Two questions, please. The first one is going a bit back to this phasing of costs, because it's the second time that we have kind of a surprise cost phasing in the last 6 months on the margin. And also going back to the statement which you made at the beginning of February saying that the results of the restructuring should be progressively improving the margins throughout the year, and here we're off to what seems like a very strong start given that there -- well, you're not able to provide the breakdown between what's underlying and what is extra costs not being taken maybe. So it's just one of those, how good visibility do you have on when these costs will come and on second quarter and then the third quarter? Because it looks like the underlying improvement here is very strong, and your comment is that it should get stronger throughout the year. Second question is on the -- on your strategy in Brazil. And you point out that you've appointed a general manager for the country. Could you talk a bit about your progress here and what your thoughts are in terms of penetrating that market, given that you typically need to have local manufacturing in order to be successful there?

Olivier Bohuon

So Adrian, take the first question?

Adrian Hennah

Sure. Inge, thank you for this question again. Yes, I think the fundamental difference -- but I think, perhaps, where we come from and a number other questions we're receiving is we do not set out to manage quarter on individual expense precisely quarter-by-quarter. We just fundamentally believe that is unhelpful to progressing the business. If you sort of got yourself into the phase where you got towards the end of the quarter and said, "Quick, spend a bit more or spend a bit less, so that we can get exactly the number we said somehow," it's not helpful to running a business, it really is not helpful to running a business. So we don't seek to do that. Does that mean we have poor or inadequate visibility? No it doesn't. It just means you're managing the business in a sensible way. So in the guidance we gave a quarter ago for the year was based on a set of dynamics, which we saw then and which we still see now, so our guidance remains unchanged. You will get quarterly variability. I mean you happen to have pleasant surprises in your eyes for the last 2 quarters. But believe me, there will be quarters the other way around too, and we just – it'll be what it is. We're not going to manage them away.

Olivier Bohuon

Okay. Regarding Brazil, yes, we have a new GM on board, actually, and it's actually critical to start the development of our operations. And we are working, as you certainly know, in Brazil through a distributor, mainly on the endo field. We roughly sell, what, about, $20 million, Adrian, in Brazil?

Adrian Hennah

Yes. In market sales...

Olivier Bohuon

Well, in market, it's much bigger than to distributor, yes. So it's roughly -- we expect here, again, the potential of Brazil according to us is certainly over $150 million of potential revenue. So here, you're right, manufacturing is a big plus when you can do it locally. So we work on that, and now that we have the GM, the strategy will start to happen.

Ingeborg Øie - Jefferies & Company, Inc., Research Division

Great. Just one follow-up on the first question. I do appreciate that you wouldn't manage your business based on quarterly margin. But just maybe checking that the statement about your expectation that the benefits of restructuring program should build progressively through the year, and that's how you communicated we should think about the bottom line development through the year that, that still holds, and that the first quarter was not sort of surprisingly strong on the restructuring, so that we won't to see this progressive development through the year?

Olivier Bohuon

Ingeborg, again, I'm going to answer these questions. You remember last quarter, we've announced a 22.5% 2011 profit margin, we said that we will expect in 2012 a modest increase. We remain on this. And I think Adrian was pretty clear on the fact that quarter-to-quarter basis, I mean we don't really look at that because this could vary for different reasons, the cost phasing, whatever, okay? At the end of the day, we need money to reinvest in the business, we have said that also clearly last year, we need more R&D, we need more SG&As and in terms of marketing expenses, to beat the competition, especially in emerging market and in the established market. So there's no doubt that we are confident that this modest increase will happen, but we don't expect a huge increase in 2012, that's what we should know.

Operator

We will now take our next question from Navid Malik from Cenkos Securities.

Navid Malik - Cenkos Securities plc., Research Division

Really, the question relates to the emerging markets. We've previously, I think, seen some great growth in China, and I'm quite interested to find out what -- which particular country is driving the growth? And particularly, in China, are you seeing any pricing pressures or is there good demand from the products that you're launching there? And just on negative pressure wound therapy. In terms of the 20% market share in Europe, which I think is the first time you've broken that out. For the austerity measures that are kicking in into Europe, what's the sort of feedback on PICO as a sort of cost-efficient product in this market? And is that helping drive -- to drive the sales and penetration into the market against competitors?

Olivier Bohuon

Yes. Thank you for your question. Regarding the growth in the emerging market, we report, and I think it's important to mention this, we report combined international market and emerging markets. What we call emerging market is BRIC. And we combined it because of the variation on a quarter-to-quarter basis of small numbers. You can have a delay in a tender, you can have a supply to a distributor which can be delayed, and then the growth rate doesn't mean anything. However, to answer your question, the BRIC are growing more than 20%, and this is mainly given by 2 countries: by China and India. We are very active with the dynamic we have in these 2 countries. So those are really the growth drivers at this stage. Brazil, as I was mentioning, is starting, okay? So we expect also to see in the years to come a strong development in Brazil. Regarding PICO, PICO is doing great. I've been, and Adrian has been also in different countries, in the U.S., discussing with people, there is always a pretty long adoption time in the hospitals. However, we are very happy. We have gained a negative pressure wound therapy, some very big accounts, we have won Cleveland Clinic, Kaiser, and we definitely have here the impression that this is a fantastic – actually the feedback we have from our customers is amazing. They are happy with the price positioning, they're happy with the pharmacoeconomic of the product, they're happy with the way it treats patient. So frankly, I think we can be pretty optimistic with PICO, which definitely is a great tool to enhance our innovative image among our customer.

Operator

We will now take our next question from Chris Gretler from Crédit Suisse.

Christoph Gretler - Crédit Suisse AG, Research Division

I have 2 question. First now relates to the Trauma business. You mentioned that you're expecting now to make certain changes and that you are unhappy with the performance there. So I mean given that CINTI [ph] now is in this merger process, and I'm surprised that you're not benefiting more of this situation. Could you elaborate a bit on your assessment of that business and what your intentions are here? And the second relates to Europe as well. I mean could you get a bit more into detail how you see the current situation in hip and knee implant, in particular, in Europe, especially also with respect to the Southern European countries, whether you see what kind of an behavior you see actually in these markets?

Olivier Bohuon

Okay. On the -- there's an echo here. Can you hear me well?

Adrian Hennah

You're on.

Olivier Bohuon

Okay. On the Trauma business first. The Trauma sales in the U.S. were disappointing, that is true. The weak performance, as noted in previous quarters, is definitely, and Adrian has mentioned that, exacerbated by the expiry over the last 3 quarters of several agreements under which we received about $10 million per annum in royalties. So this has definitely been impactful. If you exclude this, the growth in Trauma business in the U.S. is around 2%, so which is aligned to the market growth. So not much to say about that. I don't like this dynamic, because I think that I've asked all the teams to perform better than the market in general. So we are looking in depth at the structure and the business model of Trauma in the U.S., particularly. And what we are doing here, while we are trying to redefine the model, actually, with what we call "Emergency Trauma" and in the other hand, a team specialized in scheduled operating processes. So here, we have a meeting in the next month with my teams to finalize and decide on what is going to happen in the years -- in the months to come, actually, and I do expect to see a strong improvement in the Trauma dynamic in the months to come. Another point on Trauma, we have to say that we have a very mild winter in the U.S., so this has not helped in terms of dynamic. So that's the last point. Regarding the European dynamic, well, here again, I think that it's a market, which is difficult. I mean the ortho market in Europe is definitely not a strong market. If you take, let's call it out of Europe, that includes Japan, because we don't have the breakout, pure breakout of what is happening in Europe. But if you take the hip business in the -- including Japan, including Australia, including New Zealand, it's about 2%. So it's not a very strong market that we face here. We have a growth, which is slightly under the market in these geographies outside the U.S. If you take now the knee business, I think Adrian has mentioned that we grow 9% outside the U.S. market, which is about 5%. So it's a pretty strong market, but we almost double the growth of the market. So net-net in the recon business, we grew outside the U.S. 5% in a market growing at 3%. So we are pretty happy with what we do there, and regarding dynamic price erosion, is what it is. I mean there's not much difference between what we have now, and what we have seen in the past. Again, even if slightly less, I don't expect to extrapolate on this anecdotal quarter to tell you that the market will recover and the price will be flat. So that's what I can tell you on this ortho market in Europe. The portfolio we have is strong, again, and we believe that we have all the tools in hand to be successful.

Christoph Gretler - Crédit Suisse AG, Research Division

I mean I was just wondering whether there is a substantial trading down or an oil price erosion acceleration happening in Europe at the moment also. So but it's not evident from your number.

Olivier Bohuon

No. We don't have any acceleration of price erosion. Again, it's consistent with what have been shown in the previous quarters. Okay. So we'll take question for 2 more people now, and then...

Operator

We will take our next question from Julien Dormois from Exane.

Julien Dormois - Exane BNP Paribas, Research Division

Basically, 2 questions, 2 follow-up questions. The first one is on the sequential acceleration that we saw across the industry. So along with your U.S. peers and yourself, do you now have quite a lot of confidence that the inflection point in terms of procedures and especially in the U.S. is behind and that you're heading for a more positive environment in terms of volumes? And the second question is on the hip business, you're still suffering from the metal-on-metal issues with BHR. I think you previously mentioned that the year-on-year decline rate for BHR was to the tune of 20% and more. Is it still the case? And do you have a more precise idea of how long this will continue to weigh on your overall hip business?

Adrian Hennah

Okay. So on your first one, Julien, it's Adrian. In terms of do we see -- first of all, do we see, in this quarter, that there's been an acceleration in the overall reconstructive market and do we see this is as the start of a trend? Well, we certainly do see that when you look at our results and the results of our competitors that you mentioned, that there has been a slight increase in the rate of growth in the reconstructive market, particularly in the United States. Do we see this as the start of a material trend or a bounce back, a little more cautious on that, frankly. You do see quarterly variations. And as we said repeatedly, frankly, repeatedly over many quarters, it is very hard to identify the drivers on quarter-by-quarter variation within the U.S. or within Europe. So yes, we note that there's been a small increase. We are not extrapolating from that ourselves.

Olivier Bohuon

Thank you, Adrian. So on the -- on your question on the metal-on-metal, yes, we see a very strong adverse wind, which is roughly, Adrian, correct me on this, basically, the same than what we have seen, this trend is about the same.

Adrian Hennah

Yes, Mid-20 decline is what I'll tell you.

Olivier Bohuon

Mid-20 decline. Adrian have said that it is now roughly 10% of our hip sales, 2% of our business. Despite this, we still believe, and I think very important to understand, the patient safety has always been, actually is always our priority. And so we support any initiative to improve the clinical outcome for the patient for sure. We have been very disappointed by the press coverage, which we believe may have been more likely to alarm than inform the patient. The MHRA, the U.K. regulatory body, have said that the majority of patients implanted with metal-on-metal hip replacement have well-functioning hips and are at low risk of developing any serious problems. So it's important. Nevertheless, we know that a number of competitors have performed very poorly and have been withdrawn from the market. So I think it's important that we should not misinterpret this as meaning for metal-on-metal hip implants are poor. We do believe that we have a product which is different, and so we are very confident that we basically have the right product for the right patients with the right level of safety. So we are not concerned, but we face this adverse wind as all the other ones.

Operator

We will now take our final question from Yi-Dan Wang from Deutsche Bank.

Yi-Dan Wang - Deutsche Bank AG, Research Division

I have 2 questions. First of all, on the knee business, can you gives us a sense of how your business is being impacted by the competitive customized cutting instruments that have come onto the market? I believe now that all of them have been on the market, so if you could comment on that. And also, to what extent the moderating outperformance of your knee business has been a result of that? And then the second question is on the gross margin. Great to hear that the underlying gross margin has improved. Can you give us a sense of what the gross margin opportunity is going forward? Clearly, not expecting you to give us a precise number, Adrian, but if you could give us some sense of over the medium run, how we should think about that developing?

Olivier Bohuon

So I will take the first question, Adrian, on this. VISIONAIRE, well, yes, VISIONAIRE is doing great, actually. We're extremely happy, remember to have mentioned that in Q2, Q3, Q4 also that we're not very concerned about the arrival of the competition. And definitely, it's good news and bad news, because you have competitors, that's the bad news. The good news, as you know, it is really enlarging and enhancing the market growth in this field. Actually, VISIONAIRE represents about 20% of the knee procedures in the U.S. So that's pretty important for us now. And we see a growth which is extremely encouraging, so we don't, at this stage, see an impact of the competition on VISIONAIRE.

Adrian Hennah

Yes. Yi-Dan, thank you for your question on gross margin. I mean bottom line, yes, we see -- we actually see significant opportunity for taking -- for cost improvement in the cost of sales. So a significant improvement in terms of how we source, where we source from, geographical location of our sourcing. We see significant improvement in better logistical arrangements, we see significant improvement in product design to design cost out and rationalize the portfolio. So lots of actions, lots of initiatives, lots of focus on efficiency improvement and cost reduction in cost of sales, as well as SG&A. Equally, we are realistic around the sort of medium-term view of price that you've got to deal within this marketplace and our perspective on that. And the outlook for that has not changed over several quarters now. So balancing those events, we see some potential, but you've got to be realistic, it's not huge. We, frankly, see as much, probably more potential in the medium-term in SG&A than we do in cost of sales. But in the round, our overall guidance for margin is what it is, Yi-Dan.

Yi-Dan Wang - Deutsche Bank AG, Research Division

Okay. Just to follow-up on the knee performance. If we look at your relative knee performance, the outperformance has been narrowing. Can you give us a sense what's driven that sort of narrowing? That would be great. Not VISIONAIRE, by the sound of it, VISIONAIRE is not the cause.

Adrian Hennah

Well, I think your hypothesis is correct. That the -- we did have a period of time in the United States where we were pretty much the only one approved, I mean technically, there were others on with some restrictions on them, which was tremendous. And we also had this tremendous phase in VERILAST. Both of which, the rate of it or the level of that advantage has moderated. So inevitably, that is a factor in the fact that our growth above market has declined. I think you're absolutely right on that.

Yi-Dan Wang - Deutsche Bank AG, Research Division

Okay. So going forward, should we expect you to just keep your share of the market rather than still outperforming the market?

Adrian Hennah

Well, I think let's stick to the guidance we've given on the overall -- on overall reconstruction, Yi-Dan. I think to go down the sublevels of guidance, as you insistently ask us to, is something we're trying to resist, as you know.

Olivier Bohuon

Okay. Anyway, so we are confident. So thank you all for your time today. And we'll be happy to see you in July, our hip in -- at our hip and knee seminar. So I wish you a good day. Thank you.

Operator

That will conclude today's conference call, ladies and gentlemen. Thank you for your participation. You may now disconnect.

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