Business review: Smiths Medical

Srini Seshadri

President

Smiths Medical is a leading supplier of specialist medical devices and equipment for global markets.

In medication delivery, our devices help to treat cancer patients, deliver insulin to diabetics and provide relief to those in pain. Our vital care products reduce hospital acquired infections, manage patients' airways before, during and after surgery, maintain body temperature and assist reproduction through IVF therapy. Our safety products keep health workers safe by helping to prevent needlestick injuries and reduce cross infections.

Employees

8,400

Principal operating regions

Manufacturing is concentrated in Mexico, the US, the UK, Italy and Germany. We sell to over 100 markets worldwide with the US being our largest single market with 49% of sales.

Customers

We estimate that around three-quarters of our end customers are hospitals with the remainder comprising the alternate care market such as home care, clinics and other surgery centres. We have a direct sales presence in 20 countries with distribution arrangements in many others.

Contribution to 2008 Group sales^#

31%

Contribution to 2008 Group headline operating profit^#+

34%

Competitors

The competitive landscape for Medical is complex as we compete with different businesses across the wide range of product areas. Our competitors include Covidien, Teleflex/Arrow, B Braun, Becton Dickinson, Hospira, Cardinal (Alaris), Vital Signs, Medtronic among many others. In many of these examples, we only compete with a small portion of their medical businesses so comparison between peers is complex.

^#Based on revised operating structure for 2008/09 (see Segment information)

⁺Percentage relates to headline operating profit before corporate costs

Markets

Healthcare spending continues to increase worldwide, driven by demographics – aging populations and increasing prosperity, particularly in Asia. The overall world market for devices and equipment of the type supplied by Smiths Medical is estimated to be worth £3.5 billion and is growing consistently. Smiths Medical has a global reach in the design, production and distribution of medical device products, with sales and marketing activities in over 100 countries. Its product ranges serve three main markets – medication delivery, vital care and safety.

Medication delivery

Smiths Medical designs and manufactures drug delivery systems that relieve acute and chronic pain (CADD and Medfusion), chemotherapy delivery systems to treat cancer patients (CADD) and patient-friendly pumps to deliver insulin to diabetics (Cozmore). The global market for medication delivery products is estimated to be worth £1.5 billion and growing at around 4-7% per annum. This growth is due to the increase in treatment of chronic conditions, integrating medication delivery devices with hospital IT systems, and the move to treating patients outside hospitals. We are a leader in ambulatory infusion, with a strong position in hospital infusion particularly in the syringe pump market.

Vital care

Smiths Medical's products manage patient airways during and after surgery (Portex), aid patients with breathing difficulties (Portex, Pneupac), help to maintain body temperature (Level 1), monitor vital signs such as blood pressure and heart rate (BCI, Medex) and assist reproduction through IVF therapy (Wallace). The market for vital care products is showing annual growth of around 2-4%, partly due to a steady increase in the incidence of chronic respiratory diseases and obesity. Demand is increasing for single use devices such as Portex airway management products. The market is expected to continue growing as the number of operations and intensive care beds both increase. This market is currently worth about £1.5 billion a year. We are a market leader in airway products.

Safety devices

Smiths Medical makes effective safety devices that prevent needlestick injuries and reduce cross infections. These cover a range of functions including drawing blood samples (Jelco) administering injections and vaccinations (Jelco) and delivering intravenous drugs (Deltec). The global market for safety products is estimated to be worth £500m and growing at 3-5% per annum. Smiths Medical is one of the world's leading suppliers of safety needles and catheters.

In the US, Smiths Medical is benefiting from the move towards treatment of illnesses in their chronic, rather than acute stages. A number of airway management products and ambulatory pumps already address this trend - such as the CADD ambulatory infusion pump range and the Portex Acapella respiratory therapy system – and it is becoming a focus for our vital care products.

The advantages of using safety devices are well understood in the US, and there is now greater recognition of the contribution safety devices make to improving the safety and productivity of healthcare employees. In other geographic markets, conversion to safety products is in its infancy, with opportunities for rapid future growth. Safety products are also being introduced into other areas of healthcare, such as dentistry.

Performance

	2008 £m	2007 £m	Reported growth	Underlying growth
Sales	703	691	2%	0%
Headline operating profit	128	127	0%	2%
Headline operating margin	18.2%	18.4%
Statutory operating profit	106	106

At reported exchange rates, Smiths Medical's sales grew 2% while headline operating profit remained in line with last year. Excluding the impact of currency translation, the underlying growth in profit was 2% on flat sales. Operating profit margins reduced slightly by 20 basis points. Performance has been severely affected by three product recalls and by supply chain disruption caused by several long-term initiatives. The simultaneous relocation of manufacturing to lower cost regions, the integration of the Medex acquisition, and the implementation of a new ERP system have all posed operational challenges over the past two years. These factors combined to disrupt deliveries which in turn have had an adverse impact on relationships with major customers. A 24-month performance improvement programme has begun and a new global operations team recruited to address these issues. Unfulfilled customer orders peaked in June 2007 but, as a result of the performance improvement initiatives, have since fallen by 90% back to normal levels. Our immediate priority is the rebuilding of relationships with customers and the delivery of the performance improvement programme.

While overall underlying sales growth was flat, Medication Delivery grew by 3.4% but was offset by declines in Vital Care of 1% and Safety Devices of 2.9%.

Medication Delivery benefited from good growth in its infusion product range, particularly outside the US. Its performance in the US was held back temporarily ahead of the launch of CADD Solis which began in April. The access franchise, which includes some new product launches such as POWER ports and Gripper Micro, grew well. Cozmore, which serves the diabetes market, delivered strong growth outside the US but sales were held back in the US by a product recall caused by a faulty motor from a supplier. The pain management franchise grew well outside the US but supply chain problems and restructuring in the US constrained overall growth.

Vital Care's performance was affected by supply chain disruption and by a product recall in temperature management. The airway franchise grew well in spite of supply chain problems and the assisted reproduction area also delivered strong growth reflecting the growing global demand. However, these performances were offset by declines in temperature management, caused by a product recall and aggressive competitor pricing; and declines in pressure monitoring caused by supply chain disruption.

The performance of Safety Devices was affected by declines in our peripheral intravenous catheter franchise. These declines were caused largely by disruption to production schedules as a result of a problem with resin from a supplier. The problem was quickly identified and no faulty products entered the supply chain, but supplies to our customers were interrupted. Sales of safety needles also fell within the US market but saw growth outside the US. The decline in US sales was caused by the conclusion of some large OEM contracts during the year.

On a geographic basis, our largest market is the US which accounts for 49% of sales, and has experienced a 2.6% fall in sales as a result of the supply chain disruption and product recall issues. In Europe, sales have grown by 2.4%. We have seen double digit growth, albeit from a low base, in emerging markets served via our distributors, particularly in Latin America, and Saudi Arabia. Last year's investment in new infrastructure for Greater China contributed to a 30% growth in sales in that territory.

In the US, a number of significant two- or three-year contracts were agreed across the product portfolio during the period. These include a three-year Group Purchasing Organisation (GPO) contract with Premier Purchasing Partners, to supply PORT-A-CATH® implantable access systems to Premier's 1,700 hospitals and almost 50,000 other healthcare sites across the US. A new three-year agreement has also been signed with MedAssets for five categories of anaesthesia products and a contract has been secured with Amerinet, for respiratory products. We secured major GPO contracts with HPG and Broadlane for syringe pumps. In addition, we signed a number of agreements from across the portfolio with Cardinal Health which includes a ground-breaking initiative for the co-branding of Smiths EDGE safety needles. Over the past year, these and other GPO contracts totalling $32m have been secured.

There is an ongoing focus on margin improvement through cost control and efficiencies. The manufacturing rationalisation programme has resulted in site closures at Hythe, UK; and Duluth, Georgia, USA. Over the past two years, the proportion of all employees working in low-cost countries has increased from 24% in July 2006 to 35%. Of our direct manufacturing employees, 62% are now working in Mexico, compared with 44% in July 2006.

The implementation of an ERP system was restarted in June 2008 after a period of stabilisation since the project was halted in 2007. The Benelux markets successfully went live in August 2008 such that more than 50% of global sites are now operating on the new system. The project, due for completion in March 2010, will improve the quality of management information and support inventory reductions, global sourcing and deliver savings. The total budget is £32m, of which £18m has been spent to date. Once complete, the project is expected to deliver annual cost saving of £15m.

Business developments

We have announced a restructuring programme that will merge the two existing operational units in the US. This will create a more efficient organisational structure and a single route to market, giving a more coherent customer-facing organisation. The project is expected to cost £4m and, once complete, generate annualised savings of £2m.

Research and development

Total R&D investment has risen by 6%, and as a proportion of sales has increased from 3.5% to 3.7%. Looking forward, we expect this commitment to increase further. We are now focusing our investment more tightly on product areas and segments which will deliver higher growth. For example, the largest increase benefited Medication Delivery where our R&D investment in infusion pumps is typically much higher at around 7% of sales. In contrast, our R&D investment in Safety remained constant at 1.5% of sales which is in line with many of competitors. However, we have invested in automated machinery to drive capacity. In summary, we have increased the number of new product launches by about 50% in the current year.

We have increased the rate of product launches with an improved new product development process. Over the past year, we have launched several new products. CADD®-Solis, a next generation ambulatory pump system, replaces a 10 year old platform and features error detection software and data connectivity to hospital IT systems. We also launched the Saf-T Closed Blood Collection System® Devices, the dual-lumen implantable access systems (P.A.S. PORT® T2 POWER P.A.C. and PORT-A-CATH® II POWER P.A.C), the Theraheat heated humidification system and the GRIPPER® Micro Safety Needle. A full range of EDGE safety needles was also launched, together with the latest closed blood sampling product, Hemodraw, which is already winning market share in the US. Since the year end, we have launched SmartX®, a wireless blood pressure monitoring system; UniPerc TM, a tracheostomy tube for patients with large necks; SACETT, which helps to reduce hospital acquired infections and two lower cost intubation devices for the Chinese market.

Outlook

The key priority for Smiths Medical is to improve customer service and implement the performance improvement programme. The division will focus on growth in developing markets and globally through the launch of new products. The performance improvement programme will support a return to sales growth in line with its end markets. The focus in the short term will be on margin improvement through restructuring and operating efficiencies. A planned review of portfolio profitability may lead to the rationalisation of certain product lines and a short term impact on revenue growth.

Smiths Medical's revolutionary CADD®-Solis portable medication delivery system eases patients' pain enabling them to stay mobile whilst undergoing treatment. CADD®-Solis is a clinically and technologically advanced system that administers pain relief medication, including narcotics, to post-surgery, trauma, cancer and labour patients. Its innovative safety software allows hospitals to input their own standardised pain management protocols for their patients, helping to prevent accidental overdoses.

CADD®-Solis was developed in cooperation with expert clinicians and the University Health Network in Toronto.

Next division

Smiths Group divisions:
Smiths Detection, Smiths Medical, John Crane, Smiths Interconnect, Flex-Tek