December 2005 Their Own Devices Mother Nature and Medicare nip at Smith & Nephew’s healthy margins By Richard Daverman
Photo Courtesy of Smith & Nephew
Jumpin’ joints: Led by CEO Sir Christopher O’Donnell (pictured), London-based Smith & Nephew reported third quarter revenue of $608.3 million, a 10% gain compared to the year ago quarter. Memphis-based Smith & Nephew Orthopaedics again led the company’s performance, posting third quarter revenue of $302 million, a 15% gain compared to the year ago quarter.
After the September hurricanes, London-based medical device maker Smith & Nephew (S&N), which has a substantial orthopaedics division in Memphis, was one of the first to play the Katrina card, blaming the New Orleans disruptions for a coming shortfall.
It seemed a little like Adam blaming Eve for proffering the apple. Granted, the general mayhem delayed all surgical procedures in the New Orleans area. But S&N faces larger problems than temporary delays in New Orleans surgeries.
Medicare has put a lid on what it pays for replacement procedures, a price list that is followed by most of the insurance industry. Hospitals aren’t making money at the new rates, and they are, in turn, pressuring doctors to cut costs by foregoing the latest technology in replacement products.
For S&N, the latest and most advanced products have the biggest profit margins. The company has a three-pronged plan for increasing year-over-year sales: more procedures, higher prices, more expensive products. Take away even one part of that, and the growth in earnings declines.
Make no mistake, things are good at Smith & Nephew. The only debate is the rate of growth. In September, S&N cut its orthopaedics earnings forecast to 17% from 18%. The replacement joint industry is healthy, albeit competitive. As people live longer, they outlast their joints, and the industry is devoted to keeping them moving. S&N’s margins are impressive, on a level enjoyed only by software companies and the medical industry.
For S&N, orthopaedics is just one of three divisions of its medical supply business. Endoscopy is centered in Connecticut and Wound Management in the UK. In Memphis, some 1,800 people work for S&N. Breakthroughs remain important, and S&N has had its share. It recently won an engineering award for an advance that puts a ceramic surface on zirconium—a low-friction surface with the strength of metal.
But the question remains: will Medicare pay for advances when there is no certainty that the breakthrough will last longer and require fewer replacements?
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