ConvaTec full year 2016 results

Revenue

On a reported basis, revenue increased 2.3%, to $1,688.3 million in 2016 from $1,650.4 million in 2015. On a constant exchange rate basis, revenue increased 4.0% in 2016. The primary exchange rate movement that impacted revenue was the movement of the British Pound sterling compared to the US dollar.  The average British Pound sterling exchange rate was $1.356 in 2016 compared to $1.529 in 2015.  The changes in revenue are further described above.

Operating costs and expenses

Cost of goods sold

Cost of goods sold primarily comprises manufacturing and production costs, including raw materials, labour, overhead and processing costs and any freight costs borne by the Group in the transport of goods to the Group from suppliers, depreciation of manufacturing facilities and equipment and lower of cost or market adjustments to inventories.

Adjusted Gross Profit margin excluding impacts from amortisation of certain intangible assets and certain non-recurring costs in 2016 was 60.9%, as compared with 59.6% in 2015. This 130 basis points (bps) improvement in the Group's adjusted gross margin percentage reflects strong initial benefits from the first year of implementation of the MIP (90 bps), along with favorable foreign exchange impacts (40 bps). Refer to Non-IFRS Financial Information below for further details.

Reported cost of goods sold increased $21.1 million, or 2.6%, to $821.0 million in 2016 from $799.9 million in 2015, primarily due to incremental restructuring and other related costs of $31.8 million, primarily resulting from closure of the Group's manufacturing facility in Malaysia in 2016 and manufacturing operations in Greensboro, United States by early 2017, along with increased volumes sold. As a percentage of revenue, reported cost of goods sold increased to 48.6% in 2016 from 48.5% in 2015.

On a reported basis, gross profit (revenue less cost of goods sold) increased $16.8 million, or 2.0%, and gross profit margin (gross profit as a percentage of revenue) was 51.4% and 51.5% in 2016 and 2015, respectively.

Selling and distribution expenses

Selling and distribution expenses consist of advertising, promotion, marketing, sales force, and distribution costs.

Reported selling and distribution expenses increased $10.3 million, or 3.0%, to $357.0 million in 2016 from $346.7 million in 2015.  As a percentage of revenue, selling and distribution expenses were 21.1% and 21.0% in 2016 and 2015, respectively.  On a constant exchange rate basis, selling and distribution expenses increased $17.8 million (5.1%), primarily due to an increase in compensation costs and spending on marketing support programmes.

General and administrative expenses

General and administrative expenses consist of executive management, human resources, finance, information management, legal, facilities and other costs.

As a percentage of revenue, adjusted general and administrative expenses were 9.7% and 9.8% in 2016 and 2015, respectively. On a constant exchange rate basis and excluding other income and expense items discussed under Non-IFRS Financial Information below, general and administrative expenses increased by $7.5 million (4.6%), primarily due to incremental compensation costs.

Reported general and administrative expenses increased $85.1 million, or 36.5%, to $318.2 million in 2016 from $233.1 million in 2015. On a constant exchange rate basis, general and administrative expenses increased $90.0 million (38.6%), primarily due to (i) an increase in share-based compensation expenses of $74.2 million driven by the impact of the accelerated vesting of legacy equity compensation plans in 2016, (ii) an increase in professional service fees mainly related to the IPO of $23.9 million, (iii) incremental compensation and benefit costs, and (iv) impairment charges on the Group's former corporate facility located in Skillman, New Jersey of $4.6 million. These increases were partially offset by (i) settlement of ordinary course multi-year patent-related litigations in 2015 of $13.3 million (for more details, see Note 5 - Legal Proceedings - Smith & Nephew/Patent Litigations and Settlement) and (ii) lower professional service fees primarily related to a number of remediation activities that were undertaken in the prior year period to enhance the Group's compliance function and strengthen its control environment within finance.

Research and development expenses

Research and development ("R&D") expenses consist of product development and enhancement costs incurred within a centralised R&D function.

On a constant exchange rate basis and excluding other income and expense items discussed under Non-IFRS Financial Information below, R&D expenses increased by $0.5 million (1.4%).

Reported R&D expenses decreased $2.2 million, or 5.5%, to $38.1 million in 2016 from $40.3 million in 2015.  As a percentage of revenue, R&D expenses were 2.3% and 2.4% in 2016 and 2015, respectively.  On a constant exchange rate basis, R&D expenses increased $0.3 million (0.7%). This increase in R&D expense is primarily driven by spending on certain development programmes, partially offset by lower regulatory compliance costs and FDA remediation costs.

Operating profit

Adjusted operating profit increased $35.4 million, or 8.1%, to $472.2 million in 2016 from $436.8 million in 2015, primarily due higher revenue and an increase in gross margin as described above, partially offset by overall increases in the Group's operating expenses (discussed above). As a percentage of revenue, adjusted operating profit was 28.0% and 26.5% in 2016 and 2015, respectively. On a constant exchange rate basis, adjusted operating profit increased $31.2 million, or 7.1% in 2016.

Reported operating profit decreased $76.4 million, or 33.2%, to $154.0 million in 2016 from $230.4 million in 2015, primarily due to overall increases in the Group's operating expenses (discussed above), partially offset by higher revenues and an increase in gross margin as described above. As a percentage of revenue, operating profit was 9.1% and 14.0% in 2016 and 2015, respectively.

Other costs and net (expenses) income

Finance costs

Finance costs consist of interest costs, standby fees, and any loss related to debt extinguishment.

Adjusted finance costs decreased $33.6 million to $242.2 million in 2016 from $275.8 million in 2015, primarily reflecting the following: (i) a decrease in interest expense on long-term borrowings of $24.2 million and (ii) a decrease in the non-cash amortisation of debt discounts and deferred financing fees of $9.5 million. The decrease in interest expense was primarily driven by the early redemption of (i) the Payment-in-Kind notes ("PIK Notes") due 15 January 2019 in October 2016, (ii) the 7.375% senior secured notes due 2017 (the "Secured Notes") in June 2015 and (iii) the 10.5% senior notes due 2018 and the 10.875% senior notes due 2018 (collectively, the ''Senior Notes'') in October 2016. These decreases were partially offset by an increase in interest expense driven by borrowings related to the new US dollar and euro term loan A facility under the Group's Credit Agreement as a result of the October 2016 financing.

Reported finance costs decreased $32.2 million, or 10.6%, to $271.4 million in 2016 from $303.6 million in 2015, primarily reflecting the following: (i) a decrease in interest expense on long-term borrowings of $24.2 million, (ii) a decrease in the non-cash amortisation of debt discounts and deferred financing fees of $9.5 million, and (iii) a decrease in the loss on extinguishment of debt of $5.9 million.  These decreases were partially offset by the write off of deferred financing fees of $7.3 million in the aggregate, related to the Group's revolving credit facility financing in October 2016 and the commitment letter entered into in connection with the financing of the Group's credit facilities (refer to Note 4 - Long-term Borrowings for further information). The decrease in interest expense was primarily driven by the early redemption of (i) the PIK Notes in October 2016, (ii) the Secured Notes in June 2015 and (iii) the Senior Notes in October 2016, partially offset by borrowings related to the new US dollar and euro term loan A facility under the Group's Credit Agreement as a result of the October 2016 financing.

Other expense, net

Other expense, net primarily consists of net gains and losses resulting from (i) the re-measurement or settlement of transactions that are denominated in a currency that is not the functional currency of a transacting subsidiary and (ii) derivative financial instruments.

Other expense decreased $28.7 million to $8.4 million in 2016 from $37.1 million in 2015, primarily driven by a foreign exchange net gain related to (i) intercompany transactions, including loans transacted in non-functional currencies and (ii) foreign currency impact on re-measurement of the Group's long-term borrowings denominated in non-functional currency.  These gains were partially offset by (i) reclassification of foreign exchange accumulated losses of $36.4 million from other comprehensive income to the unaudited Group Consolidated Statement of Profit or Loss as a result of restructuring of certain foreign subsidiaries as part of the IPO process and (ii) a loss of $17.8 million related to the settlement of a foreign currency forward exchange contract.

Income tax (expense) benefit

After adjusting for certain financial measures which the Group believes are useful supplemental indicators of future operating performance (see reconciliation to adjusted earnings for the years ended 2016 and 2015), the adjusted tax rate on continuing operations was 22.3% and 22.7% for the years ended 31 December 2016 and 2015 respectively.

On a reported basis, income tax increased by $93.9 million to $77.0 million for the year ended 31 December 2016, compared to a tax benefit of $16.9 million for the year ended 31 December 2015. The increase is mainly driven by deferred tax expense, from a benefit of $55.8 million in 2015 to expense of $37.2 million in 2016. This change was mainly driven by a change related to unremitted earnings, due to achange in tax law in Dominican Republic. In addition, in 2016 the Group had a $10.8 million prior period impact on deferred tax related to indefinite-lived intangible assets in the United States.

The Group's pro forma effective tax rate was 14.2% and 12.0% for the years ended 31 December 2016 and 2015.

Net loss

Adjusted net income increased $54.4 million, or 43.7%, to $178.8 million in 2016 from $124.4 million in 2015. As a percentage of revenue, adjusted net income was 10.6% and 7.5% in 2016 and 2015, respectively. The increase was primarily driven by higher operating profit due to revenue growth, strong gross margin expansion and solid cost control combined with decreased finance costs as described above.

As a result of all of the above, reported net loss increased $109.4 million to a net loss of $202.8 million in 2016, compared to a net loss of $93.4 million in 2015.