Smith & Nephew plc

Welcome to the Smith and Nephew second quarter and first half results call. I'm Deepak Nath, and joining me is Chief Financial Officer, Anne-Francoise Nesmes. I'm pleased to report another strong quarter of growth. In orthopedics, we've improved our underlying dynamics and are set up to accelerate growth in the second half. The momentum in sports, medicine, and advanced wound management has continued. So these results have given us the confidence to increase our full year growth guidance. We saw the moderation we expected in the US after a very strong Q1, but that was more than offset by improving execution globally and the increasing ability of our organization to take part in stronger markets. Margin development in the first half was in line with our expectations, And this should represent the peak of the macro driven cost pressures. In the second half, we expect a clear step up in both trading margin and cash generation as we drive productivity gains and start to bring down days of inventory. And importantly, we're continuing to build the foundations for sustainable performance by delivering the 12 point plan. Overall, I'm pleased with the progress of the plan, and as with any initiative of this depth and breadth, there are varying degrees of completion, but most elements are either on track or ahead, and we're already seeing the benefits coming through. Product availability in orthopedics was much better than it was on the back of our own operational improvements, although external supply interruptions and shortages continued to hold back. overall group performance later on i'll share with you the updated kpis on operations and how we're positioned to convert those into better outcomes in the coming quarters so our high cadence of innovation has continued right across the portfolio and we've added new growth drivers in robotics and in extremities we're also pleased with our progress on a number of other initiatives including order to cash excellence pricing management, and the pursuit of cross-unit business unit deals in ASCs. For now, I'll hand over to Anne-Francoise to take you through the detail of the quarter. Anne-Francoise?

Thank you, Deepak. Good morning, everyone. So I'll start with the second quarter revenue, which was $1.4 billion, representing a 7.8% underlying growth and a 6.6% reported growth. Performance was broad-based with all business units and all retailers. but you can see that orthopedics accelerated compared to Q1 and sports medicine and advanced wound management continued to perform well. Looking by region, established markets growth has remained above historical levels. Our US business grew by 6.3% following a very strong first quarter. Other established markets maintained their performance and grew 8.5% with elective procedure volumes remaining at a high level across Europe and Asia Pacific. Emerging markets grew 11%, largely driven by recovery in China, where surgical activity returned to more normal levels after COVID outbreaks earlier in the year. I'll now go into the detail of each business unit. Orthopaedics grew 5.8% underlying. Growth in knees and hips reflected a slacking the impact of VBP. As a reminder, the lower VBP pricing from the tender was gradually implemented during the second quarter of 2022. So while China still reduced growth by around two points in knees and four points in hips, that headwind fell away for the rest of 2023. Other reconstruction growth of 21% was driven by the ongoing adoption of robotics. And our installed base of capital is increasingly nicely across both hospitals and ASCs, passing 650 units in total with a growing funnel. And customers are showing their confidence in the platform by buying second and third queries in multi-system deals. The range of surgical applications is being recognized with the majority of deals, including our HIP software. Trauma and extremities grew 2.5% underlying. This was the first quarter after lapping the trauma exit in China. And there should be further growth uplift to come as we lap other markets exit trauma grew seven percent in the quarter with evos large place plates both driving growth and showing the value of a complete solution by pulling through the use of small plates in extremities we reach another innovation milestone with the 510k clearance and the launch of vitos our next generation shoulder improving orthopedics performance has been a key priority and we're now seeing multiple train breakers lining up in quick succession. And Deepak will cover shortly the progress we've made in improving implant availability. And we're resolving supply chain challenges that limited our instrument deployments in the quarter. We have the highest pace of Cori sales activity we've seen. Evo's growth has accelerated already. And the ETO shoulder makes us competitive for the first time in that large and high growth category. So putting this all together, we're excited at what's to come for orthopedics in the coming quarters. Now moving to sports medicine and ENT, which grew at 12%, based on our multi-year stream of innovation across both capital and consumables playing an important role. Product availability remains somewhat of a constraint in the quarter with restricted capacity at some component suppliers. However, we were still able to drive an attractive level of growth. And looking by segment, joint repair grew 12.5% with broad-based strengths across procedures and region. Regenitin, other shoulder repair products, and our knee repair portfolio all grew at double-digit growth, with knee growth helped by the new ACL solutions that we launched earlier in the year. AET grew 4.6% in the quarter, with werewolf far seal and mechanical resection both seeing major being major contributors offsetting a slower quarter in in video and of course i know there is interest for many of you in the developments in any developments in around the vbp in china our team remains in close contact with the chinese government and we expect a policy to be finalized later in the year ENT growth of 38.9% reflects the continued post-COVID recovery in our core tonsil and adenoid business. We expect to return to a more normalized level of growth later in this year as we lack more of the market recovery, but ENT continues to be an attractive growth area beyond this for us. Now moving to look at advanced wound management, which grew 6.2% on the line. Within that, advanced wound care grew 2.7%, mainly driven by our foam dressings and a strong quarter in Europe. Bioactives grew 3.1% on the line, with a slower growth than Q1, mainly reflecting a normalized prior year comparator. And skin substitutes remain the primary driver of bioactives. Our portfolio has been growing ahead of the market, And we believe the outstanding clinical evidence around graphics in particular positions us for continued strong performance. Finally, advanced wound devices grew 21.4%, reflecting double digit growth from both our traditional and single use platform with similar drivers to recent quarters. In the traditional segment, we are driving account conversions to renesses with a good pipeline of other opportunities. And we're continuing to expand the single use market with increasing penetration of people. Accelerating growth in negative pressure is a key component of the 12 point plan, as you know. Now I move to the financials for the first half. Revenue was $2.7 billion in the first half, up 7.3% on an underlying basis compared to H1 2022. Reported revenue was up 5.2%, including a foreign exchange headwind of 210 basis points from the strength of the dollar against major currencies. As you can see in this chart, growth was balanced across our businesses with all three units contributing. Now, moving to the summary P&L for the first half, gross profit was $1.9 billion, resulting in a gross margin of 69.8%, which is 110 basis point decrease on the prior year. Operating expenses grew faster than sales, driven by increased spending on sales and marketing, and this results in trading profit of $417 million, with a margin of 15.3%. I'll explain the drivers of the lower margin on the next slide. Slide 12 shows a more detailed trading margin breach. There were three major headwinds compared to the first half of 2022, with the first two representing what we expect to be the peak of the macroeconomic pressures. There were around 400 basis points from raw material and staff cost inflation. Another 120 basis point from transactional FX. And as you know, the transactional FX is the result of a strong dollar on a disproportionately dollar-based manufacturing cost base delayed by from our hedging program. The final headwind was around increased selling and marketing spend as part of refreshing our commercial approach for growth in orthopedic transport and came to 110 basis points. But there were also significant positive offsets in the first half. We saw around 220 basis points of positive leverage from volume and pricing growth, and around a third of which was driven by the 12-point plan. There were also significant productivity gains with around 150 basis points from operations and procurement savings, and 100 basis points from other cost savings initiatives, including restructuring. And I'll come to the outlook in a moment. But one thing you can see from this bridge is that while the tailwinds are here to stay for some time, the headwinds are either worn off in nature or should significantly ease over the next period. The increase in orthopedics and sports commercial spend is not intended as a repeating exercise. We currently expect transactional effects to be broadly neutral in 2024. And this first half should represent the peak of the pressure from input cost inflation. Looking further down from the P&L, adjusted earnings per share declined by 8% to 34.9 cents. That's slightly more than trading profit, mainly due to higher interest expense, with our average net debt higher than in the first half of 2022. The interim dividend of 14.4 cents per share is unchanged. Trading cash flow in the period was $110 million, with trading cash conversion of 26%. That is lower than in 2022 due to a working capital outlay of $326 million. And whilst we reduce our receivables as a result of the order-to-cash initiative in the 12-point plan, the biggest driver of the working capital increase in the first half was inventories. So let's look at the inventory movement. And there are three main drivers to the increase that we expect to reverse. Firstly, we've added some stock to support acceleration in negative pressure wound therapy. This is a compelling opportunity for the business that carries some upfront inventory requirement that we expect to gradually consume as the segment grows. In addition, we've had some accumulation of both products and instrument sets that are not yet deployed and are currently being held as inventory. This is a result of ongoing supply constraint for a small number of components, which hold back assembly, set deployment, set completion, sorry, and consequent deployment. And Deepak will cover in a moment that we expect to accelerate deployments in the second half, which will start bringing down the inventories. And then within this driver of inventory growth, we've also had some excess factory inventory from spot buying of raw materials to protect our manufacturing against external supply disruption. And while there are still some areas with tight availability, general improvements in the reliability of global supply chains mean that we are now able to bring in tighter controls on raw materials buying, and we can certainly see the level of raw materials inventory coming down in the future. And finally, as you would expect, there has been inventory growth, tracking the overall growth of revenue. And that component is neutral to the ESI, but we should still see improvement in that portion as we execute the 12-point plan. And much of our inventory, as you know, sits in orthopedics. This is not the driver of the difference in the quarter or in the first half, but we're continuing to focus on driving down the orthopedics. we're committed to bringing DSI lower and you should expect to see clear progress by the end of the year. Now to conclude on the financials, net debt ended the half year at $2.8 billion. This is an increase of $314 million from the start of the year, including $201 million we paid for the final dividend of 2022. The effect of that is that the leverage finished the half at 2.3 times adjusted EBITDA, which remains within our target range of 2 times to 2.5 times. And now I'll finish with our updated guidance for the full year. On revenue, we are now targeting underlying growth of 6% to 7% versus our previous expectation of 5% to 6%. This reflects our strong growth in the first six months. further operational improvements in orthopedics as we execute the 12-point plan, and continued outperformance in sports and advanced wood medicine, while also recognizing a more difficult growth comparators in the second half of the year. Our guidance for the full year trading margin is maintained for at least 17.5%, with headwinds from input cost inflation offset by growth in productivity gains. I'd highlight that we expect to deliver this target also after absorbing 120 basis point headwind from transactional FX. Our outlook therefore represents what would be substantial margin progress on the constant currency basis. But I'm sure that you've also worked out that our guidance implies a step up in the second half of the year, in line with our previous commentary that our guidance was H2 weighted margin and cost pressures would peak in H1. So to give more perspectives on the driver of the step up, slide 18 details the components of the margin expansion in the second half. Part of the step up is a return this year to our historical margin seasonality. we should add around 270 to 300 basis points over the first half margin. And this year, we also expect a further effect of productivity improvements accumulating over the course of the year. Our cost reductions, including productivity and the 12-point plan savings, and the unwind of costs, should together come to at least a further 250 basis points of second half margin uplift. Incremental cost inflation should be relatively modest with around an 80 basis point headwind from the merit uplift we made in H1. So for what this will look like in your model, you should expect gross margin to be higher in H2 and our SG&S spend to be lower in absolute dollar than in the first half. And finally, as you think about EPSA, we have also updated our technical guidance and expect the full year tax rate on trading results to be around 17%. And with that, I'll hand back to Deepak.

Thank you, Anne-Françoise. I'll start with a reminder of the transformation that's underway at Smith & Matthew. Firstly, we're becoming a higher growth company with a target of consistent growth five plus percent growth by 2025. That's more than in the past, and we have a clear path to get there. We're fixing the foundations of orthopedics, ensuring the continuing strength of sports medicine and advanced wound management, which are already outperforming, and converting the increased R&D investment into innovation-driven growth. Each of these elements is a step up from where we were pre-COVID, which contributes to building a more attractive growth profile than we've had in the past. We're also committed to driving profitability and returning our trading margin to at least 20% by 2025. We're coming through a period of elevated macro pressures, and we're rebuilding a margin through manufacturing and COGS optimization, productivity improvements, and growth leverage. On slide 21, the 12-point plan provides a detail of how we do this. We're now approaching the halfway point of the two years, and slide 21 is an overview of where we are today, based on the milestone completion for each underpinning initiative. Taken as a whole, the plan is showing good progress. The varying stages of maturity reflect the breadth of the program, including some initiatives that could move forward immediately and others that by nature would need longer preparation, such as portfolio streamlining or manufacturing optimization. We're now well advanced with our work to rewire orthopedics. We've refocused the commercial organization, simplified the selling organization, introduced enhanced commercial processes and rolled out a new growth oriented incentive structure our renewed demand planning process is in place and starting to bear fruit and our asset utilization is moving in the right direction with set turns now around 30 higher than at the start of 2022 with better foundations in place and the delivery of key r d projects and robotics and in extremities, we're now poised to start delivering on that second block of initiatives and win better market share with our technology. I'll drill into more detail of our progress in a moment, but on improving productivity, we're quite advanced in our initiatives on value and cash processes. We've implemented better pricing, across our portfolio. And as Anne-Françoise set out earlier, we're driving DSOs down and inventory days are poised to follow in the back half of the year. What will still take time is the work around manufacturing optimization. We've identified opportunities in our network and there's a process to follow before we can move ahead. The opportunities from simplification and the cost and asset efficiencies along with it will come later in the plan. These initiatives represent an important part of the midterm margin target or margin improvement target. We've talked less about the initiatives to accelerate sports and advanced wound management. However, they're overseen by the same governance structures as the rest of the plan. and are being driven with the same urgency by their dedicated teams. With both initiatives being able to move quickly at the start of the plan, we're starting to see progress in competitive conversions and negative pressure, and the pace in cross-business unit deals into ASCs, which has more than doubled just in 2023. Orthopedics is still the single biggest lever for changing our financial outcomes, and it is where we've had the most work to do. particularly around commercial delivery. The good news is that the fix in our orthopedics foundations is now well underway. Our KPIs of product availability have continued to improve, and the charts update some of the metrics that we showed you with our full year results. Firstly, the value of overdue orders has continued to fall. These have halved since the peak in 2022 and with another 25% reduction since the beginning of the year. We've also showed data on Lifer or line item fill rate. Lifer measures the percentage of customer orders that have been filled, so it's an indicator of how well we're meeting demand. Our target is to bring our non-set Lifer to a level that matches industry best practice. As you can see in the chart, our KPIs continued on its improvement path and has now progressed to about 85% of the way to our goal from the trough level. The gap to that industry standard is now small, and Lifer for key priority products is actually moving in the right direction. In particular, Evo Small has reached and maintained the target level, and Journey 2, our key product in recon, is more than 80% of the way there. An important part of how we've made this improvement has been the new planning process that we introduced a little over a year ago. Better matching supply to demand at both the volume and mix level has enabled these improvements in order fulfillment, as well as in other operational benefits. So that's happened alongside other measures like improved logistics with a 60% improvement in customer replenishment speed, and significantly improve scores for the health of kits that are already deployed in the field. Putting all of that together, we've been able to reduce our total production while continuing to improve product availability. And this, in turn, will ultimately enable reductions in inventory and in manufacturing capacity. To convert implant availability into sales growth, we now need to step up the deployment of new instruments to customers. The sheer number of components in an instrument set makes this a complex process. So we rely significantly on third party providers and just a single missing component could be enough to stop deployment. And that has been the case in recent months with supply chain disruptions resulting in incomplete sets. Even so, we already made good progress in resolving these challenges. For example, in trauma, which was a challenged area in Q1, we had more than a 300% increase in EVO sets deployed in Q2. So we expect this pattern of greater set deployment to also follow in hips and knees in the second half. And this is being supplemented by redeployment of around 10% of existing sets across our network. I referred to this last year around this time. So greater pull-through of the more readily available implants should then follow. So innovation is another key component of our growth plans. You may remember from when I talked about this in February that we expect more than half of our growth to come from products launched in the last five years. We also said that we expect to launch 25 new products. from our average over the previous three years of around 18. So I'm pleased to report that we've delivered 13 in the first half of this year, which is a notable inflection from our past and is well on track to deliver our full year expectation. So that includes our ATOS shoulder system, which is an important part of our growth plans for trauma and extremities. ATOS is designed with both patient and surgeon benefits in mind. The metastem aligns with the market trend toward minimally invasive short stem devices. Short stems are easier to implant, have improved bone preservation and are a better fit to anatomy. Also, its compact trace system for procedures allows for shared instruments between the short stem or existing long stem shoulder and also future options. So we're continuing to work on a stemless variant And also to bring compatibility with Corey. Financially, adding ATOS to our offering enables Smith & Nephew to be competitive in the shoulder market. This is one of the fastest growing segments in orthopedics with a $1.3 billion market growing at around 9%. With this new shoulder opportunity, along with the completed EVOS platform and plates and screws, and the improvements in product and instrument supply, Trauma and Extremities is well positioned to step up to a higher growth rate. We've also added a further feature to Cori with a saw-based solution. So this provides an adjustable cutting guide-based solution that fits into the existing Cori Total Knee workflow. And this without the need for additional incisions that come with traditional pins. This features allows or adds powerful versatility to Cori, appealing to an even broader range of surgeons with varying preferences by offering both milling and sawing as options. This is another step in our journey to adding features and functionality to Cori. So in recent quarters, we've highlighted the introduction of revision capability and the unique digital tensioner. And the addition of the SaaS solution highlights our intention to continue to build out Cori at an accelerated pace. The delivery of this project is a testament to the speed of innovation that's being driven by the 12-point plan, as well as the agility of our teams in acting quickly to bring these features to market. So we just received FDA clearance, that's in June, and expect the rollout to begin in the second half of the year. Finally, I want to mention a further development in our plans to strengthen the underlying foundations of the business and how we operate. With the early changes from the 12-point plan more settled, it's now an appropriate time for us to move to a more focused way of operating. We recently began the realignment of our commercial model from franchises and regions to global commercial business units with verticalized commercial teams for orthopedics, for sports medicine, and mood. ENT is already operating in the structure. In my own experience, and when I look across the industry, this is a better way of doing business. It drives greater accountability. faster decision making and execution and increased customer focus in every area of our portfolio. The previous regional marketing organizations will also roll in to the global business units. So we'll have a single point of accountability for upstream and downstream marketing and sales and better alignment and resourcing across regions and countries. The business units are led by dedicated presidents for each of orthopedics sports medicine and advanced mood management with full global pnl responsibility and this structure industry veteran brad cannon is solely focused on leading the transformational changes required in orthopedics scott schaffner who is already leading sports medicine joins the executive committee as business unit president We're still committed to cross-business unit opportunities, and we're driving them through the governance of the 12-point plan structure. Earlier this year, Dr. Vasant Padnamabhan expanded his role to president of R&D at our ENT business, which is already operating in this verticalized model. Vasant's blend of clinical and technical expertise, business acumen, and experience bringing novel therapies to market will help strengthen our focus on ent last month dr rohit kashab joined as president of advanced wound management following simon frazier's decision to retire rohit is a seasoned customer and team focused leader with significant global multi-functional experience in wound care and surgical management Rohit's career includes more than 20 years at a facility where he was one of the principal architects of the company's strategy and led its execution. Immediately prior to joining Smith & Nephew, Rohit was president of wound and surgical businesses and chief commercial officer of Mimetics, where for the past three years, he has led the business's turnaround in culture and performance to achieve consistent growth. Rohit is an example of the caliber of talent we're seeking and attracting to continue to drive and deliver growth and increase our potential as a company. Others include a new head of U.S. orthopedic sales and an operations team for orthopedic specialists that we brought together in 2022. So you have the opportunity to hear from the presidents in due course, including at our Meet the Management event that's planned for November 29th of this year. So in summary, I'm pleased with how the first half of 2023 has developed. We've delivered growth ahead of our plans. driven all three business units and have improved our fundamental positioning through the continued operational fix and turning our innovation investments into a greater intensity of new launches. There's clearly still work to do in some areas. We're in an early stage on our productivity initiatives and are stepping up our profitability and cash generation in the second half. As we deliver that, we'll exit this year with momentum that puts us solidly on course to meet our midterm commitments. Before I finish, I would like to say a few words about Anne-Françoise and her decision to step down as CFO next year. I am saddened to lose her as a colleague. I understand why she feels that as we make our progress with the transformation of Smith & Nephew, now is the right time for her personally to reflect upon what she wants to do in her next career. It's hard to encapsulate the impact that Anne-Françoise has made on Smith & Nephew during her time as CFO. She was instrumental in us navigating the financial challenges in the pandemic and in laying the foundation for the 12-point plan. She has also been a champion of our culture and purpose and has been a strong leader. On a personal route, I am grateful for the support and the counsel that she has provided me during my time at the company. I'm also grateful that she's given us ample time, far, far more than she was required to, for us to identify a successor and ensure a smooth transition. And it is good that we will have her for the next few quarters. So now I'll take your questions or we'll take your questions. Vicky will moderate.