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.

Hi there, thanks for taking the questions. Jack Reynolds-Clark from RBC. So just starting with the revenue upgrade, obviously it implies a change in your assumptions around growth through H2. I'm wondering how much of that is coming from your changes in assumptions around market growth versus execution? Second question on pricing. I think you mentioned 2.2 percentage points of leverage coming through on volumes and pricing. Wondering how much of that is pricing, how much of that is the result of your own pricing initiatives versus generally more favourable pricing environment. Then on Cori, obviously helpful detail in your release around the Cori placements. I'm just wondering what your utilization level of Corey is at the moment. I think last time you disclosed it was around 20%. Yes.

So let me talk about the revenue picture. Our step up in the second half reflects seasonality, but our confidence comes from the fact that our revenue growth has come across all of our business units. It's orthopedics, it's sports, and it's wound, and we expect that to continue. So the primary driver for us to increase our guidance is our own commercial execution. There is, of course, market tailwind, and that's primarily an orthopedics factor, and we expect to be able to better take advantage of that. As you'll recall, we have not always been able to take advantage of that market tailwind in years past. So we expect to be able to better take advantage of that. But it's fundamentally our own commercial execution that underpins that confidence and that step up in growth in the second half of the year. Pricing is a component to that. It is one of the elements of the 12-point plan. Ashley-Anne Francoise has been personally leading that particular initiative. So there it's about our reaction to inflation and our ability to kind of pass along some of that information. um price onto our customers but the more fundamental work we're doing is actually greater price discipline across our portfolio uh and and that work uh should persist uh well past the current inflationary period so that's really the more fundamentals of our commercial execution that we plan to improve around corey

Because you referred to the 220 basis point. So we have seen, to what Deepak said, referring to the second half, we have seen positive price momentum in the first half and we're continuing the strong discipline. We're not saying what the split is, but you can assume that there is a pricing built in that compared to the historic price deflation that we used to see. So we're in positive territory for price and very successfully managing that.

And I give our teams a lot of credit for the discipline we're driving around that. And coming to your third question around Cori, we're pleased with the utilization. So we're interested not just in placement of Corey, right? The numbers of Corey are less important to me. What's much more important is the role that Corey plays in driving our orthopedics business, driving our full portfolio. And that utilization, I gave you the 20% numbers, only improved even further since that. So it is a key metric that we track. We don't necessarily report on that every quarter. But as I've said in previous forums, it's a means to an end. It's the number of core replacements is a secondary lever or secondary importance to me.

Hi, Hassan al-Waqil from Barclays. I have three questions, please. Firstly, again, on the management change, Deepak, we've clearly seen a lot of management change at Smith and Nephew over the years. I wonder if you can elaborate on why this is happening now and particularly early on in your turnaround. And related to this, Deepak, do you remain confident on the medium-term margin that you've highlighted, given the significant ramp required beyond this year of an excess of 250 basis points over two years? Secondly, the strength in NEIS looks to be driven OUS, with US growth of 2.8% below some of the peers who have already reported. What do you put this down to and how do you consider the cementless knee ramp in the US? And then finally, I'd love some commentary around how you see the US environment and backlog. Has the increased utilization peaked and when do you expect a more normalized level of growth? Thank you. Sure.

The first question around management changes. On the one hand, I talked about the importance of building a strong foundation for our business. And the move from a franchise to a business unit structure is a key part of that. What I'm trying to achieve is greater levels of accountability in our organization. speed of decision-making, remove inefficiencies, de-layering the organization, and simplifying how we operate. So those are some of the thinking behind the move from franchises into business units. And I believe, in my experience, they will stand us in good stead over the long term. In terms of the specific changes, some of those are associated with with that move, but they've been independent things. So in Moon, for example, Simon Fraser deciding to retire was a personal decision for him to retire, nothing to do with the organizational changes. So the appointment of Rohit Kashyap is a result of Simon's decision to retire. And I had previously talked about Brad Cannon's focus into orthopedics. He's a veteran of the industry with a long track record of success. Given the scale of changes that we need to make in orthopedics, I needed someone of his caliber, of his kind of track record focused solely on orthopedics. And that has already yielded great benefits in terms of how we operate and the progress we've made on the transformation. journey. So each one of these changes has had a particular context around it, but taken together, I believe that we'll go much, much better position as a company. And one final point on that, which I mentioned in my remarks, in operations, we've assembled a team within operations that are drawn from the industry. It's the first time we've had such a group that are not only strong operations leaders, but actually come from the industry, focused on driving the improvements in the operations area that are key to us transforming orthopedics. So taken together, I believe we will be as stronger as a company moving forward. So that's the ops or the management changes point. Second, do I have confidence in the midterm guidance? Absolutely. We've maintained our guidance of at least 17.5% for the year. We've kind of given you what the components of that are from H1 into H2. I am fully confident on our ability to deliver that. And you asked about midterm and the ladder up from 2023 on to 2025, we've provided some bridges in the past forum. I think there's a full year results. I am 100% confident on our ability to deliver to that. It's not just words, but rather the initiatives that underpin how we're going to get there. So that's your second point. In terms of uh the comment on knees uh you're right um we had uh compared to our peers who reported so far um we clearly are ahead outside the united states uh than we are in the u.s in the u.s we are in the early stages of improving our operations i talked about the appointment of a new u.s sales leader that occurred in q2 in addition to that there's several other components of changes first is we've simplified the organization we've de-layered the u.s organization we've gone from having six regional heads in the u.s down to three and made for the simplifications downstream in that organizations, which is first component to that. The second component is fundamentally, as I mentioned, our commercial processes were not where you would expect us to be. And the new process that was rolled out starting in Q1 right through into Q2 are starting to bear fruit. But I do believe as the quarters progress, they will really start to pay off. The third piece is a new change in incentives where we had been in orthopedics primarily focused on retention. We now have incentive programs that are more growth-oriented, and that is on the back of improved product availability. that we've already seen i've shown you some of the metrics uh around that which is a third uh component of that and a fourth and final component is refocusing the efforts of our commercial team uh around our portfolio uh right that required some fairly intensive training that we invested in the first half of the year that we alluded to um so the combination of all those things will start to yield obviously the the performance isn't quite there in the us yet But I do believe we're well positioned in the back half of the year. So that was, I believe, your third and final question. I think there was another one that I missed. Yes. So we are seeing sequential improvements in terms of growth with our leisure and consulate. We obviously have multiple offerings in Cementless. The Journey Rocks construct is an important component to that. So we're pleased with the progress. We obviously don't break out individual product or family sales, but we're continuing to see good uptake in that area. Yes, I knew there was a fourth one. I lost track of that. So Fundamentally, our growth assumptions or the guidance that we provide are based on our improved and improving commercial execution. Our guidance that we provided over the midterm does not assume some exceptional tailwind, right? It's built on more or less normalized kind of macro factors or procedure environment. Having said that, we do see tailwind. We saw that in Q1. We're seeing that obviously in Q2 to a lower level than in Q1. In terms of how long they persist or where they come from, whether it's backlog or something else, we don't really have the visibility to be able to call that, right? As a number four player in orthopedics, as I've said in the past, where we're going through a performance improvement program, it can be difficult to kind of parse how much of it is you and how much of it is the market.

On Corrie adoption, can you give us a sense for what proportion of those placements were in the ASC channel versus hospital? And more broadly, how did all those sales to the ASC channel fare during the first half? Sure.

So, with the 12-point plan, we are about where I thought we would be at this point of the year. We called out 45%. It's based on uh progress in each of the underpinning initiatives and kind of relative to the schedule that we're on right so it's it's built up a combination of those um those initiatives so 45 you know about where we expect it to be um i'm particularly pleased with and as i said there's some for the most part either on track or ahead in terms of kpis and that's true right across the board Having said that, there are some areas that are better than others. In terms of where I'm pleased, pricing is clearly an area we call that. It's one of the elements of the 12-point plan. Very pleased with the progress there. The order-to-cash initiative, very pleased with the progress that we're making there. The cross-business unit deals, which is the 12th element of the 12-point plan. both in terms of the volume of deals, the number of deals. I'm pleased with the progress that we're making. We really are taking advantage of the opportunity we have in the ASC. So that's the third one. Mooned, we're on track, I would say, against a fairly aspirational plan that we had around negative pressure. Product availability. there's two components to it. It's improving lifer, which is really tied to replenishment of sets in orthopedics is how well are we replenishing the sets that are already out there. You see the progress that we've charted that's good. The part that's not good with that is driving down the sales DSIs related to it. That has been slower, but we understand why it's slower. Fundamentally, it's because We've had supply interruptions, individual components. In the Q1, it was cross-linked polymer that are a key part of certain constructs that we were challenged in terms of supply. So that inhibited our ability to complete sets or replenish certain portions of sets. So there's things that are set, as Jean-Francois said, are stuck in inventory rather than being deployed in the field, right? So there's good reasons for why it is where it is, but the underlying improvements and process around our commercial operations and really our manufacturing operations and our ability to connect commercial and sales that we've made tremendous progress in so and there it's moving from kind of high level volume based kind of forecast to forecast that are tied to mix actual skew level and that's the real improvement that we need to make in order to better match supply to demand there i feel good about the progress progress but the kpi of inventory clearly we've got work to do that right to give you an example where we are not where we need to be In terms of how we needed to make adjustments to our plan, what I would say is not major ones. But having said that, there's a very tight level of governance around this. It's every two weeks that we meet, I chair the meeting together with Anne-Françoise. And the reason we do that is to make decisions at the pace that we need to make to be able to run a program given the imperatives that we have around improvement. so within the range of those we've had to make adjustments and refinements but not major ones and that's not because we're loath to making them it's because we've generally called it called it okay right so if we need to make it we'll do so we've got a mechanism to do it but we haven't needed to do to do it um so that's the uh part your question around asc's About a third of our Corys are in the ASC channel. We're seeing good growth, I think 20% growth in ASCs in our recon business. So we're all participating in the shift of procedures that are going in the U.S. from hospitals into the ASCs. Debson.

Thank you. It's Graham Dore from UBS. Can I ask some questions on the margin? Yeah. So the H1 margin was kind of historically weak. And I know we had a message at the start of the year that it would be H2 weighted, but it's also kind of like a historic step up in H2. So was this genuinely what you were expecting or is it sort of the bottom of the range of what you were expecting for the first half? When I look at slide 18 and you've got the building blocks up, even if I add those building blocks, I'm not getting to much more than 70 and a half. So are we just less optimistic maybe than the start of the year?

Yeah, so do you want to take that?

Sorry, I was going to take this one. So clearly our margins, as we've said in the statements, are in line with our expectations and as anticipated. And we said at the beginning of the year that it will be the margins and the profitability will be H2 weighted. So what we're expecting to see is the operating leverage, as you're pointing out to slide 18, coming through, and importantly, returning to historical seasonality. So yes, the H1 margin is lower, but that was implied in our initial guidance, given that we are returning to historical seasonality and the productivity improvements we've always signposted were in the second half. So we've already made progress in terms of cost savings, restructuring, On top of that, we're unwinding the cost spend, the pre-selling and marketing that we're seeing in the first half. So we are, you know, we're in line and tracking to what we said we would.

And just to accentuate the point, when we say on expectations, this is what our budget was built to. So we truly are on budget to age one of the year. I think the point is some of the favorability and revenue that we had that are ahead of our expectations didn't necessarily translate into favorability and margin. And we've kind of given you the bridge around that. But truly, our budget was as we came in.

maybe we just think about next year it's just a broader question the there's obviously a big step of us as a standpoint today in terms of margin to get towards that target what happens if the order market doesn't grow yeah we've got a big backlog you've got a tough comp and i know there's obviously the absolute amount of revenue will still be quite high but you've got to say you've got to go from taking very little share in the us losing share to taking a lot of share yeah is that in the plan yeah so as i reflect back to how our plan is constructed and was the anchor to our guidance

our guidance was built and our assumption was built on more or less normal orthopedic volume. So any tailwind we have is a bit upside, right? And so implied in that is share recovery. And here I want to parse what that means. Over the last couple of years, we have lost share, not because we've necessarily been displaced from accounts, but because we've given up procedures largely on the back of our failure to supply reliably right recovering that share though not easy is easier than if you had to go back into accounts that leave a completely displaced one i mean to put it simply their surgeons are already trained in our systems who have had to resort to other um uh uh you know companies products because we haven't been able to supply as well as as regularly as we should have been able to right so it's that recovery that underpins the next couple of years. The second more structural component to that is our innovations, right? We have invested in R&D, in particular in orthopedics. Robotics is a big component of that, but it's not just robotics. It's cementless, right? It's in trauma, in extremities, and in other parts of our portfolio. But let's just take robotics, right? Cori, we have a high level of What we're doing in the 12-point plan is accelerating certain features and functionality that was previously contemplated in the pipeline, but not at the pace that we're bringing this out. And there you see this, right? Every quarter I talk about something related to Cori. And that just doesn't, it didn't just happen. It represents an acceleration of the plans that we had. And so when you take a step back and look at what we brought onto Cori, right? We've got not only a milling-based approach, now we've accelerated programs to bring a cutting-based approach onto Cori. It's a platform that now has cutting and milling, and the intention is that it appeals to a broader range of surgeons. So that represents an acceleration. The digital tensioner is another thing, which is another capability where surgeons are able to plan their procedures before ever making a cut. That's a unique selling feature of the digital tensioner. We brought that out last quarter. Again, not to go down the rabbit hole of any one feature, but in totality, a significant investment. We believe in Cori. I believe that will be a driver of growth, not just in terms of robotics, right? You see our other recon line, which is where we park our robotics numbers as reasonable amount of growth. But it's really how we use Cori to drive the rest of our portfolio. That's the refocus of our commercial organization that I'm talking about, right? So there, I do feel good about how we're positioned for the midterm. So hopefully that gives you a bit of color around how our guidance is built up. Thank you. There was a question on the phone, Vicky, and I'll see that. We've got three questions on the phone, and the first of which is Veronica from Citi. So perhaps we go to that before we go to other questions in the room.

Veronica Dubu, Journal for the City, your line is open.

Excellent. Good morning and thank you guys for squeezing me in. I have two, please. The first one is to follow on a little bit on the competitive environment and how you're feeling about your performance in orthopedics. And maybe you can tie this also to the changes that you've made to the sales organization in the U.S. year-to-date. Obviously, when we look at the growth rates, clearly the gap between you and the peers has narrowed this quarter. I appreciate there's a lot of comp effects in there and noise. But do you feel you are starting to make progress versus where you were 12 months ago? And I guess maybe just talk to how the commercial organization changes, including the training program and the restructuring done year to date.

fits into that and really what your ambition is as you move into back half of the year and into 2024 and then i'll have a follow-up after that but maybe we start there yeah sure veronica thanks um so first off i mean the headline answer is um i feel good about where we are as you as you correctly note uh the gap relative to competitors at least the the the we're ahead of one of them we've narrowed the gap relative to the to the other competitors reported so far right um so i i am Pleased with where we are, but this is very much in the early stages of the improvement journey on commercial. You rightly note the changes in organization, the changes in commercial process. In the U.S., where our biggest challenge lies in terms of commercial performance in the U.S., We brought a lot of these together in Q2. It started in Q1, actually some of that, the seeds were sown back in 2022. They've come together in Q2. they've had impact very clearly yet but the bigger impact is is to come in the back half of the year and and in time beyond as you know in commercial it's it's not a switch that you turn on right you've got to make sure you lay the foundations you make sure you're thoughtful about the changes you're making and then of course let the organization do its job so i do believe that we're well positioned now having brought together the major elements but But the proof will be in the pudding, and that will be best judged in terms of our performance here on out. But just to give you a sense of timing to accentuate it, a lot of these elements came together really in Q2. So I do feel good about it, but obviously the big part of the productivity or the improvements will come in the quarters that follow.

That's very clear. And then maybe, and I apologize if this is, the question might have come across as aggressive. It's not intended as that, but it's definitely one that has come up a lot in my conversations this morning, which is that 1.1 percentage points of spend that you've called out in selling and marketing. Was this always in the plan from the outset of the year, the nature of it, the spend of it? And I guess maybe just give us the background for why we had not heard about it until now. Um, it's clearly a surprise on the profitability in the first half of the year for all of us.

Yeah, sure. I mean, it's, so some of it was planned. So for example, we had always planned to bring together, um, our commercial organization for a longer period of time than we historically do with much more intensive training than we do. And that's all about the refocus and so forth. So that was planned. The part that wasn't is around commissions. So, we saw a couple factors there that were to a higher level than we had originally planned for. So, for example, I called out supply chain interruptions. That's a very, very real factor for folks in the field, right? Whether in the orthopedic side, they're counting on sets to be delivered to drive growth. And when those sets aren't complete, that really impacts their ability to go out and get new business, right? And so it's a very real impact in the field. On the sports side, we've had quite a few challenges in being able to bring, to deliver products. products needed to drive growth. The teams have done a remarkable job selling through that, but there's been tremendous component shortages in sports, and we've had to make sure that we buffer, to some extent, the organization from those challenges. So that part of the selling spend related to commissions was to a higher level than we expected. In the back half of the year, a lot of these things are coming together because we've got line of sight to what we are able to produce. So we won't need those types of investments. So to your point, some of it expected, some of it not so.

That's very clear. Thank you, guys. I'll jump back into the queue. Thanks, Veronica.

So you can go back to the room and there's a couple more questions on the phone line, I guess. Good one in the room.

Hi, David Addington, JP Morgan. Three, please. So firstly, on the supply constraints, just wondered if you were able to give some more color in terms of what they actually are. Yeah. How much of a headwind were they overall and when you expect them to resolve? Uh, second one on free cashflow, just wondering if any guidance for the full year, whether you expect to be in positive territory for the full year or not. And then finally, just in terms of, uh, on Chinese BBP for sports medicine, uh, are you expecting any destocking ahead of that? Uh, and if so, is that factored into the guidance?

Um, so do you want to take the, the, the free cashflow, um, uh,

Yes. So in terms of free cash flow and cash conversion, as we guided with the full year results, the movements will depend on the inventory. And quite clearly, as we said today here, that the drag on the cash flow has been the increase in inventory. We are looking to address that and bringing it back. to more reasonable level. So we won't be quite a historical level of free cash flow or trading cash conversion, but we'll be getting back to near or approaching those historical level as we return inventory to a more normal position until we start decreasing, particularly the DSIs.

So supply constraints, to give you a little bit of color. On supports, We rely on basically third parties that provide different components that go into the products that we make. We've had challenges as one or the other component for quite some time. Historically, it's been semiconductors that's really impacted our AET business and sports. That has improved from last year to this year, right? And residence was another area that I called out in times past. That has largely improved, not as pre-pandemic levels, but improved relative to where we were last year. What hasn't improved is one or the other component where it's not some big category, it's just an individual component related to a challenge that a particular supplier is having either around labor or their own input raw materials. There are about six or seven of those today. There was a much longer list. We've whittled it down to six or seven today. that are really impacting the pace at which we produce. So it's reflected in raw material inventory because we've got the hundred other things that we need to complete it, but for the six or seven things we're waiting on, the stuff sits in inventories and work in progress and our field doesn't get it in the way they're expected to see it. So it's those, call it six or seven things, individual components in sports against the backdrop of improving overall situation, semiconductor and resonance, which was a topic last year for that business. In orthopedics, I want to draw a distinction between supply versus product availability. The reason we call it product availability in orthopedics, by far the biggest challenge for orthopedics was us. our ability to connect operations and commercial that led to us not being able to provide bring the products where they're needed at the time that they're needed right and there the large part of the fix was things that we needed to in-house you know all of the things that i've that i've talked about today and in previous forms there i feel good about the progress that we're making but that doesn't mean there are no supply challenges in orthopedics right and there were some The one I believe I called attention to in Q1 was cross-link polymer, which goes into some of the inserts that we make. It's a key part of certain knee constructs. When you don't have it, you don't have a construct that's complete, and you're in a painful situation in the field in terms of your ability to supply customers. That was a very significant impact for us in Q1 and impacted our ability to complete implant sets. There are other components that go into instrument sets, right? And there we are more reliant on third party versus our own manufacturing. And those have been, I would say, irregular supply where we don't get what we need, the quantities that we needed when we need it. And it's not a large number of components. So it's really a small handful, but those handful can keep you from being able to complete those instrument sets and therefore all of the stuff that's in your inventory versus being deployed and being able to help you turn sets. So it's a different type of problem manifested in similar ways. But like I said, when I look out into the back half of the year, I do see some improvement in terms of what we are expecting to get. But hopefully that gives you the color around supply to answer your first question. Your third question around China VBP and around destocking. In terms of timing of when that will occur, we're obviously in close touch with the government in China around the authorities that are tasked with bringing this to life. So it's hard to tell exactly when that will occur. But suffice it to say, we've got a range of plans to deal with destocking and other behaviors that you might see when something like this goes into effect. We obviously have some experience with dealing with this with the orthopedics VBP. We'll apply the lessons that we've learned in that process to manage this as best we can. The next question before we go to someone in the room is Robert Davies from Morgan Stanley.

Yes, thank you for taking my question. My first one was just around, I guess, your EBIT bridge into the second half of the year. I also had a couple of follow-ups on that. First one was just around the second half weighting of that EBIT bridge, which is obviously higher even than the sort of pre-COVID levels. I know you sort of cited this sort of historic seasonality, but just wondered, If you could kind of touch on the second half weighting of the EBIT as a percentage of the overall group seems to be, I think, 300, 400 basis points above what the previous kind of highs have been in terms of EBIT contribution as a proportion of the full year. And then just a couple around just we had FX guidance, I think, of 120 basis points transactional. Just where that sort of fits into your guidance in your 1H, 2H margin bridge. Is that included in the underlying numbers as part of that seasonal pickup? And then two sort of follow ups. One was just on. just on the profitability, I guess, of first half margins compared to a couple of years ago, you're 240, 250 basis points below where you were. I'd just be curious in terms of from a divisional standpoint, where are you seeing kind of higher or lower margins versus 24 months ago by divisional basis? And then a final one, if I can squeeze it in, is just on your innovation pipeline. Is any of that extra innovation sort of spend and R&D push costing you on the margin side? Thank you.

Do you want to unpack that? Yes. Good morning, Robert. There was quite a few here. So in terms of the weighting of EBIT in the second half, you're right. I mean, historically, it's been 45, 47 to 53, 55 in the second half. Here, given the pattern, it's fair to say there's a higher percentage of EBIT in the second half. a lot of that driven by returning to the seasonal uplift we've seen but also the flow through of the productivity improvement and the cost savings so that's really what's um what was driving that proportion the fx um impact is throughout the um you know the various proportion it shows through mostly in cost of goods because that's a disproportion where we we have our us cost base I would say though, and that's why we should recognize that 120 basis point of margin erosion from FX, we're absorbing. So when we talk about at least 17.5%, it's after quite a headwind in FX and we should recognize that therefore the efforts to improve margins are coming through. segmental reporting, clearly there's a range and you can find the information. Of course, from an accounting perspective, it's after allocating all costs and, you know, would it be facilities and actually allocating exchange rate. We're seeing good improvement in orthopaedics and to the earlier question, you know, the improvement in the midterm margin is mostly driven by the orthopedics segment returning to be nearer to the historical profitability level we had, which is what we discussed in the full year results earlier this year. So orthopedics is on track. We've seen good improvement. Sports is improving. When you look at the, there's a slight dilution in wound because of the investment we're making behind negative pressure. So all divisions start tracking very well and showing, you know, being where we want them to be. And the final question on R&D margin, there's no further dilution of R&D. You know, we've made the step up in the R&D investment in 18 and 19. We've kept it through the COVID period. We're now at our right position, and that's not dilutive to margin. So I think I've covered all your four questions, but I cheated. I took notes, whereas Deepak tries to memorize it.

Thank you very much.

That was very helpful.

You're welcome.

I'm told there's one more on the line. Chris Gretler from Credit Suisse.

Hey, good morning, Deepak and Francoise. Thanks. I actually still have three questions left. The first is just on the dressing business in wound care. Could you discuss that? It looks like, at least from our perspective, that you're losing share there. Could you maybe discuss how happy you are with the performance there? The second question would be on ATOS on Cori. I think you mentioned that in your prepared remarks. Could you maybe specify the timing when you expect that to become available? And the third question is just on the cost inflation, given where we stand right now, how should we expect that go into 24? It's obviously kind of easing substantially now in the second half, that headwind. Maybe just give you, if you could give us an indication there at the current levels, how that would impact your business. Thank you.

Sure. Maybe I'll take the first two and you can take the third one. So in terms of Let me start with the second question, which is Corey on shoulder. When would I want it? I'd want it tomorrow if I had my brothers, but we have to sequence that in with the other Corey programs. We've made really good progress on knee. There is a couple more elements that are still coming on knee. There's a fairly robust pipeline of projects and hips that we need to prioritize. But I'm quite excited about the applicability of Cori for shoulder. The anatomy of the shoulder is such that Cori is very well positioned to play an important role in shoulder. We recognize that opportunity. We recognize that. that the form factor for a Cori is well suited for the shoulder. So it's in place in terms of a pipeline. We just need to kind of factor it in with other Cori programs we have in place. So we'll give you some visibility, a peek behind the curtain when we have the Meet the Management session in November. So stay tuned for that. The first question now, Chris, just remind me, I just drew a blank there. AWC. Yeah.

Sorry.

Thank you. I have no reason. So maybe I should take notes. So fundamentally about wound, it's about our portfolio. You're right. There is some, you know, with with with firms and dressings, there's a you can parse this all different ways. But fundamentally, what I'm actually pleased with. is how our portfolio in Moon is performing. We've got the broadest portfolio in the industry. Not only is it broad, it's actually quite rich in terms of what we have in each of our categories, right? So, you know, our biologics portfolio is performing very, very well. Our skin substitutes business continues to be above market. There's great clinical data that we've built up over a long period of time that's fueling this growth. So I feel very, very good about where we're positioned there. Negative pressure is called out as a 12-point plan, a tremendous opportunity in the back of Renesys, a refreshed portfolio there to drive really growth in that category. So when I see those growth drivers line up, I do feel good. There's also quite a robust population. particularly around foams and dressings. So I'm very excited about what the future holds there. But when you add all of these things up, the story is one of each element of the portfolio plays its role, but it's the totality, it's the breadth and the richness that I'm most excited about. It's the source of our competitive advantage within that. In terms of cash, maybe you want to take that?

So in terms of cost to finish off, I mean, clearly, as we said here today, we expect the cost pressures or the inflation to have peaked. And our mid-term guidance always assumes that moderate inflation in 24 and 25. What we'd add, though, is, of course, as you know, the cost inflation will unwind through the cost of goods line as we sell the inventory that we've built at a higher cost. So, you know, there will be a phasing of that effect as inflation comes down.

Okay, good. I'm getting a note that we need to finish here because our first meeting is, I guess, in a few minutes. So I want to take this opportunity to thank everyone for coming. Thank you for your questions and your engagement. I'm looking forward to coming back in the next quarter and continuing to show you the story of progress. So thank you very much.