Smith & Nephew plc

Good morning, and welcome to the Smith & Nephew second quarter and half-year results presentation. I'm Deepak Nath. I'm the Chief Executive Officer, and joining me is Chief Financial Officer John Rogers. I'm pleased to report a solid set of numbers that represents a good step towards our full-year guidance and further progress on our strategy to transform Smith & Nephew. On revenue, we delivered the acceleration that we expected with 5.6% growth in the quarter. The sports medicine business continued its good momentum across categories and regions. In advanced wound management, we returned to growth with a better quarter in both bioactives and in AWC. In orthopedics, all of trauma and extremities, robotics, and ex-US recon have kept performing well. and we've made good progress with addressing our performance in U.S. recon. On profitability, 140 basis points of expansion is around the upper end of the guidance range we gave back in May. Operating leverage and our productivity measures in the 12-point plan more than offset external pressures and have positioned us well to deliver a full-year target It's very encouraging to see double digit profit growth and also importantly, translating into cash with 60% trading cash conversion, which is well ahead of where we were last year. My assessment when we began this turnaround was that Smith & Nephew was a portfolio of fundamentally good businesses with excellent technology and the right to win in every part of the company. The diagnosis of why we weren't at full potential was that we had challenges around execution and culture, and we developed a 12-point plan to address those remaining issues. The progress we've made since 2022 is evidence that we had the right diagnosis, and we are now firmly on the path to the better financial outcomes that we've been aiming for. The first half of 24 shows that we're delivering good results from the large majority of the portfolio, making up about 85% of sales. That is a transformation from where we were at the outset, and particularly in orthopedics, where we've turned around the majority of the business. Trauma and OUS Recon are now consistently delivering growth well above our history, And Cori has successfully developed from being a new challenger in the market to being recognized as a leading system with strong adoption across a range of settings from ambulatory surgical care centers to academic medical centers. And it's how we've done all of this that makes me convinced that US Recon is poised to do the same. Firstly, the specific ways we've driven the rest of orthopedics are exactly what we're doing in the US. We're driving product availability, capital efficiency, and innovation delivery through the various initiatives of the 12-point plan. Secondly, we've confirmed the strength of our technology by delivering outperformance with the same products in other markets. And thirdly, I can see the discipline and focus that has come from the 12-point plan and our shift to a verticalized, more accountable set of business units. And those benefits apply equally to every part of our portfolio. I'll return to some of these themes later, and John will talk more about cash returns and accountability in his presentation. For now, I'll take you through the detail of the quarter. Revenue in the quarter was $1.4 billion with 5.6% underlying growth and 4.6% reported with 100 basis points headwind from foreign exchange. Growth also included a tailwind from one more trading day than in the prior year. All three business units accelerated sequentially and I'll come to the detail in a moment. Geographically, the U.S. grew at 3.6%, and other established markets grew 6.9%. Emerging markets grew at 9.5%, with strong double-digit growth across the Middle East, India, and Latin America. For the business unit performance, I'll start with orthopedics, which grew at 5.8% underlying growth. Global knees and hips grew by 2.1% and 4.4% respectively. The geographic trends of recent quarters continued with higher growth in the OUS segment, particularly in Europe. Almost half of our recon business is in those international markets where we're demonstrating what our portfolio can deliver with good execution. And even as we, of course, lap stronger comps. U.S. Recon was still behind for the quarter as a whole, but there were encouraging signs of progress. Our operational improvements under the 12-point plan are now at goal, with both implant supply and now set availability at target levels. And that's for both hips and knees as well. We're also seeing indicators of commercial effectiveness moving favorably, particularly around staff retention. Other recon grew 17.8% and reflects another good quarter of robotics placements, particularly in the U.S. We've also continued to develop our offering with the launch in June of the Coriograph preoperative planning and modeling. The launch makes Cori the only robotics system to offer a choice of image-free and image-based planning and is another element of in our approach of supporting a range of surgeon preferences on a single platform. Trauma and extremities grew 11.8%, providing half of the overall orthopedics growth. The EVOS plating system continues to be a key driver within core trauma, and the growth contribution of ATOS shoulder is steadily increasing as we deploy more capital and convert new surgeons. Sports medicine and ENT grew 7.6 in the quarter. Within that, joint repair growth was 6%, including the expected headwind from volume-based procurement in China. While the implementation began only in May, we saw ordering patterns affected for the whole of the second quarter. Excluding China, joint repair growth would have been 11.8%, with a very strong quarter across our other major markets or other markets. By product, the Neap repair portfolio and Regeniton were again key contributors and were well advanced with the post-acquisition integration of CardiHeal Agility. That's one of our next generation growth drivers. Early cohorts of sales reps have completed the training and we're starting to build out patient and surgeon access. Orthoscopic enabling technologies grew by 8.7%. Higher growth in the quarter came from the expected recovery in video capital sales and continued good performance from our radio frequency platform, both from core ablation and from wearable fast seal. E&T revenue growth of 11.6% was driven by our core tonsil and adenoid business. While underlying demand continues to grow well, I'd remind you that the next quarter will have a very strong prior year comparator with the effect that the ENT growth in Q3 is likely to be around flat. Looking now at advanced wound management with return to growth at plus 3.3% with recovery, as I said earlier, with both AWC and in bioactives. In AWC, 3% growth reflected continued strong performance in foams and anti-infectives and improvement in films. In bioactives, growth came from a strong sequential recovery in Santal, along with a more normalized prior year comparator. As we've previously indicated, the recent quarter-to-quarter growth volatility or variability is quite normal for Santal, and we expect further improvement from the rest of the year. Offsetting Santal was a slower second quarter for our lead skin substitute product, Graphix, ahead of the launch of a new version called Graphix Plus. Finally, advanced wound devices revenue grew by 8%, led by our single-use negative pressure platform, Pico. Renesas Edge is also an important part of our growth plans and received CE mark in the quarter. We plan to launch in Europe in the second half of the year, adding to the U.S. rollout that's currently underway. And with that, I'll hand it over to John.

Thank you, Deepak. It's a pleasure to be presenting to you all in person this morning. Today's announcement actually marks four months into my time as CFO. And as you'd expect, I've spent a lot of my time digging into the detail of the company, the 12-point plan, and the financials. That's very much an ongoing exercise, but it has already identified opportunities to go further with some of the initiatives. So as I take you through the first half financials, I'd like to share some of my thinking on our opportunities and financial priorities in the coming years. I'll start with the P&L. Revenue for the half was $2.8 billion, up 4.3% on an underlying basis compared to half on 2023. Reported revenue was up 3.4%, including a foreign exchange headwind of 90 basis points. As you can see, growth was higher in our surgical businesses, with AWM growth reflecting the slow first quarter. Looking at the trading peer now, gross profit was 1.98 billion, with a gross margin of 70.1%, which is 30 basis points of expansion over prior year. We also delivered positive leverage across our operating expenses with good control of our cost base. That resulted in 140 basis points of trading margin expansion to 16.7% around the upper end of our guidance range and trading profit growth of 12.8% to 471 million. Slide 12 shows a more detailed trading margin bridge. Going through the moving parts, we absorbed headwinds of 120 basis points from input cost inflation and merit increases, and 50 basis points from transactional effects, but more than offset them with 120 basis points of revenue leverage from price and volume, and 190 basis points from productivity improvements, mainly from manufacturing, but also across all other areas of operating expenses. If I look back at the same bridge from last year, the overall profile of puts and takes is much more favourable today. Inflation pressure was less than half of what it was in 2023, and we were able to fully offset with revenue leverage. That means that much of what we gained through efficiency savings is now dropping straight through to trading profit. I'll talk later about where there are further savings opportunities beyond what we initially planned for. Looking further down the P&L, adjusted earnings per share grew by 8% to 37.6 cents. That's slightly less than trading profit due to the higher tax and interest expense that we pointed to in our technical guidance at the start of the year. The interim dividend of 14.4 cents per share is unchanged. Trading cash flow in the period was 284 million. with trading cash conversion of 60%, well ahead of the 26% in 2023. The improvement came from lower working capital outflows, particularly from inventory and payables. And as you know, inventory has been a focus of the 12-point plan, so it's an encouraging step for inventory days to have broadly leveled off after many years of increases. For the full year, we're targeting trading cash conversion around 85%, which is a return to our historical levels and includes the usually higher conversion in the second half of the year. Free cash flow was positive at 39 million, with improved trading cash conversion partially offset by restructuring costs related to the 12-point plan. We should see our free cash flow improve as profit steps up and planned restructuring charges are lower in the second half of the year. More broadly, we are past the peak of restructuring and we expect it to improve further in 2025. I'd like to go into a little bit more detail on inventory. Slide 15 shows the trajectory of DSI, both for the group and the business units, with 553 overall days broadly flat compared to the end of half one 2023. In fact, we had some initial buildup of inventory early in the year to support product launches, including ATOS and Renaissance Edge, and then started to see days reduce again as we exited the first half. Behind the overall number is also some encouraging progress on mix. One of the drivers of our long-term growth in inventory was past overproduction of slow-turning SKUs, and that has now reversed. Just in half one, we reduced inventory volume at the slowest turning units by 9%. Given that the offsetting increases are in new growth products, that amounts to a significant improvement in our inventory health. Our goal remains to reduce both DSIs and the absolute dollar value of imagery. We expect improvement across all business units in the second half of 2024 as the new product launches progress and as we continue to deploy instrument sets. Longer-term improvement will mainly be down to systematically better alignment of our production plans with commercial needs, down to the SKU level. That's enabled by our improved SIOP process that we established under the 12-point plan and have now fully embedded. To conclude on the first half financials, net debt ended the half year at 3.1 billion. This is an increase of 310 million from the start of the year, including 202 million from paying the final dividend for 2023 and 186 from M&A, which is principally the acquisition of Carter Hill. The leverage ratio finished the half at 2.2 times adjusted EBITDA, with the increase in the start of the year reflecting our usually seasonality from timing of cash generation and dividend payments. We expect to end the year with a leverage ratio of around two times. As we continue to improve our cash generation, capital allocation will become more of a focus, and I'll come to our thinking around that in a moment. Next, I'll cover our outlook. After a strong second quarter, we're confident in our four-year revenue guidance of 5% to 6% underlying growth. That implies higher growth in the second half than the first, so I'll set out where that will come from. Within orthopaedics, you should expect a stronger half to overall, consisting of continued good growth in trauma and extremities, OUS knees and hips, and other recon, together with improvement in US recon as we build on our progress during the second quarter. We also expect improved advanced wound management with further growth recovery, particularly in bioactives. In sports medicine, growth will continue to be tempered by VBP, which will be a headwind for the whole of the second half. In ENT, you should also note a more challenging comparator as we lap a period of backorder clearance that helped growth in the third quarter of 2023. And finally, second half growth will benefit from two additional trading days versus 2023 compared to unchanged trading days in the first half. As we've previously commented, that benefit should mainly be seen in our surgical businesses. For phasing within the half, the benefit of the trading days will come in the fourth quarter, although given where those trading days fall, we do not expect a fully proportional step-up. Our trading margin guidance is also unchanged, at least 18%, while the margin headwind from VBP will step up in the second half. We expect to see our usual season at higher profitability. Slide 18 shows the bridge to the second half margin of 19.3% that's implied by our four-year target. And starting from 19.6% from the prior year, you'll see that the drivers are mostly very similar to what we saw in the first half. We expect headwinds of around 130 basis points from input cost inflation and merit increase, 50 basis points from transactional FX, and tailwinds of around 120 basis points from revenue leverage and 150 basis points from efficiency savings. The additional factor will be around 130 basis points of headwind from China VBP pricing, with that lower joint repair pricing in place for the whole of the second half. That's a gross number representing the pure price impact before any volume or cost mitigation, and it's consistent with our previous indication of 70 basis points for the full year. Our progress in half one also keeps us on track for our 2025 margin target of at least 20%. As in the first half of 2024, leverage from revenue growth should broadly offset the effects of input cost inflation and merit increases, with a significant step up in the pace of cost savings to drive the overall margin expansion. About two-thirds of this will be in manufacturing and distribution, including the benefits of our manufacturing footprint optimisation coming through as we move through the more advanced stages of our restructuring plans, but with continued productivity improvements also continuing in our operating expenses. We still have to fully annualize China VBP in the first half, but when considered net of mitigation and other offsets, we do not expect a meaningful incremental effect on the 2025 trading margin. However, there is still an initial 2024 headwind, and as you're aware, it was not known at the time we set our margin target. We continue to seek opportunities, therefore, to make our business more efficient and offset such headwinds. Building on the existing work of the 12-point plan, we have identified further saving opportunities by applying a zero-based budgeting approach. This means that we can drive the cost savings higher than we initially planned for and also for longer. We now see total gross savings at 325 to 375 million, which, to be clear, includes both the 200 million we already announced in 2023 and also further savings newly identified in this additional review. This will help us get to the 2025 margin target and continues to accumulate through 2027 with indicative phasing shown here in the chart. I want to emphasize two things about this work. First, you can see on the right that there are comprehensive and detailed plans behind this. Over 40 initiatives across seven work streams with specific target savings and timings for each initiative The largest part will be from manufacturing and procurement, but there are savings across all parts of our business. Second, this is not a new restructuring plan. It's an extension of what we can deliver from the 12-point plan. And as such, you should expect that there will not be significant additional restructuring charges beyond what we previously guided. We're also planning a change in our segmental reporting. After the move to the business unit model, this is the next step we envisage to help embed greater focus and accountability on costs as a normal way of operating. Under our current reporting, we have $211 million of corporate costs in the first half, which is around 9% of the total Smith & Nephew cost base. There are a lot of different things included in the number, such as G&A costs from HR, finance, legal and GBS, IT costs, shared sales support functions, and some shared R&D costs. In reality, the majority aren't pure central costs, but are services to the business units. We started the process of adopting a full allocation of those attributable costs to the business units. And from the full year 2024, reporting onwards, only costs that are specifically supporting the PLC will remain as corporate. As a result, corporate costs will be around 10% to 15% of what you can see today. By making this change, both the business units and the corporate center will have greater accountability for all of their costs and better visibility on the really fully allocated underlying returns. Coming now to those returns, Little Nephew has talked less about return on invested capital in the past. but we're making it more of a priority at both the group and the business unit level. There's good opportunity to drive returns higher through both profitability and asset utilization. We've given our target for margin expansion from both operating leverage and cost savings under the 12-point plan, and the drag from restructuring and the EU MDR project should reduce over time. I've already touched on how we're working to reduce inventory, and both the manufacturing network optimization and instrument set utilization initiatives should help drive fixed asset terms. Given our progress already, we expect that the group ROIC will start to rise again in 2024. By division, that will come from orthopedics and advanced wound management, while sports medicine absorbs Carter Hill and VBP. As I mentioned earlier, capital allocation will become a more active consideration as our profitability and cash flow improves. So I've taken the opportunity to refresh our policy, which is shown on slide 23. The first priority remains investing in the business to drive organic growth and to meet our sustainability targets. The focus on ROIC at business unit level and the greater allocation of central costs will give us the visibility to target our investment more effectively and will prioritize investment in the areas where we can expect to see the highest incremental returns on capital. The second priority is to invest in acquisitions. In line with our current approach, we'll target new technologies and high-growth segments where there is a strong strategic fit and with transactions that meet our financial criteria. The third priority is to maintain an optimal balance sheet and an appropriate dividend. On leverage, we'll continue to target investment grade credit ratings and we're updating our target leverage ratio to around two times net debt to adjusted EBITDA. We have a progressive dividend policy and from 2025 onwards, we expect a payout ratio of around 35 to 40% of EPSA. For 2024, we expect the total dividend to be flat year on year. And finally, we'll return surplus capital to shareholders via share buybacks subject to these target balance sheet metrics. I'd like to finish by summarizing my key areas of focus for the finance team shown on the slide. First, there's efficiency in driving cost savings to support margin expansion and reinvestment for growth. The expansion of our 12-point plan productivity targets is an early example of that. Second, we'll also drive greater visibility and accountability through how we report both internally and externally, as with the move to full absorption of attributable central costs. A third focus is cash conversion, and that's both on trading cash conversion, including reducing working capital, and also free cash flow by reducing restructuring charges. And finally, we have a renewed focus on improving return on invested capital. We're establishing greater visibility of capital returns at the business unit level, and we'll make use of that to drive improvement for both the group and the individual business units. And part of that is to have a disciplined approach to capital allocation in line with our updated framework. Taken together, this is a wide-ranging commitment to drive improved financial performance and create shareholder value. And with that, I'll hand back to Deepak.

Thank you, John. So as I said in my introduction, we recognize at the start of this turnaround that while Smith & Nephew is a portfolio of fundamentally good businesses, we had a series of challenges around execution and culture that were holding us back. We set about addressing those challenges with a comprehensive 12-point plan, which is summarized on this slide. It should be familiar to you. It's nearly two years now since we first announced the program, so I'd like to take a moment to reflect on how far we've come. Slide 27 has some of our achievements. There's a lot on here, and that reflects the scale of the transformation that we've delivered, both by activity and also, importantly, culture. There are three key things I'd like to particularly call out. First is the successful rewiring of orthopedics, where we've addressed the longstanding challenges around getting products to customers. At the start of the plan, we had both implant shortages and rising inventory. And on the capital side, both instruments shortages and poor utilization. We've now turned all of that around. Implant availability has risen to our target levels across the key brands, and we've stopped the rise in inventory days at the same time. There's a similar picture with capital where set availability is now at goal, and set turns have risen 25% since the start of 2022. For the majority of orthopedics, this operational improvement has already produced better sales growth. The second point to highlight is the breadth of our productivity improvements. We've worked out all levers at the same time, including product pricing, procurement, and manufacturing. Clearly, the full benefit isn't yet in our recorded margins, but you should see it more clearly as we move through 24 and into 25, and particularly as we optimize our manufacturing footprint with four facility closures that we've now announced. And third, we've continued to drive the businesses that were already performing well. The verticalized business unit structure means that sports and moon have stayed focused through the changes that were happening elsewhere and have delivered on their own set of key initiatives. In sports, we've trebled the pace of cross-division deals to the point where 10% of U.S. capital sales are with cross-division support. In wound, we've brought a new growth platform to our major markets with Renesas Edge. We do understand there's a lot of interest and where we still have more to do. And I'll spend a bit more time on our progress in orthopedics. Importantly, we've already seen clear examples of operational improvements turning into revenue growth inflections. That's in trauma and extremities and in OUS recon. These are both high-performing segments now, and when we started the 12-point plan, they were in a very different place. And trauma had been a drag on overall group growth for many years. The elements of how we've turned trauma into an important growth driver map very closely to the plan initiatives. We delivered key innovation with the U.S. launch of EVOS Large in the third quarter of 2022, and that completed our plates and screws offering. Next, our implant availability stepped up with EVOS Small first hitting its Lifer target in 2022, third quarter of 2022, and then staying consistently at goal in subsequent quarters. The final piece was capital availability. when set deployments started to inflect upwards in the first quarter of 2023. With these things in place, along with good commercial execution, implant sales accelerated in the quarters that followed, getting to growth above our history, and in fact, above the market. The growth outlook has been further supplemented by our entry into extremities, particularly with the recent launch of the ATO shoulder. US Recon is not as far along in this path, but you can see that the same key elements are in there as well. On implant supply, key product Lifer reached its target in the fourth quarter of 2023, and capital availability followed soon after, with hip set shipment also at goal in Q4, and knee sets reaching their goal in the second quarter of 2024. This is also being supported by a steady stream of product launches over time, such as the newly launched short-stem HIP. So we're also making progress on improving recon across commercial execution. You'll remember this slide from the last quarter. We had already done a lot, including establishing new business unit leadership with Craig Gaffin, who had previously led our trauma and extremities turnaround. And the team has made good progress on the remaining issues in the second quarter, with those items in orange on the slide. I just highlighted better capital availability, and we now have a more settled commercial team. Key leadership roles are filled, staff turnover is back to a low level, and the new growth-oriented compensation plan is now fully in place. Between OUS Recon, Trauma and Extremities, and other Recon, 60% of orthopedics is already growing well. We know that US Recon is taking longer to turn, but we also know that what we're doing works. The US is selling the same product portfolio that's performing well in Europe. Even with some different market dynamics, It's following the same playbook that has already succeeded in U.S. trauma, and it's being driven by the same leaders. Supporting that, we've continued the high cadence of innovation, which is central to our strategy. we've announced the 510K clearance of Catalyst STEM. This is a new, shorter hip STEM suited to the direct anterior approach, which represents about half of the U.S. market and is growing at double digits. Catalyst STEM is designed to be easier to prepare and insert, including simpler instrumentation in just one tray, so it will make us more competitive and differentiated in this fastest-growing segment of hips. In robotics, we've continued to develop Cori with the addition of preoperative planning. We have a uniquely flexible platform with Cori, supporting both burr and saw-based resection, and now also image-free and image-based planning for knee surgery. And hip will soon follow. This takes us to 10 new features on Cori since 2022. And that has resulted in higher adoption with an installed base that's 70% larger than it was at the start of 2022. And importantly, utilization is also increasing. The innovation delivery has continued across the portfolio as well. The full commercial launch of ATO Shoulder was in Q2. after the initial steps were made last year in 2023. We're also commercializing Graphics+, which is a new version in the graphics skin substitute range that is easier to handle and targets the growing post-acute market. Finally, I'd like to connect all of this to what we said we would do at last year's Meet the Management event. On growth, our aim is to be consistently a higher growth company than in the past, with annual revenue growth of at least 5%. After a good Q2, we're on track for a third consecutive year of delivery against that, based on the three components of higher growth we identified at that time. The first was fixing the foundations of orthopedics, as I've just set out. Most of the business unit is now growing strongly, and the team and the necessary operational fixes are in place for the rest. The second was to continue the strength of sports medicine and advanced wound management. We're delivering that as well. Sports medicine maintained its long-term market-up performance in 2023, and although AWM has quarter-to-quarter volatility, it also had its third consecutive year of better growth at 6.4% versus 5% for the market, and is set to accelerate in the second half. And we're very proud of the innovation we've delivered across our portfolio. We've launched more than 70 new products in the last five years, and the three key launches we define as the next wave of innovation are now starting to ramp up. Atos, Renesas Edge, and Jilisi. John has set out our progress on profitability and returns. Again, the trajectory is improving. The trading margin expansion in the first half puts us on track for this year's target, and we have further margin drivers in the pipe for 2025 and beyond. Cash flow is improving, working capital costs are falling, and restructuring costs are set to also improve. The 12-point plan is increasingly delivering the outcomes that we designed it for. We identified the necessary actions for each priority, and they translated first into improving KPIs, then into better revenue growth. With these results, you can see that better profitability and cash flow is starting to come through as well. There is still work to do. and the financial benefits will continue to accumulate, supported by a new embedded culture of focus and accountability. And I'm confident that shareholder value will follow. So with that, John and I will be happy to take your questions. Philip, you want to moderate?