Smith & Nephew PLC
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Price: 986.8 GBX 1.11% Market Closed
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Earnings Call Transcript

Earnings Call Transcript
2018-Q2

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Namal Nawana
CEO

Okay. Well, good morning, everyone. It’s great to be here and finally meet everyone as well, and welcome to our second quarter and half year results. I am excited to be here, as I’m excited to be at Smith & Nephew.

With me today, I have Ian Melling, who is our SVP of Group Finance; and next to him is Phil Cowdy, Head of Business Development and Corporate Affairs. And I know you’re all familiar with Graham. Unfortunately, Graham can’t be with us today. He has an urgent family matter. But I’m grateful that Ian could step in at very short notice, so thanks, Ian. As you already know, our Q2 sales grew 4% reported and 2% underlying. Our full year guidance is unchanged. Before I give you the detail of the numbers, I know you’re excited about those, I thought I’d just share my initial thoughts about Smith & Nephew.

As you can probably imagine, it’s been a busy couple of months. I visited all of our principal sites around the world. I’ve reviewed our businesses with our leadership teams. I spent time with the operations. And I’ve assessed our R&D pipelines, again, with each of our businesses. I’ve had the opportunity to speak with employees at all levels, again, all around the world and met many of our customers from various regions of the world. And as I said, it’s been a fun and fabulous few weeks. And most importantly, from the Smith & Nephew level, it’s been a very warm welcome to the company. It has been fun just to get back into medical devices.

So today, I want to share my initial thoughts in three areas as a result. So first, on our position as a portfolio medical device company; second, why our technology is far better than our market share might suggest; and finally, how we’ve already started to improve how we do business and what we’ll do going forward. So let me start with Smith & Nephew as a portfolio medical device company, which I think is sometimes just misunderstood or overlooked. The company started in 1856 as a small pharmacy. And we moved into wound care over 100 years ago. And now we’ve began, and with that process, we began to lead what is the Advanced Wound Care industry that we see today. We expanded into orthopedics and Sports Medicine and have been at the forefront of delivering leading technologies that have improved clinical practice as well as patient outcomes. We’ve also come out of some businesses. And today, we’re at the vanguard of robotics.

Our history and profile is not unlike many of the most successful companies in the med tech world where a portfolio has proven to be a very positive model. It’s fair to say that in recent times, Smith & Nephew’s growth has been below its markets. And on aggregate, our markets are growing roughly 4%. The best-performing portfolio companies grow faster than Smith & Nephew and faster than their markets. These companies don’t operate in fundamentally different market segments from us, so why is their performance better? They focus on the highest growth opportunities in their portfolios. They run their commercial teams with absolute focus. And they have invested in additional growth, both through R&D as well as M&A.

I can tell you all that we aspire to be amongst the best. Our job, my job is to unlock the growth potential of Smith & Nephew, and that comes by examining each of the categories that we play and lifting our growth.

So thinking about our product portfolio. My first couple of months have really just validated what I saw from the outside-in before joining the company. Specifically, that the medical technologies within the company are better than their market shares indicate. After I joined, I initiated a ground-up review of each category and subsegment. And what that made clear is that less than half of Smith & Nephew’s categories or product groups are growing at/or above market. Whereas in top-performing med tech companies, that’s more like two third of their portfolio. And this, despite in many cases, having the class-leading technology for the category.

So if I can give you a couple of examples. When I was looking at Smith & Nephew, again, from the outside-in, I looked at hips as an area of underperformance. Smith & Nephew has got great products. The POLARSTEM, coupled with our VERILAST bearing technology and the R3 cup, has really got class-leading results. Right here in the UK, British Joint Registry, it’s the number one product. It should be the number one market share owner in hips. You’ve all heard about our JOURNEY II Knee, but you probably have heard less about our ANTHEM Knee, and ANTHEM was designed specifically for emerging markets. It provides for those ethnic differences in knee shapes, but importantly, it also comes with streamlined instruments making access and affordability a reality. So we’ve made a great start with ANTHEM, but it should be in even more markets, and we see further growth going forward.

Also, PICO, that is a truly disruptive product. It recently became the first negative pressure wound therapy device to achieve a nice med tech innovation briefing. And that’s for the prevention of surgical site complications. I think it’s a great example of the quality of our clinical and economic evidence, which supports that product. PICO really should be the standard of care for all surgical patients with at risk of any complications.

Then there’s NAVIO, which is our surgical robotics system. Importantly, we’re the only CT-free robotics system available. And we think that’s a critical advantage in that marketplace, particularly as we see a shift to new care settings. We’re in the process not only of reaching commercial success with NAVIO, but also looking at the multigenerational innovation pipeline for that system. Look, I found examples like this in just about every part of the business I’ve looked at, and these technologies are great, but the market shares simply aren’t.

So the fundamental question therefore is, how do we improve the way we do business to drive growth? So let me start with the commercial model. We need to focus more on our lead products, the ones that are truly differentiated and pull through the rest of the portfolio. The JOURNEY II family, NAVIO robotics, which I just mentioned, the Polar 3 hip construct, the REDAPT revision hip system, REGENETEN, which is our new acquisition in the shoulder, and PICO, which I’ve also mentioned.

We may not always be the market share leader, but where we have that technology, we can always provide leadership, and that’s our focus. And key to that focus is having a sales force that’s equipped to succeed in every way and having the most customer centric approach, anticipating customer needs, supporting them with service, evidence, innovation and professional education. So leadership really is a mindset, and I believe that’s something that we can certainly deliver on over time.

Second, we need to have a faster, more streamlined way of running the company. We have to get better at getting things done. And we believe a flatter organizational structure will help us get that done. I’ve actually already taken the first steps, initiating a new leadership structure and two new appointments already to my executive team. Also, I’ve reviewed the business and the program around APEX with Graham and taking some of the costs out of our business that don’t support our growth going forward. And I think, as you saw in the Q2 results, APEX is on track and it will help us streamline ourselves going forward.

Third, I believe that a successful business needs to have a purpose-driven culture. So the commercial and operating models are very, very important, but you need to have a culture and a team that wants to execute on those plans. And so one of the things we’ve also initiated is really asking our organization about our culture. And so far, we’ve had over 6,000 responses to our culture survey inside the organization, and that really demonstrates the strong appetite and enthusiasm for change.

Now moving to have more detailed workshops and dialogue with the team to say, what do we love about our company, what do we want to improve about our company. So look, always excited to share my initial thoughts. It’s been a great couple of months. We’re a portfolio medical device company. We have real opportunities on our commercial and operating models. And over the course of the next few months, our team is really going to apply great energy towards refining our strategic framework and bringing about the change that we know can unlock the growth of the company. So I’m sure that we’ll have many more opportunities going forward for me to update you on our progress, but let me move to our financial results.

I’m going to focus on our second quarter, and I’m going to let Ian talk you through our first half financials. The Established Markets grew 1% in the quarter, which represents an improvement over the first quarter which had minus 2% growth. Contributing to this, Japan had an outstanding quarter and the U.S. delivered a sequential improvement. Europe as a whole remained a challenging environment. Emerging markets growth was 6%. Most markets were strong, with mid-teens growth in China, with a headwind of a significant Middle East tender order in the prior year as a comparable. And without that, overall Emerging Markets growth would have been around three percentage points higher.

Turning to the individual franchises, and the fire engine. Sports Medicine and joint repair had a solid quarter with 8% growth. Strong growth in the shoulder was helped by the REGENETEN bio-inductive implant that we acquired with Rotation Medical. Enabling technologies declined by 1%, but this represented a sequential improvement from minus 5% in Q1. Recent launches, like WEREWOLF COBLATION, haven’t met our expectations, and we’re focusing on improving that performance going forward. And more broadly, I’ll just say that product launch excellence is something of an opportunity again at Smith & Nephew. Our Trauma & Extremities business declined by 5%. We talked about this as a Trauma & Extremities business, but really it is a Trauma business. Again, if we neutralize the effect of a large Middle East tender in Q2 of 2017, that really would have been flat growth for the quarter. Conversely, plates and screws inside of that number did have a good quarter, and that’s supported by the EVOS SMALL plating system and its launch. In other surgical businesses, we grew 8%, with a strong quarter for NAVIO, our robotics system in the U.S. And there, we also launched a new knee application in the quarter, which is a good system upgrade for us.

So turning to reconstruction. Let me start with our knee business. Knees grew at 3% globally, and that’s driven by JOURNEY II, our LEGION revision portfolio, and also ANTHEM. You may have seen yesterday that we announced new evidence for JOURNEY II, demonstrating improved outcomes and lower health care costs. I mentioned the ANTHEM before. ANTHEM builds on the legacy of clinical performance from of our LEGION and GENESIS II systems and has had a fabulous response. These need to get to more markets. Global hips grew 1% with 4% growth in the U.S. I talked to you earlier about having leading products in most of our franchises. And I think that -- we’ve got some fantastic products in our hip portfolio, heritage brands like SYNERGY and ANTHOLOGY, and then I’ve talked about POLARSTEM and the R3 cup.

Finally, we can turn to advanced wound management. I’m pleased to see that Advanced Wound Care returned to overall growth, up 2% in the quarter. The European business continues to be soft, and we’re continuing to refine our approach to those markets. Advanced Wound Bioactives revenues declined by 6%, which is an improvement over the minus 12% in Q1, but obviously remains a drag on our business. Advanced Wound Devices, on the other hand, grew 9% in the quarter, and that’s a very significant acceleration over Q1. And we expect growth to improve further in the second half of the year. There, I mentioned PICO, and I’m really very excited about this particular product. And not only the product itself, but the pipeline we have in that range going forward. I can see it really being used in many more applications. And as I mentioned, the nice study, I think that gives you a good indication of the level of opportunity we have there.

So with that, let me hand over to Ian to take you through the first half financials.

I
Ian Melling
SVP, Group Finance

Thank you, Namal, and good morning, everyone. Half year revenue grew 4% on a reported basis and 1% on an underlying basis, excluding the impact of foreign exchange and acquisitions. The gross margin of 73.3% was down from the prior year, principally reflecting higher inventory excess and obsolescence charges during the first half. The SG&A ratio improved by 60 basis points, benefiting from savings realized under the APEX program. Our R&D ratio remained broadly stable, as expected. Therefore, trading profit grew by 3% to $507 million and the trading profit margin in H1 was 20.8%, a reduction of 30 basis points. Moving further down the P&L. EPSA growth at 2% in the first half was in line with growth in trading profit and adjusted profit before tax. Basic EPS declined by 15% in the first half, primarily due to the restructuring charges related to the APEX program. The interim dividend is set by formula and is 40% of the 2017 total dividend. As a result, the interim dividend is $0.14.

Now turning to cash. Trading cash flow of $387 million was generated in the first half, an increase of 18% on the same period in 2017. Put another way, our cash conversion ratio improved to 76%, well above the 66% realized in the first half of 2017, reflecting lower working capital outflows of $131 million, principally from improved collection of receivables. As usual, we expect a higher cash conversion in the second half than the first half, following the normal annual cycle of our business.

Overall free cash flow in H1 was $54 million lower than the prior year at $119 million. This principally reflects higher restructuring, legal, acquisition and other costs of $147 million, which include $46 million of cash outflows related to restructuring under the APEX program, with the rest relating to legal and other costs, including metal-on-metal hip claims and EU MDR products reregistration costs.

Now let me finish with the guidance. As Namal highlighted, we have reconfirmed our 2018 guidance. I’m sure as you go around results presentations at the moment, you hear a lot about Brexit and global trade. So before you ask the question, I’ll add that with recent political developments, there is inevitably some uncertainty around how both of those issues will play out. To be clear, our guidance assumes that there is no material impact on Smith & Nephew from either. At this stage, we’re comfortable with that assumption, but like everyone else, we have to monitor developments closely as they progress.

To reiterate then. We continue to expect underlying sales growth in the 2% to 3% range for the full year. With the dollar strengthening, based on the exchange rates prevailing on the 20th of July, foreign exchange, together with the acquisition of rotation medical, will now add just over 1 points to growth, so we expect reported revenue growth of around 3% to 4%. We expect underlying sales growth to be stronger in the second half than the first half of the year, and the full year trading profit margin to be at/or above 2017 levels. As usual, our technical guidance slide in the appendix has further detail about restructuring charges, amortization and net financials. To recap then, we’re pleased to have reported improved underlying revenue growth in Q2, progress of the APEX program and improved trading cash conversion in H1, all of which were in line with our expectations and keep us on track to deliver our commitments for the full year.

And with that, I’ll hand back to Namal.

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Namal Nawana
CEO

Thank you, Ian. To summarize. I’m obviously excited to be here and to be leading Smith & Nephew. My first couple of months have reinforced to me its great potential. We operate in some great markets with some world-class medical technology. And our employees are showing me their appetite for change and improvement. Of course, there are challenges, but these are really opportunities. We’ve started to address the ones right in front of us, running the business better. We’re working to create the right strategy and make the right detailed plans to transform the business over time.

And with that, let me take some of your questions.

L
Lisa Clive
Sanford Bernstein

Lisa Clive from Sanford Bernstein. Welcome, we’re all delighted to meet you in person finally. I have three questions. First, you mentioned you are implementing some new leadership positions. There was a lot of restructuring that happened under the previous CEO, and obviously, that caused a lot of disruption. Do you think there is a need for a lot more reorganizational change? And if so, how do you manage that without too much disruption to the business? Second question, specifically focused on the sales force. It seems that there has been a lot of change in terms of how the sales force operates, particularly around cross-selling. Sometimes, there’s been a separate Trauma division. Sometimes, it’s been the Hip and Knee rep selling Trauma products. Do you think the current setup of the sales force is adequate, or do you need to make more changes there? And then lastly, there’s been a lot of promise of acceleration in growth, and clearly, you have the quality of product to do so. But do you need to do a lot of reinvestment to get there? And so therefore, can we see an acceleration in growth and also possibly margin expansion? Or are the two mutually exclusive over the next few years?

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Namal Nawana
CEO

Well, thank you, Lisa. I’m going to do my best to remember your third question by the time I’ve answered the first two. But for the first question, in terms of the organizational structure and leadership. Look, I really think it’s very, very important to start by, how do you organize yourself for growth. And to me, having a customer-centric organization means that you’re a flat organization. So I’ve already taken the first step, which is to flatten my leadership structure, and we’ve announced that to our organization. I’ve brought on two new leaders from the outside, one heading up our global operations and a new leader also leading QA and RA. And RA, for example, is a key to making sure that you’re unlocking growth because that’s part of getting new products to market. So I think that’s very important.

And we can look at the past. That’s obviously important, but I’m really looking about going forward. So if we need to make changes going forward, we’ll do that with great purpose and confidence in order to deliver growth. So I’m very pleased with the initial changes. We anticipate further realignments to ensure that our businesses have the opportunity to grow faster. And I think they’re all positive things.

With respect to the sales force, I’m really glad you asked that question, because I think that’s the heart and soul of our brand. It’s how we interact with our customers. And having the right organization and a sales force that’s equipped to succeed can, in its own right, be a very simple way of accelerating growth. So the most important thing I’d say to you is that we’ve got lots of opportunity to improve. Now on average, our markets are growing 4%, and we’re clearly not growing 4% on an underlying basis. Less than half of our product groups are growing at market. So our sales force being positioned, equipped with the right portfolio as well as all the tools they need, and supporting our customers with the right professional education, there’s lots of things that we can do there.

That being said, they’re actually reasonably focused in their own areas. I don’t anticipate there needs to be a lot of change in order to have them calling on the right customers and with the portfolios we currently have. And then as we think about the right portfolio and does it require more investment, my outside-in view is really clear. It was that this was a good portfolio. I just couldn’t understand why it wasn’t getting the results that it should get. And I would just say that I highlighted a few of the products. I’ve now had the opportunity which I didn’t have looking from the outside, which is to look at the pipeline. And I think we’ve got a really solid pipeline for the platform products that we have. Do we need to, kind of, reconfigure some of the things that we focus on? Sure. I think there’s a good opportunity for us to think about how we move the buckets around a little bit. And how we make investments from the outside also, there’s some great technologies that could bolt on to what we have. So we’ll look at all of those things to accelerate our business going forward.

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Lisa Clive
Sanford Bernstein

Follow-up. Sorry one follow-up on that last question around potential for reinvestment. Would you be comfortable, at some point, giving us midterm guidance so we can think about what the top line looks like, what the margins may look like, and when do you think you’d be comfortable enough to do so?

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Namal Nawana
CEO

I think you have our guidance for this year. I’m going to take the remainder of the year with my team to really refine our strategic framework, refine our plans and also meet our plans for the remainder of the year. So I think they’re the most important things. In terms of how we guide, I think that the traditional way that we’ve been guiding is adequate, and I think I’ve given you a sense of what we should be doing, which is really, first job, get to the market growth rates. Michael?

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Michael Jungling
Morgan Stanley

And all three questions after you. And the first question is, can you give us an indication what’s scope the board has given you to make material changes to Smith & Nephew? And would that include making some major adjustments to your portfolio? Question number two is a better feel for your strategy going forward. Is this going to be more in line with previous CEOs with some adjustments? Or are you willing to take some more courageous steps for Smith & Nephew? And question number three is, if I look at the organic growth profile of Smith & Nephew, it’s been rather disappointing or pedestrian. What do you think the three major reasons are why Smith & Nephew has done reasonably poorly in growing organically? So the three major reasons for that.

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Namal Nawana
CEO

Okay, thank you. So first of all, I’ve had very good interactions with Roberto Quarta, our Chairman and our board. I feel very supported by the board in moving Smith & Nephew forward from where we are today. So I think it’s a great start. And we’ve had really some detailed conversations about our business and particularly after I’ve had our first couple of months here, I’ve been able to comment on where I see opportunity. In terms of -- I think it was your last question which is around growth and perhaps an exciting growth. I just say Smith & Nephew has been steady. You haven’t -- it’s not one of these companies where you’ve seen big degrowth. You’ve just seen slow growth. And so I think there’s a tremendous opportunity starting by getting to just what the markets are growing at, and I think that’s very possible. And then I think that, going from there, focusing on our market-leading products and driving them in the categories that they’re specifically can change the overall outcome of the company. And we’ve had a few drags on our business as well, and I think addressing the businesses that haven’t been performing well is a good opportunity for us. Versus our composite, we have already completed benchmarking exercise of how Smith & Nephew organizes itself as well as performs against the med tech composite.

And I don’t think we’re that different in terms of our profile of portfolios and having different products to actually meet the needs of global customers. I think there are difference in the ways we organize ourselves, where we actually -- how aggressive we’ve been around M&A, the things that we haven’t done that others have done to win going forward. So I think that they’re good opportunities. As for my own leadership, I think I’ve been in medical devices pretty much all my life in one way or another. And [indiscernible] in diagnostics, and I think that, that should give you a clear example that I wasn’t afraid to make any of the changes required, in that case, focus a business into the place where it could really win, and that drove a tremendous shareholder value. And in my previous world, operating across a very broad range of medical devices, driving success not just in one business, but across portfolios. So I’m very confident about Smith & Nephew’s portfolio, and I think that we’ll take the time to refine our strategy. And I think we’ve got great opportunities to unlock the growth going forward.

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Michael Jungling
Morgan Stanley

Can I follow up on this sort of major portfolio adjustment? Do you have scope to do that if you think that’s the right strategy?

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Namal Nawana
CEO

I think I’ve got very good scope and a good partnership already established with the board and continue to build on that partnership going forward. Thank you. Yes, please?

Y
Yi-Dan Wang
Deutsche Bank

Yi-Dan Wang from Deutsche Bank. I also have three questions. So Smith & Nephew’s underlying growth has been decelerating. And can you give us some sense of how that should trend going forward? I mean, should we expect the trends to get worse before it get better? Or do you think you could actually steady the ship here and we can see reacceleration of the growth? And then the second question is on the portfolio. Do you think the current portfolio is sufficient for you to get back to market growth or above market growth? And if not, what do you need to -- I suppose are there any significant gaps in your portfolio that you need to fill before you can get there? And then, finally, for the quarter, Knee sales has not improved nearly as much as what your competitors have reported. What is the reason for that, and how should we think about that going forward?

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Namal Nawana
CEO

Firstly, in terms of growth, what was encouraging about this quarter is, firstly, the steadying the ship and getting ourselves back into having a good 2018. We’ve reconfirmed our full year guidance at 2% to 3% growth. So that -- the implied growth for the second half of the year is improving. And we’re confident with that. We’ve had a second quarter where just about across-the-board in our businesses, we saw sequential improvement from Q1. So that’s a good start. I’ll answer the third question, which is really a follow-on, around Knee growth. And I’ll just say, it’s just -- it’s steady, 3% growth, a slight improvement over Q1 of 2% growth. We’re not -- we’re probably not quite as fast as Stryker and a little better than J&J at this moment. We’re right there. And the quarter-on-quarter stuff in Knees and Hips, I think you really have to look for longer than just 1 quarter. But overall, I feel good about our Knee portfolio, right? JOURNEY II, a great product, NAVIO robotics supporting it, ANTHEM, a great product for emerging markets. So knees, in general, we’ve got a solid portfolio. And then your -- the broader question around portfolio itself. I think I highlighted it in -- it’s kind of puzzling when you do look from the outside to see why some of these great technologies aren’t doing better. And I think that that’s the right place for me to start, is to first work with our teams to think about getting better performance with our existing platforms. And we’re fortunate that, again, our principal platforms, there has been investment there. There are things in R&D that are going to support improvement going forward. But there are class-leading products in our categories, so that’s where I’m starting. Again, early days. It’s been a couple of months. Throughout the remainder of this year, we’re going to refine those plans. And then, also look outside the company. We’ve got a great balance sheet and Smith & Nephew’s done some M&A. There’s an opportunity for us to add to our portfolio should we want to do that. Thank you. Yes, please. They’re coming.

I
Ian Douglas-Pennant
UBS

Yes. It’s Ian Douglas-Pennant at UBS. First, can you just start by talking a little bit about the synergies between the wound and the orthopedic businesses as a whole, given your comments on the need to focus on key products? And secondly, do you see the need for SKU reductions in any of the businesses along the same lines that you see the need to focus in that sense? And the third question is on timing. How, when do you start making the changes in earnest, and when do we start seeing the results, do you think?

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Namal Nawana
CEO

Thanks, Ian. And first of all, on synergies. What I would say is there are opportunities. Our PICO device used with knee replacement, we’ve got very good evidence now showing reduction in infection rate, which, because of those improved clinical outcomes, can deliver better health economic outcomes. So they’re very compelling cases for PICO and knee replacement. But I’d just say that the opportunity for PICO is far beyond just the synergy with our own business. It’s much broader into closing surgical incisions. The nice med tech briefing is a very strong message around how this product can help the whole of the health care system. So, and then in terms of synergies across the key sectors, there are some. There are some real overlaps. We have the same call point. A lot of the same customers between Sports Medicine and our Orthopedic Reconstruction business. But I want to bring your focus to the category-by-category opportunity we have to succeed with each of the products in the individual categories, and that focus I think is the first step for us getting to market growth with more of our portfolio. And then as we think about, what was the second part of your question, Ian?

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Ian Douglas-Pennant
UBS

SKU reductions.

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Namal Nawana
CEO

Yes. So look, we have a broad portfolio. When we did our ground-up review of our categories and the markets that we’re in, what we did was we examined, at the subsegment level, the quality of those markets, but also all of the products that we have. And so when I talk about bringing focus, we will have a plan for advancing our portfolio, what products do we need in each subsegment. And those kinds of processes tend to mean that you have to have plans around reducing a portfolio. And you do that in a very planned way. So yes, there are opportunities, but most of those opportunities come because we’ve got such great products in certain segments, we just need to focus more on them. Yes?

I
Ian Douglas-Pennant
UBS

Sorry, there was one last one on timing, unless you’re dodging that for a reason. How long until you start doing these changes in earnest, and how quickly do we see results?

N
Namal Nawana
CEO

Yes. So it’s been a couple of months since I’ve been here. I’ll say that with humility. There’s only so much you can get done in a couple of months. But I’m actually pleased with the start we’ve made. There’s been a tremendous welcome and a lot of good energy around improving and change. We’ve already initiated things that are going to help us, and that’s what we’ll continue to do throughout the course of this year. And I think we’ll be back here after our third quarter reporting on our further improvements, and there is no time like today. Just behind you.

K
Kyle Rose
Canaccord

Great. Kyle Rose from Canaccord. One for you, Namal and, two on the quarter. I guess I realize it’s still early, but how do you want to define your success at Smith & Nephew, both over the near, medium and then long term? And then, on the quarter, I appreciate the commentary on the knee dynamic. But if we take a look just at the U.S., we strip out the one additional selling day, and then what we should expect for your seasonality Q1 over Q2? It does look like the knees took a step back relative to its peers. I’m just wondering, is there anything from a market dynamic that would have impacted in the first quarter, particularly because you have cited strong NAVIO placements in the U.S.? And then on the sports med business, the sports med, stronger in the quarter. Obviously, Rotation Medical acquisition is helping there. But it still feels like that might be having more of a pull-through effect on the broader portfolio. So I’m just trying to understand, is there a bit more of outperformance of sports med related to the Rotation Medical than you initially expected? And how should we think about that moving forward?

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Namal Nawana
CEO

It’s a great questions, Kyle. Let me start with signpost for success on an individual basis, which I think was your first question. First thing is I think, happy with Q2. It’s after Q1, that was soft, getting back on track to hitting our full year expectations as a team. Graham had forecast for you when he spoke after Q1. And then longer term, I think unlocking the growth potential of Smith & Nephew. It’s a tremendous company, tremendous history, great portfolio, but hasn’t been performing in terms of its potential of growth, and so igniting that, I think, is a real opportunity for me and one which I think is my job with the team. So they’re the comments I’d make there.

Specifically, on knees and our performance on knees versus others. What I can tell you is, quarter-on-quarter stuff and a very good year last year. We shouldn’t forget that, right? So it’s easy to say, hey, Smith & Nephew didn’t have a great quarter this quarter. We had a great year last year in knees overall. And I think there are opportunities for us to do better still in knees. And so examining what can help us do better, focus JOURNEY II, great product, LEGION Revision Systems, which have additional components now, making a more compelling revision system, particularly with the cones and the sleeves. And then our ANTHEM product, which is just starting in emerging markets, but again, great growth. So there’s nothing in portfolio there that’s going to slow us down. I think the underlying markets bubble around a little bit. I feel good about where our products sit versus others’.

And then robotics, again, it’s really early days for us. We did have a good quarter for NAVIO, typically, even having a good quarter for the robot sales mean there’s some level of lag, and hopefully, that will generate further demand without really producing much data on that, only because I think it’s just early days with robots, but that is a principal way for us, I think, to improve our market position. And as I said before, we might not be the market leader, but we can provide leadership and this is a great area for us to provide leadership. Your last question?

K
Kyle Rose
Canaccord

Just sports medicine and the impact of Rotation.

N
Namal Nawana
CEO

So look, I love this product. I love REGENETEN. I think it’s a good acquisition. We’ve just started again with that. We’re expanding our manufacturing operations to deal with the demand, which I think is going to be good and allow us to confidently launch in further markets going forward. And we’ve got other products in sports med where we’ve partially launched. So having been thrilled with our WEREWOLF performance to date. But as it turns out, that COBLATION technology is relatively new in knee arthroscopy, and we’re kind of having to show the value, in shoulder arthroscopy, that’s an established platform. And so next year, as we launch a 90-degree one, I think that will be a good uplift to that. So I feel good about our portfolio, also making investments in our [indiscernible].

And if you’d really examine our numbers, you’ll see joint repair was good performance in the quarter, but AET degrowing 1% sequential improvement versus the first quarter. So that’s where you start. You got to go step by step. And I feel that, overall, we’ve good opportunities in sports. And you’re right, we’ve got -- there is some synergy to the customers. There’s a shared customer base, not always, but there’s a shared customer base between arthroscopy and recon. And so we should leveraging that. All in all, a good outlook for our joint repair business and sports. Yes? Okay, please? We’ll take some questions on the phone, and then we’ll come back to you. Sorry.

Operator

Perfect. So we’ll now take our first question from Veronika Dubajova from Goldman Sachs.

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Veronika Dubajova
Goldman Sachs

Welcome, Namal. Great to have you forward. I’m going to keep it to three, please. My first question is just your kind of fundamental approach, Namal, as I listened to what you discussed today. It’s really trying to improve the performance in each of the individual parts of the business. I think your predecessor, one of his focuses was for a long time trying to swing the balance of the business more into the higher growth market. Am I understanding how you’re thinking about this correctly, or have I over interpreted what you’re talking about? And I guess there is follow-on to that. Does that mean that maybe we see less M&A from you and really more focus on the organic execution in the business? That would be my first question. My second question is about NAVIO. You’ve said, it was a good quarter. And I think -- I’ve been consistently asking this now for a number of quarters. Can you actually help us understand what that means, either in terms of number of placements or your installed base or how many surgeons you train? It would really help us to put that into context. Then my last question is on the guidance for the year. Looking where you are tracking at the first half, do you see still possibility that you end up with the upper end of the 2% to 3% range? Or should we really be setting our sights on the 2% for the year?

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Namal Nawana
CEO

Okay, Veronika. I could barely hear you, but I’m going to do my best here. I don’t know if anyone else in the room heard better than that. But I think the first question related to, how we’re going to approach market growth and what previous management might have indicated in terms of the priorities. I think I’ve been clear, which is, right now, less than half of our portfolio and product groups are growing at market or better. And first priority is to get more of our portfolio growing at/or better than market. In general, it’s great to expose your organization to faster-growing markets and to develop those. Of course, we want to do that going forward.

The third question, I think, was around guidance. And look, sequential improvement in Q2, we’ve reconfirmed that guidance and confidence around our full year, and we’ve guided to 2% to 3% in revenue growth. So no change, reconfirmation of guidance. What was the second question? Yes, NAVIO placement. So we haven’t commented on specifics of NAVIO placements. Because it’s early days, I don’t think that that’s going to be of great value on a quarter-by-quarter to report on each of these things. What I would say is, we feel good about this core technology, which is CT-free robotic surgery. And I think that is a real opportunity in orthopedics. You don’t have to do a CT scan prior to someone coming into the surgery. You can go into your normal procedure, and you can go back doing your work. And I think that, that’s a great place to start from. I do think that there’s further things that we can do to augment our robotic system, and that’s what we plan on all the time. And once that is an established business, that is a meaningful part of our overall revenue and our overall performance, then, perhaps, we’ll give you more detail. So I think I got to your three questions. Thanks, Veronika. And I think we had a question at the back there.

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Tom Jones
Berenberg

It’s Tom Jones from Berenberg. I had two questions. Maybe one for you, Phil, and one for you, Namal. Just for Phil, the metal-on-metal claims, if I tease out that total for $100 million legal number, it looks like metal-on-metal was in the $70 million, $80 million cash range. That does seem to be ticking up a bit. Maybe just some color on what you think the total liability here is and whether we’ve reached the sort of peak expense in this regard and when you might expect it to tail off? And then a bigger picture question for Namal. I mean, having followed this company for longer than I care to admit, I think one of the things that we, as financial analysts, don’t understand often about CEOs in your role is you’re not just looking after the interest of your shareholders. You also have to look after the interest of your other stakeholders: your employees, your customers, which is, in your case, it’s customers/patients. And over the time I’ve been following Smith & Nephew, I think one of the things that the CEOs have struggled with is trying to balance a sort of fair allocation of return for each of those three groups. Sometimes, the shareholders have done well, the customers have done less well, periods back in the early, late ‘90s when you were ramping price aggressively, for example. There have been other times when the employees have done okay, but the shareholders and maybe the customers not so well. So a question for you is, how do you see the challenge of balancing up those interests of shareholders, employees and customers? And do you think for a time, you might have to put customers and employees first and the shareholder is just going to have to wait? Or do you think the employees need to get in the neck and the shareholders can have some return? Just how do you see that difficulty within Smith & Nephew?

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Namal Nawana
CEO

Why don’t I start and then I’ll hand back to you on the metal-on-metals. But first of all, I don’t think it’s an or. I don’t think you need to have a trade-off between these things. So I’m interested in your perception that it has to be. I think you start with the customer. You start with customer needs and you organize yourself to serve customers. And that’s how you also accelerate growth. One of the first things that I did coming into the organization is to conduct a ground-up review of our products, the markets that we play in, to understand at a granular level, what our customers -- what do customers need. And so I think that then gives you a great sense of what -- how to engage employees. And I’ve talked about a purpose-driven culture in the first actually weeks of joining the company. We’re rally having a conversation around culture. And a purpose-driven culture, I mean, to me means really is focused around the customer, not just the professional customer that we might be selling products to, but that end patient that is receiving our product. And hopefully, the customer centricity really helps employees with purpose and an organization with purpose. And if you get those things right then hopefully that really important thing for a business happens more naturally, which is growth. And we need to know what to focus on, we need to know how to position our products better and to really engage our customers better. And I think that there are great opportunities for us, and I think it will be much easier to deliver shareholder returns when we get all of those things set. So with that I’ll give Ian a chance to respond to the first question.

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Ian Melling
SVP, Group Finance

Thanks, Namal. So you mentioned the $100 million in the cash flow, Tom. The first thing to say is that it’s not all metal-on-metal. So there are some other legal things going through the IP-related. We had some moots in Q4 last year, H2 last year. There’s a couple of outflows in the first half of this year. In terms of metal on metal, it is -- the cash flow is a bit lumpy. We did settle a group of claims in the first half this year. But you’ll notice if you look at the P&L, we didn’t take a charge in the half, so that should give you some confidence that our view of the liability as a whole has not materially changed at this point. It’s just some lumpiness in the cash flow.

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Namal Nawana
CEO

Do we have any more on the phone, Phil?

Operator

We will take our next question from Romain Zana from Exane.

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Romain Zana
Exane

I actually have two valid questions regarding your full year 2018 targets. The first one regarding the sales guidance of 2% to 3%. It implies a pretty significant catch-up in H2 versus H1. Can you please come back on the main contributors to this improvement? And second question. Also, can you confirm your full year ‘18 guidance of more than 10% growth in Wound Devices and the mid-single-digit decline in bioactives?

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Namal Nawana
CEO

I didn’t hear much of that. I think that was for you though in some kind of, did you get those questions? Can someone repeat that?

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Romain Zana
Exane

No. So there’s, what’s driving the catch-up in the second half, the contributors to the increased growth in the second half. And then a comment on the previous statements around greater than 10% growth in AWD for the full year and mid-single-digit decline in AWB.

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Namal Nawana
CEO

Okay. So again, we’ve looked at each of our businesses and categories, and the team has communicated what their expectations are for the second half, and we feel confident about the overall guidance in that respect. I think we have a good markup which is second quarter acceleration. We shared with you a couple of small headwinds. We had an extra day in Q2, but we also had a previous year comparable with the Middle East tender that was significant, so that seems to kind of wash out. And we’re nicely on track, I think, to be in that 2%, 3% of full year guidance. With respect of AWD, I’m very excited about the key product in there, which is PICO, and that had a double-digit growth in the quarter, and we see that actually further accelerating as the year goes on. And we’ve got good reason to have confidence with that given how well it performs clinically and the economic benefits that it brings to the health care system. So in terms of us feeling good about the second half of the year, I think the team feels good about continuing on what we achieved in Q2 and have specifically, specific plans for the remainder of the year. Yes?

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Kit Lee
Jefferies

It’s Kit Lee from Jefferies. I just have two questions on the wound business really. I guess, firstly, on the Wound Care. It’s a big piece of your business. It’s been underperforming. And as far as I can remember, the main drag has been in the, in your European business. That’s been under restructuring for quite a while now. So are you planning to make any further changes to the operations there? And when do you think we can see light at the end of the tunnel? And then the second question refers to the bioactives business. Are you making any specific changes or having any initiatives to at least stop the negative growth spiral that we have seen in the past few years?

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Namal Nawana
CEO

Okay. So first of all, we see our wound business as an opportunity. There have been challenges. And some of them, I think, after my initial reviews, relate to how we have chosen to interact with the marketplace. We had some fantastic products, like ALLEVYN, in our core portfolio. But we also have some new products like PICO. And I think the second quarter is a good start. We’ve got some improvements sequentially. I actually see opportunity for us, keep the core part of our business stable, and then we have some really good devices like PICO to accelerate growth.

Specific to SANTYL, obviously, a very challenging first quarter. My analysis is that, that had a lot to do with how customers bought in the latter part of the prior year, and that’s washed through, I think. And we’ve seen the sequential improvement, from kind of minus 12% in bioactives to minus 6% in the second quarter. I think we can stabilize that. I think that we don’t see that kind of degrowth for the remainder of the year. But equally, we don’t see it as a major area of growth with the portfolio we have. And so I would therefore go back up to what we’re trying to achieve overall with the portfolio. Our consumables business has some really great products in there, probably want to do some more in specific segments, some of the infection prevention segments, for example, and then I think really focus on our devices and PICO.

Let’s go to Michael again.

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Michael Jungling
Morgan Stanley

It’s Michael from Morgan Stanley. And two more questions. Firstly, what is your view in terms of attractiveness between, let’s say, chronic care businesses versus orthopedics? Is there one area that you prefer over the other? And how would you feel about turning Smith & Nephew into more of a chronic care business going forward? And question number two is maybe a clarification question on a question that was asked previously. And that is, in terms of driving share price, what do you think is more important here: accelerating organic sales growth at the cost of margins or striking a balance between the two on a two or three year view? Just sort of curious as to how you think Smith & Nephew’s share price would respond to various inputs.

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Namal Nawana
CEO

Yes. So first, your question relates to our portfolio, and do we have a forecast for how our portfolio might mix, and do we like any of our babies better than each other? Look, I think it’s about end market growth. We’re very objective of our business. We examine what is the strategic opportunity of end market growth in those areas. And do we have portfolios that can win in attractive markets? So I wouldn’t constrain it to chronic care or one or other business, but we should examine all of those and think about, can we win in one area more than another. So I don’t have a specific thought on chronic care, but we’ve looked at that and even since I’ve been here, we’ve looked at each of the areas that we can access more end market growth going forward. What was the second part?

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Michael Jungling
Morgan Stanley

The second part is more trying to understand how you think about driving Smith & Nephew share price. What do you think is more important?

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Namal Nawana
CEO

I think our priority is unlocking growth. I think that’s our priority. And we’ve examined the ratio of what might improve our shareholder returns, and growth is a better and more important lever than the earnings expansion. It’s a mechanical equation, in our view. So I think that getting a healthy business and being well positioned in our core areas that we operate, that’s the priority. And I think if we can do that over the next little while here, really get confident and get to market growth with more of our portfolio, that would be a tremendous uplift to this company.

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Michael Jungling
Morgan Stanley

So is it then fair to conclude that, in terms of driving share price at Smith & Nephew, that if you have to sacrifice margins a little bit to drive top line, that seems to be reconciling with what you’ve just said? Is that a fair interpretation of what you’ve just said?

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Namal Nawana
CEO

Mike, I actually don’t think that you -- again, this is not an or. You don’t have to do one or the other. I think that we want to run our business well. That’s important. And I think that we have opportunities to run our business better and be more streamlined as well as drive more growth. And I think the company has taken some good initial steps with the APEX program. I think there are some logical other steps to streamlining our operations. And I think that there -- it’s certainly not an or. I think it’s about how we -- we’re proud about how we operate and that we operate well as well as principal job which is to succeed in the categories we’ve chosen, and that starts with being at least at the market growth, right? Another phone question?

Operator

We now have our next question from Chris Gretler from Credit Suisse.

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Chris Gretler
Credit Suisse

Namal, it’s Chris here. First of all, also best wishes for this challenge. And I have actually three questions. Maybe I go one after the other. The first is, with respect to the organization, and I guess your predecessor in a typical French style made quite a decentralized -- made a very centralized organizational structure, and you mentioned that you want to have a more flatter hierarchical structure. Does this also mean more decentralized decision-making, for example?

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Namal Nawana
CEO

I think I got most of that, so it relates to our organization structure. I think what we have to do is organize ourselves to support the growth. And a flatter organization where it’s clear where decisions happen and how decisions happen quickly, I think, will help us. And so we’ve moved very quickly to change our leadership structure and get on that path, having more streamlined organization. And I do think that having more of a focus at my executive table around how each of our businesses is represented and our customers are represented, so that we can be there for them and support our success with each of them is important. So whether that means more decentralized decision-making -- decentralized decision-making to me means decisions are made at the appropriate level in the organization. And so by virtue of having a flatter organization, what we’re really saying is that, we don’t have to go up and down to get decisions out, right?

So I think that those two things tie together. But base principle is just flatter, closer to the customer and leaner way of thinking and running. Hopefully, that gets us running faster.

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Chris Gretler
Credit Suisse

Okay. That’s very clear. And the second question is with respect to the two appointments that you already made. I’m quite surprised by the speed of that. Would you also be able to share some of the background of these persons you have appointed? And actually by when we will have a full management organization in place?

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Namal Nawana
CEO

Yes. So these are just initial appointments. The first appointment I think we have posted on our website, which is Melissa Guerdan, who joins is leading our QA and RA functions. That function didn’t have representation on the Executive Committee. My initial thoughts and view is that that really benefits from being an executive-level role. And as I’ve said before, regulatory affairs critical part of accelerating growth, making sure that we don’t have lag in actually getting our technologies in the pipeline through regulators in order to access new growth once we’ve actually finished the development cycle. So that’s important to me. And also, running the business well is very, very important. I call it like preventative medicine. So in order to make sure that we don’t have any missteps going forward, having a great framework for quality systems and a great framework for operations is very important. Second part is leadership. And I have appointed a new leader and hired from the outside a new leader that, I am very confident, will help us be a better global operations company. And the specific leader is yet to join our organization, joins just in a couple of weeks, but has got strong experience in Lean and Six Sigma and all the things that go with that, 5S, Kaizen, to improve our operations, as well as in procurement and really optimizing the cost base. So both of those things are important to us going forward. And so again, I’m excited about that leadership appointment. Fighting a little bit here with the jackhammer behind me and that jackhammer is winning. Just give it a second.

[Technical Difficulty]

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Chris Gretler
Credit Suisse

Sure.

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Namal Nawana
CEO

So, I’m going to try and speak loudly for a second. And so we’ve been informed that noise is not going to stop. The workers are going to work now. So I just want to thank everyone, and we’ll follow up with each of you. And again, thanks for the excellent questions. Look forward to continuing the interaction. Take good care.