Smith & Nephew PLC

LSE:SN

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Smith & Nephew Q2 and First Half 2020 Results Conference Call.

Certain statements in this presentations are forward-looking statements. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from those included in these statements due to a variety of factors. More information about these factors is contained in the Company's filing with the Securities and Exchange Commission.

I'd now like to hand the conference over to the first speaker today, Mr. Roland Diggelmann, Chief Executive Officer. Thank you and please go ahead.

[Roland Diggelmann, CEO]

Thank you, Maria. Good morning, everyone and welcome to Smith & Nephew second quarter and first half results. I hope this finds you all well, and safe. I'm on the call here today with Ian Melling. Ian has been serving as an Interim CFO since April. And we greatly appreciate the work he has done leading the finance functions through a period of unprecedented industry challenges as you all know.

I’m also pleased to announce that Anne-Francoise Nesmes join Smith & Nephew as Chief Financial Officer on July 27. Hopefully many of you will get to speak with her over the coming months, once she had the chance to get her feet under the table.

The second quarter and first half was materially impacted by COVID-19 pandemic as we expected. We are encouraged though by the improvements seen across all segments since the trough in April. Restrictions on the elective surgery have generally eased across major markets even with the recent setbacks in certain regions.

I’m delighted with the way our team has responded in difficult conditions and I’m very confident we have the necessary resilience as well as agility as our markets continue to recover. As well as taking you through the detail of our results today, we would like to provide as much detail as we can, so we will also cover how we’re seeing the recovery play out in each segment, our progress on our work to control costs this year, and what we’ve been doing to enhance our long-term growth profile which remains a strategic priority of Smith & Nephew.

Let me start with the highlights of half year numbers. Revenue in the half was $2 billion, which is an underlining revenue decline of 18.7% and including the effect of one less selling day compared to first half 2019. Trading profit was $172 million with margins of 8.5%, reflects negative operating leverage and higher provision charges offset by cost savings. And Ian Melling will go into much more detail on this later. EPSA was $0.134.

Turning to the next page, for the second quarter, revenue was $901 million, which is a 29.3% underlining decline and 29.8% minus reported. Trading days were unchanged compared to the prior year. The impact of COVID-19 was of course the driver and we saw significant restrictions on elective procedures across major markets early in the quarter. The effect was greatest in our surgical business as expected, orthopedics and Sports Med and ENT, which were down 34% and 33.3%, respectively. While advanced Wound Management was relatively resilient. It was still significantly affected at minus 17.6%.

Looking by geography, for the quarter, the U.S declined 31.8%, other established markets by 30.8% and Emerging Markets by 20.2%, with China the first major market to improve and actually grow in the second quarter.

Now let me go into some more detail by country. We already reported that the U.S was initially more impacted than Europe with sales at the trough around 60% negative on the prior year versus around 50% for Europe. We since though also seen the U.S recover more strongly as the quarter progressed, all 50 states reopened for elective procedures during the quarter, Texas and Mississippi have introduced new restrictions in July. Although around 90% of facilities in the state are still operating.

Within Europe, we're still seeing significant variation between countries. There were strong rebounds in Germany, also in Switzerland and Austria, France and Spain by the end of the quarter, but volumes have continued to lag in some other markets, such as the U.K., which accounts for 4% of our global sales and Eastern Europe. We do expect that Europe as a whole will be one of the slower regions to recover. This reflect the more public nature of the health care systems, the condition of some systems before the crisis and differences in incentives in particularly compared to the U.S.

The Emerging Markets, have also been a similarly a mixed picture. China was already beginning to recover as we entered April and grew for the quarter as a whole, predominantly driven by surgical businesses. Capacity utilization in the health care system steadily increased as the quarter progressed and already reached above 80% during the month of June. We did see temporary restrictions, however, on surgery in Beijing following a localized outbreak late in the quarter. But these have been lifted again in the last two weeks. Other regions, such as India, then Latin America and South Africa still have COVID-19 restrictions in place, and as a result are yet to recover.

I know there's a lot of interest in how the recovery played out as the quarter progressed. So let me take a little bit more time on this slide, and then subsequently less on the following franchise slides. As you know, we already announced monthly growth rates at group level after a 47% negative in April, growth recovered to minus 27% in May and minus 12% in June. And we're seeing a positive -- a good trend for July.

Looking across the portfolio, the businesses that were most impacted initially have tended to also be the fastest to recover. The orthopedic franchise rebounded strongly through the quarter, after being down 58% in April. A number of categories return to growth in June already, such as revision hips, partial knees, trauma plates, and screws.

In Sports Med, the greatest share of business typically comes from privately paid and outpatient procedures, which again meant the hard initial impact and then a faster recovery. The picture has been quite similar between joint repair and arthroscopic enabling technologies, although recovering the capital component of AET has been lagging consumable. The customer pipeline for the tower is very strong, but we're currently seeing slower and more cautious decision making around larger investments.

ENT then has been at the slower part of the franchise to recover with some understandable caution around restarting procedures in the nose and throat. In advanced Wound Management, the drivers of the slowdown were a little different, and we're seeing a slow recovery for a number of reasons. These do include sales rep access, the geographic mix, we have a higher proportion of our sales in Europe, a patient behavior along with tiny effect for movements in wholesaler inventory levels.

Let me now move to the details of the franchises, starting with orthopedics. As mentioned, joint replacements saw significant deferrals of procedures during the quarter with the relative resilience in hips consistent across all regions. This is in part due to the head market having a higher proportion of emergency cases, but there's also an early benefit from the launch of OR3O, our Dual Mobility Hip System.

OR3O itself has been extremely well received and we’re seeing it pulling through the other components of our hip constructs. We're now starting to make it available in markets outside the U.S. Trauma was more resilient and by the end of the quarter had returned to growth in the U.S and in Asia Pacific. EVOS, our plating system had strong double-digit growth, even with the lower levels of activity in society that dampered overall trauma demand. Other reconstruction growth rates reflect the slow quarter of capital sales. However, I'm very excited to report we made the first sales of CORI in the quarter. CORI is our next-generation robotic surgery system.

Moving on to Sports Med and ENT. As with orthopedics, the franchise is heavily driven by elective surgery and was impacted by treatment referrals, particularly early in the quarter. We still continued positive growth from some of the recent launch products, such as FLOW wands and LENS 4K. Also we had the first cases for NovoStitch Pro in Europe, and we have the CE Mark granted in April for REGENETEN and we intend to launch in the coming quarter. ENT sales declined 44% in the quarter, and case volumes remain low.

Finally, advanced Wound Management, the franchise still saw a significant impact from COVID. Advanced Wound devices was the most affected segment, with negative pressure a category that's more exposed to elective surgery of course. Other headwinds included temporary closers of Wound clinics during outbreaks and the falling admissions in long-term care facilities, excuse me, many of which have not been accepting new residents. In Bioactives, we saw a slow bio tissues market across surgical cases, Wound clinics and burn centers.

Looking beyond this quarter, we've made important steps on realizing the full value of GRAFIX and STRATAFIX, which we acquired with Osiris. After a successful pilot, existing Smith & Nephew Bioactives reps will now also be promoting these products. Revenue synergies were an important part of the business case for the acquisition and most of that benefit is still to come.

So with that, I'll hand over to Ian to take you through the details of the financials. Ian, please?

[Ian Melling, Interim Chief Financial Officer]

Thank you, Roland. Starting with the P&L. Half year revenue declined 18.1% on a reported basis, and 18.7% on an underlying basis excluding the impact of foreign exchange and acquisitions. Trading profit was $172 million and the trading margin was 8.5%. We have experienced margin pressure due to the negative leverage effect from the fixed components of our cost base and the impact of reduced production volumes, due in large parts of the -- to the impact of the COVID-19 situation on our business, we also took additional charges of approximately $50 million to provisions for inventory excess and obsolescence and bad debt which are included in COGS and SG&A, respectively. These provisions reduce the margin by 2.5 percentage points.

To mitigate these impacts, we have delivered approximately $150 million cost savings in areas such as variable pay, third-party commissions and royalties, travel, promotional activity, events and consultancy spend. The R&D expense has being largely protected as we continue to invest in the innovation that's central to our strategy.

As a result, the R&D ratio steps up to 6.6% of sales in the period from 5.2% in the prior year and rose slightly in absolute dollar terms. There was a small IFRS operating loss in the half of minus $5 million, principally reflecting the lower trading profit margin, along with amortization, restructuring and legal and other charges.

Moving further down the P&L, adjusted earnings per share declined by 71% broadly in line with trading profit. Basic earnings per share declined by 67% and was helped by one-time gain from the successful outcome of a U.K tax case. The interim dividend of $0.144 is in line with the prior year. We generated positive trading cash flow of $25 million in the period with trading cash conversion of 14%.

We've continued to invest in capital expenditure as we progress changes to our manufacturing site based. The working capital outflow of $137 million includes higher inventory partially offset by declining receivables due to the declining revenue. Restructuring, acquisition, legal and other outflows increased to $112 million, of which $69 million relates to restructuring programs. The prior year included $80 million of insurance receipts for legal matters.

Cash tax was lower in H1 2020 compared to H1 2019, primarily related to a reduction in the U.S as overpayments in prior periods offset against amounts due in 2020. Overall, free cash flow is negative minus $139 million. On the balance sheet, net debts increased by just over $500 million to $2.3 billion, including around a $100 million from the acquisition of Tusker Medical. Closing net debt includes $200 million of lease liabilities and we finished the period with a leverage ratio of 2.

Our liquidity position remains strong with $3.4 billion of committed credit facilities and no debt maturities in 2020. We indicated in May that we were targeting up to $200 million in discretionary savings for 2020 in response to COVID-19. We're on track to deliver with around $150 million of savings delivered in the first half. Our approach has been to balance cost control with readiness to fully take part in the recovery of each market.

There remains uncertainty around the full year revenue outlook, and while we've identified additional savings, if they become required, we also retain the option to reinvest some savings if more favorable scenarios play out. You should still expect material negative operating leverage for as long as our sales remain under pressure from the effects of COVID-19.

And with that, I'll hand back to Roland.

[Roland Diggelmann, CEO]

Thank you, Ian. I'd like to finish with an update on what we've been doing to improve the longer term growth profile and to position ourselves for recovering demand. We've made significant steps forward on some of the priorities we talked about in February and May, particularly around innovation and launch execution in the opportunities and ASCs and the development of our people.

Let me go to the next page and you'll see that one priority was our renewed commitment to innovation as a driver to improve our growth. Our recent launch is already making a difference, and we continue to invest in R&D. Importantly, we've also been able to secure important regulatory clearances and approvals in major markets in line with our plans. For some examples, we've secured FDA clearance for the total knee application on CORI, following the earlier clearances in -- for Uni-Knees, and also for the INTELLIO Connected Tower in Sports Medicine.

In Europe, we completed requirements for CE Marking REGENETEN in April as mentioned. So these launches they're all underway. Part of our approach across our portfolio has also been to adapt with the new ways of engaging with our customers, of course. Traditional medical conferences has not been taking place. So we've used digital conferences to continue to reach out to customers. For example, more than 11,500 people visited our virtual AAOS booth.

Also in professional education, we've held a global webinar series during the second quarter, reaching across our product categories with more than 25,000 participants in total. Our medical education team was quick to recognize the digital opportunity and has been able to replace traditional in-person lectures and case discussions without the need to travel and without taking the surgeons out of the hospital. Now we're not yet at a point where every aspect of traditional training can be conducted remotely, and we are supporting lab based training and visiting student programs with appropriate safety protocols.

You can also see the strengths of the early take-up of OR3O in our hip growth and that demonstrates that we're still able to launch effectively in this changed environment. That is impressive. That is important given the impressive pipeline that we have and the innovation that we'll continue to bring to the market. We've also identified the ASCs as a strategic cross franchise opportunity for Smith & Nephew for the opportunity to bring Orthopedics and Sports Medicine together. There were already good reasons to expect acceleration of joint replacement in the setting of ASCs, including Medicare reimbursement, total knee replacement in the ASC for the first time in 2020.

It is also become clear over the quarter that part of the U.S health care system response to COVID has been to accelerate this shift. We've already seen a significant increase this year in the proportion of joint replacement procedures taking place in ASCs, in both knees and the hips. We're also seeing changes in choices made by physicians as they change settings and that does support our view that the shift can be an opportunity for us and for market share changes at the same time.

We believe we're well positioned to benefit from the shift to our service offering for ASCs through branded positive connections, and with our enabling technology, including the launch of CORI. As I mentioned, CORI is our next-generation robotic surgery system. It is faster, it's more compact than NAVIO, continues to be a modular design that will enable us to bring more applications to the platform over time, and it does not require a CT, which is important for ASCs.

So while it's early days still in a growth opportunity at ASCs, we see the developments this year as validating both our view for the potential for Smith & Nephew, and for the approach to this high growth segment. Another key priority was the ongoing, focus on our people. As restrictions have eased in each country, we've been stepping up production and opening our offices. Employees are still being encouraged to work remotely where they can and we put precautionary measures in place at all of our sites to ensure that when employees are there, they can work in a safe way.

The period of lower business activity has also been an opportunity to further develop our employees capabilities, and so further enhance our long-term effectiveness as an organization. As an example, in the first six months of the year, our sales force more than doubled the amount of time spent on product and other professional training compared to the prior year. The large majority was delivered by distance learning and we are building on that capability by developing new specific training content for a wider range of functions.

Our teams have also used our used our resources to support our communities in the fight against COVID-19. We have now assembled more than 1 million face shields at our Memphis and Costa Rica facilities to help meet the increased demands for PPE. And in hope we're supporting the trial of a technology designed to support distancing between employees in manufacturing and lab environments.

So in summary, we have made excellent progress before we entered the COVID crisis. We had really good momentum throughout the end of 2019 and the start of 2020. Managing the immediate pressures has obviously been necessary, but we've also kept developing in line with our strategy and advancing our focus areas for 2020. Our priority remains to sustainably accelerate the underlining growth of our business, while focusing on delivering innovation, strengthening our talent and capabilities and improving profitability at the same time.

So with that, I look forward to your questions. Thank you very much.

[Operator]

[Operator Instructions] Your first question comes from the line of Patrick Wood. Please ask your question.

[Patrick Wood, Bank of America Merrill Lynch]

… much. I'll keep it to two, please. The first would be just maybe a little bit of color please on the reinvestment rates that you guys are thinking of that cost savings pool, let's say, if the top line recovers. I mean, if we have 2021 looking more like a normal year for Smith & Nephew, should we expect the majority, or all of that cost savings pool to be reinvested? That will be the first question. The second one, I'm just curious if you can give us any color and thank you for the monthly data so far, but very roughly, the shape of what you've been seeing in July, a little bit more color on that in terms of the sequential improvement relative to June? That'd be really helpful. Thank you.

[Roland Diggelmann, CEO]

Thanks for the question, Patrick. On the first question, obviously, we want to continue invest because the fundamentals mid and long-term remain positive. We have actually also ring-fenced R&D in the first half, because we believe strongly in innovation and in the growth opportunities in the markets in general. So we will be cautious and we'll be behind monitoring closely the developments in the market, and we'll invest behind those. As you pointed out, the majority of the savings in the first half were discretionary costs. So that's we've already secured $150 million of savings. So I think what you can see is we have the opportunity to generate those savings. We'll monitor the market development, if need be. We can introduce more savings if the market's recover, though, we were ready and prepared to continue to invest to support the growth and the recovery. On July, I'm happy to report that July has been, I would say, a good month. If I look at the trajectory from April onwards I am positive and optimistic. We're not at the end of the month, of course, and at the same time as you will know a lot of uncertainty remains, but the trend generally is positive.

[Patrick Wood, Bank of America Merrill Lynch]

Super. Thanks for taking the questions.

[Roland Diggelmann, CEO]

Thanks, Patrick.

[Operator]

Thank you. Your next question comes from the line of Kit Lee. Please ask your question.

[Kit Lee, Jefferies International]

Thank you. Two questions, please. Just firstly on your capital equipment business, when do you think there will be more clarity on hospital budgets and your customer decisions on buying both SAEs or other equipment? And then my second question is on the provisions. How should we think about that for the second half? Do you think there'll be more provisions on the way, or is that $15 million enough for the full year? Thank you.

[Roland Diggelmann, CEO]

Thank you, Kit. I'll take the first question and then Ian will take the second on provisions. Well, indeed as expected, the hospitals were of course slower in making capital equipment decisions very understandably. I think as the markets recover, this will actually accelerate again. There is no reason to believe that CapEx or larger equipment sales will be more difficult in the future because the trends will continue. If I look at the tower that we have on offering in Sports Med, the intelligence -- it's a great solution, continue to be very excited about our Sports Med and the positioning. And then we had a very, very strong trend towards robotics entering this crisis. So I believe we'll continue to see that as technology evolves. I'm very positive about our next generation platform here with CORI. It's a great solution, great technical features. It fits very well in the ASCs and in the trend to more decentralized, more modular approaches. And I believe we also have beyond the technical features, I think we also have a very positive financial proposal here.

[Ian Melling, Interim Chief Financial Officer]

Thanks, Roland. On the -- on your second question, Kit, as you've seen we're not guiding on the second half, and that logic applies to the provisions as much as it does anything else. But what I would say is if we continue to see a recovery that we've seen across Q2 coming in to Q3, then there will be much less pressure on those provisions. If we saw our second dip approaching Q2 levels, then it might be a different story.

[Kit Lee, Jefferies International]

Okay. That's great. Thank you.

[Operator]

Okay. Thank you. And your next question comes from the line of Kyle Rose. Please ask your question.

[Kyle Rose, Canaccord Genuity]

Great. Thank you for taking the question this morning. Can you hear me all right?

[Roland Diggelmann, CEO]

Yes, we can.

[Kyle Rose, Canaccord Genuity]

Great. So just a couple of questions for me. One specifically on the knee business, obviously, I understand that those procedures are a bit more deferrable than the hip side. Just wanted to see what you've seen as far as a month-over-month trend on the knee side, and how and when you expect that business to return to growth? The second question, Roland, you talked about the ASD channel. So I appreciate the commentary, but you also talked about seeing potentially different choices from physicians in that channel. Can you maybe help us understand what that means? Does that mean different types of implants, different types of treatments? And then the last question is just your overall M&A, any thoughts about capital allocation in this period? Thank you.

[Roland Diggelmann, CEO]

Thank you, Kyle. I'll just start with your last question on M&A. I would first want to mention that our M&A strategy remains unchanged. We continue to look for technologies and innovation that fit with our general strategy that we can leverage for our existing commercial footprint. We continue to look very actively in the marketplace. There may be some distressed assets here and there, but what we want to maintain is a clear strategic approach here. And also have the ability actually to be seen as a good owner out in the market. We have made five acquisitions last year. I think this has really been, I would say, a watershed moment for us as an organization. So we continue to be interested in M&A, of course. And whilst initially of course the focus was on liquidity and cash flow, we have a very solid balance sheet and that is a positive. On ASCs and then the different choices by physicians there's typically -- there's an opportunity here because the ASC setting, of course is a different one. You do also have a different patient selection. So we see it as an opportunity, twofold: one, on the implant choices, and second, of course, on the address that we have towards the ASCs, because we're selling into these accounts for the most part already through our leading Sports Medicine franchise, we see the opportunities of converging there. And then in the future, we also see the opportunity, of course, with robotics solutions, with CORI, with a small footprint modular non-CT requiring solution.

On the knees, we continue to monitor the situation. As I mentioned, the hips were faster to recover. I think it's two elements here. One is the fact that there's more trauma related joint replacements on hips. The second one being a very successful launch of OR3O, the dual mobility. But I have no reason to believe that the knees won't pick up either. They're just lagging a little bit behind the hips at this stage, but I'm confident that they'll continue to grow as the markets recover. And here again, we have a great portfolio and of course we have CORI coming to the market, which will support that growth.

[Operator]

Okay. Your next question comes from the line of Chris Gretler. Please ask your question.

[Christoph Gretler, Credit Suisse]

Yes. Good morning. It's Chris. Hi, Ian. Hi, Roland. I have two questions actually and it relates to the cost savings. First of all, the $150 million you quote, it is actually a run rate exit at the half year end, or is this basically the total cost saving you experienced now in the first half?

[Roland Diggelmann, CEO]

So thank you, Chris. I'll take that one. So the $150 million is the cost saving that we realized in the first half against our expectations. So just to be clear, it's not a year-over-year cost saving number, it's cost saving against our expectations coming into the year in the first half.

[Christoph Gretler, Credit Suisse]

Okay. Thank you for the clarification. And then the second question is on the restructuring program. I think, earlier this year, now we had an expectation that there might be some more programs now coming up eventually. Is this in the current environment still a topic or you basically just wait and see kind of how the pandemic develops before coming up with any incremental program on top of APEX?

[Roland Diggelmann, CEO]

Yes. Thank you, Chris. We have incurred some modest costs in the first half on the new program, but also some things have been delayed as a result of COVID and we are considering our plans in that area. So we're still working through the full impacts of those and we'll come back to you all in due course with an update on that. It'll also give Anne-Francoise a chance to come in and see those plans as well. So still on the cards, still work in progress and expect to see something in due course.

[Christoph Gretler, Credit Suisse]

Okay. Thank you. And maybe one last question just quickly on these ASCs. Actually, what percent of your knees -- and I guess there is not much in hips, but at this stage, if it come from ASC for you guys?

[Roland Diggelmann, CEO]

It's still a small number, of course, because the majority of the capacity is in central hospitals. I would say for us, it is close to about 10% of our knee sales. It is a higher proportion, I believe than for others. And it has and I think that's the more important messages we've seen a good growth in ASCs during this crisis, albeit at the low level, because the entire volumes were depressed. But we continue to see this trend evolving and we feel that we're very well positioned to benefit from the move to decentral and ambulatory.

[Christoph Gretler, Credit Suisse]

Okay. Thank you. I appreciate your comments.

[Roland Diggelmann, CEO]

Thank you, Chris.

[Operator]

Thank you. Your next question comes from the line of Julien Dormois from Exane. Please ask your question. Your line is now open. Please ask your question.

[Julien Dormois, Exane BNP Paribas]

Hello. Sorry. Can you hear me now?

[Roland Diggelmann, CEO]

Yes.

[Julien Dormois, Exane BNP Paribas]

Okay. Sorry. Thank you. Good morning. We're on good morning, Ian. I have two questions, please. The first one relates to the comments that you made during the Q1 call where you alluded to the risk of pricing pressure mounting in the industry as hospitals will exceed the pandemic where we've damaged financials. What are your latest thoughts on that topic? Have you seen anything, or is that not happening at all at the moment? And the second question relates to the underlying growth momentum. You have clearly stated that the strategic focus remained on accelerating supplying, and we see lots of reasons to be optimistic in orthopedics and Sports Med with the high rate of innovation. But what are your thoughts about Wound Management? Is there -- did you have plans here to come up with maybe more innovation or more acquisitions in order to reinvigorate growth in the segment that has been lagging for some time?

[Ian Melling, Interim Chief Financial Officer]

Thank you, Julian. I'll go with the question on pricing and the pricing pressure, first. I'd say initially we haven't seen anything that would indicate more price pressure on the short-term. I think everybody has been very busy managing the COVID crisis and the situation. We've always had price pressure in our industry. I think that that's something that we know how to deal with. We'll just have to observe and see what the future brings here. So I'm relatively positive here as well. In terms of the underlining growth on Wound, you're absolutely right there in Sports Medicine and orthopedics I think I've seen very good growth coming into this crisis, very good momentum. In Wound, I think if I look at the three sub-segments in Wound care, we've made good progress in Europe coming into this situation. We've had some challenges in the U.S., but I think we can manage that. In Bioactives we have made the acquisition with -- of Osiris. So that gives us a really nice play in the Bioactive field of Wound and with GRAFIX and STRATAFIX, we have some great products. We are now cross trained our sales forces between Osiris and Smith & Nephew, and we're also going to be launching this product over time outside of the U.S. So I'm positive in that sector. The one area that's been the most impressed in the crisis is actually the one we've been strongest in which is devices, which is very much linked to surgical procedures. So -- and with PICO and then the next generation PICO coming to the market next year, I'm very optimistic that we can continue that positive trend and actually grow market share.

[Julien Dormois, Exane BNP Paribas]

Okay. That's clear. Thank you very much.

[Roland Diggelmann, CEO]

Thank you, Julien.

[Operator]

Thank you. Your next question comes from the line of Michael Jungling from Morgan Stanley. Please ask your question.

[Michael Jungling, Morgan Stanley]

Great. Thank you and good morning, all. I have two questions. Firstly, on the Q3 sales growth expectations and I'm just curious how you're thinking about Q3 pent-up demand being down by physicians. I'm trying to understand whether there is a meaningful possibility, in your eyes whether there's seasonally a low volume quarter, but at the same time, pent-up demand being used by surgeons to catch up could feasibly result in for you sort of a bit of growth, actual positive growth in the quarter for orthopedics. And then question number two is on cost savings. And is that sort of correct that the $150 million in discretionary savings for the first half was slightly better than what you had suggested earlier? And how does one think about sort of $50 million of additional savings in the context of $150 million in the first half? I'm trying to understand how much flexibility you have in that spend. It seems to me that you probably have quite a lot, but if you could quantify it and how you're thinking about it, that would be very helpful.

[Roland Diggelmann, CEO]

Sure. Thank you, Michael. So on Q3, obviously there's a lot of uncertainty still in the market, but I think you described it quite well. I absolutely believe it's possible that we will see continuing good recovery and good trend. There is certainly pent-up demand. It's not the same in every geography of course, you have to factor in when the different geographies went into the lockdown and into deferring surgery. So we're going to see probably this evolving geography-by-geography, but given the fact that the U.S is accounting for almost half of our sales and relatively quick recovery, I'm also optimistic here. We've seen two things happening, of course, the pent-up demand being worked on and then an ongoing demand being managed because of the fundamentals remain the same. The patients are out there, they need and they demand surgery and care. And so there is an incentive of the entire system and all stakeholders to provide these solutions to patients. On the savings, Ian, can you give some color?

[Ian Melling, Interim Chief Financial Officer]

Yes, absolutely. And I just add to what you said, Roland, just in response to your comment, Michael, but August is our lowest sales month and seasonally. So August is going to be a little harder to interpret, but I think as we come out to quarter with September, we should have a clear review. In terms of the savings, yes, I think we're pleased with the $150 million in the first half. It's in line with -- maybe slightly better than our expectations, but not significantly. So in terms of what to expect in the second half, I think it will depend on the top line. So if the top line comes back strongly and we see the recovery we just discussed, then we'll have lower cost savings and we'll be spending more in variable areas and sales rep compensation and the like.

[Michael Jungling, Morgan Stanley]

Okay.

[Ian Melling, Interim Chief Financial Officer]

Yes, travel is looking like it's going to come back a little slower may be, but what we will see, it depends on whether travel comes back or not. There's lots of variables and I think it will be very dependent on the top line. So, yes, it …

[Michael Jungling, Morgan Stanley]

It sounds to me that you've got quite a lot of discretion in the EBITDA that you want to show, because let's say, if the second half grows at minus 5, you seem to have quite a lot of discretion in terms of how much you want to spend on travel, on consulting, all those things that you've mentioned in the press release. Is that a fair statement?

[Ian Melling, Interim Chief Financial Officer]

We have some discretion and we have some variable costs in there as well, where it's more a case of it -- it'll be variable with sales. So yes, there is some discretion, but clearly we -- if customers are going, if people are visiting customers and we'll want to be visiting customers. So we won't want to be behind the competition by restricting spend and preventing us attending events or visiting customers.

[Michael Jungling, Morgan Stanley]

Okay. And the final follow-up please is, is the inventory obsolescence charge of $46 million in the first half, have those products been scrapped or can they still be sold in the second half?

[Ian Melling, Interim Chief Financial Officer]

The majority would still be able to be so, Michael. It's not a binary thing across the whole portfolio. There will be some exploration issues in, but the majority would still be available for sale.

[Michael Jungling, Morgan Stanley]

Great. Thank you.

[Roland Diggelmann, CEO]

Maybe just one more comment on the savings. I think from a management perspective, I think what's important for us is that we find the right balance between the savings and then of course investing such that we are in the best possible shape for the recovery, because we all know the recovery will come. The fundamentals are positive. The question is when, and in what shape are we and that's why we've taken some deliberate decisions to also protect the R&D line to ensure that we're ready with new products, innovation, but also with the sales capability for when the markets restart. And again, that restart is something that has a lot uncertainty and that looks very different in different geographies, just looking at the U.S and China, then at some markets in Europe. So it comes down to individual decisions at the market level, but we want to make sure that we are very ready and very strong when the markets recover.

[Michael Jungling, Morgan Stanley]

Very good color. Thank you.

[Roland Diggelmann, CEO]

Thank you, Michael.

[Operator]

Thank you. Your next question comes from the line of David Adlington from JPMorgan. Please ask your question.

[David Adlington, JPMorgan Chase]

Hey, guys. Thanks for taking the questions. I’m afraid a couple of numbers clarification points, please. I just wanted to check the $50 million splits of provisions and I may have missed it. But the split between the trade receivables and inventory, and just double check the inventory sitting and cost of goods and receivables within sales and marketing. Secondly, just in terms of the technical guidance, because the slides are missing again. Just wondered any updates there particularly with respect to your foreign exchange, please.

[Ian Melling, Interim Chief Financial Officer]

Thanks, David. So just on the numbers of the -- about $50 million of provisions, the majority is inventory. Very rough cut, 80% inventory, 20% bad debts. The inventory charges are in cost of sale, bad debt charges are in SG&A within the P&L. And foreign exchange, there's no significant update, David, but we will follow-up with you offline on that one.

[David Adlington, JPMorgan Chase]

Okay. The next question comes from the line of Veronika Dubajova from Goldman Sachs. Please ask your question.

[Veronika Dubajova, Goldman Sachs International]

Good morning, gentlemen and thank you for taking my questions. I'll start with one and then I'll have a follow-up. Just kind of curious, Roland, to get your thoughts and when you look at the pace of recovery and in particular, sort of what you're seeing in July in the U.S, what do you think is a realistic timeframe for the business to return to growth? Just as sort of approximate guess on when you think you might be at a point, where, on a year-on-year basis, the business is back to growth, I mean, assuming no second wave or large outbreaks somewhere.

[Roland Diggelmann, CEO]

Thank you, Veronika. You're obviously asking the big question here. That -- I wish I could give you a precise answer. I think we just don't have enough data points to give you a very precise answer. What I can tell you is that the markets in the U.S have recovered quickly. I think there is a common incentive by all stakeholders to return to a certain sense of new normal. We've seen patients being willing to go back to hospitals, which has not been the case in other markets, or to a lesser extent. We have also seen all 50 States allowing elective surgeries again. We are also seeing that even when new lockdowns or new restrictions are introduced, since everybody has learned, this doesn’t necessarily mean that elective surgeries are not performed or delayed again. So we’re seeing a lot of positives in the way the market has recovered and the speed it has recovered in the U.S. But I wish I could give you more precise information. I can only give you a little glimpse into what we’re seeing in July, although the month hasn't finished, of course. But we’ve seen a very good trend and a very good continuation of that initial trend in the months of July as well.

[Veronika Dubajova, Goldman Sachs International]

And sort of my follow-up on this is, we're hearing, I think a lot of the surgeries that are happening now are effectively rescheduled backlog that docs are working through. Do you have a sense for what the new demand generation looks like? So I'm thinking about ambulatory visits that are sort of leads into surgeries two, three months from now. I think some of your peers have kind of discussed the risk of maybe a W shaped recovery. So we have a strong rebound, but then a dip down once that backlog works through. How are you guys thinking about it? And maybe if you can share some anecdotes from the ground on what you are seeing in terms of that new demand funnel?

[Roland Diggelmann, CEO]

Yes, let me try and I think it's anecdotal information that I'm sharing here, of course. What we have indeed seen is once the restrictions were lifted and elective surgery was possible, the pickup was very, very high and very quick in the U.S. I think there was a pent-up demand and I think it is possible that there will be a bit of, you call it a W shape. I'm not sure how exactly that would look like. Anecdotally, what we're hearing is that physicians are seeing a good pipeline of new patients. They're also investing more time there. They're working longer hours, they're working more days. They're scheduling more OR capacity to accommodate for both for managing the pent-up demand and then managing the ongoing new patient demand. So I'm optimistic and positive, especially for the U.S.

[Veronika Dubajova, Goldman Sachs International]

Understood. Thank you guys very much.

[Roland Diggelmann, CEO]

Thanks, Veronika.

[Operator]

Thank you. Your next question comes from the line of Tom Jones from Berenberg Bank. Please ask your question.

[Tom Jones, Berenberg Bank]

Good morning. Thanks for taking my questions. I have two. One was just about the current recovery. We discussed that the demand side of the equation quite a lot. But I wondered if you'd like to make some comments on the supply side. Clearly there's an incentive for, physicians in the U.S., et cetera. to get back to work. But is there a risk that we end up not ever being able to get back to 100% capacity unless we make some significant changes to health care systems? I guess what I'm alluding to are things like enhanced cleaning protocols, more patient separation, et cetera, et cetera, reducing the overall functional capacity of operating departments, even if they are working longer hours, as you said. I know there's certainly been an issue in the U.K where a lot of hospitals are back to operating, but at a much, much reduced pace due to the enhanced COVID protection protocols they have in place. So just some comments on the supply side would be good, if you can. And then I have a follow-up.

[Roland Diggelmann, CEO]

Sure. I think what we have seen is the health care systems reacting quite quickly to this new situation with enhanced protocols, with admissions to hospitals was all the way to managing the way visitors are allowed into hospitals or not. So I think that's been done remarkably quickly and was very different -- very different individual approaches, of course, and also different in geographies. But I think the system has been quite agile here to react to this. Overall, again, I mentioned the fundamentals remain strong, patient demographics, access to health care and Emerging Markets, I think this is -- remains unchanged. So I'm optimistic for the mid and the long-term. The question now, of course, is how we get there. We're also seeing certain health care systems, for instance, in China and other markets reserving some extra capacity in the event or in the possible event that they were to be a second wave. And I think in particular, in Europe, the main driver here is patient confidence to going back to hospitals. This has been something that hasn't -- we haven't seen much in the U.S., probably more in the -- in Europe. How do patients go back to hospitals and are they willing to go back for planned surgery? Of course, again, a trend to decentral care and ASCs is helping here. There will be, I think, an amplified or accelerated trend to specialization as well to patient stratification, to having -- I would call it the good patients in one setting and the more complex surgeries in other settings. So all of this will have an impact. But what we've seen so far overall and in summary, is actually the system being able to cope with that in a good way. And then, of course, at the end of the day, the clinical need doesn't go away. So we -- that's why we remain very optimistic.

[Tom Jones, Berenberg Bank]

Okay. Perfect. And my second question is really kind of big picture post-COVID one. There's a lot of talk about the new normal, but I wonder, from your experience so far, what permanent changes to your industry, to your business, do you think COVID might precipitate? You've already alluded to the shift to ASCs and I guess that was a trend that was there that’s now been accelerated. But I would be interested to hear your thoughts on what other permanent changes might ensue from this pandemic. Maybe thinking marketing expenses become significantly lower, if you can do a lot more remotely, whatever it might be, just interested to hear what you think the new post-COVID world looks like for your industry and your company?

[Roland Diggelmann, CEO]

Yes, thank you. It's a great question, Tom. I think, of course, there are some trends that I think will sustain. We have an entire program internally that looks at exactly that. And how will the new normal actually look? A lot of those trends that were there before I think will be accelerated or amplified. The trend to ASCs is one. This trend -- the trend to robotics is another one, reduce the number of instruments, for instance, but then more generally, how we engage with customers that will change. It's difficult to assess how we will change exactly, but we have now learned a lot how we can keep in touch with our customers, how we can engage with them through digital needs or means, excuse me. What we'll certainly change and continue to change is how medical education is being delivered again through digital means. The large meetings, I think, or the fact that health care professionals will probably travel less, be less attending physical meetings, physical training events, training through augmented reality and other means will certainly accelerate. And then finally, also internally, we'll have -- we have made really good experiences with how we actually train and educate our sales force. I think that's also one of the trends that will sustain. So a lot of opportunities here. As you've certainly heard, there's also opportunities to deliver certain services in a less costly way, reducing the overall meeting, convention, training, travel expenses, et cetera and everything, every crisis also offers an opportunity here. We continue to monitor this very closely and we've actually had really good experiences with some of these remote engagement opportunities with customers alike, as with our sales force and our own employees.

[Tom Jones, Berenberg Bank]

Good. That's very, very helpful. I'll get back in the queue.

[Roland Diggelmann, CEO]

Thanks, Tom.

[Operator]

All right. Thank you. And your last question comes from the line of Oliver Metzger from CommerzBank. Please ask your question.

[Oliver Metzger, CommerzBank AG]

Yes. Hi, good morning. One question left from my side, it's on Wound Bioactives. Some in the past, we saw this very high underlying growth rates at Osiris out of corona. So could you give us an idea how the business performed now during crisis compared to your legacy Bioactives portfolio? And which are your expectation how fast Osiris -- of Osiris business will return to growth again?

[Roland Diggelmann, CEO]

Yes, thank you, Oliver. Osiris are the products from the Osiris legacy have actually underperformed relative to the overall advanced Wound Management business. I think there's been a couple of reasons here. First of all, we were very early in the process of integration, so we are very positive now. We have taken this opportunity to cross-train the sales force from both Osiris and Smith & Nephew legacy so they can sell both ranges of products. I think that increases the access to the market. The second access to market that we will certainly improve or achieve, we will be selling the product outside of the U.S. So far, Osiris hadn't been selling outside of the U.S. This is a process because it's registration dependent and this is a Bioactive. So the pathway is different in different markets. And then, of course, the most important reason is that the product from Osiris are linked to surgeries and surgical events. And as we've had many fewer surgeries, of course, there was a direct impact on the usage of those products. But again, as I mentioned earlier, I'm very positive we're only at the beginning of the sales synergies here and we have a very active role to play in the areas of Bioactives and Wound.

[Oliver Metzger, CommerzBank AG]

Okay. Thank you very much.

[Roland Diggelmann, CEO]

Thanks, Oliver. Well, thank you all for your questions. Before we close, thanks again for your questions, for your interest as always. You will shortly be receiving an invitation for our virtual investor event. This will be taking place on September 8. We will be having the opportunity to talk some more about -- some really exciting innovations, some of the pipeline at Smith & Nephew, in particular, of course CORI and the robotics endeavor. And we hope to speak to many of you then. Thank you very much.

[Operator]

Thank you. That does conclude our conference for today. Thank you all for participating. You may all disconnect.