Smith & Nephew PLC

LSE:SN

Earnings Call Analysis

Company Raises Revenue Growth Guidance

The company has raised its underlying revenue growth projection from 5% to 6% to 6% to 7%, enabled by strong performance, Orthopedics advancements, and gains in sports and advanced wound medicine. Full year trading margin guidance remains steady at a minimum of 17.5%, taking into account headwinds from input cost inflation but balanced by productivity improvements.

Smith & Nephew Second Quarter and First Half Results Signal Positive Momentum

Smith & Nephew, a medical technology company, announced a strong second quarter with broad-based growth across all business units. Deepak Nath, the CEO, highlighted improvements in Orthopedics and sustained momentum in Sports Medicine and Advanced Wound Management. These results have led to an increased full-year growth forecast. The U.S. market moderated after an exceptional first quarter, but this was more than compensated for by global improvements. The margin for the first half aligned with projections despite the zenith of cost pressures due to the macroeconomic environment.

Financial Performance and Expectations: Revenue Uplift and Margin Guidance

The quarter's revenue reached $1.4 billion with a 7.8% underlying growth and 6.6% reported growth. Emerging markets, especially China, showed a noteworthy recovery. A 5.8% growth in Orthopedics was seen, with Other Reconstruction driven by robotics adoption. Sports Medicine and ENT maintained double-digit growth, while Advanced Wound Management grew by 6.2%. For the first half, revenue was $2.7 billion with a gross margin of 69.8%. Operating expenses outpaced sales growth leading to a trading profit margin of 15.3%. The reduction in adjusted earnings per share by 8% to $0.349 and unchanged interim dividend reflect higher interest expenses and working capital outlay. The full-year revenue guidance is now targeting 6-7% growth, up from the previous expectation of 5-6%. The company expects a trading margin of at least 17.5% for the full year, absorbing a 120 basis point headwind from transactional FX.

Inventory and Debt Analysis: Inventory Build-up and Net Debt Increase

There was notable inventory growth associated with the business's expansion, primarily due to supporting the growth in Negative Pressure Wound Therapy and accumulation of undeployed products and instruments. This was further compounded by raw material purchasing to mitigate supply disruption. However, improvements in the global supply chain are anticipated to decrease future raw material inventory levels. The first six months showed an increase in net debt to $2.8 billion, and debt to adjusted EBITDA ratio ended at 2.3 times within the company's target range.

Operational Improvements and Productivity Gains

The company has initiated and reported substantial productivity gains, attributing around 150 basis points to operations and procurement savings and another 100 basis points to restructuring and other cost initiatives. The first half headwinds are not expected to repeat, with transactional FX projected to neutralize in 2024. This period is hoped to represent the peak of input cost inflation pressure. The overall margin uplift is expected from a combination of stronger historical margin seasonality in the second half, ongoing productivity improvements, and cost reduction initiatives, including the 12-point plan. This is anticipated to offset a modest increment in cost inflation with an 80 basis point impact from first-half inventory boosts.

Strategic Evolution and Leadership Changes

Smith & Nephew is transitioning into a higher growth entity with better market share leveraging technology, and aims to achieve a 20% trading margin by 2025. The progression of the 12-point plan underpins this goal. The company's move from the franchise to business unit structure promises greater accountability, speed, and operational efficiency. In line with these changes, they announced leadership shifts, including the appointment of Dr. Vasant Padmanabhan to oversee R&D and ENT and welcomed Dr. Rohit Kashyap as the new President of Advanced Wound Management. The company is poised to continue building upon its existing strengths with these leadership changes.

Deepak Nath Speaks on Revenue Forecasts and Long-term Targets

Regarding revenue, the company's assertion for enhanced guidance is primarily driven by exceptional commercial execution. Furthermore, there has been positive price momentum contributing to an expected total increase of around 220 basis points deriving partly from the 12-point plan. In terms of CORI system utilization, the company reports an improvement in the figure previously set at 20%. This level of CORI utilization underlies the strategic importance placed on driving the full Orthopedics portfolio. Nath reaffirms full confidence in meeting the medium-term margin goal, underlined by concrete initiatives rather than mere projections.

Anticipated Margin Step-Up and Cost Management

The planned second-half margin step-up is supported by typical seasonal effects, leading to a higher activity level and anticipated cost reductions without incremental cost increases. In the absence of significant new product launches or commercial initiatives in the second half, this margin expansion will mainly be driven by historical trends, productivity improvements, and the unwinding of first-half costs.

Earnings Call Transcript 2023-Q2

[Deepak Nath, Chief Executive Officer]

Good morning. Welcome to the Smith & Nephew Second Quarter and First Half Results Call. I am Deepak Nath, and joining me is Chief Financial Officer, Anne-Francoise Nesmes.

I am pleased to report another strong quarter of growth. In Orthopedics, we’ve improved our underlying dynamics and are set up to accelerate growth in the second half. The momentum in sports medicine and advanced wound management has continued. So these results have given us the confidence to increase our full year growth guidance. We saw the moderation we expected in the U.S. after a very strong Q1, but that was more than offset by improving execution globally and the increasing ability of our organization to take part in stronger markets. Margin development in the first half was in line with our expectations, and this should represent the peak of the macro-driven cost pressures.

In the second half, we expect a clear step-up in both trading margin and cash generation, as we drive productivity gains and start to bring down days of inventory. And importantly, we’re continuing to build the foundations for sustainable performance by delivering a 12-point plan. Overall, I’m pleased with the progress of the plan. And as with any initiative of this depth and breadth, there are varying degrees of completion, but most elements are either on track or ahead, and we’re already seeing the benefits coming through. Product availability in Orthopedics, was much better than it was on the back of our own operational improvements, although external supply interruptions and shortages continue to hold back overall group performance. Later on, I’ll share with you the updated KPIs on operations and how we’re positioned to convert those into better outcomes in the coming quarters.

So our high cadence of innovation has continued right across the portfolio, and we’ve added new growth drivers in robotics and in extremities. We’re also pleased with our progress on a number of other initiatives, including order to cash excellence, pricing management and the pursuit of cross-unit – business unit deals in ASCs.

For now, I’ll hand over to Anne-Francoise to take you through the detail of the quarter. Anne-Francoise?

[Anne-Francoise Nesmes, Chief Financial Officer]

Thank you, Deepak. Good morning, everyone. So I’ll start with the second quarter revenue, which was $1.4 billion, representing – dollars, representing a 7.8% underlying growth and a 6.6% reported growth. Performance was broad-based, with all business units and all regions contributing. I’ll come to the detail in a moment, but you can see that Orthopedics accelerated compared to Q1, and Sports Medicine and Advanced Wound Management continued to perform well.

Looking by region, established markets growth has remained above historical levels. Our U.S. business grew by 6.3% following a very strong first quarter. Other established markets maintained their performance and grew 8.5%, with elective procedure volumes remaining at a high level across Europe and Asia Pacific. Emerging markets grew 11%, largely driven by recovery in China, where surgical activity returned to more normal levels after COVID outbreaks earlier in the year.

I’ll now go into the detail of each business unit. Orthopedics grew 5.8% underlying. Growth in knees and hips reflected us lapping the impact of VBP. As a reminder, the lower VBP pricing from the tender was gradually implemented during the second quarter of 2022. So while China still reduced growth by around 2 points in knees and 4 points in hips, that headwind fall away for the rest of 2023.

Other Reconstruction growth of 21% was driven by the ongoing adoption of robotics, and our installed base of capital is increasingly nicely across both hospitals and ASCs, passing 650 units in total with a growing funnel. And customers are showing their confidence in the platform by buying second and third CORIs in multi-system deals. The range of surgical applications is being recognized, with the majority of deals, including our hip software. Trauma and Extremities grew 2.5% on the line. This was the first quarter after lapping the trauma exit in China. And there should be further growth uplift to come as we lap other markets exit in the second half.

Looking beyond those effects, we can see our investments are starting to pay off. U.S. Trauma grew 7% in the quarter with EVOS launch pace both driving growth and showing the value of a complete solution by pulling through the use of small plates. In Extremities, we reached another innovation milestone with the 510(k) clearance and the launch of AETOS, our next-generation shoulder.

Improving Orthopedics performance has been a key priority, and we are now seeing multiple trained Breakers lining up in quick succession. And Deepak will cover shortly the progress we’ve made in improving implant availability, and we’re resolving supply chain challenges that we meet in our instrument deployments in the quarter. We have the highest pace of CORI sales activity we’ve seen. EVOS growth has accelerated already and AETOS shoulder makes us competitive for the first time in that large and high-growth category. So putting this all together, we’re excited of what’s to come for Orthopedics in the coming quarters.

Now moving to Sports Medicine and ENT, which grew at 12% based on a multiyear stream of innovation across both capital and consumer, both playing an important role. Product availability remains somewhat of a constraint in the quarter with restricted capacity at some component suppliers. However, we were still able to drive an attractive level of growth. And looking by segment, joint repair grew 12.5% with broad-based strength across procedures and region. REGENETEN, our shoulder repair products and our knee repair portfolio all grew at double-digit growth, with knee growth helped by the new ACL solutions that we launched earlier in the year.

AET grew 4.6% in the quarter, with WEREWOLF Fastseal and mechanical resection, both being major contributors, offsetting a slower quarter in video. And of course, I know there is interest from many of you in the development – in any developments in – around the VBP in China. Our team remains in close contact with the Chinese government, and we expect a policy to be finalized later in the year. ENT growth of 38.9% reflects the continued post-COVID recovery in our core tonsil and adenoid business. We expect to return to a more normalized level of growth later in this year, as we lap more of the market recovery. So ENT continued to be an attractive growth area beyond this for us.

Now moving to look at Advanced Wound Management, which grew 6.2% underlying. Within that, Advanced Wound Care grew 2.7%, mainly driven by our foam dressings and a strong quarter in Europe. Bioactives with 3.1% underlying, with a slower growth in Q1, mainly reflecting a normalized prior year. And skin substitute remains the primary driver of bioactives. Our portfolio has been growing ahead of the market and we believe the outstanding clinical evidence around graphics in particular, positions us for continued strong performance.

Finally, Advanced Wound Devices grew 21.4%, reflecting double-digit growth from both our traditional and single-use platform, with similar drivers to recent quarters. In the traditional segment, we are driving account conversions to RENASYS with a good pipeline of other opportunities, and we’re continuing to expand the single-use market with increasing penetration of PICO. Accelerating growth in negative pressure is a key component out of the 12-point plan, as you know.

Now I’ll move to the financials for the first half. Revenue was $2.7 billion in the first half, up 7.3% on an underlying basis compared to H1 2022. Reported revenue was up 5.2%, including a foreign exchange headwind of 210 basis points from the strength of the dollar against major currencies. As you can see in this chart, growth was balanced across all businesses, with all three units contributing.

Now moving to a summary P&L for the first half. Gross profit was $1.9 billion, resulting in a gross margin of 69.8%, which is a 110 basis point decrease from the prior year. Operating expenses grew faster than sales, driven by increased spending on sales and marketing, and this results in trading profit of $417 million with a margin of 15.3%. I’ll explain the drivers of the lower margin on the next slide.

Slide 12 shows a more detailed trading margin bridge. There were 3 major headwinds, compared to the first half of 2022, with the first 2 representing what we expect to be the peak of the macroeconomic pressures. They were around 400 basis points from raw material and staff cost inflation, and another 120 basis points from transactional FX. And as you know, the transactional FX is a result of a strong dollar on a disproportionately dollar-based manufacturing cost base, delayed from our hedging program. The final headwind was around increased selling and marketing spend, as part of refreshing our commercial approach for growth in orthopedic transport and came to 110 basis points. But there were also significant positive offsets in the first half. We saw around 220 basis points of positive leverage from volume and pricing growth, and around one-third of which was driven by the 12-point plan. There were also significant productivity gains with around 150 basis points from operations and procurement savings, and 100 basis points from other cost savings initiatives, including restructuring.

And I’ll come to the outlook in a moment, but one thing you can see from this bridge is that one – the headwinds are here to stay for some time. The headwinds are either one-off in nature or should significantly ease over the next period. The increase in Orthopedics and Sports commercial spend is not intended as a repeating exercise. We currently expect transactional effects to be broadly neutral in 2024, and this first half should represent the peak of the pressure from input cost inflation.

Looking further down from the P&L, adjusted earnings per share declined by 8% to $0.349. That’s slightly more than trading profit mainly due to higher interest expense with our average net debt higher than in the first half of 2022. The interim dividend of $0.144 per share is unchanged. Trading cash flow in the period was $110 million, with trading cash conversion of 26%, but is lower than in 2022, due to working capital outlay of $326 million. And whilst we reduced our receivables as a result of the order to cash initiative in the 12-point plan, the biggest driver of the capital – working capital increase, is the first half – in the first half was inventory.

So let’s look at the inventory movement and there are three main drivers to the increase that we expect to reverse. Firstly, we’ve added some stock to support acceleration in negative pressure wound therapy. This is a compelling opportunity for the business that carries some upfront inventory requirement that we expect to gradually consume as the segment grows. In addition, we’ve had some accumulation of both products and instrument sets that are not yet deployed, and are currently being held as inventory. This is a result of ongoing supply constraint for a small number of components, which hold back assembly, set deployment – set completion, sorry, and consequent deployment. And Deepak will cover in a moment that we expect to accelerate deployments in the second half, which will start bringing down the inventory.

And then within this driver of inventory growth, we’ve also had some excess factory inventory from spot buying of raw materials to protect our manufacturing against external supply disruption. And while there are still some areas with tight availability, general improvements in the reliability of global supply chains, mean that we are now able to bring in tighter controls on raw materials buying and we can certainly see the level of raw materials inventory coming down in the future.

And finally, as you would expect, there has been inventory growth tracking the overall growth of revenue. And that component is neutral to the ASI, but we should still see improvement in that portion, as we execute the 12 point guide. And much of our inventory, as you know, sits in Orthopedics. But this is not a driver of the difference in the quarter or in the first half, but we are continuing to focus on driving down the Orthopedics inventory. And overall, we are committed to bring in DSI lower, and you should expect to see clear progress by the end of the year.

Now to conclude on the financials, net debt ended the half year at $2.8 billion. This is an increase of $314 million from the start of the year, including $201 million we paid for the final dividend of 2022. The effect of liability leverage finished the half at 2.3x adjusted EBITDA, which remains within our target range of 2x to 2.5x.

And now I’ll finish with our updated guidance for the full year. On revenue, we are now targeting underlying growth of 6% to 7% versus our previous expectation of 5% to 6%. This reflects our strong growth in the first 6 months, further operational improvements in Orthopedics as we execute the 12-point plan and continued outperformance in sports and advanced wound medicine, while also recognizing the more difficult growth comparators in the second half of the year.

Our guidance for the full year trading margin is maintained for at least 17.5% with headwinds from input cost inflation, offset by growth in productivity gains. I’d highlight that we expect to deliver this target also, after absorbing 120 basis point headwind from transactional FX. Our outlook, therefore, represents what would be substantial margin progress on the constant currency basis. I am sure that you’ve also worked out, that our guidance implies a step-up in the second half of the year. In line with our previous commentary, that our guidance was H2 weighted margin and cost pressures would peak in H1.

So to give more perspective on the driver of the step up, Slide 18 details the components of the margin expansion in the second half. Part of the step-up is a return this year to our historical margin seasonality. This should add around 270 to 300 basis points over the first half margin. And this year, we also expect a further effect of productivity improvements, accumulating over the course of the year. Our cost reductions, including productivity and the 12-point plan savings and the unwind of cost, should together come to at least a further 250 basis points of second half margin uplift. Incremental cost inflation should be relatively modest with around an 80 basis point headwind from the inventory uplift we made in H1.

So for what this will look like in your model, you should expect gross margin to be higher in H2 and our SG&A spend to be lower in absolute dollars than in the first half. And finally, as you think of EPSA, we have also updated in our technical guidance and expect the full year tax rate on trading results to be around 17%.

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

[Deepak Nath, Chief Executive Officer]

Thank you, Anne-Francois. I’ll start with a reminder of the transformation that’s underway at Smith & Nephew. Firstly, we’re becoming a higher growth company, with a target of consistent 5%-plus growth by 2025. That’s more than in the past, and we have a clear path to get there. We’re fixing the foundations of Orthopedics, ensuring the continuing strength of sports medicine and advanced wound management, which are already outperforming and converting the increased R&D investment into innovation-driven growth. Each of these elements is a step-up from where we were pre-COVID, which contributes to building a more attractive growth profile than we’ve had in the past. We are also committed to driving profitability and returning our trading margin to at least 20% by 2025. We’re coming through a period of elevated macro pressures, and we’re rebuilding a margin through manufacturing and COGS optimization, productivity improvements and growth leverage.

On Slide 21, the 12-point plan provides a detail of how we do this. We’re now approaching the halfway point of the 2 years, and Slide 21 is an overview of where we are today based on the milestone completion for each underpinning initiative. Taken as a whole, the plan is showing good progress. The varying stages of maturity reflect the breadth of the program, including some initiatives that could move forward immediately and others that by nature would need longer preparation, such as portfolio streamlining or manufacturing optimization. We are now well advanced with our work to rewire Orthopedics. We’ve refocused the commercial organization, simplified the [indiscernible] organization, introduced enhanced commercial processes and rolled out a new growth-oriented incentive structure.

Our renewed demand planning process is in place and starting to bear fruit, and our asset utilization is moving in the right direction, which set turns now around 30% higher than at the start of 2022. With better foundations in place and the delivery of key R&D projects in robotics and in extremities, we’re now poised to start delivering on that second block of initiatives, and win better market share with our technology.

I’ll drill into more detail of our progress in a moment, but on improving productivity, we’re quite advanced in our initiatives on value and cash processes. We’ve implemented better pricing across our portfolio, and as Anne-Francoise set out earlier, we’re driving DSOs down and inventory days are poised to follow in the back half of the year.

What will still take time is the work around manufacturing optimization. We’ve identified opportunities in our network, and there’s a process to follow before we can move ahead. The opportunities from simplification and the cost and asset efficiencies along with it, will come later in the plan. These initiatives represent an important part of the midterm margin target or margin improvement target. We’ve talked less about the initiatives to accelerate Sports and Advanced Wound Management. However, they are overseen by the same governance structures as the rest of the plan, and are being driven with the same urgency by their dedicated teams. With both initiatives being able to move quickly at the start of the plan, we’re starting to see progress in competitive conversions and negative pressure, and the pace in cross-business unit deals into ASCs, which has more than doubled just in 2023.

Orthopedics is still the single biggest lever for changing our financial outcomes, and it is where we’ve had the most work to do, particularly around commercial delivery. The good news is that the fix in our Orthopedics foundations is now well underway. Our KPIs of product availability have continued to improve and the charts update some of the metrics that we showed you with our full year results.

Firstly, the value of overdue orders has continued to fall. These have halved since the peak in 2022 and with another 25% reduction since the beginning of the year. We’ve also showed data on LIFR or line item fill rate. LIFR measures the percentage of customer orders that have been filled. So it’s an indicator of how well we’re meeting demand. Our target is to bring our non-set LIFR to a level that matches industry best practice. As you can see in the chart, our KPIs continued on its improvement path and has now progressed to about 85% of the way to our goal from the trough level.

The gap to our industry standard is now small, but LIFR for key priority products is actually moving in the right direction. In particular, EVOS SMALL has reached and maintained the target level and JOURNEY II, our key product in recon is more than 80% of the way there. An important part of how we’ve made this improvement has been the new planning process that we introduced a little over a year ago, better matching supply to demand at both the volume and mix level, has enabled these improvements in order fulfillment, as well as in other operational benefits.

So that’s happened alongside other measures, like improved logistics, with a 60% improvement in customer replenishment speed and significantly improved scores for the health of kits that are already deployed in the field. Putting all of that together, we’ve been able to reduce our total production, while continuing to improve product availability. And this, in turn, will ultimately enable reductions in inventory and manufacturing capacity.

To convert implant availability into sales growth, we now need to step up the deployment of new instruments to customers. The sheer number of components in an instrument set, makes this a complex process. So it relies significantly on third-party providers and just a single missing component could be enough to stop deployment. And that has been the case in recent months, with supply chain disruptions resulting in incomplete sets.

Even so, we already made good progress in resolving these challenges. For example, in trauma, which was a challenged area in Q1, we had more than a 3300% increase in EVOS sets deployed in Q2. So we expect this pattern of greater set deployment to also follow in hips and knees in the second half, and this is being supplemented by redeployment of around 10% of existing sets across our network. I referred to this last year around this time. So a greater pull-through of the more readily available implants should then follow.

So innovation is another key component of our growth funds. You may remember from when I talked about this in February that we expect more than half of our growth to come from products launched in the last 5 years. We also said that we expect to launch 25 new products in 2023, which is a clear step-up from our average over the previous 3 years of around 18. So I’m pleased to report that we’ve delivered 13 in the first half of this year, which is a notable inflection from our past and is well on track to deliver our full year expectation.

So that includes our AETOS shoulder system, which is an important part of our growth plans for trauma and extremities. AETOS is designed with both patient and surgeon benefits in mind. The MetaStem aligns with the market trend, to our minimally invasive short-stem devices. Short stems are easier to implant, have improved bone preservation and are a better fit to anatomy. Also, it’s compact trade system for procedures allows for shared instruments between the short stem, our existing long-stem shoulder, and also future options. So we’re continuing to work on a stemless variant and also to bring compatibility with CORI.

Financially, adding AETOS to our offering enables Smith & Nephew to be competitive in the shoulder market. This is one of the fastest-growing segments in Orthopedics, with a $1.3 billion market growing at around 9%. With this new shoulder opportunity, along with a completed EVOS platform in plates and screws, and the improvements in product and implement supply – instrument supply, trauma and extremities is well positioned to step up to a higher growth rate. We have also added a further feature to CORI, with a saw-based solution. So this provides an adjustable cutting guide based solution that fits into the existing CORI total need workflow and this without the need for additional incisions that come with traditional pins. These features allows or adds powerful versatility to CORI, appealing to an even broader range of surgeons, with varying preferences, by offering both milling and sawing as options. This is another step in our journey to adding features and functionality to CORI. So in recent quarters, we’ve highlighted the introduction of revision capability and a unique digital tensioner. And the addition of the saw solution highlights our intention to continue to build out CORI at an accelerated pace. The delivery of this project is a testament to the speed of innovation that’s being driven by the 12-point plan, as well as the agility of our teams in acting quickly to bring these features to market. So we just received FDA clearance, that’s in June and expect the rollout to begin in the second half of the year.

Finally, I want to mention a further development in our plans to strengthen the underlying foundations of the business and how we operate. With the early changes from the 12-point plan more settled, it’s now an appropriate time for us to move to a more focused way of operating. We recently began the realignment of our commercial model from franchises and regions to global commercial business units, with verticalized commercial teams for Orthopedics, for sports medicine and wound.

ENT is already operating in the structure. In my own experience and when I look across the industry, this is a better way of doing business. It drives greater accountability, faster decision-making and execution and increased customer focus in every area of our portfolio. The previous regional marketing organizations will also roll into the global business units. So we’ll have a single point of accountability for upstream and downstream marketing and sales, and better alignment and resourcing across regions and countries.

The business units are led by dedicated presidents for each of Orthopedics, Sports Medicine and Advanced Wound Management with full global P&L responsibility. In this structure, industry veteran Brad Cannon is solely focused on leading the transformational changes required in Orthopedics. Scott Schaffner, who is already leading sports medicine, joins the Executive Committee as Business Unit President.

We’re still committed to cross-business unit opportunities, and we’re driving them through the governance of the 12-point plan structure. Earlier this year, Dr. Vasant Padmanabhan expanded his role to President of R&D and our ENT business, which is already operating in this verticalized model. Vasant’s blend of clinical and technical expertise, business acumen and experience bringing novel therapies to market, will help strengthen our focus on ENT.

Last month, Dr. Rohit Kashyap, joined as President of Advanced Wound Management, following Simon Fraser’s decision to retire. Rohit is a seasoned customer and team focused leader, with significant global multifunctional experience in wound care and surgical management. Rohit’s career includes more than 20 years at Acelity, where he was one of the principal architects of the company’s strategy and led its execution. Immediately prior to joining Smith & Nephew, Rohit was President of Wound and Surgical Businesses and Chief Commercial Officer of MIMEDX, where for the past 3 years, has led the business’ turnaround and culture and performance to achieve consistent growth. Rohit is an example of the caliber of talent we’re seeking and attracting to continue to drive and deliver growth, and increase our potential as a company.

Others include a new Head of U.S. orthopedic sales and an operations team of orthopedic specialists that we brought together in 2022. So we have the opportunity to hear from the presidents in due course, including at our Meet the Management event that’s planned for November 29th of this year.

So in summary, I’m pleased with how the first half of 2023 has developed. We’ve delivered growth ahead of our plans, driven all three business units and have improved our fundamental positioning through the continued operational fix and turning our innovation investments into a greater intensity of new launches. There’s clearly still work to do in some areas. We’re in an early stage on our productivity initiatives and are stepping up our profitability and cash generation in the second half. As we deliver that, we will exit this year with momentum, that puts us solidly on course to meet our midterm commitments.

Before I finish, I would like to say a few words about Anne-Francoise, and her decision to step down as CFO next year. I am saddened to leave her as a colleague. I understand why she feels that as we make our progress with the transformation of Smith & Nephew, now is the right time for her personally to reflect upon what she wants to do in our next career. It’s hard to encapsulate the impact that Anne-Francoise has made on Smith & Nephew during her time as CFO. She was instrumental in us navigating the financial challenges in the pandemic, and in laying the foundation for the 12-point plan. She has also been a champion of our culture and purpose, and has been a strong leader.

On a personal rote, I am grateful for the support and the counsel that she has provided me during my time at the company. I’m also grateful that she has given us ample time, far-far more than she was required to for us to identify a successor and ensure a smooth transition. And it is good that we will have her for the next few quarters.

So now, I’ll take your questions or will take your questions.

[Jack Reynolds-Clark, RBC]

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

[Deepak Nath, Chief Executive Officer]

Yes. So let me talk about the revenue picture. Our step-up in the second half is reflects seasonality. But our confidence comes from the fact that our revenue growth has come across all of our business units. It’s Orthopedic, it was sports, so there’s room and we expect that to continue. So the primary driver for us, to increase our guidance is our own commercial execution. There is, of course, market tailwind, and that’s primarily an Orthopedics factor, and we expect to be able to better take advantage of that. As you’ll recall, we have not always been able to take advantage of that market tailwind in years past. So we expect to be able to better take advantage of that. But it’s fundamentally around commercial, execution that underpins that confidence and that step-up in growth in the second half of the year.

Pricing is a component of that. We’ve been – it is one of the elements of the 12-point plan. Actually Anne-Francoise has been personally leading that particular initiative. So there – it’s about our reaction to inflation and our ability to kind of pass along some of that price on to our customers. But the more fundamental work we’re doing, is actually greater price discipline across our portfolio, and that work should persist well past the current inflationary period. So that’s really the more fundamentals of our commercial execution that we plan to improve.

Around CORI, yes, please go ahead, Anne-Francoise.

[Anne-Francoise Nesmes, Chief Financial Officer]

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

[Deepak Nath, Chief Executive Officer]

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

[Hassan Al-Wakeel, Barclays]

Hi. Hassan Al-Wakeel from Barclays. I have three questions, please. Firstly, again on the management change, Deepak. We’ve clearly seen a lot of management change at Smith & Nephew over the years. I wonder if you can elaborate on why this is happening now, and particularly early on in your turnaround. And related to this, Deepak, do you remain confident on the medium-term margin that you’ve highlighted, given the significant ramp required beyond this year of – in excess of 250 basis points over 2 years?

Secondly, the strength in knees looks to be driven O-U.S. with U.S. growth of 2.8% below some of the peers who have already reported. What do you put this down to and how do you consider the cementless knee ramp in the U.S.? And then finally, I’d love some commentary around how you see the U.S. environment and backlog, has the increased utilization peaked? And when do you expect a more normalized level of growth? Thank you.

[Deepak Nath, Chief Executive Officer]

Hassan, the first question on management changes. So these – on the one hand, I talked about the importance of building a strong foundation for our business and the move from a franchise to a business unit structure is a key part of that. What I’m trying to achieve is greater accountability, greater levels of accountability in the organization, speed of decision-making, remove inefficiencies, delayering the organization and simplifying how we operate. So those are some of the thinking behind the move from franchises into business units. And I believe in my experience, they will stand us in good stead over the long-term.

In terms of the specific changes, some of those are associated with that move, but they’ve been independent things. So in wound, for example, Simon Fraser deciding to retire as a personal decision for him to retire, nothing to do with the organizational changes. So the appointment of Rohit Kashyap is a – as a result of Simon’s decision to retire. And I had previously talked about Brad Cannon, whose focus into Orthopedics, is a veteran of the industry with a long track record of success, given the scale of changes that we need to make in Orthopedics. I needed someone of his caliber, of his kind of track record focused solely on Orthopedics, and that has already yielded great benefits in terms of how we operate and the progress we’ve made on the transformation journey. So, each one of these changes has had a particular context around it. But taken together, I believe that we are much, much better positioned as a company.

And one final point on that, which I mentioned in my remarks. In operations, we’ve assembled a team within operations that are drawn from the industry. It’s the first time we’ve had such a group that are not only strong operations leaders, but actually come from the industry focused on driving the improvements in the operations area, that are key to us transforming Orthopedics. So taken together, I believe we will be stronger as a company moving forward. So that’s the ops or the management changes point.

Second, do I have confidence in the midterm guidance? Absolutely. We’ve maintained our guidance of at least 17.5% for the year. We’ve kind of given you what the components of that are from H1 into H2. I am fully confident on our ability to deliver that. And you asked about midterm and the latter up from 2023 on to 2025, we’ve provided some bridges in the past form, I think as a full year result. I am 100% confident on our ability to deliver to that. It’s not just words, but rather the initiatives to underpin how we’re going to get there. So that’s your second point. In terms of the comment on knees, you’re right, we had – compared to our peers who have reported so far, they clearly are ahead outside the United States than we are in the U.S. In the U.S., we are in the early stages of improving our operations. I talked about the appointment of a new U.S. sales leader that occurred in Q2. In addition to that, there is several other components of changes. First is, we’ve simplified the organization. We’ve delayered the U.S. organization. We’ve gone from having six regional heads in the U.S. down to three, and made further simplifications downstream in that organization, which is first component to that.

The second component is fundamentally, as I mentioned, our commercial processes. We’re not where you would expect us to be and the new process that was rolled out, starting in Q1 right through into Q2, are starting to bear fruit. But I do believe as the quarters’ progress, they will really start to pay off. The third piece is an incentive – a new change in incentives, where we had been in Orthopedics, primarily focused on retention. We now have incentive programs that are more growth-oriented and that is on the back of improved product availability that we’ve already seen, I’ve shown you some of the metrics around that, which is the third component of that. And fourth and final component is refocusing the efforts of our commercial team around our portfolio, right? That required some fairly intensive training that we invested in the first half of the year that we alluded to. So the combination of all of those things will start to yield. Obviously, the performance isn’t quite there in the U.S. yet, but I do believe we’re well positioned in the back half of the year. So that was, I believe, your third and final question. I think there was another one that I missed.

[Anne-Francoise Nesmes, Chief Financial Officer]

Cementless knee.

[Deepak Nath, Chief Executive Officer]

Hassan, Cementless knee. Yes. So we are seeing sequential improvements in terms of growth with our LEGION and CONCELOC. We obviously have multiple offerings in cementless. The JOURNEY ROX construct is an important component to that. So we’re pleased with the progress. We obviously don’t break out individual product or family sales, but we’re continuing to see good uptake in that area. Yes. I knew there was a fourth one I lost track of that. So fundamentally, our growth assumptions or the guidance that we provide, are based on our improved and improving commercial execution. Our guidance that we provided over the midterm, does not assume some exceptional tailwind, right? It’s built on more or less normalized kind of macro factors or procedure environment.

Having said that, we do see a tailwind. We saw that in Q1. We’re seeing that, obviously in Q2 to a lower level than in Q1. In terms of how long they persist or where they come from, whether it’s backlog or something else, we don’t really have the visibility to be able to call that, right, as a number four player in Orthopedics, as I’ve said in the past, where we’re going through the performance improvement program, it can be difficult to kind of sparse how much of it is you and how much of it is the market.

[Unidentified Analyst]

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

[Deepak Nath, Chief Executive Officer]

Sure. So with the 12-point plan, we are about where I thought we would be at this point of the year, we called out 45%. It’s based on progress in each of the underpinning initiatives and kind of relative to the schedule that we’re on, right? So it’s built up on a combination of those initiatives. So 45% about where we expect it to be. I’m particularly pleased with – and as I said, there’s some – for the most part, we are either on track or ahead in terms of KPIs, and that’s true right across the board. Having said that, there are some areas that are better than others. In terms of where I’m pleased, pricing has cleared an area we call that as one of the elements of the 12-point plan, very pleased with the progress there.

The order to cash initiative, very pleased with the progress that we’re making there. The cross business unit deals, which is the 12th element of the 12-point plan, both in terms of the volume of deals, the number of deals, I’m pleased with the progress that we’re making, right? We really are taking advantage of the opportunity we have in the ASC. So that’s the third one. Wound, we’re on track, I would say, against a fairly aspirational plan that we had around negative pressure.

Product availability, there’s two components to it. It’s improving LIFR, which is really tied to replenishment of sets, right, in Orthopedics is how well are we replenishing the sets that are already out there. You see the progress that we’ve charted that’s good. The part that’s not good with that is, driving down the sales – the DSIs related to it. That has been slower, but we understand why it’s slower and fundamentally, it’s because the – we’ve had supply interruptions, right, individual components in the Q1, that was cross-linked polymer, that are a key part of certain constructs that we were challenged in terms of supply.

So that inhibited our ability to complete sets or replenish certain portions of our sets. So there’s things that are set, as Anne-Francoise said, that are stuck in inventory, rather than being deployed in the field, right? So there’s good reasons for why it is where it is. But the underlying improvements in process around our commercial operations and really our manufacturing operations and ability to connect commercial and sales. That we’ve made tremendous progress in. And there, it’s moving from kind of high-level volume-based kind of forecast, to forecasts that are tied to mix, actual SKU level. And that’s the real improvement that we need to make in order to better match supply and demand. There, I feel good about the progress. But the KPI inventory, clearly, we’ve got work to do there, right? To give you an example where we are not, where we need to be.

In terms of have we needed to make adjustments to our plan, what I would say is not major ones. But having said that, there’s a very tight level of governance around this. It’s every 2 weeks that we meet, I chaired the meeting together with Anne-Francoise. And the reason we do that, is to make decisions at the pace that we need to make, to be able to run a program given the imperatives that we have for our improvement. So within the range of those, we’ve had to make adjustments and refinements, but not major ones. And that’s not because we’re loathed to making them, it’s because we’ve generally called it okay, right? So, if we need to make it, we’ll do so, we’ve got a mechanism to do it, but we haven’t needed to do it. So that’s the part. Your question around ASCs, about third of our CORIs are in the ASC channel. We’re seeing good growth, I think, 20% growth in ASC is in our recon business. So we’re all participating in the shift of procedures that are going from – in the U.S. from hospitals into the ASCs.

[Graham Doyle, UBS]

Thank you. It’s Graham Doyle from UBS. Can I ask some questions on the margin? So the vehicle margin was kind of historically weak. And I know we have mentioned in the start of the year it would be H2 weighted, but it’s also kind of like a historic step up in H2. So was this genuinely what you’re expecting, or is it sort of the bottom of the range of what you’re expecting for the first half? When I look at Slide 18 and you’ve got the building blocks up, even if I add those building blocks, I’m not getting to much more than 17.5%. So are we just less optimistic maybe than the start of the year than...

[Deepak Nath, Chief Executive Officer]

Yes, do you want to take that?

[Anne-Francoise Nesmes, Chief Financial Officer]

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

[Deepak Nath, Chief Executive Officer]

And just to accentuate the point, when we say expectations, this is what our budget was go to. So we truly are on budget to H1 of the year. I think the point is, some of the favorability in revenue that we had ahead of our expectations didn’t necessarily translate into favorability in margin, and we’ve kind of given you the bridge around that. But truly, our budget was – as we came in.

[Graham Doyle, UBS]

Yes. Maybe if we just think about next year, it’s just a broader question. There is obviously a big step, as a standpoint in terms of margin to get towards that target. But what happens if the order market doesn’t grow? You’ve got a big backlog. You’ve got a tough comp. And I know there’s obviously the absolute amount revenue will still be quite high, but you’ve got to say – you’ve got to go from taking very little share in the U.S., losing share to taking a lot of share. Is that in the plan?

[Deepak Nath, Chief Executive Officer]

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

[Operator]

Veronika Dubajova from Citi. Your line is open.

[Veronika Dubajova, Citi]

Excellent. Good morning and thank you, guys for squeezing me in. I have two, please. The first one is just Deepak maybe, to follow-on a little bit on the competitive environment and how you are feeling about your performance in orthopedics? And maybe you can tie this also to the changes that you have made to the sales organization in the U.S. year-to-date. Obviously, when we look at the growth rates, clearly, the gap between you and the peers has narrowed this quarter. I appreciate there is a lot of comp effects in there and noise. But do you feel you are starting to make progress versus where you were 12 months ago? And I guess maybe just talk to how the commercial organization changes, including the training program and the restructuring you have done year-to-date fits into that and really what your ambition is, as you move into back half of the year and into 2021? And then I have a follow-up after that. But maybe we can start there.

[Deepak Nath, Chief Executive Officer]

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

[Veronika Dubajova, Citi]

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

[Deepak Nath, Chief Executive Officer]

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

[Veronika Dubajova, Citi]

That’s fair and clear. Thank you, guys. I will jump back into the queue.

[Deepak Nath, Chief Executive Officer]

We can go back to the room, and then there is a couple of more questions on the phone line, I guess. So – good, one in the room.

[David Adlington, JPMorgan]

Hi. Yes. David Adlington, JPMorgan. Three please. So firstly, on the supply constraints, just wondered if you were able to give some more color as to what they actually are. How much of a headwind were there overall, and when do you expect to resolve? Second one on free cash flow, just wondering if any guidance for the full year, whether you expect to be in positive territory for the full year or not? And then finally, just in terms of – on Chinese VBP, the sports medicine, are you expecting any destocking ahead of that? And if so, is that factored into the guidance?

[Deepak Nath, Chief Executive Officer]

Sure. So, do you want to take the free cash flow one?

[Anne-Francoise Nesmes, Chief Financial Officer]

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

[Deepak Nath, Chief Executive Officer]

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

[Robert Davies, Morgan Stanley]

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

[Deepak Nath, Chief Executive Officer]

Do you want to take that...

[Anne-Francoise Nesmes, Chief Financial Officer]

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

[Robert Davies, Morgan Stanley]

Thank you very much. That was very helpful.

[Deepak Nath, Chief Executive Officer]

I am told there is one more on the line. Chris Gretler from Credit Suisse.

[Chris Gretler, Credit Suisse]

Hi. Good morning. Deepak, Anne-Francoise, thanks. I actually still have another three questions left. The first is just on the dressing business in wound care. Now, could you discuss that? It looks like at least from our perspective, that you are losing share there. So, could you maybe discuss how happy you are with the performance there? The second question would be on AETOS, on CORI? I think you mentioned that in your prepared remarks, could you maybe specify the timing when do you expect that to become available? And the third question is on – just on the cost inflation, given where we stand right now, how should we expect that go into ‘24, is obviously kind of easing substantially now in the second half, that headwind, maybe in order to just give you – if you could give us an indication there at the current levels, how that would impact your business? Thank you.

[Deepak Nath, Chief Executive Officer]

Sure. Maybe I will take the first two, and you can take the third one. So, in terms of – let me start with the second question, which is CORI on the shoulder. When do I – when would I want it, I would want it tomorrow, I had my brothers, but we have to sequence that in with the other CORI programs. We have made really good progress on knee. There is a couple more elements that are still coming on knee. There is a fairly robust pipeline of projects in hips that we need to prioritize. But I am quite excited about the applicability of CORI for shoulder, the anatomy of the shoulder, such that CORI is very well positioned to be – to play an important role in shoulder. We have recognized that opportunity. We have recognized that the form factor of CORI is well suited for the shoulder. So, it’s in place in terms of the pipeline. We just need to kind of factor in with other CORI programs we have in place. So, we will give you some visibility, a peek behind the curtain when we have the Meet the Management session in November. So, stay tuned for that. The first question now, Chris, just remind me, I just threw a blank there. AWC, yes, sorry, thank you. Maybe I should take notes. So, fundamentally about wound, it’s about our portfolio. You are right, there is some – with foams and dressings, you can parse this all different ways. But fundamentally, what I am actually pleased with is, how our portfolio in wound is performing. We have got the broadest portfolio in the industry. Not only is it broad, it’s actually quite rich in terms of what we have in each of our categories, right. So, our biologics portfolio is performing very, very well. Our skin substitutes business continues to be above market. This great data, clinical data that we have built up over a long period of time that’s fueling this growth. I feel very, very good about where we are positioned there. Negative pressures called out as a 12-point plan, a tremendous opportunity on the back of RENASYS, a refreshed portfolio there to drive really growth in that category. So, when I see those growth drivers line up, I do feel good. There is also quite a robust pipeline in wound, particularly around foams and dressing. So, I am very excited of what the future holds there. But when you add all of these things up, the story is one of each element of the portfolio plays its role, but it’s the totality, it’s the breadth and the richness that I am most excited about, is the source of our competitive advantage within that. In terms of cash, maybe you want to take that Anne-Francoise?

[Anne-Francoise Nesmes, Chief Financial Officer]

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

[Chris Gretler, Credit Suisse]

Thank you.

[Deepak Nath, Chief Executive Officer]

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