Smith & Nephew PLC (SNN) 2021 Q4 法說會逐字稿

Hello all, and a warm welcome to the Smith & Nephew Fourth Quarter and Full Year 2021 Results Call. My name is Lydia, and I will be your operator today.

Certain statements in this presentation 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 those statements due to a variety of factors. More information about these factors is contained in the company's filings with the Securities and Exchange Commission. (Operator Instructions)

It's my pleasure to now hand you over to our host, Roland Diggelmann, Chief Executive Officer. Please go ahead when you're ready.

Thank you, operator, and good morning, everyone and welcome to the Smith & Nephew Fourth Quarter and Full Year 2021 Results Call. With me is Anne-Francoise Nesmes, our Chief Financial Officer.

I'd like to make a few opening comments before we get into the details of the results. Also, I'm sure you'll have seen the announcement of me leaving Smith & Nephew and the appointment of Deepak Nath as new CEO, and I'll, of course, come back to that at the end.

We set out our Strategy for Growth in December to transform to a structurally higher-growth company and rebuild our trading margin. We've taken an important step already by delivering on the guidance we set in April last year on both revenue and trading margin. Renewed COVID outbreaks meant that external conditions weren't always ideal, so I'm really proud of the dedication of our team to stick to our financial commitments in 2021.

Four fewer trading days and Omicron wave made the fourth quarter complex to unpick, but when we look through all of that, it was a solid close to the year.

2022 will be about progressing our Strategy for Growth and taking the next step towards the midterm goals that we set out in December. You can expect to see us further strengthen the foundation by continuing to optimize our operations and drive productivity. And of course, we'll continue with a high cadence of innovation and product launches, which is a key component of sustainably accelerating our business.

Now moving to results, and I'll begin with the highlights of our full year numbers. Revenue was $5.2 billion, that's 10.3% growth on an underlying basis, taking us almost back to 2019 levels. Reported growth was 14.3% up, and there was 1 trading day less than in 2020.

Trading profit was $936 million, which is an 18% trading margin and 300 basis points expansion. We generated over $800 million trading cash flow and 88% conversion.

Adjusted earnings per share grew 25% to $0.809. And after maintaining our dividend in 2020, we are again proposing $0.375 for 2021.

Now looking specifically at quarter 4. Revenue growth was 1.5% reported and 0.3% underlying. A number of factors influenced the Q4 growth rate though. There were, as I mentioned, 4 fewer trading days than in the fourth quarter of 2020, which mathematically is a more than 6% reduction. And as you know, there were renewed outbreaks of COVID. Infection levels actually rose in Europe and in the U.S. as the quarter went on. New restrictions, and especially staff shortages in hospitals, resulted in slowing elective procedures from November in Europe, then December in the U.S. The effect on Smith & Nephew was that the typical December pickup in average daily sales didn't actually happen in 2021, and that was across our surgical business, with the weakness continuing into January. And by region, you see that the effects in the year-on-year declines for the U.S. and Other Established Markets, while Emerging Markets growth stayed relatively stronger at plus 8%.

There were some encouraging signs, though. Firstly, the [trauma] health care systems of being more resilient to new outbreaks has continued. Compared to pre-COVID levels, average daily sales growth for the quarter was still broadly similar to the year as a whole and average daily sales for Sports Medicine and Advanced Wound Management were still above 2019 level.

And then importantly, conditions are improving. U.S. infections seem to have peaked in mid-January and European countries have now also lifted many restrictions.

For the detail of the franchises in the quarter, I'll start with Orthopaedics, where sales fell by 2.6% underlying. As I mentioned, there was an impact from Omicron outbreaks across the surgical categories, particularly in hip, knee and extremity.

Then also hip and knee sales into the channel in China continue to be slow ahead of the VBP tender implementation this March. In total, the China destocking and provisions reduced revenue by about $25 million in the quarter and around $60 million for the full year.

And then supply constraints remained a further headwind, costing us around $30 million loss in the quarter, similar to Q3.

Recapturing our previous momentum in Orthopaedics is a strategic focus, and we're making good progress on the actions to improve performance. The rollout of the LEGION CONCELOC cementless knee is ongoing in the U.S. And as you know, not having a competitive cementless offering has been the primary drag on our Knee business. So filling this gap is another important strengthening of our foundation.

And then as I'll cover in a moment, we're going beyond that even with the acquisition of Engage Surgical, which makes us the only company with both the cementless total and UNI knees in the U.S.

And of course there is CORI. We're continuing to build the platform up with another good quarter of placement and we also obtained 510(k) clearance of the HIP software, which we then launched commercially in January.

The Sports Medicine and ENT franchise grew 2.4% underlying. As in Orthopaedics, we didn't see our usual December step-up in Sports Medicine volumes, with shoulder repair particularly affected. Again, though, remember that these growth rates are affected by trading days and so understate the strength in the franchise.

The contribution of new launch products really stood out in the quarter. In joint repair, FAST-FIX FLEX and WEREWOLF FASTSEAL are tracking well ahead of our plans as our LENS 4K and FLOW Wand in AET. 2021 launches are already adding significantly to the franchise growth rate.

33% growth in ENT was very pleasing to see. ENT has, of course, been one of the later categories to rebound from earlier COVID waves. Our adult business is back to above pre-COVID level though, and there's further improvement still to come from recovery in the pediatric business and then the rollout of our tympanostomy system, Tula.

Advanced Wound Management grew 2.4% underlying. It was another solid quarter given the impact of trading days in Omicron, with all segments still growing over 2020. And for the full year, all 3 were above 2019 levels.

Advanced Wound Care was a mixed picture, with double-digit growth in the U.S. and a slower quarter in Europe. By category, our (inaudible) business continued to grow faster than the overall segment.

Advanced Wound Bioactives grew 4.5%. And just to remind you, this is a segment that was in decline up to 2019, but that we've turned around with a combination of M&A and commercial execution. We're now seeing consistent growth for SANTYL, and that continued in Q4. The skin substitute business is also making progress, with average daily sales accelerating over the third quarter.

And then finally, Advanced Wound Devices continues to grow above the broader franchise even with the elective procedure exposure in negative pressure.

I'll now spend some time on the priorities for 2022, which are around advancing the strategy for growth that we announced in December. And as a reminder, we made midterm commitments that by concentrating our innovation and culture and customers, we'll consistently deliver 4% to 6% organic revenue growth and rebuild our profit margin. And to get there, we'll compound our outperformance in Advanced Wound Management and Sports Medicine and regain momentum in Orthopaedics.

The strategy, as you know, is based on 3 simple imperatives, which you see in the pyramid on Slide #10. The first imperative is to strengthen the foundation of Smith & Nephew. A solid base in commercial and manufacturing will enable us to serve customers sustainably and simply and deliver the best from our core portfolio.

Secondly, we'll accelerate our growth profitably through more robust prioritization of resources and investment and with continuing customer focus.

And then we'll continue to transform ourselves for higher long-term growth through investment in innovation and acquisitions.

We'll deliver these imperatives through our 4 key value builders, which are productivity, commercial execution, innovation and M&A. And our priorities for 2022 also read across these categories.

So on productivity, and moving to the next page, there are a range of activities ongoing to drive sustained improvement. Some of these are around immediate challenges, such, of course, as addressing the internal and external supply pressures that we've talked about before and reduce cost and a new go-to-market model for the Orthopaedics business in China, which is already in place.

The longer-term operations transformation program is also progressing. This work on our manufacturing and distribution will move us to a structurally more efficient and resilient supply chain over time. We have already moved to a specialist third-party logistics provider in Europe, and we'll make the transition in Memphis in 2022. Also, the new Orthopaedics facility in Malaysia is on track to supply this year already, and it is already -- and it is ahead of schedule, with multi-sourcing making us more resilient to future disruptions at any one site.

And finally, there is a portfolio simplification work that we set up in December around SKU reductions and prioritizing key profitable growth markets. This work is underway and benefits should start to come through more significantly from 2023.

The second priority is commercializing our '21 pipeline by launching effectively and at scale. We've shown already that where we bring meaningful innovation, we can move the growth rate of a segment, and we will build on this in 2022.

Some of the '21 projects are making important growth contributions already, as I mentioned, for Sports Medicine. And then others, we're just starting to ramp up, like the LEGION CONCELOC cementless knee, of course; EVOS LARGE plates in trauma, both with first procedures in Q4 of that year.

From here, it's about execution. We've been applying our improved launch processes more broadly and, ultimately, that will turn the increased R&D investment of the last few years into better financial returns.

Innovation remains a priority, and Slide 14 sets out some of the key projects for this year. I'd like to point out some important features. Firstly, we're still continuing high cadence of new products. That was the intent of the increased investment in R&D in recent years. Secondly, it's a broad pipeline with growth opportunities across the entire Smith & Nephew portfolio. And importantly, there is a good balance of project between incremental innovation and then disruptive technology. And let me just pick out a few here.

In robotics and digital surgery, there are a range of additions to further differentiate the CORI platform. Adding porous knee to CORI will help us in the rollout of the implant. CORI should also be the first robotic system to support knee revisions. And then we have a Tensioner as a really novel device for self tissue balancing.

There is also the next-generation shoulder, which is aligned with the trends towards bone preservation and simple procedures and an important component of the value of the Extremities acquisition.

In Sports Medicine, we're continuing to innovate to extend our leadership in the arthroscopy tower with further upgrades to mechanical resection and imaging.

And then in wound, we have the next generation of negative pressure devices. There's still a big opportunity here with our negative pressure portfolio, both from share gains and from market expansion in settings like surgical site complications. And a new generation here will help us capture more of that upside.

We're also continuing to pursue external innovation and continue to transform the portfolio through bolt-on M&A. We did announce the acquisition of Engage Surgical in January for up to $135 million. Engage is a further example of our commitment to innovation and the particular opportunity we see in cementless. The deal also aligns very well with the strategy we set out in December. It can shift to standard of care with what is the only cementless partial knee available in the United States. We also expand in a high-growth category, Partial knees are expected to grow faster than the overall knee market. And the cementless partial knee should grow faster than that again.

It's also a synergistic deal. The ability of sales reps to see surgeons with something completely novel will help them sell the whole of the knee portfolio. Over time, it can also be brought on to CORI. And of course, it is an excellent solution for the ASC. And then the returns are also attractive.

We'll focus on integrating the asset in 2022, then launch at scale in 2023, with ROIC then expected to exceed WACC in year 4.

So those are our strategic priorities for the coming year. Now I'll pass you over to Anne-Francoise Nesmes to take you through the full year '21 financials and then the outlook for 2022.

Thank you, Roland. So let me start with a summary P&L on Slide 17, where you can see that we are recovering from the worst of COVID in 2020.

At a high level, full year revenue at $5.2 billion grew by 14.3% on a reported basis and trading profit grew by 37% to $936 million for the full year, with an 18% trading margin. I will give more details behind some of these P&L lines in the next couple of slides.

On Slide 18, we show the details of the full year revenue, as Roland has very much focused on the Q4 revenue. As I mentioned before, total revenue was $5.2 billion, up 10.3% compared to 2020 on an underlying basis. Reported revenue grew 14.3%, including a foreign exchange tailwind of 210 basis points and 190 basis points from acquisitions.

As you can see in the chart, the contribution to growth was balanced across our 3 franchises. Orthopaedics grew by 6.4% on an underlying basis to $2.2 billion for the year. Sports Medicine & ENT grew by 14.6% to $1.6 billion. And Advanced Wound Management grew by 11.8% to reach $1.5 billion in sales for the first time.

When we compare to 2019, our Sports may be seen and Advanced Wound Management businesses returned to growth over the pre-COVID level, while Orthopaedics and ENT have more to recover.

Also, it would be helpful to describe on Slide 19 the levers impacting the margin, which improved by 300 basis points over 2020. As we have previously reported, there were headwinds to overcome. We saw around 40 basis points of initial dilution from M&A. The higher logistics rate and raw material costs that are being felt across the whole economy impacted our margins by around 30 basis points in 2021. And there was another 20 basis point headwind from transactional effects. And of course, not relating here, but we also invested behind new launches, as we see the result of our innovation coming through.

However, the positive leverage on cost of goods and SG&A expenses from recovering revenue more than offset those headwinds. It's also a reminder that there is leverage in our business model from high organic growth as well as potential from efficiency gains which we continue to drive.

And importantly, I'd like to highlight that we maintained R&D investment at around 6% of sales, in line with our strategic commitment to innovation.

Looking further down the P&L. Adjusted earnings per share grew by 25% to $0.809. That's ahead of sales growth, but below the growth in trading profit due to a onetime tax provision release in 2020.

Our trading cash flow was again strong at $828 million for the full year.

Capital expenditure, 7.8% of sales, including the continued changes to our manufacturing base and also investment in instrument sets to support further launches at cementless knee.

The return to revenue growth in the period resulted in a working capital outflow of $77 million. And as a result, trading cash conversion returned to a more typical level of 88%.

Given our strong cash flow, our net debt ended the year at just over $2 billion, as shown on Slide 22. That's an increase of $123 million in the year, net of the $230 million acquisition of the extremity Orthopaedics business.

Our recovering profitability meant that the leverage ratio came down to 1.6x adjusted EBITDA at the end of the year, leaving us with significant balance sheet capacity within investment-grade metrics.

And that financing capacity and our strong cash generation means we can both continue to invest behind our growth strategy in 2022 and beyond and still be able to return additional capital to shareholders. That's in line with the new capital allocation policy we announced in December which includes a commitment to a regular annual buyback. The buyback will begin in 2022, and we expect to return around $250 million to $300 million in the year.

Now moving to the outlook for 2022. For 2022, we are targeting underlying revenue growth of 4% to 5% for the full year. Within that, we expect stronger growth in H2 and in H1, and there are a few factors behind that timing. Firstly, we expect our business to be affected by COVID in Q1 2022 as the effect of Omicron outbreaks on Established Markets have continued into the first half of the quarter. Our guidance assume that demand is largely unconstrained by COVID outbreaks for the rest of the year, although staff pressures we currently see in health care systems are likely to continue. Also, whilst we mitigate the external supply challenges and address some internal ones, there will clearly be an effect on growth in the first half. More positively, we expect momentum in Orthopaedics and ENT to improve over the course of the year as procedures volumes in those markets continue to recover and as we see more benefit of our product launches, particularly the cementless knee.

On the trading margin, we expect around 50 basis points of expansion. Headwinds from VBP in China and cost inflation will be offset by operating leverage, productivity measures and improving acquired asset margin.

And finally, we expect the tax rate on trading results to be in the range of 17% to 18%.

So, I would now like to take a moment to go into more detail on the moving parts of the trading margin. The China VBP and knee tender is due to be implemented in March, as you know, resulting in a onetime rebate of our margin in 2022. We've now concluded our discussions with distributors and we have better visibility on the impact and the mitigations that we've been able to put into place.

Following our negotiation, we expect the pricing we received before for by around 50% in the affected categories, which is substantially smaller impact than the 80% headline reduction in prices. Secondly and importantly, we've taken steps to simplify our go-to-market model. Where we previously had multiple tiers of distributors engaged in both logistics and customer-facing activities, we've now simplified to a single logistics partner and just one tier of distributors involving customer activities. This simpler model reduces costs, improves commercial effectiveness for closer contract with distributors and simplifies inventory management. The net of this is that we expect around a 60 basis point group margin headwind from our China Orthopaedics business, in line with the earlier estimate.

You may also have heard about a regional trauma tender from '21, where the outcome is now being applied to other provinces. For us, China, Trauma, is a much smaller business and is only a fraction of a percentage point of group sales.

Higher-than-normal input cost inflation is a further headwind. Our assumption is our inflation headwinds will persist throughout the year. And while we look for pricing opportunities and mix benefits from innovation, we expect to have limited ability to see absolute like-for-like price increases in 2022. And we expect higher cost inflation to be around 125 basis point headwind for the year. However, and importantly, we expect to offset these effects and drive margin expansion of around 50 basis points, as I said before. Operating leverage from revenue growth, proactive productivity measures we are taking and the improving margin of our acquired assets should absorb most of the headwinds.

In the meantime, we're committed to our goal of a trading margin at or above 21% in 2024 and further improvement after that. Short-term headwinds should reduce. We'll continue with efficiency gains. And we expect enhanced positive operating leverage over time as the higher revenue growth from commercial execution and innovation comes through.

Now before I hand back to Roland, I would just like to say thank you, Roland. It had been a great pleasure working with you, and I wish you all the best in the future.

Thank you very much, Anne-Francoise. So to sum it up, I'm pleased with the steps we've taken towards our midterm goals by delivering on our '21 targets. And as 2022 progresses, you should see the strategy continue to advance. The efficiency and margin expansion will come, will continue, even against the short-term headwinds from VBP in China and from inflation. We'll advance the program to structurally improve supply chain resilience and we'll commercialize the pipeline from '21 and deliver the next wave of innovation across the portfolio.

I'd like to finish on a more personal note. It's been a privilege to lead Smith & Nephew over my time here. Working through the pandemic has obviously been a challenge for us all, but I'm proud of how the team has really pulled it all together. The team has stayed committed to our purpose and kept working to transform the company and continue to serve customers.

So when I look at Smith & Nephew today, the company is truly prepared for the opportunities in the coming years. We've acquired and integrated a range of new growth assets. We've put the commercial structures in place to serve the changing ways of delivering health care. And I'm really proud of the deep pipeline of innovation that's now in place across the entire portfolio. I think this is truly impressive.

I'd like to wish my successor all the best in leading this great company through its next chapter. And finally, I'd like to thank you all our investors and analysts for our interactions over the last 2 years. They've been much less frequent in face-to-face than I was hoping for, but it's truly been a pleasure.

So with that, thank you very much, and we can now take your questions.

(Operator Instructions) Our first question today comes from Hassan Al-Wakeel of Barclays.

I have two, please. So firstly, following up on margins, could you help us a bit more with the margin bridge in 2022? You mentioned, I think, 125 bps of cost inflation, 60 bps for China. What is being assumed for FX and the M&A dilution that should be easing as well as operational leverage? I'm just trying to understand why the margin guidance isn't higher and where you see potential upside risks here.

And then secondly, could you talk a bit about what you're seeing in terms of cancellations of procedures at hospitals? Has this peaked overall? And how is the staffing situation at hospitals, particularly in the U.S., impacting this?

Thank you, Hassan. Let me take the second question first. So what we are seeing is, of course, the infection rates coming down in the U.S., in Europe. We've seen quite a few restrictions being lifted in Europe, which will, of course, lead to elective procedures increasing. We feel that there is quite a bit of pent-up demand in the marketplace.

Now short term, we continue to see some cancellations differently than in the past because of the nature of Omicron actually which is much often less symptomatic. And what that leads to is actually cancellations closer to surgery because patients come to hospitals, they get tested, eventually they test positive and then the surgery has to be canceled. So these are more acute short-term cancellations that we see than in previous waves, but we believe this should ease as, of course, the -- as the number of infections continues to come down across the world.

Now Hassan, on the margin, as you've correctly said, we've guided to 50 basis points expansion. And I think the headwinds are important to note, in particular the VBP China, which is a one-time rebasing of our margin for 2022 and the 60 basis points inflation as well, 125 is material, it is significant. Having said that, we are being proactive. We've got teams looking at spot buys. We monitor inflation. And we're really being as proactive as we can be.

Offsetting that is all of the actions we're taking. And it's important to note that in 2021, we saw margin expansion from revenue growth from the operating leverage and the cost discipline that we have in the organization. So clearly, to drive margin expansion and offset the headwind, we need to drive the revenue growth, which would come through as well from the recovery, our new products, our commercial execution. And we need to drive our productivity agenda and the efficiency gains. And that will drive about 235 basis points to offset the headwind.

Now when you put that, maybe that's the gist of your question, clearly, when you put that in the context of what we've achieved in 2021, we clearly saw a large margin expansion of well over 300 basis points. But we feel that, as we've said, we -- the headwinds are actually more significant probably going into 2022.

You also had a question on FX. That's a fair one because we have previously said that we would expect a small tailwind. And as we move through the period, effectively, we are now mostly fully hedged, and we do not expect a significant transactional exposure in 2022 as we're very much fully hedged at this stage to the best we can.

The acquisition remains -- continue to be a little bit dilutive in terms of Integra in 2022. So the Extremities acquisition is dilutive in 2022, but that's not something that is that material that we wanted to bring to the attention.

So overall, we feel our guidance is our best view at this point in time, particularly in a world that remains still volatile around global supply.

That's very helpful. And if I can just please follow up on growth. How should we think about the relative growth within your guidance of the 3 franchises in 2022? And how about Q1? Given your commentary around H2 versus H1, should we expect a small improvement sequentially versus the fourth quarter?

So we -- in terms of what we've seen in Q1, and I guess you're going to tell me we're almost third of the way through, clearly, January continued to be impacted by Omicron in Established Markets. As I said, I think the infections peaked mid-January in the U.S. Many European countries have now lifted restrictions. So we did see some continued disruption earlier in the quarter, and that's what we've factored into our revenue guidance.

Clearly, for the rest of the year, we were assuming it's largely unconstrained by COVID outbreak. And the sensitivity will remain on the availability of staff, particularly in the U.S. where it's a little bit more acute, with shortages of all our staff.

In terms of the franchises, as you see, we will see Orthopaedics continuing to improve, particularly as we have launched the cementless knee. And Sports and Wound will continue their performance. And again, I want to reiterate, we are very pleased to see that they are above 2019.

Perfect. And all the best, Roland.

Thank you, Hassan. Appreciate it.

Our next question today comes from Tom Jones of Berenberg.

I had two questions really. The first was just on your 2022 revenue guidance in the context of the businesses it's performed between 2019 and 2021. I guess if I look at your underlying growth on the chart you've got on Page 5, you did minus 12% in ortho, sort of minus 2, 3 in the other divisions. Without COVID, you would have expected probably also to grow maybe 8% over that time frame. Sports Med probably something in the double-digit range cumulatively. And Wound, maybe mid-single digits. So depending on the franchise, there's somewhere between kind of 10% and 20% of the revenue that you would otherwise have expected that has gone somewhere. How much of that do you think is just straight pent-up demand? How much of that do you think is gone forever because of COVID? And how much of it do you think you've lost to competitors? I'm just trying to get a sense of kind of how much pent-up demand release you've baked into your 4%, 5% overall underlying growth guidance for 2022.

And then the second question is just on your guidance for 125 basis points of margin pressure from input cost inflation. I'm actually somewhat surprised by that number, more in the way that it seems quite low, to be honest. I mean if you look at your cost base of kind of circa $4 billion on a fully loaded basis, you're talking sort of 60%, 70%, $60 billion, $70 billion headwind at that level, which is sub 2%, which, given the wider inflationary environment, it looks like quite a low number. And even if I just look at physical input costs, probably 1/2, 1/3 of your total cost, you're still talking a low single-digit number. So I guess how confident are you in that 125 basis point headwind being as bad as it's going to get? Because it does seem like quite a modest impact in the grand scheme of the wider inflationary environment at the moment.

Yes. Thank you, Tom. On your first question on the revenue and how we built the plan, I would say, definitely, there is pent-up demand in the system. The question is how much it is, and that's very difficult to assess because we don't have patient-specific information here. But what we know is, of course, that in elective surgery, many surgeries have been deferred and we know that joint replacements are amongst the first ones always in every of those ways that were delayed or deferred. So there is a pent-up demand. There is a building of waiting list, in particular in the public sector, and more so in Europe than I would say in the U.S. And there is, of course, the underlying fundamentals, which are very much intact, which are the patient population continues to grow. And with that, there's a natural growth.

The challenge will be to see how quickly those waiting lists will be worked against. How quickly some of the hospital systems can return to full surgical volumes. And in the U.S., what the impact of the staff shortage will be, whether that's sustainable or more so acute.

Then I would say the reconstructed business, the joint replacement, hip and knees, I do foresee that all of those patients at some time come back because the patients are not end-of-life stage patients. They have these surgeries for a degenerative disease. And so they do come back. So we see very few lost patients in joint reconstruction.

It's a different story, of course, in trauma or in Sports Medicine as well. Those patients don't come back because it's acute surgery based on accident, sports injuries, et cetera.

So the last point I'd make, of course, when you look at -- when you compare some of our numbers against competition, we have been quite transparent about the fact that we have lost in knees due to not having a cementless knee. This is now corrected. So there's a level playing field, which we're really excited about. And I think we've performed well in hips, bar some of the supply challenges. And we've certainly done very well in sports and also in wound in the different categories. So that's why we are confident in the numbers for 2022.

And before moving -- sorry, Tom, are you going to follow up?

No, no, that's fine. I'll follow up in a second.

And just before moving to your inflation question, just to build on what Roland has said, is clearly the continued recovery will be more marked in H2. And whether you look at versus the 2021 comparison or growth or '19, we will see acceleration of revenue in the second half of the year.

Now moving to inflation, we've done a lot of work around that and particularly the teams in our operation. We've looked at the cost base and the key raw materials, which actually discussions were already ongoing. And we know precisely where inflation is hitting. And just to give you a couple of examples, electronic components have increased by 20%, an element of forging, which might not be on most of people's list, so that's an [11 point] price increase.

So effectively, we are assuming as well that we are countering and offsetting some of the inflationary effect. And as far as being very proactive and the team managing our purchases. So the 125 basis points sensitivity but that is based on where we know today, the prices have been under discussion. And indeed, that represents about 8% of all costs and not key materials. It does not include merit increase or a wage increase. That's important to note they use fuel raw material.

Okay. Perfect. That's clear. And then just a follow-up is kind of you mentioned (inaudible). On the supply chain issues that are affecting revenues, I think you mentioned in the presentation, you expect a gradual improvement in -- across H1. But could you just give us a little bit more color on specifically beyond if there's any franchises beyond hips that are affected and kind of the trajectory of that recovery. Is it kind of something that will resolve quickly? Or is it would just be a gradual improvement as the half progresses.

So I mean, the -- this is one that's the variable, and I think every company finds it very difficult to see -- giving timelines on when global supply disruptions will start. I mean, for us, it has been clearly on some of the components which initially impacted ortho more. But we use electronic chips in [sports], you can imagine in the tower, we use it in the pump for wound so -- and in robotics. So clearly, being proactive and making sure that we secure supply is key. So we expect that it will stabilize across the year. But that is one of the elements that we can't say for sure because we're dependent on suppliers and global conditions.

I'll just add here. We've also seen some supply constraints on raw materials, Anne-Francoise has mentioned that earlier. You think of resins, resins which are being used for sterile packaging, so it's our suppliers that have seen that constraint. We will continue to see some short-term impact. But we have been working very, very hard and diligently on the midterm here, and we already know that the situation will improve going forward.

Good. That's all very clear. And all the best for the future, Roland.

Thank you, Tom.

Our next question today comes from Veronika Dubajova of Goldman Sachs.

I have two, please. I just want to come back to the margin guidance. I think, Anne-Francoise, if I look at sort of the 125 basis points from raw material cost inflation, 60 bps from the VBP, you are calling for an underlying margin expansion in excess of 230 basis points on the top line dynamic that, frankly, isn't too dissimilar from what we've seen delivered in the past. And in the past, I think the operating leverage we would have seen in your business has been 30 to 70 basis points. This is quite a significant improvement. So I was just hoping you can decompose this a little bit for us in terms of what you're assuming from an operating leverage perspective versus efficiencies. And kind of what's your degree of confidence that these efficiencies come through? What are they dependent on? What are the risks? Because, frankly, it strikes me, given the headwinds that you have in the business, this is a fairly aggressive underlying margin improvement against the top line. So I'd just love to understand what's driving that.

And then my second question is just on the supply chain and the point of clarification maybe and again to push you both on this. I think the headwind this quarter was similar as last quarter. Have you resolved all the issues that you had in Memphis and the headwind this quarter is coming from issues other than labor availability? Or is there still -- are there still some remnants in terms of the labor headwinds that you had seen in Memphis earlier in the year? And then I guess maybe just related to that, how are you thinking about wage growth in 2022?

Veronika, in terms of the margin, I mean, it's important to make sure you all understand the components of that, it's a very valid question.

First, I'll say the statement is well made. If we have about 185 basis points of headwind, we need to drive around 230 of improvement to the margin to be around a 50 basis point expansion. Now if I take you to Slide 19 in the presentation, you can see what we have been able to accomplish or achieve in 2021. Now clearly, it was not on a higher revenue growth, I take your point, but we drove close to 400 basis points of improvement offsetting the headwind. So we see the operating leverage in the business and we see the efficiency gain.

Now we will continue to see operating leverage improvement as we rebuild -- as the revenue rebuild, as we see the leverage from SG&A and cost of goods sold or manufacturing. Importantly, we're also looking to drive say about $150 million of efficiency in the business. And I put them into 3 buckets to the extent I can. Of course, we've been very clear on prioritizing, on project prioritization. And I think you've heard us speak, for instance, in Meet the Management on being focused on where we play the market we operate, et cetera.

Then we're driving operational efficiencies, being manufacturing efficiencies. We're continuing our program of manufacturing efficiencies. And as I said, we're assuming that we can offset some of the inflation, in the prior discussion with Tom.

And the third category is about simply good cost discipline, organizational efficiencies. And that's all going to help us drive the $150 million of achievement and -- of improvement, sorry. And clearly, that's what we focus on.

And you ask about the sensitivity. It's all about execution. We need to drive the savings now in the business and we need to deliver the top line.

Now moving to your second question around supply chain. The current disruption are mostly driven by the global supply situation, which Roland and I were just discussing a moment ago. Memphis has stabilized, we've recruited. We're working through, we've done a lot of work internally around our sales and operation planning. There's more to come, I'm not going to say it's all resolved. And in particular, as you know, we're transferring to our new third-party logistics, so there's more work to do to make sure our network is resilient. But we are in a much more stable situation on that front.

And sorry, your final question. The wage growth is not a number that we want to disclose in public, but certainly assume inflation in some of the countries, particularly in the emerging markets.

Got it. And if I can just follow up, the 125 basis points in terms of the inflationary headwinds that you're guiding for this year, is that the assumption that you had in December when you gave the midterm guidance? Or has that changed?

Nothing has materially changed. Clearly, we -- by December, there were already inflationary pressures. We had worked through our budget. So nothing has changed. I think the competition for raw materials is becoming a little bit steeper, but certainly, we haven't seen. And as far as well, we are not changing importantly our midterm guidance. We are committing to delivering on margin improvement.

Excellent. And all the best to you, Roland.

Thank you, Veronika.

Our next question today comes from Lisa Clive of Bernstein.

Just a few questions on CORI. Good to see a strong uptick there. Can you comment on the sales U.S. versus outside of the U.S.? And it was interesting, I think it was at your December event that you were mentioning building out a robotics facility, I think it was in Germany. And I guess if you could just talk a little bit about how you see that business developing over time. Robotics has historically really been focused on the U.S. but you clearly see potential beyond that.

And then also in terms of sales of CORI, what proportion are to current unique customers versus competitor accounts?

Lisa, I'll try to answer. We may not have all the data for you here, but on CORI, obviously, we continue to be very excited about the technology, the uniqueness of the technology and the ability to bring new products or new surgical techniques on to CORI. So as I said, we're going to work on bringing the LEGION CONCELOC, the cementless construct on to CORI. Then also having the revision knee on to CORI. And in the future, of course, also bringing the new Engage Surgical UNI knee on to CORI. So really to build out the entire franchise there, and that's quite exciting.

As you said, the trend has been strongest for robotics surgical use in the U.S., and we believe that will continue to do so or to be so. But we're seeing increasingly different markets very interested in robotic surgery, of course, middle East, India, Asia and in Europe as well. And we -- as you said, we have announced that we will build a medical education training and innovation facility in Munich to continue to support the use of robotics in Europe. And that is also linked to the previous acquisition of the assets for hip navigation from Brainlab back in 2019. And so this will -- this is -- geographically, we're very well placed there, with that team coming actually or being in Munich.

In terms of the sales breakdown, I don't think we have disclosed these numbers. So I'm afraid I can't give you those. What we do see though, is, of course, a growing number of usage in the U.S. And where we use CORI, we see the accounts actually growing faster than the accounts that don't have a robotic system.

Our next question today comes from David Adlington of JPMorgan.

Firstly, just on VBP. I just wondered what your thoughts were on how that might expand beyond ortho either this year or potentially beyond.

And then secondly, just in terms of the pricing environment or the pricing inflation that you're seeing on the cost side. I just wondered what your ability was to pass that -- those price increases through in terms of raised prices and what your price assumption is in your guidance.

David, so in terms of VBP, we discussed about ortho a little bit more at length. You may know that they were in -- there was a tender, sorry, in 2021 for trauma in some provinces, that's being extended to other provinces or the whole of China. For us, from our sales, are small, it's a fraction of our group sales. So we don't see a big impact.

Now to your question where will it go next, we believe that where we play then in China is, of course, sports and wound. We certainly believe that in sports, you know there are not many local players. It's not of the size yet that would fall under the criteria of VBP. So we see a much longer runway and we don't anticipate any VBP in other categories where we play in the short term.

Now moving to price. Clearly, we're being as proactive as we can in terms of -- as I said in the presentation, it's really difficult in our industry, and our competitors have relayed the same, it's difficult in our world to pass on to customers like-for-like price increases. Having said that, we are reviewing our contracts. And wherever we can, we look at our list price, we're reviewing our contracts and being proactive. But it's not a lever in the short term. It will become a better lever in the medium to longer term as we renegotiate tender contracts.

Great. So pricing, we should assume sort of typical historic sort of minus 1-ish to the price this year?

Correct, Dave.

All the best, Roland.

Thanks, David.

And our final question today comes from Chris Gretler of Credit Suisse.

Roland, Anne-Francoise. Actually, just wanted to come back on the change in CEO. And sorry, maybe you addressed this at the beginning, but I was on another earnings call. Could you explain to me, what's the rationale to change the CEO right now after you just set out the new strategic goals in December? And what's actually kind of the risk that the ePAK coming in would revise no such targets? And is it fully signed up to this '24 target? That will be my first question.

So I'll let Roland comment in a minute. But clearly, first, to your last question, we are committed to our midterm guidance. We reiterate today our midterm guidance, clearly, both in terms of revenue growth of 4% to 6% and the improvement in margin by 2024. Now that needs to be at least 21%. And it's all about execution. It's about focus, and we have our clear strategic pillars articulated. And those strategic pillars were articulated and corrected in our Meet the Management session in December and were fully supported and endorsed by the Board.

So today, the Board and Roland have agreed, mutually agreed that Roland should step down, with a focus on our strategy of driving revenue growth, driving productivity, driving innovation, continuing acquisition, bolt-on acquisition is unchanged.

And I will also say to your point on Meet the Management, clearly, he was also in our Meet the management, and I hope you did so in December and you can see the strength of talent we have in the organization.

So we remain focused and we will continue to execute. And as I said in the presentation, it was a pleasure to work with Roland.

Yes, Chris, maybe just on a more personal note. I think when I took over in 2019, those were very particular circumstances. Very soon thereafter, the global pandemic broke out. That's something that nobody could foresee. And that turned this task into a very different one, right? I mean, initially, we were all in crisis mode. We were trying to see how we could continue to supply our customers, to keep our employees safe and continue to do the business. I think we've all learned tremendously through this pandemic. And at the same time, we continue the transformation of Smith & Nephew during this very challenging time. And I think that was the task at hand. I feel that I'm leaving behind an organization which is in great shape, with a great strategy, you heard Anne-Francoise, where everybody is committed to the numbers but also to the execution.

And when I look back, I think it was great that we were able to protect, for instance, our innovation capabilities; that we ring fenced R&D, we're seeing the benefits now, and they will continue to come through, this ramp-up in R&D, the continuation of the cadence of M&A. And I think the company is truly now at an inflection point where it's -- I feel confident and positive about handing this over to the next leader and for them to make -- to write the next chapter of Smith & Nephew.

Okay. Yes. No. We'll watch it with interest. No, definitely. And also wish you all the best for the future. And maybe just my second follow-up question is on the trading margin goal '24 we are on the topic anyway. I mean given this inflationary environment, how much room for maneuver is actually baked into that? Is it basically assuming that kind of inflation normalizes again? Or can you cope with the current rate of inflation and still achieve this 21% target by '24.

I think I'll step back for a minute for the exact detail of your discussion -- or your question, sorry. When you look at 2024, we do need to drive consistent improvement. And in financial terms, almost, there are 3 levers. One, it's about the revenue growth being 4% to 6%. So it's about commercial execution, it's about new product launches. Then it's about gross margin expansion, so it's about continuing our transformation in operations, it's about product rationalization or brand rationalization. And the final lever is really seeing the SG&A leverage. In other words, our OpEx growing less than our revenue growth. And that's about being very focused on where we compete, how do we optimize supply, our go-to-market model, et cetera. Those are the absolute levers when you look at a high level, over a period of time, that will drive our performance. And I think that's where we need to place ourselves when we think about our guidance, that's the midterm guidance.

We knew the inflation as we were coming in and that's the basic that was built in. But I think it's important to set the way when we think about midterm guidance of what are the levers that will help deliver these, it's about revenue growth, gross margin expansion and leveraging our cost base.

We just noticed that inflation seems to be a bit more stubborn than we all assumed maybe. I appreciate your comment, Anne-Francoise.

Thank you. We have no further questions on the line. So I'll hand back to the management team to close.

Well, I think this ends our call. Thank you very much, everyone. All the best to you all, and thanks again.

Thank you.

This now concludes today's call. Thank you very much for joining. You may now disconnect your lines.