Smith & Nephew PLC (SNN) 2022 Q2 法說會逐字稿

I'll just draw your attention to the safe harbor statement on the slide that's about to pop up in front of us. So it's a pleasure to be reporting the results of my first full quarter as CEO and also to be meeting many of you in person for the first time.

So as you can imagine, I've been spending these last few months getting into the detail of the business and building up a picture of how we can drive greater performance and value. So before we get in to the quarter's numbers, I'd like to share my initial thoughts on Smith & Nephew's positioning, some of our early priorities and our expectations.

Smith & Nephew has many exciting opportunities with a number of factors that are lining up for us to take -- go to the next level of growth. Innovation is a key driver of value in our industry, and this is a company with innovation at its core. I've seen leading technology in every aspect of the business, in established products, in recent launches and in the depth of pipeline across our franchises.

Secondly, the fundamental competitive positioning is strong. We have a clear right to win in all franchises. There are structural advantages that are distinct from our competitors and our proprietary platform technology with applications across multiple devices and procedures.

And importantly, the delivery is good in 2 out of our 3 franchises that account for about 60% of our revenue base. So there's no systemic barrier to execution. The challenges won't be surprising to you, strategic execution in Orthopedics still needs to improve. And our manufacturing and supply chain are not yet where we need them to be. Both our growth and our margin recovery have been held back as a result.

So I've spent some time going after the root causes. Although there's already some work underway. We have now developed a new structured program of execution with a deep level of oversight that I know is required to deliver this type of program and at pace. This work has already started.

Turning to our results. I would say our first half performance was mixed. Wound & Sports medicine continue to be on track, whereas Orthopedics was held back by execution and supply chain challenges and of course, the impact of China VBP. We adjusted our 2022 guidance reflecting the supply chain challenges and the difficult macro environment and Francoise will walk through the Q2 and H1 results, and then I will come back and talk in more detail about our comprehensive action plan for the future. Francoise?

Thank you, Deepak. I agree with you. It's certainly really good to be in person for the first time in 2 years as far as I'm concerned. So thank you for making the effort to come. But as Deepak said, I'll start by going through the detail of the second quarter. So growth in the second quarter was 1.2% underlying. The slower growth than we saw in the second -- than the first quarter mainly reflected a number of known factors. These were 1 fewer trading day than in 2021. The implementation of China VBP in hips and knees and lockdowns in some region of China, which particularly affected our sports franchise.

Looking at our growth by geography, the U.S. was the fastest-growing region at 2% for the quarter as a whole. Emerging markets grew 0.8%, reflecting the headwinds in China, but offset by strong growth in India, the Middle East and Latin America. And other established markets were flat, reflecting a slow quarter in Asia Pacific.

Going into the details of the franchises, overall, Orthopedics revenue fell by 1.1%. As I mentioned earlier, the VBP implementation was a significant headwind. If we exclude China, Orthopedics grew by around 2%.

In reconstruction, knees grew 2.7% and hips declined 3.7%, as well as the VBP impact on our out of U.S. revenue, the quarter reflects the need for improved execution and supply chain management that Deepak will talk about shortly. We're also continuing to roll out on cementless knee in the U.S. And while it's too early to move growth significantly in the quarter, we do expect to become more visible in the second half.

Other reconstruction returned to double-digit growth and robotics growth was well ahead of the overall segment. Our offering is continuing to develop. The first core assisted hip and cementless knee procedures were completed in the quarter. And in second half, we expect to become the first company to offer robotics-assisted new revisions. Trauma & Extremities declined 6% and was slow across most regions. As you may be aware, we opted not to participate in the broader rollout of the provincial trauma tenders in China, which explains part of the decline in the sales.

Sports Medicine & ENT grew 1.9% with joint repair growing 2.1% and Arthroscopic Enabling Technology declining by 0.5%. As I mentioned earlier, sports medicine was particularly impacted by the impact of COVID outbreaks in China. Without China, the franchise growth would have been around 5% with 7% in joint repair and 2% in AET.

Otherwise, the drivers of the business were very similar to the first quarter. The recovering knee repair market continues to drive our growth in established markets as level of physical activities return to normal. Also, we have recent launches such as FAST-FIX FLEX and FASTSEAL, which continue to track ahead of our plan and are making an increasingly important contribution to the growth.

As we mentioned before that availability of electronics remains a challenge, and this is continuing to be a headwind in AET. ENT growth of 11.2% reflects continued post-COVID volume recovery, also helped by successful price increases in the U.S. And finally, Advanced Wound Management grew by 3.8%.

Within that, Advanced Wound Care grew 3.3% driven by good growth from our infection management portfolio and a strong quarter in Asia Pacific region. And in July, we launched a WOUND COMPASS applicate -- Clinical Support App, which is a tool to help healthcare professionals assessments and choose the most appropriate treatments. It's a great example of our cross-franchise digital capability and also the value of our broad evidence backed portfolio. Bioactives grew 2.4% in the quarter, driven by our skin substitutes portfolio and advanced wound devices grew 7.9% with continued double-digit growth in PICO.

I'll now move to our first half financial results. I'll start with revenue, which was $2.6 billion in the first half, up 3.5% on an underlying basis compared to H1 2021. Reported revenue was flat, including a foreign exchange headwinds of 350 basis points given the strength of the U.S. dollar against other major currencies. And as you can note here, the M&A effect was minimal.

As you see in the chart, Sports Medicine and Wound showed mid-single-digit underlying growth. And as with the second quarter, all of these growth rates reflect 1 fewer trading day than in 2021.

Moving to the summary P&L. The gross margin in the half -- in the first half was 70.9%, which is an increase of 30 basis points. A variety of factors are at play here and are important to note. Inflation is offset by some price increases and a tailwind in the first half on the timing benefit of our hedging strategy. The trading margin, however, was lower at 16.9% compared to 17.6% in 2021.

And that comes from higher SG&A costs, where we felt the inflationary pressure in freight and logistics that you see across the economy. And we've also increased commercial activity as patterns of engagement with customers return to normal. And also I would like to highlight that in line with our strategic commitment to innovation, we've maintained our ratio at 5.7%.

And continuing down the P&L, adjusted earnings per share declined by 2% to $0.381. You'll notice, of course, that's ahead of the development in our trading profit due to a lower tax rate than in the first half of last year. And the interim dividend of $0.144 per -- per share, sorry, is unchanged from 2021.

We generated trading cash flow of $154 million in the period, with trading cash conversion at 35%, that is lower than in 2021, and the decrease was primarily driven by higher inventory, which you see in the working capital outflow of $304 million. Part of that is that we've increased spot buying of raw materials and components to secure supply and mitigate the risk of shortages. There was also a further effect from the phasing of other working capital movements that we expect to unwind in the second half.

And moving to the balance sheet. Net debt ended the half at $2.4 billion, as shown on the slide. That's an increase of $355 million in the first half with $89 million coming from the acquisition of Engage Surgical in January and $133 million coming from share buyback. The effect of all of that is that the leverage ratio finished the half at 1.9x adjusted EBITDA, which is very similar to recent levels.

And I'll finish with the guidance for 2022. Firstly, we're continuing to target underlying revenue growth of 4% to 5% for the full year. The first 6 months, as you've seen, growth was 3.5% underlying even despite the COVID restrictions in China, and we continue to expect stronger growth for our business in the second half.

For the trading margin, we expect it to be around 17.5% for the full year. This reflects the prolonged and higher impact of the inflationary environment on our business, particularly in freight and also reflects continuing external supply challenges. Clearly, we're continuing to manage input costs, but we're also maintaining critical growth investment in the future like R&D, and we do expect some of that to have an impact on our margin.

And with that, I'll hand back to Deepak to cover our action plan.

Great. Thank you, Francoise. So having covered our first half performance, I want to share with you my assessment of Smith & Nephew and how we are moving forward. So I'll start with the opportunities. I talked about our right to win, and that is critical because it gives us the confidence that we'll be able to deliver our growth aspirations as we improve our execution.

In Orthopedics, that right to win comes from our portfolio and our technology. On the portfolio, we now have a full product range across hips and knees that we can offer to our customers. There were major gaps in the past, but they've now been closed, and we're now starting to open a gap of our own against peers. For example, with the Engage, cementless uni knee.

And in some ways, our product range is too wide, and I'll talk about that later. Our implant technology is unique and differentiated. We have the kinematic profile of the JOURNEY II Knee, with motion closer to the natural knee than competitive systems. We have a propriety materials technology in OXINIUM with applications across multiple devices and outstanding long-term outcomes. There's the OR3O hip cup that takes that material and applies it to dual mobility approach.

And in trauma, we're completing our highly competitive EVOS plating system with large plates, and that gives us a comprehensive and easy-to-use system that addresses all fragmented surgical needs. And those are robotic-enabled technology platform, CORI, as well as the economic and portability advantages of CORI was designed from the beginning to be able to work on a range of other hardware and in a range of indications. We're just still at the start of the planned functionality. And you'll see -- start to see unique indications and assets added as early as later this year. And in fact, an update to what -- and Francoise just mentioned, just overnight, we got approval for indication on the vision need that she had telegraphed. So really good development for us as we continue the journey with CORI.

In Sports Medicine, we also have a complete offering for our customers with joint repair, the arthroscopic tower and customer service. So most competitors either have gaps or are just selling equipment without the deep relationships in this segment. We have leadership positions in the various segments, including being the #1 company in enabling technologies and biologics. And we have scalable synergies with other areas such as through CORI and cross-selling opportunities in the ambulatory surgical centers.

And in Wound, we have the broadest portfolio offering solutions across all key wound types, bringing together phones, devices, biologics, and I just heard from Anne-Francoise's digital. We're a leading negative pressure platform with huge potential for market expansion. And we have a catalog of strong evidence across our categories, showing proven clinical outcomes and economic value, and that sets us apart from the low-cost segment of the market.

So let me turn to these 2 franchises, Sports & Wound, we're demonstrating that as a company, we're more than capable of capitalizing on the advantages we have. As a reminder, as I mentioned, 60% of our revenue comes from these 2 segments. Sports has been outperforming the market for many years. And when I look at why I see commercial excellence built on a deep understanding of customers and a precise targeted approach for engaging with them.

And there's also a steady stream of innovation across procedures and a successful integration of assets that we've acquired. The wound team has done many of the same things as that franchise has accelerated over the last few years. We've made good use of our structural advantages by focusing on portfolio strength, breadth and evidence-based selling. We've also executed well on high-growth acquisitions like skin substitutes and leaf.

And importantly, we've successfully driven margin improvement at the same time. So both are well placed to continue in the same way. In Sports Medicine, we've refreshed the capital equipment for the last 2 years and added a new innovation platform with biologics. And in Wound, there's still an opportunity to deepen the penetration of advanced treatments with wounds today, either not being adequately treated or not being treated at all. And finally, as I mentioned, there's an exciting pipeline across these categories.

Turning to Orthopedics. That's clearly where our key challenges are. It has been a long-term outperformer but has trailed the market certainly since 2020. A key priority for me has been to understand why that happened and what we need to do to get back to winning. The aim in Orthopedics is to be a procedure innovator with best-in-class implants, as I alluded to, and paradigm-changing enabling technology on the CORI platform.

As you know, we had a major product gap, not having a cementless knee hurt us for a number of years. The fix for this is in place with the cementless LEGION that's rolling out now. It wasn't perceptible in first half results. And as -- and Francoise has mentioned, we expect that to start to register in the second half and going forward.

There are more structural factors as well. However, and that's around execution and supply chain. In terms of execution, we become more complex and less agile than our larger peers, both in terms of our portfolio and the ways in which we work. For example, we're still supporting multiple hip stems and knee systems in parallel, when peers are increasingly focusing on just 1 family.

We also haven't recognized that operations and commercial have become disconnected when they need to be working even more closely together for top class execution. The result is the supply is not always well aligned with commercial needs.

And finally, capital management has not been efficient, instrument sets are not always optimally placed with full sets at centers that may not need them and not enough sets elsewhere. The financial effect is that asset turns are lower than they should be. And on an investment, that's about half of our CapEx.

So let me turn to supply challenges. In manufacturing and in supply chain like everyone else, we're feeling the effects of increases in raw materials and freight across our businesses, but it's also apparent that our current solutions to the Smith & Nephew specific issues, and that's in orthopedics, not in wound and sports, aren't working fast enough. We're addressing the root causes efficiently.

So we've made good progress in addressing the operational issues in Memphis that hurt us in '21. For example, staffing shortages that we alluded to. The fundamental efficiency and reliability of our supply chain is not where it needs to be. The effect is not just the outright shortages that we saw last year and continue into this year, but also that reps have spent far too much of their time managing existing customers rather than acquiring new business. For example, in the case of trauma, the majority of our reps are spending 40% or more of their time managing logistics and inventory.

These challenges weren't always there. Some were made worse by COVID and for others, the disruption of the pandemic had problems as they developed. We know the importance of getting this fixed and the work is underway. Building on our previous work, the team has put together a comprehensive 12-point program of execution in the last 2 months that cover the biggest opportunities for our company.

These are at the highest level regaining momentum in Orthopedics, really fixing orthopedics across recon and robotics and trauma, improving productivity throughout the supply chain. And of course, further accelerating sports and wound. The elements have been worked out in quite some detail and are backed by robust structures for accountability, and I'm taking personal oversight, I'll come back to that in a moment.

For now, I wanted to give you a bit more detail on Orthopedics and some of the things we're working on are picked out on the slide. First, we're rewiring the commercial delivery. There are a range of aspects to this, but examples are a greater focus on differentiated products and procedural innovation, aligned incentives and a more detailed customer segmentation.

Secondly, we're going to streamline our portfolio by reducing the number of implant systems we support in a category. For example, in hips, we go from 11 systems down to 6. That will include renewing our sales efforts on the priority brands and will bring benefits from simplification and great focus throughout the organization.

We also will improve our asset utilization, particularly with instrument sets. We're establishing clear principles on where we prioritize placement, where we use consignment and where we use loaners and rolling out analytical tools to support management. This work has started already. And we're rebuilding the demand planning process, closer collaboration between operations and commercial will address short-term tactical supply chain decisions and longer-term signals to better align production with market needs. There's a lot more behind this, and I'll keep you updated on progress and provide additional detail in the coming quarters.

So turning back to the program. Some of you know this, I've driven this type of program successfully before. In my experience, a big part of the success of this work will be having the right governance and accountability to ensure that the plans are followed through and the changes become a normal part of how we operate.

We already have refreshed leadership in commercial and operations with area-specific experience and track record. You already know Brad Cannon, our Head of Orthopedics -- our Head of Orthopedics and Sports and of course, the Orthopedics leadership team that report to Brad.

On the operations side, we have Paul Connolly, who's our Head of Operations. And last summer, we brought in a new Head of Orthopedics, Operations and rebuilding other important areas.

Our new Head of Orthopedic Operations has driven similar turnaround, Ops turnarounds elsewhere. And our Head of Supply Chain, a new Head of Supply Chain, previously ran an optimization process in another orthopedics business. And our new site leader in Memphis also has deep orthopedics expertise. On the Ashwood delivery, in terms of these programs, this program that I talked about, there's a responsible named owner for each area, and we have established a high cadence of interactions with responsible teams. That's fortnightly meetings under my direct oversight.

Each area also has specific action plans with meaningful forward-indicating KPIs to track progress and again ensure accountability with -- and transparency reporting -- with reporting going all the way up to our board. Getting the full benefit of this work will take some time. We'll start to see operational benefits from some elements quickly, such as asset optimization and further benefits will continue to accumulate over the next 2 years.

As you've heard me say, there are more opportunities than challenges with Smith & Nephew. This is a great company with a great outlook, and I believe we're not far away from showing this externally in all aspects of our business. There are challenges we need to address, but things are starting to wind up even in orthopedics, where we're poised for an inflection. .

We have an outstanding portfolio already, and we're bringing the next wave of innovative implants to market like the cementless knee, the Engage uni knee, EVOS large and the next-generation shoulder. We have enabling technology and leadership already with CORI and the unique platform extensions to come. I talked about 1 of them just now.

We have a revitalized management team and we're getting on with rewiring, literally rewiring our commercial delivery with energy and at pace. I see these initiatives as part of our transformation journey as an innovation-led portfolio medical device company. And they're aligned with the strategic framework that we previously communicated to strengthen, accelerate and transform. As these foundations are fixed in orthopedics, it will free up our people and capital to take much better advantage of our clear right to win. We'll keep investing in innovation and continue with M&A across our portfolio.

Sports Medicine and ENT and advanced wound management are already showing what we can achieve when we combine leading technology and getting the execution right. And I see significant opportunities to invest further in these well-performing franchises. I'm truly excited by what's ahead. And now we'll take questions. I think Patrick was first with his hand up.

Obviously, Patrick, Bank of America. Just 3 quick ones, I guess. Short term, the supply chain, let's call it, Q2 situation. It sounds like Memphis got better. So maybe a little bit of details in terms of the other hiccups, I guess, outside of Memphis. That's the first one.

Second one, I appreciate it might be a difficult topic, but midterm margins. And any commentary there given a tougher jumping off point, let's say, given the environment? And then last one, you touched on it in terms of the orthopedics work that you're looking to do. Am I taking the right sense here that you feel like you've got the right people in place, whether it's below the leadership team, like further down. And it's more about intensity and culture? Or do you feel that further down the structure, there might be -- need to be some new people coming in. It's how you want to characterize the 2 there?

Thanks, Patrick, for the questions. So first, let me talk about the Memphis part of it. So as I noted, in terms of product availability in Orthopedics, we indeed made -- have made improvements in Memphis. The biggest issue we faced last year was around staffing. And we're largely on the other side of it, knock on wood, right? You never ever see any on the other side of staffing anywhere ever in this environment, but we've lapped that.

The issues as I find in terms of product availability in Orthopedics is supply is a piece of it, but the rest of it is in our hands. The connectivity between commercial and operations is not where it needs to be, which has led to product availability challenges and one of the highest levels of inventory in this business. So we've got stuff to put it simplistically, it's in the wrong places.

And what we're doing -- and we didn't just get there overnight. It got there over a period of time because our wiring wasn't working as intended. So we understand that problem now. So we've got to fix -- continue to improve our Memphis operations, but we've got to fix this wiring. And that's the work that's underway so that we can better connect demand at an account level to a production plan. And in the near term, when I talk about how we improve asset utilization, we're going to embark on a structured program to move inventory and sets from low consumption accounts into higher consumption accounts.

So we've been doing this sporadically in certain places. But what we're doing is taking a step back, undergoing a structured program and looking at this globally versus kind of optimizing locally. And we believe over the next 2 quarters, that will have a benefit by effectively putting staffs where they can be consumed. And that will free up some time from our reps.

Related to that, what I believe we've underestimated and we view this at 1 point, but somehow, we've lost our way on the importance of logistics, particularly last mile logistics in orthopedics. So we're embedding logistics experts in our commercial teams at the right level of aggregation, let's call it natural areas. That's the change to how we've operated in the recent past. So that will help offload all of the logistical burden that's now falling on reps on to people who are trained in this area and were able to take -- bring the right level of focus. So that's the first answer to your question.

So regarding indeed the difficult topic of second half of this year. What we see, we obviously plan for a certain level of inflation and inflationary effects at the time we set our budgets and our guidance. What we're seeing is significantly higher than our worst-case scenarios that we've modeled. And when we put that into context with other factors, and where we've seen the inflationary pressures, it's we've called out freight and distribution, but there are other impacts of that elsewhere as well.

So when we look at the add up and we see the macro factors lining up, we believe the responsible thing for us to do is to call out how we see the business evolving with the risks. So that's why we've taken the approach we've taken.

Now in terms of the leadership team, what I want to emphasize, of course, you -- some of you have met Brad, we've given an expanded responsibilities. He was previously responsible for just for sports, but now he's also responsible for orthopedics. But these are distinct organizations underneath that. What I've called out is significant changes, thoughtful changes we've made in commercial, in franchise management and in operations, not only at the 1 level that reports into Brad, but a level or 2 below that.

Many of these folks have or have just now become effective in their roles. I mean the average tenure for the new folks are between 6 months, 9 months, something like this, right? So they've just now come into place, get acclimatized and starting to really impact business in the way that we've hoped for them to be.

So in my assessment, we've got a good team in place that's experienced. They've gone from the industry. They know what good looks like and they're bringing those best practices into it. And these are people who've joined us understanding the challenges that we have, right? They want to come into this building because they believe in the product portfolio. And I can tell you personally have come into this. I was struck by the strength of our portfolio. This is not what I expected to find coming into it as an outsider into orthopedics.

And some of the folks who have come and joined us from leading companies are drawn to that and to our culture. So I feel very good about the team, several levels underneath in terms of the capability, the temperament the culture that we want to change orthopedics.

I also wanted to take at this point to call attention to the fact that we've got a chance in Orthopedics, but sports, we're working well. Wound, we're working well. We've got the right culture. We've got the right execution, the right folks, as I mentioned, combined with the innovation, so.

The leaseback that you want to make that as well, the midterm guidance, which was also some.

Oh, yes, sorry. Mid-term, I focused on this first half. Yes, the jump-off point, of course, is more challenging. And we're going into an uncertain -- we are in an uncertain environment with unprecedented macro factors. We're focused on doing the things that we need to do to secure that 3-year plan that we previously outlined. So has it gotten harder? Absolutely. The jump-off point is different.

But having said that, the things that I've outlined in orthopedics, the things that we're doing around productivity and margin expansion and around accelerating wound and sports. I believe are the right things to be doing, and then we'll see how that plays out.

Yes. Jack Reynolds-Clark from RBC. So just on the sports med in China, is that more on the demand side or the manufacturing side? And this feels like a situation that probably won't improve without a change in sort of approach to COVID from the Chinese leadership. So is there any opportunity here to kind of get ahead of the game?

And then just another quick question coming back to the guidance. So what level of inflation is already baked into guidance -- for the revised guidance for New Year? And what specifically has worsened, particularly in the last sort of quarter?

So I'll take the first one. I'll tee off the second one, and I'll hand over to Anne-Francoise, is that good. I'll give you the hard -- I'll give you all the hard questions to, Francoise. So on the first point regarding Sports Medicine, the impact indeed is from the lockdown. It's not a manufacturing related topic in terms of specific impact to China, it's a demand topic, right?

In Orthopedics, it's VBP. So just wanted to contrast the impact of China across those businesses. There are supply chain challenges in wound and in sports as well. They're related to electromechanical components and chips, those are supply chain, but they're not specific to China. They're just with large across the enterprise.

So that's the thing that addresses your China question. In terms of the inflationary pressures that we see, as I mentioned, where we're seeing a higher level than forecast impact is on freight and distribution. And that's not just us. I mean it's the nature of our network, right? We feel as we do, but it is an industry-wide topic, and we'll see how things evolve. But do you want to comment more on that.

Just to give a little bit more color. I mean, clearly, I had spoken and we've spoken about having done a range of scenarios. But things have gone tougher. And since we've spoken, there's been various geopolitical tensions, as we know. Freight is a key element for freight and warehouses. And just to give you a feel, our costs have gone up by 40% year-on-year.

So that is one of the key element. The other, of course, is people. And I know we've spoken about we have done our salary we used in the beginning of the year. But there is a cost linked to cost of living. There is a cost as you retain people as you recruit and that is flowing through, although it's a smaller component.

And the smaller one, we're tracking that -- actually we signposted quite well, it is raw materials. That is a smaller element. But again, you were talking about the microchips of just now. Electronics have gone up by 38%. I mean those are significant shifts that many industries are flat facing, and that's one we have to adjust as well. And we're working hard to offset as much as we can. And some of it will flow to the bottom line.

Deepak, maybe some questions from phone.

Okay, go ahead, please.

(Operator Instructions)

Our first question comes from Hassan Al-Wakeel from Barclays.

And apologies if these questions have been answered. We've been on other management results calls this morning. Firstly, Deepak, thanks for your update. I wonder what you put the historic underperformance of the business down to. How do you think execution will change going forward? And should we expect a meaningful resumption in M&A activity?

Secondly, where is cost inflation running at for the business? Where was it for the first half? And what is your expectation for the second half? And could you break out the margin bridge for the year and if it's just the 125 basis points that is changing or if indeed, it could be anything else, perhaps VBP getting worse?

And then finally, just following up on the midterm targets. Could you walk us through the margin bridge to '24, where you see the key opportunities and the key risks in light of what you've talked about today?

Sure. I'll call Anne-Francoise for the second part of your question, but let me take the first here, Hassan. So as I indicated in my presentation, the execution-related issues have been in orthopedics and sports and wound. We have been executing well. We've got a great portfolio, and we've got the results to demonstrate that.

In orthopedics, as I look back on it. It's a -- fundamentally, we've had in the past portfolio gaps that have been set us and have impacted our commercial performance. As I mentioned now, we've closed those gaps. We've got a full range in hips and knees across families, but we've got a full range.

And in CORI, we've got a platform that's still in the early stages in terms of functionality and indications that we're adding to it, including most recently, overnight. So that's a change from the past where we now have a portfolio and we've got enabling technologies to drive growth.

The other piece of this is the connectivity between commercial and operations that account for the product availability challenges that we see that really has hampered us. It's hampered our growth as our reps focus on inventory and logistics challenges and serving existing customers rather than going out and acquiring new business. That's 1 example of the impact of that.

The second is the fact that we've got high levels of inventory, we've got product in the wrong places, if you will, right? We haven't been good. We haven't had the process of ensuring that we're matching our supply and availability to customer needs. That's a process topic. It's an end-to-end topic that connects customer demand to a production plan and we haven't gotten that right. I don't believe we were ever particularly good at it, but we were okay for the scale of business we had. COVID really impacted that, and that's had a significant impact on us over the last couple of years.

So the good news for that is we know what the issue is, we've begun to work on addressing the issues. It's a process thing. There's not some big IT spend we've got to do. There's not some big structural barrier to us improving that. We know what we need to do on a good path to getting there, right? So that's the second piece of it that we're working on Hassan.

So I think I addressed your first part of your question. On inflation, I think he's looking for a breakdown in terms of the levels. I'll turn it to Anne-Francoise to kind of comment, some of which we covered in the last question, but perhaps you weren't on for that part of it. So Anne-Francoise, if you wanted to.

So I guess, in terms of -- there were 2 parts to your question, Hassan -- good morning. 2 Parts. The first around the inflation in H1 and H2. As you can see, just looking at our trading margin, there's an impact on the trading margin is down year-on-year. And when you look at the elements of the P&L, the inflation in the cost of goods line is not as apparent as you would think because actually, on the face of it, our gross margin is improving. There is inflation starting to flow through as we're selling materials that have has been built on a higher cost base. That is flowing through, but that's offset by the timing benefit of our hedging strategy from a foreign exchange perspective.

But you can see the cost increase in SG&A, which I've referred to earlier, which is significant, and that's where we see the freight and warehousing costs we've talked about. So that has an impact on H1, and we expect that to continue to increase in H2 particularly through the COGS line.

So when we pull all of that together and to your question, what does that mean for the full year, we had talked about three, I think, levers. Clearly, when we gave the initial guidance, we talked about the inflation being a headwind, and you referred to the 125 basis points we talked about. And we talked about CORI rightly, as you said, VBP, which we mentioned at 60 basis points.

VBP is about our current estimate, is in about the same position, probably slightly better, because of the delay in the first few months of the year. So that's not a material change in the full year. What has changed is really our assumptions around inflation, which is probably 100 basis points higher than what we assumed. And that's really where we are and the reason for the change to our guidance.

Now offsetting that, we are and we have taken price increases, so price is the lever we can push. But as we've always said, we cannot offset all of the price increases. And we're also continuing on the savings and the productive improvements we have planned.

So the real change is that the macroeconomic environment and the inflationary pressure. And therefore, that leads back to the midterm guidance and the opportunities as you see them back and that was the last time...

That's right. And just to repeat, Hassan, what I indicated earlier. Jump-off point is, of course, different now than forecast. But in terms of the steps that we need to take to achieve midterm guidance of 21% margin and 4% to 6% underlying organic growth. We -- the steps we need to take in terms of fixing orthopedics and enhancing our productivity and accelerating sports and wound are the things that we are working on are the levers that we have to pull in order to get there. And what we now have is a program under which these steps will be executed in order to get there. So we're focused on doing that.

You asked about M&A. It previously has been communicated in our strategic framework of strength and accelerate and transform that M&A would be a component of that. And I do see M&A being a component of it. As I mentioned, in some ways, we're a tale of 2 cities to invoke an analogy, we have to fix orthopedics. We know what the issues are. We're working at pace to fix them. But then we have 60% of our revenue base 2 out of our 3 franchises, they're actually working very well where all of the elements are combining and working as they should. And so we see opportunities to further invest behind that.

That's very helpful. I guess what I was trying to understand is margin bridge between the 17.5% and the 21% by 2024. Are you able to unpack the key components of that, please?

Sure. I think this is something that -- I mean, I'll give you a top line answer and maybe follow up with you. So the big contribution there is the impact of growth. As I mentioned, from Orthopedics coming back to levels that we've targeted. We see -- we expect a step-up in the second half of the year. Some of that is seasonality of our business, right? But in general, on the back of not only seasonality, but product launches, we expect to see a step-up in growth. So that's 1 part of it.

And we see that continuing as we see the full impact of things like our cementless knee, getting traction in the market, CORI placements driving further utilization of and pull-through of implants as we bring that forward, Engage, our unicompartmental knee getting traction in the market. So there's quite a -- when I talk about factors lining up, it's not any 1 factor that's particularly huge, it's the combination of these factors and the add-up of these factors that I believe is going to drive the inflection point in orthopedics.

So the big component as we walk across from 17.5% into 21% is the impact of growth. And then, of course, in terms of margin, we need to see in productivity, we are continuing the work to drive efficiency into our factories. The big opportunity is in Memphis as I mentioned, there's good progress along the way. But it's -- I didn't mean to signal that all the work is done. It's definitely continued impact of the initiatives we have in place around productivity that we expect to see.

And then, of course, in -- when I talked about the opportunities in Orthopedics, we see really good opportunities in wound and in sports medicine. On the wound side, as I mentioned -- as coming into the company, I'm struck by the opportunity to expand the market to drive penetration of some of our products, for example, negative pressure, broader adoption than is currently the case in procedures. So we're very well positioned to do that. And the portfolio breadth we have when we look at films, and you look at dressings and we look at the biologics, those are -- the skin substitutes, those are all great products, great outcomes, great clinical data that underpin them. So we see true opportunities to accelerate. And I mean, I've called out negative pressure previously. So that's the other aspect of this and the add up of all of these, I believe, will -- if we execute this right, which we are well on the way to we will get to the 21%.

I think it's Julien. Next.

Yes. Our next question comes from Julien Dormois from BNP Paribas.

I have 3, if I may. So first of all, you reiterated your comments that you would expect growth in the second half to be much stronger than in H1. So I would be interested if you could walk us through, what are the main areas in terms of orthopedics, sports medicine and wound management that would explain the step up, that would be helpful, please.

Second question relates to the recent announcement by one of your main competitors in wound management, 3M, that they are thinking about spinning off their healthcare business. That's typically the sort of situation where such a company starts to be more aggressive on pricing to make the drive look more beautiful, if you see what I mean. So are you worried that something like this could happen in the next 2 quarters and an impact of the recovery in your wound management business?

And the third question is a housekeeping one. Just curious what was the FX impact on your margin in the first half? And what we should factor in for the full year, please?

Great, Julien. So the growth in the second half, maybe I'll have Anne-Francoise walk you through a bit of the detail that we see. But just to kind of frame the answer for H2. The levers I mentioned just previously on the orthopedic side, what we see is continued placement of CORI. Of course, we're tracking not just placements and robotics is really a means to an end. It's ultimately to enable procedures and to drive implant. So it's thoughtful placement of CORI. And the impact not only of Engage uni, the LEGION CONCELOC on their own, but also the impact of pull-through of the rest of the portfolio on these.

So these are in orthopedics, 3 of the drivers. EVOS Large launched recently. And so that completes or brings our EVOS family to a place where we can sell the portfolio. Of course, the impact of that will be felt over time. We'll start to see it in H2, but really the bigger impact will be into 2023. So that's the orthopedics picture at large.

And in sports and just let me comment on sporting I've said a lot about wound. REGENETEN, we have highly, highly differentiated offering within sports. We see that as a continued driver of growth in that business. We also have great products, a great portfolio. As I mentioned, we are the leaders in enabling technologies there and in the tower. So we continue to execute on all elements of portfolio in sports, but I did want to call REGENETEN.

So those are the factors, if you want to color that Anne-Francoise a bit or?

No.

Good. Okay. So the impact of 3M. The announcement, of course, it's still relatively hot off the presses. So our top line is, we are going to be monitoring the impact commercially, obviously, carefully in the near term, we expect to go about our business and go about executing as we have.

In terms of price pressure, I would want to speculate how that's going to unfold. But I strongly believe in the differentiation of our portfolio. Our strength comes from the breadth we have across all the categories that I mentioned, but actually within the category, each of these categories and the differentiation that we have in some of our -- not only the lead products, but the second, third tier products, tier that does a value judgment.

The secondary and tertiary products within each category are also themselves differentiated. So I'm confident in our portfolio. I'm confident in our differentiation, and I'm confident in our team's ability to execute where we have been doing quite well in that regard. But obviously, we'll be monitoring the posture and how things evolve there in the field.

And in terms of FX impact, I think you can take -- you've made a comment already, but I'll let you cover that a bit, Anne-Francoise.

So Julien, in the first half, there was a positive tailwind in the gross margin, in particular, as we see the timing benefit of the fact we had to remind everyone, 50% of our revenues are in U.S. dollar or actually 75% of our cost base is in U.S. dollars. And we hedge 12 months in advance for some of those costs. So clearly, as the dollar strengthened that quickly, we do see the impact flows through the revenue much faster than on the cost as the hedging protects us for a period of time.

But of course, that starts unwinding at some point. So when we look at the FX for the full year would probably expect sort of a neutral or slightly positive impact. But I hate doing forecast on FX. I'm not a trader in FX and God knows where the economy is going. So at this point in time with current FX, we think it's slightly neutral, I would say. And as you look into 2023, we estimate a headwind of about 40 to 50 basis points on the trading margin in 2023. So sorry, I expanded the question slightly, but.

I hope that answers your questions, Julien.

Our next question comes from Chris Gretler from Credit Suisse.

I have 2 questions. First, I'm a bit surprised by the magnitude of a fix this orthopedic business requires. Could you maybe elaborate on how that's going to impact your midterm growth ambition. I think they are still 4% to 6%, particularly in light that you intend to streamline your recon portfolio. And did I hear that right that you are aiming to reduce the number of families in the hip side from 12 to 6. I think probably has not quite a meaningful impact on the gross outlook. And I guess will be similar.

Could you maybe elaborate on that specifically in orthopedics and maybe in general, how that affects your overall top line growth ambition?

Sure. So our growth ambition remains unchanged. What I'm describing is the how we intend to get there. In terms of the Orthopedics side, you mentioned the reduction in family on the hip side and knees, we don't have quite that many systems, right? So the magnitude of the change, change is going to be different. There's going to be work required to complete our family. So there is -- this is not a lever for the next 2 quarters or 3 quarters is more over the medium term that we've talked about.

But in terms of our growth aspiration in orthopedics, I strongly believe with the actions that we've outlined, we are going to get there. And even in this quarter, despite the impact of China, we were on the low end of that corridor that we indicated. So what I want to highlight is or we expect to be at the low end of that corridor. So the actions we've described are the means by which we're going to achieve the growth aspirations that we've laid out.

That is the equation as well.

So I mean just to accentuate again, thank you, Anne-Francoise, the points that I've made in terms of the factors lining up. We see great potential in CORI as a platform that is a different paradigm. We're very pleased with the reaction, the feedback from surgeons who've used it, of course, you get a spectrum of opinion. But we really are quite encouraged by the early results. And I just want to remind everyone that we're at the start of that journey.

So we've added indications to it. It's also about adding functionality, not only in the knee but also in the hip where we're really at the very, very beginning of adding functionality on CORI for the hip. So the hip remodeler that we launched last quarter is the first step along that journey.

So that innovation and it's important that we've maintained the level of investment that we've called out in innovation is the lifeblood of our industry, its core to what we do at Smith & Nephew. We've got a great sort of differentiated products across our franchises on the back of innovation that we have done over the course of time.

And so we plan to continue that investment that will be a driver for growth. So I talked about CORI. And of course, on the implant side, it's the Engage uni knee, it's LEGION CONCELOC and of course, JOURNEY II, that continues to lead the way. OXINIUM is a highly differentiated technology. The data that we have, the 5- and 10-year data on OXINIUM in independent registries, whether they come from the U.K. or Australia, are excellent. I mean, in the med tech business in my 20 years in this business, you can count on 1 hand the number of opportunities you have to talk about data that are that differentiated with OXINIUM.

And of course, different fields have different -- the role of data in terms of utilization. But having said that, we see really differentiated elements of our portfolio to drive continued growth in the orthopedic side. So I hope that answers your question, Chris.

Our next question comes from David Adlington from JPMorgan.

And also my apologies, you may have covered this off already. But just with respect to that '24 target of 21% and then coming back to Hassan's note in terms of the margin bridge, 17.5% this year. It sounds like you've got 40, 50 basis points headwind from currency next year to the margin. You obviously got some -- probably some underlying inflationary pressures next year as well, but put some offsets with respect to cost savings and probably less dilution from some of the acquisitions.

So I suppose the big question is, if you get to 18.5% next year, if we're kind of lucky that at least you were 300 basis points jump into 21%, open to this 20-odd years, and I can't think of a company that's done that sort of margin improvement in 1 year in a mature company. So any sort of comfort you can give us around that and where that's come from?

And secondly, again, bigger picture 1 for you, Deepak. You came into the role beginning of this year, and I think there was some messaging given that you sort of bought into those targets. I just wondered if you thought that they have become a bit of a millstone around your neck?

Well, David, look, there's no question that there is a bigger jump off point, whether you look at it from '22 to '23 or '23 into '24 is equally, we're facing I would say, relative to when the plans were put in place, the scale of headwinds, macro headwinds that we're getting into are significantly higher inflationary pressures being 1 of them continued pressures on supply chains from all sorts of macro factors significantly higher than anything we could have -- anyone could have forecasted in '20. So back when the plan was put in place.

So there's no question that we're going. This plan now is being executed on in a different macro environment that was envisioned. Having said this, I indicated when I first got here that I have embraced the strategy and embraced the set of targets as my own. And I met what I said. What I've done over the last 100 days or 90-some-odd since the last time I was before you, is really dig into the business and understand how we're going to get there, right?

The path that we have thought about in December needed to be refined, needed to be rethought in order to go by achieving a target. That's been the focus of my work. I acknowledge the delta and the steps that you've taken, but much of what we're doing are not incremental changes. In Orthopedics, it's a fix, right? It was a conscious choice of words because it's not working as an orthopedics business should. So it's not a linear kind of path from here to '24. The fixes that we -- that we're putting in place, I expect to pay off in nonlinear kind of ways.

Once we get the wiring right, get the commercial and operation teams working as they should and put the processes in place that any orthopedics business should have, and we've got the people who know what goods looks like, who are kind of executing on these things. I expect to have nonlinear jumps in terms of our performance in Orthopedics to drive this.

The portfolio piece of it is key. Again, we didn't have a full portfolio. We now have a full portfolio. We need to execute now with that full portfolio and the process that's in place. So I expect the benefits from that to accrue in a nonlinear fashion.

In sports and in wound, it's a different story. It's, of course, building off of an already strong base. So there is perhaps a bit more kind of, I don't want to say forecastable, but perhaps you can draw more of a straight line from where we are to where we expect to be. So there, it's about really kind of changing the trajectory, but we already have at hand the things that work.

So is it going to be easy? No. Am I going to be sleeping well at night every night between now and 2024? I can honestly say that I'm going to be spreading those stuff every day. But do I feel that the actions we've outlined are the ones that can get us there? Absolutely. So I have the opportunity to come here and talk about a different picture, right? And I'm not doing that today. I'm talking about this year's and not about everything else. And it means that have got the conviction that we can get there with the actions that we've outlined.

I think we'll call it a day there. Thank you very much.

Thank you.

Thank you. Thank you very much.