Smith & Nephew PLC Q4 FY2021 Earnings Call

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. 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 the 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 the 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 mid-term 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 one trading day less than in 2020. Trading profit was $936 million, which is an 18% trading margin and a 300 basis points expansion. We generated over $800 million trading cash flow and an 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 four. 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, four 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 and then December in the U.S. The effect on Smith & Nephew was that the typical December pickup in average daily sales didn't occur in 2021 and that was across our surgical business with the weakness continuing into January. By region, you see 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 general health care systems are being more resilient to new outbreaks. 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 levels. 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. Additionally, hip and knee sales into the channel in China continue to be slow ahead of the VBP tender implementation this March. The total China destocking and provisions reduced revenue by about $25 million in the quarter and around $60 million for the full year. 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. Not having a competitive cementless offering has been the primary drag on our Knee business. Filling this gap is another important strengthening of our foundation. 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 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 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 are 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 levels, 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. For the full year, all three 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 Foams business continued to grow faster than the overall segment. Advanced Wound Bioactives grew 4.5%. 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 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. 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. As a reminder, we made midterm commitments that by concentrating on our innovation, culture, and customers, we'll consistently deliver 4% to 6% organic revenue growth and rebuild our profit margin. 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 three simple imperatives, which you see in the pyramid on slide number 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. Lastly, we'll continue to transform ourselves for higher long-term growth through investment in innovation and acquisitions. We'll deliver these imperatives through our four key value builders, which are productivity, commercial execution, innovation, and M&A. 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 as addressing the internal and external supply pressures that we've talked about before and reducing costs through 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've already moved to a specialist third-party logistics provider in Europe, and we'll make the transition in Memphis in 2022. The new Orthopaedics facility in Malaysia is on track to supply this year already and is ahead of schedule, with multi-sourcing making us more resilient to future disruptions at any one site. 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 2021 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 2021 projects are making important growth contributions already as I mentioned for Sports Medicine. Others we're just starting to ramp up like the LEGION CONCELOC cementless knee; 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. Firstly, we're still continuing a 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. Importantly, there is a good balance of projects between incremental innovation and then disruptive technology. 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. 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. 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. 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 announced 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 aligns very well with the strategy we set out in December. It can shift to the 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. The cementless partial knee should grow faster than that again. It's 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 onto CORI. It is an excellent solution for the ASC, with attractive returns as well. We'll focus on integrating the asset in 2022 then launch at scale in 2023, with ROIC then expected to exceed WACC in year four. These are our strategic priorities for the coming year. Now, I'll pass you over to Anne-Francoise to take you through the full year 2021 financials and 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 three 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. 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 Medicine and Advanced Wound Management businesses returned to growth over the pre-COVID level, while Orthopaedics and ENT have more to recover. It would also 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. There was another 20 basis point headwind from transactional effects. 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. It's important 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 one-time tax provision release in 2020. Our trading cash flow was again strong at $828 million for the full year. Capital expenditure was 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. 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. That financing capacity and our strong cash generation means we can continue to invest behind our growth strategy in 2022 and beyond while also being 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 than 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 assumes 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. While 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 procedure volumes in those markets continue to recover and we see more benefit from 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. 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, resulting in a one-time 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 previously to drop by around 50% in the affected categories, which is substantially smaller impact than the 80% headline reduction in prices. Secondly, importantly, we've taken steps to simplify our go-to-market model. Previously, we 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 through closer contact 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 have also heard about a regional trauma tender from 2021, where the outcome is now being applied to other provinces.In terms of pricing, we are being as proactive as we can, given the challenging environment we are in. We have reviewed contracts, and where we can, we look for price increases, but it's not an easy task. The pricing lever will become better in the medium to longer term as we renegotiate tender contracts.

Thank you, Anne-Francoise. So to sum it up, I'm pleased with the steps we've taken towards our midterm goals by delivering on our 2021 targets. As 2022 progresses, you should see the strategy continue to advance. Efficiency and margin expansion 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 2021 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. 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. 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. Finally, I'd like to thank you all, our investors and analysts for our interactions over the last two years. They've been much less frequent 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.

Thank you. Our first question today comes from Hassan Al-Wakeel of Barclays. Your line is open.

Thanks for taking my questions. I have two, please. 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.

Thank you, Hassan. Let me take the second question first. What we are seeing is of course the infection rates coming down in the U.S. and in Europe. We have 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, which often showcases much less symptomatic cases. This leads to more acute short-term cancellations as patients come to hospitals, get tested, and end up testing positive resulting in a cancelation. These cancellations are different from previous waves, but we believe this should ease as the number of infections continues to decline across the globe.

Now, Hassan on the margin, as you've correctly stated, we've guided to 50 basis points expansion. The headwinds are important, particularly the VBP China which is a one-time rebasing of our margin for 2022 and the 60 basis points inflation as well. While 125 is material, it is significant. Having said that, we are being proactive. We have teams looking at spot buys; we monitor inflation and we are really being as proactive as we can be. Offsetting that is all the actions we're taking. It's important to note that in 2021 we saw margin expansion from revenue growth due to operating leverage and the cost discipline we have in the organization. So clearly, to drive margin expansion and offset the headwind, we need to drive revenue growth, which would come through as well from recovery, our new products, and our commercial execution. We need to drive our productivity agenda and the efficiency gains. That will contribute about 235 basis points to offset the headwinds. When viewed against what we've achieved in 2021, we saw a large margin expansion of well over 300 basis points. However, we believe the headwinds are more significant going into 2022. You also had a question on FX, which is a fair one because we previously stated we expect a small tailwind. As we move through the period, we are now mostly fully hedged and do not expect significant transactional exposure in 2022 as we're hedging to the best of our ability. The acquisition continues to be a little bit dilutive in terms of Integra in 2022, but that's not material enough to underline. Overall, we feel our guidance is our best view at this point, particularly in a volatile global supply environment.

That's very helpful. If I can just please follow up on growth. How should we think about the relative growth within your guidance of the three 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?

In terms of what we've seen in Q1, and I guess you're going to tell me we're almost a 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. We did see some continued disruption earlier in the quarter, and that's what we've factored into our revenue guidance. For the rest of the year, we're assuming demand is largely unconstrained by COVID outbreak. The sensitivity will remain on the availability of staff, particularly in the U.S., where it is a bit more acute due to shortages. In terms of the franchises, we expect Orthopaedics to continue to improve, particularly with the launch of the cementless knee. Sports and Wound will continue their performance. Again, I want to reiterate that we are pleased to see that they are performing better than 2019 levels.

Perfect. That’s all I have. And all the best, Roland.

Thank you, Hassan. Appreciate it.

Thank you. Our next question today comes from Tom Jones of Berenberg. Tom, your line is open. Please go ahead.

Good morning. Thanks, everyone. I had two questions really. The first was just on your 2022 revenue guidance in the context of the businesses that performed between 2019 and 2021. 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 two, three in the other divisions. Without COVID, you would have expected probably also to grow over that time frame Sports Med probably something in the double-digit range cumulatively. And Wound, maybe mid-single digits. Depending on the franchise, there's somewhere between kind of 10% and 20% of the revenue that you would otherwise have expected that has been lost. 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 how much pent-up demand release you've baked into your 4% to 5% overall underlying growth guidance for 2022. Then the second question is, just on your guidance for 125 basis points of margin pressure from input cost inflation. I'm somewhat surprised by that number as it seems quite low. If you look at your cost base of around $4 billion, on a fully loaded basis, you're talking about sort of a $60 billion to $70 billion headwind at that level, which seems sub 2%. Given the wider inflationary environment, it looks like quite a low number. How confident are you in that 125 basis point headwind being the worst of it? It seems 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, there is definitely pent-up demand in the system. The question is how much it is and that’s very difficult to assess since we don't have patient-specific information. We do know that in elective surgery, many surgeries have been deferred, and we know that joint replacements are among the first that are always delayed or deferred. So, there is pent-up demand building waiting lists in the public sector, more in Europe than in the U.S. The underlying fundamentals remain intact—the patient population continues to grow, creating natural growth. The challenge will be seeing how quickly those waiting lists will be addressed. How quickly hospitals can return to full surgical volumes and in the U.S., the impact of the staff shortage will be crucial. I foresee that all joint reconstruction patients will eventually return, however, trauma or sports medicine patients may not come back as they are based on acute surgery or accidents. So, we see very few lost patients in joint reconstruction. It's a different story in trauma or in Sports Medicine. When comparing some of our numbers against the competition, we have been transparent about the fact that we have lost in knees due to not having a cementless knee. This is now corrected, leading to a level playing field which excites us. I believe we've performed well in hips despite some supply challenges, and we’ve certainly excelled in sports and wound across different categories.

Before moving on, Tom, do you have a follow-up question?

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

Perfect. Before moving to your inflation question, to add to what Roland said, the recovery will be more marked in H2. Whether looking at comparisons against 2021 or growth versus 2019, we will see acceleration in revenue in the second half of the year. So, regarding your inflation question, we've been thorough in our assessments, particularly the teams in our operations have looked closely at the cost base of raw materials which had discussions ongoing. We've been proactive in looking at the costs, especially in electronic components which have increased by 20%, and forging which has seen an 11% price increase. Therefore, we expect the 125 basis points EBIT sensitivity based on what we currently know. It doesn’t take into account merit increases or wage increases, which is important—it's strictly about raw material.

Okay, perfect. That's clear. Just a follow-up regarding supply chain issues affecting revenues. I believe you mentioned you expect a gradual improvement across H1. Can you provide more detail on other franchises beyond hips that are affected, and the trajectory of that recovery? Will it improve quickly, or is it gradual as the half progresses?

The current disruptions are mostly driven by the global supply situation, which every company finds difficult to pinpoint exact timelines on when disruptions will ease. Initially, we saw more of an impact on Orthopaedics, but we use electronic chips in Sports Medicine for example, and in various other products. We expect stabilization across the year, but because we depend on suppliers and global conditions, we can't provide definitive timelines.

We've also experienced some supply constraints on raw materials. As Anne-Francoise mentioned earlier, think of resins used for sterile packaging; our suppliers have seen constraints there as well. We'll continue to see some short-term impact, but we are diligently working on mid-term strategies, and we know that the situation will improve going forward.

Good. That's all very clear. Thank you for that, and all the best for the future, Roland.

Thank you, Tom.

Thank you. Our next question today comes from Veronika Dubajova of Goldman Sachs. Please go ahead. Your line is open.

Hi, guys, good morning, and thank you for taking my questions. I have two, please. I just want to come back to the margin guidance. I think Anne-Francoise if I look at 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. Can you decompose this a little bit for us in terms of what you're assuming from an operating leverage perspective versus efficiencies? What are the degree of confidence these efficiencies will be achieved, and what are they dependent on? Are there risks behind achieving that? Given the headwinds in the business, it strikes me that this is an aggressive underlying margin improvement against the top line. So I’d love to understand what's driving that. My second question is just about the supply chain and a point of clarification again. If I understand correctly, the headwind this quarter was similar to last quarter. Have you resolved all the issues you had in Memphis? Is the headwind this quarter coming from other issues beyond labor availability, or are there still remnants in terms of labor headwinds in Memphis? Also, how are you thinking about wage growth in 2022? Thank you.

Hi, Veronika. Regarding the margin, it's crucial to understand the components driving this figure. If we have about 185 basis points of headwind, we must drive around 230 improvement to achieve a 50 basis point expansion. Clearly, we saw close to 400 basis points of improvement in 2021 offsetting challenges. There's strong operating leverage in our business, and we are continuing to identify efficiencies. We aim to see operational leverage improvement as revenues rebuild, seeing SG&A and goods sold or manufacturing leverage. We're also anticipating around $150 million of efficiency improvements spread across three buckets: project prioritization, operational efficiencies in manufacturing, and strong cost discipline and organizational efficiencies. That will assist us in delivering the $150 million. Clearly, it’s all about execution. We need to drive savings in the business and ensure we deliver the top line. As for the second question around supply chain, the current disruption is primarily driven by global supply challenges. Memphis has stabilized after recruiting efforts. We are working to enhance our sales and operations planning. While notable improvements have occurred, it is not entirely resolved. We're committed to a much more resilient network moving forward. Regarding wage growth, I can't disclose exact numbers, but expect inflation in some countries, especially in emerging markets.

Got it. Thank you. If I could follow up: Is the 125 basis points in raw material cost inflation that you are guiding for this year the same assumption you had in December when you provided midterm guidance, or has that changed?

Nothing has materially changed. By December, inflationary pressures were already apparent. We had worked through our budget, so nothing has changed. Competition for raw materials is growing more severe, but we haven’t seen any material changes, and we remain committed to delivering on our midterm target.

Thank you, Veronika.

Thank you. Our next question comes from Lisa Clive of Bernstein. Your line is open.

Hi there. 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.? I recall there was mention at your December event about building out a robotics facility in Germany. If you could talk 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. Lastly, in terms of sales of CORI, what proportion is to current unique customers versus competitor accounts? Thanks very much.

Hi 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 and the uniqueness behind it. It enables us to bring new products or surgical techniques onto CORI. As I said, we’re bringing the LEGION CONCELOC cementless construct onto CORI; we’re also introducing the revision knee and eventually the new Engage Surgical UNI knee as well. It’s about building out the entire franchise and that’s quite exciting. The trend remains strongest in the U.S., and we believe that will continue. However, we're seeing increased interest in robotic surgery in different markets, particularly in the Middle East, India, Asia, and in Europe as well, reflecting our plans to establish a medical education, training, and innovation facility in Munich to support the use of robotics in Europe, linked to the 2019 acquisition of hip navigation assets from Brainlab. I don’t think we have disclosed the sales breakdown, so I'm afraid I can't provide those figures. However, we notice that accounts using CORI are growing faster than those not employing a robotic system.

Thank you. Our next question comes from David Adlington of JPMorgan. Please go ahead.

Okay. Thanks, guys. Firstly, just on VBP. I wondered what your thoughts were on how that might expand beyond ortho either this year or potentially beyond? Secondly, regarding the pricing environment or inflation you're seeing on the cost side, I wanted to understand your ability to pass through price increases to customers and what your price assumptions are.

Hi, David. So in terms of VBP, we discussed ortho at length. There was a tender in 2021 for trauma in some provinces that is now being extended to others in China. For our sales, it’s small and a fraction of group sales, so we don't foresee a significant impact. As for future expansion, where we play in China is mainly in sports and wound. In sports, there are not many local players, and it’s not yet at the magnitude to fall under VBP criteria, so there’s longer runway without anticipating VBP in other categories in the short-term. Regarding pricing, we are being as proactive as possible; it’s challenging in our industry. Competitors are voicing the same concerns—it's difficult to pass on like-for-like price increases. We are reviewing contracts and increasing our prices wherever feasible. However, it won’t be a primary short-term lever, but it should become better in the medium to long term as we renegotiate tender agreements.

Great, thank you. So, we should assume typical historic pricing environment of kind of minus one-ish this year?

Correct, David.

Thanks very much. And all the best, Roland.

Thanks, David.

Thank you. Our final question today comes from Chris Gretler of Credit Suisse. Your line is open.

Thank you. Good morning, Roland and Anne-Francoise. I wanted to come back on the change in CEO. I apologize if this was addressed at the beginning, but could you explain the rationale for changing the CEO right now after just setting out the new strategic goals in December? What are the risks that the incoming CEO might revise these targets, and is he fully committed to this 2024 target?

I'll let Roland comment further in a moment, but clearly, first to your last question—we are committed to our midterm guidance. We reiterate today our midterm guidance regarding revenue growth of 4% to 6% and the improvement in margin by 2024 to at least 21%. This is all about execution and focus; our strategic pillars have been articulated clearly. The Board and Roland have mutually agreed to his stepping down while focusing on our strategy of driving revenue growth, productivity, innovation, and continuing with bolt-on acquisitions.

Yes, Chris, let me elaborate. When I took over in 2019, it was under very particular circumstances, soon followed by the global pandemic. Obviously, that was something unforeseen and shifted the goal to crisis management, focusing on how we could support customers, ensure employee safety, and sustain the business. It’s been a tremendous learning opportunity throughout the pandemic, and we've continued our transformation during these challenging times. I feel I’m leaving an organization in great shape with a solid strategy, which Anne-Francoise has already detailed. The commitment to the goals remains firm; I feel confident about handing this over to the next leader who will write the next chapter for Smith & Nephew.

Understood, and I wish you all the best for the future. My second follow-up question relates to the trading margin goal for 2024. Given the inflationary environment, how much room for maneuver is actually baked into that? Is it assuming that inflation normalizes going forward, or can you cope with the current rate of inflation and still achieve this 21% target by 2024?

I'll take a step back for the exact detail of your discussion. Looking at 2024, we need consistent improvement, and there are three levers involved. One is about revenue growth being 4% to 6%. It’s about commercial execution and new product launches. The second is about gross margin expansion—continuing our transformations in operations, product rationalization. The third lever is seeing our SG&A leverage grow lower than revenue growth, which is about focusing on where we compete and optimizing our go-to-market model. Those high-level levers are crucial for our performance over time. We knew the inflation challenges entering this period, which was built-in, but it’s essential to emphasize those levers that will enable us to achieve our midterm guidance.

Noted, thank you for your insight.

Thank you.

Thank you. We have no further questions on the line. I will hand it back to the management team to close.

This concludes our call. Thank you very much, everyone. Wishing you all the best, and thank you again.

Thank you.

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