Smith & Nephew PLC Q2 FY2025 Earnings Call

Welcome to the Smith & Nephew second quarter and first half results meeting. I'm Deepak Nath, I'm the Chief Executive Officer, and joining me is Chief Financial Officer, John Rogers. So 2025 is a key year of delivery for Smith & Nephew. I'm pleased to announce the results that put us firmly on track for both our full year growth target and the guided step-up in profitability. On revenue, 6.7% underlying growth in the quarter reflects sequential acceleration across all regions and business units. In Sports Medicine, we've maintained the strong momentum across Joint Repair and AET outside of China. In Wound, the continued performance of AWD and the rebound in bioactives produced double-digit growth for the business unit as a whole. In Orthopaedics, we delivered yet another quarter of growth and in line with our previous commitment, our Recon and Robotics business sustained its recent improvement, both internationally and, importantly, in the U.S. This is now the fourth quarter of sequential improvement in U.S. Recon and Robotics. On profitability, 100 basis points of first half trading margin expansion is slightly ahead of what we indicated as we brought some efficiency savings forward. We remain on track for our full year margin guidance of 19% to 20%, which includes the impact of tariffs. There's still a lot of uncertainty about where tariffs will settle, but we continue to expect a net headwind of about $15 million to $20 million in 2025. As previously indicated, we expect that margin expansion will pick up further in the second half. This should come from cost savings increasingly dropping through to our P&L, particularly from our manufacturing network optimization over the last two years, together with the reduced year-on-year headwind from value-based procurement in China. I've talked already about the improvements in growth and profitability. At the same time, better alignment of the commercial organization and operations has enabled us to bring down days of inventory. The delivery of our ambitious cost savings and a move to ongoing efficiencies has also brought down restructuring charges. The result is a 70% increase in trading cash flow and almost $250 million of free cash flow in the first half. Finally, I'm also pleased to announce an additional element of value creation for shareholders with a $500 million share buyback in the second half of 2025. This is made possible by the operational efficiencies delivered under the 12-Point Plan and will be fully funded by the 2025 cash flow and existing balances. So it can be delivered while maintaining our leverage and without compromising any of our growth plans. I'll return to some of these themes later, and John will talk more about profitability, cash and returns in his presentation. For now, I'll take you through the details of the quarter. Revenue in the quarter was $1.6 billion with 6.7% underlying growth and 7.8% reported following a 110 basis point tailwind from foreign exchange. Growth also included a headwind from one fewer trading day than in the prior year. All business units accelerated sequentially, and I'll come to the detail in a moment. Geographically, the U.S. grew 8.7% and other established markets grew 7.4%. Emerging markets declined 0.2%, reflecting strong double-digit growth across the Middle East and India and the impacts of volume-based procurement in China beginning to ease. Excluding China, emerging markets grew by 12.2%. As we indicated in our Q1 announcement, we have passed the peak of the China impacts, and we expect these to continue to ease through the second half as distributor destocking in Orthopaedics reduces and as we lap the effects of Joint Repair VBP. For business unit performance, I'll start with Orthopaedics, which grew 5.5% underlying, and this is an overall solid performance. Total Reconstruction Robotics grew 5.2% with the U.S. growth of 4%. This is the fourth quarter of sequential growth improvement in the U.S. on an ADS adjusted basis. Global Knees and Hips grew by 2.9% and 3.4%, respectively. Growth remains higher outside the U.S., with Knees benefiting this quarter from the timing of a tender order in the Middle East. Almost half of our Recon business is outside the U.S., where we're demonstrating that our portfolio can deliver with good execution. As you know, China has been a headwind in recent quarters due to destocking at distributors. The inventory levels have continued to come down and have approached more normal levels at the end of June. In addition, we expect the destocking to ease during the third quarter. So we should see the China headwind on our OUS sales start to fall away in the second half. U.S. Hips and Knees together showed acceleration over Q1 with 2% underlying growth and 3.6% adjusted for the one fewer day, a measure we refer to as average daily sales or ADS. This is the fourth quarter of sustained improvement for U.S. Hips and Knees combined. Hip performance was strong as we continue to roll out the CATALYSTEM Hip System, which makes us more competitive in the high-growth direct anterior segment of the market. We'll accelerate set deployment in Q3 and are also preparing to bring the platform to other markets starting in Japan. The softer U.S. Knee growth was due in part to some slowing in procedures toward the end of the quarter among our active surgeon base as well as positive actions that we are taking to increase profitability through streamlining the portfolio and focusing on higher volume accounts. Reassuringly, the balance of competitive wins versus losses has continued to remain favorable. On an ADS basis, U.S. Knees grew 0.1% and Hips at 9.1%. Other Recon grew 39.8% and reflects another good quarter of Robotics placements, particularly in the U.S., where we're seeing strong growth in ASCs and in teaching institutes. This should mean we're well positioned as the market continues to pivot away from inpatient procedures and ideally placed to capture future leading surgeons. We also continue to develop our offering with the launch in June of the CORIOGRAPH preoperative planning and modeling for shoulder replacements. Trauma and Extremities grew 4.4%. The AETOS growth contribution is steadily increasing as we deploy more capital and convert new surgeons, while the EVOS plating system continues to be a key driver, partially offset by a slower quarter for some of our legacy systems. We're continuing to refresh the portfolio with the launch this quarter of the TRIGEN MAX Tibia Nailing System, which could expand our indication range and features modernized instrumentation. Further nail launches are expected in the coming quarters, and we expect Trauma and Extremities to return to stronger growth in the second half. Sports Medicine and ENT grew 5.7% in the quarter. Within that, Joint Repair growth was 8.4%, including the expected headwind from VBP in China. This is expected to be the last quarter before we lap the effect of the implementation in Q3 of 2024. Excluding China, Joint Repair growth would have been 13.7%, representing an acceleration in Q1 2025 with a very strong quarter across our other markets. Growth was double-digit across all of knee, shoulder and hip repair with the REGENETEN and Q-FIX KNOTLESS suture anchors remaining the key contributors. We expect this good momentum to continue as we extend REGENETEN into Hip and Achilles and as we further roll out Q-FIX. We are developing CartiHeal AGILI-C as a longer-term growth platform, including a new disposable instrument set, which we expect to launch in the near future. Arthroscopic Enabling Technologies grew 2.3%, again improving sequentially. We saw continued growth from WEREWOLF FASTSEAL, which is supporting strong COBLATION revenues. ENT grew 3.6% with good growth driven by our ARIS for turbinate reduction, offsetting a softer quarter for tonsils and adenoid procedures in the U.S. Looking forward, we expect ENT to follow Sports Medicine with the VBP process in China that's expected to take effect in 2026. To give a sense of the size of our business, total ENT sales were around $35 million in 2024. So while VBP would be a noticeable drag on ENT growth, it should be a significantly more modest headwind at a group level than previous VBP processes. Looking now at Advanced Wound Management, where growth increased to 10.2% following the strong rebound in Bioactives. In Advanced Wound Care, 2.6% growth reflected continued strong performance in foams, films and skin care, offset by a decline in infection management. In Bioactives, growth came from the expected sequential recovery in SANTYL alongside double-digit growth in skin substitutes. Although we'll face tougher competitors in H2 as we lap the launch of GRAFIX PLUS, we now anticipate mid-single-digit growth for Bioactives in the year. You'll have seen the proposed updates to Medicare reimbursement of skin subs in the outpatient and physician office setting, including moving to a single payment. Since no products were excluded from participating in the market, it is unclear how clinical practice will be impacted. So while the details of the proposal are yet to be finalized, we anticipate that this will be a headwind to both Advanced Wound Management sales and profitability in 2026. And that would be before any mitigating actions. Finally, Advanced Wound Devices revenue grew by 12.7%, led by our single-use negative pressure platform, PICO, and with strong growth from Leaf, our patient monitoring system. In traditional negative pressure, competitive wins are an important part of our growth opportunity. I'm delighted that we were recently awarded a U.S. Department of Defense contract for RENASYS TOUCH, succeeding in a competitive tender process, having demonstrated clinical efficacy and operational fitness. With an initial term of 5 years, which can be extended to 10 years, this contract is worth up to $75 million. Coupled with an ongoing broader refresh of AWM, we are confident about the long-term outlook for Wound. And with that, I'll hand over to John.

Thank you, Deepak. Revenue was $3 billion in the first half, up 5% on an underlying basis compared to Half 1 2024. Reported revenue was up 4.7%, including a foreign exchange headwind of 30 basis points from the relative strength of the dollar against most major currencies versus the same period last year. As the dollar weakened in the second quarter, the ForEx headwind on revenue became a tailwind, and we now expect a circa 50 bps ForEx tailwind on revenue for the full year. Performance in China was in line with expectations. And excluding these headwinds, growth would have been 7.2% on an underlying basis. This represents a 220 bps headwind in Half 1, in line with our guided full year impact of circa 150 bps as the impact of Sports VBP unwind in the second half. Performance was broad-based with all three business units contributing significantly to the overall group. Orthopaedics grew 4.1%. Sports Medicine and ENT grew 4.1%, although again, excluding China, growth would have been 9%. Advanced Wound Management grew 7.1%. Overall, a good set of growth figures and particularly good to see that 3/4 of our growth is drawn from products launched in the last five years. Moving now to the summary P&L. Gross profit was $2.1 billion, resulting in a gross margin of 70.5%, which is a 40 basis point increase on the prior year, driven by positive variances on price and volume. We saw a further 60 basis points of positive leverage across our operating expenses as we benefited from operational savings in SG&A and only a small uptick in R&D spend driven by Half 1, Half 2 phasing. Operational savings were slightly ahead of expectations as we accelerated some of our operational savings into the first half. We also expect to catch up some of the shortfall in R&D spend in the second half, as well as absorb the bulk of the $15 million to $20 million tariff impact Deepak outlined earlier. So overall, trading profit grew 11.2% to $523 million with a margin of 17.7%, up 100 bps. And I'll explain the various drivers of the margin expansion on the following slide. Slide 12 shows the detailed trading margin bridge. Going through the moving parts, we absorbed headwinds of 130 basis points from input cost inflation and 140 basis points from the introduction of VBP in China. These costs were more than offset with 190 basis points of revenue leverage from price and volume and 170 basis points from productivity improvements, not only in manufacturing, but also across all other areas of operating expense. FX movements contributed 10 basis points. We have now sustained a trend of revenue leverage offsetting input cost inflation, which means VBP aside, cost savings have been able to drop through to trading profit. As previously guided, we expect the impact of VBP China to unwind in the second half, such that the full year impact is around 110 basis points. We expect operational savings to step up slightly in the second half versus the first, albeit not as much as previously cited given the acceleration of savings I mentioned earlier. Furthermore, we expect the bulk of the $15 million to $20 million tariff impact to take place in the second half, as well as some catch-up on R&D spend. The net effect is that we expect a step-up in margin in the second half, such that the Half 1 to Half 2 margin uplift remains comparable to previous years to deliver margin in line with our guidance of 19% to 20% for the full year. I'll now come on to trading margin by business unit. As you can see from this slide, the majority of the margin expansion came through Orthopaedics, where our transformation initiatives to reduce inventory, streamline instrument set allocation, portfolio simplification and focus on higher volume accounts resulted in 230 basis points of margin expansion in Half 1 2025. We expect these dynamics to continue into the second half. Sports Medicine and ENT margin declined 130 basis points, reflecting the VBP impact in China. If we stripped out China from these numbers, we would have seen margin accretion in the first half. As we annualize the impact of VBP on joint recovery, we expect to deliver margin accretion in the second half. Advanced Wound Management margin increased 160 basis points due to mix, ongoing efficiency gains and the timing of SANTYL revenues in the prior year. And for 2025, we reiterate that the bulk of our margin expansion will come from Orthopaedics at over 200 basis points with accretion of around 50 basis points coming from Sports Medicine and Advanced Wound Management combined. As we've already mentioned at previous results, we've changed our central cost allocation process to better align costs to the appropriate business unit. With this fuller allocation in place, only $28 million has remained as truly central costs, in line with prior year and our previous guidance that these will be broadly flat year-on-year in 2025. The purpose of the change was to create transparency and accountability, and there are already positive behavioral changes as a result. We've seen greater scrutiny of spending plans, lower demand for new projects and greater discipline in constructing robust business plans for new IT investment spend, as an example. We showed you this slide at our interims last year. As a reminder, it details the gross run rate savings of $325 million to $375 million we are targeting for 2023 through 2027. As we set out at our prelims in February, including 2023 and 2024, we have delivered a cumulative savings of $210 million. This comprised $155 million relating to the 12-Point Plan and zero-based budgeting and $55 million relating to earlier programs. That's actually the faint dotted line you see there on the 2023 column. On zero-based budget, implementation is on track across all business units and central functions. Across our five work streams, 51 initiatives have been mobilized, which over half are now complete. We anticipate $120 million to $130 million of savings coming through in 2025. And as you saw from the margin chart earlier, we delivered circa $50 million of these in the first half, slightly ahead of our plan as we were able to bring some efficiency savings forward from Half 2 into Half 1. In total, therefore, that delivers run rate savings from the 12-Point Plan and ZBB of circa $275 million to $285 million at the end of 2025 with a further $50 million to $100 million of savings to come through in 2026 and 2027, very much in line with what we set out on this chart this time last year. We've now embedded our ZBB approach into our standard processes in line with our culture of continuous improvement. Looking further down the P&L, earnings per share grew strongly, up 37% to $0.335 and adjusted earnings per share grew strongly, up 14% to $0.429, reflecting both revenue leverage, operational savings and significantly lower restructuring costs, which were $8 million in the first half compared to $62 million in the first half last year. We remain on track to incur an estimated $45 million of restructuring charge for the full year. The interim dividend of $0.15 per share is up 4.2% on Half 1 2024, in line with our policy set out this time last year of paying 40% of prior year full year dividend as the interim dividend. As you know, inventory management has been a key priority of our 12-Point Plan, and I'm pleased to report a further 46-day reduction in DSI across the group to 506 inventory days, in line with our full year 2024 year-end position. The reduction in DSI delivered a $69 million reduction in inventory value at constant currency. All business units contributed to this performance with the biggest reduction in Sports Medicine and ENT. There was still an overall increase in inventory for launch products in the first half versus the same period last year. And this means our inventory mix has also improved with the units of the slowest turning quartile of SKUs down by 14% in Half 1 2025 versus Half 1 2024 and down 22% since the start of 2023. Longer-term improvement will be down to improved forecasting and better alignment of production plans with the commercial needs at the SKU level, enabled by the improved SIOP process. There is still more work to do here, including aligning our SIOP process with our financial forecasting in a truly integrated business plan. Inventory reduction remains a focus, and we expect further progress in Half 2 2025. Trading cash flow in the period was $487 million, with trading cash conversion of 93%, well ahead of the 60% in Half 1 2024. The improvement came from lower working capital outflows, particularly from the inventory day reductions I detailed on the previous slide. Capital expenditure is slightly lower year-on-year, but we expect to catch up some of this in the second half of the year as we continue to progress the development of our new manufacturing facility in Melton. We expect to exit the year at a similar level of spend to last year. For the full year, we continue to target trading cash conversion of over 90%. With lower restructuring costs offset by slightly higher tax, free cash flow increased over 500% to $244 million. We expect to deliver free cash flow of well over $600 million for the full year. This strong cash generation broadly covered the cost of CapEx, dividend and other costs in the period, meaning net debt at the 28th of June 2025 was only $38 million higher than at year-end 2024. The leverage ratio has also decreased slightly to 1.8x. As we maintain and build on this improved cash generation, capital allocation continues to be a focus. This is our capital allocation framework that you should now all be familiar with. As Deepak mentioned in his introduction, the good start of the year in terms of profitability and cash conversion has enabled us to increase our cash returns to shareholders in line with our capital allocation policy. We intend to complete a $500 million share buyback during the second half of 2025. This will be fully financed from free cash flow and existing cash balances, so it can be delivered while keeping our leverage ratio broadly stable for the full year and without compromising any of our growth ambitions. I'll finish with our outlook for 2025, which, as you can see, is unchanged. We expect to see a step-up in margin in Half 2, in line with what we experienced in both 2023 and 2024, reflecting the timing of cost savings and reduced China headwinds. The tariffs announced by the U.S. government early in the year have continued to evolve, and it remains to be seen what the final outcome will be, but we continue to expect a net headwind of around $15 million to $20 million, mainly to impact in the second half of the year. We expect to deliver well over $600 million free cash flow for the full year, and the strong start to the year in terms of profitability and cash conversion has enabled us to increase our cash returns to shareholders with a $500 million share buyback during the second half, as I've just mentioned. You should see this as further demonstrating our commitment to value creation for shareholders in addition to our extensive operational improvements. And with that, I'll hand back to Deepak.

Thank you, John. So when we launched the 12-Point Plan, one of our core ambitions was to reposition Smith & Nephew as a consistently higher growth business. We're very much on track. In the first two years of the plan, we delivered growth of over 7% and 5%, respectively. And in the first half of the year, we've delivered yet another 5% despite some significant headwinds. That includes two fewer trading days for the half. And while the China headwind has passed its peak, it still had an impact on H1. So if you look through the detail of the quarter, you'll see we're doing what we said we would do. Sports Medicine and Wound continue to grow well. In the U.S. and the U.S. Recon specifically, we're showing progressive improvement quarter-by-quarter. And our investment in innovation is supporting the acceleration in revenue growth. Let me take a moment to go into more detail on these two last points. A year ago, we highlighted the strong performance in Trauma & Extremities based on new product introductions, implant supply, capital deployment and improved commercial execution. We also detailed that all the same elements were in place to improve performance in our U.S. Recon and Robotics business as well. As with T&E, these actions have driven four consecutive quarters of sequential improvements in U.S. Recon and Robotics revenue growth. On implant supply, key product line item fill rate reached its target in the fourth quarter of 2023, and capital availability followed soon after. With hip set shipment also was at goal in the fourth quarter of 2023, and knee sets started reaching their goal in the second quarter of 2024. This is also being supported by a steady stream of product launches over time, such as the newly launched short-stem hip. We also launched 10 new features on CORI between 2022 and 2024, further contributing to the recent recovery in our hip and knee implant sales growth. We have further new product launches planned to continue this positive momentum. Innovation has been a key significant driver in our transformation to a higher-growth business. Across '23 and '24, more than half of our underlying revenue growth came from products launched in the previous five years. In H1, this proportion was three-quarters or 75%. We continue to invest in our innovation pipeline and introduce new products across all of our business units in the first half of the year, which we're confident will help us sustain our improved revenue growth profile. In Orthopaedics, we expanded our nailing range with a new system for stable and unstable tibial fractures. TRIGEN MAX builds on more than two decades of proven performance and industry-leading design from our TRIGEN nails portfolio. In Robotics, we received FDA clearance for CORIOGRAPH pre-op planning and modeling services in total shoulder replacement during the second quarter of 2025, which expands our offering to cover all joint replacement procedures; knees, hips and shoulders. In Sports Medicine, for the first time, Smith & Nephew is able to market REGENETEN for extra-articular ligament injuries in the U.S., creating opportunities to reach more patients with soft tissue injuries around the body. With an initial focus on hips capsule repair, we have future expansion planned in other extra-articular ligament repairs. In addition to new products, we also announced a number of significant evidence milestones during the first half of 2025, supporting the adoption of key product families. For instance, a recently published randomized controlled trial of Smith & Nephew's handheld robotic system demonstrated the value for patients and surgeons of robotically assisted total knee replacement with JOURNEY II BCS. Patients experienced significantly better outcomes, including reduced pain, improved function and higher satisfaction compared to conventional surgery at the one-year time point. In conclusion, I've talked a lot about our 12-Point Plan. We're now in the final year of our three-year transformation that I first set out for you in July 2022. And Q2 performance is yet another proof point that we are on track to deliver our ambitions. Each of the three parts of the 12-Point Plan is delivering great progress. The rewiring of our Orthopaedics business is well underway with sequential growth acceleration over the last four quarters at the global ortho, U.S. ortho and U.S. Recon and Robotics levels. Orthopaedic inventory levels have improved, and we've seen the associated expected step-up in ortho margin. Both Sports Medicine and Wound Management have shown consistent momentum since the start of the program, and productivity improvements are clearly visible in the P&L. In other words, our operational improvements are increasingly translating into financial gains. In Q2, once again, we delivered revenue growth ahead of historical levels, even with headwinds from trading days and China. This higher organic growth is underpinned by fundamental competitive strengths, better commercial execution and a high cadence of innovation across our portfolio. Cash flow has also stepped up significantly in the last 12 months with better control of inventory to the point where we can start returning excess cash to shareholders through our $500 million share buyback. There's still more to do around profitability, but the 100 basis points of expansion puts us on track to deliver the guided step-up in full year margin. As a reminder, we've delivered 240 basis points group margin expansion from H1 2023 to H1 2025 despite greater headwinds than we expected when we first laid out the plan in 2022. As I told you in the full year 2024 results, since the start of '23, we've successfully offset over 700 basis points of headwinds from inflation, foreign exchange and VBP. Finally, these improvements are sustainable. A key objective of the 12-Point Plan has been to drive increased accountability and greater discipline in execution, both of which are now embedded in our culture and our ways of working. As I've said before, the 12-Point Plan is a necessary step, but it is not the limit of our long-term ambitions. We'll set out the next stage of our strategy at a Capital Markets Day in early December. I'm looking forward to seeing you all there, and formal invitations will follow shortly. So with that, we'll now take your questions.

Jack Reynolds-Clark from RBC. I've three, please. The first is on revenue guidance. So with Q2 having been, I guess, stronger than I think people were expecting, does that imply that there's upside to the 5% target for the full year? Or are you expecting things to slow down elsewhere in the business? Then on margin guidance. So I appreciate you mentioned some kind of moving around of R&D and possibly some other expenses as well. But could you walk us through, John, the bridge in H2 margin and whether the kind of upper end of the 19% to 20% margin range is possibly more achievable? And then the last question was on U.S. Knees. So could you just run us through some more detail of the work you're doing there and kind of how much of the weakness was driven by the market versus your own activities and how you're thinking about kind of growth versus margin in that segment going forward?

Sure. I'll frame this up, and I'll leave it to John to kind of give you the margin guidance. So overall, as we mentioned, given all the puts and takes that we see, we feel good about the guidance for the full year. So there are positives and negatives as we go through. We'll continue to improve commercially in the back half of the year, but we do have a step-up that we expect, both from a revenue standpoint and from a profit standpoint. We're in a more uncertain environment. We've characterized for you what we expect the impact of tariffs to be. But fundamentally, there is a much more uncertain period. That, coupled with the step-up that we need to see in the back half of the year, particularly around margins and all the various effects around comparators, China VBP falling off and other things, we feel at this point, it is prudent to maintain the guidance that we've given, both in terms of revenue and margin. In terms of U.S. Knees, as we unpack that a little bit, the headline is that at a U.S. Orthopaedics level, including Trauma and Recon, U.S. Recon and Robotics level and at a Global Orthopaedics level, we're seeing sequential improvement. And those are very, very strong proof points that the improvements in supply and product availability, commercial execution, our ability to connect all the different pieces together is delivering the desired effects. So that's the headline in terms of where we are. I'm pleased with the progress we're making. The softness in knees, which were offset by the greater-than-expected strength in hips, a couple of factors. First, we are going through a step to refocus our commercial organization to the higher volume accounts. I've said in previous settings that we've got a relatively long tail of accounts where we have surgeons use our products on an occasional basis with particular patient populations or what have you. While that's an important part of our business, we do want our commercial activities focused on driving key primary use of our knees or hip platforms. So that's some concerted effort there going on. There's also some level of portfolio rationalization work that we're doing, and I've highlighted that in the past. So we've got three Knee families that are relevant in the U.S. We are trying to get that down to two knee platforms, LEGION and JOURNEY. And there's work involved in having to transition surgeons and doing that. By and large, we're successful in retaining most of our customers when we go through that process, but not all. And that does have an impact on the top line. But these actions actually get us to a better position as far as our U.S. business is concerned from a margin standpoint. And these steps do contribute on the back of all the other improvements we're making in the factory and in terms of inventory control for the margin step-up that John talked about. But what we also saw related to this was particularly in the end of the quarter that we saw some slowdown in terms of the number of procedures in our active base of surgeons. And that did contribute to the numbers that we see. So with that, John, do you want to take the margin...

Yes. Just to sort of build on a little bit what we said, we saw the 230 bps of margin accretion in Orthopaedics in the first half, which was a reflection of those changes that Deepak just talked about. And that very much puts us on track to deliver the margin expansion that we set out last year for Orthopaedics. So we ended last year with just below 12%. And if we look forward to this year, we should end north of 14%. So a big step-up, a big improvement in margin for Orthopaedics. In terms of setting a little bit of color on the revenue guidance, I mean, you're right to highlight that we did say that we would expect to see a step-up in Q3 given China annualizing, given the reversal of the impact of trading days. So in Q3, we've got level trading days year-on-year as opposed to two less in the first half. So we will expect to see a step-up in Q3. That said, important to remind you that Q4 for us last year was a very strong quarter, particularly in the U.S. So we've got quite a tough comparator. So I would say that we're only six months of the way through the year. There continues to be significant sort of uncertainty over macro and external conditions like tariffs, for example. So now is not the time to be changing our guidance. In terms of the margin phasing, again, we talked about bringing savings forward from Half 2 into Half 1. And of course, those savings will repeat in Half 2. So that's an upside. At the same time, we've got the impact of tariffs, the $15 million to $20 million that we made reference to. And that will, of course, primarily hit us in the second half. So that broadly offsets that. And then also, we've got the U.S. OUS mix in Q4 as well. Again, we had a very strong U.S. in Q4 of last year. So again, at this stage, I would say now is not the time to be changing our guidance on margin; the 19% to 20% holds. And we've said in the past that we expect it to be broadly center of that range. And actually, if you look at the bridge from Half 2 '24 to Half 2 '25, so I'll give you a little bit of color here. We'd expect sort of cost inflation of around 1.9% or so. VBP on China will be about a drag of 80 bps or so. Remember, we said it was going to be 110 bps for the year. So that's averaging out Half 1, Half 2. We'd expect to see revenue leverage of around 200 bps or so and then operating savings of a similar amount to get us up to the circa 19% to 20% margin for the full year. So that gives you a little bit of color on the Half 2 bridge.

Richard Felton from Goldman Sachs. First one, just a follow-up on margin. John, can you remind us the drivers of the operating savings in H2? How well advanced are those programs? How much visibility do you have that, that is going to be achieved and fully derisked? And then also, what elements of those operating savings are structural? And how should we think about that dynamic into FY '26? That's the first one. The second one, just a follow-up on U.S. Knees, Deepak. You mentioned at the end of the quarter, a slightly softer procedure environment. Why do you think that happened? Why was that the case? And have you seen that continuing into Q3?

I’ll address the U.S. Knees segment. This pertains to our existing customers, and it's challenging to determine the specific reasons behind the slowdown. Vacation schedules around this time of year could play a part, making it difficult to pinpoint the cause. What we do know is that there has been a slowdown in our customer base. Historically, I've hesitated to comment on market dynamics, but we’re currently experiencing a performance recovery in the Orthopaedics sector, making it hard to differentiate our impact from broader market factors. Unlike in Wound and Sports, where we can make clearer assessments, I've been cautious in this area. That being said, our position in Orthopaedics in the U.S. is significantly better now than it was a year or two ago. I am comfortable discussing the developments within our customer accounts. It appears that the slowdown we are observing can be partially attributed to vacation schedules and surgeon transitions, where some surgeons are shifting from hospitals to Ambulatory Surgical Centers or changing networks, which has affected our base. On a positive note, regarding churn, I previously mentioned that much of 2023 and early 2024 saw us losing more surgeons than we gained due to retirements and competitive losses. However, I reported previously that this trend turned favorable in the latter part of 2024, and I am pleased to say that this positive trend has continued into Q2, building from Q1. I feel optimistic about the operational progress we’re making and am confident that by the second half of the year, we'll be in a better position. In terms of our U.S. Recon segment, we are observing noticeable sequential improvements and are closing the gap to the market. While not all competitors reported for the quarter, the trends for Q3, Q4 of 2024, and Q1 of 2025 indicate we are narrowing this gap. Additionally, outside of the U.S., we have maintained our strength over the past couple of years. Overall, I am optimistic about our positioning. Now, I’ll pass it to you, John.

So in terms of the savings and where they're coming from, again, I'd point you to the slide that we've got in the deck, which sets out, I hope quite clearly, they come from across the board. There's a big chunk clearly that come from manufacturing, procurement, but there's also warehousing and distribution, business support, sales and marketing. We're seeing savings across the entirety of our business. We had 51 different programs, most of which are all of which are already in train and many of which are already complete. And so in terms of visibility of those savings, I feel pretty confident that we'll see that margin accretion come through in the second half, as we said, consistently before. In terms of '26 and '27, again, point you to the chart, we should expect to see another $50 million to $100 million of savings flow through in '26 and '27 as a consequence of some of the changes we're making now as we see those flow through into future years.

It's Graham from UBS. Just two for me, please. On the Ortho inventory in terms of the lower cost inventory starting to flow through post the site closures over the last 12, 18 months. Have we seen much of that yet? I think we always thought that would be like a H2 sort of weighted story. So it'd be interesting to get some color on that. And then just on tariffs. One of your peers appears to be able to not pay tariffs on Hips and Knees. So just to get your sense as to have you explored the Nairobi Treaty for that protocol? And is there anything to do there?

In terms of inventory, we've noted that the benefits from our network optimization efforts will fully show in the second half of the year, and we are on track for that. This will significantly contribute to our margin growth moving forward. However, we have already started to see some effects over time. When we close a site, there are upfront costs, and we usually build up safety stock from the production there before transferring it to other parts of our network. This process takes time to reflect in our results. Additionally, we are aiming to enhance product availability through improved supply and demand connections down to specific SKU levels. We’ve made considerable progress since the start of this initiative, and while there is more work ahead, the comparison to our position in 2022 is strikingly positive. John highlighted our improved inventory health, with reduced slow-turning inventory levels which were previously imbalanced. The slower-moving inventory primarily stems from our Trauma segment, which has higher inventory needs. We've successfully reduced these levels, contributing to lower overall inventory and days of inventory. However, the impact on the balance sheet and profit and loss statements is complex due to various inflation factors. We have reduced our manufacturing capacity, yet we've managed a period of excess capacity, affecting our financials. Despite these challenges, we are on track to achieve the anticipated margin expansion in the latter half of the year. Regarding tariffs, we're exploring all options for mitigation, with an estimated impact of $15 million to $20 million. Concerning our Orthopaedics production, we operate primarily out of Memphis, Malaysia, and Switzerland, which gives us some natural hedging, although there are still specific impacts at the SKU level and from raw material sourcing. The situation remains dynamic and complex, so we have a specialized team actively monitoring it.

Just to build on Deepak's point there. If you look at our manufacturing network, as it happens, the more of the tariff impact comes through for us on Wound and Sports and less on Ortho because most of our manufacturing is U.S.-based for Ortho. So there's a little bit more of an impact in Wound and Sports than there is in Ortho.

I think, David, you had a question?

A couple from David Adlington at JP Morgan. Just on the buyback, John, given the strong cash flow in the first half, I just wondered how you're thinking about ending the year in terms of net debt to EBITDA? And then secondly, also good to see progress on the inventories. As you look into the medium term, where do you think you can get down to? And how much cash could that free up?

Yes. So on the buyback, notwithstanding the $500 million buyback in the second half, I'm still expecting us to exit the year below our 2x net debt-to-EBITDA sort of target level. So giving us plenty of capacity for all of our growth ambitions, et cetera. So very strong cash flow, which is very positive. On the inventory side, obviously, we don't want to overly guide to what we're going to deliver in the future. But you've seen the direction of travel over '24 and 2025. And we would expect that improvement to continue. I think when it comes to Sports and Wound, we're now getting down to what would be pretty good industry levels. I think the opportunity continues to exist in Ortho, and we've seen good improvement in the first half. We'd expect that to continue into the second half of this year and then further improvement in Ortho next year as well.

It's Sam England from Berenberg. So the first one, just in Hips, you called out the benefit from CATALYSTEM in Q2. How should we think about the market share gains you think this can drive, especially in the ASC channel given the focus on anterior surgery and how crowded is that space becoming now for anterior products? And then just looking at the other Recon business and the growth there that you called out was driven by Robotics. Can you just talk a bit about demand and placements for CORI in Q2? And I suppose, is more of the demand being driven by the hospital or ASC channel, just some sense for the sort of split of demand between channels?

We are pleased with the uptake of CATALYSTEM. While not all competitors have reported results, we have seen positive outcomes from two and feel confident about our position. Surgeon feedback on CATALYSTEM has been excellent, and we are experiencing traction in various settings, including ASCs, hospitals, academic centers, and community hospitals. The value proposition is strong. The market has shifted significantly over the past few years from a traditional approach to a direct anterior approach. We were not the first to enter this space, but we offer a compelling product in a rapidly growing segment. The feedback from surgeons and the acceptance across different settings are promising. Regarding Robotics, we are focusing not just on placements but also on utilization. We are seeing significant uptake, where the surgeons we collaborate with are integrating our solutions into their routine practices, which is our ultimate goal. We are also assessing whether this leads to competitive conversions, which is crucial for retaining our existing customer base. We are considering several factors related to CORI, with placements being just one aspect of our evaluation. We are also exploring opportunities in the ASC channel and educational institutions, where we have traditionally faced challenges. The progress we are making in these areas is very encouraging. Overall, we are very satisfied with CORI's performance across channels and the level of utilization we are achieving.

And just again, just to build on Deepak's comments there. We're not going to split out, obviously, numbers that go into the channel, but it's fair to say that in the second quarter, we certainly over-indexed in ASCs in terms of the proportion of our CORI placements that went into ASCs in the second quarter, which I think is really encouraging. We said before, we think that CORI in terms of its form factor, in terms of size and its footprint and also its capital cost being significantly lower than the competition, actually puts it in a very strong position, particularly in the ASC channel. And we're starting to see that come through in terms of the number of placements we're putting into that channel.

The first question comes from Veronika Dubajova of Citi.

Hope you can hear me okay. I have three, please. First one is just Joint Repair. Again, another impressive quarter for you guys with double-digit growth, excluding China. Just curious, Deepak, if you could touch upon the drivers that are enabling you to deliver that growth and how sustainable you think that is not just into the back half of this year, but also as we think about 2026? My second question is just maybe if you can elaborate a little bit on the skin substitute exposure that you have and the risks that you might see there from the new proposal and maybe just give us a flavor for where your current pricing stands relative to the $125 that's been proposed by CMS. And then my final question is around the buyback. And just to what extent do you feel this year is giving us a good indication for your ongoing recurring future capacity to return cash to shareholders?

Sure. Excluding China from our Joint Repair growth analysis, as we have mentioned several times, we will account for the effects of Joint Repair VBP as we progress into Q3. When examining our performance in other regions, we are experiencing very strong double-digit growth. The primary contributors to this success are Q-FIX and our advancements with REGENETEN. Adoption of REGENETEN within rotator cuff treatments, which was our initial focus, is increasing. Furthermore, as we broaden its use to the Achilles area, we are observing a growing share of REGENETEN applications there as well. Our ambitions don't end there; we are also targeting the hips. We anticipate REGENETEN will serve as a foundational technology, leading to its usage across various joints, with Q-FIX and REGENETEN being the main factors driving Joint Repair growth outside of China. Regarding skin substitutes, they are expected to act as a significant headwind for both revenue and profit in our Wound business. There is the pricing aspect you mentioned, but additionally, no products were removed from the market due to this situation. How practice patterns will adapt remains uncertain. However, compared to a previous scenario where we anticipated clinical evidence would reduce market players and result in lower pricing and limited adoption, we had considered the previous environment as neutral. Now, we view the current situation as a clear headwind. We have integrated this perspective into our guidance for the year, and both John and I have addressed it. We are confident in our ability to navigate through this challenge in 2025, but we are not ready to provide guidance for 2026 yet. We will remain active in this space, committed to developing products backed by strong clinical evidence, and we will monitor how the situation evolves. In relation to buybacks, would you like to address that, John?