Earnings Call Transcript - SNN Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Smith & Nephew Q2 and First Half 2020 Results Conference Call. 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 these statements due to a variety of factors. More information about these factors is contained in the Company's filing with the Securities and Exchange Commission. I'd now like to hand the conference over to the first speaker today, Mr. Roland Diggelmann, Chief Executive Officer. Thank you and please go ahead.

Roland Diggelmann, CEO

Thank you, Maria. Good morning, everyone, and welcome to Smith & Nephew's second quarter and first half results. I hope you are all well and safe. Joining me today on the call is Ian Melling, who has been our Interim CFO since April. We appreciate his leadership during this challenging period for the industry. I'm also pleased to share that Anne-Francoise Nesmes joined Smith & Nephew as Chief Financial Officer on July 27. I hope many of you will have the opportunity to speak with her in the coming months as she familiarizes herself with her role. The second quarter and first half were significantly affected by the COVID-19 pandemic, as anticipated. However, we are encouraged by the improvements observed across all segments since April's low point. Constraints on elective surgeries have generally eased in major markets, despite some recent setbacks in certain areas. I'm proud of how our team has managed under these tough conditions, and I'm confident in our resilience and agility as our markets recover. Today, we will discuss our results in detail and provide insights into how we are witnessing recovery across each segment, our cost control efforts this year, and our initiatives aimed at enhancing our long-term growth profile, which is a key strategic priority for Smith & Nephew. Let me highlight our half-year figures. Revenue for the half was $2 billion, reflecting an underlying revenue decline of 18.7%, which accounts for one less selling day compared to the first half of 2019. Trading profit was $172 million with margins of 8.5%, influenced by negative operating leverage and higher provision charges, balanced by cost savings. Ian will elaborate on this later. EPSA stood at $0.134. For the second quarter, revenue reached $901 million, resulting in a 29.3% underlying decline and a reported decline of 29.8%. Trading days remained unchanged compared to the previous year. The impact of COVID-19 was the main driver, resulting in significant restrictions on elective procedures across key markets early in the quarter. The most affected areas were our surgical business, particularly orthopedics and Sports Med and ENT, which saw declines of 34% and 33.3% respectively, while advanced Wound Management also faced significant challenges with a decline of 17.6%. Geographically, for the quarter, the U.S. experienced a decline of 31.8%, other established markets saw a decrease of 30.8%, and Emerging Markets had a decline of 20.2%, with China being the first major market to show improvement and actually grow in the second quarter. Initially, the U.S. was more affected than Europe, with sales declines of around 60% year-over-year at the lowest point compared to around 50% in Europe. However, as the quarter progressed, the U.S. showed a stronger recovery. All 50 states reopened for elective procedures during the quarter, although Texas and Mississippi implemented new restrictions in July, with around 90% of facilities still operating. Europe continues to show considerable variation between countries, with strong recoveries in Germany, Switzerland, Austria, France, and Spain by the end of the quarter, although some markets, like the U.K., which makes up 4% of our global sales, and Eastern Europe, are still lagging. We anticipate that Europe will be one of the slower regions to recover due to factors such as the public nature of healthcare systems, pre-crisis system conditions, and differences in incentives, especially compared to the U.S. Emerging Markets have also presented a mixed scenario. By April, China was already on a recovery trajectory and grew overall for the quarter, largely due to surgical business. The healthcare system's capacity utilization steadily improved, exceeding 80% in June, despite temporary surgery restrictions in Beijing due to a localized outbreak, which have since been lifted. There's significant interest in understanding the recovery's progression throughout the quarter. As a reminder, we reported monthly growth rates at the group level, following a 47% decline in April, with recovery to a 27% decline in May and a 12% decline in June, and an encouraging trend for July. Businesses most impacted at the start predominantly recovered the fastest. The orthopedic franchise rebounded robustly during the quarter, recovering from a 58% decline in April, with several categories returning to growth in June, including revision hips and partial knees, trauma plates, and screws. In Sports Med, since a large portion of business comes from privately paid and outpatient procedures, it experienced a significant initial impact, followed by a quicker recovery. Similar recovery patterns were noted between joint repair and arthroscopic enabling technologies, although capital components of AET have lagged behind consumable sales. The customer pipeline for the tower remains strong, although decision-making around larger investments has become slower and more cautious. ENT has seen a slower recovery due to understandable hesitance regarding the resumption of nose and throat procedures. In advanced Wound Management, the slowdown drivers were somewhat different, with slow recovery attributed to factors such as sales rep access and geographic sales mix, given our higher sales proportion in Europe, along with patient behavior and minor impacts from wholesaler inventory fluctuations. Now, turning to franchise specifics, starting with orthopedics. Joint replacements faced significant procedure deferrals during the quarter, although hips demonstrated resilience across all regions partly due to a higher proportion of emergency cases and the early benefits of launching OR3O, our Dual Mobility Hip System. OR3O has been very well received and is starting to influence other hip construct components. We have begun introducing it in markets outside the U.S. Trauma performed relatively well, and by the end of the quarter, it returned to growth in both the U.S. and Asia Pacific. The EVOS plating system experienced strong double-digit growth, even amid lower overall trauma demand. Growth rates in other reconstruction categories reflected a slow quarter for capital sales, but I'm thrilled to share that we recorded our first sales of CORI, our next-generation robotic surgery system, during the quarter. In Sports Med and ENT, similar to orthopedics, this franchise heavily relies on elective surgeries and experienced significant impacts from treatment referrals, particularly early in the quarter. Nonetheless, we saw positive growth from some recently launched products like FLOW wands and LENS 4K. We also had our first cases for NovoStitch Pro in Europe, along with the April CE Mark grant for REGENETEN, which we plan to launch in the upcoming quarter. ENT sales fell by 44% during the quarter, with case volumes remaining low. Finally, in advanced Wound Management, this franchise still experienced considerable impacts from COVID-19. Advanced Wound devices, particularly negative pressure, were most affected due to their connection with elective surgery. Other challenges included temporary closures of Wound clinics during outbreaks and reduced admissions to long-term care facilities, many of which are not accepting new residents. In Bioactives, we observed slow performance in the bio tissues market spanning surgical cases, Wound clinics, and burn centers. Looking beyond this quarter, we've made significant strides towards realizing the full value of GRAFIX and STRATAFIX, products we acquired with Osiris. Following a successful pilot, our existing Smith & Nephew Bioactives representatives will also begin promoting these products. Revenue synergies were a key part of the business case for this acquisition, and much of that benefit is still ahead of us. Now, I'll hand it over to Ian to discuss the financial details. Ian, please proceed.

Ian Melling, Interim CFO

Thank you, Roland. Starting with the P&L. Half year revenue declined 18.1% on a reported basis, and 18.7% on an underlying basis excluding the impact of foreign exchange and acquisitions. Trading profit was $172 million and the trading margin was 8.5%. We have experienced margin pressure due to the negative leverage effect from the fixed components of our cost base and the impact of reduced production volumes, due in large parts to the impact of the COVID-19 situation on our business. We also took additional charges of approximately $50 million to provisions for inventory excess and obsolescence and bad debt which are included in COGS and SG&A, respectively. These provisions reduce the margin by 2.5 percentage points. To mitigate these impacts, we have delivered approximately $150 million in cost savings in areas such as variable pay, third-party commissions and royalties, travel, promotional activity, events, and consultancy spend. The R&D expense has been largely protected as we continue to invest in the innovation that's central to our strategy. As a result, the R&D ratio stepped up to 6.6% of sales in the period from 5.2% in the prior year and rose slightly in absolute dollar terms. There was a small IFRS operating loss in the half of minus $5 million, principally reflecting the lower trading profit margin, along with amortization, restructuring, and legal and other charges. Moving further down the P&L, adjusted earnings per share declined by 71% broadly in line with trading profit. Basic earnings per share declined by 67% and was helped by one-time gains from the successful outcome of a U.K tax case. The interim dividend of $0.144 is in line with the prior year. We generated positive trading cash flow of $25 million in the period, with trading cash conversion of 14%. We've continued to invest in capital expenditure as we progress changes to our manufacturing site-based. The working capital outflow of $137 million includes higher inventory, partially offset by declining receivables due to the declining revenue. Restructuring, acquisition, legal and other outflows increased to $112 million, of which $69 million relates to restructuring programs. The prior year included $80 million of insurance receipts for legal matters. Cash tax was lower in H1 2020 compared to H1 2019, primarily related to a reduction in the U.S as overpayments in prior periods offset against amounts due in 2020. Overall, free cash flow is negative at minus $139 million. On the balance sheet, net debts increased by just over $500 million to $2.3 billion, including around $100 million from the acquisition of Tusker Medical. Closing net debt includes $200 million of lease liabilities, and we finished the period with a leverage ratio of 2. Our liquidity position remains strong with $3.4 billion of committed credit facilities and no debt maturities in 2020. We indicated in May that we were targeting up to $200 million in discretionary savings for 2020 in response to COVID-19. We're on track to deliver with around $150 million of savings delivered in the first half. Our approach has been to balance cost control with readiness to fully take part in the recovery of each market. There remains uncertainty around the full year revenue outlook, and while we've identified additional savings, if they become required, we also retain the option to reinvest some savings if more favorable scenarios play out. You should still expect material negative operating leverage for as long as our sales remain under pressure from the effects of COVID-19. And with that, I'll hand back to Roland.

Roland Diggelmann, CEO

Thank you, Ian. I'd like to finish with an update on what we've been doing to improve the longer-term growth profile and to position ourselves for recovering demand. We've made significant steps forward on some of the priorities we talked about in February and May, particularly around innovation and launch execution in the opportunities and ASCs and the development of our people. Let me go to the next page and you'll see that one priority was our renewed commitment to innovation as a driver to improve our growth. Our recent launch is already making a difference, and we continue to invest in R&D. Importantly, we've also been able to secure important regulatory clearances and approvals in major markets in line with our plans. For some examples, we've secured FDA clearance for the total knee application on CORI, following the earlier clearances for Uni-Knees and also for the INTELLIO Connected Tower in Sports Medicine. In Europe, we completed requirements for CE Marking REGENETEN in April as mentioned. So these launches are all underway. Part of our approach across our portfolio has also been to adapt with the new ways of engaging with our customers, of course. Traditional medical conferences have not been taking place, so we've used digital conferences to continue to reach out to customers. For example, more than 11,500 people visited our virtual AAOS booth. Also in professional education, we've held a global webinar series during the second quarter, reaching across our product categories with more than 25,000 participants in total. Our medical education team was quick to recognize the digital opportunity and has been able to replace traditional in-person lectures and case discussions without the need to travel and without taking the surgeons out of the hospital. Now we're not yet at a point where every aspect of traditional training can be conducted remotely, and we are supporting lab-based training and visiting student programs with appropriate safety protocols. You can also see the strengths of the early take-up of OR3O in our hip growth, and that demonstrates that we're still able to launch effectively in this changed environment. That's impressive. That is important given the impressive pipeline that we have and the innovation that we'll continue to bring to the market. We've also identified the ASCs as a strategic cross-franchise opportunity for Smith & Nephew, for the opportunity to bring Orthopedics and Sports Medicine together. There were already good reasons to expect acceleration of joint replacement in the setting of ASCs, including Medicare reimbursement for total knee replacement in the ASC for the first time in 2020. It has also become clear over the quarter that part of the U.S health care system response to COVID has been to accelerate this shift. We've already seen a significant increase this year in the proportion of joint replacement procedures taking place in ASCs, in both knees and the hips. We're also seeing changes in choices made by physicians as they change settings and that does support our view that the shift can be an opportunity for us and for market share changes at the same time. We believe we're well-positioned to benefit from the shift to our service offering for ASCs through branded positive connections, and with our enabling technology, including the launch of CORI. As I mentioned, CORI is our next-generation robotic surgery system. It is faster, it's more compact than NAVIO, continues to be a modular design that will enable us to bring more applications to the platform over time, and it does not require a CT scan, which is important for ASCs. So while it's early days still in the growth opportunity at ASCs, we see the developments this year as validating both our view for the potential for Smith & Nephew, and for the approach to this high-growth segment. Another key priority was the ongoing focus on our people. As restrictions have eased in each country, we've been stepping up production and opening our offices. Employees are still being encouraged to work remotely where they can, and precautionary measures have been put in place at all of our sites to ensure that when employees are there, they can work in a safe way. The period of lower business activity has also been an opportunity to further develop our employees' capabilities, and so further enhance our long-term effectiveness as an organization. As an example, in the first six months of the year, our sales force more than doubled the amount of time spent on product and other professional training compared to the prior year. The large majority was delivered by distance learning and we are building on that capability by developing new specific training content for a wider range of functions. Our teams have also used our resources to support our communities in the fight against COVID-19. We have now assembled more than 1 million face shields at our Memphis and Costa Rica facilities to help meet the increased demands for PPE. And in hopes we're supporting the trial of a technology designed to support distancing between employees in manufacturing and lab environments. So in summary, we have made excellent progress before we entered the COVID crisis. We had really good momentum throughout the end of 2019 and the start of 2020. Managing the immediate pressures has obviously been necessary, but we've also kept developing in line with our strategy and advancing our focus areas for 2020. Our priority remains to sustainably accelerate the underlying growth of our business while focusing on delivering innovation, strengthening our talent and capabilities, and improving profitability at the same time. So with that, I look forward to your questions. Thank you very much.

Operator, Operator

Your first question comes from the line of Patrick Wood. Please go ahead.

Patrick Wood, Analyst

… much. I'll keep it to two, please. The first would be just maybe a little bit of color please on the reinvestment rates that you guys are thinking of that cost savings pool. Let's say, if we have 2021 looking more like a normal year for Smith & Nephew, should we expect the majority or all of that cost savings pool to be reinvested? That will be the first question. The second one, I'm just curious if you can give us any color and thank you for the monthly data so far, but very roughly, the shape of what you've been seeing in July, a little bit more color on that in terms of the sequential improvement relative to June? That'd be really helpful. Thank you.

Roland Diggelmann, CEO

Thanks for the question, Patrick. On the first question, obviously, we want to continue to invest because the fundamentals mid- and long-term remain positive. We have actually also ring-fenced R&D in the first half because we believe strongly in innovation and in the growth opportunities in the markets in general. So we will be cautious, and we'll be closely monitoring the developments in the market, and we'll invest accordingly. As you pointed out, the majority of the savings in the first half were discretionary costs. We've already secured $150 million of savings. So I think what you can see is we have the opportunity to generate those savings. We'll monitor the market development. If need be, we can introduce more savings if the market recovers, though we are ready and prepared to continue to invest to support the growth and the recovery. On July, I'm happy to report that July has been, I would say, a good month. If I look at the trajectory from April onwards, I am positive and optimistic. We're not at the end of the month, of course, and at the same time as you will know, a lot of uncertainty remains, but the trend generally is positive.

Patrick Wood, Analyst

Super. Thanks for taking the questions.

Operator, Operator

Thank you. Your next question comes from the line of Kit Lee. Please ask your question.

Kit Lee, Analyst

Thank you. Two questions, please. Just firstly on your capital equipment business, when do you think there will be more clarity on hospital budgets and your customer decisions on buying both SAEs or other equipment? And then my second question is on the provisions. How should we think about that for the second half? Do you think there'll be more provisions on the way, or is that $15 million enough for the full year? Thank you.

Roland Diggelmann, CEO

Thank you, Kit. I'll address the first question, and Ian will handle the second regarding provisions. As anticipated, hospitals were slower in making decisions on capital equipment, which is completely understandable. I believe that as the markets recover, this process will speed up again. There is no reason to think that capital expenditure or larger equipment sales will face more challenges in the future, as the trends are likely to persist. Looking at the tower we have available in Sports Medicine, the technology is an excellent solution, and I remain very enthusiastic about our position in that sector. Prior to this crisis, we observed a strong trend toward robotics, and I expect this to continue as technology advances. I'm optimistic about our next-generation platform, CORI, which offers outstanding technical features. It integrates well into ambulatory surgical centers and aligns with the movement towards more decentralized and modular approaches. Furthermore, I believe we also have a favorable financial proposal in addition to the technical advantages.

Ian Melling, Interim CFO

Thanks, Roland. On your second question, Kit, as you've seen we're not guiding on the second half, and that logic applies to the provisions as much as it does anything else. But what I would say is if we continue to see a recovery that we've seen across Q2 coming into Q3, then there will be much less pressure on those provisions. If we saw our second dip approaching Q2 levels, then it might be a different story.

Kit Lee, Analyst

Okay. That's great. Thank you.

Operator, Operator

Thank you. And your next question comes from the line of Kyle Rose. Please ask your question.

Kyle Rose, Analyst

Great. Thank you for taking the question this morning. Can you hear me all right?

Roland Diggelmann, CEO

Yes, we can.

Kyle Rose, Analyst

Great. So just a couple of questions for me. One specifically on the knee business, obviously, I understand that those procedures are a bit more deferrable than the hip side. Just wanted to see what you've seen as far as a month-over-month trend on the knee side, and how and when you expect that business to return to growth? The second question, Roland, you talked about the ASC channel. So I appreciate the commentary, but you also talked about seeing potentially different choices from physicians in that channel. Can you maybe help us understand what that means? Does that mean different types of implants, different types of treatments? And then the last question is just your overall M&A, any thoughts about capital allocation in this period? Thank you.

Roland Diggelmann, CEO

Thank you, Kyle. I'll begin with your last question about M&A. Our M&A strategy remains the same, as we continue to seek technologies and innovations that align with our overall strategy and can enhance our existing commercial presence. We are actively exploring the marketplace for potential acquisitions. While there may be some distressed assets available, we aim to maintain a clear strategic direction and position ourselves as a responsible owner in the market. Last year, we completed five acquisitions, marking a significant moment for our organization. We remain interested in M&A opportunities. Initially, our focus was on liquidity and cash flow, but we now have a strong balance sheet, which is a positive aspect. Regarding ASCs and the varied choices made by physicians, there is an opportunity due to the unique setting of ASCs and the different patient selections involved. We see this as a dual opportunity: first, regarding implant options, and second, in expanding our presence in ASCs, where we already have strong relationships through our leading Sports Medicine franchise. We also anticipate growth opportunities in the future with our robotics solutions, including CORI, which offers a compact, non-CT-dependent option. As for knees, we are keeping an eye on the situation. Hips have recovered more quickly, driven by two factors: an increase in trauma-related joint replacements for hips and a successful launch of OR3O, our dual mobility product. However, I believe knees will also see recovery; they are just currently lagging behind hips, but I am confident they will grow as the market improves. We have a robust portfolio, and with CORI entering the market, we expect it to support that growth.

Operator, Operator

Okay. Your next question comes from the line of Chris Gretler. Please ask your question.

Christoph Gretler, Analyst

Yes. Good morning. It's Chris. Hi, Ian. Hi, Roland. I have two questions actually, and it relates to the cost savings. First of all, the $150 million you quote, is it actually a run-rate exit at the half year end, or is this basically the total cost saving you experienced now in the first half?

Roland Diggelmann, CEO

So thank you, Chris. I'll take that one. So the $150 million is the cost saving that we realized in the first half against our expectations. So just to be clear, it's not a year-over-year cost saving number; it's cost saving against our expectations coming into the year in the first half.

Christoph Gretler, Analyst

Okay. Thank you for the clarification. And then the second question is on the restructuring program. I think earlier this year, we had an expectation that there might be some more programs now coming up eventually. Is this in the current environment still a topic or you basically just wait and see kind of how the pandemic develops before coming up with any incremental program on top of APEX?

Roland Diggelmann, CEO

Yes. Thank you, Chris. We have incurred some modest costs in the first half on the new program, but also some things have been delayed as a result of COVID and we are considering our plans in that area. So we're still working through the full impacts of those, and we'll come back to you all in due course with an update on that. It'll also give Anne-Francoise a chance to come in and see those plans as well. So still on the cards, still work in progress and expect to see something in due course.

Christoph Gretler, Analyst

Thank you. One last question regarding the ASCs. What percentage of your knee procedures, and to a lesser extent hips, are currently sourced from ASCs?

Roland Diggelmann, CEO

It's still a small number, of course, because the majority of the capacity is in central hospitals. I would say for us, it is close to about 10% of our knee sales. It is a higher proportion, I believe than for others. And it has and I think that's the more important message we've seen a good growth in ASCs during this crisis, albeit at the low level, because the entire volumes were depressed. But we continue to see this trend evolving and we feel that we're very well positioned to benefit from the move to decentralization and ambulatory.

Christoph Gretler, Analyst

Okay. Thank you. I appreciate your comments.

Roland Diggelmann, CEO

Thank you, Chris.

Operator, Operator

Thank you. Your next question comes from the line of Julien Dormois from Exane. Please ask your question. Your line is now open. Please ask your question.

Julien Dormois, Analyst

Hello. Sorry. Can you hear me now?

Roland Diggelmann, CEO

Yes.

Julien Dormois, Analyst

Okay. Sorry. Thank you. Good morning. Roland, good morning, Ian. I have two questions, please. The first one relates to the comments that you made during the Q1 call, where you alluded to the risk of pricing pressure mounting in the industry as hospitals will exceed the pandemic where we've damaged financials. What are your latest thoughts on that topic? Have you seen anything or is that not happening at all at the moment? And the second question relates to the underlying growth momentum. You have clearly stated that the strategic focus remained on accelerating supply, and we see lots of reasons to be optimistic in orthopedics and Sports Med with the high rate of innovation. But what are your thoughts about Wound Management? Did you have plans here to come up with maybe more innovation or more acquisitions in order to reinvigorate growth in the segment that has been lagging for some time?

Ian Melling, Interim CFO

Thank you, Julian. I'll go with the question on pricing and the pricing pressure first. I'd say initially we haven't seen anything that would indicate more price pressure on the short term. I think everybody has been very busy managing the COVID crisis and the situation. We've always had price pressure in our industry. I think that that's something that we know how to deal with. We'll just have to observe and see what the future brings here. So I'm relatively positive here as well. In terms of the underlying growth on Wound, you're absolutely right there in Sports Medicine and orthopedics I think I've seen very good growth coming into this crisis, very good momentum. In Wound, I think if I look at the three sub-segments in Wound care, we've made good progress in Europe coming into this situation. We've had some challenges in the U.S., but I think we can manage that. In Bioactives we have made the acquisition of Osiris. So that gives us a really nice play in the Bioactive field of Wound and with GRAFIX and STRATAFIX, we have some great products. We are now cross-trained our sales forces between Osiris and Smith & Nephew, and we're also going to be launching this product over time outside of the U.S. So I'm positive in that sector. The one area that's been the most impacted during the crisis is actually the one we've been strongest in, which is devices, which is very much linked to surgical procedures. So, and with PICO and then the next generation PICO coming to the market next year, I'm very optimistic that we can continue that positive trend and actually grow market share.

Julien Dormois, Analyst

Okay. That's clear. Thank you very much.

Roland Diggelmann, CEO

Thank you, Julien.

Operator, Operator

Thank you. Your next question comes from the line of Michael Jungling from Morgan Stanley. Please ask your question.

Michael Jungling, Analyst

Great. Thank you and good morning, all. I have two questions. Firstly, on the Q3 sales growth expectations and I'm just curious how you're thinking about Q3 pent-up demand being down by physicians. I'm trying to understand whether there is a meaningful possibility, in your eyes, whether there's seasonally a low volume quarter, but at the same time, pent-up demand being used by surgeons to catch up could feasibly result in for you sort of bit of growth, actual positive growth in the quarter for orthopedics. And then question number two is on cost savings. And is it sort of correct that the $150 million in discretionary savings for the first half was slightly better than what you had suggested earlier? And how does one think about sort of $50 million of additional savings in the context of $150 million in the first half? I'm trying to understand how much flexibility you have in that spend. It seems to me that you probably have quite a lot, but if you could quantify it and how you're thinking about it, that would be very helpful.

Roland Diggelmann, CEO

Sure. Thank you, Michael. So on Q3, obviously there's a lot of uncertainty still in the market, but I think you described it quite well. I absolutely believe it's possible that we will see continuing good recovery and good trend. There is certainly pent-up demand. It's not the same in every geography, of course, you have to factor in when the different geographies went into lockdown and into deferring surgery. So we're going to see probably this evolving geography-by-geography, but given the fact that the U.S is accounting for almost half of our sales and relatively quick recovery, I'm also optimistic here. We've seen two things happening, of course: the pent-up demand being worked on and then ongoing demand being managed because the fundamentals remain the same. The patients are out there; they need and they demand surgery and care. There is an incentive of the entire system and all stakeholders to provide these solutions to patients. On the savings, Ian, can you give some color?

Ian Melling, Interim CFO

Yes, absolutely. And I just add to what you said, Roland, just in response to your comment, Michael, that August is our lowest sales month seasonally. So August is going to be a little harder to interpret, but I think as we come out to the quarter with September, we should have a clear view. In terms of the savings, yes, I think we're pleased with the $150 million in the first half. It's in line with, maybe slightly better than our expectations, but not significantly. So in terms of what to expect in the second half, I think it will depend on the top line. So if the top line comes back strongly and we see the recovery we just discussed, then we'll have lower cost savings, and we'll be spending more in variable areas and sales rep compensation and the like.

Michael Jungling, Analyst

Okay.

Ian Melling, Interim CFO

Yes, travel is looking like it's going to come back a little slower maybe, but what we will see, it depends on whether travel comes back or not. There's lots of variables and I think it will be very dependent on the top line. So yes, it …

Michael Jungling, Analyst

It sounds to me that you've got quite a lot of discretion in the EBITDA that you want to show, because let's say, if the second half grows at minus 5, you seem to have quite a lot of discretion in terms of how much you want to spend on travel, on consulting, all those things that you've mentioned in the press release. Is that a fair statement?

Ian Melling, Interim CFO

We have some flexibility and there are some variable costs involved that depend on sales. Therefore, while there is some flexibility, if customers are active and we have opportunities to visit them, we want to be engaged. We don't want to fall behind the competition by limiting our spending, which could prevent us from attending events or visiting customers.

Michael Jungling, Analyst

Okay. And the final follow-up please is, is the inventory obsolescence charge of $46 million in the first half, have those products been scrapped or can they still be sold in the second half?

Ian Melling, Interim CFO

The majority would still be able to be sold, Michael. It's not a binary thing across the whole portfolio. There will be some exploration issues in, but the majority would still be available for sale.

Michael Jungling, Analyst

Great. Thank you.

Roland Diggelmann, CEO

Maybe just one more comment on the savings. I think from a management perspective, what’s important for us is that we find the right balance between the savings and then of course investing such that we are in the best possible shape for the recovery, because we all know the recovery will come. The fundamentals are positive. The question is when, and in what shape are we? That’s why we've taken some deliberate decisions to also protect the R&D line to ensure that we're ready with new products, innovation, but also with the sales capability for when the markets restart. And again, that restart is something that has a lot of uncertainty and looks very different in different geographies, just looking at the U.S and China, then at some markets in Europe. So it comes down to individual decisions at the market level, but we want to make sure that we are very ready and very strong when the markets recover.

Michael Jungling, Analyst

Very good color. Thank you.

Roland Diggelmann, CEO

Thank you, Michael.

Operator, Operator

Thank you. Your next question comes from the line of David Adlington from JPMorgan. Please ask your question.

David Adlington, Analyst

Hey, guys. Thanks for taking the questions. I’m afraid a couple of numbers clarification points, please. I just wanted to check the $50 million splits of provisions and I may have missed it. But the split between the trade receivables and inventory and just double-check the inventory sitting and cost of goods and receivables within sales and marketing. Secondly, just in terms of the technical guidance, because the slides are missing again. Just wondered if you have any updates there, particularly with respect to your foreign exchange, please.

Ian Melling, Interim CFO

Thanks, David. Regarding the $50 million in provisions, most of it is for inventory. Roughly, 80% is inventory and 20% is for bad debts. The inventory charges are included in the cost of sales, while the bad debt charges are accounted for in SG&A within the P&L. There are no significant updates on foreign exchange, but we will follow up with you offline about that.

Operator, Operator

Okay. Thank you. And your next question comes from the line of Veronika Dubajova from Goldman Sachs. Please ask your question.

Veronika Dubajova, Analyst

Good morning, gentlemen and thank you for taking my questions. I'll start with one and then I'll have a follow-up. Just kind of curious, Roland, to get your thoughts and when you look at the pace of recovery and in particular, sort of what you're seeing in July in the U.S. What do you think is a realistic timeframe for the business to return to growth? Just as sort of approximate guess on when you think you might be at a point where, on a year-on-year basis, the business is back to growth, I mean, assuming no second wave or large outbreaks somewhere.

Roland Diggelmann, CEO

Thank you, Veronika. You're obviously asking the big question here. I wish I could give you a precise answer. I think we just don't have enough data points to give you a very precise answer. What I can tell you is that the markets in the U.S have recovered quickly. I think there is a common incentive by all stakeholders to return to a certain sense of new normal. We've seen patients being willing to go back to hospitals, which has not been the case in other markets, or to a lesser extent. We have also seen all 50 states allowing elective surgeries again. We are also seeing that even when new lockdowns or new restrictions are introduced, since everybody has learned, this doesn’t necessarily mean that elective surgeries are not performed or delayed again. So we’re seeing a lot of positives in the way the market has recovered and the speed it has recovered in the U.S. But I wish I could give you more precise information. I can only give you a little glimpse into what we’re seeing in July, although the month hasn't finished, of course. But we’ve seen a very good trend and very good continuation of that initial trend in the months of July as well.

Veronika Dubajova, Analyst

And sort of my follow-up on this is, we're hearing, I think a lot of the surgeries that are happening now are effectively rescheduled backlogs that docs are working through. Do you have a sense for what the new demand generation looks like? So I'm thinking about ambulatory visits that are sort of leads into surgeries two, three months from now. I think some of your peers have discussed the risk of maybe a W shaped recovery. So we have a strong rebound, but then a dip down once that backlog works through. How are you guys thinking about it? And maybe if you can share some anecdotes from the ground on what you are seeing in terms of that new demand funnel?

Roland Diggelmann, CEO

Yes, let me try, and I think it's anecdotal information that I'm sharing here, of course. What we have indeed seen is once the restrictions were lifted and elective surgery was possible, the pickup was very, very high and very quick in the U.S. I think there was a pent-up demand and I think it is possible that there will be a bit of, you call it a W shape. I'm not sure how exactly that would look like. Anecdotally, what we're hearing is that physicians are seeing a good pipeline of new patients. They're also investing more time there. They're working longer hours, they're working more days. They're scheduling more OR capacity to accommodate both for managing the pent-up demand and then managing the ongoing new patient demand. So I'm optimistic and positive, especially for the U.S.

Veronika Dubajova, Analyst

Understood. Thank you guys very much.

Roland Diggelmann, CEO

Thanks, Veronika.

Operator, Operator

Thank you. Your next question comes from the line of Tom Jones from Berenberg Bank. Please ask your question.

Tom Jones, Analyst

Good morning. Thanks for taking my questions. I have two. One was just about the current recovery. We discussed the demand side of the equation quite a lot. But I wondered if you'd like to make some comments on the supply side. Clearly there's an incentive for physicians in the U.S., etc. to get back to work. But is there a risk that we end up not ever being able to get back to 100% capacity unless we make some significant changes to health care systems? I guess what I'm alluding to are things like enhanced cleaning protocols, more patient separation, etc., reducing the overall functional capacity of operating departments, even if they are working longer hours, as you said. I know there's certainly been an issue in the U.K where a lot of hospitals are back to operating, but at a much, much reduced pace due to the enhanced COVID protection protocols they have in place. So just some comments on the supply side would be good, if you can. And then I have a follow-up.

Roland Diggelmann, CEO

Sure. We have observed that healthcare systems have responded swiftly to the new circumstances by implementing enhanced protocols, managing hospital admissions, and regulating visitor access. This response has been quite rapid and varies significantly between individual healthcare providers and geographic locations. Overall, the healthcare system has shown agility in adapting to these changes. As I mentioned earlier, the fundamental factors such as patient demographics, healthcare access, and opportunities in emerging markets remain stable. I am optimistic about the mid- and long-term outlook. The key question now is how we navigate this period. Certain healthcare systems, particularly in China and elsewhere, are setting aside extra capacity in case a second wave occurs. In Europe, a crucial issue is rebuilding patient confidence to return to hospitals, which has not been a significant concern in the U.S. This willingness to return for scheduled surgeries is pivotal. Additionally, the trend towards decentralized care and Ambulatory Surgical Centers is beneficial here. I also anticipate an increased focus on specialization and patient stratification, grouping straightforward cases in one setting and more complex surgeries in another. These factors will influence the overall landscape. Nevertheless, overall, we have seen the system manage these challenges effectively. Ultimately, the demand for clinical care persists, which is why we remain optimistic.

Tom Jones, Analyst

Okay. Perfect. And my second question is really kind of big picture post-COVID one. There's a lot of talk about the new normal, but I wonder, from your experience so far, what permanent changes to your industry, to your business do you think COVID might precipitate? You've already alluded to the shift to ASCs, and I guess that was a trend that was there that’s now been accelerated. But I would be interested to hear your thoughts on what other permanent changes might ensue from this pandemic. Maybe thinking marketing expenses become significantly lower, if you can do a lot more remotely, whatever it might be, just interested to hear what you think the new post-COVID world looks like for your industry and your company?

Roland Diggelmann, CEO

Thank you for the question, Tom. I believe there are several trends that will continue. We have an internal program focused on understanding how the new normal will look. Many of the existing trends are likely to be accelerated. For instance, the shift toward Ambulatory Surgical Centers and the increasing use of robotics will continue, as will changes in our engagement with customers. While it's challenging to predict the exact changes, we have learned a lot about maintaining connections with our customers through digital engagement. Medical education will also evolve, shifting to digital formats and reducing the need for healthcare professionals to attend physical meetings and training events. Instead, training can utilize augmented reality and other innovative methods. Internally, we have successfully adapted our training and education for our sales force, which is another trend that is likely to persist. This situation has also revealed opportunities to deliver services more cost-effectively by cutting down on travel and meeting expenses. Every crisis presents opportunities, and we are closely monitoring these developments. We have had positive experiences with remote engagement for both customers and our employees.

Tom Jones, Analyst

Good. That's very, very helpful. I'll get back in the queue.

Roland Diggelmann, CEO

Thanks, Tom.

Operator, Operator

All right. Thank you. And your last question comes from the line of Oliver Metzger from CommerzBank. Please ask your question.

Oliver Metzger, Analyst

Yes. Hi, good morning. One question left from my side, it's on Wound Bioactives. Some in the past, we saw these very high underlying growth rates at Osiris out of corona. So could you give us an idea how the business performed now during the crisis compared to your legacy Bioactives portfolio? And which are your expectations on how fast the Osiris business will return to growth again?

Roland Diggelmann, CEO

Yes, thank you, Oliver. Osiris products from the Osiris legacy have actually underperformed relative to the overall advanced Wound Management business. I think there's been a couple of reasons here. First of all, we were very early in the process of integration, so we are very positive now. We have taken this opportunity to cross-train the sales force from both Osiris and Smith & Nephew legacy so they can sell both ranges of products. I think that increases the access to the market. The second access to market that we will certainly improve or achieve is that we will be selling the product outside of the U.S. So far, Osiris hadn't been selling outside of the U.S. This is a process because it's registration dependent, and this is a Bioactive, so the pathway is different in different markets. And then, of course, the most important reason is that the product from Osiris are linked to surgeries and surgical events. And as we've had many fewer surgeries, of course, there was a direct impact on the usage of those products. But again, as I mentioned earlier, I'm very positive we're only at the beginning of the sales synergies here and we have a very active role to play in the areas of Bioactives and Wound.

Oliver Metzger, Analyst

Okay. Thank you very much.

Roland Diggelmann, CEO

Thanks, Oliver. Well, thank you all for your questions. Before we close, thanks again for your questions, for your interest as always. You will shortly be receiving an invitation for our virtual investor event. This will be taking place on September 8. We will be having the opportunity to talk some more about some really exciting innovations, some of the pipeline at Smith & Nephew, in particular, of course CORI and the robotics endeavor. We hope to speak to many of you then. Thank you very much.

Operator, Operator

Thank you. That does conclude our conference for today. Thank you all for participating. You may all disconnect.