Q3 results webcast transcript 4 November 2021 (pdf)

Smith+Nephew Third Quarter

2021

Thursday, 4th November 2021

Smith+Nephew Third Quarter 2021

Thursday, 4th November 2021

Introduction

Roland Diggelmann

Chief Executive Officer, Smith+Nephew

Welcome

Good morning everyone. Welcome to Smith+Nephew's third quarter call. With me on the call is Chief Financial Officer Anne-Françoise Nesmes. The third quarter was obviously still affected by resurgence of COVID infections in the United States. When we do look at that effect the majority of our portfolio is performing very well. There are challenges in Orthopaedics and we are working through this. We have announced further steps today to enhance our positioning.

Q3 performance and actions

Sports Medicine and AWM

There are a few points I would like you to take away from today. Firstly, two of our three franchises are above pre-COVID levels and growing well. Around 60% of our revenue now comes from the Sports Medicine and Advanced Wound Management. They are showing a performance that comes from both innovation and good execution.

Orthopaedics

Secondly, we know there are still issues in Orthopaedics but we are addressing them. We have announced the launch of our new cementless knee, filling a major product gap and we are working through the supply chain challenge.

Strengthened commercial model

Thirdly, we have taken the strategic step to strengthen our commercial model. Our Orthopaedics and Sports Medicine franchises will now be under a single leader. This aligns with some of the important growth opportunities in the market, namely a trend to decentralisation and specialisation, and will better leverage Smith+Nephew's strengths. I will cover those changes shortly but first Anne-Françoise will take you through the detail of the quarter.

Third Quarter 2021 Financial Performance

Anne-Françoise Nesmes

Chief Financial Officer, Smith+Nephew

Q3 021 growth vs 2020

Good morning everyone and thank you Roland. I will start with an overview of the third quarter. The revenue in the quarter was $1.3 billion with 5.5% reported growth and 2.3% underlying growth. The number of trading days was unchanged versus prior year which is different from Q1 and Q2 which had additional days. You can see on slide four our growth rate versus 2020 by franchise and region. Advanced Wound Management was the fastest-growing franchise at 10.9% and we also recorded positive year-on-year growth for both emerging markets and other established markets. The growth rates reflect in part differences in the prior year comparators. For example, you may recall that the US had returned to growth ahead of other regions in Q3 2020. Of course a comparison to 2019 is more helpful and you will find more details in our release.

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In the US procedure volumes were impacted from August by outbreaks of the Delta Variant, particularly in joint replacement. Increased hospitalisations and healthcare staff shortages resulted in lower elective procedure volumes. Growth versus 2019 was therefore slower than in quarters one and two, although it was improving as we exited the quarter despite the supply chain challenges. Our business outside of the US, which represents around half of our revenue, continued to recover and moved closer to pre-COVID levels. Europe accelerated and in emerging markets India and Latin America returned to growth over 2019. Looking specifically at China, sales remained above 2019 with healthy end market growth. However, as in previous quarters, our growth was still impacted by channel adjustments ahead of the VBP implementation. The detailed financial planning and negotiations for its implementation are still ongoing.

Orthopaedics

I will now move on to the detail by franchise starting with Orthopaedics on slide five. The decline of 5.9% reflected the headwinds of the Delta Variant in the US, the supply constraints we flagged to you in July and the channel adjustments ahead of VBP in China. These supply constraints meant we could not fully benefit from the knee and hip market rebound outside of the US, which you see reflected in the quarter's growth rate. We have a number of actions to address the challenges and Roland will cover these shortly. In other reconstruction the rollout of CORI continued with the European launch event held in August. Trauma and extremities declined by 4.2%. This segment now includes a US extremities business, which is a more elective line.

Sports Medicine & ENT

In Sports Medicine joint repair grew by 9.5% even with the quarter impacted by Delta in the US. Recent launches of FASTFIX FLEX and HEALICOIL Knotless are both performing ahead of our plan and it is encouraging to see knee repair recovering to close to pre-COVID levels. In AET we announced the launch of the WEREWOLF FASTSEAL which seals blood vessels during procedures such as total joint replacements. Importantly, the new wands bring our leading radio-frequency technology from sports medicine to an orthopaedic surgery application. This is an example of the portfolio leverage opportunities between our Sports and Orthopaedic businesses which Roland will cover more in a moment.

In ENT growth was mainly driven by our tonsil and adenoid business in the Asia Pacific region and procedure volumes in the US and Europe are still recovering. We are starting to see signs of an increase in the number of infections in the US as more children return to school and we expect an increased demand for tympanostomy procedures to follow and to drive demand for Tula.

Advanced Wound Management

In Advanced Wound Management we delivered above-market growth and the strong performance of the franchise has been across the regions and across the brands in recent quarters, reflecting the broad-based improvements in commercial execution. In Advanced Wound Care the acceleration in Europe continues and the US reached double-digit growth over 2019. Bioactives growth was largely driven by SANTYL in the quarter with slower surgical procedures in the US affecting skin substitute volumes. Finally, Advanced Wound Devices benefitted from a market expansion strategy for PICO and continued share gains and hospital

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conversions for RENASYS in the US. We are pleased to see the performance of this franchise transform over the last two years.

2021 outlook

I will finish with the outlook. You will recall that in July we reiterated our 2021 guidance of 10-135 underlying revenue growth and a trading margin of 18-19%. With three quarters of the year now gone we are in the position to be more specific. We now expect both underlying revenue growth and the trading margin to be at the low end of the guidance ranges. This reflects the revenue impact of the Delta Variant on surgery volumes in Q3, which we expect to improve in Q4, the ongoing supply constraints and the margin impact of higher cost inflation partially offset by discretionary cost control. Clearly the guidance implies a lower underlying growth rate in the fourth quarter than in the first nine months of the year. This is mostly due to the fact that there are four fewer trading days than in the fourth quarter of 2020. With that I will hand over to Roland.

Performance and Actions

Roland Diggelmann

Chief Executive Officer, Smith+Nephew

Two of three franchises above pre-COVID level YTD

New initiatives to drive Orthopaedics acceleration

When I look at the balance of the portfolio there are clearly more positives than negatives. This slide shows the contribution of each part of the business to our growth so far this year and it compares to 2019. Spots Medicine and Advanced Wound Management are above their pre-COVID levels which is great. We are very confident those will continue to outperform. ENT is still a drag on growth but that is largely a market effect and it is starting to move in the right direction. Then the combination of commercial execution, innovation and also value- creating M&A is really delivering this profitable acceleration that we want.

In Orthopaedics we are not there yet. With knees continuing to be the main headwind, some of the difference is the market. Joint replacement has proven more sensitive to the fluctuations of the COVID pandemic and then we have VBP in China, which is an additional headwind that is specific to the franchise. More optimistically some new growth drivers are still in the early days of delivery, such as the rollout of CORI, the entry into the extremities segment and then of course the launch of our cementless knee. However, there are still execution factors that need to improve and I would like to talk about the actions we are taking to address these.

Tackling the supply chain challenges

Strengthened leadership and actions underway

On the next page, first we are tackling the supply chain challenges. We have made really good progress on the factors that are in our hands. Importantly, I have also appointed a new Head of Operations with direct experience in our market, who is leading the response. He has a particular expertise in Orthopaedics. We felt these primarily in Orthopaedics indeed, although some aspects are also affecting other categories. The initial challenge was product supply from Memphis which is our main global Orthopaedics facility. The combination of a

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tight national labour market and specific local competition for people had created some temporary staffing shortages. That is improving now. We specifically set up recruitment and retention with hiring fairs and additional incentives. Training and ramp up of the new staff to full productivity takes a bit of time but that is well underway. Then a second challenge was around disruptions to logistics so actually moving finished products around the markets. This has also improved although some bumpiness remains from global freight availability. IT system improvements are helping here and we are in the process of moving to a specialised logistics partner in the US after doing that in Europe as well.

Then finally and I think it has been widely reported, there are increasing global shortages and inflation of some raw materials and components, in particular in electronics. These shortages are likely to persist for a while but we are taking actions to mitigate the impact. We have engaged with suppliers to understand the new lead times. We have adjusted our production schedules and ERP systems to work with that. We are also looking in a broader context to protect supply by seeking prioritisation for medical applications. In summary I am very confident in the team and in this plan.

Strengthening our commercial model

Bringing Orthopaedics and Sports Medicine together

Secondly and moving to the next slide, we are strengthening our commercial model. As we slowly come out of the COVID pandemic I believe it is the right moment to make a change and I have been thinking about this for some time. I have taken the decision to bring our Orthopaedic and Sports Medicine franchises together under a single leader. This change applies to our global marketing and to the US commercial teams. The changing customer and market dynamics have created new high-growth opportunities for us and the new structure will leverage our leadership in Sports Medicine and our growth Orthopaedics portfolio. I believe it will position us to go after these targets more effectively.

Just a couple of examples here. We know that care is becoming more decentralised. I think this has been widely reported. More orthopaedic procedures are moving to the ASCs or to outpatient settings. We have seen that COVID has actually accelerated that. Our Sports Medicine franchise already has deep relationships with centres that are starting to replace hips and knees. Then in Orthopaedics we also see further specialisation. Foot and ankle surgeons also specialise in both bone and arthroscopic repair which gives us another opportunity. Then also in capital equipment we can take more of an integrated approach to selling our digital surgical portfolio, including CORI and the updated arthroscopic tower.

When the two sales forces work together to pursue opportunities like these, having both franchises under the same leadership will enable greater coordination but also a more unified incentivisation. I believe this combined surgical business will be led by our President of Sports Medicine & ENT, who has taken that franchise to strong profitable growth and leadership in many categories. As some of you know, Brad Cannon has been with us for nine years and previously successfully led Europe and also Global Marketing, as well as having broad orthopaedic experience. Under his leadership I expect the team to drive strong commercial excellence throughout and also identify efficiencies over time.

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