Smith & Nephew - Q3 2023 TU

Transcript

Operator (participant)

Hello, and welcome to the Smith & Nephew Q3 2023 trading report. My name is Elliot, and I'll be coordinating your call today. If you would like to register a question during today's event, please press Star followed by one on your telephone keypad. Certain statements in this presentation are forward-looking statements. These statements are based on management's current expectations, are subject to uncertainty and changes in circumstances. Actual results may differ materially from those included in those statements due to a variety of factors. More information about these factors is contained in the company's filings with the Securities and Exchange Commission. I would now like to hand over to Deepak Nath, CEO. The floor is yours. Please go ahead.

Deepak Nath (CEO)

Good morning, and welcome to the Smith & Nephew third quarter trading report call. As mentioned, I'm Deepak Nath, I'm the Chief Executive Officer, and joining me is Chief Financial Officer, Anne-Françoise Nesmes. Before I begin today's presentation, just draw your attention to our announcement today that John Rogers will succeed Anne-Françoise as Chief Financial Officer in the first quarter of next year after the publication of our annual report and accounts. John is an experienced FTSE 100 CFO, having held the post at WPP and Sainsbury's, and I have no doubt his financial acumen and expertise in leading transformation programs will be tremendous assets to us. As I've said before, I'm very grateful to Anne-Françoise for the time she has given us to ensure an orderly handover and her continued support as we close out 2023 and complete the smooth transition.

So now let me turn to our Q3 results. I'm pleased to report another good quarter, which maintains our momentum from the first half. Orthopaedics growth has stepped up as expected, with one of the highest growth quarters for many years. Importantly, the strong underlying performance in Sports Medicine and Advanced Wound Management has also continued. There are puts and takes across the portfolio, as you'd expect, but the overall picture is of strong, innovation-driven growth, backed by improving execution. We're also advancing the 12-Point Plan with encouraging signs of delivery on outcomes. Our operational improvements under the plan are continuing to drive key metrics toward their targets, particularly around product availability. In Orthopaedics, you can see that translating into better revenue growth for more lines of the business. Our productivity measures are also progressing.

We've made cost savings as planned for 2023, and for the longer term, we announced the closure of two of our smaller factories within our network. With nine months done, we're refining our guidance for the full year. We now expect revenue growth to be towards the higher end of our 6%-7% guidance range, reflecting our good momentum and improving execution. In our profitability, we're seeing the expected step up in the second half, with the seasonal uplift and cost improvements coming through. There is some additional headwind in China as well, and we're reflecting that with trading margin guidance now of around 17.5%. I'll come back to our outlook shortly, but first, we'll take a look at the details of the quarter.

Third quarter revenue was $1.4 billion, representing 7.7% underlying growth, with all business units and regions contributing. Anne-Françoise will cover the performance of the business units in more depth in a moment, but you can see that Orthopaedics has continued to accelerate as the year has progressed, with a slower quarter in Advanced Wound Management. Looking by region, growth was broad-based, with 7.2% growth in the U.S., 7.8% in other established markets, and 9.2% in emerging markets. Within the emerging markets, China's sales were down 1.4%, with improvements in knees and hips performance, but a slowdown in Sports Medicine, where there are some significant moving parts. To cover that and the rest of the business unit detail, I'll now hand over to Anne-Françoise.

Anne-Françoise Nesmes (CFO)

Thank you, Deepak. I'll start with Orthopaedics, which grew 8.3% underlying. This follows a 3.9% growth in quarter one and 5.8% growth in quarter two. Even with more difficult comps, we've continued the positive momentum we've seen in the early part of the year. Knees and hips growth included a better quarter in China, as Deepak just mentioned. The effects of VBP are now fully lapped, and China is back to being accretive to overall recon growth. When we look at our established market recon business, there are green shoots. Some regions are further along than others, but our commercial improvements are taking shape. U.S. product availability is improving, and we are gradually stepping up set deployments across more categories, and I'll come back to that in a minute.

Other Reconstruction growth of 58.5% was driven by the ongoing adoption of robotics. We exited the quarter with over 25% of our knee procedures being placed with a robot, and with contract wins across the sites of care, including large academic medical centers and in ASCs. We're also seeing good progress with our increased range of indications. OXINIUM revisions is already approaching the overall knee utilization, and we saw the first cases completed with our new offering in the third quarter. Trauma and Extremities has become an important part of our Orthopaedics growth story, and it was a bigger sales contributor than hips in the quarter for the first time So despite us exiting some markets last year, as you may recall. Underlying growth was 10.4%, with the acceleration coming particularly from EVOS and from strong double-digit growth in the U.S.

Trauma is demonstrating what we are aiming for across Orthopaedics. We invested over many years to build out our plates and screws platform, starting with the EVOS Mini plates, then adding small, and completing our offering with the launch of EVOS Large in 2022. Our operational improvements under the 12-Point Plan established better supply and replenishment of implants, and in the last two quarters, we've also stepped up the deployment of sets. Putting all of that together with better commercial execution, is translating into sustainable higher growth. The next leg of growth is also ready to follow as we broaden the rollout of our AETOS shoulder system. Delivery of the 12-Point Plan milestones is continuing to progress, and one area where that's particularly evident is in our product availability across the portfolio.

There are still differences between categories, both on the supply KPIs and on the financials, and clearly, U.S. Orthopaedics is an area where there's still more to do. But on slide 7, you can see some of the detail. Firstly, if you look at the chart to the left, implant availability is moving in the right direction. Overall, Orthopaedics non-set Life remains on an improving path ahead of our projected plans, and the value of overdue orders have continued to fall. There is some variation within that, of course, and that's a factor in some of the differences you can see across segment. Availability of JOURNEY II with OXINIUM has been lower than the average, and the greater U.S. penetration of this construct makes it particularly relevant to the U.S. knees growth.

The good news is that JOURNEY LIF was stepping up as we exit the quarter, and should also be on an improving path from here. A second factor to be aware of is the importance of set deployments. And again, the categories of U.S. Orthopaedics are at different stages of progress towards our goal. Trauma is an early example of what success looks like. EVOS product availability has been at or above target for almost all of 2023, but set deployment only stepped up strongly in Q2, and we've seen a clear inflation in revenue growth in Q3. Hips and knees are still following. In U.S. hips, instrument deployments have started to step up through Q3 and are getting closer to the target fulfillment level. Continuing this and maintaining the implant availability should also be followed by better growth in the coming quarters.

Knees are earlier in the process and further from their target, but we've started to see positive momentum later in Q3. Together with improving JOURNEY II and OXINIUM supply, we're on the same path that we've seen playing out in trauma. Moving to Sports Medicine and AET, which were at 11.1%. Our multi-year stream of internal and external innovation was again central to our growth, and that was further helped in the quarter by better product availability. There are still some areas that are constrained, but we're still seeing steady improvements in fill rates and overdue order levels that can keep supporting our growth in the coming quarters. Sports Medicine remains a very attractive area of our portfolio, and we're continuing to invest in further opportunities. Within Sports Medicine, Joint Repair grew 11.3%. We've brought base strength across procedures in established markets.

REGENETEN again grew strong double-digit, and we are still adding new legs of growth six years after acquiring the product through Rotation Medical. Geographic expansion has continued with launches in Japan and India, and work on further regenerative applications beyond the shoulder is ongoing. AT grew 1.7% in the quarter, with WEREWOLF FastSeal, LENS 4K, and our DoubleFlo fluid management system for ASCs. But as I mentioned, the headwind in the quarter was a slowing market in China on both consumables and capital. Without China, growth would have been three percentage points higher in joint repair and four percentage points higher in AT. There was slower buying in joint repair as wholesalers reduced inventory in anticipation of the VBP process, and there was also market-wide delays in purchasing around the widely reported ongoing anti-corruption campaign. We expect China to remain a headwind in Q4.

Of course, we know there's interest in VBP, so I wanted to give you an update on the current state of development. The policy is still yet to be fully published, so many of the details are not yet known. For example, we still have to hear the full tender rules or details of the entry prices. Timing has also not been confirmed, but our current assumption is for a process before year-end, with the outcomes of the tender to be implemented in the second quarter of 2024. On the scope of the VBP, our understanding is still that the tender will be limited to Joint Repair only. However, with more information, the scope looks to be wider than it appeared from the initial data request we talked about before, and we now expect it to cover around 1.5%-2% of group sales.

Now, moving to the ENT. ENT growth was 40.2%, driven by our core tonsil and adenoid business. As we expected, demand growth has started to moderate as we lap more of the post-COVID recovery, but improving product availability meant that the quarter also benefited from clearing a significant volume of backorders. That process is almost complete, so we will expect to return to a more normalized level of growth as we exit 2023. And finally, Advanced Wound Management grew 3.6% underlying. Within that, Advanced Wound Care and Advanced Wound Devices continued with the trends we've seen in recent quarters. AWC growth of 3.2% was mainly driven by Europe and came across the categories of dressings.

21.3% growth in Advanced Wound Devices reflected continued double-digit growth from both our traditional negative pressure platform, RENASYS, and our single-use device, PICO. We are continuing to both gain share and expand the market. The slower quarter for the business unit as a whole was driven by Bioactives, which was down 4.8% in the third quarter. The decline reflects a strong comparator from the third quarter of 2022, and also delays to central shipments in the early part of the quarter as we fully completed the transition of production to Fort Worth. Our shipments are now back to normal, with Bioactives exiting September strongly, and the segment should return to more typical growth against a more normal comparator in Q4. With that, I hand back to Deepak Nath.

Deepak Nath (CEO)

Thank you, Anne-Françoise. On revenue, 7.5% underlying growth in the first nine months positions us well to meet our full-year target. There are a few moving parts to keep in mind for the remainder of the year. On the positive side, we should see higher growth again in Advanced Wound Management, mainly due to improvement in Bioactives, and we should continue a positive momentum in Orthopaedics. As headwinds, we expect slower Q4 in Sports Medicine with low- to mid-single-digit growth. This is due to the combination of the pre-VBP effects and a broader market slowdown in China, as well as strong comp from Q4 2022 in the rest of the world. Also, as Anne-Françoise just mentioned, ENT growth should normalize after Q3.

Putting all of that together, the portfolio as a whole is well positioned, and we expect full-year growth to be towards the higher end of our 6%-7% guidance range. On profitability, the dynamics so far in the second half have been as we described with our H1 results, which is encouraging. The drivers are expected H2 margin step-up are all coming through, those being the usual seasonal uplift, the unwind of one-time commercial costs from H1, and our planned cost reductions. There's still more to do, but as you may be aware, the fourth quarter is typically our highest sales quarter and therefore highest margin quarter of the year. The progress we've made already in Q3 means that the remaining uplift to hit our full-year targets is well within the historical range. The change is the headwind from China that we've highlighted.

As you know, our guidance included some pre-VBP impact. There are now other moving parts in China as well, and we'll, while we are working to offset these, there's only so much that can be done in the remaining quarter of the year. Reflecting that, our expectation for trading margin is now around 17.5%. Overall, I'm pleased with another strong quarter, progressing the fixed Orthopaedics and continuing to invest in and drive Sports Medicine and wound. The portfolio is moving in the right direction. Our 2023 financials are trending as expected, and the 12-point plan is advancing. It's a wide-ranging program where we're on track or ahead in most areas and with green shoots in the area, in the areas where there's still more to do. We've talked a lot so far about fixing our operations, but there's much more to Smith & Nephew than that.

The returns from our multi-year innovation investments are an important growth driver, too. We'll talk more about that aspect at our Meet the Management event on November twenty-ninth, and I'd encourage you all to join us in London. With that, we can move to your questions.

Operator (participant)

Thank you. If you would like to ask a question, please press star, followed by one on your telephone keypad. If you would like to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure your device is unmuted locally. First question today comes from Robert Davies with Morgan Stanley. Your line is open.

Robert Davies (VP and Equity Research Analyst)

Yes, thank you for taking my questions. My first one was just, I guess, on the progress you're making on, from a growth perspective on the Orthopaedics side. Obviously, a large part of that was, driven by the other Recon segment, but just maybe kind of walk us through, the underlying trends you're seeing in both hip and knee and any significant sort of regional variations you've got there. And then my second one, your commentary around, the margin outlook for the full year were around 17.5%. I guess there's some debate of whether that's sort of doable, I guess, with the, with the investor community. But looking forward, through 2024 and, and beyond, are you still comfortable with the, the 20% margin target and, even with the sort of new moving parts that you've highlighted today?

Thank you.

Deepak Nath (CEO)

Sure, Robert. So first off, in Orthopaedics, we're pleased with the overall growth, as I mentioned. Other Recon, which reflects the uptake of CORI, not only in terms of placements, but actually also utilization, where we're now up to 25% of our business, US business flowing through robotics, is encouraging. But in addition, as Anne-Françoise mentioned, it's not just CORI, but it's actually trauma as well, that's contributing to growth. And on top, you've got hips, stabilizing, and knees continuing to grow where the soft spot remains, the US. So in terms of regional variations, the market continued to be strong in Q3. Not as robust as Q1 or Q2, but continues to be strong.

The fact is, on the back of the operational improvements we're making, we were able to participate in the market upside, which was not always the case, as you'll recall, Robert. And if I look outside the United States, our commercial execution on top of product availability, which is coming from operational improvements, has enabled us to really participate in that growth. In the U.S., we're continuing to do that. Hips is better than in knees, and the reason knees are behind primarily has to do with continuing supply challenges, particularly on OXINIUM. So when you look at the product mix in the U.S., the particular constructs and particular SKUs in the U.S. were impacted, and that also had an impact both in replenishment and sub delivery.

The good news is, as we exited September, we saw significant improvement in OXINIUM supply that contributed to sets starting to flow again in the U.S. So I expect the momentum we built up in September to continue into Q4. So hopefully that gives you a bit of color on the drivers of growth, the regional variation. So in terms of margin around 17.5%, obviously, we've indicated that there's that we expect to step up in 2024 and in 2025. We expect more of it in 2025 than we do in 2024, but it's not going to be a hockey stick. Though it won't be linear, we don't expect a hockey stick from between 2024 and 2025. So I continue to feel good about where we're positioned relative to our midterm guidance.

As you mentioned, there are more moving pieces. There are more headwinds than at the time that we issued the guidance, the primary headwind being China, particularly around the sports VBP. But on top of that, there's been, of course, some effects from the anti-corruption campaign that's rolled out in China, and we saw the impact of that in Q2. So that remains an uncertainty. But even with that factor, then, I feel, at least at this point, good about our ability to hit our midterm guidance.

Robert Davies (VP and Equity Research Analyst)

Thank you. Maybe just one follow-up around the advanced wound bioactives. Could you just give us a little bit more color on where the softness in that particular business came from in the quarter?

Deepak Nath (CEO)

Yeah. So first off, there was a comp topic, Q3 2022 versus this. Secondly, we made the decision several years ago to transfer production in-house. We had previously been manufacturing for ourselves, and in Q3, we completed the transfer into our Fort Worth facility. That was done for resilience reasons. It was done as part of our cost reduction or productivity program. And as we transferred that production, we hit a couple of bumps within the quarter that we were able to resolve and get back on track, actually, as we hit September. So we're in a good place as we exited Q3, and we expect that to continue into Q4.

So we get into more normalized comps in Q4, and with our factory now humming in Fort Worth, we expect that to kind of normalize.

Robert Davies (VP and Equity Research Analyst)

Understood. That's great. Thank you very much.

Deepak Nath (CEO)

Sure thing.

Operator (participant)

Our next question comes from Veronika Dubajova with Citi. Your line is open.

Veronika Dubajova (Managing Director)

Hi, guys. Good morning, and thank you for taking my questions. I will keep it to two as well. The first one is just, Deepak, I know you're not going to give us 2024 guidance, but just curious on some of the moving parts that you see as you move into next year. Maybe if you could comment, one, on how you feel about the market. And obviously, I think J&J made some pretty strong comments recently about how they expect sort of, you know, elevated utilization and volume growth to continue. And also, sort of, do you think 2024 is the year when we start to see some improved momentum in knees and hips, hips on a full year basis?

And maybe for Françoise on that as well, just in terms of the P&L moving parts, I'm thinking FX and inflation, if you have any high-level thoughts at this point in time, to help us as we think about 2024, that would be super helpful. And then my second question is just maybe a follow-up to comments that, Deepak, you've already made, but just for avoidance of doubt. Obviously, now that you have more clarity on VBP, do you still feel confident in your ability to achieve the 20% midterm target? And what are some of the offsets that you see against that sort of increased scope of the VBP process in sports med? Thank you.

Deepak Nath (CEO)

Great. Thanks for the questions, Veronika. So just on the guidance of some of the moving pieces, right? We do expect positive impacts as we go into 2024 from revenue leverage. We start to see that come through in Q3, and we're going to build on that in Q4, and we expect that to continue in 2024. Pricing, there, there's, of course, the inflation offset, but some of the more strategic work we're doing on pricing, we'll expect to start to, or not start to, but continue to pay dividends as we go into 2024. Also, ongoing productivity gains under the 12-Point Plan will be a factor as we head into 2024. Then I mentioned, of course, the VBP in Sports Medicine that will act as a headwind.

Françoise talked about, previously, we had guided to, around, one to 1.5% of group sales being impacted by VBP. Based on the expanded kind of scope that we see, we think it'll be more like 1.5%-2%. So that will have an impact, that offsets some of the factors that I mentioned. In terms of transactional FX, it had been a headwind in 2023, but we don't expect that in 2024. And also we don't expect the same scale of headwind in terms of input cost inflation in 2024.

So the bridge that we provided at H1 gives some good indication as to the major factors that we see influencing our margin step up as we go into next year and, and beyond, including, you know, materials and staff cost, inflation, offset, or, or unwind rather, or COGS and manufacturing optimization, and the cost reduction programs, taking, having full year effect in 2024 in terms of what we started in 2023, and of course, as I said, the growth leverage. So as I indicated, you know, I feel good about leaving our guidance for 2025 unchanged.

And in terms of the shape of the trajectory from 2023 levels, as I said, we don't expect it to be linear, and more of it will come in 2025 and 2024, but we also don't expect it to be hockey stick. So hopefully that gives you a bit of color. I think I made the comment around FX already. So hopefully that addresses your first question. Your second question around VBP, I think I incorporated that into my response. So, in terms of the factors that we believe will offset the more expanded scope, it really comes down to the factors I enumerated earlier. It's just growth leverage from other parts of the portfolio.

It's the cost reductions, you know, having the full year effect, our productivity initiatives, the unwind in terms of input cost inflation. So those are some of the factors. And also to keep in mind that in China, not all aspects of sports medicine are covered. REGENETEN, we expect to launch in China, we expect to be a growth driver. Of course, the AET part isn't included in the VBP guidance, so we expect that to be a growth driver as well. So hopefully those pieces all make sense, Veronika.

Veronika Dubajova (Managing Director)

No, that's, that's very, that's very clear, Deepak. Maybe just quickly, if I can squeeze a quick follow-up. I, I think you've alluded to this in the press release, so you're starting to make progress on some of the manufacturing footprint optimization.

Deepak Nath (CEO)

Yeah.

Veronika Dubajova (Managing Director)

When can we expect to hear more from you on sort of how this is underpinning the 2025 margin target and anything you can share high level about how that's going at this stage?

Deepak Nath (CEO)

Sure. I mean, you should expect more at our full year results, Veronica. But as I shared, you know, our network optimization efforts continue. So we've announced that we're going to be closing two of our smaller factories within our network. That represents about 20% reduction in footprint in manufacturing. We've also reduced headcount by as part of this process as well, and so we'll give you an update specifically on the numbers in full year. So combination, those factors, we expect will contribute towards our growth margin improvement efforts.

Anne-Françoise Nesmes (CFO)

And then just to add to this, Veronika, I think two elements. One is the efforts of the network optimization will be more visible in Orthopaedics. I mean, there are actions across the whole network in terms of lean and, you know, continuous improvement. But clearly, Orthopaedics will benefit the most. So as you look at the segmental analysis, you'll see the margin improve, and one of the driver will, of course, be revenue leverage, but the other is also the action around the network and the manufacturing cost. I think the second as well, it's important to understand it doesn't flow immediately through the P&L. As you know, there's a phasing impact of cost of goods, inflation, et cetera. And you know, Deepak talked about the shape of the guidance.

Part of that is because the savings from manufacturing take longer to flow through as they, you know, you build into your inventory and the savings, and you flow through as you release the inventory that will be produced at a lower cost, so that will take some time.

Veronika Dubajova (Managing Director)

Great. Well, I look forward to hearing more about that in depth. Thanks, guys.

Deepak Nath (CEO)

Sure thing.

Operator (participant)

We now turn to Lisa Clive with Bernstein. Your line is open.

Lisa Clive (Senior Research Analyst)

Hi there. First question on CORI. Can you just comment on what the current commercial strategy is for CORI? I'm aware some of your bigger competitors are placing robots for free. So what proportion of your CORI installments are sold, leased, placed, et cetera, and how should we think about that evolution going forward? And then second, just on utilization of CORI increasing, can you just comment on why the total US knee business was down this quarter, and how we should think about the timelines for that recovering? That would be helpful to hear a little bit more on that.

Deepak Nath (CEO)

Sure thing. So, with CORI, our interest is not just placements, but it's placements plus utilization. So that's what we're looking for, and which is why I reported on the utilization number. The mix of business models in terms of cash sales, and you know, rentals and lease models and so forth, they do vary across geography and actually, geographies and actually within geographies as well, and that does vary from quarter to quarter. I'd say we're competitive, and we do our best to address the needs of customers. You know, some customers prefer cash sales, others and lease models, and we're responsive to the needs of our customers.

In the end, the strategy we're running, though, is not to place robots willy-nilly, but rather to place them where we expect to see utilization. That combination is important for us. We're also looking at where we place them, and we're encouraged by the uptake we've gotten, not only in academic medical centers, where historically we've had a weaker presence, and we're starting to see and gain traction in that, but also in the ASCs, which, as I know, is a growing segment, and CORI is very well positioned within that segment as well, and we're pleased with the uptake we're seeing there. In terms of the U.S. knee business, the primary factor in Q3 really was around some product supply challenges.

Although life overall has improved in Orthopaedics, that is, product availability overall has improved in Orthopaedics. The particular SKUs in the U.S., and our U.S. business tends to be heavy on JOURNEY OXINIUM. Some of those SKUs continue to experience challenges in Q3, particular challenges in Q3, that impacted not only replenishment of implants, but also our ability to place complete sets that can be utilized in procedures. As I mentioned, when we look within the quarter, September was where we saw significant recovery of that, and we started to continue that improvement actually into the first month of this quarter as well. So we're pleased with the movement there, and we expect now in Q4 to recover in U.S. knee.

Hopefully that addresses both of your questions, though.

Lisa Clive (Senior Research Analyst)

Great. Just one last follow-up. Just on cementless knees, what proportion of that 25% done with CORI are done with cementless? Just trying to understand whether there's a mixed improvement opportunity, if cementless is still sort of not used very widely. Thanks.

Deepak Nath (CEO)

Yeah, we don't break out, you know, cementless versus other. What we're really looking at is constructs, and in particular, cementless is not what's driving CORI. So for us, it's about selling the portfolio we've got. We're very pleased with how our portfolio is positioned relative to our competitors. So we're actually really looking at all constructs, not any one particular product line.

Lisa Clive (Senior Research Analyst)

Thanks.

Deepak Nath (CEO)

Yep.

Operator (participant)

Our next question comes from Jack Reynolds-Clark with RBC. Your line is open.

Jack Reynolds-Clark (Equity Analyst)

Oh, hi there. Thank you for taking the questions. Two for me, please. The first was on pricing. I think you touched on it earlier, but I was wondering if you could give a bit of color around kind of the contribution of pricing to your growth in the quarter. I guess that has kind of two parts to it. The first is the kind of development of price erosion or lack thereof through the quarter, then also kind of the initiatives that you're implementing as part of the 12-Point Plan. And then the second question just was on core replacements. Obviously, appreciating that your focus is on kind of penetration and utilization, which obviously seems to be trending quite nicely.

I was wondering if you could give some color on kind of where you are on that 300 placement target for the year, and then also how that's split between kind of ASCs and hospitals?

Deepak Nath (CEO)

Yeah, sure.

Anne-Françoise Nesmes (CFO)

Uh-

Deepak Nath (CEO)

Yeah, go ahead.

Anne-Françoise Nesmes (CFO)

I think-

Deepak Nath (CEO)

Go ahead.

Anne-Françoise Nesmes (CFO)

Hi, Jack. In terms of pricing, you know, it's an important element of the 12-Point Plan. It's part of one of the initiatives, as you mentioned yourself. It's also important to try to offset some of the inflationary pressure we're all seeing. And we've continued to make good progress in updating and standardizing our pricing controls, you know, across the portfolio. So we have continued to see positive pricing, that like we did at the end of last year, that's continued into a low single digits, you know, positive through the third quarter. So we're pretty pleased on the progress we're making here, and it's really great collaboration between all the teams here, you know, from commercial, the selling organization, to finance parts.

Now, looking further out, there is more strategic work to do on pricing, as we've discussed before, you know, when we launch new products, how we are pricing ladder, et cetera, but we do not depend on pricing as a, as a primary intuition to our guidance.

Deepak Nath (CEO)

On CORI, we'll update you in terms of numbers of placements at full year. We're making progress towards the goal that you mentioned, Jack. And in terms of ASC, we've got better than kind of overall share in ASC. In other words, we're pleased with the kind of traction we're getting at the ASC, which is a big growth driver. So we'll come back to you in terms of specific numbers of placements. We just don't want to get into the every quarter kind of updates and numbers of CORI.

Graham Doyle (Executive Director and Equity Research Analyst)

Yeah, no, no, understood completely. And then if I could just squeeze in another one, around AETOS. Just was wondering what your kind of thoughts were, if you had any kind of further developments around introducing that on to CORI, I guess, obviously following the launch.

Deepak Nath (CEO)

Yeah. So, as you know, you know, shoulder is a growth market within Orthopaedics. Our entry into that into an important segment with AETOS, we're pleased with the initial, kind of results. Primarily, so far, the activity has been around design surgeons, but we've also taken it beyond that initial group. So overall, you know, good, good traction that we've gotten. As I indicated, I think on the H1 call, maybe it was a Q1 call, I forget now. But, we see the potential of CORI in shoulder. The form factor of CORI is very well suited for the shoulder application, so it is in our pipeline, and, we look forward to kinda updating you on that at the right time.

But where I'll leave it is, very, very, excited about the potential for CORI in shoulder.

Graham Doyle (Executive Director and Equity Research Analyst)

Okay, great. Thanks a lot.

Deepak Nath (CEO)

Yep.

Operator (participant)

We now turn to David Adlington with J.P. Morgan. Your line is open.

David Adlington (Senior Analyst)

Hey, guys, thanks for the questions. Firstly, again, back on to CORI. I just wondered if you could give us some commentary of what you're doing differently to drive that big step up in growth and how sustainable you thought that was? And then secondly, just on, the GLP-1 impact, maybe I'm gonna touch on it. So, maybe not, not so much on ortho, but just want to get your thoughts in terms of wound care, given the importance of, diabetic and venous leg ulcers, for you for that business. Thank you.

Deepak Nath (CEO)

Sure, David. In terms of CORI, CORI is not something we're driving in isolation. At the end of the day, what matters to us is, you know, selling the portfolio, and that we have. We're very excited about the differentiation that we have within across Orthopaedics, but certainly within knee. So the focus is on selling the portfolio, CORI, together with JOURNEY and LEGION. So it's that combination. So if we're executing six plays that take into account our differentiation and where we think we can win. So our poor results are to be viewed in the context of the broader commercial execution improvements that we're making on the back of the investments in innovation.

So, you know, in terms of knee, in terms of constructs, JOURNEY II obviously is exciting in terms of true next-gen knee construct that we have. We have some great differentiators of our own. CORI is the only robotics platform to have a revision indication. Also the knee tensioner that we released recently onto CORI, where enabled to enable surgeons to do soft tissue balancing before making cuts. Right, CORI is the only platform that doesn't require imaging. And now with added functionality onto CORI, the ability to do cutting, you know, saw-based solutions on top of milling. All of these things come together for us to put together an attractive value proposition for our customers is selling the whole portfolio.

So that's really the differentiator for us. In terms of GLP-1s and wound, you know, just narrowing in on, say, diabetic foot ulcers, they're about, I think, about 20% of the wound market. And people who have diabetes, it, you know, with diabetic foot ulcers, it take, you know, 10-15 years, for these ulcers to manifest. And for this group, GLP-1s have been available for some good length of time already. And so these issues occur as a result of issues with glycemic control, not obesity per se. So some of the data you're seeing on GLP-1 and obesity is not directly applicable to DFUs.

So putting those things together, we don't expect a significant impact to our wound business, as a result of GLP-1s, or some of the new data that's coming out on GLP-1s.

David Adlington (Senior Analyst)

That's great. Thank you.

Deepak Nath (CEO)

Bye, David.

Operator (participant)

We now turn to Graham Doyle with UBS. Your line is open.

Graham Doyle (Executive Director and Equity Research Analyst)

Morning, guys, thank you for taking the questions. Just firstly, one on the short-term margin, then we'll maybe I'll ask a follow-up on 2025. And so just from what you're saying, and obviously the change to guidance from at least 17.5 to around 17.5, it kind of implies something like a 20-30 basis points lowering, and that target is seemingly driven by China and some issues over a short period of months. So could you kind of contextualize that? Because annualizing that would be, you know, kind of worrying when we think about next year. So maybe just contextualize what's actually happened there, and then how much is attributable to it. And then I'll just follow up with the 2025 question after, if that's okay.

Anne-Françoise Nesmes (CFO)

So I'll take the question on the margin, and as we've mentioned, that there's many moving parts. And the dynamics we've seen so far in the second half have been, sorry, as we described with our H1 results, you know, driving productivity, driving the operating leverage. And what we're seeing now is the additional headwind from China to consider. When we gave the guidance, we did include some pre-VBP impact, but we are there are more moving pieces, moving parts at this point in time. And to your question, whilst we're working to offset the impacts of China, there's only so much that can be done within one quarter of the year remaining, and that's why we adjusted to around 17.5%.

But clearly, we are still seeing the seasonality and the seasonally higher margin, the unwind of one-time commercial costs and the planned cost reductions coming through. We shouldn't forget that our Q4 is always the highest sales quarter, as Deepak mentioned before. Clearly, we are working through, and it's just one quarter that we cannot offset.

Deepak Nath (CEO)

Yeah, and in particular, we didn't signal 20 or 30 basis points. We just said around 17.5%, just to be clear, Graham. And, as I mentioned, the VBP is something that we had anticipated. We called out kind of the 1.5%-2% group sales. The added impact of the anti-corruption campaign, we don't necessarily think that that's going to persist into you know, for an indefinite time frame. It's hard to tell how long that will last. So VBP, of course, is more permanent. But this impact of the anti-corruption campaign, we don't believe that will be the case. But in particular, we didn't signal 20-30 basis points, just to be clear.

Graham Doyle (Executive Director and Equity Research Analyst)

Okay. No, I, I appreciate that. I suppose I just, I mean, above 17.5, and then around 17.5, there are differences-

Deepak Nath (CEO)

Yeah.

Graham Doyle (Executive Director and Equity Research Analyst)

By kind of picking that point.

Deepak Nath (CEO)

Yeah.

Graham Doyle (Executive Director and Equity Research Analyst)

Just on, so 2025. So I'm just thinking the things that have changed from when you set that guidance at the start of the year is obviously, VBP itself is new, and then it sounds to me, based on the original guidance, you know, the margin base for the end of this year is going to be lower versus where you were originally. It sounded like when we talked, I think it was the Q1 call, that you—the 20% target in 2025 had fat or had excess in it. Is it gonna be difficult, but is there a... Would you be able to share with us the degree of space you have in that number?

Because obviously, you're taking account of newer headwinds, but you still seem very confident on it, and it was something you said at Q1 as well, when we talked about VBP.

Deepak Nath (CEO)

Right.

Graham Doyle (Executive Director and Equity Research Analyst)

So would you be able to just to give us real confidence in how we think about modeling that, so we know that you've got numerous levers that could have theoretically gotten you to 21% or 22%, and then we can kind of work back that way, rather than starting at 20% as the optimum and sort of taking the headwinds off that.

Deepak Nath (CEO)

I believe contingency is the word you're looking for, Grant. Rather than fat. So all kidding aside, you know, when you put guidance out there, there's you try to have you know some amount of contingencies built in to account for things for moving pieces, right? So as I indicated in Q1, but really at H1 when the question came up, based on what we knew at that point in time around VBP, which is really the only real big factor that's changed since we set out guidance. We believe that based on that, we could you know buffer through that and offset the expected headwinds from VBP.

Even with the expanded kind of scope that we see now, we expect to be able to offset that, you know, in the guidance and still achieve what we set out in the mid-term. So that's the fundamental kind of assertion that we're making. There are other positive factors as well. So as I mentioned, the 12-Point Plan, we continued to make progress on. In some areas, we are ahead, in other areas, we're just according to plan, and but we are not according to plan, but there are actually green shoots there as well. So we're actually pleased with the traction that we're getting with the 12-Point Plan. You've seen that translate into revenue growth. You know, Q3 is further evidence of that.

I do believe we'll continue to drive growth, and that should translate into operating leverage. In terms of inflation, you know, it's anybody's guess as to how persistent that's going to be. And Anne-Françoise mentioned the fact that there is latency, right? So, you know, there's about a year gap between when you see inflation start to recede from a macroeconomic perspective and how that enters into our P&L. So that's another kind of delta, right? We've assumed a certain level of inflation, persistent inflation, actually into 2024, in terms of how our guidance is built. And I would say, so far in 2023, you can probably surmise from our comments that inflation isn't worse than we've modeled, right, in terms of how it's impacting P&L.

Those are some of the moving pieces there. Hopefully, that gives you a bit of color.

Graham Doyle (Executive Director and Equity Research Analyst)

No, that's really helpful. Yeah, probably fat isn't the word to use right now with GLP-1s, but thank you very much.

Deepak Nath (CEO)

Yeah, I wasn't thinking that, but yeah, fair enough.

Operator (participant)

Our next question comes from Hassan Al-Wakeel with Barclays. Your line is open.

Hassan Al-Wakeel (Equity Research Analyst)

Hi, good morning. Thank you for taking my questions. I have a couple, please. Firstly, on VBP, you mentioned the scope is wider now, impacting 1.5%-2% of sales versus 1%-1.5% previously. Can you explain what is incremental here? And can you also talk about the extent to which you are seeing destocking in the channel? Maybe help us by telling us what China joint repair was down by in the quarter. And then secondly, on growth, how do you think about the current procedural landscape in the U.S. and when this pent-up demand in the market may recede?

Do you think that current market expectations for 5% organic growth at 120 basis points of margin expansion next year are achievable? I guess particularly on margin, given the extra headwinds that you are talking about incrementally today. Thank you.

Deepak Nath (CEO)

Yeah. So in terms of VBP, just to ground us and to reiterate what Françoise said, China cost us about 3 points of growth in joint repair and sports in this quarter. Then we talked about the impact on AET, that isn't related to VBP, but that's related to the overall slowdown in the healthcare market, in part because of the anti-corruption campaign. So, you know, in terms of the expanded scope, it's still very much an ongoing thing, Hassan. We expect another communication here, I think, in mid-November, that'll spell out the categories. So still within joint repair, but it's just particular product categories within joint repair. So it's not that AET is now in the mix where it was previously not.

So it's really more product categories within joint repair that accounts for for why it's bigger than we originally thought. But to ground us, it cost us about 3 points in Q3. So in terms of your question around how much destocking that we see in the channel, there's a couple effects. So first of all, as we indicated, we do see that we have some experience with how ortho went to calibrate, you know, how to manage this with our distributors this time around. So what I can say is, you know, similar type of activities as we saw when Orthopaedics went at this point in the development of VBP.

It's hard to actually unpick that from what's going on in the market. There's some indications that, as it pertains to sports in particular, you know, patients are waiting to have their procedures done post-VBP because their out-of-pocket kind of pay would be lower. So there is some effect around that. And of course, I mentioned the overall healthcare market slowdown that impacted not just us, Orthopaedics or sports, but just generally in healthcare. So it can be difficult to unpick how much of this is VBP, how much of it is sports-related procedure slowdown in anticipation of VBP among patients and of course, the overall healthcare market. So those are the kind of different pieces to that.

Anne-Françoise Nesmes (CFO)

The other question was around, well, it was around margin, Hassan, wasn't it? Your second question.

Hassan Al-Wakeel (Equity Research Analyst)

Yeah, it was around the current procedural landscape in the U.S., and then also expectations for-

Deepak Nath (CEO)

Ah, yes. Yes, yes, yes.

Hassan Al-Wakeel (Equity Research Analyst)

Twenty twenty-four.

Deepak Nath (CEO)

Sorry. Yeah. So procedure-wise, I think Q3 was another robust quarter, but not nearly to the same level as that we could see in Q1 and Q2. So in terms of pent-up demand, you know, for us, our growth is going to come primarily from improved commercial execution. A tailwind in the market will help, but in the end, given where we are, given what our performance in the recent past in Orthopaedics has been, what we're counting on and what our guidance is built on is our ability to execute better commercially within an existing market. So that by far that will be the bigger driver force.

In terms of the margin number you indicated, you know, obviously, we're not going to be talking about 2024 guidance yet. We'll do that in February.

Hassan Al-Wakeel (Equity Research Analyst)

Okay. I guess if I can just follow up again on margins, maybe to ask in a different way, what's your current base case on when China anti-corruption impact abates? What is the current, you know, margin effect, if at all, and you know, to what extent could it impact your ability to hit 2025? I ask because you're talking about further headwinds today, and at H1 results, your confidence around midterm margins was abundantly clear.

Deepak Nath (CEO)

Yeah. Yeah. So just to be clear, VBP, as we envisioned it, even with kind of the broader scope, that we're getting indications of, would still have us leaving our midterm guidance where it is. The anti-corruption impact of anti-corruption campaign, it's a bit hard to tell, Hassan. We are not counting on that being a persistent effect. In other words, VBP, you know, price reductions happen, and, you know, you're not expecting that to kind of be set, right? The additional headwind for the year is the impact around, you know, capital sales and to some extent, procedures based on the anti-corruption campaign. So I was in China just about a week ago.

The indications are that there is some improvement in procedures in September, and the expectation is that it would get better in Q4, but it's hard to tell, right? It really is hard to tell how that's gonna play out. But for what it's worth, we don't expect that to be a persistent factor again to going into 2024 and beyond, and therefore, the impact on midterm margins to be negligible.

Sezgi Oezener (Equity Research Analyst)

Perfect. Thank you.

Deepak Nath (CEO)

Yep.

Operator (participant)

Our next question comes from Sezgi Özener with HSBC. Your line is open.

Sezgi Oezener (Equity Research Analyst)

Hello, thanks for taking my questions. I will have two, please. First of all, in terms of the CORI expansion that we're seeing, how much, like, do you see, like, which one do you see, like, as the bigger of a driver, like, the wider indication of CORI or the lower pricing associated with CORI? And how do you see the client base responding to that, whether the peers free offering of CORI is a decision maker, or whether the volume growth is more impactful at that?

Second of all, if we circle back to the potential costs associated with the program, how confident are you that they will remain within the realm that you had announced so far, and that we won't see any additional costs coming?

Deepak Nath (CEO)

Yeah.

Sezgi Oezener (Equity Research Analyst)

Any one-off costs coming from the program within the remainder of the year.

Deepak Nath (CEO)

Sure.

Sezgi Oezener (Equity Research Analyst)

2024 and 2025. Thank you.

Deepak Nath (CEO)

Yeah, Sezgi, so in terms of CORI, as I mentioned, CORI is not in isolation. It's, you know, it's the package, right? It's, it's CORI plus best-in-class implants, JOURNEY II best-in-class, you know, revision, capabilities, and so on and so forth. So it's, it's not just CORI. But as it pertains to CORI itself, it's, it's the form factor, right, that gives it a broad appeal, not only in larger centers, academic medical centers, but also importantly in ASCs, where its form factor, and its, and its price, I think is very attractive for, that segment. As you mentioned, CORI has some great, features and benefits. There are indications that are only available on CORI at this point. So, for example, a revision indication, it's the only robotic platform to offer that.

We've got a great package combination of CORI plus revision implants that I think is very distinctive for us. In addition, the fact that, you know, it's a milling-based solution, but now recently, we've offered a cutting approach, a saw-based solution, gives, you know, great flexibility to our surgeons. Currently, CORI doesn't require imaging. Our pipeline includes the ability to offer image-based solutions as well, so we'll talk more about that at the Meet the Management session. And then I talked about the knee tensioner. CORI is the only platform to offer the ability to do soft tissue balancing before doing cuts, and we believe that's a great addition. So you put these pieces together, you can talk about any one thing, right?

But really the power is in the combination, and the power is in the combination of CORI plus best-in-class implant portfolio, right? And that's really what I think will be the winner for us. And once we are through the 12-point plan, we fix the fundamental wiring of Orthopaedics, which we're well on track to doing. So the operational improvements, combined with the improvements we're making in commercial execution, together with a best-in-class portfolio, that is what I think will set us apart in terms of driving growth. In terms of restructuring costs, Sezgi, we feel good about the number we put out, and we're tracking well to that. We, of course, are keeping a close eye to that, and we report that out every quarter, you know, to our board.

And obviously, we are monitoring that very carefully. We feel good about where we're positioned relative to the envelope that we indicated.

Sezgi Oezener (Equity Research Analyst)

Thanks very much.

Deepak Nath (CEO)

Absolutely.

Operator (participant)

This concludes our Q&A. I'm going to hand back to Deepak Nath, CEO, for closing remarks.

Deepak Nath (CEO)

Great. Thank you very much. As I said, I'm pleased with what was another strong quarter for us. We're making great progress in our 12-Point Plan. We're starting to see the results of that come through in the financials. We've got a lot to be excited about, and as I said, in addition to fixing our operations, we're very excited about what the investments and innovations that we've made are starting to deliver, and I'm very excited to be able to talk about that at our Meet the Management session on November twenty-ninth, which I hope you will all attend. So thank you very much for your questions.

Operator (participant)

Ladies and gentlemen, today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines.