Ladies and gentlemen, welcome to the Smith+Nephew second quarter trading and first-half 2021 results call. My name is Nadia, and I'll be coordinating the call today. If you would like to ask a question at the end of the presentation, please press star followed by one on your telephone keypad. Please note, 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 filings with the Securities and Exchange Commission. I would like to hand the conference over to the speakers today, Roland Diggelmann, Chief Executive Officer, and Anne-Francoise Nesmes, Chief Financial Officer.
Thank you very much, operator. A very good morning to all of you. Welcome to Smith+Nephew's first half results. As mentioned, with me on the call is our CFO, Anne-Francoise Nesmes. I'm very pleased to report a good first half and another quarter of solid progress for the group, which sets us up well for the future. Firstly, we continue to recover from COVID. More of our end markets are now approaching, or in some cases actually even exceeding pre-COVID levels of activities, and our business is recovering well with them. Secondly, we're on track to meet our 2021 guidance. To remind you, we expect a 10%-13% underlying revenue growth and a trading margin of 18%-19%. Finally, we're delivering on our strategic priorities for the year. Our work in commercial execution and efficiency is progressing on growth.
Recent launches and acquired assets are performing well across the portfolio. In a moment, I'll take you through our performance in the quarter, then Anne-Francoise will cover the financials for the first half, and I'll update you on some of our strategic progresses. Turning to the next page, I'll begin with the highlights of our first half. For the first half, revenue was $2.6 billion. That's 21.3% growth over the first half of 2020 on an underlying basis, and 27.8% on a reported basis. This does include the benefit of three extra trading days. Now, I'll talk about comparisons to 2019 as well in a couple of slides. Trading profit was $ 459 million, which is a 17.6% trading margin, and adjusted earnings per share were $ 0.388. We have preserved our dividends through the pandemic, and the interim dividend for 2021 is again unchanged.
Shifting to the revenue by region. Let me start with some comments about the markets around the globe, and especially also as they would continue to respond to the COVID pandemic. In the U.S., procedure volumes have continued to recover. Some categories now above pre-COVID levels and with very few remaining formal restrictions at this time. Conditions also improved on balance in other established markets, although with a mixed picture by region. In Europe, surgery volumes rose sequentially but are still behind pre-COVID levels. In Japan and Australia, the situation has weakened in the quarter as infection rates rose, and that of course led to more postponements of surgeries. In China, end market volumes returned to growth as early as 2020 April, and they have actually maintained the recovery since. In the first quarter, we saw a headwind in hips and knees in China, though.
That is due to a change in ordering patterns by distributors ahead of the forthcoming volume-based purchasing tenders, the VBPs. In many other emerging markets, procedure volumes remain significantly COVID-affected and following recent outbreaks. On the next page, as you saw previously, our total revenue for the quarter was $1.3 billion, with 40.3% underlying growth. Slide six shows the usual revenue split that we provide for you on a year-over-year growth rate by franchise. The growth rates actually largely reflect the trends in the prior year rather than the underlying development in the business. Certainly because the peak impact of COVID on our business was in the second quarter of 2020. If I move on, just to give you a little more color on the performance against 2019. This gives you an additional perspective. I'm moving to slide number seven.
Of the 3 franchises, 2 are now back to above pre-COVID levels on an underlying basis. This is Advanced Wound Management, which was 5.1% above the second quarter of 2019, again, showing the benefit of the work to improve commercial execution. Sports Medicine & ENT was 1.3% ahead of the 2019 quarter, even with a slower recovery in ENT procedures. Orthopedics isn't there yet, 6% below 2019. I'd point out three factors here. Not having a cementless knee, as you know, remains a relative drag. The headwinds I mentioned in China from the ordering patterns from distributors ahead of the VBP, and we've had some near-term supply constraints in certain product lines. Specifically on the next page, let's look at the individual segments. Here, Orthopedics.
The higher growth that you can see for knees versus hips in the quarter, we believe reflects a greater COVID impact in quarter two of 2020 as a comparator. When we look through that prior year effect, the recent trend of a strong hip business has indeed continued, and it's supported by the great progress of our OR3O Dual Mobility rollout. In knees, we continue to work towards the cementless options as stated, and we remain on track to launch actually towards the end of this year. Trauma and extremities included strong growth from EVOS and from external fixation as case volumes returned. Finally, Other Recon. The growth was driven by U.S. sales of CORI, our next generation robotics platform. We're now expanding into new regions.
We have had launches in India and Australia, in the United Arab Emirates in the quarter, and we have regulatory approval in Japan. Shifting to Sports Medicine & ENT. Joint repair delivered really good performance across both the meniscal and the shoulder categories, with sales of the acquired products, NOVOSTITCH and REGENETEN, more than doubling. In July, we also announced the U.S. launch of FAST-FIX FLEX, the next generation of our leading meniscal repair family. This is a great device, gives better access to around 40% of tears that are hard to reach with the currently available technology. AET or Arthroscopic Enabling Technologies also saw strong growth from the recent launch products, with sales of both LENS and FLOW wands more than doubling. After 510(k) clearance in Q1, the DOUBLEFLO Fluid Management System also launched in the second quarter.
The ENT market, however, remains challenging despite the 45% year-on-year growth. The tonsil and ear tube markets are showing slow recovery, slower than other areas of surgery and in particular in pediatrics, and procedure volumes remain well below historical levels. The focus with Tula is currently on training surgeons and targeting early opportunities in specific U.S. states. Finally moving on to Advanced Wound Management. All 3 segments of the franchise showed growth over pre-COVID levels. Within each segment, performance was strong across multiple brands as we continue to build on our improved commercial execution. In Advanced Wound Care, the recent acceleration in Europe continued, and all other regions contribute to the overall growth. Bioactives growth came from both SANTYL and the skin substitutes portfolio, all returning to above pre-COVID levels.
Finally, Advanced Wound Management returned to growth as well, helped by the ongoing recovery in elective surgery. Negative pressure remains the main driver of the segment, with RENASYS continuing to win business in a post-acute setting. With that, I'll now hand over to Anne-Francoise to take you through the first half financials.
Thank you, Roland, and good morning, everyone. As Roland has covered the Q2 revenue performance in detail, I will now move to the overview of H1. This slide shows the evolution of our revenue by franchise in the first half, and as you can see, all three franchises contributed to the recovery in overall revenue, which was $2.6 billion. Orthopedics, our largest franchise, grew by 19.2% on an underlying basis to $1.1 billion for the half year. Sports Medicine & ENT grew by 28% to $0.8 billion. Our Advanced Wound Management business grew by 18% to $0.7 billion, in part reflecting the greater resilience of the franchise in 2020. As you can see on the next slide, the picture by region is very similar. As we all know, the timing impacts in 2020 of COVID varied by market.
When we look at the first half, the U.S., other established markets, and emerging markets all contributed to growth. As Roland said, we are pleased with our performance in H1, and you can see our improved position in our P&L. Our half-year revenue was $2.6 billion, up 21.3% compared to 2020 on an underlying basis. On a reported basis, revenue grew 27.8%, including a foreign exchange tailwind of 470 basis points and 180 basis points benefit from acquisition. Trading profit grew by 166% to $459 million, resulting in a 17.6% trading margin. The margin expansion reflects improved trading compared to 2020, together with strong control over discretionary costs. Compared to pre-COVID levels, though, we are still seeing headwinds, namely increased investment in R&D, M&A, and new launches as expected, and ongoing COVID-related negative leverage from fixed costs and higher logistics and freight costs.
Adjusted earnings per share grew by 189% to $ 0.388, with financial leverage driving growth above trading profits. As we mentioned at the beginning, we're proposing to keep our interim dividend unchanged, having maintained it through 2020, in line with our progressive dividend policy. Moving to cash flow. We generated positive trading cash flow of $404 million in the period, with trading cash conversion at 88%. We continued to invest in capital expenditure in the first half as we progressed changes to our manufacturing network. You should expect that CapEx may increase further in the second half, both from the manufacturing investment and also from instrument sets to support expected product launches. The working capital outflow of $76 million shown on this slide was primarily driven by higher receivables, resulting from a return to revenue growth in the period.
Overall, our free cash flow was positive at $160 million, a significant improvement over the prior year. We continue to have a strong balance sheet with access to significant liquidity. Our net debt ended the period at $2.2 billion. That is an increase of just over $250 million. $ 237 million of that came from the acquisition of the extremity orthopaedics business, which closed in January. Even with a higher net debt, our recovering profitability meant that the leverage ratio came down to 1.6x adjusted EBITDA at the end of the period. Finally, I'll move to our outlook. The first half results are consistent with the view of the market we set out in April, and we are on track to meet our guidance for 2021.
Our target remains for underlying revenue growth of 10% to 13% and a trading margin range of 18% to 19%. After a 17.6% margin in the first half, the range implies, therefore, less margin seasonality in 2021 that we normally see, and that's indeed what we expect. There are a number of factors contributing to that effect. First, a planned increase in a step-up in OPEX. Some events, like AAOS, are taking place in the second half of the year, but would more typically come in earlier. There's also the marketing and promotional spend that we paused in 2020 and that is now returning as we see markets recover. We're also expecting a greater effect in the second half from some inflation in costs such as higher global logistic and freight costs, for example, on product we ship between Asia and Europe.
As before, we all know there's still unknowns around COVID, and we've made some assumptions about the course of the pandemic. Conditions improved in Q2, as we expected, and our targets continue to assume that surgery volumes are largely unconstrained by COVID in the second half. With that, I'll hand back to Roland to cover the strategic progress.
Thank you, Anne-Francoise. I'll now move on to update you on the priorities that we set out for 2021 at the start of the year. These were, firstly, to return to top-line growth and to recapture momentum, then to drive further operational improvement, and of course, to contribute to respond effectively to COVID. Moving to slide 19, this shows the component of the first priority, which is growth. Last quarter, we highlighted the Wound franchise as a case study, certainly in driving commercial excellence, and the results from that have become more visible in numbers in the recent quarters. As you've seen, they continued also in quarter two. I'd like to spend a bit more time today, though, on the second component of our growth story, which is delivering value from the acquired assets.
We began a more intense period of M&A from the first half of 2019, aiming at accessing external innovation, being in higher growth markets, and also generating value through sales and cost synergies. Moving to the next page, as you know, we've been active across all three franchises. In orthopedics, the deals have increased our exposure to high-growth segments. The transaction with Integra brought us scale in the extremities business, while with Brainlab, Atracsys, and other digital assets, we have built out our portfolio of digital surgery technologies. In Sports Medicine & ENT, we've added exciting new products that tuck in to our existing offering that are building on successful strategy of commercial execution of REGENETEN, for instance. We have NOVOSTITCH PRO from Ceterix, Tula from Tusker, which are at earlier stages.
They also have the potential to change the standard of care in meniscal repair and in the placement of ear tubes, respectively. In wound management, the deals have expanded our portfolio offering, again in high-growth categories, bringing the Osiris skin substitute product into our portfolio, and that has enabled co-selling with OASIS, while then LEAF is sold alongside our foam dressings and skincare offerings as part of our portfolio solutions, in particular for pressure injury prevention. We're still in the early stages of most deals, as you can see on the next page. Like the whole industry, these segments have been affected by COVID in the last 12 months. However, we've still been accumulating evidence of operational and financial delivery.
I'll start with Rotation Medical, which has commercially been part of Smith & Nephew since early 2018 and is an important example of a tuck-in acquisition where the business case has had time to play out. The operational steps we've taken to drive Regeneten, such as selling through a larger sales force and bringing it to new regions, will also be repeatable with other acquisitions. Importantly, this has translated into successful financial outcomes. Regeneten was a key driver behind the acceleration of joint repair from a mid-single digit growth to a double two digits growth. When we acquired Osiris in 2019, an important part of that business case was co-selling. Having completed commercial integration, both the existing Smith & Nephew BioActive products and the acquired products are now being sold by the combined sales forces.
Finally, Osiris is at an earlier stage than Rotation Medical, of course, but we're now seeing the acceleration of BioActive that we expected. The trading profit contribution is also ramping up with the transaction adding to the group margins for the first half. Brainlab was a very different type of acquisition of transaction with a value much more driven by technology. An important component of the deal was a development partnership around robotics and digital surgery, and that's also progressed really well. We have now key projects on track, such as bringing Brainlab's leading technology to the CORI robotics platform and helping us move into new indications. The extremity orthopedics assets are early in their time at Smith & Nephew, of course, but there's good progress on integration.
We've also started training the large sales teams on the new products, and the existing Smith & Nephew sales force is now selling total shoulder and ankle replacements, and former Integra sales reps are selling Smith & Nephew technology such as EVOS SMALL and spatial frames. When it comes to returns, Rotation Medical had already met the hurdle of ROIC exceeding WACC before the pandemic. Other transactions are at a different point of integration maturity, of course, and they have varied in how much COVID has affected the deal models and the timing. However, the majority, including Osiris, remain on track to meet our ROIC hurdle at the latest, that is five years post-acquisition. Shifting to key pipeline progress in 2021 on the next slide.
Launching an expanded pipeline is, of course, another component of the growth strategy, and it's in line, very much in line with our commitment to innovation. I earlier covered two of the launches in sports medicine, FAST-FIX FLEX that launched in July and has had the first patients treated, DOUBLEFLO launched in April. It's a further element of the systematic upgrade of our arthroscopic tower. We've also made progress with our robotic surgery system, CORI, which we first launched in the U.S. in 2020. We've now also launched in India, in Australia, and in the Emirates. We expect to further develop the platform in the second half, adding hip software and a digital tensioner, which is a novel gap balancing device to work with CORI in knee surgery. This is all pending regulatory approval.
Moving on, driving operational improvements was a second of our priorities for 2021. In February, we announced the new operations transformation and process efficiency plan targeting around $ 200 million of annualized cost savings. Optimizing our manufacturing work network is an important work stream, and we've now announced plans to sell or close 5 of our smaller factories. Much of the production will ultimately be consolidated into other larger sites over the coming years as this process continues to complete. This rationalization will simplify the network, and it will, of course, support greater efficiency and automation. At the same time, construction of our new large-scale and high-tech facility in Malaysia is almost complete and is planned to begin production in 2022. Once it's in operation, we'll be able to support more of our future growth from a lower cost location and also increase our presence in a high-growth region.
This will also make our manufacturing supply chain more resilient to the types of challenges and supply constraints that we're currently seeing. To summarize my last slide, our progress in the second quarter shows that we're on track to achieve 2021 guidance to deliver on our strategy and to recapture the growth momentum from before the pandemic. When I look at each franchise, the Wound business is showcasing our approach to growth with improved execution in wound care, with value coming from M&A in BioActives, and the long-term success story of innovation in devices. Sports Medicine was performing very well going into COVID, the signs are that we're picking up right where we left off as the market recovers.
In orthopedics, we believe we're in good shape in two of the three categories, with hips and trauma, with more drivers then still coming, like the next generation shoulder and, of course, the cementless knee. The effects of the pandemic have not gone away totally, but overall, we're emerging from COVID with the majority of our portfolio either outperforming already or with important new drivers coming very soon. I believe we've shown the ability to convert these opportunities into improved growth, and of course, it's growth that ultimately drives our P&L leverage. With that, thank you, and I'll take your questions.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your telephone keypads. If you choose to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure that your phone is unmuted locally. Our first question comes from Patrick Wood of Bank of America. Patrick, please go ahead. Your line is open.
Perfect. Thank you very much. I'll keep it to three please. Maybe just on the one, very fast recovery on wound care. I guess I kind of thought hips and knees and orthopedics would be the one to recover and then wound care would be a bit later. Why do you think wound care has been so much stronger, at least in the short term, than ortho? As a second question, could you give us a little bit of color maybe on how you saw things move through the quarter? I'm guessing, obviously everything has a lot of volatility, towards the back end of the quarter, things were presumably generally picking up a little bit relative to the first part of the quarter. Curious on the sort of general exit rate. Last one, just a small sort of technical one.
I'm just curious, is there any ability for you guys to roughly, and apologies if I missed this, but to quantify the de-stocking effects that you saw in China? Was that material in the quarter or was it just kind of a nothing? Thanks.
Thank you, Patrick. Thanks for your questions. On wound care, I think it's been a combination of factors. I think obviously wound has been quite resilient through the pandemic, with a proportion of sales coming from the chronic markets. I think we've had some early wins that we couldn't really execute on that we're now seeing that we have really been able to convert. At the same time, I think it's also showing the ongoing execution, the focus really on commercial execution. Lastly, there's been one shift in ordering patterns from late 2020 into early 2021 that also had an impact. You would've seen that mostly in the first quarters, though. Overall, very pleased with our progress across the wound franchise. On the quarter, start to end of the quarter and the exit rates, indeed, we continue to see some improvements.
Hard to quantify in the broader context, but I'd just say geographically, we continue to see the same trends. In the U.S. was a good and strong recovery. In China, with the volumes being up to pre-COVID levels. With a slow recovery across the big European markets. The challenge looking forward is, of course, that we have limited visibility to potential further outbreaks, to variants that have an impact. We know that elective surgeries are, of course, the first ones that get deferred and canceled, and we're seeing some of these effects locally, like in Australia, like in Japan right now. That's where the external factors continue to have an impact on the pace of the recovery. Finally, the de-stocking effect in China. I think we've seen it, and we've seen it in our numbers in China and our sales numbers.
I think what it is really is distributors are anticipating the introduction of the VBP, so the volume-based purchasing. With that, they have withheld some of their orderings. When we look at the volumes in market, they're very robust, they're very strong. They're at the level of the pre-pandemic. From that end, this is very positive. Now the VBP has been delayed a couple of times. We now expect the award somewhere in the third or fourth quarter. The impact will probably not be material for us for the full year. Of course, we're seeing this in the ordering patterns.
Fabulous. Thank you.
If I may just add to Roland's last comment on China. It affects the ordering pattern and the value of that inventory in the channel, so that's what we see as well and impacts the margin.
Got it. Thank you.
Thank you, Patrick. Our next question comes from Christoph Gretler from Credit Suisse. Chris, please go ahead. Your line is open.
Thank you, operator. Good morning, Roland and Anne-Francoise . I have two questions. First on the topic of supply constraints. You mentioned that this had an impact on some product lines. Could you maybe elaborate a bit more on the magnitude of the impact you've seen and how that will likely kind of affect the second half?
Sure. Thank you, Chris. Thanks for your question. It is very hard for us to quantify the effect, so I don't have any hard numbers for you at this stage. Of course, it was important enough to call it out to you. What it is, essentially it's affecting orthopedics. We have experienced some delays in freight and in logistics, along also with higher cost. We have encountered a labor shortage in one of our big hubs, namely Memphis, which is where the majority of orthopedics products are being produced. We have addressed this. Obviously, this is of key importance to us. I think it goes in line with other industries reporting labor shortages across the United States, and we expect that to improve, of course, going forward.
Okay. The second question is just with respect to your full-year growth guidance of the 10%-13%. If I analyze your first half performance, basically, you're already at the low end, a bit out, anticipating any growth for the second half. Could you maybe elaborate a bit more on the assumption? I guess in some markets you are still well below the 2019 level, particularly emerging markets, Europe, et cetera. Basically, do you anticipate that the constraints continue in those markets or is it not the case?
Yes. It's a great question, of course. I think what we're going to continue to see here is a mixed picture relative to the external factors. Again, the U.S. doing well, Europe progressively picking up, China volumes being high. The comps will get really difficult. Obviously, we've had a good quarter three last year, and a recovery and then a second wave in quarter four, so the comparables will become difficult. The other we're factoring in here is, technically speaking, we have four fewer trading days in quarter four than in 2020. That will inevitably have an impact. It's a combination of our scenario planning with respect to the recovery, the unknowns around the pandemic, the restrictions, the variants, and then a lower number of billing days in the fourth quarter.
Okay. Got it. Thanks. Appreciate your comments, particularly also on the kind of the details on the acquisition performance or the performance of the acquired businesses. Thanks.
Thanks, Chris.
Thank you, Chris. Our next question comes from Tom Jones of Berenberg. Tom, please go ahead. Your line is open.
Good morning. Thanks very much. I had two, three areas I wanted to touch on. one was guidance and two was pricing. The guidance front, your revenue growth guidance language is stated as including largely unconstrained surgery volumes. How would you quantify the current constraints on surgery volumes in the context of that "largely" statement? Are we sort of somewhat constrained, largely constrained, unconstrained? I guess, if we look at the outlook for H2, one would, I think most of us would assume that U.S. and Europe continues to see an improvement in the pandemic situation. Some of the more emerging markets where vaccination programs are less advanced, potentially seeing some problems. If we look at those smaller markets where there's a higher likelihood of the pandemic getting worse before it gets better, to what extent would that affect the guidance range?
Is it of an order that would just push you towards the lower end rather than the higher end, or are those markets collectively big enough to have a more meaningful impact? The second question on guidance, probably more one for Anne-Francoise, was on the current supply chain issues. Given that you're talking about it pretty openly now, these don't look like issues that have suddenly popped up from nowhere, and that you've maintained your margin guidance. Is it fair to assume that these supply constraint issues, both on a sort of availability perspective and a cost perspective, are fully factored into your existing guidance?
Thank you, Tom. I'll address the first part. As you said, maybe Anne-Francoise can take up the second part of your questions. Obviously difficult when we get into the semantics of how constrained the markets are. In a nutshell, I would say we feel confident that we will hit the margin and that we will hit the guidance. We are expecting a further improvement of the environment with a further recovery. That's what we're building in. Of course, we have different scenarios. When I look at our sales guidance of 10 to 13, we of course also have a certain corridor. You're absolutely right when we talk about the regions. The U.S. market continues to do well. Europe, I think, will progressively improve. The emerging markets will have a slow recovery.
That's just given, as you said, the vaccine program rollout, but just the general state of the healthcare markets. Of course, we have a good business in emerging markets, and we have factored this in. In summary, we expect to meet the guidance on the sales and on the trading margin side.
Cool.
Just to follow up on that guidance on trading margin, we confirm our guidance. We are comfortable with it. To your question, what weighs in, weighs out. It is always based on a range of scenarios, and we had signposted what will impact, what flows down to the bottom line. As you know, we have talked about the R&D investment, the M&A, the FX, and we have also talked about negative operating leverage from COVID. That is in part, production levels not being quite back to 2019 level, and other cost inflation or pressures that we have seen in the channel or in our networks or our manufacturing network. Clearly, we believe, and I can confirm, that our guidance includes all the various elements that we can foresee at this point in time.
Perfect. Just a follow-up question on the cost side of things. The cost issues that you're currently facing aren't unique or specific to Smith + Nephew. They're largely macro-driven issues. We're all just assuming that feeds through to margin pressure and there's no compensatory pricing increase. Why is that assumption necessarily correct? The industry largely has the same structure as it did in the noughties, a period where it enjoyed quite significant positive pricing. Given that everyone in the industry is facing similar issues and similar price pressures, why should we continue to assume that pricing is the usual sort of low single-digit percentage negative? At what point is there some potential for you to start pushing prices back up, ending the kind of circa 10-year decline in pricing that we've seen?
That's an interesting question actually, because we have discussed in the last few calls our concern and the risk that price pressures will increase, given where governments find themselves. Our view is price pressure may increase in the future. We haven't seen so far price erosion on the revenue line, continues to be at historical level. When you look at the future of our market, it's very hard to drive price increase, except in the case of innovation when we launch new products. Which is why, again, it's one of the reason why innovation and cycle of innovation is so important in our industry. Apart from that, unfortunately, the COVID crisis will lead possibly to further price pressures.
When you combine that with the cost inflation that any business sees, as you say to your point, that's why revenue growth, volume growth is so important to drive leverage in the P&L as well.
Okay. That's an interesting answer. I'll get back in the queue. Thanks for that. It was all very helpful.
Thank you, Tom. Our next question comes from Kyle Rose from Canaccord. Kyle, please go ahead. Your line is open.
Great. Thank you for taking the question. I wanted to start on wound. I appreciate the incremental color from the earlier answer. I wondered if you could just give us a little bit of a better sense of when you're looking at the wound business, particularly in the bioactive side, how much of that is truly the cross-selling opportunity from Osiris and the sales forces, being cross-trained, really playing out versus just the natural market recovery? Similarly on the devices side, RENASYS, I think a few years ago, you talked about starting to see some contracting wins in the U.S. Obviously, that was impacted by COVID as far as the ability to service and train. Are we starting to see those contracting wins fully play out in numbers? Are we still going to see continued momentum there, or has that been fully realized?
Secondarily, on the ortho side, when we think about the cementless launching, just can you help us understand when we should expect cementless to be available and usable on CORI? Any trends from CORI and enabling technologies more broadly, we've seen some of your competitors talk about a shift towards utilization and earn-out based commercial models. When you look at the market now, how are you seeing the purchase trends from upfront versus volume-based agreements? Thank you.
Thank you, Kyle. Starting with Wound, I think on the biologics, it's clearly many factors that contribute, which is a real positive. I think it's first, of course, the market recovery, which we're benefiting from. I think there is the cross-selling, which just means more competence and more feet on the street. Certainly it's on the basis of a strong portfolio. We have really good products there that are also differentiated. I think we will continue to see good momentum there. Same on RENASYS. I think we've had some contract wins. Not everything has been already converted. This is an ongoing process. This is about execution. It's about tendering. I think we have a great product with RENASYS and I'm very positive for the entire wound franchise. In orthopedics, we will launch the first components for cementless for LEGION at the end of this year.
That is, of course, then a multi-quarter introduction, many components on our two main brands, on LEGION and on JOURNEY II. The real impact will be in 2022 and beyond. We will, of course, we are working on then providing this on the CORI platform as soon as possible. This is an integral part of our development and of our portfolio development. On the commercial models, I would just say that we're seeing all different models in the marketplace. We have the flexibility to offer all the models from an outright sale of the robotics platform of CORI to, of course, to connecting it to volume, and to other means. There we're really as flexible as anybody, because that's just a model that's continuing to drive adoption.
Not different from other sectors in the industry, actually. I think overall what we're seeing is the adoption of CORI is going well, and when CORI is brought in, we see an increase in the number of procedures, and that's actually just supporting our case, and that's exactly what we want to see.
Thank you very much. Just one final M&A related question. I really appreciate the incremental color on the M&A commentary there. Obviously, the team's doing well. Largely been tuck-ins. How should we think about the veracity and the appetite for perhaps transformative deals moving forward? We've also seen commentary from other players in the sector regarding divestitures and in portfolio management. Do you remain committed to the end markets you're currently in?
Yes. The short answer is yes. I think very pleased with the end markets we're in. I think naturally you see more of a convergence between orthopedics and Sports Medicine. You see this playing out in the ASC, so naturally a very good position for us there. Of course, wound continues to be an attractive segment in itself. Good growth rates, good margins, less capital intensive. It's given us some good protection through the pandemic, so absolutely committed to the end markets. With regards to M&A, yes, we want to continue to be active on the acquisition front. Of course, the focus is always on the known areas, to invest. That is naturally then tuck-ins, that is technology driven.
We're looking at differentiation potential and then at being able to leverage these tuck-ins and as you've seen, and the technologies through our commercial footprint and through complementing the existing portfolio. Now, we also have a very healthy balance sheet, which potentially would put us in a good position for something larger. That's not the focus at this stage, but it's always good to be observing the market, the developments, from a, I would say, comfortable position with a strong balance sheet.
Thank you.
Thank you, Tom.
Thank you. Our next question comes from Michael Jüngling from Morgan Stanley. Michael, please go ahead. Your line is open.
Great. Thank you. I hope you can hear me. Thank you for taking my questions. I have three. On the 2021 guidance, can you comment on how close you were to raising organic sales growth guidance for 2021? Question two, Roland, I think in the last quarter, I asked you a question about why you think Smith & Nephew's share price has underperformed and been pretty material over the last 18 months. I guess today's share price performance is not helping. What do you think you can do to help change things? Right now it's not easy, 1:0 . Thirdly, on the divisions, do you think one of them, whether it's ortho, endo or wound, are underappreciated by the market?
Do you think it would be sensible to perhaps list one of them and spin out separately with Smith & Nephew holding a material share? A number of companies have done that, and it seems to have worked quite well. Just your thoughts about that sort of concept of you spinning out one of the divisions that may be the most underappreciated. Thank you.
Thank you, Michael. You're bringing in interesting questions here. Difficult for me to comment on some of them. Obviously, we had a really good look at the guidance. We felt that we were comfortable where we are today. We have different scenarios that would play out one or the other way. At the end of the day, looking at our performance, looking at where we are both in sales and on trading margin, we felt that we're very comfortable at confirming the guidance. Of course, we still continue to see uncertainty around the macro factors, the markets in general, which are outside of our influence. On the share price, I can't really comment on the share price. I probably have to throw that question back at you guys. I do think that it is about the execution. It is about executing on our strategy.
It's about delivering on the guidance. It's about progressing, continuing to transform this organization. It's about leveraging the potential of Smith + Nephew. I think we have a new management team. We have a new strategy. We have new structures. I think we are in a position to do all that. Finally, on your questions on divestitures, that's not a consideration of us at this stage. I think the three franchises in their own markets have a good position. They have growth opportunities. They have potential. As I mentioned earlier, I think wound in itself is an attractive business. Sports medicine is where we really differentiate. We have a great beachhead there. I think it will continue to serve us very well as the markets in general, both in orthopedics and in sports, continue to move to more decentralized settings, to more specialized settings.
We are well-positioned to leverage that. Finally, I would just say, this all is underpinned by our commitment to innovation and driving the portfolio forward. We have a great portfolio in the making, exciting products coming. I think we have the opportunity again to deliver and to execute.
Okay. Thank you.
Thanks, Michael.
Thank you. Our next question comes from Hassan Al-Wakeel from Barclays. Hassan, please go ahead. Your line is open.
Thank you. I have three, please. Firstly, based on what you've seen year to date, how do you think about pent-up demand going forward in some of your key markets, and whether this could still provide any upsides in Q3 and Q4 relative to your expectations? Secondly, another question on guidance. Assuming the recovery continues as per your base case, are you able to signal whether the top end of guidance on sales is more likely? Is this less likely on margins given your commentary around higher costs? Finally, could you provide an update on the CORI performance and whether you think you're gaining good share in robotics amidst an increasing competitive environment? How does this compare in the ASC versus the hospital setting? Thank you.
Thank you, Hassan. Let me start with the demand side, and then I'll go on to CORI and maybe Anne-Francoise and I, we can then tackle the guidance question together. Undoubtedly, there is pent-up demand in the system. It is difficult to predict when that comes true. It is also difficult to identify on an individual basis what is pent-up and what is just, I would say, organic, because we don't have access to that data. We have anecdotal feedback from the customers, of course, who tell us where their volumes have increased against pre-COVID times and where they're adding capacity. I would say by and large, again, this is a part of the recovery pattern, and it is driven by the system and by the healthcare in general. Just to take an example, the U.S. is a for-profit healthcare market. The recovery there has been quicker.
It continues to be more dynamic. The public healthcare systems are lagging behind. The incentives are different ones. Finally, what needs to be taken into consideration is, of course, the state of the healthcare system and the ability to increase capacity or not. For instance, as another example, U.K. NHS, which has already flagged that there will be long waiting lists for elective procedures because the system can just not absorb the pent-up demand. I would say, relative to Q3 and Q4, we continue to expect a further recovery. We, at the same time, with the patterns that we've seen with the variant, with the slow rollout of vaccine, and some challenges in emerging markets, of course, we don't expect a full recovery. It will be a gradual recovery.
That's the pattern that we've seen, and there's no reason to believe it will be different going forward. CORI, the share of robotics, I think we're very pleased with certainly this first half and how we continue to roll out CORI and the adoption rates of CORI. As we mentioned earlier, this is a different system. It is image-free, so you don't need a CT. It is very well-suited to be used in a decentral setting as it's versatile. It has a small footprint, and it is a different system in that it is a handheld robotics system. That takes a certain training and education. When I look at the markets, when I look at the feedback, I'm very positive. When I look at the translation from CORI to higher volumes in those sites, that's also something that is very positive.
I also believe CORI is very well-suited for ASCs, as it is, of course, for central hospital settings. In particular, on same-day, short-term, special logistics required ASC settings, I think it's very well-suited. Maybe on the guidance, difficult question to answer. Just really first of all, being very confident with our guidance, hence confirming it. We have our internal scenarios that are also influenced by the overall recovery. I didn't want to go into speculating whether we're going to be ending up at the top end or at the low end. I think you've heard our comments on the cost side, which will influence the trading margin for sure. On top end, it will be our ability to really continue to benefit from the recovery. That, as I mentioned, is to some extent, of course, dependent on external factors.
That's helpful. I wonder if I could just follow up on the CORI point and really how adoption rates are differing between hospitals and ASCs, and whether the feedback is more favorable in ASCs than it is in hospitals.
We believe we just have a great system here. It is very well-suited for the hospital setting. I'd say some of the advantages, the small footprint, the versatility, the short time to set up the system, literally five minutes. In particular, the ability to run the robotic system CT-free are particularly well-suited for ASCs. That's how we see it. That's also the feedback that we're being given from our customers and from adopters and users.
Thank you.
Thanks, Hassan.
Thank you. Our next question comes from David Adlington from JPMorgan. David, please go ahead.
Hey, guys. Thanks for taking the questions. Again, one on revenues, one on margins. On the revenues, Roland, to sort of pick you up on your comment earlier where you said you've got tough comps in the second half. You're down 4% in the third quarter and down 7% in the fourth. Just sort of trying to square that circle. I know there's a lot of commentary around emerging markets and COVID, but that just seems very conservative. Secondly, just on the margins, particularly gross margin, where I think that's probably the most dependent on volumes, and it looks like your revenues are actually going to be above 2019 next year.
I know there's some acquisition impact, but even so, your gross margins look like they're going to be substantially down on 2019, and I just wanted to sort of try and square that circle in terms of the cost pressures or whatever else we're seeing. Thanks.
Very good. Thanks, David. I'll start with revenues and then maybe Anne-Francoise on the gross margin. Obviously, I mentioned the comp will come in for quarter three and quarter four. I would say that relative to Q2, of course, Q3 was a much better quarter in 2020. We had, at the time, seen actually a very quick recovery at the end of the first wave, where elective surgeries were by and large allowed and permitted and scheduled, and so the recovery was quite strong in the third quarter of last year. That's why I said the comp is a more difficult one. I think, with everything that we're seeing, we will see also a continued recovery. Emerging markets remains a question mark to some extent. Of course, they are having generally more difficulties in recovery.
Many of the emerging markets also are now in the winter period in the southern hemisphere. That is not helping the recovery overall. Finally, just to re-emphasize the fact that we will have four days fewer in the first quarter. That's why we made the comments that we made. Again, very confident that we'll hit that guidance.
Hi, David, to pick up on the gross margin point, it is clear there are headwinds on the gross margin versus 2019 as you've picked up. Some of those are linked to what we've talked about, the FX and the M&A as well as the higher inflation, but the higher freight cost that we're seeing, and the fact that we still have lower production volumes than 2019. The final element that impacts the gross margin is the China VBP, possibly that's factored into our guidance.
Thanks, Anne-Francoise. Maybe I can just pick up on that and think about how some of those headwinds could evolve as you go into next year.
We know the exchange rate becomes a tailwind in 2022. I think total trading margin, not gross margin, it's about 40 basis points from memory. I think the cost inflation, we offset partly by our APEX benefit. Sorry, our program, our transformation in operations, but only partly offset some of the cost inflation. I guess the volume will depend on how efficient we want to be as well in terms of managing our supply chain, our inventory. In a nutshell, I'd summarize what I've said, some will stay, some we will manage and offset by the activities we're currently doing.
Understood. Thanks very much.
Thank you, David. Our next question comes from Kit Lee from Jefferies. Kit, please go ahead. Your line is open.
Yep. Morning, guys. Thanks for taking my questions. My first one is just on hip and knee. I think the performance gap you have versus peers in Q2 is a lot bigger compared to the last few quarters. I'm just wondering if this is mostly related to the supply constraints you have, or is there any other factor in play which explains the underperformance there? My second question is on the trading profit margin as well. Just given there are quite a few moving parts, how should we think about the phasing of the margin in the second half versus the first half? I think in the past, you've had probably 200-200 basis of seasonality between the first half and the second half. Does that still apply for this year or is that going to be a different situation? Thank you.
Thank you, Kit. Just on the hip and knee performance, obviously you have a lot of variability quarter- to- quarter. Yes, we looked at those numbers. We saw the comparisons. We also looked at it from a half year perspective, which gives you a very different picture. If I look at the half year performance so far, I think we're right there, with I think a very good performance on the 20% growth for the half year. Yes, some of it has to do with some short-term supply issues around orthopaedics in particular. Some I think have just got to do with the variability from quarter- to- quarter. Some has to do with the fact that we are proportionally selling more in Europe and in emerging markets and in China.
That's also contributing to the mix. Overall, I think still the 40% on the quarter is a good performance. Then I look at the different segments. I think we're well-positioned for the third and fourth quarter.
Kit, the question on profit margin is fair and a 17.6% trading margin at H1, and when you link that with our guidance range of 18%-19%, implies less margin improvement or seasonality that we've seen in the past. There are a few reasons for that. The first one is the timing of the cost is very different from our historical pattern, in particular in sales and marketing. As I said during the presentation, some events have been deferred, but we also see our A&P, our advertising and promotion spend increasing as we market return to growth. There's also a step up in our R&D spend, particularly on the acquired asset. That's the OPEX perspective with a different pattern than usual.
Finally, there's also the impact of some of the cost factors we've talked about here in terms of inflation in freight costs and the impact of the channel inventory adjustments in China. That's what leads to less margin uptick in the second half. I would say, though, it does assume an improvement in margins here.
Okay. No, that's great. Thank you.
Thank you, Kit. Our next question comes from Veronika Dubajova from Goldman Sachs. Veronika, please go ahead. Your line is open.
Hi, guys. Good morning, and thank you for taking my questions. I have three, please. One, just want to understand a little bit the sort of better the nature of the supply constraints that you're seeing. I guess there seem to be two elements. One is obviously higher cost, but the second is product availability. Especially on the second one, would love to understand whether you think the revenues that you lost in the second quarter, are those recapturable as you look at Q3 and Q4, or are those gone forever? Just a confirmation that you are no longer sort of product constrained and to the extent that you're getting orders, you are able to fulfill those. That would be kind of my first question. My second question is just a quick one.
There's been a little bit of debate among some of your peers around sort of the dynamics in the third versus the forth quarter, especially given sort of maybe unusually pronounced summer vacation seasonality. I don't know, Roland, if you're willing to comment on what you're seeing in July and August and how you're thinking about maybe the timing of the ongoing recovery that you expect between those two quarters on the elective side. My last question is a question on ASCs. I know you've kind of talked about this as a big competitive advantage for Smith & Nephew. We're certainly seeing from our due diligence that there is a lot of growth on the outpatient segment more broadly in the U.S. Can you just remind us from a pricing perspective and maybe a margin perspective from Anne-Francoise what that ASC shift means for you guys?
Obviously incremental volumes, but my understanding is that the pricing might look a little bit different, so it would be great to understand how that flows through the P&L. Thanks, guys.
Thank you, Veronika. Let me try to answer your questions. Firstly, on the supply. Not much more than what I said earlier, of course, the challenges that we're experiencing are some of them have been documented globally around freight and logistics, some challenges, some delays. Other are internal, such as the labor shortage that we have had as a consequence of different factors, especially in our largest orthopedics hub in Memphis. Really hard to quantify, but wanted to call it out nonetheless. I think what we're seeing is, of course, that will come back. That will certainly come back as our supply capabilities continue to improve. Of course, the surgeries that haven't taken place now, they will not come back. Overall, we believe that this will come back.
We have had a huge effort in certainly hiring in Memphis and ensuring that we have the capacity from a systems perspective, from a labor and resource perspective. Of course, you know that this is a complex supply chain when we look at all the sizes, when we look at the different variations and features. It is a complex operation, but it's something that we're going to get back on track on. Quarter three versus quarter four or what we're seeing anecdotally, of course, what we're seeing is generally, I would say customers that have worked very hard, that some of them are now thinking about taking a bit more of a vacation. Others, on the contrary, say that now that they're able to perform surgery, they'll just push through and they increase their capacity. It's a very mixed picture.
I think by and large, if you look at it from a broader society perspective, people are tired. People need a break. People want to take some time off, and that's what we're hearing from the different markets. Very difficult to really read a trend into that other than I would say that the recovery continues to go on, that it is real, that it's going well, at the same time, as I mentioned, that it is dependent on some external factors. On ASCs, indeed, a huge shift into ASCs, a massive shift into outpatient. I think that is absolutely real and will continue to accelerate. I believe it is because all the incentives are now aligned. You have the regulatory approval, you have the reimbursement behind it, and of course, you have the technology advancements to allow for same-day surgery.
That shift is certainly there. We're seeing more volumes shifted into ASCs. We're seeing more ASCs being established. Some often patient, customer or surgeon-physician-owned, some in affiliation with hospitals that transfer. When it comes to pricing, the reimbursement envelope, of course, is a lower one that has been widely publicized. I don't have the numbers on top of my head, but those are available. Of course, it's what you make with it. How can you compensate for some of that, with volume, with mix, with the service. There again, I think we have an opportunity, given that we're also calling on these ASCs through the Sportsmed franchise, through the ENT franchise, and we can actually leverage our position in the ASCs. I hope that answers your questions, Veronika.
That is really helpful, Roland. Can I just circle back to the supply constraints? When do you think you will no longer be supply constrained? Is that a third quarter event or a fourth quarter event?
Very difficult to tell you here. I think it will be a gradual improvement, of course. That's not one measure that fixes everything at one time. As I mentioned, it is multifactorial. There is, of course, the freight and the logistics piece, and then there is the in-house labor piece. We have onboarded many of those operators now. We're onboarding them, training them. It's a gradual improvement through the quarters. We have a team that's focused on this. That's all they do. I think we'll continue to see improvements through the course of this year.
Understood. Thanks, guys.
If I may just add there, Veronika, for clarity. We've confirmed our guidance, so we are working through issues. We've been transparent, as Roland said, but that does not affect our guidance, which we've confirmed today.
Understood. Thank you both.
Thank you, Veronika. That was our final question. Today's Q&A session has come to an end, so I'll hand the call back over to Roland and Anne-Francoise for any closing remarks.
Well, thank you, operator, and thank you all for your interest. Smith & Nephew, thanks for your questions. Wish you a great day here.