Zimmer Biomet Holdings, Inc.

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet second quarter 2023 earnings conference call. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded today, August 1st, 2023. Following today's presentation, there will be a question and answer session. At this time, all participants are in a listen-only mode. If you have a question, please press the star followed by the one on your push-button phone. I would now like to turn the conference over to Carrie Maddox, Chief Communications and Administration Officer. Please go ahead.

Thank you, Operator, and good morning, everyone. Welcome to Zimmer Biomet's second quarter 2023 earnings conference call. Joining me today are Brian Hansen, our Chairman, President, and CEO, EVP and CFO, Suki Upadhyay, and COO, Yvonne Tornos. Before we get started, I'd like to remind you that our comments during this call will include forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please note, we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements. Additionally, the discussions on this call will include certain non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q2 earnings release, which can be found on our website, ZimmerBiomet.com. With that, I'll turn the call over to Brian. Brian?

All right. Thanks, Carrie, and thanks to everyone for joining us on the call this morning. You know, it's always good to be with you. But I would say it's even a little better and certainly more fun when we have great performance in the quarter. So we're pretty happy about the results that we get to discuss today, and I can tell you we're looking forward to the dialogue. And I'll start things off as we normally do. I'll talk about our Q2 performance and the key drivers inside of the quarter. But I think also really important is to talk about the key drivers that we see continuing to move this business forward. And then Sookie will walk us through the financial details of the quarter. and importantly discuss how we are, again, raising our full-year financial guidance. And then, of course, we'll close things out with a Q&A session, and we look forward to answering your questions and having a dialogue in that session. Okay, to kick things off, I'm just going to take a step back, which I've been doing now for the last handful of quarters, and I think deservedly so, because I want to say thank you. I want to say thank you to each and every one of our team members around the world, because it's your hard work, it's your dedication to getting the job done that is moving this business forward. And I gotta tell you that I'm proud to say that you have delivered another very strong quarter while once again making ZB a certified great place to work. And you've done all of this while improving our scores and as a result of that our rankings on the environmental, social, and governance front. So I think simply stated we are doing well while also doing good. And that means for our team members, our patients, our customers in our communities, and even our planet. So once again, I want to say thank you to our team for all that you do for ZB and to move our mission forward, and most importantly, for doing it together as one team, one ZB team. Now let's talk about the second quarter. And I'm just going to say simply, we delivered another strong quarter, again, beating our own expectations. And that performance positions us to, again, raise our financial guidance on both the top and bottom lines. And this is in the face of some pretty significant macro factors that are impacting us and the entire market. Ongoing supply challenges are very real, and I'll talk about those in a minute, but also inflationary pressure, a tough labor market, and a geopolitical landscape that is putting pressure on everybody. But against that, I feel very confident about our pipeline, our execution, and the team's demonstrated ability to navigate these headwinds, which gives us confidence to increase our financial outlook. Okay, with that said, let's talk about the key drivers inside of Q2, and there were some positives and there were some negatives. I'll start with the positives, and the most important one, in my view, is that our team's execution remains flawless. We're seeing significant traction, probably the best we've ever seen with our new product innovation, and that paid dividends in the quarter for sure, but most importantly is it pays dividends as we move this business forward. And I would say that procedure recovery continued in the quarter, again, showing no meaningful impact from COVID or staffing challenges. And that allowed for a tailwind from increased provider capacity. And that resulted in backlog pull through in the quarter. In terms of headwinds, I would say that the team is doing a great job of managing the supply constraint environment. But I would say that it is still very clearly a governor to our overall growth in the quarter. And it continues to be a distraction for the organization. See, if I combine these things, though, all in all, our momentum continues, and it continues to grow. And I've said before, my confidence in this business, our confidence in this business, is as high as it's ever been. And it's high for a good reason. If we just look at the knee franchise alone, our innovation strategy is working. We now have four meaningful pillars inside of this business, all of which can drive pricing stability, mixed benefit, and competitive conversions. First, let's look at the ROSA robotic platform combined with our persona cementless knee. This is a powerhouse combination that is and will continue to accelerate growth. And based on the traction we're seeing so far, we continue to believe that ROSA and persona cementless together will enhance our robotics and cementless penetration from the current mid-teen level to 50% or better, 5-0% or better. The second pillar that we're focused on is persona revision. This provides meaningful conversion and mixed opportunities inside the revision category But importantly, it also acts as a powerful tip of the spear product for conversions and primary needs. And then third, it's just the overall shift of the ZB legacy knee systems to our now fully rounded out persona portfolio. And this is a meaningful mixed benefit that we can take advantage of that I would say is somewhat unique to our business. And then fourth, on top of all this, we have the world's first and only smart knee, which is persona IQ. And I know this is still in limited launch, but already, It offers surgeons unparalleled data access and is attractive to patients, those patients who want more direct engagement with their care recovery. And we're taking on a similar approach to our HIP portfolio, where we continue to launch meaningful innovation, again, giving us the opportunity for price stability, mixed benefit, and competitive conversions. And we have four pillars of focus here as well. First, it's ROSA and HIP Insight. These are technology shifts in robotics and mixed reality that are setting up the ZB HIP portfolio for greater adoption and growth. Second is the Avenir Complete. This is our current flagship product combined with G7, which gives us a very strong position in both the attractive direct anterior and revision submarkets of HIP. And then third, this position will be enhanced with work being done on a triple taper stem which will fully round out our direct interior approach portfolio. We believe this new portfolio, combined with the G7, which is the most versatile acetabular component available, will be unmatched in the industry. And then fourth, HAMR. This is our upcoming full launch of an automated impaction system that builds on a proven need in the market, and we fully expect that this launch will create surgical efficiencies while bringing personalized precision to each and every patient. And then finally, in SET, we are being disciplined and targeting investment in our growth driver categories, upper extremities, sports, and CMFT, and each of these categories continue to perform. And given our momentum in these businesses and continued investment in innovation and dedicated infrastructure, we fully expect the SET business to be a mid-single-digit grower in a normalized market environment. So overall, we know we're very excited about our innovation momentum. You know, it's very real. You know, remember, we've called out that we have 40 planned product launches between this year and the end of 2025, with the majority in 4% plus growth markets. And that's important because these innovations will certainly drive near-term growth, there's no question about that, but also create better sustainability of that growth because of the markets they're in. This portfolio shift that we're seeing and the team's execution capabilities are clear signs that our ZB transformation has taken hold. But I can tell you right now that we're not going to stop there. The goal is to continue to enhance our growth profile through our ongoing focus on active portfolio management, and that is supported by our already strong and strengthening balance sheet. And with that, I'll turn the call over to Sukhi for a closer look at Q2 and our latest expectations for the remainder of 2023. Okay, Sukhi.

Sukhi Nathanael- Thanks, and good morning, everyone. As Brian noted, we had another excellent quarter. Our results were driven by strong end markets as well as strong execution across the entire organization. As a result, we are again increasing our full-year financial outlook. With that, let's turn to our results and updated full-year guidance. Unless otherwise noted, my statements will be about the second quarter and how it compares to the same period in 2022, and my commentary will be on a constant currency and adjusted operating basis. Net sales were 1.870 billion, an increase of 4.9% on a reported basis and an increase of 6%, excluding the impact of foreign currency. Additionally, we had a selling day headwind of less than 50 basis points in the quarter. Overall, the business continues to benefit from a recovery of elective procedures driven by continued market normalization, including hospital staffing and procedure cancellations returning to pre-COVID levels. we also benefited from some backlog recapture. While market momentum is strong, we continue to face certain macro challenges, including global supply chain pressures that muted performance across the business. U.S. growth of 5% continued to outpace our expectations and international growth of 7.2% was driven by strong performance in both EMEA as well as Asia Pacific. All regions benefited from continued recovery of elective procedures Backlog recapture as well as strong commercial execution and new product uptake. Turning to our business category performance. Global needs grew 10.5% with U.S. growing 9.8% and international growing 11.4%. The strong performance in needs was driven by the four pillars that Brian mentioned earlier, centering on a very attractive persona portfolio combined with the benefits of our ROSA robotics platform. Global Hips grew 4.9% with U.S. Hips up 2.7% and International up 7.1%. Both regions posted good growth on the back of new product flow, execution, and market recovery. Next, the SET category was down 30 basis points year over year. Inside of that, we saw continued strong performance from our three focus areas within the business segment. As expected, we saw pressure from reimbursement headwinds within the restorative therapies business, In addition, we experienced more acute supply challenges within sports and trauma. In the backdrop of this, we believe we will move beyond these headwinds, and this segment will rebound in the second half of the year. Finally, our other category grew 6.5%. Now moving on to the P&L. In Q2, we reported gap-diluted earnings per share of $1 compared to gap-diluted earnings per share from continuing operations of 73 cents in the prior year. The increase was driven by higher revenues combined with lower non-operating expenses due to ZMV investment losses from the prior year that did not repeat, as well as lower spend related to restructuring costs. These benefits were partially offset by increased investment in R&D and commercial initiatives to drive future growth. On an adjusted basis, we reported diluted earnings per share of $1.82 or flat to the prior year. Higher year-over-year revenues and better gross margins were offset by higher R&D expenses, increased investments into commercial infrastructure for new product launches, and higher interest expense. Our adjusted gross margin was 72%, up 40 basis points from the prior year, despite absorbing current year inflationary pressures, as well as pressure from prior year that was capitalized and flowing into this year's P&L. Favorable mix and FX hedge gains also helped support the increase in gross margin. Adjusted operating margin for the second quarter was 27.5%, down 50 basis points from the prior year. While gross margin was up, this was offset by higher operating expenses due to increased investments in R&D, aligned to our plan to improve our vitality index through new product innovation, as well as higher commercial infrastructure costs to support new product uptake. Net interest in other non-operating expenses of $57 million was higher than our expectations and significantly higher than the prior year due to certain foreign currency losses in the quarter as well as higher interest rates. Our adjusted tax rate of 16.3% was in line with expectations. Turning to cash and liquidity. Operating cash flows were $348 million and free cash flow totaled $165 million. We ended the quarter with cash and cash equivalents of $320 million. Our balance sheet remains strong, providing strategic and financial flexibility for future growth. Moving to our updated financial outlook for 2023. Based on another strong quarter of results, we are again raising our full year 2023 outlook. We are confident that we will continue to grow our top line above market rates and expand operating margin while continuing to reinvest in our business for future growth. We are increasing and narrowing our constant currency revenue growth range to 7% to 7.5%, with an expected foreign currency exchange headwind of 50 basis points. We are also increasing our adjusted EPS guidance range to $7.47 to $7.57. Additionally, due to certain FX-related pressures and higher interest rates, We now expect net interest and other non-operating expenses to be around $200 million for the year. Our expectation around tax rate and total shares outstanding remain unchanged, and we continue to expect free cash flow to be in the range of 1 to 1.1 billion. Our Q3 and Q4 revenue cadence expectations are unchanged. Q3 revenue dollars are expected to be sequentially down versus Q2, and in line with normal seasonality, and Q4 will be our strongest quarter on a dollar basis. While we expect momentum gained from the first half to flow into the second half of the year, recent and new sanctions on Russia may mute growth. And regarding selling day impact, we continue to expect Q3 to have a selling day headwind of about 150 basis points, while Q4 will have about 100 basis point tailwind. Overall, the net day rate impact for the full year is not meaningful. From a margin perspective, we expect Q3 to be our low watermark for the year, from both a gross margin and operating margin standpoint. While gross margin will have less variability from quarter to quarter, we expect Q3 operating margin to step down sequentially between 150 and 200 basis points due to the normal seasonality of our business. We expect Q4 to step up significantly on a sequential basis, delivering our highest operating margin for the year. Importantly, we remain committed to investing for future growth while delivering meaningful full-year margin expansion in 2023. We're really pleased with how our team is navigating a challenging environment. In summary, we delivered another quarter of excellent top-line results, beating our expectations while managing very real supply chain challenges. We are building on our early momentum through continued execution and are again able to increase our full-year guidance. We are also reiterating our confidence and expectation to be a 4% plus or even mid single digit top line grower in a normalized market while delivering strong earnings. In short, our business has never been stronger. With that, I'll turn the call back over to Carrie.

Thanks, Suki. Before we start the Q&A session, just a quick reminder to please limit yourself to a single question and one follow up so that we can get through as many questions as possible during the call. With that, operator, may we have the first question, please?

Thank you. We'll go first to Travis Steed with Bank of America.

Hi. Good morning, Bronnie and Suki. Nice quarter. I guess I'd start out with looking at the hips and knees in the quarter. I would think that knees, you know, 2x the growth rate of hips this quarter. Backlog would be similar there. Is the elevated knee growth mostly the mix shift from some Ellison Rosa coming through? And curious how much supply is limiting growth and hips and knees here and what you're assuming about that improving in the back half.

Thanks, Travis. And what I think maybe I'll do because, you know, obviously Yvonne's here with us and as close to the action as any of us. So maybe I'll pass it to him to answer the question. Yvonne.

Thank you. And good morning, Travis. I will say that the growth in knees is mainly innovation. We continue to see great momentum with ROSA penetration. So a pretty dramatic increase in penetration in the U.S. and core markets for U.S. The launch of Persona Oceotide or Semendes launch is gaining great traction here in the U.S. In the prepared remarks, Brian mentioned how we plan to go from 15%, 1.5 to 5.0. I won't disclose where we end the Q2, but it was a significant uptake in that side as well. We did also see great momentum in the ASC. We continue to grow here in the U.S. double digit in the ASC space. And yes, there was some backlog in key markets around the world. We saw better backlog consumption in EMEA than here in the U.S., but nonetheless, backlog was part of the performance. And to the latter part of your question, certainly supply was a governor. I do believe, we do believe that in a normal environment with better supply, but already very compelling growth rate could have been even higher. But all summarized, backlog, innovation, and great commercial execution were the key drivers behind the NE performance.

Great. Thanks for that. And I guess looking forward to the sustainability of this kind of the plus and the four plus. And I think I heard the comment even mid-single-digit growth. It sounds like even with some tougher comps, you're still confident in that, you know, seeing the plus and the four plus. And then, you know, I'd assume that, you know, price is better. You've got the makeshift Backlog's probably still lasting through 2024. Just kind of love to hear your confidence and kind of seeing the upside to that four plus.

Yeah. Hey, Travis. This is Suki. So, yeah, very perceptive on our comments. Yeah. You know, we've got confidence in our business in a normalized environment that we're going to be a four plus or, as I said, a mid-single-digit grower. You know, there's a few things. First, I'd focus on qualitatively execution is incredibly strong. Right now, we've got, if you think about our WAMGR, weighted average market growth, continues to improve. That's been steadily improving, one, by investing in R&D organically in higher growth submarkets, even within recon, but then in sports extremity and trauma. And then if you look at the M&A that we've been doing, it's been in higher growth markets and in sports upper extremities as well as CMFT. So overall, our weighted average market growth has been improving. Next, it's really around our innovation and what that innovation brings in terms of the ability to compete in the market, what it brings relative to share of wallet, as well as mix is all very positive as well. And then the last is our performance relative to market. I think we've demonstrated for a number of quarters now that we can perform at or better than market on a consistent basis. So really, execution is the primary driver of why we've got confidence behind that. And secondly, you're also seeing some improving market dynamics. One, we think that overall the patient dynamics are changing. You're seeing a lowering of the average age of our patients. That's expanding our overall market. Two, we think that they're getting more confident in the outcomes of recon procedures and sports procedures, again, because the technology, the innovation is improving. We're bringing real value to the marketplace. And I think the last thing is really the convenience and the comfort with the ASC setting is also helping to accelerate the over-market. So the market dynamics are still early and preliminary, but the execution is very strong and very real. So we've got a lot of confidence qualitatively. And I think if you look at the back half of our guidance, the implied growth rate of being roughly about 5%, I think that's another proof point quantitatively that gives us that confidence. So again, thanks for picking up on that. And those are the things that give us confidence. Thanks a lot.

Thanks, Travis. Katie, can we go to the next question in the queue?

We'll go next to Richard Newitter with Tourist Securities.

Hi. Thanks for taking the questions. Let me just looking at the margins. I'm trying to calibrate, you know, if we're kind of back to normalized levels sustainably, what your normalized margin and margin improvement prospects are. You know, you did about 200 basis points of year-over-year operating leverage in the first quarter, and you grew double digits on the top line. Now you're at about 100 – basis points roughly in the back half. And that's like you said, a mid single digit implied growth rate on the top line. So can we assume like that those are basically the right level of operating leverage to correlate to, you know, call it, you know, upper mid single digits, you're getting north of 100 basis points, something more in the lower mid single digits or upper low single digits, your 50 basis points plus operating leverage?

Yeah, so first of all, thanks for the question, Rich. You know, I'll just step back a little bit and just say, you know, if you go back to 2022, even in a very challenging market with a lot of inflationary pressure, supply chain disruption, et cetera, we were able to grow our operating margins. As you look at 2023, you take our implied guidance, it would suggest we're going to grow operating margins by almost another 100 basis points at the midpoint. So we feel really good about what the company's been doing. And inside of that, we've been doing that with very strong, as you see, mid-single-digit growth, very good gross margin performance. I'll break that down in just a moment. Offsetting continued challenges with inflationary pressures, but also inflation from 22 that capitalized into this year, which we've talked a lot about, while still investing against the business for future growth, right? So very strong profile. Good top-line growth. Good gross margin offsetting the challenges and continue to invest against the business. So, I do think our ability to sustain these very high, very attractive margins this year into the future is absolutely table stakes. But I also think that we're going to be in a position going forward in a normalized market. We're going to be able to expand margins from here. That's that's how we think about things. I won't try and break down. between what level of revenue growth, how much margin expansion. There are a lot of factors that play into that. The big picture takeaway is we're at a really good level now. We're going to sustain that, if not grow that, into 24 and beyond.

Okay, thanks. And just maybe feeding that into M&A, you know, as we think about your M&A and tuck-in strategy, how should we think of the prioritization of top line from tuck-in M&A versus margin and earnings dilution trade-offs? Yeah.

So, you know, we kind of how to work around this as a leadership team. And clearly what you see by looking at other companies in our sector is that valuations are correlated at a very high level to revenue growth. So understanding the ability to get our revenue growth at a higher rate, you know, the mid single digit is a great accomplishment given where the company was just three to five short years ago, and we're happy about the progress we made, but we're not satisfied, right? And we believe that M&A investing into faster growth markets absolutely is the right thing to do and ultimately will improve our overall weighted average market growth and the overall growth rate for the company. And then once you get there, you get natural leverage, the P&L starts to flow through, and over time, you start to get to a profile where you get very strong earnings growth well ahead of revenue growth. And so that's the profile that we're going for long term. From an M&A standpoint, our first priority is that revenue growth and that diversification of the company into faster growth markets. That may come with some near-term dilution, but we're also going to be very conscious about driving P&L discipline and looking for accretion in a reasonable amount of time, let's say within the first two years. So that's how we think about M&A. The priority is going to be about accelerating the overall company's growth.

Thanks, and congrats on the quarter.

Thanks so much. Katie, can we go to the next question? We'll go next to Peter Chickering with Deutsche Bank.

Hey, good morning. Thanks for taking my questions. Can we touch more into SCT? You talked about strength in three focus areas, but also supply challenges. What were those issues? Are they fixed at this point? How should we be modeling SCT in the back half year? And if the supply challenges are fixed, should we think about bolus in the third quarter?

Yeah, so a couple of things that inside the 2nd quarter on one, we continue to work through some of the reimbursement changes. In our restorative therapies business that we talked about a year ago, we believe we've now sunset of those. So those shouldn't be a challenge as we move into Q3 and Q4 the rest of the year. However, we did see some pretty acute supply issues, especially in our sports business, and to a lesser extent, trauma, that muted growth. But underneath that, our priority areas of sports, upper extremities, and CMFT all performed incredibly well. And so we're happy with the continued progress and momentum we're making in those businesses. We do expect an inflection in the back half of the year for the SET category as a whole to rebound. It's likely going to be stronger in the fourth quarter as we continue to work through the fluid situation of supply in the third quarter.

Okay, great. And then looking at the script, you talked about Russia muting growth. Can you walk us through how Russia can impact growth at this point and quantify the revenues and raw materials exposed to Russia?

Sure. So overall, Russia is less than a percent of total sales on a full year basis. We became aware towards the end of the second quarter that new and unexpected sanctions were being placed on certain medical device products. Our products fell into that category. So we basically have to go back and reapply for licensing against all of our products. We don't think that that's going to be a governor in perpetuity, but at least for the third quarter, it's going to create a bit of a headwind, potentially a little bit into Q4, worst case. We think that that headwind's roughly about 50 basis points in the back half of the year, and again, most of that will be felt in the third quarter. From a raw materials exposure, I think the biggest area, and we've talked about this at length, is Our titanium supplies coming out of Russia have been relatively stable. That's a good sign. But we also took the additional measure at the end of 22 to create some redundancy and to find alternate suppliers, multiple suppliers outside of Russia. So we feel good about our titanium supplies. Great.

Thanks so much.

Thanks, Peter. Yeah.

Katie, can we go to the next question in the queue? We'll go next to Jeff Johnson with Baird.

Thank you. Good morning guys. Congrats on the quarter. Kind of, I guess we're ticking through all the segments here. So maybe if we just look at the other segment, that 6% growth, it was, you know, at least a nice step up from what we've seen kind of on a trailing 12 month basis. Maybe any insights there, what drove that and just kind of how we're seeing mix between leasing contracts and or outright purchases on ROSA. Thanks.

Yeah, sure. Hey, Jeff, I'll take that sticky again. I think the biggest driver was bone cement. Not surprising when you see the recon growth numbers in the second quarter to see a very good other performance, especially from bone cement. We also saw some good performance outside in surgical as well, which also creeped up. You know, your last question inside of that was around ROSA placements versus outright sales. And consistent with prior commentary, we're seeing the majority of our rows of placements or installments, I should say, being done through the placement strategy versus sales. So that trend continues.

All right, great. And then maybe just to follow up, just on backlog, I know you don't guide on backlog and, you know, any high-level comments, though, on how you're thinking about that backlog clearing in EMEA and what you saw in the U.S. and just kind of comfort with that backlog still continuing to provide some tailwinds maybe over the coming year or two. Thanks.

Yeah, definitely felt it in the second quarter, as we talked about. That helped offset some of the supply challenges that we had. We expect backlog to continue to contribute through the rest of this year. You know, it's always difficult to determine exactly how much was in any given quarter and to predict how much will come through. It's a little bit of amorphous, but we know that it's there and we have high confidence that it's going to, we're going to continue to see it through the back end of this year and likely through 2024. Thanks, Jeff.

Katie, can we go to the next question in the queue?

We'll go next to Larry Beagleson with Wells Fargo.

Good morning. Thanks for taking the question. Congrats on a nice quarter here. I'll ask a couple on the pipeline. Persona IQ, do you guys have what you need now for a full launch from a clinical data standpoint? And if so, what data are you going to promote and file for the label? And I had one follow-up.

Absolutely, Larry. I'll take that one. First and foremost, we remain on track. We saw the limited market release. We've been saying all along that by January Q1 of 2024, we'll be ready for a full launch. And I will say that we're almost there in getting all the data. We're approaching a billion data points from multiple patients, thousands of implants by now. And really, we're answering three questions. Number one is, to your point, what is the value proposition? Can we demonstrate a reduction in the length of the episode of care? Can we bring objectivity to a range of motion metrics? Can we demonstrate better gait performance given better technique, better surgery? Can we compare recovery curves? Who does better post-implantation? There's a lot of data we get in that regard. We'll be filing some claims once we digest the multiple data points that we're getting. So that's question number one. Question number two in the limited market release is how do we make the whole thing seamless? This is new to the world technology. It's got a home-based station, as you know. It involves the patient, it involves the surgeon, the caregiver. We want to make sure that it's a best-in-class experience, and there are some things that we're working around. And then the third question, and I know this is near and dear to you, is who's going to pay for the technology? To that end, we got the NTAP kicking in at the beginning of October. You'll be pleased to know that we follow up with your question around TPT, transitional pass-through. We got a deadline of August 23rd to submit. We're in the final stages on evaluating what the submission could look like. We're evaluating commercial payout strategy as part of this limited market release. So we continue to think about the payout as well. So with all of that said, the what, the how, and the who will pay, I think we're going to be in a good position to start to see a full market release by January, if not late Q1 2024.

Ivan, thanks so much for that comprehensive answer. Maybe another one for you. on the robot for the shoulder application for the robot. I think you just confirmed that you still expect to be first to market and what still needs to be done. And if you'll give any more color on that timeline, that would be great. Thanks so much.

I'd love to give you more color, but Brian and Kerry will shoot me. I will tell you that we remain convinced, capital letters, that we'll be first to market in shoulder robotics And beyond the speed to market, what I like is what the actual platform offers. Faster surgeries, more accurate outcomes, shorter recovery. So I love what we've seen. We've done our final validation labs with customers, both friends and family customers, surgeons, and also competitive surgeons, and the feedback has been outstanding. Beyond the platform dynamics that I mentioned around shorter recovery, faster surgery, I just love the integration that Rosasolder will have with the rest of the CBH ecosystem. So, more on that soon.

Thank you.

Thanks so much, Larry. We'll go next to Ryan Zimmerman with BTIG.

Hey, thanks for taking the questions. We all heard, you know, UnitedHealthcare's comments this quarter. There's evident results, but it was specific to Recon and Medicare. I'm just wondering if you kind of parse out the procedure environment within SET. It's hard to see, you know, given some of the supply chain dynamics. I'm just wondering if you can kind of speak to that environment relative to recon and your expectations for durability of, you know, its robustness, if you will, through the remainder of this year, similar to the recon environment.

Thank you, Ryan. I'll take that one as well. So obviously it varies from region to region. What I will tell you here in the U.S., we saw greater backlog consumption coming from knees than hips. It was actually quite the opposite in EMEA. When it comes to SEP, a lot of those cases here in the U.S. are done in an ASC environment. A lot of those cases are commercial payers, and it's been pretty consistent. But again, it varies quarter to quarter, geography to geography. We do believe that the backlog is going to be here for a while. And I will see fluctuation given ASC, non-ASC in the U.S., and then again, different variables outside of the U.S.

I think the key takeaway is that you just don't see as much impact on the SED business as you do the recon business when you think about backlog.

Fair. That's helpful, Brian. And then, you know, we talked about Russia. Last year, it was China and the impact of EVP. I'm just wondering if you could articulate specifically What the status is in China? We've heard from many of your peers, you know, China's improving. You know, what are your expectations for China growth as we kind of laugh, as we start to laugh the VBP impacts?

Yeah. So, first of all, VBP is not a material driver for us at all in 2023. We sort of turned the corner on that between the end of 21 and 2022. So, we actually see China as a growth driver for us, albeit at a lower level. but we do believe that that market has some very strong growth for us. I'd say pre-VVP, that market was growing in the low double-digit ranges, and we'd be surprised if we didn't return to that level, if not better.

Thanks, Ryan. Thanks.

Katie, can we go to the next question in the queue? We'll go next to Mike Mattson with Needham & Company.

Yeah, good morning. Thanks for taking my questions. You know, Back to the set business. So, you know, Brian called out kind of the subcategories there that seem to be the area of focus. But the things I didn't hear him mention were lower extremities, i.e., foot and ankle, or trauma. So, you know, can you maybe just comment on why those were, you know, kind of left out of the comments?

Yeah, sure. I can take that as well. So, I think Suki alluded to the trauma headwinds that we had in the quarter. We had some supply challenges, and obviously you got the comp in China, which was a year ago. Here in the U.S., there were some contracts that we lost about a year ago. We're anniversarying out of those. There were some product launches that were delayed, 22 and 23, that are coming out now. So I would say that moving forward, given the better comps in the U.S. and the contract capabilities now in the U.S., along with innovation, the trauma business is going to be in a better position. Food and ankle is being one of the businesses, frankly, within SET that we didn't prioritize. We wanted to prioritize upper extremities, sports med and CMFT. That being said, I do think there is a couple of product launches that are going to make a difference in the space. So all in all, I do think you'll see better performance, but trauma, food and ankle are not the key priorities within SET.

Yeah, and to be clear, it doesn't mean that we don't see foot and ankle trauma in restorative therapies as potentially attractive markets. It's just we want to be disciplined in the way that we're going to invest. And if you look at the strap plans that we have for upper extremity CMFT in sports, they're very attractive. So we're going to focus our investment there. Now, at the end of the day, if the individuals running foot and ankle trauma or restorative therapies put a plan in place that's attractive, they could become growth drivers. But today, We want to differentiate those growth drivers to non-growth drivers. Nothing against any of the categories. It's just the plan right now is very attractive in those three.

I'm just going to have restorative therapies. I don't know if restorative therapies was part of your question, but we anniversary out of the reimbursement change, July of 2023. So you should expect that business to do dramatically better now.

All right, got it. And then just in terms of the supply chain issues, I don't know if it's possible, but is there any way you could quantify the impact either to your revenue growth and or your margins in the quarter?

I think we'll try to stay away from quantifying. It's pretty challenging, actually, because when you talk about supply issues, you always get feedback from the field on what could have happened if you had more supply, and you've got to make sure that you're kind of sifting through what's real, what's not. But the fact is, it is a governor for us right now, and that's why we continue to say it. What's important, though, is it's a macro challenge. There's not a company in orthopedics right now that is not being impacted by supply challenges. So it's impacting everyone. WAOS just did a survey, actually, with surgeons asking this question. And across the board, regardless of who they were using, they were experiencing supply challenges. Really important thing for us is that it's built into the guidance that Sufi just provided. So that's key. But when I think about that growth driver, the impact it's having on our ability to grow, I think it's important to look at that. That means it's getting in the way. of our team using new innovation to drive mixed benefit and competitive conversions. We truly do believe if it was not a factor, we'd be getting more mixed benefit, we'd be getting more competitive conversions because the demand is there. So it's frustrating. We have great momentum in the business, great innovation, and supply is in the way of driving that growth.

And we believe it's going to continue to be there for a period of time.

Thanks, Mike.

Katie, can we go to the next question with you? We'll go next to Robbie Marcus with J.P. Morgan.

Oh, great. Thanks for taking the questions and congrats on a good quarter. Maybe I could start on margins. If I take the third quarter and fourth quarter commentary that you provided, I have a little trouble getting to the high end of the range. So maybe just speak to some of the pluses and minuses there and what you need to get to the top of the range. And then second question I'll just throw in as well. You have a big gross margin benefit from currency in 23. There's a pretty wide range of operating margin expansion next year or contraction on the street. Any early thoughts into how we should be thinking about your ability to grow operating margins next year? Thanks a lot.

Yeah. Yep. Sure, Robbie. Great to talk to you. So one of the biggest drivers in the overall profile in the back half of the year, by the way, we do believe operating margin in the back half will be modestly better than what you saw in the first half. That's largely going to be driven by better revenue, mostly coming from the fourth quarter. Fourth quarter is always our strongest from a dollar perspective, from a sales view. The second thing is you're likely going to see a step down in overall operating expenses from the second quarter. That was sort of our high watermark as we were dealing with a number of inflationary pressures, but quite frankly, also investing pretty handsomely against things like R&D, which was up like 19% in the quarter. investing against commercial infrastructure in places like sports and upper extremities to continue to specialize that sales force as well as ASCs. So the two common combined things of higher revenue, lower OPEX as we move into the back end of the year is what's going to drive that margin expansion improvement versus the first half. As we look into 2024, you're right. We did talk about some FX hedge gains this year, which we sized at about 50 basis points on the full year. That won't repeat into next year. That will be a headwind. But we're still confident that we can grow operating margins into 2024. It may not be at the same level of 100 basis points that you're seeing this year, but we do believe, as I said earlier, that we can take this sort of high watermark that we are in operating margins and continue to enhance that As we move into 2024, what are some of the building blocks? One, you know, pricing is still a headwind, but we're seeing really great performance. It's not the headwind that it used to be for the company. And what's even more exciting about that is we're truly seeing very strong mixed benefit inside the company. And that's coming from our new products and the innovation into the marketplace, which is helping to offset that price erosion. So we think that that can be a tailwind for us. Secondly, we continue to work aggressively on our site optimization in manufacturing and supply chain, which we think can generate some tailwind in cost of goods as we move forward. And then as you move through the rest of the P&L into SG&A, There's still ample opportunity with our global business services agenda that we just started a few short years ago. We've got a completely different culture and mentality when we think about go-to-market and market profitability, where at one time it was revenue growth at all costs, and now it's all about revenue growth at the right profitability level and with earnings growing faster. And so there's just those cultural shifts, and that discipline is also driving some really nice margin expansion there. both in the U.S. as well as outside. So these are just a few levers that, quite frankly, we've been pulling on already. There's still room to go and why we feel confident that we can take this high-water mark of 2023 and grow it into 2024. Great. Thanks a lot.

Thanks, Robbie. Katie, can we go to the next question in the queue?

We'll go next to Rick Wise with Stiefel.

Good morning. And maybe starting off with a couple of the key new product launches that you highlighted. Brian, you said, as you were talking about the four pillars of knee growth, that ROSA plus the cementless knee launch, that was your first comment, your first focus area, taking cementless from mid-teens to 50% over time. Related to that point, where are you in the rollout? When or are you even at full launch now or what's required? And how do we think about the acceleration of that launch over the next year or two? Thank you.

Yeah, thanks. Thanks, Rick. What I'd say first is just to make sure that I clarify, I'm saying that both ROSA and cementless will move from the mid-teens to, you know, 50% plus, 5-0% plus, so not just cementless. And they kind of do play off of each other. They benefit each other as you're trying to get adoption in the marketplace. But speaking specifically to cementless, maybe I can pass that to you.

Yeah, I would say, Rick, that it's early innings, frankly, both for ROSA as well as cementless. We are in what I think is not still a full launch for cementless, given some of the supply constraints. I think as we exit 2023 and early 2024, we'll have as much supply as we need to meaningfully drive the penetration of cementless with the goal of going from 15% to 50%. I won't say when 50% is going to happen, but that's definitely the North Star. And with ROSA, it's the same situation. We launched True Platform Sydney. We are about to launch ROSA Parts CL this summer, a new and improved version of that. We're working actively on Next Generation Total Me, which will be a meaningful launch going into 24. We got all kinds of CBH add-ons, data technology solutions that are going to augment penetration there. But I would say net-net, both for the ROSA cementless and some of the peripheral launches around those two components, we are in the early innings.

Great.

And Brian, if I could, for a second question, I would like to hear from you. your personal priorities? It seems like execution is going well. Yvonne's doing a great job and the team's doing a great job with the pipeline and execution and driving the business forward. Sookie's taking the financial organization in a positive direction. What are your priorities now as you look ahead to the next year or two? Are you focused on efficiency, portfolio? What just What are you thinking about and that we should hear about and ask about today? Thank you.

Thanks, Rick. I mean, I'll kind of tongue in cheek say we're thinking about everything, but obviously that doesn't get you anywhere if you don't focus. And we've been very clear from the very beginning that we had three phases of the transformation of this company. Phase one is always going to be alive, but we're in great shape. Phase two is kind of what you just said. We have a great innovation pipeline. We're executing from an organic standpoint. We feel very confident in that phase. And now we're squarely in phase three, as we've been saying. And the big focus for us is that portfolio transformation that will leverage our balance sheet. And the balance sheet is strong and strengthening, just as I said in the prepared remarks. And that is the area of focus for us. How do we continue to move our weighted average market growth forward? I can tell you we've already made great progress in the focus area here. We've already moved it north. With the balance sheet strength, we expect it to continue to move in the right directions. So that's an area of focus, not just for me, but for this entire team.

Great. Thank you.

Thanks for the question, Rick. Yeah. Katie, can we go to the next question in the queue?

We'll go next to Josh Jennings with TD Cowan.

Hi. Good morning. Thank you. Josh, do we still have you?

We'll go next to Jason Bedford with Raymond James.

Thank you. Good morning. Thanks for taking the questions. I apologize if I missed this, but what was the impact of price in 2Q and of your expectations around price changed at all?

It was about 1% erosion year over year in the second quarter. I think in the first quarter, I think the average is somewhere around one, two for the first half of the year. We would expect in the second half for somewhere to be between 100 to 150 basis points of erosion. We're seeing really good traction there for the number of reasons that I've talked about at length previously. But again, I think the really exciting thing is we're starting to see that mixed benefit come through from our new product introductions and helping to offset even an improved price erosion profile.

Okay, great. And then just secondly, on the supply challenges, are these new issues or are they kind of legacy carryover issues? And then, Brian, I think you mentioned that you expect this dynamic to continue for some time. Does the impact lessen with each quarter going forward and any visibility as to Kind of when these issues will abate.

I'll start by saying that we have not seen anything new. All along, there were really three buckets that summarized the problem. Materials, labor, and sterilization. Augmented, we frankly just put demand plan on our side because the demand that we saw kept getting better and better and better. Sequentially, we've seen improvement. We've seen better forecast accuracy on the demand side. And then as we think about labor, at the tier one level, our labor capabilities are much better than before. We're hiring people in our sites. When you think about sterilization, we have the right strategies. Materials continue to be a challenge, but again, it's much better than before. So I would say improvement versus the past. And sequentially, we continue to see improvement across both supply and demand.

I mean, the challenge, it's a fixed equation, right? I mean, as you start to improve, as we would expect, in materials, labor, and sterilization, because we put great planning around that, as demand continues to be strong, it's going to delay supply recovery. And so that's what we're seeing, is we're seeing a great dynamic, strength in the marketplace, better traction in our new innovation than we even expected, but that puts pressure on that equation, and it pushes the supply challenges out.

Thanks so much, Jason. Yeah. Katie, can we go to the next question in the queue?

We'll go next to Kyle Rose with Canaccord.

Great. Good morning, everyone, and thank you for taking the questions. Suki, just circling back on gross margins, strong in 2023, obviously. You walked through some of those benefits. I guess just help us understand maybe how much of an impact inflation in the supply chain has been on underlying gross margins. I mean, I understand the positive tailwinds that you've outlined earlier, but How much have you truly been offsetting? And I guess just trying to understand how much when you talk about supply chain challenges and increased unit costs and wages, is there a potential to see a second shoe drop? And I'm just kind of trying to understand as inventory turns, you know, flow through the business, if and when we'll actually ever see that impact through the P&L. And then secondly, You know, lots of talk about, you know, returning to a normalized operating environment. Like, I think we all understand it's been a dramatic, you know, three to four years. But I guess just when is it fair to start thinking about, you know, when we will be in that more of a normalized operating environment, whether it's, you know, supply challenges the industry is facing, staffing challenges? Just how should we think about actually getting set back to that, you know, mid-single digits? Thank you.

Yeah, sure. Kyle, thanks for the question. So, first on gross margins. Um, from an inflationary standpoint, recall that we have about 100 basis points from 22 that's capitalized and hitting our, our this year and we're seeing that come through that that's happening. In addition, we are seeing some incremental inflationary pressure, new pressure. 2023. primarily related to continued spot buying with some raw materials around packaging, Tyvek, some of our metals that we use. But we're also seeing it in really the cost to serve. What do I mean by that? Really around the need to have to ship product a lot more than you might have to in a stable supply environment. That's one area of incremental inflation or higher costs that we're seeing. The 2nd, is we've made the decision to actually pay incremental incentives to our commercial field Salesforce because we know how challenging it is out in the marketplace. Dealing with these supply challenges, we've been incredibly impressed with how they've been responding. So these are a couple of elements that are also flowing into the, you know, by the way, we're offsetting those. and investing against the business while increasing operating margin for this year. So the company and the team have been incredibly disciplined in the backdrop of better revenue and still dropping very, very substantial operating margin expansion. As we move into next year, there could be some of this incremental inflationary pressure that we're seeing this year that makes its way into 2024. It's going to be nowhere near what we saw happen in 22 and 23. It'll be much more modest. And like I said, I think we have more levers to help offset that as we move into 2024. But again, I'm not going to give guidance on 2024 and exactly what gross margin and operating margin look like, but there are some moving parts there. That'll be potentially another modest headwind, but again, we have a number of tailwinds to help offset things. Returning to a normalized market, clearly we're not there yet. Revenue growth may look and feel normal, but The underlying dynamics are still not normal. We don't believe, at least standing where we are today, at least the beginning part of 2024, that we're going to be there. It's a long way away. We'll see where we get to in 2024. But once we do get to that sort of normalized growth, we do believe that we can sustainably hit that four-plus or mid-single-digit growth profile that I talked about earlier.

All right. Katie, I think we might have time for one last question in the queue.

We'll go next to Matt Mixick with Barclays.

Hey, thanks so much for squeezing me in. So just a couple of follow-ups. One on margins. And I know there's been a fair amount of talk about on the call and progress in terms of driving leverage, commitments to leverage this year. I was wondering if we could sort of zoom out and think about where margins were pre-pandemic, you know, in that kind of like low 30s range. If you could remind us, is that a target to get back to and maybe the timeline for getting there? And then just one quick follow-up on the Persona IQ, if I could.

Thanks.

Yeah, so the margins in the low 30 range, I'm not sure what you're referring to there, Matt, maybe just at the merger of Zimmer and Biomet, but since then, those margins were obviously impacted by a lack of investment in supply chain, commercial infrastructure, et cetera. So, again, I don't know that that's the right reference point. What I can tell you is that, you know, pre-pandemic to where we are now, we are expanding margins. operating margins as we continue to drive top-line revenue growth and investment in the company. So I feel good about where we are and where we're headed moving forward. Sorry, your second question? Yeah. Do you want to take that?

Sure. Just to follow up on Persona IQ, I think the number, I think maybe that was mentioned earlier, was something like 1,000 implants. I mean, it's a pretty small percentage of total, you know, maybe 1%, less than 1% of your total implants a year. And I just want to get a sense of, you know, at what level do some of the data start coming through? Is it a couple thousand implants? Is it 3,000 to 5,000 implants? When do you expect to see some of the results you mentioned earlier in the call? Thanks so much.

Yeah, thanks. Yeah, thank you, Matt. First and foremost, we don't disclose the number of patients, but I'll tell you, it's far greater than 1,000 patients. When are we done with the limited market release? I think we're about to complete that. The size matters more for certain claims than others, but I will tell you, we've got enough of a sample size to be able to engage in a full market release by 2024. What's the expectation moving forward? This is going to be a flagship product for Zima Biomed. We plan to see meaningful penetration of this technology, first in knees, then in hips, and then at some point in shoulders as well. What's the right penetration? Again, we won't disclose that, but given the unique technology, we will leverage this to the fullest.

Thanks, Ivan. And Matt, thanks for your question. I think we're almost at the bottom of the hour.

I'll actually turn it over to Brian just for some closing remarks.

Just maybe a quick summary, too, on what you were just talking about, Sookie. When we think about a normalized market, and we're saying 2024, in our view, is not going to be normalized for two factors. You're still going to have backlog that we're going to have to pay attention to. We would deem backlog as a neutral to potentially negative, depending on whether it stays the same or decreases. We don't think there's going to be an increase in it. And the second one is supply. You know, that is going to be neutral to positive because as we continue to see supply benefits, that will create a tailwind for next year. So those are pretty big variables that would tell us that we don't have a normal year in 2024, but they're offsetting. So that's the reason why we think 2024, even though not normal, air quotes, could look a lot like a normal year from a growth perspective. I just want to make sure that that's clear. And then I'm just going to sum it up. First of all, thanks again for joining us this morning. And I think it's pretty clear in the way that we talk about the business right now that we're not just excited about where we are as a company, but the future of this company. And I think that's really important. We've already made disciplined portfolio decisions that have increased the weighted average market growth of this business. That's already happened. And that gives us confidence in the growth of the organization, not just today, but in the future. And the balance sheet says that we're going to continue to be able to strengthen our position in those fast growth markets. And we will absolutely do that. That is phase three. of the transformation. And the innovation pipeline, as Yvonne continues to talk about, is as strong as it's ever been. And that gives us the ability to drive mixed benefit, pricing stability, and competitive conversions. And when supply gets out of the way, that will even happen more. So we're very excited about that. And I've been doing this long enough to know when a team has got that skip in their step and they've got the ammunition to be able to drive the performance of the business sustainably. And we are in that place. Okay, with that, I'll go ahead and close it out. And thanks for joining us.

Thanks, everyone. We'll talk to you soon. And obviously, if you have any further questions, please don't hesitate to reach out to the IR team.

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