Zimmer Biomet Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2023

Key Takeaways

  • Q2 sales beat expectations with net revenue up 4.9% (6.0% ex-FX) and management raised full-year guidance to 7.0–7.5% revenue growth and adjusted EPS of $7.47–$7.57.
  • Ongoing supply chain constraints and inflationary pressures continued to mute growth, most notably causing acute headwinds in the Sports and Trauma businesses.
  • Innovation momentum remains strong with 40 planned product launches through 2025, led by ROSA/Persona cementless knee, Persona IQ smart knee and HIP InSight robotics platforms.
  • The SET category experienced muted performance due to reimbursement headwinds in restorative therapies and Sports supply issues, though a rebound is expected in H2.
  • Zimmer Biomet generated robust cash flow—$165 million free cash flow in Q2—and ended with $320 million in cash, raising full-year FCF guidance to $1.0–$1.1 billion.
AI Generated. May Contain Errors.
Earnings Conference Call
Zimmer Biomet Q2 2023
00:00 / 00:00

There are 19 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded today, August 1, 2023. Following today's presentation, there will be a question and answer session. At this time, all participants are in a listen only mode. I would now like to turn the conference over to Carrie Maddox, Chief Communications and Administration Officer.

Operator

Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. Welcome to Zimmer Biomet's 2nd quarter 2023 earnings conference call. Joining me today are Brian Hanson our Chairman, President and CEO EVP and CFO, Suki Upadhyay and COO, Ivan Tornow. Before we get started, I'd like to remind you that our comments during this call will include forward looking 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.

Speaker 1

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?

Speaker 1

All

Speaker 2

right. Thanks, Carrie, and thanks to everyone for joining us on the call this morning. 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 And I can tell you we're looking forward to the dialogue. And I'll start things off as we normally do.

Speaker 2

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 Suki 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 and A session And we look forward to answering your questions and having a dialogue in that session. Okay.

Speaker 2

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 got to tell you that I'm proud to say that you have delivered another very strong quarter While once again making Zevia 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.

Speaker 2

And that means for our team members, our patients, our customers and 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 Q2. 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 line. And this is in the face of some pretty significant macro factors that are impacting us and the entire market.

Speaker 2

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 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.

Speaker 2

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 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 constrained 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.

Speaker 2

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 I just look at the knee franchise alone, our innovation strategy is working. We now have 4 meaningful pillars inside of this business, all of which can drive pricing stability, mix benefit and competitive conversions. First, let's look at the ROSA robotic platform combined with our PreSonus cementless knee. This is a powerhouse combination that is and will continue To accelerate growth.

Speaker 2

And based on the traction we're seeing so far, we continue to believe that ROSA and Persona Cementless together We'll enhance our robotics and Synelis 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 mix opportunities inside the revision category, But importantly, it also acts as a powerful tip of the spear product for conversions in primary knees. And then third, it's just the overall shift The ZB legacy knee systems to our now fully rounded out Persona portfolio. And this is a meaningful mix Benefit that we can take advantage of that I would say is somewhat unique to our business.

Speaker 2

And then 4th, 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 unlimited 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 HIT portfolio where we The launch meaningful innovation again giving us the opportunity for price stability, mix benefit and competitive conversions and we have 4 pillars A focus here as well. First, it's ROSA and HIP In Sight. These are technology shifts in robotics and mixed reality that are setting up the ZV HIP portfolio For greater adoption and growth.

Speaker 2

2nd is the Avanir 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 4th, HAMR.

Speaker 2

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 business 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're very excited about our innovation momentum. It's very real.

Speaker 2

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 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 are already strong and strengthening balance sheet.

Speaker 2

And with that, I'll turn the call over to Suki for a closer look at Q2 and our latest expectations

Speaker 3

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.

Speaker 3

Unless otherwise noted, my statements will be about the Q2 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 $1,870,000,000 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.

Speaker 3

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.

Speaker 3

Turning to our business category performance. Global knees grew 10.5% with U. S. Growing 9.8% and international growing 11.4%. The strong performance in these was driven by the 4 pillars that Brian mentioned earlier, centering on a very attractive Persona portfolio combined with the benefits of our ROSA robotics platform.

Speaker 3

Global hips grew 4.9 percent 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 30 basis points year over year.

Speaker 3

Inside of that, we saw continued strong performance from our 3 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 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 and L.

Speaker 3

In Q2, we reported GAAP diluted earnings per share of $1 compared to GAAP diluted earnings per share from continuing operations of $0.73 in the prior year. The increase was driven by higher revenues combined with lower non operating expenses due to Zimvi 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 and 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 and D expenses, increased investments into commercial infrastructure for new product launches and higher interest expense.

Speaker 3

Our adjusted gross margin was 72%, up 40 basis points from the prior year absorbing current year inflationary pressures as well as pressure from prior year that was capitalized and flowing into this year's P and L. Favorable mix and FX hedge gains also help support the increase in gross margin. Adjusted operating margin for the 2nd quarter was 7.5%, 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 and 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 $57,000,000 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.

Speaker 3

Our adjusted tax rate of 16.3% was in line with expectations. Turning to cash and liquidity. Operating cash flows were 348,000,000 and free cash flow totaled 165,000,000 We ended the quarter with cash and cash equivalents of $320,000,000 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 results, we are again raising our full year 2020 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.

Speaker 3

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 $200,000,000 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 $1,000,000,000 to $1,100,000,000 Our Q3 and Q4 revenue cadence expectations are unchanged. Q3 revenue dollars are expected to be sequentially down versus Q2 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.

Speaker 3

From a margin perspective, we expect Q3 to be our low watermark for the year from both the 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 basis points 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.

Speaker 3

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.

Speaker 1

Thanks, Suki. With that, operator, may we have the first question please?

Operator

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

Speaker 4

Hi. Good morning, Brian 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, 2x the growth rate of hips this quarter, backlog will be similar there.

Speaker 4

Is the elevated knee growth mostly the mix shift from some Intellis and Rosa coming through? And curious how much supply is limiting growth and hits the knees here and what you're assuming about that improving in the back half?

Speaker 5

Thanks, Travis. And what I think maybe I'll do because 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

Speaker 6

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.

Speaker 6

And core markets for U. S. The launch of Persona OsteoTie or Cementos launch It's gaining great traction here in the U. S. In the prepared remarks, Brian mentioned how we plan to go from 15%, 1.5% To five-0.

Speaker 6

I won't disclose where we ended Q2, but it was a significant uptick 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.

Speaker 6

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 a normal environment with better supply, but already very compelling growth rate could have been even higher.

Speaker 6

But all summarized, backlog, innovation Great commercial execution were the key drivers behind the new performance.

Speaker 7

Great. Thanks for that.

Speaker 4

And I guess looking forward about the sustainability of kind of the plus and the 4 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 seeing the plus and the 4 plus and then I assume that price is better, you got the mix shift Backlog is probably still lasting through 2024. Just kind of love to hear your confidence and kind of seeing the upside to that 4 plus.

Speaker 8

Yes. Hey, Travis, this is Suki. So, yes, very perceptive on our comments. Yes, we've got confidence In our business in a normalized environment that we're going to be a 4 plus or as I said, a mid single digit grower. There's a few things.

Speaker 8

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, 1, by investing In R and D organically and higher growth submarkets, even within recon, but then in sports, extremity and trauma. And then if you look at the M and A that we've been doing, it's been in higher growth Markets in sports, upper extremities as well as CMFT. So overall, our weighted average market growth has been improving.

Speaker 8

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 where we've got confidence behind that. Secondly, you're also seeing some improving market dynamics.

Speaker 8

1, 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. 2, we think that they're getting more confident in the outcomes Recon procedures and sports procedures, again, because the technology, the innovation is improving. We're bringing real value to the 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.

Speaker 8

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.

Speaker 4

Thanks a lot.

Speaker 1

Thanks, Travis. Katie, can we go to

Speaker 9

the next question in the queue?

Operator

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

Speaker 7

Hi. Thanks for taking the questions. Just

Speaker 10

looking at

Speaker 7

the margins, I'm trying to calibrate if we're kind of back to normalized levels sustainably, What your normalized margin and margin improvement prospects are? You did about 200 basis points of year over year operating leverage in the Q1 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 Call it, 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?

Speaker 8

Yes. So first of all, thanks for the question, Rich. I'll just step back a little bit and just say, If you go back to 2022, even in a very challenging market with a lot of inflationary pressure, supply chain disruption, etcetera, 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 is points at the midpoint. We feel really good about what the company has been doing.

Speaker 8

And inside of that, we've been doing that with very strong, Setting continued challenges with inflationary pressures, but also inflation from 2022 that capitalize 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 continuing 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 how we think about things. I won't try and break down Between what level of revenue growth, how much margin expansion?

Speaker 8

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 'twenty four and beyond.

Speaker 7

Okay, thanks. And just maybe seeding that into M and A, we think about your M and A and tuck in strategy, how should we think of the prioritization of top line from tuck in M and A versus Margin and earnings dilution trade off.

Speaker 8

Yes. So we kind of how to work around this As 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. The mid single digit is a great accomplishment given where the company was just 3 to 5 short years ago. And we're happy about the progress we made, but we're not satisfied, right?

Speaker 8

And we believe that M and A investing into faster growth markets Absolutely, it's 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 and 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 and 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 and L discipline and looking for accretion in a reasonable amount of time, let's say, within the 1st 2 years.

Speaker 8

So that's how we think about M and A. The priority is going to be about accelerating the overall company's growth.

Speaker 7

Thanks and congrats on the quarter.

Speaker 1

Thanks so much. Katie, can we go to the next question?

Operator

We'll go next to Pito Chickering with Deutsche Bank.

Speaker 11

Good morning and thanks for taking my questions. Can we take a touch more into STT? You talked about strength in 3 focus areas, process of Supply challenges, what were those issues? Are they fixed at this point? And how should we be modeling NTT in the back half of the year?

Speaker 11

And if the supply challenges are fixed, should we think about bolus in the Q3?

Speaker 8

Yes. So a couple of things that inside the second quarter on SCT, 1, 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 sunseted 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.

Speaker 8

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 those for the SCT category as a whole to rebound, it's likely going to be Stronger in the Q4 as we continue to work through the fluid situation of supply in the Q3.

Speaker 7

Okay, great. And then, looking at the

Speaker 11

script, you talked about Russia muting Can you walk us through how Russia can impact growth at this point and help quantify the revenues and raw materials exposed to Russia?

Speaker 8

Sure. So overall, Russia is less than a percent of total sales on a full year basis. We became aware at the end of Towards the end of the second quarter, that new and unexpected sanctions were being placed on certain medical device products. Our products sell into that category. So we basically have to go back and reapply for licensing against all of our products.

Speaker 8

We don't think that that's going to be a governor in perpetuity, but at least for the Q3, it's going to create a bit of a headwind, potentially a little bit into For worst case, we think that that headwind is roughly about 50 basis points in the back half of the year. And again, most of that will be felt in the Q3. 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 2022 to create some redundancy and to find alternate suppliers, multiple suppliers outside of Russia.

Speaker 8

So we feel good about our titanium supplies.

Speaker 11

Great. Thanks, Pito.

Speaker 1

Thanks, Pito. Yes. Katie, can we go to

Speaker 9

the next question in the queue?

Operator

We'll go next to Jeff Johnson with Baird.

Speaker 12

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 At least a nice step up from what we've seen kind of on a trailing 12 month basis.

Speaker 12

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.

Speaker 8

Yes, sure. Hey, Jeff, I'll take that. Suki again. I think the biggest driver was stone 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 ROSA placements versus outright sales.

Speaker 8

And consistent with prior commentary, we're seeing the majority Of our ROSA placements or installments, I should say, being done through the placement strategy versus sales. So that trend continues.

Speaker 12

All right, great. And then maybe just a follow-up just on backlog. I know you don't guide on backlog and any high level comments 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 2?

Speaker 12

Thanks.

Speaker 8

Yes, definitely felt it in the Q2 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. 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 a morphus, 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 20 24.

Speaker 1

Thanks, Jeff. Katie, can we go to

Speaker 9

the next question in the queue?

Operator

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

Speaker 4

Good morning. Thanks for taking

Speaker 13

the question. Congrats on the 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?

Speaker 13

And I had one follow-up.

Speaker 6

Absolutely, Larry. I'll take that one. 1st and foremost, we remain on track. We've sort of limited market release. We've been saying all along that by January Q1 of 2024, we'll be ready for a full launch.

Speaker 6

And I will say that we're almost there Again on the data, we are approaching 1,000,000,000 data points from multiple patients, thousands of implants by now. I'm really with answering 3 questions. Number 1 is, to your point, what is the value proposition? Can we demonstrate a reduction in the length of the episodic care? Can we bring objectivity to a range of motion metrics?

Speaker 6

Can we demonstrate better gait performance given better technique, better surgery? Can we compare the 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 1.

Speaker 6

Question number 2 in the limited market release is how do we make the whole thing seamless? This is new to the work 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.

Speaker 6

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 23 to submit. We're in the final stages on evaluating what the submission could look like.

Speaker 6

We're evaluating commercial payer 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.

Speaker 13

Luban, 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 needs what still needs to be done? And if you'll give any more color on the timeline, that would be great. Thanks so much.

Speaker 6

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 would 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 recoveries. So I love what we've seen.

Speaker 6

We've done our final validation labs with customers, both Friends and family customer 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 ROSA Soldier will have with the rest of the CBH ecosystem. So

Operator

We'll go next to Brian Zimmerman with BTIG.

Speaker 14

Hey, thanks for taking the questions. We all heard 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 Given some of the supply chain dynamics, I'm just

Speaker 6

wondering if you can kind

Speaker 14

of speak to that environment relative to recon and your expectations for durability of Its robustness, if you will, through the remainder

Speaker 15

of this

Speaker 14

year, similar to the recon environment.

Speaker 6

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 and hips.

Speaker 6

It was actually quite the opposite in EMEA. When it comes to SET, 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.

Speaker 6

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 we'll see Fluctuation given ASC, non ASC in the U. S. And then again different variables outside of the U. S.

Speaker 5

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

Speaker 14

Fair. That's helpful, Brian. And then 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, China is improving.

Speaker 14

What are your expectations for China growth as we've kind of lap as we start to lap the VBP impacts?

Speaker 8

Yes. So first of all, BBP is not a material driver

Speaker 2

for us

Speaker 8

at all in 2023. We sort of turned the corner on that between the end of 2021 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 VBP 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.

Speaker 1

Thanks, Ryan.

Speaker 8

Thanks.

Speaker 1

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

Operator

We'll go next to Mike Matson with Needham and Company.

Speaker 16

Yes, good morning. Thanks for taking my questions. Back to the SET business. So Brian called out kind of the subcategories there that seem to be the area So I'm focused, but the things I didn't hear or mention were lower extremities, I. E.

Speaker 16

Foot and ankle or trauma. So can you maybe just comment on why those were kind of left out of the comments?

Speaker 6

Yes, 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 versus a year ago. Here in the U.

Speaker 6

S, there were some contracts that we lost about a year ago. We're going to be seeing out of those. There were some product launches that were delayed, 2022 and 2023 that are coming out now. I will say that moving forward, given the better comps or U. S.

Speaker 6

And the contract capabilities now in the U. S. Along with innovation, the trauma business is now being in a better position. Pura and ankle is being one of the businesses, frankly, within set that we didn't prioritize. We wanted to prioritize upper extremities, SportsMed and CMST.

Speaker 6

That being said, I do think there is a couple of product launches that 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 now the key priorities within ZYNTH. Yes. And just

Speaker 5

to be clear, it doesn't mean that we don't see foot and ankle trauma and 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 CMFP and sports, they're very attractive. So we're going to focus our investment there. Now at the end of the day, the individuals running foot and ankle, trauma or restorative therapies put a plan in place that's attractive, They could become growth drivers.

Speaker 5

But today, we want to differentiate those growth drivers to non growth drivers,

Speaker 6

nothing against any of the categories.

Speaker 5

Just the plan right now is very attractive in those 3.

Speaker 6

And just on restorative therapies, I don't know restorative therapies It 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.

Speaker 16

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?

Speaker 5

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. 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.

Speaker 5

So it's impacting everyone. AAOS just did a survey actually with surgeons asking this question Across the board, regardless of who they were using, they were experiencing supply challenges. Really important thing

Speaker 6

for us is that's

Speaker 5

built into the guidance that Sufi just provided.

Speaker 8

So that's key. But when

Speaker 5

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 mix benefit and competitive conversions. We truly do believe if it was not a factor, We'll be getting more mix benefit, we'll be getting more competitive conversions because the demand is there. So it's frustrating when you 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.

Speaker 1

Thanks Mike. Yes, Katie, can we go to

Speaker 9

the next question in queue?

Operator

We'll go next to Robbie Marcus with JPMorgan.

Speaker 17

Great. Thanks for taking the questions and congrats on a good quarter. Maybe I could start on margins. If I take the Q3 and Q4 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.

Speaker 17

And then second question, I'll just throw in as well. You have a big gross margin benefit from currency in 2023. 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?

Speaker 8

Yes. 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 Q4.

Speaker 8

Q4 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 2nd 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 and 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 2 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.

Speaker 8

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 that continue to enhance that as we move into 2024. What are some of the building blocks? One, 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.

Speaker 8

And what's even more exciting about that is We're truly seeing very strong mix 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 and L into SG and 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.

Speaker 8

And so there's just those cultural shifts and that discipline is also driving some really nice margin expansion, 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 watermark for 2023 and grow it into 2024.

Speaker 3

Great. Thanks a lot.

Speaker 1

Thanks, Robbie. Katie, can we go to

Speaker 9

the next question in the queue?

Operator

We'll go next to Rick Wise with Stifel.

Speaker 18

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 4 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?

Speaker 18

And how do we think about the acceleration of that launch over the next year or 2? Thank you.

Speaker 5

Yes. 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 50% plus, 5 0% plus, so not just cementless. And they kind of do play off of each other.

Speaker 5

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.

Speaker 6

Yes. I would say, Rick, that it's early innings. Frankly, both for ROSA as well as Cementes. We are in what I It's not still a full launch for Cementes, given some of the supply constraints. I think as we exit 2023 early 2024, We'll have as much supply as we need to meaningfully drive the penetration of Cementes, with the goal of going from 15% to 50%.

Speaker 6

I Won't say when 50% is going to happen, but that's definitely the North Star. And we're also in the same situation. We launched 2 platforms, Sydney. We are about to launch ROSA partial this summer, a new and improved version of that. We're working actively on next generation Tolemy, which will be a meaningful launch going into 'twenty four.

Speaker 6

We got all kinds of CBH add ons, data technology solutions that are going to augment the penetration there. But I will say net net both for the ROSA CEMELIS and some of the peripheral launches around those two components, we are in the early innings.

Speaker 18

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. The Yvonne is doing a great job and the team is doing a great job With the pipeline and execution and driving the business forward, Suki is taking the financial organization in a positive direction. What are your priorities now as you look ahead to the next year or 2? Are you focused on efficiency, portfolio?

Speaker 18

What Just what are you thinking about and that we should hear about and ask about today? Thank you.

Speaker 5

Thanks, Rick. I mean, I'll kind of tongue in cheek say we're thinking Not 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 3 phases of the transformation of this company. Phase 1 is always going to be alive, but we're in great shape. Phase 2 is kind of what you just said.

Speaker 5

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 3 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, 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?

Speaker 5

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 direction. That's an area of focus not just for me, but for this entire team.

Speaker 18

Great. Thank you.

Speaker 1

Thanks for the question, Rick. Yes. Katie, can we go to

Speaker 9

the next question in the queue?

Operator

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

Speaker 8

Hi, good morning. Thanks.

Speaker 7

Good morning.

Speaker 6

Josh, do we still have you?

Speaker 7

You got electrocuted. Hope Josh is okay.

Speaker 6

Hey, Josh, it will

Speaker 1

be okay. We can go to the next one in the queue and then pull Josh back

Operator

And we'll go next to Jayson Bedford with Raymond James.

Speaker 1

Thank you.

Speaker 6

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

Speaker 8

It was about 1% erosion year over year in the second quarter. I think in the Q1, I think the average is somewhere around 1.2 for the first half of the year. We would expect in the second half for somewhere to be Between 100 basis points to 150 basis points of erosion. We're seeing really good traction there for the number of reasons that I've talked about I'd like previously, but again, I think the really exciting thing is we're starting to see that mix benefit come through from our new product introductions and Helping to offset even an improved price erosion profile.

Speaker 6

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 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?

Speaker 6

I'll start by saying that we have not seen anything new. All along, there were really 3 buckets that summarize the problem: materials, Label and sterilization. Augmented with frankly just poor 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.

Speaker 6

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.

Speaker 6

I mean, the challenge

Speaker 5

is 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.

Speaker 1

Thanks so much, Jason. Yes. Katie, can we go

Speaker 9

to the next question in the queue?

Operator

We'll go next to Kyle Rose with Canaccord.

Speaker 8

Great. Good morning, everyone, and

Speaker 10

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 I mean, I understand the positive tailwinds that you've outlined earlier, but how much have you truly been offsetting? And then I guess just trying to understand How much when you talk about supply chain challenges and increased unit costs and wages, are we still is there a potential to see a second shoe drop?

Speaker 10

And I'm just Kind of trying to understand as inventory turns flow through the business, if and when we'll actually ever see that impact through the P and L. And then secondly, Lots of talk about returning to a normalized operating environment. I think we all understand it's been a dramatic 3 to 4 years. But I guess just When is it fair to start thinking about when we will be in that more of a normalized operating environment, whether it's supply challenges the industry is facing, Staffing challenges, just how should we think about actually getting that back to

Speaker 6

that mid single digits? Thank you.

Speaker 8

Yes, sure. It's Kyle. Thanks for the question. So first on gross margin, from an inflationary standpoint, recall that we have about 100 basis Points from 2022 that's capitalized and hitting our P and L this year and we're seeing that come through. That's happening.

Speaker 8

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 shift 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 second is we've made the decision to actually pay incremental incentives to our commercial field sales force because we know How challenging it is out in the marketplace, dealing with these supply challenges.

Speaker 8

We've been incredibly impressed with how they've been responding. These are a couple of elements that are also flowing into the P and L. By the way, we're offsetting those and investing into business while increasing operating margin for this year. So the company 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.

Speaker 8

It's going to be nowhere near what we saw happen in 2022 and 2023. It will 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.

Speaker 8

That will 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.

Speaker 8

We'll see where we get to in 20 24. But once we do get to that sort of normalized growth, we do believe that we can sustainably hit that 4 plus or mid single digit growth profile that I talked about earlier.

Speaker 1

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

Operator

We'll go next to Matt Miksic with Barclays.

Speaker 15

Hey, thanks so much for squeezing me in. So just a couple of follow ups. 1 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 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.

Speaker 15

Thanks.

Speaker 8

Yes. So the margin is 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, etcetera. So, again, I don't know that that's the right reference point.

Speaker 8

What I can tell you is that 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 Feel good about where we are and where we're headed moving forward. Sorry, your second question was around? Yes. Yes.

Speaker 8

Yes. Let me just Milan, do you want to take that?

Speaker 15

Sure. Just a follow-up on PersonaIQ. I think the number, I think maybe that was mentioned earlier was something like 1,000 implants. I mean, that's a pretty it's a pretty small percentage of total, maybe 1%, less than 1% of your total implants a year. And I just want to get a sense of at what level do some of the data start coming through?

Speaker 15

Is it a couple of 1,000 implants? Is it 3000 to 5000 implants. When do you expect to start seeing some of the results you mentioned earlier in the call? Thanks so much.

Speaker 6

Yes. 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.

Speaker 6

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 going forward? This is going to be a flagship product for Zimmer Biomet. We plan to see meaningful penetration of this technology, First in NEIS, then in HEETS, and then at some point in SOLIDERS as well. What's the right penetration?

Speaker 6

Again, we won't disclose that, but given the unique technology, We will leverage this to the fullest.

Speaker 1

Thanks, Yvonne. And Matt, thanks for your question. I think we're almost at the bottom of the hour. I'll I'll turn it over to Brian just for some closing remarks.

Speaker 5

Just maybe a quick summary too on what you were just talking about Sooki. When we think about A normalized market. And we're saying 2024 in our view is not going to be normalized for 2 factors. You're still going to have backlog that we're going 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.

Speaker 5

And the second one is supply. 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, could look a lot like a normal year from a growth perspective. I just want to make sure that that's clear.

Speaker 5

I was 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 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.

Speaker 5

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 3 of the transformation. And the innovation pipeline as Yvonne continues to talk about is as strong as it's ever been and

Speaker 8

that gives us the ability

Speaker 5

to drive mix benefit, pricing stability and competitive conversions. 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.

Speaker 6

Okay. With that, I'll go ahead

Speaker 5

and close it out and thanks for joining

Speaker 1

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.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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