Enovis CORP Q4 FY2023 Earnings Call

Good morning, and welcome to the Enovis Fourth Quarter 2023 Earnings Call. Please note this event is being recorded. I would now like to turn the conference over to Kyle Rose, VP, Investor Relations. Please go ahead.

Good morning, everyone. Thank you for joining us today for our fourth quarter 2023 results conference call. I'm Kyle Rose, Vice President of Investor Relations. Joining me on the call this morning are Matt Trerotola, Chair and Chief Executive Officer; and Ben Berry, Chief Financial Officer. Our earnings release was issued earlier this morning and is available in the Investors section of our website enovis.com. We will be using a slide presentation in today's call, which can also be found on our website. Both the audio and the slide presentation of this call will be archived on the website later today. During the call, we'll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward-looking statements are subject to risks and uncertainties, including those set forth in the safe harbor language in today's earnings release and in our filings with the SEC. Actual results might differ materially from any forward-looking statements we make. The forward-looking statements speak only as of today, and we do not assume any obligation or intend to update them, except as required by law. With respect to any non-GAAP financial measures referenced during the call today, the accompanying reconciliation information relating to those measures can be found in our earnings press release and in the appendix of today's slide presentation. With that, let me turn it over to Matt, who will begin on Slide 3.

Thanks, Kyle. Hello, everyone, and thanks for joining us today. 2023 was a year of significant progress toward our long-term strategic goals, and I'm excited about the future of our high-value med tech growth company. We had a terrific year with continued share gains across geographies and business units, strong execution on new product initiatives, solid margin expansion, and truly transformative acquisitions. We completed the year with total revenue growth of 9%, which included 8% organic growth, right in line with our high single-digit strategic goal. Our talented team continues to develop exciting technologies and solutions that improve patient outcomes and satisfaction around the world. In Recon, we made considerable progress expanding this high-growth and high-margin platform and drove full year organic growth of 14%. We delivered double-digit organic growth across all major segments, continued to win in the ASC in the U.S., and had strong execution internationally as we continue to ramp our very successful 2021 Mathys acquisition. We also closed the year with the strategic acquisition of Lima that step-changes our Recon business starting in 2024. In P&R, we've been reshaping the business for sustained mid-single-digit organic growth. In 2023, we once again outgrew our markets with full year organic growth of nearly 5%. We improved innovation vitality in this business from close to 0 in 2018 to double digits as we exit 2023, and have a strong pipeline for 2024 and beyond. We also made good progress on margins in 2023, improving our EBITDA margins by 70 basis points, more than offsetting growth investments and headwinds from M&A currency inflation. Our gross margin improvement is a result of our mix-enriching strategy and the powerful impact of our EGX business system driving operational productivity and pricing improvements. And finally, we continue to accelerate our growth through focused M&A. Our acquisitions from the past few years grew double digits and started to scale. We expanded geographically and enhanced our innovation capabilities with Lima and NovaStep, and we continue to follow our proven EGX playbook to ensure each acquisition delivers strong strategic impact, financial contributions, and long-term shareholder returns. And they bring great talent into our company. Let's go to Slide 4 and talk about how we finished the year. We grew organically by 8% in the fourth quarter, with 11% growth in Recon and 6% growth in P&R. We continued our trend of double-digit growth and share gain in Recon as our markets had normal seasonality. We believe the elective surgery markets we serve remain healthy, with higher-than-normal procedural demand in early 2023 and the potential for above-normal demand again in 2024. In P&R, we had another strong quarter, showing our reestablished leadership in these markets with global share gain and a stable market environment, plus a bit of tailwind from the light prior year comp. We expanded our gross margins by 150 basis points, reflecting continued impacts from productivity, mix, and the scaling of recent acquisitions. Overall, we exited 2023 with strong momentum in line with our strategic goals and are excited for a great 2024. Digging a little deeper in Recon, on Slide 5, we had double-digit growth in the U.S., led by 11% organic growth in Hip & Knee as well as Extremities. Outside the U.S., we grew 11% organically in a resilient market. I know there are a lot of 11s on the page, trust me it's just a coincidence. We have a very strong Recon innovation pipeline that will allow us to continue to gain share. We're off to a great start on the ramp of our EMPOWR Revision Knee, and we've also launched an updated Arvis 2.0 with full EMPOWR capability. Additionally, in Foot & Ankle, we recently launched the Evolve34 Lapidus Correction System for bunions, one of the fastest-growing market segments in the U.S. We've had terrific feedback from surgeons on all of these great new products. In P&R on Slide 6, our organic growth reflects a healthy market environment and disciplined execution, albeit against the easiest comp of the year. Overall, this business is performing in line with our strategic plan, with global bracing driving share gains from strong customer service, improved innovation, and MotionMD clinic conversions. Here, too, our pipeline is strong and includes a new OA brace called ROAM and the next generation of clinical electrotherapy products for our Recovery Sciences team. Gross margins in this segment expanded by 240 basis points as we continued to sustain traction on price versus cost and roll out additional EGX tools, which are driving consistent productivity improvements. On Slide 7, I want to pause and quickly highlight our significant progress in our first 2 years as a stand-alone med tech player. We continue to execute on our strategic pillars and have quickly built to consistent high single-digit organic revenue growth. We've also delivered operationally with EBITDA expansion ahead of our annual commitment of 50 basis points, even with headwinds from inflation and dilutive strategic acquisitions. 2024 is setting up to be a transformative year for Enovis as we integrate Lima and execute on major new product launches. We are confident in our ability to continue to drive this compounding growth and margin formula. On Slide 8, we highlight several of our key new products for 2024, many of which were on display at last week's American Association of Orthopedic Surgeons Conference in San Francisco. It was great to see the teamwork at our booths between our Enovis team members and the talented leaders who have joined us with Lima. I'm excited about the lineup of new products for 2024, and our R&D pipeline for the next several years is more robust than ever. On the Recon side, we continue to make substantial progress with the rollout of our EMPOWR Revision System. This gives us access to almost 20% of the knee market that we could not previously access, an opportunity to sell deeper into existing surgeons and also to continue to drive conversions. The late 2022 launch led to very strong Knee growth in 2023, even with inventory constraints and without cones for more difficult cases. We enter 2024 with healthy inventory and recently received 510(k) clearance for Lima's 3D printed trabecular titanium clip cones for use with our EMPOWR Revision System, quickly enabling one of our first major cross-selling opportunities. Arvis 2.0 continues to get positive market feedback after the launch in Q4. This breakthrough enabling technology gives our knee and hip surgeons a space, time, and cost-efficient solution for repeatable procedures and interoperative data capture. The 2.0 version brings a simplified procedural workflow and registration process to provide the physician with a unique wearable navigation system suited for all operating settings from the ASC to a hospital. This is our first step in interoperative enabling technology. We plan to bring Arvis to additional anatomies shortly and also have an exciting pipeline beyond Arvis. Our Foot & Ankle business also continues to execute well with a powerful boost from the acquisition of NovaStep in mid-2023. We have one of the most compelling product portfolios in the market and are excited about our expansion into the $1 billion fast-growing 4-foot segment, where we've recently launched the Evolve34 and Pecaplasty systems. These products give our teams the most comprehensive suite of technologies for the bunion indication, including MIS approaches. In P&R, we formally launched the ROAM OA single upgrade brace for patients with osteoarthritis at our sales meeting last month, and the feedback has been very positive. The single upgrade category is a sizable growing segment where we have limited share. The simplicity and comfort offered by ROAM will be meaningful differentiators for patients and clinicians, and we expect to capture significant share through our powerful channel and clinic presence. And we continue to build momentum and vitality in our Rehab business with the global launch of our next generation of electrotherapy products, Intelect Legend and Transport. These bring freshness for our very strong Chattanooga brand in the largest global rehab treatment modality segment. Turning to Slide 9. I want to take a moment to remind everyone of the powerful strategic and financial impact of our Lima acquisition, which closed the first week in January. The addition of Lima represents the next step in the evolution of Enovis as we execute against our strategic goals as a high-growth med tech innovator with a clear pathway for sustained operating margin expansion. The transaction reshapes our mix to faster-growing, higher-margin recon and increases our exposure to the fastest-growing parts of the recon market and extremities. We took advantage of the opportunity to do significant planning before the acquisition closed and really hit the ground running in January, with the new combined leadership team and a robust integration process in place on day 1. The feedback from customers has been very positive, and we're already gaining strong traction on both cost and growth synergies. It's been really exciting seeing our teams come together and start to shape global innovation roadmaps that leverage our combined technologies. We remain confident in our ability to deliver the 2024 financial benefits previously shared and exit the year with strong double-digit organic growth momentum across all of Recon. I look forward to giving you additional updates throughout the year. Moving to Slide 10. Before I hand it over to Ben, I want to reiterate my excitement about the momentum we built in 2023 and the great opportunities we have in 2024 and beyond. We have a diverse global business, a talented and energized team, and a powerful business system that we will continue to use to drive our compounding value improvement journey. Now I'll let Ben take you through the P&L details and our 2024 guidance.

Thanks, Matt. Hello, everyone. And as Matt said, we'll start on Slide 10. We're pleased to report fourth quarter sales of $455 million, up 11% versus the prior year, 8% organic growth. The growth was fueled by strong demand for our products and solid commercial execution in both business segments. Fourth quarter adjusted gross margin was 58.6%, up 150 basis points year-over-year. Growth was driven by leverage from higher sales, favorable product mix, and cost discipline. We continue to leverage our EGX business system to drive productivity in the supply chain, and the results continue to read through in our gross margins. Fourth quarter adjusted EBITDA margin of 18% was down 30 basis points versus 2022. The year-over-year decline was driven by one-time cost benefits in 2022 and some dilution from recent acquisitions. But results came in as expected with a strong sequential step-up to finish the year. The fourth quarter's effective tax rate was 22%. This is compared to 22% last year. Interest expense was $4 million in the quarter, versus $5 million in 2022. Overall, we posted strong adjusted earnings per share of $0.79, a 10% earnings growth versus the prior year. For the full year 2023, we delivered high single-digit organic growth of 8%, expanded our adjusted EBITDA margins by 70 basis points, and produced double-digit underlying earnings growth. We continue to strategically shape our business mix to Recon and utilize our EGX capabilities to scale and drive leverage across our business segments. We're delighted with these results and the momentum we've built in 2023. I would like to take a moment to thank and congratulate the entire Enovis team for delivering another strong year. Slide 11 lays out our execution in 2023 relative to our guidance over the course of the year. We were able to deliver results consistent with or better than our commitments to stakeholders, and we look forward to managing our business for more of the same in 2024. Moving to Slide 12. It details our quarterly progression in 2023. Our 8% revenue growth was highlighted by 14.3% in Recon and 4.6% in P&R. With notably stronger results in the first half of the year driven by strong Recon markets and some softer prior year pandemic-related comparables. Overall, our results reflect underlying share gains in both of our businesses. Our adjusted EBITDA margins increased sequentially throughout 2023 as we improved mix and demonstrated operating productivity in our supply chain. Impacts from recent acquisitions and foreign currency offset our core margin improvement of 130 basis points. However, for the year, we managed to improve margins by 70 basis points while managing external headwinds and investing for future growth. Turning to Slide 13. In 2024, we are projecting another strong year of operating performance and expect revenues in the range of $2.05 billion to $2.15 billion. We expect another year of double-digit growth in Recon against a normalized market backdrop, and stable P&R growth in the low to mid-single digits. Our expectation for Lima remains consistent with prior revenue guidance of $290 million to $300 million. On margins, we are expecting at least 50 basis points of underlying margin improvement in the core business, along with $70 million to $75 million contribution from Lima, resulting in an estimated range of $365 million to $380 million of adjusted EBITDA. From a phasing perspective, we expect revenue and margins to follow a similar sequential trajectory over the course of the year, like we experienced in 2023. Depreciation is expected to be in the range of $115 million to $120 million, driven by growth investments in our Recon segment and the addition of recent M&A, including NovaStep and Lima. We expect interest and other expenses to be in the range of $70 million to $75 million. Considering the impact of Pillar 2 and the composition of Lima revenues and profits, we expect an adjusted tax rate of approximately 21% in 2024. We note that this represents a $0.03 headwind to adjusted earnings per share. Along with these estimates, we expect a share count of approximately 56 million shares and are forecasting our adjusted earnings per share to be $2.50 to $2.65. Overall, we are excited about our opportunity to create strong shareholder value in 2024. To summarize, on Slide 14, we had another strong year in 2023 and have been building solid momentum as we turn the page to 2024. We have demonstrated clear focus and execution towards achieving our strategic goals and have shaped the business towards accelerated growth and scale with the acquisition of Lima.

The first question is from Vijay Kumar with Evercore ISI.

Congratulations on the impressive results. Matt, regarding my first question about the Q4 performance, the double-digit Recon growth is quite solid. However, when I look at the market, it seems your competitors also had a strong Q4. While I don't want to diminish your achievements, it feels like the market has accelerated, and the gap between your performance and the market's may have narrowed. I'm curious if there were any timing factors involved or if the 11% Recon growth in Q4 met your expectations.

Yes, Vijay, I think we finished in line with our expectations. I think you really have to look at the multiyear numbers to kind of see the picture a little bit clearly. We've had kind of strong comp, and even if you go back to the 2019 comps, you can see that the pattern from Q3 to Q4 is a quite normal one and that some of the differences in sequential patterns kind of come out the wash when you look at the multiyear views.

Understood. And Ben, one for you. The margin expansion, I think I heard you 50 basis points for core, maybe 75 for Lima. But I thought Lima was supposed to be 150 basis points accretive to gross margins. So I'm curious, are there any OpEx assumptions that are different, why the gross margin accretion should slow down to operating margins, and the cadence of that $40 million cost synergies that's assumed in the guidance?

Yes, Vijay, I mean, everything is coming in relatively consistent with what we kind of expected in terms of the overall numbers. There's a little bit of shifting as you think about the translation of U.S. GAAP versus IFRS. So that's probably kind of 1 area where maybe our assumptions between gross margin and OpEx kind of flipped a little bit. But overall, still fully in line with kind of the thoughts that we had in terms of the profit that we can generate in year 1, which would assume some cost synergies that we get after right away, but still very much confident in the pathway to $40 million by year 3.

Understood. Matt, I have a quick question about the Lima integration. You previously provided some insightful comments. However, I recall you mentioned that the guidance takes into account some disruption from the integration. I'm interested in learning about the early experience. Are the disruptions aligning with your expectations or perhaps deviating from the plan? That would be helpful to know.

Yes. As we mentioned, we have included Lima numbers in our guidance for this year, as we announced when we secured the deal. We have been actively planning and beginning the integration processes in various markets worldwide. Our aim is to minimize any disruption as we bring everything together. We understand there will be some, but our goal is to keep it to a minimum. We remain confident in the guidance we provided regarding the expected impact. It is still early, and we are working through the integration.

Next question is from Xuyang Li with Jefferies.

I guess to start, I wanted to hear a little bit about just the new product cycle that you mentioned earlier, multiyear cycle. It seems like some attention is being paid on enabling technologies and Foot & Ankle. But I wanted to hear a little bit more about specific areas and what are some of the white spaces you're looking to fill or improvements made on existing products?

Yes, thank you for the question, Yang. As we mentioned, we are currently in a phase where we are experiencing ongoing momentum from last year's launches as they progress, along with exciting new launches planned for this year and next. This creates a healthy environment for enhancing our business vitality. In the Recon sector, we are maintaining a strong focus on vitality, now supported by enabling technology like Arvis, which was launched late last year for the knee and hip markets. We also see opportunities to introduce more enabling tech into various anatomical areas throughout this year. On the P&R side, we've transitioned from a period of low activity to one where we are experiencing significant growth, having launched several successful bracing products over the past year that are gaining traction. Furthermore, we have more launches planned for this year and the next, including new knee segments and advancements in the spine bracing market, as well as some extremity braces. This presents a promising lineup for our bracing products. In terms of Recovery Sciences, we are focusing on our largest category, electrotherapy, which has lacked innovation for quite some time. We are introducing some exciting new products in this area. Overall, it’s a promising period for us, and while we are seeing positive contributions now, we anticipate even stronger results as we progress through the second half of the year.

All right. Great. Very helpful. And then I guess a follow-up, just, I guess, more specifically on Arvis 2.0 and AR in general. It's been getting a lot of attention from surgeons. A lot of times when we ask them just broadly, what are you excited about, AR comes up pretty frequently more often than not. I guess from your perspective, how's the receptivity been on the surgeon side? And what do you think is needed to make it more of a mass market product?

Thank you for your comments. We are receiving similar positive feedback. Surgeons are excited about AR because it helps them implement surgical plans more effectively during procedures. They want to make informed decisions, collect relevant data, and perform surgeries efficiently while marketing advanced technologies. Importantly, they do not want to increase costs or time for the procedures, and AR appears to be an ideal solution since it provides inter-operative guidance with minimal impact on costs and time. We have received excellent feedback from both past and new surgeons who have joined us because of Arvis. Feedback indicates that the improvements implemented since last year's launch have enhanced usability. This is a groundbreaking technology in our industry, and as we continue to navigate the learning curve, we are getting positive responses regarding the usage of the 2.0 version. We are eager to expand its application in the knee and hip areas and are actively exploring its potential in the shoulder anatomy, confident that AI can be as impactful there as it has been in the knee.

The next question is from Vik Chopra with Wells Fargo.

Sorry, I was on mute. Thanks for taking the questions, I had 2. So maybe the first one is just on the state of the market. How long do you expect above-market growth for Recon? And maybe just talk about your expectations for 2024?

Yes. Thanks for the question there, Vik. Look, I think we've consistently said that if you look at the math back to '19, there's 1.5 years of growth missing for the market, and maybe we worked off a little bit of that last year with some of the above-market growth. But I think there's definitely a fact base that suggests that there should be some pent-up demand around the world for surgery because the patients continue to need it but there was a period of time when less surgery could be done. So we still believe that there's more pent-up demand to come. We saw some of it last year. And we really saw last year was that there were periods of the year where capacity utilization was able to go to very high levels. In the U.S., it was early in the year. There was just a very good period there early in the year where I think surgeons were able to really kind of run at the upper end of their capacity utilization. There are certain countries around the world that consciously opened up capacity utilization early in the year. And when that happened, we ran above normal rates. So I think that certainly last year had at least a point or 2 of extra growth in the elective surgery, orthopedic surgery area, from a market standpoint. You can see that extra in our very strong 14% growth for the year. And certainly this year, if we hit periods where you have that extra utilization opportunity in the marketplace, there should be an opportunity for that above-normal type of demand as well. We planned for a normal Recon growth year. And then you can see we've guided double-digit growth again in light of a normal Recon growth year. There's certainly the opportunity for more. And certainly, the shape of the year is going to mirror last year because there's some very, very tough comps early in the year. And so the growth is going to build through the year just in terms of the market environment, and then for us, we'll also have the ramp of the innovation pipeline.

And just sticking to the same theme maybe, just a follow-up question on GLP-1s. Are you starting to see an impact of patients coming into the funnel?

Yes. I mean certainly, we have heard from the marketplace an expectation that there can be more patients in the funnel due to weight loss that could come from GLP-1. I wouldn't say that it's a meaningful effect at this point. But we continue to have the same view that we've stated that, for our portfolio overall, likely that's over time more of a slight positive than a negative. But I wouldn't say that it's having any meaningful impact at this point in time.

The next question is from Brandon Vazquez with William Blair.

Maybe first, can we focus on Lima for a second? Just wanted to go through, you mentioned a little bit on the revision side, you've already started to cross-sell kind of the cone from Lima. But can you remind us maybe what are the biggest products that you can take maybe from your U.S. organization over into the international markets with Lima, and then vice versa? And maybe what are the milestones for these products through 2024?

Yes. I think there's great cross-selling opportunity with Lima, and even quite a bit left to go with Mathys that we acquired a few years ago. If we start from the shoulder, our market-leading AltiVate shoulder is the lateralized design of reverse shoulder, which has become very strong here in the U.S. and is starting to build more and more momentum outside the U.S. We see a nice opportunity to sell our AltiVate reverse shoulder in certain markets outside the U.S., while at the same time Lima has got a few different shoulder designs, one that is a little different design that we reversed, that will set up for surgeons that want to stick with a little bit less lateralized design. But then they also have this SMR, which is a convertible platform that really has been something that is very good for some of the more tough indications, enabling surgeons to make interoperative choices between an anatomic and reverse, or to go back to an anatomic after the fact and convert to reverse. A really nice complementarity in the shoulder portfolio, taking the AltiVate outside the U.S. and bringing some of those technologies Lima has for some of the toughest revisions in shoulder into the U.S. Kind of a similar picture as we get over into the knee space, our EMPOWR 3D with its dual pivot capability has shown to be a better need that leads to better patient satisfaction. In the U.S. and in the places we've taken it outside the U.S., there's been a lot of excitement about that need. But we have not had as much of a focus on revisions. We've been just moving into revisions here in the U.S. Lima has not had the strongest primary need but has been very strong in revisions around the world, including a little bit of traction here in the U.S. And again, just a perfect opportunity to cross-sell great products from here to there. Lima is excited to start to bring our enabling technologies with Arvis into the business. We're very excited about the 3D printing. Promade is a custom 3D printing capability that at this point is used on some of the very toughest revisions and situations, but over time could have some good broader applicability as well. So a whole set of cross-selling opportunities. We've been able to hit the ground running in terms of having plans in place and, in some cases, already having the market access to start to pursue those cross-selling opportunities and, in other cases, having active initiatives to go ahead and get the additional market access.

Great. Regarding the EBITDA margin guidance for the year, if I exclude some of the benefits from Lima, it suggests that EBITDA margins for legacy and NovaStep will increase by about 80 basis points year-over-year. Am I correct in this calculation? If so, what is giving you the confidence to achieve another strong year of legacy margin expansion despite potential challenges from the integration of Lima?

Yes, thanks, Brandon. I mean I think the way that we're thinking about it is we continue to execute our strategy of driving good mix improvement in the business, continuing to scale acquisitions that we've done, and then generating operating leverage into the plan. So as we think about it, we remain consistent in terms of feeling our confidence around generating at least 50 basis points or more of core margin improvement while we add on Lima and do the work to integrate that at a high level. So overall, we feel confident with the guidance that we've put out there, and we feel that's a good kind of strong step-up year for us in terms of overall margins with the addition of Lima.

The next question is from Caitlin Cronin with Canaccord Genuity.

Congrats on a great quarter. Just starting with 2024 revenue guidance, the 7% core business growth really kind of implies a slight slowdown year-over-year. What are really the expectations that are built into this?

Yes. I think I wouldn't really look at it as a slowdown in terms of our performance versus the market. I think it's sort of broadly accepted that the recon market had at least 1 point or 2, maybe 2 or 3 points, of tailwind on it last year. And then we also, on the P&R side, had some extra price that we know it's going to start to moderate. The 7% guide is pretty similar relative growth performance versus the markets, but also it's consistent with our approach of trying to be a little conservative in terms of how we're creating our plans and how we're guiding as we come out of the year until we see how the market is going to unfold a little bit in the early parts of the year.

Got it. And then you said earlier, similar cadence sequentially throughout the year versus last year, but Q1 was particularly strong in 2023. Do you kind of expect that similar strength in Q1 this year?

Yes, Caitlin, I think in terms of my comments there, as I think about kind of the percentage of the year, in terms of what Q1 was of the full year in terms of revenue and EBITDA. That's kind of what the comments I was trying to convey in my commentary, is we think kind of what we've seen in 2022 and 2023 is kind of a new normal kind of seasonality that we'll see. So if you kind of do the math and look at how 2023 played out and look at kind of the percentage of each of those quarters, that's kind of how we're thinking about providing the guidance of quarterly movement.

Got it. That makes sense. And then just one more quick one. The $40 million of cost synergies for Lima by year 3, what does that really look like in years 1 and 2, and where do you really see most of the effect down the P&L?

I will begin by discussing the first year. When we established our guidance after announcing the deal, we projected EBITDA of $70 million to $75 million, which includes some of the immediate synergies we can leverage. In terms of cost synergies, we are focusing on areas where there is duplication or overlap. For instance, we no longer need to pay for separate booths at events now that we are combined as one company. Additionally, we are experiencing some overlap in leadership, enabling us to make swift decisions. This allows us to realize some synergies early in the program, which I estimate to be in the range of $5 million to $10 million for the first year, increasing to around $40 million by year three.

The next question is from Danielle Antalffy with UBS.

Congratulations on a strong finish to the year. I have a question regarding the competitive landscape. A competitor recently announced the approval of their robotic solution for shoulder procedures. I'm interested in understanding what aspects of potential competition you have factored into your guidance for the robotics segment. Additionally, could you provide an update on the progress of your own robotic solution?

Yes, sure. I mean, first, I'll say, our guidance contemplates the full competitive environment that we're in right now. In Shoulder, we're a leader in Shoulder; we've been an innovation leader in Shoulder for many years. We've got the best shoulder implant in AltiVate with the longest data, and also we've got continuing innovation that we've done around that. Enabling tech has been a significant force in shoulder for a while. We've had an industry-leading mass point solution for creating preoperative plans being able to then feed them into the surgery, being able to do patient-specific instrumentation to find the glenoid volt in difficult cases. We have also been a leader in enabling tech in Shoulder for many years. That ability to kind of do pre-surgical planning and use patient-specific instruments is something that's been around for a while in shoulder and is well used and part of what's enabled us to continue to succeed. We definitely see opportunities over time for additional enabling tech in Shoulder. We've made significant investments as a company in augmented reality as well as predictive analytics. We can see opportunities to take what is already quite valuable to shoulder surgeons in terms of the preoperative planning and some of the patient-specific instrumentations. Simplify the workflow of that with augmented reality guidance and predictive analytics and create the next step change in terms of workflow in the shoulder, and do it in a cost-effective and space-efficient way that I think there's quite a bit of excitement about over on the knee side as we're bringing Arvis into that. So we're confident that, as the year plays out, we will remain a technology leader in Shoulder and that we'll have the right offering at the right time.

Okay. Great. And then on Lima, I know your guidance for Lima sales includes some exits of product lines, et cetera. Have you guys confirmed where you're exiting yet? Or how should we think about that transpiring over the year?

Yes, this is something that will unfold throughout the year. We have stepped back from some smaller revenue streams because they were not particularly appealing. Most of the revenue impact we've accounted for this year relates to our approach of working country by country and aligning channels, which sometimes requires tough choices that can lead to a loss of revenue. We expect to start seeing some of this impact in the first quarter, but not significantly. In the coming quarters, we anticipate observing the remainder of the overall impact for the year. We are making strong efforts to minimize that and to identify additional synergies. Each instance of breakage presents an opportunity for synergy on the opposite side, typically. There is some uncertainty regarding the timing and how quickly breakage can be offset by synergy. However, we are confident in the guidance we've established regarding Lima's revenue.

Yes. Danielle, I would just pile on that and say that as we think about how Lima strengthens the overall portfolio and the registration environment around the world, there's not going to be any kind of major product line discontinuation. We're going to make the full portfolio available to our customers. Over time, we're going to continue to refine that and strengthen it as we drive new innovation, as we get registrations cleared in certain countries, and things like that. So I wouldn't expect any kind of major gaps or discontinuations in product line in the near term. There are some kind of choiceful things, as Matt said, that we'll be doing kind of in the near term. Overall, I think this only strengthens our portfolio in terms of our ability to serve customers.

The next question is from George Sellers with Stephens Inc.

Maybe just switch to the P&R segment. You mentioned a few new launches there. Could you just parse out that low to mid-single-digit growth? What's assumed from the new launches, maybe what's assumed from pricing? And then just from an underlying market growth perspective, what is all baked in?

Yes. I mean, looking at last year, it was a pretty normal P&R market overall with maybe a tiny bit of tailwind in the market, but not as significant as on the Recon side, but a healthier price environment in terms of recovering some of the inflationary pressure from the previous years. When you look at our growth that was pushing 5% on a full year basis, that's a little elevated from what we envisioned being able to do on a go-forward basis in that business. We've got 1% or so of price that we expect to more flatten out and probably a little bit of tailwind there was in the market last year. We still have a P&R long-term view in the sort of 3% to 4% range, which would reflect getting into a more normal price environment. As the innovation that we've been talking about continues to ramp its way through the business, that's how we can kind of push towards that 4% realm we have shown consistently over the past few years, but with a little extra price into it. We're still guiding it in the 3% to 4% range. We're still working on making it something that we can guide in the 4% to 5% range.

Okay. That's helpful. And then maybe on margins. You talked about a little about price and then also with the new product launches. How should we think about flow through to margins? I think some of the EXG initiatives, as you've been developing some of these, are maybe driving some more attractive margin profiles with these new devices. But just curious, for this segment specifically, how should we think about margins progressing through this year and beyond?

Yes. Again, George, I think from a PR perspective, I think that's your question. What Matt said is we continue to look at how do we drive shaping moves within that portfolio, focusing on higher-margin products. It would be around continuing to try to drive some improvements in the mix of the business within P&R, driving some leverage on the growth that we're getting while continuing to drive good behavior and productivity within the supply chain there. Overall, we see it to consistently increase margins year-over-year.

The next question is from Mike Matson with Needham.

This is Joseph on for Mike. I will start with a question on Arvis. Could you maybe remind us all how you guys expect to sell the product? I guess, will this be a direct source of revenue? Will you use it to drive implant sales indirectly or some combination of both?

Yes, sure. So far, we are primarily placing Arvis as CapEx. It has a relatively low cost. In most of the places we put Arvis, we've placed it there, and we're getting a recurring revenue stream on that on a per procedure basis, which we've been able to get on contracts at rates consistent with some of the other enabling tech devices out there. In some cases, where we placed it, it's one of our existing surgeons, and it's a way to strengthen and deepen our relationship with them. In other cases, we've been able to convert surgeons and get new implant sales with it. We're tracking both the way that we ramp the recurring revenue there with placements, the way that we ramp the recurring revenue there, but then also the pull-through revenue on implants where we bring it into competitive environments. We expect it to contribute in all those ways. We have also been able to very successfully sell it as capital, and we'll make thoughtful decisions about when it's better to sell it versus place it. One of the real advantages that we have with Arvis is that it is a primarily software-based solution. There is not a very large cost related to placing it or selling it. That gives us a lot of business model flexibility. I think in a health care environment where there's a lot of pressure on the system around health care economics, I think that over the next couple of years you're going to see a lot of excitement, as was mentioned earlier in the call, around augmented reality, even mixed reality, as a way to really bring some of the real marketing benefits as well as the procedural benefits of enabling tech in knee and then other anatomies, while at the same time being much more cost-based and time-efficient.

Okay. Yes. And then maybe just one on Lima. In the quarter, could you maybe give us some color or tell us what Lima's gross margin or operating margins were in the quarter? Just given that the ongoing integration of Lima, could you maybe talk about your outlook for M&A? Can we assume that some deals may be on hold as you guys continue to integrate the Lima?

Yes. Let me share my thoughts. Firstly, Lima is aligning with our financial expectations. They wrapped up the year with strong growth and a solid margin profile. As we developed our plan for 2024, we were able to incorporate the expected Lima revenue, profit, and margin impact seamlessly into our existing strategy. We are very confident about this based on everything we have learned and the initiatives currently underway. We feel optimistic about the initial phase with Lima and the anticipated improvement in our margin as we move forward. Regarding acquisitions, we have a considerable workload ahead this year to ensure Lima's success. We are gradually capitalizing on the Foot & Ankle acquisitions we've made, and even the laser acquisition from a few years ago is still being fully leveraged. We are actively working to maximize the benefits from our recent acquisitions. Additionally, we have some financial flexibility for appealing strategic bolt-on acquisitions, and the current environment is conducive for such deals. We have a robust pipeline of opportunities, but we will be selective in 2024, focusing only on the most strategic ones that fit within our financial framework and operational capacity. Meanwhile, we will also pursue medium or larger opportunities for 2025 and beyond, but only after we achieve a successful integration of Lima and improve our balance sheet.

Great. Congrats on the quarter.

The next question is from Dane Reinhardt with Baird.

Maybe just 2 kind of follow-ups at this point in the call. The first one, though, kind of on the revenue guidance. If we just take out Lima, can you just kind of help us level set kind of what other factors you're expecting in there as it relates to FX? I think you still have some contributions from NovaStep and SEAL in there. It looks like you also pointed out some selling day impacts in the slide deck. So just help us kind of frame all those things together.

Yes, Dane, thanks. The guidance range that we've put together contemplates the factors that you mentioned, which again, I think from an underlying core business growth, we're kind of seeing around 7%. Right now, if you look at kind of where currencies are, we would say that's kind of relatively flat in terms of the impact outlook for the year. You've got kind of within the guidance there, the full contribution of both NovaStep and Lima as well. So overall, kind of feel like all the components are there and kind of fit within the guidance that we gave.

Okay. Sounds good. And then the second one, just kind of a follow-up on Vijay's point regarding the Hip & Knee growth, I think 11% this quarter, relative to 18% last quarter. I think your prior year comp from last year actually eased a little bit. So, I mean, just anything else that we can kind of point to regarding that comp-adjusted slowdown, either from a competitive standpoint or potentially end markets?

Our Knee growth continues to drive the overall Hip and Knee growth figures. While we're experiencing solid growth in hips, the Knee segment remains particularly strong. We've already seen some strong contributions from the Revision launch, which has impacted the Knee growth a bit, resulting in a slight deceleration from Q3 to Q4. The market conditions changed from the first half of last year being elevated to more normal levels in the second half. However, quarter to quarter, there will be some fluctuations, but our focus remains on achieving full double-digit growth annually and aligning our growth with market trends across all segments we have committed to discuss.

The next question is from Jason Wittes with Loop Capital.

ROTH MKM, but that's okay. So just some follow-ups at this point as well. First off, in terms of just the margin expansion this year, can we assume most of that is in gross margin? And there are some offsets in SG&A? Or how do we think about how to model that for 2024?

Yes. I mean I think I would say that, yes, you're thinking about it right in terms of how the composition happens here. Again, we'll work through that as we get the full integration of Lima into the organization. But again, in terms of the kind of the macro level picture, again, we see really strong EBITDA margin improvement lifted by adding Lima plus getting the core expansions that we've also talked about. Overall, we would say a lot of that comes from gross margin, but then we'll kind of see how it all plays in as we start to integrate Lima.

Okay. That's helpful. In terms of modeling, I understand you haven't specified details for '24 until now. You mentioned that Lima would be accretive, which it is. However, looking at how I model it, even consensus shows that EBITDA is significantly better, which is great. On the other hand, EPS seems a bit lower based on guidance. I assume this is largely due to interest rates, or are there other factors I might be missing?

Yes. I think you're right on, Jason. So think about it this way, underlying core business EPS growth of double digit, slightly accretive lima. You got about 1 point tax headwind, so that's about $0.03. And then with interest rates and the paydown that we were able to do in Q4 with the financing that we did for Lima, so we paid down the revolver, we got about a $0.05 benefit as well. If you kind of take all those components and look at the underlying growth, you would say you see nice strong core EPS improvement and contributions from Lima.

Okay. That's helpful. And then a comment you made earlier about having sort of tailwinds in 2023, largely catch-up from COVID, et cetera. But it sounds like you don't feel that initially that will repeat for 2024. Just curious in terms of what you're basing that off of. Is that just looking at physician backlogs? Or just kind of what indicators are out there from a macro standpoint?

Yes. I mean, it's really a conservative planning assumption, right? I think, as I said earlier in the call, last year demonstrated that if you get periods of time when the utilization of surgery can be high for whatever reason, if you get periods of time when there's extra ability to drive surgery, last year showed that both in the U.S. and outside the U.S., there is pent-up demand, and we can have elevated growth rates as that pent-up demand gets worked through. I think the math suggests that there's still quite a bit of pent-up demand that really wasn't satisfied through the COVID period. We expect that this year and in the coming years, if we hit parts of the year where things are really clean, where there are no COVID or flu or storms or whatever, if we hit parts of the year that are very clean, like the early part of last year, the system is going to run at a higher utilization rate in the U.S., and you're going to get extra growth. We saw that early last year, as well as an easy comp early last year. Outside the U.S., there were decisions early in the year by a couple of countries to increase capacity utilization early in the year. When that happened, we ran above normal rates for part of the early part of last year. We think a reasonable planning assumption for this year is a normal Recon growth rate, which would indicate a little bit of that tailwind from last year gets recreated, but we don't get extra growth. But at the same time, there is certainly the opportunity for more of that pent-up demand to be worked off and to have another oversized market growth rate. We just think it's more prudent not to plan for that.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Trerotola for any closing remarks.

Thank you for joining us this morning. I want to end the call by thanking our team members around the world for the success of 2023. We're stepping into 2024 with a lot of momentum and excitement across the organization and remain committed to delivering value for all of our internal and external stakeholders. Thank you for listening today, and we look forward to sharing our first quarter results with you in May.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.