Zimmer Biomet Holdings Inc

NYSE:ZBH

Earnings Call Analysis

Company Projects Mid-Single Digit Growth

The company aims for mid-single digit ex-FX growth in H2 with subsequent operating margin expansion. Headwinds for 2024 include higher tax rates due to OECD's Pillar Two and FX pressures. Despite this, strong end markets, portfolio performance, and moderated pricing erosion boost revenue outlook confidence. They project mid-single digit top-line growth ex-FX for 2024 and expect earnings to outpace revenue growth, powered by operational efficiencies and SG&A programs.

A Promising Quarter for Zimmer Biomet with an Echo of Leadership Change

At Zimmer Biomet, there's a sense of a new beginning as this quarter marks Ivan's first earnings call as CEO, indicating continuity and potential for fresh strategic imperatives. The company delivered a solid quarter, characterized by a 5% reported revenue increase compared to the previous year and a notable 4.7% constant currency growth, despite a selling day headwind. U.S. and international growth were resilient, with particular strength in the U.S. market.

Robust Product Performance Underpinning Growth

Product categories like global knees saw a 7.3% increase, demonstrating the effectiveness of Zimmer Biomet's portfolio enhancements and technology like the ROSA robotics platform. The U.S. market was robust, whereas international growth faced challenges due to external pressures, especially in China and Russia, affecting the hips category. Despite these hurdles, the company predicts continued growth in this sector, backed by product expansion.

Steady Financial Metrics Amidst Tax Settlement Impacts

Zimmer Biomet reported a decline in GAAP diluted earnings per share compared to the previous year, mainly due to a favorable tax settlement that did not repeat. However, adjusted diluted earnings per share increased thanks to revenue growth. Gross margin improvements also contributed, albeit partially offset by higher R&D expenses needed to fuel product innovation and research.

Bullish on 2023 with the Wind at Their Back

Looking into 2023, Zimmer Biomet maintains an optimistic outlook, forecasting over 7% constant currency revenue growth and 9% EPS growth at the midpoints of their range, even considering a 100 basis point headwind from foreign exchange. Full year operating margins are expected to improve amidst these challenges, demonstrating management’s ability to pursue profitability even in tougher environments.

Gaining Traction in the Market Amid Stable Sector Growth

Zimmer Biomet is confident about its market share gains, particularly in the U.S., and is not reliant on a single quarter’s performance for validation. The company sees underlying market trends, including the rise of Ambulatory Surgical Centers (ASCs) and demographic shifts, as sustainable drivers for future growth. Moreover, the ability to innovate with new technologies and efficiencies supports this outlook into 2024.

2024: A Vision of Consistent Mid-Single Digit Growth

With a transparent approach towards investors, Zimmer Biomet shed light on the expected headwinds and tailwinds for 2024. Macro factors like the OECD’s Pillar Two and foreign currency pressures might challenge the company. Yet, stronger end markets and an aggressive product launch strategy, including 40 new products over 36 months, feed into the strategy for mid-single digit growth and earnings outpacing revenue into the next year.

Strategic M&A to Fuel Future Growth Trajectories

Zimmer Biomet has underscored that M&A remains its top strategic priority, especially in high-growth segments such as the S.E.T. category. The company’s positive momentum entering Q4 and the focus on innovation and market dynamics position it to continue this trajectory of growth through 2024 without reliance on backlogged demand.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, November 7. [Operator Instructions] I would now like to turn the conference over to Keri Mattox Chief Communications and Administration Officer. Please go ahead.

[Keri Mattox, executive]

Thank you, operator, and good morning, everyone. Welcome to Zimmer Biomet's Third Quarter 2023 Earnings Conference Call. Joining me today are Ivan Tornos, our President and CEO; and EVP and CFO, Suky Suketu. Before we get started, I'd like to remind you that our comments during this call will include forward-looking statements.

Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please note, we assume no obligation to update these forward-looking statements, even if actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements. Additionally, the discussions on this call will include certain non-GAAP financial measures.

Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q3 earnings release, which can be found on our website, zimmerbiomet.com. With that, I'll turn the call over to Ivan. Ivan?

[Ivan Tornos, executive]

Thank you very much, Carrie, and good morning, and greetings everyone from Wars Indiana, the orthopedic capital of the world. Welcome to our Q3 earnings call, my first call as the CEO of this amazing organization, really grateful that all of you are joining us here this morning. I'd like to begin by saying how truly cared I am to be in the new role, what I deem to be a very inspiring time not just in musculoskeletal health, which it is, but also in Medtech in general.

Simply put, the space is not what it used to be just so 5 years ago. When you look at orthopedics, when you look at the entire category, it's changed. It changed a lot. Groundbreaking technologies are shaping how procedures are done. Beyond the backlog and continued favorable demographics, global demand for treatment is higher than it has historically been. This is driven by better clinically reported outcomes. This is driven by shorter episodes of care. This is driven by better, more comfortable ways to do physical therapy. This is driven by growth in the U.S. with the rapid shift of cases moving to an ASC, while also preserving what are very compelling volume levels, in the traditional inpatient and outpatient savings.

So in plain English, healthy market, great patient dynamics, new technology, disruptive innovation, a lot has changed, and I don't see us going [indiscernible] to a 4, 5 years ago. So again, a very inspiring time to be in musculoskeletal health and orthopedics in general. All of these markets accelerating trends are opening new doors for countless patients to benefit from what we do here at CV, which is to drive life change in solutions. We do that every single day for countless patients. And the best part about it, we're just getting started.

So I could not be more excited to be here in my new role. With this encouraging market dynamics, sustainable trends and building on the solid track record of execution that the CV team has enabled. It's great to be here today to report what it is another solid quarter of strong performance while strongly reaffirming our year-end guidance for the year 2023. Even more exciting, as I look forward to our future, I'm more convinced than ever that Zimmer Biomet will continue to lead the way on customer-centric innovation, already a competitive advantage and solid commercial execution, enabling not just the delivery of mission but also improving on our other key value creation drivers, those regaining and sustaining top quartile performance. And again, this is something that we treat with a lot of rigor and something that is mandate for the organization. We must regain and sustain top quartile performance.

For today's call, I want to first share my thoughts on my first 2 months as CEO of Zimmer Biomet while also providing key insights into what I have learnt, how my learning has shaped, who are going to be my 3 key priorities as the new CEO of the enterprise. This would answer the question of what is fundamentally going to change around here in the next chapter for transformation.

After that, I'm going to talk about the key drivers behind the solid Q3 performance. Next Sue will take over, and we'll discuss the financials for the quarter as well as the expectations for the rest of the year and then our February part of the call. Before we move into these updates, I do want to take a moment to thank the global Zimmer Biomet team for their unwavering commitment to our purpose, to our plans. I want to thank them for the sense of urgency in driving some execution. I want to think them for everything that they do. This is a highly engaged and focused team that has been operating at a very rapid speed and is eagerly deciding to do even more, more for patients, more for customers, more for the team, more for each other, more for the company, more for the communities where we work and live, like right here in Werson and frankly, far more for the shareholders.

This team gone through a lot, and a lot is a lot. This team has done a lot of heavy lifting. And now with a heavy lifting behind from a remediation standpoint. It's great to be in a different stage. And it's great to be able to show to the world what the Zimmer Biomet team can do and will do. I'm beyond proud of the organization, and I'm generally inspired by what they do each and every day.

We do this for a while around the world, and I can truly tell you I have never worked with a better team than the 1 we have here at Zimmer Biomet. And again, I can hardly wait to showcase our results in quarters to come. So thank you. I also want to say Brian Hanson for all the branded to bring Zimmer Biomet to this moment. We are grateful and we're stronger because of his leadership. So thank you, Brian.

Now let me share some perspective as the new CEO of Zimmer Biomet. During my first 11 weeks or 77 days in the job, I've spent significant time with team members, customers, analysts, investors or Board, my peers, health care executives across med tech, government officials and other key stakeholders in health care, so that I could listen, I could learn and I could get the property insights. I've been in every Zimmer Biomet region around the globe have interactive with every key manufacturing facility. I have visited hundreds of decision makers across every major continent, and I have collected countless pages of feedback and recommendations.

Most critically, obvious this reflection time, to ensure that we, at Zimmer Biomet are boldly prioritized what needs to get done. And this, I can assure you, will be a trademark of my time as CEO of Zimmer Biomet,having the courage to say no to several things so that we can become truly great in those things that will drive the most value for the enterprise and our key stakeholders. These key priorities are purpose and people, number one. We have a winning culture. We have the absolute best talent in the industry.

It has been a foundational priority for CV and will continue to be critical under my leadership, people, purpose, talent, culture. We have a very data-centric organization. We use the same level of data centricity to track how it is that we're doing with our human capital. To that end, we track level of engagement, development, DEI, engage span across different segments and geographies, high potential ratings and everything in between.

I'm really excited to report that our most recent engagement survey, which we completed about 6 weeks ago deliver the absolute best scores in the history of the company. Let me say that again, the latest engagement score for organization, close to 20,000 employees showcase the absolute best scores in the history of the organization, frankly, going up across every single category.

This tells me that the team is energized. This tells me the team is ready. And this tells me that the team is about to unleash a lot of greatness for the organization. The second priority is to create and sustain a framework of operational excellence across the board. Simply put, it's about being great when it comes to running the business. This means simplifying what we do, where we play and how we play.

This means being courageous and bold about the choices that we make. It starts with being intention about driving sustainable revenue growth. We know this is the #1 driver of total performance. And we also know that innovation, customer-centric innovation and commercial execution are the 2 key drivers of sustainable revenue growth. So we will accelerate that. But at the same time, we're not going to forget that we can and will do better across the entirety of the P&L.

We're going to drive a culture of ownership by every single employee across the globe with all of us waking up every single day acting as key investors in the business and thinking of time and money as the key currencies of the organization. This means continuing to align our incentives with an even greater emphasis on best-in-class performance from both top and bottom.

By delivering on operational excellence as a mandate or mindset for the organization, we're going to enable, number one, revenue growth of at least 100 to 200 basis points of our market while growing earnings faster than revenue and free cash flow growing faster than the rate of earnings. Number two, operational excellence will enable best-in-class supply and operational outcomes by simplifying a rather complex operations, a manufacturing footprint. And then thirdly, operational excellence as a mandate is going to enable an agile, nimble and simplified company that can anticipate, can be proactive in successfully navigating market trends.

So again, operational excellence and mindset is going to deliver revenue growth of at least 100 to 200 basis points of a market while growing earnings faster than revenue and free cash flow faster than the rate of earnings while enabling best-in-class supply and operational outcomes by making Zimmer Biomet agile, nimble and a very simplified company that is proactive in what it does.

Based on where we are as we close the year 2023, and based on our latest guidance, we're already on track to deliver the metrics that I mentioned above around revenue, earnings and free cash flow, the way we run the company, but we expect to do it again with even greater rigor in 2024. To that end, we look forward to hosting an Analyst Day. It's something we've not done ever since we measure 2 companies.

And at the Analyst Day, we're going to be sharing more details on this thought that I have highlighted and the specific drivers of these goals. So this becomes truly the DNA of Zimmer Biomet. Third priority is about innovating and diversifying Zimmer Biomet into high-growth markets, table stakes. We must enter higher growth markets. We do need to diversify our portfolio. And we will do that. We're going to do it through organic and inorganic means. We're going to do it through innovation and M&A.

On the innovation front, we're going to innovate by continuing to boldly invest in the right segments of R&D. So that is new product development so that we always think customer problems and bringing solutions to those products. We're going to make sure that those projects are in attractive growth areas that are mission-centric but also are in the ride markets. And by bringing those solutions, we're going to become and remain market leaders in these categories where we choose to play, aided by more product and solutions launches that will enable category leadership for Zimmer Biomet.

We're going to be relentless about the CytoCare opportunities, namely the ASC opportunity here in the U.S., where we're already growing in the strong double-digit rates, but we know we're far from realizing true potential. This journey, by the way, innovation journey has already started. We then try to launch over 40 new products over the next 36 months, and the value -- the dollar value of our pipeline today it's twice the dollar value that we had back in 2018.

So a lot of new exciting technologies are about to get launched here at Zimmer Biomet. In addition, 80% of our products in our pipeline, we study markets that are growing at least 4% many in areas that are growing more than 4%. Equally viral, we're going to ensure that our innovation journey accelerates value creation through making sure that we're monitoring not just the revenue associated with these launches, the vitality index, but also what we call our innovation, profitability index, or IPI.

And thus the gross margin dollars coming from new products. We've got to make sure that these new products are driving margin accretion to the overall margin profile of the organization. So again, it's about innovation and it's about value creation at the same time. Mission and margin expansion will coexist and will coexist as part of our innovation journey. To materially change our portfolio, we're going to also leverage the strength of our balance sheet, which is stronger than ever. We will do M&A. We're going to be thoughtful and disciplined about the spaces we prioritize.

We're going to ensure that the spaces are mission-centric. And at the same time, these patients are the areas where Zimmer Biomet has the right to win. We focus on opportunities that are going to hit strategic thresholds, but also hit financial thresholds. We're going to make sure that these acquisitions drive strong returns and create long-term shareholder value.

It is worth noting that this diversification of our business has started already. Yes, we have bolder and we will be bolder but it has already started. In the last 2, 3 years, we have shifted our portfolio already into mid-single-digit or above market environment, and our weighted average market growth rates have already increased from 50 basis points, and this happens through thoughtful resource allocation and some of the active portfolio management we've done.

Again, we're going to be bolder, but the journey has already started. I'm excited about where we can and will do a ports 3 priorities. It's about, first and foremost, people, human capital, having a best-in-class culture. Secondly, it's about delivering operational excellence as a company mindset or mandate and fairly is about making sure that we diversify and innovate in a far bolder way through organic and inorganic means.

Those are the 3 priorities. So now that you got a better sense of our priorities, I want to talk about Q3. And again, I want to reiterate that we're really excited about the performance that we saw in the quarter. Performance that was driven by continued execution, especially in the key areas where we've been investing.

In particular, I want to talk about Niche, it was a great quarter for Niche, where we delivered a broad market performance in key markets around the world. We also grew in areas that are mission-critical within SEP, upper extremity CMFT as well as Sports Medicine. We had solid performance in the ASC environment, and we saw a revenue generation coming strongly from our data, technology and solutions platform, primarily within ROSA and now mobility. In Niche personal star highly are differentiated semenless platform continues to perform above our expectations. I was recently in Dallas at the hip any society, and the feedback continues to be super I can't wait until we continue to bring this technology to other geographies. ROSA had a strong quarter. I continue to see great adoption. We've seen a lot of ROSA adoption happening in the ASC setting, where speed we're dealing with higher volumes, that's matter.

In the ASC, we continue to see growth in the teams, and we're executing contracts daily or portfolios second to none, and we're benefiting from the recent acquisitions we've done, such as Embody and ReLine. Against the backdrop of this strong execution, med tech sector stocks have been facing pressure related to GLP-1 drugs and their impact or their perceived impact on obesity and this was a long-term perspective.

We're mission-centric pace in the bore organization. So if this drug class truly does accelerate and improves patient health. And if these drugs truly do become the end of the obesity pandemic around the world, that is great news for everyone as long as truly, this is sustainable in the long term. What I can tell you that we spend a lot of time researching GLP-1 drugs, engaging third parties, engaging thought partners and key opinion leaders across every major market and these GLP-1 drugs today become a [indiscernible] force. The [indiscernible] the root causes of osteoarthritis, a disease which impacts 528 million people around the world according to the World Health organization. The top stopes factors are ranking order, age, genetics and join injury.

Obesity certain accelerator of the disease and certainly is an element of the disease or a driver of the disease, but let's not forget that once the cartilage is damaged, there is no recovery. Once you get osteoarthritis, you will not get rid of osteoarthritis. And drop in weight is not going to cure osteoarthritis. Again, this is a generative and non-tenable disease that we're talking about.

If anything, obesity is a blocker today to join surgery as many surgeons are uncomfortable operating on patients with a BMI greater than 40 [indiscernible] countries or even above the 30 thresholds in some locations. So why could GLP-1s then be a tailwind for orthopedics, 3 compelling reasons. First, if you can lower the patient's BMI below a certain threshold 40 or 30 some cases, these patients now become eligible for surgery.

And all the data points that we're getting in primary markets like the U.S. is that there is a large percentage of patients who today are not going through surgery because their BMI is too high. Secondly, if a patient does lose the way -- and I would say this is pretty logical. And they do become more active, there would be a greater risk for additional joint procedures because there will be injury.

And third, if a patient loses wait, they are likely to live longer [Audio Gap] Minimal obesity rates but very, very long life expectancy dynamics. We don't see any near-term impact from GLP-1s, and we've seen the long-term impact would be a positive 1 for orthopedics and Zimmer Biomet. We've engaged independent third parties to perform surgeon surveys have gathered U.S.-based claims data. What it still is early in the process. We are very excited about the initial findings, and we look forward to sharing them.

So in a nutshell, more of a tailwind. We'll be sharing data very soon. We think that the logic will prevail, and this will be the end of what has been so far a rather emotional argument that is not being fact-based. In closing, I hope you can tell that I'm very confident about the future of this organization. I'm very excited to be here.

Our end markets have never been stronger, and we believe that this market beyond the backlog is sustainable. Our execution is strong and is also sustainable. We've been delivering consistently for a while, and we'll continue to do so with even greater focus and speed. We know what we need to do.

The strategy is clear, and we will execute on the strategy. We have financial flexibility to invest in higher growth markets, and we are going to continue to shift our portfolio mix and diversify our business. I generally believe this is the time for Zimmer Biomet. I'm proud of what we've done and even more proud of the work that we're going to be doing ahead.

This is why I'm excited to be the CEO and even more excited to be a proud Zimmer Biomet shareholder as I believe that now is the time for real value creation. With that, I'll turn the call over to Suky for a run-through of our Q3 financials. Suky?

[Suketu Upadhyay, executive]

Thanks, and good morning. I'd like to start my prepared remarks today by welcoming Ivan to his first earnings call as the Zimmer Biomet CEO. Ivan has been a constant force and a driver within the organization for several years, and I'm proud to work with him, and I'm excited by the partnership. As Ivan noted, we had another strong quarter driven by healthy and improving end markets, and continued strong execution across the organization. Overall, we remain on track to deliver mid-single-digit constant currency revenue growth and adjusted operating margin expansion in the back half of the year just as we committed to on our second quarter call.

Moving to results. Unless otherwise noted, my statements will be about the third quarter and how it compares to the same period in 2022. And my commentary will be on a constant currency and adjusted operating basis. Net sales were $1.754 billion, an increase of 5% on a reported basis and an increase of 4.7%, excluding the impact of foreign currency. Additionally, we had a selling day headwind of about 150 basis points that impacted all regions and product categories at about the same level.

Excluding the selling day impact, consolidated ex FX sales would have grown just over 6%. U.S. growth was 6% and international growth was 2.9%. In the U.S., our strong year-over-year results were driven by Recon and a step-up in our SET category in tandem with strong capital sales. Outside of the U.S., we saw more moderated growth across Europe and Asia, driven by tough comps and geopolitical headwinds, which I'll discuss in our product category section.

Global Knees grew 7.3% with the U.S. growing 6.1% and international growing 9.1%. The strong performance in these was driven by continued uptake from our Persona product portfolio, combined with the benefits of our ROSA robotics platform. Global Hips declined by 60 basis points with the U.S. growing 3% and international declining by 4.2%.

Tough comps in China and headwinds in Russia disproportionately impacted our OUS hip business. Excluding these impacts, our international hip business grew in the low single digits. Looking ahead, portfolio expansion will continue to support growth in our hips business. Next, the SET category grew 2.8%. Again, as a reminder, there was about 150 basis point selling day headwind across all categories and regions.

Our key focus areas within SET, including sports, upper extremities and CMFT, continued to post double-digit growth which was partially offset by other subsegments within the category. We remain confident that SET will grow in the mid-single digits in the fourth quarter. Finally, our other category grew 16.4%, driven by ROSA sales. Now moving on to the P&L. In Q3, we reported GAAP diluted earnings per share of $0.77 compared to GAAP diluted earnings per share of $0.92 in the prior year. While we had higher year-over-year revenue and higher pretax operating profits, post-tax income was lower due to a favorable tax settlement in 2022 that did not repeat this year.

On an adjusted basis, we reported diluted earnings per share of $1.65 compared to adjusted diluted earnings per share of $1.58 in the prior year. The step-up is primarily driven by revenue growth in the quarter, partially offset by higher operating expenses and higher interest costs. Our adjusted gross margin was 70.9%, up 20 basis points from the prior year, primarily driven by favorable mix. Adjusted operating margin was 26.4% and up slightly versus the prior year.

Better gross margin and savings from efficiencies across SG&A were partially offset by higher R&D expenses that will support upcoming product launches, ultimately driving a continued increase in our Vitality Index. Net interest and other adjusted nonoperating expenses of $48 million was higher than the prior year due to certain foreign currency exposures as well as higher interest rates. And our adjusted tax rate was 16.7% in the quarter.

Turning to cash and liquidity. We had operating cash flows of $338 million and free cash flow of $189 million in the quarter. We ended with cash and cash equivalents totaling just under $300 million. Our balance sheet remains strong, providing us financial flexibility and strategic optionality as we move forward. Now regarding our outlook. Overall, for 2023, the outlook remains largely unchanged from the prior quarter, implying over 7% constant currency revenue growth and 9% EPS growth at the midpoint of our range.

We expect reported growth for the full year to be 6% to 6.5% and are maintaining our ex FX growth expectations for the year of 7% to 7.5%. I Inside of that, the U.S. dollar has strengthened, so we are increasing our outlook for foreign currency to be about a 100 basis point headwind to revenue growth for the full year. Additionally, we are reiterating our EPS guidance of $7.47 to $7.57 for the full year despite the strengthening dollar, which we project to be about a $0.04 headwind to fourth quarter earnings.

This guidance implies that we will increase full year operating margins by about 100 basis points in the backdrop of a challenging environment. In addition to our formal guidance ranges, I will reiterate that there is no material impact from selling days on the full year revenue growth expectations. However, we do expect about a 100 basis point tailwind in the fourth quarter. Additionally, our expectations for interest and other nonoperating expenses as well as tax rate and shares outstanding remain unchanged.

We expect free cash flow for the year to be between $950 million and $1 billion. In summary, we delivered another excellent quarter on both the top and bottom lines. We remain confident in our 2023 expectations and are excited about the next year with revenue growing in the mid-single digits and earnings growing faster than the top line. With that, I'll turn the call back over to Keri.

[Keri Mattox, executive]

Thanks, Suky. [Operator Instructions] With that, operator, may we have the first question, please.

[Operator]

[Operator Instructions]

We'll go first to Robbie Marcus with JPMorgan.

[Robert Marcus, analyst]

Great. I'll ask both upfront as they're kind of interrelated. Ivan and Suky, I was hoping you could address just the health of the ortho market. You talked to it, but we see your results and we see your peer results, and most of them were in line to slightly below in the quarter. So one, how you're thinking about the health of the market? And then second, you touched last quarter and then this quarter as well on longer-range guidance for '24.

You talked newer guidance this time about 100 to 200 basis points above your end market growth. I think last quarter, it was implying something like 4% plus. Is that a change? And how do we think about margins for next year? I think previously, it was slightly up.

[Ivan Tornos, executive]

Thank you, Robbie. I'll start. I'll talk about the market dynamics and briefly a comment on '24. I'll pass it on to Suky to provide more color on '24 and maybe discuss what he can discuss at this point when it comes to the margin profile. But I'll start with the market dynamics.

We are the fourth company to report in Q3. So by now, everybody sees that the markets are healthy. And quite frankly, I won't match about Q4, but so far, so good. So this is not a one quarter type of market dynamic. The reasons behind the market profile, the market growth profile and why I continue to say this market is different than 4, 5 years ago is the things that I alluded to in my prepared remarks.

The explosion of ASCs, the movement, the set to ASC is real. That means new ASCs are opening in the U.S. That means new ratio surgery are happening. Demographics around the world play a factor. We continue to track data in terms of the age for someone to get a hip or a knee. And these are younger patients. In the U.S., we're also see more days of surgery. And I don't think this is just a backlog dynamic.

Pricing, you see what every single one of us is reporting these days is not the same pricing dynamic that we had in the past. And beyond that, the technology. We are driving disruptive innovation. We got more efficient solutions surgeries are shorter and the episodes are shorter. So we're dealing with the patients, the final patients with more efficiency.

Again, this is a durable trend. It's happening in Q3. As I think like Q4, nothing is really changing. As we look into 2024, every early indicator suggests that things are not going to change. And relative to performance, well, look, in the background of these healthy market dynamics in the U.S., we gained share in Q3 in both categories, really proud of being #1 in Niche for the quarter. We don't pay a lot of attention to any given quarter but that is a fact that we're the fastest-growing company in the quarter.

And then globally, net of a couple of one-timers, both in Russia and China when it comes to hips, our performance was in line with hips, and knees was very strong. And then as we get to 2024, I'll let Suky comment, but we will be mid-single digit. That's the point of entry. And nothing has really changed. It's just getting closer to the end of the year and realizing that these market trends are sustainable. And the innovation pipeline that we have will drive the type of growth. But I'll pass it on to Suky to comment on all the drivers.

[Suketu Upadhyay, executive]

Robbie, thanks for the question. The first thing I'd say is, starting with the back half of this year, we committed to mid-single-digit ex FX growth for the second half of the year with operating margin expansion, both sequentially and year-over-year. Q3 was a really another strong validation proof point of that, and we feel confident in that profile.

The reason I mentioned that is I think it gives us a running start as we go into 2024. And so I do want to talk a little bit about '24 back to your question. First, we've already provided a lot of color, I think, on '24 than most of our peers, but we feel that being transparent, giving you guys a robust view of what we're going to do not only this year but into the future is really important. But let me talk a little bit about the headwinds and tailwinds as we see it going into '24.

And some things have modestly changed. First, I'll start with the headwinds. One, we do see a higher tax rate into next year because of the OECD's Pillar 2. Secondly, based on where FX rates are today, we see some additional pressure from a foreign currency perspective into next year. Again, both of these are more macro versus execution, right? There are things that are outside of our control, but we're going to contend with them, we're going to deal with them. I'll tell you a little bit about how.

On the tailwind side, I would say, yes, we are more confident in our outlook for revenue next year. Our end markets are stronger than they've ever been. Our portfolio and new product launches have been executing extremely well in some areas above our expectation. Our performance relative to market has been very strong, and that's consistent and durable.

And quite frankly, we're seeing a more moderated pricing environment still erosion, but much more moderated than what we've seen historically. All of those elements give us confidence that we're going to be able to close to mid-single-digit growth top line, ex FX into 2024. And then despite those sort of P&L headwinds I talked about, we do believe that we're going to be able to grow earnings faster than revenue. I talked about gross margin next year stepping down because of the FX hedge gains from this year, not repeating at the same level. That will still happen, but we're going to be able to offset some of that.

The operations and manufacturing team has been working really hard at efficiency. And so we feel more optimistic about where our gross margin is going into next year. Secondly, as I said, we've already got a running start and a lot of SG&A efficiency programs in the back half of this year that are going to run into next year.

So when you combine those 2 elements together, again, we feel really confident that we're going to be able to do that mid-single-digit top line growth next year as well as earnings growing faster than revenue.

[Operator]

We'll go next to Drew with Morgan Stanley.

[Andrew Ranieri, analyst]

just maybe on '24 also, you haven't talked about backlog much at recent conferences. You kind of pointed out that you think it's going to carry through '24. But just maybe help us a bit more of how you're factoring that into your mid-single-digit directional guide for next year. I know it's not -- I know your growth is not all dependent on backlog. But just how do you think about that helping to support the orthopedic market growth? And maybe just talk to us about your ability to capture a disproportional amount of share of that backlog?

[Ivan Tornos, executive]

Yes. And first things first, you should be in your honeymoon considering that you got married recently. So I'm disappointed you're here. Look, I'm going to keep this short and sweet. We don't see backlog as a major driver in our growth profile for the next year. So when Suky and I said on mid-single digit, we're not assuming any real meaningful backlog. So not a key driver. We believe we spend a time going back on for some backlog that is going to remain here throughout the end of '24 at least, but we are not a backlog depending -- backlog dependent type of company. So we don't have or focus on that. What we're tracking is innovation, the pipeline that we have. What we're tracking is the investments we made in the ASC, we're tracking is commercial execution and in the background, just sustainable pricing dynamics. So no backlog.

[Andrew Ranieri, analyst]

And just a second, as a follow-up, your commentary was very strong that you're expecting mid-single-digit set growth into next year. But just remind us about what's it going to take to really accelerate set? And maybe just talk a bit more about the lift on the organic side and maybe what you're thinking about in terms of M&A to get that growth rate higher and more sustainable.

[Ivan Tornos, executive]

Yes, absolutely. Great question. First things first, Q3 said was in line as we move into Q4, we're actually going to be a mid-single-digit grower. I'm not going to talk about a dynamics for '24. We'll do that coming guidance, but very excited in terms of where we are. We integrated a couple of companies within Sports Med, those are performing very well or upper extremity. so their business is growing in the mid- to upper single digits in most regions. When you look at our CMFT, craniomaxillofacial thoracic, which is part of -- as -- it has been performing very well. It continues to perform very well. So again, lots of reasons to believe that as we get in '24, you should expect a sustainable performance in SEB.

In terms of M&A, again, we'll comment more on that later, but it remains the #1 recipient of capital allocation. We haven't changed in that regard. And you have said is one category that is very attractive given higher market growth dynamics or position in this space. So you should assume that this is one area where we're going to be focusing from an M&A standpoint. But again, net of M&A already delivering mid-single-digit growth entering Q4 strongly and really excited about 2024.

[Operator]

We'll go next to Matt Taylor with Jefferies.

[Matthew Taylor, analyst]

Congrats on a good quarter. I was curious about your outlook comments for 2024, and I was hoping you could specifically address the concern I think investors have about growth especially in the first half of the year with a new air quotes on this, but tough comps, especially in Q1. So maybe you could address how you think you can grow throughout the year and address investor concerns about those tough comps in the first half?

[Ivan Tornos, executive]

Yes. I'll start, Matt, and again, Suky, maybe want to chime in here. But we're confident about 2024 because the market dynamics are sustainable. There's been a lot of back and forth in terms of what's going to happen once the backlog is out and all that, first, the backlog. We don't think it's going to be out anytime soon. And then pricing is sustainable. And all the things that I mentioned -- my answer to Robbie are here, they move to see the shorter episodes of care, more diesel surgery. So macro-wise, every data point we get, Matt, is very compelling. And then on the micro, we are seeing a bolus of innovation being launched. We've got 40 new products that we're going to be launching over the next 36 months. Some of these products are very compelling.

We launched our Persona OsseoTi, which is a sameness construct earlier in '23. That is going to be a full -- truly full market release in the U.S. in '24 with right amount of sets and that's high growth. As we enter the first semester of '24, to your point, there's another 2 or 3 very meaningful product launches, some in robotics and within Rico, some in SED said, that's very compelling. The integration of embody, the integration of ReLine continues to generate revenue.

I could spend an hour, but I will tell you that is the balance of really sustainable macro dynamics and solid innovation. And then on top of that, you got great commercial execution with a highly engaged sales force. So I'm not -- we're not deeply concerned about the comps.

[Suketu Upadhyay, executive]

Yes. I think just building on that, remember, the first half of this year, which was very strong, was more about comps versus 2021 -- or excuse me, versus 2022 than it was something about abnormal market growth. So again, just building off what Ivan said, we feel confident in that. Now we're not, of course, giving specific guidance, and we're certainly not giving quarterly guidance into next year. So as always, quarters can be choppy or driven by seasonality mix changes. But overall, we're confident in that position.

[Ivan Tornos, executive]

Maybe one last comment here, Matt, quickly, and then we move on. Don't forget that the first semester of 23, while we had very solid comps also had pretty challenging dynamics from a supply standpoint. So as we think about 2024, that we believe is going to be a tailwind.

[Operator]

We'll go next to Shagun Singh with RBC Capital Markets.

[Shagun Singh Chadha, analyst]

I'm just going to try to ask the Q4 implied in 2024 guide in a different way. Your Q4 implied guidance assumes a deceleration from Q3. And your commentary seems pretty positive. It implies a deceleration even on a back to year basis, which has just become. So should we just assume that it's conservatism. And then if you look at growth on an underlying basis adjusted for China VBP selling days and all onetime items, I think even plus 6% in '22, you're looking to do 7% to 7.5% in '23 guidance -- sorry, consensus looking for about 4.5% growth in '24. I know, Evan, one of your targets is to drive that revenue growth acceleration. You've indicated that you will not be satisfied with 4% to 5% growth for the company. So just what is your reaction to that 4.5%? Does it look conservative to you in the context of the comments that you made?

[Suketu Upadhyay, executive]

Sure. Shagun, this is Suky. So just first on the fourth quarter, I'll just keep going back to -- we don't give quarterly guidance. And obviously, with our implied, you can pretty much squeeze into the last quarter of the year. We talked about mid-single-digit growth. Margins expanded in the back half of this year, and we're going to deliver on that. We have a range around our guidance, obviously, to the downside, geopolitical factors continue to be erosive or supply doesn't continue to -- that very positive trend has been on, then you're towards the bottom end.

However, that supply picks up and it remediates even faster than it's already been improving, then as well as better execution on our new products, we could be at the upper end. So there's a range around that. And so I'll just leave it at that. But overall, we feel really good about where we're ending in the second half of this year and where our end markets are. As we look into next year, I think you've seen a bit of a pivot where our commentary was before anchoring quarter 4, maybe even better to now where we're saying mid-single bit. And I think that reflects the momentum that we've seen, pointing 2023.

[Shagun Singh Chadha, analyst]

Got it. And if I could just ask on M&A...

[Ivan Tornos, executive]

Go ahead. Yes. Go ahead, Shagun.

[Shagun Singh Chadha, analyst]

Okay. Great. Just on M&A, Evan, if you could just elaborate a little bit more in your thinking of tuck-ins versus larger deals, high-growth adjacencies that may allow you to diversify elective procedures? And then I'm most interested about ASCs. A lot of your business is moving to ASC. That is a growth driver. What do you need to further succeed that you need a broader bag or more depth?

[Ivan Tornos, executive]

Yes, absolutely. So on M&A, as I already mentioned, and it was in my prepared remarks as well, it will remain our top strategic priority from a capital allocation standpoint. So that's not changing. And we're excited about the opportunities that we have in front of us. We're going to continue to focus on growth markets or areas that are not only mission-centric but offer an exciting growth profile. And that is 3 things: no rank in order, 3 key areas, segments within Recon that are growing faster than our WAMGR or collected -- our collective market growth rates. And there's a lot in there. You got navigation, you've got data, technology elements of weaker really attractive.

True is a set, as we've done already buying things in Sportsmed, buying things in CMFT, and then looking at other categories that I don't want to get into for competitive dynamics, but again, optionality there. And the ASC is also one attractive area. It's one area where we have dedicated resources. We're growing in the teens. We have currently 10% to 15% of our sales in that space and there is opportunities there to acquire things.

So that's a bit of the strategic summary of where we've gone from an M&A perspective. In terms of financials, we're not changing the story. We like to do things up to $2 billion in acquisition price. And again, that gives you a lot of options. You can do a midsize deal. You can do some tuck-ins, combination of different things. We want these deals to be EPS neutral within 2 years. And we spoke about high single-digit ROIC within 5 years. So that's a bit of a strategic and financial profile.

As we look into the next 3 or 5 years, we spend a lot of time. So can I have spent a lot of time looking at the trapplan, what is the growth profile? The great news is that we convinced that the free cash flow generation is solid. So we're going to be able to do M&A and potentially do other stuff when it comes to capital allocation. So that's the answer to your first question. Look, I don't think we need to do much more.

We're growing in the strong teams already here in the U.S. in the ASC. I mentioned 10% to 15% of our sales are there. We got the right portfolio. This is not where we were, let's say, 3, 4 years ago. we got the rig robotic platform for the ASC. We got a great cementless need that is gaining share very quickly. We got a full bag in sports and across it. We got best-in-class technologies. So the portfolio is great. We got dedicated resources, which we very much need in an ASC environment. We have a dedicated sales force. We've got simple contracting, simplify contracting. Look, what we don't have organically, we partner with others. So whether it's sterilization, [indiscernible] or other staff, we've got the right partnerships. So very, very confident that we're going to continue to perform in the ASC environment.

[Operator]

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

[Joshua Jennings, analyst]

One to just follow up on your ASC comments. I wanted to ask about the migration of total joint surgeries to ASCs. Any back-envelope assumptions you would have us use just in terms of where the penetration or the migration for knees and hips has been what percentage of cases for each category is reported in ASCs currently here at the end of 2030 versus 2022? And then any metrics you can share just with ROSA penetration in ASCs and then any pricing dynamics for Total Joyce as this migration is occurring, that's a multipart question, but I appreciate you taking it.

[Ivan Tornos, executive]

All right. Let's see if my memory is as good as I think it is. So starting with ASC, macro-wise, we believe that roughly between 40% to 60% of cases in the next 5 years are going to move to ASC. And I will say that a large portion of cases are already moving to the ASC. What we like about this dynamic is that as cases are moving to the ASC, other cases are coming to inpatient an patients. So it's a little bit of a double dip happening there, Joss. But yes, the number is 40% to 60% over the next 3 to 5 years, and I would say a good percentage has already moved.

We are growing in the upper teens when it comes to ASC. And today, around 10% to 15% repeating myself or cases or revenue, rather, of Zimmer Biomet comes from the ASC. I will tell you that it's pretty equal in terms of both hips and needs. So we don't see one category being above the other. And I like the fact that given the recent CMS changes, you're going to see solar cases also accelerating the ASC.

We believe that's a great opportunity for us here at Zimmer Biomet. So that's the answer on ASC. In terms of ROSA dynamics, I think we've been very transparent in terms of 1/3, roughly 1/3 of all of our installations are happening in the ASC. That's a trend that has been happening for a few quarters. And that's a trend that we continue to see happen in the next quarters.

In an ASC environment, speed matters, not having to get engaged in complex preplanning matters. Efficiency does matter. And having a need that you are confident it's going to be the right need does matter. And those dynamics are driving ROSA penetration in ASC. And then outside of the sea, ROSA continues to perform.

We are selling and placing ROSA frankly, at a rapid pace. You see in the other category, we saw a nice increase that was driven by ROSA. And we are on track to at least install 300 units at the end of the year 2023 when it comes to ROSA. So really satisfied. And that's before we launched next-generation ROSA across Recon and delivered the first shoulder robotic platform. So excited about both AEC and ROSA.

[Operator]

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

[Larry Biegelsen, analyst]

I have enjoyed watching your post on LinkedIn, looks like you've traveled around the world literally since you've taken over as CEO. I wanted to ask, Suky, you start on the margins. You're going to end '23 with an operating margin of about 20.5%, which is towards the high end of med tech. Where -- what do you see as peak margins for Zimmer? I mean 5, 10 years ago, the margins were in the low 30s. Is that still realistic? And I have one follow-up.

[Suketu Upadhyay, executive]

Yes, sure. So Larry, thanks for noticing. It's actually 2 years in a row where we've expanded margins in the backdrop of a really challenging environment. By the way, while also accelerating revenue. I think in '22, we expanded margins, operating margins by about 40 to 50 bps. And this year, you're right, the implied is about 100 basis points.

So again, really proud of what the ZB team has done collectively. Again, in the backdrop of still investing for growth, which we've been able to demonstrate. As we move into next year, I think we've been pretty front-footed in our ability to continue to grow margins in quite frankly, we're going to do that in every year after 2024 and continue to deliver a profile where earnings are growing faster than revenue.

I'm not going to go out and put a marker out there as to where we think it can get to. But historical levels, we'll look for over time to definitely beat and exceed those. So I'll just leave it there. Again, really happy with where the team has performed over the last couple of years. very confident in what we're going to do next year, quite excited about our outlook in the longer term.

[Larry Biegelsen, analyst]

Yes. The other category was obviously very strong. We heard you talk about ROSA sales in the quarter. What was the change in the quarter that drove that strength and how sustainable is that?

[Ivan Tornos, executive]

Yes. I don't think there is anything changing really. There's not a change of strategy. It's we continue with ROSA, we continue to show strong clinical efficacy. We continue to demonstrate time neutrality after a few cases. We continue to see great adoption in an ASC environment. We have 3 ROSA indications today with Enrico. So total knee, partial and heal. We've done a lot of podium presence. If you attended the Dallas meeting this last weekend, there was a lot of noise around posters and whatnot. So I think we're just getting the right adoption is moving quickly. And then a driver, I will tell you, has been tremendous. A lot of these cases that are done in the ASC do like or do one, a lot of surgeons in an ASC on the combination of robotics and cementless. In the past, we didn't have the right cementless construct. We do not with personal time. So I think there's been a bit of a tailwind. But I wouldn't say it's a major change of strategy. It's just the fact that it's been 2, 3 years in market now and just trying to see the data. So really excited in terms of what we are.

[Suketu Upadhyay, executive]

And Larry, just to get back -- Larry, just to get back to your original question, just to make sure I'm completely clear. I do see getting back to historic margins are better over time, absolutely a nibble objective for us. now having greater insight and taking over for ops and supply chain, I would say this is an area where we can certainly do better. We're going to do better going forward.

And I can tell you that the company's focus on not just revenue growth but operating profit and free cash flow generation has been more acutely stronger than it's ever been. So I think we've got the pathway. We've got the culture we've got the levers to get there over time.

[Ivan Tornos, executive]

Larry, thank you for being my warm follower on LinkedIn. The whole time at was my wife and disappointing.

[Operator]

We'll go next to Chris Pasquale with Nephron.

[Christopher Pasquale, analyst]

I just wanted to follow up real quickly on Larry's ROSA question. Was the mix of sales versus placements different in 3Q than what we saw in the first half of the year? Just trying to figure out whether that played a role or the acceleration in other sales was really driven by volume.

[Ivan Tornos, executive]

Yes. Thank you, Chris, for the follow-up. We did see more sales. We haven't changed the strategy. So it's reflective of the fact that there is capital in the hospital systems across the world. And we saw people wanting to buy them, and we sold the units. It's not a fundamental change. It's not a change in strategy. We've settled along that we prefer placing given the annuity factor and whatnot. But yes, capital is strong, and we did do some deals in some ASCs and in some of the systems. And that's why you see the other category growing.

[Christopher Pasquale, analyst]

That's helpful. And then on SET, is the strategy there to lean into these focused categories that are already growing pretty well? And then hope that the overall performance improves. Is that becoming a bigger part of the mix? Or do you see an opportunity to reinvigorate areas like lower extremities that maybe aren't on that list today?

[Ivan Tornos, executive]

Yes. Let me start with the second part. We really don't do hope here. So we do have plans to drive better performance in the 3 areas that so far have not been that compelling because being restorative therapies for an angle and trauma. What I will tell you is that we start the therapies, biologics, the issue there was a reimbursement change a year ago, that's been resolved. So that's not a concern moving forward. And then food and ankle, lower extremity is something that we're looking at. may require some organic, inorganic place.

But given the space, we're paying close attention to what is that we need to do. And in trauma, for many markets continues to be very attractive. We own some smaller tuck-ins. So I would expect that the declines that we have seen in the past are going to disappear. So again, not really doing hope there. We got plans to remediate and to get back to growth in those 3 categories. That said, the 3 most compelling priorities within said, remain upper extremity solder, sports medicine and CMFT, and those 3 are performing very nicely.

[Operator]

We'll go next to Travis Steed with Bank of America.

[Travis Steed, analyst]

I guess a quick follow-up on M&A. Any way to frame how much margin or EPS dilution you're willing to take in years 1 and 2 realize, you said neutral by year 3, but curious kind of what the framework is on year 1 and 2. And when you think about [indiscernible] spreads, is it a deal something you think you could get done this year? Or is it probably more something for 2024?

[Suketu Upadhyay, executive]

Travis, this is Suky. I'm not sure I completely got that second question. Can you repeat that?

[Travis Steed, analyst]

Yes. In terms of like when you think about like good [indiscernible] and the progress on your conversations, is a deal happening in [indiscernible] ?

[Suketu Upadhyay, executive]

So first of all, on your first question around earnings per share dilution, that's really going to depend on the type of asset that we acquire, the size of the transaction, what markets in where it is and its journey and its life cycle. It's a product that's just launched or something that's very mature in marketplace.

So I'm not going to sort of give a guide post on year 1 or year 2 because I think that would be premature because it is going to be very situation dependent. But what we will commit to is that we're going to look for break even by at least 24 months, if not sooner than that. So that's the profile that we look for in our M&A relative to bid-ask and timing, of course, for a variety of reasons, mostly proprietary. We're not going to get into the timing of any specific deal.

As you know, those are often opportunistic situation based. So here's what I would say is that we've got a lot of strategic flexibility on the balance sheet in the strongest position it's been since the merger of Biomet, we feel really good about the optionality we have going forward.

And we think we can deploy capital to continue to accelerate our growth profile and diversify the company, but I'm not going to get any specific timing. I'm sure you can appreciate that. But thank you for the question.

[Travis Steed, analyst]

Yes. That's fair. And a couple of housekeeping questions. The OUS onetime stop in hips this quarter, does that get better in Q4? And when you think about tax rate next year, I heard your comments, but curious if that being less than 100 basis points or more than 100 basis points on tax rate. And when you think about the interest line, you've got, I think, $850 million of debt coming due. So is interest of a headwind or a tailwind next year?

[Ivan Tornos, executive]

I'll briefly comment on Q4, I'll keep it simple. It does go away. So this is a one timer. And in Q4, we get back to growth in terms of the tax and interest, Suky, do you want to want to comment on that?

[Suketu Upadhyay, executive]

Yes. So on the interest expense line, right now, we're not going to give full guidance on that. So we'll unveil that. I think the one thing you want to keep in the backdrop is we do believe we can grow earnings, we will grow earnings faster than revenue. On the tax rate, right now, our best estimate is that it will be about 150 basis point increase off of our full year 2023 tax rate.

[Keri Mattox, executive]

I think we have time for maybe one last question. Katy, is there one in the queue.

[Operator]

We'll go next to Vijay Kumar with Evercore ISI.

[Vijay Kumar, analyst]

Maybe just one question from me. This U.S. hips, I think you called out Russian headwinds. Is that done within fiscal '23, should that continue into fiscal '24? And I think you did speak about M&A. Can you comment on your hurdle rates you've given current interest rate in modeling for a deals?

[Suketu Upadhyay, executive]

Yes. Sure. BJ, it's good to hear from you. So on the OUS hip headwind, specifically to Russia. If you go back to last quarter's call, second quarter, I talked about Russia being about a 50 basis point headwind in the back half of 2023. And that estimate is still largely true, and most of that occurred in the third quarter.

So we're going to see a little bit of pressure in the fourth quarter, but it's largely behind us. We don't see that as being a headwind at this time into 2024. And I'm sorry, Vijay, can you repeat your question around...

[Vijay Kumar, analyst]

Sorry, on Deals. M&A, given current interest rate environment, can you talk about your hurdle rates for deals?

[Suketu Upadhyay, executive]

Yes. So look, we would still look at debt financing over equity financing all day long, even though it's 2x of where it was a year ago, it's still versus historical rates still a pretty attractive source of capital. It has become marginally more difficult to make the deal economics work at these interest rates. So it just means that we've got to be that much more disciplined on our valuation and our purchase price. And so that's how we view things right now.

[Keri Mattox, executive]

Thanks, Vijay, everyone, for the questions. Yes, absolutely. I think now we're probably nearing the end of the call. I'll turn it back over to Ivan just for any closing remarks.

[Ivan Tornos, executive]

Yes. Thank you, Keri, and I'll give it to 2 minutes or less here, so we can close on time. But couple of things here. Number one, really, really pleased with the progress here at Zimmer Biomet. I'm really proud of the team and the work that they have done, they are doing and most importantly, they were that now that we are going to continue to do excited about the markets, lots of questions on market dynamics.

Every data point suggests that they're healthy markets, they're durable markets. No, we're not concerned about GLP-1, and I'll say that with utmost respect and humility. But every data point shows that this is not something we should be concerned about. The performance is strong, and it's going to continue to get there.

We saw a great Q3 performance in Recon, net of the POS. It was solid. I like where we are with both Hips and East here in the U.S., in the largest market. I like the fact that we've seen set being in line now. I like the profile as we enter Q4 and as we get into 2024, I believe this will be the year for set. And I like the optionality that we got to run M&A. So healthy market, solid portfolio, a great opportunity to leverage the balance sheet, I do think is a different place, a different environment.

So really hard to be here. Look forward to leading this great team and look forward to answering more questions in quarters to come. Thank you for your time today.

[Keri Mattox, executive]

Thanks, everyone, for joining us. The IR team will be in touch, of course. And if you have questions or comments, please feel free to reach out.

[Operator]

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