Zimmer Biomet Holdings, Inc. (NYSE:ZBH) Q1 2023 Earnings Call Transcript May 2, 2023

Zimmer Biomet Holdings, Inc. beats earnings expectations. Reported EPS is $1.89, expectations were $1.64.

Operator: Good morning, ladies and gentlemen. And welcome to the Zimmer Biomet First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today May 2, 2023. Following today’s presentation, there will be a question-and-answer session. At this time, all participants are in listen-only mode. [Operator Instructions]. I would now like to turn the conference over to Keri Mattox, Chief Communications Officer. Please go ahead.

Keri Mattox : Thank you, operator and good morning, everyone. We’re joining you from our Warsaw Indiana headquarters and are happy to be with you today. Welcome to Zimmer Biomet’s first quarter 2023 earnings conference call. Joining me are Bryan Hanson, our Chairman President and CEO; EVP and CFO, Suketu Upadhyay and COO, Ivan Tornos. Before we get started, I’d like to remind you, that our comments during this call will include forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements, due to a variety of risks and uncertainties. Please note we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially.

Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements. Additionally, the discussions on this call will include certain non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q1 earnings release, which can be found on our website, zimmerbiomet.com. With that, I’ll turn the call over to Bryan, Bryan?

Bryan Hanson : All right. Thanks, Keri. And thanks to everyone for joining us on the call this morning. We don’t get the opportunity to do this too often. So I’m going to take advantage of it. And I’m just going to start the call by simply saying this was a phenomenal quarter, where pretty much everything went better than expected. And importantly, as a result of that momentum, we are significantly raising our full year top and bottom line outlook, which Suke Upadhyay is going to talk about in just a minute. With that said, and maybe taking a step back, for today’s call, I’ll talk more about our Q1 performance and the drivers of that performance. And then Suke will get into more details for the quarter and importantly, also our financial guidance for the rest of the year.

And then we’ll make sure that we save plenty of time for your questions which we look forward to addressing. But before we do any of that, I just want to take a minute to speak directly and personally to the ZB team. And it really just say thank you, truly say thank you. For yet again, you have delivered beyond our expectations. And I’m very proud of what this team is doing to navigate an environment that while improving, there’s no question it’s improving, it is still fluid. And it presents us with challenges that quite frankly seem like daily challenges. And it is truly impressive how you’re navigating that environment right now. And I’m very proud of the dedication, the resilience and the innovative thinking that you’re bringing to your roles each and every day.

It is truly making a difference. But I’m most proud of how together and I do mean together, we are living the ZB mission to alleviate pain and improve the quality-of-life for people around the world. And as we know, we do that every eight seconds, 24 hours a day, seven days a week, which is really what it’s all about in the first place. So thank you. Thank you for what you do for ZB, thank you for what you do for our customers and most of all, and most importantly, what you do for our patients, the patients that we serve every day. Okay, so let’s take a look now at the first quarter. And as some of you may recall coming into the year, our guidance assumed that Q1 would have the easiest comp of the year, but also experienced some headwinds from both staffing and COVID-related challenges that we felt would put pressure on elective procedures during the quarter.

We also assumed that there would be a pretty high level of supply pressure in the first quarter. Our assumptions also believed that all three of these headwind variables would then improve throughout the year providing less impact to the business. But then outside of the easy comp, Q1 would be pretty bumpy. Okay, so what actually happened in the quarter? And why was it considerably stronger than we expected? Well, first and foremost, procedure recovery was much better than we anticipated, really having almost no material or meaningful impact from COVID or staffing challenges in the quarter. And second, we manage the supply constrained environment better than we originally anticipated. Make no mistake, supply is a real problem. And it’s putting pressure on the business.

But this team has done an excellent job managing that environment, probably leveraging some muscle memory from the past. And then third, and I think really importantly, our team’s execution and traction with our new product innovation is even stronger than we anticipated. And that’s important because it’s going to continue to provide benefit to the rest of the year. And so because of this, we saw another quarter of very positive year-over-year momentum in large joints, with our global hip and knee businesses growing approximately 13% and 18% on an ex-FX basis. Our overall S.E.T. category grew more than 6%, driven by strong low-double-digit performance in our growth drivers in S.E.T. which we’ve talked about before being sports, CMFT and upper extremities.

And then this was partially offset as expected, from headwinds from our restorative therapies business, where these headwinds will anniversary, and as you remember, these are reimbursement change headwinds that we have in that business, they should anniversary by the back half of this year. And then finally, our other category grew 11% in the quarter. So needless to say it was a pretty strong quarter. And the momentum is real in this business and our confidence is extremely high. And there’s good reason for this competence. If we just think about this quarter alone, we officially launched our new cementless knee form factor Persona OsseoTi, and this is adding to the Persona family and really strategically rounding out that portfolio. And this new keel design tray is extremely versatile, it’s anatomic because it is the Persona family and it’s stable.

And it’s the only knee that you can do a cemented or cementless procedure with an inter operative decision possible for the surgeon. And that’s a big deal. We believe that this will enhance the potential for cementless penetration, because surgeons can go into a questionable bone quality procedure with the intent to use cementless, but then they have the ability to pivot back to cement it as the bone quality isn’t there. And for this reason, and a lot of other reasons, customer feedback so far has been extremely positive, as we’ve launched this product. And as you may know, our cementless penetration is already in the mid-teens. But we believe that this can get to 50% or higher penetration. And we’re excited about that. And we truly do believe that this premium product can accelerate that growth for ZB and is already doing so.

It’s still early days. Our full launch is planned for the middle of this year as more sets become available. Make no mistake, this is a real driver for not just our knee franchise, but for the overall company. So we’re very excited. As you remember, back in February, we also closed our acquisition of Embody, which is providing access to differentiated products and an innovative pipeline for our sports medicine business. And this investment helps expand ZB’s presence in this very attractive high growth market, while also in that market, serving our customers and our patients better. And this combined with a very strong innovation pipeline that we have in sports, and this dedicated commercial channel that we put into place gives us continued confidence in our global sports franchise.

And if you’re at the AAOS meeting, you would have seen that we previewed our Hammer product, which is designed to ensure consistent and reproducible compaction for hip procedures, while allowing the surgeon to dial up or dial back the force of the strike, depending on the individual patient need. And this ability to be more personalized, actually differentiates Hammer versus other compaction devices on the market. So needless to say, we’re excited about this differentiated product. We believe this could actually increase not only the consistency for surgeons, but also the procedure efficiency, which is really important right now. And our current expectation is to launch Hammer in the third quarter of this year. And if you just look at these combined products, this is actually building on other launches that we’ve talked about the Persona IQ, Hip Insights, the Identity Shoulder system, and in total, we’ve introduced more than 50 new products from 2018 through the end of 2022, with the majority of those products coming in markets growing 4% or faster.

And we’re geared to continue that momentum, doesn’t stop here with another 40 planned product launches between this year and the end of 2025, again, with the majority of those products to be launched in 4%-plus growth markets. And this shift not only continues to transformation of our product portfolio, because the short term revenue growth, but it also improves our weighted average market growth. And ultimately, as a result of that gives us more confidence that our markets and our portfolio mix positions to company for sustainable mid-single-digit growth. And with this kind of traction around our product pipeline, increasing strength of our balance sheet, and our team members’ ability to execute, ZB continues to be well positioned to deliver value today and in the future and achieve our mission as a company.

And with that, I’m going to turn the call over to Suke to take a closer look at Q1 and our latest expectations for 2023. Okay, Suke.

Suketu Upadhyay : Thanks, and good morning everyone. As Bryan mentioned, we had an excellent quarter with better than expected results. As a result of continued market normalization and the strength of our performance, we are increasing and narrowing our full year financial outlook. With that, let’s turn to our results in updated full year guidance. Unless otherwise noted, my statements will be about the first 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 $1.831 billion, an increase of 10.1% on a reported basis and an increase of 13.2%, excluding the impact of foreign currency. As we noted on our last call, we had a selling day tailwind of about 100 basis points this quarter.

Overall, the business back from faster than expected recovery of elective procedures driven by the easing of staffing related headwinds, normalization of cancellation rates, and some backlog recapture. Also, we’ve benefited from lighter comps, strong commercial and supply chain execution and new product uptake. While we continue to face macro supply headwinds, our teams have been doing a great job mitigating these challenges. U.S. growth of 12.7% was well ahead of our expectations with elective procedure volumes recovering and procedure cancellation rates returning to pre-pandemic levels. International sales grew 14%, EMEA growing ahead of expectations, driven by faster recovery and strength across both developed and emerging markets. And in APAC, we saw some pressure in China as anticipated, but results were generally in line with our expectations.

Turning the business category performance, global knees grew 18.2% with us growing 18.1% and international growth at 18.2. Specifically, we saw strong uptake across the full Persona product portfolio and traction in all regions. We now have the Persona, Primary, Partial, Revision and OsseoTi cementless options rounding out our full product line. And we are seeing very encouraging results across that new cementless form factor. This full Persona product line not only improves and enhances our product mix benefit, but also supports the continued utilization of Rosa and associated pool through. Global hips grew 12.9% with U.S. hips up 12.3% and international up 13.5%, driven by continued traction across the Avenir and G7 product lines, along with ongoing uptake of Rosa hip.

And we are encouraged by the early impact of the Hip Insight launch. The S.E.T. category grew 6.4% driven by continued strong performance across our key focus areas of CMFT, sports medicine and upper extremities, all of which grew in the teens. This was partially offset by lower growth in other parts of S.E.T., which includes the reimbursement changes in restore therapies that will anniversary mid this year. Finally, our other category grew 11.1% partially driven by some larger orders and surgical products which may not repeat over time. Moving to the P&L. For the quarter, we reported GAAP diluted earnings per share at $1.11, compared towards GAAP diluted earnings per share of $0.35 in the prior year. While investments in R&D and commercial infrastructure increased, net earnings were higher this quarter driven by revenues improve gross margins and losses in the prior year related to ZimVie.

On an adjusted basis diluted earnings per share was $1.89 represents a 17% increase from $1.61, in the first quarter of 2022. Adjusted gross margin was 72.8%, up 220 basis points from the prior year. These results were positively impacted by favorable mix related to large joints performance and foreign currency hedged gains. Excluding these items, underlying gross margin was broadly in line with our expectations related to inflation. We’re seeing some incremental pressure from spot buying and contract manufacturing pricing, but overall inflationary pressure has largely stabilized. Our adjusted operating margin for the first quarter was 28.4%, up 200 basis points primarily driven by revenue better gross margin and continued discipline around our investment profile.

Interest in non-operating expenses of $46 million and our adjusted tax rate of 16.3% were broadly in line with our expectations. Turning to cash and liquidity. Operating cash flows were $308 million and free cash flow totaled $178 million. We ended the quarter with cash and cash equivalents of approximately $330 million. And moving to our updated financial outlook for 2023. Based on strong Q1 results and our ongoing strong execution, we are raising and narrowing our full year 2023 outlook. Constant currency revenue growth is now expected to be 6% to 7% versus 2022, with an expected foreign currency exchange headwind of 100 basis points. We’re also updating our adjusted EPS guidance range now expecting $7.40 to $7.50. While we initially gave color that adjusted operating margin would be flat to slightly better in 2023, or Q1 results in tandem with an improved rest of your outlook gives us the confidence that we will expand operating margins this year.

We continue to expect interest and other non-operating expenses, along with our tax rate to be in line with our previous commentary. Finally, we now expect free cash flow for the year to increase to a range of $1 billion to $1.1 billion. In terms of quarterly cadence throughout the year, our expectations remain unchanged. Q1 will be the highest revenue growth quarter followed by Q4, which should benefit from improving supply and contribution from new and innovative products, as well as a selling day tailwind of about 100 basis points. Q2 and Q3 are expected to be lighter growth quarters given tougher comps and a net selling day headwind of about 100 basis points. Again, selling days will have a net neutral impact for the full year. We expect adjusted operating margin to largely follow revenue with second half operating margins being slightly better than the first half.

In summary, we delivered excellent top-line results, beating internal expectations in nearly every category while posting very strong adjusted earnings performance. Our business is executing well our pipeline is delivering and our momentum is real. We feel very confident as we move forward. With that I’ll turn the call back over to Keri to start the Q&A.

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

Q&A Session

Operator: We’ll take our first question from Steve Lichtman with Oppenheimer.

Operator: We’ll go next to Shagun Singh with RBC.

Operator: We’ll go next to Matt Taylor with Jefferies.

Operator: We’ll take our next question from Vijay Kumar with Evercore ISI.

Operator: We’ll take our next question from Robbie Marcus with JPMorgan.

Operator: We’ll go next to Matthew O’Brien with Piper Sandler.

Operator: We’ll take our next question from Joanne Wuensch with Citi.

Operator: We’ll take our next question from Lawrence Biegelsen with Wells Fargo.

Operator: We’ll take our next question from Travis Steed with Bank of America.

Keri Mattox: Thanks so much for the question. Yeah. And I think that wraps us up through the queue, and we’re at 9:30. So thanks, everyone, for your comments and your questions. The IR team is obviously available today, and we’ll continue the conversations as we go through the day. Please feel free to reach out with any others.

Operator: Thank you again for participating on in today’s conference call. You may now disconnect.