Zimmer Biomet Holdings, Inc. (NYSE:ZBH) Q2 2023 Earnings Call Transcript

Zimmer Biomet Holdings, Inc. (NYSE:ZBH) Q2 2023 Earnings Call Transcript August 1, 2023

Zimmer Biomet Holdings, Inc. beats earnings expectations. Reported EPS is $1.82, expectations were $1.81.

Operator: Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Keri Mattox, Chief Communications and Administration Officer. Please go ahead.

Keri Mattox: Thank you, operator, and good morning, everyone. Welcome to Zimmer Biomet’s Second Quarter 2023 Earnings Conference Call. Joining me today are Bryan Hanson, our Chairman, President and CEO; and EVP and CFO, Suky 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 and in addition to the inherent limitations of such forward-looking statements.

Additionally, the discussions on this call will include certain non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q2 earnings release, which can be found on our website, zimmerbiomet.com. With that, I’ll turn the call over to Bryan. Bryan?

Bryan Hanson: All right. Thanks, Keri, and thanks to everyone for joining us on the call this morning. It’s always good to be with you. But I would say it’s even a little better and certainly more fun when we have great performance in the quarter. So we’re pretty happy about the results that we get to discuss today, and I can tell you, we’re looking forward to the dialogue. And I’ll start things up, as we normally do, I’ll talk about our Q2 performance and the key drivers inside of the quarter. But I think also really important is to talk about the key drivers that we see continuing to move this business forward. And then Suky will walk us through the financial details of the quarter and importantly, discuss how we are again raising our full year financial guidance.

And then, of course, we’ll close things out with a Q&A session, and we look forward to answering your questions and having a dialogue in that session. Okay. To kick things off, I’m just going to take a step back, which I’ve been doing now for the last handful of quarters and I think deservedly so, because I want to say thank you. I want to say thank you to each and every one of our team members around the world because it’s your hard work, it’s your dedication to getting the job done that is moving this business forward. And I will tell you that I’m proud to say that you have delivered another very strong quarter, while once again making ZB a certified Great Place to Work. And you’ve done all of this while improving our scores and as a result of that, our rankings on the environmental, social and governance front.

So I think simply stated, we are doing well, while also doing good. And that means for our team members, our patients, our customers and our communities and even our planet. So once again, I want to say thank you to our team for all that you do for ZB and to move our mission forward. And most importantly, for doing it together as one team, one ZB team. Now let’s talk about the second quarter. And I’m just going to say simply, we delivered another strong quarter, again beating our own expectations. And that performance positions us to again raise our financial guidance on both the top and bottom line. And this is in the face of some pretty significant macro factors that are impacting us in the entire market. Ongoing supply challenges are very real, and I’ll talk about those in a minute, but also inflationary pressure, a tough labor market and the geopolitical landscape that is putting pressure on everybody.

But against that, I feel very confident about our pipeline, our execution and the team’s demonstrated ability to navigate these headwinds, which gives us confidence to increase our financial outlook. Okay. With that said, let’s talk about the key drivers inside of Q2, and there were some positives and there were some negatives. I’ll start with the positives, and the most important one, in my view, is that our team’s execution remains flawless. We’re seeing significant traction, probably the best we’ve ever seen with our new product innovation. And that paid dividends in the quarter for sure, but most importantly, is it pays dividends as we move this business forward. And I would say that procedure recovery continued in the quarter, again showing no meaningful impact from COVID or staffing challenges, and that allowed for a tailwind from increased provider capacity, and that resulted in backlog pull-through in the quarter.

In terms of headwinds, I would say that the team is doing a great job of managing the supply-constrained environment. But I would say that it is still very clearly a governor to our overall growth in the quarter, and it continues to be a distraction for the organization. See if I combine these things, though, all in all, our momentum continues, and it continues to grow. And I’ve said before, my confidence in this business, our confidence in this business is as high as it’s ever been. And it’s high for a good reason. If you just look at the knee franchise alone, our innovation strategy is working. We now have 4 meaningful pillars inside of this business. All of which can drive pricing stability, mix benefit and competitive conversions. First, let’s look at the ROSA Robotic Platform combined with our Persona cementless Knee.

Now this is a powerhouse combination that is and will continue to accelerate growth. And based on the traction we’re seeing so far, we continue to believe that ROSA and Persona cementless together will enhance our robotics and cementless penetration from the current mid-teen level to 50% or better, 5-0% or better. The second pillar that we’re focused on is Persona revision. This provides a meaningful conversion and mix opportunities inside the revision category. But importantly, it also acts as a powerful tip-of-the-spear product for conversions and primary needs. And then third, it’s just the overall shift of the ZB legacy knee systems to our now fully rounded out Persona portfolio. And this is a meaningful mix benefit that we can take advantage of that, I would say, is somewhat unique to our business.

And then fourth, on top of all this, we have the world’s first and only Smart Knee which is Persona iQ. And I know this is still in limited launch, but already, it offers surgeons unparalleled data access and is attractive to patients, those patients who want more direct engagement with their care recovery. And we’re taking on a similar approach to our hip portfolio where we continue to launch meaningful innovation, again, giving us the opportunity for price stability, mix benefit and competitive conversions. And we have 4 pillars of focus here as well. First, it’s ROSA and Hip Insight. These are technology shifts in robotics and mixed reality that are setting up the ZB Hip portfolio for greater adoption and growth. Second is the Avenir Complete.

This is our current flagship product combined with G7, which gives us a very strong position in both the attractive direct anterior and revision submarkets of hip. And then third, this position will be enhanced with work being done on a triple taper stem which will fully round out our direct interior approach portfolio. We believe this new portfolio, combined with the G7, which is the most versatile acetabular component available will be unmatched in the industry. And then fourth, HAMR. This is our upcoming full launch of an automated impaction system that builds on a proven need in the market, and we fully expect that this launch will create surgical efficiencies while bringing personalized precision to each and every patient. And then finally, in S.E.T., we are being disciplined and targeting investment in our growth driver categories, Upper extremities, Sports and CMFT, and each of these categories continue to perform.

And given our momentum in these businesses and continued investment in innovation and dedicated infrastructure, we fully expect the S.E.T. set business to be a mid-single-digit grower in a normalized market environment. So overall, we’re very excited about our innovation momentum. It’s very real. Remember, we’ve called out that we have 40 planned product launches between this year and the end of 2025. With the majority in 4%-plus growth markets. And that’s important because these innovations will certainly drive near-term growth. There’s no question about that, but also create better sustainability of that growth because of the markets they’re in. This portfolio shift that we’re seeing and the team’s execution capabilities are clear signs that our ZB transformation has taken hold.

But I can tell you right now that we’re not going to stop there. The goal is to continue to enhance our growth profile through our ongoing focus on active portfolio management, and that is supported by our already strong and strengthening balance sheet. And with that, I’ll turn the call over to Suky for a closer look at Q2 and our latest expectations for the remainder of 2023. Okay, Suky?

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Suketu Upadhyay: Thanks, and good morning, everyone. As Bryan noted, we had another excellent quarter. Our results were driven by strong end markets as well as strong execution across the entire organization. As a result, we are again increasing our full year financial outlook. With that, let’s turn to our results and updated full year guidance. Unless otherwise noted, my statements will be about the second quarter and how it compares to the same period in 2022. And my commentary will be on a constant currency and adjusted operating basis. Net sales were $1.870 billion, an increase of 4.9% on a reported basis and an increase of 6%, excluding the impact of foreign currency. Additionally, we had a selling day headwind of less than 50 basis points in the quarter.

Overall, the business continues to benefit from a recovery of elective procedures driven by continued market normalization, including hospital staffing and procedure cancellations returning to pre-COVID levels. We also benefited from some backlog recapture. While market momentum is strong, we continue to face certain macro challenges, including global supply chain pressures that muted performance across the business. U.S. growth of 5% continued to outpace our expectations and international growth of 7.2% was driven by strong performance in both EMEA as well as Asia Pacific. All regions benefited from continued recovery of elective procedures, backlog recapture as well as strong commercial execution and new product uptake. Turning to our business category performance.

Global Knees grew 10.5% with U.S. growing 9.8% and international growing 11.4%. The strong performance in Knees was driven by the 4 pillars that Bryan mentioned earlier, centering on a very attractive Persona portfolio, combined with the benefits of our ROSA robotics platform. Global Hips grew 4.9% with U.S. Hips up 2.7% and international up 7.1%. Both regions posted good growth on the back of new product flow, execution and market recovery. Next, the S.E.T. category was down 30 basis points year-over-year. Inside of that, we saw continued strong performance from our 3 focus areas within the business segment. As expected, we saw pressure from reimbursement headwinds within the Restorative Therapies business. In addition, we experienced more acute supply challenges within Sports and Trauma.

In the backdrop of this, we believe we will move beyond these headwinds, and this segment will rebound in the second half of the year. Finally, our Other category grew 6.5%. Now moving on to the P&L. In Q2, we reported GAAP diluted earnings per share of $1 compared to GAAP diluted earnings per share from continuing operations of $0.73 in the prior year. The increase was driven by higher revenues combined with lower nonoperating expenses due to ZimVie investment losses from the prior year that did not repeat as well as lower spend related to restructuring costs. These benefits were partially offset by increased investment in R&D and commercial initiatives to drive future growth. On an adjusted basis, we reported diluted earnings per share of $1.82 were flat to the prior year.

Higher year-over-year revenues and better gross margins were offset by higher R&D expenses, increased investments into commercial infrastructure for new product launches and higher interest expense. Our adjusted gross margin was 72%, up 40 basis points from the prior year despite absorbing current year inflationary pressures as well as pressure from prior year that was capitalized and flowing into this year’s P&L. Favorable mix and FX hedge gains also helped support the increase in gross margin. Adjusted operating margin for the second quarter was 27.5%, down 50 basis points from the prior year. While gross margin was up, this was offset by higher operating expenses due to increased investments in R&D, aligned to our plan to improve our vitality index through new product innovation as well as higher commercial infrastructure costs to support new product uptake.

Net interest and other nonoperating expenses of $57 million was higher than our expectations and significantly higher than the prior year due to certain foreign currency losses in the quarter as well as higher interest rates. Our adjusted tax rate of 16.3% was in line with expectations. Turning to cash and liquidity. Operating cash flows were $348 million and free cash flow totaled $165 million. We ended the quarter with cash and cash equivalents of $320 million. Our balance sheet remains strong, providing strategic and financial flexibility for future growth. Moving to our updated financial outlook for 2023. Based on another strong quarter of results, we are again raising our full year 2023 outlook. We are confident that we will continue to grow our top line above market rates and expand operating margin while continuing to reinvest in our business for future growth.

We are increasing and narrowing our constant currency revenue growth range to 7% to 7.5% with an expected foreign currency exchange headwind of 50 basis points. We are also increasing our adjusted EPS guidance range to $7.47 to $7.57. Additionally, due to certain FX-related pressures and higher interest rates, we now expect net interest and other nonoperating expenses to be around $200 million for the year. Our expectation around tax rate and total shares outstanding remains unchanged. And we continue to expect free cash flow to be in the range of $1 billion to $1.1 billion. Our Q3 and Q4 revenue cadence expectations are unchanged. Q3 revenue dollars are expected to be sequentially down versus Q2 and in line with normal seasonality, and Q4 will be our strongest quarter on a dollar basis.

While we expect momentum gained from the first half to flow into the second half of the year, recent and new sanctions on Russia may mute growth. And regarding selling day impact, we continue to expect Q3 to have a selling day headwind of about 150 basis points, while Q4 will have about 100 basis point tailwind. Overall, the net day rate impact for the full year is not meaningful. From a margin perspective, we expect Q3 to be our low watermark for the year from both a gross margin and operating margin standpoint. While gross margin will have less variability from quarter-to-quarter, we expect Q3 operating margin to step down sequentially between 150 and 200 basis points due to the normal seasonality of our business. We expect Q4 to step up significantly on a sequential basis, delivering our highest operating margin for the year.

Importantly, we remain committed to investing for future growth while delivering meaningful full year margin expansion in 2023. We’re really pleased with how our team is navigating a challenging environment. In summary, we delivered another quarter of excellent top line results, beating our expectations while managing very real supply chain challenges. We are building on our early momentum through continued execution and are again able to increase our full year guidance. We are also reiterating our confidence and expectation to be a 4% plus or even mid-single-digit top line grower in a normalized market while delivering strong earnings. In short, our business has never been stronger. With that, I’ll turn the call back over to Keri.

Keri Mattox: Thanks, Suky. 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?

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Q&A Session

Operator: [Operator Instructions]. We’ll go first to Travis Steed with Bank of America.

Travis Steed: Good Morning Bryan and Suky. Nice quarter. I guess I’d start out with looking at the Hips and Knees in the quarter. I would think that knees 2x the growth rate of hip this quarter, backlog will be similar there. Is the elevated knee growth, mostly the mix shift from cementless and ROSA coming through? I’m curious how much supply is limiting growth in Hips and Knees here and what you’re assuming about that improving in the back half?

Bryan Hanson: Thanks, Travis. Well I think maybe I’ll do because obviously, Ivan is here with us and as close to the action as any of us. So maybe I’ll pass it on him to answer the question. Ivan?

Ivan Tornos: I will say that the growth in knees is mainly innovation. We continue to see great momentum with ROSA penetration, so a pretty dramatic increase in penetration in the U.S. and core markets OUS. The launch of Persona OsseoTi or cementless launch is gaining great traction here in the U.S. In the prepared remarks, Bryan mentioned how we plan to go from 15%, 1-5 to 5-0- I won’t disclose where we are in Q2, but it was a significant uptake in that side as well. We did also see great momentum in the ASC. We continue to grow here in the U.S. double digit in the ASC space. And yes, there was some backlog in key markets around the world. We saw better backlog consumption in EMEA than here in the U.S., but nonetheless backlog was part of the performance.

And to the latter part of your question, certainly, supply was a governor. I do believe — we do believe that in a normal environment with better supply or already very compelling growth rate could have been even higher. But all summarize backlog, innovation and great commercial execution were the key drivers behind the knee performance.

Travis Steed: Great. And I guess looking forward that the sustainability of this kind of the plus and the 4 plus, and I think I heard the comment even mid-single-digit growth. It sounds like even with some tougher comps you’re still confident in that seeing the plus in the 4 plus? And I assume that price is better. You got the mix of backlog is probably still lasting through 2024. I just kind of love to hear your confidence in kind of seeing the upside to that 4-plus?

Suketu Upadhyay: Yes. Travis, this is Suky. So yes, very perceptive on our comments. Yes, we’ve got confidence in our business in a normalized environment that we’re going to be at 4 plus or, as I said, a mid-single-digit grower. There’s a few things. First, I focus on qualitatively execution is incredibly strong. Right now, we’ve got — if you think about — our WAMGR, weighted average market growth continues to improve. That’s been steadily improving, one, by investing in R&D organically in higher-growth submarkets even within recon, but then in sports, Extremity and Trauma, and then if you look at the M&A that we’ve been doing, it’s been in higher growth markets in Sports, Upper Extremities as well as CMFT. So overall, our weighted average market growth has been improving.

Next, it’s really around our innovation and what that innovation brings in terms of the ability to compete in the market, what it brings relative to share of wallet as well as mix is all very positive as well. And then the last is our performance relative to market. I think we’ve demonstrated for a number of quarters now that we can perform at or better than market on a consistent basis. So really execution is the primary driver why we’ve got confidence behind that. And secondly, you’re also seeing some improving market dynamics. One, we think that overall, the patient dynamics are changing. You’re seeing a lowering of the average age of our patients. That’s expanding our overall market. Two, we think that they’re getting more confident in the outcomes of recon procedures and sports procedures, again, because the technology, the innovation is improving, we’re bringing real value to the marketplace.