Zimmer Biomet Holdings, Inc. (NYSE:ZBH) Q4 2022 Earnings Call Transcript

Zimmer Biomet Holdings, Inc. (NYSE:ZBH) Q4 2022 Earnings Call Transcript February 3, 2023

Operator: Good morning ladies and gentlemen and welcome to the Zimmer Biomet fourth quarter 2022 earnings conference call. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded today, February 3, 2023. Following today’s presentation, there will be a question and answer session. At this time, all participants are in a listen-only mode. If you have a question, please press the star followed by the one on your pushbutton phone. I would now like to turn the conference over to Keri Mattox, Senior Vice President, Chief Communications and Administration Officer. Please go ahead.

Keri Mattox: Thank you Operator and good morning everyone. I hope you are all well and safe. Welcome to Zimmer Biomet’s fourth quarter 2022 conference call. Joining me today are Bryan Hanson, our Chairman, President and CEO; EVP and CFO, Suke 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 Q4 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, great. Thanks Keri, and thanks to all of you for joining us this morning for the call. We’ve really got three sections for the call this morning. First, I’m going to talk briefly about our fourth quarter performance and spend a few minutes on our teams, what I just define as solid execution, as well as our innovation and drivers for continued strong performance. Then for the second section, as usual, Suke will provide more detail on the quarter itself and very importantly our 2023 guidance and expectations. Then of course, we’ll close things out by addressing any questions that you might have. Before we get started, I wanted to take a minute to thank really the ZB team, just the full ZB team not only for their work in making Q4 another successful quarter but also for their resilience.

The innovative thinking and dedication to getting the job done throughout all of 2022, even in the face of very real adversity, there’s no doubt in my mind that this team is the engine that is driving us forward, so again thank you. I can tell you that I’m very proud to be on this journey with you. Now as we turn to Q4 results, know that each and every one of you made the quarter happen, and I can tell you it was a solid quarter. We again saw better than expected growth driven by continued procedure recovery, strong execution, and a solid momentum with our new innovation, and as expected, we also benefited from some favorable comps in the quarter. Inside of this, we saw another positive quarter of year-over-year momentum in large joints with our overall global hip and knee business growing more than 8% and 10% on an ex-FX basis, and our overall set category grew in the high single digits driven by strong performance in our business growth drivers, which as we said before, are supports, CMFT, and upper extremities, as well as the expected tailwind from BBP comps in our trauma business.

That said, we are clearly seeing overall market stabilization, but our fourth quarter execution and procedure recovery is still set against a macro backdrop that is challenging and fluid. Foreign currency has improved but remains a challenge and supply, inflation and staffing pressures continue. In fourth quarter, our team was once again able to navigate these challenges, flexing what I would just define as a muscle memory that I think, fortunately or unfortunately, is a bit unique to ZB and has served us well over the past year during 2022. But make no mistake – the challenges are real and they’re ongoing, but regardless of this environment with COVID mainly in the rear view mirror, I have confidence that the ZB team will continue to deliver.

Our culture, our strategy, innovation and execution are coalescing right now, driving tangible momentum and importantly belief from the team, and as a result confidence in our business continues to grow. Let me just give a few examples from Q4. In the quarter, we announced the approval of our new cementless knee form factor which is adding to our Persona family and strategically rounding out that portfolio. The first procedures have been completed with this new keel design, and the feedback, as expected, has been very positive. We continue to belief that our cementless knee penetration will grow significantly and that this differentiated, premium product can really accelerate that growth. It’s early days with full launch planned for the middle of the year, but make no mistake, this is a real growth driver for our knee franchise.

This launch builds on other recent product launches, like hip insights and our Identity shoulder system introductions, bringing now our total to more than 50 new product launches from 2018 through 2022, and importantly the largest majority of these launches came in markets we see growing in the mid single digits or better. That’s really important, being launched in markets that we see growing in the mid single digits or better. This strategic prioritization and output from our innovation pipeline has helped ZB more than double our vitality index over that time, and very importantly increase our revenue in faster growth markets and sub-markets, which of course drives positive increases in our weighted average market growth. That momentum continues.

We expect to launch another 40-plus products between now and the end of 2025, once again with the majority of those launches in 4%-plus growth markets. This will drive further increases in our vitality index and weighted average market growth, and most importantly bring real and meaningful innovation to the patients and customers that we serve. So what I know for sure is that our current momentum, very robust new product pipeline, and our strengthening balance sheet focused on accelerating our portfolio transformation positions ZB well for the future, and as a result, I feel increasingly confident about ZB’s ability to transform our business, drive growth, deliver value, and achieve our mission to alleviate pain and improve the quality of life for people around the world.

With that, I’ll turn the call over to Suke for a closer look at Q4 and again our expectations for 2023. Suke?

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Suketu Upadhyay: Thanks and good morning everyone. For today’s call, I’m going to focus on three topics: first, our fourth quarter results; second, how that performance and recent macro trends translate into our 2023 guidance; and third, I’ll provide a brief update on our long term financial priorities. With that, I’ll turn to the fourth quarter results. Unless otherwise noted, my statements will be about the fourth quarter of 2022 and how it compares to the same period in 2021, and my commentary will be on a constant currency and adjusted continuing operations basis. Net sales in the fourth quarter were $1.825 billion, an increase of 2.7% on a reported basis and an increase of 8.3% on a constant currency basis. As previously noted, we had a selling day headwind of 150 to 200 basis points that impacted each category at about the same level.

U.S. sales grew 6.2%, driven by strong elective procedure recovery and commercial execution, especially in our knee and hip businesses. In addition, the U.S. business saw strength across our three priority areas within SET. International sales grew 11.1% driven by strong procedure volumes across most markets in EMEA and APAC, in tandem with lighter comps and continued strong commercial execution. EMEA performance was driven by recovery in developed markets and continued strength in emerging markets. APAC was impacted by COVID-19 surges and lockdowns in China that were broadly offset by strength in other markets. Now turning to our business category performance, global knees grew 10.2% with U.S. knees up 10.8% and international knees up 9.3%, with strong performance driven by knee procedure recovery across most regions and an easier comp outside of the U.S. Continued global traction for our Persona knee system, including both Persona primary and revision in the U.S., and continued increase in Rosa procedure penetration and pull through.

Global hips grew 8.4% with U.S. hips up 9.5% and international hips up 10.8%, driven by strong international procedure recovery and easier comps outside the U.S., continued traction across hip products including the G7 revision system, and Avenir Complete primary hip, which is focused on the direct anterior surgical approach, and lastly continued solid Rosa pull through in the hip category, especially in the U.S. The sports extremity and trauma category grew 7.6% and was impacted by continued strong performance across our key focus areas of CMFT, sports medicine, and upper extremities. SET was also impacted by a comp tailwind from China VBP that was partially offset by reimbursement changes in restorative therapies. Finally, our other category grew 1.3%.

Moving to the P&L, for the quarter we reported GAAP diluted loss per share of $0.62 compared to GAAP diluted loss per share of $0.40 in the fourth quarter of 2021. The change was driven by higher revenues partially offset by a goodwill impairment in EMEA as a result of macro factors. On an adjusted basis, diluted earnings per share of $1.88 represented an increase from $1.79 in the fourth quarter of 2021. Adjusted gross margin was 71.7%, bringing full year gross margin to 71.2% or about in line with full year 2021, despite significant headwinds from inflationary pressure. Our adjusted operating expenses were $791 million, an increase versus the prior year due to inflationary pressures in tandem with higher investments into R&D and commercial infrastructure to support new products.

For the year, overall opex was flat to 2021 with an increase in R&D and lower SG&A. We remain disciplined in realizing efficiencies while investing in our priority areas and offsetting headwinds. Adjusted operating profit margin for the quarter was 28.3%, up slightly from the prior year, bringing total year operating margins to 27.3%, ahead of full year 2021 despite macro headwinds. The adjusted tax rate was 16.9% in the quarter, slightly higher than our expectations due to certain one-time discrete tax items. For the full year, the adjusted tax rate was 16.5% and in line with our full year guidance. Turning to cash and liquidity, operating cash flows were $244 million and free cash flow totaled $115 million for the quarter, bringing our total free cash flow for the full year to $910 million.

We continued to reduce our net debt by approximately $150 million in the fourth quarter, excluding the effect of foreign currency, and ended the quarter with cash and cash equivalents of approximately $375 million. Moving to our financial outlook for 2023, we’ve based our projections in the following key assumptions. We expect to experience procedure cancellations and staffing challenges, but the impact will be less acute than what we experienced in 2022. Supply chain headwinds will continue throughout the year but with improvement in the second half of ’23. Pricing headwinds are expected to be slightly better than our historic average of 200 to 300 basis points. Inflationary pressure will remain stable to 2022 exit, and an expected adjusted EPS dilution of about $0.05 to $0.10 due to our acquisition of Embody in the first quarter of 2023.

Against this backdrop, our expectations for the full year ’23 financial outlook are reported revenue growth in the range of 1.5% to 3.5% versus 2022, an expected foreign currency exchange headwind of approximately 150 basis points resulting in revenue growth of 3% to 5% on a constant currency basis, and adjusted diluted earnings per share in the range of $6.95 to $7.15. Inside of that guidance, at our midpoint we expect adjusted operating profit margins to be flat to slightly up compared to 2022 levels. We also expect net interest and other non-operating expenses will be about $190 million primarily due to higher interest rates. Our adjusted tax rate should be broadly in line with 2022 and total shares outstanding are expected to remain in line with full year 2022 average fully diluted shares outstanding.

Finally, we expect our free cash flow to be in the range of $925 million to $1.025 billion. In terms of cadence through the year, we expect that the constant currency revenue growth rate for the first half will be slightly higher than the growth rate in the second half, and we do expect choppiness by quarter. Q1 is projected to be our highest growth quarter due to easier comps and will be followed by the fourth quarter, driven by improved supply and innovation building throughout the year. Q2 and Q3 will be lighter quarters given tougher comps. Lastly, we don’t expect any material day rate impact of full year results; however, Q1 and Q4 will benefit by about 100 basis points of tailwind that will be offset by headwinds in Q2 and Q3. In summary, we delivered accelerated growth in 2022 with a margin profile that is better than ’21 as we overcame headwinds while investing in our priority areas.

We navigated a number of macro challenges and delivered on our commitments to all of our stakeholders. As we look forward to 2023, while the environment remains dynamic, we see a path to delivering solid growth and earnings performance with robust free cash flow. To close out, let me make a few comments about our financial priorities moving forward. We’ve made significant progress over the past few years in strengthening our balance sheet through improved financial performance and ongoing reductions in debt. This ultimately provides ZB with greater strategic flexibility as we look to transform our portfolio with a focus on increasing our WAMGR and driving improved long term growth. We will remain committed to our investment-grade rating and will continue to look at ways to accelerate profitable growth with a focus on achieving our mission.

I’m so very proud of the ZB team for their perseverance and dedication throughout 2022 and I’m excited about what we can accomplish in 2023. With that, I’ll turn the call back over to Keri.

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?

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Q&A Session

Operator: Thank you. We’ll go to Ryan Zimmerman with BTIG.

Ryan Zimmerman: All right, can you hear me okay?

Bryan Hanson: Yes, we can hear you.

Ryan Zimmerman: All right, good morning. Thanks for taking the questions, Bryan and Suke. Bryan, maybe starting with guidance, if I think back to third quarter, you were asked whether 4% organic growth was an appropriate way to think about ’23, and at the time you said ’23–you know, you didn’t see ’23 as normal. But then in January, you said we’re in a better place, procedures are kind of normal and we’d expect that to continue in ’23. So as we sit here today with guidance at, you know, 4% constant currency at the midpoint, just help us understand kind of that shift that’s occurred in the fourth quarter that gives you a more optimistic view of the year ahead. Really, the key to my question is, this 4%, do you view that as a floor, do you view that as realistic or aspirational, and just help us kind of characterize where you’re sitting in guidance and the year ahead.

Bryan Hanson: Got it, thanks for the question, Ryan. Maybe what I’ll do is, Suke, you could provide color around the way we’re thinking about guidance, because there’s a lot that goes into it. We still don’t believe it’s a normal year, obviously – there’s a lot of puts and takes on either side of the equation, but you could walk through those, perhaps, and then I will give you some color around what we’re seeing so far in January and how that’s making us feel as well. But why don’t you go ahead and start?

Suketu Upadhyay: Yes, so Ryan, thank you for the question. Good to be with everyone. First of all, I’d say we had a really good close to the year. We ended top line, bottom line, and free cash flow at the top end of our third quarter guidance, so a really strong finish. There was a number of variables behind that, but the key one is really about execution, so feel really good about the momentum that we have. As we move into 2023, some of the key variables that underpin our guidance, I talked a little bit about them on our–in the scripted remarks. The first is around stabilization related to case cancellations, staffing shortages and things of that nature. We expect that to continue to improve throughout 2023. We’re not completely at normal markets – there are still some underlying dynamics impacting the overall market, but things are definitely improving and we expect that to continue to work through the rest of this year, so procedure recovery for sure in ’23.

The other thing we have to think, though, to balance that out is we’re continuing to see supply challenges. We saw those in the fourth quarter. Our supply chain team as well as our commercial teams responded incredibly well to those challenges, but we’re assuming that those supply challenges remain at least through the first half of this year and begin to improve in the second part of this year. But as we put all that together, we’ve got a lot of confidence against our full guidance range. We’re optimistic about where trends are going and, like I said, we’re really excited about where the business is headed. I don’t know, Bryan, if you want to talk a little bit about what we’re seeing so far?