Zimmer Biomet Q2 2021 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2021

There are 15 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Second Quarter 2021 Earnings Conference Call. As a reminder, conference is being recorded today, August 3, 2021. Following today's presentation, there will be a question and answer session. At this time, all participants are in a listen only mode. I would now like to turn the conference over to Keri Maddox, Senior Vice President, Investor Relations and Chief Communications Officer.

Operator

Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. I hope you are all well and safe. Welcome to Zimmer Biomet's 2nd Quarter 2021 Earnings Conference Call. Joining me today are Brian Hanson, our Chairman, President and CEO and EVP and CFO, Suki Upadhyay. Before we get started, I'd like to remind you that our comments during this call will include forward looking statements.

Speaker 1

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 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 now turn the call over to Brian. Brian?

Speaker 2

All right. Great. Thanks, Carrie, and thanks to everyone for joining us for our call this morning. As we're all aware, obviously, given the news recently, COVID is still very much with us and we're watching it very closely, as

Speaker 3

you can

Speaker 2

imagine. But given that even, we've seen some real progress since our last call and I think that's obvious to everybody. The world has not returned to normalcy yet, but Travel is returning. We have more team members in our offices and I am personally looking forward to attending the AAOS meeting in about a month in San Diego. So really looking forward to that meeting.

Speaker 2

We have a lot of great technology that we're going to be able to showcase there and just really happy it's going to be in person again finally. I want to thank in that same vein, thank our team again for their dedication to safety and really just across The Board, their commitment to making all of our ZB Manufacturing facilities and offices as safe as we possibly can. You, our team members, are the driving force for this progress that we've seen in our own facilities and certainly in our communities as well. Also want to say that I hope in our investor community that you're continuing to stay safe and have been hopefully able to travel over the last few months to see family and friends. This is an opportunity for us to take advantage of some travel as we begin to turn to more of a normal environment, of course not there yet and we know this isn't happening Inconsistently anyway in all regions, but overall, we are encouraged and we're doing our part to keep this moving forward.

Speaker 2

And Every single day, we are supporting our customers and patients that they serve. And we're doing this safely, obviously, But this is a big focus for us as a mission driven organization to be there for our customers, so they can complete the procedures that they have And we can make sure that the patients receive the care that they deserve. And with that, I think it's a good lead into our Q2 call. Today, I'm just going to spend here in the beginning just a few minutes on a couple of quick remarks and then I'm going to turn it over to Suki, who's going to get right into a deeper view of our Q2 results And I think most importantly, our 2021 guidance view on a go forward basis. And then I'll come back to close out the call with some updates on our active I'll wait to do that after he provides the guidance information.

Speaker 2

So just to set him up a little bit, overall, let me just say that Performance in the quarter improved meaningfully from the Q1 of this year, and that was pretty much across all regions and product categories. And as recovery When the global pandemic continued

Speaker 3

to take hold, we saw that

Speaker 2

the recovery in our procedures also move in the right direction. While we certainly anticipate some ongoing COVID pressure, we currently think it's going to be manageable by hospitals and we expect that the recovery will continue to build sequentially throughout the second half of twenty twenty one. Again, not out of the woods yet, But we do believe, thanks to the hospital's ability to better manage these COVID patients and the vaccine rollout continuing, we believe it will be manageable through the back half And with that, I'm going to turn it over to Suki for our financial update and then I'll be back with you in a few minutes to close out the call before the Q and A.

Speaker 4

Thanks and good morning everyone. For this morning's call, I'm going to discuss our Q2 results, walk through the updates we've made to our full year 2020 one financial guidance and provide color around our current expectations for the 3rd Q4. Moving forward, unless otherwise noted, my statements will be about the Q2 2021 and how it compares to the same period in 2020. And my revenue and P and L commentary will be on a constant currency or adjusted basis. Also, I'll provide constant currency revenue growth versus 2019 as we think that is a more relevant comparison for this quarter.

Speaker 4

Net sales in the 2nd quarter were $2,027,000,000 A reported increase of 65.3 percent and an increase of 60.7% on a constant currency basis versus the same period in 2020. When compared to the Q2 of 2019, net sales were flat on a constant currency basis And we did not have a material impact from selling days. Overall, consolidated and regional results were slightly better The expectations we provided on our last quarterly call with growth versus 2019 in the Americas and Asia Pacific and sequential improvement in EMEA. For the quarter, the Americas increased 68.3 were up 1.9% versus 2019. We continue to see variability by country within the region with the U.

Speaker 4

S. Growing 66.2 percent or 3.3% versus 2019. EMEA grew 80.5 percent or down 7.3% versus 2019 with continued COVID pressure being a factor. We did see improvement in EMEA as we move through the quarter and we expect that trend to continue through the back half of this year. Lastly, Asia Pacific grew 24.4 percent or 2.8% versus 2019 in spite of some unexpected headwinds.

Speaker 4

While the region has been largely stable in recent quarters, it was impacted late in the second quarter by channel inventory contraction in our knee and hip categories within China in advance of the rollout of volume based procurement or VBP. In addition, we saw a resurgence and increase of COVID-nineteen in a number of markets including Japan. Despite these headwinds, the region continued Turning to our business categories. The global knee business increased 72.2% or down 6 0.3% versus 2019. In the U.

Speaker 4

S, knees increased 77% or was flat versus 2019. While we are seeing sequential improvement in the recovery of procedural volumes in large joints, the path back to normalized market growth is taking a bit longer than most Still we continue to be encouraged by the team's execution and ongoing strong momentum for Persona and Rosanie. Our global hip business increased 39.9 percent or down 2.8% versus 2019. In the U. S, HIP grew 46.6 percent or up 3.1% versus 2019.

Speaker 4

Strong demand and favorable feedback continues for the Avenir which continued adoption for both gold and platinum accounts. The sports, extremities and trauma category increased 53% or up 10.8% versus 2019, driven by solid growth in sports medicine, CMFT and upper extremities. We continue to see strong surgeon registrations of the Signature 1 surgical planning system for shoulder procedures. Our dental and spine category grew 69.4% or up 0.8% versus 2019 fueled by recovery in dental. New products and better commercial execution drove growth in the quarter with strong contributions from implants and digital solutions in our dental business.

Speaker 4

Finally, our other category grew 105.9% or up 7.5% versus 2019. This reflects the ongoing demand for ROSA Robotics And strong capital purchases in the quarter. We saw improvements both sequentially in versus Q2 2020 in units sold as well as increased revenues from software due to launch of our partial knee application. Moving on to the P and L. For the quarter, we reported GAAP diluted earnings per share of $0.67 Our reported GAAP diluted earnings per share were up The increase in year over year GAAP earnings was driven by higher revenue offset by normalized spending levels and IPRD investments within the quarter.

Speaker 4

In addition, the Q2 of 2020 had some one time GAAP charges that did not repeat. On an adjusted basis, diluted earnings per share of $1.90 was significantly higher than the prior year, driven as expected by the recovery of elective procedures since the Pandemic trough in the Q2 of 2020. Adjusted gross margin was 71.7% and in line with expectations. Our adjusted operating expenses of $923,000,000 stepped up sequentially versus the Q1 due to higher variable selling expenses related to higher sales and increased discretionary spending to support investments in commercial infrastructure and innovation through R and D. Improved revenue performance and stable gross margins more than offset higher spending to drive 26.2 operating margins, a slight improvement over the Q1 of this year.

Speaker 4

The adjusted tax rate of 16.5% in the quarter was in line with our expectations. Turning to cash and liquidity. For the quarter, operating cash flows were $453,900,000 and free cash flow was robust at $358,700,000 and we ended the 2nd quarter with cash and cash equivalents of just over $1,000,000,000 We continue to make good progress on deleveraging the balance sheet and expect to make another $300,000,000 in debt repayments in the 3rd quarter. Moving to our financial guidance. As noted in this morning's press release, we have updated our full year 2021 outlook.

Speaker 4

We are tightening our guidance range to better reflect our year to date performance and a more informed view of the potential impact of COVID. There are some key assumptions that underpin our 2021 financial guidance. We assume no worsening of elective procedure trends due to COVID And that procedure volume recovery continues in the second half of the year, but recovery may not be linear by region and or by product category. We also expect to see seasonality impact the 3rd Q4 as we have observed in prior years. With the narrowing of our guidance range, we are now expecting reported revenue growth to be 14.5% to 16.5% versus 2020.

Speaker 4

With the impact of foreign currency unchanged at about 150 basis points of a tailwind for the full year. On a constant currency basis compared to 2019, we expect Q3 to grow sequentially over Q2 and for that improvement to continue in the Q4. Turning to the P and L, our adjusted diluted earnings per share is now in the range of $7.65 to $7.95 and we have narrowed our adjusted operating margin projection to be 26.5% to 27% for the full year. Our updated EPS guidance reflects our performance to date, our expectation of improved growth in the second half and that discretionary operating expenses remain consistent with Q2 through the balance of the year. While operating margins are expected Decline sequentially in the 3rd quarter in line with lower sales revenue and steady investment levels versus the 2nd quarter, We expect overall second half operating margins to be stronger than first half operating margins.

Speaker 4

Our adjusted tax rate projection is unchanged at 16% to 16.5% for the full year. And finally, our free cash flow Estimates remain in a range of $900,000,000 to $1,100,000,000 We will continue to update you on market dynamics and financial expectations as we move through the remainder of the year. To summarize, our performance in Q2 was slightly better than our that we have communicated to you through the Q2. While we anticipate some ongoing COVID pressure, we have more confidence in the momentum of the recovery and our ability to execute against that backdrop. With that, I'll turn the call back over to Brian.

Speaker 5

All right. Thanks, Suki. And I'm going to now just hit 3 topics before we move to Q and A. First, I want to talk about execution And some of the product and pipeline highlights that we have under that category. 2nd, I'm going to talk about our progress against active portfolio management, Which is a big effort for us, obviously.

Speaker 5

And then there is innovation. And inside of that innovation, how we believe we're going to be able to drive attractive long term growth That ultimately will deliver value to you, our shareholders. So let's start with our team's execution. I've said this before and I'll continue to say it that the things that Zeebee was able to directly control over the past year, year and a half, the team is They delivered against and I'm very proud of the team for doing that during a time of significant turbulence around them. And in Q2, in the recent weeks, we've

Speaker 3

hit key milestones with our ZV products and

Speaker 5

our solutions. Rosa, for With our ZV products and our solutions, Rosa for partial knee was approved back in April as we've talked about before and our first patient surgery was We performed early in the quarter and we've continued to see good traction with that technology so far and great feedback And it's important for us because partial knee, as I think most of you know, is a market where Zeebe has a sizable market share position. So we're very excited about the possibilities here, not just from a revenue standpoint, but also the potential impact for patients in the surgery area. And then if I

Speaker 2

just look at ROSA overall, we

Speaker 5

did see another strong quarter in Q2 of market demand and traction with ROSA Total Knee as well With placement momentum broadly continuing across the world, not just in the U. S, but internationally as well. And that's important. We want to see strength in the U. S, but we want to see that OUS And we did get to see that kind of mix again in Q2.

Speaker 5

We also saw capital expenses for our customers being much stronger in Q2. And as a result of that, we saw a shift back to upfront sales of ROSA. So more of those happened in Q2 than what we would And again, that just speaks to the strength of capital budgets and people's desire to acquire in that way. But what is clear is that there's a real focus for Hospitals to be bringing in robotic systems for their ORs, whether they buy them outright or they get them through other arrangements. Either way that momentum, that demand is very real.

Speaker 5

EnRosa continues to be a cornerstone, one of the key ones of our ZB Edge suite of connected solutions and our forward looking robotics pipeline is going to be robust as a result of That's a big part of our strategy. So again, a lot of enthusiasm on what that will mean in coming years in terms of expansion of indications and overall robotics penetration for ZB. Also in the quarter, we saw revision continue its very strong momentum. Again, this is a great tip of the spear product Where we can go in and get competitive conversions and revision, but also use those competitive conversions for access to the typical total knee as well for that surgeon. So very exciting not just on the revision side, but also opening the door to a much larger opportunity to get their typical knee conversion as well.

Speaker 5

We're also excited about adding another key variable to our ZB Edge portfolio of connected technologies and that is our Persona IQ, which will be 1st and only smart implant on the market. And we certainly still have to get FDA approval on that. We're working diligently with them to help with any information they need to move that forward. And we're certainly hoping to receive approval in Short term, but ultimately again that timeline is up to the FDA. And it's important for us because it takes the Persona implant, which is that known and trusted design in an And it combines it with Canary Medical's Tibial Extension, which has the sensor technology in it.

Speaker 5

And the combination of those two things will now inside the body Give us an opportunity to measure the range of motion of that patient's step count, walking speed and other mobility metrics That we believe are going to be indicators of post surgery progress. So again, helping us close the loop in those connected technologies that we have in ZB Edge. So more to come when we hear back from the FDA, but once we do get that approval, we would look to limited launch the technology for a quarter or 2 And then post that timeframe move into full launch. Okay. So let's move to my second topic that is on active portfolio management and our efforts around active portfolio management.

Speaker 5

We have the ZB portfolio management strategy in place. We have the right process in place And we have definitely built our capabilities to move this forward over the last year and a half to 2 years. So we're excited about this phase of the organization. And we're focused, as we said before, on mission centric M and A that is WAMGR accretive. So in other words, weighted average market growth accretive to the organization.

Speaker 5

And you've seen us move this forward already with the selective tuck in acquisitions that we did late last year that really illustrate our strategy at work. These are smaller deals, again tuck in size deals that were designed to fill portfolio gaps and better position us as an organization in high growth, high priority markets like Sports Medicine, ASC, and external closure, we truly do believe we have a right to win in attractive markets with strong profitability. And of course, there is the planned spin off transaction of our spine and dental businesses that is fully underway and on track. We continue to be encouraged By the energy and the momentum around NewCo as CEO of Afajamali builds out his team and refines his corporate strategy And we believe creates 2 independent and even stronger companies that is going to maximize value for not just our customers, but also for you, our shareholders. All right.

Speaker 5

And that brings me to the last topic that we have before we move

Speaker 3

to the Q and A

Speaker 5

and that's going to be around innovation. And really inside of innovation, How we see our ability to drive attractive long term growth that will ultimately deliver value to all of our stakeholders, including you, obviously, our shareholders. We are focused on evolving ZV from what I would define as a metal and plastic provider of implants into a leading medtech innovator. We have a lot of shots on goal across a number of programs to do this, including a number of robotics launches over the near term, Smart implants that we have today, but also the technology roadmap that we have in Smart Implants, new functionality with Mymobility and really just the broader ZB Edge Ecosystem of those connected technologies that are going to help us drive mix benefit and share of wallet benefit, but also competitive conversions. And I've mentioned before, more than 70% of our new product development investment is directed towards ZB Edge and those Technologies inside of ZB Edge.

Speaker 5

And our exclusive partnership with Apple continues to be productive and collaborative. And we forged several other Alliances that we know are going to drive future innovation that will benefit patients. And I believe this fundamental shift is coming For ZB and for our core markets with technology advancements potentially changing the care paradigm for patients in the future and that's really what our focus is. So the momentum is real on the innovation front and we think it will ultimately allow us to drive long term growth that is very attractive to us and to you. And most importantly, it also gives Zbee the chance to really change the lives of patients around the world.

Speaker 5

All right. And let me close by saying that I continue to be highly confident in the ZB team and our business momentum. While there continues to be uncertainty due to the global pandemic that we cannot control, I truly believe that we are ready and well positioned for success And our strategy is absolutely working. The transformation of our business is well underway and I'm excited about the value we can drive for our shareholders on a go forward basis. I also want to make sure that I take the time to thank the entire ZB team.

Speaker 5

Your dedication to safety is critical and your focus on delivering on our mission is unmatched You do it daily. I remain incredibly proud of what we're accomplishing and what we're accomplishing together. And with that, I'm going to turn it back to Keri for our Q and A session. Carrie?

Speaker 1

Thanks, Brian. Before we start the Q and A session, just a 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?

Operator

Thank you. Ladies and gentlemen, at this time, we will now begin the question and answer session. Our first question comes from Josh Jennings with Cowen.

Speaker 6

Good morning. Thanks for the update and thanks for taking the questions. Brian, I was hoping you could just share How internally your team has been tracking Zimmer Biomet's U. S. Hip and knee market share and any breakout of And the progress in the de novo and revision segments would be helpful.

Speaker 6

And then as you think about your revenue growth acceleration journey post spin, Do you envision the introduction of enabling and sensor technologies driving that positive mix shift And expanding or accelerating U. S. Knee and hip WAMGR up into the mid single digits or how do you see the U. S. Large joint markets Growth evolving in the next coming years.

Speaker 6

Thanks for taking the questions.

Speaker 3

Yes. No problem, Josh. Let me start maybe with the second part of your question, because I would say beyond sensors, just what we define as ZB Edge, Which is these interconnected technologies that actually do pull data for the patient journey. We really do believe that those technologies including robotics, Sensors in the body, my mobility, ortho intel, so on and so forth, will absolutely bend the curve When it comes to growth rate in knees and hips and other areas as well because we would proliferate those beyond just knees and hips. So I just I do believe that that technology Which is being absorbed by the folks in orthopedics right now does provide us an opportunity to enhance our growth rate as an organization For two reasons.

Speaker 3

1, because I do believe that we can get that share of wallet benefit or mix benefit per procedure. And 2, I really do believe it sets us up to take share The competition because it's unique to us. So yes, on the second question, I see that as being able to enhance our growth rate. When I think about the share, I'm pretty focused on this as you would imagine. This is something that in a turbulent market, We got to pay attention to it.

Speaker 3

And when I think about the last five quarters that we've seen, we just had abnormally large spreads between the top and the bottom player in large joints. This speaks to just a very turbulent market that we're experiencing because of COVID. And inside of this, I'm Ultra focused on share gains or losses, because it's the very thing that would tell us whether we're performing well Versus our competition, because the market itself is difficult to understand. And I'm focused on this in regular times, but I'm ultra focused on it during turbulent times. And that said, in a normal I try not to get too excited or depleted based on any individual quarter performance.

Speaker 3

There's just too many variables inside of an individual quarter, particularly now. But what I do is to take a look at a rolling 4 quarters and that's the way we do it every time we see results out. When I think about the rolling 4 quarters, particularly prior to Q2, we definitely took share in our large joints Market, we didn't beat every competitor every quarter, but every quarter over the 4 quarters preceding Q2, we were ahead of market in both knees and hips. And that obviously gives us confidence as we move forward. So I really try to look at it with the data that's provided from the major companies That is public to all of us and I just track that over a 4 quarter rolling period to determine whether we are or not taking share.

Speaker 3

And I do believe that even though it's been positive for us over those 5 quarters, I do believe the technology that we're launching is going to enhance that going forward.

Operator

Our next question comes from Vijay Kumar with Evercore ISI.

Speaker 7

Hey, guys. Thanks for taking my question. Brian, I'll roll both of my questions into Back to your prior comments here on share gains versus the market. But I guess the street is focused more on Near term sequential trends here. Why would Zimmer perhaps be seeing different trends versus your peers?

Speaker 7

I think you made some comments about And the backlog burn being a little bit slower, etcetera. Maybe put that in perspective for us. And my second question is, Your Rose, I think one of the key advantages of the system is ease of use, the higher throughput. Given there is a backlog, are you seeing increased traction here? Are customers appreciating this speed advantage of Froza?

Speaker 7

And what does that translate to total installed base or share gains perhaps for Zimmer?

Speaker 3

Yes. So maybe I'll start with the ROSA throughput. And as you probably remember, we spent a lot of time thinking about the design characteristics of ROSA. One of the primary things we want to focus on is to make sure that we did not disrupt the surgical flow and certainly did not want to add time to the surgical procedure. And that has benefited us.

Speaker 3

There's no question. To me, it wouldn't matter whether we're in a COVID environment or a non COVID environment. That is something that our surgeons are pursuing and they very much appreciate the fact that it's not disrupting their flow and it's not dramatically increasing Any of the other times to do procedures. So that is a benefit for us for sure. And again, I don't think it really matters whether you're in a COVID environment or not, but that's just a benefit.

Speaker 3

One of the things relative to share gains that you talked about in our view on backlog, I don't know that our outlook in What we've described is really any different than anyone else who plays in large joints like us with such a significant share position. It seems pretty consistent with to me anyway. If I think about the deferred patients, I just say that like most people at this point, That just becomes more challenging now as time continues to be added to the equation. It's just unprecedented right now that what we're dealing with just And how long this has gone on, and there are just too many variables in my view to really size this appropriately. And I think anyone would probably say this now.

Speaker 4

But that said, we still believe

Speaker 3

that there's been no structural shift in the disease state. That's what we've been saying all along. And as a result of that, there's got to be a sizable deferred patient population out there. And when we originally analyzed what we thought would happen with that deferred population, we looked at Q3 of last year And we assume that when based on what we saw in Q3 that when the vaccine was available, you would have a pretty significant return of deferred patients relatively quickly. Again, that's what we saw in parts of Q3 last year when the virus was subsiding.

Speaker 3

So we just assume that would happen this year. Now, fast forward today, the vaccine is here and we've got more current data and more data points that are playing out right now. And we've got more current data and more data points that are playing out right now. And this doesn't seem to be materializing for anybody. And as such, our current thinking is that deferred patient demand will likely come at a more gradual pace and probably be more consistent over a longer term period of time as So, I think that's really what we're contemplating by the way when you think about the midpoint of the revenue range that we just provided, the implied range for the back half of the year.

Speaker 3

That actually is the top of that range. As I think most people would say, we would need to see a change in the current pacing of that recovery. So in other words, You'd have to see it reflect an increase in deferred patient demand that would also be matched by capacity increases to get to that top end of the range. Hopefully that helps.

Speaker 7

No, that's helpful. Thanks guys.

Speaker 1

Thanks, P. J.

Operator

Our next question comes from Anthony Petrone with Jefferies.

Speaker 8

Thanks. Hope everyone is doing well. And maybe just a quick follow-up on backlog. Is it safe too soon, Brian, That it's still short of at least a $700,000,000 opportunity and that perhaps Could certainly extend into 2022, but maybe even beyond a bit. It sounds like perhaps that's where you're headed.

Speaker 8

And then a few quick follow ups on PersonaIQ. It does sound to us from our checks that there is pent up demand for the sensing capability. So a few questions here. Do you need to be standardized on ZB Edge to take full advantage of the implantable recorder? And will Persona IQ actually drive additional surgeon reimbursement over time?

Speaker 8

Thanks again.

Speaker 3

Sure. So maybe I'll start with the backlog just because it's maybe a simpler answer. I just I don't Want to try to size it because I think it's gone on too long. And as I said before, I just don't know how we look at this unprecedented situation and try to put a size to it. All I would say is that based on our assumption of no structural change in the disease data, it's got to be big.

Speaker 3

I'll leave it at that, but I don't want to try to size it. And yes, my current thinking is based on the data points that are available to us is that it's likely going to be a slower roll with that deferred patient group coming in And that would indicate that this should take a while for us to work through it. That could change at any time, but that's the data points that we have right now. Relative to IQ, I'm glad that you're hearing there's pent up demand because certainly we're feeling that as well and we're getting excited about the launch, pending launch. Now we still obviously cannot market the technology because we don't have FDA approval, but we do believe that that should be coming soon.

Speaker 3

And yes, we're excited about it, but you do not actually need to have the full ZB Edge infrastructure to take advantage of it. What we would like to see people do Is to have Mymobility and the PersonaIQ combined, because we believe the combination of the data collection between those two It's extremely beneficial, but you don't really even need that, but that would be the goal for us to have that move in concert and be able to have the MyMobility In concert with the IQ implant. And we do feel that all the components are there for remote patient monitoring. That's the whole idea behind this Through MyMobility, through IQ is to be able to remote patient monitor and as a result of that input provided, you'll be able to make decisions on what You do or don't want to do with the patient. And so we believe that we have what would be required for a surgeon to get a reimbursement for RPM.

Speaker 3

So that's the way we're looking at today. At the end of the day, it's not our decision on whether it happens or not, but we do believe we have the components to make that available to surgeons.

Speaker 4

Thanks again. Sure.

Operator

Our next question comes from Steven Lichtman with Oppenheimer.

Speaker 9

Thank you. Hi, guys. I'll ask my 2 upfront. Brian, you talked about the momentum sequentially And Rosa, obviously we saw that in the reported numbers. As we think about the implant pull through opportunities, can you give us a sense of what And then Suki, just as a follow-up on gross margin in the first half, Ran ahead of the second half of twenty twenty.

Speaker 9

Do you see upside to your original expectations for 2021 on gross margin, which I think was to be about in line with the second half of last year? Thanks.

Speaker 3

Great. Stephen, I'll go ahead and start with the ROSA question and then, Suki, I'll pass it off to you. I would just say that, yes, again, we're excited about the traction we're seeing. And as the way I look at this, it's not just The traction that we're seeing with ROSA, I'm excited because there seems to be a significant openness in orthopedics for technology And that's really important, I think for 2 major reasons. 1, because I truly do believe the technology is going to change the care paradigm for patients.

Speaker 3

You're going to get better And when you have that happen, I believe more patients will enter the funnel because they're going to have higher confidence in the procedure. Remember, there's still 20% of knee patients that are not happy with the outcome. And if we can reduce that through technology, I believe you've got patients sitting on the side In Orthopedics overall. And when we think about our placements, it's interesting because we focus in 2 major areas. We spend most of our time in platinum accounts and gold accounts.

Speaker 3

And both of those would just be very large accounts. The difference between the 2 would be platinum, we have A higher share position and in gold, we have a lower share position, but those are the two areas that we concentrate mostly with ZV Edge and ROSA. Now what's interesting about that though is even when we go into that Platinum account, it's very rare that we would have a homogeneous knee usage in the account. So even when we get a platinum customer that is using us in knee to move into ROSA, we typically get competitive conversions to ROSA Because you have competitive surgeons in those accounts. And of course, in gold accounts, you get the same thing.

Speaker 3

So it's almost every placement that we have, very rarely otherwise,

Speaker 4

Yes. Hi, Stephen, it's Suki. Good morning. You're right. When we talked about gross margin for 2021, We talked about it being stable to back half of twenty twenty, right?

Speaker 4

We said it may not be the same for each quarter because there are a lot of variables that impact gross margin. But we said broadly that it would be in line or stable and that comes off with many years of declining gross margin. So it's a good first step in actually seeing that stability. First half fortunately was a little bit better than the back half of last year and so we're encouraged by that. We expect the second half of this year Pretty much in line with the second half of last year.

Speaker 4

So very consistent with how we previously guided. When you average those 2 together, the first half of this year being a little stronger And the second half being in line that would suggest that the full year should be slightly better than what we saw in the back half of last year. So we're encouraged by what we're seeing there. I do want to just thank and recognize the supply chain team as well as the commercial team for a lot of great efforts on our cost down initiatives, Looking more strategically at E and O and really looking for opportunities to become more efficient And our cost of goods just overall. So seeing some good progress so far, so we're encouraged and that's how we thought about and that's what's baked into our guidance moving forward.

Speaker 9

Great. Thank you, guys.

Operator

Our next question comes from Larry Biegelsen with Wells Fargo.

Speaker 10

Good morning. Thanks for taking the questions. Suki, I just want to make sure I'm understanding the second half revenue guidance and cadence. When I look back before 2020, the last 5 or 6 years, Q3 is typically down about 6% and Q4 is typically up about 11 percent sequentially quarter over quarter. Based on your comments earlier, I thought I heard you say Q3 would be down maybe 3%, But Q4 would be up, call it, 14% to 15% to kind of get to your midpoint of your guidance.

Speaker 10

So it's better than kind of we've historically seen. Can you comment on July trends? And am I right to think that you expect a little bit better seasonality in the second half Of 2021 versus what you've typically seen? Thanks for taking the question.

Speaker 4

Yes, absolutely. So my comments earlier in the call were really versus 2019, and so that's kind of where I'll play for this answer. We do expect to see Seasonality, on an absolute basis, Q3 generally tends to be lower in absolute sales dollar than Q4. And we That to play through for the second half of this year as well. We do expect versus 2019 where Q2 was about flat as we mentioned earlier for the Q3 to step up and as you suggested that is a little bit better than what we've seen historically, but it really underpins The continued recovery, which ultimately underpins our guide for the back half of the year and then again for that to step up Again sequentially in Q4, again all versus 2019.

Speaker 4

So that's how we currently see it. And again, it's Pretty much based on that continued recovery that we've already seen in Q2. What we've seen early on in Q3, we're not going to Talk about individual or specific months as we move through the rest of this year. But so far what we've seen in July underpins and supports what we've provided earlier today.

Speaker 3

Hey, Suki, let me just add some color to that. How are you doing, Larry? I just when I think about what Sufi just referenced that we've got a pretty significant assumption in our guidance range that says COVID pressure doesn't Get worse and the recovery built through the second half. But we didn't just assume that. There are some proof points that we're seeing and that might speak to your question, Larry, Maybe a little more.

Speaker 3

There's really kind of 2 things that we're seeing that would give us confidence in that assumption. And the first one is that even with the recent Virus surges that are all over the news. I mean, if you can't look at the news anytime during the day and not see something about the virus surge, But it doesn't seem to be translating into the same significant revenue disruption that we've seen in the past and that's certainly not helping us, But it's not translating into that same kind of revenue disruption we've seen in the past. So and I believe that's likely because you've got more vaccines out there, Which is impacting the way people feel when they get sick, but also I just think that hospitals seem to be managing this patient population better. And the second kind of proof point for us when we thought about this as an assumption inside the guidance range is that the vaccine is available.

Speaker 3

I mean, let's face it, it's available globally anywhere, Anybody who wants it can get it. And I truly do believe even though it stalled a bit in certain parts of the world, I do believe as people get more educated on the delta variant And the risk associated with that, that may be a good motivator for people to come in that have been waiting to actually get the vaccine. And so those are kind of the proof points that we have to give us confidence that we should see that continued recovery in the back half. Thanks, Brian. Sure.

Operator

Our next question comes from Chris Pasquale with Guggenheim.

Speaker 11

Thanks. Two questions, just trying to understand some of the moving pieces in the quarter a little bit better. First, Can you quantify at all the impact of the China inventory drawdown? It did seem like Asia Pacific was the source of the shortfall versus consensus in hips And knees this quarter, so it'd be great to just understand magnitude there a little bit better. And then can you put any numbers around the ROSA contribution In this quarter, the other revenue line was a big upside driver.

Speaker 11

It would just be helpful to know how much of that came from increased system volume Versus that shift in the preference between placements and upfront purchases for your customers?

Speaker 3

Yes. So maybe Suki, why don't I take a shot at the ROSA piece and then I'll pass it to you on VBP impact. But on the ROSA side, I probably don't want to speak Specifically to the dollar amount, but obviously it was a big enough shift for us to talk about it. So that might help you kind of size it in your mind. But what I would tell you is that the way I think about it is in a normal quarter, what we would typically see is better than 50% of our placements being done Through a long term contract, which is that we actually like that, because it does link us to the customer and it usually has a competitive pull through commitment as a result of that arrangement.

Speaker 3

And in this quarter, we just saw that flip, the higher than 50% move to upfront purchases, which is different than what we've seen in the past. What I don't know for sure is if that's going to continue. I mean, clearly, there were budgets that were available to people and they flexed those budgets that could continue. I'm happy either way we place arose. We're going to be very flexible with our customers as we go forward and make sure that we're there to support them.

Speaker 3

Our preference, as I've said in the past, is those long term contracts, But I'll take it upfront sale as well. So hopefully that helps on the ROSA side. And then Suki, I'll pass it to you on the VPP impact.

Speaker 4

Yes, sure. Thanks, Brian. Hi, Chris. Good morning. Yes, as we noted, Asia Pacific sales were impacted in the quarter Really by 2 things.

Speaker 4

1 is the VBP impact that we talked about, which was essentially some distributors taking And some of our larger markets like Japan and Australia and New Zealand that also slowed some of our growth down and that hit Pretty much across both of those VVP as well as slowdowns in our VCON business. But it was encouraging that despite those headwinds that we were able to manage through that and actually grow the region a little bit ahead of expectation. And we would expect that growth To continue in the back half of this year. Regarding China VBP, for competitive reasons, we're not going to Size that, it was a contributor but not the only contributor in that performance in Asia Pacific as I mentioned. I think the important thing is how do we think about this going We've looked at BBP and done a number of scenarios based on what we know at this time.

Speaker 4

Again, the final rules, Pricing and volumes aren't expected to be issued for, let's call it another few months, but that timing has been shifting around. So It could continue to shift, but based on what we know today, we don't expect there to be a material impact from inventory change going forward. And that's what's represented in our guidance moving forward. But again, we're going to learn a lot more about VDP over the coming months We'll update you as we learn more. But again, it was great to see that Asia Pacific did grow through that.

Speaker 4

And I would say also Fundamentally within China, we're seeing very strong demand. And so obviously that was the first market to be impacted by COVID-nineteen And it was the 1st market to recover and we continue to see good strength and progression in that market. And as you know, we're a leader within China And expect to maintain that leadership position as we move forward.

Operator

We'll take our next question from Matt Miksic with Credit Suisse.

Speaker 12

Hey, good morning. Thanks for taking the questions. I have one on SAT and just a follow-up on ROSA, if I could. So on SAT, Brian Or Suki, if you could provide some color on sort of the components within that business that was Driving some of the strength, at least outside to our estimates, trauma, extremities, was it sports is a little smaller, but was That way you saw some of the strength. And as I mentioned, I have one follow-up on Vosa.

Speaker 3

Yes. That's One of the highlights that I saw in the quarter, clearly, we are heavily penetrated when we think about our overall revenue in large joints. And As I think everybody has been saying and recognizing, large joints has just been a little slower to recover than some of the other categories that we have. And What I've been very happy to see is our strength in set and we believe that that's going to continue through the back half of the year. Pretty much across The Board, we showed good performance.

Speaker 3

Standouts for us were sports. The upper extremities business For sure, it was solid. Trauma was solid for us. And of course, when we look at our CMFT business, our thoracic business was quite strong as well. So, we're excited to see that the tuck in acquisition that we did in CMFT is playing out the way we expected.

Speaker 3

And then some of the acquisitions that we did that were really just product launches, it's filling out gaps that we had in sports and also in the AFC. They're also providing benefits right now and that was the whole idea, right, to fill out that product portfolio, as a result of that have a fight have a right to fight and win And that's playing out right now. So we're feeling good about the strength in SCT, probably have more confidence now in that being able to continue on a go forward basis just given what we have in So very happy to see that strength in set and we would expect that to continue.

Speaker 12

That's helpful. Thank you, Brian. And just to follow-up on ROSA. So I don't think many of the other folks Putting robots into the field or seeing the kind of shift back to capital that you're seeing. It seems like it's been pretty stable.

Speaker 12

And I'm wondering maybe if you could talk a little bit about The mix of accounts, maybe the mix of ASCs or the larger centers, if there's any change in the mix that might be driving Some of that preference for cash payment versus commitment to long term contracts. Thanks.

Speaker 3

Yes, sure. Really no dramatic shift. I mean, even if I think about U. S, OUS, for instance, we typically do, it's not always exactly This way, but if I look at the number of quarters and just kind of aggregate them, we typically do kind of a seventy-thirty split U. S.

Speaker 3

OUS and that was pretty consistent in this quarter. For us, again, we did see that shift. We believe that it's mainly because people have more budget right now on the capital side. I don't see a shift in our customer base that drove it. So nothing that just stands out for me.

Speaker 3

It's just more that there was capital available. People like to flex the capital when they have it and some customers just don't want the long term contractual obligation bringing a piece of capital in, they just rather buy it. And so I think that's really the culprit. There's nothing beyond that that I've seen. I will certainly pay attention to it as we go forward, but nothing that was disruptive in any way The mix that would have changed that change in placements.

Speaker 12

Thanks for the color. Sure.

Speaker 3

Our next

Operator

question comes from Rick Wise with Stifel.

Speaker 13

Good morning to you both. Brian, maybe just to start with M and A, you obviously highlighted That M and A remains a top priority and I heard you about the WAMGR accretive and you listed some areas. How do we think about the next 6, 12, 18 months? Do you feel like you have a lot of targets? Do you feel like you have a lot of opportunities?

Speaker 13

Do you feel like you're moving faster and the points you mentioned about robots and smart implants, etcetera, etcetera, I mean, do we envision that it's more about acquiring enabling technologies or incremental technologies enable you to achieve that or no, you're ready for something larger freestanding to accelerate? Then I'll ask a second question.

Speaker 3

Okay. Maybe just quickly here and I'm going to pass it to Suki, because At the end of the day, the M and A strategy is only as good as the funding for it. So obviously, we're both Focused on moving this forward, but let me maybe pass it to Suki. He can give you the same color I would on what we're looking for from an M and A standpoint, but also give some color on How we're feeling about our firepower there, Mississippi?

Speaker 4

Yes, absolutely. So we continue to build out, I think an attractive pipeline, Potential tuck in targets, very consistent to what Brian said earlier about things that are mission centric where we have a right to win, Strategically makes sense, financially are strong and have a low level of synergy disruption and very consistent with So the deals we did at the back end of 2020, which so far through the integration process, we're very pleased with how those are progressing. So we're going to continue to look at opportunities very similar to those. And the good thing is our firepower continues to build and With the recovery of the pandemic, we're seeing our EBITDA improve significantly. We've turned the corner on the Q2 of 2020, which was a Cliff for us as you know a trough if you will on EBITDA and with a rolling 12 month EBITDA number as we sunset the Q2 of We're seeing a pretty big step up in our EBITDA number and a nice improvement in our overall leverage ratio.

Speaker 4

When you combine that with The debt pay down we've done so far, the debt pay down we're committing to in the back half of this year and the over $1,000,000,000 on the balance sheet, we feel we're in a stronger position than we have been for the last 15 months to execute on that tuck in M and A strategy. And So I feel really good about where we are and how we're moving forward on that. I would also say another big component of that is our Spin transaction. We're really pleased with How the team has been progressing on that? We've made significant progress with our tax private letter ruling, Great progress with our carve out financials in our 10 S, which we hope to file in the not too distant future with the SEC on a private basis.

Speaker 4

Good progress from Vafa in formulating this go forward strategy and building out his team. So just overall really, really impressed with how the team has handled this in the backdrop of also integrating those transactions we did at the back end of this last year. That muscle, that capability that we've been building over the last couple of years is really playing out to our benefit right now.

Speaker 13

Got you. Thank you, Suki. Go ahead, Brian.

Speaker 3

Yes. I was going to say, and you are right. I mean, Two areas where we're spending a lot of time right now when we look at targets and are pulling that bolt in of targets would be around enabling technology. Great example of that is what we did with Canary in that relationship that that's been created and that's going to then obviously spin out IQ for knee, but also Sensors and other areas of the body as well. And then we'd be looking at near adjacencies very much like what you've seen recently from us in sports, the ASC, thoracic, Areas that we feel confident we have a right to win, they are accretive to our overall weighted average market growth and they are profitable.

Speaker 3

Those are the things that we are looking at today. And as Toby said, if the firepower opens up, then we'll begin to flex that firepower in those areas.

Speaker 13

Just as a follow-up, I was reflecting Brian on your comment about specifically about revision where you said revision capability now opening the door to competitive conversions. I was reflecting just that, maybe you could flush out your comments here. I mean, I get it that revisions specifically will help, But so PersonaIQ, so we'll continue to rollout of ROSA, etcetera, etcetera. Just my question is, As we reflect on the next 6, 12, 18 months, what should we imagine? What are you thinking about as the biggest driver of Competitive conversions and share gain, is it these incremental products?

Speaker 13

Is it the totality of everything? Is it something about execution? Just trying to understand where you'd have us focus in thinking about that kind of a concept? Thank you so much.

Speaker 3

Beauty of the situation and why my confidence is high that we're going to continue to see share gains as we have over the last 4 quarters, 5. And that's because we just have so many shots on goal. If you think about me in particular, we already have ROSA out That's getting great traction. Rosa Partial was just launched. Persona Revision has been out for a while, but the momentum is still very strong And there is that spin off opportunity to get the typical total need.

Speaker 3

You still have Mymobility driving conversions. You haven't even launched Persona All of these give us an opportunity to create a differentiated environment for our customer and provide the opportunity for not only that Share gain or mix gain, but also competitive conversions. And specifically on revision, the reason why I bring it up is Typically, in somebody's practice, you get about 10% of the overall revenue associated with provision and it's more like 90% Comes from your typical total knee. And many times, we use that revision as a tip of the spear to convert a surgeon that is a competitive surgeon because they love the revision system. And that gets us in the house then to try to pursue that much larger portion of the business, which is your standard need.

Speaker 3

So that's why I keep going back to We have significant dollars now that we're paying attention to where we have a revision customer that is using a competitive total knee system and that gives us a great Opportunity and kind of a hunting ground to go to get those conversions, but it's certainly not the only area that would give us the opportunity to take share. It's pretty much all of these.

Speaker 13

Thank you so much.

Speaker 1

Lauren, we probably have time for maybe one more question.

Operator

Up next, we have Matthew O'Brien with Piper Sandler.

Speaker 14

Good morning. Thanks for So Brian, just a little bit more on the knee side of things. When I look at your numbers, I know what you're saying about over the last several You're trending in the right direction. But when I look at the last two, it seems like things have flattened out a little bit. If not, you're actually down a little bit on the knee side In terms of share, so I'm just wondering, especially in the U.

Speaker 14

S, that's actually down versus 2019 here in Q2. Are there things that are impacting you specifically because you are the biggest player on the market? Are there some higher volume accounts that are on vacation? Are you in bigger COVID hotspots? More training on the partial knee side that has slowed things down a little bit for you guys versus what we've seen from some of your peers?

Speaker 3

It's so hard to say. That's why I was referencing before. When I look at share gain or loss, I never look at and spend too much time on a specific quarter, even when things are Typical. But in these crazy times, so many things can impact your performance versus the market. So again, I try not to get too worked It could be.

Speaker 3

I mean, the fact is share right now in a specific part of the country, For instance, can be meaningful to whether you do better or worse than the competition because that particular state or county could be challenged by So there's always those things that could impact a specific quarter. That's why when I look at over a 4 quarter period of time, that usually eliminates Those hotspots and that's why I feel more confident, more comfortable with more of that trend, which through that trend basically eliminates the noise around the noise of a specific quarter. But that's why I still feel confident that we're in good shape that we have all these shots on goal that we should continue to take share. But hey, I'm disappointed. I look at the quarter, I don't really care what the reason is.

Speaker 3

I want to win every single quarter and this one we didn't. But again, I'll look more at the trend and take more from that on the prediction of share taking in the future. And I would just say in a nutshell, I believe that we're going to be net share takers.

Speaker 14

That's helpful. And then just really quickly on ROSA placements. I think you mentioned more a better trend line on the OUS side. So can you just talk a little bit about what internationally as far as ROSA placements go. And then here in the States, there's been some talk about some moving into ASCs.

Speaker 14

And Just in terms of ROSA placements, what are you seeing in terms of where these things are going, higher volume accounts that you're getting into inpatient or even in the ASC Even on the ASC side of things? Thanks.

Speaker 3

Yes, that's a nice thing. I feel really good about our distribution. We're taking advantage of momentum in the ASC. See, ASC absolutely loves the fact that we're an efficient robotic system that they're all about efficiency in the ASC. There's been a benefit for us there for sure.

Speaker 3

We've seen it in the hospital as well. We've seen it around the globe in Europe, Middle East and Africa as well as Asia Pacific. I'm just very pleased with the distribution of the technology across pretty much all sites of care and around the globe. And again, we focus our attention not always, but let's call it 80 plus percent of the time in those larger accounts. We're spending our time in those Gold and Platinum accounts Because that's where the big payback is if you're going to spend the time.

Speaker 3

So again, the distribution has been good. I mean, it's been across settings, across region, And we've been focused on the larger accounts for sure. Thank you.

Speaker 12

Sure.

Speaker 1

Thanks, Matt, for the question. And I think that brings us to 9:30. Brian, I'll turn it back over to you just for any closing remarks before we wrap up.

Speaker 3

Yes. Thanks, Gary. I wouldn't mind making a couple of And first of all, thanks for spending time with us here this morning. I just want to say and I think this is probably obvious to everybody. We certainly have an outsized dependence on elective procedures versus really any of our med tech peers or competitors, Particularly large cap companies, we're just an outsized impact there.

Speaker 3

And as a result, we're very sensitive to COVID ebbs and flows. And we spend a lot of time, As you would imagine analyzing this, and we try to remain prudent in our expectation setting as a result and because we've seen it. We've seen it firsthand that COVID can move our business pretty rapidly given that dependence on elective procedures. And this has been what was reflected In the updated guidance and why our implied range for the back half is still pretty wide, because again, there are things that can happen here to move us up or down Pretty rapidly because of that dependence on elective procedures. Now relative to Q2 specifically and Suki said this before, even with some of the unexpected challenges that we had in the quarter, Hey, we delivered better than expected results, which I think speaks to 2 very important things.

Speaker 3

Number 1, and this is more short term, but it's important, The recovery from COVID is moving in the right direction now. It's definitely not happening the way we anticipated and I don't think it is for anybody, But it's moving in the right direction nonetheless. And the 2 and I think this is important not just for now, but the long term, our team continues to execute And deliver against the things we can control and both of these things were deeply considered in our updated guidance. And this gives us confidence That continued recovery through the back half of the year is going to happen and we see a path to end 2020 at 4% to 5% organic growth 4% to 5% we've been talking about without the need for any material benefit from clearing the deferred patient queue. And I got to say, given where we started just a few years ago And with COVID in between, with very flat to negative growth with consistent share losses as a company, I for 1 am super proud of the team for putting ZB in this position.

Speaker 3

And I look forward to not just talking about it, but delivering it for you, our customers and our patients. With that, we'll go ahead and end the call and we'll look forward to talking to you again soon. Thanks so much.

Operator

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

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Earnings Conference Call
Zimmer Biomet Q2 2021
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