Zimmer Biomet Q3 2022 Earnings Call Transcript

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Provided by Quartr
November 2, 2022

There are 14 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to the Zimmer Biomet Third Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded today, November 2, 2022. Following today's presentation, there will be I would now like to turn the conference over to Keri Maddox, Senior Vice President, Chief Communications and Administration Officer. 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 Q3 2022 earnings conference call. Joining me today are Brian Hanson, our Chairman, President and CEO EVP and CFO, Suki 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.

Speaker 1

Actual results may differ materially from those indicated by the forward looking statements Actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward looking statements. Additionally, the discussions on this call will include certain non GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q3 earnings release, which can be found on our website, zimmerbiomet.com. With that, I'll turn the call over to Brian.

Speaker 1

Brian?

Speaker 2

Thanks, Carrie, and thanks for joining us for the call this morning. We've got three sections 1st, I'm going to briefly talk about our Q3 performance and really the momentum that we saw in Q3 that has allowed us to increase our outlook for the year. In doing so, even in the face of some pretty meaningful macro pressures that we're certainly still facing. I also want to spend time talking about RZB innovation. This is clearly the driver of our continued strong performance and will be the driver as we go And for the second section, Suki will provide more detail on the quarter, but probably more importantly, our 2022 guidance update.

Speaker 2

Thank you to the ZB team members that I know are listening. I know a lot of you listen to the call and I appreciate that. Your continued strong performance It's just built on day in and day out execution. You're just focused on driving results. And I know you're showing up and facing some very, Very real macro challenges right now, and I appreciate it.

Speaker 2

The fact is, I'm just really proud that even in the face of these challenges, you're delivering results for customers, you're delivering results for our patients and for our shareholders, and you're moving the mission of this company forward every single day. I know it's not easy, but I promise you it is much Appreciate it. Okay. So turning to the Q3. Although the beginning of the quarter was a bit choppy when it comes to procedure cancellations, We did see very nice improvement throughout the quarter and we finished strong.

Speaker 2

And that execution and recovery occurred in all of our regions, but especially in our OUS regions with both EMEA and APAC performing better than our expectations. Inside of this, we saw good in our large joints business with our knee franchise growing in the high single digits and our hip business growing just above 10%. And as you've seen, this was somewhat offset by the telegraphed and expected pressure in our SCT business and our other category. Now although we did see the strength in the quarter, we continue to face significant challenges across foreign currency, supply, inflation and staffing. That said, the team has been able to navigate these challenges In short, our underlying business is clearly strong and I truly do believe it's getting stronger.

Speaker 2

And just as an example, when we look at the quarter, we announced The first of its kind 3 year agreement with Hospital For Special Surgery or HSS. The partnership creates HSS, Zimmer Biomet Innovation Center for Artificial Intelligence and Robotic Joint Replacement. We're focused here with HSS to develop new tools that will be powered by AI to provide data driven recommendations or insights to surgeons for robotic assisted joint surgery. It's really it's a big deal. We're clearly very excited about it.

Speaker 2

We really do believe this is a future of medicine opportunity and we're excited to be involved with HSS. In our Q3, our new product pipeline continued to deliver as well. While it's early, we are definitely excited about the launch of HipInsight. This is the 1st FDA cleared mixed reality navigation system for total hip replacement. HipInsight is the latest addition to our OptiView portfolio and it further expands our ZV Edge suite of solutions.

Speaker 2

Additionally, we announced the FDA clearance of our IDENTITY shoulder system. This is a technology that has proprietary capability of aligning each surgeon's approach to an individual patient's anatomy. All of this with the goal first and foremost of alleviating pain, but also optimizing the range of motion for that patient. And I got to tell you, our existing product portfolio kept up the momentum as well. Demand continues for ROSA both in knee and hip.

Speaker 2

Persona Revision traction in the U. S. Remains strong and Our limited launch of Persona IQ is driving positive feedback and interest and we're focused on aggressive data collection so that we can establish clinical use benefits. And we expect to build on this momentum with new product launches in the coming months, including as we've talked about our new Persona cementless form factor, additional launches in our set category and a hip product launch that we're excited about in early 2023. And I can tell you that all of these product innovations, Coupled with our ongoing efforts to reshape our business and accelerate ZV's transformation position us very well for future growth.

Speaker 2

We continue to strive to be a best and preferred place to work for our team members and we continue to strive to be a top quartile performer for our shareholders and to be a trusted partner Very real macro headwinds that are definitely muting our growth. But we're also seeing an offset via COVID recovery, Very strong execution from the team and meaningful innovation in the field. And against that backdrop, our team continues to execute our strategy, and I feel increasingly confident about our future as a company. And with that, I'm going to turn it to Suki to talk more in-depth about Q3 and give you an outlook for 2022 guidance. Okay, Suki?

Speaker 3

Thanks, Brian, and good morning. Overall, we We delivered another good quarter driven by strong execution and continued recovery of elective procedures. While we continue to navigate challenges, Our Q3 performance gives us the confidence to raise our full year financial guidance. With that, I'll turn to our Q3 results. Unless otherwise noted, my statements will be about the Q3 of 2022 and how it compares to the same period in 2021.

Speaker 3

And my commentary will be on a constant currency and adjusted continuing operations basis. Net sales in the 3rd quarter were $1,670,000,000 a decrease of 0.9% on a reported basis and an increase of 5% on a constant currency basis. U. S. Sales grew 3.2%, driven by strong elective procedure recovery and commercial execution, especially in our knee and hip businesses.

Speaker 3

This was partially offset by expected declines in the SET and other categories. International sales grew 7 3% driven by strong procedure volumes across most markets in EMEA and APAC in tandem with lighter comps and continued strong commercial execution. EMEA performed better than expected driven by recovery in developed markets and continued strength in emerging markets. And APAC performed better than expected with China largely in line with expectations and strength in Japan. Turning to our business category performance.

Speaker 3

Global knees grew 7.2% with U. S. Knees up 7.3% and international knees up 7%. Action of our Persona knee system, especially with Persona revision in the U. S.

Speaker 3

And continue to increase INROSA procedure penetration and pull through. Global hips grew 10.5% with U. S. Hips up 5.3% and international hips up 15.5%, driven by strong international procedure recovery and an easier comp outside of the U. S.

Speaker 3

Continued traction across key hip products, including the G7 Revision System and Avenir complete primary hit, 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 extremities and trauma category declined 2.1% and was impacted by a tough comp in 2021 and the expected pressure around BBP, which is expected to reverse in Q4 and reimbursement headwinds in U. S.

Speaker 3

Restorative therapies that will anniversary in mid-twenty 23. Within the category, we continue to deliver strong performance across our key focus areas of CMFT, Sports Medicine and Upper Extremities. Finally, our other category declined 0.4% driven by tough comps and expected lower capital sales related to a higher mix of ROSA placements versus upfront sales. Moving to the P and L. For the quarter, we reported GAAP diluted earnings per share The increase was driven by a decline in litigation related expenses and a tax benefit in the quarter from a favorable tax liability outcome.

Speaker 3

On an adjusted basis, diluted earnings per share of $1.58 represents a decrease from $1.71 in the Q3 of 2021. Adjusted gross margin was 70.7 percent in line with expectations. As previously discussed, Heightened inflationary pressure will drive full year gross margins to be slightly down when compared to the prior year. As previously noted, increasing input costs from this year will pull through into 2023 And we now expect the headwind from inflation in 2023 to be at the upper end of our previously communicated 50 basis points to 100 basis points range. Our adjusted operating expenses were $742,000,000 an increase versus the prior year due to inflationary pressures and higher investments into R and D to support future product launches.

Speaker 3

Our adjusted operating margin for the quarter was 26.3%, A 200 basis point decline from the prior year and largely driven by increased inflationary pressures and continued investments into the pipeline and product portfolio. Despite ongoing macro headwinds, we continue to expect our efficiency programs to drive improved second half operating margins versus the first half of the year with a step up in the 4th quarter in tandem with higher revenue. The adjusted tax rate was 15.3% in the quarter, in line with our expectations. Turning to cash and liquidity. Operating cash flows were $451,000,000 and free cash flow totaled $332,000,000 for the quarter.

Speaker 3

We reduced our debt by about $160,000,000 in the 3rd quarter, excluding the effects of foreign currency and ended the quarter with cash and cash equivalents of about $5,000,000 On a related note, despite a higher interest rate environment in 2022, interest expense is expected to be broadly in line with our previous expectations for the year. However, we would expect a step up of interest expense into 2023. We have made significant progress in strengthening our balance sheet through improved financial performance and ongoing debt reduction, ultimately provide a greater strategic flexibility for the company. Moving on to our updated financial outlook for the year. Constant currency revenue growth is now expected to be 5.5% to 6.5% versus 2021 with an expected foreign currency exchange headwind Based on recent spot rates of 5.50 basis points versus our previous assumption of 500 basis points.

Speaker 3

This means that reported revenue growth will be in the range of 0% to 1% versus 2021. Also related to revenue, based on the recent spot rates, we estimate that the strengthening of the dollar through 2022 will create about a 300 basis point headwind to revenue growth in 2023. Additionally, We are tightening our expected adjusted diluted EPS range to $6.80 to $6.90 All other metrics in our 2022 financial guidance remain unchanged from our 2nd quarter update. As a reminder, we expect Q4 revenue growth to be slightly higher than the Q3 due in part to a tailwind related to Q4 2021 VBP charges that will be partially offset by about a one day selling day headwind. In summary, we had another solid quarter underpinned by market recovery and good execution, and we are pleased to again raise our full year outlook.

Speaker 3

While we expect to have to continue to navigate a number of persistent macro headwinds, ongoing market recovery in tandem with strong execution and attractive product pipeline leaves us confident about our future. And lastly, I'm extremely proud of and want to thank our broader ZV team

Speaker 1

With that, operator, may we have the first question please?

Operator

Thank you. We'll take our first question from Shagun Singh with RBC.

Speaker 4

Great. Thank you so much for taking the question and congratulations on a strong print here despite a pretty challenging environment. So Brian and Suki, I was just wondering if you can elaborate a little bit more on 2023. Just On the top line, how should we think about the durability of growth? I think last quarter you talked about a 4% floor, But it looks like you have stronger momentum going into next year with a 6% exit rate.

Speaker 4

And then on margins, given the incremental impact You called out from FX and inflation. Do you still believe you can drive operating margin expansion next year or is that going to be more challenging? And then I have a follow-up.

Speaker 2

Okay. Two really good questions right out of the gate. So maybe Suki, I'll start with the revenue side of that equation and then you could answer on the margin side. Certainly any color you want to provide that I might miss, feel free to do that. Maybe just to make it simple, I'll just start with the end of the story And then I'll get into some of the details around variables that I think are important to consider.

Speaker 2

But just going to the end of the story, we said that in an undisturbed market, We would be disappointed if we couldn't grow 4%. Now I would say that we do not see 2023 as a normal market or a non disturbed market, Too many variables moving, but we do see we still do see a pathway to 4% growth. Okay, so that's kind of the end of the story. Now let's take a look at some of the puts and takes that we have to look at that could either benefit or detract from that. On the positive side of the equation, I'm I'll start first with those things that are controllable by our company.

Speaker 2

There are really 3 major things that I look at that give me confidence and should give you confidence. Number 1, it's around innovation. I'm just going to call it the innovation flywheel here at ZB is really moving in the right direction and it's creating a solid pipeline That importantly is translating into moving our vitality index north and that continues to move north for us and we expect to continue to do that on a go forward basis. So innovation is a really big part of our confidence. The other is just the team is executing, really strong execution right now and hitting a stride, which important for momentum in the business.

Speaker 2

And the third one is around a continued focus from this organization on moving our weighted average market growth north through very disciplined portfolio decisions. I'm talking about not just active portfolio management, but truly looking at the way we spend in research and development, commercial infrastructure, the way we compensate our people, the way we actively move things out of the portfolio that are not helping our WAMGR and move things into the portfolio that do. That has allowed us to increase our weighted average market growth and we're continuing to do so. So those are the positives coming into 2023. From a macro standpoint, we

Speaker 5

have a couple of positives as well.

Speaker 2

I really look at the backlog of patients in orthopedics As being real, I can't put a number to it. It's hard to size. It's hard to say when it's going to be impacting the markets, The pace that's going to impact the market, but at some point, this has got to begin to work its way through the system and that could provide a tailwind to 2023 and then comps as well in 2023. It's going to be choppy. We've got choppy comps, so you're going to see differences in growth rates by quarter.

Speaker 2

But the fact is when I look at the full year, we should look at comps as a slight positive to 2023. On the negative side, it's the stuff that everybody is talking about We do have a very constrained supply challenge situation and we're managing through it, but it's a tough road And that's going to continue throughout 2023, we believe. And then staffing in OR capacity is not as difficult as it was, But that's going to remain a headwind for us in 2023. And then we also look at recession risk on elective procedures, particularly if it impacts unemployment. But all that to say 2020 3 is not a normal year given all these variables.

Speaker 2

There's a lot to manage, a lot to think through and a lot to contemplate in the way that we set up our range. But based on what I'm seeing today, I expect there to be a fore handle in that range, which may or may not sound like a lot to people looking at MedTech, but to us, knowing where we started, that's a pretty significant step up from where we started the journey, And we're proud of it. And again, we're just getting started. So that gives you a sense for revenue components and our view on revenue as we come into 2023.

Speaker 5

And then Sophie, I'll pass it

Speaker 2

to you on the margin side.

Speaker 6

Yes. Thanks, Brian, and good morning, Sherry, and thanks for the question. On the margin side, you're right. The macro environment has become incrementally more challenging here in the back half than we originally assumed. That's been reflected And our rest of your outlook and despite those challenges, we've been able to raise the back end of our year.

Speaker 6

So we're pretty proud of that and the team is doing a great job. As that rolls into next year, it has become incrementally more challenging, but we still see a path to maintaining or slightly improving our operating margin versus 2022 despite some of these headwinds. And that assumes current market conditions if things erode or if things improve, we'll revisit that. But Where we are today and assuming some stability on some of those headwinds, that's how we're thinking about 2023. The biggest move for us really has been around FX.

Speaker 6

So as you know, we increased our full year outlook by 50 basis points to 550. That means we're exiting the year at 600 basis points headwind on revenue. That translates to about 300 basis points of headwind into next year. So that's got Pretty significant impact on the top line in absolute dollars and of course there's a flow through to margin and to earnings on that. But Despite that pretty big drag, again, we believe there is a pathway and we're committed to maintaining or growing margins into next year.

Speaker 6

The other major area you touched on was inflation. Our previous estimate was that we'd have 50 basis points to 100 basis points Capitalize out of 22 into 23. We're now at the top end of that, but still within our overall purview that we gave earlier this year. The real driver of that increase has been less about supply and raw material costs and less about wage and inflation, which were the bigger areas. It's more about higher freight costs right now trending higher as well as energy costs, especially in Europe.

Speaker 6

But again, At least on the bigger components of that, we're starting to see some stabilization. So hopefully that's a positive light towards the end of the tunnel. And then interest expense, again, just recognizing the higher interest rate environment we're in, we would expect overall interest expense to be modestly higher next year, so just making sure that folks have that as an update to their model. But look, We're continuing to address our efficiency programs. We're going deeper and faster.

Speaker 6

I really want to commend the overall ZB team for embracing these challenges and hitting them head on. They've done a fantastic job. And again, just based on that execution and assuming current market conditions hold into 2023, We think we've got a pathway to maintain or slightly improve.

Speaker 4

That's really helpful. Thank you so much for the color. Just as a follow-up, I was just curious to get your on portfolio management. In the context of shift of procedures to the ASC setting, we are hearing about 60% of recon procedures Thank you so much for taking the questions.

Speaker 2

Yes, thanks. Maybe I'll start off with that and then Yvonne, if you want to wade in, Feel free to do so. We clearly still see the ASC as an attractive submarket of our Recon business and also clearly other parts of our SET business. It's one of the faster growth submarkets and we're clearly increasing our focus and spend in that area. And we're doing it in a Number 1, we're putting infrastructure in place.

Speaker 2

We've got dedicated commercial teams that focus only on the ASC. And that's important because you've got to have contracting prowess in that space and we've done that over the last couple of years and you're really getting good traction as a result of it. Additionally, we're making sure that we scale up in the product categories that the ASC is looking for. We wouldn't have purchased a booms and light company if we didn't want to have that infrastructure for the ASC. Not to take anything away from booms and lights, but it's not an area that we would have waded into if it wouldn't have given us scale in the ASC marketplace.

Speaker 2

Same thing in sports acquisitions that we've done in other parts of our business. So we're really doing it 2 ways, commercial infrastructure, product portfolio, so that we have a broad based contracting opportunity in the ASC. And we're seeing traction as a result of that. We do expect the ASC to continue to move north relative to the number of procedures being done in the ASC versus the hospital. I don't know that I would agree with the numbers you stated, but certainly we believe that it's going to continue to move north and we want to make sure that we're taking advantage of that.

Speaker 2

So Ivano, if you have anything else

Speaker 5

you want

Speaker 2

to add?

Speaker 7

Yes. Good morning, Segun. I think you covered pretty much everything, Brian. But I do think one of the drivers of having a complete portfolio now is that we have best in class contracts. So There were contracts back in 2020 and 2021 that were not a part of.

Speaker 7

Zimmer Biomet was not a part of and we're a part of today. So indeed, the portfolio has been remediated. The dedicated structure is working. And while we don't disclose the specifics in terms of growth, we are growing at double digit in the ASC category here in the U. S.

Speaker 7

We believe we'll continue to grow at double digit rates.

Speaker 4

Thank you.

Speaker 8

Thanks, Jagadish. Those are the questions. Yes, operator, can we go to the next in queue, please?

Operator

Thank you. We'll take Steven Lichtman with Oppenheimer and Company.

Speaker 9

Thank you. Good morning. I was wondering if you could talk about the strength you're seeing In the hip side of your business, particularly as it relates to ROSA pull through, what are you seeing as it relates to surge in interest on the hip side with Rosen, would you say you're still in the early days in terms of that being a tailwind?

Speaker 2

Yes. I'll probably pass the just that it's product related more than anything. I'll probably pass it to Yvonne to speak to the hip performance. And also, Yvonne, maybe speak to some of the things that without too much specificity that we're predicting in the future to help the business as well.

Speaker 7

Absolutely. Thank you. Steve, I will just summarize the performance so far when it comes to robotics above expectations. We like the fact that this is the only pinless robotic system in the world. We like the fact that it remains CT scanless, Which is a great advantage for the ASC setting that we're talking about.

Speaker 7

We've seen average versus conventional hip procedures A similar level, if not higher level of accuracy in the procedure. So for all the clinical research that I'm alluding to, continues to be a best in class product launch. We are right now placing installing about 30% of all robotics, including KISS, in ASC settings. Again, a major advantage in settings where that time and efficiency makes sense. Beyond robotics, beyond hip robotics, also excited about other product launches.

Speaker 7

We got it on a hips. I think you might have heard from Brian in the opening remarks. We got a partnership in Mixed Reality with a company called Surgical Planning Associates That enables Zimmer Biomet to be the only FDA approved mixed reality platform in hips in the U. S. What do we solve through mixed reality?

Speaker 7

We get better visibility in hip surgery. We get better accuracy and overall better efficiency. This is some of the technologies that we're going to be displaying in Dallas this week, Rosa Heat as well as Mixed Reality Heat Insights, It's a cater of other products that continue to have momentum. We continue to perform strongly globally with Avenir Complete. We believe that we have the best robotic platform with G7 and Arcos.

Speaker 7

So again, multiple examples of innovation that are gaining some traction, both here in the U. S.

Speaker 9

Great. Thanks, Yvonne. And then Suki, just a follow-up. Thanks for the color on the 2023 inflationary headwinds. Just wondering if you could talk about offsets.

Speaker 9

You mentioned some of the internal efficiency programs, but What about on pricing? Are you seeing any progress on pricing initiatives? Any color you can provide on that and what potential impact they may that might have on the offset side.

Speaker 6

Yes. Thanks for the question, Steve. So we have so far this year seen an improvement overall pricing erosion at the company level. Our historic pricing erosion was in the 200 to 300 basis points per year coming into 2022. And so far this year, we're tracking about 100 basis points to 150 basis points.

Speaker 6

So there's been some marked improvement. We've been making investments around data and analytics systems, better governance. We've hired additional capabilities. Yvonne talked a little bit about contracting. All of these are contributing strategically and tactically to that improved price.

Speaker 6

As we move into next year, we do expect there to continue to be pricing erosion, But we would hope that and expect it to be at the lower end of our historic average, if not better. So while we do expect it to be better than where we've been for the last several years, it will still be a headwind year over year. Now having said that, there are a number of other programs that we're targeting to help offset some of these headwinds like our new global business services or shared services operating model that we created through the pandemic. Portfolio management that Brian spoke about looking at products that have lower margin, lower growth opportunities and thinking differently about those investment profiles. These are all things that are going to help contribute to offset those headwinds.

Speaker 9

Got it. Thanks, Judy.

Speaker 8

Steve, thanks so much. Yes. And operator, can we go to the next slide in the queue, please?

Operator

We'll take our next caller from Vijay Kumar with Evercore ISI.

Speaker 10

Hey, guys. Thanks for taking my question. Brian, maybe my first one on your 4% for fiscal 'twenty three as a starting point. I'm curious, what is that for, assuming? It looks like there is no backlog.

Speaker 10

Pricing still continues to be a headwind. And it looked like you sounded pretty bullish on new products, but I'm assuming that 4 is assuming minimal contribution from new products. Could you just go through the assumptions, please?

Speaker 2

Yes. I think you've kind of laid them out already. When I think about So when I think about the calculus on revenue growth going forward, there's no question that we've included innovation. We're spending a lot of money and a lot of focus in research and development. We're bringing great products to the market and we absolutely expect that to buoy our revenue growth.

Speaker 2

That's part of The reason why we came from a 0% growth business in 2017, 2018 and now we're predicting we can get to 4%. So that's been a big part of that movement. The execution of our team is another part of it. There's no question. I know that it's hard to put a dollar amount on momentum in an organization, but momentum does matter and we have it right now.

Speaker 2

And the other big one is that weighted average market growth. We have moved our weighted average market growth north during the last 5 years. So as we get closer for our weighted average market growth to that 4%, it gives us more confidence that without share taking, we can deliver 4% in a consistent way. Now certainly, we wouldn't stop there. Active portfolio management is Phase 3 of this organization and we're going to have more financial flexibility going forward.

Speaker 2

We're going to continue to change that weighted average market growth rate up, but getting to the 4% to start is a good thing. The negatives against that because you're saying, okay, we got all these positive and why isn't it more than that. We still have real challenges around supply and that is a distractor for growing your business. So we're going to have to manage through that as we get through 2023. We believe at least through the middle of 2023 potentially beyond.

Speaker 2

And even though staffing in our capacity isn't as acute as it was before, it's no question that this is going to be a headwind for us And of course, we have to calculate some potential risk associated with the recession if that does occur. So I think it's all those things combined in concert with This concept of having some backlog that we're hoping we can count on in 2023, but as of yet, we haven't seen it. Even Q3, which was a great quarter, We still don't believe backlog was consumed. We certainly might have had some backlog in certain areas consumed, but it was offset by some of these negative headwinds that we actually think backlog built So those are the variables that we're looking at as we think about 2023 and beyond.

Speaker 10

That's helpful, Brian. And Suki, one for you on your free cash flows year to date, it's really been impressive, up year on year, Free cash conversion north of 80%. You're probably one of the few medtech companies to have free cash flows up. Is that a timing impact or anything else going on in the free cash flow line item?

Speaker 6

Yes, Vijay, we did we have posted a really good 9 months here. I would say there is some timing benefit in the Q3 that will reverse in the 4th quarter. It has to do with some payments around, VBP as well as some tax payments that normally would fall in the 3rd quarter, but now All in all, I think you nailed it. We're having a pretty good year in cash, and we feel confident in our overall range for this year.

Speaker 2

Understood. Thanks guys.

Speaker 9

Yes. Thank you. Thanks, BJ.

Speaker 5

Thanks, BJ.

Speaker 8

Operator, can we go to the next question?

Operator

We'll take our next question from Travis Steed with Bank of America.

Speaker 5

Hey, good morning, everybody. I wanted to follow-up a little bit more on I think before you had said EPS to grow faster than revenue growth. And so now that, that was with op margins up. Now margins are kind of flat to slightly improving. So I was just curious how we should think about EPS growth now versus the 4% constant currency growth, If EPS is still up, but probably less than 4%.

Speaker 5

And I did want to clarify on the interest expense. You said higher interest expense, but I think you have no floating debt. So just kind of curious What's driving the higher interest expense?

Speaker 6

Sure. So Brian, I'll go ahead and take those. So one thing to remember on the EPS line is, I talked about 300 basis points of headwind on revenue into next year. And so as Brian thinks talks about that 4% on an ex FX basis, you'd need to take into consideration the foreign currency headwind that That matriculates into next year. So having said that, with the margins kind of being relatively in line, maybe slightly up, And with interest expense up year over year, which I'll talk about in a moment, you would expect on a reported basis to see EPS Kind of travel in line with overall reported revenue.

Speaker 6

So hopefully that gives you a little bit more color. Again, that's our best view right now. Things can obviously change between now and when we finally give guidance for 2023 in the Q1 of next year. On your question related to interest expense, you're right, we are on face value in fixed debt, but we also do and have done some previous strategies to swap out our fixed to floating. So it's really the interest burden on those swaps that create that higher interest expense.

Speaker 5

Okay. No, that's helpful color. And then and Brian, I wanted to ask on M and A, like you've kind of always talked about getting more aggressive with M and A once the market It seems like 2023 is a year where we're in a much more almost a normal market. So I guess willingness to do something On M and

Speaker 11

A that can maybe move

Speaker 5

the needle a bit more and more adjacent to the portfolio versus some of the things you've been doing historically, Which are more smaller private stuff than that?

Speaker 2

Yes. So, first of all, I want to be careful what I say because it's Pretty competitive space right now. We don't want to telegraph too much what we want to do, but clearly, we as an organization are squarely in the Phase 3 of our transformation. And we Travis, we've been very clear that Phase 3 is all around active portfolio management to transform the portfolio, shifting toward more WAMGR accretive markets and diversifying our business. So that's kind of broad based way of looking at what Phase 3 is all about for our company.

Speaker 2

And we've already made some changes here. I know you're saying there's been smaller acquisitions that we've done, but we haven't had as much firepower, obviously. But we have spun businesses out as well that have helped in this strategy. That said, COVID is getting behind us. There's no question.

Speaker 2

And as a result, Just exactly the way you're saying, we would expect to have more strategic flexibility going forward. What I'll probably be willing to say and maybe not give any more We want absolutely something that can drive WAMGR accretion for our organization and it's got to translate into revenue growth that's accretive. Just because you're in a fast growth market, if you don't have good asset, you don't necessarily get the growth rate out of it. And it's got to accelerate our EPS growth over That's kind of the vetting. And then the categories that we're going to look at would be 1st and foremost, probably closest to the best would be fast growth subcategories of recon.

Speaker 2

So that would be things like data, robotics or building more scale in the ASC setting like we were talking about just a minute ago. It would be faster growth areas outside of Recon, but still in orthopedics. And that would be mainly in our set category. So that diversifies our business away from just Recon in those fast growth subcategories of orthopedics. And then to your point, attractive white spaces that are completely out of orthopedics, Less elective in nature and provide more diversification again out of orthopedics.

Speaker 2

I don't want to say which of those we're going

Speaker 5

Great. Thanks for the color.

Speaker 2

Absolutely.

Speaker 8

Thanks. And operator, I think we can go on to the next question in the queue.

Operator

We'll take our next question from Robbie Marcus with JPMorgan.

Speaker 12

Great. Thanks for taking the questions and congrats on a good quarter. Maybe to start, Brian, I'd love to hear a little bit more about what you're seeing on the capital equipment environment. I know it's a smaller overall component For Zimmer Biomet, but you talked about lower capital sales in the quarter. It sounded like it was a bit more placement versus upfront sales, but any color on ROSO, what you're seeing if it's different U.

Speaker 12

S. Versus OUS and how you expect that to trend Going forward over the next 12 to 18 months.

Speaker 2

Yes. I'll make some comments and then Yvonne can correct anything I say incorrectly. But clearly, capital is not as big a component for us. So I almost don't like talking about The capital market because I don't want to say anything that's going to hurt those businesses that depend more on the capital market. But from our perspective, where we do focus on it, it hasn't been a major barrier for us.

Speaker 2

Again, we really focus on from a ROSA perspective trying to place through agreements that allow for payment commitment of business. That is what we focus on and we did more of those in the quarter and that's a good thing for our business. But we do have opportunities to continue Any further color to provide around that, you can help as well.

Speaker 7

Absolutely, Brian, and good morning, Robbie. I'm pretty sure they're correcting my boss publicly. It's a bad career move, so The other thing I'll add is that it is really a global performance. So 50% of the installations are in the U. S, 50% are OUS.

Speaker 7

As I referenced earlier, around 30% of all robots are going to ASC and that segment is growing. We've seen exciting momentum with the HIF software. So I would say all in all, our robotic installations, placement, sales are in line. They They continue to move in the right direction. And as we enter Q4, we're very excited about where we are now from a roster standpoint.

Speaker 12

Great, thanks. Maybe as a follow-up, I think Brian you said last quarter extremities grew double digits. This A little less visibility in this line item. Anything you could give us on extremities? I know Sports Medicine has the reimbursement changes, so that there's some pressure there.

Speaker 12

But any color of what we're seeing extremities versus trauma and sports and how that might shake out U. S,

Speaker 2

So maybe just as a quick reminder for everybody, when we think about our SET business, There's really no proxy for SET in other businesses because we have different categories in it than others would probably consider. We have the upper extremities business inside of SET, trauma, CMST, which is our cranial, maxillofacial and Jurassic business, sports, separate from sports would be restorative therapies and then foot and ankle. Those are the categories that we manage across the set categories. The pressure that you were talking about in CMFT and Sports. It doesn't mean the other businesses aren't important.

Speaker 2

They just don't get the same level of resourcing at this point. And those 3 that we do concentrate on did have another good quarter. And if I look at all three of them without giving specifics, I would say they ranged anywhere from mid single digits to double digit growth again this quarter. So in the areas where we're concentrating, there's no question that we're getting the performance in the field. A lot of that has to do with commercial infrastructure and then the incremental support that we're giving in research and development to those areas and of course the acquisitions that we've been tucking in to drive around Asia Pacific pressure and trauma, mainly associated with VBP, which will reverse next quarter, and then that restorative therapies pressure from a reimbursement change in GEL-one.

Speaker 2

And unfortunately, that will carry through to the middle of 2023 or so.

Speaker 12

Appreciate it. Thank you.

Speaker 5

Sure.

Speaker 8

Thanks, Robbie. Operator, can we go to the next question in the queue, please?

Operator

We'll go next to Joanne Wuensch with Citibank.

Speaker 4

Good morning and thank you so much for taking the question. I'd wonder if you can step back a little bit and talk about the orthopedics market. What you're viewing as maybe changes or not changes in the competitive landscape, maybe something in physician practices, pricing, Or generally what you think of as sort of the state of the union? Thanks.

Speaker 2

That's a great question. It's an interesting question. I think what I'll probably do is again maybe start off on some of the things that I'm seeing that I think are interesting. And then Yvonne, Suki, Kerry, anybody Just the rapid adoption and open arms that I'm seeing from an orthopedics customer perspective to technology. There was a lot of question marks in my mind coming over to Orthopedics on whether or not that transition could truly occur.

Speaker 2

We saw it with Mako obviously in robotics, but we're bringing a lot of other technologies to And I've been very excited to see all companies kind of doubling down on the technology front, robotics and data. We're all moving in that direction and I'm hearing from our customer base that they're looking for it and very importantly willing to pay for the value that it brings. That's really important because as that type of innovation comes into a marketplace, particularly in medtech, it usually doesn't leave. And And when you do bring that kind of technology, it is more sticky than previous technology. And it does have the ability to impact pricing dynamics, Because the more technology that has stickiness to it, the longer the term contracts and the better stability you have in pricing.

Speaker 2

And you also get this benefit of increased, It's called share of wallet or mix for every procedure. So if you can bring technology in to the very same procedure you had yesterday, You get more revenue for that procedure. As we see that adoption continue to move up of things like robotics and data or cementless technologies in knee, That actually allows a mix benefit for the entire market and that could buoy the overall market growth rate, taking pricing stability, moving that forward, Bringing more revenue per procedure that has a real positive effect for the overall orthopedic space. And so that's a dynamic that's happening real time. Pretty exciting in my view anyway.

Speaker 2

But I'll open it up to anyone else who want to add anything.

Speaker 7

Maybe quickly here, Brian, I'll just recap some of what you said. Four bullet points here. Number 1, as it was mentioned earlier, the shift of care On to the ASC, and frankly, in some cases, some things getting done at home like physical therapy is real.

Speaker 11

So no

Speaker 7

longer is all about the inpatient unit. It's a real shift of care again to ASC, and then post surgery, somebody start getting down at home. So that's number 1. Number 2, clearly, the decision maker is not just the physician or the provider. The patient plays a role.

Speaker 7

That's why we're excited about satellite technologies that we're launching that directly target consumers' patients. So it's no longer just a physician provider, it's patient, physician, provider and payer. Some of the data and the technology that Brian is talking about becomes really a powerful tool for us to engage payers in demonstrating that we have not just a solid clinical value proposition, but also an economic value proposition. Number 3, and I think this aligns with the pricing star. Sorry, there is an emphasis in discussing value just as much as pricing.

Speaker 7

Some of the discussions that we're having today around length of stay, reducing length of stay, some Some of the discussions we're having around lowering readmission rates, increasing patient satisfaction, having a shorter surgery with the same outcomes No discussions that were happening maybe 3 years ago and they're happening right now. And then number 4, the role of innovation. I've been in MedTech for 28 years. I was working in orthopedics 15 years ago. When I rejoined or I joined orthopedics again 4 years ago, I would say that things were pretty much the same, made of a couple of robotic introductions.

Speaker 7

Over the last 3, 4 years, we've seen a lot of innovation coming from therapeutics, In each reality, in infection management, in bringing machine learning, in really thinking about the entire picture of care. So I would say those are the 4 key things I would pay attention to. We think we'll have a competitive advantage in those areas.

Speaker 4

Very helpful. Thank you.

Operator

We'll take our next question from Richard Newitter with Truist Securities.

Speaker 5

Hi. Thanks for taking the questions. I wanted to just follow-up first, Brian, on what you were talking about on kind of some of the pricing you mentioned with new technology, mixed reality, smart implants. I'm curious within the buckets of mix, The ability just to preserve your pricing as contracts roll off and discrete opportunities to charge for some of these newer areas, Particularly on that 3rd bucket, can you give some examples of where these new technologies might be able to fall into that 3rd category or which of those buckets Should we expect more of the pricing impact from?

Speaker 2

Yes. It's and I'm making sure that I understand your I understand your question specifically, but when I think about the innovation that we're bringing and not just us by the way, that's what I like about it, there's momentum Across the entire orthopedic space and all the major players are moving in this direction. I think in certain areas we're ahead, but make no mistake, everyone's moving in this direction. So if I just take a couple of examples and hopefully this will answer the question that you're asking. Think about MyMobility, for instance, which is one of the first launches that we had in data collection, leveraging relationship that we have with Apple.

Speaker 2

This uses an Apple Watch to collect data and then ultimately uses machine learning to be able to do some predictive analysis. And we're actually now looking at that through an opportunity to tell a surgeon and the patient when they're falling out of the norm for recovery. Okay. So that's the type of thing that we're able to do and we do sell that. So there's an opportunity to monetize that application.

Speaker 2

So it's not just But there's also a discrete way of making money or monetizing that MyMobility application. So that's one example. Another example is robotics. I mean robotics comes in, you get that natural gravitational pull for competitive surgeons to come over, But you also get an uplift every time they use a robotic procedure because you get the uptick in disposable value. So that procedure Now costs more for the account to do, but to get the benefit of robotics inside of that, so it's a fair trade.

Speaker 2

Those are two examples of the way technology Is leaning in, in that way. Same thing with Persona IQ. That's the first smart implant that will be on the market. It's collecting data in a very compliant way because you can't take it off. It's there nonstop for the patient and that will also drive a premium in the marketplace.

Speaker 2

So if you're going to use Persona IQ, You're going to pay discreetly for that sensor capability and that's the way we're monetizing this. So you could see a combination of things where we monetize the technology or sometimes it just brings value that is unique to us that would allow us to pull in additional implants. But it's some combination of those two things. And again, Ivan, if you wanted to add anything else or Suki or anybody else.

Speaker 7

I see you've done a very thorough job, Brian. We can go to next question.

Speaker 5

Great. And just on PersonaIQ, it seems like the infection prevention capability or the ability to detect infection before it occurs. That's probably going to be the killer app for a product like that that will allow you to get that kind of premium. I guess what should we think of timelines on the data collection to be able to get an approval for infection prevention indication?

Speaker 9

Yes.

Speaker 2

What I've learned over the years is committing to timelines in a situation like this is always A bad idea. What I can say is that we are absolutely sprinting and using our limited launch focused on Getting users that will use significant quantities and be able to collect data with us, so that we can ultimately look for different ways To provide the insights that will matter to our customers, the things that we want to focus on first would be what are those things that we could predict that will obviously be good for the patient, but also derail cost associated with caring for the patients, so reduce the cost of caring for the patients. And infection is great. If you could get there, that's fantastic. If we could predict a risk of infection Before it occurs, that would be fantastic.

Speaker 2

Certainly something that we're going to be looking to do, but it doesn't happen very often. So you just think about the power, The number of patients you're going to have to have and the amount of data, it's going to take us a little longer to get there. What we're also going to be looking at though is just loosening, Which also happens. Can we predict loosening before it happens? You're looking at stiffening.

Speaker 2

There are certain things you've got to do from a stiffening perspective that if we can get out ahead of, we can reduce the amount of care that needs to be provided to the patient. So there's a lot of other things that we're looking at to try to predict that will derail The cost or reduce the cost of caring for the patient and make sure for better outcomes for the patient. So I don't want people to get hyper focused on infection. It's something that we're going to pursue. It will take longer.

Speaker 2

But the real goal right now is to be able to look at the data that we're collecting, which is significant already, and then be able to derive those insights that will change the way we care for our patients. Once we get to those, we can define those that will really begin to bolster That value proposition that we have for the product and be able to support a higher price point for PersonaIQ.

Speaker 5

Thank you.

Speaker 8

We'll take our

Operator

next question from Jeff Johnson with Baird.

Speaker 11

Yes, thanks. Good morning, guys. Brian, maybe even building further out on this pricing discussion, I think it's all interesting stuff. And The premiums you can get on new technologies, on sensor based technologies, moving that mix higher and all that, that all makes sense. I'm more interested or equally interested, I guess I should say, on kind of your base business.

Speaker 11

I don't know what your vitality index is right now, but let's say 70% or 80% of your revenue is generated products that are a few years or older in the portfolio. Where are hospitals that in understanding that they can't keep extracting 2 or points of price even out of those base products every single year, if you're going to continue to invest and develop this new technology in that. Are those conversations with hospitals improving at all in this especially in this inflationary environment?

Speaker 2

Yes. Probably what I'll do is I'll turn this equation that we think are going to benefit the company going forward. But maybe Suki, you could talk about the variables that we do look at when we think about pricing. And I know, Vain, you probably

Speaker 6

Yes. So we do think overall that this can help pricing discussions, they're becoming much more strategic in nature and more centered around value. We're not completely there where we want to be, But we're starting the dialogue more around value versus just straight price and transactions. But maybe, Ivan, you want to talk a little bit because I know

Speaker 2

you've got some real world

Speaker 7

Yes, absolutely. It's a real discussion. It's happening, Jeff, in pretty much every country. As you think about our vitality index, there is a direct correlation between improvements in vitality index, percentage of sales coming from new products and stability around price. And it may not be mix The product launch itself that you launch in a given year.

Speaker 7

But as you launch, as an example, PersonaIQ, that creates a category contracting opportunity where we contract that for the rest of the portfolio in knees, they got to keep a certain price. And again, that is a real discussion and one very real example of how we think about it. We do that in knees. We do that in hips across the board. So again, a very direct correlation between new product introductions, vitality index And keeping the price premiums for the product a couple of years later, but also for the category of products in a given space.

Speaker 11

That's helpful. Thank you. And then maybe just a follow-up and I think Suki it's probably for you, but as I think about this placement strategy with ROSA or kind of how the market has shifted over the last 6 12 months to more of a placement strategy and it sounds like that's probably going to continue at least for the foreseeable future. When do we get that crossover where the minimum purchase commitments, maybe the minimum price points, things like that that are guaranteed in those contracts. Those start to outweigh on the good guys side versus I'm sure which are some upfront costs you're having to eat here on this placement strategy and it's probably not helpful in the very short run on the margins, things like that.

Speaker 11

So just when does that cross overhead and that the longer tail of those positives really start to kick in? Thanks.

Speaker 6

Yes. I'll start with and then turn it over to Yvonne. You're thinking about it the right way, right? Upfront

Speaker 7

I would say the governance when it comes to robotics is second to none. So when we do install and place our robotic unit In any center globally, there is a minimum commitment of cases that the center has to perform where we take the unit back. One reason is financial. The other reason, perhaps more important, is from a compliance standpoint. Given a fair market value exchanges, we cannot have capital equipment in centers That are not delivering on the contracted number of cases.

Speaker 7

That's why we keep talking about how we prefer to place units versus any units, so we'll get the annuity. On the other side of the equation, as we think about those cases, there is also a governance around disposables. There is 0 When it comes to pricing discounts on the disposables, the peripheral items that are part of the robotic case. So again, I would say that The robotic governance is second to none and really early innings here in terms of where we are in the journey.

Speaker 11

Thank you.

Speaker 8

Yes. Thanks for the question. Yes, I think, operator, we have time for maybe one more.

Operator

We'll take our next question from Matthew O'Brien with Piper Sandler.

Speaker 13

I just want to put a finer point on this top line number that you're talking about for next year. First of all, is that 4% kind of the floor that you're thinking about For the business next year and just as I think about the components that you're talking about between VBP and pricing and ASCs, etcetera. It just seems like the environment, for hips and knees specifically is going to get more robust or really levered to hips and knees. Why wouldn't 4% be the floor and there's the potential for some meaningful upside to that as we head into next year? Thanks.

Speaker 2

So the positive news is that's the question I'm getting and not a question of whether we can deliver the 4. So we're making progress there. I would say that, I still think that, as I talked about before, there are a lot of headwinds that we have to pay attention to. So I don't want to say that first of all, we're giving more color than we would ever give in a normal year just given all the challenges that everybody is facing, trying to help you out here. But I would say 4 is a number that I'm saying is doable.

Speaker 2

We see a pathway to 4. But make no mistake, there are challenges that are out in the market, macro just not things that are internal to our own organization that could stress that. And there are opportunities from a macro perspective that we just talked about that could also help that. We're trying to take a balanced view of what could happen, positive or negative, to what we think organically we can do in 2023. And that's the reason why I would say, 4, you should not consider a floor.

Speaker 2

4, you should consider a good way to look at, All things considered a fair way to look at growth in 2023. And by the way, 2023 was just a normal year and we didn't have all We believe that 4% is about the right way to think about our business. Given all the portfolio moves that we've made, the WAMGRIC improvements that we've made, the innovation fly I will that we are now moving. We believe that's what we deserve. Could we do more than that?

Speaker 2

Certainly, particularly as we start to continue to move our active portfolio management strategy. We have more financial flexibility and we continue to move that weighted average market growth rate north. But I don't want people thinking that I mean 4 as a floor. I didn't mean to attend that.

Speaker 13

Understood. Thank you.

Speaker 2

Sure.

Speaker 8

Operator, I think we're a little past 9:30. Unless there's any closing remarks or Brian anything you'd add, we're probably good to end the call.

Speaker 2

I probably just said it. I think I want people to continue to focus on the transformation that has occurred at Zimmer Biomet. We've been extremely disciplined in our portfolio decisions and portfolio to me is in all aspects of the business. We are biasing our spend, whether it be research and development, commercial infrastructure, the way we compensate people in active portfolio management through M and A has already happened and more of it will happen on a go forward basis. And I keep talking about that innovation flywheel, but that was non existent just a few years ago.

Speaker 2

The vitality index is moving in the right direction in a rapid way, and we expect that to continue. All of that combined with the execution that we're seeing from

Speaker 8

Thanks so much, Brian. And thanks everyone for joining the call this morning. Of course, if you have questions, please feel free to reach out to the IR team. I know we'll speak to many of you today. So thanks for joining.

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Earnings Conference Call
Zimmer Biomet Q3 2022
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