Zimmer Biomet Holdings, Inc. (ZBH) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Third Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, October 30, 2024. [Operator Instructions] I would now like to turn the conference over to David DeMartino, Senior Vice President of Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to Zimmer Biomet's Third Quarter 2024 Earnings Conference Call. Joining me on today's call are Ivan Tornos, our President and CEO; and CFO and EVP, Finance, Operations and Supply Chain, Suky Upadhyay. Before we get started, I'd like to remind you that our comments during this call will include forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please note, we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements. Additionally, the discussions on this call will include certain non-GAAP financial measures. Some of which are forward-looking non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures and an explanation of our basis for calculating these measures is included within our second quarter earnings release, which can be found on our website, zimmerbiomet.com. With that, I'll turn the call over to Ivan. Ivan?

Good morning, everyone, and thank you for joining today's call. Welcome, David, to your very first Zimmer Biomet earnings call. Truly lucky to have you. We love what you bring to the team already. I'd like to start today the way that I always do by taking a moment to recognize and to show my gratitude to the over 18,000 Zimmer Biomet team members who each and every day across this move for business and our mission forward. Thank you for your commitment to the organization. Thank you for your tireless work. Thank you for your very strong performance and most importantly, thank you for what you do for our customers and patients every single day. As I said in the past, and as I will continue to say as long as I'm here, the Zimmer Biomet workforce and the culture that we have truly is one of our key competitive advantages. During the call today, I'm going to cover 4 things. First, I'll give an update on the recent ERP implementation and the challenges associated with it. Secondly, I'll cover some general comments on the quarter and the broader market dynamics. I'll move to them talk about a brief innovation overview. And then fourth and last, I'll close with a usual update on our 3 strategic priorities. After this, Suky's going to cover our financials in more detail. I will make sure to leave plenty of time for questions at the end of the prepared remarks. To begin, I'm very excited to report that we made greatest strides in managing the ERP implementation challenges outlined in early September. Through the dedicated work of the Zimmer Biomet team and our external partners, we now expect the impact of this challenge in the second half of 2024 being lower than the 100 basis points of annual sales that we initially communicated. And we also fully expect to be back to normal shipping levels by the end of the year 2024. Turning to results. In Q3, we grew sales at mid-single digit level, including strong results in Knees, in Hips and in S.E.T. This quarter, the third quarter now marks the 11th consecutive quarter of mid-single digit or better constant currency revenue growth for Zimmer Biomet. In addition to the strong revenue performance, adjusted EPS once again grew faster than revenue. Our combined Knee and Hip businesses, what we call our reconstructed platform grew in the mid-single-digit range globally while S.E.T. delivered upper single-digit growth, aided by strong performance across our key growth drivers. Suky is going to cover this later, but I'm very proud of these results and specifically, I love the consistency of growth in the key categories. Beyond commercial execution, our performance was fueled by mid-single digit growth in our end markets, which we anticipate continuing based on all the analytics that we have at hand. And aging and increasing active population, combined with technological advancements, driving procedures to outpatient settings like the ASC here in the U.S. accelerating recovery times and best-in-class outcomes should continue to provide tailwinds to market growth in the coming years. So again, we see the markets being healthy, and we don't foresee these markets slowing down. From an innovation standpoint, Zimmer Biomet has the most robust product cycle in recent memory with over 50 meaningful plan product launches over a long-range plan horizon. I'm particularly excited about the momentum we are generating in our Hips platform as evidenced by the improved results in this business and particularly in the U.S., where we delivered almost 5% growth in the third quarter with Z1 or new triple taper hip stem for interior hip implant procedures and with our surgical impact of HAMMR as well as comprehensive navigation, robotics and platforms in navigation like OrthoGrid, we are going to continue to be on the offense when it comes to gaining share in Hips. So great innovation, and we expect consistency in execution over the next several quarters. In Knees, our cementess Persona OsseoTi continues to gain rapid traction, while the recently launched Persona IQ [ study ], the short stem for Persona IQ is driving continued uptake of this differentiated technology. Early in the launch, the feedback has been super. Within extremities, ROSA Shoulder has the potential to change the treatment paradigm in Shoulder implants. It's a platform that allows for reproducible, anatomic and reverse procedures. Finally, Zimmer Biomet is the only orthopedic company offering both a CT scanless robotic system in ROSA. And through our recent partnership with in THINK Surgical, we also offered a smaller footprint handheld CT scan based system in TMINI. So when it comes to navigation and robotics, we got the most comprehensive suite of solutions. Beyond all of this, we're expecting to launch a [ catering ] of new robotic applications in the short to midterm with and without CT scan capabilities as well as other differentiated features. In the ROSA franchise alone, we expect to launch 3 new indications in the next 18 to 36 months. While the underlying business performance remains strong, the team continues to execute on the same 3 strategic priorities that I have outlined in the past. Those being people and culture, which is foundational to everything that we do, operational excellence, innovation and diversification. As I said at the beginning of the call, people and culture are key competitive advantages for Zimmer Biomet. Recently, we appointed new leadership in our Hips, Knees, S.E.T., in our ASC and in our digital technology and solutions businesses. I'm excited about these leadership changes, and I'm confident that the growth under the leadership of this new individuals is going to accelerate. In addition, we have upgraded talent in critical areas like IT, information technology and operations. On the second imperative, operational excellence, we are maintaining expectations for the long-term financial commitments that we outlined at our Investor Day earlier in the year. With the terrific progress we made towards the resolution or the ERP issues, we feel even more confident in delivering mid-single digit revenue growth, adjusted earnings per share growth of at least 1.5x revenue and free cash flow growing at least 100 basis points faster than earnings throughout 2027. So again, the same commitments towards revenue, EPS and free cash flow remain. Finally, we continue to make progress in diversifying our business to increase the company's growth and profitability profile. This includes a highly disciplined approach towards M&A as well as internal capital allocation dynamics. To that extent, the value of Zimmer Biomet's pipeline of new products expected to be launched over our long-range plan is more than twice the value that it was just a short 5 years ago. And 80% of these new product launches are accretive to the Zimmer Biomet WAMGR of 4%. In conclusion, we're very proud of the progress in organization, and we look forward to continuing to execute above and beyond expectations. I love the fact that we're impacting the lives of millions of people, and I'm deeply inspired every day in knowing that my teammates and I are living the Zimmer Biomet mission of eliminating pain and improving the quality of life for people around the world. And with that, I'll turn the call over to Suky. Thank you very much.

Thanks, and good morning, everyone. As Ivan mentioned, we closed another solid quarter, showcasing the resilience and winning attitude across our nearly 18,000 team members. Despite ERP-related headwinds, we grew sales over 4%, while maintaining steady operating margins, generating $1.74 in adjusted earnings per share and $310 million in free cash flow. Given the challenges we have outlined related to our ERP implementation, we are now updating our 2024 full year guidance, which I'll touch on later. I would like to start by discussing the ERP implementation. As Ivan reviewed, we cut over to a new system in the third quarter for North America distribution, which resulted in slower shipping levels of products to our customers. We disclosed this disruption in early September and initially noted that the ERP-related headwinds could impact up to 1% of annual sales in the second half of the year. Through the excellent work of our team members, we now believe the impact will be 60 to 80 basis points of annual sales, split about evenly between the third and fourth quarter. We continue to expect to be back to normalized service levels exiting 2024. Moving on to results. Unless otherwise noted, my statements will be about the third quarter of 2024 and how it compares to the same period in 2023, and my commentary will be on a constant currency and adjusted operating basis. Net sales were $1.824 billion, an increase of 4% on a reported basis and 4.1% excluding the impact of foreign currency. Consolidated pricing was 70 basis points positive in the third quarter, marking the third consecutive quarter of positive pricing. Our U.S. business grew 2% and international grew 7.1%. Growth in the U.S. was driven by strong performance from hip and S.E.T., partially offset by other, which saw the largest impact from the ERP headwinds. Our international business continues to perform well with strength across Knees and S.E.T. Global Knees grew 5.5% in the quarter with U.S. growing 2.9% and international 9.2%. Our international business continues to benefit from our Persona portfolio in our ROSA robotics platform. Global Hips grew 3.7%, with the U.S. growing 4.9% and international 2.4%. As Ivan mentioned, with the launch of Z1, accelerating rollout of HAMMR and closing of the OrthoGrid acquisition, we now have a complete product portfolio in Hips and are on the offensive. Next, our S.E.T. segment grew 7.3%, led by CMFT, sports and upper extremities, which all grew between mid-single digits and high teens. This marks the fourth consecutive quarter of at least mid-single-digit growth in S.E.T. and a trend we expect to continue. Finally, our other category declined 9.5%. The decline was driven by a combination of difficult comps from the prior year as well as our surgical business being disproportionately impacted by ERP-related challenges. Turning to our P&L. We reported GAAP diluted earnings per share of $1.23 compared to GAAP diluted earnings per share of $0.77 in the prior year. The increase in GAAP earnings was driven by higher revenue, combined with a lower tax rate and share count. On an adjusted basis, we delivered diluted earnings per share of $1.74 compared to $1.65 in the prior year with earnings growing faster than revenue. Adjusted gross margin was 71% and adjusted operating margin was 26.3%. Despite the ERP-related headwinds in the quarter, gross margin and operating margin were largely in line with the prior year. Net interest and other adjusted nonoperating expenses were $51 million in the quarter, up slightly on higher net debt and interest rates. Our adjusted tax rate was 17.7%, higher than 2023 due to the implementation of Pillar 2 and fully diluted shares outstanding were 203 million, down year-over-year due to share buybacks. Turning to cash and liquidity. We generated robust operating cash flow of $396 million, free cash flow of $310 million, bringing year-to-date free cash flow to $652 million and ended the quarter with $569 million of cash and cash equivalents. Aligned with our capital allocation strategies to return at least 65% of free cash flow to shareholders over the LRP, we repurchased approximately $600 million in shares during the third quarter. Through the end of October, we have repurchased over $850 million in shares in the open market, and we maintain flexibility to continue our share repurchase program. Regarding our outlook for the rest of the year. Given the ERP-related headwinds, we are updating our full year financial guidance. We now expect 2024 constant currency revenue growth of 4.25% to 4.75%. With recent exchange rate fluctuations, we now anticipate about a 75 basis point headwind from currency in 2024, resulting in reported revenue growth expectations of 3.5% and to 4%. Also, we now expect full year pricing to be flat to 50 basis points positive. For margins, we anticipate full year gross margin to be down slightly from 2023, while operating margin is still projected to be up year-over-year, marking the fourth consecutive year of operating margin expansion. We are reiterating our expectations for net interest and other nonoperating expenses at about $205 million and an effective tax rate of 18%. Fully diluted weighted average shares outstanding for the year are expected to be about 204 million, resulting in adjusted diluted earnings per share of $7.95 to $8.05. And we expect full year free cash flow to be about $1 billion. In summary, despite the challenges, this was another solid quarter for Zimmer Biomet. With that, I'll turn the call back over to David.

Thank you, Suky. Operator, let's open it up for questions. [Operator Instructions] Operator, please go ahead.

[Operator Instructions] We'll take our first question from Travis Steed with Bank of America.

I wanted to understand, first, why are you cutting the guide by more than the ERP issue on an organic basis for 2024? And how to think about 2025 and the ERP? Is there a catch-up there? Should we think about 2025 kind of the low end of your 4% to 6% LRP?

Thank you, Travis, Ivan here. So just on the first part of your question on the guidance for '24. Look, listen, we're going to be somewhat conservative when it comes to the year and allow us to be conservative given the PTSD, if you will, or the recent ERP challenge. In Q4, all kinds of things happen. We want to see where we end up with pricing. Pricing has been positive for the entire year. Let's see where we end up in Q4 with all the puts and takes that happened around rebates, et cetera, et cetera. I want to make sure that we see the commercial execution that we need to see around new product introductions. We've got 3 very meaningful new product introductions as we speak. We're late to get some of the sets out given the challenges with ERP. So again, I want to get at least a solid month, 1.5 months before I get to positive on Q4. And then, look, there are some macro factors early in the quarter. We saw some disruption with the hurricane and whatnot and the IV bags. We believe those are going to come in within the quarter. As a matter of fact, we are seeing those cases coming back already in the quarter. So allow us to be somewhat conservative, and we'll see what we end up in Q4. Relative to 2025, we're very positive. The ERP constraint or challenge is well contained within the year. We'll update you in early 2025 when it comes to what 2025 is going to look like. But I would say today, we're feeling very positive, given new product introductions, the resolution of the ERP, et cetera, et cetera.

Our next question from Larry Biegelsen with Wells Fargo.

This is Vik Chopra in for Larry. Ivan, can you provide us with your updated thoughts on M&A and areas of interest? Why haven't we seen more deals from you given that valuations have come down?

Thank you for the question. While -- let me start with the latter part. So why have you not seen more deals? We have said all along that we don't need to do deals to remain a mid-single-digit revenue grower over the life of the long range plan. 11 quarters now, we've been growing mid-single-digit revenue or above, delivering mostly the time EPS faster than revenue and generating meaningful cash flow. Obviously, we're excited about M&A and the potential to diversify even more beyond the 4% WAMGR. The deals need to make strategic sense and financial sense, valuation are down. Yes, they are. But I will tell you, as we go through the filters, there is not a single deal that is jump on as saying we have to reallocate capital and do this deal immediately. We continue to evaluate deals. Deals in higher growth segments within Recon, opportunities within our S.E.T. business and things that are in the ASC space. We've done deals that are exciting. OrthoGrid is the fastest navigation company today in the U.S. We've done some tuck-ins in areas of S.E.T. And when the right deal comes our way, we will jump on it. Thank you for your question.

We'll move to our next question from David Roman with Goldman Sachs.

I was hoping you could dive a little bit deeper into the reconstructive businesses and maybe starting with Knees, where I know you had called out some supply chain dynamics last quarter that negatively impacted your U.S. business. That looks to have turned around here. Have you fully recovered from that? And maybe you could take us through a little bit more what's going on outside the U.S. because it also looked to be an area of strength this quarter? And how should we think about the geographic performance across Recon on a go-forward basis here?

Yes. Thank you, David. So let's start with Knees overall. So international grew almost 10% in the quarter. In the U.S., we grew 3% constant currency, that is. The challenges that we highlighted in the Q2 call, they were pre-ERP related. It was revision shortage that we had that's been resolved. So I will tell you, as we see here and I hit in the year, there are no supply constraints when it comes to our Knee performance. The one thing that did slow down our Knee growth in the quarter relative to the U.S. is the ERP challenges. While the impact of ERP was primarily in other, we could have had more Persona OsseoTi S.E.Ts. going into the market. We could have done a better job in pulling through the multiple ROSAs installed in the U.S. So that has been the challenge. As we enter Q4, we're excited about where we are with Knees, and we really look forward to 2025.

We'll move to our next question from Matt Miksic with Barclays.

Operator, we can go to the next question.

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

This is Allen on for Robbie. I wanted to dive a little bit deeper into the guidance question that we kind of opened a Q&A session with. Just because you -- despite the ERP challenges that you had in the quarter, you ended up beating your -- what kind of where I think expectations were for constant currency and organic guidance for the quarter. So could you just help us a little bit more to kind of quantify some of the headwinds that you're not being a little conservative on, whether that's the disruption from the hurricane or the IV bags because you're seeing those cases coming back through. Just help us kind of bridge the gap between the beat that you had this quarter, the fact that ERP challenges are coming in better than expected and the 100 basis points lower guide.

Thank you, Allen. I'm not sure that I can offer any more color than what I offered. There is a level of conservatism given the multiple variables. Again, we just reactivated shipping volumes. We got through the ERP. We want to make sure that we like what we see. And again, it's no more complex than that. Don't read too much into it. We got one month behind in the quarter. We love what we see. And again, let's see what happens in November and December, but nothing else to add on the guidance question.

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

Would love to talk a little bit about the S.E.T. performance in the quarter because that was strong. It was a 2-year stack acceleration. And as I think about that category, the growth that we're seeing overall across the category plus the margin profile, I'm just curious what that can do for Zimmer Biomet as we head into '25. Can it really help drive us to that mid-single digit, upper -- even upper end of the range at 6%. And then what it might do for the profitability profile of the business as well.

Sure. I'll cover the first part, and I'll let Suky elaborate on the margin opportunity here with S.E.T. So this is the fourth quarter in a row where we have grown S.E.T. at the mid-single-digit revenue or above. Actually, this quarter is low upper single digit. We typically don't talk about the geographic split U.S. or U.S. for sale. But I'm pleased with the U.S. S.E.T. performance and where we grew 5% in the quarter. Once again, virtually all of the 6 drivers within S.E.T. grew above our expectations. The 3 growth drivers with S.E.T., Sports Medicine, Shoulder and CMFT continue to perform very strongly. As we've been saying for a while, here is where we have invested a lot of innovation over the last 3 years. And what you see now is the early results of all those launches. And yes, we do believe that the growth is sustainable as we get into '25 and '26. As we highlighted in the investor -- at the Investor Day, this is a category that has to be growing at this pace, if not above, and there is plenty of new products together. Suky, you want to comment on the margin piece?

Yes. I won't give too much detail on 2025. But overall, it's a very attractive segment as Ivan said, from a growth profile perspective, but also from a margin perspective, margins in those key 3 businesses that Ivan talked about are above our overall company average. And so that's a good thing. They are slightly under our Recon business. But again, from an overall growth and EBITDA perspective, we're very excited about how that business is performing and where it's going.

One last comment I'll throw in there related to the financial performance. Typically, this business, these segments require less instruments on working capital. So again, it's another enabler of free cash flow growth over the life of the plan. Thanks for the question.

We'll move to our next question from Chris Pasquale with Nephron.

You announced that you're going to be rolling out Z1 in a couple of weeks. Our data suggests that triple taper stems have become a big portion of the U.S. hit mix for your competitors. So it would be great to hear how you're thinking about that opportunity as you plug that hole in your portfolio? And could you also talk about what your supply situation is going to look like with Z1 initially? And at what point you could have broad availability of that product in the U.S.?