Zimmer Biomet Holdings, Inc. Q1 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet First Quarter 2022 Earnings Conference Call. This conference is being recorded today, May 3rd, 2022. 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 Mattox, Senior Vice President Investor Relations and Chief Community Officer. Please go ahead.

Thank you, Operator. And good morning, everyone. I hope you are all well and safe. Welcome to Zimmer Biomet first quarter 2022 earnings conference call. Joining me today are Bryan Hanson, our Chairman, President and CEO; EVP and CFO Suky Upadhyay and COO Ivan Tornos. Before we get started, I'd like to remind you that our comments during this call will include forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please note, we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties, 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 Q1 earnings release, which can be found on our website, zimmerbiomet.com. With that, I'll turn the call over to Bryan.

Alright, thanks, Keri, and thanks to all of you for joining us this morning. I'm going to talk briefly about our Q1 performance and our revised expectations for the full year. I'm also going to spend a few minutes talking about our recent innovation and our key drivers for long-term growth. And then after that, I'm going to turn it over to Suky, who will get into more details on the quarter, but also very importantly, our full-year guidance update. And then we'll close out the call with your questions, of course. So, let's get started with Q1. We had a strong quarter, well above our own expectations and obviously above external expectations. And the primary reason for that level of overachievement was stronger than anticipated COVID recovery in the quarter, particularly when we looked at the back half of the quarter. If I look at the U.S. recovery, it was stronger and faster than I think anyone expected pretty much across the board. And while we continue to see COVID surges in EMEA and China, the impact on overall procedure cancellations has been minimal at least so far. Inside of that we saw very strong performance in large joints, and in particular our Knee franchise, while our set recovery lagged our core recon business at this point. We know it's still early in the year but based on what we saw in the quarter, and really current trends in the Q2, our confidence in 2022 growth has definitely increased. And as a result, we're raising and tightening our full-year guidance. Now there are clearly a number of headwinds that we're facing. Supply challenges, inflation, Russia, Ukraine. But given our revenue dependent on elective procedures, COVID recovery outweighs those headwinds. And that's why even in the face of these challenges, we're able to raise our outlook for the year. Okay. So, turning the page a bit, outside of external influences on our business, our strategy is working and our underlying business is very strong. Our new product pipeline continues to deliver. We're adding more innovation and value to our ZBEdge ecosystem. If you were at AAOS, you saw our recently launched WalkAI. This is ZB's first AI-based solution. We also showed recently launched functionality for the Mymobility platform, this is under the umbrella of our exclusive partnership with Apple. Our ROSA Robotics momentum continues to be very strong. And the early feedback on Persona IQ, even though it's in a limited launch, is very positive. All of these things combined are highlighting the possibilities around data collection and integration on the patient experience. We also continue to drive significant demand and traction with Persona Revision in our Knee franchise. With Avenir Complete in our Hip franchise, and our signature ONE planner in shoulder. And our new product pipeline remains very strong with additional product launches planned for 2022, especially across our Knee portfolios. We're also continuing to reshape our business and accelerate ZB's transformation. That means of course, streamlining and modernizing our operating model, but also focusing on making ZB a best preferred place to work and a trusted partner. Just in Q1, we scored 100% on the human rights campaign’s corporate equality index. We made Forbes' best large employers list and were named one of the most innovative companies by FastCompany for our ROSA Robotics platform. We have also prioritized our environmental, social, and governance, or ESG commitments, and our actions in this area continue to expand. We have committed to key environmental standards, delivered on social giving pledges, and set diversity, equity, and inclusion standards and long-term goals in this area. And we've enhanced our overall reporting of ESG progress internally to our own team members, but also to investors. Finally, our transformation also includes, as you know, active portfolio management; as a part of this, we completed our spin of ZimVie on March 1st. That was ahead of schedule and certainly as a part of our active portfolio management strategy. So, in summary, even though there are real macro headwinds that we will have to manage, and I have confidence in our team to do so, the recovery, the shift in recovery really in COVID is the bright spot we've been waiting for. We're excited about it, and it's certainly changed our view of 2022. With that, I'm going to turn the call over to Suky for a deeper dive into Q1 and our revised expectations for the full year. Okay, Suky.

Thanks, and good morning, everyone. We had a good quarter driven by a faster-than-expected recovery of elective procedures, giving us the confidence to raise our full-year revenue and earnings per share outlook. Let's turn to our Q1 results and how that translates into our updated full-year financial guidance. Unless otherwise noted, my statements will be about the first quarter 2022 and how it compares to the same period in '21, and my commentary will be on a constant currency and adjusted continuing operations basis. Please note we have changed our geographic revenue reporting to U.S. and international, and we released a Form 8-K last week to provide unaudited recasted financial information related to our ZimVie spin-off, as well as a change in non-GAAP reporting of in-process R&D-related expenses. Moving to first-quarter performance, net sales in the first quarter were $1.663 billion, up 3.9% on a reported and 6.8% on a constant currency basis. As previously guided, selling days contributed about a 130 basis points of tailwind in the quarter. Revenue was driven by continued execution along with stronger and faster-than-expected COVID recovery across most markets, with the largest uplift in the U.S. After significantly pressured January, recovery ramped through the quarter with improvement in February and a strong rebound in March. On a consolidated basis, March grew versus pre-pandemic levels, and that recovery has continued into April. U.S. sales grew 5.8% driven by strong recovery as COVID cases subsided and elective procedures returned. By the end of the quarter, U.S. cancellation rates have returned to pre-pandemic levels, and procedure volumes were above 2019. International sales grew 8.1% driven by strong growth across Europe, and we saw continued recovery despite COVID surges in certain European markets in China. Turning to our business category performance in the first quarter. As a reminder, China's value-based procurement is expected to be about neutral to overall revenue growth for the full year. So far, the 2022 impact is broadly in line with our original expectations. While we don't expect a material impact from VBP on full-year 2022 growth, we do expect there to be fluctuations by quarter. In the first quarter, we saw about a 200 to 300 basis points of pressure across our global Knee, Hip and surgical equipment segments, which we expect to be broadly offset through the next three quarters with the majority coming in the fourth quarter. Global knees grew 11% with U.S. knees up 11.7% and international knees up 10.1% driven by solid commercial execution, continued traction for Persona Revision, robotics pull-through, and strong knee procedure recovery across most markets. This decrease was driven primarily by an unrealized investment loss due to a decline in the value of our investment in ZimVie, and higher litigation-related and restructuring charges. On an adjusted basis, diluted earnings per share from continuing operations of $1.61 represents an increase from $1.55 in the first quarter of 2021. The increase was largely driven by higher sales and lower interest expense. Adjusted gross margin was 70.6%, lower than the prior year as expected due to VBP and higher input and manufacturing costs, which were partially offset by higher volumes and better mix. Our adjusted operating expenses were about $735 million, up from the prior year driven by higher investments in R&D. Our adjusted operating margin for the quarter was 26.4%, down versus the prior year, but ahead of expectations and driven by higher revenue. The adjusted tax rate was 16.1% in the quarter in line with our expectations. Now turning to cash and liquidity. Operating cash flows from continuing operations were $360 million and free cash flow totaled $223 million for the quarter. We reduced our debt by about $650 million, excluding the effects of foreign currency and ended the first quarter with cash and cash equivalents of about $435 million. Our improving financial performance in tandem with our ongoing debt reduction continue to strengthen our balance sheet. Moving to our updated financial outlook for 2022 while we continue to manage through macro headwinds related to foreign currency, Russia, inflation, and supply chain challenges, a faster and stronger COVID recovery, in tandem with a positive first quarter give us the confidence to raise and tighten our financial guidance. Against this backdrop, our current expectations for the full year are as follows: On a constant currency basis, we now expect to grow 2% to 4% versus 2021, with an expected foreign currency headwind of approximately 350 basis points. This translates into a reported revenue growth projection in the range of negative 1.5% to positive 0.5% versus 2021. Note that the selling day tailwind that we saw in the first quarter will be fully reversed in the fourth quarter with no material full-year selling day impact. Adjusted operating profit margins continue to be in the range of 26.5% to 27.5%, this assumes inflationary pressure of about 150 basis points versus our original estimate of about 50 basis points. Of the incremental 100 basis points of pressure, half will hit 2022 but be offset by expected higher revenue, and roughly half will be capitalized and impact 2023. Adjusted tax rate expectations remain in the range of 16% to 16.5%, adjusted diluted earnings per share is now expected to be higher at $6.65 to $6.85. We are increasing free cash flow to $750 million to $850 million. Inside of that guidance, we have a tougher comparison in the second quarter due to COVID recovery we experienced in 2021. But we do expect revenue to grow in the low single-digits over the second quarter of '21 and to exceed pre-pandemic levels for the full quarter. In summary, we expect that the environment will remain dynamic, but we believe the pace of recovery, our continued execution, and the strength of ZB's underlying business fundamentals position us well to improve our financial outlook. With that, I'll turn the call back over to Keri.

Thanks, Suky. Before we start the Q&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?

Thank you. Ladies and gentlemen, at this time, we will now begin the question-and-answer session. One moment, please, for the first question. Our first question comes from Joanne Wuensch with Citi.

Good morning and thank you for taking the question. Very nice quarter. I'd be interested in your view of what's happening at the hospital level. We've been hearing all season about staffing headwinds, about CapEx spending headwinds. And I'd be curious to get your opinion on that. Thank you.

Yes, thank you. I'll start by mentioning that Ivan is sitting next to me. We are currently in Europe, taking the opportunity to begin Q2 on a strong note. I want to emphasize that we are still experiencing staffing challenges, which we expect will persist throughout the year. Regarding the quarter, it was tough in January due to COVID and staffing issues, but it improved in February and was very positive. In March, we actually saw growth compared to 2019, indicating true growth beyond pre-pandemic levels, and this trend has continued into April. While we anticipate ongoing staffing challenges, they may not be as severe as we initially expected at the beginning of the year. Ivan, since you're more active in the U.S., perhaps you can add to that.

Thank you, Bryan. I agree that it continues to be a challenge. In the U.S., we have noticed that our cancellation rates are starting to resemble those from 2019. Previously, most cancellations were related to fear and anxiety, particularly during the early part of 2021, which was largely due to staffing issues. Now, the situation seems to be improving, especially in Europe compared to other U.S. markets, but it still presents a challenge here.

Sorry, capital?

Joanne, was your follow-up about capital and the capital markets, net pressure?

Yes, there is capital purchasing. Thank you.

So, I'm having a hard time hearing her for some reason. I don't know if maybe Keri, you could repeat the question. I couldn't hear it.

Sure Bryan, Ivan. Joanne was asking about capital purchasing and what we're seeing on those trends.

Yeah, I can see that question as well. So primarily we sell capital in two businesses, for surgical business and obviously robotics, Knee and Hip. We are not seeing anything that tells us that there's a shortage of capital. What the strategy for the quarter is being more around placements than selling robots. But under the surgical side, we're not seeing a challenge; we're not seeing that we've seen less fluidity than in Q4. So, I'm actually pretty optimistic in terms of where we are when it comes to a capital allocation from a hospital standpoint. But again, as I mentioned, we are doing more placements than sales in the quarter. We did more placements than sales in the quarter. Thanks for the question.

Thank you.

Thanks, Joanne. Lauren, can we go to the next question, please?

Our next question comes from Travis Steed with Bank of America.

Hi. Good morning. Thank you for the questions and congratulations on a strong quarter. I appreciate the insights regarding the margin pressures, but I want to clarify how we are perceiving the impact of these pressures on 2023. It seems there is an additional 50 basis points of pressure at this moment. However, I am also interested to know if there are any offsets such as pricing, as I noticed that pricing was not mentioned in the press release this quarter for the first time. I'm curious about your thoughts on that.

Yes. Sure. Hey, Travis, this is Suky. Thanks for the question. I'll start and then maybe turn it over to Ivan on the pricing question that you had. So, you heard correctly; we think that inflationary pressures are going to be roughly a 150 basis points of a headwind on margins this year. Our original estimate back on the Q4 call was 50 basis points. So, we think we're somewhere in the additional 100 basis points range from where we originally were. We were seeing that pressure grow post our call, but it really started to accelerate with the war in Ukraine. I don't think that's inconsistent with what you're hearing across this sector and probably in other industries as well. Now, the way this works is part of that pressure, about half of that will hit this year, but given the way we account for costs and variances, and given the higher level of inventory that we carry, about half of that additional pressure will be capitalized and deferred into 2023. I would say that the key challenges that we're seeing, again are very consistent across the sector from a supply chain standpoint. First, freight is higher; commodity costs are higher, energy costs, and labor costs. But the biggest culprit within that is our commodity costs. The good thing is we're starting to see some stabilization around that. We do still see some higher costs related to stainless steel, packaging materials like plastics and resins, and of course titanium, which we're doing a lot of spot buys to secure our safety stock and supply chain. But what we're hearing from our supply chain organization is that things are starting to stabilize. The environment is still very dynamic, so we'll keep you posted as the year progresses. The good thing is that the largest headwind that we've got feels like it's beginning to stabilize a bit. Inside of that from a pricing standpoint, we did see a slightly better quarter this quarter on a pricing perspective year-over-year. Some of that is due to some specific strategies and tactics that the team is putting in place to better control pricing erosion year-over-year. Some of that I think is just a little bit still opportunistic because with the continued COVID headwinds that we saw in the beginning part of the quarter, that results in lower volumes, which then results in lower rebate thresholds for some of our customers. That sort of helps a tailwind on our pricing probably temporarily while our volumes are more muted. But maybe Ivan, you want to talk a little bit about what you're seeing in the pricing environment and our ability to offset price or pass price pressure onto the end markets.

Absolutely, Suky. Hey, Travis, Ivan here. So as Suky mentioned too, the normal price erosion is around 2 to 300 basis points. We did achieve better at price erosion in the quarter; some components of that are sustainable, while others remain to be seen. But I will tell you that we got over next today in the U.S. and frankly in Europe and APAC that we didn't have in the past, as we see our vitality Index or percentage of sales coming from new products; we see that as a tailwind. And again, we'll see how that develops in quarters to come. From an incentive standpoint, for the first time we will have very clear incentives in all commercial transactions to maintain or gain price. So, we're not making a commitment to do any better than the 2 to 300 basis points, given that a large percentage of the business is contracted. But certainly, we have the plans and the governance that we didn't have before. So, fingers crossed on that one.

I appreciate all that color. And Suky, one follow-up on China. Just want to make sure we're modeling that correctly. It sounds like it was 200 to 300 basis points headwinds to total company organic growth this quarter, but that comes back in Q4. If you just look at China volume with the shutdowns, I'd love to hear how that's playing out in Q2 and the recovery there from a volume perspective.

The volumes in China have clearly been affected negatively due to some of the COVID surges that have been reported, particularly in Shanghai, where we experienced additional lockdowns in other cities earlier in the quarter. Currently, there are no lockdowns beyond Shanghai; although there is limited movement in other provinces, there are no shutdowns, and we are still performing cases there. Shanghai remains the most critical situation in China. To provide some context, China accounts for a small portion of revenue for the entire company, with Shanghai only representing a modest fraction of that. While there are ongoing pressures in that province, I believe the situation is manageable and somewhat improving. Overall, aside from Shanghai, we are seeing stabilization and improvement. We need to closely monitor China, specifically Shanghai, but your understanding of the impact of VBP is accurate.

Okay, thanks for the insights.

I might add some commentary here. Even though there are many unexpected developments in China, the overall impact for the quarter was largely what we anticipated, and this trend is continuing into Q2. Different factors are at play, but the reality is that while we are experiencing lockdowns in Shanghai and facing disruptions, we are also seeing delays in VBP implementation. These factors are almost offsetting each other. Therefore, although China presented challenges for the quarter, both from a revenue and profit perspective, the results aligned closely with our expectations, albeit for different reasons.

Great. Thanks, Brian and Suky.

Thanks. Travis. Lauren, can we go to the next question, please?

Our next question comes from Amit Hazan with Goldman Sachs.

Thanks. Hey, good morning. Maybe start with market share, and I wanted to ask you the question. I know it's hard to tell the trends given the last couple of years. But as we look at three-year CAGR and just try to make sense of what's going on in the U.S., it's actually not very clear that you are consistently gaining share. I'm trying to think about this in the context of the 600 or so ROSA at least that you have in the field. I'm sure that's a little bit higher now. And just trying to understand if there are offsets there or how you're thinking about market share in the U.S., for knees in particular, but knees and hips, because the data doesn't strongly suggest that you're gaining share.

So, I'll take that and then I'll pass it over to you, Bryan. I'm going to talk about some specifics. But it probably all depends on how you're running your data because I would probably argue the different outcomes. The fact is it's choppy. It's really choppy. We're looking at this in every different way you can; sequential growth versus the previous quarter, we're looking at it versus prior year, versus 2019 because that was your last good year. We're looking at it on a stack basis. You name it; we're running the analysis to get a sense for what we're doing. What I've said always is that I don't really trust any given quarter, but I do look at trends, and almost any which way I slice it, I do see us moving in the right direction. Of course I also see things that you can't see in our own business. The combination of the trends that I'm seeing, looking at it a lot of different ways and also just the things that I see in my own business, I feel very confident that we're moving in the right direction and we're doing the things that we need to do to be able to drive attractive growth. A big one that I look at is vitality index. We had a more slow vitality in the business, we've doubled that in the last few years and that continues to move north. We've got a very strong pipeline of products. So, to me, when I think about that performance, it's clear. I mean, the transformation is real. The good news for us is that as COVID and staffing issues start to clear and continue to clear, that the reported performance that we have as a business will finally start reflecting what we actually know is happening in the business.

But what gives us a lot of confidence again, are the innovations. So maybe Ivan, you want to talk about some of the innovation that gets you excited.

Yes, I look forward to having objective market share data, as I have a different perspective on it. I'm very excited about our future. As for the products we frequently mention, the number of ROSA units is actually higher than 600 now. We are achieving strong penetration in key accounts, both in hospitals and outpatient settings. We have plenty of indications on the way. Our revision product has just launched in the U.S. and is growing at an unprecedented rate, which is benefiting our primary knees as well. I could discuss the numerous advancements you probably saw in Chicago, including WalkAI and Mymobility. We recorded the highest number of enrollments last quarter. Our cementless knees are also gaining traction, even before we introduce a new device at the end of this year that will really make a splash in the category. Regarding hips, Avenir Complete and our direct anterior revision platform are performing strongly, which we don't highlight enough. The surgery side is also doing very well. While there was some early uncertainty in trauma this year, we have new product launches on the horizon. There is so much forthcoming from us, and the data on our technology supports that. Although we might have different views on market share, I firmly believe that, given our innovation story and the vitality index being twice what it was, coupled with a significantly higher pipeline than three years ago, we will continue to outperform market growth.

Thanks for that color. We'd love to know specifically if you do have the data on the U.S. knees and hips, what your data set; I'm sure it's better than ours. But the second follow-up would be for you, Bryan. Just on capital allocation. Just how you're thinking about M&A post the spin now in this particular environment. If you want us to be thinking about natural limits to kind of the size of the deal you'd be looking at and how you're thinking about adjacencies versus whiteboard opportunities. Just any color would be super helpful. Thanks so much.

Yeah. So maybe I'll start kind of topline and then I'll hand it to Suky to talk about capital allocation and our current focus there. But yes, for sure, M&A and active portfolio management is a big part of what we define as Phase 3 of the transformation. Just as a quick reminder, we started this whole journey in Phase 1, which I'm just going to define as kind of the hearts and minds. In other words, kind of mission and culture focus. Significant upgrading in talent at the leadership team level to make sure we have the right people to transform the business and then stabilizing just a number of significant issues around quality compliance, turnover supply, you name it. Phase 2 was more around a true long-term strategy, making sure that we're shifting to innovation versus remediation. And really changing the kind of innovation we were focused on and then augmenting our structure and operating mechanisms to ensure that we truly do drive execution and accountability to the strategy. And Phase 3 is where we are in kind of to your question. We are looking to transform the portfolio of the company. COVID has hampered us this ability to do that because it's put pressure on the business. We haven't had as much firepower. But the fact is, we have made decisions here that are moving the needle. Number one, we've got the spin of the dental and spine businesses, which we think is the right thing for both businesses. Although they have been smaller because we don't have the firepower, we've done acquisitions to be able to build, scale, and attract as basis. But for sure we will continue to focus on active portfolio management, acquiring companies that can drive weighted average market growth for us in our mission-centers. I'm not going to get into specifics on where we would focus because as you probably know, it's pretty competitive out there right now for assets. But this is something that we absolutely will focus on in Phase 3. The good news is, as we continue to see stabilization in the market, we're going to be able to continue to buy down debt, which is important to us and eventually increase the firepower to do this. Suky, maybe I'll just turn it over to you to talk about current capital allocation.

Sure. Thank you, Bryan. And thanks Amit for the question. Our focus has been very consistent in ensuring that we continue to pay down debt and maintaining our investment-grade. Just a little back point here. Since 2019, we've paid down almost $3 billion of debt and that's in the backdrop of a pandemic that’s had significant pressure on our financial performance. It speaks to the strength and durability of our cash flows as a company. But when you combine that priority as capital allocation together with improving financial performance relative to growth and EBITDA, it really does start to set us up pretty nicely for more strategic optionality as Bryan talked about with active portfolio management. I think in a bigger way, it enables us to look at opportunities to accelerate the top and bottom-line growth for the company while diversifying it as well. And I think all of those things are very credit positive. And so, while we will probably take more of a front foot in that active portfolio management category as Bryan talked about, especially now, coming off the spin. Quite frankly, the organization has gotten more bandwidth having undertaken and gotten that very heavy lift behind us. We will undertake that active portfolio management with an eye towards maintaining our investment-grade ratings. So feels good to start to turn the corner on that and to know that all of our hard work in de-levering the balance sheet, improving financial performance is actually starting to pull through.

Thanks for the questions. Lauren, can we go to the next question, please?

Our next question comes from Jeff Johnson with Baird.

Thank you. Good morning, everyone. To address Travis's question regarding gross margins, I understand that the 50 basis points being capitalized will be recognized next year. What I was hoping to clarify is whether there are any offsets to that, or if we should view the 50 basis points decrease as a conceptual guide for the gross margin decline next year. Thank you.

The team is actively searching for ways to counter any challenges, whether they relate to the current year or future years. Therefore, it's premature to determine what next year's gross margin will be. Although we are facing additional challenges, the team is exploring potential procurement and category savings to help mitigate these issues. You've heard Ivan discuss pricing; we are making progress in enhancing our price discipline and overall performance. We will continue to seek ways to offset these challenges, but at this moment, it’s too early to specify how the anticipated 50 basis points will impact 2023.

Yeah, understood. And then I think you guys are pretty clear on kind of the R&D spending, things like that. But where are we on a recovery in spend on things like conference attendance, doctor training, corporate travel, things like that? Are we at a level now that is back to normalized and just grow off that? Or is there a recapture that still has to happen there?

I would say we've definitely increased since 2021 and obviously since the depths of the pandemic. I think there's likely a little bit more room to go to bring back spending as we continue to see topline performance improve throughout the year. And especially in the backdrop of the new products launches that we've got coming out. We want to ensure that we're investing appropriately from a commercial perspective to make sure that those launches are successful. I don't know Ivan, if you want to say anything else there, but I guess the key thing we'd expect to see a modest increase that'll involve.

Just maybe quickly answering that Jeff, I will tell you that the department has not slowed down from an R&D perspective. We've made no cuts when it comes to innovation. The number of new product introductions in '21 and '22 is dramatically different than in past years as we get into '23 and '24; it's even higher. So definitely no cuts when it comes to true innovation. And relative to events, that's another area that we're trying not to cut. We might have done some adjustments throughout the pandemic, but I will tell you we are full force globally when it comes to R&D. So, R&D initiatives remain sacred cows here from an investment standpoint. Thanks, Jeff.

Thanks, Jeff. Lauren, can we move into the next question in the queue, please?

Our next question comes from Shagun Singh with RBC.

Thank you so much for taking the question. So Q1 ex-FX revenue results in 2022 guidance imply lower quarterly growth for the balance of the year. So, what's assumed in your guidance beyond Q1? How should we think about the cadence of that? Perhaps you can touch on both revenue and EPS. Any color on Q2 will be helpful. And then just as a follow-up on portfolio management, how are you thinking about your diversification strategy that you've previously alluded to? It seems like a lot of these procedures, at least on the outpatient surgery centers, are coming in from the ASC. So, any color there would be helpful. Thank you.

So, Suky, why don't you start with the cadence of growth, as much color as you want to provide there. Obviously, we're not providing quarterly guidance, but you can get more color there. And then I'll talk about the diversification.

You're correct that our updated guidance indicates a forward-looking growth rate of approximately 3% on an ex-FX basis, compared to flat year-over-year previously. However, we anticipate lower ex-FX growth rates for the remainder of the year based on our first quarter performance. This is mainly due to more challenging comparisons as we progress through the year. In the first quarter, we were comparing to the same period in 2021, which experienced significant COVID-related impacts. It was expected that our first quarter would outperform the rest of the year. Thus, the reasons for the lower growth rate for the remainder of the year can be attributed to these comparisons. Looking at revenue growth patterns, we forecast the second quarter to show low single-digit growth on an ex-FX basis. Based on typical seasonal trends, we predict the second quarter will outpace the third quarter, with the fourth quarter being the strongest of the year, consistent with past seasonal patterns observed last year and in 2019 before the pandemic. We also anticipate earnings will reflect this trend. As our revenue improves, operating margins should also strengthen, leading earnings to follow the same growth trajectory as revenue.

Great. On the concept of diversification, when we think about active portfolio management, it's definitely still there. Clearly, we want to make sure that we're diversifying our business and we think about it really in three ways. It's not just product segment diversification. Clearly that's an area of concentration for us because there are faster growth categories that we play in that we want to build scale in, but also geographic expansion to make sure that we're taking advantage of fast-growth areas in the world. ASC; you referenced ASC as an attractive setting, we've actually already acquired areas to build our scale in that setting, and we've built commercial infrastructure to pursue ASC as well. We look at it for sure in diversification to drive weighted average market growth, but we don't just look at it to be a product, not just by geography, not just by setting, but all three of those.

Thank you.

Thanks, Shagun. Lauren, can we go to the next question in the queue?

Our next question comes from Drew Ranieri with Morgan Stanley.

Hi, thanks for taking the questions. Just on your surgical equipment business for a moment. I appreciate that it lagged in the first quarter, but just trying to get a better sense of how that progresses through the rest of the year. I think you mentioned in your prepared remarks that there's some new products coming later this year, but maybe go into a little bit more detail there, just how are you thinking about your surgical equipment market or surgical equipment growth from a business perspective. Thank you.

Maybe just quick topline and then Ivan, maybe you could speak to some of the things you're seeing inside of surgical equipment. First and foremost, it is an area that we're very interested in. Not all the sub-segments of surgical equipment are created equal for us or certain categories that we're investing more heavily in because they're more attractive, and we think we've got a better chance to win. Quite frankly, we really do believe that we've got scale that we can continue to move forward. So not all equal but certainly an area of overall concentration for us. I would say that you're going to continue to see some pressure in the next couple of quarters. A lot of that comes from the fact that we still have pressure in VBP and in trauma. I think as you get to the end of the year, particularly some of those new products being launched, you might have an opportunity to see some of that move in the right direction. Make no mistake; surgical equipment is an important area for us. We've put commercial infrastructure in place, we've acquired technologies in this space, we continue to innovate in the space and we will continue to focus in surgical equipment.

Just maybe just back up a little. We've seen that inside the category as I mentioned earlier, sports are going very well. The acquisition and integration are going exceptionally nicely here in the US and in Europe. We've seen increasing penetration on Signature ONE. We're now integrated in shoulder. We Mymobility, which is the integration of ZBEdge components into the shoulder platform. Comprehensive shoulder is growing, with a strong team globally. So, as sports and upper extremities have done very well, CMFT and integration is also going very well. We continue to gain share on hip trauma; we encountered some headwinds, primarily in APAC, but also in the U.S. at certain times because of some contracts. Overall, the category with the exclusion of trauma right now seems to be going really, really well. And as I mentioned, we have more product launches in the segment in 2022 at the end of this year and in 2023, than we have had since 2015, 2016. So, the innovation is starting to show that as well. So, things are on track.

Got it, thank you. That just on robotics, I think I heard you mention that there was a struggle. It was a struggle quarter on placements than capital. Can you just talk about whether you expect that trend to continue through 2022? What drives is just the hospital spending environment or are you doing new sales strategy with how to place robotics? Thank you.

Absolutely, thanks. So, it's very fluid; it's very customer-centered. We give the option of the placement, we obviously give the option of selling the ROSA. There are sometimes we do a hybrid. In 2021, we did more sales than we anticipated. Given some of the macro-dynamics as we entered 2022, we see on a particular placement that that delivers better financial returns; we want more of that. That said, we still are selling robots. As I said earlier, we're not seeing any clear headwind today that capital is not at a low for the robots, both in the hospital setting and in the ASC.

Thanks, Drew. Lauren, can we go to the next question?

Our next question comes from Matthew O'Brien with Piper Sandler.

Morning. Thanks for taking the questions. Bryan, your comment on recovery, that was interesting. As we look at the market as far as deferred procedures go, we come up with the kind of $1 billion to $2 billion of deferred orthopedic revenue globally over the last couple of years. If we get to maybe a third of that here in 2022, I know you can't get to all of it because of staffing headwinds. But given your market share position, can this be kind of a 100 to 200 basis points of tailwind to the top line? Is that what you're trying to communicate today as far as what kind of impact to the business we should expect this year from the backlog?

Yes, we still believe there is a backlog. Given that there hasn't been a fundamental change in the disease state, there should be a backlog based on the events of the past couple of years. However, we are not indicating that we expect a significant portion of that backlog to affect our numbers this year. As we approach the second half of the year, we anticipate returning to a normal environment, without making assumptions about capitalizing on or benefitting from the backlog. We think that at some point, it will come through, yet we don't expect it to have a major and immediate impact. There will be capacity issues associated with it. We believe it will serve as a tailwind, but we expect the effects to unfold over years rather than months or quarters. To clarify, we are not factoring backlog recovery into our current guidance.

Okay. Thanks for that. And then maybe, Suky, because I know you monitor this pretty closely on the ROSA side of things, you've been placing a lot of systems over the last couple of years. Maybe talk a little bit about that pull-through revenue that you're going to get on the implant side and where we are in that cycle. Is it going to be a meaningful contributor to the Knee business here in '22 or is it more kind of spread out over the next couple of years? Thanks.

Yes, sure. Perhaps Suky could provide more insight, and maybe Ivan could also discuss this because the realization of pull-through is happening now. Ivan, would you like to talk about that?

Maybe I won't give too many details because you never know who's listening. But the facts are that penetration of Cementless associated with ROSA, is sort of at an exciting peak. The pull-through of a lot is going to be pointed. The Knee performance in Q1 is ROSA related. The 600 plus robots that we placed; roughly 50% to 60% of those are in the U.S., half of those are in competitive accounts, so we've seen meaningful revenue growing from those areas. All of that is in the early innings. As we get into the additional launches on Hip, as we get through all other modalities of ROSA Knee. We've got a $7 billion innovation pipeline. We have to continue to see a nice pull-through there. Cementless is one of the elements of our pull-through, as is regular knees. We also have disposables, and another component, CVX, that many accounts get contracted as part of the ROSA placement or sale, and that's another source of revenue. We don't disclose the revenue associated with robots, but I will tell you that it has been above expectations so far.

Thank you.

And Suky, sorry to step in here. But I figure that was more of a commercial discussion versus a financial one.

Is that what you were going to ask? Or you want to change the answer here?

Lauren, I think we are ready for the next question in the queue.

Our next question comes from Ryan Zimmerman with BTIG.

Thanks for taking the questions. Good morning. A couple for me. When you think about '23 in the streets; I think modeling about 8.3% growth or so. There's a lot of puts and takes this quarter. We've now shed spine and dental. Bryan, when you think about the business segments, I mean, I think we know the answer to this, but I’d love your perspective from a business segment perspective. What's accretive to growth? What's dilutive to growth now? When you look out on the business? I think we know the answer to this; it would be helpful I think to walk through where you think the growth rates could be for knees and hips versus surgical equipment, etc. Then my second question I'll just ask it now; Suky, you may have spoken this before, but just help us understand any dis-synergy assumptions post-spin on ZimVie?

So, I'll start and then obviously you can transition to Suky. We're feeling really good actually. The funny thing is when you think about Knee, most people think about it and rightly so as a pretty slow growth market. But in reality, there's more innovation entering the Knee space than we've ever seen before. We've got our, us, our competitors, all focused on data, robotics, and other forms of technology and share wallet opportunities that we just haven't seen in the past. Even though one might view that as a relatively slow growth market, I actually see it as a real potential to see some acceleration in that market growth. I feel very confident that we can grow well because of all the shots on goal that we have. I also think all boats will float here. I mean, it's really great because you've got a lot of technology entering the space. What we've seen is that it's being digested. When I think about that, what are the implications? You've got the same number of procedures being done; but you're getting more share of wallet for every procedure that drives up the entire space. Usually when you bring innovation as Ivan was alluded to earlier, when you have a vitality in a space, that also drives better pricing stability. Because you signed longer-term contracts when somebody converts, for instance, to ROSA, they usually come right back, you try to knock it down from a pricing perspective. So, vitality really does drive stability and pricing as well. So, I think even in a space like that, that you might not believe would be attractive for overall revenue growth, I do believe it is sustainably an attractive area for us to invest in growth. It’s very profitable for us as well. Surgical equipment is pretty obvious. The categories are surgical equipment that we're concentrating on are attractive market growth that everybody knows. We believe we have an ability to win and we’ll continue to scale in those areas. So pretty much across the board when I look at large joints score surgical equipment, I see them as attractive markets given the technology and innovation that we're bringing to bear.

Yes. And hey, Ryan. On your question related to the spin and I believe it was on dis-synergy. If you look at the recasted financials that we put out last week, you would see that overall, we see operating margin accretion of about 190 basis points from the transaction, which is a little bit better than our original expectations; that's a good thing of further validation of why we entered into that transaction. Inside of that, that would then imply and suggest about $40 million to $50 million of stranded costs remaining with Zimmer Biomet. I would say that we're already making progress against those stranded costs this year. We believe that there's more opportunity going into next year and we kind of just see that as part of our overall operating base as a potential source of opportunity for future efficiency. Hopefully, that gets to your question on where we see and how we size the dis-synergies. But make no mistake about it, we're going after those as aggressively as we can while ensuring we don't disrupt the business and the recovery that we're starting to see.

Thank you.

Thanks, Ryan. Lauren, we have another question in the queue.

Our next question comes from Mike Matson with Needham and Company.

Good morning. Thanks for taking my questions. I wanted to ask one on Persona IQ. I know you made some brief comments on it, but maybe you can give us a more detailed update on the launch. And then is this something that could be material to your Knee growth this year or next year in terms of adding 100-plus basis points in Knee growth?

Yes, we're fortunate to have Ivan on the call today because he has extensive knowledge of Persona IQ, particularly regarding its application in Knee and the potential future developments with smart implants. We are currently in a limited launch phase as we have stated, and we're focused on ensuring we do this correctly. We are taking our time to gather the necessary insights to prepare for a successful full launch. The initial phase is very promising. What's interesting is that this innovation is also generating interest for our organization. Even those who are not yet ready for IQ are viewing us differently; they see Zimmer Biomet as an innovative player in the industry, and many want to be associated with such innovation. As a result, even customers who were not initially interested in IQ are expressing interest in transitioning to the standard Persona.

Absolutely, Mike. First and foremost, we're progressing well with our limited market release. I prefer full launches, but given the complexity and market disruptions, we decided to take a cautious approach and gather data. While I won't disclose the number of hospitals we've onboarded, it is significant. Our base and pipeline are also substantial. We are collecting data on mobility and range of motion, tracking thousands of baseline metrics. The Persona IQ platform is now fully integrated, enhancing our mobility and the overall CDA ecosystem. We haven't encountered any surprises concerning the qualified data we've gathered. Excitingly, we have a technology roadmap that extends beyond knee applications, with signed agreements for shoulders and other categories. Regarding the second part of your question, I won't comment on its materiality, but I can say it's material for patients. The logic should prevail if it's significant for patients. So far, everything looks good, and I'm very excited about the next steps.

Thank you. As a follow-up, I wanted to ask about your competitive position in the ASC sector. Do you believe your growth in ASC has been faster than your growth in hospitals? It seems that way for the overall market based on what we've heard.

Yes, I can take that one as well. So pleased with where we are; we are gunning for ASC. Clearly, we started later than others in this environment, given our strong position in hospital settings, inpatient, outpatient, and whatnot. We put a plan together to get around 40 components, making sure we have the right portfolio, the right people, the right partnerships, and the right products we don't have. We fill the gaps on basic things like implantable devices and carts. We launched that ASC-friendly innovation around robotics. We have increased our Cementless penetration. So, I think that the portfolio is hitting a sweet spot, especially now that we've added these portable approvals in the U.S. We have a large group of people that each and every day get update training, and they are driving volume from the ASC. We've also found this with key relationships in the U.S., where we are developing technology together that is applicable to the ASC. We have done a ton of medical allocation, figuring out where we find these key centers. So, I think that the plan is working well. We're growing faster than expected; I'm not sure these days are growing faster or not than the others. The ASC performance in Q1 was above our expectations, and as we think about the rest of the year, I think we're in good position to continue to grow.

Great. Thank you.

Lauren, I think we have time for maybe one or two final questions.

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

Great. Thanks for taking the question. Maybe I could ask the surgical equipment business as the slowest grower this quarter; it's 25% of sales. We don't get geographic breakout or segments there. I was hoping you could walk us through sort of the different components and any geographic differences to point out. Just given that a lot of your competitors called out extremities and sports medicine as positives this quarter. Thanks.

Maybe also get a chance some of this, Ivan. The fact is we did have a pretty significant headwind. If you look at the difference in regions, the most challenging region that we had was Asia-Pacific, and a big part of that as we all know, is the trauma, VBP, and the weight that that's having on the overall segment. Outside of that, when we look inside of surgical equipment, I would say the same thing. Our upper extremities business did very well – the innovation is helping us drive our performance there – but also the focus that we have. Sports did very well as Ivan talked about before, and that's happening both in the U.S. and Europe. When you think about our CMFT business, we continue to see traction there, not just because of the acquisitions that we've had, but also because of the now, what I would define as organic growth from those acquisitions. Again, the focus that we have commercial in CMFT; so those are kind of the bright spots that we have, and those are across all regions. The big headwind for us is in trauma, a lot of that being in Asia-Pacific.

I guess, if I had to add to what Bryan is saying, I'll be saying the same thing with a different action. I want to extend myself, but that it started about the dedicated channel in key geographies in Europe and the U.S. primarily, and the innovation that is coming later in the year and going into 2023. Sports is going well; extremities are going well. Again, we have some noise with trauma—two of the three key components are performing very nicely, and they love to perform even at a faster basis. Thanks, Robbie.

And are you guys willing to give any ex-China growth rates for extremities and trauma?

I think you could probably just read from what Suky said; in your prepared remarks, Suky, but 200 to 300 basis points of headwind is what you could look at in the quarter on the global business as a result of China.

Great. And maybe just one quick follow-up for me. As you think about China, that is a country with the difficult pathway forward with the no COVID policy. I just want to make sure, are you assuming continued pressure from lockdowns through the rest of the year, or are you assuming that it resolves in the near-term? Thanks a lot.

Yeah. The reason for the range that we have in the guidance is to make sure that we're accommodating risk or opportunity in places like China. So, it's already calculated in the range that we have. What I would tell you is, again, within a little bit of luck there, sometimes it's okay to be lucky rather than always just good. But the fact is we've had that offset. We have had some pressure when we look at Shanghai lockdowns, but we've also had delays in VBP implementation which helps us from a pricing standpoint, and they've offset each other. At this point in time, even though the mix of how we're getting to the revenue and the bottom line that we assumed we would get in China has changed, the overall impact is about where we thought it would be. So, I guess all that to say, even if we see continued lockdowns, as long as we see continued delays in VBP, they seem to be offsetting each other.

Thanks, Robbie. I think we're at 9:30, so we probably need to wrap there. Lauren, thank you so much. Bryan, don't know if there's any closing remarks from you or any other members of the team, applies there just to see if you'd like to make any comments before we wrap up on this end.

No, I think the nice thing is we've captured a lot of what we wanted to say via the questions. The fact is it was a good quarter. It feels good to have; I think probably the most important thing, even though there are a lot of challenges that everyone is talking about right now, that we're going to have to deal with it. We're going to have to manage through and have confidence in the team can manage through those. The difference now is it's the same challenges for everybody where we've been disproportionately impacted by COVID. If I had to select, I would take the challenges that we currently have in place and their impact to the business versus continued COVID impact. That's the positive for us. That's been kind of a light at the end of the tunnel that we've been waiting for, which is COVID receding. I truly do believe if it does recede and it continues to recede, that the actual performance that we see in the business will begin to be reflected in the performance that you see in the business. With that, we'll go ahead and end the call.

Thanks, Bryan. Thanks, everyone for joining. Of course, if you have any other questions, please feel free to reach out to the IR team at any point.

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