Zimmer Biomet Holdings, Inc. Q3 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet’s Third Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded today, November 7. 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, Chief Communications and Administration Officer. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to Zimmer Biomet’s third quarter 2023 earnings conference call. Joining me today are Ivan Tornos, our President and CEO; and Suky Upadhyay, EVP and CFO. 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 Q3 earnings release, which can be found on our website, zimmerbiomet.com. With that, I’ll turn the call over to Ivan.

Thank you very much, Keri. And good morning, everyone, greetings from Warsaw, Indiana, the orthopedic capital of the world, and welcome to our Q3 earnings call. I want to express my gratitude for all of you joining us here this morning. I’d like to begin by sharing how truly excited I am to be in this new role. This is a very inspiring time, not just in musculoskeletal health, but also in med-tech in general. It’s not what it was just five years ago. The space has changed significantly. Groundbreaking technologies are shaping how procedures are done. Due to continuing demographic shifts and global demand for treatment, we are experiencing a higher demand now than historically observed. This is driven by better clinically reported outcomes, shorter episodes of care, and more comfortable ways to approach different disease states. The market is healthy, and we are just getting started. I could not be more excited to be here in my new role. With the encouraging market dynamics and solid execution that the Zimmer Biomet team has demonstrated, it’s great to report another solid quarter of strong performance while reaffirming our year-end guidance for 2023. As I look forward, I am more convinced than ever that Zimmer Biomet will continue to lead the way in customer-centric innovation and improving our value creation drivers. Today, I want to share my thoughts on my first two months as CEO, along with key insights into my three priorities as the new CEO of this enterprise. After that, Suky will cover the financials for the quarter and our expectations going into the rest of the year, and finally, we will open up for Q&A. I would also like to take a moment to thank the global Zimmer Biomet team for their unwavering commitment and sense of urgency in driving execution. This highly engaged and focused team is eager to do more for our patients, customers, and communities, as well as for our shareholders. I am beyond proud of this organization and genuinely inspired by the work being done every day. I want to share some perspective on my first 11 weeks in this role. I've spent significant time with team members, customers, analysts, and investors to gather feedback and insights. I’ve interacted with our key manufacturing facilities and decision-makers across every major continent, collecting pages of feedback and recommendations. Our key priorities moving forward will focus on our people and purpose, creating and sustaining operational excellence, and innovating and diversifying in higher growth markets. These priorities are vital for driving our future as we strengthen our market presence and achieve sustainable growth. We’ve seen solid performance in key markets and are well-positioned for the future growth of Zimmer Biomet.

Thanks, Ivan, and good morning, everyone. I’d like to start my remarks by welcoming Ivan to his first earnings call as Zimmer Biomet’s CEO. Ivan has been a constant force and driver within the organization for several years. I’m proud to work alongside him, and I’m excited about our partnership. As Ivan noted, we had another strong quarter driven by healthy and improving end markets and continued strong execution across the organization. Overall, we remain on track to deliver mid-single-digit constant currency revenue growth and adjusted operating margin expansion for the back half of the year, just as we committed to in our second-quarter call. Net sales for Q3 were $1.754 billion, an increase of 5% on a reported basis, and an increase of 4.7% excluding the impact of foreign currency. We did experience a selling day headwind of about 150 basis points that impacted all regions and product categories. U.S. growth came in at 6%, while international growth was 2.9%. The growth results were driven by our strong product portfolio, with knees growing 7.3% globally. While global hips experienced a slight decline impacted by tough comps and geopolitical headwinds, our S.E.T. categories continued to make progress. We’re confident in our guidance for full year 2023, maintaining our expectations for revenue and EPS growth targets. Our cash and liquidity remain strong, with operating cash flows of $338 million and free cash flow of $189 million in the quarter. Overall, we delivered another excellent quarter on both the top and bottom lines.

Thanks, Suky. Before we start the Q&A session, just a quick reminder to please limit yourself to a single question and one brief 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. We’ll go first to Robbie Marcus with JPMorgan.

Thanks for taking the questions. I was hoping you could address just the health of the ortho market. You talked to it, but we see your results and we see your peer results, and most of them were in line to slightly below in the quarter. So, how are you thinking about the health of the market? And then the second part of my question is on your longer-range guidance for 2024. You talked about mid-single-digit growth implying something like 4% plus. Is that a change? And how do we think about margins for next year?

Thank you, Robbie. I’ll start by talking about the market dynamics and briefly discuss 2024, then I’ll pass it on to Suky for more detail on 2024 and margins. We’re seeing healthy market dynamics. This is not a one-quarter phenomenon; the overall market has been trending positively. The reasons behind the growth are driven by several factors, including the shift to ASCs, changing demographics, and advancements in technology. Our market position in Q3 has allowed us to gain share in both hip and knee categories. We believe that these market trends are sustainable, leading us to maintain a mid-single-digit growth outlook for 2024. The underlying dynamics of our innovation pipeline support this outlook. I'll let Suky provide more color on the specific drivers for our guidance.

Yes, hey Robbie. Thanks for the question. First, I’d say that we committed to mid-single-digit growth for the second half of the year with operating margin expansion. We feel confident in this profile as we transition into 2024. In terms of headwinds and tailwinds for next year, we expect a higher tax rate due to OECD’s Pillar Two, and foreign exchange pressures based on current rates. On the positive side, our end markets are stronger, and our new product launches have been performing above expectations. With the overall portfolio performing well, we're anticipating mid-single-digit revenue growth ex-FX in 2024, and we expect earnings to grow faster than revenue.

Thanks, Robbie.

We’ll go next to Drew Ranieri with Morgan Stanley.

Hi Ivan and Suky. Thanks for taking the questions. On 2024, could you help us understand how you're factoring backlog into your guidance? I know it's not the only driver for growth, but how does it support the orthopedic market? And how about your ability to capture a disproportionate share of that backlog?

Thank you, Drew. We don't see backlog as a primary driver for growth in the next year. While it remains a factor, we believe our innovation pipeline, investments in ASCs, and overall commercial execution will drive our performance. We're committed to tracking innovation metrics rather than relying heavily on backlog dynamics.

Yes, to add to Ivan's points, we have strong fundamentals that will drive growth, but we are not overly dependent on backlog. The strength of our new launches and our operational efficiencies will allow us to achieve our revenue targets.

Thanks, Drew.

We’ll go next to Matt Taylor with Jefferies.

Hey, thanks for taking the question. I’m curious about your outlook for 2024 and your ability to grow throughout the year despite tough comparisons, particularly in Q1. How do you plan to navigate those comparisons and ensure growth?

We are confident about 2024 despite the tough comps, as the market dynamics remain strong. We don’t believe the backlog will significantly impact our growth profile; rather, our focus on innovation and product launches will support our success. We anticipate that our solid pipeline and operational capabilities will drive our growth, and we have multiple product launches slated for the coming year.

We’ve seen positive performance in the second half of this year that will help set a strong foundation for 2024. While there may be seasonal variability, we believe our internal focus on efficiency and execution will help us navigate those obstacles. We’re optimistic about mid-single-digit growth next year.

Thanks, Matt.

We’ll go next to Shagun Singh with RBC Capital Markets.

Thank you. I wanted to clarify on the Q4 implied guidance for 2024. It suggests deceleration compared to Q3, despite your positive outlook. Should we assume this is a conservative approach? Also, how do the underlying growth rates stack up in light of the items you’ve discussed?

On the one hand, yes, there is some conservatism built into our Q4 guidance. Yet, we can navigate variability based on market dynamics. It’s important to note that while we're experiencing positive growth, we expect multiple factors to come into play as we proceed further. Our visibility suggests that our growth trajectory is improving, moving us toward mid-single-digit performance.

I agree with Suky. As we advance, we remain focused on our growth strategies and performance initiatives, which we believe will position us well for sustained success going forward.

Thanks, Shagun.

We’ll go next to Travis Steed with Bank of America.

Hey, thanks for taking the question. Can you frame how much margin or EPS dilution you're willing to accept in years one and two for potential M&A? Is there a chance deals occur in 2023, or are we likely looking at 2024?

We seek to minimize short-term dilution and aim for break-even by 2024 or sooner. The timing and specific details of future transactions remain uncertain, as these are often opportunistic, but we have the flexibility and means to pursue the right opportunities when they arise.

Thanks, Travis.

We will go next to Vijay Kumar with Evercore ISI.

Hey, thanks for squeezing me in here. To clarify on OUS hips, is the pressure from Russia resolved or will it impact fiscal 2024? And on M&A, can you talk about your hurdle rates given the current interest environment?

Regarding OUS hip pressures, the majority have been absorbed by now, and we don’t expect this to significantly impact 2024. As for M&A, while current interest rates present some challenges, we’ll remain disciplined and focus on deals that can deliver strong returns for us over time.

Thanks, everyone. I think we’re nearing the end of our call. I’ll turn it back over to Ivan for any closing remarks.

Thank you. I’ll wrap this up briefly. I’m proud of the progress at Zimmer Biomet and the remarkable work of our team. Market dynamics remain healthy and we see sustainability as we continue to execute on our strategies. We’re confident in our performance moving forward and look forward to driving value creation for our stakeholders in the future. Thank you for your time today.