Zimmer Biomet Holdings, Inc.

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet first quarter 2024 earnings conference call. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded today, May 2nd, 2024. Following today's presentation, there will be a question and answer session. At this time, all participants are in a listen-only mode. If you have a question, please press the star followed by the one on your push button phone. I would now like to turn the conference over to Carrie Maddox, Chief Communications and Administration Officer. Please go ahead.

Thank you, Operator, and good morning, everyone. Welcome to Zimmer Biomet's first quarter 2024 earnings conference call. Joining me today are Yvonne Tornos, our President and CEO, and CFO and EVP Finance, Operations and Supply Chain, Suki 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 the 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 Q1 earnings release, which can be found on our website, ZimmerBiomed.com. With that, I'll turn the call over to Yvonne. Yvonne?

Thank you, Keri, and thank you, everyone, for joining the call here this morning. I'd like to start today the way that I typically do, by taking a moment to recognize and to show my gratitude to the 18,000 Zimmerbaum Ed team members across the globe who each and every day work relentlessly in driving our mission forward. Simply put, I'm very proud of each and every one of you. Thank you for your dedication, for your commitment, resilience, and for your strong performance to start off this year, 2024. It is truly this great workforce and the culture that we have here in place at Zimmer Biomed that gives me, gives us confidence behind the financial commitments that we're making. Given the fact that we have a very robust investor day coming up in just a few weeks, I will keep my opening remarks short with the goal of moving quickly into today's Q&A session. I'll touch on three key areas briefly. First, I'm going to provide some general comments on the results in the quarter. versus our own expectations. Secondly, I'll cover the drivers of the performance, and we'll touch on why we believe that these drivers are sustainable. And then lastly, I'll close with a brief summary on our progress against our three strategic priorities, which have been discussed since day one, those being people and culture, operational excellence, and diversification innovation. Starting with the quarterly results, overall, we are very encouraged with our Q1 performance, which was ahead of our own expectations, driven by healthy end markets, combined with a strong execution across the organization globally. We ended the quarter continuing the momentum that we saw in 2023, delivering 4.4% constant currency revenue growth while overstepping a sizable day rate headwind and facing rather difficult comps versus a year ago. In fact, it is reassuring to see that on a day rate adjusted basis, our growth for the quarter was greater than 6% with several areas of the business and geographies contributing to such solid results. In addition to the sound revenue performance, we drove adjusted margin expansion and grew adjusted earnings even while our effective tax rate increased over 200 basis points. These results to start 2024 give us great confidence that Zimmer Biomed will deliver 5% to 6% constant currency revenue growth in the year, while driving sizable adjusted operating margin expansion. So pleased to reaffirm our guidance for the year. This, in turn, will enable mid to high single-digit adjusted earnings growth while realizing our commitment of seeing free cash flow growing faster than earnings. Suki is going to provide more color around these areas later, but strong performance in the quarter, and again, reaffirming guidance for the year. NetNet is encouraging to see us exiting Q1 of 2024 with a revenue growth run rate in the mid single-digit range, which is consistent with where we exited the second half of 2023. With new products, new product introduction ramping later in the year, we like what we see in terms of sustainability in our growth trajectory, which we have said all along will accelerate in the second half of 2024. Key drivers behind our Q1 results came from both a macro and micro standpoint, starting with macro factors or in markets, as we've been saying all along, remain very healthy, driven by high levels of patient demand due to demographic shifts. The continued shift to the ASC here in the U.S. is also a tailwind. And across the board in the industry, we've seen better surgical outcomes and technological advancements, which are driving more patient demand. On top of that, you got improved pricing dynamics. And to that end, pleased to report that pricing in the quarter was about flat, as opposed to the 200 to 300 basis points of price erosion that this space, this industry, has seen historically. From a macro standpoint, the main enablers of Q1 results were the adoption of ROSA technology globally with a correlated pull-through of persona needs. We also saw sound execution of drug drivers within SET, particularly in shoulders, within sports medicine, and in our CMFT, cranio-maxillofacial thoracic business, in conjunction with rapid adoption of Persona Osteotype, that is our CEMENDES platform, which is quickly gaining share in the markets where we have launched the product. As we enter the second half of 2024, these new product introductions, as well as other new product entries, will become more meaningful from a revenue growth standpoint with Persona Oceotide entering then full launch status, seeing higher utilization of Hemr or Surgical Impactor, which we recently launched, and also gaining traction with Rosa Solder, which we started doing cases recently here in the U.S. On top of that, we're going to be entering the market with our triple taper hip stem, that's Z1, which is going to allow us to better compete in the direct anterior hip category. So really excited about the completed portfolio in hips and the upcoming launch, FDA approved now, for Z1 hip stem. In addition to driving successful 2024 annual results, We are committed to the three strategic priorities that I outlined in my first earnings call as the CEO in November 2023. This, no doubt, will enable long-term success for the organization. I continue to repeat these three priorities over and over at every Zimmer Biomed meeting around the world, and I can tell you that they are resonating with the audience as the absolute must-dos for the long-term success of the organization. Once again, these three imperatives are people and culture, number one, operational excellence, number two, and innovation and diversification, number three. I would like now to quickly provide you with an update in terms of key progress across these three areas. Further detail will come during our May 29th Investor Day in New York City. First, in the area of people and culture, we continue to operate Zimmer Biomed with best-in-class engagement metrics and low employee attrition. We have been recognized across different areas when it comes to people and culture, and recently we've been showcasing various publications, including Newsweek, Great Places to Work, and Forbes. In the area of people and culture, it's worth noting also that our restructuring program which we announced a quarter ago, has now been implemented almost entirely with no major disruptions to report. We have realized substantial benefits post this initiative, including realizing cost savings earlier than initially expected, as well as achieving increased operational agility and enhanced accountability. In the second area of operational excellence, we've made robust progress in implementing or enhance inventory management programs around the world. Working intensely with third-party firms, we developed a plan, and we executed against that plan. We remain committed to a meaningful improvement in DOH in the year 2024, and in years to come, again, more color in that regard during our investor day. In operational excellence, We have also established core initiatives around best-in-class product launches to ensure that these new product introductions gain traction sooner than expected. And we launch these products in a better way than we have launched in the past. This is beyond critical for Zimmer Biomed as we continue to deliver a rapid cadence of product launches. We plan to release more than 40 new products in the next 24 to 36 months. One final comment in operational excellence in the area of pricing, we've made structural changes to further enhance the pricing strategy that we put in place over the last several quarters. Moving on to the third and final strategic priority in the area of innovation and diversification, we're making solid progress. We continue to see a strong traction in key brands such as Persona Oceotide. I mentioned already gaining share in the markets where we have launched. We've seen progress with ROSA. We continue to gain momentum with Signature One planning guides in the solar space. And we like what we're seeing with our embodied soft tissue franchise. Team FT continues to deliver new product introductions, gaining share in the markets where we partake. And I'm very excited about the new product introductions that we have seen and will continue to see in our ASC portfolio in the U.S. We've also made tremendous strides in new products with a more focused pipeline that today, as of Q1 2024, has twice the dollar value that we had at the end of 2018. So the dollar value of the pipeline in innovation is twice what it was four or five years ago. Worth reminding everyone that north of 80% of these products in the pipeline reside in markets growing above 4% And many of them are accretive from a gross margin standpoint. So we continue our commitment of innovating from a customer-centric standpoint, but also innovating to see incremental profitability and an increased WEMGAR profile. In addition to driving results in core markets, we'll also focus on diversifying our portfolio into more attractive, faster growth in markets with the goal of increasing our WEMGAR, weighted average market growth rate. We have made significant progress over the past several years, balancing to where it is today. And this fact, in addition to the confidence around future free cash flow generation, give us the optionality and the far power to execute on the right deals at the right time, that most importantly, mirror internal hurdles from both a financial and a strategic perspective. So again, lots going on inorganically, potentially, as well as organically with the size of the pipelines. While we have flexibility in the size of the deals to come, we continue to favor smaller tuck-ins to mid-size deals that's up to $2 billion in acquisition price that become EPS neutral within two years and that, from a ROIC standpoint, return on invested capital will deliver upper single digit to low double digit within five years. As I mentioned earlier, we're very encouraged with our Q1 performance, a quarter in where we grew 4.4% in constant currency, north of 6% in day rate, while overcoming a number of headwinds and tough comps. It is these quarter results from the first quarter of 2024 that give us strong confidence that in the year 2024, we'll realize our guidance of delivering 5% to 6% in revenue growing 100 to 200 basis points above market, while delivering earnings growing faster than revenue, and delivering free cash flow above the earnings growth. This is a commitment that we're making for 2024, and it's a commitment that we're going to reiterate in our investor day for years to come. Before closing the call, I'd like to announce that Kerry Madox has made a decision to depart from Zimmerman at the end of May. Carrie has been a trusted partner and a very close collaborator and friend on this journey, and has enabled great things for Zimmer Biomed in her four plus years here with CV. She's going to be missed, and we wish her the best in her future endeavors. A search for a head of IR position is in progress with a leading executive search firm, and we hope to announce Carrie's replacement here very soon. Zach is going to continue to lead IR interactions for Zimmer Biomed. So a plan for continuity is in place. In conclusion, we're very proud of how far we have come as an organization and are even more excited about where we can go. Strong confidence on the year 2024. We continue to make commitments and deliver on those commitments as evidenced by these results and as evidenced by the new product introductions commitment that we made and we're realizing. I love the fact that we're impacting the lives of millions of patients around the globe. And I'm inspired by the fact that my teammates and I are living the Zimmerbaum mission of alleviating pain and improving the quality of life for people around the world. And with that, I'll turn the call over to Suki. Suki?

Thanks, and good morning, everyone. As Yvonne mentioned, we had another good quarter driven by healthy end markets and solid execution across the organization. Overall, we remain on track to deliver on our 2024 financial guidance with mid-single-digit constant currency revenue growth, adjusted operating margin expansion, and over $1 billion of free cash flow. Assuming current market conditions, this is a financial profile that we believe is durable going forward. Moving to Q1 results. Unless otherwise noted, my statements will be about the first 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 $1.889 billion, an increase of 3.2% on a reported basis and an increase of 4.4%, excluding the impact of foreign currency. Additionally, we had a selling day headwind of about 200 basis points that impacted all regions and product categories at about the same level. Excluding the selling day impact, consolidated constant currency sales would have grown above 6%. U.S. growth was 3.7%, and international grew 5.4%. Growth in the U.S. was driven by solid performance in recon, in our priority areas within SET, as well as our other category. Outside of the U.S., EMEA saw stronger than expected growth on a regional basis, and from a portfolio perspective, OUS growth was primarily driven by our need category. Global needs grew 4.3% in the quarter, with the U.S. growing 2.2%, and international growing 7.3%. Growth in our knee business continues to be driven by our Persona product portfolio and Rosa robotics platform. We remain excited about the growth coming from new and recent product launches across the knee segment. Global hips grew 1.5% in the quarter, with the U.S. growing 1% and international growing 2%. We remain focused on accelerating performance in the hip segment with key product launches that Yvonne mentioned earlier. Next, the SET category grew 5.3%, led by our key focus areas of CMFT, upper extremities, and sports, growing on average about low double digits. This strong growth was partially offset by the other subsegments within the category. Despite the chalkiness within SET, we remain confident this business will drive mid-single digit or above growth for the full year. Finally, our other category grew 12.2%. driven by continued strong ROSA sales. We expect growth in the other category will moderate lower as we move through the rest of the year. In Q1, we reported GAAP diluted earnings per share of 84 cents compared to GAAP diluted earnings per share of $1.11 in the prior year. Higher revenue and a lower share count in Q1 2024 was offset by higher selling costs and expenses associated with our restructuring program. On an adjusted basis, we reported diluted earnings per share of $1.94 compared to $1.89 in the prior year. The step-up is primarily driven by revenue growth, accelerated savings pull-through from the restructuring program, and a lower share count, partially offset by higher interest expenses and taxes related to Pillar 2. Foreign currency was a headwind of about $0.04 in the quarter when compared to the prior year. Our adjusted gross margin was 72.9%, driven by higher manufacturing costs, which were offset by better pricing and lower royalties. Overall gross margin was in line with expectations and with the prior year. Adjusted operating margin was 28.6%, slightly ahead of the prior year. The increase in operating margin was driven by higher sales and lower SG&A related to the restructuring program I referenced earlier. Net interest and other adjusted non-operating expenses were $49 million in the quarter, slightly higher than the prior year. And our adjusted tax rate was 18.5%, and we continue to project our full-year rate at 18%. Turning to cash and liquidity, we generated operating cash flows of $228 million, free cash flow of $91 million, and we ended the quarter with $393 million of cash and cash equivalents. Regarding our outlook for the rest of the year, we are reiterating our full-year guidance, including constant currency growth of 5% to 6%, or 4.5% to 5.5% reported revenue growth with a 50 basis point currency headwind. Additionally, we continue to expect earnings to be between $8 to $8.15, and that we will generate between $1.5 billion to $1.1 billion of free cash flow. From a cadence perspective, we still expect constant currency revenue growth for the first half of the year to be at the lower end of mid-single-digit growth and the second half of the year to be at the upper end of mid-single-digit growth. As a reminder, Q2 and Q3 will each have about 150 basis point tailwind due to selling days. And the selling day impact for Q4 and for the full year is expected to be immaterial or less than 50 basis points. Regarding the P&L, we expect adjusted gross margin to be broadly in line with 2023 and slightly better than our original thinking due to less FX headwinds than originally assumed. Given the strengthened dollar, FX hedge gains are not as big a step down in 2024 as originally expected. Looking at gross margin, we expect Q1 to be the high watermark followed by a modest sequential step down throughout the year. Overall, first half gross margins will be about 100 basis points higher than the second half as we continue to feather in capitalized inflationary costs from the second half of 2023. Turning to adjusted operating margin, we are pleased with the start to the year as our restructuring efforts are delivering slightly ahead of schedule. Overall, second half operating margins will be higher than the first half, and we expect for the full year that at the midpoint of our guidance, we will increase operating margins by about 80 basis points. In summary, Q1 was a good start to the year. We delivered results ahead of expectation and continue to feel confident in our 2024 outlook as evidenced by the reiteration of guidance. With that, I'll turn the call back over to Carrie.

Thanks, Suki. And thanks, Yvonne, for the kind words. It's been such a privilege to be part of the Zimmer Biomet team these four and a half years. and I wish the team much continued success moving forward. Now, 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 Travis Steed with Bank of America.

Hey, thanks for taking the question, and Carrie, great working with you, and good luck in your next endeavors. I guess kind of high level, you guys have this kind of algorithm, you know, 5% to 6% revenue growth, potential for some margin expansion, and possibly kind of low double-digit EPS growth. And just trying to think about how we should think about that algorithm, you know, over the long term. Is it more of a base case or kind of best case? You know, there's just a lot of skepticism from the investor community on that algorithm and trying to think about you know, what's the Zimmer growth rate, you know, kind of on a sustainable basis in a normalized market? And then just the second question I'll go ahead and throw out, too, is just any color on Q2 sequentially, it's usually down, HIPAA needs are usually down a little bit sequentially, but with some of the selling day stuff, just wanted to make sure there wasn't any titration on Q2. Thanks a lot.

Hey, Travis. Good morning. Ivan here. Thanks for the question. I'll touch on both components of your question, and I'll make sure that Suki speaks up here as well. So starting with the algorithm on revenue, EPS, and free cash flow. We're going to give more color in the investor day, but I will tell you today, as per the prepared remarks, this is a long-term commitment. So it's not a 2024 only deliver revenue above market, EPS above revenue, and free cash flow above EPS growth. And unpacking the drivers here on revenue is all about new product introductions. We're going to gain share by delivering innovation that matters. 200, 100 to 200 basis points, large is going to come from new product introductions. And as we said all along, we got a pipeline that we didn't have before. 40 new product introductions over the next 24 to 36 months, and more in the making. So that's the number one driver on revenue, in addition to obviously pricing dynamics and commercial execution. On EPS growth, we're doing things differently when it comes to margin. I already mentioned pricing. But other components, how we think about inventory in excess and obsolescence, how we think about allocation of OPEX, where we get the greatest return, et cetera, et cetera. And then free cash flow, the main driver, is the fact that we have run this company in quite an inefficient way when it comes to inventory management. North of 400 days on hand when it comes to inventory, not really engaging on prioritization or geographies. Portfolio management is not what it needs to be. So those are the key drivers on the sustainability. I'll touch on number two, and then I'll give it to Suki. In terms of Q1 to Q2 to Q3 to Q4, what happened sequentially? Look, we're not going to get into the gymnastics on what happens quarter over quarter, all kinds of timing, one quarter to the other. We're having similar conversations in Q4. Here's what I'll leave you with. Q1 was very strong, 4.4% growth in constant currency, north of 6% in day rate. As we see here, looking at the year, we're confident at the very beginning of the year in the guidance of 5% to 6%. A quarter behind, we're extremely confident on that guidance. The growth drivers that get us there are working in the right direction. So very, very confident, very proud of Q1. And again, we'll talk more about the dynamics at Investor Day. Suki?

Yeah, I think Yvonne summarized it really well, so I'll just try to build some incremental points here. I think at that the single-digit growth top-line profile that Yvonne mentioned, we do have a durable path to operating margin expansion as well as improvements in overall free cash flow conversion. On the earnings outlook, you know, this year, if you look at our guide, it's 6% to 8%, which, again, we reiterate and feel confident in. If you, you know, on an underlying basis, if you back out the step-up in tax rate that we saw out of Pillow 2, as well as headwinds that I think everyone's facing on interest as well as FX, The underlying growth from the bottom line is much better than 6 to 8, maybe 3 to 400 basis points better on an online basis, which puts us kind of in that high single digits, low double digits. And if you look at what we did in 23, I think we were also there. As we look forward, you know, using your words, Travis, base case, et cetera, we think there's a pathway to low double-digit earnings growth. I wouldn't say it's our base case or our commitment. Again, we're going to provide more color on our analyst day. But as we think about margin expansion with revenue growth, we just want to make sure we've got the right investment profile in the company to make sure that that growth is durable. So is that our base case? I wouldn't necessarily go there. I'd say we have a pathway there. But we're going to provide a lot more color in just a few more weeks. So thanks for the question, Travis. Of course.

Thanks so much. Katie, can we? Yeah, thanks, Travis. And thanks for the comment. Katie, can we hear the next question in the queue?

We'll go next to Steve Lichtman with Oppenheimer and Company.

Thank you. Congratulations on the quarter, guys. And, Kerry, it's been great working with you. I guess I'll first start on pricing commentary. I thought that was notable. Yvonne, can you talk about where the positive surprise came from on that front? Are the benefits of your efforts coming sooner? Just some general comments on the pricing environment would be great.

Yeah, we're very, Steve, thank you. We're very pleased, obviously, with price and performance. Recall that in 2023, the second semester of 23, so the last half of 23, we're already flat east when it comes to price. So this is a business that in previous years was having 300 to 500 basis points of price erosion in the U.S., pretty significant in the U.S. That's not the change that we have going on. We put a structure in place. We put governance. New product introductions are helping from a category contracting. I wouldn't say there's any real surprises. Europe may be doing slightly better than anticipated. You've got all kinds of tender dynamics that are coming in and out. But net-net, we're at a point where it's pretty predictable. We like the strategy in place. We like the governance. We're not going to commit here to doing dramatically better. But no real surprises. Solid Q1 and a great outlook for the rest of the year. Suki, I don't know if you have any other comments.

I think overall, we're, we're in a more favorable environment than we've been. Let's call it 3, 4 years ago when you combine that with some of the structural changes we're making inside the company. That's I think those 2 things are really leading to better price performance. I'll tell you, I'm really impressed and. Optimistic about the cultural change quite frankly, within similar biomed as I talked to. Distributors or field level reps, and, you know, their desire to want to make sure that we're getting the value for the products that we bring the market. That's that's encouraging. And I think that makes it durable. In the quarter, we were roughly flat. I do expect us to be, you know, when I set out the year, I thought we'd be 100 to 150 basis points of erosion. I think we're now under 100 basis points of erosion, especially given what we saw in the first quarter. I don't expect that flat profile to continue through the rest of the year because we've got a number of things that happened at the back end of last year, especially in Europe, where we took some pretty large price increases and devalue sort of currencies and markets. That will sunset later on this year. Also, we've got some new contracts that are coming up, which will create a little bit of pressure. So I don't expect that flat profile to continue through the rest of the year. But nonetheless, we're in a much better spot than we were a few years ago. And again, expect overall pricing to be somewhere under 100 basis points for the full year 24.

Great. Thanks for that. And then just to quickly follow, or just the one to follow up, Becky, real quickly on the ROSA shoulder. You know, just on the initial launch and your outlook for grant this year.

Yeah, thank you. Obviously very excited in terms of this product launch. We did the first cases at the Mayo Clinic a couple of weeks ago. Feedback was very solid. It is a product that has a high degree of accuracy in the cuts, in the visibility of the anatomy. It is efficient from an instrumentation standpoint. It's fully interconnected with the rest of the CVH ecosystem. Case over case, the feedback was that you do achieve time efficiencies, so the learning curve is rather short. So very solid clinical feedback. In terms of the impact, we said all along that we're going to take it slowly in the first phase. call it 90 to 120 days, and you will see the real impact as we get closer to the end of the year. But a very, very meaningful product launch for the company. I'm very excited about it. Thanks, Steve.

Great. Thanks, guys.

Thanks. We'll go next to Larry Beagleson. Larry Beagleson with Wells Fargo.

Hey, good morning. This is Vic Chopra and for Larry Beagleson. Thanks for taking the question. Carrie, thanks for all your help and good luck. So two for me, you know, just want to get a sense as to kind of what we can expect at your upcoming investor day at the end of the month with regard to financial goals. Will you have specific LRP goals for revenue or will it be relative to the market? You know, for example, growth of 100 to 200 basic points above market and then how to follow up. Thanks.

Yeah, no, we'll definitely cover how we plan to achieve these three commitments we're making from a financial perspective in terms of what are the drivers for revenue, EPS, and free cash flow. So, we'll definitely provide those details. We'll cover the new product introductions within that. We'll talk about the capital allocation of the strategy moving forward. So, it's going to be very robust. So, that's the analyst day.

Got it. You know, the two ESPs. The second question I had was, you know, you beat consensus EPS by about seven cents, but you didn't really raise the guidance on EPS. Can you just provide some color of that? Thank you.

Yeah, you know, I think Yvonne said it really well in his opening remarks. We had a good start to the year, and it was great to see the better than expected performance and revenue, and we saw very good flow through all the way to the bottom. So I love the discipline that we've got throughout the company. I would say that this just reinforces and gives us more conviction in the guidance range that we provided earlier this year.

Thank you.

Thanks, Nick. Katie, can we go to the next question in the queue?

Thank you. We'll go next to Rick Wise with Stiefel.

Good morning, and we'll miss you, Gary. Thank you. I'll ask. My question and my follow-up at the same time, Yvonne, You know, obviously, on the new product front, you have all these new introductions, Asetai, Hammer, the robotic shoulder, and all of them sound like they'll be meaningful, and I assume will help pricing, will help gain share, will help leverage.