Zimmer Biomet Q2 2022 Earnings Call Transcript

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Provided by Quartr
August 1, 2022

There are 12 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to the Zimmer Biomet Second Quarter 2022 Earnings Conference Call. As a reminder, this Conference is being recorded today, August 2, 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 Maddox,

Speaker 1

Thank you, operator, and good morning, everyone. I hope you are all well and safe. Welcome to Zimmer Biomet's Q2 2022 earnings conference call. Joining me today are Brian Hanson, our Chairman, President and CEO EVP and CFO, Suki Upadhyay and COO, Ivan Tornos. Before we get started, I'd like to remind you that our comments during this call will include forward looking statements.

Speaker 1

Actual results may differ materially from those indicated by the forward looking statements 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 Q2 earnings release, which can be found on our website, zimmerbiomet.com. With that, I'll turn the call over to Brian. Brian?

Speaker 2

All right, great. Thanks, Carrie, and thanks to all of you for joining us this morning for the call. We've got 3 sections for the call this morning. The first section, I'll talk briefly about our Q2 performance from an overall perspective And how a combination of strong execution and COVID recovery have actually enabled us to revise our expectations up again for the full year. That's in the face of some pretty significant macro pressures, especially around FX.

Speaker 2

I'll also spend a few minutes talking about ZB Innovation. That's a primary contributor to our performance today and certainly our performance in the future. So we want to make sure we touch upon that. And for the second section, I'll switch it to Suki, And Suki will obviously provide details on Q2, but I think even more importantly and probably more interesting is to talk about 2022 guidance and our updates there. And then for our favorite section of the call, we'll close things out by addressing any questions you might have either on Q2 or any other topic.

Speaker 2

So let's go ahead and get started with Q2 and I'll start this section by saying that despite some very real and what I would define as universal challenges in Our sector, I'm very proud of the fact that the team delivered again another solid quarter that actually was above our internal expectations. And I think this Speaks to the teams, I'm just going to define it as muscle memory associated with effectively managing through challenging times and that's exactly what we have right now. With the supply concerns that are out there, it is a challenging time and it's great to know that our team has that muscle memory to manage through it effectively And they continue to show that. The primary reason for the overachievement was stronger than anticipated COVID recovery for sure, which happened in the quarter, but also just really solid and focused execution from the team across our regions

Speaker 3

and all of our business segments.

Speaker 2

From a procedure volume standpoint, the momentum that we saw in Q1, particularly at the end of Q1, actually continued through April May, But we did see a bit of a slowdown in June and that has actually carried over through to July. The recovery pace was different depending on where you were in the world in Q2. It was strong everywhere, but it was really strong outside the U. S. Where we saw strong performance pretty much across the board in all of our areas OUS.

Speaker 2

And inside of this, we saw solid momentum again in knees and hips. I'm really pleased to see another strong quarter in large joints And excited that we continue to get traction for our innovation in this area. The momentum in large joints was then offset by some expected pressure in our set businesses and our other category and Suki will provide more detail here in a minute. I think it's pretty clear for all of us actually that foreign currency is a challenge. Supply challenges are very real.

Speaker 2

Inflationary pressures are with us right now and those Hurt us in Q2, all of these did. They're going to continue to pressure us through the back half of 'twenty two and potentially beyond. But just given our business momentum this far into the year, Our new product innovation and the traction we're getting there with our customers and COVID recovery, at least a profile today, our overall confidence in 2022 has actually gotten better. And as a result of that, we are raising our full year guidance for revenue, operating margin and earnings per share. And I think this should be a solid indication that our strategy is working and our team is executing, really just getting it done And our underlying business is gaining strength and a big part of that, the big part of this momentum is our new product innovation and continuing to deliver and delighting our customers.

Speaker 2

And in Q2, we debuted another element of our ZB Edge ecosystem. This is an within our OmniSuite smart OR system that focuses on optimizing surgical workflow and increasing procedure efficiency. And I'd say that's important right now. It's really important because of the capacity constraints that our customers have. Now separate from that, from a ROSA perspective, ROSA robotics momentum continued in both knee and hip for the quarter And our placement pipeline remains extremely strong.

Speaker 2

And while it's still in limited launch and very early days, the feedback and interest in Persona IQ is positive. And we're focused on collecting as much early data as quickly as we possibly can with an eye toward clearly establishing clinical use benefits, so we move into full launch in Our new product pipeline is just as exciting. We have additional product launches planned for the second half of twenty twenty two, especially across our knee and set portfolios. In knee, our soon to be launched Persona cementless form factor will complement our current form factor And provide additional momentum for cementless conversions, particularly as we get into 2023. And in our set businesses, I'm very excited about our IDENTITY Shoulder System launch.

Speaker 2

This is going to be a much more customizable shoulder for a more personalized feel for the patient This should optimize movement in the shoulder. We're also continuing to reshape our business and accelerate ZB's transformation. We've made Significant progress in streamlining and modernizing our operating model, but we've also really focused on making ZB a best and preferred place to as well as a trusted partner, which are 2 of our strategic pillars for the company. In Q2 Zimmerbaume was certified by Great Place TO Work. This is a global authority on workplace culture.

Speaker 2

The U. S. Certification was based on direct survey feedback from our team members, which I think makes it even more compelling. We also established a new function for refining and driving our environmental, social and governance strategy, But also the commitments and actions we're taking in this area as well. We have already seen significant improvements across almost every element of ESG And truly we're just getting started.

Speaker 2

We see this as an important responsibility as a company for sure, but also something we believe is critically important to our team members, Our customers and our investors. You'll be hearing more from us on the ESG front as we make further progress and as we continue to enhance our reporting in this area. So in summary, even though there are real macro headwinds that our team is managing, the recovery shift in COVID continues and the execution of our strategy is making a difference. We'll need to stay close to the headwinds into the recovery. The last couple of years have proven that things are fluid, but I do feel confident And our team's ability to navigate the path forward and I'm excited about where Zeebee is going.

Speaker 2

And with that, I'm going to turn the call over to Suki for a deeper dive into Q2 And again, I'll look at our revised expectations for the year. Okay, Suki?

Operator

Thanks and good morning, everyone. Overall, we had a good quarter driven by strong execution and faster than expected recovery of elective procedures across most markets. While we continue to face heightened headwinds and challenges related to foreign currency, inflation and supply chain disruptions, our 2nd quarter gives us the confidence to raise our full year revenue and EPS outlook. With that, I'll turn to our Q2 results and how that translates into our updated My commentary will be on a constant currency or adjusted continuing operations basis. Net sales in the 2nd quarter were 1 point $782,000,000,000 up 1% on a reported and 6% on a constant currency basis.

Operator

As Brian mentioned, strong procedure volume recovery extended from the Q1, especially as we moved into April May with moderation of recovery in June. U. S. Sales grew 1.3%, driven by strong recovery in execution as COVID cases subsided and elective procedures returned, especially in knee and hips. This was partially offset by lower SET growth and declines in the other category.

Operator

International sales grew 12.2% driven by Asia Pacific overall grew in line with expectations with China performing largely as projected and Japan growing better than anticipated. Turning to our business category performance. Global knees grew 11.2% with international knees up 20.1%. These results were driven by easy comparisons OUS along with especially with Persona Revision in the U. S.

Operator

And ROSA penetration and pull through. Global hips grew 8.6% with U. S. Hips up 2.6% and international hips up 14.9%, driven by easier comparisons to OUS in tandem with strong international procedure recovery. We also saw continued traction across key hip products, including our Arcos and G7 system for revision and our Avenir complete primary hip, which is focused on the direct anterior surgical approach.

Operator

And lastly, we continue to see solid ROSA pull through in the hip category. Force Extremities and Trauma category increased 0.1% and was impacted by a tough comp in 2021, Expected pressure in trauma due to VBP implementation as well as expected pressure in restorative therapies due to a reimbursement shift for our GEL-one product. Within the category, we continue to deliver strong performance across our key focus areas of CMFT, Sports Medicine and Upper Extremities. Finally, our other category declined 6.1% driven by tough comps and expected lower capital sales related to a higher mix of ROSA placements versus upfront sales in the quarter. Moving to the P and L.

Operator

We reported GAAP diluted earnings per share of $0.73 compared to our GAAP diluted earnings per Share of $0.68 in the Q2 of 2021. Higher revenue and lower IPR and D charges more than offset restructuring costs and mark to market losses on our retained ZIMVI stake. On an adjusted basis, diluted earnings per share of $1.82 represented an increase $1.51 in the Q2 of 'twenty one. Higher sales in tandem with lower IP R and D in the quarter More than offset lower year over year gross margins. Adjusted gross margin was 71.6%, Slightly ahead of expectations due primarily to better mix and lower pricing erosion.

Operator

As a note, We expect heightened inflation to temper our observed second quarter favorability as we move through the rest of the year. We continue to project full year gross margin to be slightly down when compared to full year 2021 gross margin. And as we've said, increasing inflationary pressure will pull through into 20 And we now expect about 50 to 100 basis points of headwind from inflation in 2023 versus our previous estimate of about 50 basis Our adjusted operating expenses were $777,000,000 lower than the prior year, primarily due to the 2021 IPR and D charges referenced earlier. Our adjusted operating margin for the quarter was 28%, up from the prior year. As previously noted, full year margins will be pressured versus the prior year due to inflation, supply chain headwinds and China VBP, with partial offset by the ongoing realization of our efficiency programs.

Operator

Despite these ongoing headwinds, We expect those efficiency programs to drive improved second half operating margins versus the first half of the year. The adjusted tax rate was 16.5% in the quarter and in line with our expectations. Operating cash flows were $346,000,000 Free cash flow totaled $240,000,000 for the quarter. We paid down about $100,000,000 of debt in the 2nd quarter and ended with cash and cash equivalents of about $390,000,000 Our improving financial performance in tandem with ongoing reductions in debt continue to strengthen our balance sheet for greater strategic And now moving to our updated financial outlook for the full year 2022. We're raising our financial guidance based on the following key assumptions.

Operator

COVID and customer staffing pressures will continue through 2020 but with a lesser impact than previously anticipated. Supply chain and inflationary pressures stabilize at current levels And foreign currency will be a 500 basis point headwind in 2022 versus our previous projection of 3 50 basis points. Also, we assume about a 30% flow through of FX related revenue headwinds falls to EPS and That the FX headwinds applies to the full range of EPS guidance. Against this backdrop, I'll walk through our updated financial guidance for the year. Constant currency revenue growth is now expected to be 4% to 6% versus 2021, with an expected foreign currency headwind of 500 basis points.

Operator

This means that reported revenue growth is expected to be in the range of negative 1% to positive 1% versus 2021. We're raising adjusted operating margin by 25 basis points to the range of 26.75 percent to 27.75 percent. Adjusted tax rate guidance remains in the range of 16% to 16.5%. Adjusted diluted earnings per share is now expected to be higher at $6.70 to $6.90 And free cash flow is now expected to improve to $800,000,000 to $900,000,000 And lastly, net interest expense and non operating expense will be modestly higher than the $160,000,000 we anticipated early this year due to higher interest rates in foreign currency. We expect to see typical seasonality in the back half of the year, which would suggest stronger revenue dollars in Q4 than in Q3.

Operator

Additionally, we expect Q4 revenue growth to be higher than Q3 growth, in part due to the easier 4th quarter comp related to China VBP headwinds we observed in the Q4 of 2021. Operating margins are and executing well. We are raising our 'twenty two financial guidance due to better than expected COVID recovery, the strength of our execution and our confidence ZB's underlying business fundamentals. With that, I'll turn the call back over to Carrie.

Speaker 1

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

Operator

We will begin with Rick Wise with Stifel.

Speaker 4

Good morning, everybody. Hi, Brian. Hi, Suki. Maybe I'll start off with your commentary about the outlook For the second half from a couple of perspectives. Brian, you talked about the April, May Strengthening maybe some softening in June and continuing.

Speaker 4

Help us understand where you're seeing it? What do you think is happening? And maybe better understand what you've dialed into the second half. We recently did a survey of 50 orthopedic surgeons who We're cautious about the 2nd quarter, but the most ebullient, exuberant about their volume for the second half of any doctor group we surveyed. I'm confused about how we So, reconcile those two points of view?

Speaker 2

Yes. Thanks for the question, Rick. So, what I would tell you is that, what we experienced and of we talk to a lot of our customers as well as you would imagine. But what we experienced is in June and then carrying through to July, not fewer procedures, But more cancellations of those procedures and most of that was driven by either 1, the staff member having COVID or testing positive for COVID For the patient testing positive for COVID and as a result of that they could not carry on with the procedure. And what we're saying is that we believe that could continue.

Speaker 2

We believe that could continue until we see a shift, we're going to assume it will continue at least through the Q3. That's just what we're experiencing. The good news is when I think about the quarter, we had a really strong quarter and the business momentum, the underlying Business momentum is real and we believe that's going to continue. But outside of that, I don't know if you want to speak more Suki to just our second half view. Yes.

Speaker 2

So good

Speaker 3

morning, Rick. Good to with you today. So if you look at our implied guidance in second half at the midpoint versus what we did in the first You would get about 4% operational ex FX growth for revenue. And really what interpins that is 3 key assumptions we've made inside 1, you've got tougher comps in the second half than you saw in the first half. You see that especially with EMEA.

Speaker 3

If you just think about the Q2 growth we posted, but it really translates to other markets as well. So tougher comps. 2, we have one less selling day in the second half of the year. So we've accounted for that. And 3rd, as Brian talked about, we're just taking a prudent view on COVID, especially given our index to elective We did see some softening of procedures due to those cancellations as we exited the 2nd quarter.

Speaker 3

And we're assuming that that continues into the Q3 with a step up or improvement in COVID in the Q4. Now I would say if we don't see that pressure continue all the way through the Q3, that would likely take us to the top end of our range. So Those are some of the big building blocks that we've assumed in our second half growth rate. But as Brian said, we feel really confident about the execution of the team, Where our pipeline is going and our ability to execute on our recent product launches. So feeling really good about the second half.

Speaker 4

That's great. And maybe just as a follow-up to follow on to some of these thoughts. Maybe Suki, and this is always I know your This is kind of favorite question on calls like this at this time of the year. Talk about the setup for 2023. Just hearing some of the factors you're talking about improved internal execution, major new products being launching, the Positive impact of your efficiency programs, it would seem like I'm leaving this feeling more encouraged about that setup For the next year that I might have, appreciating that the many uncertainties as well.

Speaker 3

Yes. So I'm glad you're feeling encouraged because we're feeling encouraged as well about the outlook. As we we're not going to get into guidance obviously for 2023. There's lot more to play out in 2022. But as we think about a normalized market and normal market dynamics, We would expect revenue at a floor of 4%.

Speaker 3

And inside of that, based on all the operational efficiencies the team has been very successful in making and things that we've got planned for next year. We believe we can offset this headwinds that we're seeing this year related to Inflationary pressures and we believe we're in a position where we can expand margins into 2023. Now, albeit it won't be as Great margin expansion as you would have we didn't have these inflationary pressures this year, but we still feel confident that we can expand margins with that type of top line growth profile Into next year?

Speaker 2

Yes. I'll just maybe make additional comment on that. I would agree. I think that the execution of the business and the team is very real. The momentum in the business is real.

Speaker 2

The product pipeline that we have is very strong that we haven't even launched yet. So for all those things coming together in a normal market, I would Very disappointed if we didn't deliver at least a 4% growth rate. And that said, that's not where we're going to stop, right? We clearly have a little more cash flexibility And that opens up options for us from an acquisition standpoint and we're going to be looking to add accretive WAMGR acquisitions, potentially diversifying acquisitions To bolster that growth rate over time.

Speaker 4

That's incredibly helpful. Thank

Speaker 5

you.

Speaker 1

Thanks, Rick. Jake, we can go on to the next question.

Operator

We will hear from Pito Chickering with Deutsche Bank.

Speaker 6

Hey, good morning guys. Thanks for taking my questions. Looking at your 2022 guidance on the margin side, can you help us understand the increase of inflationary pressures And the FX headwinds and how that's offset by stronger revenue growth and margin leverage. Then if you usually have around positive pricing or mix in your updated guidance for the year?

Speaker 3

Yes. Hey, Peter, this is Suki. So I'll start with the operating margin guide. So Inside of that gross margin, we do expect to step down in the second half versus the first half. We are experiencing Greater headwinds due to inflationary pressures, that's baked into our operating margin guide.

Speaker 3

And that's increased in the quarter from our Q1 call. And what we now see is where we originally anticipated about 50 basis points of that incremental Inflationary pressure landing in 2023, we now think it's closer to 50 to 100 basis points. But again, we've completely Included that in our new operating margin and gross margin guide or expectations for the rest of this year. Now I would say inside of that, Our assumption is that inflationary pressures stay relatively stable to where we exited the Q2 as we think about the rest of the year. If you take that operating margin, you would expect perhaps a bigger EPS flow through.

Speaker 3

But as you're seeing with across the sector, FX has been a significant headwind, taking our number up from 3.50 basis points of headwind now to 500 basis points of headwind. And so if you think about our EPS guide and our raise, the way to think about it is while we're increasing our ex FX operational growth by 200 basis points, our reported growth at the midpoint is only going up by 50 basis points. And so if you take that 50 basis points that translates to about an incremental $35,000,000 in revenue including Q2 performance And if you flow that through that would get you to about a nickel. And so that helps support or helps to give the big building blocks around the $0.05 raise that we just put in there. So hopefully that gets to your questions, but happy to take any follow ons you might have.

Speaker 6

Yes. I just want a quick follow-up here, so on the 2023 commentary with this sort of 5 FX hit you're seeing, assuming that this were comps out next year, can you just refresh us how

Speaker 7

that would flow through the P and L

Speaker 6

in 2023?

Speaker 3

Yes. So, right now, we're assuming that FX is flowing through to net income at about 30%. And that's inclusive of any natural hedges we have plus any FX gains and losses. Now I would say that 30% can vary over time for a number of variables. It can vary based on mix of regional profit.

Speaker 3

It could vary because of timing of foreign currency changes. It could vary because of the Timing of FX gains and losses. But right now, our best estimate is 30%. And as that changes over time, we'll keep you updated.

Speaker 6

Great. Thanks so much.

Speaker 1

Thanks, Kito. Jake, can we go to the next question, please?

Operator

We will now move to Larry Biegelsen with Wells Fargo.

Speaker 3

Good morning. Thanks for taking the question and congratulations on a really nice quarter here. Brian or Suki, I just want to confirm there was international was really I just want to confirm there was nothing kind of one time, no catch up there. And then just set and other, maybe just some color What accelerates those two businesses? Is it the new shoulder inset?

Speaker 3

When does that happen? And the outlook for other, Given some of your comments more Rosa rentals or lease agreements, what's the outlook there? Thanks for taking the question.

Speaker 2

Sure. Yes. And thanks, Larry. So what I would tell you is that there was nothing other than some easy comps, obviously, had OUS. There was no one time event that buoyed the quarter that somehow skewed the quarter.

Speaker 2

It was just the factors that we referenced already That came together and allowed for a very strong quarter OUS. So that's the first answer. I'll hit set and then maybe Suki, you could talk about other or You can as well. So on the set side, I think it's probably good to just take a step back because we don't talk about the sub Categories that often have set and just kind of reorient everybody. We have 6 businesses underneath that.

Speaker 2

We have our CMFT, which is our cranial, maxillofacial and Business, sports med, upper extremities, foot and ankle, trauma and restorative therapies. And I would just say in the quarter, we saw a very strong performance In our three focus areas, upper extremities, CMFT and Sports, with upper extremities and CMFT both growing double digits in the quarter and we think that's sustainable, Sports Medicine growing mid single digits even with a pretty tough comp in that area. That was offset by expected pressure from Asia Pacific and Trauma. And to be very clear, we expect that to continue that pressure in Asia Pacific to continue through Q3, but then reverse itself in Q4. And then in the U.

Speaker 2

S, we saw pressure in restorative therapies. This is due as Sophie had already mentioned because of a reimbursement change in GEL-one, but What's important on this is, that's going to accelerate into Q3 and continue through about mid-twenty 23 and then it will annualize out. Okay. So just net net, I would expect SET to stay pressured in Q3 and then improve in Q4. And again, we feel pretty confident that we're going to continue to see momentum in our focus areas.

Speaker 2

And maybe, Ivan, you could speak to some of the innovation And some of the things that give you confidence about those areas.

Speaker 7

Sure. Thanks, Larry. Thanks, Brian. So you mentioned shoulder, whether it's just one device that is driving the growth. I think the answer, Larry, is that that's not the case.

Speaker 7

It's more than one product. You are familiar with sort of Signature 1 Planner and Guides. We launched that about 2 years ago that today about 50% of all procedures are done using this technology. And the feedback continues to be really compelling around accuracy, around the simple interface with the surgeon, The integration of the workflow and just the fact that the surgery is in control. Nano or stemless shoulder was also launched and is getting great momentum.

Speaker 7

The big launch that I think you're talking about hasn't happened yet or Identity launch, which is going to be your biggest shoulder launch in the last 5 years, It's about to get launched and that is going to be as spacing centric as it gets. Truly a personalized solution, it has the Ability of doing inlay and onlay reconstruction, I can spend an hour talking about it. I know you're a product guy. What I will tell you is going to be transformational. Beyond shoulder and Sportsmail, we have filled the portfolio very quickly, still integrating ReLine, the acquisition that we did about 12 months ago.

Speaker 7

It is an all in one arthroscopic surgical platform. The feedback continues to be great both on the capital and consumable side. We got new products on anchors. And again, I can continue to go on and on, but I would say that our portfolio in Sports Med today has everything that we need to have. And then lastly on CMXT, as Brian referenced, that is a double digit growth business with a combination of organic and inorganic plays.

Speaker 7

We launched new products on thoracic and neuro. We're about to launch as many as 6 to 7 different products in the next 12 to 18 months. We're making a lot of investments in that business. So it's not one product, it's not one category, at least 3 categories are growing really strongly globally. And then on top of that, I will say our commercial execution is best in class when it comes to the focus, specialization, incentive plan and our contracting capabilities.

Speaker 7

So really excited about Seth and the momentum that we got, Larry.

Speaker 2

Great. Thanks, Ivan. Maybe so could you just Yes.

Speaker 3

So you had 2 other questions in there, Larry. 1 was on the quarter for knee and hip and anything that we saw in there. But I would say it's a Very clean quarter. We really didn't see anything material or meaningful relative to shifts and timing on tenders or anything. It was pretty straightforward on both Well, on Recon in total.

Speaker 3

And then relative to other, it was down primarily driven by the mix Of ROSA, I would say the installments continue to be very strong. As a company, we're very happy with how that the continued uptake of ROSA and the utilization increases we're seeing, but the mix of placements versus sales was different than the prior year where we saw This year more placements or this quarter more placements than we saw absolute dollars in sales. And then we did see just a little bit a modest level of pressure in surgical capital within our other business. So again, that was the those were the 2 key drivers to the year over year declines in the quarter.

Speaker 8

All right. Thanks so much guys.

Speaker 7

Yes.

Speaker 1

Thanks, Larry. Jake, we can go on to the next question in the queue, please.

Operator

We will now hear from Josh Jennings with Cowen.

Speaker 9

Hi, good morning. Thanks for taking the questions. Brian, wanted to just ask about competitive wins in joints And what you think is driving in the marketplace decision making by your surgeon customers? Robotics provided an edge at one point, now all the big four have the robotic systems commercialized. Do you think that Surgeons are shifting back to making decisions in terms of what brand based on implant or is robotics still driving competitive wins?

Speaker 9

And Just in the same vein, just how should we think about the evolution of ROSA from here in robotics? I'm sure it's probably a Combination of implant and the robotic system, but what is Zimmer doing to evolve the ROSA system And anything that's any software updates that you guys have implemented so far in 2022? Just have one follow-up.

Speaker 2

Yes. Thanks, Josh, for the question. I would say that it's always been a combination of the implant and the value of the implant to the surgeon and will always Be that way. In concert with the technology you bring that surrounds the implant, that could be robotics, it could be mymobility, it could be our entire ecosystem That surrounds the implants. So, it's always been a combination of those two things.

Speaker 2

When I look at our performance, just those things are now coming together in a cleaner market We've had in the past. And so the underlying strength we've had as a business has been masked by some external things. As those clouds begin to move, I think you're going to see the real performance of the business With that said, obviously, Ivan is here. He's much closer to it even than I am. So maybe you could speak to what you're seeing out

Speaker 7

Yes, absolutely. So on question number 1, Josh, I concur with Brian. The physician is clearly the decision maker. But the role of the provider and the payer is also very, very important. And obviously, we target those decision makers as well.

Speaker 7

Relative to ROSA, I'll tell you, Joss, what makes ROSA unique is not that it is one product. It is a part of an ecosystem That consolidates a lot of different parts and pieces. It's fully integrated with a lot of pre op staff or partnership with Apple and MAM Mobility or Planning software. The fact that you can use ROSA with the number 1 in the world persona, the connectivity with some data points Also Intel data platforms and obviously PersonaIQ at some point. So I think it's more of an integrated solution than just one product That is driving those decision makers to come away.

Speaker 7

If you go ahead and ask physicians why or payers for that matter, why are they choosing ROSA Other than the outcomes and the technology at play, they like the efficiency, they like the fact our pre planning is easier. They're seeing the outcomes, And I think those are the reasons why we're seeing the great momentum with ROSA. So hopefully that answers your question.

Speaker 9

Thank you. And Brian, just wanted to ask about If there's any opportunities you see for maybe product line pruning or even if you're working through any product line obsolescence That could you could drop some maybe anchor product lines and help catalyze some stronger growth at your different business units? Thanks for taking the questions.

Speaker 2

It's a great question. It's interesting because when I first started at Zimmer Biomet, I made the mistake one time on an earnings call talking about fact that we were going to reduce SKUs and the stock just tanked, because normally what happens when you do that, there's risk associated with revenue. What we've done then is just to be kind of quiet about it, but we've also been doing it. We've had dramatic decreases in SKUs over the past 4 years, dramatic. And we're going to continue to focus on that because there's a lot of inefficiencies in orthopedics if you have multiple product lines you're trying to cover It reduces focus in the field.

Speaker 2

So, we really are trying to focus on the main brands, push from an incentive standpoint our teams to focus on those brands And rationalize categories, they're just not as important to us. So again, we've been doing that very quietly, Very effectively over the last four and a half years.

Speaker 9

Great. Thank you. Sure.

Speaker 1

Thanks, Josh. Jake, we can go to the next question in the queue.

Operator

Our next question will come from Jayson Bedford with Raymond James.

Speaker 5

Good morning and congrats on the progress. Just a couple of quick ones. In response to Rick's Question earlier, Suki, you mentioned margin expansion in 'twenty three, and I was just a little unclear. Was that in reference to gross margin, op margin or both?

Speaker 3

Yes, Jason, great question, good clarification. It's really more about operating margin expansion. As I said, we've got some inflationary Pressure this year that's going to capitalize into next year, which is going to put some headwinds into gross margin year over year. I don't want to get into exactly where we think gross margins are But just know that year over year as a starting point, you've got 50 basis points to 100 basis points working against you because of things that happened this year. Having said that, quite excited about all the progress the team is making to help offset those.

Speaker 3

We're doing some really good things around pricing, which is improving our profile. You saw that in this quarter. We expect to see some of those more strategic and tactical Levers continue to play through for the rest of this year and into next year. Really happy about what the supply chain and commercial teams are doing relative to Site optimization and cost down in manufacturing, even in the backdrop of a very dynamic supply chain Market and the challenges with trying to get product in packaging materials and logistics all sorted out in a very, again, volatile market. And then beyond that in SG and A, we're going to continue to look at improvements in our go to market models, commercial models across the world.

Speaker 3

We've already implemented a number of those, for instance, in Europe, where we've looked to restructure and rethink how we go to market in lower margin Markets as well as lower margin business categories. And then, the global business services operating model that we created during the Pandemic is ripe for further leverage and we think that we can continue to drive efficiencies by putting more of our activities into those service centers. So we feel really good that despite ongoing gross margin pressure because of these inflationary headwinds that we can we see a clear path to operating margin expansion into 'twenty three. So hopefully that gives you a little bit more color and clarification on where we expect to see it.

Speaker 5

That's very helpful. Just as a bit of an unrelated follow-up. In terms of patient backlog, I thought it was somewhat refreshing that you didn't Talk about hospital staffing issues. So my question is, what do you think is posing the biggest hurdle To kind of unleashing that backlog, is it just patient reluctance to come in, whether it be COVID or economic Rodney McMullen:] Or is it still hospital staffing? Yes.

Speaker 2

I think it's a good question. I would say it's a bit Balance is multifactorial. I would say that even in the quarter, in the second quarter, we didn't talk about backlog much, but I do believe in certain areas where you had capacity capabilities, we did see some backlog come through. Unfortunately, what we continue to see is also an offset typically of that In other areas that have either COVID or staffing pressure that then drive the numbers down. So I've kind of continued to see this kind of offsetting Of areas that can drive forward and pick up backlog in other areas that are probably building backlog.

Speaker 2

So, I don't know when that's going to stop. It's hard to predict. But the good news is that what we're seeing now anyway is very strong procedure growth. We're just seeing cancellations being the thing we're concentrating on. So we're not seeing COVID driving ICU beds in the wrong direction or capacity of ICU beds being a challenge.

Speaker 2

It just is a patient wants to come in, the procedure is being scheduled, either the patient or the staff member gets COVID and they can't conduct procedure. That's what we're seeing and that's what we saw more in June July so far.

Speaker 1

Thanks for the questions, Jason. Jake, can we go to the next question in the queue, please?

Operator

Yes. We'll hear from Kyle Rose with Canaccord.

Speaker 6

Great. Thank you for taking the questions and good morning. So I just Suki, you made some comments And the last question just about pricing updates. I wonder if we could just take that one level deeper. Where are you seeing the biggest success, I guess in price pressures near term.

Speaker 6

And then when you think about strategically over the long term, I mean where do you see pricing power and opportunities To potentially flex from a pricing perspective longer term?

Speaker 3

Yes, thanks for the question. I'll actually turn it over to Yvonne. He's probably the closest and Doing the day to day contact on this.

Speaker 7

Yes, absolutely. Thanks. So I'll tell you, when I joined this business 4 years ago, The normal price erosion was 3, even 400 basis points per year, in some categories, 500 basis points. That's not where we are, that's not where we're going to be. I would be extremely disappointed.

Speaker 7

It was not at the low end of the range of 2%. That is in a bad day, if you ask me, 200 basis points of price erosion. Relative to what are we doing, what are we seeing success, first of all, I'll define the journey as a 3 Stage Journey, tactical, number 1 strategic, number 2 transformation, number 3. We completed number 1. We've done a lot of tactical stuff, raising price For non core products, raising price in non core markets, thinking differently about different customers based on segmentation, all of that has been done.

Speaker 7

We're guiding great success. Stage number 2 strategic, I would say we probably midpoint in that stage. It's about category contracting. We have a number one position in hips and knees in many We've not done a good job in leveraging that position to bring set and other categories. That is happening.

Speaker 7

Now that we have truly an ecosystem of solutions, We are bundling, I don't like the word, but that's the one that comes to mind, or ecosystem and contracting across the entire piece of the care. We're doing a lot of things in terms of thinking ASCs. We incorporate a ton of people in our contracting group That are thinking more strategically about those relationships, line extensions and whatnot. And then at some point, we'll get into the transformational stage. And that is how do we leverage all this data that we're getting to do risk sharing agreements.

Speaker 7

Now that we launched product platforms like WorkAI, are we able to engage in predictive analytics? How are we going to leverage that to really understand what happens 3, 6 months after a surgery is So 3 different stages, I would say again with our stage number 2. And if we are not at least or at worst, at 2% price erosion, We're now doing our job. Thanks for the question.

Speaker 6

Thank you. That's very helpful. And then just one follow-up on ROSA. Maybe just talk a little bit about the utilization And some of the positives, and then I'll take a stab. But overall, installed base and percent of knees and hips flowing through that would be very helpful.

Speaker 2

I think you've always got to try to take a stab at those two things, but we're just not going to provide it. But I do want, Yvonne, if you could just talk That's momentum. I mean, we're seeing really strong momentum in ROSA. It was a little off from the other category given the mix as Suki referenced before, we sold less Than we did the prior year, but the placements were still strong. And the pull through on those placements are also still strong, but maybe you can Yes, sure.

Speaker 7

Absolutely. I'll tell you, I'm really proud of the work that the team has done globally. We are now in 40 countries with ROSA Over the last 3 years, but I'm even more energized about what's happening or what's going to happen over the next 3 years. But to throw some colors, I won't disclose the number of placements. Brian has done that in the past.

Speaker 7

I won't talk about penetration, but I will tell you that it's double digit here in the U. S. We had a solid Q2. Sequentially, we grew both on sales and placements, overall installments, Q222 Versus Q1 of 2022 versus last year comps, it was a headwind. We continue to see a nice mix in terms of In an inpatient unit and in an ASC unit, I mentioned earlier that the feedback from customers is very compelling When it comes to efficiency, and today about 30% of all installations are happening in the ASC.

Speaker 7

So that's a great lead indicator to what's going to happen here given the migration Into that setting. From a competitive standpoint, we track that obviously very closely about 40% to 50% of installations Are happening in competitive accounts. And again, the number of returns and the feedback has been very, very positive In that space as well. So really excited about where we are. It's a global business, continue to see penetration in the right direction.

Speaker 7

And as I think about the next 3 years with as many as non indications coming, would say that we're in the really, really early innings of this game.

Speaker 1

Thanks, Kyle. Jake, can we go to the next question, please?

Operator

Yes. Next, we will hear from Jason Wits with Loop Capital.

Speaker 10

Hi, thanks for taking my questions. Maybe a follow-up on what you meant. Appreciate the detail on ROSA. Curious on the competitive accounts that you're getting in with ROSA. Are they using multiple robots or is it usually just a single robot that's a ROSA?

Speaker 10

Or how would you characterize those competitive inroads?

Speaker 7

Absolutely, Jason. Thank you. It really depends. We are in a lot of teaching institutions. And as you can imagine, when you're talking to HSS Hospital for Special Surgery For Special Surgery New York or the Cleveland Clinic or Mayo, they do like to have a wide array So it's not uncommon to see 2 or even 3 robotic systems there.

Speaker 7

So that comes to mind when it comes to selection. As you look at other settings, it really does depend. It depends on the preference. When you have high volume surgeons that they used to use in Persona, Then they tend to gravitate towards ROSA because it does integrate persona and it drives a different level of efficiency. So it does depend on the volume of the surgeon, teaching Non teaching institution.

Speaker 7

Yes, we do have examples here in the U. S. And globally where you have as many as 2 or even 3 robots in an account.

Speaker 2

Yes. And it's not surprising that that occurs. Even if you just look at the implants, even in a very strong account that we would have, usually it's not homogeneous You typically have some competitive implants in there as well. So it would follow suit that if you're going to move into robotics, you likely will have more than 1 robotic system.

Speaker 10

Okay, okay. That's I appreciate that detail. And then a follow-up on Persona IQ. I know you mentioned you're kind of working out or Building up the case for the value proposition, I assume that's going to be a premium price product and it sounds like you're ready to fully launch In 2023, how do we think about that in terms of the price and the value proposition for the patient in the hospital?

Speaker 2

You're absolutely right. It is going to be it is today and it will be a premium price product. It is one of those opportunities Just like you would see in robotics disposables, you would see in MyMobility, you would see in a cementless uptick in price point. And that's why we're Sprinting right now to be able to collect data to prove out the value proposition, as I said in my prepared remarks. But Ivan, obviously, you're very close to the launch, maybe you could

Speaker 7

Yes, I'm not sure, Jason, that we're ready to commit to a launch date. We knew early on when we acquired this technology, when we partnered with Canari on this technology, That this was going to be a limited market release, and it could take 6, 12 or even 18 months, depends on the level of data that we're getting. We knew that this LMR was more of a clinical exercise than a commercial exercise. We are on track with the things we want to get. Really, the LMR has Number 1 is validation of the value proposition.

Speaker 7

And again, we're getting millions, and I'm talking millions of data points so far in this LMR. Anything from what happens in trial upon resection, gap balancing, the level of alignment, the cutting, what happens post op In terms of range of motion, in terms of gait, speed and all kinds of things, with all those data points, we need to understand what is the true value proposition for that patient, that provider and that physician. The second part is how do we once we really do launch the product, how do we make this What's the pathway towards activating sites at a faster speed? How do we train surgeons? How do we deal with the data questions around privacy and whatnot?

Speaker 7

Then number 3, it's really what's next. We don't want to be just a smart knee company. We want to be a smart solutions company. So we got a pathway to get into hip. We got a pathway to get into shoulder.

Speaker 7

Well, I understand both cemented and cementless needs, different platforms. And to that end, it's a lot of data we're getting to understand what is that we're going to do from a portfolio standpoint. So I'm not going to commit to a date for launch, but I will tell you we're on track in terms of gathering all the data and the roadmap ahead.

Speaker 10

And maybe thank you. That's helpful. And just maybe one quick conceptually question here. And is the market ready to pay up For these AI technologies, these planning technologies, I mean traditionally the market's been very focused on implants, implant costs. So this is a

Speaker 3

bit of a

Speaker 10

shift. Has the market been receptive? Do you think they're receptive? Do you think 2023 they are receptive To paying these types of premiums for these sort of new take on technologies?

Speaker 2

I'll answer it in a couple of ways. I think First, I look at data points that would suggest that the market is ready and I just look at ROSA. I look at robotics in general. It wasn't that long ago that there was an assumption that Orthopaedics would not pay a premium to bring robotics into play. I think we're finding that's changing very rapidly.

Speaker 2

I really do believe robotics will become a standard of care at some point. I think it's the same thing. This is the next leg of the stool. I really do believe that data collection and the informatics capability as a result of that will be something that people will desire and pay for. We have to prove it.

Speaker 2

We have to collect the data, create the data lake, create the insights as a result of that and give guidance to surgeons from that data. Once that occurs And we can then predict things ahead of time and change care as a result of that. There's value in that. There's no question. Remember, there's still a large Percentage of patients somewhere in the neighborhood of 20 percent to get a knee procedure that are not happy for whatever reason.

Speaker 2

And when you talk to surgeons, even really good surgeons, they don't always know why. They'll say, hey, I had the best surgery day. The X-ray looks fantastic. That patient is not happy. I do not know why.

Speaker 2

We don't either. But I'm pretty confident with the data we're collecting, we'll be able to predict it in the future and then change the care for that patient. And that's really good for the patient. That's why we're doing it.

Speaker 7

I'll just maybe quickly add that in addition to the example of ROSA, which I think is a great example of the market being ready to pay for technology, We already have thousands of patients in our MyMobility by Apple platform. So it's another example of when you do provide the right data, People will pay for it. There's 2 questions that every day we are trying to solve with payers and providers. Can we lower the length of the stay in a hospital for surgery? Okay.

Speaker 7

We lower readmission rates. And if you can do that through data and technology, the market will pay for that. And we're making more bets that we're going to be able to do both of those.

Speaker 1

And

Operator

We'll hear from Chris Pasquale with Nephron.

Speaker 11

Thanks. Just following up on the PersonaIQ question. Can you give us a sense For the scope of what you're collecting and is this something we should expect at the AAOS meeting in the spring or is the timing not going to line up with that?

Speaker 7

Well, I'll tell you, I could spend an hour talking about these things that we're collecting. But from pre op to intra op to post op through different device, Now with Persona IQ, which is obviously intraop and postop, we're looking at things such as resection data, gap balancing, The accuracy on cuts, the overall alignment, the range of motion expectations. We're looking at post op asymmetry of the actual implant, the What else? Gait speed. How well are you doing physical therapy, post surgery.

Speaker 7

Again, I can go on and on. In addition to those patient centric measures, we're looking at how to design products in a better way based on how the implants are functioning post surgery. But I think in the economy, you'll see much more in this space. And again, the idea going back to value proposition is out of all these multiple data points, What are the 2 or 3 that are going to drive that premium and that willingness to pay? I'm looking forward to sharing that in the academy.

Speaker 2

Yes. And I think it's important, you said it, it's not just IQ. It is an ecosystem of capabilities that allows us to collect data across all areas of the procedure Before, during and after. And it's a combination of those things that will create that data lake that is just too vast for us to make any sense of. But with machine learning, we can look for patterns in this And ultimately provide insights as a result of it.

Speaker 11

Got you. Thank you. And then I just wanted to clarify on the pricing commentary. You guys used to give the impact of price by business, went away from that this year. But if I look back over the past 7 or 8 years, the average impact was just a little bit over 2%.

Speaker 11

So I'm a little confused by the 3 to 4 point comment and how much of an improvement we should really expect if 2% is a target going forward. Maybe clarify that. Thanks.

Speaker 3

Yes. So I'll take that one. Excuse me. So Overall, on a consolidated basis, you're right, it was somewhere in the 200 to 300 range. But if you deconstructed that and actually look By category and we did provide that level of data, you would see that knee and hip or recon was higher on price erosion than the overall And you saw generally lower than that average in SCT, so that was your offset.

Speaker 3

I don't know, Vivek?

Speaker 7

Just to be clear on the 300 basis points to 400 basis That is large joints in the U. S. So when you look at the overall category, it might have been different. But yes, it was not unusual to see 3.40, even higher than 400 point here in the U. S.

Speaker 7

Given the way that we contract and historical factors.

Speaker 11

Got it. Thank you.

Speaker 1

Thanks, Chris. Jake, we have time for maybe 1 or 2 more questions. Can we go to the queue?

Operator

Yes. We'll hear from Steve Lichtman with Oppenheimer.

Speaker 8

Thank you. Good morning. Follow-up on SCT. You talked about the pipeline you have coming in your focus areas. As you think about overall SCT versus WAMGR for those markets, do you see a pathway to improved Foot and ankle growth versus that market either through internal innovation or M and A, your overall thoughts on your foot and ankle from here?

Speaker 2

Yes. So, I'd tell you is again, all 6 of the categories we have in set are interesting and attractive categories. There's no question. We do bias our investment in our focus areas, which are the ones that are referenced, CMFT Sports and Upper Extremities, mainly because Those businesses have either been able to acquire a full portfolio, have a full portfolio, and we see a cleaner path to leadership in those spaces. And so they get disproportionate amount of investment.

Speaker 2

And as a result of that, we expect above market growth in those spaces. In the other categories, they still get investment. They're still important to us. We just expect a different performance because the investment level is different. Now, if any one of those businesses comes back with a pathway through acquisition or otherwise That would also show a clear path to leadership.

Speaker 2

They could become a focus area as well. I don't know if you want to

Speaker 7

add anything. I'll just keep it very succinct and say we have not given up On Foot and Ankle, there is, I would say, a meaningful amount of R and D that is going to that space. We recently closed the buyout of an extremity, We now have a more complete offering in forefoot, midfoot and heme foot. We got some biologic solutions that we're launching as we speak. We got a partnership with our sports medicine group on sutures.

Speaker 7

So there is a compelling portfolio I will label it that we've seen that we're going to be able to launch here.

Speaker 8

Got it. Okay. And then Brian, you said before that as you guys moved into Phase 3 of your transformation, M and A got crimped obviously by COVID. The impact there from a procedure volume Basis has ebbed, but obviously there are some other macro headwinds, your balance sheet is in good shape. How do you feel overall about the environment for Zimmer to go out and do some deals here over

Operator

the next 12 to 18 months?

Speaker 2

Well, I'd tell you a lot better now than I did before. That's for sure. The fact is our financial flexibility is improving. The balance sheet looks strong And we've earned the right now to be able to truly increase our focus in this area. Don't get me wrong, all along Since we've been in Phase 3, we've been looking at the market, looking for assets that we could pursue.

Speaker 2

But now our ability to execute this phase of our transformation is more real. And just to give you some color there, we truly will be looking at mission centric targets because that's the number one criteria. We're also assets and then those things that as a result of that can drive faster growth and faster EPS growth over time. The size it, we're probably looking more small to medium sized deals and it would be across 3 areas. Number 1 would be to diversify side of traditional orthopedics with an eye towards those things that are a little less elective in nature.

Speaker 2

And then inside of Recon, we're actually looking to Enhance our position in those faster growth submarkets of recon so we can bring our WAMGR up there as well, things like data and robotics. So that's where we're going to focus in. We've been at Phase 3 for

Speaker 5

a while. We've got a lot

Speaker 2

of things that we're interested in. And now we have a little more financial flexibility to move in that direction.

Speaker 1

Yes. And Jake, we probably have to end there. I know we're a little bit above 9:30 here, but thanks for all the questions. All great from the queue. Brian, don't know if there's any closing remarks that you'd make round out the call?

Speaker 2

Yes. I think when I say, hey, it was a strong quarter, but it's just a quarter. The fact is the momentum has been there for a long time. And I'm just really happy that finally with some of the clouds being removed, you can actually see the performance that the team is actually delivering. I think I do want to make sure that we're clear.

Speaker 2

As we think about that concept of we should at least do a 4% growth rate, it's going to be choppy for a while. The fact is it's not a clean market, It's not an undisturbed market and it's not going to be for a while. So you could expect quarters that might be above that 4%. You might expect to see quarters that are below that 4%, Just given all that noise in the market, make no mistake, the business momentum is real. The team is executing right now flawlessly and our product pipeline It's really, really strong.

Speaker 2

So our confidence is high. Even though it's going to be choppy for a while, our confidence is very high.

Speaker 1

Thanks, everyone, for the questions. Of course, if you have others, please don't hesitate to reach out to the team today, and I'm sure we'll talk soon. Thanks for joining.

Operator

And this concludes the Zimmer Biomet quarterly earnings call. Thank you for your participation.

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Zimmer Biomet Q2 2022
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