Zimmer Biomet Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 12 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet 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 Carrie Maddox, Chief Communications and Administration Officer, please go ahead.

Speaker 1

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 EVP and CFO, Suki Upaiyay. 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.

Speaker 1

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.

Speaker 1

Ivan?

Speaker 2

Thank you very much, Kerry, and good morning and greetings everyone from Warsaw, Indiana, the orthopedic capital of the world. Welcome to our Q3 earnings call. My first call as the CEO of this amazing organization, really grateful that all of you are joining us here this morning. I'd like to begin by saying how truly excited I am to be in the new role. I would like to be a very inspiring time, not just in musculoskeletal health, which it is, but also in medtech in general.

Speaker 2

Simply put, the space is not where it used to be just 5 years ago. When you look at orthopedics, when you look at the entire category, it's changed. It's changed a lot. Groundbreaking technologies are shaping how procedures are done. Beyond the backlog and continuing favorable demographics, global demand for treatment is higher than it has historically been.

Speaker 2

This is driven by better clinically reported outcomes. This is driven by shorter episodes of care. This is driven by better, more comfortable ways And this is driven by Sato treatment migrations like the one we're seeing here in the U. S. With a rapid shift of cases moving to an ASC, while also preserving what are very compelling volume levels In the traditional inpatient and outpatient settings.

Speaker 2

So in plain English, healthy market, great patient dynamics, new technology, disruptive innovation, A lot has changed and I don't see us going back to 4, 5 years ago. So again, a very inspiring time to be in musculoskeletal health and orthopedics in general. All of these market accelerating trends are opening new doors for countless patients to benefit from what we do here at CB, which is to drive life changing solutions. We do that every single day for countless patients. And the best part about it, we're just getting started.

Speaker 2

So, I could not be More excited to be here in my new role. With this encouraging market dynamics, sustainable trends and building on this solid track record of execution that the CB team has enabled, It's great to be here today to report what it is another solid quarter of a strong performance, while strongly reaffirming our year end guidance for the year 2023. Even more exciting as I look forward to our future, I'm more convinced than ever that Cyma BioMed will continue to lead the way on customer centric innovation, already a competitive advantage I'm sorry, commercial execution, enabling not just the delivery of our mission, but also improving on our other key value creation drivers, those regaining And sustaining top quartile performance. And again, this is something that we treat with a lot of rigor and something that is a mandate for the organization. We must regain and sustain top quartile For today's call, I want to first share my thoughts on my first two months as CEO of Zimmer Biomet, While also providing key insights into what I've learned, how my learning has shaped what are going to be my 3 key priorities as the new CEO of the enterprise.

Speaker 2

This will answer the question on what is fundamentally going to change around here in the next chapter of our transformation. After that, I'm going to talk about the key drivers behind the Q3 performance. Next, Shugli will take over and will discuss the financials for the quarter, as well as the expectations for the rest of the year, And then our favorite part of the call, Q and A. Before we move into these updates, I do want to take a moment to thank the Global Cima Biomet team for their unwavering commitment to our purpose, to our plans. I want to thank them for their sense of urgency in driving Sun execution.

Speaker 2

I want to thank them for everything that they do. This is a highly engaged and focused team That has been operating at a very rapid speed and is eagerly deciding to do even more, more for patients, more for customers, more for the team, more for each other, more for the company, More for the communities where we work and live, like right here in Warsaw, and frankly, far more for our shareholders. This is a team that has gone through a lot, And a lot is a lot. This team has done a lot of heavy lifting. And now with the heavy lifting behind from a remediation standpoint, it's great to be in a different stage.

Speaker 2

And it's great to be able to show to the world what the Zimmer Biomet team can do and will do. I'm beyond proud of the organization and I'm genuinely inspired By what they do each and every day. We've been doing this for a while around the world and I can truthfully tell you, I've been able to work with a better team than the one we have here at Timber Biomed. And again, I can hardly wait to showcase our results in quarters to come. So thank you.

Speaker 2

I also want to thank Brian Hanson for all that Brian did to bring Zimba Baumann to this moment. We are grateful and we are stronger because of his leadership. So thank you, Brian. Now let me share some perspective as the new CEO of Zimmer Biomet. During my 1st 11 weeks or 77 days in the job, I've spent significant time with team members, customers, analysts, investors or Board, my peers, Healthcare executives across medtech, government officials and other key stakeholders in healthcare, so that I could listen, I could learn And I could get the proper insights.

Speaker 2

I've been in every Zimmer Biometre region around the globe. I've interacted with every key manufacturing facility. I have visited hundreds of decision makers across every major continent and I have collected countless pages of feedback and recommendations. Most critically, I've used this reflection time to ensure that we at Zimmer Biomet are boldly prioritizing what needs to get done. And this, I can assure you, Would be a trademark of my time as CEO of Zimmer Biomet.

Speaker 2

Having the courage to say no to several things, so that we can become truly great in those things That will drive the most value for the enterprise and our key stakeholders. These key priorities are focus on people, number 1. We have a winning culture. We have the absolute best talent in the industry. It has been a foundational priority for CB and we continue to be critical under my leadership.

Speaker 2

People, purpose, talent, culture. We are very data centric organization. We use the same label of data centricity to track How it is that we're doing with our human capital. To that end, we track level of engagement, development, DEI, Engagement across different segments and geographies, high potential ratings and everything in between. I'm really excited to report that our most recent Let me say that again.

Speaker 2

The latest engagement score for organization close to 20,000 employees showcase the absolute best scores In the history of the organization, frankly, going up across every single category. This tells me that the team is energized. This tells me that the team is ready and this tells me that the team is about to unleash a lot of greatness for the organization. The second priority is to create and sustain a framework of operational excellence across the board. Simply put, it's about being great when it comes to running the business.

Speaker 2

This means simplify what we do, where we play and how we play. This means being courageous and bold about the choices that we make. It As we've been intention about driving sustainable revenue growth, we know this is the number one driver of top quartile performance. And we also know that innovation, Customer centric innovation and commercial execution are the 2 key drivers of sustainable revenue growth. So we will accelerate that.

Speaker 2

But At the same time, we're not going to forget that we can and will do better across the entirety of the P and L. We're going to drive a culture of ownership by every single employee across the globe, with all of us waking up every single day acting as true investors in the business I'm thinking of time and money as the key currencies of the organization. This means continuing to align our incentives with an even greater emphasis on best in class performance from both top and bottom. By delivering on operational excellence as a mandate or mindset for the organization, We're going to enable, number 1, revenue growth of at least 100 to 200 basis points above market, while growing earnings faster than revenue and free cash flow growing faster than the rate of earnings. Number 2, operational excellence will enable best in class supply and operational outcomes by simplifying our rather complex operations and manufacturing footprint.

Speaker 2

And then thirdly, operational excellence, as a mandate, It's going to enable an agile, nimble and simplified company that can anticipate can be proactive in successfully navigating market trends. So again, operational excellence and mindset is going to deliver revenue growth of at least 100 to 200 basis points of our market, While growing earnings faster than revenue and free cash flow faster than the rate of earnings, while enabling best in class supply and operational outcomes And by making Zimmer Biomet agile, nimble and a very simplified company that is proactive in what it does. Based on where we are, as we close the year 2023 and based on our latest guidance, we're already on track to deliver the metrics that I mentioned above around revenue, Our earnings and free cash flow, the way we run the company, but we expect to do it again with even greater rigor in 2024. To that end, we look forward to hosting an Analyst Day, something we've not done ever since we merged the 2 companies. And at that Analyst Day, we're going to be sharing more details on these thoughts that I have highlight it and the specific drivers of these goals, so that this becomes truly the DNA of Zimmer Biomet.

Speaker 2

Our priority is about innovating and diversifying Zimmer Biomet into higher growth markets, stable stakes. We must enter higher growth markets. We do need to diversify our portfolio and we will do that. We're going to do it through organic and inorganic means. We're going to do it through innovation and M and A.

Speaker 2

On the innovation front, we're going to innovate by continuing to boldly invest in the right segments of R and D. So that is new product development. So that we always think customer problems and bringing solution to those problems. We're going to make sure that those problems are in attractive growth areas That are mission centric, but also are in the right markets. By bringing the solutions, we're going to become and remain market leaders in these categories where we choose to play, Aided by both product and solutions launches that will enable category leadership for Zimmer Biomet.

Speaker 2

We're going to be relentless about the starter care opportunities, Namely the ASC opportunity here in the U. S. Where we are already growing in the strong double digit rates, but we know we're far from realizing our true potential. This journey, by the way, innovation journey has already started. We're on track to launch over 40 new products over the next 36 months And the value, the dollar value for pipeline today is twice the dollar value that we had back in 2018.

Speaker 2

So a lot of new exciting technologies are about to get launched here at In addition, 80% of our products in our pipeline, we study markets that are growing at least 4%, many In areas that are growing more than 4%. Equally vital, we're going to ensure that our innovation journey accelerates value creation through Making sure that we're monitoring not just the revenue associated with these launches, the vitality index, but also what we call our innovation profitability index or IPI. And that's the gross margin dollars coming from new products. We got to make sure that these new products are driving margin accretion to the overall margin profile So again, it's about innovation and it's about value creation at the same time. Mission and margin expansion will coexist and will coexist as part of our innovation journey.

Speaker 2

To materially change our portfolio, we're going to also leverage the strength of our balance sheet, which is stronger than ever. We will do M and A. We're going to be thoughtful and disciplined about the spaces we prioritize and we're going to ensure that the spaces are mission centric and at the same time these spaces are the areas where Zimmer Biomet has a right to win. We focus on opportunities that are going to hit strategic thresholds, but also hit financial thresholds. We're going to make sure that these acquisitions drive strong returns and create long term shareholder value.

Speaker 2

It is worth noting that this Diversification of our business has started already. Yes, we have to be bolder and we will be bolder, but it has already started. In the last 2, 3 years, we have shifted our portfolio already into mid single digit or above market environments and our weighted average market growth rates have already increased around 50 basis points. And this happened through thoughtful resource allocation and some of the active portfolio management we've done. Again, we're going to be bolder, but the journey has already started.

Speaker 2

I'm excited about what we can and we'll do across these three priorities. It's about 1st and foremost people, human capital, having a best in class culture. Secondly, it's about delivering Operation excellence as a company mindset or mandate. And thirdly, it's about making sure that we diversify and innovate in a far bolder way Through organic and inorganic means. Those are my 3 priorities.

Speaker 2

So now that you got a better sense of our priorities, I want to talk about Q3. And again, I want to reiterate that we're really excited about the performance that was on the quarter. Performance that was driven by continued execution, especially in the key areas where we've been In particular, I want to talk about NICE. It was a great quarter for NICE, where we delivered a broad market performance in key markets around the world. We also grew in areas that are mission critical within set, upper extremity, CMFT, As well as Sports Medicine, we had solid performance in the ASC environment.

Speaker 2

We saw revenue generation coming strongly from our data technology and solutions platform, Primarily within ROSA and Man Mobility. In East, Persona Ocetag, our highly differentiated cementless platform, Continues to perform above our expectations. I was recently in Dallas at the Hip and East Society and the feedback continues to be superb. I can't wait until we continue to bring this technology to other geographies. Rosa had a strong quarter, continue to see great adoption.

Speaker 2

We've seen a lot of ROS adoption happening in the ASC setting, where speed, we're dealing with higher volumes that matter. In the ASC, we continue to see growth in the teams and we're executing contracts daily. Our portfolio is second to none. We're benefiting from the recent acquisitions we've done such as Embody and Reliance. Against the backdrop of this strong execution, medtech sector stocks have been facing pressure related to GLP-one drugs And the impact or the perceived impact on obesity, this is from a long term perspective.

Speaker 2

We're a mission centric pace in the Board of Organization, so if this drug class truly That's accelerate and improves patient health. And if these drugs truly do become the end of the obesity pandemic around the world, That is great news for everyone, as long as truly this is sustainable in the long term. What I can tell you is that we spend a lot of time researching GLP-one drugs, Engaging third parties, engaging sub partners and key opinion leaders across every major market, and these GLP-1 drags today Let's start by framing the root causes of osteoarthritis, a disease which impacts 528,000,000 people around the world According to the World Health Organization, the top osteoarthritis factors are ranking order, age, genetics and joint injury. Obesity is certainly an accelerator of the disease and certainly is an element of the disease or a driver of the disease, but let's not forget that once the cartilage is damaged, There is no recovery. Once you get osteoarthritis, you will now get rid of osteoarthritis And dropping weight is not going to cure osteoarthritis.

Speaker 2

Again, this is a degenerative and non treatable disease that we're talking about. If anything, obesity is a blocker today to joint surgery as many surgeons are uncomfortable operating on patients with a BMI greater than 40 in some countries Or even above the 30 thresholds in some locations. So why could GLP-1s then be a tailwind for orthopedics? 3 compelling reasons. First, if If you can lower the patient's BMI below a certain threshold 40 or 30 in some cases, these patients now become eligible for surgery.

Speaker 2

And all the data points that we're getting in primary markets like the U. S. Is that there is a large percentage of patients who today are not going through surgery because their BMI is too high. Secondly, if a patient does lose the weight, and I would say this is pretty logical, and they do become more active, there would be a greater risk for additional joint procedures because there will be injury. And third, if a patient loses weight, they are likely to live longer, again expanding the patient final for an orthopedic procedure.

Speaker 2

A good example of this fact is Japan, the 2nd largest market in the world for osteoarthritis with minimal obesity rates, but very, Very long life expectancy dynamics. We've not seen any near term impact from GLP-1s and we've seen the long term impact would be a We are very excited about the initial findings. I will look forward to sharing them. So in a nutshell, more of a tailwind. We'll be sharing data very soon.

Speaker 2

We think that the logic will prevail and this will be the end of what has been so far a rather emotional argument That is not being fact based. In closing, I hope you can tell that I'm very confident about the future of this organization. I'm very excited to be here. Our end markets have never been stronger, and we believe that this market beyond the backlog is sustainable. Our execution is strong and is also sustainable.

Speaker 2

We've been delivering consistently for a while and we'll continue to do so with even greater focus and speed. We know what we need to do. The strategy is clear and we will execute on the strategy. We We have financial flexibility to invest in higher growth markets and we are going to continue to shift our portfolio mix and diversify our business. I generally believe this is the time for Zimmer Biomet.

Speaker 2

I'm proud of the work we've done and even more proud of the work that we're going to be doing ahead. This is why I'm excited to be the CEO and even more excited to be a proud Ziva Biomet shareholder as I believe that now is the time for real value creation. With that, I'll turn the call over to Suki for a run through of our Q3 financials. Suki? Thanks and good morning.

Speaker 2

I'd like

Speaker 3

to start my prepared remarks today by welcoming Ivan to his first earnings call as Zimmer Biomet's CEO. Yvonne has been a constant force and a driver within the organization for several years and I'm proud to work with him and I'm excited by the partnership. As Yvonne 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 in the back half of the year, just as we committed to on our Q2 call. Moving to results, unless otherwise noted, my statements will be about the Q3 and how it compares to the same period in 2022 and my commentary will be on a constant currency and adjusted operating basis.

Speaker 3

Net sales were 1 $754,000,000 an increase of 5% on a reported basis and an increase of 4.7% excluding the impact of foreign currency. Additionally, we had a selling day headwind of about 150 basis points that impacted all regions and product categories at about the same level. Excluding the selling day impact, consolidated ex FX sales would have grown just over 6%. Percent and international growth was 2.9%. In the U.

Speaker 3

S, our strong year over year results were driven by Recon and a step up in our SET category in tandem with strong capital sales. Outside of the U. S, we saw more moderated growth across Europe and Asia driven by tough comps and geopolitical headwinds, Which I'll discuss in our product category section. Global knees grew 7.3% with the U. S.

Speaker 3

Growing 6.1% and international growing 9.1%. The strong performance in these was driven by continued uptake from our Persona product portfolio, Combined with the benefits of our ROSA robotics platform. Global hips declined by 60 basis points with the U. S. Growing 3% And international declining by 4.2%.

Speaker 3

Tough comps in China and headwinds in Russia disproportionately impacted our OUS hip business. Excluding these impacts, our international hip business grew in the low single digits. Looking ahead, portfolio expansion will continue to support growth in our hips business. Next, the SCT category grew 2.8%. Again, as a reminder, there was about 150 basis selling day

Speaker 2

headwind across all categories and regions.

Speaker 3

Our key focus areas within SET, including sports, Upper extremities and CMFT continued to post double digit growth, which was partially offset by other sub segments within the category. We remain confident that SCT will grow in the mid single digits in the 4th quarter. Finally, our other category grew 16.4% driven by ROSA sales. Now moving on to the P and L. In Q3, we reported GAAP diluted earnings per share of 0.77 compared to GAAP diluted earnings per share of $0.92 in the prior year.

Speaker 3

While we had higher year over year revenue and higher pre tax operating profits, Post tax income was lower due to a favorable tax settlement in 2022 that did not repeat this year. On an adjusted basis, we reported diluted earnings per share of $1.65 compared to adjusted diluted earnings per share of $1.58 in the prior year. The step up is primarily driven by revenue growth in the quarter, partially offset by higher operating expenses and higher interest costs. Our adjusted gross margin was 70.9%, up 20 basis points from the prior year, primarily driven by favorable mix. Adjusted operating margin was 26.4 percent and up slightly versus the prior year.

Speaker 3

Better gross margin and savings from efficiencies Across SG and A were partially offset by higher R and D expenses that will support upcoming product launches, ultimately driving a continued increase in our vitality index. Net interest and other adjusted non operating expenses of $48,000,000 was higher than the prior year due to certain foreign currency exposures as well as higher interest rates. And our adjusted tax rate was 16.7% in the quarter. Turning to cash and liquidity, we had operating cash flows of 338,000,000 and free cash flow of 189,000,000 in the quarter. We ended with cash and cash equivalents totaling just under $300,000,000 Our balance sheet remains strong providing us financial flexibility and strategic optionality as we move forward.

Speaker 3

Now regarding our outlook. Overall, for 2023, the outlook remains largely unchanged from the prior quarter, implying over 7% constant currency revenue growth and 9% EPS growth at the midpoints of our range. We expect reported growth for the full year to be 6% to 6.5% and are maintaining our ex FX growth expectations for the year of 7% to 7.5 Inside of that, the U. S. Dollar has strengthened.

Speaker 3

So we are increasing our outlook for foreign currency to be about 100 basis point headwind to revenue growth The full year. Additionally, we are reiterating our EPS guidance of $7.47 to $7.57 for the full year. Despite the strengthening dollar, which we project to be about a $0.04 headwind to 4th quarter earnings. This guidance implies that we will increase Full year operating margins by about 100 basis points in the backdrop of a challenging environment. In addition to our formal guidance I will reiterate that there is no material impact from selling days on the full year revenue growth expectations.

Speaker 3

However, we do expect about 100 basis point tailwind in the 4th quarter. Additionally, our expectations for interest and other non operating expenses as well as tax rate And shares outstanding remain unchanged. We expect free cash flow for the year to be between $950,000,000 $1,000,000,000 In summary, we delivered another excellent quarter on both the top and bottom lines. We remain confident in our 2023 expectations And are excited about the next year with revenue growing in the mid single digits and earnings growing faster than the top line. With that, I'll turn the call back over to Carrie.

Speaker 1

Thanks, Suki. Before we start the Q and 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

Operator

Thank you. We'll go first to Robbie Marcus with JPMorgan.

Speaker 4

Great. Thanks for taking the questions. I'll ask both upfront as they're kind of interrelated. Yvonne and Suki, 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.

Speaker 4

So one, how you're thinking about the health of the market? And then second, you touched last quarter and then this quarter as well on longer range guidance for 24. You talked newer guidance this time about 1 to 200 basis points above your end market growth. I I think last quarter it was implying something like 4% plus. Is that a change?

Speaker 4

And how do we think about margins for next year? I think previously it was slightly up. Thanks a lot.

Speaker 2

Hey, thank you, Robbie. I'll start, I'll talk about the market dynamics and briefly I'll comment On 24, I'll pass it on to Suki to provide more color on 24 and maybe discuss what he can discuss at this point when it comes to the margin profile. But I'll start with the market dynamics. We're the 4th company to report in Q3. So by now everybody sees that the markets are healthy.

Speaker 2

And quite frankly, I won't talk much about Q4, but so far so good. So this is not a 1 quarter type of market dynamic. The reasons behind the market profile, the market growth profile, why I continue to say this market is different than 4, 5 years ago, It's the things that I alluded to in my prepared remarks. The explosion of ASCs, the movement, the shift to ASC is real. That means new ASCs Our opening in the U.

Speaker 2

S, that means new days of surgery are happening. Demographics around the world play a factor. We continue to track data in terms of the age support someone to get a hip or a knee and these are younger patients. In the U. S, we'd also see more days of surgery And I don't think this is just a backlog dynamic.

Speaker 2

Pricing, you see what every single one of us is reporting these days. It's not the same pricing dynamic that we had in the past. And beyond that, the technology. We are driving disruptive innovation. We got more efficient solutions.

Speaker 2

Surgeries are shorter and the episodic care is shorter, so we're dealing with the patients, the final patients with more efficiency. Again, this is a durable trend. It's happened in Q3. As I think about Q4, nothing is really changing. As we look into 2024, every early indicator Suggest that things are not going to change.

Speaker 2

And relative to performance, well, look, in the background of these healthy market dynamics in the U. S, we gained share in Q3 in both categories, Really proud of being number 1 in this for the quarter. We don't pay a lot of attention to any given quarter, but that is a fact that we're the fastest growing company in the quarter. And then globally, in Europe, a couple of one timers, both in Russia and China when it comes to hips, our performance was in line with hips And that needs was very strong. And then as we get to 2024, I'll let Suki comment, but we will be mid single digit.

Speaker 2

That's the point of entry. Nothing has really changed. It's just getting closer to the end of the year and realizing that these market trends are sustainable and the innovation pipeline that we have We'll drive the type of growth, but I'll pass it on to Suki to comment on all the drivers. Yes.

Speaker 3

Hey, Robbie. Good morning. Thanks for the question. First thing I'd say is, starting with the back half of this year, We committed to mid single digit ex FX growth for the second half of the year with operating margin expansion, both sequentially and year over year. Q3 was a really another strong validation proof point of that and we feel confident in that profile.

Speaker 3

The reason I mentioned that I think it gives us a running start as we go into 2024. And so, I do want to talk a little bit about 2024 back to your question. First, we've already provided a lot of color, I think, on 24, more than most of our peers. But we feel that being transparent, giving you guys A robust view of what we're going to do not only this year, but into the future is really important. But let me talk a little bit about the headwinds and tailwinds as we see it going into Some things have modestly changed.

Speaker 3

First, I'll start with the headwinds. 1, we do see a higher tax rate into next year Because of the OECD's Pillar 2. Secondly, based on where FX rates are today, we'd see some additional pressure from a foreign currency Into next year. Again, both of these are more macro versus execution, right? There are things that are outside of our control, but we're going to contend with them.

Speaker 3

We're going to deal with them. I'll tell you a little bit about how. On the tailwind side, I would say, yes, we are more confident in our outlook for revenue next year. Our end markets are stronger than they've ever been. Our portfolio and new product launches have been executing extremely well, In some areas above our expectation, our performance relative to market has been very strong and that's consistent and durable.

Speaker 3

And quite frankly, we're seeing a more moderated pricing environment, still erosion, but much more moderated than what we've seen historically. All of those elements give us confidence that We're going to be able to post the mid single digit growth top line ex FX into 2024. And then despite those Sort of P and L headwinds I talked about. We do believe that we're going to be able to grow earnings faster than revenue. I talked about gross margin next year Stepping down because of the FX hedge gains from this year not repeating at the same level.

Speaker 3

That will still happen, but we're going to be able to offset some of that. The operations and manufacturing team has been working really hard at efficiency, and so we feel more optimistic about where gross margin is going into next year. Secondly, as I said, we've already got a running start on a lot of SG and A efficiency programs in the back half of this year that are going to run into next year. So when you combine those two elements together, again, we feel really confident that we're going to be able to do that mid single digit top line growth next year as well as earnings growing revenue. So thanks again, Robbie, for the question.

Speaker 4

Appreciate the color. Thanks a lot.

Operator

Thank you. We'll go next to Drew Ranieri with Morgan Stanley.

Speaker 5

Ivan and Suki, thanks for taking the questions. Just maybe on 24 also, You haven't talked about backlog much. At recent conferences, you kind of pointed out that you think it's going to carry through 2024. But just Maybe help us a bit more of how you're factoring that into your mid single digit directional guide for next year. I know it's not I know your growth is not all dependent on backlog, but just how do you think about that helping to support the orthopedic market growth?

Speaker 5

And maybe just talk to us about your ability to capture a disproportional amount of share of that backlog. Thank you.

Speaker 2

Yes, Drew, thank you very much. And first things first, you should be in your honeymoon considering that you got married recently. So I'm disappointed you here. Look, I'm going to keep this short and sweet. We don't see backlog as a major driver in our growth profile for the next year.

Speaker 2

So when Suki and I are talking about mid single digit, we're not assuming any real meaningful backlog, so not a key driver. We believe We spend a lot of time going back and forth on backlog that is going to remain here throughout the end of 2024 at least. But we are not a backlog depending Backlog dependent type of company. So we don't have we don't focus on that. What we're tracking is innovation, the pipeline that we have, What we're tracking is the investments we made in the AFC, we're tracking is commercial execution and in the background just sustainable pricing dynamics.

Speaker 2

So no backlog. Thank you.

Speaker 5

And just second as a follow-up, your commentary was very strong that you're expecting mid single digit set growth Into next year, but just remind us about what's it going to take to really accelerate set And maybe just talk a bit more about the lift on the organic side and maybe what you're thinking about in terms of M and A to get that growth rate higher and more sustainable?

Speaker 2

Yes, absolutely great question. First things first, Q3 said was in line. As we move into Q4, we're actually going to be a mid single digit grower. I'm not going to talk about say dynamics for that 24, we'll do that coming guidance, but very excited In terms of where we are, we integrated a couple of companies within Sports Med, those are performing very well Or the upper extremities, so shoulder business is growing in the mid to upper single digits in most regions. When you look at our CMFT, Craniomaxillofacial thoracic, which is part of our set, it has been performing very well.

Speaker 2

It continues to perform very well. So Again, lots of reasons to believe that as we get in 24, you should expect a sustainable performance in ZEB. In terms of M and A, again, We'll comment more on that later, but it remains the number one recipient of capital allocation. We haven't changed in that regard. And yet, scent is one category that is very attractive given Higher market growth dynamics or position in the space.

Speaker 2

So you should assume that this is one area where we're going to be focusing From an M and A standpoint, but again, net of M and A already delivering mid single digit growth entering Q4 strongly and we're excited about 2024. Thank you.

Speaker 1

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

Operator

We'll go next to Matt Taylor with Jefferies.

Speaker 6

Hey, thanks for taking the question. Congrats on a good quarter. I was curious about your outlook comments for 2024, and I was hoping You could specifically address the concern I think investors have about growth, especially in the first half of the year with all new air quotes on this, but tough comps, Especially in Q1. So maybe you could address how you think you can grow throughout the year and address Investor concerns about those tough comps in the first half.

Speaker 2

Yes. I'll start, Matt, and again Suki maybe I want to chime in here, but we go for about 2024 because the market dynamics are sustainable. So there's been a lot of back and forth in terms of What's going to happen once the backlog is out and all that, first the backlog, we don't think it's going to be out anytime soon. And then pricing is sustainable. Now all the things that I mentioned, excuse me, my answer to Robbie are here.

Speaker 2

They moved to ASC, the shorter episodes of care, more days of surgery. So macro wise, Every data point we get in Matt is very compelling. And then on the micro, we are seeing a bolus of innovation being launched. We got 40 new products that we're going to be launching over the next 36 months. Some of these products are very compelling.

Speaker 2

We launched or Persona Osteotide, which is a seamless construct earlier in 2023. That is going to be a full Truly full market release in the U. S. In 2024 with a right amount of sets and that's high growth. As we enter The first semester of 24, to your point, is another 2 or 3 very meaningful product launches, some in robotics, some within recon, As Sami said, that's very compelling.

Speaker 2

The integration of Embody, the integration of Reliance continues to generate revenue. I could have spent an hour, but I will tell you that is the balance of really sustainable macro dynamics and solid innovation. And then on top of that, you got great commercial execution with highly engaged sales force. So I'm not we're not deeply concerned about the comps.

Speaker 3

Yes. I think just building on that, remember the first half of this year, which was very strong, was more about comps versus 2021 or excuse me, versus 2022 than it was something about abnormal market growth. So again, just building off what Yvonne said, we feel confident that now We're not, of course, giving specific guidance and we're certainly not giving quarterly guidance into next year. So as always, quarters can be choppy or driven by seasonality Makes changes, but overall we're confident that we're seeing the vision.

Speaker 2

Maybe one that's coming here, Mike, quickly and we're going to move on. Don't forget that the 1st semester of 2023, Well, it had very solid comps, also had pretty challenging dynamics from a supply standpoint. So as we think about 2024 that we believe is going to be a tailwind.

Speaker 6

Great. Thanks, guys. I'll leave it there. Thank you. Thank you.

Speaker 1

Thanks, Matt.

Operator

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

Speaker 7

Thank you so much. I'm just going to try to ask the Q4 implied in 2024 guide in a different way. Your Q4 implied guidance assume the deceleration from Q3 and your commentary seems pretty positive. It implies a deceleration even on a stack to your basis, which had just become. Should we just assume that it's conservatism?

Speaker 7

And then if we look at growth on an underlying basis adjusted for China VBP selling days and all one time items, I think you did plus 6% in 2022. You're looking to do 7% to 7.5% in 2023. Our guidance sorry, consensus is looking for about 4.5 percent growth in 24%. I know, Ivan, one of your targets is to drive that revenue growth acceleration. You've indicated that you will not be satisfied with 4% to 5% growth for the company.

Speaker 7

So just what is your reaction to that 4.5%? Does it look conservative to you in the context stop the comments that you

Speaker 3

made. Sure. Hey, Shagun, this is Suki. Thanks for the question. So Just first on the Q4, I'll just keep going back to, we don't give quarterly guidance.

Speaker 3

And obviously, with our implied, you can pretty much squeeze into The last quarter of the year. We talked about mid single digit growth margins expanding in the back half of this year, and we're going to deliver on that. We have a range around our guidance, obviously. To the downside, geopolitical factors continue to be erosive or supply doesn't continue to That very positive trend has been on, then you're towards the bottom end. However, if that supply picks up and it remediates even faster than it's already been improving, then as well as better execution on our Our new products, we could be at the upper end.

Speaker 3

So there's a range around that. And so I'll just leave it at that. But overall, we feel really good about where we're ending the second half of This year and where our end markets are. As we look into next year, I think you've seen a bit of a pivot where Our commentary was before anchoring towards 4, maybe even better to now where we're saying mid single digit. And I think that reflects the momentum that we've seen to your point in 2022 and 2023.

Speaker 1

Got it. And if

Speaker 7

I could just ask a question on M and A

Speaker 2

Yes. Go ahead. Thanks, Shagun.

Speaker 7

Okay, great. Just on M and A, Ivan, if you could just elaborate a little bit more in your thinking of tuck ins versus larger deals, High growth adjacencies that may allow you to diversify outside of elective procedures. And then I'm most interested about A lot of your business is moving to ASC that is a growth driver. What do you need to further succeed there? Do you need a broader bag or more depth?

Speaker 7

Thank you for taking the questions.

Speaker 2

Yes, absolutely. So on M and A, as already mentioned and it was in my prepared remarks as well, We'll remain our top strategic priority from a capital allocation standpoint. So that's not changing and we're excited about the opportunities that we have in front of us. We're going to continue to focus on our growth markets or areas that are not only mission centric, but offer an exciting growth profile. And that is 3 things, no ranking order, 3 key areas.

Speaker 2

Segments within Recon that are growing faster than or WEMGAR or Collective market growth rates and there's a lot in there. You got navigation, you got data, technology, elements of recon that are really attractive. Choo is set as we've done already, buying things in Sports Med, buying things in CMFT And then looking at other categories, I don't want to get into for the competitive dynamics, but again, optionality there. And then ASC is also one attractive area, It's one area where we have dedicated resources. We're growing in the teams.

Speaker 2

We Have currently 10% to 15% of our sales in that space and there is opportunities there to acquire things. So that's a bit of the strategic summary of where we go from an M and A perspective. In terms of financials, we're not changing the story. We like to do things Up to $2,000,000,000 in acquisition price. And again, that gives you a lot of options.

Speaker 2

You can do a midsize deal. You can do some tuck ins, combination Of different things. We want these deals to be EPS neutral within 2 years. And we spoke about high single digit ROIC We've seen 5 years. So that's a bit of a strategic and financial profile.

Speaker 2

As we look into the next 0 to 5 years, we spent a lot of time, 2 can have spent a lot of time looking at the strat plan, what is the growth profile. The great news is that We convinced that the free cash flow generation is solid. So we're going to be able to do M and A and potentially do other stuff when it comes to capital allocation. So that's the answer to your first question. On ASC, look, I don't think we need to do much more.

Speaker 2

We're growing in the strong teams already here in the U. S. In the ASC. I mentioned 10% to 15% of our sales are there. We got the right portfolio.

Speaker 2

This is now where we were, let's say, 3, 4 years ago. We got the right robotic platform for the ASC. We got a great cementless knee that is gaining serve very quickly. We got a full bag in sports and across it. We got best in class technology.

Speaker 2

So the portfolio is great. We got dedicated resources, which you very much need in an ASC environment. We have a dedicated sales force. We've got simple contracting, simplified contracting. Look, what we don't have organically, we partner with others.

Speaker 2

So whether it's sterilization, Booms and Lights or other stuff, we got the right partnerships. So very, very confident that we're going to continue to perform in the ASC environment.

Speaker 1

Thank you. Thanks so much, Jagan. Katie, we'll go to the next question in the queue.

Operator

We'll go next to Josh Jennings with TD Cowen.

Speaker 6

Good morning. Thanks, Simon, Suki and Carey. Wanted to just follow-up on your ASC comments. Ivan wanted to ask about the migration of Total joint surgeries to ASCs, any back of the envelope assumptions you would have as you just in terms of where The penetration where the migration for knees and hips has been what percentage of cases for each categories reported in ASCs currently here at the end of 2030 versus 2022. And then any metrics you can share just with ROSA penetration and ASCs and then any pricing dynamics for total joints as This is migration, Mr.

Speaker 6

Kearney. Thanks. Multi part question, but I appreciate you taking it.

Speaker 2

All right. Let's see if my memory is as good as I think it is. So Starting with ASC, macro wise, we believe that roughly between 40% to 60% of cases in the next 5 years are going to move to ASC. And I will say that a large portion of cases are already moving to the ASC. What we like about this dynamic is that as cases are moving to the ASC, Other cases are coming to inpatient and outpatient.

Speaker 2

So it's a little bit of a double dip happening there, Joss. But yes, the number is 40% to 60% over the next 3 to 5 years. And I would say a good percentage has already moved. We are growing in the upper teens when it comes to the ASC And today around 10% to 15%, repeating myself for cases or revenue rather of Zimmer Biomet comes from the ASC. I will tell you that is Pretty equal in terms of both hips and knees.

Speaker 2

So we don't see one category being above the other. And I like the fact that given the recent CMS changes, You're going to see shoulder cases also accelerating in the ASC. We believe that's a great opportunity for us here at Tumor Biomed. So that's the answer on ASC. In terms of ROSA Dynamics, I think we've been very transparent in terms of 1 third, Roughly 1 third of all of our installations are happening in the ASC.

Speaker 2

That's a trend that has been happening for a few quarters And that's a trend that we continue to see happen in the next quarters. In an ASC environment, speed matters, not having to get engaged in complex pre planning matters, Efficiency does matter and having a need that you are confident is going to be the right need that matter and those dynamics are driving ROSA penetration in the ASC. And then outside of the sea, ROSA continues to perform. We are selling and placing ROSA's frankly at a rapid pace. You see in the other category, we saw a nice increase that's driven by ROSA.

Speaker 2

And we are on track to at least install 300 units at the end of the year 2023 When it comes to ROSA, so really satisfied. And that's before we launch next generation ROSA across recon and deliver the 1st shoulder robotic platform. So excited about both ASC and ROSA. Thank you for the question, Jos.

Speaker 1

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

Operator

We'll go next to Larry Biegelsen with Wells Fargo.

Speaker 8

Good morning. Thanks for taking the question. And Yvonne, I have enjoyed watching your post on LinkedIn. It looks like you've traveled around the world literally since you've taken over as CEO. I wanted to ask, Suvi, start on the margins.

Speaker 8

You're going to end 23 with an operating margin of about 28.5, Which is towards the high end of medtech. Where do you see as peak margins for Zimmer? I mean, 5, 10 years ago, the margins were in the low 30s. That's still realistic. And I have one follow-up.

Speaker 3

Yes, sure. So good morning, Larry. Thanks for noticing. It's actually 2 years in a row where we've Expanded margins in the backdrop of really challenging environment. By the way, while also accelerating revenue, I think in 'twenty two, we expanded margins operating margins By about 40 to 50 bps and this year you're right, the implied is about 100 basis points.

Speaker 3

So again, really proud of what the CD team has Collectively, again, in the backdrop, we're still investing for growth, which we've been able to demonstrate. As we move into next year, I think I've been pretty front footed in our ability to continue to grow margins in 2024. And quite frankly, we're going to do that in every year after 2024 And continue to deliver a profile where earnings are growing faster than revenue. I'm not going to go out and put a marker out there as to where we think it can get to. But historical levels, we'll look for over time to definitely beat and exceed those.

Speaker 3

I'll just leave it there. Again, really happy with where the team's performed over the last couple of years, very confident in what we're going to do next year, quite excited about our outlook in the longer term.

Speaker 2

That's helpful. And then just a quick follow-up. You had a little bit of color there.

Speaker 8

Yes, other the other category was obviously very strong. We heard you talk about ROSA sales in the quarter. What was the change in the quarter that drove that strength and how sustainable is that?

Speaker 2

Yes, I don't think there is anything changing really. There's not a change of Strategy is we continue with ROSA, we continue to show strong clinical efficacy, we continue to demonstrate time neutrality after a few cases, We continue to see great adoption in an AC environment. We have 3 ROSA indications Today, we can recon. So total knee, partial and hip. We've done a lot of podium presence.

Speaker 2

If you attended the Dallas meeting this last weekend. There was a lot of noise around posters and whatnot. So I think we just get in the right adoption. It's moving quickly. And then a driver, I will tell you, has been cementless.

Speaker 2

A lot of these cases that are done in the ASC do like or do want a lot of surgeons in an ASC want the combination of robotics and Cementless. In the past, we didn't have the right cementless construct. We do now with personnel share tag. So I think that's been a bit of a tailwind. But I wouldn't say it's a major change of a strategy.

Speaker 2

It's just the fact that it's been 2, 3 years in market now and you're starting to see the data. So really excited in terms of what we are.

Speaker 3

Thank you. Hey, Larry, just to get back to your original question, just to make sure I'm completely clear. I do see Getting back to historic margins are better over time, absolutely a definable objective for us. Now having greater insight and taking over for ops and supply chain, I would say this is an area where we can certainly do better. We're going to do better going forward.

Speaker 3

And I can tell you that The company's focus on not just revenue growth, but operating profit and free cash flow generation has been More acute and stronger than it's ever been. So I think we've got the pathway, we've got the culture, we've got the levers to get there over time.

Speaker 6

Thank you.

Speaker 2

Larry, yes, thank you for being my warm follower on LinkedIn. The whole time I said was my wife, I'm disappointed. Appreciate it.

Speaker 1

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

Operator

Thank you. We'll go next to Chris Pasquale with Nephron.

Speaker 9

Thanks. I just want to follow-up real quickly on Larry's ROSA question. Was the mix of sales versus placements different in 3Q than what we saw in the first half of the year? Trying to figure out whether that played a role or the acceleration in other sales was really driven by system volume.

Speaker 2

Yes. Thank you, Chris, for the follow-up. We did see more sales. We haven't changed the strategy. So It's reflective of the fact that there is capital in the hospital systems across the world.

Speaker 2

And we saw people wanting to buy them and We sold the units. It's not a fundamental change. It's not a change in the strategy. We've settled along that we prefer placing given the annuity factor and whatnot. Yes, capital is strong and we did do some deals in some ASCs and in some of the systems and that's why you see the other category growing.

Speaker 2

Thank you, Chris.

Speaker 9

Thanks. That's helpful. And then on SCT, is the strategy there to lean into these focus categories that are already growing pretty well and then Hope that the overall performance improves as they become a bigger part of the mix? Or do you see an opportunity to reinvigorate areas like lower extremities That maybe aren't on that list today.

Speaker 2

Yes. Let me start with the second part. We really don't do hope here. So we do have plans to drive better performance in the 3 areas that so far have not been that compelling, those being restorative therapies For an ankle and trauma, what I will tell you is that we started therapies biologics. The issue there was a reimbursement change a year ago.

Speaker 2

That's been resolved. So that's not a concern moving forward. And then foot and ankle, lower extremities is something that we're looking at. It may require some organic inorganic place, but given the space, we're paying close attention to what is that we need to do. And then trauma for many markets continues to be very attractive.

Speaker 2

We don't some smaller tuck ins. So I would expect that the declines that we have seen in the past are going to disappear. So again, not really doing a hold there. We got plans to remediate and to get back to growth in those 3 categories. Now that said, the 3 most compelling priorities within ZEP remain Great.

Speaker 2

Thank you. Thank you.

Speaker 1

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

Speaker 2

We'll go

Operator

next to Travis Steed with Bank of America.

Speaker 10

Hey, thanks for taking the question. I guess a quick follow-up on M and A. Any way to frame how much margin or EPS dilution you're willing to take in years 12, realize you said neutral by year 3. But curious kind of what the framework is on year 12. When you think about bid ask spreads, is a deal something you think you could get done this year?

Speaker 10

Or is it probably more something for 2024?

Speaker 3

Hey, Travis, this is Suki. I'm not sure I completely got that second question. Can you repeat that?

Speaker 10

Yes. In terms of like when you think about like bid ask spreads and the progress on your conversations, is a deal happening in 2023 A possibility or is it probably something that

Speaker 2

we need to wait to

Speaker 10

2024 to see M and A?

Speaker 3

Yes. So first of all, on your first question Around earnings per share dilution, that's really going to depend on the type of asset that we acquire, the size of the transaction, what markets it's in, Where it is in its journey and its life cycle is a product that's just launched or something that's very mature in marketplace. So I'm not going to sort of give a Ipost on year 1 or year 2, because I think that would be premature, because it is going to be very situation dependent. But what we will commit to is that we're going to look for breakeven By at least 24 months, if not sooner than that. So that's the profile that we look for in our M and A.

Speaker 3

Relative to bid ask and timing of course for a variety of reasons, mostly proprietary, we're not going to get into The timing of any specific deal, as you know, those are often opportunistic situation based. So here's what I would say is that we've got a lot of Teachable flexibility to balance sheets in the strongest position it's been since the merger of ZYN environment. We feel really good about the optionality we have going forward. And we think we can deploy capital to continue to accelerate our growth profile and diversify the company. But I'm not going to get into specific I'm sure you can appreciate that, but thank you for the question.

Speaker 10

Yes. No, it's fair. Thank you. Thanks for the answer. And a couple of housekeeping questions.

Speaker 10

The OUS One time stuff in hips this quarter, does that get better in Q4? And when you think about tax rate next year, I I heard your comments, but curious if that'd be like on a less than 100 basis points or more than 100 basis points on tax rate. And when you think about the interest line, You've got I think $850,000,000 of debt coming through. So is interest a headwind or a tailwind next year?

Speaker 2

I'll I'll briefly comment on Q4 and I'll keep it simple. It does go away. So this is a one timer and in Q4 we get back to growth. In terms of the tax and interest, Suki, do you want to comment on that?

Speaker 3

Yes. So on the IPS expense line, Right now, we're not going to give full guidance on that. So we'll unveil that. I think the one thing you want to keep in the backdrop is we do believe we can grow earnings. We will grow earnings faster than revenue.

Speaker 3

On the tax rate, right now, our best estimate is that it will be about 150 basis point Increase off of our full year 2023 tax rate.

Speaker 10

Thanks a lot.

Speaker 1

Thanks Travis. I think we have time for maybe one last question. Katie, is there one in the queue?

Operator

We'll go next to Vijay Kumar with Evercore ISI.

Speaker 11

Hey, guys. Thanks for squeezing me in here. Maybe just one question from me. This whole U. S.

Speaker 11

Hips, I think you called out Russia headwinds. Is that done within fiscal 2020? Should that continue in the fiscal 2024? And I think you did speak about M and A. Can you comment on your hurdle rates you've given current interest rate environment for deals?

Speaker 3

Yes, sure. Hey, Vijay, it's good to hear from you. So on the OUS hip headwinds, specifically due to Russia, if you go back to last Quarter's call, Q2, I talked about Russia being about a 50 basis point headwind in the back half 2023, that estimate is still largely true and most of that occurred in the Q3. So we're going to see a little bit of pressure in It's largely behind us. We don't see that As being a headwind at this time into 2024.

Speaker 3

And I'm sorry, Vijay, could you repeat your question around

Speaker 11

Sorry, on the deals, M and A given current interest rate environment, can you talk about your In a hurdle rates for deals?

Speaker 3

Yes. So look, we would still look at Debt financing over equity financing all day long, even though it's 2x of where it was a year ago, it's still Versus historical rates still a pretty attractive source of capital. It has become marginally more difficult to make the deal economics work At these interest rates. So it just means that we've got to be that much more disciplined on our valuation and our purchase price. And so that's how we view things right now.

Speaker 1

Thanks, Vijay, and thanks everyone for the question. Yes, absolutely. I think now we're probably nearing the end of the call. I'll turn it back over to Ivan just for any closing remarks.

Speaker 2

Yes. Thank you, Carrie. And I'll keep it to 2 minutes or less here, so we can close on time. But a couple of things here. Number 1, really, really pleased with the progress here At Zimmer Biomet, really proud of the team and the work that they have done, they are doing and most importantly the work that I know that we are going to continue to do.

Speaker 2

Excited about the markets, lots of questions on market dynamics. Every data point suggests that they're healthy markets, they're durable markets. No, we're not concerned about GLP-1s and I'll say that with the utmost respect and humility, but every data point shows that this is not something we should be concerned about. The performance is strong and it's going to continue to get there. We saw a great Q3 performance in recon, net of the hip issue of U.

Speaker 2

S. It was solid. I like where we are with both hips and knees here in the U. S. In the largest market.

Speaker 2

I like the fact that we've seen ZED being in line now. I like the profile as we enter Q4 and as we get into 2024. I believe this will be the year for Seth. And I like the optionality that we got to run M and A. So Healthy market, solid portfolio, great opportunity to leverage the balance sheet.

Speaker 2

I do think it's a different place, a different environment. So really excited to be here. Look forward to leading this great team and look forward to answering more questions in quarters to come. Thank you for your time today.

Speaker 1

Thanks everyone for joining us. The IR team will be in touch of course. And if you have questions or comments, please feel free to reach out.

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Earnings Conference Call
Zimmer Biomet Q3 2023
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