Zimmer Biomet Q2 2024 Earnings Call Transcript

Thank you, David. Good morning. Maybe quickly here, 20 seconds big picture, and then I'll talk about the US. So big picture. It was a good quarter. We here at Zimmer Biomet deliver 5.6% ex FX. As I noted in my prepared remarks, this is the 10th quarter in a row growing mid-single digit or above. And we're pleased with the double-digit growth in adjusted EPS. S.E.T. performed above expectations, third quarter mid-single digit or above. I'm pleased to report that for the first time in a while, every single business within S.E.T., and there are six of them, actually grew, which is something we didn't see before. Enabling technologies, which is robotics primarily, grew double digit in Q2. It grew double digit in Q1.

The US robotics grew 16% in the quarter, so strong in that regard. And as we announced this morning, we did close the gaps in hips that we had, which frankly is one of the reasons why we lost market share. Just throwing the summary to highlight the fact that unlike five years ago, we're not just a US knee-centric type of company. That said, relative to knees and the US performance, look, David, not pleased with the quarter. It was softer than expected. And what I will tell you is that there are three main reasons why we did not do better in the US, and these are solvable reasons. The first one is, we had a large amount of high volume surgeons -- Zimmer Biomet high volume surgeons that were out of the territory for a variety of reasons. We hosted large medical education events and we did have a large group of surgeons that were not performing surgeries in the quarter.

The second piece is that we had some challenges from a supply standpoint when it came to one of our knee platforms, what we call limb salvage, which is part of knee revision cases. These are high ASP cases. And candidly, this didn't help the quarter. And then the third reason on why knees in the US was softer than expected is comps. We delivered knee growth of 10% -- almost 10%, 9.8% to be exact in Q2 of 2023, which was close to mid-single digit, and the US grew 5%. So comps didn't help. So in the background of those surgeons being out, supply constraints, the comps didn't help out.

What I will tell you is that these three elements have gotten resolved as we move out of the quarter and sitting here, July behind us, the US Recon performance is very strong. On the second part of your question, David, cementless continues to track very nicely. Candidly, I hope we can get more sets out. The adoption rate is very high. We are converting accounts and we hope to have cementless not just in the US, but outside of the US very soon. So that's the summary of what's happening here in the US.

Yeah. First of all, good morning, David. Thanks for the question. Just to remind everyone, we talked about or announced our restructuring program at the early part of this year. We talked about $200 million of run rate savings as we exit 2025. I would say where we are right now is we're slightly ahead of that overall trend, at least from a timing perspective, still expect to generate $200 million on a run rate, but it's happening probably a little bit faster than we originally expected. That's definitely contributing to operating margin expansion.

You see that in the second quarter, where we're up 100 basis points year-over-year. So very nice progress there. And that's in the backdrop of continuing to invest in R&D, as well as in certain areas across commercial, whether that's building specialized sales forces across S.E.T., additional complement in our technology, components of Recon and other parts of commercial. So we are, as I would say, just summarizing, going a little bit faster than expected on the savings program, and we're in line and on track with that reinvestment plan.

Thanks, David. Can we go to the next question, please, Katie?

Thank you, Matt. The short answer was we have already started. So again, July, so far so good when it comes to hip recovery. We launched our surgical impactor HAMMR midpoint into Q2 and the adoption has been great so far. As you heard from us, we will be launching our triple taper stem, that's Z1, which is going to enable share regaining in direct anterior. That's going to get launched late in Q3, early Q4. We have the quantity that we need. We got the commercial plans in place. So that should be another driver.

And the third leg was to have elegant navigation systems, and we got three of them. This morning, we announced the acquisition of OrthoGrid. That should close later in the year. It's one of the fastest growing navigation platforms in the US. So I would say the combination of triple taper stems, surgical impactors, and three different modalities of navigation put us in a position to regain market share in the US and outside of the US. Outside of the US, we're going to be launching a second generation of robotics, hip posterior robotics, and that's another driver of share regaining. So we're very confident about where we are today and we will get the share back.

The market is very strong. By now, all of us have reported. So you see that the market growth rates remain above pre-pandemic levels. So nothing relative to market. And again, I just want to emphasize that the two, three things that I talked about, the large volume surgeons being out of the territory, we saw in July a recovery. On the revision constraints, those are largely soft, and again, that's one portion of our platform. And again, so far so good. So yeah, market is healthy.

Thanks, Matt. Katie, could we have the next question?

Yeah. First of all, good morning, Drew. Thanks for the question. There are really three building blocks to the growth in free cash flow from where we start here in the second quarter or third quarter, I should say. And by the way, the asymmetry between first half and second half of free cash flow is typical in our business. The three building blocks are, really, you have a lot of headwinds in the first half of the year related to rebates from the previous year fourth quarter that you have to pay in the first quarter, bonuses and different levels of incentive payments that happened in the first half. So there are certain headwinds that typically happen in the first half that don't repeat in the second half.

In addition, in the second half, you're going to have improved EBITDA through growth as you pointed out. But secondly, a pretty meaningful improvement in working capital, specifically around inventory. We've already seen that inventory improve from second quarter versus first quarter, and we're going to continue to see that sequentially improve in the third quarter, fourth quarter as well. So that's a pretty big driver of the overall free cash flow generation and step-up into the second half of the year. Relative to where we're prioritizing, we continue to prioritize in making sure that we've got the right assets and the right level of investment on our organic business.

As Ivan talked about, we're actually stepping up our instrument capex around OsseoTi. Demand, quite frankly, has outstripped our original expectations, which is a great thing, and we're now catching up on getting those sets out into market. And so, we feel really good about that and we're actually putting more dollars against that. But outside of that, I think what you're seeing also is that we bought some shares back in the second quarter, aligned to our overall capital allocation strategy, which we outlined on our Investor Day. So overall, feel good about where we're headed for cash for the full year. You will see a second half step-up, typical in every year, and we're going to continue to prioritize our organic investments. And then from there, our capital allocation remains balanced between M&A and return of capital to shareholders.

Thank you, Drew. Very excited. So one word is optionality. Now Zimmer Biomet is the only company in the world with three different forms of navigation. With ROSA Hip, you got anterior today, robotic navigation, at some point soon posterior as well. With OrthoGrid, we have AI surgical guidance. It's a lighter, faster option for some of the surgeons that want to use a non-robotic option. And then the third vector here, as you know, we have a partnership with Hip Insights, which is the only FDA-approved mixed/reality navigation, and that pretty much gives the surgeon X-ray vision over the patient's anatomy, instruments, and implants.

So again, a different modality, which some customers seem to like. So we got three different ways to do navigation and that appeals to pretty much every customer in that regard. The broader strategy, we want to be a company that delivers faster, better solutions, and navigation is an enabler of that. And again, in the big picture, this will enable Zimmer Biomet to regain some of those 200 basis points to 300 basis points of market share that we lost over the years.

Thanks, Drew. Can we have the next question, Katie?

Hey, Joanne, good to talk to you. Good morning. I think I said over the next four quarters to eight quarters, but if it is three, let's keep it to four. We're not going to get into a lot of details, given competitive reasons. But what we are committed to launch is a posterior application for some of the OUS markets, where posterior is more prevalent than interior. As you know, we're going to get into full launch mode for ROSA Shoulder later in the year. And again, so far, the voice of customer has been super. We want to get at some point a different version of ROSA. We're launching two different ROSAs for knees. One is going to be late this year, early 2025. We call it ROSA B-15, which has different levels of workflows, smart positioning, it's got a different auto-balance procedure, and it will be a platform that is going to deliver a kinematic aligned type of knee.

In 2025, at some point, we will have a ROSA CT scan base for some of our ROSA users that like that type of device. So those are four or five examples of what's coming here again over the next four quarters to eight quarters. In addition to ROSA, we have the partnership with THINK Surgical. And we got, as I just mentioned, very comprehensive navigation systems. In terms of the revenue contribution, we don't really give details on that. What I will tell you is that we're growing today, end of Q2 double digit in the US, when it comes to enabling technologies, we grew double digit in Q1 and we don't expect that to slow down, and that's pull-through for implants.

Thank you, Joanne.

Thanks, Joanne. Can we have the next question?

Hey, thank you, Larry. First part of your question on Persona IQ, we remain excited. The adoption is speeding up. We should see some acceleration in the second half of 2024, part of the new product contribution for 2024 and in a more meaningful way in 2025. We've now crossed 3 billion data points around range of motion, mobility and what not. We launched what we call Recovery Curves, which enables the opportunity for us to cross-reference how certain patients are performing versus others. We're going to be having a data discussion with payers so that we can engage in some risk-sharing type of agreements. So again, leveraging the data.

On the stubby part of your question, we're going to be launching that at the -- full launch at the end of 2024. So we got the approval. The design is ready to go, the sets are ready to go. And again, that's part of the acceleration in the second half of 2024, more meaningfully in 2025. We've now signed agreements, partnerships with some of the major hospitals around the US. And then in terms of TPT, we did look at it. We engaged a third-party consultant. We pulled the TPT application, because it didn't make economic sense. It didn't make as much economic sense as we thought. And again, we believe there are different, better ways to monetize the technology. We still have NTAP, but TPT didn't make sense.

Yeah. Good morning, Larry. On your questions on gross margin, I think, actually, you largely got it right, but let me just step back and go through it for you. Just year-over-year overall, we expect gross margins to be in line with '23, but potentially slightly down. That's the new element there and that's largely driven by the mix of our business. We're just seeing much stronger international sales, which have a lower gross margin than the US. So it's really mix related. But again, in line to potentially slightly down. In the second quarter, you're right, it was a little bit lighter than our expectation, again, back to that mix component where the US was just much stronger from a growth perspective than the US for all the reasons that Ivan spoke about. Even in the backdrop of that, Larry, we still managed to expand operating margin by 100 basis points and grow earnings quite nicely.

On the cadence, you got it right, and it's consistent with everything that we provided earlier this year, which is to say gross margin will step down sequentially in the second half versus the first half. And you should see that also Q2 to Q3, Q3 to Q4 sequentially down. The primary driver of that, again, going back to our earlier comments from this year, are really around the inflationary pressure we saw in third-party manufacturing costs in 2023. That got capitalized and are now feathering into the P&L throughout this year. So that's the driver of the cadence there. But again, I'll just revert you back to the backdrop of all that is we do still expect to see meaningful operating margin expansion for the full year and we do expect to see operating margin in the second half step up versus the first half, again, driven by the restructuring program despite the sequential lowering of gross margin. So I'm sorry for all the detail there, but I wanted to get it all out in sort of one compact commentary.

Thanks, Larry. Katie, can we have the next question, please?

Hey, thank you, Ryan. Look, TMINI is not going to replace ROSA just like OrthoGrid is not going to replace ROSA. It's all about having breadth of portfolio.TMINI offers CT scanning, which some surgeons like and TMINI is the only handheld robotic platform in the world, which is something that, in an ASC environment, surgeons seem to like. What I will tell you is that we are deeply committed to ROSA, point in case, all these new platforms and indications we're going to be launching over the next four quarters to eight quarters, point in case, the commitments we made at the Investor Day of doubling our penetration from somewhere in the 20% of all US knees done robotic with ROSA to 40% in the next three years.

ROSA continues to be one of the fastest growing platforms here at Zimmer Biomet. We grew again in the US or capital sales for ROSA 16% in Q2. Overall, it was double digit globally. ROSA today is already outside of the US, the leading robot platform, number one in Asia Pacific, fast growing in EMEA. And I think we're very pleased with where we are with ROSA, but we know we need to have optionality and we like our chances when it comes to that. In terms of the revenue contribution of robotics, is one of the most meaningful ones. And as we the double penetration, you should assume that our knee and hip number and shoulder later in the year is going to continue to grow.

Hey, Ryan, Suky. Good morning. Thanks for the question. Let me start with price and then I'll go to your question on manufacturing costs. So price, as I noted in my earlier commentary, we were positive 80 basis points in the second quarter, and that marks overall a positive pricing first half for the company. I think it's probably the first since I've been here. The way that breaks down is, we saw really strong performance in EMEA, APAC was about flat to slightly up in the second quarter, and the US was down year-over-year on pricing. But overall, a very good quarter. That's a combination of a number of variables. One, a more favorable environment; two, we're getting greater discipline in analytics and governance around pricing and a better culture, I would say, around pricing; and the third is, we saw some one-time benefits, especially in EMEA, that helped drive that positive performance in price for the second quarter.

Our outlook for the full year on price, originally, I started out the year saying that we thought we'd be about 100 basis points. I would say now we're going to be somewhere flat for the full year to potentially down 50 basis points. And the reason why that flip is in the second half is because some of those one-time benefits that we saw in EMEA in the second quarter, we don't expect to repeat at the same level or intensity in the second half. So that's a little bit about price. Definitely seeing much better improvement in performance this year. And we think a large part of that is going to run into 2025, because a large part of our business is contracted. So again, we'll give more color on '25 when we get to that point, but really happy about the trend that we've got going here on pricing in 2024.

Relative to manufacturing costs, yeah, manufacturing costs are higher this year, again, because of the capitalization for 2023. I'm not going to give specific guidance into '25, but rather, I'll refer back to our LRP in our Investor Day, where we talked about operational stability in gross margin over the LRP. That, in fact, implies that we should start to see operational stability in manufacturing costs through that LRP. But again, as we continue to progress through '24 and into '25, we'll provide more color on that. All right. I feel good about the progress...

Yeah. I feel good about the progress the team's making on manufacturing costs. And I will say, we're finally starting to see some stabilization in overall inflation, both on raw materials, as well as third-party manufacturing costs. So glad to see that inflection.

Thanks, Ryan. Katie, could we have the next question?

Yeah. I'll take that, Robbie. Good talking to you here. So the volumes outside the US remain very strong, in particular in Europe, and within Europe, in the UK, where we know there is a prominent backlog. So market dynamics are very healthy, more in EMEA than APAC, but very healthy overall. One of the biggest drivers of growth outside of the US is robotics. I mentioned that earlier in my answer to Ryan, I believe. We continue to see fast adoption of ROSA in key markets outside of the US. We are the number one platform in Asia Pacific. We continue to drive adoption in key countries like Japan, as well as Australia and New Zealand. We have accelerated Persona growth, moving from NexGen to Persona in these key geographies. So it's a combination of market dynamics and great commercial execution. That's the answer there.

Thanks, Robbie. Katie, can we have the next question? Go ahead, Robbie. Sorry.

I'm sorry, Robbie. Sorry. As I say, the US dynamics that I mentioned are relative to the US. You mentioned surgeons being out of the territory. That is very, very focused in one month, in one quarter within the US. So this is not a dynamic that we saw outside of the US. Wanted to answer your second question.

Go ahead with your follow-up.

Yeah.

Yeah. Thanks, Robbie. I won't get into a lot of detail here. What I will tell you is that the growth drivers, those being CMFT, sports, and shoulder, are growing either upper-single digit or double digit. And the other three, foot and ankle, trauma, and restorative therapies, are growing at different levels, but all of them growing. So the challenge we've had with RT reimbursement-wise, that's behind. So great to see all six businesses within S.E.T. performing.

Thanks, Robbie. Katie, could we have the next question?

Can you repeat the question?

No. We continue to S.E.T. and Recon performing the way that we anticipated early in the year. So again, some timing in Q2 with US Recon. But as we get into the second half, the expectation remains the same, is no one bigger than the other.

Yeah. Thank you. I would call it a more focused strategy. 15 countries today account for 93%, 95% of the overall market potential. In the past, we've been candidly all over the place. In the last two years, call it, we refocused the strategy to those key markets that matter the most. And I won't go through every one of those countries, but it is 15 countries. So opex and capex is being reallocated to those geographies. Our commercial infrastructure has been modified in those countries and the way that we focus in those countries is different. So that's what we're doing outside of the US.

Thanks, Jayson. Katie, can we go to the next question, please?

All right.

Sure. So I'll start with the question on whether ROSA Hip is performing. The penetration is double digit. It continues to meet the expectations that we had. We believe that we need to have a ROSA posterior application to gain market share outside the US, and that development is in motion. And we also believe that to a certain segment of customers here in the US that want a less expensive, faster, lighter application, surgical AI by OrthoGrid is going to be a good modality. But so far, our expectations have been met with ROSA Hip and navigation in general.

Thanks, Josh. And thanks, everyone, for the questions this morning. I'll turn it over to Ivan for some closing remarks.

Well, I'd like to close the way that I started with, gratitude. I'm very thankful to all the Zimmer Biomet team members for the progress.

As I alluded to earlier in the call, this is the 10th quarter in a row where we're growing mid-single digit or above. We're pleased with the quarter, delivering close to 5-point -- or actually 5.6% ex FX revenue, with double-digit EPS. We've proven that we can make commitments and deliver on those commitments. I like the fact that we have a diversified portfolio. We don't depend on one segment in one country. It's a well-diversified sustainable performance. And what we'll tell you is that we are more confident than ever that we will deliver in the guidance that we reaffirmed today.

So thanks to everyone for joining the call, and I look forward to the next update.