Zimmer Biomet Holdings Inc (ZBH) 2022 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Zimmer Biomet Fourth Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded today, February 3, 2023. (Operator Instructions) I would now like to turn the conference over to Keri Mattox, Senior Vice President, Chief Communications and Administration Officer. Please go ahead.

Thank you, operator, and good morning, everyone. I hope you are all well and safe. Welcome to Zimmer Biomet's Fourth Quarter 2022 Earnings Conference Call. Joining me today are Bryan Hanson, our Chairman, President and CEO; EVP and CFO, Suky 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. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please note, we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements.

Additionally, the discussions on this call will include certain non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures is included within our Q4 earnings release, which can be found on our website, zimmerbiomet.com.

With that, I'll turn the call over to Bryan. Bryan?

All right. Great. Thanks, Kerri, and thanks to all of you for joining us this morning for the call. We've really got 3 sections for the call this morning. First, I'm going to talk briefly about our fourth quarter performance and spend a few minutes on our teams, what I would just define as solid execution as well as our innovation and drivers for continued strong performance.

And then for the second section, as usual, Suky will provide more detail on the quarter itself and very importantly, our 2023 guidance and expectations. And then, of course, we'll close things out by addressing any questions that you might have.

Before we get started, I want to take a minute to thank really the ZB team, just the full ZB team, not only for their work in making Q4 another successful quarter, but also for their resilience, the innovative thinking and dedication to getting the job done throughout all of 2022, even in the face of very real adversity.

There's no doubt in my mind that this team is the engine that is driving us forward. So again, thank you, and I can tell you that I'm very proud to be on this journey with you. And now as we turn to Q4 results, I know that each and every one of you made the quarter happen. And I can tell you, it was a solid quarter.

We again saw better-than-expected growth driven by continued procedure recovery, strong execution and a solid momentum with our new innovation. And as expected, we also benefited from some favorable comps in the quarter. Inside of this, we saw another quarter of positive year-over-year momentum in large joints, with our overall global hip and knee business growing more than 8% and 10% on an ex FX basis.

And our overall S.E.T category grew in the high single digits, driven by strong performance in our business growth drivers, which as we've said before, are sports, CMFT and upper extremities as well as the expected tailwind from BVP comps in our Trauma business.

With that said, we are clearly seeing overall market stabilization, but our fourth quarter execution and procedure recovery is still set against a macro backdrop that is challenging and fluid. Foreign currency has improved, but remains a challenge and supply, inflation and staffing pressures continue.

In fourth quarter, our team was once again able to navigate these challenges, flexing what I would just define as a muscle memory that I think fortunately or unfortunately, is a bit unique to ZB and has served us well over the past year, during 2022.

But make no mistake, the challenges are real and they're ongoing. But regardless of this environment, with COVID mainly in the rearview mirror, I have confidence that the ZB team will continue to deliver. Our culture, our strategy, innovation and execution are coalescing right now, driving tangible momentum and importantly, belief from the team.

And as a result, confidence in our business continues to grow. Let me just give a few examples from Q4. In the quarter, we announced the approval of our new cementless knee form factor, which is adding to our Persona family and strategically rounding out that portfolio.

The first procedures have been completed with this new keel design and the feedback, as expected, has been very positive. We continue to believe that our cementless knee penetration will grow significantly, and at this differentiated premium product can really accelerate that growth. It's early days, with full launch planned for the middle of the year, but make no mistake, this is a real growth driver for our knee franchise.

This launch builds on other recent product launches like HipInsights and our Identity Shoulder System introductions, bringing now our total to more than 50 new product launches from 2018 through 2022. And importantly, the largest majority of these launches came in markets we see growing in the mid-single digits or better.

That's really important, being launched in markets that we see growing in the mid-single digits or better. This strategic prioritization and output from our innovation pipeline has helped ZB more than double our vitality index over that time, and very importantly, increase our revenue in faster-growth markets and submarkets which, of course, drives positive increases in our weighted average market growth.

And that momentum continues. We expect to launch another 40-plus products between now and the end of 2025, once again with the majority of those launches in 4% plus growth markets. This will drive further increases in our vitality index and weighted average market growth and most importantly, bring real and meaningful innovation to the patients and customers that we serve.

So what I know for sure is that our current momentum, a very robust new product pipeline and our strengthening balance sheet, focused on accelerating our portfolio transformation positions ZB well for the future. And as a result, I feel increasingly confident about ZB's ability to transform our business, drive growth, deliver value and achieve our mission to alleviate pain and improve the quality of life for people around the world.

And with that, I'll turn the call over to Suky for a closer look at Q4, and again, our expectations for 2023. Okay, Suky?

Thanks, and good morning, everyone. For today's call, I'm going to focus on 3 topics. First, our fourth quarter results; second, how that performance in recent macro trends translates into our 2023 financial guidance; and third, I'll provide a brief update on our long-term financial priorities.

With that, I'll turn to the fourth quarter results. Unless otherwise noted, my statements will be about the fourth quarter of 2022 and how it compares to the same period in 2021, and my commentary will be on a constant currency and adjusted continuing operations basis.

Net sales in the fourth quarter were $1.825 billion, an increase of 2.7% on a reported basis and an increase of 8.3% on a constant currency basis. Previously noted, we had a selling day headwind of 150 to 200 basis points that impacted each category at about the same level.

U.S. sales grew 6.2%, driven by strong elective procedure recovery and commercial execution, especially in our knee and hip businesses. In addition, the U.S. business saw strength across our 3 priority areas within S.E.T.

International sales grew 11.1%, driven by strong procedure volumes across most markets in EMEA and APAC in tandem with later comps and continued strong commercial execution. EMEA performance was driven by recovery in developed markets and continued strength in emerging markets.

APAC was impacted by COVID-19 surges and lockdowns in China that were broadly offset by strength in other markets. Now turning to our business category performance. Global Knees grew 10.2% with U.S. Knees up 10.8% and International Knees up 9.3%, with strong performance driven by knee procedure recovery across most regions and an easier comp outside of the U.S.

Continued global traction for our Persona Knee system, including both Persona Primary and Revision in the U.S. and continued increase in ROSA procedure penetration and pull-through.

Global Hips grew 8.4% with U.S. Hips up 5.9% and International Hips up 10.8%, driven by strong international procedure recovery and easier comps outside the U.S. continued traction across Hip products , including the G7 revision system and Avenir Complete primary hip, which is focused on the direct anterior surgical approach.

And lastly, continued solid ROSA pull-through in the Hip category, especially in the U.S. The Sports Extremity and Trauma category grew 7.6% and was impacted by continued strong performance across our key focus areas of CMFT, Sports Medicine and Upper Extremities.

S.E.T. was also impacted by a comp tailwind from China VBP that was partially offset by reimbursement changes in restorative therapies.

Finally, our Other category grew 1.3%.

Moving to the P&L. For the quarter, we reported GAAP diluted loss per share of $0.62 compared to GAAP diluted loss per share of $0.40 in the fourth quarter of 2021. The change was driven by higher revenues, partially offset by a goodwill impairment in EMEA as a result of macro factors.

On an adjusted basis, diluted earnings per share of $1.88 represented an increase from $1.79 in the fourth quarter of '21. Adjusted gross margin was 71.7%, bringing full year gross margin of 71.2% or about in line with full year 2021 despite significant headwinds from inflationary pressure.

Our adjusted operating expenses were $791 million, an increase versus the prior year due to inflationary pressures in tandem with higher investments into R&D and commercial infrastructure to support new products.

For the year, overall OpEx was flat to 2021 with an increase in R&D and lower SG&A. We remain disciplined in realizing efficiencies while investing in our priority areas and offsetting headwinds. Adjusted operating profit margin for the quarter was 28.3%, up slightly from the prior year, bringing total year operating margin to 27.3%, ahead of full year 2021 despite macro headwinds.

The adjusted tax rate was 16.9% in the quarter, slightly higher than our expectations due to certain onetime discrete tax items. For the full year, the adjusted tax rate was 16.5% and in line with our full year guidance.

Turning to cash and liquidity. Operating cash flows were $244 million and free cash flow totaled $115 million for the quarter, bringing our total free cash flow for the full year to $910 million.

We continue to reduce our net debt by approximately $150 million in the fourth quarter, excluding the effects of foreign currency and ended the quarter with cash and cash equivalents of approximately $375 million.

Moving to our financial outlook for 2023. We based our projections on the following key assumptions: we expect to experience procedure cancellations and staffing challenges, but the impact will be less acute than what we experienced in 2022.

Supply chain headwinds will continue throughout the year, but with improvement in the second half of '23. Pricing headwinds are expected to be slightly better than our historic average of 200 to 300 basis points.

Inflationary pressure will remain stable to 2022 exit and an expected adjusted EPS dilution of about $0.05 to $0.10 due to our acquisition of Embody in the first quarter of 2023. Against this backdrop, our expectations for the full year '23 financial outlook are reported revenue growth in the range of 1.5% to 3.5% versus 2022, and expected foreign currency exchange headwind of approximately 150 basis points, resulting in revenue growth of 3% to 5% on a constant currency basis, and adjusted diluted earnings per share in the range of $6.95 to $7.15.

Inside of that guidance, at our midpoint, we expect adjusted operating profit margins to be flat to slightly up compared to 2022 levels. We also expect net interest and other nonoperating expenses will be about $190 million, primarily due to higher interest rates.

Our adjusted tax rate should be broadly in line with 2022 and total shares outstanding are expected to remain in line with full year 2022 average fully diluted shares outstanding.

Finally, we expect our free cash flow to be in the range of $925 million to $1.025 billion. In terms of cadence through the year, we expect that constant currency revenue growth rate for the first half will be slightly higher than the growth rate in the second half, and we do expect choppiness by quarter.

Q1 is projected to be our highest growth quarter due to easier comps and will be followed by the fourth quarter, driven by improved supply and innovation building throughout the year.

Q2 and Q3 will be lighter quarters given tougher comps. And lastly, we don't expect any material day rate impact on full year results. However, Q1 and Q4 will benefit by about 100 basis points of tailwind that will be offset by headwinds in Q2 and Q3.

In summary, we delivered accelerated growth in 2022 with a margin profile that is better than '21, as we overcame headwinds while investing in our priority areas. We navigated a number of macro challenges and delivered on our commitments to all of our stakeholders. As we look forward to 2023, while the environment remains dynamic, we see a path to delivering solid growth and earnings performance with robust free cash flow.

To close out, let me make a few comments about our financial priorities moving forward. We've made significant progress over the past few years in strengthening our balance sheet through improved financial performance and ongoing reductions in debt.

This ultimately provides ZB with greater strategic flexibility as we look to transform our portfolio with a focus on increasing our WAMGR and driving improved long-term growth. We remain committed to our investment-grade rating, and we'll continue to look at ways to accelerate profitable growth with a focus on achieving our mission.

I'm so very proud of the ZB team for their perseverance and dedication throughout 2022, and I'm excited about what we can accomplish in 2023. With that, I'll turn the call back over to Keri.

Thanks, Suky. (Operator Instructions) With that, operator, may we have the first question, please?

We'll go to Ryan Zimmerman with BTIG.

All right. Can you hear me okay?

Yes, we can hear you.

Bryan, starting with guidance. If I think back to third quarter, you were asked whether 4% organic growth was an appropriate way to think about '23? And -- at the time, you said '23 -- you didn't see '23 as normal. But then in January, you said we're in a better place, procedures are kind of normal, and we'd expect that to continue in '23.

And so as we sit here today with guidance that 4% at constant currency at the midpoint, just help us understand kind of that shift that's occurred in the fourth quarter that gives you a more optimistic view of the year ahead?

And really, the key to my question is this 4%, do you view that as a floor, do you view that as realistic or aspirational? And just help us kind of characterize kind of where you're sitting in guidance in the year ahead?

Got it. Thanks for the question, Ryan. Maybe what I'll do is, Suky, you can provide color around the way we're thinking about guidance because there's a lot that goes into it. We still don't believe it's a normal year, obviously, there's a lot of puts and takes on either side of the equation, but you could walk through those perhaps. And then I will give you some color around what we're seeing so far in January and how that's making us feel as well. But why don't you go ahead and start?

Yes. So Ryan, thank you for the question. Good to be with everyone. First of all, I'd say we had a really good close to the year. We ended topline, bottom line and free cash flow at the top end of our third quarter guidance. So a really strong finish. There's a number of variables behind that, but the key one is really about execution.

So I feel really good about the momentum that we have. As we move into 2023, some of the key variables that underpin our guidance. I talked a little bit about them on our -- in the scripted remarks. The first is around stabilization related to case cancellations, staffing shortages and things of that nature. We expect that to continue to improve throughout 2023.

We're not completely at normal markets. There are still some underlying dynamics impacting the overall market, but things are definitely improving, we expect that to continue to work through the rest of this year.

So procedure recovery for sure, '23. The other thing we have to think though, to balance that out is we're continuing to see supply challenges. We saw those in the fourth quarter. Our supply chain team as well as our commercial team responded incredibly well to those challenges. But we're assuming that those supply challenges remain, at least through the first half of this year and begin to improve in the second part of this year. But as we put all that together, we've got a lot of confidence against our full guidance range. We're optimistic about where trends are going. And like I said, we're really excited about where the business is headed. So I don't know, Bryan, if you want to talk a little bit about sort of what we're seeing so far?

Yes. I mean, clearly, a lot of variables that are still moving. But if I just think about the kind of the here and now, and just look at what we've already accomplished in January, I'd just say it was a really strong start to the year.

Again, we're still looking at those variables. But when I think about the things that we can control, things around execution and innovation. They're going in the direction we want. When I think about the things we can't control, it's procedural recovery and supply chain challenges, those are also coalescing in a nice way.

And so I guess suffice to say, based on those things, the momentum right now, and it's early days, but the momentum right now in 2023 is feeling really good. So again, we'll continue to monitor those other variables, but we feel pretty good about how we're starting.

Very helpful. And then if I could ask a follow-up? Suky, The Street's margin expectations going into today -- for operating margins were essentially flat, maybe up 10 basis points, so really in line with your guidance. But just maybe walk us through kind of the levers that you think are at your disposal here on the operating margin line that could maybe move that up a little bit higher than where we're starting today?

Yes. I think one of the key drivers is obviously going to be revenue growth, right? So if we continue to navigate the challenges around supply as we have been and as we saw in the fourth quarter, if we continue to see stabilization in the market and start to trend towards the upper half of the range, clearly, that will help drive some margin expansion as we continue to leverage our overall cost base.

Beyond that, there's still normal block and tackling that this company has gotten accustomed to over the last 4 or 5 years. We're going to continue to drive sourcing improvements around site optimization, Six Sigma, procurement.

I'll tell you the commercial team has really stepped up. I've never seen a focus on mix, on simplification of the supply chain and the SKU rationalization on pricing that I've -- before in the company's history. So I think we've made really good strides from a commercial perspective, which I think could be some levers to potential upside.

And then across SG&A, we're still in the early innings of fully leveraging our shared service operating model, which we started through the pandemic. So I think we have a number of things at our disposal that can help either expand margins or derisk our margin aspirations in a downturn. So feeling really good about what the overall team has been able to accomplish and where we can go with this.

Ryan, thanks so much for the question.

We'll go next to Mike Matson with Needham.

I guess, I'll start with the Recon market. It looks like it grew about 8% in 2022, and this is well above the 3% to 4%, we were seeing prior to COVID. What do you think is driving this above-normal growth? It seems like it's got to be the COVID backlog because I don't think pricing has been all that strong. But maybe you could comment on that? And do you think that this type of high single-digit market growth can you carry into 2023?

Yes. So I would say that probably the biggest reason that you're seeing that outsized growth overall, I wouldn't define it as backlog consumption, I don't believe we've started to consume the backlog.

I would define it more as comps. You just had easier comps. Maybe you call that procedure recovery versus the prior year. So that, to me, is not something that's necessarily sustainable, but it was just easier comps being that we had more pressure last year.

Pricing was better, though, across the board, whether it's our company or other companies, we did a better job in pricing as a group. And as a result of that, that buoyed us as well. And Suky has talked before about what our expectations are in pricing as we move into 2023, but I'm sure we'll get another question around that.

So those are probably the 2 biggest things that wouldn't be as sustainable. But make no mistake, I feel like the market is strong. And some of the things that we look to that can buoy sustainably the market growth is innovation and innovation adoption right now in orthopedics is really promising.

Not just the typical innovation, but technology innovation that absolutely can drive up the share of wallet or mix benefit you get with that new innovation.

We'll go to Larry Biegelsen with Wells Fargo.

Congrats on a nice finish to the year here. Suky, FX of negative 1.5%, can you tell us the rate you're using, that seems a little high and the EPS flow through?

Yes. Sure, Larry. It's good to be with you today. So you're right, we pegged FX as a headwind year-over-year and 150 basis points. That's an improvement from our original commentary back on our third quarter call. Originally, we were thinking 300 basis points. And so we did see some moderation of the dollar at the very back end of 2022 and early part of '23.

So that drove the improvement. The way to think about it is we use recent rates. We look at the full cadre of all of our foreign currency exposures. One of the things to recall or remember is that about 40% of our revenues foreign currency exposed, half of that is euro and yen, right? So the other half is a lot of other currencies that you have to take into consideration.

So when we aggregate all that, we're at 150 basis points. Now hopefully, we see -- continue to see things improve throughout this year and things turn favorable. But for right now, that's our latest estimate.

The flow-through on that, we expect it to be about 20% to 30% down to earnings, that's a little bit less than what we said last year. And as I said last year, when we quoted 30%, there are a lot of variables that can affect that, but it's still a reasonable drop-through to historical norm. So again, 150 basis points based on recent rates, euro and yen , making up about half of our foreign currency exposure and the flow-through being about 20% to 30%.

That's helpful. And then on S.E.T., it was about 2% in 2022. Can you help us think about the growth that's embedded in the 4% constant currency at the midpoint? And how you're thinking about the different subsegments there?

Yes. So if we think about overall S.E.T., I think what you're asking, Larry, is how we view that business in an undisturbed market going forward. Is that kind of what you're asking?

Yes. And certainly for '23, Bryan?

Yes. Yes. So when we come into 2023, even though it's not going to be a normal market, what we're still thinking about S.E.T. as being able to be a mid-single-digit grower. That's the way we're looking at that and in an undisturbed market, we would think the same thing.

Remember, in the first half, though, we're going to be a bit pressured still by the Restorative Therapies Group and that change in reimbursement. But even with that, throughout the year, we believe that, that segment can grow in the mid-single digits. And the key drivers for that because we don't treat all the businesses the same from an investment standpoint would be our growth drivers, which would be upper extremities for us, our sports business and in certain portions of our CMFT business.

Thanks, Larry.

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

Congrats on a nice quarter. I wanted to ask about the robotic shoulder opportunity. I think before you said you'd be first or second to market now that Stryker has given more definitive timelines, I wonder if you can kind of clarify if you will be first or second or kind of timing there and how you're thinking about the opportunity and from a mix and share perspective?

Travis, good morning. Ivan here. So I don't know where they are. We don't pay attention to where competitors are. We pay attention to where we are in the process. I'll tell you, frankly, I'll be very surprised we're not first to market, given where we are in the development cycle.

So my expectation remains that we're going to be ahead. The most important part is not just the speed in the actual launch. It is the quality, the features and benefits that we have in the platform. And given the mix of developers that we have involved in the project, I do think it's going to be a transformation on that platform. So that would be my answer.

Okay. And then -- that's fair. And then a quick clarification on the 3% to 5% constant currency growth. How much of the revenue is coming from Embody in that? And then -- and Brian, a question for you on M&A. Just kind of curious what your willingness is in 2023, now that markets are a little more diversified beyond electives or is 2023 is more of a tuck-in year from an M&A perspective?

Yes. Sure, sure. May be I'll just start with the Embody thing. Then it's a relatively small acquisition. I would probably think more about that as a product launch. So it's not overly material, but it's a very attractive subspace of Sports.

And as we're building out that commercial channel, it's one of those things you really need in your bag to attract talent to that commercial channel. And so it's important to us but I wouldn't look at that as a significant or material impact to the year, only in the sense that we're going to be able to bring that channel in place and get good momentum in Sports overall.

From an M&A standpoint, yes, we are clearly in Phase III of the transformation of the company, which I've clearly talked about looks at portfolio transformation focused on getting more revenue and faster growth markets in its simplest form. And that's exactly what we're going to concentrate on. The fact is, as our balance sheet continues to strengthen, our flexibility, your strategic flexibility goes up.

And we will look at acquiring technologies that make sense from a mission standpoint for the company, that we see a path to leadership in, that we think will increase our weighted average market growth because that's important for sustainability and we see a path to be able to increase the growth rate in EPS.

And I've said before, there are 3 areas that we'll look at for acquisitions, mainly kind of smaller to midsized deals, but we look at things that would enhance our position in recon in those faster-growth submarkets that could be robotics data or the ASC settings. In orthopedic areas diversification that would be in vast growth subsegments like Sports or CMFT or Extremities. And then as you said, those things that might be outside of orthopedics that would help us diversify the business away from elected procedures, but also in vast growth markets.

All those things are on the table right now. And again, as our balance sheet strengthens, our ability to action that obviously also increases. We're going to stay disciplined. There's no question about it, but we are clearly on the hunt for targets that make sense in those ways.

Thanks for the question, Travis.

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

Maybe, Bryan, just to start for a question for you. You've talked about your confidence in the business, and I understand that your thinking is this year is not normal relative to prepandemic times, but just it's been a while since you kind of last discussed long-term plans.

I'm just curious how you're thinking about the business longer term and your confidence in gross margin expansion opportunities ahead. Just anything that you could help frame investors with in terms of thinking about the business from a margin or growth perspective?

Yes. Yes. So maybe I'll start and Suky, I'll pass it you on the margin side. Yes, my -- I would say, not mine, our team's confidence is as high as it's ever been, quite frankly. I just think about that in the short term. It is not a normal environment.

There are a lot of challenges that we're having to deal with from a supply chain standpoint. But I do go back to what I said in the prepared remarks, I have a lot of confidence in this team because of the muscle memory we have over the last 5 years in dealing with a lot of adversity.

And so just in this moment of a non-normal environment, I would rather have this team than any other team because I believe they can fight to those challenges, and they've proven it. That's number one.

Number two, outside of those challenges, we're just hitting our stride. From a momentum standpoint, we've had a lot of kickoff meetings here recently. I'd love to go to those meetings and get a real sense for how people are feeling, just having a conversation with sales reps, that's where it all starts.

And the momentum there, the confidence there, the belief there is as good as I've ever seen it. So all those things add up to me that say, particularly in a normal environment, we're in a good place. And I feel confident that we can continue to deliver the innovation and drive real revenue growth. We -- I don't want to give too many views of what the future revenue growth of the company will be, but know this, as we increase the weighted average market growth of the company, as we get to a 4%, that's organic, that we can commit to and sustain, that won't be good enough.

We'll continue to look at portfolio transformation to drive it north of that. But right now, I feel really good. I feel really good about the confidence that the team has, and I feel really confident about the team's ability to drive the results that we've just guided to in 2023.

Maybe you want to talk more about the margin expansion?

Yes. I'll actually level up from margin expansion, talk a bit more about how we think about it, which is earnings power inside the company. And our goal is to drive a leveraged P&L, right? And what do I mean by that? So we're looking for earnings growing faster than revenue.

And as we approach those revenue kind of outlook that Bryan just talked about, we see a very clear path to being able to do that. Now margin expansion will be a key building block in that, but it's not the only one, right? Obviously, sales leverage and then our ability to continue to leverage our interest rate as well as tax.

There are a number of levers at our disposal to drive that earnings power higher than revenue. Inside of that for margin, we continue to have the same variables that I've been talking about for quite some time, and the companies continue to show improvement on all those fronts, whether it's pricing, manufacturing and simplification, cost improvement, SG&A improvement.

I mean just look at our SG&A this year, we've been flat year-over-year while driving expansion in a number of areas in commercial infrastructure. So we've shown that we can do this. I'm confident we can continue to do it forward, and we start to really see that durable revenue expansion that Brian talked about, I'm very confident we can drive earnings power faster than revenue.

Great. And just as another question. We had a survey out with hospital CFOs, and they kind of pointed to orthopedic robotics being kind of a key capital spending category for this year. Just curious what you're seeing in the environment in terms of both hospital purchases? And it would be great to really kind of hear where you're seeing or having the most success in ROSA, whether it's greenfield placements or multisystem orders, hospital versus ASC and maybe what your share shift has been within ROSA accounts and cementless mix?

I'm happy to take that, Andrew. I'll tell you, Q4 was solid, both from ROSA installation and purchasing standpoint. I'm not aware of any deal that we've lost, what is here in the U.S. or U.S. relative to capital.

We also do small capital deals in the surgical business, and those were on track as well. So sequentially, Q3 to Q4 of 2022 was solid. Because of comps, obviously is a lower number than a year ago. But so far so good when it comes to capital. So nothing that I've seen so far leads me to believe that we're going to have a challenge when it comes to robotics.

Yes. And I think we do a really nice job of not just getting individual deals, but also getting multiple placements in the same account. You do typically have hybrid accounts where you've got us in there with robotics and potentially another competitor, but it's not just greenfield. It is existing accounts where you've gone to the point where you don't have enough capacity for that robotic system and they want to buy another system. So it's a combination of those 2 things.

Thanks for the question, Drew. Sorry, cementless mix, is that part of the question as a follow on?

Can you repeat the question? We didn't catch this now, I'm sorry?

What was your cementless mix in Knees?

Yes, I can take that as well. So we've been in the low-teens, as we've been disclosing. That's obviously prior to the launch of Persona OsseoTi, which is now in the market. It's been around for 2 weeks. So the expectation is that number is going to dramatically increase.

And as you know, Drew, in combination with robotics, you're going to see a collateral effect. You're going to see increase of cementless mix and you're going to see increase of robotic penetration. So we're very bullish about what we're going to end at the end of the year. We don't disclose that externally. But you should expect something fairly aggressive.

Just to make sure no one's confused that Persona OsseoTi, we've not used the name before, but that is the new form factor for cementless for Persona.

Yes. Thanks, Drew.

We'll go next to Josh Jennings with Cowen.

I was hoping, Bryan, to ask you, you teed up the question for us on price and Suky and just maybe a recap of how you fared in '22? And I'm not sure if you quantify pricing assumptions and guidance topline for '23. But maybe if you could also just directionally help us out to think about the difference in terms of the pricing environment in the U.S. versus Europe and Asia Pac?

Sure. I'll take that. So first of all, thanks for the question, Josh. On pricing, we had a really good fourth quarter. If you look at our disclosure in our press release, you'd actually see that pricing was positive in the fourth quarter. Now I would say, on an underlying basis, pricing was -- had erosion of about 100 to 150 basis points.

We benefited by some year-over-year comps due to VBP and we also had some onetime rule adjustments that were favorable in the quarter, that drove us to be positive in the fourth quarter. But on an underlying basis, I would still think about it as 100 to 150 basis points erosion, which is still incredibly good versus our historical average of 200 to 300 basis points.

We ended the year at about 150 basis points of erosion, right, again, so a pretty clear step change to where we've been historically. I talked about in my scripted remarks, we expect next year -- or this year, I should say, 2023, to be slightly better than that annual average that we had before 2022.

So maybe not as good as '22, but definitely better than where we've historically been. There are a number of drivers inside that. Some of them are transitional, some are more structural in nature. The ones that I'm more excited about are the structural improvements that we've made.

We've made a lot of investments around capabilities, around systems, around analytics. We've got better governance. We've got better discipline. It's an area we the Santa Fe source off of now. So there are a host of things that structurally are improving our price performance as we move to 2023, and that's sticking in part of our guide. If you think about the dynamics between U.S. and EMEA and Asia Pacific, maybe I'll let Ivan talk a little bit about what he's seeing.

Yes. Well, so far -- thanks, Suky. So far, we've not seen the performance when it comes to pricing being a single region, frankly, 2022, all 3 regions, a bit of expectations when it comes to pricing.

And the most important part, I do think that is sustainable and in line with the guidance that we've given for 2023. The role of innovation also is a critical component of the sustainability of the pricing, as you think about bundled deals, as you think about bring innovation that is going to drive mix, and in some cases, price -- better price performance.

Maybe just a follow-up. I think we -- entire team has been tracking share for in large joints in the United States more effectively than international. But I was hoping maybe you could just help us understand where you think you had success capturing share in Knees and Hips in Europe and Asia Pac? And just where that stands and how you're thinking about share capture in those markets with international markets in '23?

Yes. So it's first of all, and I think it's really important, we never really pay a whole lot of attention to any individual quarter. Obviously, this quarter is a pretty strong one for us globally and in the U.S. But we don't try to over index on that. We do an 8-quarter trend and we look at how we're trending versus market. And I even try to stay away from specific competitors, but just the overall market growth, looking at the largest players.

And I would tell you in that 8-quarter trend as that continues to roll, we're seeing good performance versus market in large joints, both hip and knee probably more in knee than hip. But overall, we're feeling pretty good. I mean you got to go back to before Q2 2020 as you probably remember, we had 20 straight quarters of being below market in every quarter, so 5 years below market in Large Joints.

And so we definitely have seen a sea change in our ability to perform at or above market in Large Joints which, as you know, is our biggest business. So that's the way we think about it, and we break it in a bunch of different ways. Year-over-year, we look at it on a stack basis, we look at it sequentially, but in all those areas, when we look at that a 8-quarter trend, we're feeling good about where we are.

Thanks, Josh.

We'll go next to Robbie Marcus with JPMorgan.

Congrats on good quarter. Maybe to start. In the script, you talked about improving supply moving throughout the year, but you also talked about it as benefiting fourth quarter sales. What are the products that are supply limited right now? And how should we think about the potential benefit to sales from improving supply?

Yes. So maybe I'll start off on a broad-based basis because there's really 2 factors that you talked about, Suky, and being able to drive performance in the fourth quarter. One, would be supply challenges alleviating, but also the innovation building because those almost 2 separate things.

So we'll make sure that we talk about both of those and Ivan, maybe talk about some of the innovation. For us, when we think about the supply challenges, it really comes down to material shortages that we're seeing, that we think are going to get better as we move in through the year, labor shortages that we think are going to get better as we move into the year.

And then sterilization capacity, which everybody is dealing with right now that I do believe is going to catch up at some point. So that's why we think supply challenges are going to get better, but it's pretty broad-based. I can't look at supply challenges and say, it's just this product or that product because it's in packaging.

It's in resins. It's almost everything that we're dealing with has some form of supply challenges like sterilization, for instance. And so I wouldn't isolate the supply challenges to a product or product set, it's just a broad-based pressure that we're feeling. Outside of that, it's around innovation that's going to be building and maybe you can talk to some of the things you're excited about there?

Yes, sure. Good to talk to you here today, Robbie. So innovation, as we discussed at JPMorgan earlier in the year, could be a 3-hour conversation. So I'm going to try to keep it more or less (inaudible) but I will tell you, I truly do believe today, innovation is a key competitive advantage.

And true data points rather the (inaudible) that I mentioned, our vitality index, the percentage of sales coming from new products, that's more than double over the last 3 years, and we expect the number to increase dramatically over the strategic horizon.

And in the second part, we filed in 2022, the highest number of 510(k)s in the history of the company. And actually, we got the largest number of approvals, public information when it comes to the peer group. Breaking down innovation in 3 or 4 buckets when it comes to Knees, I already mentioned Persona OsseoTi, that is the new cementless form factor device that we got here at Zimmer Biomed.

The clinical data that we got on that product is compelling. We believe it's highly stable, when it comes to the mechanical and biological fixation. It's extremely versatile. You can all the way to the end of the surgery, decide whether you want to go cemented or cementless. It has used the Persona technology, so it's highly anatomic.

You can customize the device to any kind of anatomy. We've got the broadest size of ranges. I'm excited with Persona Smart, we don't talk much about it because we still are in the limited market trials. But I like where this is going.

I like the opportunity that we have with Personal Smart especially later in the year. When it comes to Hips, in the prepared remarks, Bryan talked about HipInsight. It's the world's first and only mix reality digital surgery platform for hip arthroplasty.

This is making procedures faster. This is increasing accuracy in the actual procedure. When you come to the median in Vegas at the academy, I think you'll be impressed. It has effectively give the surgeon x-ray vision over the anatomy of the patient, the instrument, the implants. You're going to get more accuracy, faster procedures.

It is going to be transformational. I like the momentum we had with both ROSA in Hips and Knees. We got strong portfolio when it comes to Shoulder. We talk about Identity, the transformational launch that we did at the end of 2022. That is followed by a cadence of launches on Glenoids on Signature ONE planning, I can spend an hour on that. And then through organic and inorganic means, I think we have a best-in-class portfolio in sports med.

So I guess it will be my 3-minute summary on all of the things that are happening from an innovation standpoint. But I'll close it by saying, again, I do believe this is a true competitive advantage for Zimmer Biomet.

Yes. And Robbie, just back to your question around supply chain, our comments on Q4 and then 2023. Look, we did see pressure in the fourth quarter around supply chain. I think you've heard us comment on that and not inconsistent with what you're hearing around the sector. We expect those challenges to continue into 2023.

The commentary on Q4 is just to provide a little color that we think that our group did a really nice job in navigating that. The situation continues to be dynamic into '23, but our expectation is that we're going to continue to navigate that really well.

Great. And you touched on inorganic, you did Embody in the business line. How should we think about overall inorganic in your view at Zimmer Biomet in '23 and beyond? And how should we think about the size of deals you're looking to do and how fast you're looking to move to take the own inorganic and help expand the WAMGR higher?

Yes. Yes, we're ready now. And again, the balance sheet is moving in a place that allows us to have even more strategic flexibility than we've had in the past, which is a good thing. And as I said, it's probably more of those smaller to midsized deals that would be a bit closer to the best for now. In other words, closer to the orthopedic space that we are already in.

But we're ready, we're definitely ready. Now it comes down to opportunistically finding the right target at the right price and the right returns. But we are ready to move into phase III of the transformation, for sure.

Robbie, thanks so much for the question.

We'll go next to Jayson Bedford with Raymond James.

Just a couple. Clarification on the growth cadence in '23. I think you said that organic growth would be the highest in the first and fourth quarter, but I think those are your toughest comp quarters. So I'm just wondering why 2Q and 3Q are a bit softer from a relative growth perspective? Is it simply the day rate dynamic?

Yes. Let me take that one. So you heard us correctly. First half will be stronger than the second half from a growth rate perspective, topline ex FX. First quarter will be the strongest followed by the fourth quarter and then the second and third quarter.

Let me go into a little bit more detail. On the first quarter, that will be our strongest one, primarily due to procedural recovery. Remember, we're comparing against the first quarter of 2022 which had omicron in it. And therefore, you you've got a nice comp benefit.

In the fourth quarter, that's generally from a seasonality perspective from growth, usually one of our strongest quarters -- and we're assuming a nice benefit from the innovation, the momentum of innovation build throughout the year from new products and execution. So that's why we characterize that as our second largest quarter.

And then inside of that, the second and third quarter will actually have tougher comps because that's when you began to see some recovery last year relative to Omicron. The day rate impact, you're right, we said 100 basis points for each of Q1 and Q4, that's a tailwind, which will be offset by headwinds in Q2 and Q3. So you've got it largely right there.

Okay. Maybe just on M&A, the $0.05 to $0.10 dilution tied to the Embody deal is a bit heavier than we expected. Can you just talk about the return profile there? And when can this be additive or at least neutral to earnings?

Yes. We would see this as breakeven to positive in the first 24 months. So it's very attractive from a margin profile, from an earnings accretion profile. As Bryan said, it's more or less like a product launch right now. But as that begins to ramp up from a revenue standpoint and begins to cover some of the investments we're making in a very important sector in sports and extremities, we feel good about the return profile. It meets all of our hurdles from an NPV, IRR, ROIC metric perspective. And so again, it's just early days, but again, neutral within the first 24 months.

Jayson, thanks for the questions.

We'll go next to Kyle Rose with Canaccord.

Great. Just wondering and apologies if I missed it, I wondered if you could give us a little more insight into where you're at from an inflationary perspective into 2023? I think previously you talked about being at the higher end of the range of 50 to 100 bps. I just wanted to see if that was the way to think about inflationary impact in the P&L in '23? And then maybe update us on the actual headwinds you did see in 2022?

Yes. So you're right, we did point to the higher end of our range back in '22 of 50 to 100 basis points flowing into '23. We're actually seeing that come through year-over-year as a headwind to gross margin. I could say, though, I'm very pleased with how the commercial and supply chain teams have reacted to that.

And we believe we're going to be in a position to offset all of that and pretty much hold gross margin flat year-over-year. And that's coming from a number of variables. But again, we're really proud of what the team has done to offset that.

And the impact that we saw in 2022 was, I would say, about 100 basis points as well. And if you actually look at gross margin performance, it was flat to 2021. So again, the team did a really nice job in offsetting those headwinds. So once again, we're demonstrating and showing that we can be disciplined, we can offset these headwinds and help our earnings growth over time.

Great. That's helpful. And then overall in the commercial channel, you talked a lot about historically about making investments in specialized sales forces and investing alongside your distributors to support some of the higher-growth market segments. Just wondered, can you help us understand how these initiatives are trending?

And then any potential updates in kind of where you stand from a distributor versus a direct model across some of those higher growth segments?

Maybe I can take that one, Kyle. So first thing first, on the 3 segments, we think there are growth drivers, sports med, Upper Extremities and CMFT. We have double, if not triple, the number of people dedicated to these specialties.

The sports med expansion is very real, now that we have the portfolio. So the number of dedicated to specialized people has dramatically increased in these 3 categories.

In tandem, we also increased the number of people that are fully dedicated to the ASC environment. And that's because these procedures, for the most part, do take place in that space, but that goes beyond sales reps. It also touches on the contracting of the organization.

As far as your second question, the percentage of direct or indirect, I don't think that we disclose that externally. We like where we are. We like the mix that we have direct, indirect. We just left our sales meeting in Denver, nearly 2,000 people were there. And I'll tell you the mood is very solid, whether you're an indirect or direct territory leader. I think people feel it's a good time to be a part of the company, but I don't think we break down the percentages externally.

All right. Kyle, yes, thanks so much for the questions.

We'll take our next question from Chris Pasquale with Nephron.

Just a quick one first. I was hoping you could give us an update on the ROSA installed base exiting '22?

Yes. I'll keep it short and sweet here. In any year, we expect to do no less than 300 installations, and we exceeded that expectation across all 3 regions. And as you think about the future, '23-'24 and whatnot, that's frankly the point of entry.

I would be disappointed, maybe even jobless if we don't exceed a number given the new applications in shoulder next-generation and other technologies coming in, but we so far exceeding those expectations.

Okay. And then, Bryan, I thought your comment that you had not started to work through the COVID backlog yet was interesting. It certainly felt like the market had some pent-up demand benefit last year, but I understand your point that the comps weren't exactly normal. My question is, if you haven't started to make progress on the backlog yet, do you think you ever will? And are you assuming any progress on that front in '23?

That is the question that I think we're all grappling with. There's clearly backlog. You might call it as longer waiting list backlog, you can define it the way you want, but the fact is there's pent-up demand for these procedures.

The rate limiting factor is really capacity at the provider level. You could -- because of the supply challenge environment, maybe even capacity constraints, at the company level. But I think the bigger capacity constraint at this point is at the provider level.

We actually had a third-party run this analysis for us because we really wanted to get in tune to what is the size of the backlog based on a third party's view. And then also when they believe the backlog would start coming through and at what pace.

And what we found in that is that, number one, they came back with -- there is a very sizable backlog in orthopedics. Actually, it was their analysis came back smaller than what we expected, but still very material. And they said that when we start to work through it, it would be constrained again because of the capacity.

And it was a relatively minor impact, tailwind for sure, but impact to the overall market growth, just given the capacity constraints you're going to have in the provider for some period of time.

The good news about that, I guess, is when we start to digest the backlog, it will come as a positive tailwind likely for years and it wouldn't be overly material in any given year, but it would be a tailwind for multiple years.

So that's the analysis that we have. And we just, again, just doing the math, we don't believe that we're into that backlog yet. Hopefully, we'll see some of that come in 2023, but we're not depending on that when you look at the center of our guidance range.

All right. Katie, I think we have time for just 1 final question.

We'll take our next question from Rick Wise with Stifel.

Can you hear me now? Sorry about that.

Yes.

Great. Two questions. I'll just have them right up front. First, I don't think you commented on China, Bryan, it seems like the latest COVID surge is subsiding. We're seeing sort of mostly negative, but sort of mixed results, some doing a little better.

How are you thinking about China factoring it in to the first quarter and to the full year? And a quick one for Suky. Suky, Bryan asked me to ask you about the shared services initiatives. You're in the early innings. He said, why isn't it moving faster? Just kidding Suky, just kidding.

That's a great question. That's a great question. Rick, he really knows me.

Yes. So we're seeing China and COVID surges clearly start to stabilize in the first quarter. It was pretty acute there in the fourth quarter. Fortunately, we were able to offset it with strength in other markets. So overall, China wasn't as big a factor in the fourth quarter.

And we don't see it as a material mover at least from a COVID standpoint in the first quarter. We do see China as a very attractive market for overall growth in '23 and beyond, especially now that we've moved through all of the pain and noise of BVP, which is now sunset and behind us. So really feeling good about where that market is. And now that team can start to position towards not only growing the business but start to really work on the margin structure of China as a whole coming out of BVP. So again, feel very optimistic about where we are there.

Yes. On the -- what a way to end a call on a good quarter and good outlook with shared services. But I love your ambition, and I'm going to share that with the leadership team that we've got to move faster. So thanks for the question.

Thanks, Rick, and thanks for all the questions. I'll turn it over to Bryan just to close out the call.

Just a couple of thoughts. First of all, thanks for joining us this morning. And I would say I hope it's clear that the phase I and phase II of the transformation of this company are well on track, and we're feeling very good about where we stand. And I can tell you, because of those 2 phases, I feel that we'll at least take our fair share of the markets that we play in. We certainly hope to do more than that.

Now we're moving on to phase III, and that really is the portfolio transformation of our company, looking at changing the mix of our revenue to make sure that we have more of that mix in high-growth markets. And we're going to do that in 3 ways, which is kind of a combination phase II, phase III.

The first one is innovation. We're going to invest in innovation in the right areas, in faster growth markets so that we build more revenue through that innovation in those attractive markets, gives you real-time revenue growth, but it also makes it sustainable by increasing the weighted average market growth of the company. The second is investment in the commercial channel. You've got to have the commercial channel and capability to drive that innovation and make it real.

And the third is portfolio -- active portfolio management, really looking at moving things into the organization and out of the organization that can drive our weighted average market growth rate up. So we are clearly in that phase. We have a better balance sheet right now that we're going to be able to leverage in that part of the transformation.

Make no mistake, we feel very confident about phase I, phase II and now phase III, given that balance sheet freedom that we're going to have going forward. And with that, I think we'll go ahead and end the call.

Yes. Thanks, everyone, for joining us. I'm sure we'll talk today. And of course, if you have questions, please don't hesitate to reach out to the IR team. Have a great day.

Thank you again for participating in today's conference call. You may now disconnect.