Richard J. Heppenstall; Executive VP, CFO & Treasurer; ZimVie Inc.
Vafa Jamali; President, CEO & Director; ZimVie Inc.
Robert Justin Marcus; Analyst; JPMorgan Chase & Co, Research Division
Good afternoon, and welcome to ZimVie's Fourth Quarter and Full Year 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Marissa Bych from Gilmartin Group for introductory disclosures.
Hi, and thank you all for joining today's call. Earlier today, ZimVie released financial results for the quarter and year ended December 31, 2022. A copy of the press release is available on the company's website, zimvie.com, as well as on sec.gov.
Before we begin, I'd like to remind you that management will make comments during this call that 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 refer to the company's most recent periodic report filed with the SEC and subsequent SEC filings for a detailed discussion of these risks and uncertainties.
In addition, the discussion on this call will include certain non-GAAP financial measures. Reconciliations of these measures to the most directly comparable GAAP financial measures are included within the earnings release and/or the investor deck issued today found on the Investor Relations section of the company's website.
This conference call contains time-sensitive information and is accurate only as of the live broadcast today, March 1, 2023. ZimVie disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise.
And with that, I will turn the call over to Vafa Jamali, President and Chief Executive Officer of ZimVie.
Thank you, Marissa. Good afternoon, and thank you all for joining us. I'd like to kick off the call by providing an update on the significant progress we've made in our first year as an independent company, before turning the call to Rich Heppenstall, our Chief Financial Officer, to review our financial performance for the quarter and year ended December 31, 2022.
Understanding that we still have substantial work ahead of us, I'd like to take a moment to commend our internal teams who have demonstrated tremendous capacity, adaptability and efficiency as we complete the steps to stand up our business post spin and lay the foundation for future growth. We knew that turning this business around would take immense operational effort, fiscal discipline and a commitment to product innovation and execution over the course of several years, not quarters, and that remains true today.
I'm pleased that we've addressed and crossed hurdles in each of these areas already while implementing the right structure initiatives to create value over the 3- to 5-year post-spin time line that we outlined a year ago. 2023 is the year we focus energy on the commercial side of the portfolio to be able to grow into 2024 and beyond.
Our most critical imperative as we build for long-term success is the health of our innovation platform. Over the past year, we've made considerable progress actively reshaping our innovation portfolio to ensure that our growth plans into the future are supported by differentiated products that drive better clinical outcomes and workload benefits.
In dental, we're thrilled with the launch of several new and next-generational products. 2022 was the first time in 10 years, we launched a new dental implant line to the market, led by the introduction of our T3 PRO implant in June, alongside our Encode emergence abutment, then by our next-generation TSX implant in November. We're seeing strong demand in the market for these implants with excellent feedback from adopters around stability, predictability and ease of use.
We're also excited to share that we, just last week, we launched our RealGUIDE computer-aided designer CAD and FULL SUITE modules within our digital dentistry software platform. This offering allows physicians to complete detailed and sophisticated implant and tooth restoration procedures and create seamless workflow throughout the procedure. Our software platform is now the only offering in the market with implant planning and guide design within the same module as restorative care, including crown and denture design, allowing substantially greater efficiency for customers.
These launches marked the beginning of the next wave of innovation in our dental portfolio, and we are really excited about our role in increasing the adoption of dental implants with these solutions. Our dental business is positioned very well to grow and generate cash flow for our business as a whole.
Moving to spine, we're equally focused on refreshing our spine portfolio. For example, in 2022 we announced the launch of the Virage navigation system, which allows for the navigation of bone preparation instruments and polyaxial screws in the spine, and is compatible with commercially available navigation systems. This compatibility with third-party navigation systems supports our desire to be more active in the minimally invasive surgery, or MIS procedures, in an effort to improve overall patient outcomes.
Building on this launch, today we are very excited to announce a partnership and global development agreement with Brainlab for spine-enabling technologies to provide our customers and patients the deepest level of integration between ZimVie products and Brainlab's industry-leading portfolio of spine imaging, planning, navigation and robotic-assisted solutions. Work is already underway to integrate our minimally invasive Vital and Virage systems into Brainlab's innovative solutions, allowing us to bring differentiated technology into the operating room to enhance workflow and accuracy while reducing interoperative x-rays and radiation exposure.
At the time of the spin, I announced that we would partner, rather than build, an enabling technology offering with an established leader in the space, and Brainlab fits exactly with our strategy to leverage broadly compatible solutions with an established footprint to drive greater pull-through across our spine portfolio.
Shifting to another focus within our spine portfolio, the Tether, our differentiated non-infusion spinal device for the treatment of idiopathic scoliosis. As we have detailed in the past, we remain critically focused on driving therapy access for children who can benefit from this device. We received a major positive policy decision from Anthem in mid-2022 expanding coverage to 30-plus million lives. And today, I'm pleased to announce that we have also received a positive policy decision from Highmark, expanding coverage by another 4-million plus lives.
The Tether is a great example of the innovative piece of our portfolio that is making a significant difference in the lives of our patients. We are excited by this growth opportunity this technology offers us. Looking forward, we will continue to innovate on and around our existing solutions while we rationalize opportunities that are not value creating, and optimize our position in markets where we are positioned to win. We look forward to announcing our progress on the innovation front throughout the year.
In addition to our focus on innovation, a significant portion of our energy in 2022 was directed towards many operational accomplishments since spin-off. We are pleased to have successfully separate operations from our former parent, Zimmer Biomet. As part of separation, we have established a world-class leadership team with a focus and experience to position the business for long-term growth and value creation.
In our first year as a stand-alone company, the team has completed several major operational enhancements to accelerate our independence. On the IT side, we successfully completed 3 major ERP conversions, one for each commercial region that we operate in. Also as part of our -- exiting our TSA agreements, these are the transition agreements with the parent, we refreshed our core IT systems, moving over 950 servers to new data centers and transitioning over 200 applications to modern and largely cloud-based platforms.
We have also focused on inventory and physical footprint. We materially reduced inventory and plan to seize additional opportunity for inventory reduction in 2023. We also identified a significant amount of fixed cost waste in the organization. Over the past year we have closed, reduced the footprint or transformed 5 facilities worldwide. And as a direct benefit of these efforts, we have improved our spine manufacturing fill rates from 65% to 95%. In summary, we've made measurable progress against our most vital operational goals to create a strong foundation from which ZimVie can grow.
This brings me to a relevant note on our position in global markets, specifically an update on our operations in China. As part of rationalizing our brands and focusing on improving growth and profitability, we are now in the process of fully exiting the China market in spine and evaluating our position in dental following recent VBP decisions. We are confident that this is the best decision to optimize our focus in markets that can be both growth and margin accretive to ZimVie over time.
Before turning the call over to Rich to outline our financial performance, I want to once again underscore our immense progress and strong execution on the operational and organizational goals over the year. While our financial performance has been impacted by separation dynamics and multiple challenging macroeconomic factors, we are establishing the pillars to support a growing, efficient and profitable business over the next several years.
We acknowledge that our top line and bottom line expectations for the year ahead do not reflect the progress we have made within the business in our first year, nor the long-term trajectory that we expect ZimVie to achieve. But we are committed to transforming and driving a better company that we stepped into last March, and we are confident that our plan is on track to revitalize ZimVie for future growth and create shareholder value while addressing real patient needs in the dental and spine markets.
I'll now hand over the line to Rich.
Richard J. Heppenstall
Thanks, Vafa, and good afternoon, everyone. I'll begin by reviewing our fourth quarter 2022 results, and will then close by providing commentary on our outlook for the full year 2023.
Total third-party net sales for the fourth quarter of 2022 were $228.2 million, a decrease of 12.4% on a reported basis and a decrease of 9.1% in constant currency. We implemented 3 major ERP conversions in the back half of the year. Unfortunately, the implementations negatively impacted the quarter by approximately $7 million due to disruptions meeting customer demand in our spine segment. The quarter was also impacted by 1 less selling day in 2022 versus 2021, which impacted growth by approximately 1.5 percentage points. After adjusting for the revenue disruptions and 1 less selling day, fourth quarter third-party net sales declined 8.3% and 4.9% in reported and constant currency, respectively.
Additionally, fourth quarter sales were impacted by disruption in China due to macroeconomic challenges, including COVID and China volume-based procurement. We estimate the China distributor order slowdown ahead of VBP specifically accounted for a $3 million headwind or 1.3 percentage points to fourth quarter sales. Given the situation in China, we are also making proactive changes to our footprint, which will impact our 2023 guidance, something I will talk about shortly.
Shifting to our two segments. Q4 global dental third-party net sales were $115.8 million, representing a 7.6% decrease on a reported basis, and a 2.9% decrease in constant currency when compared to the prior year period. Our performance was impacted by macro-related headwinds in our end markets, softness in China ahead of volume-based procurement and 1 less selling day. Normalizing for 1 less selling day and the impact of China, the global dental business was approximately flat year-over-year in the fourth quarter on a constant currency basis.
In the U.S., dental third-party net sales of $67.5 million decreased by 2.8%, hampered by the loss of 1 less selling day versus 2021. Outside of the U.S., dental third-party net sales of $48.3 million decreased by 13.6% on a reported basis and 2.9% in constant currency, including an approximate 3.2 percentage point impact related to China.
Q4 global spine third-party net sales were $112.3 million, a 16.9% decrease on a reported basis and a 14.8% decrease in constant currency when compared to the prior year period. The decrease was driven by the exit of certain unprofitable markets in late 2021, product discontinuation from our brand rationalization program, 1 less selling day, China, and revenue disruptions resulting from ERP implementations outside the U.S. When adjusting to these 5 items, spine sales decreased by 3.1% and 1% on a reported and constant currency basis, respectively, when compared to an Omicron-variant impacted Q4 2021.
In the U.S., spine third-party net sales of $90.9 million decreased by 10.2%, hampered by the loss of 1 selling day versus 2021. Outside of the U.S., spine third-party net sales of $21.5 million decreased by 36.8% on a reported basis and 28.5% in constant currency, and net sales outside of the U.S. include a 6.3% impact related to China VBP and a 24.6% impact from ERP implementation disruptions as previously noted.
Q4 adjusted gross profit was $156.7 million compared to $167.2 million in the prior year period. Adjusted gross margin was 68.7%, an increase of 450 basis points when compared to 64.2% in Q4 2021. The increase in gross margin versus prior year is driven by a substantial reduction of inventory charges in the quarter and greater gross profit dollars from higher dental implant sales.
Full year 2022 adjusted gross margin of 67.5% increased 160 basis points over the prior year towards the top end of our expected range of mid-60s gross margin. We are pleased with the progress we have made to manage inventory since spin and will continue to drive our operational excellence initiatives to review further inefficiencies out of the company.
Q4 2022 adjusted research and development expenses of $11.6 million, or 5.1% as a percentage of third-party sales, a decrease of 40 basis points compared to the prior year period. Q4 2022 adjusted selling, general and administrative expenses of $133.6 million, or 58.5% of third-party net sales, was 560 basis points higher than the prior year period. Lower variable selling expenses from lower net sales and the favorable impact of the organizational growth realignment we completed in Q2 of 2022 were offset by higher fixed and semi-fixed cost as a percentage of revenue.
Adjusted EBITDA in the fourth quarter 2022 of $28.1 million, or 12.3% of third-party net sales, reflects an increase of 70 basis points from 11.6% in the prior year period. Full year 2022 adjusted EBITDA margin of 13.5% of third party net sales is 50 basis points higher than the prior year adjusted EBITDA margin of 13.0%, and this is towards the top end of our guidance range as expected. The increase in adjusted EBITDA margin is primarily due to higher gross margin, partially offset by higher selling, general, administrative expenses as a percentage of revenue as previously discussed.
Adjusted earnings per share in Q4 2022 was $0.16 on a fully diluted weighted average share count of 26.1 million shares. Full year 2022 adjusted earnings per share of $1.84 was driven largely by income tax benefits realized in the period, partially offset by higher interest expense.
Touching on working capital, liquidity and debt. We are pleased with our progress on capitalizing on the strength of assets on our balance sheet and the application of our disciplined financial framework to optimize our allocation of capital and to monetize certain assets to drive cash and increased financial flexibility. Our efforts have resulted in a reduction in net inventory of $13 million since December 2021, and a significant reduction of approximately $25 million in the planned amount of capital spend on spine instruments as we focus on driving increased set utilization in the field.
We ended the fourth quarter with approximately $90 million of cash and equivalents, inclusive of approximately $10 million of cash earmarked to settle certain post-spin-related transactions and to fund ERP implementations to decouple from our prior parent company. ZimVie spun in March 2022 with approximately $80 million of cash, inclusive of $22 million to settle post-spin-related transactions. After adjusting for the earmarked cash, we generated approximately $22 million of cash since we spun out as our own independent company on March 1, 2022.
Consistent with our capital allocation priority of increasing financial flexibility and paying down debt to reduce our leverage profile over time, I'm pleased to announce that prior to the end of 2022, we prepaid all of our required 2023 principal payments on our term loan debt. We took this action to provide further financial flexibility in 2023 as we continue to execute on our operational and commercial initiatives. Our $175 million revolver remains undrawn.
I'll now turn to our full year 2023 outlook. Before I begin, I want to highlight that guidance details are reflected in our investor deck posted on the Investor Relations section of zimvie.com to give some additional transparency.
Starting with revenue. We expect 2023 net sales to be in the range of $825 million to $850 million, reflecting a 7.9% year-over-year reported net sales decline at the midpoint. Our guidance includes an anticipated 1.4% year-over-year negative impact from core foreign currency headwinds, which we expect to be more pronounced in the first half of the year, leveling out in the second half.
Our guidance also includes a 1.2% year-over-year negative impact from exits and scale back of operations in China. Therefore, excluding the foreign exchange impact and excluding China's scale back, our guidance reflects a net sales decline of 5.3% at the midpoint.
Looking at our segments. We expect dental to grow in the flat to low single digits, in line with our end markets in 2023, inclusive of a 1.5 percentage point headwind due to foreign exchange and an expected approximate 0.5 point impact from China. We expect spine to decline in the teens, inclusive of an approximate 3 percentage point impact to our spine business from our decision to exit the China market, and a 1.0 percentage point negative impact of foreign exchange.
Moving to adjusted EBITDA. We expect full year adjusted EBITDA margin to be in the range of 13.5% to 14.0% of net sales. As we have previously discussed, we are implementing steps to continue to expand margins despite our anticipated top line decline.
Adjusted earnings per share is expected to be between $0.30 a share and $0.50 a share on a fully diluted share count of 28.6 million shares. Our earnings per share guidance reflects an approximate $0.70 year-over-year headwind due to higher interest expense; and a $0.50 year-over-year headwind from tax expense as the choppiness of activity post spin starts to normalize. Thus, rising interest rates and change in our tax rate are the primary contributors of lower year-over-year adjusted earnings per share.
Although we do not provide quarterly guidance, we expect quarterly revenue to follow our traditional historical seasonality, with Q4 and Q2 being our strongest quarters and accounting for approximately 52% of total revenue, and Q3 being our lowest performing quarter due to summer vacation schedules, which we expect to account for less than 24% of total revenue.
2022 did not follow traditional seasonality trends due to the Omicron impact in late 2021 and early 2022. As a reminder, supplemental guidance is available in our investor presentation located on zimvie.com.
With that, I'll now turn the call back over to Vafa.
Thank you, Rich. Companies and spin-off situations generally face significant disruption in their first year as a stand-alone entity. This is especially the case when the business is heavily entangled with the parent company.
We made the choice against a choppy macro environment to focus on what we could control within the business and accelerate our separation in the first year, to ultimately accelerate our independence. I feel good about our accomplishments in this area as a whole, and I'm confident that this is the best approach to getting ZimVie through the separation period quickly, allowing us to dedicate more time now and going forward to commercial success within dental and spine. This remains our priority as we continue our mission to transform patient lives.
Lastly, I'm pleased to share that we'll be showcasing our new dental and front line in 2 weeks at the International Dental Show in Cologne, Germany. We will be hosting a virtual interactive dialogue with 2 KOLs, an oral surgeon and a periodontist the following week to discuss the use of the benefits of ZimVie's digital dentistry platform and implant solutions.
We will share greater detail shortly and hope that many of you can join us at one or both of these events. With that, we will open it up to questions.
Question and Answer Session
(Operator Instructions) And our first question coming from the line of Robbie Marcus with JPMorgan.
Robert Justin Marcus
Great. Maybe we could start with fourth quarter, and it came a bit below consensus in both spine and dental, even excluding China and currency. So maybe you could spend a minute on the trends you're seeing in each of those businesses and the shortfall in fourth quarter, and what you're seeing so far in first quarter in each of them.
Richard J. Heppenstall
Rob, it's Rich. Yes, so Q4, I'll start a little bit -- I'll start with the headline around ERP challenges. So when we talked at the end Q3, we had guided $915 million to $930 million, we said we're going to be towards the bottom end of that range. We were impacted by about $7 million relative to ERP implementations, as mentioned on the call, that would have put us kind of squarely towards the bottom end of the range.
What we saw in some of the dynamics between dental and spine for the fourth quarter is from the dental business, we were obviously impacted by spine, it slowed down actually quite a bit for us going into VBP. And then on the dental side, also, what we did see is a little bit of kind of macroeconomic uncertainty in the kind of, frankly, in December that this kind of further impacted sales on the dental side.
On the spine side of things, that was more related to China and the ERP implementations more than anything else. That's how we kind of finished the fourth quarter. To your question around the first quarter, we're actually seeing some stability. We actually had a pretty decent January, for us. And so we're starting to see some stability in dental and starting to see some stability in spine. So the quarter is off to kind of as we're expecting through the first, almost 2 months.
Robert Justin Marcus
Great. And maybe if we take it to 2023. I think the dental outlook looks pretty reasonable, but the spine growth, it's a bit even below market growth still and probably lower than you were thinking a year ago. So maybe talk to some of the issues there that your experience -- or plan to experience in 2023, and how you can overcome that and return that business to market growth?
Sure. Rob, it's Vafa. So like you said, dental is doing well. We think that, that portfolio is positioned well to compete. We think our pricing is good. Our profitability is good. Our commercial infrastructure is very healthy. So we're really happy with dental.
With spine, we were a little bit behind in terms of the portfolio. We had some gaps. And frankly, we had some commercial activities that we uncovered through the year that were frankly suboptimal and we need to really perform and manage some of our commercial operations.
So with all that volatility inside spine, we focused on the portfolio. So we added an opportunity to do a development, an R&D program with Brainlab. That's going to fill a gap for us with respect to enabling technology. It's a gap that we had coming out of Zimmer Biomet that I think we've effectively filled and we'll start to work towards that. That will be healthy.
We've invested in Mobi-C, and what that needs to do is to regenerate and reinvigorate that one. In 2022, with respect to Tether, which is an outstanding product, we hit some reimbursement hurdles which we resolved, and we continue to get some wins. We got Anthem. And then following Anthem, we had High Point. And really that's giving our Tether surgeons a lot of confidence that if they -- that they can get reimbursement for their patients when they're getting them.
So I think a number of these things are pieces that we have to put together. There still is disruption in spine that we're living through. I think the first half of the year is going to be the toughest part. And I think you're going to see a much, much healthier spine business in the back end of the year for ZimVie.
So that's kind of how I see it. But I really do think that there's enough disruption, enough volatility out there, that we just felt like we should give ourselves some room to make the changes we need to do to really get to a point where we have the portfolio and the commercial team that we need that can actually win that in this market for us.
Robert Justin Marcus
Great. And maybe one more for me. As you think about the below-the-line items, it's taking a significant chunk of EPS out for next year. How are you thinking about your EPS growth over the long run? And when do you think you could get back to 2022 levels?
Richard J. Heppenstall
Robbie, this is Rich. So we spent a fair amount of time looking at EPS. And so I boil down the EPS change year-over-year and there was a couple of different -- actually 4 different categories, right?
So EPS actually was higher year-over-year by about $0.23 or so, give or take, given higher profitability and then some lower depreciation and amortization expense, which obviously increases net income. That's offset by some higher share-based compensation and a little bit of dilutive impact.
And so the net of those 2 numbers is about a 4% decline year-over-year on EPS between those 2 items. Where the rubber really meets the road on EPS is in 2 items. And the first one is interest expense, which is about $0.75.
So if you recall, our debt is SOFR plus 1 in 3 quarters. And when we spun, that debt was priced at about 2.3%, we're at about 6.7% today. And so obviously, the fixed floating-rate debt, so obviously the Fed increase in the interest rate is impacting us because of our debt load. And that's the biggest piece, which is about $0.76.
And then the other piece is tax expense. What we've talked to you about -- and the investment community about is that our adjusted income tax expense is, generally speaking, about 25% of adjusted profit before tax. In 2022, there were a number of items that were cleaned up post-spin, that we actually realized a tax benefit of about -- a tax rate of about minus 3.8% of adjusted profit before tax. And just that -- that's just not going to recur, right? I mean you can't obviously have a favorable -- a [native] tax rate in perpetuity, and so that normalizes into 2023 as we cleaned up a lot of these kind of post-spin transactions in 2022.
So if you kind of think about kind of 2024 and beyond, 2023 is actually probably more of a re-baseline based on the current environment relative to interest expense and tax expense. And then we'll be able to grow from there.
Robert Justin Marcus
Okay. So, fair to say it could be a while before you get back, given the current interest and tax forecast?
Yes. If interest expense is the highest part of it, I think that, that will be the right approach.
Richard J. Heppenstall
Yes. I mean if you look at the entirety of it, Robbie, right, I mean about $1.20 is between interest and having a negative tax rate in 2022.
And our next question coming from the line of Matt Miksic with Barclays.
This is Sarah on for Matt. Just one from us, and I know we just talked about this. But in dental, if you can just go a little bit deeper into the trends, specifically OUS, U.S., I know you called out the VBP. Is there any additional color you can provide there and any visibility in terms of timing of when things can turn around?
Richard J. Heppenstall
Yes. So do you want -- so I'll start and I'll let Vafa add some color. So the dental business, actually, in Q4 year-over-year was basically flat, right? So there were a couple of impacts that we had in the fourth quarter, as we mentioned just on the prepared remarks, one being foreign currency exchange headwind, and then the other one was an impact of China. And then, of course, Q4 had 1 less selling day.
When you actually normalize for those items in Q4, our dental business was flat. And I think it was relatively flat U.S. and OUS, when you kind of normalize those particular items. And we believe our dental business is still performing at, or perhaps even a little bit better than the market.
And so if you look at some of our peers, as they've announced, many of them are kind of performing at that same level. So we continue to feel as though our dental business is really well positioned. It has -- the market acceptance, so our new products has been really strong. We've got a global footprint, direct sales force.
And so as we look at 2023, we continue to think that dental is going to perform kind of at or a little bit better than market. I think there's a little bit of a macro headwind that we're seeing, but that's consistent across the space. And then we have a little bit of an FX headwind in China into 2023. But like I said, we should be (inaudible) over the market.
Further to that, Sarah, I think VBP is significant in China, and we've purposely given ourselves enough room to make the right decision on how to approach that market, whether you stay as is or you reconfigure your team to address a market that isn't as impacted.
But the price cuts were significant, so we've given ourselves enough room to make the right choice on how to satisfy that market or not. So that remains a question for us. But I think it's implied within our guidance that we'll be looking at a different approach to China. The short of China, I'd say most OUS and U.S. is pretty similar.
Thank you. And I'm showing no further questions at this time. I will now turn the call back over to Mr. Vafa Jamali, for any closing remarks.
Just -- thank you very much for your attention, and we look forward to sharing better news in future quarters. So thank you very much, and I wish you a great rest of the day.
Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.