Zimmer Biomet Holdings, Inc. (ZBH) Earnings Call Transcript & Summary

Good morning, everyone. Thanks very much for attending the next session. We're extremely, extremely happy to have Zimmer Biomet with us picking up coverage a little over a year ago. So it's extremely exciting for me to have the management here. We're going to do a full fireside chat rather than a prepared slide presentation. With me to the right is Suky Upadhyay, who's Executive VP and Chief Financial Officer; and to my left is Keri Mattox, who's Senior VP, Investor Relations, and Chief Communications Officer. Keri just joined about, what, middle of January?

Yes.

So recent. So thank you, and welcome.

Thank you.

So I think what we'll do is, to start off, maybe, Suky, you could provide just some basic perspective on the company and then we can jump into some specific Q&A.

Yes, sounds good, Larry, thank you for having us. It's great to be here. So the first thing I'd talk about is -- are close to what I consider to be a pretty pivotal and transitional year for the company, 2019. And if you saw our results that we provided just a short month ago, what you would have seen is a profile where we actually began to show growth above our overall weighted average market growth rate, which is an aspiration that we have been striving for and also a profile where we had leveraged earnings, right? So we're growing earnings faster than revenues. And I would say we did that in a really high-quality way. And what I mean by that is we saw improvement across all of our regions and just about all of our businesses from a revenue perspective and we expanded, and as I said, leveraged earnings while still investing for long-term growth against the business. All of that in the backdrop of some pretty instrumental improvements across a number of operational areas of the business: one, continuing to stabilize supply and actually move from stabilization of supply to efficiency; two, improvements in our overall quality profile, which is something that has been a challenge for the organization for the last few years, but also continuing to advance our innovation profile, all in the backdrop of announcing and initiating pretty large-scale restructuring program, which is going to afford us the opportunity to mix shift investment from lower-growth markets to higher-growth markets. So it's really, a really good year and a really good close to year. That gave us the confidence to come out in 2020 with a higher aspirational top line revenue growth of 2.5% to 3.5%. It was just 6 short months earlier than that where we were saying somewhere around 2% to 3%. So the confidence we had in the back half of the year gave us the opportunity to increase our overall outlook for 2020. So we feel really good about where we are from an underlying business standpoint against operational execution, innovation and overall value generation. So there are definitely some things that have happened since that February 4 earnings call, around coronavirus, which we'll probably talk about in a minute, but I just want to make sure that folks understand that the underlying substrate of the business continues to improve as expected, if not a little bit ahead.

Terrific. Yes, so let's get this out of the way because, obviously, it will come up and then we can really dive into the other parts of the business that are doing extremely well. So with coronavirus, clearly, the situation is dynamic. It feels like it's changing on a daily basis. But with that being said, clearly, elective procedures are likely to be curtailed. So maybe just help us think about, from a revenue perspective and a supply chain perspective, how we should be thinking about China and then perhaps how we -- what you've seen thus far as it's moved outside of the [indiscernible].

Sure. Yes. Happy to do it. As you said, the situation is incredibly fluid. Every morning, you wake up, open up The Wall Street Journal, there's a new article on the coronavirus and how it continues to evolve. Look, the way I look at it is our most acute challenge is within China. That should be obvious. Just to kind of put it into frame and give some perspective. China is about a little less than 5% of our overall global revenue. It's growing in the low double digits. So it's a very meaningful market for us from not only a scale perspective, but from a growth perspective as well. And what we've seen relative to coronavirus is actually a pretty significant reduction in elective procedures. In fact, about 85% to 90% reduction in elective procedures through February. So it's been a pretty significant headwind for us. We've not seen any significant or material improvement or recovery in February. So we expect that, at a minimum, to continue through March, right? So from a sizing perspective, just kind of how we're thinking about China, it's overall size and scale relative to the company and what we're seeing around elective procedures, again, at least through the first quarter, if not beyond. We do have manufacturing in China. We've got about -- not about, we have 3 of about 30-or-plus plants that are based in China, some local-for-local manufacturing, but also some local-for-global manufacturing. Each of those plants is at 90% production or better so we're really pleased with how our employee base there has responded. We're happy to say that none of our employees have been detected with the virus. So that's something that we feel really good about. We've increased our overall screening procedures, but also our overall sort of hygiene procedures and just preventative actions relative to this. But I should say, it continues to be fluid, Larry, because what we're learning is that if we do have a particular employee who does get detected positive, that it could be up to a 2-week quarantine within that particular facility. So right now, 90% or better production, but that situation remains a little bit tentative. As you move beyond China, we're beginning to see in Asia Pacific, some early signs in some of our markets, such as Korea, that there continues to be some headwinds around this, but it's nowhere near the scale that I talked about relative to China. And then beyond Asia Pacific, we continue to monitor trends both in EMEA, primarily Europe and some Middle Eastern countries. But then also you can start to see there's a little bit of uptake in the U.S. Too early to call what those trends look like. But again, overall, if you sort of bake all that together, and in the backdrop of this, what you're seeing as well is maybe slightly correlated is some FX headwinds, right? So the dollar is increasing in value relative to some of our European currencies as well as Asian currencies. And so that presents yet another headwind relative to our guidance just 4 weeks ago. So baking all that together, we do see a significant headwind in the fourth quarter. It's too early to tell what that means for the full year. Because we don't know how far this will spread, what the duration of that will be, but then also, what could potentially be the recovery of some of these elective procedures over time. So again, it remains pretty fluid.

Yes. I know there's probably no direct analogues. But I'm assuming that typically, when somebody has taken the step to go ahead and schedule a procedure, this may get delayed. But presumably, they're going to -- you're going to get that business back.

You'd get that business back. What we don't know is -- you won't get all of it back. And the reality is some of those people who signed up for the elective procedure may have other co-morbidities that, over time, now they're no longer eligible, unfortunately, they may have expired or there may be other reasons for them not to come back. The other thing we have to watch is just what's the hospital system capacity. So while they do come back, how quickly they come back is something we've got to monitor. So yes, we do believe they'll come back. It's just a little too early to tell.

Understood. And relative to the supply chain, it sounds like, thus far, you've been able to manage that pretty well here. I guess, 2 questions there; one, are you trying to run the facilities harder to make sure that you can build inventory where you need it? And then, secondly, have you seen any changes in the ability to get product out of China that you're using elsewhere?

Yes. We've not seen specific challenge of getting product out. Shipping costs have gone up modestly, but that's -- I wouldn't say that's material to the company on the year. So overall, the supply chain situation in China has been relatively stable. We are thinking about where to build excess capacity -- sorry, excess inventory where necessary to make sure that we preserve the underlying business, but also to your point, if those elective procedures come back, there will be some pent-up demand, and we want to make sure that we can service that exactly.

Okay. Great. All right. I think we've addressed that. We can always come back to different questions later. But let me just start at a really high level. So you joined about 8 months ago or so, and when you came in, there was this really great focus on the supply chain, the sales force, and the product development and launch, of getting FDA clearances, and we'll definitely touch on a bunch of these. But I just wanted to start with the culture of the organization because I get a sense that, that under Bryan's leadership has changed a lot. And I think that when you've got a turnaround story, the cultural aspect is oftentimes somewhat forgotten, but it's very important.

Yes. You're right. It's often underestimated. Bryan, what I asked him about his early days 2 years ago, he started mission, talent, culture. And he is just maniacal about those 3 and then making sure that everyone in the organization understands how what they do ladders up to our ultimate mission, which is to alleviate pain and improve the quality of people's lives. So he's -- we spend a lot of time making that connection. But then also helping folks within the organization understand what they do, how it ladders up to our 3 strategic pillars, best and preferred place to work. We want people to be engaged. We want them to feel great about where they work. Second is trusted partner. We have an obligation to our regulatory authorities, to our customers, to our patients, to our investors, to our employees. We make commitments, and we stick to them. That's a big part of the culture change of the new Zimmer Biomet. And the last -- the third is around being the top quartile performer. We know what good looks like when it comes to financial performance. There are certain metrics that we embed throughout the organization that we make sure the entire company knows about as to where our focus of investment, where our focus of time and energy is going to go to. So it's those aspects, making people understand against those 3 strategic pillars how they ladder up to them and then how ultimately those translate to our company's mission. It's been a meaningful difference in change. I've only been there a short amount of time. But even in my 7 months, I can see a sea change.

Okay. And I guess that dovetails with the sales force. Again, I think there were a lot of issues when there were supply constraints. Sales force doesn't want to be put in an awkward position with surgeons. They disengage a bit. So not only is product supply important and getting FDA clearance important for new products, but really having engagement of that sales organization is a key dynamic in driving the growth. So again, sort of where do you think we are with getting the sales force really as fine-tuned as it should be.

Yes. I think we're in a good spot. There's always room for improvement. But if you kind of step back, you can imagine how frustrating it was for a distributor and sales network when you're asking them to create demand that you ultimately can't fill, right? That is not a winning situation. We're now at the point where we've got supply stability. We're less than a day of back order from an overall global supply perspective. So we're in a really good spot from that perspective. When you take that, but also take into consideration the new product innovation that we've launched into the marketplace, ROSA Robotics just being one of many, the investments we're making around education awareness, medical education and training, in addition to the new incentive schemes that we put into place for the field sales force, where there's a significant opportunity for them to economically do much better if they grow the business, these are all, I think, positive contributing factors to a raise in the overall engagement of the sales force. I had the opportunity to spend time at the U.S. sales force and I could just tell in my conversations people are really jazzed about where Zimmer Biomet is going. It's night and day from where it was. Again, always room to improve. But I think we're in a much better place.

Okay. Great. Let's start with, and we'll kind of work our way down the P&L, and I guess, some of the comments will be in the context of, again, fluidity around coronavirus. But let's just step back and say, so you grew, if my numbers are right, just under 1% in 2018 on a constant currency basis. You did 2.2% in 2019. And now you talked about growing 2.5% to 3.5% in 2020. So I guess the question is, how do you accelerate the growth? And how should we be thinking about that growth in the second half of the year because your comps are also going to get tougher.

Yes. No. It's a great observation. I think the first thing I'd point you to is the second half of 2019, where you really began to see acceleration in our business through innovation and new products, but you also start to see some meaningful improvement in our base business and in the Americas. Just mathematically, you've got to win there. You've got to grow those 2 businesses for us to really show acceleration. So there's momentum in the second half of the year that's going to continue into 2020. And again, putting coronavirus to side, I just sort of put it into some very basic building blocks. So our knee business, we expect to continue to accelerate global knees. ROSA Robotics is going to continue to be a big part of that. But then also what comes with the robotics and pull-through of our base needs, but then also our introduction of Persona Revision, which is a major application into the market, we think that, that's got yet a lot of runway ahead of it to 2020. You've had physicians that were very loyal to Persona as a knee implant, but did not have a -- did not have the revision application. So they were using somebody else's revision. They now will clearly come to Persona Revision. So that's a big upside for us. The second area is you had some physicians who wanted to go to Persona, but were hesitant because it didn't have a revision system to it. And so now you could start to see some conversions, and we'll start to see some conversions into the Persona implant, but then also the revision application. So those are just 2 potential tailwinds we have. Then we have, I think, a pretty meaningful cementless opportunity, still going to take some time to get to where our competitors in that. But as you have ROSA robot out there with the accuracy of those cuts, it gives the physician more confidence to take a cementless application versus a cemented. There is a mix shift benefit with cementless that's going to provide a tailwind. And then those are just a few examples. I hate to go into the -- it's not sexy, but just the operational execution of the business. Operating mechanisms of targets, quarterly targets, incentive metrics, holding people accountable to their targets. These are just the -- again, the blocking and tackling types of things that maybe weren't there in the past, but are clearly generating some upside for us. So we feel confident, again, coronavirus aside, that the underlying business was going to accelerate into 2020.

Got it. And look, I want to talk a little bit about the longer-term aspirations because while 2.5% to 3.5% is great when you're comparing to sub-1, it's not anything that people are going to get super excited about. I mean, I get it, it's in line with the average growth rates of the markets that you're in. But I think investors are looking for ways for this management team to try to move above and beyond that. So again, talk to us how you want to tackle that?

You're right on point, Larry. I'd say we're happy with the progress, but not satisfied. Nobody is getting excited about low single-digit growth. Our aspiration of our long-range planning period of 3 to 5 years is to get to that mid-single-digit growth range on an organic basis. Now the building blocks to get there are pretty simple, and I'll try and spell those out. One, as I said, just given the sheer math and the size of the global knee business, we've got to accelerate that above our weighted average market growth. And the way we're going to do that is by investing in driving submarkets that are growing faster than just the core knee implant. So when we think about robotics, mini robotics, informatics, making the operating room more efficient, operational execution, we've got a number of shots on goal, both currently in the market and in the R&D pipeline that we believe over that 3- to 5-year time horizon will get us to the point where we can actually grow above weight. Now we're going to have to get our base knees business moving. We started to make progress, but quite frankly, we're still seeding share to our competitors. They've been in the market longer with their robotic system, and that's going to take time to work through. But that's focus point number one. Number two is our sports extremity and trauma business. This overall is a category growing in the mid-single digits. We need to -- and we've demonstrated in some quarters that we can get there, but we need to do that on a consistent basis. We've got to double down in our shoulder application where we have a right to win. We've got to create a specialized sales force, build scale there and continue to launch products as we did in 2019. And then in lower extremities, again, it's about building a dedicated sales force and a greater investment in R&D, both organically, but potentially even inorganically to continue to fill that portfolio. But we've got to get that business growing in the mid-single digits. We -- we've got a glide path there. Hips, it's got to grow sort of at market's rate. We've got to maintain our market leadership in hips. So we've got to defend that segment. And then you think about spine and dental, we think we've made good progress on dental in getting that to sort of market growth or low single digits on a consistent basis. We've got to maintain that profile. And quite frankly, we've got to turn spine around a little bit faster than we have. So those are the building blocks that get us to that mid-single digit. But we don't stop there, Larry. We think we aspire to get to that upper single digits, that's going to require some inorganic opportunities. And fortunately, because of our cash flow generation and the progress we made on delevering the balance sheet, we believe that, one, the capital structure can support it, but, two, operationally, we're building the muscle to be able to handle inorganic means of growth as well.

Got it. And when you think about that mid-single-digit growth, the appropriate way to think about it is over a 3- to 5-year planning period. Is that the right way to sort of think about it?

That's right. Yes.

Okay. So you touched on this, but I think it's a really important point. So we have seen over the last 2 quarters, and I'm turning to knees now. We have seen the initial traction around ROSA, which has been very exciting because, again, if I'm accurate, you've seen sequential growth in units placed over the last couple of quarters and I assume that you would expect that again in the 1Q as well. But -- so I know that, that's going to continue to come and there's this pull effect on your knee business. But the base business, which you noted is still seeding share is still seeding share. So here, you've got, what, 40-ish percent market share. You're the leader out there. So how do you turn that base business around? Because, to me, that's a big component here of getting this growth going.

You're absolutely right. And I think we've already started making progress in slowing that share erosion. But it's going to come down to continuing to get placements with ROSA because there is that pull-through effect. There's a lag on that pull-through effect of 6 to 12 months, but there is a pull-through. Two, we've got to continue to drive our revision application. And three is we've got to continue that mix shift over to cementless. And then I'd say fourth is the continued investment in infrastructure around robotics and sales force and promotion. Those are the levers. It's not -- it will get us there. It's not going to be overnight, but those are the building blocks that ultimately get us to a point where we can stabilize base knee share and then potentially start to grow in the back end of that planning horizon.

Okay. So let's talk about ROSA. I guess, 2-part question. Number one, you, as an organization, I think, had a goal and I think the spirit was in 2020 to place about 100 ROSA TKA system. So one, wanted to see if we're thinking about that accurately? And then, two, now you've been out there essentially for almost a year with ROSA post AAOS last year. What's the feedback you're getting on the system?

First of all, we're incredibly pleased with how ROSA has progressed. We continue to see it as a growth driver into 2020 and we're looking at multiple ways to get more placements, whether they're revenue-generating or they're in fact placements because they can then generate commitments downstream. So we're really happy with where that's going. We're hearing really positive feedback. At any launch, there's always a little bit of noise around how you can improve the system, how you can improve training, how you can improve utilization, and that's primarily where the feedback has come. It's not been around any technical glitches. It's really been around how do you register, how do you maintain registration. So they're more training type applications as opposed to technical. That's good, especially at -- you want to get those kinks out early. What we're hearing is really positive feedback on a number of fronts. One, there are a large cohort of physicians who want to maintain control of this all. So the haptics becomes an advantage to them with the ROSA application. Two, from a patient outcome perspective, the ability to just rely on an X-ray instead of a CT scan: one, it's less radiation; two, it's less cost; but three, there's less disruption to the whole registration and integration process and workflow. Three, physicians are telling us that it's relatively time-neutral to a non-robotic application, that's really important. If you can improve outcomes, if you can improve OR efficiency, you've got a good product that's going to do well in the marketplace. And then what we also get excited about is just the scalability of ROSA on the number of other applications, such as hip revision, spine, potentially into sports and extremity, the interconnectivity with mymobility, which we're the only partner out there with Google on, and then also the application with robotics and mini robotics with Walter. There's a lot of opportunity out there, so we're really excited about where ROSA is headed.

And that 100-ish unit placement, is that still...

We haven't given out specific numbers. I'd be incredibly disappointed if we didn't meet that or even exceed it.

Got that. Okay. Perfect. I want to save a little bit of time because there are some exciting opportunities around cash flows and charges that we can get to, but I just want to come back to 1 thing on provision. So am I correct in understanding that if you don't need a CT and you're using X-ray, that's a benefit if you're doing a Revision Knee because you really can't use CTs on Revision Knees?

That's exactly right. So we see that as a clear differentiator and a procedure that is significantly more challenging and difficult than just the primary knee implant, right? So the Revision surgeries are incredibly difficult and challenging. So the ability to do that with just the x-ray is I -- we think, is going to be meaningful.

Okay. So I guess, as CFO, really, what are your priorities for the company? Again, you said you've been there just over 7 months, so you've gotten your teeth into things. Where are you focusing your time?

I kind of look at 1 of our strategic pillars, top quartile performer. We've gone back, looked at case studies of what drives top quartile shareholder performance in our sector, what are the metrics that drive it and how are they correlated to returns and market value. And basically, it comes back to 4 key metrics we measure the company on: revenue growth, not surprising; two, earnings growth; three, free cash flow conversion; and the fourth is return on invested capital. My role -- my priority as CFO is to make sure we're absolutely pushing the pedal as far as we can on all 4 of those. So on revenue growth, we announced a major restructuring plan. That enables the mix shift from lower-priority assets to these higher-growth submarkets and to accelerate and really put fuel on that fire to generate that top line growth because we know that durable mid-single-digit to high single-digit revenue growth is your best path to margin expansion and free cash flow generation. That's not lost on us. Then margin expansion. So we're driving this restructuring program. We're driving a number of improvements across our supply chain to be able to offset constant headwinds from a pricing standpoint. And then from a free cash flow generation standpoint, look, we've got a big opportunity in inventory. So we're putting a lot of structural things in place that over time can lead to a meaningful improvement in working capital. So if you ask me where I'm spending my time, that's where the focus is going.

Got it. So let's come back to that restructuring. So you're going to save $200 million to $300 million by the end of 2023. The messaging I got was that will allow you to both invest as well as drive operating margin expansion. You've talked at least 30% operating margin.

That's right.

Which is great. But on top of that, I sit there and I look at -- and I just looked at the 10-K, and this is a number that just blows me away is that the obsolete and excess inventory charges are in excess of $220 million.

Yes.

And that's versus $128 million in 2017?

That's right.

So it's just ballooned. So why are the charges so large? And how do you get at this and kind of what the time lines are getting at this?

It's multivariable, but to keep it very simplistic is because of where the company was relative to supply and the need to just try and get supply stabilized, we've probably been less efficient in building inventory, right? So we've built a lot more inventory than we potentially need it. And it wasn't always done in a very smart way based on the true demand signals, right? We just have too much inventory. That inventory, over time, based on overall demand in the marketplace can potentially become excess and obsolete. And it's because of that inventory proliferation, the lack of demand there on the back end, that's creating the need to write this stuff off. So what would we need to do to fix that? We need to fix our inventory situation. The way we do that is there are structural fixes. These are not quick or easy. We got to consolidate our ERP environment. That takes time, that takes resources, it takes energy. And two, we've got to change the way we process our demand signal, get more accurate, more data-driven versus tribal knowledge, all the way down to what is our global inventory position, which the company did not have a view into to then inform what do we need to make, when do we need to make it and where do we need to spend it. So structural changes that we need to do. So I think E&O can be a significant improvement over time. It's not going to be a step change. There's going to be some quick hits in the near term, but I'd say over that next 3 to 5 years, you should expect a meaningful reduction.

And Larry, just a quick point on to the reorg and the savings. That $200 million to $300 million is annual run rate that we're talking about to getting to by the end of 2023. So looking at how that affects the business.

Yes. Fair, fair point. Is there anything structurally that would preclude you from getting back to that 2017-ish level?

Yes -- I hope not, Larry. I just want to get to the next step. I don't want to get ahead of myself. Let's -- there's a lot of work to do to fix this. We will get there. We've got the things in flight, but we'll fix that one.

Okay. And then, lastly, because we're about to run out of time here. But dovetailing off of that, inventory days are in the 400-day range. Again, it's sort of just mind-boggling to me. I guess, this all goes part and parcel with the things that you have to do. But just tell me there's room to take that down. I mean, 400 is not the right way for this business to be run.

No. And orthopedics business will naturally have higher than other med tech peers just because the model physician goes in the operating room, they need multiple sets there because anything could happen. That's one. That's a natural occurrence. But then, we're on top of it, just inefficient. We've got to get better.

Yes. Okay. Perfect. We are just about out of time here. We have time for one question from the audience if there is one. Okay. So with that, we will adjourn here. Management will be available in Amarante 1, which is downstairs. Thank you, Suky. Thank you, Keri.

Thank you, Larry.

Thanks, Larry.

Appreciate it.