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

Good morning, and welcome to the Virtual Healthcare Conference. [Operator Instructions] Also, please be advised that today's conference is being recorded. Thank you.

All right. Good morning, everyone. Sorry for the late start here. I'm Larry Biegelsen, the medical device analyst at Wells Fargo. And today, I'm pleased to have with us the management team from Zimmer Biomet. I think the Zimmer folks are going to be just dialing in, so it's going to be audio-only. Joining us from the company are Bryan Hanson, the CEO; Suky Upadhyay, I'm sure I mispronounced her last name, Suky, apologies, the CFO; and Keri Mattox, the Head of Investor Relations. Everyone, thank you so much for joining us virtually. Can you hear me okay, Keri or Bryan?

Yes, we can hear you fine.

Yes. Thanks, Larry.

Okay. So Bryan, I wanted to start off with a discussion around the recovery, but I wanted to spend the bulk of our time kind of on how you're reshaping Zimmer Biomet to be a faster-growing company and increasing the WAMGR that you talk often about. So maybe if we just start on the recovery. You gave a lot of data on the Q2 call. Any color that you can provide on how the recovery is progressing and how you expect the recovery to progress?

Yes. So what I would do -- first of all, Larry, I'm glad that I'm not the only one that mispronounces Suky's last name, so that makes me feel better. So I would say that we're pretty much on track with what we had said before during the earnings call that we felt that July was a pivotal moment for us because it was where we were seeing some of the resurgence of the virus. And the good news is, even with that resurgence, we still saw improvement in July versus June. That was, to me, really important because we needed to see how policy decisions would be made in the face of the virus picking up. And so that was a pivotal moment for us. And we predicted from there that we would continue to see sequential improvement, just at a less fast pace than what we had seen in the second quarter. And the good news is that that's materialized. And so far into August and now early September, we've seen that sequential improvement, as we had stated we thought we would, which is great news. And we think it will continue. We really do. And there's a lot of variables, obviously, that are out of our control. But if they continue to act the way they have, we would expect that to continue on a go-forward basis, as we had said before. Suky, I don't know if you had anything you would want to add to that, but that's just broad based. We're seeing what we expected.

That's a great summary, Bryan. And I would say, we talked about exiting the second quarter in June at down 13% to 14% for the month, and we've been better than that in both July and August. And I think a really positive leading indicator from my standpoint is even in areas where we've -- whether it's states or markets outside the U.S. where we've seen second surges, we've not seen anywhere near the impact we saw back in April and May. In fact, just as an anecdote, some of the hardest hit states that we talked about on our second quarter call, like California, Texas and Florida, we're still operating at 80% to 90% level, so again, even with a pretty deep second wave. So things are improving, as Bryan said. Now there are still some challenged areas in various markets. What we're seeing is nothing is homogeneous, and it's tough to predict one market from the next, and there's a lot of fluctuation from week to week. But by and large, as you consolidate and on the aggregate, we are seeing that sequential improvement that we expected and maybe a little bit better than what we expected.

That's great to hear. Very encouraging. You talked about some places being at maybe 90%, Suky. I guess, The Street has you guys at flat in Q4. Is it possible to get back to flat by Q4? Or do you think we need widespread adoption of a vaccine before we get there? Any thoughts on that?

I mean I...

Go ahead, Bryan.

Maybe I can start and then, Suky, you could provide some color or commentary to it. But I would say, to the very specific question, do we think we can get flat in Q4? I think we can. I really see a path to being able to accomplish that. There's the caveat that I'll put in place to that is it requires 2 pretty significant assumptions, one that I have control over, one that I don't. The first assumption is that we continue to execute, I would just define as, flawlessly our strategy. The new product launches with ROSA, with Revision with the ONE Planner system. So far, the team has really been on top of it, and I would expect that to continue. So that assumption, I feel very confident in. The other assumption that we're making is that we don't see any major changes in things like fear of patients impacting the patient flow any more than it already is. And we're expecting not to see significant resurgence of the virus beyond what we're seeing today. If those things remain firm, I do see a path to being able to be flat in Q4. The unfortunate thing is it could change. If -- in the winter months that we see a significant resurgence, and that changes our view, then that could impact our ability to do that. But outside of that, we're on the trajectory that would allow us to get there. Suky, I don't know if you wanted to add anything?

No, I think that's well summarized. And Larry, you asked about a vaccine, a vaccine would certainly help. I don't know if it completely mitigates some of those headwinds or variables that Bryan talked about. But we're really encouraged about our underlying execution in the business. And we talked about that backlog, and we see that as a tailwind into the second part of this year and potentially into 2021.

That's very helpful. And we're at the time of the year where people are asking more about 2021, and I think we all recognize there's a lot of uncertainty. Is there a framework you could provide? I mean, is the right way to look at 2021? Or how you look at it or how you want investors to judge you? Is to compare the growth in '21 over 2019? The Street right now has you up about 2% in '21 over 2019. And then Suky, on the margin profile, is it going to lag? Or could it actually do better because of the cost savings from things you're going through right now?

Yes. Go ahead, Suky.

Yes. So I would say, first, on the top line, it really is too early to tell. Could we see ourselves getting back to '19 levels in 2021? I think for all the reasons Bryan laid out, I think, yes, there is a path. But there is, of course, enough uncertainty where we don't want to peg anything at this time, but clearly, there's a path. On the margin front, I think you characterized that well, Larry, is that we would expect that revenues in '21 got to '19 levels that margins would follow, and we would expect margins to also get to '19 levels, however, perhaps not for the full year because there could be a 1- to 2-quarter lag. There are a number of investments that we've sort of deferred as we continue to navigate COVID and make sure that our liquidity profile is strong. We're going to catch up on those investments because our underlying business is doing so well, and we want to make sure that we continue to fuel that top line. The second is, with lower volumes this year, we've had some underutilization of capacity. That's going to translate into some fixed charges into cost of goods that, of course, get deferred and be recognized in '21 and beyond. And so for those 2 reasons, margins may lag a bit, but they will be strong, and they will, within the year, get back to '19 levels.

That's helpful. That's good.

Yes. Maybe making a comment on the 2021 revenue number. If you just think about it mathematically, we've talked about the amount of backlog that we have now being in the hundreds of millions of dollars. And if we do see a vaccine come in, number one, the timing that people have been talking about it, so let's call it, the beginning of 2021, maybe even earlier, and that vaccine is effective. So effective in 2 ways, in my mind, one, reducing patient fear or potentially even completely eliminating it and actually being effective in stopping the virus from recurring. Then just mathematically speaking, 2021 could be a very good year for us, at a minimum, coming in at 2019 volumes. But just if you can eliminate the 2 big headwinds that we have, which are the fear factor and the risk of the recurrence of the virus, either on policy decisions or just actual capacity in ICU beds, those things go away, and you still have hundreds of millions of dollars of backlog that you can work through. It could be a very attractive year for us. So the biggest thing is, does that vaccine come through and does it have the impact that we would expect?

That's very helpful, Bryan. I wanted to ask one question on 2020, the 30% operating margin goal by the end of 2023. And I think the -- your language has been at least 30%. Is that for a full year 2023? Or getting to at least 30%, call it, at some point in 2023, like Q4? Just wanted to understand that a little bit better. And how you get there?

Yes. So I would say we would get to that run rate in 2023, Larry, so you would see a full year of that in 2024, which was our comments. Now look, that's still a ways off, and we may be able to do better than that based on some of the learnings we've gotten through COVID with potential rationalization -- further rationalization of our cost base. So there could be upside. But right now, we're staying committed to what we provided earlier this year. Some of the things that are going to drive that is think about the major components of our P&L. First, on gross margins, the company has eroded gross margins by 100 or maybe even more than 100 basis points per year over the last 4 to 5 years. So we're just -- we're at a point where we're going to get to stability and we're going to look for stability in the near term. So holding kind of margins constant as opposed to this erosion we've seen sequentially year-over-year. The second is on SG&A, we have a number of transformative initiatives that are underway that are going to liberate funding that we're going to reinvest in the top line, but also partly drop to the bottom line. And so when you think about accelerated top line growth, for a number of the reasons that Bryan has been talking about up to this point and in this call, accelerated top line with sort of constant margins, gross margins, again, margins not declining, but sort of normalized, with a leaner SG&A, those are the things that are going to get us there. Now within that, within gross margin, you have things like procurement, site optimization, Six Sigma value engineering that are going to drive that. And then within SG&A, you've got things like delayering, zero-based budgeting, nonregret moves in procurement and T&E. So we have a number of initiatives that we're completely rallied around as an LT and monitor on a weekly and monthly basis. So we're pretty confident that we're going to get to that leveraged P&L that we aspire to.

That's very helpful. And Bryan, I wanted to spend some time just kind of on the strategic evolution of Zimmer. You provided a lot of clues in your public commentary. You've talked about tuck-in acquisitions, and we've also seen -- but I wanted to start with your interest in adjacencies because we've seen some trademarks that you filed for surgical equipment. So maybe we can start with that, just your interest in adjacencies. How you see -- what role do you see adjacencies playing in increasing that WAMGR? And any public commentary you can make on the surgical equipment, those trademarks you filed.

Yes. So just to answer the question directly, and then I'll give some color. We absolutely see adjacencies and investment in those, both internally and externally, as being extremely important part of increasing the weighted average market growth of our business. And it will be something that we are highly concentrating on. And it's really just part of the phases of the turnaround that we kind of had in place. I look at it as 3 phases of the turnaround. The first one was kind of obvious. It was more around hearts and minds and just the execution challenges we were having as an organization. That's getting into the mission and the culture of the organization, changing some of the top talent, making sure supply stability was there, quality was on track, compliance, across the board, just the basics that we had to get accomplished. And then we moved really to phase 2, which was more around truly bringing innovation to the market versus just supply stability, restructuring the organization to make sure that we could follow the strategy of the organization more purposely and making sure that we had very specific strategic pillars in place that we have strategic pillar priorities that we could pursue against. And so that was really more around phase 2, which is continuing, and we're really getting good traction. Now we're moving the phase 3, which is really more around transforming the organization for the future. And that will involve portfolio management in all of its components. And I look at portfolio management in 3 ways. The first one is we're going to make very clear investment decisions internal to the organization in those priority areas that we've talked about, all right? We've talked about knees being a significant priority area for us, particularly those subcategories that are fastest growing in knees, like robotics, provision and cementless. S.E.T. has got to be better for us, and we're going to make sure that we have internal investments there as well. And we want to make sure that we continue to invest in robotics and data and informatics across all of our categories. So those -- that's a big part of the transformation. But then also ensuring that in the second form of portfolio management that we look at acquisitions that can get us there faster, get us there scaled in those areas that we don't have as big a presence in today that are much faster growth markets. And then the last one is potential divestitures, where we have businesses that are not germane to our strategy, where somebody else may find them more attractive than we do and willing to pay us money that we think is appropriate. So all 3 of those things are in play right now to make sure that we do begin to transform the organization into something that looks more attractive from a WAMGR perspective. Another big part of that is not just in those key areas of S.E.T., not just in the ecosystem that we have for large joints, but also to make sure that we have a rock-solid presence in ASC. And we want to make sure that we have as much as we can possibly provide in the operating room, right, from a share of wallet perspective. So we can offer more value to our customers and be able to provide the value that we need to provide in the ASC. So again, we are squarely in that phase 3. We're looking for active portfolio management to be a bigger part of the play for Zimmer Biomet on a go-forward basis.

That's very helpful. Bryan, any -- just one follow-up on adjacencies. How are you thinking about adjacencies? Adjacencies could -- I don't know, there's a lot of ways to think about them. And any -- can you comment directly on that surgical equipment, your interest in getting into that market?

I probably would stay away from commenting too directly on any of the specific adjacency areas. But I would say that, and we've been pretty clear on, we want to make sure that we're investing in our S.E.T. business. We're not going to invest equally across the S.E.T. business, but those areas that we think are most attractive, areas that we believe we have a right to win, where we're underpenetrated today and have a higher WAMGR than our business. And that's exactly what we're going to do. It's not an irrational thought to think that we would increase our OR suite to increase the capability of the ecosystem that would be available to the ASC. So I'm not going to necessarily confirm nor deny, but I would say that it would be a rational thought that we would increase our presence in the operating room in that way.

That's helpful. And you've talked a lot about tuck-in acquisitions. One question there. Do you have capacity to do meaningful deals today? Or do you have to do -- you mentioned potential divestitures. Do you have to kind of do divestitures to do tuck-in acquisitions?

I'll let Suky answer this more specifically, but what I would say is that we -- given the COVID impact to our business in the way that rating agencies would look at debt leverage ratios, we've got to be careful today because April was a very difficult month for us. Obviously, Q2, in general, was a difficult quarter. And that put significant pressure on EBITDA, which is an important calculation in that debt leverage ratio. And as I think most people know, it's a 12-month trailing EBITDA view when you calculate that number. And so until we get past April of next year, we're going to have to be careful how much cash we deploy for acquisitions. And so we're going to balance that equation to make sure that we stay investment grade, but still make smart investments where we can. But Suky, maybe I can -- I'll let you to provide any additional color.