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

Good afternoon, everyone. Coming to you live from the Morgan Stanley Healthcare Conference Year 2020. My name is David Lewis, medical device analyst at Morgan Stanley. And thanks for joining us here as we progress through the afternoon. It's our pleasure to have with us here members of management of Zimmer Biomet, both Bryan Hanson, CEO; and Suky Upadhyay, the CFO; and Keri is here as well. We're going to jump right into Q&A.

Bryan, I think we're going to dispense with the preamble. And I want to start, Bryan, just on recovery here with COVID-19. We had a pretty bullish intraquarter here post the second quarter. Just want to kind of talk about a little bit about what has happened from a trend line perspective here in July, August and into September?

Yes. So can you hear me okay?

We can.

All right. Great. Yes. So yes, we were pretty bullish on the earnings call, and I would tell you that what we had predicted at the time was that we would continue to see sequential improvement even beyond July. We did say that we thought it would be more tempered than we had seen in the second quarter. But in fact, we have seen that sequential improvement, and it's probably been a little better than we expected to tell you the truth. So early September, obviously, we're not that far into it. But the fact is what we've seen so far, both August and September so far, we're seeing sequential improvement in both months.

Okay. Very helpful. And then, how are you feeling about kind of getting back to some segments of normalcy by the fourth quarter towards the end of the year?

It all depends on how you define normalcy, I suppose, right? I mean there's going to be -- I don't think we're going to see normalcy in the sense of just typical patient volume for a couple of years just because it's going to be muddled by all these major variables. But if I think about just procedural volumes, I do believe that we could get back to normal relatively quickly. The fact is you've got a large backlog of patients that we're working our way through. That's a pretty big variable on this. You've got this fear associated with the virus. It's a pretty big variable. That's a headwind. And then you've got the surges in the virus. And I think the combination of those 2 things, all those 3 things right now can get us to normal procedural volumes, even though it's really not a normal way to get there, right? So I can certainly see a pathway if things stay consistent in those variables and the way that we've been seeing them today to getting there in the fourth quarter. And I would define normal as similar volumes to what we saw in 2019.

Okay. One of the things that were concerned about orthopedics was that we saw the significant backlog in procedures that drove recovery, but then there was not going to be sort of this new patient demand or new patient willingness. Do you have a decent sense of what the backlog dynamic is versus sort of the new patient demand because I do think investors are concerned about economic fortunes, willingness, things that sort of catch-up to you later in the year?

Yes. It's a challenge, David, because we're trying to track that for a while with this idea of how much of the backlog are we kind of eating through that deferred patient versus a new patient. And it's become a bit muddled because out of the gate, we were able to look at those patients that were in the funnel and delayed. And I think we'll work through those pretty quickly. But you still, every day that we're not at market growth, we're building another backlog, right? So it becomes challenging to know as patients come into the funnel, are they new or are they just now delayed patients? The good news is that, again, every day that we're not seeing at normal procedural volumes, the backlog is growing. And what we've learned in history is that 80-plus percent of those people eventually come back into the funnel.

Okay. Suky, thinking about 2021, I know it's very, very early, but some of our CEOs and CFOs have started to comment large gap Medtech about what '21 could look like. I think I look at my model, I have sort of '21 at 2%, 3% above 2019 and margins sort of flattish in '21 versus 2019? What can you kind of help us with qualitatively or quantitatively on '21 relative to '19?

Yes. I think there could be a path where '21 looks at '19 levels or potentially better, right? It's going to come down to those variables we've been talking about, around backlog, which is clearly going to be a tailwind for us, as Bryan said. Even though we may work through the majority of the initial backlog from April and May, we're continuing backlog every day that were below market growth. And most of that comes back to us. The tailwinds are a little bit tougher to predict right now -- or sorry, the headwinds. And those are really around that new patient dynamic that you referenced earlier in your question. And when does that get back to normalcy. Also, we have to watch the second surges that are still very prominent. And then we're entering into the flu season. So there are a couple of dynamics here that are still -- create a little bit of uncertainty. But if everything continues to play out as we've seen through the third quarter, and that continues through the fourth quarter and beyond, there is a pathway to getting back to '19 revenue levels potentially, maybe even better.

Okay. And then on margin, Suky, as I think about -- I got flat margins in '21 versus 2019. To the extent you can get back to growth, can we start to see margin expansion in '21? There are some tailwinds in the business like gross margin and things like that, that could come into play. But how are you feeling about margins '21 versus '19?

Yes. I would say the margin profile is likely going to lag by 1 quarter to 2 quarters versus the revenue. We're still being a little bit cautious on some of our investment profile, given that there is uncertainty left in the remaining part of this year. So we'll have to turn that investment back on. That will likely come sometime back into 2021, if we're seeing that the durable new patient flow is there. So that will be a bit of a headwind. But again, it's a headwind there to help accelerate revenue growth for the longer term. So some investment will turn back on. The second piece that could cause a bit of a lag in that margin progression versus revenue would be, we've had a number of fixed overheads this year because lower volume that are just going to get deferred as unfavorable variables -- or unfavorable variances into next year. So it gets a little bit complicated, so there is a bit of a headwind there. But make no mistake about it. If revenue is there, the durable underlying margin growth will also be there. But again, just maybe lag by a quarter to 2.

Okay. So Bryan, when you took over, we talked about a couple of things in terms of like our thesis on say on, right, stabilize the business, they can grow it and then maybe optimize the portfolio. And a funny thing happened, as COVID started, we started to see momentum improvement in new business last year, early this year. Then COVID hit. And while ICU has gotten more conservative from a messaging perspective on what your business could grow, you got more aggressive, right? We're talking about 2% to 3%, and now we're talking about 4% to 5%. What is it during COVID that is giving you this kind of conviction because I think a lot of investors are saying, he saying very interesting things, but I can't see it in the numbers. So why 4% to 5% now? Why are you so bullish?

Yes. It's kind of a broad-based answer. But what I would say is we've looked at the turnaround for Zimmer Biomet in really 3 major phases and the way I thought about it. The first was really around kind of hearts and minds, making sure that we capture people's energy, focus of One ZB versus the 2 individual companies that we had previously. And really just the issues that we had around execution. We had real challenges on execution. So now that we've gotten to the point where the engagement is high in the organization, the fact that we don't have some -- supply issues anymore, we don't have things looming on quality side. Everything is working from an execution standpoint. That's just out of our one share right now, which is really important how to get to that point. The second phase is more around crystallizing the strategy and launching innovation. It's not good enough just to be able to supply the product, just have the engagement, you've got to have new innovation. And the new innovation is working. I mean, ROSA is doing well, Revision is doing well, ONE Planner is doing well, mymobility is doing well, pretty much everything we've launched is doing well in the marketplace, and we're executing flawlessly. So it's a combination of just getting rid of the baggage that was holding us down. And in concert with that, launching products that are actually working that truly people want and are desiring at a high level. And so to me, it's that combination before even 1.5 years ago, I didn't think we could get there. Truthfully, just with all the baggage and everything, 2% to 3% make sense to me. But now that I look at it with the new innovation coming, I feel more confident over time with that mid-single-digit growth. Now it's not all created equally. You know the components that I've talked about in getting there. I feel very confident about overperformance in the knee. We have all the components in place, and we did get a glimpse of it before COVID. So we had an opportunity to see the execution of the base business and the strategy starting to drive real traction in the knee business. So I knew it was there, and I know it's continuing because we're continuing to move in that direction. Hips done pretty well too. With the Avenir Complete has done really well for us and stayed kind of the upper end of the market growth. The one thing that I don't feel yet 100% confident around is that we just haven't had the ability to prove quarter-over-quarter that ability to be in the mid-single digits if not the high end of that. But I do believe the components are in place, I just haven't proven it yet.

You had given us a rough time frame for when the business could go from stabilization to 2% to 3%. What's the right time frame to think about the 4% to 5%? Is it an equivalent period? Maybe you pull in that time particularly to go from 0 to 2 to 3, is that how we should think about going from 2 to 3 to 4 to 5, which should be sort of another 2 years?

Yes. My hope is it would not be 2 years. I really do believe we've got to firm up the set side of the business. And in reality, we're not that far away now from robotics launch on the hip's side. And if we've been able to be on the upper end of that market growth in hip, with robotics coming, I've got a chance for overachievement there, maybe in a quicker time period than we expected. So my hope would be that you're not looking at a 2-year window. The challenge that we're going to have is you're going to have some muddleness in the way that we look at the numbers. So even if I know that we're doing well, we might have a backlog of patients coming through that's offsetting fear and surges in the virus, so we look better than we actually are. And then if that happens, eventually, you're going to have that as a headwind in 2022. So I think it's going to be challenging for us to prove where we are. But I can tell you that the components are there on the knee and the hip, and S.E.T. should be coming. I look at the product launches that we have, I look at the commercial organization, I look at the traction that we're getting, I feel confident we just have improvement here.

Okay. So 4% to 5% growth on an underlying basis, there could be some noise and you think 2 years or so or 2 years earlier is a pretty decent target?

Yes, exactly. Yes. Let's put it this way, I feel very confident about our ability to grow 4% to 5% organically in the way that we've described in the not-too-distant future. And I feel even more confident that we can begin to surpass that by moving into active portfolio management.

Okay. And so as a second piece, and it's a good segue, you're like my straight man this afternoon. But I think about 4% to 5%, but I say to myself, can Zimmer really be a 4% to 5% grower with the pieces in hand. At least my next point, which is that I'm not sure you can. There's 2 ways to grow a Medtech, right? You're going to be in faster-growing end markets, so you got to take share in the markets you're in. And it sounds like you want to do both. You made that statement on the second quarter call when the businesses are going to get outsized investment in the ones that are not. And when you make a statement like that in a public forum, I think, it gets people, including myself thinking, maybe those businesses don't need to be part of a hole. So number one, can you get to 4% to 5% with the current makeup of this corporation? And then what are you trying to signal about businesses like dental and spine over time?

Yes. So I would say, I do believe that we can get to 4% to 5% if you change nothing from a portfolio management standpoint in our business, kept everything the way it is and then performed in the categories that I referenced before. So my confidence level is high, we can do that. Separate from that, we are now in Phase III of this turnaround for ZB. And Phase III to me is transforming the portfolio, which is active portfolio management. Now I think of active portfolio management in 3 categories: one is it's basic, it's internal focus, it's making sure the resources are going to those areas that we define as growth, right? They are growth drivers, which I have communicated. Just because something doesn't fit in a growth driver, it doesn't mean that it's not important to us. It just doesn't -- it's just not going to receive the out investment -- the outperformance investment. The second piece of it would be M&A. Can we acquire in faster-growth subcategories to be able to build our weighted average market growth in those businesses that could be profitable for us? So that would be another component of active portfolio or management that we're very focused on right now. And the third one is potentially divestiture or spin. Are there categories that don't fit into our strategic priorities, that somebody else sees us more valuable than we do, and as a result of that, we would potentially exit those businesses. All 3 of those things right now are on the table, and all 3 of those things could be actioned in the near term.

Okay. And then Suky, I think everyone used to assume that dental was an area that made more sense. It was the area that made less sense inside of Zimmer. I felt a year ago that perhaps that was not necessarily the case. And again, we believe that because it's quasi orthopedics, there some biological synergies that spine belongs inside of this business. How are you feeling about those 2 pieces independently about what makes more sense strategically inside the company?

Yes. I think it's important to state too that because something is not defined as a growth driver today, whether that be dental, whether that be spine, CMFT, or other businesses that we have, it doesn't necessarily mean that they couldn't be a growth driver in the future. If the management team over that segment puts out a road map that looks compelling to us with the right investment strategy and the right returns, it could certainly become a growth driver for the organization. So I just don't want you to think that because something is not a growth driver, it's immediately for sale. That's not the case. It could very well be a business that we just managed differently, be able to take cash from and also spend from and invest in the growth drivers. But they're all important. All the businesses that we have serve a purpose, there may be a different purpose, but they serve a purpose for the organization. So what I would tell you is that just because dental and spine because everybody keeps bringing those 2 up, are not a growth driver does not mean I'm selling them. If somebody came along and said, "Hey, they're very interesting to me, and I'll pay you more than you think they're worth," then I would certainly pay attention.

With that being said, you're trying to take urgent action across the business. You're not trying to get to 4% to 5% growth in 5 years. You just said you want to get to 4% to 5% growth in less than 2 years. And when you make a public statement about where you're putting money and where you're not putting money, I think, it makes a message to the firm into investors about how urgently you're trying to reshape the portfolio. So my sense is, is 2 years a good time frame for investors to be thinking about in terms of portfolio optimization as well?

Yes. I don't want to speak specifically to give an area. But what I would tell you is that in the next 12 to 24 months, when I think about active portfolio management in the 3 categories I referenced, you will definitely see action in that total category. I don't want to speak to specific cylinders inside of it, but all of it is on the table. And the goal is to transform the portfolio over the next 5 years. And that means taking action as quickly as we can to move in that direction.