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

Good morning. I'm Josh Jennings from the medical devices team, representing my teammates, Neil Chatterji, Brian Kennedy and Eric Anderson. We're moving through the medical device track here on the last day of the 41st Annual Cowen Health Care Conference. And excited to have the Zimmer Biomet management team joining us today. Bryan Hanson, President and Chief Executive Officer; Suky Upadhyay, Executive Vice President and Chief Financial Officer; and Keri Mattox, Senior Vice President of IR and Chief Communications Officer. Thank you so much, Zimmer Biomet team, for joining today, and I want to give you a special thank you for making this audio-only, so I didn't have to go side-by-side to the charismatic faces that you all have. But it's great to have you here this year.

Maybe I could just start. I think everyone understands the COVID-19 trends that are in place and then lingering into Q1. But -- and you guys just had your earnings call -- fourth quarter earnings call in early February. But is there anything new to call out outside of what you provided back in February?

Suky, I might just let you just take that one. Obviously, you've been answering more of these than me. So why don't you just go ahead and take that?

Sure. So Josh, first of all, it's great to be here. Thanks for having us. Yes, we talked about the first quarter being down versus 2020, low single digits to mid-single digits, when we provided our fourth quarter earnings in early February. And our outlook remains consistent. There are, of course, some puts and calls within our -- what we originally thought to where we think we're going to land, but largely at the consolidated level, that's where we are. The building blocks to get to that guidance or that color or shaping was really around expecting a very deep trough in January versus December of last year because, again, we saw the most acute impact or resurgence of COVID towards the very end of December, and that carried through January as expected. And then what we thought we would see is, again, sequential improvement in February and then a step-change improvement into March. Coming through February, by and large, we did see that improvement. Asia Pacific, probably a little bit better than expected. The U.S., kind of in line, maybe slightly behind because of some weather issues in the month of February. And then EMEA continues to struggle, probably a little bit worse than where we expected it to be. Now as we move to March, we are expecting a pretty significant step-up relative to February. We believe that, that step-up will occur. And depending on the rate of that step-up, that will determine where in that range of low single digit to the mid-single digit we'd land. But I just want to keep reminding folks that most of the categories we operate in are progressive diseases, they're serious diseases where patients do need help. And we believe for every day that we operate at below normal market levels that we are building a very robust backlog. And the good thing is we're anticipating and seeing that the vaccine rollout in many parts of the world is actually a little bit ahead of schedule. And so that gives us even renewed optimism that we can start to turn the corner on this, perhaps even sooner. And that, that backlog can start to provide a nice tailwind to underlying market growth. But I would say that we still have to get through March. There's still some uncertainty. But in many parts of our largest markets, we're hoping that the worst is behind us.

We appreciate those updates, and thank you for sharing some of those details. I think we fully understand, most understand that the approach to hold off issuing guidance for 2021 is prudent. And I guess, the question would be, what would you need to see or experience in order to institute revenue and EPS targets for 2021?

Yes. So I would say, first of all, I hope we can provide guidance soon because that would mean that we've got to a level of stabilization and predictability in our largest markets that provide us confidence in our outlook. And that means that we've moved beyond or started to really turn the corner on COVID and started to hit sort of that natural cadence of underlying market growth. There are host of variables we look at from market to market. It's tough to generalize because each market is incredibly unique. But we're hoping that, that day is not too far off. And again, as the vaccine we're seeing in certain parts of the world come in and being adopted faster than expected, we're hoping that providing guidance is not in the too distant future. Believe me, I want to get there. But I will say, when we do provide guidance, the one thing to keep in mind, this will probably be a bit of a wider range than we typically provide. Because even when we provide guidance, there will likely be some lingering markets that have some impact or still some pressure due to COVID. And because of that uncertainty, we'll have to widen sort of the bottom end of the range. And then on the top side, again, we're excited about what this backlog could bring to underlying fundamental market growth, and that could provide some additional spread on that variability or that range that we might provide when we do eventually give guidance. So just one thing to keep in mind that when we do provide it, it could be a little wider than normal. And I don't think that's out of context for what you're seeing in the rest of the sector. The last thing I would say there, Josh, about that is one thing we count on is our execution and controlling what we can control. So guidance, we know is absolutely important. We want to get there. But it doesn't stop us or prevent us from executing every day and waking up with that mission towards helping patients and then ultimately beating the market. So the lack of guidance in no way is in any way hampering our ability to execute.

Understood. Understood. And maybe just a follow-up. Your team has been, Bryan and Suky and Keri, talked about this backlog potential a little bit more than some other large-cap management teams. Any other details you can provide in terms of how you're thinking about the backlog, where you think it stands? I think it's impossible to quantify, but if you are willing to take a shot at quantifying it, that'd be great.

I think what Suky just referenced is probably the best way to think about it. We started out early on, really trying to get every level of detail and input and every variable we could think of to build some calculus to determine what that backlog was worth. But what we came down to is that we were going to be wrong either way. And so what we really do look at is any time that the market is not performing as typical, we're building a backlog. And again, this is only in those categories where we have patients that we know will come back in the funnel because they're in progressive disease states. And so that's what we've used. We decided whenever in those categories we're below market, we are building a backlog. And I can tell you that, again, we're not correct in the number, but we're directionally correct in the overall size of the backlog, and it's hundreds of millions of dollars. I mean it's significant. And that's what's so interesting about it is we really have no precedent for this. We know it's big. We know eventually it's going to come back into funnel. But given the size of it and the magnitude globally, we're not sure how long it's going to take to come back in because we don't know the capacity constraints that we're going to be running up against. But the good news is it's a sizable backlog. And at some point, it will provide a tailwind for us.

All right. Wanted to move on and just -- and talk about the big announcement on the fourth quarter -- around the fourth quarter call about the spin-off of the spine and dental units. And maybe to just start off high level, anything you can share on just how your team concluded the spin was the right move versus an outright sale of the spine and dental units?

Yes. I mean, obviously, when we looked at the spine and dental businesses, we knew because they weren't one of our growth drivers, and they didn't meet some of the characteristics of what was attractive for us. It doesn't mean they're not attractive businesses on their own, but they didn't just meet the characteristics of what's attractive to us that to build real value in those businesses, they needed to not be in our portfolio. And we looked at, obviously, a number of different pathways over the last 12 to 18 months to determine how we might unlock that value for our shareholders and for our customers, our patients and our team members. And in looking what was available to us, we decided that the spin was -- made the most sense. And the fact is, if you look at this historically speaking, these spins do create value. And we certainly expect that to be the case here. You see both RemainCo and NewCo drive value as a result of a spin. And we would certainly, again, expect that to occur. The fact is, we just had not put the same level of focus from a resource standpoint or just a mind share perspective on the dental and spine businesses. And the fact is they deserve more than that, and they're going to get it now that they've got a CEO that's 100% dedicated to both of those businesses.

Understood. I think for investors to try and kind of value the future independent companies and make a determination of how much value is being unlocked by this move, there's some metrics that people need or investors need to kind of do some of those analyses. Is there any incremental insights you can provide? I understand there's going to be intense focus, more intense investments, which are important things, no doubt. But anything else to help investors understand how the spin can unlock value by unleashing the spine and dental units into a combined business?

I mean you've captured a lot of it. And Suky, maybe you could get into some of the detail we've already provided. I think we've provided quite a bit, actually. I think what's important to recognize, though, when we provide the impact to RemainCo, you can then derive based on that impact to RemainCo some sense of what the revenue growth profile was that we expected for those businesses in a steady-state environment and also the profitability. But what I would tell you is as they become separate from Zimmer Biomet with that focus that you've referenced, we believe, obviously, they're going to perform better than what we had assumed underneath Zimmer Biomet. So even though you can draw some conclusions to what that revenue growth profile might be, what the profitability might be, my sense is, again, with Vafa Jamali coming in to run this business, you're going to see an acceleration in revenue growth and an acceleration of profitability. But maybe, Suky, you could remind everyone what it is we said in the past about the impact of RemainCo.

Yes. Sure. So on the RemainCo side, we said post-spin, that from a revenue standpoint, this would accelerate RemainCo's revenue growth profile by approximately 50 basis points over the next several years; and then from a margin perspective, would add about 125 basis points on a pro forma basis to operating and EBITDA margins. And again, that -- I think both of those measures, one, instill even more confidence and certainty in us reaching those mid-single-digit 4% to 5% top line growth aspirations and bottom line, 30% by the time we exit '23; and potentially even brings them in and provide some upside to that. So we feel really good about that. And then on the NewCo, on the building blocks there, Bryan really put it. I think with the focus, the attention, better allocation of resources, we believe, opposite -- what I think, what I believe to be, what we believe to be an attractive portfolio, for example, in spine, in attractive submarkets within the spine market around our cervical disc portfolio, around our opportunity to take Tether potentially closer to or to become standard of care in pediatric scoliosis or our ROSA platform within spine are all very powerful growth drivers. And again, in faster sub-growth markets within spine, that lead to attractive opportunities to grow that business faster than they would otherwise under the Zimmer Biomet portfolio. From a resource allocation standpoint, I would say, when you think about NewCo relative to RemainCo, the OpEx percentage in NewCo is significantly higher than it is in RemainCo. And I think that you can kind of get there if you looked at all the math on the metrics I provided earlier, which gives you an indicative view of what NewCo could look like. But that high level of investment, it's not an underinvestment in those businesses. I think it's an opportunity for mix shift and to optimize that investment. So if you take the ability to optimize those investments, opposite what we believe to be very attractive assets both in spine, dental and in OBT, in better growth submarkets within those overall marketplaces, we think that there's clear opportunity there. In fact, we actually started to demonstrate that, right, with better focus, better management attention, the right investment mix, perhaps a little bit of incremental investment in dental. We took a business that was declining every quarter sequentially since the merger to a business in 2019 that started to actually turn around and grow in the low single digits. So again, taking that same playbook and applying it and accelerating it in dental, applying it to spine and turning that business to low single-digit growth, again, we believe that the opportunity is there to create more value than it otherwise would have in the total portfolio. So hopefully, that gives you a little bit more color, Josh, on the building blocks to get there.

Oh, that's helpful. Definitely. And I mean, just -- I think it's too early to provide any details on the potential cap structure of NewCo. But I mean, when do you think you'll be able to provide some of those metrics to investors? Should that be closer to the close of the transaction or any time in front of that?

Suky, if you're talking, you're on mute.

Yes. Sorry. So no change in the time to close the transaction. We still are working towards mid-2022. And we're still, quite frankly, working through all the details on what the specific of that transaction will look like, how it will be structured, what's the capital structure look like for NewCo. But we're operating under some basic guiding principles. For example, on NewCo, when you think about capital structure, we want to set that business up to succeed. We think it's already in a relatively solid, strong profile, and we're going to invest a little bit more actually this year to give it a running start. So when it is on a stand-alone basis, it's already moving towards that growth profile that I talked to earlier. And we'll put a capital structure in place that allows us to use its relatively strong EBITDA profile to pay down debt if there is debt on the balance sheet of NewCo. So that it can engage in active portfolio management not too long after spin.

Okay. And then just congrats on recruiting Vafa over as the CEO of NewCo. How should we think about his access to ROSA Spine? And just where will the -- how work mechanistically will they have an independent robotics team that will sell systems? Or will your robotics franchise sell NewCo ROSA Spine systems at a transfer pricing honed to the patents? Any details that you can provide just on the mechanics of getting ROSA Spine over to NewCo?

Yes. I think in simplest terms, I would just say that, absolutely, Vafa and team will have access to ROSA for Spine. There's no question about that. He is going to have the rights to determine what the technology road map is, the amount of investment that he want to make -- he wants to make to drive that technology forward and, obviously, the commercial focus as well. To be honest, relative to structure, I just don't know yet. We haven't really worked through the mechanics of it. I would assume that there'll be some form of a TSA in place for a period of time on the R&D side of things. But on the commercial side, I would think it would transfer pretty quickly to his responsibility and his responsibility solely. But just given the infrastructure buildup costs associated with that type of R&D infrastructure, we would assume that we would continue to be a partner with him for some period through a TSA. But again, we just haven't worked through it completely yet.

Got you. And just one more question on NewCo and ROSA Spine. Without being able to attend the NASS 2020 late last year in person, I think we fell behind into understanding where ROSA Spine sat in terms of the commercial launch and development progress and where the technology kind of sits today relative to some of the other platforms that are out in the marketplace for Medtronic and Globus. Any details you can share just in terms of where you are in the launch and where the technology sits relative to the competitors?

Yes. We're pretty early on in the launch. We're still in limited launch phase, and that's actually a really good example of probably the difference in focus that you're going to get from someone like Vafa and what we had on spine robotics. We've put it on the back burner. We could have launched earlier than this. But as we said before, we've put it on the back burner for spine because we wanted to concentrate our efforts in orthopedics. That was one of the key areas we absolutely had to win in. We wanted to move fast, and so we delayed the launch of the spine application. And if you were a stand-alone spine company, just given that there's very few that actually have robotic systems that are effective, you would be all-in. I mean you would be moving very fast, would be the primary area of concentration. So that just gives you a great example right there of the difference you're going to have as a stand-alone organization and the concentration they're going to have. And so just to put a -- to then kind of just answer your question, it's pretty early. We have only a handful of systems out in the marketplace. We're learning as we go. We want to make sure that we launch in an effective way. And we're learning as a result of that and what we need to see in version 2, which we are already investing in, and we would expect over the next 24 months to have additional launches inside of ROSA for spine. So that's where we are early on, good feedback so far. But we're seeing some opportunities to enhance the system, and we're already working on those.

Great. Maybe we can -- we move over to ROSA total knee and just talk about the momentum you guys captured. Higher percentage of outright system sales in the fourth quarter suggest that the capital spending environment in the United States and in some other countries is improving despite the lingering pandemic headwinds. Any change to what you downloaded on the fourth quarter call just in terms of the capital environment? And then if we -- are there other checks to suggest that there's continued progress? And budgets seem to continue to open up. But wanted to just sit and check that one. It's only been a month since your last call.

Yes. Fourth quarter is always that quarter, though, that you probably see an outsized focus from hospitals to use up their capital budgets for the year. So it's not atypical to see a strong fourth quarter from a capital perspective. It was a little better as we referenced in the call. This fourth quarter, I think people had more budget due to some of the help they got because of the pandemic. And they were spending it. And we certainly took advantage of that. You usually would see a deceleration coming out of the fourth quarter then as a result. And when you do see, even in any quarter, really, you see at the end of the quarter is when people typically try to spend the money. So as much as you're trying to get people to move during the quarter, they typically wait towards the end before they actually do the transaction. So it's still early for us in the first quarter. But I would agree. I think that people are feeling more confident because the vaccine is rolling out. They feel more confident because the surges are coming down from a virus perspective. And they're feeling, as a result, more confident in their capital budgets. And certainly, we want to make sure that we take advantage of that. What we will not let happen, though, is if capital budgets are, in any way, shape or form, pressured, we're not going to let that get in the way of us rolling out ROSA. As we've talked about, we have other methods to be able to put ROSAs in hospital systems. And if people are tight on the capital budget but they'll commit to us competitive conversions, I'm perfectly happy with placements that drive those competitive conversions. As a matter of fact, that's very attractive because it gets us linked with an account for multiple years. Usually puts more pricing stability in place and then obviously drives competitive conversions, which is more of an annuity, anyway.

Excellent. I mean your team has talked about 40-plus percent of the ROSA placements going into competitive accounts. There's -- investors are focusing now on J&J catching up and launching Bellus. It's early days for them. But can you just remind us where your competitive wins in terms of ROSA placements disproportionately weighted towards a few customers? And what do you think the potential impact will be to Zimmer from J&J's Bellus launch?

Yes. I would say, I wouldn't use that 40% number. I don't know if that's a good way to think about it. I think that it really depends. I would say every system that we place is in an account that does have competitive users. So even if it's one that we would consider a stronghold ZB facility, it's very atypical to see an account be completely homogeneous with 1 manufacturer from a plant perspective. So even in those that we would consider to be a strong hold account for us, there is opportunity, and we are actually seeing conversions of those competitive surgeons that want to use robotics. So it's almost every placement gives you an opportunity to get a competitive conversion, even if it's a strong account for us. Relative to a new launch from J&J, I think it's good for the robotics market and for the orthopedics market as a whole. We saw in the fourth quarter that we had the best placement numbers since launch of our system. And at the same time, one of our competitors had their best placement numbers in the fourth quarter as well. And that just indicates that there is significant momentum right now towards robotics in orthopedics. And we have significant under penetration, which means you've got a pretty significant tailwind that we can take advantage of for some time. And I think as you have other players like J&J bring their system to market, it brings more credibility to robotics. And to me, that creates a tipping point in the market to eventually allow robotics to be standard of care, which I think is good for everybody. It's good for patients because you're going to get better outcomes, we truly do believe. It's better for surgeons because they feel more comfortable doing the procedure. And it's great for the market.

Understood. And just to follow up on some of those comments. It is -- it's rare to see a total knee practice with multiple surgeons having 60%-plus share of 1 manufacturer's implants. So I mean, just thinking about that dynamic and now with all 4 of the major players having robotic systems in place, how do you see the landscape evolving with robotics? I mean do you anticipate high and medium volume, total knee centers ultimately buying multiple systems from multiple manufacturers? And could we see in the next 5 years HHS have a MAKO, a ROSA, a Bellus and an ambulant system at some point?

I think you could, for sure. Yes, yes. I think, again, it's rare to see this homogeneous account. And I think that will reflect in robotics as well. The thing that I like about this is once it becomes closer to a standard of care and the expectation is there in robotics, and that's a pretty significant barrier to entry, too. So as you're players that have robotics begin to show the value robotics can bring to their customers, it's going to be harder for others to play in that space because they can't provide the same level of value. So I actually do believe that you've got plenty of tailwind associated with robotics penetration in the marketplace and also becomes that nice barrier to entry for players that don't have a robotic system. So I'm pretty enthusiastic about that. I really am. So yes, we feel confident about where we are in the placement strategy. We think having new entrants will actually provide a benefit to us in the marketplace, and we continue to push our strategy as a result. One other thing I would say, though, is even though I think there's plenty of opportunity for all players with robotics, and I truly do believe it will be a tailwind for all kind of an all boats rise, we don't want to just get our fair share. We absolutely want to make sure that we get more than our fair share. And we want to do that through robotics, for sure, because we think we have some differentiation, but we also believe that the ecosystem around robotics is going to make us stronger. We've had mymobility for a while now with Apple to be able to collect data before and after the procedure. We've got ROSA collecting in the procedure. We're going to have smart implants collecting in the patient post-procedure as well. I know we've got OrthoIntel as the backbone to be able to take the data, eventually through machine learning, gain insights. And then through those insights, use artificial intelligence to provide predictive ways to care for the patients. And we think that, that strength in the data that we're going to be able to have will differentiate us, not just with robotics but the entire ecosystem, and allow us to get more than our fair share. But make no mistake, I think there's plenty of room for all players with robotics. We just want to get more than the rest of them.

No, that makes sense. And just to build on that answer, Bryan. You've had some nice share gains with the launch of Persona Revision. How -- I think our understanding is that every point of share gain in Revision on a dollar basis -- because Revision systems are 2.5 to 3x standard de nova system, you have to look at the entire market on a dollar basis, it's more like 2 to 3 points of share gain. Can you just help us think through that, for one? And then for two, one of the promises of the ROSA total knee launch and the design was the potential to have a robotic Revision solution. Maybe you could touch on those 2 points and how big the Revision segment is for -- how long the Revision tail is and then ROSA in Revision.

Yes, just real quick on the ROSA side. We do see there is an opportunity to have a Revision application. And actually, we think that's a pretty interesting path to try to pursue. I don't want to give specifics on when we think it might happen. But that's a difficult procedure to do. It's one of the more challenging procedures, obviously. And if you could get robotics to help in that procedure, it's a real benefit. Outside of the fact that we already believe we have the best Revision system and the best tool set, for that Revision system to be able to have a ROSA application that would further help the surgeon be successful in that procedure would be a good thing. So it's certainly something we're going to pay attention to. On the Revision front, yes, the tailwind is there. Actually, I just got a note from Ivan Tornos saying that they were adding classes to be able to train. I think they even doubled the number of classes to be able to bring surgeons in to train them on Revision systems. So that just tells you, even with the demand that we already had for the system, we didn't have enough training programs in place to be able to bring through all the surgeons that want to get in the funnel to convert. So it's pretty exciting. That technology continues to be something that just thrills surgeons, and the momentum continues. And as you referenced, it's really a tip of the spear technology. You get in, get a competitive conversion to come over, and now you've got access to that other knee business as well, which is typically larger than the Revision numbers that they do. So it's a very attractive product for us. Surgeons continue to be excited about it. We are excited about it. And it's giving us momentum into 2021, for sure.

Great. There's so many elements to the Zimmer story to touch on. We only have a condensed time here, but maybe my last question, just with the renewed focus of the pandemic starting migration of orthopedic procedures to ASCs. Maybe just if you could just share with us Zimmer's ASC strategy. It's probably not -- didn't leave enough time to answer this fully. But maybe just help us understand whether you believe Zimmer is better positioned than some of your competitors to capitalize on this migration.

I'll tell you real quick then. I think we've been disadvantaged during the pandemic as a result of our presence in the ASC. We -- as a percent of our revenue, or even our market share, we have higher market share in the hospital systems than we do in ASC. Because of that mix difference between hospitals and ASCs for us, as patients have come back in the funnel, they've come faster to the ASC. And that's actually been a negative for us relative to growth from a mix perspective during the pandemic period. But that's also an opportunity for us. And so we are absolutely now focused on the ASC. We have a direct infrastructure in place to get after it. We just did an acquisition of booms and lights in our sports area to be able to build more scale. And we are going after now getting to the same market share position in ASCs as we have in the hospital system. So we actually look at it as an opportunity for us to be able to pursue ASCs, build scale on those areas and contract more effectively. But it has hurt us in the short term because we have -- we don't have the same market share in ASCs as we do in the hospital.

Great. Well, I think we've got to wrap it up there. Brian, Suky, Keri, thanks so much for joining the 2021 Cowen Health Care Conference, and hopefully, we can do it live next year in Boston.

Very good. Thanks so much. Thanks for having us.

Thanks, everyone.

Thanks.

Thank you.