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

Okay. Sorry about that. All right, sorry, everybody. A little technical difficulty there. I apologize. It's Bob Hopkins from BofA on with the next fireside chat. I really appreciate everybody being here, and we're honored and excited to have the senior leadership team from Zimmer Biomet today. On the line with us is Bryan; and Suky; and Keri, CEO, CFO, Head of Investor Relations. I'm sure everybody knows who they are, and we really appreciate your participation today. So thanks for being here. Bryan, do we have you on the line?

Yes. Can you hear me okay?

Excellent. Yes. We can hear you just fine. And Suky, we have you too, right?

Yes. Good to be with you, Bob.

Excellent. Yes. Really appreciate your being here.

So yes, we'll just kind of get right into the question list here. And we're obviously coming off your first quarter, and we've heard from all the orthopedic players now, so we have a sense for where things were in the first quarter. I wanted to get, to start out, Bryan, your sense for just kind of where we are right now in terms of the recovery in hips and knees. Stryker gave us some data on March, April. You guys kind of hinted at your thoughts there. And I just wanted to kind of get your take as to where we are right now because it seems like, obviously, slow first quarter and then some encouraging signs in March, April. But we're not quite back to an exciting level yet. But I just wanted to kind of start out, get your take on where we are today on the pace of the recovery in hips and knees, and then we'll go into a whole bunch of other topics.

Okay. Great. Yes. So why don't I start with that answer, Bob? And then, Suky, obviously, if I miss anything, you can fill in the gaps. Obviously, you're extremely close to this as well. What I would say is that we are definitely seeing acceleration from Q1 to Q2, which I know everybody is looking forward to. And we would expect that acceleration to continue into Q3 and into Q4 and again, see that sequential improvement. What I would tell you though inside of that is that -- I'll talk about the U.S. first because it's probably the cleanest one to look at. We are seeing movement in the right direction. And everything is aligning exactly the way you would want it to. You've got the vaccine rate going really well. You've got surges coming down. You've got surgeons saying they're ready to do procedures. You're seeing hospitals are saying they've got the capacity to absorb it. You've got patients that must be in pain because they have a disease that just progresses in that way. So all the components are clearly there for this thing to begin to take off. But I would tell you that it's not quite there yet though. I mean everything is there. It just hasn't quite happened yet. And it would be a good analog that would be if you were having a dinner party at 7:00 p.m., and you invited a bunch of people and you pretty much know everyone's coming, but 7:15 and nobody is there yet, right? So you know they're eventually going to come, but you're a little nervous because it's 7:15 and you were thinking it was going to start at 7. And that's kind of where we are right now. It's coming, there's no question, but that's the reason why we gave the guidance that we did. We gave the color on the balanced guidance for the year. It's the color we gave in Q2, was to assume that this may take a little bit longer than we were hoping. That's when I look at the U.S. So it's coming for sure. It's just a question of when, and our guidance takes into account that timing. So if we catch this earlier than we expected, and we could see more strength in the second quarter, we're going to be at the high end of our guidance. If it takes a little longer, we could be at the low end of the guidance. But that was the whole reason for the range that we provided. Now outside of the U.S., what I would tell you is that it was a little different depending on where you are. But Latin America continues to be a challenge. Canada right now is a challenge for us. Pretty much all of Europe is lagging behind the U.S. from a vaccination standpoint, will be a challenge probably a quarter beyond, behind that. And then parts of Asia Pacific, mostly Asia Pacific is strong, but you're still having problems in India and Southeast Asia. So that's kind of the way that we look at it. And we really tried to capture that balanced view of what we thought would happen for the year. But my hope is the takeaway is we're just about there. It really feels like we're just about there for it to move in the right direction.

Yes. Yes. Great. That's helpful. I guess kind of just loosely speaking, from a market perspective, do you think where we are right now is kind of pretty close to where we were in 2019 at this time? Is that kind of a fair way of thinking about it from a United States perspective?

When you say that, you mean like a -- just to make sure, if you can maybe say that in another way.

Global, like a global -- just -- yes. Sorry, sorry. The global hip and knee market, kind of where we are right now roughly versus 2019.

Oh, I see what's you're saying there. What we said about Q2, and I'll just take that Q2 as a snapshot, that we felt we would exit the quarter at 2019 levels with the potential to be slightly above. But we did not think we would be at 2019 levels for the entire quarter, right? So if I just think about 2019 -- when I say 2019 level, it's total revenue that you'll be able to see in 2019. And so that's the way we're looking at it from a global standpoint. It could be a little different by region. But from a global standpoint, that's the way we're viewing it.

Okay. Okay. And then, Bryan, when you look at -- because everyone's just constantly asking all these orthopedic companies about backlog and what you're seeing and how big could it be. I mean obviously, it's -- it's not an unimportant question, but it is a fairly -- it will be sort of transient, but it's still a question that people want to ask. So are there parts of the world where you actually see that backlog kind of kicking in, or is that something we're still waiting for on a global basis?

Yes. It's an interesting question, Bob, because it's always hard to ascertain exactly what you're getting when a patient comes through because it's kind of become a little more blurry to understand is this a backlog patient or a new patient anymore. But what I would tell you is that the way we look at it is, first of all, to answer your question, there are places in the world today, like Australia, for instance, that we do believe is a net positive. They're getting more backlog right now, and it's overcoming pressure from the virus. And so you're going to see that in certain parts of the world. But if you look at it on a global basis, the way we look at it is everyday that we're not growing at market is a day that the backlog is growing because there's been no fundamental shift in the disease itself or the incidence rate or the pain associated with it. So if we're not growing at a typical rate, that would indicate that patients are not entering the funnel that should, and they eventually should enter the funnel. And it's not an unimportant question at all. I mean this is a very sizable backlog. And I would just give you a sense. Our guidance, the midpoint of the guidance, would actually assume that we will start 2022 with a bigger backlog than we started 2021 with. And it's a very sizable backlog. And it's very important, I think, for the orthopedic space once that backlog begins to outweigh the pressure of the COVID disease itself.

Okay. Okay. That's helpful perspective, too. And I also just wanted to get a sense -- and by the way, just to kind of step back for 1 second, I wanted to kind of start out with some of these questions just following up from the Q1 call about the market and the other topics we'll touch on here, China tenders and a little bit about your guidance. And I did want to leave some time at the end because you made some really important comments on your quarterly call about the kind of the long-term growth outlook for orthopedics. So I'm going to get to all of those. But just to finish sort of this first thought process on the shorter term, on the Q4 call, you guys had talked a little bit about getting a boost to your results from some bulk purchasing. And do you -- I know there -- you said there wasn't really any bulk purchasing that went on here in the first quarter, but if I look at the -- your -- sequentially, do you think that, that bulk purchasing that went on in Q4 kind of stole a little bit from Q1? I just wanted to kind of complete that thought since you guys talked about it on the Q4 call.

Yes. And so quick answer is yes. And I'll step back for a second but I'll just say, hey, Suky and I and Keri, we're very, very big on making sure that we're as transparent and balanced as possible when we talk to you, Bob, obviously, and everybody and all of our investors. And we take that very seriously, spent a lot of time on it to make sure that we are that way. And that was the reason, when we were in the fourth quarter, we had some extraordinary purchases. We wanted to make sure you know about it, first of all, because it's the right thing to do, right? It's that transparency, this whole philosophy that we have. But secondly, because what you're saying, or your question, typically, when you have those, it does bleed out in the next quarter. And so we would have expected that. It happened. The good news is that the underlying strength of the business was strong enough, where we still performed very well versus market. But there's just no question, that's what you would expect. And then also, the other reason to do it is because, eventually, a year later, that becomes a headwind. And I would much rather talk about the headwind when it's a positive than when it's a negative. And so those are the reasons why we disclosed it. Obviously, it's important for us to tell you what's happening. But the good news is, is that we were able to overcome any of that headwind in the first quarter and still performed very well versus the market.

Yes. Okay. Great. Just kind of wanted to confirm that because we're looking at numbers in ways that -- in a little bit more detailed ways than we have in the past simply because COVID makes year-over-year stuff challenging. So we looked more sequentially and just want to make sure we're understanding all the moving pieces. So before we get to, Bryan, some of your comments on the innovation cycle going on in orthopedics and what that means for the industry, which is, again, a very important topic, I did want to hit on one other sort of shorter-term topic. And that is just to kind of make sure we're really getting our arms around your latest thoughts on the national tenders that are going on in China and what that might mean for the business kind of potentially next year. So maybe if you don't mind, just kind of give us the latest on what you're hearing in terms of timing and magnitude, and then we can talk about the potential impact on the business as well.

Yes, absolutely. So I would tell you, first of all, from a timing standpoint, the way we're seeing it right now, and anything could happen, you're dealing with the Chinese government, anything could flex, but right now, we would expect, over the next couple of months, to be able to finalize the rules of engagement, actually submit tenders, the bid, and then get a decision on who wins the bid and to what extent. But then you would likely have a 3- to 4-month delay in implementing the tender because you've got to have -- the Chinese government has got to let people build up inventory to be ready from a channel standpoint, to be able to service the business that they have just won the tender for. So my guess is you're talking about really mainly a 2022 impact, maybe a little bit in the fourth quarter this year, but mainly a 2022 impact. So that's -- again, any of that could change. But based on what we have today, that would be the timing of it. One other thing I would reference here is we're not new to VBP. We've been doing provincial VBPs for a while, and then actually, the organization has been pretty successful. ZBH has been pretty successful there. And the good news is, at least today, what they're saying is that if you have won provincial tenders in the past, those will be grandfathered in and would coexist with the national tender. Now once they finish, then you would transfer to the national tender, but that helps us too because we've been pretty successful there. So I'll just give you that as a backdrop. But if we try to put some context to the order of magnitude here, we have a little less than 2% of our business, global business, all-in business for ZBH, that would be in China and that would be applicable to the national tender, the VBP. Inside of that, there are certain categories that are not going to be included, at least today, in the VBP, which is good for us. But then that piece that would be, let's just call it a little less than 2%, even if we took a 50%, 5-0-percent write-down, which is pretty aggressive because remember, this is a -- at the hospital reduction, we don't take all of the reduction that you hear in the news, we get a portion of it because some of it is shared with our distributor partners. Well, let's just say it's 50% because it's easy math. But then you're talking about exposure of about 1%. And that would be a pretty bad case situation because that would mean you get no upside volume or anything else. But if you just took the write-down, 50% reduction, you got about 1% risk, right, for the global business. Now I would be very disappointed if we don't do better than that, but that would just be to put some context around it. Some of the things that we're going to leverage is that we've got a local brand. That is a higher-margin brand for us because it's lower cost that we're going to maximize here, and it also reduces exposure from a pricing standpoint external to China. We have certain products that we're not going to bid that we think are very good products because there's still 20% that they can buy off of VBP that we could then pursue with those products. And we have a lot of waste, from a margin standpoint, in our channel. And our whole channel strategy is going to be adjusted as a result of that to be able to pursue a reduction of the revenue impact and the margin impact. So there's a lot of variables that are included in this equation that we're going to be flexing. And again, we do have some experience in this with the provincial VBPs.

Okay. Okay. Yes, I realize there's a lot of factors to consider when you try to think through what the impact could be. But what other -- or 1 or 2 other questions on this. Do you -- one of your competitors has said that they would not be surprised if this -- this tender process includes spine and trauma sometime later this year or early in 2022. Are you guys hearing the same thing?

I mean we're hearing a lot out of the government. But I think trauma could be. I think it's a more -- much more challenging category, just given the complexity associated with trauma, and spine potentially as well. But it really comes down to how well-equipped local players are to be able to compete in the space or how concerning it would be if it does pursue it, if it does go in that direction. But there's nothing that is solid outside of large joints, for us anyway, that would indicate that anything is coming right now. Anything could change, but I don't have any information that would say those things are going to occur in 2022. Not saying they won't, I just don't have any facts associated with it.

Yes. All right. Before we move on, one other thing we've heard from other players in this space is that, potentially, distributors slowing down purchases ahead of the China tender. I know it's a pretty small part of your business overall, but do you hear anything along those lines?

Just to make sure I got that right, can you say that again?

Yes, just that distributors in China slowing down purchases ahead of the China tender. That's something that Smith & Nephew threw out there. I mean I'm not sure how you measure that or what the impact might be. Just curious if that's something you had heard as well.

Typically, what you find in China is that distributors hold a little more inventory than other parts of the world. It could be months of inventory. So we wouldn't necessarily feel it. The growth in China has been pretty good for us. And so if it is happening, I'm actually happy about that because that would say that we're growing right through it. But I don't have any facts that would speak specifically to folks de-inventorying right now.

Okay. And revisions are excluded from this, correct?

Right now, revision and partial are not on the tender, and that would be good for us. Obviously, we've got a good position in both of those categories.

Okay. Okay. All right. That's helpful. I appreciate you indulging me there. And I realize that it could be a scenario, back to your point on backlog, where you don't even know there's tenders going on potentially if the backlog is coming through the way it might over the next 2 years, but it's still important to have kind of the facts on China. And so I appreciate your answers to those questions.

No problem. I mean what you just said is important because if this has got to happen and there is some risk associated with it, well, you would rather have it happen now when you got the potential for a significant backlog, [ that's a pretty good tailwind ].

Right. Right. Yes, exactly. And then before, Bryan, we move on to that last topic, we got talking about orthopedic markets longer-term, I did want to talk a little bit about the earnings guidance that you guys gave for 2021. It was kind of interesting to know you're one of the few companies where the EPS guidance was actually above where consensus was. And so just kind of curious, maybe for Suky, if you're still on, what -- just kind of what the thought process was behind the guidance for this year and just maybe what you're assuming on kind of gross margin and operating margin trends for the year and just kind of give us a little bit of background there as to the thought process that went into the guidance.

Sure. Thanks, Bob. First of all, I'll just step back and say, with revenue, our guidance ranges are a little bit wider than usual, and I think that reflects still some uncertainty in the market related to COVID, and then, of course, we're pretty heavily [ indexed with elective ] procedures. So at least in the near term, it reflects that there continues to be some uncertainty. But it feels good to have guidance out there because that ultimately means we feel like the worst of volatility is behind us. From a revenue perspective, we provided, I think, a fair bit of color on where Q2 could end up. That would imply a back half at our midpoint, that would suggest what we consider to be sort of a normal level of growth, somewhere in that sort of 3% to 4% range. And within that midpoint, we kind of think that the backlog of deferred patients was neither building nor depleting in any kind of material way, right? You're sort of running down the middle of the road there relative to the backlog. On the lower end of the guidance, we're assuming that the pandemic impact is a little bit longer than expected versus our midpoint, and it extends a little bit further into Q2 -- sorry, Q3 and the back half of the year, which means that we'll be building a little bit more backlog in the back half of the year. And of course, the upper end of our guidance range suggests that we actually start to deplete some of that backlog. And so that's how we've thought about the major building blocks of our revenue guidance. In either of those scenarios that you're left with, I think a very meaningful level of backlog that will be a tailwind into what we hope is normalized market growth in 2022. So that's how we think about the revenue guidance we provided. Relative to operating margins, I'd just step back, point us to what we said about our aspirations of 30% operating margins as we exit 2023. And if you think about that, what we've said, there were really 3 major building blocks. One is gross margin stability coming out of the back half of 2020, right? And that's coming out of many, many years of gross margin declines. And so first is getting to that stability of gross margin coming out of 2020. But that doesn't mean gross margin is going to be flat. Every quarter, there are a lot of variables that impact gross margin, both up and down, from period to period, but broadly speaking, stable coming out of 2020. The next building block was, hey, we're running a lot of transformation programs. I'm very proud of what the team has been able to execute even through the pandemic. That is making our SG&A more efficient. Some of that is dropping to margin, but more of that is actually being reinvested to drive the top line. That's the third building block, accelerating that top line for that mid-digit -- sorry, mid-single-digit growth rate that we've talked about as we exit 2023, maybe even sooner than that. And so when you put all those together, faster growth rates, stabilized gross margin, more efficient investment base, that's how you get to that longer term, more durable operating margin expansion story that we believe is very real. And by the way, that's an expansion of margin on an already very attractive margin base relative to our sector. 2021 is simply one step in that journey. And that's, I think, another proof point of our confidence in hitting that longer-term aspiration, but it's very consistent with that overall story and it's very consistent with how we've talked about as revenues begin to normalize versus 2019, we would expect that operating margin to expand. And that's what the guidance reflects. Inside of that, again, gross margin may be a little bit stronger in the first half than the second half because of regional mix. But overall, we feel pretty good about where gross margin is going to land for the year. And then on an OpEx standpoint, you're going to see a step-up in absolute dollars of investment as we continue to invest in many of the priorities that Bryan, I'm sure, will talk about here in the near future. But they will grow at a slower rate than overall revenue, but you will see [ that one ]. So hopefully, that gives you a little bit more color inside of our guidance as well.

It does. And can you just comment really quickly on how you're thinking about supply costs? We hear a lot about inflation coming back into the picture. And how is that affecting margins right now? Just some broad thoughts there.

Yes. It's a great question, Bob. So first of all, the first thing we look at is supply disruption, right? Are we seeing any kind of pinch points that would suggest we can't get the raw materials or the products that we need to ultimately supply the market? We are not seeing that. Currently, we do not expect to see that anytime in the near future. So that's our primary concern. The second is on raw material costs. And like everyone, every year, we deal with increasing prices, believe it or not, whether you're in an inflationary market or not in an inflationary market. So this is not something new that we're [ contending with ]. We're keeping our eyes closely on that. But I would say our supply chain manufacturing organization has done a great job of ramping up a number of cost improvement and cost-down initiatives that will help to mitigate any inflationary pressure [ we ] see. But right now, we don't think our guidance ranges that we provide on operating margin are at risk of inflation. That's been baked into this.

Okay. Okay. Right. I'm sure we can get into more detail on that at another time. But for now, it's important to understand that it seems real but very manageable. Bryan, I wanted to end because we only have about 4 minutes left, but I did -- I wish we had 45, but it's the nature of the beast. So you made a couple of comments and reiterated a few times on the Q1 call, you were referencing kind of the innovation cycle within orthopedics and what that might mean for the growth rate of the entire market as we think out over the next couple of years. So I was just wondering if you could kind of just summarize the point you were making there. And is that mostly robotics and sensors and related to that? Or just what were you referencing? And I just was wondering if you could give us some color on those comments.

Yes, absolutely. Yes. I truly do look at orthopedics differently now than I did 2 years ago, even 1.5 years ago, to be honest, just given the uptake that we're getting in people looking towards technology. And I think the technology revolution is not going to stop. And when we talk about ZBH in this ecosystem, you're going to see similar things from other players as well. And the beauty of that is it's going to bring in advancements in technology into these procedures that actually will take the revenue up per procedure, which, clearly, by itself, will have an opportunity to drive the market growth up for the market. But that's not where it ends in my view. I think that's a big part of it. But as you do have this technology that will become a requirement of standard of care in the future, companies that can't get there, can't provide that value, will likely cede share to those that can. And I truly do believe because of that value equation and the longer-term contracts, you might get some reduction in pricing pressure as well. Another big benefit, Bob, that I look at is there are outcomes. We're doing this to be able to drive the mission of the organization forward and ultimately get better outcomes in orthopedics. And if you do that, there are definitely patients that should be getting a surgery today but are afraid of the outcome that are not entering the funnel. If we can get the outcomes -- more confidence in the outcomes and we can show more technology, I think you're going to have people enter the funnel, and that will also drive volume. So it's a number of different ways that I think we could structurally change the market growth of orthopedics. And the kind of the neat thing about it is we're living it right now, and ultimately, we have to do it. We have to get these standards of care shifted, but we're in it and the technology is there and other major players are heading in that direction as well.

And to finish on that same topic, just one of the more visible parts of this, of course, is Persona iQ. And can you just kind of, as a closing comment, give us a little bit of an update on kind of where we are from a time line perspective there and your confidence on the reimbursement front? And then we'll close.

Yes. Yes. And so we still got to get FDA approval. Obviously, that's step one, and so we're waiting on the agency to come back to us, but we have confidence there, obviously. We would expect to be in limited launch this year, for sure, assuming FDA approval. And right now, we did a pretty significant survey, kind of a conjoint analysis with a third party of 300-plus customers, surgeons, providers, and really asked the question in a way that would say, no question about additional reimbursement or anything else, but would you pay more for this technology given the feature set? And it was a resounding yes, there would be a premium that should be deserved as a result of the feature set provided. So we're excited about that. We know the market is ready for it, and we're excited about taking advantage of that. And the fact is, remember, when we talk about ZBH, this is another variable in that interconnected equation that will help set us apart from even those other players that have an ecosystem like what we're referencing. So we're excited about it. We're looking forward to the launch. And we do not require, based on again this conjoint analysis, additional reimbursement to make it successful. We certainly will pursue getting it, but we don't require it.

Yes. Well, great. We're out of time. Sorry, this had to be so short, but Bryan, Suky and Keri, thank you very much for participating in our conference today and in this fireside chat. We always appreciate your time. Hope you enjoy the rest of the conference, and look forward to seeing you live next year. So thank you very much.

Thanks, Bob.

Okay. Thank you.