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

All right. Good morning, everybody. I'm Lee Hambright, U.S. medical devices analyst at Bernstein. We're thrilled to host Zimmer Biomet this morning. Joining us virtually are CEO, Bryan Hanson; and CFO, Suky Upadhyay. Just a reminder, investors can submit questions at any time through the live Q&A tab on the right side of your screen. First of all, Bryan and Suky, thanks so much for joining us.

Absolutely.

Great to be here.

Thank you. Thank you. Maybe just to kick it off, Bryan, it's been about 3.5 years since you took over as CEO. When you joined the company, you had been donating market share for several years and was dealing with some major supply disruption and FDA quality issues. You've been clear from the start about your 3-phase plan for the business. And you made a lot of progress despite all the disruption from COVID-19. I wonder if maybe you could just kick us off by setting the context a bit on where we are in your turnaround plan for the business.

Sure. Yes. So I would say that COVID threw us a couple of curveballs there. We're pretty well on track. And I got to tell you, a big part of being able to do this was to be able to get the engagement of the team. And we made a lot of changes in the early years, made complete changes almost to the leadership team, added a new mission, changed the culture of the organization. And a lot of that had to take root for us to really progress. And I've been very pleased with how quickly the organization has pivoted in those areas. So I would say that we're pretty far along in transformation. I've talked about the 3 phases you just referenced. Phase 1 was all around that engagement. It was all around talent changes at the top. It was around fixing a lot of the issues that we had with regulatory issues, quality issues, issues with the DOJ, SEC. We have just about everything you could ask for what was happening to us. And we had to fix those first. The second phase is more around bringing real innovation, having a long-term strategy that made sense, make sure that we have the right structure and operating mechanisms to drive accountability to that strategy. That's in full swing. And now we're in Phase 3, which is really more around active portfolio management, making sure that we have the transformation in the portfolio that we need. So I've been really pleased. Things have progressed even with the disruption of COVID.

That's great. You mentioned culture in there. Culture has been a focus for you from the start. You moved really quickly to reengage with the sales force and reshape the leadership team. Culture can take time to change, and there's always risks associated with making major changes to leadership. I wonder, can you give us a little bit of a sense for kind of what inning you're in with respect to efforts to enhance the organization and culture?

Yes, absolutely. Great question. I appreciate you asking it. What I would say is I have a very, very specific business philosophy, and it sounds very basic. But I think about mission, talent, culture and then strategy and execution. And I think about them almost maniacally in that order. I think all of them are important, obviously, all very important variables. But I'm pretty maniacal about that order. And we reset the mission of the organization. That was the first thing we did here to make sure that we had [indiscernible] mission. And we went to work on talent, as you said. We had a lot of changes. We made a lot of changes to the culture of the organization. We've been spending a ton of time there. And I would say that I think we're further along than maybe what I expected. I thought, with the changes that we made and the aggressive stance that we took on the change in culture, that people might rail against it. But in reality, that is not what's happened. It's moved faster than I expected. So to answer your question specifically, we're in late innings, which is great. But what I would tell you, in this game, it's perpetually extra innings. It never ends, right? The game never ends. So even though we're in late innings and I feel good about that and maybe got there faster than I expected, It will never end. The focus on talent, the focus on culture, that will be something we just do as part of our DNA.

Got it. So the pandemic, of course, has been a big surprise for all of us. Besides COVID-19, what elements of the turnaround have been maybe more difficult than you might have expected? Maybe where have you spent more time than you got -- you might have expected to spend?

Yes. Well, yes, COVID was unexpected for sure and, boy, it's eaten up a ton of time. Interesting enough though on that other question for culture, it actually -- even though COVID was something I would erase if I could, it actually probably helped us on the culture side of things. So as much as it was disruptive and it was something we did not expect, the way that we manage through it as a team, I think, actually brought us closer together. And so I think it actually facilitated that movement in the culture view for us. So as much as it was unexpected, it was actually a positive. Outside of COVID, the things that I would say probably surprised me most when I was here, when I first got here and the things that I wanted to change and where I focused a lot of attention, I'd say #1 was, even though a lot of people would say that I moved quickly on bringing in leaders in the organization and making leadership changes, I moved a lot slower than what I normally would. And the reason for that is I was a little surprised on how connected -- I've been in med tech in my entire life, but I've not been in the orthopedics. I was a little surprised of how connected the surgeons are with the folks in the organization. And so you got to be careful once you start to learn that on how quickly you make changes, so you don't disrupt that link. And that surprised me a bit, and I went a little slower as a result of that. And not only went slower, but also was very careful in being extremely involved in those decisions so that we had an amicable split when people left the organization. And we treated those people very well. And we made sure that we did not have the disruption as a result of that leadership change. So that probably took a little longer than I expected and probably took a little more of my time than I expected, to be honest. So that was a big one. Another one that I would say is we got pretty aggressive early on with changing the way we invest in research and development and what we invest in research and development. And you probably underestimated the response you might get from the organization in doing that. This has been an organization that has lived and breathed implants, and that has been where all the R&D dollars go. When you start to say I'm going to shift 70% to 80% of that spend to this thing we're calling ZBEdge that nobody even heard about, people respond to that. Sometimes not always positively. And so that was probably another one that maybe I didn't expect, and we had to spend a little more time communicating the why of that. But those are probably two of the big ones. Another one that Suky is going to resonate with, too, is there was a lot that we could do when we got here. Suky was like, "This is a target-rich environment relative to efficiencies. And just systems that were deficient, processes that were deficient, just a number of things that we're just surprised at where the organization was. And we had to be disciplined to not try to do everything at once." I mean, it was just so target rich. Your -- everything in your body wants you to go do it all, but we know that we can't. And so we've been pretty disciplined as a result of that and organizing what we're going to do first, what we're not going to do, which is very important and make sure that we don't overwhelm the organization. So those are probably the 3 biggest things that hit us. Now the good news, the fact that we have had to be focused on that efficiency place, is we've got more efficiency to come, which is great. But that was probably more surprising than I expected, how much opportunity there really is in the organization to drive efficiency.

Great. Excellent. So maybe let's spend a few minutes -- I want to come back and touch on a lot of the topics you just mentioned. But let's spend a few minutes on COVID recovery first. You were asked about the pace of recovery a few weeks ago. And you said we were kind of close, but not quite there yet. You used this analogy of a dinner party that was supposed to start at 7:00. The table is set. Everything is ready. You're pretty sure everybody is coming, but it's 7:15, and nobody showed up yet. Can you just give us an update on where we are now? Have your dinner guests showed up for the party yet?

Yes. It's funny because I think whenever I talk from that one, I'm going to use either analogs or analogies or something because I spent half a day with investors that day, and the only thing anybody remembers is that the dinner part. But it resonated with me, and it just kind of came out because It is kind of that feeling. If I just kind of continue to go with that analog, if you will, we have fundamentally all of these patients that have been invited to the party. And the reason why I say that is because I don't believe, none of us believe, that there's been a structural shift in the disease state. And so all of a sudden, people stop getting the disease. That's not the case. And I can't believe that there's been any structural change in the pain associated with that disease and the progressiveness of that pain or people's ability to deal with the pain. So if you just say that that's logical to think that way, there's a lot of people then as a result that have been waiting to get the procedure that eventually should come to this party. And so that's why I do the analogy. And when you have a party and you've prepared for it, which we have, we have all the inventory that we need, we have the infrastructure ready to go, we're going to be there for those patients when they come, when they actually come into the door and the party starts. And so now we're sitting there, saying, "Okay, when are they going to come?" And I would say that they're coming, that there are people coming in the door. But what we know is that there -- at any day, there could be a bolus of patients that enter the procedures, and it could be material. And that's the reason why we gave the guidance range that we did. Now if that happens sooner than we expect, we're going to move pretty quickly to the high end of the range that we provided you. If it takes longer than we expect, we could go to the low end of the range. So we're not outside of the range by any means. Actually, we're probably right square in the middle of what we know we expected from a recovery standpoint. But the reason why I bring it up is because, as time goes on, you get a little nervous, you're like, "Hey, this should be happening. Why isn't it?" But right now, we feel pretty good about the pace. And again, if it goes faster, we could zoom right to the top of that. And if it goes slower, we'll let you know when that happens, but we can go towards the bottom. The good news is, though, we've got a lot of patients waiting and we're prepared for them.

The topic of backlog, maybe for the generalist on the call, you've spoken before, you just mentioned it that your osteoarthritis incidence rates haven't changed, and this is a progressive disease. It keeps getting worse, and the pain gets harder and harder to deal with. And every day, volumes are below normal. You're adding to this backlog of patients who you believe will eventually come in. Maybe can you -- you quantified that backlog back in August at about $700 million or $800 million of revenue, and it has to have grown, I think, since then, given where volumes have been. Can you just give us the latest on how you're thinking about that backlog? And maybe help us think about like could this be a multiyear tailwind for ZBH.

So Suky is the backlog king. He spends more time on this analysis than anyone in the organization. So I'm going to just pump that over to him. So Suky, go ahead.

Yes. So thanks, Bryan. And Lee, it's great to be here with you and everyone else. And I would say the first thing is that if somebody invites me over for dinner and food is involved, I'm going to be there right on the clock because I don't want to miss a single minute of it. But anyway, regarding backlog, your calculus is the way we think about it as well. When the pandemic first hit, we were going through a lot of gyrations, looking a lot of data to try and calculate the backlog. And what we found was that, really, there were just too many variables to think about this very accurately and consistently over time. And so what we said is let's just step back and kind of think about it the way you looked at it and say, "Structurally, we believe that the end markets in many of the categories we operate have been undisturbed.' And so if you look at that relative to what we're actually seeing come through on a patient or volume basis, yes, we're creating this backlog. And we sized it back at the end of last summer. And since then, all the data will tell you that it's grown and it continues to be very sizable for us. Now when do we expect that backlog to come through? I think it's still a moving target. And Bryan, I think, articulated based on our guidance ranges, gives you some semblance of when we think that backlog might come through. The first data point is going to be, are we at normalized market growth? And then secondly, how is the backlog either providing a tailwind to that or not coming through or potentially we're not at normalized market growth at the bottom end of our range? So the timing of that backlog, I think, is still to be determined. But we do know it is a sizable backlog, and we believe will be a tailwind at least into 2022. The other thing that we're theorizing right now, and again this is unprecedented. We've never seen a backlog of this size. So it's -- we still have to see a lot more unfold. We don't believe it will be the same pull-through market-by-market or region-by-region, right? And so if you think, first of all, Asia Pacific, for instance, they didn't have a very large backlog coming into 2021 because it kind of got to normalized market, normalized growth rates towards the end of last year. And so they had a very small backlog. Probably by the end of this year, we'll likely be worked through -- we'll have worked through their backlog. If you look at regions like EMEA and Europe, where you're more of a public-type system, there's less incentive to move patients through that backlog than you would see in the U.S. And so it's likely that the backlog will remain longer in Europe than it does in the U.S. But putting all of that together, I think your key points are how we think about it is that the backlog is sizable. We should see it as a tailwind at a minimum into 2022 and potentially longer depending on when it starts and the pace of which it comes through.

Excellent. Excellent. If you think about it from a supply-demand perspective, is it fair to say that it's the demand piece that's the rate-limiting factor right now, patient's willingness to come in? And once demand is no longer the rate-limiting factor, how far can supply kind of flex up to meet that demand, 105%, 110%, 115% of normal?

Yes. So I would say, right now, it's definitely in my view. And based on the data input that we have, it's definitely the patient right now. The flow is just not there. And I think as we're seeing the vaccination rates, particularly in the U.S. go so high, I don't think anymore. It's because of not being vaccinated, it may not even be associated with fear of COVID. It might just be that people have been cooped up for a year plus, and the first thing they're going to do when they're not -- when they not have to be stuck at home is they're not going to be going to get a procedure and be laid up for another 6 weeks. And so it might just be that people are out there right now trying to enjoy a little bit of time with their families, their grand kids, that kind of thing. And so that could be what it is and why some of the delays there, why we're seeing some fashionably late people to the dinner party, right? But either way, we know it's going to come at some point. And when that happens, we do believe that people, particularly in certain markets like the U.S., will flex up for capacity. To put a number on it is pretty challenging because, again, we've never actually seen this. But if I use just as a proxy to this, even though it was a very short period of time, Q3 of last year in the U.S., we did see some states that passed up to 110% of typical volume. Now whether you can sustain that for a long period of time, I have no idea. But that did give us some hope, obviously, and some guidance on what the capacity could potentially move to. But what we don't know is how long that can last. Are people going to be willing to work later in the week, going to be willing to work on weekends? And I think Suky referenced, it's going to be very different depending on the market. In those public health care markets, you're probably not going to see the same drive to get the patients through because you're not looking for profit in the same way. But in markets like the U.S., my guess is people are going to be fighting for those patients. And so when the patients come back, I can't believe that people aren't going to see them because my sense is when you're in that kind of pain, you're going to get a procedure. If someone's putting you off, you're going to go somewhere else. And so I think just supply-demand is going to be there, and we're going to see that capacity go up. I just don't know by how much. And certainly, as Suky referenced, we just don't know for how long.

Yes. Got it. Okay. Great. Just a couple of near-term focused questions and then we'll zoom out a bit. So first, it's been a little bit over 7 months since Stryker closed the Wright Medical deal. I wonder if you're seeing any disruption out there in the market, anything you can take advantage of in the extremity space.

As you know, the upper extremities area for us is pretty important. We're one of the market share leaders there. We've got a heavy focus in this area. We've got great innovation. We've talked a lot about pre-surgical planning with Signature ONE. So it's an area of concentration for us for sure. And so we're sticking pretty much to our strategy, trying to not pay too much attention to what's happening around us and just focus on what we know is going to be able to allow us to win in that space. So we've been doing that from an innovation side, and it's working. The other side of that equation, though, as we've been talking about, is to build more commercial infrastructure that is directly focused on just that category. And so serendipity here, but because we're building that organization and you do have some disruption out there where people are concerned whether they're going to have a job or not, not everybody is going to have a job when the music stops there. We have been able to pick up folks that are qualified and capable that we are looking for anyway. And so certainly, that's been a benefit to us as we built out that sales organization because you can always get folks that will join the organization. But to get folks that actually know the space and have those relationships is important, and we've benefited from that.

That's great. China is moving forward with finalizing the framework for a national tender process for large joints. You've characterized the worst-case impact as about 100 basis point headwind to global growth with ZB, with most impact hitting in 2022, maybe a little bit in Q4 this year. Any update to that view or latest thoughts on China?

I think that's a good way to look at it. And just the quick math on that, obviously, you've heard me talk about it before because you just referenced it, it's a little less than 2% of our overall business. And I'm not talking about large joints, I mean our global business. In China, the categories that would be in the BBP process is they're about 2% of our overall revenue. And if we just say that there's going to be a 50%, 5-0 percent, price write-down, which would be somewhat aggressive actually because remember, it's the hospital pricing that is being reduced. It's not our pricing to the distributor. So we're going to share some of that reduction with the distributor. But let's just say it's 50% to use that math. That's where we came up with the 1% potential risk. Certainly, the team is going to do whatever they can to mitigate that. We're not just going to say, okay, it's 1% hit. Here we go. They're going to do whatever they can to mitigate it. But it's a headwind. There's no question that we're going to have to pay attention to it. The good news and the way I look at it is it's going to happen, when you look at the timing you just referenced, around the time that the backlog, the people are coming into the party and we should have that tailwind that should easily offset that impact, not specifically for China, obviously, but certainly for our global business. So as much as we're keeping an eye on this thing, we're paying attention to it, we're trying to mitigate it. We think it's going to occur pretty much concurrently with a nice tailwind of the backlog patients coming through.

Great. Okay. So maybe you mentioned ZBEdge a little bit earlier, zooming out a little bit. I think longer term, you believe ZB can accelerate organic growth from the low single digits historically to 5% or -- 4% or 5% or better. On the Q1 call, you talked about how ortho market growth is inflecting, thanks to some of these new digital technologies like robotics and smart implants. I think skeptics might say that patient outcomes are already pretty good. 10-year vision rates have come down. Maybe can you explain a little bit how do digital technologies really improve patient outcomes and what could that do for market growth over time?

Yes. Yes. So first -- on the first part of your question, I'm going to react a little bit to that because when I got here, there wasn't even low single-digit growth. There was no growth. It was negative growth. And so we had to get over that hurdle. First, I remember when we first started talking about to get to 1% to 2% was going to be a big win, remember that. So we did accomplish that. Now we have our sights on mid-single digits as we've been talking about it, and we definitely think that's in the cards for us in the near future. But when I think about the part of that, and I think just structurally potentially the way we could change the growth of the overall market is technology. And I feel pretty bullish on it, not because I'm just wishing it to be the case and I'm just hoping that it's going to be the case, but because we're seeing it play out. I mean, MAKO was the first, but people were clearly willing to pay premium for technology that matters. And we've seen it with ROSA. We've seen it with mymobility. We've seen it with cementless technology because it removes time from the procedure. So you're seeing the orthopedic space be willing to pay for technology that matters to them. And even though the outcomes are good, I would say, in knee, for instance, there are still a lot of patients that are not happy with the overall outcome. They did not get what they expected. It may be better than before because they're not in pain, but they're not getting the mobility they expected. And so I still believe there's plenty of opportunity to make that patient happier. You still have 20% that are saying they didn't get what they expected. To me, that's not good enough. And so that's why I do believe that robotics, in concert with the ecosystem around robotics, eventually smart implants, is going to provide us a data set that will be important. And there's a lot of things that we're assuming inside of that, that I think will come true as we build that data lake. But ultimately, if you build a big enough data lake and you've got a patient that shows up with certain characteristics before the procedure, you're going to know based on what you've seen in the past with thousands of other patients that look just like that. What kind of cut you should do during the procedure? And robotics can give you that accuracy. What kind of tissue balancing you should do? Robotics can give you that accuracy. What kind of rehab you should do post that because you've seen it before? That's the kind of insight we just did not had as a space, and we're going to have that. So I truly do believe that at some point in the future, because of that capability, that you're just not going to see procedures done without the ecosystem. That's how bullish I am on it. And how long that takes? I don't know. But I've been pretty pleased so far with the ramp-up of technology, at least so far in orthopedics.

That's great. Maybe for generalists who aren't in the weeds on the product. Your new smart implant Persona iQ is an important piece of the whole ecosystem you just mentioned. Can you just talk a little bit about the expectations for that implant and kind of what data you collect from that product?

Yes. I'm trying to stay away from too much specificity around what we -- what exactly we collect because there's some competitive stuff going on here that I want to be careful of. But what I would tell you is we're very excited about it. We start to get FDA approval, it's the first step. So that has to happen first, and we're well down that path. And we have high expectations there, and we believe that we're in good shape, but that's got to occur. But we've done a lot of homework on this one. When you got something that we think could be as game-changing as this, it's almost like another robotics launch into the market, but it's using a smart sensor inside the body. We wanted to really get smart on how we commercialize this. So we brought in a third party, did a conjoint analysis to really understand what did people value in the technology that we're going to bring to bear and what would they pay for it. And it's pretty clear that people value the data collection capability, and they are willing to pay a premium for that technology inside the DRG that exists today. So we don't need any additional reimbursement to be able to get an ASP premium for this technology. So that's pretty exciting for us, obviously, to hear that, and that's a big part of the commercialization plan. But we're excited because, today, we collect a lot of data with the Apple Watch and the relationship we have with Apple. It's just between us and them. And then mymobility app and the OrthoIntel background to be able to pull that out. Those data insights are important. But you can take that watch off. And we try to get patients to keep it on, but you can always get the compliance you're looking for. We're not going to take your knee implant out. So for 20 years, that knee implant is going to be talking to you as the patient and it's going to be talking to the surgeon and the provider for 20 years. And that is unprecedented. We just haven't seen that in the space. So we're excited about it and the people that are paying attention to what data can do in this area are absolutely excited about it. So a lot still to do, a lot still to prove in the marketplace, and it's going to be really next year when we start to get in the full launch. But this is an exciting one for sure.