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

All right. Good morning, everyone. Thank you for joining us. I think we're going to get started. My name is Jeff Johnson. I'm the senior medical technology analyst at Baird. Our next presentation this morning is from Zimmer Biomet, a leader in the $37 billion global orthopedic market. With us today from Zimmer, we're very happy to have CEO, Bryan Hanson; and CFO, Suketu Upadhyay. Bryan and Suky, I think we're just going to go straight into Q&A. It sounds like we didn't have any prepared remarks. So I usually turn it over to you for that. But let's just go straight into Q&A.

And Bryan, I'm sure the question you're getting a million times, so I apologize, and it's short-term focused, so I apologize for that as well. But orthopedic end markets. I want to focus most of our time today on strategic longer-term decisions, but there's been a lot of focus recently on pacing of recovery. Stryker NuVasive in the last couple days have both just kind of pointed to some incremental pressures on hips and knees and spine cases in the U.S. and globally, even over the past 4 to 6 weeks. So first, Bryan, I think I'll just turn it over to you if there's anything you want to comment on specifically from that perspective, especially as I think Suky on the 2Q call, you suggested guidance assumes end market demand does continue to improve from 2Q into 3Q and then into 4Q. So just anything you can say on end markets here relative to what you guided to 6 or 8 weeks ago.

Yes. Great. Thanks, Jeff. And no problem on the short-term question. Obviously, as you would imagine, we're getting a lot of those exact same questions. So I completely understand. And what I would just say, I'm going to answer just quickly top line and then I'll pass it over to Suky to give more detail. But yes, we're not immune to this. I mean the Delta variant is definitely putting pressure on elective procedures. We're feeling the pressure as a result of that and it is impacting our business. So we're not any different than what you've heard from NuVasive, what you've heard from Stryker and probably others. But why don't I just pass it on to Suky to maybe give a little bit more details on that. Yes, Suky.

Yes. Thanks, Bryan and Jeff, thanks for hosting us today. To say things are fluid is an understatement; it's probably the most commonly words we use in these updates since March of 2020. But if you go back to our guidance that we put out on our second quarter call, it was really predicated under the key assumption that we put out there that we would see no worsening with the pandemic and its impact on elective procedures and that, in fact, we would see sequential improvement as you noted, going into Q3 and Q4. The fact is at a macro level, we have seen a worsening of the pandemic and its impact on elective procedures. I think that's consistent with what you're hearing across the sector, likely consistent with what you're seeing in your own research. So having said that, through the third quarter so far, we are seeing some sequential improvement and sequential growth. However, it's coming at a much slower rate than we originally expected. And I will say September is our largest month in the quarter, even in normal times, let alone during COVID. And in fact, the back half of September tends to be a very important part coming at the Labor Day weekend. So a lot still rides on the quarter and what's going to happen here in the next 2 weeks. But as I said, so far, we are seeing some sequential, modest sequential improvement. But that pressure continues to be there from the pandemic, greater than we originally thought. And that pressure is likely to continue through the quarter and into the early part of the fourth quarter. Now having said all that, we still believe our guidance ranges that we provided for the full year implied for the second half are still intact. However, given that pressure that we're seeing in that slower uptake in recovery, it's more likely that we're towards the bottom end of that guidance range. But again, that's primarily because of -- or solely because of the market dynamics that we're seeing around the pandemic. I am encouraged by the commercial execution, the pipeline execution we're seeing across our teams through the third quarter. But again, that's in the backdrop of a very choppy market. So that's kind of how we see it a little bit more detailed than we generally do intra-quarter, but we think it's important to keep you updated as the market continues to evolve.

Yes, that's helpful, Suky. And maybe if I push just one point on there. So I think when you talk about sequential improvement, I'm assuming just so we're all clear that's the sequential improvement in the 2-year growth rate, the way we've all started looking at kind of constant currency, 2-year growth. And then on top of that, the second quarter, you were down just slightly on a 2-year constant currency. So instead of going plus 2 or 3, probably think flat to up slightly would be kind of the sequential improvement in 2Q. And again, you might not want to comment on those numbers, but that's kind of what you're trying to imply there, a little bit better than the slight decline on a 2-year constant currency growth in the 2Q that we saw.

Yes, that's a good clarification. So when you look at the second quarter, we were about flat versus 2019. So if you're taking -- I think very similar to what you're saying. And so we haven't commented exactly what 3Q and 4Q meant in our original guidance, and we're not going to get into that level of detail. But again, our Q3 is just starting out, but slower than we originally thought.

Yes. Fair enough. And then as I think about 4Q, have you seen anything so far at all in September and I know that's not 4Q, but are we seeing any kind of stabilization in some of those headwinds? We're maybe seeing some evidence in the Southeast and the Midwest that some of those hospitalization rates have at least started to plateau, although that's debatable in the data. So just kind of how are you thinking about it as we get into 4Q, any evidence yet that you're feeling less concerned or anything you can say there?

Yes. I'd say, as with anything, there are some headwinds, some tailwinds related to COVID here that we're seeing in the third quarter that will likely extend into the fourth quarter. One, we are starting to see some plateauing in some of our hardest-hit states down south. So that's a good sign; it's a positive leading indicator. Secondly, hospital or physician visits, primary care physician visits are increasing. So we think that, that's a good leading indicator and a positive sign. Again, I'm talking primarily about the -- solely about the U.S. market. As a headwind, however, kind of that we've got to keep our eyes on is really this emergence of staff shortages around hospital utilization capacity. So that's one thing we're keeping our eyes on. So that's kind of how we see some of the net puts and takes. But like I said, hopefully, we're on an upward trend here as we move into the fourth quarter.

Okay. And just because you did kind of clarify that those are U.S. comments, I mean, outside the U.S., we know that Australia is still kind of in some lockdowns, Japan may be still pressured, but we are seeing some improvements in Europe. So net-net, anything to call out from an international perspective other than maybe the China tenders and things like that, that we'll get into maybe in a few minutes and then that won't even impact until next year. But international markets, anything to really call out there?

Nothing materially different than how you just characterized it and our largest markets in Asia Pacific are Japan, Australia and China. China continues to perform really well from an end demand and capacity standpoint. Japan is stable subsequent to the Olympics, maybe a slight upturn in Australia and New Zealand. Again, some challenge, but overall, relatively stable. In Europe, the good thing is we are seeing some modest uptake through the fourth -- sorry, through the third quarter. So we are seeing some modest relief from the pandemic. But again, we're still below where we need to be on a normalized basis in Europe.

Okay. Well, maybe if we kind of dialed down now or dig down a little bit into Zimmer versus market. If I look, Bryan, at hips, we all have different ways of calculating market growth rates in that, but Zimmer's 3% 2-year global hip revenue decline in the second quarter, it did seem to lag the market by maybe a few points. I know Zimmer reps are pretty focused on ROSA and knees right now. But help us understand kind of that underperformance in hips and what plans you might have to get growth back to market at least from a hip perspective over the next 3 to 6 to 12 months?

Yes, yes. So first of all, hopefully, our reps were listening to you because they should be very focused on ROSA right now, and I'm sure that they would be jumping up and down saying yes, I am. But the good news is we also now have the hip application, which is another variable that we have as a benefit to us in ROSA. But if I just look at hip in Q2 specifically, first, I'd just say that I probably -- again, I say this all the time, even when I'm up or when I'm down, I don't put a lot of weight into a single quarter performance versus market. There's just too many variables that can influence a quarter, particularly during COVID, that could give you either a false sense of concern or confidence versus market in a quarter. So I always look at trends across multiple quarters to help neutralize those variables. And again, if we look at the last 5 quarters in the way that we calculate this, and it's all public information, we've been above-market growth in hips 4 out of 5 quarters, and that's globally and in the U.S. specifically and in some quarters significantly over market. So I guess when you ask what are we going to do to ensure that we continue to grow above market, we're going to do exactly what we've been doing. The only difference is that we're going to have the robotics application to add to the portfolio and leverage that going forward. So that's really what we're focused on. We did have some impact in the quarter relative to VBP, the inventory, which hurt us a bit. And if that wasn't in the quarter, we would have had -- we'd have been more attractive versus the market, but it is what it is. And I do believe probably in China, given that the inventory and given our market share that would have been an outsized impact for us versus peers. But hey, I'm not going to use anything as an excuse. Fact is we want to see more quarters above market than below, but I always look at trends versus a single quarter.

Yes. No, that's helpful. And maybe we'll come back to the VBP point in a second. But in knees, I guess if I follow up the hip question there, knees were a little softer on a 2-year growth, although, again, we know there's more deferability there, and that's a market, not a Zimmer issue. That knee growth at minus 6% on the 2-year stack as we look at it for you guys anyway, it was better than 2 out of 3 of your competitors. But Stryker obviously is setting the market growth there a little higher than that, just given their strength. So again, kind of what's your confidence level on getting back to market growth in knees? And is ROSA the key driver of that? Is it continued penetration in cementless, just how to think about really the drivers there?

Yes, yes. So I guess probably the same answer as I just gave for hips. Again, I go back to out of the 5 quarters that we've been above in 4 and above every competitor in 3 of those quarters. And the only quarter below market was really Q2 and even there, we were above 2 of the 3 largest competitors that we have. So I look at it and say, in those quarters, we had significant outperformance versus market, but I never got too excited about any individual quarters, as I said. So I think the trend will tell the story. And my sense is we'll see that trend play out in Q3 with our performance versus market. And what's going to continue to drive it is what has been driving it. We have a lot of new products. The revision has been very successful for us. Persona Revision has been very successful. That gives us a tip of the spear conversion where we can get the competitive business, but we also have the opportunity to get the primary knee as well. ROSA has been fabulous. Mymobility has been a momentum driver for us. And now we have Persona IQ that we have not had before. And of course, in ROSA, we have the partial application that we just launched as well. So I would just say that everything that we've had, we're going to continue to focus on, and we're going to add to that the partial application in ROSA and Persona IQ.

Okay. Great. Well, you brought up IQ, you brought up some of the mymobility stuff. I want to get to all that stuff, but let's kind of finalize or finish the hip, knee discussion, maybe with VBP. It looks like those numbers came out this morning, pricing down about 80%, maybe a little worse than that, that's from Google Translate as best I can do anyway. So one, have you seen those numbers? Can you confirm those numbers? We had been thinking excluding inventory that the headwind next year for you guys would be about 100 basis points, but that was with a 40% to 50% expected price cut. Do we now up that to 150 to 200 basis points? Just kind of help us kind of complete that mosaic on VBP.

Yes, yes. So yes, we did just get hot off the presses information this morning. We're on with the China team actually and the APAC team to talk through it. And you never want to celebrate an 80% hospital price reduction, but the fact is, even though it was a bit bigger than what we expected at the hospital level, we did get all 8 categories that we were pursuing. So that's always positive to be able to ensure that you're in play in those categories. I think we're the only company actually to get a position in all 8 of the categories that were on the docket. So that was positive. The incremental price reduction, not so much. But even if I look at that, if I think about the drag or the impact of the exposure, I still believe that kind of that 100 bp exposure risk is probably realistic. We got to work through quite a bit more from here. We still got to start negotiations with distributors to talk about who actually digests that reduction in price at the hospital level. So a lot to do still over the coming months. But nothing that we saw today would make us believe that we're at significant risk of exposure beyond that 100 bps.

Okay. And then I guess 2 follow-ups there. One, I didn't see Zimmer's name in some of those 8 categories, but I'm assuming that's the Beijing, Montagne or whatever. Is that right because Google Translate does not do a good job with that translation. So I thought that's what I was thinking.

That's pretty good.

Okay. Yes. Just wanted to make sure. And number two, the 100 basis points you say you still feel relatively comfortable with, is that after assuming there's some inventory rebalancing and reuptake of inventory next year to offset the bigger price headwinds? Or could volumes still offset even that 100 basis points? Just trying to get is that 100 basis points the new net target or a gross before volume kind of number?

Yes. The way I look at it is kind of 3 variables that would impact that 100 bps and they're kind of all-in in that assumption. The first is the headline news that we got this morning, which is the hospital price. The second is going to be then how much of that hospital price reduction is digested by the distributors versus us. That's going to be a pretty big variable, and that's going to be pretty intense negotiations over the next couple of months. And then the obvious one and the big one is volume shifts. That could come with inventory, the inventory amounts that distributors are going to keep. And it can come with share taking, which is obviously something that we're going to be highly focused on and trying to drive in 2022. So I think all of those things combined would put us in that range of hopefully 100 bps or less in exposure.

Okay. That's helpful. And then anything going on VBP with trauma or spine? And would you have a similar exposure there? It's just -- it does sound like we're starting to hear some rumblings there in trauma, spine even implants, although that will be less impactful post the split there, but -- and I was talking dental implants there, I'm sorry. So just thoughts on anything beyond hips and knees with VBP?

We've been hearing the same rumors about Trauma & Spine that could be on the docket for 2022. Too early to probably say whether that's real or not. I think trauma is pretty complex. So we'll see what happens. But what I would just say, outside of that, we do have a dramatically smaller impact in those 2 areas. If I just look at the size of the trauma business or the spine business in China, it's dramatically less than what we have in large joints. So as much as I'm keeping an eye on it, it's not nearly the impact that we would have in large joints.

Okay. And remind me, VBP, Suky, it goes in March or is it Q1? I thought I caught a March date in the press releases today.

Yes.

Yes, I'm sorry, Suky. I will answer. Yes. We're still kind of working through it with the team. Again, it's pretty hot off the presses. We couldn't tell for sure if it would start right away in the first quarter or it'd be at the end of the first quarter. But we should be working through that pretty soon and understand it.

Okay. Fair enough. So one last question, I guess, just on the hip and knee market, as I think about it. We know there's probably, what, 150,000, 200,000 hips and knees in the U.S. that have been deferred I think is a reasonable number at this point, maybe even higher than that, 18 months in, quite a bit larger than that outside the U.S. You guys have talked about it on your calls, we've heard it from surgeons, that the capacity for the system maybe isn't there. There's not a lot of flex in that capacity. We're not going to bring all that back in 6 months or even 12 or 18 months. Do you think market growth just picks up 1, 1.5 points over the next 2 or 3 years? So should we be thinking about kind of core orthopedics as you guys would define it being a 4% to 5% market instead of a 3% to 4% market for the next few years?

I think some of the logic assumptions that you're playing in make sense. I mean let's think about this. The fact is I've completely given up on trying to size the backlog. There's just too many unprecedented variables in the equation. So it's just difficult to truly size it, but we definitely believe it's pretty sizable. And I'm hearing the same things. I'm out in the field quite a bit. I'm hearing feedback from the field. I don't believe either that we're going to see a large influx of deferred patients that are going to materially impact the market growth in the short term. I do believe, based on what you said and what I'm hearing that you're going to see these deferred patients come through gradually kind of reenter over a longer time period, which would certainly be less material, but still a positive tailwind to the market. And so I think under that premise, it could provide a tailwind to market growth, just the size of which and really the specific timing are pretty difficult to determine.

Yes. Okay. Fair enough. Well, let me ask it this way. If my assumption of market growth 4% to 5% is anywhere close to accurate for the next several years, I think you've talked about your growth goals of that 4% to 5% that you always talk about, but we are going to be taking share with that 4% to 5%. So if market goes to 4% to 5%, would you expect Zimmer has a path to even north of 4% to 5% growth over the next few years?

Yes, you're restating when we talk about 4% to 5%, definitely built into that assumption is that we would be taking share in knees and now hips as well now that we've launched the ROSA hip application. We've always said outside of that, that set would be at market growth, but we'd be shooting for the higher end of market growth. And so that would be our assumption going in. So again, to use your logic here, we set that 4% to 5% before we even knew about COVID. And so it was definitely net of COVID. And COVID is either going to positively or negatively impact it. Right now, it's negatively impacting our ability to do that. But if we did see deferred patients come through and we saw that as a tailwind, that would be a benefit that would be accretive to that growth rate.

Yes. Okay. Well, let's talk about maybe some of the drivers of that growth wherever it ends up. But I think the shift to software and connected technologies, ZBEdge efforts, you're saying 70% to 80% of R&D is focused on going in that direction moving forward. And that there is maybe some chatter coming out of AAOS that the near-term pipeline was a bit disappointing for you guys, at least relative to so many new products we saw from a couple of your competitors. But look, I think it's hard to showcase software and services. We're all used to going on these booth tours and looking at a shiny hip or a shiny knee or a big robot or something. So one, what are you doing in that area of software and services? And when I went to some lectures, especially on sensor-based technologies and mymobility and Orthointel and that, there were some definite surgeons there who seemed like the efficiencies you're bringing into the ASC are going to be a good growth driver going forward for them, and I would assume that translates to you. So it's a little bit of a set-up, a little bit of a softball for you. But kind of what's going on with mymobility, Orthointel, ZBEdge? It seems like to me maybe there's more going on there than we can see when we just walk through a booth.

Yes. Yes. I would completely agree. When I think about our growth rate -- organic growth rate targets, it actually significantly depends on innovation. And I would argue that at the AAOS, the feedback was exceptional. I got almost the opposite, polar opposite that we had a lot of interest in the booth. We had a lot of interest in the technology, and we felt real momentum coming out of it. But if I think about our growth going forward and what we need to see, it's really to kind of categorized in 2 things in the way I think about it. First is that meaningful innovation that we just talked about. Second is this kind of focused and really just highly disciplined commercial execution. And if I think about innovation, it kind of serves us in 2 ways and this is where this technology comes in, you can get a real mix benefit or kind of a share of wallet benefit by bringing this valuable technology to the marketplace where you go to the same procedure that exists and because of the value you're bringing you get a higher price point. So that is definitely giving us -- this innovation is giving us that opportunity to not get a new procedure, a new surgeon, a new patient and just drive up the amount that we make in that procedure, that you can see that in robotics, mymobility, cementless, Persona IQ, the list goes on. The second piece, it does it gives us a share capture opportunity, and we're definitely taking advantage of that. We think about ZBEdge and that total offering that does integrate these technologies and it provides data across the full care continuum, that's important to surgeons, and that is giving us a leg up to be able to take share. But if you go back to regular implants, Persona Revision is knocking it out of the park. And that's the tip of the spear product where we're getting a conversion in revision, but we're also opening up the door to get that primary knee as well, which is very exciting. So I'd tell you, innovation is an important part of both share capture and mix benefit and we're driving those. And it's not just the stuff we've launched. We've got over 20 planned new product launches over the next 24 months so we're going to continue to drive that vitality index up. So that's a big part of what we're focused on. And then the other part is just disciplined commercial execution. Number one, we're specializing in key areas like sports, extremities, CMFT and ASC. We're significantly consolidating and upgrading our distributor network with a meaningful shift to the direct territories. We've got a very disciplined operating mechanism to ensure focus and accountability. We've changed our compensation structure to bias towards growth. So it's all those things together that are giving us that confidence to grow not just in the ASC, but in the total market.

And how was the data received? Bryan, I thought some of the most fascinating data I saw coming out of AAOS was your physical therapy data and how you could almost reduce those physical therapy visits and net-net the patient recoveries are at least on par, we don't know of any better yet, but at least outcomes were equivalent, if not better, by doing this all at home. Again, when I think about global 90-day reimbursement rates and moves to ASCs and efficiencies and these ASC docs not being able to afford to have a full physical therapy staff and nurse practitioners surrounding every single patient every day. And that to me, that's a powerful savings if you can knock out a lot of that PT and do this rapid rehab at home. How important is that, I guess, to the ASC strategy going forward?

I'd say it's important to everybody, but definitely the ASC as well for all the reasons that you've referenced. And also very important thing for the ASC with our robotic system is that it does not slow down procedure time. They're looking at cranking things out and driving that fixed cost with as many patients that they can move through it and robotics, our robotics platform allows them to do that. But definitely, people are attractive, particularly those that are paid in a bundled fashion and those that are both hospital and provider, they're very interested in being able to reduce that rehab cost.

Okay. Great. Great. Sorry, I'm just getting a couple of e-mails here, but I think I've asked most of these. So let me just move on, I guess, 2 things. One, Persona IQ. Obviously, it was great to see approval for that product. Should we think of that as a first-generation product that maybe we need to get another sensor into the femoral side as opposed to just tibia to get more information? Is it something where the cement needs to move to cementless? What -- should we think of uptake the next year or 2 as something that drives market share and incremental growth for you? Or is this kind of a first-generation product that we think about a few years from now could be huge, but in the near term, it's more kind of slow, steady early evolution?

Yes. So we definitely are very excited about Persona IQ, just the fact that it's the first smart implant on the marketplace, gets us excited and gives us the ability to be a market leader and in I think an area that will become standard of care over time. And what I would tell you is that there's no question this is just the first launch. There's a whole technology road map behind this that we'll continue to do future launches. But make no mistake. This particular iteration is exciting, and I think will be digested well by our customers. So as much as there's a whole technology road map behind it, product road map behind this that we expect to launch over the coming years, we are very excited about this one, and we do believe it will be digested well. We don't believe that the need to use cement is going to be a barrier here. We really do believe that the commercialization plan already reflects that, and it's still pretty exciting. I just want to make sure that I rightsize expectations. 2021 is more of a limited launch for us, and we'll be moving into full launch in 2022. But nonetheless, that's part of the plan.

Yes. No, makes a ton of sense. Great. And then Suky, just on the margin side, again, I know every single call like this that you guys do, everybody brings up that 30% LRP to hit that operating margin by 2023. I still am unsure. Are we talking about 30% by 4Q of '23? Are we talking about 30% for all of '23? Number one. And number two, given what we know today, with where we are in COVID, that's hopefully a short-term issue, but you still feel comfortable there?

Yes. So thanks for the question. Just to clarify, what we said when we initially came out with that 30% was we would hit that 30% on a full year run rate basis by the end of 2023. So another way of saying that, Jeff, is when you get to 2024, you should expect to see a 30% operating margin for the full year, right? So as we exit 2023, we'll be at that run rate to deliver that 30% operating margin. We still feel confident. Again, it's predicated on a couple of building blocks. One is this notion of coming out of the back half of 2020, we see a stabilized gross margin. So roughly, I think we posted about a 71% or maybe slightly below. Now some years, some quarters will be higher, some will be lower. A lot of variables that go into that number. But that's generally how we see it over the next 3 years from that point where we made that declaration. The second thing is from an SG&A perspective, I'm really happy with all the work that's going on, the progress that we've done in SG&A in making that more efficient and improving our operating margin, which is ultimately allowing us to reinvest money back into the top line in our key pillar priorities. If you put those 3 things together, which ultimately accelerates top line growth to that 4% to 5% that Bryan has talked about, with that stabilized gross margins at a more efficient SG&A base, we feel confident in that 30%, which, by the way, is on top of an already really attractive gross margin, operating margin platform when you look at us across the sector.

Yes. Understood. Last question, we're down to one minute, so I don't mean to give a short trip. But on the SpinCo side of things, in NewCo, you did announce a new name stay. Am I saying it correctly, it's ZimVie, is that right?

ZimVie, that's correct.

Good. What is the post-spin capital allocation going to look like for that business? And I know that might be a better question for Vafa. But will it have enough room to kind of drive acquisitions and kind of an inorganic strategy going forward from day one?

Jeff, we haven't finalized the capital allocation or the capital structure, I should say, of NewCo. It's not uncommon for there to be some debt transfer between RemainCo and NewCo in these types of transactions. I would expect that in this one, but we haven't sized that yet because we're still working through it. The 1 guiding principle we are using, Jeff, is we want to make sure that we set up NewCo to be successful, and therefore, we'll have a capital structure that enables it to embark on an inorganic strategy over a reasonable period of time.

Okay. And I know it's, hopefully, just a short answer, but for ROSA, we do think about ROSA someday moving into the spine. If that is part of RemainCo, how does SpinCo or ZimVie get access to ROSA in the future?

Yes. It's -- obviously, as you would imagine, in this, we have a lot of TSAs that we're working through that will live beyond the spin. This was absolutely one of them, the technology TSA to make sure that they leverage the capability we have on the ROSA side.

Fair enough. Well, with that, I think our time is up. So everyone who's on the presentation, please join me in thanking Suky and Bryan for a helpful overview here of Zimmer. And just as a reminder, the next presentation is set to begin at 11:25 A.M. Eastern Time. They include Owens & Minor, Inspire Medical Systems, Metabolon and Gamida Cell. Thanks guys. I appreciate the time as always.

Thanks, Jeff.

Thank you, Jeff.