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

All right. Good afternoon, everybody. Thanks so much for joining us. I'm Matt O'Brien, I cover Medtech here at Piper. Very excited and privileged to have the Zimmer Biomet team here with us. From the company is Suky, who's the CFO; and then Ivan, who is the Chief Operating Officer of the company. Gents, thanks so much for coming. Keri's down in the audience as well. So thanks, everybody, for coming. Really do appreciate it.

Yes. Thank you, Matt. And I don't want to thank you there for the time because my man here is from Spain and literally the Spain, Japan match is going on right now. So I got to keep this guy [indiscernible].

We'll keep it short. I mean, come on, Spain is going to win, so don't even worry about it. I know my audience here.

But so for starters, just hit this upfront, one of your competitors out today talking about good traction and the recovery here in Q4 and then some excitement about what things are going to look like for the hip and knee market in '23 and '24 as well. And there we've done some work. It seems like a big backlog there. Would you share that kind of enthusiasm about the outlook for the market over a couple of year period as far as getting some of these patients [ through that ] to defer their procedures?

Let me start with just backing up on where we are this year because that's obviously your launching pad into '23 and '24. So when we provided our full year outlook on our Q3 call and the Q4 implied guidance, we were seeing strength coming out of the third quarter, and we're seeing that continue into the fourth quarter. There are a number of puts and calls around a lot of different variables. But overall, things are on track and in line with the guidance that we provided. So we feel really good about where we are in the fourth quarter. And then we talked about -- we actually provided a lot of color, I think, on '23 around our potential growth rate. We characterize it and there's a lot of variables that are still going on. We said if in a normalized market, we would absolutely be disappointed if we didn't see at least a 4% on our growth rate ex-FX, operational, right? But we also said that we don't think that '23 is going to be a normalized market, at least when we enter into '23. We'll see what the rest of the full year brings, but at least as we walk into '23, we don't think it's going to be normal based on where we are right now. And why is that? [ You ] have a number of variables going on. So supply chain continues to be a bit of a drag. You still have some pockets where you're seeing episodic cancellation of elective procedures because of staffing concerns, not so much COVID but because of staffing concerns. And so when you take those 2 things as potential headwinds, you do have, I think, a counter to that, which is a very nice sizable backlog that we've been consistently saying is out there. It's very difficult to size that with precision and or to predict when that's going to come through. But we do think that, that could be a tailwind and likely for a number of years into the future.

Okay. So can we drill down a little bit on that then? So you've got -- staffing was just a headwind? Is it -- it seems like it's pretty stable, maybe getting a little bit better on the margin, but not a ton? But next year incorporates staffing kind of as is does not assume a lot of the backlog comes through, is that fair? And then is a supply chain issue really more focused on the chip side of things for ROSA or other parts of the business, where does it really fall?

Yes. So the supply chain is less on chips. We're less reliant on chips. ROSA, very meaningful, but the volumes just aren't there to really have chips. We are a rate-limiting factor for our business. It's more on other parts of our business in the raw materials. And not so much the ability to get them but just the predictability of when you can get them, can you get them to the right place at the right time. So there's still some modest disruption because of that creating some back order. But we're starting to work our way through it. I don't know if you want to talk a little bit about that.

[indiscernible] definitely not ROSA. So there are 3 elements of supply chain constraints. It's materials, resins, packaging, some of the noise we have had with titanium, which are well managed, it's labor and it's some [ installation ] staff. But it's not impacting ROSA. I think the expectations that we have gone into '23 are well managed and this industry dynamics is in different pockets of the business. There is no one business that I would say is into a worse position than the rest, that we'll manage overall.

We put all that together, Matt, I would say we're still very confident in seeing the pathway to having a [ 4 handle ] on our operational growth inside of our guidance range for '23.

Operations. Okay. So that was the next question. I think the Street landed at 4.2% for next year, and that's a reported number, right? So there's going to be more FX headwind for next year. So the operational number will be higher than that. No, no, no. 4% is the operational number. And then you have a 300-basis point headwind on FX. Right. Sorry, for '23.

For '23.

Okay. So the reported number -- I thought the reported number was at 4.2%, maybe I just did the math wrong. Okay. That makes a ton of sense. If you -- if we were to get some of the backlog, though, you -- is it reasonable to think that there's potentially been some meaningful upside to the top line number for next year on an operational basis.

It could be. That's one of the structural tailwinds that we potentially have in addition to, I think, more importantly, is all the innovation and the execution that we're seeing in the business and the fact that we've actually, I think, meaningfully improved our overall WAMGR over the last couple of years just through some active portfolio management, but also where we invest organically in faster growth submarkets.

And let's not forget, Matt, the backlog is real and I'm officially retired from the backlog forecasting business as I always get it wrong. But just because the patients are waiting doesn't mean that the capacity from an operating room standpoint is there. So to your point earlier on staffing, that's much better than before. Supply chain, we believe that we have it under control going into '23. The one thing we don't control is operating room productivity. So there is a certain amount of hours you can have. There's a certain amount of days that you can operate. In orthopedics, you have to do it early in the week, so you can have 2, 3 days to take care of the patient. Those dynamics we cannot control. So that may mean that some of this backlog, it'll get resolved over a certain amount of quarters. It could be 2, 3, 4, 5 years over a period of time. So it's not a one and done 2023 event.

Are people coming in with more complicated cases because they've deferred things so long? Does that take longer to do case? Is that another issue that's slowing things sound?

There is definitely an element of the longer you wait, the more complex your surgery is going to be. Potentially, the worse the outcome can be. So it's an element of trying to bring some of the earlier patients coming in, yes, which by the way, that still creates additional backlog because now that patient that has a simple primary case, [indiscernible] for now, it's going to get delayed so that the older patients are first in the funnel.

Got it. Okay. Ivan, talk about cementless and how big a deal that is for you? Because if I go back and look at 1 of your competitors, when they launched cementless, they just crushed it. Now they had -- they had the robot to go along with it. Those 2 marry up really well. You've got ROSA now as well. And I also heard that cementless with ROSA is really good. So how big of a tailwind could that be for you guys?

I feel like it's a [ leading ] question. You said my competitors crushed it. So what am I supposed to say. We really excited -- we really -- really excited. So let me begin by saying that this is a project that we started 8 years ago. We've taken our time. We've got some of the leading global surgeons behind this project, centers around -- literally around the world. We believe it's going to be a major contributor. Obviously, we don't disclose that externally. It's a truly differentiated platform from a [indiscernible] standpoint. We got clinical data that proves that this a highly stable platform. And what that means in knees is that you don't see micromotion. You don't see the loosening even though you're not using cement. It's extremely versatile, which is another differentiator. You can literally to the end of the procedure for the last 2, 3 minutes of the procedure, you can decide whether you use cement or you got cementless. And let's not forget, this is part of the Persona family, which means that you have all cancer codes, you can really personalize the solution. So stable versatile anatomic. 8 years in the making, we have a high expectation on converting competitive accounts, and frankly, bringing some of our cemented users over to cementless. So I cannot wait [ its ] approved, and we're going to start December 21.

And we're ready with all the right kits and so sort of going full launch right after [indiscernible]. Pretty exciting.

So -- and you may debate this. I don't have all your numbers. And so -- but it does look like over the last 2 years, not the last quarter, but the last couple of years, you have been losing some market share in knees. Do you think you're going to get back like right way because of cementless maybe Persona IQ as well, but that's small but getting back to taking share within this category, I think you can do that in '23?

I can't wait until we get some objective data on market share. 50% of the time I got people congratulating us for gaining market share. 50% of time, I've got people asking me, when are you going to gain market share. Here's what we know. We know that over the last 8 quarters, we beat the market. We know that for a fact. Whether it's one versus another one competitor versus the other, different dynamics and whatnot, I don't know. And frankly, I'm more interested in the future than the past, but we do know that we're above market. When you think about portfolio, Matt, Persona cementless, which we call Persona OsseoTi; Persona IQ; Robotics really cranking; Persona Revision, we've done $400 million in the U.S. as we launched with a pandemic in between. Still have great momentum to continue to gain Revision share and the pull-through of [ primary ]. When you look at the things we're doing in mixed-reality in knees, we got the entire portfolio. So we do believe we're going to continue to beat market and gain share. In addition to that, quite frankly, there is a huge opportunity to really think less about market share and [ more ] about WAMGR, increase the revenue per procedure. And all the investments we've done around data, technology and solutions are going to help us in that regard. So I'm pretty bullish. That's where we are. By the way, both in new [ chips ] and the rest of the portfolio.

So Ivan, I mean, when I think of a knee case, what do I know, but I think like that's $4,000 per case, roughly a little less. I mean, are you thinking you can take that $4,000 per case at Zimmer to a much higher level? And how high can you take it?

I don't know about a much higher [indiscernible] an expectation for you, and I know that my boss is listening to this call. So I don't want to use the word much higher, but we're definitely going to bring it higher. We still have a very low percentage of the overall DRG. Our peers have done that in the past. We've not done that as successfully as we should, and we're going to do it. Now that we have cementless with the ROSA ecosystem with the peripheral ancillary components. Yes. I don't want to give you a percentage, but you should expect that the share of wallet is going to increase.

That's where I was going to go. There's definitely a mix shift share of wallet gain here, which also is going to help contribute to that overall increasingly WAMGR.

Does it matter [ side ] of care?

We haven't seen on a [ side ] of care [indiscernible] this morning on a revenue per se or on a price per se or price for the products in an inpatient, outpatient and ASC are comparable. What we are seeing in ASC is that it is more of an appetite to bring the rest of the technology. A lot of these ASC are [indiscernible]. They understand that reducing the length of stay, increasing patient satisfaction scores, lowering readmission is far more important from a clinical and economic standpoint. So I do think the share of wallet that plays is actually more compelling in an ASC than in an inpatient, outpatient setting.

Interesting. Okay. And I swear this is the last knee question, will hopefully, but ROSA, we can't really see placements versus sales and things like that, but I think it's all turning in the right direction. Suky, with that, you guys -- when you're placing systems get a lot of implant volume in the future, where are we on that curve as far as some of the implant guarantees, but just arrangements since you've had in terms of really seeing an inflection in those?

The good thing is we're still in the early innings, which means we've still got a lot more uptake to get to on the penetration and the utilization of each count because each time we do that, there is a tertiary benefit with disposable revenue and other sources of revenue beyond just the implant. So that's the good thing is we've got a lot more room to go.

Got it. Okay. That's great to hear. Ivan, you mentioned some of these new products for next year. I don't know what you're comfortable talking about, but how impactful could some of these new products be?

I'm really excited about the pipeline, Matt. So let me give you some data points and then maybe I'll touch on a few other products. So let's start with our innovation Vitality Index, which is the percentage of gross sales coming from new products. It was around 4% when I joined 4 years ago. That's actually [ 3x ] the number now, and it's going to continue to increase over the next 4 to 5 years. Innovation is real here. We moved from being a remediation type of company to an innovation type of company. Our pipeline, we don't disclose the value of the pipeline, but it's exponentially higher than it was 4 years ago. In terms of specific products that I'm excited about, maybe I'll talk about knees and hips and then S.E.T. quickly here. In knees, I already mentioned Cementless. Persona IQ going to move from a limited market release to a full launch at some point in late '23. I think that it's going to be a transformational product. I like where we are with Revision, but I do think there is an additional opportunity to continue to capture Revision cases. In hips, we have a meaningful launch that is going to happen in Q1 of '23, which I think is going to complement the ecosystem of [ solutions ] that we have. We have 2 modalities on ROSA Hip, one that we launched [ direct anterior ]. We got the posterior application going in '23. We signed an agreement with a company called Surgical Planning Associates in Hips that makes us the only FDA-cleared provider of a mixed-reality solution in hips. Going to S.E.T., we have a full portfolio for sports med, we didn't have before, whether it's in ablation, sutures, anchors, [ booms and likes ] that's happening. Identity in shoulder is the most meaningful product launch we have had in 5, 6 years. I can ramble for an hour. What I'll tell you is that there is a solid cadence of product launches across pretty much every category in '23. And as you look over the next 5 years, it's only going to get more meaningful given the pipeline, the size of the pipeline.

Okay. So I want to talk about that a little bit. How big was the VBP to that business here in '22? How big a headwind?

Yes, it was pretty significant headwind in the third quarter. That's going to sunset and actually reverse in the fourth quarter because last year is when we took a big charge for VBP. So that will be a nice tailwind into the fourth quarter. We haven't sized exactly how much VBP was inside of the third quarter, but it was a large component of that and the restorative therapies reimbursement change were really the big drags on the S.E.T. number in the third quarter.

But a majority of those pressures should subside as we head into next year. Is that the case?

Yes. Yes. The VBP should sunset, right? We should get rid of that noise as we move into 2023. The restorative therapies reimbursement issue, that will sunset in the second half of '23 because that started in the sort of second half of '22. And those are really the major headwinds.

Okay. Got it. Within that business, Ivan, I remember several [ AWS's ] ago, seeing the shoulder portfolio at Zimmer and I was like that's pretty good but it never really took off. So why is it going to be different this time around? That's a big market. A lot of competitors, it's a great market but it's a tough category, it's really a share.

Quite frankly, when Zimmer and Biomet merged and we integrated portfolios given some of the challenges remediation around the portfolio quality and what not back then, all of that behind. We prioritize innovation on hips and knees. And the amount of product launches in S.E.T., particularly in shoulder was not a compelling. We're sitting here today, we got one of the fastest-growing technologies on preplanning, Signature ONE with solid penetration in the 30%, 35% range. We have a customized volume [ planned ] with Identity. We got a new set of [ glenoids ]. We have a pathway through leadership to enter the market in Robotics, which I think is compelling with an elegant solution that we believe that we could be first to market. Why do we think that now is better than before? I know what -- the time reference for you. But I'll tell you, this is the most comprehensive portfolio we have had in shoulder for sure, [ part one ]. And all of that gets augmented by the fact that we do have the data and technology solutions component we didn't have before so I'm really excited. I mean, commercially, and I'm sure, I can talk an hour on shoulder. We never had specialized direct salespeople in the market as a major difference. So now innovation and focused commercial execution puts it in a different place than before.

Okay. So just to push a little bit, though, are these bone conserving implants that you have you have reversed, and then you have the preplanning software, it sounds like to go with it as well.

We do, we do. Signature ONE planning, yes.

Okay. Got it.

With the direct selling organization.

With the direct selling organization in the key markets.

Got it. What about the lower side of the market? What are you doing there in the lower extremities?

In the lower extremities. In a world of choices, we have prioritized the right components, what I believe are the right components within S.E.T. So there are 6 businesses in S.E.T. Upper extremities, we need to be a leading force, number one. Number two, CMFT, craniomaxillofacial thoracic, which is a double-digit -- solid double-digit growth business for us and then sports med. So the trade-off is that we're going to be good enough in a trauma, we're going to be good enough in foot and ankle, lower extremities. And we're going to get out of this noise that we got when we [ restart ] these therapies. So I guess what I'm trying to answer in simplistic way is that we believe we have a better [indiscernible] to be above market, and our extremities will be happy to be at market.

Okay. Got it. What about on the Sports Medicine side. That's a huge category. Even traumas' a huge category. Can you grow at or above those market rates? I think they've been growing pretty well historically.

We have to. We have to. And by the way, outside of the U.S., we're already doing that. Why outside of the U.S. we're doing that is because we have dedicated structure. We have people that jump on this portfolio a little within the U.S. Now we got, as I mentioned earlier, Matt, a full portfolio. This is not a single portfolio [indiscernible] that we have when it comes to sports med, whether it's ablation, whether it's visualization, whether it's sutures, anchors, we do not have any [ gaps ]. We're expanding -- we don't disclose the numbers, but we're expanding dramatically when it comes to sports med, the number of people that we had before and the number of people that we have now. So we need to be above market, absolutely.

Okay. Okay. Got it. I guess the question I would really have is on S.E.T. I mean collectively, what do you think that market is growing? And where do you think Zimmer can get to? I mean, I know the e-parts growing quickly. Trauma, I think mid-single digits, sports going to be a little above that.

First of all, let me just make sure everybody is clear that the way that we talk about S.E.T. is different than others. So it's difficult to quantify, right? We've got 6 things and 3 of those don't match the S-E-T acronym. So there's a lot of things [indiscernible] versus others. But we think this is a mid-single-digit, mid to upper maybe in some regions, but overall globally 5%, 6%, the market growth rate there, maybe slightly higher.

Okay. Got it. And another area that doesn't get any attention. Shocking and it's doing well as the hip business. What's been going on there is driving all that growth?

I'm going to have to talk to my Global President of hips, and I mentioned that you said they're not getting any attention. It's going well. It's going well. I mean, look, I don't think we have any major [ gap ] in hips. I mentioned earlier already today that we have 2 modalities, [ one already in ] market in Robotics, one to come. The only company with a robotic platform that is painless, ROSA Hip. The only company that's going to have both modalities of anterior and posterior. We have a product launch coming in that I cannot disclose today, but it's going to happen in the first, call it, 90 to 120 days in Q1 of '23. So we don't have [ gaps ]. So he's getting attention. I'll be honest with you. That was a [indiscernible] comment. We did prioritize knees, post remediation. We did have some [ gaps ] around Robotics. So that's why you didn't see the same number of product launches. But as you look at '23 and '24, you will see a significant product launches in the hip space.

Okay. Got it. So Suky and I appreciate that. The swaps, I think, confused everybody or surprised everybody on the last call. I'm absolutely no expert. Is there anything you can do on the interest expense side of things to try to improve some of the pressures you're going to see there as we head into '23?

Yes. I mean we always look at lowering our cost of debt or cost of capital. So there are a number of strategies we're going to look at but by and large, the interest rates have gone up, and so that's going to put some modest pressure on the interest expense line. But despite that, like we've talked about in the backdrop of a lot of other headwinds at that sort of 4% growth rate, we're still committed to holding margins slightly improving, which I think is a...

How much underlying improvement are you seeing in margins right now? We can't see them because of FX and inflation, but what are you seeing?

Well, the way to think about it is we've talked about this quite front-footedly. So far this year in cost of goods, we've talked about 100 to over 100 basis points of pressure. Meanwhile, we've not taken our [ partial ] number down, we've held it, right? So we're offsetting it and we're doing that through SG&A leverage as well as other cost and efficiency programs. We talked about next year, there's inflationary pressures that are going to capitalize and roll into next year, about 100 basis points. But we're saying, "Hey, we see a pathway to maintaining margins." So there's underlying programs that are going on beyond sales leverage that are just true cost down, both in cost of goods as well as SG&A that we think are structural and durable.

Okay. So to that end, I mean, you have a huge amount of inventory like everybody does in ortho. Can we see a big snapback in gross margins in a year? Or is it [ highs ] and low, it's probably been more steady?

I would say it's more steady. We've eroded gross margin 150 basis points for 5 years post the merger of the 2 companies. First step was to stabilize, and we're starting to get there. That's going to be first step. Next step will be the expand.

Got it. And then at the last minute or so here, let's just talk about the deal side of things. You've -- you pushed off some part of the business that wasn't growing very quickly. Are you more interested in smaller tuck-ins? I know Bryan has talked a little bit about that. I mean -- or would you do something a little bit more large-scale transformative even gets you a little bit outside of orthopedics?

Yes. I mean our preference right now is to do the smaller tuck-in type acquisitions just because there's less call on capital, they're less execution risk, we can find a lot of areas where we can help increase our WAMGR as a business and find accretion through those deals. But the good thing is given the strength of our balance sheet that we've got now over the last 1.5 years or so, we have the optionality to go bigger. And so M&A is always episodic. You can't predict what you're going to get, when you're going to get it et cetera, et cetera. So the good thing is, if we see something larger out there that meets our filter criteria, meets all of our financial criteria. We think we've got the bandwidth to do it. And more importantly, the capabilities to do it. And more importantly, the underlying business is in sort of good shape where we can take on something like that.

Do you want to stick in ortho or are you amenable to going outside of ortho a bit?

We're keeping our options open. We look at things in sort of 3 buckets, enhance ortho, recon, move, stay in ortho, but outside of recon, knee and hip into sports -- S.E.T., and then the third leg could be something outside of that, which diversifies ourselves beyond elective procedures.

Well, I've kept this over the allotted time, so we'll cut it there. Appreciate all the feedback. Very, very helpful.

Thank you.

Absolutely. Thank you, Matt.

Thanks. And good luck to Spain on the soccer.