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

Good afternoon, everyone. I'm Robbie Marcus, the medtech analyst at JPMorgan. Very happy to introduce our next session with Zimmer Biomet. I'm going to bring up Bryan Hanson, CEO, and then we'll do a little Q&A after. Bryan?

Thanks, Robbie. All right. Hi. Can you guys hear me okay? All right, great. No applause, please. All right. So I'm obviously the Bryan Hanson, CEO of Zimmer Biomet, and I'm going to spend hopefully about 20 minutes going over some content that I think will be helpful for the discussion that we have after for the Q&A. This is the sexiest slide that I have in the deck. There's a lot of words on this. I'm not going to go through those words, thank goodness. But I think you guys know the story around forward-looking statements. So I'll give you a minute to peruse this just so legal knows you looked at it. That was the pause. Okay. So here's -- I'm going to spend just a little bit of time taking a step back because not everybody knows the company that well. And I want to make sure that you know a little bit about who we are as an organization, not just the financials, but what makes us, us at Zimmer Biomet. The first one is a really important one. We are a mission-centric organization. And I'm going to spend time talking about the mission of this company and why it's so important to the organization and its success. And we play today in orthopedics, and we're a pretty big player in orthopedics, particularly in large joints and knees and hips. We are going to be looking to diversify our business over time, but today, we're a very real player in orthopedics. As you can see that we are focused on innovation that actually matters, truly changes the curve for patients. We're looking to shape tomorrow in the spaces that we play. That's a big part of the mission of this organization and the culture promises that we make to each other. We're a global organization. We have about 18,000 team members, not employees, but team members around the world. We're in a bunch of different countries relative to infrastructure and over 100 countries from a revenue standpoint. And we are a Fortune 500 company with about $7 billion in annual revenue. And that revenue is split in this way. If you look from a geography standpoint, we do about 56% of our business in the U.S. and the rest, obviously, OUS. I would say actually for orthopedics, that's a pretty good split. That's a healthy OUS business. And I can tell you that our OUS business, we have confidence in, it will continue to grow as well as our U.S. business. But you can see also here from a distribution in our businesses, we're a little bit heavy in slow-growth markets today. We play pretty heavily in knee and hip, and those are both low single-digit growth businesses. Our S.E.T. business differently than that is 25% of our revenue, but it's faster growth. And as you'll see, as I get into this, we're looking to move more of our revenue into those faster growth markets and ultimately, as a result of that, increase the weighted average market growth of our business. Now that's kind of the financials of our organization. This is really the heart and soul of our organization, and this is one that we spend a lot of time on. I can pretty much tell you every day this slide is presented at Zimmer Biomet. And it is really the why we wake up in the morning, what we do, what we believe in, where we're going and how we actually show up as an organization. If you start right in the middle of this slide, it is the mission of this organization. It is the why we do what we do. It's the reason we get out of bed and work hard every day. The fact is we help patients around the world. We alleviate their pain, and we improve the quality of their life. When we do that, we help their family as well. And I can tell you that puts a skip in everybody's step at Zimmer Biomet, and we're focused on it, very focused on that mission. And we actually measure it. We do this every 8 seconds. Every 8 seconds, 24 hours a day, 7 days a week, somebody receives a product that our team members brought to life and made that patient better and their family better. Now on the other side of the slide, on the left side, this is the -- basically what we believe in as an organization, the principles of our mission. And we start first and foremost with our team members. We believe that our team members are the solution for continuous improvement, listening to the diverse opinions of our team members and responding to how we need to change is the way we get better every single day. And the fact is if our team members are happy, they're going to make the rest of our constituents very happy. So that's number one. Number two is we always, and trust me when I say always, put patient safety before profits at this company. We always make sure that, that happens. And we do that through a fantastic quality system that we put into place, and I'll talk more about that. And we also put integrity first. We are here to win, make no mistake. This company is here to win in the spaces that we play, but we will always win with integrity and compliance in mind. And we're going to be focused. You can read that mission statement and say we can go in a lot of different directions. We want to focus in the areas where we can make a difference for the patient and that goes into the next one, which is value. And we're in those spaces. We want innovation that actually means something, that means something for the patient and our provider and there's a fair value exchange as a result of that. That is a sustainable relationship. Otherwise, it's not sustainable. And we want to give back. We want to make sure that we're giving back to those that are less fortunate around the world. We want to give back to the communities where we work and play. And we want to make sure that we're also giving back to our own team members when they're in need. On the right side of the slide is the where we need to go as an organization. We will become a destination workplace. We will become a best and preferred place to work for our team members. We will be a trusted partner for all of our constituents, from regulators to investors, to customers, to patients, to our own team members, we will be a trusted partner, which means we do what we say, and we always do it the right way. And we will be a top quartile performer when it comes to total shareholder return. And then around the mission are our culture promises. And we mean that on purpose. It's a promise to each other, as a team, that we will do these things. We will show up this way. This is how we show up. We're not here to play the game. We're here to win the game. So we're going to focus to win. We absolutely want to shape tomorrow. That's part of the mission of the company. And we're only going to do that if we have it through collaboration. So we want to say ignite collaboration as a team. Okay. So that's really who we are on one page and what we focus on. I tell people all the time. If you're doing something, doesn't connect back to this, stop doing it because we don't want you to. right? And so I knew when I came into the organization about 5 years ago that there was no way that we could move all of that forward right away. If you remember correctly, we had a lot of challenges back 5 years ago. And I knew that we had to phase out the way that we were going to approach this. And it isn't so much that these are independent of each other, these phases. There's a lot of connections between them, but it was the mind share that we would have in specific moments of the transformation of this company. The first one was hearts and minds. We needed to go to work on getting the hearts and minds of this organization aligned to the new ZB. And then we needed to transition from that and the execution challenges to true strategy and innovation. And then finally, in phase 3, which we're in now, is transformation of the company for the long term. Okay. So those are the 3 phases. And if I dig into those more deeply, I can tell you that my philosophy on business is pretty simple. I believe that there are key variables to a successful business, and they've got to be in a specific order. I look at mission, talent and culture coming first, that's the foundation, and then strategy execution, in that order, all the time. So it's not surprising when I got here at Zimmer Biomet, I focused on those things first. We built a One ZB mission, a One ZB culture, and we made sure that we didn't just send that out in communication. We flew around the world and we presented that mission, that purpose, to the organization, [ gave out medallion ], shook hands and made sure that everybody was connected to that purpose, that bigger purpose. And I can tell you, we do engagement surveys every year. Over 90% of our team members respond that they know the mission, they know the purpose and most importantly, they know how they connect to that mission and purpose, which is very motivating for a team. The other thing I did is bring in the talent that we needed to transform the business. When you're going to make transformation, you've got to have people come in and think differently about how you're going to do business. We brought in a lot of people thinking differently about the orthopedic space. And through that, we also created some diversity on the leadership team, true diversity in the leadership team, where we went to -- from less than 20% diversity to almost 70% diversity. And usually, when you do that, that trickles down. And if you look at our VP positions, we have women in VP positions going up by 8% over that time frame and people of color by 6%. And make no mistake, we've got a lot more that we want to do, but that's a lot of diversity of thinking in an organization. I promise you, that is the way you make change, that is the way you continuously improve. And then we had to deal with the challenges that we had in execution. From supply to commercialization, we had a lot of them. On the supply side, if you remember correctly, we had more than 4 days of back order that we were dealing with. It's hard to believe we could continue to service the customer at all. And after that period, when we fixed it, we had a long period of time until now where everybody else is challenged with supply of truly creating a supply-free issue for our team members and our customers. And from a quality standpoint, we had some challenges. We had 3 warning letters coming in. In 2017, we had over 60 recalls, 60 recalls in one company. Right now, we have 1 warning letter left, and we're on our path to be able to remediate that, working closely with the FDA. And for 2 years running, we've been in the single digits from a recall standpoint. And I would tell you that I think we have one of the best quality cultures, which is the most important, and quality systems in the marketplace. Same with compliance. I don't think people knew or not, but we were in a monitorship, the DOJ, SEC monitorship when we joined, and we put a lot of time, a lot of effort and a lot of resources against ensuring that we got that certification. And again, I truly do believe we have a compliance culture that's second to none and a great compliance system. And from a commercial standpoint, when we came in, there was a trust factor issue between the commercial organization and the corporate organization. We went to work in solving that myself, Ivan Tornos, who have been -- we carried the bag in the past. We got connected with the team, and we made sure that, that breakdown, that trust breakdown, was eliminated. Then we also got to work at cleaning house. There were folks that just weren't getting the job done. And once you start innovating and you start having supply come out of the challenge, you can see who's doing the job and who's not. And we consolidated pretty significantly, we went to the best leaders that we had, and we brought in new leaders as well, and then we specialize the commercial channel. So a lot of changes that we've made to make sure that we eliminated that as an execution challenge. Then we moved to phase 2, which was really moving more towards a true 5-year strategic plan. As important as deciding what we were going to do, we decided what we're not going to focus on, and that was a big part of what we did. And we created strategic pillars as a result of that. And I promise you, everyone in the organization has a strategic pillar or a sub pillar that goes right down to their individual objectives. So everybody is aligned on the strategy of this company, and everybody is moving it forward. We also then built the organizational structure, operating mechanisms to make sure that we held ourselves accountable for the discipline around focusing in these areas. And then we shifted our innovation as a part of the strategy change. We didn't want to just be a product company. We wanted to be a solutions company and truly bring data-driven ecosystem to the market. And that's what we did with ZBEdge. And you can see the impact. We went from a very low vitality index to more than doubling that over the time from 2018 to 2022. And we have a very rich pipeline that says we can do another 50% on top of that over the next 3 years, and I'll talk more about that in a second. And it paid off. The Q2 2020 was the first time in 20 quarters, 20 quarters, that this company was able to be at or above market in our large joints business, which is obviously 2 of the biggest businesses that we have. And ever since that time, as we look at the 8-quarter trend, we've been pretty consistently above market in both, either at or above market in both. And you also look at top quartile performance. That's one of our strategic objectives. If I look at the 5 years that we've been transforming the company, if you take COVID out of it, the 2 years where COVID was a heavy impact, and you look at those 2 years with no COVID and then 2022, where it was a limited impact, we've had 2 out of those 3 years as a top quartile performer in total shareholder return, actually in the 90th percentile versus our peer group. And that's not hand-selected peer group. That's ISS and Glass Lewis peer groups that they have assigned to us, okay? So clearly, it's working. You can see the innovation. We're getting accolades for being an innovator again in the orthopedic space. That is part of the mission, that's part of shaping tomorrow, and we're getting notice for it again. This is really the stats. Over the last 5 years, we launched 54 products. And very importantly, it's not just the short-term revenue growth that you get from the products. These are very focused in those markets that are faster growth, in our growth drivers, not surprisingly above 4% growth markets. And that means that you're building scale for sustainable revenue growth, not just short-term revenue growth. And as we look forward, same thing. We've got 40 new products just over the next 3 years. So you can see acceleration in the NPI that innovation flywheel is really moving. And those innovations will also be focused in those faster growth markets so that we can build scale and increase our weighted average market growth. And down at the bottom, this is the way we change the innovation. If you look at this, we played pretty specifically in the interoperative phase. We looked at the operation itself, the implant you're going to use, the tools, the instruments that you're going to use to do the procedure and maybe the procedural approach, but we did not look at the full continuum. Now we're focused on data collection before, during and after, and we're using those data insights to be able to change the way we care for patients. So a different view of how we innovate as a company as well. And then we move to phase 3, which is really transforming the portfolio of the company, transforming the operating model of the company so that we become more efficient and ultimately continuing that next level talent development. And I can tell you that this is an important area. We started this in about 2020. Obviously, the first part of this, the transformation of the portfolio, was a bit disrupted because of the COVID pressure on our business. As you know, it was disproportionate to us. We have over 80% of our business in elective procedures. So COVID was tough times for us and put a damper on the amount of capital that we had to spend in transforming the portfolio. But we've been focused on this for a while, and you can see on the right side of the slide, we've had some activity, either moving things out of the portfolio, acquiring things or doing partnerships. On the operating model side of the business, we had a lot of transformation to do, and we've been focused on it. The fact is we needed to consolidate the way we did things. We needed to change reporting lines to make sure that we could do that consolidation. And we needed to make sure that once we did that, we brought those operating models to GBS locations. We didn't even have global business services back in that time. In 2020, we put those in place. We have 3 locations around the globe, and we're maximizing that transformation of our business model. From a talent development standpoint, again, it was one of the first things that we focused on at the top level of the house. But now I want to make sure in 2020 and beyond that we focus on actually driving it down to the entire organization, that we're selecting the best talent and that we're developing that best talent and that we're ensuring that we retain the best talent. That is, in my opinion, the second most important thing in driving a sustainable business. So that's really the future of the organization. This is the transformation of the organization. When we think about the portfolio transformation, which is one of the most important, we thought about it in 3 ways. First and foremost, this is outside of the financial metrics that you would meet on acquisitions or divestitures. But we thought about it in 3 ways. Number one, and this might surprise you because I said we wanted to diversify away from just large joints, but we want to look at potentially adding scale in the faster-growth submarkets of knees and hips. Those are pretty slow growth markets, but there are very attractive fast-grow submarkets of knees and hips. And so robotics, it could be the ASC setting, it could be a direct approach -- a direct interior approach to hip. We wanted to build scale in those areas in faster growth parts of our large joint business because if we do that, we can drive our weighted average market growth rate up over the broader market growth. And that's the intent. That's true portfolio management. The other piece was being able to build revenue and/or scale in 2 areas. one, in orthopedic areas that we already play, like sports and extremities, but build scale in those areas; or two, truly look at opportunities that would get us outside of orthopedics, diversify this organization beyond orthopedics and make sure that we're moving away from elective procedures. And the final thing is to make sure we're looking at active portfolio management in 2 ways. It's not just what comes in, but it's what goes out. And there are certain businesses that we looked at and said, you know what, these are not the right businesses for us. We want to make sure that we remove them from the organization and give them opportunity to grow somewhere else. So what do we do so far even though we've been capital constrained because of COVID? The fact is, we knew that because we were capital constrained, we could at least move the initiative forward by moving things out of the portfolio. So we spun our spine and dental businesses, set up an opportunity for them to be successful because they can focus on investing in their business like they should, and it set us up to be able to focus on our core growth drivers. And at the same time, through that spin, we increased our weighted average market growth, which is an intent that we're focused on. We increased our revenue growth and our profitability as a company. We also used the limited capital that we had to acquire the companies that you saw before in our S.E.T. business and also in the ASC setting. We did technology relationships to make sure that where we didn't want to build competency in the organization, we had those partnerships to move ZBEdge forward. And we wanted -- all along, we were very disciplined in paying down debt and as a result of that, really bettering our debt to leverage ratio. And so going forward, as a result of that, we're going to have a lot more cash to put to work in phase 3 of the transformation. Now clearly, we want to make sure that we stay investment grade. And that's the goal. We're going to stay investment grade, and we want to make sure that we hold firm to our dividend. But outside of that, with the capital that we're going to have and it's going to be stronger capital going forward, we want to deploy that to transform the portfolio of this company. So as you can tell, it's been a pretty busy 5 years. We've had a lot going on in each of these phases. And there's no question in my mind we have corrected the integration challenges that were in place. We fill the gaps associated with purpose and mission in this organization and culture in this organization and talent. And we fixed a lot of the execution challenges, anywhere from quality to regulatory, to compliance, to the commercial challenges that we had. And I can tell you now, we've leveraged -- even though it's been limited capital and internal investment, we've leveraged those investments to ensure that we increase our weighted average market growth, going from somewhere close to 3% to somewhere close to 4% over the last 5 years. And with that momentum that we have, that stability of the company that we have today and the way the organic business is running, and with the product pipeline that we have that is as rich as I've ever seen and a better balance sheet looking forward, I feel very confident, I feel very confident this company, ZB, is positioned well for the future, and that means we're positioned well for growth. And with that, we'll move to the Q&A.

Good. So we have Suky, the CFO; and Ivan, COO; joining Bryan here to help out with questions. And maybe we could kick off. If we look back 2020 and 2021, orthopedics was fairly impacted by COVID and hospitalizations, ICU beds filled with COVID patients. I look at 2022, it looks like this market recovered very nicely and appears to be sort of back to normal, if not maybe on track to do a little better than normal. So what are you seeing from the inside? And how do we look at these trends, U.S. and outside the U.S. with respect to that?

Sure. Maybe I'll start and, Suky, if you want to add some color commentary as well.

Yes, sure.

So first of all, I would say that, yes, 2022 ended up being a lot better than we expected. As you remember, we set our guidance in the beginning of 2022 assuming that the COVID pressure that we experienced in '21, kind of given a recency bias, would actually go through 2022. And that didn't happen. The good news is, after Q1, we saw a great recovery and procedures came back, and that certainly helped our year. No question about it. I would just say that I wouldn't call it normal, though. We're in a better place. Procedures feel good. They're actually at about typical historical procedural volumes. But the way you get there is different. There's a lot of variables that are anything but normal, but the combination of those things have gotten us to kind of normal procedures. And we would expect that to continue into 2023. You're still going to have supply challenges that are going to be a challenge for every organization as we move into 2023. And that does put a governor on revenue growth. You are still going to have challenges associated with cancellations, procedure cancellations, not the way we used to, where you have ICU runs and as a result, you don't have capacity, but because people getting sick and can't do the procedure. And that's going to be offset by the fact that we have a lot of innovation coming, and we have some easier comps in the first quarter. So I think it's unusual in the sense that you've got a lot of variables you typically wouldn't have. But I think that the procedure volume will be about normal.

Maybe said another way, demand seems to be coming back to normal, it's more industry factors that hopefully are temporal and should resolve in the near to midterm.

Agreed. Yes, that's the right way to think about it.

You talked about in the slides, Zimmer Biomet's weighted average end market growth has improved from 3% the last few years up to close to 4%. And you talked about how in a normal environment and also 2023, Zimmer Biomet should have a 4% handle in the guidance range. So we'd love to all see Zimmer Biomet do weighted average end market growth and with the innovation you're having get above-market growth. How should we think about how get to market? And then how far above market do you think you can realistically do with all the technology that you bring to market?

Sure. It really kind of depends on -- first of all, we want the same thing. We want the same thing. And that's the intent. And in the areas that we've chosen as growth drivers, that's the absolute intent. If we're focused on a specific business and we have specific growth drivers in mind, and we're over indexing on our spend in those areas, R&D, commercial infrastructure, acquisition, we fully expect those categories to grow above market, no question. In those areas that we're using to fund those investments, we would expect more market or even submarket growth, and we're okay with that balance. The key thing [ to us ], Robbie, is really building that weighted average market growth rate up. That doesn't lie. If your revenue is in those markets, you should be able to at least get the average of those markets in that growth rate. So I'm hyper-focused. The team is hyper-focused on continuing to increase that weighted average market growth. And as we have more balance sheet to work with going forward, we absolutely intend to do that. So the most important thing for us is get more of our revenue in those faster-growth markets to make it easier to be able to have that sustained growth.

I guess there's sort of 3 levers you can poll, not just Zimmer Biomet, but the whole industry to get growth up and you specifically. You can grow volumes. Probably in the markets you're in, it's a bit more mature. So volumes aren't going to move a whole lot. In some of them, yes, mixed with new products, and that can help. And then also price. And that's the one I want to hit on for a minute because we have seen price go from minus maybe 2, 3 a couple of years ago to better and better. Where did you end or qualitatively, you haven't reported fourth quarter results, how have you done throughout 2022? And what's on deck for 2023 in terms of pricing?

Yes. So we did pretty well in 2022. And I'm going to let Suky answer this because he has the most elegant answer that I've ever heard about.

You're right, Robbie. Historically, we've been about a 200 to 300 basis point price erosion company since the merger of Zimmer Biomet. Through the third quarter of 2022, we were doing much better. We were about 150 basis points of price erosion. And I would say that's really driven by kind of 2 factors. One, our area of things that are -- we consider transitory or temporal, the other being more structural. The transitory type things are around, one, we didn't see as much in contract period renegotiation by hospitals or accounts. In other words, they were not approaching us midway through their contracts to try and get price concession. There's a variety of reasons for that. I won't go into a lot of detail, but that was one lever. The second was because you saw some COVID impact earlier in the year, many accounts didn't hit their volume thresholds, which then made them eligible for more discounts. So those 2 things, we consider more temporal and helped in that 150 basis points versus our historical average. The thing that's more exciting to me are the more substantive and structural changes we're making around price. One, we've invested a lot in hiring the right capabilities to set the right pricing strategies, to set the right corridors, to set the right governance and pricing within the company. The second is we've invested substantially into systems, data and analytics, which are helping us better understand the elasticity of pricing at the account level, helping us understand better the profitability of pricing decisions that we're making across the globe and a variety of other levers that are more fundamental or substantial or structural in nature. So if you put all that together, we think as we move into 2023, we're likely going to be at the lower end of that historical average of 200 to 300 basis points with an opportunity to do better if some of those temporal things continue into 2023. But I'll tell you, we've not stopped continuing to focus on pricing and to get that number even lower as we move beyond 2023.

Do those comments hold on a global basis? Are you able to take price or give less price in international markets as well as the U.S.?

Yes. We've seen that across the board. The U.S., EMEA has done a fantastic job in that. And then even within Asia Pacific, our performance relative to the company average is even much better. I don't know.

I'll just say we had, in 2022, without getting into specifics, probably -- probably no. Every single region performed better from a pricing perspective, '22 versus '21.

If I go back to the 3 drivers of growth, volume, price and mix, if we touch on mix, which I view more as new products, you have a lot. You have robotics with ROSA, you have Persona IQ, you have cementless, amongst others. And maybe you could just give us an update on where you stand and how you feel about each of those as it relates to the business and your goals as Zimmer Biomet, where you want to be with those launches.

Sure. Maybe I'll make just a top line comment, if you wouldn't mind hitting the specifics. What I would say is, first of all, one of the maybe underappreciated things that we're seeing right now in orthopedics is that technology adoption is pretty rapid right now. And you're seeing it across all the major players and pretty much all providers are moving in that direction. And that's important because, to your point, as you bring in new technology that has more value, you get more revenue per procedure, more mix benefit. And I truly do believe as you see that adoption continue in robotics and data and things like cementless, you're going to see the overall market growth rate in orthopedics go up. It has to, just mathematically speaking, as you're bringing that innovation in. The other thing that innovation does for us, specifically, is when you bring innovation, your vitality index goes up, you're negotiating with the customer changes because now you're bringing in new technology, you've got a longer-term contract, and as a result of that, your price stability is better. So both of those things are happening with us, obviously, but also as a market as well. Ivan?

So Robbie, first of all, I'm happy that we're talking about innovation versus remediation, which we're talking about 4, 5 years ago.