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

Good morning, everybody. Travis Steed, medical device analyst at BofA. And next up, we have Zimmer Biomet. We got the full team up here, Bryan, Suky and Ivan. So thanks for coming, and welcome.

Thanks for having us. Great.

I was thinking to break the conversation up kind of 3 pieces. We'll talk kind of Q1, Q2, more near-term trends. And then kind of move to the second bucket, more of the longer-term structural growth drivers for ortho, and how some of that potentially could be structurally different? And then maybe M&A is kind of the longer-term transition for Zimmer Biomet. So that's how we think about breaking the conversation up. And then so for some of the Q1 stuff, it seems like there was a lot of moving parts in Q1. There was a comp benefit. There was an easier staffing environment. There was also the offsets on some of the supplies. So maybe kind of walk through some of those moving pieces and kind of get to a normalized growth rate, if you will, for Zimmer Biomet?

Yes. So we knew that Q1 was going to be the strongest quarter of the year, largely driven by the comp benefit in first quarter of '23 versus '22. Remember in '22, you still had Omicron kind of floating through the system in January and February. So that gave rise to a very large comp benefit. From there, I think it was -- the next biggest factor was likely the easing of staffing pressures that we had seen through most of 2022. From there, we did see some backlog in the quarter. It was probably the next biggest variable. And then again, you saw, I think, very good execution from the team. As you said, an offset to that was continued supply headwinds, but that -- those are sort of the building blocks that made up the quarter. As we think about moving forward relative to the rest of the year, we not only increased our guidance by that Q1 overperformance, but we actually said we're going to see that momentum pull through in the rest of the year, and sort of looking at the middle of our guidance range on revenue, that would imply about a 4% to 5% growth rate for the rest of the year. Now the quarters are going to look a little bit different, but that's the way you should think about the sort of underlying growth of the growth through the rest of the year. Now inside of that, while that might feel normal, the elements that make that up are not yet normal. We're still assuming there's just going to be some modest pressure from staffing, supply is going to continue to be a headwind and that there will be some level of backlog that will help offset that.

And on the supply side, kind of what are you -- the visibility there on the supply getting better and potentially, you've assumed for the full year?

Yes. I'd say it's gotten maybe incrementally more challenging, and you really got to break it down into 2 components. There's the supply side, which, fortunately, we're actually seeing some easing in some spots like labor, some elements of raw material and supplies. Sterilization is sort of stabilizing. So the supply side is getting, like I said, stable to marginally better. The challenge is the demand side. I mean with the uptick in the volume, it's required us to dig a little bit deeper into our inventories out in the channel, which could potentially put some incremental challenge through the rest of the year. But no doubt, the team has been doing a great job in navigating that so far.

Kind of the same question on the staffing. As what you kind of assumed for the rest of the year, potential for that to get better. On the -- kind of the staffing, on the overall environment, and I guess another question on that would be more as like are you seeing the staffing get better, the procedure environment better more in the inpatient or ASC. We've heard some stuff about ASCs really driving a lot of the volume uptick in Q1?

I'll take the first part of the question and maybe ask Ivan to take the second. So overall, our original guide had assumed that we would continue to see improvements in the overall macro environment on those 2 factors. We're just seeing it happen a little bit faster and better than originally anticipated, but maybe you can give some input.

On the second part, in the ASC, there is no staffing issues whatsoever. And on the inpatient outpatient, we've seen some minor glitches, if you will. But overall, the story is almost identical to 2019. So it's not a headwind by any means today.

Okay. So it feels like the ASC is probably driving a little bit of the upside in Q1?

There's probably a couple of things that are driving the better volumes, if you will, in addition to whatever the backlog may be. One, you are seeing more days of surgery. So in the old days, the old days for me is now anything before March of 2020 COVID, cases were done on Mondays and Tuesdays. You wanted as a surgeon to release the patient by Friday, you don't need to do anything over the weekend. Now we're seeing that Wednesdays are surgical days, length of stage is lesser, given technology, efficiency models and whatnot. So you are seeing an additional day of surgery in many cases. So that's number one. And then number two is ASC. We're seeing a shift to the ASC that is real. We'll talk about 40% or talk about 50%. I have no idea what it is, but it's a real shift into the ASC. So those are true volume drivers that were very acute in Q1 of 2023.

And then the comp benefit, the way I was thinking about it is Zimmer grew like 13% in Q1. You're thinking about kind of 6% to 7% guidance in the back half of the year. Is kind of the difference there by 500 to 600 basis points more the comp?

It's hard to peel apart all those components. But the large component, the biggest driver of that Q1 versus rest of the year is the comp benefit.

Okay. And then I think you also said some backlog was starting to come through. Maybe talk about you're seeing that measuring it in terms of the opportunity on the backlog side of things?

So we did see some benefit in the first quarter. I kind of went through some of the elements that made up the first quarter performance. We're assuming we're going to see some backlog benefit through the rest of this year. We do believe that there continues to be a sizable backlog out there. It's tough to pinpoint exactly what the size of that is. And at this point, how long that will be sustained. In other words, that potential tailwind of backlog. But maybe you want to give a little bit of color on what you're seeing on the field.

We know there is some backlog. And I'm not trying to be cute when I say, I don't know what it is because it changes depending on who you ask, have been fired from the backlog analysis team already 3 times. So I got to be careful what I say here, but we've seen that there is backlog in some areas. So they build on say that is backlog. They've seen there is just a new bolus of patients, so who knows. What we know is that whatever backlog is happening, it's not going to get resolved right away. It's going to be here for a while, we know which are the other drivers that are going to get the volume sustainability there.

So potentially, it could last longer than the 6 quarters that others have seen.

Well, that's what competitors are saying, I don't know. I really don't know. But it's not something gets resolved today. And sometimes backlog creates additional backlog, but it's something that we've got to get better at.

I mean I would tell you; we've done a lot of work on this. We talked about it before. We've used 2 external part that are unbiased and have looked at it and tried to solve the equation, both came up with different values of the backlog and both came up with different times that they would actually be consumed. We're going to learn. We're learning right now. And the first time we've actually consumed backlog was in Q1. So every month that goes by, we're going to get smarter on this and be able to predict it more. But it's just challenging to come up with the actual size and the timing today. And as Ivan said, depending on who you ask, it's a different answer. Guaranteed, we're getting smarter every day, though.

Right. I mean how do you think about it as an incremental growth driver. So you're getting backlog this year, getting backlog next year kind of consistent given the supply of staffing? And do you think that could be in a growth driver next year? And the second part of that question would be, obviously, if it's not, it's still incremental dollars and incremental profit dollars. And so would you let that flow through? Or would you use that for kind of investment?

So I'll handle maybe the first part and then Suky you can talk about our investment strategy versus flow through. First of all, if it stays consistent, and again, we got to learn more to say whether it can, but let's make the assumption that it does that it goes through all 2024. Then from a growth perspective, it's a net zero, right? There's really no value associated with that. because it's already built into your base. And so that's kind of the way we're thinking about it, don't think about it as an acceleration of growth into next year. It just goes away. It's in your base and it's no longer an impact. But if you can speak to because you still get the dollars, what we would do with the actual profits.

Yes. The building blocks of our earnings power story has always been about maintaining revenue at least that 4% to 5%, stabilizing gross margin, mix shift within SG&A to our higher priority areas and leveraging that fixed cost in our SG&A base, which ultimately expands margins over time. If we do to say or we do actually see additional volumes through backlog. The great thing is we'll have the optionality, right? And we believe we can do both. We can both invest a portion of that in the business, while dropping some to the bottom line and margin enhancement as well.

Great. Maybe we can touch on kind of a lot of things could potentially be telling to the ortho market. So pricing less, you've got product mix. You've got some post-COVID stuff that you've talked about. I don't know maybe you could start with some of the post-COVID changes -- structural changes is that you were starting to look at kind of expand upon some of that?

Yes. So I look at it probably 2 different ways, and you guys' chime in any time. But the first part is the things we can control and what is giving us confidence about our momentum. And the first thing is maybe you know, maybe you don't. We've done a lot of work over the last 5 years to increase our weighted average market growth, which is really important for overall growth of the company. Our innovation is very strong, and that's giving us a catalyst not only for a mix benefit, but also a competitive conversion opportunity, which we're taking advantage of. And our pricing has gotten much better, much more disciplined for various reasons. So we're just better at managing and governing pricing on a global basis and our execution right now is flawless. All those things give us confidence in our momentum, but separate from that, I think, is what you're talking about, it feels like there's a change in patient behavior as well, and we're trying to validate this, where patients are feeling more confident now about the outcome of the procedure, and that is a motivation to go get a procedure. You have a lot of patients who sit on the sidelines. They don't get entry in the funnel, even though they should. If they have more confidence in the outcome, that's a reason to enter. The second is there's a comfort level with the ASC environment versus the hospital. And let's face it. No one wants to go where a lot of sick people are in the hospital, it's overwhelming. The ASC is like a concierge service. It's dedicated to that procedure. It just feels less overwhelming. And the final one is just convenience. I mean, you've got a lot of outpatient procedure now. So you're going to go in, you're going to be home very quick. And even if you do a rehab, if you're in a flexible work environment, that's even less disruptive. So there's a lot of things that we're looking at that just are happening around us. give us confidence in the strength of the market, not just our business.

And you're starting to see some signs of that and some of the work you're doing?

Exactly, exactly.

On some of the pricing side, like, I guess, if you think through like some of your competitors are kind of seeing flattish pricing for ortho, is that kind of where we're going? And is that sustainable in the longer term?

Yes. We'll see. Definitely, the pricing environment, we've seen more elasticity in pricing over the last 12 to 15 months because of the inflationary environment we've been. And we'll have to see how that progresses as inflation starts to moderate moving forward. But as Bryan said, there have been temporal factors versus structural factors that have improved our pricing performance year-over-year. Those structural elements will continue to help us perform better regardless of what the environment is moving forward.

Maybe talk about some of the pricing things that you put inside like some of the pricing muscle and things that you're doing differently that you weren't doing in the past?

Yes. We've hired capabilities and resources around this one, we put a pricing are in place, who's got a very deep background in orthopedics and MedTech. He has built resources around him in each one of our regions. So one is resources and capabilities; two, we've put systems and analytics into place. We didn't have a view account by account when we were making pricing decision, what that meant to profitability. We now have that, and we can make much more disciplined decisions. We didn't quite frankly, have a very good pricing strategy overall, and how do we use the full breadth of our portfolio at an account level versus pricing on an individual product. So there's a number of factors that are driving that. We feel really good about there's always room to improve from here.

Maybe I'll throw 2 quick ones there. One's on simple that has been transformational. We pay people on pricing. We didn't use to do that. So general managers around the world, we're not incentivized or penalized on pricing, today, they are. And at the sales rep level, we are paying people on those margins. So that's one element. The other one is far earlier. On the new product development cycle, we think about the dynamic. So we obviously have vitality index, a percentage of sales coming from new products. We also have what we call the IPI, the innovation profitability index. Are we certain that products, we're going to command a higher price. Are we going to get expansion in gross margin with this innovation. And by the way, as we launch this new innovation, are we going to lock in pricing for peripheral items around that product? So I would say that in addition to the data, to the contracting, to the people there's a change, a mindset change around how we think about gross margin and pricing. They're really sustainable even in a better inflation environment.

That's helpful. On the new product innovation, Ivan, I know what you're most excited about?

Yes. So I'm going to be here for the next 45 minutes, let's grab a drink. I'm excited about the fact that it's a different Zimmer Biomet. You guys have been following us for a while. Four years ago, we were talking about remediation. Today, we're talking about innovation. And I generally believe it is the competitive advantage of Zimmer Biomet. We don't disclose the size of the pipeline, but it's dramatically higher than it was in 2018. Our vitality index, the percentage of sales coming from new products, gross sales, new products is 2x, if not 3x what it was in '18. We launched 50 new products in the last 3 years. And by the way, it's not just the quantity, it's the quality of the new products. These are first to market. These are Vanguard accretive for our new products. And we have a commitment to launch 40 new products over the next 3 to 5 years. And again, this is not competitive centric products. They're not [ mutual ] products. They're customer centric. They're going to command the #1 or #2 position. With that framework, we've got innovation going on in each and every category. We recently launched our cementless platform. The goal is to go from 15% penetration to 50% penetration in a rapid amount of time. If my boss was not here, I will tell you what a rapid amount of time looks like, but it's not over multiple years. We got what we need when it comes to robotics. We are less than 12 months away from launching triple tapered stem. That is a gap in our hip portfolio. We got surgical impaction devices in hip, that is our [indiscernible] launch that we disclosed at the Academy. I think that, that is going to give us an edge in hip. We got our [ TonaVista ] in the ASC, whether it's on anchor sutures, whether it's in [indiscernible], whether it's, you name it, we have what we need to compete in the ASC. Our CMFT, craniomaxillofacial thoracic business, our portfolio through inorganic and organic means is best-in-class. Hence what we're growing that business in the solid double-digit growth rate. And beyond that, on data, technology and solutions, partnerships with Apple and Microsoft, we're innovating rapidly when it comes to things like mixed reality, things like data and informatics and across the board. So again, I could spend literally an hour on this, but it is a competitive advantage to Zimmer Biomet.

And then the cementless knee. What do you think the key differentiator there is? And is this more of a play on gaining share or more mix?

Yes. I'll give you 3 words, and I'll explain on each of those words, stable, versatile and anatomic. And I'm sounding like a sales guy, I used to be a sales guy, a really bad one, but I was a sales guy. Stable. We have proven technology around stability of the device. And that stability means better mechanical fixation and long-term biological fixation. And if you understood nothing of what I said, what this means is that the implant will stay with you forever. We achieved that stability because of the porous plasma spray with the type of material that we use that we've been using in hips forever and because of the actual design. So the stability of the cementless knee is second to none. On the versatility, we are the only company that has a device where you can choose to do cemented or cementless all the way to the end of the procedure. And that matters because you've got a large percentage of customers that are now convinced that a cementless knee is the way to go. So for those surgeons, for those customers, they have the optionality all the way to the end of the case to choose one versus the other. And then the third one was anatomic. This is part of the Persona family. Persona is the world's most personalized knee. You can customize the implant for any type of patient, any type of anatomy and that's something we have in the cementless configuration as well. So stability, versatility and the anatomic design are the 3 main advantages of the product.

And do you have something to say?

Yes, I was just going to say that for all those reasons, we see it as a mix benefit for sure because as you cannibalize your cement did, you get that mix benefit. But we also see it as an opportunity to take share. There's no question. And it's not just in the cementless portion. But now that we have the full Persona family, even the Persona family, the entire portfolio becomes more attractive to our customers. So we really have an opportunity through this closing out that full portfolio to then take Persona and go get customer conversions we couldn't get before.

And within your competitors has been an attach rate something less with a robot, kind of both penetration rates went up together. Now that you've got both, it feels like there could be an inflection point in both robotic penetration as well as cementless penetration?