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

Good afternoon, everyone. My name is Danielle Doria. I'm with the Jefferies Investment Banking team, and welcome to the Jefferies Global Healthcare Conference. It is my pleasure to introduce Zimmer Biomet Holdings.

Great. Thanks, everybody, for joining. I'm Matt Taylor, the U.S. medical supplies and devices analyst here at Jefferies, and we have several members of the Zimmer management team with us today. To my left here is Suky Upadhyay. I think I nailed it again, all right, CFO; and Ivan Tornos as well COO, and then in the audience here, we have Keri Mattox, who heads up the Corp Comms function and is the CAO; and then Zach Weiner, who many of you may know from his days here before he left us to go to Zimmer. Sorry, this is the [ last year ], I'll do that. So for this session, we're going to do some Q&A with the team. Always kind of want to give you a chance to kick things off high level and maybe talk a little bit about where we are in the river, how the year's started with some stronger trends and, of course, maybe zooming out a little bit the last few years have been an evolution of the company to be much more now front-footed, which has been good to see, but let me give you the floor, and then I'll jump into some Q&A.

Yes, absolutely. So we started the year first quarter. I think you all would saw the results. It was a fantastic quarter for the company, top to bottom, all the way through cash flow on a number of fronts. We posted 13% ex FX growth. We knew it would be our largest growth quarter for the year, largely because of a comp benefit that we got versus the first quarter of '22, where we're still dealing with Omicron. But beyond that, we had some durable structural things that were going really well for the company. One, we were seeing good recovery from a COVID perspective. What do we mean by that? Basically, COVID level hospitalizations were a nonfactor. We're starting to see staffing issues ease. Cancellation rates we're getting back to normal. So overall, underlying market demand was quite strong. Beyond that, very good execution commercially as well as from our supply chain and the innovation is real. And the mix shift benefit that we're seeing in the uptake and the ability to take new business with those new products is very real. Beyond that, we also saw some backlog actually start to come through the system, which was also a tailwind. And while supply chain challenges were a pretty stiff headwind, we were able to navigate those quite well as an organization. And so all of those things for me are more exciting because they remain intact and sort of that structural enabler of our growth going forward. So we're pretty excited about where we are. So you take that end markets improving and pretty close to normal. You take that our execution is very strong. You also look at our performance from a capital structure standpoint and the balance sheet has never been stronger as in the organization. The mission, talent culture has never been stronger within the organization. You're right, Matt. It's time now that we're more on the offense than the defense.

Great. So let me just further down a little bit with 2 questions. I'll start with current trends, which I'm sure a lot of people are interested in. You talked about a number of things that help Q1 staffing, backlogs, supply chain challenges, but improving. Maybe you could discuss what's in the guidance for the rest of the year regarding some of those high-level factors? What's not in the guidance for the rest of the year that, that was in Q1? and what could take you to the higher end?

Yes. So if you rewind back to 2022, we started to say with a lot of confidence that in a normal market environment, we would be disappointed if we didn't see ourselves at least 4% growth rate, if not maybe a bit better. And if you look at our guidance that we put out after our first quarter, our increase in guidance, I should say, from a top line perspective of 6% to 7% ex FX, and you sort of squeeze out what happened in the first quarter, that would imply that we have a CAGR Q2 through Q4 of around 4% to 5%. So we're starting to say, structurally, we're at that market normalization. But I would say things inside of that growth rate are still not completely normal. The 2 things that we think could drive our growth rate in the back end of this year higher or lower from the midpoint of that guidance is, one, if we saw supply chain challenges abate more quickly, we could potentially see some upside. Likewise, if they intensify, you could some variability to the downside. And the other factor is backlog. We continue to see backlog perform as it did in the first quarter or better, you could potentially see us to the upside and likewise to the other side on the downside. So we have a little bit more variability than normal because there are some market dynamics that aren't 100% normal, but we've got confidence in our overall growth rate. And I would say just having now gone through 2 months of the second quarter, we feel really good about where we are, not only for the quarter but for the rest of the year.

And since supply is a hot topic, maybe you could take us inside that a little bit and talk about how it's evolved and sort of where you are now? What are the challenges that you're seeing? And how is that preventing both sales and margin aside from that?

Yes, maybe maybe I'll take that one. So first things first, it is better than a year ago and it's gradually getting better as weeks, days go by. There are 3 -- 4 key components behind the supply chain challenges in 2 categories. On the supply side, we have materials or a material shortage, and that's pretty much across the industry, not across every industry, whether it's technology, whether it's real estate aviation, but in health care, whether it's resi, whether it's key components of parts and pieces has become, in the past, a challenge to get those materials. And I say in the past because now it's better. So that's number one. Number two is labor dynamics. Don't ask me why or how. But in some factories, in some sites around the world, is complex to hire people. We pay more, and it's complex to hire people. And then thirdly, and I'm sure that everybody is heard of this is sterilization. A large percentage of our products are sterilized and there is a bottleneck given some EPA dynamics and whatnot, it's been somewhat of a challenge. So materials, labor sterilization has been a bit of a headwind. And I'll say 2 things. The worst is behind and everything that we're seeing today is within the guidance that we have given. So that's on the supply side. On the demand side, forecast has been a challenge. What I mean by that, every week, we roll out a forecast. And every week, we've been wrong, likely for us on the good side. We said we're going to sell 10 and we end up with 17. Next week, we roll out the forecast. We think it's 20, and it's 28. So that's been part of the challenge in that regard. So all of that said, I do think we're in a much better position than we were before. And as Suky said, the team has done an amazing job in navigating some of these uncertainties.

Yes, I was going to say, related to supply, obviously, we've been impacted by inflationary pressures in 2022. We're seeing that roll into our P&L this year, but able to offset it. The good thing is we're not -- we're seeing stabilization in the pricing environment. There's a couple of areas that we're watching such as contract manufacturing, pricing as well as some raw materials continue to be a little bit spotty. But we're seeing some tailwinds in some other areas around freight as well as energy cost. So broadly, I would say, stabilize, but we just got to keep our eyes on things. And I would say what's really impressive about that is as you move through '22 in that hyperinflationary environment, we were one of the, I think, outliers of companies that were able to actually maintain the margins. And then if you take the implied guidance that we provide this year, even in the backdrop of some of those inflationary pressures that capitalize in this year, we would imply margin increases this year. So pretty happy about our execution from a team perspective there.

And maybe I'll try to round this out with 2 additional questions. So one is, when you talk about supply chain, I think the first thing a lot of people think about is margin. But actually, we discussed this before, it's preventing you from attacking some new business. So I'd love for you to address that and how that's maybe a shorter-term headwind that could unlock?

Yes. I would be lying to you, Matt, if I were to tell you that our sales forces around the world are not spending a disproportionate amount of time trying to just service what we got going on. Demand is very high. And obviously, we're prioritizing, we have prioritized our existing customers. That's time that we could have been spending converting accounts. If supply was not a limiting factor, I will tell you, our growth profile would be higher than it is today. So it's definitely been a challenge or a headwind.

And then the second piece on the margins. I know you've alluded to next year, fiscal '24 potentially having margins be flat or up a little bit on top of an improvement this year. Maybe help us understand if we do see significant improvement in the inflationary environment, could that be upside to that commentary?

It could be. It could be. But remember, that will take some time to capitalize into the P&L. So there are a lot of moving parts. I think just inflation is just 1 variable amongst a number of them. We've got a clear focus on continuing to expand our earnings power over time, especially in the backdrop of improving revenue growth. So we're always going to find ways to offset that or improve it.

Maybe we could zoom out a little bit. Talking about this idea of going on offense. I've been impressed by how many products the company has been launching and you plan to launch, I think it's 40 products in the next 18 months. So maybe talk about that cadence going forward and highlight a few of the top products that investors should be focused?

Sure. Maybe I'll start with a correction. I think what we said is 40 new products in the next 36 months, so not 18 months. But hopefully, within the first 50% of the 36 months, there's a lot going on guys. There's a lot going on. This is a company that has moved from remediation to innovation. We merged Zimmer and Biomet back in 2015, June 24th. And the first 3, 4 years was about integration. It was about quality. It was about supply remediation in a very complex way, now what we got going on. and along came 2018, and it was a different journey. It was about innovation. It's about -- it was about changing the standard of care. COVID slowed down that, but the study is real today. We will be launching at least 40 new products over the next 36 months. Many of these products, 90% or above are in higher growth segments. Many of these products are going to enable a #1, #2 position in the markets where we play. What I like about the innovation story is that it's no longer just a product-centric type of innovation. We're innovating in a solution-centric approach, merging data, technology and implants. We believe that we're going to continue to expand our Vitality Index as the percentage of sales coming from gross sales, coming from new products. We already tripled the number versus 2018, and the goal is to continue to increase that number, at least 50% over the next, call it, 3 to 5 years. In addition to the revenue profile for new products, a; like what we're doing from a margin expansion standpoint. We track what we call the IPI Innovation and Profitability Index. And we always want to see that the margin dollars coming from new products continues to be accretive to the overall organization. So all of that to say that innovation is a competitive advantage for Zimmer Biomet today.

I guess beyond the next 3 years, is this kind of the new cadence of product innovation that we should expect in the next decade, basically?

I'll say, launching -- I've been in the industry for 29 years, launching 50 plus 40, there's many products in a 5-, 6-year horizon. Meaningful products is a typical. Some of it was the backlog of the start that we should have done that before. So I don't know if I'm willing to commit to 100 new products every 5 years. What I will tell you is that you should expect Zimmer Biomet to continue to increase the Vitality Index in a meaningful way. You shall see -- you should continue to see a history or store innovation that we didn't have in the past. So -- by the way, across the key categories, not just hips and knees.

One of the biggest product launches and cadences that people are focused on, I think, today is the continued penetration of ROSA, how that can help get more pull through. And on top of your best-in-class implants and now with the cementless knee. So maybe we could discuss sort of where we are on the penetration curve and how having more and more of these implants to support it can help your value prop?

Sure. So what Matt is talking about, there are 2 really meaningful product launches that we got today. One has already been in the market for about 3 years. That is ROSA or robotic platform. We have an indication for primary knees, partial knees, hips and soon shoulder. We still are in the mid-teens when it comes to penetration, given the fact that some of our peers are in the 50%, 60% range, we see nothing but upside. The technology is real. It applies to inpatient, outpatient settings. So the point of entry for us is to get to the 50%, 60% range in a relatively short amount of time, and we're not going to disclose what relatively short means here at Zimmer Biomet. So that's on the robotics front. And then the other key product is cementless. Persona OsseoTi, O-S-S-E-O-T-I. I don't come up with the names. I just mispronounce them. That is our cementless platform that we launched early this year. And again, a similar story. We have a 15% 1-5 penetration in cementless knees, and we see ourselves getting to the 50%, 60% range because, again, our peers have done that. So those are 2 very compelling products. They carry what I would call, a very compelling financial profile. Anytime we place robots and sell implants, we gain 10% to 15% on the pull-through. And anytime we move from cemented knee to cementless knee, we get at least capital letters, at least 10% to 15% accretion on our ASP. So very exciting.

I think maybe just to round up the product discussion. The 2 top products that we probably get asked about the most that are coming or going to be ramping are the smart implants in the identity shoulder. And so I was hoping that you could talk about the catalyst pathway for each and when they could start to become more material?

Sure. So I'll go in sequence. So Persona is smart, that is sort of smart knee technology in collaboration with Canary Medical that we are right now in a limited market release space. So right now, the intent is to collect as much data as possible around this new-to-the-world technology. I won't disclose the number of patients that we want to have before we do the full market release. What I will tell you guys is that we'll be launching Persona Smart by the end of 2023, if not early '24. By the time we launch, we know whether we're going to be pursuing an inflection management claim, whether it's just about clinical dynamics around range of motion, gait or a combination of all of the above. But what I do know is that by the time we launch, it will be a compelling value proposition. Working through the setup from a patient perspective, working through some of the "early glitches", that are on the way. And by early 2024, this would be a meaningful product. And by the way, a product that we see ourselves expanding into other areas. Today, we are in knees. Tomorrow, we will be in shoulders, in hips and other categories. Your second question, speaking of the second product, Matt is talking about identity. That is the most meaningful product launch that we have seen at Zimmer Biomet in the shoulder space. We probably spend 30 minutes talking about it. I'll give you the short version of the clip notes. It will make surgeries faster. It will be much more of a customizable procedure. It will give surgeons optionality in terms of the technique they want to use only and all of this is going to enable a shorter, faster surgery and a faster recovery time for the patients. So again, a groundbreaking product from a financial and from a patient-centric standpoint.

Okay. I'll ask a couple of more questions and I think the last 5 minutes, we'll actually open it up to the audience here. But I wanted to back out again, I think a couple of key topics that people are focused on in the short runner recession? And are you seeing any disruption from what's been going on in the news in China in the last month or 2?

Yes. Maybe I'll take the recession and Ivan, you can do the China one. So yes, of course, we're keeping our eyes close on overall macro economy from a number of advantages and lenses, one of them being recession. We've not seen any impact to our overall demand. The market's demand for that point due to macro recessionary pressures. And I would say if we do happen to see a recession or move into a recession, I think there are a couple of dynamics that are different about the environment we're in today. One is you have a very strong labor market and so one could see the potential move in recession, but still have relatively low unemployment. And remember, our business is heavily correlated to access. So as long as people have employment, have access to health care are not afraid to take a couple of days off or a week or 2 off for their recovery because they're worried about job loss. I think that's going to be a different dynamic than what you've seen to the favorable side than what you've seen with past recessions. I think the second thing is if we were to see a recessionary impact on overall patient flow, remember, we still do have a sizable backlog out there. And so there is the opportunity that if somebody did drop out of the system because they didn't have the access because of the loss of a job or some other reason, you potentially have a line of other patients willing to take that spot. So I do think things could be different if we do end up in recessionary environment that could potentially mitigate the impact.

I'll keep the China answer very short so that we give the audience time to ask questions here in the last 5 minutes. We have not seen any case cancellations. We've not seen anything that led us to believe that there is another emerging wave that is going to shut down or business or impact our business in a material way. So nothing so far.

Great. So we have a few minutes left, now we could open it up and see if anybody in the audience wants to ask a question. If not, I'll keep talking. All right. Sure, we have one over here in the...

[Indiscernible]

All right. So the question is around Bactiguard. Bactiguard is a technology we got out of Europe. Actually, it's a technology that was used in other spaces in the past as an antimicrobial, anti-infective platform. It's a coding platform, silver -- gold, silver, palladium that you put over our implants, we got got the approval. We are commercializing that in Europe, [indiscernible] and whatnot. It's working very well. The idea is to bring beyond trauma into other implants. One of our major commitments from a safety standpoint in orthopedics is to be the #1 company in anti-infective platforms, and this is one of the plays. So we bring it from Europe over to the U.S. We bring it from trauma to other areas. It's not the only play. We're looking at iodine and other components, but we do think this is groundbreaking. Relative to your second question, I'm not going to disclose where we are in terms of an approval. Obviously, we're working with the FDA in understanding what is the commercial or rather regulatory pathway to bring this to market. But clearly, there is a solid intent to bring this groundbreaking technology into the U.S.

Great. Any other questions from the group? Maybe I'll throw related to margins. We've talked about some changes in pricing dynamics over the last couple of years. Could you give us an update on where you are as an organization on your ability to maintain price and how that could impact gross margins going forward?

Yes. So historically, we've been at about a 200 to 300 basis point year-over-year erosion -- price erosion-type profile. Last year, we were able to significantly improve that. We were at about 150 basis points. And this year, we've said that we expect to be lower than the historic average. So somewhere below 200 basis points. And I think for the first quarter, we were at 140, 150 somewhere in that. So clearly, there's been a step change difference in our pricing performance. It's really some of those are temporal, some of those more structural in nature. The more exciting thing is the structural things we're doing, which is around hiring capabilities, data analytics, new governance, new strategies, pricing at a portfolio level versus a product level. Those are the things that will, I believe, help us continue to improve our pricing regardless of what the overall pricing dynamic might be. What I get more excited about, though, than our ability to improve our pricing performance year-over-year is when we talk about pricing, we talk about product A, year-over-year pricing and the erosion associated with it. What doesn't go into that calculus is the mix shift benefit that we get when you take, let's say, our new cementless form factor and you place the old form factor of cementless, you actually get an ASP lift that actually improves revenue and also improves margins. And to me, that's the more exciting, more durable kind of path forward for the company, both top line as well as bottom line.

Have you ever quantified mix shift in the past or I guess what it could be going forward because of all the new products that you're going on?

We have not quoted in the past. We may as we move forward, especially because the pipeline of our products that we've recently launched and will launch is becoming more pronounced that Vitality index is becoming more pronounced. So you could see us talk a lot more overtly about mix as we move forward.

And then we might have time for one more or 2 more. I think to round out the margin discussion in the past, you've talked about getting a lot of your leverage from SG&A. We haven't talked about some of the programs that you've been running there. Could you give us an update on those and how they could contribute to margin expansion?

Yes. Our building blocks towards margin expansion have remained consistent. It's about really investing and ensuring that we get the top line growth into sort of that 4% to 5% consistently durably while maintaining gross margin stable to maybe slightly improving over time and leveraging our fixed cost base by allowing operating expense to increase year-over-year, but at a rate much slower than revenue. And we think we can do that a couple of really successful things that we've done is just blocking and tackling at the market level. Zimmer Biomet had a culture of growth at any cost many years ago. We've changed that over the last several years to say, hey, no, there's a difference here. You need to maintain a certain threshold of margin. That may mean you have to price differently. You have to go to market differently, you have to think about your investment structure differently. That's had really positive dividends and changed the culture and the mindset of every market that we have out there. It's been a really positive tailwind to margins for us. We think there's more room to go on that. Another area is our ability to leverage many of our back office operations into lower-cost markets, we think that there's still opportunity to leverage those types of structures and operating models. So there's a number of shots on goal that we continue to pull forward. But make no mistake, we're going to continue to increase our OpEx, but the idea is we're doing it at a lower rate than revenue, which provides that earnings power.

Great. I think that's a good place to end. Thanks so much for all the thoughts and a well-rounded discussion, and thanks for your interest in Zimmer Biomet.

Thank you, Matt.

Thanks.