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

Joining us -- Matt O'Brien, I cover medtech here at Piper. We're very, very fortunate to have the Zimmer management team here with us this morning. From the company, we've got Ivan, who is CEO; Suky, who is the CFO; and then several members of the IR team as well. Thanks so much for coming out. Really do appreciate it. Great to be here.

So the question that comes up a lot that I'm sure you're prepared for and probably tired of answering is really the backlog that we're seeing and I know, Ivan, you're still pretty bullish as far as where we are in that process. How much longer can the backlog really be a tailwind for this sector? And then what do things look like when we start to kind of cycle out of backlog.

Sure. So first things first, good morning. Great to be here. On the backlog, we know in a data-centric way that it's sizable. We know that it varies from region to region. I was in Europe last week and very large, especially in places like the U.K. APAC, Asia Pacific may be lower. In the U.S., you hear of cases being postponed. You hear of volumes surges in the U.S., being busy for the next 7 to 8 months. With all these data points, we know that it's going to be here through at least the end of 2024. Who knows what's going to happen in 2025. Now what I will say is that we do not count on the backlog as one of the reasons why we're committing to grow mid-single digit in '24 and beyond. So we're not a backlog-centric company, certainly helps, but the growth that you're seeing right now is not backlog-centric or dependent.

Okay. That's interesting. So I want to get back to that in a second. But let's just get through this GLP-1 step upfront and get it out of the way if you don't mind.

What's the GLP-1?

Yes. I'm sure this whole audience isn't sick of talking about this, but we've got some data coming out, I think, from Novo in the next month or 2, maybe in February. Just talk about what people should be anticipating as far as that data. What data have you guys looked at specifically that makes you comfortable that GLPs are not going to impact your space going forward.

Thanks, Matt. Well, look, what can I say, 3, 4 months ago, we're not paying attention to this. Today, we're paying very close attention to this. We engaged third-party sources. We're working with the largest societies around the world to track the data. What I can say is that we're not concerned about it, frankly. On the study coming up, it looks at WOMAC scores pain management. You can have less pain, but you're not going to get rid of osteoarthritis. Once you calculate this damage, we run a company that deals with osteoarthritis. Osteoarthritis is, cartilage that is damaged. Pain is a consequence of that, but it's not the root cause. So the study is looking at pain scores associated with osteoarthritis and the impact of weight on that study. Clearly, if you lose weight, you're going to feel less pain. That doesn't mean that the disease is gone. So that's on the study. Relative to GLP-1s, we believe it's a tailwind. Too soon to tell whether we're seeing higher volume because of GLP-1s. But what I will tell you is that the data we're getting shows that a lot of the patients that are going through surgeries are on a GLP-1. We've seen patients that lower their weight, but they're able to go through the surgery. We've seen patients that lower their weight, they're active. Motion injury is the #1 reason why osteoarthritis can happen. It's not weight, it's not genetics, it's not age. So net-net what I would think is that it's a tailwind. We're not concerned about it.

Got it. And just last piece on this, and I'm tired of talking about it, but do you think we'll see any Zimmer-specific data at Academy extra to talk about?

You will, you will. So we're working with, again, some of the largest societies. We're running our own research with a third party. I've been asked not to disclose the name of the societies or the third party yet, but come in Academy, we're going to have the data. What I will tell you, so far it's looking very positive.

Okay. I appreciate that. So let's move on past that. The knee franchise, that's really been carrying Zimmer, recently very good performance there. How much of that is really a function of just ROSA uptake? And then how much of it -- I don't know if this is for Suky or not, but ROSA versus Cementless.

So we, in Q3, had a great quarter. We delivered 6% growth in the U.S., 9% plus outside the U.S. It's a combination of things. We got what I believe is the best portfolio in the market with a leading knee in the world, Persona. We are one of the fastest, if not the fastest-growing company in robotics with ROSA. We recently launched our cementless knee, Persona OsseoTi, which is capturing share very quickly. 1/3 of all the cementless knees that we get is from our competitor. We get a 10% to 15% uplift pricing wise with our product. And we've got an ecosystem of solutions. So that's what's driving Knee. Beyond that, yes, there is some backlog in there. We have great commercial execution. Are we an independent company? No. It is around 40% of our revenue. But we're doing great things instead. We're doing great things in the U.S. in Hips, so I think it's a very balanced approach.

Okay. But do you think Knee is going to be your primary growth driver in the next couple of years?

I think it's going to be more balanced. We had to early on focus on knees because it is 40% of the revenue. S.E.T or Sports Extremities Trauma business today is growing mid-single digits in the quarter. As we look into 2024, we're making a commitment to grow mid-single digit or above. We got the portfolio that we need in sports. We got shoulder growing in upper single digit, double digit in some regions. So the short answer is no. We're not going to depend on knees only.

And so then if you're not going to depend only on knees, as I look at the hip performance last couple of quarters, 2 quarters on a 2-year stack basis, it has decelerated a little bit. You've got some more competition from Stryker with Insignia, I know they're pushing hard there. Is there something outside of Russia that's going on in hips. I don't know if everybody -- these reps are focusing on knees because they're going so well and forgetting hips.

Yes. So let's just break down the answer in 2 parts. You've got the U.S. and you go outside of the U.S. In the U.S. in Q3, we don't like to talk about specific quarters, but it's important to note that in the U.S. Zimmer Biomet actually was at market in hips. And actually, we performed above Stryker, above Insignia and that platform. As to the U.S., we do have some comps, some challenges in Russia. I think everybody is having some challenges there, some issues in China. Yes, there are products in the hip category that were delayed that we're launching as we speak. So moving forward, I don't think you're going to see the hip performance that you see in the last 2 years. But in the U.S., it's been pretty solid. I know Insignia, that is a triple-tapered stem. It's not been at the right concern. We're launching our own triple-tapered stem. So this is for direct anterior approach sometime in the early part of 2024. So I think we're in a good place when it comes to it.

Okay. Understood. Appreciate that as well. And then on ROSA, I was really interested in Q3. You guys had a really good quarter with ROSA. Stryker had a really good quarter with Mako. I don't know if there was a trialing of Wallis that was going on or people were just slower because of that trialing, but why did the market for robots accelerate in Q3?

So Wallis, Johnson & Johnson, Mako, Stryker, ROSA, Zimmer Biomet, look, I think penetration of robotics remains very low. It's somewhere in the 18% to 20% range as a whole. So I think as we get more data out, we improve efficiency, it's an all boats rise type of event. So I think the demand for robotics in general for all of us is going to continue to grow. Relative to Q3, we saw demand for purchases. In some cases, it's educational facilities that want to buy the device and runs in clinical trials. In some cases, cash that is in the system. It goes up and down. I'm not sure that next quarter, we're going to have the same level of purchases. We prefer to do installments. But that's how it worked out in Q3.

Okay. Understood. So the demand and the appetite for robots is still extremely strong. I know capital...

Very high. And again, we prefer to place them, but if you want to buy, I will sell it to you.

Okay. On the S.E.T. side of things, you said things are starting to get better there. It has been an area that's underperformed last kind of year-ish, what's going to help really accelerate growth areas of new product introductions, et cetera?

So probably it's worth for the audience to break down S.E.T. Because the acronym makes no sense whatsoever. There are 6 businesses under S.E.T. You got sports, you got extremities, you got trauma, you got restorative therapies, you got biologics and you got foot and ankle. So that's 6 different businesses and 3 letters. Out of those 6 businesses, the areas where we focus: sports medicine, upper extremities, and CMFT, craniomaxillofacial and thoracic, I didn't mention that one. They're doing really well. Growing upper single digits, in some instances, double digits. We invested in those businesses. And again, they're gaining share across the key geographies. The other 3 that didn't perform that well, those being foot and ankle, we started the therapies and trauma. I believe now we have the portfolio that we need to elevate the growth in those 3 areas. We had a reimbursement headwind in our Restorative Therapies business, and that's behind. So a complex way to tell you that the commitment is real. We've not done well in the past, but we got the innovation. We got the specialized sales force. We got the contracting capabilities to deliver mid-single-digit growth across the world.

Okay. Specifically within S.E.T, how is Embody doing? I know it's early days, but how is that doing and what do you think about that product longer term?

Sure. So Embody is the acquisition that we made, I want to say, probably I don't know, 6, 8 months ago, something like that. It is above the model. TAPESTRY for soft tissue repair. It's a procedure that happens very frequently, especially in ASC, it's going really well. Today, still it's not that material. But it's not that material. We think it will be at some point, but today is not the lion's share of the growth that we're seeing in the category.

Okay. And are you seeing off-label use? I'm not sure you're not promoting for it, but are you starting to see off-label use of that product?

I'm not going to comment on that.

Okay. All right. So they're just sticking on one indication. Got it. On the pricing side of things, that's been an area that's been a tailwind finally after 20 -- I've been covering the space 20 years and it's never been a tailwind. How long do you think that's going to be more of a tailwind-neutral factor versus a headwind that you're seeing.

Out of respect to the fact that Suky is also wearing a suit, I'm going to allow Suky to answer that question.

Look, I think we have performed much better this year than our historical norm of 200, 300 basis point erosion. I think some of those are environmental, some are structural. We believe that this environment will continue at least through 2024. Where it goes from there? Tough to predict. But the structural changes will continue. The way we're thinking about this for next year is, again, another 100 to 200 basis points, which is significantly below our historical average. I'd say, Matt, the thing that's really interesting though is our pricing year-over-year is on a product level basis, so what it does not take into consideration is when you transition somebody from, let's say, a Vanguard knee into a Cementless platform on ROSA robotics, right? So you get a mix up shift because of that. And actually, this year, what we're seeing is that mix is effectively offsetting the price decline. So that's showing up in revenues as well as in EBITDA. We expect that trend to continue into '24 and beyond. So again, we're seeing a bit of a favorable pricing environment. We're doing some structural things to change our inflection going forward, and we're also seeing very positive expansion.

Okay. I think I misunderstanding a little bit, Suky. I think you said, like historically, you've been a couple hundred basis points headwind. Now you're more flat, right, on the pricing?

We were flat in the third quarter, but for the year-to-date, we're about 100 basis points.

Negative or positive?

Negative.

Okay. So then the mix is offsetting that because the mix has always been more of a benefit historically, right?

Not to the extent that it is now with the new innovative pipeline that's coming out with Cementless, with ROSA.

So as you get more and more Cementless, ROSA continues to build, and that dynamic should be a tailwind for you for a while?

Yes.

Okay. That's great to hear. Something you've talked a lot about, Ivan, is the R&D engine. I think you said 80% of your new products are going to areas growing north of 4%. What's the WAMGR look like of those areas?

Yes. So it's 4 plus. So first thing is first, I don't think that most people understand the changes we made at Zimmer Biomet over the last 4, 5 years from a WAMGR standpoint. When I joined the company back in '18, WAMGR was around 3.3, 3.4. And through divestitures, through R&D, through innovation, we are today around 3.8, 3.9. 80% of the products are going to be at least in the 4 plus. A component of those are going to be in higher categories, especially in S.E.T and whatnot. But you should think for weighted average market growth rate is 4% plus.

How competitive are those categories? And can you take share aggressively?

Yes. We will not be launching these products if they were not innovative, differentiated. So I would say 80% in the past was more reactive. We had to catch up in robotics. We had to launch cementless knees. We had to get our act together on triple-tapered stems. For hip, I would say, moving forward, 80% of those products have the pathway to be #1, #2 category.

Okay. You also mentioned something new in robotics. Is that within hips and knees, like ROSA 2.0? Or is it new applications?

There's a lot in robotics. So we made a very bold commitment to the robotic digital space back in '18, and you've seen the outcomes of those R&D investments. So we got 2 key -- 3 key applications in the U.S. globally right now beyond CMFT. You got total knee, you got partial knee and you got hip on the anterior modality direct anterior. We will be the first company to launch or sold a robotic platform. And that's going to happen at some point rather soon. Then we have next-generation ROSA for knees, which has a better customer interface, more integration with the rest of the digital ecosystem and driving better efficiency in an operating room. And then we're going to be launching sometime next year, the posterior application for hip. So again, we got anterior, which is very prevalent in the U.S., posterior, which is the main technique outside of the U.S. So those are 3 product launches that are coming.

Okay. how do we think about product launches over the next couple of years versus maybe the couple of years or the past 2 years?

It's a totally different story. Again, Zimmer Biomet, we merged in 2015. We got into pretty serious issues from a quality standpoint. We invested our money on quality remediation. The integration wasn't great. The R&D engines were shut down through probably '18. And as I mentioned earlier, now you've seen the output of all the investments we made since '18. 40 new product launches in the next 36 months. Our pipeline is twice what it was in 2018. As I mentioned already, Matt, 80% of those products are category leaders, #1, #2. I will say that by 2024 midpoint, there'll be no gaps in our portfolio from a hip, knee or S.E.T standpoint. So I do believe innovation is a competitive advantage for us.

Okay. All right. Great to hear. Let's shift over to the inorganic side of things, right? You've been very vocal about, let's get aggressive from an M&A perspective. You've got assets all over the place that are both in your core markets and then even tangential that are down 40%, 50% on the public side of things. Are you going to get really aggressive now.

I love the word aggressive. I'm not going to comment on the pipeline. I'm not going to comment on timelines. What I would tell you is that our capital allocation strategy remains M&A-centric, primarily. We do have the list of targets. Some of these targets are down 40%, 50%, 60%, but they don't act like they're down 40%, 50%, 60%. We are in a great position today from a balance sheet perspective. We've got a good leverage ratio, good standing with investors. We will flex the balance sheet and we'll do the things that make sense at the right time and at the right value.

Okay. And is it going to be within musculoskeletal only? Or will you go elsewhere?

We're looking at 3 categories, not necessarily in order. It depends on the opportunity, but we like to stay within the core. And again, when people think reconstructive orthopedics, they're thinking low-growth markets. That applies to some categories, but you have high-growth categories within reconstructing. Data, technology, robotics, next-generation robotics. Certain implants are in high-growth categories, and there's a lot of opportunity in that space. Second bucket, again, not in order, is S.E.T. On this area where I mentioned you have 6 different businesses, these markets are growing upper single digits. Craniomaxillofacial and thoracic is going up single digits. Shoulder is growing upper single digit. Sports is growing up. There's a lot of opportunity in that area. And then the third area would be within the ASC, Ambulatory Surgical Centers. There's a lot of opportunities. Once you are in there, you can do things in anti-infective. You can look at other plays that are core to our -- or core point. I don't envision us we won't be doing something totally out of left field. We don't need to do it, so I'd like to stick to those 3 here as I mentioned.

Okay. And sorry to push a little bit here, but you don't want to be a 3% to 4% grower. You need something that's adding about $70 million in incremental revenue per year to get you an extra 100 basis points of growth. Doesn't that limit you more to the S.E.T side of things versus other areas or what am I missing?

First of all, thank you for the challenge. First of all, I don't think we need to do M&A to grow at the pace that we are suggesting. $70 million of growth is something we can get through the innovation that I mentioned, commercial execution and market dynamics. So we don't need to do M&A to grow at that pace. I'm not saying we're not going to do it, but we're not dependent on M&A. If we are to do M&A, do we need to do S.E.T, again, not necessarily. You got categories within recon that are growing at a fast clip. It would be easier to do things within S.E.T. And again, we're looking at those categories, lots of opportunities. Foot and ankle, it's a great opportunity as well.

Okay. Understood. And then one more question. This one is for Suky. Just on the balance sheet side of things, you're 2x levered that would give you, I think, comfortably about $5 billion of dry powder. Is that -- first of all, is that about the amount that you have to deploy potentially? And how do you think about bigger deals versus just tuck-in deals that you've done historically?

Yes. First of all, I'd say as Ivan said, the balance sheet is in a very strong position. We are in the low 2s on a net-debt-to-EBITDA basis. The way I think about sizing is if you took that low 2s and you took it up by a turn, maybe up to 2 turns on an adjusted EBITDA basis of $2.5 billion plus you start to get in that ZIP code. That does not include, by the way, the EBITDA of the target that you would bring over, right? So it could even be bigger. So all that to say, we've got a lot of strategic optionality and financial flexibility. And I would say whatever we do, we're going to do in the backdrop of maintaining investment grade. So that's going to be one of the guardrails that we focusing on. Relative to sizing, what we talked about is our preference is in the tuck-in to midsized deals. On the midsize, on the outside, I'd characterize that as probably about $2 billion plus or minus as our outside limit. And then, of course, inside of that, you could get a lot of opportunity on the tuck-in side.

What about taking on dilution? How do you feel about that? I know you don't want to take that at the time, but...

Yes. I think overall to increase the WAMGR on a long-term basis is very value accretive, so that's what we're focused on. In the near term, we had to take on some dilution for up to 24 months, we'd be willing to do that, but we're going to look for breakeven inside of the 2 years. And in ROIC, that's at the high single digits to low double digits by year 5.

And has the interest rate environment changed that ROIC much?

It has. It started to elevate it for sure. Cost of capital has increased our expectation and our bar.

Making it a little bit harder to do some of these deals and..

We're going to remain bold, but disciplined.

Okay. So I'm just thinking of what, Ivan said about like these companies are not acting like they're down 40% to 50% plus the higher interest rates. I mean, is it the environment just isn't super ripe? Or is it okay, but not great? How do we think about that?

Okay, but not great. It's getting better. I think as these valuations continue to season, and Boards, management teams start to looking at a rearview mirror and that 52-week high gets further and further away, I think we're going to start to see things improve.

Okay. It makes a ton of sense. Ivan, going to the ASC side of things, lots of growth there, obviously, on the procedural side of things, but Zimmer doesn't sell booms, lights and all the other stuff that goes into ASC. So how big of a headwind is that not having the full complement of products? And how can you really still participate in that growth?

Yes. Start with a small correction. We do sell booms and lights. We have a -- we need to spend more time talking about it, a platform called Omni Suite, where we do booms and lights. And we do have a standing agreement with legacy Hillrom for the Baxter, where we can do booms and lights together. Look, I am not aware of any deal that we lost because we don't bundle stuff, right? We think that product leadership is the one driver of gaining share in the ASC. Products do matter. If we need to bundle, we can bundle with other partners. Again, I'm not aware of any deal that we lost because we didn't bundle something. If bundling or putting a bunch of stuff together was the primary source of revenue, Johnson & Johnson like would be #1 in the ASC. They're not. Alike what we're adding in the ASC space, we're growing in the upper teens. Our market share is growing every quarter. Our growth is in the teens, double digit every single quarter. We got the portfolio that we need. We got again, booms and lights. We got the sports medicine portfolio we didn't have before. We remain the #1 knee and hip in the ASC space.

Okay. How -- where are we at in terms of penetration on the ASC side in hips and knees? And then where do you think it can go to?

Low. I mean, I think I'm not saying anything new. I mean there is a drastic shift into the ASC. 10% to 15% of our sales are in the ASC space. ASCs are opening up very frequently. I don't want to say anything hyperbolic here, but very frequently. Cases are moving to the ASC shoulder so far recently, is moving to the ASC with new reimbursement dynamics. That's a great opportunity. Yes, I like the future. I like the potential. A lot of the cases from the backlog are moving to the ASC. That's where you're seeing higher volumes.

Okay. So switching gears here a little bit. You have a partnership with Canary Medical. They had a very favorable reimbursement update recently. Can that be a meaningful contributor in '24?

It depends how you define...

50 basis points to the top line.

I won't comment on that. I think it's going to be meaningful. .

You have, I mean. So...

I didn't expect you have an answer. The new to the world technology -- NTAP, new technology add-on payment kicked in, in the U.S., October 1, 2023. So now you get $800 per knee that you do with this device, which again is the only device in the world that has a sensor that tracks what happens with the patient moving forward. Technology is best-in-class. Price is not an issue. Reimbursement is healthy. So drive your own conclusion to that.

Okay. 50 bps, got it. All right. And then 2 more for Suky here as we finish up. On the guidance side, you talked -- you gave some commentary on the puts and takes for earnings next year, there was just -- there was a lot going on. Can you kind of sum up the impact to the bottom line?

Yes, absolutely. So obviously, we're not going to give guidance here and I think we've given a lot of color. Overall, the key takeaway is looking on the top line, we've talked about a mid-single-digit growth profile durably. I think that's very true for 2024, and a bottom line that's growing faster than revenue. That, we believe, we're going to deliver that in the backdrop of a couple of new headwinds that have emerged recently. One is around FX, which will be based on today's rates, headwind, who knows where they go from here, but as we stand right now. The second is Pillar Two and the tax impact of that, global minimum tax of 15%, primarily in Europe, which could add about 150 basis points of headwind to our tax rate. But despite those, we still believe we can grow revenue -- sorry, earnings faster than revenue. And the key building blocks there are natural leverage from mid-single-digit level growth. We don't think the impact to gross margin that we previously commented will be as negative as we once thought. And then quite frankly, we're doing some structural changes inside of SG&A to simplify the company, make it more efficient, reallocate resources. When you put all those things together, we've got confidence in our ability to grow earnings next year.

Okay. I appreciate that. And you've mentioned the top line, and I don't know if it's FX-related, but when I look at the Street models, they're all modeling 4% growth next year. You've said more mid-single digits. So is the Street getting it wrong? Are you more like 5% to 6%? I know you don't want to get into guidance, but is the Street just low?

Look, I'm not going to get in guidance. We're looking forward to providing a lot more detail as we move into next year, and we feel good about where we're positioned.

Okay. And then last one, just real quick. Pillar Two gets talked about a lot and you're talking about 150 basis points. Is there a way to mitigate some of that impact quickly.

I would say in the near term, likely not, but longer term, structurally, can you start to move around some of your strategies potentially.

Got it. Okay. All right, we've covered a boatload. We're out of time, so I think we can go ahead and wrap it up there. Thank you guys so much.

Thank you.

Thank you. Appreciate it.