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

Great. Thanks, everyone. We can get started here. If you want to take a seat. My name is Robbie Marcus. I'm the Medtech analyst at JPMorgan. Really happy to introduce our next session. I'm going to bring up Ivan Tornos, the CEO of Zimmer Biomet for a presentation, then we'll do some Q&A afterwards. Ivan?

All right. Good morning. I was expecting some music, some ACDC and [indiscernible], but I guess I'm not getting that today. Yes, thank you, Robbie. My name is Ivan Tornos. I'm the President and CEO of Zimmer Biomet. I've been with the company, 5 years. I've been in this job, 111 days and 2 hours. So I look forward to some questions later on. But before we get started, I do want to thank you, Robbie, for hosting this decision. I want to thank, obviously, everybody for being here this morning. I want to thank my team. We got about 10 people here from Zimmer Biomet. I want to thank all of you for a great 2023, for everything we're doing over the last 5 years, and most exciting for everything that I know we can do over the next 5, 10 years. All right. I don't think I need to cover this slide unless you want me to, and I can mispronounce each and every word in this slide, or I can just summarize it by saying, you know that any time you talk about forward-looking statements, there are some sort of risk associated with it. So that's disclaimer #1. And the disclaimer #2, there is a non-GAAP data in this presentation. I know it's been quite a confidence already. We've been here for a day and a half, to some of us probably feels like already a week. I'm sure you're fatigue, I'm sure that like me, yesterday, you attended a couple of social events. So let me recap the entire presentation in a couple of bullet points. And this, to us, is probably the most important slide and the key takeaway, the end of the movie. This is not the same Zimmer Biomet. I'll say that again, this is not the same Zimmer Biomet that maybe you've been tracking over the last 5, 10, so many years. And what makes this company different today is 2 things that end up on a third thing, which is expectations. It's not the same Zimmer Biomet because the markets are different. Orthopedics is not what we believe a 2% to 3% growth market. Combination of demographics, combination of the shift to the ASC here in the U.S., the access to technology, all kinds of elements tell us that today, orthopedics as a market is probably closer to 4% than 2% to 3%. On top of that, within the market dynamics, we at Zimmer Biomet have already increased our Vanguard from 3.5% to around 4%. Divested spine, divested dental, added 2, 3 companies within CMFT, craniomaxillofacial and thoracic added a couple of companies in our Sports Medicine business. So again, the market is no longer just low single digit. Historically, it was. That's not the case today, far healthier market, and no, it's not the backlog, and no, GLP-1s are not going to kill this market. So that's key takeaway #1. Key takeaway #2 is that internally, this company is in a different stage. If you go back to 2015, June 24, 2015, we merged Zimmer and Biomet. It was quite an intense period. We ended up with 4 warning letters. We had some compliance remediation to do. We had a lot of integration challenges. Those are behind. As of today, we have 0 warning letters. We cleared the last one, December 27, 2023, right at the buzzer. We do not have any compliance challenges. We are in great standing with every key government agency. It's a different company. All the integration established behind. So we moved from being on remediation stage to being on growth stage. And I think that's something that most people don't realize because they think, hey, you've been growing 1% to 2%, how you're going to grow 5% over 2024 onwards. And the short answer to that question is we moved from remediation to growth, and we'll talk about that later. Because a different market profile, because the company is at different stage, we're ready to make different commitments. And the commitments we're making, starting with the earnings call in Q3, and we'll continue to make is that this company will have to always grow at least 100 to 200 basis points of a market, already quoted 4%, you can do the math. And we got to do a better job and we will do a better job in making sure that earnings is always growing faster than revenue and free cash flow is always going to grow faster than earnings. Not ready to make a comment today on 2x leverage earnings to revenue. I'm not going to quantify today what free cash flow is going to do versus earnings. But the expectation, the commitment is that we will see leverage on earnings, leverage on free cash flow, growing mid-single digit or above. That's the most important slide in the deck. I'm going to go quickly through the rest of the slides, and I'm going to look -- and we look forward to the Q&A. All right. So now we -- the end of the movie, let's start with the very beginning. We've been in business for almost 100 years. So 1927 was Indiana's small but [indiscernible] town in Northern Indiana. What defines what we do is the great mission statement of Zimmer Biomet, 13 words, elevating pain and improving the quality of life for people around the world. Bucket #2, we do believe that innovation is the competitive advantage. There's a few things that we do right. But as I think about the one thing is definitely innovation. We are first in many categories. We launched a lot of groundbreaking technologies. We are the only company with a smart technology niche. We're going to be first to market in shoulder robotics. We've done a lot of leading things when it comes to anti-infection. We still have the #1 market share position in reconstructive. This is a leading company. Innovation is the key competitive advantage. Number three, we got close to 20,000 employees around the world. We operate in around 125 countries. I'm not sure that's an advantage. That's something we're evaluating. Do we need to be in so many countries. What we do know is that in those countries that we're going to participate, we're going to be best-in-class. And yes, we are a Fortune 500 company revenue at the end of 2022, obviously, haven't disclosed 2023 yet, was around $7 billion just as a proxy, and to make sure that we're all tracking that we're more in the right direction. In the year 2022, we actually -- our growth profile was close to 7%, 6.6% to be exact. And we did grow earnings that year, excluding FX, 12%. So that's who we are. This is a slide that we've been covering for the last 5 years. The answer is 4 key questions: the why, the what, the who we are, and the what we're going. The why is the mission statement. I already mentioned the certain words right at the center of the wheel, who we are, culture-wise. We're a company that believes in focus to win. Again, not being all over the place. We believe we can disrupt tomorrow, save tomorrow through the introduction of groundbreaking technology, and we believe that we prioritize teamwork over other things. Regarding [indiscernible] to the left, I won't cover those, and then 3 strategic outcomes, where we're going. We want to be a best and preferred place to work. We want to be a trusted partner and then I highlighted top-quartile performance because when you think about the other strategic outcomes, I would say we are mostly there. We just did our last engagement survey, and we achieved the highest engagement scores. I don't know we are the best and preferred place to work on earth today, but I will tell you that we have the best engagement scores in the history of the company. Trusted partner, that's behind, and now it's all about delivering the top-quartile performance. Throughout the last 5 years, we have had that status. We delivered TSR better than 75% of our peers. That is not a definition of winning. We want to be top quartile each and every year. Three things you're going to hear from us in today's presentation to deliver top-quartile performance. We're going to continue to leverage people and culture as a competitive advantage. We're going to run the company like operators. That's about operational excellence. An operational excellence to us is not just Six Sigma. It's not just efficiency models. It starts with a mindset and where each and every us truly thinks like an operator and an investor of the company. And beyond that is the, where we invest and how we invest? And we'll talk about that later. And then lastly, innovation diversification. We're going to continue to leverage innovation as a competitive advantage. We got 40 very meaningful new product introductions in the next 24 to 36 months. I look forward to the questions during Q&A. We did $7 billion, already mentioned, in 2022 with the guidance we gave at -- in the Q3 call, of $7 billion to $7.5 billion, you can do the math, it's somewhere around the $7.2 billion, $7.3 billion. If you look to the wheel in the left, 2/3 of our business is in Recon, 1/3rd is in S.E.T. I envision that the pie is going to change. You'll see more diversification going into S.E.T. And then geographically speaking, U.S. is around 58%. O-US is 42%. The markets, $43 billion is the sum of our parts, large joint is $17 billion. We are #1 in that category. I'd love to see my buddy from Johnson & Johnson, Aldo Denti, in the back. We are #1. We expect to remain #1 in the category. Sports -- next time you have to wear a hat, Aldo. Sports is $9 billion. It's a high-growth segment. We're #6. We don't expect to be #6 for long. Trauma and Extremities is a bunch of stuff, but in the categories where we focus, we're #2, #3. And then lastly, CMFT, craniomaxillofacial and thoracic is an area where we allocated capital. We're #1 in sternal, #2 in rib. I love this segment, it's high growth, it's good margin. We're going to continue to invest in this business. At the very south part of the slide, you see the historic, I want to make sure that we understand this, historic market growth rates. I started the presentation talking about large joint. We don't believe this is 1%, 2%, 3% growth anymore. All right. [indiscernible] to go and then we'll do the Q&A. I mentioned this company has come from remediation to acceleration, from remediation to growth. I don't want to bore you with all the drama in the white, but I do want to leave you with a key takeaway. I've been in business, I've been in Medtech for 30 years. I've never been part of a company with 4 warning letters with the Department of Justice monitoring how you do commercial practices. I've never been in an integration that win as the one that Zimmer and Biomet win, and all of that is behind. All of that is behind. The focus in the past was about remediating all those issues and driving top line growth. As we look at the next 3 years, it's a different story, it's about continuing to leverage people and culture, as I mentioned, it's about operational excellence, innovation and diversification, and we're going to quantify that over the next 4 slides. Let's talk about people and culture. I already mentioned highest engagement scores in the history of the company. The other data point I'm going to give you is that back in 2018, our turnover rate, the people that were leaving the company was around 23%. So think about running a business in where every year, 1 out of 4, if not 1 of 5 people, are leaving the company. Our turnover rates today employee-wise are in the low single digit. That's one very compelling data point. We've got a highly engaged team that loves what we're doing, believes in the company. I do believe that is a competitive advantage. It doesn't matter what I say, it matters what other people say. And again, I'm not going to do the victory lap here, but whether it's Fortune [indiscernible] Newsweek, pick any of these magazines, they believe that Zimmer Biomet is the best and preferred place to work across different functions and across different areas of the company. On operational excellence, we have committed to 5% plus starting year 2024. We have committed to earnings growth above revenue and free cash flow. Some of the things we're going to be doing. We're going to optimize our footprint. And this is something that already started. We're going to accelerate in 2024. We're going to do a far better job when it comes to commercial execution, right products, right countries, right customers, make sure that we are great in those categories, make sure that if we're not great in those categories, we'll allow somebody else to take over those businesses. On earnings per share is about S.E.T. optimization. It's about managing SG&A in a different way. I'm not proud to run a company with 42% OpEx. We are not going to run a company with 42% OpEx moving forward. And on free cash flow, I'm not proud to be part of a company with 400 plus -- 415 days on him. We will do the things that we need to do around inventory management. Again, operational excellence is running the company top to bottom. Historic has been about revenue. Now it's going to be about revenue, it's going to be our earnings, and it's going to be our free cash flow, and we're making very compelling commitments when it comes to the free cash flow profile over the next 5 years. You cannot be operationally excellent today, if you don't have a meaningful position in ASC. And again, you can read this slide better that I can pronounce it, but I will tell you there is 0 deficiencies when it comes to the ASC. We got what we needed from a people standpoint. We got what we needed from a portfolio standpoint. While we don't have internally, we can contract. There is this whole, I guess, thing going around that other companies are able to do better contracting because we have those capabilities. There is not a single capability that we like in the ASC. Point in case, we got over 500 contracts with ASCs around the U.S. We're growing in the upper teens in the U.S., 10% to 15% of our sales are in the ASC. One of every 3 robots that we places in the ASC, every single week, we get a new contract in the ASC. Again, you can read the slide. I'm sure that this will come up in the Q&A. We're in a great position when it comes to the ASC environment. The third tier on top-quartile performance, people and culture, operational excellence; number three, innovation and diversification. We had to shut down the innovation story in the remediation days. We're open for work. We launched 50 new products over the last 3 years. We've got 40 more to come. Our vitality index is more than twice -- 2x what it was 3 years ago. We're making a commitment to increase that by 50%. I believe over the next 36 months, our vitality index would be solidly in the 20% of sales. Again, for those of you who don't know what Vitality index is, that's the percentage of gross sales coming from new products. Quantity matters, but quality matters more. These are going to be new-to-the-world products in leading categories. We are one of the few companies that talks about vitality index, but also talks about what we call IPI, innovation and profitability index. Vitality index is sales coming from new products. Innovation and profitability index is gross margin dollars coming from new products. And early in the R&D cycle, we're asking the question, are we solving our customer problem with this technology? Are we going to be accretive from a margin dollar standpoint, and those do go in tandem. Our pipeline today is twice what it was in 2018, and we're partnering with best-in-class institutions to deliver innovation quicker to market. So not only we do research and development, we also do search and development, leveraging our balance sheet. A picture, my fellow Spanier, Pablo Picasso said that is worth a thousand words. I think this is the picture of 40, 50 new products in the back, 40, 50 new products in the front. In 2024, we're committing to be the first company to launch shoulder robotics. Aldo, I hope you heard me loud and clear. We're going to be the first company to launch a shoulder robotic system in the U.S. On top of that, we're going to remediate some of the gaps that we have had in our hip portfolio, surgical impactors. Next-generation hip robotics. We are going to continue to leverage the fact that we are the only company in the market with Mixed Reality in hips, excited about Oxford Partial and cementless. This is the partial cementless knee that will be commercialized in Europe for 10 years with a 60% market share. This will be the first PMA-approved product here in the U.S., expect to launch that in the U.S. in the first half of 2024, and I do think that it's going to be groundbreaking. Already got great growth on revision knees. Persona Knee, 2, 3 years in market, close to $1 billion in gross sales. We continue to gain market share in this space. So again, I don't expect you to remember all these things, but I do expect you to remember the picture. Innovation is a competitive advantage for Zimmer Biomet. So the sum of our parts, the best-in-class culture that we have with very compelling data points, high engagement, low turnover, operational excellence, innovation and diversification as a competitive advantage, a strong balance sheet, which can accelerate that journey on diversification equals top-quartile performance. We are committing to at least 5% next year, mid-single-digit growth with earnings growth being faster than revenue and free cash flow dollar growth being faster than earnings per share. I know I went quickly. I look forward to Q&A. Started with a thank you and I want to close with a thank you. Robbie, the floor is yours.

Well, great. Maybe we could start with your last comment, 5% growth for 2024. And I'd say, historically, people have looked at Zimmer Biomet's weighted average end market growth is 3% plus. You have a lot of new product launches, pricing has improved in the industry a bit over the past few years. Maybe just help us bridge where Zimmer Biomet was and how you get to the point where you can feel very confident putting out a 5% organic sales growth guidance for next year?

Sure. So first things first. We'll be giving official guidance in -- I think, it's February 8, 2024. Definition of winning, if we're not doing 100 basis points above market, we're not winning. So when you hit our guidance, if that is not somewhere in the 5% plus, we're not winning. And [indiscernible] be very black and white in the definition. But again, specific guidance around top, bottom, everything we'll come up on February 8. What gives us confidence? It really is the Slide 3, the macro and the micro. This is a far healthier environment than it was over the last 3, 5 years. And it's not just backlog. We didn't even think of backlog as a meaningful contributor toward a 7% to 7.5% guidance for '23 and the 5% plus for 2024. I think is the fact that younger patients are coming into the pie. The shift to the ASC is driving more cases in markets like the U.S. [ CytoCare ] changes are happening in other markets around the world. Definitely seeing sustainable pricing improvement. Back in 2018, in the U.S., we're losing 400 basis points of pricing hips, 300 basis points in pricing hips or in knees rather. Around the world, price erosion was meaningful. Today, we've seen 100 to 150 basis points, we're not going back. So the macro environment is far healthier. On the micro side, it's those 2 things: innovation and commercial execution. You cannot launch 40, 50 new products in 24 to 36 months and outgrow 100 basis points of a market unless they are the [indiscernible] products. You cannot have a low turnover from a commercial standpoint and drive 100 basis points. 100 basis points by the way to quantify is $70 million, $70 million divided our sales force, it's not a lot of money. So a combination of macro and micro reasons, we believe that, that is the point of entry, extremely confident. And by the way, we don't have the challenges from a supply standpoint we had before. We don't have the remediation challenges with the FDA we had before. We don't have all the drama that we used to have.

You can look at growth on the top line 2 ways, right? You can launch new products with better pricing than the products they're replacing and gain share, and you could drive it organically. You could also be in better end markets and add inorganically or enter organically into new growth markets. So maybe spend a minute on how you think about both of those new product innovation versus external, especially considering that your balance sheet is in the best place it's been in years.

Again, repeating myself, the 3 things that I talked about, people, operational excellence, number three, diversification innovation, it's probably what you're talking about Robbie. So internally, we shifted our R&D dollars or innovation dollars to higher growth segments of the markets where we operate. Those 40 new products that I keep quoting, 80% of them are in categories that are growing 4-plus percent. So already internally, there is a meaningful way to increase our Vanguard. As a matter of fact, we already have our Vanguard prior to the divestiture of spine, dental and the shift in R&D was around 3% to 3.2%, today our Vanguard, as we see here, today is closer to 4%. So innovation internally is already doing that. Externally, we're doing some partnerships are helping with that. And the diversification is putting the balance sheet to work. We have a very strong balance sheet or a net debt ratio or leverage today is around 2.2x. We got the credit rating that we needed BBB with Moody's. Actually, our credit rating agencies are telling us to use the cash. And we are going to use -- thoughtfully going to use that cash to diversify into high-growth areas.

Something that's a little bit orthopedic specific, but I would say Medtech broadly overall? Two things here. One is the backlog of patients that the disruption from COVID had on procedure volumes globally for several years, one, and then how that impacted first quarter 2023 with some very high growth rates for Zimmer Biomet and across the industry. So how are you thinking about the size of the backlog today? How much of a tailwind and how durable is that to the top line? And then I'll -- once you're done with that, I'll ask about first quarter.

Well, let me start with the first part of the question or comment. So Q1 '23 was high growth. The combo of Omicron versus Q1 of '22. So we are expecting that Q1 of '24 is going to be wanky. It's not going to be the same growth profile. As we think about the rest of the year, we don't count on backlog. I don't know how to quantify backlog, maybe Aldo does. I don't know how to quantify. We run different models. What I will tell you, we don't think it as meaningful as all the people expect. It's a capacity element. It's not that you can bring all those patients every quarter. So that's what I will tell you. We don't think -- first of all, it's not part of this mid-single digit and above. We do believe that it's going to resolve itself. We say over 2 years, ending at the end of '24, I don't know if I'm right or wrong, but it's not one of the key drivers of sustainable performance, mid-single digit or above.

Maybe asking the first quarter question a different way. Do you feel like you're in a difficult place to be able to comp first quarter? Or do you think it should act from a sales to sales year-over-year? Or is it more of a normalized typical quarter?

It's starting to be more normal, but yes, it is going to be more difficult. Sequentially, it's going to be similar to other years, normal years, but Q1 of '24 versus Q1 of '23 is going to be tougher, yes.

Okay. Maybe just kind of in that same vein. We saw in 2023 a return to pre-COVID seasonality with a pretty sharp up in second quarter, down in third quarter, hopefully up in fourth quarter. I would say what we've seen across some of your orthopedic peers that are preannounced, it seems like fourth quarter was particularly healthy. I don't know if you want to comment on that, but how do you feel about seasonality and the return to seasonality?

Yes, I would say we are back to normal seasonality, obviously, for obvious reasons, I won't talk about Q4. We guided to be in the mid-single-digit range for the second semester. We guided what we guided for the rest of the year 2023, $7 billion to $7.5 billion. I will tell you that volumes were healthy in Q4 of '23. So I would say that things are back to normal for the most part.

Great. Maybe we could touch on Zimmer's ambitions for inorganic activity. And you kind of touched on it a little bit, but it's been years, I think, since we've had just external M&A from Zimmer Biomet. So I think it'd be healthy, both with you -- was 110 days and 2 hours in this -- what's your view on how Zimmer Biomet can utilize M&A? And then maybe, Suky, if you want to jump in, how you think about sizing and thoughts around financials?

Yes. Let me start by saying we have done some M&A. And I think part of the promise that we haven't been pretty vocal about the things we've done in CMFT. We allocated $0.5 billion in capital in this business, added a couple of companies that are growing at a meaningful rate. We bought a couple of companies in Sports. So we've done some. We're going to be bold, but not reckless. M&A continues to be the #1 source of capital allocation. Are we going to do the right things at the right time? I'm not going to get [ bully ] into doing a deal with the cost of capital being twice what it was 18, 24 months ago. I'm sure that all of us are thinking about the same assets. I'm sure that all of us have the same data around what are those higher growth markets. At the right time, at the right cost, we will do deals to diversify Zimmer Biomet. Things that we like, we like subsegments of Recon that are growing at a faster pace, and it's a lot in there. Within data, technology solutions, navigation in hips and knees, a lot of stuff that immediately increases Vanguard in areas where we have a leading position. The second area is S.E.T., and the third area is ASC capabilities. In S.E.T., we like lower extremities. We like some elements of upper extremities. We continue to love CMFT. There is a lot of optionality in that regard. Financially, what we said before, deals that are tuck-ins up to $2 billion in acquisition price that would be non-dilutive in year 2. They're going to be ROIC neutral within 5 years -- 4, 5 years. So that's kind of like the financial threshold. What I would leave you with, Robbie, is that we will do deals at the right time and at the right cost. We don't feel the urgency that this aspiration of having to do a deal now because we haven't done a meaningful deal over the last 5 years, Suky?

Yes. I would say, Robbie, the organic story is playing out just as expected. It's quite robust, in fact. And what that means is that we can be patient. When you can be patient, you can be disciplined about deals. And so that's how we think about it. Ivan covered the key metrics that we look at financially. I would say from a sizing standpoint, you're right, the balance sheet has never been stronger, probably in the low 2x net debt leverage ratio perspective. We're going to get even better as we move through 2024. So that gives us a lot of optionality. So if you think about a turn to 2 turns on that at a $2 billion to $2.5 billion adjusted EBITDA number, that's a significant amount of capacity. Now our view is not to use all that capacity into a big, large transformational deal. In fact, we like more of the tuck-in type profile up to a midsized deal that could be somewhere in the ZIP code of $2 billion purchase price. So that's probably the upper limit of where we'd go somewhere around that $2 billion. But again, the -- I think the focus is really on the smaller tuck-ins, which have played out really well for us so far.

Great. If I think back to the new product launch slide, there was a very crowded area in 2024 plus new products can help with market share. They can help with mix benefits, and they could also probably down the road help with more sustainable pricing benefits for Zimmer Biomet. So as we look out to 2024, specifically, what do you think are the most impactful new product launches both from an overall share perspective and also from a revenue perspective?

Sure. Maybe I'll break down the question in 3 parts. I'll talk about hips, I'll talk about knees, and I talk about S.E.T., and I'll be careful how much I disclose here in this room today. But I'm really excited about Persona IQ where we are in the launch of the only smart technology within knees and then potentially in other areas. So we're moving from a limited market release in '23 to a full market release in '24. Really excited, as I mentioned earlier, around Oxford Partial Cementless, the only PMA-approved product that will be in the U.S. market. It's a huge opportunity, especially in the ASC, again, 60% market share in the European market in knees. Really excited about Persona [indiscernible]. This is our cementless platform that we launched -- really launched second half of 2023, it's getting a lot of traction. It was a limited market release. It's going to be a full market release in 2024. Our cementless penetration is around 15%, 16%, something like that in the U.S. Some of our competitors are in 60% range or above, we have a pathway to get there, and we gained 10% to 15% ASP uplift when we do that. And by the way, that also pulls ROSA Knee. So those are 4 very compelling opportunities within knee. In hip, excited about surgical impactors, what we call [indiscernible], which drives efficiency and accuracy in an operating room. It directly competes with other players. We've done a great job in this space. I love the fact that we got FDA-approved Mixed Reality that continues to increase penetration and share. I love the upcoming launch of what we call a triple-tapered stem. I'm sure most of you don't know what is triple-tapered stem, but it's a very meaningful category within [indiscernible], another gap that we had in the portfolio and so forth and so forth. Instead, we will be the first robotic company in shoulder, driving accuracy and efficiency in shoulder cases. With CMS moving a lot of the cases from inpatient to ASC, having a shoulder robot that drives speed and efficiency is very meaningful. When you are #1 in that space, it's twice as meaningful. I love the integration of embody in soft tissue repair. I like where we are with identity. I believe we're going to be launching a groundbreaking product in Stemless Shoulders, and there is a lot of different products in different categories within S.E.T. So it's difficult to pick one area, but I do like the fact that it's quantity and quality of products going into 2024.