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

Okay. Welcome to this next session here at the Jefferies Conference. I'm Matt Taylor, the U.S. Medical Supplies and Devices analyst here at Jefferies. And I'm pleased to be joined by management from Zimmer for this session. In the center of the stage over here, we have Ivan Tornos, the CEO; and also Suky Upadhyay, who is the CFO. We'll have about a half hour of Q&A and fireside chat that I'll kick off. And most importantly, I just want to flag if you haven't seen it, that Zimmer is out to terminate market share with its new Chief Movement Officer, Arnold Schwarzenegger. He couldn't be here today, but...

He may. He may come. He'll be back.

That's right. So just to kick things off, Ivan, I'd love for you to just talk a little bit about how's Zimmer evolving? Because I think a lot of people remember the challenges that Zimmer had with Biomet, you've moved beyond those. So maybe talk about what you're doing now that you've been able to move beyond some of the quality issues in terms of driving growth and fostering more rapid innovation.

Yes, absolutely. And first things first, Matt, thank you for hosting this. And good afternoon, everybody. Zimmer Biomet is a different company. And I'll try to keep my answer here somewhat brief, but it is a different company. Go back to 2015, we merged 2 iconic companies, Zimmer and Biomet, at the time, #1 and #4 in orthopedics, is now #5. We expected things to go well. It didn't go well. When you think about the 3 or 4 key ingredients that make up a company; strategy, operations, culture and value creation for you, the investors, we got most of them wrong. On the strategy front, we speculated that being bigger just for the sake of being bigger was the way to go, without thinking about elements of product leadership, it didn't work out. Becoming a bigger company resulted in us getting 4 FDA warning letters, a monitorship with the Department of Justice, complexity around allocation of capital, both internal and external. It was a challenge. We'll talk later about where we are today strategy-wise. Operationally speaking, it was a nightmare. Beyond the remediation of quality, beyond the remediation of the portfolio, the monitorship with the Department of Justice, we ended up with something like 5, 6 days of back order. We created a manufacturing footprint that made no sense whatsoever. And we pay for those consequences. We increased our COGS dramatically. We embarked on a journey of inefficiencies, not a well-run company. And then from a cultural standpoint, we ended up probably demotivating a lot of internal employees. And then the fourth vector of value creation, it was -- it's been a choppy journey. So when you think about strategy, operations, culture and financial returns, it was not the merger that we anticipated. We started to recover and along came COVID. By '19, we're growing around 1% from decliner being flat around the year '19, we started to turn the corner and then COVID hit in March of 2020. And for a company like ours, that does so many elective surgeries that was definitely a challenge. Fast forward, '21, '22, '23 and now '24 soon to be '25, I'll talk about the financials. And then I'll briefly talk about those 4 vectors on strategy, operations, culture and value creation. So 2021, we delivered growth of 10%, constant currency revenue with EPS growing around 12%. In 2022, with the divestiture of spine and dental, so the numbers are somewhat choppy. But nonetheless, we grew 6.5% constant currency. In 2023 last year, we delivered adjusted EBITDA growth of 9.5%, on revenue growth of 7.5% and then this year 2024, prior to the ERP challenge, which is now behind, midpoint into 2024, we're delivering 5.5% constant currency growth. So it's a different revenue profile from '15 to '19, as you think '21 through '24 soon to be '25. Quickly touching on those 4 buckets: strategy, operations, culture and value creation. On a strategy, what I will tell you is that we have a laser-focused strategy in terms of the problems we're trying to solve clinically around safety, efficiency and best-in-class clinical outcomes. When it comes to the places where we want to be, we are laser-focused on customers, countries and what portfolios we need to focus upon, and how we move from a lower growth market environment to a higher growth market environment. And then on priorities, every single member of my organization is talking about people and culture, innovation and diversification and operational excellence. So the strategy is very clear. When it comes to operating the company, I will tell you this company today is run by operators. In the past, it was all about revenue at the sake of whatever. Today, we're thinking revenue, EPS, free cash flow. I can truthfully tell you that the governance that we have today at Zimmer Biomet is like nothing I've seen in my 30 years in MedTech. On the culture and talent front, we had the highest engagement scores in the history of the company, now 2 years in a row, in spite of the challenges we've been having. And then on the fourth and final vector on value creation, certainly, there is work to be done. But we are so confident on the strength of the balance sheet, we are so confident on our ability to generate revenue and EPS that recently, we committed to returning 2/3, 65% of all the free cash flow that we generate to you, the investors. And that's in the form of dividends, in the form of buybacks and then doing some strategic M&A. So a bit of a lengthy answer, but I think that sets the tone, Matt, for who we are today versus who we were back in 2015.

Great. Maybe just to set the backdrop, could we review your LRP guidance? And maybe just talk about the health of the end market. We've been seeing some very healthy end markets kind of across orthopedics post COVID. And I think investors wonder, is that a bolus? Or is this sort of a new normal. So maybe you could comment on that.

B, it is the new normal by all means. So we spend a lot of time, and frankly, a lot of money trying to crack the answer on, hey, why are these markets growing 4% to 5%? Is this pent-up demand? We partnered with a company called IQVIA. IQVIA is part of IMS. So it's a data company attracts all pharmaceuticals. We also run some retrospective analysis to look at commercial claims, CMS claims in the U.S. And what we can tell you all factually here today is that for the last 6 quarters, last 1.5 years, we have not seen any meaningful impact coming from a backlog going back to COVID, with the exception of 2 countries. . Ironically, one of them is the one that we are in today, the U.K., there is backlog, given Brexit, NHS and some other elements and Japan, where you still have some backlog. Other than that, in the U.S., there is no backlog. And if you look at the waiting list here in Europe, you can tell that they are dramatically lower than in the year 2020, '21. So the growth that you see today is not pent-up driven, it's not backlog driven. The health of the market, we peg it at 4% to 4.5%. Some of our competitors think is 5%, is driven by 4 things. One is the rapid explosion of the ASC shift in the U.S. 40% to 60% of cases will move into an ASC. In 2019, 2% of our sales came from the ASC, today it's 15%. And with the shift to the ASC, there is a double dip in effect. It's not like cases are moving to an ASC, but hospital HOPD units are remaining idle. There are cases, complicated cases going to hospital units, older patients, revisions, patients with comorbidities and whatnot. And there's a lot of patients going to an ASC. So it's a double dip in effect. So that's factor #1, the shift of care. #2 is truly innovation. And innovation is not just us here at Zimmer Biomet, innovation is innovation that comes from Johnson & Johnson, Stryker, Smith & Nephew and other players. The disruption we see in orthopedics in the last 4 years is making episodes of treatment shorter, time in surgery shorter, rehab time being quicker. So now there is a higher appetite, if you will, as a patient to come and embark on the journey. So that's #2. #3 is absolutely pricing, which is sustainable. We delivered price positive performance in Q3. We guided flat to 50 basis points for 2024. For 3 years, pricing has been moving in the right direction. Not every quarter, every year has been price positive. But definitely, we're seeing price as a durable element of the market growth currently for the time to come. And then the fourth and final ingredient, behind the durability of these end markets, is actually demographics. The whole thing about baby boomers is real. 10,000 to 12,000 patients are turning 65 years of age in the U.S. We've been waiting for this moment for a while. And I think that the reality is that element is here now. If you take a look at orthopedics, but you also take a look at cardio, general surgery, urology, bariatric surgery, I mean we take a look at all MedTech spaces, they're all growing. So it can be that all of a sudden, this is backlog in every one of these specialties, right? Strokes are up in '24 versus 2019. I don't think that COVID created a backlog in stroke because [indiscernible] going to have a stroke in 2020, I'm going to wait until 2024. So clearly, the baby boomer element is a factor as well.

Great. Maybe I'll give Suky, a shot here. Could you talk about the updated 2024 guidance? And generally, your approach to setting guidance? And maybe touch on the ERP issue and how that's been...

Sure. Happy to do it. And thanks for having us, Matt. First, I'll start with some facts. So we started out the year 2024 top line at ex FX, 5% to 6%. And as we move through the second quarter, we were delivering right in that range, I think, almost 5.5%. Then of course, we hit the speed bump with the ERP, which I'll come back to, but that adjusted our guidance down. We came out as soon as we knew that that could potentially be a material impact. And we ultimately revised down to top line of 4.25% to 4.75%, which implies the fourth quarter will be somewhere around 3% to 5% ex FX. Halfway through the quarter, we still feel confident in that full guidance range. So we feel pretty good. And going back, if you actually look at our commitments back to '21, '22, '23, we've -- I think, for just about every single quarter, met or beat our expectations. So as we think about this year, as we think about going forward, I don't think a lot is going to change fundamentally about our guidance, but we clearly understand what investors are looking for; stability, the ability to continue to beat and raise, and that's, of course, going to inform how we think about guidance moving forward. As it relates to the ERP, we've made -- really proud of the team's tremendous progress. We initially thought that the impact could be up to about 100 basis points of revenue impact in the second half of the year. And we -- on our third quarter call came back and said, hey, look, we think it's going to be less than that because we were able to respond more quickly. We continue to put near-term, long-term fixes in. We're seeing really high volumes in the fourth quarter, as you would normally expect in the fourth quarter, a very seasonal business. All of that demand being met by supply. So we feel really good about the remediation actions that we put in place, and that continues to give us even greater confidence that we're going to be completely out of this by the time we exit this year. .

Worth noting that our shipping levels today are at pre-ERP implementation levels. So in that regard, we have normality.

so maybe just a continuation of that question, any spillover effect from ERP next year? Maybe remind everybody what the LRP guidance is and the approach that you took there? .

Yes. So our LRP set through 2027, 4% to 6% ex FX top line. We said that you should expect earnings to grow at at least 1.5x the revenue growth rate and free cash flow would grow at 100 basis points faster that -- faster than earnings. And we still feel very confident in that. As it relates to the ERP and the impact on that, like I said, we don't believe that there will be any shipping interruptions as we move into 2025. There's going to be some headwinds and tailwinds related to the ERP and of course, on the broader macro scale, there's going to be a lot of headwinds and tailwinds. So of course, we're not going to give guidance yet on '25. We'll do that in the first quarter of next year as we normally do. . But you should think about, hey, look, there could be some tailwinds relative to some comp in the second half. Also some recovery of cases that may get pushed into 2025. But on the same time, there could be some headwinds related to, hey, we had a number of new products that were expected to be up to ramp and flowing in a very robust way by this point, that will get pushed out to 2025. So there's going to be some puts and takes into next year. And again, we're going to come back with that guidance in the first quarter, but still feel very confident in that 4% to 6% top line over our LRP.

May be we could double-click on innovation a little bit. Really hard to cover 50 products. But could you talk about a few of the bigger ones. I think cementless and robotics, maybe one or what you're doing on the hip side?

Yes, lock the doors and I will cover 48. How is that? Look, it's an exciting time here at Zimmer Biomet. So we have committed to launching at least 50 new products in the next 30 to 36 months. What I like is not just the quantity, the quality of the products. Many of these are first-to-market products around smart implants, [indiscernible] robotics, anti-infective platforms, different designs in hips and knees and just a lot of great technology. . I'll limit my answer to what we got in knees, in hips and maybe in enabling technologies and S.E.T. So in knees, there are 4 products to remember. Here in the -- or there in the U.S., we are in a full launch mode for Persona OsseoTi, which is our cementless knee. As a reminder, we're not able to compete in this category, which is about 40% of all knees done in the U. S. Our #1 competitor has 60% penetration, just going from 20% to 50% is a huge opportunity in the U.S. alone. So that's Persona OsseoTi. Second product to remember is Persona IQ. About 4 weeks ago, we launched the shorter, stem version of Persona IQ. The feedback has been outstanding. We are seeing greater adoption with the longer stem. And as we get into '25, that is going to be a full launch. Really excited to bring a product from Europe to the U.S. called Oxford Partial cementless. This is the only PMA, Premarket Approval product in the partial cementless category that will be in the U.S. So the competitive barriers are very high. With the explosion of the ASC environment, which we discussed, we believe there's going to be a major tailwind. And lastly, yesterday or this morning, I'm lost in time, we sent the press release about Persona Revision, which is a product that generated north of $2 billion in gross sales over the last 4 years in the U.S., that product is coming to Europe. So these are 4 key products in knees. Going quickly hitting hips, we lost over the last, call it, 5 to 7 years, around 200 to 400 basis points of market share in hips because we're lacking 3 products. We have a triple-taper stain, which is critical for direct anterior procedures. We are in active full launch of Z1, a triple-taper stem. We did not have a surgical impactor to compete in the category, and we have it now. It's called HAMMR. And then lastly, we have comprehensive navigation. We have it now through ROSA Hip as well as the acquisition of OrthoGrid. So full portfolio in knees, full portfolio in hips, no excuses behind losing market share in those 2 categories. And then the third bucket in S.E.T. will take forever, but we got the most robust sports medicine portfolio in the history of the company. We don't have any gaps in our CMFT, Craniomaxillofacial thoracic business. And then on technology, in addition to the acquisition of OrthoGrid, we got a partnership with THINK Surgical for small footprint, high held robotics. We have 3 ROSA launches in the next 18 months, so no gaps in that space either. So again, high quantity of products, high quality of products and no gaps in the portfolio moving forward.

Great. I wanted to also go back to your ASC strategy, touched on that as one of the key growth drivers. I think some investors might be surprised that you've gone from 2% to 15% and also a leader in the ASC area. Maybe talk about your strategy and how that's contributing to your growth.

Yes. We are the #1 reconstructive ASC company in the U.S., factual statement. Different people define ASCs in different ways, some include MedSurg, some include other areas; endoscopy, neuro, whatever. But when it comes to knees and hips, we are the undisputable #1 company. Our strategy is anchored on what we call the 3 Ps: products, partnerships and people. On the product side of things, we had gaps. We didn't have a sports medicine portfolio. . We did not have a cementless knee. We didn't have a robot until '19. We didn't have a small robotics. We didn't have a lot of staff. So we got the full portfolio today. On the partnership side of things, some of our competitors do a much better job than we do in story telling. They talk about category leadership, we have it all. So do we. We have booms and lights. We have a partnership with beds, wheelchairs, if you want them. We have an exclusive partnership with CBRE, the world's largest commercial real estate entity where we can design an ASC for you, soup to nuts. If you need access to capital, we had that as well. One of the biggest problems in the ASC environment is the sterilization complexity. You have to sterilize products. It requires real estate. It requires know-how. We have an exclusive partnership with STERIS. We also have other vendors, and we partner that as well. I can go on and on, but the partnership is there. And then the third P is people. We didn't have dedicated contracting people. We have incentives in place for people to sell in an ASC environment. And today, we have that as well. So when it comes to products, no gaps; when it comes to partnerships, no gaps; when it comes to people, we have the largest sales force in the history of the company, both from a contracting and selling standpoint in the ASC environment.

Great. Suky, I'll pivot back to you. Let's talk a little bit about margin trajectory. And as you've talked about in the future, getting at least 30 basis points of margin expansion, talk about the sources of that going forward.

Yes. Sure. So let's first start with -- we have a relatively high margin -- operating margin inside of our sector. And if you look at 2024, based on our implied guidance, even after the ERP announcement, this will be the fourth consecutive year where we increase operating margins and at not an insignificant level. And that's even in the backdrop of hyperinflation over the last couple of years. . You're right, we have committed to at least 30 basis points of operating margin expansion on average per year through our LRP. The main sources are really around, first and foremost, our revenue leverage, growing mid-single digits, as we said, as part of our LRP with a relatively large percent of our cost base being fixed or semi-fixed, gives us a tremendous amount of leverage there just alone and generating operating margin expansion. We do expect gross margins to be largely stable through the planned horizon with some near-term headwinds that we've talked about because of FX, but operationally, relatively stable to what you saw in 2024 and 2023 and then perhaps on an operational basis, growing towards the latter part of the strat-plan or the LRP as we continue to consolidate and optimize our plan at foot work -- network. And then within SG&A, they are still at 43% OpEx, still some target-rich areas, some of the back-office opportunities inside of our sales organizations globally, sustaining engineering, which could be optimized by offshoring a fair number of activities and then continued leverage of our global business services for back-office operations like finance, IT, HR, et cetera. Those are the building blocks that give us confidence in that 30 basis points, which actually is a little bit less than what we've been doing consistently now for the last 4 years.

And then a big element of that annual growth could be pricing. So I wanted to double click on that. It's been so much better than it was a few years ago with pricing this year flat to up potentially. And your LRP adds 100 basis points of degradation a year. So maybe talk about why that could be conservative in the factors that are contributing to better pricing today?

Yes, you're right. So prior -- pre-pandemic and, I mean into the early part of 2020s, we were generally at about 200 to 300 basis points of price erosion per year, which had a not insignificant impact on gross margins, as you can imagine. Over the last couple of years, we've made tremendous progress in bringing that inside of 100 basis points. And actually, year-to-date in 2024, we're positive in fourth quarter, we were -- sorry, third quarter we were positive, and that's why we revised our guidance upwards for pricing. Our LRP, I think, prudently conservatively says that we would see or expect to see 100 basis points of pricing erosion per year. The reality is, internally, we've got ambition to do much better than that. There's really 3 levers around that. One, from a market standpoint, innovation is being rewarded, and we're bringing a lot of innovation to market. Also inside the market, we're seeing that the bigger players are being rational about pricing. They're all trying to catch up with the hyperinflation. They've had to deal with on input costs over the last couple of years. And again, we're seeing some rationality there. Number two, just our systems, our processes, our governance, our incentives are just so much smarter than they ever were at Zimmer Biomet, where the idea of just growing top line for the sake of top line is no longer accepted. It has to be top line in service of EBITDA and cash flow. And that's brought a whole new culture to how we price. And what we found is that actually, our pricing is a lot more elastic than maybe we originally thought. And the third is we're taking opportunistically price increases maybe where we haven't in the past. We've seen some hyperinflationary environments in some emerging markets and we're taking price up to match at. Now that may not be consistent and durable over time depending on where inflation goes. But those are the 3 levers that lead us to believe that pricing will consistently be better than where it historically has been. And I'm going to hold out an ambition that we can do better than that 100 basis points per year.

Great. Well, I think we're right on time. So I'll thank you guys for your time, and thanks a lot for your interest in Zimmer Biomet, and great update on the story. Thank you.

Thanks, everybody.