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

Thanks so much for joining us. My name is Matt Miksic, I cover medical devices here at Barclays. And I am so pleased to have with us today Zimmer Biomet. So Ivan Tornos, President and Chief Executive Officer; Suky Upadhyay, CFO. Thanks so much, especially busy week at AAOS and making it to the last day of our conference. I can't thank you enough for coming.

Great to be here.

So I wanted to maybe start with a comment on just the market because that's something I think you have -- you've been sort of vocal about where we are in this post pandemic, elevated but maybe settling volume environment in orthopedics. What's been your message? How we should think about this year versus last year and maybe the next couple of years in terms of just volume growth and demand and opportunity?

Sure. Well, first things first, good morning to everybody. Matt, you are the only banker that I know that knows how to pronounce his last name, extremely impressive already. Market, this is a new normal. This is a new normal. And we got a lot of data to validate this is the new normal. And what I mean is that the current volumes that we're seeing and the pricing stability that we're seeing, we believe is durable. We picked the market around 4% to 4.5%. The Academy this week, some of our competitors think is 4.5% to 5%, so call it 4% to 5% in terms of market growth. We're not going backwards. What's driving this market is stability, external and internal reasons. Externally, you know the deal with demographics. We're getting older. We are active. 10,000 to 12,000 people turn 65 years of age in the U.S. every day. That's a fact that you see across all of medtech. So if you talk to people in cardio, general surgery, diabetes, it's not an orthopedic phenomenon. This is the reality of demographics. ASC is here in the U.S., ambulatory surgical centers. That is a huge tailwind for volumes. Before, you had to go get your kids down in an inpatient, maybe outpatient hospital setting, now people are going to ASCs, going a Saturday morning, leave the same night. Hospitals are not idle. They're not sitting there without cases. I tell people, orthopedics is the second highest margin contributor to any hospital. With the average hospital in the U.S. operating with 1.5% to 2% operating margin, there is one specialty that don't want to lose is orthopedics. So all of that to say that it's a double dipping effect. Cases going into ASC, cases going into an inpatient HOPD at the hospital level. Internally, it's technology. The fact that we're making this case is better, the fact that the surgery is faster, the fact that we are taking complexity out of the overall episode of treatment is another tailwind for people to go in there and want to do the surgery. I want to say we, I'm talking to Zimmer Biomet, Stryker, Johnson & Johnson, Smith & Nephew. There is a lot of disruption in technology, and that creates a situation where patients are more willing to go through the procedure. The surgery is simpler and so is the physical therapy. It used to be 3 months. Now you see people up and running 6 weeks later. And then the last one I'll talk about is pricing. We've seen now 3, 4 years of pricing dynamics moving in the right direction as an industry orthopedics. The product side of the equation, the implant is now something like 20% to 25% of the DRG, whereas 10, 20 years ago, it was north of 50%. We are not the main offender in the economic side of the equation there. So we continue to see price durability. 80% of the book of business is contracted. So this is the new normal.

Yes. No, that makes a lot of sense. We had a clinician panel earlier in the week and talking about the sort of the wave of sort of older patients that are finally really starting to show up. And in addition to that demographic wave, maybe talk a little bit about -- and maybe this gets to your point about patients willing to have the procedure also maybe surgeons willing to suggest the procedure for younger patients.

I'll start with the age factor. So prior to COVID, in the U.S., the average age for a knee replacement according to CMS was 66 years of age, today, 61. For hips, it's gone down from somewhere in the upper 50s to the low 50s. And then shoulder went from 53, 54 to 49, 50. So again, the fact that we're getting active, the fact that technology is better is inciting surgeons to say, "I'm okay, now putting a shoulder on you or near a hip because maybe you don't need to go through a revision 10 years, 15 years from now, there is better data there." And that's on the product clinical side. On the side of care, I'll say it again, you used to go to a hospital on a Monday, your length of stay was averaging around 3 days. A lot of those cases are now day cases for both knees and hips. You go in the morning, you leave at night for a lot of hip -- knee cases and then for hip may be a one night stay. So definitely a different reality that we see.

Right. And it's been an ASC build out I think in very, very early days, it was a fear that ASCs would pick up, and they would sort of take all these cases from the hospital, but from what we see, and you see much better than we do. But is that the ASCs are built out and it's basically just expanded capacity.

That's it.

So bandwidth benefit as well.

That's it. So volumes are very strong. They're going to continue to be strong. 40% to 60% of all cases are going to move to ASCs over the next 3 to 5 years. And again, I am not aware of any single hospital in the U.S. that now has operating rooms that are not doing orthopedic cases, so double dipping.

And then the last thing, I'll just ask about comment about the market is that this is one of the folks get a cardiac procedure when they need a cardiac procedure, but this is a sort of patient expectation, patient activity driven procedure. Like I want to have a life that involves golf for some and therefore, I need to do this procedure. Maybe talk about how activity levels, I don't know, health and wellness has just generally driven higher demand for folks being able to walk and do things into their 70s, 80s, and 90s.

Well, we sponsor pickleball for a reason. There is a lot of desire to be active, and we are seeing exactly that, that people do want to have a different lifestyle. The last 2 years, our Sports Medicine business has been growing double digit, our shoulder business upper single digit, parts of S.E.T. that are directly related to mobility are in the teens. So it is real. It is real.

Okay. So with that in mind, you're sort of taking your growth up, you put your LRP out, you're shooting higher for things like share and overall portfolio growth. You can talk about the additions to the portfolio in a second. But what parts of the core reconstructive business, the key hip and knee business, do you feel like you've been executing well at and which parts are you sort of leaning into sort of hit some of the higher growth rates that you talked about in your LRP?

Yes. So our book of business has 3 components. You got reconstructive, which is knees and hips, then you got what we call S.E.T., which is 6 businesses. You got shoulder replacement, upper extremities. You got CMFT which is craniomaxillofacial and thoracic. You got sports medicine. Those are the 3 key product categories I said, and you got foot and ankle, you got biologics and you got trauma. And then the third segment is technology, other. So starting with reconstructive. We still are the #1 knee and hip company in the world. We've not done what we had to do in the hip category. We lost -- over the last 3 or 5 years, we lost here in the U.S. 300 to 500 basis points of market share. So averaging about 100 basis points per year. Why? Well, we didn't have the portfolio. Today, as we enter 2025, we do have the full portfolio. We'll talk about products later. So there's no reason why we should not be gaining or regaining market share. On knees we are staying afloat. But given the introduction of 4 key products over the last year, 1.5 years, we should accelerate our growth rate in knees. So that's on recon. On S.E.T. we had, as I mentioned, 3 product categories that were growing strongly, CMFT, shoulders and sports medicine. I just mentioned some of them growing double digit but we were declining in foot and ankle that's going to stop with the integration of Paragon 28. So that would be another growth driver, a strong mid-teens growth driver. And then that leaves you with trauma and biologics. We believe that biologics is going to be accelerated. And then trauma right now is a different business. We like the cash flow that it generates. We don't like the working capital requirements of trauma. We are fifth in that segment. It's not the one area where we want to deploy capital. And then you've got technology and other. Technology, we continue to see great adoption of ROSA. We're launching 3 ROSA indications in the next 18 months. Beyond ROSA or flagship robot, we've got 3 different forms of navigation. You got mixed reality, less complex navigation and surgical guidance powered by AI, that's OrthoGrid. So all of that to say that, that is another growth driver for the company. And in the other, I'm not going to go through all the categories, but they grow where they need to be growing. So that's a bit of the summary of the portfolio.

Okay. So it's prepared to kind of lean back into share with the portfolio changes. Maybe talk about some of the catalysts in knees a bit, but then also even going back to what we just talked about with the market, more younger patients, more revisions. How is like your revision system and the addition to the portfolio in that category kind of positioned you to do better in knees?

So maybe for extra credit I'll answer knees and hips. So 2 for 1. So the 7 products that we pay attention to this year is what we call the Magnificent 7. I didn't come out with a tagline, but I do like the tagline, right? So we had 7 products that we believe get Zimmer Biomet to consistent above-market growth rates in reconstructive. From left to right, in order of importance, you got Persona OsseoTi that is our cementless knee. This is a product that we launched really early, if not late 2023. So early '24, late '23, got the full deployment of sets throughout 2024. That is a major tailwind for the company. We generate a 15% ASP uplift every time we move from cemented to cementless. I was just at Academy this week. The feedback on the product is outstanding. So this is a huge category with the shift to the ASC. It's going to be a great tailwind. So that's number one. Number two, you got Oxford Partial Cementless. This is the only partial cementless knee in the U.S. We're launching that as we speak. If you want to compete with me, you have to go through a PMA. If you're going to do a PMA, a premarket approval clinical trial, that's going to be a 10- to 15-year-old deal, very expensive. And again, with the shift to the ASC, that is going to be a major tailwind for Zimmer Biomet. The third product in the knee category is Persona Revision. You were talking about Revision in Europe, CE mark at the end of 2024. That is a major category, both in the U.S. and in Europe. In Europe, the market is about $0.5 billion and growing upper single digit. Here, the market is near $2 billion. Revision cases carry 7x. I say that again, 7x the ASP of primary cases. We have a 51% market share here in the U.S., not committing to the same market share in Europe. But yes, we're committing to get to a leading position in revision cases in Europe. And then the fourth knee product as part of the Magnificent 7 is Persona IQ, the shorter stem, 30 millimeters. So it's a shorter stem, this is a smart implant. As a reminder, we are the only company that has a smart implant in the world. We own 95% of the IP in the space. So a sensor in the tibia component that is creating or bringing objective data to a subjective procedure. How is your walking post surgery? Do you have the right gait? Are you doing the right level of activity? Potentially, is there a risk of dislocation, dislocation equals infection and plenty of other things. So those are the 4 key products that we pay attention in knees. And then in hips is Z1, what we call our triple tapered stem. Really excited about this one out of the gate in 2025, is above our expectations. This enables Zimmer Biomet to compete in the direct anterior category, which is roughly 40% to 50% of all the cases. Again, one category where we're not participating, part of the reason why we lost market share at the tune of 300 to 500 basis points. Surgical impactors to drive efficiency in the case, HAMMR. And then the seventh and final product is a category, it's navigation. And I alluded to this earlier. We don't do just robotics. We have navigation, we got mixed reality, and we got a large footprint and a small footprint robotics. So that's the portfolio. I know that's the longest answer you got in all week, but I think that that saves time in future questions.

That's a great answer. Let's talk about the portfolio for a minute. Exciting news and acquisition announcement around Paragon 28. As you said, teens grower or mid-teens grower, maybe talk a little bit about sort of where you are in the integration process. I mean I have to ask the question. I think I may have asked it on the call, is the musculoskeletal sales reps, sales force kind of integrations have been challenging. I'd say Zimmer Biomet for putting aside some of the operational problems that happen after [Audio Gap]. The migration I think went extremely well. Maybe talk a little bit about how you plan to bring that force on and keep them running on all cylinders.

Yes. First of all, I don't think the integration of Zimmer and Biomet went well, we did very nice. I actually think that integration was a disaster. It set us back a few years. That said, we're not going to repeat the same mistakes. But we are going to treat this or we are going to treat this with a lot of rigor. We announced Paragon 28 on January 28. So a cool number for a cool deal. Over the last 5, 6 weeks, I've been directly involved in the integration. While I'm not running the integration, Suky and I are micromanaging the hell of this integration every day. There are 3 things we've got to protect the commercial channel. We already announced to the 250 reps in the U.S. that they are going to be our channel. We don't have a channel head of Zimmer Biomet. Lots of excitement. I was at the sales meeting. So they're already guaranteed to be part of the company. So no changes there, done on that one. The commercial leadership is already retained. So from the CEO, Albert DaCosta to the Chief Commercial Officer to the leadership at the commercial level. I was with them this week in San Diego. They already are part of the company. So that's been announced. And then the second thing we're protecting is innovation. We're keeping the design center in Denver, Colorado. So they got something like 50 different products coming over the strat plan period across all 6 key categories. We're going to maintain that. And then operationally, the things that we need to adjust, we will, but we're going to allow them to run the show. We bought a company -- we are buying a company that is doing close to $300 million, growing in the upper teens, in a market that is growing 6% to 8%, we will not screw that up.

Okay. Yes. And that is a clear difference between your core -- some of your core markets and foot and ankle. It's just the volume of implants, the types of procedures and sort of like the intensity of new product launch and new product introduction. So I think you can see the value of bringing on an engine that's demonstrated its ability.

It's a huge opportunity.

Right. So maybe pivoting a little bit into margins. Maybe talk about, Suky, if you could sort of like puts and takes to some of the investments that you're making, including around Paragon and then some of the leverage that you expect to see coming out of this year and then going forward, both on the, say, the gross margin and the operating line?

Yes. So thanks, Matt. So first thing I would say is you just zoom out a bit, we've got very healthy, in fact, class-leading gross margin as well as operating margins. We've just delivered our fourth straight year of operating margin expansion even in a pretty tough environment there for '22 and '23 with a lot of inflation to overcome. But having said that, the team responded incredibly well. The key building blocks there are revenue growth in the mid-single digit. You just take our natural flow-through, that provides a pretty healthy level of margin expansion just in and of itself. Stabilized gross margins even while input costs continue to go up, maybe not at the same levels of '22 and '23, but there's still inflationary pressures there, and we're able to hold gross margins largely because we're doing much better in price, but also we're driving a lot more efficiency that -- now that we've moved beyond remediation of quality and building excess capacity, which needed to be done. And then within operating margins, with SG&A, we continue to find areas of opportunity. We currently travel at about 42% to 43% of OpEx and SG&A. So we still consider it to be a target-rich environment. So those are the building blocks that have delivered the last 4 years. They are the building blocks that are going to deliver '25. And we've made a commitment of at least 30 basis points on average of operating margin expansion organically over our LRP. We're very confident in that profile. What's great about Paragon 28 is, yes, it's going to be dilutive in the near term, but we love the fact that it's a very fast-growing platform in a very healthy end market. At the end of the day, you know this, everyone out here knows this that revenue is your best path to earnings power and margin expansion. So that's great. It's got an accretive gross margin. It's not going to be significant on the consolidated level just given the size, but it's great to have an asset that you're bringing in that has better margins than your company average. And then from an operating margin perspective, we're going to continue to invest, and that's why we're saying it's going to be dilutive for the first year, breakeven by the end of the second year because what we don't want to do is starve that business when it's performing so well, introducing so much great innovation into the marketplace. So we are going to invest there. But not only are we investing in Paragon 28 to your point, I think what you're seeing is very obvious, we're investing against our base business. You see that in DTP. So really improving awareness, which Ivan has brought to the organization over the last 18 to 24 months has been paying dividends. We're specializing our sales forces, right? So we don't have hip and knee sales reps now sort of part-timing sports and extremities. We're individualizing and specializing in those channels. So that's another big area of focus for us. We're making -- I wouldn't even say incremental, I think we're making bold investments in a number of areas. And that's being fed from some of the areas that Ivan talked about, which we're deprioritizing. It doesn't mean they're not important. They just have a different role to play in the company than what they used to. And so we take investment from there, put them into the areas that have stronger market growth, better margin opportunities. And so far, it's been playing out. So I feel bullish on it.

That's great. And so getting through the integration and the breakeven and then accretion of Paragon is one thing kind of on the core U.S. business. Maybe if you could talk a little bit about the opportunity you see to expand this globally given your global footprint?

On paragon 28?

Yes, yes.

I think it's a huge opportunity. They focused on the U.S. being a new company, sort of early in their commercial scaling, which is apparent and probably the right decision, which gives us plenty of opportunity to bring those products and leverage our existing infrastructure. So we're excited about that.

Okay. So similar and maybe untapped opportunity to bring this overseas?

Yes, which, by the way, we didn't use a large level of revenue synergies to sort of validate the deal. So I think those potentially could be a source of upside for us.

It's like a stage 2 opportunity maybe.

Well said.

Got it. So all right. And then you mentioned -- I have to ask about the rest of the portfolio. You made some changes since -- not under your watch necessarily, but there have been changes in the portfolio. Any further changes on the -- let's talk about the positive side. You just announced the deal, you're going to be in the middle of integrating the deal. So one question is, is when should we see -- expect you to be out there again and active acquisitively, but as importantly, how do you feel about the rest of the portfolio?

On the core portfolio, we've never been in a better position. So again, we had gaps in Recon. I'm not going to repeat myself, all those gaps are filled. On S.E.T., out of the 6 categories, 4 are going to be growing very strongly, upper single digit, double digit. And one is going to do trauma what it needs to do. And the other one, I do think is going to get accelerated. That's a $2.5 billion business set now, growing double digit with just a very nice opportunity to continue to grow. On technology, we have everything that we need. We launched in 3 indications. So again, the core base is strong. Inorganically, we're always going to be looking at deals that make sense. And deals like Paragon 28 make a lot of sense, buying $300 million that is growing at mid-teen rate, that within 2 years, you can absorb the EPS dilution that creates a platform. Those kind of deals we're going to continue to look. We're going to focus on integrating Paragon 28 before we start looking at other opportunities. But yes, we see a path to continue to grow our WAMGR from 4% today to 5%, and that is going to take some organic stuff that we're doing and some responsible inorganic strategies.

That's great. So we're coming up on time with 40 minutes -- 40 seconds or so that we have remaining on like what would you like to wrap this up or leave with investors that they think is important.

In 29 seconds. Well, I speak fast, but I don't speak that fast, so I'm going to tend to just say that summarizing the markets are very strong. And now this is not backlog. This is not a onetime short-term centric event. And then internally, Zimmer Biomet is in a totally different position than we've been even a year ago. But even in the tough times like last year, we did deliver our guidance of close to 5% revenue growth with leverage EPS and nice growth on free cash flow. So as we enter 2025, we're very confident that we're going to do even better than that. And there's 2 seconds left.

Fair enough. Well, thanks so much. We will leave it there.

Thank you for having us.

Really pleased to have you.

Thanks, Matt.