Zimmer Holdings, Inc. (ZMH) The 30th Annual JPMorgan Chase Healthcare Conference January 10, 2012 10:30 AM ET
Michael N. Weinstein - JP Morgan Chase & Co, Research Division
Good morning, everybody. Welcome to Day 2 of the JPMorgan Healthcare Conference. It's our pleasure to kick off today's conference with David Dvorak, the Chairman and Chief Executive Officer -- Chief Executive Officer, I made you Chairman -- Chief Executive Officer of Zimmer Holdings. We will have a breakout session immediately following this, down the hall. David?
Well, thanks very much. And for the early-morning crowd, we appreciate your interest in Zimmer, getting up early. We're excited to talk to you about the prospects for our company going forward. I'm going to spend a bit of time this morning focusing on providing you with an overview of our musculoskeletal health portfolio. I'll talk specifically about some of the growth prospects that we're focused on, as well as a topic that we haven't talked about in great detail in prior public settings, but our transformation and operational excellence initiatives. And then finally, round out the discussion this morning by reiterating our disciplines around capital deployment.
This is our Safe Harbor statement, the typical statement that points out the presentation this morning will include forward-looking statements. For a list of some of the factors that could cause actual results to differ, you can take a look at our securities and exchange filings.
I will say that, because of the timing of this presentation, we won't talk about Q4 2011 results. So I'll reference some of the growth numbers as I talk about our market subsets year-to-date through the third quarter of 2011, as well as our performance numbers. I will, however, provide you with some of our aspirational targets for 2012 and beyond. So let me start by emphasizing these 3 pillars for value creation. The first is growth. Our core purpose as a company is to restore mobility, alleviate pain and improve the quality of life for patients around the world. And we have a wonderful foundation to work from with our leadership position on the reconstructive side of orthopedics, primarily large joint replacements in knees and hips. That's a leadership position that I'll describe in greater detail, but it puts us in a position to leverage many assets to accelerate the growth in other key growth opportunities, including our emerging businesses and key emerging markets. We also have an extremely robust innovation pipeline. We've worked a great deal over the last several years to restructure our processes, as well as our organization, to bring those resources closer to the customers in identifying clinically relevant and critical needs that those customers have and innovate in a very cost-effective way. That pipeline is starting to shows fruits and some of the products that I'll describe to you this morning are products that have been developed due to those improvements that we've made to the innovation pipeline. I will tell you that in the 10 years I've been involved with the company, I don't think that we've ever been at a point where we've had a stronger pipeline, either broader or deeper, across all of our franchises.
With respect to our transformation and operational excellence initiatives, we believe that we have the opportunity there to unlock literally hundreds of millions of dollars of expenses and capital deployment. And our initiatives are underway. I'll describe those in a little bit more specificity. We began this effort about 18 months ago and we saw some of those benefits get reinvested in our growth initiatives. But going forward, we believe that this is going to be a source for our growth priorities as well as allow us the opportunity to expand our margins, improve our cash flows and enhance our return on invested capital. We run the company with a strict degree of financial discipline, have a strong balance sheet and cash generation capabilities and we're committed to returning any excess cash. To the extent that we don't see good opportunities to redeploy cash at a particular point in time for inorganic growth and external development opportunities, that cash will be returned to stockholders, and I'll describe that in a bit more specificity going forward.
So by way of background, let me start by giving you a perspective on the market. The bar chart to your right shows the global population over the course of the next 40 years and you can see the growth in the 65 and older subset of that population. So right now, there are about 0.5 billion people aged 65 or above, globally. In the coming 4 decades, that will grow threefold to 1.5 billion. And a percentage of the population, 65 and older, will increase from round numbers 8% to 16%. That's very relevant for our business. Because the 65 and older age population are the principal ages for people that are most apt to need a joint replacement, a knee or a hip. So the demographic drivers are unmistakable. And the penetration rates for these procedures are very different across various jurisdictions. It isn't that the need is fundamentally different. That's not the case. Patients need these joint replacements, irrespective of whether they're in the Americas, Asia Pacific or Europe, Middle East and Africa. But the healthcare infrastructure differs in different jurisdictions and I'll give you a little bit of perspective on that. In the United States, aged 65 and above, out of every 1,000 individuals, about 20 or 30 will receive a joint replacement today. In China, that number is about 0.8. So 1 versus 20 or 30 individuals. You start looking at that penetration rate as the healthcare infrastructure is developed in a jurisdiction like China and that's going to expand in the coming years. Multiply it by the population base and you can understand why healthcare companies are so focused on that market and it's one of the reasons that we've made that a key priority market going forward.
So that's one of the drivers. Just the sheer numbers and the demographics. Now to be sure, these procedure rates have slowed down a little bit due to the macroeconomic conditions, but there is no other solution for these patients. So for an individual that's suffering from advanced stage osteoarthritis, those procedure deferments are just that. They're not going to go get that problem solved with another solution, it's a deferment. And as the economy stabilizes and picks -- and begins to pick back up, you're going to see those procedures come along with it.
Other dynamics that are driving increased usage across the globe include, on the one hand, active lifestyle. So individuals that are exercise fanatics, outdoors-oriented or just through their work habits, wear and tear on the joints can be extreme. On the flip side of that coin is, those that lead sedentary lifestyles place a lot of stress on the joint primarily because of weight, with the epidemic around obesity on a global basis. But patients are also becoming much better informed as to what solutions are out there for them and their expectations are much, much higher than they used to be. So less invasive procedures, more personalized solutions that can allow those individuals to get back to the lives that they want to lead, and be able to pursue the activities that they used to be able to pursue is a key focus within our innovation pipeline.
And the other element that I will highlight as I talk about our various franchises and some of our new products is we want to be the provider of those solutions to the healthcare professionals across the entire continuum of care. So whether it's a focal defect in cartilage for a young patient or the need for a total joint or the revision of that total joint, Zimmer should be the provider anywhere within musculoskeletal space. And so any anatomic sites where we aren't participating right now, you can rest assured that, through either internal development or external development, we have plans to get there.
These are the 3 key drivers for value creation for us. Our aspiration is to grow each of our business franchises in each of our geographic segments above market growth rates. At the same time, we want to be very disciplined about how we're deploying our capital and spending money and continue to support best-in-class margins within the industry. Finally, the capital deployment. We're going to apply some very strict disciplines around any investment decision, whether it be supporting instruments that get deployed to the field, property plant and equipment or external development. Our requirements are strict. We're constantly comparing that investment relative to other things that we can do with the cash, including returning it to our stockholders. We believe that we're positioned, at this point, to run this business even in the current economic climate, so that we can grow earnings per share in a range of 8% to 12%. And that's going to be off, low- to approaching mid-single-digit top line growth. Now as I said, as those deferred procedures come back and the macroeconomic conditions stabilize, we would expect to drive our top line growth rate up into a solid mid-single digit to even upper-single digit. And that would provide us with the opportunity to accelerate our earnings per share growth rate into the mid-teens.
Let me talk a little bit more specifically about each of those growth and creation -- value creation drivers. I already referenced our sizable product pipeline. We have a lot of depth in each of our franchises. We've reorganized research and development resources into the business unit so they're closest to the customer. The brand management group formulates the plans and priorities within each of those business units and then they go off and develop products. Oftentimes collaborating with experts around the world whether those are healthcare professionals, research centers, whatever the needs of that particular project might dictate. And we believe that we're in a position, at this point having committed about $0.25 billion a year to research and development, to sustain this increased pace of innovation. At the same time we're constantly looking for externally developed technologies and product lines to augment our internal development efforts. So to the extent that someone halfway across the world has a better idea as to how to address a patient's clinical issue, we want to go get that technology or that product line and add it to our portfolio. And I'll reference some of the deals that we've done over the last year or 2, that are producing some nice results and rounding out our offerings. We're complementing our expanding product portfolio by inserting more feet on the street and more marketing resources and more medical training and education in key markets, and that's helping us drive nice above market growth in several of those markets.
Let me move to the transformation initiatives. As I said, we believe that we have the opportunity to unlock several hundred million dollars and we would look to reinvest a certain amount of this money to our growth priorities. But we also believe that we're well-positioned to expand our margins, expand our cash flow generation, at the same time improve our return on invested capital through these efforts. We just completed a management restructuring in 2011. We reduced the number of layers of management, so decision-makers are now closer to our customers. It puts them in a position to be more responsive to those customer needs. We also expanded those manager spans of control, so that they are more empowered to get the things that they need to get done to drive the business forward and be responsive to those customers. So a very successful project, it's yielding benefits. Some of which I referenced in the product development area. We also are centralizing certain services, so purchasing or strategic sourcing. This is something that we had not done much of historically. There's a big opportunity for us to do this. And certain functional support areas, our reforming centers of excellence. So the benefits of those efforts will take multiple operating periods, but the initial benefits will start to flow our way in 2012. Some of the bigger opportunities that we have include manufacturing. We'll be very focused on our quality systems, but we want to drive the best product in the most cost-effective way out the doors of those production facilities. And so this is another very large opportunity for us on the transformation and operational efficiency side.
Capital allocation. Just last month, we announced the inaugural dividend. This is an $0.18 dividend for the first quarter of this year. So the record day will be March 30, and payout will be around April 27. We also announced a new share repurchase program, a $1.5 billion program. Multi-years, it runs through 2014. Those are vehicles that provide us with the opportunity to return, as appropriate, cash to our stockholders. But we continue to run the business with a great deal of financial discipline around our investment opportunities, as I described. And we also have a line management's long-term incentives with some of the previously mentioned initiatives.
Let me move into the franchises and give you a brief overview of each of them. So you can see on the left-hand side our reconstructive businesses starting from the bottom, knees, hips and extremities. The right-hand side includes our various emerging businesses, dental, spine, trauma, and surgical. I'll breakout knees first. This is a $7 billion market where we have the #1 global position. The NexGen knee system is the best performing knee system according to overseas registries, as measured by revision rates. This is a market that's been relatively flat, probably more impacted even than hips, over the course of the last couple of years. We've been growing relatively in line with market, outperforming outside of the United States, with 6.5% growth in each of the EMEA markets and the Asia-Pacific markets. And part of what's driving that growth are some of the innovations that are making their way into those markets. You can see up in the left-hand corner our posterior referencing Instruments. This takes our NexGen system to surgeons that traditionally had a philosophy that there was posterior referencing and were less apt to adopt the NexGen system. So we're doing well with that. The patient-specific instruments, personalized solutions is a big theme. It's making a difference for patients, for the healthcare professionals. It's an area that we continue to concentrate our innovations on. And that's one example. This is an instrument set that grew 70% in the third quarter for us. And we look to do a lot more in the way of intelligent and technologically-leading instruments that help the surgeons place these implants just right for that particular patient's anatomy.
Hips is our second largest franchise, a $6 billion market. It's a market that's growing at about 2% through the first 3 quarters of 2011. We grew our business in the third quarter 3.9%. But some of the products that you see here, that are launched already in the overseas markets such as the patient-specific cups and the patient specific stems, have allowed us to outperform the market. 6.5% growth in EMEA, 10.7% growth in Asia Pacific. So those products include the Continuum and Trilogy IT cups, in the upper right-hand side. That's a cup system that gives the surgeon inter-operator flexibility to choose a bearing surface in accordance with that particular patient's needs. Similarly, you can see the modularity of the stem. In the center at the right hand slide, that's an M/L Taper with Kinectiv Technology. And then on the bottom, that is our large diameter head ceramic-on-ceramic Maxera Cup. Launched in Europe at this point in time and we're seeing nice traction with that product. So it's a franchise that is performing well right now, relative to the market, and we believe has great support in the product pipeline to be able to continue that performance moving forward.
Extremities is the next franchise. This rounds out our reconstructive portfolio. This is a bit of a smaller market but it's growing at a very attractive rate. Low-double digits through the first 3 quarters of last year. We are doing a good job in the shoulder and elbow category here, and looking to develop still more products to address other anatomical sites within the extremities market. So this is a very attractive space and we look to do more. At this point in time, a #3 market position, but we ought to be moving up as we move into the coming operating periods.
I'll turn now to our emerging businesses. And now these are businesses where we typically have much lower market share presently. But we have many assets that can be leveraged to help us accelerate the growth and take market share within each of these segments. So whether it's technology to be leveraged or research and development, manufacturing capabilities, distribution channel or customer relationships. Probably most importantly, the Zimmer brand can be leveraged into these businesses. We're really excited about each and every one of these.
So we'll start with the dental market. It's a business that we grew 9.2% in the third quarter of 2011. It was probably a market that was more heavily impacted by the economic conditions going back a couple years. But it began to stabilize in 2011, because this is a market that is more private-pay-oriented, the nature of the implant. We have 7% market share. And you can see, again our ability to take some of our technologies from the reconstructive side, bony in-growth is important for any of these implants and so we've incorporated Trabecular Metal Technology onto that implant that you see in the upper right hand corner of this slide. It's launched in Europe. We're finding great clinical feedback from the clinicians in Europe. At this point in time, we look to bring it in the United States market this year, yet.
I'll move then to spine. A very large market, $9 billion in size. We have just 2% of that market at this point in time. But we've been overdriving our investment in research and development. We're starting to see the benefits of these products coming out. And so we're really optimistic about improving our performance and taking market share in spine. You can see, again Trabecular Metal, those are cervical inter-body implants on the upper right-hand corner. And then on the center right-hand side of that slide is our next-generation MIS pedicle screw system. This is the Pathfinder NXT. The bottom of that slide shows a product that was just cleared in the fourth quarter of 2011, it's the InViZia, and this is a low-profile windowed cervical plate. So we're anxious to get these products into the hands of our customers and potential customers and very optimistic about what we're going to be able to do on the spine segment going forward.
I'll turn to Trauma. A $5 billion market, we have 5% of it at this point in time. But over the last 3 quarters, we've been growing at a rate of 2x to 3x the market. It's a business that we grew 14.2% in the third quarter of 2011. We had a very strong traditionally plate-and-screw offering, but there are 2 other elements that you must have to be competitive in Level 1 and Level 2 traumatology centers. One of which is an intramedullary nail line. And you see that on the upper right-hand corner of this slide. That's a system that we've launched over the last couple of years. A tibia nail, an antegrade and retrograde femoral nail, as well as a cephalomedullary nail. And the final piece to that puzzle is external fixation. And just last quarter, we acquired a company with a terrific external fixation system and so you see those products featured there. So we have all 3 of the legs of the stool when it comes to trauma and we look to go out and take a lot of market share, so we're well-positioned to continue a nice run that we're on within that segment. And finally, our last category, the surgical and other. Here, we're looking to participate more deeply in procedures and expand customer relationships that already exist. And so bone cement is sold through this division, tourniquet products, blood management products. And most recently about a year ago, we closed on the acquisition of a Swiss-based company, with the SoPlus line of power equipment. So, again, this is a $1 billion market that we didn't participate in, in advance of this acquisition. And we look to take these products to market, in earnest, in 2012 as well. On the left-hand side you see some of the things that we're doing in the biologics area. That's DeNovo NT. And again, across that continuum of care, this is on the very early side of an intervention opportunity for a surgeon. If a patient has a focal defect in his or her cartilage, the surgeon might be able to use the DeNovo NT to not only repair but potentially regenerate cartilage within that patient. So we've done over 2,000 implantations to date and received terrific feedback from surgeons. Just the beginning of some of the big things that we expect to do on the biologics side going forward.
So let me summarize, again, by coming back to the principal value creation drivers. We think that we're very well-positioned with a great existing product offering and a very robust product portfolio to go out and take share. In reconstructive, as well as these emerging businesses: Spine, Dental, Trauma, Surgical and Biologics. We're making the right investments and executing very well and establishing leadership positions in key emerging markets. And we're increasing our focus on some of these transformation and operational excellence initiatives. This will put us in a position to continue to invest in the growth drivers, but at the same time expand our margins on a go forward basis, enhance our cash flow and our return on invested capital. To the extent that we generate excess cash, we're well-positioned with a couple of vehicles that would allow us to return cash to the stockholders, both in the form of dividends and potentially continuation of share repurchases.
Fundamentally, we're excited about the future and we're committed to creating stockholder value. So again, thanks for getting up early, at least West Coast time. We appreciate your interest in Zimmer and look forward to taking your questions in the breakout session.
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