Dvorak’s Zimmer Biomet Integration Playbook

David Dvorak, the CEO and president of Zimmer Biomet Holdings, Inc. acknowledged during a conference call with analysts on July 30, 2015 that the acquisition of Biomet, Inc. took longer than expected and as a result the company lost some “offensive momentum.”

Stagnant Sales

By the end of 2014 and into 2015 sales growth decelerated and finally flatlined this past quarter. Dvorak attributed this to an absence of “investment and offensive measures, ” by the sales team during the pendency of closure period. But now expects to get back to at- or above-market rate growth.

This isn’t Dvorak’s first big time M&A rodeo. In addition to handling the Centerpulse AG integration, he also had to handle the sudden departure of his predecessor Ray Elliott while also juggling U.S. Attorney Chris Christie’s orthopedic industry witch hunt. Zimmer’s stock plummeted and new compliance programs instituted by Dvorak, and overseen by former U.S. Attorney General John Ashcroft, had a disrupting effect on sales.

But eventually day-to-day business returned to normal and Dvorak has been riding the orthopedic demographic wave ever since. At least until the announcement of the Biomet acquisition and a prolonged regulatory review got in the way.

Getting Rolling Again

But Dvorak promises to get the offense rolling again.

How?

First, Dvorak and his senior executives, including newly appointed CFO Dan Florin (who was Biomet’s CFO) will use the playbook used by Dvorak when Elliott let his, then corporate attorney, handle the integration of Centerpulse into Zimmer in 2003. One year after the closing of the deal, Zimmer announced that integration efforts were ahead of schedule and announced that cost savings were greater than originally predicted. Zimmer completed the acquisition on October 2, 2003. Twelve years ago.

On the July 30, 2015 conference call with analysts, Dvorak and Florin detailed the playbook steps to integrating Biomet and Zimmer. They told analysts the synergies are there to accelerate revenue growth and attain “extremely attractive” financial results through significant cross selling opportunities.

Were the analysts buying?

Before going in for the deep dive, let’s look at the mid-year numbers.

Second Quarter Blues

Total revenue for the second quarter was $1.168 billion, a 5.7% constant-currency increase. However, net currency impact for the quarter pulled sales down 7% or $83 million. Acquired revenue from the Biomet transaction contributed 5% or $60 million in the quarter. Stand-alone Zimmer increased sales 0.7% or 1.2% on a like-billing-day basis in the quarter.

The company missed consensus analyst revenue estimates by $8 million.

Recon sales, when accounting for currency, rose only 0.7%. Knees rose 2.3%, but hips lost 1.3% and extremities dropped 1%. Trauma sales came in 0.7% lower. Only spine had a strong quarter, rising 4.7%.

Zimmer likely lost recon share in the quarter. And the disruption from the Biomet deal has to have been a factor.

DePuy Synthes Replay?

Bob Hopkins, Bank of America’s senior analyst, wrote that the sales numbers of the past few quarters are causing investors to wonder if the challenges of integrating Zimmer and Biomet may lead to “multiple years of stagnant growth” as we’re seeing with the DePuy Synthes deal.

But Hopkins thinks that is a bad comparison. He says Zimmer Biomet is not forcing direct sales people to join distributorships like DePuy Synthes required. He says there are also fewer “undisrupted alternatives” for sales people to move to. Finally, echoing the Centerpulse playbook, Hopkins says Zimmer management (Dvorak) executed the last major ortho merger “flawlessly.”

Dvorak’s Playbook

So how’s that playbook going to play out?

With a detailed integration plan that Dvorak says has 400 distinct projects and more that 7, 000 process milestones. In the Centerpulse playbook Zimmer completed more than 3, 000-plus milestones representing approximately 280 individual projects.

In addition, Dvorak said the company created “extremely” detailed plans for cross-selling with the right sales team expected to be in place by the end of year. They’ve prebuilt inventory and trained the sales staff. They will “ramp up the offense.”

Sales Team Revamp

But ultimately, plans are made by people in offices. Sales are made in the field by salespeople.

Dvorak says he feels good about his sales team, noting that sales leaders at the executive and top levels were appointed pre-close and have “terrific” compensation opportunities.

The chosen sales leaders in the U.S. have compounded annual growth rates hundreds of basis points above those not selected. Retention has been “excellent” and attrition has been at historic levels. He thinks that may tick up into the single-digits by year end. Zimmer is retaining reps because there are “too many opportunities to lose good reps. He said the tone is “upbeat” among the sales force.

The company is also reorganizing into specialized commercial sales teams and has appointed over 2, 000 specialized sales reps and plans to expand that numbers “significantly” through the rest of the decade. The company has also designed compensation plans for selected leaders to drive sequential growth by the end of 2015 and into 2016.

Historically, Zimmer’s and Biomet’s sales forces were oriented towards large joints, but now with a focus on sales force specialization, there will be more emphasis on a comprehensive portfolio to compete in level 1 trauma centers. Dvorak says this puts the company in a “sweet spot” with “critical mass.”

Best Bag in Ortho

He believes the combined portfolios, with “no better bag in the industry, ” the best sales leaders, outstanding training and leveraging existing relationships at the surgeon level for cross selling will be part of the plan to drive accelerated growth. Florin noted cross selling opportunities of Biomet’s premium technologies.

What’s in that Zimmer Biomet bag?

Knees

Dvorak said the company’s market-leading knee business continues to be led by Persona, the personalized knee system, and the “clinically-trusted” Vanguard and NexGen knee systems. “In addition, our impressive knee lineup includes the Vanguard Select and Vanguard 360 revision system. Finally, our portfolio is further differentiated by our bicruciate-preserving artheroplasty options, including the clinically-proven Oxford partial knee, and our new Vanguard XP total knee system.”

Hips

The hip offerings, said Dvorak, address the full range of patient anatomy and surgical philosophies. “Our Taperloc Complete Microplasty stem, and Avenir Hip System, for example, meet the rising demand for minimally-invasive techniques that incorporate the anterior supine surgical approach. Our portfolio is also complemented by the Arcos Femoral Revision System, and our multi-bearing, premium-cup options, featuring the G7 and Continuum Acetabular Systems.”

SET – New Product Category

In the newly-formed SET (surgical, sports medicine, extremities, foot & ankle and trauma) product category, Dvorak sees the sports-medicine business as a particularly attractive source of “quick wins across our sales channel.” Joining the early intervention Gel-One and subchondroplasty treatments will be the JuggerKnot Soft Anchor System.

Sports medicine will include joint preservations therapies.

Dvorak says he believes the product category represents $12 billion of a $50 billion market that will grow in the mid-single-digit range. It is currently 20% of Zimmer Biomet’s revenue base and the company plans to compete “aggressively” in that market.

Dvorak is “extraordinarily excited, ” about this new product category where the company has historically had some “skill challenges.” He sees Zimmer Biomet attaining mid-single digit growth, but aspires to drive it “much higher.” He sees big immediate cross selling opportunities.

“We’re bullish on the union of our complementary extremities portfolios, highlighted by the cross-selling opportunities represented by the comprehensive Total Shoulder System, which commands a wide clinical audience in a rapidly growing market, and the Nexel Total Elbow.”

The growth prospects in the foot and ankle category are also extremely promising, said Dvorak, including the Trabecular Metal Total Ankle, the Phoenix Ankle Arthrodesis Nail System, and the A.L.P. S Total Foot Plating System. “Backed by a broad portfolio of solutions, we’ll bring heightened focus to this attractive market. For our focused trauma sales teams, immediate opportunities include the ePAK Single-Use Delivery System, featuring the DDR CrossLock distal radius plate, as well as the Cable-Ready Cable Grip System.”

Surgical

The surgical business, says Dvorak, also stands to benefit from “the enhanced focus and sales force specialization we’re leveraging to drive our broadened clinical portfolio. Zimmer Biomet also positions a diversified dental business, offering critical scale to address the faster-growing, value-market segment, with our line of PI-branded offerings.”

Spine

The company’s spine performance has been a bright spot and Dvorak says they’ll continue to build on a successful cadence of commercial releases from 2014. “This global business offers a differentiated pipeline and a comprehensive portfolio that address minimally-invasive procedures with our Pathfinder NXP Pedicle Screw System, as well as lateral access surgeries, with the Timberline Lateral Fusion System.”

Synergies

No talk of integration of giant companies is complete without discussing “synergies.”

The company expects synergies of $135 million (net-annual pretax operating earnings) in the first year, rising to $350 million by year three. The cost savings will be accomplished by the following:

• Eliminate SG&A (Selling, General and Administrative) redundancies
• Pursue strategic sourcing
• Share services
• Optimizing manufacturing and distribution network
• Institute “lean” principles

2015 and Beyond

In the year ahead, Dvorak and Florin expect to see ongoing, but stable pricing pressures and hip and knee markets growing in the low, single-digit range. They believe procedural demand is being driven by demographics and growth in emerging markets and underpenetration in developed markets. The company expects revenue to grow 1.5 to 2.0%, on a constant currency basis, to over $6 billion by the end of the year.

Digesting Biomet will not take attention away from other business development or acquisition activities. Florin said the company will continue to “actively” look for tuck-in opportunities. In R&D, Florin said the combined company will be able to invest in some higher risk, higher reward differentiated products and sees opportunities to expand R&D.

With the deal now closed, BMO Capital Market analyst, Joanne Wuensch, says “the tide should also begin to turn.” She notes Dvorak’s assurances that synergies inherent in this merger will accelerate the growth and generate “extremely” attractive results; that the company has identified a host of cross-selling opportunities; and that the long closing turned into an opportunity to pre-build inventory and pre-train sales reps.

She adds that it will “take some time” for the pipeline to rebuild and restore momentum.

A few years ago, Ray Elliott told us to talk to his corporate counsel, Dave Dvorak, about a smaller acquisition the company had made. He told us Dvorak was going to be the guy to make things work.

Must be that playbook.