Zimmer Biomet Production Blues
Walter Eisner • Mon, July 3rd, 2017
In the competition for surgeon customers, nothing makes a device rep crazier than not being able to deliver his or her product to the surgeon. Surgeons have to find alternative devices and the lost opportunity is hard to recapture.
A shortage of orthopedic devices due to production problems at Zimmer Biomet Holdings, Inc.'s Biomet-legacy North Campus in Warsaw, Indiana, is giving sales reps those challenges.
Dave Dvorak, the president and CEO of Zimmer Holdings, Inc., admitted as much to Wall Street analysts during a May conference call when he acknowledged that "greater-than-expected number of temporary and occasional production delays," of certain Biomet brands, resulted in "lower-than-expected levels of finished goods and strained inventory availability."
“Profound and Challenging” Delays
Dvorak said the impacts of the delays were more "profound and challenging than initially expected."
A Zimmer Biomet spokesperson told us that the North Campus is a legacy Biomet location. The original portion of the building was completed in 1981 and the building has been expanded several times since its original construction.
You can chalk this up to integration challenges from the Zimmer $14 billion purchase of Biomet in 2015.
Zimmer leaders have had a pretty good track record at acquisitions and integrations going back to the Centerpulse AG acquisition in 2003. That acquisition was followed by acquisitions of Implex Corp (2004); ORTHOSoft, Inc. and Endius, Inc. (2007); Abbott Spine (2008); Medizin-Technik GmbH and Knee Creations, LLC (2013); Biomet, Inc. (2015); and LDR (2016.)
Former Zimmer CEO Ray Elliot, told OTW years ago that his then Corporate Counsel, Dave Dvorak, deserved much of the integration credit of those acquisitions. He told us that Dvorak was a guy to watch.
Audit and FDA Inspection
Dvorak and his team do their homework. So, in the first half of 2016 after the Biomet acquisition, the company completed internal audits of Biomet's North Campus. These audits reportedly identified several compliance-related issues, and a remediation program was established in July 2016. This was followed by an FDA inspection which resulted in a 60-page "Inspection Observation (Form 483).”
The FDA inspection resulted in one the "longest and most serious" 483s ever encountered by a legal expert quoted by Wells Fargo analyst Larry Biegelsen. The company's remediation program identified 7 of the 14 Form-483 observations and 6 of the 15 discussion points prior to the start of the FDA's inspection.
The FDA wrote the 483s in such a way as to argue that these were not just technical violations, but ones that potentially go to safety, e.g., whether products were properly sterilized or steps adequately documented so that the safety is known.
The expert believed it would take the company at least a year to address all issues and would be ready for a re-inspection sometime in 2018.
Product ship holds were issued on September 29, 2016 to stop shipments of all final products cleaned, sterile packaged, and sterilized at the North Campus. Initial product ship hold releases under interim controls began on October 21. None of the health hazard evaluations completed to date resulted in any field actions.
Dvorak acted fast. Five operations and quality executives were dismissed. Replaced were the senior vice president of global operations and logistics; the vice president of quality assurance at all Zimmer-Biomet’s Warsaw sites; the quality assurance director for the Warsaw North Campus; the compliance director of the Biomet network; and the QA director for post-market surveillance and complaint handling for the Warsaw site.
During a conference call with analysts reviewing the first quarter of 2017, Dvorak addressed the issues directly.
He told analysts that the company has made ongoing investments into the North Campus and was in position to get back on "offense."
The company expects special items expenses for the year to rise to $550 million, an increase of $20 million from previous guidance to Wall Street’s analysts. This includes an expected $40 million increase in quality remediation expenses, which is expected to reach $210 million.
Dvorak said the company is continuing to implement operational process improvements at the North Campus. "As we implemented these process adjustments during the [first] quarter, we experienced a greater-than-expected number of temporary and occasional production delays. While our overall production throughput improved during the quarter, these delays resulted in lower-than-expected levels of finished goods and strained inventory availability of key brands throughout the quarter."
"The efforts have resulted in an improved and more consistent production output in recent weeks. This progress supports our confidence in our ability to restore adequate supply and accelerate growth during the second half of 2017."
The company has been working through the integration process to harmonize and optimize its quality and manufacturing systems as part of the integration. "Those efforts as it relates to the Warsaw North Campus were greatly accelerated as a consequence of both internal audit findings as well as the FDA's inspection that concluded in the fourth quarter of last year. So, we had a pretty fluid situation in the fourth quarter leading into the beginning of this year," said Dvorak.
"We were focused on ensuring that the production was coming back up to satisfy, in a prioritized way, existing customer demand and then working towards replenishing safety stocks that would allow us to go back on offense. Because some of these key brands that come out of that facility provide us with some of our best competitive opportunities, so they're a very important set of brands and strategically relevant to the acceleration of the top line.”
"It really is a matter that is focused on that facility.” said Dvorak.
“And as we got into the beginning of the year and production began to accelerate back up, it just took us longer to ramp that production back up. You can understand why we'd be operating with an abundance of caution, most importantly, with the interest of the patients that are served by these products in mind. These are high-quality products.”
“We want to make sure that we're putting them out without any compromise, and so the monitoring processes are very sensitive. The implementation of these processes, as I said, this was done on a very accelerated basis for obvious reasons, and it just took us longer to ramp up that production in the first quarter than we originally anticipated.”
Back on Offense
"In the summer months, we expect to make a lot of progress on that front and to put ourselves in a position then to not only fully satisfy existing customer demands but then to go back on offense."
Analysts asked Dvorak if he had any sense of the company's ability to retain share within the customer base given the shortfall in terms of product availability. Furthermore, they asked, what are some of the programs that the company was putting in place to retain its customers?
Dvorak said that the teams have done an excellent job of moving product around and being very responsive to the customer demands. "There are instances where we aren't able to satisfy those demands in particular cases, but you should think about it predominantly as instances where we're missing cases with existing customers. But the larger relationship is maintained, and that is part of the reason we have such a high degree of confidence that, as these production flows begin to replenish stocks out in the field, that we'll be regaining those cases. And we think it's very achievable to regain those cases, and we'll begin to do that here in the latter part of the second quarter."
Pressed about the level of confidence the company has in solving these problems, Zimmer Senior Vice President and CFO Dan Florin said the way to think about this is that the first quarter production throughput delays pushed the company's time horizon out by approximately two months in clearing back orders and replenishing safety stock.
“And importantly as David said, in recent weeks, we've reached production throughput out of that campus to levels that are necessary to fuel that. So, we've already demonstrated in the past couple of weeks the level of output necessary to fuel that growth. Now there's a time lag between it coming out of the facility, getting through terminal sterilization and pushed out to the field, having complete sets and then going on offense. Those are the—that time lag. But I think it's really important that we have, in fact, been performing, from an output perspective, to the degree that we need to, to fuel the second half growth,” added Florin.
Finally, addressing the FDA, Dvorak said the company has developed a comprehensive remediation plan to fully address the issues cited by the FDA, and are going to continue to communicate with the agency as they execute that plan. “We're going to take the necessary steps to address these gaps in that operation. And I would tell you we also would express that we remain confident in the quality and safety efficacy of these products. So, it just is an ongoing process and we'll keep everyone up to date with any appropriate disclosures as that process unfolds.”
Dvorak made integration excellence a hallmark of his tenure at the post-Ray Elliott Zimmer. As we’ve just seen, integration excellence also entails responding well to the inevitable, unforeseen event.
Bottom line, while Wall Street may have built a wall of worry around Zimmer as a result of these operational challenges, Dvorak and his team appear to have knocked that wall down in record time.