Zimmer Biomet Holdings Inc (ZBH) 2015 Q3 法說會逐字稿

Good morning.

I would like to turn the call over to Bob Marshall, Vice President Investor Relations and Treasurer.

Mr. Marshall, you may begin your call.

Thank you, George.

Good morning, and welcome to Zimmer Biomet's third-quarter 2015 earnings conference call.

I'm here with our CEO, David Dvorak, and our CFO, Dan Florin.

Before we start, I would like to note that our results reflect the same number of billing days in the current-year quarter as in the prior year.

During our call, we will be comparing revenues on an adjusted pro forma basis.

This means that the revenue per prior year period has been adjusted to reflect the inclusion of Biomet revenue, and the impact of previously-announced divestiture remedies.

Additionally, expense ratios and related margin analysis through operating profit will likewise be compared to pro forma financials, as revised, which include Biomet results for the same period in the prior year adjusted in both year periods for inventory step-up and other inventory manufacturing related charges, certain claims, special items, intangible asset amortization, financing, and other expenses related to the Biomet merger and certain tax adjustments.

I would also like to remind you that our discussions during this call will include forward-looking statements.

Actual results may differ materially from those indicated by forward-looking statements, due to variety of risks and uncertainties.

Please refer to our SEC filings for a detailed discussions of these risks and uncertainties.

Finally, the discussions during this call will include other certain non-GAAP financial measures.

Reconciliations of these measures to the most directly-comparable GAAP financial measures are included within the earnings release, which is available on our website at investor.

ZimmerBiomet.com.

With that, I'll now turn the call over to David.

Thanks, Bob.

This morning, I will review our third-quarter financial results and highlights from our performance.

Dan will then provide financial details, as well as discuss our updated guidance.

I'll state all sales in constant currency terms measured against prior year adjusted pro forma financials, and all earnings results on an adjusted basis.

Let me begin by highlighting some of our important achievements during the quarter.

The Company made great strides across all geographies by accomplishing significant commercial integration milestones.

We largely completed the appointment of our global sales leaders during the quarter, and we expect to substantially complete all commercial integration efforts by the end of this year.

As evidenced by our sequential sales improvement in the Asia-Pacific and Europe, Middle East, and Africa regions, as well as in several product categories, we have already begun to see the benefits of the progress we have made on our sales channel integration.

Going forward, we will continue to execute our detailed cross-selling plans, in order to leverage the depth and breath of our musculoskeletal portfolio of solutions.

During the quarter, we also began to execute our well-defined road maps to capture the net operating synergies inherent in this merger.

Our progress to date is reflected in our adjusted earnings out-performance, and continued delivery of expanded operating margins.

I would now like to comment on market conditions and pricing during the quarter.

Musculoskeletal markets in general continued to demonstrate stability, consistent with the prior two fiscal years.

In terms of pricing, Zimmer Biomet experienced modestly negative pricing pressure, consistent with our prior expectations.

Our resulting price decline in the third quarter was 2.1%.

In this context, Zimmer Biomet accelerated revenues growth in several geographies and product categories.

Consolidated net sales for the third quarter were $1.76 billion, an increase of 59.3% reported, or 0.7% against strong prior-year adjusted pro forma results.

Our Asia-Pacific business delivered 4.7% growth in the quarter, and our sales increased by 1.7% in the Europe, Middle East and Africa region.

Revenues in the Americas decreased by 0.7%, reflecting flat sales in the United States, and the impact of macro economic issues in Latin America.

Turning to our product categories, sales from Zimmer Biomet's knee business increased in the third quarter by 1.7%, reflecting positive volume and mix of 4%, and negative price of 2.3%.

The strength of our combined knee portfolio is already evident by this quarter's robust performance in key overseas geographies.

Our Asia-Pacific business delivered strong 9% growth over the prior-year period.

Our Europe, Middle East and Africa region grew sales by 6%, and our Americas segment recorded a sales decrease of 1.8%.

Our sales growth continued to be led by Persona, the personalized knee system, and the clinically-trusted Vanguard complete knee system, as well as our Vanguard 360 revision knee system.

We also drove sales of our bicruciate preserving arthroplasty options, including the clinically-proven Oxford partial knee and our new Vanguard XP total knee system.

Sales from our hip business decreased by 0.3% in the third quarter, including positive volume and mix of 2.3%, and negative price of 2.6%.

Our Europe, Middle East and Africa sales increased by 1.2%, compared to the prior year period.

Our Asia-Pacific region sales decreased by 0.3%, and our Americas segment recorded a sales decrease of 1.1%.

We're encouraged by our consolidated sequential revenue improvement, supported by the solid growth of our multi-bearing G7 and Continuum acetabular systems.

In addition, the ongoing performance of our Taperloc Complete Microplasty stem and Avenir hip system demonstrates how our comprehensive hip portfolio meets the rising demand for contemporary surgical techniques, such as the anterior supine approach.

Turning to our SET product category, sales increased 1% over the prior-year period.

Our extremities business achieved high single digit sales growth with solid performances in all geographies, due primarily to steady demand for the comprehensive total shoulder system.

This growth was partially offset by the performance of our surgical business, and to a lesser extent, trauma.

We continue to be excited about the promising growth of our sports medicine business, where we're achieving ongoing traction with our Gel-One hyaluronic acid offering, and our minimally invasive Subchondroplasty joint preservation treatment.

In the quarter, we announced the release of this innovative biologic solution for foot and ankle indications, representing our expansion into an attractive new clinical market.

Worldwide dental sales decreased by 0.9% in the quarter.

Our positive performances in the United States and Asia-Pacific region were offset by slower sales in the Europe, Middle East and Africa region, and the balance of the Americas.

Looking to future quarters, our dental sales channel will remain focused on bringing critical scale and improved execution to all segments of this category, with a product portfolio that offers a breadth of implant systems and best-in-class regenerative solutions.

Zimmer Biomet's spine, CMS, and thoracic category revenues increased by 0.3% over the prior-year period.

Our spine sales teams continue to prepare to exploit our cross-selling product opportunities, which include the Timberline lateral fusion system and the Pathfinder NXT pedicle screw system.

We expect these commercial opportunities will help to offset anticipated sales dyssynergies inherent in our US spine integration in particular.

In the quarter, a healthy double digit growth rate for our cranial, maxilla, facial, and thoracic business was driven by demand for our TraumaOne and SternaLock Blu systems, as well as growing market acceptance for our recently-launched RibFix Blu system.

With that, I'll turn it over to Dan, who will continue this discussion in greater detail, as well as review our guidance.

Dan?

Thank you, David and good morning.

Our total revenues for the third quarter were $1.762 billion, a 59.3% increase as reported, compared to the third quarter of 2014.

On an adjusted pro forma basis, total constant currency revenues increased 0.7% over the prior year, reflecting sequential growth from Q2.

This is despite a relatively tough comp of 4.7% adjusted pro forma growth in the prior-year quarter.

Net currency impact for the quarter decreased revenues by 6%, or $113 million.

The negative currency impact for the quarter related principally to our Japanese yen, euro, and Australian dollar-dominated revenues.

Our adjusted gross profit margin was 76.2% for the quarter.

The margin ratio improved 70 basis points when compared to the third quarter of 2014.

Ongoing but consistent price declines were offset by continuing gains from our cash flow hedging program, along with positive results from our manufacturing network.

R&D expense in the quarter was $83 million or 4.7% of net sales.

Our R&D teams have made good progress in reviewing and prioritizing projects within the combined portfolio, while also redirecting redundant project dollars towards innovative programs that address unmet customer needs.

Selling, general, and administrative expenses were $692 million in the third quarter, and at 39.3% of sales, were 200 basis points below the prior year period.

This reduction in SG&A as a percentage of sales is primarily reflective of cost savings from our synergy program, and to a lesser extent, efficiencies currently embedded across a number of spending categories, which provide future opportunity to fund additional organic growth initiatives.

The cost synergy savings realized in the quarter included the benefit of certain actions that were implemented earlier in the quarter than previously projected.

As such, we are updating our net synergy target for the first 12 months post close to $155 million, compared to the previous amount of $135 million.

Approximately $15 million of the $20 million in accelerated year-one savings were realized in Q3, with the remainder expected in Q4.

The accelerated timing of these year-one synergy initiatives does not impact our year-three EBIT run rate synergy commitment of $350 million.

In the quarter, the Company recorded pretax charges of $439 million in special items, which primarily consist of amortization expense of $123 million, inventory step-up charges related to the Biomet merger of $127 million, and approximately $140 million in integration-related costs.

Our adjusted third-quarter 2015 figures in the earnings release exclude the impact of these charges.

Our adjusted operating profit in the quarter amounted to $567 million.

At 32.2%, our adjusted operating profit to sales ratio was 270 basis points higher than the prior-year third quarter.

Net interest expense for the quarter amounted to $89 million, which was higher than the same prior-year quarter, and reflects the incurred debts associated with the Biomet transaction.

Adjusted net earnings were $338 million for the third quarter, an increase of 35.5% when compared to the Zimmer stand alone adjusted net earnings from the prior year.

Adjusted diluted earnings per share increased 13.1% to $1.64 on 205.7 million average outstanding diluted shares.

At $0.11, reported diluted earnings per share decreased 89.1% from the prior year third quarter reported EPS of $1.01.

Our adjusted effective tax rate for the quarter was 28.2% and 30.2% on a reported basis.

The Company had approximately 203.7 million shares of common stock outstanding as of September 30, 2015, an increase as compared to the 169.3 million as of September 30, 2014.

The increase is due primarily to the 32.7 million shares issued in connection with the Biomet transaction.

Operating cash flow for the quarter amounted to $151 million, compared to $256 million in the third quarter of 2014.

The decrease was driven primarily by integration expenses tied to our synergy program of $102 million, and final expenses related to the merger transaction of $225 million.

Free cash flow in the third quarter was $15 million, reflecting CapEx spending of $136 million, which was comprised of $82 million for instruments, and $54 million for property, plant and equipment.

During the quarter, we repaid $150 million on our term loan from funds on hand in the United States.

The outstanding balance on the term loan as of September 30 was $2.850 billion.

I would like to now turn to our guidance for 2015.

In our earnings release this morning, we updated the Company's expectations for full-year 2015 revenues and earnings.

Implicit in this guidance is a stable to slightly improved revenue performance in the fourth quarter, relative to our growth rate in Q3 after adjusting for billing day shortfalls expected in that quarter.

Revenue growth for the fourth quarter is expected to be in a range of 0.5% to 1.5% on a constant currency adjusted pro forma day rate basis.

I would remind you that the fourth quarter will have one-half less billing day, in consolidation, which is inclusive of two fewer billing days in the EMEA region, due to an accounting change that we made earlier this year for certain of our international entities.

Adjusting for the one-half less billing day difference which negatively impacts the growth rate by approximately 75 basis points, our adjusted pro forma constant currency growth is expected to be in a range of negative 0.25% to positive 0.75%.

Taken together with an expectation of foreign exchange impact of negative 4.5%, our reported revenue for the fourth quarter is expected to decrease between 3.75% and 4.75%.

The Company now forecasts full-year revenues to increase between 1% and 1.5% constant currency, on a comparable adjusted pro forma basis, when compared to 2014.

The resulting full-year revenues would therefore be approximately $6.01 billion.

We now expect the gross margin ratio for the full year to be at the high end of the previously guided range of 75% to 75.5%, and within that range in the fourth quarter.

Our guidance for R&D is now approximately 4.5% for both the fourth quarter and the full year.

We now expect SG&A as a percentage of revenues to be below the low end of the previous range of 38.5% to 39% for the full year, and between 37% and 37.5% for the fourth quarter.

Moving down the income statement, net adjusted interest expense guidance remains unchanged, while the estimated full-year tax rate is now expected to be approximately 26.5%.

Our previous guidance had been in a range of 26.5% to 27%.

Taken together with year to date performance, the fourth-quarter's adjusted tax rate should be approximately 25.5%.

We expect fully-diluted share count for the fourth quarter should be approximately 206 million shares, and approximately 190 million for the full year.

I would like to note that given a significant movement in fully diluted share count during 2015, the full-year adjusted earnings per share result will differ from the simple arithmetic sum of each quarter's adjusted earnings.

Our full-year adjusted EPS guidance range reflects cumulative adjusted net income, divided by the full year diluted share count of 190 million shares.

Turning now to capital allocation, as noted in our press release this morning, the Company is reinstating its previously-suspended share repurchase program.

The program that authorized the repurchase of shares up to $1 billion was temporarily suspended in April of 2014, when the Biomet merger was announced.

As a reminder, the Company has $599.5 million of share repurchase authorization remaining as of September 30, 2015.

Full-year 2015 adjusted and fully diluted earnings per share guidance has been updated, and exceeds the high end of our previous range of $6.65 and $6.80.

We now forecast adjusted fully-diluted earnings per share to be in a range of $6.83 to $6.87 on the 190 million fully-diluted share count.

Our adjusted EPS for the fourth quarter is expected to be in a range of $2.02 and $2.06, again, using a 206 million fully diluted share count.

Before turning the call back over to David, I want to inform you that late in the quarter, we identified errors in legacy Zimmer's accounting for certain accruals, and our Q2 accounting of product line divestitures.

The errors impact several prior operating periods.

The Company assessed the applicable guidance issued by the Securities and Exchange Commission and the Financial Accounting Standards Board's, and concluded that these misstatements were not material to Zimmer Biomet's historical consolidated financial statements.

However, due to the low Q3 reported net income of $22.2 million, the Company concluded that correcting these prior period errors in the current quarter would have been material to the Q3 consolidated statements of GAAP earnings.

As a result, the Company is revising prior period financial statements to reflect the proper timing of these adjustments, along with all previously-determined immaterial adjustments in their respective periods.

To be clear, we are not restating any previously-issued filings; rather we are making immaterial revisions to the prior periods.

The most notable revision is a downward adjustment of $0.05 of adjusted earnings per share recorded in the first half of 2015.

Importantly, the impact of this revision on 2015 adjusted fully diluted earnings per share has been considered within today's updated guidance.

Further, it has no impact on our view of the performance of the business.

A reconciliation of the revision amounts and timing from 2013 to 2015 is available on our investor relations website, and included in Form 8-K that we filed today.

Lastly, as a reminder, we will be providing detailed 2016 financial guidance during our fourth-quarter earnings call in January.

David, I'll turn the call back over to you.

Thanks, Dan.

As a global leader in musculoskeletal innovation, Zimmer Biomet is uniquely-positioned to anticipate and serve the needs of an evolving health care environment.

We're excited about the progress of our teams and the course of our global integration, and we will remain focused on capturing the synergies of this merger at every level.

Together, we're accelerating the Company's growth strategies, while generating attractive stockholder returns.

And now, I would like to ask George to begin the Q&A portion of our call.

(Operator Instructions)

Our first question comes from Bob Hopkins with Bank of America Merrill Lynch.

Please go ahead.

So David, it looks like you're doing a really good job on the cost side.

I wanted to focus my question on sales growth and sales force retention, and integration progress.

So I guess the way I would ask the question is, when you look at the Q4 guidance, adjusting for days, it looks like the sales growth in Q4 is maybe a little lighter than Q3.

Can you talk a little bit about why that is?

And more broadly, how are things going in terms of sales force retention and turnover?

Are the turnover rates what you expected?

A little more color in what is going on with the integration so far.

Sure, Bob.

Obviously in the third quarter, our focus was on appointment of sales leaders out in the field.

These were steps that we were unable to take prior to close, although we had very detailed plans.

And so its been an execution quarter where we have done a lot across the globe to clarify future leaders, and then allow those individuals to form their teams all the way down to the rep level.

So some of that second-half piece that is clarification of territories, compensation plans, product bags, is work that is ongoing, and we expect to be substantially complete with all of that work by the end of the year.

Now, that said, we're already seeing positive traction, having made these leadership appointments.

And that's evident in our performance.

In the OUS markets in particular, there are pockets and product categories within the United States market where that is already evident.

Retention rates have been consistent with expectations.

Obviously, when these decisions are made, one expects a little bit of an impact in that regard, and so we did see an expected uptick, but we're also seeing a pipeline of new sales positions and hiring activities picking up, and so all of that bodes very, very well as we finish out 2015 and move into 2016.

This positions us extraordinarily well to take advantage of the cross-sell opportunities, and so we expect to see a bit of that retrieved in the fourth quarter here, and then sequentially throughout 2016, more and more of that will be realized on the cross-sell opportunity.

What we're forecasting really is stability, Bob, sequentially, from Q3 to Q4.

There's a billing day impact that causes three-quarters of a point headwind in our constantly currency growth rate.

But when that's factored in, our sales guidance range contemplates stability to potentially a little bit of an uptick from Q3 to Q4.

Okay.

Thank you for that.

As a follow-up, I realize this is a slightly shorter-term oriented question, but can you walk us through, relative to the guidance that you gave last quarter, why the revenue growth guidance is down a little bit this quarter?

Maybe just put that in context for us, just what changed?

For Dan, I was just wondering, you previously said, regarding 2016, that earnings growth would be 15% to 20% higher than 2015, I believe.

And so does that still hold, relative to this higher 2015 number?

Thank you.

Sure, Bob.

Let me take the first of those.

The consistency expected in Q4 and what we saw in Q3 across all of the primary businesses is noted.

And I think that the only significant change that exists relative to our view of the market falls in the category of emerging markets.

And I think this is something that others have seen.

It is macro economically driven, it obviously impacted our Americas performance most prominently, because we saw the biggest downturn in our Latin America business out of the emerging markets.

Frankly we saw less of a downturn in Asia-Pacific and hence the stronger performance, was contributed in that regard.

And then more of a flattish emerging market performance in the EMEA businesses, consistent with our overall performance there.

That headwind, particularly in Latin America, but across the various emerging markets, is the reason for the tweak to the guidance from Q3 to Q4.

Everything else is tracking absolutely consistently with our plans and expectations.

And, Bob, with respect to 2016, certainly our performance in 2015 gives us strong confidence with respect to 2016.

As I mentioned, we will provide detailed guidance in our January call.

Importantly, our 2016 operating plan is well underway, and within that context, we will make decisions about resource allocation and funding of growth initiatives.

And as you have said, we have express confidence in EPS, 15% to 20% off the prior EPS range of $6.65 to $6.80.

The analyst community has collectively construed that as 15% growth off of the high range of $6.80, which yields something in the $7.82 range.

I would say that's probably a good way to think about it for where we are right now, and we will provide the detailed guidance in January.

And, again, as we have spoken about, as 2016 progresses, the cross-sell opportunity is realized.

We will be working towards achievement of market growth rates, as we progress through 2016.

Very helpful.

Thank you.

(Operator Instructions)

Our next question comes from Mike Weinstein with JPMorgan.

Please go ahead.

Thanks.

And just a quick follow of up there, is that basically you're comfortable with the current Street consensus for 2016?

That's correct.

Okay.

David, the -- I've been trying to track what some of the actions you have taken to date.

And it feels like a lot of what you have done on the sales front is consolidate sales management, while leaving the actual sales personnel intact.

Is that -- A, is that accurate, and B, my question is, as you go into -- as you go into a distributor or go into a territory where you're direct, particularly on the distributor side, and you say to the distributor, hey, the Biomet distributor or in the other case the Zimmer distributor has a better presence in this territory, better market share, we're going to give responsibility for this territory to this other distributor, but we're going to keep your sales people, we're going to keep your reps.

How does that work?

And how is that not immediately disruptive to that business in that territory?

If you can just walk through those conversations, that would be great.

Mike, those decisions are unique and very fact and circumstance oriented.

It can be a situation where you end up continuing to work with each of those sales leaders, but generally speaking, the scenario that you paint is a true one.

You have two sales leaders.

You're going to select one, configure a territory that is going to be historically the strongest sales leader performance-wise, their growth track record, their capability to select talent and execute the commercial plans has been superior.

I will tell you, in the case of those leaders selected, that differential is between them and the non-selected in the US, recon, SET channel is about a 300 basis point difference.

So it's substantial.

And it's really a benefit of the combination to be able to select from a pool of competent sales leaders and select the best of the best to take the organization forward.

Now that said, we said from the beginning that we were continuing to preserve the sales representative positions, and that holds true through our integration plans.

The comprehensive product portfolio puts us in a position where we need all of those sales positions to fully realize the opportunities that we have out in the marketplace.

These were obviously sales positions that's were busy and fully occupied, and servicing customers prior to the deal, and they continue to do so.

So it's a matter of transitioning over those sales reps into the go-forward structure, whether that's a hybrid or an independent sales model, and it's different in different geographies, and take those sales reps, integrate them into one team, cross-train them the other company's product bag and start to go after running the execution of the offense.

So that's the state we're in now.

And I would tell you, it's going very well and probably the overarching reason is we have good plans, we have good sales and other leaders executing those plans.

But at the sales rep level, they're enthusiastic about the product portfolio.

As they get exposed through these cross-training efforts and gain deeper knowledge of that product portfolio, they see their opportunities going forward to grow their businesses and continue to make a good living.

So the execution has gone very smoothly, and the pipeline build for the cross-sell opportunities is creating nice visibility, and we believe it will be expressed on the scoreboard as we move into 2016.

Okay.

Just one follow-up for Dan.

The reinstatement of the share repurchase authorization, can you help us with how you want us to think about that, given the debt on the balance sheet from the acquisition?

How aggressive do you want to be?

And obviously recognizing as well that you will have access to a fair amount of OUS cash shortly.

How aggressive should we think about a buy-back over the next 12 months?

Sure, Mike.

In December, we will have access to -- we will complete the intercompany loan transaction, which opens up the access to our OUS cash.

That has always been a necessary step, so we're on target for that in December.

We have reinstated the program.

So the table has been set.

I would tell you, certainly in our January guidance we will give explicit details on what our plans are in 2016, but I would just ask you to think broadly about our capital allocation policy as it has always been, which is being very disciplined in the deployment of that capital, considering returns and are weighing options for the best use of those excess funds.

I would say our priorities include funding our organic growth initiatives, funding our synergy program, given the return profile of that, maintaining our dividends in proportion to earnings, and deleveraging the balance sheet that meets our leverage goals.

M&A that meets our financial hurdles, and then share repurchases to the extent we have excess cash, and those returns are attractive at that point in time.

So that's how I would think about it, and that's how we're approaching it as we come into 2016.

Okay.

Great.

I'll let someone else jump in.

Thanks, guys.

The next question coming from Larry Biegelsen with Wells Fargo Securities.

Go ahead.

Actually it's Craig on for Larry.

First question, I wanted to -- I wanted to talk about the Americas business.

I appreciate the color on the Latin American weakness, but I did want to talk about the flat US growth.

How does that compare to the pro forma growth you saw in Q2, and then, how do you see that progressing sequentially, relative to some of your comments on the whole company growth?

Sure, Craig.

That sequentially from Q2 to Q3, that's a slight decline in Americas.

And a substantial contributor to that decline again, were the Latin American markets.

But we would expect that core Americas business and the US business in particular to show stability to slight improvement as we move into the fourth quarter.

And then, I mean in terms of 2016, is it a similar -- I guess the question is, do you expect increased disruption, at least in Q4, or maybe early 2016, or do you see a sequential improvement like you do on the worldwide growth?

Yes.

Sequential improvement throughout 2016 is the way to think about it, at this point in time.

And it can be different in different product categories.

As we noted, the expectations dissynergies because of the inherent nature of the integration on the US spine side is more profound than it is on large joint or SET business.

But certainly the large joint SET business having clarified roles and responsibilities down to the rep level by the end of this quarter and moving into 2016, we would expect thereafter to realize the cross-sell benefits, and show sequential improvement throughout that year.

Okay.

Thanks.

That's helpful.

Just as a quick follow-up, Dan, is there any preliminary P&L color that you can give for 2016?

Maybe relative to the guidance that you provided for 2015?

Craig, I would go back to the earlier comments relative to our previous comments of 15% to 20% off the prior guidance.

Our earnings performance in 2015 increases our confidence with respect to earnings in 2016, but I would point to what seems to be the Street consensus that is out there as an area that we're comfortable with, currently.

Okay.

Thanks, guys, for taking the questions.

And our next question comes from Joanne Wuensch with BMO Capital Markets.

Please go ahead.

You said in part of your prepared remarks that there were certain regions that you're seeing the benefits of the combined organization.

Can you talk about what those regions are, what you're seeing, and then how you leverage that to the places that it's not happening in yet?

Sure, Joanne.

I think, most prominently you can see the sequential improvement and strong performance, likely market share gain performance, already in the overseas markets, both Asia-Pacific and Europe, Middle East and Africa.

And what is noteworthy there is, in a big business with a leadership position, we grew our knee business in Asia-Pacific upper single digits, and in Europe, mid single digits.

And those are share gain numbers in both of those markets.

So some of that opportunity is dependent upon the channel structure and the cadence of the integration plans, we're able to get after those opportunities sooner.

I think what it does though, is validates that the combined company product offering is extraordinarily strong.

And as we get deeper into the integration and moving towards a more offensive execution mode as a Company in other jurisdictions, most importantly the United States, among the geographies, then we're going to start to realize those benefits in that important market, as well.

That's helpful.

As a follow-up, we've been spending almost all of the last year and a half talking about the merger between the two companies and the benefits, and worrying about the dyssynergies.

If we look forward next year, can we think about new products, or is there something that you can start to highlight to frame that out for us?

Thank you.

That's a good point.

The short term opportunity, and it's the reason that we have all probably been over indexed on it is, the existing product offering really represents the mother of all launches for both sides, the legacy Zimmer and the legacy Biomet side, because they're picking up new products that are innovative.

They may be gap-filling for that respective sales rep, and so there's a lot of energy around that to get that moving.

But I can tell you it's equally exciting to us as we have come together and prioritized the pipeline of innovative products, to look ahead and see what we have to launch.

We're extraordinarily excited about how that comes together.

I think you're going to see an incredible cadence of new offerings, by virtue of the combination.

What it allows us to do in the intermediate to longer term is to repurpose dollars into more differentiated innovation, and get after it in a more aggressive way addressing unmet clinical needs because of the scale that we have as a business, not just in large joints, but in the other product categories that are oftentimes faster-growing markets.

So we will highlight for you, as we move into full commercialization of some of those products.

There are a few of them that are really important that are on a more limited release at this point in time.

And we will come back to you, Joanne, and highlight those as we move those into full launch.

Don't want to get out of that process for obvious competitive reasons, but it's a powerful pipeline, and it's going to be a quick pace of cadence, and sustain that top line growth as we get that restored in the intermediate and long-term.

Thank you very much.

And our next question is from David Lewis with Morgan Stanley.

Please go ahead.

David, it sounds, reading through all this commentary, that you're starting to see stabilization in your core business here in the early days of the merger.

But obviously EMEA is a bit slower.

We have heard this comment from several orthopedic providers.

Do you have a sense of whether this EMEA slowdown is tied to distributor destocking, and what I'm specifically asking is do you have decent enough visibility on underlying demand to feel decent about your fourth-quarter assumptions?

Yes.

We do.

And we have very good visibility in those markets, David, as to what was happening in Q2, with the pending close moving into Q3, and the stabilization appointment of sales leaders irrespective of the channel structure in those geographies.

As it relates to the emerging markets, that market did slow down in EMEA, and I would tell you it moved more towards a flattish growth number.

We continued to have nice growth coming out of Asia-Pacific, and we can disaggregate what of that is integration related versus seemingly market.

And then there's no doubt that when it comes to the Latin American emerging markets, that there was a substantial slowdown, and would expect that to continue because of the macro economic underpinnings to it.

Okay.

And then just going back to the buyback here for a second.

Dan, a lot of -- what I heard in response to Mike's question was more of a tempered approach to the buyback.

Not all companies, but a lot of companies look at two factors in thinking about the buyback.

Business visibility, and obviously relative valuation of the stock.

Most people would agree that the valuation is somewhat compelling.

It sounds like from David, the business visibility is returning.

Am I reading you correctly that the approach to the buyback is more tempered because it seems like a more opportune time to be less tempered and more aggressive?

Thank you.

David, I would say that we are looking at that within the context of the 2016 operating plan.

And we'll as we look at excess funds, we get that cash access to OUS creates that opportunity.

We will be disciplined, I guess is the right way to think about it, and opportunistic, when it makes sense.

I would leave it at that.

The table is set, and we will proceed accordingly.

Okay.

Thank you very much.

Our next question is from David Roman with Goldman Sachs.

Please go ahead.

I wanted to go into some of the detail of the businesses and go back to the SET franchise.

I think in your prepared remarks, you said extremities grew in the high single digits.

Maybe you could help just dissect for us in a little bit more detail what is happening in the trauma and surgical franchises, and then specifically what are some of the factors we should be monitoring to bring the growth rate of that business up, perhaps to something closer to what you're seeing in the extremities franchise?

Yes.

A lot of that is just germane to the cadence of our integration efforts in general, David.

But we did see a strong performance, and some pretty substantial sequential improvement, as it relates to the extremities business.

That's a leadership position business for us, so obviously very, very important.

And it is an early sign of how powerful the combined product portfolio is going to be in that category.

Executing on some of those opportunities in the other categories embedded within SET, we're expecting to take a bit more time.

But I would tell you that we have good visibility in the coming quarters to improvement in those categories, too.

And our expectation here is to work that business from where it is to up to mid single digits, and ultimately to high single digits in growth, because of the nature of those categories.

So, right now we have to improve our performance in categories like surgical and trauma in particular, and those businesses were slightly down.

More so in surgical's case, than trauma.

But, again, I think that as we move through and develop a more focused sales force effort at the sales rep level on a global basis, we have got the scale and the comprehensive nature of the product portfolio that justifies those specialized sales forces across the globe to exploit the opportunities, and bring more focus to those markets.

And it's a major premise to the combination itself.

Okay.

That's helpful.

Maybe just a follow-up on R&D spending.

I know you have talked about in the past taking the two companies' R&D dollars and combining them and reallocating resources to higher-growth areas, which you talked about in your comments.

If I just simplistically take the R&D in the quarter multiply by 4, that is $40 million on a run rate basis lower than where the combined entities were doing, I think it's something close to $370 million or so.

Is that more a factor of timing, of allocating those dollars, or are you seeing opportunities within R&D to see some cost savings as you go through the integration plan?

And to what extent could that represent upside to the three-year synergy targets that you have provided?

Yes.

It is not a targeted area for synergy, David.

It really is an area that we would expect to be more at that prior combined run rate that you noted, as opposed to what is reflected in Q3.

That said, this is an area where obviously we were walled off from open sharing of pipeline projects until the close.

So those teams are just getting into the hard work to examine those projects, and so as a consequence, there is a moderation of spend that you ought to expect to see step back up and reflect something more towards the sum of those two line items pre-close.

Okay.

Thank you very much.

Our next question comes from Glenn Novarro with RBC Capital Markets.

Please go ahead.

I wonder if you could elaborate a little bit more on the accelerated cost savings that you saw in the third quarter.

I'm assuming this is mostly headcount, but was this mostly in SG&A?

And as a follow-up to that, do you think that you can accelerate the cost synergies and savings in year two?

And then I had a follow-up on the gross margin.

Sure, Glenn, this is Dan.

With respect to the synergies this quarter, importantly these were programs already on the road maps.

We were just able to pull the trigger on those earlier than contemplated.

So that brings an incremental benefit to calendar 2015 and the first year post closing.

I think maybe by way of example, think about a duplicate office lease agreement that was in place.

And our original projections perhaps had that termination of that lease set for October, but we were able to terminate that in August.

And that couple of months of savings, by virtue of that lease was pulled into 2015.

So that's why it doesn't affect the run rate.

That lease is worth a certain amount on an annualized basis.

That's unchanged, as we move forward.

It really was a timing issue, and acceleration of planned for initiatives on the synergy front.

I would also say -- we're very confident in the $350 million year three run rate synergies.

I would also say to the extent that there is further opportunity to exceed on the synergy side, we're going to be very smart about reinvesting that over performance on synergies into growth initiatives.

Back to the theme of getting the top-line accelerated, getting back to market growth rates, above market growth rates, we will invest in those areas, and make prudent decisions about what we drop through versus invest on any over performance on the synergies moving forward.

Thanks.

And just quickly on the gross margin, it looks like 4Q guide, the gross margin sequentially may be down from the third quarter.

Is that purely a function of the less selling or less billing days in the fourth quarter, or was 3Q elevated because of currency?

I'm just trying to understand the slight down tick in the gross margin from 3Q to 4Q.

Sure.

In the fourth quarter, the gross margin is expected to come down slightly, primarily due to less gains on our foreign currency hedge contracts.

So as those gains will start to step down from the Q3 level as we progress in Q4 and into next year.

And that will put some pressure on the gross margin rates, beginning in Q4, and then progressing through next year.

Okay.

Great.

Thanks, Dan.

Our next question is from Matt Keeler with Credit Suisse.

Please go ahead.

I guess just a follow-up on the last question.

Can you give us a sense of what the magnitude of FX benefits has been year to date, and what that implies for a drag next year?

Sure, Matt.

From an earnings per share perspective, foreign currency has been a significant headwind in 2015.

When you account for the translation loss of revenue, and the impact that has on reported earnings in US dollars, despite our hedging gains, there is still a significant FX impact at the EPS line.

And that impact is in the neighborhood of 7% of EPS headwind.

That's the magnitude from an EPS dollar perspective.

From a rate -- a margin ratio perspective, less impactful.

But on a dollar basis, it's that type of significance.

So if rates were to hold where they are today, and we look out through 2016, and we will provide more color in January on this, as I just mentioned, the dollar benefit of our FX hedge gains does decrease in 2016 relative to 2015 and that will create some pressure at the margin rate line, as well as from an EPS dollar perspective.

That will all be fleshed out in January in that detailed guidance.

Thanks.

That's helpful.

And just back to LatAm, I'm wondering, were there businesses that were affected more than others, or was it broad based?

And could you give us a sense of combined Zimmer Biomet, what the Americas exposure is to LatAm?

Yes.

The business is not a large business in the scheme of things.

But the downturn was significant in the context of the quarter, and is anticipated to continue in Q4.

So it really is across all product categories within the Americas unit, so you can't isolate any single product category and its influence.

I would tell you that the emerging market as it represents our total consolidated revenues, is somewhere in the 7% to 8% range, and it's probably less significant just by sheer size, in the context of Americas relative to the other two geographic segments.

Okay.

Thanks.

That's helpful.

Thanks for taking my questions.

George, we have time for one additional question.

All right.

And our final question comes from William Plovanic with Canaccord Genuity.

Clarification, I think a lot of people have tried to circle around this Latin America issue.

If you looked at your US total joint business, just the US, separate it out from the Americas, would that have been flat up or down year over year?

And then my second question is really more of a broad-based question with the CCJR in mind and bundling long-term.

Do you see any advantage to becoming a more vertically integrated player in orthopedics, adding call points distribution into the office or rehab channel, given the size of the product offering at this point?

Thank you very much.

Sure.

If one disaggregates the revenue source within Americas and backs out Latin America, our business would have been on the US front, flat to slightly positive in the quarter.

And let me come back to CCJR.

I do think that there's a lot of opportunity, and we've been innovating in a manner to exploit those opportunities.

Thematically, we believe that finding innovations that address unmet clinical needs and help providers, payors, HCPs deliver care in a way that enhances the quality of the outcome at the same time that the costs are managed more efficiently, is where the world needs to go.

And we think that proposals like CCJR are just expressions of that reality.

So we feel like, if anything on a combined basis, we're uniquely positioned to address those demands in that evolving health care environment.

And rest assured that both from clinical as well as service and solution innovations, that we would look to be an integrator and a more comprehensive provider of solutions in that context.

Great.

Thank you.

And just for clarity, it was total joint, so knees and hips in the US was flat to slightly positive year over year?

Yes.

Large joints would have been slightly negative.

All product categories, excluding Latin America, would have been flat.

Great.

Perfect.

Thank you very much.

So with that, I would like to thank everyone for joining the call today, and for your continued interest and support for Zimmer Biomet.

We look forward to speaking with you on our fourth-quarter conference call which is scheduled for 8:00 AM on January 28, 2016.

I'll turn the call back to you, George.

Thank you, sir.

Ladies and gentlemen, thank you again for participating in today's conference call.

You may now disconnect.