Zimmer Biomet Holdings Inc (ZBH) 2016 Q1 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.

Good morning, and welcome to Zimmer Biomet's first-quarter 2016 earnings conference call.

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

Before we start, I'd 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 a variety of risks and uncertainties.

Please refer to our SEC filings for he detailed discussion of these risks and uncertainties.

During our call, we will compare revenues on a constant currency adjusted pro forma basis.

This means revenues for prior-year periods have been adjusted to reflect the inclusion of Biomet revenues, and the impact of the previously announced divestiture revenues.

Additionally, expense ratios and related margin analysis through operating profit will be computed on the basis of adjusted pro forma financials, as revised, adjusted in all periods for inventory step up and other inventory and manufacturing related charges, special items, intangible asset amortization, financing and other expenses related to the Biomet merger and certain tax adjustments, as applicable.

Reconciliations of the non-GAAP financial measures discussed during our call to the most directly comparable GAAP financial measures are available on our website at investor.

ZimmerBiomet.com.

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

Thanks, Bob.

This morning, I'll review our first-quarter financial results, including key highlights from our performance.

Dan will then provide additional financial details, and discuss our updated guidance.

We'll state all sales rates in constant currency terms, and all earnings results on an adjusted basis.

We're pleased to report that Zimmer Biomet's revenue was on the high end of our first-quarter expectations coming into the year, which further supports our confidence in achieving sequential improvement, as we progress through 2016.

Our comprehensive portfolio of musculoskeletal solutions and services provides a broad range of new opportunities for our sales channel, including a strengthened presence in a number of faster-growing product categories.

Together with the increased stabilization and focused execution of our commercial teams, we remain on pace to exit the year at or above market growth rates.

As we look to the future, Zimmer Biomet will continue to drive our established leadership, with clinically proven devices and therapies, advanced surgical technologies, and comprehensive consultative services.

The strong combination of our broad portfolio, pipeline, and unmatched musculoskeletal expertise, allows us to play a leadership role in defining the future of healthcare through partnership opportunities with hospitals, surgeons and their patients.

We'll bolster our portfolio throughout 2016 with strategic internal and external development opportunities.

Our planned commercialization schedule includes over 50 new product launches this year, of which we've completed a dozen in the first quarter.

These product launches included expansions to our market-leading knee and hip reconstructive systems, which I'll discuss in a moment.

Our ongoing commercial introductions provide a firm foundation for sustainable revenue growth.

Global musculoskeletal market conditions remained stable in the first quarter, with continued strength in the United States and the Asia-Pacific region.

While there were ongoing challenges in certain emerging markets, these conditions were relatively consistent with recent quarters, and in line with our expectations.

With regard to pricing, we experienced price pressure of negative 0.9% in the quarter, consistent with our expectations.

For the balance of the year, we continue to expect price pressure of approximately negative 2%, when factoring in anticipated dynamics such as the biannual price adjustments in Japan.

Against this backdrop, Zimmer Biomet delivered consolidated net sales of $1.9 billion for the first quarter, an increase of 67.8% reported, and 1.2% adjusted over the prior-year period.

Our first-quarter performance was highlighted by ongoing sequential sales growth for our US reconstructive business, which posted a 180 basis point improvement.

Our overall sales in the Americas increased by 1.8%, and by 3.6% in the Asia-Pacific region, while our revenues decreased by 1.5% in the Europe, Middle East and Africa region.

Importantly, Zimmer Biomet's knee business increased sales by 3.5% in the first quarter, reflecting positive volume and mix of 4.8%, and negative price of 1.3%.

We accelerated our US knee performance, which contributed to a 3.3% year-over-year sales increase in the Americas.

We also maintained strong revenues in the Asia-Pacific region, where we delivered solid growth of 7.2%.

Our knee sales increased by 1.9% in the Europe, Middle East and Africa region over the prior-year period.

In the quarter, our knee results were driven by our leading cross sells, Persona, the Personalized Knee System, the Vanguard 360 Revision Knee System, and the Oxford Partial Knee system.

We were also excited to announce two commercial releases that expand the capabilities of our knee portfolio.

Our OsseoTi Tibial Sleeve Augments are a cutting edge porous metal technology, that adds to the breadth of the trusted Vanguard 360 Revision Knee System.

We also introduced the Persona Medial Congruent Bearing, an innovative expansion of the Persona Knee System, designed to recreate a more natural feeling knee, by maximizing joint stability throughout the full range of motion.

We'll continue to pursue growth with our knee portfolio, which combines market-leading reconstructive systems with advanced surgical planning tools and intelligent instrumentation, to offer patients and surgeons an extensive range of personalized solutions.

Sales from our hip business increased by 0.5% in the first quarter, including positive volume and mix of 2.2%, and negative price of 1.7%.

Our hip revenues grew by 2.9% in the Asia-Pacific region, increased by 1.3% in the Americas, and decreased by 2.2% in the Europe, Middle East and Africa region, compared to the prior-year period.

In the quarter, we were pleased with the growth of our Taperloc complete system, as well as our revision portfolio and solutions that leverage our Vivacit-E and E1 vitamin E infused advanced bearing materials.

We also expanded the T7 acetabular system with the introduction of the G7 Dual Mobility Construct and strengthened our options for the rising adoption of the anterior supine surgical approach, with the introduction of the Echo Bi-Metric Microplasty Stem.

These product additions, along with the balance of our comprehensive hip portfolio, continue to position this business for renewed growth.

Turning to our SET category, revenues increased 0.2% over the prior-year period.

Strong US sales of our ATS Automated Tourniquet System contributed to the growth of our surgical business in the Americas, and we were encouraged by the solid results of our surgical power tools in certain overseas geographies.

The steady growth of our extremities business, most notably in the Americas and Asia-Pacific region, also added to our SET revenues.

Our SET results were negatively impacted in the quarter by our trauma performance.

We expect to deliver improved growth in the second half of the year with our trauma business, supported by the increased stabilization and productivity of our commercial channel.

Within sports medicine, we continue to be pleased with steady sales of our joint preservation treatments.

Gel-One hyaluronate and the Subchondroplasty procedure, which was expanded in 2015 to address the growing foot and ankle market.

And earlier this week we announced that we've entered into a definitive agreement to acquire Arizona-based Cayenne Medical.

This acquisition, which remains subject to customary closing conditions, will enhance our sports medicine capabilities, and add a successful portfolio of soft tissue repair and reconstructive solutions for knee, shoulder and extremities procedures.

Our dental sales decreased by 6% in the first quarter, due primarily to headwinds associated with a voluntary product action in the fourth quarter.

We expect supply to fully recover by the end of the second quarter.

We also continued to make good progress with the ongoing harmonization of our dental commercial channel.

Backed by our broad dental portfolio, we're focused on achieving improved results in the second half of the year for this business.

First-quarter sales from our Spine Cranial Maxillofacial and Thoracic category decreased by 1% from the prior-year period.

Our Cranial Maxillofacial and Thoracic team delivered noteworthy growth in the quarter, as they continued to generate strong sales of our TraumaOne and SternaLock Blu systems.

Additionally, they made great progress with the recently launched RibFix Blu system, and the OmniMax MMF system.

In spine, our commercial teams continued to stabilize throughout the first quarter, which supports our confidence for an expected return to growth later this year.

We also achieved sales growth for innovative offerings across our spine portfolio, including the Timberline Lateral Fusion System and the Virage OCT Spinal Fixation System.

Looking to the future of this business, we're excited for the opportunities represented by our commercial pipeline and focused sales channel.

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

Dan?

Thank you, David.

I will review our first-quarter performance in more detail, and then provide additional information related to our second-quarter and full-year 2016 sales and earnings guidance.

Our total revenues for the first quarter were $1.904 billion, an increase of 1.2% constant currency, compared to the first quarter of 2015 on an adjusted pro forma basis.

The Company recorded the same number of billing days in the quarter as compared to the first quarter of 2015.

Net currency impact for the quarter decreased revenues by 1.6%, or $30 million.

The negative currency impact for the quarter was related to the ongoing relative strength of the US dollar against many international currencies.

Our adjusted gross profit margin was 75.7% for the quarter, and 30 basis points lower when compared to the prior-year adjusted pro forma result, due to the impact of foreign exchange and price decline, mostly offset by gains from our cash flow hedging program, and a reduction in the expense recognition of the Medical Device Excise Tax.

The Company's R&D expense was 4.5% of revenue at $85.7 million.

As David noted, we commercially launched a dozen new products in the first quarter, and we expect to continue that pace throughout the balance of this year, with introductions coming from across the entirety of our product categories.

Adjusted selling, general and administrative expenses were $716.9 million in the first quarter, or 37.7% of sales, 130 basis points lower than the comparable period in the prior year on an adjusted pro forma basis.

The positive variance was driven by continued savings in SG&A expense categories, stemming from synergy capture initiatives, which were partially offset by ongoing investments in our specialized sales force, in addition to medical education and training programs.

We remain on track to deliver cumulative net EBIT synergies of $225 million by the end of 2016, per our original full-year guidance.

Synergies realized in the first quarter were in line with our expectations.

In the quarter, the Company recorded pretax charges of $393.6 million in special items primarily related to the Biomet acquisition, as well as integration-related expenses.

Adjusted first-quarter 2016 figures in the earnings release exclude the impact of these charges, which includes $285 million of non-cash amortization and inventory step-up charges, as well as $109 million of integration and other costs.

A full reconciliation of reported net earnings to adjusted net earnings is included in this morning's press release.

Adjusted operating profit in the quarter amounted to $639.1 million, or 33.6% of sales, which was flat when compared to the prior-year period.

Net interest expense and other non-operating expense totaled $90.7 million.

Adjusted net earnings were $404.3 million for the first quarter, an increase of 51.5% compared to the prior year period.

Adjusted diluted earnings per share increased 29.9% to $2 per share on 202 million weighted average fully diluted shares outstanding.

Our adjusted effective tax rate for the quarter was 26.3%.

The Company had approximately 200.7 million shares of common stock outstanding as of March 31, 2016, increasing from 172.8 million shares as of March 31, 2015, due primarily to the Biomet transaction.

During the quarter, the Company invested $415.5 million to repurchase 4.2 million shares.

Our share repurchase activity during the quarter was expanded relative to our original guidance, and this provided approximately $0.02 of EPS benefit in the quarter.

Operating cash flow for the quarter amounted to $265.2 million, which included $85 million of cash expenditures for integration, and initiatives related to our synergy program.

Capital expenditures for the quarter totaled $112.7 million, which included $85.1 million for instruments, and $27.6 million for property, plant and equipment.

Free cash flow in the quarter was $152.5 million, which was essentially flat with the first quarter of 2015, and in line with our expectations.

During the quarter, the Company repaid $400 million on our term loan, leaving $2.1 billion outstanding at March 31, and this reflects $900 million of repayment since the closing of the Biomet transaction.

With that, I'd like to now turn to our guidance.

I will provide updated revenue and adjusted earnings per share guidance for the full year, and expectations for the second quarter.

For 2016, we now estimate our adjusted pro forma revenue growth to be in a range of 2.0% to 3.0%, on a constant currency basis.

This update is reflective of our confidence in the ongoing progress of our cross-selling initiatives, and increasing sales channel productivity.

Foreign exchange is now expected to decrease revenue by 1%, compared to our previous estimate of 2%, with the US dollar weakening modestly across most currency pairs.

Taken together, reported revenue growth for the year should be in a range of 1.0% to 2.0% or a range of $7.525 billion to $7.600 billion.

For modeling purposes, we would have you update the fully diluted share count estimate to reflect the noted acceleration in timing of share repurchases embedded in our prior guidance.

We now anticipate that diluted weighted average shares outstanding for the full year to be approximately 202 million shares.

Therefore, after updating our assumptions for foreign exchange and our fully-diluted share count, our full-year adjusted diluted earnings per share is now projected to be in a range of $7.85 to $8.

Our guidance takes into account our noted investment into our sales channel specialization, innovative research and development programs, and medical education and training to drive sustainable longer term growth.

Our guidance reflects approximately 100 basis points of forecasted operating margin expansion over the prior year, on an adjusted pro forma basis.

Now turning to the second quarter, and including the benefit of slightly more than one extra billing day, which equates to about 180 basis points, we expect constant currency revenues to increase between 3.0% and 4.0%.

At this time, assuming currency rates remain where they've been during the first month of this quarter, we anticipate foreign currency translation will decrease our reported second quarter revenues by approximately 1%.

Taken together, reported revenue growth would be in a range of 2.0% to 3.0% for the quarter.

Therefore, revenue would be expected to be in a range of $1.885 billion to $1.905 billion.

Lastly, we expect second-quarter adjusted earnings per share to be in a range between $1.93 and $1.98.

Finally, please note that our full year guidance reflects the anticipated contributions from our recently-announced acquisition of Cayenne Medical.

Assuming that the transaction closes in the second quarter, which in total represents about 10 basis points of top line growth for the full year.

However, our guidance does not include any impact from other potential business development transaction, or unforeseen events.

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

Thanks, Dan.

Look forward to building on Zimmer Biomet's first-quarter performance throughout the balance of 2016, as well as maintaining our progress towards exiting the year at or above market growth rates.

We'll continue capitalizing on the growing strength of our commercial organization, and our comprehensive musculoskeletal portfolio.

Lastly, we'll also remain focused on sustaining our earnings performance and driving operating margin leverage in 2016 while continuing to meet our financial commitments and exercising disciplined capital allocation.

And now, I'd like to ask Leona to begin the Q&A portion of our call.

(Operator Instructions)

We will now take our first question from Matt Taylor from Barclays.

Please go ahead.

Your line is open.

This is [Yung Lee] in for Matt.

Thanks for taking the questions.

I guess to start off, was wondering if you can maybe talk about some of the initial CJR feedback or experience, any impact since the program officially started earlier in the month?

Understand that various players in the system had time to prepare for it, but is there anything surprising or notable so far, that you would like to call out?

Well, I would tell you that first of all we're excited about the opportunity that CJR provides.

Going back a decade now, we've been building out a comprehensive set of not only implant solutions, but services of a comprehensive nature in anticipation of a world that would be more consistent with what CJR is contemplating.

That is, how do we go about developing deeper partnerships with customers to bring higher quality of care in the most cost efficient way possible.

Our acquisition going back nine years ago of Accelero and the services that they bring to the patient flow are focused exclusively on that area, and we've been able to bridge technologies, and still more services, to help develop those partnerships, and build out a comprehensive care package that gets into patient engagement earlier in that episode of care, all the way through post acute care with rehabilitative services.

And coming back to your question, that last area is probably where the light is going off in our customer conversations, with realizations that as much as 40% of the cost of care is incurred post acute, so the rehabilitation end of joint replacement.

I would tell you that the customers are in different places right now, in their level of developing plans that are truly going to be responsive to the economic model that they're going to be living within going forward.

So the early adopters and more progressive thinkers have been very sophisticated, and we're far along in developing deep partnerships and enhancing their capabilities to be prepared for that day.

Others are coming to grips with the reality that, over time their world is going to shift away from fee for service.

But in any event, we feel like we have a lot to offer, with a full portfolio of solutions and services in that context.

And it is the case, I do believe, that as I was just referencing, that it's caused more energy on the customer part to be focused over to the post-acute care dimension of delivering the total joint solution.

Okay.

Great.

Thanks for that color.

I guess, regarding the trauma weakness in the quarter that you called out, can you go into a little more detail as to what drove that?

Is it impact from weather, or any weakness in geographies you want to call out?

I don't think that it's as much of a market dynamic as it is us rebuilding momentum and focus within the commercial execution side.

We have a very strong portfolio.

It is the case that weather and other external drivers can impact the trauma market, but I don't think that usually measures up to be anything more than 100 or a couple hundred basis points.

So we are highly confident, as we continue to build out specialized sales force within that category, on a global basis, that is, and continue the cross-selling training on the product side, that we're going to show material improvement in that business unit as we progress through 2016.

Great.

Thank you for taking the questions.

Our next question comes from Bob Hopkins from Bank of America.

Please go ahead.

Your line is open.

Congrats on the good start to the year.

Thank you.

Two questions.

One thing that really struck me was your guidance for revenue growth in the second quarter.

You're calling for some very nice acceleration there, and I was wondering if you could just talk about some of the things that you see really driving that acceleration in the second quarter, versus the first.

Is that on the hip and knee side, is it across the portfolio, I assume a little bit of it is dental.

Just maybe talk about the really nice acceleration you expect in Q2?

You got it.

We referenced, just so you have an apples-to-apples comparison sequentially, Bob, the impact of billing days.

So there's an enhancement by virtue of billing days in the second quarter.

But notwithstanding that, we show continued progression in our forecast as we displayed from Q4 to Q1, and we just believe that everything that we're doing to stabilize the sales force, to invest in the non-large joint categories in particular, with expansion of that sales force, the cross-training, the medical training education events, all of that is building towards progress in each of the product categories.

And so I would tell you that it is very broad-based, quite literally every geographic segment and every product category is anticipated to improve sequentially between now and the end of the year.

And it's one of the reasons that we have such strong confidence in that progression is there isn't a single category that's driving it.

Rather, every category is expected to improve in each quarter between now and the balance of the year.

I think we're seeing it earlier probably in large joints and it stands to reason that would be the case with the size of the business and those portfolios and the historic culture being ultra focused on large joints and knees in particular.

So I think knees is out ahead, even within large joints of hips, but we're seeing the same signs of continued improvement in hips.

And then I would tell you that the SET category is expected to show some very material improvement, beginning in the second quarter, and continuing into the second half of the year.

It's driven by the cross-sell primarily but we're starting to lace in, as we've begun to emphasize some of the new product introductions too.

As we get into the second half of the year, we'll see some of the early signs of traction with those product launches that went out in the first quarter.

Thank you for that.

One other quick thing I wanted to touch on was in EMEA, is there an action plan.

That seemed to be one area in the large joint side that was a little weaker, so maybe is there an action plan to turn that a little bit, and maybe just talk about the prospects for EMEA as you look forward the rest of the year?

Yes, you're right.

This is one where we've seen excellent historic progress and generated great results over a long time period, and so that team are proven leaders and winners within that market.

We have all the talent that we need, and in an enhanced portfolio I think that it's probably a geographic segment that has had more work to do on the integration front.

If you think about integrating within those jurisdictions, you have work councils, and some external pacing items, that create inhibitors to getting after the cross-sell opportunity, for example.

We're pushing through those, consistent with our plans, and I think that what you saw in Q1, Bob, was a consistent performance, if not on large joints, a bit of sequential improvement from Q4 to Q1, and we expect to see another step in that direction, and a pretty significant step-up in the SET category.

So we have good visibility to improve performance and that ought to stair step in Q2, Q3 and Q4 within EMEA.

Terrific.

Thanks for taking the questions.

Appreciate it.

Our next question comes from David Lewis from Morgan Stanley.

Please go ahead, your line is open.

I wanted to start off on a financial question for Dan on earnings.

I guess, Dan, a couple things going on here.

One, solid quarter, obviously better than our expectations, a little bit.

You also have currency going for you, specifically with the yen.

And then look, given that you're holding the line on cost and driving synergies, and you had this improving revenue outlook, it just seems to me like with that increased drop through, earnings guidance is a little on the conservative side.

Can you walk me through any headwinds I could be missing?

I feel like better quarter, better guide, better currency, the guide could have come up more.

I appreciate it's early in the year, but are there factors that we're not missing that suggest that we have some earnings headwinds?

David, I wouldn't call them earnings headwinds.

I'd call them intentional investment to drive top line growth.

Smart investments focus that top line growth.

As we've indicated, for example, on the Medical Device Tax, the suspension of that, the reinvestment of that, that's embedded in our guidance.

It's still embedded in our guidance.

And then as we look at the balance of the year, with respect to the currency tailwind, we do see opportunities to continue to make investments in our areas of focus, such as specialized sales forces, medical education and training globally, but also importantly in the emerging markets, to sustain that growth.

Our R&D program, investing in personalized solutions and consultative services that add value across the continuum of care that David spoke about, enhanced instrument deployments to further drive cross-sell, and things of that nature.

So as we look at the opportunity to reinvest, we're keenly focused on proper drop-through of that earnings, but also reinvesting that where it makes sense to reinvest.

Okay.

Safe to assume you feel pretty good about your earnings and cash flow visibility right here?

Yes.

David, another thing we're not expecting was this early in the year to raise your confidence in your organic numbers, constant currency numbers for the business on the top line.

Our sense is there's two dynamics going on here, in the first quarter.

One is, the market certainly feels a little better in reconstruction, based on some of your peers, but it also does appear on the margin you're narrowing the gap from a competitive share loss.

Can you talk to us about those two dynamics?

How you feel about the market, and how you feel about narrowing your share gap?

Thank you.

Sure, David.

Both of those dynamics are very accurate.

We've seen, particularly in the US, a step-up in large joints.

I think that the EMEA market is healthier than what we're currently experiencing, as we were just responding to the prior question on that front.

So the market is healthy in large joints, and we know that we have big opportunities in the other product categories as well, to focus on the large joint categories.

We have been improving our performance sequentially, even above the rate of the improvement in the market growth rates.

So over 100 basis points of gap closure in large joints as a whole, and that's been driven both by US and O-US knee improvement.

We see the US knees improving about 70 basis points relative to market performance, O-US knees improving about 160 basis points relative to market, and US hips as well going from Q4 to Q1 improved about 120 basis points.

So those gap closures are really important measures, as you reference, but it's always nice to be participating in a robust market itself, and both those factors contribute to the visibility that we have to improve the performance and close the gap, and as a consequence, raise our guidance for the full year to the 2% to 3%.

Okay.

Thanks so much.

Very clear, David.

Our next question comes from Joanne Wuensch from BMO Capital Markets.

Please go ahead.

Your line is open.

Thank you for putting me in.

Forgive me, I've been jumping between calls.

One of the things that we've been seeing a lot has been a strength in the overall market for medical devices, and again, I apologize if you have gone into this already.

Is that what you're witnessing also?

And if so, do you have a theory why?

I think that the fundamental demographic drivers, Joanne, I think we are seeing healthy markets, stable.

There's a bit of an offset, obviously as everyone else has been discussing, relative to certain of the emerging markets, the Latin America headwinds are still real, consistent with expectations coming into the year.

But Q4 and Q1 have been healthy markets in the developed countries, and we certainly have benefited from that.

We look to benefit to a greater extent as the quarters progress in 2016, with our execution.

Thank you very much.

We will now take our next question from Mike Matson from Needham & Company.

Your line is open.

I was just wondering if you could maybe give us an update on where you stand with the efforts to develop your specialized sales forces?

I know you've been focusing more on that since you completed the merger with Biomet.

Thanks.

Sure.

Well, we have a good pipeline, and we've made progress even in the first quarter in that regard, Mike.

Right now, outside of large joints on a global basis, we have round numbers, 2,000 sales reps exclusively focused in the other categories.

And between now and the balance of the decade, we look to expand that sales force in a material fashion, and 2016 represents our first installment.

So you can measure our plans in the hundreds in that regard.

In 2016, we're tracking consistent with that plan.

Step one was obviously the second half of 2015, to make the integration steps, and stabilize those sales forces.

We rebuilt the pipeline of talent, and that talent is coming to fruition.

So we're in a net add position as of Q1 even, and we would look to accelerate that for the balance of the year.

So I feel like we're executing those plans very well, and we're already seeing some of the early signs of traction.

It's part of what gives us confidence in accelerated top line growth between now and the balance of the year.

Okay.

Thanks.

And then just in the trauma business, this seems like a market where having scale and breadth is really critical, and I was just wondering now, with Biomet products in the mix, do you feel like you've got the critical mass to really compete against the leaders, De Puy and Stryker?

We absolutely are confident that we do.

We have the existing portfolio to compete effectively, and you're right, scale does matter and in this category, the level ones and the level twos demand comprehensive portfolios, and it's tough to be a niche player in that space.

And the combination greatly enhances our competitiveness within trauma.

The other thing that it does is -- and it's consistent across some of the other non-large joint categories for us, it puts us in a position to continue to innovate in a more diversified way, and get after some of the higher risk, higher return projects, to address unmet needs in that category.

And so, rest assured that not only do we expect to execute with the current portfolio in an effective manner, but our pipeline is going to be more diverse than it's ever been, and the scale gives us that opportunity.

So we would look to address unmet needs and push out and really establish ourselves as true innovators within the trauma space in due time.

Thanks a lot.

Our next question comes from David Roman from Goldman Sachs.

Please go ahead.

Your line is open.

I wanted just to start with a comment you made in response to a prior question regarding reinvesting some of the better expected top line performance, as well as the earnings upside in Q1.

Can you maybe give us a little bit more detail on where those dollars are going, whether that's on the sales and marketing side, or R&D?

When you would expect us to see a return on that incremental investment?

Sure, David.

It's Dan.

I responded earlier in terms of the types of investments, so there will clearly be a focus on the R&D line.

So you can expect to see our spend at the R&D line to improve, or to expand sequentially, as we progress through the year, and that's a fairly broad-based set of investments, focused on large joints, SET, programs aimed at our personalized solutions portfolio, as we discussed.

You'll also see in the SG&A category some reinvestments, medical education and training, so that takes the form of training new surgeons around the world, capitalizing on the opportunity to cross-sell, investments in med ed in emerging markets, and specialized sales forces.

David just mentioned adding hundreds of incremental focused sales reps, particularly in the SET categories, and things of that nature.

So I think you'll see it mainly in the R&D line, but also in SG&A, as we progress through the year.

And then maybe a broader question for David.

You've had three quarters since the Biomet transaction was completed, now under your belt.

You have seen an improvement in your revenue growth rate.

Maybe you could just help us think about what you observed over the past several quarters, and how that -- and any learnings that you think will inform your go-forward investments that gets you back to that market growth rate.

Because clearly things are getting better, but still sitting below that 3% level.

So what are you seeing in your experience thus far, and are there any changes you're making on your go-forward strategy to help accelerate the pace of getting back to market growth?

Sure, David.

I think that we had an opportunity, because of the pendency period that was prolonged for 14 months between signing and closing, to do extensive planning.

And the teams took advantage of that time and developed extraordinarily detailed integration plans to go after the top line opportunities, as well as the operating expense opportunities.

And it's pretty clear, based upon our execution, that we've been able to, if anything, retrieve and realize the operating expense synergies in an accelerated fashion, as evidenced by last year's performance in that regard.

I think to your question, you end up with the best visibility one can have in planning those top line opportunities, and now we're in a stage where we're executing.

And so we're making refinements, and part of what Dan is outlining, by the way of reinvestment, would include something like the products that are going, and beyond, in theory having a cross-sell opportunity, we're realizing success.

We're upping production, we're ordering more instruments.

And so that's a good example of the reality.

With any new product launch, and this as we referred to it as sort of the mother of all product launches, you end up having some surprises, both negative and positive, and where we see the positive surprises, we're going to fuel that growth.

So we've got a stable channel.

We're on a net basis adding sales reps in an intelligent way relative to our opportunity to make sure that our coverage is going to exploit fully the broad bag that we have, and then we're dialing et it up in medical training, and education, instruments and inventory, where we see the growth opportunities, because of early traction in the sales force.

And that visibility is extraordinarily helpful, gives us line of sight as to sequentially between now and the end of the year what we think we can do.

Okay.

Can I sneak one more quick one in here?

Dan, what does it all mean for the cash flow profile of the business, and if you're upping medical training, inventory, et cetera, are you still comfortable with the cash flow guidance you provided last quarter, or does this -- do some of these initiatives soak that up?

And then I'll drop.

David, we're still comfortable with the previous cash flow guidance that we provided, both on an operating and free cash flow basis.

Thank you.

Our next question comes from Matt Miksic from UBS.

Please go ahead.

Your line is open.

And I hope I haven't asked a question here that's already been covered, but David, I'd love to get your sense on some of the pricing trends we're seeing in the market have been more favorable.

I think at the lower end of your range, it's not the first quarter I think for you and some other folks that reported some similar trends.

I would just love to get a sense of what you think is driving that, or not to diminish, less of your pricing, but is it possible that it has anything to do with your year-over-year SKU for SKU calculations with the deal?

Color would be helpful.

I have one follow-up.

Sure, Matt.

We're comfortable with the consistency of the calculation and the visibility that's provided.

We had a successful quarter in managing the business in this regard in Q4, and as you know, another successful quarter in Q1 of 2016.

Some of it had to do with just our forward visibility to contracts and renewals, and what's in the pipeline.

And so we came into the year expecting minus 2. We continue to expect something closer to that in subsequent quarters.

Q2, Q3 and Q4 of 2016 and contributing to that potential uptick relative to where we were in Q1 is going to be the biannual price adjustment in Japan, which comes online here at the beginning of the second quarter.

So that's already been quantified.

It's consistent with most of the past adjustments, say in mid single digits, based upon our product mix.

So you can look at that as being the potential for round numbers, a 20 basis point uptick on a consolidated basis, but I think that we're managing the business intelligently.

One of the benefits of the combination is the capability with this broad portfolio to product position, and with the breadth of the portfolio and the capability to tier these products, and better match the demands and needs of customers, it puts us in a better position to maintain pricing on premium technologies, for example, across the globe, that is.

And with the increased transparency on pricing across the globe, that's a big asset.

So it's a good news story.

The teams are taking advantage of that opportunity.

But again, it's two good quarters in that regard, and we don't want to call it a stronger trend at this point in time.

That probably does cause us to moderate a bit the negative 2% price expectation coming into the year, but we think that we're going to edge up above the 0.9 that we experienced in Q1, as we move into Q2 and beyond.

That's helpful.

I appreciate why we wouldn't necessarily want to get too excited about pricing, given where we've been, but that is encouraging.

And I had one follow-up on the subject that you talked about, I think earlier in the Q&A, on bundling.

Coming out of AAOS, it struck me that, yes, most of the costs that could come out of this bundled payment push, and we're early in that understanding, that is downstream after post-op and rehab, et cetera.

But it also strikes me that you've talked about, I think, some of your other larger orthopedic competitors have talked about stepping into the void for some of these networks, to help them understand and deal with managing those downstream costs, which are often out of the hospital or with third-party partners.

And so I'd love to understand how that -- how you see that playing out in terms of sort of the value you're providing, and the benefit that you would hope to get from that sort of expanded relationship in networks, as you team up to get your arms around, or get their arms this change?

it's a big dynamic and a big opportunity, Matt, and it's so consistent with our focus on musculoskeletal care, up and down the continuum and across the episode of care with systems, solutions, and services, and this has been our strategy going back for the better part of a decade.

So we really do believe we're uniquely positioned, and these conversations and the partnerships that we're entering into reflect the fact that the breadth of our portfolio and our commitment to developing these partnerships in a manner that adds value is going to be long-term and deep.

I will tell you, every one of those conversations is validating to the work that we've done, as I said over the last decade.

I think that you can envision a day where it's very much the case that the end-to-end patient engagement is something that we're more deeply involved with, and as a consequence of the data and insights that we glean in partnership with customers that are progressive thinkers in this regard, that we're mining that data, creating the right treatment algorithms, and the right clinical and economic support, that announces where the unmet needs are and the opportunities for continuous improvement on both clinical and economic bases.

And that's our vision, and there are a lot of customers across the globe that share that vision.

And I think that, again, there are limited numbers of companies that can sit at the table with the offerings that we have to bring value to that conversation, and be able to follow through and deliver.

So we're excited about the opportunity, and you're going to hear a lot more from us going forward on that front.

And just if I could, if I'm still on the line here.

You are.

Okay.

Sorry.

Thanks for that.

The difficult part for us, I think, in looking at that engagement, is the value exchange.

Clearly, I think you can provide value to your large customers in a way that a smaller player can't, and a less broad provider can't.

I guess how do we think about -- not to be all about share and compliance and penetration, but how does Zimmer benefit from this over the long term?

Is it contracting?

How should we think about it?

I think it's deeper partnerships, Matt.

And I think that one doesn't want to take too superficial of a view, and jump to the monetization of that relationship.

Rather, I think it needs to be about value creation.

And if there's true value creation opportunity, and we believe that there is true value creation opportunity through those deeper partnerships, there's going to be plenty of opportunity to share in that upside, and broader relationship up and down, again, again, that continuum of care and that episode of care, and you can envision from the point of diagnosis and joint preservation through sports medicine, partial, total, revision, salvage, and the large joint, biological solutions, but interventions that make sense, both clinically and economically, we are convinced that there's value to be gathered for both parties, and all the other stakeholders, and most importantly, patients.

If we get that right, we're going to be able to figure the rest of it out.

So that's the mindset that we have in entering into those relationships.

A lot of flexibility and agility to get after making a difference for patients, and that's going to redound to all the other stakeholders' benefits.

I'm sure we'll participate in that in an appropriate way.

Thanks for that additional color.

Leona, we have time for one additional question.

We'll take our final question from Raj Denhoy from Jefferies.

Please go ahead.

Your line is open.

Wonder if I could ask two questions.

You did note the gap in joints in the market has certainly improved, which was great to see.

Some of the other business, the other 40% of the business continued to lag a bit, and I know you've described your plans for getting those back up.

But perhaps you could just describe whether the integration of those businesses has proven to be a bit more challenging perhaps than the large joint side?

Is there anything to that or is it really just taking a bit longer?

I think it's just timing to get after the opportunity more than anything, Raj, as it relates to the SET businesses.

The opportunity that we have with this combination to materially enhance the focus from a commercial standpoint is one that we're taking advantage of.

And we're going to start to see, in the short term as in Q2, some of the benefits in the SET categories.

And then you jump outside of the SET categories, dental, we had a you unique event with a field action back in Q4.

As we've referenced, we were working through that challenge in Q1.

We'll be out of that challenge by the end of Q2, and that's going to help enhance the performance of the dental business.

And then as we noted all along, the commercial integration on the spine side was known to be more challenging, and so we're going to like the result, but that one's going to take a quarter or two longer than the large joint.

So we're tracking very consistently with what our integration plans contemplated, Raj, and the teams are doing an excellent job from our perspective on the execution front.

Great.

Just one last one, just on cash use.

The cash flow the next several years is going to be pretty significant for you, as well as your access to cash.

In the quarter you did a small deal, but you also bought back a lot of stock.

And so really just curious how you're thinking about the balance between those two efforts, as well as perhaps paying down debt a bit sooner?

Whether your thinking has evolved or really where it stands right now.

Raj, I would say that our thinking on that remains as it has been, which is, we continue to be interested in smart business development opportunities with a strategic focus remaining on musculoskeletal.

We'll remain disciplined in that regard.

We'll look for targets that leverage our sales channel to drive sustainable growth and maximize shareholder value.

And we'll also stay focused, to ensure sustainable and solid returns within a reasonable time horizon.

So I wouldn't think of any shifts in that regard.

We're still very focused on driving improvements in our free cash flow yields out over time.

That will continue to be a focus and it gives us a lot of flexibility as we progress looking at debt paydown, M&A activity, dividend payment, and so on and so forth.

So we will stay very disciplined, as we always have been.

Great.

Thank you.

Nice quarter.

Thanks, Raj.

And with that, I'd 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 second-quarter conference call which is scheduled for 8:00 AM on July 28th.

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

Thank you.

Thank you again for participating in today's conference call.

You may now disconnect.