Zimmer Biomet Holdings Inc (ZBH) 2017 Q2 法說會逐字稿

Good morning.

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

(Operator Instructions) Mr. Abernethy, you may begin.

Thank you.

Good morning and welcome to Zimmer Biomet Second Quarter 2017 Earnings Conference Call.

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

Before we start, I would 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 a detailed discussion of these risks and uncertainties.

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

Reconciliations to 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 Dan.

Thanks, Matt.

Before I discuss our results for the quarter and outlook for the remainder of the year, I want to take a minute to thank David for his contribution to Zimmer Biomet for the past 16 years.

During David's tenure, the company became a global industry leader and made tremendous progress, establishing a world-class portfolio of technologies, solutions and personalized services, and we wish him success going forward.

I am honored to serve as interim CEO as well as by this opportunity to efficient talented and dedicated team.

Since stepping into this role, I have been closely engaged with Zimmer Biomet's board, the management team, commercial leadership and other team members across the organization.

While we have a lot of hard work ahead, I am encouraged by the team's commitment to ensuring that we capture the promising opportunities in front of Zimmer Biomet.

With respect to the CEO search process, the board has retained a leading executive search firm to identify and evaluate external candidates for the permanent CEO role.

That process is ongoing and the board is committed to moving diligently and swiftly.

I have communicated to the board that I am committed to leading the company in the interim capacity as long as necessary.

During the second quarter, we achieved net sales of $1,954,000,000, an increase over the prior year quarter of 1.1%, which included approximately 240 basis points of contribution from the LDR acquisition.

Our results were negatively impacted by approximately 100 basis points as a result of having 1 less billing day during the quarter.

On a constant currency basis, net sales increased 2.1%, including a solid 6.8% sales increase in our Asia-Pacific geography and 2.5% sales growth in the Americas.

Our continued strong growth in the Asia-Pacific region was the result of focused commercial execution and a historically low level of product mix out of the Warsaw North Campus.

Our sales in the Europe, Middle East and Africa region decreased 1.8% on a constant currency basis compared to the prior year quarter.

However, we recorded positive growth on a selling day adjusted basis.

As we've highlighted previously, there are 2 primary factors that contributed to top line results being below our expectations.

First, production delays within certain key brands impacted our ability to reduce back orders at the targeted rate.

Second, sales recapture from previously-affected customers in the United States was impacted by our delayed production output.

As a consequence of lower-than-anticipated second quarter results as well as updated assumptions on production levels and sales recapture, we are revising our 2017 sales and earnings guidance, which I will detail later in my remarks.

I'd like to now spend a few minutes providing more detail on our key focus areas to address these challenges going forward, as well as some of the initiatives already underway.

During the quarter, we delivered production consistency with significantly less disruption than we saw in the first quarter.

Notably, we delivered the highest quarterly output on record from our Warsaw North Campus manufacturing facility, allowing for some of our brands to achieve the full production levels that we had previously anticipated.

However, reaching full production of certain brands has proven to be more challenging than initially anticipated due to the complexity of validating certain material types and production processes as well as ensuring quality control with regard to sourcing.

This resulted in lower than anticipated supply availability of these brands during the second quarter, and we have therefore updated our expectations for the second half of the year.

We continue to make progress meaningfully reducing back orders on many of the brands manufactured at the Warsaw North Campus, and we expect to continue building safety stock of these products through the third quarter.

For those brands that were delayed in the second quarter, we anticipate that we will substantially reduce back orders through the third quarter and early into the fourth quarter.

Importantly, we expect to reach sufficient safety stock levels across our entire portfolio as we exit 2017.

Clearing back orders allows us to more fully meet the existing customer demand, and we expect that achieving sufficient levels of safety stock will enable us to return to greater sales offense and bring on new customers.

While we are disappointed that the timeline for recovery of certain product lines has extended beyond our initial expectations, our cross-functional teams continue to execute well, and we are focused on restoring adequate supply in line with these new timelines.

We continue to more broadly invest in manufacturing and quality enhancements across our entire network, and I will address these investments in further detail when I review our financial performance and guidance.

Now turning to our sales recapture program.

On prior calls, we have discussed headwinds associated with our ability to fully meet existing customer demand.

These same factors carried into our second quarter.

We still see an opportunity to recapture this business, but we expect that this will occur at a slower pace than previously anticipated as a result of the supply delays that I have described.

We have established focused initiatives to deeply engage with our customers, sales forces and team members in order to more fully meet existing customer demand.

Fully restoring product supply is the first step in this process, with enhanced commercial execution and customer engagement being the other key elements to our renewed growth program.

We continue to make investments in and offer incentives to our sales forces and commercial team, enabling us to work closely with our customers and prioritize growth opportunities as we progress through the year and into 2018.

Our global sales forces and team members have shown tremendous resiliency through these past several quarters, and I am proud of their collective efforts.

I can assure you that we are not going to stand still waiting for our new CEO to arrive.

We know what we need to do, and we have an incredibly talented team that wants to win.

As we look forward, the clinical heritage of our products, our strong innovation pipeline and our best-in-class sales forces gives the board and our entire management team confidence in the promising opportunities in front of Zimmer Biomet.

As I'll discuss in a moment when I walk through our business results, we have delivered ongoing, market-leading growth in the Asia-Pacific region, and we've substantially completed our commercial integration with LDR Spine, both of which reinforce our confidence in the fundamental strength of our global business.

We are confident in our ability to remedy recent challenges and are eager to get back on the offensive and do what we do best.

As we continue to work through this process, we are approaching our challenges head on to ensure we get back on the right track.

During the second quarter, we continued to observe steady market demand across the globe.

With regard to pricing, we experienced negative pressure of 2.6% during the second quarter.

The slight sequential increase in pricing pressure from the first quarter to the second quarter was attributable to certain markets in the Asia-Pacific region.

Before I review our performance by category, I'll remind our listeners that as previously mentioned, our net sales were negatively impacted by approximately 100 basis points, resulting from 1 fewer billing day during the quarter.

Our knee net sales decreased 1.3% from the prior year quarter, reflecting positive volume and mix of 1.5% and negative price of 2.8%.

While we continue to achieve solid results in the Asia-Pacific region, supply challenges hampered our growth in the Americas as well as in the Europe, Middle East and Africa region.

By focusing on fully restoring product supply of certain brands manufactured at our Warsaw North Campus, along with the further development of our strong product pipeline, we are positioning the company for improved knee performance.

During the quarter, our limited launch of the Persona Partial Knee received excellent early clinical feedback from surgeons.

We expect to begin the full commercial launch of this product later this quarter.

We have also continued to execute our Persona TM Tibia cementless knee and Persona revision development projects with initial launches expected in the second half of 2018.

In support of our flagship total knee brands, during the quarter, we announced the commercial availability in certain European markets of our X-PSI guides, the world's first CE mark surgical planning system that enables patient-specific implant positioning using a guide that is manufactured from 3D anatomic models generated from x-ray images.

Importantly, this next generation system offers economic value in health care by replacing MRI and CT scans with standard x-ray technology.

Turning to our hip category.

Our sales decreased 0.2% from the prior year quarter, reflecting positive volume and mix of 2.4% and negative price of 2.6%.

We continue to see strong demand for the G7 Acetabular system, including our proprietary 3D printed OsseoTi Porous Metal Technology, as well as the Taperloc Complete Hip stem and Arcos Modular Femoral Revision System, although these positive trends were offset primarily by supply shortfalls at the Warsaw North Campus.

Additionally, we have received regulatory clearance in the U.S. to market our clinical graphics technology for femoroacetabular impingement.

This platform enhances our hip preservation portfolio with 3D range of motion simulation software designed to inform treatment decisions.

Turning to our S.E.T.

product category.

We delivered 3.6% year-over-year sales growth.

This performance was driven in large part by our surgical business and sports medicine offerings such as Gel-One, Subchondroplasty and Quattro Link, as well as our A.L.P.

S. Plating System within our foot and ankle portfolio.

Our growth was partially offset by supply constraints on certain product lines.

Fully restoring product supply remains a key priority, along with continued expansion of our specialized sales channels.

Our second quarter dental sales decreased 5.7%, primarily due to headwinds in certain European markets where we restructured our dental sales organizations for long-term success.

Importantly, we had positive dental sales growth in the United States during the quarter.

We also recently appointed a new general manager to lead our Dental business.

Together with our focus on enhanced product positioning, targeted commercial strategies and strong execution, we believe that we will be better positioned for improved performance in this attractive market.

Turning to our spine, craniomaxillofacial and thoracic category, sales increased 33.5% during the quarter.

As in recent quarters, we continued to benefit from strong demand for the Mobi-C Cervical Disc.

With the integration of our U.S. spine sales force now substantially completed, we expect to begin capitalizing on the significant cross-sell opportunities that the LDR combination provides.

Among our craniomaxillofacial and thoracic offerings, we achieved another strong quarter of growth.

We continue to be pleased with the ongoing sales of our SternaLock Blu and SternaLock 360 primary closure systems as well as the RibFix Blue Thoracic Fixation System.

I'll now turn to our other second quarter financial details before providing additional information relating to our third quarter and full year 2017 sales and earnings guidance.

Our adjusted gross profit margin was 74.3% for the quarter and was 70 basis points lower than the prior-year period, due primarily to the impact of price declines, additional manufacturing costs at our Warsaw North Campus manufacturing facility and lower gains from our cash flow hedging program, particularly associated with the Japanese yen and the euro.

Our R&D expense was 4.6% of revenue at $90.1 million, consistent with the same period in the prior year.

As previously highlighted, we continue to prioritize R&D spending on what we believe are the most impactful programs, including our important knee programs, robotic applications and Zimmer Biomet Signature Solutions, among others.

Adjusted selling, general and administrative expenses were $748 million in the second quarter or 38.3% of sales, 50 basis points higher than the comparable period in the prior year.

The negative variance was driven by a full quarter impact from our 2016 strategic acquisitions, including LDR, Medtech, CD Diagnostics and others, which negatively impacted SG&A expense by 60 basis points.

We also incurred higher freight costs in the quarter due to expedited product shipments and continued investments in our specialized sales force.

These increases were offset in part by continued savings in various SG&A expense categories stemming from synergy capture initiatives.

In the quarter, we recorded pretax charges of $331 million in special items, which include $192 million of noncash amortization, inventory step-up and in process R&D impairment charges, as well as $54 million of quality remediation expense and $85 million of integration expense and other items.

Our diluted earnings per share for the quarter were $0.90 versus a loss of $0.16 in the prior year period.

Adjusted second quarter 2017 figures in the earnings release exclude the impact of the special items that I just mentioned.

Adjusted operating profit in the quarter amounted to $613.5 million or 31.4% of sales, which was 120 basis points lower when compared to the prior year period.

Our adjusted effective tax rate for the quarter was 19.5%, a decrease of 520 basis points from the second quarter of 2016.

The second quarter tax rate was consistent with previous quarter's guidance and is primarily due to the favorable resolution of various tax matters, which will have future benefits on our effective tax rate.

Adjusted net earnings increased 4.3%, or 9.7% excluding the impact of foreign exchange, to $424.6 million for the second quarter.

Adjusted diluted earnings per share for the quarter increased 3% over the prior year period, or 8.4% excluding the impact of foreign exchange, to $2.08 on 203.7 million weighted average fully diluted shares outstanding.

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

Operating cash flow for the quarter amounted to $440.5 million, which reflects $120 million of cash expenditures for our synergy program and quality remediation initiatives.

Capital expenditures for the quarter totaled $116.9 million, including $86.2 million for instruments and $30.7 million for property, plant and equipment.

Our free cash flow in the second quarter was $323.6 million, which was $63 million higher than the second quarter of 2016.

During the quarter, the company retired a $500 million senior note, which matured in early April.

Additionally, we fully repaid the $400 million drawn from our senior credit facility that had been previously used to bridge our senior note retirement.

Therefore, when combined with our first quarter activities, gross debt reduction during the first half of 2017 was $650 million.

I'd like to now turn to our updated guidance.

As a result of the previously- described manufacturing remediation efforts related to certain brands manufactured at our Warsaw North Campus facility, as well as slower than expected sales recapture, primarily in the U.S, we are adjusting our third quarter and full year revenue and earnings outlook.

For the third quarter, we expect revenues to be in a range of $1,815,000,000 to $1,845,000,000, which reflects a negative impact from foreign exchange of 0.5%.

On a constant currency basis, our growth rate is expected to be in a range of negative 0.5% to positive 1.0% inclusive of a 30 basis point contribution from the LDR acquisition, as well as an approximately 130 basis point negative impact from fewer billing days when compared to the prior year period.

Therefore, our billing day adjusted growth rate excluding the contribution of the LDR acquisition is now expected to be in the range of 0.5% to 2.0%.

This compares to 0.7% in the second quarter.

Regarding the fourth quarter, based upon our current expectations for supply recovery and timing of sales recapture, we are anticipating a billing day adjusted growth rate in the range of 1.0% to 3.0% over the prior year period.

Note that the projected weighted average billing day impact on our fourth quarter growth rate is a favorable 20 basis points and that we fully anniversary out of the LDR acquisition during the third quarter.

Current foreign exchange rates would have a favorable impact of 80 basis points in the fourth quarter.

Therefore, for the full year 2017, our estimated revenue growth is now expected to be in a range of 1.5% to 2.4% over the prior year.

Foreign exchange is now expected to decrease revenues by 0.3%, a 90 basis point improvement from previous guidance as the dollar has weakened versus many currencies.

Taken together, constant currency revenue growth over 2016 is expected to be in the range of 1.8% to 2.7%, inclusive of 120 basis points of acquired revenue from the LDR acquisition.

In dollar terms, our full year 2017 revenues are expected to be in a range of $7,800,000,000 to $7,870,000,000.

Our expected dollar range is down from our previous guidance range of $7,835,000,000 to $7,915,000,000, with favorable foreign exchange partially offsetting the reduction in our constant currency growth rate.

Turning to projected full year 2017 earnings.

We have 3 primary factors influencing our earnings for the remainder of 2017.

The negative impact from lower sales expectations, continued investment in critical programs and incremental manufacturing costs from our Warsaw North Campus facility.

Earnings impact from our lower sales expectations has a disproportionately negative impact on our profitability due to the operational sales mix, which is only partially offset by favorable currency adjustments versus our previous outlook.

Additionally, we continue to invest in critical programs such as specialized sales forces, sales incentive programs, core R&D initiatives including the knee and robot projects previously mentioned and sales support cost to maximize customer engagement.

These investments are critical for long-term value creation for our company.

Finally, we will continue to incur incremental manufacturing and distribution costs, primarily in the Warsaw North Campus facility.

The expected negative impact of these costs on our full year 2017 earnings approximates $60 million, which is an increase of approximately $30 million versus our previous guidance.

These increased manufacturing costs are expected to continue to have a negative impact on gross margin throughout 2018 until we implement more efficient and automated manufacturing and quality control processes.

Special items for 2017 are estimated at approximately $1,235,000,000.

This is an increase of $30 million from our previous guidance and wholly attributable to non-cash write-offs of Biomet-related in-process R&D.

We expect investments in our quality remediation program for 2017 to be consistent with previously-stated amounts.

We now estimate our full year 2017 earnings per share to be within a range of $4.15 to $4.35.

Excluding the impact of amortization, inventory step-up and special items, we are reducing our full year 2017 adjusted earnings per share guidance to a range of $8.20 to $8.30.

This EPS range represents approximately 3% to 4% growth over prior year, or 7% to 8% growth when excluding the impact of foreign exchange.

Due to the negative impact of our operational results, we are revising our full year 2017 expected free cash flow range downward to between $1,100,000,000 and $1,300,000,000.

We expect to continue prioritizing our free cash flow in the second half of 2017 towards debt repayment, continuing our path towards our previously-stated leverage target of approximately 2.5x by the end of 2018.

Our third quarter projected EPS is in the range of $0.60 to $0.70.

After the elimination of amortization, inventory step-up and special items, our adjusted EPS is expected to be in the range of $1.72 to $1.77.

Our third quarter and second half 2017 effective tax rate is expected to be in the range of 23.5% to 24.5%.

We expect our full year effective tax rate to be in a range of 22% to 22.5% as we continue to execute important initiatives that will have permanent benefits to our future effective tax rate.

Finally, please note our guidance does not include any impact from other potential business development transactions or unforeseen events.

Before moving on to our Q&A, I'd like to emphasize how pleased and enthused I am with the entire team's focus and effort since I stepped in to my interim role as CEO.

We have much work to complete in the coming months, and I am encouraged by the commitment I'm seeing across our global organization as we tackle these challenges.

With that, I'd like to open it up to questions.

(Operator Instructions) Our first question comes from Bob Hopkins with Bank of America.

So 2 questions, one on 2017 and then one looking out a little bit.

So first on 2017, just to be clear, so are you saying that the supply issues will be behind you exiting 2017?

And then also in 2017, can you quantify the total incremental investment that you're making versus your previous guidance?

Sure, Bob.

First, with respect to the supply issue, we are saying that by the end of this year, we will have basically cleared back orders, restored safety stock levels to normal levels, which enables our sales force to not only fulfill existing customer demand but also to start going after new business, which has been a missing piece of our performance.

So certainly the expectation is that during Q3, as we've described, we'll continue to make progress on all brands.

There are these certain brands with more complex remediation and manufacturing processes associated with them, which will lag a bit.

But even those certain brands we expect to be in a good shape by the end of 2017.

The incremental costs and the changes compared to the prior guidance really has to do with the production costs that we're incurring in the North Campus.

There is no change to the remediation cost and the programs associated with that.

That remains at approximately $210 million here in 2017.

So the incremental costs to prior guidance that's included in our adjusted P&L relate to the manufacturing variances out of the North Campus, and that's an incremental $30 million in this new revised guidance.

Okay, that's very helpful.

And then sort of the obvious follow-up to that is looking out a little bit longer term and how we should think about those incremental expenses, you're revising your 2017 guidance down.

That's obvious in the press release.

What I'm curious about is do these investments continue into 2018?

And when we preliminarily, at least, think about 2018, can you grow earnings high single digits in 2018?

Or are these expenses going to kind of limit growth more to maybe mid-single digits in 2018, again preliminarily?

Sure.

So first, let me just talk a little bit about the production environment in the North Campus and what's driving those incremental costs and then what's the path to recovery, if you will, from a cost profile perspective.

I think the way I would describe our approach with the North Campus production is to remediate first and optimize later.

And so what I mean by that is we've certainly prioritized our remediation activities on the North Campus, per the commitments we've made to the FDA, and we're operating that facility under what we call interim process controls.

And I think it's important to realize that these interim controls include a significant number of manual production and quality control processes and monitoring systems, and that's resulted in significantly higher variable costs of production.

So the end state solution is to implement processes with inherently more process capability and consistency, and this will take some time.

In addition, the lesson we've learned, we need to create redundant capacity in the network to avoid single points of failure with respect to customer order fulfillment.

So as I said in my prepared remarks, the incremental costs will be with us through 2018.

And as we think about 2018, we'll provide the official guidance, of course, later this year.

But I would describe it as this way, Bob.

We're certainly prioritizing our investment to restore full product supply, to make the progress we need on the production and quality enhancements that I've described and prioritizing investments to drive growth.

Now that said, we do have levers available to us, value creation opportunities, whether it be in the COGS area or the SG&A area.

But again, we're prioritizing our investments towards growth and production and quality enhancement.

So our goal will continue to be to have a levered P&L next year, growing earnings per share faster than sales.

The details of that forthcoming however.

Our next question comes from Matt Taylor with Barclays.

So I guess, I wanted to understand some of the assumptions in your 2017 guidance.

You touched on a few of them in the prepared remarks and in response to the first question.

But can you talk a little bit more about your customer recapture assumptions and how you think the supply delays are impacting your ability to recapture customers?

And maybe within that, what are you doing on the hiring front in terms of the sales force?

Sure, Matt.

So in developing our guidance, we've considered as best possible about the risks and opportunities.

First and foremost, associated with the production, both volume and mix out of the North Campus, to clear back orders and replenish safety stock.

The assumptions along the timing and success rate of recapturing lost business and the timing of going back on offense to bring on new surgeon customers have also been updated.

They're inherently linked, of course, with production.

Healthy product supply will ensure that we're not missing cases.

And importantly, free up our sales rep time from being in the mode of case logistics experts to getting back on offense and winning, an important element that's one of those I would describe as indirect impacts of the supply issues.

With respect to recapture, we are seeing instances where some surgeons are waiting to move their business back to us until they see a full product offering with a steady flow of supply for a period of time.

So while we're getting healthy on certain brands of a particular family, if there is other subsegments of that family that have not yet healthy on supply, we are seeing instances where the surgeon customer may be waiting to flip the business back over to us.

So that's why getting full supply across the full spectrum of parts is so critical to that recapture assumption.

In terms of going back on offense, again, we've been prioritizing existing customers and have not been able to bring in new customers to offset some of that natural churn of surgeon activity that takes place in the normal course of business.

So bottom line, Matt, we're in the early stages of getting healthy on supply and then experiencing what that recapture rate looks like.

What we're doing to ensure that the sales teams are ready to run with that full supply is looking at rolling in some incremental incentives on win-back and growth.

So that's all in motion.

But really first and foremost starts with getting healthy on supply.

And then lastly, with respect to the field force and headcount, we had another quarter of net positive adds in total to the sales channel.

Okay, that's helpful.

And just 1 follow-up on the pipeline.

You have a number of knee products and some other products like in shoulders that you've talked about launching over the next 18 months, let's say.

How are these issues impacting those timelines, if at all?

As you said, Matt, we have some critical new products that are in the pipeline, particularly in the knee portfolio, that are going to fill critical gaps in the portfolio.

And we will be launching the Persona Partial Knee, a full commercial launch, later this quarter.

And just to remind folks, the Persona Partial Knee replaces the fixed bearing knee that had to be divested as part of the merger.

So that's an important segment of the partial knee market that we've not been participating in.

The early clinical feedback on that product is excellent, and we have high hopes for Persona Partial Knee.

So again, that will launch later this quarter.

We also called out the Persona TM cementless knee.

Again, a very important subsegment of the knee market, a fast-growing subsegment of the knee market.

So that'll be launching in the second half of 2018.

That brings with it impactful mix and new business opportunities.

So that remains on track with that time frame.

As does the Persona revision in the pipeline, second half of 2018.

We've been without a revision system to the Persona.

That's a critical new product launch.

The robotic application on the total knee application, that program, high priority program, we continue to move that forward in line with our original expectations.

So broadly speaking, with respect to how we're prioritizing R&D resources, it is the case that we've had to move some engineering capability over towards the remediation program.

What we've been doing is taking another look at the critical R&D list and focusing that list down, narrowing it to the most critical R&D programs and then ensuring that those critical programs are fully staffed, they've got full support of all supporting teams and driving those to keep those programs on track.

Our next question comes from Mike Weinstein with JPMorgan.

I was hoping you could spend a minute on a couple of items that you kind of briefly mentioned here.

So one was the incentive program you're putting in place for the existing sales reps to a, recapture accounts and b, go on the offensive.

Is that program in place?

Is that a 2018 program?

Or is that something for the balance of the year?

That program is for the balance of the year, Mike.

Our -- I'm not going to get into the details of it, but just broad strokes.

I mean our existing comp program incentivizes growth, just to be clear on that.

So what we're looking at is incremental incentives to make sure that the sales teams are again ready to run as full supply is restored.

So those are new programs that we'll be rolling out that specifically reward growth and win-back or recapture of lost business and with the full intention of restoring momentum in the field.

Okay.

And the second item is, you've commented on the call, like you have in other calls, that the net sales force is up globally.

I know that you've been building out your dedicated sales force in new categories, where prior to the acquisition, Zimmer didn't have one.

Can you just talk a little bit about where you are in that process in the various areas, obviously trauma, extremities?

Sure, sure.

So the comment in terms of adds to the channel was a U.S. comment, but it holds true globally as well.

So it has been a key focus and remains a key focus for us, Mike, to continue to build out focused sales forces and specialized reps, particularly in categories in the S.E.T.

category.

So within surgical, throughout the -- since the merger closing, we've been adding dedicated salespeople within surgical.

That will continue.

The surgical team continues to do an excellent job with some new products, an excellent job on commercial execution.

Within sports medicine, the same playbook.

Let's add specialized sales reps that can focus on sports only.

We've added reps along the way, and we'll continue to add sports med reps throughout the future.

The sports med category and then the trauma category and the extremities category, those 3 areas in particular have been impacted by the North Campus production disruption.

So in general, it is clearly our intent to continue to build out and add more dedicated sales reps.

We're pacing that as we sit here today in accordance with that supply recovery.

But make no mistake, it's our clear intent to continue to invest in focused sales reps.

And on the core recon sales force, what has the turnover looked like?

Yes, the attrit rate is normal, Mike, which with respect to everything the team has been through, I think is a remarkable testament to their belief in our portfolio and our belief and the belief that we're going to restore full supply.

So I'd describe that build as kind of normal course.

The real incremental investments are in the specialized sales force.

But the core recon sales force in the U.S. is stable.

They're anxious to get supply, needless to say.

And look, a big part of supply, whether it's the direct impact of supply or indirect impact of supply, the key next step is to, of course, get full supply and start restoring trust; trust within our sales force, trust within our surgeon base that they no longer -- there is a day where they will no longer have to worry about product being available.

And we know that day is coming.

Again, we want to make sure we have the right people, the right quantities of people, the right incentives in place to catch that and run with it.

We'll take our next question from David Lewis with Morgan Stanley.

Dan, I want to focus on a couple of issues.

The first is visibility.

The second is on some of these costs that you walked through.

So can we just talk about visibility into the back half of the year?

I guess specific question is your third quarter guidance doesn't imply much improvement when you sort of adjust for the comp.

So how does that fit with sort of moderately improving supply dynamics into the third quarter?

But as you look into the fourth quarter, you actually do get that acceleration in momentum.

So I guess the question is, why don't you see it in the third quarter?

And frankly, what's your visibility in that more material fourth quarter acceleration?

How confident are you in these numbers?

Sure, David.

As we look at the recovery on supply, one of the real lessons in Q2 and we've brought this -- these learnings into Q3 and Q4 is the importance of having the full bag ready to go.

And I mentioned before that again, it's early days but there's some indication that surgeons may be waiting to give us back our Vanguard business, for example, until we have all variants of Vanguard ready to go.

And while we're healthy in many brands, there are other brands that are lagging behind.

So the approach we've taken with this guidance to account for kind of the state of the state or the dynamics that we're dealing with is number one, we've broadened the range as you see from what we've done historically.

And we've looked at the timing of getting healthier across all those brands.

And that's -- so that's what we've contemplated in the Q3 guide.

So even though the comp is easier year-on-year, the business momentum is built on a sequential go forward basis, and that's how we've approached Q3, again, with a wider range, the 0.5% to 2% pegged against what we just did at 0.7%.

So that's reflective of the pace of production, the mix, the recapture.

And all of our -- our dashboard clearly indicates that we expect all brands to be healthy mid-Q4, which again, enables not missing existing accounts or cases and going back on offense and acquiring new business.

So I think the bottom line is that we firmly believe in the opportunity that's still there, David, and our guidance for the back half reflects some momentum building throughout the second half.

And we've widened the range from where we've been before just to account for the dynamics.

So on the upper end of that guide, that's indicating that we land the production volume and mix, the sales force catches it and runs and executes really well.

Okay.

So in the interest of not being cute, it's sort of if you build it, they will come.

You're building in the third quarter and the customers come back in the fourth.

Does that sort of paraphrase it?

I mean, we're still looking to win business during Q3, David.

So but to your point, it's certainly a more modest growth rate relative to what we expect in Q4.

So yes, we will be building momentum through Q3 and start really landing those -- that new business in Q4.

Okay.

And then just on cost, Dan, I know you talked about these things sort of broadly, but I want to see if we could pencil you in on sort of what these costs are.

And obviously, we don't have all the math here.

But if at the midpoint, you're lowering kind of $0.30 and maybe $0.10 of that is the adjusted for selling day revenue reduction, I kind of come up with $0.20 of sort of underlying reinvestment, so that's about $60 million or so.

Is the way to think about that $30 million of sort of gross margin from the plant and then $30 million of sort of SG&A reinvestment?

And if I think about those 2 buckets, Dan, how do those play out in '18?

Do we still have the $30 million of gross margin expense through the end of '18, but we sort of get back some of that $30 million SG&A reinvestment?

Sure, David.

I think the -- just listening to your question, I think the math around the revenue takedown is off a bit.

Now and it's really because when you think about the revenue takedown is really skewed towards some of our most profitable products and really concentrated in the United States.

So the drop-through to EBIT on that revenue takedown is more significant than what you're modeling there.

So it's clearly well above our corporate average, in other words.

So I think that's, for modeling purposes, something to take into account.

And that's a takedown for all the reasons that we've described that we expect that to turn around.

So as we think about through 2018, recovering that growth particularly in the United States, the drop-through on that turns back around, right.

So that comes back in our favor in 2018 as we restore momentum in the U.S. channel.

So that's a big element in terms of the EPS takedown.

The variances as described, a total in the 2017 P&L, it's a total of about $60 million that's in the P&L from a variance perspective, an incremental $30 million.

Thinking about that next year that -- assume that, that's in the P&L next year.

So then back to your question about what other levers do we have.

We want to make these investments whether they're incentives or training and education programs, sales support costs, keeping these critical R&D programs moving ahead as well.

As we exit this year and think about guidance for next year, we have a line of sight to additional levers to pull on.

Of course, I have a point of view on that.

When the new CEO comes in, I will review that with the new CEO, and we'll decide how we want to approach 2018 from a reinvestment perspective.

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

Understanding that all of the changes that have happened regarding your CEO search are relatively fresh, do you have a sense of timing?

Do you internally or does the board internally have a view towards, okay, we should probably be doing this before year-end or something of that sort?

Sure, Joanne.

As I said in the prepared remarks and in our release, the board has retained an executive search firm, so that firm is now in place.

As described, the board is looking for a proven growth-oriented leader with a strong background, both operationally and strategically.

So clearly, we're moving forward with a sense of urgency, but there's no defined timetable.

The board's willing to take its time to find the right candidate.

So that's really the -- that's the plan and we're off to a strong start.

Okay.

And then to get into some of the more line item idea, can you discuss what's happening in your spine business?

It's a little over a year since you purchased LDRH.

That appears to be integrated.

But what is going on in broadly the spine market and your business within it?

Sure.

So I think importantly, you're right.

We've anniversaried here in July with the acquisition of LDR.

The commercial integration, meaning the sales force integration of that channel, is largely complete.

And similar to the orthopedic sales channel, that's a critical -- it's a critical asset.

It's a critical part of the integration, and getting that right is mission critical.

It's taken us the full year to do that.

I think in the past, we've described how we've oriented the channel to make sure that we have full coverage of our full spine portfolio.

So we've got representation across the full surgeon base.

The Mobi-C product line continues to perform exceedingly well.

We have very high hopes for Mobi-C.

It's clearly a differentiator.

The non-Mobi-C part of the portfolio has been challenged with the integration.

So there's been some level of dis-synergies as we've been integrating the channel.

So our expectations -- with the channel complete, our expectations is that in the fourth quarter of this year, we have a global spine business on an apples-to-apples basis that's growing and contributing to overall Zimmer Biomet growth.

Our next question comes from Richard Newitter with Leerink Partners.

Dan, the first one is on the recapture side and then my second one is on the manufacturing.

On the recapture, you indicated that -- well, I was hoping you could just break out for us, of those customers that have been supply-impacted, what percentage are in this kind of, we want to come back but we want to wait for a thorough portfolio availability versus those that you've identified that are probably kind of trialed and out of the Zimmer camp?

Rich, it's still really early days to fully know the answer to that question.

I will just say that we have clear line of sight to the surgeon level in terms of where we've been gaining business, where we've been losing business, surgeons that have been added to the funnel or lost, so to speak, in the funnel.

So clear line of sight to where that business and opportunity is.

So without getting into the weeds on that, we still have high confidence that surgeons again want to use our product.

We've described it as the broader issue is the case where surgeons have moved some of their business to a competitor because of our inability to fully supply them.

So we're referring to that as kind of borrowed market share.

So our ability to recapture that is critical.

We're still confident we're going to be able to do that with a full supply.

And again, that aspect of being on offense is a critical part of the growth and momentum story as well, just making sure that we're able to attract new surgeons while at the same time serving existing customers.

Okay.

And then in response to an earlier question, I think it was David's question, what gives you confidence kind of in the ramp or what maybe you miscalculated when you gave guidance on the manufacturing remediation efforts and where you would be by the second quarter into the third quarter last time?

It sounded like it was a little bit more you maybe miscalculated this issue of what it would take for customers who wanted to come back online to actually come back online.

That seems more on the demand side.

But on the manufacturing side, you're also running a little bit behind your schedule.

So I guess my question is why should we have confidence that you're kind of -- by end of 4Q of 2017, these manufacturing issues are behind you, where you kind of had that timeline planned out before?

Has anything changed in your planning processes, the team that's in place that's overseeing this?

What can you say to give us confidence that you've got the right kind of target here?

Sure, sure.

We've, obviously, been learning a lot through this, okay.

I described before the approach to the North Campus is first and foremost to remediate the plant and then to optimize it.

I think just taking a step back a little bit, just to remind people that the Biomet Warsaw facility has historically had an excellent FDA track record, producing products for decades with a strong and lengthy clinical heritage.

And the plant has operated in a particular manner for decades, with established manufacturing and quality processes.

And we're -- look, we're on a journey to remediate those processes and also raise the plant up to more contemporary quality standards.

And without a doubt, the journey has been more complex than we anticipated.

So I think I want to acknowledge that due to the ongoing remediation work and interim process controls in the North Campus, of course, there's some risk of future disruption in production.

We believe we have a strong grasp on the issues, Rich, and we're implementing the appropriate solutions.

We're running the plant under these interim controls with more manual production and quality control.

So kind of the inherent risk is above normal.

And I think we've learned from that.

Our updated timetables, I believe, account for that as we look through the journey in the back half of the year.

And there's -- we've made changes from a personnel perspective.

I believe strongly we have the right team in place with the right focus and the team's doing everything possible to meet these revised dates.

And we'll take our next question from Larry Biegelsen with Wells Fargo.

It's Craig on for Larry.

I want to start with top line growth progression.

Obviously, Q3, you expect an acceleration; Q4, an acceleration on -- a sequential acceleration on top of Q3.

So just want to think about 2018, and is that 2% the right way -- could it be thought of as a jumping off point for 2018?

And then also just wanted to see, is 4% that you've mentioned before, before some of the production issues, is that still the right long-term target growth for the company?

Sure, Craig.

We absolutely believe 4% is the right long-term top line growth rate for the company.

The Q4 range of 1% to 3%, the high end of that range says that we've executed commercially- and manufacturing-wise in the right manner.

That opportunity exists to exit in that, take the midpoint, 2%, to your point.

So the path to 4% is absolutely clear to how we deliver that.

And it first and foremost starts with better performance in the U.S. with respect to hips and knees.

And again with full supply, with a sales force ready to run, that's our goal through 2018.

And the importance of the new product flow that's going to be coming into that channel starting later this quarter with Persona Partial Knee and then the cementless and revision Persona coming later next year is an important part of that.

You combine that momentum with the S.E.T.

category, a spine business, as I said, that we expect to contribute to growth in the fourth quarter and carry that momentum into 2018.

So 4% is clearly the goal.

We still believe that's very achievable.

One other point with respect to production feeding that and the North Campus is I just want to make the point about the importance of the buffer inventory that we'll be building in the back half of this year and how important that is to restoring trust in the channel.

With safety stock inventory or buffer inventory, that really does protect the field from disruptions from a production perspective.

So that's why we've been so focused on clearing back orders, building safety stock, getting back on offense.

That safety stock buffer is a critical part of the equation.

That's helpful.

And as a follow-up, Dan, you've talked about the spine business quite a bit.

And with the management change upcoming with respect to the spine business and the dental business, I just wanted to see if there's any change in strategy going forward.

I know at times, there's been discussion about potentially divesting the dental business.

So just wanted to get a sense for if there's any change in the spine or dental strategy.

Craig, I would tell you that our strategic priorities and objectives are unchanged.

Accelerated top line growth with full product supply and with strong commercial execution, while at the same time making progress on our production and quality enhancement program and then moving ahead with the critical R&D programs that we've talked about.

Management and the board frequently discuss and evaluate many strategic alternatives: divestiture, acquisitions, adjacencies -- focusing on what would deliver long-term value to shareholders.

So that's always the conversation.

We believe in the spine and dental markets.

The spine market, again, we believe we're going to be growing in that market in Q4.

We're very excited to have the LDR portfolio as part of that business.

The dental side, as we've described, dental did decline in the quarter.

That actually was consistent with our internal expectations for Q2.

That was really tied to disruption in our European commercial organization as we reposition that for long-term growth.

Importantly, the U.S. had a positive growth quarter, the first one in quite some time.

So that's very encouraging.

As we've described previously, Craig, we like the dental market.

We estimate that market growing 3% to 5%.

The business provides an attractive return on invested capital.

We need to get it growing.

We're making adjustments to the portfolio.

We've just hired an excellent leader for the dental business.

And as we sit here today, we believe in the market and our ability to restore momentum in the dental market.

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

Dan, can you just give us a quick update on how the dialogue is going with the FDA regarding the 483s on the North Campus?

There are a number of 483s.

Where are you in kind of the remediation effort, kind of checking the box off on the observations?

And it seems to me, though, that even with all the observations, you're still going to be getting approval out of these facilities given the timelines you've given, for example, on some of the Persona products.

So that's my first question and I had a quick follow-up.

Sure, Glenn.

We continue to communicate with the FDA regarding the status of the corrective action, the remediation work for the North Campus.

So that process is ongoing.

The team's making excellent progress, consistent with our responses to the 483s.

And we will keep all stakeholders up to date with appropriate disclosures in our periodic filings.

So -- sorry, go ahead.

Well, I was going to say at this point, one of the concerns we often hear from investors is could this lead to a warning letter?

Can you comment on your thoughts there?

It's hard to predict, Glenn, what the ultimate outcome is.

We continue to communicate with the FDA on the progress we're making towards that remediation plan that we've detailed out.

So we're kind of heads down, executing that remediation plan and moving forward.

Okay.

And then just my last follow-up, you talked about supply constraints in the S.E.T.

segment.

Are those products coming out of the Warsaw plant?

Or is this a different plant?

No, they are coming out of the North Campus, the Biomet Warsaw facility.

So specifically across legacy Biomet sports medicine, legacy Biomet extremities, upper extremities, and then certain trauma products are -- come out of that North Campus.

So yes, that is impacting the S.E.T.

growth it on a temporary basis.

So thanks, everyone.

Thanks for joining the call today, and we look forward to giving you an update on our progress on our third quarter conference call.

Thank you.

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

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