Zimmer Biomet Holdings Inc (ZBH) 2017 Q4 法說會逐字稿

Good morning.

I would like to turn the call over to Derek Davis, interim Vice President, Investor Relations.

As a reminder, today's call is being recorded.

Mr. Davis, you may begin your call.

Thank you, and good morning.

Welcome to Zimmer Biomet's Fourth Quarter and Full Year 2017 Earnings Conference Call.

Joining me today is our President and CEO, Bryan Hanson; as well as our CFO, Dan Florin.

Before we get started, I'd like to remind you that our comments 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 the call will include certain non-GAAP financial measures.

Reconciliation to these measures to the most directly comparable GAAP financial measures are included within the earnings release found on our website.

In addition to the earnings release issued this morning, we have posted a quarterly presentation on our website at investor.zimmerbiomet.com to supplement the content we'll be covering this morning.

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

Thanks, Derek.

Good morning, and thank you for joining us today on my first earnings call as President and CEO of Zimmer Biomet.

Since joining the company 6 weeks ago, I've had the pleasure of beginning a dialogue with our key stakeholders, including many of our customers and distributors, senior Zimmer Biomet leadership and team members from around the globe.

I've also connected with a number of our investors in addition to analysts who follow our stock.

Candor and transparency have been important parts of this process.

And having an active and continuous dialogue allows me to integrate a broad range of perspectives in developing our plans to lead Zimmer Biomet to higher levels of innovation, commercial success and profitability.

Through these meetings, I have been gaining deeper insight into Zimmer Biomet's operations and opportunities, both what we're doing well today and importantly where we need improvement.

Overall, my initial impressions have reaffirmed my rationale for taking the job as well as my confidence that my background aligns well with the work that the Zimmer Biomet team does and what needs to be done to position the company for improved performance.

In speaking with our stakeholders, it's clear that Zimmer Biomet is working from a strong foundation that includes the industry's broadest portfolio, a robust commercial pipeline, meaningful market share in key end markets and world-class sales teams.

By virtue of those strengths, we also have the potential to go beyond our share of leadership in large joints to drive diversified growth in a number of attractive markets, such as sports medicine, extremities and trauma.

Our global scale and depth of portfolio also position us to continue expanding access to our solutions in underpenetrated patient subsets in global markets.

In terms of our innovation capabilities, Zimmer Biomet is uniquely positioned to leverage platform technologies across our entire portfolio, including advanced proprietary materials and surgical robotics applications.

As a company, we plan to build on this foundation.

We'll have an unwavering emphasis on patient safety and quality excellence, creating an engaged and innovative workplace and working to position the company to deliver top quartile total shareholder returns.

And on a personal level, I've been inspired by the way surgeons have expressed their confidence in our portfolio and in our people.

Zimmer Biomet's 90-year reputation has been built on serving the needs of patients and surgeons, and that resonates with my own values.

All that said, I'm not naïve about the company's current challenges.

I'm committed to turning Zimmer Biomet's performance around with a deliberate emphasis on rebuilding revenue momentum in the near term as well as execution that leads to value creation.

To get us there, I plan to draw on what I've learned from leading and building large global medical technology businesses.

Working closely with the management team at Zimmer Biomet, we have been reviewing the 2018 operating plan to clearly define our go-forward strategies in a number of key areas.

Although our review of the operating plan is ongoing, we have identified several immediate opportunities to improve Zimmer Biomet's operational execution and address certain near-term challenges.

First, we will continue completing our quality remediation efforts at the Warsaw North Campus.

Our teams have been undertaking this focused work over the past 13 months for the benefit of input from expert consultants.

To support the success in quality compliance of our manufacturing network, we will also continue investing in the development of a best-in-class quality management system.

Second, in order to return to offense and accelerate sales recapture, we will remain focused on fully restoring the supply of certain key brands within our knee, hip and S.E.T.

categories.

To that end, our teams continue to make progress on increasing the production levels of these products, which had been supply constrained due to quality remediation requirements and the non-automation of the North Campus.

I've reviewed the team's detailed plans for revenue acceleration through supply recovery.

And I'm confident, as I've said before, that we have the right overall strategy in place.

As I've dug into the details with the team, I see both opportunities and risks associated with the milestones within our schedule.

My sense at this time is that these milestones represent more risk than opportunity.

We will provide more details on our progress in this area when we provide full year guidance on our Q1 earnings call.

Turning to our commercial strategy.

Our immediate priorities are to restore supply, engage with the sales channel and return to offense.

I carry a sales bag when I started my career, which means I absolutely understand the vital role of the commercial team.

Zimmer Biomet's leadership is fully committed to reconnecting and rebuilding trust with our sales forces as they engage with our customers.

In addition to sales recapture, we will also be focused on a significant number of commercial releases we have scheduled in 2018, including the critical additions of cementless and revision systems to our Persona Knee family as well as a limited launch of the robotic application for knees.

We have stressed to our commercial leaders that these new product introductions must be launched with excellence to ensure that they are catalysts for growth and share recapture.

Last but not least, we are currently focused on gaining a deeper understanding of Zimmer Biomet's culture.

Together, we will build a cohesive company where our team members are engaged and valued, feel accountable for delivering on our commitments and act with a sense of urgency.

Looking to 2018 and beyond, we will be focused on improving the predictability and consistency of our top line growth, which is a commitment to shareholders that I take very seriously.

While I recognize that there's a lot of hard work in front of us, I am confident that with the focused execution of our immediate goals, targeted investments in this business and a strong culture, we will raise our performance to a higher level and drive sustained shareholder value.

With that, I want to turn now to fourth quarter results.

On a consolidated basis, we delivered improved top line growth in the fourth quarter.

Our results benefited from several tailwind events in the quarter, including stronger-than-expected underlying U.S. market growth, which likely reflected a step-up in procedures due to insurance dynamics and a recovery from the Q3 hurricane impact.

In addition, we experienced an acceleration in growth of our already solid performing Asia Pacific business, which benefited in the quarter from strong distributor orders.

Consolidated fourth quarter net sales were $2,074,000,000, an increase of 3% over the prior year period and 1.5% on a constant currency basis.

Billing day differences provided a slight tailwind to the year-over-year growth.

In the Asia Pacific region, we delivered a strong 7.2% quarterly sales growth and our Americas region grew 0.8% in the quarter.

In Europe, Middle East and Africa, our revenues were relatively flat at a minus 0.3%.

Full year net sales for 2017 were $7,824,000,000, an increase of 1.8% over 2016 results on a constant currency basis, which included approximately 130 basis points of contribution from the LDR acquisition.

From a market perspective, fourth quarter U.S. knee and hip procedural volumes were quite strong.

We estimate that U.S. knee and hip increased around 2.5% during Q4 compared to flattish in Q3.

With regard to pricing, we experienced negative pressure of 2.9% during the fourth quarter and negative 2.5% for the full year.

Knee sales were flat compared to the prior year and were slightly better than our Q3 growth rate due primarily to the stronger U.S. market and increased demand for our Persona Partial Knee System, which has continued to garner positive feedback.

Despite the improved growth rate in Q4, we believe that the gap between our Americas knee growth and the overall market continued to widen in the fourth quarter.

Looking forward, we will remain focused on restoring full supply of our knee product line as well as launching a number of important new products to drive future growth and narrowing our gap to market.

Hip sales increased 1.6% during the fourth quarter and were driven by our strong performance in the Asia Pacific region, where we had double-digit sales growth.

Although we improved quarterly sales of our Taperloc, G7 and Arcos systems, supply constraints continue to limit our ability to meet the demand of these high-growth brands.

S.E.T.

sales grew 4.6% over the fourth quarter of last year with numerous products across this category contributing to growth.

We drove solid quarterly sales of our surgical portfolio.

And within upper extremities, we saw strong demand for the Comprehensive Shoulder during the quarter.

Since November, we have received several FDA clearances in this subcategory.

And we are particularly excited about the U.S. clearance of our Sidus stemless shoulder.

However, while we are encouraged that demand for these key brands remains high, we must restore supply before we can fully capitalize on these opportunities.

As we work through resolving the supply constraints that are a headwind on our S.E.T.

performance, we will continue to invest in the success of these higher-growth businesses.

Turning to our dental business.

Sales were relatively flat during the fourth quarter.

While dental sales in both the Americas and Asia Pacific region grew, challenges from the restructuring of our dental sales organization in certain key Western European markets continued to impact our performance.

We remain focused on our commercial and product initiatives to position this business for a sustainable growth.

During the fourth quarter, sales of our spine, craniomaxillofacial and thoracic businesses increased by 0.5%.

While we benefited from strong demand of our Mobi-C Cervical Disc, our spine business continued to underperform due to revenue dis-synergies related to our U.S. spine sales force integration.

We continue to work to resolve the impact of these dis-synergies, including recent senior leadership changes.

And we expect to realize the benefit of cross-selling opportunities in the future.

Our CMF and thoracic business contributed to sales growth during the fourth quarter with continued strong demand for thoracic products, driven by our SternaLock and RibFix Blu brands.

With that, I'll turn the call over to Dan, who will review our fourth quarter results in greater detail as well as our first quarter 2018 sales and earnings guidance.

Dan?

Thank you, Bryan.

I'll provide details on our fourth quarter financial performance, and then cover sales and earnings guidance for Q1 2018.

As Bryan covered, our net sales in the quarter increased by 3.0% over the prior year period with an increase of 1.5% on a constant currency basis.

Our adjusted gross profit margin was 72.7% for the quarter, in line with our expectations.

This was 190 basis points lower than the prior year period due to continued incremental manufacturing and inventory costs, primarily at our Warsaw North Campus facility as well as the impact of price declines.

Our operating expenses were higher than provided in our original Q4 guidance due to incremental spending on critical projects in our R&D portfolio as well as investments in our commercial channel.

We also incurred additional expenses related to planning and implementing strategies related to U.S. tax reform legislation.

Our R&D expense was 4.6% of revenue at $95 million, essentially in line with the prior year.

SG&A expenses were $771 million in the fourth quarter or 37.1% of sales, which reflects lower non-sales force incentive-based compensation expense compared to the prior year.

In the quarter, we recorded pretax charges of $668 million in special items, $150 million of which were cash outflows for quality remediation, business integration and other items.

The noncash charge is related to intangible amortization, certain legal matters and a goodwill impairment write-off related to our spine business unit.

Our diluted earnings per share for the quarter were $6.16, which includes a onetime tax benefit of approximately $6.40 resulting from the recently enacted U.S. tax reform legislation.

This adjustment is reflected in the income tax line and has been removed from our adjusted earnings.

Adjusted fourth quarter 2017 figures in the earnings release also exclude the impact of the other special items that I mentioned.

Adjusted operating profit in the quarter amounted to $644 million or 31% of sales, which was 130 basis points lower when compared to the prior year period, driven by the previously described decline in gross margin.

Our adjusted effective tax rate for the quarter was in line with our expectations at 23.4%.

Adjusted diluted earnings per share for the quarter were $2.10, a decrease of 1.9% from the prior year period on 204.1 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 $403 million, inclusive of the $150 million of previously mentioned cash special items.

And our free cash flow was $275 million.

During the fourth quarter, the company repaid $300 million of debt, bringing the total 2017 debt repayment to $1.25 billion.

I'd like to now turn to Q1 2018 guidance.

For the first quarter, we expect revenues to be in a range of $1,955,000,000 to $1,995,000,000, which includes approximately 300 basis points of favorable foreign exchange impact.

On a constant currency basis, our revenue is expected to decline within a range of negative 4% to negative 2%.

As a reminder, we have 1 less billing day in the quarter compared to the prior year quarter, which is negatively impacting these results.

This headwind will reverse in quarters 2 through 4, so that for the full year of 2018, there is no net billing day impact.

The step-down from our Q4 revenue growth rate is due to a number of factors, including the impact of 1 less billing day; an assumption that the worldwide orthopedic market will soften somewhat from the Q4 growth rate; our expectation of a slower growth rate in our Asia Pacific region in light of a very strong fourth quarter performance, which benefited from distributor orders; as well as a temporary reduction in elective procedures in the U.K. Regarding North Campus production, we expect our Q1 production output to be at least at the level we achieved in Q4.

While we are not providing full year guidance today, I would like to share some details to help your models.

We expect improvement from our Q1 sales growth rate as the year progresses, driven by the normalization of billing days; increasing supply levels as we progress through the year; enhanced commercial execution; and to a lesser extent, the contribution from new product launches.

Importantly, these new product launches should create momentum for our sales teams as we exit 2018 and enter 2019.

Turning to EPS.

For Q1 and the full year, our gross margin rate will be in a range between 72% and 73%, likely towards the lower end of that range in Q1 and improving slightly in subsequent quarters.

Our gross margin rate will be a significant headwind for us in the first half of 2018 compared to the first half of 2017, and then should normalize in the second half of 2018 as we anniversary into the North Campus variances.

We will continue to invest in critical areas on the commercial side of the business with a bias towards investments that drive near-term growth as supply recovers as well as core R&D initiatives, including the knee and robot projects previously mentioned.

As we continue to assess our 2018 operating plan, there will likely be further changes to our investment profile.

As a result, our first quarter projected diluted EPS is in the range of $0.73 to $0.88.

After the elimination of amortization, inventory step-up and special items, our adjusted diluted EPS is expected to be in the range of $1.84 to $1.91.

This guidance assumes a first quarter effective tax rate in the range of 19% to 20%.

In addition to my prior comments in gross margin, to help you with your P&L models, you should expect our full year adjusted effective tax rate to be in the same range as Q1, between 19% and 20%.

To be clear, we plan to reinvest the tax savings into the business to drive top line growth.

Further, as we mentioned earlier this month at a conference, we have a year-over-year expense headwind on non-sales force performance-based compensation programs.

This headwind, which approximates $35 million, is a result of not paying out full bonuses in 2017 due to shortfalls in operating performance.

The majority of that expense is recorded in SG&A.

We expect our Q1 2018 free cash flow to be in the range of $250 million to $300 million.

As a reminder, our goal is to allocate substantially all of our free cash flow towards debt repayment in 2018.

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

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

Bryan?

Thanks, Dan.

Before we move to Q&A, I just want to take a minute and thank Dan.

Over the last 6 months, he decided to not just have the hat of CFO but also become the CEO of the organization.

And I can tell you from talking to people, his leadership during that time really made people feel confident about the business.

I just want to say thank you for the effort that you've put in over the last 6 months and for the time that we've already spent together, and I look forward to working with you.

With that, I'll turn the call back to the moderator, who will begin the Q&A portion of our call.

(Operator Instructions) And our first question will come from Mike Weinstein of JPMorgan.

Bryan, as a starting point before we kind of get into the details of the businesses and the comments, I'd be interested in the feedback that you've gotten from the commercial teams, from the distributors and reps as you've had some early meetings with them.

I know you've been traveling around a fair amount early on.

Kind of what you've heard on their view on the business, what the current state of morale is and their relative enthusiasm for the changes that have already taken place and what's to come.

Yes, great.

So I've spent as much time as I possibly can with the commercial team so far, had an opportunity to spend a lot of one-on-one time with folks in the field, as I think I've mentioned to you before.

And really it's kind of a hand-in-hand, let's go visit the customer, let's go to cases and let me live the life that you've got in the day that I'm there.

And I've got to tell you that, that combined with the recent kickoff meeting that we had for the Americas, where there were a couple thousand sales representatives there, I've had really good exposure early on to the organization.

The first thing I would say is that we, no doubt in my mind, have the best sales organization in the industry.

I feel very confident about that.

This is a team that is engaged with the surgeons, is extremely knowledgeable about the space, has energy around what it is that they think we can do.

And so I'm very confident that we've got the right team.

But what I see inside of it though and what I'm hearing from the organization is there has been what I would define as maybe a lack of focus from senior leadership and engagement with the sales organization, that they felt a little orphaned, if you will.

And that's going to change.

It's changed already.

I feel like just the time that I've spent with them has been getting out pretty quickly.

It's creating almost like a wildfire, if you will, the news of the time I've been in the field and had an opportunity to spend about an hour presenting to that broad team at the kickoff meeting.

And I could tell you that my enthusiasm on the stage was fueled by the enthusiasm that I felt from the audience and what they were hearing.

And so, like I say, we're early on in this.

But I believe we've already made, as a senior management team with the focus we've had with the commercial organization, an impact.

So to sum it up, I think we've got a great team.

I think that we've got to work on the morale and the engagement, and we've already begun that process.

But I feel real confident about the team.

Mike, this is Dan.

I'll just add to that briefly.

Having been to a number of these sales meetings before, I can tell you the energy, enthusiasm and excitement of our sales team is off the charts compared to where it's been.

And the energy in the room, people were just oozing it with enthusiasm.

And Bryan did a terrific job and really connected with the sales team.

That's good to hear.

Let me follow up on the supply side.

Bryan, your comments is that with -- I think you said the milestones represent more risk right now maybe than opportunity.

Could you just update us on where you are on supply coming out of the North Campus and maybe set expectations for the year in terms of the cadence of when you think you'll see product and when you'll be in a better position to go on the offensive?

Sure, yes, appreciate the question.

So I'm going to give you kind of a comprehensive view of this thing because obviously I've been thinking a lot about it.

So I apologize for probably a longer-winded answer here.

But I think, first of all, it's important to recognize, I think Dan said it earlier, that our performance out of that factory has stayed consistent with our expectations.

And so right now, we're consistent with what we've been saying.

And I want to be real clear.

The strategy that I see for the supply recovery and really the comprehensive project plan that we see around this is sound.

I have confidence in it.

I do feel that the timeline we've communicated in the past, the end of Q2 recovery, is a possibility.

So I just don't want to take that off the table.

I do feel that's a possibility.

That said, I do think there's more risk probably in the timeline than opportunity.

And let me just give you an explanation for this.

And I kind of bifurcate my thinking on this in 2 different ways.

The first piece that I think about is just the raw project plan, the risk of actually achieving the timeline of recovery, so that plan itself.

And then the second piece is what I'd define as kind of the delay that I think we're going to see in translating that recovery, that product recovery, into accelerated revenue growth, right?

So those are kind of the pieces that I break this up in.

And let me just first hit the supply piece.

Again, I think that there are key milestones that we have in front of us that I think both have risk and opportunity in them.

But the complexity of the project just tells me, just given my history with projects like this, that most people believe inside of these timelines that things are going to go as planned.

And I put that in kind of air quotes.

What I've learned over the years, and I think most people have that run these complex projects, is things never go as planned and unplanned events always occur.

And as a result of just knowing that in kind of the Spidey sense if you will and looking at it, I believe there's more risk than opportunity in the timeline that we see.

So it just comes down to the complexity.

History with projects like this, you usually see more slippage than you do see people pulling it in.

That's the first piece.

The second piece is really a thing that we probably most care about, which is how do we then take the supply recovery and turn that into or translate that into actual acceleration of revenue growth?

And I think it's going to be more delayed than what maybe you're thinking and maybe even what I thought when I came in.

And a lot of this is as a result of the time I've been spending with the sales organization.

And so here's my sense on this, it's kind of on 2 fronts.

One, there's just a lack of trust right now from the sales organization for corporate.

We have given them timelines that we have failed on.

And they've gone out through the information they've received from us, approach the customer, only to have to pull back again.

And so that lack of trust is going to create a situation where even when we have supply available, they're going to wait.

They're going to wait.

They've been defending their surgeons through logistics hoops they've been jumping through.

They're going to wait with this new inventory, defend their surgeons without having to jump through those hoops.

And when they feel really confident that those surgeons are in place and intact, then they're going to go on the offensive.

And when you think about this, and I've been in sales, so I understand the process, it isn't a light switch that occurs.

You've got to go out now and build the trust to folks because they haven't been on the offensive, right?

You've got to build the trust of other surgeons.

You've got to build your offensive bullpen.

And then ultimately, as a result of that bullpen, you start converting business.

So there's a delayed impact of supply recovery as a result of that.

So I just want to make sure that, that's clear in the way that I'm thinking about it now and as I've gotten more educated on the topic and spent time with our reps.

And again, I'm not going to give you specifics right now because that's going to come in our first quarter earnings call with guidance.

But I will give you just kind of the way I'm thinking about it right now, and you should be thinking about it the same way.

I see this as a gradual revenue recovery into 2019.

And if you're thinking about it in that way, I think it's the right way to put a lens on this.

And as we get smarter around the topic and burn down some of these risks to the milestones, we'll give you more insight.

But that's where my thinking is right now.

That's helpful.

And then before I let others jump in, I assume the FDA has not been in yet for reinspection?

They have not.

And obviously, that's a very material milestone that we're paying attention to.

Our next question will come from Bob Hopkins of Bank of America.

My first question, I just want to follow up on some of the things that Mike was talking about as it relates to your comments about risk versus opportunity.

And I just wanted to be very clear on your pipeline and whether or not the comment on risk versus opportunity, what that might imply for some of the things you guys have been talking about for a while now.

Specifically, could you comment on the timelines for cementless, for Persona Revision, for the robotic platform?

Are those affected by the potential for more risk than opportunity as it relates to the North Campus?

No, it's a -- so I'll give you just kind of my broad thinking on this because obviously again, this is a vector that I've been spending a lot of time on.

And I feel really good about the product pipeline that we've got.

And as I said before, I've been out with stakeholders a lot.

And you can have the general managers and the marketing folks, who are great people, give you a feel for whether or not we've got the right products in the pipeline.

But what really sells it for me is when I go talk to surgeons who know about the pipeline and I talk to our sales reps who ultimately have to sell the pipeline.

And both those stakeholders were telling me, "We've got the right pieces inside of the product portfolio." And they're excited about getting those in the field as quickly as they can.

I feel pretty confident about the timelines that we have.

There's always in these things, as you get closer to the end launch dates, you get some slight slippage.

But I don't see anything material there.

The key to it though is this, right?

When you look at just taking knee as an example because it's a big franchise for us, we've got the partial knee out now using the Persona technology, which is getting great traction.

That's a big first step in the right direction.

We've got cementless coming up.

And the timelines we've communicated are ones that we still feel comfortable with.

We've got revision and then robotics coming as well.

That to me is the full portfolio that we need to truly get back on the offensive, right, truly get back on the offensive.

The key thing though is it's not the limited launch.

That's where you're doing the learning.

What really for me is when we get those out, get through the limited launch and get into full launch, that's when you've got full capacity with the bag.

And the way you should be thinking about that, particularly with revision and robotics, is the full launch will come anywhere from 4 to 6 months after limited launch, which puts us close to the middle of 2019.

So if you're thinking about full capability, full bag in that very important segment for us in the knee, that comes around mid-2019.

Doesn't mean we won't get opportunity to take advantage of the stuff that launches in between that, but fully loaded for bear attitude from the sales representatives will come in that mid-2019 time frame.

Okay, that's very helpful.

And then just one other question I want to ask is a little bit more on -- centered on the fourth quarter and the comments on the first quarter and the guidance.

Could you maybe help us sort of quantify some of the tailwinds that you benefited from in Q4 that you think will fall off in Q1?

I mean, I think you mentioned Asia, the hurricane, maybe the market softening a little bit.

Just -- I also assume there's probably a little bit of conservatism in those numbers as well.

So maybe just talk -- help us quantify some of the things that helped you in Q4 that you don't think will be there in Q1.

So I'm going to pass it to Dan, but I just want to make a comment.

I really do believe as we look at that Q4 to Q1 that this is a realistic number.

I just want to make sure that, that's clear.

I see this as a realistic number with balance on both sides but realistic in the view that we have on it.

And Dan can speak to some of the specifics around it.

Sure.

So Bob, in our prepared remarks, we talked about Q4 benefiting from a strong U.S. market, which we had anticipated coming into the quarter.

And it ended up being even slightly stronger than we initially guided to.

So based on our models, we think knees are close to 3%, hips, close to 2%, something in that range, so clearly a strong U.S. market in hips and knees and shoulders and really procedurally across the board in the fourth quarter.

And difficult to precisely quantify how much of that is the hurricane.

We came into the quarter signaling that could be as much as 30 basis points.

I'd probably stick with that type of an estimate in terms of strength in the U.S. market.

We called out Asia Specific.

Asia Pac, really since the merger closed, continues to post above-market growth on a consistent basis.

The team is driving excellent execution, Japan, China, other countries as well.

The stocking orders or the distributor orders in the fourth quarter also did benefit us.

And then dental actually was stronger than we had expected on Q4.

Now as we approach Q1, we bring in a lot of factors.

We do our best at looking at the past number of years in terms of seasonality from a stronger-than-expected Q4 and what that may look like in Q1.

So as we said in the prepared remarks, our assumption is that the worldwide orthopedic market does step down a little bit more than normal into Q1 as a result of the strength in Q4.

So that's an element.

We talked about the billing day differences, the Asia Pac step-down because of the absence of distributor orders in Q1 and the U.K., the NHS announcing that they were going to push elective procedures out through February due to some capacity constraints that they have over there.

And the last part would be based on the strength of Q4, I think it's fair to assume that our field inventory levels on high-running brands are really still depleted.

And that will recover as the year progresses.

So hopefully, that gives you a sense of the tailwinds and the headwinds into Q1.

We will now move to David Lewis of Morgan Stanley.

Just a quick clarification on Bob's question.

There's a lot of factors, Bryan and Dan, that vary from fourth quarter to first quarter.

The one factor that does not appear to be a headwind fourth to first is some change in the supply-related dynamics.

It sounds like fourth to first, supply is either at or better than it was in the fourth quarter.

Is that a fair way of thinking about it?

Yes, that's a good assumption.

To me, it's a non-variable when you look at the difference between Q4 and Q1.

Okay, perfect.

And then Bryan, kind of a strategic and financial question for you.

I mean, if you think about the guidance for the first quarter, it obviously doesn't reflect necessarily at all 2018.

Your gross margin is pretty close to what we thought.

There does appear to be a little more incremental SG&A investment.

Some of that was compensation, which we knew about.

But it does appear that you are going to reinvest in this business.

Could you just share with us a little bit about where you think that reinvestment needs to go?

I think most investors are supportive of you doing it?

Any thoughts you have on where you think it's needed, I think, would be helpful for people.

And then I had one quick follow-up for Dan or you.

Yes, so 100% on the same page.

We've got to have investment.

We, as an organization, we've been chasing the bottom line because we've had top line misses.

And as a result of that, just obvious things that we should have been doing to invest for growth just haven't happened in those moments for all the right reasons.

But the impact of that is negative now.

And so we've got some catch-up that we need to do.

The things that we're going to be concentrating on is obviously investing for growth as a primary vehicle for growth.

There's going to be 2 kind of pieces to this.

We're going to have a bias to near-term growth.

I think that you guys would want that as well.

But inside of it, we're still going to make sure that we earmark money for research and development.

We've got to spend more in research and development and bring out innovations that don't just help us in the near term but also help us in the longer term.

So some of the money will go to R&D.

And unfortunately, there will be a longer tail to the impact of that from a revenue recognition standpoint.

But that will be where some of the money goes.

The rest of the money is going to focus on the commercial organization, which is really where we can invest, take advantage of the portfolio we already have.

And I see that in just broader investments in the commercial structure to be able to have more feet on the street, some of those being specialized so that we can take advantage of the opportunity in S.E.T.

But a lot of it will be focused on just driving incremental feet on the street, focused on driving the portfolio we already have and taking advantage of the new products that we're going to be launching and very importantly beginning to diversify our growth engines into sports, extremities and trauma.

Okay, very helpful.

And then just last question for me is just this quarter is sort of remarkable within hips and knees for a couple of reasons.

One, it's the strongest hip and knee quarter you posted in a year.

But it's also against the strongest pricing headwind that I think you've seen in 2 years.

I think you've talked about the factors of the hip and knee momentum that may not occur in the first quarter.

But Dan or Bryan, what is that, that pricing number of 3.5% in hips and knees?

Was that sort of mix-related in the fourth quarter?

And how do we think about that number heading into 2018?

Sure, David.

We've seen fluctuations quarter-to-quarter on price declines.

So at a company level, negative 2.9% in the fourth quarter.

Q3 was negative 2.1%, so actually below the average.

So second half was down 2.5%.

First half was down 2.5%.

So we're not concerned about that.

We're still operating in that type of a range.

Clearly, when you get some distributor orders, you've got some customer mix.

That comes into that math.

But overall, we still see price declines in the band that we've been experiencing recently.

Our next question will be from Matt Taylor of Barclays.

So I just wanted to follow up on that pricing question.

I was curious because of the magnitude this quarter.

Do you think that your supply constraints are impacting your ability to get price or negatively impacting price at all?

Or is this just within a regular band of areas?

Yes, we're definitely looking at it right now as just a variation that occurs probably more due to mix.

If you think about APAC, for instance, with the strength that we saw in the quarter, for the same products in APAC, you typically get a little lower price.

And so that mix, I'm sure, has some play into the quarter.

But we're not looking at this as something that's sustained or that we're worried about increasing over the next 12 months.

And when I think about the supply constraints, I don't feel that the organization is putting price reductions in place to retain customers, which I think is what you're asking.

So I don't feel that, that's happening right now.

And we've got pretty good controls over pricing, flexibility in the field.

And our confidence level is high that, that's not occurring.

And just a follow-up on the supply discussion.

We noticed that you had taken off extremities from the watch list.

And the presentations, you didn't mention that they were constrained.

I guess, my question is can you talk about some of the lines of product that have improved or not improved and just remind us sort of where you are constrained now?

Yes.

Just quickly, that might have been just an oversight.

The extremities, as we've been talking about, continue to be constrained as a result of the North Campus.

So I'm not sure why we missed that.

But that would be consistent with what we've said before, it is still impacted.

What I'd tell you is that generally the way I think about supply recovery is this.

And again, this is coming from direct interaction with the field.

Even though we're getting rolling recovery in certain categories or getting more healthy quicker than others, the sales organization is still waiting to get to full recovery.

They still are concerned when we have other issues with other products that we're going to creep into the spaces that we've already recovered because we've had lapses like that in the past.

So it kind of goes back to that trust piece.

Even though things are recovering, they're waiting for full -- truly a full comprehensive product recovery before they go on the offensive.

So I just -- I think we're not seeing the translation yet, even in those areas of full recovery because people are waiting to get it all there, so they know they can go on the offensive.

A perfect example of that, Dan, maybe you could provide, is the Oxford and what you've heard on...

Sure.

Yes, I think Bryan's point is an important one, which is that lack of trust in the field, the hesitancy to go on offense and the need to have the full bag in order to truly drive offense.

So there are brands out of the North Campus that we've restored to full supply as we expected.

But the translation to revenue acceleration, that timeline that Bryan is talking about is an important distinction.

Part of that is trust.

Part of it is the duration of the supply situation but still feel very optimistic that out over time, we're going to bring all of the supply and new products together to drive that acceleration into 2019.

You want to give maybe the specific example because I think it really kind of rings true with even telling the sales organization we're in full supply in Oxford and seeing the delay.

Sure.

Yes, with Oxford, we're at full supply in Oxford entering the fourth quarter.

We're excited to have the Persona Partial Knee in there as well.

So now you've got a full bag of mobile bearing and fixed bearing in the partial knee space.

But still even with that full supply of Oxford, saw some delay in terms of the revenue uptake on Oxford.

It's taking longer than we expected to see that accelerator.

So that's, I think, a proof point of what we're describing.

We will now move to our next question.

And that will be from Kristen Stewart of Deutsche Bank.

Just kind of, I guess, big picture for you.

I guess, to what extent, I guess, are you still excited about [collars] taking kind of a life of its own, that kind of feel?

What extent do you still feel very optimistic about the future for Zimmer?

Because I feel like this -- you've kind of pointed out a lot more the risk factors.

So maybe if you could take a step back and talk about maybe some of the things that you've kind of come in and looked at with Zimmer, the pluses and minuses, since taking over the helm 6 weeks ago that you might be more excited about longer term as you look at the company more strategically over the next several years.

Is it just kind of your view of looking at Zimmer from an orthopedic company?

Can you maybe talk about how you may look at Zimmer from shaping the company more directionally?

Is it diversification?

Is it just getting the company back to -- are you satisfied with the low single-digit growth rate?

Can you just talk more directionally over kind of a longer-term perspective?

Yes.

So Kristen, first, I'm going to correct you that this is Zimmer Biomet, not Zimmer -- and I think that's important because one of the key things that I'm going to be concentrating on is culture in this organization.

And some of the things that are in the way of that culture creation right now is we just haven't yet become a fully integrated new organization.

There's still camps of Zimmer and Biomet.

And we need to create the Zimmer Biomet, forget the legacy companies.

And so sorry to do that, but I think I would be remiss in not doing that because I know that my own team is listening right now.

So that was a focus for them.

So just to give you a sense for -- I've kind of liked to think about things that I experienced over the last month that maybe I didn't like as much as I would have expected, and then things that I liked more than what I expected.

And then maybe I can kind of distill that to say based on those things, how am I feeling about accepting the job and the future of the company.

And so I'll start with the negative and finish with the positive.

The things that I probably experienced in a more negative way than I expected is just the complexity and the challenges, the scope of the challenges associated with quality remediation and supply recovery.

It's more complex than I think I assumed when I came in.

So that would be on the negative side, obviously.

The culture gap, which was kind of what I was just referencing on the Zimmer Biomet discussion we just had, is wider than I expected.

And I've got to tell you that this organization, because of what they've been through throughout the organization, is fatigued.

I can feel the fatigue in the organization.

And when the culture is not rock-solid, that fatigue is exponential, right?

And I think that's the issue that I'm seeing.

And that was -- it's probably not as good as I was even hoping.

So those would be the things that, on the negative side, I've experienced over the last 30 days or so.

On the positive side, we've got great employees.

And I've spent a lot of time in skip-level meetings, one-on-ones, just walking around and popping in people's cubicles, spending time out in the sales organization, spending time in our factories.

We have a solid team.

And the sales organization, as I think I've said already, is even better than I thought.

We have a first-class sales organization.

I didn't -- like I've said, that's a surprise, but it's a relief, right?

The portfolio is very attractive.

I thought that coming in.

But I'm hearing from our surgeon partners that we have the deepest, broadest portfolio in the industry, they just need access to it, obviously.

And they're very excited about the portfolio of products we're going to launch.

So that my confidence level there is higher than it's ever been.

This kind of surgeon loyalty, and again I've spent time specifically with surgeons, and the stickiness associated with that customer is better than I have ever seen in any business that I've been with.

And so that's a surprise on the positive side.

And here's one that's maybe a little softer, but it's really important to me.

The employees that I've met feel very open to me and almost desire a different form of leadership, a more inspirational, positive form of leadership.

And this is something that I love to bring.

And so I'm not feeling any resistance at all to it.

I'm feeling an acceptance of it.

And that obviously is one of the things that I was hoping for, but I'm realizing.

And so kind of just if I distill these things, I feel and I think the takeaway has got to be this.

The cadence of recovery may not be what you were hoping for.

But my confidence level right now is better than ever that this business is going to get turned around.

I'm 100% confident it's going to happen based on what I'm seeing.

And to answer your question further, once we get to that stability place, when we got to our fair share of that market that we already play in, then I do want to take step back and take a look to say, "Are we in the right markets to allow for a better weighted average market growth?" And ultimately, through that weighted average market growth allow us to grow in that mid-single-digit growth rate at some point in the future because that's the only way you're going to get the double-digit EPS growth on a consistent basis.

And so I don't want to go there yet.

I'm not always patient.

But right now, I'm trying to be patient, put that on the back-burner.

Let's get to health first, and then ultimately, let's take a look at the portfolio and make the right decisions.

So hopefully, that answers your question.

Yes.

And then just one for Dan, I guess, or maybe you, I guess.

In terms of just the guidance, what is the main sticking point or what's the main catalyst in terms of determining what the investment trigger is going to be?

Is it mainly just what the right level of spend is for the remediation?

Is that why the hesitance to push off into the first quarter to give 2018 guidance in terms of giving why not a wide range for 2018 instead of no range for 2018, since you're giving [us] gross margin guidance?

And I'll just give you my viewpoint on it Kristen, and then Dan, provide any color.

What I look at this is, as I've mentioned, there are a lot of moving pieces and parts right now, pretty material events that need to happen here over the relatively short term.

And until we get through some of those, in either one, burn down risk as a result of passing those milestones or experience risk, I think that we just want to be cautious in giving you guidance until we get a little smarter on those topics.

And the only thing that's going to make us smarter beyond the assumptions that we've made is actually pushing through the milestones and experiencing the good or the bad.

And when we get to the earnings call after Q1, we're going to be a lot smarter on that topic.

And so we're really just trying to enable guidance for you that is more realistic and more informed.

And that's the reason why we're delaying it.

There isn't a specific thing.

There are a number of things that are pushing us in that direction.

And Dan, I don't know if you have any other color on it.

Look, Kristen, I would say that we tried to give you some markers on certain elements of the P&L so that you can reflect those in your models.

Look, I would expect that the consensus estimates for both revenue and EPS are probably going to come down after today in light of what we have shared.

But that does not diminish at all the long-term opportunity that Bryan has talked about.

We will now take a question from Joanne Wuensch from BMO Capital Markets.

Can we also take a look at what the milestones are or the steps are either near term that will increase our confidence in giving the guidance or just over the next 12 months?

I feel like we have some sweeping verbiage on execution in North Campus facility and supply.

But is there a way to get just a little bit more granular on what really needs to be checked off?

Yes, probably one of the -- I'm not going to get into too much detail.

But I think just broadly, when we think about supply recovery, which I think all of us would agree is one of the most important components of that revenue acceleration we've been talking about.

First and foremost, you've got to again kind of bifurcate the activities that we've got in place.

One of these is taking those processes that are most important to us with high-volume products that are nonautomated in the North Campus and moving them to contract manufacturing that ultimately have a more automated process, proven track record of supplying products like these for others in the industry and transitioning that volume to them.

Now just inside that one piece, so that has to go right, it's not just 1 or 2 codes.

These are families of codes, right?

There's a lot of SKUs that have to go through this process.

There is a verification and validation process that ensues.

And there's nothing you can really do to speed this up.

It's time-sequenced because a lot of it would be like fatigue testing, for instance, for an implant.

Now you can get through a million different iterations or movements with this product to check fatigue testing, find out that it fails because you've got to get to 5 million, then you've got to find out why it failed and restart the whole process.

So verification and validation is something that sounds very easy.

And ultimately, we will absolutely get through it.

But things always go wrong inside of that, and you've got to restart the clock as a result.

So one of the biggest things that I'm focused on is what is our target date associated with families that we have that we're moving out on that verification and validation time frame?

When do we think that should close, right?

And so when we hit those and we pass them, and that will be we should hit all of those before the quarter earnings call.

And so we'll get a lot smarter on whether or not we had major issues or not.

That's just one example of things that need to go right to be able to get that supply recovery because the only pathway to full capacity is through that contract manufacturing.

On the other side of the coin, when you look at our factory, the North Campus, one of the big things, and Mike mentioned it, the FDA still has to come in and sanction what it is we're doing with supplier -- with quality remediation.

But we have a great team working on this.

We've been working on it for months.

We're spending a lot of money in this area and a lot of effort of senior management.

And we have consultants that I think are some of the top-notch folks in the industry following us on this and giving us their unbiased view of whether or not we're achieving what we said.

But at the end of the day, the FDA has got to come in and look at what we're doing and agree with us.

If they, for whatever reason, come in and disagree and there are further things we have to take action on with remediation, that could impact our ability to supply product out of that North Campus.

But these are just 2 examples of pretty significant things that we just got to have time tell us whether we're on the right track.

And there are many others.

I don't want to oversimplify it, but those are pretty big milestones.

That's actually very helpful.

And then a little bit more of a specific question.

Can you pull apart a little bit what's going on in your spine and CMF franchise as it relates to LDR and then the broader market?

Yes.

So if I kind of break those businesses up, within spine and CMF, obviously 2 different businesses.

But CMF is actually doing pretty well.

That's a solid team that we have, good strategy.

They continue to deliver results and really help that overall franchise out.

So I'd just say, "Kudos, let's keep doing what we're doing over there and get more of it." On the spine side, I think we've got all kinds of opportunity in spine.

This is an amalgamation of different acquisitions over time, LDR being the most recent.

And where we're falling down right now is the channel integration is not going as planned.

And we're experiencing, as we said in the comments, just dis-synergies associated with that channel integration.

And just to be honest, we had to make some changes at the senior leadership team for that organization.

We think we've got the right team in place right now.

Now they've got to get focused on reversing some of these dis-synergies and getting a better channel strategy in place.

I do believe that can happen.

It's going to take time because just looking at it, it's not anywhere, where we need it to be.

And we've got to unwind some of the things that have occurred there.

But at the end of the day when that gets past us, we have a very full portfolio that's exciting for our customers and exciting for our sales reps.

We just don't have the channel strategy to implement it right now.

And that question will come from Richard Newitter of Leerink Partners.

I was hoping to -- just on the outlook that you plan to provide next quarter.

And I appreciate if you don't want to go too far in advance of yourself.

But maybe just the question is a little bit more on the process.

Coming off of a period here where we haven't been able to just fully bank on kind of the given timelines or thresholds that you've provided, Bryan, what's going to change in the way that you approach kind of the underpromise, overdeliver?

And within the context of you've seen a lot of things that are out of your control, how should we be thinking about when you do provide that outlook, what kind of bottoms-up processes need to change at the organization so that you feel confident that whatever you do provide, we can kind of take at face value?

Appreciate the question.

So some of the things that I've learned over the years, and I've been blessed by working with 2 very good companies, Covidien with a lot of time there and Medtronic more recently.

And on the Covidien side, there's a level of discipline and rigor that I received from my old boss and mentor, Joe Almeida.

And that rigor and discipline will be something that we put in place here.

And I'm not saying it doesn't exist.

But the level of focus that I will have with this team in putting a process together that allows us to feel more confident in the guidance that we give will be something that we do.

And not new to me, and there is process that I'm used to following, and we're going to make sure that we bring that here.

And we've got good people to be able to do it.

It's just a level of discipline and rigor that I've seen that I want to make sure that we have here as well.

And so that's one piece.

And I think it will be helpful.

We're obviously not ready to give 2018 guidance, certainly not anything beyond that.

But I do want, again with this idea of full transparency, I want to give everyone a view of kind of what I'm thinking about this right now.

And I kind of again think about it in 3 major components that we've got to get in front of us here.

The first one, as I've already talked about, is supply recovery.

And I don't want to forget that supply recovery is the first step.

The second step is translating that supply recovery into actual revenue acceleration, right?

And I've talked a little bit about why I think some delays could occur there.

But that's got to happen.

It's got to be supply recovery, acceleration as a result.

Second piece is we've got to launch these products.

It's an excellent product pipeline that I've talked about.

We've got to get to full launch as quickly as we can.

I'm seeing that as being somewhere in the mid-2019 time frame.

But that has to happen and we've got to do it effectively, right?

And then the second -- the third piece to me is really around this idea of a culture shift.

I know that people consider it soft.

It is a very important thing to me.

And right now, we have gaps in the culture, and we've got to enhance the culture.

So those 3 things need to happen.

And I just think logically about those from a supply recovery and resulting acceleration, that's going to happen later in the year, guys.

It's later than what you've been thinking because translating that into revenue growth is going to take longer than maybe what you're assuming.

I already said the pipeline is really full swing in mid-2019.

And anyone who's done any kind of a culture change knows that it takes time.

That said, I can say right now, we're going to have an immediate impact in this area.

We're going to get quick results out of the gate.

But to make it sustainable, it's just going to take time.

It's a continuous improvement gain.

So when I just kind of put all those things together, I think realistically the way we should be thinking about this is a gradual recovery towards market growth, if you will, through 2019, okay?

So think about it in that way.

That's where I am.

I'm going to get smarter on this topic.

I'm going to learn more as we go and the very things we decided to burn down risk areas.

But this is the way I'm thinking about it today.

Some of you may have hoped for a faster recovery than that, and I get it.

And potentially, maybe it can be.

But just based on everything that I'm seeing right now, I'm setting the expectation that I think is realistic that, that's probably not probable, okay?

It is likely going to be what I just said.

It's going to be a gradual recovery through 2019.

Hopefully, that helps provide color at least in the way we're thinking about the business right now.

I think that's the last question.

I just -- I'd like to -- we just threw a lot at you in a very short period of time, some of it probably stuff you didn't want to hear or didn't expect to hear.

At the end of the day, the whole idea behind this, from my perspective and Dan's, is we want to be as transparent with you as we possibly can.

And that was the intent of the conversation today, let you know what we know, up to a reasonable point, obviously.

We didn't get to this place overnight.

And you shouldn't expect us to be able to recover from it anytime soon.

It's going to take some time to get there.

That said, based on everything I've learned, I am more confident than ever that this business is going to turn around.

Although the pacing may not be what you expected or hoped for, I'm 100% confident that the endgame is going to be something you're going to be very happy about.

So thanks so much.

I appreciate you joining the call today.

I'm looking forward to connecting with you between now and earnings call, I'm sure, through various events, but really looking forward to connecting on the first quarter earnings call as we give guidance for 2018.

Thanks so much.

And thank you again for participating in today's conference call.

You may now disconnect.